If you are looking for an event-driven idea, don’t bother reading this.

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If you are looking for a turn-around or relative value idea, don’t bother reading this.

If you are a value investor who believes in absolute value and patience, keep reading.

Summary: Life Insurance Company of Alabama (“LICOA”) is a specialty life & health insurer that trades at 53% of TBV and 6.6X trailing earning. The company focuses on supplemental health insurance and some basic life insurance but ran into some problems that have mostly been put behind them. I think this could trade to 75-80% of TBV for a 50-60% return.

Overview: The company was founded in 1952 by the current CEO’s father, Colonel Clarence William Daguette, Jr.  LICOA has focused on supplemental insurance, similar to AFLAC, but using independent agents. The company does not disclose much about its operations although they have tended to target teachers in rural school systems, as well as hospitals. The company is most noted for selling cancer policies.

About 75% of the business comes from four states, with Alabama being the largest. Here is distribution of 2013 direct written premium:

Capital Structure: There are two classes of stock. The regular common trades as “LINS” and the “A” shares trade as “LINSA.” The “A” shares are worth 1/5^th of the common shares and have no voting rights, except in special cases. There are 87,554 common shares and 595,173 “A” shares. All share counts in this report will use “A” share equivalents of (5 X 87,554) + 595,173 = 1,032,943.

Insider Control: The Daguette family controls almost 60% of the voting control, with most shares held in a family trust. Six of the ten board members are family related. Besides the CEO, Clarence Daguette, III, there are his two sisters, Anne Renfrow and Alburta Lowe (who hold no other positions in the company), two brother-in-laws, Raymond Renfrow and Marvin Lowe (who do hold executive positions) and the Renfrow’s daughter, Rosalie Causey, who is an executive. Here is the breakdown on the board stock ownership:

Little Company, Big Problems:  LICOA did very well for many years but started running into problems in the late 1990’s. First, I need to provide some background on how claims are handled for cancer policies at LICOA. These policies are supplemental and pay the insured, not the medical providers. The insured files a claim by submitting a medical bill related to his or her cancer treatment. That’s fine in a normal, rationale world but not in American medical billing, where there are large differences between the billed amount and what is generally accepted for payment. Throw in medical advances and escalating costs of cancer treatments, and you can see an issue. But wait, it gets worse.

When LICOA began writing cancer policies, there were not a lot of treatments for cancer. For whatever reason, LICOA decided to write cancer policies with no limits. It was probably a great marketing tool early on but, in hindsight, it was incredibly stupid. The combination of unlimited policies and paying the billed amount took its toll on the company. As a result, they decided to address both issues.

For the unlimited benefits, LICOA began raising rates while also introducing policies with limits. Many insureds exchanged the unlimited for the limited policies due to the cheaper premiums. It has taken over a decade, but most of the unlimited policies have been terminated.

To deal with the medical billing issue, the company decided to only pay the generally accepted amounts. However, LICOA made a huge gaff by not informing their policyholders about this change. This resulted in lawsuits like the following:

http://caselaw.findlaw.com/al-court-of-civil-appeals/1572379.html

http://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=2&ved=0CFMQFjAB&url=http%3A%2F%2Fwww.ca6.uscourts.gov%2Fopinions.pdf%2F12a0191p-06.pdf&ei=UepyU7OlLrbLsQTwv4HQBA&usg=AFQjCNENAfYQTFtylX8_DKJDJxyEDkQjVw&sig2=PjAwqFoR7LZ1CF-mU0PGyw&bvm=bv.66699033,d.cWc

LICOA has settled two class action lawsuits related to this and recently received an upgrade from A.M. Best:

OLDWICK - FEBRUARY 26, 2014
A.M. Best has upgraded the financial strength rating to B++ (Good) from B+ (Good) and the issuer credit rating to "bbb" from "bbb-" of Life Insurance Company of Alabama (LICOA) (Gadsden, AL) [OTCBB: LINSA]. The outlook for both ratings has been revised to stable from positive.

The rating upgrades reflect LICOA's established niche market in its supplemental accident and health/life insurance segment, consistent earnings trends, robust risk-adjusted capitalization and improvement in its historically elevated risk profile.

LICOA is a small, closely held public company that offers supplemental insurance products to employer groups and individuals. In recent years, the company has reported consistently favorable operating results, despite some one-time items and unfavorable results in its unlimited cancer block of business.

The earnings have continued to bolster the company's risk-adjusted capitalization, which remains strong as measured by Best's Capital Adequacy Ratio (BCAR).

A.M. Best believes that LICOA has materially reduced its exposure in its unlimited cancer block. This is the result of the settlement of two class action lawsuits in late 2011--much of which had been previously reserved while in dispute--combined with the conversion of the majority of its unlimited cancer policies to limited benefit policies. A.M. Best will continue to monitor the impact that this block of business has on the company going forward, as well as the success of its premium rate increase strategy.

Offsetting rating factors include LICOA's flat premium revenue in recent years due to policyholder conversions from higher premium unlimited cancer policies to lower premium limited cancer policies, lower sales driven by local economic conditions and a mandatory one-year premium rate freeze in 2012 on parts of its cancer block. In addition, the company has business concentrations in the cancer insurance market and in four southeastern states.

A.M. Best notes the unlikelihood of upward rating movement in the near-to-medium term given LICOA's rating upgrades. Conversely, negative rating actions could occur if the company is unable to meet its modest growth projections, cannot achieve greater diversification of its revenue and earnings and/or material litigation/excessive claims arise in its remaining unlimited cancer business.

http://www3.ambest.com/ambv/bestnews/presscontent.aspx?altsrc=14&refnum=20839

[I added underlining for emphasis.]

Additional Information: Since LICOA only has one insurance company, a great resource for more detail is the market conduct exam. These are done by the state insurance department where a company is domiciled and are usually available to the public. You will find some historical information as well as receive an idea of how the company operates. LICOA tends to be a little sloppy with paper work but otherwise received a sound assessment. Here is the link to the 2008 exam performed by Alabama:

http://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=1&cad=rja&uact=8&ved=0CCkQFjAA&url=http%3A%2F%2Fwww.aldoi.gov%2FPDF%2FCompanies%2FLife%2520Insurance%2520Company%2520of%2520Alabama%252012-31-08.pdf&ei=-OZRU8GYD8zUsASpoYDQBQ&usg=AFQjCNEDvQa1AQlKXZZFOxfH1WpKGtXYjA&sig2=Wt3E-GjGV6EZjwu_MZrfiw&bvm=bv.65058239,d.cWc

Financials: Most of the financial data can be obtained from the Annual Statements that the company has to file with the regulators. Here is a table of some key info:

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While premiums and income have gone down, it is because LICOA has removed a lot of uncertainty related to those unlimited cancer policies. Less reward but a lot less risk.

Management: I was not able to find much on the CEO, Clarence Daguette III other than a long

family history with Jacksonville State University. Clarence Sr. was president of the college for

43 years, when it was called Jacksonville State Normal School. For those not familiar with what

a normal school was, it was a teachers’ college. That probably explains LICOA’s success in

marketing to teachers.

Risks: Illiquid, family-controlled, cancer policies.