What are we looking for?
Investing possibilities in U.S. property and casualty insurance stocks.
This is an intriguing sector, where several stocks are selling for less than their book values – a classic indicator that they are cheap. The question is whether that constitutes an investing opportunity or a value trap.
A bit of background: Insurers typically make little or no money from the actual business of taking in premiums and paying out claims. They generate most of their profits from the returns on their investment portfolios (which get a boost from the "float," or money that is being held in reserve to pay future claims). Weak stock markets and low interest rates – like now – are bad news for insurers because they depress investment returns.
But things may change. The insurance business is subject to a regular cycle in which a period of "soft" markets with low premiums and stiff competition drives out weaker competition, ultimately leading to "hard" markets with higher premiums.
That suggests the industry's current soft patch may eventually give way to better conditions. The challenge is to spot companies well positioned to prosper.
How we did it
We screened for property and casualty and full-line insurance companies traded on U.S. exchanges that have a "combined ratio" of less than 100. The combined ratio is the sum of losses and operating expenses divided by revenue from premiums.
A combined ratio of less than 100 indicates a company is paying out less money than it's taking in – a positive sign, since it suggests the firm is making money on the insurance it is writing.
What we found
An intriguing list of insurance companies, many of which look cheap on the basis of their price-to-book ratios and low combined ratios. (Remember that the lower the combined ratio, the better.) Several of these companies also offer attractive dividends.
Investors should do their own research before buying any of these stocks. And keep in mind that low interest rates look as if they will be a drag on insurers' investment results for a considerable time to come.
Ian McGugan