HSBC(LSE: HSBA) (NYSE: HSBC.US) is one of the FTSE 100s dividend champions, supporting a dividend yield of 4.8% at present levels. However, the bank is facing numerous headwinds and there has been some speculation that management could be forced to slash the dividend payout to save cash.
With this in mind, Ive swapped my HSBC holding for insurer,Lancashire Holdings(LSE: LRE).
Uncertain future
HSBCs dividendyieldmay seem attractive at first glance but as the banks earning start to fall, the payout may come under pressure. For example, the banks earnings per share fell by around 8% during the first half and as a result, dividend cover fell from 1.9 times to 1.7 times.
Then theres the issue of fines from regulators, which could dig into HSBCs capital reserves. HSBC was slapped with a $500m mortgage mis-selling fine earlier this year and regulatory compliance costs are now rising at a rate of $200m per year.
Slow and steady
Insurance may not be the worlds most exciting industry but it can be highly lucrative. Lancashire is no ordinary insurer, the company only insures risks, which produce a high return. For example, you wont catch the company entering the UK motor insurance market, theres just too much competition.
Instead, the companyoperates within the property, aerospace, space and offshore insurance market, amongst others. Whats more, Lancashire uses excess of loss contracts meaning that each policy has a defined limit of liability arising from one event, when the limit is reached, no additional payouts are required.
Historically, Lancashires underwriters have been extremely conservative and, since inception, the companys combined ratio has averaged 59%. The industrys combined ratio for 2014 is expected to come in at 98%. So, its easy to see how Lancashire is beating its peers.
Industry trends
Right now the insurance industry is being flooded with cheap capital, as investors hunt for yield in this low-yield environment. Unfortunately, this influx of capital is pushing down profitability within the industry but Lancashire is not worried.
You see, the company has buckled down and remains true to its roots, only writing risks when the risk/reward is attractive. And right now, the insurance marketis not providing the returns that Lancashire is used to so the company is reducing its exposure.
For investors, this is great news. Management has stated that if Lancashire cannot find any opportunities within the insurance market, any excess capital will be returned to investors.
Indeed, this policy has results in special dividend payouts every year since Lancashire came to market. When you factor in these special dividends as well as regular payouts, an investment in Lancashire has risen four-fold since 2007. City analysts currently expect the company to support a yield of 8.6% this year and 8.7% the year after.
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Rupert Hargreaves owns shares of Lancashire Holdings. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.
