HCI Group, Inc. — Q3 2013 Form 10-Q Summary
Business context and reporting period
HCI Group, Inc., formerly Homeowners Choice, Inc., is a Florida-based property and casualty insurer focused primarily on homeowners, condominium owners, and tenants in Florida. Other operations include reinsurance, real estate, and information technology. The company changed its name in May 2013. This unaudited Form 10-Q covers the three and nine months ended September 30, 2013, compared with the corresponding 2012 periods.
Financial results and key metrics
| Metric | Q3 2013 | Q3 2012 | 9M 2013 | 9M 2012 |
|---|---|---|---|---|
| Total revenue | $54.7 million | $31.5 million | $175.8 million | $112.0 million |
| Net premiums earned | $52.9 million | $30.6 million | $170.8 million | $108.1 million |
| Income before taxes | $21.6 million | $5.1 million | $81.2 million | $28.5 million |
| Net income | $13.4 million | $2.8 million | $50.0 million | $17.1 million |
| Income available to common stockholders | $13.4 million | $2.8 million | $49.9 million | $16.8 million |
| Diluted EPS | $1.13 | $0.27 | $4.32 | $1.79 |
| Combined ratio on net premiums earned | 62.4% | 86.1% | 55.4% | 77.2% |
| Combined ratio on gross premiums earned | 40.7% | 49.6% | 38.5% | 51.7% |
Gross premiums earned increased 53.0% in Q3 and 52.1% for the first nine months, primarily due to policies assumed from Citizens Property Insurance Corporation in November 2012. Net premiums earned increased 73.0% in Q3 and 58.0% year to date.
Losses and loss adjustment expenses were $14.5 million in Q3 and $47.8 million year to date, compared with $15.0 million and $50.4 million, respectively, in the prior-year periods. The company reported favorable reserve development of $0.4 million in Q3 and $2.4 million year to date. Q3 2012 included approximately $3.2 million of claims from Tropical Storm Debby and Tropical Storm Isaac; the nine-month 2012 period included approximately $4.0 million from those storms.
Policy acquisition and other underwriting expenses increased to $8.9 million in Q3 and $22.2 million year to date. Other operating expenses increased to $8.8 million in Q3 and $22.3 million year to date, driven primarily by higher compensation, restricted stock expense, and administrative costs. The company had 171 employees in Tampa and 68 in Noida, India, at September 30, 2013.
Net cash provided by operating activities was $46.6 million for the nine months ended September 30, 2013, versus $37.3 million in 2012. Investing activities used $33.9 million, primarily for purchases of available-for-sale securities and property and equipment. Financing activities provided $31.0 million, principally from the issuance of senior notes.
| Balance sheet metric | September 30, 2013 | December 31, 2012 |
|---|---|---|
| Total assets | $468.4 million | $338.3 million |
| Cash and cash equivalents | $273.9 million | $230.2 million |
| Total investments | $90.5 million | $60.9 million |
| Losses and loss adjustment expense liability | $43.5 million | $41.2 million |
| Unearned premiums | $188.1 million | $154.2 million |
| Long-term debt | $40.3 million | None reported |
| Total stockholders’ equity | $166.5 million | $121.3 million |
Material changes versus the prior comparable period
- Growth was driven primarily by the November 2012 Citizens policy assumption, which contributed approximately $32.3 million of Q3 gross premiums earned and $97.7 million for the nine-month period.
- Profitability improved materially: nine-month net income rose from $17.1 million to $50.0 million, and diluted EPS rose from $1.79 to $4.32.
- Underwriting performance improved, with the nine-month net combined ratio declining from 77.2% to 55.4%.
- The company issued $40.25 million of 8% senior unsecured notes due January 2020. Net proceeds were approximately $38.7 million after issuance costs; the effective interest rate is approximately 8.7%.
- Available-for-sale securities increased to $74.1 million from $44.8 million at year-end 2012. The company reported $0.7 million of net unrealized investment losses for the nine months, after tax effects, in other comprehensive income.
- Series A preferred shares outstanding declined to 149,919 from 241,182 as holders converted 91,263 shares into common stock. Common shares outstanding increased to 11.5 million from 10.9 million.
- The quarterly common dividend increased to $0.225 per share during Q3; a $0.275 per share dividend was declared in October 2013.
Guidance, outlook, risks, contingencies, and unusual items
- No formal earnings or revenue guidance is provided in the filing. Management expects future liquidity needs to be met primarily through operating cash flow, premium receipts, and investment income.
- The company expects to begin writing policies in Alabama during 2014 after receiving regulatory approval, supporting geographic diversification.
- On November 5, 2013, the company assumed approximately 35,000 policies from Citizens, representing approximately $78 million of additional annualized premiums.
- Reinsurance contracts with retrospective provisions generated benefits of $5.5 million in Q3 and $6.8 million year to date. Management states that these benefits could be reversed or negatively affect earnings if a catastrophic loss occurs.
- The company writes Florida property insurance and is exposed to hurricanes, tropical storms, claims volatility, reserve uncertainty, reinsurance availability and pricing, regulatory restrictions, and premium-rate pressure. The insurance business is seasonal, with the principal catastrophe period from June 1 through November 30.
- At September 30, 2013, $22.4 million of the $43.5 million loss reserve represented incurred-but-not-reported claims. Actual ultimate losses may differ materially from estimates.
- The Florida Department of Revenue proposed approximately $1.9 million of premium-tax assessments, including interest, primarily relating to the disallowance of salary credits for the three-year period ended December 31, 2012. The company has not accrued the amount and intends to contest the proposed assessment.
- The company disclosed related-party reinsurance arrangements involving Moksha and Oxbridge. Certain company directors, executives, and their family members participate in those counterparties; the exposures are described as fully collateralized by trust accounts.
- Environmental remediation obligations include approximately $35,000 remaining accrued for a petroleum contamination matter. Management does not expect additional costs to materially affect liquidity or financial condition based on information available at September 30, 2013.
- HCI Group depends on subsidiaries to transfer funds to service corporate debt. Dividend payments from the insurance subsidiary are subject to Florida regulatory restrictions, which could affect the parent company’s ability to fund debt service or pay dividends.
- Management concluded that disclosure controls and procedures were effective, with no material changes in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether premium and earnings growth remains sustainable after the Citizens policy assumptions and whether future policy assumptions carry comparable economics.
- The impact of the $6.8 million year-to-date retrospective reinsurance benefit and the potential earnings reversal if catastrophe losses occur.
- Reserve adequacy, including the $22.4 million incurred-but-not-reported reserve component and the sustainability of favorable reserve development.
- Florida catastrophe exposure, reinsurance limits, exclusions, reinstatement premiums, collateral quality, and reinsurer creditworthiness.
- The resolution and potential cash impact of the approximately $1.9 million Florida premium-tax assessment.
- Parent-company liquidity and the ability of regulated insurance subsidiaries to upstream funds for the 8% senior notes and shareholder dividends.
- The effect of the new $40.25 million debt issuance, ongoing interest expense, and contractual debt payments through 2020.
- Related-party reinsurance terms, governance safeguards, and the adequacy of collateral supporting those arrangements.