HCI Group, Inc. — Q2 2014 Form 10-Q Summary
Business context and reporting period
HCI Group, Inc. is a Florida-based property and casualty insurance group, primarily writing homeowners, condominium, and renters insurance in Florida through Homeowners Choice Property & Casualty Insurance Company. It also operates reinsurance, information technology, and real estate businesses. The filing covers the unaudited quarter and six months ended June 30, 2014, compared with the corresponding 2013 periods.
Key financial metrics
| Metric | Three months ended June 30, 2014 | Three months ended June 30, 2013 | Six months ended June 30, 2014 | Six months ended June 30, 2013 |
|---|---|---|---|---|
| Total revenue | $66.3 million | $59.3 million | $134.4 million | $121.1 million |
| Net premiums earned | $62.6 million | $57.3 million | $129.0 million | $117.9 million |
| Income before taxes | $26.4 million | $26.4 million | $54.7 million | $59.6 million |
| Net income | $16.4 million | $16.2 million | $34.1 million | $36.6 million |
| Diluted EPS | $1.39 | $1.40 | $2.84 | $3.20 |
| Operating cash flow | Not separately provided for the quarter | Not separately provided for the quarter | $59.9 million | $42.5 million |
| Loss ratio on net premiums earned | 29.3% | 30.4% | 28.6% | 28.2% |
| Expense ratio on net premiums earned | 34.4% | 27.0% | 33.2% | 24.0% |
| Combined ratio on net premiums earned | 63.7% | 57.4% | 61.8% | 52.2% |
At June 30, 2014, total assets were $599.7 million, cash and cash equivalents were $302.0 million, investments were $179.2 million, total liabilities were $423.6 million, and stockholders’ equity was $176.1 million. Long-term debt had a carrying value of $128.2 million, consisting of 8% senior notes due 2020 and 3.875% convertible senior notes due 2019. The reported fair value of long-term debt was $143.1 million.
Six-month investing cash outflows were $28.1 million, primarily reflecting purchases of available-for-sale securities and $2.6 million funded under a real estate development arrangement. Financing cash outflows were $23.2 million, including $17.8 million of share repurchases and $6.3 million of dividends. Cash increased by $8.7 million to $302.0 million.
Material changes versus the prior comparable period
- Gross premiums earned increased 11.3% for the quarter and 12.5% for the six-month period, primarily due to policies assumed from Citizens in November 2013.
- Net premiums earned increased 9.3% for the quarter and 9.4% year to date, while net premiums written increased 4.2% and 5.6%, respectively.
- Net income increased modestly in the second quarter but declined 7.0% for the first six months. Diluted EPS declined from $3.20 to $2.84 year to date, partly reflecting higher share-based dilution and expenses.
- Investment income rose to $1.5 million in the quarter and $2.5 million year to date, versus $0.3 million and $0.4 million, respectively, as the investment portfolio expanded.
- The loss ratio improved slightly in the quarter but was broadly stable year to date. The expense ratio increased materially because of higher compensation, stock-based compensation, premium taxes, commissions, and interest expense.
- Interest expense increased by $1.8 million in the quarter and $3.7 million year to date following the December 2013 convertible debt offering.
- Available-for-sale securities increased to $160.2 million from $129.8 million at December 31, 2013. Net unrealized investment gains, after tax, contributed $2.9 million to six-month comprehensive income.
- The company repurchased 488,346 shares for $17.8 million during the first six months under a $40.0 million authorization; $22.2 million remained available at June 30, 2014. Series A preferred stock was fully converted or redeemed, leaving no preferred shares outstanding.
Outlook, risks, contingencies, and unusual items
- Management expects future liquidity needs to be funded primarily through operating cash flow, including premiums and investment income. Primary uses are claims, reinsurance premiums, interest, dividends, and operating expenses.
- The insurance business is seasonal, with hurricane and tropical-storm exposure concentrated from June 1 through November 30. A major catastrophe could materially affect quarterly results and disrupt operations.
- Loss reserves totaled $43.0 million at June 30, 2014, including $21.5 million for incurred-but-not-reported claims. Prior-period reserves developed favorably by $0.6 million during the first six months, but management emphasizes that reserve estimates remain uncertain.
- Retrospective reinsurance provisions reduced ceded premiums by $10.5 million year to date. The company had accrued a $15.3 million benefit and deferred $6.3 million of ceded premiums that could affect earnings if catastrophic losses exceed specified coverage limits or as future coverage is recognized.
- The company remains exposed to reinsurer credit risk because it remains liable for claims if reinsurers fail to perform. Reinsurance commitments totaled $38.7 million, including minimum premiums under multi-year contracts.
- Greenleaf Capital entered into a real estate acquisition, development, and construction arrangement with a maximum commitment of $9.8 million. The carrying value was $2.6 million at June 30, with $7.2 million unused and an estimated maximum exposure to loss of $2.6 million.
- A Florida premium-tax dispute involved a proposed adjustment of approximately $1.9 million. Management had accrued no liability and intended to contest the proposed adjustment. The Florida state income-tax audit for 2010–2012 resulted in no material changes.
- The IRS was examining the company’s 2011 federal income tax return. The filing does not provide a clear estimate of any potential resulting liability.
- Management reported effective disclosure controls and no material changes in internal control over financial reporting. No material changes to previously disclosed risk factors were reported.
Most important facts for investors to verify
- Whether premium growth from Citizens assumptions is sustainable and how policy retention, pricing, and geographic concentration evolve.
- The adequacy and volatility of loss reserves, particularly the $21.5 million incurred-but-not-reported component, after the 2014 hurricane season.
- The economic sensitivity of retrospective reinsurance benefits and the potential earnings impact of a catastrophe exceeding reinsurance limits.
- Reinsurer financial strength, collateral arrangements, and the company’s net catastrophe exposure under the June 1, 2014 treaty renewals.
- The effect of the convertible notes on future diluted share count, interest expense, and debt maturities.
- The company’s ability to continue dividends and repurchases while maintaining insurance-subsidiary capital and satisfying regulatory dividend restrictions.
- The resolution of the Florida premium-tax matter and the pending IRS examination.
- The terms, funding requirements, and return assumptions for the real estate development arrangement and related-party reinsurance transactions.