Investment Thesis
Universal Insurance Holdings (NYSE:UVE) has seen a massive increase in profitability, reporting an annualized average return on common equity of 38.1% in the first quarter of 2024 earnings report, highlighting its strong underwriting approach. While impressive, the stock well reflects this impressive performance with a premium to book value of around 33% as of the time of this writing. I think investors should proceed with caution by holding shares of this insurance holding company while being careful about the exposure it has to Florida, one of the riskiest states in my opinion to underwrite property insurance in the USA. Excessive high growth and profits attract both competition and increased risks in my opinion, so I rate shares neutrally at this price.
Company Overview
Universal Insurance Holdings is a "leading holding company of property and casualty insurance and value-added insurance services" according to its website. They do property and casualty insurance under subsidiaries "Universal Property and Casualty Insurance Company and American Platinum Property and Casualty Insurance Company" as outlined in their main homepage. Like any other insurance company, they make their money through underwriting policies and investing the float of the premiums into fixed income securities to generate investing income.
As of 2023, the company has reported spectacular profits, with a return on equity for the year of 21.2%. A combination of higher interest rates which increased investment income with strong underwriting performance has helped profitability reach high levels, and management has been pretty keen on returning capital to shareholders. Through dividends and buybacks, investors have reaped the rewards of a solid return with the shares increasing 17% YTD as of the time of this writing.
The company spots strong ratings according to the annual report,
Our Insurance Entities, UPCIC and APPCIC, are both currently rated “A” (“Exceptional”) by Demotech, Inc. (“Demotech”) and “A-” by Kroll Bond Rating Agency (“Kroll”), which are rating agencies specializing in evaluating insurer financial strength and stability.
With a strong, growing capital surplus of around $380 million, I believe the ratings suggest that Universal Insurance Holdings has gained the experience necessary to be a successful underwriter in its markets, particularly the challenging market of Florida. Furthermore, they also have a good track record of intelligently using reinsurance, and the most recent press release demonstrates they "successfully secured a combined UPCIC and APPCIC catastrophe reinsurance program with no material changes to historical reinsurance partners or terms and conditions".
Most of their premium comes from Florida, as their annual report explains that "we currently sell insurance policies in 18 states with Florida representing 81.4% of our direct premiums written". This concentrated exposure to one of America's most challenging and dynamic insurance market leads me to believe there are upcoming risks that may put profitability at risk. While the past has been great, I believe changing regulation, climate change, and growing competition from new entrants can make profitability a challenge for Universal Insurance.
Florida's Regulators Lower Barriers To Entry
As most of the business for Universal Insurance comes from Florida, it is worth mentioning how regulations have lowered the bar for new entrants to write policies for property insurance. Within the past few months, the Florida Office of Insurance Regulation admitted eight property and casualty insurers to write insurance in Florida,
The Florida Office of Insurance Regulation (OIR) announced Wednesday that "following historic legislative reforms designed to promote market stability," eight property and casualty insurers have been approved to enter Florida’s insurance market.
The report cites the need to reform market stability and make insurance more affordable, so letting in new competitors makes the market more efficient as competition takes over to make insurance cheaper. As homeowner's insurance is required by lenders for people who borrow money to buy a home, it's the one thing that is making the cost of living quite difficult for Florida's citizens. Auto insurance is incredibly expensive, according to one news report,
“According to rate data, on average, Florida auto insurance costs $3,244 per year for full coverage insurance policies, which is 62% higher than the national average,” according to MarketWatch.
With high rates and expensive premiums, the Florida state government is lowering the barrier to entry by letting more competitors in, and I expect the excessively high profitability Universal Insurance is experiencing is temporary and will eventually revert to the mean. With ROEs over 20%, I see high profits attracting competition and expect excess profits to fall, leading to a potential decrease in earnings for Universal Insurance. All in all, Florida's regulators seem incentivized to stabilize the insurance market, encouraging more competition to make insurance more affordable, which could pose a headwind for Universal Insurance.
Concentration In Florida A Double-Edged Sword
I believe the concentration of premiums in Florida is a double-edged sword which both amplifies the good years and bad years, making the financial results very volatile. When there aren't hurricanes or storms in Florida, the earnings can be very attractive, but one bad year could potentially undo several good ones. Therefore, I view the lack of diversification as a potential risk, even though the company has a strong track record of obtaining reinsurance to cover their policies.
Growing global warming and increasing climate change makes Florida a particularly challenging market to profitably insure. I'm not sure if anyone can do it, as many insurers have left the market completely after painful losses over the years. Inflation has raised the replacement values of properties, making it more difficult to profitably write policies, so for a whole host of reasons I believe Florida remains a very challenging insurance market.
So far, the financial results look good as Q1 2024 earnings show a remarkable growth in the fundamentals. Adjusted earnings, core revenues, and premiums were up significantly YoY, and has contributed to the nice share price rally. However, I think investors should remind themselves that Universal Insurance's exposure to risk in Florida makes their financial results very volatile, and bad years can potentially undo the good years that Universal is currently experiencing.
Overall, I have a mixed view of the company because of its concentrated exposure to Florida and believe shareholders should prepare for volatility in the financial results accordingly. I think management ought to diversify more outside of Florida, which would likely increase the financial stability of the business as well as improve their combined loss ratio, which is currently at 95.5%. This would give me more confidence in the sustainability of earnings as the company can weather the storms and pool risk from more diverse sources to cover their future claims.
Valuation - $20 Fair Value
I believe the stock is appropriately priced because it is trading at a premium valuation to book value. Book value has seen remarkable growth over the past quarter according to the Q1 2024 earnings press release,
Book value per share of $12.68, up 20.0% year-over-year; adjusted book value per share of $15.34, up 13.5% year-over-year
With the stock price at around $20, I believe shares are fairly valued as they are appropriately above the book value, trading at around a 33% premium to adjusted book value per share. This is because book values are increasing YoY in the double-digits, so this growth deserves a premium valuation. However, I question whether this growth is sustainable as new entrants move in and compete away superior profits.
I rate shares neutrally with a hold rating because I believe the upside from here is modest, and investors will likely match the SP 500 from here on out. Over time, I expect the growth to flatten out as Universal Insurance eventually runs out of profitable underwriting opportunities that are a good risk to take. Earnings should grow modestly according to Seeking Alpha's earnings estimates, but the stock price is already reflecting this growth, in my opinion.
Annualized adjusted ROCE was reported to be 29.4% according to Q1 2024 earnings, which in my opinion is unsustainable and will eventually revert to the mean. Florida continues to be a very dynamic and volatile market, so I find it unwise to assume that superior profitability today will continue indefinitely into the future. As insurance markets cycle between soft and hard markets, I figure that eventually efforts to stabilize the market by regulators will reduce this unusual profitability to normal levels again, bringing earnings back down.
Risks
My neutral thesis has some risks as the company may be able to sustain superior profitability for longer than I expect. If earnings stay where they are and continue to grow in the double digits, then my valuation analysis is probably too conservative, and it deserves a much higher price target. Changes in regulations could make claims processing and underwriting much more favorable to insurance carriers, which could make Universal Insurance stronger than I initially thought.
Like most insurance companies, Universal Insurance may have insufficient reserves, liquidity, poor investment performance, and fraudulent claims, all of which negatively impact business performance. Also, it can still be relatively easy for customers to sue their insurers in Florida for mishandling claims, delaying payments, and other issues.
The company relies on reinsurance to protect itself from extreme financial loss in the case of natural disasters. While this may work for now, in the future reinsurers may be reluctant to cover property insurance policies in Florida due to the severity and frequency of claims. Investors should be careful about the reinsurance policies that Universal relies on, as it may change in the future.
Hold Universal Insurance
I see no reason to buy or sell shares here, so I rate shares neutrally and believe the stock is fairly valued. The recent quarter has been very strong, with profits and revenues up dramatically, but I question the sustainability of this run. Reversion to the mean is a powerful force in markets, and I think eventually the unusually high returns on equity will come back down to more average levels. Therefore, I think shares will remain flat for the near-term and perform in-line with the SP 500, which leads me to rate shares as a hold.
Bargain Buyer
Amateur value investor seeking bargains in any market, with a specific focus on emerging markets. Admires great investors such as Li Lu and Peter Lynch, and am not afraid to go against the grain. Willing to buy any company at the right price, and is looking for low-risk and high uncertainty bets. My purpose is to share investment ideas and to clarify my own thinking. It is good to keep an investment journal to monitor past successes and learn from failures. This is a good way to keep a scorecard and to make my ideas public for all to judge. Primarily adopts an owner-mindset, and largely ignores macro-environment noise. I'm an investor, not an economist. Investors make money, economists make forecasts.Graduated from NYU Stern, with a Bachelors in Business and a Concentration in Finance.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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.
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