HCI Group, Inc. Q4 FY2022 Earnings Call

Good afternoon, and welcome to HCI Group's Fourth Quarter 2022 Earnings Call. My name is John, 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 April 8, 2023, starting later today. The call is also being broadcast live via webcast and available via webcast replay until February 8, 2024, on the Investor Information section of HCI Group's website at www.hcigroup.com. I would now like to turn the call over to Matt Glover, Gateway Investor Relations. Matt, please proceed.

Thank you, John, and good afternoon, everyone. Welcome to HCI Group's Fourth 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 fourth 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 at www.hcigroup.com. Before we begin, I would like to take the 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 and conditions, but rather are subject to various risks and uncertainties. Some of these risks and uncertainties are identified in the company's filings with the Securities and Exchange Commission. Should any risks or uncertainties develop to actual results, 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. HCI Group reported net income of $2.6 million and diluted earnings per share of $0.18 for the fourth quarter, an improvement over last year and last quarter. Let me start with our insurance division. Results in our insurance subsidiaries benefited from three factors: first, prior rate actions; second, a decline in our gross loss ratio to 39.4%. The 39.4% includes costs associated with Hurricane Nicole and Winter Storm Elliott. Third, investment income nearly tripled over Q4 last year as we put our balance sheet to work at yields over 4% while maintaining short duration and ample liquidity. As for Hurricane Ian, the claims received for Homeowners Choice and TypTap Insurance totaled just over 13,000. We continue to support policyholders impacted by Hurricane Ian, leveraging our technology and resources to expedite the claims handling process. Mark will provide more detail in his remarks. On the legislative front, in December, the legislature passed Senate Bill 2A which squarely addresses the rising cost of litigation and social inflation in the Florida property insurance market. The provisions of this law build on Senate Bill 2D passed in May and represent substantial changes to the law governing the litigation of property insurance claims in Florida. Provisions in this landmark bill include three main items: it eliminates one-way attorney fee provisions related to property claims, abolishes assignment of benefits, and reduces the filing deadline to one year for policyholders reporting a claim. Mark will detail the favorable impacts we're seeing in our business; we have heard some industry experts projecting a reduction to loss expenses on the order of 25% to 40%. Obviously, the level of improvement will vary from company to company, but we expect to see a significant change in litigation costs as these changes take full effect. We commend Governor DeSantis and the Florida legislature for taking decisive action to stabilize the property insurance market in Florida. Now moving to our real estate subsidiary, Greenleaf Capital, we will disclose in our 10-K that we are under contract to sell two of our retail shopping center investment properties for gross proceeds of more than $31 million. Similar to the sale of Cypress property in 2020 and the Century Park right-of-way in 2022, these transactions highlight our ability to capitalize on the strength in the Florida real estate market. We plan to provide more detail on these transactions on our next call. Finally, a word on capital. In a difficult year for the industry, HCI continued to return capital to our shareholders through dividends and share repurchases. During the quarter, we repurchased nearly 3% of outstanding shares at an average cost of $37 per share and paid our 49th consecutive quarterly dividend to shareholders at $0.40 per share. These actions underscore the strength of our balance sheet and the commitment we have to our shareholders. Now I'll turn it over to Mark, who will provide more detail on our financial results.

Thanks, Karin. So as Karin mentioned, net income this quarter was $2.6 million or $0.18 per share. Net income includes a small revaluation gain of about $800,000 related to the UPC book and loss expenses include $7.5 million for the combined cost of Hurricane Nicole and Winter Storm Elliott. Even with these storm losses included, the fourth quarter consolidated loss ratio was 39.4%, which is the lowest of the year and one point lower than the fourth quarter last year. There are a number of things helping to lead to a lower loss ratio: First, claim frequency has been declining. In the second half of 2022, claim frequency was 12% less than the second half of 2021. Second, while the average premium per policy is going up, claim severity has started to level off. While severity climbed steadily from the first quarter of 2021 to the second quarter of 2022, it has not changed much since then. Third, litigation frequency has started to moderate. For the full year, litigation frequency was only down slightly, but in the fourth quarter of 2022, litigation frequency was 15% less than the fourth quarter of 2021. Looking ahead, we are confident that the downward trajectory of the consolidated loss ratio will continue. As Karin mentioned, the Florida legislature has passed legislation that should further reduce loss expenses as follows: First, because 15% to 20% of our total claims are AOB claims, we expect claims to drop by a similar percentage. Second, because the average severity of an AOB claim is higher than a non-AOB claim, we also expect claims severity to decline. Third, with the abolishment of the one-way legal fee statute and AOB being unenforceable, we expect lawsuit frequency to drop by 30% or more. In terms of the overall impact on loss expenses, we've seen models showing a 25% to 40% decrease in loss expenses, and while we are modeling at the lower end of that range, we expect this to have a material positive impact on loss expenses. There are a couple of other trends in the business that I also wanted to point out. As you can see, investment income was about three times what it was in the fourth quarter last year. When interest rates were low, we kept most of our investable assets in cash so we could capitalize when interest rates increased as they have. At the end of last year, we had $40 million in fixed income investments, and at the end of this year, we had over $480 million invested, which combined with higher rates, is driving higher investment income. Another positive trend is in policy acquisition expenses. Gross premiums earned were up 17% from the fourth quarter last year to the fourth quarter this year, yet policy acquisition expenses are slightly lower because of the mix of renewals versus new business, lower commissions, and lower costs related to the UPC business. Now I wanted to move over to a couple of things on the balance sheet. As you know, Hurricane Ian landed in Florida right at the end of the third quarter. Since then, we've had time to evaluate the claim development, and we have adjusted the ultimate down by about 15%. This, of course, has no impact on the income statement, but it is important. We're getting more comfortable about the impact of the storm being significantly less than expected. In terms of non-CAT claims, I mentioned that the loss ratio was down, but we didn't get there by decreasing reserves. In fact, we have been increasing them. During the year, the early loss expense was about $40 million higher than losses paid, and reserves are 25% higher at the end of this year than they were at the start. This is significant because it means that loss ratios are going down even as we have increased loss reserves. Just a few other things. We're in a good surplus position with each of our underwriters with an RBC ratio of over 330% for both. In terms of holding company and liquidity, we have just under $150 million of cash and financial investments at the holding company level and our $50 million credit facility with Fifth Third. Karin mentioned that we completed our share buyback program in the fourth quarter. The total dollar amount bought back under that program was $17 million for the year, and when combined with the shares bought back as part of our convert offering, the total number of shares bought back in the year was over 1.4 million or about 14% of the shares outstanding at the start of the year. So in summary, average premium per policy is going up, loss ratios are coming down, profitability is improving, legislative changes should lead to further improvement. If you own shares of HCI stock at the beginning of the year, you own 16% more of the company than you did a year ago. And with that, I'll hand it over to Paresh.

Thank you, Mark. I want to begin with a reflection on our history and then discuss the future. We have a track record of being good allocators of capital and doing what we thought was best for shareholders, even if it's seen counter to industry views. For example, we patiently maintained our large cash position when interest rates were at record lows for several years. Now we are seeing a significant increase in investment income. We've deployed the cash in short-term treasuries and the full impact of our decisions will flow through over time. Second, we are leveraging our investment in technology to change how underwriting is done. TypTap has now grown to have $320 million of in-force premium and is writing business in 13 states. This is up from just $100 million in premium and only operating in one state two short years ago. TypTap is just getting started, and we will continue its geographic expansion. Last May, we saw an opening to raise capital at attractive terms and executed on that opportunity. Because of this, we have a tremendous amount of liquidity at the holding company, and this gives us the flexibility to execute on any new opportunity that may arise. And as Karin highlighted, Greenleaf is trading assets now, both buying and selling real estate and creating tremendous value for the parent company. But looking to the future, we want to build on that track record and deliver consistent profitability and strong returns for our shareholders. And in 2023, there is an opportunity, we think, to do both. Let me provide some context and color. Florida is an overlooked opportunity. Putting it simply, look at where the industry is today versus where it was a year ago. In 2022, because of actual inflation as well as social inflation, the industry was playing catch-up raising rates in order to bring back sound operational margins. Those rate actions are now coming through because of the lag on the implementation. But the elimination of one-way attorney's fees and AOBs will lead to improved loss trends. And as Mark highlighted, we are already seeing improvement in our gross loss ratios. A year ago, reinsurance costs were increasing, and there were some concerns about the availability of reinsurance. This year, for the upcoming June 1 renewal, we expect reinsurance costs to increase. It's normal given there was a loss. However, it appears to be just a cost issue, not an availability issue, which is fantastic. And this is something that we can handle. A year ago, operational and G&A costs were increasing due to inflation in a very tight labor market. This year, those costs have stabilized. And given our disciplined approach to managing our investment portfolio, our investment income is increasing this year versus last year. So when you combine all of these different inputs for the first time in several years, there are more tailwinds than headwinds for the Florida insurance industry. The decisions that we made over the last several years have positioned us for this day. And with the improving operating environment in Florida, the moment has arrived. And with that, I will open up for questions. Operator, please provide instructions.

Our first question comes from Mark Hughes with Truist.

On the reinsurance outlook, you say it's not availability, but cost. Any way to frame that up a bit? It seems like folks have talked about 30% to 50% increases. What do you think?

Sure thing, Mark. Yes. I think some of the rates could go up that much, but it's also a question of will you be paying that across every single dollar of reinsurance spend. To put this into perspective, for both companies, about 60% of the reinsurance limit is purchased from the Florida hurricane CAT fund. And while that is expected to go up a little bit, it's not going to be 30% to 50%. Secondly, both of our underwriters, both Homeowners Choice and TypTap deferred the wrap layer from last year. So those layers will now be provided in 2023 and they come at zero cost. So that actually tends to drag down the cost of reinsurance for us. The private market reinsurance will go up to some of the numbers you talked about, but we also have Homeowners Choice, which has a large section at the bottom of the reinsurance program placed on a multiyear basis with fixed renewal terms. So given all of these things, yes, it will go up, but it won't be the headline 30% to 50% that you're looking at.

How much of the program is exposed to more private market adjustments?

For Homeowners Choice insurance, I would estimate very little, maybe around $150 million of private market limit out of a $900 million tower. TypTap is likely similar, but TypTap doesn't have the advantage of the multiyear deal that Homeowners Choice has.

Okay. Was there any reserve development in the quarter?

Yes, there's some. We've been consistent with this over the last couple of years. It's quite similar to what it was in the fourth quarter of last year and at year end. If you consider the full year, it's also similar to what it was for the entire year. So, there aren't any significant changes.

What was it in the fourth quarter last year?

I think it was about 12.5%, something like that, 10%, 12%, similar to this year.

But I think it's included in the 39.4%.

Okay. Yes. And then you mentioned the $800,000 gain that separate from the $3 million remeasurement item in the income statement. Are those separate? And could you explain both of them?

Yes, there were two simultaneous occurrences that required us to adjust the valuation on the UPC as it was initially recorded. Firstly, we had an asset that was decreased by a couple of million dollars, resulting in an expense. Secondly, we also lowered the contingent liability related to commissions owed over a certain threshold. Both the contingent liability and the asset experienced reductions, offsetting each other, with a net impact of about $800,000 to $900,000. However, these adjustments appear in two separate lines, which is why you see the $3 million reflected in the revenue line.

Yes. Okay. You mentioned that you see potential losses improving by 25% to 40% once fully implemented. When do you anticipate that will happen? I believe you indicated that you're projecting outcomes closer to the lower end of that range. When do you think that will be fully realized?

Well, I mean, it's a little hard to say because these things are going to transition, right? So when we talk about the low end of that range, say, 25%, I think it's probably going to take a couple of years. It could potentially take a couple of years to fully get to that as some of the AOBs transition through. But you'll see significant improvement, obviously, in 2023. So I think that we had talked before about the loss ratios coming down over time. And I think that will continue through 2023 and 2024 as that sort of transitions through the book.

And then final question, your growth, presumably, you're modulating your growth depending on what you see here in the market. It looks like you were a little more restrained in the fourth quarter, correct me if you see it differently? How do you see that stacking up in 2023, your enthusiasm about growing the top line?

Mark, it's similar to what I mentioned earlier. We have more positive factors than negative ones, but the cost of reinsurance poses a challenge, especially since we are currently in a catastrophe-prone country. Considering these factors, we are excited about growth but want to ensure we pursue opportunities at the right time and in the right manner. We have already turned down some deals in recent months because they weren't suitable for us at that moment. It's about recognizing and acting on opportunities as they come.

Mark, it's Mark. Just one thing I just wanted to add in there. I know you embedded in your question there, I think you were probably referring to the gross written premium number in Q4, which is down.

Yes, that's right.

Yes, so part of that is there's a bit of an anomaly there in the way that the UPC quota share agreements are accounted for. So in the fourth quarter of last year, we signed the fourth UPC quota share agreement. And the way those are booked is when you set up the quota share, you book all of the unearned premium that gets booked to written premium, and then the offset is an unearned premium. So that was $35 million in the fourth quarter of last year. And then the written premium you see in the fourth quarter this year is just sort of as the book renews. So you have to sort of factor that out. And if you do that, gross written premium is up about 7% quarter-over-quarter. And premiums enforced, which you could argue may be a better way to look at it, premiums enforced have continued to grow throughout the year. So that drop that you see in the fourth quarter is a little impacted by that, just that UPC thing. Does that make sense?

Yes.

The next question is coming from Matt Carletti with JMP.

If I try to summarize what has been discussed, there has been a lot of focus on the impact of the reforms and their timing. While we recognize that reinsurance costs are increasing, you are doing well in managing rates and inflation. Looking ahead to the two-year period Mark mentioned, what do you think the combined ratios will look like? Do you believe we will return to the 85% to 90% range that I associate with long-term DTI performance, or what level do you think is achievable?

Great question, Matt. To address this, I want to highlight a few points. We've been very diligent in our approach to loss provisioning each quarter. For instance, we've already reserved funds for losses linked to the data incident in Q1 2022, even if the claims come in later. Currently, we're observing a decrease in claim submissions, which is significant because if claims are minimized, the possibility of accompanying lawsuits also diminishes. This trend is expected to improve our required reserves for future quarters. Each quarter, we reassess potential costs, which underscores the need for a robust insurance sector. Collectively, we've incurred significant expenses between $20 billion and $30 billion, covered through private insurance and reinsurance. We're grateful for the legislative reforms that promise better outcomes. To clarify with some examples, a year ago, if you collected $1 in premium, approximately $0.36 to $0.38 went toward reinsurance, with negligible investment income and around $0.40 allocated to non-catastrophic losses, along with $0.23 for policy acquisition and overhead. This left us with a marginal profit of about 1%. Moving forward, corporate overhead is expected to remain stable, while the recent legislation may reduce attritional losses from $0.40 to approximately $0.30. Reinsurance costs, however, might increase from $0.38 to about $0.45. On the brighter side, with a better-positioned investment portfolio, returns may rise from $0.01 to $0.03. Given the rising rates, we anticipate earning around $1.20 in premium, which will enhance margins significantly and help replenish surplus, fostering a healthy insurance environment in Florida. Overall, these developments lead to a very positive outlook, especially concerning margin improvements.

Yes. Very helpful and very, very easy way to think about it. One other, if I could, just a quick one. You mentioned Greenleaf selling or entering an agreement to sell the two retail properties, I think I heard $31 million of gross proceeds. What are those carried at in terms of book value today? And any guidance you can give on when you think that transaction might close?

Yes, Matt. We wanted to highlight this because it's included in our 10-K, and not everyone reviews it along with subsequent events. The two properties are under contract but have not yet closed. We typically don’t count the dollar amounts until they are actually in our possession. We mentioned it to ensure full transparency. As Karin noted, we will provide more details at the next earnings call, during which we hope to report that the two properties have been sold.

The next question comes from Casey Alexander with Compass Point. The two properties are under contract but have not yet closed. We don't typically disclose the amounts until the transactions are complete. We mentioned it for the sake of transparency. As Karin indicated, we will provide more details in the next earnings call when we expect to announce the sale of the two properties.

A lot of my questions have been answered, but I do have one question. The expected 25% improvement in loss expenses would really only apply to those expenses that come from the state of Florida, if I understand it correctly. So as you look forward and the expansion of the book, including TypTap outside the state of Florida, what percentage of your losses would you be expecting to come from the state of Florida as opposed to that percentage that you would expect to be coming from outside the state of Florida?

Yes, you're correct. The 25% improvement we mentioned pertains to the loss expenses in Florida, which represents about 80% of our portfolio. Therefore, the 25% decrease does not apply to the non-Florida segment. However, there are additional factors influencing the loss ratio, such as rate reductions and frequency trends that we have begun observing even prior to the new legislation. When we discuss the consolidated loss ratio potentially declining from 40% to 30%, we are primarily referring to that 25% improvement on the Florida portion, but I also believe the loss ratio in Florida will decrease even more due to these other factors. This could bring us to an overall 25% improvement in the consolidated loss ratio, even though 20% of our portfolio is outside Florida.

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.

Yes. 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 our health 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 you with an update on our progress on our next earnings call. Thank you very much.

At this time, this concludes our question-and-answer session. This concludes today's call. You may now disconnect.