A Conversation with Paresh Patel Executive Chairman of the Board of Homeowners Choice, Inc.

It became news that Homeowners Choice (HCII) had self re-insurance through their own subsidiary, Claddaugh, through which they have made a significant profit. Upon that news, it is my opinion that Homeowners Choice has a transparency issue and, as a fiduciary to my clients, I then immediately contacted the firm.

Homeowners Choice is taking on more risk than I had personally believed and investors realized, and as a result from taking that additional risk they benefited significantly; about $9 million dollars better. So, we talked to Paresh Patel, Chairman of the Board, about it.

He claims that all of Claddaugh funds are solely to help the clients and provide an avenue to reduce their highest cost re-insurance. Additionally, he claimed that state regulations mandated Homeowners Choice to carry some re-insurance that is “at very high cost” making it much more desirable and profitable to self insure.

On the disclosure issue, Paresh stated that this matter was disclosed to shareholders in SEC documents, and, because of “competitive reasons”, he had chosen to withhold this information. In our opinion, being that this is close to 10% of their business it is a material matter. The additional risk alone to many shareholders, including our group, wasn‘t originally understood. It was not at all contained or communicated in the last two conference calls, nor detailed in the published earnings.

Paresh further explained that all funds and cost are sitting in a bank in Bermuda, and that, again, this is just being done for the best interest of the shareholders. He claims that top management pay and compensation is no higher than what’s being reported in the SEC documents. We are reviewing this.

From June 1, 2009 to May 31, 2010, Homeowners Choice paid and continues to pay Claddaugh $750,000 per month. In other words, the subsidiary makes the majority of Homeowners Choice profits. As Paresh claims, that’s why his Homeowners Choice, the corporate umbrella, is profitable, and many competitors based only in Florida were not. Homeowners Choice’s Florida operations appear to be above break even and better than it’s closest rivals, but only marginally profitable. As it is in a free market, Homeowners Choice and specifically it’s Claddaugh subsidiary takes on more risk than the other local competitors last year and, with no major abnormal negative events like a hurricane, they benefited while outperforming their peers. Knowing Homeowners Choice profited nicely this last year, their is no guarantee that this strategy will work again next year. They need to disclose the level of risk Homeowners Choice is taking. Knowing their new approach on the internal risk, only Mother Nature has the final say!

Moving forward

In the last quarter, Homeowners Choice had excellent execution. The only disappointing issues were their large re-insurance fees, which they established in early 2009. They had a very strong quarter regarding their internal business, which they can control.

They confirmed that new rates will come into effect on April 10, when the current policies rollover. So, this will be a slower process.

They reconfirmed that the re-insurance rates, adding the many moving parts together, would be about 5-15% percent lower when they sign new rates in mid to late May. I believe that three months ago they were saying 5-10%.

Homeowners Choice has assumed 23,000 homeowner’s insurance policies from Citizens Property Insurance Corporation, Florida’s state-owned insurance company. They believe that the new accounts being transferred in will roughly be a wash with the other accounts leaving through attrition.

Paresh believe’s that currently, this quarter, it will be the lowest point in their profit cycle for their business, due to adding both the rate increase and the lowered re-insurance cost.

Doing some simple calculations by adding in these factors, we came up with $1.00 to $1.40 going forward in earnings. So, I asked Paresh if my quote of $1.40 in earnings after tax was accurate. He responded by saying he “would be disappointed” if it’s not at least that much. But, of course, his next comment was that he “can not give any guidance.”

With a 15 PE, assuming a 1.2 midpoint and their large cash holding, our valuation is that for HCII to be equal to their peers in PE it would be around a $36 stock. With that said, their lack of transparency and the additional risk (thus, the lower trust factor for our clients) makes a 10 PE more realistic, or a $12 price.

Both Paresh and Jay, the investor relations professional, were very quick, responsive and completely professional in trying to clear up my (many) questions, over many phone contacts. We at Durig Capital would like to thank both of them for their extended time and effort that they provided us.

Disclosure

Durig Capital, Randy Durig, their clients and related accounts have purchased Homeowners Choice with the majority around $8 dollars.