Heritage Insurance Holdings, Inc. — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016. Unaudited consolidated results. Heritage writes personal and commercial residential property insurance, principally in Florida, and expanded into Hawaii through its March 2016 acquisition of Zephyr.
Financial performance
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Gross premiums written | $177.3 million | $135.6 million | $324.6 million | $269.6 million |
| Net premiums earned | $108.9 million | $94.8 million | $215.3 million | $196.3 million |
| Total revenue | $115.3 million | $99.1 million | $226.8 million | $204.2 million |
| Losses and loss adjustment expenses | $48.8 million | $33.9 million | $115.8 million | $66.4 million |
| Net income | $18.4 million | $25.4 million | $25.8 million | $55.5 million |
| Diluted EPS | $0.62 | $0.84 | $0.86 | $1.84 |
| Operating cash flow | Not provided by quarter | $104.3 million | $85.1 million |
- For the six months, gross combined ratio was 90.5% versus 67.9%; net combined ratio was 86.0% versus 58.5%. Q2 gross combined ratio was 85.7% versus 71.1%, and net combined ratio was 78.5% versus 61.3%. The filing attributes the deterioration mainly to higher losses and reinsurance costs.
- Six-month loss ratio on gross earned premiums increased to 36.7% from 26.3%; expense ratio increased to 22.0% from 19.2%. Q2 gross loss ratio was 29.8% versus 26.7%.
- At June 30, total assets were $1.123 billion, investments $550.1 million, cash and cash equivalents $143.0 million, restricted cash $18.6 million, total liabilities $750.6 million, and shareholders’ equity $372.4 million. Book value per share was $12.71.
- Cash declined $93.3 million in the first half. Investing used $177.6 million, including $111.9 million for the Zephyr acquisition; financing used $20.0 million, including $16.6 million of share repurchases and $3.4 million of dividends.
- The filing does not provide a clear funded-debt balance; no separate borrowings are identified on the balance sheet.
Changes and significant items
- Revenue rose, but earnings fell: Q2 net income declined 28% and first-half net income declined 54% year over year. Management cited higher loss ratios and less favorable reinsurance economics than in 2015.
- Losses included $14.1 million of unfavorable prior-year reserve development in the first half, compared with $4.4 million of favorable development in the prior-year period. The unfavorable development was in personal lines, principally involving litigated and attorney- or public-adjuster-represented claims, with much of the 2016 emergence in Miami-Dade, Broward, and Palm Beach counties. Management revised its estimated 2015 personal-lines ultimate loss ratio from 34.5% to 38.2%.
- Zephyr was acquired on March 21 for approximately $111.9 million, net of cash acquired. Its preliminary allocation included $40.8 million of goodwill and $29.2 million of identified intangibles; purchase accounting remained subject to revision. Zephyr contributed $9.3 million of Q2 revenue and $5.9 million of pretax income, before acquisition-related intangible amortization.
- At June 30, approximately 331,000 policies were in force; about 23% were associated with the Zephyr acquisition. Premiums in force were approximately $659.6 million, versus $510.2 million a year earlier.
- Investments increased to $550.1 million from $400.1 million at year-end 2015. Accumulated other comprehensive income improved to $5.6 million from a $2.0 million loss, largely reflecting unrealized investment gains.
Outlook, risks, and management commentary
- No numerical earnings or revenue guidance was provided. Management said available capital and operating cash flow were expected to meet anticipated working-capital needs for at least 12 months, while noting this was not assured.
- The 2016–2017 catastrophe reinsurance program covers Florida and Hawaii and provides up to $1.9 billion for a first Florida event, $1.1 billion for a first Hawaii event, and $3.0 billion of potential multiple-event coverage, including retentions. Coverage depends on event severity and frequency. The program’s stated cost was approximately $240 million, versus $177 million for the prior program.
- Cash is held for hurricane-season needs; management reported approximately $65 million was used in July 2016 for reinsurance premium deposits. Hurricane exposure, reinsurance availability, cost and collectability, reserve uncertainty, claims litigation and investment-market risk remain material concerns.
- Combined statutory surplus was $284.0 million at June 30, up from $216.6 million at year-end, but the insurance subsidiaries reported a statutory net loss of $0.6 million for the first half. The company reported compliance with applicable premium-to-surplus requirements.
- The company reported no material change in its previously disclosed risk factors, no material adverse effect expected from pending ordinary-course legal proceedings, and effective disclosure controls at period-end.
Important facts for investors to verify
- Whether reserve assumptions adequately capture the adverse personal-lines development, IBNR estimates, litigation and assignment-of-benefits claims, especially in South Florida.
- Whether the expanded reinsurance program’s cost, limits, retentions, reinstatements and collectability provide adequate protection through the hurricane season.
- How the Zephyr acquisition’s preliminary purchase-price allocation, intangible amortization, integration and expected reinsurance synergies develop.
- Liquidity after the approximately $65 million July reinsurance payment, and the effect of hurricane losses on cash, statutory capital and claims-paying capacity.
- How continued repurchases and dividends affect capital: 1.14 million shares had been repurchased for $16.6 million by June 30, with $53.4 million remaining under authorized programs.