AVEMCO shows less can be more in insurance

VIEW FROM WALL STREET

November 18, 1990|By Thomas Easton | Thomas Easton,New York Bureau of The Sun

NEW YORK — New York--As the disastrous performance of USF&G underscores, insurance can be a difficult and risky business.

But insurers retain the right to step away from the market if conditions are sour and that has beenthe highly successful approach of AVEMCO, a relatively small, niche underwriter in Frederick that has thrived serving the general aviation market, a potentially highly volatile area, by knowing when to say no.

Rather than retain market share by underwriting at what it considered unacceptable pricing, AVEMCO permitted the amount on its books to decline from $127 million in 1986 to about $68 million this year.

"I would hope we have enough discipline to let that number go to zero," the company's unrepentant Chief Executive William Condon told security analysts at a meeting last week in New York.

The company's combined ratio, a rough measure of what an insurer takes in on underwriting versus what it pays out on claims, was 85.3 during the past nine months, meaning it makes 15 cents on every dollar it receives in premiums. The ratio has never exceeded 91 during the past decade.

The six-month average for the insurance industry is 109.4, meaning insurers on average lose about 9 1/2 cents on every dollar of premiums they receive. USF&G's ratio is worse than average, 111.5 for the first half of the year, and worse still in the third quarter at 112.5.

Companies that underwrite at a loss typically hope to make up the difference in investments. Sometimes that works, for instance when interest rates are very high.

Often, though, it doesn't, as USF&G and several other major insurers recently demonstrated. The losses are simply too much and, even worse, the riskier investment strategies typically employed by underwriters oriented this way can backfire. For USF&G, third-quarter losses in the tens of millions of dollars were dwarfed by investment losses in the hundreds of millions of dollars, which took a double-digit toll on the company's equity base. For Travelers Corp., a $650 million write-down on real estate investments recently helped transform its nine-month earnings from a profit of $306.1 million last year to a loss of $306 million this year.

Still, pricing a product to make a profit when others are willing to price at a loss puts tremendous pressure on a company's customer base. AVEMCO's ratio of direct clients to those served by brokers has grown from 50 percent three years ago to 74 percent today. This is largely because customers who use brokers -- the largest segment of the business -- are more likely to be influenced by price and to take the better deal.

Consequently, AVEMCO has dramatically cut its overhead to reflect a smaller business. Selling, general and administrative expenses dropped from $28.6 million in 1988 to $24.7 million last year and have been trimmed another 7 percent through the first three quarters of this year. Employment has been reduced from 489 people in 1987 to 369 today, but through a hiring freeze and attrition rather than layoffs. "By staying lean," Mr. Condon told an inquiring analyst, "you don't have all those tugs on your heartstrings" that come with firings.

The result has been that AVEMCO has been able to produce continuous profits and an above-average return on equity in an industry known for neither. Profits have declined from a 1987 peak of $2.06 per share to $1.55 per share last year but they are running this year at a slightly higher rate.

Moreover, the company has been able to steadily increase its dividend, a lynch pin of USF&G's strategy that recently had to be foregone, without suffering the negative result USF&G did -- eroding its own capital base. Indeed because of its reduced underwriting and the continued profits from policies, it has confronted the opposite problem: an overly swollen capital base that would dilute returns.

In response, during the past three years it has repurchased about 20 percent of its outstanding shares. Enough capital remains, however, for the company to triple its underwriting if conditions improve and still remain within conservative statutory limits, Mr. Condon said.

AVEMCO "has been hurt by trends beyond its control, managed them as well as it could, and can now benefit in an industry that has been weakened," said John Falk, an investment manager with A. R. Schmeidler & Co. Inc.

Still, declining returns, even from a highly superior level to merely a superior level, is unlikely to stimulate enthusiasm among shareholders, particularly when insurance stocks are being dumped across the board. AVEMCO's stock price has declined from an all-time peak of 30 1/8 to $23 recently.

And even analysts who are extremely positive about the company's long-term prospects like Mr. Falk suggest the company's share price may not be "exciting in the short term."

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