Travellers: excellent performance, but a change in monetary policy could hamper performance (TRV)
On Thursday, January 20, 2022, P&C insurance giant The Travelers Companies, Inc. (TRV) announced its fourth quarter 2021 results. The company’s results were quite impressive as the company managed to exceed expectations of analysts in terms of revenue and profit. The company has also managed to produce some pretty impressive investment results, as we will see later in this article. The market seemed to agree as it sent the stock up 3.19% in the trading session following the earnings announcement, which was perhaps even more remarkable given that the overall market was down during the session. Travelers has long been one of the top insurance companies and these results certainly back up that claim.
As my regular readers are no doubt aware, I usually share the highlights of a company’s earnings report before diving into an analysis of its results. Indeed, these highlights provide context for the rest of the article and serve as a framework for the resulting analysis. Accordingly, here are the highlights of the results of Travelers’ fourth quarter 2021 results:
- Travelers reported total revenue of $9.011 billion in the fourth quarter of 2021. This represents a 7.31% increase from the $8.397 billion the company reported in the year-ago quarter.
- The company managed to achieve a combined ratio of 88.0% during the reporting period. That’s a bit worse than the 86.7% combined ratio the company achieved in the year-ago quarter.
- Travelers reported net investment income of $743 million in the most recent period. That compares quite favorably to the $677 million the company reported in the equivalent period last year.
- The company reported base revenue of $1.289 billion in the current quarter. This represents a 2.14% increase from the $1.262 billion the company reported in the corresponding quarter last year.
- Travelers reported net income of $1.333 billion in the fourth quarter of 2021. This represents an increase of 1.76% from the $1.310 billion the company reported in the fourth quarter of 2020.
One of the first things anyone looking at these highlights is likely to notice is that Travelers has seen a significant year-over-year revenue increase. One reason for this is a sharp increase in net premiums written, which is the total amount of premiums collected during the quarter minus the amount the insurance company paid out to reinsurance companies. The company saw that number increase by 9.99% over the year, from $7.269 billion to $7.995 billion. This is certainly an impressive performance and the management of the company seemed very pleased with it during the conference call.
Travelers is generally considered a business insurer for very good reason. This reason is that the commercial insurance unit of the company is by far the largest. The deal earned net written premium of $3.966 billion in the quarter, or 49.6% of the company’s total. However, this unit only saw its net written premium increase year over year by only 9%, which was in fact the lowest proportional increase of any business unit in the company. This business unit, however, saw a much larger gain in revenue, which is almost certainly more significant for most investors. This business unit saw its segment revenue increase 22% year-over-year, primarily due to improved underwriting gain. This is one of the most important things for an insurance company because underwriting gain is ultimately the main driver of its profits. The underwriting gain is the difference between the amount the company collected in premiums and the amount it had to pay in claims under these policies. The improved performance here therefore clearly tells us that the company has had lower losses compared to its premiums received, allowing it to add more money to its reserves, which constitute the bulk of the investment portfolio. of the society. It should be easy to see why a higher underwriting gain is therefore preferable.
In a previous traveler post, I said COVID-19 lockdowns were ultimately good for this business, which was obviously a big departure from the experience many businesses had. This was particularly notable in the company’s personal insurance business, which sells insurance products to ordinary people. The reason for this strong performance last year is that people were driving much less than normal, meaning car accidents and similar occurrences were less frequent than usual. Also, events that would lead to landlord claims were less frequent because people were home more often. Unfortunately, that has reversed somewhat this year as the economy has largely reopened and people have begun to return to their pre-pandemic lives. This is reflected in the business unit’s results, as the personal lines business saw its segment revenue decline 27% year over year. Fortunately, however, the unit still had an underwriting profit, which tells us that Travelers generally prices its products appropriately. We will discuss the importance of this later.
One of the most important numbers to consider when analyzing an insurance company for investment purposes is the combined ratio. This tells us what percentage of total premiums the company uses to pay claims against it. If this ratio is less than 100%, it means that the company collects more premiums than it pays claims and thus generates an underwriting profit. The reverse is also true, as a ratio above 100% indicates that the company is paying more in claims than it actually collects in premiums from its customers. As mentioned in the introduction, Travelers managed to achieve a combined ratio of 88.0% across all of its business units during the fourth quarter. It’s a sign of a conservative underwriting culture and it’s something that sets Travelers apart from some other insurance companies. During weak markets, one thing some more aggressive companies do is deliberately undervalue their policies. Basically, what these companies will do is price their policies below expected claims, which pushes the combined ratio over 100%. This can be a good strategy for building a customer base, especially in life and health insurance businesses, as ordinary consumers are a bit more price sensitive than businesses. Unfortunately, this also forces the insurance company to make enough profit on its investment portfolio to compensate for losses in the insurance business. This is not necessarily a problem in bull markets, although it may require the insurer to invest more aggressively than many policyholders would like. This is undoubtedly a risky strategy, as the profits from investments are not always guaranteed and it can create problems in the event of a bull market. Travelers does not and instead the company still aims to have a combined ratio below 100%, as we have seen this quarter. This ensures that the company’s insurance business can stand on its own and better position the company to weather difficult conditions with ease. This is exactly the kind of thing that risk-averse investors can appreciate.
As is the case with most insurance companies, Travelers invests its underwriting profits in a variety of assets. The largest asset class is bonds, which make up around 94% of the portfolio. As we have also just seen, Travelers regularly generates an underwriting profit, which allows it to steadily grow this portfolio. Indeed, the company has managed to grow its portfolio by 21% over the last ten years:
As I have pointed out in the past, one of the characteristics of fixed income investments like bonds is that prices move inversely to interest rates. This benefited travelers during the fourth quarter, as interest rates during the last quarter were slightly lower than in the fourth quarter of 2020. This boosted the value of the company’s long-term bond holdings, but unfortunately, it also reduced the interest rates the company received from the newly purchased bones and, as we just saw, the company’s underwriting profit allowed it to add a lot of money to its investment portfolio. ‘investment. Fortunately, this newly added capital was enough to offset the impact of lower interest rates and the company managed to generate $437 million in after-tax profits on its bond portfolio, up from $434 million in the quarter. the previous year. Unfortunately, the Federal Reserve recently said it plans to start raising interest rates in the near future, so it seems likely that the company will start seeing unrealized losses on its bond portfolio going forward. Fortunately, however, the company does not depend on its investment portfolio to cover claims against its insurance business, so such a scenario would not be particularly material to the company.
In conclusion, Travelers delivered exceptional results during the fourth quarter of 2021. This is even more remarkable in the current environment of incredibly low interest rates when considering its extremely conservative investment strategy. Unfortunately, this could spell trouble for the company in the coming quarters if the Federal Reserve follows through on its recent statements and begins to tighten monetary policy. That said, the company does not depend on its portfolio of investments for its profitability, so it should be able to handle any changes in monetary policy with ease. Overall, I continue to like this business as a long-term conservative investment.