Monday, August 25, 2008

White Mountains Insurance (WTM) Analyst Day - Review of Esurance

White Mountains Insurance (WTM) held its annual analyst meeting on June 17, and I finally got around to listening to the webcast. The URL is here if you want to listen yourself.

I have written four other posts on the meeting. They are:

WTM - Introductory Comments

WTM - The Reserve Issue

WTM - Review of One Beacon

WTM - Review of White Mountains Re

Review of Esurance

Gary Tolman, President and Chief Executive Officer of Esurance led off with the same opening slide as the other segments with a notable exception – the slide omitted net written premiums and used direct written premiums, and instead of combined ratio, it had policies in force.

I suppose this should be expected since the company is focused on growth, and its combined ratio is significantly over 100%. The company says this is because of arcane accounting rules, which require the company to amortize expenses over an arbitrary short time frame instead of the life of the policy. Since the company is a direct writer of business, it must amortize its acquisition expenses over six months. It adjusts this by reporting both a GAAP combined ratio and what they call an economic combined ratio. After this adjustment, the combined ratio drops from 116% to 104%.

Tolman reviewed Esurance for the audience:

  • Personal auto insurer
  • Company writes non-standard insurance but not the bottom of the barrel risk.
  • 70% of business is acquired online.
  • Focus is on the younger market with an average age of 35, with about 40% in the 20’s.
  • Underwrites in 28 states – entering this year into UT and OK – 85% of market covered.
Esurance spent $125 million on advertising in 2007, and will reduce it to $100 million in 2008, because they want “to spend it wisely and focused on achieving an acquisition cost per policy that make sense for us and at this point that feels right if there are opportunities than we can increase it.”

Tolman then discussed Answer Financial, an online agency that WTM owns 69% of. (WTM bought the balance of the company in July 2008)

Answer Financial is an agency that writes business in all 50 states, offering quotes from 15 different auto insurers. The company earned $40 million in commission on $350 million in premium volume.

Esurance has an 8% conversion rate on quote requests because many of the requests are for coverage in states that it doesn’t write in. It can now send this business to Answer Financial. WTM is already 30% of its business. They also have $300 million in net operating losses (NOL) that can be monetized.

My Comments

Esurance has always been a controversial asset for WTM, and many investors don’t like the idea of writing non-standard auto insurance. This paranoia was stoked recently by an adverse reserve development last year of $30 million for the years 2005-2006. Loss ratios were also up by 3 points. The adjustment from GAAP to economic combined ratio does not wash with some value investors who view any adjustment to numbers as heresy, second only to high treason.

Answer Financial seems like a decent company, but my concern is that once is becomes part of the WTM family, will the other 14 auto insurers who sell through Answer Financial take business to another agency since Esurance is its competitor. Also, because Answer Financial has no hard assets, the purchase price that WTM paid is being assigned mostly to Goodwill on the balance sheet. Goodwill is another heretical term in the Value investing community, which has typically been the investor base of WTM. The appearance of goodwill is also leading to WTM reporting an adjusted book value every quarter. I will discuss this change in a future post.

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