Gainsco (GANS): A Dark Nonstandard Auto Insurer That’s Cheap Based on Recent Underwriting Results
Gainsco (GANS) is a dark stock. It does not file with the SEC. However, it does provide both statutory (Gainsco is an insurer) and GAAP financial reports on its website. These reports go back to 2012 (so, covering the period from 2011 on). Not long before 2011, Gainsco had been an SEC reporting company. Full 10-Ks are available on the SEC’s EDGAR site. Anything I’ll be talking about with you here today about Gainsco’s historical financial performance has been cobbled together through a combination of GAAP financials for the holding company (Gainsco), statutory financials for the key insurance subsidiary (MGA), and old 10-Ks.
Before I even describe what Gainsco does, let’s start with the company’s combined ratio.
An insurer’s combined ratio is the flipside of its profit margin. However, it covers only the underwriting side of the business. It ignores investment gains on the float generated by underwriting. A combined ratio of 100 means that economically the insurer is getting use of its float at no cost. A combined ratio above 100 means the float costs the insurer something. A combined ratio below 100 means the insurer is making a profit even before it invests the float. The combined ratio has two parts. One is the loss ratio. The other is the expense ratio. These ratios are calculated as fractions of the premium revenue the insurer takes in. So, the loss ratio gives us some idea of how much higher the insurer is pricing its premiums than actual losses will be. For example, a loss ratio of 75% would indicate the insurer priced premiums at about $1.33 for every $1 it lost (100%/75% = 1.33x). The expense ratio gives you an idea of how much of premiums are eaten up immediately by things like commissions, marketing, and a lot of the fixed costs of running an insurance operation. It’s everything other than the stuff that relates to losses.
Here is Gainsco’s combined ratio from 1998-2018 (excluding 2010):
1998: 134%
1999: 99%
2000: 124%
2001: 163%
2002: 143%
2003: 105%
2004: 97%
2005: 95%
2006: 108%
2007: 98%
2008: 99%
2009: 100%
EXCLUDED
2011: 99%
2012: 103%
2013: 99%
2014: 96%
2015: 99%
2016: 99%
2017: 94%
2018: 94%
Something obviously changed there. Till about 2004, Gainsco did other things besides “nonstandard” auto insurance. For the last 15 years, it’s stuck to just writing nonstandard auto insurance in a few (mostly Southern) states.
My guess is that about 80% of drivers seeking coverage in the total U.S. auto insurance market – this might be a bit different in the states Gainsco is in – would be considered standard or preferred risks. So, Gainsco only writes coverage for the bottom 20% of drivers. Gainsco is more of a niche business than just that though. A lot of Gainsco’s policyholders are Spanish speaking. And most are drivers in the states of Texas and South Carolina. My best guess is that Gainsco’s policyholder base is disproportionately made up of: 1) Spanish speaking drivers, 2) In the states of Texas, South Carolina, Florida, and Georgia, 3) Seeking the minimum legally required coverage in that state.
Most (but not quite all) of the coverage Gainsco writes is for the minimum liability and damage coverage required by law in that state. For example, Gainsco’s biggest market is Texas. Texas requires all drivers have liability coverage of $30,000 per person up to $60,000 per accident and $25,000 of property damage.
Because Gainsco covers non-standard drivers, the average Gainsco driver’s premium cost would be higher than the cost paid by most drivers seeking the same low level of coverage.
Based on SEC filings, I would guess that about 10 years ago, the average Gainsco driver was paying around $100 a month in premiums. I don’t know what they’re paying today. And the calculation would be complicated by how the premiums are paid. Gainsco’s drivers would tend to use payment plans, fail to make payments, make late payments, seek to have lapsed insurance (due to non-payment of premiums) reinstated, etc. which would all come with additional fees and such.
Also, an insurer like Gainsco would need to charge more in premiums to take the same level of actual auto risk, because the risk of cancellation by the policyholder is higher. There are auto insurers with retention rates of like 90%. About 10 years ago, I would calculate Gainsco’s retention rate at maybe 40%. About 10 years ago, half of Gainsco’s policyholders would cancel their policies during the term – before the policy even came up for renewal at the end of the 6-month or 12-month term. Cancellation was almost always due to a failure to pay premiums.
Given the low retention rate, etc. – what’s attractive about this stock?
Well, based on recent past results it’s cheap. It also has – again, based on recent results – a solid ROE. And it’s been growing fast. Let’s look at the last 3 years. (I have incomplete 2019 data – results weren’t as good in 2019 as 2018, but the combined ratio, etc. was still fine):
Combined Ratio
2016: 97%
2017: 94%
2018: 94%
Return on Equity
2016: 13%
2017: 17%
2018: 22%
Premium Growth
2016: 9%
2017: 16%
2018: 19%
Dividends Per Share
2016: $2.50
2017: $1.50
2018: $2.00
The stock is trading at $32 a share right now. So, that’s a dividend yield of about 4.7% to 7.8% based on those 3 years of dividends. On a P/E basis, it’d be something like 8 times earnings. On a price-to-book basis, it’d be something like 1.3 times book. A stock growing by 9-19% a year, shouldn’t trade at a P/E of 8. And a stock with an ROE of 13-22%, shouldn’t trade at a price to book of 1.3. Nor should an insurance stock be priced to yield 5-8% a year in dividends when the longest investment grade corporate bonds out there yield less than 4%. Two warnings: 1) Gainsco didn’t pay a dividend last year (2019). And 2) those dividends in 2016, 2017, and 2018 were special dividends – not regular diviends.
Nonetheless, if you had complete faith that Gainsco’s future performance will match its performance these last 3 years – you should stop reading this article and just go out and buy the stock now.
I have doubts.
It’s an insurer. So, the business is very, very cyclical. We are also – for 2017 and 2018 – looking at literally the lowest combined ratio this company has achieved in more than 20 years. So, it’s a cyclical business showing wider profit margins than ever before. Also, the low combined ratio is completely a result of a low loss ratio – not a low expense ratio. Gainsco’s expense ratio has been 25-29% of premiums since it changed its business model entirely around 2004 (more on this later). The expense ratio hasn’t been what’s fluctuated. It’s been the loss ratio bouncing around. The loss ratio in 2017 and 2018 was the lowest loss ratio Gainsco has ever achieved (65% and 64% respectively). Even after changing its business model, Gainsco had experienced loss ratios as high as 78% in 2012 and 82% in 2007. In fact, from 2006 though 2016 – Gainsco’s loss ratio was NEVER below 70%. The last two years, it has plunged to 64-65%. To put this in perspective, a loss ratio of 64% versus a loss ratio of 70% is the difference between a combined ratio of 94 or 100. For Gainsco it’s the difference between an underwriting loss or an underwriting profit. And, during the last two years, Gainsco’s underwriting accounted for 70-75% of earnings (the other 20-25% came from the bond portfolio funded by float). So, Gainsco stock is cheap if you assume results for the last couple years are a good guide to future results. But, it would only take a return to Gainsco’s past loss ratios to wipe out 75% of earnings and make this stock jump from a P/E of about 8 to a P/E of about 30. Buying a cyclical stock when it has a low P/E (like 8) that could skyrocket to a high P/E (30) the moment the cycle turns is usually a bad idea.
But, I might be overstating Gainsco’s cyclicality. The stock may be a lot less likely to return to bad underwriting results than I’m assuming. Let’s look at the combined ratio for the years since Gainsco stopped filing with the SEC.
2011: 99%
2012: 103%
2013: 99%
2014: 96%
2015: 99%
2016: 99%
2017: 94%
2018: 94%
2019 (first 9 months): 94%
If we go far back, we also see a premium growth pattern that matches nicely with the improving combined ratio. Premium growth increased quite a lot during strings of consecutive years of strong underwriting profit and premium growth – this is going back a long way – and then was basically nothing during periods where the combined ratio was poor. For example, take that 103% combined ratio. In the two years following that 103 number, Gainsco grew premiums by just 3% and 2%. After that, the combined ratio hit 96 and would only rise as high as 99. It has now been at 94 for 3 consecutive years. Well, during that time period, Gainsco’s premium growth by year was: 12%, 9%, 16%, 19%, and now 7%. Of course, it’s possible that premium growth is due to premium price increases causing a reduction in the loss ratio and keeping the combined ratio below 100. Without these price increases, premiums wouldn’t be growing and the combined ratio wouldn’t be under 100. That’s possible, however it’s worth mentioning that Gainsco’s expense ratio has been a poor predictor of its combined ratio. The expense ratio has tended to be low in bad years (it was 25% in 2012) and high in good years (it’s been 29% for the last 3 years). Especially considering Gainsco’s retention rate is likely very low – it’s difficult to believe high premium growth and low combined ratios are being caused largely by increasing premiums on existing policyholders. It’s more likely the improvement in Gainsco’s combined ratio has something to do with the losses it has been experiencing.
So, let’s look at the loss ratio since Gainsco changed its business model. This was roughly 2004.
2004: 69%
2005: 67%
2006: 71%
2007: 82%
2008: 73%
2009: 74%
EXCLUDED
2011: 72%
2012: 78%
2013: 72%
2014: 70%
2015: 72%
2016: 70%
2017: 65%
2018: 64%
We basically have two very bad year (2007 and 2012) out of the last 15 or so years. Maybe we are seeing a rate of 1-2 bad years out of 10. None of the last 6 years (actually, 7 – I’ve seen 2019 results for the first 9 months) could count as any sort of test of what Gainsco would look like in a bad year.
Since this is an “initial interest post” I am really simplifying things by ignoring Gainsco’s reserves for losses. Like any insurer, Gainsco also faces a timing issue due to ultimate losses being determined and paid out quite a bit after the event that Gainsco is insuring actually happens. My guess is that 60% of Gainsco’s ultimate losses are paid out in the same calendar year as the event and about 90% within 3 years. About 10% of ultimate losses may not be determined and paid till 4 or more years after the event. Gainsco would only be able to reprice its policies on – I’m assuming – usually like a 6-month lag. In reality, Gainsco has policies that renew monthly, once every 6 months, and once every 12 months. I’m just assuming 6 months is the norm for most of its policies.
Finally, Gainsco isn’t a one-man organization. The company has a Dallas HQ and a pretty big office in Miami too. It can’t turn on a dime. So, even if someone in the organization realizes that something is amiss with their reserves, their premiums are too low, their expansion into a particular state or through some agent or something is resulting in different losses than expected – the company isn’t going to make a change instantly. So, the lags here are serious. It takes time before anyone in the organization realizes an issue, it takes time for the organization to decide to do something about that issue, policy pricing can’t be changed till months after the organization wants to change them, and the company is still paying for past mistakes years after making them. This shows up in things like the reserves by accident year tables. We can see periods where ultimate losses were consistently higher than Gainsco originally estimated – meaning the combined ratios I showed you were too optimistic – and we can see periods where ultimate losses were consistently lower than Gainsco originally estimated. Often, these are not one-off years. The insurer keeps overestimating or underestimating for a few years in a row.
Part of this can be due to competitive factors and herding. If it starts to be common in the industry to underprice or overprice risk, two things will happen: 1) Insurers are aware of how their competitors are pricing similar risks and may become less sure of their own judgment and more inclined to assume the herd must know something – even if it doesn’t, and 2) Incentives to win business and make the most underwriting profit possible mean that copying the moves of others in the industry may help the company achieve its short-term objectives of growth and profitability even when the herd believes differently than the organization. If competitors cut rates when you believe rates shouldn’t be cut, there’s still an incentive to avoid losing too much business and so to cut rates as far as you’re comfortable. Likewise, if competitors raise rates, there’s little incentive to deeply underprice them – you might as well raise rates as far as you think is appropriate on a relative pricing difference between you and them. In other words, Gainsco’s combined ratio would naturally fluctuate due to actions taken by competitors even if Gainsco does not become any more or less accurate in pricing risk. It may be that the company has to run pretty fast to stay in place (in terms of underwriting profit) if the average competitor shifts to a worse position in terms of profitability.
For these reasons, it’s hard to know whether the low P/E or pretty reasonable P/B ratio here indicate the stock is really a good buy. It depends on whether the company maintains good profitability over a full cycle.
On the other hand, it’s very easy to underestimate how great a stock Gainsco could turn out to be if the recent past is a good indicator of its underwriting results far into the future. Given VERY recent ROE, premium growth, etc. – Gainsco would be capable of paying a dividend of like 5%, while growing EPS like 10%, and the P/E multiple would likely double at some point before you sold the stock. It’s not impossible for a stock like this to return 20-25% a year for the next decade. I know that’s hard to see by looking at this dark, illiquid, nonstandard micro-cap insurer. But, that’s just the way the math works for a small insurer that is growing a very small market share position while achieving high returns on equity. If an insurer like that really does have a better mousetrap and it proves durable for a decade or more, you end up with a huge winner in the stock market.
I haven’t discussed some of the specific issues I see with Gainsco. One, it is a dark stock. On the other hand, it provides statutory reports – so, I can see far more detail on the exact investments it holds, the exact lines it writes, how much it writes in each state, what losses it has been having each year in each state, etc. than you’d ever get from a 10-K. I didn’t discuss these specifics in here. But, I’ve read both the GAAP and statutory reports. So, I’ve seen all this stuff itemized to an incredible extent.
But, that’s really just numbers. There’s no info from the company on their business strategy, the people involved, how the business changes from year to year, and how sustainable anything is.
And some things have changed about Gainsco at times for reasons I don’t fully understand.
They recapitalized the business about 15 years ago. It needed to be recapitalized. And it needed a strategy shift. It got both. It also ended up with 3 major shareholders – who all seem connected to me – named John Goff, Bob Stallings, and Jim Reis. I can find some info on some of these people. They’re local to the area I live in (Dallas-Fort Worth). There have been insider deals before. Bob Stallings sold a Hyundai dealership to Gainsco. John Goff – or employees at his firm – were originally managing Gainsco’s bond portfolio as a condition of a recapitalization. The condition was removed eventually. Historically, it didn’t seem like the board granted themselves a lot of shares. But, then, in the last 2 years or so – something incredible like 8% of the company was given to directors. It’s hard to overcome a 4% a year drag on the stock returns caused by share issuance. But, I’m not convinced the company will keep issuing much stock every year to these big shareholders.
Finally, the financial strength of Gainsco isn’t that amazing. The company’s A.M. Best Rating is “B+”. It had been increased from the time the company switched its approach around 2005 till around 2012 or so. But, it has not had its rating increased meaningfully since then. An “A-“ or something is more along the lines of what plenty of competitors of Gainsco have.
The company’s bond portfolio is higher risk than you might expect. It has very, very little in higher quality investment grade corporate bonds. The securities portfolio is disproportionately in shorter-term, higher risk corporate bonds. We’re talking lower end of investment grade due in less than 5 years. Because I don’t have management discussions after they stopped filing with the SEC – there’s no explanation for why they shifted the investment strategy. It’s very possible the shift was simply done for 2 reasons: 1) They wanted an adequate (3%+) type yield on their money and 2) They didn’t want to take interest rate risk, be in stuff that wouldn’t turn to cash relatively quickly. A decade or more ago, it would’ve been possible to have a portfolio of like 3 year bonds paying decent yields with little credit risk. Now, it’s not. So, maybe they are just taking more credit risk to avoid getting no yield at all.
The bond portfolio doesn’t deeply concern me or anything. But, it’s another cyclical issue you need to pay attention to. If you are at a cyclical high point for returns in these kinds of bonds and a cyclical high point in terms of underwriting profits for nonstandard auto insurers – it’d be very easy to think you’re buying at a P/E of less than 10 when you’re really buying in at a P/E of more than 30. All of this company’s earnings come from a combination of underwriting profit in nonstandard auto (which is cyclical) and returns in short-term corporate bonds with some credit risk (which is also cyclical). It’s just something to be aware of.
Without doing some scuttlebutt on this company, learning more about the people involved, trying to figure out what changed here and why and how likely it is to stay changed – Gainsco is probably too hard for me to come to a conclusion on.
It looks like a potentially attractive stock though.
I just don’t know if you can do enough research on this one to get comfortable.
Geoff’s Initial Interest: 50%
Geoff’s Revisit Price: $24/share (down 25%)