HCI Group, Inc. — FY2012 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2012. The filing is an annual report, not a quarterly filing; fourth-quarter results are included in the unaudited quarterly data. The registrant was named Homeowners Choice, Inc. and primarily operated through Homeowners Choice Property & Casualty Insurance Company, Inc. in Florida.
Business context
HCI is a Florida-based insurance holding company providing homeowners, condominium-owners, and tenants insurance. Growth primarily came from policy assumptions from Citizens Property Insurance Corporation and HomeWise. In November 2012, HCI assumed approximately 60,000 Citizens policies representing approximately $150 million of additional annualized premiums. Non-insurance operations include real estate, marinas, a restaurant, and software development and were described as immaterial to consolidated results.
Key financial metrics
| Metric | 2012 | 2011 | Change |
|---|---|---|---|
| Gross premiums earned | $233.6 million | $143.6 million | +62.7% |
| Net premiums earned | $157.7 million | $88.1 million | +79.0% |
| Total revenue | $163.1 million | $93.8 million | +73.8% |
| Losses and loss adjustment expenses | $66.3 million | $48.2 million | +37.5% |
| Income before income taxes | $49.6 million | $16.4 million | +202.2% |
| Net income | $30.2 million | $10.0 million | +202.7% |
| Income available to common stockholders | $29.8 million | $9.1 million | +226.1% |
| Diluted EPS | $3.02 | $1.34 | +125.4% |
| Net cash from operating activities | $106.3 million | $56.0 million | +89.7% |
| Cash dividends paid | $8.6 million | $3.8 million | +124.0% |
Margins and underwriting: Net income margin was approximately 18.5% of total revenue, compared with approximately 10.6% in 2011. The loss ratio improved to 42.1% from 54.8%, the expense ratio improved to 29.9% from 33.1%, and the combined ratio improved to 72.0% from 87.9%. Management also reported a combined ratio based on gross premiums earned of 48.6%, versus 53.9% in 2011.
Liquidity and capitalization: At December 31, 2012, cash and cash equivalents were $230.2 million, total investments were $60.9 million, total assets were $338.3 million, and stockholders’ equity was $121.3 million. HCPCI reported statutory capital and surplus of $69.8 million versus a required minimum of $19.7 million. No dividends were available for payment from HCPCI to its parent under applicable Florida restrictions.
Debt and preferred securities: The filing did not report senior debt outstanding at December 31, 2012. In January 2013, HCI issued approximately $40.3 million of 8.00% senior notes due 2020, generating approximately $38.7 million of net proceeds. Series A preferred shares outstanding declined to 241,182 from 1,247,700 after conversions during 2012.
Material changes versus the prior comparable period
- Premium growth reflected the full-year contribution from the 2011 HomeWise assumption and the November 2012 Citizens assumption.
- Premiums ceded increased to $75.9 million from $55.5 million, but declined as a percentage of gross premiums earned to 32.5% from 38.7%.
- Loss reserves increased to $41.2 million from $27.4 million, primarily because of the larger policy base. Prior-year reserves developed favorably, including $11.1 million of reductions related to 2011 reserves and $4.7 million related to 2010 and prior years.
- 2012 losses included approximately $1.4 million from Tropical Storm Debby and $2.1 million from Tropical Storm Isaac.
- Policy acquisition and underwriting expenses increased to $25.9 million from $18.1 million. The increase included a one-time $1.2 million adjustment from adopting ASU 2010-26, reducing 2012 net income by approximately $741,000, or $0.08 diluted EPS.
- Other operating expenses increased to $21.1 million from $11.0 million, driven largely by compensation, stock-based compensation, India operations, and staffing for acquired policies.
- HCI raised approximately $20.1 million net from a common-stock offering and received $11.9 million from warrant exercises. It also acquired Treasure Island marina and restaurant real estate for approximately $8.2 million and recorded a $179,000 bargain-purchase gain.
Outlook, risks, contingencies, and unusual items
- Management expected liquidity requirements to be funded primarily by operating cash flow, premiums, investment income, and potentially future debt or equity offerings.
- The business is concentrated in Florida and is highly exposed to hurricanes, tropical storms, tornadoes, litigation, claim severity, regulatory changes, and reinsurance availability and pricing.
- Loss reserves and catastrophe exposures are inherently uncertain. A severe catastrophe could exceed reinsurance protection, while reinsurer insolvency or non-collectability could increase HCI’s retained losses.
- Florida regulation affects rates, policy forms, renewals, cancellations, capital, reinsurance, investments, and dividends. Competitive pressure and the absence of an A.M. Best rating may constrain growth, although HCPCI held a Demotech “A Exceptional” rating.
- HCPCI recorded approximately $1.1 million of Florida Insurance Guaranty Association assessments in 2012; $657,000 was expensed and $482,000 was recorded as recoverable from policyholders. The company expected recovery through policy surcharges beginning in 2013.
- An environmental remediation liability of $150,000 was assumed with the Tierra Verde marina acquisition; $53,000 had been paid and $97,000 remained accrued at year-end. Additional costs could exceed the current estimate.
- At December 31, 2012, deposits at two national banks represented 90.7% of cash and cash equivalents, creating a disclosed concentration of cash balances.
- The independent auditor issued unqualified opinions on the consolidated financial statements and internal control over financial reporting.
Investor verification checklist
- Reconcile reported policy growth, annualized premiums, retention, and the financial contribution of the November 2012 Citizens assumption.
- Review catastrophe reinsurance limits, retentions, reinstatement provisions, collateral, and reinsurer credit quality for the 2013 treaty year.
- Test reserve adequacy and subsequent development, particularly for the 2012 loss year and Florida catastrophe claims.
- Assess the effect of the January 2013 senior notes on interest expense, leverage, covenants, and holding-company liquidity.
- Confirm whether FIGA surcharge recoveries were achieved and how the resulting credits affected 2013 earnings.
- Evaluate regulatory restrictions on dividends from HCPCI and the extent to which cash is accessible at the holding-company level.
- Monitor environmental remediation costs, marina and restaurant operating losses, and the concentration of cash deposits.