Welcome to the Homeowners Choice second quarter 2012 earnings 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, Mr. Jay Madhu, Vice President of Investor Relations for Homeowners Choice. Thank you. You may begin.
Thank you. Good afternoon. Welcome to Homeowners Choice second quarter 2012 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 Property and Casualty Insurance Division. Following Paresh's opening remarks, Richard will review our financial information for the quarter and then turn the call over to Scott for an operational update and outlook. Finally, we will open up the call to your questions. To access today's webcast, please go to 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 concern 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 no 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 filing 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. Homeowners Choice, Inc. disclaims all the obligations to update any forward-looking statements. Now, I'll turn the call over to our Chairman and Chief Executive Officer, Paresh Patel. Paresh?
Thank you, Jay. Good afternoon, everyone. Thank you for joining us on today's call to discuss our second quarter results. Our second quarter this year marked our 19th consecutive profitable quarter. The HomeWise integration is almost complete and continues to perform as anticipated. Highlights for the quarter include the following items. One, Scott Wallace, the former CEO of Citizens, came on board in late April. He will provide some color later on the call on the insurance business. Two, we completed our follow-on offering of 1.84 million shares in late April as well. Three, we closed on the purchase of the Treasure Island property, and it is now reflected in our numbers, including a bargain purchase gain of $179,000 in the second quarter.
In summary, as we enter the main part of the hurricane season for 2012, the company is well-positioned from a leadership perspective, from an infrastructure perspective, as well as a financial perspective. We are now beginning to plan for the end of the hurricane season and the next chapter in the company's history. I would like our CFO, Richard Allen, to walk you through the financial results for the quarter and the year to date. Richard?
Thank you, Paresh, and good afternoon, everyone. The second quarter income available to common stockholders totaled $7.2 million or $0.74 per diluted earnings per common share, a significant improvement from the $1.9 million or $0.30 diluted earnings per common share for quarter two of 2011. For the six-month period, income available to common stockholders was $14 million or $1.60 diluted earnings per common share, compared with $2.7 million or $0.43 diluted earnings per common share for the six months ended June 30th, 2011. Gross premium earned increased 72% in the quarter ended June 30th, 2012 to $53.8 million, compared with $31.2 million in the same period a year ago. For the six-month period, gross premium earned increased 75% when compared with the prior year period. This increase is primarily due to the revenues from policies acquired from HomeWise in November of 2011.
Reinsurance costs premium ceded were 33% of the company's gross premiums earned, compared with 45% for the quarter ended June 30th, 2011. For the six-month period ended June 30th, 2012, premiums ceded were 29% of gross earned premiums, compared with 46% in the prior year. The policies assumed from HomeWise were not subject to our excess catastrophe reinsurance until June of 2012. Going forward, we anticipate our reinsurance costs will range from 43%-45% of gross premiums earned for the reinsurance treaty year that began June 1, 2012. Net premiums earned increased 113% to $36.3 million from $17 million in the second quarter of 2011. This improvement was primarily due to the minimal reinsurance cost through May 31st, 2012, associated with the policies acquired from HomeWise. Net premiums earned for the six-month period reflect an increase of 127% to $76.6 million, compared with $33.7 million in the prior year.
Losses and loss adjustment expenses total $16.2 million compared with $10.5 million in the same year-ago period. It's important to note that the second quarter of 2012 includes approximately $2 million related to approximately 300 claims from Tropical Storm Debby, which occurred in June of 2012. Additional increases are attributable to the increase in policies and exposures related to the premium growth. Loss and loss adjustment expenses for the six months ended June 30th totaled $35.4 million compared with $20.9 million in the same year-ago period. Policy acquisition and other underwriting expenses were $5.9 million for the quarter ended June 30th, 2012, compared with $2.8 million in a comparable period in 2011, reflecting commissions payable to agents for production on the renewal of policies and premium taxes and policy fees.
For the six-month period, policy acquisition and other underwriting expenses were $12.5 million compared with $7 million for the prior year period. Contributors to the increase include the impact from the adoption of the revised guidance on deferred acquisition cost of $741,000 and commissions to agents for production of premiums, which increased significantly. Other operating expenses in the quarter totaled $4.7 million compared with $2.4 million in the second quarter of 2011. For the six-month period, other operating expenses were $9.3 million as compared with $4.5 million for the prior year period. This increase is primarily due to increases in compensation, administrative, and other general expenses in both periods. Turning to the balance sheet, investments in fixed income and equity securities total $49 million versus $40 million at December 31st, 2011.
Cash, cash equivalents, and time deposits total $138 million compared with $113 million at the end of the prior year. Unearned premiums were $120.4 million compared with $108.7 million at December 31st, 2011. Loss and loss adjustment expense reserves were $37.3 million compared with $27.4 million at December 31st, 2011. Turning to our financial ratios. Loss ratio for the quarter was 45% compared with 62% in the prior year quarter. This decrease is attributable to the substantial increase in net premiums earned in the quarter of 2012. Our loss ratio for the six months ended June 30th was 46% compared with 62% in the prior year. Our expense ratio for the quarter was 29% compared with 30% in the same year-ago period. Expense ratio for the six months ended June 30th was 28% compared with 34% in the prior year.
The combined loss and expense ratio, a key measure of underwriting performance traditionally used in the property and casualty industry, decreased to 74% for the second quarter of 2012 from 92% for the second quarter of 2011. Our combined ratio for the six months ended June 30th was 75% compared to 96% in the prior year. Generally, combined ratio under 100% reflects profitable underwriting results, whereas a combined ratio over the 100% reflects unprofitable underwriting results. As you can see, we did have very successful underwriting results for the three and the six months period ended June 30th, 2012. I would like to turn the call over to Scott. Thank you. Scott?
Thank you, Richard, and good afternoon to our listeners. During the second quarter, we successfully placed our reinsurance treaties for the 2012-2013 catastrophic season. Our catastrophic plan for reinsurance now provides approximately $550 million of coverage. As Richard mentioned, we expect our reinsurance cost to be approximately 43%-45% of gross written premiums beginning in June of this year based on current run rates. As we all know, the storm season for this year began June 1st, and many of you are quite familiar with the Tropical Storm Debby that affected the state of Florida. This was largely a heavy rain event but did cause some losses. This tropical storm, which never turned into a hurricane, did hit during the second quarter, being in June specifically. As such, we have already paid many claims and established reserves for this storm
Which are, for the most part of our second quarter numbers. In summary, we estimate receiving approximately 300 claims from Tropical Storm Debby and a total loss payout of $2 million, which as mentioned earlier, has already been reserved in our second quarter numbers. We are encouraged by our second quarter results and remain focused on executing on our long-term goals, including diversifying our portfolio, increasing market share, and providing exceptional service to our policyholders. We continue to be well-positioned to capitalize on our building momentum for the remainder of 2012 and beyond. Before we open the call for questions, I would like to express a few of my personal thoughts since joining Homeowners Choice only 90 days ago.
In short, I see a staff that is dedicated to their profession, committed to providing superior customer service, and a staff that is anxious to learn more and take on new challenges. I am truly honored to lead the property division and look forward to continued growth in the years ahead for this division. On behalf of our entire management team, I would like to say thank you all for your support. With that, we are ready to take questions. Operator?
Thank you. Ladies and gentlemen, we will now be conducting a question-and-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. Our first question is from Casey Alexander of Gilford Securities. Please go ahead.
Hi, good afternoon. I have a few questions here. First of all, despite the $2 million in claims from Tropical Storm Debby, the loss and loss adjustment expenses were still significantly lower than they were in the first quarter. Was there a huge absence of claims on a standard run rate? Or was there a bulge in the first quarter that was related to a different event that we didn't hear about?
Casey, it wasn't any of those things. One of the items that's there in everybody's balance sheet, and Richard can speak further about this to some degree, is that as you increase the size of the business, you do have to build up your IBNR. In the first quarter, we were building up the IBNR on the acquired HomeWise business.
Right.
At this point, I think we've set aside enough for that.
Yeah.
That's what you saw, right? If we think of that as it there was a startup charge that you had in the first quarter.
Okay. Well, secondly, the policy acquisition and underwriting costs, despite the higher level of business, also shrank considerably in the second quarter as compared to the first quarter.
If you remember from the fourth quarter call, Casey, when we adopted that new guidance, our actual deferral rate decreased.
Okay.
For acquisition costs.
Okay. Secondly, there was $1 million of policy fee income versus maybe a half a million during the first quarter. Is there any way to model this, or is this just going to be a lumpy number that's going to sort of come at us as it comes?
A very simple answer to that is that income has gone up because the way our book is shaped, we do the bulk of our renewals in the second quarter. Consequently, that's when the policy fee income maximizes out. I think the third quarter is the second most renewals. First quarter is the third most, and the fourth quarter, there's very few renewals. Yeah? Roughly to give you an idea as to how that bulge goes through the book, yeah?
Okay. The other thing is that other runs kind of lumpy. Can you kind of deconstruct what the other income is? Is there something in particular that is recurring in that line? Again, I'm not quite sure how to model it when it comes as lumpy as it does, a couple of $100,000 in the first quarter, a $1 million in the second quarter.
The second quarter includes approximately $500,000 on return of brokerage fees from the excess of catastrophe reinsurance treaty. This just came up this year.
Okay.
Yeah.
Is that really one time?
It's going to be recognized throughout the next 12 months.
Yeah. Casey, I think what's being said is that as that line item suggests, that income, because of all the different transactions that you now have in a complicated organization, you end up with some miscellaneous numbers quarter-over-quarter. Unfortunately, it is just the way of life. We try to maximize the efficiency of the business, shall we say, yeah?
Right. Okay. Richard, I'm going to give you my quarterly question. I'm going to give it to you a different way this time. Can you give me the basic and the fully diluted share count?
Yeah. Just a moment. I've got it right here. Do you want it for the quarter, or do you want it for the six months?
I'll take it both ways.
Okay. The basic for the three months is $7,112,000. Oh, excuse me. That's incorrect. The basic is $8,325,000. Fully diluted is $9,651. That's for the three months.
Right.
For the six months, it's $7,326,000. Diluted is $8,814,000.
All right, great. Predictable. This time you had it.
Well, thank you.
Thank you.
I knew you would be here.
Thank you. Next question is from Robert Paun of Sidoti & Company . Please go ahead.
Good afternoon.
Good afternoon, Robert.
Hi there. Good afternoon, Robert.
Just a few questions here. First on pricing. Last August, you filed for a 12% rate increase. Did you file for another increase this year? If so, what was that number, if you can share that? If you could talk about how you look at rates and where they're headed, that would be helpful as well.
Robert, the August rate increase, it's Paresh, by the way. Robert, the August rate increase you're talking to wasn't filed in August. It was actually approved to be effective in August. The reason I'm making the distinction is at this point, as we have to do every year, we've filed our rate indication, whatever, for the coming months. It is sitting with the department. They will obviously review it, et cetera. There will be, at some future point, a rate adjustment. That's called a rate increase that will be agreed upon, and that will go into effect, I would suspect, before the end of this year. I think we're talking about our expectation it's going to be in the single digits, in terms of what kind of rate increase, if any, there will be. Being a regulated company, that's exactly how this works, yeah?
Yes. Okay. On pricing, do you expect weak economic growth to have any impact on you pushing higher rates?
This is Scott Wallace. I don't think there's any real direct correlation between the economic growth and the rate adequacy needed for covering the exposure for the risks that we're covering.
Okay. Is it more of a function of the competition in the market?
Well, probably even less than that. As Paresh accurately pointed out, rates are a function, and largely controlled by the Florida Office of Insurance Regulation here in Florida, as with other states. This particular product line is so heavily regulated, there's only so much room in the rates, so to speak, as far as deviating from what would be an actuarially sound rate.
Okay. You're about nine months into the deal with HomeWise. Can you just provide an update on how that book of business has performed, and maybe how it compares in performance relative to the original book of business?
Robert, it's Paresh. To that point, as I said in my opening comments, it is performing as we had anticipated. What I mean by that, to add a little bit more color to it, is there are always going to be certain differences. One is it's a newer book. Homeowners Choice was a slightly older book. The geographic dispersion was highly different. The rates were highly different. As we renew the book, there's a lot of moving parts. Things like the retention rate from the HCI book is much greater than the HomeWise book, et cetera. The claim dispersion is slightly different just because the policy dispersion is slightly different as well. There are various moving parts.
At the end of the day, the combined book is pretty much performing really as anticipated, and I think you're seeing that in the numbers, because that ultimately is a final scorecard, yeah?
Yeah. Okay. Just one last question on the investment side. The investment income was down about $200,000 from last year's second quarter and from the first quarter. I know it's a pretty small absolute number, but is there anything going on there? Can you talk about what caused that?
I can probably tell you what really is the occurrence is that I think as the yield curve keeps getting flatter and flatter, the ability to make any kind of investment income becomes more and more difficult. As we have generally stated in the investment committee, we try to be very conservative. Even though there's a much bigger investment portfolio, we're not putting that to work, just hypothetically to, say, make a quarter of a point in or whatever the two-year CDs are going for, two-year treasuries are going for at this point. Consequently, that's what's impacting somewhat of the ability to generate income, yeah?
Okay. Thank you for the answers.
Thank you.
Thank you. The next question is from Ron Bobman of Capital Returns. Please go ahead.
How you doing, guys?
Hi, good afternoon.
Good afternoon.
I just had a couple of questions. A little bit more specific on the HomeWise. Could you talk about retention, sort of what portion of the renewals that you've kept?
Would you give us the total PIF number and how it's maybe changed the last couple of quarter ends? Presumably growing.
Yeah. Simple, these are ballpark numbers.
Right.
Yeah. I think the HomeWise retention rate has been somewhere in the low seventies.
Okay.
Okay. As far as PIF counts, as is our normal practice, it sort of peaks out at the end of the year and then sort of slides down as the year goes through to the end of the hurricane season. I think, and these are ballpark-ish numbers, I think we were sitting just slightly north of 120 at the beginning of the year.
Okay.
We were at around 115, 17, 18, something like that, at the end of the first quarter. I think we're about 110 at the end of the second quarter. It's that gradual roll-off as we would expect, and that's to do with that retention and so on as renewals occur, yeah.
What happens? That's an interesting dynamic. Why does PIF go down as the storm season approaches?
It's not to do with the storm season.
Okay.
The PIF count goes down because whenever you issue renewals, as a normal function of homeowners, people tend to change carriers a little bit more at renewal than they do.
Right. Of course.
Middle of the year, shall we say. Right. As renewals come up, you will have always the PIF count tending to decrease. Then obviously throughout the year, there's also a decrease in PIF count because people buy and sell their homes, et cetera kind of thing, yeah.
In any given book, not just Homeowners Choice, there's a natural tendency.
Right
For the PIF count to go down over time, yeah.
I guess something unique to Florida is sort of growth comes from the takeouts and the HomeWise type transactions, and less so from new business. you have that retention.
Yeah. I think depending on how much new growth you do.
How much you're getting rate.
Yeah. It tends to reduce the rate of decline. Unless you have huge amounts of new business, it's not going to offset that decline, yeah?
Okay. Thanks. If I pull out the $2 million from Debby, I just want to check my math. Is an attritional loss ratio of around 39%, is that pretty good? I mean, as far as for me to use in my estimating.
Are you going on a year to date?
Well, the second quarter, you had $16.2 of losses in LAE.
Okay.
If I pull out the $2 million from Debby and just take the $14.2 and divide it by $36.2, I think I'm getting 39%. Well, I'm just asking you.
It's a proper formula.
Okay. Okay. There's no reason that the attrition changes much during the calendar year, right? Or does it?
The 36 you're using, is that net premiums or gross? 39.
Net premium, actually. I got 39. I'm using net premiums earned as my denominator.
Yeah.
Just to keep the convention.
I think. Look, we're having a technical conversation here. The item that shows up in that is that don't forget that net premium number is being affected by reinsurance costs.
Understood.
Yeah. You're going to have your attritional loss ratio, while you're doing it in the classic sense, is going to move around based on reinsurance costs.
Reinsurance rather than just-
Yeah
losses at the home level. Okay. Understood.
Yeah.
If you just bear with me. I'm sorry. I think that actually That's it for me. I'll circle back if I forgot something. Thanks a lot, and best of luck.
Thank you.
One item. The other line item in the income statement, $1,000,062. I don't know if the first questioner was touching on that, but I missed. If you answered it, I'm sorry. If not, would you answer what that is?
I think he answered it.
Okay. I'll check the transcript.
Yeah.
Thank you. The next question is from Howard Halpern of Taglich Brothers. Please go ahead.
Good afternoon, guys. In the quarter, you said you handled the 300 claims from Tropical Storm Debby. How would you assess your staff's handling of those claims, given your increased size?
This is Scott Wallace. Thank you for that question. To be honest with you, I was extremely pleased in the way that this was dealt with. It was a very small test, but nonetheless, a test of how the different components to proper claims handling for this type of event are handled. It really came out very well. We handled claims quite quickly, quite efficiently. We have not, to my knowledge, received any kind of complaints as far as delays in getting adjusters out there to assess the damage and to ultimately make proper payment.
I'm very pleased with how it has turned out, and I feel very comfortable that with other events that hopefully do not take place, that we are still in a good position to address these things.
Okay. Can you describe a little bit about I know the law was recently implemented and changed, but with regards to how structural damage is viewed, have you seen enough evidence that that has changed significantly under the new law?
This is Scott Wallace again.
Yep.
Yes. I think in time, it'll have a significant impact by referring to, you're talking about the reliance on having to prove structural damage in the first case.
Correct. Yeah.
The difficulty, as with many things in insurance, there's always a lag period where claims that still may be interpreting that may have originated several years ago, which might be interpreted to become under prior language or broader language, so to speak. I definitely think that the components of 408 will definitely have a positive impact as far as tempering the loss ratios for sinkhole.
Okay. One last one. I know it might be early, could you just give a general landscape on what you envision or what you see out there in terms of potential policy additions in November and December of this year?
Well, I think to look at it, right now, being at this time of year, we're really keeping most of our focus on weather-related events that may take place in this next quarter. As we go through that period, towards the end of that period, assuming conditions are right, we will then look at several different opportunities. Certainly, we have taken out business from Citizens Property Insurance. We've also assumed carriers, and we've also grown organically. These are all areas in which we have opportunities to continue to grow the book of business for Homeowners Choice. It really is a little too early to tell which opportunities best fit our risk profiles and requirements. We'll get there soon enough.
Okay. Thanks, Scott.
Thank you.
Thank you. The next question is from Gregory McCusker of Lord Abbett. Please go ahead.
Yes. Thank you. Perhaps an elementary question, but just go through the reinsurance treaty and the fact that the loss ratio, the expected reinsurance ratio is going to basically remain the same as it was in the second quarter. Again, you had a period in this current quarter without, I guess a month or two of needed coverage from the policies you acquired.
Sorry. I'm having trouble understanding what.
Well, my point is that the ratio is the same, yet you were not required, I think, in the current quarter to. You didn't need to have coverage because it was out of hurricane season, I believe. Yet, was the pricing so advantageous relative to that policy that you're able to expect that 43%-45% to go forward?
Yeah. I think the way you are seeing the numbers is, I think in the release, we're talking about what the second quarter numbers were this year versus last year.
Right.
Now you see the advantages. I think third quarter onwards, you are going to get all three months like over like, so it's going to jump up to the number Scott had put out there, about 43%-45%.
Right.
It's going to jump up from, I think, 33 is what he said the number in the second quarter.
For the six months.
Yeah.
Right.
That's what's going to happen, is that we've gone the five months. The first five months, we weren't in hurricane season because there are no hurricanes in January.
The requirement there, the need there was limited, obviously.
Yes, absolutely. As we now do the new policy, the new contract, which went into effect in June 1, is now going to amortize over the next 12 months. You're going to see that step in the third quarter.
Okay. Do you expect that sort of the retention, this is where you expect to be on a longer term basis?
I think every year we renegotiate the reinsurance contract, and some of it is because it's a set function. We go through this every year. Good years, it can be in the high 30s. Bad years, it's actually gone as high as the high 40s. It's a movement around. Of course, the other side of this is it's now fixed. As Scott has said, it's 43%-45% based on the current run rate. Depending on what we do in terms of growth, et cetera, in the fourth quarter, that'll move as a function.
Okay. Then finally, with regard to the-- you mentioned that there's a lot of insurance regulatory controls regarding pricing and the rates. Is it not possible for others to reduce the rates if they so choose below what is stipulated by the commission?
This is Scott Wallace. In essence, no. For this line of business, I have certainly seen in the last few years, a number of companies make filings, and the Office of Insurance Regulation came back and said, "Your filing is inadequate. You have to charge even a higher rate," because the Office of Insurance Regulation must have had other concerns as far as a reflection of the overall financials of the organization. No, I don't think it's that easy if you're an admitted carrier to come in and think that you're going to undercharge or grossly undercharge the marketplace if your losses are going to be similar to the rest of the market.
Okay. Thank you very much.
Yep.
Thank you. Ladies and gentlemen, that is all the time we have for questions. I would now just want to flip back over to Mr. Madhu for closing remarks.
Thank you, operator, and thank you everyone for your questions and time today. These are exciting times for the company, and we're glad to have you be part of it. We look forward to the remainder of 2012 and keeping you appraised of our progress. Thank you for joining our presentation. This concludes our call. You may now disconnect.
Thank you, ladies and gentlemen. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.