Insurance companies have a unique business model that can, theoretically, perform well no matter what the market is doing. Essentially, insurers collect insurance premiums from their customers and then invest those premiums and pocket the gains. One major characteristic of crash-resistant companies is that they provide services that are needed in any economic environment. During crashes or recessions, people still need to insure their cars, homes, and other possessions, so insurance companies can still count on having money to invest and generate gains. Further, insurers invest the premiums they collect in relatively safe assets -- mostly investment-grade corporate bonds, municipal bonds, and Treasuries.
Continue Reading Below
So, during bad times, insurance companies' products are still in demand, and their investments can be counted on to provide steady income. Let's take a look at which insurance companies are best-positioned to deliver market-beating performance, even if the stock market crashes.
What to look for in "crash-proof" companies
First of all, there is no such thing as a completely crash-proof company. All companies have the potential to be affected by adverse economic conditions. That said, some companies are more crash-resistant than others, so they tend to outperform their peers and the overall market during hard times.
Let's go over some general criteria for crash-resistant stocks. Then we'll discuss how these apply to some insurance stocks.
- Low debt: Companies with high debt loads tend to struggle more during tough times. Debt costs money, and when earnings drop in a recession or a crash, companies with lots of debt may struggle to pay it back.
- Diverse revenue stream: Companies that have a variety of revenue sources tend to do better than those that depend on a single source of revenue. The most crash-resistant insurers offer many different insurance products and operate in many geographical regions, so weakness in a single business unit or region will not bring down the entire company.
- Competitive advantage: In short, a competitive advantage -- what Warren Buffett refers to as a "wide moat" -- is something that allows a company to perform better than its peers. This could be an innovative product, great brand recognition, or simple economies of scale.
- Dividends: Companies with strong dividend histories tend to perform well in recessions. In tough times, a dividend can help create a "price floor," and this is especially true if the market perceives the dividend as safe.
- History of crash-resistance: One of the best ways to gauge how well a company would perform in a crash is to see how well it did in the last crash. While past performance doesn't guarantee future results, it's a good indicator of the potential damage a crash could cause.
3 solid insurance stocks for a crash
With the above criteria in mind, here are three insurance stocks I feel would do well in a stock market crash. Bear in mind that this isn't an exhaustive list, and not all of the above criteria apply to each stock.
Continue Reading Below
1. Progressive Progressive specializes in auto insurance, and it has a market-leading position in motorcycle insurance. Despite the fact that it sells just one type of insurance, I believe there's good reason to believe Progressive is a crash-resistant insurance company.
First, Progressive has a conservative financial policy, preferring to keep its debt levels low (below 30% of capital) and instead leverage its surplus. And its superior technology and marketing capabilities give the company an edge over its peers. After all, Progressive's advertising campaigns are becoming even more recognizable than the GEICO gecko.
Additionally, Progressive's historical performance speaks for itself. Most insurance companies simply break even on their underwriting income and make all of their money from investing. In fact, the industry average underwriting margin over the past decade has been a paltry 1.4%. Progressive has averaged a 7.9% margin from underwriting revenue alone, giving it a strong edge over peers if things go sour. This has contributed to Progressive's 17.8% average return on equity during that time period -- which, keep in mind, included one of the worst recessions in history.
2. Aflac Aflac could be an especially good stock to own in the event of a U.S. stock market crash. Many investors don't realize it, but nearly three-fourths (72%) of Aflac's revenue comes from Japan.
One of Aflac's strengths is its leading position in the supplemental life and health insurance businesses. The company has agreements with 90% of Japanese banks to sell its products, and it has a vast network of more than 14,500 sales agencies that also sell Aflac's insurance.
Aflac has produced 32 consecutive years of dividend increases, and it has produced an ROE of more than 16% throughout the past decade. This number would have been significantly higher if not for the weaker Japanese yen -- though this actually gives U.S. investors another opportunity to profit if the yen begins to strengthen.
However, bear in mind that the company's large Japanese exposure also has some negative aspects. For example, Aflac is significantly more volatile than the other two insurers I mention, thanks to the added variable of USD-yen fluctuations. And although Aflac isn't quite as vulnerable to a U.S. recession, economic weakness in Japan could do serious damage. Nevertheless, I feel that the long-term reward potential justifies the risks.
3. Travelers -- Travelers is a property-casualty insurance company with a diverse mix of products. About 61% of Traveler's revenue comes from business and international insurance products, such as workers compensation insurance and commercial property and auto insurance. Another 30% comes from personal insurance products such as homeowner and auto insurance, and the other 9% comes from bond and specialty insurance products. This kind of diversification is a valuable asset when there's weakness in any single area of the insurance business.
Furthermore, Travelers has expanded its international presence (Canada) in recent years and maintains a very low debt-to-capital ratio of 21.8%.
It's also worth mentioning that for all three of these companies, as well as other insurers, investment income could increase significantly if interest rates begin to rise later this year, as most experts are predicting. Most insurance companies primarily invest in "safe," fixed-income securities, and they could see their investment income soar if yields rise.
Finally, as far as performance during the last crash is concerned, consider that all three of these stocks outperformed the S&P in 2008.
These three insurance companies could perform well (and have performed well) in both good times and bad. Not only could they provide you with good downside protection, but their excellent returns could really add up over time.
The article Insurance Stocks for a Stock Market Crash originally appeared on Fool.com.
Matthew Frankel has no position in any stocks mentioned. The Motley Fool recommends Aflac and Progressive. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
Copyright 1995 - 2015 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.