INDUSTRY FOCUS:
Insurance Companies
Presented by Lynn Ostrem
President, Crow River Investment Club
Assoc. Director, NAIC Mpls/St. Paul Chapter
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Class Summary
PART ONE: How Insurance Companies Work
PART TWO: Focus on Life & Health
PART THREE: Focus on Property & Casualty
PART FOUR: Working with Industry Ratios
PART FIVE: Finding Industry Resources
PART SIX: Insurance Study Candidates – The 1st Cut
BREAK
PART SEVEN: Paring Down our Choices
And Finally…
YOU GET TO CHOOSE!
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Class Materials
All class materials can be found at:
www.bivio.com/crowriver
Club Folders | Insurance Industry Study
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PART ONE
HOW INSURANCE COMPANIES WORK
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Welcome to the Wonderful World of Insurance!
●Important part of the U.S. economy
●Affects the lives of most Americans
●Maturing and saturated industry
●Understanding future drivers is key
Population is aging
Over 65 group will grow from 12% now
to 20% by the year 2030
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The Game of Risk
● The Big Insurance Bet:
You say, "I bet you $300.00 that I'll die this year."
The insurance company says "I'll bet you
$100,000.00 you don't." (I hope they win!)
● Spread the Risk
● If we know 1 in 2000 will die
● Risk is spread among 2000 families
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Risk Diversification
Risks are:
•sickness (health insurance)
•house fires (home owner's insurance)
•physical injury (disability insurance)
•car accidents (automobile insurance)
•medical mistakes (malpractice insurance)
•bizarre incidents (casualty other)
•and even re-insurance!
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How it works
● Insurers collect premiums
● Invest those premiums
● Some earn fees on services, too
An insurer’s prosperity depends largely on
its ability to quantify the ultimate cost of
claims from the risks that it assumes.
● Reserves too high – Profits appear low
● Reserves too low – Profits appear inflated
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How it works
●Premiums = Sales; #1 source of revenue
●Premium Written vs. Premiums Earned
●$1,200 for a 12 month policy (written)
●$100 for 12 months (earned)
●Investment Income; 2nd source of revenue
●Realized Investment Gains; 3rd source
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Expenses
Expense components for:
L&H Insurers
P&C Insurers
Commissions
Commissions
Benefits--Death,
Annuity, Disability,
Accident & Health, &
Surrender
Claims and ClaimsRelated Expense
Underwriting Expenses
Underwriting Expenses
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Income Statement Comparison
Industrial Company
Sales
Insurance Company
Premium (written or earned)
- Cost of Goods Sold
- Claims/Benefits (Loss Ratio)
- GS&A Expenses
- Underwriting Expenses
(Expense Ratio)
= Pre-Tax Profit
= Underwriting Profit
(Underwriting Margin)
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Ownership Structures
●Mutual Insurance Company
Owned by policyholders
Earnings belong policyholders
Distributed as dividends or reduced premiums
Solely exists for the benefit of its policyholders
Capital is Policyholder Surplus
Aren’t required to provide financial information
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Ownership Structures
●Stock Insurance Company
Owned by shareholders
Earnings belong shareholders
Distributed as dividends
Exists to make a profit for shareholders
Capital is Shareholder Equity
Financials are disclosed to the public
Can sell stock when they need capital
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Demutualization
Demutualization occurs when a mutual
company converts to a stock company
•Up Side: Access to Capital
•Down Side: Conflict of Interest
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Two Accounting Methods
●Statutory Accounting Principles (SAP)
Requires immediate expensing of all costs
Best used to gauge financial stability
Reported to policyholders & regulators
●Generally Accepted Accounting Principles
(GAAP)
Attempts to match income & expenses
Best used to determine earnings growth
Reports to everybody!
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Regulation
● Governing Body: National Assoc. of
Insurance Commissioners (NAIC)
● Serves 3 primary functions:
1. Monitor financial condition & claims paying
ability
2. Serve as watchdogs, watching for overcharges
and discrimination
3. Ensure that essential insurance coverage is
readily available for all consumers
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PART TWO
Focus on Life & Health Insurance
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Life & Health Insurance Players
Types of Insurance
●Term Life
 Predetermined Period
 No Benefits at the End
●Whole Life
Period - Life of the Insured
 Savings Component
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Life & Health Insurance Players
●1,500 L&H Insurers in the U.S. (as of 6/2004)
●Top 10 Players –
Controlled 71% of the industry’s $880.1
billion in assets
●Top 5 Players –
Controlled 52% of the industry’s assets
●Top 2 Players –
TIAA/CREF & Hartford Life controlled
37% of the industry’s assets
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PART THREE
Focus on Property & Casualty Insurance
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How the P&C Industry Works
Lines of Coverage (Per A.M. Best):
●Misc. Other
●Personal Auto Liability
●Personal Auto Physical Damage
●Homeowners Insurance
●Workers’ Comp
●Commercial Multi-Peril
●Commercial Auto
●Reinsurance
●Accident & Health
24%
22%
15%
11%
10%
7%
5%
4%
4%
100% 21
How the P&C Industry Works
Catastrophic Loss–
defined as an event or series of events that
produce $2.5 million or more in insured
losses.
●2003 – 9 catastrophes, $529 million
●2002 – 25 catastrophes, $5.9 billion
●2001 – 20 catastrophes, $28.1 billion
($9 billion for 9/11)
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How the P&C Industry Works
•10 largest write 28% of the premiums
•5 largest write 20%
•2 largest State Farm and Allstate write 14%
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How the P&C Industry Works
Based on A.M. Best, total assets of the P&C
industry were estimated at $1.1 trillion:
●Bonds accounted for
●Common stocks
●Mortgage loans & real estate
●Cash and equivalents
●Preferred stocks
67%
16%
9%
7%
1%
100%
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PART FOUR
Working with Industry Ratios
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Ratios
•Three primary factors are important to
consider when analyzing a life insurer:
•Profitability (its ability to make money),
•Liquidity (its ability to convert assets into cash
to pay policyholder obligations), and
•Leverage (the extent to which the insurer uses
its capital to produce business).
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Profitability
Return on Assets (ROA)
● Net Income / Avg. Total Assets
● Average for L&H is 0.4%-0.9%
P&C .5%-2%
Return on Equity (ROE)
● Net Income / Avg. Shareholders’ Equity
● Average for most L&H is 9%-15%
P&C 8%-18%
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Profitability
Net Investment Yield
● Net Investment Income / Average
Invested Assets
● Average L&H is 4%-10%
Average P&C is 4%-12%
Return on Revenues (ROR) (L&H Only)
● Net Income / Total Revenues
● Average for L&H is 2%-5%
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Profitability
Combined Ratio (P&C Only)
● Loss Ratio—Loss/Loss Adj. Expenses /
Earned Premiums (+)
● Expense Ratio—Other Underwriting
Expenses / Written Premiums (+)
● Dividend Ratio—Policyholders’
dividends / Earned Premiums (=)
Combined Ratio!
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Profitability
Combined Ratio (P&C Only)
● 100% is break-even
● <100% - indicates a profit
● >100% - indicates a loss
1952 to 1998 – industry earned a profit in
15 out of 47 years!
1H 2003 was 99.8% (first time since 1978)
1H 2002 was 105.1%
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Liquidity
Positive Cash Flow
Current Ratio
● Total Liabilities / Total Assets
Financial Strength
● See Value Line’s Financial Strength
Rating (bottom right corner)
● See S&P Stock Report Investability
Quotient Percentile
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Leverage
Reserve Account
Minimum
Surplus
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Drilling Down
Other Considerations for All Insurers:
● The Profitability of Underwriting
The Rate of Premium Growth
Reinsurance
Allocation Strategy
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PART FIVE
Finding Industry Resources
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Finding Industry Information Resources
● S&P Industry Surveys/Reference Section
● Mergent’s Industry Reports
● Value Line’s Industry Page
● S&P Stock Report Sub-Industry Page
● Google Search
● Company Annual Reports/10K
● Searching NAIC Website
● Crow River Website/Research Section
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Finding Stocks for your Industry Study
● Primary—
S&P Industry Surveys
Value Line
Toolkit’s OPS Industry Feature
● Secondary-Yahoo, MSN, Quicken, etc.
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Deciding on the Data for your Study
● Primary—
Company Financial Statements
S&P Stock Report
S&P Compustat Data Files (OPS)
Value Line Survey Page
Combination
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PART SIX
Insurance Stock Candidates
The 1st Cut
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S&P Industry Surveys
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AFL
AMH
DFG
L&H
LNC
MET
PL
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PRU
SFG
TMK
L&H
UCI
UNM
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AFC
AFG
AIG
HIG
Multi Line
HCC
HMN
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LTR
UTR
Multi Line
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ACE
ALL
ABK
P&C
BER
CB
CINF
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FNF
FAF
LFG
P&C
MBI
OCAS
ORI
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PHLY
PGR
RLI
P&C
SAFC
SIGI
STC
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XL
ZNT
P&C
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RE
Reinsurance 
AJG
AOC
BRO
Brokers
HRH
MMC
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AFL
MET
That leaves us
with these
L&H stocks…
PL
SFG
TMK
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Only MultiLine stock…
AIG
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ABK
MBI
PHLY
RLI
These P&C
stocks…
ORI
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BRO
AJG
HRH
MMC
And, these
Broker
stocks…
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BREAK TIME!
Please be back in your seat in
15 minutes
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PART SEVEN
Paring Down our Choices
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Our Check List:
1.Create Industry Ratio Worksheet (SCG) for
side by side comparison of peers.
2.Review SSGs for quality and growth
3. Replace Assets for Sales & review long-term
growth rate, R2, and Section 2B (ROA%Sales)
4.Create summary of past growth and future
estimates and use it to complete the SSGs
5.Complete Stock Comparison Guides
6.Choose best candidate(s)
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Wrapping Up
Remember, your judgments are PRELIMINARY!
Next step…Order an Investor’s Packet
on your stock of choice
Now the REAL work begins!
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QUESTIONS?
All Information in this seminar is available at:
www.bivio.com/crowriver
Club Folders – Insurance Industry Study
Reach Lynn at: garbagecop@foxinternet.net
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