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Old Republic International: Mispriced Insurance with Juicy Dividend Yield

September 14, 2012 | About:
Business description: ORI (Old Republic International Corporation) is engaged in insurance business in three major segments: General (property and liability insurance), Title Insurance, and the Republic Financial Indemnity Group (RFIG) run-off business. It owns around 27 different insurance companies, which are doing businesses in both the U.S. and Canada. The RFIG run-off business contains two operations: the Mortgage Guaranty (MI) which has been in run-off mode since August 2011, and Consumer Credit Indemnity (CCI) since 2008, meaning that those two operations have stopped writing new policy since those times.

So for ORI, there are two issues we need to consider: One is the continuing businesses of General Insurance and Title Insurance, the other is whether RFIG claims affect to the bottom line, solvency and the ability to pay dividends of ORI.

Insurance operation

Over the last three years, the consolidated business is suffering from a loss, mainly of Mortgage Guaranty line, whereas the General and Title Insurance are still doing quite well. The combined ratio for General Insurance and Title Insurance segment are around 97-103% in the last three years:

Combined ratio 2011 2010 2009
General Insurance 96.9 103 102.1
Title Insurance 99 101 101.7


With such a low combined ratio and below 100 ratios for 2011, the General Insurance and Title Insurance segments, after two years of having small underwriting losses, have begun to generate underwriting income. When having underwriting income, it means that the two insurance segments of ORI are paid to use the policyholders’ money to invest. The estimation of the float is in the table below, which is equal to the loss reserves, adding loss adjustments reserves, the funds held under reinsurance assumed and unearned premium reserves, deducting agents balance, prepaid acquisition costs, prepaid tax and deferred charges on reinsurance. ORI is managed to have the consolidated float increasing over the last three years, with the slower growth in 2011 compared to 2010.

USD millions 2011 2010 2009
Float 6597.2 6541.1 6231.7
Earned premium (1) 3695 3225 3115
Capital + Surplus (2) 3772.5 4121.4 3891.4
(2)/(1) 102% 128% 125%


According to Shelby Davis, a legendary insurance investor, if the company’s capital and surplus is 100% its earned premium, it’s considered to be in a comfortable underwriting position as far as the capacity is concerned. The ratio of ORI indicates that ORI is still having comfortable equity as a cushion to write this level of earned premium.

In addition, as of June 2012, the company has managed to pay down around 40% of debt, bringing down the total to 15% of its equity.

Investment portfolio

As of June 2012, ORI’s investment portfolio is mainly in fixed maturities securities, with the estimated fair value on its balance sheet is nearly $8.4 billion. Of that, 80.6% is in corporate types, and the rest in tax-free and U.S. and Canadian government securities.

The great deal of fixed-maturity securities in the company’s portfolio are rather short to medium term, with a range of one to ten years. A near-term due date would help to stabilize the market fluctuations.

Over the last three years, ORI’s investment portfolio has provided the company with stable investment income, mainly coming from taxable interest, on the total net investment income of $383.5, $379 and $364.6 million for the year 2009, 2010 and 2011 respectively.

Dividends

ORI has a history of paying increasing dividends for 44 consecutive years. Currently it paid out nearly 18 cents in its quarterly dividend per share. With the share price of $8.8, the dividend yield is reaching more than 8%.

The company has been questioned about the ability to pay out such dividends, as the RFIG run-off business is mounting losses, especially with the mortgage insurance line. I think the probability of continuing that high dividend rate is quite high because of two factors. First, because the mortgage insurance line has been packaged with CCI to put in the run-off segments. Second, the rest of the businesses in ORI outside mortgage guaranty generate around 20 cents per share quarterly. During the conference call, its CEO Aldo Zucaro showed the belief that the mortgage insurance would not be an issue for the rest of ORI as an ongoing business, combining with the action of buying shares in the market for his personal holdings. He mentioned in its recent earnings conference call: “Because the runoff or receivership of the RFIG subsidiaries, i.e. in this case the Mortgage Guaranty subsidiaries has got nothing to do with the actively managed companies we’ve in the General Insurance business, let’s say, right? The capital structures and the obligations of those companies do not coalesce.”

The management tried to indicate that RFIG has no claim on the assets or cash flows of the company and its other divisions, the parent company can receive the cash flow from the good operations, but the negative cash would not drain from the parent. As RFIG is the run-off segment, no additional capital would be put into it. So the dividend is quite sustainable.

Insider trading

From the middle of 2011, the chairman and CEO, Aldo Zucaro, has been gradually buying shares of the company in the open market, along with other directors. Aldo is the most active with the total value of purchase of nearly $1.2 million since August 2011. Now he is holding 1,220,000 shares with the market value of more than $10.7 million. That insider-buying signal indicates the belief of the chairman and CEO of ORI in the long-term value in the company.

Risks

ORI’s risk is its exposure to the RFIG run-off businesses, but as described above, I think the probability of ruin is quite low. The chairman and CEO has consistently purchased ORI’s shares in the open market for nearly a year, and he is the largest non-institution shareholder in ORI according to the company’s filings.

Valuation

At the time of writing, with the current share price of $9.45 per share, ORI is worth nearly $2.5 billion in the market. It is trading at 0.7x book value, offering investors a rich dividend yield of 7.5%. The bonds held in its investment portfolio are worth far more than the market price of the company’s share. Buyers of ORI share will get his or her money’s worth in the slice of the portfolio. As a bonus, they will get the ongoing insurance business for free. In addition, they will get dividend yield of 7.5%, around three times the yield on the long-term Treasury bond.

ORI is considered a long-term holding for value investors so that investors can enjoy the hefty dividends over time and reinvest the dividends for maximum compounding over years. ORI is estimated to be worth at least 1x to 1.2x its book value, making the target price $14 to $17 per share.

Disclosure: Long ORI

About the author:

Anh Hoang
Money manager into global equities, especially with US and Vietnam markets. CFA level 3 candidate. Lecturer for Stalla - CFA course in Vietnam

Visit Anh Hoang's Website


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