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Fixed Income

Unintended Consequences Of Corona - Positive View For Income Investors Apr. 8, 2020 8:22 AM ET12 comments | 8 Likes by: The Money Madam

Summary

Sad as this COVID-19 experience has been for everyone, there are some positive consequences.

Without a doubt, we will have fewer auto accidents, and that should lead to fewer claims paid by insurers. That makes me look for an auto insurer to add to my portfolio.

In my portfolio, I own Prudential. But I no longer own a property and casualty insurer.

I looked at a bunch of insurers, and out of this group, the best yield is MCY, which is the most pure property and casualty play.

Unintended consequences of COVID-19 include less crime, reduced spread of communicable diseases, fewer auto accidents.

Fewer miles driven makes for few accidents. Auto insurers should benefit from fewer accidents and payouts. Looking for a stock with an A rating. Looking for an insurance stock with a high yield. Looking for a stock that is optionable.

Sad as this COVID-19 experience has been for everyone, there are some positive consequences. Governor Cuomo commented on a reduced crime rate. With the social distancing and the wearing of masks and the unrelenting hand washing, we have to be reducing the incidence of communicable diseases in general.

Another unintended consequence is driving behavior. With stay-at-home behavior, people are driving and even riding in cars fewer miles and fewer hours. Fewer miles driven translates to fewer accidents. This is an interesting article on the impact of recessions and other events on traffic. This morning on my local news channel, we learned that auto accident deaths in our State are down.

Explore Premium Featu

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Without a doubt, we will have fewer auto accidents, and that should lead to fewer claims paid by insurers. That makes me look for an auto insurer to add to my portfolio.

In my portfolio, I own Prudential (PRU). But I no longer own a property and casualty insurer. In 2017, I wrote up a post that applied my dividend machine fundamentals to a group of insurers. I ended up owning several of those, but they were all either called away on options or I sold them for other reasons as their prices increased.

Today, I looked at a bunch of insurers, including Markel Corp. (MKL), Safety Insurance Group (SAFT), Hartford Financial Services Group (HIG), Chubb (CB), MetLife (MET), American International Group (AIG), Mercury General Corp. (MCY), ProAssurance Corp. (PRA), and CNA Financial Corp. (CNA). Out of this group, the best yield is MCY, and it is the most pure property and casualty play. SAFT has a good yield and generates most of its business from private passenger auto insurance. But SAFT is limited to the North East.

Another factor that determines which of these stocks I want to pursue is their credit rating. For insurance companies, there are several credit rating agencies. AM Best and Fitch are two that are well-known. While MET has an A+ rating by AM Best, it really is not as pure a play on auto insurance. Take a look below at the credit rating categories of insurers.

Categories Rating

symbols

Rating

notches

Comments

Superior A+ A++ Assigned to insurance companies that have a

superior ability to meet their ongoing insurance

obligations

Excellent A A- Assigned to insurance companies that have an

excellent ability to meet their ongoing insurance

obligations

Good B+ B++ Assigned to insurance companies that have a

good ability to meet their ongoing insurance

obligations

Fair B B- Assigned to insurance companies that have a fair

ability to meet their ongoing insurance obligations

Financial strength is vulnerable to adverse

changes in underwriting and economic conditions

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Marginal C+ C++ Assigned to insurance companies that have a

marginal ability to meet their ongoing insurance

obligations

Financial strength is vulnerable to adverse

changes in underwriting and economic conditions

Weak C C- Assigned to insurance companies that have a

weak ability to meet their ongoing insurance

obligations

Financial strength is very vulnerable to adverse

changes in underwriting and economic conditions

Poor D - Assigned to insurance companies that have a

poor ability to meet their ongoing insurance

obligations

Financial strength is extremely vulnerable to

adverse changes in underwriting and economic

conditions

SAFT carries a BBB+ rating, whereas, MCY carries an A rating. Both are acceptable, but I like A over triple B plus.

Once I narrowed this group down, I look at dividend fundamentals that I use for every dividend stock I add. Here is how MCY stacks up.

MCY Annual EPS Annual Div

Earnings>Dividend $5.78 $2.52

Debt to Equity Ratio 0.23

Dividend Yield 6.45%

3 Yr. Rev. Growth 6.08

3 Yr. Div. Growth 0.03%

Cash Flow/Share $9.39

P/E Ratio 6.5

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Mercury General has a long history, and that is so useful when making the decision to add a new position. Looking at the table above, MCY shows me that its earnings are adequate to pay the dividend, and that yield is hefty at 6.45%. I also see a D/E ratio that is low, but typical of insurers. Revenue has adequate growth and P/E ratio is downright cheap.

The only negative I see is the lack of dividend growth. I will take the big yield on a solid balance sheet while I work shares to maximize income while this low accident rate catalyst works.

When I add a new position, I want good yield, a solid balance sheet and a solid history of dividend payments. Looking back on their history during the 2007-2009 market disruption, I see a stock with a solid history of paying the dividend through thick and thin.

Fr

(Graph from DividendChanel.com)

I also like a stock that is optionable because I make a lot of extra money selling calls on my dividend stocks. I don't want to necessarily lose all my shares should I be called away, therefore, I sell calls on only a portion of my position. Each call requires 100 shares. If I own 500 shares, I might sell 2 calls and keep the other 300 shares unencumbered by a call option.

I started this article on 4/6/2020, but executed the trades today, 4/7/2020. As soon as I bought my shares, I sold this call.

Price on Open Call Expiration

MCY $40.11 6/19/2020

Cost Basis: 4/7/2020 $39.90

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Strike Price: $45.00

Call Premium: $1.25

Dividend 6/16/2020 $0.630

Call Yield on Basis 3.13%

Call + Dividend Yield on Basis 4.71%

$ Gain if Assigned $6.98

Max Return if Assigned 17.49%

We all hope this crises is shorter-lived than we currently expect. Moreover, we hope the underlying business of America goes on. Currently, the options buyers are out there, and that is most important for income investors like me who use a covered call strategy for income maximization.

M* MoneyMadam

Disclosure: Expect to add MCY and expect to sell calls against a portion of the position.

Original Post

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

Dividend Scores Very PoorPoorNeutralGoodVery Good

Ticker Company Name Div Yield Relative Yield Consistency Safety Growth

MCY Mercury General Corporation 6.10%

SAFT Safety Insurance Group, Inc. 4.30%

HIG The Hartford Financial Servi… 3.25%

CB Chubb Limited 2.53%

MET MetLife, Inc. 5.32%

AIG American International Grou… 5.22%

PRA ProAssurance Corporation 5.73%

CNA CNA Financial Corporation 4.52%

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Ticker Company Name Div Yield Relative Yield Consistency Safety Growth

PRU Prudential Financial, Inc. 7.77%

Comments (12)

Tawm Madam: the issue of how insurers survive in a ZIRP/NIRP environment is key. Perhaps another article?

12 Apr 2020, 11:16 AM

The Money Madam Contributor

Author’s reply » Dear Tawm: we are all interested, please do write one up. M*

12 Apr 2020, 04:53 PM

user1416 I think Progressive is probably the only auto insurer I would consider holding- and I sold them when rates went to zero, along with Travelers and Chubb.

Insurers have run out of places to park their reserves and generate investment income.

11 Apr 2020, 01:41 AM

The Money Madam Contributor

Author’s reply » Dear User1416; Not enough yield from Progressive. M*

11 Apr 2020, 02:37 PM

Jeff Swan Good thesis if you're a short term trader but not as a long term investor. Eventually things will return back to normal.

09 Apr 2020, 10:45 AM

Retired Investor Contributor PREMIUM Marketplace

Many auto insurers are refunding premiums due the drop in driving. Other drivers might ask for a lower rate if mileage now below 7500, a typical point that allows that to happen.

09 Apr 2020, 10:19 AM

113467

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Tawm You are so right.

09 Apr 2020, 08:13 AM

Tawm There is no “Mayor” Cuomo, just a preening, self-absorbed thug who is governor of a very corrupt state, who is being preened by the media to replace a demented Biden at the virtual convention. otherwise, agree with your thesis.

08 Apr 2020, 09:24 AM

The Money Madam Contributor

Author’s reply » Edit submitted. M*

08 Apr 2020, 10:39 AM

Magnum1 Thanks for the article and the stock idea!

09 Apr 2020, 06:55 AM

Jack'sson @Tawm Funny! Demented Biden when the current president can't even read the lies Mitch has given him!

09 Apr 2020, 10:54 AM

Rudester @Tawm How about the demented tenant at the White House?

09 Apr 2020, 11:06 AM