Good afternoon, and welcome to HCI Group's second quarter 2017 earnings call. My name is David, 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 September 2nd, 2017, starting later this evening. The call is also being broadcast live via webcast and available via webcast replay until September 2nd, 2017, on the Investor Information section of the HCI Group website at www.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 second 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 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 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 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 in 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 to turn the call over to Paresh Patel, our Chairman and CEO. Paresh?
Thank you, Kevin, and welcome everyone. Similar to prior calls, I'd like to start by providing a brief overview of our company for those new to the HCI story. HCI Group is a holding company with subsidiaries engaged in diverse yet complementary business activities. Our principal operating subsidiary is Homeowners Choice Property & Casualty Insurance Company, which provides homeowners insurance in Florida. We also have TypTap Insurance Company, which currently focuses on providing flood insurance to Florida homeowners. TypTap features typtap.com, our internet-developed online platform for quoting and binding flood insurance policies. Accessible from any internet-capable device, including your mobile phone, typtap.com provides a quote in seconds and a policy in minutes. In addition to Homeowners Choice and TypTap, we have a Bermuda-based reinsurance subsidiary called Claddaugh Casualty Insurance Company that participates in our reinsurance programs.
To support all of our different insurance operations, we also have an information technology subsidiary called Exzeo that develops insurance-related products and services, several of which are used in our day-to-day operations. In fact, as I mentioned before, Exzeo developed the technology that powers typtap.com. It also developed Atlas Viewer, our map-based technology that enables us, in real time, to identify, track, and manage daily claims as well as claims associated with catastrophic events. Looking ahead, we expect to find additional means to leverage the new technology developed by Exzeo, including the development of new products and services for third parties. Finally, we have Greenleaf Capital, which owns and manages our growing portfolio of Florida real estate, which currently includes two office buildings, two parcels of waterfront property, and two grocery anchor shopping centers.
Turning to second quarter results, the highlights include that Q2 was our 39th consecutive quarter of profitability. Secondly, we paid a $0.35 per share dividend, which is our 27th consecutive quarterly dividend. On April 3rd, we redeemed all of our 8% senior notes using some of the proceeds from our March sale of $144 million of convertible senior notes. On April 18th, the board of directors accelerated the expiration of our shareholder rights plan, which was due to expire in 2018. During the quarter, we completed our reinsurance program for the 2017-2018 reinsurance year. This program significantly improves coverage and reduces risk. The overall cost in dollars is about the same as last year. In June, we applied to expand our flood insurance operations into nine additional states. The expansion is part of our overall strategic plan to diversify geographically and also by product mix.
May 10th marked the 10th anniversary of the day we began business as a licensed insurance company. During the decade that we have been in business, we have grown from a small insurance company with $12 million in surplus and a handful of employees to over $200 million in surplus and about 400 employees. In fact, we are now one of the 10 largest homeowner insurance companies in the state of Florida. We hope to work every day for the next 10 years to achieve similar success. Before I go further, I would like to invite our Chief Financial Officer, Mark Harmsworth, to walk us through the financial performance for the second quarter. Mark?
Thanks, Paresh. I'm going to go over some of the financial highlights from the quarter, try to add a bit of color, and discuss some of the trends that we are seeing. Fully diluted earnings per share were $0.93 in the second quarter, up from $0.71 in the second quarter of last year. The increase was driven by higher net premiums earned, higher investment income, and a lower effective income tax rate, offset partially by an increase in loss reserves, interest expense, and a one-time expense related to the redemption of our 8% senior notes. The net result of all that was an increase in after-tax net income from $7 million in the second quarter of last year to $9.5 million in the second quarter of this year.
Similar to the past four quarters, net premiums earned were up despite gross premiums earned being down because of the lower rates on our 2016-2017 reinsurance programs. Ceded premiums were 31% of gross premiums earned this quarter, compared to 38% in the second quarter of last year. Investment-related income of $4.6 million was more than double that of the same quarter last year. A number of things are happening here. First, we are cautiously putting more money to work in our investment portfolio. Second, we are earning higher rates of return on cash and cash equivalents. Third, our income from limited partnerships is up. Lastly, we realized a $1.8 million gain on sale of some securities in the quarter. I wanted to point out a few things related to our expenses.
First, you'll notice that interest expense was about $4.4 million compared to $2.7 million in the second quarter of last year. We issued our new senior convertible notes in March and redeemed our 8% senior notes in April, so our new debt structure is fully reflected on the balance sheet, and our interest expense is indicative of what it will be going forward. We expect our annualized interest expense to be about $17 million, including amortization of the debt discount. Also in our expenses this quarter, you'll see an expense of $743,000 for loss on repurchase of senior notes. This relates to the 8% senior notes that were redeemed in April of this year. This is a one-time write-off of the unamortized debt discount at the time of redemption and is a non-recurring expense.
In the second quarter, we reported loss expenses of $27.7 million versus $26.3 million in the second quarter of last year, resulting in a loss ratio of 30.7%, which is somewhat higher than the 27.7% in the same quarter last year. Policy count and gross premiums earned are down from last year, and a number of claims trends are favorable. However, we continue to be cautious in our loss ratio assumptions. When looking at our income tax expense, you'll notice that we have a lower than average effective tax rate this quarter. Normally, this would be about 37% to 38%. However, it was 33.3% this quarter, which reflects the realized tax benefits related to certain stock-based compensation plans. As you know, we recently announced our 2017-2018 reinsurance program, where we purchased coverage up to $968 million for a first event and a total limit for all occurrences of $1.78 billion.
We expect annualized net reinsurance premiums under this program to be $113 million, which is about the same as the 2016-2017 program. Going forward, ceded premiums should be similar to the last four quarters, and we will not see the significant quarter-over-quarter reductions in the premium ceded that we have seen in the last four quarters. While we kept net reinsurance premiums constant, we are taking less risk in that our captive reinsurance company, Clada, is not on risk for a second cat event as they were in our last program. Turning quickly to the balance sheet. As I mentioned earlier, we have been capitalizing on our strong cash position and liquidity by investing more in fixed income securities. At the end of the quarter, we had $325 million in fixed income, equity, and limited partnership investments.
This is an increase of $76 million from the end of last year. While we are investing more, we continue to be cautious and are slowly putting money at work with high-quality liquid debt issues at the shorter end of the yield curve, given the current interest rate environment. We still plan to maintain flexibility by maintaining a strong cash position. At the end of the quarter, we had $296 million in cash, of which $70 million is at the holding company level. Book value per share at the end of the quarter is $25.99, up from $25.63 at the end of the first quarter. We bought back 900 shares for a total of $40,000 during the quarter as part of our 2017 stock buyback program. In summary, it was a good quarter for us.
After-tax net income was up, fully diluted earnings per share grew, we paid a dividend of $0.35 per share, grew book value per share, and strengthened our liquidity. With that, I'll turn it back to Paresh.
Thank you, Mark. Let me begin with a quick note about Tropical Storm Emily, which crossed Florida on Monday. The state experienced some heavy rain and gusty winds. We have received less than 50 claims thus far, and we don't expect Emily to be a material event. On to the regular business. One of our growth areas is flood insurance. Since its inception, TypTap, our flood insurance subsidiary, has sold more than 5,500 policies with gross written premiums of over $7 million. We believe there is significant room for growth in this line of business. I mentioned in my opening remarks that we plan to expand our flood insurance operations to other states. We have applied to enter into nine additional states. They are: Arkansas, California, Maryland, North Carolina, New Jersey, Ohio, Pennsylvania, South Carolina, and Texas.
We have already received regulatory approval in Arkansas and Pennsylvania, and expect more approvals soon. This expansion is consistent with our philosophy to invest prudently and patiently. While our enhanced balance sheet and liquidity, we continue to look for strategic opportunities to put our cash to work. We believe this conservative but proactive approach has enabled us to generate solid return on investment over the past 10 years, and will continue to do so in the future as well. 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. If at any time you wish to remove your question from the queue, please press star two. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Our first question is from Matt Carletti with JMP Securities.
Hey, good afternoon, guys.
Afternoon, Matt.
A few questions. I thought maybe I'd start with you kind of where you ended a little bit, kind of on TypTap and the flood. Can you just update us on kind of the reception by the market of TypTap, kind of how that progress has gone? What have been any of the surprises, good, bad, or otherwise?
Sure. For most of the second quarter, every week was a record week in terms of business production. Every passing week, we are seeing more and more people, more business being generated, and the policy counts increasing. To put this into perspective, 14 short months ago, we started out with a new brand name, TypTap, and the fifth insurance company also had no agents. There was no takeout or assumption business to be had, so everything had to be done from scratch, building a new company. Also along the way, as you know, our commission structure for TypTap is materially different to that of the NFIP.
Against all of that backdrop of difficulty to start a company, TypTap has come through in flooded fashion and now is started to be deployed as a known brand, and agents are now calling us to be appointed, whereas a year ago, we were trying to recruit agents. All of these things all lead to a much more positive future, and that's just within our own control. On a different note, of course, the NFIP reauthorization is going to be due by the end of September, and we look to see what Congress will do about that matter in the next couple of months.
Okay, great. Just another high-level question before a few numbers. You just came off your reinsurance renewal, really the one following what really was the largest major cat event the state's had in a while, even though it ended up just to be a glancing blow, that being Matthew. What are your takeaways from the renewal? I'm not so much thinking about, I think you've laid it out pretty well in terms of price and how much risk retained and so on, more so the intangibles in your discussions with the reinsurers. Did anything stand out in terms of, is really a lot of their first chance to get real evidence of differentiation amongst books as opposed to maybe just modeled differentiations? Did anything stick out there, or was it just business as usual?
No. Matt, I can tell you that, as you know, we never root for storms of any kind because it's bad for us, bad for our policyholders, bad for our reinsurers, et cetera. One of the things that came out from Matthew was when we went to all the reinsurers, they suddenly could see the difference in how different companies handled, which was the first major storm in a decade. One of the big differentiators that everybody appreciated was the Atlas Viewer program that I talk about frequently. What we did was before the storm came, we sent a link to all of our reinsurers so they could track our handling of the claims that were associated with Matthew in real time. We sent that link to all of our reinsurers, as well as all the regulators of the Florida OIR, et cetera.
The result of that was that when we went to see them well after the event, what they all said was, "Wow, that was great," because for the first week after Matthew came by, we were trying to get a handle as to what the numbers looked like, what the damage was, et cetera. With a lot of companies, we were asking, and they were still trying to grasp as to what was going on in their world. Meanwhile, we could log into Atlas Viewer and see what Homeowners Choice was doing hour by hour. It was very transparent and very much on the mark.
That turned out to be a big differentiator, and one of the byproducts of that was we had a lot of reinsurers who were not on our panel last year, who all wanted to join the panel this year, just because word of how the company handled itself During Matthew has got around. Other little items that was noted was that we took 94% of the claims that came in, were handled by people inside this building. We didn't use a call center. We did use a call center if somebody called in at 3:00 in the morning, but the bulk of the claims were handled by people right here in the building, and that also resonated well, both with the agents and with policyholders.
All of those kinds of intangibles have really seemed to have created a viewpoint in the marketplace that, HCI, Homeowners Choice, is a very professional group that looks after its policyholders in times of need. Switching on a different note, the other thing that also benefited out of both Matthew and Hermine, to a lesser extent, was for TypTap, which has only been around for a year, and one of the early issues that people were raising last year was that how will TypTap perform in handling flood claims compared to, say, the NFIP, which has been doing it for 50 years. Well, the OIR kept records on that, and what they finally found out was not only we're doing as good as the NFIP, but we were closing claims. We were handling them much faster and quicker than the NFIP.
That also resulted in lots of positive business development in 2017 for us.
Great. That's great to hear. Lastly, just a few numbers, questions, maybe for Mark.
Net written is $106.2 million.
Okay.
Weighted average, fully diluted, Matt?
Yes, fully diluted.
Yeah, $12.33 million.
Okay. The last one, numbers-wise, is you mentioned in both, I think the opening commentary and definitely in the release, that there's some prior period adverse in the loss number. Can you quantify how much that is?
Yeah. In the second quarter we've put about $5.5 million in for reserve strengthening as part of the 27.7.
Okay, mostly AOB related?
Yes. Yeah.
Okay, great. All right. Thank you very much for the color and congrats on a nice quarter.
Thanks, Matt.
Thank you.
Our next question is from Arash Soleimani with KBW.
Thank you. Good afternoon.
Afternoon, Arash.
Hi, just few questions. Thanks for providing net premiums written. Can you also just provide gross premiums written?
Yeah, $134.4 million.
$4 million. Okay. You mentioned in the prepared remarks that you, in terms of some of the technology products that Exzeo is working on, that you might have the opportunity to, I guess, monetize that with third parties. Could you just expand on that comment a little?
Yes. I'll go back to discussing Atlas Viewer. It was a tool that we developed a couple of years ago. We actually had showed it to a lot of people in the marketplace as to how great it was and how it helps you handle the logistics of a large number of claims, and also keep all the different parties that need to be kept appraised of what's going on in a large event, and keep them all on the same page. When we were showing that a couple of years ago, people sort of looked at it and said, "Well, this is nice, but why would we need this?
During Matthew, suddenly everybody saw the value of having a system like this already up and running. We are getting some inquiries as to can other parties get it, et cetera. We are obviously in the business of technology, so we would obviously look at that, but stay tuned as to when that actually occurs, yeah?
Okay. I apologize if you said this already. Were there any repurchases, share repurchases in the quarter?
Yeah. That was in my remarks. There were 900 shares.
$40,000.
$40,000 in total.
900 shares for $40,000? Okay.
Yeah.
In terms of the, I know you mentioned just now the $5.5 million of reserve strengthening. Can you just provide, I guess, a general update on AOB and what changes you're seeing, and how it's kind of changed quarter-over-quarter from since last time we spoke on the call?
Arash, what we're seeing is a couple of things, right? In some ways, we're seeing lawsuit numbers do tick up in the second quarter, but part of that is what's happening is that now that Matthew has aged by about nine months, we're starting to see the Matthew lawsuits start to come in. It was expected and it's occurring. I don't want to imagine that it was a surprise, which is breaking down numbers, but those things are occurring. You are seeing some lawsuit increase. The other side of that is the lawsuit numbers this year are higher than last year, but they're along the lines of what we expected. All of those aspects are playing out. For this year and this accident year, claim counts are down. The lawsuits obviously for this year will not have come in yet.
They won't even start coming in till late this year or early next year. You've got all those various items that play out. We are out of an abundance of caution, and obviously AOBs keeps going on and on. We keep every quarter adding more and more to reserves and strengthening them until the issue is behind us. As I think Mark said in his numbers, we've got fewer policies this year than last year. We've got fewer claims this year than last year. The business is smaller, et cetera, but we are putting away the same amount of money for losses just so that we have plenty of reserves for any outcomes in the future. Yeah?
Okay. I know the second quarter was a heavy rain quarter. Are you able to quantify the amount of, I guess, weather-related losses you had?
Actually, we debated about that. Can we quantify it? Yes, we could. The only item about it, and yes, the stuff you're referring to is the heavy rains that were there in the last three weeks of June. The only trouble with quantifying that is we also had a first quarter where there was very little weather events. Some of these weather events, while they were there, they're just normal course of business. It occurs, right? That's why we didn't break it out separately. It's just baked into the numbers.
Okay. How would you look at, I guess, the weather year-over-year? I know there were tornadoes last year, or tornadoes were 1Q. 2Q 2016, I think, was a pretty quiet weather quarter. I guess what I'm trying to back into is how much of the loss ratio uptick was from just heavier rain in 2Q 2017 versus 2Q 2016?
Yeah. Look, I can actually quantify that. I'll help you with that in some way, and this is the reason why we don't break these things out, because it can be very distorting unless you're paying close attention. Second quarter last year wasn't quiet. We had, I think, Tropical Storm Colin, which would have been a similar kind of rain event to what the rains in June were. You did have something in both quarters.
Okay.
Yeah?
All right. Okay, no, that's actually very helpful. With the rain we saw this quarter, did TypTap have any, I guess, material claim activity?
No.
Not really, okay.
Yeah, it's been very wet, but I don't actually know that we've had extensive flooding, yeah?
Okay. When do you plan to start writing? I know you mentioned those nine states. When do you plan to start, or when do you expect to start writing in any of those nine?
I'm optimistic that sometime in the fourth quarter. It is obviously subject to getting through all the regulatory approval process that you have to in each of these states, because we are doing it as an admitted carrier. There is some time that's needed in these states to get licensed, approved, and then rates and forms approved, recruit agents, all those kinds of things before you write your first policy. I'm hopeful that we will be doing it in some of these states before the end of the year.
Okay. How are you targeting the agents that you're appointing or that you plan to appoint in the other states?
It's been interesting. Just because of the fact that we announced that we were going into these places, this goes back to how the TypTap brand seems to be getting more and more known out there. We've been receiving phone calls from agents asking us that as soon as we get approved in their state, can we appoint them? We are almost keeping a tally of people who are interested in writing flood with us when we get to their state. This is without actually actively going and trying to recruit agents. I think it'll work itself out in due course of time.
Okay. Sorry, I think you mentioned this in your prepared remarks. Can you remind us what's the in-force policy count or in-force premiums within TypTap currently?
I think I said about 5,500 policies have been written, the in-force count will be something lower than that. The gross written premiums was just north of $7 million.
All right. Was that a 2Q number, or was that an in-force premium number?
Sorry, say that again?
Was the seven million in-force premiums within TypTap?
It's seven million worth of policies sold. Some of this stuff is going to be slightly different timing-wise, because when we sell policies, we're selling them two or three months in advance of their effective date.
Okay.
We've sold about $7 million of policies. The in-force premium would probably be something less than that because not all policies will be effective at this moment in time.
Okay. I think I was just going back. Last quarter, I think as of 1Q, you mentioned it had $4 million of in-force premiums. Is it fair to assume it's somewhere above that, but below $7 million?
Yeah, Yes.
This might be a question for Mark. I think other operating expenses that had ticked up as a percentage of gross earned premium. Just wondering, can you remind us what runs through that line and if there was anything notable there?
The other operating expenses line?
Yep.
Yeah. There's a long list of things that are in there. There isn't really anything significant there that's jumping up. From Q2 to Q2, professional fees were up a bit, system expenses up a bit, but it's-
It's a new company
one or two percent.
All right, thanks. Last question, do you have the Florida homeowners policy count?
Yeah. It's around 138 or so.
139,000 at the end of June. 139,000.
All right. Perfect. Thank you very much for all the answers.
Once again, if you'd like to ask a question, please press star one on your telephone keypad. Our next question is from Mark Hughes with SunTrust.
Yeah, thank you. Good afternoon.
Good afternoon, Mark. How are you?
The competitive environment in Florida, could you talk about that in terms of your sense on new production and maybe organic production in the homeowners? Maybe tie that to gross written premiums. You were down a few points this quarter, pretty good performance. How should we see that playing out over the balance of the year in light of what you're seeing on competition, new business trends?
Mark, the key thing about that is, yes, our gross premiums are down, but we've positioned ourselves and stated that was our objective for several quarters now, given the evolving AOB crisis. Where we are now, I think, is that we've reached a point whereby we think we have got a handle on this stuff, and we may actually look to see where we can grow and expand, whether it's within the state or outside the state. For us, the numbers may be starting to move in a different direction. In terms of competitive environment, my sense from what we get from agents and everybody else is more and more companies seem to be rethinking their Tri-County strategy, especially the ones who were looking at growing last year in Tri-County.
They seem to have had a change of heart as, I think, the losses there continue to mount. You know, we've been shrinking down in Tri-County for several years, we're quite happy with where we are.
Is that making it tougher in the markets you want to be in?
Actually, no. I think my overall sense of the Florida homeowners market is that the days of people churning between different insurance companies every year or twice a year or whatever seem to be somewhat behind us, the market tends to be stable in most places. I say that because there isn't any news of any carriers shedding lots and lots of policies and/or somebody growing with lots and lots of policies. I think generally the marketplace seems to be stable with low churn.
The renewal of flood insurance, anything in that has the potential to help out, or you think that'll be business as usual?
I wish I knew what Congress was going to do. Obviously, the NFIP reauthorization is due by the end of September, and at different moments over the last three months, there have been people saying that reauthorization and reform will all be done before the end of September. Other times, there's been conversations that nothing will get done. Other times, there's conversations that they will just do a temporary reauthorization so they can spend more time on it. I'm really not qualified to make a judgment call as to which of those three will occur. We are watching closely, as you can imagine.
Any comments on M&A opportunities or deal flow that might be of interest? Is there a little more, a little less of that as you stand here today?
Yeah. I think things have stabilized out in the second quarter compared to the first quarter because the people who needed to infuse capital into their companies because of Demotech, because of year-end results in 2016, et cetera, all of that has been done. The industry seems to be stable. Nobody's imminently planning on selling. Beyond that, I'm sure there will be consolidation that will occur over the course of the next few years. The other item that I would note is I would think it'd be very difficult for anybody to start a new carrier at this point. Consequently, if you're not adding new carriers, and that gives you the same pool to choose from, and eventually with consolidation, there will be fewer carriers.
Is there anything in the takeout market that interests you?
There might be. Just so that people aren't shocked when they hear it, is that we probably will apply for a fourth quarter takeout. Applying for a fourth quarter takeout, actually executing a takeout, and what you ultimately get as customers are three totally different things. The first item shouldn't be read into meaning the third item will occur.
Thank you.
Yeah. Finally, by way of note is, I think Citizens hasn't yet started to grow to the level that everybody expected it to. They're still below 500,000 policies last time I looked.
Thank you.
Great.
Our next question is from Brian Hollenden with Sidoti.
Hi, guys. Thanks for taking my question.
Hey, Brian.
Brian, how are you?
That 8% rate increase that was put in place, did that take effect yet? How has that affected policy retention so far?
Okay. Simple answer to that rate increase goes into effect as of September 1. It would not be in the numbers that you have in front of you. Obviously, its effects will be felt really starting in Q4 onwards. In terms of how it's gone over, et cetera, obviously those renewals are out there with the policy holders, but the first true read of that is going to happen at the end of September when you've got a month's worth of renewals and you see what retentions, et cetera, are like. It's in process, but it's a little bit early to get an accurate read on what's going to happen.
Okay, just one point of clarification. When you talked earlier in your prepared remarks about the ceded premiums, did you say $113 million or $118 million?
For the new program going forward, $113 million.
113.
Okay. All right. 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 policy holders. We look forward to updating you on our progress in the near future.
The event playback has concluded. Thank you.