Note: This article was originally published January 9, 2019 on Cash Flow Kingdom, a Seeking Alpha subscription service.
My portfolio is mainly composed of insurers, as I consider that the place where I can add the most value. Due in part to my profession as an actuary, I understand how an insurance company makes money. That’s why I decided to focus on writing articles on insurers and putting my money where my mouth was.
In 2018, my stock portfolio had a poor return, -10.7%, primarily due to a significant pullback in December (-11.7% in December 2018). Unfortunately, all my choices were not winners. I lost money in several positions, but it was hopefully partially offset by some good decisions. I also missed some opportunities and dodged some bullets.
In a nutshell, my year could be summed up in eight stocks. Let’s discover them.
The Worst Choice of The Year: Maiden Holding: -67.7% In 2018
Maiden Holding (MHLD) is a reinsurer, which was founded by AmTrust’s (AFSI) founders. The first time I invested in Maiden, I was aware of the problems that the company faced: a weak operating performance combined with too high a dividend. Nonetheless, the company was trading at a massive discount to book value. I expected the company to be able to restore its margins, unfortunately, Maiden turned out to be inexpensive for good reasons.
Quarter after quarter, the stock price dropped, as the company released poor results, mainly due to the necessity of strengthening its reserve level. The dividend was cut, the shareholders’ equity shrank, and the stock price dropped by more than 75% in one year. Undoubtedly, it was not a good decision to invest in this Bermuda-based reinsurer.
During the year, I had some windows to sell my stocks with a profit, but I did not. I was too stubborn, and paid the price for that stubbornness. I re-learned a lesson I had forgot: the discount to book value for an insurance company is important but not everything; the operating performance matters as well and it is better to invest in a slightly-overvalued company with high underwriting margins than in a would-be undervalued insurer which struggles to restore low margins.
Did I sell my stocks? No. Will I sell my shares in 2019? I tend to say “yes”, as I have lost confidence in management. Some price rebounds have occurred following news released by Maiden Holding’s executives. However, I’m not convinced that the future is brighter; the track record regarding operating performance has been feeble.
The Stars Were Also Not Aligned In 2018 for Atlas Financial: -58.2% In 2018
Atlas Financial Holding (AFH) is one of my favorite stocks. The company is present in a niche market, the light commercial insurance segment, and is focused on covering taxis, limos and para-transit vehicles.
Source: Q3 2018 Presentation
The company has succeeded over the years in combining growth with strong operating performance. Until 2016, the combined ratio averaged around 90% per year.
Source: Q3 2018 Presentation
Unfortunately, the company reviewed its portfolio in 2016, and found some skeletons hidden in the closet. The insurer increased its reserves and reported losses. Book value dropped, shareholders were unhappy and ran away. I stayed, considering the problem likely to be easily solved over the next quarters.
Sadly, I was unlucky. In 2017, the company decided to strengthen the level of its reserves once again. Shareholder confidence in Atlas’ management disappeared and some investors decided to sue the company. Still, I stayed. In 2018, I sold some puts and bought some calls.
I was partially rewarded for my bravery. Nonetheless, I was not able to exercise my calls, as the market did not reward the efforts made by the company to focus on profitably over growth enough. The company is still paying for the sins of the past, and I do understand that. The fear of additional increases to reserve is still there, with the market waiting for Q4 2018 results to know if the situation has been resolved. Nonetheless, I remain confident about the 2019 outlook.
First of all, the insurer has continued to focus on limo and para-transit accounts over the traditional taxi business. As mentioned by the management during the prior conference calls, non-emergency para-transit is growing, and livery/limo continued to expand.
Second, the company launched a new program with a leasing company in connection in a major transportation network company.
Finally, the firm, aware of the ongoing consumption change, launched during the third quarter of 2018, a digital usage-based product, designed for part-time transportation network drivers branded as OptOn.
Based on Atlas’ research, the addressable market associated with the rideshare drivers could be anywhere from $500 million to $1 billion. Even if Atlas competes with other major insurers, like Travelers (TRV) or Progressive (PGR), Atlas has the necessary strengths to be at least a second-tiered player of this commercial insurance subsegment.
HCI, A Place In The Sun: +82.73% in 2018
In 2016, Darren McCammon, who invited me to join Cash Flow Kingdom for covering insurance industry, shorted HCI Group (HCI). He considered that there were considerable risks for HCI to be harmed by catastrophe events. Fortunately for Darren’s portfolio , HCI did fall in price creating a positive 23.7% return. After declining considerably in the book value between 2016 and 2017, the book value per share increased slightly in 2018, mainly driven by the $20m buy-back plan.
The combined ratio remained well-monitored for the first nine months of the year, even if the underwriting margins suffered from retrospective commissions under certain contracts due to losses incurred by Hurricane Irma.
On November 10, 2017, I bought my HCI shares at $33.29, trading fees included. The current stock price is around $50 with a peak of $55, at the beginning of December 2018. With an annualized dividend of $1.475 per share, the dividend yield (based on my purchased price) is around 4.5% with a low payout ratio of about 30%.
The dividend yield is not terrific, but I do not complain about it for several reasons. First of all, I do not depend on dividends for my own income. Don’t get me wrong I like receiving them; however, if the company considers there are better opportunities than redistributing the capital surplus to its shareholders, I am fine with this approach. Additionally, I prefer buying companies’ stocks with a small but well-covered dividend rather than one’s which stretch too far to maximize payout. Thus, I am not a high dividend yield hunter, but rather a patient investor. I am relatively young and thus have plenty of time to wait for gradual dividend increases.
The real question is will HCI be one of my big winners in 2019? Honestly, I am puzzled. Firstly, HCI remains over-exposed to Florida Hurricanes.
Both the vast majority of its policyholders and all of HCI’s real estate portfolio is located in Florida.
A massive hurricane in 2019 would make HCI suffer, even if the company decided to further diversify its revenues by continuing to write policies in the states of Arkansas, California, Maryland, North Carolina, New Jersey, Ohio, Pennsylvania, South Carolina, and Texas. Florida remains the primary market of the insurer.
Second, since mid-December, some threats regarding the overall market valuation have appeared. HCI is a small cap. In the case of a global market pullback, HCI will be in turmoil. Nonetheless, I remain confident on a long-term horizon, but am aware that 2019 will likely not be as extraordinary as 2018.
Aflac Inc., The SWAN Company: +13.7% in 2018
For those who don’t know about Aflac (AFL), they should take some time to understand what Aflac does and is.
Aflac was founded in 1955 by three brothers, John, Paul & Bill Amos. The Amos family is still running the company as Daniel Amos, the current chairman and CEO of Aflac is the son of Paul Amos. Aflac Inc. is an insurance company focused on health products. Their products are sold in the US and Japan, with Japan being the largest contributor in terms of revenues and pre-tax income.
This company is very shareholder-friendly. For more than three decades, Aflac has continually increased its dividend. Moreover, the firm has periodically repurchased its shares actively as well.
Adjusted for the stock split which occurred in 2018, Aflac’s outstanding shares were reduced by around 20% from 2012 to the third quarter of 2018.
Source: Aflac’s Financial Reports (Author's calculations)
Just in 2018, the anticipated annual capital return will be in the range of $1.1 and $1.4 billion.
Yes, the company’s turnover and revenues do not grow fast and may fluctuate because of the dollar/yen exchange rate. Nonetheless, the company focuses on profitability over growth and has succeeded to main high underwriting standards throughout the years.
In 2018, my Aflac investment returned 13.7%, dividends included. Will Aflac’s shares deliver the same return in 2019 than in 2018? It might be possible, for at least two reasons. The first one is that the quarterly dividend will be increased during the first quarter of 2019. I expect 5% growth. The second reason (the main one) is Aflac has made some good strategical moves since last year.
First, the company decided to increase the investment in dollar-denominated assets to reduce the risks related to the yen/dollar fluctuations. Secondly, Japan Post Holdings might take a minority stake in Aflac. Under the new strategic alliance agreement, Aflac and Japan Post agreed to jointly consider new product development. In other words, the premium growth of the Japanese subsidiary might be positive in 2019, not the case during the last few years.
Finally, Aflac has announced a $20M minority equity investment in Singapore Life Pte. Ltd., a digitally focused life insurance company based in Singapore. Aflac also announced plans to enter a reinsurance agreement on certain protection products with Singapore Life. In other words, Aflac is entering a new Asian market. I want to look further into the details to make sure the deal will be profitable. Nonetheless, I would expect Aflac Inc. to be very conservative regarding the underwriting processes.
Gjensidige, The Resilient Viking: +7.04% In 2018
Gjensidige Forsikring (OTC:GJNSF)(OTCPK:GJNSY) is relatively unknown to the American investor because it’s not a US-based company. The firm is a Norwegian insurer, which is listed in the US through the ADR system.
The company is one of the Nordic leaders of the property and casualty insurance markets. Gjensidige competes mainly with Sampo (OTCPK:SAXPF) (OTCPK:SAXPY), Topdanmark (OTCPK:TPDKY), Tryg A/S (OTC:TGVSF)(OTC:TGVSY).
Furthermore, the Norwegian insurer is present in the pension market and until recently in the bank sector, with its subsidiary Gjensidige Bank. In 2018, Gjensidige and Nordea agreed on the sale of Gjensidige’s bank subsidiary for an amount of NOK 5.5 billion. The cash received from Nordea will not be used to pay a special dividend but instead will be redeployed to acquire or develop insurance portfolios in Sweden, Denmark or the Baltic states.
With a 25% market share in Norway, Gjensidige is exceptionally dependent on its domestic market and wants to expand its activities outside Norway. In 2022, Gjensidige targets a total underwriting result outside Norway at NOK 750 million (excluding positive or negative run-off impacts). It plans to get there by acquiring small and mid-sized portfolios and duplicating the best practices from the Norwegian business.
Source: Investors’ Presentation
In 2018, Gjensidige suffered from worse-than-expected weather conditions. Underwriting performance was lower than in the past, and the market had some concerns regarding the company’s ability to increase its juicy 6% dividend.
I started to buy Gjensidige’s on April 25, 2018, just after the Q1 2018 results were released. At that time, my purchase price was NOK 127.6 per share, trading fees included. After that, I accumulated more shares each time I considered the company oversold. By the end of 2018, my average purchased price was NOK 127.28 per share, with the year-ended closing price at NOK 135.20.
I did not buy Gjensidige’s shares for the dividend, but instead for other reasons. First of all, Gjensidige is the non-life insurance market leader in Norway. Secondly, as with many Nordic insurers, Gjensidige is focused on maintaining a low expense ratio of around 15%.
Last, I was happily surprised by the decision of the company to make growing its insurance portfolios outside Norway, especially in the Baltic States, a priority.
In 2015, Gjensidige succeeded to acquire PZU's Lithuanian subsidiary, doubling its size in the region and started to rationalize processes to increase margins. In 2015, the reported combined ratio was 115.4%, representing an underwriting loss of NOK 98.9 million. In 2017, the underwriting loss was NOK 7.2 million, resulting from an improved but still too high combined ratio of 100.7%.
Source: Gjensidige’s 2017 Annual Report
Management promised to make Baltics’ business profitable in 2018, and so far Gjensidige succeeded. For the first nine months of 2018, the Baltics reported an underwriting gain of NOK 51.1 million. Thus, currently the Baltics segment represents a small underwriting profit. However, I doubt the rationalization process is over; Gjensidige will likely expand commercially in the Baltic States while also maintaining good underwriting margins.
For all the above reasons, I bought Gjensidige’s stocks. It is not the bargain of the decade. The stock is not cheap, as it is trades currently at three times the book value. But over the last years, the return on equity has been above 20%, thanks to the hard efforts by the company to lower its expenses and monitor the underwriting processes well.
What I expect in 2019 is the following. 2019 will likely be a year of the difficult but healthy decisions, including repricing of the Norwegian portfolios and the workforce reduction. With the cash received from the Nordea’s deal, I expect Gjensidige to acquire small or mid-sized portfolios in Sweden, Denmark and the Baltics. The positive and accretive impacts of the acquisition(s) will probably not be seen in 2019. But it will be a good start to reach 2022 targets set up by the company.
On the long-term horizon, I am very confident in Gjensidige’s abilities to maintain its moat in Norway and improve the margins of its foreign subsidiaries.
Progressive Corporation, The Long Opportunity I Missed
Progressive (PGR) is the third-largest auto insurer in the U.S. and one of the top 20 home insurance companies. Over the last few years, the insurer has succeeded in combining double-digit growth with profitability. At the beginning of 2018, the stock price was around $55 per share, a price I considered expensive.
By November 2018, the stock price had risen to $73, or a 32% return in eleven months (dividend excluded. At that point, I still considered it expensive with a price-to-book ratio at almost three for an annualized return on equity slightly more than 20%.
Progressive’s stock ended the year at $60.33.The company has suffered from the global market pullback and potential fears from the investors due to a change in the dividend policy. Nonetheless, I am quite bullish for Progressive in 2019 and might invest in the company before both December 2018 and year-ended results come out, that is if I succeed in gathering some cash.
Trupanion, The Short Move I Did Not Dare To Make But Should Have
Trupanion (TRUP) is an insurance company which provides insurance coverage for pets. From many years, the firm was not profitable and struggled with operating performance issues. Nonetheless, in Q3 2018 the company became profitable reporting a net income of $1.2 million and recording an improved year-to-date combined ratio of 100.4%.
Source: Trupanion's Reports (Author's calculation)
Meanwhile, investors think of and value the firm as a tech company. Trupanion however is not a tech company. It is oresent in one of the most boring industries I know: the insurance sector. By mid July 2018, the company’s valuation became insane. At $45 per share, the price to book value per share was ridiculously large representing more than ten times the shareholders’ equity. Investors seemed convinced the most critical point was not being profitable but rather first creating a moat with hopefully profitability coming afterward.
I felt the market was wrong because the expectations of investors was simply too high. I knew but did not do anything about it, because I was not brave enough to short the company (I have never shorted a stock in my life).
Trupanion’s stock price ended the year at $25.46, or a 44% decline from mid of July 2018.
Blue Capital Reinsurance: The Bullet I Dodged
Blue Capital Reinsurance (BCRH) is one of Darren’s positions. He was attracted by the juicy dividend and the discount on the book value. He made the same mistakes than I did with Maiden Holding. Both of us have been fooled. The reasons for the stock decline of both companies were quite similar.
Blue Capital was too aggressive regarding its pricing and reserving processes suffering in 2017 from the mega-catastrophes which hit all the US-exposed insurers.
In 2018, the company continued to pay for the sins of the past, as the prior year claims developed unfavorably and new catastrophes occurred.
Shareholders’ equity receded significantly, as the $0.30 per share quarterly dividend was maintained, but results were negative. The stock price dropped from $12.15 to $5.50 or an about 55% decline. Meanwhile, investors received $0.90 in 2018 dividend. So total return was -47%.
I don’t want to criticize any investors who invested in Blue Capital. I did worse with Maiden. Furthermore, if I were obliged to invest in Blue Capital or Maiden today, I would choose Blue Capital, even as I feel the current dividend level is not sustainable.
Blue Capital’s operating performance has been quite erratic over the past years, but at least in some years, the company has performed very well, with a yearly combined ratio in the range of 45 - 70% between 2014 and 2016.
Furthermore, the company has the support of Sompo (OTCPK:OTCPK:NHOLF)(OTCPK:OTCPK:SMPNY), a well-respected Japanese insurer and reinsurer, which has maintained its ownership in Blue Capital, even while the operating performance has been negative.
If I write this, it's not to butter up Darren; he doesn’t want or need that, but rather just to be straightforward and honest. I still consider the risks associated with Blue Capital are extraordinarily high and require extreme caution. Honestly, I will continue to stay away from the company until there are more green lights. The renewal rates of the reinsurance treaties which will be shared in February and July with the investors need to be scrutinized. Potentially a dividend cut might be the right decision on a long-term horizon, although dividend-oriented investors will complain about this change.
2019 will be a risky and revealing year for Blue Capital. If the stars align perfectly (lower catastrophe losses, increase in the renewed premium rates), Blue Capital’s share might skyrocket up to book value. If not, more shareholders’ value will be destroyed.
What’s next for 2019?
2018 is over. I learned some painful and costly lessons. I missed some good opportunities but also dodged a few bullets. From an investment point of view, 2018 was not profitable, with my portfolio returning -10.7%. This however is the name of the game with insurance investments. Some years’ experience more claims than others.
Nonetheless, for most of my investments, I am quite optimistic about their long-term horizon. Will I outperform the market? I don’t know, I do not have a crystal ball. But, when I will finalize cleaning up my portfolio (by selling my Maiden’s shares for example), I will sleep a bit better at night than now (I sleep just fine now).
I do think other investors will also tend to sleep well if they consider putting at least a portion of their portfolio in insurance companies. Historically they make a great diversifier for most portfolios.
If you are wondering what is the best way to invest in insurance trade, please visit Cash Flow Kingdom.
Cash Flow Kingdom
Cash Flow Kingdom, the investment community where "Cash Flow is King", is an exclusive research service for investors interested in small-cap equities with solid cash flows. It now provides exclusive content on the hidden gems of the insurance sector, covered by The CrickAnt, an insurance expert. You will have access to investment opportunities, in-depth analyses, cash-flow oriented advice and the ability to engage in insightful discussions with someone passionate about insurance investments.
Disclosure: I am/we are long AFL, MHLD, AFH, GJNSF, GJNSY, HCI. 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.
Additional disclosure: I also purchased PGR's calls (expired by May 2019)