Heritage Insurance Holdings, Inc. — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019. Amounts below are in U.S. dollars; financial statement amounts are generally in millions unless stated otherwise. The interim financial statements are unaudited.
Business context
Heritage is a property and casualty insurer with business concentrated in coastal markets. It writes personal and commercial residential insurance through subsidiaries, with Florida remaining its largest market. The company continued exposure management in Florida while expanding outside the state; it began writing commercial residential business in New Jersey.
Key financial results
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Gross premiums written | $254.8 | $263.7 | $465.2 | $468.0 |
| Net premiums earned | $114.1 | $111.2 | $223.8 | $217.3 |
| Total revenue | $122.8 | $118.0 | $241.1 | $230.0 |
| Losses and loss adjustment expenses | $74.3 | $66.0 | $136.4 | $119.1 |
| Operating income | $3.1 | $8.2 | $14.6 | $33.0 |
| Net income | $0.7 | $2.4 | $7.7 | $17.2 |
| Diluted earnings per share | $0.02 | $0.09 | $0.26 | $0.65 |
| Net combined ratio | 105.0% | 98.7% | 101.3%* | 90.7% |
Margins and drivers: The combined ratio above 100% indicates underwriting losses on the reported net basis. Q2 net loss and LAE ratio rose to 65.1% from 59.3%; net expense ratio was 39.9% versus 39.4%. For the first half, the net loss and LAE ratio increased to 61.0% from 54.8%, and the net expense ratio to 40.3% from 35.9%. Management attributed weaker results primarily to higher catastrophe and non-catastrophe weather losses, lower vertically integrated operations income, and reduced ceding commissions; 2018 also benefited from NBIC purchase-accounting effects. The six-month narrative gives a combined ratio of 101.2%, while the table reports 101.3%.
Q2 net investment income was $3.8 million; net realized gains were $1.3 million. Management’s discussion describes investment income inclusive of realized and equity valuation gains as $5.1 million for Q2 and $9.8 million for the first half. First-half net cash provided by operating activities was $76.4 million, compared with $48.3 million a year earlier; investing activities used $36.8 million, and financing activities used $25.7 million. Cash, cash equivalents and restricted cash ended the period at $276.3 million.
Balance sheet, debt and liquidity
- At June 30, 2019, total assets were $1.934 billion, total liabilities $1.495 billion and stockholders’ equity $438.9 million.
- Cash and cash equivalents were $262.5 million; restricted cash was $13.8 million. Management also reported $840.5 million of unrestricted cash, cash equivalents and investments.
- Long-term debt, net of discounts and issuance costs, was $132.4 million, down from $148.8 million at year-end 2018. Principal debt was $138.0 million, including $73.1 million term loan, $10.0 million revolver, $23.4 million convertible notes, $19.2 million FHLB borrowing and $12.3 million mortgage loan. The revolving facility had $40.0 million of its $50.0 million capacity undrawn.
- The company said it was in compliance with debt covenants and believed liquidity and capital resources, including revolver availability and operating cash flows, would meet anticipated working-capital needs for at least 12 months. This is management’s assessment, not a guarantee.
- Combined statutory surplus at the insurance subsidiaries was $347.1 million, down from $376.3 million at December 31, 2018. Subsidiaries met applicable financial and regulatory requirements at quarter-end.
Material changes and notable items
- Q2 gross premiums written fell 3.3% year over year. Premiums-in-force were $922.5 million, down 0.9%; growth outside Florida was offset by a 16.3% decline in Florida’s Tri-County region. Outside-Florida premiums-in-force grew 6.3%.
- Q2 net income declined 70%, and first-half net income fell 55%. First-half revenue increased 4.8%, but operating expenses increased 15%, led by losses and acquisition costs.
- Current-quarter net weather losses were $21.5 million, including $13.4 million of net catastrophe losses, mostly associated with Florida and North Carolina. Prior-year reserve development was favorable by $1.3 million in Q2, the fourth consecutive quarter of favorable development; the comparable 2018 quarter had $16.1 million of unfavorable development.
- Effective June 1, the 2019–2020 catastrophe reinsurance program provided first-event limits of up to $1.5 billion for Heritage P&C, $708 million for Zephyr and $936 million for NBIC, with first-event retentions of $20.0 million, $20.0 million and $13.8 million, respectively. The company reported $2.6 billion of potential coverage for multiple events and an estimated net program cost of approximately $249.2 million. Losses above available reinsurance remain the company’s responsibility; recovery also depends on reinsurer performance and event severity/frequency.
- NBIC did not renew its gross quota-share treaty for the fiscal year beginning June 1, 2019; its net quota-share program ceded 52% of net premiums and losses. Reinsurance recoverables were $330.4 million, while reinsurance payable was $324.8 million at quarter-end.
- First-half share repurchases totaled $7.3 million; the company had $42.7 million remaining under its $50 million authorization through December 2020. The quarterly dividend was $0.06 per share; a further $0.06 dividend was declared August 1, payable in October.
- The company adopted lease accounting guidance in Q1 2019, recording approximately $2.8 million of right-of-use assets and lease liabilities at adoption; management said the adoption did not materially affect results or cash flows. No goodwill or intangible impairment was recorded in Q2.
Outlook, risks and contingencies
The filing provides no specific earnings or revenue guidance. Management emphasized its focus on risk diversification, reinsurance protection, investment income and liquidity. The business is seasonal, with hurricane season generally running June through November and winter storms affecting the first and fourth quarters.
Key risks include coastal catastrophe exposure, losses exceeding reserves or reinsurance limits, reinsurance cost, availability and collectability, pricing and claims-management errors, competition, legal and coverage trends, regulatory requirements, and investment-market fluctuations. The company’s fixed-income portfolio had a reported estimated fair-value decline of 9.8% under a hypothetical 300-basis-point interest-rate increase. Management stated that pending ordinary-course legal proceedings were not expected to materially adversely affect financial position, results or cash flow. A federal tax examination of 2015–2017 returns had been initiated; management did not expect an adverse financial-statement impact. No material risk-factor changes were reported.
Most important facts for investors to verify
- Whether elevated catastrophe and other weather losses persist and how they affect underwriting profitability and the combined ratio.
- Actual Florida exposure reductions, growth outside Florida, and resulting premium and renewal trends.
- The adequacy, cost, terms and collectability of the 2019–2020 reinsurance program, including protection against multiple events.
- Reserve development and the estimate for unpaid losses, including the $159.7 million of net IBNR reported at June 30.
- Liquidity and debt-covenant compliance under adverse claims, reinsurance-recovery or investment scenarios; confirm statutory capital and surplus trends.
- The combined-ratio presentation discrepancy: 101.3% in the six-month table versus 101.2% in the narrative.