A Small-Cap Insurer Offers Big Potential

 | Dec 06, 2011 | 12:26 PM EST  | Comments
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Investors as a group haven't had many positive things to say about Florida over the past couple of years. The Sunshine State has been home to one of the most devastating real estate declines in over 50 years. Yet tucked away in Fort Lauderdale is Universal Insurance Holdings (UVE), a $150 million property and casualty underwriter that looks appealing from all angles.

Many traders who see only the surface will scoff at Universal. Its principal line of business is homeowners' insurance. And while the company has recently expanded into neighboring states, the vast bulk of its policies and premium revenue is derived from the state of Florida.

But what at first may seem to be a hurdle is actually an opportunity. As one of the states hardest hit by the real estate crisis, Florida will likely be one of the strongest to recover. The lure of no state tax and the great weather will continue to appeal not only to retirees but to others looking to migrate. Nonetheless, the company's recent forays into Georgia, North Carolina and Hawaii indicate that it is expanding its scope.

Florida is also a generally favorable state to underwriters of homeowners' insurance. The Florida Office of Insurance Regulation (OIR) supports the growth of private underwriters. The OIR has approved Citizens Property Insurance, the state-sponsored insurance company and by far the largest underwriter of homeowners insurance, to transfer policies to private underwriters. As of March 31, 2011, Citizens had nearly 1.3 million policies in force, representing $2.6 billion in premiums.

Universal, through its Universal Property and Casualty Insurance Company, has nearly 600,000 policies representing $680 million in gross premiums. So the potential to "take out" policies from Citizen alone represents substantial growth opportunity, regardless of how quickly the real estate market improves in Florida.

Universal trades for $3.78 a share as of midday Tuesday, against book value per share of $3.92. For the nine-month period ending Sept. 30, 2011 net premiums were $147 million, compared with total expenses of $130 million, or a combined ratio of 88%. In the insurance business, a CR below 100% confers an underwriting profit. As a point of reference, it is not uncommon for quality insurance businesses such as Alleghany (Y) and Markel (MKL)  to have CR in excess of 100%. Such underwriting losses are acceptable, because the investment gains earned off the float typically lead to overall profitability.  Berkshire Hathaway (BRK.B) has achieved success despite having combined ratios well in excess of 100%.

Universal's balance sheet consists of over $328 million in cash and an investment portfolio currently valued at over $128 million. More than 60% of its investment portfolio is in equity securities. Because of volatile market conditions, the company recorded an unrealized loss of $23 million, primarily stemming from the decline in the equity portfolio for nine months of 2011. That mark-to-market loss resulted in net income of $0.57 a share for the nine months ended Sept. 30, 2011, compared with $0.71 a share in the comparable year-ago period. Absent those unrealized losses, EPS would have been over $1 a share for those nine months. Given the strong cash position of the business, Universal has time to see the value of its investment portfolio improve.

Universal trades at a price-to-earnings ratio of 5. The company pays an annual dividend of $0.32, which is good for a 9.4% yield. Current statutory capital levels are well above OIR requirements. The company maintains significant reinsurance coverage because of the catastrophic nature of hurricanes in Florida.

Of course, with any insurance company, significant catastrophes almost always lead to losses. A company must be well equipped to survive for the next cycle. Universal has been around since 1990 and currently offers investors a great combination of growth and income at current levels.

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