There's Safety in Insurance Stocks

NEW YORK (TheStreet) -- There's a great deal of money to be made in the business of risk mitigation, a.k.a. "risk management".

It's not the kind of business where you will see gigantic leaps in quarterly earnings growth. However, it does involve a steady flow of multiple revenue streams that offer billions of investment dollars with which these companies can invest and reward shareholders.

I'm speaking of the insurance business -- the largest business in the world when measured by revenue.

Almost everyone with anything to protect -- a home, a car, a business, a career or a life -- spends hundreds if not thousands of dollars each year buying insurance that we hope we won't need.

The insurance companies collect the premiums month after month, year after year, and are able to use that money to increase corporate profits. Their aim is to collect more than they have to pay out in claims, and keep the remainder. It's a win-win business formula.

Take a company like Aflac ( AFL), which reports second-quarter 2012 quarterly earnings on Tuesday, July 24.

It brings in $49 billion to $50 billion a year in revenue. That's almost $50 per share, and the company has been growing its quarterly revenue at a 20% year-over-year clip.

Aflac pays a 3% dividend to shareholders, which is a very sustainable payout ratio of only 25%. How does it keep firing on all financial cylinders?

American Family Life Assurance Company of Columbus (that's what Aflac stands for) provides supplemental health and life insurance for individuals and groups.

The company offers various voluntary supplemental insurance products, including cancer plans, general medical indemnity plans, medical/sickness riders, care plans, living benefit life plans, ordinary life insurance plans and annuities, in its Japan division.

It also provides loss-of-income products, such as life and short-term disability plans; and products designed to protect individuals from depletion of assets, which comprise hospital indemnity, fixed-benefit dental, vision care, accident, cancer, critical illness/critical care, and hospital intensive care plans, in the United States. This is what I mean by "multiple streams of income" and revenues.

Through careful underwriting and actuarial calculations, it successfully collects more premiums than it pays out in claims. And it is doing a stellar job of it.

In first-quarter 2012, it grew its quarterly earnings by almost 102% and its PEG ratio (5-yr expected) is only 0.60, which often signals that a company's stock is nicely undervalued.

You can also look at Dow Jones Industrial Average component Travelers ( TRV) and you'll see yet another example of a cash-cow insurance company that's generating $64-per-share in trailing 12-months revenues.

TRV recently reported its second-quarter 2012 results. It produced $499 million in net income, which represents $1.26 per diluted share. Year to date, its return on equity is at 10.5%. Not bad for a business model that takes in billions of dollars at no carrying costs whatsoever.

That's one of the reasons why the most successful investors like Warren Buffett own insurance businesses. His company Berkshire Hathaway ( BRK.B) owns car insurance powerhouse Geico.

Most states have laws requiring drivers to have auto insurance. So Geico is available in all 50 of them with competitive pricing and aggressive advertising campaigns. It also does homeowners and renters insurance, which comprises a growing amount of its revenues.

Its cash-generating success is one of the biggest reasons Berkshire Hathaway investors have averaged an annual total return of around 16% over each of the past three years.

As Buffett wrote in a recent annual letter to shareholders concerning the advantages of being in the insurance business, "We have now operated at an underwriting profit for nine consecutive years, our gain for the period having totaled $17 billion."

Buffett elaborated on this theme: "I believe it likely that we will continue to underwrite profitably in most -- though certainly not all -- future years. If we accomplish that, our float will be better than cost-free.

"We will profit just as we would if some party deposited $70.6 billion with us, paid us a fee for holding its money and then let us invest its funds for our own benefit."

It's hard not to love an industry built upon the idea that it takes in billions of dollars of other people's money at no cost, and is able to keep every dime that it doesn't have to pay out in claims and operating expenses.

With the money these insurers keep, they can invest in all kinds of profitable ventures like real estate, lending companies, international sovereign debt, precious metals or whatever asset classes are profitable.

Two of my personal favorite companies that are on my watch list include The Hartford Financial Services Group ( HIG), which is selling at a forward PE ratio of around 4.5 (cheap!) and reports earnings on August 1.

MetLife ( MET) is the other one. It provides insurance, annuities and employee benefit programs in the United States, Japan, Latin America, the Asia Pacific, Europe and the Middle East. Shares are selling for only 5 times current earnings and 5 times forward earnings.

Like The Hartford, MetLife pays a 2.5% dividend, and may possibly retest its June 5, 2012 intraday low of $27.60, which would bring its yield-to-price up to 2.7%. As the next chart of MET illustrates, the share price seems to follow revenue growth in the insurance industry.

MET Revenue Growth Chart MET Revenue Growth data by YCharts

Now let's take a look at the same kind of chart, comparing price to revenue growth for The Hartford:HIG Revenue Growth ChartHIG Revenue Growth data by YCharts

The correlation looks similar. The point being, when it comes to insurance companies, watch both their quarterly earnings as well as revenue growth.

Also keep an eye on the payout ratio of their dividend. MetLife's payout ratio is only 14%, which indicates that there's room to raise the dividend, which could help boost the share price.

Begin watching and listening to the earnings reports and conference calls for these insurance companies. MetLife's next one is on August 1.

Buy the shares of your favorite insurance companies when they are sucked lower on days when the stock market is in panic mode. Then when they begin looking stretched and over-priced, sell them and look for the next good buying opportunity.

It's a savvy way to balance your holdings and diversify your stock portfolio. It's a unique sub-sector that isn't going away and will become more substantial as the world's economies and populations grow.

At the time of publication, the author held no positions in any of the stocks mentioned, although positions may change at any time.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

Most large cap stocks were once small and mid-cap stocks. Bryan Ashenberg is here to help you find the cream of the crop amongst the market chaos.

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