Ensure Your Dividends With These Insurance Stocks

This article originally appeared on The DIV-Net July 21, 2011

As any other dividend growth investor knows, maintaining dividends is of the utmost priority for an investment. Raising dividends is, of course, extremely important as well, but a dividend cut is disastrous. It would result in the loss of income and the likely significant drop in share price/market value. This is, for the most part, unacceptable so we try to shield ourselves from such events through diversification, research, maintaining relatively strict entry criteria and most importantly investing in companies with rising earnings and sustainable payout ratios.

The insurance industry has many different companies that have sustainable, and rising, dividend payouts. I really like the insurance industry. An insurance company can be extremely profitable if the underwriting is performed correctly. An insurance company profits by charging a client a premium up front for coverage and then investing that premium (called the “float) from which they (hopefully) receive a high rate of return. It is from that return that they pay out claims, or reinvest the money. Insurance is wonderful because they are basically investing other people’s money and they get to keep the capital gains on those investments. Why do you think Warren Buffett loves Geico so much? The float is a very powerful aspect of the insurance business model.

Here’s a look at three different insurance companies that I currently find attractive:

Harleysville Group Inc. (HGIC)

Harleysville Group provides insurance services. The company underwrites property and casualty insurance policies, primarily in the Eastern and Midwestern regions of the U.S. It offers commercial automobile, workers’ compensation, and multiperil insurance, as well as personal automobile and homeowner’s insurance. The company markets its policies through almost 2,000 insurance agencies, and maintains offices in about a dozen states. 

Forward P/E Ratio: 10.6
Dividend Yield: 4.55
Years of Dividend Growth: 24

Aflac Incorporated (AFL)

Aflac offers supplemental health insurance and life insurance in the two largest insurance markets in the world, the U.S. and Japan. In addition to its cancer policies, the company has broadened its product offerings to include accident, disability, and long-term care insurance. It markets its products through independent distributors, selling most of its policies directly to consumers at their places of work.

Forward P/E Ratio: 7.2
Dividend Yield: 2.66
Years of Dividend Growth: 28

The Chubb Corporation (CB)

With roots dating back to 1882, Chubb began in marine insurance, but over the years expanded to become a global, multiline insurer focused in property and casualty. Today, Chubb is the 12th-largest property-casualty insurer in the United States; it went public in 1984. Most of Chubb’s revenue (75%) comes from the United States, but its international operations are growing. Chubb’s largest unit is commercial insurance, followed by personal and specialty.

Forward P/E Ratio: 10.6
Dividend Yield: 2.54
Years of Dividend Growth: 46

Insurance companies have their own risks. Losses due to bad underwriting policies, excessive claims due to natural events or other disasters, and bear markets which lead to distressed investments can all have a negative impact on the balance sheet and lead to low margins or loss of revenue.

I really like insurance companies but due diligence is always required before investing. Currently, all three of the aforementioned securities are trading at low valuations and multiples. However, the tsunami in Japan and distressed investments make investing in Aflac a little shaky in this environment. Harleysville has had slow revenue growth and has a limited footprint. Chubb has a low yield and lack of any type of economic moat. With that being said, all three are currently on my shopping list.

Are you buying any insurance companies?

Full Disclosure: I’m long HGIC.

Thanks for reading.

Comments

  1. Ray says

    Hi Mantra,

    thank you for your articles and the time and work you spend on your blog. I keep thinking that you deserve some regular replies and thought I’d give my (brief) thoughts:

    Your hint about Warren Buffett and Geico is spot on, the insurance business is one of the most profitable in the long run. You get lots of money today (and collect the fees early) for something that might or might not happen sometime in the future. Thousands of staticians value the chances of an event, then you add your margin on top and voila!

    Competition is very strong, lots of insurance companies have been reporting stagnating revenues for some years now. They still earn good money, especially if they have been able to build an area of expertise. Thats were your picks come into play, I also like AFLAC because of their very strong history and presence in Japan and Chubb but also Travelers. Markel is in my portfolio but is not paying a dividend (compounding internally such as BRK).

    BUT, there are some things I do not like at all.
    Life insurers such as AFLAC need to pay at some time and are often guaranteering a specific pay out. The market has been rough lately and the interests low. Instead of buying dividend yielding blue-chips like us, they keep pumping all their money into state bonds and other low yielding paper money (portfolio percentage near record levels). So they are facing a high risk of losing lots of value in case of further market turmoil (dollar+euro), and are also not taking advantage of some opportunities out there (and therefore won’t be taking part in stronger markets).
    I glimpsed at Aflac’s holdings and did neither like nor recognize much at first sight. The same is probably true for the property&casualty insurers. At least they won’t have to pay for sure at some stage, instead they are more cyclical and unsteady in their earnings and revenues.

    So at the moment I stay away from insurance stocks, but I do like them in general, especially longer term. AFL, CB, TRV are on my list, as well as the Canadian FFH and POW/PWF.

  2. says

    Mantra,

    Thanks for the article, Insurance is surprisingly cheap right now. I’m long AFL but am concerned about the risk with Japan and was considering swapping for Chubb. I’ll also consider HGIC now.

    Thanks,
    Selling Theta

  3. says

    I’m long AFL, they just reported a solid quarter and beat estimates. I believe the stock is way oversold and I’m a buyer on any market sell off like this week. CB is also on my list. I’m not quite sure about HGIC, the market cap seems too low for me and the dividend yield is high for an insurance company. What’s your take DM? Is the dividend increase sustainable long term? The 5 year average increase is around 20%. Perhaps HGIC is a take over candidate.

  4. says

    Ray,

    Thanks for the kind compliments. I’m glad you enjoy the blog…and you are right it is time consuming. It’s much more consuming than I ever thought it would be.

    I agree with you on all points. Competition is strong and revenues have been very flat for a lot of insurance companies. I also agree with you on the eventuality of payment for life insurers. All great points. However, I wonder how much of this (bad) news is already priced in? Insurance is a very cheap sector, it’s not just Aflac and its woes. Perhaps this entire sector is a little contrarian.

    Good stuff. I appreciate your time and your comment!

  5. says

    Selling Theta,

    I would appreciate your thoughts on HGIC. Take a look under the hood and let me know what you think. I know a few fellow dividend bloggers are long on Harleysville. I’m not extremely impressed, but I think it’s a value play with a good yield…along the same lines as KMB. Not a fantastic business, but a good value play.

  6. says

    Henry,
    We
    I seen that. AFL had quite a pop today. I think it’s undersold as well. That doesn’t quite eliminate my concerns about Aflac, but it makes it a nice value play. The low entry yield is probably the only thing keeping me away right now. I would like a larger margin of safety and entry yield to take on the risk. We’ll see how the next month or so goes for my capital and I may or may not initiate a position.

    Thanks for stopping by.

  7. says

    Some insurers are badly hit when a natural calamity strikes if they are in home insurance business. AFL could offer potential buying spots. You mentioned a link to AFL analysis in the weekly reading.
    Inq

  8. says

    Inq,

    That is true. Natural disasters are always looming on the horizon, and impact revenue when they occur. Major disasters are the black swans of this industry. Always something to have on your mind.

    Take care.

  9. says

    Rene,

    CINF has some issues. The payout ratio is sitting at 88% and earnings/revenue has been on the decline for some time now. Dividend growth has been practically non-existent over the last few years. I think there are better buys in the insurance space, of which I highlighted above. AFL has taken a beating lately and is no trading below $38 a share.

    Keep in touch :)

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