HCI Group, Inc. (HCI) Q2 2012 Earnings Report, Transcript and Summary

Greetings and welcome to the Homeowners Choice second quarter 2012 earnings call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Jay Madhu, Vice President of Investor Relations for Homeowners Choice. Thank you. You may begin.

Thank you and good afternoon. Welcome to Homeowners Choice second quarter 2012 earnings call. With me today are Paresh Patel, our Chairman and Chief Executive Officer, Richard Allen, our Chief Financial Officer and Scott Wallace, President of our Property and Casualty Insurance Division. Following Paresh’s opening remarks, Richard will review our financial information for the quarter and then turn the call over to Scott for an operational update and outlook. Finally, we will open up the call to your questions. To access today's webcast, please go to the Investor Relations section of our corporate website at www.hcpci.com. Before we begin, I would like to take the opportunity to remind our listeners that today's presentation and responses to questions may concern forward-looking statements made pursuant to the Private Securities Litigation Reform Act of 1995. Words such as anticipate, estimate, expect, intend, plan and project and other similar words and expressions are intended to signify forward-looking statements. Forward-looking statements are not guarantees of future results and conditions, but rather are subject to various risks and uncertainties. Some of these risks and uncertainties are identified in the company's filings with the Securities and Exchange Commission. Should any risk or uncertainties develop into actual events, these developments could have material adverse effects on the company's business, financial conditions and results of operations. Homeowners Choice, Inc. disclaims all the objections to update any forward-looking statements. Now, I'll turn the call over to our Chairman and Chief Executive Officer, Paresh Patel. Paresh?

Thank you, Jay. Good afternoon, everyone and thank you for joining us on today’s call to discuss our second quarter results. Our second quarter this year marked our 19th consecutive profitable quarter. The HomeWise integration is almost complete and continues to perform as anticipated. Highlights for the quarter include the following items; One, Scott Wallace, the former CEO of Citizens came on board in late April. He will provide some color later on the call on the insurance business. Two, we completed our foreign offering of 1.84 million shares in mid-April as well. And three, we closed on the purchase of the Treasure Island property and it is now reflected in our numbers including a bargain purchase gain of $179,000 in the second quarter. In summary, as we enter the main part of the hurricane season for 2012, the company is well positioned from a leadership perspective, from an infrastructure perspective as well as a financial perspective. We are now beginning to plan for the end of the hurricane season and the next chapter in the company’s history. Now, I would like our CFO, Richard Allen to walk you through the financial results for the quarter and the year-to-date. Richard?

Thank you Paresh and good afternoon everyone. The second quarter income available to common stockholders totaled $7.2 million or $0.74 per diluted earnings per common share. A significant improvement from the $1.9 million or $0.30 diluted earnings per common share for quarter 2 of 2011. For the 6 month period, income available to common stockholders was $14 million or $1.60 diluted earnings per common share, compared with $2.7 million or $0.43 diluted earnings per common share for the 6 months ended June 30, 2011. Gross premiums earned increased 72% in the quarter ended June 30, 2012 to $53.8 million compared with $31.2 million in the same period a year ago. For the 6 month period, gross premiums earned increased 75% when compared with the prior year period. This increase is primarily due to revenues from policies acquired from HomeWise in November of 2011. Reinsurance cost premium ceded were 33% of the company’s gross premiums earned compared with 45% for the quarter ended June 30, 2011. For the 6 month period ended June 30, 2012, premiums ceded were 29% of gross earned premiums compared with 46% in the year prior year. The policies assumed from HomeWise were not subject to our excess catastrophe reinsurance until June of 2012. Going forward, we anticipate our reinsurance cost will range from 43% to 45% of gross premiums earned for the reinsurance treaty [ph] year that began June 1, 2012. Net premiums earned increased 113% to $36.3 million from $17 million in the second quarter of 2011. This improvement was primarily due to the minimal reinsurance cost through May 31, 2012 associated with the policies acquired from HomeWise. Net premiums earned for the 6 month period reflect an increase of 127% to $76.6 million compared with $33.7 million in the prior year. Losses and loss adjustment expenses totaled $16.2 million compared with $10.5 million in the same year ago period. It’s important to note that the second quarter of 2012 includes approximately $2 million related to approximately 300 claims from Tropical Storm Debby which occurred in June of 2012. Additional increases are attributable to the increase in policies and exposures related to the premium growth. Loss and loss adjustment expenses for the 6 months ended June 30th totaled $35.4 million compared with $20.9 million in the same year ago period. Policy acquisition and other underwriting expenses were $5.9 million for the quarter ended June 30, 2012 compared with $2.8 million in the comparable period in 2011, reflecting commissions payable to agents for production on renewal of policies and premium taxes and policy fees. For the 6-month period policy acquisition and other underwriting expenses were $12.5 million compared with $7 million for the prior year period. Contributors to the increase include the impact from the adoption of the revised guidance on deferred acquisition cost of $741,000 and commissions to agents for production of premiums which increased significantly. Other operating expenses in the quarter totaled $4.7 million compared with $2.4 million in the second quarter of 2011. For 6-month period, other operating expenses were $9.3 million as compared with $4.5 million for the prior year period. This increase is primarily due to increases in compensation, administrative and other general expenses in both periods. Turning to the balance sheet, estimates in fixed income and equity security totaled $49 million versus $40 million at December 31, 2011. Cash, cash equivalents and time deposits totaled $138 million compared with $113 million at the end of the prior year. Unearned premiums were $120.4 million compared with $108.7 million at December 31, 2011. Loss and loss adjustment expense reserves were $37.3 million compared with $27.4 million at December 31, 2011. Turning to our financial ratios. Loss ratio for the quarter was 45% compared with 62% in the prior year quarter. This decrease is attributable to a substantial increase in net premiums earned in the quarter of 2012. Our loss ratio for the 6 months ended June 30th was 46% compared with 62% in the prior year. Our expense ratio for the quarter was 29% compared with 30% in the same year ago period. Our expense ratio for the 6 months ended June 30th was 28% compared with 34% in the prior year. The combined loss and expense ratio, a key measure of underwriting performance traditionally used in property and casualty industry, decreased to 74% for the second quarter of 2012 from 92% for the second quarter of 2011. Our combined ratio for the 6 months ended June 30 was 75% compared to 96% in the prior year. Generally, combined ratio was under 100% reflects profitable underwriting results whereas combined ratio over 100% reflects unprofitable underwriting results. As you can see, we did have very successful underwriting results for the 3 and the 6 months’ periods ended June 30, 2012. Now I would like to turn the call over to Scott. Thank you. Scott?

Thank you, Richard, and good afternoon to our listeners. During the second quarter, we successfully placed our reinsurance treaties for the 2012-2013 catastrophic season. Our catastrophic plan for reinsurance now provides approximately $550 million of coverage. As Richard mentioned, we expect our reinsurance cost to be approximately 43% to 45% of gross written premiums beginning in June of this year, based on current run rates. As we all know, the storm season for this year began on June 1 and many of you are quite familiar with the Tropical Storm Debby that affected the state of Florida. It is largely a heavy rain event but did cause losses. This tropical storm, which never turned into a hurricane, did hit during the second quarter, hitting in June, specifically, and as such, we have already paid many claims and established reserves for this storm which are, for the most part, part of our second quarter numbers. In summary, we estimate receiving approximately 300 claims from Tropical Storm Debby and a total loss payout of $2 million which, as mentioned earlier, has already been reserved in our second quarter numbers. We are encouraged by our second quarter results and remain focused on executing on our long-term goals including diversifying our portfolio; increasing market share and providing exceptional service to our policy holders. We continue to be well positioned to capitalize on our building momentum for the remainder of 2012 and beyond. Before we open the call for questions, I would like to express a few of my personal thoughts since joining Homeowners Choice only 90 days ago. In short, I see a staff that is dedicated to their profession, committed to providing secure customer service and a staff that is anxious to learn more and take on new challenges. I am truly honored to lead the property division and look forward to continued growth in the years ahead for this division. On behalf of our entire management team, I would like to say thank you all for your support and now with that we are ready to take questions. Operator?

[Operator Instructions] Our first question is from Casey Alexander of Gilford Securities.

I’ve a few questions here. First of all, despite the $2 million in claims from Tropical Storm Debby, the loss and loss adjustment expenses were still significantly lower than they were in the first quarter. I mean, was there a huge absence of claims on standard run rate or was there a bulge in the first quarter that was related to different events that we didn’t hear about?

Casey, it wasn’t any of those things. A lot of the items that’s there in everybody's balance sheet and Richard will speak further about it to some degree, is that as you increase the size of the business, you do have to build up your IBNR and the first quarter we're building up the IBNR on the acquired HomeWise business. And at this point, I think we've set aside enough for that and that’s what you're seeing in our rate [ph] . So if you think of that as a -- there was a startup charge that you had in the first quarter.

Okay, well secondly the policy acquisitions and underwriting costs despite the higher level of business, also shrank considerably in the second quarter as compared to the first quarter?

If you remember from the fourth quarter call, Casey, when we adopted that new guidance our actual deferral rate decreased for the acquisition cost.

Okay. Secondly there was $1 million of policy fee income versus may be a $0.5 million during the first quarter. Is there any way to model this or is this just going to be a lumpy number that’s going to sort of come out just as it comes?

Very simple answer to that is that income has gone up because we are bookish [ph] shaped, we do the bulk of our renewals in second quarter and the constant reduction in the policy fee income maximizes out. I think the third quarter is the second most renewals, first quarter is the third most and the fourth quarter there is very few renewals, yes? So roughly to give you an idea is to how that bulge goes through the book, yes?

Okay. The other thing is, "other" runs kind of lumpy, can you kind of deconstruct what the other income is I mean is there something in particular that is recurring in that line? Or again I am not quite sure how to model it when it comes as lumpy as it does couple of hundred thousand in the first quarter, $1 million in the second quarter?

The second quarter includes approximately $500,000 on return of brokerage fees from the excess of catastrophe reinsurance trading. This just came up this year.

Okay, so that really one time?

It’s going to be recognized throughout the next 12 months.

Casey what's being said is I think what being said is as that line item suggests, that income; because of all the different transactions that you now have in a complicated organization, you end up with some miscellaneous numbers, order of a quarter and unfortunately it is just the way of life. We try to maximize the efficiency of the business shall we say, yes?

Right, okay. And Richard I am going to give my quarterly question. I am going to give it to you in a different way, can you give me the basics and the formally diluted share counts?

Yes, just a moment I got it right here. You want it for the quarter or do you want it for the 6 months?

I will take it both ways.

Okay the basic for the 3 months is 7,012,000 fully diluted -- excuse me, that's incorrect the basic is 8,325,000, fully diluted is 9,000,651 and that is for the 3 months and for the 6 months it is 7,326,000 and diluted is 8,814,000

Next question is from Robert Paun of Sidoti & Company.

Just a few questions here first on pricing, last August you filed for 12% rate increase. Did you file for another increase this year? If so, what was that number if you can share that and if you can talk about how you look at rates and where they are headed, that will be helpful as well.

Robert, the August rate increase -- it's Paresh by the way. The August rate increase you are talking to wasn't filed in August; it was actually approved to be effective in August. And the reason I'm making the distinction is at this point as we have to do every year, we filed our rates indication, whatever, for the coming months. It is sitting with the department, they will obviously review it, et cetera and there will be at some future point a rate adjustment, let's call a rate increase that will be agreed upon. And that will go into effect, I will suspect before the end of this year. And I think we are talking about our expectation is going to be in the single digits in terms of what kind of rate increase, if any, there will be. And being a regulated company, that's exactly how this works.

Yes, okay, also on pricing, do you expect weak economic growth to have any impact on you pushing higher rates?

This is Scott Wallace. No, I don't think there is any real direct correlation between the economic growth and the rate adequacy needed for covering the exposure or the risk that we are covering.

Okay, is it more of a function as a competition in the market?

Well, probably even less than that. As Paresh accurately pointed out, rates are a function and largely controlled by the Office of Insurance Regulation here in Florida as with other states. So this particular product line is so heavily regulated as if there's only so much room in the rates, so to speak, as far as deviating from what would be a naturally sound rate.

Okay. And you are about 9 months into the deal with HomeWise, can you just provide an update on how that book of business has performed and maybe how it compares in performance, relative to the original book of business?

Robert, it’s Paresh. To that point, as I said in my opening comments, it is performing as we are anticipated and what I mean by that to add a little bit more to it, is there will always going to be some differences. One, it’s a newer book, Homeowners Choice's is a slightly older book, the geographic disclosure looks slightly different. The rate looks slightly different. So as we renew the book, there is a lot of moving parts, things like the retention rates on the HCI book is much greater than the HomeWise book et cetera. The claim disclosure is slightly different just because of policy disclosure is slightly different as well. So there are various moving parts, but at the end of the day, the combined book is pretty much performing really as anticipated and I think you're seeing that in the numbers because that ultimately is the final scorecard, yes?

Yes. Okay, and just one last question on the investment side. The investment income was down about $200,000 from last year’s second quarter and from the first quarter. I know it's a pretty small absolute number, but is there anything going on there? Can you talk about what caused that?

I can probably tell you what really is the occurrence, is that I think as the yield curve keeps getting flatter and flatter, the ability to make any kind of investment income is -- becomes more and more difficult and as we’ve generally stated in the investment committee, we try to be very conservative. So even though there is a much bigger investment portfolio, we’re not putting that to work just hypothetically the same [indiscernible] quarter of a point in -- or whatever the 2 year CDs are going for, 2 year treasuries are going for at this point. So consequently, that was impacting somewhat of the ability to generate income, yes?

The next question is from Ron Bobman of Capital Returns.

I just had a couple of questions. Could you -- a little bit more specific on the HomeWise. Could you talk about retention, sort of what portion of the renewals that you kept? And would you give us a total pitch [ph] number and it's maybe changed the last couple of quarter ends? I --presumably growing?

Yes, simple and it is the ballpark numbers because -- I think the HomeWise retention rate has been somewhere in the low 70s. And as far as hit counts, as is our normal practice, it sort of peaks out at end of the year and then sort of slides down as the year goes through to the end of the hurricane season. I think, and these are ballpark-ish numbers, I think we were sitting just slightly north of 120 at the beginning of the year, it went from 115, 117, 118, something like that at the end of the first quarter. And I think we’re about 110 at the end of second quarter. It is that gradual low loss as we would expect and has to do with that retentions and so on as renewals occur, yes?

So what happens, it’s an interesting dynamic. Why does this discount [ph] go down as storm season approaches?

It’s not to do with the storm season. The discount [ph] goes down because whenever you issue renewals as a normal function of Homeowners, people tend to change carriers a little bit more at renewals than they do during the year. [indiscernible] So as renewals come up, you will have always the discount [ph] tending to the decrease and then obviously throughout the year there is also a decrease in discount [ph] because people both buy and sell their homes et cetera kind of thing. So in any given book, not just Homeowners Choice, there is a natural tendency for the discount [ph] to go down over time, yes?

So I guess some of you needs to [ph] Florida, if sort of growth comes from the takeouts in the HomeWise-type transactions and less so from that new business so you have that retention?

Yes, I mean I think depending how much new growth you do, [indiscernible] it tends to reduce the rate of decline. Unless it is huge amounts of new business, it’s not going to offset that decline, yes?

If I pull out the $2 million from Debby, I just want to check my math, is an attritional loss ratio of around 39%, is that pretty good as far as from me using my estimating?

Regarding on the year-to-date or on the --

As far as the second quarter you had $16.2 million of loss I think [ph] . If I took off $2 million from Debby and just take the $14.2 million and divide it by $36.2 million, I think I am getting $30 million. Well, I am just asking you.

It’s a proper formula.

Okay. And there is no reason that the attrition changes much during the calendar year right or does it?

The $36 million you are using, is that net premiums or gross?

That's $39 million actually. I got $39 million. I am using net premiums earned as my denominator, it is the convention.

Yes. Look and -- very technical conversation here. The item that shows up in that is that -- don’t forget that net premium number is being affected by reinsurance cost. Yes, so you are going to have the attrition loss ratio, while you are doing in the classic sense it is going to move around based on --

Cash reinsurance rather than just losses at the home level. Okay understood. One item, the other line in the income statement a $1.062 million. I don’t know if this was the first question we touched or not, but I missed -- if you answered it, I’m sorry. If not, would you answer what that is?

I think I answered it.

The next question is from Howard Halpern of Taglich Brothers.

In the quarter you said you handled the 300 claims from Tropical Storm Debby. How would you assess your staff's handling of those claims, given your increased size?

This is Scott Wallace. The answer to that we are extremely pleased in a way that this was dealt with. It was a very, very small test, but nonetheless in terms of how the different components to proper claims handling for this type of event are handled. And it -- it really, really came up very well. We handle claims quite quickly, quite efficiently. We have not, to my knowledge, received any kind of complaints as far as delays in getting adjusters out there to assess the damage and to ultimately make proper payments. So I am very pleased with how it has turned out and we feel very comfortable that with other events that hopefully do not take place, that we are still in a good position to address these things.

And can you describe a little bit about, you know I know the law was recently implement and changed, but with regard to structural damage is viewed, have you seen enough evidence that, that is changed significantly under the new law?

This is Scott Wallace, again. Yes, I think in time it will have a significant impact, by referring to, you are talking about the reliance on having to prove structural damage in the first case. And the difficulty as with many things in insurance is always a lag period where claims still may be surfacing that may have originated several years ago which might be interpreted in some other prior language or broader language, so to speak. But I definitely think that the components of 408 will definitely have a positive impact as far as tempering the loss ratio for [indiscernible].

Okay and one last one, I know it might be early, but could you just give a general landscape on what you envision or what you see out there in terms of potential policy additions in November and December of this year?

Well, I think to look at it right now, seeing in at this time of the year, we're really keeping most of our focus on weather related events that may take place in the next quarter. But as we go through that period, we will, towards the end of that period, assuming conditions are right, we will then look for several different opportunities. Certainly we’ve taken our business from citizen’s [ph] property insurance, we’ve also assumed carriers and we’ve also grown organically. So these are all areas in which we have opportunities to continue to grow the book of business for Homeowners Choice and it really is a little too early to tell which opportunities that fits our risk profiles and requirements. But we’ll get there soon enough.

The next question is from Gregory Macosko of Lord Abbett.

Perhaps an elementary question, but just go through the reinsurance treaty and the fact that loss ratio, the expected reinsurance ratio basically remains the same as it was in the second quarter. Is this, I mean, and again you had a period in this current quarter without, I guess, a quarter, right, a month or 2 of needed coverage from the policies you acquired?

I am having trouble to understanding --

Well, my point is that the ratio was the same and yet you were not required I think in the current quarter to, you didn’t need to have coverage because it was out of hurricane season, I believe, and yet was the pricing so advantageous relative to that policy that you were able to expect that the -- that 43% to 45% to go forward?

I think the way you are seeing the numbers is I think in the release, we are talking over the second quarter numbers were this year versus last year. There, you see the advantages. I think third quarter onwards you are going to get all 3 months like over like, so it’s going to jump up to the numbers Scott had put out there, about 43% to 45%. So it’s going to jump up from I think 33% is what he said it was the number in second quarter. So that’s what’s going to happen is that we have gone the 5 months. The first 5 months there was -- we weren’t in hurricane season because there are no hurricanes in January.

So the requirement there that the need there was obvious?

Yes, absolutely and as we now do the new policy as the new contract, which went into effect in June 1, is now going to be amortized over the next 12 months. So you are going to see that step in the third quarter, yes?

Okay, and you expect that to sort of the retentions, this is where you expect to be in a longer term basis?

I think every year we renegotiate the reinsurance contract and some of it because it takes step [ph] function. We have -- we go through this every year. Good years, it can be in the high 30’s. Bad years, it’s actually going high as high 40s. So it's a movement around. Of course the other side of this is it’s now fixed. And as Scott had said, it is 43%, 43%, 45% based on the current run rate, depending on what we do in terms of growth et cetera in the fourth quarter that will move as a function, yes?

And then finally with the regard to the -- you mentioned that there is a lot of insurance regulatory controls regarding pricing and the rates. Is it not possible for others to reduce the rates if they so choose below what is stipulated by the commission?

This is Scott Wallace. In the essence, no. For this line of business, I have certainly seen in the last few years a number of companies make filings and the Office of Insurance Regulations came back and said your filing is inadequate. You have to charge even a higher rate because the Office of Insurance Regulations must have had other concerns as far as, as a reflection of the financials, the overall financials of the organization. So no, I don’t think it is that easy if you were an intermittent carrier to come in and think that you are going to undercharge or grossly undercharge the market place if your losses are going to be similar to the rest of the market.

Ladies and gentlemen, that’s all the time we have for questions. I would turn the floor back over to Mr. Madhu for closing remarks.

Thank you, operator, and thank you, everyone for your questions and time today. These are exciting times for the company and we are glad to have you be part of it. We look forward to the remainder of 2012 and keeping you appraised of our progress. Thank you for joining our presentation. This concludes our call. You may now disconnect.

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