Good morning, welcome to Heritage Insurance Holdings' third quarter 2014 financial results conference call. My name is Keith, and I will be the operator today. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentations. To ask a question, you may press star then one on a touch-tone phone. To withdraw your question, please press star, then two. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. As a reminder, this conference call is being recorded. All the matters discussed on this call are forward-looking statements based on current management's expectations involving risks and uncertainties that may result in those expectations not being realized.
Actual events, outcomes, and results may differ materially from those expressed or forecasted in forward-looking statements made on this call due to numerous risks and uncertainties, including but not limited to, the risks and uncertainties described in this conference call or press release issued yesterday and other filings made by the company with the SEC from time to time. Forward-looking statements made during this presentation speak only as of the date on which they are made, Heritage Insurance Holdings specifically disclaims any obligation to update or revise any forward-looking statements to reflect new information, future events, or circumstances or otherwise. Now, at this time, I would like to turn the conference over to Mr. Bruce Lucas, Chairman and Chief Executive Officer of Heritage Insurance Holdings. Please go ahead, sir.
Thank you, good morning to everyone joining us for the call. This is Bruce Lucas, Chairman and CEO of Heritage Insurance, and with me is Steve Rohde, our CFO. I would like to welcome all of you to our third quarter earnings call. Before we begin the discussion of the quarter, I would like to take a moment to thank all of our employees. Our accomplishments to date are a reflection of our exceptional employees and their commitment to our company. We had a successful and exciting third quarter. From a financial perspective, we had an excellent quarter. Our gross written premium increased significantly, attritional loss ratios remained stable, we generated an attractive return on equity for our shareholders.
In addition to our strong financial results, we accomplished a number of things during the quarter that we believe align with our strategic vision for the company and position us for continued success in the quarters and years to come. For example, we completed the migration of policies from Sunshine State Insurance to Heritage Insurance. Our retention levels are currently better than expected, we have received widespread support from the agent community. The acquisition of these policies creates a better geographic spread of risk throughout Florida. In addition, we launched our commercial residential program last quarter and have grown the division to 10 members, which we believe is the deepest and most experienced commercial residential department in Florida. We are now fully staffed, ramping up our voluntary production.
We continue to have a tremendous year-over-year success in growing the company, as evidenced by a 133% increase in gross premiums written for the third quarter of 2014 as compared with the third quarter of 2013. Additionally, we received a 155% increase in net premiums earned through the third quarter of this year compared to the third quarter of last year. We also had a 102% increase in policy count compared to the prior quarter in 2013. We are very pleased with our growth to date and have exciting plans for the company in the near future. Now for the financial results, I will turn the call over to Steve Rohde, our Chief Financial Officer. Steve?
Thank you, Bruce, good morning. First, I'd like to give you a few financial highlights from the third quarter. Our gross written premiums were $86.8 million. Net income was $10 million. Our combined ratio as measured against gross earned premium was 82.9%, stockholders' equity was $231.5 million. Our policy count reached 171,700 policies at September 30th, an increase of approximately 102% over September 30th of 2013. Our total in-force premium at September 30 was $322 million, an increase of 92% over the prior year. As of September 30th, approximately 68% of our policies were from Citizens takeouts, 19% from policies acquired from Sunshine State, 13% from our voluntary business. The significant increase in our policy count has fueled the growth in our gross premiums written and gross premiums earned.
In addition to an increase in in-force premium, our results were favorably impacted by significantly lower reinsurance costs as measured against gross premiums earned. Reinsurance costs were lower following the placement of our reinsurance program on June 1st due to favorable reinsurance market conditions and the issuance of a $200 million of cat bonds through Citrus Re, as well as the improved geographic spread of risk resulting from the Sunshine State policy acquisition. Our ceded premium ratio as measured against gross premiums earned was 30.5% for the third quarter of 2014 compared to 37.5% for the third quarter of 2013. Of this 17 percentage point improvement, about 12 points were related to lower reinsurance costs and about five points were related to a modest 1.8% increase in our in-force premium this year from Q2 to Q3, versus a 4.2% decrease from Q2 to Q3 of 2013.
We did a small 4,000 policy takeout from Citizens in August. This, combined with our successful efforts to retain over 95% of the policies acquired from Sunshine State, helped us manage our in-force premium very effectively this year during the wind season, resulting in a lower ceded premium ratio. Our loss experience continues to be positive and well within our expectations. Our loss ratio, as measured against gross earned premiums, was 27.9% for the quarter and 30.3% year-to-date. Our loss ratio on a reported basis was approximately 23% for the quarter and 24% for the nine months ended September 30th, with IBNR increases making up about five points of the loss ratio for the quarter and six points year-to-date. In total, our unpaid loss and LAE reserves at September 30th, 2014, were $42 million, which included $23.8 million of IBNR, or 57% of the total loss in LAE reserves.
For the quarter, our loss ratio of 27.9% was 3.8 percentage points higher than the third quarter of 2013. However, on a reported basis, excluding the impact of IBNR, this year's third quarter loss ratio was 23.1% versus 24.8% for the third quarter of 2013. We are still a new company with limited loss development experience, and as a result, we have to rely significantly on industry experience when establishing our reserves. Because of this, we have set IBNR using management's current best estimate at the top of the indicated range. While their loss trends, as evidenced by our reported loss ratios for the quarter and for the nine months ended September 30th, as well as our actual loss development factors, appear to be favorable at this time. We, however, can provide no assurances that this trend will continue.
Our expense ratio as a percentage of gross earned premiums was 24.5% for the quarter and 21.1% year-to-date. The $10 million acquisition payment for the SSIC policies was capitalized in June and is being amortized in relation to the earning out of the unearned premium that we acquired. The amortization of the SSIC acquisition payment was approximately $4.5 million in the quarter, which had a 5.6 percentage point impact on the expense ratio. For the quarter, the SSIC policies produced approximately $1.8 million in pre-tax earnings, taking into account the amortization of the acquisition cost, the incremental reinsurance costs and operating expenses we incurred, and actual loss experience with a load for IBNR. This equates to an 87% combined ratio for the quarter.
When we were analyzing the SSIC transaction back in June, one of the biggest unknown factors was the expected retention rate of the policies because of the uncertainties of the receivership and competitive factors in the marketplace. We lost only 900 policies or 2.7% related to the uncertainties of the receivership, and in the three months following the acquisition, we have renewed over 95% of the policies that have come up for renewal. These results are far exceeding our original expectations when evaluating the acquisition price. Our combined ratio as a percentage of gross earned premiums was 82.9% for the third quarter and 81.6% for the nine months ended September 30th. We are very pleased with these results, especially when considering each component of our combined ratio, reinsurance, losses, and expenses were in line or better than our expectations.
We believe this underlying base of profitable business, when combined with our significant fourth quarter Citizens takeout activity thus far, especially the commercial residential business, should position us well for the coming quarters. On the balance sheet side, stockholders' equity increased to $231.5 million compared to $100.9 million at December 31st of 2013. Our May 2014 IPO increased equity by approximately $101 million, with retained earnings contributing $27.4 million this year. Statutory surplus in our insurance company subsidiary at September 30th was $124.7 million. Our invested assets at September 30th were $251.1 million, with approximately $213 million invested in bonds with an average credit quality of A and a duration of 4.0. Our cash position was $102 million at September 30th, which included $50 million held in a collateral trust account to cover the reinsurance exposure of our captive reinsurance subsidiary, Osprey Re.
Our total assets were $523 million at September 30th. Overall, the third quarter was an excellent quarter for Heritage. With that, I'll turn it back to Bruce.
Thank you, Steve. We will now take questions from our analysts.
Thank you. At this time, we will now begin the question-and-answer session. To ask a question, press star then one on your touch-tone phone. If you are using a speakerphone, please pick up the handset before pressing the keys. To withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. The first question comes from Mark Hughes with SunTrust.
Thank you very much. I wonder if you could give us your latest thoughts on what premium you are expecting from the takeouts that you've done here in the fourth quarter. Once you get through the opt-out period, I'm curious what your outlook is for premium. If you could break that out by the commercial residential and the residential as well.
Hey, Mark. Thanks for the question. It's Bruce Lucas. We can certainly give you some just rough cut numbers in terms of what we were approved for and what we've submitted in terms of our mail out policies. As you know, there's still open opt-out periods, et cetera, throughout the quarter, so anything that we provide would be nothing more than just a guesstimate at this point. With that, I can turn it over to Steve, and he can give you at least the approval numbers and the tag numbers that we have.
Okay. For the October take out, commercial residential, we were approved for about $95 million of premium. After the 30-day opt-out period, that was down to about $78 million. We're still getting the final opt-outs being processed through October 14th. Those numbers are holding pretty well for us at this point. The October personal residential, after the opt-out period, the 30-day opt-out period, we were at 13,500 policies, and that opt-out period runs through till October 21st. Until November 21st, I should say, for the late opt-out period. We still have some time yet on that one. For the November take out, we were allocated just over 38,000 policies from Citizens on the personal line side, and we're still in the initial opt-out period on that. The commercial residential, after the opt-out period on that, we are about 140 policies.
In December, we just received our allocation on the personal residential, we received allocation of 14,115 policies. On the commercial residential, we received an allocation of 390 policies.
The overall premium on that, Mark, though, is such a fluctuating number because you don't know what policies will or won't opt out until you complete the process. I think it's pretty safe to say that the total number will be well in excess of $100 million assumed on a gross written premium basis annually for the quarter. If you just look at October right now, you're probably looking in the $90 million-$100 million range. I would say, November, you're probably looking at gross written premium somewhere around $50-plus million, and December still remains to be seen, but I would say probably $25 million or so. Definitely ahead of our initial projections of where we were even last quarter and at the IPO. We like the metrics on these policies.
The profitability on them in terms of the combined ratio is running consistent with all of our past Citizens takeouts. We feel pretty confident about where we're heading in the fourth quarter. It should be a pretty good number.
Thank you for that.
I'm just going to add on those premium numbers, that's the gross written premium, and of course, we only book the unearned premium that was transferred to us, which generally equates to just north of 50% of the total written premium.
Right. On a run rate basis, you still sustain those policies on a gross basis?
Absolutely, yes.
Yeah. The commercial residential, can you talk about how the trends have been lately in your voluntary business?
Pretty encouraging through the first month of active writing on the voluntary side, we've written about $1.6 million in premium. We are now fully ramped up and writing throughout the state. Volume has definitely picked up for us. It looks pretty good right now. We're definitely trending ahead of expectations there as well.
Then the losses seem like they're coming in pretty well. Can you kind of frame that up in terms of frequency, severity? How much is having your own water mitigation capacity making a difference in terms of those losses?
Sure. When you look at our frequency and severity, this is measured against all our claims reported, so it includes claims closed without payment. Our frequency for the year is running 5.1%, and the average severity is just above $9,000. That's been fairly consistent through the year. We feel the water mitigation company we acquired and the operations is having an impact on our loss ratio already. I would suggest that just from the doing it ourselves, as opposed to having somebody else doing it, probably improving our loss ratio by a couple of points. That's not taking into account that we think it also improves the overall scope of the loss by reducing the creep that comes in a lot of claims. That would be on top of the two- to three-point improvement just from the cost standpoint itself.
Thank you, Mark.
Thank you.
Thank you.
The next question comes from Matthew Carletti with JMP Securities.
Hi, it's actually Christine Worley for Matt. Just wanted to turn back to the Citizens takeouts on the personal residential side. As you stated, your appetite now, you're a bit ahead of where you thought you'd be at the IPO. What have you sort of seen that has changed your appetite between now and then?
I wouldn't say that there's a change in appetite. I just think we came in with fairly conservative numbers. It's always better to underpromise and overdeliver. We have not changed our underwriting guidelines. We have not changed the policy selection criteria that we normally use. There's just some pretty good policies there, and we wanted to be conservative on our forward projections at the IPO.
Okay. That's great. Thank you very much.
Thank you. The next question comes from John Barnidge with Sandler O'Neill.
Good morning, and congrats on the results. I have a couple questions. There has been a soft reinsurance environment. As we look out to next year, how much of a savings on a price per unit basis are you expecting?
Well, we do not know really where things are going to trend until we see the 1/1 renewals with the rest of the market. That will give you a good indication of where the market is headed. I hate to speculate as to what your reinsurers are going to charge or not, but I can tell you that we are hearing that rates are going down. We are hearing probably 5-10 points across the board. We really will not have a good indication of what that is going to be until we see what 1/1 renewals come in at.
Okay. Then just one other question. As I look at your policy acquisition ratio, it has increased in the last couple quarters, and I know you mentioned it is partially due to the increase in new and renewal policies. Where should we see that ratio kind of settling in at?
Okay. This is Stephen Rohde. I think on our ongoing ratio, our expense ratio against gross premiums earned is in the 22%-23% range right now, about 22.5% actually. When you have no benefit from doing the takeouts, and the takeouts, as you know, we do not pay any ceding commission to, or acquisition cost to take those policies out, so we do get a benefit from that. Likewise, this quarter, we have an amortization of Sunshine State acquisition costs that impacted our expense ratio. I think on a going forward basis, we're running about 22.7%. Our G&A expenses as a percentage of premium keep going down. For the third quarter, they were about 9% of premium, and last year in 2013, they were about 12%, so we have about three-point improvement there just from economies of scale, basically.
Our variable expenses on a go-forward basis, excluding any favorable impact from takeouts, is about 13.8%.
Okay, thanks. I will requeue.
All right. Thank you.
Thank you.
As there are no more questions at the present time, I would like to turn the conference back over to Mr. Lucas for any closing comments.
I just wanted to say thank you for everyone for your participation on the call and your interest in Heritage, and we look forward to speaking with you in the next quarter.
Thank you. The conference call concluded. Thank you for attending today's presentation. You may now disconnect. Have a nice day.