T11 Capital Management has taken a long position in 1347 Property Insurance Holdings Inc (NASDAQ:PIH) during the first quarter of 2016.
1347 Property Insurance Holdings Inc, through its subsidiary, Maison Insurance Company, provides property and casualty insurance products to individuals in Louisiana. The company offers homeowners insurance, manufactured home insurance, dwelling fire insurance, and wind/hail insurance products, as well as reinsurance products. It distributes its insurance policies through a network of independent agents. The company was formerly known as Maison Insurance Holdings, Inc. and changed its name to 1347 Property Insurance Holdings, Inc. in November 2013. 1347 Property Insurance Holdings, Inc. was founded in 2012 and is based in Tampa, Florida.
During 2015, 1347 Property Insurance through their wholly owned subsidiary Maison Insurance began operating in Texas, writing wind and hail policies in partnership with Brotherhood Mutual.
1347 Property Insurance Holdings Inc Overview
1347 Property Insurance is a relatively new property and casualty insurance company that was formerly 100% owned by Kingsway Financial (NYSE:KFS). Kingsway Financial was profiled by T11 Capital Management in April of 2014. In 2014, 1347 participated in an IPO for 2,272,727 shares at a price range between $10-$12 per share. The primary purpose of the IPO was to provide further capital for the Maison Insurance subsidiary, as well as to provide capital for expansion opportunities in Florida, Texas and Hawaii. The 1347 business model is based on the belief that a group of highly-experienced managers with a history in niche, difficult to insure regions of the United States can grow profits at an above average rate while managing risk appropriately through historically low-priced reinsurance. The abandonment of hurricane and storm prone regions of Louisiana, Texas and Florida by large, nationally recognized insurers creates substantial opportunity for experienced operators such as 1347. Additionally, the recent movement towards depopulation of state run insurance agencies provides numerous opportunities for taking over policies, creating substantial growth both presently and over the long-term.
The management team is headed by CEO Doug Raucy. Prior to 1347 Mr. Raucy founded three separate homeowners' insurance companies. He was also the head of Allstate's national catastrophe team with over 20 years experience at the company.
CFO, John Hill, has over 15 years in the Florida homeowners' market, formerly CFO of three other property & casualty insurers.
Dean Stroud is the VP of Underwriting. He brings with him 40 years of experience underwriting policies in Louisiana. He was formerly President of Audobon Insurance, an AIG (NYSE:AIG) subsidiary.
In April of 2015, 1347 Property Insurance appointed Scott Wollney to the Board of Directors for the company. Mr. Wollney is the current CEO of Atlas Financial Holdings (NASDAQ:AFH), a Nasdaq listed commercial automobile company. Mr. Wollney has 25 years of experience in the insurance industry. He has managed to grow Atlas from nearly nothing when he started in 2010 to an operation with a $200 million market cap and a stock price that has increased by nearly 200% since its IPO in 2013.
The experience management possesses in relation to the specialty insurance markets they are targeting brings with it a number of benefits, the most obvious of which is adept and efficient management of risk across a variety of policies. It also brings with it the added benefit of a network of independent agents who are comfortable selling policies underwritten by Maison Insurance (1347). This allows for rapid expansion in targeted areas.
The areas 1347 Property Insurance is targeting have among the highest property insurance rates in the country. They are also predominantly areas where income levels fall into the low to middle income ranges. This combination of factors allows for significantly profitable underwriting of policies, but also provides a distinct competitive advantage to those companies that can provide value to consumers in a difficult to insure region of the country.
The above is according to ValuePenguin
Consumers are strongly driven by price in property and casualty insurance market, positioning 1347 Property Insurance well to compete in its chosen markets.
The original goal of 1347 Property Insurance was to capture 2%-3% of the Louisiana market. According to recent data Louisiana has $2.6 billion in premiums written. The mid-point of 1347's goal would mean $65,000,000 in premiums written for Louisiana.
Growth & Valuation
A majority of the growth inception to date has occurred purely as a result of the Louisiana market. The company has a substantial network of independent agents who effectively distribute the policies to homeowners. Mr. Raucy has reiterated that the independent agents become comfortable working with Maison as a result of previous established relationships and adept, efficient handling of new claims, making them more likely to promote Maison's policies on an ongoing basis.
The primary question with respect to property & casualty insurers is the efficiency of their underwriting practices. For purposes of measuring the efficiency, the combined ratio of the company is an accurate measure.
The combined ratio essentially takes the sum of incurred loss and expenses for a company and divides them by earned premium. The ratio is typically expressed as a percentage, with a combined ratio below 100% indicating underwriting profitability, whereas a combined ratio above 100% indicates an underwriting loss. It is important to note, however, that even with a combined ratio over 100% an insurance company can still extract a profit from investment returns from their float.
1347 Property Insurance has been an effective underwriter with an average combined ratio of 79.64% since Q1 2014. In Q2 and Q3 of 2015 the company experienced severe weather conditions in their insured regions, leading to a combined ratio well in excess of normal expectations.
The combined ratio should normalize in the quarters ahead as the residual effects of the recent storm incident lessen.
While 1347 Property Insurance has managed to grow premiums substantially since inception, while possessing efficient underwriting practices overall, the company has not been able to substantially expand book value since 2014, leading to a decline in share price that currently reflects a substantial discount to book. In fact, the company is also trading at a discount to net cash as 1347 participated in a 2.5 million share secondary offering in 2014 at $8 per share. The secondary offering has over-capitalized the company causing a lag in return on equity (ROE). Presently, including the float as a liability, the company has approximately $7.50 per share in cash. The company has a book value of $7.67 per share and is trading at a 0.81 (mrq) price/book.
1347 Property Insurance shares are trading at a substantial discount to peers given that the company is a recent startup in the industry without any institutional coverage or recognition.
The lag in book value is set to reverse in quarters ahead due to a number of factors:
- The CEO Doug Raucy has explicitly stated that the company is searching for growth opportunities to deploy their $50 million in cash. This could come in the form of an acquisition or investing in growth areas where management has a competitive advantage due to experience. They have been diligent in deploying these funds, taking their time to find the right opportunity since 2014.
- The company has expanded into Texas as of September 2015, writing wind/hail policies in the state for the first time. This is a stepping stone to other opportunities in the state for growth. In the most recent conference call, Mr. Raucy said the following, "We expect to see premiums accelerated throughout the fourth quarter and into 2016. Texas represents a sizable market and we have already devoted time and resources to developing the strategy of utilizing the number of distribution channels. We are continuing to explore and review opportunities in other coastal states that closely match the characteristics of Louisiana and Texas."
- Concurrently, with Louisiana and Texas, Mississippi and Florida are undergoing depopulation from state run agencies. This creates opportunity for further growth in other states where 1347 will have a tangible edge.
With respect to the Texas business that the company became involved with in September of 2015, as of September 1st a new law in Texas allowed for the state to participate in a depopulation program. Texas Windstorm Insurance Association (TWIA) insures more than half the market along the Texas coast. This is a situation that is unsustainable for TWIA, causing them to incentivize private insurers, such as 1347 Property Insurance, to take over the policies. The partnership that 1347 formed with Brotherhood in September 2015 allows them to accelerate growth in the state to take advantage of the recently implemented depopulation.
What is likely to occur with 1347 Property Insurance is that their ROE will normalize when all 3 of the above events take place. The ROE of 1347 doesn't accurately reflect the potential for unexpected acceleration in returns therefore increasing book value simultaneously.
As measured by equity to assets ratio 1347 Property Insurance is far and away the most conservatively positioned company in terms of balance sheet health in a peer comparison.
The conservatively positioned balance sheet as expressed by the above equity to assets ratio allows for ROE to move at an above average pace once their various initiatives start bearing fruit.
The average ROE since Q1 of 2014 for PIH has been 6.47%, leaving quite a bit of room for acceleration to match their peer group as capital is deployed and initiatives gain traction.
Average price to book value in the industry among peers is 1.65. 1347 Property Insurance requires some degree of recognition before it can achieve a normalized price to book value. The success of their ongoing initiatives for growth along with any future acquisitions will determine greatly whether they fall in line with peers.
Assuming management continues to experience growth in policies fair value for 1347 relative to peers on a price to book basis is close to $13 per share. A CAGR of 19.27% in book value, which may be conservative for 1347 given their emerging state, puts book value at $18.51 in 5 years time. Assuming an identical price/book ratio of 1.65 puts share price at $30.54 by early 2021 for a total gain of 366% from the current share price.
Attractive Reinsurance Components
Reinsurance rates continue to decline to historic lows due to the convergence of a lack of major catastrophes and the emergence of non-traditional market participants, such as the numerous large hedge funds that setup offshore reinsurance companies to take advantage of the returns on the float made through their capital investment expertise.
This is an excerpt from a report from Dixon Hughes Goodman on the reinsurance sector:
Primary insurers have been able to become more competitive due to reductions in the cost of treaty reinsurance as a consequence of increased levels of reinsurance capacity and a lack of natural catastrophes," said Andrew Chester, CEO of Bowring Marsh, Marsh's specialist international placement unit. Further, reinsurance pricing has been in decline and as such the cost to transfer risk for direct insurers has become increasingly favorable. This bottom line benefit is driving competition among insurers to write more business and non-traditional investors to show interest in gaining insurance industry exposure.
According to the above data 1347 Property Insurance has maximum coverage of $140,000,000 for the first catastrophe event and $137,000,000 for the second catastrophe event.
The competitive landscape for reinsurance has allowed 1347 to mitigate a good degree of the risk faced by insurers in difficult to insure regions such as Louisiana and Texas. The advantageous nature of the reinsurance landscape also allows 1347 to expand at a faster pace into new regions than would otherwise be possible. In other words, there is certainly no lack of reinsurance capital looking for a home.
Recent Earnings & Opportunities
As of Q3 2015:
- Gross premiums written increased 39.1% to $11.8 million for the quarter ended September 30, 2015 compared to $8.5 million for the quarter ended September 30, 2014.
- Net premiums earned increased 44.6% to $6.4 million for the quarter ended September 30, 2015, compared to $4.4 million for the quarter ended September 30, 2014.
- Our general and administrative expenses, as a percentage of gross premiums earned, decline to 16.6% for the third quarter of 2015, compared to 20.5% for the prior year period. We expect our G&A expenses expressed as a percentage of gross premiums earned continue to decline as our premium basis increase.
- Our overall net expense ratio declined from 57.4% to 51.6% for the third quarter 2015 as compared to 2014. We are gaining operating efficiency as expected; we continued to see this trend improve as we achieve efficient scale.
- Excluding the impact of the claim development from the weather events occurring during the second quarter 2015 our combined ratio would have been 79.8%.
- From June 15 to September 30, the company purchased approximately 158,000 shares at an average price of $7.83 per share. As our Board of Directors has approved to repurchase of up to a total of 500,000 shares, we anticipate that we will continue to buyback shares periodically in the coming quarters.
- As of September 30, 2015 the Company held cash, cash equivalents and investments with a carrying value of $69.7 million.
The company did have to contend with some weather events during both Q2 and Q3 that have led to underwriting losses. These losses should be mitigated entirely in the quarters ahead with the combined ratio moving back into 80% territory, making the company net profitable moving forward.
Additionally, the CEO commented in the most recent conference call with respect to the Texas market:
We're getting ready to launch our homeowner product which should be out sometime in the next couple of weeks and by year end we are hoping to have our dwelling fire product out there as well. So we're building our independent agency network, we have over a 100 agents already signed up and we're putting a lot of effort and a lot of resources behind ramping up Texas.
The first ever depopulation of the state run Texas Windstorm insurance market opens up a tremendous growth opportunity for 1347 Property Insurance. There are $11.4 billion in homeowners direct premiums written in the state of Texas with a 5.8% four year CAGR. The early partnership with Brotherhood paired with capital on the balance sheet allows for 1347 to aggressively pursue growth in the state.
In the most recent conference call, Mr. Raucy stated the following:
We are also looking at some expansion opportunities and then we really do think Texas has lot of opportunity to grow, which will assume some of our or consume some of our capital to so. Even if we don't do an M&A activity, we think with the expansion that we have on the board and our ability to ramp up Texas based on what we think we can get out of that state that the capital will start being deployed and by the end of 2016 will be a lot further along with that capital deployment that we are today.
During the four years since inception of 1347 Property Insurance, the company has managed to capture slightly more than 1% of the Louisiana property insurance market. The Texas market is five times the size of Louisiana. Applying the same pace of potential success for Texas equates to $114 million in premiums for Texas within four years.
1347 has a clear, replicable strategy of entering property insurance markets through depopulation programs, practicing efficient underwriting through specific knowledge of that particular market, employing sales teams to gains customers, while competing on price and service in order to retain those customers. Therefore, the assumption that the Texas market can emulate their achievements in New Orleans is a viable one, especially when considering the amount of capital the company has in its possession awaiting investment.
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