Heritage Insurance Holdings, Inc. — Q2 2017 Form 10-Q
Reporting period: Three and six months ended June 30, 2017. Amounts below are in U.S. dollars; financial statement amounts are converted to millions unless otherwise noted.
Business context
Heritage writes personal and commercial residential property insurance, principally in Florida and Hawaii, with operations also in North Carolina, South Carolina and Georgia. It operates as one reporting segment. At June 30, 2017, it had approximately 316,000 policies in force; about 48.1% were assumed from Citizens, 29.1% came from voluntary sales and 23% related to the Zephyr acquisition.
Financial performance
| Metric | Q2 2017 | Q2 2016 | H1 2017 | H1 2016 |
|---|---|---|---|---|
| Gross premiums written | $159.3 | $177.3 | $301.5 | $324.6 |
| Net premiums earned | $90.5 | $108.9 | $182.6 | $215.3 |
| Total revenue | $96.9 | $115.3 | $196.2 | $226.8 |
| Operating income | $13.1 | $29.8 | $25.0 | $41.8 |
| Net income | $6.6 | $18.4 | $12.6 | $25.8 |
| Diluted EPS | $0.23 | $0.62 | $0.44 | $0.86 |
Q2 gross and net combined ratios were 95.7% and 92.7%, respectively, versus 85.7% and 78.5% a year earlier. For H1, gross and net combined ratios were 96.3% and 93.8%, versus 90.5% and 86.0%. H1’s gross loss ratio improved to 30.2% from 36.7%, but the ceded premium ratio rose to 40.5% from 31.8% and the gross expense ratio rose to 25.6% from 22.0%.
Net investment income was $3.0 million in Q2 and $5.5 million in H1, up from $2.2 million and $4.3 million, respectively. H1 net realized investment gains were $0.6 million, broadly unchanged from 2016. Return on average equity was 7.3% for Q2 and 7.0% for H1; book value per share was $12.97 at June 30.
Financial position, liquidity and cash flow
- At June 30, cash and cash equivalents were $134.2 million, restricted cash was $18.4 million, and investments were $601.2 million. Total assets were $1.149 billion; total liabilities were $783.4 million; stockholders’ equity was $365.3 million.
- Operating cash flow for H1 was $35.5 million, compared with $104.3 million in H1 2016. Cash increased $28.4 million to $134.2 million. Management attributed lower operating cash flow primarily to higher reinsurance payments, claims payments including those related to Hurricane Matthew, and the absence of Citizens assumed-premium receipts recorded in 2016.
- H1 investing activities provided $5.0 million, compared with $177.6 million used in 2016, when the company paid approximately $110.3 million for Zephyr. Financing activities used $12.2 million, including $8.6 million for share repurchases and $3.6 million in dividends.
- Senior secured notes had $79.5 million principal outstanding, with a $73.3 million carrying value net of issuance costs. The notes bear interest at 8.75% plus three-month average LIBOR; the effective rate was approximately 10%. Quarterly principal payments begin December 2018; maturity is December 2023. The company reported covenant compliance.
- Insurance subsidiaries reported combined statutory surplus of $264.5 million at June 30, 2017, down from $276.1 million at year-end 2016, and a combined statutory net loss of $4.5 million for H1.
Material changes and management commentary
- H1 total revenue declined to $196.2 million from $226.8 million, and net income fell to $12.6 million from $25.8 million. Management cited lower premium in force and net earned premiums, increased ceded premiums, higher expense ratios, and interest and debt-cost amortization on notes issued in December 2016.
- Premium in force was approximately $604.2 million at June 30, 2017, versus $659.6 million a year earlier. Management said it continued to reduce exposure in locations with disproportionate attritional losses or uneconomic catastrophe risk. No Citizens business was assumed in H1 2017.
- H1 loss reserves included a $2.1 million favorable prior-year development, compared with a $14.1 million prior-year deficiency in H1 2016. The filing links much of the earlier adverse development to Florida personal-lines litigation and attorney- or public-adjuster-represented claims. At June 30, net unpaid losses and LAE were $120.3 million, including $65.3 million of IBNR.
- The 2017–2018 catastrophe reinsurance program cost approximately $225 million, versus $247 million for the prior season, and provided first-event coverage, including retention, up to $1.75 billion in Florida and $731 million in Hawaii, with up to $2.6 billion of potential multiple-event coverage. First-event retention fell to $20 million from $40 million. Actual recoveries depend on event severity, frequency and remaining coverage; losses above program limits remain the company’s responsibility.
Outlook, risks and unusual items
- No quantified earnings or revenue guidance was provided. Management said available capital and operating cash flow should be sufficient for anticipated working-capital needs for at least 12 months, while noting this is not assured.
- Major risks include catastrophe exposure and the concentration of business in Florida and Hawaii, reserve estimation uncertainty, reinsurance cost and availability and reinsurer collectability, pricing and underwriting risk, claims litigation and emerging coverage issues, and investment-market risk. The business is seasonal, with hurricane season running June through November.
- On August 8, 2017, after quarter-end, Heritage agreed to acquire NBIC for $210 million cash plus approximately $40 million in Heritage stock, subject to a book-value adjustment and customary closing conditions, including regulatory clearance. Closing was expected in Q1 2018.
- The company repurchased 684,022 shares for $8.6 million in H1; $35.8 million remained under its $70 million authorization at June 30. It declared quarterly dividends of $0.06 per share, including a subsequent Q3 declaration. Management stated pending ordinary-course legal proceedings were not expected to materially affect financial position, results or cash flow.
Key facts investors should verify
- Whether premium and policy-in-force declines continue, and whether management’s geographic exposure reductions improve underwriting returns.
- How renewal of catastrophe reinsurance affects ceded premiums, net combined ratios, coverage limits and retained catastrophe exposure.
- Whether the favorable H1 reserve development persists, particularly given IBNR’s share of net reserves and prior Florida litigation-related adverse development.
- How cash generation and liquidity develop alongside reinsurance installments, claims payments, debt service, buybacks and dividends.
- The final NBIC purchase consideration, financing, regulatory approvals, closing timing and any resulting dilution or capital impact.