Good afternoon, welcome to the HCI Group Inc. fourth quarter and full year 2018 earnings call. My name is Tom, I'll be your conference operator this afternoon. At this time, all participants are in a listen-only mode. Before we begin today's call, I'd like to remind everyone that this conference call is being recorded and will be available for replay through April 7th, 2019, starting later this evening. The call is also being broadcast live via webcast and available via webcast replay until April 7th, 2019, on the Investor Information section of HCI Group's website at www.hcigroup.com. I would now like to turn the call over to Kevin Mitchell, HCI's Senior Vice President of Investor Relations. Sir, please proceed.
Thank you and good afternoon. Welcome to HCI Group's fourth quarter and full year 2018 earnings call. With me today are Paresh Patel, our Chairman and Chief Executive Officer, and Mark Harmsworth, our Chief Financial Officer. Following Paresh's opening remarks, Mark will review our financial performance for the quarter, and then turn the call back to Paresh for an operational update and business outlook. Finally, we will take your questions. To access today's webcast, please visit the Investor Information section of our corporate website at hcigroup.com. Before we begin, I would like to take the opportunity to remind our listeners that today's presentation and responses to questions may contain 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 risks or uncertainties develop into actual events, these developments could have material adverse effects on the company's business, financial conditions, and results of operations. HCI Group Inc. disclaims all the obligations to update any forward-looking statements. With that said, I would like now to turn the call over to Paresh Patel, our Chairman and CEO. Paresh?
Thank you, Kevin, and welcome everyone. I want to start by saying a few words about Hurricane Michael, which hit the Florida Panhandle in the fourth quarter. Our primary focus, as always, is on taking care of our policyholders affected by this event. Fortunately, we have a minimal policyholder footprint in that area. We don't expect Michael to be a major insurance event for us. We did, however, incur a full retention loss, which contributed to an adjusted net loss of $0.48 per share for the quarter. For the full year 2018, we earned $3.23 per share on an adjusted basis. Mark Harmsworth, our CFO, will go into more detail in a moment. Other highlights for the fourth quarter include we paid our 33rd consecutive quarterly dividend. At the quarter end, we increased our quarterly cash dividend by 6.7% to $0.40 per share per quarter.
This is our ninth dividend increase since we started paying dividends nine years ago. Also, during the quarter, we continued our successful launch of TypTap Home, our technology-driven home insurance product. TypTap Home is now available in most parts of Florida. I will explain our important growth plans for TypTap and HCI after Mark's comments and numbers for the fourth quarter.
Thanks, Paresh. As Paresh mentioned, in the fourth quarter, we lost $0.48 per share on an adjusted basis. On a GAAP basis, we lost $0.95 per share. There were a few significant things that led to the loss this quarter. The first, of course, was Hurricane Michael. As you know, Hurricane Michael struck the Florida Panhandle on October 10th, 2018. While it was a devastating storm, it was not in an area of significant policy concentration for us. We have estimated the ultimate loss for Hurricane Michael at $22.25 million, including flood. Some of this has been ceded to reinsurance, and a net loss of $16.5 million is included in our loss expense for the quarter. Second, in the fourth quarter, we booked about $5 million of adverse development on prior period non-cat losses, as well as some development related to Hurricane Matthew.
The third item relates to the late year decline in equity markets, which dropped about 12% in the fourth quarter. In accordance with the new accounting rules, the change in value of equity securities now runs through the income statement. We recorded a loss of $5.7 million in the fourth quarter. As I've mentioned before, the new accounting rules can inject earnings volatility in periods of stock market volatility, and this is certainly one of those periods. Speaking of which, as you know, in the first quarter of 2019, we've seen a bit of a reversal of some of the equity market declines from last year. While there's certainly no certainty around what will happen in March, the recovery to this point would suggest that a significant portion of the unrealized losses in the fourth quarter may be recovered this quarter.
Let's turn to the full year results for 2018. For the year, after-tax net income was $17.7 million, compared to an after-tax net loss in 2017 of $6.9 million. Diluted earnings per share for the full year were $2.34 on a GAAP basis and $3.23 on an adjusted basis. There are a few things related to our full year results that are worth mentioning. First, net investment income was up about 45% from $11.4 million in 2017 to $16.6 million in 2018. Second, as was the case in the fourth quarter, the decline in the equity markets led to an unrealized loss of $10.2 million for the full year 2018. Third, loss and loss adjustment expenses were down about $56 million from 2017 to 2018. The biggest part of the decline was, of course, the impact of hurricanes.
The $16.5 million net loss from Hurricane Michael was $37 million less than that of Hurricane Irma in 2017, and explains a big chunk of the decrease in loss expenses. Another part of the decrease in loss expenses relates to loss development. Given the environment around assignment of benefits litigation, we have made some significant adjustments for prior year development in recent years. However, the development booked in 2018 was about $6 million less than what we booked in 2017, which also helped to reduce overall loss expenses this year. The rest of the decline, about $13 million, is explained by the fact that the 2018 accident year is performing significantly better than 2017. When the impact of hurricanes and prior period development are removed, what you see is that 2018 is shaping up to be a very good accident year.
The number of claims reported for the accident year were down 22% compared to 2017. The number of lawsuits reported for the 2018 accident year were down 34%. As a result, the ultimate core loss ratio for 2018 is expected to be lower than 2017, again, driving loss expenses down. We think the experience to date for 2018 is encouraging, and actually just as a side note, while we booked some adverse development this year for all accident years combined, we actually had favorable development on accident year 2017, which is also encouraging. Before moving to the balance sheet, I wanted to make a quick comment about our effective tax rate. We have mentioned a few times that we expect our effective rate to be around 27%.
Our rate was somewhat lower than that in the fourth quarter this year, and somewhat higher for the full year, but these were temporary fluctuations related to accounting for certain restricted stock that will expire. Going forward, we still expect our effective rate to be about 27%. Now to the balance sheet. The first thing that stands out when comparing December 2018 to last December is changes to our investment mix. While the total value of investments hasn't changed that much, we have been making structural changes that are resulting in a portfolio with lower average duration but higher yield. Combined with better returns on cash, this has driven higher investment income, while at the same time reducing volatility and risk. The other change I wanted to mention on the balance sheet is a change from September to December. Total reserves are up about $69 million from September to December.
There are two reasons for this. First, Hurricane Michael was a fourth quarter event, we set up the appropriate reserves for that this quarter. Second, we increased the consolidated ultimate expected loss for Hurricane Irma from $326 million at the end of September to $411 million, including flood, at the end of December. The total reserves for Hurricane Irma of just over $113 million are significantly higher than they were in September. A few other quick numbers. In the fourth quarter, we bought back 3,338 shares, which brings the total number of shares bought back under the 2018 buyback program to 511,628, and fully utilized the $20 million allocated to the program.
The number of common shares outstanding at the end of December 31st was 8,356,730, down about 5% for the year, and the number of fully diluted shares outstanding at the end of the year was 11,586,478. Lastly, book value per share as of December 31st was $21.71. Before turning it back to Paresh, just a quick comment on holding company liquidity and capital structure. As you know, we have a convertible debt issue which is maturing on the 15th of this month. The obligation is just under $90 million, and we have the funds set aside in the holding company to settle this obligation. As a reminder, if the notes are settled in cash, our fully diluted earnings per share should go up about $0.10 to $0.12 per share per quarter beyond what they otherwise would have been.
If the obligation is settled in stock, our book value per share should go up between $5 and $6 beyond what it otherwise would have been. Either settlement mechanism is a positive result for us. In terms of holding company liquidity, we had $115 million of cash and securities at the holding company level at the end of the year, not including limited partnership investments, we will have cash left over at the holding company even if all of the notes are settled in cash. In addition, we have the new $65 million revolving credit facility available at our discretion if we wanted to make any strategic investments. The balance sheet is in great shape. We have two insurance companies with plenty of surplus.
We are paying down debt, the holding company has cash and an inexpensive source of additional funds available at LIBOR plus two if any strategic investment opportunities come up. With that, I will turn it back to Paresh.
Thank you, Mark. Obviously, with Hurricane Michael and the gyrations in the stock market, Q4 was not our best quarter. However, we expect to bounce back to our usual profitability in Q1 of this year. On a core basis, Homeowners Choice continues to be a healthy book of business, with about 18% margins despite the difficulties in the Florida market. Those margins are necessary to handle retention losses such as Michael when they occur. I want to talk about the long-term future of the HCI Group. We have always thought Homeowners Choice was a great book of business, and the best thing we could achieve would be to create another insurance company with similar profit margins. Unfortunately, the Citizens assumption well ran dry several years ago. We've been working on a different way to get there, and we're there.
We've developed data and technology that turns every single family home in Florida, about 5.3 million rooftops, into a Citizens-like takeout opportunity. Our quoting and administrative system instantly applies our proven takeout algorithms to each opportunity that we quote. Put it all together, and you have the TypTap Insurance company. TypTap is now three years old and has been through five hurricanes, but its operating results are very promising. TypTap is beginning to show real growth. In-force premium at the end of February is about $17 million, and policies in force are almost 12,000. Going forward, TypTap is adding about $500,000 in new business premium per week, and it is accelerating. Keep in mind that 500,000 of premium at a 20% margin produces about the same margin dollars as doing $2 million of new business at only a 5% margin.
It's not just all about growth, it's about profitable growth. Numbers that I alluded to before but are now publicly available. According to the filings of stat numbers for companies with the Florida insurance regulators, TypTap's pretax margins of 23.5% for 2018 are the best in the industry. Just to provide some color, most of the industry on average ends up at about 2%. With that, it makes it very simple. Our path forward is straightforward. We aim to grow TypTap to about $300 million or more. That's on top of the profitable Homeowners Choice book, and we have no need for acquisitions, Citizens to be repopulated, or need for the additional capital. We have plenty of all of the above. This is a plan for the next few years to do that.
One more thing, Florida is just the first state in regards to our growth plans. Just imagine us applying this technology into other states and lines of business. We are just beginning to explore the full power of this technology and the analytics that go with it. With that, we are ready to open the call for questions. Operator, please provide the appropriate instructions.
Thank you, sir. Ladies and gentlemen, the floor is now open for your questions. If you do have a question, please press star one on your telephone keypad at this time. If you are using a speakerphone, we ask that while posing your question, you pick up your handset to provide favorable sound quality. Again, ladies and gentlemen, if you do have a question or comment, press star one on your telephone keypad at this time. Please hold while we poll for your question. Our first question comes from Matthew Carletti with JMP Securities. Please go ahead, sir.
Thanks. Good afternoon.
Good afternoon, Matt.
Paresh. Just had a few questions. Maybe to start with, there's been some news this week from Demotech regarding guidelines for reinsurance purchasing, I think primarily the first event being raised to 130 years from 100 years. Can you give us your view on that, the impact, if any, on HCI, as well as the industry more broadly?
Sure, Matt. We got that memo last Thursday along with everybody else. The net effect of going from 100 year first event limit to 130 basically means your tower, if it was at 100-year level, has to go up about 14%. For us, that delta is not as big because we were already buying to greater than one in 100. Secondly, because of the way our tower is structured, 45% of that number is already more than marked for because of the Florida Hurricane Catastrophe Fund. To us, the impact is not as great as to other folks, but it is material to most people, especially if you've been buying it just to one in 100.
Okay, you mentioned the Cat Fund there, and I guess that leads into my next question. There's been some movements. Some have stayed at 75%. We've seen another peer move to 90%. You guys are at 45%. Any color on your likelihood to stay at 45%, why you might like being there, if you intend to move it higher, just kind of the likelihood at this point as you approach renewal?
Yeah. Absolutely, Matt. We had to all make selections last Thursday to do this.
Right.
We chose to stay at 45%. I think everybody's selections in that just became public this morning. I can tell you the color as to why we stayed at 45%. It's for a couple of reasons. One is years ago, when we had moved from 90% to 45%, we had been very clear as to why we did it. We weren't doing it to buy cheaper reinsurance. We were doing it to buy better reinsurance. Even historically, our additional 45% that we've been buying from the market has been slightly more expensive than the Cat Fund. It's not always about the cost, it's about the value of this. The simple decision about should we stay at 45% or 90%, we didn't make it lightly.
We talked to our reinsurance brokers at Guy Carpenter, and they came back with a very simple idea, which was that take Irma, your losses in Irma, assume you had got the Cat Fund at 90%, see what position you would be in at this point. It's a universal thing you can do. As soon as you do that, you realize that you buy the 90% Cat Fund and you get an Irma, you are seriously concerned about going to the top of your tower.
Right.
Heaven forbid, if Hurricane Irma had been into Miami. Once you look at that number, and by the way, you can do that for every carrier, it becomes very sobering as to what size tower you should buy. Actually, in that context, Demotech's one in 130 might actually provide additional safety for a number of carriers.
Right. That makes sense. Then just last one. I mean, it was, I guess three or four quarters ago that you talked a bit about making an offer for one of your peers that recently reached a deal to acquire another mostly ex-Florida, but also Florida insurer. Any thoughts on, obviously M&A yourself? There's a 30-day shop period there. I don't know if you can comment on if that would be of any interest to HCI. Just any thoughts on that matter would be appreciated.
Sure. Matt, yes, the deal that you're talking about, I think was announced on the 25th of February.
Yep.
It did have a 30-day go shop period. As you can imagine, lots of people have been reaching out to lots of other people about if they're interested in the go shop. We were obviously contacted as well. A couple of items about that. One is the economics and synergies and stuff that were being considered for the deal and maybe possible. You have to look at it in the new light of the Demotech requirement of buying additional limit of insurance. That will-
Right
definitely affect the deal economics. There's one part of it. The second part of it, from our own perspective, we're sitting on opportunity to organically grow our business by a couple of hundred million dollars with 20% margins, right? It doesn't necessarily make a whole lot of sense to focus on trying to take on the business that's making low single-digit margin business and also paying a premium. If you're in that world, that might make sense. It just doesn't make sense for us at this point. Given the deal terms that have already been laid out, we're trying to find a justification as to why we should get involved. So far at least, we haven't been able to make a compelling business case.
Okay, great. Thank you very much for the color and best of luck in 2019.
Thank you.
Thanks, Matt.
We'll take our next question from Mark Hughes with SunTrust.
Yeah. Thank you. Good afternoon.
Good afternoon, Mark.
Mark.
You had expressed an openness to look a little more closely at the South Florida, the Tri-County area. I think you had suggested you saw a good opportunity perhaps. Is that still on the table or is TypTap more likely to be the focus of growth?
Actually, when we talked about South Florida opportunity, we were talking about TypTap. As TypTap is growing and doing this $500,000 of premium a week, it's actually looking more and more like Homeowners Choice. If you look at the Homeowners Choice book, about a third of it's in the Tri-County, a third of it are in the Tampa Bay area, and a third of it's in the rest of the state. The TypTap homeowners book is being assembled along those same metrics, albeit with better margins.
When you think about the performance, the persistency of the HCI book, how do you think about the growth for 2019 and 2020? I hear what you're saying, that the profit impact is more meaningful for TypTap. I wonder if you could just give some general thoughts about top line, and then maybe underwriting profit as well.
Okay. In terms of top line growth, we've already stopped shrinking, and it's not visible in the fourth quarter, but we're starting to see that in the late part of the first quarter. We are having TypTap organic growth far offset any shrinkage in the Homeowners Choice book at this point. As time goes on, that should hopefully start moving us closer, first of all, to the $400 million mark as a group, and then hopefully beyond that to the $500 million mark. We are on that path. That part is occurring. As far as the profitability goes, again, we had started seeing that we were doing this and it was working very well. We wanted to give it some time to make sure that it was fairly sustainable and published Yellow Book numbers from 2018 speak for themselves for that matter.
Whatever weather was, whatever issues there were, TypTap suffered through the same thing as the rest of the industry, but the results are materially different.
I'm sorry. I lost my train of thought. The core loss ratio for 2018 has improved over 2017. We have enough information to back into that. Could you maybe talk about 2019? I think a lot of the lawsuit activity has been absorbed by maybe some of the reinsurers as they picked up the tab. Do you think some of that energy will get redirected back at you as we progress through the year? Just kind of your general thoughts on AOB trends.
Mark, this is a slightly complicated answer. For the industry as a whole, what we are seeing in the AOB trends, et cetera, is because of Irma and the growth of AOB lawsuits, et cetera, across the industry, it has started to spread beyond South Florida into places like Orlando, the East Coast of Florida, and even some in Tampa Bay. There is a growth in AOB abuse outside of South Florida that is now starting to occur. We see that on industry trends and everything else. The number that Mark talked about what we did in 2018 in Homeowners Choice, is actually partly because of Irma. A lot of it is also to do with underwriting actions we took back in 2016, in terms of how to reposition the book, et cetera. You're seeing the results of that come through.
We keep seeing that number month after month. Of course, we've been seeing that improved performance for about a year now. You don't want to take three dots, three months' worth of performance, and extrapolate forever. We continue to keep seeing this improved performance. If you use 2017 and pre-Irma as a benchmark, we keep getting a much better result from starting January 2018 and going forward. That trend hasn't reversed yet. Maybe it will someday. So far so good.
Thank you.
We'll take our next question from Freddie Sleiffer with KBW.
Hi, good evening. Firstly, I was wondering if you have an update to your Irma gross loss estimates.
Yeah. I mentioned it in my prepared remarks. We updated it to $411 million, including flood.
Okay. Michael is still the same?
Yeah. Michael was a fourth quarter event. This is the first time we've posted losses for Michael. As I mentioned, the total gross loss, $22.25 million, again including flood, and a net loss of $16.5 million, again including flood.
Okay. I think I heard you say that there was about $5 million in adverse development. Which accident years did this mainly come from?
Well, I would sort of tend to look at all of the adverse development that we booked in the year. As I mentioned in my prepared remarks, we actually had favorable development related to 2017. The bulk of it was, it was sort of a mix of 2016, 2015, and a little bit of 2014, which has been fairly consistent. We actually had, as I mentioned, favorable development for 2017 that we booked.
Right. Okay. Since you already made the Catastrophe Fund election, I was just wondering what your current expectations are going into the mid-year renewal in terms of pricing, and maybe any structural changes that you're thinking of making to your program?
I don't think that we'll be making any major structural changes to our program, but as far as pricing goes, we are just starting the trips to London and Bermuda and the negotiations as they will go on over the next two months. It would be inappropriate for me to comment as to what the ultimate pricing will be. Obviously, it's going to be a drawn-out negotiation this year, but we'll know better when we do the first quarter earnings call in May.
Okay. What return period do you currently buy to for the first event in your reinsurance program? What % increase would it cost, all things being equal to last year, to increase that to 1 in 130 year return period?
Great question. It was the first thing we asked when we saw the Demotech memo. I think if you did this from the 2018 tower, based on what we had done, we would probably have had to buy an additional $20 million or $30 million of limit at most, because we were already that far up in the tower. The Cat fund would have gone beyond that, yeah?
Right. Okay. Mark, I think you said in your prepared remarks that the net investment income was higher this quarter, since you've been making some structural changes with the lower average duration but a higher yield.
Yeah.
Usually, I think shortening the duration would lead to lower yields. How are you approaching and achieving this?
Well, there's a few things going on. I guess sort of the biggest change that we made was throughout the year, we really significantly reduced our exposure to municipal bonds, which had an average duration of six or seven years. We moved that for a time into shorter duration, with a slight reduction in yield, but much lower term. We kept that money really short, and now we're starting to place that money out again at yields that are, just because of what's happened in the yield curve and good timing, we've started now to place that money out at rates that are higher than what we were paying on those munis, with like two-year term to maturity rather than an average of seven. It's just sort of managing the timing of these things and paying really close attention.
As you know, there have been a lot of shifts in the short end of the yield curve. The other thing that's going on too is when you compare year-over-year or quarter-over-quarter, we've got a pretty significant difference in the yield that we're getting on cash. We're getting 2.25% on cash now instead of back in the day when we really got nothing. You put those things together and you're starting to see an upward trend in investment income. We had a good year with limited partnership income as well. Generally, things are trending up and it's what I think of as that proactive restructuring of the portfolio and anticipating on what's going on and it's working out well for us and we'll continue to see that in 2019.
Okay, great. Thanks. Were there any one-time benefits this quarter in your G&A expenses? I saw that was down quite a bit from the previous three quarters.
Yeah. Whether you look at personnel expenses or whether you look at personnel expenses and OpEx all put together, it will move around from quarter to quarter. We were up over the fourth quarter last year, but down over the third quarter this year. A lot of that is truing up bonus accruals based on what's going on in the business. If you look at it over time, it averages about a total of about $10 million a quarter. If you look at the full year 2017 to 2018, the total of all that changed by about 0.5%, I think. There really isn't. You can get movement from quarter to quarter, but if you look at it over the period of a year, it doesn't tend to move around very much.
Okay. Paresh, just one last one, if I may. I think you mentioned in your closing comments something about applying the TypTap technology in other states. Is this something you're considering? Since I know previously you'd said you didn't really have an intent of expanding outside of Florida.
Yes, we are. Actually, we have multiple different opportunities because of the technology. We don't necessarily need to apply it whereby we go into, hypothetically, Ohio and start licensing and writing business there. Because of how we've got the technology, we could partner with one of the top five carriers in the state of Ohio and have them use the technology to drive better margins for themselves, and we will just be licensing the software. We have different ways of expanding beyond Florida without necessarily taking on balance sheet risk.
Okay, great. Thank you very much for the answers.
At this time, this concludes our question and answer session. I would now like to turn the call back over to Kevin Mitchell, who has a few closing remarks.
On behalf of the entire management team, I would like to express our appreciation for the continued support we receive from our shareholders, employees, agents, and most importantly, our policyholders. We look forward to updating everyone on our progress in the near future.
Ladies and gentlemen, thank you for joining us today for our presentation. This concludes today's call. You may now disconnect.