Philadelphia Consolidated Holdings Corporation (NASDAQ: PHLY) is an insurance holding company with assets of nearly $2.8 billion holding less than 1% of the total US Proprety and Casualty Insurance market, where it operates exclusively. It is included in the Russell 1000. Its subsidiaries' principal activities are to design, market and underwrite specialty commercial and personal property and casualty insurance products. Its target market includes, among others, homeowners' associations, rent-a-car industry, automobile leasing industry, non-profit organizations, the health, fitness and wellness industry, sports centers and selects classes of professional liability. The products of PHLY are marketed through 330 underwriting professionals and 38 regional offices located in the United States.
PHLY is known for its firm control of its costs and combined ratios, its broad distribution network, and its innovative niche market strategy. Its successful management structure has been attributed to the fact that its managers own over 20% of the company shares, and their compensation tied to key performance ratios, which aligns their interests closely to that of their shareholders' in a business where day-to-day decisions determine long-run profitability. However, in the face of a weak economy fueling price competition, and in particular a depressed market in Insurance companies, PHLY also stepped up its acquisition efforts from 2007, using the new networks it acquired to increase sales. However, PHLY still has competitors of both the niche and the large variety, and is looking to its managers for new products as well as its actuarial team to further improve combined ratios.
|Total Losses and Expenses ($M)||$1,044.3||$819.1||$810.6|
|Net Investment Income ($M)||$117.2||$91.7||$63.7|
PHLY operates solely within the United States through its 38 regional and field offices. Its business strategy is to design, market, and underwrite specialty commercial and personal property and casualty insurance products for select markets or niches by offering differentiated products through multiple distribution channels. The company's operations are classified into the following three reportable business segments which are organized around its three underwriting divisions:
PHLY recognized a $7.5 million net loss and loss adjustment expense estimate for the October 2007 California wildfires during 2007, a sum which was not incurred during 2006.  In the year ended 2005, PHLY recorded catastrophe losses of $3.9 million due to Hurricanes Dennis, Katrina, Rita, and Wilma. As of 2008, PHLY had already reported losses from hail, tornado and wind incidents in Summer 2008 totaling in a reduction of net income by $13 million. The company also noted an increase in natural-damage claims not classified as catastrophes - highlighting the vulnerability of the company's exposure to risks from climate change. The Company began reducing its exposure to catastrophic weather losses from 2006 (resulting in a near halving of Personal Line business), but only expects to complete this process in June 2009.
PHLY targets markets that are both under-covered and niche oriented. Its 2007-2008 forays into outdoor recreation, antique and collector autos, sports and fitness, religious organizations and others all point to opportunities unearthed by management as underserved niches. 50% of its business represent 501c-3 or non-profit-type organizations, which are attractive risks to underwrite when in terms of frequency and severity aspects of claims in these lines of business. With no workers' comp underwriting, the tails associated with the package remain shorter than most, providing a higher degree of transparency around the company's reserve position. In 2008 alone it launched a comprehensive coverage product for apartments, designed for the above average, professionally managed and well maintained market rate apartment, and a Business Auto Fleet product, offering coverage for automobile liability and physical damage. The goal of management is to add two or three new products per year, while maintaining a disciplined approach to adding new products to ensure risk management.
In addition to under-served markets, PHLY targets niche areas or products with crowded distribution channels. Unlike other insurance companies, PHLY emphasizes distribution of product. Its 5-point distribution model focuses on 30,000 cold calls per month through 300 licensed representatives, 13,000 broker relationships, 194 Firemark Preferred Agents, and Internet and wholesale marketing. PHLY searches for layered distribution channels where the firm can wield its marketing prowess and win business from less flexible competitors. This specific strategy pursues "layered" markets where larger competitors write business using Managing General Agents (MGAs). Due to the small account sizes PHLY underwrites, many larger competitors lack the commitment or time to develop substantial expertise in such markets. Therefore larger competitors may subcontract the underwriting to an MGA. However, in doing so, the broker receives a smaller commission, since the MGA must also be compensated. PHLY, on the other hand, possesses the underwriting expertise and broker relationships within these smaller niche-type markets, avoiding the need for the MGA. This results in higher commissions for the broker, and potentially, a greater incentive to transact business with PHLY. Its "Firemark" preferred agent program is growing at 15% per year as of 2008.
Total investments grew from $2,542.3 million at of December 31, 2006 to $3,121.5 million at December 31, 2007. Investment income grew from $91.7 million in 2006 to $117.2 million in 2007.The growth in investment income was primarily due to increased investments which arose from investing net cash flows provided from operating activities, even during a period in which the general level of interest rates increased and in which PHLY increased the average duration of its fixed income portfolio. 89% of PHLY's assets are invested in fixed income, and 11% in securities. The company has stated that it will allocate larger amounts of capital toward municipal securities, with the corresponding implications for risk of its Investment Income, which in 2007 made up a fifth of Net Income.
The company is notable for its consistency in underwriting performance. Over 16 years, PHLY averaged a statutory combined ratio of 86.6%, ahead of the industry average of 105.0%. The company generated many of its returns over the years without the benefit of an actuarial staff. With the addition in 2002 of a full actuarial staff, underwriting results are expected to improve further. However investors need to consider the benefits of the hard market.  However, following past success, PHLY managers have committed to growing its revenue at a double-digit pace, despite a soft market. Investors are concerned that the company is under-pricing risk in order to reach this target and this pace of growth might eventually impact margins.
Directors and officers of PHLY collectively own close to 20% of the shares, and because managers risk their personal net worth, it is unlikely shareholders' capital will be destroyed via shabby underwriting. The compensation of management is also tied to EPS and combined ratio measures. PHLY's underwriting margin was close to 15% since 1994, which places it at the head of the underwriting class. However the firm's savvy risk selection and pricing are the result of seasoned managers executing daily. This powerful advantage can erode over time, and PHLY's competitive advantage can disappear with it.
Over time, policyholders tend to gravitate to the lowest-price policy. Philadelphia's agents, when faced with the prospect of lost business, will either press for lower prices or advise the policyholder to switch to a cheaper insurer. This constant pricing pressure coupled with minimal switching costs cast some doubt on Philadelphia's future success. However PHLY compensates for this by letting its best agents to share equally in its underwriting margins, luring productive agents to PHLY and offering a strong incentive for the agent to submit moneymaking risks. The price pressures have also meant that PHLY has benefited from the general industry consolidation. In March 2008 PHLY announced the acquisition of Gillingham and Associates, Inc., adding about 2.5% of its existing Gross Premiums Written to its 2008 figures, gain in access to 1,600 agency relationships over all 50 states, which will serve as more channels for its broad distribution system.
In its 10-K, management noted receipt of a "class action complaint" against its personal lines subsidiaries regarding policies written in Florida. The complaint reflects an amount in "excess of $5.0M" ($0.04 per share after-tax) and regards alleged unfair business practices regarding claims between 2003 and 2006. This caused a sell-off of 9.0% in shares. The company believes the charges to be unwarranted.
|Company||Rev. 2007 ($M)||Total Losses and Expenses ($M)||Combined Ratio||Total Investments||Net Investment Income ($M)|
|Philadelphia Consolidated Holding (PHLY)||$1,051||$810||78.1%||$1,935||$63.7|
|RLI Corp (RLI)||$652||$405||71.4%||$1,878||$7.32|
|American International Group (AIG)||$110,064||$101,121||90.3%||$697,268||$28,619|
|Tower Group, Inc. (TWGP)||$411||$346||80%||$655||$5.14|
Philadelphia is too small to rank in the top 25 rankings of the US Property/Casualty Insurance market, however its size can still be compared with competitors like AIG.
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