Good afternoon, and welcome to HCI Group's first quarter 2018 earnings conference call. My name is Latonya, and I'll be your conference operator this afternoon. At this time, all participants will be in listen-only mode. Before we begin today's call, I would like to remind everyone that this conference call is being recorded and will be available for replay through June 1st, 2018, starting later this evening. The call is also being broadcast live via webcast and available via webcast replay until June 1st, 2018, on the Investors Information section of the HCI Group website at hcigroup.com. I would now like to turn the call over to Mr. Kevin Mitchell, Vice President of Investor Relations for HCI Group. Sir, please proceed.
Thank you, and good afternoon. Welcome to HCI Group's first quarter 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 disclaims all the obligations to update any forward-looking statements. With that said, I would now like to turn the call over to Paresh Patel, our Chairman and CEO. Paresh?
Thank you, Kevin, and welcome everyone. The first quarter was another positive one for us. We earned $10.8 million, and as Mark will discuss in greater detail, $12.7 million on a non-GAAP adjusted basis. Also, we continued our normal path of paying dividends, repurchasing shares, and increasing book value. Here are some noteworthy events from the quarter. We experienced positive non-CAT claims trends with fewer claims and fewer losses. We think this is because of good weather, also the contracted public adjuster focusing on Hurricane Irma, and also the implementation of positive underwriting technology. We'll talk about that more later. Hurricane Irma claims have unfolded as we predicted last October. We are comfortable with our current loss estimate. We also repositioned much of our investment portfolio due to changes in the tax code and the flattening yield curve. Finally, after the quarter ended, the board increased the quarterly dividend.
Mark will discuss all of these things in detail. At this time, I would like to turn it over to our CFO, Mark Harmsworth, who will walk us through the financial performance for the first quarter. Mark?
Thanks, Paresh. Fully diluted earnings per share in the quarter were $1.11 on a GAAP basis. Adjusted earnings per share were $1.26, up from $1.15 in the same quarter of last year. As mentioned on our last call, the new accounting treatment for unrealized gains and losses on equity investments introduces new volatility in earnings when equity values change. To better compare to prior periods, we have disclosed and explained adjusted earnings per share, which takes out the impact of unrealized gains and losses in equities. As you look at the income statement, one of the things you'll notice is that our loss expense is down 23% from the first quarter of last year. A couple of things explain the decrease. In the first quarter of last year, we booked $2.5 million of adverse development, and there was no material adverse development in the first quarter of this year.
Second, non-CAT claims and lawsuits are down and down significantly. The number of non-CAT claims in the first quarter of this year was 26% less than the first quarter of last year, and the number of non-CAT lawsuits was 28% less. There was very little weather in the quarter, but claim volumes were down across the spectrum. As we discussed before, our income tax rate has declined significantly as a result of the federal tax changes effective January 1st, 2018. While a number of things impact the rate, the 27% effective tax rate in the first quarter should be a reasonable estimate of the normal rate going forward. Before leaving the income statement, I wanted to add that our gross pre-tax margins in the quarter were 17.25% on a GAAP basis and 20.25% on an adjusted basis.
This, as well as our combined ratio, highlights the continued efficiency of our operations. Now turning to the balance sheet. As you know, we live in a dynamic investment environment, and so we have been strategically repositioning our investment portfolio. We sold a number of longer-term corporate and municipal bonds and invested the proceeds into shorter-term treasuries and certificates of deposit. The net impact of these changes was to cut our average term to maturity in half. While our average yield declines somewhat, this should be balanced out by increasing yields on cash. More importantly, it will reduce volatility and allow us to take advantage of opportunities created by rising rates. Given the volatility in the equity market, we also locked in some gains and reduced our equity exposure during the quarter from $60 million-$46 million.
Also in the balance sheet, you'll notice that our reserves continue to decline as we process payments for Hurricane Irma. At this point, we are maintaining our original estimate of $267 million for the ultimate exposure to Irma. Last comment on the balance sheet. Book value per share on March 31st, 2018, was $22.45, up slightly from $22.14 at the end of last year. Now a few comments on capital management. Our capital position and liquidity remain strong. We have over $160 million of surplus in Homeowners Choice, just under $25 million of surplus in TypTap, and about $100 million of cash and liquid investments at the holding company level. During the quarter, we bought back just over 184,000 shares at an average purchase price of $35.39, for a total investment of $6.5 million.
The weighted average number of fully diluted shares outstanding in the quarter was 11,897,791, and the number of shares outstanding for purposes of calculating book value per share and dividends at the end of the quarter was 8,593,850. The steady reduction in the number of shares outstanding through our buyback programs has helped us to increase earnings per share, but it has also allowed us to increase dividend payments to existing shareholders without an increase in the total dividends paid out by the company. On April 16th, our board of directors approved an increase in our annual dividend from $1.40 to $1.50 per share. The dollar amount of our dividend payment in the second quarter of this year will be about the same as it was in the second quarter of last year. In summary, it was another good quarter for us. Earnings per share were strong.
Our efficiency ratios look good. We are repositioning the investment portfolio to increase returns with less risk, and we are maintaining a strong level of liquidity at the holding company level. With that, I will turn it back to Paresh.
Thank you, Mark. First, a quick note on reinsurance. Our renewals for the 2018 hurricane season are near completion, and we expect ceded premiums will remain flat year-over-year. Today I want to talk about our insurance operations and the impact of our internally developed technologies. We've been talking about our investments in technology and data analytics for some time now. Our performance during Hurricane Irma and the first quarter results show the power and possibilities of our in-house technology. It is not speculation. It is actually in our results. Due to the positive underwriting technology that we have developed, we have industry leading ratios. Using the technology, we started TypTap entirely powered with it, and it has enabled TypTap to grow with little marketing, without excessive commissions or the benefit of large insurance company networks.
Note that in two years, TypTap has survived three hurricanes and grown to $10 million of premium in force without any additional capital infusions from the parent company. That's a great outcome. Finally, we believe this technology can be married with any existing book of business and materially improve its operating results. We know this because we speak from experience. Therefore, our future plans are to increase the volume of business we put through our technology platform. How do we plan on doing that? We will do that through a combination of three things. One, geographic expansion, like the nine additional states that we will be selling flood insurance into in the coming months. Secondly, adding new products like TypTap Home, which was launched just a little while ago, which expands the industry leading platform we have for quoting and binding home business.
Finally, through mergers and acquisitions, because more volume through this platform will only make it more efficient. Finally, with that, we're ready to open the call for questions. Operator, please provide the appropriate instructions.
Thank you, sir. At this time, we will be conducting a question and answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment while we poll for our first question. Our first question comes from Brian Hollenden with Sidoti. Please proceed with your question.
Hi. Thanks for taking my call.
Hi there.
In terms of potential acquisitions, how does your internally developed technology capabilities play a role? Would you be able to use your platform to lower an acquired company's combined ratio?
That's an interesting question, Brian. Historically, our approach has been to focus on companies that were failing financially and acquire them at a fair price to book multiple. Although we still are focused on that discipline, we have evolved our thinking based on the recent success of the positive underwriting technology. Today, when we evaluate companies, we often look for well-run organizations who have failed to proactively invest in technology, because it's going to be needed going forward. If we were to merge with a competitor, to answer your question, we would implement our technology suite and would have a material impact on their combined ratio. We just said it earlier. For example, kinds of things that we've gotten into, we approached FedNat earlier this year about a merger. That would be an excellent example of something we could do where the combined companies would do fantastic together.
At least in this particular case, the board decided not to engage in discussions with us, and the deal is dead. There are still plenty more fish in the ocean similar to FedNat, and we'll find somebody to do this with.
I guess it's very situational dependent, but just from a high level, would you expect 500 basis points- 900 basis points of improvement? What sort of range do you think you could bring to an acquisition in terms of overall savings?
I think you've sort of pretty much hit the range, 500 basis points- 900 basis points.
Turning to the reinsurance renewals, just wanted to make sure I heard you correctly. You're expecting the ceded premiums to remain flat?
Yes. Basically, the amount that we ceded in the first quarter is what we would expect to cede in the second and third quarter on a dollar basis.
Just if I can follow up there, I guess some of us were expecting and maybe going into the renewals, I would think would have been expecting a rate bump. I guess, just maybe can you walk us through maybe why you didn't get a year-over-year rate increase on the reinsurance renewals?
Partly. I don't want to speak about the specifics because we're still in the middle of the negotiation, so it would be inappropriate to comment. One general overarching comment that I think has been stated various points throughout the industry is that the expected huge rate increases for 6/1 that were expected, do not appear to have materialized, mainly because of an overabundance of reinsurance capacity. Obviously, we're benefiting from some of that.
All right. Thank you, and congrats on a strong quarter.
Thank you.
Thanks, Brian.
Our next question comes from Mark Hughes with SunTrust. Please proceed with your question.
Yeah. Thank you. Good afternoon.
Good afternoon, Mark.
Hello. Is your retention changed at all in the reinsurance? Is it going to be similar to last year's program or the current program?
I can answer one part of it. Another part of it is still under discussion. The part of it in Homeowners Choice, the insurance subs retention will probably remain consistent with last year. As far as the HCI Group goes, how much retention we take as a group is subject to some negotiation that we're going through currently. It will not be much greater than last year.
Not greater than last year. The rate online, I don't know if there's any detail you could provide there. Your premium is, I think the overall book is down a little bit in the Homeowners Choice. Is the rate online up?
Again, I think these are all questions that we will gladly answer much more crisply once the negotiations are finished in the next quarter. We're still in the middle of some of these things, we really don't want to get into the details at the moment.
Understood. The TypTap Home platform that you launched recently, could you talk a little more about that? How do you anticipate that'll get traction? How do you market that, bring it to consumers' attention?
Actually, we've already started on the same path that we started with the TypTap Flood product two years ago. Mainly, we're making agents aware of it. We've had very positive feedback in the initial feedback from them. What'll occur is as time goes on, people become more and more familiar and accustomed to it, and we should see an increasing stream of business coming from it, like we currently enjoy from the TypTap Flood program.
Then any thoughts, any projections you might share in terms of the volume? You had a nice release the other day about hitting the $10 million mark. Care to make some prognostications about where you might be at the end of this year or the following year?
Okay. Maybe I can help it out this way. By the way, to your previous question also, one of the key things about why TypTap Home is very different to anything that's gone before it only requires about four or five questions then you get a price. It is so simple and easy to use. It's as simple and easy to use almost as the flood product is. I should have made sure I got that plug in there. In terms of volume production, et cetera, currently TypTap is adding something a little bit north of $100,000 of written premium a week. If you take us at a $10 million slip, currently, you can add it growing by about 100,000 a week and it'll project out into the future.
Obviously, we are working hard every day to try and accelerate that growth from 100,000 a week to a higher number.
Right. Okay. The $1.26 in adjusted earnings, I assume that includes the $2.2 million investment gain?
Yes, it does. We were trying to do this on an apples-to-apples basis. The $2.2 is realized investment income. It would have been there under the old GAAP standards.
Yep.
Yep.
It removes the, I guess, mark-to-market, the unrealized gain.
Good point. Yeah.
Any comment on the lawsuits overall? Is there still just as much activity in the system, it's just shifted over to the storm claims? Is there some reason to think that the underlying situation might be improving?
It's a great question, I'm going to give a multi-part answer. From what we're observing, the overall number of lawsuits is up, not only for us, but across the industry. It's because about half of those lawsuits now being filed are Hurricane Irma related. When you put the normal daily lawsuits in, plus the Hurricane Irma related ones, the overall volume is definitely much higher. For our own part, our Hurricane Irma lawsuits at this point far exceed, on a weekly basis, our daily lawsuits. Our daily lawsuits, as Mark indicated earlier, are down year-over-year. As, again, to illustrate the point, we think that decrease is a combination of two items. One is the lawyers and the PAs, et cetera, focusing more on Hurricane Irma, so that has produced some reduction. We see that across a number of other companies too.
Secondly, what we are seeing, which we think hopefully is more material, is because of some of the steps we took a little while ago due to the positive underwriting technology, we are seeing an increased drop-off, more than it would explain just by Hurricane Irma and those kinds of things. That's specific to us.
Thank you very much.
Thank you.
Our next question comes from Matthew Carletti with JMP Securities. Please proceed with your question.
Hey, thanks. Good afternoon.
Good afternoon.
I just have a couple left. Brian and Mark covered a lot of ground. On the low non-CAT claims, kind of following on the last discussion there.
Kind of in dollars or loss ratio points, how much below normal would you estimate that was versus what you would have expected in the quarter? Have you seen those trends continue into April?
The loss ratio that our historic loss ratio is around the 25%, 26% mark.
The loss ratio in the first quarter was about 23%. That's the difference between.
Got you.
Those couple million dollar difference between what you'd normally expect. In terms of trend, that's a trend that's been going for some time. The reduction in the number of claims, the reduction of incurred, the reduction in lawsuits, and it just sort of continued in the quarter and we'll see where it goes. It's difficult to say what will happen in the second quarter, but it's definitely a trend that's helpful.
Okay, great. Just one other numbers question. I think you mentioned that the $267 million ultimate Irma estimate held tight.
Yeah.
Where are you on a paid basis?
Sorry?
About $200 million, I think.
Yeah. The paid were at about $210, incurred is a little higher. Paresh mentioned the lawsuits are starting to come in, I think the important thing there is that there's still some significant room to run in terms of the reserves that we've set. The lawsuits are starting to come in, we expected the lawsuits to come in, we allowed for that from the start. It's a little early to tell how many that will ultimately turn out to.
So far we've got a fair amount of room to run there.
Okay, great. Thanks for the answers, congrats on a nice start to the year.
Thanks, Matt.
Thank you.
Our next question comes from Sean Reitenbach with KBW. Please proceed with your question.
Hi. Thank you. I was wondering, going forward, do you think the AOB environment has stabilized, or is it still you guys think it could get worse from here?
It depends on which context you look at this. What we are clearly seeing is on an industry-wide basis, the number of lawsuits filed in the first quarter was at a record number. Some of that, as we said, was due to Irma, and some of it's also the daily stuff. You do have a mixture of both items. I don't think the AOB problem on a statewide basis goes away all by itself. If anything, it might be getting worse because Irma has accelerated the spread of the AOB disease, shall we say. We can tell this because we see new law firms popping up, et cetera, that are in the AOB business. We see that clearly, and that's occurring. As far as our own book goes, obviously, we try not to be just passive participants in this and wait for these things to happen.
Using some of the technologies and items that we've developed over the years, we are trying to combat it and sometimes we come out a little bit ahead as we seem to be at the moment, and the overall claim lawsuit count is decreasing a little bit. I'm sure we'll have good quarters and bad quarters going forward.
Okay, thanks. Do you guys expect to receive any approval for additional rate increases in 2018? Following up on that, do you expect the tax reform to drive rate competition, if at all?
Okay. One part of the question is about rates going up, the other one's about rates going down. No, and that's fine. I was just extrapolating. We've always, and again, speaking for our company, not the industry as a whole, we've always approached rate setting with the idea that we like stable rates. We don't like rates to increase dramatically or decrease dramatically. It's not how we tend to do business. We are just beginning to assemble the data to submit to the OIR for our annual rate submission. I'm sure they will review it, and we will have a discussion as to what the appropriate thing to do, given our performance, the new tax law, et cetera, would be.
My sense, and this is a sense, not anything other than that, is I don't necessarily know that we feel we should have a material rate increase or a material rate decrease. A few points this way or that way.
Okay, great. Also, what type of claims infrastructure do you plan to set up in your new states? Or are you thinking about outsourcing to third parties?
I think we have systems and tools and everything else capable. Because the field work is done by third parties already anyway, but all the claims reserving, check issuance, all that stuff, we can do that from our existing operations. Until we get large in other states, I don't necessarily know that we need to set up operations there to that degree.
Okay, thank you. Finally, I was wondering, going back to the approach to FedNat, we were wondering, was this disclosed before?
Yeah. I'm looking at my general counsel. He's shaking his head. I guess at this point, he's going to be working through the night to make sure we get all the correspondence disclosed by tomorrow morning. Sorry.
Okay. Yeah. What was the back-and-forth nature? Was it proposed by HCI or any idea why the board wouldn't engage? Did they give a reason?
The only item I can tell you is, yes, we did initiate the approach. As far as all the back and forth, I think once we disclose everything overnight, everybody can read for themselves, yeah?
Yeah. Great. Okay. Thank you very much.
Thank you.
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 you on our progress in the near future.
Thank you for joining us today for our presentation. This concludes today's call. You may disconnect your lines at this time.