HCI Group, Inc.
Q1 2018 Earnings Call Transcript

Published: 1 May 2018

[Operator:]

Good afternoon, and welcome to HCI Group’s First Quarter 2018 Earnings Conference Call. My name is Latonia, and I will be your conference operator this afternoon. At this time, all participants will be in a listen-only mode. Before we begin today's call, I would like to remind everyone that this conference call is being recorded and will be available for replay through June 01, 2018, starting later this evening. The call is also being broadcast live via webcast and available via webcast replay until June 01, 2018, on the Investor Information section of the HCI Group website at www.hcigroup.com. I would now like to turn the call over to Mr. Kevin Mitchell, Vice President of Investor Relations for HCI Group. Sir, please proceed.

[Kevin Mitchell:]

Thank you, and good afternoon. Welcome to HCI Group’s first quarter 2018 earnings call. With me today are Paresh Patel, our Chairman and Chief Executive Officer; and Mark Harmsworth, our Chief Financial Officer. Following Paresh’s opening remarks, Mark will review our financial performance for the quarter and then turn the call back to Paresh for an operational update and business outlook. Finally, we will take your questions. To access today’s webcast, please visit the Investor Information section of our corporate website at hcigroup.com. Before we begin, I would like to take the opportunity to remind our listeners that today’s presentations and responses to questions may contain forward-looking statements made pursuant to the Private Securities Litigation Reform Act of 1995. Words such as anticipate, estimate, expect, intend, plan and project and other similar words and expressions are intended to signify forward-looking statements. Forward-looking statements are not guarantees of future results and conditions but rather are subject to various risks and uncertainties. Some of these risks and uncertainties are identified in the company’s filings with the Securities and Exchange Commission. Should any risks or uncertainties develop into actual events, these developments could have material adverse effects on the company’s business, financial conditions and results of operations. HCI Group, Inc. disclaims all the obligations to update any forward-looking statements. With that said, I would now like to turn the call over to Paresh Patel, our Chairman and CEO. Paresh?

[Paresh Patel:]

Thank you, Kevin, and welcome, everyone. The first quarter was another positive one for us. We earned $10.8 million and as Mark will discuss in greater detail $12.7 million on a non-GAAP adjusted basis. Also we continued our normal path of paying dividends, repurchasing shares and increasing book value. Here are some noteworthy events from the quarter. We experienced positive non-GAAP claims trends with fewer claims and fewer losses. We think this is because of good weather. Also the contracted public adjusted focusing on hurricane Irma and also the implementation of our positive underwriting technology. We'll talk about that more later. Hurricane Irma claims have unfolded as we predicted last October. We are comfortable with our current loss estimate. We also repositioned much of our investment portfolio due to changes in the tax code and the flattening yield curve and finally after the quarter ended, the Board increased the quarterly dividend. Mark will discuss all of these things in detail. So at the time, I'd like to turn it over to our CFO, Mark Harmsworth who will walk us through the financial performance for the first quarter, Mark?

[Mark Harmsworth:]

Thanks Paresh. So fully diluted earnings per share in the quarter were $1.11 on a GAAP basis. Adjusted earnings per share were $1.26 up from $1.15 in the same quarter last year. As mentioned on our last call, the new accounting treatment for unrealized gains and losses on equity investments, introduces new volatility in earnings when equity values change. To better compared to prior periods, we have disclosed and explained adjusted earnings per share, which takes out the impact of unrealized gains and losses in equities. As you look at the income statement, one of the things you'll notice is that our loss expense is down 23% from the first quarter of last year. A couple of things explain the decrease. In the first quarter of last year, we booked $2.5 million of adverse development and there was no material adverse development in the first quarter of this year. Second, non-cash claims and lawsuits are down and down significantly. The number of non-cat claims in the first quarter this year was 26% less than the first quarter of last year and the number of non-cat lawsuits was 28% less. It was very little weather in the quarter, but claimed volumes were down across the spectrum. As we discussed before our income tax rate has declined significantly as a result of the federal tax changes effective January 1, 2018. While a number of things impact the rate, the 27% effective tax rate in the first quarter should be a reasonable estimate of the normal rate going forward. Before leaving the income statement, I wanted to add that our gross pretax margins in the quarter were 17.25% on a GAAP basis and 20.25% on an adjusted basis. This involves our combined ratio highlights of the continued efficiency of our operations. Now turning to the balance sheet, as you know we live in a dynamic investment environment and so we have been strategically repositioning our investment portfolio. We sold a number of longer-term corporate and municipal bonds and invested the proceeds into shorter-term treasuries and certificates of deposit. The net impact of these changes was to cut our average term to maturity in half. While our average yield declined somewhat, this should be balanced out by increasing yields on cash. More importantly, it will reduce volatility and allow us to take advantage of opportunities created by rising rates. Given the volatility in equity market, we also locked in some gains and reduced our equity exposure during the quarter from $60 million to $46 million. Also in the balance sheet you'll notice that our reserves continue to decline as we process payments for hurricane Irma. At this point, we are maintaining our original estimate of $267 million for the ultimate exposure to Irma. Last comment on the balance sheet, book value per share on March 31, 2018 was $22.45 up slightly from $22.14 at the end of last year. Now a few comments on capital management. Our capital position and liquidity remained strong. We have over $160 million of surplus in homeowners choice, just under $25 million surplus in TypTap and about $100 million of cash and liquid investments at the holding company level. During the quarter we bought back just over 184,000 shares at an average purchase price of $35.39 for a total investment $6.5 million. The weighted average number of fully diluted shares outstanding in the quarter was 11,897,791 and the number of shares outstanding for purpose of calculating book site per share and dividends at the end of the quarter was 8,593,850. This data reduction in the number of shares outstanding through our buyback programs has helped us to increase earnings per share, but it has also allowed us to increase dividend payments to existing shareholders without an increase in the total dividends paid out by the company. On April 16, our Board of Directors approved an increase in our annual dividend from $1.40 to $1.50 per share. However, the dollar amount of our dividend payment in the second quarter of this year will be about the same as it was in the second quarter of last year. So in summary, it was another good quarter for us. Earnings per share were strong. Our efficiency ratios look good. We are repositioning the investment portfolio to increase returns with less risk and we're maintaining a strong level of liquidity at the holding company level. With that, I'll turn it back to Paresh.

[Paresh Patel:]

Thank you, Mark. First, a quick note on reinsurance. Our renewals for the 2018 hurricane season are near completion and we expect ceded premiums will remain flat year-over-year, but today I want to would talk about our insurance operations and the impact of our internally developed technologies. We've been talking about our investments in technology and data analytics for some time now, but our performance during hurricane Irma and the first quarter results show the power and possibilities of our in-house technology. It is not speculation, it is actually in our results and due to the positive underwriting technology that we have developed, we have industry-leading ratios. Using this technology, we started TypTap entirely powered with it and this has enabled TypTap to grow with little marketing, without excessive commissions or the benefit of large insurance company networks and note that in two years, TypTap has survived three hurricanes and grown to $10 million of premium in force without any additional capital infusions from the parent company. That's a great outcome. Finally, we believe this technology can be married with any existing book of business and material improvement to operating results. We know this because we speak from experience. Therefore, our future plans are to increase the volume of business we put through our technology platform. How do we plan on doing that? We will do that through a combination of three things. One, geographic expansion like the nine additional states that we'll be selling flood insurance into in the coming months. Secondly adding new products like TypTap home, which was launched just a little while ago, which expands the industry-leading platform we have for coating and binding hub business. And finally through mergers and acquisitions, because more volume through this platform will only make it more efficient. Finally with that, we're ready to open the call for questions. Operator, please provide the appropriate instructions.

[Operator:]

Thank you, Sir. At this time, we'll be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Brian Hollenden with Sidoti. Please proceed with your question.

[Brian Hollenden:]

Hi thanks for taking my call.

[Paresh Patel:]

Hi there.

[Brian Hollenden:]

In terms of potential acquisitions, how does your internally developed technology capabilities play a role? Would you be able to use the platform to lower acquired companies combined ratio?

[Paresh Patel:]

It's an interesting question Brian. Historically, our approach has been to focus on companies that were failing financially and acquire them at a fair book-to-price -- price-to-book multiple. Although we're still focused on that discipline, we have evolved our thinking based on the recent success of the positive underwriting technology. Today when we evaluate companies we often look for well-run organizations who have failed to proactive invest in the technology because this is going to be needed going forward. So if were to merge with a competitor to answer your question, we would implement our technology suite and would have a material impact on their combined ratio, that was said earlier. And for example, kinds of things that we've gotten into, we approached [Fednet] earlier this year about the merger. That would be an example of something we could do where you could -- the combined companies would do fantastic together, but at least in this particular case, the Board decided not to engage in discussions with us and the deal is dead, but there are still plenty more fish in the ocean, similar to Fednet and we'll find somebody to do this with.

[Brian Hollenden:]

And I guess it's very situational dependent, but just from a high level, I mean would you expect 500 to 900 basis points of improvement or what sort of range do you think you can -- you could bring to an acquisition in terms of overall savings?

[Paresh Patel:]

I think you sort of pretty much hit the range 500 to 900 basis point.

[Brian Hollenden:]

Okay. And then turning to the reinsurance renewals, just wanted to make sure I heard you correctly. So you're expecting the ceded premiums to remain flat?

[Paresh Patel:]

Yes basically, demand that we ceded in the first quarter is what we would expect to see in the second and third quarter on a dollar basis.

[Brian Hollenden:]

And just if I can follow-up there I guess some of us kind of were expecting and maybe going into the renewals you would have been I would think would have been expecting a rate bump. I guess just maybe can you walk us through maybe why you didn't get a year-over-year rate increase on the reinsurance renewals?

[Paresh Patel:]

Partly, I don't want to speak about the specifics because we're in the middle of the negotiations. So it would be inappropriate to comment, but one general overarching comment that I think has been stated various points throughout the industry is that the expected huge rate increases was 61 that were expected, do not appear to have materialized mainly because of an over-abundance of reinsurance capacity and obviously we're benefiting from some of that.

[Brian Hollenden:]

All right. Thank you and congrats on the strong quarter.

[Paresh Patel:]

Thank you.

[Mark Harmsworth:]

Thanks Brian.

[Operator:]

Our next question comes from Mark Hughes with SunTrust. Please proceed with your question.

[Mark Hughes:]

Yes. Thank you. Good afternoon.

[Paresh Patel:]

Good afternoon, Mark.

[Mark Hughes:]

Hello. Is your retention changed at all, the reinsurance, is it going to be similar to last year's program or the current program?

[Paresh Patel:]

I can answer one part of it and another part of it is still under discussion. The part that homeowners choice, the insurance subs retention will probably remain consistent with last year. As far as the HCI Group goes, how much retention we take as a group is subject to some negotiation that we're going through currently, but we don’t think it's greater than last year.

[Mark Hughes:]

Not greater than last year. And then the rate online, I don’t know if there is any detail you could provide there, your premium is I think the overall book is down a little bit and the homeowners choice, is the rate online up?

[Paresh Patel:]

Again I think these are all questions that we'll gladly answer much more quickly once the negotiations are finished in the next quarter, but we're still in the middle of some of these things. So we really don't want to get into the details at the moment.

[Mark Hughes:]

The TypTap, the home platform that you increased and could you talk a little more about that, how do you anticipate that or traction, how do you market that bring it to consumer's attention?

[Paresh Patel:]

Actually we've already started on the same path that we started with the TypTap flood product two years ago. Mainly we're making agents aware of it. We've had very positive feedback and initial feedback from them and what will occur is as time goes on, people become more and more familiar and accustomed to it and we should see an increasing stream of business coming from it, like we currently enjoy from the TypTap flood program.

[Mark Hughes:]

And then any thoughts, any projections you might share in terms of the volume? You had a nice release the other day about hitting the $10 million mark. Care to make some prognostications about where you might be at the end of this year or the following year?

[Paresh Patel:]

Okay. So maybe I can help it out this and by the way to your previous question also, one of the key things about why TypTap Home is very different to anything that's gone before it. It only requires about four or five questions and you get a price. It is so simple and easy-to-use is that simple and easy-to-use almost as the flood product is. So I should have made sure I got that plug in there. In terms of volume production etcetera, currently TypTap is adding something little bit north of $100,000 of premium, written premium a week. So if you take us at a $10 million flip, currently you can add it's growing about 100,000 a week and it will project out into the future. Obviously, we are working hard every day to try and accelerate that growth from 100,000 a week to a higher number.

[Mark Hughes:]

Right. Okay. The $1.26 in adjusted earnings, I assume that includes $2.2 million investment gain.

[Paresh Patel:]

Yes it does because that's realizing -- we were trying to do this on apples-to-apples basis. The 2.2 is realized investment income. So it would've been there under the old GAAP standards the…

[Mark Hughes:]

And then it's removed I guess the mark-to-market the unrealized gain how about -- and any comment on lawsuits overall, do you think there -- is there still just as much activity in the system, it's just shifted over to the storm claims, is there some reason to think that the underlying situation might be -- might be improving?

[Paresh Patel:]

It's a great question and I am going to give a multipart answer. From what we're observing, the overall number of lawsuits is up not only for us, but across the industry, but it's because about half of those lawsuits now being filed, are Irma related. So when you put the normal daily lawsuits in plus the Irma related, the overall volume is definitely much higher. For our own part, our Irma lawsuits at this point far exceed on a weekly basis, our daily lawsuits and our daily lawsuits as Mark indicated earlier are down year-over-year and as again to illustrate the point, we think that that decrease is a combination of two items. One is the lawyers and the PAs etcetera focusing more on Irma. So that has produced some production and we see that across a number of other companies too. But secondly, what we're seeing, which we think hopefully is more material is because of some of the steps we took a little while ago due to the positive underwriting technology. We are seeing an increased drop off more than that would be explained just by Irma and those kind of things, but that's specific to us.

[Mark Hughes:]

Thank you very much.

[Paresh Patel:]

Thank you.

[Operator:]

Our next question comes from Matt Carletti with JMP Securities. Please proceed with your question.

[Matt Carletti:]

Hey thanks. Good afternoon. Just have a couple left, Brian and Mark covered a lot of ground, on the low non-cash claims kind of following on the last discussion there how in dollars or loss ratio points, how much below normal would you estimate that was versus what you would have expected in the quarter and have you seen those trends continue into April?

[Mark Harmsworth:]

The loss ratio that -- our historic loss ratio as you know is around the 25%, 26% mark and the loss ratio in the first quarter was about 23%. So that's sort of the difference between couple million dollars difference between what you would normally expect and you know it's in terms of trend, that's a trend that's been going for some time, the reduction in the number of claims, the reduction has incurred, the reduction lawsuits and it just sort of continued in the quarter and we'll see where it goes. It's difficult to say what will happen in the second quarter, but it's definitely a trend that's helpful.

[Matt Carletti:]

Okay. Great. And just one other numbers question. I think you mentioned that $267 million ultimate Irma estimate held tight, where are you on a pay basis?

[Mark Harmsworth:]

Sorry. So the paid were at about $210 million and incurred a little higher, but Paresh mentioned the lawsuits, they are starting to come in and I think the important thing there is that there's still some significant room to run in terms of the reserves that we've set and the lawsuits are starting to come in, but we expected the lawsuits to come in and we allowed for that from the start and it's a little early to tell how many that will ultimately turn out to. But so far, so far we've got a fair amount of room to run there.

[Matt Carletti:]

Okay. Great. Thanks for the answers and congrats on a nice start to the year.

[Mark Harmsworth:]

Thanks Matt.

[Operator:]

Our next question comes from Sean Reitenbach with KBW. Please proceed with your question.

[Sean Reitenbach:]

Hi. Thank you. I was wondering going forward do you think the AOB environment has stabilized or is it still you guys think it could get worse from here?

[Paresh Patel:]

It depends on which context you look at this. What we are clearly seeing is on a industry-wide basis, the number of lawsuits filed in the first quarter was at a record number, but some of that like as we said was due to Irma and some of it's also the daily stuff. So you do have a mixture of both items. I don’t think the AOB problem on a statewide basis goes away all by itself if anything it might be getting worse because Irma has accelerated the spread of the AOB disease shall we say and we can tell this because we see new law firms popping up etcetera that are in the AOB business. So we see that clearly and that's occurring. As far as our own book goes obviously, we try not to be just passive participants in this and wait for these things to happen. So using some of the technologies and items that we've developed over the years, we are trying to combat it and sometimes we come out a little bit ahead and as we seem to be at the moment and the overall claim lawsuit count is decreasing a little bit. I'm sure we will have good quarters and bad quarters going forward.

[Sean Reitenbach:]

Okay. Thanks. Do you guys expect to receive any approval for additional rate increases in 2018? And kind of following up on that, do you expect any, do you expect the tax reform to drive rate competition if at all?

[Paresh Patel:]

Okay. So one part of the question is about rates going up and the other one is about rates going down. So no, that's fine. I was just extrapolating. We've always and again speaking for our company, not the industry as a whole, we've always approached a rate setting with the idea that we like stable rates. We don't like rates to increase dramatically or decreased dramatically. It's not how we intend to do business. So we are just beginning to assemble the data to submit to the OIR for our annual rate submission. I am sure they will review it and we will have a discussion as to what the appropriate thing to do given our performance, the new tax law etcetera would be, but my sense and this is a sense, not anything other than that is I don't honestly know that we feel we should have a material rate increase or a material rate decrease. So a few points this way or that way.

[Sean Reitenbach:]

Okay. Great. Also what type of claims infrastructure do you plan to set up in your new states or are you thinking about outsourcing to third parties?

[Paresh Patel:]

I think we have systems and tools and everything else capable that we could -- because the field work is done by third parties already anyway, but all the claims deserving check issuance all that stuff, we can do that from our existing operations. So until we get large in other states, I would honestly know that we need to set up operations there to that degree.

[Sean Reitenbach:]

Okay. Thank you. And finally I was wondering going back to the approach to Fednet we were wondering was this disclosed before?

[Paresh Patel:]

I am looking at my General Counsel who is shaking his head. I think I might I guess at this point it's going to be working through the night to make sure we get all the correspondence disclosed by tomorrow morning, sorry.

[Sean Reitenbach:]

Okay. What was the back-and-forth nature? Was it proposed by HCI or any idea why the Board when engaged, did they give a reason?

[Paresh Patel:]

The only item I can tell you is yes, we did initiate the approach. As far as all the back-and-forth I think once we disclosed everything overnight, it should, everybody can read for themselves.

[Sean Reitenbach:]

Yes. Great. Okay. Thank you very much.

[Operator:]

Thank you. At this time, this concludes our question-and-answer session. I would now like to turn the call back over to Kevin Mitchell who has a few closing remarks.

[Kevin Mitchell:]

On behalf of the entire management team I would like to express our appreciation for the continued support we receive from our shareholders, employees, agents and most importantly, our policyholders. We look forward to updating you on our progress in the near future.

[Operator:]

Thank you for joining us today for our presentation. This concludes today's call. You may disconnect your lines at this time.