HCI Group, Inc. quarterly report, Q1 FY2014

HCI Group, Inc. — Q1 2014 Form 10-Q Summary

Business context and reporting period

HCI Group is primarily a Florida property and casualty insurer through Homeowners Choice Property & Casualty Insurance Company, Inc. Other operations include reinsurance, information technology and real estate. The filing covers the three months ended March 31, 2014, with comparisons to the three months ended March 31, 2013. Financial statements are unaudited and presented in thousands, except per-share data.

Property and casualty insurance represented 96.2% of total revenue, compared with 94.6% in the prior-year quarter.
The company began offering limited flood coverage as a policy endorsement in January 2014 and expects its Alabama subsidiary to begin writing policies during 2014.

Key financial metrics

Metric	Q1 2014	Q1 2013	Change
Gross premiums earned	$93,888	$82,547	+$11,341
Net premiums earned	$66,380	$60,551	+$5,829
Total revenue	$68,117	$61,811	+$6,306
Income before taxes	$28,310	$33,170	-$4,860
Net income	$17,620	$20,387	-$2,767
Income available to common stockholders	$17,623	$20,353	-$2,730
Diluted EPS	$1.44	$1.81	-$0.37
Operating cash flow	$35,068	$15,277	+$19,791
Cash and cash equivalents at period end	$296,576	$279,327	+$17,249

Net income margin was approximately 25.9% of revenue, compared with 33.0% in Q1 2013. The estimated effective tax rate was 37.8%, compared with 38.5%.

Loss ratio on net premiums earned increased to 28.0% from 26.2%.
Expense ratio on net premiums earned increased to 32.0% from 21.1%.
Combined ratio on net premiums earned increased to 60.0% from 47.3%; on gross premiums earned, it increased to 42.4% from 34.7%.
Total investments were $172,435 at March 31, 2014, including $155,985 of available-for-sale securities.
Total assets were $549,815 and stockholders’ equity was $168,712 at March 31, 2014.

Debt, liquidity and cash flow

Long-term debt was $127,559 at March 31, 2014, consisting of $40,250 of 8% senior notes due 2020 and $87,309 carrying value of 3.875% convertible senior notes due 2019.
Interest expense increased to $2,574 from $686, primarily because of the convertible debt issued in December 2013.
Operating cash flow of $35,068 was more than sufficient to fund $22,338 of investing cash outflows and $9,569 of financing cash outflows, resulting in a $3,178 increase in cash during the quarter.
Investing outflows primarily reflected $27,015 of purchases of available-for-sale securities.
Financing outflows included $6,987 for share repurchases and approximately $3,035 of net cash dividend payments.
Contractual obligations totaled $232,522, including $182,526 of principal and interest obligations on long-term debt and $48,700 of minimum reinsurance payments.

Material changes versus the prior comparable period

Premium growth was primarily attributable to policies from the Citizens assumption completed in November 2013. Gross premiums earned increased approximately 13.7%, while total revenue increased approximately 10.2%.
Profitability declined despite revenue growth. Net income decreased approximately 13.6%, reflecting higher underwriting, compensation, interest and other operating expenses.
Policy acquisition and other underwriting expenses increased to $9,129 from $5,968, primarily due to renewing assumed policies subject to commissions and premium taxes.
Other operating expenses increased to $9,539 from $6,115. Compensation and related expenses increased by approximately $3,311, including higher stock-based compensation and accrued bonus expense.
Stock-based compensation expense increased to $2,085 from $389, largely due to restricted stock awards.
Premiums ceded increased to $27,508 from $21,996 and represented 29.3% of gross premiums earned versus 26.6%. The 2014 amount included a $5,484 reduction from retrospective reinsurance provisions; no comparable reduction was recorded in Q1 2013.
Loss reserves were $43,597 at March 31, 2014, compared with $41,751 at March 31, 2013, and included $22,263 of estimated incurred-but-not-reported losses. Prior-period reserve development was favorable by approximately $349 in Q1 2014.
The company repurchased 210,836 common shares for $7,805 under a new $40,000 authorization, leaving $32,200 available at March 31, 2014. Holders converted 100,478 Series A preferred shares into common shares during the quarter.

Outlook, commentary, risks and unusual items

The filing provides no formal quantitative earnings or revenue guidance.
Management expects future liquidity needs to be funded primarily from operations, including premiums and investment income, but may use additional debt or equity financing to support growth and investment opportunities.
Insurance results are seasonal because hurricane and tropical-storm activity generally occurs from June 1 through November 30. The annual reinsurance treaty year also begins June 1, so changes in reinsurance pricing or exposure will affect results from that date.
Retrospective reinsurance provisions generated a $5,484 reduction in ceded premiums in Q1 2014. The company had accrued a $12,803 benefit and deferred $5,202 of ceded premiums at March 31, 2014; these amounts could be charged to earnings if a catastrophic loss exceeds applicable coverage limits.
Key risks include Florida hurricane and catastrophe exposure, reserve-estimate uncertainty, reinsurance availability and collectability, reinsurer insolvency, premium-rate restrictions, rate pressure, insurance regulation, interest-rate risk and equity-price risk.
A 300-basis-point increase in interest rates was estimated to reduce the fair value of fixed-maturity securities by $19,592, or 14.72%.
The IRS was examining the company’s 2011 federal income tax return. A Florida premium-tax audit proposed approximately $1,913 of adjustments, primarily related to $1,754 of salary credits; no liability was accrued because management intends to defend its position.
The company reported no material changes to previously disclosed risk factors, no material pending legal proceedings, and no off-balance-sheet arrangements.
Florida law restricts dividends from the insurance subsidiary to the parent and may require regulatory approval, potentially affecting future shareholder dividends.

Most important facts for investors to verify

Whether premium growth from Citizens assumptions and expansion into new products and Alabama produces sustainable underwriting profitability.
Whether the higher expense ratio and combined ratio normalize or remain elevated as the acquired policy base renews.
The adequacy of loss reserves, particularly the $22,263 incurred-but-not-reported component, and the effect of future catastrophe claims.
The economic substance and recoverability of retrospective reinsurance benefits totaling $18,005 in accrued and deferred amounts.
Reinsurance renewal terms and pricing beginning June 1, including coverage limits, reinstatement premiums and reinsurer credit quality.
The company’s ability to fund dividends, share repurchases, debt service and insurance obligations while maintaining required statutory capital and surplus.
The resolution of the IRS examination and the proposed Florida premium-tax adjustment.