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Is Insurance a Sure Thing?


Insurance premiums are climbing, and that should be bullish for property-casualty firms. Yet investors are so down on the industry that it sells for about 10 times this year's earnings, 20% below the historical average price-earnings ratio.

But if they are like Indianapolis-based analyst Michael Harris of mutual-fund operator Strong Capital Management and believe that the higher premiums and tougher underwriting standards will last, then today's prices are a buying opportunity. "It's an industry that is growing its top line at a double-digit rate and will likely turn in profits soon," says Harris. Among the largest companies, Harris especially likes American International Group (AIG) just because it's one of the world's largest, best-capitalized, and most diversified insurers. AIG trades at 15 times 2003 earnings -- about half the valuation it reached in late 2000. Strong holds 1.5 million shares of AIG.

Perhaps the more attractive investments are in some smaller property-casualty insurers and reinsurers you've never heard of -- Arch Capital Group (ACGL), Endurance Specialty Holdings (ENH) and Montpelier Re Holdings (MRH) What they all have in common is that they were launched after September 11 and are incorporated in Bermuda. "These Bermuda companies have no legacy issues like asbestos hanging over them, and they have had excellent results so far," says Bryon Ehrhart, president of Aon Re Services, an advisory division of insurance broker Aon.

The Bermuda companies also pass along the tax savings they enjoy from being incorporated on that island. What they offer -- specialized forms of coverage for directors and officers and errors and omissions for accountants -- is risky, but they collect hefty premiums for taking on those risks. And they're cheap. Arch Capital, which generated revenues of $436 million in the first quarter of 2003, is now trading at 12 times 2003 earnings. Endurance, with 2002 revenues of $800 million, is trading at a p-e of 10. These companies are small and relatively untested, though most have been started by well-regarded industry veterans. They don't have AIG's top-drawer A++ rating, but they have strong ratings: Endurance and Montpelier earned single-A ratings from A.M. Best for financial strength, and Arch received an A-.

Asbestos has been a drag on earnings of major insurers, which have had to take charges because of huge jury awards. However, Jeffrey Arricale, an analyst at T. Rowe Price (TROW) Group in Baltimore, says it's worth giving Hartford Financial Services Group (HIG) another look -- because at nine times 2004 earnings, the stock is cheap. "Hartford is already heavily fortified against asbestos," says Arricale. Congress is considering legislation that would limit asbestos-related payouts. "If that happens, the company will have extra reserves to play with," he says, and so will other insurers.

Such a move would give the stocks some extra oomph. But at current valuation levels, they don't need it to make money for investors. By Pallavi Gogoi


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