On Thursday, July 21, 2022, property & casualty insurance giant The Travelers Companies, Inc. (NYSE:TRV) announced its second quarter 2022 earnings results. The stock initially fell on the news despite the fact that the company beat the expectations of its analysts in terms of both earned premiums and earnings per share. This was probably because its catastrophe losses were higher than in the year-ago quarter. Fortunately, the company’s stock began to recover some of its losses as the market began to digest the news, although it did still finish down on the news.
A much closer look at the results reveals that overall there is a great deal to like here, as essentially every negative thing in the earnings was a one-off event while the recurring factors are all quite positive and will serve to benefit the company during the coming quarters. Overall, The Travelers Companies continues to earn its reputation as one of the premier companies in its industry and should prove to be a stalwart in anyone’s portfolio as the nation begins to head into a recession.
As my long-time readers are no doubt well aware, it is my usual practice to share the highlights from a company’s earnings report before delving into an analysis of its results. This is because these highlights provide a background for the remainder of the article as well as serve as a framework for the resultant analysis. Therefore, here are the highlights from Travelers’ second quarter 2022 earnings report:
- The Travelers Companies reported total revenues of $9.136 billion in the second quarter of 2022. This represents a 5.17% increase over the $8.687 billion that the company brought in during the prior-year quarter.
- The company reported a core income of $625 million in the most recent quarter. This compares rather unfavorably to the $879 million that the company reported in the year-ago quarter.
- Travelers had total catastrophe losses of $746 million in the reporting period. This was a substantial increase over the $475 million that the company had in catastrophe claims last year.
- The company achieved a combined ratio of 98.3% in the current quarter. This was substantially worse than the 95.3% that the company had in the equivalent quarter of last year.
- Travelers reported a net income of $551 million in the second quarter of 2022. This represents a 41.01% decline over the $934 million that the company reported in the second quarter of 2021.
It seems essentially certain that the first thing that anyone reading these results will notice is that, with the exception of revenues, every measure of financial performance was worse than the prior-year quarter. The biggest reason for this was the fact that the company had much higher losses due to catastrophe-related claims during the quarter than it did in the corresponding quarter of last year.
Travelers does not explicitly state what these catastrophes were, and admittedly we did not see a significant hurricane during the quarter, which makes June 2022 the first June since 2014 to lack a named hurricane. There was a major tornado outbreak in Alabama during April, as well as one in the Northern Plains and Upper Midwest in June, so it is possible that these were contributing factors.
Historically, the Travelers Companies sees higher catastrophe losses in the second and especially thing quarters than at other times during the year. However, 2021 was abnormally low for these events so what we are seeing here is a return to more normal conditions and is overall nothing that we need to worry about. Travelers has one of the more conservative underwriting cultures in the industry and prices its policies appropriately to be able to absorb catastrophe losses of this level so there is little reason for us to worry about the increase in claims.
We can clearly see that Travelers has appropriately priced its policies to handle these catastrophe losses by looking at the company’s combined ratio. The combined ratio is a critical figure to look at when analyzing an insurance company. That is because this figure tells us what percentage of its collected premiums it had to use to pay out all of the claims against it. As stated in the highlights, Travelers reported a combined ratio of 98.3% in the most recent quarter, which was somewhat worse than the company had in the prior-year quarter.
Although the decreased performance here is disappointing, Travelers still performed acceptably. That is because this figure was still lower than 100%, which means that the company collected more in premiums than it had to pay out in claims against its policies. This was true despite the substantial increase in catastrophe losses that Travelers suffered. This allowed Travelers to invest the excess money into its investment portfolio, which is critical for the company to maintain in case something very bad happens. As we will see later in this article, the profits that the firm makes from these investments is a critical part of its business. Obviously, we would rather see Travelers grow its portfolio than have to spend it to cover claims so the fact that the company is able to consistently deposit its excess premiums into this portfolio is very nice to see.
The Travelers Companies is generally thought of as an insurer of commercial property and this perception makes a great deal of sense since its business insurance division is substantially larger than any other business unit. During the second quarter, this business unit had total net written premiums of $4.373 billion, which was an increase of 9.87% over the $3.980 billion that the unit had last year. It would also represent 48.48% of the total across the entire company. Curiously, this business unit also saw its combined ratio improve compared to the prior-year quarter:
|Q2 2022||Q1 2021|
|Business Insurance Combined Ratio||93.2%||95.3%|
This was not due to the company’s business customers being immune to the catastrophe losses. Indeed, catastrophe claims made by Travelers’ business customers were higher year-over-year just as they were company-wide. Rather, the improvement was caused mostly by insurance premiums paid by these customers increased by more than catastrophe claims did. Travelers did not provide a reason for this, but it is possible that the insurance industry is entering into a tight market. A tight market is typically caused by a weakening economy or periods of inflation that drive up the amount that insurers have to pay out in order to settle claims. We have certainly been seeing these things recently so this could very easily be the case.
In addition to this, insurance carriers such as Travelers are having an increasingly difficult time earning investment profits, which we will see in just a moment. When this happens, insurance companies tend to tighten underwriting standards and increase the prices that they charge customers in order to maintain their reserves and profits.
Travelers is not exclusively an insurer of commercial enterprises. The company also has a large personal insurance unit. Unfortunately, this business unit did not perform nearly as well as its business insurance operation:
As we can see here, with the exception of the year-over-year increase in net written premiums, most measures of financial performance were worse than a year ago. The most significant of these was the business unit’s segment income going negative compared to its profit last year. The biggest reason for this was that catastrophe losses were higher than in the year-ago quarter.
However, there is another reason that might not be expected. In a previous article, I discussed how Travelers was one of the few beneficiaries of the COVID-19 pandemic. This is because fear of the virus along with various governmental lockdown orders resulted in many people staying at home and limiting their driving. This caused a reduction in automobile-related claims. It also caused a reduction in homeowner claims because people tend to have fewer losses involving their property when they are actually present at it. This was still generally true in the second quarter of last year despite the economy generally reopening in many areas.
However, many people have now begun to return to their pre-pandemic lives. This, combined with inflation, resulted in Travelers having more homeowner and automobile losses that were not connected to a catastrophe. Unfortunately for Travelers, personal insurance buyers tend to be more price-sensitive than businesses, so the company does not have the same flexibility to raise prices for these policies. These factors combined have all put a great deal of pressure on the personal insurance unit. With that said though, it would have been profitable was it not for the catastrophe losses.
Travelers also has a business unit that issues surety bonds and other specialty types of insurance like directors’ and officers’ liability insurance. This is historically a very stable line of business relative to the others because it is not particularly affected by catastrophes or other things that tend to be one-off events. We certainly saw this in the most recent quarter, as we can see here:
As we can clearly see, every measure of financial performance showed significant year-over-year improvement, with segment income increasing by a very impressive 21.93%. Unfortunately for Travelers, this business unit is too small to have a significant impact on the company as a whole since it only accounts for 10.67% of the company’s net written premium. Travelers did not provide any reason for the performance increase except for prices being slightly higher and losses being slightly lower than last year. The differences were fairly minor statistically, though, which as already mentioned is common for this business unit.
As already mentioned, Travelers invests the excess premiums that it collects beyond what it has to pay to settle claims into a variety of assets. Over the company’s long history, this portfolio has grown to a size of $80.5 billion, most of which consists of bonds:
As we can see, only 7% of the company’s portfolio is invested in things other than fixed-income securities. Unfortunately for Travelers, this 7% of its portfolio proved to be a drag on the company’s year-over-year financial performance. As everyone reading this is no doubt well aware, the market has not performed nearly as well this year as it did in the first half of 2021. While Travelers’ non-fixed income allocation is mostly in private equity and real estate as opposed to stocks, these assets tend to perform much better when the stock market does.
As a result, Travelers delivered weaker investment profits than it did in the second quarter of 2021. In the second quarter of 2022, Travelers reported a net investment income of $707 million, which was a 13.57% decline over the $818 million that it earned in the prior-year quarter. When we combine this weaker performance with the losses in the personal insurance unit, it more than offsets the higher segment income that the company had in the other areas of its business and results in the company’s weaker financial performance than a year ago.
As everyone reading this is no doubt well aware, the Federal Reserve has been very aggressively hiking interest rates in an effort to combat the incredibly high inflation rate that the United States has been suffering from over the past year. This has proven to be a drag on Travelers’ reserves, which I predicted would be the case in previous articles on the company. This is due to the very high allocation to bonds. Although the long-term bonds themselves continue to pay the company the same amount that they always have, their value varies inversely to interest rates. Basically, when interest rates rise, bond prices go down. This is because the bond prices adjust so that previously issued bonds with lower coupon yields deliver the same yield as newly issued bonds with higher coupon yields. Were this not the case, nobody would ever buy older bonds that were issued when interest rates were higher.
We can see the impact of this by looking at Travelers’ book value per share, which primarily consists of the net asset value of its investment portfolio. As of June 30, 2022, the company had a book value of $96.39 per share compared to $119.77 at the start of the year. It seems likely that the company will continue to see this value decline should the Federal Reserve continue to raise interest rates, as it has stated is its intention. Fortunately, these are essentially unrealized losses that Travelers is suffering. As we have already seen, the company typically collects more in premiums than it has to pay out in losses, so it is not dependent on selling the assets in its portfolio to cover the claims against it. This is one of the nicest things about this company as it allows us to not have to worry about the unrealized capital losses that Travelers is suffering from the central bank’s current policy.
In conclusion, Travelers’ results may have been disappointing at first glance because it generally performed worse than last year. This is despite the fact that it did beat the expectations of analysts. However, a closer look reveals that there is nothing to worry about here as the firm is continuing to generate an underwriting profit that allows it to not have to lock in the unrealized losses in its portfolio by selling assets. Travelers overall continues to be one of the best companies in the insurance space and thus makes an excellent core holding for anyone’s portfolio.