Heritage Insurance Holdings, Inc. — Q2 2020 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2020. Unaudited results; financial amounts below are in millions unless stated otherwise. Heritage is a super-regional property and casualty insurer focused primarily on personal and commercial residential coverage.
Financial performance
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Gross premiums written | $290.4 | $254.8 | $519.5 | $465.2 |
| Net premiums earned | $129.1 | $114.1 | $255.1 | $223.8 |
| Total revenue | $136.0 | $122.8 | $268.7 | $241.1 |
| Operating income | $7.0 | $3.1 | $19.7 | $14.6 |
| Net income | $4.1 | $0.7 | $11.8 | $7.7 |
| Diluted EPS | $0.15 | $0.02 | $0.42 | $0.26 |
| Net combined ratio | 100.0% | 105.0% | 97.6% | 101.3% |
Quarterly gross premiums written increased 14% year over year; management cited growth in commercial residential and personal residential business. Premiums-in-force were $994.6 million, up at a 15.3% annualized rate from Q1 2020. For the six months, gross premiums written rose 12% and net premiums earned rose 14% year over year.
Q2 net income improved primarily on higher net premiums earned, lower net loss and expense ratios, and a lower effective tax rate, partly offset by lower investment gains. Six-month earnings also benefited from premium growth and a lower net loss ratio, while lower investment gains and other income were offsets. Q2 net investment income was $3.3 million; including realized/unrealized investment results, investment contribution was approximately $3.3 million versus $5.1 million in Q2 2019. Six-month net investment income was $7.0 million, down from $7.5 million; investment gains were also lower than in the prior-year period.
Balance sheet, cash flow, debt and capital
- At June 30, total assets were $2.17 billion, total liabilities $1.70 billion, and stockholders’ equity $462.5 million. Book value per share was $16.67, up 6.4% from year-end 2019 and 11.2% year over year.
- Cash and cash equivalents were $288.3 million, with $11.8 million of restricted cash. Six-month operating cash flow was $131.8 million, investing cash flow was negative $97.0 million, and financing cash flow was negative $17.6 million. Cash, cash equivalents and restricted cash increased $17.2 million to $300.2 million.
- Long-term debt, net of issuance costs, was $126.1 million; debt principal totaled $130.2 million, including $65.6 million under the term loan and $10.0 million under the revolving facility. The company reported compliance with applicable debt covenants. The revolving facility has $50 million capacity; a June amendment increased its letter-of-credit sublimit from $5 million to $40 million.
- Insurance subsidiaries’ combined statutory surplus was $338.7 million, down from $351.8 million at year-end. The company said its subsidiaries met applicable regulatory requirements.
- Six-month cash returned to shareholders included $10.0 million of share repurchases and $3.5 million of dividends paid. The quarterly dividend was $0.06 per share; the board declared another $0.06 dividend in August for payment in October.
Material changes and operating drivers
- Q2 net loss and LAE was $78.9 million, up 6% year over year, while the net loss and LAE ratio improved to 61.1% from 65.1%. The net combined ratio improved to 100.0% from 105.0%; the six-month ratio improved to 97.6% from 101.3%.
- Favorable prior-year reserve development was $5.0 million in Q2 and $9.1 million for the first half. It was the eighth consecutive quarter of favorable development. Management said current-quarter net weather losses were $26.8 million, including $17.6 million of catastrophe losses, versus $21.5 million and $13.4 million, respectively, a year earlier.
- The ceded premium ratio declined to 46.6% in Q2 and 46.5% for the first half, primarily reflecting lower costs from the prior reinsurance program and reduced quota-share coverage, partly offset by the higher cost of the 2020–2021 catastrophe program. The new program’s estimated net cost is approximately $272.1 million.
- At June 30, the catastrophe program provided first-event limits of up to $1.35 billion for Heritage P&C, $965 million for NBIC and $690 million for Zephyr. The company disclosed that losses exceeding its reinsurance protection remain its responsibility and that available coverage for subsequent events depends on prior-event severity.
Outlook, risks and contingencies
The filing provides no quantified earnings or revenue guidance. Management said COVID-19 had limited business impact during the first half and viewed residential insurance demand as relatively resilient. It nevertheless warned that prolonged economic weakness could reduce new business and home purchases, disrupt independent-agent distribution, delay or impair premium collections, increase claims-handling costs, and affect investment markets and income. Management believed cash, the revolving facility and expected operating earnings were sufficient for anticipated liquidity needs for at least 12 months, while noting that future financing could become more difficult or costly.
Key risks include catastrophe exposure, especially hurricanes and other severe weather; the possibility of reserve inadequacy; reinsurance availability, cost and counterparty collectability; pricing and renewal performance; investment-market and interest-rate changes; and COVID-19-related economic disruption. The portfolio included $698.3 million of available-for-sale fixed maturities, with $26.3 million of gross unrealized gains and $0.1 million of gross unrealized losses. Management recorded no credit-loss allowance for securities in an unrealized loss position, citing its assessment that it did not intend, and was unlikely to be required, to sell them before recovery.
Ordinary-course claims-related legal proceedings were disclosed; management did not believe pending matters would materially adversely affect financial position, results or cash flow. No material goodwill or intangible impairment was recorded. The filing reported no material subsequent events requiring adjustment or additional disclosure; after quarter-end, a $36 million letter of credit was issued to support reinsurance collateral, and a $0.06-per-share dividend was declared.
Investor verification points
- Track reserve development and the adequacy of loss and LAE reserves, including the significant IBNR component.
- Assess catastrophe exposure, reinsurance cost and remaining limits after events, as well as reinsurer credit and recoverability.
- Monitor premium growth, retention, weather losses and whether the combined ratio remains at or below 100% without relying on favorable reserve development.
- Confirm liquidity and covenant capacity, including the effect of the $36 million letter of credit and seasonal reinsurance payments.
- Evaluate COVID-19 effects on new business, premium collections, distribution, claims costs and investment income; no quantified company forecast was provided.