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Using the Value Line Page: Using Travelers to Understand an Insurance Company Part 2
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. Last week, we discussed Traveler’s corporate history and Property Casualty Premiums Earned per share, Investment Income per share, Underwriting Income per share, and Investment Income/Total Investments.
Although this week won’t include a lengthy discussion of Travelers as a company, a quick review of the Business Description on the company’s stock research report provides a quick backdrop from which to start this week’s discussion.
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). The per share number at the top of the page allows subscribers to compare insurers of different sizes, but does not necessarily provide a full picture of a company’s business. This is why the absolute number is also shown lower down on the page. In Traveler’s case, Property/Casualty Premiums Earned in 2010 were $21.4 billion.
Below the absolute figure for Premiums Earned in the Statistical Array are three percentages, Loss to Premium Earned, Expense to Premium Written, and Underwriting Margin. Loss to Premium Earned is the dollar amount of losses that an insurer incurs, the claims that are filed by its customers, divided by Premiums Earned. In years without major catastrophes, this ratio provides a sense of how good the company is at selecting its customers. The lower the loss ratio (another term for Loss to Premium Earned) the better. In the case of Travelers, the 2010 figure of 61.1% was in-line with recent results, but well below the levels seen in the early 2000s.
This, however, is only one aspect of the company’s business, as an insurer has operations to support the paying of claims. Thus, Expenses to Premium Written, or expense ratio, reflects an insurance company’s general operating costs, including actuarial costs, office-related expenses, support and staff salaries, among others. Again, the lower the percentage the better, as it shows the company is operating efficiently. Of course, a number that is too low might hurt performance, as riskier accounts might slip through the cracks and safer accounts could be turned off by what they view as poor responsiveness. Interestingly, Travelers had a much lower expense ratio in the early 2000s when the company’s loss ratio was higher. More recently, the expense ratio has moved slightly higher, but the loss ratio has trended downward.
The Underwriting Margin, meanwhile, is the difference between 100% and the sum of the loss and expense ratios (the sum of these two figures is also called the combined ratio). The Underwriting Margin may be either positive (indicating an underwriting profit) or negative (indicating an underwriting loss). This figure provides an overall sense of how well a company is handling its operations. A positive number is obviously preferable.
As noted in the previous article, however, insurance companies also earn money on their portfolio of investments, so having a negative Underwriting Margin does not mean a company is losing money—it just means its insurance operations are losing money. Note that Travelers had negative Underwriting Margins between 2002 and 2005 but still had positive earnings. That said, a material catastrophe can easily push an insurance company into the red.
Another aspect of an insurance company that should be considered is Book Value. This figure is particularly important for insurers because it takes into account the insurer’s investment portfolio. Book Value per Share is provided in the Statistical Array and allows for a relevant comparison between the insurer’s price and its book value. An insurance company trading below its book value per share could be viewed as undervalued. That said, it could also be the market passing judgment on the company’s prospects, and should not be used as the sole criterion of selection.
The Statistical Array also includes the figure Price to Book Value on a year-by-year basis. A percentage above 100% indicates the shares are trading for more than book value. Although the current valuation provides a sense of what the market is valuing a company at today, it doesn’t give a sense of the historical range the market has afforded the company. The year-by-year figures provide just such a context for subscribers.
In Travelers case, Value Line’s estimate of the Book Value per Share for 2011 is $63.25. With a Recent Price, found in the Top Label section, of $61.23, the shares would appear modestly undervalued. That said, shares of Travelers traded at a premium to Book Value, as noted in the Price to Book Value row of data, until 2008. In 2009 and 2010, the shares traded below Book Value per Share. Although there are reasons for the current lesser valuation, it is also interesting to look at Value Line’s three- to five-year projections for this figure—which is 110% in the case of Travelers. So, whatever the reason for today’s malaise, Value Line expects things to improve in the future.
Clearly, there is more to consider with any investment than what has been reviewed here. Every company is unique. However, the two articles in this series should help provide a base from which to analyze property and casualty insurers using a Value Line report.
At the time of this article's writing, the authors did not have positions in any of the companies mentioned.