HCI Group, Inc. annual report, FY2015

HCI Group, Inc. — FY2015 Form 10-K Summary

Business context and reporting period

HCI Group is a Florida-based insurance holding company whose principal subsidiary, Homeowners Choice Property & Casualty Insurance Company, provides homeowners, condominium, renters, wind-only and limited flood coverage primarily in Florida. The company also operates reinsurance, real estate and information-technology businesses, but reports one operating segment. This Form 10-K covers the fiscal year ended December 31, 2015; fourth-quarter figures are included in the filing but the report is annual rather than a standalone Q4 filing.

HCI had approximately 160,000 policies in force and approximately $400 million of annualized gross premiums at year-end. Historical growth has depended substantially on policy assumptions from Citizens Property Insurance Corporation and the acquisition of HomeWise policies.

Financial performance and key metrics

Metric	FY2015	FY2014	Change
Gross premiums earned	$423.1 million	$365.5 million	+15.8%
Net premiums earned	$282.5 million	$252.1 million	+12.1%
Total revenue	$286.0 million	$266.1 million	+7.5%
Income before taxes	$106.2 million	$101.0 million	+5.2%
Net income	$65.9 million	$62.7 million	+5.1%
Diluted EPS	$5.90	$5.36	+10.1%
Operating cash flow	$45.3 million	$88.7 million	-49.0%

Net margin was approximately 23.0% of total revenue. The effective tax rate was 38.0%, compared with 37.9% in 2014. Dividends increased to $1.20 per common share from $1.10, and cash dividends paid totaled $11.7 million.

• Loss ratio on net premiums earned: 30.9%, versus 31.5% in 2014.
• Expense ratio on net premiums earned: 32.7%, versus 34.0%.
• Combined ratio on net premiums earned: 63.6%, versus 65.5%.
• Combined ratio on gross premiums earned: 42.5%, versus 45.2%.
• Premiums ceded increased to $140.6 million, or 33.2% of gross premiums earned, from $113.4 million, or 31.0%.

Balance sheet, debt and liquidity

• Cash and cash equivalents declined to $267.7 million from $314.4 million.
• Total investments increased to $232.9 million from $168.8 million, including $173.2 million of available-for-sale securities.
• Total assets increased to $637.0 million from $598.6 million.
• Stockholders’ equity increased to $237.7 million from $182.6 million.
• Long-term debt was $129.4 million carrying value, consisting principally of $40.25 million of 8% senior notes due 2020 and $103.0 million of 3.875% convertible senior notes due 2019.
• Operating cash flow of $45.3 million was more than offset by $80.4 million of investing outflows and $11.5 million of financing outflows, producing a $46.7 million decline in cash.
• Contractual obligations totaled $213.2 million, including $170.9 million of principal and interest obligations, $23.0 million of minimum multi-year reinsurance premiums and $18.2 million of unfunded limited-partnership commitments.

Management stated that existing capital and anticipated retained income were expected to support operations, while noting that catastrophe losses, reserve deficiencies, reinsurance availability and growth could create additional capital needs. At December 31, 2015, $81.1 million of consolidated retained earnings was available for dividends without prior insurance-regulatory approval, subject to applicable requirements.

Material changes versus the prior comparable period

• Gross premiums earned benefited from the assumption of approximately 6,000 homeowners multi-peril and 30,000 wind-only policies from Citizens in December 2014, plus approximately 4,000 primarily homeowners multi-peril policies in February 2015.
• Policies in force decreased to approximately 160,000 from 180,000, despite higher earned premiums.
• Net premiums written decreased to $255.7 million from $294.2 million because of higher ceded premiums and lower gross premiums written.
• Losses and loss adjustment expenses increased to $87.2 million from $79.5 million. FY2015 included $8.9 million of unfavorable prior-year development, primarily related to 2012 and 2014 loss years, as well as weather-related claims.
• Investment performance weakened: net investment income fell to $4.0 million from $4.9 million; realized investment results changed from a $4.7 million gain to a $0.6 million loss; and other-than-temporary impairment losses increased to $4.7 million from $0.1 million.
• Investing activity expanded materially, including $24.6 million of limited-partnership investments, $7.0 million of real-estate development funding and purchases of available-for-sale securities.
• HCI adopted new accounting guidance requiring debt issuance costs to be presented as a deduction from debt; the adoption affected balance-sheet presentation but not operating results or cash flows.

Guidance, outlook, commentary and unusual items

• Florida regulators approved rate decreases effective January 1, 2016: approximately 5% for homeowners multi-peril, 2% for condominium multi-peril and 8% for renters multi-peril. Management estimated a $4.5 million to $5.5 million reduction in 2016 net income and approximately $14 million lower gross premiums earned.
• HCI expected to offer standalone flood policies in 2016 and planned to expand direct-to-consumer sales through its website and applications. TypTap Insurance Company was authorized in January 2016 and received a $25 million capital contribution, including $0.3 million for its statutory deposit.
• In January 2016, a real-estate subsidiary entered into a 15-year secured loan for $9.2 million at a fixed 4% annual rate.
• The 2015 reinsurance program was modeled to cover a probable maximum loss from a 1-in-260-year event, compared with 1-in-182-year protection for the prior program.
• Retrospective reinsurance arrangements produced $21.7 million of accrued benefits in 2015. HCI held $35.7 million of accrued benefits and $3.1 million of deferred ceded premiums that could be charged to earnings if a qualifying catastrophe occurs or coverage adjustments reverse.
• A shareholder settlement resulted in $0.9 million of 2015 expense and cancellation of 160,000 restricted shares in March 2016, including 100,000 shares awarded to the chief executive officer.
• The board authorized a one-year plan to repurchase up to $20 million of common shares; $1.6 million was used in 2015.

Principal risks and contingencies

• Concentration in Florida exposes HCI to hurricanes, tropical storms, tornadoes and other catastrophes that could exceed reinsurance protection.
• Loss reserves are inherently uncertain; adverse claims severity, litigation, judicial developments or late-reported claims could require material reserve increases.
• Premium rates, policy forms, dividends, capital and affiliate transactions are subject to Florida insurance regulation. Competitive pressure and mandated rate reductions may constrain profitability.
• Reinsurance may become unavailable or more expensive, and reinsurers may fail to pay obligations. Retrospective reinsurance assets also create potential earnings volatility.
• Growth has historically relied on Citizens assumptions and renewals; future assumptions may not be available on acceptable terms.
• Investment risks include interest-rate sensitivity, credit losses, equity-market declines and illiquidity of private partnerships and real-estate investments.
• HCI Group, Inc. depends on subsidiary distributions to service holding-company debt and pay dividends.
• Information-technology failures, cybersecurity incidents, key-person dependence, environmental liabilities at marina properties and risks from India operations could adversely affect results.

Most important facts for an investor to verify

• Whether policy count, retention and net premiums written continue to decline despite growth in earned premiums.
• Development of the $51.7 million loss and loss-adjustment-expense reserve, including whether the $8.9 million unfavorable prior-year development persists.
• The effect of the 2016 rate reductions on premiums, underwriting margins and capital generation.
• Actual catastrophe exposure, reinsurance limits, attachment points, exclusions, collateralization and the collectability of the $35.7 million retrospective-reinsurance asset.
• Liquidity after dividends, share repurchases, the $25 million TypTap contribution, investment commitments and the $9.2 million real-estate loan.
• Refinancing or conversion risk associated with the $103 million convertible notes due 2019 and the $40.25 million senior notes due 2020.
• Statutory capital and surplus, risk-based-capital ratios and restrictions on transfers from insurance subsidiaries.
• Related-party reinsurance arrangements involving Oxbridge Reinsurance and company executives or directors.
• Management’s assertion that disclosure controls and internal control over financial reporting were effective; the independent auditor issued unqualified opinions.