Understanding an insurance company is often an inexact science, but the conference calls can be a great way to see if executives' promises turn out to be money good for investors.
In this segment from the Industry Focus: Financials podcast, The Motley Fool's Gaby Lapera and Jordan Wathen discuss why insurance companies may be better off broken up, and why an insurer's track record is the single greatest source for understanding how good insurance companies are at measuring, forecasting, and pricing risk.
A transcript follows the video.
This podcast was recorded on April 4, 2016.
Gaby Lapera: Is it better to buy stock in a stand-alone insurance company, or in one of these mega financial institutions that do a little bit of everything, like AIG (AIG -3.94%) for example.
Jordan Wathen: That's a million dollar question. If you're going to put me on the spot, I personally would prefer to invest in a pure insurance company, because if you're taking the insurance risk I just want the insurance risk. If you look at the really big insurance companies out there, most of them, especially AIG, hasn't done particularly well recently. It's because I think personally it's very hard to run a company where you're taking so many different risks and truly understand it.
Lapera: Yeah. I don't know if you all know about this but Carl Icahn ... am I pronouncing his last name right? I think I've only ever read his name, I don't think I've ever heard his name.
Wathen: I think you're getting it right.
Lapera: Yeah. He is like this activist investor type person, except he's just one person instead of a group of people. He's taken an interest in AIG, and he really wants AIG to split up its divisions, and partially that's a good idea because that way it will dip underneath the systemically important financial institution line. But he says also that it makes business sense for them, they'll make way more money as a separate set of businesses, as opposed to this conglomeration that they have now.
Wathen: Mm-hmm (affirmative). To some extent I wonder if he might just be a little upset at management personally.
Lapera: He does.
Wathen: Because they finally have a CEO who really doesn't have any industry background, and I think it really concerns a lot of investors, for good reason. If you want a good insurance company executive, you really want someone who's familiar with underwriting and familiar with risk, so that when they see, "Here's what we're actually risking this year," they actually truthfully understand the number.
Lapera: Yeah. That's another thing of course just like any other company, insurers also have management that you have to look into. It's really interesting, because I feel like with a lot of the technology companies or consumer goods companies, they have super dynamic CEOs and you know a lot about them, but with insurance companies and banks and BDCs, there's not really ever a ton of information on managers. It's like, "They went to Harvard and graduated in '89."
Wathen: You're right, they studied engineering, they went to Harvard and then they became a financial industry executive. I just wrote 95% of insurance or financial people's background.
Lapera: Yeah. It's like I don't know whether or not I should trust this guy. In order to do that you look at their track record. The other thing I really like to do is read conference call transcripts, because I think that you can get a sense of whether or not people are being honest and forthright via what they say. I know that's a nebulous thing to quantify, it's just a gut feeling whether or not you trust these people. But besides track record that's all you can really do.
Wathen: Right. Progressive (PGR 0.52%) usually has a really clear conference call. They're very plain and open about what they're looking for. They'll straight up say, "We're shooting for this underwriting margin and we think we can grow by doing this," for example. That's something they've done recently, targeted a lower, or a higher combined ratio rather, getting back to how that's confusing, a higher combined ratio but also growing the top line. Over time you'll see, especially with property and casualty, car insurance, things like that, you can figure out really quickly if they're a good company at underwriting or not, because those policies expire within a year, so either you nailed it or you didn't.