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Investment Overview for Travelers (NYSE:TRV)
Below are the key drivers of Travelers with potential upside or downside to the Travelers stock price.
- Investment Income Operating Margin: Travelers invests premium income - or float - collected from policyholders, mostly in government and corporate bonds, to generate returns. The company usually maintains high premium rates and underwriting discipline in order to generate float at negative costs. The cost of float can be defined as the ratio of underwriting loss to average float. The average cost of float in the last five years has been around -2.5% (barring 2012 and 2011 which were high catastrophe years). We allocate expenses from the insurance divisions to the investment division to calculate margins. We expect a short term increase in margins as the combined expense ratio normalizes. However, long term, the margins will be be affected by lower yields from investments. However, there would be a 5% downside to our price estimate if the margins were to remain at 2012 levels.
- Travelers' U.S. Workers' Compensation Market Share: Travelers' Business Insurance division is the company's most important segment. Workers compensation accounts for almost 30% of the premiums earned by the Business Insurance division. Business customers who pay large sums of money on multiple policies are very price sensitive during times of economic crisis, and are less concerned about fast and hassle-free payment of claims than individuals. Also, a large portion of Travelers' business customers are small and medium enterprises (SME), which have generally not seen earnings improvement to the same extent as larger corporations. Therefore we expect Travelers, which generally charges higher premiums than most competitors and maintains high underwriting margins, to continue to see a modest decrease in its market share until the U.S. economy rebounds fundamentally.
We expect Travelers market share to remain stable in the coming years as the company enforces rate increases to compensate for low investment returns. Rate hikes will be lower as interest rates normalize allowing Travelers to gain market share in the long term. We expect a slight recovery in later years, with market share settling around 7% by the end of our forecast period. However there is an 6% upside to the Trefis price estimate if Travelers is able to avoid increase market share and touch 10% by the end of Trefis forecast period.
Travelers is one of the largest property and casualty (P&C) insurance company by market capitalization in the United States. The company's operations are primarily spread throughout the United States, with a limited international presence. The company provides auto and home insurance to individuals and auto, property, general liability, workers compensation, financial and professional insurance to businesses. Customers buy Travelers insurance policies because of the company's reputation for excellent customer service, fast and fair claims processing, as well as its ability to meet its financial obligations. Travelers is also known for its conservative culture because it invests most of its insurance premiums in investment grade bonds which helped the company come out of the financial crisis relatively unscathed.
Business & Financial Insurance Premiums
Travelers' main source of value is the business and financial insurance division. Travelers collected $17 billion in premiums for business insurance in 2014. This division's products include workers' compensation, commercial automobile, commercial multiperil and financial/bond insurance.
Investment of Insurance Premiums
Travelers invests the premiums that it collects from its customers in order to generate income to pay for insurance claims and pay dividends to shareholders. Insurance companies primarily invest in bonds, stocks, short-term securities and alternative assets such as real estate, hedge funds and private equity. Travelers' investment of insurance premiums constitutes about 6% of our price estimate for the company's stock. Travelers is generally considered one of the most conservative insurance companies, as 90% of its investments are in investment grade bonds while many other insurance companies also hold substantial investments in equities and other risky assets.
Travelers' personal insurance division offers property, auto and liability insurance to individuals and households. This division generated $7.1 billion revenues in 2014. Travelers has been slowly losing market share in the personal insurance market, primarily because of higher premiums relative to competitors. The company maintains high underwriting margins with a negative cost of float.
Growth in U.S. P&C Insurance Premiums
The property and casualty (P&C) insurance market was not significantly impacted by the financial crisis. U.S. P&C market premium volume increased slightly, but for Travelers this was offset by a slight decrease in market share. Going forward we expect market premium volumes to increase slightly and we expect Travelers to marginally increase its market share in both the Business and Personal Insurance segments. The catastrophes of 2011 and 2012, including Hurricane Irene and Superstorm Sandy, had hurt the balance sheets of most P&C insurers, forcing them to raise insurance premiums. Comparatively, Travelers escaped without much damage and instead reported underwriting profit in 2012. Since then Travelers' underwriting discipline has remained at similar levels, allowing the company to take advantage of growing market in the coming years.
Investment Gains Likely to Rise
The majority of Travelers' investment portfolio is composed of investment grade bonds, both corporate and government, which are sensitive to changes in interest rates. In an extended period of low interest rates, which we expect in light of the Federal Reserve's recent actions, yields on these investments will be modest. Additionally, the company has significant investments in municipal bonds, many of which face potential ratings downgrades which would result in a decline in their value. We expect the current macroeconomic environment to pressure Travelers' return on its investment portfolio in the near-term, after which we expect an increase in returns concurrent with an economic recovery.
How Does Trefis Modelling Work?
How do we get the historical numbers for this chart?
Trefis has a team of in-house Analysts who gather historical data from company filings and other verifiable sources. When historicals are available, we explain how we got them at the bottom of the Trefis analysis section below.
Who came up with the Trefis forecast for future years?
The Trefis team of in-house Analysts considers a variety of factors when projecting any forecast. The rationale for our projections is explained in the Trefis analysis section below.
How does my dragging the trendline on the chart impact the stock price?
- We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.
- We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.
See more on: DCF Methodology
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