HCI Group, Inc. Q1 FY2023 Earnings Call

Good afternoon and welcome to HCI Group's First Quarter 2023 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 is being recorded and will be available for replay through June 8, 2023, starting later today. The call is also being broadcast live via webcast and available via webcast replay until May 9, 2024, on the Investor Information section of HCI Group's website at www.hcigroup.com. I will now 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 First Quarter 2023 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 first quarter of 2023, 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'd 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, 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 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'd like to turn the call over to Karin Coleman, Chief Operating Officer. Karin?

Thank you, Matt, and welcome, everyone. HCI Group reported a strong first quarter with pretax income of $23.1 million and diluted earnings per share of $1.54. Our Homeowners Choice, TypTap, and Greenleaf subsidiaries all contributed to earnings with several noteworthy accomplishments during the quarter. TypTap Insurance Group, our insurance and technology subsidiary, reached a milestone with its first quarter of profitability on a GAAP basis and more than $350 million of in-force premium. At both of our insurance companies, loss ratios improved from last quarter, driven by lower claim volumes partially due to legislative reforms enacted in Florida last year. Our real estate division, Greenleaf Capital, earned over $9 million, reflecting gains on the sale of two properties disclosed on our last call. As a reminder, over the last three years, Greenleaf realized gross proceeds of close to $90 million and a gain of $60 million on just four transactions. We believe there is still plenty of upside in our real estate portfolio. In addition, our investment portfolio earned $9 million during the quarter, with 90% of it coming from interest income alone. This is a result of steps we took to reposition the balance sheet into short-duration, interest-earning assets over the last year. We now have an investment portfolio capable of generating $30 million in interest income on an annualized basis with a low risk profile. We also continued to deliver on our commitment to shareholders, paying a $0.40 per share dividend, our 50th consecutive quarterly dividend. In summary, it was a solid, profitable quarter with all three of our main divisions contributing to the success of the quarter. And now I'll turn it over to Mark, who will provide more detail on our financial results.

Thanks. As Karin mentioned, pretax income for the quarter was $23.1 million, and diluted earnings per share were $1.54, up from $0.09 in the first quarter of 2022. We discussed several positive trends over the past few quarters, and those trends are translating into material, sustainable improvements in earnings. First, gross premiums earned are up despite policies in force being down, driven by rate adjustments made over the past few quarters. This means that while revenue is up, exposure is down. Second, investment income is going up. As Karin mentioned, we had a gain from our real estate portfolio, but even if that is excluded, the remaining $8.8 million of investment income is more than three times what it was in the same quarter last year. This increase in investment income is being driven by steadily increasing interest income on our bond investments and on cash. When interest rates were low, we held on to our cash, and when they started to go up, we carefully invested some of that cash in bonds. At the end of Q1, we have $500 million invested in fixed-term securities at an average yield of 3.7% compared to $150 million invested at 1.6% a year ago. We have continued to manage the risk as well. Our average term to maturity in the bond portfolio was just over one year, and we still have over $300 million in cash. The third positive trend is that policy acquisition expenses are declining as a percentage of gross premiums earned. In Q1, policy acquisition expenses were 12.6% of gross premiums earned, down from 16.4% in the same quarter last year because of lower commissions and a change in the mix of new versus renewal business. This reduced expenses by more than $7 million for the quarter. I saved the last trend, declining loss expenses, for last as it deserves more explanation. In the first quarter, our consolidated loss ratio was 33%, down considerably from 40% in the same quarter last year. The lower loss ratio was driven by higher average premium per policy, moderating claims severity as well as lower claim and litigation frequency, some of which is a result of the legislative changes in Florida. I should note that we did not get to these lower loss ratios by reducing reserves. While we have slowed the pace of reserve increases, we have not yet started to reduce them. So stepping back, those are four positive trends that I went through, and the combined impact of all of these trends is a material positive impact on the operating performance of the company, as evidenced by the strong earnings in the quarter. These trends have also positively impacted our insurance and technology subsidiary, TypTap Insurance Group. Higher average premium per policy, higher investment income, and a lower loss ratio and a lower expense ratio led to TypTap Insurance Group being profitable for the quarter. Our real estate division also had another very strong quarter. As Karin mentioned, we sold two of our commercial properties for a gain of $8.9 million, another example of our opportunistic real estate strategy. Just a few other quick things. Consolidated cash flow from operations was $99 million or about $11 per share compared to $57 million in the same quarter last year. Book value per share increased to $20.97 from $18.91 during the quarter. A quick comment on holding company liquidity. Cash and financial investments outside the insurance entities were $160 million at the end of the quarter, up from $145 million at the start of the quarter. This does not include the $120 million in value represented by our investments in real estate and Greenleaf. In summary, this was a strong quarter for us. Our operating strategies are paying off, the insurance market in Florida is improving, and we've positioned the business to deliver superior ongoing operating results. And with that, I'll hand it over to Paresh.

Thank you. Mark and Karin outlined our strong financial results for the quarter. We are seeing the benefits of the company's underwriting and rate actions as well as the bold leadership provided by the Florida legislature in 2022. These benefits should continue in the upcoming quarters and provide a solid foundation for the future. Before talking about future prospects for HCI, I wanted to briefly comment on reinsurance. We are finishing up the placement for both of our insurance companies, and like prior years, we will provide full details when everything is finalized. Our reinsurance program is progressing as expected. We came into the renewal with the majority of the program already set. Between the Florida Hurricane Cat Fund, the Reinsurance Assist Policyholders, or RAP program, and our multiyear contract, TypTap and Homeowners Choice had secured approximately 70% of their plan limit purchase. The remaining 30% is being placed in the pilot market now, where enough capacity is available. On a blended basis, we think the rates will be higher, but the cost will be within expectations. Now looking toward the future. Homeowners Choice continues to be regarded as one of the best performing homeowners carriers in Florida. And Greenleaf continues to prove its worth as a separate real estate division that delivers solid long-term returns. Both Homeowners Choice and Greenleaf at this point have solid proven track records on which we continue to build. Now let's talk about TypTap Insurance Group. It made a GAAP profit in Q1 of this year. Last year, we talked about TypTap seeing periods of profitability. The first quarter of this year shows that we're executing on that vision. But our work is not done. We continue to leverage our technology and optimize our book of business while maintaining strong retention ratios, and we plan to build on the current momentum in TTIG. Finally, we continue to make progress on items we mentioned in previous calls. We had talked about setting up additional insurance companies. We are in the process of setting up two new carriers named Tailrow and perRisk. We still have work to do before these new companies write their first policies, but progress is being made. In closing, from our perspective, we are starting to see a turn in the operating environment in Florida. The underwriting actions we've taken over the past several months along with the benefits of legislative reforms have started to show up in our Q1 results. On prior calls, we highlighted that there will be an opportunity for us in the near future. We are seeing that opportunity unfold in front of us. The days ahead are even brighter. With that, I'd like to open the call to questions.

Our first question comes from Mark Hughes with Truist.

Mark, you listed a number of drivers of the improvement in the loss ratio to 33% from 40%, higher premiums, and then you mentioned two or three other things. Could you repeat those? I didn't write them down.

Yes. So part of it is obviously higher average premium per policy. The other thing I mentioned is claims severity is moderating. But really more importantly, claims frequency is declining and also litigation frequency is also declining. Those are the four drivers, number three and four probably being the most important.

And how much of that do you attribute to the reform?

I mean, it's hard to say for sure. I mean, we talked about it on the last call. Any comment I'd make about this, we'd sort of preface it by saying that it's early. But we talked about the expectations that we had of what we thought would happen. We talked about the decline. We expect the declines in claim frequency of 15% to 20%. We talked about a decline in litigation frequency of about 30%. And like I said, it's early, but from what we have seen so far, it would indicate that those assumptions were pretty reasonable. So it's definitely a significant part of it.

Excellent. How much did the better weather help this quarter, do you think? How would you characterize the...

Yes, that’s a good question. It was somewhat of a factor, but not a major issue. You may remember that last year in Florida during the first quarter, we experienced more weather than is typical for that time. This year, we had less weather in Florida during the first quarter compared to last year; however, in the Northeast, we incurred more weather-related expenses and losses this quarter compared to the same period last year. So overall, weather was not a significant factor in the drop; it had a slight impact, but it was mostly balanced out by the conditions in Florida.

I'm interested in your thoughts on your overall interest in new business as you set up the two new carriers. It seems that the written premiums have seen a significant boost. What are your goals with these two new carriers? Could you refresh my memory on that?

Absolutely. Mark. Two things, in terms of just growing the top line, we can do that just within the two carriers that are already up and operating. The two new carriers are being set up because we are now starting to set up for the next phase of our growth. And while we haven't disclosed how they fit into the group and what exactly they'll be doing, we clearly are doing this in a manner where those two new carriers will be both expansive and complementary to the current two carriers that we have, yes?

Yes. And then Mark, you had mentioned that you started to slow the pace of reserve increases. You hadn't gone in the other direction though. Could you give us some dimension of magnitude of that? How much have you changed? How much are you still kind of working away at that quarter-to-quarter?

Yes. We experienced a period where we were recording more expenses than we were disbursing, which caused our reserves to rise. This was due to our growth and the increasing number of ongoing and anticipated lawsuits. In the first quarter of this year, our net reserves remained stable; we neither increased nor decreased them. Consequently, our loss expense has aligned closely with the incurred loss expense and the paid losses. At this point, we haven't started to lower the reserves, but based on the trends and data we're observing, it could become a possibility in the future. That likely represents the next stage for us.

The next question comes from Matt Carletti with JMP.

Just wanted to circle back on one of the questions Mark had there on weather, with kind of Florida being a little maybe below normal and Northeast a little above normal, netting out to sounds like pretty normal. Would that comment hold true for TypTap when we think about kind of it being GAAP profitable but it did so in kind of a normalized weather quarter, or did it run a little hot or a little cool?

Yes, that comment applies to both regions. In Florida, we experienced less severe weather, while the Northeast had more weather activity. The improvement in the loss ratio primarily came from a significant decrease in claims frequency, even when we adjust for weather. If we exclude weather-related claims in both quarters and focus on the weather-adjusted frequency, it showed a much larger decline than we anticipated. This aligns with our previous statement about loss ratios, with expectations of them dropping from around 40% to 30%. The data we observed in the first quarter suggests we are on track to achieve that.

As we consider growth throughout the year, particularly regarding exposure growth as we launch new companies or expand existing ones, how should we approach the timing relating to reinsurance inceptions and the impact of hurricane season? Additionally, how does the reinsurance adjustment later in the fall fit into this? Is it sensible to anticipate that the growth may be more back-end weighted, or am I mistaken in this perspective?

Mike, you're thinking about it exactly correctly. Growth will be back-end weighted in the context of new count.

Yes, exactly. Okay, great. And then just a numbers question probably for Mark. You have the net written premiums for the quarter?

Yes, so it's $129.4 million.

We have a follow-up coming from Mark Hughes with Truist.

The improvement in severity, any comment around inflation, building materials? Is that part of this? Is that moderating?

Yes. So good question. So I used the term moderating. And you might recall, inflation obviously was an issue, is an issue. I think it was probably the second quarter of last year where we really saw probably the biggest impact of that increase. But it started to kind of level out after that. I think Paresh has mentioned it, we track the cost of those things, and I think it's sort of been level since then. If you look at claim severity in the first quarter of this year, it's higher than the first quarter of last year. It is up. But it took that bump in Q2 of last year and since then hasn't moved a lot, and that's why I used that term moderating. So it's higher than it was in the first quarter of last year by, I think, about 10% or so. But it's not having the adverse effect that it was having in prior quarters.

So you essentially lapped that in the current quarter?

Yes, Mark, a different way of looking at this is in the second quarter last year, it was unknown whether severity increasing was going to be repetitive in that follow-through quarter after quarter after quarter. I think what Mark is saying and what we're seeing is that the average rate took a jump in Q2 of last year. So then it's been flat since then. So it's more of a step function, right, as opposed to an increasing ramp, which is obviously very good news.

Yes, Mark, do you have any insights on the loss ratio? Maybe not for the entire year, but more about the underlying trend? It seems you're indicating that there's improvement, though we’re still on the way to full recovery. Currently, we have a 33% loss ratio, which is quite good. Also, it appears that weather hasn't played a significant role. What would you consider the appropriate run rate?

Yes. So I'll go back again to something that we said in the last earnings call, and I just mentioned that we felt that overall impact on the consolidated loss ratio is in the 25% range. Paresh talked about it going from 40% to 30%. We still think that makes sense and that that's the ramp that we're headed towards. Second quarter, that doesn't necessarily say that that's going to happen every quarter. Second quarter, I think everybody knows it's sort of a quarter where there's usually some weather. The loss ratio in the second quarter is usually a little higher than it is in the first quarter. But I think we're headed back down toward that 30% range. I think we'll see it. Again, you have to be careful because it's only one quarter, right? Those trends that we're seeing are good, but we need time to make sure that they settle in. So does that answer the question?

It does. Have you noticed any weather so far in the first quarter? We're nearly halfway through, and we likely have April accounted for. There are many opportunities for other events to occur, but do you have any thoughts so far?

Paresh here. We are considering timing in the second quarter, which aligns with typical expectations. Although the spring has been a bit inconsistent, it's not beyond our expectations, which is promising. To summarize the discussions with Mark, the shift from a 40.6% loss ratio last year to 33.6% this year is not due to a temporary boost, such as reserve relief or an unusually mild quarter. There are no such anomalies in the Q1 figures. This indicates a genuine reduction in the loss ratio that appears to be sustainable. While there might be slight fluctuations in the second quarter due to potentially worse weather, we are clearly on a path toward improved loss and combined ratios.

Understood. Paresh, you mentioned that 70% of the reinsurance program is already placed. You referred to the Cat Fund, the Florida Hurricane Cat Fund, and the RAP program. What else did you mention?

Also, we have one or two multiyear contracts so those rates were obviously set last year.

Yes, the 30% of the reinsurance program is now placed. Are there any observations regarding the capacity or capital in the market? Has there been any recent shift in sentiment, particularly as ILS spreads have narrowed? What implications might that have?

Mark, we've noticed similar trends and movements. What we are primarily focused on right now is ensuring that we can successfully implement our program, and we feel confident in that. While we do hear various rumors and discussions about the industry's overall situation, our current priority is to ensure that our progress is completed.

Yes, that's a good point. One more thing to consider is the improvement in commission expenses. You mentioned a decline in commission rates, possibly due to a mix. If you're not pursuing much new business in the second or third quarters, might the rates remain stable, and the mix stay the same for new and renewal? Will we see an increase again in the fourth quarter? How much of this change is permanent, and how much is just temporary?

I think it does depend a little bit on that mix. However, it has been coming down for a while, and at its current level, I expect it to decline a bit more but not significantly. So if you're modeling that, the rate we have now is likely a solid estimate.

And I'll maybe ask one more, if I might. Anything in Greenleaf around some of these concerns around commercial real estate, the lending environment? Does that have any impact on valuations or liquidity in the market? I know Florida is hot, but I'm just curious.

Mark, we either own our real estate outright or have long-term fixed-rate mortgages. From our standpoint, we feel confident that there is no pressure on real estate values. Additionally, as Karin noted in her comments, our strategic asset sales over the past three years, including the recent sales of two shopping plazas, have significantly increased capital for the HCI Group, releasing approximately $31 million.

Yes, Mark, I would like to add that there is a significant difference between the book value of our real estate and its appraised value based on bank valuations or our own estimates. Even after several transactions, this gap remains substantial. There is still a $50 million discrepancy between our real estate's value on the books and the bank appraised value. However, we possess high-quality properties that are minimally leveraged. The total debt relative to the $120 million value is around $4.5 million. The properties are in desirable markets, and up to now, their value has been preserved. The leverage remains low, and as Karin outlined, it has been a worthwhile investment for us.

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

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. Thank you.

This concludes today's call. You may now disconnect.