Earnings Call Transcript - ACIC Q2 2021

Operator, Operator

Greetings. Welcome to the United Insurance Holdings Corporation's Second Quarter 2021 Earnings Call. Operator provided instructions and please note this conference is being recorded. I will now turn the conference over to your host, Adam Prior of The Equity Group. Thank you. You may begin.

Adam Prior, Host / Investor Relations (The Equity Group)

Thank you, Alex, and good afternoon, everyone. Thank you 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. We also welcome you to contact our office at (212) 836-9606, and I'd be happy to send you 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 statement 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 the federal securities laws, including statements relating to trends in the company's operations and financial results and the business and the products of the company and its subsidiaries. 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 U.S. Securities and Exchange Commission. UPC specifically disclaims any obligation to update or revise any forward-looking statements whether 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, Chairman and Chief Executive Officer

Thanks, Adam. Hello, and thanks for joining us on our Second Quarter Earnings Call. I'm Dan Peed, Chairman and CEO of UPC. I'm planning to offer an overview and discussion of some of our activities and then turn it over to Brad Martz and he'll go over specific numbers. The second quarter results reflect continued execution of our 2021 transition plan. The plan is to rotate to a dramatically reduced named and non-named CAT retention level and increased quota share of protection, both of these to de-stress capital and reduce volatility. These actions drive a significantly increased reinsurance spend, which reduces our margin during the transition, but are subsequently priced into the portfolio, meaning that we capture the increased price of our reinsurance and our policy premiums. We continue to stay focused on the steps necessary to achieve a strong underwriting profit, beginning in 2022 and continuing to grow in 2023, along with reduced volatility at the same time from both our commercial and personal lines businesses. These steps include compounding rate increases, adequate reserving, exposure management and enhanced risk selection. Many of the underwriting actions that we began to take in the second half of 2020 are beginning to flow through as written and subsequently earned premium. In the second quarter, our personal lines average rate was, again, up by 10.4% and commercial lines average rate was up by nearly 18%. Our personal lines renewal business premium increased over the last 12 months on like-for-like accounts by $89.9 million with a record $27 million increase in the second quarter. Our current filings across all states will yield an average renewal business rate increase in the third quarter of nearly 20% and near 15% in the fourth quarter. Note that these rate increases are compounding on top of at least one, if not two prior rate increases. Despite these rate increases, we have renewal retention rates, excluding nonrenewals, of 90.6% in personal lines and near 94% in commercial lines. On top of these rate increases, we are reassessing the replacement cost estimate of both our personal lines and commercial lines portfolios, given the rapid increase in construction and materials costs. We expect this to add an additional $30 million to $50 million of written premium to the personal lines portfolio over the next 12 to 18 months. We are shrinking our exposure in personal lines with a TIV reduction of 5.8% in only the second quarter and on track for a portfolio annual P&L reduction of nearly 13% by September 30 of this year. This had a major impact on reducing the pressure on our June 1 CAT reinsurance placement. The June 1 XOL CAT reinsurance placement was very successful and included most of our long-term reinsurance partners. The reinsurance tower continues on a strong aggregate cascading basis, offering stronger first event protection than a traditional placement. We also were able to significantly reduce our hurricane retentions. Our first and second event retentions are $15 million per occurrence plus we buy an aggregate protection for losses in the pooled companies at $31 million for the year. This retention is a significant reduction from the approximately $200 million retention in the 2020 hurricane season. Effective July 1, 2021, Florida adopted Senate Bill 76, which was an insurance reform package that, among other reforms designed to protect consumers, addressed litigation trends experienced by Florida carriers. We believe there are several material changes that will reduce litigation over time. However, it is still too early to estimate the impact to loss costs given the July 1 effective date. Looking forward, we plan to continue to rebalance our portfolio towards a 50-50 mix of personal lines and commercial lines over the next several years. In the second quarter, our commercial lines direct written and assumed premium is up 18.4%, while our personal lines direct written premium is down 12.2%. See our investor supplement for results broken down by personal lines and commercial lines. We continue on track for a third quarter launch of Skyway Technologies, our managing general agent, direct-to-consumer platform, beginning with an HO6 product. The technology developed by Skyway will create a new distribution channel for UPC, reduce acquisition expenses, reach the new generation of insurance buyers and transform how UPC deploys its data and technology resources. We plan to expand this suite of products offered through Skyway Technologies, and we are currently developing a strategy to launch HO3 products in Florida through Skyway Tech in 2022. The current insurance market continues to be as firm as it has been in years, and the Florida market is expected to remain hard for an extended period of time, especially for personal lines business. 2021 continues to be a transition year for UPC as we rotate to reduce CAT retentions and reduce personal line exposure, but that incurs an additional reinsurance cost and a reduced margin during the transition. However, as we get through the transition, we expect to return to a strong underwriting profit and targeted margins beginning in 2022 and continuing to grow into 2023. With that, I'll turn it over to Brad Martz.

Brad Martz, President and Chief Financial Officer

Thank you, Dan. And hello, this is Brad Martz, President and CFO of UPC Insurance. I'm pleased to review UPC's financial results, but encourage everyone to review our press release, investor presentation and Form 10-Q for more information regarding the company's performance. While we're disappointed with our results so far this transition year in some respects, Page 4 of our investor presentation summarizes good progress we've made delivering on several important strategic initiatives to reduce volatility and improve results. Our response to these challenges in our business is creating a foundation for profitable growth in future periods. Evidence of this progress includes, but is not limited to, improvements in our reinsurance program that has significantly reduced our Group's net exposure to hurricane risk, underwriting actions to ensure rate adequacy and proper insurance to value that are expected to fuel significant increases in net premiums, reorganization of insurance operations to better connect information technology, underwriting, actuarial and analytics and our CAT modeling teams under the common leadership of our CIO, Chris Griffith, to ensure data and technology are at the heart of our risk selection and exposure management processes going forward. And finally, we're proud of formalizing our ESG strategy and making certain commitments that we expect to improve decision-making, associate engagement and our results over time. For more information on our ESG strategy, you can refer to Page 15 of our investor presentation, and the full report is available on our website. For the quarter ending June 30, 2021, the company reported a GAAP net loss of $23.5 million or $0.55 a share. On Page 5 of our investor presentation we reconcile our core loss of $24.6 million or $0.57 a share to our underlying core earnings that exclude CAT and prior year development, which declined roughly $6 million or $0.14 a share year-over-year. The decline in core earnings was primarily driven by two things: First, a $40 million decrease in net premium earned, which was partially offset by an $11 million decrease in policy acquisition costs resulting from reinsurance strategies designed to reduce operating leverage and retention of risk in our personal lines business. The 100% cessation of our business in Connecticut, Massachusetts, New Jersey and Rhode Island, along with the inclusion of American Coastal Insurance Company in our 23% quota share are the biggest differences in ceded premium earned year-over-year. Second, a $16.4 million increase in net loss and loss adjustment expense, driven by CAT losses of just over $40 million compared to just under $30 million in the same period a year ago due to higher gross losses and the absence of our now-expired catastrophe aggregate program that ceded approximately $30 million of CAT losses in the second quarter of 2020. Direct premiums written for the quarter were almost flat year-over-year despite a significant decline in total insured values in personal lines, which was offset by strong growth in commercial lines. Page 6 of our investor presentation shows our evolving mix by line of business, but growth in commercial appears muted by the change in assumed premiums written that peaked over $104 million in 2018, but decreased to approximately $45 million in 2020 and will be zero this year due to those quota share reinsurance relationships being placed into runoff. Assumed premiums in the current quarter decreased by $12 million year-over-year, but that was offset by an increase of approximately $36 million in American Coastal's commercial residential business that continued to perform very well. Commercial Lines produced core income of roughly $4 million in the second quarter and $12 million year-to-date. Our results by line of business are shown on Page 8 of our investor supplement. Ceded earned premiums were $211 million, an increase of $52.3 million or 33% year-over-year, due mainly to more business being ceded via quota share reinsurance, which is partially offset by ceded losses and ceding commissions earned. Other items included in total revenues during the second quarter included $4 million of fee income, a decline slightly due to reduced personal lines policy count, investment income of $3.7 million, which declined $2.2 million due to lower yields and dividends from a smaller common stock portfolio and unrealized gains from equities of $2.4 million compared to over $20 million a year ago. UPC's second quarter net loss and loss adjustment expense was $118.1 million, an increase of $16.4 million or 16% year-over-year. Catastrophe losses added nearly 28 points to our net loss and combined ratios, but reserve development was favorable and did not have a significant impact this quarter. Page 10 of our investor presentation shows just how challenging the non-hurricane CAT environment has been during the first half of the year. And while gross losses have increased, our reinsurance programs have responded to help contain our net losses, but the real long-term solution to mitigating CAT risk continues to be exposure management. Excluding these two items, our underlying loss and LAE was $78.2 million, up $5.5 million or 8% year-over-year. This produced an underlying net loss ratio of 53.7%, which was up 14.5 points from 39.2% in the second quarter last year, due primarily to the normalization of frequency and severity of non-CAT losses that were suppressed by the COVID lockdown last year. Page 11 of our investor presentation also illustrates some of the inflationary pressures we've seen on loss costs in the current accident year. UPC's operating expenses were $67.9 million, a decrease of $14.8 million year-over-year or 18%. This decline was driven mainly by higher ceding commission income in the current quarter, which is reflected in lower acquisition costs. However, our net expense ratio increased roughly two points to 46.7% due to the increase in ceded premium churn. On the balance sheet, UPC's assets totaled $3.1 billion, including cash and investments of approximately $1.2 billion. The modified duration of our fixed income holdings decreased to 4.3 years, with our overall composite rating of A+ being unchanged. GAAP equity attributable to UIHC stockholders declined approximately 14% from year end to $339 million, with a book value per share of $7.85. Unrestricted liquidity at the holding company was approximately $28 million at quarter end, net of $17 million of additional capital committed to our pooled group during the second quarter. And our statutory surplus of our combined group was $294 million at June 30. That concludes our prepared remarks, and we're now happy to take any questions.

Operator, Operator

Operator provided instructions. Our first question comes from Greg Peters with Raymond James.

Greg Peters, Analyst, Raymond James

To start things off on your exposure management strategy: Dan, in your comments you said you're targeting, by the end of September, to have it down 13% or 14%. I'm wondering if there are other levers you can pull to drive it lower, further, quicker?

Dan Peed, Chairman and Chief Executive Officer

Yes. Thanks, Greg. So September 30 is when the Florida Hurricane Catastrophe Fund and other things reset, and that's how we measure the exposure for this year, and that's why it's been our target. We did target 13%. I don't have the numbers right at hand, but I believe we're ahead of pace on that target. That, of course, is our exposure management of our main personal lines and commercial lines. But we have done other things such as the sale to HCI of the four Northeast states that obviously will reduce our exposure in an expedited manner. And then the other side of that equation, as we've discussed, is the increase or kind of dramatic increase in our reinsurance and moving our retentions down like we said from what was last year about, I think, $208 million to this year, having an aggregate protection for the pooled companies of $31 million. I remember our target on the first quarter call was $25 million on the second event and $70 million aggregate. So we actually improved upon that number. Those things all are mitigating our exposure.

Greg Peters, Analyst, Raymond James

Right. And then when I look at your press release, I think on Page 3, you disclose premium by state. With such a challenging environment in Florida, it's the only state where you're showing positive change, yet I'm pretty sure you're dropping your TIV. So that variance is all rate, is that the right read?

Dan Peed, Chairman and Chief Executive Officer

That's right. And the key thing happening there is that the commercial and personal figures are together, and we're growing most dramatically from a rate perspective in our American Coastal book, which is 100% in Florida. So that moves those totals that you're seeing.

Greg Peters, Analyst, Raymond James

Okay. Two more questions. First, on the table where you go through the underlying loss and LAE ratios: with all the rate you've applied to the book, I was surprised to see such a dramatic deterioration in that ratio year-over-year — going from 39.2% last year to 53.7%. Obviously COVID had a favorable influence on the prior-year number, but this seems higher than I'd have expected. Can you comment?

Dan Peed, Chairman and Chief Executive Officer

Yes. I can comment on that. It is higher than we expected. We watch that underlying ratio as an important indicator of how the book is doing, excluding CATs and prior-year development. In this quarter, and to some degree in the half, both the non-CAT as well as the CAT claims seem to be bouncing back from the COVID impact. The second quarter of 2020 was impacted by COVID, reducing frequency and severity, whereas the second quarter of 2021 seems to have gotten the other end of that slingshot. We have social inflation associated with litigation and we also have physical inflation. We added a slide in our investor supplement showing the price of lumber, which demonstrates short-term supply-demand imbalances. We're incurring those costs as we adjust our claims through the first half of this year. I wouldn't say this is purely interim, but I do think it's being impacted by the rebound from COVID.

Greg Peters, Analyst, Raymond James

Got it. Final question: capital is an important metric given the stress in the group. Given what was a difficult first half but should be a better second half considering your new reinsurance program, can you give an updated perspective on how you're positioned capital-wise through the end of the year?

Dan Peed, Chairman and Chief Executive Officer

Yes. Brad mentioned that our unrestricted liquidity is about $28 million, and that's net of $17 million that was contributed to the statutory companies in the second quarter. Capital raising is something we watch all the time with the Board of Directors, and that is under evaluation. One of our alternatives could be an increased quota share. The sale of the four states destresses capital. The exposure management we've discussed — trimming our outwards portfolio by 10% to 15% and materially increasing ceded reinsurance premium — decreases our net written premium. We also announced last quarter that we were exploring the potential divestiture of Interboro. These actions are designed to reduce or raise capital as needed. So that's under continuous evaluation by the Board.

Operator, Operator

Operator provided instructions. Our next question comes from Elyse Greenspan with Wells Fargo.

Elyse Greenspan, Analyst, Wells Fargo

My first question is about inflationary trends and higher loss costs that you discussed. How do you think about the underlying loss ratio trending through the rest of the year?

Dan Peed, Chairman and Chief Executive Officer

Thanks, Elyse. We expect the underlying loss ratio to trend more favorably through the second half of this year. Our non-named CAT activity was largely incurred in the first and second quarters, and that's dramatically reduced in the third and fourth quarters. Our exposure in the third and fourth quarters is primarily hurricane-related, and we believe we've crowded that risk down given the retentions we put on our hurricane protection. Along with the rate increases I mentioned — we expect to average around 20% or slightly over 20% in the third quarter on our personal lines — when we combine those factors, we certainly hope to see the underlying combined ratio decline.

Elyse Greenspan, Analyst, Wells Fargo

And as that rate gets earned in, do you expect to see some improvement this year and then incremental improvement into 2022?

Dan Peed, Chairman and Chief Executive Officer

Absolutely. We've had roughly a 10% average rate increase on our personal lines book for at least four to five quarters. It's escalating to about 20% in Q3, with some overlapping rate increases, and then that reverts to about 15% in Q4 and into Q1 and Q2 of next year. Those will earn through the portfolio. We're already one to two years into this process; it takes time, but we started some time ago.

Brad Martz, President and Chief Financial Officer

Elyse, this is Brad. I'd add that Page 14 of our investor supplement lays out a roadmap of exactly what Dan is talking about and how it's trending and what the current run rate is.

Elyse Greenspan, Analyst, Wells Fargo

That's helpful. As you rejigger the business mix and earn more rate, how should we think about policy and premium growth trending from here?

Dan Peed, Chairman and Chief Executive Officer

Think about two components: personal lines and commercial. For personal lines, we would expect about a 10% to 20% reduction in exposure due to exposure management, with about a 15% average rate increase through the year. That results in roughly flat premium on a shrinking exposure base for personal lines, excluding the four Northeast states sold. On commercial lines, we would expect about a 15% to 20% rate increase; we hit 18% this last quarter with a consistent exposure base, giving topline growth in that range for commercial lines.

Elyse Greenspan, Analyst, Wells Fargo

That's helpful. Last quarter you mentioned some movement in Irma losses; those have held steady at this point?

Brad Martz, President and Chief Financial Officer

Yes. No increase to Irma in the second quarter. We feel good with our ultimate and still have approximately $239 million of IBNR reserves on top of $120 million of case reserves. So no concerns about Irma at the moment.

Elyse Greenspan, Analyst, Wells Fargo

Quarter-to-date, it seems you haven't seen much on the CAT loss front, but as you approach the peak of hurricane season, is there anything you're monitoring on the CAT loss side for the third quarter?

Brad Martz, President and Chief Financial Officer

We've had events like Elsa, which impacted Florida and a few other states. We've received a little less than 300 claims and don't expect it to be a significant event for us.

Operator, Operator

Operator provided instructions. Ladies and gentlemen, we have reached the end of the question-and-answer session, and I will now turn the call over to Dan Peed for closing remarks.

Dan Peed, Chairman and Chief Executive Officer

Thank you. And with that, we'll wrap up our call for today. I want to thank our entire team for their tireless efforts and also thanks to all of you for joining our call today. Thanks again.

Operator, Operator

This concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation, and have a wonderful evening.