Heritage Insurance Holdings, Inc. — Q3 2016 Form 10-Q
Business context and reporting period
Unaudited results cover the three and nine months ended September 30, 2016. Heritage writes personal and commercial residential insurance, primarily in Florida, and also operates in North Carolina, South Carolina and Hawaii. The March 2016 acquisition of Zephyr expanded the company into Hawaii; operations are reported as one segment. Unless otherwise indicated, financial amounts below are in millions of dollars.
Financial results and liquidity
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Total revenue | $109.3 | $89.2 | $336.2 | $293.5 |
| Net premiums earned | $101.6 | $82.4 | $316.8 | $278.7 |
| Net income | $10.9 | $16.8 | $36.7 | $72.3 |
| Diluted EPS | $0.37 | $0.55 | $1.23 | $2.39 |
| Combined ratio, gross basis | 93.4% | 83.8% | 91.4% | 73.2% |
| Combined ratio, net basis | 89.3% | 74.8% | 87.0% | 63.3% |
- Nine-month gross premiums written were $471.8 million, up from $418.6 million; net premiums earned rose 13.7%. Revenue increased 14.5%, while net income fell about 49%.
- Losses and loss adjustment expenses were $169.7 million for the nine months, versus $102.2 million a year earlier. The nine-month loss ratio on gross earned premiums rose to 35.3% from 26.8%; the gross expense ratio rose to 22.1% from 19.5%.
- At September 30, total assets were $1.054 billion, including $549.8 million of investments and $130.8 million of cash and cash equivalents. Restricted cash was $19.3 million. Stockholders’ equity was $377.2 million. The balance sheet does not show a conventional debt balance; it does include insurance and reinsurance liabilities.
- Operating cash flow was $99.6 million for the nine months, versus $117.5 million. Investing activities used $179.2 million, including $110.3 million for the Zephyr acquisition; financing activities used $25.8 million, including $20.6 million of share repurchases and $5.2 million of dividends. Cash and cash equivalents declined $105.4 million from year-end 2015.
- Combined statutory surplus of the insurance subsidiaries was $277.1 million at September 30, 2016. Their combined statutory net income for the nine months was $24 thousand, compared with $45.0 million for full-year 2015.
Material changes versus the prior comparable period
- Profitability weakened despite premium growth, reflecting higher loss costs and reinsurance expense. Management cited severe weather, unfavorable prior-year reserve development and increased litigation and attorney/public-adjuster-represented claims in Florida personal lines.
- Nine-month prior-year reserve development was unfavorable by $17.3 million, compared with favorable redundancy of $6.8 million in 2015. Management revised its estimated 2015 personal-lines ultimate loss ratio from 34.5% to 38.8%. Most unfavorable development was in Florida’s Miami-Dade, Broward and Palm Beach counties.
- The 2016–17 catastrophe reinsurance program provides approximately $3.0 billion of potential multi-event coverage, including retention, versus approximately $2.2 billion in the prior program. Management reported program cost of approximately $244 million versus $177 million. Higher ceded premiums weighed on results.
- Zephyr was acquired for approximately $110.3 million net of cash acquired. The preliminary purchase allocation includes $40.2 million of goodwill and $24.2 million of intangible assets and remains subject to revision.
- Heritage repurchased 1.425 million shares for $20.6 million through September 30 and declared dividends during the period. Approximately $49.4 million remained under the authorized repurchase plan at quarter-end.
Outlook, risks and unusual items
- Management said current capital resources and operating cash flow are expected to meet anticipated working-capital needs for at least the next 12 months, while noting it cannot provide assurance. It holds substantial cash during hurricane season and uses cash for reinsurance deposits.
- Hurricane Matthew affected Florida and North Carolina after quarter-end. As of the filing, the company had received approximately 2,500 claims and estimated fourth-quarter 2016 pretax catastrophe losses of about $30 million; it did not expect to incur its full $40 million retention.
- Q3 results included approximately $4 million of losses from Hurricane Hermine. Catastrophe frequency and severity, reinsurance cost and availability, collectability of reinsurance, claims inflation/litigation, reserve estimation and Citizens depopulation activity are key risks.
- The filing reports ordinary-course claims and legal actions; management did not expect currently pending proceedings to materially adversely affect consolidated financial position, results or cash flow. It reported no material change in risk factors and concluded disclosure controls were effective.
- No quantified earnings or revenue guidance is provided. Forward-looking statements are subject to risks and uncertainties, and the filing cautions that interim results are not indicative of full-year results.
Important facts for investors to verify
- Subsequent disclosures on Hurricane Matthew claim counts, ultimate losses and reinsurance recoveries.
- Further development of loss reserves, especially 2015 personal-lines claims, litigation and Florida tri-county experience.
- Actual reinsurance cost, coverage availability and recoverability under the 2016–17 program, including multiple-event protection.
- Final Zephyr purchase-price allocation, acquired intangible lives and resulting amortization expense.
- Statutory capital and earnings at the regulated subsidiaries, and the effect of dividends and continued share repurchases on available capital.