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.
Brendan Mathews is short shares of Homeowners Choice. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.