Understanding How I View Insurance Stocks

Insurance stocks are tricky for several reasons. There are probably more unique accounting rules for insurance, then any other industry. Why? The cost of goods sold is not known at the issuance of a policy. Every dollar into an insurance company is equal, but every promise made is not equal. Over time, estimates of cost become more accurate, but with long-tailed lines the progress is often fitful at best.

Life reserving is a science (please ignore the new funky investment derivatives inside some policies). Short-tailed P&C reserving is close to a science. Long-tailed P&C reserving is an art, and a dark art. I’m not sure that even the internal actuaries reserving the long-tailed lines can be that comfortable with the accuracy of the reserves.

This is why it pays to stick with conservative and competent managements that have shown that they can manage the soft part of the cycle. I may miss some speculative gains managing this way, but for the most part, I will miss out on the losses. To give you further insight into my philosophy, here’s a presentation that I gave to the Southeastern Actuaries Club. (I am available for other speaking engagements if I can show my employer a business purpose.)

10 thoughts on “Understanding How I View Insurance Stocks

  1. David, I just finished reading your presentation. There’s a lot of interesting stuff there; more than I could absorb in one reading.
    You mentioned that you try to understand the other players, when evaluating an investment. How do you do that?

  2. I wrote a series of four articles on this topic for RealMoney. The basic idea is to analyze the various parties around a stock — analysts, current holders, potential holders, and ask questions about how their ability to carry the positions, and what events or price movements would lead them to change their minds.

    Read the articles, not all at once, unless you’re really interested in this. I plan on writing a series of posts on various topics in investing, and using articles that I wrote at RealMoney to illustrate them. This will be one of the topics.

  3. David, thank you for the link and welcome to the blogoshere. I added you to my blogroll on my site, thanks again.

  4. David, Thanks for pointing me to the series of articles you wrote for Realmoney. I noticed your reference to a buy of telecom and tech stocks in the dregs of 2001-02. That was well-timed. It probably helped your timing ie.slowed your decision-making, that these stocks weren’t in your usual investment sphere. It seems like there is a tendency among investors (me included), to enter this type of situation too soon.
    I’ve read opinions on sub-prime mortgage lenders, that range from “buy now” to “head for the hills”. In your opinion, is there a risk to the entire financial system or will it be contained to the specific companies. Could there be some good long opportunities in this area, when it settles down?

  5. The firm I work for had its best week in a long while by being short a variety of weak lenders. Because I work for this firm, and I am the insurance analyst, and not the mortgage or banking analyst, I defer to them.

    You are correct in saying that when this is done, there will be a lot of opportunities here on the long side. When I was buying technology and telecom stocks during 2001-2002, I was frequently getting them for less than net cash. Some even had earnings. But they all had balance sheets strong enough to survive the cycle, even if the cycle got worse.

    The way I would play this if I were off on my own would be to buy companies involved in subprime lending that have strong balance sheets, and are getting hurt, even though subprime is only a part of what they do. Then I would wait for the turn, which might take a few years. Companies that survive will have the opportunity to benefit from the next cycle. Most of the current pure plays will likely too impaired to benefit as much.

    Here’s one more of my RealMoney articles to give you some more insight into how I rotate into different industry groups. Thanks for your question.

  6. David, Thanks for referring me to your Realmoney article. It’s interesting to read how the composition of your investment portfolio changed, over the years. Do you keep a diary of your stock trades?

  7. Hi David,

    You make a good point about ascertaining how competent/conservative insurance co. managements are…for an example of one who wasn’t, you need look no further than SCT…reinsurance is a tough business, and most of the people at the top there were bankers, not insurance people…and I never felt like they were in it for the long haul, either

    You are right about insurance companies having a certain amount of leeway wrt reserving…ditto for setting capital levels and amortizing DAC…and as principles based reserving becomes a reality, management competence/prudence will be even more important, imho

    none

  8. Frankel — For my insurance portfolio at the hedge fund, no, I have no journal, aside from the fact that I mention all major trades over at RealMoney. For my broad market account, I have the data in Quicken, and could export it to Excel. I am considering posting that for readers, together with my accounting summary that I personally use for tracking performance.

    aliens8mycow — SCT, alas, it was my dumbkopf move of 2006. You are dead right that principles-based reserving comes into effect, management/actuarial competence and prudence will be as important as it is now with P&C insurers. Comparability of results will be slowly destroyed. I wonder if the sell side is ready for this. I don’t think so. (BTW, I still hold shares in your firm… it’s a great company.)

    long a minuscule amount of SCT and only for legal reasons

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