American Coastal Insurance Corporation (ACIC) Q1 2017 Earnings Report, Transcript and Summary

Greetings and welcome to UPC Insurance 2017 First Quarter Financial Results Conference Call. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Adam Prior of The Equity Group. Please go ahead.

Thank you and good morning everyone. Thank you for joining us. You can find copies of UPC earnings release today at www.upcinsurance.com in the Investor Relations section. You're also welcome to contact our office at 212-836-9606 and we'd be happy to give you a copy. In addition, UPC Insurance has made this broadcast available on its website. Before we get started, I'd like to read the following statement on behalf of the company. Except with respect to historical information, statements made in this conference call constitute forward-looking statements within the meaning of the federal securities laws, including statements relating to trends and the company's operations and financial results and the business and the products of the company and subsidiaries. Actual results from UPC may differ materially from those anticipated in these forward-looking statements as a result of risks and uncertainties, including those described from time-to-time in UPC's filings with the U.S. Securities and Exchange Commission. UPC specifically disclaims any obligation to update or revise any forward-looking statements, whether as a result of the new information, future developments or otherwise. With that, I'd now like to turn the call over to Mr. John Forney, UPC's Chief Executive Officer. Please go ahead, John.

Thanks Adam. Good morning everybody. This is John Forney, President and CEO of UPC Insurance. With me today is Brad Martz, our Chief Financial Officer. On behalf of everyone at UPC, we appreciate your taking time to join us on the call. Q1 2017 was a quarter of continued growth and diversification for UPC Insurance. For the third year in a row, our Q1 year-over-year premium growth rate was above 20% and over 60% of our exposure is now outside Florida. Our field sales reps continue to do a terrific job in advancing the UPC value proposition to our independent agents across our geographic footprint. Like much of the industry, we experienced a high level of weather-related losses in the quarter. Cat and non-cat weather losses contributed over 12 points to our gross loss ratio, which hurt our bottom-line results, but we experienced no adverse development in the quarter and are seeing very positive trends in our claims department overall. During the quarter, we also received approval for rate increases in Texas and Rhode Island and we filed for a rate increase on our legacy [Indiscernible] product in Florida. We have three other states ready to go in Q2. We want to remain competitive in these states, but loss trends make it necessary for us to take these actions. During Q1, we also rolled out a brand-new HO3 product in Florida, which has showed great promise during our pilot program. The big news of the quarter though was the final approval for our merger with American Coastal, which closed on the first business day of Q2. The enhanced scale and reduced volatility that American Coastal brings will accrue immediate benefits to our combined company and we will act aggressively to seize new growth opportunities created by the combination. Stay tuned in that regard. For now, we're thrilled to team with Dan Peed and his team at American Coastal and AmRisc. At this point, I'd like to turn it over to Brad Martz to discuss our financial results in more detail. Brad?

Thank you, John and good morning everyone. I'm Brad Martz, CFO of UPC Insurance. I'm pleased to review the financial highlights for our most recent quarter. But before we get to those, I would like to remind and encourage everyone to review our press release and Form 10-Q for more information. Highlights of UPC's first quarter 2017 included net income of $3.9 million or earnings press share of $0.18. EPS included cat loss of just under $11 million or $0.32 a share. Our underlying combined ratio was 90.9%, and our book value per share increased to $11.37 per share. UPC saw continued impressive organic premium growth during the quarter. Gross premiums written of $169 million were up 24% year-over-year. Gross premiums earned of $182 million were also up 24% year-over-year. Net earned premium growth was only about 6% year-over-year due primarily to the $21.9 million of seeded earned premium under the company's quota share reinsurance treaty, which incepted December 1st, 2016. Direct premiums written for the quarter were derived approximately 45% from the Florida region, 24% from the Gulf region, 18% from the Northeast and 12% from the Southeast. Florida grew a modest 2% on a direct basis year-over-year and all other regions were up 41% and represented virtually all of the growth in direct written premiums. Investment income increased 23%, consistent with written premiums. Total policies in-force at March 31 grew approximately 27% year-over-year to just under 462,000, with total insured value of $81.4 billion in Florida, up 37%; and $137.8 billion or 63% outside of Florida. UPC's first quarter losses decreased 1.4% from $64.3 million last year to $63.3 million in the current quarter. Our first quarter gross loss ratio improved over nine points compared to Q1 of 2016 and the net loss ratio improved over four points from 63.4% last year to 59.1% in the current quarter. Included in those results were approximately $11 million of net retained catastrophe losses and approximately $0.5 million of favorable reserve development on prior accident years during the quarter, which added roughly 9.4 points to the net loss ratio in the current quarter. The cat losses were primarily from five PCS events, primarily impacting Texas, Florida, Louisiana and other southern states. Excluding the impact of net catastrophe losses and prior year reserve development, UPC's gross underlying loss ratio improved two points year-over-year, but the underlying net loss ratio increased over four points due to lower levels of catastrophe losses in the current year and higher seeded earned premiums related to our quota share reinsurance program, which was not in place last year. During the quarter, the company also saw its non-loss operating expense increase approximately $13.7 million or 35% year-over-year. $8.4 million or 61% of the change was driven by policy acquisition costs, which are consistent with UPC's direct written premium growth in states with higher agent commissions and premium taxes. The remaining $5.3 million or 39% of the change was driven by all other operating expenses, which are primarily due to labor costs related to our initiative to shift claims litigation work away from independent adjusters back in-house to UPC associates, amortization of intangible assets for Interboro Insurance Company, IT and underwriting-related costs as well as expenses related to our merger with American Coastal. This resulted in our gross expense ratio increasing 2.3 points to 28.9%, which is driven by commissions of about one point; amortization, half a point; operating and underwriting expenses, half a point; and premium taxes, three tenths of a point. Non-recurring deal costs included MD&A [ph] expense for the quarter were approximately $0.5 million or 0.5 point. Most importantly, the net expense ratio had a disproportionately higher increase of over 10 points due primarily to the quota share accounting treatment. Under our quota share agreement, we cede 20% of premiums to our reinsurance partners. In return, they pay losses associated with those premiums and pay us a ceding commission designed to cover the expenses we incur in generating those premiums. But that ceding commission is accounted for as other revenue rather than an expense offset, so it causes the net expense ratio to look higher than it actually is. That's why we deduct the ceding commission from expenses in calculating the underlying combined ratio. Using the proper allocation, the net expense ratio was 41.3%, up 2.9 points from last year's first quarter due to the same factors that drove our gross expense ratio. Our balance sheet remains in great shape, UPC ended the quarter with total assets of $949 million, including over $665 million of cash in invested assets, an increase to our flow of approximately $84 million year-over-year. Shareholders' equity was $247 million, with a book value per share of $11.37. Combined statutory surplus of the group was approximately $222 million. During the quarter, our team was also working hard on our upcoming catastrophe reinsurance renewal to the effect of June 1st, 2017 and I'm pleased to share that we fully expect to achieve the following goals; to place a single combined program for all companies, including American Coastal, to obtain the reinsurance synergies previously disclosed, improve terms and coverage, and to lower our attention as a percentage of our group's total capital. We're currently in the contracting phase now as all coverage has been balanced and an 8-K with more information and details on the program will be released in the following weeks. Another significant focus for the company has been rate indications. As John mentioned, UPC has already received approval for rate increases in Texas of 6.5%, Rhode Island of 9.8%, have a filing pending in Florida for approximately 8% and expect to submit filings in Massachusetts for plus 9% and New Jersey of approximately plus 7% in the next 30 days. These five states represent 74% of our homeowners' premium in-force and will have a very meaningful contribution to earnings in future quarters. This will obviously take time to earn to our book and we will continue to monitor rate adequacy very carefully. Finally, the results of American Coastal's operations in the first quarter 2017 are not included in our consolidated results this period but they also had a very solid quarter, with written premium of just under $75 million, net earned premium of $37 million, net income of $6.5 million, a combined ratio of 74.9% and shareholder's equity of $203.7 million. Needless to say, UPC is very excited about the earnings power of the combined company that will commence in the second quarter of 2017. We're currently in the process of preparing an 8-K/A filing to share the pro forma combined financial results for United Insurance Holdings Corporation and AmCo Holdings required by SEC Reg S-X that will also include AmCo's audited financial statements for 2016. With that, I'd like to reintroduce John Forney for some closing remarks.

Thank you, Brad. At this point, we would like to open the call up to any questions.

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Elyse Greenspan with Wells Fargo. Please proceed.

Hi good morning. My first question is just on the American Coastal transaction since that closed subsequent to the end of the quarter. When you guys announced the deal over the summer, you just gave us some financials in terms of accretion to earnings and ROE as well as the potential impact on book value. Has anything changed over the subsequent months or can you basically reaffirm the financials as you set out when you announced the deal?

I think we can essentially reaffirm the financials and the benefits of the transaction as we've outlined previously.

Okay, great. And then in terms of the environment in Florida, you guys didn't see any adverse development. First off, if you can just say where the favorable development did stem from within your book. But then more in terms of Florida, how have you seen trends in the state in the first quarter of the year, just especially on the AOB side? I know you guys have taken action within your book in terms of curbing exposure to some of the more impacted areas. But have you just seen any changes in environment to start the year?

Elyse, this is John. I'll address briefly and Brad can add anything that he has. Our goal is not to have adverse development or reserve releases as a consistent feature of our book. We want to have the reserves be the right reserves. And as you know, we significantly increased our reserves over the last year to address the loss trends that we were experiencing, especially in Florida. So, we have a bunch of reserves on our books, and so there wasn't any development on that, thank goodness. And there was very slight reserve releases. Basically, we think our reserves are adequate where they are. We continue to strengthen and bolster reserves each quarter and we did so again this quarter. In terms of the loss environment in Florida, it's still very difficult. We have not really seen a lessening of the trend for folks to be seeking to get these AOB settlements and litigation trends. We're better positioned because we're linking our book in the part of the state that's most prone to it. But from our standpoint, the AOB game is still as lucrative as ever for all those folks that play it and so we have to be prepared to continue to battle it.

Elyse, this is Brad. I would just add that frequency is very, very stable. We don't see anything that concerns us on the frequency side. In fact, we see improvement on frequency. Severity continues to be primary challenge. First quarter 2017 was impacted by some high severity from fire. Almost 8.6% of our gross loss -- or 8.6 points of our gross loss [Indiscernible] from fire. That's a pretty random peril. There's no adverse trend whatsoever related to that. So, all other cause of losses actually showed pretty significant improvements, so we were pleased overall.

Okay. And then in terms of thinking about the expense -- level of expenses going forward, if we adjust for the one-time transaction cost you called out in the quarter, just given the shifting of your book, is the remaining expense base kind of the right level for us to think about on a quarterly basis going forward?

For policy acquisition costs, yes. I believe that is true. We are seeing some reduction in policy administration cost, which relates to our system -- consolidation initiatives. We saw that ratio fall from 3% to 2.6%. That's embedded in policy acquisition cost during the quarter. Everything else is trending up consistent with our change in mix.

Elyse, this is John again. One thing to keep in mind, as you know, there will be additional significant amortization of intangibles related to the merger with American Coastal that will impact -- its non-cash, obviously, but it's going to impact our expenses going forward.

Yes, we will cause retention to the amortization going forward. This quarter, it was $2 million compared to $900,000 a year ago, so up $1.1 million, that hits G&A. Not a terribly significant item but it will be more significant going forward.

Okay. And then one last question. How has the level of cat losses been to-date? I think April also saw a decent level of losses in the U.S, especially some storms in Texas towards the end of the month. Do you have a feel for how your level of losses have been trending, I guess, as of today or at least through April?

Yes, April was a very active cat month nationally. And for UPC, I think we had right around $9 million of cat losses in the month of April.

Okay. And then so on a combined basis, you're probably sitting at about $90 million and maybe $10 million more of losses and then you would go into your reinsurance cover?

Yes, correct.

Okay, great. Thank you very much.

Thank you. Our next question comes from Anthony To with KBW. Please proceed.

Hi, good morning. Thank you for taking my questions.

Good morning.

So, it looks like American Coastal has been shrinking for the last two quarters. What's been driving that? And do you expect to -- that trend to reverse?

American Coastal is a very disciplined underwriter that assesses the long-term profitability of each account very carefully using sophisticated risk management tools, many of which are proprietary, and that underwriting discipline isn't possessed by all market participants. And so American Coastal has been very selective in the accounts and the pricing that it chooses to renew and that's why it continues to produce very strong underwriting results and will throughout the cycle. There are other participants in the market that may not have that same fate.

Thanks. That was helpful. And one more, if I may. Just to jump on Elyse's previous question on expense, how long should we expect the expense ratio to be elevated, particularly considering that the in-sourcing of policy systems should benefit the expense ratio yield?

I would suggest the current expense ratio is -- we'll see some benefit related to our merger with American Coastal. They also operate with a fairly high expense ratio as well, but I think instead of focusing on the expense ratio, we should be focused on the combined ratio.

Great. Thanks. I'll hop back in the queue.

[Operator Instructions] Our next question comes from Samir Khare with Capital Returns Management. Please proceed.

Hi good morning and congrats on the approval of American Coastal.

Thank you.

Just on the historical GAAP financials that you provided, I think you said you provided 2016. If you guys could provide another year, that would be very helpful for of us, I think, so [Indiscernible] -- sorry go ahead.

Go ahead, Samir.

I want to start on the rate increases that you guys were talking about in the different states. They're pretty impressive. But usually, the rate increases follow troubled experience. I was wondering if you could -- we know about Florida and Texas, could you talk about Rhode Island, Massachusetts and New Jersey?

Sure. I guess I would take a little bit of an exception to your statement that rate increases follow troubled experience. Rate increases are a normal and natural part of the cycle as you go through an experience level in a state as cost continue to go up at various levels in different states, but you're not seeing deflation in the United States certainly. And so loss costs are going to continue to go up and so you're going to need some modest level of rate increases on a consistent basis just to keep pace with inflation. So, it's not necessarily an indication of troubled experience. With that said, obviously, the last couple of years, a lot of people have noted that there seems to be an enhanced level of weather-related losses in coastal areas throughout the United States. We have not been immune from that nor have we failed to note that trend. And to make sure that we can continue to serve our policyholders well and our shareholders well, we need to make sure that our rates cover those expected costs. And so we will always try to stay ahead of the curve on that and not be reactive, but rather be proactive and that's really what we're trying to do in all of our states.

Yes, I will also add these are modest single-digit increases, which we feel the market will absorb without any incident or impact on our retention.

Okay. And then as you guys look at your [Indiscernible], you said that progress is -- you guys are deep in the process right now. Is RMF 2017, is that playing a role into how reinsurers are looking at your model loss cost?

No.

Okay. All right. As you continue to expand outside Florida as you guys have been, how are you guys thinking of changing your reinsurance program, if any, to dampen the type of volatility we've been seeing for the past years?

Well, we have changed our reinsurance program pretty significantly. The cat agg program that we purchased last year, we expanded this year. That's a new program. This year, we purchased only 45% from the Florida Hurricane Catastrophe Fund and did not replace it with a cat fund replacement layer like we did at last year. Instead, we bought expanded coverage for outside the State of Florida compared to inside the State of Florida, which the cat fund only covers Florida, as you know. So, we've taken multiple steps to evolve our reinsurance program as we've expanded outside of Florida, and it's a really robust excellent program.

Okay. And sorry that 45% that you're just talking about, you're not replacing that for this upcoming renewal?

We're replacing it with capacity that covers all of our states, rather than Florida-specific capacity.

Got it. Okay. And just on the quota share, I'm just looking at the ceded premium that you guys reported there. I think you guys previously said that the quota share premium, which kind of modeled about 17% to 18% of the total homeowners premium and that would represent United P&C premium, subject premium? Is that a good way to model it going forward? It seems to come in at more like 12%, 13% for the quarter. Just trying to figure out a run rate going forward?

Well, you got to remember there's a cat allowance that is -- makes this a net quota share, so you got to deduct that first. That's probably the piece you're missing. So, you first take out that 70% of the actual the UPC amount and that's how the math works.

Yes, the quota share is ceding 20% of UPC, net of a 30% cat allowance. Does that make sense?

Yes, it does. And I think you guys maybe touched on this a little bit, but I just want to make sure I understood. The amortization expense comes in through G&A, and the policy acquisition costs are not offset by any ceding commission because it comes into the other revenue line, correct?

Right.

So, I guess my question is policy acquisition costs as a percentage of gross written premium was about 19.5% this quarter and I'm struggling to figure out how high are the commissions outside Florida such as it's already creeping that high?

I can tell you the agent commission and incentive expenses. I'll reconcile the 19.5% for you. It's 13.9% for agent commissions and incentives; 2.6% for policy administration, which is our policy administration systems; premium taxes are 2.7%, this is all gross earned premium; and all other pack, which is certain cost of various included premiums were three tenths of a point. So there's your 19.5%. The call it 14% for agent commission is about where we would expect it to be long-term. 15% is sort of a standard commission in most places. Florida is obviously lower than that. Some states like in the Northeast are higher than that, but I think we're getting to the point where the book and that number should be far more stable going forward.

Okay. And then you guys saw considerable growth in the Northeast. What's the initiative there? What's the push there?

Remember, Samir, that this is the -- Q1 last year did not have Interboro in it.

Got it, that makes sense. And then can you -- I don't know if you call this utterly but what were the onetime expenses that you guys incurred in relation to the ACIC acquisition?

They're minor. Just printing and postage and legal and accounting.

Okay, that's it from me. Thanks guys.

Thank you.

Thank you. Our next question comes from Greg Peters with Raymond James. Please proceed.

Good morning guys. Sorry, I missed part of the call. So, if I ask a question that's already been answered, I apologize up front. Have you talked about what type of merger-related expenses might flow through the second quarter result? I think I heard you talk about cat losses in the second quarter, so I thought about asking about merger expenses.

Most of the merger-related expenses will flow through the second quarter. That's correct. We don't have an exact number for you right now, but they'll be significant.

So, when you report your second quarter results, I presume that you're going to one, call out and identify the amortization expense, the cat expense, and then the one-time merger expenses, correct?

We will be very explicit in that.

Perfect. Thank you. Have you -- in your -- have you talked about the underwriting results by state? Or in another -- asking in another way, are certain states more problematic than others? And can you give us a sense of how the book is performing in that regard?

Sure. We have talked a little bit about underwriting results by state. And I don't know if you were on the call when we talked about we have three states where -- two states where we received approval for rate increases Q1, one state where we filed for rate increases and three more pending in Q2 that together comprise over 70% of our book. So, we have active rate management initiatives in process everywhere. But the bottom-line is all of our regions were Florida, Southeast, Gulf, and Northeast were profitable, ex cat Q1. The only of those that was not profitable after factoring cat was Florida. We had $4 million of cat losses in Florida in addition to the non-cat stuff, which put -- made Florida unprofitable Q1 but the other states even with cat were all solidly profitable Q1. So, we don't see any real signs of distress anywhere. The ongoing kitty cat, especially Q1, Q2, have been problematic the last couple of years for sure, and we're taking actions to make sure that we're staying ahead of the curve.

So, when you comment about the rate increase, the amount of rate increase that you're going to push through these different states, do you expect that it's going to be somewhat disruptive to your -- if you will, your renewal block? Or is it your actions consistent with what you're seeing other players in the market in those states do?

We always want to be competitive, but we never lead with price. As you know, Greg, we have a value proposition that's based on five different foundations, starting with financial stability, the second is great products, the third is great claim service, the fourth is ease of doing business, and the fifth is fair pricing. So, we've never been a market leader in terms of price. That's never been our value proposition. And so we do not think that the level of rate increases that we're putting through will negatively impact our market position, given the mind share that we have with agents across our geographic footprint.

Okay. I'll just ask two more questions. First, can you speak to your relationships with your distribution partners, Allstate and GEICO? And can you talk about how those relationships are progressing? And then I'll follow up with a question on reinsurance.

Sure, two words with regard to those relationships: strong and stronger. They're very good partners for us. Their books produce great results. They're happy with the partnership and so are we, both are growing.

Okay. And then can you remind us of your targeted reinsurance savings you expect to generate this year on the combined entity? And did you disclose how much total limit you intend to buy for this cat season?

Greg, this is Brad. We have not -- I mentioned that we would -- an 8-K would be forthcoming as soon as we complete the contracting phase. We have bound all the coverage, so we know we're going to purchase close to $2.8 billion worth of limit. I can't answer that. The reinsurance synergies disclosed last year were $20 million and those will be easily achieved.

And when you say $2.8 billion worth of limit, what is that on a one in 100 year, one in 200 year, what kind of -- how does that sort of benchmark?

It depends on what model you use. As always, there's wide variation in the models. But the model view of that is some model view is above one in 400. We buy our typical model view that we've used the last few years. We've been almost at one in 200 the last few years, and this is well above that.

What does a one in 400-year event look like? I've never heard a thing.

We don't know and hope not to find out.

It looks like UPC being the last man standing, that's what it looks like.

Perfect. Thanks for the answers guys.

Thank you, Greg.

I would now like to turn the floor back over to management for closing comments.

As always, we appreciate the confidence and support of our investors and shareholders. We're working hard every single day to try to continue to grow our company and produce bottom-line results that are going to give you great returns in the long run. As you know, we're all in this together. Management and the Board, especially with the addition of American Coastal shareholders, own a significant portion of this company. So, our interest are completely aligned with yours and we'll work hard every day to make sure we advance those interests. So, thanks again for your time and your interest in our company. At this point, we'll conclude the call.

This concludes today's teleconference. Thank you for your participation. You may disconnect your lines at this time.