HCI Group, Inc. quarterly report, Q2 FY2020

HCI Group, Inc. — 2020 Q2 Form 10-Q Summary

Reporting period: Three and six months ended June 30, 2020; filed August 7, 2020. Dollar amounts are in thousands unless otherwise stated. HCI is primarily a Florida-focused property and casualty insurer operating through HCPCI and TypTap, with additional real estate, information technology, marina and restaurant operations.

Business Context and Key Developments

Insurance operations generated approximately 96% of segment revenue in the second quarter and represented 85.9% of combined segment assets at June 30, 2020.
HCPCI issued approximately 40,000 short-term replacement policies to former Anchor policyholders effective April 1, 2020. Anchor-related gross premiums earned were approximately $14,220 in the second quarter.
Policies in force increased to approximately 164,000 at June 30, 2020 from approximately 124,000 a year earlier. TypTap policies in force reached 31,715.
The company transitioned employees to remote work during COVID-19 and reported no plan to reduce its workforce as of the filing date.

Financial Performance

Metric	Three months ended June 30, 2020	Three months ended June 30, 2019	Six months ended June 30, 2020	Six months ended June 30, 2019
Total revenue	$80,717	$58,630	$136,097	$119,264
Net premiums earned	$73,449	$51,998	$135,095	$103,182
Income before taxes	$11,823	$10,315	$12,480	$19,598
Net income	$8,936	$7,553	$9,483	$14,291
Diluted EPS	$1.08	$0.90	$1.23	$1.72
Effective tax rate	24.4%	26.8%	24.0%	27.1%

Second-quarter net income increased 18.3% year over year, while six-month net income declined 33.6%. Approximate net income margins were 11.1% in the second quarter of 2020 versus 12.9% in the prior-year quarter, and 7.0% for the first six months versus 12.0% in the prior-year period.

Underwriting and Investment Metrics

Second-quarter loss ratio on net premiums earned was 54.25%, versus 46.72% in the prior-year quarter. The expense ratio improved to 39.55% from 46.20%, producing a 93.80% combined ratio versus 92.92%.
Six-month loss ratio was 50.28%, versus 49.71%; the expense ratio improved to 41.23% from 46.88%, and the combined ratio improved to 91.51% from 96.59%.
Combined ratio measured against gross premiums earned was 63.91% for the quarter and 61.75% for the six months, compared with 57.99% and 60.07%, respectively, in the comparable periods.
Gross premiums earned increased 29.4% in the quarter and 20.6% year to date, driven by Anchor replacement policies and TypTap growth. Net premiums written increased 34.7% in the quarter and 32.5% year to date.
Second-quarter investment results benefited from $1,435 of net realized gains and $2,884 of net unrealized gains. For the six months, net investment income fell to $1,412 from $7,504, and net unrealized investment results were a $1,921 loss versus a $6,619 gain.
Limited partnership investments produced a $2,747 loss for the six months, compared with $832 of income in the prior-year period.

Cash Flow, Liquidity and Capital

Cash and cash equivalents were $422,464 at June 30, 2020, compared with $229,218 at December 31, 2019. Cash, cash equivalents and restricted cash totaled $423,164.
Six-month operating cash flow was $109,988, compared with $28,834 in 2019. Management stated that the 2020 amount was unusually high because it included approximately $28,745 of net cash receipts from Anchor.
Investing activities provided $85,995, primarily from securities sales, maturities and redemptions. Financing activities used $2,686.
Outstanding borrowings included $23,750 under the revolving credit facility and $161,839 of long-term debt. The company borrowed an additional $14,000 under the revolving facility and was in compliance with its covenants at June 30.
Long-term debt principal totaled $169,649, including $139,200 of 4.25% convertible senior notes. The company repurchased $4,550 principal amount of those notes in June and recognized a $150 loss.
The company paid approximately $6,315 of cash dividends during the six months and insurance subsidiaries paid $15,500 in dividends to HCI, subject to applicable regulatory restrictions.
Unfunded limited partnership commitments totaled $13,660. Total contractual obligations and commitments were presented at $229,791, including debt, revolving borrowings, leases, service agreements and unfunded commitments.

Material Changes Versus the Prior Comparable Period

Premium growth materially increased revenue, but higher loss costs, policy acquisition expenses and personnel expenses offset much of the benefit.
Second-quarter underwriting profitability weakened modestly on a net-premium basis because the loss ratio increased, although the expense ratio improved.
Year-to-date earnings declined primarily because of weaker investment results and higher losses and underwriting expenses.
Loss and loss adjustment expense reserves were $211,162 at June 30, 2020, down from $214,697 at year-end 2019. The company established approximately $50,483 of 2020 loss-year reserves, partly offset by reductions in prior-year and catastrophe reserves.
The company adopted the credit-loss standard effective January 1, 2020, recording a $453 cumulative adjustment to beginning retained income. At June 30, allowances included $526 for available-for-sale securities and $104 related to reinsurance recoverables.
The company repurchased 128,685 common shares for $5,141 during the first six months, compared with 192,576 shares for $8,006 in the prior-year period.

Outlook, Risks and Unusual Items

Management stated that COVID-19 had not produced a direct material increase in insurance claims or losses as of the filing, but had adversely affected investments and could impair premium collections, policy renewals, rental receipts and reinsurance recoveries.
Management identified increased reinsurance costs, reinsurer liquidity and credit risk, financial-market volatility, catastrophe losses, reserve uncertainty, regulatory restrictions and premium-rate pressure as significant risks.
The insurance business is seasonal, with hurricane and tropical storm exposure concentrated from June 1 through November 30. Reinsurance pricing and coverage also reset generally on June 1.
As of June 30, $166,238 of the $211,162 loss reserve represented estimated incurred-but-not-reported losses, making reserve adequacy particularly judgmental.
On July 24, 2020, the Florida Department of Transportation acquired the company’s Tampa headquarters through eminent domain for $47,500. HCI recognized an approximately $37,000 net gain from involuntary conversion and has until July 24, 2023 to vacate.
On July 29, 2020, HCI repaid the $7,062 principal balance of its 4% promissory note secured by the acquired headquarters.
The board declared a $0.40 per share quarterly dividend on July 2, 2020, payable September 18, 2020.
The company is pursuing litigation against Kroger relating to a guaranty of a commercial lease involving bankrupt Lucky’s Market. Management did not expect currently pending proceedings to have a material adverse effect.

Investor Verification Checklist

Verify the sustainability of premium growth from the Anchor policy transition and TypTap, including renewal rates and policy profitability.
Monitor loss-ratio trends, catastrophe activity, litigation-related development and the adequacy of IBNR reserves.
Assess the effect of COVID-19 on investment valuations, limited partnership results, premium collections, rents and reinsurance recoverables.
Review the terms, available capacity and cost of the June 1, 2020 catastrophe reinsurance program.
Reconcile operating cash flow excluding the unusual Anchor cash receipt and evaluate recurring liquidity generation.
Review debt maturities, particularly the assumed early-call treatment of the convertible notes and the large 2021 contractual payment exposure.
Confirm the accounting, cash proceeds, tax effects and future operating implications of the headquarters eminent-domain transaction.
Consider regulatory limits on dividends from the insurance subsidiaries and their effect on future holding-company dividends.