Warren Buffett has become one of the world’s most successful investors by learning to recognize value. And insurance is one of the industries that the Oracle of Omaha has consistently turned to in search of that value. While Buffett’s Berkshire Hathaway has made headlines recently for its large purchases of railroad Burlington Northern Santa Fe and chemical maker Lubrizol, insurance is still at the heart of the conglomerate. In his latest letter to shareholders, Buffett called it “Berkshire’s core operation and the engine that has propelled our expansion over the years.”
Berkshire’s insurance companies include GEICO (auto insurance), Berkshire Hathaway Group (annuities), Berkshire Hathaway Homestate Companies (workers comp and commercial auto and property insurance), Central States Indemnity Company (specialty insurance), Gateway Underwriters Agency (property and casualty, specialty and professional and personal insurance), General Re (reinsurance), Medical Protective (medical malpractice insurance), National Indemnity Company (property and casualty insurance) and United States Liability Insurance Group (small business underwriting).
Buffett has focused on insurance with good reason. As he wrote in his latest letter to Berkshire Hathaway shareholders, “Our insurance operations continued their delivery of costless capital that funds a myriad of other opportunities. This business produces ‘float'—money that doesn’t belong to us, but that we get to invest for Berkshire’s benefit. And if we pay out less in losses and expenses than we receive in premiums, we additionally earn an underwriting profit, meaning the float costs us less than nothing. Though we are sure to have underwriting losses from time to time, we’ve now had nine consecutive years of underwriting profits, totaling about $17 billion. Over the same nine years our float increased from $41 billion to its current record of $70 billion. Insurance has been good to us.”
Not all insurance companies are managed so well. But their access to “costless capital” is nearly unique among businesses, and gives them the potential to be incredible investments.
You could just buy Berkshire Hathaway (BRK.B). You could certainly do worse than trusting your money to Buffett. But there are other opportunities in the insurance industry as well, including many that pay very nice dividends.
One of the most popular with income investors is Aflac (AFL), with a 3.3% current yield. Aflac was recently recommended by Steven Check in The Blue Chip Investor. He wrote:
“Aflac is one of the most successful insurance companies in the world. Management concentrates only on profitable niche segments and manages the firm’s capital structure with great care. Over 75% of Aflac’s sales and operating profits derive from activities in Japan, where it provides supplemental health, cancer and life insurance. Indemnity medical insurance in America makes up the remainder of Aflac’s business. Aflac’s policy-renewal rate is well over 90%, exceeding that of almost all other insurers.
“Since the financial crisis, Aflac has worked to lower its investment-portfolio risks. This risk reduction produced substantial losses but is now essentially complete.
“Due to the size of its Japanese operations, the firm’s performance is very sensitive to foreign-exchange fluctuations, and recent results have benefitted from the strength of the yen. Q1 revenues rose 22% to $6.24 billion, while operating earnings per share (EPS) grew 7% to $1.74. Full-year EPS are likely to approach $6.50. Aflac will resume buying back shares in Q4. The stock now yields over 3%.”
Check recommends buying AFL under $50.
On the (much) smaller side is a company recommended in the latest Dividend Digest by Jim Oberweis, editor of The Oberweis Report. He wrote:
“Homeowners Choice, Inc. (HCII) is a Florida-based property and casualty insurance holding company. The company began operations in 2007 when it began participating in Florida’s ‘take-out program’ aimed at reducing the state’s risk exposure by encouraging private companies to assume policies from Citizens Property Insurance Corp. Since their inception, the large pool of policies held by Citizens and the volume of policies the company has been able to assume with each Citizens transaction have allowed Homeowners Choice to grow significantly.
“Recent growth in written premiums was driven by insurance policies acquired from HomeWise Insurance in November of 2011, which doubled the company’s policy count to approximately 120,000. These assumptions have contributed to immediate premium growth as well as cost efficiencies by minimizing or reducing marketing and policy acquisition costs.
“The company is looking to expand geographically outside of Florida, possibly into Alabama, either by obtaining an insurance license or via acquisition. ... In the company’s latest reported fourth quarter, sales increased approximately 115%, to $36.9 million, from $17.1 million in the fourth quarter of last year. Homeowners Choice reported earnings per share of $0.62 in the latest-reported fourth quarter, versus $0.27 in the same quarter of last year. ... Buy.”
Despite being small, HCII currently yields a nice 5.9%.
Finally, in the April 11 Dividend Digest, Argus analyst John Eade recommended The Allstate Corporation (ALL), which currently yields 2.6%. Allstate provides property, liability, auto, life and other insurance. Eade wrote:
“We are upgrading Allstate to BUY from HOLD and setting a target price of $36. The company’s balance sheet remains strong, and valuation multiples are below both historical and peer group averages. After several quarters of uneven earnings, results appear to be more consistent, as management has focused on profitability instead of growth. Management has also toned down its formerly combative approach with the Street, and has now launched a second share buyback program. ... The shares remain more than 50% from their all-time high of $65, which was established in late 2006.”
Income investors looking to copy Warren Buffett’s success would do well to consider one or more of these “costless capital” generators.
Wishing you success in your investing and beyond,
Chloe Lutts
Editor of Investment of the Week
