Good morning, and welcome to the Heritage Insurance Holdings Fourth Quarter 2018 Financial Results Conference Call. My name is Keith, and I will be the operator today. At this time, all participants are in listen-only mode. A brief question-and-answer session will follow the formal presentation. Please note this event is being recorded. I’d now like to turn the conference over to Arash Solemani, Executive Vice President at Heritage. Please go ahead, sir.

Good morning and thanks for joining us today. We invite you to visit the Investors section of our website, investors.Heritagepci.com, where the earnings release and our earnings call will be archived. These materials are available for replay or review at your convenience. Today's call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are based on management's current expectations and are subject to uncertainty and changes in circumstances. In our earnings press release and in our SEC filings, we detail material risks that may cause our future results to differ from our expectations. Our statements are as of today, and we have no obligation to update any forward-looking statements we may make. For a description of the forward-looking statements and risks that could cause our results to differ materially from those described in the forward-looking statements, please refer to our annual report on Form 10-K, earnings release and other SEC filings. With us on the call today are Bruce Lucas, our Chairman and Chief Executive Officer; and Kirk Lusk, of our Chief Financial Officer. I will now turn the call over to Bruce.

Thank you, Arash. I would like to welcome all of you to our fourth quarter 2018 earnings call. Before we begin the call, I’d like to thank all of our employees for their dedication to our Company. The fourth quarter was very-active on several levels, most notably Hurricane Michael made landfall in the Florida Panhandle is a high category for a hurricane. Michael had devastating impacts to the Panhandle and decimated entire communities. Heritage has very stringent underwriting criteria, and we never focused on Panhandle business, because we thought that building codes were not adequate with far too many older frame construction homes. As a result, our loss experience on Michael is among the best in Florida and our incurred loss is $33 million. Contractors’ Alliance Network or CAN once again improved that Heritage has a superior claims model. CAN was our first response to Michael, and we were responding the claims immediately after landfall. CAN removed trees, tarped roofs and mitigated water damage. These efforts reduced losses for our reinsurance partners and provided much needed assistance to our policyholders. Most claims are closed and we are not seeing much activity related to Michael, at this time. We've booked a full second event retention of $16 million in the fourth quarter, but our third-party reinsurance tower was only minimally impacted. Similarly, our Hurricane Florence losses continued to outperform modeled loss estimates due to our stringent underwriting and CAN response. While other insurers focused on the North Carolina coast, we focused on the Inland counties that have significantly lower hurricane volatility and lower reinsurance pricing. In the fourth quarter, we marginally increased our ultimate loss pick to $23 million from $20 million as of the third quarter of 2018. This modest increase resulted in an incremental $0.5 million of net retention…

Thank you, Bruce. Good morning. Net income for the quarter was $3.9 million, which was an increase of $9 million from the fourth quarter of 2017 loss of $5 million. The fourth quarter of 2018 was negatively impacted by Hurricane Michael and also the cost associated with our refinancing efforts partially offset by our CAN profits. Although the fourth quarter of 2017 did include minimal storm activity, it was significantly impacted by a $34.1 million non-cash non-core charge associated with convertible notes. Net income per diluted average share for the quarter was $0.15 and $1.04 for the full year of 2018. For the full year of 2018, net income was $27.2 million, compared to a loss of $1.1 million in 2017. Absent the $42 million of non-cash charge associated with the convertible notes in 2017, net income for the full year of 2017 would have been $41 million. For the fourth quarter of 2018, gross premiums earned were up 28% over the fourth quarter of 2017 due to full quarters of NBIC revenues, which were partially offset by planned reductions in the Heritage portfolio. Net earned payments for the quarter were up 17%, again reflecting the same rationale as the increasing gross earned premiums but a lower growth rate due to the larger ceding percentage at NBIC. Losses for the quarter were $14.9 million higher than the fourth quarter of 2017 and resulted in a net loss ratio higher in the fourth quarter of 2018 by 6.3 points. The loss ratio variance can mostly be explained by the storm retention during the fourth quarter of $17.7 million, which includes $1.4 million of storms in the northeast, which were partially offset by favorable development in the quarter of $1.3 million and profits generated from CAN. The fourth quarter of 2017 had…

Yes. Thank you. We will now begin the question-and-answer session. [Operator Instructions] And the first question comes from [indiscernible] with KBW.

So, firstly, I was wondering if you could provide us with an update on your gross Irma and Michael losses. And are you still seeing a lot of claims coming in for Irma and are any of these being litigated?

Yes. So, our Irma update right now, our incurred loss is approximately $900 million. It's been holding fairly steady for quite some time now. We are seeing new claims come in to this day, everybody in Florida is, but it's very modest. We're maybe getting 125 to 150 claims a month at this point. The number keeps dropping every month as we get further away from Irma. We do have some litigated claims. Out of our open claim count right now, we've got about 2,000 open claims, say approximately half of them are represented by an attorney. Again, that is incredibly low for the Florida market. So, we are seeing some continued development on Irma, but it's just nothing that we're really seeing in terms of acceleration of that gross development.

Okay, great. And although this wasn't really an issue this quarter, but you guys did have some adverse AoB development before, and you did underestimate the Irma losses quite a bit. What plans do you currently have in place to improve your ability to estimate these catastrophes and attritional losses more accurately?

Right. Well, on the on Irma side, I would disagree that we underestimated the Irma loss. We were very clear to our markets that the modeled median loss was X dollars. That number was between $550 million and $600 million. We came out with that modeled loss estimate right after Irma was call it within six months of landfall. Once we had actual experience, we were the first Florida company to massively increase our loss reserves to $850 million. Since that time, it has developed to about $900 million of incurred losses, and what we're seeing in the market in that same time period are companies doubling and tripling loss estimates because they kind of missed the mark very early on and didn't mark the book early. In terms of our daily claims, we have absolutely called this one correct. We've been saying for years that Florida companies simply are under-reserved and they have too much Tri-County business in their portfolio, which makes them incredibly risky and volatile. So, we led the market three years ago in pulling out of the Tri-County; we’re the first major Florida carrier to announce that moratorium. Since that time our open Tri-County inventory has plummeted, open lawsuits have also declined meaningfully, and we're seeing positive reserve trends across the portfolio right now, two quarters in a row of favorable development and I mean more importantly, you can just see it in the stats. So, if you look at year-over-year 2017 to 2018, we had a 39% reduction in new Tri-County claims. And overall in the Florida portfolio, we had a 19% reduction in claims. Yet, we were the first company to increase our loss reserves and as of the third-quarter of 2018, we had more loss reserves than any other Florida carrier. So, I think we've been extremely proactive on both fronts, especially the daily claims. You're just not going to see the massive reserve development on our portfolio that you've seen, let’s just say, announced recently.

Okay, great. Thank you. And then, just moving on to reinsurance, what percentage did you renew your Florida Hurricane Cat Fund participation at, and how was risk-adjusted pricing year-over-year on your private layer alongside the cat fund.

So, we are still in market right now for the private layers, and that process has been taking place over the past month. We still have another month or two before we’ll wind up the reinsurance tower. So, I can't comment on what our private layer expenses are because we haven't placed the program. On the FHCF, we went to a 90% of FHCF participation. In my opinion, I do believe you're going to see most of the Florida carriers move to a minimum of 75 if not 90, across the board due to uncertainties around reinsurance pricing. So, when we do the math on that, if everybody went to 90%, which I suspect will be the norm, that's about $3 billion of open market capacity that would normally go to the private market that will be sucked out as a result of the 90% participation across Florida. We think that will have a very, very positive impact on reinsurance pricing as we move throughout this program here.

Okay. Because you were at 45% before, right?

Correct. Our position prior was that you should use the cat fund as a hedge. And so, if reinsurance rates are incredibly low, and you can bind private layers at or below the cat fund cost, you should to go to 45%, and then use the cat fund at 90% in the event that there is a hardening event in the reinsurance market that could potentially move rates higher. By going from 45 to 90, we're locking in reinsurance pricing at incredibly modest rate increase compared to what is potentially out there in the private market. So, it serves as a pretty big hedge on year-over-year price increases for the reinsurance tower.

Okay, great. And then, I was just wondering on your Safeco relationship, how much premium does that generate for you right now? And also, do you expect the partnership spread outside of -- I believe you said, it's just northeast coastal right now?

Yes. So, we just launched the program. So, there is no premium update and the program just went in the market. Yes, it’s in the northeast coastal zones for now. And then, we'll see how the relationship develops over time.

Okay. And then, just one last question. How much were your CAN revenues this quarter, and has this picked up since Florence and Michael?

Yes. So, CAN, we really look at CAN -- first of all, we don't break out separately CAN revenues. It’s just part of our claims group. That's proprietary information to us. Other Florida carriers are more than welcome to try their hand at building out that network that we've done over the last seven years. So, we don't report those numbers separately. However, we do view CAN as a profit center in lowering daily losses, for example. If we can get out to a water loss and we can serve as the policyholder, stop an assignment of benefit or a public adjuster, that obviously saves the company money that is a profit center for the organization. And we've been very successful on the daily claims and getting to these losses quickly. And you're seeing that in terms of a positive reduction in year-over-year water claims, costs, reserve charges, you see favorable development across the portfolio. It's been highly successful for us. And it is an absolute differentiator in terms of managing the daily losses. And then, in catastrophe events, we really view CAN as a way to reduce the total incurred loss on the event. So, if we can get out to the house quickly, tarp a roof, remove tree, dry it out, et cetera, and we're stopping third-party bad actors in entering the home, it reduces our reinsurance retention. So, take hurricane Florence for example. A lot of the models we're saying that we should expect $60 million to $80 million ultimate loss on Florence, our ultimate loss right now stands at $23 million, 99% of the claims are closed, and I think we had 10 claims last month. And a big reason for the outperformance was our initial response and Contractors’ Alliance Network. So, it does serve as very effective edge in cat years and it’s a continuing hedge in terms of claims management.

Thank you. And the next question comes from Tom Shrimp [ph] with Sandler O'Neill.

First question has to do with the accounting. The Company reports for net income number that doesn't adjust for non-recurring items, other guys report an adjusted operating earnings number, why do you guys not and do you intend to in the future?

Well, we do have an operating income which, I guess, if you look at the income statement, you can look at the interest expenses and the non-operating expenses. So, from our view, I think even looking at it from a gap perspective, you can get there. We also think that going forward, the number of non-operating items we expect to be relatively minimal. So, therefore, that is why we have at this time, even though there were a number of them, but going forward, we just don't expect there's going to be significant amount.

Okay, fair enough. And then, I just wanted to ask another question about the expense ratio. I believe on the second quarter call you guys provided a guidance of 40% to 41%? Does that still hold true or do you have a revised estimate since it came in a bit below that in 2018?

Are you referring to the gross?

I believe it was the net expense ratio guidance, 40% to 41%.

Yes. It's going to be probably right around the -- I think when we look at some of the synergies and some of the things that we're doing with the integration, I think probably right around the 40% would probably be about right.

Thank you. And the next question comes from James Naklicki with Citi.

Yes. Thank you. Good morning, guys. My question was on the expected reduction to debt in the future. You said you'd be using earnings to reduce that number. So, I was curious what you envision the debt to capital would be at the end of 2019? And then, I had a follow-up. Thank you.

Yes. James, we haven't really modeled what we think the debt to cap ratio is going to be at the end of 2019. Obviously, we've had a massive reduction in our debt to cap ratio over the past 12 months and significantly improved the capital position for shareholders. Our comment is more along the lines of we do expect strong earnings from Heritage in 2019. And we've had pretty consistently strong earnings across a very volatile market over the past several years. I expect we’ll probably come in second, again, in Florida, in terms of net income. We have sources and uses of that capital. And in the uses of it, we're really going to focus on debt reduction, and potentially share repurchases. So, both of those things are on the table. We do have an outstanding share repurchase authorization that's in place. And we're going to analyze the opportunities on a quarter-over-quarter basis and just make the right decision long term for shareholder returns.

And then, what was the unrestricted cash balance at the end of the year for the Company?

$250 million was the number.

Is that at the parent company…

Restricted or unrestricted cash?

Unrestricted. Yes. Cash at the parent, I'm looking for.

Oh, you want the parent. Yes, we have on a consolidated basis. We’ll pull that number out for you, James. Yes.

Okay, thanks. Yes. We could follow up offline. That’s fine.

Yes. Thank you.

Thank you. And as there are no more questions at present time, I would like to return the floor to management for any closing comments.

Yes. Thank you. I think there are two issues I would like to touch upon that were not in my earnings script. First is, is loss reserves. I do think it's important for investors to understand what we've been doing and why we've been leading the market on this point. I mentioned earlier that three years ago we took a look at claim activity in the Tri-County and made a very bold decision to significantly reduce our exposures there. Since that time, we have dropped our total insured value in the Tri-County by $15 billion. That easily ranks as number one in Florida in terms of Tri-County derisking. And during that same time period, we have consistently come out and marked our loss reserves higher as we’ve move forward, reflecting our conservative reserving position. We believe the combination of these two activities have really positioned as well for future performance as a company. We're seeing a lot of companies, as predicted, report significant adverse development across their portfolios. And it's no secret that those companies have lower loss reserves and higher market shares than Heritage. So, as a result, we do want investors to know that we believe that we are on very strong footing with our loss reserves. We have had three or four independent actuaries come in and review our numbers over the past two quarters, just to make sure that our numbers are validated and reliable. So far, everything looks pretty stable. And we're seeing a massive reduction year-over-year in Tri-County claims, lawsuits, paid losses, water claims. And that's not just Tri-County, that's across the state of Florida. So, we do think that we have a nice positive trend going in terms of our selective underwriting and how that translates into our loss reserves IBNR, and then…

Yes. Actually, we do have a question from Bill Broomall with Dowling and Partners.

Great. Thank you. Just following up on the LAE that you just kind of mentioned, when you go from the 45% to the 90% the FHCF, obviously FHCF has that 5% LAE cap, just at a high level, can you maybe talk about kind of how you think the industry will shake out when you kind of -- we're talking about renewing up the side of the FHCF, given that LAE such a hot topic right now?

Yes. You're right, Bill. I mean, it is the hot topic and has been really since Irma made landfall. I remember out a news interview the day after Irma and predicted 20 plus percent LAE in the Florida market we had and everybody's known about it. We're at a point now where the reinsurers are going to look at the individual LAE performances of the Florida carriers. and most reinsurers that I have spoken to modeled between 10% and 14% LAE on a normal basis; we’re at 13%. We are within the modeled range. So, yes, while the FHCF only covers 5% LAE, that does put some pressure on the layers alongside and above the FHCF. Our loss experience in terms of LAE on Irma is within the modeled ranges. And as our opinion that we should not have to pay a significantly higher reinsurance pricing, based on the industry's LAE, when our actual LAE leaves the Florida market in terms of 13% in total.

Great, perfect. Thank you. And just a small point, looking into 2019, now that you NBIC, did you -- have you seen any pick up in claims, given some of the cold weather that we've had up in the northeast, pipes and whatnot?

No. We haven't really seen anything unusual. It's actually been a very quiet quarter in the northeast.

Perfect, great. Thank you very much.

Thank you, Bill.

Thank you. And as that was the last question, that does conclude the conference call and the question session. So, thank you so much for your participation. The call is now concluded. Thank you for attending. You may now disconnect your lines.