HCI Group, Inc. Q3 FY2022 Earnings Call

Good afternoon, and welcome to HCI Group's Third Quarter 2022 Earnings Call. My name is Paul, and I will be your conference operator. 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 December 8, 2022 starting later today. The call is also being broadcast live via webcast and available via webcast replay until November 8, 2023 on the Investor Information section of HCI Group's website. I would now like to turn the call over to Matt Glover, Gateway Investor Relations. Matt, please proceed.

Thank you, Paul, and good afternoon. Welcome to HCI Group's Third Quarter 2022 Earnings Call. On today's call is Karin Coleman, HCI's Chief Operating Officer; Mark Harmsworth, HCI's Chief Financial Officer; and Paresh Patel, HCI's Chairman and Chief Executive Officer. Following Karin's operational update, Mark will review our financial performance for the third quarter of 2022, and then Paresh will provide a strategic update. To access today's webcast, please visit the Investor Information section of our corporate website. Before we begin, I would like to take this opportunity to remind our listeners that today's presentation 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 or 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 disclaims all obligations to update any forward-looking statements. Now with that, I would like to turn the call over to Karin Coleman, Chief Operating Officer. Karin?

Thank you, Matt, and welcome, everyone. Before we discuss the quarter, I would like to express our sincere sympathy for all who have been impacted by Hurricane Ian, the Category 4 hurricane that hit Florida just six weeks ago. Every day, as we work with our customers, we're reminded of the thousands who have been affected and the time it will take to fully recover. Serving our policyholders remains our top priority. It is why we're here. Having navigated 15 storm seasons and several major hurricanes, HCI was prepared when Ian made landfall on September 28. Our dedicated customer service teams answered calls, providing a human voice to our policyholders while keeping wait times to a minimum. After just 14 days, we had received over 10,000 claims across Homeowners Choice and TypTap. We thank all of our associates for their hard work and dedication to our policyholders. Immediately after Ian made landfall, our proprietary technology showcased its ability within the claims handling process. Our systems are specifically designed to drive efficiency in claims processes through resource allocation, management oversight, and report automation. We have real-time information at our fingertips. This unique transparency is invaluable and is a proven differentiator in claims handling. On October 10, we shared our preliminary reviews of Hurricane Ian in a presentation posted to our web page. To date, we have received just over 12,000 claims in line with our initial estimates and consistent with the loss that is comfortably within our reinsurance towers. Now moving on to our third quarter financial results. The pretax impact of Hurricane Ian was $78 million for the quarter, resulting in a loss of $51 million for the company. If not for Ian, we would have reported a profit for the quarter. Gross premiums earned grew more than 20% over last year, while our loss ratio, excluding Ian, improved more than six points sequentially to 41%. This improvement in our loss ratio reflects both a decline in daily claims frequency and rate actions at both of our carriers. Mark will provide more detail on these numbers. Investment income was another bright spot in the quarter, highlighting the power of our diversified business model and the potential to generate additional income from our balance sheet. In the third quarter, net investment income increased $16 million over last year, including a $13 million gain from the sale of 1.5 acres of land in our Greenleaf subsidiary. Excluding this gain, income from our investment portfolio doubled over last year, as we put cash to work in short-duration debt instruments. With rates increasing and plenty of liquidity on hand, we look forward to generating more income from our sizable investment portfolio. Finally, we remain committed to returning capital to shareholders. During the quarter, we continued to execute our share buyback and paid our 48th consecutive dividend at $0.40 per share. And in October, we declared a similar dividend to be paid in the fourth quarter. And now I'll turn it over to Mark to provide more detail on our financial results. Mark?

Thanks, Karin. Hurricane Ian was obviously an event that had a significant impact on our results for the quarter. I'll discuss that impact as well as some positive trends in the business that are a little harder to see because of Ian. Last month on our website, we presented the net impact of Ian, and those numbers have not changed. The total expense related to Ian this quarter was $77.6 million, which includes $65 million of higher loss expense and $12 million of higher reinsurance expense as we reversed some accrued benefits under our multiyear reinsurance agreement. I also wanted to explain the gross loss estimates. As you know, we have a few different reinsurance towers, and I'll explain the impact by reinsurance tower. For Homeowners Choice, the gross loss estimate is $550 million, and the reinsurance tower limit is $936 million. For TypTap, the gross loss estimate for Florida wind is $370 million, and the reinsurance tower limit is $610 million. For TypTap flood, the gross loss estimate is $40 million, and the reinsurance tower limit is $61 million. And lastly, for the non-Florida tower, the expected gross loss is $10 million against the reinsurance limit of $525 million. These are, of course, estimates. While things are progressing as expected, it’s still early, and these numbers could change. However, we have significant additional capacity in our reinsurance towers should claims start to develop outside of these expectations. So let's turn to the rest of the quarter. On a pretax basis, we lost $63.6 million in the third quarter. The loss from Ian was $77.6 million. Therefore, before Ian, we made just over $14 million pretax, which is obviously a strong quarter. There are two positive trends that I wanted to point out. Loss ratios are coming down, and investment income is going up. Let's talk about the loss ratio first. If you remove the impact of Ian, the loss ratio this quarter was 41.4%. This is more than six points lower than the second quarter this year and lower than the third quarter last year. There are three main factors that drive the loss ratio: frequency, severity, and average premium per policy. Claims frequency is down for both Homeowners Choice and TypTap. It is significantly lower than the second quarter this year and lower than the third quarter last year. The other thing that's happening is the average premium per policy is increasing, while increases in average claim severity have started to moderate. In other words, average premium per policy is going up faster than average severity. The combination of all these factors is resulting in lower loss ratios for both Homeowners Choice and TypTap. On our last call, I said we expected the loss ratio to start coming down, and it has come down faster than expected. Looking ahead, we are hopeful the legislative changes already passed will provide a further tailwind for continued lower loss ratios. The second trend I mentioned is that investment income is going up. Investment income this quarter was just over $18 million; $13 million came from the sale of a small land parcel as previously announced. When that's taken out, investment income of about $5 million is double what it was in the same quarter last year, and it will continue to increase. We are starting to see the impact of higher interest rates in a very beneficial way. Our strategy has been to remain disciplined with a preference for cash and short-term assets. With returns now improving, we are putting more money to work, and this is beginning to have a meaningful impact on our results. I wanted to touch on holding company liquidity. At the end of September, we had just over $150 million of cash and financial assets at the holding company level and well over $100 million of unlevered real estate. Before the end of the year, we may downstream some capital into our two insurance companies, but we have more than enough capital available to do that. This is one of the advantages of having a strong holding company with a solid liquidity position. Just another couple of things quickly. To the end of September, we've bought back 149,000 shares under our buyback program. When combined with those bought back as part of the convertible issue, we have bought back a total of 1,186,000 shares so far in 2022. As of September 30, the number of shares outstanding was 8,926,000, which is 12% lower than at the start of the year. In conclusion, while Ian was obviously a significant event, we are prepared for these events with a well-structured reinsurance program and a solid balance sheet. Looking ahead, the fundamentals are starting to improve, and we look forward to playing an important role in the evolving Florida homeowners' market. And with that, I'll hand it over to Paresh.

Thanks Mark. Let me start by offering my deepest sympathies to those who have been impacted by Hurricane Ian. We are here to help our policyholders move forward and rebuild their lives. While the entire company is currently working to take care of our policyholders, this is an earnings call, and everyone is expecting a business outlook, which is why the following commentary is focused on the business aspects of the company and the future outcome. So let us begin. Clearly, Ian has been a devastating event that has caused a massive disruption to the Florida market. However, history suggests that with great disruption comes great opportunity as well, and Ian has firmly established the value of our main business, which is insurance, not only to our policyholders, but to others as well, including the Florida legislature. As Ian approached, no one thought they had too much insurance. Everyone appreciated the coverage they had and some wished they had even bought more. Going forward, the demand for insurance will only increase. No one is considering going without insurance in the next hurricane season. The Florida legislature must solve for the availability of homeowners' insurance next year, and they will have a special session next month to do just that. Under any range of outcomes from that session, we are poised to benefit. Why is that? Because we know what it takes to succeed in Florida. There are four imperatives: capital, technology, reinsurance, and then in addition, you need a seasoned management team that can deliver the results. In the past, people have underappreciated everything with the need for capital. We have always talked about the need to be good at all four, and HCI Group is uniquely positioned in all four areas. But let's go through them in detail. First, there is a shortage of surplus capital in Florida, but we raised capital earlier this year and have significant liquidity at the holding company level. Second, we have invested in cutting-edge technology for over a decade now, and our systems are proven at this point, both within Florida as well as outside Florida. This is neither cheap nor quick to replicate. Our technology not only provides efficiency but has been proven to drive superior underwriting results. Third, there is a concern regarding reinsurance in the industry. But let's be clear: The debate is about reinsurance capacity shrinking and repricing, not about the total lack of reinsurance. Homeowners Choice has already secured about three-quarters of its Florida reinsurance needs for next year, and TypTap is not that far behind. The balance of reinsurance needs to be secured, but there will be a flight to quality, and we should be the beneficiary. Simply put, we expect there to be enough reinsurance available for our needs in 2023. Finally, we have an experienced management team that has navigated successfully in Florida for 15 years. We are up for the upcoming challenges in 2023. In summary, we expect Ian to be a watershed event for the Florida market. Next year, we expect policyholders, capital providers, and reinsurers will gravitate towards high performance. We think we have a company to thrive in that environment. With that, we will open for questions. Operator, please provide the instructions.

Thank you, sir. The first question is from Matt Carletti from JMP. Matt, your line is live, please proceed.

Thanks, good afternoon. Paresh, I was hoping I could actually just kind of follow on from those last points you made. Last quarter, you provided us with an update in terms of plans to establish a new subsidiary company with a pretty sizable opportunity in terms of potentially a few hundred million dollars’ worth of business you put on the books fairly quickly. Fast forwarding a few months now post Ian, can you update us on your thought process there in terms of if you still see the same opportunity, a better opportunity, a worse opportunity? And if your timeline you're thinking about that has changed at all?

Sure, Matt. So in terms of the timeline, we have been making progress towards setting up those subsidiaries. That continues as previously stated, and we expect them to be hopefully up and operating sometime next year. As for the opportunity in Florida, I think, as I said in my prepared remarks, Ian has really crystallized the value of the product that we sell: insurance. The demand for it is going to be greater than ever, and it's just a question of making sure you have a mechanism to provide insurance to people who will be our customers in a healthy, profitable manner, which is what we're working at every day.

Okay. Great. And then you made some comments there about your reinsurance and having Homeowners Choice secured about three quarters of its needs already and TypTap not far behind. Is there any other color you can provide, even at a high level, in terms of magnitude of change in pricing or if it requires significant changes to retentions or if you just haven't crossed the bridge on those items yet in terms of having to make a decision?

Yes. Matt, a simple answer to that is: I don't know the extent of the repricing or any of those aspects or how much the supply will shrink. But what I do know is it isn't going to zero. There will be a flight to quality, and we are the folks that people think of first when they think about who they want to place reinsurance with. So those are the nature of the comments. I was just providing perspective that the debate that's going on in the industry about reinsurance is about a reduction in supply, not an elimination of reinsurance.

Okay. Great. And then, Mark, if I could just follow up on some of your comments. You talked about the underlying attritional loss ratio. Obviously, we've seen the improvement come faster than planned. Can you talk a little bit about expectations moving forward? Are you seeing continued improvements in some of the items that you talked about that we should expect continued improvement? Or have we just kind of gotten to the finish line quicker, and we should expect more stabilization maybe?

Yes. Good question. Obviously, anything that I say about trends is going to be weather dependent. But we do expect continued improvement. As I mentioned in my prepared remarks, the trends are moving in the right direction. Frequency is coming down, and arguably more important, average premium per policy is going up faster than severities. In the third quarter, the average premium per policy was about 17% higher than the third quarter last year, while average severity was up about 8%. So there's a good gap there. I think that gap may well widen because some of the seasonal increases are just starting to kick in. For example, in the third quarter, we wrote 9% or 10% more in gross written premium with 13% fewer policies. And obviously, claims don't come from premium; they come from policies. I think that gap may likely widen. We expect it to drop a couple of points from the third quarter to the fourth quarter, weather dependent, of course.

Very helpful. Thank you both for the color.

Thank you. The next question is from Mark Hughes from Truist. Mark, your line is live, you may proceed.

Yes, thank you, good afternoon. Mark, on formulation, you just gave us severity up 8%. What did you say for pricing?

So that number was on a consolidated basis, and it was a floor number. The average premium per policy as of the end of the third quarter is up about 17% from Q3 last year to Q3 this year.

And then severity up 8%?

Yes, 8%, 8.5%, something like that.

Mark, it's mostly the limit if you just measure it in terms of how much limit you're buying. In terms of dollars, I'll go through Homeowners Choice because that's the one I mentioned. We have a multilayer cover down low, then we have the cat fund, which will be available to us next year, and we defer the wrap layer for those reinsurance versus policyholders that were passed in the special session on May 24. All of those pieces will be there for us in the upcoming year. The general tenor of my commentary and the numbers Mark was talking about is we are not disputing that Ian was a watershed event and that Florida and reinsurance will have challenges for the industry as a whole. We were just trying to distinguish that for us specifically; the future is much brighter than the general commentary going on in the industry.

Understood. How much capital do you think will be downstreaming? And could you kind of give us an update on any appropriate capital ratios at the subsidiaries once you do that leverage?

Yes. Let me answer that and say no comment. The reason for that is, I think, with the special session upcoming and the legislative items they pass, it will definitely color what we do afterwards for year-end. I think as Mark alluded to, we already have the money. But how we allocate and what we do with it will be dependent on what is done in the special session.

When you mentioned the $150 million of the holding company and then $100 million of unlevered real estate, that's separate from the $150 million, correct?

Yes, yes, yes. That $150 million is mostly cash or near cash at the holding company level. The real estate stuff is outside of the insurance company, but that's in addition to it. I'm also not counting the credit facility in that either.

What about the development? You had a little, I think, adverse last quarter. How are you seeing that lately?

Yes. I mean there's some in Q3 as well. I would say the same thing that I said in the last quarter: there are a couple of specific things. Ed is one of them, a couple of accident quarters for TypTap back in 2020 that we're just working through. So it's there, similar numbers to Q2. So yes, there's still some of that. But that's included in that loss ratio. And the other thing too, I've said this before, it's still true, we're expensing more than we're paying out. If you take away cats because the timing of reinsurance payments can distort things a bit, but if you just look at regular non-cat reserves, we’re about $29 million higher in reserves at the end of September than we were at the end of December. Those loss ratios, while they're improving, we're still dealing with some adverse conditions and we're still in a situation where we're expensing more than we're paying. We're still building reserves.

Yes. How are you looking at growth here in the fourth quarter as we speak? Are you kind of biding your time until the legislature acts? Do you think this is a good time to be growing?

Mark, let me take that one. I think given Ian, we sort of paused writing the business. And given what's laid out for the balance of this year, it makes sense to pause until you know what the legislature does.

Okay, I think that was it from me. Thank you very much.

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

Thank you. On behalf of the entire management team, I would like to thank our shareholders, employees, agents, and most importantly, our policyholders, for their continued support. As we end this call, I want to summarize my earlier comments. There is an increasing demand for our product and a realization of the importance of a healthy insurance market. We have all the pieces in place to benefit from a tremendous opportunity in front of us, and we have the right management team to execute on this opportunity. We look forward to providing an update on our progress in our next earnings call. Thank you. Have a great evening.

Thank you, ladies and gentlemen. This does conclude today's conference. You may disconnect at this time. Thank you for your participation.