European insurers offer attractive dividends, but when choosing individual names, quality matters.
“A high yield one year doesn’t necessarily mean a high yield in following years,” says Morningstar equity analyst Henry Heathfield.
“Our experience tells us (in European insurance, anyway) that persistence and balance sheets are important features.”
Insurance Stocks With Reliable Dividends
Using these criteria, Heathfield identifies four European insurance stocks with reliable dividends:
• Admiral (ADM)
• Allianz (ALV)
• Munich Re (MUV2)
• Zurich Insurance (ZURN)
“Our shortlist focuses on firms that have a track record of minimal dividend reductions and omissions, and have balance sheets that can withstand solvency stress tests that still leave them in a position to pay forecast dividends,” Heathfield explains. “These firms provide investors with reliable mid-single-digit and real yields.”
While dividends may not be perceived to have the same importance as capital gains, “we think they are important and drive the share price performance of at least one half of our coverage,” says Heathfield.
Before the 2007-09 financial crisis, European insurers paid out less than 30% of their earnings in dividends, he says. But in the years since, payouts have risen by more than half, even exceeding 65%. While yields have increased since the pandemic, high inflation took a bite out of those returns. “Only with inflation falling into late last year have European insurers again started to offer yields that are real,” Heathfield says.
When looking at dividends, “there is a tendency to search solely for yield,” Heathfield says. But “high yield says nothing of staying power.” Investors should consider persistence as much as the level of yield, because while yield should provide strong income, without persistency, that may only be the case for a year. Plus, many stocks with the highest yields have weak balance sheets.
Additionally, if a company has omitted its dividends 10% of the time or more, Heathfield thinks the stock should be excluded from consideration because that shows “poor capital management” over its history. As one example, he points to Aegon, which has omitted its dividend eight times over the last 20 years. A substantial income cut would be acceptable once, since the cut could fit in the average cycle of a cyclical sector.
But a second “would or could lead to impaired ability to match expenses or an awkward reduction in disbursements to underlying investors,” Heathfield explains. “Whether an individual is investing in a stock for income, or whether a fund is investing for yield, we think stability of cash flows is important, because an individual investor is likely to use it for expenses and a fund is likely to distribute this yield.”
Focusing on Stocks with Annual Dividends
Prioritising the companies that pay dividends annually versus on the interim is another strategy Heathfield recommends. He sees annual dividends as more secure than interims. The first six months of the year are more stable for insurance than the second half because of the significant claims that tend to surface in that time.
“While this particularly pertains to reinsurers, it can catch primary insurers out as well if they haven’t promptly caught an ongoing trend,” Heathfield says. “Where there is an interim dividend, this can be particularly problematic because that distribution is based on the earnings generated over the first six months of the year. If that distribution has been too high and trading conditions turn, this can leave the business in an unenviable position for the final at the end of the year.”
When a company records its dividends on an interim basis, Heathfield believes the final dividend is the more important one, because there’s a more formal process to determine that dividend, one that considers the annual report and accounts.
Screening for Insurance Company Dividend Payers
Tying it all together, Heathfield looked “for the most obstinate payers based on history and combined with those the most obstinate capacity to maintain their yield.”
Among other criteria, he screened out companies that have made dividend cuts of 10% of more than once in 10 years. That meant the list excluded Aviva, which cut its dividend by more than 10% three times in a 10-year time frame. Heathfield then gave greater weight to companies that pay annual dividends over those that pay them at interims. The list was narrowed further by focusing on stocks Heathfield feels offer dividends at reasonable and maintainable levels, and for companies whose balance sheets are strong enough to sustain their payouts.
Top Insurance Sector Stock Picks and Analyst Commentary:
Admiral
• Fair Value Estimate: £30.70
• Morningstar Rating: 4 stars
• Economic Moat: Narrow
“We recommend Admiral as a company that has achieved double-digit earnings growth, maintains a competitive advantage, and delivers investors with a solid mid-single-digit yield. The business has a track record of better underwriting and better market-timing than peers. Admiral is also delivering improvements in the quality of its home insurance and international car businesses.”
Allianz
• Fair Value Estimate: €310.00
• Morningstar Rating: 4 stars
• Economic Moat: None
“We also recommend Allianz, a company that reduced its dividend only once in a quarter of a century and offers a buoyant yield. The company is a steady grower, particularly in life and health, and has a complementary best-in-class asset management business. Allianz delivers consistent results, and the firm has led the way in technology investments in the universe of large multilines”
Zurich Insurance
• Fair Value Estimate: CHF 495.00
• Morningstar Rating: 3 stars
• Economic Moat: Narrow
“Our almost-final recommendation is Zurich because it provides investors with access to a business with a first-rate management team. Its commercial insurance unit is one of the largest in the world and is now growing into more profitable midmarket risks. Farmers is highly competitively advantaged unit, and while Zurich may be the slowest grower, it is probably the best quality and offers a solid mid-single-digit yield.”
Munich Re
• Fair Value Estimate: €358.50
• Morningstar Rating: 2 stars
• Economic Moat: None
“As a dividend stock for the radar, we recommend Munich. We think Munich is one of the most, if not the most, obstinate payers, and it operates with ironclad solvency. Like Zurich, Munich is a slower grower and operates with a first-rate management team. It has been a pioneer of inspection-based insurance services. With three times the required capital, we think there is room for a dividend increase. The payout ratio has been trending down and is one of the lowest in our European insurance list.”
