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Insurance companies enjoy a two-sided business model, which explains their popularity with investors. Not only do they collect premiums on the policies they write, but they're then able to pool their capital and invest it, earning even more money.
That explains why legendary investor Warren Buffett is such a fan of insurance companies. He proved it by buying Geico, and has made billions from the investment for him and Berkshire Hathaway's investors.
Funny commercials, serious money
For investors interested in insurance stocks, your research should begin with supplemental insurer Aflac (NYSE: AFL ) . You've likely seen Aflac's commercials, and while its namesake duck makes for humorous advertisements, its underlying business is a serious money maker.
Interestingly, Aflac is essentially an American company in name only. You may be surprised to know that that the vast majority of the company's business is done far outside of the United States. In fact, Aflac derived 78% of its revenue from Japan in 2012.
From an operational standpoint, Aflac is a very high-quality business. In the last fiscal year, total revenue was up 14.4% to $25.4 billion versus a year ago. Operating earnings for the full year were $6.60 per diluted share, compared with $2.9 billion, or $6.27 per diluted share, in 2011.
And, even better, Aflac is off to a good start to the current fiscal year as well. Revenue and operating earnings were up 2.4% and 1%, respectively, in the second quarter.
This consistent profitability is what has allowed Aflac to reward its shareholders with 30 years of consecutive annual dividend increases.
Of course, Aflac isn't the only insurance company with a strong track record of increasing shareholder rewards. Property and casualty insurer RLI (NYSE: RLI ) has provided its shareholders with 38 years in a row of increased dividends.
RLI is successful in its own right, having reported 9% higher operating earnings over the first six months of the year, but it's a much smaller industry player that is struggling to perform as well in its underlying investment portfolio.
Fellow insurer and Dow component Travelers (NYSE: TRV ) reported 2% higher revenue over the first half of the year and, like Aflac, aggressively rewards shareholders with a strong 2.5% dividend.
A promising road ahead
Aflac stands apart from the competition because of its strong brand recognition, superb investment performance, and new products that are currently seeing success. Aflac's sterling operations resulted in an annualized return on average equity of 22% for the second quarter. This performance beat Travelers, which reported 14% return on equity in its own second quarter.
And, whereas Aflac reported 16.6% and 3.1% growth in investment income in Japan and the United States, respectively, RLI saw its investment income drop 15% over the first six months of the year.
Furthermore, in Japan, Aflac Chief Executive Officer Daniel Amos reiterated his belief in the company's new products, including cancer and medical supplemental insurance, which Aflac refers to as third-sector products.
He recently stated: "We continue to believe consumer response to our third-sector products will be strong in the second half of 2013." This is hard to disagree with, especially considering the rapidly evolving health care needs of aging global populations.
The Foolish conclusion
Successful companies in the insurance industry have the flexibility to provide shareholders the increasing stream of profits and dividends that most investors love. For investors looking to gain exposure to the financial-services industry who may be wary of buying stocks in banks, insurance companies should be on your watchlist.
Aflac's strong operations, well-known brand, and commitment to shareholders makes it a compelling buy for income investors looking to diversify into financials. While Travelers and RLI are profitable and likely to serve their investors well, neither can match Aflac's ability to generate returns on shareholder capital nor on investment performance. As a result, investors should give Aflac clear preference among these three companies.
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