Some Insurance for Your Stock Portfolio

NEW YORK ( TheStreet) -- After the mugging Hurricane Sandy delivered to a huge swath of the U.S., many investors became turned off to insurance stocks. It has led to a buying opportunity. Let's dig a little deeper.

All insurance companies are not created equal and their exposure to the devastation of Sandy isn't equal either. That's why the analyst at Morgan Stanley who covers insurance companies recently predicted many companies will take an earnings hit in the fourth quarter to cover the losses they'll be paying.

Earnings estimates for insurers like Dow 30 member Travelers Insurance ( TRV) and "good hands" insurance star Allstate ( ALL) have been cut by as much as 50% due to the Sandy-related payout costs.

Yet, according to an editorial in the Wall Street Journal by Brett Arends, "... T he industry has more than $500 billion in capital to pay claims, and the final bill will be a tiny fraction of that." He claims the real issue for shareholders is the insurance industry has too much money, and that the results have been "...a price war, as underwriters have cut fees, especially on commercial policies, in order to keep market share."

As we all know, no matter what industry we're focused on, a price war can often make all the players suffer. That's why, according to Meyer Shields, an insurance analyst at financial services firm Stifel, Nicolaus, " Insurance prices fell 50% to 60% from 2004 to 2011. Insurers were not earning their cost of capital. There was too much competition."

The result, according to industry analysts, is that insurers now pay out more in claims and expenses than they collect in premiums. They try to make up for the shortfall by investing those premiums, but that hasn't worked too well. Their average return on capital has been a paltry 3% to 5%.

The Journal article claimed the major publicly traded insurance companies have averaged share price gains of around 16% so far this year. Finding that hard to believe, I looked for an ETF that trades mainly insurance-related companies. Much to my surprise I found one.

The SPDR S&P Insurance ETF ( KIE) attempts to correspond to the total return performance of an index that tracks the performance of publicly traded companies in the insurance industry.

Its year-to-date performance is up 15% and shares of KIE were trading at around $43.20 as of Monday. That's down a little from the 52-week high of $45.20. It yields around 1.7% and has a three-year average return of a little more than 7%.

Here's a five-year chart that compares it with the S&P 500 SPDR ETF ( SPY). KIE Chart KIE data by YCharts

KIE sports an average PE of around 9, which also happens to be the forward (one-year) PE for ALL. TRV's forward PE is around 10. According to Arends' article, "Allstate shares...trades at roughly the net per-share value of the company's assets, and for about 63% of annual per-share revenue. The median for the past 15 years... is 93% of revenue."

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The part of the insurance business that caught my eye and that benefits from the potential of rising insurance rates going forward is the major insurance brokers. The Journal article pointed out the industry is a "global oligopoly, controlled by a handful of companies..."

In reverse alphabetical order they are Willis Group Holdings ( WSH), Marsh & McLennan ( MMC) and Aon ( AON).

A recent press release by claims that , "... the effects of Hurricane Sandy on the industry appear to be lower than originally expected, and some companies have been able to turn in quarterly earnings that beat Wall Street's expectations."

Analysts and fund managers who own the insurance brokers seem to be favoring AON and WSH. AON soared after it beat expectations on the third-quarter results, partly boosted by the outstanding performance by its human resources division. AON pays a 1.1% dividend and sells for 11.59 times forward earnings.

WSH, which is rebounding back to pre-Sandy levels, pays a more impressive 3.14% dividend based on a share price of $34.40. At that price it's trading approximately at 12.52 times forward earnings. On Oct. 24 it had an intraday low of $31.98, which lifts the yield-to-price to 3.38%.

Here's a five-year comparative price-per-share price chart on both AON and WSH. It appears that WSH is the best priced at the current moment. AON Chart AON data by YCharts

Since the major insurance brokerage firms like WSH have their revenue linked to the value of the contracts they negotiate for clients, if premium prices rise they receive a proportionate raise in revenue.

My take is to watch all three of them, including MMC, which pays a 2.7% yield-to-price and is selling for around 14 times forward earnings. If you can pick up shares close to the Oct. 24 or Oct. 25 intraday lows you'll begin collecting some sweet yields and be better positioned for upside potential.

At the time of publication the author had no position in any of the stocks mentioned.

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

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