The Travelers Companies

Narrow-moat Travelers has been generating strong profitability amid multiple industry tailwinds recently, but second-quarter results were surprisingly strong.

Why it matters: Travelers generated an annualized 27% return on equity in the quarter, dramatically above its midteens historical average. In the quarter, favorable market conditions were boosted further by relatively low catastrophe losses and strong favorable reserve development. In the business insurance segment, the reported combined ratio improved dramatically year over year due to lower catastrophe losses and better reserve development, but the underlying combined ratio (which excludes these factors) was basically flat, coming in at 88.2%, compared with 88.3% last year. Underwriting margins in the personal insurance segment continue to improve, with the underlying combined ratio coming in at 77.3% compared with 79.3% last year driven mainly by personal auto. But with pricing increases in personal auto having disappeared and increases in homeowners starting to moderate, we question if this improving trend can be maintained for long.

The bottom line: Travelers is tracking ahead of our expectations for the year, and we expect raise our $252 fair value estimate by a mid-single-digit percentage to account for this. However, we continue to see shares as materially overvalued. While we appreciate current industry tailwinds and the fact that Travelers appears to be fully exploiting them, we think the market is extrapolating this favorable period too far into the future. We believe weaker pricing will be the primary catalyst for a move back to more normalized returns and see signs that this is starting to occur in certain lines. Beyond underwriting, Travelers continues to see benefits on the investment side, with investment income in the quarter up 14% year over year. However, yields on the fixed income portfolio appear to have levelled out over the past couple of quarters.

We are increasing our fair value estimate for Travelers to $262 per share from $252, due to some modest changes to our assumptions based on the company's recent performance. Our fair value estimate equates to 1.7 times 2025 year-end book value and 1.9 times book value excluding goodwill and accumulated other comprehensive income.

We expect net earned premiums to grow at a modest 3% compound annual rate over our five-year forecast. Given the company's leading position in mature markets, we believe the company's underlying growth over the long term will be very modest, and a weakening pricing picture is likely to weigh on premium growth going forward.

Underwriting profits in 2025 took a material hit due to the pretax $1.7 billion loss on the California wildfires, but this was partially offset by relatively low catastrophe losses through the rest of the year. We expect underlying underwriting results in both commercial and personal lines to remain attractive in the near term. However, in the back half of our projection period, we expect compression in underwriting margins, as higher interest rates reduce the need for underwriting income and industry conditions normalize. Over the five-year forecast, we project an average combined ratio of 94%, roughly in line with the company's average over the last 10 years. We have explicitly modeled one large catastrophe year in the back half of our projection period in order to better capture the volatility of the insurance market.

The average adjusted ROE over our projection period is 16%.We think the company will continue to benefit from relatively favorable market conditions in the near term, but that returns will pull back in line with historical averages over the next few years. We use a cost of equity of 8.9% in our valuation.

In general, insurers do not benefit from favorable competitive positions. Industry competition is fierce, and the products are essentially commodities. Furthermore, most participants do not know their cost of goods sold for a number of years, allowing them to underprice policies without knowing it. Firms have a large incentive to chase growth without regard for profitability, a cycle that repeats itself as competitors are forced to match artificially low prices or risk losing business.

We believe Travelers' narrow moat is centered on its commercial operations, which account for about 60% of premiums. As one of the three largest US commercial lines insurers, Travelers has been able to develop expertise in less commodified areas of the P&C market, such as oil and gas, agribusiness, and inland marine, and its customer base skews toward middle-market companies. We believe the company's established presence confers a competitive advantage as well, as being one of the first insurers considered creates opportunities to underwrite preferred risks. Further, the company's commercial operations contain a material portion of business that we would consider specialty lines. The unique risks covered by these lines help insulate the company from competition.

We generally view the company's personal lines business, which accounts for about 40% of premiums, as being largely commodified, and we don't believe Travelers' personal lines business has a meaningful maintainable competitive advantage. While Travelers is a large player in these lines, we think its use of independent agents moots any scale advantages.

Travelers' personal lines operations dull the company's advantages to some extent, but we believe a narrow moat rating for the company as a whole is still appropriate, and we think an average adjusted ROE of 15% over the past decade supports the idea that Travelers can consistently earn solid excess returns.

We think Travelers is relatively conservative in its investing choices, which lowers its risk profile.

The diversification of Travelers' business insulates it from issues in any specific lines.

Pricing has improved in both personal and commercial lines.

Travelers has significant exposure to natural catastrophes and weather-related losses, which introduces material volatility into its results. Climate change introduces a new point of uncertainty for insurers, and future returns could be negatively impacted if the price response is not adequate.

Travelers' reliance on independent agents does not allow the company to control customer relationships.

Travelers' diversification could mute overall returns.