Universal Insurance Holdings, Inc. Q3 FY2020 Earnings Call

Good morning, everyone, and welcome to the UVE Third Quarter 2020 Earnings Conference Call. This call is being recorded.

Thank you and good morning, everyone. Welcome to our discussion on our third 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 and UVE's SEC filings, all of which are available on the Investors 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. We continued to see headwinds in the third quarter as we dealt with elevated industry-wide weather events year-to-date, particularly in coastal states. Our catastrophe response teams have directly engaged with our insureds to ensure they receive the attention they deserve. As previously announced, we were affected by full retention events from Hurricanes Isaias and Sally in addition to other PCS events year-to-date. As the statute of limitations for Hurricane Irma approaches its ending, we experienced increased prior year companion claims, as the window closed. This increase in claims led us to increase our reserves in years prior to 2020. We feel good to have Hurricane Irma behind us, the ability to strengthen reserves appropriately, and we are proud of our employees for their contributions during these unprecedented times. Our vertically integrated suite of capabilities continues to differentiate us in our home state. Our primary rate increases continue to flow through our book, as evident by our strong direct premiums written growth of 19.4% in the quarter. We continue to selectively write new business, are quickly approaching $1.5 billion in premiums in force, and are optimistic about our prospects in the future. 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 a loss of $0.10 on a GAAP basis and a loss of $1.43 on a non-GAAP adjusted EPS basis. Year-to-date, GAAP EPS was $1.14 and negative $0.08 on a non-GAAP adjusted EPS basis. Despite elevated activity year-to-date, we produced an annualized year-to-date return on average equity of 10% with a book value per share that remained relatively flat since the end of 2019 at $15.15. As to underwriting, direct premiums written were up 19.4% for the quarter, led by strong direct premium growth of 18.8% in states outside of Florida and 19.6% in Florida. The quarter's growth benefited from organic new business growth and primary rate increases continuing to flow through the book. On the expense side, the combined ratio increased 36.9 points for the quarter to 134.7%. The increase was primarily driven by previously announced increased weather events in addition to prior year's reserve development and the continuation of accruing incremental reserves for current accident year loss cost. In addition, higher reinsurance costs affected the base of the ratio. These increases were partially offset by a benefit from our claims adjusting business and a reduction in the expense ratio. Turning to services, total services revenue increased 14.9% to $17.1 million for the quarter, driven by commission revenue earned on ceded premiums and an increase in policy fees. On our investment portfolio, net investment income decreased 40.1% to $4.6 million for the quarter, primarily due to lower yields on cash and fixed income investments during 2020 compared to 2019. Realized gains for the quarter were $53.8 million and resulted from taking advantage of increased market prices on our available-for-sale debt investment portfolio. We took the opportunity to monetize the increase in fair value of our investment portfolio as a means to enhance surplus for UPCIC. This facilitates our growth strategy in a hardening primary rate market while strengthening reserves. Cash and cash equivalents increased 122.5% to $405.1 million when compared to the end of 2019 as a result of the actions taken to realize investment gains leading to higher investment cash flows. As a result of the sales and reinvestment, future portfolio investment income will reflect current market rates. In regards to capital deployment, during the third quarter, the company repurchased approximately 534,000 shares at an aggregate cost of $9.9 million. Year-to-date, the company repurchased 1.4 million shares at an aggregate cost of $26.5 million. On July 6, 2020, the Board of Directors declared a quarterly cash dividend of $0.16 per share of common stock, which was paid on August 7, 2020, to shareholders of record as of the close of business on July 31, 2020. As mentioned in our release yesterday, we are updating our full year guidance to reflect increased top-line revenue, offset by elevated third quarter loss and loss adjustment expense. We now expect a GAAP EPS range of $1.80 to $2.10 and a non-GAAP adjusted EPS range of $0.55 to $0.85, assuming no extraordinary weather events in the fourth quarter of 2020 and no realized or unrealized gains for the fourth quarter. This would yield a return on average equity derived from GAAP measures of between 11.1% and 14.1% for the full year. Let me now turn it over to Jon to walk through some additional specifics.

Thank you, Frank, and good morning, everyone. We continue to make significant progress in resolving the remaining open claims on prior year catastrophe events. And as Steve noted, we reached the statute of limitations milestone for Hurricane Irma claims. We did see over 2,000 new Irma claims reported during the third quarter, and we elected to book the Irma gross ultimate at $1.55 billion. The modest run-up in claims filed in advance of the 3-year statute of limitation for filing new Irma claims that expired in the second week of September was expected, but we were surprised and disappointed to see quite a number of non-cat Irma companion claims filed simultaneously. This phenomenon contributed to a portion of our third quarter prior year adverse development. We will continue to monitor the effects of these late-reported Irma and Irma-related claims going forward. But we are extremely pleased with the diligence of our claims adjusting staff. As of September 30th, Hurricane Michael had a little over 100 claims open, as we start to approach the end on this storm. We did elect to book the Michael gross ultimate at $386 million. This change does not impact our net loss position. In regards to third quarter 2020 weather events, as noted in our September 23 press release, and again in our release last night, we did experience losses from two specific hurricane events during the third quarter, Hurricanes Isaias and Sally. Each of these events was booked at September 30, expecting a full retention loss under its respective reinsurance program. For Hurricane Isaias, that was $15 million pretax under our other states program, and for Hurricane Sally, that was $43 million pretax under our all states program. Together, these two events resulted in a total net impact of approximately $58 million pretax, approximately $44 million after-tax. 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 Tom Shimp from Piper Sandler.

Just hoping to get more color on the companion claims, the non-cat claims. Can you give me an example of what type of claims those are and just why that caught you guys by surprise? Just any more color on that would be greatly appreciated.

Yes, thanks, Tom. A companion claim is one that is filed at the same time as a catastrophe claim. Generally, with the assistance of a public adjuster or an attorney, we see a Hurricane Irma catastrophe claim filed alongside a non-cat claim for the same property. The aim of the policyholder or their representatives is to ensure that their client has the chance to be compensated for one or both claims. This concept is not new; in fact, we've had over 10,000 of these claims submitted since Irma made landfall over three years ago. What was unexpected, and somewhat disappointing, is that we observed a significant number filed again in the third quarter of 2020, with over 2,000 cat claims coming in. Typically, when these non-cat claims arise, they correspond to older accident years, which means we need to increase our reserves for those specific years.

Okay. So I just want to make sure I understand this correctly. It sounds like from a perspective of the 3-year statute of limitations has passed now, that claim count for that really shouldn’t go up. And it's not really a classification issue that had the potential to develop further?

No, that's right. Yes, you're correct. Our goal really with everything we've done here in the third quarter, Tom, is to try to get Irma cat claims and Irma-related non-cat claims in the rearview mirror. With what we've booked here from a gross cat perspective, as well as what we've done to bolster the older year reserves related to some of these companion claims, we're really hoping to put Irma behind us.

All right, great. That's very helpful. And then if we could talk about just capital strategies, you guys are holding onto more cash, you're still buying back some shares, and the company is reporting strong growth. So how's the comfort level trending around capital adequacy? I know you guys took the gains on some of the investment portfolio, but if organic growth opportunities continue to present themselves, could management envision other avenues to support the growth, taking advantage of low rates, raising some capital. Is that a possibility?

Good morning, Tom. This is Frank Wilcox, I appreciate the question. Just a reminder about our business model and how we accumulate and deploy capital. In addition to the opportunity to accumulate capital at the insurance entity levels, with our vertically integrated structure, we also have the capacity to accumulate capital outside. That capital, of course, is used to return value to shareholders in the form of dividends, share buybacks, and from time to time, if needed, to support growth at UPCIC. Right now, we're okay with capital. If the need be to look elsewhere, certainly, that capital raise would be to support growth.

Okay, great. The net investment income was a bit lower than I expected. I understand that yields are decreasing and we are holding onto cash more. Can we discuss the declining net investment income and whether we should consider this a reasonable rate moving forward?

Yes, well, the decrease in interest rates had an impact first on our cash equivalents and our short-term investments, as those reprice regularly. The book of fixed income, long-term fixed income securities as they matured, or as they were paid down before maturity, we're repricing into a lower interest rate market. So those are contributing factors. Going forward, I think you need to keep in mind the fact that we monetized the unrealized gains, and those unrealized gains basically represented future collection of interest income. So we accelerated the collection of that interest income, and now, as we replace our investment portfolio, the majority has been replaced. And the composition of the portfolio is very similar to what we had in the past, which is very conservative in nature. And of course, that served us in the past. But as we continue to deploy the available cash, we're expecting a yield of somewhere between 130 to 160 basis points depending on the adviser that we're working on.

Okay. And then I just wanted to touch on just a high-level question here. Obviously, the Florida insurers in general are struggling right now. Can you just discuss what you're seeing in the operating environment, the potential, any opportunity to take further rate increases and how the regulator would respond to that? And just in general, what are your thoughts on the ability to get enough rate to stabilize margins for the Florida peers?

Thanks for the question, Tom. The Florida market has shown signs of hardening, with many competitors exiting certain areas of the state. Our approach to rating has always focused on ensuring adequate pricing rather than simply following the competition. As a result, we are now able to write policies in regions where we previously could not, largely because our premiums were significantly higher than those of our competitors. With the shift in the market, our capacity to write and underwrite policies has grown considerably, which we find promising. I believe our reinsurance partners will appreciate this growth as it occurs outside of the tri-county area. As we work to balance our portfolio, we see this as a substantial opportunity moving forward. In terms of claims management in the state, we are actively adjusting claims and have been using certain practices for the past few years. Many insurers are more receptive to our methods of handling claims remotely, rather than insisting on in-person adjustments. We have conducted regular virus testing for our field staff to mitigate health risks, and we've informed our insureds about this while encouraging them to notify us if they have had any exposure. This approach is somewhat unique to Universal, and not all third-party adjusters in the state have met our standards. Overall, we feel confident in what we have established to manage the current situation. If there's a specific aspect of your question that I haven't addressed, please let me know, and I’d be happy to expand on it.

No, I think that hits it, but it brings up another question. As you guys try to move away from Tricounty, I've been hearing some discussion that some of the issues that are in Tricounty moving to other counties throughout the state. Is that something you guys have been seeing too? How has that been trending in your thoughts?

Yes, we track that on a regular basis, as you can imagine, Tom. And the infrastructure that we've built to deal with Tricounty, should we experience that, we feel that we are strategically positioned to combat whatever comes at us in any other markets. Again, that being said, our rate adequacy is the key to our ability to operate around the state effectively and efficiently. So our lawyers are ready, our specialists in claims are ready. But thus far, we have not seen the increase in premium result in an increase in litigation or public adjusters, etc., around other markets in the state. They're there, we know they're there, we know who they are, and I'd like to think they know who we are, and that we have the right tools to combat and compete, should they decide to pursue frivolous claims.

Okay, great. And then just lastly, I was hoping we could revisit the impacts from COVID. We're a lot farther into the pandemic now. Are you guys seeing any beneficial impacts, be it direct distribution or possibly less non-attritional losses, as homeowners work from home?

Tom, that's an interesting question that we receive often. We haven't observed any significant changes in claim development or requests. Some individuals have sought relief related to the pandemic, but our policies explicitly do not provide coverage for that. After reviewing the claims, we’ve only received a small number, maybe in the hundreds, over the last nine months, which isn’t substantial. However, we haven’t made any payments due to the language in our policies that we are fortunate to have in place. Are you noticing any positive effects from homeowners being at home, or is it still too early to tell? I believe that the positive impact we’re experiencing comes from the incredible associates we've brought on board at Universal and our capacity to respond, engage, and operate efficiently during these times. The technology we've adopted in the Claims Department over the years has worked very well for us. Consumers can use their phones to take pictures of their claims, which helps us facilitate the repairs they want. I'm also pleased with the construction industry; while we aren't directly involved, it seems that homeowners are managing to find workers to help with repairs, allowing them to return to normal and mitigate further damage to their claims, which has been beneficial. Overall, our associates are doing an excellent job. Third-party construction firms continue to support our insured clients and help them get back to their previous situations. Our use of technology in claims processing has been effective, including our proprietary claims app that allows customers to track their claims on their phones, which has proven to be quite advantageous.

Our next question comes from the line of Bill Broomall from Dowling & Partners.

If I could begin, you have previously discussed your direct loss pick and your perspective on it. Has there been any update regarding that?

No…

No, I'm sorry. Go ahead, Frank, you go first.

I was simply going to say that it hasn’t changed from what we previously announced.

Can you help me understand the transition from direct to net adverse development? I'm thinking Michael and Irma contribute to this, but is there anything else? I'm trying to reconcile the change from 136 down to 31 or 30.

No, you're right. Irma and Michael would be the largest contributors to that.

Okay. Got it. On the cash component on your balance sheet, I was just wondering how much of that cash is at the holding company?

Well, that's disclosure that we do annually through our 10-K. There are financial statements at the end. It's not a number that we publish in the interim, Bill, but last year, the amount was between $80 million and $90 million.

Got it. That would be year-end 2019?

That's correct.

Okay. And just following up on one of Tom's comments, is there a leverage ratio that you think about writing at the sub level?

Are we talking about debt?

Sorry, I apologize for the underwriting leverage, premiums to surplus, and how you think about what you're writing at. Are there some tools you can utilize?

Yes, there are several measures that we monitor. We monitor gross written premiums to surplus, net written premiums to surplus, and of course, RBC ratios. And we do that in order to maintain regulatory standards but also to support our ratings. So yes, we do constantly monitor those measures.

Could you share your current position in terms of the leverage ratio when considering the bands of what you prefer to write at?

Well, those are annual figures so we're looking at that in conjunction with our forecast for the rest of the year. We have had tremendous growth from opportunities in the State of Florida, and we recognize that we need surplus in order to support that growth. And we have, in the past, infused capital from the holding company down to the insurance entities, and we stand ready to do the same if necessary.

Now did you downstream anything in Q3?

I'm sorry, what was the question?

In your prepared remarks, I believe, Frank, you mentioned about the surplus. And did you downstream any capital to the end of this year to support the growth?

We did. We infused $44 million from the holding company.

And Bill, this is Steve. We still have funds at the parent. We're very comfortable with where we sit from a capital perspective. And our ratios, as we sit here today, are better than they were at the end of 2019 and Q1 so generally. So we feel good about where we're at, and as Frank talked about, the focus on capital is constant. And he's always running in and sharing where we're at and what we're doing, and what we need to do. And fortunately, the company has been built in a manner that we can continue to do the necessary things, and thus far, have had no need to enter capital markets for additional assistance.

Great, both those commentaries were very helpful. And I might've missed this, Jon, but what are the number of open Irma claims? I know you had 2,000 new ones, but I think at the end of Q2, you had about 450 and I was just wondering what the open claims were on Irma.

Yes, open Irma claim count as of September 30 was 418, so that number, it sounds like it went down just a little. But obviously, we made progress on the new claims that came in during the quarter.

Yes, okay, yep, yep. And in the past, you’ve paid a special dividend. I was just wondering when does the Board meet to review that, or what's the process when you think about reviewing the dividend?

Yes, Bill, that's part of our ongoing capital management strategy that we employ, and the Investment Committee will meet. We have a Board meeting this week. The Investment Committee met last week on some matters, and have discussed it. So we're in regular discussion. We generally like to get us through the hurricane season as possible, and currently, we sit in a position where the capital is there to deploy barring any unforeseen circumstances. So again, it's part of our ongoing strategy. We feel good about it. And the capital is there today and as we maturate through the next few weeks, we should be in a position to announce.

Thank you. This does conclude the question-and-answer session of today's program. I'd like to hand the program back to Stephen Donaghy for any further remarks.

Yes, thank you, Jonathan. In closing, I would like to thank our associates, consumers, agents and stakeholders for their continued support of Universal. And all those on the line, we wish you the best in these unprecedented times and look forward to speaking to you at the end of the year. Have a great day.

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.