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The Travelers Companies (TRV)

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POTENTIAL UPSIDE & DOWNSIDE TO TREFIS PRICE

Below are the key drivers of Travelers with potential upside or downside to the Travelers stock price.

Business Insurance

  • 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 10% 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' workers compensation market share to gradually decline going forward as customers look to cheaper insurance policies as a means of cutting costs. We expect a slight recovery in later years, with market share settling around 5.6% by the end of our forecast period. However there is an 8% upside to the Trefis price estimate if Travelers is able to avoid further near-term share loss and maintain a market share of about 6% throughout the Trefis forecast period.

BUSINESS SUMMARY

Travelers is the sixth largest property and casualty (P&C) insurance company in the United States, on the basis of direct written premiums. The company has a strong presence across the country, with California and New York being the largest contributors. Also, it has a minor international presence, with the largest contribution from Canada. 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 fixed income securities, which helped the company come out of the financial crisis relatively unscathed.

SOURCES OF VALUE

Business & Financial Insurance Premiums

Travelers' main source of value is the business and financial insurance division. Travelers collected $15.2 billion in premiums for business insurance in 2012. 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 10% 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.

Personal Insurance

Travelers' personal insurance division offers property, auto and liability insurance to individuals and households. This division generated $7.6 billion revenues in 2012. 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.

KEY TRENDS

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, have hurt the balance sheets of most P&C insurers, who will be forced to raise insurance premiums in coming years. Comparatively, Travelers has a strong balance sheet and will be in a strong position to offer insurance policies at competitive prices and as a result expand its market share.

Investment Gains Likely to Decline

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 over the next 2-3 years, after which we expect an increase in returns concurrent with an economic recovery.

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