Heritage Insurance Holdings, Inc. Q1 FY2022 Earnings Call

Good morning. And welcome to the Heritage Insurance Holdings, First Quarter 2022, earnings conference call. All participants will be in a listen-only mode. I would now like to turn the conference over to Kirk Lusk, Chief Financial Officer. Please go ahead.

Good morning. And thank you for joining us today. We invite you to visit the Investors section of our website, investors.heritagepci.com, where the earnings release and our earnings call will be archived. These materials are available for replay or review at your convenience. Today's call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are based upon management's current expectations and subject to uncertainty and changes in circumstances. In our earnings press release and our SEC filings, we detail material risks that may cause our future results to differ from our expectations. Our statements are as of today, and we have no obligation to update any forward-looking statements we may make. For a description of the forward-looking statements and the risks that could cause our results to differ materially from those described in the forward-looking statements, please refer to our annual report on Form 10-K, earnings release and other SEC filings. Our comments today will also include non-GAAP financial measures. The reconciliations of and other information regarding these measures can be found in our press release. With me on the call today is Ernie Garateix, our Chief Executive Officer. I will now turn the call over to Ernie.

Thank you. Kirk and I would like to thank everyone for joining the call today. I would like to thank our Heritage employees for their dedication to the company, as well as our policyholders. I also would like to thank our valued reinsurance partners for their commitment to our program. On this call, we will begin with an overview of our performance for the quarter ending March 31, 2022, provide updates on key financial performance metrics and then open the call for Q&A. The first quarter of 2022 marked another quarter impacted by severe weather losses. These higher weather losses resulted in a net loss of $30.7 million or $1.15 per diluted share. Despite the substantial increase in net current accident year weather losses during the quarter, we remain encouraged by the rate and form changes implemented throughout the book of business over the last 18 months. These changes, coupled with additional geographic diversification and more restricted underwriting for new and renewal business will continue to positively impact our portfolio. These changes are highlighted by the improvement in our attritional loss ratio for new business quarter-over-quarter. The initiatives to tighten underwriting and increase rates have improved our average premium per policy by 10.7% from the first quarter of 2021. The impact of existing rate increases has not worked its way through our entire book of business. Therefore, this amount does not include rate changes on policies which have not yet renewed. For perspective, our 2022 voluntary homeowners’ renewals for all states are averaging a 21% rate increase over the prior year with our existing rate changes. We will continue to see rate changes commensurate with our cost of doing business. Rate changes are implemented at policy renewal and are earned throughout a one-year policy period. We are committed to proactively and appropriately raising rates to offset higher loss costs and taking underwriting actions to improve our profitability throughout the year. We look forward to finalizing our CAT XOL reinsurance program, which should be completed by the end of this month. We used our SPV, Citrus Re, again this year for a portion of our CAT XOL program specific to the Northeast. We were pleased with the pricing of this $100 million reinsurance cat bond as we continue to successfully access the capital markets as part of our risk transfer program. This concludes my remarks. Let me now turn things over to Kirk Lusk for a review of the key metrics and numbers.

Thank you, Ernie. Good morning. In-force premiums grew by 4.7% during the quarter to $1.2 billion primarily due to rate increases while policies enforced for the same time frame were down 5.5%. We believe the rate in underwriting changes being implemented will have an impact later this year as volatility of loss costs are reduced and produce meaningful improvements in the bottom line. We recognize that the litigated claims environment has made the Florida market very difficult, and we're taking rating and underwriting actions that we believe will position the company well in the future. This could dampen our future growth in the Florida market. Efforts to shift business from Florida have resulted in a 19.1% reduction in personal lines policies enforced in the state. As a result of the continued execution of our diversification strategy, 74% of our TIV was outside of Florida, up from 69% as of the first quarter of 2021. We think it's important that the TIV increase outside of Florida was distributed among nearly each state where we conduct business, which improves our overall diversification of risk. The ceded premium ratio was 46.8% in the first quarter, down 60 basis points from 47.4% in the first quarter of 2021. The decrease primarily stems from gross premiums earned growth outpacing ceded premiums growth. The first quarter weather losses were up substantially to $63.8 million. Current accident year weather losses include $45 million of net current accident quarter cat losses. While we're up from $15.4 million in the prior year quarter, this year-over-year increase also includes $18.8 million of weather losses, up from $16.1 million in the prior year quarter. First quarter 2022 weather losses are primarily attributed to events in Florida, particularly severe storms in mid-January and mid-March. Our pre-announcement of weather losses last week reflects our commitment to transparency with our shareholders as well as an appropriate approach to estimating losses. Our net loss ratio of 91.6% ended the quarter 22.8 points higher from the prior period due to the higher weather losses outlined. We believe the social inflation affecting Florida claims is driven largely by litigated claims practices which drives up the loss costs associated with each weather event. The Florida legislature has taken up some actions to address this issue by Senate Bill 76, and we're interested in seeing the outcome of the special session later this month. Our net expense ratio decreased by 90 basis points to 37.9% driven by our continued drive to manage G&A expenses. Policy acquisition costs are relatively flat as a percentage of net earned premiums. The net combined ratio for the quarter of 2022 was 129.5%, which is up from 107.7% in the prior-year period, reflecting a higher net loss ratio, partially offset by a lower net expense ratio. Total capital returned to shareholders during the first quarter of 2022 was $6.7 million, reflecting a $0.06 per share regular quarterly dividend and the repurchase of shares. During the quarter, we repurchased 721,118 shares at an average price of $6.93 per share, totaling approximately $5 million. Many of our markets, especially Florida, are challenged by social and economic inflation, continued litigation, and increasingly severe weather. We have taken considerable actions to mitigate their effects and improve our underwriting results, including taking rate, increasing our inflation guard factor, tightening underwriting standards, and managing exposures. Our actions have improved our portfolio, while claims inflation and litigation associated with continued severe weather continue to dampen the impact of those improvements. As such, you can expect the management to accelerate our initiatives. The management team is focused on improving margins and returns to shareholders. We are committed to taking rate where it is needed, tightening our underwriting standards even further while remaining compliant with state regulatory requirements, and changing our products, coverage, and exposures. All in an effort to accelerate the changes we believe are necessary until we achieve our target returns. We will consider all options to realize the value of our entities, and we will also take the actions necessary to improve margins. That concludes our prepared remarks. Operator, we're ready to begin the question-and-answer portion of the call.

We will now begin the question-and-answer session. At this time, we will pause momentarily to assemble our roster. Our first question is from Marla Backer with Sidoti. Please go ahead.

Thank you. So, stepping back and looking at some of the initiatives that you have done and accomplished over the past several quarters, do you see any area of perhaps where some of the diversity that you hope to inject into the underwriting book might not have lived up to your expectations? Are there any areas in addition to Florida where you think perhaps you should pull back now as well?

Hey Marla, this is a good question. So, we continue to look at the book and we're pleased with the actions that are taking. But I think to understand that some of those actions, whether they're non-renewals or increasing rates, take 12 to 18 months to flow through the book. So, we are on a monthly and quarterly basis constantly looking at those actions and seeing where it's appropriate to take. But to understand the full effect of those, it does take 12 to 18 months. So, we continue to look in those areas outside of Florida that we are constantly examining, but we're overall pleased with the direction in which we're heading regarding the underwriting performance.

Yeah. In addition to that I'd say we're also much more surgical. So, for example, we will look at each individual state and our distribution within that state by county between coastal and mainland and adjust the portfolio where we aren't seeing the returns we want to. So, it's not a carpet launch view of the different diversification because it's much more surgical than that.

And then once you take a decision to either, as you think, surgically, shift a little bit to tweak the portfolio. Is it still the same 12-month process before you see that shift actually happen?

Yeah. It will take a bit of time to roll through the book because you do have to give a non-renewal notice, right? Or for example, in some areas where we've terminated agents, that takes some time for those policies to roll off. So those things, unfortunately, do not happen overnight; it takes a little bit of time for that. You've got to get proper notice if it's a non-renewal and some of the rates that we take on our renewal basis, so by the time you get those approved, it does take a bit of time.

Thank you for taking and the last question for me is, can you give us a little bit more color on some of the partnerships that you formed and that where you see those – that part of the business going?

Yes. So, we do have some large partnerships with Liberty Mutual, GEICO, Safeco, and NatGen, and we're constantly in communication with them regarding the business that we're looking to target. They have been very cooperative, very good about looking at those pieces. And obviously, in a true partnership, there are times where we have to pull back in certain areas and they understand, but then we refocus in other areas where it's more profitable for us and they have been very good partners with respect to that.

Thank you.

The next question is from Paul Newsome with Piper Sandler, please go ahead. Mr. Newsome, your line is open on our end, perhaps it's muted on yours.

I'm sorry. I hope you can hear me now.

Yes, I can.

I want to home in on the CAD losses to start with. They were unusually large by your standards, as well as really anybody else in the industry. So was there anything that would lead us to suggest that this was just a particular concentration of an area, or maybe you could talk about how you define your CAD losses. Maybe you're having a different definition than the standard industry. Anything that would give us some insights into why Heritage's CAD losses were an anomaly in the quarter versus their peers.

There were six PCS events categorized as PCS 2211, 2212, 2218, 2219, 2220, and 2221. The largest was 2212, which primarily affected Alabama, Georgia, Florida, and North Carolina, with the majority of losses occurring in Florida. Regarding our reserving practices, since the third quarter of 2018, we've generally seen favorable development until this quarter, where we experienced a slight unfavorable development of about $2.4 million. Prior to this, we had favorable development amounting to about $30 million. We believe our reserving is both prudent and accurate. I cannot comment on other companies' losses or their reserving practices, but this is our perspective.

Your reserving certainly has been a relative strength versus your peers. I would give you my second question wondering if you had reserve development or not. Could you maybe focus on that given it's an unusual development for you?

Yeah, we did have $2.4 million worth of development. And again, this first quarter is the first time in a long time that there was really nothing in particular about that as far as where it was coming from. It was just a myriad of things. There are a couple of the storms, Elsa, Fred, and Ida, which are all retained for us. They're not into our cat layer. So those did deteriorate slightly and therefore those are fully retained.

Could you discuss the profitability of the Florida book compared to the non-Florida book? Was there a significant difference from the rest of the book this quarter, or any initial details you can provide?

The Florida book had a poor performance due to weather-related losses. Looking ahead, we anticipate improvements on a quarter-over-quarter basis because of the rate increases in the Florida market and the stricter underwriting standards. However, this quarter's results are heavily influenced by the weather events.

The main discussion over the past year has been about the relationship between claims inflation and rates. If you reflect on the last year and examine the next 12 months, how do you feel about the comparison between rates and claims inflation? It might appear that, when looking at the return on investment over the year, there was a loss of momentum. Is that an accurate assessment? Please share your thoughts on this.

I believe claims inflation is currently around 12% overall, which influences how we manage the portfolio. This figure is factored into our pricing strategy and aligns with our observations from the past year. From this perspective, I think we are incorporating it correctly. We have also raised our inflation guard factors across our regions to address this, in addition to the rate hikes we are implementing. I feel we have accurately assessed the current inflation levels. However, as is well known, these can fluctuate, and there is inherent volatility. Social inflation and weather patterns are likely more challenging to forecast.

Let some other folks ask questions, but appreciate the help as always.

Again, if you have a question, please press star one. The next question is from Matt Carletti with GMP. Please go ahead.

Hey, good morning.

Good morning.

Just want to go to trying to better understand the cap/ weather losses in the quarter. If you get some of your peers that have similar kind of footprint, your guys' number is magnitudes of what they've reported. Can you define for us what is the cat for Heritage and what is weather for Heritage? It seems that the weather bucket is the majority of it, and the cat bucket isn't necessarily so sizable.

Well, the cat bucket was $45 million. And the other weather was the $187 million. So, it is predominantly the cat number. And as defined by the PCS events. So that is what we put into that bucket is PCS events.

PCS events. I'm sorry, PCS events are defined cats?

Yes.

Property catastrophes.

We're putting the PCS events into the cat bucket, correct. So, it's a non-cat.

Okay. Do you have handy like how many claim counts that came off of those events that relate to that $64 million of weather?

As far as reported claims, as of March 31, there were 876.

Okay. Thanks. And then just a separate question. Could you give us a backdrop of obviously a lot of your peers in the market are struggling quite a bit. Can you just update us on how you view your capital position as you sit here today?

Our capital position is strong, and we have resources we can utilize. We also have our service companies, MGAs, as well as a syndicate of banks and a revolver available to us. From this perspective, we believe we are in a solid position regarding our capital, and we will keep monitoring it going forward.

Great. Thank you for the answers.

Yeah. In addition to that, I would mention the fact from a cash position, our non-regulated cash is $35 million.

Okay. Thank you.

The next question is from Nick Lacoviello with Dowling and Partners, please go ahead.

Hi, good morning.

Hi Nick.

First question was on Holdco liquidity, but that $35 million, correct? And then,

That's correct.

So where is the group stat surplus as of the quarter end and was there anything downstream at this point in time?

See here. Let me pull that up real quick. Yeah.

Yes. Total stat surplus is $294 million across the entity.

Thank you. Regarding the G&A expense, it was relatively consistent year-over-year, but it increased compared to the last three quarters. Can you help me understand how to think about this on an annual basis and its quarterly trends moving forward?

Yes. I think you're going to see it a little bit higher in the first quarter of each year and then drop slightly throughout the year. I know last year it probably dropped; first quarter was higher and then it dropped a fair amount in the second quarter. I would expect it to drop some into the second through the fourth quarter, but probably not to the extent it did last year.

Thank you. And then I guess on the renewals, I don't know how much you can talk about now, but are you guys able to disclose, I guess from a for stuff that the capacity has done secured at this point in time or not?

Are you talking about reinsurance?

The reinsurance placement?

I'm sorry, you broke up there. You're referring to the reinsurance placement?

That is correct. The reinsurance placement.

Yes. So, we did go out to the market early. We've met with all our large reinsurance partners. We're very pleased about what we're seeing and we're in the process of that being placed. We're very optimistic again; we've got a lot of commitments and we're in the process and expect that to be fully placed by the end of the month. And then obviously, you know, in the announcement, we didn't go out early and make the cat bond placement as well.

Got it. Thank you. That's all I had.

All right. Thank you.

This concludes our question-and-answer session. I would like to turn the conference back over to Ernie Garateix for any closing remarks.

We thank everyone for joining the call today and wish everyone a great weekend.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.