Heritage Insurance Holdings, Inc. — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018; filed November 6, 2018. Heritage writes residential property and casualty insurance across Florida, Hawaii and northeastern and southeastern states. Results include Narragansett Bay Insurance Company (NBIC), acquired November 30, 2017, so comparisons with 2017 are not fully like-for-like.
Financial performance and condition
- Third quarter: Total revenue was $125.3 million, up 19% year over year; net premiums earned were $118.2 million, up 24%. Operating income was $14.2 million versus $1.4 million; net income was $6.0 million, or $0.23 per diluted share, compared with a net loss of $8.7 million, or $0.34 per share.
- First nine months: Gross premiums written were $701.6 million, up 54%; total revenue was $355.3 million, up 16%; net premiums earned were $335.6 million, up 21%. Operating income was $47.2 million, up 79%; net income was $23.2 million, or $0.88 per diluted share, versus $3.9 million, or $0.14 per share.
- Underwriting: The nine-month net combined ratio improved to 91.8% from 97.8%; Q3 was 93.9% versus 105.5%. The nine-month net loss ratio was 53.0%, while the net operating expense ratio was 38.8%. Ceded premiums increased substantially, with the nine-month ceded premium ratio rising to 51.5% from 39.6%.
- Cash flow and liquidity: Nine-month operating cash flow was $60.3 million, down from $97.6 million, principally reflecting Hurricane Irma claim payments and timing of reinsurance recoveries. Cash, cash equivalents and restricted cash totaled $233.8 million at September 30; cash and cash equivalents alone were $221.5 million. Cash, cash equivalents and investments were approximately $752.7 million. Management said it expected available capital and operating cash flow to cover anticipated working-capital needs for at least 12 months.
- Balance sheet and debt: Total assets were $1.825 billion, liabilities $1.435 billion and stockholders’ equity $390.6 million. Long-term debt carrying value was $178.3 million; principal outstanding was $197.0 million. Total contractual obligations were $521.5 million, including $216.8 million of reinsurance obligations due within one year.
- Insurance capital: Combined statutory surplus was $367.8 million, down from $376.2 million at year-end 2017. The insurance subsidiaries reported a combined statutory net loss of $71.4 million for the nine months, versus a $12.9 million loss in 2017; the company said they met applicable regulatory requirements.
Material changes and management commentary
- NBIC contributed $256.1 million of nine-month gross written premiums and $54.9 million of net premiums earned. Its addition was a major driver of growth, while legacy Heritage insurers’ written premiums declined about $10.3 million, largely due to Florida exposure management.
- Higher ceded premiums reflected NBIC’s catastrophe and quota-share reinsurance arrangements. Management cited quota-share ceding commissions and reinsurance synergies as contributors to lower reported expense ratios.
- Nine-month losses included $14.7 million of unfavorable prior-year reserve development, driven by personal-lines litigated claims, particularly accident years 2016 and 2017. Q3 Hurricane Florence losses were approximately $20.0 million gross and $16.0 million net. First-quarter winter-storm losses at NBIC were approximately $54.3 million gross and $8.9 million net.
- The 2018–2019 catastrophe program was estimated to cost approximately $252 million. It provided first-event coverage up to $1.6 billion for Heritage P&C, $801 million for Zephyr and $1.0 billion for NBIC; coverage available for later events depends on prior-event severity and exhaustion of layers. Heritage remains responsible for losses exceeding available reinsurance.
Outlook, risks and unusual items
- Hurricane Michael: The October 7 storm occurred after quarter-end. Management initially projected gross losses of at least $25 million and expected to record the maximum potential retention of $16 million pre-tax in Q4; the filing said the ultimate financial impact was not yet determinable. This is an estimate, not a reported Q3 loss.
- Reserves and reinsurance: Loss estimates can change, including reinsurance recoverables on unpaid claims. The company remains liable if reinsurers do not meet their obligations. Coastal concentration and hurricane, winter-storm and other catastrophe exposure are significant risks.
- Accounting control deficiency: The company identified an inconsistency in applying its accounting policy to NBIC’s catastrophe reinsurance at June 30. The omission overstated neither earnings nor equity but understated both prepaid reinsurance premiums and reinsurance payable by $51 million. It was corrected in Q3 by recording $39.3 million net of Q3 amortization. Management concluded no prior period was materially misstated and disclosed a significant deficiency in policy deployment and post-acquisition integration; remediation was underway.
- Other items: Intangible-asset amortization was $19.7 million for the nine months. The company repurchased $10.6 million principal of convertible notes for $13.4 million during 2018 and reported a further $3.1 million principal repurchase after quarter-end. A new authorization permits up to $50 million in share repurchases through December 2020. Quarterly dividends of $0.06 per share were declared for each of the first three quarters; future dividends remain subject to board discretion and legal and regulatory restrictions.
- The filing provides no specific earnings guidance. Management’s liquidity assessment and Hurricane Michael estimate are forward-looking and subject to uncertainty. Other stated risks include reserve inadequacy, reinsurance cost or availability, pricing and modeling risk, claims management, competition, regulation and investment-market risk.
Important facts for investors to verify
- How Hurricane Michael’s ultimate gross losses, net retention and reinsurance recoveries compare with the initial estimate.
- Whether reserve development from litigated claims continues, and how net reserves and IBNR estimates evolve.
- Collection and timing of reinsurance recoverables, including the remaining capacity of catastrophe layers after events.
- Progress in remediating the NBIC accounting-control deficiency and whether controls operate effectively in subsequent filings.
- How NBIC’s contribution, ceded premiums and ceding commissions affect sustainable underwriting results and comparisons with prior periods.
- Debt service, liquidity needs, statutory capital and the capacity to maintain dividends or repurchase shares amid catastrophe losses.