Greetings, welcome to the Homeowners Choice third quarter 2013 earnings conference call. At this time, all participants are in a listen-only mode. A brief 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, Kevin Mitchell, Investor Relations. Thank you. Mr. Mitchell, you may begin.
Thank you, good afternoon. Welcome to the call. With me today are Paresh Patel, our Chairman and Chief Executive Officer, and Richard Allen, our Chief Financial Officer. Following Paresh's opening remarks, Richard will review our financial performance for the most recent three and nine months of 2013, then turn the call back to Paresh for a brief update and business outlook. Finally, 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 www.hcigroup.com. Before we begin, I would like to take the opportunity to remind our listeners that today's presentation and responses to questions may contain forward-looking statements made pursuant to the Private Securities Litigation Reform Act of 1995. Words such as anticipate, estimate, expect, intend, plan, and project, and other similar words and expressions are intended to signify forward-looking statements.
Forward-looking statements are not guarantees of future results and conditions and 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 will 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 are excited to report our outstanding results for the three and nine months ended September 30th, 2013. Besides our financial results, among the highlights of the quarter were another quiet hurricane season, with the first hurricane not actually forming until September 10th. Obviously, a quieter quarter than the corresponding quarter last year. Secondly, the approval we received in August 2013 to assume additional policies from Citizens. As of today, we consider the assumption of over 34,000 of those policies. Three, we continue to rebrand the company to HCI Group, which helps avoid confusion amongst our parent company, our insurance subsidiary, and our other enterprises. Finally, we were named 13th on the Fortune list of 100 Fastest-Growing Companies based on average revenue growth, profit growth, and relative stock performance over the past three years.
I would like to turn the call over to our CFO, Richard Allen, to walk through our financial performance for the third quarter. Richard.
Thank you, Paresh, and good afternoon, everyone. For the third quarter of 2013, income available to common stockholders totaled $13.4 million, or $1.13 diluted earnings per common share. This is an improvement from $2.8 million or $0.27 diluted earnings per common share in the third quarter of 2012. For the nine months ended September 30th, 2013, income available to common stockholders totaled $49.9 million or $4.32 diluted earnings per common share. This compares with $16.8 million or $1.79 diluted earnings per common share for the nine months ended September 30th, 2012. Gross premiums earned in the third quarter of 2013 increased 53% to $81.2 million from $53.1 million in the same period a year ago. For the first nine months of 2013, gross premiums earned increased 52.1% to $245.7 million from $161.6 million in the first nine months of 2012.
The increases were primarily due to revenue from policies acquired from Citizens in November of 2012. Net premiums earned for the third quarter increased 73% to $52.9 million from $30.6 million in the same previous year quarter. For the first nine months of 2013, net premiums earned increased 58% to $170.8 million, compared with $108.1 million in the same period a year ago. Net premiums earned reflect a benefit from the multiyear reinsurance treaties of $5.5 million for the third quarter of 2013 and $6.8 million for the nine-month period just ended. This benefit was discussed in the earnings call for the second quarter. Premiums ceded in the third quarter of 2013 were 34.8% of our gross premiums earned, compared with 42% in the third quarter of 2012.
For the nine-month period ended September 30th, premiums ceded were 30.5% of our gross premiums earned, compared to 33.1% in the same previous year period. Losses and loss adjustment expenses incurred totaled $14.5 million in the third quarter of 2013, compared with $15 million in the third quarter of 2012. For the first nine months of 2013, losses and loss adjustment expenses incurred totaled $47.8 million. This compares with $50.4 million in the first nine months of 2012. Losses and loss adjustment expenses incurred in the third quarter and nine months periods of 2012 include $3.2 million and $4 million respectively related to claims from tropical storms Debby and Isaac. Even with the increase in policy exposures since the third quarter of 2012, we continue to notice favorable trends in the frequency of reported claims as well as the average severity per claim.
We are constantly monitoring claim activities for the development of trends in frequency, severity, and cause of loss for the potential impact on incurred loss and loss adjustment expenses. Policy acquisition and other underwriting expenses for the third quarter of 2013 were $8.9 million, compared to $6.6 million in the third quarter of 2012. For the nine months ended September 30th, 2013, policy acquisition and other underwriting expenses totaled $22.2 million versus $19.7 million for the comparable period of 2012. Other operating expenses, which include a variety of general and administrative expense, totaled $8.8 million during the third quarter of 2013. This compares to $4.7 million in a comparable period a year ago. For the nine months ended September 30th, other operating expenses totaled $22.3 million versus $13.4 million for the comparable period of 2012.
Interest expense related to our January bond issue was $800,000 and $2.4 million respectively for the three and nine-month periods ended September 30th. Turning to our financial ratios. Our loss ratio applicable to the third quarter of 2013, which we define as loss and loss adjustment expenses related to net premiums earned, was 27.4%, compared with 49.1% in the third quarter of 2012. For the first nine months of 2013, the loss ratio was 28%, compared with 46.6% in the same prior year period. The expense ratio applicable to the third quarter of 2013, which we define as underwriting expenses, interest, and other operating expenses related to net premiums earned, totaled 35%, compared with 37% in the same prior year quarter. The expense ratio applicable to the nine months ended September 30th was 27.4%, compared with 30.6% in the same period of 2012.
Expressed as a total of all expenses related to net premiums earned, the combined loss and loss expense ratio to net premiums earned in the third quarter of 2013 was 62.4%, compared with 86.1% in the previous year. For the first nine months of 2013, the combined loss and loss expense ratio to net premiums earned was 55.4%, compared with 77.2% in the same nine-month period of 2012. The improvements in these ratios reflect a significant increase in net premiums earned and continued favorable trends in costs related to our losses and loss adjustment expenses incurred. Turning to the balance sheet. Investments in fixed maturity and equity securities totaled $74.1 million at September 2013, compared to $44.8 million at December 31st of 2012. Our cash and cash equivalents at quarter end totaled $273.9 million, compared with $230.2 million at the end of 2012.
During the quarter, we added approximately $22 million to our investments in fixed maturity securities. Unearned premiums at September 30th were $188.1 million, up from $154.2 million at December 31st. Loss and loss adjustment expense reserves totaled $43.5 million at September 30th, compared with $41.2 million at December 31st. As you can see, we have had another successful quarter of positive underwriting results, with continued strengthening of our balance sheet in the period ended September 30th. Now I'd like to turn the call back over to Paresh. Paresh?
Thank you, Richard. As you can see from our Q3 results, the core business, even when carrying a full reinsurance load, produces solid results. We are well positioned to capitalize on the integration of Citizens' policies from the assumption that is effective today, which will further enhance the insurance company. As a company, we are more focused on the future and the next set of opportunities that present themselves. There are plenty of diverse avenues by which we can grow the company. We just have to be patient and opportunistic. One example of that is the 34,000 policies we just assumed from Citizens.
While we have the financial capital to assume more policies, we maintain the operational discipline to select only those policies that met our established underwriting standards. We expect this assumption to bring our estimated total annualized gross premium to about $400 million with approximately 170,000 policies in force. We have also announced plans to enter the flood insurance market in the state of Florida. Many Florida residents are seeing drastic increase in the cost of flood insurance, and we decided as a company to offer flood insurance to our existing policyholders most hard hit by these rate increases. Our policyholders have always been very important to the company, and we wanted to help them by offering insurance priced at the near current rate without the drastic federal mandated increases that are going to be due on the Biggert-Waters Act.
That being said, we will enter this market cautiously and with a strict focus on underwriting guidelines and calculated risk management. Moving away from insurance, our other enterprises continue to progress on schedule, and we hope one day to grow them to be of a size similar to our current insurance business. This is obviously our medium-term goal. On a less joyous note, you should know that Richard Allen, as Chief Financial Officer, is giving consideration to, and we are discussing his stepping down as CFO, which we expect to occur sometime in 2015. I repeat, 2015, not 2014. Again, this is reflective of the HCI culture, where we plan and discuss items long before their implementation. Finally, on behalf of the entire management team, I would like to express our appreciation for the continuous support we receive from our shareholders, employees, agents, and most importantly, our policyholders and customers.
We look forward to our joint continued success. With that, we're ready to open the call for your questions. Operator, can you please provide the appropriate instructions?
Sure. 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 pull for questions. Our first question comes from Casey Alexander with Gilford Securities. Please proceed.
Yeah. Good afternoon, and congratulations on the results. I have a number of questions. First of all, as you said, in relation to your growth strategy, only taking down 34,000 policies, that's not exactly stressing your capital base. What is the company's capital allocation strategy going forward? With that, also, can we get an update on Exzeo and its progress into becoming a revenue-generating entity? I'd like some color on both of those, please.
Okay. Good afternoon, Casey. Let's start with the Exzeo stuff first. Exzeo is basically, as we've always said, a medium-term opportunity, and it's based on a freemium model. Its monetization and revenue stream is actually probably about two, three years off. We're okay with that because it'll be a growth play as we go down the road. We obviously are already internally using it for all of our claims activity. We are beginning to talk to other companies after having a shakedown over the summer to see if they want to use it as well. Of course, the price we're charging is zero. Hence no revenue in the short term. Like LinkedIn, that's the kind of model we're after. As the community has grown and developed, there will be follow-on revenue opportunities, and that's what we look to capitalize on. That's Exzeo.
In terms of the capital position of the company, et cetera, the 34,000 policies we took down, it's an interesting item. We take down what's available as opposed to try to hit a target number and take on inappropriate risk, shall we say. We continue to wait for the opportunities when they come to us, and they do come to us. This flood insurance thing might be a whole different area if it plays out correctly. It's early days yet, but we shall see how that plays out. As a final note, in terms of capital allocation, et cetera, there's an issue that has been brought up in conference calls in the past about what we are doing or not doing with the investment portfolio. As people noted at the end of the second quarter, we had almost $300 million in cash.
We had stated that we were unwilling to deploy that money to sort of try and make 50 basis points in treasuries, which was really the situation that was occurring back in the early part of the year. As the year has developed, treasury rates have come up, the 10-year treasury has gone from 1.5% all the way up to at one point almost 3%, and I think it's kind of sitting around 2.6%. What that has let us do is start to deploy some of that cash into things like munis, et cetera. This will start adding to the investment income of the company.
Just to give somebody a rough color as to what kind of things we're talking about, if you can put $300 million to work earning 4%, which was nearly impossible to begin the year, but it's quite probable at this point in time, $300 million at 4% yields an income of about $12 million annually. We could have a growth spurt coming from something that we've been very patiently building for the last few years.
Okay, great. Thank you.
Thank you.
Secondly, the quarter that you just reported is really the only pure quarter where we can see the percentage of premiums that are being ceded to reinsurance. Is that 34.8%, or let's call it 35%, a reasonable level to assume until next June on the base book of business? Obviously, that book of business that doesn't include the new Citizens policies that you took down.
That's correct, Casey.
Okay.
The 34.8% should be relatively stable and, as you said, excluding the impact of the new assumption.
Right. Okay. Next, I assume that before you started making any public declarations of the flood insurance, that you were aware of what some of the underwriting assumptions were in terms of loss ratios and how much penetration of that 170,000 policy book that you have that you might be able to tack flood insurance onto. I know it's going to take a while for you to penetrate that book, but at the end of the day, what are kind of the assumptions that you went into this with in terms of how much additional premium per policy you might be able to charge for flood insurance and what some of the loss ratios were? Is there any way to give us any color on that?
Short answer, no, but I'll try anyway, okay?
Okay.
Okay. Yeah, before we went public with this thing, we spent weeks analyzing the data and everything else that came with it. In terms of loss ratios, et cetera, we think it's a doable item on our part to be able to do this. The reason we can do this is because we obviously have pretty healthy, pretty reasonable gross margins, and we know how to underwrite books one policy at a time, even when there's large volumes involved. We did a lot of those kinds of blocking and tackling and computer modeling and all those kinds of things that go with it. That's why we will stick to our underwriting discipline. The big thing that we found was that how the NFIP views this world is different to how we look at it.
They look at it in terms of subsidized and non-subsidized, which are nice labels. We look at it in terms of adequate premium and inadequate premium. We look at the rates online, et cetera. It gives a different viewpoint on the matter. Another aspect of this is what this does is We're not looking at it while it will grow the top line. We're not looking at it to grow the bottom line anywhere nearly as much. Our reasons more for doing this is more of a differentiation tool, which helps us retain our existing customer base and possibly actually attract new customers. We're doing this as much to differentiate ourselves from the rest of the industry as opposed to it being a widely profitable line, shall we say.
Okay. All right. I'll table that until we get further into that business, maybe we'll have some more pertinent questions. Recently, the company enacted a shareholder rights plan. Can you give us sort of what the board's thinking was behind that?
Sure.
I don't see the company necessarily in the hands of any activist shareholders or hostile shareholders, and you guys have done a great job creating shareholder value. I'm just curious as to what the board's thinking was behind that.
It's very simple in the sense of, we've always stated my job as Chief Executive Officer is if somebody wants to take over the company and they contact us, I get on a plane, I go talk to them, try to get as good a deal as possible, bring it back, make sure the board signs off on it, and then it's up to the shareholders. We've always stated that, and that hasn't changed. The item that we are more mindset of is if you look back two years ago, the stock price was $8. If somebody had come along and offered 16, people would have jumped at it. A year ago, the stock was around the low 20s. People would have jumped at it at $30 at that point. We keep looking and we keep seeing more opportunity ahead of us than we've seen in the past behind us.
Consequently, we didn't want somebody to come along and suddenly say, "Hey, we'll offer $60 a share," and we suddenly end up in a proxy war and bear hugs and have to talk to every shareholder as to why 60 is not a good price or whatever. It would be very distracting to management in running this company. Clearly, we sort of have plans for the future at this point whereby we can see a much bigger company. We just wanted to make sure that if somebody wanted to try and do an end run around that they would at least have to have a discussion with us before they just put us in a bear hug, because that would be extremely distracting to the operations of the company. Just as a slight aside, good news is we're a $500 million company.
Bad news is we're only a $500 million company. We do live in a world where there are companies worth billions, if not hundreds of billions of dollars. We just wanted to make sure that we wouldn't be defocused or distracted by somebody issuing a letter or a bear hug or something of that nature.
Yep. All right. Fair enough. I'll jump back into the queue and let somebody else ask some questions.
Okay.
Thank you. Our next question comes from Ray Cabillot with Farnam Street Capital. Please proceed.
Paresh, congratulations on a great quarter.
Thanks, Ray.
Two questions. The first on the flood insurance, you had stated that most likely that might be a lower margin business or less will drop to the bottom line. Could you describe if you expect that to be from a higher percentage of premium ceded through reinsurance, or would it be more from a claims perspective? In addition to that, can you give a bit of a picture for kind of the relative cost of reinsurance to homeowners insurance in Florida to get a feel for if every policyholder bought it from you, which I know will not be the case, what the premium amounts might be, but then also someone can play around with what kind of percentage penetration would result in what type of revenue?
Okay. Let's start with the premiums. Our typical policyholder pays around $2,200. Somewhere between $2,200 and $2,500. For the purpose of this conversation, I'm strictly talking about homeowners policies, not condos, not fire lines and those kinds of things. It's the bulk of our book. Just to set the stage, the typical premium is around $2,200. The typical flood policy, not everybody has to have a flood policy, it's only if you're in the 100-year flood plain that you do. If you're not in the 100-year flood plain, your typical policy can be as little as $200-$400. If you are in the worst of the flood plain, it can range up to as high as $5,000 or $6,000. That's the range.
What's happening under the Biggert-Waters Act is they're talking about the people, especially in the flood plains, which is the Zone A and the Zone V, maybe even in the right set of circumstances, having to pay not $2,000 or $4,000, but maybe 4 or 5 times that amount of money, that's what caused the issue.
We can step in and do it at the original prices for a number of reasons, is because the same things that we did before. Unlike the federal government, we're not insuring everybody, we're insuring a select group of people. That gives us a slightly different edge. Secondly, we're talking about doing this as an endorsement to our existing policy as opposed to a brand new policy. That does provide some efficiencies or a lack of waste, shall we say, because there's not all the new policy issuance and all the expenses that go with all of those things and administration. It does let us be more efficient in those kinds of areas. As you look at those things, we can do this at a cost basis that is less than what the federal government could do it at.
Finally, as far as the reinsurers, et cetera, go, we have been in discussions with some of our key reinsurers on the matter. Clearly, we're not looking to do this across 100% of our book because not 100% of our book is affected, nor would we get 100% penetration. It's a small subset of the book. Adding this will increase our reinsurance cost somewhat, but our expectation is it'll be offset by the revenue we'll be collecting.
It becomes a wash in that sense. As far as the loss ratios, the flood insurance loss ratios tend to be very bifurcated. In event free years, it tends to be very low. On the other event, when you get a hurricane, it tends to obviously spike up tremendously. That's risk management, and we do that with wind insurance all the time anyway. We risk manage it, and that's what we're doing here.
Thank you.
Yep.
One additional question. I'm not sure the best method to ask this, when you were answering the question about the shareholder rights plan, you kind of implied, I think you looked and said there a couple of years ago at $8 a share, people didn't know the opportunity going forward. It seemed like there was an implication that right now, as you look out, you see something much more than maybe the outside shareholders would see. I'm not sure if that's something you can comment on, but if you can, it would be interesting to hear.
Yeah. Really, officially, I can't comment on it, but I think, I continue to look to the growth of this company, and on an operational basis, I see more opportunity come by every day.
Thank you.
So.
That's it for me. Thank you.
Thank you.
Thank you. Our next question. Once again, if you would like to ask a question, please press star one on your telephone keypad. Our next question comes from Gregory Macosko with Contrails Advisors. Please proceed.
Hello. Thank you for taking my call. Just with regards to the 34,000 policies that were acquired. Yes, that was somewhat smaller than you've done in the past, could you talk about what your expectations are with respect to the fall off in those? In other words, typically you lose some of those policies over time. Have you looked at those, were you more careful in expecting maybe more of those to be retained over time?
Good to hear you, Gregory. I hope your retirement's treating you well.
Oh, very well. Yes.
With regards to the policies, I think the official number is 34,872. I say that's the official number because we know it's going to drop a little bit from that. If last year's anything to go by, it's around 10%, if that will drop off. What's occurring is every year, every time we do a takeout, and this is our 10th takeout, the drop off is getting to be less and less. Consequently, what we're expecting to roll off here is actually fairly minuscule. If last year's anything to go by, both our Citizens' assumption and our core book both had about a 90% retention rate. We are starting to have a very solid traction with our policy holders.
Okay. Finally, with regard to the use of capital, you mentioned 4% share in Florida, you're looking at the flood insurance, et cetera. What about outside of Florida? Could you give us any color on that? You didn't mention any possibilities in other states.
Yeah. Absolutely. The item that's always been there is we keep moving along in Alabama, we hope to write our first policy sometime in the first quarter over there. All of those plans are going along. The other thing that was there was, as we had said in the second quarter, because we were going into hurricane season, that we wanted to try and keep capital and the powder dry in case there had been an event over the summer. We're all very glad that there wasn't, in case there had been, we had to be prepared. Now that we're on the far end of that, obviously we'll be looking to see what we can do to deploy the capital.
It may be everything from things we talk about in terms of purchasing commercial real estate to actually, we may get a competitive acquisition that may show up. It doesn't have to be in Florida. It could be in one of the other states. These are all items that we look at and opportunities we review every day. We stay disciplined in the sense of, until the opportunity is right, it's better to wait than make an unwise acquisition, shall we say.
Greenfield is not part of the thinking, at least at this point, in any other states. You're in Alabama. I understand that. You're being careful there. Is Greenfield a possibility?
Yes, it is. Absolutely. The thing that we run slightly different to, say, a number of other carriers who look like us in terms of Florida specialists, is that our viewpoint is we shouldn't try to expand into, say, South Carolina unless we have some knowledge and/or advantage and a strategy as to how to do that profitably. Otherwise, it'd be very good to get on the call and tell you we're in eight states, and we're losing money in seven of them. I don't think that benefits anybody.
Okay. Thank you very much for that.
Thank you. Our next question comes from Robert Pond with Sidoti & Company. Please proceed.
Good afternoon.
Hey, Robert.
Hey. I wanted to follow up on the latest Citizens' assumptions. Are these policies similar in size to your current book of business in terms of the average policy size? Maybe you could talk about the competition for Citizens' policies. Seems like there are more players willing to take these policies now. Is that a fair assumption?
Yes. Let me get the routine numbers out the way. We are looking at about 34, 35 thousand policies and about $78 million in premium in force attached to those policies. I think it works out about $2,250 a policy or something of that nature. I'm presuming you're asking that for your modeling purposes.
Yes, that's right.
Yeah, that should get you to that situation. As far as the number of people doing takeouts, I think what you're seeing is two things. Just to give quantifiable numbers to everybody, there are 16 companies doing takeouts between November and December of this year. To put this into contrast, if you went back to 2010, there was maybe one or two companies doing it in that period. It's suddenly become very popular. The popularity is partly due, I think, because everybody has now understood how and why timing and proper selection really works, mainly because of looking at Homeowners Choice over the years. It's made it a very popular thing to do. Having said that, I think that's why we wanted to make sure we talked about the 34,000 policies we took. There is also a question of, is Citizens a fished out pond?
That stuff starts becoming very relevant as you go into next year and people sort of start imagining the benefits of the clearinghouse. I think all the established carriers who wanted policies that are currently in Citizens are basically undertaking them out in November and December. It was always going to be the case, and you're seeing that play out.
Okay. Also, looks like you bought more fixed income investments in the quarter. Can you talk about what you bought there? Was it corporates, munis, any other securities? Do you plan to put more of the cash to use in those investments going forward?
Okay, great question. I think we put about $22 million to work in the third quarter, and I think the bulk of it was in munis. There was some dislocation in the muni market due to the Detroit bankruptcy. We didn't go buy any Detroit bonds or any Puerto Rico bonds in case people pay that level of attention to this stuff. That disconnection, plus at one point, the 10-year treasuries were almost approaching 3%, let us put some $23 million to work, and I think we got an average yield across that new portfolio north of 4%. That was wonderful. As the quarter ended and we're now looking into the fourth quarter, as we stated, we're looking to put more of the cash pile to work, and it's starting to add, hopefully, a meaningful number to our investment income.
As interest rates are starting to climb a little bit, we are starting to see opportunities. In a perfect world, we'd like to see 10-year treasuries go up by another 100 basis points from here. I suspect that we're the only insurance company saying that.
Right.
Yeah.
Right. Also, one final question. Richard, were there any reserve adjustments, favorable or unfavorable in the quarter?
No actual reserve adjustments. We've continued review of the trends, and things are continuing as they have in prior quarters.
Okay. Thank you for the answers.
We've run out of time. I would like to turn the floor back over to management for closing comments.
Once again, guys, thank you all for the support you showed to the company. We continue to move forward, and we're looking forward to a glorious fourth quarter and hopefully a good holiday season for everyone. Thank you.
This concludes today's teleconference. You may disconnect your lines at this time.