Universal Insurance Holdings Inc. (UVE) is a Florida based home owner’s insurance company that is working on diversifying its footprint and risk profile by developing a presence in other states. The company started operating in 1990 in more or less the same manner as our earlier pick HCII by taking over policies from the Citizens Insurance in Florida. This may be an interesting case study to peek at the future of HCII as well
UVE, with its wholly-owned subsidiaries is a vertically integrated insurance company performing all aspects of insurance underwriting, distribution and claims. Through its wholly-owned subsidiaries, including Universal Property & Casualty Insurance Company (UPCIC) and American Platinum Property and Casualty Insurance Company (APPCIC), the Company is principally engaged in the property and casualty insurance business offered primarily through a network of independent agents. Risk from catastrophic losses is managed through the use of reinsurance agreements. The Company’s primary product is homeowners’ insurance offered in five states as of June 30, 2012. While Florida still makes up 97% of the policies in force, the company is adding new states to its portfolio through its UPCIC subsidiary including North Carolina, South Carolina, Hawaii, Georgia and most recently in Massachusetts.
Why is it attractive?
We will start by looking at the balance sheet for the company and then later we will look at a few other operating issues that have bearing on our investment decision.
The data below is based on the market close price of $3.88/share as of Oct 12, 2012. All $s in millions.
|Market Value: $155.86|
|Book Value and Tangible BV: $161.76||P/B, P/TBV: 0.96|
|Short Term Cash: $356.33||Total Debt: $48.61|
|Restricted Cash: $74.27||Debt/Equity: 30.05%|
|Long Term Investments: $86.22||Annual Dividend: 0.32, 8.2% yield (variable)|
Aside: $74.27 m in cash is restricted cash, which includes contribution to their segregated trust fund to self reinsure a part of the catastrophic risk (it also includes deposits they need to maintain at various states they do business in). This is a curious way of reinsuring their own risk as it keep the risk within the corporation. The advantage is that in the "no loss" years, the deposits are available to the company for other uses. Aside from this one anomaly, the company does reinsure a large portion of their catastrophic risk with traditional reinsurers such as Odyssey Re, Everest Re, Renaissance Re and Llyod’s of London. The company also reinsures through the Florida Hurricane Catastrophe Fund. While this is curious, it is not enough to be of too much concern
Getting back to the balance sheet, it is important to note that the company’s assets are primarily cash based. Either as plain cash, or premiums received, reinsurance paid, deposits, etc. All in all, the company owns $17.7 million in non-cash hard assets (offices, etc). So in a way, the equity or the book value of $161.76 m is more or less the amount you will get when you settle all the cash accounts for the company. While the cash balance looks very attractive, it is offset by liabilities such as unearned premiums that is earned over time of the policy in force.
So essentially, if you were to buy the company in its entirety, decide to close shop and just service the existing contracts and let them run off (expire as the contract term ends), you will break even.
So Why Even Consider UVE?
Generally, value investors find that one missing piece of the puzzle that every one misses. In UVE’s case, it is the table below:
State of Florida mandated hardening of the home structures and roofs to resist high winds (hurricanes) in 2005. If the homeowner does the changes and gets them inspected by certified inspectors, they can qualify for wind mitigation credits from their home insurance company in the premiums they pay. Each inspection is valid for 5 years.
Over a period of time, it is expected that these structural improvements will reduce catastrophic losses and help the insurance companies. However, in the last 7 years this has been in force, it has had the effect of severely reducing the premium revenues and profitability for Florida insurers.
The credits given vary by the improvements as well as the location of the houses. Hurricane prone areas receive higher credits as they are already paying a higher wind storm component in their home insurance premium.
As you can see from the table above, the initial surge of credit claims from existing homes have leveled off and begun to subside. As this continues, the profitability of the insurance companies will improve.
In UVE’s case, there are several contributing factors in mitigating the impact of the wind mitigation credits
- UVE received premium increases of 14.9% in 2011 and another 14.9% in 2012. Future increases are not guaranteed but given the state of the insurance industry in Florida (Florida’s insurer of last resort, the state run Citizens, recently nullified wind mitigation credits for 62% of its policies due to "improper claims"), the State of Florida is keenly aware of the industry distress due to the credit program
- UVE is expanding to new states where they are less exposed and do not have to worry about wind coverage, and,
- Over time, the loss reduction with real structural improvements will show up as decreased claim payouts
So we may be looking forward to increasing revenues and decreasing expenses over the next few years as this plays out.
The past results of operations have not been too bad, although it has seen its margins decline as its expenses rose.
Keep in mind that while the company pays a juicy 8.2% yield, the payout is determined on a quarter by quarter basis and is uneven. The company ran a combined ratio of 120% in 2011 in its largest subsidiary (UPCIC), which means unprofitable underwriting. In response, the company has been pruning unprofitable policies and reducing re-insurance costs. The company also invests its float aggressively in the market and earns (or loses) investment income depending on the market conditions. Other income include commission revenues and various policy fees.
$81.9 million of its long term investments (of $86.22 million) is invested in equity securities. The rest being invested in US government debt. The equity securities are a combination of common stock and ETFs and break down as follows:
1. Metals and Mining: $45.98 m
2. Agriculture: $18.17 m
3. Energy: $13 m
4. Indices and other: $4.5 m
The investment portfolio should be up quite a bit this quarter. A quick check on the ETF performance shows that
1. US Agriculture Index is up 22.42% last 3 months
2. Industrial metals are breakeven, Precious metals are up 8%-10% with gold miners up close to 20% in last 3 months
3. Energy – Oil ETFs are up about 10% in last 3 months while natural gas is break even or marginally down
4. Market tracking indices (SPY) are up about 7% in last 3 months
Depending on the actual ETFs and Stocks held in the portfolio, I expect the investment portfolio to be up 5% – 10% for the quarter resulting in $4 m to $8 m in unrealized investment gain. Is this significant for the quarter? In the last quarter, the company reported $7.8 m in net income so we may be looking at a significant increase. This of course depends on them keeping the same allocation and not doing anything detrimental like trading in and out of the securities.
The key investment thesis rests on the high likelihood of improving profitability in the next few years and moderating risk profile of their policy portfolio. While the undervaluation does not appear to be much, the potential gains in the investment portfolio already in the bag offers us a good margin of safety until the time we can start seeing improved results in its quarterly reports. At this time, I recommend buying the stock as follows:
Purchase price < $4/share
Allocation = 5% of your portfolio
Holding period = 2-3 yrs
Target price = 1.5x Book, currently $6/share
Discuss UVE in the forum here. (link removed as it is members only)
Update (April 2, 2013): Buy target raised to $4.44/share and Sell target raised to $6.66/share (link removed)