Universal Insurance Holdings (UVE): A Cheap and Fast-Growing Florida Hurricane Exposed Insurer I’m Going to Pass On
This is a stock I talked about on a podcast with Andrew. It looked cheap based on the simple ratios you might use to decide if something’s a value stock. And the business of writing homeowner’s (and renter’s) insurance in Florida seemed like something that could be good enough (in some years) and simple enough for me to understand and possibly invest in.
However, what I found when looking into Universal is a lot of stuff I don’t really like. Having said that, the stock is cheap. It is very leveraged to good underwriting results. So, in a good year (especially a tame year in terms of Florida hurricanes) the stock could easily go up a lot. It is a value stock. It’s cheap. But, it’s unlikely to be something I’d buy.
Let’s start with how cheap it is. If you look at something like QuickFS.net you’ll see that UVE is trading at around book value. The P/E doesn’t look good. But, the “E” part of an insurance company like this is going to involve both investment results and underwriting results. Underwriting results at UVE are going to depend mostly on the loss ratio (the expense ratio shouldn’t vary a lot here) and the loss ratio is going to depend a lot on weather. UVE uses a lot of reinsurance. However, the way these reinsurance agreements are set up – UVE is very exposed to the frequency (not so much the magnitude) of hurricanes in Florida. As a result, I suspect that recent weather related losses for UVE are larger than you might expect. You’d expect them to be manageable because there haven’t been a lot of really bad hurricanes in a while. However, there actually have been a lot of events. You can read about the reinsurance deals in the company’s investor presentation. I’ll sum it up by saying that UVE stands to lose fairly similar amounts – much more similar amounts than I expected before reading about the reinsurance deals – from each event per year than you might think. So, you might be scared off by the risk of one really big hurricane and underestimate the impact of several medium sized hurricanes.
This brings me to the company’s “plan” and its guidance. This is the first thing I don’t like about UVE. The company does earnings calls. And it gives guidance. I don’t think it’s a good idea for a company like this to guide. UVE is guiding on the basis of weather performing “to plan”. So, it is basically plugging in something like 10% of each premium into weather related losses. But, some years the actual losses could be 30% of premiums instead of 10%. In another year, it could be almost nothing. On a recent call, an analyst asked about the fact that the company had performed below plan for many consecutive quarters in a row. That’s the problem with guiding around normal weather. It’s actually not as abnormal as it might sound to have 3 straight years of guidance misses due to weather and yet still be correct on the long-term average level of losses from weather. There are other reasons besides weather that could explain poor underwriting results recently. These include higher litigation than expected in Florida (bigger awards, more lawyers taking on more cases) and inadequate rates. On the podcast we mentioned UVE is rated by Demotech instead of A.M. Best. Demotech rates insurers in places like Florida (which have heavy hurricane risks) and also insurers that cede a lot of their premiums and just generally make heavy use of reinsurers. As I mentioned in that podcast, UVE’s financial position is not necessarily weak. However, it is the largest homeowner insurer in Florida. And it is focused on that market (some of the other biggest insurers – though not all – are diversified nationwide insurers). Demotech did mark out Florida insurers as a group as something to watch carefully.
Also in that podcast, I said reinsurance rates might explain UVE’s good performance for years. And I think that’s true. From 2009 to 2017, UVE had strong earnings per share growth. Reinsurance rates – as best I can tell from UVE’s disclosures – fell during this period from a base of $1 to 62 cents on the dollar. This is like a company’s material costs of some key commodity or something falling by 38%. There were very few increases in any years. Reinsurance rates have since risen. Although, to be fair, primary insurers are seeking rate increases now. But, the general pattern is one of very favorable conditions for UVE during the first part of the last 10 years or so that probably led to returns beyond what would be normal.
That doesn’t mean the stock isn’t cheap now though. At its peak, the company averaged EPS of $2 to $3 a share from 2014-2016. And UVE is guiding for earnings (under normal weather conditions) next year within that same range. The stock trades for $15-$16 a share. So, we are talking about a price to guided for (and previous average peak earnings) of 5-8x. Basically, the stock has a 5-8x forward P/E if you believe management’s guidance and if weather cooperates. That is very cheap compared to some insurers.
The company also writes such high premiums relative to the current market cap that it wouldn’t take much to produce really strong earnings per share relative to the stock price. You just need one unusually good year for losses.
The trend in the combined ratio has not been good.
2014: 74%
2015: 74%
2016: 83%
2017: 85%
2018: 87%
2019: 104%
And then in 2020, it went to 114%
Remember, the combined ratio is basically the flipped “operating margin” you are used to seeing with non-financial companies. So, in 2014 and 2015, the company was making 26 cents per dollar of premiums earned and in 2019 and 2020 it was losing 4-14 cents per dollar of premiums earned.
The culprit is the loss ratio.
2014 Loss Ratio: 38%
2015: 37%
2016: 48%
2017: 51%
2018: 54%
2019: 72%
Reinsurance pricing got better for the company in 7 out of 8 years prior to the last 3. In the last 3, it has gone up each year. So, you have increasing losses over time. Increasing reinsurance rates. And then also a higher frequency of weather events very recently.
Are these fixable problems?
Insurance is cyclical. And if other insurers lose as much or more than UVE, they will pull back and pricing will improve. Remember, you are looking at a company that has really a pretty narrow business. If bigger insurers broke out every line they wrote, you’d see cyclicality that might surprise you in pricing versus losses.
The bigger problem for me here is the difficulty of assessing management and their approach to what is happening in the business. They are not especially communicative about mistakes and risks of underestimating certain trends occurring in the business. So, it is hard to know if the loss ratio can get down 20 or more points and stay down in normal times. Obviously, a return to the kind of loss ratios they had years ago would produce very good earnings.
The business has grown a lot. I gave you 2014 results. So, let’s use 2013 written amounts to get a feel for how much they were doing back then going into a year that worked out well for them. The company had written about $300 million of premiums back then. It wrote more than 3 times that amount now.
To be fair, the biggest increases in premiums occurred under better profitability. But, that’s a normal and not necessarily comforting pattern. When your estimates show you are profitable, you write more business. When your estimates show you aren’t profitable, you dial it back. Also, when you can get price increases – profitability improves. When you can’t – it doesn’t. Throughout the period of worsening results, UVE was still growing about 10% a year. It has not had years where it basically didn’t grow. And these aren’t just dollar increases in premiums. The company’s “policies serviced” have risen by about 80,000 policies a year in each of the last 5 years. The company is a lot larger today than it was 5 years ago. In fact, my best guess is that policies have increased by about 10% per year in volume terms and about 0% a year in price terms over the last half decade. That’s not promising considering the risk of higher losses in nominal terms is definitely higher today than it was 5 years ago (property values increase, loss of use and anything other than property values probably inflates at CPI type levels, and litigation doesn’t get cheaper over time). Reinsurance pricing had once been getting cheaper. But, all I have to go on with that is if we look back 10 years, reinsurance seems to have been about 30% more expensive than it is now. Maybe reinsurance was too expensive then. But, this is all stuff that is difficult for me as an outsider to evaluate.
Having said all that, these are cyclical type factors that tend to get worked out through the economic responses you’d expect. Usually, prices do go up to put things back in a situation where it is profitable to write insurance.
Capital is another possible issue here. When investment assets are rising, it makes it easier to write more insurance. The company has retained a lot of its earnings. And so, assets have grown. They’ve close to doubled from the starting point (2014) of those combined ratio results I showed you. A decline in the value of investment portfolios could make insurers less willing to write as much and could contribute to better pricing.
There are, of course, political risks in a place like Florida. Insurers are regulated. And this is an important expense for the people in the state. The average claim is meaningful to a household’s finances (it’s over $8,000 – and that’s a severely lagging “lifetime of the business” number that I’m sure underestimates what claims would average if they occurred today). There are always concerns that rate increases will be inadequate. And I don’t live in Florida or know much about the environment in which the company operates in with regard to regulators, the courts, etc. That doesn’t make it impossible to invest in a stock like this – if you love management, their track record, and the way they clearly communicate their approaches to the risks taken on with growing policies this fast. But, it does make it pretty much impossible when I don’t have a good feel for management and the organization. I’ve read the investor presentation, the SEC filings, and the earnings call transcripts. And I have zero feel for management here.
So, UVE is a pass for me.
This doesn’t mean there is a lack of upside. Like I said, the market price vs. premiums is very low considering how much an insurer like this can make in just one good year. You get three good years in a row at some point, and the stock will have to skyrocket. But, without a lot of confidence in management – I don’t think I can buy into an insurer like this. Buying UVE here would really be a bet on Florida homeowner insurance pricing rising strongly enough in the years ahead. It may be the right cyclical bet to make. But, I’m going to pass.