Heritage Insurance Holdings, Inc. (HRTG) Q3 2015 Earnings Report, Transcript and Summary

Good morning, and welcome to Heritage Insurance Holdings Third Quarter 2015 Financial Results Conference Call. My name is Chad and I will be the operator today. At this time, all participants are in a listen-only mode. [Operator instructions] Please note, this event is being recorded. I would now like to turn the conference over to Melanie Skijus. Please go ahead.

Good morning. The third quarter earnings release can be found in the Investors Section of heritagepci.com. The earnings call will be archived and available for replay. Today' call may contain forward-looking. These statements which we undertake no obligation to update represent our judgment and are subject to risk, assumptions and uncertainties. For a description of the risks that cause our results to differ materially from those described in the forward-looking statements, please refer to our Annual Report on Form 10-K and other fillings made with the SEC from time to time. With us on the call today are Bruce Lucas, Chairman and CEO and Steve Rohde, Chief Financial Officer. I would now turn the call over to Bruce.

Thank you, Melanie. I would like to welcome all of you to our third quarter earnings call. Before we begin the discussion of our quarter, I would like to take a moment to thank all of our employees for their relentless focus in driving our company forward and operating policy holders for best possible customer experience. We had another strong quarter in which we earned net operating income of $16.8 million. Our business plan continues to produce strong financial results for our shareholders. Our gross written premium continues to steadily grow. Personal lines voluntary production increased 27% versus the third quarter of 2014. Our commercial residential production once again outpaced our internal expectations. This trend has significantly increased at the start of the fourth quarter, as evidence by record production in October which by itself nearly doubled the new business premium written during the entire third quarter. With respect to citizens insurance, the opt-out percentage in September was significantly lower than recent trends and expectations. In total, we assumed approximately 26,000 policies during the quarter, which represents approximately 55 million in annualized premium. Our integration of BRC Restoration is progressing very well. The acquisition will provide better customer service by allowing our in-house contractor to work directly with the insurer to repair their home with professionalism and experience. This will help Heritage control claim expenditures by negating [ph] some of the assignment of benefit issues and performing the repair and re-construction work at the appropriate price. Our innovative approach to the claims process is been well received by our customers and agent and differentiates Heritage from our peers. During the third quarter, Heritage was licensed to write new business in North and South Carolina and we have applications pending in Massachusetts and Rhode Island and we additionally filed applications in Georgia, Alabama and Mississippi. The company is in the process of filing the Form A with the Hawaii department of insurance in connection with our previously announced acquisition of Zephyr Insurance. The acquisition of Zephyr Insurance is expected to close in the fourth quarter of 2015 or the first quarter of 2016, subject to customer closing conditions and regulatory approvals. We expect it will accretive to our 2016 earnings, as Zephyr' net operating income without any reinsurance synergies is expected to be approximately $13 million and we expect to achieve significant reinsurance synergies in addition to that amount. As previously mentioned, we do not intend to issue any equity in connection with the Zephyr acquisition and we intend to pay for the transaction with existing cash on hand. We continue to have tremendous success in growing the company as evidence by a 72% increase in gross premium written, as compared to the third quarter of 2014, a 48% increase in net premiums earned, as compared to the third quarter of 2014, a 40% increase in policy count, as compared to the third quarter of 2014, net income of $16.8 million, which is an increase of 69% as compared to the third quarter of 2014, a combine ratio of 83.8% for the quarter and 73.2% year-to-date. Shareholders equity increased 44% compared to the third quarter of 2014 and return on average equity year-to-date has been 32.8%. In closing, the team believes that through our pro active approach in the market place we are better servicing our policyholders. We are excited about this quarter and results for the first nine months of 2015 and the progress we are making in our expansion initiatives We are focused on shareholder returns, posting a return on average equity of nearly 33% year-to-date. I look forward to answering your questions at the end of our prepared remarks. And I'll now turn the call over to Steve Rohde, for a recap of our financial results. Steve?

Thank you, Bruce, and good morning. Gross premium driven for the third quarter were $149 million, up 72% year-over-year, resulting from approximately $116 million of direct premium written and $33 million of assumed premiums written. We participated in citizen takeouts during the July and September resulting in approximately 26,000 policies assumed. We netted approximately $55 million of annualized premiums from these two assumptions of which roughly $39 million was from the September assumption. As a reminder, we only record the unearned premium that is transferred from citizens as assumed written premium. The opt-out rate of 45% for the September assumption was significantly better than what we had experienced. The effective date of the September assumption was September 22nd, therefore only 9 days of premiums were earned during the third quarter. The reinsurance associated with this approximately $55 million of annualized premium assumed from citizens will not need to purchased until July 1st of 2016. Thus we expect our operating results through May 2016 will be favorably impacted when compared to our third quarter results. Our total personal lines policy count increased during the quarter to approximately 238,000 policies, an increase of approximately 19,000 policies from last quarter. Our voluntary personal lines policies increased by almost 4,000 policies during the quarter. Our total premiums in-force at September 30 of 2015 were $542 million, an increase of 68% from the same quarter one year ago, an improvement of 6% from last quarter. Commercial residential premiums in-force were approximately $91 million, an increase of $3.6 million from .last quarter. This level of in-force premium result in $128 million of gross premiums earned compared to $80 million for the third quarter of 2014. The significant growth in gross premiums earned was a primary reason for our growth to net income when compared to the previous year. Additionally during the quarter we generate realized capital gains of approximately $1.9 million compared to $80,000 during the third quarter of 2014. Our ceded premiums ratio was 35.8% for the quarter, compared to 30.5% for the third quarter 2014. The increase in the ceded premiums ratio is attributable to our commercial residential business which has a higher cost of reinsurance and conversely a lower loss ratio in personal residential business. In the third quarter of 2015, commercial residential represent approximately 18% of our gross premiums earned, while it represented only 2% in the third quarter of 2014. Our loss ratio was measured against growth premiums earned was 27.9% for the quarter, which was as same as the second quarter of 2014. The current quarter’s loss ratio was favorably impacted by the inclusion of commercial residential business and favorable prior quarterly development and was unfavorably impacted by weather related claims in personal lines due to the heavy rainfalls in certain parts of Florida during the quarter. Our reported loss ratio for commercial residential after one year of being in this line of business is in a low single digits. During the quarter, we increased IBNR incurred by not reported reserves by $1 million to $40.5 million. IBNR represent approximately 54% of our total loss reserves at September 30th and accounted for 8 points of a loss ratio for the quarter compared to 3.2 points for the third quarter of 2014. Favorable prior quarter development in commercial residential accounted for their improvement of IBNR on a loss ratio. Weather related claims impact the loss ratio for the third quarter by approximately 6 points compared to 4 points for the third quarter 2014 and 3 points for the first half of 2015. Our expense ratio as a percentage of gross earned premiums was 20.1% for the quarter compared to 24.5% for the third quarter of 2014. The year-over-year improvement in our expense ratio is primarily related to the Sunshine State Insurance Company policy acquisition fees amortized during last years third quarter. All the fees associated with the SSIC acquisition were fully up amortized as of June 30th, 2015. Thus there was no impact to the just closed quarters ratio, while increase to third quarter 2014 gross expense ratio by 5.6 points. Also impacting expense ratios for both the third quarter of 2015 and 2014 were assumed earned premium from citizen take-outs, while there are no acquisition expenses associated with the premium. This improved the Q3 expense ratios for 2015 and 2014 by approximately 2.8 points and 3.9 points respectively. Our combined ratio as a percentage of gross premiums earned was 83.8% for the quarter compared to 82.9% for the third quarter of 2014. The third quarter is a quarter we typically see the smallest economic benefit from growth, particularly from assumed business out of citizens. We believe our underlying base of profitable business representing $542 million of in-force premium position us well for the coming quarters, particularly when factoring in the economic benefit we expect to achieve from the third and fourth quarter take-outs. On the balance sheet side, stockholders equity increased to approximately $332 million compared to $255 million at December 31, 2014. Statutory surplus in our insurance company subsidiary at September 30 was approximately $201 million. Our invested assets at September 30 were $396 million with approximately $364 million invested in bonds with an average credit quality of A and with the capital gains that we took during the quarter the duration has reduced to approximately 3.8 years, a move we saw prudent in light of the potential of arising interest rate environment. Our cash position was increased to $201 million, in anticipation the closing of our acquisitions with Zephyr Insurance company, as well reinsurance payment due in the fourth quarter. And our total assets were $855 million at September 30th. Overall we had an excellent quarter, one we are very proud. And with that Bruce and I are now available to take your questions.

Thank you. [Operator Instructions] First question comes today from Arash Soleimani with KBW. Please go ahead.

Thanks. And congrats on the quarter. Just had a few questions here, in terms of your reinsurance synergies that you are expecting on Zephyr so, so is $13 million of EPS accretion without any reinsurance synergies at all, and then what would I guess conservatively say their reinsurance synergies could be?

Yes. Arash, this is Bruce. It’s a little early for us to model those results, we would expect on a low end to be a couple of million dollars potentially greater than that. We really need to see what the in-force portfolio looks like toward the end of the first quarter after we close the acquisition. But I think that’s a good conservative base line.

Okay. And then in terms of your – one you ramped up in some other states, I know you mentioned a few licenses, what are your expectations for, like for example – and I don’t know why, but North Carolina, South Carolina those types of states for your voluntary production there, is there anyway we should be thinking about that?

Yes, I would think, right it’s a little early to give a projection on 2014 voluntary production in those states. We are targeting a 11 launch date for new business in North Carolina, that would be the first state to come online, I believe South Carolina would be the second, now thought we are licensed there. I would probably look at end of first quarter, early second quarter for that launch, but I would think in 2016 that total new business would be fairly modest between $5 million $10 million and the expansion states as we move forward, we do have licenses or applications pending, the Massachusetts, Rhode Island to Georgia, Alabama and Mississippi. Massachusetts and Rhode Island were filed maybe 60 days ago, and we are working with those departments and addressing any comments or questions they have. So it’s a little early to say when in that those programs would come online in terms of 2014 – our 2015 production.

And is the National General Partners is that North Carolina?

Yes, that’s correct. We also do business with them in Florida.

Okay. And then just kind of more broadly in terms of organic growth in Florida, are you seeing signs of positive organic growth there when you take into account attrition, and mid term cancellations and its not yet, what point do you think your, I guess the progress you've been making on the commercial front and on the voluntary personal residential funnel so get to you positive there?

Arash, this is Steve. Commercial we did go up about $4 million in in-force premium over the quarter, resulting from about $6 million of commercial residential new business during the quarter and as Bruce mentioned October is a fantastic month, so we are gaining traction there going forward. And then on personal line side, after cancellations we increase our policy count by about 4000 policy, so we are at 36,600 voluntary policies in-force and that was at about 32,700 at the end of the second quarter.

Thanks. And just last question, on the citizens takeout that you had done, was there anything [ph] September was the big month, was there anything in October and if so how much time is left on the opt out process assumption there?

Yes, October would be of smaller assumption when compared to September, the first opt out period for October has expired, I don’t have that number in front of me, but I would think that we're probably in the neighborhood of 15,000 policies or so for October and there is still another 30 day window here for policyholders to opt out.

For comparables at end of 30 days for the September we were at about 26,000 policies, so its roughly 10,000 policies less at this point.

Okay. All right. Thanks for the answers.

Thank you.

[Operator Instructions] The next question comes from Samir Khare with Capital Returns Management.

Good morning. Congratulations on the quarter. I was wondering about the take-outs, if you can give us the number of commercial residential policies versus wind versus other and then the average premiums in each of those buckets?

Sure. Commercial in September accounted for 33 policies with the average premium about $49,000 and then the wind-only policies we assumed in September was about 13,000 policies with an average premium of about $1750. And then – so then the remainder was about 13,000 policies that had an average premium of slightly over $2000.

Okay. Great. And then the M&A pipeline, you guys talked about in the press release little bit, could you just gives us – remind us to what you guys are looking for in terms of profile of the company and then what your budget is for such M&A opportunities and what the resources you have?

Well, I think Zephyr is a good comparable in terms of what type of profile we're looking for. I mean, that’s a multi diversification, lottery insurance synergy, has an excellent management, very stable company that’s been incredibly consistent over the years in terms of its production and profitability. We like that market a lot. It is a non-correlated risk profile. So Zephyr of course really hit that sweet spot for us. We will look at more companies that are outside of Florida and as we continue on this M&A track and if there is good reinsurance synergy and really good management team, as well that’s to us equally important, that’s something that we definitely look for because it gives us good diversification. And there are some companies in Florida as well that we think could be very compelling to us in terms of reinsurance synergies, top-line production and some back office synergies that would results from the scale that you acquire. So in terms of deal size, I am really going to put a number on that, I mean, we would – we have no intent to really to go out and delude shareholders. We've been saying that for quite a while now. We use caps on hand, it is our intent to close the Zephyr transaction and as it stands right now, if we had another acquisition that we would have signed up move forward with, we could look at adding a little bit of leverage on to the balance sheet. We have none at currently. We could do an equity raise, but my strong preference is to avoid any dilution to shareholders. And so if we were to do an acquisition that would be inclined to pursue the path where you're getting maximum shareholder appreciation.

Great. Okay. And just for storms in the quarter, I think you guys said that, that was worth about 6 points. Two questions to that, is that 6 points from a gross earned premium or the net earned premium and then how many claims does that represent?

Yes, on the gross earned premium, I actually don’t have it, it represent about additional – the frequency increased I would say almost 2 points. We're kind of averaging abut 5% frequency and then for the quarter it was creeping towards 7%. Now lot of those claims end up being closed without payment because we don’t cover flood –that’s been flood related, we cover when the water comes to the roof. And…

Do you have an average severity for the…

It was about $8000 which is about 2000 less than our normal severity. So again an indication that will always - claims were closed without payment. But we did send out independent adjustors to scope with the loss, we did have some loss adjustment expenses associated with it.

Okay. Thank you.

[Operator Instructions] This concludes our question and answer session. I would like to turn the conference back over to Bruce Lucas for any closing remarks.

I would like to thank everyone for their participation in our third quarter call.