Buying life insurance has to rank right up there with watching paint dry or grass grow in terms of just how boring it is. There’s nothing exciting about listening to an agent rattle on about the various types of policies, cash surrender values, and the numerous riders you can tack on. Boring city.
But insurance stocks on the other hand can be pretty exciting. Especially when they continue to make some serious bank on their floats and underwriting standards.
And one of the best could be mid-cap Cincinnati Financial Corp. (CINF ).
CINF has already earned the right to be a called a dividend champion, but recent moves into some growth areas have helped the company deliver further on the cash flow and dividend front. For investors looking to add some serious dividend growth potential to their portfolios, Cincinnati Financial could be a great pick.
All About That Float
People forget that Berkshire Hathaway (BRK-B) is technically an insurance business. The key for BRK’s success is that Warren Buffett and his various managers have used its immense float to their advantage. Cincinnati Financial is doing the same thing, albeit on a smaller scale.
An insurance company’s float is basically all the premiums it has collected but hasn’t paid out yet. So you pay your car insurance bill and your insurance company holds that cash until you file a claim. In the meantime, the insurance company doesn’t just stuff that cash under a mattress. It invests it. Think of float as an interest free loan that you’re paying to the insurance company. Float is even more powerful when you combine it with an underwriting profit, meaning you don’t actually have to hand any of the float back as claims.
Now many insurance companies will invest this float into boring fixed-income securities and other time deposits. But they don’t have to within certain regulatory standards. What’s driven BRK’s returns as well as CINF’s is the two insurance firms have plowed a hefty bit of their floats into the stock market.
For Cincy, just north of 30% of its total investment portfolio is in common stocks. And like Buffett, CINF’s managers have tended to focus on value and dividends within that portfolio. Top holdings in CINF’s portfolio include dividend stalwarts like 3M (MMM ), Genuine Parts (GPC ) and Duke Energy (DUK ). As a result, Cincinnati Financial has been able to realize great investment gains. For all of 2015, the insurer was able to boost its total investment income by 7% on the back of double-digit dividend income growth.
Those investment gains are all gravy for the insurer and its investors. You and I don’t get anything back from “lending” the insurance company any money. This extra boost from stocks has helped Cincy on the earnings front in recent years. The profits on its float was a major contributor to its recent 53% year-over-year boost to first-quarter earnings.
More Avenues for Growth
Cincinnati Financial is technically considered a property and casualty insurer, meaning it provides coverage that helps protect the stuff you own. That includes car and homeowners insurance. However, over its history, the firm has expanded into other business lines such as life, surety, and disability income insurance. These are still very bread and butter insurance businesses that provide steady premiums and the ability for underwriting profits.
And while CINF has plenty of boring under its umbrella, it has plenty of growth opportunities as well.
That includes expanding its reinsurance businesses. Reinsurance is basically insurance for insurance companies and it comes with hefty margins and underwriting premiums. Cincinnati Re was one of the largest contributors to CINF’s results in recent quarters as well as its float.
In addition, CINF has expanded into offering products in more states. Currently, the firm has agents in 40 states with California expected to come online this year. That will provide plenty of new markets for its life and business insurance lines.
Speaking of business insurance, Cincy has also expanded into providing various loss control and prevention services. A company essentially will pay CINF for services in order to NOT use its insurance that Cincinnati Financial is providing. That’s a win-win for CINF and its float.
A Long Dividend History
For CINF, the success with its float and underwriting standards have resulted in one thing: big-time dividends. The insurer is considered dividend royalty and is one of only eight U.S. stocks that have records of dividend increases longer than 50 years. In fact, Cincinnati Financial has had 55 years of rising payouts.
Its payout ratio of 71% is a tad on the high side. However, when you consider its robust cash flows from its float and its ability to grow underwriting premiums from its new business lines, there’s still plenty of room for the firm to raise its payout more or hand out special dividends, which CINF likes to do. The latest one was 46 cents per share.
Without those extra boosts, Cincinnati Financial still yields a healthy 2.98%.
The Bottom Line
For investors in Cincinnati Financial, insurance is far from boring. The firm’s top notch investment gains on its float as well as new initiatives/markets to grow that float will continue to boost earnings for years to come. Ultimately, that will help keep up its long history of rising dividend payouts.