A Safe 9% Dividend Yield in a Unique Insurance Stock

Insurance is a straightforward business. Most insurers earn a profit on premiums collected and investment income earned, less claims paid and business expenses.
Though a straightforward business, insurance can be remarkably profitable when done right. Just ask Warren Buffett. His Berkshire Hathaway (NYSE: BRK-B) is technically an insurance company.
Insurers have been a profitable and popular investment since early 2009. The SPDR S&P Insurance ETF (NYSEArca: KIE) is up 161% compared to 120% for the S&P 500. The run-up in insurers’ share prices means dividend yields have been run down. The SPDR S&P Insurance ETF yields a mere 1.7% these days.
But investors can still find decent yield among the insurers if they look hard enough.
Blue Capital Reinsurance Holdings (NYSE: BCRH), a reinsurance company based in Bermuda, is unique in that it makes its money underwriting insurance. Many insurers will actually accept an underwriting loss in order to collect premiums to invest. Nearly all insurers invest premiums received in a portfolio of fixed-income and equity investments.
Blue Capital, in contrast, backs its policies with cash and short-term Treasury securities in the equivalent amount of its maximum liability. This approach insulates the company from the market risk that virtually all other insurers are exposed to.
Blue Capital’s risk lies with nature. Blue Capital shares could move lower on a major storm, but not on a major market sell-off. This means Blue Capital is an insurance stock that will be uncorrelated with many of the investments in your portfolio.
You can gauge an insurer’s underwriting profitability by its combined ratio. This is the sum of all expenses and claim payouts divided by premiums received. The lower the combined ratio, the higher the underwriting profits.
In the latest quarter, Blue Capital reported a combined ratio of 50.8%, compared to 73.1% in the year-ago quarter. Examine most insurers, and you’ll be lucky to find a combined ratio in the low-90% range.
The benefits of a lower combined ratio were revealed in earnings. Blue Capital reported earnings per share of $0.50, easily beating the consensus estimate for $0.35. During the same year-ago quarter, Blue Capital reported EPS of $0.37. It’s on track to earn $2.20 per share this year.
The dividend, though, is what really sets Blue Capital apart from the competition. The company’s stated goal is to pay 90% of cash earnings as dividends. That’s good news for income investors.
Three of Blue Capital’s quarterly dividends are set at $0.30 per share. The fourth is a variable dividend based on current earnings. The last variable dividend was $0.66 per share. That produces a $1.56 annual dividend and a 9% yield at Blue Capital’s market price. Based on current earnings projections, Blue Capital is on track to pay another exceptional variable quarterly dividend in early 2016.
Best of all, you can buy Blue Capital’s high-yield dividend at a value price. Blue Capital is cheap: Its shares trade at less than 8 times current EPS. They also trade at a 17% discount to book value. I chalk up the discount to the lack of institutional following. Blue Capital’s market cap – at $152 million – keeps it off most Wall Street firms’ screens.
If high-yield income is your goal, you should consider keeping Blue Capital – and others like it – on your screen.