HCI Group, Inc. Q2 FY2023 Earnings Call

Good afternoon and welcome to HCI Group's Second 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 call 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 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 Second 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 second 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 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 into actual results, these developments could have material adverse effects on the company's business, financial conditions, and results of operations. HCI Group disclaims all the 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 another strong quarter with pretax income of $20.3 million and diluted earnings per share of $1.28. Operating earnings improved over last quarter, again reflecting positive contributions from each of our business segments. In insurance, gross premiums earned were stable, while losses and expenses declined, driving increased profitability in the quarter. Our consolidated loss ratio was approximately 34%, down from 47.9% last year and consistent with our expectations. Homeowners Choice continued to generate healthy earnings, while TypTap Insurance Group reported its second straight quarter of GAAP profitability. In May, we finalized our reinsurance program for the coming year, with rates and terms that were consistent with our expectations. We filed an 8-K detailing this program with the SEC on May 31. In investments, net investment income totaled $8.8 million, almost entirely derived from interest on our cash and fixed income holdings. Our portfolios continue to generate steady streams of income, benefiting from higher interest rates, short duration, and reinvestment yields above 5%. Finally, HCI Group continued to deliver on its commitment to shareholders, paying a dividend of $0.40 per share, our 51st consecutive quarterly dividend. To summarize, this quarter highlighted the underlying strength of our diversified businesses and the true earnings power of HCI Group. And now I'll turn it over to Mark to provide more details on our financial results.

Thanks, Karin. So as Karin mentioned, pretax income for the second quarter was $20.3 million, and diluted earnings per share were $1.28. The pretax income was similar to that of the first quarter this year with one significant difference. In the first quarter, we had a gain of almost $9 million from the sale of real estate, and this quarter's profit was driven simply from the regular ongoing operations of our insurance businesses in what we see as a strong, repeatable operating quarter. In the past few quarters, we've highlighted several positive trends. And as you can see from the results, these trends continue to support sustained profitability. The trends we've discussed are higher average premium per policy, increasing investment income, lower policy acquisition costs, and most important, a lower gross loss ratio. Let's take a look at each of these. First, as was the case in the first quarter, gross premiums earned are up despite policies in force being down driven by rate adjustments made over the past few quarters combined with the natural attrition of the book. Our consolidated average premium per policy is about 25% higher than it was a year ago, which helps reduce the loss ratio and improve earnings. The second positive trend is that investment income is up. Investment income of $8.8 million is more than double what it was in the same quarter last year driven by increasing interest income on fixed-term investments and on cash. Our investment strategy is working. And while our yield is up considerably, we still have a short term to maturity, which gives us the opportunity to further increase investment income in the coming quarters. The third positive trend is that policy acquisition expenses are declining as a percentage of gross premiums earned. In Q2, policy acquisition expenses were 12.4% of gross premiums earned, down from 14.8% in the same quarter last year because of lower commissions and the transition of the UPC book. The last and most important trend is the decline in the consolidated loss ratio, which is following the glide path we've been discussing over the past few quarters. On previous earnings calls, we said we expected a material beneficial impact from the new legislation in Florida, and that impact is starting to show up in our results. The consolidated gross loss ratio was 34% this quarter, down considerably from 47.9% in the same quarter last year driven by lower claim frequency, flattening claim severity, lower litigation frequency, and higher average premium per policy. Wanted to mention TypTap just for a minute. You may recall that TypTap Insurance Group was profitable in the first quarter, and it was a gain in the second, reflecting some of the same trends discussed on a consolidated basis, higher average premium per policy, higher investment income, and a lower loss ratio. Just a few other quick things. Book value per share increased significantly from $18.91 at the start of the year to $21.92 at the end of the second quarter. Cash and financial investments at the holding company level were $164 million at the end of the quarter, up from $140 million at the start of the quarter. Before turning it over to Paresh, I wanted to step back from the numbers to just add one thing. What I hope comes through in my comments here is that the trends that have led to these results are the same continuing trends we've been discussing for some time now, and we think that they are sustainable. We've managed the business carefully to get to this point. And while we can never predict the future, this quarter reflects what we expect to see going forward. And with that, I'll hand it over to Paresh.

Thanks, Mark. Karin talked about our positive Q2 results, and Mark laid out why the results this quarter are sustainable. There are several items that we've talked about on previous calls that I think are worth reviewing. First, we've positioned our investment portfolio to provide investment income in a meaningful and sustainable fashion. By staying on the short end of the curve, we maintain maximum flexibility, and we are making a healthy income from that side of the business. Second, following legislative reform that was passed last year in Florida, we anticipated that the loss ratio would come down, and it has. Third, the uncertainty around the availability and affordability of reinsurance is now behind us with the placement of our 2023 reinsurance program. And lastly, a year ago, we took decisive rate action to combat economic inflation, and those rate actions continue to work through our book of business. So overall, while earned premium has been roughly level year-over-year, the profitability of the business has improved considerably. And all of this is important as a backdrop because we now have a healthy stable business. We can now look to the future, and the obvious thing to do is to expand and grow the business, especially in Florida, and that is exactly what we plan to do. We've applied with the Florida OIR for a Citizens' depopulation in the fourth quarter of this year. We are starting from a baseline of approximately 200,000 policies and $740 million of in-force premium throughout the U.S. at the end of Q2. We will now resume growth to a higher number in the future. In summary, going forward, we are looking to grow our policy count, grow our in-force premium and grow our profitability. With that, I will turn over for questions. Operator, please give instructions.

The first question comes from Matt Carletti with JMP.

I'll start by picking up where you left off regarding the news about applying for a Citizens' depop. Can you share any details about whether this is expected in Q4, specifically regarding the number of policies and the amount of premium you hope to achieve? Or should we hold off for more information later?

It's a combination of both. However, Matt, just so you know, there will be updates in about 30 days. As you are aware, we have been through this process many times before. We have applied for 75,000 policies in November, specifically on November 21. It’s important to note that this is the maximum number; the actual number of policies we will receive will be less than that. This is simply how the process operates as we navigate through the necessary steps. The precise number of policies and the premium will be clearer on November 21, the date of the assumption. So, we are on this path until then, correct?

Yes. Can you provide some guidance on this? We could refer to past takeouts you've completed, which have been numerous over the years, although not recently. The market was favorable for those. However, I understand there have been some legislative and regulatory changes affecting Citizens regarding whether people need to go or not. Can you share any insights on how this might influence the potential conversion rate? Or is it still too early to tell, and we won't know until we go through the process?

Historically, the numbers have fluctuated between 20% and 65%. This range is impacted by the new Citizens takeout rules and methods, as well as regulations encouraging people to leave Citizens. We also cannot determine how many others are applying for takeouts in November. With 1.3 million policies in Citizens, this represents a small segment. Given these factors, there is some variability in this number. For a carrier with 200,000 policies, particularly with 130,000 in Florida, any change is significant.

Yes, that's very helpful. From a broader perspective, while the focus is on Florida, TypTap has expanded beyond state lines and we're observing major brands adjusting their strategies on a national level, largely due to climate change. I consider HCI to have significant experience in a state that has faced these challenges over the past couple of decades. Is there a long-term opportunity for HCI? What insights have you gained from operating in Florida's environment that might be applicable elsewhere when the timing aligns?

Yes. Matt, I think, obviously, reading the headlines and the press releases and the statements and earnings calls from a number of other carriers, especially outside of Florida, you sort of get the level of angst that is going on. I think if I was to predict what's going to occur judging by what happened in Florida probably like 15, 20 years ago, the supply and number of people willing to offer policies is going to shrink. Demand isn't going away because every household still needs policies. So supply is going to shrink. Demand is going to stay the same or grow. It'll take a while for premiums to adjust to the new reality that I think everybody is facing, using climate change as an example that you used. But eventually, all that will stabilize out, and there will be somebody, let's just say, by 2030 who will be providing insurance and will be doing it in a profitable manner, right? It's just between now and then, there will be a lot of churn in terms of both who the carrier is and what the rates are. That is what I think is starting to unfold throughout the country. We've seen this happen before because that's exactly what happened in Florida after the '04, '05 storms, yes?

Yes, that makes perfect sense. I have a couple of quick questions regarding the numbers, specifically for Mark. You mentioned that policy acquisition costs have decreased to about 12.5%, down from a few points higher last year. Can we go over the adjustments that have contributed to this, such as lower commissions? Where do you think this could trend in the future?

Yes. I think that's about where it's going to be for the foreseeable future unless there's any other changes. It might drift down a little bit, Matt, but I think the bulk of that improvement that you've seen there is reflected in the numbers now.

Great. And then just a quick numbers one. Do you have net written premiums handy?

Yes. So it's $113.6 million.

The next question comes from Mark Hughes with Truist.

You have made significant progress in a short time regarding loss costs. Could you clarify how much of the improvement can be attributed to more favorable weather this quarter, how much is due to your pricing initiatives, and how much represents actual progress from regulatory reform? Paresh, you mentioned that you believe losses will decrease to the 30% level. Is that still an accurate estimate? Could it drop further based on the current observations?

Mark, it's Mark. So to the first part of your question about the weather, so there really was not a discernible difference in the weather between Q2 last year and Q2 this year. So the decline in the loss ratio from second quarter last year to the second quarter of this year really didn't have anything to do with weather, right? There's always weather in Q2. We had a significant amount of weather in Q2 last year. We had a significant amount of weather in the second quarter this year. So that's not the reason that the loss ratio is down. So the loss ratio is down for the three or four things that I mentioned earlier. And average premium is up. Obviously, that's going to help. Frequency is down, which helps. And the average ultimate cost of a claim is down because litigation is down. So those three things work their way through the loss ratio at a different pace. You see the impact of the average premium per policy going up, you see that first. So that's probably maybe 60%, 65% of the reason for the drop this quarter, the balance being some of the legislative changes. But I think the most important thing to say, and I think I said it in my comments, is we developed an expectation of what we thought would happen to the loss ratio when the legislation came out, and that is still our expectation. What we've seen in the first half of the year is consistent with what we saw. Frequency is coming down. Litigation is coming down. And to your point about the 30%, I think Paresh and I have both mentioned that we think the consolidated loss ratio will come down from about 40% to about 30%. And we'd take some time to get there, but we still feel that that's where we're headed. So the trends are moving in the right direction, and we're really encouraged by the progress.

How much are you going to pursue voluntary business as the year progresses? Are you going to be more dependent or look to drive growth on the takeout? The acquisition costs are certainly pretty attractive. Is that going to be the focus?

Mark, it's Paresh. In response to your question, we are already engaged in voluntary business. The difference in our numbers is primarily how they reflect in our books. The takeout opportunity, which we've been anticipating for some time and discussed in previous calls, is now available, and we are leveraging it. It complements the other initiatives we've been pursuing. The overarching message we want to convey is that after two quarters of results, many have been inquiring about the implications and the extent of the impact. We have modeled various scenarios and attempted to forecast the developments. Halfway through the year, we can confidently say that outcomes are aligning with our expectations, and our results are now reflecting this. The follow-up actions we previously mentioned, contingent on achieving these results, are what we are outlining for the second half of the year.

Yes. Understood. The premiums ceded, is that a good run rate with the new reinsurance in place in terms of dollars?

Yes, it's Mark. It's very similar to what we reported in our 8-K, which is around $67 million, close to what it was in Q2.

Okay. Has there been any change in your previous practice of incrementally increasing reserves each quarter? You've moved away from that approach. Did this shift have any effect on the loss ratio?

Not really. Our net reserves have been pretty flat this year. We didn't experience much adverse development in the first quarter, booking just under $1 million. There's not much activity in that area. For the most part, reserves are aligning with our expectations, so we haven't had to make adjustments for prior periods, keeping net reserves stable for now. There are some signs they could start to decline, but for the moment, we are maintaining them at a flat level.

Yes. TypTap written in the quarter was down year-over-year. Is that nonrenewal of flood business? What was driving that?

Yes. There's some variation in those figures. A portion of it, about $8 million, was due to flood-related issues. Last year, we had around $4 million in written premium in Q2, but this year we experienced a decrease in written premium since we returned some unearned premium. Additionally, UPC Southeast contributed to the decline, as written premium was lower in the second quarter due to timing factors. You may recall that with changes at UPC, many policies that typically renew in Q2 were renewed in Q1 this time around. Consequently, we saw higher written premium in Q1 and less in Q2, with Q2 for UPC Southeast showing a slight negative. Thus, the Q2 written numbers have quite a bit of noise, making them somewhat difficult to interpret. However, we anticipate that Q3 will return to the usual pattern of written premium.

How much cash at the holding company?

So as I mentioned, cash and financial investments at the holding company level is about $164 million. I think the cash component of that is about $135 million, something like that.

We have a couple of questions in queue, the first coming from an unidentified analyst.

What an outstanding quarter, very pleasant. I want to get an idea from you on how the whole reinsurance environment is shaking out. I know there's been a lot of changes in different directions. Now that you've completed it and seen how it ended up last month, what's the outlook going forward from that?

Lee, simple answer about the reinsurance outlook, and I didn't make it in my prepared remarks, was that beginning of the year, there was some uncertainty about the availability and affordability of reinsurance, right? And all of that speculation goes on. And I think from what Mark has said and Karin has said and what was released in the 8-K, we placed our reinsurance program because we had anticipated these changes, et cetera. The numbers are there. It's now in the 8-K. So at least for us, we don't have a reinsurance variability anxiety until next June at the earliest, yes? The other thing on a general reinsurance industry, I think, which is the nature of your question, I think the anxiety level amongst reinsurers, at least in terms of Florida, seems to have abated, especially by what happened in May. I think lots of reinsurance availability is now starting to normalize. Affordability is a different price, but that's just what that is, yes?

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

I just wanted to clarify my understanding of the depopulation process. You'll take the premium that you successfully obtain, and there aren't any significant reinsurance or acquisition costs until those policies come up for renewal or until the next storm season. Is that the correct way to view the financial impact?

Yes, Mark, I want to clarify that when making an assumption, you will recognize gross written premium on the assumption date based on any earned premium. The acquisition cost will remain zero until those policies expire and renew under our terms, at which point it will return to normal. Additionally, the reinsurance cost for those policies will also be zero, with very few exceptions, until June 1 of next year. So, while these three components may fluctuate slightly differently, I wanted to confirm that understanding.

Yes. What are your thoughts on the quality of the policies in Citizens following the increase? How viable is the takeout opportunity?

Citizens has 1.3 million policies, as I recall, until the end of June, which is quite a significant number. We are looking to select a maximum of 75,000 policies. If we have 65,000 policies, that would represent 5% of their total book. Our goal is to identify 5% that we find favorable from such a large pool. We are optimistic about our chances, but I am not making any comments on the overall pool. My primary focus is to determine if I can find 75,000 policyholders that we may want as HCI customers, and the answer is yes.

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.

On behalf of the entire management team, I would like to thank our shareholders, employees, agents, and, most importantly, our current policyholders as well as our anticipated future policyholders for their continued support. We look forward to updating you on our progress in the coming quarters. Thank you, everyone.

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