Market Mad House

In individuals, insanity is rare; but in groups, parties, nations and epochs, it is the rule. Friedrich Nietzsche

Market Insanity

Will Auto Insurance Companies make more money in California?

Auto insurance companies could make more money in California because of gender equity. To explain, the Gender Non-Discrimination in Automobile Insurance Rating Regulation makes it illegal to base car insurance premiums on sex.

However, it is not clear how the regulation will affect auto insurance rates. For instance, a 2013 European Commission ruling mandating gender neutrality in insurance raised rates in the UK. In fact, The Telegraph estimates an 18-year-old woman’s auto-insurance premium increased by 50%.

On the other hand, a 2017 Consumer Federation of America survey found women between 40 and 60 with perfect driving records paid a higher rate than men with the same characteristic. Thus, auto insurers could make less money because they will have to charge men less for car insurance.

Will Auto Insurers Make Less money from Car Insurance in California

Uniquely, California’s constitution gives an elected official; the Insurance Commissioner, the power to set insurance rates. In addition, a 1988 ballot initiative; Proposition 103, requires auto insurance companies to base premiums on driving records, The San Francisco Chronicle reports.

Conversely, Proposition 103 allows insurers to use optimum factors when setting premiums. The state of California regards gender as an “optimum factor” until they changed regulations on New Year’s Day 2019.

Therefore, auto insurers will need to establish new criteria for auto-insurance rates in California. That could be difficult because they base current rates on a variety of bizarre criteria and actuarial tables.

Can Auto Insurers Make Less money with Telematics

For example, some insurance companies charge students with good grades lower premiums. The questionable thinking behind this practice is that a good student will be a more responsible driver. 

Setting criteria for auto insurance rates is hard because risk factors are difficult to gauge. Driving records, for instance, rarely reflect an individual’s true driving habits.

That is why insurers like Progressive (NYSE: PGR) push policyholders to adopt telematics devices. To explain a telematics device uses Wi-Fi to transmit data about driving to an insurer.

The insurer uses the data to set premiums for drivers. For example, a person might get a lower rate for driving low mileage, not driving at night, or driving lower speeds.

Thus auto insurers will switch to usage-based insurance (UBI) business model with telematics. Obviously, insurers could make less money with usage-based insurance because premiums could be lower.

Why Berkshire Hathaway and Auto Insurance Companies could make less money in California

For example, an insurer will make slightly more money or more float with higher premiums. In fact, Warren Buffett bought GEICO for Berkshire Hathaway (NYSE: BRK.B) for the premiums.

By collecting vast numbers of auto-insurance premiums each month, GEICO generates a vast amount of float. To clarify, float is cash that Uncle Warren can tap for purposes like acquisitions or to borrow against. In fact, insurance premiums are Buffett’s classic example of float.

Therefore, California could limit the amount of float, Berkshire Hathaway (NYSE: BRK.A) brings in by changing the way auto insurance rates calculated. For instance, women could pay less and men more through gender-neutral auto insurance.

In addition, gender-neutral insurance will give customers a stronger incentive to adopt telematics and UBI. For instance, older men and younger women who currently get lower premiums because of their sex could pay higher rates.

Moreover, insurers will take a greater risk because actuarial tables show that men get into more accidents. Thus, there will be pressure to adopt new data-based insurance methodologies.

Are Auto Insurance Companies Still a Value Investment?

Under these circumstances, we have to ask if auto insurance companies are making money and if they are still a value investment.

The answer is maybe, Mercury General (NYSE: MCY); a California-based insurance brokerage saw its revenues increase by 4.25% in 3rd Quarter 2018. In addition, Mercury General’s gross profit increased from $279.84 million in 2nd Quarter 2018 to $80.74 million in 3rd Quarter 2018.

Plus Mercury General had an operating income of $74.54 million and a net income of $58.58 million in 3rd Quarter 2018. Mercury General is a good company to look at to gauge insurance in California, because it focuses its business on the Golden State.

Mercury General’s business is generating cash in the form of a $133.62 million free cash flow and a $141.12 million operating cash flow for 3rd Quarter 2018. That gave Mercury General $261.68 million in cash and equivalents on 30 September 2018.

Importantly, Mercury General had a lot of float in the form of $665.52 million in receivables (presumably insurance premiums) on the same day. Thus Mercury General is making money from California auto insurance.

Mercury General (MCY) is a good dividend stock

Finally, Mercury General (MCY) is a good dividend stock. For instance, Mercury General shareholders received a dividend yield of 4.82%, an annualized payout of $2.51 a share, and a payout ratio of 114.1% on 14 January 2019.

Best of all, Mercury General has experienced 33 years of dividend growth, calculates. Specifically, the last Mercury General dividend was 62.7¢ paid on 27 December 2018. That dividend was up slightly from 62.5¢ in December 2017 and 62.3¢ December 2016.

Hence, Mercury General pays a good dividend that rises at a sensible rate. Therefore, I conclude Mercury General is a good dividend stock and value investment for those who need steady income. Mercury General (MCY) had an attractive price of $51.88 a share on 14 January 2019.

Are Auto Insurance Companies Good Dividend Stocks?

Okay, so Mercury General (MCY) is a good dividend stock and value investment but what about other major auto insurers?

I think Progressive Corp (NYSE: PGR) looks good right now because it reports a revenue growth rate of 25.09% for 3rd Quarter 2018. In addition, Progressive records a gross profit of $2.972 billion on revenues of $8.495 billion for 3rd Quarter 2018.

That enabled Progressive to accumulate a net income of $928.4 million and an operating income of $1.172 billion for 3rd Quarter 2018. Characteristically, Progressive records an operating cash flow of $1.718 billion and a free cash flow of $1.656 billion on 30 September 2018.

However, Progressive is not keeping that much cash. For instance, it had just $122.7 million in cash and equivalents on 30 September 2018. However, Progressive offered a lot of potential float in the form of $7.156 billion in receivables at the end of 3rd Quarter 2018.

Mercury General is a better Auto Insurance Stock than Progressive Corp

On the other hand, Progressive is scheduled to pay a yearly dividend of $1.125 on 9 February 2019. This dividend is actually lower than Mercury General’s because it is for the entire year. Additionally Progressive offers no dividend growth, a dividend yield of 1.82% and a payout ratio of 24.8%.

Hence, Mercury General is a better stock than Progressive because it is cheaper and pays a better dividend. Notably, Progressive Corp was trading at $61.68 on 14 January 2019. In particular, I think Mr. Market overpriced Progressive at that level.

Therefore, auto insurance companies can still be good value investments. However, I am leery of this sector because the technology it is about to disrupt auto insurance beyond recognition.

How Data will Disrupt Auto Insurance Companies

In fact, autonomous and internet-connected vehicles will supply a vast amount of data that will make the creation of new auto-insurance products possible. For example, insurers could tailor an auto policy specifically for a 46-year-old accountant who lives in Pomona, California and drives ten miles each day.

Connected vehicles could make such products possible by supplying detailed data about drivers or vehicles. Notably, Ford (NYSE: F) is developing a Transportation Mobility Cloud that will aggregate data from autonomous vehicles.

The Cloud will pool the data from thousands of Ford vehicles so customers; like insurers, will have real-time data about drivers in the real world. Under those circumstances, a brokerage like Mercury General could write specific policies for individual drivers.  Mercury’s underwriters could acquire enough data to assess risk about specific drivers.

In conclusion, auto insurance is a value investment but the industry is changing because of technology and regulations. Thus, investors need to be ready for nasty and sudden disruptions in the world of auto insurance.