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The Safety of Travelers

As once-safe insurance companies face a rough climate, one stock may weather the storm.

February 19, 2009
By Katie Benner

It's a sure sign of the bad times when safe, stable and unexciting insurance companies are cracking up.

Not only has demand for insurance slowed, but companies from Aetna (AET, Fortune 500) to AIG (AIG, Fortune 500) have lost billions of investment dollars as the markets tanked and blowback from bad banks hit just about every financial name.

But while the 2009 forecast calls for more bad times, investors may find a little safety under the big red umbrella of The Travelers Companies.

The current storm hits insurance companies in two big ways: a drop-off in business and investment portfolios losses. But Tom Forester, manager of the Forester Value fund, says Travelers, which offers auto, home, and business insurance, should be able to weather both big issues.

"In this environment people tend to lower the insurance coverage they have, but Travelers is a quality company and, especially after the AIG meltdown, people will want to do business with a company they can trust," he says. "The underlying credit of its $70 billion investment portfolio is very good and they have been conservative investors. They didn't get caught up in structured finance."

Travelers chief executive Jay Fishman is unwilling to make declarations about future pricing or market bottoms, but he will say that pricing power has improved over the last three months.

"There is some cause for cautious optimism," he tells Fortune. But he adds: "We are in uncharted waters. We have $350 billion in Federal money already invested in the financial services industry, and we're facing an economic contraction of a size not seen since the 1930s. Anyone who says they've seen this before isn't telling the truth."

And the truth is that the insurance industry is going to hit a rough patch for some time to come. Demand for worker compensation insurance will shrink as employers cut payrolls. Corporate America will see less capital investment, and fewer businesses will start up. Fewer consumers will buy cars and homes. All of these trends take aim at how many policies Travelers can write.

But in order to offset a demand loss, Travelers has been actively containing costs. As the economic meltdown gained steam over the past year, the company slowed its hiring. It ended 2008 with a lower aggregate headcount, allowing attrition through retirement rather than significant layoffs.

Management has also been buying back less stock in order to conserve cash at the St. Paul, Minn.-based company. The move suggests "confidence in Travelers' capital position," Citigroup analyst Joshua Shanker wrote in a note.

Travelers (TRV, Fortune 500) issued earnings guidance for 2009 of $4.50 to $4.90 a share, about a dollar lower than the average analyst forecast, due to the "current uncertain economic environment." But Shanker, who thinks the company could earn $5.50 a share, says management does not include $700 million in increased reserves. Last month, Travelers said its quarterly profit fell 27% on an income drop from investments, but it did beat Wall Street expectations.

As for the investment portion of its portfolio, Travelers counts on safe bets. Like most other insurance companies, it invests money from insurance payments in order to generate additional income. Travelers is 95% invested in bonds, 80% of which are AA or AAA rated. Many of those securities are municipal bonds, which all have strong AA ratings even without bond insurance.

Keeping its nose clean

Travelers owns no CDOs, SIVs or asset-backed paper, and is not a party to any credit default swaps, the derivatives that sank AIG. Realized losses on its portfolio were less than 1% of its book value in the fourth quarter, a testament to how cautiously the company has invested in the past.

Plus, Travelers did not offer annuities, as insurance giants like Hartford Financial did, eliminating the worry that some companies face, of not making enough money to cover their fixed annuities payment obligations.

Travelers is very transparent, says Susan Byrne, chairman and chief investment officer of Westwood Holdings Group. "You can actually follow its income statement and balance sheet, which has not been the case with AIG and other insurers."

And the stock is also a value if you believe Travelers will come out the other side of the economic crisis intact. It trades at a forward price-to-earnings ratio of seven, and it pays a dividend yield of 3%.

For 2008, Travelers' operating return on equity was 12.4%, and its combined ratio was 85.9%, an impressive result - especially compared with life insurers that are struggling to honor insurance obligations. Combined ratio is the amount of money insurers pay out in claims and expenses versus how much money that comes in from writing new business. If the ratio goes above 100%, the company is paying out more than it takes in. Book value per share increased 2% whereas many competitors saw their book values fall.

"Looking forward to 2009, we believe that Travelers is well positioned in the current uncertain economic environment. Our balance sheet is strong with capital at or above all of our target levels, our debt to capital ratio of 19.5% is below our target of 20% and holding company liquidity of $2.1 billion is approximately twice our target level," CEO Fishman told investors on a conference call.

It's a conservative company that has the cash on hand to pay its debts, is not dependent on the commercial paper market for financing and has more than $9 in cash per share.

"I don't know how long the downturn will last, but can I make a judgment now about which high quality companies will be standing in five years," says Byrne. "I think Travelers will be around."

Says Forester: "I bought this stock so I could sleep at night."

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