Over the past 6 months Assurant  (AIZ) has so far managed to get through the credit crisis unscathed. A few weeks ago a Barron’s article even suggested that Assurant will ultimately benefit from a continually weakening housing market. Although Assurant will continue to write more creditor placed homeowners policies, the company still has significant exposure to the credit crunch and a weakening economy.

First, let’s take a look at mortgage exposure.

In the latest 10-Q Assurant showed $1,470,477,000 in assets listed as mortgage loans on real estate. Although Assurant’s investment portfolio declined slightly from the previous quarter, the write downs associated with Assurant’s mortgage loans and mortgage-backed securities were only $37,875,000. This write down seems small considering what has happened to the mortgage market in this time frame. Assurant is essentially saying that the value of the mortgages and mortgage-backed securities portfolio declined by about 2.5% for the 3 months ended March 31, 2008. We expect a much larger write down in the next 10-Q.

The latest 10-K breaks out sub-prime exposure for the mortgage-backed security portfolio at about 8%. However, Assurant does not breakdown the rest of the mortgage-backed securities portfolio. Although the precise makeup of the rest of the mortgage-backed securities portfolio is unclear, Assurant mentions in the 10-K that the sub-prime crisis has created volatility in other high risk products such as alternative documentation loans (high credit scores, lack of income documentation). This implies that the rest of mortgage-backed portfolio has exposure to alternative documentation loans, but the extent of this exposure is not quantified in the 10-K.

Interestingly, Assurant goes out of its way to break down the level of assets (1,2, or 3) in its fixed maturity portfolio, but they fail to provide this analysis for the mortgage portfolio. Presumably, the majority of the mortgage portfolio consists of level 3 assets (illiquid assets that require qualitative judgments by management to obtain fair value prices).

The Assurant Solutions group provides credit insurance both internationally and domestically. This group also provides extended warranty policies. The credit insurance division faces obvious problems as the economy weakens, but the extended warranty business could also face tough comparables considering that extended warranties are about as discretionary as it gets in the insurance business. We expect consumers to cut back on extended warranties as the economy weakens and gas prices continue to climb.

Perhaps the biggest problem that Assurant faces lies with the Assurant Health division. It is no secret that stocks for most publically traded health insurance companies have traded down sharply over the last 6 months. Industry wide issues including increasing costs, shrinking margins, and increased competition have taken heavy tolls on most health insurance stocks including United Health (UNH), Cigna (CI), Coventry Health Care (CVH), and WellPoint (WLP). This group of stocks is down an average of just over 45% since the beginning of March.

Yesterday United Health issued a revenue and profit warning following a warning from Coventry Health Care a few weeks ago. Both companies cited increased competition, escalating inpatient costs, and high outpatient utilization as reasons for lowering profit forecasts. Assurant Health has exposure to the same market forces that have already led to big declines in the pure play health insurance stocks.

An increase in unemployment related to the current economic downturn could have a significant negative effect on Assurant. As unemployment rises, Assurant gets hit with the double whammy of increased credit insurance loss ratios and fewer employees requiring health insurance coverage.

Overall, Assurant is not immune to the problems facing the health insurance industry, the company has exposure to illiquid mortgage-backed securities, and competition for creditor placed homeowners insurance is likely to increase as troubled insurance giants try to replace lost revenue. Although the concept of finding a stock that benefits from the credit crisis is intriguing, Assurant is not that stock. The Barron’s analysis is short sighted and does not reflect Assurant’s total exposure to a weakening economy. We think that Assurant’s stock has been inflated by the inaccurate Barron’s article and Assurant represents a compelling short sell opportunity at current prices.

Suggested Trades:

• Short Sell Assurant (AIZ) over $67 (currently $68.30)

• Buy to Cover Assurant at $50

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