HCI Group, Inc. Form 10-Q Summary
Business Context and Reporting Period
HCI Group, Inc. is a Florida-based holding company with property and casualty insurance, reinsurance, information technology, and real estate operations. Its principal business is Florida homeowners, condominium, renters, flood-endorsed, and wind-only insurance. The company reports one operating segment, with property and casualty insurance representing 90.0% of third-quarter revenue and 94.4% of nine-month revenue.
This unaudited Form 10-Q covers the three and nine months ended September 30, 2015, compared with the corresponding 2014 periods. The company had 10,890,921 common shares outstanding as of October 23, 2015.
Financial Performance and Position
| Metric | Q3 2015 | Q3 2014 | 9M 2015 | 9M 2014 |
|---|---|---|---|---|
| Gross premiums earned | $103.8 million | $88.9 million | $321.2 million | $274.1 million |
| Net premiums earned | $62.8 million | $61.3 million | $220.9 million | $190.3 million |
| Total revenue | $61.3 million | $67.0 million | $222.5 million | $201.4 million |
| Income before taxes | $11.9 million | $22.8 million | $88.6 million | $77.5 million |
| Net income | $7.4 million | $14.1 million | $54.8 million | $48.1 million |
| Diluted EPS | $0.71 | $1.23 | $4.84 | $4.07 |
| Operating cash flow | Not separately provided | Not separately provided | $106.3 million | $63.9 million |
Third-quarter net income declined 47.5% year over year, while nine-month net income increased 13.9%. Nine-month net income benefited from premium growth and improved underwriting ratios. The effective tax rate was 38.3% in the third quarter and 38.2% for the nine-month period.
- Third-quarter loss ratio on net premiums earned was 41.7%, versus 35.9% in 2014; the expense ratio was 36.9%, versus 36.2%; and the combined ratio was 78.6%, versus 72.1%.
- Nine-month loss ratio was 29.8%, versus 31.0%; expense ratio was 30.9%, versus 34.1%; and combined ratio was 60.7%, versus 65.1%.
- Measured against gross premiums earned, the combined ratio was 47.5% in the third quarter and 41.7% for nine months, compared with 49.7% and 45.2%, respectively, in 2014.
- Cash and cash equivalents were $331.5 million at September 30, 2015, compared with $314.4 million at December 31, 2014.
- Total investments were $233.2 million, including $180.6 million of available-for-sale securities, compared with total investments of $168.8 million at year-end 2014.
- Total assets were $702.9 million and stockholders’ equity was $229.1 million at September 30, 2015, compared with $602.2 million and $182.6 million, respectively, at December 31, 2014.
- Long-term debt was $131.6 million, consisting primarily of $40.3 million of 8% senior notes due 2020 and $91.4 million carrying value of 3.875% convertible senior notes due 2019.
Cash Flow, Liquidity, and Capital
- Operating activities generated $106.3 million during the first nine months of 2015.
- Investing activities used $79.8 million, primarily for purchases of available-for-sale securities, limited partnership investments, and real estate development funding.
- Financing activities used $9.4 million, including $9.1 million of dividends and $1.6 million of share repurchases, partially offset by $1.8 million of tax benefits from stock-based compensation.
- The company stated that it believes liquidity is sufficient to pay claims, operating expenses, debt service, dividends, and commitments, including in the event of reinsurer insolvencies, reserve deficiencies, or unforeseen events.
- Contractual commitments included $33.0 million of future multi-year reinsurance premiums, $20.4 million of unfunded limited partnership commitments, and $1.1 million remaining under an acquisition, development, and construction financing arrangement.
Material Changes Versus the Prior Comparable Period
- Gross premiums earned increased 16.8% in the third quarter and 17.2% for the first nine months, primarily from Citizens policy assumptions completed in December 2014 and February 2015.
- Premiums ceded increased to 39.6% of gross premiums earned in the third quarter from 31.1%, reflecting higher Florida Hurricane Catastrophe Fund rates, increased reinsurance purchased for the 2015/16 season, and lower retrospective reinsurance benefits.
- Third-quarter earnings were reduced by $1.9 million of net other-than-temporary investment impairment losses, a $0.3 million net realized investment loss compared with a $3.3 million gain in 2014, and a $2.4 million loss from a limited partnership investment.
- The company recorded $3.9 million of other-than-temporary impairment losses for the first nine months, compared with none in 2014. These included impairments on two fixed-maturity securities and eight equity securities.
- Third-quarter losses and loss adjustment expenses increased 19.1% to $26.2 million, driven by significant weather-related events and unfavorable development on older claims.
- Loss reserves increased to $57.2 million from $48.9 million at December 31, 2014. The company recorded unfavorable development of $1.8 million in the third quarter and $2.3 million for the first nine months.
- Limited partnership investments increased to $22.2 million from $2.6 million at year-end 2014 and generated a $6.1 million aggregate net loss at the partnership level for the first nine months.
Guidance, Outlook, Risks, and Unusual Items
- Florida regulators approved rate filings effective January 1, 2016, providing an average 5% rate decrease for homeowners multi-peril policies, a 2% decrease for condominium policies, and an 8% decrease for renters policies. Management estimated a $4.5 million to $5.5 million reduction in 2016 net income and approximately $14.0 million lower gross premiums earned based on the current book of business.
- The company’s 2015/16 reinsurance program was modeled to cover the probable maximum loss from a one-in-260-year event, compared with one in 182 years for the 2014/15 program.
- Florida hurricane and tropical storm activity is seasonal, generally concentrated from June 1 through November 30. A major catastrophe could materially affect quarterly results and operations.
- Key risks include claim frequency and severity, reserve uncertainty, catastrophe exposure, reinsurance pricing and collectability, regulatory limitations on premium rates, competition, and the availability of future Citizens policy assumptions or acquisitions.
- Retrospective reinsurance arrangements included $31.1 million of accrued benefits and $4.9 million of deferred ceded premiums at September 30, 2015. These amounts could be charged to earnings if qualifying catastrophe losses occur or coverage conditions change.
- The company provided a $0.55 million bridge loan to a real estate developer at 11% interest, due by January 31, 2016. It also acquired 2.32 acres of Riverview, Florida land for $2.7 million in October 2015.
- A Florida premium-tax contingency was substantially resolved; the company reversed approximately $0.14 million of previously accrued liability during the third quarter.
- Three shareholders demanded rescission of portions of compensation paid to the chief executive officer and certain directors. No lawsuits had been filed as of the filing date, and management did not expect a material financial impact.
- The board declared a quarterly dividend of $0.30 per common share payable December 18, 2015.
Investor Verification Priorities
- Verify the sustainability of premium growth after the 2014 and 2015 Citizens policy assumptions and the effect of the 2016 rate reductions.
- Assess adverse claims development, weather losses, reserve adequacy, and the proportion of reserves attributable to incurred-but-not-reported claims.
- Review reinsurance limits, exclusions, retrospective provisions, premiums, and reinsurer collateralization, particularly for a major Florida catastrophe.
- Evaluate the liquidity impact of $20.4 million of unfunded private-equity commitments, $33.0 million of reinsurance obligations, and real estate financing commitments.
- Monitor investment portfolio volatility, impairment charges, limited partnership performance, and interest-rate sensitivity.
- Confirm restrictions on dividends from the insurance subsidiary and the company’s ability to fund future shareholder dividends from insurance operations.
- Review related-party reinsurance arrangements involving Oxbridge Reinsurance and company executives or directors.