HCI

Business Context and Reporting Period

Company: Homeowners Choice, Inc. (HCI Group, Inc.)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2009
Business Overview: A Florida-based property and casualty insurance holding company providing homeowners, condominium, and tenants insurance. The company primarily operates through a "take-out program," assuming policies from Citizens Property Insurance Corporation. As of June 30, 2009, the company held approximately 61,000 policies in force.

Key Financial Metrics

Note: The company reported no long-term debt. Liquidity is maintained through cash, short-term investments ($35,042), and held-to-maturity securities ($1,889).

Material Changes vs. Prior Period

• Revenue Growth: Net premiums earned increased 102% to $40.9 million for the six months ended June 30, 2009, compared to $20.3 million in the same period in 2008. This growth is driven by the completion of six assumption transactions from Citizens, compared to four in the prior year.
• Profitability: Net income rose 38% to $9.3 million from $6.7 million year-over-year. However, diluted earnings per share decreased slightly to $1.28 from $1.30 due to an increase in the weighted average number of shares outstanding.
• Loss Ratios: The loss ratio increased to 55.26% from 31.82% in the prior year. Management attributes this to higher actual claims incurred and strengthened case reserves reflecting increased policy volume and insured values.
• Expense Ratios: The expense ratio improved significantly to 12.21% from 20.33%. This improvement is largely due to a reduction in assumed commission rates from Citizens (dropping from 16% to 6%) and operating leverage as revenue grew faster than fixed administrative costs.
• Reinsurance Costs: Effective June 1, 2009, the company entered into new catastrophe reinsurance treaties increasing coverage to $376 million per event. This increased annual reinsurance premiums to approximately $56 million (54% of gross earned premiums) compared to $25 million (27% of gross earned premiums) in the prior year.

Outlook, Risks, and Management Commentary

• Reinsurance Impact: Management expects the higher reinsurance costs for the 2009-2010 hurricane season to result in a decline in net premiums earned and a corresponding increase in the loss ratio for the remainder of 2009 compared to 2008.
• Seasonality: The company anticipates increased losses and loss adjustment expenses between June 1 and November 30 due to hurricane season, which may negatively impact operating profits during this period.
• Share Repurchases: The company has an authorized plan to repurchase up to $3.0 million of common stock. As of June 30, 2009, $2.387 million remained available. During the quarter, 110,196 shares were repurchased at an average price of $5.18.
• Key Risks:
  • Catastrophic Events: Exposure to hurricanes and natural disasters in Florida.
  • Reserve Adequacy: Uncertainty in estimating incurred but not reported (IBNR) losses; $8.4 million of the $23.3 million loss reserve is IBNR.
  • Regulatory Environment: Dependence on Florida state approval for rates and policy forms, and restrictions on dividends from the insurance subsidiary.

Investor Verification Checklist

• Reinsurance Adequacy: Verify the sufficiency of the new $376 million catastrophe coverage given the increased insured values and rising reinsurance rates.
• Reserve Development: Monitor future quarters for the stability of the $8.4 million IBNR reserve and the impact of the increased loss ratio on future profitability.
• Renewal Rates: Assess the company's ability to retain policies from Citizens at profitable rates, given the requirement to offer renewals at rates equivalent to or less than Citizens.
• Liquidity Position: Confirm the company's ability to meet claims obligations and reinsurance premiums ($56 million annual cost) given the current cash position of ~$80 million.
• Share Count Dilution: Track the impact of outstanding warrants (938,334 shares reserved) and stock options on future earnings per share.