Taking stock: what insurers do right to keep the investment market interested in their common stock.

Insurance might be viewed as a somewhat stodgy industry--if you measure it in terms of how often it's the hot topic at cocktail parties.

Insurance company stock, on the other hand, may not exactly be winning headlines, but is a popular investment, especially among investors who've taken the rime to understand it.

Who Buys Insurance Stock

Investing legend Peter Lynch--the manager of Fidelity Magellan, which returned 29% per year for 13 years under his leadership--looked for companies in industries that are "mildly distasteful," said Bill Mann, a senior analyst with Motley Fool Hidden Gems. "Most people, when they think about insurance itself, think of it as a necessary evil. Not the happiest thought for your readers, but there's a lot of truth to that."

But insurance is something that everyone uses and consumes, even if it's not as "sexy" as Pepsi or Starbucks coffee.

Mann said when he and Motley Fool cofounder Tom Gardner both independently picked insurance companies as recommendations for their Hidden Gems newsletter (Mann picked Montpelier Re and Gardener had chosen United Fire & Casualty), their readers reacted with surprise.

"They said 'we can't believe that you both came up with insurance companies. They're not as exciting as something we could find for ourselves,'" Mann recalled. "One of the reasons I'm interested in insurance companies is the long-term superior return on capital. It's not necessarily a story that the average investor is going to be able to grasp, but some will."

Most investors in insurance stocks are institutional investors, said Ann Northrop, senior insurance analyst at Zacks Investment Research, an independent research company based in Chicago. "I think it would be difficult for the average retail investor to purchase an insurance stock and really know exactly what they are buying, unless they have been buying the stock for years," Northrop said.

U.S. institutional investors-including pensions, investment companies, insurers, banks and trusts, and foundations--own about $7.974 trillion in equities or 59.2% of outstanding equities in the United States, up from $6.6 trillion or 51.8% of equities in 2000, according to the Conference Board's Institutional Investment Report 2005.

Institutional investors as a group also are gaining even greater equity control over the largest 1,000 corporations. By 2004, they controlled 69.4% of these corporations, up from 61.4% in 2000.

For individuals interested in buying insurance stock, Northrop recommends that they specialize in either property/casualty or life insurance stock. "They are very different animals, and very difficult to understand. Certain P/C companies are clearly more volatile than others," she said.

Insurance is a relatively complex industry, which may drive some would-be investors away, said Adam Klauber, director of research for Cochran, Caronia & Co., an investment banking firm. "But from a retail investment perspective, the industry has relatively good dividend yields, which has historically been a significant motivation for investors."

Complex Industry, Smart Investors

Part of the challenge of investing in insurers is trying to understand the industry's accounting.

"You don't really know as an outsider if they've accurately priced a policy until months or even years later," Northrop said. "But you tan look at the reserve additions or releases, and it can tell you how they reserved in the past."

A company that's repeatedly had to beef up reserves might not be a wise investment, she said.

"If they have a history of under-reserving, we'll tend to shy away from them," Northrop said.

Insurance stocks trade at a discount compared to the Standard & Poor's 500 or other financial sectors. That's because of the high level of uncertainty related to insurance, especially property/casualty insurance.

"Insurance is an area where investors can make better than average returns, both in the near term and long term. That's a result of the insurance sector being seen as more volatile," Klauber said. "Insurance may be more volatile than other financial sectors, but if you can get the stock at the right price, you can make outsized financial returns compared to other financials. Where there's higher returns, there's also higher risk."

It's that volatility that can lead to outstanding returns, said Mann.

"Look over a 10-year period. Insurance returns on capital have been higher than any other industry. There's a reason that Warren Buffett has been attracted to insurers as an investment. One of the real idiomatic statements about Wall Street is that it hates uncertainty. And what is it that insurance companies buy? They buy uncertainty," Mann said.

Investors had a bitter taste of that volatility this year, when Hurricane Katrina hit, causing an estimated $40 billion in insured losses.

But while many P/C companies saw their stock price drop immediately after the storm hit, most stocks quickly rebounded, even as insured losses were still being totalled.

Insurers also have been well received when they tapped the market to raise new capital after Katrina. As of Oct. 11, insurers had announced plans to raise $5.31 billion in new capital, 81% of that as common stock, according to the Insurance Information Institute.

It's an interesting phenomena," Klauber said. "Given the magnitude of the loss, the risk-bearing stocks did relatively well. Most investors are assuming you'll have an upside: a better pricing environment. They want to bang on to their stock, or even buy more. It's a sign of sophisticated investors who did not panic and sell."

It's also a sign that insurers are doing a good job of getting their message across to investors.

Improving Investor Relations

Insurers seem to be making a concerted effort to reach out to investors and make their financial results more transparent.

"Many large insurers are providing supplemental earnings information to make it easier to find out what's going on in their market," Northrop said.

For instance, Progressive provides monthly earnings reports. Allianz lets investors receive share price and investor news on their mobile phones, BlackBerry devices or PDAs.

While the emphasis is on equity stocks, investors in debt offerings are important to insurers, too.

Liberty Mutual, a mutual company, has no stock, but issues quarterly earnings and established an investment relations department to field questions from investors who buy its debt offerings.

Mike Oakes, treasurer of James River Group, which recently raised $92 million in an initial public offering, said the company had a typical IPO: its executives talked to mostly institutional investors about buying the stock, and worked to make sure the investors were well informed about the Richmond, Va.-based excess & surplus lines writer.

"In our case, we thought out offering went well," Oakes said. "Insurance tan be volatile, but the market understands insurance."

Markel Corp., a niche property/casualty writer, aims to attract long-term, committed investors. Following in the footsteps of investing legend Warren Buffett, head of Berkshire Hathaway, Markel doesn't split its stock, which currently trades at more than $300 a share.

"We are as niche marketed in out investor relations as we are in out investment business and insurance business. We don't go with the herd," said Bruce Kay, vice president of investor relations for Markel.

"We work really hard to identify a shareholder base that we think will come to meet us, be our long-term business partners, and listen to what it is we were trying to do. Every time a Katrina or Hurricane Andrew or earthquake hits, we want them to call us and not just sell because there's bad news in a headline," Kay said.

Kay admits that like all insurers, Markel's quarterly earnings may not always shine.

"But even though it's a bumpy ride, it's a ride where we take advantage of the marketplace, and we strive to achieve long-term superior growth," Kay said.

Kay said he tries to talk with institutional investors in Markel several times a year. He estimated about 70% of the stock is owned by institutions, and the remaining 30% is owned by individuals with an interest in Markel, including employees, directors and officers, and their families.

"What you don't want is these guys to dump your stock when they sec some sensational headline in the newspaper. You want them to be knowledgeable about your business plan and your ability to execute it," Kay said.

Markel so admires Buffett that it holds an annual brunch for investors and interested potential investors following Berkshire Hathaway's annual meeting. "One of the secrets of success at Markel is developing long-term relationships, with out customers, out distribution partners, our reinsurers and our shareholders. Trading in and out of the stock isn't a long-term partnership," Kay said.

Northrop, of Zacks, said it's ingenious of Markel to piggyback on Berkshire's shareholder meeting, which is annually attended by thousands eager to hear the investing wisdom from the "Oracle of Omaha."

"It gives them attention that they wouldn't otherwise get," Northrop said.

Insurers as Mutual Funds

Insurers themselves are institutional investors, and control a hefty share of the U.S. equity markets.

Looking at the mix of institutional investors, pension funds owned 40.7% of total U.S. equity assets in 2003; investment companies, 22%; insurance companies, 23.3%; bank and trust companies, 11.7%; and foundations, 2.4%. These percentages represent a change in the mix during the past 25 years as investment companies and mutual funds have grown the fastest--2.6% of assets in 1980 to 22% in 2003--followed by pension funds--32.6% in 1980 to 40.7% in 2003. At the same time, bank and trust companies have declined substantially--38.8% of total assets in 1980 to 11.7% in 2003, according to the Conference Board.

It might be counterintuitive, but insurers often buy the stock of other insurers, as an investment. For instance, Markel owns Berkshire Hathaway shares.

In some ways, insurance companies are financial intermediaries, not unlike mutual funds, Kay said.

"Insurance is the business that generates the money that you tan invest," Kay said. "Once you underwrite profitably, the issue is how to maximize the investment returns. Markel is really a mutual fund. What you are buying [when you buy Markel stock] is an investment portfolio of stocks and bonds that are funded by the policyholders."

Key Points

* Property/casualty insurers outperformed the New York Stock Exchange Composite Index year to date despite Hurricanes Katrina and Rita.

* Insurers have announced that $5.3 billion in new capital will be raised, 81% through common stock.

* Insurers themselves invest in other insurers, and own about 23.3% of all U.S. equity assets.

Learn More

Markel Corp. Group A.M. Best Company # 19746 Distribution: Brokers, Direct James River Insurance Co. A.M. Best Company # 12607 Distribution: Brokers

For ratings and other financial strength information about these companies, visit www.ambest.com.

Top 20 Stocks in Best's Composite Insurance Index,
Ranked by Market Capitalization

As of Sept. 30, 2005
($ Billions)

Rank   Company                             Exchange

   1   American International Group Inc    NYSE
   2   Berkshire Hathaway Inc              NYSE
   3   UnitedHealth Group Inc              NYSE
   4   WeIIPoint Inc                       NYSE
   5   Manulife Financial Corp.            NYSE
   6   Allstate Corp.                      NYSE
   7   Prudential Financial Inc            NYSE
   8   St Paul Travelers Companies Inc     NYSE
   9   Aetna Inc                           NYSE
  10   Hartford Financial Services Group   NYSE
  11   AFLAC Inc                           NYSE
  12   MetLife Inc                         NYSE
  13   Sun Life Financial Inc              NYSE
  14   Progressive Corp.                   NYSE
  15   Chubb Corp.                         NYSE
  16   Marsh & McLennan Cos.               NYSE
  17   Cigna Corp.                         NYSE
  18   Ace Limited                         NYSE
  19   Principal Financial Group Inc       NYSE
  20   Genworth Financial Inc              NYSE

                                                      Mkt Cap *
Rank   Company                             Ticker    $ Billions

   1   American International Group Inc    AIG           140.13
   2   Berkshire Hathaway Inc              BRK           126.28
   3   UnitedHealth Group Inc              UNH            70.99
   4   WellPoint Inc                       WLP            46.52
   5   Manulife Financial Corp.            MFC            42.54
   6   Allstate Corp.                      ALL            36.31
   7   Prudential Financial Inc            PRU            35.13
   8   St Paul Travelers Companies Inc     STA            30.31
   9   Aetna Inc                           AET            24.98
  10   Hartford Financial Services Group   HIG            23.11
  11   AFLAC Inc                           AFL            22.73
  12   MetLife Inc                         MET            22.21
  13   Sun Life Financial Inc              SLF            21.91
  14   Progressive Corp.                   PGR            18.89
  15   Chubb Corp.                         CB             17.76
  16   Marsh & McLennan Cos.               MMC            16.27
  17   Cigna Corp.                         CI             15.15
  18   Ace Limited                         ACE            13.57
  19   Principal Financial Group Inc       PFG            13.25
  20   Genworth Financial Inc              GNW             9.95

* Market capitalization based on total shares outstanding or float
(shares available for trading by the public) when float is more than
5% below total shares outstanding.

Sources: A.M. Best Co., Bloomberg.

Top 20 Globally Traded Insurance Stocks,
Ranked by Market Capitalization

As of Sept. 30, 2005
($ Billions)

Rank   Company                             Exchange

   1   American International Group Inc    NYSE
   2   Berkshire Hathaway                  NYSE
   3   UnitedHealth Group Inc              NYSE
   4   ING Group NV                        Amsterdam
   5   Credit Suisse Group                 VIRT-X (Pan-European)
   6   Allianz AG Holding                  XETRA (Germany)
   7   WeIIPoint Inc                       NYSE
   8   Manulife Financial Corp.            Toronto
   9   Axa SA                              Paris Bourse
  10   Allstate Corp.                      NYSE
  11   Prudential Financial Inc            NYSE
  12   Assicurazioni Generali SpA          Milan
  13   St Paul Travelers Companies Inc     NYSE
  14   Millea Holdings Inc                 Tokyo
  15   Aetna Inc                           NYSE
  16   Zurich Financial Services AG        VIRT-X (Pan-European)
  17   Aviva PLC                           London
  18   Hartford Financial Services Group   NYSE
  19   AFLAC Inc                           NYSE
  20   MetLife Inc                         NYSE

                                                      Mkt Cap *
Rank   Company                             Ticker    $ Billions

   1   American International Group Inc    AIG           140.13
   2   Berkshire Hathaway                  BERK          126.28
   3   UnitedHealth Group Inc              UNH            70.99
   4   ING Group NV                        ING            59.28
   5   Credit Suisse Group                 CSGN           53.96
   6   Allianz AG Holding                  ALVG           53.62
   7   WeIIPoint Inc                       WLP            46.52
   8   Manulife Financial Corp.            MFG            42.54
   9   Axa SA                              7088429        41.92
  10   Allstate Corp.                      ALL            36.31
  11   Prudential Financial Inc            PRU            35.13
  12   Assicurazioni Generali SpA          GASI           34.66
  13   St Paul Travelers Companies Inc     STA            30.31
  14   Millea Holdings Inc                 8766           27.57
  15   Aetna Inc                           AET            24.98
  16   Zurich Financial Services AG        ZURN           24.63
  17   Aviva PLC                           AV             24.42
  18   Hartford Financial Services Group   HIG            23.11
  19   AFLAC Inc                           AFL            22.73
  20   MetLife Inc                         MET            22.21

* Market capitalization based on total shares outstanding or float
(shares available for trading by the public) when float is more than
5% below total shares outstanding.

Sources: A.M. Best Co., Dow Jones Indexes, Bloomberg.

Insurers Outperformed Market

The insurance sector as a whole outperformed the
S&P 500 based on their total returns in 2005,
year to date through Oct. 7.

S&P 500            -1.32%
Life/Health        12.10%
All Insurers        8.20%
P/C (1)             2.55%
Multiline          -0.34%
Reinsurers (2)     -6.19%
Brokers (3)         3.36%

(1) P/C insurer stocks outperforming the market
despite Katrina & Rita

(2) Reinsurer down more on Katrina and Rita news

(3) Brokers up on tight market hopes

Source: Insurance Information Institute

Note: Table made form bar graph.

jpg 0095

Announced Insurer Capital Raising

As of Oct. 11, insurers had announced plans to raise $5.3 billion
in a new capital, 81% as common stock.

($ Millions)

Ace Ltd.          $1,438
Argonaut             $37
Aspen               $404
Axis                $250
Endurance           $600
Everest Re          $475
Fairfax Finl.       $300
Max Re              $303
Montpelier Re       $620
Navigators          $143
Odyssey Re          $102
Platinum            $164
PXRE                $476

Note: Table made from bar graph.

Type of Capital Raised

Common Stock          81%
Debt                 3.8%
Preferred Stock     15.3%

Note: Table made from pie chart.

Source: Insurance Information Institute