FedNat Holding Company
Q2 2020 Earnings Call Transcript

Published: 9 Aug 2020

[Operator:]

Good morning and welcome to the FedNat Holding Company's Second Quarter 2020 Conference Call. My name is Dexter and I will be your conference operator this morning. At this time, all participants will be in listen-only mode. 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.fednat.com. Now, I would like to turn the call over to Bernard Kilkelly for FedNat Investor Relations. Bernie?

[Bernard Kilkelly:]

Thank you, operator. Good morning and welcome again to FedNat's second quarter 2020 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 second quarter 2020 conference call. Ron Jordan, our Chief Financial Officer; and Erick Fernandez, our Chief Accounting Officer, are on the call with me today. I'm going to give an overview of the quarter. Then Ron will provide more details on the financial results. Then we will open the call to questions. Before we discuss our second quarter results, we wanted to acknowledge the ongoing challenges that countless Americans are experiencing within the states and communities in which we operate. Our hearts continue to go out to everyone affected by the COVID-19 pandemic. FedNat is committed to the safety and wellbeing of all of our stakeholders, especially our staff, policyholders and partner agents. I want to recognize our employees who continue to demonstrate incredible resilience and dedication while providing the highest quality service to our policyholders and agents during the crisis. The vast majority of our staff continue to work remotely as they have since we put our business contingency plan in place back in March. As we restated, when we released our first quarter results in May, we do not expect the COVID-19 pandemic to directly impact FedNat's underwriting results. But since the pandemic is having such a widespread impact on the economy, there could be impacts to FedNat. We are continuing to closely monitor the situation and more specifically within the states and communities in which we operate, to track and adjust our operations to any long-term effects that may develop. Turning now to our second quarter results, as previously announced early in July, the main storyline in the quarter was the $48.3 million of pre-tax net catastrophe losses driven by a high number of severe weather events in Florida and across the entire southeast region of the country. We also preannounced that we strengthened reserves by $7.5 million pre-tax in our Florida homeowners line of business for prior accident years, primarily related to the 2019 accident year. We proactively took this action because the property claims environment within Florida continues to be challenging. While the number of AOB lawsuits continues to decline sharply, the powerful plaintiff's bar in Florida remains diligent in finding avenues to bring litigation against insurers. As a result, adverse experience continues to impact our financial results plus outpace the rate increases that we have implemented. As such, we continue to limit our appetite to write new business within Florida until our premiums more accurately reflect these increased costs. Our strong 2021 reinsurance program has been successfully placed with our reinsurance providers and provides us approximately $650 million of private reinsurance for our non-Florida states, plus an additional $650 million of limit within Florida for approximately $1.3 billion of first-event coverage in excess of $31 million, and an aggregate cover of $1.9 billion, at a total cost of $265 million, subject to adjustments at different points in time in the coming months. We also recently purchased additional reinsurance that lowers our retention to as low as $10 million for potential second and third events inside of Florida, as detailed in our prior public disclosures. We are pleased with the high-quality of the participants in our reinsurance tower and we continue to appreciate the strong support we receive from our reinsurance partners. Having addressed our primary headwinds, let me turn to the execution of our strategy to drive improved operating results and capital efficiency in the second half of 2020 and beyond. Our efforts are ongoing to improve the profitability of our Florida homeowners book of business by continuing to raise rates and restrict new business. We have a 7.4% statewide average increase that took effect on June 15 and have since filed for an additional 5.6% increase related to the higher reinsurance costs, which if approved, will take effect in October. Monarch also recently filed for rate increases within Florida, averaging over 12%, plus we have rate filings pending in Texas and Louisiana, which I will touch on in a moment. Ron will share additional specifics, but in aggregate, filed rate increases across all states along with past increases that are still earning out, will add $65 million of incremental gross earned premiums on our existing book of business within calendar year 2021 compared to 2020. [This is] [ph] throughout Florida during wind season and expect policies in force to continue to decline throughout the balance of this year. We have continued our long-term strategy of shedding policies that are not meeting our expectations. A comparison to 2017 aptly illustrates the point. Policies in-force in Florida at the end of the second quarter in 2017 - I'm sorry, in the current year is $230,000, a decline of over 15% from $272,000 at the end of 2017. Premiums in-force in Florida are down by less than that due to our rate increases, indicating a strong trend of higher average premiums per policy. We expect that trend to continue, given the filed rate increases that are yet to earn-out. To put a finer point on it, over the past 3.5 years, our cumulative rate increases in Florida have reached 36%. When factoring in the impact of compounding, the cumulative percentage grows to 42%. We have clearly demonstrated that we have the discipline to limit growth in our Florida book until our approved rates are more in line with the higher claims and reinsurance costs that we continue to incur. The profitability of our non-Florida homeowner's business, excluding the impact of severe weather events continue to meet our expectations in the second quarter. We remain focused on our long-term growth strategy of expanding profitably in more attractive coastal homeowner markets outside of Florida. These markets continually - sorry, currently have a more favorable operating environment, including less litigation and more flexibility in terms of setting rates. We continue to be pleased with the performance of Maison and with our strong partnership with SageSure. We significantly improved the capital efficiency of our relationship with SageSure in the second quarter by entering into a new 50% quota share reinsurance treaty with Anchor Re, an Arizona domiciled wholly owned reinsurance subsidiary of SageSure. This treaty became effective on July 1 and will run through June 30, 2021 with the expectation of an annual renewal. This quota share will not have any impact on FedNat's pre-tax operating results, as it essentially mirrors the existing 50% profit share arrangement, which continues to be in place. But it will affect components of the combined ratio, including a reduction to net earned premium. We expect that our insurance carrier, FedNat, will receive statutory surplus relief from this quota share treaty. Just as we are doing in Florida, we continue to see great increases and maintain strict underwriting discipline in our non-Florida markets to increase profitability. FNIC has filed for a rate increase of over 9.5% in Texas and Louisiana to take effect in November, and if approved in November. And Maison has filed for 15.9% increase in Louisiana to take effect in November, if approved. Our investment portfolio performance was solid in the second quarter, which Ron will discuss in more detail. The quarter was highlighted by a strong rebound in the equity markets after the declines of the first quarter. FedNat's balance sheet and capital position remains solid and will enable us to maintain our strong commitment to returning value to our shareholders through our dividend and periodic share repurchases. After several successful months of purchasing back our shares at below book value, we paused this initiative early in the second quarter in light of the unknown challenges associated with the macroeconomic environment as well as weather losses at that time, prudently focusing on the maintenance of our capital base. We have remaining authorization of $10 million in buybacks at our disposal for the balance of 2020. Our board will continue to make decisions on repurchases based on market conditions and the capital needs of the company, though our repurchases typically are quite limited during wind season. Looking ahead, we are continuing to move forward with our strategy of optimizing our homeowners book in Florida until we achieve adequate rates and focusing on profitable growth in more attractive markets outside of Florida. Our dedicated staff and network of partner agents will allow us to continue to meet the needs of our policyholders and generate value for our shareholders. Now I'll turn the call over to Ron to go over the financials in more detail.

[Ronald Jordan:]

Thanks, Mike, and good morning, everyone. As Mike mentioned, our results were impacted in the second quarter by a high number of severe weather events, which included hail, windstorms, tornadoes and even a wildfire. We also stepped up to ongoing challenges in our Florida homeowners business, both in terms of prior year and current year accident reserves, including having booked the current accident year at 42.5% year-to-date for FNIC's Florida business. At the same time, we were pleased with the profitability of our non-Florida business, excluding the cat losses, and remain committed to our long-term strategy of focusing on profitable growth opportunities outside of Florida. Now let's dive deeper into our second quarter results. As previously disclosed in our 8-K filed a few weeks ago, our pre-tax net income was reduced by $48.3 million from catastrophe losses, net of all recoveries, including reinsurance. There were 14 PCS designated cat events in the quarter, including tropical storm Cristobal, plus a Florida Panhandle wildfire. Aggregate gross losses from these events were $94.2 million. These gross losses were reduced by approximately $46 million of recoveries from 3 sources

[Michael Braun:]

Great. Thank you, Ron. Operator, with that, we would like to take some questions. If you can open up the lines, please.

[Operator:]

Okay. [Operator Instructions] First question comes from the line of Greg Peters.

[Gregory Peters:]

Let's step back. I know you provided some comments around Florida. I would like to get a better understanding on, at this point going forward, how you're setting your reserves for the 2020 accident year, so we don't have another reserve hit when we're at this point next year? In other words, maybe you can tie this in, Mike and Ron, with the discussion around what are the legal challenges you're facing in this post-AOB reform marketplace that continue to challenge the company.

[Michael Braun:]

Okay. In terms of the legal environment, Greg, clearly AOB was a significant headwind for a number of years. And we did have AOB reform in July of last year. So that piece of the puzzle has decreased, but there continues to be some of that - those scenarios that work through the book with a date of loss prior to that. But really what I would say is the legal environment has evolved around that cure. And while our AOB suits are down massively and our total suits are down from prior year, we're still seeing some challenges with that. Ron can go in more detail on the math. But in terms of what we're picking for reserves, this is the highest ratio at 42.5% that we've ever been reserving at. This is a book of business that was trending at about 30% for a number of years up until 5 years ago. And since then, we have continuously raised rates as we've seen challenges in the claims environment and have not seen any corresponding relief in the attritional loss ratio. Let me say that slightly different. Our attritional loss ratio has actually increased faster than our rate increases have. So I think Ron can give more color on that.

[Ronald Jordan:]

Yeah, I guess, to start, 42.5% loss ratio on a book that's had all of these rate increases is the equivalent - is even stronger than that relative to the book that we had 2 years ago, 3 years ago before these rate increases. We use a Big-4 actuarial firm and they don't like to miss, and we don't like them to miss, and our Board doesn't like them to miss. So what I can tell you is we are always appropriately booked and recorded relative to the actuarial best estimates. That's always been the case. But I can also tell you, Greg, that with recording this 42.5% year-to-date for 2020, in my time here as CFO, I certainly would say I'm as confident or more confident in our reserves of prior years and current year as I've ever been in my time here. As far as AOB reform goes, our attitude is, look, there has clearly been a sharp drop in AOB-related suits. But there are other avenues for lawsuits, as we all know. And the plaintiff's bar is creative and works hard at their craft. With that said, we are seeing in the first half of 2020, we have seen a decline in the total number of suits, not just AOB suits, but total suits. We've seen a decline in the first half of 2020 versus the first half of 2019. With all that said, we and our actuaries are not assuming any goodness. We're not counting any chickens before they hatch. Until beneficial trends show up in the loss triangles, they don't exist. And that's our attitude and we feel good about our reserve position on both prior year and current year.

[Gregory Peters:]

Thanks for that answer. Maybe as a follow-up on that, Ron, maybe if you can give us an idea when you - when there is a first notice of loss, how do you go about setting a case reserve in IBNR? And how do you go about establishing a number for potential litigation?

[Ronald Jordan:]

Yeah. And I'm sure Mike will jump in and supplement. But it all starts, Greg, with a careful historical analysis of our past trends and our past loss triangles. So if our average severity for a given cause of loss, let's say, is $8,500, then the second that FNOL comes in, we put up that average severity, that historical average severity of $8,500. At that point, the claims adjusting process begins, including claims adjusters getting out and inspecting. And so, within a fairly quick time frame of the FNOL, that $8,500 historical would be adjusted to an actual expectation based on the adjusters review of the case. From there, obviously, there's different paths it could go. Our strong objective is to quickly and fairly pay and settle that claim because that's going to be the best outcome in the long run for both the policyholder and for us. When there are delays, that's when third-parties may get themselves involved, and that can end up being a worst experience for the policyholder as well as for us. And, Mike, I don't know if you have anything to add.

[Michael Braun:]

Yes, absolutely, Greg. I mean, based on, once again Ron said it, we set the initial reserves at FNOL. The adjustor continuously works the file and adjusts case reserves as appropriate throughout the claim life. And in terms of bulk reserves, those are loss triangles that are continuously monitored. And once again, going from a 30% attritional loss ratio in 5 years' time to 42% that is a massive increase. It's been painful for us, for our shareholders, for our policyholders and we have felt it. But it's even more remarkable when you look at the amount of rate that we've taken simultaneous, which is 36%, which is compounded to 42%. Simultaneous to that, we restricted the book of business in excess of 50,000 to 60,000 policies. It's truly an interesting time in what we've seen in Florida. I believe Florida has taken a small bite of the apple with AOB reform. I think more work is needed. And until the legislators enact more reform, it's going to limit the appetite of us and other insurance companies until our rates more accurately reflect these trends. And that's why you're seeing the state entity citizens experience quite a bit of growth. And there's a lot of documentation out there as well.

[Gregory Peters:]

So now that you're at a 42% attritional loss ratio and that's your assumption, why are you not approaching the Florida OIR and saying we need even more rate? Is there a governor at this point and at this juncture on how much more rate you can get to get that number back down?

[Ronald Jordan:]

Yeah, Greg, we're going back continuously. So in terms of rate, not only did we take rate in the beginning of the year, we took 7.5% - 7.4% we filed in January that became effective in June. And then, immediately, the day we announced our reinsurance, we filed an additional 5.6%. And then, we've also had another rate filing, and I'm speaking about Florida FNIC homeowners. And we already have another filing ready to go. And right now as it stands, I believe that the current rate filing should be approved within the next 30 days. And I anticipate another rate filing going in of approximately 8%. So let me clarify. You can only have one rate filing in at a time based on that line of business. And the question may be, well, why would you need additional rate increases? And what we're doing is we're taking the indication as these numbers become available. So as soon as that reinsurance cost was known to us and those policies were bound, the reinsurance contracts, we went and filed. And now that we're seeing development in the current year and prior year, we're immediately going back to the department and asking for additional rate to ensure that that's reflecting in our premiums.

[Gregory Peters:]

Got it. Thank you for the detail. The other question I have would be around the relationship with SageSure. You, in the reinsurance - the new reinsurance program, there is a quota share, which means that now when there's catastrophe losses, et cetera, outside - well, in the business related to that, that they are going to share in some of those losses. So can you spend a minute and talk to us about the capital position of SageSure, if they have - if we have an active hurricane season outside of Florida in the markets where they've written business on your behalf? Do they have the capital to pay for these claims? Is there going to be a reinsurance collection issue that we're going to be facing at some point in the next year?

[Michael Braun:]

Greg, SageSure has been a long-term partner of ours for more than a decade in a variety of businesses that we've been involved with them. They produce business for us. It's $150 million, $160 million plus book of business. There's always been a profit share, a 50/50 profit share with them, and we've never had issues. And they are a well-run, well-managed company, that have the capital to support those operations. We've recently transitioned the profit share into a quota share, which really does not impact financials from a simplistic statement. However, from a statutory perspective, it provides capital relief on a statutory base for the carrier, which creates benefit obviously. So we're comfortable with their capital position. We appreciate the partnership. It's been successful and we're going to continue with that. We believe they've got the capital to maintain and the operations that they've always had.

[Gregory Peters:]

Got it. Thanks for the answers.

[Michael Braun:]

Thank you, Greg. Have a good day.

[Operator:]

[Operator Instructions] Your next question comes from the line of Doug Ruth from Lenox Financial Services. Your line is open.

[Douglas Ruth:]

Hi, good morning, gentlemen.

[Michael Braun:]

Good morning, Doug.

[Douglas Ruth:]

I think a lot of these issues are way - include FedNat, but they also are bigger industry issues. When I read that the industry had - the Florida insurance industry had a $684 million underwriting loss in 2019 and then a net loss of $340 million. This has to get some people's attention. Can you talk about that? And do you see anybody standing up and helping FedNat and the other Florida carriers?

[Michael Braun:]

Yeah. Good question, Doug. So there's been substantial headwinds in the Florida property market not only for FedNat, it's not exclusive to us at all. And it's the whole Florida property market. And I think the Florida OIR, the Office of Insurance Regulation, and specifically the commissioner, Commissioner Omari, has been very vocal and has tried to educate the legislators and inform people as best he can. But honestly, we have not yet seen the action that we need to see to contain these costs. Absent that, we will not grow the book of business. We will, therefore, take additional rate. And it's truly amazing how much rate that we've taken over the last 4 to 5 years. As I just stated, we've got rate filings pending. We've got more rate filings going in. And it's unfortunate, because I think these costs can be better contained with a more fair environment. But we're adapting. And once our rate is more reflective of these costs, we may increase that appetite. The biggest challenge we see in the State of Florida is primarily related to Orlando, where the change in the attritional losses have moved materially over the last 3 to 4 years, materially. And we've seen our rates go up in excess of 50%. That's really unfortunate for the policyholders. It really is. So a lot of it's related to the attritional losses. To a lesser extent, it is related to our increased reinsurance costs as well as weather events. And the reinsurance costs went up this year. And in particular, it was noted that the reinsurers have reevaluated the risk of weather within Florida, driven by the claims of Irma. And Irma's losses for the industry have continued to come in nearly 3 years out. So rate is needed. I'm hopeful for legislative action to make it a more fair environment to contain costs, but I don't see anything on the near horizon for that, Doug.

[Douglas Ruth:]

Yeah. Well, the other thing that I'm reading is Citizens now is adding 2,000 policies a week, which shows that, I mean, the crisis in Florida is growing. They were - had a lot of success shrinking their book and now it's going the other way. It seems like it's going to rapidly expand again.

[Michael Braun:]

Yeah. So Barry Gilway runs Citizens and I think he does a great job, not only running it, but really the transparency and the - being an advocate for reform. He does not want to grow. He's been very successful in shrinking it. So I do see Citizens continuing to grow back to what we can do with that. We have no problems growing the business within Florida, but have no desire to do so. The only challenge that could occur would be Citizens' count that how much rate they can take. So they're capped at a collar of 10%. So if the industry continues to move at double-digit rates and Citizens does not, Citizens will become even that much more competitive and will attract that much more business. And it's well documented the risk to the entire State of Florida when Citizens becomes too large. A decade ago, they had 1.5 million policies. Now the amount of risk retained by the state in that scenario is significant. So once again, hope to see reform. Until then, we're going to continue to restrict business until our rates more accurately reflect these increased costs.

[Douglas Ruth:]

Okay. I think that's all good. And I also would hope that maybe the 5 Florida companies, the 5 public companies could maybe work together to talk and get the word out. We had read some news about one of the law firms in Florida that was involved in a large number of litigation, a large amount of litigation being powered by the Supreme Court. That would seem to indicate that there's really an organized approach to ripping off these insurance companies. Could you maybe talk about that for a minute?

[Michael Braun:]

Yeah. In terms of the plaintiff's bar, they're very well organized and they're effective in what they do. You're correct. The industry could probably do a better job. There are different organizations that the insurance carriers work with and participate in. But I think the carriers are always reluctant to do that for a variety of reasons. So I think that education that the commissioner has provided in the past is very effective. And hopefully, the legislators are receptive to that information and that education. And not only the commissioner has done a great job with it, I think Barry Gilway running Citizens, I think he's done a great job as well. And I think as these rate increases are felt by the policyholders across the state of Florida by all carriers, hopefully then that that will stimulate a response for a meaningful reform to hold these rates down. But until then, rates are going to continue to climb.

[Douglas Ruth:]

Okay. Well, thanks for answering the questions and being available to the shareholders.

[Michael Braun:]

Thank you, Doug. Have a good day.

[Operator:]

[Operator Instructions] We have a question from Bill Broomall from Dowling & Partners. Your line is open.

[Bill Broomall:]

Great. Thank you. I just had a quick question, Mike, on your comment a moment ago about the rate increases. I think you mentioned 7.4% in January, the 5.6% after the reinsurance, and then you'll have another 8% for later this year planned. And that's all for FNIC. The question I had was is there any limitation on a 12-month period of how much rate you can file for before you might have to go before a public rate hearing to - and then which might slow down the process at all? Because if I add those all up, it seems like they're all over - cumulatively would be over like a 15% that I think of as requiring a public rate hearing. And I'm just wondering if that - if there's any roadblocks or anything that could slow down the approval process.

[Michael Braun:]

Yeah. In terms of rate filings, you're correct, if it's 15% or more, statutorily there needs to be a rate hearing. And the department has the ability, I believe, that they can wave off under certain circumstances. If it's less than 15%, if the department would like, they can have a rate hearing. So it really becomes mandatory once you're at 15% and above. So my statement with these rate filings, especially when you need so much rate - and I say so much rate, when it's more than 1% or 2%, I call that so much rate. And time - the time element is significant in regards to these rate filings. So we do take a smaller bite of the apple. We try to keep these rate filings as clean and as possible so that they can get through as quick as possible. So it is possible that we will have a hearing. It is possible it could be delayed and that is part of our strategy, which is taking what we believe is appropriate in these indications, not being afraid to take these rate increases as quick as possible. So what's driving this rate that we're going to be taking once this one is approved? And the answer is, additional pressure on these loss ratios. So we're quick to act on that. We are telling you that we have new information that the attritional loss ratio is continuing to have pressure and we're passing that through. Unfortunately, it hurts the income statement as an expense. But as you recognize that, as you feel that, it allows you to go ahead and put these filings in with the state to remediate the challenge on a go-forward basis. So that's - time is important.

[Bill Broomall:]

Got it. Okay. So it's really - just to summarize, it's really up to the OIR whether they want to look at the 3 rate filings as a combined filing and whether they'd ask you additional questions. That's fair?

[Michael Braun:]

You're correct. This could - we could have a rate hearing. And we have no issue with the rate hearing. Once again, we - our preferences is to keep these rate filings quick and simple. However, we will not shy away from a rate hearing. There are a few rate hearings that are scheduled - 2 of them, I believe, in the next week or so for a few of our competitors and others that have occurred. And there's really no fear of them. And I think it actually may create additional transparency for the public benefit. But once again, our indication is - our inclination is to take rate as quick as we can when we're seeing such large movement in our experience.

[Bill Broomall:]

Got it. Okay. That makes sense. And then just switching gears for the - your quota share was - that you renewed, was there any major changes to the structure? And I'm thinking of any changes to cat sub-limits or seeding commissions or anything in that quota share?

[Ronald Jordan:]

No, no substantial changes, yeah.

[Bill Broomall:]

Great. Thank you. That's all I had.

[Michael Braun:]

Thank you, Bill. Have a good day.

[Operator:]

Okay. There are no further questions at this time. I would now like to turn the conference back to Mike Braun.

[Michael Braun:]

Thank you. Thank you all for participating on today's call. Before we close, I want to once again recognize our FedNat community, including our staff, partner agents and policyholders. Our team continues to rise the occasion in these unprecedented times, maintaining our commitment to excellent service and stringent underwriting. These efforts, along with the continued strength of our balance sheet and financial position, will enable FedNat to continue returning capital to shareholders and build long-term value. With that, everyone have a great day, and thank you for your participation.

[Operator:]

Ladies and gentlemen, this concludes today's conference call. Thank you for joining. You may now disconnect.