Insurers are a common go-to for investors seeking a reliable business to own for the long term. Indeed Warren Buffett, often held up as the world's best investor, has a famous love affair with insurers. In fact, his company Berkshire Hathaway is a significant shareholder in Insurance Australia Group Ltd (ASX: IAG) ("IAG").
I personally am not very enthused about IAG as I am a younger investor, and believe that the insurance titan will not grow very much over the next decade. However, there are 3 very good reasons why you might want to hold it in your portfolio:
- Business is reliable
Insurance Australia Group's core businesses sell motor vehicle insurance and house insurance. These policies protect a citizen's most important assets and, with most of Australia subject to the occasional wild weather event, many of these policies will be purchased every year for life.
That also leads to the occasional dip in profit and dividends when major cyclones or similar cause damage greater than the amount that IAG keeps reserved for natural disasters each year. However, by and large, it is a steady business model.
- Massive balance sheet
IAG has literally billions invested in assets like bonds and shares – equivalent to approximately $1.30 per share in net investments. Investment returns are an important contributor to the company's profit, especially in strong years, but the more important thing is the sense of security that the company's balance sheet offers to shareholders.
There is the potential for some long-tail liabilities like the Canberra earthquake to rear up out of the darkness and eat into profits, but the chance of IAG going bankrupt appears very low. The quota-share arrangement with Berkshire Hathaway also helps reduce some of the company's claims expenses.
- Consistent dividend
As I mentioned above, the company's profits are vulnerable to unusually large claim events, such as natural disasters. This can lead to a cut in dividend, because management aims to pay out around 70% of profits as dividends. The company also saw a decline in its profits and dividends in the years following the GFC.
However, the chance of Insurance Australia Group Ltd going bankrupt is very low, and with customers continuing to buy insurance every year, the dividend will likely recover. IAG has paid a dividend every year since 2001.
As a reliable part of an income-generating portfolio, there is a good case for owning shares in Insurance Australia Group Ltd.
