The Travelers Companies, Inc. (NYSE:TRV) stock has risen by around 10% since the company announced earnings in January. Despite catastrophe related losses of $689 million due to superstorm Sandy, the company reported a 73% increase in net income for the fiscal year. This increase was affected by company’s pricing initiatives, which led to an 8% increase in average premiums from renewed policies in the business insurance division.
However, it must be noted that the 2011 top line was affected by catastrophe related losses of more than $1 billion due to the devastation caused by hurricane Irene and tropical storm Lee during the year. We believe that the markets have overreacted to the earnings report. Our price estimate of $70 for Travelers implies a discount of 10% to the current market price.
Losing Market Share
Travelers is one of the biggest property and casualty insurers in the U.S. The company primarily focuses on business insurance and its main lines are workers’ compensation, commercial multi-peril and commercial automobile. The product lines account for 29%, 26% and 16% of the net written premiums in the business insurance division respectively. In terms of market position, Travelers is in the pole position in the commercial auto product line, second in other liabilities and third in worker’s compensation. 
However, the property and casualty insurance market in the U.S. is quite mature, with around 2,500 companies competing for market share. Travelers has been losing market share in the last few years. Ranked by net premiums written, it was the fifth largest P&C insurer in the U.S. in 2010.  In 2011, it was displaced by AIG (NYSE:AIG) and was ranked in the sixth spot. While AIG has yet to disclose results for 2012, we believe that Travelers market share in the business and financial insurance domain has been reduced from 6.52% in 2008 to 6.17%. We also estimate that the company’s share will decline albeit gradually in the coming years.
Increasing Catastrophe Related Losses
Losses incurred by insurers due to weather related phenomena have been increasing for the last 30 years.  Natural disasters like hurricane Irene caused damages of around $32 billion for the industry in 2011. In 2012, superstorm Sandy caused further devastation, leading to high losses. Risk management solutions, which is one of the market leaders in modelling catastrophe risks has recently developed a new model for Atlantic storms, which shows that the probability of a category 3 storm hitting the U.S. coast is now 20% higher than it was five years ago.  According to the new model, losses along the Gulf Coast, Florida and the Southeast are expected to increase by 40% in the next five years, while losses in the mid-Atlantic and Northeast coastal regions are expected to increase by 25% to 30%.
The combined ratio is one of the measures used by insurers to determine underwriting results. This statistic measures the losses incurred by the company as a percentage of net premiums earned. High catastrophe related losses have affected Travelers’ combined ratio in the last few years. The ratio was around 88% from 2007 to 2009, but increased to 93% in 2010. In 2011, the ratio was 105%, indicating an underwriting loss for the company and improved only marginally in 2012 to 97%. This is still much higher than the historical figures.
While we maintain a more optimistic view of the storm scenario, we believe that Travelers’ operating margins in the business and financial insurance stream are unlikely to increase beyond 15% in the coming years. You can modify the interactive chart below to gauge the effect a change in forecast will have on our price estimate.
Impact Of Investments
Returns from invested assets are crucial for an insurer’s profitability. Travelers has a very conservative investment portfolio with 93% of its $74 billion asset pool invested in fixed maturity and short term investments. Persistent low interest rates are likely to hamper the company’s yield from investments in the coming years. We will discuss this aspect in more detail in an upcoming article.Notes:
- NATIONAL ASSOCIATION OF INSURANCE COMMISSIONERS [↩]
- The Top 25 Property/Casualty Insurance Writers, Risk Management Monitors, March 24, 2011 [↩]
- Stormy Future For U.S. Property/Casualty Insurers:the Growing Costs and risks of extreme Weather events, Ceres [↩]
- The Impact of Changes to the RMS U.S. Hurricane Catastrophe Model [↩]