Good morning, ladies and gentlemen, welcome to the UVE Q3 2018 earnings call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. If anyone should require assistance during the conference, please press star then zero on your touchtone telephone. As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host, Dean Evans. Please go ahead, sir.
Thank you, Casey, good morning, everyone. Welcome to the third quarter 2018 earnings conference call for Universal Insurance Holdings, Inc. My name is Dean Evans, I'm the Vice President of Investor Relations here at Universal. With me in the room today are Chairman and Chief Executive Officer, Sean Downes; President and Chief Risk Officer, Jon Springer; Chief Financial Officer, Frank Wilcox; and Chief Operating Officer, Stephen Donaghy. Following Sean's opening remarks, Jon will provide an update on several important current topics, Frank will review financial results. The call will be reopened for questions. Yesterday afternoon, we issued our earnings release, which is available under the press releases section of our website at www.universalinsuranceholdings.com. A replay of this presentation will be available on the homepage of our website until November 13th, 2018.
Before we begin, please note that this presentation may contain forward-looking statements about our business and financial results. Forward-looking statements reflect our current view of future events and are typically associated with words such as believe, expect, anticipate, or similar expressions. We caution those listening, including investors, not to rely solely on forward-looking statements as they imply risks and uncertainties, some of which cannot be predicted or quantified, future results can differ materially from our expectations. We encourage you to carefully consider the risks described in our filings with the Securities and Exchange Commission, which are available on the SEC's website or the SEC Filings section of our website. We do not undertake any obligation to update or correct any forward-looking statements. With that, I'd like to turn the presentation over to our Chairman and Chief Executive Officer, Sean Downes.
Thank you, Dean. Thank you, everyone, for joining us today. Before I begin, I would like to express our heartfelt condolences for anyone affected by the tragedy that occurred in Pittsburgh last weekend, as Pennsylvania is not only a state where Universal writes business, where many of us also have personal connections and family. Additionally, Universal is intently focused on helping all policyholders who have been affected by recent natural disasters, including Hurricane Florence, Tropical Storm Gordon, Hurricane Michael. Our catastrophe teams have been on the ground in the affected areas since the events made landfall. We are processing claims as fast as possible, we are available for any other assistance that policyholders require during this time of need. Please do not hesitate to follow up with a Universal representative should you need assistance. Moving on to our third quarter earnings discussion.
I'll begin by providing some highlights from the quarter, and will then review our growth initiatives and strategy. Jon will cover several important current topics, and Frank will conclude by discussing financial results. We will then open up the call for questions. We are pleased with our third quarter 2018 results as we reported net income of $37.4 million and diluted EPS of $1.4 for an annualized ROE of 28.4%. This result is particularly impressive in light of the increased catastrophic activity experienced during the quarter, most notably Tropical Storm Gordon and Hurricane Florence, each of which occurred within our geographic footprint. We reported excellent top-line growth in the third quarter, with 12.5% growth in direct premiums written, including 9.1% growth within Florida and 34.9% growth in other states. Our underwriting profitability was strong with an 82% combined ratio for the quarter.
This includes weather losses above expectations of $7.5 million or four points. Our service company subsidiaries continued to contribute to our bottom-line results as Universal Adjusting Corporation and Blue Atlantic Reinsurance Corporation contributed $16.7 million and $0.6 million, respectively, to third-quarter results. Lastly, as was also the case during both the first and second quarter, our effective tax rate benefited from the federal tax reform that was passed in late 2017, which had a meaningful positive impact on our net income for the quarter when compared to the prior year. I'd now like to discuss our growth outlook heading forward. We believe we have positioned Universal well for the future by pursuing various organic growth avenues, which have resulted in a more stable, diversified, and balanced business. Our core Florida book continues to produce strong organic growth with direct written premium growth of 9.1% in the third quarter.
This includes our growth in policy count, as well as the average statewide rate increase of 3.4% that was approved in December 2017. Our 2018 Florida rate filing currently remains in process, and we will provide an update as the situation continues to develop. We continue to believe that we can profitably grow on an organic basis in Florida, writing business through both our independent agency network and our direct-to-consumer platform, Universal Direct. Geographic expansion is another key element of our growth strategy, and direct premiums written within our other states book grew a strong 34.9% in the third quarter. We are now active in 17 states with licenses in an additional three states, Illinois, Iowa, and West Virginia. We expect to continue to expand our geographic footprint in a prudent and conservative manner going forward.
Universal Direct, our unique direct-to-consumer online homeowners insurance platform, is available in all of our active states and continues to demonstrate a solid growth trajectory. Universal Direct has approximately 12,700 policies in force for approximately $16.2 million of in-force premium. We continue to believe that Universal Direct is well-positioned to continue to contribute to our growth efforts going forward. We continue to grow our book of business, and we remain confident that our multi-part organic growth strategy will enable us to deliver profitable premium growth. We have a solid balance sheet with a conservative investment portfolio, minimal debt or goodwill, and an appropriately set loss reserve position. We are protected by a comprehensive reinsurance program.
Our unique vertically integrated structure positions us well to capitalize in the event of a disruptive industry event, as evidenced by the income generated by Universal Adjusting Corporation and Blue Atlantic Reinsurance Corporation in the wake of Hurricane Irma. We are excited about what the future holds for Universal, and we expect to continue to deliver substantial value to our shareholders for the remainder of 2018 and beyond. With that, I will turn the call over to Jon Springer.
Thank you, Sean. I would like to first start with another quarterly update on Hurricane Irma. I will also discuss the third quarter weather events, Tropical Storm Gordon and Hurricane Florence, touch on Hurricane Michael, a fourth quarter event, and lastly, provide a recap of our reinsurance program in light of the catastrophic events we've seen in recent months. Following another three months of actively settling Hurricane Irma claims, we have increased our estimate of gross losses relating to Hurricane Irma to $754 million. This change in gross loss comes due to the continuation of new reported claims and the continued aggressive nature of plaintiff attorneys on claims in Florida. This increase in gross losses for Hurricane Irma had a negligible change on our net retention, which remains at approximately $29 million for the event.
We had over 4,000 new claims reported during the third quarter, down from over 10,000 new reports in the first quarter and almost 8,000 new reports in the second quarter, bringing our total claim count as of 9/30 to just under 86,000 claims. We have closed almost 78,000, roughly 90% of these claims, with an average loss and LAE severity of approximately $7,200 across all claims, and an average loss in LAE severity of approximately $10,000 on claims closed with payment. As a result of Hurricane Irma, the past four quarters have each included the benefit of additional revenue within our service provider subsidiaries, Universal Adjusting Corporation and Blue Atlantic Reinsurance Corporation. The additional revenues have led to a higher level of profitability than would otherwise be the case in a normal quarter. Switching now to the third quarter of 2018.
Our third quarter results include a total of $7.5 million, four points of weather events beyond plan, compared to $37 million, 21.2 points of weather events beyond plan booked in the third quarter of 2017. The current quarter's losses relate to Hurricane Florence, $35 million-$45 million of gross loss, resulting in a $5 million net loss, and Tropical Storm Gordon, $2.5 million of gross loss, all retained net. Moving on to the fourth quarter event of Hurricane Michael, which initially made landfall as a strong Category 4 hurricane along the Florida Panhandle on October 10th, impacting Florida, Georgia, and several other Southeastern states.
While it is still very early days in the claims reporting cycle of an event like Hurricane Michael, the storm is expected to produce gross losses and loss adjustment expense of $300 million-$350 million, resulting in net pre-tax losses and loss adjustment expenses of $35 million. To the extent the company experiences any additional reinsurance recoveries from its supplemental non-Florida reinsurance program, those recoveries could serve to partially reduce its $35 million retention. Lastly, a few general comments relating to our reinsurance program. The overall program structure and design has worked exactly as originally planned, and we continue to be extremely appreciative of the support we have received from our reinsurance partners. Since Hurricane Irma made landfall in September 2017, we have received nearly 100,000 reported catastrophe claims in less than 14 months.
We are pleased to be trading with the type of reinsurance partners that understand the hard work and daily challenges our team faces in giving each of these claims the attention they deserve to bring them to successful closure. With that, I'll now turn the discussion over to Frank Wilcox for our financial highlights.
Thank you, Jon. For the third quarter of 2018, net income was $37.4 million, while diluted EPS was $1.4. We reported strong total revenue growth of 8.4% for the quarter, driven by growth in premiums, net investment income, commission revenue, policy fees, and other revenues. Direct premiums earned grew 13.2% to $288.4 million, while net premiums earned grew 8.3% to $188.9 million. Ceded premiums earned as a percent of direct premiums earned was 34.5% for the third quarter of 2018, compared to 31.5% in the third quarter of 2017.
The ceded premium ratio includes $13.5 million of reinstatement premiums paid during the quarter related to Hurricane Irma. Excluding this item, the ratio would have declined to 29.8% for the third quarter of 2018. Commission revenue, policy fees, and other revenue each grew in the mid-single digits versus the prior year's quarter. Included within commission revenue was $0.6 million of fee income related to the reinstatement commissions received by Blue Atlantic in the third quarter of 2018. We generated a net combined ratio of 82% in the third quarter of 2018, compared to 99.5% in the third quarter of 2017. The net loss in LAE ratio improved to 45.5% from 66.7% in the prior year's quarter.
As Jon pointed out, the third quarter of 2018 included $7.5 million, or 4 points, of weather events above plan, with $5 million relating to Hurricane Florence and $2.5 million relating to Tropical Storm Gordon. The prior year's quarter included $37 million, or 21.2 points of weather losses above plan, entirely relating to Hurricane Irma. Both the third quarter of 2018 and the third quarter of 2017 include a negligible amount of prior year reserve movements. As Sean mentioned earlier, the third quarter of 2018 loss adjustment expenses include a benefit of $16.7 million, or 8.8 points from additional service profits earned by Universal Adjusting Corporation.
Our underlying loss in LAE ratio increased compared to the prior year, reflecting continued geographic expansion as non-catastrophe loss ratios in our other states book are generally higher than they are in Florida, and the marketplace dynamics within our home state of Florida, including the impact of AOB-related claims. Our net expense ratio was 36.5% in the third quarter of 2018, compared to 32.8% in the third quarter of 2017. The net policy acquisition cost ratio increased to 22.6% in the third quarter of 2018 from 20.2% in the third quarter of 2017, driven by geographic expansion as our other states book typically has a higher commission expense than Florida. Our other operating expense ratio was 13.9% in the third quarter of 2018 versus 12.5% in the prior year's quarter.
We note that the current year's ratio is in line with our expectations, and that the prior year's ratio was lower due to the impact that Hurricane Irma losses had on executive compensation expense, which is included within this line item. Net investment income was $6.6 million, growth of 115.3% from the third quarter of 2017, driven by growth in cash and total investments, improving yields, and steps taken to optimize treasury management. We reported $403,000 of realized investment gains during the third quarter of 2018, compared to $803,000 of realized investment gains in the third quarter of 2017. We reported $2.5 million of unrealized investment losses during the third quarter of 2018, driven by a decline in value of our equity securities portfolio. Total unrestricted cash and invested assets were $1.11 billion at September 30th, 2018, growth of 8.6% from September 30th, 2017.
We take a conservative approach to managing our investments and maintain a high-quality investment portfolio composed primarily of fixed maturity securities, which are 99.5% investment grade. The weighted average duration of the fixed maturity investments in our available for sale portfolio at September 30th, 2018, was 3.1 years. The effective tax rate for the third quarter of 2018 was 26.9%, compared to 40% in the prior year's quarter. The decrease in our effective tax rate is primarily the result of the enactment of the Tax Cuts and Jobs Act of 2017, which resulted in a reduction in the federal corporate tax rate from 35% to 21%, effective January 1, 2018. We remain committed to actively managing our capital position. We did not purchase any shares during the third quarter of 2018, but expect to continue to consider share repurchases in the future as market conditions dictate.
Our current share repurchase authorization program has $8.7 million remaining and runs through December 31st, 2018. We paid a regularly quarterly dividend in the third quarter of $0.16 per share, which is a $0.02 per share increase from the dividends paid in the first and the second quarter of 2018. This new dividend equates to an annualized dividend yield of 1.4%, based on current share price levels. Stockholders' equity was $531 million. At September 30th, 2018. Growth of 7.9% from June 30th of 2018, while book value per common share was $15.20 as of September 30th, 2018, growth of 7.7% from the second quarter of 2018, or 24.5% from the end of the third quarter of 2017. Combined surplus for our insurance entities was $364 million at September 30th, 2018, compared to $357 million at June 30th of 2018, and $324 million at December 31st of 2017.
Annualized return on average common equity was 28.4% for the third quarter of 2018, compared to 9.2% in the prior year's quarter. We remain dedicated to providing value to our shareholders and believe this level of return on equity is an excellent result. At this point, I'd like to turn the call back to the operator.
Thank you. Ladies and gentlemen, if you have a question at this time, please press the star and the number one key on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Thank you. Your first question comes from Christopher Campbell with KBW. Please go ahead. Your line is open.
Yes. Hi. Good morning, gentlemen.
Morning, Chris.
Morning.
I guess, my first question's on the core loss ratio. Just breaking out the Hurricane Irma claims income benefit for this quarter, I calculate about 490 basis points of higher core loss ratio year-over-year. I guess just thinking about that, how much of that delta would be attributable to assignment of benefits versus geographic expansion?
First of all, out of that increase, you've got to take into consideration the reinstatement premium, which affected the denominator in that calculation. That pushed that down, elevating the loss ratio by about 3%. The underlying increase in the core loss ratio is closer to about 3% versus the 4.9% that you just mentioned. As far as the breakout between the state expansion, and the AOB benefits, I would say that it would be an even split between the two.
Okay. Out of the 3%, once you back out the reinstatement, if you were the 3% higher, about 150 basis points would be AOB, and then the other half of that would be geographic expansion? Is that the right way to think about that?
I think that's fair.
Yeah, I think that's fair.
Okay, great. That's very helpful. Just thinking about, I know you guys are in progress for the rate change this year. I was looking at last year, and it looked like you filed a 3.4% increase back in June. You did have some adverse development, which would kind of indicate maybe there's a rate taking opportunity in 4Q. Just kind of, and I know there's a moratorium right now because of the storm in terms of rates, but just what's kind of driving that rate change delay this year?
There's another moratorium in place right now. We have done the work for the rate indication, and we will be making a filing sometime during the fourth quarter.
Okay. That's helpful. Given the significant deterioration in Irma's gross losses, how do you think that might impact pricing for next year's reinsurance renewal?
I think it's really too early to tell. In terms of the reinsurance cycle, reinsurers right now are obviously focused on their January 1 renewals, which includes some amount of Southeastern business. The vast majority of the business that was impacted by Hurricane Irma will not be renewed, obviously, until next June. I think we're way too early in the process to start speculating on how the rates may change due to Irma loss changes, and/or due to Hurricane Michael losses.
Got it. Two separate companies, you guys are going to set your reserves, the reinsurers are going to set their own. How reliant are the reinsurers in your panel on your gross loss estimates? Or are they already putting out independent loss picks?
It's a better question to ask them. I would tell you that in the recent months, we are trying to be as transparent as possible with our reinsurance partners in terms of the type of losses that are being reported and the challenges associated with closing out that proverbial last 10% of the claims.
Okay. Just switching to the claims income, it was a little bit more than we were expecting this quarter. I guess what's just driving the persistence in this income stream so far after the event? How should we be thinking about modeling the ongoing Hurricane Irma, the positive impact on your core loss ratios, plus now the incremental benefit of likely Hurricane Michael claims adjustment income as well?
Yeah, Chris. I think, basically, this just comes down to a timing and a process. Obviously, we made a large push going into hurricane season to try to get as many of our Hurricane Irma claims settled as we could. I think when you're looking at that increase in Q3, it just has to do with the timing. I think you're going to see Hurricane Irma level off here pretty good. I think, obviously, as you mentioned, you're going to see now Hurricane Florence as well as Hurricane Michael participate to Universal Adjusting's revenue going forward.
Okay. Just a question on the buybacks. I think Frank had mentioned in his script, no buybacks this quarter. I guess just how are you thinking about the relative attractiveness of dividends, share repurchases, et cetera?
Yeah. As we've always said, this management team and board is constantly evaluating our cash needs. We've always been historically conservative in Q3, obviously, because of the catastrophic environment. We try to support the stock, we planned on doing so in the event of a hurricane, but we are in a blackout period prior to Hurricane Michael, it prohibited us from making any more purchases.
Okay, great. Well, thanks for all the answers. Best of luck in 2019.
Thank you very much for your time.
Your next question is from Samir Khair with Capital Returns Management. Please go ahead, your line is open.
Good morning. I have a couple of questions on, I guess, the moving parts in the quarter. Kind of dovetailing off Chris's question on the loss ratio. Just so I understand, if we remove the effects of $16.7 million from UAC revenues, remove the effect of $7.5 million of CATs, and then remove the, I guess, the effect of $13.5 million of additional ceded premium expense. On a gross basis, that puts you at your expected loss ratio of 33%. Is that correct?
That's fair. That's what we're currently booking to on a direct basis.
Okay. I guess I misunderstood. I thought before you guys said you had additional for AOB, but it sounds like that's already in there. Okay. Then, if the Irma loss continues to develop, what's the maximum additional ceded premium you could have from additional reinstatement premiums?
The maximum number-
Yeah
would be approximately $9.4 million-
Another $9.4.
remaining beyond the $13.5 that we already booked this quarter.
Okay. How much additional gross loss does that represent? How much would Hurricane Irma have to creep to realize that $9.4 million?
Well, that's a difficult question to answer because the Florida Hurricane Catastrophe Fund comes into play at some point, which has no reinstatement cost. I can tell you in terms of additional ceded losses to our open market reinsurance program, that would be roughly $165 million more.
Great. Okay. The additional 4,000 claims that you guys had from Hurricane Irma in the quarter, can you describe the complexion of them? Are they reopens? Are they claims coming that are attorney represented upon first notice of loss? Anything like that?
It's a mixed bag, Samir. A lot of it is attorney-represented claims, and then it's your loss assessment claims.
All right. Just in the fourth quarter thus far, can you give us an idea of how much claims revenue you guys have accrued for Hurricane Irma and any that you've accrued for Hurricane Michael?
We don't have that information right now, Samir, but we can get back to you on that.
Okay. Just talking about Hurricane Michael a little bit. Can you give us some claim metrics? How many claims you have, severity, how many are total losses, % close, et cetera?
Yes. Roughly right now, approximately 5,500 in Florida and another 1,500 in other states. Obviously right now, the severity in Florida is much greater than in other states. The claims that we've seen in the other states, more than 50% have been closed with no pay because they're not above the deductible. Obviously, we still think we're going to receive a lot more claims in Florida. There's a lot of places right now that I think people just are getting through the process, getting back to their homes and are in the process of filing claims. As of right now, most of the loss is associated with Florida.
Okay. I guess for Michael, this is considered your second event for purposes of the retentions, is that right? It drops down to $3 million for out of state?
That's correct.
Okay. Of the $350 million that you guys have pegged for gross loss for Michael, can you delineate that? How much of that is in Florida? How much is it extra Florida?
That's our gross estimate at this point, and we're not going to share how much we think may come from outside of Florida at this point. It is very early in the claims reporting cycle on Hurricane Michael, and it would be inappropriate to try to guess right now.
Okay. On Universal Direct , how much premium was written from Universal Direct in the quarter inside Florida and outside Florida?
Can you repeat that one more time, please?
Yeah, just how much premium was written in the quarter from Universal Direct inside Florida and outside Florida?
60% was written in Florida, 40% basically in other states.
Sorry, was it all premium-based that was written in Universal Direct?
Thus far, it's entirely in $16 million, just over $16 million.
Okay. That's in force though, right?
Correct.
Okay. Any updates to the Universal Direct partnerships or any new ones in the pipeline?
We continue to entertain and talk to people about how we can continue to monetize the organic leads driven to Universal, it'd be premature to announce anything without concrete agreements, et cetera, in place.
Okay. Your reinsurance tower, how much of it renews next year in premium dollars? Approximately how much of that is the FHCF?
Just a high-level breakdown. Roughly 40% of our ceded premium is Florida Hurricane Catastrophe Fund, and roughly 25% is already pre-negotiated. The remaining 35% of our spend is up for renewal at June 1, 2019.
Great. Frank, last year, I recall the reinsurers, they fronted the money for reinsurance recoverables, and that resulted in a higher net investment income line. Are we going to experience the same in Q4 because of Hurricane Michael?
That's a very marginal benefit that we get that reinsurers will advance money. There's a small investment income associated with that.
Okay, great. Thanks, guys. Appreciate the answers.
Thanks a lot. Take care.
There are no further questions at this time. I will turn the call back over to Sean Downes for any closing remarks.
As always, in closing, I would personally like to thank all of our shareholders, employees, board of directors, policyholders, and my management team for their hard work and loyalty to Universal. This concludes the call. Thank you.
Ladies and gentlemen, this concludes today's conference. Thank you for your participation, and have a wonderful day. You may now disconnect.