September 09, 2011 - 10:10am EST by
2011 2012
Price: 7.75 EPS $0.7048 $0.00
Shares Out. (in M): 12 P/E 11.0x 0.0x
Market Cap (in $M): 93 P/FCF 11.0x 0.0x
Net Debt (in $M): -39 EBIT 14 0
TEV ($): 54 TEV/EBIT 4.0x 0.0x

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A Canadian Insurer (Not Named Fairfax)

EGI Financial Holdings, Inc. (EFH.TO) represents, in my opinion, a compelling opportunity for significant, risk-adjusted returns over the long term.  EGI is a specialty insurer headquartered in Toronto, Canada that focuses on two markets: personal lines (non-standard automobile and motorcycle) and niche products.  While the great majority of the company's business is Canadian, it is currently starting-up a non-standard automobile operation in the United States, focused primarily on the Southeast (Florida and Texas).  

The short version of the thesis is that EGI is a well-reserved insurer trading at 63% of tangible book value and, unlike many other lines of insurance, it may very well be entering a firming non-standard automobile market in Canada.  Currently profitable and sporting a fortress balance sheet, the company is the second largest non-standard automobile writer in Canada.  It boasts a management team and board that have built and sold another non-standard automobile writer in the past.  Significant regulatory changes and more rationale competition also seem poised to help drive returns.  Modest book value growth assumptions and a return to a more respectable valuation would drive strong returns will significant downside protection.

Since about 72% of 2010 written premiums were derived from the personal lines segment it makes sense to start there.  As mentioned the company is the second largest non-standard writer, behind Westaim Corp. (TSX: WED).  Westaim is the current owner of the former non-standard businesses of Kingsway Financial Services Inc. (TSX: KFS), known now as JEVCO.  Kingsway, which has had its struggles over the last several years, sold the businesses to Westaim, a shell company, in early 2010.  The other two main competitors are Pafco (a subsidiary of Allstate) and Perth (a mutual looking to demutualize).

The remainder of the 2010 premiums came from the company's niche lines of business, which are more akin to the excess and surplus market here in the United States.  While smaller in scope, the company is spending a fair amount of time and resources to grow this business given that it is a strategic priority for them.  In addition to the niche business in 2011 we are starting to see some premiums from the company's international expansion into the United States. 

Canadian Non-Standard Market and Cycle

Non-Standard Cycle

Like all lines of insurance, Canadian non-standard automobile is governed by underwriting cycles.  In the case of Canadian non-standard automobile, the cycles may very well be influenced at least equally by regulation.  A few years ago the Ontario market, which is the primary Canadian market, was significantly impacted by regulatory rate pressures and tort changes.  As rates came down and claims rose due to aggressively lawyering, results for the industry declined significantly.  This was exacerbated, as is often the case in non-standard auto, by standard writers taking pieces of the business as the line blurred on what exactly was non-standard.  The biggest geographic issue became the greater Toronto market which is significant to the overall market.  EGI was quick to essentially pull-out of the GTA (Greater Toronto Area), where combined ratios exceeded 120-130.  An initial set of legislative changed were initiated in October of 2010, which was preceded by several months of difficult loss ratios.  However, recent rate increases, broker non-renewals and the legislative actions have started to change the trend.  EGI has resorted to six month only policies and cumulative rate increases of approximately 20% over the last eight months which essentially mirrors the rate increases at JEVCO.  Combined with standard writers fleeing the periphery of the non-standard market, these initial developments bode well for a firming market.

Changing Competitive Landscape

Kingsway has been a troubled and distracted institution over the last several years.  While I don't have intimate knowledge of their operations, I view it as a positive that JEVCO is now in the hands of a stable, financially-driven competitor.  I'm not saying Kingsway's former businesses were chasing premiums, but the probabilities suggest their attention was not on the business at all times.  Now controlled by the Alberta Investment Corporation and Goodwood Inc., an investment manager, JEVCO is in good hands.  In most businesses a better capitalized, more focused competitor would be a negative, but in insurance it can very much be a positive. This should bring some further rationality to the market. 

Possible Canadian Consolidation

It may very well make sense for there to be further consolidation in the market.  I could see EFH being an acquirer (they have excess capital) or being acquired (I'd obviously prefer the later!).  Given that Westaim is the fruits of a financial backer and the changing market I wouldn't be surprised to see them pursue a consolidation strategy.

US Efforts

EFH previously attempted to enter the US market by way of a reinsurance business.  While this clearly was not profitable, the effort was designed in such a manner to avoid jeopardizing the group.  Management rightly saw that they could not control underwriting and claims management and decided to pursue a direct underwriting operation in the US. 

Current earnings and book value growth are being hampered by the start-up operation, which has an approximate $2 mm cost (LTM underwriting loss of C$1.6 mm on C$.6 mm in premiums).  The current underwriting loss in the international operation is being absorbed by the underwriting income at the company's Canadian operations and the company's investment income.  While I'm cautious about my expectation with this business, I believe the efforts here are measured and perhaps timely.  All you have to do is look at a company like Hallmark Financial Services (HALL) to see how entering the Florida non-standard market at the wrong time with a wrong pricing model can be detrimental.  Management believes they are seeing the same signs of firming in a market like Florida that they are seeing in Canada.  Capital is leaving the market, prices are starting to rise (though more moderately) and standard writers are retreating.


The current management team at EGI is comprised of a number of executives from what used to be an independent non-standard auto underwriter in Canada named Pafco Insurance Company.  Pafco (including Pembridge, Inc.) was sold to Allstate in 1998 at what appears to be a greater than 3x multiple to tangible book value and the management team eventually landed at Echelon in a deal with The Co-operators Group to restructure the company.  Current Vice Chairman Douglas McIntyre, who was Pafco's CEO at the time of its sale and several other members of management (  were instrumental in building and selling Pafco.  Pafco is now the third largest non-standard writer in Canada, having seen its premium volume decline by upwards of 50% over several years.  It would appear that the team at EGI knows how to grow and sell a business and more importantly it seems you would want a lengthy non-compete if you were to buy a business from them!



EGI Financial Holdings, Inc.  
Segment Combined Ratios (TTM)  
Period Personal Line Niche International *
31-Dec-06 83.36% 98.08% #DIV/0!
31-Mar-07 83.41% 91.84% 99.66%
30-Jun-07 81.88% 97.31% 99.16%
30-Sep-07 85.69% 93.27% 99.00%
31-Dec-07 87.84% 98.76% 100.21%
31-Mar-08 90.26% 102.96% 103.00%
30-Jun-08 90.44% 110.81% 110.62%
30-Sep-08 90.97% 109.64% 113.19%
31-Dec-08 92.85% 106.92% 119.11%
31-Mar-09 91.57% 109.49% 122.66%
30-Jun-09 93.97% 97.59% 130.32%
30-Sep-09 95.85% 99.16% 143.71%
31-Dec-09 100.68% 108.61% 174.04%
31-Mar-10 104.72% 109.46% 243.87%
30-Jun-10 107.97% 114.13% 470.70%
30-Sep-10 110.51% 114.02% 682.26%
31-Dec-10 106.04% 99.54% 934.81%
31-Mar-11 101.94% 96.21% 671.66%
30-Jun-11 99.97% 97.42% 363.80%
* The combined ratio for internation is extremely high given the start-up nature of the business.  Only recently have premiums begun to be recognized.  Until the business reaches even a bit of scale this will continue.


EGI Financial Holdings, Inc.                
Insurance Ratios                
  2003 2004 2005 2006 2007 2008 2009 2010
Loss Ratio 75.80% 66.90% 60.30% 57.20% 59.50% 67.30% 72.40% 73.10%
Expense Ratio 30.20% 28.20% 27.70% 28.80% 31.90% 32.60% 33.90% 32.90%
Combined Ratio 106.00% 95.10% 88.00% 86.00% 91.40% 99.90% 106.30% 106.00%
ROE 13.10% 23.00% 25.90% 21.40% 16.10% 5.40% 3.60% 3.00%

EGI Financial Holdings, Inc.              
Reserving History              
  2003 2004 2005 2006 2007 2008 2009
Original Estimate 79,191 107,196 129,173 146,101 169,091 185,255 207,220
Latest (Or 5 Yr Later) * 76,504 91,281 110,577 134,173 164,290 189,093 203,920
Redundancy (Deficiency) 2,687 15,915 18,596 11,928 4,801 -3,838 3,300
   As % of Original Estimate 3.39% 14.85% 14.40% 8.16% 2.84% -2.07% 1.59%
* Data provided in the company's annual report on calendar year reserve adjustments extends five years.

Other Items

Insider Buys

2011 YTD - Executives at EGI have collectively purchased 31,462 shares in 2011, net of the shares sold by one executive.  Buyers included Paul Little (board member), Steve Dobronyi (CEO) and Henraj Singh (CFO).  Most of the share purchases took place in June and all share buys were in the range of C$8.00 to C$8.70.

8/18/11 - Ian Delaney, Chairman of Westaim bought approximately C$2 mm worth of stock.  While not an insider buy at EFH, I would submit this large purchase speaks to what Delaney sees for his company in the coming market.  It was also, as noted later, at a significantly higher valuation than where EGI is trading today.

Capital Management

Given that the shares are trading where they are trading and the company's excess capital, I would be pleased to see a share buyback, but I unfortunately don't see that in the cards.  Management is clearly on the look-out for an acquisition, which might be positive in the acceleration of their US strategy but is not, in my opinion, the most optimal use of capital at the moment.  I hope they surprise me.

Niche Issues

In the niche business, the company struggled with its first two seasons offering emergency health travel insurance.  This business was a health policy primarily targeted at Canadians traveling abroad where their national insurance didn't travel.  EGI's former executive Mark Sylvia had helped EGI turn around a similar line of business that was previously sold to Co-operators.  The company believed they could repeat that strong performance with a start-up niche line.  Unfortunately, the company failed mightily in their efforts on back-to-back seasons (very seasonal business) and Mr. Sylvia recently left.  The business line was discontinued, though the company still writes a small amount of group business in this niche.  This is the primary reason behind the poor performance in the niche business, especially in 2008 and 2009.

Return Possibilities


EGI Financial Holdings      
Return Possibilities - 5 Year IRR    
  Bear Case Base Case Bull Case
Assumed BV Growth 2.50% 10.00% 15.00%
BV Multiple Achieved:      
0.70 x 10% 19% 24%
1.00 x 13% 21% 26%
1.30 x 19% 27% 33%

The average ROE for EGI from 2003 through 2010 was 13.9%, which I believe represents a full cycle.  I therefore would argue that my base case is more than reasonable, especially considering that I don't believe the emergency health travel problems mentioned earlier will resurface.  It also must be noted that the stronger book value growth numbers, driven by higher ROE's would likely drive higher book value multiples.  That is if EGI achieves 15% book value growth for the next five years it is less likely to be trading at 70% of tangible book than it is at 130% of tangible book.  Of course the reverse is also true. 

Trading Multiples (Current, Transactions, Historical)

Current P&C Public Universe (Canada and US) (Capital IQ)

Mean -  1.04x TBV

Median - .88x TBV

Direct Comparable

Westaim Corp. (TSX: WED) - .92x TBV

EGI Financial Holdings Trading Multiples        
Price to Tangible Book Value          
  2005 2006 2007 2008 2009 2010 2011
Average 1.49x 1.27x 1.30x 1.01x 0.83x 0.82x 0.68x
High 1.52x 1.61x 1.45x 1.35x 1.06x 1.01x 0.73x
Low 1.46x 0.98x 1.15x 0.52x 0.65x 0.65x 0.63x
Close 1.48x 1.17x 1.35x 0.66x 0.99x 0.66x 0.64x


Property and Casualty Acquisitions              
Under $250 mm in Size              
Date Target Company Acquiror Company Type Size ($mm)   Price / BV   P / TBV
10/14/2004 Penn-America Group Inc. United National Group Ltd. Public Entity $186.02   1.10 x   1.10 x
6/1/2006 American Physicians Insurance Company American Physicians Service Group Inc. Public Entity $29.72   1.12 x   1.07 x
10/31/2006 Merchants Group Inc. American European Group, Inc. Public Entity $70.90   0.89 x   0.88 x
4/27/2007 Employers Direct Insurance Company Alleghany Corp. Subsidiary of Public Entity $192.50   1.46 x    
6/25/2007 Professionals Direct, Inc. The Hanover Insurance Group Inc. Public Entity $29.54   1.81 x   1.92 x
9/20/2007 RTW Inc. Rockhill Holding Company Public Entity $67.59   1.23 x   1.18 x
1/3/2008 North Pointe Holdings Corp. QBE Holdings, Inc. Public Entity $199.03   1.45 x   1.65 x
1/10/2008 AmCOMP Incorporated Employers Holdings, Inc. Public Entity $223.94   1.14 x   1.14 x
8/27/2008 Hermitage Insurance Company CastlePoint Reinsurance Company, Ltd. Subsidiary of Public Entity $133.00   1.50 x   1.46 x
6/21/2009 Specialty Underwriters' Alliance Inc. Tower Group Inc. Public Entity $125.20   0.91 x   0.94 x
6/30/2010 Vanliner Group, Inc. National Interstate Insurance Company Subsidiary of Private Company $140.00   1.00 x   1.00 x
11/30/2010 Mercer Insurance Group, Inc. United Fire & Casualty Company Public Entity $183.45   1.00 x   1.05 x
11/30/2010 American Physicians Service Group Inc. ProAssurance Corporation Public Entity $222.12   1.33 x   1.33 x
12/6/2010 Michigan Insurance Company Donegal Group, Inc. Subsidiary of Mutual $42.00   1.22 x   1.22 x
4/15/2011 Fremont Michigan Insuracorp, Inc. Auto Club Insurance Association Public Entity $67.69   1.30 x   1.30 x
3/13/2008 National Atlantic Holdings Corp. Palisades Safety and Insurance Management Corporation Public Entity $69.47   0.48 x   0.49 x
12/9/2010 Bancinsurance Corp. Falcon Equity Partners Public Entity $11.40   0.90 x   0.90 x
    Average   $117.27   1.17 x   1.16 x
    Median   $125.20   1.14 x   1.12 x
    Average (Ex National Atlantic & Bancinsurance) *   $127.51   1.23 x   1.23 x
    Median (Ex National Atlantic & Bancinsurance) *   $133.00   1.22 x   1.16 x
* National Atlantic is excluded in this calculation because the company was under extreme financial distress at the time of acquisition.  Bancinsurance was also excluded from this version of the calculation because the company was controlled by the acquiring entity.


I think the above exhibits show that on the basis of current public company valuations, a direct competitor valuation, EGI's previous public company valuations and recent transaction multiples that the company is significantly undervalued from a number of perspectives.  I believe it also lends credence to the book value multiples contemplated in the returns exhibit.



Underwriting Cycle in Non-Standard Does Not Improve or Worsens

Recent price increases by EGI and followed by JEVCO, the largest writer, would seem to suggest that pricing is not deteriorating.  While unlikely to change quickly, this is certainly a risk always present in the business.  I think the more relevant risk to the thesis is the risk that pricing doesn't continue to improve, in which case the more aggressive base and bull case growth in equity would be in jeopardy. 

Niche Programs Continue to Underperform

After the company fixed the emergency health travel business by discontinuing the line, the company ran into an additional problem area recently.  Last year it wrote a large specialty group commercial auto policy that has hurt this segment recently.  This policy was not renewed and the issues should now be contained, but the risk of adverse development from this policy is a real (though manageable) risk.

US Efforts Fail Spectacularly

Given the management team involved, the cautiousness of the company's entrance and the timing of entrance this seems to be somewhat mitigated.  However, this is perhaps the biggest risk.  Does this company come down from Canada and waste a bunch of capital in the US?  Time will tell, despite the mitigating factors.

Investment Portfolio Issues

EGI has significant investment leverage.  At the end of June the company had approximately C$29.74 per share in investments.  Equities per share were C$5.56 and represent 45% of tangible book value.  As you might expect being a Canadian insurer, a significant percentage of the equities are in energy, financial services and materials.  In fact, at the end of 2010 these industries represented 72% of those equities.


While this can of course be hedged, those that don't should consider the currency, especially since there is little natural hedge as yet (i.e. no US business to speak of).  As a reference the US$ has declined from 1.16 to .96 at the end of June from the start of 2007.


Being a sub-$100 mm market cap company it is less liquid than many names.  10,000 shares seems to be a rather good day over the last six months, though it has been a bit better than that at other points in time.

Why is This Cheap?
  • Many insurance companies are cheap (though perhaps not as cheap as EGI)
  • Small cap Canadian company
  • Little recognition that the industry dynamics are changing in this specific line of business
  • Recent poor performance
  • Worry over US efforts
  • No dividend, no buyback, acquisition focus


- possible dividend
- consolidation
- further recognition of firming Canadian non-standard market
- continuing decline in price to tangible book value ratio
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