In Good Hands With Canada's Top Insurer

05/03/2011 12:32 pm EST

Focus: GLOBAL

Gavin Graham

Chief Strategy Officer, INTEGRIS Pension Management Ltd

Intact Financial has boosted dividends through thick and thin while consistently outperforming rivals, writes Gavin Graham in The Income Investor.

Intact Financial (Toronto: IFC, OTC: IFCZF) is the largest private property and casualty insurer in Canada, insuring 4.6 million individuals and businesses in Ontario, Quebec, Alberta, and Nova Scotia.

Intact is a well-managed industry leader with a good yield, and is still selling below its price five years ago. Management has demonstrated its willingness to reward shareholders by consistent dividend increases, even during downturns.

The company has a market share of approximately 11% in auto and home insurance through its Intact Insurance and Grey Power brands. It sells through brokers (77.4% of sales), its own affiliated network (9.8%), and directly via belairdirect (12.8%).

Intact wrote $4.2 billion worth of insurance in 2009, against $3.4 billion for Aviva (8.8% market share) and $2.2 billion for Co-operators (5.8%). In fiscal 2010, sales increased by 5.2%, to $4.5 billion.

About half (49.7%) of its premiums in 2009 were for personal auto insurance, followed by 23.3% for personal property insurance, 19.5% for commercial P&C insurance, and 7.5% for commercial auto.

The company is conservatively managed, with a combined ratio of costs to premiums consistently below 100% (98.7% in 2009 against 101.7% for the Canadian P&C industry and 104.8% for the top ten P&C companies).

The significance of this is that it actually made money on its insurance business. Most property-casualty insurers have a ratio above 100%, meaning that they lose money on underwriting and make it up by investment income from their portfolios.

IFC is rated A+ by A.M. Best, the insurance specialist, and A3 and A (low) by Moody's and DBRS.

Property-casualty is a notoriously cyclical business, as bad weather or a price war in auto insurance can rapidly change the profitability of the sector. I recommended selling Intact in late 2007, after it became clear that the exceptional profits the company enjoyed in the middle of the decade were falling rapidly.

The share price reflected the bad news, dropping 30% in 2006 and 2007, and bottoming out in 2009 at half its 2006 high.

No Poison Apples
But the company’s conservative investment discipline served it well. The company has minimal US or European exposure and no leveraged investments. Meanwhile, its minimum capital test ratio, which had fallen from 215.8% to 187.9% between 2005 and 2007, rebounded to 231.9% in 2009.

The upswing in the cycle appears to be continuing, making Intact an attractive buy right now for a combination of cash flow and capital gains potential.

Another 8.8% increase in its dividend was announced in March, to 37 Canadian cents per quarter (C$1.48 a year) from 34 cents, so the yield for the next 12 months will be just under 3%. Taking the latest increase into account, Intact has increased its annual payout by an average of 8.2% in recent years.

Charles Brindamour, the actuary who has been CEO for most of the last decade, forecast that Intact's return on equity would remain at least five percentage points better than the industry's 7% for 2011. He noted that the industry (but not Intact) would continue to lose money in underwriting, as improvement in claims would be offset by lower yields on investments.

The company anticipates that rate increases will continue at mid-single digits for auto insurance and at high single digits for property this year, reflecting higher medical claims in the former and increased weather damage in the latter.

NEXT: The Proof Is in the ROE

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The Proof Is in the ROE
Over the ten years to the end of 2009, Intact's premiums have grown by 8.5% per year, against 6.8% for the property-casualty industry. Its combined ratio has averaged 96%, vs. 99.8% for the industry, 3.8 points better, and its return on equity has averaged 17.4% vs. 9.9%, a 7.5 point gap.

Thanks to its disciplined underwriting, economies of scale, and superior investment performance, Intact has consistently outperformed the industry on an operating basis.

Intact's former parent company, Dutch insurer ING, placed 61% of its 70% stake with institutional investors in early 2009, to raise cash to offset its heavy losses in the financial crisis.

There are 115 million shares outstanding, giving the company a market capitalization of over $5 billion—and the stock usually trades between 100,000 to 250,000 shares per day, so liquidity is not an issue.

Intact has historically been an acquirer, with 11 acquisitions in Canada since 1998. It is reportedly eyeing the Economical Mutual Insurance Company of Waterloo, with $4.6 billion in assets and $1.1 billion in surplus capital, which is holding a vote to demutualize this month. A sizeable acquisition such as this could see Intact issuing new shares to finance the takeover.

While property-casualty insurance is cyclical, Intact and other insurers are benefiting from the upside of the cycle, and should have at least another couple of years of improving rates ahead of them. Investors willing to tolerate some volatility should buy for the sake of a good and increasing dividend.

Intact is the largest player in the field and, as the best managed, will benefit the most.

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