Heritage Insurance Holdings, Inc.
Q2 2019 Earnings Call Transcript

Published: 2 Aug 2019

[Operator:]

Good morning and welcome to the Heritage Insurance Holdings Second Quarter 2019 Financial Results Conference Call. My name is Cole and I will be the operator today. At this time, all participants are in listen-only mode. A brief question-and-answer session will follow the formal presentation. Please note this event is being recorded. [Operator Instructions] I would now like to turn the conference over to Arash Soleimani, Executive Vice President at Heritage. Please go ahead, sir.

[Arash Soleimani:]

Good morning and thanks for joining us today. We invite you to visit the Investors section of our website, investors.heritagepci.com, where the earnings release and our earnings call will be archived. These materials are available for replay or review at your convenience.Today's call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are based on management's current expectations and are subject to uncertainty and changes in circumstances.In our earnings press release and in our SEC filings, we detail material risks that may cause our future results to differ from expectation. Our statements are as of today, and we have no obligation to update any forward-looking statements we may make.For a description of the forward-looking statements and risks that could cause our results to differ materially from those described in the forward-looking statements, please refer to our annual report on Form 10-K, earnings release and other SEC filings.With us on the call today are Bruce Lucas, our Chairman and Chief Executive Officer, and Kirk Lusk, our Chief Financial Officer.I will now turn the call over to Bruce.

[Bruce Lucas:]

Thank you, Arash. I would like to welcome all of you to our Second Quarter 2019 Earnings Call. Before we begin the call, I'd like to thank all of our employees for their dedication to our company.Despite severe weather losses, we had excellent second quarter operating results. We continue to execute on our diversification strategy that is designed to reduce exposure in Florida, especially in fraud-prone areas like the Tri-County while growing in other states have less volatility.Our ex-Florida sales are significantly accelerating across our footprint as we launch new states and expand with strategic partners. In the southeast, ex-Florida, new business premium increased 90% year-over-year and 44% quarter-over-quarter. In the northeast, new business premium increased 25% year-over-year and 35% quarter-over-quarter. In Florida, personal alliance new business premium decreased 6% year-over-year, but increased 27% quarter-over-quarter. Across our entire platforms, 64% of personal alliance, new business premium was generated outside of Florida.We have used our exported growth to offset strategic non-renewals in the Tri-County. In the second quarter, we dropped a remarkable $6.2 billion of total insured value or TIV and in Florida's Tri-County year-over-year. This is a unique approach to diversifying away from the Tri-County in Florida in general that we do not believe is occurring with any of our competitors. Although new business premiums outside of Florida and of Tri-County are significantly lower, they are more profitable because there is less broad litigation and reinsurance costs. Long term, we believe our portfolio will outperform peer companies that continue to focus on top line growth versus bottom line profit.We strongly believe that aggregation in Florida in the Tri-County will continue to cause higher loss ratios and adverse prior year reserve development across the sector. With the exception of Heritage Insurance, adverse development continues to plague the Florida market and it is our belief that it is largely related to Tri-County claims that have elevated severities.Three years ago we began to pull out of the Tri-County and diversify away from Florida. Since then we have evolved from a Florida company to a super-regional carrier that has 70% of our TIV outside of Florida. During this time period, our claim statistics related to the Tri-County have continually improved and we are at all-time lows for percentage of claims and losses related to the Tri-County. Fewer Tri-County policies and claims means less volatility related to reserves. As a result, I'm not surprised that Heritage stands alone as the only carrier to report favorable prior year development four quarters in a row.Our reserving philosophy is different. I've noted several times that our reserves have been the highest in the peer group despite having lower exposures in Florida and the Tri-County and we believe we have a more conservative and accurate approach to setting loss reserves as evidenced by our consistent favorable prior year development.This was particularly an issue in the second quarter in Florida as we had a surge in newly reported Assignment of Fenefit or AoB claims and advance of the July 1 statutory reform. In particular, we received a large influx of roof-related claims for hail events of prior quarters and for one PCSE [ph] in Florida during the second quarter.Including the Florida PCS [ph] which impacted multiple southeast states in the quarter, we had a total of four PCS events that impacted our southeast book print. Unlike the first quarter, we did not have a single event that was large enough to trigger reinsurance recoveries. As a result, we incurred approximately $21.5 million of current accident quarter severe weather losses that overshadow and otherwise stellar quarter across all metrics.It is worth noting that the vast majority of this loss is related to Incurred But Not Reported or IBNR versus paid claims and this approach is consistent with our reserving philosophy. If these claims are truly related to a surge in AoB and/or do not develop, we will potentially have a significant amount of IBNR to release in the future quarters. However, until and if that occurs, it is prudent to establish sufficient reserves now rather than incur adverse development later.Moving on to capital management. We repurchased $2.3 million of common stock at a discounted book value. We have been stockpiling free cash at the holding company and we'll be opportunistic and intend to retire additional shares in 2019 as long as our share price is below fair value.I will now turn the call over to Kirk to provide more details on our financials.

[Kirk Lusk:]

Thank you, Bruce. Good morning. Net income for the quarter was $700,000 and was down from $2.4 million reported during the second quarter of 2018. As announced in our July 18 press release, weather losses during the second quarter of 2019 were the main driver of the year-over-year variance.Gross written premiums for the quarter were $255 million which was down from $264 million for the second quarter of 2018. The drop in the second quarter reflects the continued derisking in the Tri-County region of Florida. Imports premium reductions in the Tri-County area for the second quarter of 2019 was one of the largest import reductions since the derisking began in 2016.In-force premiums in the Tri-County area decreased by over $35 million year-over-year and by over $23 million in the second quarter of 2019 alone. Largely offsetting the significant reduction in the Tri-County area in-force premiums year-over-year outside of the Tri-County area grew by over $25 million. We anticipate that our growth outside of the Tri-County area will continue and accelerate as we direct our marketing efforts outside that region and continue to evaluate our exposure in the Tri-County area.Despite the significant amount of derisking, gross earn premiums are relatively flat from the prior year quarter. Ceded earned premiums are down year-over-year by 3.2% and down 2.5% from the first quarter of 2019. The decrease reflects NBIC related synergy savings on a CAT/XOL reinsurance treaty and also the June 1, 2018 reduction of NBIC's [indiscernible] contract from 18.8% to 8% and the June 1, 2019 elimination of the gross quarter share which was partially offset by an increase in the NBIC net quarter share last December from 49.5% to 52% and increases in other reinsurance structures.2019 second quarter net earned premiums were up 2.6% from the second quarter of 2018 reflecting the slight reductions in the gross earned premium which was more than offset by the decrease in ceded premiums earned just mentioned.Losses in LAE were up 12.6% or $8.3 million from the prior year quarter. The net loss ratio was 65.1% for the second quarter of 2019 compared to 59.3% for the second quarter of 2018. Current accident quarter hail and non-catastrophe weather losses from multiple events impacted the net loss ratio for the quarter by 18.8 points and for the year-over-year loss ratio variance by 10.4 points. The remainder of the variants is attributable to the chance in loss development and reduced activity in our vertically integrated contractors' alliance network.Policy acquisition cost were up $7.7 million predominantly due to the exploration of the purchased accounting benefit obtained during the first half of 2018 and reduced ceding commissions associated with changes to our quota share reinsurance programs.General and administrative cost are down $6 million from $24.4 million at second quarter 2018 to $18.4 million at the second quarter of 2019 and relatively flat from the first quarter of 2019. The reduction from the prior year quarter is predominantly due to acquisition and integration expenses incurred in 2018 which was partially offset by a ceding commission reduction.The combined ratio for the quarter as a percentage of net premiums earned was 105% which is up from the 98.7% as of the second quarter 2018. The increase reflects the weather losses previously discussed with a relatively flat expense ratio.Shareholders' equity at June 30, 2019 increased to $438.9 million from $435 million at the end of the first quarter 2019. The change predominantly reflects the net income for the quarter and the tax affected net unrealized gains in investments partially offset by dividends to shareholders and stock buybacks. Book value per share is $14.99, up from $14.78 at the end of Q1 and $14.43 at year-end.Total cash plus invested assets increased $62 million from year-end mostly driven by the receipt of reinsurance recoverables related to hurricane claims. Total assets are $1.9 billion at the end of Q2.Bruce and I are now available to take your questions.

[Operator:]

We will now begin the question-and-answer session. [Operator Instructions] Our first question today comes from Mark Hughes with SunTrust. Please go ahead.

[Mark Hughes:]

Thank you. Good morning. On the ceded premiums one, is that $116 million this quarter? How should we think about that for our Q3 when we get the full run rate on the new Florida reinsurance treaty?

[Bruce Lucas:]

When you look at that, it only reflects like one month of the reduction so we will get a little bit more of a reduction and you can't extrapolate fully the reduction, multiply x3. But I would think that when you look at the quarter-over-quarter reduction from Q1 to Q2, we're going to have about that same type of magnitude in the third quarter going forward.

[Mark Hughes:]

Okay. Then how about the G&A expense that's been a little bit volatile? Is $18 million to $19 million, is that a good number? Or how should we think about that?

[Bruce Lucas:]

I think that probably it's going to tick up a little bit as we look at some of the initiatives, we have both on the growth and on the claims side. So the claims side will actually move over to the last dollars, but some of the activity we're going to incur. I will look at that going up slightly.

[Mark Hughes:]

Okay. And then the AoB. Talk about the surge in the filings in Q2. Was that captured in your Q2 loss ratio? Is that going to have a spill over into Q3 on losses?

[Bruce Lucas:]

No. It is captured in Q2, Mark. We, along with everyone else, all the surge, in AoB as they were raising to get their AOBs and before the July 1 deadline, there was a big ramp up out there in the market trying to recruit insurers to participate in the scam. We saw that increase. A lot of it what we saw was related to hail and other miscellaneous wind events. We have a hard time getting the AoB contractor to tell us exactly when these losses happened because they don't know. Those losses were captured in that $21.5 million severe weather number that we put out. The vast majority of the losses are IBNR. When you see an increase in claim activity like that, unfortunately you have to reserve for it like that's your latest trend. We've put up significant reserves and we'd rather be wrong about the reserves and have favorable development going forward like we've been doing the past four quarters, but we can't change our reserving philosophy quarter-over-quarter. One quarter is not the trend to make, so if these things don't develop, we should have a lot of reserves to release. But until and if that happens, we have to make sure that we're doing things according to our standard reserving protocols.

[Mark Hughes:]

I'll ask one more modeling question. I apologize for that. But when you think about your underlying loss ratio, this quarter you clearly called out -- that was 19 points from the severe weather. If we think of on a go-forward basis, do we just strip out the 19 points and then make some assumptions about the Cat or what have you? Or would you say we ought to keep in some additional buffer for normal weather volatility?

[Kirk Lusk:]

There should be a little bit of a buffer for normal weather volatility and specially Q2 and going into Q3 because those are the rainy months. But what we saw this quarter was I think we had four separate PCS events. Four of them head our southeast book ex-Florida, one of them hit directly in Florida. That's kind of unusual, but we put up a lot of reserves on those. Like I said before, hopefully we overshot it, but we won't know for another year to be honest with you. But you're always going to have a little bit of weather volatility. As we expand our footprint, you're going to get more frequency events. But over the long haul with reinsurance synergies, lower fraud cost, lower claim cost, it should more than bounce out and should be pretty accretive to the bottom line as we continue with the business plan.

[Mark Hughes:]

Thank you.

[Kirk Lusk:]

Thank you, Mark.

[Operator:]

And our next question comes from Christopher Campbell with KBW. Please go ahead.

[Christopher Campbell:]

Yes, good morning. Congrats on the quarter.

[Bruce Lucas:]

Thank you.

[Christopher Campbell:]

I guess my first question is on the core loss ratio increase. I'm assuming most of that is the storm-related income rolling off. Was there anything else that drove that increase as well that we should be thinking about as we model that forward?

[Bruce Lucas:]

The core loss ratio is impacted by higher reserves especially in the quarter. We've masterly increased accident quarter IBNR to encapsulate the surge in claims that we had. It's that factor and in addition, we just generally noted across Florida that the environment for claims abuses is getting worse. I really can't say that I've seen it improving. So that just goes to the heart of why we have been making this pivot for the last three years to diversify away from Florida and to be honest with you, you can do AoB reform and you change the format of the fraud, but the fraud will continue and I just don't see it really ever going away particularly in the Tri-County, Orange, in Osceola, or to other big ones. We just got to hit it with rate which we're doing. We're getting about an average of 14% plus rate increases across our personal line platform in Florida and that's in response to the higher loss cost that we're seeing across the board.

[Christopher Campbell:]

Got it. And post AoB reform, I know you guys are only like a month in. Are you seeing any drop in litigation or anything like that on the Florida book? Has there been a noticeable improvement in your operational claims metrics?

[Bruce Lucas:]

Yes. You're right. It is pretty early and I can tell you that what our stats tell us is on litigation, we actually saw -- I'd say pretty consistent levels in July because you have a lot of AoB claims that were say, from first quarter or second quarter, they didn't get the exact amount of money that they were looking for. So they end up filing suit and because those AoBs are pre-July 1, they're not covered by the new statute. We haven't really seen that tail off as much because there's a bit of a lag there. Last half of July was lower than the first half, I can tell you that. And in terms of AoBs that we have seen since July 1, yes, we have seen a pretty sharp decline. And of the ones that were filed with us, I think in total we had a few hundred AoBs which really isn't that much and only about 30 or 40 of them even attempted to comply with the new statute. So they were summarily rejected. We've seen that pretty big drop off in the amount of AoB activity on front-end claims in the month of July.

[Christopher Campbell:]

Okay, got it. And there's no other area that the plain as far as being creative about like trying to open up new areas for...

[Bruce Lucas:]

They are. I won't mention them on the call, but we have different lawyers trying different strategies to try to circumvent the AoB statute. We're on top of those issues as well, but that kind of goes to my point. You can't stop the fraud in certain areas of Florida. You can't stop it. It will find a way to creep into your numbers through one mechanism or another. It is there, it is not going away. We've noticed it getting worse every year of our operation which is why we've so steadfastly been derisking out of those areas and growing outside of Florida. The only way to stop the fraud is to not have the actual exposure.

[Christopher Campbell:]

Okay, thanks. And then can you give us color -- I know you guys aren't interested in M&A in Florida, but has the environment post reinsurance rate increases for competitors who took higher rate increases than you guys did, has that changed the outlook of sellers and are you seeing more companies down there willing to entertain offers?

[Bruce Lucas:]

That's a really good question. We've paneled at the market on the M&A front. We are not interested in M&A in Florida, but I can tell you that there are several companies that are teasing potential sale to perspective buyers. We're just not seeing the buyers come in for those companies. They're generally smaller in scale, they have a lot of Tri-County business, you got to get in the reserves, they don't have the reinsurance leverage that the bigger carriers have. We're really not seeing any activity. The only activity I'm aware of is one company that I believe acquired a book of business from another within Florida, but I don't think they actually took on the entity itself.

[Christopher Campbell:]

Got it. Would there be a price if something was trading like a large price to book discount? Would there be a discount at which you might get -- Florida might look more attractive. It's like you could get something for 70% a book?

[Bruce Lucas:]

Maybe. I'm never going to say no. But for us, we need to find -- let's just say that hypothetical, we would need to find a company that has our reserving philosophy and I can just tell you that nobody has that. That's the reason we're the only carrier that has been reporting favorable prior year development every quarter. I'm not really looking to inherit somebody else's headaches. We're diversifying the company away from Florida. That is our business plan. It's different than everyone else in this market. We're going to stick to it, it is working for us. We've seen it in our operating profit over the last several years, has been very strong. We're going to have frequency events -- more of them as we expand outside of Florida. But in general, we just find incredibly stable claim markets, environments outside of the state of Florida, particularly outside of Tri-County, Orange and Osceola.

[Christopher Campbell:]

Got it. And then as you diversify outside of Florida, what are the ROEs? Florida has pretty large premiums and it's like very volatile market, but usually pretty high ROEs. Now as you expand outside of Florida, are you expecting those to compress? And then just thinking about the high level about valuation -- I'm thinking like price to book as a function of future ROE -- if you're standing outside of Florida, how does your competitors that change were as most people will throw you in with the other four Floridian -- does your competitors that change and should we be thinking about the valuation any differently as you become a super-regional versus a predominantly Florida carrier?

[Bruce Lucas:]

A really good question. I would say no, that the ROEs are not compressing as we expand outside of Florida and there are several reasons for that. First, we have lower claim experiences outside of Florida. It's way more stable, there's less fraud, there's just losses that don't exist, PAs don't exist. We don't see them in our books. We're not in Louisiana; we're not in Texas where you see this stuff. We've purposely removed ourselves from those markets. The markets that we're in are very, very stable. They have higher retention ratios and we are also -- that's the first reason. The second reason that we don't believe that ROEs are compressing and in fact we think they're accelerating, is because we're getting significant reinsurance synergies as we expand the footprint away from Florida. The reinsurance cost that we have in Florida are significantly higher than ex-Florida. So more concentrations outside of Florida particularly where our books lie in the southeast that's more of an inland book, not a coastal book like some of our peer companies and we're picking up tremendous reinsurance synergies that are helping the bottom line. And you get right of the fraud and the fluctuations and IBNR, those things are very, very positive for the company.In terms of part B of your question which is the competitive landscape, yes, we're going head-to-head with more of the major carriers. There's no doubt about that. We do see some of the Florida peers in our states. There's one in particular that we see a lot, but we are focused more on inland book versus the coastal book in a lot of these states that I think is a differentiator, but we are going against companies like travelers and big household names that you would normally see, but we're growing at a remarkable pace outside of Florida, well in excess of what we have modeled. So our strategy is working and we are gaining traction in market shares. We moved the footprint away from Florida.

[Christopher Campbell:]

Great. Well, thanks for all the answers. Best of luck on the third quarter.

[Bruce Lucas:]

All right. Thank you, Chris.

[Operator:]

And our next question comes from Matt Carletti with JMP. Please go ahead.

[Matthew Carletti:]

Thanks. Matt Carletti at JMP. A few questions. Bruce, I was hoping you could just back on the weather losses real quick. Can you give us the rough split of what were Florida events and were ex-Florida events? I know you mentioned North Carolina is the biggest one, but how that splits out?

[Bruce Lucas:]

Yes. I think the most of it was related to Florida, related to the AoB claims that we got in the quarter. I don't know that I have that split in front of me. I'm kind of looking at the screens now, but we have a much bigger portfolio in Florida than we do in North Carolina. Although Georgia, Alabama and North Carolina got pounded pretty hard by these PCS events, I would say that the majority of the loss came out of Florida.

[Matthew Carletti:]

Okay. And then sticking on ex-Florida. Can you talk a little bit about -- you've added some new partnerships with other larger companies? How are those coming along and are you pleased with what you're seeing so far?

[Bruce Lucas:]

Yes. They're actually going very well. The three main large partnerships that we have are Geico, National General and Seiko. Those are the three more national carriers, the wheels that we're partnered up with. I can tell you that the relationships there with all three companies has been fantastic. It is helping us with our growth, no doubt about it. We're looking to expand that relationship in the new markets and products, especially here in the second half of the year. I would never give actual data about any of those three carriers that we feel is proprietary and we would need their consent to release, but their relationships have definitely outperformed what our expectations were.

[Matthew Carletti:]

Okay, great. Thanks. And then just one quick number of questions on the investment portfolio with the pull back in rates here. What's the new money yield and what's the book yield?

[Bruce Lucas:]

Our yield is about 2.84, duration is at 3.49.

[Matthew Carletti:]

That's book yield?

[Bruce Lucas:]

Oh, yes.

[Matthew Carletti:]

And then what's new money rate?

[Bruce Lucas:]

Don't have the new money rate. We'd have to look at that.

[Matthew Carletti:]

Okay. All right. Thanks a lot.

[Kirk Lusk:]

All right. Thank you, Matt.

[Operator:]

[Operator Instructions] And our next question comes from John Barnidge with Sandler O'Neill. Please go ahead.

[John Barnidge:]

Thanks. Growth premiums written growth has decelerated every quarter since Q2 2018. I know it's a real positive derisk reduction in Tri-County, but as we look forward, when should we expect that risk reduction eventually turn into growth given the real strong growth, you're having in the expansion states and partnerships?

[Bruce Lucas:]

Well, the derisk that we had in the second quarter was the largest in the company's history. We did that in advance of reinsurance season to be honest with you. We just didn't want to have all that TIV on our books during wind season and pay the cap premium for it. It's a great question. There's a lot of factors that kind of go into play. We saw positive growth in the first quarter. Second quarter was the largest derisk in the company's history as mentioned, yet our in-force premium went down less than 1% year-over-year. So it was very negligible, but that was a targeted reduction. As we're seeing acceleration at the ex-Florida states which has been incredibly strong, we do think that plus rate increases move us into positive growth trajectory moving forward. But Q2, because of the derisk for the reinsurance purposes was a big offset to that tremendous growth we had in the second quarter.

[John Barnidge:]

Is the derisking completed or maybe asked another way, the $6.2 billion in TIV reduced during the quarter? How much on a percent basis does that represent of the current Tri-County exposure?

[Bruce Lucas:]

It's a good question. I'll let them pull up TIV metrics here, we'll try to get you that number. But I can tell you rough numbers, we're going to derisk more and that is our trend. Investors that like less fraud volatility and adverse development, this is how we get there. There is more policy derisking that will take place. We're not writing any business down there at all for personal lines. You could bank every year on at least the team to 20% of those policies disappearing just from natural attrition. We have been very focused on commercial residential in the Tri-County. We've noticed that there are some companies that are still underwriting those exposures at what we believe is an insufficient rate so we have done a lot of derisking and commercial residential, particularly in [indiscernible] where we do not believe that market rates are sufficient cover the cap load and the attritional loss ratios that you have for that book.

[John Barnidge:]

Okay. You mentioned you've got no interest in Florida M&A, really. Do you have interest in M&A outside of Florida? And if so, what geographies or lines of business?

[Bruce Lucas:]

Yes, another great question. Yes, we would look at M&A outside of Florida. It is not our focus. We were focused on zephyr [ph] and there again, so they were the two targets, we closed on both transactions. We are not actively pursuing any M&A in the market right now but if we did look at M&A, it would have to be outside of Florida unless there was just some crazy deal out there that made a lot of sense to us.

[John Barnidge:]

All right. I think this will be my last question. You're getting at it sounded like a 14.9% earn rate increase on your Florida book. But can you dimension what your claims inflation level is? I'm just trying to triangulate how long we should be thinking about underlying margin deterioration perspectively.

[Bruce Lucas:]

Well, a lot of that depends on severe weather and a lot of that depends on how much favorable or unfavorable redevelopment we have in the book. I can just tell you that lost cause in Florida are elevated versus the year ago, versus two years ago. That is really related to the unique fraud mechanisms that are in place in Florida with or without AoBs yet. There is going to be some lost cause inflation in the portfolio offset by the rate increases. The lost cause weren't there; we wouldn't be able to get 14.9%. And that rate increase has really targeted that Tri-County where the average rate increase is 25% on that filing. You take a state-wide average of roughly 15%, but 25% is going to three counties. Its shows you that the lost cause inflation X Tri-County isn't really that high, it's the Tri-County portfolio which is why I mentioned in my comments earlier that we believe a lot of the adverse development occurring in the market right now is happening as it related to or in connection with Tri-County exposures.

[John Barnidge:]

Great. Thanks for the answers and good luck.

[Bruce Lucas:]

Great. Thank you, John.

[Operator:]

This will conclude our question-and-answer session. I'd like to turn the conference back over to Bruce Lucas for any closing remarks.

[Bruce Lucas:]

I would just like to thank everyone for participating in our Q2 earnings call.

[Operator:]

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines. Have a good day.