Can Insurance Companies Be A Sound Investment?

counseling session or salesman
Image by: SalFalko
By Michael Sterling

A lot of investors are hesitant to invest in companies which hold money for their clients, i.e. financial firms and insurance companies, mostly because the infrastructure of these businesses are quite complicated. However, once you educate yourself on exactly how they make decisions and why, you may be able to create a bright and sound investment to add to your portfolio.

How Can I Spot A Valuable Insurance Company?

The secret comes in two terms: price to book (P/B) and return on equity (ROE). P/B is the insurance company’s stock price to its book value. Book value, i.e. shareholder’s equity, is simply the company’s cash value should it ever be liquidated, like a cash register.

ROE is the money a company generates as a percentage of shareholders equity (or book value). The higher the better in this case, really, anything above 10% shows that the company is well-run and is delivering good returns for their shareholders.

Before you ever decide on investing in insurance companies, take a look at their financial statements. The New York Stock Exchange and Nasdaq are good sources to have. They have word and PDF printable versions of a public company’s statements.

Keep this in mind. MetLife (MET) is one of the biggest insurance companies in the industry, and the largest U.S. insurer based on total assets. Last month, its market capitalization level was $53 billion.

China’s China Life Insurance Co. (LFC) at $71 billion and the United Kingdom’s Prudential (PRU) at $50 billion are other big insurance companies worth taking a look at in the market. MetLife’s ROE, however, is above average and its P/B is below 1% which is better than anyone else.

Investigate Their Premiums

It’s important to understand that insurance companies do not own the money they receive. Customers pay premiums to offset the risk of any kind of loss, be it related to health, life, or property and casualty. As an investor, by looking at the premiums these companies offer, you may be able to decipher a reasonable idea as to what their value may be.

In a way, insurance providers run and manage investment portfolios. This is, after all, the strategy of how they run their business. In order to pay for these portfolios, they “reinvest” from their profits. And where do they get these profits? From the premiums their clients pay.

Before you make a drastic investment decision, make sure you trust that the company is making reasonable assumptions to  balance the premiums they take in with the future losses they will eventually have to pay out to their clients. In other words, make sure they’re not gambling with your money. The smallest of mistakes can put an entire company in a hole.

*Tip: take a look at which type of insurance the company specializes in. A lot of offer many different kinds. Be cautious if it’s a life insurance company. A wrong gamble in that case can set a company back decades, depending on the type of payment in losses.