A:

Insurance companies could be an attractive addition to an investment portfolio offering a good balance of capital appreciation and dividends. Similar to other financial services firms, valuing insurance companies poses difficulties to analysts due to small capital expenditures and depreciation that have little effect on insurers' profitability. Additionally, insurance companies do not have standard working capital accounts such as inventories and accounts receivable and payable, making relative valuation multiples based on capital useless. For these reasons, analysts focus on equity multiples, one of which is the price to earnings (P/E) ratio. In April 2015, the average trailing 12 months P/E ratio for the insurance companies with positive earnings is approximately 20.6.

The P/E ratio is calculated as current market price divided by the earnings per share (EPS). There are different variations of this ratio depending on which EPS are used in the denominator. Forward P/E ratio is calculated based on expected EPS in the next 12 months. The TTM P/E ratio is based on earnings for the most recent four quarters. The P/E ratio for insurance companies depends on the expected earnings growth, risk, payout and profitability of the insurer.

The insurance industry is divided into a wide variety of categories including property and casualty, surety and title, accident, and health and life insurance. Each type of business commands its own P/E ratio since there are differences in risk profile and expected earnings growth.

The average P/E ratio should be used with caution since large outliers can greatly influence it by the average. Analysts ordinarily supplement the average P/E ratio with the median P/E ratio, which is 12.5 in April 2015. The large difference between the average and the medium is due to a few companies that have very large P/E ratios that skew the average statistic.

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