Quality Business Models Triumph: What Insurance Broker Stock Returns Can Teach Us

At MyPlanIQ, we firmly believe that for average individual investors, investing in low-cost stock funds that focus on high-quality businesses is the most reliable approach to stock investments. Over the years, we have delved deeply into this concept and demonstrated that industries or sectors with inherently superior business models are more crucial to investment success than individual company selections. You can review some of our past newsletters on this topic below:

• Investing In Industries With Better Business Models To Outperform Market Indexes
• S&P Good Sectors Review

In this newsletter, we highlight stocks from a particularly excellent yet somewhat surprising industry—insurance brokers—that have consistently delivered higher returns compared to stock indexes such as the S&P 500. This reinforces our thesis that investing in ‘good’ industries and ‘sectors’ can provide long-term, market-beating returns with lower risk.

Insurance brokers: who are they?

To understand this segment of business, it’s important to first grasp what a typical insurance broker is. Let’s examine Marsh McLennan Companies (MMC), one of the largest insurance brokers. MMC acts as an intermediary between businesses and their insurance providers. The types of insurance it covers include property insurance, casualty, cyber risk, employee benefits, and more. Additionally, MMC assists companies with risk management and other business consulting services, such as retirement and pension benefits. In essence, MMC functions not just as a broker but as a comprehensive business consulting and service provider.

These business brokers and service companies have the following key characteristics:

• Very High Entry Barriers: Unlike smaller, local insurance brokers or other consumer oriented auto insurance brokers, these companies must possess significant expertise and establish strong relationships with clients for in-depth business understanding and knowledge. This creates a high barrier to entry for new competitors.

• High Stickiness: Due to the need for a deep understanding of insurance coverage and risk management, it is unusually difficult for businesses to switch brokers. The engagement process is lengthy and complex, making client relationships highly sticky.

• Minimal Business Disruption: Unlike other businesses, brokers do not face liabilities that can disrupt their operations. In fact, their services often see increased demand during challenging economic times, as companies seek more comprehensive risk management solutions.

• High Return on Equity (ROE): These businesses typically have low capital expenditure but achieve consistently high ROE and Return on Invested Capital (ROIC), which are critical metrics for evaluating business performance. See the following table that shows the figures for the top 4 insurance brokers.

Insurance brokers add significant and complex value when managing insurance for businesses. For example, during a time-consuming and intricate claims process, brokers utilize their extensive experience and expertise to ensure that all necessary documentation and evidence are properly prepared and submitted. They provide strategic advice on policy coverage and assist in interpreting policy language, which is crucial for maximizing claim settlements. Furthermore, brokers advocate for their clients during negotiations with insurers, leveraging their industry relationships and market knowledge to expedite resolutions and secure fair compensation. This comprehensive support not only alleviates the administrative burden on businesses but also enhances the likelihood of a favorable claim outcome.

Return on Equity (ROE) (%)

Return on Invested Capital (ROIC)

We observe that all the companies have double-digit ROEs and excellent ROICs.

To summarize, insurance brokers are specialized businesses characterized by low capital expenditure, high ROE, and significant switching costs. They are outstanding businesses.

Outstanding and consistent returns

Here are the past returns of the top five insurance brokers:

*: NOT annualized

The 15-Year Rolling Returns Comparison:

The 15-Year Rolling Returns Comparison:

Observations: 

• The portfolio has consistently outperformed the S&P 500 over the past 3, 5, 10, 15, and 20 years, as well as since 1984 (a remarkable 40 years!). Over these 40 years, it has achieved an additional annualized return of 5% (16.1% vs. 11.1%) compared to the S&P 500. This is a significant accomplishment.
• It is abundantly clear that the portfolio has consistently outperformed the S&P 500 in almost any 10- and 15-year period in the past, with only a few exceptions in earlier years.
• Additionally, this portfolio has a much lower maximum drawdown (the decline from peak to trough): 39.6% compared to 55.3% for the S&P 500.

We also conducted a comparison between Warren Buffett’s Berkshire Hathaway (BRK-A) and the portfolio:

Note that BRK-A data is only available from January 16, 1990.

The same trend continues: the portfolio has outperformed BRK-A over the past 3, 5, 10, 15, and 20 years, as well as since 1990!

Interested readers can also use our static portfolio tool to construct a portfolio that includes WTW. Although this may slightly reduce returns, the portfolio still significantly outperforms the S&P 500.

No wonder Warren Buffett once said, “I would rather invest in a company with a good business and mediocre management than in a company with a mediocre business and good management.”

Market Overview