Heritage Insurance Holdings, Inc. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018; unaudited. Heritage writes residential property and casualty insurance across coastal states and Hawaii. Results include Narragansett Bay Insurance Company (NBIC), acquired November 30, 2017, so year-over-year comparisons reflect the acquisition as well as legacy business.
Financial performance
Amounts below are in millions of dollars, except per-share data and ratios.
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Gross premiums written | $263.7 | $159.3 | $468.0 | $301.5 |
| Net premiums earned | $111.2 | $90.5 | $217.3 | $182.6 |
| Total revenue | $118.0 | $96.9 | $230.0 | $196.2 |
| Operating income | $8.2 | $13.1 | $33.0 | $25.0 |
| Net income | $2.4 | $6.6 | $17.2 | $12.6 |
| Diluted EPS | $0.09 | $0.23 | $0.65 | $0.44 |
| Net combined ratio | 98.7% | 92.7% | 90.7% | 93.8% |
- Q2 revenue grew 17.8%, while net income fell year over year. Higher losses, legacy reserve strengthening, weather losses, and increased interest expense weighed on quarterly earnings.
- Six-month revenue increased 14.7% and net income increased year over year. Management attributed much of the premium and earnings growth to NBIC; NBIC contributed $33.9 million of the six-month increase in net premiums earned.
- Six-month losses and loss adjustment expenses were $119.1 million, versus $92.7 million. Policy acquisition costs fell to $31.6 million from $45.2 million, substantially reflecting NBIC quota-share ceding commissions. General and administrative expenses rose to $46.4 million from $33.4 million, including acquisition integration and infrastructure costs.
- Six-month net investment income was $5.9 million; net realized investment losses were $0.3 million. Other comprehensive income included a $5.1 million after-tax investment-related loss for the six months.
Financial position, cash flow, and debt
- At June 30, total assets were $1.991 billion, total liabilities $1.605 billion, and stockholders’ equity $386.1 million. Cash and cash equivalents were $218.3 million; restricted cash was $16.9 million; investments were $524.9 million.
- Six-month operating cash flow was $48.3 million, compared with $33.0 million in 2017. Investing activities provided $30.9 million, and financing activities used $18.6 million. Cash, cash equivalents, and restricted cash ended the period at $235.2 million.
- Long-term debt, net of discounts and issuance costs, was $177.3 million, compared with $184.4 million at year-end 2017. Principal debt was $197.1 million. Interest expense was $10.2 million for the six months, up from $4.4 million. The company repurchased $10.6 million principal of convertible notes for $13.4 million in April.
- Unpaid losses and LAE were $488.6 million, including $315.3 million recoverable from reinsurers; net unpaid reserves were $173.3 million. Reinsurance recoverable on paid and unpaid claims totaled $467.9 million on the balance sheet.
- Combined statutory surplus of the insurance subsidiaries was $342.5 million, down from $376.2 million at year-end. The subsidiaries reported a combined statutory net loss of $61.1 million for the six months. The filing says they met applicable financial and regulatory requirements at June 30.
Material changes and management commentary
- NBIC’s acquisition expanded geographic reach and materially increased written and earned premiums. Management cited reinsurance and operating synergies, but also higher integration and systems implementation costs.
- Q2 legacy-company losses included approximately $10 million of increase associated with reserve strengthening and non-catastrophe weather losses. For the six months, prior-year reserve development was unfavorable by $17.9 million, compared with favorable redundancy of $2.1 million in 2017.
- NBIC experienced seven Northeast winter storms in Q1, with gross losses of approximately $56 million and net losses of approximately $9 million.
- The 2018–2019 catastrophe reinsurance program, effective June 1, provides first-event coverage up to $1.6 billion for Heritage P&C, $801 million for Zephyr, and $1.0 billion for NBIC. Management estimated program cost at approximately $252 million. Coverage for later events depends on the severity and frequency of earlier events and remaining limits.
- Management stated it believed liquidity and capital resources, together with operating cash flow, would be sufficient for anticipated working capital needs for at least 12 months. It also cautioned that reinsurance recoveries depend on reinsurers’ ability to pay and that estimates of recoveries on unpaid losses may change.
- No earnings or revenue guidance was provided. The company identified catastrophe exposure, reserve uncertainty, reinsurance cost and collectability, pricing, competition, and regulatory changes among its risks. It reported no material change in previously disclosed risk factors and no pending legal proceeding expected to have a material adverse effect.
Other notable items
- The federal corporate tax rate reduction contributed to a lower six-month effective tax rate: 26.0%, versus 38.5% in 2017.
- The company reported a $0.5 million gain on repurchase of debt in Q2. Investment fair values declined, with accumulated other comprehensive loss reaching $8.3 million at June 30.
- The prior repurchase authorization expired June 30. On August 1, the board authorized a new program for up to $50 million of common-stock repurchases through December 31, 2020. The board also declared a $0.06-per-share dividend payable October 3, 2018.
- Management concluded disclosure controls and procedures were effective as of June 30, 2018; it reported no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- How much of premium and earnings growth is attributable to NBIC versus organic growth in legacy operations, and how integration costs develop.
- Whether the $17.9 million unfavorable prior-year reserve development signals further adverse claims emergence, particularly for litigated and weather-related claims.
- Reinsurer credit quality, collectability of the $467.9 million reinsurance recoverable, and the remaining protection and reinstatement terms after catastrophe losses.
- The effects of the estimated $252 million reinsurance cost, elevated ceded premiums, and statutory surplus decline on future earnings and insurer capital.
- Debt service and interest costs, including the secured notes’ variable rate and scheduled principal payments beginning December 2018.
- Quarterly earnings were materially lower despite revenue growth; monitor the net loss ratio and combined ratio, especially the legacy business results.