Greetings, welcome to the Homeowners Choice third quarter 2014 earnings conference call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Kevin Mitchell, Vice President of Investor Relations. You may begin.
Thank you, good afternoon. Welcome to HCI Group's third quarter 2014 earnings call. With me today are Paresh Patel, our Chairman and Chief Executive Officer, Richard Allen, our Chief Financial Officer, and Scott Wallace, President of the Property and Casualty Insurance Division. Following Paresh's opening remarks, Richard will review our financial performance for the quarter, then turn the call back to Paresh for an operational update and business outlook. We will open up the call to 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 all 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, other similar words and expressions, are intended to signify forward-looking statements. Forward-looking statements are not guarantees of future results and conditions, but rather are subject to various risks and uncertainties. Some of these risks and uncertainties are identified in the company's filings with the Securities and Exchange Commission. Should any risks or uncertainties develop into actual events, these developments could have material adverse effects on the company's business, financial conditions, and results of operations. HCI Group, Inc. disclaims all the obligations to update any forward-looking statements. I would like to turn the call over to Paresh Patel, our Chairman and CEO. Paresh?
Thank you, Kevin, good afternoon, everyone. As Richard will expand on shortly, we reported solid quarters for our third quarter ending September 30th, 2014. This marks our 28th consecutive quarter of profitability. In September, we paid 27 and a half cents per share common dividend, 27 and a half cents per common share dividend, which represents our 16th consecutive quarter of paying common dividends. Our core insurance business continues to deliver excellent results. Policyholder surplus is approximately $150 million. Put this into perspective. It was $50 million at the end of 2011, and since then, it has grown, it has almost tripled, without the holding company making any significant contributions to capital and none at all since December of 2012. Moving on.
During the quarter, we repurchased and retired 246,578 shares of HCI common stock at a total cost of $10 million, or an average price of approximately $4.58 per share. This brings the total number of shares repurchased and retired in 2014 to almost 735,000 shares at a total cost of $27.8 million, an average purchase price of $37.85. As of September 30, 2014, we have approximately $12.2 million remaining under our board-approved plan that was implemented in March of 2014. On a different note, our real estate division, Greenleaf Capital, has finalized two retail shopping center transactions. The first is a loan arrangement and the second is a joint venture. Both projects include a purchase option and we expect more from Greenleaf in the coming months.
We also learned during the third quarter that HCI Group ranked number two on Fortune's list of the 100 fastest-growing public companies in the U.S. The ranking is based on average revenue growth, profit growth, and relative stock performance over the past three years. It's a wonderful achievement and we're glad to have been recognized. I just want to make sure everybody's aware that we are highly unlikely to repeat that because the metrics are so high to keep doing this year after year. Nevertheless, it was a good recognition. Before I go on, I'd like to invite our CFO, Richard Allen, to take us through our financial performance for the third quarter. Richard?
Thank you, Paresh, and good afternoon, everyone. Year-over-year, our third quarter income available to common stockholders grew 5.2%, and diluted earnings per common share increased 8.8%. There are a few items I would like to highlight that have driven results in 2014. Gross premiums earned are up year-over-year for both the three and the nine months ended September 30th. The 9.5% increase during the quarter and 11.5% increase year to date is primarily due to premium revenue from policies assumed from Citizens in November of 2013. The third quarter is an important quarter as we recognize the full impact of the current year reinsurance costs. Our ceded premiums were $626,000 lower in the quarter ended September 30th, 2014, compared with the same period in 2013, reflecting a slightly lower run rate for the 2014-15 hurricane season as compared with the prior treaty year.
As has been discussed in prior earnings calls, we have recorded certain benefits related to the retrospective provisions of the multi-year reinsurance treaties, which amounted to $6.4 million in the third quarter of 2014, compared to $3.9 million in the third quarter of 2013. Our net investment income in the third quarter was significantly higher than in the third quarter of 2013, reflecting a year-over-year increase in the size of our investment portfolio. We also realized a $3.3 million increase in realized investment gains year-over-year for the third quarter as we took advantage of market conditions. Losses and loss adjustment expenses during the third quarter of 2014 were up $7.5 million compared with the third quarter of 2013. Due to this increase, our loss ratio to net premiums earned for the third quarter of 2014 was 35.9%, compared with 27.4% in the third quarter of 2013.
The increase in claims in 2014 is a result of an increase in severity, primarily from fire-related claims, as well as an increase in frequency over exceedingly good levels last year. Policy acquisition, other underwriting expenses in the third quarter of 2014 were $1.1 million higher than in the prior year quarter. This year-over-year increase is primarily attributable to the renewal of policies assumed from Citizens in 2012 and 2013, which are now subject to commissions and premium taxes on renewal. Other operating expenses increased by $752,000 year-over-year for the third quarter and $6.2 million for the nine months. These increases are primarily due to increased compensation and related expenses. Interest expense from our senior notes increased $1.8 million for the third quarter of 2014 compared with the third quarter of 2013. The year-over-year increase for the nine-month period was $5.4 million.
The increase is attributable to the company's 3.875% convertible notes issued in December of 2013. Our total combined operating ratios to gross premiums earned, including investment income and reinsurance costs for the three months ended September 30th, 2014, was 74.4%, compared to 73.2% for the same period a year ago. Total stockholders' equity at the quarter end was $179.6 million, up 11.9% from $160.5 million at December 31st. Book value per common share has increased 17.1% to $17.19 at September 30th from $14.68 per share at December 31st. As always, we constantly review claims experience for the development and identification of trends in frequency, severity, and causes of loss being reported. We are encouraged by our results for the third quarter and remain committed to increasing shareholder value in future periods and years ahead. With that, I'd like to turn the call back over to Paresh. Paresh?
Thank you, Richard. Once again, for this quarter, we achieved four things simultaneously. We paid a healthy dividend, we reduced share count meaningfully, we increased book value, and we increased shareholder equity all at the same time. While we were doing this, we were obviously still pursuing growth opportunities as they arose. Our core business delivered profitable results and we continue to apply strict underwriting standards while providing our policyholders with the highest level of service. Subsequent to the quarter's end, we were approved to assume policies from Citizens for December. We expect the policies we assume will have an annual return premium in the range of $80 million-$100 million. We will not know the final number of policies assumed until December 16th of this year. The majority of assumed policies are slated to be wind only.
We will only be responsible for the peril of wind and not for such exposures as theft, fire, or water leaks. Until hurricane season starts on June 1st, 2015, we believe that our exposure will be minimal relative to these policies. HCI Group has a history of growing at strategic moments throughout the years. This December Citizens assumption is just one recent example of how we wait for the right moment and then pounce. Looking forward, our consistently profitable core business, coupled with our strong cash position of over $300 million, allows us to patiently seek accretive growth opportunities while we remain relentlessly focused on the bottom line. With that, we're ready to open your call for your questions. Operator, please provide the appropriate instructions.
At this time, we'll be conducting a question-answer session. If you'd 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'd 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 is from the line of Casey Alexander with Gilford Securities. Please proceed with your question.
Good afternoon. First of all, I heard that I'd missed a little something on the $10 million worth of shares that were repurchased during the quarter. What was the number of shares and the share price?
Okay, Casey, hang on. I'm just leafing back to that part of the script. Yeah. We repurchased 246,578 shares, total cost of $10 million, average purchase price of $40.58.
$40.58. Okay, great. Thank you. I guess that the loss in the LAE came up to a more normal level from a level that had been almost exaggeratedly low. Was there an event or a geography or a type of claim that cropped up or an increase to IBNR? Is there any type of color that you have on the sort of change in % of the loss in LAE as compared to as a % of gross premiums?
Yeah. Casey, look, I think you hit some of the points already in the question. Year-over-year comparisons are particularly stark because last Q3 was such a good quarter. You have a little bit of that playing into it. Beyond that, what we did have in the quarter, one, it was a very wet summer, so we ended up with a lot more claims. We just tend to get more claims in the summer. I think it's to do with the rain. We got a little bit more of that this year. Secondly, we had some significant fires, right? A few fires tend to move the number around dramatically, right? It's part of the risk nature of the business, yeah?
Right. Okay. On a quarter-to-quarter basis, the gross premiums earned declined by about 2.5%, which would suggest about a 10% annualized attrition rate. Is that a fair rate to use in modeling going forward?
Casey, normally people ask us this stuff in terms of PIF counts and those kinds of things, and we typically have been talking about keeping retention rates in the high 80s, 85, 88, that kind of range, maybe 90, yeah? I think, yeah, you're right in line with that. Some of this quarter-over-quarter variance occurs also because we don't renew our policies evenly throughout the year.
Right.
You have some quarters with a lot of renewals, and policy drop-offs tend to occur around renewals, yeah?
What was the policy count at the end of the quarter?
Don't have it exactly in front of me, but I think it would be somewhere around 150,000, give or take one or two.
What was that, 150 or 158?
No, 150 ±1,000 or 2,000, right?
150 plus or minus a couple grand.
Yeah.
Okay. All right, great. I'll jump back in the queue, and if I have something else, I'll come back in.
Okay.
Our next question comes on the line of Matt Carletti with JMP Securities. Please proceed with your question.
Yeah, thanks. Good afternoon.
Good afternoon.
Afternoon, Matt.
I have a few questions. First one, you guys have a history of being, let's call it pioneers into kind of areas that maybe others don't want to go and have a pretty good track record at it. I'm curious, wind only is an area that people have really stayed away from. There's been a few that haven't done so well there. Can you walk us through what you see in the wind-only policies and what you see as the opportunity for HCI and why you were attracted to them?
Yes, Matt. It's an intricate path we had to walk because we had to make sure that we take out these policies, you can reinsure them, because if you think about it, reinsurance would cover most of the peril of these policies because it's wind only. To make sure that you can pay for your corporate expenses and buy reinsurance at a sufficient value, sufficient price to be able to cover these policies.
Getting the formulas and the algorithms right to be able to pick the right book of business took quite a while. The stuff I'm telling you about is exactly the same concerns the department would have over the matter, and we had to show them why what we were doing worked. All of those things led us into this path. What also got us here, where we feel are in a different position to most of our other brethren, is a couple of things. One is that the wind-only policy tends to obviously be on the coast, right on the beach kind of thing.
Those are also the places where you might want to write them a flood policy.
Right.
Funny enough, this conversation had gone on with the department well over a year ago in the sense of flood policies and wind-only policies tend to be the same policy, yeah?
The same risk. We have been working on all of those things, but it takes a while to get that formula right and have the right structure with which to do this.
Obviously, time will tell as to how well we did this, yeah?
Yep. Do you think that, I know this might be tough to answer because you never know when a storm's going to hit, I guess assuming that you're paying for the reinsurance and it's enough reinsurance to cover the storm, in theory, it doesn't really matter one way or another, at least until the renewal, whether a storm hits or not. Do you think that the wind only policies are accretive, dilutive, about the same in terms of ROE to your business as the other policies in the book, or the aggregate of the other policies?
It depends on which measures you do. When you talk about ROE, clearly it's going to be accretive because you've just added a big piece of revenue to the top line, you haven't had to increase E by any, and profits are going to go up, so ROE is going to go up.
I guess I think about it from the standpoint of there's got to be some amount of incremental required capital because it increases PMLs and whatnot. On that, after adding in the incremental capital that it requires, and I realize you have that capital, I'm kind of thinking of it in terms of excluding excess capital, thinking about it in terms of required capital.
Yeah. I guess you're asking, is it a more profitable line of business than our existing line of business?
Yeah, essentially.
Yeah. I think it may be slightly less profitable than our existing book on a wind-only basis, but clearly, because of the fact that we have flood opportunities, et cetera, that may change over time, yeah? In fact, it will.
Okay. Next question I have is, does doing the takeout change your share repurchase appetite at all? Should we expect to continue to see you repurchase shares, or does this put that on hold and there's a new growth avenue?
Simple answer is, I think we have made that commitment about the $40 million. I think that's been earmarked as such.
Okay.
What may make a difference, just in terms of full disclosure, is where the shares trade at. Yeah?
Of course.
Yeah.
That makes sense. All right. Last one, just kind of cleaning up numbers questions. Do you have gross and net written premiums and weighted average and quarter end share count?
Gross premiums for the quarter?
Yep.
Gross written premium was $86,085,000.
Great.
Net premium written was $58,401,000.
All right.
Quarter end, fully diluted shares was 11,518,000.
Perfect.
Year to date for the nine months, it's 11,787,000.
All right. Thank you very much, and congrats on the quarter.
Thank you.
Our next question is from Dan Farrell with Sterne Agee . Please proceed with your question.
Thanks, good afternoon. Just a question on progression of the other expense ratio. We saw a trend up through the year last year, and part of that I think was for timing of accruals for compensation incentive comp expense. I think you've been doing that at a more even pace through the year, but we've still seen a gradual climb, however, and I'm wondering if that pattern would continue into fourth quarter, if that's an expectation we should be thinking about.
There should be a slight decrease in that.
Okay. It is more even. Okay.
Yeah
That's helpful. Then just, I guess, a longer-term question on thinking about reinsurance as we look ahead in reinsurance purchase. You guys obviously have a multi-year agreement that's served you well. I'm wondering if you think you'll see opportunities to do additional multi-year as you go forward, or if that's something that you think would be attractive to do versus standard one-year type coverages.
Dan, it's Paresh. A simple answer about some of this stuff is, it's a long time between now and next June, and the perception of the marketplace is shifting, right? That's why I'm going to give you a slightly fuzzy answer. Last year when we were doing multi-year deals, a lot of our reinsurance partners were reluctant or hesitant in doing so. They just didn't want it in their business model. I think what people are now thinking about is that if you did a multi-year deal last year, you locked in better rates than you will get on the open market this year. You now have people, the reinsurers, who might be more not only willing, but looking forward to doing multi-year deals. I'm not saying they're going to be, but there are some people that are changing their thoughts on this.
Equally well, on this side of the table, people are going, "Do I want to lock in a multi-year deal if rates are going to be lower next year?" There's a shift in thinking going on both sides of the table. Where all this plays out, who knows? We remain comfortable with the multi-year deals that we do have, and then the amount of single-year coverage that we would have to buy or additional coverage we will have to buy on June 1 of next year. I think we're well-positioned for both sets of outcomes. Putting it differently, we're well hedged, yeah?
That's helpful. Then just one last question. Just with regard to the wind policies that were taken out of Citizens, as we think about modeling that, what kind of differences in loss ratio would there be on that? Then also, we've seen some of the experience of what the retention is on past takeouts. Is there any reason to think the retention of this takeout will be materially different, or could we use what you've seen in the past as a proxy for that? Thank you.
Yeah. All right. Let's start with the retention levels, right? Our expectations are it should be about the same. Having said that, obviously, we're dealing with a new class and a new group of customers, if you like. They may behave differently. As we do with everything else, we'll be monitoring this closely. To date, we don't have any reason to believe that the retention rates won't be similar. Equally well, we don't have a track record of saying that it will be the same, yeah?
That's that. In terms of the losses and those kinds of things, if you look at our multi-peril business, et cetera, the bulk of our losses obviously come from other perils, things like fire, theft, water leaks, as we talked about. When you do a wind-only policy, about the only thing the losses you cover basically are hurricanes and things like tornadoes and hailstorms, very specific events. Especially when things like tornadoes and hail, and knock on wood, never say never, but those are not common perils that occur in Florida between the months of December and June. Yeah?
Yep. No, that's helpful. That's what I was getting at. Okay. That's all I have. Thank you very much.
Thank you.
Thank you.
Our next question comes from Arash Soleimani with KBW. Please proceed with your question.
Hi, good afternoon.
Good afternoon.
Just a couple questions here. It sounds like obviously you're saying the main attraction of the wind-only policy is the opportunity within flood. Just in terms of thinking about that, both in the short term and long term, because I know you mentioned maybe a couple of calls ago that the flood uptake was a bit slower. In terms of these takeouts, what's your anticipation for when the flood piece of it really starts to flow through?
Good question. We keep fine-tuning this and playing away at it. There are progress items that you should be aware of. One is, I think FEMA has laid out its new rate tables for next year, and I think the premiums are going up for about from between, I think like 15%-30%, if I remember correctly.
Okay.
When those kinds of things flow through, obviously the fact it was slow this year, it may not be that slow next year as people start feeling the increases of these, the effect of these rate increases. That's what we have been trying to communicate all along is that be patient, eventually things will go in a certain direction. Those aspects of things are all falling into place. Obviously something like this wind-only takeout complements that because a lot of the people who we're looking to convert will already be our customers. If you imagine that somebody currently is buying a wind-only policy, a flood policy, and an X-wind policy to cover their property, we really don't have any of those three relationships with them right now. By doing the Citizens takeout, we are going to get the wind-only relationship with them.
Their flood-only relationship is going to, shall we put it this way, is going to start deteriorating over time because-
Okay
FEMA, then I think you can connect the dots from there on out, right?
Right. Obviously, you've had the flood initiative in place, or the idea of it for a bit of time. Why was it that prior the wind only wasn't as attractive to you? What made it more attractive during this takeout, given, again, just that the flood idea was already in play?
It wasn't a question of attractive or not attractive. There is a lot of science that goes behind this in terms of policy selection and making sure you're in a comfortable position to be able to buy reinsurance, not only next year, but subsequent years for these policies. We're doing this because, and it took us this length of time to do it, because we wanted to make sure we got it right.
Okay.
Yeah?
Yeah. No, that makes sense. Then just in terms of kind of a general rate question, when you're renewing policies now and over the next few months, what are you seeing in your book in terms of the primary rates?
Very simple. It's been flat because we haven't applied for any rate increases. We don't have any rate decreases pending, I think it's safe to say that the current rate trend is downward.
Okay. With that said, given the sort of reinsurance environment, do you expect it to be sort of margin neutral, or do you think it'll be a bit hurtful to underwriting margins?
Good question. Look, I think next few months, it's downward. It should be margin neutral, but this is Florida. One storm and all of these projections will go in a different direction, yeah?
Yeah. The takeout you mentioned, December 16th, you get the final numbers. When does the actual assumption itself occur?
It actually occurs on December 16th.
Actually occurs okay. With the multi-year benefits you mentioned, are those benefits just an offset to ceded earned premiums?
Ceded written and ceded earned.
Okay. The 2.6 was within earned then, that I think you quoted a $2.something million number.
That's it. It reduces the written and the earned by the same amount.
Oh, okay. Just last two numbers questions. What were duration and prior period development in the quarter?
I don't think we have it handy in front of us here. We'll get back to you on it, yeah? It'll be in our stat filings, we'll get back to you on it. Yeah?
Okay. Thank you. That's all I had. Thanks for the answers.
Thank you.
Our next question is from Casey Alexander with Gilford Securities. Please proceed with your question.
Hi. The real estate portion is up to about 5% of your investable assets. Is there a limitation to how far you can go with that, either as a percentage of your assets or how do you feel about that, and could you give us a little bit more delineation of the real estate strategy applied?
Yeah. Casey, I think, that whole thing about the investable assets kind of thing, I think you're thinking for the insurance hub. The real estate we're talking about doing is in Greenleaf, and Greenleaf's capital comes from the parent, the hold co, not from the insurance sub. Basically, the real estate deals we're talking about is being paid out of shareholder funds, not policyholder funds.
Casey, there are requirements for segment reporting. I'm not sure the percentage of total assets and total income for that, quote, division. We're not near that yet.
Yeah. As far as what we go off and do with this, we're just playing along with it. We take opportunities as they come along.
Okay, great. Thank you.
It appears there are no further questions at this time. I'd like to turn the floor back over to Mr. Kevin Mitchell for 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. Thank you. Have a great evening.
This concludes today's teleconference. Thank you for your participation.