Cigarbutt Posted June 19, 2021 Share Posted June 19, 2021 Note: -This is a low liquidity issue/small cap idea -The stock/company is going through an interesting phase -The interest on my part here is idiosyncratic (relatively low conviction and tiny position size) and the interest here may be absolutely and relatively irrelevant to present trends; it’s clearly not a Great Gatsby stock Just in case, -Thesis Unico American Corporation (UNAM) is a commercial property-casualty insurer based in California. Unico is a small player with a long (and slightly twisted) history and has focused on some niche markets. It is presently going through a rough patch, with some similarities to what happened a few years ago (early 2000s), and the typical lag in recognizing developing poor results, and then improvements, means now an opportunity to buy at a discount to intrinsic value and to sell at intrinsic value within 3 years for a compound annual return of around 20-25%. The thesis is related to a tendency for insurers’ performance to return to the mean if they don’t fail and if factors behind the recent underperformance are identifiable and reversible. -History Unico was founded in 1969 (incorporated in 1969, initially as an insurance brokerage firm and then, since 1984, a long history of commercial niche underwriting in California) by Erwin Cheldin. There have been some deviations from trend but, basically and to this day, it has remained a commercial player focused in the California market and their main product is a multiple-peril policy in specialized markets. -The troubles in the early 2000s and the recovery after Unico did not react by moving away from eventually realized unprofitable business lines related to the very soft markets of the late 1990s while simultaneously pushing for geographic expansion outside of California. Here are key numbers for the period (in M, except % for CR): 2000 2001 2002 2003 2004 2005 2006 Net premiums written 26.4 32.1 38.4 47.4 51.1 46.0 38.2 Surplus 39.6 27.5 26.3 26.1 29.4 36.6 50.0 Shareholders’ equity 51.4 40.6 38.4 38.5 42.4 48.4 60.9 Total investments 98.2 94.7 102.7 118.6 118.5 140.6 147.3 Combined ratio 116 169 126 107 89 83 63 EPS (diluted) 0.07 (1.97) (0.59) 0.19 1.02 1.20 2.09 Diluted shares outstanding 6.1 5.5 5.5 5.5 5.6 5.6 5.7 The years 2000-3 were marked by poor underwriting results with significant negative reserve development on prior years (4.3M in 2000, 19.3M in 2001, 7.8M in 2002 and 2.8M in 2003). This was associated with rating downgrades (from A to A- to B+) and many ratios outside of normal ranges for IRIS (regulatory ratios signaling risk to policyholders). However, the company led by the founder was able to right the ship (improved underwriting standards, efficient runoff of policies outside of California and outside of their core business lines) and benefited from a significant hard market. Erwin Cheldin also provided (temporarily) 1.5M in capital to help maintain surplus above 25M. During 2001-2 (around the trough in recognized operating results), share price, represented through market cap went to about 0.4 to 0.5 of book value and the ratio of total investments to market value went to about 5. The rebound was very impressive and in correlation to the hard market with underwriting profitability increasing significantly and with significant favorable reserve development starting in 2005. AM Best increased the rating to B++ in 2006 and to A- around 2008-9. -The succession plan and business conditions leading to this opportunity Starting in 2006, because of softening in rates, Unico walked away from potentially unprofitable lines and significantly shrunk net premiums written. In 2009, Erwin Cheldin, the founder, was followed by his son Cary Cheldin as CEO. From 2009 to 2014, underwriting and general profitability slowly dwindled and Unico remained conservatively capitalized, with NPW going slightly down (from 29.6M to 27.8M) and with cumulative EPS of 2.30 and cumulative dividends of 1.92 (share count overall fairly constant). From 2015 to now (Cary Cheldin ‘retired’ in August 2020), there were various operational difficulties (information technology upgrade projects) and underwriting results deteriorated. This was compounded by irregular growth in a soft market (up to 2019) and then a recognition of significantly poor results (prior and actual reporting years). There was an impression that the 2018 year marked a positive turning point but that proved to be a false dawn. Here are key numbers for the period (in M, except for per share data and % for CR): 2014 2015 2016 2017 2018 2019 2020 Net premiums written 27.8 31.0 32.6 31.6 25.9 28.7 28.6 Surplus 63.5 61.4 59.1 50.4 50.1 46.5 26.9 Shareholders’ equity 55.1 35.0 Total investments 85.0 83.6 Combined ratio 78 87 95 114 103 118 161 EPS (diluted) 0.16 (0.22) (0.26) (1.64) (0.60) (0.59) (4.05) Diluted shares outstanding 5.3 5.3 Strengthening of reserves was 8.0M in 2020 (3.2M in 2019, 2.9M in 2018 and 7.1M in 2017) and this loss within the longer term poor underwriting trend triggered a company action level action of the CA DOI with the RBC’s adjusted capital at 278% (below 300%) and a combined ratio at or above 120%. This required the submission of a plan (submitted March 24, 2021) and means relatively close scrutiny from the regulator. The plan could involve a capital injection. At year-end 2020, Unico also had 3 of the 13 IRIS ratio tests outside of usual value range. In 2019, AM Best downgraded Unico to B++. In February 2021, the B++ rating was maintained but the outlook moved from stable to negative. The 2020 insurance year was associated with the Covid-19 issue. This meant business interruption claims (151 claims) which will likely not be enforceable. It also meant lower premium levels in certain lines (ie bars and taverns) but growth in other insurance lines (it’s not possible to define premium price increase vs increased volume from disclosures) allowed NPW to remain essentially flat (some growth in GPW). However, given overall market conditions and the markets where Unico operates, it’s likely that premium prices have been increasing significantly. There are many similarities now versus what happened to Unico in the early 2000s. Cary Cheldin retired in August 2020, there is new management in place unrelated to the Cheldin’s family and the Board is now composed of 5 out 6 directors recently put in place. Erwin Cheldin remains a director, holds 44.4% of the stock but is 89. Underwriting standards are being improved during a significant hardening of the market. Underwriting standards have degraded, especially since 2015 and policies were inappropriately priced but the level of social inflation was difficult to discount and premium prices have likely caught up with previous cost trends. -Unico’s business in general More than 90% of revenues (93.6% in 2020) come from core insurance underwriting operations. For a very long time, Unico has maintained related business revenue streams (various fees, commissions) which have been quite stable and are value neutral for the enterprise. 99.9% of core underwriting revenue (GWP) comes from California and involve 1-Transportation, 2-Food, Beverage & Entertainment, 3-Garage & Mercantile and 4-Apartments & Commercial Buildings. CMP policies made up 99.6% of GWP in 2020 (and 98.2% of reserves). They use reinsurance (cede business on an excess of loss basis) and the arrangements have been quite standard for some time. It has been a bad deal for reinsurers for a while (reserve deficiency shared with the reinsurers) and rates have been going up. The investment portfolio is quite conservative and standard for an insurer with a focus on fixed income. The average weighted maturity was at 8 years and yield on average invested assets was at 2.4% in 2020. The have some exposure to corporate debt and a small recent allocation to equities. -Opportunity now (as of year-end 2020) With improving underwriting standards, the most likely scenario is for improved underwriting results in 2021 (combined ratio expected above but closer to 100%), a neutral result in 2022 and an underwriting profit in 2023 with an expectation of a price to book value at around 1.0 at the end of 2023, in a way comparable to what happened in the early 2000s. Presently (end of 2020), market price to book is between 0.6-0.7. The ratio of total investments (cost) to market cap stands at about 3.5. With a portfolio yield at 2.4% and about a 10% tax rate on fixed income revenue, the portfolio, by itself, would supply an about 6.5% after-tax return on market price paid now, with modest float growth expected going forward. In 2020, Unico recognized a deferred tax asset valuation allowance of 10.6M (2.5M in 2019). These deferred tax assets correspond mostly to NOLs that begin to expire in 2035. With a return to profitability, this valuation allowance is likely to reverse and a discounted amount of this allowance needs to be integrated to expected book value going forward. -Results in Q1 2021 Here are key numbers for Q1 2021 (in M, except for per share data and % for CR): Q1 2021 Net premiums written (annualized) 30.8 Shareholders’ equity 36.3 Total investments 93.1 Combined ratio 116 EPS (diluted) 0.43 Diluted shares outstanding 5.3 GWP was up 13.9% and Unico ceded more (likely related to more expensive reinsurance rates) as NWP was up less at 6.6%. In Q1, there were proceeds from the sale of the HQ (12.0M) for a realized gain of 3.7M. Net income was 2.3M (EPS of 0.43) as the combined ratio was at 116%. Underwriting changes continue to be applied and growth is occurring in the transportation line of business. However, the accident year combined ratio was at 136% reflecting favorable reserve development in prior years (18%) combined with an unusual quarter with 1.4M losses related to an unusually high number of property fires (5). Positive reserve development came in at 1.2M and it’s the first time in a while when there are two subsequent quarters with positive development (positive 0.2M in Q4 2020). Market price to book is at 0.66 at quarter end. Total investments (cost) to market cap now stands at about 3.9. With a portfolio yield at 2.3% and about a 10% tax rate on fixed income revenue, the portfolio, by itself, would supply an about 8.1% after-tax return on market price paid now, with modest float growth expected going forward. Also, as of the end of Q1, the company had an unusually high cash and cash-equivalents balance of 7.8M which is not included in the total investments numbers above. -Potential catalysts The thesis rests on a regression to the mean for core insurance operations to be realized by the end of 2023. This would imply an annual compound return of 20 to 25%. Share price is now at around 4.50 and book value of 8.00 per share is expected at end of 2023. There also exists a relatively low probability that a buyout (as a going concern) is made and this would likely imply bridging the gap to intrinsic value more rapidly. Even if put into runoff, the enterprise should fetch a 0.8 to book value ratio under present circumstances and with adequate runoff expertise. An interesting aspect is that Sardar Bigliari (who is sometimes discussed here) has been holding, through the Lion Fund, for a while, as a passive investment, a 9.9% stake. -Risks Apart from the usual risks related to a property-casualty insurer, the company is small, not greatly diversified and trades with low liquidity. The biggest risk lies in the fact that it is still unclear how far the company is advanced in the recovery process concerning prior years, how efficiently new management and Board can improve underwriting standards and how hard and durable the present hard market really is in Unico’s markets. My assessment based on the above is that the worst is over for prior years, reversion to the mean (operations and underwriting) is likely under UNICO’s specific business circumstances and that the hard market has legs for a while given the unusual softness in underwriting in general and the low interest rate environment. ----- Disclosures: -i’ve built a very small position in one of my accounts -I’ve owned the stock before on two occasions when there was nothing (or not much) else to do Link to comment Share on other sites More sharing options...
benbuffett Posted June 19, 2021 Share Posted June 19, 2021 Another small insurance company that might interest you is Atlantic American Corporation (AAME). Biglari has small passive investment in this one as well. The CEO's wife and mother- in- law own the lions share of company. Link to comment Share on other sites More sharing options...
Cigarbutt Posted June 22, 2021 Author Share Posted June 22, 2021 ^Yes, this was an interesting company to look at. There are some parallels: long history, entrenched interests in place etc However, AAME had an unusually strong 2020 year in the Medigap segment, they have large unrealized gains in the float portfolio which is definitely skewed to reach for yield in this environment. Also, it seems Mr. Bigliari has recently cut his stake. ----- it seems an activist type of fund is trimming its large stake in UNAM. Link to comment Share on other sites More sharing options...
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