Assurant, Inc. ((NYSE:AIZ)) is a specialty line insurance company currently trading at a 33% discount to my estimate of fair value of $52.00 per share. While regulatory scrutiny of their profitable force placed insurance business has decreased future earnings visibility, the cheap valuation, strong management and rapidly decreasing share count more than offsets this risk.
Assurant operates in four segments: Solutions, Specialty Property, Health and Employee Benefits. Solutions provides service contracts, credit insurance and pre-need insurance through a diverse distribution network of retailers, banks, insurance agents and funeral homes. Health and Employee Benefits provide health, dental and other insurance products to individuals as well as small businesses. Specialty Property is the company's most profitable unit, providing force placed insurance as well as property and flood insurance.
Assurant is the leading provider of force placed insurance in the United States. The company works with mortgage servicers to monitor existing home insurance policies in the servicer's portfolio, flagging policies that have lapsed and providing coverage to protect the lender's interest in the property. The property owner is notified and is responsible for the cost of the force placed policy. This business expanded dramatically following the housing crisis and subsequent foreclosure boom. As a result, the Specialty Property segment has accounted for a majority of Assurant's net income since 2007.
The profitability of force placed insurance has attracted the attention of state insurance regulators. The company recently agreed to a 30.5% reduction in premium rates for force placed insurance products in California that would result in a reduction of net earned premiums in that state of $124M in 2011 by $33M. New York is currently considering changes to pricing that would affect $64M of net earned premiums in 2011, although the impact on premium rates is not yet known. There is a likelihood that rate reviews in other states may also result in reduced premium rates going forward.
The threat of reduced premium rates coincides with an improving housing market and economic growth, both of which are expected to result in a reduction in the number of forced placed insurance policies to more sustainable levels as fewer homeowners allow their insurance policies to lapse. These two factors are responsible for Assurant currently trading at P/B of 0.54 and a P/E of 6.27 times 2011 EPS of $5.58. However, these factors are mitigated by the current attractive valuation of the stock and uncertainty in the timing of a complete recovery in the housing market. Until such time, Assurant's placement rates will likely remain above long-term sustainable levels.
The following table annualizes YTD 9/30/12 net income by segment to determine the effect of decreases in earnings in the Specialty Property segment. Because insurance claims and investment returns are lumpy, this only a rough guess of future earnings and is somewhat consistent with the segment results from previous years. Earnings per share are calculated assuming the 79,456,860 shares outstanding as of 9/30/12. Figures are in thousands.
Earnings per Share
Segment Income - YTD 9/30/12
Assume 50% decrease in Specialty Property
Assume 75% decrease in Specialty Property
Outstanding Shares (9/30/12)
Current Share Price
YTD net income is on pace for $611.6M annualized. Assuming a 50% reduction in net income for the Specialty Properties segment to $196.5M annualized would result in a reduction in net income to $415.1M. This should account for lower premium rates and reduced placements going forward and represents a reasonable assumption for future net income for the Specialty Property segment. With 79.46M share outstanding, this would result in EPS of $5.22 annualized. I believe that this represents a conservative estimate of the impact of premium rate reviews on net income. The current market value of the company is basically assuming Specialty Property segment income will fall 75%. While this is a possibility, I believe it is unlikely.
Assuming all of the projected net income of $415M is distributable to the holding company, management could repurchase an additional 9.16M shares annually at $35/share after paying dividends totaling $0.84/share annually. With 79,456,860 shares remaining as of 9/30/12, the company could repurchase all existing shares within 9 years at the current price of $35.00/share assuming 9.16M shares repurchased per year.
Because insurance companies have complex accounting and sell complex products with risks that are often difficult to assess, management quality is very important. Assurant's management has proven itself to be conservative managers of risk, restricting operations to segments in which they can operate profitably. In addition, management has demonstrated considerable discipline in capital allocation, repurchasing 39.36M shares over the last 2.75 years and a total of 67.43M since the IPO in 2004, representing approximately 46% of outstanding shares. The majority of share repurchases were made below book value and resulted in substantial increases in book value per share. Book value per share has grown from $23.58 as of 6/30/04 to $65.82 as of 9/30/12. Book value excluding AOCI has grown from $22.63/share as of 6/30/04 to $53.70/share as of 9/30/12.
Applying a P/E of 10 to projected EPS of $5.22 would result in a fair value of $52.00 per share. The current price of approximately $35.00/share represents a 33% discount to this estimate of fair value and would provide a return of 49%. Once regulatory reviews are completed on force placed insurance premium rates, the uncertainty surrounding future earnings should be reduced and valuation multiples should revert to more reasonable levels. Strong management, prudent capital allocation and a very attractive valuation make Assurant one of the more compelling investment opportunities in today's market.
Please perform your own due diligence. Long AIZ.
Disclosure: I am long AIZ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.