Why insurance companies should be part of your portfolio

Why insurance companies should be part of your portfolio

It’s no secret that stocks have gotten beaten up over the past few months. Over the past year, the S&P 500 is down 3.2% and down 15.3% year to date.

Investors have shown concerns about inflationary pressures in the economy, and the Federal Reserve is raising interest rates to address those concerns. Growth stocks have taken the biggest hit, with the Vanguard Growth ETF down 10.6% in the last year.

One area of the stock market that has held up during the sell-off is value stocks. Specifically, companies that generate strong cash flow have held up well. One stock with strong cash flows and a cheap valuation is Chubb (NYSE: CB). The international insurance company has seen its stock gain 23.1% over the past year despite the market’s broader sell-off.

Insurance companies can make stellar long-term investments — just ask famed investor Warren Buffett. Buffett has often talked about his love of the insurance industry , which began when he purchased insurer National Indemnity 55 years ago. Since then, Buffett has incorporated several insurance companies into the Berkshire Hathaway conglomerate, like GEICO, General Re, and Berkshire Hathaway Reinsurance.

Buffett likes investing in insurance companies because of the business’s cash flow. Insurance companies make their sales upfront, collecting your premium payment at the beginning of your policy period. After filing a claim, the company will have to dish out cash to resolve the claim.

Because insurers collect premiums upfront and pay claims later, they sit on a mound of cash, also known as a float, that is unused until claims are paid out. The best insurance companies are great risk managers and consistently take in more premiums than they pay out. Chubb is one of the best at what it does

Chubb is one of the world’s largest property and casualty insurance companies. The company writes a range of policies, from commercial lines of coverage like workers’ compensation to personal lines like auto and homeowners insurance.

Last year, Chubb earned $36.3 billion in net premiums and posted a stellar net income of $8.5 billion. Chubb’s stellar performance continued during the first quarter, as the insurer brought in $8.7 billion in premiums, up 6.4% from last year. Net income dropped from $2.3 billion last year to under $2 billion, but that was due to investment gains that were $780 million lower than the year before.

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The company has done a stellar job of balancing risk to reward on the policies it writes. To measure risk, insurance companies will use a metric called the combined ratio. The combined ratio is the ratio of losses plus expenses to the total earned premiums. A ratio below 100% is desirable because it means the insurer is collecting more premiums than it’s paying out in claims and expenses, and the lower the ratio, the more profitable its policies are.

Last year, Chubb’s combined ratio was 89.1% and an even better 84.3% in the first quarter. Chubb has done a stellar job of underwriting policies for years now. From 2002 through 2020, Chubb achieved an average combined ratio of 91.8%, well below the industry average of 99.7% during that same time. Chubb has increased dividends for 28 years straight

Chubb’s strong underwriting ability has put it in a strong capital position and is why the company has achieved Dividend Aristocrat status, a title given to S&P 500 companies that have increased dividend payouts annually for 25 years or more. Over the past 12 months, Chubb has raked in $11.5 billion in free cash flow and paid out $1.4 billion in dividends.

The company trades at a meager price-to-earnings ratio of 11 — near its lowest valuation over the past decade.

Chubb is a great company trading at a cheap valuation and is in an industry that can continue to perform in this uncertain market environment — making it a solid stock to include as part of your diversified investment portfolio.


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