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.