Everything You Need to Know About Insurers: Evaluation
As we've seen in this series, insurance is a necessary part of most people's financial lives, but the business can be complicated to understand. Today we'll look at the three keys to evaluating an insurance company, as well as three businesses that exemplify the mastery of those criteria.
No. 1: premiums growth
As the lifeblood of any insurance business, premiums are key to the success and long-term viability of a company. Monitoring premiums growth is tantamount to keeping an eye on how the company is expanding, managing its pricing, navigating changes in the market, and so on.
When you begin your analysis of a company's premiums, there are a few things to keep in mind.
Is the current market hard or soft? That will affect the company's pricing strategy.
What are the company's primary markets? This will help you identify any aging markets where premiums growth may be slowing.
Has it been expanding into new territory? This can help you identify areas of new growth opportunities.
Has the company expressed any set goals for premiums growth or development of new products?
American International Group has been on the rise since its near bankruptcy during the financial crisis. Since that time, the company has refocused on its core operations as an insurance provider, which has helped the business tremendously. One of the core areas of premiums growth for AIG has been its mortgage guaranty division.
Though its involvement in the mortgage market was one of the keys to its stumble in 2008, AIG re-entered the mortgage market earlier this year. Since that time, new insurance written by the unit has risen 62%. With plenty of evidence that the private mortgage insurers will continue to see new policies and their premiums grow, this segment of AIG's operations is a key one to monitor.
No. 2: Investments
Premiums may fuel the ship, but investments drive it to profitability. By investing the float (or accumulated premiums not paid out in claims), insurers can greatly increase their bottom lines.
Some of the key things to focus on when analyzing an insurer's investments is to note what types of investments the company is making (i.e., government bonds versus corporate debt) and what the company's risk profile looks like. Keep in mind also that the insurers are very sensitive to macro issues, like the current low-interest-rate environment. With rates so low, their future investment income is likely to be lower as they invest in lower yield instruments. Some insurers have noted that their investment strategies have changed to accommodate the current rate environment.
One of the best investors in the insurance world is Markel . Under the guidance of Chief Investment Officer Tom Gayner, the company has consistently provided investors with 17% annualized returns. Since the second quarter of 2012, Markel has made some changes to its portfolio mix, presumably to offset some of the pressures from current low interest rates.
Fixed Investment Type
U.S. government bonds
Foreign government bonds
Source: Markel Second quarter 10-Qs (2012, 2013).
By monitoring how an insurer invests its float, you can view how management is dealing with pressures from the macro environment. This will also allow you to determine whether the company's tolerance of risk is suitable to your portfolio.
No. 3: The intangibles
Though a company lives and dies by its financials, sometimes the intangibles can be a huge part of your investment thesis. Since the importance of different factors will pay various roles for different investors, I won't give you specific guidance on exactly what to look for. Instead, I will simply advise you to not focus solely on the financials of an insurer, along with an example of how I look at the intangibles.
Let's look at one of the biggest players in the insurance market -- Berkshire Hathaway . Not only does Berkshire Hathaway operate one of the top auto insurers (Geico), but it also operates the two largest reinsurance businesses in the world. So once we've gotten comfortable that Berkshire's insurance divisions are chugging away with premiums growth and investments, there are two things we can't ignore: management and operations diversity. Of course, the latter is something that can be quantified. You can go through each of Berkshire's divisions (newspapers, jewelers, railways, etc.) and determine whether they are right for you, but more simply, do you view the diversity as a potential cushion to the insurance operations or a potential hindrance? If you're comfortable with the insurance operations, but not the rest, maybe taking the time to do the deep dive would be your next best step.
Management is always a big area to consider. And with Warren Buffett at the helm of Berkshire Hathaway, there's no question that the company is in good hands. But with Buffett's age and knowledge come the inevitable question -- how long will he be there? So your next step would be to look at the other executives, and determine whether Buffett has ingrained his style into the business, so that once he's gone it will continue to operate the same way it always has, or whether that is another hindrance for you.
So much to consider
Of course, these three steps won't encompass all of the risks associated with investing in an insurer, but hopefully it will get you on the right track and start your process off well. Insurers are a prime example of key financial firms that offer necessary products to consumers in all demographics. And they can be a successful part of your portfolio, as long as you take your time and evaluate which one is right for you.
Investing like Buffett
Investing in insurance businesses has really allowed Warren Buffett to become the key figure in investing today. He has often stated that when he says his thanks, he says it twice for Geico. Buffett has made billions through his investing, and he wants you to be able to invest like him. Through the years, Buffett has offered up investing tips to shareholders of Berkshire Hathaway. Now you can tap into the best of Warren Buffett's wisdom in a new special report from The Motley Fool. Click here now for a free copy of this invaluable report.
The article Everything You Need to Know About Insurers: Evaluation originally appeared on Fool.com.
Fool contributor Jessica Alling has no position in any stocks mentioned. The Motley Fool recommends and owns shares of AIG, Berkshire Hathaway, and Markel and also has options on AIG. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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