Description

AMIC is an illiquid, complex, reinsurance subsidiary of an obscure, but public, insurance company, which itself is controlled by a spotlight-shy septuagenarian.  So no wonder it’s cheap and neglected, at an adjusted 0.9x book.  But it also happens to be well-run, in a consolidating industry, with large NOLs, and some interesting growth opportunities.  Not a bad combination, cheap and quality.

DESCRIPTION

AMIC is 48%-owned by Independence Holding Company, ticker IHC.  IHC acquired control of AMIC in 2002 when AMIC was a failed internet company with large NOLs, and turned it into a reinsurer that took on business that IHC ceded to it through pro rata treaties.  In effect, AMIC is a little tax-free version of IHC, so to know AMIC, you really need to know IHC.

IHC’s Chairman is Ed Netter, who controls the company through his private investment vehicle Geneve Holdings.  Ed is 74.  He made his mark as a clever and prescient insurance analyst in the1960s as a colleague of Sandy Weill and for the past few decades has been mostly out of the public eye, managing his wealth.  Ed is no longer directly involved in the operations of IHC or AMIC, but his oversight is not to be underestimated, evidence the nifty move to capture AMIC and its tax benefits.  IHC has compounded its book value per share at 12% since 1990 through a mixture of conservative underwriting, conservative investing, shrewd acquisitions, and share buybacks.  Its main line of business is employer medical stop loss, but it has significant group life and disability plus a few other smaller lines.  More recently, fully-insured health insurance has become a large part of the mix.  IHC and AMIC share the same executive management team.

Through pro rata reinsurance treaties, IHC cedes to AMIC up to 30% its stop loss business (currently doing 23%), and 10-20% of some of the other lines.  About 60% of the earned premiums for AMIC in 2007 will be in stop loss, with most of the rest in fully insured health.  The stop loss market generally runs in five to seven year cycles and it’s been in a soft market since 2003.  Thus, earnings are depressed for IHC and AMIC.  While the stop loss market is cyclical, it is generally a reliable source of profit, given that it is short-tail and not exposed to true catastrophes.

VALUE

AMIC stock closed at $9.16 per share.  It has tangible book value of $60 million, or $7.05/share.  So P/BV is 1.3x.  But AMIC also has a whopping $276 million in NOLs, expiring between 2019 and 2022.  On a nominal basis, this is worth over $11 per share.  Assuming just moderate profit growth for AMIC off the current base, the NOLs are worth around $3/share today.  There is some potential value here for AMIC to more fully utilize the NOLs through acquisitions or rapid growth.  In fact, given management’s creativity in the past, I’d say it’s more than likely that that will be the case.  But just subtracting the $3 from today’s share price gets you the equivalent of a stock trading at 0.9x tangible book value.  You don’t find too many respectable insurers trading below book.  The something-for-nothing is that AMIC has some interesting prospects for very good profit growth over the next several years.

PROFIT OUTLOOK

Due to higher than expected claims from 2006 policies, and correspondingly higher loss assumptions for 2007, AMIC had to add to reserves in the third quarter.  Backing out the 2006 reserve additions, AMIC is on track for about $0.50 in cash earnings per share this year.  That’s the bad news.

The good news is that the earning potential is much higher.  As recently as 2004, AMIC earned a dollar a share in cash earnings.  2004 was neither a particularly good nor bad year for stop loss (it was year two into the softening market), so let’s use that $1 as a base from which to think about the earning potential today.  The investment portfolio is larger today, and with higher rates, that adds about $0.15-0.20/share.  The fully-insured health business didn’t exist in 2004 but will do close to $40 million in premiums this year.  If you assume a modest 5% underwriting margin, that should add $0.20-0.25/share.  Since 2003, IHC has ramped up its stop loss ceding percentage from 13% to 23%, but is allowed to go up to 30%.  Every point increase adds $0.02-0.03/share to AMIC at current premium levels.  Add these all up and AMIC could be earning around $1.50 within a few years, just allowing the cycle to play out.

Hard to quantify, but very significant, are two other elements.

The stop loss market has undergone significant consolidation in the past several years, and it’s realistic to expect that when the turn comes, it will be more profitable than the last cycle.  The #1 player, HCC, entered stop loss in 1999 through an acquisition.  HCC is well-known as a disciplined underwriter, and about a year ago, they bought the U.S. stop loss business of Allianz, one of the least disciplined writers.  The #2 writer is Sun Life, which vaulted to that position after buying Genworth’s benefits business earlier this year.  And the #3 player is Symetra Financial, which is the old Safeco Life that White Mountains bought in 2004.  So AMIC is in agreeable and improving company.

The other element is that AMIC is starting to write business directly, to reduce its reliance on the IHC pro rata agreements and take advantage of its excess capital.  AMIC is now licensed to write directly in most states by next year, as opposed to only half the states a year ago.  It signed an agreement with an agency that will transfer all of its $30 million in premiums, in both stop loss and fully insured health, to AMIC by the end of this year.  In November, A.M. Best upgraded AMIC’s insurance sub to A-, from B++, which is a crucial upgrade for certain distribution channels.  This could all be a very big growth driver, but admittedly, aside from the $30 million, it’s still in the what-if stage.

Catalyst