I wrote this piece once, and lost it, 1000 words.  Going to try again.

1) The first thing to realize is that diversification across insurance subindustries usually does not work.

Do not mix:

  • Life & P&C
  • Financial & Anything
  • Health & Anything

Maybe you can mix P&C, Mortgage & Title, after all Old Republic survived.  The main point is this.  Insurance is not uniform.  Coverages are sold and underwritten differently.  Generally, higher valuations will be obtained on “pure play” companies  Diversification is swamped by management inability.  These are reasons for AIG and Allstate to spin off their life operations.

2) Middle-sized companies tend to do best from a valuation standpoint: the large have nowhere to grow, and the small are always questionable on their viability.  With a few exceptions, I like sticking with focused mid-cap companies with my insurance names.

3) Be aware of total subindustry capital relative to need.  After a big disaster, those that underwrote well will have capital to deploy into a stronger underwriting environment, where capital is scarce.  But don’t make too much of it because capital has become very fluid in insurance; the barriers to entry and exit are low.  Still, it is best to be an investor after a disaster, when everyone is running scared.  When total capital is high, and companies are fat, dumb, and happy, it is time to leave.

4) It’s good to look through the Statutory statements [regulatory statements filed with state insurance regulators] of their operating insurance subsidiaries to look for odd entries.  Occasionally, you will run into problems that do not have to be reported under GAAP accounting.  (Note: they should be reported under the spirit of GAAP, but not the letter of GAAP.  I have a saying, “It is okay to violate GAAP to be more honest, but not to be less honest.”)

Here’s an example: I ran across a life company that had to post an extra statutory reserve because they would lose money if interest rates rose.  That’s a significant admission, and the company was invested far more aggressively than almost all the other life companies we were tracking.  We shorted it, and got ripped as the credit markets surged 2003-2005.  We got out with a small gain when their earnings proved inadequate as interest rates rose, and credit losses rose.  But it took a long time.

At this point, I would be looking for special reserves established for secondary guarantees established for Term and Universal Life, and Variable Life & Annuity policies.  There is no specific requirement to hold those reserves on a GAAP basis, even though there may be general principles that would encourage additional reserves or disclosures.

5) There are ways of multiplying capital across subsidiaries — Subsidiary A reinsures liabilities of subsidiary B, while Subsidiary B reinsures liabilities of subsidiary A.  This is a way to create hidden leverage, so be aware of what is being done at the subsidiary level.  Doing these sorts of things is dumb, though legal.

Reviewing leverage is a good idea as well, where it is located, and what conditions it has.  The practice of insurance subsidiaries issuing surplus notes to parent companies has become all too common, which allows subsidiaries to write more business at the risk that when a subsidiary becomes impaired, the domiciliary state takes it over, and the parent company gets little to nothing.  (Payments on surplus notes can only be made with the approval of the insurance commissioner. In insolvency surplus notes typically receive nothing.)

The thing is, it is a lot harder to produce return on assets than return on equity. Though part 6 focused on ROE, in the short run, insurance companies can improve their ROE through substituting debt for equity.  The same applies to insurance companies that write GIC Medium Term Notes.  It’s just a cheap way of making a little extra income arbitraging your subsidiary’s high claims paying ability rating.  It fascinates me that regulators have allowed the insurance industry such latitude with deposit contracts that are called annuities, but have never once been annuitized.

Another hidden source of leverage are financial reinsurance agreements.  Down in the insurance subsidiaries, companies trade away a portion of future profits for surplus today.  These are usually bad deals to enter into, but because some insurance companies have a sales culture that requires continual growth, even if the sales that don’t justify the cost of capital required to back the policies.

6) Free cash flow is difficult to determine for financials, this applies to insurers as well.  Each regulator has rules on how much can be paid in dividends to their holding company.  Typically, subsidiaries can dividend away surplus so long as they are still strongly capitalized after the dividend.  (If it is large, they may have to petition their regulator for approval)  So if you want to approximate free cash flow for an insurer, try the following:  (Income or loss outside your insurance companies for the current period) + (Distributable Income from insurance companies for the current period).  The latter figure is statutory income +/- any decrease/(increase) in capital required to maintain the remaining business with adequate financial strength, calculated separately for each subsidiary.

7) Last note: on DAC/VOBA [deferred acquisition costs, value of business acquired; they  are similar, so I will just talk about DAC].  Once I had to convince a boss that though it is an intangible, like goodwill, it is not like goodwill in that it is more rigorously tested for recoverability.  If DAC gets written down (as opposed to amortized) that means that the future sum of profits on some of the insurance business is expected to be less than the acquisition costs deferred for the business.

Now, DAC can be done conservatively, by product and class year.  The more disaggregated it is, the more conservative, generally.  A few cells getting written down is no big thing.  But DAC can be as liberal as having one cell, which means if DAC is written down, the total value of future profits from existing business has been reduced — the company is worth a lot less.  The change in value is even more than the reduction in the DAC, because in the writedown process, the discount rate on the DAC went from a positive number to zero.  All other things equal, a DAC asset is worth more the higher its discount rate.

S0 pay attention: if DAC amortization is high relative to net income before tax, it means there isn’t that much margin for adverse deviation in the DAC.  Also, all other things equal, lower levels of DAC as a fraction of net worth are better.

Close with a story: before Mony Group was bought by AXA, it was doing DAC for the company as a whole.  A value investor, seeing the discount to book value, and sensing opportunity bought a lot of Mony.  Profitability was so bad, they had to write down DAC.  Book value declined & price to book value declined as well.  The value investor agitated for a sale, and AXA stepped in, buying it for moderate premium to where it was trading.  The group I was with went long for an arbitrage trade on a cash deal.

But the value investor thought the premium wasn’t high enough and agitated for more.  Because the takeout price was 70% of book, the idea seemed plausible.  But when you factored in the DAC earning 0% and a few other items, it looked generous enough to me.  So when the price got several percent above the deal terms we sold our stake and went short as much as we could find without having to pay much interest on the borrow.  Bit-by-bit the stock price moved down until a few days before the deal would close, when the price collapsed below the deal price, and we covered.  We even arbed a little more on the long side, but the trade was over.

And the point is this: it may look cheap, but test your assumptions on the values of assets and liabilities before committing a lot of capital to a any insurance stock.  GAAP, Tax and adjusted Statutory income validate book value, so a cheap stock with a low return on equity or assets is often not cheap.

This piece is the sixth out of seven in a series that I have been writing at Aleph Blog.  Here are links to the first five pieces:

Recently I decided to spend some time analyzing the insurance industry.  It’s a different place today than when I became a buy-side analyst ten years ago.  Why?

First, for practical purposes, all of the insurers of credit are gone.  Yes, we have Assured Guaranty, and MBIA is limping along. Old Republic still exists. Radian and MGIC exist in reduced states.  The rest have disappeared.  In one sense, this should not have been a surprise, because the mortgage and credit guaranty businesses never had a scientific model for reserving.  I’m not even sure it is possible to have that.

Second, the title insurers are diminished.  Some, like LandAmerica are gone. Fidelity National seems to be diversifying itself out of insurance, buying up a restaurant chain last year.

Third, health insurers face an uncertain future.  Obamacare may disappear, or Obamacare could slowly eliminate insurers.  It’s a mess.  Insurers debate to what degree they should compete in insurance exchanges.

But beyond all of that, valuations are fair-to-cheap across the insurance industry.  Part of that may stem from ETFs.  Insurers as a whole are smaller than the banks, but not as much smaller as they used to be.  Now, if you are a hedge fund, and you want to short banks, you probably have the best liquidity shorting a basket of financials, which shorts insurers as well.

That may be part of the issue.  There are other aspects, which I will try to address as I go through subindustries.

Offshore

By “Offshore” I mean P&C reinsurers and secondarily insurers that do business significantly in the US, and who list primarily on US exchanges, but are not based in the US.  Most of them are located in Bermuda.

In 2011-2012, many of them were challenged by the high levels of catastrophes globally.  But the prices of the reinsurers did not fall because pricing power returned, and investors expect higher future earnings as a result.

Before I go on, I need to explain that what I will use to give a rough analysis of value is a Price-to-Book vs Return on Equity analysis [PB-ROE].  For more details, you can read my article here.  The short explanation is that companies in the insurance business (and other financials) are constrained by the amount of equity (net worth) that they have.  The ability to earn a return as a percentage of the equity [ROE] drives the market valuation as a fraction of the equity [P/B].

Here is a scatterplot for PB-ROE for the Offshore group:

Offshore

 

Companies above the line may be overvalued, and companies below the line may be undervalued.  ROE is what is expected by analysts for the next fiscal year, not what has been obtained in the past.

The fit is fairly tight, and indicates mostly logical valuations for this group.  The companies that are possibly overvalued are: Arch Capital [ACGL] and Renaissance Re [RNR]. Possibly undervalued: Tower Group [TWGP] and Endurance Specialty [ENH].

Now, this simple model can fail if you have an intelligent management team that has a better model.  Arch Capital and Renaissance Re may be that.  But with an expected ROE of less than 20%, it is hard to justify their valuation, when the average stock in this group needs an expected 11% ROE to be valued at book.

Why such a high ROE to get book?  Earnings quality.  Reinsurers have noisy earnings due to catastrophes.  You don’t give high valuations to companies that run hot or cold.  But the trick here is to see who is accumulating book value the fastest – they tend to be the stars over time.  Endurance and Arch have been good at that.

Life

The life insurance business would be simple, if it indeed were only life insurance.  Much of the industry is handed over to annuities, and all manner of asset gathering.  Even life insurance can be made more complex through variable and variable universal life, where assets are invested in stocks, and do not receive a rate from the company.

Part of the trouble is that variable products are not simple, but the insurers offer guarantees for a fee.  When I see those products, my reaction is usually, “How do they hedge that?!”

Thus I am concerned for insurers that are “equity-sensitive” as I reckon them.  Here is the PB-ROE scatterplot:

Life

 

A tight fit.  The insurers that are seemingly undervalued are equity-sensitive ones: Phoenix Companies [PNX], Aegon [AEG], and ING [ING].  Those that are overvalued are Citizens [CIA], Eastern Insurance Holdings [EIHI], and Atlantic American [AAME].  For the undervalued companies, I am unlikely to buy because I am skeptical of the accounting.  I would look further down the list and consider buying some companies that are more reliable, like Assurant [AIZ], National Western [NWLI], and Fortegra Financial Corp [FRF].

One more note: to get book value in Life Insurance, you need a 9.8% ROE on average.  That’s high, but I expect that is so because investors are skeptical about the accounting.

Property & Casualty

This graph gives PB-ROE for the entire onshore P&C insurance industry:

Onshore

 

It’s a good fit.  Again, the casualties of the last year weigh on the property-centric insurers, but for the most part, this is logical.

Potential underperformers include First Acceptance [FAC], Employers Holdings [EIG], and Erie Indemnity [ERIE].  Below the line: Hartford Financial Services [HIG], Hilltop Holdings [HTH] Hartford Financial [HIG], and United Insurance Holdings [USIH].

Again, these are only screening tools.  Before buying or selling, understanding management and reserving quality, and riskiness of the lines of business makes a considerable difference.  Erie Indemnity has an “asset light” model where it manages insurers, but does not bear underwriting risk.  Hartford has a significant life insurance and annuity exposure.  Models are models, and we have to understand their limitations.

Health

With Obamacare, I don’t know which end is up.  It could end up being a giant sop to the health insurers, or it could destroy the health insurers in order to create a government single-payer model, rather than the optimal model for cost reduction, where first parties pay directly, or pay insurers.  You want reductions in medical costs, get the government out of healthcare, and that includes the corporate deduction for employee health insurance.

My rationale is this: it could mess up the private market enough that the solution reached for is a single payer solution. I’ve talked with a decent number of health actuaries on this. The ability to price risk is distinctly limited. Young people pay too much, older folks too little. That’s a formula for antiselection. I think Obamacare was badly designed. I will not achieve its ends, and when the expenses start coming in, they will be far higher than anticipated. That has been the experience of the government in health care in the US. Utilization is underestimated, the further removed people from feeling its costs.

There are many models for profitability here, which makes things complex, but here is the present PB-ROE graph:

Health

It’s an okay fit, with the idea that the following companies might be undervalued: Wellpoint [WLP] and Humana [HUM].  And the following overvalued:  Molina Healthcare [MOH].

I don’t regard myself as an expert on the health insurance sub-industry, so treat this with skepticism.  I include it for completeness, because I think the PB-ROE concept has value in insurance.  One more note, the PB-ROE model thinks of this as a safe investment subindustry, because to have a book value valuation, you have to have an ROE of 1.8%.

Financial Insurers

This group comprises the surviving mortgage, title and financial insurers, and two companies in the ghoulish business of buying life insurance policies from sick people.  Here’s the PB-ROE graph:

Financial

This graph is weird, because it slopes down, and does not have a good fit.  That’s because we’ve been through a rough period financially, and in many cases GAAP accounting does not do a good job with these companies that take a lot of credit risk.

We can still look for companies that have high price-to-book, and low ROEs – note Life Partners [LPHI] and Radian [RDN] as possible sell candidates. We can also look for companies that have low price-to-book, and high ROEs – note Assured Guaranty [AGO] and MBIA [MBI] as possible buy candidates.

This subsector is more difficult than most, because credit is not an underwritable risk.  It is feast and famine.  We are in a period of feast now, so in some ways what is bad is good.  The more risk, the more return.  But winter may come soon – who knows what the Fed may do?  In general, I avoid this subsector for longs.

Insurance-Related Companies

This is a group that is a non-group.  It comprises brokers and insurance service providers.  Here’s the PB-ROE graph:

Insurance Related

It doesn’t look like much of a group.

As it is the potential outperformers include Brown & Brown [BRO], and Aon [AON], two leading insurance brokers.  A potential underperformer Willis Group [WSH], another leading insurance broker.

Summary

Insurance is complex, and the accounting is doubly complex, which is a major reason why many stay away from it.  But insurers as a group have had reliable and outsized returns over the rememberable past, which should encourage us to do a little kicking of the tires when a decent amount of the industry trades below its net worth and is still earning money with little debt.

In my opinion, this is a recipe for earnings in the future, and why I own a lot of insurers for myself, and for clients.

In the final part of this series, I will go over some nuances of insurance accounting – I leave it to the end because it is kind of dull, but can make a lot of difference, because some companies look cheap and aren’t really cheap.

Full disclosure: long AIZ, ENH, NWLI for clients and myself

 

The Squishy Stuff

I think I have just one more post left after this one, and this series ends.  This post deals with qualitative factors, which are harder to ascertain than the quantitative factors, and require more experience in order to learn.  But maybe I can aid my readers with a few pointers so they can learn faster.

Before we go, this series published at The Street.com University is an excellent start for any analyst, and includes many insurance examples.  But now for the rest.

Some products cannot be underwritten.  Anytime the insured knows more than the company, that is not a policy to write.  As an example, I toss out Long-term care policies, where the insurance industry has lost and lost again.  The insureds know their likely claims far better than the insurers do.  I feel the same about credit and mortgage insurance, where losses are so correlated that in a real crisis the insurance company fails, and those relying on the insurance fail as well.

I feel the same way about variable annuity living benefits at present — a rising market sets up the losses for when the market falls.

Avoid investing in companies where the law of large numbers does not apply.  This is true of all financial coverages.  If there is one big macro factor that drives your business it is not a safe place to be.

On Management

Management teams should be reliable.  They should always give complete and consistent answers to all questions, and demonstrate that they are managing the business, with underwriting being profitable.  They also should be willing to let results fall short of analysts’ estimates when it is true.

Though the short-term stock performance will be bad, the honesty will support the stock nearer to book value.  Investors appreciate honest companies, even when they do badly.

Finally if management has any sustainable competitive advantages (rare in insurance) they will use the advantages, and describe them in general terms so hat other insurers don’t reverse engineer them.

Be sure and read my series listed above.  It offers far more than what I have written here.

This will be a short but important part in this series on insurance investing.  It deals with the accounting, and applies to all areas of insurance.  Insurance accounting is complex. When an insurance policy is written, the insurer does not know the true cost of the liability that it has incurred; that will only be known over time.

Now the actuaries inside the firm most of the time have a better idea than outsiders as to where reserve should be set to pay future claims from existing business, but even they don’t know for sure.  Some lines of insurance do not have a strong method of calculating reserves.  This was/is true of most financial insurance, title insurance, etc., and as such, many such insurers got wiped out in the collapse of the housing bubble, because they did not realize that they were taking one big nondiversifiable risk.  The law of large numbers did not apply, because the results were highly correlated with housing prices, financial asset prices, etc.

Even with a long-tailed P&C insurance coverage, setting the reserves can be more of an art than science.  That is why I try to underwrite insurance management teams to understand whether they are conservative or not.  I would rather get a string of positive surprises than negative surprises, and you tend to one or the other.

There are a couple ways to analyze this:

1) This had more punch when interest rates were higher, because insurance managements were more tempted to compromise underwriting, because they had compelling investment opportunities, but asking the anti-question, “How are you planning on growing the top line next year?” is a good one.

An inexperienced or liberal management team will try to talk about business opportunities.  An experienced, or conservative management team will say, “We don’t target top line growth.  We aim for growth in fully converted book value per share.  We only grow the top line when the market favors that, and ability to write risks at favorable prices is easy.”

Conservative investors should be wary of any financial company that is growing aggressively; finance is a mature industry, and sustainable competitive advantages are few.

2) What is the company’s attitude on reserving?  How often do they report significant additional claims incurred from business written more than a year ago?  Good companies establish strong reserves on current year business, which depress current year profits, but gain reserve releases from prior year strongly set reserves.

So get out the 10K, and look for “Increase (decrease) in net losses and loss expenses incurred in respect of losses occurring in: prior years.”  That value should be consistently negative.  That is a sign that he management team does not care about maximizing current period profits but is conservative in its reserving practices.

One final note: point 2 does not work with life insurers.  They don’t have to give that disclosure.  My concern with life insurers is different at present because I don’t trust the reserving of secondary guarantees, which are promises made where the liability cannot easily be calculated, and where the regulators are behind the curve.

As such, I am leery of life insurers that write a lot of variable business, among other hard-to-value practices.  Simplicity of product design is a plus to investors.

In all things as investors, aim for a margin of safety.  That is the hallmark of value investing.

Subtitle: The Value of Momentum and Mean-Reversion

In the extreme short-run, mean-reversion dominates.  Over a year, momentum dominates.  Over a four year period mean-reversion returns.

The same applies to insurance stocks.  This is perhaps more true of insurance stocks, because the accounting is so opaque.  When accounting is opaque, it takes a longer period of time for market prices to catch up with the underlying reality.

I do not trust momentum naively.  I compare it to fundamentals and ask if it has more room to run or fall.  Remember, insurance is a mature industry… there are few sustainable competitive advantages here.  Near turning points, valuations are stretched or in the dumps.

That said, here is my table of momentum for the insurance industry:

companytickerimg_desc

mktcap

prchg_52w
Radian Group Inc.RDN0715 – Insurance (Property & Casualty)               882.0

155%

Homeowners Choice, Inc.HCI0715 – Insurance (Property & Casualty)               241.1

146%

Stewart Information Services CSTC0715 – Insurance (Property & Casualty)               528.1

100%

Imperial Holdings, Inc.IFT0712 – Insurance (Miscellaneous)                 89.7

86%

Kingsway Financial Services InKFS0715 – Insurance (Property & Casualty)                 54.0

68%

Atlantic American CorporationAAME0709 – Insurance (Life)                 69.7

63%

eHealth, Inc.EHTH0712 – Insurance (Miscellaneous)               506.9

59%

Investors Title CompanyITIC0715 – Insurance (Property & Casualty)               135.2

59%

First American Financial CorpFAF0715 – Insurance (Property & Casualty)           2,522.8

58%

Coventry Health Care, Inc.CVH0706 – Insurance (Accident & Health)           6,239.6

57%

Hilltop Holdings Inc.HTH0715 – Insurance (Property & Casualty)               753.0

55%

CNO Financial Group IncCNO0709 – Insurance (Life)           2,315.5

52%

Allstate Corporation, TheALL0715 – Insurance (Property & Casualty)         21,154.9

51%

Symetra Financial CorporationSYA0709 – Insurance (Life)           1,629.6

50%

American International Group,AIG0715 – Insurance (Property & Casualty)         54,180.4

46%

Sun Life Financial Inc. (USA)SLF0709 – Insurance (Life)         17,505.2

46%

Platinum Underwriters HoldingsPTP0715 – Insurance (Property & Casualty)           1,595.2

43%

Hartford Financial Services GrHIG0715 – Insurance (Property & Casualty)         10,829.2

41%

Lincoln National CorporationLNC0709 – Insurance (Life)           8,005.7

41%

Amtrust Financial Services, InAFSI0715 – Insurance (Property & Casualty)           2,232.4

40%

HCC Insurance Holdings, Inc.HCC0715 – Insurance (Property & Casualty)           3,989.2

39%

Fidelity National Financial InFNF0715 – Insurance (Property & Casualty)           5,669.5

38%

Horace Mann Educators CorporatHMN0715 – Insurance (Property & Casualty)               847.4

38%

Montpelier Re Holdings Ltd.MRH0715 – Insurance (Property & Casualty)           1,341.4

37%

Seabright Holdings IncSBX0715 – Insurance (Property & Casualty)               249.3

37%

Verisk Analytics, Inc.VRSK0712 – Insurance (Miscellaneous)           9,172.3

37%

AEGON N.V. (ADR)AEG0709 – Insurance (Life)         13,026.1

36%

Fortegra Financial CorpFRF0712 – Insurance (Miscellaneous)               179.3

35%

XL Group plcXL0715 – Insurance (Property & Casualty)           8,353.8

35%

Primerica, Inc.PRI0709 – Insurance (Life)           1,877.3

34%

Allied World Assurance Co HoldAWH0715 – Insurance (Property & Casualty)           2,946.7

34%

Travelers Companies, Inc., TheTRV0715 – Insurance (Property & Casualty)         29,569.3

33%

Everest Re Group LtdRE0715 – Insurance (Property & Casualty)           5,944.0

33%

Prudential Public Limited CompPUK0709 – Insurance (Life)         38,254.3

33%

CIGNA CorporationCI0706 – Insurance (Accident & Health)         16,718.9

33%

United Insurance Holdings CorpUIHC0715 – Insurance (Property & Casualty)                 91.9

32%

Partnerre LtdPRE0715 – Insurance (Property & Casualty)           5,236.2

32%

Cincinnati Financial CorporatiCINF0715 – Insurance (Property & Casualty)           6,959.7

29%

Protective Life Corp.PL0709 – Insurance (Life)           2,500.8

29%

Argo Group International HoldiAGII0715 – Insurance (Property & Casualty)               926.7

29%

Hallmark Financial Services, IHALL0715 – Insurance (Property & Casualty)               171.6

26%

Aspen Insurance Holdings LimitAHL0715 – Insurance (Property & Casualty)           2,380.3

26%

Alterra Capital Holdings LtdALTE0715 – Insurance (Property & Casualty)           2,911.1

25%

Torchmark CorporationTMK0709 – Insurance (Life)           5,314.2

24%

Alleghany CorporationY0715 – Insurance (Property & Casualty)           6,048.5

24%

Eastern Insurance Holdings IncEIHI0709 – Insurance (Life)               135.2

24%

Berkshire Hathaway Inc.BRK.A0715 – Insurance (Property & Casualty)      242,512.2

23%

Manulife Financial CorporationMFC0709 – Insurance (Life)         26,899.6

23%

Arch Capital Group Ltd.ACGL0715 – Insurance (Property & Casualty)           6,188.5

22%

Enstar Group Ltd.ESGR0715 – Insurance (Property & Casualty)           2,006.2

22%

Axis Capital Holdings LimitedAXS0715 – Insurance (Property & Casualty)           4,664.5

22%

Genworth Financial  IncGNW0709 – Insurance (Life)           4,647.8

21%

Aon PLCAON0712 – Insurance (Miscellaneous)         18,361.6

21%

American Equity Investment LifAEL0709 – Insurance (Life)               862.9

20%

White Mountains Insurance GrouWTM0715 – Insurance (Property & Casualty)           3,585.0

20%

ACE LimitedACE0715 – Insurance (Property & Casualty)         28,999.2

20%

Markel CorporationMKL0715 – Insurance (Property & Casualty)           4,581.2

19%

United Fire Group, Inc.UFCS0715 – Insurance (Property & Casualty)               595.0

19%

Employers Holdings, Inc.EIG0715 – Insurance (Property & Casualty)               658.7

18%

W.R. Berkley CorporationWRB0715 – Insurance (Property & Casualty)           5,643.1

18%

Amerisafe, Inc.AMSF0715 – Insurance (Property & Casualty)               517.4

18%

National Interstate CorporatioNATL0715 – Insurance (Property & Casualty)               592.7

18%

Old Republic International CorORI0715 – Insurance (Property & Casualty)           2,906.0

17%

Kansas City Life Insurance CoKCLI0709 – Insurance (Life)               418.7

17%

Brown & Brown, Inc.BRO0712 – Insurance (Miscellaneous)           3,901.8

17%

Aetna Inc.AET0706 – Insurance (Accident & Health)         16,644.7

17%

Crawford & CompanyCRD.B0712 – Insurance (Miscellaneous)               305.5

16%

Universal Insurance Holdings,UVE0715 – Insurance (Property & Casualty)               182.4

16%

Chubb Corporation, TheCB0715 – Insurance (Property & Casualty)         21,220.1

15%

National Western Life InsurancNWLI0709 – Insurance (Life)               593.0

15%

American Financial GroupAFG0715 – Insurance (Property & Casualty)           3,862.0

15%

Loews CorporationL0715 – Insurance (Property & Casualty)         17,109.9

15%

Endurance Specialty Holdings LENH0715 – Insurance (Property & Casualty)           1,839.7

14%

China Life Insurance Company LLFC0709 – Insurance (Life)         91,295.3

14%

State Auto FinancialSTFC0715 – Insurance (Property & Casualty)               602.7

14%

Principal Financial Group IncPFG0706 – Insurance (Accident & Health)           9,036.6

13%

EMC Insurance Group Inc.EMCI0715 – Insurance (Property & Casualty)               324.6

13%

Maiden Holdings, Ltd.MHLD0715 – Insurance (Property & Casualty)               758.2

13%

RenaissanceRe Holdings Ltd.RNR0715 – Insurance (Property & Casualty)           3,982.5

13%

Validus Holdings, Ltd.VR0709 – Insurance (Life)           3,340.1

12%

Selective Insurance GroupSIGI0715 – Insurance (Property & Casualty)           1,106.6

12%

UnitedHealth Group Inc.UNH0706 – Insurance (Accident & Health)         57,244.5

11%

Hanover Insurance Group, Inc.,THG0715 – Insurance (Property & Casualty)           1,821.7

11%

Cna Financial CorpCNA0715 – Insurance (Property & Casualty)           8,351.3

11%

ProAssurance CorporationPRA0715 – Insurance (Property & Casualty)           2,752.6

11%

Assured Guaranty Ltd.AGO0715 – Insurance (Property & Casualty)           3,264.4

11%

Marsh & McLennan Companies, InMMC0712 – Insurance (Miscellaneous)         19,053.5

10%

Safety Insurance Group, Inc.SAFT0715 – Insurance (Property & Casualty)               728.8

10%

Unico American CorporationUNAM0715 – Insurance (Property & Casualty)                 68.2

10%

Progressive Corporation, ThePGR0715 – Insurance (Property & Casualty)         13,682.1

10%

Independence Holding CompanyIHC0709 – Insurance (Life)               167.3

10%

AFLAC IncorporatedAFL0706 – Insurance (Accident & Health)         25,077.1

10%

Navigators Group, Inc, TheNAVG0715 – Insurance (Property & Casualty)               751.0

10%

Metlife IncMET0709 – Insurance (Life)         41,077.8

9%

Kemper CorpKMPR0715 – Insurance (Property & Casualty)           1,874.3

8%

ING Groep N.V. (ADR)ING0709 – Insurance (Life)         37,707.5

7%

Arthur J. Gallagher & Co.AJG0712 – Insurance (Miscellaneous)           4,502.5

7%

American National Insurance CoANAT0715 – Insurance (Property & Casualty)           2,070.2

7%

Prudential Financial IncPRU0709 – Insurance (Life)         27,417.8

6%

StanCorp Financial Group, Inc.SFG0706 – Insurance (Accident & Health)           1,776.7

4%

Global Indemnity plcGBLI0715 – Insurance (Property & Casualty)               535.1

4%

WellPoint, Inc.WLP0706 – Insurance (Accident & Health)         20,092.9

3%

FBL Financial GroupFFG0709 – Insurance (Life)               902.6

2%

Unum GroupUNM0709 – Insurance (Life)           6,407.6

2%

Infinity Property and CasualtyIPCC0715 – Insurance (Property & Casualty)               684.9

2%

Baldwin & Lyons, Inc.BWINB0715 – Insurance (Property & Casualty)               340.7

1%

Molina Healthcare, Inc.MOH0706 – Insurance (Accident & Health)           1,357.9

-2%

Reinsurance Group of America IRGA0706 – Insurance (Accident & Health)           4,098.1

-2%

Assurant, Inc.AIZ0709 – Insurance (Life)           3,039.7

-3%

RLI Corp.RLI0715 – Insurance (Property & Casualty)           1,439.5

-6%

Erie Indemnity CompanyERIE0715 – Insurance (Property & Casualty)           3,283.2

-7%

Citizens, Inc.CIA0709 – Insurance (Life)               459.8

-8%

American Safety Insurance HoldASI0715 – Insurance (Property & Casualty)               196.8

-8%

Tower Group IncTWGP0715 – Insurance (Property & Casualty)               740.9

-10%

Willis Group Holdings PLCWSH0712 – Insurance (Miscellaneous)           6,032.0

-10%

Mercury General CorporationMCY0715 – Insurance (Property & Casualty)           2,183.3

-11%

OneBeacon Insurance Group, LtdOB0715 – Insurance (Property & Casualty)           1,308.7

-12%

Greenlight Capital Re, Ltd.GLRE0715 – Insurance (Property & Casualty)               835.9

-12%

Donegal Group Inc.DGICA0715 – Insurance (Property & Casualty)               371.4

-12%

Universal American CorporationUAM0706 – Insurance (Accident & Health)               801.3

-13%

Humana Inc.HUM0706 – Insurance (Accident & Health)         11,855.7

-14%

CNinsure Inc. (ADR)CISG0712 – Insurance (Miscellaneous)               330.1

-17%

Health Net, Inc.HNT0706 – Insurance (Accident & Health)           2,204.9

-24%

MGIC Investment Corp.MTG0715 – Insurance (Property & Casualty)               581.9

-26%

MBIA Inc.MBI0715 – Insurance (Property & Casualty)           1,631.2

-30%

Meadowbrook Insurance Group, IMIG0715 – Insurance (Property & Casualty)               318.1

-36%

Phoenix Companies, Inc., ThePNX0709 – Insurance (Life)               156.1

-36%

Life Partners Holdings, Inc.LPHI0712 – Insurance (Miscellaneous)                 50.3

-40%

I note that the basement contains a lot of funky companies with issues.  The penthouse contains a lot of credit-sensitive companies that have rallied off of the strong equity market, and moderately strong housing market.

I do not have much trust in the momentum now, because many are trusting in the rosy scenario where losses have been normalized.  I do not think that is the case, and think that there will be additional losses from credit risk coming soon.

If you grow book value, particularly if your liabilities are short, you will grow market value.  Many reinsurance and insurance companies aim at growing fully convertible book value per share.

Fully convertible book value per share assumes that you invest your dividends in the common stock (without taxation), and thus compound your gains through reinvestment, taking account of dilution.  Hmmm… when will someone dream up the idea of structuring an insurance company as an MLP or a REIT?  I don’t think it is likely, but maybe someone could dream it up.

It also implies that all possible dilution is factored in from convertible preferred stock or convertible bonds.  Now insurance companies tend to trade near book value over the long run, so companies that can grow their book value rapidly and pay dividends can be interesting investments.  Particularly where the liabilities of the company are short — property reinsurance or personal lines insurance, growth in book value plus dividends tends to be a reliable indicator of value creation.

If liabilities are longer, it gets more questionable, because under-reserving becomes more likely — it is very hard to be certain of the reserving of long-dated or volatile coverages.

Anyway, here is a list of insurance companies, and how they have accumulated book value plus dividends over the past seven years.  Note that this is a mathematical calculation off a limited database, and that splits and M&A can throw this calculation off.  With that caveat, here is the list:

companytickersicimg_descmktcapGrowth of FCBV
Life Partners Holdings, Inc.LPHI64110712 – Insurance (Miscellaneous)

50.7

76%

Universal Insurance Holdings,UVE63310715 – Insurance (Property & Casualty)

185.2

75%

CNinsure Inc. (ADR)CISG64110712 – Insurance (Miscellaneous)

337.6

56%

Amtrust Financial Services, InAFSI63310715 – Insurance (Property & Casualty)

2,128.7

38%

Employers Holdings, Inc.EIG63310715 – Insurance (Property & Casualty)

652.6

32%

Enstar Group Ltd.ESGR63310715 – Insurance (Property & Casualty)

1,951.0

26%

Tower Group IncTWGP63310715 – Insurance (Property & Casualty)

734.8

25%

Amerisafe, Inc.AMSF63310715 – Insurance (Property & Casualty)

508.5

23%

Humana Inc.HUM63240706 – Insurance (Accident & Health)

11,297.2

21%

Allied World Assurance Co HoldAWH63310715 – Insurance (Property & Casualty)

2,856.1

21%

Arthur J. Gallagher & Co.AJG64110712 – Insurance (Miscellaneous)

4,441.2

20%

Willis Group Holdings PLCWSH64110712 – Insurance (Miscellaneous)

6,009.5

20%

China Life Insurance Company LLFC63110709 – Insurance (Life)

94,339.3

20%

ProAssurance CorporationPRA63310715 – Insurance (Property & Casualty)

2,698.5

19%

RenaissanceRe Holdings Ltd.RNR63310715 – Insurance (Property & Casualty)

3,949.8

18%

National Interstate CorporatioNATL63310715 – Insurance (Property & Casualty)

576.7

18%

Argo Group International HoldiAGII63310715 – Insurance (Property & Casualty)

910.3

17%

Brown & Brown, Inc.BRO64110712 – Insurance (Miscellaneous)

3,851.4

17%

AFLAC IncorporatedAFL63210706 – Insurance (Accident & Health)

24,134.6

16%

Endurance Specialty Holdings LENH63310715 – Insurance (Property & Casualty)

1,796.8

16%

W.R. Berkley CorporationWRB63310715 – Insurance (Property & Casualty)

5,455.7

15%

American Financial GroupAFG63310715 – Insurance (Property & Casualty)

3,772.7

15%

Horace Mann Educators CorporatHMN63310715 – Insurance (Property & Casualty)

830.9

15%

Eastern Insurance Holdings IncEIHI63110709 – Insurance (Life)

135.5

15%

Validus Holdings, Ltd.VR63310709 – Insurance (Life)

3,296.1

15%

CIGNA CorporationCI63240706 – Insurance (Accident & Health)

16,104.2

14%

Reinsurance Group of America IRGA63210706 – Insurance (Accident & Health)

4,143.2

14%

Safety Insurance Group, Inc.SAFT63310715 – Insurance (Property & Casualty)

715.6

14%

Chubb Corporation, TheCB63310715 – Insurance (Property & Casualty)

20,701.5

13%

Loews CorporationL63310715 – Insurance (Property & Casualty)

16,854.0

13%

ACE LimitedACE63510715 – Insurance (Property & Casualty)

28,285.6

13%

HCC Insurance Holdings, Inc.HCC63310715 – Insurance (Property & Casualty)

3,937.5

13%

Travelers Companies, Inc., TheTRV63310715 – Insurance (Property & Casualty)

29,108.4

13%

Coventry Health Care, Inc.CVH63240706 – Insurance (Accident & Health)

6,080.9

12%

Markel CorporationMKL63310715 – Insurance (Property & Casualty)

4,456.4

12%

Torchmark CorporationTMK63110709 – Insurance (Life)

5,103.5

12%

UnitedHealth Group Inc.UNH63240706 – Insurance (Accident & Health)

55,732.6

12%

Partnerre LtdPRE63310715 – Insurance (Property & Casualty)

5,116.2

12%

Meadowbrook Insurance Group, IMIG63310715 – Insurance (Property & Casualty)

311.6

12%

StanCorp Financial Group, Inc.SFG63210706 – Insurance (Accident & Health)

1,704.1

12%

Prudential Financial IncPRU63110709 – Insurance (Life)

26,777.4

12%

Infinity Property and CasualtyIPCC63310715 – Insurance (Property & Casualty)

688.6

12%

Assurant, Inc.AIZ63110709 – Insurance (Life)

2,935.0

12%

Greenlight Capital Re, Ltd.GLRE63310715 – Insurance (Property & Casualty)

837.4

12%

Progressive Corporation, ThePGR63310715 – Insurance (Property & Casualty)

13,738.8

11%

Protective Life Corp.PL63110709 – Insurance (Life)

2,451.0

11%

Axis Capital Holdings LimitedAXS63310715 – Insurance (Property & Casualty)

4,508.1

11%

Molina Healthcare, Inc.MOH63240706 – Insurance (Accident & Health)

1,300.1

11%

American Equity Investment LifAEL63110709 – Insurance (Life)

834.1

11%

Symetra Financial CorporationSYA63110709 – Insurance (Life)

1,578.3

11%

Aon PLCAON64110712 – Insurance (Miscellaneous)

18,199.1

10%

Mercury General CorporationMCY63310715 – Insurance (Property & Casualty)

2,169.0

10%

Everest Re Group LtdRE63310715 – Insurance (Property & Casualty)

5,843.7

10%

American Safety Insurance HoldASI63310715 – Insurance (Property & Casualty)

197.1

10%

Prudential Public Limited CompPUK63110709 – Insurance (Life)

38,071.4

10%

Aspen Insurance Holdings LimitAHL63310715 – Insurance (Property & Casualty)

2,324.9

10%

Berkshire Hathaway Inc.BRK.A63310715 – Insurance (Property & Casualty)

236,577.4

9%

EMC Insurance Group Inc.EMCI63310715 – Insurance (Property & Casualty)

326.3

9%

RLI Corp.RLI63310715 – Insurance (Property & Casualty)

1,439.1

9%

Hanover Insurance Group, Inc.,THG63310715 – Insurance (Property & Casualty)

1,781.6

9%

Unico American CorporationUNAM63310715 – Insurance (Property & Casualty)

66.6

9%

Montpelier Re Holdings Ltd.MRH63310715 – Insurance (Property & Casualty)

1,318.1

9%

Seabright Holdings IncSBX63310715 – Insurance (Property & Casualty)

249.0

9%

Alleghany CorporationY63310715 – Insurance (Property & Casualty)

5,950.7

8%

Hallmark Financial Services, IHALL63310715 – Insurance (Property & Casualty)

176.8

8%

White Mountains Insurance GrouWTM63310715 – Insurance (Property & Casualty)

3,509.0

8%

Investors Title CompanyITIC63610715 – Insurance (Property & Casualty)

139.1

8%

Marsh & McLennan Companies, InMMC64110712 – Insurance (Miscellaneous)

19,020.9

8%

FBL Financial GroupFFG63110709 – Insurance (Life)

869.4

8%

Erie Indemnity CompanyERIE63310715 – Insurance (Property & Casualty)

3,264.4

8%

Metlife IncMET63110709 – Insurance (Life)

39,615.8

8%

Aetna Inc.AET63240706 – Insurance (Accident & Health)

15,698.1

8%

WellPoint, Inc.WLP63240706 – Insurance (Accident & Health)

19,054.4

8%

Hilltop Holdings Inc.HTH63310715 – Insurance (Property & Casualty)

773.3

8%

Citizens, Inc.CIA63110709 – Insurance (Life)

485.8

7%

Donegal Group Inc.DGICA63310715 – Insurance (Property & Casualty)

370.9

7%

National Western Life InsurancNWLI63110709 – Insurance (Life)

596.1

7%

Navigators Group, Inc, TheNAVG63310715 – Insurance (Property & Casualty)

766.0

7%

Kemper CorpKMPR63310715 – Insurance (Property & Casualty)

1,842.8

7%

Allstate Corporation, TheALL63310715 – Insurance (Property & Casualty)

20,817.6

7%

Cna Financial CorpCNA63310715 – Insurance (Property & Casualty)

7,982.2

6%

Lincoln National CorporationLNC63110709 – Insurance (Life)

7,626.2

6%

Arch Capital Group Ltd.ACGL63310715 – Insurance (Property & Casualty)

6,084.7

6%

Platinum Underwriters HoldingsPTP63310715 – Insurance (Property & Casualty)

1,565.0

6%

Baldwin & Lyons, Inc.BWINB63310715 – Insurance (Property & Casualty)

339.5

5%

Selective Insurance GroupSIGI63310715 – Insurance (Property & Casualty)

1,086.8

5%

United Fire Group, Inc.UFCS63310715 – Insurance (Property & Casualty)

587.9

5%

Universal American CorporationUAM63240706 – Insurance (Accident & Health)

793.6

5%

Principal Financial Group IncPFG63210706 – Insurance (Accident & Health)

8,663.8

5%

American National Insurance CoANAT63310715 – Insurance (Property & Casualty)

2,055.2

4%

Kansas City Life Insurance CoKCLI63110709 – Insurance (Life)

416.9

4%

Cincinnati Financial CorporatiCINF63310715 – Insurance (Property & Casualty)

6,771.0

3%

Independence Holding CompanyIHC63110709 – Insurance (Life)

169.1

3%

State Auto FinancialSTFC63310715 – Insurance (Property & Casualty)

582.5

3%

Unum GroupUNM63110709 – Insurance (Life)

6,190.3

3%

Sun Life Financial Inc. (USA)SLF63110709 – Insurance (Life)

17,283.4

3%

Alterra Capital Holdings LtdALTE63310715 – Insurance (Property & Casualty)

2,861.2

3%

Assured Guaranty Ltd.AGO63510715 – Insurance (Property & Casualty)

2,911.2

3%

Fidelity National Financial InFNF63610715 – Insurance (Property & Casualty)

5,838.5

3%

Atlantic American CorporationAAME63110709 – Insurance (Life)

69.2

2%

Health Net, Inc.HNT63240706 – Insurance (Accident & Health)

2,140.7

2%

Hartford Financial Services GrHIG63310715 – Insurance (Property & Casualty)

10,641.6

2%

ING Groep N.V. (ADR)ING63110709 – Insurance (Life)

37,878.4

2%

Manulife Financial CorporationMFC63110709 – Insurance (Life)

26,357.8

2%

Genworth Financial  IncGNW63110709 – Insurance (Life)

4,500.3

2%

AEGON N.V. (ADR)AEG63110709 – Insurance (Life)

13,073.0

1%

Old Republic International CorORI63510715 – Insurance (Property & Casualty)

2,994.2

1%

OneBeacon Insurance Group, LtdOB63310715 – Insurance (Property & Casualty)

1,328.8

0%

Global Indemnity plcGBLI63310715 – Insurance (Property & Casualty)

555.8

-4%

CNO Financial Group IncCNO63110709 – Insurance (Life)

2,192.9

-5%

Crawford & CompanyCRD.B64110712 – Insurance (Miscellaneous)

326.7

-5%

Stewart Information Services CSTC63610715 – Insurance (Property & Casualty)

536.7

-9%

XL Group plcXL63310715 – Insurance (Property & Casualty)

8,182.5

-9%

Phoenix Companies, Inc., ThePNX63110709 – Insurance (Life)

155.4

-14%

First Acceptance CorporationFAC63310715 – Insurance (Property & Casualty)

51.2

-17%

Radian Group Inc.RDN63510715 – Insurance (Property & Casualty)

820.6

-23%

MBIA Inc.MBI63510715 – Insurance (Property & Casualty)

1,561.5

-24%

Kingsway Financial Services InKFS63310715 – Insurance (Property & Casualty)

53.4

-25%

MGIC Investment Corp.MTG63510715 – Insurance (Property & Casualty)

567.7

-28%

American International Group,AIG63310715 – Insurance (Property & Casualty)

51,803.5

-32%

eHealth, Inc.EHTH64110712 – Insurance (Miscellaneous)

501.2

Maiden Holdings, Ltd.MHLD63310715 – Insurance (Property & Casualty)

725.7

United Insurance Holdings CorpUIHC63310715 – Insurance (Property & Casualty)

92.7

Homeowners Choice, Inc.HCI63310715 – Insurance (Property & Casualty)

240.0

Verisk Analytics, Inc.VRSK64110712 – Insurance (Miscellaneous)

9,103.9

Primerica, Inc.PRI63110709 – Insurance (Life)

1,868.1

First American Financial CorpFAF63610715 – Insurance (Property & Casualty)

2,648.6

Imperial Holdings, Inc.IFT64110712 – Insurance (Miscellaneous)

86.3

Fortegra Financial CorpFRF64110712 – Insurance (Miscellaneous)

177.3

Now, it makes a lot of difference how dividends are set, and how buybacks are done.  Dividends should reflect a conservative estimate of how much free cash flow that a company is willing to part with.  Buybacks should only be done when it is at a discount to the intrinsic value of the firm.  If you have to distribute capital when the stock price is above fair market value, do a special dividend.

And when capital is dear, stop the buyback, maybe even reduce the dividend, or do a small secondary IPO.  When there are genuinely profitable opportunities to write business take them.

This is yet another reason why insurance stocks tend to trade near book — capital is so flexible that if capital can enter and exit easily, it should trade near book, because capital enters and exits at book, for the most part.

Ignore the extremes, but realize that companies that compound their fully converted book values can be excellent investments.

Shrinking the Share Count

This post was prompted by this post from Avondale Asset Management on how the share count from The Travelers has shrunk since 2005 (two years after their merger with The St. Paul, a company that I once worked for).  Only 57% of the shares remain.  Way to go.

Now, buying back stock is not a panacea.  It is only good when the shares are trading below or not much above fair market value.  What’s fair market value, you ask?  Well, that’s not an easy question to answer in most places, but in insurance, it means around 1.3x book value, adjusting for intangibles that have no economic significance.

Now if a company has some proprietary products, technologies or methods that give it a sustainable competitive advantage, that multiple can rise — AFLAC might be an example of that.  But sustainable competitive advantages in a mature and competitive industry like insurance are rare.  Above the 1.3x book value hurdle, it would be better to do special dividends.

Avondale was spot-on to feature The Travelers.  They are in the upper end of those that bought back shares 2005-2012.  Here’s my list:

CompanyTickerIndustry% of shares remaining since 2005
WellPoint, Inc.WLP0706 – Insurance (Accident & Health)

52%

Infinity Property and CasualtyIPCC0715 – Insurance (Property & Casualty)

56%

Travelers Companies, Inc., TheTRV0715 – Insurance (Property & Casualty)

57%

Aetna Inc.AET0706 – Insurance (Accident & Health)

58%

Employers Holdings, Inc.EIG0715 – Insurance (Property & Casualty)

59%

White Mountains Insurance GrouWTM0715 – Insurance (Property & Casualty)

60%

Torchmark CorporationTMK0709 – Insurance (Life)

61%

Assurant, Inc.AIZ0709 – Insurance (Life)

61%

Chubb Corporation, TheCB0715 – Insurance (Property & Casualty)

67%

Erie Indemnity CompanyERIE0715 – Insurance (Property & Casualty)

68%

RenaissanceRe Holdings Ltd.RNR0715 – Insurance (Property & Casualty)

69%

Endurance Specialty Holdings LENH0715 – Insurance (Property & Casualty)

69%

Loews CorporationL0715 – Insurance (Property & Casualty)

71%

Allied World Assurance Co HoldAWH0715 – Insurance (Property & Casualty)

71%

W.R. Berkley CorporationWRB0715 – Insurance (Property & Casualty)

72%

Health Net, Inc.HNT0706 – Insurance (Accident & Health)

72%

Platinum Underwriters HoldingsPTP0715 – Insurance (Property & Casualty)

72%

Allstate Corporation, TheALL0715 – Insurance (Property & Casualty)

73%

CIGNA CorporationCI0706 – Insurance (Accident & Health)

75%

UnitedHealth Group Inc.UNH0706 – Insurance (Accident & Health)

77%

Progressive Corporation, ThePGR0715 – Insurance (Property & Casualty)

78%

Montpelier Re Holdings Ltd.MRH0715 – Insurance (Property & Casualty)

78%

Verisk Analytics, Inc.VRSK0712 – Insurance (Miscellaneous)

78%

American Financial GroupAFG0715 – Insurance (Property & Casualty)

80%

StanCorp Financial Group, Inc.SFG0706 – Insurance (Accident & Health)

80%

Primerica, Inc.PRI0709 – Insurance (Life)

80%

Investors Title CompanyITIC0715 – Insurance (Property & Casualty)

81%

Hanover Insurance Group, Inc.,THG0715 – Insurance (Property & Casualty)

83%

Coventry Health Care, Inc.CVH0706 – Insurance (Accident & Health)

84%

RLI Corp.RLI0715 – Insurance (Property & Casualty)

84%

Kemper CorpKMPR0715 – Insurance (Property & Casualty)

84%

Axis Capital Holdings LimitedAXS0715 – Insurance (Property & Casualty)

85%

First Acceptance CorporationFAC0715 – Insurance (Property & Casualty)

86%

Everest Re Group LtdRE0715 – Insurance (Property & Casualty)

89%

Eastern Insurance Holdings IncEIHI0709 – Insurance (Life)

90%

Prudential Financial IncPRU0709 – Insurance (Life)

91%

Horace Mann Educators CorporatHMN0715 – Insurance (Property & Casualty)

92%

FBL Financial GroupFFG0709 – Insurance (Life)

92%

AFLAC IncorporatedAFL0706 – Insurance (Accident & Health)

93%

Cincinnati Financial CorporatiCINF0715 – Insurance (Property & Casualty)

93%

Kansas City Life Insurance CoKCLI0709 – Insurance (Life)

93%

Kingsway Financial Services InKFS0715 – Insurance (Property & Casualty)

93%

HCC Insurance Holdings, Inc.HCC0715 – Insurance (Property & Casualty)

94%

Unum GroupUNM0709 – Insurance (Life)

94%

EMC Insurance Group Inc.EMCI0715 – Insurance (Property & Casualty)

95%

eHealth, Inc.EHTH0712 – Insurance (Miscellaneous)

95%

OneBeacon Insurance Group, LtdOB0715 – Insurance (Property & Casualty)

95%

Aspen Insurance Holdings LimitAHL0715 – Insurance (Property & Casualty)

96%

Unico American CorporationUNAM0715 – Insurance (Property & Casualty)

97%

Markel CorporationMKL0715 – Insurance (Property & Casualty)

98%

Safety Insurance Group, Inc.SAFT0715 – Insurance (Property & Casualty)

98%

Humana Inc.HUM0706 – Insurance (Accident & Health)

99%

Atlantic American CorporationAAME0709 – Insurance (Life)

100%

State Auto FinancialSTFC0715 – Insurance (Property & Casualty)

100%

A.F.P Provida SA (ADR)PVD0718 – Investment Services

100%

American National Insurance CoANAT0715 – Insurance (Property & Casualty)

101%

Baldwin & Lyons, Inc.BWINB0715 – Insurance (Property & Casualty)

101%

Mercury General CorporationMCY0715 – Insurance (Property & Casualty)

101%

Marsh & McLennan Companies, InMMC0712 – Insurance (Miscellaneous)

101%

National Western Life InsurancNWLI0709 – Insurance (Life)

101%

Brown & Brown, Inc.BRO0712 – Insurance (Miscellaneous)

101%

Selective Insurance GroupSIGI0715 – Insurance (Property & Casualty)

101%

Sun Life Financial Inc. (USA)SLF0709 – Insurance (Life)

101%

Life Partners Holdings, Inc.LPHI0712 – Insurance (Miscellaneous)

101%

Aon PLCAON0712 – Insurance (Miscellaneous)

102%

ProAssurance CorporationPRA0715 – Insurance (Property & Casualty)

102%

Principal Financial Group IncPFG0706 – Insurance (Accident & Health)

102%

First American Financial CorpFAF0715 – Insurance (Property & Casualty)

102%

China Life Insurance Company LLFC0709 – Insurance (Life)

103%

Genworth Financial  IncGNW0709 – Insurance (Life)

103%

Navigators Group, Inc, TheNAVG0715 – Insurance (Property & Casualty)

104%

National Interstate CorporatioNATL0715 – Insurance (Property & Casualty)

104%

Amerisafe, Inc.AMSF0715 – Insurance (Property & Casualty)

104%

Cna Financial CorpCNA0715 – Insurance (Property & Casualty)

105%

Donegal Group Inc.DGICA0715 – Insurance (Property & Casualty)

106%

Stewart Information Services CSTC0715 – Insurance (Property & Casualty)

106%

Berkshire Hathaway Inc.BRK.A0715 – Insurance (Property & Casualty)

107%

Prudential Public Limited CompPUK0709 – Insurance (Life)

107%

Willis Group Holdings PLCWSH0712 – Insurance (Miscellaneous)

107%

Crawford & CompanyCRD.B0712 – Insurance (Miscellaneous)

111%

Old Republic International CorORI0715 – Insurance (Property & Casualty)

112%

Molina Healthcare, Inc.MOH0706 – Insurance (Accident & Health)

112%

United Fire Group, Inc.UFCS0715 – Insurance (Property & Casualty)

113%

Partnerre LtdPRE0715 – Insurance (Property & Casualty)

113%

Protective Life Corp.PL0709 – Insurance (Life)

114%

Manulife Financial CorporationMFC0709 – Insurance (Life)

114%

Independence Holding CompanyIHC0709 – Insurance (Life)

116%

ACE LimitedACE0715 – Insurance (Property & Casualty)

116%

Reinsurance Group of America IRGA0706 – Insurance (Accident & Health)

118%

Citizens, Inc.CIA0709 – Insurance (Life)

119%

Universal Insurance Holdings,UVE0715 – Insurance (Property & Casualty)

121%

Phoenix Companies, Inc., ThePNX0709 – Insurance (Life)

122%

AEGON N.V. (ADR)AEG0709 – Insurance (Life)

124%

Symetra Financial CorporationSYA0709 – Insurance (Life)

124%

Arch Capital Group Ltd.ACGL0715 – Insurance (Property & Casualty)

127%

Fidelity National Financial InFNF0715 – Insurance (Property & Casualty)

128%

Hilltop Holdings Inc.HTH0715 – Insurance (Property & Casualty)

130%

Arthur J. Gallagher & Co.AJG0712 – Insurance (Miscellaneous)

131%

ING Groep N.V. (ADR)ING0709 – Insurance (Life)

135%

Argo Group International HoldiAGII0715 – Insurance (Property & Casualty)

136%

Seabright Holdings IncSBX0715 – Insurance (Property & Casualty)

138%

Global Indemnity plcGBLI0715 – Insurance (Property & Casualty)

141%

Metlife IncMET0709 – Insurance (Life)

143%

MBIA Inc.MBI0715 – Insurance (Property & Casualty)

145%

Hartford Financial Services GrHIG0715 – Insurance (Property & Casualty)

146%

American Safety Insurance HoldASI0715 – Insurance (Property & Casualty)

150%

CNO Financial Group IncCNO0709 – Insurance (Life)

153%

Universal American CorporationUAM0706 – Insurance (Accident & Health)

153%

Radian Group Inc.RDN0715 – Insurance (Property & Casualty)

155%

American Equity Investment LifAEL0709 – Insurance (Life)

159%

Hallmark Financial Services, IHALL0715 – Insurance (Property & Casualty)

160%

Validus Holdings, Ltd.VR0709 – Insurance (Life)

160%

Lincoln National CorporationLNC0709 – Insurance (Life)

161%

Enstar Group Ltd.ESGR0715 – Insurance (Property & Casualty)

169%

Meadowbrook Insurance Group, IMIG0715 – Insurance (Property & Casualty)

172%

Greenlight Capital Re, Ltd.GLRE0715 – Insurance (Property & Casualty)

173%

Alleghany CorporationY0715 – Insurance (Property & Casualty)

191%

Tower Group IncTWGP0715 – Insurance (Property & Casualty)

196%

Alterra Capital Holdings LtdALTE0715 – Insurance (Property & Casualty)

197%

CNinsure Inc. (ADR)CISG0712 – Insurance (Miscellaneous)

208%

XL Group plcXL0715 – Insurance (Property & Casualty)

215%

MGIC Investment Corp.MTG0715 – Insurance (Property & Casualty)

220%

Amtrust Financial Services, InAFSI0715 – Insurance (Property & Casualty)

259%

Assured Guaranty Ltd.AGO0715 – Insurance (Property & Casualty)

262%

American International Group,AIG0715 – Insurance (Property & Casualty)

1265%

On the top side, and I did not see any of these, be aware of reverse splits, which can reduce the share count, are a sign of a badly run company, but do nothing for the economics of a firm, aside from keeping them listed on a major exchange.

On the bottom side, factor in large mergers paid for with shares.  Most large-scale mergers don’t work out well, so I don’t mind those companies being near the bottom of the list.

On a closing note, there is a weak positive correlation in most mature industries between stock price performance and relative decreases in share count, assets, and sales.  This sounds counter-intuitive, but good management teams know when to grow and when not to grow.  They don’t do acquisitions for scale.  They don’t grow sales if the sales growth won’t justify the cost of capital.  Building the assets of the company bigger does nothing for the bottom line; selective asset sales can free up cash for more productive uses.  Good management teams do not build empires — they add when it makes sense (grow), subtract when it makes sense (shrink), divide when it makes sense (spinoffs), and multiply when it makes sense (IPOs, JVs, new projects).

PS —  What does the WSJ have today?  An article on buybacks.  Enjoy.

Photo Credit: richard winchell  || No, don’t study the Kabbalah…

To my readers, for a little while, I am going to be doing some “best of” posts along with some smaller articles.  You should see eleven “best of” articles before this is done.  If this bugs you, just turn me off for a little while.  These articles are important, because there are some re-publishers that mine these pieces for content, and sometimes translate highlighted articles into languages other than English.

This era probably had the greatest density of “Rules” posts.  In my view, these were my best posts written between May and July 2013:

Improve Your Skills

How do you protect those whom you love and yourself from economic obsolescence?

In Defense of Concentrated Portfolios

Why it is good to have asset managers that are not closet indexers, unlike most actively managed money in the market today.

Many Will Not Retire; What About You?

Thinking about the different streams of income in society, and which might be more likely to fail.  Also, thoughts on how low interest rates fit into this picture.

On Captive Insurers

On how life insurers compromise rules on reserving using reinsurers that they own as subsidiaries.  Also examines other ways that insurers weaken solvency.

On Insurance Investing, Part 6

On Insurance Investing, Part 7 [Final]

On how insurance has changed for investors over the past ten years, Price-to-Book vs Return on Equity Diagrams, and miscellaneous issues for those investing in insurance companies.

On Long-Term Care Insurance

Really, it is not an insurable risk, which is why most companies underwriting LTC have lost money on it, and coverage has become less and less generous.

“As for those with long-term care policies, if they are old, keep paying on them, you will likely do well on them when you finally need to draw on the policies.  You have benefits that benefits that can no longer be purchased.  Enjoy the exclusive club you are in.”

On News

“In summary, all news is not equal.  The reactions to news, and the lack thereof, can tell us a lot about the intentions of large market actors.  Do your homework well, and prosper off of the knowledge that it gives you regarding reactions, over-reactions, and under-reactions.”

On Risk-Based Liquidity, and Financial Regulation

On the Designation of Systemically Important Financial Institutions

The beginning of my arguments against the pointy-headed Financial Stability Oversight Commission [FSOC] and their inability to understand the solvency of non-bank financials.

On Stock Splits

“This brings me to my conclusion: stock splits are a momentum effect, but it is larger when companies are still have a cheap valuation.”

On the Value of Writing Well

Qualitative reasoning is important.  Read a lot, and learn to write well.

Risk Control Upfront

Risk Control Upfront, Redux

All good risk management prepares in advance to avoid risk, with strategies to mitigate risk as it happens taking a distant second place.

Temporary Prosperity at the Cost of Longer-term Prosperity

It’s easier for a generation to become prosperous if they push the bills onto their children and grandchildren.  Eventually it catches up with a nation, and reduces opportunity for average people.

The Problem of Small Accounts

Is it better for small accounts to get no advice or advice that is conflicted?  It is very hard to provide quality advice to small accounts.

The Rules, Part XXXVII

The foolish do the best in a strong market

The Rules, Part XXXVIII

There is probably money to be made in analyzing the foibles of money managers, to create new strategies by taking on the opposite of what they are doing.

The Rules, Part XXXIX

The trouble with VAR and other mathematical models of risk is that if it becomes the dominant paradigm, and everyone begins to use it, it creates distortions in the market, because institutions gravitate to asset classes that the model makes to appear artificially cheap.  Then after a self-reinforcing cycle that boosts that now favored asset class to an unsupportable level, the cashflows underlying the asset can no longer support it, the market goes into reverse, and the VAR models encourage an undershoot.  The same factors that lead to buying to an unfair level also cause selling to an unfair level.

Benchmarking and risk control through VAR only work when few market participants use them.  When most people use them, it becomes like the portfolio insurance debacle of 1987.  VAR becomes pro-cyclical at that point.

The Rules, Part XL

Unions create inefficiency.  This creates an opportunity for new technologies that perform the same function, but aren’t as labor-intensive.  (E.g. integrated steel vs. mini-mills)”

The Rules, Part XLI

If businesses anticipate a flow of financing, they will depend on it.  Then a diminution or increase in the flow of investable funds will affect markets, even if the flow of investable funds remains positive or negative.

The Rules, Part XLII

During a panic, it is useful to reflect on the degree to which the real economy has been driven by the financial economy.  In the Great Depression, the degree was heavy; in the seventies, it was light.  Today, my guess is that it is in-between, which makes it difficult to figure out the right strategy.

The Rules, Part XLIII

Modify Purchasing Power Parity by adding in stocks and bonds

An optimal currency board price basket would contain both assets and goods.

The Rules, Part XLIV

Expectations are a part of the game.

The Rules, Part XLV

Market rents are typically fixed in size.  When a strategy to exploit a particular market inefficiency gets too big, returns to the rent disappear, or even go negative prospectively, even if they appear exceedingly productive retrospectively.

The Rules, Part XLVI

Speculative companies should be evaluated on cash, burn rate, probability of success, size of potential market and margins at maturity.

The Rules, Part XLVII

Crashes are the result of a shift from a positive self-reinforcing cycle to a negative self-reinforcing cycle.

The Rules, Part XLVIII

If an asset-backed security can produce a book return less than zero for reasons other than default, that asset-backed security should not be permitted as a reserve investment.

The Stock Price Matters, Regardless

Roughly one dozen ways that the stock price affects the marketing, operations and financing of publicly traded companies.

What NOT to do in Job Interviews

A somewhat humorous article of mistakes that I have made in job interviews.  Also a comment on making sure that you fit the culture of the firm at which you are interviewing.

What to Do When Things are Nuts?

So you think that the market is overvalued?  How do you adapt to that condition, while still leaving some room for opportunity if the market continues to rise.

In my view, these were my best posts written between February and April 2013:

Wall Street Hates You

I have a saying, “Don’t buy what someone wants to sell you. Buy what you have researched.”

And so I would tell everyone: don’t give brokers discretion over you accounts, and don’t let them convince you to buy unusual bonds, or obscure securities of any sort.  By unusual bonds, I mean structured notes, and eminent men like Joshua Brown and Larry Swedroe encourage the same thing: Don’t buy them.

The Education of a Mortgage Bond Manager, Part III

Why being careful with credit ratings is smart.

The Education of a Mortgage Bond Manager, Part IV

Be wary of odd asset classes; they are odd for a reason.

The Education of a Mortgage Bond Manager, Part V

Where I do odd things in order to serve my client.

The Education of a Mortgage Bond Manager, Part VI

The Education of a Mortgage Bond Manager, Part VII

The Education of a Mortgage Bond Manager, Part IX

Odd stuff, but particularly insightful into some of the perverse dynamics inside investment departments.

The Education of a Mortgage Bond Manager, Part VIII

How I led the successful effort to modify the Maryland Life Insurance Investment Law, and acted for the good of the public.

The Education of a Mortgage Bond Manager, Part X (The End)

Where I explain the odd bits of being portfolio manager, while succeeding with structured bonds amid difficult markets.

Berkshire Hathaway & Variable Annuities

I explain the good, bad, and ugly off of Berkshire Hathaway’s reinsurance deal with CIGNA.

Advice to Two Readers

Where I opine on some Sears bonds, and also on flu pandemic risk at RGA.

What I Would & Would Not Teach College Students About Finance

Mostly, I would teach them to think broadly, and realize the most of the complex investment math is easy to get wrong.

My Theory of Asset Pricing

My replacement for MPT using contingent claims theory.

On Insurance Investing, Part 4

On finding companies with conservative insurance reserving

On Insurance Investing, Part 5

On the squishy stuff, where there are no hard guidelines.

On Time Horizons

People shorten and lengthen their time horizons at the wrong time.

The Education of an Investment Risk Manager, Part IV

On two odd situations inside a life insurance company.

The Education of an Investment Risk Manager, Part V

On how we replaced a manager of managers.

Value Investing Flavors

Explains how there are many ways to do value investing.

Classic: Using Investment Advice, Part 1

Classic: Using Investment Advice, Part 2

Classic: Using Investment Advice, Part 3

Classic: Using Investment Advice, Part 4 [Tread Warily on Media Stock Tips]

Understand yourself, understand the advisor, understand the counsel that is offered, and finally, we wary of what you here through the media, including me.

Classic: Avoid the Dangers of Data-Mining, Part 1

Classic: Avoid the Dangers of Data-Mining, Part 2

There are many ways to torture the data to make it confess what you want to hear.  Avoid that.

Classic: The Fundamentals of Market Tops

Where I explain what conditions are like when market tops are near.

At the Towson University Investment Group’s International Market Summit, Part 5

Where I answer the question: Where does academic theory fail in finance and in economics?

Classic: Separating Weak Holders From the Strong

Classic: Get to Know the Holders’ Hands, Part 1

Classic: Get to Know the Holders’ Hands, Part 2

Articles that explain the fundamental  basis that underlies technical analysis.

Classic: The Long and Short of Trend Investing

How to play trends without getting skinned.

Full Disclosure: long RGA and BRK/B

I get a lot of interesting letters — here is another one:

First, let me say how much I appreciate your blog. I started my career in sellside research covering life insurers (after interning in insurance M&A). Your posts on insurance investing were invaluable in developing my understanding of the industry. My superiors did not have time to teach me the basics – I would have had a hard time getting started without your blog. 

 I’m now in equity research at a large mutual fund company, also covering insurers (and asset managers). However, I do not have an actuarial background. So I am very interested in why you think financial & mortgage insurers don’t have an actuarially sound business models. 

 And as a former life insurance analyst, I am curious what aspect of life insurance reserving you view as liberal – I’m guessing secondary guarantees on VAs? 

 Finally, to digress, do you have any views on medical malpractice insurance? I’ve been looking at PRA, and find it pretty compelling at first glance: massive excess capital, consistently conservative and profitable underwriting, and a relatively reasonable valuation. 90% of policies are claims made. There are headwinds: Obamacare, the reserve releases from mid-2000s accident years rolling off, and a diversifying business model (although PRA has historically proven competent at M&A). My only concerns are management continuing to underwrite at too low a level (currently writing at 0.32x NPW / Equity; regulators would be fine with up to 1.0x), and potentially squandering that capital. 

In the interest of full disclosure, I own no insurance stocks personally for compliance reasons.

Thanks for writing.  Let’s start with mortgage and financial insurance.  It’s not that there isn’t a good way to calculate the risk (in most cases), it is that they do not choose to use those models.  The regulators do not subscribe to contingent claims theory.  They do not look at default as an option, even if it is not efficiently exercised.  They should use those models, and assume efficient execution of default risk.

Even if they use approximations, the recent crisis should have forced reserves higher for mortgage credit, and other credit exposures.

Credit and mortgage insurers are bull market stocks.  When I was a bond manager, I sold away my few financial insurer bonds from MBIA and Ambac, and avoided the mortgage insurers.  The possibility of default was far higher than he market believed.

With respect to Life Insurers, it is secondary guarantees of all sorts, especially with variable products.  Options that have a long duration are hard to price.  Options that have a long duration, and involve significant contingencies where insureds may make choice hurting the insurer are impossible to price.

On Medmal, I have always liked PRA, but it has never been cheap enough for me to buy it.  Always thought they were the best of the pure plays.  They have survived many other companies by their clever management.  I would not begrudge them their conservatism, Medmal is volatile, and it pays to be conservative in volatile businesses.