HCI Group, Inc. (then Homeowners Choice, Inc.) — Q3 2012 Form 10-Q
Business context and reporting period
Unaudited quarterly filing for the three and nine months ended September 30, 2012, filed November 13, 2012. The company is a Florida property and casualty insurance holding company focused primarily on homeowners, condominium-owners, and tenants insurance in Florida. It manages catastrophe exposure through excess-of-loss reinsurance.
Key financial metrics
| Metric | Q3 2012 | Q3 2011 | 9M 2012 | 9M 2011 |
|---|---|---|---|---|
| Gross premiums earned | $53.1 million | $31.7 million | $161.6 million | $93.9 million |
| Net premiums earned | $30.6 million | $18.5 million | $108.1 million | $52.2 million |
| Total revenue | $31.5 million | $19.7 million | $112.0 million | $57.2 million |
| Net income | $2.8 million | $2.1 million | $17.1 million | $5.2 million |
| Income available to common stockholders | $2.8 million | $1.9 million | $16.8 million | $4.6 million |
| Diluted EPS | $0.27 | $0.27 | $1.79 | $0.70 |
| Operating cash flow | Not separately presented | Not separately presented | $37.3 million | $18.5 million |
| Combined ratio on net premiums | 86.1% | 88.5% | 77.2% | 93.5% |
| Combined ratio on gross premiums | 49.6% | 51.7% | 51.7% | 52.1% |
At September 30, 2012, total assets were $282.3 million, cash and cash equivalents were $141.9 million, investments totaled $73.9 million, total liabilities were $181.2 million, and stockholders’ equity was $101.1 million. Available-for-sale securities had a fair value of $50.9 million. The filing does not present borrowings or interest-bearing debt as a material balance-sheet item; cash paid for interest was zero in both comparable periods.
Material changes versus the prior comparable period
- Nine-month gross premiums earned increased 72% and net premiums earned increased 107%, primarily reflecting the November 2011 HomeWise policy assumption transaction and renewals.
- Nine-month net income increased from $5.2 million to $17.1 million. The improvement benefited from higher premium volume, favorable prior-year reserve development, and lower reinsurance costs as a percentage of gross premiums.
- Nine-month loss ratio improved to 46.6% from 60.0%; the expense ratio improved to 30.6% from 33.5%.
- Q3 losses included approximately $3.2 million of case-reported claims from Tropical Storms Debby and Isaac. Despite these claims, the quarterly combined ratio improved to 86.1% from 88.5%.
- Loss and loss adjustment expense reserves increased to $38.7 million from $27.4 million at December 31, 2011. The increase reflected expanded policy exposure, partly offset by favorable development on prior accident years.
- The company adopted ASU 2010-26 prospectively on January 1, 2012. The adoption resulted in approximately $1.2 million of additional amortization and reduced nine-month net income by approximately $741,000, or $0.09 diluted EPS.
- The company raised approximately $20.1 million of net proceeds through an April 2012 common stock offering and received approximately $2.5 million from warrant exercises. Holders converted 916,175 Series A preferred shares into common shares during the nine months.
- Cash increased by $41.6 million during the nine months, ending at $141.9 million. Operating cash flow of $37.3 million and financing inflows exceeded $13.7 million of investing outflows.
Guidance, outlook, risks, contingencies, and unusual items
- No formal earnings or premium guidance is provided.
- On November 6, 2012, after the reporting date, the company assumed approximately 60,000 Citizens policies representing approximately $150 million of additional annualized premiums.
- The company acquired John’s Pass Marina and related real estate operations on April 2, 2012 for approximately $8.2 million and recorded a $179,000 pretax bargain-purchase gain. Marina and real estate activities contributed to lower investment income and introduce diversification outside insurance.
- Florida catastrophe risk remains significant. Hurricanes and tropical storms are concentrated in the June 1 through November 30 season, and actual claims may exceed reserves or reinsurance protection.
- The company remains liable for claims if reinsurers cannot perform. Reinsurance pricing, availability, collectability, and regulatory restrictions on premium rates are key risks.
- Reserve estimates, including $17.7 million of incurred-but-not-reported reserves at September 30, 2012, are judgmental and could change materially.
- An environmental remediation liability of $97,000 remained accrued for a previously acquired marina site. Additional monitoring or remediation could increase costs, although management did not expect a material liquidity or financial-condition impact based on information then available.
- A related-party reinsurance arrangement involved capital contributions from the chief executive officer, the vice president of investor relations, and members of the chief executive officer’s immediate family. The arrangement was collateralized by $9.8 million in trust assets.
- Florida insurance regulations restrict dividends from the insurance subsidiary to the parent and may affect future dividend capacity. The board declared common dividends of $0.225 per share plus a $0.10 special dividend for payment in December 2012.
Important facts for investors to verify
- Whether the November 2012 Citizens policy assumption achieves the stated approximately $150 million annualized premium contribution without materially increasing catastrophe or reserve risk.
- The adequacy of the $38.7 million loss and LAE reserve, including assumptions for incurred-but-not-reported claims and favorable prior-year development.
- Reinsurance treaty limits, retentions, reinstatement premiums, counterparty strength, and collateral arrangements for the 2012–2013 treaty year.
- The effect of the ASU 2010-26 accounting change on future acquisition expense recognition and comparability of reported margins.
- The sustainability of underwriting profitability after adjusting for favorable reserve development, the bargain-purchase gain, and other nonrecurring items.
- The financial performance and potential liabilities associated with the marina and other real estate investments.
- The impact of common-share issuance, preferred-share conversions, outstanding warrants, and future dilution on per-share results.