FedNat Holding Company
Q2 2021 Earnings Call Transcript

Published: 10 Aug 2021

[Operator:]

Good morning, and welcome to the FedNat Holdings Company Second Quarter 2021 Conference Call. My name is Pasha, and I will be your conference operator this morning. Before we begin today’s call, I’d like to remind everyone that this conference call is being recorded as well as broadcast live via webcast. Additionally, today’s call will be available via webcast replay later this afternoon and accessible by visiting the Investor Relations section of FedNat’s website at www.fednet.com. Now, I’d like to turn the call over to Bernie Kilkelly for FedNat Investor Relations. Bernie?

[Bernie Kilkelly:]

Thank you. Good morning, and thank you to everyone for joining FedNat’s Second Quarter 2021 Conference Call. Our earnings release and prepared remarks include references to non-GAAP measures, such as adjusted operating income. We use these non-GAAP measures to provide greater transparency and a more meaningful, efficient comparison to prior year’s results. Our non-GAAP and reconciliations from the GAAP measures to the non-GAAP measures are available in our earnings release. Statements in this conference call that are not historical facts are forward-looking statements. Words such as anticipate, estimate, expect, predict, project and other similar words or phrases are intended to identify forward-looking statements. The matters discussed on this call that are forward-looking statements are based on current management expectations involving risks and uncertainties that may result in those expectations not being realized. Actual events, outcomes and results may differ materially from what is expressed or forecasted in forward-looking statements made on this call due to numerous risks and uncertainties, including, but not limited to, the risks and uncertainties described in this conference call, our press release issued yesterday and other filings made by the company with the SEC from time to time. Forward-looking statements made during this conference call speak only as of today’s date and FedNat specifically disclaims any obligation to update or revise any forward-looking statements to reflect new information, future events or circumstances or otherwise. Now I will turn the call over to FedNat’s Chief Executive Officer, Mike Braun.

[Mike Braun:]

Thank you. Good morning, and welcome to our second quarter 2021 conference call. Ron Jordan, our Chief Financial Officer; and Erick Fernandez, our Chief Accounting Officer, are on the call with me today. After my remarks, Ron will go into more detail on the financial results for the quarter and then we will take questions. Our second quarter 2021 results were significantly impacted by 3 factors. The first was higher-than-expected catastrophe losses driven by 15 separate weather events. These events are primarily convective storms and hail events in fact in Texas, Florida and Louisiana. The pretax impact of these cat losses was approximately $23.5 million net of reinsurance recoveries and fee income. The quarter’s results were also impacted by higher-than-expected expenses from additional reinsurance purchases and reinstatement premiums as we work to minimize the impact of cat losses on our statutory capital. As you may recall, we communicated this item at the time of our first quarter earnings call. Fee increases, increased our expenses on a pretax basis of $17.3 million. The third factor was a onetime noncash charge of $17 million for the recording of a valuation allowance against our net deferred tax asset. I will discuss this item in more detail. But as I stated in our earnings release yesterday, we expect the deferred tax assets to be realized in the future. However, the timing of this recognition will depend on the timing of pretax income as we earn it in future quarters. Turning back to the extra purchases and reinstatement premiums in the second quarter, those were made under our 2020-2021 reinsurance program. As you know, this program was stressed by a record high number of severe weather events in the second half of 2020, along with Winter Storm Uri in Texas in February, which drove back up purchases and additional reinstatement premium. We started with a cleaning slate on July 1 with our new reinsurance tower for 2021-2022. This new tower has a lower overall cost compared to the previous year’s total expense, resulting from a progress we have in our initiatives to reduce our total insured values and overall size of our book. With the growth of our non-Florida business, we also benefited from separating the overall program in 2 reinsurance towers. We continue to work on a large number of our long-term high-quality reinsurance partners, and we appreciate their continued support. The overall cost of the new 2021-2022 program is expected to be approximately $288 million. This compares to overall cost for last year’s program of $311 million, which included approximately $41 million additional purchases. The new program provides a total of $1.4 billion of single event coverage, which is approximately $100 million higher than last year’s program. We also have a lower retention of $10 million per event in our main reinsurance program and a separate $8 million retention in our SageSure book of business compared with $25 million in last year’s program. We now have $2.25 billion of aggregate reinsurance coverage within our 2 reinsurance towers versus $1.9 million in last year’s single tower. As I mentioned, a major reason for the expected reduction in our reinsurance costs is the progress made in our initiatives to reduce our total insured exposure and raising rates in instructing business in both our Florida and non-Florida markets. Insured rates more adequately reflect our increased cost of gain business, including reinsurance costs. Looking at the Florida homeowners market, the environment has been challenging, but we are encouraged by portions of SB76 with form legislation that was signed by the governor on June 11 and became effective on July 1. In particular, we are pleased with the measures to reduce the time limits for filing certain claims from 3 years to 2 years and more significantly, initiatives to better control plaintiff attorney fees. We are cautiously optimistic that some of the issues driving increased costs have been addressed. At the same time, we believe the significant rate increases that have rolled into our book much better reflect the increased cost and have enabled us to achieve improved attritional loss ratios. In the current environment in Florida, we continue to focus on reducing the number of policies we have, while keeping in-force premium relatively flat through rate increases. Our Florida policy in-force decreased to 180,000 at the end of the second quarter, down 9% sequentially from $197,000 at the end of the first quarter. This represents a significant reduction of over 1/3 on the book of business since 2017, and we had 272,000 policies in force. Our rate increases in Florida include a recent 6.7% increase that took effect in March, a 7% increase that was implemented in April and an additional 3.9% increase that is expected to take effect in September. As a result of these initiatives, our average premium per policy increased by $177 in the second quarter compared to the first quarter of 2021. This was also $432 higher than the second quarter of 2020. This increase translates into approximately $72 million more in premiums on the 180,000 policies in-force in the second quarter of 2021 as compared to last year with decreased risk. Turning to our non-Florida booking business. We are continuing to manage our total insured exposure, including concentrations in key areas such as Houston, New Orleans and Charleston. Our non-Florida policies in-force continue to decline as well as shown by a 3% decrease sequentially $244,000 at June 30 from $149,000 at March 31. We continue to file rate increases to pass through our increased cost of gain business. Business written through our SageSure managing general underwriting partner includes inflation guard, which is currently producing a 5% increase in all states due to the increase of primarily labor costs. SageSure also implemented a 6.9% rate increase in South Carolina effective in April, a new business and in May on renewal basis, also expecting to take an additional 6.9% in South Carolina in the near future and more rate filings thereafter. Texas has a recent rate increase of 9.5% to be effective in August on a new business in November on renewal business. This is in addition to a recent 9% increase in Texas effective in April on new and on renewal business in May. For Louisiana, an increase of 15% is to be effective in September on new business and in October on renewal business. This is in addition to the 9.9% increase that was effective in December 2020 on new business and in January in renewal business. For Maison, a rate increase of 15.9% took effect in Louisiana in December of 2020, followed by an additional rate increase of 11.1% in July of 2021 and an 18.9% increase expected to take effect in November, a 12.3% increase took effect from Maison in Texas in February, and we expect to file for additional rate increases later in 2021. Our non-Florida markets continue to have more favorable operating environment, including less litigation. Excluding the impact of severe weather events, we continue to be pleased with our underlying performance and profitability of our non-Florida homeowners business. Our non-Florida attritional loss ratio, excluding capacities is generally in the mid-20s compared to approximately 40% for Florida. As a result of our expansion in more favorable noncore markets, our non-Florida insured exposure is now just under 50% of our total on the basis of total insured value. Our overall rate increases in Florida and non-Florida are on track to generate over $75 million in incremental gross earned premiums in 2021 as compared to 2020 based on our fourth quarter 2020 book of business. We anticipate that when fully earned out in the second half of 2022, these increases will contribute over $224 million of cumulative increases in premium in 2021 and 2022 and $156 million of incremental premium annually thereafter as compared to the fourth quarter 2020 buck. We continue to be proactive to maintain appropriate capital position within our 3 carriers through additional reinsurance purchases and capital infusions. At the same time, we maintained approximately $40 million of liquidity at the holding company level heading into the third quarter. This was in large part due to the capital raises we completed in March and April, including the common stock offering of $17 million and a convertible notes offering of $21 million. As you know, last November, our Board of Directors formed a special Board Committee to oversee a review of strategic alternatives including exploring options to strengthen the company’s capital position. The work of the committee is ongoing and the committee continues to work with Piper Sandler as its financial adviser. Before I turn the call over to Ron, I want to briefly mention Hurricane Elsa, which was a third quarter event, making landfall in Florida on July 7. This event has not had a significant impact to date We have received approximately 150 claims totaling approximately $1 million with about 65% of the plans in Florida and the remainder mostly in South Carolina. We will need additional claims history to estimate our total losses from the storm, which we will report after we close on our third quarter. I’ll now turn the call over to Ron for more details on our second quarter financial results.

[Ron Jordan:]

Thanks, Mike, and good morning, everyone. As Mike mentioned, our second quarter 2021 results were significantly impacted by higher-than-expected cat losses, expenses from additional reinsurance purchases, including reinstatement premiums and the recording of a valuation allowance against the company’s deferred tax assets. Second quarter also includes approximately $5 million of net adverse impact from reserve strengthening primarily related to winter storm Uri. Our net loss in the second quarter was $50.4 million or $2.89 per share compared to a net loss of $21.5 million or $1.57 per share in last year’s second quarter, which was also impacted by a high number of severe weather events. Adjusted operating loss in the second quarter was $50.5 million or $2.90 per share compared to adjusted operating loss of $28.1 million or $2.05 per share in the second quarter of 2020. Looking more closely at the 2 most meaningful pretax impacts on the quarter, our pre- and post-tax earnings were reduced by $23.5 million of catastrophe losses, net of all recoveries, including reinsurance and affiliated claims handling fees and $10.7 million of recoveries presented in net realized and unrealized gains, losses as described in more detail in our press release and in our 10-Q. There were 15 separate events, including convective storms and hail, primarily in Texas, Louisiana and Florida. Aggregate gross losses from these events are estimated to be approximately $90 million. These gross losses were reduced by recoveries of approximately $62 million, consisting of $55 million related to reinsurance treaties, excess of loss reinsured treaties and $7 million under quota share treaties. Net of related affiliate claims handling fees, these cat events added approximately 96 points to our loss ratio and combined ratio in the quarter and reduced our earnings by $1.35 per share. Now I’ll turn to the second large impact, which was the extra costs we incurred in the quarter from additional reinsurance purchases and reinstatement premiums. All of these expenses related to our 2020-2021 catastrophe reinsurance program, which ended on June 30. Given the terms and conditions of the 2020-2021 program, combined with the record number of retention events that occurred in that treaty year, we made numerous backup purchases to replace utilized limit and minimize exposure to subsequent events. In addition, we had co-participations on reinstatement premium in portions of the tower. In the second quarter, these purchases and reinstatement premiums added a total of $17.3 million in incremental excess of loss ceded premium expense. This extra spend in the quarter added 94 points to our combined ratio by reducing the net earned premium denominator of that calculation. Of course, our reinsurance program reset on July 1, which gives us a clean slate starting in the third quarter along with reduced costs for the new ‘21-’22 3-year program. As Mike mentioned, the initial overall cost of the new program is $288 million or $72 million per quarter, $85 million of ceded XOL cost was recognized here during the second quarter, which is $13 million higher than our expectations for the third quarter of $72 million that I just cited. The third major impact in the quarter was the booking of a valuation allowance against our deferred tax assets, which increased to the quarter’s loss by $17 million. As Mike said, management expects these deferred tax assets to be fully realizable over time. However, generally accepted accounting principles set the bar pretty high when there is a recent history of losses and thus, we had to set up a valuation allowance this quarter. This amount -- the amount of the charge consists of the tax benefit foregone on the second quarter operating loss and the reversal of the tax benefit recorded during the first quarter. Staying high level, this noncash charge is accounting-driven. And at the end of the day, amounts to a timing difference with respect to when tax benefits and tax expenses will be recorded. Here in 2021, we are foregoing the recording of tax benefits against our losses. But when we generate taxable income in the future, we’ll be able to forgo recording any tax expense against that income until we are made whole on our 2021 loss. Lastly, I’ll mention one smaller impact in the quarter, which was the reserve development from first quarter ‘21 and prior. In the second quarter, we increased ultimate loss estimates by $162 million across numerous catastrophe retention events, including the 5 named storms from the second half of 2020. Approximately 90% of the increase was covered by related catastrophe reinsurance coverages. After all recoveries and offsets including estimated catastrophe claims handling fees, the net impact on our second quarter 2021 earnings was approximately $5 million. If one were to adjust our second quarter operating loss by the 4 impacts that I just discussed, which were cats, extra XOL expense, the tax charge and then the catastrophe reserve strengthening and then apply the federal tax rate to that result, it indicates that FedNat’s adjusted operating income in the quarter would have been approximately $10 million absent the items named. With the additional gross earned premium that we expect to realize from the rate increases that Mike described, we anticipate FedNat will achieve ex-cat earnings growth in the second half of 2021 as the approved and pending rate increases roll into our book. We continue to see ourselves as a low double-digit ROE company in years where catastrophe losses approximate the models with higher ROEs attainable when cat losses come in favorably as compared to the models. We continue to make strong progress in reducing the size of our book and the related total insured value, enabling us to reduce our total catastrophe reinsurance costs. This is reflected in the decline of our Florida policy count and total insured value, which are down 22% and 18%, respectively, when comparing June 30, ‘21 to June 30, 2020. We are continuing to shrink our book of business in Florida until rates are adequate and are managing our exposure in both Florida and non-Florida markets by raising rates. Non-Florida policies in-force were 144,000 at June 30 and compared to 149,000 just 3 months ago, reflecting our desire to limit growth in these states at this time. Our geographic mix on a policy count basis at June 30 was approximately 56% Florida and 44% non-Florida as compared to a 61-39 split at June 30 of last year. Despite these intentional reductions in our book, gross earned premiums were flat with 2Q ‘20, as Mike has already mentioned, indicating strong growth in average premium per policy an indicator that the profitability of our book is improving. Net premiums earned in the second quarter declined to $35 million from $111 million in the prior year due primarily to a $70 million -- $75 million increase in ceded premiums, including the extra XOL reinsurance costs I have described. The remainder of the ceded premium increase was driven by additional quota share sessions in both Florida and non-Florida which we entered in during the second half of 2020. In FNIC’s Florida book, 40% quota share continues to be in effect, representing $28 million of ceded premiums in the quarter compared to just $8 million in the second quarter of 2020 when only 10% quota share coverage was in place. For non-Florida markets, our 80% quota share treaty on FNIC’s non-Florida book remains in place as compared to 0% quota share during the second quarter of 2020 driving a $24 million increase in ceded premium. Note that the ceded quota share premium figures are net of cat reinsurance allowances that are built into the various treaties. And of course, losses and operating expenses in our results are also lower as a result of corresponding sessions and/or allowances pursuant to the treaties. Turning now to our balance sheet and capital position. We maintained our commitment to ensuring appropriate statutory capital in our insurance companies and liquidity at the holding company. We continue to maintain surplus in our 3 insurance carriers consistent with RBC ratios of 300% or above. We have made capital infusions to our insurance companies of approximately $40 million effective as of June 30, and we currently estimate that holding company liquidity is approximately $40 million heading into the third quarter. We expect the inception of our new reinsurance tower with its lower per store retentions to be a notable benefit in terms of conserving capital going forward along with the lower quarterly cost of the XOL program and the continued earn-out of our rate increases. At the end of the second quarter, we held total investments of approximately $424 million. In addition, we ended the quarter with total cash and equivalents of approximately $111 million. We continue to maintain our discipline to invest in higher-quality liquid bonds and a handful of preferred securities with no common stock exposure in the portfolio. And overall, the portfolio has a duration of 4.0 and a composite credit rating of A-. And with that, I will turn the call back over to Mike.

[Mike Braun:]

Thanks, Ron. And with that, operator, if you can open up the lines to any questions.

[Operator:]

And your first question is from the line of Paul Newsome with Piper Sandler.

[Paul Newsome:]

On the DTA, am I correct that effectively in the future, you should assume an effective tax rate gets close to 0 now that the DTA has been -- went off?

[Ron Jordan:]

Yes, that’s correct, Paul.

[Paul Newsome:]

Would there be a couple of points of state taxes? Or is that also part of the DTA?

[Ron Jordan:]

There’s also valuation allowances against the state income taxes. So 0 on that side as well. And again, in both cases, 0 if we have future losses but also 0 for a time when we begin to generate earnings again.

[Paul Newsome:]

Great. Could you talk a little bit -- explain a little bit more about the holding company liquidity and how that’s precisely constructive? Is it just all cash? Or is there debt capability? How do you think of the whole recovery liquidity piece?

[Ron Jordan:]

Sure. It’s not all cash. There are short-term working capital types of components to it as well. Those would primarily consist of short-term receivables that convert into cash in the near term. We certainly exclude anything that’s not cash in the near term, such as deferred tax assets, for example, or long-term tax receivables buildings, equipment, et cetera. So we -- and we talk about this in the capital and liquidity section of our 10-Q, which was filed last night. But as of 6

[Paul Newsome:]

Is the DTA and asset for statutory purposes?

[Ron Jordan:]

We have valuation allowances up for statutory reporting as well.

[Operator:]

[Mike Braun:]

And thank you operator. With that, what we’ll do is go ahead and conclude the call today. Just a brief overview once again. Over the last 4 quarters, we incurred 6 major weather events. Our main reinsurance program had a $25 million retention. That is massive. We had 2 in the second -- in the third quarter, 3 in the fourth quarter and then 1 in the first quarter. So you combine those up, that’s $150 million. There were some benefits on there, some fees, et cetera, that brought that down a bit on quota share, but nonetheless, a huge number. And then on top of that, we had subsequent XOL reinsurance purchases of $40 million. And it was a massive expense that we’ve incurred and that’s behind us. We now have a new reinsurance program that is lower as a percentage of total dollars and lower as a percentage of premium. We’re also seeing favorable movement in Florida on our attritional loss ratio, down year-over-year in excess of 5 points. I would say that’s also occurring while some of the headwinds remain in Florida in the first half of the year where a lot of lawsuits were pushed in before insurance reform, but we expect to continue to see the Florida attritional loss ratio drop. And the reason for that is primarily driven by rate. I would call it a tsunami of rate that we have that’s rolling into the book, that’s in excess of, let’s call it, roughly $25 million per quarter with all the different lines of business that we have. So with that, we’ll go ahead and conclude. So I just wanted to recognize our FedNat team as well for providing the highest quality service to all of our policyholders and our partner agents. We did transition to a remote environment about 14, 15 months ago and have converted back to a hybrid environment. So the health and safety of our team and our policyholders is a top priority. So with that, if there’s follow-up questions or comments, please do reach out to us. And everyone, have a great day. Thank you.

[Operator:]

Thank you, ladies and gentlemen. This concludes today’s conference call. We thank you for participating and ask that you now disconnect your lines.