Tariq Ali of Street Capitalist has a great interview with Dave Carlson of Tourmaline Advisors about insurance stocks. You may remember, I interviewed Tariq a while back.
The interview is full of helpful advice, like when Tariq asked Dave what metrics investors should use to analyze insurance stocks:
Price to book and combined ratio are good starting points. Return on equity, underwriting leverage ratio and investments to equity are other metrics that I look at. On combined ratio, it is also useful to look at the difference between what is reported on a GAAP basis and what is reported on a statutory basis. The “stat” basis is more conservative than GAAP, it’s what the regulators look at, and is a better measure.
Dave mentions 3 insurance stocks: Penn Millers (PMIC), Donegal Group (DGICA), and Seabright Holdings (SBX).
He also talks a bit about Prem Watsa’s Fairfax Financial Holdings (FFH):
As for relying on investment income, yes, Fairfax does rely on it more than most. In their annual report, Prem Watsa mentions the net premiums written to statutory surplus ratio, a.k.a. the underwriting leverage ratio. The ratio at the end of 2009 was around 0.5 for Fairfax whereas most insurers are well over 1.0 and closer to 1.5. Watsa has purposely structured Fairfax so that the underwriting contributes less to results. That’s a good thing because it is a lousy business! This also means that the Fairfax insurance companies are overcapitalized relative to premiums written. Once they satisfy the regulatory/rating requirements for safe investments, they are free to invest the excess capital in things besides bonds. The Fairfax business plan comes straight from Buffett.