Good afternoon. Welcome to HCI Group's second quarter 2015 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 September 4th, starting later this evening. This call is also being broadcast live via webcast and available via webcast replay until October 4th 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, the Vice President of Investor Relations for HCI Group. Sir Mitchell, please proceed.
Thank you, Tim. Good afternoon. Welcome to HCI Group's second quarter 2015 earnings call. With me today are Paresh Patel, our Chairman and Chief Executive Officer, Richard Allen, our Chief Financial Officer. Following Paresh's opening comments, Richard will review our financial performance for the second quarter of 2015 and then turn the call back to Paresh for an operational update and business outlook. Finally, we will answer questions. To access today's webcast, please visit the investor relations section of our corporate website at hcigroup.com. Before we begin, I'd 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 this 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 of these 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. Now I would like to turn the call over to Paresh Patel, our Chairman and CEO. Paresh?
Thank you, Kevin. Good afternoon, everyone. Welcome to HCI Group's second quarter 2015 earnings call. As most of you know, HCI Group is a holding company with subsidiaries engaged in various business activities. Our principal operating subsidiary is Homeowners Choice Property & Casualty Insurance Company, which provides homeowners insurance in Florida. Based on written premiums, Homeowners Choice is the fifth largest homeowners insurer in the state of Florida. In addition, we have a Bermuda-based reinsurance subsidiary called Claddagh Casualty Insurance Company, which participates in the Homeowners Choice reinsurance program. We use Claddagh to retain selected levels of catastrophic risk and avoid the associated third-party reinsurance premiums. We also have an information technology operation, Exzeo, which develops innovative products and services for Homeowners Choice, the insurance industry, and perhaps others as well. We have high expectations for our IT operations.
Finally, we have our Greenleaf Capital division, which owns and manages a diversified and growing portfolio of real estate investments. We continue to investigate strategic opportunities to add to and further diversify our operations. Turning to our results for the quarter. The second quarter of 2015 marked our 31st consecutive quarter of profitability. During the quarter, we generated $22 million of net income or $1.93 of diluted earnings per common share. We also paid $0.30 per share in dividends, our 19th consecutive quarter of paying dividends. This brings the total dividends paid to date to $4.35 per share. We increased our book value also, and at the end of the quarter was at $22 exactly per share, up from $17.92 per share at the end of last year. This represents an increase of over 23%.
Finally, we also successfully placed our reinsurance programs for the 2015 hurricane season effective June 1st. The program provides event coverage up to approximately $1.45 billion, which according to catastrophic models, is sufficient to cover the probable maximum loss resulting from a one in 260 year event. All of our private reinsurers are either AM Best rated A-minus or better, or they have fully collateralized their exposure to us. As Richard Allen will expand on in a moment, Homeowners Choice continues to operate with a high degree of efficiency. We believe our operating ratios lead the industry and that these efficiencies are the result of our adherence to strict underwriting guidelines, our focus on minimizing operating costs, and our ongoing commitment to customer service. I invite our Chief Financial Officer, Richard Allen, to take us through the financial performance for the second quarter. Richard?
Thank you, Paresh, and good afternoon. For the second quarter of 2015, income available to common stockholders totaled $22 million or $1.93 diluted earnings per common share.
An increase of 34% and 38.8% respectively from the $16.4 million and $1.39 diluted earnings per common share in the second quarter of 2014. For the six-month period ended June 30th, net income available to common shareholders increased to $47.4 million compared with $34.1 million in the same period of a year ago, an increase of 39.2%. Net premiums earned for the second quarter of 2015 increased 21.9% to $76.4 million from $62.6 million in the second quarter of 2014. Net premiums earned for the six-month period reflect an increase of 22.5% to $158.91 million, compared with $129 million for the year-ago period. This increase is primarily due to the mix of business generated through the December 2014 and February 2015 Citizens' assumptions and subsequent renewals. Direct and gross premiums written for the quarter were $156.2 million and $155.3 million respectively.
For the six-month period, corresponding amounts were $238.1 million and $236.8 million. For the second quarter of 2015, reinsurance cost of $31.4 million or 29.1% of gross premiums earned as compared with 31.3% in the same quarter a year ago. Year-to-date ceded premiums of $59.2 million are 27.2% of gross premiums earned, compared with 30.3% for the same period of 2014. We anticipate that ceded premiums for the remaining quarters of the 2015 treaty year will be in the range of $40 million-$42 million per quarter. During the three and six months ended June 30th, 2015, as a result of our placement of the multi-year reinsurance treaties that began in June of 2013, we have accrued benefits of approximately $6 million and $12.4 million respectively.
As of June 30th, 2015, we had a total of $40.5 million of accrued benefits and $6.7 million of ceded premiums deferred related to these adjustments as discussed in prior earnings calls. Our loss ratio applicable to the second quarter of 2015, which we define as losses and loss adjustment expenses related to net premiums earned, was 26.9%, compared with 29.3% in the second quarter of 2014. For the six-month period ended June 30th, 2015, our loss ratio was 25.1%, compared with 28.6% for the period ended June 30th, 2014. Decreases in our loss ratio are related to the mix of business that we insure. The expense ratio applicable to the second quarter of 2015, which includes underwriting expenses, interest, salaries and wages, and other operating expenses related to net premiums earned, totaled 30%, compared with 34% in the second quarter of 2014.
The expense ratio for the six months ended June 30th, 2015, was 28.5%, compared with 33.1% for the six months ended June 30th, 2014. Year-over-year decreases are primarily due to a decrease in the stock-based compensation expense. Expressed as a total of all expenses related to net premiums earned, the combined loss and loss expense ratio for the second quarter of 2015 was 56.9%, compared with 63.7% in the same quarter of 2014. For the six-month period ended June 30th, 2015, the combined loss and loss expense ratio was 53.5%, compared with the same period in 2014 of 61.8%. The improvements in these ratios reflect a significant increase in gross premiums earned, as well as a change in the mix of policies as already mentioned. Investment-related income was impacted by the recognition of $293,000 of other than temporary impairment losses in the second quarter.
With the current market volatility and the size of our investment portfolio, investment impairments may develop. Year-over-year for the six-month period, investment income reflects a decrease, primarily the result of these other than temporary impairment adjustments in our portfolio values. Investments in fixed maturity and equity securities total $225.8 million at June 30th, 2015, an increase of $83.1 million from December 2014 level of $142.6 million. During the six months ended June 30, 2015, we added approximately $68.4 million to our investments in fixed maturity securities. Total stockholders' equity at June 30, 2015, of $225.7 million compares to $182.6 million at December 31st, 2014, an increase of 23.6%. Paresh mentioned net book value per share has increased to $22 per share as of June 30th from $17.92. This is based on 10,263,149 shares outstanding at June 30th.
As these results demonstrate, we have experienced solid year-over-year improvement during the second quarter of 2015. I'd like to turn the call back over to Paresh.
Thank you, Richard. As I stated earlier, we've secured our reinsurance program for the 2015 hurricane season. Looking ahead, we believe that our program would enable us to comfortably absorb 2 Hurricane Andrew type storms in a single year. We have also mentioned on our previous call that our strong financial position allows us to increase the level of risk we retain in Claddagh. For the 2015 hurricane season, Claddagh retains approximately $78 million of risk while displacing $26 million of third-party premiums, which adds directly to our profit from operations. We think this is a prudent risk and one that we are very capable of affording. Other items of note, we continue to see small areas of value in certain pockets of Citizens policies. We also see our real estate portfolio continue to grow. We plan to offer new products and services and put our technology to use.
Finally, our strong financial position should enable us to act quickly should accretive opportunities become available. In summary, we are very pleased with our results and the actions we have taken for the future. We are excited for the challenges and opportunities that lie ahead of us. With that, we're ready to open the call for questions. Operator, please provide the appropriate instructions.
Thank you. We will now 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, please, while we poll for questions. Our first question comes from the line of Matt Carletti at JMP Securities.
Thanks. Good afternoon.
Good afternoon, Matt.
Just had a couple questions, kind of big picture type questions. They're kind of related. The first one is, just love to get your view, kind of being one of the companies that's started the Citizens takeouts, been doing it for a long time of where you think that opportunity stands today. I know it's just one of the opportunities you have, but love to hear your up-to-date thoughts.
Sure, Matt. I think Citizens consists of a number of different books of business. It's not just one block. Clearly, the main multi-peril pool for personal lines is fairly picked over and tapped out at this point. We do see opportunities in things like the wind-only book. If you recall, last year we were one of the first companies to do a big wind-only takeout because what we saw was an untapped pool. That pool still remains largely untapped, we are extremely aware that there are a number of other companies looking at that pool now a year later, having realized what we saw last year. We are looking to possibly do something with that pool in the fourth quarter.
Then more broadly, maybe just a growth question on, that's kind of just one opportunity, but where do you see the biggest growth potential over the next few years? Obviously, you have flood, you have some IT initiatives, the commercial real estate book. Just be curious to hear where an update on where you think your best opportunities lie.
Okay. I think our best opportunities lie across the whole piece, right? We'll start with the real estate. The real estate opportunity is basically Greenleaf, to some degree, operates almost like a REIT-like structure, owning lots and lots of real estate and adding more to it. The only difference being is that the cash it needs to acquire more properties, if you were a REIT, you would have to keep issuing more shares. We can do it from the cash flow coming off the insurance operations. That represents an opportunity for growth where we don't have to go into other states or anything else. The second item in terms of growth is I think everybody is rapidly looking just to grow by growing top line. We are looking at it differently. We're saying we should grow in places where the opportunity lies in our favor, not increasing competition.
For example, we could expand to other states in multi-peril lines, but the market is softening and competition is increasing in every state in those areas. The stuff we are concentrating on, like the wind-only takeout at Citizens, and the flood opportunity, which is more of a national opportunity, both markets, the primary rates are going up quarter after quarter, year after year for those policyholders. We're entering markets where rates are still hardening. Everybody else seems to want to compete for market share in areas that are softening. In both areas, we sort of have a untapped field ahead of us. Historically, this is how we've always operated and done very well at. We chase hard markets, and everybody else follows us later on and chases the markets when they become soft. We continue to do that for the coming quarters and years. Okay.
Our next question comes from the line of Casey Alexander of Gilford Securities.
Hi, good afternoon.
Afternoon, Casey.
The reinsurance treaties that you put into place, for a one in 260-year storm, is the highest that the company has ever chosen to protect their book. Obviously, that comes with a trade-off in terms of the reinsurance premiums that you're ceding. Can you give us sort of what the company's thinking was, in terms of putting together such a strong treaty?
Absolutely, Casey. It's a couple of things. One is, yes, on an absolute number, that number is the highest it's ever been. Part of that is we also have requirements that we're supposed to buy to, both from the OIR and from Demotech, our rating agency. What we bought definitely conforms to all of those things. Part of what you're seeing in the one in 260 is a result of two things that have materially changed year-over-year. One is adding the wind-only book means that you really end up buying reinsurance that works slightly differently. Secondly, the cat fund is shifting around in our reinsurance tower as well. Thirdly, the cat fund is in itself, and how much coverage it provides is shifting. All of those things combine together to move us to the number that we are at.
It is a very large number. It definitely means that Homeowners Choice is very well protected from any major storm, because to go through the top of this tower would require a lot of outcome. I think you can do some very simple math whereby if you divide the top of the tower, which is $1.45 billion, by the number of policies we have, you end up at a number of something like $8,000 per policyholder or something that we have, just for one event, which is a huge number.
Okay, great. Thank you. Secondly, because this has become a lot more complicated than it has been in the past with the captive reinsurance company, can you sort of define the company's retention, both traditional cat, and then you've sectioned off a flood side of the portfolio. Can you give us a feel for kind of the two sides of this portfolio and what the company's retention is?
Sure. Casey, look, the way to look at this is, as we have multiple divisions, we do look at them slightly differently. Job one is to make sure that the Homeowners Choice, which is the regular insurance subsidiary, is very well protected. As I said, even after two Hurricane Andrew style events, that company would be very well capitalized to continue doing business going forward. We made sure that happens, one. Because you have that, you can then do other things. One of the ways we did this was when we got into the flood business 18 months ago, there was some uncertainty about what that risk meant, et cetera. We constructed reinsurance in a fashion whereby Homeowners Choice really has all losses from flood losses covered by third parties.
The third party is being Claddagh at the lower end of the tower, and third party reinsurance above that. Having done that, it gets everybody safety that the flood tower in no way affects, and the flood exposure nowhere affects anybody in Homeowners Choice. Having segmented that, everything else is in what we call the main tower, which is the main reinsurance that we talk about. What we did there was Homeowners Choice subsidiary, again, that subsidiary only has $16 million of retention in the first event and $16 million of retention in the second event. When you look at that against a business that has $180 million of surplus and probably a lot of tax credits that it can recoup in the event of losses That's really not a great deal. That protects Homeowners Choice.
Once we know that is so well protected, we can look at the capital in the rest of the group and say, "What can we do with it?" That's when we came into the Claddagh part of it, where Claddagh had an opportunity that we had an arm's length transaction lined up from Homeowners Choice, where we were going to cede $78 million of risk to third parties, but the premium associated with that was $26 million. When you look at those numbers, you say, if you can afford to keep it, why wouldn't you keep it? We did. We basically met three criteria. Criteria one, was we only retained risk after Homeowners Choice was fundamentally secured. Two, even in the softening reinsurance market, the premium was of such amounts that it made sense for Claddagh to take it.
Three, Claddagh actually had the capital with which to collateralize it, which it did. Meeting all those three criteria enabled us to do this. What you're now seeing, the true value of the book of business and the diversified operations that we run. That in any given quarter, we always have a lever we can pull in one division or the other, and we're quite happy to do it as long as we collectively deliver the results our shareholders expect of us.
Our next question comes from the line of Arash Soleimani at KBW.
Hi. Thanks, good afternoon, everyone.
Good afternoon, Arash.
Sure. Thanks. Just have a few questions. One, I know these are pretty small, but I'm just curious, what are the OTTI losses from Q1 and Q2 coming from?
Some of our investment portfolio includes equities. Joys of equities is they go up, and they go down. Given the numbers we are posting, when you have anything that goes down, OTTI is a great way of adjusting your cost basis.
One of our criteria, Arash, is it's got to be in an impaired situation for a minimum of 12 months before we consider it. We look at probable downgrades in the stock by various analysts, and then what's our potential to hold it to sale or hold it to maturity on some items.
Yeah. A lot of these things, because they're equity, we do hold on to them, and that's why they become OTTI. If we had sold them because we didn't believe that they would have any issues, then it would've just run through the income statement.
Yeah.
These things are showing up as OTTI because they're down in the market, we don't think they are over and done with, we sort of continue to hold on to them. Sometimes these things have a way of coming back. Richard, from his side of the table, marks them down as it meets the criteria. From the investment committee side of the table, they continue to hold them because they still think it's a good investment, especially as some of these things that are being marked down actually also have a very nice yield attached to them.
Okay.
Things like BDCs, oil sector investments, those kinds of things. Yeah.
Okay. That makes sense. Thanks. A few numbers questions. One, could you provide gross premiums written and policy count?
I think-
Gross premiums written I mentioned, but just a second, I'll dig it back out for you here.
Yeah. I think the policy count at the end of the quarter was around 170,000 or so.
Okay. Do you track, I guess, organic policy generation for the quarter?
No, we don't because it's almost so meaningless in our measurements over the years that we just don't track it.
Okay. That's.
Arash, gross premiums written for the quarter?
Okay
$155.3 million.
Great.
looking that up. Was there any development, favorable or adverse, in the quarter?
As far as losses? No.
No. Okay. My next question is, do you guys have any filed rate increases for flood?
Actually, that's an interesting question, Arash. I don't think the department's in a mindset to approve any increases of any rate at the moment.
Okay.
I'm sure we might have some flood rates out there somewhere, but it'd be wishful thinking to imagine that you actually are going to get an increase through the department.
Okay. Do you have any rates filed in other states?
Not on an admitted basis.
Okay.
We have got E&S licenses in a couple of places, that's a different situation.
Okay. I wanted to confirm something from Casey's question. Did you respond to Casey's question that there's no exposure for flood inside your statutory subsidiary? It's only within Claddagh and within third parties.
There's minimal exposures retained within the insurance company.
Okay.
Less than 5%.
I'm sorry, what was that?
Less than 5%.
Yeah. I think it's-
Minimum
it's minimum in rounding errors kind of thing. If there's anything there that shows up. We're just saying that out of an abundance of caution. I think it really may be zero, but we never like to say zero, yeah?
Basically all of HCI, all of the exposure for flood is basically in Claddagh then for HCI. Is that correct?
Mostly, yeah.
Primarily.
Yeah.
Okay. The stock-based compensation, does that flow through other operating expenses?
Yes.
Okay. My other question on the cat fund, you mentioned in your comments that it's shifting for HCI. Can you, I guess, just talk about how it's shifting and how that impacts you?
Yeah. Absolutely. I think two things. One is as you do a wind-only book mixture, those policies carry a higher cat fund premium and have higher coverage associated with them. That moves the thing around. The other thing is, a number of companies opted out of the 90% crunch of their election this year, which meant the rest of us, the ones that did keep the 90% election, actually got a lot more limit for the same dollar. It added to the amount of reinsurance cover provided by the cat fund. I think it increased it by about 10% more than it would have, if people hadn't taken down the retentions or their participations.
Did you have to pay more for that, or were you able to get that at your existing rate?
No, it sort of comes right out of the cat fund. What the cat fund does is tells everybody to select their participations. Based on that, they charge everybody whatever the premiums they're going to charge. The other side of that is they then divvy up $17 billion based on everybody's participation. We just got a greater share of the $17 billion because a lot of people went down from 90% to 45% at the last moment.
Okay. When you said in your comments, I think you mentioned flood is a national opportunity. Can you talk, I guess, expand on that a bit more?
Absolutely. Let me just give you three sets of numbers then tell you how big an opportunity it is if you know what you're doing.
Okay.
Don't get me wrong, there's ways of losing money in any market. People routinely prove that to us. Using the NFIP's numbers, I think the NFIP writes about $3.5 billion worth of premium throughout the United States. Of that $3.5 billion, $2.5 billion is in the East Coast states. That's going from Texas, around the Gulf, through Florida and up to Maine. Of that $2.5 billion, almost $1 billion of it is in Florida. We think over the course of time, this could help us expand into all these other East Coast states, we could probably easily pick up 15%-20% market share. I don't mean next week or next month or next year, but over the course of the next number of years.
Just doing simple math, 20% of $2.5 billion is around $500 million.
Okay. You mentioned the rates were hardening in two places. One was flood. What was the other one?
The wind-only book inside Citizens.
Oh, wind-only. Okay.
Yeah.
What are the rate increases you're seeing on the wind-only side?
Well, I think Citizens filed rates for this a year ago, where they went up about 10% or so.
Okay.
I don't know the exact number that you would have to ask Citizens, but I think there was some rate increase that went into effect as of February 1 this year, yeah?
Okay. In terms of your IT initiatives, I guess my question there is, do you have plans, not necessarily in the next 6 months, but just generally maybe in the next 2 or 3 years, are there plans to monetize some of the IT products that you have? Or is the idea there more so to use them internally and to kind of save money by not having to outsource those functions?
I would answer both. As far as internally, using internally, I think, and monetizing by using it internally, we already do that. I think our numbers speak to that effect in terms of efficiency, et cetera. As far as monetizing it with third parties, I think eventually, third parties will realize the value of these tools, and at some point, we are quite open to licensing them to third parties. When we do, there will be some valuation that will be created for that subsidiary because all the tools are designed such that Exzeo develops them. Homeowners Choice is merely the first licensee of those tools, but they are available to be licensed by third parties.
Okay. Thanks. Just very last question. On the expense ratio, I know you said stock-based compensation drove it down. Again, year-over-year, it went down like 400 basis points. Was that all from stock-based compensation or was something else flowing through there as well, the entire year-over-year decrease?
The stock-based compensation was a primary piece of it.
Okay. All right. Okay. Well, thank you very much for the answers and your time.
You're welcome.
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.
Thank you. 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 continued success in 2015.
Thank you for joining us today for our presentation. This concludes today's call. You may now disconnect.