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Using the Value Line Page: Using Travelers to Understand an Insurance Company part 1 - June 17, 2011
As an insurance company, Travelers’ (TRV - Free Travelers Stock Report) Value Line stock report differs from most others in The Value Line Investment Survey. The main differences reside in the Statistical Array, which has been adjusted to show the most important statistical aspects for an insurer. It is important to understand these statistics if one is to be in a good position to evaluate an insurance company and its underlying stock.
Travelers was founded in 1864 in Hartford, Connecticut. The company was formed through an off-hand transaction of only two cents. The two-cent transaction occurred on March 24th of that year, when a Hartford businessman, James Batterson, met a local banker, James Bolter, in the post office. Bolter had heard that Batterson and several townspeople were organizing a company for the purpose of introducing accident insurance to North America. Bolter said that he was on his way home for lunch and wondered how much he would charge to be insured for that trip. Batterson quoted two cents and tucked the two pennies into his vest pocket. Bolter walked the four blocks to his home without mishap.
Bolter’s two-cent “premium” is a souvenir treasured by the company Mr. Batterson founded, Travelers. The company officially began doing business on April 1, 1864 while the American Civil War was still raging. Batterson was head of Travelers for more than a third of the company’s first century, before he passed away in 1901.
The company is noted for introducing the automobile policy, airline coverage, and a policy for space travel. In the 1990s it went through a series of mergers and acquisitions. In 1993, it bought Primerica. Two years later, it was renamed The Travelers Group, and in 1996, it purchased Aetna’s property and casualty insurance business. In 1998, the Travelers Group merged with Citicorp to form Citigroup (C). However, the synergies between the banking and insurance arms did not work out as well as planned. Hence, Citigroup spun off Travelers’ Property and Casualty business into a subsidiary in 2002. (A few years later Citigroup sold Travelers’ life and annuity arm to MetLife.) In 2004, St. Paul and Travelers merged and renamed itself St. Paul Travelers, with the company headquartered in St. Paul, Minnesota. The name was subsequently changed to The Travelers Companies in 2007.
Neither Sales nor Revenues per share exist on the Statistical Array of a Property and Casualty insurance company. These figures are replaced by Premium Income, Investment Income, and Underwriting Income per share. They are shown because each is a very distinct aspect of an insurers’ business. For Travelers, P/C Premiums earned per share totaled $49.31 in 2010, Investment Income per share was $7.04, and Underwriting Income was $3.06 per share.
Premiums Earned per share is the actual dollar amount that an insurer receives from its policyholders. In other words, it’s the premium the insurer receives from its customers in order to compensate it for the risk undertaken (the insurance provided). Increases in net premiums earned are based on many factors including rate increases, new business wins, and more favorable terms and conditions.
Note, however, that the premium income earned figure takes out reinsurance fees. Insurers frequently buy reinsurance to protect themselves from losses above a certain threshold. For instance, if one were to contract for a life insurance policy in the morning and then get hit by a bus that afternoon, the insurer would be responsible to pay the entire policy to the deceased’s beneficiaries without having received any premium payments. Reinsurance helps to limit some of this risk, by shouldering some of the burden of an unprofitable contract in return for policy fees from the original underwriter. This practice reduces the profitability of contracts that reach maturity, but it is an important part of the hedging process for those that do not.
Investment Income per share is the dollar value return that an insurer receives from its investment portfolio. The return a company receives on its investments is often highly correlated to stock market returns and the availability of attractive yields on fixed-rate securities, such as bonds. It provides an indication of how well management is handling its shareholders’ money. Subscribers can find the percentage return lower in the Statistical Array in the line item Investment Income/Total Investments. For Travelers, this figure was 4.6% in 2010.
While a 4.6% return might seem unexceptional in a year when the average stock followed by Value Line advanced 24.8%, this has to be viewed in light of the market. Indeed, interest rates are at historic lows and the company’s fixed-income portfolio is $62.820 billion (this figure can be found in the Financial Position box on the Value Line report), or approximately 86% of its portfolio (the value of the company’s total portfolio can be found on the balance sheet statement). While this may seem an extremely high percentage, it is not when considering the way the insurance industry works. Travelers must be able to pay out any claims it receives from the premiums it is paid. While it may invest those premiums, doing so in anything but a conservative manner would risk the company’s solvency as it might not be able to pay claims—thus, fixed-income investments will likely be the largest percentage of any insurer’s portfolio. While this will limit potential returns, especially in times of low interest rates, it also ensures their ability to pay losses.
The next item in the Statistical Array is Underwriting Income per share. For Travelers this figure is $3.06. Underwriting income is the difference between the revenues generated by premiums and the costs of settling claims. In years with significant claims, an insurance company can lose money on the policies it underwrites. This happened to Travelers in all but one year between 1995 and 2005 (as highlighted in the footnotes, prior to 2004, the figures represent only St. Paul’s results).
Although it is clearly a negative that an insurance company would not make a profit on its underwriting activities, such an event is not uncommon at all. In fact, some companies take on riskier business (prone to higher losses) in order to boost net premiums earned, and thus increase their invested assets. For these firms, investment income is particularly important because it is their only form of income. Losses can take place across the entire industry if major catastrophic events occur, such as hurricanes and earthquakes. Note, too, that the pricing environment can also influence a company’s Underwriting Profit. When there are few catastrophic events, the cost of insurance often declines, leaving less room for the insurance companies to earn a profit on its policies at all, let alone if a major event were to take place. In this situation insurance companies may actually sell policies at levels they know will result in losses in an effort to retain market share.
This reviews only four items in a Value Line report on a Property and Casualty insurer. Next week, we will use Travelers to review several more items that are unique to insurers.
At the time of this article's writing, the authors did not have positions in any of the companies mentioned.