Heritage Insurance Holdings, Inc. — Q3 2014 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2014; financial statements are unaudited. Amounts below are in U.S. dollars. The company writes personal and commercial residential property insurance in Florida, primarily through its insurance subsidiary, Heritage P&C.
Business context and developments
- At quarter-end, Heritage had approximately 171,700 policies in force: about 68% assumed from Citizens, 19% from Sunshine State Insurance Company (SSIC), and 13% voluntary business.
- The June SSIC transaction brought approximately 33,000 policies and $58.9 million of annualized premium. Approximately 31,700 policies, representing about $57 million of annualized premium, remained in force at September 30. Heritage paid $10 million for the transaction and amortizes the cost as policies earn.
- The May IPO and concurrent private placement generated approximately $78.6 million in net proceeds; warrant exercises generated a further $22.5 million. Outstanding common shares increased to 29.8 million from 14.0 million at December 31, 2013.
- After quarter-end, Heritage assumed Citizens commercial residential policies representing more than $80 million of gross written premium, subject to policyholder opt-outs. The filing also reports that voluntary commercial policy writing began in October.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Gross premiums written | $86.8m | $37.2m | $254.9m | $134.6m |
| Net premiums earned | $55.5m | $21.8m | $142.1m | $63.4m |
| Total revenue | $58.0m | $22.8m | $148.4m | $91.7m |
| Losses and loss adjustment expenses | $22.3m | $10.0m | $62.1m | $23.1m |
| Net income | $10.0m | $5.3m | $27.4m | $33.4m |
| Diluted EPS | $0.33 | $0.35 | $1.12 | $2.43 |
| Gross combined ratio | 82.9% | 83.9% | 82.1% | 72.6% |
| Net combined ratio | 75.5% | 69.3% | 74.2% | 61.2% |
Q3 net income rose with substantial premium growth, while diluted EPS was lower year over year as the share count increased following the IPO and warrant exercises. Nine-month net income and EPS declined from 2013, which included $26.1 million of non-recurring retroactive reinsurance income. The nine-month 2014 combined ratios worsened, reflecting higher loss and expense ratios; management cited policy growth, loss development and acquisition costs, including SSIC transaction-cost amortization.
- Investment income: Net investment income was $1.1 million in Q3 and $2.5 million for nine months, versus $0.3 million and $0.6 million, respectively, in 2013, as invested assets grew.
- Cash flow: Nine-month operating cash flow was $53.3 million, down from $82.8 million. Investing activities used $118.0 million; financing activities provided $101.3 million, largely from equity issuance and warrant exercises.
- Liquidity and capital: September 30 cash and cash equivalents were $101.6 million, restricted cash $4.3 million, and investments $251.1 million. Total assets were $522.8 million, liabilities $291.3 million, and stockholders’ equity $231.5 million. The filing shows no material outstanding debt; interest expense was nil for the nine months.
- Insurance subsidiary capital: Heritage P&C reported statutory surplus of $124.7 million at September 30, versus $63.1 million at year-end 2013. Statutory net income for the first nine months was $3.4 million, versus $22.3 million in 2013.
Changes, outlook, and risks
- Premium growth reflected Citizens policy renewals and assumptions, SSIC policies, and voluntary sales. Gross premiums written increased about 89% in Q3 and 90% for the nine-month period year over year.
- Ceded premiums rose with the larger book, but management attributed improved reinsurance economics to favorable market conditions, broader geographic spread and catastrophe-bond capacity. The 2014–2015 reinsurance program provides up to $990 million of coverage for a first catastrophe, including retention, and includes $200 million of Citrus Re catastrophe-bond coverage. Actual protection for subsequent events depends on amounts used in earlier events.
- At September 30, unpaid losses and loss adjustment expenses were $42.0 million, including $23.8 million of IBNR reserves, approximately 57% of the total. Management said reserves reflect its estimates; actual claims may differ. Prior-year reserve development was a small redundancy.
- Management expects to hold substantial cash during hurricane season and stated that it believes liquidity and reinsurance are adequate. It expected approximately $29 million of SSIC unearned premium to be received from FIGA and the Florida Department of Financial Services during Q4 2014; operating cash flow was affected by the timing of this receipt and related transaction payments.
- There is no numerical earnings or premium guidance in the supplied filing text. Management describes voluntary personal and commercial business as growth opportunities. Results remain exposed to Florida catastrophe frequency and severity, reserve-estimate uncertainty, reinsurance pricing and availability, regulation, premium-rate restrictions and claims trends.
- Controls: Management concluded disclosure controls were ineffective at September 30 because an unremediated material weakness in internal control over financial reporting remained. The weakness related in part to stock-based compensation, equity transactions and income taxes. Management reported remediation efforts and stated that it believed the financial statements were fairly presented.
- The company reported ordinary-course claims-related litigation and said pending proceedings were not expected to have a material adverse effect. It reported no material changes to previously disclosed risk factors.
Key investor verification points
- Track reserve development and the adequacy of the $23.8 million IBNR component as claims mature.
- Confirm receipt of the expected SSIC transaction premium and assess how it affects cash generation and liquidity.
- Verify actual policy retention and renewal rates, including opt-outs from the post-quarter Citizens commercial assumption, and the economics of voluntary growth.
- Review catastrophe-reinsurance terms, collateral, counterparty exposure and remaining limits after any events; compare protection with the company’s growing insured exposure.
- Monitor statutory surplus, statutory earnings and any constraints on upstream dividends from the regulated insurance subsidiary.
- Follow remediation of the material weakness and evaluate the effects of the expanded share count on per-share results.