I despise paying insurance, a necessary evil in our modern world. However, I do think insurance companies can be a great stock market investment for long-term holding. By focusing on capital management, the insurance company aims to price risk effectively, bringing in more revenue in premiums than it spends on payouts.
Catastrophic event insurance
FTSE 250 Lancashire Holdings is a small independent insurer specialising in catastrophic events such as hurricanes, along with dedicated cover for aspects of property, marine, aviation and energy sectors.
Global warming dictates that extreme weather is likely to increase in frequency and intensity as time marches on. Insuring ageing oil rigs and natural disasters in the face of climate change may seem like tempting fate, throwing caution to the wind and taking on precisely the opposite of carefully managed exposure. However, that’s exactly what this business is set up to deal with, so in areas where natural disasters are a possibility, premiums are set accordingly and portfolios structured to ensure loss to the firm is minimal. Coverage over a range of sectors also helps diversify the risk.
It sells policies through three platforms: Lancashire, Cathedral and Kinesis, each of which provides tailored underwriting, ensuring a balance of risk and return. Through Kinesis, its reinsurance fund, Lancashire has access to investor capital in loss situations rather than relying solely on its own.
The dividend appears low at a yield of 1.7% but this is topped up annually with a ‘special’ discretionary dividend, which regularly brings it up over 6%. This strategy means that the company can return any excess capital to shareholders in a good year and maintain capital for paying out excessive claims if necessary.
Lancashire has a debt ratio of 63%, but this looks favourable to me as gross premiums written increased by 94% in the fourth quarter of 2018.
Resilience in the face of adversity
FTSE 100 company Hiscox, together with its subsidiaries, also provides insurance and reinsurance services. Over the past five years, Hiscox’s share price has steadily climbed.
The two biggest aspects of the group’s income come from big-ticket business, such as disaster cover, and smaller retail business, which is less volatile and grows between 5-15% per annum. At the end of May the company announced a new product specialising in Cybersecurity – CyberClear365 – supporting clients facing cyber challenges.
Hiscox has a higher debt ratio than Lancashire at 79%, but its PEG ratio is very low at 0.20, which is an excellent indicator of value.
It returned 11% over the past year, which outperformed the insurance industry’s -3.4%. Although this is another company with a low dividend yield at 1.95%, rumour has it that this is likely to increase considering future revenue growth rate is approximately 15%.
Insurance premiums are the bane of our lives, having to spend hard-earned cash on a ‘what if’ possibility. Nowadays we are actively encouraged to buy insurance for anything and everything: appliances, pets, natural disasters, risk of redundancy, critical illness or death. So why not jump to the other side and take advantage of the gains these insurers make?
I consider these to be two resilient companies in a volatile sector, and would contemplate adding both to a long-term portfolio.
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Kirsteen has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.