UNIVERSAL INSURANCE HOLDINGS, INC. quarterly report, Q2 FY2014

Universal Insurance Holdings, Inc. — Q2 2014 Form 10-Q

Reporting period: Three and six months ended June 30, 2014; balance-sheet comparisons are with December 31, 2013. The company is a vertically integrated property-and-casualty insurer focused primarily on homeowners coverage, with most policies in Florida. Interim financial statements are unaudited; the independent accountant performed a review, not an audit.

Key financial results

Metric	Q2 2014	Q2 2013	First half 2014	First half 2013
Net premiums earned	$73.4m	$66.9m	$137.2m	$132.3m
Total premiums earned and other revenues	$87.0m	$77.8m	$161.3m	$145.2m
Net income	$17.1m	$17.0m	$30.7m	$29.0m
Diluted EPS	$0.49	$0.44	$0.87	$0.73
Net loss and LAE ratio	37.7%	37.7%	39.7%	39.1%
Net investment income	$0.4m	$0.1m	$0.9m	$0.1m

• Q2 pretax income was $30.4m; net income increased 0.6%. First-half pretax income was $53.5m, up 8.2%, and net income rose 5.8%. Effective tax rates were 43.7% for Q2 and 42.7% for the first half.
• Q2 realized investment gains were $4.0m; first-half realized gains were $4.9m, versus a $16.0m realized loss in the first half of 2013. The prior-year period also included $7.9m of unrealized investment gains. Management attributed much of the year-over-year earnings improvement to the absence of 2013 trading-portfolio losses.
• Operating cash flow was $98.2m for the first half, compared with $192.1m a year earlier. Investing activities provided $21.8m, versus $341.1m used in 2013; financing used $35.9m. Cash and cash equivalents ended at $201.4m, up from $117.3m at year-end; restricted cash was $2.6m.
• At June 30, total assets were $950.4m, liabilities $772.3m, and stockholders’ equity $178.1m. Long-term debt was $31.0m. Management reported total capital of $209.1m, a 14.8% debt-to-total-capital ratio, and a 17.4% debt-to-equity ratio. Debt declined from $37.2m at year-end, including a $6.0m term-loan principal payment in May.
• Insurance-subsidiary statutory capital and surplus was $167.9m for UPCIC and $13.3m for APPCIC; both met Florida capitalization requirements. Ordinary dividends payable by UPCIC to its parent without prior approval were limited to $0.29m for 2014; APPCIC had no such capacity.

Material changes and management commentary

• Direct premiums written were nearly flat in Q2 at $220.0m, while first-half direct written premiums fell 2.9% to $411.9m. Net written premiums rose 66.8% in Q2 and 43.6% for the first half, chiefly because ceded premiums declined as reinsurance costs fell and the quota-share cession rate was reduced.
• Effective June 1, 2014, UPCIC reduced its quota-share cession from 45% to 30%. Management expects to retain more premium and improve profitability, but the change also increases retained catastrophe and other loss exposure and reduces ceding commissions. The higher retained share contributed to increased net losses and LAE.
• Q2 general and administrative expense increased 26.4% to $28.9m; first-half expense rose 20.8% to $53.3m. Cited drivers included higher deferred acquisition cost amortization, stock-based compensation, advertising, catastrophe-related coverage costs, and lower recovery of Florida Insurance Guaranty Association assessments. Commission revenue declined 30.4% in Q2 and 24.4% in the first half.
• Management reported 536,989 policies at June 30, up slightly from year-end. Florida represented 92.1% of policies; its count declined from year-end but increased from March 31. Policies in other states grew 17.8% from year-end. The company cited selective Florida rate reductions, improved renewal rates, and geographic expansion; Delaware began writing business in 2014, and North Carolina’s annual premium restriction was lifted in July.
• The 2014–2015 UPCIC catastrophe program provides Florida coverage up to $1.774bn, with a $21m pre-tax retention for the first three catastrophic events. Management described the program’s terms as more favorable than the prior year, but emphasized that a major or multiple catastrophe, reinsurer insolvency, or losses beyond coverage could materially affect solvency, results, and liquidity.
• Management said premiums should meet working-capital needs for at least the next 12 months and expects operating cash flows to continue meeting liquidity requirements. No earnings or revenue guidance was provided. The company declared $0.20 per common share in dividends for the first half and authorized up to $10m of share repurchases through August 1, 2015.

Risks, contingencies, and other notable items

• Key risks include hurricanes and severe weather, claim frequency or severity exceeding assumptions, reserve uncertainty, reinsurance availability and credit risk, regulatory constraints on pricing and distributions, and investment-market volatility. Florida accounts for most of the portfolio’s policies and insured value.
• Reinsurer-related balances were significant: $190.7m due from major counterparties identified in the filing, including prepaid premiums, receivables, and net recoverables/payables. The company remains liable to policyholders even if a reinsurer fails to pay.
• The investment portfolio shifted toward fixed maturities: their fair value was $323.1m at June 30, while equity securities fell to $12.4m from $65.0m at year-end, following sales primarily of equities. Management said it realized gains ahead of a potential equity-market correction. A hypothetical 20% decline in equity-security prices would reduce fair value by $2.5m.
• The company repurchased 1.225m shares from its former CEO for $14.7m and 446,271 shares in the open market for $5.5m during the first half. Share-based compensation and tax-withholding payments were also material cash uses.
• Routine claims-related lawsuits were not considered material by management; no non-routine litigation expected to have a material effect was reported. An IRS examination related to a loss carryback to the 2009 tax year was underway. UPCIC also had a $5.99m office-property purchase agreement, with closing due no later than February 5, 2015, subject to conditions.
• Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. The filing reported no material change to previously disclosed risk factors.

Important facts for investors to verify

• Whether the reduced quota-share cession improves underwriting profitability enough to offset greater retained catastrophe risk and lower ceding commissions.
• Florida policy-count and premium trends, rate adequacy, and the pace and profitability of growth outside Florida.
• Catastrophe-program limits, retentions, total reinsurance costs, counterparty concentration, and recovery timing under stress scenarios.
• Claims development, reserve adequacy, loss-ratio trends, and whether higher acquisition and operating expenses persist.
• How much reported earnings growth depends on realized investment gains, and the portfolio’s exposure to market and interest-rate changes.
• Cash availability at the parent versus regulated insurance subsidiaries, regulatory dividend restrictions, debt covenants, and the funding implications of dividends, repurchases, and the planned property purchase.