Business Context and Reporting Period
Homeowners Choice, Inc. and subsidiaries filed an unaudited Form 10-Q for the quarter and six months ended June 30, 2012. The Florida-based property and casualty insurer provides homeowners, condominium-owners, and tenants insurance in Florida, with substantial exposure to hurricanes and other catastrophes. The filing was signed August 14, 2012.
Growth primarily reflects the November 2011 acquisition of HomeWise policies. The company also acquired John’s Pass Marina and related assets in April 2012 to diversify its property portfolio.
Financial Performance and Position
| Metric | Three Months Ended June 30, 2012 | Three Months Ended June 30, 2011 | Six Months Ended June 30, 2012 | Six Months Ended June 30, 2011 |
|---|---|---|---|---|
| Gross premiums earned | $53.8 million | $31.2 million | $108.5 million | $62.1 million |
| Net premiums earned | $36.3 million | $17.0 million | $76.6 million | $33.7 million |
| Total revenue | $38.9 million | $19.5 million | $80.5 million | $37.5 million |
| Net income | $7.3 million | $2.3 million | $14.2 million | $3.1 million |
| Income available to common stockholders | $7.2 million | $1.9 million | $14.0 million | $2.7 million |
| Diluted earnings per share | $0.74 | $0.30 | $1.60 | $0.43 |
| Combined ratio on net premiums earned | 74.0% | 91.9% | 74.5% | 96.3% |
| Combined ratio on gross premiums earned | 49.9% | 50.2% | 52.7% | 52.3% |
- Six-month operating cash flow was $24.0 million, compared with $22.9 million in the prior-year period.
- Cash and cash equivalents were $131.1 million at June 30, 2012, versus $100.4 million at December 31, 2011.
- Total assets were $280.8 million and stockholders’ equity was $98.0 million at June 30, 2012.
- Losses and loss adjustment expense reserves were $37.3 million at June 30, 2012, up from $27.4 million at year-end 2011.
- The balance sheet does not present a debt balance; cash paid for interest was zero for both six-month periods.
- Available-for-sale securities totaled $48.8 million at fair value, including $40.1 million of fixed-maturity securities and $8.7 million of equity securities.
Material Changes Versus the Prior Comparable Period
- Six-month gross premiums earned increased 74.6%, and net premiums earned increased 127.3%, primarily because of the HomeWise policy acquisition.
- Six-month net income increased from $3.1 million to $14.2 million. Diluted EPS increased from $0.43 to $1.60, although the share count also increased materially.
- The six-month loss ratio on net premiums earned improved to 46.1% from 62.1%, while the expense ratio improved to 28.4% from 34.2%.
- Premiums ceded increased to $31.8 million from $28.4 million, but ceded premiums declined as a percentage of gross premiums earned because the new HomeWise exposure had minimal reinsurance costs during the first part of 2012.
- Other operating expenses increased to $9.3 million from $4.5 million, reflecting higher compensation, administrative costs, professional fees, and expansion of the workforce.
- The company adopted ASU 2010-26 prospectively on January 1, 2012. The adoption produced a $1.2 million additional amortization adjustment and reduced six-month net income by approximately $741,000, or $0.09 diluted EPS.
- In April 2012, the company issued 1.84 million common shares, generating approximately $20.1 million of net proceeds. During the six months, 655,376 Series A preferred shares converted into common shares.
Cash Flow, Liquidity, Outlook, and Risks
- Operating cash flow of $24.0 million was partially offset by $12.0 million of investing outflows, including the $8.2 million marina acquisition, securities purchases, and capital expenditures. Financing activities provided $18.7 million, primarily from the common stock offering and warrant exercises, less $3.2 million of dividends paid.
- For the June 1, 2012 through May 31, 2013 treaty year, the company obtained approximately $531 million of non-affiliate catastrophe reinsurance coverage per event and expects annual reinsurance premiums of approximately $96.0 million, compared with $55 million for the prior treaty year. Management expects reinsurance costs to represent approximately 43% to 45% of gross earned premiums.
- The insurance business is seasonal, with hurricanes and tropical storms concentrated from June 1 through November 30. Management stated that liquidity is sufficient for claims, operating expenses, and unforeseen events, but actual results may be affected by catastrophes, reinsurer insolvency, reserve deficiencies, premium-rate restrictions, regulation, and changes in reinsurance pricing or availability.
- June 2012 losses included approximately $2.0 million related to 274 Tropical Storm Debby claims. Prior accident-year reserves experienced favorable development of approximately $11.4 million during the six months.
- The company acquired the marina and restaurant property for approximately $8.2 million and recognized a preliminary $179,000 bargain-purchase gain, subject to possible purchase-price-allocation adjustments.
- An environmental remediation liability of $118,000 remained accrued at June 30, 2012. Additional testing or remediation could materially exceed the current estimate, although management did not expect a material adverse effect on liquidity or financial condition based on information then available.
- A related-party reinsurance transaction with Moksha Re SPC Ltd. involved $13.8 million of assumed exposure and approximately $4.0 million of premiums. Company executives and their family members contributed $1.8425 million to the collateralized capital-partner structure.
- The board declared a $0.20 per common share dividend payable September 21, 2012. Florida insurance regulations restrict dividends from the insurance subsidiary to the parent and may require regulatory approval.
Important Facts for Investors to Verify
- Whether the improved loss and combined ratios remain sustainable after the higher-cost 2012–2013 reinsurance program is fully reflected.
- The adequacy of the $37.3 million loss and LAE reserve, including the $17.3 million estimated for incurred-but-not-reported claims.
- The financial strength, collateralization, and collectability of the company’s reinsurers, including the related-party Moksha arrangement.
- The effect of catastrophe activity during the 2012 hurricane season and the company’s net retention after reinsurance.
- The extent to which earnings benefited from nonrecurring items, including approximately $0.9 million of other income and the $179,000 bargain-purchase gain.
- The impact of common share issuance, preferred-stock conversions, warrants, and restricted stock on future dilution and per-share results.
- The ultimate cost and regulatory status of the marina environmental remediation obligation.