The Rising Sun Sector

While central bank policies have lifted global stock markets over recent years, quantitative easing has weighed on the insurance sector heavily. With artificially inflated bond prices leading to yield compression, investment income for insurers has declined rapidly.

The consequence of this has been highlighted in dividend cuts by both RSA Insurance and Aviva during the early stages of 2013. However, with the US economy firmly on the road to recovery, the Federal Reserve has now begun to unwind its $85 billion per month asset purchase program. This is an action that can be said to herald the beginning of the end for an era of ultra low interest rates.

Now that the FOMC has begun to taper, just one of the obvious consequences over the coming months will be a rotation higher in short dated treasury yields. With this dynamic in play, valuations still attractive and the insurers currently receiving the silent treatment because of adverse weather conditions and flooding; now seems an ideal time to take another look at the sector. One of the insurers to have made our list for regular coverage is Hiscox Insurance Ltd.

Hiscox Ltd are a specialist insurer with a core focus on catastrophe risk as well as additional lines such as marine and aviation, political risk, fine art, terrorist attack and HNWI kidnapping and ransom. The company also underwrites interplanetary probes and observation satellites alongside maintaining a significant reinsurance footprint.

Although the majority of the investment case for Hiscox centres very much around a significant exposure to short dated US treasuries, as a business it has grown exponentially since being established.

The stock currently trades on a multiple of 9.8 x earnings while it also pays a yield of just over 3% which is covered 2.9 times over. Relative to other insurers, and given the company’s growth prospects, this is cheap.

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With an annualised ROE in excess of 25%, steady earnings per share growth and a consistent increase in premiums underwritten, Hiscox presents an attractive proposition for equity investors. This is particularly true for those who are seeking a yield as well as a hedge against any downside that may occur in the markets when the Federal Reserve’s tapering program nears completion.

The above graphic illustrates the significant exposure that Hiscox has to the bond market within its investment portfolio. Revenues from the portfolio have been under pressure for some time and have dropped off significantly over the last year in particular. This is because a significant amount of Hiscox’s bond portfolio is comprised of US treasuries. The below graphic illustrates this.

With treasury yields expected to rise in the near future and US dollar strength due to accompany this, Hiscox earnings through investment income will be likely to experience some welcome relief.

In addition to the cheap valuation and improving investment outlook, the business is growing strongly in an organic fashion. All areas of underwriting continue to see steady and sustained growth in written premiums while the company’s combined ratio remains stable. In short, the investment case for the company continues to remain sound with the business appearing to have a bright future ahead of it.

The next management update to investors will be full year results on 24 February. These will reveal whether the aforementioned trends have continued into 2014. Results are also likely to include some form of guidance regarding the anticipated impact of tapering upon Hiscox’s bond portfolio.

As a result, we will continue to monitor the company over time. This is while our current outlook sees the shares trading above previous highs toward our internal price target of 720.00 pence over the coming months.

HISCOXDECEMBER13

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