An Insurer on the Verge of a Turnaround

04/08/2009 1:00 pm EST


Vahan Janjigian

Editor, Bottom Line's Money Masters Stock Report

Vahan Janjigian, editor of Forbes Growth Investor, says Chubb is in good shape to survive the financial crisis and the shakeout in the insurance industry.

Chubb (NYSE: CB) is one of the largest property and casualty (PC) insurance companies in the US, yet about 25% of premiums were derived from clients in Canada, Europe, Australia, Latin America, and Asia.

Chubb Commercial Insurance (CCI) accounted for 42% of 2008 net premiums written. This group sells property, casualty, marine, multiple peril, and workers’ compensation policies that protect employers and employees.

Chubb Personal Insurance (CPI) was responsible for 32% of net premiums written. These policies primarily cover high-end homes and automobiles. CPI also offers coverage for boats, jewelry, art, antiques, and other valuables. CPI policies are tailored and offer higher liability limits than typical policies.

Chubb Specialty Insurance (CSI) accounted for 25% of net premiums written. It offers professional liability products for private and public companies. These include directors and officers’ liability insurance and errors and omissions insurance. CSI also sells surety bonds that protect parties in contractual agreements such as construction projects.

The insurance business is marked by periods of tight underwriting capacity and high rates followed by periods of excess capacity and low rates. The combined ratio (i.e., losses and expenses as a percentage of premiums) is a key measure of profitability. A lower number is better. Unfortunately, this ratio deteriorated from 82.9% in 2007 to 88.7% in 2008 as net premiums written fell 0.8% year-over-year to $11.78 billion.

Rapid deterioration in fixed income securities, particularly during the second half of 2008, took a toll on the investment portfolios of many insurance companies. Fortunately, CB had no exposure to subprime mortgages or collateralized debt obligations (CDOs). Its $38.7-billion investment portfolio was down just 3.4% for the year. Investment income in the fourth quarter declined 5.6% year over year to $391 million, and net premiums written fell 3.7% to $2.9 billion. Net income fell 35.7% to $1.8 billion, or $4.92 per share.

Demand for PC insurance tends to fall during recessionary periods, and the shrinking value of investment portfolios puts pressure on insurers’ abilities to meet potential future claims or pay dividends. PC insurers are also at risk of loss due to catastrophes.

Finally, AIG’s problems present a challenge to the industry. That troubled company has been slashing rates, pressuring profits at competitors and prompting accusations of anticompetitive practices.

Despite these risks, the cyclical downturn in insurance rates may be near a bottom. Indeed, rates have recently risen for certain policies and the decline in rates for others has slowed. Nonetheless, management is forecasting a 1% to 4% decline in premiums for 2009 with a combined ratio of 90-92%. Investment income could fall 4% to 6%.

However, results will be stronger if insurance rates rebound. CB has also been taking market share from weaker competitors. We believe the possibility of higher rates combined with a growing market share make CB an attractive buy at this time. (The stock closed around $41 Tuesday—Editor.)

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