PIH - 1347 Property Insurance Holdings

[yadayada]

saw it on VIC as highly rated idea so i dug into it. I know next to nothing about insurance, so this:

 

http://shookrun.com/fa/value/fabuffett_insurance.htm

 

Is a good primer on insurance. This idea is a micro cap insurance doing property insurance that just IPO'ed, but didnt generate the anticipated interest.

 

Alot of big insurance firms have ran out of their market in louisiana due to pricing their premiums too low and big losses. So now a niche exists in the louisiana market. There is a shortage of supply of insurance for wind damage on homes. Citizen program took some of this over, but they are now looking to unload their insurance.

 

But I wonder why arent the big guys moving in and taking advantage of this supply shortage in insurance? Now is the time you can charge big premiums right?

 

The guys running this have like 100 years of experience together in the  industry. But since you cannot look back on a track record here I have some problems valuing them.

 

They expect to capture 2-3% of the louisiana market in the next 3 years. If you assume 2%, that is about 50 million$ in premiums a year. So 50 million $ revenue. What kind of % do they make on that I wonder? Would love to hear a view from people who know more on insurance.

 

Another thing is how fast can a insurance company grow? Current annual revenue  would be something like 10 million$.

[jouni1]

The guys running this have like 100 years of experience together in the  industry.

 

quoted part is true for most insurance companies.

 

anyway, brand new insurance companies are pretty hard. you really have to trust the managers. most of these seem to be managed with something else than shareholders in mind.

 

they can grow as fast as they want to, but they need capital for it. usually insurance companies growing fast is a red flag of bad underwriting. as you said, somebody else would move in if it was that easy and the rates were good.

[yadayada]

some reading on the guys behind this

http://www.kingsway-financial.com/wp-content/shareholder_letters/03-31-14%20Shareholder%20Letter.pdf

 

It seems they are very solid, in a market of opportunity and the stock seems to be mispriced now?

 

It is somewhat risky, but conservatively there is like 100% upside over the next few years right?

 

It reads very warren buffetesque (if that is a word :D). It seems the risk that they will just blindly accept anyone at any rate is extremly low. There is some concentration risk tho, because at first they will only write policies in louisiana.

[motownsf]

What happens when there is another big hurricane in Louisiana? Playing with fire in my opinion.

[yadayada]

http://www.cornerofberkshireandfairfax.ca/forum/general-discussion/kingsway-financial-in-the-red/

 

Hmm.

 

I guess I have to be carefull of the buffett imposters, talking the talk, and not walking the walk.

 

I guess Ill pass :D

[WideMoat]

I was always wondering how the relationship between 1347 and Kingsway would go...

 

"1347 Property Insurance Holdings, Inc. (NASDAQ:PIH) (“PIH” or the “Company”), announced today that it has entered into a definitive agreement with 1347 Advisors LLC (“Advisors”), a subsidiary of Kingsway Financial Services Inc. (“Kingsway”), to terminate the management services agreement...

 

Pursuant to the transaction, which closed today, Advisors will receive the following consideration:

 

· $2 million in cash;

· $3 million of 8% preferred stock of PIH, redeemable in five years;

· A Performance Share Grant Agreement with PIH, whereby Advisors will be entitled to receive 100,000 shares of PIH common stock if at any time the last sales price of PIH’s common stock equals or exceeds $10 per share for any 20 trading days within any 30-trading day period; and

· Warrants to purchase 1,500,000 shares of common stock of PIH with a strike price of $15, expiring in seven years."

 

http://www.sec.gov/Archives/edgar/data/1591890/000091476015000080/p88627_991.htm

 

Seems a generous parting gift...

[Aman1]

So there is an excellent write up on this company by a fund called T11 Capital and no point duplicating good work:

 

http://www.t11capital.com/wp-content/uploads/2016/02/T11-PIH-research.pdf

 

I'm just updating my own model to reflect Q415 results and call guidance, will post comments in due course.

[kab60]

Thanks. Another way to play this might be via Kingsway Financial that T11 also has as a core holding.

 

I think PIH looks interesting trading at a big discount to NCAV, but Q1 will be tough on them. Since I'm not an expert on insurance I would like insiders to have more skin in the game so as to make sure they underwrite conservatively. Two of the quarters last year sported combined ratios above 100 pct., and Q1 2016 doesn't look good either. I think it all might be priced in though.

[Aman1]

Hi kab60,

 

Last year, despite two bad quarters which each reported a combined ratio over 100%, the full year combined ratio was still 91.6%, generating an EPS of 0.28 after stripping out the one-off payment to cancel a management services agreement (former parent from which this is an IPO carve-out) which was essentially a profit share.

 

So into 2016 they have had one bad quarter and you would expect at least 1-2 more bad quarter due to the wind season to come. However, at the same time you should see an acceleration of policy growth and revenue from the 2015 level of +43% sales. So there's a good chance of an "okay" combined ratio on a growing asset base - I'm actually modelling 35c of EPS in 2016 based on roughly flat YoY combined ratio and the projected policy growth from entering Texas.

 

However, as seen in 2014, there will be times where no major cat event takes place or only one quarter in the year gets hit. in 2014 this drove an EPS of 82c. If something similar happened in 2017 (for example) on the materially higher policy base, you could be looking at EPS in the 1-1.50 range (versus current share price of 5.90).

 

Moreover, in most cases they will not post a negative EPS due to the reinsurance contracts in place which have a maximum $5m loss in any period ($1 per share hit) set against any other profit posted in a given year that will offset this.

 

Against this, the company has current book value of $7.69 which means the company trades on a P/B of 0.76x versus the cat industry at 1.5x - 2x.

 

This company is deserving of a discount right now (though still really at a level above book) due to the limited geographical diversification, but over the next couple of years, there will be greater exposure in Texas (launched late 2015) and other coast states which should help act as a diversifier and normalize the rating versus the peer group.

 

I agree with your point on insider ownership at PIH. While there are lots of options that will lead to decent ownership, it's not quite the same as management investing their own cash. That said, it's an experienced management team that come across well in investor calls and were hand picked by the activist owners of KFS, so I'm prepared to give management the benefit of the doubt for now.

 

KFS itself is an interesting story in its own right due to the activist control and significant insider ownership, enormous tax losses and recently deleverged balanced sheet setting them up to use insurance float for a big acquisition (essentially a tax free SPAC with an existing insurance and insurance service business). However they only own 20 % of PIH (and have a bunch of warrants that are deeply out of the money) so it's not a clean play on PIH but an interesting story in its own right (I also own some KFS stock).

[scorpioncapital]

The only thing that doesn't make sense is a small cap company looking to grow buying back even a single share. Very odd use of capital where they should need every penny - if not issuing shares, regardless of discount to b/v.

[Aman1]

They should have plenty of cash to cover the rollout across Texas over the next few years.

 

If peers trade at 2x book and you can buy back your own shares at 0.7x book (and indeed a discount to cash on hand), a buyback seems an absolute no-brainer to me.

 

Assming you have some mean reverersion over 3-5 years, say, and with long term steady state RoE targeted of 15%, you could be looking at a return on buybacks of 30-50% pa - it's quite a high benchmark set for use of capital.

 

I agree they need enough cash to build out Texas at least (to diversify the geography which adds value) but beyond that I'd be buying stock at least up to book value. If anything, I'm somewhat surprised by their restraint, which augurs more towards your point around maintaining high levels of capital on hand to grow organically.

[muscleman]

The guys at KFS are supposed to be really smart. Why did they choose to sell a major stake in PIH and retained the other insurance business?

[Aman1]

KFS has a history of using IPO carve-outs to raise capital for insurance businesses that KFS itself does not have the capital for. It did this with Atlas Financial (AFH) in 2013 and that has roughly tripled since IPO. They were then able to monetise their residual stake through sales over time at a cumulative value that likely would have exceeded keeping 100% of a capital constrained business.

 

They also sold their "Assigned Risk Solutions" business in 2015, which was also a relatively big operating business for them; so KFS has  a history of looking for ways to raise capital and monetise assets effectively if the price is right.

 

I would disagree with your original point and say that relative to these other disposals, KFS has actually retained significant more equity in PIH versus other historic disposals: they remain the #1 shareholder of PIH and in addition they will be granted shares at various strike prices over $10 per share (and a sizeable warrant). Arguably, they are more geared to PIH's longer term equity upside than most of their other disposals in recent years.

 

The use of proceeds on prior dispoals has been to clean up the balance sheet (pay down debt) so that they can a) have the flexibility to carry out buybacks and b) carrying out large leveraging transactions. KFS trades at around $4.50 and has $2 of NAV and around $20 of tax loss assets per share. KFS is seemingly setting themselves up for a position to go out and raise a load of debt and pref equity to buy something big, then I suspect as that asset performs, they will use FCF to buy back pref and ordinary equity over time.

 

One final point; the "really smart" guys include Joseph Stillwell the activist investor behind KFS; in addition to the indirect ownership of PIH through KFS, Stillwell Value also has taken a direct stake in PIH (albeit relatively small)

[muscleman]

KFS has a history of using IPO carve-outs to raise capital for insurance businesses that KFS itself does not have the capital for. It did this with Atlas Financial (AFH) in 2013 and that has roughly tripled since IPO. They were then able to monetise their residual stake through sales over time at a cumulative value that likely would have exceeded keeping 100% of a capital constrained business.

 

They also sold their "Assigned Risk Solutions" business in 2015, which was also a relatively big operating business for them; so KFS has  a history of looking for ways to raise capital and monetise assets effectively if the price is right.

 

I would disagree with your original point and say that relative to these other disposals, KFS has actually retained significant more equity in PIH versus other historic disposals: they remain the #1 shareholder of PIH and in addition they will be granted shares at various strike prices over $10 per share (and a sizeable warrant). Arguably, they are more geared to PIH's longer term equity upside than most of their other disposals in recent years.

 

The use of proceeds on prior dispoals has been to clean up the balance sheet (pay down debt) so that they can a) have the flexibility to carry out buybacks and b) carrying out large leveraging transactions. KFS trades at around $4.50 and has $2 of NAV and around $20 of tax loss assets per share. KFS is seemingly setting themselves up for a position to go out and raise a load of debt and pref equity to buy something big, then I suspect as that asset performs, they will use FCF to buy back pref and ordinary equity over time.

 

One final point; the "really smart" guys include Joseph Stillwell the activist investor behind KFS; in addition to the indirect ownership of PIH through KFS, Stillwell Value also has taken a direct stake in PIH (albeit relatively small)

 

 

Thank you very much!

 

I didn't update my post, but I did take notes in the last few days that they originally had 1000k shares outstanding in 2013, and then by March 2014, they IPO'ed and sold 2,100k or so shares at $8, and then by June 2014 they sold another 2,300k or so shares at $8, so you are totally right. They did the right thing and there is nothing suspicious.

 

 

Right now I am looking at the loss ratio. I can't find publicly traded competitors in LA state. I checked FL state insurers like UVE, and their loss ratio is 41% for the past two years, but PIH is only 38%. Not sure if this is normal. Given PIH's insurance policy is the second cheapest in LA, I'd expect a higher loss ratio than other insurers. But comparing a FL insurer with an LA insurer may not be fair.

 

I'll call them or try other ways to find the statutory books. I think it is important to check on that for insurers.

 

 

 

 

[muscleman]

How much do you know about Joe Stilwell? I googled him and the top thing showed up is this:

https://www.sec.gov/litigation/admin/2015/ia-4049.pdf

 

[Aman1]

 

Thank you very much!

 

I didn't update my post, but I did take notes in the last few days that they originally had 1000k shares outstanding in 2013, and then by March 2014, they IPO'ed and sold 2,100k or so shares at $8, and then by June 2014 they sold another 2,300k or so shares at $8, so you are totally right. They did the right thing and there is nothing suspicious.

 

 

Right now I am looking at the loss ratio. I can't find publicly traded competitors in LA state. I checked FL state insurers like UVE, and their loss ratio is 41% for the past two years, but PIH is only 38%. Not sure if this is normal. Given PIH's insurance policy is the second cheapest in LA, I'd expect a higher loss ratio than other insurers. But comparing a FL insurer with an LA insurer may not be fair.

 

I'll call them or try other ways to find the statutory books. I think it is important to check on that for insurers.

 

Just to complete the circle on this - the reason why they didn't raise the capital at KFS (as the growth in profits could be shielded by tax losses) is due to the rules around those very same sizeable tax losses. I'm not totally clued up on tax loss laws, but broadly speaking my understanding is that (what the IRS considers) a change in ownership can impact the ability to utilize tax losses; clearly KFS wanted to avoid that at all costs.

 

I appreciate the loss ratio is useful, though I'm probably just as focused on the overall combined ratio and it's constituents. The company presentation includes a peer group of coastal P&C small caps you can use to benchmark the company (looks like that's what you have used?). Personally, I think a through-the-cycle writing of profitable business (combined ratio <<100%) with an RoE of around 15% would be good to see for these guys. The worry is clearly that as they are growing rapidly, getting comfortable that they are writing good business.

 

They are reporting the latest quarter numbers after hours tomorrow with a public call on Friday morning, so you have an excellent and timely change to follow up with management.

 

 

[Aman1]

How much do you know about Joe Stilwell? I googled him and the top thing showed up is this:

https://www.sec.gov/litigation/admin/2015/ia-4049.pdf

 

Yeah, I had seen this. This was settled last year (http://www.reuters.com/article/sec-stilwell-idUSL2N0WI1SF20150316)

 

Appreciate it doesn't look great (inter-fund loans) but doesn't appear to have been an attempt to defraud investors.

 

I think the more important "behind the scenes" man in this situation is Larry Swets, the CEO and a major shareholder of KFS. He's also a board member of PIH and hired the CEO Doug Raucy when it was a division within KFS.

[muscleman]

 

Thank you very much!

 

I didn't update my post, but I did take notes in the last few days that they originally had 1000k shares outstanding in 2013, and then by March 2014, they IPO'ed and sold 2,100k or so shares at $8, and then by June 2014 they sold another 2,300k or so shares at $8, so you are totally right. They did the right thing and there is nothing suspicious.

 

 

Right now I am looking at the loss ratio. I can't find publicly traded competitors in LA state. I checked FL state insurers like UVE, and their loss ratio is 41% for the past two years, but PIH is only 38%. Not sure if this is normal. Given PIH's insurance policy is the second cheapest in LA, I'd expect a higher loss ratio than other insurers. But comparing a FL insurer with an LA insurer may not be fair.

 

I'll call them or try other ways to find the statutory books. I think it is important to check on that for insurers.

 

Just to complete the circle on this - the reason why they didn't raise the capital at KFS (as the growth in profits could be shielded by tax losses) is due to the rules around those very same sizeable tax losses. I'm not totally clued up on tax loss laws, but broadly speaking my understanding is that (what the IRS considers) a change in ownership can impact the ability to utilize tax losses; clearly KFS wanted to avoid that at all costs.

 

I appreciate the loss ratio is useful, though I'm probably just as focused on the overall combined ratio and it's constituents. The company presentation includes a peer group of coastal P&C small caps you can use to benchmark the company (looks like that's what you have used?). Personally, I think a through-the-cycle writing of profitable business (combined ratio <<100%) with an RoE of around 15% would be good to see for these guys. The worry is clearly that as they are growing rapidly, getting comfortable that they are writing good business.

 

They are reporting the latest quarter numbers after hours tomorrow with a public call on Friday morning, so you have an excellent and timely change to follow up with management.

 

 

Everyone talks about composite ratio. But composite ratio = loss ratio + expense ratio.

 

What's PIH's moat? Is it a low cost insurer?

 

Insurance business is a commodity business. If T11 touts about PIH's greatness as the 2nd cheapest insurer in LA, then the loss ratio must be higher than other insurers. Basic math. You suffer the same amount of losses, and your premium is lower, so your loss ratio is higher. This should be fine for GEICO, because it is a low cost insurer, so the expense ratio is lower than competitors to offeset the higher loss ratio. But I need to find PIH's comps and check their loss ratio and expense ratio.

 

Have you checked their statutory reports and compare with other insurers? I can send you if you can't find it.

[muscleman]

There is one catastrophe every two years in LA. PIH said the 2016 Q1 composite ratio is 124%, and excluding the catastrophe it would have been 75%. If we take an average of these two numbers, we get 99.4%, a roughly break even insurer.

LA_hurricanehistory.pdf

[Aman1]

Hi muscleman, plenty of points you've made! I'll try to give my thoughts on these; this is just my opinion and I welcome any feedback / constructive criticism (I'm on here in the first place to have a sounding board for my investment case).

 

Everyone talks about composite ratio. But composite ratio = loss ratio + expense ratio.

 

So I should caveat my comments by saying I'm a generalist that has only recently spent a bit of time looking at the insurance sector, so my view could be blown out the water by those with deep experience in insurance. But my view is that the combined ratio (and it's two constituents) tell you an awful lot more than the expense ratio alone.

 

combined ratio = loss ratio + expense ratio

 

So loss ratio is the insurance loss on the book, cool, straightforward enough.

 

One way to think of the expense ratio is to think of it as the resourcing used to build and manage that book of insurance. In other words, imagine two equally efficient insurance companies: Insurance company A, however, hires a load more underwriters for the same sized book than insurer B. They, as a result, have a much better loss ratio - as they have spent far more in resources in scrutinizing individual risks and building a much higher quality book than insurer B. However, the expense ratio is then far higher at insurer A as a result of all those extra personnel and systems in place. So looking at the loss ratio alone doesn't help assess the underlying business model and it's profitability.

 

In the real world, Progressive and Geico are insurers A and B respectively. Progressive runs a high expense ratio but a low loss ratio. Their business model is one of paying up to ensure a relatively high quality book. Geico on the other hand actually runs quite a high loss ratio, but a remarkably low expense ratio as they clearly accept the low cost, lower quality book is a reasonable trade off. Remarkably both have combined ratios pretty close to each other - i.e. the two business models actually net off to the same thing.

 

What's PIH's moat? Is it a low cost insurer? Insurance business is a commodity business.

 

I totally agree that generally speaking, insurance is a commodity  business.  Mainstream car insurance is a commodity business, and price is the biggest single factor in decision making (though I do think there is some value attached to management of claims, which should resonate for anyone that has had to claim against a high value insured loss). Something like car insurance is also pretty predictable at an actuarial level and short tail, so prices can be adjusted quickly due to cyclical factors (more miles driven in boom times, hence more accidents). This is therefore a stable, predictable but low return insurance business. You would expect "good" operators to have combined ratios in the high 90s, making a small margin and benefiting from the investment income off the float.

 

However, my thesis is that there are likely to be niches in the insurance world that mainstream insurers don't always go after, and my hypothesis is that coastal insurance is a niche market. El Nino, the increasing frequency of bad weather, the straight-up negative press associated with mismanaging the odd claim in large events like Katrina means that a lot of the mainstream insurers have left the market, leaving a profitable niche to exploit. However, going into a spot where large low cost capital might be leaving is not sufficient to make money. You also need people that know which risk to go after in these markets and to price it correctly. My working assumption is that PIH management's long history in the Louisiana, Florida and broader coastal markets means they have a good idea of which risks to go after and a good view on pricing. That is the key risk in this investment case but one I believe I'm prepared to back. The second element of potential competitive advantage is knowing which agents are legit that will bring in good business, and having relationships with the better guys to ensure that those agents will trust you, the insurer, and will want you to bring business to you. The key here is relationships and again, I'm betting on management to have long and quality relationships to exploit like they say they do.

 

In a nutshell, this therefore becomes a bet on the management team exploiting their relationships and knowledge of a niche market, rather than a commoditized low-cost play.  Anyway, this is broadly the thesis, hope this helps clarify my thinking somewhat.

 

There is one catastrophe every two years in LA. PIH said the 2016 Q1 composite ratio is 124%, and excluding the catastrophe it would have been 75%. If we take an average of these two numbers, we get 99.4%, a roughly break even insurer

 

Thanks for sending this data through , pretty interesting - I'm not entirely clear on your maths though. Using your data and from my thinking, if there is one catastrophe every 2 years, that would mean one maximum cat reinsurance excess hit of $4m every 4 years. If they did 85% average for 7 quarters then 124% for that one quarter in eight, that would get you to 89.9% combined ratio over the period. Personally, I think there's a decent shot they could average a better combined ratio than this over time; though my working assumption is that there will be more quarters than 1/8 that are over 100% but there will be some quarters and even years with exceptionally low loss ratios (but luck around the weather and the cost of reinsurance over the medium term will both factor into the upside/downside scenarios here).

[Guest MarkS]

I'm from Louisiana. Most people believe that Louisiana is the worst run state in the Union.  But that's the wrong comparison. We're actually the best run State in the Carribean. I'd be very careful buying companies that are insuring property here.  Our court system is not for the faint of heart.

Thanks

Mark

[Aman1]

Hi MarkS - thanks for the post. Since you're a local, can I ask who you use for home insurance, how often you change provider and how the cost of your premium has trended over the last 5-10 years?

[Guest MarkS]

I'll try to answer your questions. Currently we're with ASI Lloyds.  We switched about rwo or three  years ago (from Hanover?) - going from very expensive to just expensive. I just got a quote from State Farm that was about 10% higher then what I'm currently paying.  I don't know if that is a harbinger of higher rates to come.  I'm certainly no expert on the subject of insurance in Louisiana. I've just lived a relatively long time and seen a lot of companies come and go.  We've historically had some of the most expensive insurance rates (property and auto) in the  country. As i understand it the high rates are directly related to our rather unfriendly court system and regulatory bodies.

Thanks

Mark

[Aman1]

I've just lived a relatively long time and seen a lot of companies come and go. 

 

Thanks Mark - and I agree, I think this is a key risk here; there's a lot of guys that have raced into the market, growing rapidly through the depopulation programs where they've bought large books of policies off the state insurer (Citizens) then blown up due to the poor policies taken on. It's one of the things I'm most careful about watching with these guys. Positively with these guys (so far), the initial high growth through depopulation policies has now slowed with organic growth being the main driver of new business at this point.

 

I'd be interested to know how Maison Insurance (1347's trading name) compares for insurance for you (though I appreciate you might not have the time to look into it). My understanding based on reading consumer reviews is that they are markedly cheaper but also offer a much tigher scope of coverage (i.e. a poorer product in terms of insured risks covered) so aligns up to a low price point (key selling point) but only slightly better in terms of the true value proposition. Maybe worth taking a look when you renew?! :) Unfortunately I'm based in the UK so frustratingly it's not really possible for me to "shop around" for quotes to compare the pricing and risk insurers are taking on locally.

 

On pricing, I'm guessing the weather and geography is probably the biggest single factor for the higher cost of insurance in LA rather than regulations. I've got a meeting with management forthcoming, so I will be sure to ask them about regulatory regime and the local judicial system - so thanks for flagging this point.

[Guest MarkS]

Aman1, have you looked at this site? https://www.ldi.la.gov/consumers/insurance-type/homeowners

Mark