American Coastal Insurance Corporation (ACIC) Q2 2020 Earnings Report, Transcript and Summary

Greetings, and welcome to the UIHC Second Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. A 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.

Thank you. And good afternoon, everyone. Thank you for joining us. You can find copies of UPC's earnings release today at www.upcinsurance.com in the Investor Relations section. In addition, the company has made an accompanying presentation available on its website. You're also welcome to contact our office at 212-836-9606, and we'd be happy to send to a copy. In addition, UPC insurance has made this broadcast available on its website as well. Before we get started, I'd like to read the following 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 federal securities laws, including statements relating to trends in the company's operations and financial results and the business and the product of the company and its subsidiary. Actual results from UPC may differ materially from those results 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 Securities and Exchange Commission. UPC specifically disclaims any obligation to update or revise any forward-looking statements as a result of new information, future developments or otherwise. With that, I'd now like to turn the call over to Mr. Dan Peed, UPC's Chief Executive Officer. Please go ahead, Dan.

Thanks, Adam. Hello. This is Dan Peed, Chairman and CEO of UIHC. Thanks for joining our call today. Our second quarter was a big quarter. Effective June 30, John Forney resigned to pursue other opportunities. We are friends with the company he's joining, and we wish them well. Effective July 1, the Board of Directors appointed me to the role of Chairman and Chief Executive Officer. I have been a part of the UIHC Board of Directors since the 2017 acquisition of American Coastal, and I'm excited to jump in to this new role as CEO. Just to provide a touch of information on my background. I co-founded AmRisc in 2000 and served as underwriter, President, CEO and finally, Vice Chairman, retiring at the end of 2019. AmRisc is an MGA owned by BB&T Truist and is now one of the largest catastrophe oriented MGAs in the U.S., writing a large portfolio of commercial cat and specialty commercial property business with a 20-year track record of outstanding underwriting results. As AmRisc continues to underwrite for American Coastal, UPC continues to share a very strong relationship and partnership with AmRisc. I've been involved with UPC since the sale of American Coastal to UPC in 2017. At that time, I joined the Board of Directors as Vice Chair. Effective July 1 is my appointment as Chairman of the Board. Greg Branch assumes the role of Chairman Emeritus. Mr. Branch has provided excellent leadership since the founding of United, and he will continue to actively serve on the Board. We also promoted Brad Martz to assume the role of President, while continuing in his role as CFO. Lastly, we promoted Chris Dittman to the newly formed position as Chief Risk Officer. Chris will focus on portfolio optimization and risk management while continuing his responsibilities of overseeing our reinsurance placement. I'm very excited about the opportunity to lead this executive team here at UPC. There is a huge opportunity to take our underwriting to the next level and improve our results, and we are well on our way. I'd like to give you an overview of our Q2 and our year-to-date performance, and then Brad Martz will walk through the numbers. We are a cat-focused specialty underwriter with competitive advantages in cat-exposed coastal areas. We are planning to prioritize an underwriting profit by staying within our specialty and further leveraging our competitive advantages. It is critically important that we are intensely focused on our underlying combined ratio, generating an underwriting profit that is sufficient to absorb hurricane and non-hurricane catastrophe losses. I mentioned we are prioritizing our focus on generating an underwriting profit. This may slow our top line growth some, but we are committed to generating a consistent non-cat underwriting profit before we pursue top line growth. While we are focused on the bottom line, given the tailwinds of this hardening market, it's possible we might continue to see some top line growth due to rate increases. And where we feel rates are adequate, we are likely to continue to grow. However, we intend to limit exposure growth in areas outside of our cat-focused footprint and nor are we interested in writing new business in areas where rates appear to be an asset. We have taken numerous rate increases in various states over the last 18 months, and these rates are working their way through the financials. We expect to continue taking rate increases to accommodate anticipated changes in reinsurance costs and loss costs. Our success is driven by several components. First, we have our underlying non-cat underwriting bonds. Then we have our non-named cat, our named cat, our reinsurance expense, our reserves, operating expense and investment income. I'll touch on each of these briefly. For non-cat, the good news is we started down the path of rate increases and improved risk selection and underwriting over the last 4 to 6 quarters. We turned positive with our first quarter results this year, and we continue to improve in 2Q, an underlying combined ratio of below 84%. This success is mostly due to continuing filings, reflecting rate increases as well as improved risk selection underway. As additional rate increases are in over the next 4 to 6 quarters, we are positioned for our underlying combined ratio to generate more non-cat market. Secondly, we have our non-named cat losses. In the second quarter, we experienced a heavy non-named cat quarter, consistent with our peers. This resulted in a $29.8 million net loss, which was in line with the $30 million we preannounced. While we were disappointed with our non-named cat season, we had a non-cat underwriting margins that enabled us to absorb the cat and yet continues to generate a positive underwriting profit and core income. For named cat, in the second quarter, we had 3 small name storms with the largest being Tropical Storm Cristobal, which on a relative basis is estimated in a mid-single-digit new yields, net of reinsurance. More importantly, we completed our June 1 cat treaty renewal on time and as reported, we were happy with the results. One competitive advantage we have is excellent long-term relationships with our reinsurers, including many years of underwriting profits. While 2017 and 2018 generated significant cat losses, most of the other years were loss free, and the majority of reinsurers that have been with us 5 years or more, remain in an underwriting profit position. We believe this enabled our successful placement even in a difficult year, and we expect this competitive advantage to continue in the future. Reserves; for 2Q, we continued our first quarter favorable prior year development and management is comfortable with our current reserving position. Expenses. Brad will give you the numbers, but our expense ratio continues to improve on both the gross and net basis. We continue to invest in our technology systems, which we believe will drive further expense ratio improvement as we migrate to our new policy administration and billing platform called Agent Connect. We rolled out Agent Connect in Texas and currently expect to roll out all our products in this space over the next 18 months. As we migrate away from various legacy systems into a single system, we will be better positioned to realize significant automation and expense reductions. Investments; Brad will provide specific numbers, but we had a strong quarter with a rebound in unrealized gains in both stock and bonds, and we were rewarded to seeing the opportunity to invest further and equities within our existing investment strategy towards the end of the prior quarter. I will comment on COVID. We do not anticipate that we will have a material COVID-driven loss. Our personal lines book does not appear to have material exposure. Our commercial residential book, heading to American Coastal, does not have associated business interruption, or BI, so we don't expect to have a material exposure there either. Our commercial specialty portfolio typically has a specific buyers. So again, we don't expect a material loss there. To summarize, in 2Q, we continued our turn towards profitability with the low to mid-80s underlying combined ratio. So even in a very active cat quarter and a named storm with a modest net loss, we delivered a core income of $0.20 per share and $0.30 per share, excluding named wind storms. Not yet where we want to be, but moving in the right direction. We are working hard on executing our underwriting plan, focusing our generation of a significant non-cat underrating profit. We expect our underwriting expense to strengthen our exposure units, all given, rate increases, we could continue to see top line growth. I'm very excited to be here and excited to work with this management team. As of the end of July, we crossed over 1 billion premium in force on our personal lines book, which is beginning to reflect the rate increases we've taken over the last couple of years and has the potential to generate significant underwriting profitability forward. We have American Coastal, a premier market-leading Florida commercial residential insurer, which generates solid rating. And we continue to grow our commercial specialty disclosures within Journey, our best-rated subsidiary. We've launched an excellent technology platform called Agent Connect, which will enable us to reduce expenses and potentially to expand our distribution channels. So as I said, I'm excited to be here and looking forward to working with the team. With that, I'd like to turn it over to Brad Martz Martin, and then we'll be happy to address your questions.

Thank you, Dan, and hello. This is Brad Martz, President and CFO of UPC Insurance. I'm pleased to review UPC's financial results but also encourage everyone to review our press release, Form 10-Q and investor presentation for more information regarding the company's performance. Highlights for the second quarter ended June 30 include: core income of $8.8 million or $0.20 a share versus a loss of $3.5 million or $0.08 a share last year; gross premiums earned of approximately $344 million, an increase of $14 million or a little over 4%; a combined ratio of 99.4%, an 8.8% improvement year-over-year, which included 16 points of current year catastrophe losses, totaling $29.8 million, approximately $0.57 a share after tax; a modest favorable reserve development of $823,000, leading to an underlying combined ratio of 83.7%, which compares very favorably to 91.8% last year. Improvements were fueled by favorable non-cat loss frequency and lower policy acquisition costs. Premiums for the quarter decreased $10 million, approximately 2.2% from a year ago, driven by first, increases in direct premiums written of $32.9 million, offset by a $43 million decrease in assumed E&S premiums written. The direct premium growth was a combination of almost $22 million or 8% growth in personal lines and $11 million or 10% growth in commercial lines. The decline in assumed E&S premiums written was driven by the termination of a quota share reinsurance agreement on a cut-off basis, effective June 1, 2020. UPC is still assuming commercial E&S business via one remaining quota share treaty we renewed at June 1, and is expected to produce approximately $50 million during the treaty period, ending May 31, 2021. Florida premium written grew modestly at 8.2% and accounted for over 60% total premium growth year-over-year, while the Gulf region grew 16.3%, the Southeast grew 10% and the North East region was down 1%. Ceding on our premiums were 46.1% of gross premiums earned compared to 42.3% last year. This change was due to the increased sessions to our quota share reinsurance program, which were 13% of gross premiums for $44.7 million in the current quarter versus only 9.2% of gross premiums earned or $30.3 million last year. Other significant items impacting total revenues during the second quarter included unrealized gains from equity securities of $20.5 million compared totaling $2.7 million from the same period a year ago; and investment income of $5.9 million, which declined $1.7 million from the prior year due to lower yields on cash, deposits and fixed maturity securities. UPC's second quarter net loss in LAE was $101.7 million, a decrease of $14.6 million or 12.5% year-over-year. UPC's gross loss ratio of 29.5% improved 5.7 points and a net loss ratio of 54.8% improved over 6 points compared to the second quarter last year. As I mentioned, cat losses of $29.8 million and added 16 points to our net loss ratio, which is partially offset by $823,000 of favorable reserve development. Excluding those 2 items, our underlying loss in LAE was $72.7 million, down $12.4 million or 15% year-over-year resulting in an underlying gross loss ratio of 21.1%, which also compared favorably to 25.8% a year ago. UPC's operating expenses were $82.7 million, a decrease of $7 million or approximately 8% year-over-year. The decrease was primarily driven by policy acquisition costs, which declined $9 million due to higher ceding commissions earned and lower E&S production. Our gross expense ratio was 24%, an improvement of 3.2 [ph] points over the prior year. On the balance sheet, UPC's assets totaled $2.8 billion, including cash and invested assets of just under $1.4 billion. The modified duration of our bond holdings was unchanged at 3.54 years with an overall deposit rating of 8-plus at June 30. GAAP shareholders' equity attributable to UIHC stockholders was $528.3 million, resulting in a book value per share of $12.27 or $11.58, excluding accumulated other comprehensive income. In our group statutory surplus was $427.2 million at the end of the current quarter. That concludes our remarks, and we'd now be happy to take any questions.

[Operator Instructions] Our first question today comes from Elyse Greenspan of Wells Fargo.

My first question, just on the underlying loss ratio. So pretty favorable relative to where you've been trending. From the prepared remarks, you guys highlighted earning and some rate. And then I think, Brad, you pointed to a lower level of non-cat loss frequency trends in the quarter. So just hoping to get some more color and the sustainability there. In answering that question, do you think that there was any benefit on the loss side just from COVID in the quarter?

Elyse, thanks for your question. Yes, the frequency trends remain favorable in our business. They were favorable prior to COVID. We're not sure how much COVID assisted in the improvements we saw during quarter run frequency, and we obviously can't comment on forward-looking projections. But just to give you a flavor, we look at frequency, company by company, product by company -- or product by product. United Property and Casualty, our largest insurance company. If compare Q2 of '18 and '19 to '20 the frequency has gone down from -- in Q2 of '18 at 3.24%, down to Q2 of '19, 3.07%, Q2 of 2020, all the way down to 2.41%. Whereas, the full year '19, actually in '19 was 2.76% frequency. So, there is obviously a favorable trend that was already in place due to very aggressive underwriting initiatives. We've taken to curve our risk exposures, but there could be a related benefit associated with the current environment due to COVID.

Did the favorable trends persist in July?

Can't comment on that.

Okay. And then in terms of on the expense side, we've heard some companies kind of call out some COVID-related expenses just from lack of T&E and things like that. Was there a benefit on the expense side from COVID in the quarter?

It was minimal. The big benefit, as I mentioned in my remarks, was related to ceding commissions earn. We did not have bandwidth security insurance company as part of our quota share for 2 of the 3 months in 2019. So -- and what ceding commissions we did have were mostly unearned. So full 12 months of earning ceding commissions and then our E&S assumed premium business went down, and there are higher acquisition costs associated with commercially lines business than our personal lines business. So that had a favorable impact on the expense ratio as well.

And then, sometimes on these calls you guys will give a little bit of color on like the forward quarter cat. Obviously, there's an ongoing tropical storm so that might be too soon to comment. But how has the kind of cats trended so far in the third quarter?

So we've had two events we've seen in the third quarter. I think they're relatively small industry losses. There are various industry loss estimates floating around out there. I mean, we've seen just under 1,700 claims on Hurricane Hanna that impacted Texas. We've got a little over 450 claims on Isaias, mostly in Northern Carolina and New York, but it's very early to estimate the impact of those events, but we're working through it as we speak.

Okay. And then, one last numbers question. The tax rate seems a little low in the quarter. Was there anything there or just sometimes quarterly variability?

Yes. There was approximately a net benefit of about $2.2 million that would be nonrecurring that drove the -- it's primarily related to the CARES Act. We did some additional work during the quarter, engaged outside tax assistance from PwC to confirm our ability to carry back some additional losses and did record a benefit during the quarter that would be nonrecurring.

The next question is from Greg Peters of Raymond James.

I wanted to -- I was looking at your Investor presentation. And the slides that caught my attention were Slide 7, where you run through the pipeline of rate that is coming, going to be coming through. And then Slide number 8, where you have this target of almost a 10% reduction in PML by the end -- or by September of next year. Can you sort of walk us through with how that's going to evolve because with such a tremendous pipeline of rate, I'm not sure how your projected premium is still going to be down. So maybe you can help bridge the gap on that.

Okay. Thanks, Greg. So the rate increases, we have been taking rate increases for the last 4 to 6 quarters. And I know that, that takes a while to be approved, our writing and then earn through the portfolio. So we're really in the middle of that turn, we're well on the way, but there's quite a ways to go and that Slide 7 is showing some of the various specific rate filing actions that we have planned over the rest of the year. And we are planning to continue with those rate increases. They are supported expertly. And they, of course, within our [indiscernible] with the next 24 months. Slide 8 is -- might be a little bit more interesting that you pointed out and this is a portfolio optimization exercise and something that itself and specifically, Chris and that team has been involved with over the past 15 years. And it just demonstrates that we can take some exposure management steps that eliminate a relatively small portion of our renewal premium and generate a much bigger reduction in the amount. And that, of course, puts us in a better position as we move forward on our reinsurance contracts and our reinsurance partnerships next year. We won't see exactly those numbers because, of course, we'll lose some policies and we'll write other policies. But directionally, you can say -- see that, that makes a pretty big improvement on our rate to capital measures.

That's -- yes, it does look pretty meaningful. What is -- when I think about the portfolio optimization, is that going to include exiting states? Or is it just going through and looking at almost on a granular basis, risk by risk and figuring out what you're keeping and what you're not. Maybe you can just help me understand how that process works.

Yes, absolutely. So it's very granular. It's done, the policy and then we actually individually look at those policies and look at the situation and the agents and so -- and it's not at all on a state-by-state basis, it's not even on a county-by-county basis, but it's taking the least efficient policies in our portfolio and with exposure management we can slide those policies for non-renewal.

Got it. The other area that is worth having you guys comment on would be the Florida and the legal environment in Florida. Assignment of benefit reform passed, some of your peers have just reported that the legal problems still continue and are a serious impediment to the prospects for improving results in the state. And so when I look at the reserve development that you posted in the second quarter, I'm trying to sort of bridge the difference between what you're reporting, which is relatively stable reserve position with the rhetoric from others about a legal environment that continues to be very challenging for the insurance industry. And I'm just curious how you guys are thinking about that, how you're approaching it? And what gives you some comfort that your reserves are at the right levels at this point?

Good question, Greg. This is Brad. I'll answer that. Yes. I think we saw some of that activity last year and moved quickly to do some reserve strengthening last year. And we can confirm we are seeing more litigated claims year-over-year. And it is a problem through the state of Florida, no question about that. But we've not taken the reserve releases that our actuary allows us would seem to indicate we might or could do because of litigation. That's a big driver of why we are being very slow to release reserves from the prior accident years. So our actual development was less than our expected development again this quarter. We pointed that out in the first quarter. But yes, just for reporting a modest amount of favorable reserve development because we don't want to be too quick, given the trends we're seeing on litigation. So, we think we're well positioned and more than adequately reserves for that turn.

Okay, great. I guess the final question I would have for you, you talked about in this release the June 1 reinsurance renewal. And maybe you could just revisit at a high level because we are now in catastrophe season, what we should be thinking about in terms of first event retention and subsequent retentions, et cetera?

Sure. So on Slide 9, we've got a nice summary of all our in-force or reinsurance programs at the moment. Retentions vary by company and geography. So it really doesn't depend on state and the location of a storm where the product exposure is based. But we believe the retentions are reasonable. In a worst-case acceptable relative to our capital position and our growing earnings power of the business. I will say that we're grateful and thankful to our reinsurance partners. They've really stepped up to the plate again this year. It was a very challenging renewal. I'd be remiss to say that our team probably worked harder than ever this year, so -- to get it done, but we're very proud of the program we have. It's unparalleled in terms of its first event severity protection in Florida.

Got it. And that's the $58.8 million retention for the first event and $17.5 million for the second?

That's correct.

[Operator Instructions] The next question is from Matt Carletti of JMP Securities.

Dan, I wanted to step back kind of 30,000-foot view and just ask you, as you kind of come in and take the reins. When we look at UPC in, say, 24 months' time, what will look the same about UPC? And what will look different about UPC as we sit from the outside and assess things?

Well that's a good question. Thanks, Matt. I think that we will start from the position, which I think you've heard numerous times in my opening remarks that job one is to make an underwriting profit and that we do that by starting with our core non-cat combined ratio, underlying combined ratio. And the good news is we're really well down that path, but we're going to continue on that. And that's our first priority. The second one is that we love American Coastal. It is a premier, it is the largest Florida condominium association writer with very good margins, and we will continue to grow that. And then thirdly, we want to continue most of my experiences in the commercial, specialty and commercial cat space. And we are building our Journey insurance company there. And we want to continue growing that commercial specialty cat business and make that potentially a larger portion of our book and the percentage that the American Coastal and the Journey has right now. I'm really excited about the technology platform that we're rolling out. There are a lot of different capabilities with that and a lot of different ways we could go with that. So you may see something there. Those would be the core things, I think, of what you would see in 24 months.

Great. And actually, the last one you touched on there was where I was going to my next question, the Agent Connect portal. You mentioned kind of once it's rolled out, once it's implemented, there's expense ratio leverage opportunity. Just in rough numbers down the road, can you give us some idea of what the kind of order of magnitude there might be in terms of how much do we shaved off the expense ratio once you get that fully rolled out and implemented?

I think I'll be careful with forward-looking statements there. But I think that in part, there's the expense ratio. But in a bigger part, is really the ease of use for the agents and also the potential -- the potential that, that opens up for us from a technology perspective.

Okay. And then a couple of just quick numbers questions for probably for Brad. On the reduction in assumed premiums, the quota share that canceled, can you give us what will be the premium impact in future quarters if you have that? Or did it all cut off in the current quarter?

Yes. Basically, I just highlighted what we think the annualized treaty year premiums are for the one remaining quota shares. So -- which we believe from June 1 to May 31 of next year, we'll produce about $50 million of assumed written from that commercial and E&S both underwritten by AmRisc. So that you can just compare that to the previous periods. But it's a significant change. There is going to be less E&S assumed written as we move away from that assumption position.

Okay. And then the last one, just you touched on the investment income or investment income down in the quarter, mostly due to yields. Is that -- was there any kind of one-timers pushing that one way or the other? Or is that a decent proxy for where you expect things to be in the near term?

I think it's a decent proxy. The biggest hit was on the short-term deposits and some money market funds and things where we stockpiled lots of cash and have a lot of investment income. And you can see those numbers in the 10-Q once it's available.

The next question is from Bill Broomall of Dowling & Partners.

Just a couple of quick follow-ups on some previous comments. To Dan's comment about commercial specialty maybe being a larger percentage of the mix going forward, is that in Florida or Southeast region? How should we think about the split in that comment?

I would say that the commercial has two components really, American Coastal, obviously, with commercial residential is all Florida. And then on the commercial specialty, we have both Journey as well as our assumed E&S. Our assumed E&S is more national in nature, not really into the Northeast, but everywhere from the Carolinas through Texas. And then our Journey, we have rolled out in Texas, and we're in the process of rolling it out in South Carolina and -- I mean Florida, process of rolling it out in South Carolina and Texas.

Got it. Okay. And Brad, a follow-up on your comment about the claims in North -- sorry, in York. Would that be subject to the interval retention, given the little...

Well, not necessarily. The loan [ph] book is smaller than our United P&C book and the United P&C is part of the UIHC core group and the UIHC Group. So there could be a little bit overlap there, but there probably is a small amount of [indiscernible] -- but larger amounts on United's.

Okay. And then also following up on your litigation comment, Brad, about being up year-over-year. Is that for hurricane-related litigation or non-cat weather litigation? Or maybe is it kind of both?

It is both, the daily claims. It's AOB, too, and Irma-driven. So yes, it's all three of those.

And Irma, is it -- do you think it's tied to this 3-year statute? Or -- and I guess, if you look at in recent quarters for the Irma, are the new claims consistent, following a consistent pattern, what you've seen in recent quarters? Or are they coming down or up? Any thoughts?

I can't really comment on that. I think Irma is in a pretty stable position. We've got over 39,000 clients that have been reported to us, about 9,800 had been -- so 92% closed, but fairly stable on the incurred development at this point with lots of IBNRs still left. So we feel comfortable with our reserve position, but we're watching it carefully.

Okay. And then, on the -- in the slide deck, you talked about gross losses of, I think, $76 million, and then you're ceding a piece of that out to get to your net of almost $30 million. How should we think about the split of those losses among your different reinsurance programs that you list on Slide 9? I'm kind of thinking of your aggregate versus maybe your quota share or anything like that?

We just say for the second quarter of 2020, we ceded $30 million to the aggregate and the rest of the other $16.5 million to the quota share; essentially, so that's the split. And depending on how losses go in the second half of the year as our retention rises, we may unwind some of those losses ceded to the aggregate. We may not, depending on how are those losses turn out for the year. It was a pretty significant non-hurricane cat quarter, as Dan mentioned, that we did have also three named storms that being sum of this space a little bit. But we've got some reinsurance programs in place to manage that volatility.

Perfect. That's helpful. And then on the quota share, effective June 1, was there any change in the cat sub limit in that quota share or ceding commissions or anything like that? Or was it similar structure to the past?

I would just say it's a very similar structure, and we're not going to comment on the specific terms of the treaty. And there was a little bit of a reclassification related to we're previously bifurcating ceding commissions between ceded risk premiums and policy acquisition costs just from an income statement classification perspective, but effective June 1, with the new treaty, wording changes have now has all of those ceding commissions are being classified as policy acquisition costs going forward.

Okay, got it. And just on the main -- your main core cat XOL program, were the -- kind of in the past, your comments have talked about having long-term reinsurance partners. Did you see similar -- are there similar participants this year as in the past?

Yes, very stable panel, very stable and more new participants than exiting participants. So we feel good about that.

There are no additional questions at this time. I would like to turn the call back to management for closing remarks.

Thank you. And thanks again for your time and attention. I'm excited to be here and looking forward to working with the team. Thank you.

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