Unico American (UNAM) is a small property and casualty insurer focused largely on commercial multi-peril underwriting in California. In addition to its already low valuations to book value and trailing earnings, Unico has been undergoing favorable recent trends in loss experience, and has a significant part of its asset portfolio in low-yield fixed income securities currently nearing maturity, which will significantly boost results in the coming years as these are reinvested at prevailing rates.
Unico's price/book value ratio near 1.0 is significantly below the insurance industry average, and its assets consist of a high-quality fixed-income portfolio (81% US treasury and agency securities with the balance mostly investment-grade industrials) which is currently heavily weighted toward shorter maturities and will soon see significant benefits from today's higher rates. After expanding reserves and refocusing on the California business following a period of poor profitability in non-core markets several years ago, Unico is now experiencing much more positive trends in insured loss development, with actual loss trends during the past two-year period implying that liabilities will be less than previously reserved. Though there is some regional risk in case of a future California-specific disaster, thanks to its market scope UNAM was completely spared the impact of the recent devastating hurricane season, while big payouts from national insurers may be a restraining force on competition going forward.
UNAM's trailing P/E of 7.5 is also attractive on an absolute basis and compared to the industry average, and as I'll detail below, management's recent past overweighting of short-maturity assets will soon create additional earnings power at the firm. As rates have risen and the economy continues to show strength, Unico is in an enviable position with a substantial chunk of its portfolio invested in near-maturity Treasuries. With the recent 250bp bump bringing the Fed funds rate to 4.25% vs a 2.25% year-ago level, interest income will rise significantly as these short-dated assets mature and are reinvested at more attractive yields. Specifically, Unico reports the following holdings by calendar-year maturity:
Maturities by Par Amortized Market Average
Calendar Year Value Cost Value Yield
------------- ----- ---- ----- ----
December 31, 2005 $22,500,000 $22,497,419 $22,439,135 2.16%
December 31, 2006 62,672,000 62,733,924 62,197,246 2.79%
December 31, 2007 39,875,000 39,904,640 39,774,404 4.00%
December 31, 2008 2,410,000 2,474,030 2,512,223 5.45%
December 31, 2009 7,000,000 7,146,357 7,328,440 5.27%
If securities maturing throughout 2005 and 2006 were reinvested at a yield of just 4.3%, this would add over $1.4M in annual investment income going forward. Further increases could come with reinvestment of the $40 million in 2007 maturities. UNAM completed a "paperless office" overhaul of its IT systems in October; taken together with $250k worth of further upgrades due this year, management anticipates payback of the total $750k in IT capital costs within three years from significant operating cost efficiencies, implying a potential added annual boost of $250k from operating savings. Unico is already trading at attractive valuations on a trailing basis and the outlook going forward appears quite positive.
Importantly, UNAM is focused on writing profitable business over rapid growth of premiums, and management's comments consistently emphasize creating shareholder value through profitable underwriting and deemphasize the need for "growth at all costs". Looking at recent profitability by combined ratio, losses and adjustment expenses plus policy acquisition costs were just 84% of net premium earned in the latest trailing 9 months, versus 90.9% in the equivalent period a year ago.
Insiders own a majority of the common, have reasonable compensation and no history of self-dealing, and have bought on the open market at lower levels. The company has a good history of share repurchases - there is currently a 945,000 share buyback authorization out of which 869,000 have been bought back; with the pending completion of IT capex and healthy developments in loss reserves and interest income the board could soon be in a position to resume the dividend or again invest in the repurchase of shares.
Overall, Unico is currently trading at attractive book value and TTM earnings multiples and has added catalysts in the form of favorable loss experience trends and enhanced investment income from the reinvestment of maturing low-yield fixed income assets, making it an excellent value investment at this price.
Higher prevailing rates substantially boost interest income as the large low-yield portfolio nearing maturity is reinvested
Solid book value and TTM earnings valuation provides margin of safety while share price corrects toward industry norms
Profitability-focused and incentivized management creates an attractive long term home for invested capital