Description

Global Indemnity (GBLI) is a $393MM market capitalization property and casualty insurer headquartered in Bala Cynwyd, Pennsylvania.  GLBI is a small but diverse underwriter with operations in four different business segments:  Commercial Specialty, Specialty Property, Farm, Ranch & Stable, and Reinsurance.  The company’s profitability is dominated by small-ticket excess and surplus lines exposures – an area experiencing a firming pricing environment. 

While Global has been statistically cheap on a consistent basis over the last several years, we believe there are multiple positive data points that the market has failed to comprehend.  

On August 28th, Global completed a re-domestication where the company’s structure converted from a Cayman Islands corporation to a domestic LLC taxed as a partnership.  While this was a complex transaction driven by tax considerations and a desire for simplification, we believe that the most interesting part of the transaction is that the conversion allowed the company to dividend up a majority of the company’s significant excess capital from the operating subsidiaries to the parent company.  In conjunction with the re-domestication, Global moved $250MM in capital from the company’s insurance subsidiaries to the parent company.  This capital is not needed to support the underwriting activities of the company.  

We believe that management will likely distribute this capital to shareholders in the form of a large special dividend of approximately $15-$18 per share.  When combined with solid book value growth, a safe 3.7% dividend, and an eventual takeout of the company, we believe GBLI offers a tremendous risk/reward proposition.  

There are several core tenant to the Global Indemnity investment thesis:

1. Global Indemnity is an incredibly undervalued and orphaned small-cap insurer.  GBLI trades at an anemic valuation of 54% of book value, 57% of tangible book value and 9x estimated 2021 EPS.  The stock offers a compelling and safe 3.7% dividend yield.  Book value is understated due to Global’s consistent history of positive reserve development.  Reserves have developed positively in 13 of the prior 16 years and in every year since 2013.  At year-end 2019, 71% of net reserves were “incurred but not reported” (IBNR).  GBLI’s balance sheet is “A” rated or excellent by A.M. Best.  The company has a high-quality and transparent investment portfolio.  Global is orphaned.  The company has zero investor outreach and no analyst coverage.  In conjunction with Global’s conversion to an LLC, the stock was removed from the Russell 2000 and has underperformed.  In a market dominated by flows, there have been no natural buyers of the stock.   During this same time, Chairman and founder Saul Fox purchased $20MM in stock on the open market.  Fox had not purchased stock since 2010 and historically his purchases have been well-timed.  

2. The property and casualty market is experiencing improving market conditions and GLBI’s excess and surplus franchise is benefiting.  Commercial lines pricing in the P&C industry is improving in a broad-based manner for the first time since the early 2000s cycle turn.  Per the Council on Insurance Agents and Brokers (CIAB), 3Q pricing rose by 11.7%.  Driving factors include social inflation, lower aggregate industry reserve redundancies, historically low interest rates, and high catastrophe losses and business interruption claims (GLBI has a pandemic exclusion on all business interruption policies).  Looking back to the prior cycle turn, P&C stock valuations moved from a trough of 1x book value to 1.9x book value as measured by the S&P 500 P&C Insurance industry.  In particular, industry sources have confirmed that excess and surplus pricing is very robust. 

3. Global is a high-probability intermediate-term takeover candidate.  Global is a logical takeover candidate due to their attractive E&S exposure, strong reserve position, hardening market conditions, size, and an aging controlling shareholder.  The company is taking many steps that characterize a company that is moving towards a likely sale: 

• GBLI has simplified their corporate structure by re-domesticating the business

• They have de-risked their investment portfolio by selling $200MM in common equities

• The company has de-levered, paying down over $170MM in debt including calling the company’s 2045 subordinated debt issue with a rate of 7.75%

• Global has culled catastrophe risk exposure in all lines and fully exited Property Reinsurance

• The company has been more aggressively releasing reserves.  Year-to-date reserve releases are $31.6MM.  This is a common page of the playbook for companies that are looking to sell, as buyers are unwilling to pay a multiple for excess reserves.  

In aggregate, this fact pattern forms a mosaic of a company that is likely to pay out a large special dividend in the near-term, followed by a likely sale of the business in the intermediate term. 

Background/History

Global Indemnity has a dual-class voting structure with the controlling shareholder Saul Fox and his firm Fox Paine having 82% voting control and aggregate ownership of 41%.  Fox is a tax attorney who was formerly employed at KKR in the 1980s.  He joined the firm in 1984 after working as a tax attorney for 6 years.  Fox led KKR’s foray into the insurance industry and was the lead on the American Reinsurance (660% ROI, 57% IRR) and Canadian General (360% ROI, 55% IRR) deals.  After 12 years at KKR, Fox left to partner with Bankers Trust executive Dexter Paine to form Fox Paine, an independent private equity firm.  Global Indemnity was one of six investments in Fox Paine’s second fund.  Fox Paine is largely an inactive firm at this point.  They provide “advisory services” on a regular basis to Global Indemnity and often over-charge GBLI for their services.  This is the most legitimate criticism of the company. 

Global was formed in 2003 and began operations post the $240MM acquisition of United National, an excess and surplus lines carrier.  The company completed a $170MM IPO shortly afterward.  In 2005, Global acquired Penn America, an E&S carrier focused on “main street” commercial exposures for $161MM as well as Penn Independent, an insurance agency & broker and control shareholder for $99MM.  GBLI subsequently divested the brokerage business.  In 2008, Global completed a rights offering backstopped by Fox Paine.  In 2010, the company acquired Collectibles Insurance Services – a small, but profitable underwriter for $15MM. 

In 2015, Global acquired American Reliable (ARIC) for $100MM in cash from Assurant (the acquisition was priced at tangible book value.)  ARIC was a specialty personal lines insurer of manufactured housing, semi-rural habitational properties, and farms and ranches.  Later in 2015 Global repurchased 11.7MM shares (approximately 45% of the company’s float).  The buyback was completed at a 35% discount to book value leading to 29% accretion in book value.  Of note, neither Fox nor associated Fox Paine principals have sold any stock to date.

Results from the acquired ARIC lines produced sub-par results from 2016 to 2018.  While elevated industry catastrophe losses hurt results, management took steps to cull exposures in catastrophe-exposed ARIC lines, replaced management and completely exited Property Catastrophe Reinsurance.  In 2018 and 2019 the company reorganized and recapitalized its structure to accommodate changes in tax laws including the elimination of intra-group or affiliate reinsurance, and co-obligating domestic affiliates with parent company debt.  In August of 2020 the company re-domesticated the business from the Cayman Islands to the United States. In conjunction with this announcement the company called its 2045 7.75% subordinated note issue.

Business Overview/Segments

GBLI generated $637MM in 2019 gross written premiums.  The company is focused on excess and surplus lines (E&S) and specialty admitted exposures.  E&S lines provide coverage that is unavailable in standard/state-regulated terms with regards to terms and conditions.  Sample exposures include couriers and freight brokers, vacant properties, and orthotics and prosthetics physicians’ offices.  Specialty admitted exposures are state regulated, but GLBI is focused on niche markets including manufactured homes, ranches and equine mortality. 

GBLI operates out of four segments:  Commercial Specialty accounted for 47% of gross written premiums and 75% of underwriting income in 2019, Specialty Property accounted for 26% of gross written premiums and 18% of underwriting income, Farm, Ranch & Stable accounted for 14% of gross written premiums and negative 2% of underwriting income and Reinsurance accounted for 14% of gross written premiums and 9% of underwriting income.  

Commercial Specialty – Commercial Specialty is the dominant driver of profitability at Global Indemnity.  This segment includes Penn-America, United National, Diamond State and Vacant Express.  This segment has strategic value and would command a solid valuation in a buyout.  In particular, Penn-America and National United have been in existence since the 1950s and have long and profitable underwriting histories.  Specialty Commercial generated $297MM in gross written premiums with an 86.4% combined ratio in 2019 leading to an underwriting profit of $32MM.

• Penn America - Penn-America markets property and general liability products to small commercial businesses through a select network of MGAs.  Management notes that typical insureds are retail stores, artisan contractors, restaurants, auto services, and residential and commercial landlords/building owners.  The average account generates under $3K in annual premium with a focus on commercial property and general liability.  Underwriting and marketing are conducted out of Los Angeles, Atlanta, Philadelphia, San Antonio and Chicago.  Management claims that their competitive advantages are strong local relationships, customized product development and a robust technology platform.  MGAs are compensated with contingent profit commissions based on the agent’s ability to manage a profitable and growing book of business.

• United National – United National markets products including commercial property, general liability, inland marine and professional liability through program administrators who have specialized underwriting expertise for specific class and lines of business and “tailored underwriting authority” customized to their skill set.  Unlike Penn-America, these are larger dollar policies with examples being property and general liability coverage for real estate investors and property and general liability for orthotics and prosthetics manufacturers.  United National has a dedicated underwriting team out of their Philadelphia office that deals with managing program administrators.  Management asserts that their largest historical competitive advantage is the willingness to eschew premium growth if it is unprofitable.

   

• Diamond State Group – Diamond State markets property, casualty and professional lines through wholesale brokers as well as through program administrators with binding authority.  Much of the business serves larger accounts and is focused on property coverage with high deductibles.  They focus on maintaining healthy relationships with large wholesale brokers who have established market positions. 

   

• Vacant Express – Vacant Express is a niche underwriter that primarily insures dwellings that are currently vacant, undergoing renovation, or are under construction.  Products are marketed through aggregators, brokers and retail agents.  The group writes on both an admitted and an un-admitted basis. 

Specialty Property - In the first quarter of 2019 Global reclassified its “Personal Lines” segment and divided it into Specialty Property and Farm, Ranch and Stable.  This was made in conjunction with a change in the management of the division.  Specialty Property is managed out of Scottsdale, Arizona and is branded under the American Reliable Insurance Company (ARIC) name.  Specialty Property writes personal lines property and casualty products through general and specialty agents. The segment has a focus on manufactured homes, vacation and rental properties, boats and collectibles.  Management asserts that Collectibles Insurance Services is a small but highly profitable business.  In 2019 Specialty Property generated $163MM in gross written premiums a combined ratio of 95.7% and underwriting income of $8MM. 

Farm, Ranch & Stable - The Farm, Ranch & Stable business was broken out as its own segment in the first quarter of 2019.  This segment is also from the 2015 acquisition of ARIC and has struggled with regards to underwriting profitability although recent results reflect improvement.  In 2019 the segment generated $88MM in gross written premium, a combined ratio of 101.2% and an underwriting loss of $.8MM.  The segment provides specialized coverage of commercial farm auto and excess/umbrella coverage for the agriculture industry as well as specialized insurance products for equine mortality and medical.  For clarification purposes, this is not crop coverage.

Reinsurance – Global’s Reinsurance business is focused on two areas.  They write casualty reinsurance providing coverage for general liability, professional liability, directors’ and officers’ omissions, medical malpractice and cyber liability.  Additionally Global writes a niche high-attachment point professional errors and omissions umbrella program for select top-tier law, accounting and consulting firms.  This segment has been largely restructured and de-risked over the last several years.  GBLI exited two international catastrophe treaties in 2019 that had contributed $53MM in gross written premiums and they now have no property exposure.  In 2019, the segment generated $88MM in gross written premiums, a 94.8% combined ratio and $4MM in underwriting profits. 

Reserves

GBLI has a redundant reserve position which implies that book value is actually understated.  The company has experienced seven consecutive years of positive reserve development and has had positive development in 13 of the last 16 years. 

Investment Portfolio

Global has a high quality and transparent investment portfolio.  The book yield at 9/30 was 2.4%.  The fixed income portfolio has an average credit rating of AA- and a duration of 4.2 years.  Below is a summary of the composition of the company’s portfolio at 9/30/2020: 

A sober look at the investment portfolio and the anemic yield at which it is earning – in conjunction with the tremendous excess capital position of the company – points to the clear logic of a special dividend.  We believe the “playbook” here is quite obvious.  In fact, management has already shown us their hand:

• Management stated at YE 2019 that their excess capital position above and beyond what was needed to maintain an AM Best “A” rating was $214MM.  We estimate that currently this number is approximately $250MM or $17.50 per share.  

• Global disclosed that they moved $250MM from their operating subsidiaries (confirming that they do not need this capital to support the underwriting activities of the company) to the parent company.  They are now able to return this capital to shareholders in a tax-free manner – the transaction would be treated as a return of capital.

• Due to the anemic yields in the fixed income market – the loss of investment earnings would likely be only $6MM.  We estimate on a pro-forma basis, post-dividend, that GBLI can still earn $2.71 per share with potential to earn well in excess of $3.00 per share post the special dividend. 

• An ancillary benefit from this transaction would be that the company’s ROE would see meaningful improvement, garnering support for a higher valuation.

• Post the return of capital and the recent actions taken by management to clean up the operating profile and the corporate structure, we believe Global is a likely seller.  There are multiple buyers who would likely covet the company’s E&S franchises --  particularly considering the current pricing environment. Below is a P&C insurance transaction comp sheet.

Global Indemnity potentially offers a 2-3x total return over the next several years driven by the combination of a large special dividend, solid book value growth, an attractive $1.00 per share regular dividend, and an eventual exit through M&A at a premium to tangible book value.

Looking to the downside, the risk of impairment is de-minimis considering the current valuation of 57% of understated tangible book value, safe 3.7% dividend yield, enormous excess capital position and redundant reserves.  

There are multiple risk factors:  

• CEO Cindy Valko announced her retirement on Tuesday and that has led to near-term pressure on the stock.  While we respect Valko, she is 66 and is remaining involved to a degree in a consulting role.  Ultimately Fox runs the company. 

• As an insurer, ultimately your COGS is an actuary’s estimate.  There is always an element of the unknown investing in a P&C insurer.  The company’s reserve history gives us comfort

• Continued low investment yields will pressure earnings

• The company is exposed to catastrophe losses despite culling risks.  This led to weakness in 3Q results 

• There is a controlling shareholder who may choose to squander the company’s excess capital.  One scenario is that Fox hires a new CEO and chooses to grow through M&A versus the highest and best outcome of paying out excess capital and selling.  Fox Paine may charge a large advisory fee for a deal and the company completes a transaction that is dilutive to book value.  While this is NOT a preferred outcome, in this scenario a transaction would likely prove extremely accretive to earnings as the current yield on fixed income is so anemic.  Even in this "negative" scenario the stock would likely appreciate.

Catalyst

*Special dividend

*Sale of the business

*Continued strong underwriting results and book value growth