Anatomy of a Long-Term Hold

When considering new investments in US equities, we usually look for companies that we could own for ten years or more. That said, once investment is made, the average holding period ends up being around three to four years, which is considerably shorter. That number hides a certain amount of variability. Some investments may be held for just a few months due to factors such as takeovers or shifts in investment thesis, while others, where the thesis is developing gradually and intrinsic value is being built, could remain for a decade or longer.

A ten-year timeframe is substantial and during this period, a business can either maintain its trajectory or undergo significant transformation. This article aims to compare two companies within the same industry that have delivered similar value to their shareholders but have achieved it through markedly different approaches.

Travelers Co (TRV) is a traditional regulated insurer. It stands out in the market by selling commercial and personal property/casualty insurance through a network of independent agents and brokers. While this approach may seem outdated to consumers accustomed to online comparison sites, it remains a dominant form of distribution for most insurance lines.

Source: independent agency market share report (https://www.independentagent.com/media/Pages/2024/bigi-releases-2024-market-share-report.aspx )

Commercial, workers' compensation, and other lines are an area of strength for Travelers, which is 80%+ reliant on independent agents primarily because small and middle market businesses rely on the agents to understand each company’s unique situation and tailor the insurance offering to the needs.

Last year, Travelers' segment breakdown looked like 2013, with more than half of the premiums generated by the commercial insurance lines. Curiously, one area of outstanding growth has been personal auto insurance, where the company continues to effectively compete despite strong competition from DTC operators such as Geico and Progressive.

Source: Company Financials, Firebird Value Advisors Research

Over the last decade, Traveler’s gross written premiums grew by 5.9% per annum, precisely in line with the growth of the overall P&C market.

Underlying profitability also stayed roughly the same, with the combined ratio, a key measure of insurance company profitability, fluctuating between 90% and 100% for most years, including the most recent period showing profitability.

Source: Company Financials, Firebird Value Advisors Research

The company’s solid yet admittedly unremarkable performance raises the question of why it was a good company to be invested in for the last decade and, more importantly, why it has the attributes to be successful going forward. The answer is in capital allocation.

Over the ten years, Travelers generated $57 billion of operating cash flow, which happens to be roughly equivalent to the company’s current market cap. $30 billion was returned to shareholders as dividends and buybacks, with the remainder added to the investment portfolio that now stands at $90 billion and supports insurance operations. Thanks to the repurchases, shares outstanding declined by nearly 30%, one of the main reasons Travelers shares have a compounded return of over 11% per annum despite premiums and operating cash flows growing at a single-digit pace.

Source: Company Financials, Bloomberg, Firebird Value Advisors Research

Equally important, the contribution of trading multiple change to Traveler's investor returns has been negative, whereas the S&P 500’s 13% per annum primarily came from multiple expansion.?

Travelers Co looks largely the same as it did ten years ago, which cannot be said for Assurant Inc (AIZ).

Assurant, a significantly smaller company with a market cap of $10 billion compared to Travelers' $50 billion, has a unique business model. It specializes in two niche insurance types – extended service contracts for consumer electronics and lender-placed home insurance. Despite the apparent dissimilarity, both businesses share a common trait - the separation between the decision-maker and the payer - a factor contributing to Assurant's healthy profitability.

In the case of extended service contracts, the rates are negotiated with mobile service providers and paid for by customers who choose to add this feature to their mobile plans. Mobile operators are encouraged to upsell this service through commissions and profit share arrangements.

Lenders force lender-placed home insurance onto homeowners who need to get adequate insurance on their own. Lenders care only about the quality of the insurance provider and not about the cost of the insurance passed onto homeowners. Selling a product to a party that cares about the quality more than the price generally results in healthy profitability for the provider. Assurant's lender-placed home insurance is no exception, with the margins from this business usually hovering around 10% — a very healthy level for an insurance company.

Ten years ago, these lines of business represented roughly 60% of premiums, with the remainder made up of health insurance, employee benefits, and pre-need funeral expenses coverage. These were all sold off in a series of transactions for a total of around $2.3 billion. In exchange, Assurant purchased The Warranty Group for $2.5 billion in cash and shares. The acquired company had a significant presence in extended service contracts and automotive extended services coverage.

These transactions, which took place between 2016 and 2021, have significantly reshaped Assurant's business. The company, while remaining roughly the same in terms of premiums, is now more concentrated in segments where it has clear competitive advantages and a healthier level of profitability. The combined expense ratio has improved, dropping from roughly 100% of ?premiums to around 95%, indicating a more efficient operation.

? Source: Company Financials, Firebird Value Advisors Research

Regarding the shareholder return drivers, margin expansion and shareholder returns have been the primary source of value over the last decade. Growth in premiums is relatively pedestrian at 2%, but the M&A transactions obscure it. The core segments of extended warranty and global housing have shown steady growth, averaging 4% per year since the acquisition of The Warranty Group.? Unlike with Travelers, shareholders benefited from slight multiple expansion, but arguably, in this case, it is warranted given the improvement in the underlying business quality.

Source: Company Financials, Bloomberg, Firebird Value Advisors Research

Both Travelers and Assurant grew intrinsic value at a double-digit rate over the last decade through a combination of market growth and smart capital allocation. The conditions are in place for these companies to continue to do so for the foreseeable future.

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Steve Gorelik is a portfolio manager for Firebird Management LLC ("Firebird"). This report was prepared based upon information from sources that are believed to be reliable. However, neither Mr. Gorelik nor Firebird make any representation or warranty as to the accuracy or completeness of the information contained in this report. This report may include estimates and projections. No representation is made as to the accuracy of such estimates or projections or that such projections will be realized. Mr. Gorelik and Firebird have no obligation to update or keep current any information or projections contained in this report. Firebird is registered as an investment adviser with the US Securities and Exchange Commission. Mr. Gorelik, Firebird and Firebird’s principals, employees and affiliates and accounts managed or advised by Firebird own interests in securities issued by Travelers and Assurant.