Thursday, July 21, 2011

Ensure Your Dividends With These Insurance Stocks

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 others 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.


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