Earnings Call Transcript - ACIC Q3 2020

Operator, Operator

Greetings, and welcome to the United Insurance Holdings Corp. Third Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Adam Prior of The Equity Group. Thank you, sir. You may begin.

Adam Prior, Investor Relations / Moderator

Thank you. Good afternoon, everyone, and thanks for joining us. You can find copies of UPC's earnings release today at www.upcinsurance.com in the Investor Relations section. In addition, the company has made an accompanying presentation available on its website. You're also welcome to contact our office at 212-836-9606, and we'd be happy to send a copy. In addition, UPC Insurance has made this broadcast available on its website as well. Before we get started, I'd like to read the following on behalf of the company. Except with respect to historical information, statements made in this conference call constitute forward-looking statements within the meaning of federal securities laws, including statements relating to trends in the company's operations and financial results and the business and the product of the company and its subsidiary. Actual results from UPC may differ materially from those results anticipated in these forward-looking statements as a result of risks and uncertainties, including those described from time to time in UPC's filings with the Securities and Exchange Commission. UPC specifically disclaims any obligation to update or revise any forward-looking statements as a result of new information, future developments or otherwise. With that, I'd now like to turn the call over to Mr. Dan Peed, UPC's Chief Executive Officer. Please go ahead, Dan.

Dan Peed, Chief Executive Officer (CEO)

Thanks, Adam. Hello all, and thanks for joining our call. I'd like to offer an overview of our third quarter results, and then Brad Martz will provide some specific numbers, and then we'll take questions. In the third quarter, we made excellent progress towards increasing our underwriting profit on an ex-named storm basis. Most importantly, our core income ex-named storm margins continued to grow with a third consecutive quarter-over-quarter improvement. We are demonstrating continued progress as increasing rates and enhanced underwriting risk selection activities earn their way through the portfolio. In Q1, we returned to profitability on core income ex-named storm, earning $0.20 per share. In Q2, progress continued with $0.30, and in Q3, we earned $0.35 per share. The Q3 number includes a nonrecurring expense of $2.8 million due to our decision to discontinue an office development project, or $0.05 per share. So the adjusted quarterly run rate on core ex-hurricane earnings is $0.40 per share. Year-over-year, core income ex-named storm jumped from the 2019 Q3 loss of $0.11 to income of $0.35 in the most recent quarter; a $0.46 improvement. Additionally, our gross non-cat loss ratio is down 1.5 points year-over-year to 23.4%, and our year-over-year gross expense ratio also improved to 26.1%; a 0.9 point reduction despite the nonrecurring charge. We are continuing our portfolio optimization activities, many of which are enabled by the hardening U.S. windstorm market for both our personal lines and commercial lines portfolios. Our ongoing PML exposure management strategy targets nonrenewal of the lowest tier of our exposures, which we believe improves capital efficiency as well as mitigating some of the challenges on our core catastrophe excess and loss placement at 6:1. Top line gross written premium increased by 15% in the third quarter, which is driven mostly by rate. As shown on page 8 of our investor presentation, we have over a dozen filed and approved additional rate increases in our biggest states, just becoming effective over the last 90 days, which will enable us to continue our rate growth through 2021 and 2022. We're also taking numerous underwriting actions to refine and focus our portfolio. First, we are increasing use of a proprietary online inspection technology to enable us to focus on best-in-class risk. We are also refining our appetite on new business to restrict writings in peak exposure zones and unprofitable geographies. We are exiting products and territories that lack profitability or scale. Additionally, we are implementing minimum deductibles in Florida with plans to expand to the rest of our footprint. And we also plan to refine our agency plan on addressing final quartile producers. All these activities are expected to drive a significant continuing improvement to our underlying combined ratio, which helps to generate underwriting profit needed to absorb the catastrophe risk inherent in our portfolio. Speaking of catastrophe risks, unfortunately, 2020 is turning out to be a record-setting year for U.S. land-falling named storms, with 11 year-to-date. This is more than the previous record set over 100 years ago in 1916. Within Q3, we had seven named storms, which impacted our policyholders in 11 different states. This frequency is unprecedented. If you model five storms that exceed $1 billion of industry loss, it models out to be approximately a one in 44-year recurrence, or put another way, a 2.3% chance of happening in any one year. And as a windstorm specialist, the high frequency moderate severity tends to have a much greater impact on us than a single hurricane with a one-in-50-year storm severity. Our 3Q gross catastrophe loss is currently estimated at about $290 million. But with seven cumulative retentions, our named storm catastrophe losses net of reinsurance totaled approximately $125 million. We still have over $3 billion of remaining limit in our core catastrophe aggregate tower. The catastrophe losses, including early estimates of Q4 events, Delta and Zeta, have impacted our capital position and our reinsurance plans for 2021. Our gross written premium in 3Q is up by 15%, and our cash and investments at the end of 3Q are up by 16%, yet our total capital is down by 7.6%. Earned premium to stockholders' equity increased from 149% to 166%, increasing the leverage on our capital. Additionally, year-to-date book GAAP value is down by 9.9%. These decreases are disappointing and more than we would anticipate with even a four-storm stress test. However, they appear to be manageable given our modest current quota share cessions, and we have an excellent panel of long-term reinsurance partners. We are nearing the completion of additional quota share capacity. This is expected to decrease leverage correspondingly, and we would anticipate this to have an immediate favorable impact on RBC. However, we would also point out that several variables remain unknown including any losses that may result from Eta or any subsequent 4Q named or non-named catastrophe events. Additionally, finalization of our quota share support and other deleveraging activities are not entirely under our control. We are also working on our core catastrophe excess loss program and are better positioned due to a mix of multiyear capacity, quota share, reinsurance, catastrophe bonds and a reducing PML in our portfolio. As such, a significant majority of our core catastrophe tower limits are already secured for a June 1, 2021 placement, and we expect to have redundant capacity available in the limits remaining to be secured next spring. With a strong group of key reinsurance partners, we anticipate an orderly completion of our core catastrophe program for June 1, 2021. Based on the impacts to our results from named storm frequency in 2020, we plan to decrease our net named storm retentions in 2021, as well as address our non-named catastrophe exposure. We expect this to drive an increased reinsurance spend. However, that will be offset by strong gross written premium rate growth and achieving reduced net volatility in 2021. For me as the new CEO and for our company, this quarter has been a significant challenge, but expected continued improvement in the escalating non-cat margins should drive future profitability and also enable a profitable underwriting margin on our catastrophe exposures. It is truly a challenge to be a catastrophe specialist in record-setting catastrophe years. However, the elevated regional non-named and named catastrophe activity over the last several years, exacerbated by the impacts of global catastrophe and uncertainties of COVID-related risks to the broader market has created a hardening market in both personal and commercial lines that we expect will enable strong margins moving forward for best-in-class underwriters. We are taking the steps necessary to focus our portfolio on core competitive advantages, and we currently expect these steps to bring us back to peer-group profitability over the next four to six quarters and position us well as a top-quartile specialist over the long term. With that, I'd like to turn it over to Brad Martz.

Brad Martz, President and Chief Financial Officer (CFO)

Thank you, Dan, and hello, everyone. This is Brad Martz, the President and CFO of UPC Insurance. I'm pleased to review UPC's financial results, but also encourage everyone to review our press release, investor presentation and Form 10-Q for more information regarding the company's performance. For the quarter ending September 30, 2020, the company reported a GAAP net loss of $74.1 million or a loss of $1.73 per share and a core loss of $83.8 million or a loss of $1.95 a share. These results included $140 million of catastrophe losses, which came in slightly higher than our pre-announcement on September 22nd that excluded Tropical Storm Beta. Net retained losses from seven named windstorms during the third quarter were $125.1 million or roughly $2.30 a share. We anticipated our company would experience hurricane losses in the third quarter, but this year's record-setting season led to higher net retained losses and a disappointing result this period. However, if you strip away the noise created from named windstorm activity in the current and prior year, you will see a more comparable underlying view of our business that has improved each quarter this year. As Dan mentioned, excluding named windstorms, we produced core income of approximately $15 million or $0.35 a share compared to a loss of $4.5 million or $0.11 a share last year, which is nearly a $20 million improvement in our underlying results year-over-year. Page five of our investor presentation paints a nice picture of core income, excluding named windstorms, for each quarter this year compared to 2019. And we present this information not to disclaim ownership of hurricane losses, but to reiterate, this is the earnings stream we are focused on growing to absorb hurricane losses when they occur. Premiums written for the quarter increased $48.6 million, over 15% from a year ago, driven by new business and rate increases primarily in Florida and Texas, plus 10% growth in our commercial property book, fueled primarily by rate change, not exposure growth, as total insured value rose less than 1% year-over-year in commercial lines. Ceded earned premiums were 46.7% of gross premiums earned, compared to 44% last year. The change was due to increased cessions to our share reinsurance program, which were 13.6% of gross premiums earned or $48.1 million in the current quarter versus 12.2%, or $42.2 million last year, as well as higher costs related primarily to our core catastrophe reinsurance program that renewed on June 1st of this year. Other significant items impacting total revenues during the third quarter included realized gains of $25 million, stemming from the sale of roughly $107 million of equity securities, representing approximately 80% of our common stock holdings at the time of disposal. This was partially offset by unrealized losses from equities of $11.6 million for a net investment gain of $13.4 million in the current period, compared to $2.6 million a year ago. Investment income of $6 million declined $1.8 million or 23% from the prior year, due primarily to the collapse in short-term yields back in March of 2020. UPC's third quarter net loss and loss adjustment expense was $218.7 million, an increase of $70.5 million or 47.6%. That included $140 million of catastrophe losses, which added over 74 points to our net loss and combined ratio, which was partially offset by $4.2 million of favorable reserve development. Non-cat reserve development continued at a slower pace than expected during the third quarter. Excluding these two items, our underlying loss in LAE was $82.9 million, down approximately $2.8 million or 3.3% year-over-year. This produced an underlying gross loss ratio of 23.4%, which compared favorably to 24.9% a year ago. UPC's operating expenses were $92.4 million, a decrease of $679,000 year-over-year. Policy acquisition costs declined $3.1 million, due to higher ceding commissions earned, which is an offset to the change in ceded premiums earned. Underwriting and operating expenses increased $2.3 million due to higher system and software costs, and G&A was basically flat year-over-year. But as Dan mentioned, it included a nonrecurring charge of $2.8 million related to our abandonment of capitalized costs for a new home office building project. COVID definitely played a part in reassessing our long-term office space needs, but we also want our team 100% focused on underwriting results right now. So the cost and distractions from that project have been taken off the table. Our gross expense ratio was 26.1%, an improvement of nearly a point from the prior year, but would have been closer to two points without that nonrecurring charge. The same holds true for our underlying combined ratio, which was essentially unchanged from last year, but would have improved 1.4 points to 91.4% excluding the expense item for the discontinued real estate project. On the balance sheet, UPC's assets totaled $3.1 billion, including cash and investments of $1.48 billion. The modified duration of our fixed income holdings increased to 3.9 years, but the overall composite rating of A+ remained unchanged at September 30th. GAAP equity attributable to UIHC stockholders declined approximately 10% from year-end to $454 million, with a book value per share of $10.54 or $9.80 excluding AOCI. Our group statutory surplus declined to $371 million at the end of the quarter. In conclusion, we believe UPC is well positioned and heading in the right direction, so we greatly appreciate your interest. I'd like to thank you for investing your valuable time today to learn more about our company. We are now happy to take any questions.

Operator, Operator

Thank you. At this time, we will be conducting a question-and-answer session. Our first question comes from the line of Greg Peters with Raymond James. Please proceed with your question.

Greg Peters, Analyst, Raymond James

Hi, good afternoon. I wanted to start off with some questions around your exposure management. The gross written premium is up pretty significantly in the quarter, and that, as you suggest, is all rate. How much more aggressive can you get with exposure management in the context of limiting your gross written premium growth?

Dan Peed, Chief Executive Officer (CEO)

Greg, this is Dan. I think that we are taking numerous steps that fall under that bucket of exposure management. Rate is one of them. So I mentioned the bottom PML-driven risk selection; we're inspecting much more of the new business. We also have looked at all of our lines of business in all of our states to determine if any of them didn't have the scale or profitability and whether it was better to focus on our key areas where we can be profitable. I think that the market is hardening, and I believe that it will continue to harden even more and that we will be able to continue improving the class of risk that we write as well as improving the terms and conditions under which we write it.

Greg Peters, Analyst, Raymond James

Well, it certainly seems like it is. It just feels like you could deal with a lot less loss. Can you spend a minute and describe — I know you break out in your press release the by line of business, so the personal side versus the commercial side. Has there been a difference in underwriting performance of those businesses, or are they performing in this high-frequency catastrophe environment similarly?

Dan Peed, Chief Executive Officer (CEO)

I think that the personal lines takes longer to turn, and we really started improving the terms and the results and the rate of the personal lines book a year ago, but it had further to come. It is getting there, and it seems to be continuing to improve on a pretty steady basis for the core ex-hurricane numbers. The American Coastal commercial residential book, which has always been a gem, is profitable, significantly profitable this year even with the named storms. And our commercial specialty business has gone through some changes as we've moved from three different contracts to one. But we believe that it has a great prognosis in the commercial specialty line.

Greg Peters, Analyst, Raymond James

Interesting. The other question that's popping up for the companies in your space is just capital. There are, as you know, almost all of the companies in the Florida market are under various levels of stress. And there is rhetoric about some, maybe a number of them, losing their capacity going forward. Can you talk about your capital position, your Demotech rating and your RBC ratio in the context — I think you mentioned some anticipated additional quota share. Ultimately, what we're looking for is your ability to withstand this year. In the fourth quarter, you're going to have some more catastrophe exposures. And the bottom line is your ability to withstand this year and to live on and fight for next year.

Dan Peed, Chief Executive Officer (CEO)

Right. That's a good question. We feel pretty good about our position right now. We've been working with our reinsurers. As we stated, we're very close to adding some additional quota share and we believe that additional quota share would be what is needed to move our leverage back into where it was before this season. I think if you solve the RBC problem, then you're pretty consistent with solving the Demotech questions also. So we feel pretty comfortable, but we want to also say that, obviously, we'll be dealing with the Q4 catastrophe exposures, and those aren't all known at the moment. So there's some unknown, and some part of that remains outside of our direct control. But we feel pretty comfortable that we've got the levers that we can pull to handle it.

Brad Martz, President and Chief Financial Officer (CFO)

Greg, this is Brad. I would just add that rating agencies recently affirmed ratings for several members of our core group. Obviously, all that's subject to change depending on how the fourth quarter plays out. But as Dan said, I think we feel very good about our ability to utilize reinsurance to close that gap between our direct writings and our net premium risk retention. Obviously, we're well aware of that. We understand that reducing operating leverage and earnings volatility is a top priority for us right now.

Greg Peters, Analyst, Raymond James

Got it. Can you just conclude — last question. Can you give us an idea — I think you said in your prepared comments you still have a lot of limit left. But as we think about the storms that have happened in the fourth quarter and the one that is lurking out there, what's your per-event retention as it currently stands, and as we sort of model out for the fourth quarter results?

Brad Martz, President and Chief Financial Officer (CFO)

Sure. Yes, we still have 91% of our core reinsurance program in place, over $3 billion of a $3.3 billion tower. So no worries there. We could experience a very significant event if Eta turned into something significant. It wouldn't be a problem for us. Our retention is $25 million on a go-forward basis. So we're prepared for the worst and hoping for the best with that event. Probably if it comes into Florida as a tropical storm, I don't think it will be a full retention event for us.

Greg Peters, Analyst, Raymond James

Got it. I’ll let others ask questions. Thanks.

Operator, Operator

Thank you. Our next question comes from the line of Matt Carletti with JMP Securities. Please proceed with your question.

Matt Carletti, Analyst, JMP Securities

Hey, thanks. Good afternoon. Greg grabbed most of mine. So I just have a follow-up on the capital and additional quota share potential conversation. As we think about that additional quota share and where the market is — the reinsurance market is getting firmer, and reinsurers are getting more selective — how should we think about the terms on that? Should you expect them to be materially different than what you have in place so far? Or another way of thinking about it is should we expect on a net earned premiums basis upward pressure on an expense ratio when we think about ceding commission coming in as opposed to negative pressure?

Brad Martz, President and Chief Financial Officer (CFO)

Hi, Matt. The terms we've already received are from existing panel partners. I definitely think if we were in the market trying to put together a brand-new program with no quota share experience, the terms could be very challenging. But because we've got great support from existing partners, it's fairly straightforward to expand the cession rate without any significant changes or even any changes to the main terms of the existing agreement. So that's our first preference. We are exploring all options. But we've got great partners. We've got offers already on the table in hand. Hopefully, we'll have something to formally announce shortly.

Matt Carletti, Analyst, JMP Securities

All right. Thanks, Brad, best of luck. Thanks.

Operator, Operator

Our next question comes from Elyse Greenspan with Wells Fargo. Please proceed with your question.

Elyse Greenspan, Analyst, Wells Fargo

Hi. Thanks. Good evening. My first question: you mentioned for go-forward events your retention is about $25 million. Do you have a sense of where the catastrophe losses for the fourth quarter sit today based off of some of the events we've already had?

Brad Martz, President and Chief Financial Officer (CFO)

Yes. We stated on page 3 of our investor presentation that Delta and Zeta are likely to be between $50 million and $55 million. There is a retention for the core group at $25 million, but there could be a little bit of additional loss related to our E&S business in that blue-line tower. But we think the losses are contained within that range; it is preliminary.

Elyse Greenspan, Analyst, Wells Fargo

Okay, that's helpful. Based on the questions you've had with Demotech, is there a timeframe they would want you to have additional capital support in place? In your conversations, under what timeframe have you pointed to working towards getting your leverage back to where you were before these storms?

Brad Martz, President and Chief Financial Officer (CFO)

They haven't requested anything from us. We're being proactive in our modeling and capital planning in anticipation of questions they may have after reviewing our third quarter results, but they haven't expressed any desire to see us do anything at this moment.

Elyse Greenspan, Analyst, Wells Fargo

So when you think about the conversations you've had with some partners and the losses you mentioned for the fourth quarter, when do you envision getting your leverage back to where you were before these storms?

Brad Martz, President and Chief Financial Officer (CFO)

This quarter, we're targeting an effective date of December 1. That could clearly change, but that is our target at the moment. And we bought some of that capital release to help bolster our RBC here in 2020.

Elyse Greenspan, Analyst, Wells Fargo

Okay. And Dan, you mentioned the real key to your success is growing underlying core profit margin because when you have that rate and that margin to work with, it's not difficult to have additional quota share partnerships. Is that the correct takeaway?

Dan Peed, Chief Executive Officer (CEO)

Yes. The real key to our success is the growing underlying core profit margin, because when you have that rate and that margin to work with, it's not difficult to have additional quota share partnerships.

Elyse Greenspan, Analyst, Wells Fargo

Okay. Then you mentioned a good amount of rate you're getting in your book, which triangulates into pretty good gross premium growth in the quarter. Could you give a little more color on the rate increases we should expect from here — how much more price you expect to put through your book of business?

Brad Martz, President and Chief Financial Officer (CFO)

It's pretty significant. On the personal lines side, page 8 does a pretty good job of laying out what some of the changes we've already made and are planning to make. We think the effect of these changes could be upwards of $100 million of additional premium with no increase in marginal exposure. And as that rate earns in, it's extremely powerful. Obviously, our capital position will dictate how much of that we get to keep. We're happy to share some of that with our reinsurance partners to the extent we need to. But we're going to be taking, as Dan mentioned, some pretty aggressive action to rein in the direct writings over time. Reinsurance is a long-term strategy, but quota share is probably more of a short-term tool to help us manage leverage until we refine the risk portfolio and get the direct writings dialed in where we want them.

Dan Peed, Chief Executive Officer (CEO)

I'll also note on page 8 of the investor presentation that a lot of the rate you see, for example in Florida — 14%, 13% — is the second rate increase. So we already have been working for a year under rate increases made last year, which is what's driving up our core right now, but these are rate-on-rate. We're seeing retention ratios that remain very consistent, so we're not seeing a large uptick in non-renewals because of the rate changes.

Elyse Greenspan, Analyst, Wells Fargo

Okay, that's helpful. Last question for me: you mentioned $4.2 million of favorable development. Brad, can you give more color on what that stems from and which accident years — was it catastrophe or non-cat?

Brad Martz, President and Chief Financial Officer (CFO)

Primarily all non-cat on the most recent accident year, so 2019.

Elyse Greenspan, Analyst, Wells Fargo

Okay, thank you for the color.

Operator, Operator

Your next question comes from Bill Broomall with Dowling & Partners. Please proceed with your question.

Bill Broomall, Analyst, Dowling & Partners

Great. Thank you. If we can go to Slide 12 of the presentation: you talked about the aggregate program, which has been hit three years in a row. Can you talk about the interest you're seeing from reinsurance partners in terms of participation? I know the presentation says you're going to switch to a fixed percentage or fixed retention rather than a sliding scale, but can you talk about the interest you're hearing right now for that?

Brad Martz, President and Chief Financial Officer (CFO)

I will be the first to admit aggregate coverage is difficult to come by these days; a lot of companies have struggled with placing their aggregates. We're in a unique position because we have one strategic partner who provides a flexible limit, and it is part of a shared limit with our core catastrophe reinsurance program on the 1:1 placement, 6:1 placement. So we've got a great deal of flexibility in how we can utilize that limit and structure something that works for both parties. I will admit that we understand it has to work for them as well, and we want to address that. The primary goal this year is to have some fixed retention instead of one that varies with premium. Because of that phenomenon, where as the retention goes up, if your losses are unchanged, the possibility exists for you to recapture losses previously ceded and have catastrophe losses incurred in a quarter where you didn't really have any new catastrophe. That's what we'd like to solve for. We don't have that finalized, so stay tuned. But our goal is to have a fixed amount of catastrophe protection and stop our losses at that point in time.

Bill Broomall, Analyst, Dowling & Partners

Okay. In the press release this evening, you talked about UPC Re and you reached an exhaustion point. Can you explain what that is?

Brad Martz, President and Chief Financial Officer (CFO)

UPC was a participant on layer one of our core reinsurance program. They had a $12.5 million exposure that was hit by Hurricane Laura, and they hit the maximum liability under their contract. That's included in the $125 million of net named windstorm losses retained in this quarter.

Bill Broomall, Analyst, Dowling & Partners

Got it. But your tower is full cascading, right? So the higher layers will drop down for any future events, correct?

Brad Martz, President and Chief Financial Officer (CFO)

Oh yes, absolutely. That was fully collateralized, and it doesn't change the structure at all. Everything is cascaded down. There are no gaps in coverage in our program.

Bill Broomall, Analyst, Dowling & Partners

Okay. If I think about the additional quota share you're looking to place and the Q4 storms, how much buffer do you think you'll have in your RBC ratios after this? If Eta comes or another storm, would that buffer be enough so you won't have to do something else to address surplus? Anything you can comment on there?

Brad Martz, President and Chief Financial Officer (CFO)

I would just say, we don't want to be anywhere near that 300% line if we can help it. We want to be well above it. We're going to do our best to provide a margin of safety that is reasonable. That's about all we can say at this point in time. RBC is complicated, but the de-risking of the company is ongoing now, and the additional reinsurance support should have us in a good position at year-end.

Bill Broomall, Analyst, Dowling & Partners

Great. Maybe one last one: how much cash do you have at the Holdco? And what was the surplus at $930 million?

Brad Martz, President and Chief Financial Officer (CFO)

The unrestricted liquidity at the Holdco was $42.2 million at September 30, and the statutory surplus for the group was $371 million.

Bill Broomall, Analyst, Dowling & Partners

Great. Thank you so much.

Operator, Operator

That concludes our question-and-answer period. I'd now like to turn the call back to management for closing remarks.

Dan Peed, Chief Executive Officer (CEO)

This is Dan. Thanks again for your time and attention. I want to say that I continue to be excited about the future with the executive team we've put together over the last quarter and our employees and our key distribution and reinsurance partners, enabling us to navigate this market together. So thanks again.

Operator, Operator

Ladies and gentlemen, this does conclude today's teleconference and webcast. We thank you for your participation, and you may disconnect your lines at this time.