Four Red Flags for This Insurer

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HCI Group (NYSE: HCI  ) , formerly known as Home Owner's Choice, is a Florida-based property and casualty insurer. Earlier this month, Fool Brian Pacampara wrote that the company was poised to keep popping. I take a less optimistic view, and I'd advise Fools to tread with caution on this stock. Here are four reasons to think twice before hopping into this fast-growing insurer.

1. Adequacy of loss reserves
It's not clear that the company has enough reserves to pay losses in the case of a major disaster. The company chose not to submit to an A.M. Best rating, considered the gold standard for insurers. Instead, the company selected Demotech for its rating, a lesser-known firm.  According to Gavin Magor at Wiess Ratings, HCI Group scores a "D" for financial strength, and it's the weakest of the 12 Florida take-out insurers that he evaluated.  A major hurricane could spell disaster for this company. 

2. Unorthodox investment strategy
Most insurers invest premiums held in reserve against future payments in conservative bonds and other fixed-income securities. This allows the insurer to earn investment profits while still maintaining its ability to pay claims. HCI Group has taken quite a different approach. HCI Group is actually holding mostly cash -- $297 million of its $347 million in financial assets are in cash. And even stranger, the company has purchased real estate -- it spent $13.7 million to buy two marinas and an adjacent property that are susceptible to Gulf of Mexico storms.

3. Related party transactions
HCI Group buys reinsurance from Claddaugh Casualty Insurance Company, a captive subsidiary of HCI Group. Claddaugh, in turn, has ceded some of its premiums and liabilities to Moskha Re and Oxbridge Reinsurance. It happens that HCI Group CEO Paresh Patel, his family members, and other HCI Group directors are investors in Moskha Re and Oxbridge Reinsurance. This presents a major conflict of interest.

4. Insiders are selling
While insider sales can happen for many reasons, such as an executive's need to diversify his or her portfolio, it's still worth tracking. It sometimes signals insiders jumping ship ahead of a disaster. HCI Group Co-Founder and Director Martin Traber has sold aggressively -- over $4 million worth in the past six months. And, newly hired head President of Property & Casualty Scott Wallace has already sold over $350,000 in stock according to Capital IQ. On the other hand, it is worth noting that CEO Paresh Patel still holds almost 7% of the shares outstanding, and he doesn't appear to be selling any large chunks.

Foolish Bottom Line
If you're considering a purchase of HCI Group stock, make sure you do your due diligence. Personally, despite the company's growth and profitability, I'd be very skeptical because of potential reserve inadequacy, questionable investments, related party transactions, and insider selling.

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Read/Post Comments (5) | Recommend This Article (9)

Comments from our Foolish Readers

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  • Report this Comment On August 22, 2013, at 7:24 PM, prginww wrote:

    I don't understand why people keep badmouthing this company.

    You talk about doing your due diligence and your homework. Well it's clear you didn't do yours.

    You say "It's not clear that the company has enough reserves to pay losses in the case of a major disaster." And then you go on to say that "$297 million of its $347 million in financial assets are in cash.". Well guess what, this cash is to cover the losses in the event of a major disaster.

    Furthermore, HCI has a plan in place to cover a major disaster, 850M$+ .

    "To mitigate risk from hurricanes and other catastrophes, each year the subsidiaries within our Homeowners Choice property and casualty insurance division implement a comprehensive reinsurance program whereby we pay premiums to other entities that agree to pay portions of any policyholder claims caused by certain catastrophic events. We have secured our reinsurance program for the year June 1, 2013 through May 31, 2014 by entering into contracts with multiple private reinsurance companies and with the State Board of Administration of Florida, which administers the Florida Hurricane Catastrophe Fund.

    The private reinsurance companies include Renaissance Reinsurance Ltd., Amlin AG, Aeolus Reinsurance Ltd., Montpelier Reinsurance Ltd., various Lloyd’s syndicates and National Liability & Fire Insurance Company, which is an affiliate of Berkshire Hathaway, Inc. Portions of the reinsurance program are secured through our own reinsurance subsidiary, Claddaugh Casualty Insurance Company Ltd., which has mitigated its risk through retrocession contracts.

    The reinsurance contracts offer various coverages, limits, retentions and durations. The private reinsurance contracts cover in general hurricanes, tropical storms, tornados and other catastrophes. The Florida Hurricane Catastrophe Fund agreement covers storms designated as hurricanes by the National Hurricane Center. The reinsurance program provides coverage for an event up to $850 million which according to sophisticated computer models approved by the Florida Office of Insurance Regulation is approximately sufficient to cover the probable maximum loss resulting from a 1 in 150 year hurricane event. The total cost of our reinsurance program (including retrocession premiums paid by Claddaugh) is approximately $134 million with significant portions of the premium payments divided into installments throughout the contract year. Retention under the contracts is approximately $11 million in a single event. In addition, we have purchased and paid for an additional $199 million of coverage for second and subsequent events and, if necessary, will purchase up to an additional $166 million of coverage at preset premium rates. All our private reinsurers are AM Best rated ‘A-’ or better or have fully collateralized their potential obligations to us."

    It's no secret that they have a second-layer company for reinsurance. The purpose is to protect the main company HCI, in case their reinsurer fail.

    Step up

  • Report this Comment On August 25, 2013, at 10:37 PM, prginww wrote:

    Hi Narkon -

    Thanks for reading the article -- I had no intention to "badmouth" the company. I just want investors to be aware of the risks they are assuming.

    As I said, it's not clear the company has adequate reserves to pay claims in the case of a major hurricane. Maybe the company can pay, maybe not. But, it looks risky to me.

    Here are the numbers: the company wrote $279m in gross premiums in 2012 and paid $134m for $850m in reinsurance. And it has $347 million in cash and fixed income investments. I'm not an actuary, but that simply looks fishy to me. Considering the company has never had major hurricane, I'll remain a skeptic.

    Again, I'd tread carefully with the company. Insuring hurricanes in Florida is a tough business.



  • Report this Comment On August 30, 2013, at 3:54 PM, prginww wrote:


    Today's news must be tough to swallow considering your short position!

    I have been watching HCI for some time now and they seem to be doing all the right things to grow the business and build a strong foundation for future growth.

  • Report this Comment On September 17, 2013, at 11:26 AM, prginww wrote:

    Thanks to commentor Narkon for setting the record straight. Thanks to the author for the news flash ... investing in stocks involves risks. Considering my >75% returns from HCI, the unlikely chance that I'll have to give back 15% of that 75% (while being paid a 3% yield to wait for the next 15% gain) seems a reasonable risk/reward proposition to me.

  • Report this Comment On September 18, 2013, at 9:02 PM, prginww wrote:

    hi djohn1969 -

    Thanks for reading the article, and congratulations on the success of your short-term investment. I'm glad that you enjoyed Narkon's post (it's worth considering both sides of an argument).

    Perhaps, what you didn't appreciate is that HCI doesn't publish its total liability in the case of a hurricane. I'm not sure if they even know -- it's very hard to guess. My best guess, based on its premiums written, is many billions. That will dwarf the company's cash and reinsurance protection.

    Of course, I'm only able to speak to my own analysis and educated opinions. I could always be wrong. Best of luck to you, though please proceed with caution with HCI.



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