Assurant Seems To Be Baking In Much Tougher Times

By Stephen D. Simpson, CFA | September 17, 2012 AAA

There can be a lot of money in targeting specialized insurance markets, as there's often less competition and substantial rewards for building up expertise in underwriting. It's a strategy that has served companies like Berkshire Hathaway (NYSE:BRK.A, BRK.B) and W.R. Berkley (NYSE:WRB) pretty well. In the case of Assurant (NYSE:AIZ), though, analysts are taking a generally dim view of this company's ability to continue growing premiums and maintaining a profitable combined ratio. While the stock is not especially interesting if the bearish predictions are in fact accurate, financial outperformance could power a strong recovery in these shares.

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Regulators May Tighten the Screws on a Profitable Business
One of Assurant's largest businesses is in lender-placed insurance; essentially a type of homeowners insurance that protects the mortgage holder (a bank, investor or GSE most commonly) if the homeowner's coverage lapses. More than 20% of the company's premiums come from this business, where Assurant and QBE together hold more than 90% of the market.

Unfortunately, this business is under pressure not only from foreclosures and lower housing purchase activity, but also from regulators. Consumer advocates have complained that rates are just too high and these companies are making too much money. Although it's true that recent years have been profitable, that overlooks the fact that Florida (more than one-third of the market for LPI) hasn't had a major hurricane in going on seven years. The risk, then, is that regulators put the screws to Assurant on premium growth and leave the company vulnerable to future underwriting losses (to say nothing of diminished profitability even in the absence of catastrophes).

Can the Company Work Around Health Insurance Reform?
The arrival of Obamacare is going to significantly change health insurance for companies like Unitedhealth (NYSE:UNH) and WellPoint (NYSE:WLP), and Assurant is no different. In the case of Assurant, the mandate to force minimum medical loss ratios is leading the company to shift its business towards access and supplemental programs that fall outside the MLR controls. This has worked well recently, but I do worry a bit that companies like Chubb (NYSE:CB), Unitedhealth and so on may also look to these same markets to supplement their own profits.

SEE: Intro To Insurance: Health Insurance

The Economy Is a Threat
Although insurance companies are not widely seen as economically sensitive, matters are a little different for Assurant. Products like extended warranties/service contracts and pre-need life insurance (in essence, prepaying for funeral expenses) don't sell as well in tougher times, and the decisions of potential wireless clients like Apple (Nasdaq:AAPL) to self-insure doesn't help matters.

Likewise, the company's credit and employee benefits products also come under pressure in tougher times. When people struggle to pay their bills, credit insurance products tend to rack up bigger losses, and likewise employee benefits programs don't sell as well when companies aren't hiring new workers.

The Bottom Line
Analysts are pretty down on Assurant right now. Although the company has shown some annual premium growth since 2004 and has generally posted double-digit returns on equity, analysts are now looking for annual premium contraction of about 2% over the next five years, with returns on equity falling into the 7 to 8% range. Buybacks should help boost EPS growth into the green over that span and it looks as though the company should be able to fund higher dividends, but overall growth prospects seem sluggish by these numbers.

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With that sort of expectation in place, it's not so surprising that Assurant stock trades at about three-quarters of its tangible book value and a mid-single digit trailing P/E. With an excess returns model, those dismal assumptions likewise don't fuel an attractive target price. If Assurant can maintain 10% returns on equity, though, and continue with just a bit of premium growth, these shares could be poised to outperform. There are a lot of risks to that more positive scenario, though, so this is a stock that only really makes sense for aggressive investors willing to roll up their sleeves and do some pretty thorough due diligence.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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