Insurance is generally sold “direct” by insurance companies’ paid employees or sold via agents/brokers also known as third party distributors. The economics of an agent/broker are very attractive. They charge a commission/fee for their services (typically a percentage of the premiums) and do not assume underwriting risk – they are only middlemen in the insurance placement and sale. Insurance industry premiums are correlated to economic and population growth, and agent/broker client retentions are typically >90%. These factors yield steady, predictable revenues and margins, with only modest capital needs.

There are thousands of agents/brokers in the U.S. The attractive economics of the business, combined with readily available and cheap credit, have fostered a robust M&A environment in recent years. This consolidation has left public investors with fewer options to invest. However, publicly traded agents/brokers remain active buyers of private properties, adding another layer of growth to the long-term business model.

There is some cyclicality in the business. Insurance industry premiums reflect exposure (economic activity) and price (actuarially determined). When economic growth accelerates, the exposure piece of the premium equation increases, which tends to increase commissions and fees for the agents/brokers. The converse is also true. When property-casualty prices are increasing (to offset increases in claims/reserves), the price piece of the premium equation contributes similarly to the revenue model. Interestingly, the COVID-19 environment contributed to both exposure declines and price increases – the ultimate net impact to agents/brokers remains to be seen. However, we expect the business models to prove their resiliency.

We maintain long-term investments in this group. The valuations attributed to the publicly traded agents/brokers are reasonable, given the capital-light business models and long-term growth (organic and M&A) opportunities. We view these stocks as conservative investments in uncertain times.

Everyone uses insurance, but few people realize how attractive these companies can be from an investment standpoint.

If this topic is of interest to you, we invite you to read more from this white paper entitled,“The Nuances of Insurance Investing.” Please click on the graphic below to download the full piece.

Editor's Note (February 26, 2021): The post above is part of a white paper that was originally published September 9, 2020, but has been updated in light of current events.