FedNat Holding Company
Q3 2014 Earnings Call Transcript

Published: 31 Oct 2014

[Operator:]

Good afternoon and welcome to the Federated National Holding Company’s Third Quarter 2014 Financial Results conference call. My name is Andrew and I will be your operator today. Please note that today’s call is being recorded. At this time, all participants are in a listen-only mode. Later, we will be conducting a question and answer session. If you would like to queue up for the question and answer session early, you may dial star then one on your touchtone telephone. In the interests of allowing everyone to ask questions today, we request that you limit your question to one, but you can feel free to rejoin the queue as many times as you’d like. Statements in this conference call that are not historical fact are forward-looking statements. Without limiting the generality of the foregoing, words such as anticipate. believe, budget, contemplate, continue, could, envision, estimate, expect, guidance, indicate, intend, may, might, plan, possibly, potential, predict, probably, pro forma, project, seek, should, target, or will, or the negative thereof or other variations thereon, and similar words or phrases or comparable terminology 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 the 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 today, and other filings made by the company with the SEC from time to time. Forward-looking statements made during this presentation speak only as of the date on which they are made, and Federal National Holding Company specifically disclaims any obligation to update or revise any forward-looking statements reflecting new information, future events or circumstances, or otherwise. Now at this time, I would like to turn the conference over to Mr. Michael Braun, Chief Executive Officer and President of Federated National Holding Company. Please go ahead, sir.

[Michael Braun:]

Good morning and thank you for joining us today to discuss Federated National Holding Company’s third quarter 2014 financial results. I’m joined on the call by Pete Prygelski, our Chief Financial Officer. Our financial results for the quarter can be found in our earnings press release. I will go over some brief highlights from the quarter and then we will open up the line for questions. Highlights as compared to the same three month period last year, except where noted

[Operator:]

[Operator instructions] Our first question is from the line of Arash Soleimani from KBW. Your line is open.

[Arash Soleimani:]

Hi, good morning.

[Michael Braun:]

Good morning, Arash.

[Arash Soleimani:]

Can you disclose what gross premiums earned were in the quarter, please?

[Peter Prygelski:]

Yes - $83 million.

[Arash Soleimani:]

Eighty-three million – okay, great. With the profit sharing, can you talk a bit about the accounting for that? Obviously I know if there is a storm in the future, it kind of would reverse itself, the accrual. But just generally speaking, how does that sort of work? Is there a specific threshold that you’re kind of held to, and is it a sliding scale within that threshold?

[Michael Braun:]

Arash, before Pete gets into the more specifics, let me say globally we have not done quota share in the past. However, we had an opportunity with one of our strong reinsurance partners to complete our CAT program, our catastrophe reinsurance program, with quota share versus our traditional excess of loss. This is the first time we’ve utilized that, and we did that with this partner who has been in our program for many years because it’s enabled us to do so in a more cost-effective manner. In addition to the more cost-effective manner, there is a profit share contingency that’s rather complicated, that Pete can go in much deeper than I.

[Peter Prygelski:]

Yes, I’ll just touch on it briefly because we discussed this on the last call, and we haven’t changed—on the second quarter call, and we haven’t changed the methodology. The way the arrangement is written basically is if we maintain a 30% loss ratio as measured against gross earned, and there are no storms for two years, we would recognize $32 million. We took a weighted average approach, meaning what’s the likelihood that we’re going to achieve the AOP loss ratio, what’s the likelihood of no storms, and we’ve begun accruing $14 million beginning July 1. That $14 million is about $583,000 a month, times three you get to the 1.7. That’s the methodology – it’s pretty straightforward.

[Arash Soleimani:]

Okay, so you could get up to 32. You’re assuming you’ll get 14 conservatively.

[Peter Prygelski:]

That’s correct.

[Arash Soleimani:]

Okay.

[Peter Prygelski:]

But Arash, there’s a lot of math there—

[Arash Soleimani:]

With that, I saw with the reinsurance—or with this quota share piece, you had some numbers in there where you said, okay, premiums are lower by X-amount and then it’s offset by lower reinsurance costs and profit sharing, so on and so forth to get the balance to about $400,000. The piece in there you had about a $6.1 million reduction in reinsurance costs, wouldn’t that have just been an offset to earned premiums? Like, if the reinsurance or if the net earned premiums were down 16.5, would that 6.1 have just been an offset to that, that shows up in ceded, or which line item in the financials can we—

[Peter Prygelski:]

That would have been ceded premium, so the 6.1 would have reduced to 16 down to 10.

[Arash Soleimani:]

Okay, so it would just reduce it down – okay.

[Peter Prygelski:]

Right, yes.

[Michael Braun:]

And Arash, the other thing I wanted to add, Pete’s talking about $32 million. That’s a gross number. There’s offsets according to that, and if you look on our press release under the sixth bullet, it really kind of goes into more detail, so there’s a benefit but also on the other side there is also a change of some of those expenses, including an allowance for our catastrophe reinsurance program, for acquisition of policies, and for AOP as well.

[Arash Soleimani:]

Okay, great. Thanks.

[Operator:]

Thank you. Our next question is from the line of Ryan Byrnes from Janney Capital Markets. Your line is open.

[Ryan Byrnes:]

Good morning, guys. Just had—again, I realize we’re focusing on some numbers here, but—so you guys are accruing for $14 million, so does that imply a storm? I’m just trying to figure out how we should think about the profit share.

[Michael Braun:]

It implies—again, we could talk about this offline. I don’t want to get into too much detail, but it implies a 49% likelihood of a storm over—including this year and next year, so that’s what the factor is, 49%.

[Ryan Byrnes:]

Got you. Great, okay – this year and next year, perfect. And then just wanted to get an update on where Monarch is. I realize we’re probably two months away, but just wanted to see where you guys are in that process, and again initial thoughts as to where you think you can ramp it up next year.

[Michael Braun:]

The application is with the Florida OIR, and it’s pending. I’m actually going to be in Tallahassee on Monday to meet with the department. Nothing really new to report. The application is in, there is the customary Q&A back and forth, which is well underway, and then also we’ve already filed rates, rules and forms, for us assaying—I should say progressing with loading it in software, things like that. We clearly have a demand for the product from our agents. They have asked about it, so we’re shooting for January 1. I think January 1 might be an aggressive date. I’d like to see this launched in the first quarter, but nothing really new to report. No issues at this time, and we’ll keep moving forward.

[Ryan Byrnes:]

And just want to make sure I understand the timeline. So you need to meet with the Florida OIR, and that’s the only real—that’s the last step for you guys? Just trying to figure out a timeline for that response from them.

[Michael Braun:]

Well, the regulatory process, they have to not only give us what’s called a certificate of authority, but also rates, rules and forms need to be approved, so there’s a lot to that. As an admitted carrier, everything we do receives scrutiny, and that does take time, so I don’t know. I don’t know when that will happen. Like I said, we’d like—we were originally shooting for January 1, but hopefully we can get this up and running in the first quarter subject to approval, obviously, from the department.

[Ryan Byrnes:]

Okay, great. Thanks for the answers, guys.

[Operator:]

Thank you. Our next question is from the line of Samir Khare from Capital Returns Management. Your line is open.

[Samir Khare:]

Good morning, guys. Great results. I just had a quick question on the loss ratio. Was there any reserve development baked in there, one way or another?

[Peter Prygelski:]

No, just the timing of our claims and the payments that we make, but there’s nothing unusual.

[Samir Khare:]

All right, perfect. Then do you—what did you guys end up a stat surplus for the quarter and how much did you push down to the sub?

[Peter Prygelski:]

Was your question, what our statutory surplus was as of 9/30?

[Samir Khare:]

9/30, and then how much did guys push down to the sub as well.

[Peter Prygelski:]

The statutory surplus is approximately $99 million, and as far as any transfers of money from the holding company to the insurance subsidiary, we usually do those in the fourth quarter.

[Samir Khare:]

Okay.

[Michael Braun:]

To that, Samir, we’re most comfortable around 3 to 1. It appears that we may write homeowners maybe $340 million. We won’t know that until the end of the year, maybe $350 million, yet in the other lines maybe it’s 375. So I think there’s going to be capital going in. The board will decide how much capital we want to put in, but like Pete said, we’ll decide that with the closing of the fourth quarter. But clearly, some capital will go in and we’ll be determining that soon.

[Samir Khare:]

Okay. In terms of the rate of how much you guys are writing per week, you guys have given that stat before. What are you guys at right now, and what were you guys in during third quarter?

[Michael Braun:]

Third quarter, we wrote approximately 40.7 of new Florida homeowners business. In the fourth quarter, the first four weeks here of the fourth quarter, we’re averaging a little over, I would say, $3.2 million to $3.3 million a week, so really no change to that. Usually the third quarter is the slowest of the quarters for writing new business, just because of the wind season and traditionally not a lot of policies expire.

[Samir Khare:]

Great. Appreciate the comments on Monarch. I’m actually just curious – will they have the iVantage appointment as well, just given that you guys are running it?

[Michael Braun:]

That’s a decision by iVantage and Allstate. There is definitely interest in it, and that will be determined by iVantage and their parent, which is Allstate. We have a very good relationship, Federated National with Allstate and iVantage, and I think they look very favorable on us. We’ve been called a preferred partner with them, so I think that we have a very good relationship and we’re hopeful that will occur. But those discussions won’t be formal with the management of iVantage until we have a certificate of authority, if and when, I should say, when we have a certificate of authority from Monarch.

[Samir Khare:]

Great, okay. Just lastly, in September there was a pretty negative report coming out from a rating agency called Weiss, it largely put most of the Florida homeowner companies in the same bucket. I’d just be curious of your view of how the industry, the rating agency as well as the reinsurers, they differentiate between the Florida companies.

[Michael Braun:]

Sure. I think Weiss has been pretty consistent over the years. I think it’s maybe five or 10 years they’ve gone back, and I don’t know that they’ve been positive on the industry ever, so we understand that. We do have our rating with Demotech, which is important to us, and that enables us to sell policies on homes that go through Fannie and Freddie Mac, so we’re comfortable where we’re at. I think we’re very well capitalized. I think we have a billion dollars of reinsurance – that’s a tremendous amount of resources for us when a storm hits. So I think we’re in a great place operationally and financially.

[Samir Khare:]

All right, great. Thanks guys.

[Michael Braun:]

Thank you, Samir.

[Operator:]

Thank you. Our next question comes from the line of Doug Ruth from Lenox Financial Services. Your line is open.

[Doug Ruth:]

Congratulations on a fabulous report. How is the new space that you rented working out for you folks?

[Michael Braun:]

Well, we’ve obviously expanded. We’re at about 210 staff, so obviously we’ve had to expand. We’ve taken over another 14,500 square feet, and it’s working out well. We’ve got room – we’ve got approximately 40 to 50 workstations for continued growth as needed.

[Doug Ruth:]

Wonderful. Could you talk about the investment portfolio and the composition a little bit?

[Peter Prygelski:]

Sure, Doug. Not much has changed in the last quarter, or not much has changed over the last year in our philosophy, which is to stay short duration. The average duration of the portfolio is about 3.73 years. We’ve reduced equities significantly over the last, I guess, year – we’ve gone from 20% to 10%, that’s with equities as of September 30 with 10% of the portfolio. We continue to invest in high quality, average rating double-A. We’ve shifted some money from taxables into some muni bonds that are tax-free bonds that are also highly rated, so really no significant change.

[Doug Ruth:]

Okay. Could you talk a little bit about expense control and what’s happening in that area?

[Peter Prygelski:]

Yeah, I’ll briefly touch on it. If you look at our expense ratio, and you consider the fact that year-over-year we’ve increased our gross written premiums by 52%, our expense ratio as measured against earned premiums has only gone up 1.6 points over that same period, so we continue to operate in a very lean manner and a very efficient and effective manner.

[Doug Ruth:]

That’s wonderful. Congratulations on the report and we’re looking forward to the future.

[Michael Braun:]

Thanks Doug.

[Operator:]

Thank you. Our next question comes from the line of William Meyers from Miller Asset Management. Your line is open.

[William Meyers:]

Hi. I just wanted to check – it seemed like you had a great year-over-year but then a sequential premiums written and revenue decrease, and you said that—you had just said in response to a previous question that Q3 is usually the slowest quarter. I just wanted to check if there was anything more to that than seasonality.

[Michael Braun:]

Well in terms of writing business, we’ve written quite a bit of new business this year. Off the top of my head, I believe we wrote about $47 million of new business in Q1, $50 million in Q2 – those are busier quarters for us, and about $40 million, $40.7 million in Q3. In terms of our whole book of business, it tends to run at about 88% in terms of retention, so that’s consistent. But obviously specifically with analysts, this quota share is taking some time to digest for people, so that’s absolutely impacting the numbers within the income statement and the balance sheet, but operationally we’re continuing to grow. We write all of our business through our partner agents in an organic, voluntary manner. We don’t do any wholesale-type assumption of policies from citizens, and we have healthy demand for our product. I believe that we are a preferred carrier in the eyes of the agents, and that any time we have a competitive quote with most any carrier near us, that we should get the business. So operationally, all is well in that regard; however, the quota share is leading to a lot of accounting questions and I’m sure Pete will have his phone ringing after this call with some more questions on that as well.

[William Meyers:]

Okay. At this point with your capital, you have plenty of capital to write the business you want to write, and that would be true for at least the near term. Is that right?

[Michael Braun:]

Yes, I think we’re very well positioned. As Pete said, we’re at about $99 million statutory surplus. We’ll be moving capital from the holding company over to the carrier during the fourth quarter, that amount to be determined. We have a pending commitment for capital in Monarch, and the question we get frequently is, do we need more capital? We were very specific in the capital that we raised. We raised $30 million and really exhausted that with two quarters of new business. Raised another $46 million and we think we’re in good shape. We were very clear, though, that we didn’t want to raise too much capital because we don’t want to create a moral hazard that would create an incentive for us to write business that we would not otherwise want to write, and we wanted to have enough capital to keep doing what we’re doing, have enough dry powder to do what we’re doing. So to your question, I think what you’re saying is do we need more capital. As we sit here today, the answer is now. Could that change in three to six to nine months? Absolutely, and we’re going to write voluntary business as the opportunity presents itself, and we will capitalize the company as needed.

[William Meyers:]

Okay, sounds good. Thank you.

[Michael Braun:]

Thank you.

[Operator:]

Our next question comes from the line of Arash Soleimani from KBW. Your line is open.

[Arash Soleimani:]

Hey, just a couple follow-ups. This might be something that is better to discuss offline because it’s more accounting-type questions, but looking at your ceded premiums earned as a percentage of gross premiums earned, obviously that ticked up pretty dramatically because of the quota share. But I guess my question is I would have thought of the quota share as starting July 1, 30% of all your gross written goes to the quota share reinsure, and then that flows into earned premiums sort of gradually over the next four quarters. But it looks like it immediately sort of hit earned premiums fully, so can you just talk about that accounting real quick? I guess that was the wrong to think of it, that it would gradually go from written to earned.

[Peter Prygelski:]

Yes, we could talk about it offline, but basically in July, August and September, we ceded 30% of our gross earned to our reinsurers, and if you want to call me later, we can get into the specific accounting, but we ceded 30% of our gross earned to our quota share partners for those three months.

[Arash Soleimani:]

Okay, so based off that, then, I’m assuming it’s fair that that 58% ceded premiums earned as a percentage of gross premiums earned is a fair run rate roughly, or is that going to bounce around?

[Peter Prygelski:]

Well, we can discuss that offline, but it’s hard to just look at that number because then you’re not seeing the benefit of we’re also ceding 30% of our incurred losses. So you can’t get caught in the trap of looking at what net premiums earned is without then looking at the reduction in commission expense because of the ceded premium, without looking at the reduction in losses because we’re ceding 30% of the losses, without looking at what we’re accruing for the profit share, and then without looking at what we would have spent on XOL reinsurance had we not had the quota share. So it’s hard to look at any one piece separate and distinct. You’ve got to look at the whole story. We can go through it afterwards.

[Arash Soleimani:]

Okay, no, that’s perfect. I’m trying to see what else I had here. Then with the expense ratio, that 48% in the quarter, it went up only a bit year-over-year. Why is it that the third quarter is so much higher seasonally than the first and second quarter when you guys were running in the low 30s?

[Peter Prygelski:]

Well, a couple reasons, and I’ll just go through them quickly here. Last year we had a reinsurance purchase of $68 million on July 1, and you’re asking why the ratio was so low in the first and second quarter. Well, that $68 million was consistent, yet we continued to write business, so earned premium was ramping up and the reinsurance expense was fixed at $17 million, so that makes the loss ratio lower.

[Arash Soleimani:]

Okay.

[Peter Prygelski:]

That’s what makes first and second quarter better. Third quarter is always the highest expense ratio because we buy reinsurance as of in-force premium as of September 30, so you have 90 days of the expense in the period but you might have wrote some of the policies or a lot of the policies on September 15, so you’d only have 15 days of earned premium over 90 days of the expense. See what I’m saying? So the ratio will continue. Again, as we continue to grow, then the ratio is going to get lower each quarter.

[Arash Soleimani:]

So is that 40% run rate that you’ve mentioned in the past still kind of a fair overall estimate for annually going forward? Is that still your target, or not target but, you know—

[Peter Prygelski:]

Yes, that is, but remember that is over total revenue. When we gave that 40%, it’s over total revenue, not over just earned premium. So yes, I do believe that is—the way I calculate it, we hit 38% this quarter over total revenue.

[Arash Soleimani:]

Okay, and then looking at the loss ratio, the net loss ratio, that went down from 50.4 last year in the third quarter to 43.8. Can you talk about some of the factors driving that?

[Peter Prygelski:]

It’s really one main factor, and that’s the fact that we have—Mike has purchased—we have some reinsurance on our all other peril, you know, typical losses. So we carry the reserves and we’re reimbursed by our reinsurers as they’re actually paid, so it’s just the timing of case reserves turning into payments and then getting reimbursed.

[Arash Soleimani:]

Okay, okay. The gross premium growth, I think you said it was 54%. (Indiscernible) growth looks like it was closer to 70%. Does that just imply that you’re kind of growing outside of the tricounty, just assuming the tricounty is higher premiums, higher risk-type policies? So does the faster (indiscernible) growth imply that you’re growing in other areas of the state?

[Michael Braun:]

Yes, that’s part of it. I mean, there’s pressure on rate, obviously – it’s a competitive marketplace, but you’re seeing continued growth outside of tricounty, so when you look at the state, the map of the state, generally speaking the farther north you go, the lower the premiums. So you could have the same risk in Jacksonville priced at $500 in that range, and then as you move that to south Florida it could be a $3,000-plus risk, so that’s part of it. Also, we’re writing more not only non-tricounty but we’re also writing what’s called HO6’s, which is condos. We’re writing quite a few of those. Those are individual units that have much lower premium, as well as we write renter’s units which has very low premium, and we also write what’s called a BP3, which is basically a dwelling policy that landlords have, so that has less premium on it as well. So I think you’re going to see the average premium continue to drop compared to our historical averages that we’ve had.

[Arash Soleimani:]

All right, thanks. Lastly, I know there have been some announcements of other players getting into the commercial residential space. What are your thoughts on that space, and any interest on your part?

[Michael Braun:]

We’ve been in that space, and we vacated it. Don’t see the opportunity there. Commercial has an extremely low AOP, so your all other peril, we experienced, I think it was 2, 3%, 4%. It’s incredible. My concern on that is when a storm hits. It works great as long as there’s no storms, but really reinsuring it can be tricky. We had, I think it was over 70% of premium on reinsurance, and we still just couldn’t get our head around making sure that we had enough reinsurance on that structure, so we’re not in that space.

[Arash Soleimani:]

Okay, great. Thanks guys.

[Operator:]

Ladies and gentlemen, as a brief reminder, you can queue up for a question with star then one. If your question has been answered or if you wish to remove yourself from the queue, you may press the pound key. Just one moment, please, while we wait for more callers.

[Michael Braun:]

Well, we’ll wrap it up unless another caller dials in here in a moment or so. I want to thank everyone for their support. We continue to do what we do, which is we have incredible people, 210 people that work for the company that I think provide exceptional service to our partner agents and to our insureds. That will continue. I think it’s well received in the marketplace with our agents, and that’s why you’re seeing continued growth in our business. So really, we’re just staying the course in what we do. So obviously, Pete and I are available for calls afterwards. I know the quota share has generated a lot of questions, some of them rather granular, and Pete will be happy to go in as deep as anyone would like, if they’d like to give him a call, and I am always available as well. So with that, I don’t believe we have any other questions.

[Operator:]

No other questions in the queue.

[Michael Braun:]

All right, thank you. We’ll go ahead and wrap up the call. Everyone have a great day.

[Operator:]

Ladies and gentlemen, thank you for your participation in today’s conference. This now concludes the program, and you may all disconnect. Everyone have a great day.