Of the financial services companies, I tend to like insurance companies better than banks (and not only because I'm an actuary). It's darn hard to figure out what the banks have on their books. Loan-loss reserves are, to put it charitably, highly discretionary. Rosy earnings usually may turn out to be phantom earnings when the next downturn hits. You more or less have to take the bank's word that the quality of their earnings are indeed good.
Insurance companies, especially the property/casualty ones, are slightly more transparent. Their assets are usually pretty conservative stuff--investment-quality bonds--because they have to have liquid assets to pay off claims. The trick, of course, is that insurance claims are what we call "long-tail", meaning that it takes a while from the time an accident happens to actually pay off the policyholder (informing, processing, investigation, etc.) In the meantime you get to invest the premium as "float" as pocket the earnings on it. And when you leverage up your balance sheet up 10-to-1, that "float" is very lucrative.
Einstein was once asked what is the best invention of mankind, and he said compound interest. Insurance company is the closest and surest thing to a perpetual interest compounding machine. It is not as sexy as investing in a Cisco or Microsoft, but you're more unlikely to be sideswiped. Now, you may ask, what about those annoying hurricane and earthquate catastrophes (known in the industry as CAT risk)? Don't they just decimate an insurance company. That's true, which is why you should invest in huge, well-capitalized geographically diversified insurance companies. And here is the beaut: when a CAT hits, that's also the time an insurance company gets to raise rates w/o "consumer advocates" ( I call them parasites) howling. This is why when big CATs hit, the insurance companies' stock prices actually tend to rise, because investors know that's the time insurers raise rates. It is actually during tranquil times when insurance stocks tend to stagnate, because the available excess capital capacity among insurers cause them to do the good 'ol fashioned dog-eat-dog competition, which cause everybody's earnings to go down and underprice risks.
If you look at the successful investors out there, you'd notice that they all have an insurance company's as their core investment and "cash flow" machine. Warren Buffet has GEICO and Berkshire's CAT underwriting business, Leow's Laurence Tisch has CNA financial, Sandy Weill has Travelers. Of course, then there is Hank Greenberg of American International Group (AIG), who I admire greatly (and own stock in).
So what kind of insurance company should you look @? Find one that actually has consistent "underwriting profit". That means the ratio of claims and expenses to incoming premium is under 100% (called the "combined ratio"). This is an indication that the company has a competent risk underwriting staff and good marketing niche in the brutally competitive insurance business. This also means that any earnings on investment is pure gravy for the insurance company and not needed to pay claims -- this is where the magic compounding machine comes in.
I tend to like American global insurers like AIG or Travelers, but that's only because I live in the U.S. and it's easier for me to get information from them. There are other big global insurers like AXA and Zurich Re, but I am not as familiar w/ them. Just keep in mind that AIG and Travelers are pretty expensive right now. I have been eyeing for Asian insurers, but I have found that the Asian insurance market is either cartelized or gov't controlled, although that is changing w/ deregulations. One result of cartelization and gov't control is that the insurers are not as careful w/ risk management, and they load up on real estate or "flip" real estate among the cartel members. If there is one thing you don't want an insurance company to do, it is to load up on illiquid investment like real estate or junk bonds. That's why I shy away from the Asian insurers so far, but that could change w/ time.
Just some of my random thoughts. Sorry for the long-windedness. |
