HCI Group, Inc. — First Quarter 2017 Form 10-Q Summary
Business Context and Reporting Period
HCI Group is a Florida-based insurance, reinsurance, real estate and information technology company. Its principal business is Florida property and casualty insurance, with additional flood products through TypTap and HCPCI. Insurance operations represented 96.5% of segment revenue for the quarter.
The filing covers the unaudited three months ended March 31, 2017, compared with the three months ended March 31, 2016. The company had approximately 148,000 policies in force at March 31, 2017, compared with approximately 158,000 one year earlier.
Key Financial Metrics
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Gross premiums earned | $91.6 million | $98.8 million | Down $7.2 million |
| Net premiums earned | $63.0 million | $58.4 million | Up $4.6 million |
| Total revenue | $67.7 million | $60.7 million | Up $7.0 million |
| Income before taxes | $19.1 million | $9.7 million | Up $9.4 million |
| Net income | $12.0 million | $6.1 million | Up $6.0 million |
| Basic EPS | $1.27 | $0.60 | Up $0.67 |
| Diluted EPS | $1.15 | $0.60 | Up $0.55 |
| Operating cash flow | $24.3 million | $27.3 million | Down $3.0 million |
Net income margin was approximately 17.8% of total revenue, compared with approximately 10.0% in the prior-year quarter. The effective tax rate was 37.2%, compared with 37.5%.
- Net investment income increased to $2.8 million from $1.5 million, primarily because limited partnership investments generated $0.8 million of income versus a $0.9 million loss in Q1 2016.
- Losses and loss adjustment expenses declined to $25.5 million from $27.1 million. The net loss ratio improved to 40.5% from 46.3%.
- The net expense ratio improved to 36.6% from 41.0%, and the net combined ratio improved to 77.1% from 87.3%. Measured against gross premiums earned, however, the combined ratio increased to 53.0% from 51.7%.
- Cash and cash equivalents were $407.9 million at March 31, 2017, compared with $280.5 million at December 31, 2016. Total assets were $788.1 million and stockholders’ equity was $232.2 million.
- Long-term debt increased to $273.0 million from $138.9 million, principally because of the March 2017 issuance of $143.75 million of 4.25% convertible senior notes.
Material Changes Versus the Prior Comparable Period
- Gross premiums earned decreased because of policy attrition and the continuing effect of rate decreases on new and renewal policies beginning in January 2016.
- Premiums ceded declined to $28.6 million from $40.4 million, reflecting lower costs under the 2016/2017 reinsurance program and higher reductions from retrospective reinsurance provisions. This drove the increase in net premiums earned despite lower gross premiums.
- Net premiums written increased to $42.8 million from $35.2 million.
- Q1 2016 included approximately $5.0 million of weather-related losses; Q1 2017 included $2.3 million of prior-period loss development, primarily associated with 2016 claims and assignment-of-benefits litigation.
- Net other-than-temporary impairment losses decreased to $0.2 million from $0.7 million. The company reported three impaired equity securities in Q1 2017 versus 11 in Q1 2016.
- In March 2017, the company issued $143.75 million of 4.25% convertible senior notes due 2037, received net proceeds of approximately $138.8 million, repurchased common shares for approximately $29.7 million through related transactions, and converted its $9.4 million revolving credit facility into a 3.95% promissory note.
- Shares outstanding declined to approximately 9.1 million at March 31, 2017 from approximately 9.7 million at December 31, 2016, reflecting share repurchases and prepaid forward contracts.
Cash Flow, Liquidity and Capital
Operating activities generated $24.3 million of cash. Investing activities used $0.8 million, after $11.8 million of distributions from limited partnerships and $11.7 million of proceeds from investment sales. Financing activities provided $103.9 million, primarily from the convertible note issuance, partially offset by share repurchases, debt issuance costs and dividends.
Management stated that it believes liquidity is sufficient to pay claims, operating expenses, debt service and dividends, including under unforeseen circumstances such as reinsurer insolvencies, inadequate premium rates or reserve deficiencies. The company expects future liquidity primarily from insurance premiums and investment income.
Material commitments included $38.8 million of minimum premiums under multi-year reinsurance contracts, $11.2 million of unfunded limited partnership commitments and $347.5 million of long-term debt principal and interest obligations. During the quarter, HCPCI paid an $18.0 million dividend to HCI, subject to Florida insurance regulatory restrictions.
Outlook, Risks and Unusual Items
- No specific earnings or premium guidance was provided. Management expects flood products offered through TypTap and HCPCI to become significant contributors to future results and plans to pursue additional products and opportunities inside and outside Florida.
- The insurance business is seasonal, with Florida hurricanes and tropical storms generally occurring from June through November. Reinsurance costs also typically reset on June 1 and may materially affect future results.
- Loss reserves totaled $69.9 million at March 31, 2017, including $50.2 million of estimated incurred-but-not-reported losses. Reserve estimates are inherently uncertain and may change materially due to claim severity, litigation, regulation, inflation or other developments.
- Assignment-of-benefits litigation remains a material claims risk. Management reported $2.3 million of prior-period adverse loss development during the quarter, primarily related to the 2016 loss year.
- Retrospective reinsurance arrangements produced $8.3 million of accrued benefits and $3.0 million of deferred ceded premiums at March 31, 2017. A significant catastrophe could require these amounts to be charged to earnings, and the company remains exposed if reinsurers fail to perform.
- Investment portfolios are exposed to interest-rate, credit and equity-price risk. A hypothetical 100-basis-point increase in rates would have reduced the estimated fair value of fixed-maturity securities by approximately 4.0% at March 31, 2017.
- Subsequent to quarter-end, the company redeemed its 8% senior notes for approximately $40.8 million, including interest, and recognized a $0.7 million early-extinguishment charge. The board also declared a $0.35-per-share quarterly dividend and terminated the Series B preferred-share rights agreement.
- The filing reported no material changes to previously disclosed risk factors, no material adverse effect expected from pending ordinary-course legal proceedings, and effective disclosure controls.
Important Facts for Investors to Verify
- Whether policy attrition and lower rates continue to reduce gross premiums and policy counts.
- Whether assignment-of-benefits litigation causes further adverse reserve development, particularly for the 2016 loss year.
- The renewal cost and coverage terms of the reinsurance program beginning June 1, 2017, including exposure to retrospective provisions and reinsurer credit risk.
- The company’s ability to service approximately $273.0 million of carrying-value debt while maintaining dividends and share repurchases.
- Whether TypTap and other flood products achieve the expected growth and profitability contribution.
- The effect of Florida regulatory limits on dividends from insurance subsidiaries to the holding company.
- Changes in investment fair values, interest rates and catastrophe losses that could affect equity, liquidity and reported earnings.