HCI Group, Inc. quarterly report, Q1 FY2013

HCI Group, Inc. (formerly Homeowners Choice, Inc.) — Q1 2013 Form 10-Q Summary

Business context and reporting period

Unaudited results cover the three months ended March 31, 2013, compared with the same period in 2012. The company is a Florida-based holding company whose principal business is homeowners property and casualty insurance in Florida, supplemented by reinsurance, real estate, and information technology operations. Management expected shareholder approval of a name change to HCI Group, Inc. in May 2013.

Property and casualty insurance represented 94.6% of total segment revenue in Q1 2013. Growth primarily reflected a November 2012 assumption of Citizens Property Insurance Corporation policies.

Key financial metrics

Metric	Q1 2013	Q1 2012	Change
Gross premiums earned	$82.5 million	$54.7 million	+50.9%
Net premiums earned	$60.6 million	$40.4 million	+49.8%
Total revenue	$61.8 million	$41.7 million	+48.5%
Income before taxes	$33.2 million	$11.4 million	+191.4%
Net income	$20.4 million	$7.0 million	+192.6%
Income available to common stockholders	$20.4 million	$6.8 million	+200.0%
Diluted EPS	$1.81	$0.88	+105.7%
Operating cash flow	$15.3 million	$17.5 million	-12.7%

Net income margin was approximately 33.0% of total revenue, compared with approximately 16.7% in Q1 2012.
The loss ratio on net premiums earned improved to 26.2% from 47.4%; the expense ratio improved to 21.1% from 27.5%; and the combined ratio improved to 47.3% from 74.9%.
Measured against gross premiums earned, the combined ratio was 34.7%, compared with 55.3%.
Cash and cash equivalents were $279.3 million at March 31, 2013, up from $230.2 million at December 31, 2012. Total assets were $407.6 million and stockholders’ equity was $139.7 million.
Available-for-sale investments totaled $45.1 million at fair value. The company reported no other-than-temporary investment impairments.
Losses and loss adjustment expense reserves were $41.8 million at March 31, 2013, versus $41.2 million at December 31, 2012. Approximately $22.5 million represented incurred-but-not-reported reserves.
The effective income tax rate was approximately 38.5%, compared with 38.8% in the prior-year quarter.

Debt, liquidity, and capital allocation

In January 2013, the company issued approximately $40.3 million of 8.00% senior unsecured notes due January 30, 2020. Net proceeds after issuance costs were approximately $38.7 million. The effective interest rate was approximately 8.7%.
Long-term debt was $40.3 million at March 31, 2013; interest expense was $686,000 in Q1 2013.
Financing activities provided $36.3 million, principally from the senior-notes offering, partially offset by $1.5 million of issuance costs and $2.5 million of dividends paid.
Operating activities provided $15.3 million, while investing activities used $2.4 million, including $2.4 million for property and equipment.
The company paid a $0.225 per-share common dividend during the quarter and declared another $0.225 per-share dividend payable June 21, 2013.
The holding company depends on distributions from subsidiaries to service its debt and pay dividends. Florida insurance regulations restrict distributions by the insurance subsidiary and may require regulatory approval for certain dividends.

Material changes versus the prior comparable period

Premium growth was driven primarily by approximately $29.4 million of Q1 2013 revenue from the November 2012 Citizens policy assumption, partly offset by policy attrition.
Net premiums written increased to $47.3 million from $22.6 million.
Losses and loss adjustment expenses declined to $15.9 million from $19.2 million, including approximately $1.1 million of favorable prior-period reserve development.
Policy acquisition and underwriting expenses declined to $6.0 million from $6.8 million, partly because Q1 2012 included a $1.2 million one-time charge related to a change in deferred acquisition cost accounting.
Other operating expenses increased to $6.1 million from $4.3 million, primarily due to higher compensation, professional fees, and administrative costs.
Net investment income declined to $139,000 from $522,000, primarily reflecting operating losses from acquired real estate activities.
Series A preferred shares outstanding declined to 210,555 from 241,182 as 30,627 shares converted into common stock. Common shares outstanding increased to 10.9 million.
The company purchased a $2.0 million property in Ocala, Florida, intended for insurance operations and as a catastrophe-contingency location.

Guidance, outlook, commentary, and risks

Management expected reinsurance costs for the June 1, 2013 through May 31, 2014 treaty year to increase because of the larger policy exposure, estimating costs at approximately 39% to 42% of gross written premiums.
Insurance results are seasonal, with hurricanes and tropical storms generally occurring from June through November. A major catastrophe could materially affect quarterly results.
Key uncertainties include catastrophe frequency and severity, reserve development, reinsurance pricing and collectability, reinsurer insolvency, premium-rate restrictions, regulatory changes, and increased rate pressure.
Management stated that it believed liquidity was sufficient for claims, operating expenses, and unforeseen events, but reserve estimates remain inherently uncertain and may change materially as claims develop.
The company had no off-balance-sheet arrangements. Contractual obligations totaled approximately $64.5 million, including $62.9 million of principal and interest on the senior notes.
An environmental remediation liability of $92,000 remained accrued. Additional costs are possible, although management did not expect a material adverse effect based on information available at March 31, 2013.
Management reported effective disclosure controls and no material changes in internal control over financial reporting.

Important facts for investors to verify

Verify the sustainability of the unusually low 47.3% net combined ratio, including the effect of favorable reserve development and policy-assumption growth.
Assess the effect of the expected 39%–42% reinsurance cost on post-reinsurance premiums and profitability beginning June 1, 2013.
Review catastrophe exposure, reinsurance attachment points, limits, reinstatement provisions, and reinsurer credit quality.
Evaluate the holding company’s ability to receive subsidiary dividends while meeting the 8.00% senior-note obligations and maintaining common dividends.
Monitor reserve adequacy, particularly the $22.5 million incurred-but-not-reported component and future claims development.
Confirm shareholder approval and completion of the planned name change to HCI Group, Inc.