Good afternoon, and welcome to the HCI Group's third quarter 2007 earnings call. My name is Tim, and I will be your conference operator this afternoon. At this time, all participants will be in a 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 December second, 2017, starting later this evening. This call is also being broadcast live via webcast and available via webcast replay until December second, 2017, on the Investor Information section of the HCI Group website at hcigroup.com. I would now like to turn the call over to Kevin Mitchell, Vice President of Investor Relations for HCI Group. Sir, please proceed.
Thank you, and good afternoon. Welcome to HCI Group's third quarter 2017 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, 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 Relations 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 presentations 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, 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. HCI Group Inc. 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, welcome everyone. While this call is about financial numbers, I would like to state that I've been in the office every day for pretty much the last seven weeks since Hurricane Irma hit Florida. I'm reminded constantly that there is a human element to the business that we're in, and it affects real people. With that, I wanted to express our sympathy to all those suffering from Hurricane Irma and other recent catastrophes. I wanted to thank our employees and vendors who are working diligently with dedication to restore the lives of those affected. Having said that, let's get right to the financial numbers. I am disappointed to report that Irma has ended HCI's run of 39 consecutive quarters of profitability. Our earnings release contains a link to a map showing our Irma-related claims.
This map, produced by Exzeo's Atlas Viewer claim tracking technology, visually demonstrates that Irma was a massive storm, stretching across Florida from coast to coast. It's almost as if we were hit by multiple hurricanes. Irma was a Category 4 hurricane in the Florida Keys, a Category 3 hurricane in Southwest Florida, a Category 2 hurricane in Southeast Florida, and a Category 1 hurricane in the rest of the Florida peninsula. We estimate the number of Irma claims will be approximately 18,000, including about 200 flood claims. Our total gross losses from Irma are expected to be approximately $270 million, and our total net impact after reinsurance recoveries will be $69 million. Some perspective on those numbers. Despite Irma's size and strength, we used less than one-third of our reinsurance tower, and our balance sheet and cash position remains strong.
None of our three insurance companies need any additional operating capital. This is worth repeating. Considering the size and intensity of Hurricane Irma, we used less than one-third of our reinsurance tower, and none of the insurance subsidiaries need cash. Furthermore, the holding company is holding approximately $100 million in liquid reserves. There were some other highlights here from the quarter. We paid a $0.35 per share dividend, our 48th consecutive quarterly dividend. Also during the quarter, we received regulatory approvals to expand our flood insurance operations into six additional states, Pennsylvania, Arkansas, Maryland, South Carolina, New Jersey, and Texas. Just after the quarter's end, we received approval from North Carolina, and we currently have applications pending in California and Ohio. Finally, we launched our internally developed online quoting and binding platform for homeowners insurance.
This platform utilizes a positive underwriting model, and I'll have more on that in a moment. First, I'm going to turn the call over to Mark for the financial numbers. Mark?
Thanks, Paresh. As Paresh mentioned, the big story for this quarter was Hurricane Irma, and our results from the third quarter were significantly impacted by that. We've estimated the ultimate loss exposure to be $267 million, including flood. Our retained exposure for losses is expected to be approximately $54 million, and the balance will be assumed by our reinsurance partners
It is important to note that the $267 million is an estimate. If it increases or decreases over time, it should not have a material impact on the $54 million estimate for net losses retained by HCI. In addition to the $54 million in net losses, the impact of Hurricane Irma has caused us to adjust premiums ceded under our reinsurance programs. We had previously estimated the cost of these programs to be $28.25 million per quarter, including $3 million of estimated premium benefits under those agreements. The losses from Hurricane Irma caused us to increase the estimated cost of these agreements to $31.25 million per quarter. We reversed $12.6 million of benefits accrued to June 30, 2017. The result is premiums ceded being $15.6 million higher than they would have been before Irma.
Combining the impact on reinsurance premiums with our estimated retained losses, the total impact of Hurricane Irma in the quarter is estimated at $69 million. Looking to the full results for the quarter, our pre-tax loss was $66 million, again reflecting the $69 million estimated impact of the hurricane. After adjusting for income taxes, the net loss for the quarter was $40.5 million or $4.04 per share. Because our convertible notes and stock options are anti-dilutive this quarter, basic and fully diluted losses per share are the same. Looking now to the balance sheet, there are a few things to point out there. First, you'll see a new asset for reinsurance recoverable. The $213 million here reflects the difference between our estimated ultimate for Irma of $267 million and our estimated retention of $54 million.
Second, total reserves for loss and loss adjustment expenses of $344.7 million is up significantly from the second quarter. Of the $271 million increase, $260 million relates to reserves for Hurricane Irma. In the third quarter, we also booked an adjustment to the estimated ultimate for Hurricane Matthew of $2.5 million and strengthened our reserves for prior years. Shareholders' equity declined during the quarter to $193 million, and our book value per share is now $21.37, down from $25.99 at the end of the second quarter. We paid dividends of $3.2 million and repurchased 124,849 common shares for consideration of $4.6 million. Lastly, I want to make a few broader comments about our financial position. While Hurricane Irma was a significant storm, we still have a strong balance sheet with more than $290 million in cash and $390 million in investments.
We have two strong insurance companies and a capital reinsurance company, all with more than adequate capital. We have cash and investments at the holding company level. There is no need to put any additional funds into any of our insurance companies or any need to raise additional funds in the financial markets. In summary, our balance sheet and reinsurance programs performed as expected. While this interrupted our string of profitable quarters, we are in a healthy financial position and expect to return to our strong operating results in the quarter ahead. With that, I'll turn it back to Paresh.
Thank you, Mark. Now looking ahead, we continue to execute our strategic business plan. Part of that plan is diversification into other businesses and products. I'll talk about them in a second. As I stated earlier, we have regulatory approvals to sell flood insurance in 7 states outside of Florida and expect approvals in 2 more states soon. We plan to begin writing flood insurance outside of Florida in early 2018. We believe the continued financial difficulties within the National Flood Insurance Program, or NFIP, bode well for us as we expand and try to establish our flood insurance program as a leading alternative to the flood program. In addition, news reports of catastrophic flooding in Houston and the areas of Florida that were flooded in Irma has tended to increase people's awareness of flood insurance and purchase more flood policies.
They learn from these reports, and we have seen an uptick in business accordingly. Our flood revenues at this point are beginning to positively impact on our operational results. Our flood policies in force now exceed 6,400, and our gross written premiums from flood exceed $8 million. That is just in Florida. It is too soon to tell, but we may have reached an inflection point where organic revenue growth across the wind and flood business exceeds the loss of revenue from policy attrition in the wind business. Turning to our real estate operations, another example of our diversification efforts, last month, Greenleaf Capital added another office property to its expanding portfolio. The office property is right across the street from our current headquarters here in Tampa.
The building is entirely occupied by the Bank of America under a long-term lease, but there is also sufficient land on the property to construct a second building if we so choose. Also, as part of our strategic plan, we continue to invest in technology. I'm pleased to report that our internal developed claims tool, Atlas Viewer, is working quite well and is allowing us to predict trends and monitor claims progress in real time. This technology has enabled us to become increasingly efficient at handling claims for both major and daily events. We believe that sharing this data with the reinsurers gives them the confidence in our results and will ultimately result in lower reinsurance costs for us.
As I mentioned earlier, we recently expanded our TypTap platform to include online quoting and binding for homeowners insurance in a fashion similar to the platform we use for flood insurance. This new technology utilizes our brand new positive underwriting model. Basically, we have pre-identified the properties in Florida we wish to insure, thereby speeding up the underwriting process for agents and prospective policyholders and bringing precision to our marketing efforts. Currently, this platform is being beta tested by in-house insurance agency. Early results are very promising, and we don't think anyone else in the industry has this technology and very few have the resources to duplicate it. Finally, with adversity often comes opportunity. Hurricane Harvey, Irma, and Maria have changed the homeowners and flood insurance market.
In the coming months, we believe these both industries will transition from a soft market to a hard market, creating growth and expansion opportunities for companies with excess cash and innovative technology. We have a strong balance sheet, and we'll be prepared to move quickly and aggressively to pursue any strategic opportunities that may present themselves. With that, we're ready to open the call for questions. Operator, please provide the appropriate instructions.
Thank you. 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, and 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, please, while we pull for questions. The first question comes from the line of Matthew Carletti of JMP Securities. Please proceed with your question.
Hey, thanks. Good afternoon.
Good afternoon, Matt.
Two questions. Maybe let's start with the gross loss estimate for Irma. Mark, I appreciate your comments that whichever way it moves, it won't impact you on a net basis much because of the reinsurance. I'm just more curious, is that estimate at this point this far removed from the storm, is it largely based on kind of the actual claims that you have had roll in and kind of ground up, or is a decent component of it still based on what RMS and AIR spit out on behalf of your portfolio?
Matt, it's Paresh. Look, the way we came up with the number is a mixture of a number of things. Joys of having, again, Atlas Viewer there and the technology, we could track things in real time and see how things are progressing. Basically, it consists of, first of all, being able to estimate what we think the ultimate number of claims from Irma are going to be, and I think we've said about 18,000. We obviously factor in based on the claims that we've already closed, et cetera, see what the average severity per claim is. We add that in there. We also obviously make an allowance for other integral expenses, et cetera, to go with the claim.
The final part that we're adding on top of that, this is where the variability is going to come in, which is going to be what's going to develop over the course of time in the form of lawsuits and AOB and loss creep in that fashion that will occur. We put all of those numbers together to end up at the $270 million number. We don't expect to spend $270 million between now and, say, Christmas, we think Irma will eventually develop to be that kind of number.
That makes sense. Maybe a follow-on to that. My next question was on AOB and kind of just more generally, kind of your view of where things stand and how Irma might impact kind of the forward outlook. Any thoughts you have there, I'd appreciate it.
Yes. I looked at the stats, the state numbers earlier in the day. 25% of the claims statewide have come out of the Tri-County area. Putting it differently, 200,000 claims out of 800,000 claims reported to the OIR as of last Friday seems to have come from Tri-County, and that's the area where AOB is prevalent, as we know. A further 100,000 claims have come out of Ocala, which is the secondary hub of AOB. Given those two sets of numbers, you would expect that there would be quite a lot of lawsuit and AOB activity to come in 2018. In anticipation of that's why we added those valuations in our number. Yeah?
Got you. Makes sense. Last question, on the flood business, it's grown nicely. It's still small, obviously, relative to the whole. My question is, there haven't been a lot of tests for it, and this is probably one of the better tests. I was just curious what you observed in terms of the underwriting of the product and how you selected properties and maybe any lessons learned post-event.
Okay. In terms of lessons learned post-event, every event gives you the opportunity to learn additional things. We did learn a few things both on the flood side and TypTap and on the wind side and Homeowners Choice. The key takeaway from this was that on the flood side, we're about a quarter of the way into our reinsurance tower, very similar to where we are on the wind side. That is a very good outcome given the size and scale and where we were concentrated, et cetera. In both Homeowners Choice in the wind business and TypTap in the flood business, we feel very comfortable and validated about our underwriting guidelines and models and how we've set up the business. Let me put this in a different context.
If six months ago you had been told with certainty that Florida was going to get hit by a Category 4 hurricane the size of Irma, the outcome you would not have predicted is that both of our insurance companies would be less than 30% into their reinsurance towers.
Right.
That's a very positive outcome, yeah?
Yeah, absolutely. All right, great. Thank you very much for the color. Appreciate it.
Our next question comes from the line of Mark Hughes of SunTrust. Please proceed with your question.
Yeah, thank you. Where do your insurance subsidiaries stand in terms of underwriting leverage, as you measure it? What ratio do you not want to go above in these circumstances?
Mark, there's a number of metrics that I'll tell you what those numbers are, but we are so far below those numbers that it's going to seem slightly redundant. The numbers that we as an industry generally watch is the RBC ratios, which we'll have to worry about for the stat filings at the end of the year. Gross premium to surplus and net written premium to surplus. Typically, I think you try to work yourself into, obviously, the RBC over 300. You have to keep the net written roughly around two to one at most, and gross written at about four to one at most. In orders of where we are currently, Homeowners Choice, which would be our most leveraged subsidiary, is sitting at about 2.4 to one gross written to surplus. That's post-Irma. Yeah?
Okay. Very good. The ceded premiums or the reinsurance premiums for the fourth quarter, Mark, were you suggesting should we use a number like 31 or 32 on a go-forward basis?
You're talking about just loss-
Ceded premiums.
Yeah. If you look at the ceded premium in Q4, you take the $12.6 off of what we've got in Q3, and you get to around $31, $32 million. That's about the right number for Q4.
Q1 as well, we'll see what happens in Q2?
Yeah. I think Q1 and Q2 would both be similar.
Okay.
Again, the only thing that's unusual in Q3 is that 12.6, going forward should be pretty consistent with that.
I'm sorry if I could have calculated this with what you've given, but the underlying loss ratio in the quarter when you exclude the CATs and the strengthening, what was that? Do you think that's representative of the go-forward number?
When you take that stuff out, I think we're around the 26%, 27% range. As I said on the last call, generally speaking, we expect to be in that $25 million-$27 million per quarter. The third quarter is about 27% when you back out those unusual things that I mentioned. Going forward, that's still around where I would expect us to be.
Great. Thank you very much.
Our next question comes from the line of Brian Hollenden of Sidoti & Company. Please proceed with your question.
Hi, guys. Thanks for taking my call. Could you provide a little bit more color around the continued reserve strengthening from the prior period's Assignment of Benefits? Particularly, was that about $7 million in reserve strengthening just from the AOB?
The strengthening that we did in the third quarter is a little over $8 million. That's just continuing to look at how losses are progressing for prior years against what we would have expected. I think we're being conservative there and continuing to add to our reserves. Generally speaking, a lot of the adverse comes obviously from lawsuits, both in terms of frequency and severity. In this environment, that continues to be an issue, and we continue to take a conservative approach to our reserves as a result.
Okay. Paresh, you mentioned with these storms, most likely the market's going to transfer from soft to hard. I guess, what is your sort of expectation on timing, on price increases, on market share gains? Can you just provide some color around that?
Yes. What makes me say that? A couple of things. I think rate increases are still a ways away, so they will have some impacts on that. We were fortunate that we had just done our rate filings and got everything approved so that our rates were appropriately set as of September 1. That rate increase is going to do that. That's actually turned out to be fortunate timing. There will be rate increases coming, but I think they'll take some time to work through the system. That's speaking for the industry as a whole. The other part about the hard market versus soft market is, I think those ratios that Mark asked about earlier, RBC ratios, et cetera, are going to force the industry as a whole to worry about its leverage ratios and probably raise additional capital for the insurance subsidiaries.
All of which is having a damping effect on people being open for new business, which obviously, people not writing new business leads to is what changes a soft market to a hard market. We're already seeing early signs of that, and that should lead to there being less price competition in terms of new business. All of those things are things that we are very favorably positioned, mainly because we don't need any additional capital to get all of our ratios in line.
All right. Thank you.
I would like to remind all of our participants, at this time, if you would like to ask a question, please press star one on your telephone keypad. Our next question comes from the line of Arash Soleimani of KBW. Please proceed with your question.
Thanks. In order to push through primary price increase, I know you already have the 8% that you mentioned, to get further price increases, can you get them as a result of the hurricane, or is it that you have to wait and see if your reinsurance pricing goes up, and then you can essentially pass some or all of that through to the end consumer?
Arash, that's a great question. I think most of the industry, and I don't speak for the industry, but my sense of the industry has been that everybody has been more focused over the last seven, eight weeks in taking care of their policyholders and making sure that their lives are restored and that claims are settled and everything else. Doing all of those things has been the primary focus of most of the insurance companies. I don't think many of the management teams have thought about if and when and how quickly they get a rate increase through or any of those kinds of questions. I think in the coming months, people will look at their profitability of their book of business.
They will go to actuaries, look at the numbers, rate increases will have to either be granted, or if the rates aren't sufficient, companies will tend to slowly bleed out, so to speak. In order for there to be a healthy insurance market, insurance companies have to stay reasonably profitable, because if they don't make any money, there won't be any insurance. That's just the way this works. It's just too early right now to tell. I don't think there's any companies that are going out of business or anything else. I just think that as time goes on, there will have to be rate adjustments to make sure everybody's equally profitable. It's just too early to tell when that will occur.
I meant also more from the perspective of maybe the OIR, like would they approve increases, just based off the fact that there was a storm that generated losses? Would they say, "Well, let's see if your reinsurance costs go up," is the storm itself enough, or do you need actual input costs in the form of reinsurance to go up for the OIR to approve a rate increase?
Well, I would answer that question slightly obliquely in the sense of, I think the OIR stance was already reaching to that point, that rate increases are going to be necessary because of the ongoing AOB and one litigation statute crisis that is engulfing the industry. That was already in place before Irma ever showed up. I think things have gone into hibernation mode for a while the industry digests Irma and takes care of its policyholders. At that point, the math is not going to get any better, and it was already pointing towards rate increases before Irma ever showed up. I don't see another gap. We're just debating what kind of rate increases and when.
Wow.
I think there were rate increases on the way, even without any reinsurance price adjustments.
Right. I guess what I'm also trying to get at is, obviously, Citizens and other industry players have said, besides the rate increases that were approved this year, storms aside, just from an AOB perspective, everyone would need kind of another round of rate increases next year again. My question is, to the extent that you would need also rate increases from the storms, there's kind of two reasons you would need the rate increases, AOB and then storms. Does that imply a rate increase that's larger than what would realistically get approved?
I don't know. It depends on what that number eventually works out to be, right?
Putting all of those things together, if that requires a rate increase, and I'm just speculating here. Hypothetically, if the rate increase, putting both of those things together requires an 8% rate increase, I could see that occurring all in one go. If putting those two things together requires a rate increase of 40%, I can believe that the OIR will not let you do that right off the bat because it would be bad for the consumer. It would have to be factored in over multiple rate increases. It's going to depend on the size of the rate increase. That's historically how that works.
Right. I don't know if you said, but what was the flood retention? Was it $5 million?
We didn't.
Are you able to disclose it, or?
We'd rather not because we are also extremely aware of how many other companies are trying to understand how our flood model works, and so we're trying to maintain our head start as much as we can.
Okay, that's fair. The other question, I apologize if you mentioned this in your prepared remarks. Did you provide a gross written?
Yes, it's $94.9 million.
$94.9. The adverse, did you say more than eight or did you specify like 8.3 or whatever?
It's 8.4.
8.4. Okay. Okay, great, guys. Thank you for the answers.
Thanks.
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 want to express our sympathy to all those suffering from Hurricane Irma and other recent catastrophes. We look forward to updating everyone on our progress next quarter.