Published on November 5th, 2015
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Chubb (CB) is one of the older insurance companies in North America. The company was founded in 1882 and has grown its dividend payments for 33 consecutive years.
Chubb sells home, car, business, and supplemental health insurance policies through its network of independent agents and brokers located in North and South America, Australia, Europe and Asia. The company operates in 3 primary segments. Each segment is shown below along with a brief description of the types of insurance it covers:
- Personal Insurance: automobile, homeowner
- Commercial Insurance: multiple peril, casualty, workers compensation, property & marine
- Specialty Insurance: professional liability, surety
Despite its global network of independent agents, Chubb is primarily a United States company. Chubb generates around 75% of its premium revenue in the United States.
Chubb is the 5th largest publicly traded property and casualty insurer in the United States based on its market cap of $29.4 billion. The company’s larger rivals are listed below:
- Berkshire Hathaway (BRK.A) has a market cap of $339.0 billion
- American International Group (AIG) has a market cap of $78.9 billion
- Ace Limited (ACE) has a market cap of $36.8 billion
- The Travelers Companies (TRV) has a market cap of $34.6 billion
The Most Important Insurance Metric
The combined ratio is arguably the most important metric for an insurance company. The combined ratio is calculated as follows:
(claims paid + expenses) / premium revenue
A combined ratio under 100% means the company’s insurance operations are profitable without additional investment income.
When a company has a combined ratio under 100% that means it gets paid to invest its float. This is like receiving a negative interest rate loan you can invest into interest bearing (or dividend paying) securities.
Chubb’s combined ratio has been below 100% every year since 2002. The image below shows the company’s combined ratio for each full fiscal year since 2002:
Source: Chubb 2014 Annual Report, page 2
The Amazing Compounding Power of A Low Combined Ratio
Here are a few interesting facts:
- Chubb’s premium revenue has grown at 0.1% a year over the last decade
- Chubb’s earnings-per-share have grown at 7.9% a year over the last decade
Chubb’s actual business has experienced virtually no growth in a decade. Normally, this would be a cause for concern. Despite this, Chubb’s shareholders have realized solid earnings-per-share growth near 8% a year. How is this possible?
Almost all of Chubb’s growth over the last decade has come as a result of share repurchases. The company has repurchased a phenomenal 6.3% of shares outstanding a year on average over the last decade.
Chubb’s business model is simple:
- Write profitable insurance policies
- Invest float primarily in safe debt securities
- Use earnings to repurchase shares and pay dividends
The company has been able to repurchase over 6% of its outstanding shares a year on average over the last decade because its price-to-earnings ratio has been around 10 for much of the past 10 years. This gives the company an earnings yield of 10% a year. Chubb pays out 25% to 30% of its income as dividends, and ~60% as share repurchases.
The Chance to Own Chubb is over
Chubb used to be one of the top recommendations using The 8 Rules of Dividend Investing. This is no longer the case.
Chubb’s stock price has soared 32% in the last 6 months. This is not what you’d expect from a stable insurance company.
Chubb’s stock price surge is a result of the company being acquired. Remember… There are only 4 property and casualty insurers larger than Chubb.
ACE Limited (ACE) recently announced it will acquire Chubb Group (CB) for $28.3 billion. This sent Chubb’s stock significantly higher. The deal is the largest property and casualty insurance transaction ever.
It also makes Chubb a sell. Chubb stock is now a merger arbitrage play rather than a stable Dividend Aristocrat that will compound investor wealth far into the future. As a result it is not a suitable holding for dividend growth investors.
Good Things Happen To Great Businesses
Chubb is an excellent example of a high quality businesses. When Chubb was recommended to Sure Dividend readers, I had no idea the company would be acquired.
High quality businesses that can withstand the test of time often have favorable surprises. After all, Chubb wasn’t going anywhere. Even with premium revenues virtually flat over a decade, the company was generating solid total returns for shareholders.
I thought investors in Chubb would continue to benefit from the company’s growth over a very long period of time. That didn’t happen. Instead, the pending Ace acquisition gives investors in Chubb an excellent exit point to lock in capital gains and reinvest them into other high quality dividend growth stocks.
There is now only 2 other insurance industry Dividend Aristocrats; Aflac (AFL) and Cincinnati Financial (CINF). Of the two, I believe Aflac to be the better long-term investment.
Aflac has maintained a combined ratio of around 85% for much of the last decade. The company is highly profitable, and also is addicted to share repurchases. You can read more about the investment merits of Aflac at this link.