How To Buy Stock In Insurance Companies

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How To Buy Stock In Insurance Companies

Insurance firms provide items that most of us need while also taking on numerous dangers that we do not want. Insurance firms are sometimes seen as large, uninteresting financial corporations, although they are in the business of protecting people from financial loss and risk management.

Key Takeaways

  • Until recently, most insurance businesses were formed as mutuals, with policyholders rather than external investors owning them.
  • Demutualization is the process of transforming mutual funds into stock corporations, which are presently traded on major stock markets.
  • When it comes to investing in insurance companies, there are significant distinctions between the business structures of life and health insurers and property causality insurers.

Demutualization of the Insurance Industry

Historically, insurance businesses were established as mutual companies that were owned by policyholders and managed only for their benefit. Stock firms, on the other hand, are owned by shareholders and endeavor to maximize shareholder returns. Many mutual firms have changed to stock corporations in recent years, a process known as demutualization. Because mutual firms can not issue public shares, only stock corporations may be traded on the stock exchange.

Insurance firms provide policies that guarantee a benefit to the policyholder if a covered event happens during the policy’s term. The insured’s death is a covered occurrence under life insurance. A house fire, storm damage, or theft might all be covered by homeowners insurance.

The policyholder pays the insurer premiums in return for insurance coverage, which are invested to produce a profit for the firm until they are required to pay out claims.

Investing in Insurance Companies

Insurance firms have particular challenges that distinguish them from other financial organizations such as banks or lenders.

Every insurance company has a set of future obligations that they must pay out if a qualifying event occurs. As a consequence, they must invest premiums collected prudently in order to maintain a ready reserve of liquid assets to pay out claims. Asset-liability management (ALM) is used by insurance company portfolio managers to match assets to liabilities, as opposed to asset-only management, which seeks to optimize return while limiting portfolio risk.

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As a result, insurance company portfolios are predominantly comprised of fixed-income instruments such as high-quality bonds issued by the US government or AAA-rated bonds issued by significant firms.

Outside of the health industry, there are two sorts of insurance companies: life insurance and property and casualty insurance. Each has unique implications that investors should bear in mind.

Life Insurance Companies

When analyzing life insurance firms, keep in mind that government regulations require them to keep an asset valuation reserve (AVR) as a buffer against significant losses in portfolio value or investment income. As a result, these businesses have less financial leverage at work than other types of financial organizations. This raises the possibility of valuation issues since it suggests that insurers value assets at market value but liabilities at book value.

Actuarial science has created mortality tables that are quite good at predicting when life insurance claims will become payable when policyholders die. Because life insurance policies are provided with specified death benefits that do not change for inflation, the magnitude of such obligations is also known in advance. Because the quantity and time of obligations are pretty well understood, these firms strive to invest in portfolios that match the size and duration of those liabilities. The surplus is the amount of extra return, or the amount by which assets surpass obligations. The primary goals of life insurance portfolios are to maximize surplus value and to maintain stability. Because life insurance policies often do not pay a payout for many years, these businesses’ investment portfolios typically consist of high-quality bonds with maturities several years in the future.

Life insurance businesses must also consider disintermediation risk when policyholders remove cash value (or take loans against that cash value) from permanent policies, producing an increase in the portfolio’s need for liquidity. This is more common during times of high interest rates. At the same time, high interest rates cause insurers’ portfolios to shrink since they are mostly invested in bonds, and bond values fall when interest rates rise. During times of high interest rates, this combination of characteristics may contribute to higher volatility of returns and increased risk.

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MetLife (MET), Prudential (PRU), Genworth Financial (GNW), Lincoln National (LNC), AXA (AXAHY:OTC), and Aegon are among the major publicly traded life insurance firms (AEG).

Investing in Property & Casualty Companies

Property and casualty firms must also manage their assets and liabilities, but their risk exposures differ from those of life insurers in many ways. While the product offers are more diversified – house, vehicle, motorcycle, boat, liability, umbrella, flood, and so on – the periods of these liabilities are considerably shorter: a year or less per policy. As a result, these organizations’ investment portfolios will often consist of high-quality bonds with maturities ranging from a few months to a year.

Furthermore, claims might take a long time to settle and pay out. The claims procedure may be controversial, and it may take years of litigation before the claim is paid – if at all.

Many non-life insurance plans are also subject to inflation risk, since they guarantee to completely replace the value of an item even if that item is nominally more costly in the future owing to inflation. The time and quantity of liabilities are both more unclear than in life businesses.

Property and casualty insurance businesses also go through an underwriting cycle, which normally lasts 3-5 years. Prices on policies are cut during periods of high corporate rivalry in order to retain business and grab market share (think of all the advertisements claiming to lower the cost of your car insurance).Frequently, the values of securities in an insurance company’s portfolio fall below sustainable levels, resulting in losses when policy claims are paid out. To augment cash flow, the corporation must dispose portfolio assets, which may cause share values to fall. Insurers are obliged to boost policy premiums, and profitability starts to rise again, paving the way for fresh competition. As a consequence, property casualty insurance firms would often invest in taxable bonds during times of loss and move to non-taxable bonds, such as municipal bonds, during periods of profit.

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Allstate (ALL), Progressive (PGR), Berkshire Hathaway (which owns Geico and a number of other insurance firms), Travelers (TRV), and Zurich are some of the major property and casualty insurance businesses listed on stock exchanges where investors may acquire shares (ZURVY:OTC).

Several ETFs are now available to provide investors with a broader view of the insurance business, including the SPDR S&P Insurance ETF (KIE), the Invesco KBW Property & Casualty Insurance ETF (KBWP), and the iShares U.S. Insurance ETF (IAK).

The Bottom Line

Knowing the unique conditions under which insurance businesses operate helps in determining if a publicly traded insurance company is a suitable investment and whether the economic climate is favorable to success for these firms.

High interest rate settings may be harmful to life insurance firms due to the danger of disintermediation. The ebbs and flows of the profitability cycle affect property and casualty insurance firms. Recognizing when the economics of these businesses change may result in appropriate purchase or sell recommendations. Keeping in mind the length and maturities of the bonds in the portfolios of various types of insurance firms may also assist estimate how interest rate changes will affect each.

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