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Advoguard Insurance Company is a medium-sized U.S. property and casualty (P&C) insurance company, with headquarters in New York City. The company has been in business for 55 years and has been moderately successful. Advoguard has shown steady growth in net premiums and regularly reports a small gain from operations. Over the last several years, premiums for P&C insurance have declined, which has made it more difficult to maintain profitability. Deregulation has led to mergers and acquisitions and the creation of very large firms that compete on price. Investment income is another component of Advoguard’s earnings, but since the company has a very conservative investment philosophy, investment income is a relatively small percentage of total income. A majority of the company’s investments are in fixed-rate securities, and with declining interest rates in the U.S., total return has been relatively low.
Advoguard’s book of business is exclusively in the United States, and primarily focused on individual consumers. The company does, however, sell commercial P&C policies as well. One specialized insurance line for home-based businesses has not done well. Premiums for home business insurance have been low and losses high; however, this is a small percentage of the overall book of business.
The insurance rating agency, A.M. Best, gave Advoguard a rating of A, or Excellent, one level lower than A+, or Superior. In addition to other factors, A.M. Best evaluates leverage, liquidity, and profitability when evaluating insurance companies. Advoguard has a solid reputation and has never had a problem paying claims. For high-risk policies, the company enters into reinsurance contracts with several large reinsurance companies.
In general, the insurance industry is becoming highly competitive. Although it is not easy to enter the insurance business from the outside, other financial services firms can create competing products. Also, other insurance companies can offer comparable products at low prices to capture market share. Individual consumers do not have a significant impact on prices, but they do have a choice and often move their insurance needs to the company with the lowest price. Large corporate consumers do have influence on the price of insurance and have negotiated their liability premiums down to historically low levels. Capital and employee expertise are the resources that drive success for insurance companies.
The longtime CEO of Advoguard has recently retired and the Board of Directors has hired Cynthia Barnes as the new CEO. The Board wants Barnes to deliver higher earnings growth and a higher stock price. The shareholders enjoy a steady but moderate annual dividend, but the stock price lags the overall market and underperforms compared to some of the other insurance industry stocks. Its price earning (PE) ratio is 8.4, while the average industry PE ratio is 23.2. The average return on equity (ROE) for the insurance industry is 12.1%, and Advoguard’s most recent reported ROE is 4.6%.
The VP of Planning met with Barnes and recommended that the company diversify into other related business, such as life insurance and investment products. He also recommended expanding into markets outside the U.S, like Europe, the Middle East, and Asia. He believes that becoming a multiline global insurance company is the only way to grow as a business and sustain that growth well into the future. Life insurance companies, many of which have global business customers, are currently undervalued, according to several industry securities analysts. Many of these life insurance companies have also diversified into investment products, such as annuities.
Barnes shares the recommendations with the company’s Chief Risk Officer (CRO). The CRO believes that although there is additional profit potential in diversification of products and markets, the risk would be too high for Advoguard. The company recently added to its loss reserves because management initially underestimated losses on a particular piece of business. The CRO argues that insurance is an inherently risky business and adding new unfamiliar businesses and selling into unfamiliar markets would increase the company’s risk profile.
