Insurance stocks aren't the kind of investment that will make you rich overnight, but they can certainly make you wealthy. Smart operators in this sleepy industry can generate double-digit returns on equity over years, delivering stellar returns supported by fat dividends and big share repurchases. With this in mind, here are two insurance stock I believe should be on any insurance investor's watch list.
1. A small New England insurer
It's no household name, but Safety Insurance Group (NASDAQ:SAFT) looks compelling after the company reported less-than-impressive first quarter earnings. The Massachusetts-based property and casualty insurer (it insures mostly cars and homes) experienced unusual insurance losses due to the headline-grabbing snowstorms in the winter of 2015. Snowfalls reached nearly 8 feet in Boston, and more than 9 feet in other Massachusetts communities, resulting in losses that hit its reinsurance program for the first time ever.
It's difficult to believe that its first-quarter losses were more than just an unfortunate case of bad luck, though. After all, the company's history shows that it has been a prudent risk manager, generating an underwriting profit most years by adequately pricing its policies for losses and operating expenses.
In fact, Safety has historically over-reserved for losses, only to later realize favorable prior-year developments. In other words, Safety often assumes that it will lose much more than it actually does, a habit that is all too rare in a world where executives focus on short-term results at the cost of long-term predictability and profitability.
A combination of rising rates and increased pricing in its core market to reflect recent catastrophe losses could give earnings a lift. The company's shares, which trade for about 1.2 times book value and 14 times last year's earnings, currently yield about 5% per year. It's rare to find such a sizable dividend from a company that would stand to benefit, not falter, if interest rates tick up.
2. A giant personal and commercial insurer
Moving on to a large cap insurance company, Travelers Companies (NYSE:TRV) fits the bill as one of the better operators and capital allocators in recent years.
The steady-as-she-goes insurance company isn't much for growth; its premium revenue has grown less than 20% in the last 10 years. But its earnings per share have grown more than four-fold, mostly due to its appetite for repurchasing stock. It repurchased more than half its shares over the past decade, as it aggressively bought back stock during and after the financial crisis.
Part commercial insurer and part personal insurer, Travelers Companies manages its risks well. The company's combined ratio has historically come in below 100%, resulting in underwriting profits on top of investment profits from its massive bond portfolio.
The result is a return on equity that ventured into the double digits in 7 of the last 10 years. At 10 times earnings and 1.3 times book value, Travelers is an above-average operator trading at an average price.
Safety and Travelers are mature insurance companies that understand their markets and their limitations. Neither have shown any tendency to overextend and grow for growth's sake, instead choosing to return the bulk of their profits back to shareholders in the form of repurchases and dividends. I think that's a noble attribute, and their records of careful risk management suggest these are stocks that should be on the short list of any insurance investor.
Jordan Wathen has no position in any stocks mentioned. The Motley Fool recommends Safety Insurance Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.