HCI Group, Inc. 2016 Q3 Form 10-Q Summary
Business context and reporting period
HCI Group is a Florida-based holding company with property and casualty insurance, reinsurance, real estate and information technology operations. Insurance represented 88.0% of total revenue in the quarter and 89.2% for the nine-month period. The filing covers the unaudited three and nine months ended September 30, 2016, compared with the corresponding 2015 periods.
Key financial metrics
| Metric | Q3 2016 | Q3 2015 | 9M 2016 | 9M 2015 |
|---|---|---|---|---|
| Total revenue | $69.8 million | $61.3 million | $192.1 million | $222.5 million |
| Net premiums earned | $63.3 million | $62.8 million | $180.3 million | $220.9 million |
| Net investment income | $2.8 million | $(0.5) million | $6.0 million | $2.7 million |
| Income before taxes | $20.0 million | $11.9 million | $41.0 million | $88.6 million |
| Net income | $11.3 million | $7.4 million | $24.4 million | $54.8 million |
| Diluted EPS | $1.10 | $0.71 | $2.41 | $4.84 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $91.5 million | $106.3 million |
| Combined ratio on net premiums | 78.6% | 78.6% | 83.8% | 60.7% |
| Combined ratio on gross premiums | 53.8% | 47.5% | 52.8% | 41.7% |
Q3 net income margin was approximately 16.2% of total revenue, compared with approximately 12.0% in Q3 2015. The nine-month net income margin was approximately 12.7%, compared with 24.6% in the prior-year period.
At September 30, 2016, total assets were $684.3 million, cash and cash equivalents were $291.9 million, available-for-sale securities were $221.5 million, total liabilities were $439.8 million and stockholders’ equity was $244.5 million. Long-term debt was $138.2 million carrying value, or $148.2 million of principal. Debt fair value was $144.1 million.
Material changes versus the prior comparable period
- Q3 total revenue increased 13.9%, despite an 10.9% decline in gross premiums earned, primarily because premiums ceded declined by $11.8 million and investment income improved.
- Nine-month total revenue declined 13.7%, driven by a $34.9 million reduction in gross premiums earned and a $5.7 million increase in premiums ceded.
- Nine-month net income fell 55.4% and diluted EPS declined 50.2%, reflecting lower net premiums earned, higher losses and loss adjustment expenses, and higher underwriting expense ratios.
- Nine-month losses and loss adjustment expenses increased to $79.3 million from $65.8 million. Management cited weather-related events, Hurricane Hermine, assignment-of-benefits trends and related litigation, as well as unfavorable prior-year reserve development of $10.6 million.
- Q3 net investment income improved by $3.3 million, largely because limited partnership investments generated $1.1 million of income versus a $2.4 million loss in the prior-year quarter.
- Available-for-sale investments increased from $173.2 million at December 31, 2015 to $221.5 million at September 30, 2016. Accumulated other comprehensive income improved to $4.9 million from a $1.8 million loss.
- The company repurchased $18.0 million of common stock during the first nine months and $11.3 million of convertible senior notes, while issuing $18.2 million of promissory debt. Shares outstanding declined to 9.63 million from 10.29 million at year-end 2015.
Cash flow, liquidity and capital allocation
- Nine-month operating cash flow was $91.5 million, investing cash outflow was $46.4 million and financing cash outflow was $20.9 million, producing a $24.1 million increase in cash.
- Cash at September 30, 2016 was $291.9 million, compared with $267.7 million at December 31, 2015.
- Future contractual obligations totaled $229.3 million, including $176.1 million of debt principal and interest, $38.8 million of multi-year reinsurance premiums and $13.6 million of unfunded limited-partnership commitments.
- The company paid a $19.0 million dividend from HCPCI to HCI during the first nine months. Insurance-subsidiary dividend capacity is subject to Florida regulatory capital and approval requirements.
- The board declared a $0.30 per-share quarterly dividend payable December 16, 2016. The $20.0 million share-repurchase plan was completed November 1, 2016, after the quarter-end.
Guidance, outlook, management commentary, risks and unusual items
- Management expected the 2016/17 reinsurance program to reduce reinsurance costs by approximately $48 million compared with the 2015/16 program. The new program was modeled to cover a probable maximum loss from a 1-in-165-year event, versus 1-in-260-year coverage in the prior program.
- HCPCI was approved to assume approximately 27,000 Citizens Property Insurance policies, with approximately 17,000 assumption letters expected to be sent. The company had approximately 145,000 policies in force at September 30, 2016, versus approximately 165,000 a year earlier.
- TypTap began writing standalone Florida flood coverage in March 2016, and management expects TypTap and HCPCI flood products to become significant contributors to future results.
- On August 16, 2016, the company acquired a Florida retail shopping center for $12.25 million, financed partly with a $9.0 million, 3.75% promissory note. The transaction generated a $2.1 million bargain-purchase gain and $2.6 million of intangible assets.
- Hurricane Matthew occurred after the reporting date. As of October 27, 2016, the company had approximately 2,000 claims and $13.0 million of initial pre-tax losses; expected gross losses were $20 million to $25 million, below the company’s reinsurance retention. No third-party reinsurance recovery was expected.
- Key risks include Florida catastrophe exposure, reserve-estimation uncertainty, assignment-of-benefits litigation, premium-rate restrictions and pressure, reinsurance availability and pricing, potential reinsurer insolvency, investment-market risk and reliance on anchor tenants in real estate operations.
- The company reported effective disclosure controls and no material changes to internal control over financial reporting.
Most important facts for investors to verify
- Whether Hurricane Matthew losses ultimately remain within the stated $20 million to $25 million estimate and below reinsurance retention.
- The sustainability of the materially lower reinsurance cost structure and its effect on net premiums and combined ratios.
- Development of 2015 and prior-year claims, including assignment-of-benefits litigation and the adequacy of the $57.2 million loss reserve, of which $37.6 million was IBNR.
- Policy growth, retention and profitability from the Citizens assumption program and the new flood products.
- Compliance with insurance-subsidiary capital requirements and the resulting capacity to fund future dividends to the parent.
- Execution and tenant concentration risks associated with the newly acquired retail property and other real estate investments.