HCI Group, Inc. 2017 Form 10-K Summary
Business context and reporting period
HCI Group, Inc. is a Florida-based holding company whose principal business is property and casualty insurance through HCPCI and TypTap. Its other operations include reinsurance, real estate, marina and restaurant activities, and information technology. The filing covers the fiscal year ended December 31, 2017, with comparisons to 2016 and 2015. Insurance operations generated 96.2% of segment revenue in 2017.
HCPCI primarily writes residential property insurance in Florida, while TypTap primarily offers standalone residential flood insurance through an online platform. HCI continued to rely substantially on policies assumed from Citizens Property Insurance Corporation and subsequent renewals. Policy opportunities from Citizens have diminished, although HCPCI received approval in 2017 to write property and casualty insurance in eight additional states; it had not begun operations in those states by year-end.
Financial performance and condition
| Metric | 2017 | 2016 | Change |
|---|---|---|---|
| Gross premiums earned | $358.3 million | $378.7 million | Down 5.4% |
| Net premiums earned | $224.6 million | $243.6 million | Down 7.8% |
| Total revenue | $244.4 million | $264.4 million | Down 7.6% |
| Losses and loss adjustment expenses | $165.6 million | $124.7 million | Up 32.8% |
| Income before taxes | $(15.6) million | $46.9 million | Declined $62.5 million |
| Net income | $(6.9) million | $29.0 million | Declined $35.9 million |
| Diluted earnings per share | $(0.75) | $2.92 | Turned to a loss |
| Net cash from operating activities | $16.4 million | $88.0 million | Down 81.3% |
| Cash and cash equivalents | $255.9 million | $280.5 million | Down 8.8% |
| Total investments | $380.3 million | $298.7 million | Up 27.3% |
| Total assets | $842.3 million | $670.1 million | Up 25.7% |
| Long-term debt | $237.8 million | $138.9 million | Up 71.3% |
| Stockholders' equity | $194.0 million | $243.7 million | Down 20.4% |
The 2017 loss reflected a 73.8% loss ratio and a 115.8% combined ratio on net premiums earned, compared with 51.2% and 89.3%, respectively, in 2016. Measured against gross premiums earned, the combined ratio was 72.6% in 2017 versus 57.5% in 2016. Net investment income increased to $11.4 million from $9.1 million, and net realized investment gains increased to $4.3 million from $2.6 million.
At December 31, 2017, HCI had $198.6 million of gross unpaid losses and loss adjustment expenses, including $97.8 million net of reinsurance and $100.8 million of reinsurance recoverables. Long-term debt included $89.99 million of 3.875% convertible senior notes due in 2019, $143.75 million of 4.25% convertible senior notes issued in March 2017, and approximately $26.3 million of promissory notes. Contractual principal and interest obligations totaled $300.1 million.
HCI paid $12.8 million of cash dividends during 2017 and declared dividends of $1.40 per share, up from $1.20 in 2016. The board authorized a new share repurchase plan of up to $20 million through December 31, 2018. HCI repurchased approximately $45.9 million of common stock during 2017, including purchases associated with convertible-note transactions and its existing repurchase plan.
Material changes versus the prior comparable period
- Hurricane Irma generated approximately $54.0 million of net losses, and Hurricane Matthew added approximately $2.5 million. Gross Irma losses were approximately $267.0 million, substantially offset by reinsurance.
- HCI recorded approximately $16.2 million of additional reserve strengthening related to assignment-of-benefits trends and related litigation. Prior-year unfavorable development totaled approximately $18.7 million, primarily from 2015 and 2016 loss years.
- Policies in force declined to approximately 139,000 from 150,000, reflecting policy attrition and rate decreases effective for new and renewal policies beginning in January 2016.
- Premiums ceded represented 37.3% of gross premiums earned in 2017 versus 35.7% in 2016. Hurricane Irma caused retrospective reinsurance adjustments that increased ceded premiums by approximately $5.7 million on a net basis.
- HCI issued $143.75 million of 4.25% convertible senior notes, redeemed its $40.25 million of 8% senior notes, and incurred a $0.7 million loss on the early extinguishment.
- Operating cash flow fell sharply because of the loss year and a $103.1 million increase in reinsurance recoverables. Investing cash outflows were $80.2 million, while financing activities provided $39.0 million.
- Insurance statutory capital and surplus remained above regulatory minimums. HCPCI had approximately $153 million of statutory surplus and TypTap approximately $24 million at year-end.
Guidance, outlook, management commentary, risks and unusual items
The filing does not provide quantitative earnings or premium guidance. Management expects liquidity needs to be funded primarily through insurance operations, investment income, and existing investments, while continuing to evaluate real estate, geographic expansion, new products, acquisitions, and technology investments.
Management considers current capital and anticipated retained income sufficient under its operating plan, but notes that catastrophe losses, reserve deficiencies, reinsurance availability, regulatory restrictions, growth, acquisitions, and market disruptions could change capital requirements. The filing states that HCI maintains reinsurance at levels management considers adequate, but reinsurance may be unavailable or uneconomic and reinsurers may fail to pay.
- Florida concentration exposes HCI to hurricanes, tropical storms, wind events, regulatory changes, litigation, and other state-specific conditions.
- Loss reserves are inherently uncertain. A 10% increase in claim severity would reduce equity, net of tax, by approximately 6.29%; a 20% increase would reduce equity by approximately 12.58%, based on the filing's sensitivity analysis.
- Assignment-of-benefits litigation, changing judicial standards, inflation, repair costs, and coverage interpretations could increase claim severity and reserve requirements.
- Insurance rates and policy forms are heavily regulated, limiting HCI's ability to offset inflation or loss-cost increases through pricing.
- The 2017 Tax Cuts and Jobs Act produced a provisional $1.4 million tax benefit. Management expected the final accounting to be completed when the 2017 tax return was filed, and adjustments could be material.
- HCI had $14.3 million of unfunded limited-partnership commitments, $25.4 million of minimum future reinsurance premiums, and $300.1 million of long-term debt principal and interest obligations.
- The company disclosed a related-party reinsurance relationship with Oxbridge Reinsurance Limited, involving the chief executive officer and certain directors.
- The independent auditor issued unqualified opinions on the consolidated financial statements and internal control over financial reporting. Management and the auditor concluded that internal controls were effective as of December 31, 2017.
Most important facts for investors to verify
- Whether reserve strengthening and assignment-of-benefits litigation costs continue after 2017, particularly for the 2015 through 2017 loss years.
- The ultimate collectability and timing of the $100.8 million of reinsurance recoverables, including concentration with two reinsurers.
- The adequacy, cost, and catastrophe protection limits of the 2018 reinsurance program after Hurricane Irma.
- The refinancing or repayment plan for the approximately $91.1 million of debt obligations due in 2019 and the terms governing the convertible notes.
- Whether policy attrition stabilizes and whether geographic expansion, TypTap flood insurance, and voluntary business can replace declining Citizens-related opportunities.
- The effect of the 21% federal corporate tax rate and final Tax Cuts and Jobs Act accounting on future earnings and deferred taxes.
- The regulatory capital, dividend capacity, and restrictions governing transfers from HCPCI and TypTap to the holding company.
- The sustainability of dividends and share repurchases given the 2017 net loss, reduced equity, increased debt, and lower operating cash flow.