FedNat Holding Company
Q3 2021 Earnings Call Transcript

Published: 9 Nov 2021

[Operator:]

Good morning, and welcome to the FedNat Holding Company’s Third Quarter 2021 Conference Call. My name is Kim, and I’ll 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 all for joining FedNat’s third 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 these 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.

[Michael Braun:]

Thank you. Good morning, and welcome to our third 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. Before I review our third quarter results, I want to discuss the shift and FedNat’s strategy that we announced yesterday. We announced our intent to refocus our operations on the Florida property market, which has been our historical focus since the company's founding in 1992. The geographic expansion strategy that was launched in 2013 to write homeowners insurance in coastal markets outside of Florida, and then accelerated in 2019 was well intended given the challenges we were facing in the Florida homeowners market. The acquisition of Maison Insurance to a lesser extent, the expansion of FNIC’s non-Florida book, ended up being poorly timed due to the unprecedented number of catastrophe weather events that have affected our Texas and Louisiana books of business. The impact of these catastrophic weather losses put a strain on FedNat’s capital position and further action was necessary. We are therefore exiting the non-Florida markets and refocusing our efforts on the improving Florida homeowners market where we believe pricing is the most appropriate relative to increase costs that we have seen in a number of years, in conjunction with the decision to focus on Florida. FedNat has elected to commence an orderly run off of Maison's Insurance operations. Maison will be filing appropriate documentation with its insurance regulators in Louisiana, Florida and Texas, concerning a withdrawal plan, which is subject to regulatory review. We expect to begin non renewing Maison’s Louisiana policies on the expiration dates of each appropriate policy beginning in January 2022, and Maison’s Texas policies beginning in February 2022. The non-renewal Maison’s Florida policies is expected to begin in June 2022 FNIC non-Florida book has been written through our third-party managing general underwriter SageSure and SageSure owns the renewal rights to these policies. After careful coordination and collaboration with SageSure, we expect that in December 2021, SageSure will begin making offers of coverage to FNIC policyholders to renew policies on alternative insurance carrier partners of SageSure in Texas and Louisiana that are not affiliated with the company. FNIC policies in South Carolina, Alabama and Mississippi that were written through SageSure will continue to be renewed by FNIC until such time, as SageSure is affiliates obtain the necessary licensing in those states, possibly in the second quarter of 2022. We expect the transition to be smooth, that’ll obviously subject to appropriate regulatory approvals. We expect the process of running off the Maison book and transferring the SageSure policies to take approximately 18 months to complete. Our commitment to honoring all existing policies remains the same and all policyholders and agents will receive the same professional service they've always received from FedNat. Upon completion of the transition, we expect, FedNat to be right sized to our current capital position, and therefore financially stronger company. We anticipate that we will have approximately $450 million of in-force premiums exclusively in Florida, with less exposure to weather frequency, and therefore less volatility and our underwriting results. We expect the benefits of the transition to begin to materialize immediately in the form of lower capital requirements, and lower exposure to catastrophe weather losses. Over the past five years, we have taken dramatic action to shrink our Florida homeowners book until rates more accurately reflect the increase of doing business, including attritional losses, weather events, and higher reinsurance costs. Our exposure management efforts have reduced our Florida book by over a third from 272,000 policies in-force in 2017 to 168,000 at the end of the third quarter. At the same time, we have an increased FNICs rates by almost 70% human alone. In that time period, restoring rate adequacy in our book. Insurance reform legislation in recent years, including AOB reform legislation, passed in 2019 and SB76 that went into effect in July have also provided some health improving our attritional loss ratios. So we believe now is the right time to refocus on our historical roots in Florida, while FedNat continues to have significant market share strong on underwriting and claims processing capabilities, and strong agent relationships. Turning now to our third quarter results, we reported a net loss of $24.8 million or $1.42 per share in the third quarter 2021 compared to $20.7 million or $1.51 in the third quarter last year. This year's quarterly results were impacted by approximately $20 million of catastrophe weather events including hurricane Ida and other smaller named storms that impacted Louisiana, Texas and Florida. The claims handling infrastructure we have in place, has performed admirably to handle the massive influx of claims from Ida and other events, and have also generated organic capital liquidity that helps soften the blow of the storms to FedNat on a consolidated basis. Ron will provide more details on the impact of the catastrophe events in his remarks. Looking at the Florida homeowners market. The environment continues to have its challenges, though we are pleased with the trends we are seeing in improved attritional losses in both our new and renewal business as they renew at increased rates. These increases include a 6.7% increase that took effect in March and a 9% increase that was implemented in April. We have a 5.7% increase pending that is expected to take effect in November. As a result of these initiatives FNICs average premium per policy increased by $109 in the third quarter, compared to the second quarter of 2021 and $482, higher than the third quarter of 2020. This increase translated into approximately $74 million more in premiums and the $154,000 FNIC policies in-force in the third quarter of 2021 compared to last year, with decreased risk. Importantly, the end result of this increase is got the attritional loss ratio, and FNICs Florida book dropped to approximately 39% for the third quarter of 2021 as compared to 44% a year ago, demonstrating why we are much more comfortable with the Florida market now than we were just a few quarters ago. We remain cautiously optimistic about potential benefits from portions of SB76 reform legislation that became effective on July 1. We are pleased with portions of the legislation, such as measures to reduce the time limits for filing claims from three years to two years, and to better control plan of attorney fees, which are significant issues driving increased costs. At the same time, we believe the significant rate increases that have rolled into our book reflect these increased costs and have enable us to achieve an improved attritional loss ratio. We have maintained appropriate capital positions at FedNat insurance company and Monarch National Insurance Company with a capital infusion into FNIC of $20 million, as of September 30. FedNat elected to not infuse any additional surplus into Maison in the third quarter, and we do not anticipate needing to make any capital infusions in the future. We continue to maintain approximately $40 million and liquidity at the holding company level heading into the fourth quarter. 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 advisor. Now I'll turn the call over to Ron for more details on the third quarter results.

[Ronald Jordan:]

Thanks, Mike. And good morning, everyone. As Mike mentioned our third quarter 2021 results were impacted by significant cat losses from several named storms, including hurricane Ida, and other smaller events, including Elsa, Fred and Nicholas. In total, our third quarter net income was reduced by approximately $20 million, or $1.15 per share net of all reinsurance recoveries in affiliated fees. Because we are not recognizing any tax benefits from our deferred tax assets here in 2021, the impact of the cat losses in the third quarter was the same on both the pretax and an after tax basis. Aggregate gross losses from these third quarter events are estimated at approximately $599 million, $575 of which is attributable to hurricane Ida. These gross losses were reduced by seeded losses of approximately $562 million, consisting of $558 million under our access to the loss reinsurance treaties and $4 million under quota share treaties. The resulting $37 million of retained catastrophe losses within our insurance subsidiaries was partially offset by the accrual of $17 million of earnings, family related claims handling and other revenues in affiliated entities driven by the significant size of Ida. Net of the related affiliated claims handling fees, these cat events added approximately 38 points to our loss ratio and combined ratio in the quarter. If one were to adjust our third quarter operating loss for the impact of the cat events, and then apply the federal tax rate, it indicates the FedNat’s adjusted operating loss in the quarter would have been approximately $4.4 million or $0.26 per share with the change in our strategy Mike just described to refocus on our foreign markets. And with the approved and pending rate increases that are rolling into our book, we expect FedNat to achieve Xcat earnings improvement in 2022. To illustrate the future benefits of the strategy shift, I would point out that since the beginning of 2020, our non-Florida business has contributed almost 70% of our net catastrophe losses before fee offsets, despite representing less than 40% of our in-force premium. Going forward, we will continue to work to achieve low double digit ROEs 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, which enabled us to reduce our total catastrophe reinsurance costs for the '21, '22 treaty year. Our Florida policy count at September 30 is down almost 7% sequentially from June 30 and down almost 23% from September 30 of 2020. The total insured value of our Florida book at September 30 is down over 17% from a year ago. We have continued to manage our exposure in Florida over the past few years until rates adequately reflected our cost of doing business. Importantly, we think we have largely accomplished that objective, and now expect to begin bearing the fruit of our disciplined approach. Other than normal ongoing exposure management pruning, we expect our Florida policy count to level out and perhaps increase slightly, such that in the coming quarters rate increases will begin to add to our gross written premium, rather than in air quotes funding exposure management initiatives, as they have done in recent years. Despite the intentional shrinking of our policy count, grocer in premiums declined less than 3% from last year third quarter. Due to the strong growth in average premium per policy resulting from our rate increases. Net premiums earned in the third quarter declined to $54 million from $83 million in the prior year, due entirely to a $24 million increase in seated premiums, driven by increases in the percentages of quota share reinsurance in effect. As communicated in previous earnings calls, this reduction in net earned premiums is largely offset by corresponding reductions in loss and LAE in commission expense. Our net loss ratio, net expense ratio and combined ratio are of course elevated by the higher level of seated premiums. So it's worth pointing out that our gross expense ratio continues to perform well at less than 26%. Turning now to our balance sheet and capital position, we continue to maintain surplus in FedNat Insurance Company and Monarch National, consistent with RBC ratios of 300% or above. We made a capital infusion to FNIC of approximately 20 million effective as of September 30. We also maintained our commitment to having appropriate liquidity at the holding company. And we currently estimate that holding company liquidity is approximately $40 million heading into the fourth quarter. As Mike discussed, we elected to not make any capital infusion into Maison in the third quarter, and we do not anticipate needing to make future capital contributions to Maison. Maison’s Capital of course remains part of the FedNat consolidated group and will be redeployed within our structure at the appropriate time subject to regulatory approval. At the end of the third quarter, we held total investments of approximately $355 million in addition we ended the quarter with total cash and equivalents of approximately $167 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. Overall, the portfolio has a duration of 3.9 and a composite credit rating of A minus. And with that, I'll turn the call back over to Mike.

[Michael Braun:]

Great. Thank you, Ron. Operator, with that we'll go ahead and take any questions that there's an analyst that has a question for us.

[Operator:]

Our first question comes from the line of Paul Newsome with Piper Sandler. Your line is open.

[Paul Newsome:]

Good morning. I was hoping you could help me with some modeling questions related to the expense levels prospectively given the runoff. Are there expenses that we will incur that are related to the runoff itself? That could be elevated in the short term? And if we think about longer term, where do you expect things like your general administrative expenses and in sort of commission level type expenses to run prospectively given the run off in the focus in the Florida business?

[Michael Braun:]

Yes, hey, good morning, Paul. This is Mike, Ron can go a little deeper on the math. But I don't think there's going to be any significant costs to exit the market. As you know, in our business, the vast majority of our expenses are variable expenses. So acquisition and overhead, that's commissions to agents as well as commissions to our managing company to run the business. There's an attritional loss. So as the books decreases, those attritional losses would obviously decrease proportionately. And then there's also the weather, net weather retained. And once again, I would say those would be in line. The only fixed costs would be reinsurance what we call XOL reinsurance excess of loss. That is a variable expense, but it's kind of locked-in for a period of time. And what that means is that September 30 that we did lock-in that expense. So we do anticipate that the book will gradually shrink in the beginning of 2022. But I don't think it will significantly affect our expense ratio for the ceded premium. And then just to clarify, in terms of staffing, we have about 360 employees, and do not see much of any change on our staffing levels. And what I mean by that is, is with Maison, that book of business is handled organically. And we're pretty mean and lean with our staffing, I'll put it that way. And any folks that have been specifically committed to the Maison business could easily transition over to the other business that we have both with FNIC as well as MNIC. And in addition, the same is true for our folks in claims. And obviously all the other departments within the company, really support all functions, IT, HR, accounting and so on. So not sure Ron if you want to go deeper on the math there. But really the most of our expenses are variable expenses.

[Ronald Jordon:]

I guess, just a couple things to add. In terms of the commission and acquisition costs, one thing I will say is that with the SageSure book, acquisition costs have been higher there given that we, of course, pay an MGA fee over to SageSure. So I do think as that book becomes a smaller percentage of our total, our overall weighted average commission and other underwriting expenses would trend down to be more in line with just the Florida marketplace. I think that's probably the only additive comment.

[Paul Newsome:]

With the general and administrative expenses have been running sort of $23 million $24 million a year. Is that a good run rate prospectively?

[Michael Braun:]

Yes, it really is. Those, those costs really did not go up as we increased in size very much at all. And I really don't expect them to come down too much as we contract a little bit outside of Florida, consistent with the remarks that Mike just made.

[Paul Newsome:]

I’ll let somebody else asked their question. Appreciate the help and the insights.

[Michael Braun:]

Yes, no, absolutely appreciate that.

[Operator:]

[Michael Braun:]

Yes, operator. While we're waiting to see if anyone else joins any other analysts joining the queue. I just did want to share an email from the long-term shareholder, Doug Ruth who is not able to get on the call. He was just asking for an update on the Florida marketplace. So I just want to elaborate a little bit I have said repeatedly over the last three, four years that we have no desire to write the Florida business rule the Florida business until our rates more accurately reflect our increased cost of doing business. So why the change of heart in Florida? And the answer is, our costs are up 70%. I don't think I don't say that, that's a good thing to our policyholders to all the hard working people throughout the state of Florida, but it's a reality that their rates had to go up because of the operating environment in which we are operating in. So we do feel that we're doing the correct service to our policyholders. Its unfortunate rates had to go up like that. Hopefully there'll be more reforms at the state level to bring those costs down. But with those elevated costs, we feel that rates are now more accurate than they have been in a number of years. And we're seeing that Florida is a hard market, it's a difficult market that a lot of non-carriers are writing. However, we're seeing signs that things are going to be changing in the near future. I encourage people to look at Barry Gilway, he runs Citizens Property Insurance Corporation. He did a presentation into the banking and insurance commission at the Senate, Florida Senate. And he talks about numerous investors trying to get into Florida, numerous investors. And how one company in particular, tried to take policies on the citizens about 23,000 and only got about 10,000 of those. So I think the Florida market is changing. I think the rates are more accurate. I think AOB reform has taken a small bite of the apple, I think SB76, has taken a small bite of the apple. But the truth is greats have really changed materially to reflect these increased costs. So I just want to stress that. And then the other question that Doug had sent over via the email was separate from the Florida market places than non-Florida market, our thoughts on the non-Florida market. I think the expansion into other states with the same lines of business, and the same risks was appropriate at the time, our Florida market was really under attack with increased costs. So once again, we were still exposed to a homeowner type policies in coastal states. And the last 15 months has been absolutely brutal. I've been doing this for 20 plus years. And that was off the charts, what we saw. So we do have new capital position, and we do need to respond appropriately. So I think that shrinking that non Florida book, the SageSure book, and they've been a very good partner. But once again, the weather has been very unkind of that book. And also with Maison, the weather has been very unkind, we have to respond. So those two books of business represent approximately $270 million of premium. And that would reduce us down to the $450 million, much more appropriate for our capital base. So with that I return it back to the operator, see if we have an analyst questions.

[Operator:]

Yes, we do have another question from the line of Paul Newsome with Piper Sandler. Your line is now open.

[Paul Newsome:]

I apologize for another modeling question. But other income has been an important component of your revenue, and is a little bit more difficult I think, for outsiders to model. Can you talk about sort of what the outlook is for that, and it will continue to be important component of your profitability?

[Michael Braun:]

Yes, absolutely, Paul. So Florida is an MCA state. And what that means is this post-pandro , the way the regulators and State of Florida attracted capital was to create this MGA model, where not only do you have a carrier, where you have affiliates, and these affiliates perform work. So we have always had an MGA within our business model, since we've been writing property. And I can tell you that what we have found is that our policyholders are best service, when we have our folks handling these claims, and doing as much as possible. So what we do is we do charge fees for those services and they're based on market pricing, what we see that others would get, so fortunately, I do believe, obviously there's some financial benefit on a consolidated basis. But I truly believe there's a significant benefit to our policyholders, and all of our partners to make sure that we can handle these claims as quickly as possible with the goal being to hand it off as little as possible. One of the challenges in Florida, as when you have smaller companies when there's multiple people handling a claim, so we're trying to get out to the policyholder, as quick as possible when they have a claim, primarily a weather claim, help with remediating that we've done an incredible amount of tarping after Ida, and then doing whatever we can to move that claim through our process and try to get that policyholder, whole as quick as possible back to their original position. So that's the intent. In terms of specifics on modeling that, it's tough because it's really dependent on weather, but obviously, I defer to Ron on best ways to communicate that.

[Ronald Jordon:]

And I'll just add on a few remarks there. Another one of the notable contributors fall through the other income line specifically is brokerage income that we earn from our internal reinsurance broker that's involved with the placement of our XOL tower each year, and certainly that will continue to be a meaningful income stream. Certainly over time, our XOL spend will come down as we become Florida centric, and so brokerage income would come down with that. Broker's income was particularly elevated, as you'll recall, during the treaty year that ended June 30, because we had a lot of backup purchases, and additional seated XOL premium and that contributed to elevated brokerage income, particularly in the first half of 2021. It kind of reset as of July 1 along with the new reinsurance tower. And so Q3 is certainly much more indicative of the run rate currently, based on the current treaty year that we're in.

[Michael Braun:]

Paul also I'll just, there's a table in our 10-Q, that you'll be able to look at, with respect to other income to get little detail into that number.

[Paul Newsome:]

Thank you very much.

[Michael Braun:]

Thank you, Paul.

[Operator:]

I'm showing no further questions at this time. I would now like to turn the conference back to Mike Braun.

[Michael Braun:]

Thank you very much. Thank you all for participating on today's call. Before we close, I want to recognize our FedNat team who continue to provide exceptional service to our policyholders and partner agents, particularly in their times of need. The dedication and hard work of our team has enabled FedNat to maintain our high quality reputation for close to 30 years, and we look forward to continuing to meet the highest standards of customer service, as we refocus on our historical home market in Florida. So with that, I just want to thank everyone once again, and if there’s follow-up questions, please reach out to myself, Ron or Bernie. And everyone, have a great day. Thank you.

[Operator:]

This concludes today's conference call. Thank you for participating. You may now disconnect.