Business Context and Reporting Period
Homeowners Choice, Inc. and subsidiaries, now identified in the request metadata as HCI Group, Inc., filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2011. The company is a Florida property and casualty insurance holding company focused primarily on homeowners, condominium-owners, and tenants insurance in Florida. It also operated marina, real estate, and related businesses.
Insurance policies were primarily obtained through Citizens Property Insurance Corporation assumption transactions and subsequent renewals. The company uses catastrophe excess-of-loss reinsurance to reduce hurricane and other catastrophe exposure.
Financial Results and Key Metrics
| Metric | Three Months Ended September 30 | Nine Months Ended September 30 | Change Versus Prior Period |
|---|---|---|---|
| Gross premiums earned | $31.7 million | $93.9 million | 7.9% and 4.6% increase |
| Net premiums earned | $17.8 million | $51.6 million | 18.2% and 9.8% increase |
| Total revenue | $20.1 million | $57.9 million | 17.7% and 12.5% increase |
| Income before taxes | $3.3 million | $8.4 million | 30.3% and 46.6% increase |
| Net income | $2.1 million | $5.2 million | 25.2% and 42.1% increase |
| Income available to common stockholders | $1.9 million | $4.6 million | 12.0% and 25.7% increase |
| Diluted earnings per share | $0.27 | $0.70 | Compared with $0.25 and $0.54 |
| Operating cash flow | Not separately reported | $18.5 million | Down from $26.3 million |
Net income margins based on total revenue were approximately 10.3% for the quarter and 8.9% for the nine months. The filing does not present a separate debt balance; no cash interest payments were reported. Total liabilities were $115.0 million and stockholders’ equity was $59.2 million at September 30, 2011, compared with $94.3 million and $46.6 million, respectively, at December 31, 2010.
Liquidity included $62.0 million of cash and cash equivalents, $54.5 million of investments, and $40.1 million of available-for-sale securities at September 30, 2011. Total assets were $174.2 million, versus $140.9 million at year-end 2010.
Insurance Operating Metrics
| Ratio | Q3 2011 | Q3 2010 | Nine Months 2011 | Nine Months 2010 |
|---|---|---|---|---|
| Loss ratio on net premiums earned | 58.5% | 58.2% | 60.8% | 62.7% |
| Expense ratio on net premiums earned | 35.7% | 38.1% | 35.3% | 34.7% |
| Combined ratio on net premiums earned | 94.1% | 96.4% | 96.1% | 97.4% |
The combined ratio remained below 100%, indicating underwriting profitability under the company’s stated convention. The combined ratio measured against gross premiums earned was 52.9% for the quarter and 52.8% for the nine months, compared with 49.4% and 51.0% in the prior-year periods.
Material Changes Versus the Prior Comparable Period
- Net premiums earned increased primarily because gross premiums earned rose and premiums ceded to reinsurers declined modestly.
- Net premiums written increased to $25.6 million for the quarter and $64.8 million for the nine months, compared with $21.2 million and $50.7 million, respectively.
- Net income increased, but the nine-month comparison benefited from a $936,000 pre-tax, $575,000 after-tax gain on a bargain purchase.
- Other income increased to $1.2 million for the quarter and $2.1 million for the nine months, primarily from marina and rental operations.
- Other operating expenses increased by $0.8 million for the quarter and $2.0 million for the nine months. The company had 93 employees at September 30, 2011, compared with 63 a year earlier.
- The company issued 1,247,700 shares of 7% Series A cumulative convertible preferred stock in March 2011, generating approximately $11.3 million of net proceeds. Preferred dividends reduced income available to common stockholders by $218,000 in the quarter and $596,000 year to date.
- The company repurchased and retired 248,794 common shares during the nine months for approximately $1.9 million, including purchases from a director and the chief executive officer.
- Available-for-sale investments increased materially, including fixed maturity securities of $35.3 million and equity securities of $4.8 million at September 30, 2011, compared with $28.6 million and $0.9 million, respectively, at December 31, 2010.
Cash Flow, Outlook, Risks, and Unusual Items
- Operating cash flow was $18.5 million, while investing activities used $19.1 million. Investing outflows included $5.1 million for the Tierra Verde Marina acquisition, $35.0 million for securities purchases, and $3.0 million for property and equipment.
- Financing activities provided $7.7 million, principally from the preferred stock issuance, partially offset by $2.2 million of dividends and $1.9 million of common-stock repurchases. Cash increased by $7.1 million to $62.0 million.
- The April 2011 acquisition of Tierra Verde Marina involved $5.1 million of cash consideration for net assets preliminarily valued at $5.7 million. The resulting $936,000 bargain-purchase gain is subject to possible purchase-price-allocation adjustments.
- Effective November 1, 2011, the company assumed approximately 70,000 Florida homeowners policies representing approximately $106 million of annual gross premiums. It expected to receive approximately $53 million of related unearned premiums and receivables, less a 10% ceding commission, subject to cancellations and refunds.
- In connection with the HomeWise transaction, the company expected to issue warrants to purchase 500,000 common shares at $9.10 per share, estimated to have a value of $500,000 to $750,000, and agreed to reimburse $250,000 of legal and other costs. It also received an option to acquire the equity of an entity indirectly controlling HomeWise for $500.
- Management provided no specific earnings or premium guidance. It stated that results are subject to seasonality, with higher potential losses from June through November due to hurricane and tropical-storm activity.
- Key risks include Florida catastrophe exposure, reserve-estimation uncertainty, reinsurer collectability or insolvency, premium-rate and regulatory restrictions, competitive pressure, inflation, and potential adverse claims development.
- Loss reserves were $23.7 million at September 30, 2011, including approximately $7.0 million for incurred-but-not-reported claims. Prior accident years experienced favorable development, but management cautioned that reserves could change materially as claims develop.
- The company assumed a $150,000 environmental remediation liability related to the marina acquisition; $137,000 remained accrued at September 30, 2011. Additional monitoring or remediation could materially exceed the current estimate, although management did not expect a material liquidity or financial-condition impact based on information then available.
- The IRS examination of the company’s 2008 and 2009 tax returns concluded with no 2008 adjustments and minor, immaterial 2009 adjustments, subject to final approval, which was issued October 3, 2011.
Important Facts for Investors to Verify
- Verify the final accounting and earnings impact of the Tierra Verde Marina bargain-purchase gain.
- Assess the financial and regulatory effects of the November 2011 HomeWise policy assumption, including actual premiums, cancellations, ceding commissions, and required capital.
- Review the terms, dilution potential, and valuation of the HomeWise-related warrants and existing warrants and convertible preferred stock.
- Monitor Florida catastrophe losses, reinsurance protection, attachment points, reinstatement costs, and reinsurer credit quality.
- Evaluate reserve adequacy and the sustainability of favorable prior-year loss development.
- Confirm restrictions on dividends from the insurance subsidiary and the parent company’s ability to fund future dividends or investments.
- Reconcile the increase in operating expenses and employee count with future revenue growth and underwriting profitability.