Greetings, and welcome to the HCI Group, Inc. fourth quarter and full year 2013 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. I would now turn the conference over to Mr. Kevin Mitchell, Vice President of Investor Relations. Thank you, Mr. Mitchell. You may begin.
Thank you, good afternoon. Welcome to HCI Group's fourth quarter and full year 2013 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 our Insurance division. Following Paresh's opening remarks, Richard will review our financial performance for the quarter and fiscal year, then turn the call back to Paresh for a brief update and business outlook. We will open up the call for 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, 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. 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 obligations to update any forward-looking statements. I'd like to turn the call over to Paresh Patel, our Chairman and Chief Executive Officer. Paresh?
Thank you, Kevin, good afternoon, everyone. As Richard will expand on shortly, we reported outstanding results for the 3 months and fiscal year ended December 31st, 2013. Business highlights for the quarter were, 1, we received approval from the Florida Office of Insurance Regulation to offer flood insurance coverage to our Florida policyholders. In January of this year, we sold our first policy with flood coverage. 2, we raised $103 million through the issuance of senior convertible notes in December. The notes are unsecured, bear interest at a rate of 3.875% annual, are due in 2019. They're convertible into common shares at a price of $50.47 per share, only after the occurrence of certain events. This offering strengthens our cash position and may enable us to capitalize on further growth opportunities should they arise.
Three, additionally, in November 2013, we assumed approximately 34,000 policies from Citizens Property Insurance Corporation, Florida's state-owned insurance company. Fourth, we increased our regular common dividend by 22% to $0.275 per common share per quarter. Before I go on, I would like to turn the call over to our CFO, Richard Allen, to walk us through our financial performance for the fourth quarter and fiscal year 2013. Richard?
Thank you, Paresh, and good afternoon, everyone. For the fourth quarter of 2013, income available to common stockholders totaled $15.5 million, or $1.31 diluted earnings per common share. This is an increase of 19% and 10% respectively from $13.1 million, or $1.19 diluted earnings per share for the fourth quarter of 2012. For the year ended December 31, 2013, income available to common stockholders totaled $65.5 million, or $5.63 diluted earnings per common share. This compares to $29.8 million, or $3.02 diluted earnings per common share in 2012. Net premiums earned for the fourth quarter of 2013 increased 28% to $63.4 million from $49.6 million in the fourth quarter of 2012. For fiscal 2013, net premiums earned increased 48.6% to $234.2 million from $157.7 million in 2012.
For the fourth quarter and year 2013, a benefit of $5.7 million and $12.5 million was recognized respectively, resulting from the multi-year retrospective reinsurance treaties as has been discussed in prior earnings calls. Our loss ratio applicable to the fourth quarter of 2013, which we define as losses and loss adjustment expenses related to gross premiums earned, was 18.9%, compared with 22.1% in the fourth quarter of 2012. For the full year of 2013, the loss ratio was 19.3%, compared with 28.4% in 2012. The expense ratio applicable to fourth quarter of 2013, which we define as underwriting expenses, interest, and other operating expenses related to gross premiums earned, totaled 24.8%, compared with 19.6% in 2012. Expense ratio applicable to 2013 was 20.6%, compared with 20.2% in 2012.
Expressed as a total of all expenses related to gross premiums earned, the combined loss and loss expense ratio to gross premiums earned in the fourth quarter of 2013 was 43.7%, compared with 41.7% in the previous year period. For 2013, the combined loss and expense ratio to gross premiums earned was 39.9%, compared with 48.6% in 2012. The improvements in these ratios reflect a significant increase in gross premiums earned and continued favorable trends in costs related to our loss and loss adjustment expenses. We constantly monitor claim activities for developments of trends in frequency, severity, and causes of loss for the potential impact on incurred loss and loss expenses. Investments in fixed maturity and equity securities totaled $129.8 million at December 31, 2013, an increase from $44.8 million at December 31, 2012. During the fourth quarter, we added approximately $64 million to our investments in fixed maturity securities.
Total stockholders' equity at December 31, 2013 was $160.5 million, compares to $121.5 million at December 31, 2012, an increase of 32.4%. Net book value per share has increased to $14.68 at the end of December 2013 from $10.93 per share at the prior year-end. We are pleased with these results for the fourth quarter and full year of 2013, and remain committed to increasing shareholder value in future periods. Now, I'd like to turn the call back over to Paresh.
Thank you, Richard. 2013 was another record year for our company. As our results demonstrate, the operational momentum we established in the past continued throughout the year. Our core business delivered profitable results as we remained focused on applying our strict underwriting standards and minimizing operating costs while providing our policyholders with the highest level of service. Just to put this into perspective, I think the pre-tax earnings for 2013 are about two times the market cap of the company about three years ago. That's an astounding rate of growth. Our entry into the flood insurance space at a time when Florida residents are facing drastic increases in their flood premiums further distinguishes Homeowners Choice from other companies in Florida. It helps to build upon the image of the brand, and we think it's going to pay off dividends in the future.
Looking forward, our consistent profitable core business, coupled with our strong and ever-growing cash position, allows us to patiently seek accretive growth opportunities while we are being amply rewarded for being patient until that opportunity arrives. With that, we're ready to open the call for your questions. Operator, please provide the appropriate instructions.
Thank you. Ladies and gentlemen, we will now be conducting a question-and-answer session. If you would like to ask a question, please press *1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press *2 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. Our first question is from Arash Soleimani of KBW. Please go ahead.
Hi, thank you. Just had a couple questions. In terms of legislation for flood, I was just wondering if you could provide an update on that. More specifically, if it turns out that rate increases get capped there, will that significantly, I guess, prohibit you from operating in that space?
Good question. In terms of the legislation that's pending, they keep saying it's on again, off again, so it's an interesting situation to watch. Who knows what Congress will do? As far as, let's take the scenario where they push off the rate increases. The rates that we've set are actually pre-Biggert-Waters rates, so we would still be competitive with the NFIP even if they repeal Biggert-Waters. If they don't, or if they put it on a glide path or any of those kinds of things, we're just debating degrees of cost advantage that we would have over the federal flood program. In most events, our ability to offer flood insurance would be more competitive than NFIP in every scenario that is currently being considered.
Okay, great. Thanks. Also, just given the overall increase in your share price over the last 12 months, is equity financing something that comes on your radar at all, or you think that's not in your future plans at the moment?
Again, good question. We never say never, I think as the last two financing rounds that we have done would seem to indicate, we tend to be looking more towards debt financing as opposed to equity financing. Frankly speaking, I think we look with a very jaundiced eye at a thought of diluting our existing shareholders by doing more equity offerings, et cetera.
Right. In terms of the increase within your fixed income investments during the quarter, can you just provide the duration on that portfolio?
I think the duration of the portfolio is actually five to seven years. It isn't really that far out. The other side of that, obviously, is that in terms of numbers Richard put forward, you're starting to see some increase in investment income as you put cash to work. As we've stated in previous calls, it's a work in progress, and it'll slowly build over time. It's a new profit center that will hopefully open up over the course of 2014 for us.
Okay, great. Then just finally, in terms of the expense ratio, I know in the release you mentioned that that went up a bit due to some compensation expenses, I just wanted to know if you could elaborate on that a bit, just because with the growth in earned premiums, I thought that would offset some of that a bit. Can you just elaborate a bit on that, please?
Yeah. Very basically, I think, personally speaking, I'm responsible for some of that, given the bonus I think the board granted me, that's part of it. The bigger chunk of it that also goes on is that in order to align management interests along with shareholders, we have been granting some restricted shares to basically everybody in the management team, that, while it being a non-cash charge, does accumulate an expense ratio. Correct, Richard?
Correct.
Okay, great. Thank you so much for the answers.
Okay.
Thank you. The next question is from Robert Pond of Sidoti & Company. Please go ahead.
Good afternoon.
Afternoon, Robert.
Afternoon.
Can you talk about the loss experience in the quarter, and more specifically, about the absolute claim count? If I remember correctly, last fourth quarter, you experienced a sizable drop in total claims. How was your experience this quarter compared to a year ago?
When you consider the increase in overall exposures quarter to quarter, there was a drop fourth quarter last year, slight increase this year compared to the fourth quarter of last year, but it was stable with the prior quarters this year. The actual severity of losses has not increased. It was just in the fourth quarter, the frequency was up a little bit, but it was steady with the rest of the year.
Okay, thanks. I also had a question on pricing. There's been talk about downward pressure on Florida rates. What are your thoughts on industry pricing? Given your profitability in the last few years, have you had any pushbacks from agents on some of your rates?
Robert, it's Paresh. The answer to that question, really, rates are set through a rate filing process. Obviously, we're a regulated entity. We're about due to put a rate filing in even as we speak. Generally speaking, rate and pricing pressures do not so much come from agents as much as either competition or regulators. Given where the industry is currently and given how 2013 has shaped up, I think the industry as a whole, and us included, are looking at probably flat to lower pricing in our next rate filings. I think we should be seeing a similar number for us. Obviously, it takes 90 days or so after we file to sort out really what the final agreed rate is with the regulators.
I would expect our rates to be flat or on a slight downward trajectory going forward, at least given the current state of circumstances.
Just one more. I know your June 1st is approaching, and I wanted to ask about the upcoming reinsurance contract. I'm sure you're starting to begin discussions with some reinsurers. I was wondering if you could comment on how those discussions are coming along, and has your thinking changed at all with the softening of pricing in the reinsurance market? Any comments there would be helpful.
Simple comments in terms of upcoming conversations. Yes, there is a general belief that reinsurance rates on June 1 will be softer than last year, obviously, depending on your perspective as to what degree of discount is going to be over last year on a per unit of reinsurance. The prices are coming down. Against that, from our perspective, you also have other things playing out, such as we have a bigger book, so we will probably be buying more units of reinsurance. Third item that's been talked about, I think in some of the other conference calls, has been about the new Demotech memo that came out in December, which is, I think, compelling everybody to buy more units of reinsurance on an apples-to-apples basis to last year.
The fourth item that plays in our reinsurance expenditure on June 1 is going to be the ongoing effects of our multi-year contracts that we already have in place, which as reinsurance years roll over, actually contribute positively to its ordinary reinsurance expenses. Given all of those different things pulling in different directions, at least our initial expectations are that as a percentage of gross revenue, we do not expect reinsurance to change that much year over year.
Okay. Thank you for the answer.
Obviously subject to final contract negotiations and all the caveats that I can throw in there, yeah?
Right. Thank you for the answers.
Thank you. The next question is from Casey Alexander of Gilford Securities. Please go ahead.
Hi, good afternoon.
Afternoon, Casey.
Now that you've had the 34,000 policies from Citizens on the books for a few months, how is it settling out in terms of the retention of those policies? What is working out to be sort of the average premium per policy?
Casey, offhand, we are doing our usual stuff of retaining approximately 90% of it. When we assume 34,000, we do take a first month hit because people still have 30 days to opt out. I think we're down to what we would expect around the 32,000 mark, 32,500 mark. I think if past history is anything to go by, we will probably retain approximately at the end of the year, we'll still have 30,000 of these people still as customers. It's roughly that kind of range we're looking at. In terms of the average price per policy, I think it came in around $2,250.
I think that was it.
Yeah, something like that, in that nature. It is a slightly different lower number than it was in the 2012 takeout, and the reason for that is that the policy mix, in this case, includes a lot more dwelling and fire policies than 2012 did.
Okay. All right, great. Secondly, in the other operating expense line, is there any one-time to sort of the increase in other operating expense or is this number that we are looking at sort of a reasonable go-forward rate?
What is in the other operating expense line for this year, Casey, is basically.
I mean for the quarter.
For the quarter?
Yeah.
For the quarter, Paresh kind of hit it on the head when he answered the gentleman from KBW's phone call. There's some things in there for bonuses for some staff, some stock compensation costs.
I think what Rich is trying to say is, I don't expect that that's the number that's going to be the same number going forward.
No.
Okay. Well, that's what I'm trying to figure out is, are you accruing for that over the course of the year, or did the vast majority of that get dumped into one quarter?
We accrued for some of it, and a large portion of it got accrued in the fourth quarter.
Okay. All right.
Accrued and paid in the fourth quarter.
All right. That's helpful. On the flood underwriting, assume that there's no change in legislation and things go as you expect. At what point in time would you expect the flood business to start to show up in sort of the revenue and earnings of the companies and start to make a tangible difference? Because really, you wrote the first policy, that was one policy. This is not like a takedown from Citizens where a massive amount of policy comes online at one time. This is more of an organic growth. How long is it going to take for that to make a measurable difference to gross premiums and earnings per share?
Probably by the end of the year.
Okay.
It depends on what you define as meaningful. There was a time where we used to think $10 million was very meaningful. The numbers keep growing bigger. I think, if they don't repeal anything, assuming FEMA starts enforcing Biggert-Waters, it is going to start having an effect. The reason I'm saying all these things in that category, the way the business is being written by us and how we're getting the business is that people are aware of Biggert-Waters and everything else, and it's an interesting conversation piece. When they receive their flood renewal bill, suddenly we become a very prized info company to have around.
Urgent matter.
It becomes an urgent matter. As this thing rolls out, it's going to gather steam. What we've done in January up to now has really been the first, the tip of the iceberg. Or sorry, the tip of the spear. Yeah?
Okay. Last question. Since the stock was $16, $17, $18 a share, there's been a pretty persistent around 2.2 million share short position in the stock, which is a pretty high percentage. Not only of the shares outstanding, but certainly a very high percentage of the float when you take out management's positions. Do you have any thoughts on the short position or explanation for the size of the short position and the persistence of the short position?
Casey, generally speaking, we tend not to talk about share positions, et cetera. As far as the size and rationale of those people, unfortunately, I think most of them have their own viewpoint, so I can't really comment on that. There is one item that I wanted to point out about the short position. Are we aware of them? Yes, we are, because they do occasionally write nice articles about us, right? We do get that. The item that has become a mathematical item is that with the issuance of the convertible debt, basically, in order to raise that debt, we can settle it with 1.6 million shares of common stock. Roughly, that works out to about $52.47 a share. We did that in the convertible debt offering. Obviously, we took that money in.
We've already bought back about 600,000 shares, basically the net dilution to the shareholders that will occur out of this transaction on a worst-case basis right now is about 1 million shares. Against that, we've received about $70 million in cash that we still have. If you look at it from that perspective, we clearly can do things such as buy shares at $48 a share, and it would be a net positive transaction for the long shareholders, which are the people, obviously, that we're supposed to take a look at. One of the interesting things about the short position, I think the thesis has been that the stock's overvalued, which is always the reason why people short stuff, ultimately.
The interesting situation we find ourselves in is that you have, in the hands of management, the ability to do a substantial buyback at current share prices, and it'd actually be beneficial for shareholders.
All right. That's great. Thank you very much, and thank you for taking my questions.
Thank you.
Thank you.
Thank you. The next question is from Matt Carletti of JMP Securities. Please go ahead.
Hi, this is actually Christine Worley for Matt. I have a couple of sort of numbers questions. First off, on the policy fee income side, it sort of seemed to take a pretty precipitous drop off. Is there anything driving that? Is that sort of the sustainable level going forward?
The big change in 2013 on that was we are recognizing that over the term of the policy now. In 2012, we were recognizing it as received. It was pointed out to us by our auditors that the proper method is to recognize it over the term.
Okay. Something sort of closer to that 85 level would be a go-forward number per quarter.
Correct.
Okay. Then sort of same thing, other side of the coin on the other income line, it seemed to take a pretty decent step up. Is there anything driving that?
A large part of the other income, as is fully disclosed in our K, which hadn't been filed yet, is a large piece of the real estate operations. We showed a profit in some of the real estate pieces for this last quarter.
Okay. That was a bit more one-time. Sure.
Allen?
That also includes the results of the Aon settlement that was received in the fourth quarter.
Okay. Thank you very much. That's all I've got.
Thank you. The next question is from Edward Hemmelgarn of Shaker Investments. Please go ahead.
Yeah, I had a few questions here. First of all, how many policies were in force at the end of the year?
I believe the number was around 163,000 or so after opt-outs and stuff from the November takeout.
Okay. In terms of just as a follow-up on the policy fee income, basically, did you just take with the only recognized $85,000 in the quarter, was that just kind of like a catch-up to because of the fact that you took greater amounts in the prior quarters, and now in the future, you're going to average it out over a, it should be a fairly equal number in future quarters?
You recognize it over the term going forward of the policy.
It should be, I guess what I was trying to say is then is it should be basically as opposed to having the number bounce around like it did in the four quarters in 2013, it'll be a fairly average number.
Right.
Average of all those numbers.
Correct
in the future. Okay. All right. It's not 85. Okay, one more or a couple more questions. In terms of the cost of the reinsurance for this coming year, I think you indicated that you didn't expect the rate or the reinsurance to change much. Are you talking about the absolute dollar amount that you pay or the rate that you're going to pay?
I think the way we tend to think about it being on parity is as in a % of premium in force as of June 1.
Okay. You're talking about the rate then. Yeah. Okay. You would expect it to go up because you're going to have more premiums in force effective June 1st?
On a dollar basis, yes.
Yeah, the absolute dollar will probably increase somewhat, but the rate will be relatively stable.
Okay. Then lastly, how are you going to grow in 2014 now? What are your plans?
It's the question everybody keeps wondering about. I know it causes a degree of concerns out there, and people talk about this because how do you do this in a world of Citizens clearing house, et cetera? I'd like to point out a few basic facts. Citizens clearing house is actually having the reverse effect, at least from our perspective. We are seeing a lot more quote activity and people wanting to do business voluntarily with us because getting a quote out of the clearing house takes so much effort. We're actually seeing a slight different version that on a voluntary basis. The second item that everybody sort of gets concerned about is the Citizens pond fished out?
An interesting thing, if you look at our history over the last five years, this is a company that has usually shrunk in size from January all the way through the end of September, even October.
It always finishes a year bigger than it was the year before. Fundamentally, that hasn't changed. I say it that way because if you look at some of our biggest wins, if you like, if you had asked us in March about that event occurring, nobody would have said so. For example, HomeWise wasn't even on anybody's radar till mid-August or even early September in 2011, and there it was, a 70,000 policy acquisition by early November. We've had the same situations occur in 2012 and 2013 regarding takeouts, et cetera. I think one of these concerns everybody has is about where will you grow from. We ourselves are not worried about it because what we know about the business is March, things look one way.
By the time you get to September, the world usually looks very different because what hasn't changed is we are about to go through a hurricane season. The interesting thing at this point is what everybody should be aware of is we are positioned to grow really well after a hurricane. The concerns everybody seems to have about how will you grow seems to rely on the fact that there will not be any hurricanes. This is Florida we're talking about, right?
I'm well aware of that, yeah.
So.
I was just curious what your plans were. You would expect to be, what you're saying is, continue to be opportunistic, and you think those opportunities will arise.
Yes, we will continue to be opportunistic, and we've got a track record now and a history thereof that these opportunities do seem to come along on a periodic basis. The only unfortunate part about these opportunities is that they're tough to predict any more than two or three months in advance. Do they show up with some frequency? They do.
Okay, great. Thanks.
Thank you. The next question is from Buzz Hiteke of Heidtke & Co.. Please go ahead.
Yes. Let's see. My first question is, your gross premiums written was up 26%, and then your policy acquisition costs were up about 51%. Will that probably start coming down some next year? Went from $6.2 million up to $9.5 million. Or stay about the same.
It should stabilize.
At 9.5?
Around 9.5, at that % based on our premium volume.
Okay then. My last question is, you all were expected to earn $1.45. Didn't quite make that. You got any reasons in a sense or two why?
It's an interesting situation. The $1.45 I think actually even seems to have occurred because, I think my good friend Casey upgraded the estimates a few weeks ago.
Before that, I think the estimate was around $1.32 or so. We were right in line with that. Part of the way our business works, and we've already said that, is that there is some degree of volatility to earnings. We are now in that situation whereby what is considered a, to use a better phrase, a miss for most people.
Would be a fantastic outcome, right? We have always run the company to look at it in the sense of making sure we get a good risk/reward blend, and we continue to do so. Part of the other thing that's held down the earnings for the fourth quarter has been that, given what a banner 2013 we had, we wanted to make sure that we sort of took whatever we could in 2013 expenses, as you would expect to do in these kinds of situations. We weren't really trying to hit $1.45 or $1.50 or $1.60. We were trying to make sure the company was well-positioned for 2014, which it is.
Okay, the last question. Your operating expenses, of course, you mentioned that they went up 50% from a year ago. They'll probably come down a little bit, won't they, next quarter or this quarter we're in?
Yes.
Yeah. I think the other thing you should look at is operating expenses when you get the K. I should try to drill down as to how much of it is cash expenses versus-
How much cash, how much is related to the stock compensation. There's a myriad of things in that category.
Yeah. A large chunk of that is because of non-cash expenses in stock grants, et cetera. Part of the situation we're seeing in that is we're taking big charges of that because the share price has done so well.
Yeah.
Right? If we were granting the same amount of shares with a share price at $10, it would be a very different number.
Are you all getting it on the number of shares? Is that the way it is instead of a dollar price, primarily?
I think it's to do with what the share price is at the date of the grant, regardless of the duration of the grant, et cetera. Basically, a mathematical calculation is done based on number of shares and the share price. Obviously the projected share price. Once that's locked in, it's locked in and amortized over some length of time.
Depending on the conditions of the grant, there's either a Black-Scholes or a Monte Carlo method that you use to value these as of the grant date. There's a lot of variables that go into those.
Okay, then.
Yeah. In an interesting manner, this is being done at the grant date as opposed to at a date when the.
Vesting date.
Okay. All right. Well, thank you very much.
Thank you. The next question is from Cliff Orr of JAM Capital Partners. Please go ahead.
Good afternoon. Thanks for taking my call. First question, why did book value decrease by about $6 million? What was going on with APIC?
APIC? Partially due to the long-term debt that was issued in December.
The book value was because of share buyback.
Yeah. The buyback, there was $29 million impacted on APIC. That's offset by a $15 million deferred tax. No, excuse me. Yeah, that's correct. Equity component on the convertible debt and the deferred taxes on a debt discount all amounted to decreasing that approximately $15 million.
Okay, the $29 million in buybacks was in the open market?
Yes.
Actually, let me clarify that. I think it was done through a forward contract, prepaid forward contract.
Yeah, prepaid forward contract.
Yeah. I'm sort of clarifying that because I don't want anybody to sort of have the impression that somebody was out there that on our behalf, actually buying back the appropriate 600,000 shares. We just did a forward contract with Deutsche Bank, I believe was the party.
Yeah.
Whether they've gone and bought back shares or not or whatever, we wouldn't be privy to that.
Okay. All right. The forward that you executed with them could have resulted in them offsetting that in the open market.
They may or may not. Whether they did buy those shares in the open market or not would be speculation on our part.
Okay. Fair enough. Paresh, you had made the comment about on the heels of the clearinghouse, you've noticed that the company's getting some sort of voluntary quoting from customers who maybe have been dissatisfied with the clearinghouse process. Could you explain that a little bit further?
Sure I can. Part of the thing with the clearinghouse is that the clearinghouse isn't a quoting mechanism as much as it is an offer of coverage mechanism. Seems like the difference between those two statements, what it is that in a quote, you're just trying to give somebody an idea as to what something would cost. An offer of coverage basically says, "Here's my price, and if you sign here, you at least have that for 30 days." Consequently, to do that offer of coverage, each carrier involved in the clearinghouse gets a lot more concerned and focused on making sure all the questions that they need answered are answered before this offer of coverage is made. Consequently, one of the things that's happening in the clearinghouse is that somebody applying for, looking for coverage has to go through 80 questions before they get a quote.
What they call a quote, what Citizens would call an offer of coverage. Clearly, this takes a long period of time, and you get asked a lot of questions, which you go, "I just want to know what the price is. Why are you asking me these other questions?" Causes that kind of a consternation on part of the user. It isn't to say it's good or bad. This is just facts of life. Yeah? In that environment, the fact you can come to Homeowners Choice and get a quote in five minutes creates a different kind of differentiation, yeah?
Okay. Dissatisfaction sort of with the clearinghouse process is driving people to approach you guys for quotes on their own accord?
I would say that we are seeing early signs of that, right? The clearinghouse has only been in effect for a month. So far, clearinghouse opens up, we see an uptick in business.
Yeah
Are you-
Any interest or thoughts of joining or entering the clearinghouse to participate in?
Sorry, can you repeat the question?
Any thoughts of entering the clearinghouse as a participating company?
Citizens is on a plan whereby they're bringing people on a staggered basis. They brought the first four carriers on, now they're bringing the next block on, and so on. The first 20 carriers that have been scheduled have been laid out all the way to, I think, mid-to-late July, and we're not on that list. Somewhere down the road, would we join the clearinghouse? Quite possibly, but it's at a minimum several months away.
Okay.
To put that in perspective, why for us that also makes sense, and we did this in conjunction with Citizens, I don't want to give the impression that we didn't want to join or they said no. We run a business model, as I stated before, that our business tends to be stable or on a slightly downward trajectory from January through probably the end of September. Given that kind of period of time, it would be very unlikely that we would be sitting there taking lots of policies from the clearinghouse, even if we were already signed onboard and there was lots of available business. It just doesn't fit in our business model. We had that conversation with Citizens, and we sort of moved towards the end of the back of the queue. Yeah?
Okay. All right, lastly, you gave your previous commentary around really the sort of the intra-year trajectory of policy counts and how it's always naturally ebbs until the fall takeouts. I wanted to understand better, logically, the dynamic with Citizens has changed somewhat with the clearinghouse. One, you're going to have less policies entering Citizens, and two, those that renew out of Citizens are going to leave a smaller policy count, within Citizens, and those policies should be relatively less attractive from a price risk perspective. Given that dynamic, how do you think about being opportunistic and what is admittedly just a different operating environment whereby Citizens may not have large policies that are of equivalent attraction, in October and November, barring some catastrophic event?
Great question. We've sort of got this thing hedged in a number of different ways. If you go with the scenario you're suggesting, that clearing house is a great success, policies don't go in there, and Citizens shrinks. Oh my God, what would we do next? Couple of counterpoints to that. One is this whole idea of Citizens shrinking, clearing house, et cetera. All of this is being projected in a straight line, assuming that there is no storms. One storm, and Citizens is going to increase in size very, very quickly. It's just what tends to happen in Florida. This is not a great prediction on my part. You just got to go back and look after every storm what has happened in Florida over the last 20 years.
This idea about the pool being fished out or not fished out changes in the space of 10 days if there's a storm. That item says what you're looking at this moment in time is not something you should be therefore projecting forward for any length of time, especially with wind season coming up. That's item one. Item two is we've already taken steps to move in a different direction. When we are doing this combined flood wind policy, the folks that are now starting to be affected, and that number is going to grow assuming Congress doesn't repeal this thing. Just by that sheer nature of that, we are seeing a marked differentiation of the Homeowners Choice brand.
Now, if Biggert-Waters doesn't get repealed, obviously there will be a group of customers who will come to us because they need us to desperately help them out, and we will be glad to do so. What is even bigger, and that is also occurring, is because we took the initiative to step up and solve this flood problem and actually stand up for these folks when everybody in Congress and everybody else dithered around on the matter, it is creating a tremendous wave of goodwill for the company, in Florida, because people seem to understand that do you want to be with an insurance carrier who looks at whenever you have an issue and say, "Not my problem," or is trying to say, "My policyholders are people that we care about and we try to take care of whenever we can." Right?
This whole thing of why we're in the flood business has ramifications and opportunities which go beyond the simple economics of the flood business itself. We are being starting to be perceived as the insurer of first choice. You know how Citizens tries to be the insurer of last choice? We're trying to go the other way. All of these items do add up. The final item is imagine all of these things don't happen, and then what will you do? Well, I do point out that, as I said earlier in my opening commentary, that we're looking at a business that last year, if we just continued on into this year, just from that following through projections, is on a pre-cash basis, earning a number that is significantly greater than even what the market cap was a few years ago.
Given this degree of cash flow, you just got to wait patiently till the next opportunity comes along, and it will come along.
Following up on the flood insurance, just so we understand the distribution strategy there, that's through the current policyholder base?
Sorry, you were breaking up. Can you repeat the question?
Absolutely. Just to understand the distribution strategy around flood insurance that is targeting the current HCI policy base as a retention mechanism in large part.
Actually, since we announced that we're doing this, people are randomly calling us up because they hear about it, and they say, "We would like to switch to HCI." We're getting as many phone calls, not from our customer base, as we are getting from the other 96% of the Florida marketplace that is not our customer base.
All right. Well, thank you. I appreciate your time and answers.
Thank you.
Thank you. The next question is from Lee Matheson of Broadview Capital Management. Please go ahead.
Good afternoon, guys.
Good afternoon.
Good afternoon.
A couple of questions. I guess just to summarize on some of the things you said about where you take this business next. In the event that the clearinghouse eliminates the ability for you to do large takeout transactions, I guess at this point, in terms of writing voluntary business in Florida, you're currently not really writing any voluntary business. Do you have the relationships in place to get the brokerage community on site to get that going?
We have 4,000 agents under contract who we send a commission check to every month. Right? I think we have the network.
Okay. What you miss with that, obviously, is you're now going to take a, call it a 15% commission that you're not currently paying on a takeout policy. You're not going to be able to recognize the takeout in one fell swoop and kind of play the seasonal arbitrage that you're able to do under the depops. I guess, obviously, you guys have come a long way and have been tremendously successful, but how do you back in from being a three and a half times tangible book stock to just going to being kind of a run-of-the-mill traditional voluntary insurance underwriter in the Florida market?
Let me answer the question in a number of different ways. One, if you want to look at what our run-of-the-mill numbers look like, look at our third quarter numbers, because that's with a full reinsurance load and a full commission load and everything else. That's a recurring revenue stream. Right?
Correct.
We're not exactly running at a 96% combined ratio or anything else. This is a very profitable business just on a renewal basis. We've already crossed that threshold. We've got that as a basic item. Second item, I think you said that when we write a voluntary business, we will pay 15% commission, but we wouldn't have paid that in Citizens. In reality, at all renewals, the only time we get a commission advantage is the first year of an assumption. As soon as the policy renews, we are paying the agent the same commission rate as if he voluntary writes the business with us. There isn't really that huge of a price differential. Third item is, yeah, is doing a takeout more advantageous than doing voluntary? Absolutely.
The interesting situation about this is we've been saying that for 7 years, and for five and a half out of the 7 years, everybody else sort of told you how bad that business was, and now everybody is concerned that that terrible business is going away. By the time everybody's jumped on board, we've already fished out Citizens for the stuff that we needed. In reality, for us, we have an advantage over most of our competition that we can really post very good numbers just by maintaining the status quo. Everybody else has to do something to have an incremental growth outlook. As far as price, the book, et cetera, look at ROE. Right? You have a business that's putting an ROE that is of a very, very different nature, and this is in a world with a 40% tax bracket.
Sure.
When you look at all of those things, yeah, at this moment in time, given the number we just posted for 2013. Are you expecting 2014 to go-- and 2013 was double 2012. Are you expecting 2014 to double on a pre-tax basis? Tough to imagine. Having said that, even if, and I'm just saying even, I'm not making a projection here. Even if you only make, and wonderful ironic term, only make $80 million pre-tax in 2014, it would be the second-best year in the company's history, and run rings around anybody else in the state. If this is what we're worried about, I think we should step back and take a deep breath because that assumes we sit here and we find no opportunities, nothing happens, this thing just rolls along.
You do look at a management team that somehow inevitably has always managed to find something to do over the course of the 12 long months that are a given year.
Right.
Yeah?
Right. Okay.
That's.
Yeah. All right. I guess at the end of the day, do you feel that the amount of, to some degree, because of your profitability in doing these transactions, you maybe attracted capital to the space that has some degree arbitraged out your opportunity to continue to exploit the nature of those transactions?
I don't know.
I mean, you work. Sorry.
Yeah, I think, yes, our success has attracted a lot of capital to the space, but the capital coming to our space hasn't destroyed our profitability. It has basically maybe limited some degree of our growth. The interesting thing about this business is one storm can change that in a hurry. A hard reinsurance market can change this in a hurry as well, yeah?
Yeah. I get, when we look into and see the 35,000 policy takeout that you did more recently versus, say, I think it was 60,000 the year before, or 70,000, even though obviously your capital base is materially higher than it was. Was that an issue of just not being able to find enough policies that met your criteria?
Absolutely. See, this is the way of saying Citizens is already a fished-out pond from our perspective. Other people suddenly are looking at it as a great opportunity. If we took out 60,000 policies in 2012, we clearly have the capability and the operational expertise to do it in 2013. The only reason we wouldn't have done such a thing is because we also have the discipline of maintaining underwriting standards. Right? It's not about policy count, it's about maintaining underwriting discipline because you are about to go into a world where everybody's suddenly going to say, "Value me just because of my growth in my policy count.
Right.
It isn't your top-line growth that's the important thing, it's your bottom line. Right?
Your ideal scenario is essentially, sorry to interject, your ideal scenario essentially that a big storm comes through in hurricane season, knocks some of the under-capitalized players onto their butts, and you step in and are able to do a very creative transaction, kind of like the HomeWise one you did a couple of years ago. Is that sort of the best way to summarize how you would move the value needle in a quantum leap in this environment?
Well, let me just say one thing about that. Unfortunately, you started the sentence with a saying in an ideal situation, right? Florida ever getting hit by a hurricane is not something that we
Sorry. Pardon me. Yeah.
look forward to or whatever, right? Having said that
Financially, yeah.
Yeah. Having said that, it does raise all the right conversation pieces. If you are running an insurance company in Florida, right, and you look back at our business for years gone by, the biggest concern everybody had about being an investor in this company was, "Oh my God, what happens if a hurricane hits?" Right? This is always the concern, the knock against Florida insurance carriers. Right? We heard all our shareholders were worried about that, and we set out on a step-by-step mission to find a way of putting their minds at ease. Ironically enough, I guess we succeeded too well because the angst in our shareholders at this point is, "What if Florida doesn't get hit by a hurricane?" Right?
Right.
If that is your worst concern about this company, right, I think you've got a pretty good investment.
Okay.
Yeah.
That's all for me. Thanks, guys.
Thanks.
Thanks.
Thank you. The next question is from Chris Starkey of Clear Pond. Please go ahead.
Hi, guys. Thanks for the time today. I appreciate it.
Hi there.
I was wondering if you could break out how much of the net income you've had over the last four or five quarters has been from the arbitrage out of the clearinghouse?
Clearinghouse only went into business a month ago, really.
Oh, yeah, I'm sorry. The Citizens, sorry, I misstated the question. The Citizens policies that you got, what was the contribution of those to the net income line? Over the last four or five quarters. Just trying to get a sense of normalized net income versus the favorable higher marketing policies.
Yeah, Chris, that's kind of tough to break out. Let me tell you a simple way that we do it. We look at ourselves, I think a lot of us look at our competitors and everybody else. If you look at everybody's third quarter numbers, that tends to be a fully normalized quarter because you have the same amount of premium throughout the quarter, and it's been fully reinsured. If you only take those third quarter numbers, the only thing you have to allow for is if there's been any one-time storms or anything else in the quarter. In the third quarter 2013, there was none of that. Third quarter 2013 would give you a very good understanding of our normalized earnings before the latest takeout. Beyond that, it gives you a pretty good core underlying business.
The new takeout would be adding to that. Yeah? Very simple way of looking at it.
I guess maybe I'm confused here, isn't this a really easy number for you guys to provide? What's the difficulty in just breaking out the line item for your investors?
It is actually a lot more complicated than that because how much of management overhead do you want to apply to your takeout versus your core business?
How do you want to allocate all the expenses?
Okay. Great. Well, I appreciate the perspective there. You mentioned the combined ratio before. I don't have it in front of me, you're in the 70s, I think. Is that.
Our-
Yeah.
To gross premiums, our combined ratio for the year was, just a second here, I'm looking it up real quick.
Allen
39.9 compared to 48.6 for the year 2013.
Okay.
Go ahead.
Sorry, go ahead. No, please. Sorry.
On a net basis, it's in the upper 60s, low 70s, approximately.
Okay. Yeah, I was referring to net. Is that sustainable relative to the company's history, or do you expect that to revert back to industry standards over time?
Well, I think from where we are and where industry standards are, they're miles and miles apart. A huge disconnect. Will that number move up or down a little bit? Yeah, it will. It'll move around. It obviously has been a very good number. It has more room to move to the less favorable side than the more favorable side, given how well it's done. Having said all of that, on balance, we're not talking about it getting cut in half or anything else in the near future.
Yeah, certainly credit to you folks for doing a great job managing the company. I guess the question on everyone's mind is what makes HCI capable of sustaining better than average industry combined ratios over time by a really wide margin, as you just said. I'm just trying to understand, I guess, how you guys over time will be able to outpace the industry by such a margin.
It's an interesting question. The interesting observation I have is the larger we've gotten, the more efficient our combined ratio has gotten. Stay tuned. We'll try to keep working and see how much we can do to improve it, but as we do every day. I'm blessed with a staff who shows up every morning to try and figure out how to make that number even better, no matter how great it is. One of these days they won't succeed, but I look forward to them trying every day.
Okay, great. I'm a little bit confused, I guess, on the hurricane discussion, maybe you guys can help me understand. I've always thought that having hurricanes were a negative for the insurers, particularly if you're insuring marinas in Florida. It sounds like maybe you guys have a different perspective. Just trying to understand why that would be a positive in 2014 for you folks.
First thing, we're not insuring marinas in Florida. Just for people who bet against the stock, let's clear that up. The second item is where that conversation and that dialogue has come from, has been the fact that we've said that all of these conversations about the clearinghouse and Citizens drying up, et cetera, those are all conversations and functions of a world where the industry isn't hit by a hurricane. When the industry is going to be hit by a hurricane, what history will tell you in Florida, you will have a number of companies of various size decide to pull back from the state and/or shrink their book of business, which creates a tremendous opportunity for those people who want to grow to take on additional policies. We seem well poised for that, so that would be an opportunity for us.
The concern on the call obviously is that what if that hurricane doesn't happen and nobody wants to get rid of policies, how will you grow then? Hence the reverse conversation.
Thank you. Ladies and gentlemen, that is all the time we have for questions. I'd like to turn the floor back over to Mr. Mitchell for closing remarks.
On behalf of the entire management team, I'd 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 continuing our success in 2014.