Better Margins And Macro Recovery Can Lift Travelers Results
The Travelers Companies, Inc. (NYSE:TRV) is expected to report earnings for the second quarter of 2013 on July 23. [1] The insurer reported a reported a 11% year-on-year growth in both net and operating income for the first quarter with the combined ratio or the ratio of expenses to premiums increasing from 92.2% in the first quarter of 2012 to 88.5%. The company has maintained a strong underwriting performance and a negative cost of float for the last few years and is expected to maintain its discipline this quarter.
We presently have a price estimate of $94 for Travelers, implying a premium of 10% to the current market price.
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Business And Financial Insurance Is the Key
Travelers is the sixth largest property and casualty insurer in the U.S. with a market share of 4.5%, in terms of premiums earned. [2] The company earns nearly two-thirds of its revenues and operating income from business and financial insurance offered to institutions across the country. The main products offered are workers’ compensation insurance and commercial multiperil insurance accounting for 20% of the division’s premiums each. Travelers’ main insurance product line is workers’ compensation accounting for almost 30% of the net written premiums.
The unemployment rate in the U.S. has improved from the peak of 10.1% observed during the financial crisis in 2009 to a four-year low of 7.5% in April, which remained at 7.6% in May and June. [3] A growing job market will fuel demand in the insurance market. Manufacturing employment has increased by 4.3% since 2010, while jobs in the construction industry have increased by 5.4% since the start of 2011. [4] Both manufacturing and construction are big markets for workers’ compensation and growth in the job market will lead to increased demand for insurance in the coming years.
Travelers’ is currently the second largest insurer in the workers’ compensation line in the U.S. behind MassMutual. The company’s market share has increased from 6% in 2010 to 7.31% in 2012. Travelers has maintained high retention rates, over 80% despite insurance rate hikes of 6% to 10% across various lines in the last quarter. We expect its market position along with market expansion to help the company’s performance.
Travelers is also the market leader in the commercial automobile insurance business with a market share of 7.8% and has a share of 8.84% in the commercial mutiperil business. These lines of insurance account for 15% and 25% of the business premiums respectively, and will see growth with the recovering economy.
Margin Expansion
Investment income is very important for insurers’ margins. Companies collect premiums from clients in exchange for coverage, and the income from these premiums is invested, primarily in “safe” securities like government and corporate bonds, to generate returns for the company.
Around 93% of Travelers’ assets are invested in fixed maturity and short term investments. Of these, 60% are invested in bonds issued by states, municipalities and other political subdivisions in the U.S. The highest investment is in the state of Texas followed by California. Municipal bonds came primarily from the water and sewer as well as the higher education sectors.
Bond yields in the U.S. have been climbing in the last two months following speculations that the Federal Reserve’s Quantitative Easing program which includes $85 billion in monthly bond purchases might be coming to an end. [5] The 10-year Treasury yield has climbed from 1.76% at the end of 2012 to around 2.75%. Higher yields from investments in bonds will allow Travelers’ margins to expand.
Also, the lack of natural disasters like Superstorm Sandy last year will allow Travelers to improve its catastrophe ratio, and thus its margins. Barring the Moore tornado in Oklahoma in May, [6] there have been few catastrophes in the U.S. this year.
The Fed has stated a threshold of 6.5% unemployment rate as a target for the economic recovery before it might start increasing interest rates. [7] Our current forecast is based on this threshold as a benchmark for long term yields.
Canadian Expansion
During the second quarter, Travelers announced its decision to acquire The Dominion of Canada General Insurance Company from E-L Financial Corporation Limited for $1.1 billion in cash. [8] The transaction is expected to be completed in the fourth quarter of 2013.
The Dominion is a Canadian property and casualty insurer, and the twelfth largest in the country with a market share of 2.9%. [9] The acquisition will allow Travelers to expand in the Canadian property and casualty market, particularly in the automobile section where the Dominion has a market share of 4%. The acquisition of the Dominion follows the 2010 acquisition of Brazilian insurer J. Malucelli Participacoes em Seguros e Resseguros SA.
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Notes:- Investor Relations [↩]
- NATIONAL ASSOCIATION OF INSURANCE COMMISSIONERS PROPERTY AND CASUALTY INSURANCE INDUSTRY 2012 TOP 25 GROUPS AND COMPANIES BY COUNTRYWIDE PREMIUM [↩]
- U.S. Department of Labor, Labor Force Statistics from the Current Population Survey [↩]
- Overview and Outlook for the Workers Comp Market: Growth, Performance and the Economic Environment, Insurance Information Institute [↩]
- Analysis: Higher interest rates? Not a problem for some U.S. stocks, Reuters, July 16 [↩]
- Satellite picture reveals the scar left behind by Moore tornado”. NBC News. Retrieved June 17, 2013. [↩]
- Bernanke Offers Possible Timetable for Tapering [↩]
- Travelers Companies Inc : Travelers to Acquire The Dominion of Canada General Insurance Company [↩]
- 2013 IBC Fact Book [↩]