Published January 15th, 2017 by Bob Ciura
Insurers enjoy a high level of profitability, because they make money in two ways.
First, insurance companies collect premium income on the policies they underwrite.
But they also make money a second way, by investing the large sums of accumulated premiums that have not been paid out as claims. This is known as the ‘float’.
Because of this, insurance companies have been among the most rewarding to own over the past several decades. Many of the Dividend Aristocrats and Dividend Achievers are in the insurance industry.
The insurance industry has created many great fortunes. That’s because it’s slow changing and highly profitable (if done well). Investing in insurance stocks is how Shelby Davis made $900 million from $50,000 starting in his late 30’s.
It’s also no coincidence that Berkshire Hathaway (BRK.A) – Warren Buffett’s corporation – is primarily an insurer (but does not pay a dividend).
Going forward, the insurance industry should benefit from a key growth catalyst, which is rising interest rates. Higher interest rates widen the spread between what insurance companies earn on their invested capital, versus what they pay out in claims.
With that in mind, income investors looking for strong dividend stocks to buy in 2017 and beyond should take a closer look at the following six insurance companies.
AFLAC is a Dividend Aristocrat – a select group of stocks with 25+ consecutive years of dividend increases. It has raised its dividend for the past 34 consecutive years.
AFLAC sells supplemental insurance products. These are designed to compensate policy holders in the event they become unable to work due to illness or injury.
AFLAC generates approximately 75% of its premium income from Japan. This means the company’s earnings-per-share are dependent in part on exchange rates between the yen and the dollar.
When the yen rises against the dollar, it helps AFLAC because each yen is more valuable. But when the yen weakens, it results in fewer dollars to be reported.
AFLAC enjoyed a favorable currency tailwind for many years, from 2006-2012, due to the strong yen.
However, the rally in the U.S. dollar versus the yen in the years since, has taken a toll on AFLAC’s bottom line.
Source: Investor Fact Sheet, page 2
This had a significant impact on AFLAC’s earnings in 2015. The company reported $4.1 billion in operating profit for the year. It would have earned $4.4 billion, excluding currency effects.
That being said, currency is a purely financial impact. It is more important to focus on the health of the underlying business.
Fortunately, AFLAC’s fundamentals are sound.
Going forward, AFLAC sees the potential for continued growth in the U.S. and Japan. The over-arching factor behind the outlooks for both countries, is their aging populations.
Despite the pressures of a strong dollar, low interest rates, and a declining birth rate in Japan, the company is expected to grow at a modest rate.
In the U.S., the company projects 3%-5% compound annual growth through 2019.
Source: 2017 Outlook presentation, page 6
Its strategic initiatives to grow the U.S. business include a two-channel distribution model. This means the company will continue to focus on expansion of its core distribution procedures, as well as increased adoption of ‘one day pay’, to increase customer satisfaction.
Meanwhile, AFLAC’s operational goals in Japan include further expansion of the company’s third-sector product sales.
Third-sector products are non-traditional supplemental policies. One of the company’s third-sector products seeing strong growth is cancer insurance. This product is for people who have had cancer but are cancer-free for five years or longer.
These products are popular in Japan, which has an aging population.
Source: 2017 Outlook presentation, page 7
AFLAC expects 4%-6% annual growth in Japan, thanks largely to third-sector sales.
AFLAC has a $128 billion investment pool, and should benefit greatly from higher interest rates.
Over the first nine months of 2016, revenue and earnings-per-share increased 6.8% and 11%, respectively. Growth was due to higher premium income as well as growth of investment income.
AFLAC stock trades for a price-to-earnings ratio of 11. And, it offers a 2.5% dividend yield, in addition to regular dividend growth each year.
The company recently raised its dividend by 4.9% to extend its streak of annual hikes. AFLAC’s long dividend history, above average yield, safety, and solid growth prospects have helped it to consistently rank well using The 8 Rules of Dividend Investing.
Cincinnati Financial (CINF)
Cincinnati Financial may not be a familiar name for investors, but it has a very impressive dividend track record.
The company has raised its dividend for 56 years in a row, making one of the rare Dividend Kings—stocks that have increased their payouts for the past 50 consecutive years.
There are only eight U.S. publicly-held companies that can match its dividend increase record.
Plus, it maintains a modest payout ratio. Cincinnati Financial has averaged a 63% dividend payout ratio over the past decade.
Source: Investor Handout, page 5
Cincinnati Financial stock has an annualized dividend of $1.92 per share, which comes out to a 2.5% dividend yield based on its current share price.
In addition, Cincinnati Financial occasionally passes along a special dividend. In 2015, the company declared a $0.46 per share special dividend payout, in addition to its regular quarterly dividends.
The reason for its excellent dividend history is because of the company’s strong fundamentals.
Cincinnati Financial was formed in 1950, by four independent insurance agents. It has grown steadily in the six decades since.
Cincinnati Financial and its subsidiaries are among the top 25 property and casualty insurance companies in the U.S., based on premiums written. It attributes its success to it agency-focused business model.
The company focuses on agency relationships that are strengthened by an in-person approach to building customer relationships.
Its main businesses are business, home, and auto insurance. It also offers other insurance and financial products through its subsidiaries, including life and disability income insurance, fixed annuities and surplus lines property and casualty insurance.
Most of the company’s annual premiums written are for commercial customers. A breakdown of its $4.5 billion in 2015 premiums is as follows:
- 67% Commercial
- 24% Personal
- 5% Life
- 4% Excess & Surplus
2016 was a very strong year for the company. Through the first three quarters of the year, Cincinnati Financial’s net premiums increased 6%.
Over the past five years, Cincinnati Financial’s premium growth has doubled the industry average.
Source: Investor Handout, page 13
And, the company has realized 13 consecutive quarters of growth in net investment income.
Its premium income and investment income growth epitomize why insurance companies are such strong investments. This growth resulted in 7% revenue growth and 12% growth in book value over the first three quarters of 2016.
Management judges the company’s success by what it calls the value creation ratio. This is the cumulative gains from underwriting new policies, as well as returns on its investment portfolio.
It has maintained a positive value creation ratio for many years, despite the pressure of low interest rates.
Source: Investor Handout, page 5
In addition to its modest payout ratio, the company’s growth means it should have little trouble continuing to raise dividends for many years.
Mercury General (MCY)
Mercury General primarily underwrites automobile insurance in California. It is the fourth-largest private automobile insurance company in California, and has total assets over $4 billion.
However, it also has a hand in a variety of other lines of business. Mercury also writes automobile insurance in Arizona, Florida, Georgia, Illinois, Nevada, New Jersey, New York, Oklahoma, Texas, and Virginia.
And, it underwrites other insurance products including mechanical breakdown and homeowners insurance.
Mercury General is a Dividend Achiever. These are the companies that have raised their dividends for at least 10 years in a row.
You can see the entire list of all 272 Dividend Achievers here.
And, it has the highest dividend yield of the six insurance stocks on this list. Mercury General has a hefty 4.1% current dividend yield. This is approximately double the 2% average dividend yield of the S&P 500 Index.
One reason why the company maintains such a high dividend yield is because of its strong profitability. The company has generated impressive growth in premiums written over the past two decades.
Source: 2015 Annual Report, page 4
Not only is the company reporting strong growth in premiums written, its underwriting business is highly profitable. It achieves this by effectively managing its combined ratio.
The combined ratio is calculated by adding up incurred losses, deducting expenses, then dividing the result by earned premiums.
A combined ratio below 100% indicates that the company earns a profit from its underwriting business. This is an important metric for insurance companies, because underwriting is a core function for insurers.
For the most part, Mercury General’s combined ratio has outperformed the industry averages over the past five years.
Source: 2015 Annual Report, page 3
The company has seen mixed results to start 2016. Revenue increased 6% over the first nine months of the year.
However, operating profit declined 37% in the same period, because catastrophe losses more than doubled.
Catastrophe losses throughout 2016 were due to severe storms in Texas and Northern California, as well as claims from the Sand Fire in Southern California.
The good news is that premium income continues to grow, which is a better indication that the company’s products are popular with its customers.
Going forward, higher interest rates would be a significant tailwind for Mercury General. Its after-tax net investment income declined 2.4% over the first nine months of 2016.
Approximately 85% of Mercury General’s investment portfolio is concentrated on fixed maturity securities. By contrast, just 9.3% of its total investments are made up of equity securities.
Therefore, higher interest rates would allow the company to earn more income from its bond investment portfolio.
Higher investment income would help the company accelerate its dividend growth, which has slowed in recent years. For example, in 2016 Mercury General raised its dividend by 0.4%, which was less than inflation.
Still, it is difficult to argue with Mercury General as a dividend stock, due to its hefty dividend yield.
The Travelers Companies (TRV)
Travelers is the largest insurer on this list. It has a $33 billion market capitalization. In 2015, Travelers generated $24.1 billion in net premiums written.
Its policies are split into the following categories:
- Business & International Insurance (60% of premiums written)
- Personal Insurance (31% of premiums written)
- Bond & Specialty Insurance (9% of premiums written)
Since the company is strongly profitable and generates solid growth each year, it has been able to reward shareholders with high dividend growth for many years.
Like Mercury General, Travelers is a Dividend Achiever.
Source: Investor Toolkit
And, Travelers has paid dividends to shareholders for 145 years. Over the past 20 years, it has increased dividends by 10.1% compounded annually.
Travelers has accomplished such strong dividend growth rates because of its effective strategy for creating shareholder value. The company’s long-term strategy is to generate return on equity in the mid-teens each year.
Source: Travelers Introduction presentation, page 2
The company has reached this goal. Return on equity has significantly exceeded its cost of capital over the past several years.
Source: Travelers Introduction presentation, page 7
One reason why this has happened, is because Travelers works to keep costs of capital low. The company strives for a ‘AA’ credit rating, which helps in that regard.
Plus, the company only raises enough capital that is necessary to support the business and future growth objectives, so long as it does not endanger its credit rating.
Any excess capital generated by the business is returned to shareholders. Travelers not only pays dividend, but it also rewards shareholders with buybacks.
The company initiated its share repurchase program in 2006. Since then, Travelers has returned $36.8 billion to investors in combined dividends and repurchases.
These strategies have worked very well for shareholders. Over the past 20 years, Travelers’ book value increased by 9.7% compounded annually.
The company’s operating earnings-per-share declined 13% over the first nine months of 2016, which is discouraging. Most of the decline was due to higher non-weather related catastrophe losses.
However, the core business remains healthy. Net written premiums increased 4% in the same period. In the third quarter, Travelers’ net written premiums rose 3% to a record $6.38 billion.
Travelers has a very cheap stock. Shares trade for a price-to-earnings ratio of just 10. This compares very favorably to the valuation of the S&P 500 Index, which has an average price-to-earnings ratio of 26.
In addition, Travelers stock has a 2.3% dividend yield.
As a result, shareholders could easily generate 10% annualized returns or more going forward. Future expected returns will be comprised of earnings growth, dividends, and the potential for expansion of the valuation multiple.
Putting it all together, Travelers has something to offer nearly all investor types. The stock appeals to investors looking for value, growth, income, or a combination of all three.
Old Republic International (ORI)
Old Republic is a Dividend Aristocrat, and has the longest dividend increase streak on this list. It has raised its shareholder payout for the past 35 years.
Going back further, the company has paid uninterrupted dividends to shareholders for 75 years.
Old Republic traces its beginnings to 1923. It is one of the 50 largest publicly-traded insurance companies in the U.S. It operates primarily in commercial products, mostly in general and title insurance.
The company has a diversified customer base, made up of many different industry groups. Over the past five years, Old Republic has slightly reduced its exposure to the housing, financial, and energy industries, while increasing its exposure to transportation and general industry.
Source: 2015 Annual Report, page 5
Old Republic’s diversification has stabilized its annual revenue and operating profit over the past decade.
Source: 2015 Annual Report, page 6
The stock has been a very rewarding investment for a prolonged period. According to the company, during the 25 years ended in 2015, the stock returned 12.2% per year.
This demonstrates the strength of the insurance business model.
2015 was another year of steady growth for the company. Old Republic increased revenue and earnings-per-share by 7.9% and 2.8%, respectively, for the year.
The company enjoyed success across several categories. Earned premiums set a new record in 2015. One of the strongest lines for Old Republic last year was title insurance. Title insurance premiums surpassed $2 billion and hit a company record.
Another key advantage for Old Republic is its investment portfolio, which has performed extremely well for the company. Last year, net investment income rose 12%.
This was driven by higher assets, as well as higher return on assets. The company strategically invested more of its portfolio in common stocks.
Thanks to the equity market’s strong performance over the past few years, this decision has paid off for Old Republic.
Continued growth lasted into 2016. Revenue and earnings-per-share rose 2% and 1%, respectively, over the first nine months of 2016.
Old Republic’s growth slowed down a bit over the course of 2016. One reason was because the company’s investment portfolio has not performed as well as it did in 2015. Net investment income rose just 0.9% over the first three quarters of 2016.
Separately, the company’s premium income rose 1.7% over the first nine months of 2016. This was satisfactory enough, but below 2015 growth because of weakness in a couple of industries.
In particular, the company reported weaker-than-expected premium underwriting in the construction and energy industries.
Still, the company is highly profitable and is a growing business. Plus, Old Republic stock is cheap.
Old Republic is a very attractive stock for value and income investors. Shares trade for a price-to-earnings ratio of 12.
Considering its strong fundamentals and low valuation, Old Republic stock appears to be significantly undervalued.
And, the stock has a current dividend yield of 3.9%.
Infinity Property and Casualty Corporation (IPCC)
Last but not least is Infinity Property and Casualty, the smallest insurer on this list. The company has a market capitalization of $961 million, which makes it a small-cap stock.
Some investors prefer small-caps because of their higher growth potential, and Infinity is a good example.
In the past 10 years, Infinity stock rewarded investors with an 82% return, compared with a 59% return for the S&P 500 Index in the same period.
Infinity provides personal automobile insurance in the U.S. Most of its business is in personal and commercial auto insurance, but it also offers life insurance.
The company’s product line mix is as follows:
- Personal Auto (90% of written premiums)
- Commercial Vehicle (9% of written premiums)
- Classic Collectors (1% of written premiums)
Infinity aims for a specific competitive advantage to set it apart from other insurers. It is based on geographic concentration.
Primarily, the company seeks to be a leader in urban areas. And, Infinity’s corporate mission is to focus on the Hispanic market.
The reason for this strategy is because the company has identified the Hispanic market as one of the fastest-growing demographics in the country.
Source: Investor Presentation, page 7
To take advantage of this demographic shift in the U.S., the company is targeting urban zones in four states: California, Arizona, Texas, and Florida.
These states account for 60% of the U.S. Hispanic population. Infinity estimates the urban areas in these four states cumulatively holds $60 billion in potential premiums.
Among product line, the company is focusing on commercial vehicles for future growth.
Population growth among the targeted demographic has resulted in strong growth in commercial vehicle premiums over the past several years.
Source: Investor Presentation, page 12
This is the centerpiece of Infinity’s growth strategy, and it has paid dividends thus far. From 2011-2015, the company grew revenue and earnings-per-share by 28% and 34%, respectively.
With such strong growth, the company returns a great deal of cash to investors through dividends and share repurchases.
Source: Investor Presentation, page 17
Infinity stock currently yields 2.4%, which is only slightly above the average S&P 500 Index yield. But it makes up for this with high dividend growth rates. For example, the company raised its dividend by 21% in 2016.