When you are creating a diverse investment portfolio, you may want to consider adding stock from car insurance companies. Although it may not be as exciting an industry as artificial intelligence or robotics, insurance is usually a safe investment that can pay off long-term. In general, insurance companies are a buy-and-hold investment.

Understanding the Structure of Insurance Companies

Before investing in any company, it is important to understand its structure and competition. If you look at a list of car insurance companies that are operating today, you will see more than 200 businesses competing for consumers. In general, car insurance companies sell policies to consumers that promise to pay them if an accident or other covered event occurs. In exchange, the company receives monthly premiums from the consumer. This is why car insurance is known as a property and casualty insurance line.

Every car insurance company has future liabilities that may require a payout. For example, a policyholder may get into a serious accident covered by the insurance company, and it could cost the company thousands of dollars. This means that most insurance companies invest their premiums conservatively because the risk of payout is high, so they are less likely to take enormous risks with their money. In addition, the insurance industry is highly regulated by federal and state governments. For investors, this means that car insurance companies are usually not a high-risk investment and tend to be a safe choice.

Figuring Out Pricing Risk

The way a car insurance company prices risk is at the heart of its ability to make a profit or suffer a loss. Car insurance is a short-tail insurance line, which means claims tend to occur within the terms of the policies or right after they expire. For instance, if a person totals a car in January, the car insurance company usually responds quickly to the claim and issues a settlement within a few weeks or a few months for more complex cases. Since most policies are six months long, the claim falls within the term.

On the other hand, long-tail insurance lines such as disability insurance operate differently. They often struggle to predict how much healthcare will cost in the future, and they may not get a claim for decades. This makes it harder to assess risk.

Car insurance companies have an advantage because they are short-tail lines. It is easy to see if their prices are correct since they can calculate the costs after an accident faster. They also have a large pool of policyholders that makes it easier to see how often claims happen and how much the repairs or other bills cost.

Seeing Returns

Every investor wants to see high returns, but car insurance companies generally do not give huge returns in the short-term. Instead, you should view them as long-term investments that have a chance of growing over time. If you use the DQYDJ stock return calculator and the Vanguard index fund to research popular car insurance companies, you will find that several of them perform well. For example, Progressive Insurance has a 13% 15-year compounded return, and RLI Corp., which owns RLI Transportation insurance for commercial vehicles, has a 15% 15-year compounded return. You can also use a return on investment calculator to try to predict future results.

Picking Car Insurance Companies

When you are selecting car insurance companies to add to a portfolio, it is important to focus on profits. How much profit does the car insurance company show? In general, profits in this type of industry come from several areas. First, they can make a profit by selling insurance at a higher price than they get claims. Second, they can invest the premiums from policyholders in an appropriate way to make more money. The best car insurance companies pay out less in claims than they earn from policyholders, so they make a bigger profit.

As you are comparing car insurance companies, consider looking at these three ratios: loss ratio, expense ratio and combined ratio. You can find these numbers when you look up a company’s earnings reports online. These ratios are a good way to compare businesses and can save you time on research. The loss ratio is calculated by dividing insurance losses by premiums earned. The expense ratio is calculated by dividing operating expenses by premiums earned. Finally, the combined ratio is calculated by adding the previous two ratios together.

Investing Wisely

If you are interested in a quick return and want to see an investment double fast, then you should reconsider car insurance companies in a portfolio. However, if you are comfortable knowing that this is a long-term investment with smaller but safe returns, then car insurance companies are a good choice. As long as people drive or own cars, insurance companies will stay in business.