The great thing about the insurance industry is that most people find insurance as exciting as a visit to the local dentist. As a result, there are tons of insurance companies and not many investors looking at them, compared to, say, Google or Yahoo. Thus, even though I'm not excited about property and casualty insurers as a whole (combined ratios are at historical lows), I'm still able to find some stocks that might be interesting.

Cheap is in the eye of the beholder. I like to look for an insurer that trades at a low multiple-to-book value, has a high earnings yield, and has high returns on equity. Before we get into the good stuff, here's a quick refresher on those metrics.

Book Value
Book value is total assets minus total liabilities. If an insurer has $100 in assets and $50 in liabilities, it has a $50 book value. If I can buy that insurer for $25 bucks, then I could theoretically liquidate that insurer by letting its contracts run off and pocket the $25 profit for a 100% return (assuming I don't have to incur huge expenses to liquidate the company). Thus, book value can be considered a margin of safety.

Earnings Yield
If you invert the P/E ratio, you get the earnings yield, thus a P/E of 10 becomes a 10% earnings yield. Obviously, it's better to have a higher earnings yield than a lower one.

Return on Equity
Book value equals equity. When you buy shares of an insurer, technically, as a stockholder, you are only entitled to the equity -- the rest belongs to the policyholders (float) or creditors (debt). Thus, net income -- which is profit after paying policyholders, operational expenses, and creditors -- belongs to shareholders. This net income can either be returned to shareholders via buybacks or dividends, or reinvested into the business, which increases equity. Thus, we're concerned here with how much income trickles down to stockholders, or return on equity.

When buying an insurance company, investors need to decide what multiple of book value and earnings they're willing to pay. If I do a quick Yahoo screen for property and casualty insurers trading at less than 20 times earnings with a low price-to-book multiple, a number of interesting opportunities pop out.

Cincinnati Financial
Property and casualty insurer Cincinnati Financial (NASDAQ:CINF) is trading at a pretty cheap 1.2 times book value. Year to date, Cincinnati Financial wrote at a 94% combined ratio (a combined ratio over 100% is an underwriting loss, less than 100% is an underwriting profit), and from 2002-2005 it earned combined ratios of 99.7%, 94.7%, 89.8%, and 89.2%. These are some stellar numbers and they illustrate Cincinnati's strong underwriting culture. However, 1995-2001 was a bit rougher for Cincinnati (and the industry in general), with combined ratios ranging from 98%-112%.

Cincinnati Financial also creates shareholder value through its stock picking prowess. As of the latest quarter, the company's equity portfolio (Cincinnati is one of the few insurers that has more of its investment portfolio in equities than fixed income) had a cost basis of $2.3 billion and a market value of $7 billion -- meaning its stock holdings have more than tripled in value. For example, the company bought $283 million worth of Fifth Third Bancorp (NASDAQ:FITB) that's now worth $2.8 billion, and its $134 million investment in ExxonMobil (NYSE:XOM) is now worth $601 million. To put some icing on the cake, Cincinnati's trading at a paltry 8 times trailing net income.

Mercer Insurance Group
Mercer Insurance Group
(NASDAQ:MIGP) trades at about 1 times book value and 10 times trailing net income. The company writes a wide variety of property and casualty lines, such as commercial auto, personal auto, worker's compensation, fire, and homeowners insurance. Year-to-date, Mercer earned a 97% combined ratio, and over the past five years has had combined ratios of 94%, 96%, 104%, 99%, and 95%.

The most compelling thing about Mercer is that the company is underleveraged. In 2005, Mercer's earned premiums-to-equity ratio was only 75%. In contrast, Markel (NYSE:MKL), another conservative insurer, had a 114% earned premiums-to-equity ratio. As Mercer increases this ratio, it should be able to leverage its operating and underwriting expenses and increase profitability -- and if it doesn't, its low price-to-book value ratio should provide a downside cushion.

Finally, a household name. As you are probably aware, Progressive (NYSE:PGR) writes personal and commercial auto insurance. It currently trades at 11 times trailing net income and more than 2.5 times book value. Progressive is also a rare breed, as one of the last publicly traded direct sellers of auto insurance. The only "pure plays" in this space are 21st Century Insurance Group (NYSE:TW), which recently got a buyout offer from majority shareholder AIG (NYSE:AIG); GEICO (a subsidiary of conglomerate Berkshire Hathaway); and USAA, which isn't publicly traded.

Currently, Progressive Direct accounts for 30% of its total earned premiums and should be a healthy grower. Because direct-to-consumer sellers don't have to give independent agents a cut, they often have a cost advantage over their non-direct brethren. According to a presentation by 21st Century, direct-to-consumer auto insurers have captured 4.6% market share since 1999, whereas the independent channel captured 1.6% over this time period (each percent of the $160 billion in annual auto insurance premiums is worth $1.6 billion).

In the independent agency channel, Progressive is also a low-cost provider, thanks to its scale efficiency as the third-largest writer of auto insurance. Although Progressive's aggregate expense ratio was higher than pure direct insurers USAA, GEICO, and 21st Century, Progressive's costs were lower than State Farm, Allstate (NYSE:ALL), Farmers, and Mercury General (NYSE:MCY). Auto insurance pricing could soften as a result of low combined ratios over the past couple of years. Nevertheless, I believe Progressive has a long-term competitive advantage in its agency channel and healthy exposure to the direct business, and should provide solid long-term shareholder returns.

To learn more about the companies mentioned in this article:

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Fool contributor Emil Lee is an analyst and a disciple of value investing. He doesn't own shares in any of the companies mentioned above and appreciates your comments, concerns, and complaints. The Motley Fool has a disclosure policy.