UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Form 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2019
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number
001-34126
HCI Group, Inc.
(Exact name of Registrant as specified in its charter)
5300 West Cypress Street, Suite 100
Tampa, FL 33607
(Address, including zip code, of principal executive offices)
(813) 849-9500
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
Trading
Symbol
Name of Each Exchange
on Which Registered
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T(§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
If an emerging growth company, indicate by check mark if the Registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
The aggregate number of shares of the Registrant’s Common Stock, no par value, outstanding on July 31, 2019 was 8,180,174.
HCI GROUP, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
Item 1
June 30, 2019 (unaudited) and December 31, 2018
Three and six months ended June 30, 2019 and 2018 (unaudited)
Six months ended June 30, 2019 and 2018 (unaudited)
Item 2
Item 3
Item 4
Item 1A
Item 5
Item 6
Signatures
Certifications
PART I — FINANCIAL INFORMATION
Item 1 — Financial Statements
Consolidated Balance Sheets
(Dollar amounts in thousands)
Assets
Fixed-maturity securities, available for sale, at fair value (amortized cost: $207,563 and $184,670, respectively)
Equity securities, at fair value (cost: $27,770 and $45,671, respectively)
Short-term investments, at fair value
Limited partnership investments, at equity
Investment in unconsolidated joint venture, at equity
Assets held for sale
Real estate investments
Total investments
Cash and cash equivalents
Restricted cash
Accrued interest and dividends receivable
Income taxes receivable
Premiums receivable
Prepaid reinsurance premiums
Reinsurance recoverable:
Paid losses and loss adjustment expenses
Unpaid losses and loss adjustment expenses
Deferred policy acquisition costs
Property and equipment, net
Intangible assets, net
Other assets
Total assets
(continued)
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Consolidated Balance Sheets — continued
Liabilities and Stockholders’ Equity
Losses and loss adjustment expenses
Unearned premiums
Advance premiums
Assumed reinsurance balances payable
Accrued expenses
Deferred income taxes, net
Revolving credit facility
Long-term debt
Other liabilities
Total liabilities
Commitments and contingencies (Note 18)
Stockholders’ equity:
7% Series A cumulative convertible preferred stock (no par value, 1,500,000 shares authorized, no shares issued or outstanding)
Series B junior participating preferred stock (no par value, 400,000 shares authorized, no shares issued or outstanding)
Preferred stock (no par value, 18,100,000 shares authorized, no shares issued or outstanding)
Common stock (no par value, 40,000,000 shares authorized, 8,053,573 and 8,356,730 shares issued and outstanding at June 30, 2019 and December 31, 2018, respectively)
Additional paid-in capital
Retained income
Accumulated other comprehensive income (loss), net of taxes
Total stockholders’ equity
Total liabilities and stockholders’ equity
See accompanying Notes to Consolidated Financial Statements
2
Consolidated Statements of Income
(Unaudited)
(Dollar amounts in thousands, except per share amounts)
Revenue
Gross premiums earned
Premiums ceded
Net premiums earned
Net investment income
Net realized investment (losses) gains
Net unrealized investment gains (losses)
Net other-than-temporary impairment losses
Policy fee income
Other
Total revenue
Expenses
Policy acquisition and other underwriting expenses
General and administrative personnel expenses
Interest expense
Other operating expenses
Total expenses
Income before income taxes
Income tax expense
Net income
Basic earnings per share
Diluted earnings per share
See accompanying Notes to Consolidated Financial Statements.
3
Consolidated Statements of Comprehensive Income
(Amounts in thousands)
Other comprehensive income (loss):
Change in unrealized gain (loss) on investments:
Net unrealized gain (loss) arising during the period
Other-than-temporary impairment loss charged to income
Call and repayment losses charged to investment income
Reclassification adjustment for net realized loss (gain)
Net change in unrealized gain (loss)
Deferred income taxes on above change
Total other comprehensive income (loss), net of income taxes
Comprehensive income
4
Consolidated Statement of Stockholders’ Equity
For the Three Months Ended June 30, 2019
(Dollar amounts in thousands, except per share amount)
Common Stock
Balance at March 31, 2019
Total other comprehensive income, net of income taxes
Exercise of common stock options
Issuance of restricted stock
Forfeiture of restricted stock
Repurchase and retirement of common stock
Repurchase and retirement of common stock under share repurchase plan
Common stock dividends ($0.40 per share)
Stock-based compensation
Additional paid-in capital shortfall allocated to retained income
Balance at June 30, 2019
5
For the Three Months Ended June 30, 2018
Balance at March 31, 2018
Common stock dividends ($0.375 per share)
Balance at June 30, 2018
6
For the Six Months Ended June 30, 2019
Balance at December 31, 2018
Common stock dividends ($0.80 per share)
7
For the Six Months Ended June 30, 2018
Balance at December 31, 2017
Total other comprehensive loss, net of income taxes
Cumulative effect adjustments for adoption of new accounting standards:
Reclassification of after-tax net unrealized holding gains related to equity securities
Reclassification of stranded tax effects related to available-for-sale fixed-maturity and equity securities
Purchase of noncontrolling interest
Common stock dividends ($0.725 per share)
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Consolidated Statements of Cash Flows
Cash flows from operating activities:
Adjustments to reconcile net income to net cash provided by operating activities:
Net amortization of premiums on investments in fixed-maturity securities
Depreciation and amortization
Deferred income tax expense
Net realized investment losses (gains)
Net unrealized investment (gains) losses
Other-than-temporary impairment losses
Loss (income) from unconsolidated joint venture
Net income from limited partnership interests
Distributions received from limited partnership interests
Foreign currency remeasurement (gain) loss
Changes in operating assets and liabilities:
Income taxes
Reinsurance recoverable
Reinsurance recovered in advance on unpaid losses
Accrued expenses and other liabilities
Net cash provided by operating activities
Cash flows from investing activities:
Investments in limited partnership interests
Purchase of property and equipment
Purchase of real estate investments
Purchase of intangible assets
Purchase of fixed-maturity securities
Purchase of equity securities
Purchase of short-term and other investments
Proceeds from sales of fixed-maturity securities
Proceeds from calls, repayments and maturities of fixed-maturity securities
Proceeds from sales of equity securities
Proceeds from sales, redemptions and maturities of short-term and other investments
Net cash provided by (used in) investing activities
9
Consolidated Statements of Cash Flows, continued
Cash flows from financing activities:
Cash dividends paid
Cash dividends received under share repurchase forward contract
Proceeds from revolving credit facility
Proceeds from exercise of common stock options
Repayment of long-term debt
Repurchases of common stock
Repurchases of common stock under share repurchase plan
Purchase of non-controlling interest
Debt issuance costs
Net cash used in financing activities
Effect of exchange rate changes on cash
Net decrease in cash, cash equivalents, and restricted cash
Cash, cash equivalents, and restricted cash at beginning of period
Cash, cash equivalents, and restricted cash at end of period
Supplemental disclosure of cash flow information:
Cash paid for income taxes
Cash paid for interest
Non-cash investing and financing activities:
Unrealized gain (loss) on investments in available-for-sale securities, net of tax
Receivable from sales of equity securities
Receivable from maturities of fixed-maturity securities
10
Notes to Consolidated Financial Statements (unaudited)
(Amounts in thousands, except share and per share amounts, unless otherwise stated)
Note 1 — Summary of Significant Accounting Policies
Basis of Presentation
The accompanying unaudited, consolidated financial statements for HCI Group, Inc. and its majority-owned and controlled subsidiaries (collectively, the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information, and the Securities and Exchange Commission (“SEC”) rules for interim financial reporting. Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with U.S. GAAP have been omitted pursuant to such rules and regulations. However, in the opinion of management, the accompanying consolidated financial statements reflect all normal recurring adjustments necessary to present fairly the Company’s financial position as of June 30, 2019 and the results of operations and cash flows for the periods presented. The results of operations for the interim periods presented are not necessarily indicative of the results of operations to be expected for any subsequent interim period or for the fiscal year ending December 31, 2019. The accompanying unaudited consolidated financial statements and notes thereto should be read in conjunction with the audited consolidated financial statements for the year ended December 31, 2018 included in the Company’s Form 10-K, which was filed with the SEC on March 8, 2019.
In preparing the interim unaudited consolidated financial statements, management was required to make certain judgments, assumptions, and estimates that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures at the financial reporting date and throughout the periods being reported upon. Certain of the estimates result from judgments that can be subjective and complex and consequently actual results may differ from these estimates.
Material estimates that are particularly susceptible to significant change in the near term are related to the Company’s losses and loss adjustment expenses, which include amounts estimated for claims incurred but not yet reported. The Company uses various assumptions and actuarial data it believes to be reasonable under the circumstances to make these estimates. In addition, accounting policies specific to reinsurance with retrospective provisions, reinsurance recoverable, deferred income taxes, and stock-based compensation expense involve significant judgments and estimates material to the Company’s consolidated financial statements.
All significant intercompany balances and transactions have been eliminated.
Adoption of New Accounting Standards
In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards UpdateNo. 2016-02 (“ASU 2016-02”), Leases (Topic 842). The guidance establishes new principles that lessees and lessors will apply to report useful information to users of financial statements about the amount, timing, and uncertainty of cash flows arising from a lease. ASU 2016-02 is effective for the Company January 1, 2019 and supersedes accounting for leases prescribed in Topic 840, Leases. ASU 2016-02 leaves lessor accounting substantially unchanged. The key change affecting the Company is the requirement that operating leases be recorded on the balance sheet. Topic 842 was subsequently amended by ASU No. 2018-01, Land Easement Practical Expedient for Transition to Topic 842; ASU No. 2018-10, Codification Improvements to Topic 842, Leases; ASU No. 2018-11, Targeted Improvements; ASU No. 2018-20, Narrow-Scope Improvements for Lessors; and ASU No.
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2019-01, Codification Improvements to Topic 842. The new standard establishes aright-of-use (“ROU”) model that requires a lessee to recognize a ROU asset and lease liability on the balance sheet for all leases with a term longer than 12 months. Leases will be classified as finance or operating, with classification affecting the pattern and classification of expense recognition in the income statement. The Company was initially required to use a modified retrospective method and apply this standard at the beginning of the earliest comparative period presented in the financial statements. Subsequently, the FASB permitted the application of this standard at the beginning of the adoption period as an alternative.
Effective January 1, 2019, the Company adopted the new standard using the effective date as its date of initial application. As a result, financial information is not updated and the disclosures required under the new standard are not provided for dates and periods prior to January 1, 2019. The Company elected a package of practical expedients, which permits the Company to not reassess under the new standard its prior conclusions about lease identification, lease classification, and initial direct costs. Upon adoption, the Company, as a lessee, recognized ROU assets of approximately $771 and lease liabilities of approximately $812 for all operating leases except for those that have a lease term of 12 months or less.
Leases
The Company leases office equipment, storage units, and office space from non-affiliates under terms ranging from one month up to ten years. In assessing whether a contract is or contains a lease, the Company first determines whether there is an identified asset in the contract. The Company then determines whether the contract conveys the right to obtain substantially all of the economic benefits from use of the identified asset or the right to direct the use of the identified asset. The Company elects not to record any lease with a term of 12 months or less on the consolidated balance sheet. For such short-term leases, the Company recognizes the lease payments in expense on a straight-line basis over the lease term.
If the contract is or contains a lease and the Company has the right to control the use of the identified asset, the ROU asset and the lease liability is measured from the lease component of the contract and recognized on the consolidated balance sheet. In measuring the lease liability, the Company uses its incremental borrowing rate for a loan secured by a similar asset that has a term similar to the lease term to discount the lease payments. The contract is further evaluated to determine the classification of the lease as to whether it is finance or operating. If the lease is a finance lease, the ROU asset is depreciated to depreciation expense over the shorter of the useful life of the asset or the lease term. Interest expense is recorded in connection with the lease liability using the effective interest method. If the lease is an operating lease, the ROU asset is amortized to lease expense on a straight-line basis over the lease term. For the presentation of finance leases on the Company’s consolidated balance sheet, ROU assets and corresponding lease liabilities are included with property and equipment, net, and long-term debt, respectively. For the presentation of operating leases on the Company’s consolidated balance sheet, ROU assets and corresponding lease liabilities are included with other assets and other liabilities, respectively.
The Company as a lessor leases its commercial and retail properties, boat slips, and docks tonon-affiliates at various terms. If the contract gives the Company’s customer the right to control the use of the identified asset, revenue is recognized on a straight-line basis over the lease term. Initial direct costs incurred by the Company are deferred and amortized on a straight-line basis over the lease term. The Company also records an unbilled receivable, which is the amount by which straight-line revenue exceeds the amount billed in accordance with the lease.
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Reclassification
Certain reclassifications of prior year amounts have been made to conform to the current year presentation.
Note 2 — Recent Accounting Pronouncements
Accounting Standard to be Adopted in Fiscal Year 2020
In June 2016, the FASB issued Accounting Standards Update No. 2016-13 (“ASU 2016-13”), Financial Instruments—Credit Losses (Topic 326), effective January 1, 2020. This update amends guidance on the recognition and measurement of credit losses for assets held at amortized cost and available-for-sale debt securities. For assets held at amortized cost, ASU 2016-13 eliminates the probable initial recognition threshold and, instead, requires credit losses to be measured using the Current Expected Credit Loss (“CECL”) model. The CECL model requires the measurement of all expected credit losses based on historical experience, current conditions, and reasonable and supportable forecasts which incorporate forward-looking information. For available-for-sale debt securities, credit losses will continue to be measured in a manner similar to the current standard. ASU 2016-13 requires a valuation allowance, rather than a write-down, to be recognized for the Company’s expected credit losses. The valuation allowance account is a deduction from the amortized cost basis of the financial assets to reflect the net amount expected to be collected. Any subsequent changes to the expected credit losses of the financial assets will be recorded in earnings. The Company is required to use the modified-retrospective method by recognizing a cumulative-effect adjustment to the beginning retained income of fiscal year 2020. As for debt securities in which an other-than-temporary impairment had been recognized before the effective date, the prospective transition method will be used. The Company does not anticipate a material impact on its financial position as a result of adopting this update.
Note 3 — Cash, Cash Equivalents, and Restricted Cash
The following table provides a reconciliation of cash, cash equivalents, and restricted cash reported within the Company’s consolidated balance sheets that sum to the total of the same such amounts shown in the statements of cash flows.
Total
Restricted cash primarily represents funds held by certain states in which the Company’s insurance subsidiaries conduct business to meet regulatory requirements.
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Note 4 — Investments
a) Available-for-Sale Fixed-Maturity Securities
The Company holds investments in fixed-maturity securities that are classified as available-for-sale. At June 30, 2019 and December 31, 2018, the cost or amortized cost, gross unrealized gains and losses, and estimated fair value of the Company’s available-for-sale securities by security type were as follows:
As of June 30, 2019
U.S. Treasury and U.S. government agencies
Corporate bonds
State, municipalities, and political subdivisions
Exchange-traded debt
Redeemable preferred stock
As of December 31, 2018
Expected maturities will differ from contractual maturities as borrowers may have the right to call or prepay obligations with or without penalties. The scheduled contractual maturities of fixed-maturity securities as of June 30, 2019 and December 31, 2018 are as follows:
Due in one year or less
Due after one year through five years
Due after five years through ten years
Due after ten years
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Sales ofAvailable-for-Sale Fixed-Maturity Securities
Proceeds received, and the gross realized gains and losses from sales ofavailable-for-sale securities, for the three and six months ended June 30, 2019 and 2018 were as follows:
Three months ended June 30, 2019
Three months ended June 30, 2018
Six months ended June 30, 2019
Six months ended June 30, 2018
Other-than-temporary Impairment
The Company regularly reviews its individual investment securities for other-than-temporary impairment. The Company considers various factors in determining whether each individual security is other-than-temporarily impaired, including-
the financial condition and near-term prospects of the issuer, including any specific events that may affect its operations or earnings;
the length of time and the extent to which the market value of the security has been below its cost or amortized cost;
general market conditions and industry or sector specific factors and other qualitative factors;
nonpayment by the issuer of its contractually obligated interest and principal payments; and
the Company’s intent and ability to hold the investment for a period of time sufficient to allow for the recovery of costs.
There was no impairment loss recognized for the three and six months ended June 30, 2019. For the three and six months ended June 30, 2018, the Company recognized $40 and $80, respectively, of impairment loss on one fixed-maturity security. At June 30, 2019, none of the fixed-maturity securities were considered other-than-temporarily impaired versus one fixed-maturity security at June 30, 2018.
15
Securities with gross unrealized loss positions at June 30, 2019 and December 31, 2018, aggregated by investment category and length of time the individual securities have been in a continuous loss position, are as follows:
At June 30, 2019, there were 22 securities in an unrealized loss position. Of these securities, 19 securities had been in an unrealized loss position for 12 months or longer.
At December 31, 2018, there were 82 securities in an unrealized loss position. Of these securities, 35 securities had been in an unrealized loss position for 12 months or longer.
b) Equity Securities
The Company holds investments in equity securities measured at fair values which are readily determinable. At June 30, 2019 and December 31, 2018, the cost, gross unrealized gains and losses, and estimated fair value of the Company’s equity securities were as follows:
June 30, 2019
December 31, 2018
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The table below presents the portion of unrealized gains and losses in the Company’s consolidated statement of income for the periods related to equity securities still held.
Net gains recognized
Exclude: Net realized (losses) gains recognized for securities sold
Net unrealized gains (losses) recognized
Sales of Equity Securities
Proceeds received, and the gross realized gains and losses from sales of equity securities, for the three and six months ended June 30, 2019 and 2018 were as follows:
c) Short-Term Investments
Short-term investments consist of the following at June 30, 2019 and December 31, 2018.
Certificates of deposit
Zero-coupon commercial paper
17
d) Limited Partnership Investments
The Company has interests in limited partnerships that are not registered or readily tradeable on a securities exchange. These partnerships are private equity funds managed by general partners who make decisions with regard to financial policies and operations. As such, the Company is not the primary beneficiary and does not consolidate these partnerships. The following table provides information related to the Company’s investments in limited partnerships:
Primarily in senior secured loans and, to a limited extent, in other debt and equity securities of private U.S. lower-middle-market companies. (b)(c)(e)
Value creation through active distressed debt investing primarily in bank loans, public and private corporate bonds, asset-backed securities, and equity securities received in connection with debt restructuring. (b)(d)(e)
High returns and long-term capital appreciation through investments in the power, utility and energy industries, and in the infrastructure sector. (b)(f)(g)
Value-oriented investments in less liquid and mispriced senior and junior debts of private equity-backed companies. (b)(h)(i)
Value-oriented investments in mature real estate private equity funds and portfolio globally. (b)(j)
Represents the Company’s percentage investment in the fund at each balance sheet date.
Except under certain circumstances, withdrawals from the funds or any assignments are not permitted. Distributions, except income from late admission of a new limited partner, will be received when underlying investments of the funds are liquidated.
Expected to have a ten-year term and the capital commitment is expected to expire on September 3, 2019.
Expected to have a three-year term from June 30, 2018. Although the capital commitment period already ended, the general partner could still request an additional funding of approximately $843 under certain circumstances.
At the fund manager’s discretion, the term of the fund may be extended for up to two additional one-year periods.
Expected to have a ten-year term and the capital commitment is expected to expire on June 30, 2020.
With the consent of a supermajority of partners, the term of the fund may be extended for up to three additional one-year periods.
Expected to have a six-year term from the commencement date, which can be extended for up to two additional one-year periods with the consent of either the advisory committee or a majority of limited partners.
Unless extended or terminated for reasons specified in the agreement, the capital commitment is expected to expire on December 1, 2019.
Expected to have an eight-year term after the final fund closing date, which has yet to be determined.
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The following is the summary of aggregated unaudited financial information of limited partnerships included in the investment strategy table above, which in certain cases is presented on a three-month lag due to the unavailability of information at the Company’s respective balance sheet dates. In applying the equity method of accounting, the Company uses the most recently available financial information provided by the general partner of each of these partnerships. The financial statements of these limited partnerships are audited annually.
Operating results:
Total income
Balance Sheet:
For the three and six months ended June 30, 2019, the Company recognized net investment income of $1,043 and $832, respectively, for these investments. During the three and six months ended June 30, 2019, the Company received total cash distributions of $3,073 and $4,086, respectively. Cash distributions representing return on investment were $2,603 and $3,616 for the three and six months ended June 30, 2019, respectively.
For the three and six months ended June 30, 2018, the Company recognized net investment income of $247 and $852, respectively. During the three months ended June 30, 2018, the Company received total cash distributions of $595, representing $114 of returned capital and $481 of return on investment. During the six months ended June 30, 2018, the Company received total cash distributions of $723, representing $114 of returned capital and $609 of return on investment. At June 30, 2019 and December 31, 2018, the Company’s cumulative contributed capital to the partnerships at each respective balance sheet date totaled $30,106 and $28,354, respectively, and the Company’s maximum exposure to loss aggregated $30,790 and $32,293, respectively.
e) Investment in Unconsolidated Joint Venture
Melbourne FMA, LLC, a wholly owned subsidiary, currently has an equity investment in FMKT Mel JV, a Florida limited liability company treated as a joint venture under U.S. GAAP. At June 30, 2019 and December 31, 2018, the Company’s maximum exposure to loss relating to the variable interest entity was $791 and $845, respectively, representing the carrying value of the investment. There was no cash distribution during the six months ended June 30, 2019 and 2018. At June 30, 2019 and December 31, 2018, there was no undistributed income from this equity method investment. The following tables provide FMJV’s summarized unaudited financial results and the unaudited financial positions:
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Total revenues and gain
Net (loss) income
The Company’s share of net (loss) income*
Included in net investment income in the Company’s consolidated statements of income.
Cash
Members’ capital
Total liabilities and members’ capital
Investment in unconsolidated joint venture, at equity**
Includes the 90% share of FMKT Mel JV’s operating results.
f) Real Estate Investments
Real estate investments consist of the following as of June 30, 2019 and December 31, 2018.
Land
Land improvements
Buildings
Tenant and leasehold improvements
Total, at cost
Less: accumulated depreciation and amortization
On February 27, 2019, the Company acquired approximately nine acres of undeveloped land located near its current headquarters in Tampa, Florida for a purchase price of $8,500, which was primarily financed by the Company’s revolving credit facility. The transaction was accounted for as an asset acquisition. As such, all acquisition-related costs were capitalized.
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Depreciation and amortization expense related to real estate investments was $422 and $402 for the three months ended June 30, 2019 and 2018, respectively, and $754 and $796 for the six months ended June 30, 2019 and 2018, respectively.
g) Net Investment Income
Net investment income (loss), by source, is summarized as follows:
Available-for-salefixed-maturity securities
Equity securities
Investment expense
Limited partnership investments
Short-term investments
Note 5 — Comprehensive Income (Loss)
Comprehensive income (loss) includes net income and other comprehensive income or loss, which for the Company includes changes in unrealized gains or losses of investments carried at fair value and changes in the unrealized other-than-temporary impairment losses related to these investments. Reclassification adjustments for realized (gains) losses are reflected in net realized investment gains (losses) on the consolidated statements of income. The components of other comprehensive income or loss and the related tax effects allocated to each component were as follows:
Unrealized gain (loss) arising during the period
Other-than-temporary impairment loss
Reclassification adjustment for realized losses
Total other comprehensive gain (loss)
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Note 6 — Fair Value Measurements
The Company records and discloses certain financial assets at their estimated fair value. The fair value hierarchy prioritizes the inputs to valuation techniques used to measure fair value into three broad levels as follows:
Valuation Methodology
Cash and cash equivalents primarily consist of money-market funds and certificates of deposit maturing within 90 days. Their carrying value approximates fair value due to the short maturity and high liquidity of these funds.
Short-term investments consist of certificates of deposit and zero-coupon commercial paper with maturities of 91 to 365 days. Due to their short maturity, the carrying value approximates fair value.
Fixed-maturity and equity securities
Estimated fair values of the Company’s fixed-maturity and equity securities are determined in accordance with U.S. GAAP, using valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. Fair values are generally measured using quoted prices in active markets for identical securities or other inputs that are observable either directly or indirectly, such as quoted prices for similar securities. In those instances where observable inputs are not
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available, fair values are measured using unobservable inputs. Unobservable inputs reflect the Company’s own assumptions about the assumptions that market participants would use in pricing the security and are developed based on the best information available in the circumstances. Fair value estimates derived from unobservable inputs are significantly affected by the assumptions used, including the discount rates and the estimated amounts and timing of future cash flows. The derived fair value estimates cannot be substantiated by comparison to independent markets and are not necessarily indicative of the amounts that would be realized in a current market exchange.
The estimated fair values for securities that do not trade on a daily basis are determined by management, utilizing prices obtained from an independent pricing service and information provided by brokers, which are level 2 inputs. Management reviews the assumptions and methods utilized by the pricing service and then compares the relevant data and pricing to broker-provided data. The Company gains assurance of the overall reasonableness and consistent application of the assumptions and methodologies and compliance with accounting standards for fair value determination through ongoing monitoring of the reported fair values.
Limited Partnership Investments
As described in Note 4 — “Investments” under Limited Partnership Investments, the Company has interests in limited partnerships which are private equity funds. Pursuant to U.S. GAAP, these funds are required to use fair value accounting; therefore, the estimated fair value approximates the carrying value of these funds.
Revolving Credit Facility
The Company’s revolving credit facility is a variable-rate loan. The interest rate is periodically adjusted based on the London Interbank Offered Rate plus a spread. As a result, its carrying value approximates fair value.
The following table summarizes components of the Company’s long-term debt and methods used in estimating their fair values:
3.875% Convertible senior notes
4.25% Convertible senior notes
3.95% Promissory note
4% Promissory note
3.75% Callable promissory note
4.55% Promissory note
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Assets Measured at Estimated Fair Value on a Recurring Basis
The following table presents information about the Company’s financial assets measured at estimated fair value on a recurring basis. The table indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value as of June 30, 2019 and December 31, 2018:
Financial Assets:
Fixed-maturity securities:
Totalavailable-for-sale securities
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Assets and Liabilities Carried at Other Than Estimated Fair Value
The following tables present fair value information for assets and liabilities that are carried on the balance sheet at amounts other than fair value as of June 30, 2019 and December 31, 2018:
Financial Liabilities:
Long-term debt:
Total long-term debt
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Note 7 — Other Assets
The following table summarizes the Company’s other assets.
Benefits receivable related to retrospective reinsurance contract
Prepaid expenses
Deposits
Lease acquisition costs, net
Right-of-useassets – operating leases
Total other assets
Note 8 – Revolving Credit Facility
In February 2019, the Company borrowed $8,000 to fund the purchase of the undeveloped land as described in Note 4 — “Investments” under Real Estate Investments. The Company incurred and capitalized $459 of issuance costs in other assets. During the second quarter of 2019, the Company borrowed an additional amount of $1,500 for general corporate purposes. For the three months ended June 30, 2019, interest expense was $127 including $40 of amortization of issuance costs. For the six months ended June 30, 2019, interest expense totaled $196, which included $79 of amortized issuance costs. At June 30, 2019, the Company was in compliance with all required covenants, and there were $9,500 of borrowings outstanding.
Note 9 — Long-Term Debt
The following table summarizes the Company’s long-term debt.
3.875% Convertible senior notes, due March 15, 2019
4.25% Convertible senior notes, due March 1, 2037
3.95% Promissory note, due through February 17, 2020
4% Promissory note, due through February 1, 2031
3.75% Callable promissory note, due through September 1, 2036
4.55% Promissory note, due through August 1, 2036
Finance lease liability, due through August 15, 2023
Total principal amount
Less: unamortized discount and issuance costs
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The following table summarizes future maturities of long-term debt as of June 30, 2019, which takes into consideration the assumption that the 4.25% Convertible Senior Notes are repurchased at the earliest call date.
Due in 12 months following June 30, 2019
2020
2021
2022
2023
Thereafter
Information with respect to interest expense related to long-term debt is as follows:
Interest Expense:
Contractual interest
Non-cash expense (a)
Capitalized interest (b)
Includes amortization of debt discount and issuance costs.
Interest was capitalized for a construction project.
Convertible Senior Notes
On March 15, 2019, the Company repaid the remaining principal balance of its 3.875% Convertible Notes totaling $89,990 plus accrued interest of $1,744. Prior to the repayment, the conversion rate of the 3.875% Convertible Notes was 16.4074 shares of common stock for each $1 in principal amount, which was the equivalent of approximately $60.95 per share.
4.25% Convertible Notes. Since May 2018, the Company’s cash dividends on common stock have exceeded $0.35 per share, resulting in adjustments to the conversion rate of the 4.25% Convertible Notes. Accordingly, as of June 30, 2019, the conversion rate of the Company’s 4.25% Convertible Notes was 16.3280 shares of common stock for each $1 in principal amount, which was the equivalent of approximately $61.24 per share.
As of June 30, 2019, the remaining amortization period of the debt discount for 4.25% Convertible Notes was expected to be 2.75 years.
Note 10 — Reinsurance
The Company cedes a portion of its insurance exposure to other entities under catastrophe excess of loss reinsurance contracts and one quota share reinsurance agreement. The Company remains liable for claims payments in the event that any reinsurer is unable to meet its obligations under the reinsurance agreements. Failure of reinsurers to honor their obligations could result in losses to the
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Company. The Company evaluates the financial condition of its reinsurers and monitors concentrations of credit risk arising from similar geographic regions, activities or economic characteristics of the reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. The Company contracts with a number of reinsurers to secure its annual reinsurance coverage, which generally becomes effective June 1st each year. The Company purchases reinsurance each year taking into consideration probable maximum losses and reinsurance market conditions.
The impact of the reinsurance contracts on premiums written and earned is as follows:
Premiums Written:
Direct
Assumed
Gross written
Ceded
Net premiums written
Premiums Earned:
Gross earned
There were no ceded losses recognized during the three and six months ended June 30, 2019. During the three and six months ended June 30, 2018, ceded losses of $58,671 and $58,466, respectively, were recognized as a reduction in losses and losses adjustment expenses. At June 30, 2019 and December 31, 2018, there were 31 and 38 reinsurers, respectively, participating in the Company’s reinsurance program. Total amounts recoverable and receivable from reinsurers at June 30, 2019 and December 31, 2018 were $78,080 and $123,911, respectively. Approximately 36.0% of the reinsurance recoverable balance at June 30, 2019 was concentrated in five reinsurers. Based on the insurance ratings, the payment history and the financial strength of the reinsurers, management believes there was no significant credit risk associated with its reinsurers’ obligations to perform on any prepaid reinsurance contract and to fund any reinsurance recoverable balance as of June 30, 2019.
One of the reinsurance contracts includes retrospective provisions that adjust premiums in the event losses are minimal or zero. For the three and six months ended June 30, 2019, the Company recognized reductions in premiums ceded of $1,226 and $1,738, respectively, related to these adjustments. In contrast, these adjustments were reflected in the consolidated statements of income as net increases in ceded premiums of $378 and $715 for the three and six months ended June 30, 2018, respectively, of which $400 and $448 related to the Company’s contract with Oxbridge Reinsurance Limited, a related party, which was terminated effective June 1, 2018.
In addition, adjustments related to retrospective provisions are reflected in other assets. At June 30, 2019 and December 31, 2018, other assets included $4,440 and $3,136, respectively. Management believes the credit risk associated with the collectability of these accrued benefits is minimal as the amount receivable is concentrated with one reinsurer and the Company monitors the creditworthiness of this reinsurer based on available information about the reinsurer’s financial condition.
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Note 11 — Losses and Loss Adjustment Expenses
The liability for losses and loss adjustment expenses is determined on an individual case basis for all claims reported. The liability also includes amounts for unallocated expenses, anticipated future claim development and losses incurred, but not reported.
The Company primarily writes insurance in the state of Florida, which could be exposed to hurricanes or other natural catastrophes. The occurrence of a major catastrophe could have a significant effect on the Company’s quarterly results and cause a temporary disruption of the normal operations of the Company. However, the Company is unable to predict the frequency or severity of any such events that may occur in the near term or thereafter.
Activity in the liability for unpaid losses and loss adjustment expenses is summarized as follows:
Net balance, beginning of period*
Incurred, net of reinsurance, related to:
Current period
Prior period
Total incurred, net of reinsurance
Paid, net of reinsurance, related to:
Total paid, net of reinsurance
Net balance, end of period
Add: reinsurance recoverable
Gross balance, end of period
Net balance representsbeginning-of-period liability for unpaid losses and loss adjustment expenses lessbeginning-of-period reinsurance recoverable for unpaid losses and loss adjustment expenses.
The establishment of loss reserves is an inherently uncertain process and changes in loss reserve estimates are expected as these estimates are subject to the outcome of future events. Changes in estimates, or differences between estimates and amounts ultimately paid, are reflected in the operating results of the period during which such estimates are adjusted. During the three and six months ended June 30, 2019, the Company recognized losses related to prior periods of $2,877 and $5,552, respectively, which were primarily attributable to unfavorable development resulting from litigation. Included in adverse development for the three and six months ended June 30, 2019 were losses related to Hurricane Matthew of $242 and $1,052, respectively. Losses for the 2019 loss year included estimated losses of $5,250 related to one severe storm event during the first quarter.
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Note 12 — Segment Information
The Company identifies its operating divisions based on organizational structure and revenue source. Currently, the Company has three reportable segments: insurance operations, real estate operations, and corporate and other. Due to their economic characteristics, the Company’s property and casualty insurance division and reinsurance division are grouped together into one reportable segment under insurance operations. The real estate operations segment includes companies engaged in operating commercial properties the Company owns for investment purposes or for use in its own operations. The corporate and other segment represents the activities of the holding companies, the information technology division, and other companies that do not meet the quantitative and qualitative thresholds for a reportable segment. The determination of segments may change over time due to changes in operational emphasis, revenues, and results of operations. The Company’s chief executive officer, who serves as the Company’s chief operating decision maker, evaluates each division’s financial and operating performance based on revenue and operating income.
For the three months ended June 30, 2019 and 2018, revenues from the Company’s insurance operations before intracompany elimination represented 95.2% and 95.6%, respectively, of total revenues of all operating segments. For the six months ended June 30, 2019 and 2018, revenues from the Company’s insurance operations before intracompany elimination represented 94.9% and 95.2%, respectively, of total revenues of all operating segments. At June 30, 2019 and December 31, 2018, insurance operations’ total assets represented 84.6% and 85.9%, respectively, of the combined assets of all operating segments. The following tables present segment information reconciled to the Company’s consolidated statements of income. Intersegment transactions are not eliminated from segment results. However, intracompany transactions are eliminated in segment results below.
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Revenue:
Net realized investment losses
Net unrealized investment gains
Expenses:
Amortization of deferred policy acquisition costs
Income (loss) before income taxes
Total revenue from non-affiliates(c)
Other revenue under real estate primarily consisted of rental income from investment properties.
Other revenue under corporate and other primarily consisted of revenue from restaurant and marina businesses.
Represents amounts before reclassification to conform with an insurance company’s presentation.
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Net realized investment gains
Net unrealized investment losses
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Net realized investment gains (losses)
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The following table presents segment assets reconciled to the Company’s total assets in the consolidated balance sheets.
Segment:
Insurance Operations
Real Estate Operations
Corporate and Other
Consolidation and Elimination
Note 13 — Leases
At June 30, 2019, the Company had operating leases’ ROU assets and corresponding liabilities of $629 and $672, respectively. In addition, the Company had one finance lease with a ROU asset of $61 and a corresponding lease liability of $50 at June 30, 2019. The following table summarizes the Company’s operating and finance leases in which the Company is a lessee:
Class of Assets
Operating lease:
Office equipment
Storage units
Office space
Finance lease:
At the end of the lease term, the Company can purchase the equipment at fair market value.
There are no variable lease payments.
Rent escalation provisions exist.
There is a bargain purchase option.
As of June 30, 2019, maturities of lease liabilities were as follows:
Due in 12 months following June 30,
2019
Total lease payments
Less: interest and foreign taxes
Total lease obligations
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The following table provides quantitative information with regard to the Company’s operating and finance leases.
Lease costs:
Finance lease costs:
Amortization — ROU assets*
Operating lease costs*
Short-term lease costs*
Total lease costs
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows — finance leases
Operating cash flows — operating leases
Financing cash flows — finance leases
Weighted-average remaining lease term:
Finance leases (in years)
Operating leases (in years)
Weighted-average discount rate:
Finance leases
Operating leases
Included in other operating expenses of the consolidated statement of income.
The following table summarizes the Company’s operating leases in which the Company is a lessor:
Retail space
Boat docks/wet slips
There are no purchase options.
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Note 14 — Income Taxes
During the three months ended June 30, 2019 and 2018, the Company recorded approximately $2,762 and $5,117 respectively, of income taxes, which resulted in effective tax rates of 26.8% and 44.4%, respectively. The decrease in the effective tax rate was primarily attributable to the derecognition of deferred tax assets of $1,620 for restricted stock awards with market-based vesting conditions that would not vest and the disallowance of the deductibility of the $1,727 expense representing dividends cumulatively paid on such restricted stock awards, both of which occurred in the second quarter of 2018 (see Restricted Stock Awards in Note 17 — “Stock-Based Compensation”). During the six months ended June 30, 2019 and 2018, the Company recorded approximately $5,307 and $9,130, respectively, of income taxes, which resulted in effective tax rates of 27.1% and 34.7%, respectively. The decrease in the effective tax rate in 2019 as compared with the corresponding period in the prior year was primarily attributable to the negative effect of the aforementioned derecognition of deferred tax assets and the nondeductible expense related to reclassified dividends. The Company’s estimated annual effective tax rate differs from the statutory federal tax rate due to state and foreign income taxes as well as certain nondeductible and tax-exempt items.
Note 15 — Earnings Per Share
U.S. GAAP requires the Company to use the two-class method in computing basic earnings per share since holders of the Company’s restricted stock have the right to share in dividends, if declared, equally with common stockholders. These participating securities affect the computation of both basic and diluted earnings per share during periods of net income or loss.
A summary of the numerator and denominator of the basic and diluted earnings per common share is presented below.
Less: (Income) loss attributable to participating securities*
Basic Earnings Per Share:
Income allocated to common stockholders
Effect of Dilutive Securities:
Stock options
Convertible senior notes
Diluted Earnings Per Share:
Income available to common stockholders and assumed conversions
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Loss attributable to participating securities for the three and six months ended June 30, 2018 included the reclassification of cumulative dividends paid on certain restricted stock with market-based vesting conditions from retained income to expense. See Restricted Stock Awards in Note 17 — “Stock-Based Compensation” for additional information.
Note 16 — Stockholders’ Equity
In December 2018, the Company’s Board of Directors authorized a plan to repurchase up to $20,000 of the Company’s common shares before commissions and fees. During the three months ended June 30, 2019, the Company repurchased and retired a total of 160,787 shares at a weighted average price per share of $41.44 under this authorized repurchase plan. The total cost of shares repurchased, inclusive of fees and commissions, during the three months ended June 30, 2019 was $6,668 or $41.47 per share. During the six months ended June 30, 2019, the Company repurchased and retired a total of 192,576 shares at a weighted average price per share of $41.54 under this authorized repurchase plan. The total cost of shares repurchased, inclusive of fees and commissions, during the six months ended June 30, 2019 was $8,006, or $41.57 per share.
In December 2017, the Company’s Board of Directors authorized a plan to repurchase up to $20,000 of the Company’s common shares before commissions and fees. During the three months ended June 30, 2018, the Company repurchased and retired a total of 174,951 shares at a weighted average price per share of $40.97 under this authorized repurchase plan. The total cost of shares repurchased, inclusive of fees and commissions, during the three months ended June 30, 2018 was $7,174, or $41.00 per share. During the six months ended June 30, 2018, the Company repurchased and retired a total of 359,522 shares at a weighted average price per share of $38.11. The total cost of shares repurchased, inclusive of fees and commissions, during the six months ended June 30, 2018 was $13,711, or $38.14 per share.
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On April 8, 2019, the Company’s Board of Directors declared a quarterly dividend of $0.40 per common share. The dividends were paid on June 21, 2019 to stockholders of record on May 17, 2019.
Note 17 — Stock-Based Compensation
Incentive Plans
The Company currently has outstanding stock-based awards granted under the 2007 Stock Option and Incentive Plan and the 2012 Omnibus Incentive Plan. Only the 2012 Plan is active and available for future grants. At June 30, 2019, there were 1,738,164 shares available for grant.
Stock Options
Stock options granted and outstanding under the incentive plans vest over periods ranging from immediately vested to five years and are exercisable over the contractual term of ten years.
A summary of the stock option activity for the three and six months ended June 30, 2019 and 2018 is as follows (option amounts not in thousands):
Outstanding at January 1, 2019
Granted
Outstanding at March 31, 2019
Exercised
Outstanding at June 30, 2019
Exercisable at June 30, 2019
Outstanding at January 1, 2018
Outstanding at March 31, 2018
Outstanding at June 30, 2018
Exercisable at June 30, 2018
There were 10,000 options exercised during the three and six months ended June 30, 2019. Tax benefits realized for the exercise of common stock options totaled $88 for the three and six months ended June 30, 2019. For the three months ended June 30, 2019 and 2018, the Company recognized $200 and $136, respectively, of compensation expense which was included in general and administrative personnel expenses. For the six months ended June 30, 2019 and 2018, the Company recognized $425 and $246, respectively, of compensation expense. Deferred tax benefits related to stock options were $20 for each of the three months ended June 30, 2019 and 2018, and $39 for each of the six months ended June 30, 2019 and 2018. At June 30, 2019 and December 31, 2018, there was $2,280 and $1,359, respectively, of unrecognized compensation expense related to nonvested stock options. The Company expects to recognize the remaining compensation expense over a weighted-average period of 2.9 years.
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The following table provides assumptions used in the Black-Scholes option-pricing model to estimate the fair value of the stock options granted during the six months ended June 30, 2019 and 2018:
Expected dividend yield
Expected volatility
Risk-free interest rate
Expected life (in years)
Restricted Stock Awards
From time to time, the Company has granted and may grant restricted stock awards to its executive officers, other employees and nonemployee directors in connection with their service to the Company. The terms of the Company’s outstanding restricted stock grants may include service, performance and market-based conditions. The fair value of the awards with market-based conditions is determined using a Monte Carlo simulation method, which calculates many potential outcomes for an award and then establishes fair value based on the most likely outcome. The determination of fair value with respect to the awards containing only performance or service-based conditions is based on the market value of the Company’s common stock on the grant date.
Information with respect to the activity of unvested restricted stock awards during the three and six months ended June 30, 2019 and 2018 is as follows:
Nonvested at January 1, 2019
Vested
Forfeited
Nonvested at March 31, 2019
Nonvested at June 30, 2019
Nonvested at January 1, 2018
Nonvested at March 31, 2018
Nonvested at June 30, 2018
The Company recognized compensation expense related to restricted stock, which is included
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in general and administrative personnel expenses, of $1,269 and $897 for the three months ended June 30, 2019 and 2018, respectively, and $2,523 and $1,659 for the six months ended June 30, 2019 and 2018, respectively. At June 30, 2019 and December 31, 2018, there was approximately $15,712 and $11,199, respectively, of total unrecognized compensation expense related to nonvested restricted stock arrangements. The Company expects to recognize the remaining compensation expense over a weighted-average period of 2.9 years. The following table summarizes information about deferred tax benefits recognized and tax benefits realized related to restricted stock awards and paid dividends, and the fair value of vested restricted stock for the three and six months ended June 30, 2019 and 2018.
Deferred tax benefits recognized
Tax benefits realized for restricted stock and paid dividends
Fair value of vested restricted stock
In May 2019, 260,000 shares of the Company’s restricted stock awards granted to employee and nonemployee directors were forfeited for not meeting their market-based vesting conditions. For the same reason, the Company expects another 24,000 shares of restricted stock awards with similar vesting conditions to be forfeited in November 2019. Any dividend payment associated with these awards was expensed when declared. As a result, for the three months ended June 30, 2019, the Company recognized dividends of $113 related to these awards in general and administrative personnel expenses for $85 and in other operating expenses for $28. For the six months ended June 30, 2019, the Company recognized dividends of $227 in general and administrative personnel expenses for $170 and in other operating expenses for $57. In May 2018, the Company reclassified from retained income dividends of $1,727 cumulatively paid on unvested restricted stock awards with market-based vesting conditions to general and administrative personnel expenses for $1,346 and to other operating expenses for $381.
Note 18 — Commitments and Contingencies
Obligations under Multi-Year Reinsurance Contract
As of June 30, 2019, the Company has a contractual obligation related to one multi-year reinsurance contract. This contract may be cancelled only with the other party’s consent. The table below presents the future minimum aggregate premium amounts payable to the reinsurer.
Due in 12 months following June 30, 2019*
Premiums payable after September 30, 2019 are estimated.
Capital Commitment
As described in Note 4 — “Investments” under Limited Partnership Investments, the Company is contractually committed to capital contributions for four limited partnership interests. At June 30, 2019, there was an aggregate unfunded balance of $14,552.
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Note 19 — Subsequent Events
On July 2, 2019, the Company’s Board of Directors declared a quarterly dividend of $0.40 per common share. The dividends are payable on September 20, 2019 to stockholders of record on August 16, 2019.
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ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion under this Item 2 in conjunction with our consolidated financial statements and related notes and information included elsewhere in this quarterly report on Form 10-Q and in our Form 10-Kfiled with the Securities and Exchange Commission (“SEC”) on March 8, 2019. Unless the context requires otherwise, as used in this Form 10-Q, the terms “HCI,” “we,” “us,” “our,” “the Company,” “our company,” and similar references refer to HCI Group, Inc., a Florida corporation incorporated in 2006, and its subsidiaries. All dollar amounts in this Management’s Discussion and Analysis of Financial Condition and Results of Operations are in whole dollars unless specified otherwise.
Forward-Looking Statements
In addition to historical information, this quarterly report contains forward-looking statements as defined under federal securities laws. Such statements involve risks and uncertainties, such as statements about our plans, objectives, expectations, assumptions or future events. These statements involve estimates, assumptions, known and unknown risks, uncertainties and other factors that could cause actual results to differ materially from any future results, performances or achievements expressed or implied by the forward-looking statements. Typically, forward-looking statements can be identified by terminology such as “anticipate,” “estimate,” “plan,” “project,” “continuing,” “ongoing,” “expect,” “believe,” “intend,” “may,” “will,” “should,” “could,” and similar expressions. The important factors that could cause actual results to differ materially from those indicated by such forward-looking statements include but are not limited to the effects of governmental regulation; changes in insurance regulations; the frequency and extent of claims; uncertainties inherent in reserve estimates; catastrophic events; changes in the demand for, pricing of, availability of or collectability of reinsurance; restrictions on our ability to change premium rates; increased rate pressure on premiums; and other risks and uncertainties detailed herein and from time to time in our SEC reports.
OVERVIEW – General
HCI Group, Inc. is a Florida-based company that, through its subsidiaries, is engaged in property and casualty insurance, reinsurance, real estate and information technology. Based on our organizational structure, revenue sources, and evaluation of financial and operating performances by management, we manage the following operations:
Property and casualty insurance
Reinsurance
Other Operations
Information technology
Other auxiliary operations
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For the three months ended June 30, 2019 and 2018, revenues from insurance operations before intracompany elimination represented 95.2% and 95.6%, respectively, of total revenues of all operating segments. For the six months ended June 30, 2019 and 2018, revenues from insurance operations before intracompany elimination represented 94.9% and 95.2%, respectively, of total revenues of all operating segments. At June 30, 2019 and December 31, 2018, insurance operations’ total assets represented 84.6% and 85.9%, respectively, of the combined assets of all operating segments. See Note 12 — “Segment Information” to our unaudited consolidated financial statements under Item 1 of this Quarterly Report on Form 10-Q for additional information.
Property and Casualty Insurance
Our insurance business is operated through two insurance subsidiaries: Homeowners Choice Property & Casualty Insurance Company, Inc. (“HCPCI”), our principal operating subsidiary, and TypTap Insurance Company (“TypTap”). We provide various forms of residential insurance products such as homeowners insurance, fire insurance, flood insurance and wind-only insurance. We are authorized to write residential property and casualty insurance in the states of Arkansas, California, Florida, Maryland, North Carolina, New Jersey, Ohio, Pennsylvania, South Carolina and Texas. Currently, Florida is our primary market.
Since the beginning of 2019, TypTap business has expanded rapidly. We expect this expansion to continue and contribute to our future growth.
We have a Bermuda domiciled wholly-owned reinsurance subsidiary, Claddaugh Casualty Insurance Company Ltd. We selectively retain risk in Claddaugh, reducing the cost of third party reinsurance. Claddaugh fully collateralizes its exposure to our insurance subsidiaries by depositing funds into a trust account. Claddaugh may mitigate a portion of its risk through retrocession contracts. Currently, Claddaugh does not provide reinsurance to non-affiliates.
Our real estate operations consist of properties we own and use for our own operations and multiple properties we own and operate for investment purposes. Properties used in operations consist of our Tampa headquarters building and a secondary insurance operations site in Ocala, Florida. Our investment properties include one full-service restaurant, retail shopping centers, one office building, two marinas, and undeveloped land near our headquarters in Tampa, Florida which we acquired in February 2019. See Note 4 — “Investments” under Real Estate Investments to our unaudited consolidated financial statements under Item 1 of this Quarterly Report on Form 10-Q for additional information.
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Information Technology
Our information technology operations include a team of experienced software developers with extensive knowledge in developing web-based products and applications for mobile devices. The operations, which are in Tampa, Florida and Noida, India, are focused on developing cloud-based, innovative products or services that support in-house operations as well as our third party relationships with our agency partners and claim vendors. These products include TypTapTM, SAMSTM, Harmony, CasaClueTM, Exzeo®, and Atlas ViewerTM.
Recent Events
On July 2, 2019, our Board of Directors declared a quarterly dividend of $0.40 per common share. The dividends are payable on September 20, 2019 to stockholders of record on August 16, 2019.
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RESULTS OF OPERATIONS
The following table summarizes our results of operations for the three and six months ended June 30, 2019 and 2018 (dollar amounts in thousands, except per share amounts):
Operating Revenue
Other income
Total operating revenue
Operating Expenses
Total operating expenses
Ratios to Net Premiums Earned:
Loss Ratio
Expense Ratio
Combined Ratio
Ratios to Gross Premiums Earned:
Earnings Per Share Data:
Basic
Diluted
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Comparison of the Three Months ended June 30, 2019 to the Three Months ended June 30, 2018
Our results of operations for the three months ended June 30, 2019 reflect income available to common stockholders of approximately $7,553,000, or $0.90 earnings per diluted common share, compared with approximately $6,403,000, or $0.92 earnings per diluted common share, for the three months ended June 30, 2018. The quarter-over-quarter increase in net income was primarily due to a decrease in income tax expense of approximately $2,355,000, a $1,621,000 decrease in interest expense, and a net increase in income from our investment portfolio of $955,000, offset by a $967,000 decrease in net premiums earned and an increase in losses and loss adjustment expenses of $2,490,000. Our income tax expense in 2018 was negatively impacted by the derecognition of deferred tax assets and the nondeductible expense associated with reclassified dividends as described in Note 14 — “Income Taxes” to our unaudited consolidated financial statements under Item 1 of this Quarterly Report on Form 10-Q.
Gross Premiums Earned for the three months ended June 30, 2019 and 2018 were approximately $83,315,000 and $85,919,000, respectively. The $2,604,000 decrease in 2019 was primarily attributable to a net decrease in policies in force.
Premiums Ceded for the three months ended June 30, 2019 and 2018 were approximately $31,317,000 and $32,954,000, respectively, representing 37.6% and 38.4%, respectively, of gross premiums earned. The $1,637,000 decrease was primarily attributable to a reduction in premiums ceded attributable to retrospective provisions under one reinsurance contract as opposed to a net increase in premiums ceded in the corresponding period in 2018. The decrease was offset in part by an increase in premiums ceded attributable to a lower retention level effective June 1, 2018. In addition, we incurred additional premiums ceded of approximately $1,222,000 resulting from the termination of our contract with Oxbridge Reinsurance Limited, a related party, during the second quarter of 2018.
Our premiums ceded represent costs of reinsurance to cover losses from catastrophes that exceed the retention levels defined by our catastrophe excess of loss reinsurance contracts or to assume a proportional share of losses as defined in a quota share agreement. The rates we pay for reinsurance are based primarily on policy exposures reflected in gross premiums earned. For the three months ended June 30, 2019, premiums ceded included a decrease of approximately $1,226,000 related to retrospective provisions. For the three months ended June 30, 2018, premiums ceded reflected a net increase of approximately $378,000. See “Economic Impact of Reinsurance Contracts with Retrospective Provisions” under “Critical Accounting Policies and Estimates.”
Net Premiums Written for the three months ended June 30, 2019 and 2018 totaled approximately $102,124,000 and $99,418,000, respectively. Net premiums written represent the premiums charged on policies issued during a fiscal period less any applicable reinsurance costs. The increase in 2019 resulted from the decrease in premiums ceded as described above combined with an increase in gross premiums written during the period. We had approximately 124,000 policies in force at June 30, 2019 as compared with approximately 132,000 policies in force at June 30, 2018.
Net Premiums Earned for the three months ended June 30, 2019 and 2018 were approximately $51,998,000 and $52,965,000, respectively, and reflect the gross premiums earned less reinsurance costs as described above.
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The following is a reconciliation of our total Net Premiums Written to Net Premiums Earned for the three months ended June 30, 2019 and 2018 (amounts in thousands):
Net Premiums Written
Increase in Unearned Premiums
Net Premiums Earned
Net Realized Investment Losses for the three months ended June 30, 2019 were approximately $133,000 versus approximately $2,662,000 of net realized investment gains for the three months ended June 30, 2018. The gains in 2018 resulted primarily from sales intended to rebalance our investment portfolio.
Net Unrealized Investment Gains for the three months ended June 30, 2019 were approximately $1,326,000 in contrast to approximately $1,557,000 of net unrealized investment losses for the three months ended June 30, 2018, reflecting a net favorable change in the fair value of equity securities.
Our Losses and Loss Adjustment Expenses amounted to approximately $24,293,000 and $21,803,000 for the three months ended June 30, 2019 and 2018, respectively. The $2,490,000 increase primarily resulted from the strengthening of loss reserves pertaining to non-catastrophe claims in the prior loss years in response to an upward trend in litigation. See “Reserves for Losses and Loss Adjustment Expenses” under “Critical Accounting Policies and Estimates.”
Interest Expense for the three months ended June 30, 2019 and 2018 was approximately $2,884,000 and $4,505,000, respectively. The $1,621,000 decrease resulted from the repayment of our 3.875% Convertible Senior Notes in March 2019.
Income Tax Expense for the three months ended June 30, 2019 and 2018 was approximately $2,762,000 and $5,117,000, respectively, for state, federal, and foreign income taxes resulting in an effective tax rate of 26.8% for 2019 and 44.4% for 2018. The decrease was primarily attributable to the derecognition of deferred tax assets and the disallowance of the deductibility of dividends reclassified to expense from retained income, which occurred in the second quarter of 2018. See Note 14 — “Income Taxes” to our unaudited consolidated financial statements under Item 1 of this Quarterly Report on Form 10-Q.
Ratios:
The loss ratio applicable to the three months ended June 30, 2019 (losses and loss adjustment expenses incurred related to net premiums earned) was 46.7% compared with 41.2% for the three months ended June 30, 2018. The increase was primarily due to an increase in losses and loss adjustment expenses as described previously.
The expense ratio applicable to the three months ended June 30, 2019 (defined as underwriting expenses, general and administrative personnel expenses, interest and other operating expenses related to net premiums earned) was 46.2% compared with 48.1% for the three months ended June 30, 2018. The decrease in our expense ratio was primarily attributable to the decrease in interest expense.
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The combined ratio (total of all expenses in relation to net premiums earned) is the measure of overall underwriting profitability before other income. Our combined ratio for the three months ended June 30, 2019 was 92.9% compared with 89.3% for the three months ended June 30, 2018. The increase was attributable to the decrease in net premiums earned combined with a net increase in total expenses.
Due to the impact our reinsurance costs have on net premiums earned from period to period, our management believes the combined ratio measured to gross premiums earned is more relevant in assessing overall performance. The combined ratio to gross premiums earned for the three months ended June 30, 2019 was 58.0% compared with 55.0% for the three months ended June 30, 2018. The increase in 2019 was attributable to the factors described above.
Comparison of the Six Months ended June 30, 2019 to the Six Months ended June 30, 2018
Our results of operations for the six months ended June 30, 2019 reflect income available to common stockholders of approximately $14,291,000, or $1.72 earnings per diluted common share, compared with approximately $17,194,000, or $2.03 earnings per diluted common share, for the six months ended June 30, 2018. The period-over-period decrease was primarily due to a $3,305,000 decrease in net premiums earned and $9,831,000 increase in losses and loss adjustment expenses, offset by a net increase in income from our investment portfolio of $6,344,000, which contributed to a decrease in pre-tax income of $6,726,000. In addition, our income tax expense in 2018 was negatively impacted by the factors described previously.
Gross Premiums Earned for the six months ended June 30, 2019 and 2018 were approximately $165,912,000 and $171,691,000, respectively. The decrease in 2019 compared with the corresponding period in 2018 was primarily attributable to a net decrease in policies in force.
Premiums Ceded for the six months ended June 30, 2019 and 2018 were approximately $62,730,000 and $65,204,000, respectively, representing 37.8% and 38.0%, respectively, of gross premiums earned. The $2,474,000 decrease was primarily attributable to a reduction in premiums ceded attributable to retrospective provisions under one reinsurance contract as opposed to a net increase of premiums ceded associated with retrospective provisions and the recognition of additional premiums ceded resulting from the termination of the reinsurance contract in the corresponding period in 2018 as described earlier.
For the six months ended June 30, 2019, premiums ceded included a reduction of approximately $1,738,000 related to retrospective provisions. For the six months ended June 30, 2018, premiums ceded included a net increase of approximately $715,000 related to retrospective provisions. See “Economic Impact of Reinsurance Contracts with Retrospective Provisions” under “Critical Accounting Policies and Estimates.”
Net Premiums Written for the six months ended June 30, 2019 and 2018 totaled approximately $138,321,000 and $137,315,000, respectively. The $1,006,000 increase in 2019 resulted primarily from the decrease in premiums ceded as described above offset by a decrease in gross premiums written during the period.
Net Premiums Earned for the six months ended June 30, 2019 and 2018 were approximately $103,182,000 and $106,487,000, respectively, and reflect gross premiums earned less reinsurance costs as described above.
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The following is a reconciliation of our total Net Premiums Written to Net Premiums Earned for the six months ended June 30, 2019 and 2018 (amounts in thousands):
Net Realized Investment Losses for the six months ended June 30, 2019 were approximately $505,000 as opposed to approximately $4,894,000 of net realized investment gains for the six months ended June 30, 2018. The gains in 2018 resulted primarily from sales intended to rebalance our investment portfolio to mitigate the impact from a rising interest rate trend and to decrease our holdings in municipal bonds as they became less attractive in a low tax rate environment.
Net Unrealized Investment Gains for the six months ended June 30, 2019 were approximately $6,619,000 versus net unrealized investment losses of approximately $4,157,000 for the six months ended June 30, 2018, reflecting an improvement in the fair value of equity securities.
Our Losses and Loss Adjustment Expenses amounted to approximately $51,289,000 and $41,458,000 for the six months ended June 30, 2019 and 2018, respectively. The increase in 2019 was primarily attributable to approximately $5,250,000 of losses related to a severe storm event in March 2019, the strengthening of loss reserves due to litigation arising from non-catastrophe claims in prior years, and additional losses pertaining to Hurricane Matthew. See “Reserves for Losses and Loss Adjustment Expenses” under “Critical Accounting Policies and Estimates.”
General and Administrative Personnel Expenses for the six months ended June 30, 2019 and 2018 were approximately $15,362,000 and $14,123,000, respectively. Our general and administrative personnel expenses include salaries, wages, payroll taxes, share-based compensation expenses, and employee benefit costs. Factors such as merit increases, changes in headcount, and periodic restricted stock grants, among others, cause fluctuations in this expense. In addition, our personnel expenses are decreased by the capitalization of payroll costs related to a project to develop software for internal use and the payroll costs associated with the processing and settlement of certain catastrophe claims which are recoverable from reinsurers under reinsurance contracts. The period-over-period increase of $1,239,000 was primarily attributable to higher share-based compensation expense and merit increases for non-executive employees effective in late March 2019 offset by capitalized and recoverable payroll costs.
Interest Expense for the six months ended June 30, 2019 and 2018 was approximately $7,221,000 and $8,975,000, respectively. The decrease resulted from the repayment of our 3.875% Convertible Senior Notes as described earlier.
Income Tax Expense for the six months ended June 30, 2019 and 2018 was approximately $5,307,000 and $9,130,000, respectively, for state, federal, and foreign income taxes resulting in an effective tax rate of 27.1% for 2019 and 34.7% for 2018. The decrease was primarily attributable to the factors described previously.
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The loss ratio applicable to the six months ended June 30, 2019 was 49.7% compared with 38.9% for the six months ended June 30, 2018. The increase was primarily due to the decrease in net premiums earned and the increase in losses and loss adjustment expenses as described above.
The expense ratio applicable to the six months ended June 30, 2019 was 46.9% compared with 45.8% for the six months ended June 30, 2018. The increase in our expense ratio was primarily attributable to the decrease in net premiums earned.
The combined ratio is the measure of overall underwriting profitability before other income. Our combined ratio for the six months ended June 30, 2019 was 96.6% compared with 84.7% for the six months ended June 30, 2018. The increase was attributable to the decrease in net premiums earned and the increase in losses and loss adjustment expenses as described above.
Due to the impact our reinsurance costs have on net premiums earned from period to period, our management believes the combined ratio measured to gross premiums earned is more relevant in assessing overall performance. The combined ratio to gross premiums earned for the six months ended June 30, 2019 was 60.1% compared with 52.6% for the six months ended June 30, 2018. The increase in 2019 was primarily attributable to the decrease in gross premiums earned combined with the increase in losses and loss adjustment expenses.
Seasonality of Our Business
Our insurance business is seasonal as hurricanes and tropical storms affecting Florida typically occur during the period from June 1 through November 30 each year. Also, with our reinsurance treaty year typically effective June 1 each year, any variation in the cost of our reinsurance, whether due to changes in reinsurance rates or changes in the total insured value of our policy base, will occur and be reflected in our financial results beginning June 1 each year.
LIQUIDITY AND CAPITAL RESOURCES
Throughout our history, our liquidity requirements have been met through issuances of our common and preferred stock, debt offerings and funds from operations. We expect our future liquidity requirements will be met by funds from operations, primarily the cash received by insurance subsidiaries from premiums written and investment income. We may consider raising additional capital through debt and equity offerings to support our growth and future investment opportunities.
Our insurance subsidiary requires liquidity and adequate capital to meet ongoing obligations to policyholders and claimants and to fund operating expenses. In addition, we attempt to maintain adequate levels of liquidity and surplus to manage any differences between the duration of our liabilities and invested assets. In the insurance industry, cash collected for premiums from policies written is invested, interest and dividends are earned thereon, and losses and loss adjustment expenses are paid out over a period of years. This period of time varies by the circumstances surrounding each claim. Substantially all of our losses and loss adjustment expenses are fully settled and paid within 100 days of the claim receipt date. Additional cash outflow occurs through payments of underwriting costs such as commissions, taxes, payroll, and general overhead expenses.
We believe that we maintain sufficient liquidity to pay claims and expenses, as well as to satisfy commitments in the event of unforeseen events such as reinsurer insolvencies, inadequate premium rates, or reserve deficiencies. We maintain a comprehensive reinsurance program at levels management
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considers adequate to diversify risk and safeguard our financial position. In December 2018, we entered into a credit agreement with one financial institution for borrowing capacity of up to $65,000,000 to fund future operations and acquisitions. The credit facility had an unused balance of $55,500,000 at June 30, 2019.
In the future, we anticipate our primary use of funds will be to pay claims, reinsurance premiums, interest, and dividends and to fund operating expenses and real estate acquisitions.
Revolving Credit Facility, Senior Notes, and Promissory Notes
The following table summarizes the principal and interest payment obligations of our indebtedness at June 30, 2019:
Maturity Date
Interest Payment Due Date
Finance lease
See Note 9 — “Long-Term Debt” to our unaudited consolidated financial statements under Item 1 of this Quarterly Report on Form 10-Q.
Our limited partnership investments consist of four private equity funds managed by their general partners. These funds have unexpired capital commitments which are callable at the discretion of the fund’s general partner for funding new investments or expenses of the fund. At June 30, 2019, there was an aggregate unfunded capital balance of $14,552,000. See Limited Partnership Investments under Note 4 — “Investments” to our unaudited consolidated financial statements under Item 1 of this Quarterly Report on Form 10-Q for additional information.
Share Repurchase Plan
In December 2018, our Board of Directors approved a one-year plan to repurchase up to $20,000,000 of common shares under which we may purchase shares of common stock in open market purchases, block transactions and privately negotiated transactions in accordance with applicable federal securities laws. At June 30, 2019, there was approximately $12,000,000 available under the plan. See Note 16 — “Stockholders’ Equity” to our unaudited consolidated financial statements under Item 1 of this Quarterly Report on Form 10-Q.
Sources and Uses of Cash
Cash Flows for the Six Months Ended June 30, 2019
Net cash provided by operating activities for the six months ended June 30, 2019 was approximately $28,834,000, which consisted primarily of cash received from net premiums written as well as reinsurance recoveries (of approximately $45,832,000) less cash disbursed for operating expenses, losses and loss adjustment expenses and interest payments. Net cash provided by investing activities of $45,836,000 was primarily due to the proceeds from sales of fixed-maturity and equity
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securities of $35,826,000, the proceeds from redemptions and maturities of fixed-maturity securities of $47,788,000, and the proceeds from sales and maturities of short-term and other investments of $66,897,000, offset by the purchases of fixed-maturity and equity securities of $91,505,000, the purchase of real estate investments of $9,892,000, limited partnership investments of $1,751,000, and the purchases of property and equipment of $1,313,000. Net cash used in financing activities totaled $97,000,000, which was primarily due to the repayments of long-term debt of $90,647,000, $6,428,000 of net cash dividend payments, and $9,029,000 used in our share repurchases, offset by $9,500,000 of borrowings from revolving credit facility.
Cash Flows for the Six Months Ended June 30, 2018
Net cash provided by operating activities for the six months ended June 30, 2018 was approximately $27,591,000, which consisted primarily of cash received from net premiums written and reinsurance recoveries less cash disbursed for operating expenses, losses and loss adjustment expenses and interest payments. Net cash used in investing activities of $46,778,000 was primarily due to the purchases of fixed-maturity and equity securities of $71,808,000, the purchases of short-term and other investments of $125,001,000, the purchases of real estate investments of $6,520,000, and the limited partnership investments of $2,638,000, offset by the proceeds from sales of fixed-maturity and equity securities of $118,205,000, the proceeds from redemptions and maturities of fixed-maturity securities of $27,207,000, and the proceeds from sales and maturities of short-term and other investments of $15,117,000. Net cash used in financing activities totaled $20,132,000, which was primarily due to $14,652,000 used in our share repurchases and $4,421,000 of net cash dividend payments.
Investments
The main objective of our investment policy is to maximize our after-tax investment income with a reasonable level of risk given the current financial market. Our excess cash is invested primarily in money market accounts, certificates of deposit, and fixed-maturity and equity securities.
At June 30, 2019, we had $239,775,000 of fixed-maturity and equity investments, which are carried at fair value. Changes in the general interest rate environment affect the returns available on new fixed-maturity investments. While a rising interest rate environment enhances the returns available on new investments, it reduces the market value of existing fixed-maturity investments and thus the availability of gains on disposition. A decline in interest rates reduces the returns available on new fixed-maturity investments but increases the market value of existing fixed-maturity investments, creating the opportunity for realized investment gains on disposition.
In the future, we may alter our investment policy as to investments in federal, state and municipal obligations, preferred and common equity securities and real estate mortgages, as permitted by applicable law, including insurance regulations.
OFF-BALANCE SHEET ARRANGEMENTS
As of June 30, 2019, we had unexpired capital commitments for four limited partnerships in which we hold interests. Such commitments are not recognized in the financial statements but are required to be disclosed in the notes to the financial statements. See Note 18 — “Commitments and Contingencies” to our unaudited consolidated financial statements under Item 1 of this Quarterly Report on Form 10-Q and Contractual Obligations and Commitment below for additional information.
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CONTRACTUAL OBLIGATIONS AND COMMITMENTS
The following table summarizes our material contractual obligations and commitments as of June 30, 2019 (amounts in thousands):
Operating leases(1)
Service agreement(1)
Reinsurance contracts(2)
Unfunded capital commitments(3)
Long-term debt obligations(4)
Represents a lease for office space in Miami Lakes, Florida, a lease and maintenance service agreement for office space in Noida, India, and leases for office equipment and storage space. Liabilities related to our India operations were converted from Indian rupees to U.S. dollars using the June 30, 2019 exchange rate.
Represents the minimum payment of reinsurance premiums under one multi-year reinsurance contract. Reinsurance premiums payable after September 30, 2019 are estimated and subject to subsequent revision as the premiums are determined on a quarterly basis based on the premiums associated with the applicable flood total insured value on the last day of the preceding quarter.
Represents the unfunded balance of capital commitments under the subscription agreements related to four limited partnerships in which we hold interests.
Amounts represent principal and interest payments over the lives of various long-term debt obligations. See Note 9 — “Long-Term Debt” to our unaudited consolidated financial statements under Item 1 of this Quarterly Report on Form 10-Q.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
We have prepared our consolidated financial statements and related disclosures in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements and related disclosures requires us to make judgments, assumptions and estimates to develop amounts reflected and disclosed in our consolidated financial statements. Management bases its estimates on historical experience and on various other assumptions it believes to be reasonable under the circumstances. Actual results may differ from these estimates and such differences may be material.
We believe our critical accounting policies and estimates are those related to losses and loss adjustment expenses, reinsurance recoverable, reinsurance with retrospective provisions, deferred income taxes, and stock-based compensation expense. These policies are critical to the portrayal of our financial condition and operating results. They require management to make judgments and estimates about inherently uncertain matters. Material estimates that are particularly susceptible to significant change in the near term are related to our losses and loss adjustment expenses, which include amounts estimated for claims incurred but not yet reported and reinsurance contracts with retrospective provisions.
Reserves for Losses and Loss Adjustment Expenses
Our liability for losses and loss adjustment expense (“Reserves”) is specific to property insurance, which is our insurance division’s only line of business. The Reserves include both case reserves on reported claims and our reserves for incurred but not reported (“IBNR”) losses. At each
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period end date, the balance of our Reserves is based on our best estimate of the ultimate cost of each claim for those known cases and the IBNR loss reserves are estimated based primarily on our historical experience. Changes in the estimated liability are charged or credited to operations as the losses and loss adjustment expenses are adjusted.
The IBNR represents our estimate of the ultimate cost of all claims that have occurred but have not been reported to us, and in some cases may not yet be known to the insured, and future development of reported claims. Estimating the IBNR component of our Reserves involves considerable judgment on the part of management. At June 30, 2019, $111,417,000 of the total $154,242,000 we have reserved for losses and loss adjustment expenses is attributable to our estimate of IBNR. The remaining $42,825,000 relates to known cases which have been reported but not yet fully settled in which case we have established a reserve based on currently available information and our best estimate of the cost to settle each claim. At June 30, 2019, $37,946,000 of the $42,825,000 in reserves for known cases relates to claims incurred during prior years.
Our Reserves decreased from $207,586,000 at December 31, 2018 to $154,242,000 at June 30, 2019. The $53,344,000 decrease is comprised of net reductions in our Reserves of $17,715,000 for 2018 and $63,658,000 for 2017 and prior loss years offset by $28,029,000 in reserves established for claims occurring in the 2019 loss year. The $28,029,000 in Reserves established for 2019 claims is primarily driven by an allowance for those claims that have been incurred but not reported to the company as of June 30, 2019. The decrease of $81,373,000 specific to our 2018 and prior loss-year reserves is due to settlement of claims related to those loss years.
Based on all information known to us, we consider our Reserves at June 30, 2019 to be adequate to cover our claims for losses that have occurred as of that date including losses yet to be reported to us. However, these estimates are continually reviewed by management as they are subject to significant variability and may be impacted by trends in claim severity and frequency or unusual exposures that have not yet been identified. As part of the process, we review historical data and consider various factors, including known and anticipated regulatory and legal developments, changes in social attitudes, inflation and economic conditions. As experience develops and other data becomes available, these estimates are revised, as required, resulting in increases or decreases to the existing unpaid losses and loss adjustment expenses. Adjustments are reflected in the results of operations in the period in which they are made and the liabilities may deviate substantially from prior estimates.
Economic Impact of Reinsurance Contracts with Retrospective Provisions
One of our reinsurance contracts includes retrospective provisions that adjust premiums in the event losses are minimal or zero. In accordance with accounting principles generally accepted in the United States of America, we will recognize an asset in the period in which the absence of loss experience obligates the reinsurer to pay cash or other consideration under the contract. In the event that a loss arises, we will derecognize such asset in the period in which a loss arises. Such adjustments to the asset, which accrue throughout the contract term, will negatively impact our operating results when a catastrophic loss event occurs during the contract term.
For the three months ended June 30, 2019, we recognized an increase in accrued benefits of $1,026,000 versus a decrease in accrued benefits of $243,000 for the three months ended June 30, 2018. We recognized a reduction in premiums ceded of $200,000 for the three months ended June 30, 2019, whereas we recognized additional premiums ceded of $135,000 for the three months ended June 30, 2018. In combination, for the three months ended June 30, 2019, we recognized a decrease in ceded premiums of $1,226,000 as opposed to an increase in ceded premiums of $378,000 for the three months ended June 30, 2018.
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For the six months ended June 30, 2019 and 2018, we accrued benefits of $1,304,000 and $186,000, respectively. We recognized a decrease in premiums ceded of $434,000 for the six months ended June 30, 2019. For the six months ended June 30, 2018, we recognized additional premiums ceded of $901,000. In combination, for the six months ended June 30, 2019, we recognized a decrease in ceded premiums of $1,738,000 as opposed to a net increase in ceded premiums of $715,000 for the six months ended June 30, 2018.
As of June 30, 2019, we had $4,440,000 of accrued benefits, the amount that would be charged to earnings in the event we experience a catastrophic loss that exceeds the coverage limit provided under such agreement. At December 31, 2018, we had $3,136,000 of accrued benefits related to these agreements.
We believe the credit risk associated with the collectability of these accrued benefits is minimal based on available information about the reinsurer’s financial position.
The above and other accounting estimates and their related risks that we consider to be our critical accounting estimates are more fully described in our Annual Report on Form 10-K, which we filed with the SEC on March 8, 2019. For the six months ended June 30, 2019, there have been no material changes with respect to any of our critical accounting policies.
RECENT ACCOUNTING PRONOUNCEMENTS
For information with respect to recent accounting pronouncements and the impact of these pronouncements on our consolidated financial statements, see Note 2 to our Notes to Unaudited Consolidated Financial Statements.
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ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our investment portfolios at June 30, 2019 included fixed-maturity and equity securities, the purposes of which are not for speculation. Our main objective is to maximize after-tax investment income and maintain sufficient liquidity to meet our obligations while minimizing market risk, which is the potential economic loss from adverse fluctuations in securities prices. We consider many factors including credit ratings, investment concentrations, regulatory requirements, anticipated fluctuation of interest rates, durations and market conditions in developing investment strategies. Our investment securities are managed primarily by outside investment advisors and are overseen by the investment committee appointed by our board of directors. From time to time, our investment committee may decide to invest in low risk assets such as U.S. government bonds.
Our investment portfolios are exposed to interest rate risk, credit risk and equity price risk. Fiscal and economic uncertainties caused by any government action or inaction may exacerbate these risks and potentially have adverse impacts on the value of our investment portfolios.
We classify our fixed-maturity securities asavailable-for-sale and report any unrealized gains or losses, net of deferred income taxes, as a component of other comprehensive income within our stockholders’ equity. As such, any material temporary changes in their fair value can adversely impact the carrying value of our stockholders’ equity. In addition, we recognize any unrealized gains or losses related to our equity securities in our statement of income. As a result, our results of operations can be materially affected by the volatility in the equity market.
Interest Rate Risk
Our fixed-maturity securities are sensitive to potential losses resulting from unfavorable changes in interest rates. We manage the risk by analyzing anticipated movement in interest rates and considering our future capital needs.
The following table illustrates the impact of hypothetical changes in interest rates to the fair value of our fixed-maturity securities at June 30, 2019 (amounts in thousands):
Hypothetical Change in Interest Rates
300 basis point increase
200 basis point increase
100 basis point increase
100 basis point decrease
200 basis point decrease
300 basis point decrease
Credit Risk
Credit risk can expose us to potential losses arising principally from adverse changes in the financial condition of the issuers of our fixed-maturity securities. We mitigate the risk by investing in fixed-maturity securities that are generally investment grade, by diversifying our investment portfolio to avoid concentrations in any single issuer or business sector, and by continually monitoring each individual security for declines in credit quality. While we emphasize credit quality in our investment selection process, significant downturns in the markets or general economy may impact the credit quality of our portfolio.
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The following table presents the composition of our fixed-maturity securities, by rating, at June 30, 2019 (amounts in thousands):
Comparable Rating
AA+, AA, AA-
A+, A, A-
BBB+, BBB, BBB-
BB+, BB, BB-
CCC+, CC and Not rated
Equity Price Risk
Our equity investment portfolio at June 30, 2019 included common stocks, perpetual preferred stocks, mutual funds and exchange traded funds. We may incur losses due to adverse changes in equity security prices. We manage the risk primarily through industry and issuer diversification and asset mix.
The following table illustrates the composition of our equity securities at June 30, 2019 (amounts in thousands):
Stocks by sector:
Financial
Consumer
Energy
Industrial
Technology
Other(1)
Mutual funds and exchange traded funds by type:
Debt
Equity
Represents an aggregate of less than 5% sectors.
Foreign Currency Exchange Risk
At June 30, 2019, we did not have any material exposure to foreign currency related risk.
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ITEM 4 – CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of our chief executive officer (our principal executive officer) and our chief financial officer (our principal financial and accounting officer), we have evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report, and, based on this evaluation, our chief executive officer and our chief financial officer have concluded that these disclosure controls and procedures are effective.
Changes in Internal Control Over Financial Reporting
There have been no changes in our internal controls over financial reporting during the quarter ended June 30, 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Limitations on Effectiveness of Controls and Procedures
In designing and evaluating the disclosure controls and procedures, we recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, implementation of possible controls and procedures depends on management’s judgment in evaluating their benefits relative to costs.
PART II – OTHER INFORMATION
ITEM 1 – LEGAL PROCEEDINGS
The Company is a party to claims and legal actions arising routinely in the ordinary course of our business. Although we cannot predict with certainty the ultimate resolution of the claims and lawsuits asserted against us, we do not believe that any currently pending legal proceedings to which we are a party will have a material adverse effect on our consolidated financial position, results of operations or cash flows.
ITEM 1A – RISK FACTORS
With the exception of the items described below, there have been no material changes from the risk factors previously disclosed in the section entitled “Risk Factors” in our Form 10-K, which was filed with the SEC on March 8, 2019.
Our credit agreement contains restrictions that can limit our flexibility in operating our business.
The agreement governing our revolving credit facility contains various covenants that limit our ability to engage in certain transactions. These covenants limit our and our subsidiaries’ ability to, among other things:
incur additional indebtedness;
declare or make any restricted payments;
create liens on any of our assets now owned or hereafter acquired;
consolidate, merge, sell, or otherwise dispose of all or substantially all of our assets now owned or hereafter acquired; and
enter into certain transactions with our affiliates.
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An increase in interest rates may negatively impact our operating results and financial condition.
Borrowings under our revolving credit facility have a variable rate of interest. An increase in interest rate would have a negative impact on our results of operations attributable to increased interest expense.
ITEM 2 –UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
(a) Sales of Unregistered Securities and Use of Proceeds
None
(b) Repurchases of Securities
The table below summarizes the number of common shares repurchased during the three months ended June 30, 2019 under the repurchase plan approved by our Board of Directors in December 2018 and also the number of shares of common stock surrendered by employees to satisfy their minimum federal income tax liability associated with the vesting of restricted shares in May 2019 (dollar amounts in thousands, except share and per share amounts):
For the Month Ended
April 30, 2019
May 31, 2019
Represents the balances before commissions and fees at the end of each month.
Working Capital Restrictions and Other Limitations on Payment of Dividends
We are not subject to working capital restrictions or other limitations on the payment of dividends. Our insurance subsidiaries, however, are subject to restrictions on the dividends they may pay. Those restrictions could impact HCI’s ability to pay future dividends.
Under Florida law, a domestic insurer may not pay any dividend or distribute cash or other property to its stockholder except out of that part of its available and accumulated capital and surplus funds which is derived from realized net operating profits on its business and net realized capital gains. Additionally, a Florida domestic insurer may not make dividend payments or distributions to its stockholder without prior approval of the Florida Office of Insurance Regulation if the dividend or distribution would exceed the larger of (1) the lesser of (a) 10.0% of its capital surplus or (b) net income, not including realized capital gains, plus a two year carry forward, (2) 10.0% of capital surplus with dividends payable constrained to unassigned funds minus 25% of unrealized capital gains or (3) the lesser of (a) 10.0% of capital surplus or (b) net investment income plus a three year carry forward with dividends payable constrained to unassigned funds minus 25% of unrealized capital gains.
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Alternatively, a Florida domestic insurer may pay a dividend or distribution without the prior written approval of the Florida Office of Insurance Regulation (1) if the dividend is equal to or less than the greater of (a) 10.0% of the insurer’s capital surplus as regards policyholders derived from realized net operating profits on its business and net realized capital gains or (b) the insurer’s entire net operating profits and realized net capital gains derived during the immediately preceding calendar year, (2) the insurer will have policy holder capital surplus equal to or exceeding 115.0% of the minimum required statutory capital surplus after the dividend or distribution, (3) the insurer files a notice of the dividend or distribution with the Florida Office of Insurance Regulation at least ten business days prior to the dividend payment or distribution and (4) the notice includes a certification by an officer of the insurer attesting that, after the payment of the dividend or distribution, the insurer will have at least 115% of required statutory capital surplus as to policyholders. Except as provided above, a Florida domiciled insurer may only pay a dividend or make a distribution (1) subject to prior approval by the Florida Office of Insurance Regulation or (2) 30 days after the Florida Office of Insurance Regulation has received notice of such dividend or distribution and has not disapproved it within such time.
During the six months ended June 30, 2019, our insurance subsidiaries paid dividends of $14,000,000 to HCI.
ITEM 3 – DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4 – MINE SAFETY DISCLOSURES
ITEM 5 – OTHER INFORMATION
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ITEM 6 – EXHIBITS
The following documents are filed as part of this report:
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64
65
66
67
68
Management contract or compensatory plan.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized, who has signed this report on behalf of the Company.
/s/ Paresh Patel
/s/ James Mark Harmsworth
A signed original of this document has been provided to HCI Group, Inc. and will be retained by HCI Group, Inc. and furnished to the Securities and Exchange Commission or its staff upon request.
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