UNIVERSAL INSURANCE HOLDINGS, INC. quarterly report, Q2 FY2012

Universal Insurance Holdings, Inc. — Q2 2012 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2012. The company is a vertically integrated property and casualty insurer, focused primarily on Florida homeowners insurance. Unless noted otherwise, amounts below are in millions of dollars. Interim statements are unaudited and were reviewed by the independent accountant, not audited.

Financial performance and position

Metric	Q2 2012	Q2 2011	Six months 2012	Six months 2011
Total premiums earned and other revenues	$59.9	$53.7	$120.2	$118.0
Net premiums earned	$55.7	$49.5	$104.3	$97.5
Income before income taxes	$13.0	$13.1	$29.2	$36.2
Net income	$7.8	$7.5	$17.7	$21.4
Basic / diluted EPS	$0.20 / $0.19	$0.19 / $0.19	$0.44 / $0.44	$0.55 / $0.53
Net loss and LAE ratio	52.9%	52.2%	53.3%	53.4%

Q2 net income increased 3.0%; for the first half it declined 17.7%. First-half total revenue rose 1.8%, while operating costs and expenses rose 11.2% to $91.0 million.
First-half investment results were volatile: $9.2 million of realized losses and $3.4 million of unrealized gains, versus $6.6 million of realized gains and $7.1 million of unrealized losses in 2011. Net investment income was negative $0.1 million, compared with $0.2 million income.
Operating cash flow was $131.8 million for the first half, down from $195.5 million. The filing shows substantial working-capital movements, including changes in reinsurance receivables and payables; cash flow should therefore be considered alongside those balances.
At June 30, cash and cash equivalents were $356.3 million and restricted cash was $74.3 million. Total assets were $1.116 billion, total liabilities $954.4 million, and stockholders’ equity $161.8 million. Long-term debt was $21.0 million; reported debt-to-total-capital and debt-to-equity ratios were 11.5% and 13.0%.
Cash dividends declared were $0.10 per share in February and $0.08 per share in April. The latter was paid July 9.

Material changes versus comparable periods

Q2 net earned premiums increased 12.5%, while first-half net earned premiums increased 7.0%. Management attributed direct-premium growth chiefly to rate increases; ceded premiums also rose, partly reflecting reinsurance arrangements.
Direct premiums written increased 6.7% for the first half, and net premiums written increased 25.4%. Policies in force declined to 574,000 from 593,000 at year-end 2011, amid rate increases and non-renewals. Florida accounted for 97% of policies in force.
First-half general and administrative expenses rose 18.7% to $35.3 million. Management cited lower quota-share ceding commissions and the direct expensing of costs under new deferred-acquisition-cost accounting.
Effective January 1, 2012, new acquisition-cost guidance reduced earnings by $2.7 million pretax ($1.7 million after tax, or $0.04 per diluted share) in Q1. The filing says this changes the timing of expense recognition rather than creating incremental charges over time.
Total assets increased from $894.0 million at December 31, 2011, driven in part by higher cash and reinsurance-related receivables. Reinsurance payable increased to $273.8 million, which management primarily attributed to unsettled amounts following the change in quota-share reinsurer.

Outlook, commentary, risks and contingencies

No formal earnings or revenue guidance is provided. Management said premiums should meet working-capital needs for at least the next 12 months and expected to declare $0.08 quarterly dividends in Q3 and Q4, subject to board discretion and financial and regulatory considerations.
The 2012–2013 reinsurance program began June 1. UPCIC reduced its quota-share cession from 50% to 45%, which management expects to improve profitability but also increases retained risk and reduces ceding commissions. Management described overall program terms as more favorable than the prior year, with pricing largely unchanged and direct earned premiums expected to increase.
Catastrophe exposure remains central: approximately $126.2 billion of in-force policyholder wind coverage was reported. The company remains responsible for losses beyond reinsurance limits and for amounts unpaid by reinsurers. Reinsurer creditworthiness and the collection and timing of recoverables are material considerations.
Management reported UPCIC’s Demotech Financial Stability Rating of A was affirmed in June. It also disclosed that Demotech’s updated guidance would no longer give full credit for the mandatory Florida Hurricane Catastrophe Fund layer, creating a risk of a rating downgrade or related capital requirements.
Florida rate approvals in 2012 averaged approximately 14.9% for homeowners and 8.8% for dwelling fire. Sinkhole coverage changes were also approved. Rate increases may be partly offset by wind-mitigation discounts and policy attrition; the filing states 58% of policyholders received such credits at June 30.
Investments are exposed to market volatility; metals and mining represented approximately 54% of trading-portfolio fair value. A hypothetical 20% decline in equity, derivative and other investment prices would have reduced fair value by $16.4 million at June 30.
A July 2012 dispute with a reinsurer over an expired contract could result in a pretax loss from zero to $5.4 million; timing of resolution was unknown. Management said routine claims-related lawsuits were not material and disclosed no non-routine litigation expected to materially affect results, financial condition or liquidity.
UPCIC and APPCIC met Florida statutory capitalization requirements; UPCIC had no capacity to pay ordinary dividends to the parent during 2012 based on 2011 statutory results. UPCIC was reported in compliance with surplus-note covenants.
Other key risks include catastrophe frequency and severity, reserve adequacy, reinsurance availability and recoverability, Florida market concentration, regulation and investment performance. Management reported disclosure controls were effective and no material change in internal control over financial reporting.

Most important facts for investors to verify

Whether the reduction in quota-share cession and the full 2012–2013 reinsurance program improve earnings without creating excessive retained catastrophe exposure or reinsurance-collection risk.
How the $5.4 million maximum potential reinsurer-dispute loss is resolved, and whether other reinsurance balances are collected on schedule.
Whether rate increases offset wind-mitigation discounts, policy attrition and rising acquisition and operating costs.
How investment volatility—particularly the metals and mining concentration—affects earnings, capital and liquidity.
Whether policy-level and statutory capital remain adequate after catastrophe losses, and whether Demotech’s FHCF treatment affects UPCIC’s A rating or capital requirements.
How much of reported operating cash flow reflects sustainable insurance operations versus reinsurance and other working-capital timing.