Insurance stocks can make a valuable contribution to your dividend portfolio. Unlike banks, insurance companies tend to be less cyclical, as the demand for insurance is generally stable over the business cycle. This stable demand base and the less risky investment strategy employed by them allows them to generate relatively stable patterns of earnings, which in turn enables them to make consistent dividend payments.
We will look, in particular, at three general insurance companies, because of their attractive dividend yields and relatively low P/E valuations. The low valuations attached to these companies partly reflects the uncertainty surrounding the impact of Solvency II on their capital ratios, which could affect their dividend payouts. Difficult market conditions is another factor, as premiums remain low because of aggressive competition and as customer retention falls. Although competition is expected to remain fierce, there are some signs of a bottoming in the market, particularly in UK motor, as some insurance companies are looking to withdraw capacity from the market.
Direct Line Group
Direct Line (LSE: DLG) has a regular dividend yield of 4.0%, based on its regular dividend of 13.2 pence per share paid in 2014. But with the cash proceeds of £430.5 million from the sale of its international division, Direct Line does appear to be holding excess capital. This could mean the group could quite likely make further special dividend payments. It had made two special dividends in 2014, totalling 14 pence per share. Direct Line trades at a forward P/E ratio of 12.1.
Despite having two very well-known brands, including Direct Line and Churchill, the group has seen its market share fall in its motor and home insurance markets. But as the insurer ceded market share to its competitors, its profitability had improved significantly. This was also helped by its cost-cutting programme, with expenses falling faster than the net reduction in premiums. Its combined ratio, a measure of underwriting profitability, rose 0.2 percentage points to 95.0% for 2014. This follows a 2.6 percentage point improvement in the previous year. A combined ratio of below 100% represents an underwriting profit. Management expects the combined ratio, absent from major weather events, would lie between 94% and 96% in 2015.
Amlin (LSE: AML), unlike the other two insurers, focuses on commercial and speciality lines of insurance. Similar to home and personal motor insurance markets, pricing has come under pressure, with average rates falling. However, underwriting profitability is generally stronger, because of the more complex nature of risks insured. Amlin produced a combined ratio of 89% in 2014, having worsened from 86% in 2013. The insurer paid a regular dividend of 27.0 pence per share in 2014, which represents a dividend yield of 5.6%. Amlin trades at a forward P/E ratio of 11.6, and has a forward dividend yield of 5.9%. Its dividend cover for 2015 is estimated to be 1.46x.
esure Group (LSE: ESUR), with a market capitalisation of £1.02 billion, is the smallest of the three. Similar to Direct Line, esure focuses on motor and home insurance markets. esure’s combined ratio worsened by 2.5 percentage points to 92.4% in 2014, as the cost of claims rose. Although earnings per share is expected to fall by 4.5% in 2015, the earnings decline is modest and temporary. Its valuation is attractive though, especially with the prospect of premium rate increases in the UK motor market. The insurer’s forward P/E ratio is 12.8, and has a forward dividend yield of 6.4%. Dividend cover is expected to fall to 1.21x, from 1.29x in 2014.
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Jack Tang has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.