Heritage Insurance Holdings, Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; unaudited. Dollar amounts below are in millions unless stated otherwise. Heritage writes residential property insurance, principally in Florida and Hawaii, and also operates in several other southeastern states. The company reports one operating segment.
Financial results and position
| Metric | Q1 2017 | Q1 2016 |
|---|---|---|
| Gross premiums written | $142.2 | $147.3 |
| Net premiums earned | $92.2 | $106.3 |
| Total revenue | $99.3 | $111.6 |
| Operating income | $11.9 | $12.0 |
| Net income | $6.0 | $7.4 |
| Diluted EPS | $0.21 | $0.24 |
| Operating cash flow | $6.5 | $57.0 |
- Revenue fell about 11% and net income about 19% year over year. Lower net premiums earned were the main revenue drag.
- Gross premiums earned increased slightly to $154.6 million, but ceded premiums rose to $62.4 million from $45.6 million, reflecting the reinsurance program and business mix. Net premiums earned consequently declined.
- Losses and loss adjustment expenses fell to $46.6 million from $67.0 million. The 2017 period included $1.2 million of favorable prior-year reserve development; Q1 2016 had $14.5 million of unfavorable development and more severe weather activity.
- Policy acquisition costs increased to $23.4 million from $18.1 million; general and administrative expense rose to $17.3 million from $14.4 million. The company cited a full quarter of Zephyr operations, infrastructure costs and Zephyr intangible amortization.
- Combined ratios were 96.9% gross and 94.8% net, compared with 95.5% and 93.6%, respectively, in Q1 2016. The lower loss ratio was offset by higher ceded-premium and expense ratios.
- Net investment income was $2.5 million, up from $2.0 million; net realized investment gains were $0.8 million. Total comprehensive income was $8.0 million.
- At March 31, total assets were $955.4 million, investments $605.8 million, cash and cash equivalents $104.7 million, and restricted cash $18.4 million. Stockholders’ equity was $360.8 million.
- Debt included $79.5 million principal of senior secured notes, with $73.0 million reported net of issuance costs. The notes bear interest at 8.75% plus three-month average LIBOR; effective interest was approximately 9.8%. Quarterly principal payments begin in December 2018. The company reported covenant compliance.
- Book value per share was $12.67; return on average equity was 6.7%. Combined statutory surplus of the insurance subsidiaries was $267.2 million, and they reported a statutory net loss of $2.2 million for the quarter.
Changes versus the prior comparable period
- Zephyr, acquired in March 2016, contributed a full quarter of business in Q1 2017 versus only ten days in the prior-year quarter. Management reported a $12.5 million increase in Zephyr gross written premium, partly offset by a $17.5 million decrease at Heritage P&C.
- Heritage P&C reduced exposure, especially in areas associated with disproportionate attritional losses; voluntary new business did not fully offset policy attrition. Q1 2017 also had no Citizens assumed premium, unlike Q1 2016.
- Ceded premiums rose, and the ceded premium ratio increased to 40.3% from 30.0%. Management attributed this to the current treaty and mix, including commercial residential and wind-only business, and accelerated exposure management.
- Interest and debt-issuance-cost amortization reduced pretax income by about $2.2 million in Q1 2017; neither expense was reported in Q1 2016.
- Operating cash flow declined to $6.5 million from $57.0 million. Management cited higher reinsurance payments, claims payments (including Hurricane Matthew-related payments), and the absence of Citizens assumed-premium receipts recorded in the prior-year period.
- Investing cash use was only $1.2 million versus $113.2 million in Q1 2016, when the company paid $110.3 million net for the Zephyr acquisition.
Outlook, risks and unusual items
- Outlook: The filing gives no numerical earnings or revenue guidance. Management stated it believes current capital and operating cash flows should meet anticipated working-capital needs for at least the next 12 months, while noting this is not assured.
- Catastrophe and reinsurance exposure: The June 2016–May 2017 program provided first-event coverage, including retention, up to $1.9 billion in Florida and $1.1 billion in Hawaii; multiple-event availability depends on losses in earlier events. Losses beyond available coverage remain the company’s responsibility. Reinsurance collectability, cost and availability are identified risks.
- Reserves and claims: Net unpaid losses and LAE were $130.3 million, including $72.7 million of IBNR, or 55.8% of net reserves. Actual losses may exceed estimates. Management cited prior adverse development associated largely with Florida personal lines, litigation and attorney/public-adjuster-represented claims, including Assignment of Benefits.
- Other risks: Business concentration in Florida and Hawaii, hurricanes and other catastrophes, underwriting and modeling uncertainty, competition, renewal rates, investment-market risk and ability to manage claims. The filing reported no material change to the risk factors in the 2016 Form 10-K.
- Capital returns: The company repurchased 361,211 shares for $4.5 million in March and declared a $0.06-per-share quarterly dividend payable April 4, 2017. A further $0.06 dividend was declared after quarter-end, payable July 5, 2017. Future dividends are at the board’s discretion.
- Contingencies and controls: The company is involved in ordinary-course claims-related legal matters and said pending proceedings were not expected to have a material adverse effect. Management concluded disclosure controls were effective at March 31, 2017; no material change in internal control over financial reporting was reported.
Key facts for investors to verify
- How the higher reinsurance cost and exposure-management actions affect renewal retention, premium growth and future net premiums earned.
- Whether reserve estimates remain adequate, particularly for Florida litigation and Assignment of Benefits claims, and how subsequent development compares with the Q1 reserve release.
- Available catastrophe protection, exclusions, retentions, reinstatement terms and counterparty collectability under the applicable reinsurance program.
- Liquidity and claims-paying capacity given the sharp year-over-year decline in operating cash flow, seasonal reinsurance payments and catastrophe exposure.
- The secured-note interest burden, covenant terms and intended use of proceeds; the filing cited potential acquisitions, strategic investments and general corporate purposes.
- Regulatory capital and dividend restrictions, including the difference between GAAP net income and the insurance subsidiaries’ statutory net loss.