Universal Insurance Holdings, Inc. Q1 FY2020 Earnings Call

Ladies and gentlemen, thank you for standing by and welcome to the Universal Insurance Holdings First Quarter 2020 Results Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. I would now like to hand the conference over to your speaker today Vice President of Corporate Strategy and Investor Relations, Mr. Rob Luther. Sir, please begin.

Thank you and good morning everyone. Welcome to our discussion on our first quarter 2020 earnings results, which we reported yesterday. On the call with me today is Steve Donaghy, Chief Executive Officer; Jon Springer, President and Chief Risk Officer; and Frank Wilcox, Chief Financial Officer. Before we begin, please note, today's discussion may contain forward-looking statements and non-GAAP financial measures. Forward-looking statements involve assumptions, risks, and uncertainties that could cause actual results to differ materially from those statements. For more information, please see the press release, our earnings presentation and UVE's SEC filings, all of which are available on the Investor Section of our website at universalinsuranceholdings.com and on the SEC's website. A reconciliation of non-GAAP financial measures to comparable GAAP measures is included in the quarterly press release. With that, Steve, I'll turn it over to you.

Thank you Rob and good morning everyone. Thank you for joining us today. As we mentioned in our release yesterday afternoon, the circumstances over the past few months in all of our communities have been both difficult and inspiring. Our hearts go out to all those affected by the COVID-19 pandemic. We are inspired by the healthcare providers, the first responders, the ingenuity of our communities, businesses and governments. We commenced business operations more than 20 years ago, intent on protecting and serving our consumers in their most critical time in some of the most challenging coastal areas in the United States for natural disasters. We have remained highly proficient and steadfast in that commitment. We entered this critical time in a position of strength, with a debt-to-equity ratio less than 2%, currently accruing more reserves than at any point in the company's history and with a highly experienced rapid response disaster team. We were off to a good start in 2020, with solid first-quarter results, including an annualized return on average equity of 16.1% and progress on our reinsurance renewals for June 1. In this dynamic environment, we continue to support our consumers whether they are shopping for new policies, submitting claims, refinancing or extending terms, while having substantially all of our employees in our rapid response virtual protocol. On those last two points, I would like to highlight the following. First, since March 15, we have extended favorable terms to consumers of all states upon request. Secondly, around the same mid-March timeframe, we implemented our rapid response virtual protocol, which included outfitting employees with remote capabilities and enhancing our consumer outreach via virtual solutions. In addition, we have accelerated the use of our virtual inspection software and trained an additional 100 employees on the application. We have utilized various virtual tools to continue to attend appraisals, mediations and depositions. All of our continuous improvement training has been uninterrupted through the use of Microsoft Teams, led by our learning and development organization. Most importantly, we continue to accelerate the use of virtual desk adjusting when appropriate. And for the claims that cannot be adjusted virtually, we recognize the increased hardship placed both on the consumer and our field staff. So, as an essential business, we have outfitted our adjusters with the appropriate personal protective equipment. We do not have exposure to many lines of business directly impacted by COVID-19, but we continue to monitor the currently unknowable longer tail impacts to the housing and rental markets. We believe we remain well-positioned for 2020 and remain resolute in serving our consumers and creating value for our stakeholders. So, with that, let me now turn it over to Frank to walk through our financial results. Frank?

Thank you Steve and good morning everyone. As a reminder, discussions today on adjusted operating income and adjusted EPS are on a non-GAAP basis and exclude effects from unrealized and realized gains and losses on investments and extraordinary reinstatement premiums and related commissions. Adjusted operating income also excludes interest expense. EPS for the quarter was $0.61 on a GAAP basis and $0.79 on a non-GAAP adjusted EPS basis. Direct premiums written were up 15.7% for the quarter, led by strong direct premium growth of 19% in other states and 15% in Florida. Net premiums earned were up 5.3% for the quarter, reflecting an increase in direct premiums earned offset by increased costs for reinsurance. On the expense side, the combined ratio increased seven points for the quarter to 94.1%, driven primarily by increased losses in connection with the continued diversification in the company's underlying business in the states outside of Florida and increase in core loss pick for 2020 and increase in prior year adverse development, partially offset by a lower level of weather events in 2020 and a small reduction in the expense ratio. Turning to services. Total services revenue increased 25.6% to $15.3 million for the quarter, driven primarily by commission revenue earned on ceded premiums. On our investment portfolio, net investment income decreased 16.1% to $6.8 million for the quarter, primarily due to significantly lower yields on cash and short-term investments during the first quarter of 2020 when compared to the first quarter of 2019. The prior year also includes one-time income benefits from a special dividend received and a one-time reduction in investment expenses. The company continually monitors the Federal Reserve’s actions, which has impacted effective yields on new fixed income and overnight cash purchases. During March of this year, as a result of the COVID-19 pandemic, we saw extreme instability in the fixed income market prior to the Federal Reserve providing liquidity into that market. As a result of the instability, we had a decline in the amount of unrealized gains in our fixed income portfolio, which affected the balance sheet only. That said, we still ended the quarter with an overall unrealized gain in our fixed income portfolio of $15.4 million, which has further improved subsequent to the end of the first quarter. To be clear, the impact COVID-19 had during the first quarter on debt and equity markets affected our book value per share by approximately $0.45 made up of approximately $0.27 related to the balance sheet-only impact from the decline in the amount of unrealized gains in our fixed income portfolio, with the remainder being attributable to the effect of unrealized losses on our equity securities reflected in the P&L and consequently in retained earnings. With the exception to these factors, our book value per share growth would have been enhanced in the quarter. The credit rating on our fixed income securities was a plus at the end of the first quarter with the duration of 3.6 years, which we feel gives us a strong foundation to weather the current market conditions. Unrealized losses on our equity securities were again driven by market volatility related to the COVID-19 pandemic, resulting in an unfavorable outcome for the quarter. In response to the pandemic, the Board's investment committee has approved measures to continue building our portfolio's cash position to preserve capital for both risks and opportunities. In regards to capital deployment, during the first quarter, the company repurchased approximately 312,000 of UVE shares at an aggregate cost of $6.6 million. On April 16, 2020 the Board of Directors declared a quarterly cash dividend of $0.16 per share payable on May 21, 2020 to shareholders of record as of the close of business on May 14, 2020. Let me now turn it over to Jon to walk through some additional specifics.

Thank you, Frank and good morning everyone. As we have done every quarter since Hurricane Irma made landfall, I would like to start with some additional color on past CAT events, then talk briefly about one key weather and lastly provide an update on our June 1 reinsurance placement efforts. On past CAT events, we continue to make progress in resolving the remaining open claims and, of course, handling the newly reported claims as quickly as possible. Our in-house claims and legal staff continue to deliver day-in and day-out for our company and for our reinsurance partners, as we approach the finish line on these CAT events. As of 3/31 hurricanes, Matthew and Florence, each were approaching single-digit open claims and are very near the end. Hurricane Michael had approximately 200 open claims and continues to be booked at the same $360 million as year-end. On Hurricane Irma, despite the fact that new claims continued to be reported throughout the first quarter, we still successfully reduced the remaining open claim count down to below 600. As we prepare for the three-year statute of limitation for filing new Irma claims, we elected to add another $50 million of IBNR to this event. This brings our book to ultimate to $1.45 billion at 3/31. As a reminder, at this point in the lifecycle of Hurricane Irma, the vast majority of any increase in ultimate is covered by the Florida hurricane catastrophe fund. However, booking this level of additional IBNR did result in some net exposure as outlined in our release. Turning now to 1Q weather. For the most part, 1Q weather for us was within plan. However, we continue to closely monitor two smaller CAT events, one occurring in mid-January impacting us primarily in Georgia and Alabama, and a second occurring in early February and impacting us primarily in Florida and the Carolinas. As noted in our release, we have added an additional $1 million to accident year 2020 losses, as we monitor these events. As a reinsurance update. Over the course of the past several months, we've met with nearly all of our reinsurance partners to discuss our upcoming June 1 reinsurance renewal. As you might imagine, most of these meetings were forced to be conducted virtually, but the reinsurance market overall was very receptive and appreciative of the time and effort put forth to be able to share our message and answer their questions directly. As is our normal practice from a timing perspective, we have already begun securing the necessary catastrophe capacity to be effective at June 1. It goes without saying that the impacts of COVID-19 are being felt by many of our longtime reinsurance partners and we could not be more appreciative of their professionalism in the face of this challenge. What we all might like to press pause on this reinsurance renewal that is unfortunately not an option. We will not be sharing any pricing specifics today as the negotiations are still in progress. However, I do feel it important to provide a few high-level comments on the overall status of our core first event reinsurance tower for this year. As we disclosed during our year-end earnings call, with capacity already locked in via the Florida hurricane catastrophe fund and multi-year deals, we stood at over 75% of our desired core first event reinsurance tower complete. The market pricing for the remaining capacity has already been sent into the worldwide catastrophe reinsurance market for its proper subscriptions, and since last week we have already been receiving authorizations from our reinsurance partners for the June 1, 2020 program. As of today, the percentage complete is approaching 90%, so we're well on our way. With that, I'll turn it back to Rob.

Thanks, Jon. I'd like to ask the operator to now open the line for questions.

Our first question comes from the line of Bill Broomall of Dowling & Partners. Your line is open.

Great. Thank you. Just to start with the growth, it looks like Universal showed another quarter of strong top line growth. Can you guys help us? Let me think about, what do you think has allowed you to be so successful in growing the top line? And maybe can you help us think about rate versus exposure growth?

Good morning, Bill. The growth we've seen is primarily a result of our organization's commitment to conducting our own underwriting and building our business organically since our inception. Without a carefully underwritten organic book of business, you risk taking on accounts that may not be adequately priced or aligned with our underwriting and reinsurance objectives. Furthermore, while the term relationships is often overused, I believe that the connections we've established with our agents and our eagerness to collaborate with them in expanding our business have been beneficial. Additionally, we are among the few online platforms that allow for the complete fulfillment of a bindable policy in our Clovered business. This success is due to various factors, but execution on the ground is crucial. We've been particularly effective in Florida and have successfully expanded those practices into other states.

Can you discuss the growth in the Clovered segment of your business and its success compared to the other parts of your book? I'm interested in understanding how Clovered contributes to your overall growth.

The strategy we implemented three years ago was designed to enter a new market, establish leadership in the direct-to-consumer channel, and protect our growth as others enter the online space. Our experience has led us to develop a system that not only serves our consumers but also challenges our underwriting team and others to ensure our systems are adaptable to the online environment. Currently, Clovered is our fastest-growing agency out of 10,000 agents appointed with us, all located in one room serving customers. We also have agency partners with over 150 locations doing the same with highly capable individuals who assist us daily. The efficiencies built into our platform benefit us greatly. We closely monitor our loss ratio and the spread of our business, which have served us well. Additionally, as the COVID pandemic persists, we've noticed a different type of consumer engaging with Clovered, primarily those at home receiving insurance bills and researching online. We have been very pleased with the organic leads we've generated since the pandemic began and have effectively assisted consumers with their policy inquiries while they are at home.

Perfect. Staying on the topic of COVID, I noticed in your press release that you mentioned the rental and homeowners market. From your perspective, is this the main area where you believe COVID might have the greatest impact? Are there any other concerns outside of this? I'm trying to understand the various factors that could affect Universal, especially in comparison to other insurance companies we've heard about in the media. I'm looking to categorize the different lines of business that might be impacted, even if not significantly.

It's a great question. We consulted our internal legal team in early March as we anticipated some events related to the pandemic. While we didn't foresee the magnitude of this situation, our legal team conducted a thorough review. We haven't seen significant direct physical damage in the rental market and other areas due to the pandemic. However, we have received a small number of claims, and after discussions with consumers, they understand that exclusions for contaminants or communicable diseases typically prevent payments under those policies. We're just beginning to assess the situation but will monitor it closely and keep you updated as necessary.

These claims were homeowners claims related to the virus under the homeowners policy. Is that accurate? You mentioned policy wording. Do your policies include virus exclusions or something similar?

They have a series of exclusions related to disease and contaminants, Bill. We always try to be considerate of the callers. Sometimes we receive inquiries about work limitations and coverage availability, which we can often answer easily since we don't provide coverage in many cases. Some individuals are worried about additional residents in their homes and whether they can file claims for various reasons. We strive to address these concerns as politely as possible. So far, we haven't encountered a request significant enough to warrant any reserve or special consideration. However, that doesn't mean something unforeseen couldn't arise in the future.

Okay. Got it. Regarding the IBNR, it was a modest amount, but traditionally Q1 has shown no development over the past two years. I was curious about what you observed in Q1 compared to the review from last quarter that led you to increase the IBNR grant by two points. Any insights would be appreciated.

Yes, Bill, this is Jon. The two points we discussed were mainly related to IBNR concerning previous CAT events. As we monitor Irma, which is nearing the statute of limitations in a little over four months, we are paying close attention to ensure we have the right IBNR set up for new claims that are still coming in for that event.

Got it. Can you explain the small increase for Irma? Why wasn't there any reinstatement premium included in the reconciliation? I thought if it goes to FHCF, it wouldn't be, but I'm trying to understand why the earnings didn't reflect any reinstatement premium even though you adjusted the Irma loss.

We have added another $50 million of fresh IBNR for Irma, increasing the total to $1.45 billion. This leaves us with just over $1.3 billion of FHCF limit at the 90% level for coverage. It's crucial for listeners and readers to recognize that we still have $1.33 billion available at that level. With our claims and legal teams' capabilities, we can manage these remaining claims and any potential new claims internally, resulting in minimal outside loss adjustment expenses.

Got it. That's helpful. With COVID shutting down many states and its impact on Florida, how has it affected litigation trends and the trial bar's aggressiveness in filing claims? As we discussed this quarter and with the three-year mark approaching, has there been any slowdown? Additionally, as Governor DeSantis talks about reopening the state, do you think litigation trends will change once the economy starts to reopen? Any insights on this activity would be helpful.

It's a wide-ranging question, and I'll do my best to address it, though I may not cover every point. Please feel free to remind me if I overlook anything. In comparison to other states, we are seeing lower litigation trends than we typically observe in Florida, and that trend continues. Within Florida, CaseGlide has certainly benefited us. Our litigation claims are gradually decreasing, not drastically, but in a consistent downward trend, which we find encouraging. Regarding the current situation, our legal team, consisting of over 150 members, has been able to work remotely since we declared that intention on March 17. Today, we feel good about handling more claims, and we have noticed a less aggressive response from the trial bar since the pandemic took effect. Looking ahead, while I don't have a crystal ball, we maintain an optimistic outlook but prepare for possible challenges. We are doing our best and hope this trend continues. Overall, we feel positive about our current position, and CaseGlide is a strong indicator of our future business state.

Great. Thank you very much. I think that's all I have.

All right. Thanks, Bill. Stay safe.

Thank you. Our next question comes from Tom Shimp of Piper Sandler. Your line is open.

Hi. Good morning guys.

Good morning.

Morning, Tom.

I was hoping we could talk about the guidance you guys gave on the fourth quarter. Your underlying loss ratio picked up a few points year-over-year. How do you guys feel in regards to the guidance that you guys gave in the fourth quarter, now that we're at quarter-end?

Yeah. Thanks, Tom. We feel good about the guidance and we continue to stand behind it. We were very thoughtful in our approach to issuing guidance for the first time. And as we looked and contemplated and we saw in the market that it was fair for many people to withdraw their guidance for a host of very valid reasons. The key variables within our model continue to represent our ability to execute within the range we provided. And those variables are considerable and extensive. And we sat and talked a lot about it and as we indicated when we issued the guidance, if one of the large pillars or something would change, we would revisit that with the market when we see it. But as we sit here today, we feel good about it, about the range and the variables that roll into that guidance continue to move favorably for our stakeholders.

Yeah. This is Frank. To follow up on Steve's comments, when we set the guidance at the beginning of the year, our GAAP EPS and operating GAAP were aligned, as we do not plan for unrealized gains and losses or reinstatement premiums, along with realized gains and losses. As these factors naturally arose throughout the year, particularly in the first quarter, discrepancies occurred. Therefore, it's fair to say that our operating EPS guidance has remained unchanged, but GAAP could be influenced by those unexpected events.

Okay. And then this relates to COVID. Various jurisdictions have been pushing for payment forgiveness and grace periods and whatnot. Does your expense ratio include any assumption for bad debt related to the potential for that?

We implemented the new accounting principle known as CECL this quarter. We have credit exposure in three main areas: when policyholders don't pay their premiums, when we don't collect amounts due from our reinsurers, and the credit risk associated with our fixed income portfolio. In late 2019, we tested the CECL model on these areas and determined the potential impact would be immaterial. We have made the necessary adjustments and disclosures in our 10-Q, including a change to our beginning retained earnings. In our business model, we typically collect most of the premium before it is earned. We currently have about $1.4 billion in enforced premium and a receivable of about $65 billion from agents. Historically, our write-offs for uncollectible amounts range between $400,000 and $500,000 annually, which grows proportionately with our growth. We maintain an allowance for these receivables of approximately $600,000 to $700,000, so we do not feel the need to reevaluate based on the CECL model. The agent balances receivable remain immaterial under CECL. For reinsurance recoverables, these are mostly collateralized by trust amounts or letters of credit from certain reinsurers, and we have never written off any uncollected amounts from them, so this is also not material. We did not make any adjustments for reinsurance recoverables in the first quarter. Regarding our investment portfolio, the average credit quality is A plus, and since the start of the COVID pandemic, we've only seen three downgrades, which are not material to our business. We have calculated potential impacts under the CECL model, looking at unrealized losses at various points, and none exceeded $1 million. Based on calculations as of March 31, we established a standing allowance effective January 1 at just under $800,000, affecting retained earnings by less than $600,000 after tax. Clearly, this is not material, but we will keep monitoring the credit quality of our investment portfolio and take appropriate actions, and as mentioned, we will inform stakeholders if any issues arise.

I appreciate it. I wanted to discuss working from home. Many of your employees are likely still working remotely. Do you have any thoughts on whether this arrangement might become permanent for some? I mention this knowing that you have an office building under construction for future growth, so I'd like to hear your thoughts on this issue.

We are actively developing our plan. As a Florida domestic carrier, we've always focused on disaster preparedness. Currently, our business continuity and disaster recovery plan is around 320 pages, and it didn't take into account a pandemic with everyone working from home. Thankfully, we were able to acquire enough laptops and have equipped over 98% of our associates to work remotely. We also adjusted our technology to monitor production and productivity effectively. So far, all our controls and metrics have performed remarkably well. Moving forward, we intend to listen to state officials, assess what is needed, and adjust our plans accordingly. You mentioned our building under construction, and we anticipate its completion to align closely with the start of hurricane season. We will consider social distancing to protect our associates' health and safety, such as providing more space rather than stacking cubicles closely together. We are also considering varying shifts throughout the week, as there are clear benefits to having employees on-site for training and collaboration. Our goal is to ensure both the safety of our people and the smooth operation of our business. Our management team has been together for a while and has built a strong cooperative spirit, partly due to the challenges posed by previous hurricanes. Overall, we value each other and are fortunate to work in this trusting environment. I know that was a lengthy answer, but it covers a lot of important points. I hope that clarifies things.

No, I appreciate it. Thank you. Are you seeing any potential benefit from loss mitigation due to customers staying at home? For example, if there's a leak in the kitchen or bathroom, are customers able to address that loss more quickly compared to when they're at work, which could lead to a much larger loss?

That's an interesting question, Tom. There are a few factors to consider. When you're at home and there's a water leak, you can turn it off or fix it right away. This could help us, as a claim that might have escalated could be resolved more quickly. Additionally, many people in my neighborhood are working on their homes, which may reduce the risk of potential claims. There's a lot of attention being given to our insured's most significant asset, their home. We hope this results in positive outcomes. Regardless, we're ready to handle whatever challenges arise.

Okay. Lastly, you mentioned your Board approved measures to strengthen the company's cash position. Should we expect any information regarding stock buybacks for the remainder of the year?

Tom, there's an environment out there with a lot of different perspectives. We're ending up a very strong quarter and we're not adjusting our guidance. We will review with the Board and our Executive Chair how to proceed with buybacks when appropriate, but we would not want to do anything that would lead people to question our intent and our integrity so to say going forward. So, we'll try and be very thoughtful and seek counsel from folks in the business, as we look to that.

All right. Thank you for your answers.

Yeah, thanks Tom. Have a great day.

Thank you.

You too.

Thank you. We have a follow-up from Bill Broomall of Dowling & Partners. Please go ahead.

Thank you for the update on reinsurance. Last quarter, you mentioned that 75% of your capacity, including FHCF, was completed, and this quarter it's 90%. Regarding this increase, did you see any previous reinsurers returning to participate again this year? Additionally, have there been any changes in terms and conditions from the reinsurance community as you've navigated this process?

Thank you, Bill. Regarding the first part, you know us well enough to understand that we are consistent buyers. We purchase from the traditional market and over 95% of our panel remains very similar from year to year. We occasionally consider adding new capacity. The increase from 75% to nearly 90% is simply due to our existing partners who have authorized changes on our firm order terms. We have been very pleased with the results so far. Most partners who have decided on our terms have authorized increased capacity. Everything is going well up to this point, but we still have a long way to go. We are awaiting feedback from many of our reinsurance partners who are still assessing their options in this challenging environment. Overall, we are satisfied with our current position as of April 28. We believe we are in a strong position, and most of our reinsurance partners see Universal as a reputable partner regarding counterparty credit risk, which is becoming increasingly important to them. Additionally, they view the terms we have offered as fair for this renewal.

Okay. Do you have any updates on whether there has been any pressure from the reinsurance market for changes to terms and conditions?

Yeah, I think it's been fairly well publicized that there's a few reinsurers that are pushing for some rather significant changes. And I think some of those changes may make sense. Others I think have challenges associated with them and they really need to be discussed from a company-to-company standpoint. They're not the type of changes that should be just broadly painted across the entire marketplace. So, we've had those conversations with those reinsurers and with all of our reinsurers about the ones that we feel that are appropriate for a company like Universal. Like I said, a consistent buyer year in and year out buying from the traditional market, offering fair terms. One thing they can count on is that we're here this year. We're going to be back next year. It's unlikely that you see us making radical changes in our buying behavior, and I think our reinsurance partners appreciate that.

Perfect. Thank you very much.

Thank you. At this time, I'd like to turn the call back over to Steve Donaghy for closing remarks. Sir?

Thank you. In closing, I would like to thank our associates, consumers, agents, and our stakeholders for their continued support of Universal. We find ourselves living through surreal and incredible times and adapting to a new normal. I'm extremely proud to lead an organization that was able to seamlessly transform our business to ensure the team's safety and continued operating success. Our highly experienced and battle-tested individuals have us ready to weather and navigate this storm, while ensuring we are in a position of strength as a company going forward. Stay safe, and thanks for your time today.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.