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spk01: Good morning and welcome to FedNet Holding Company's third quarter 2021 conference call. My name is Kim and I'll be your conference operator this morning. At this time, all participants will be in listen-only mode. Before we begin today's call, I'd like to remind everyone that this conference call is being recorded as well as broadcast live via webcast. Additionally, today's call will be available via webcast replay later this afternoon and accessible by visiting the Investor Relations section of FedNet's website at www.fednet.com. Now, I'd like to turn the call over to Bernie Kilkelly for FedNet Investor Relations. Bernie?
spk03: Thank you. Good morning, and thank you all for joining FedNet's third quarter 2021 conference call. Our earnings release and prepared remarks include references to non-GAAP measures, such as adjusted operating income. We use these non-GAAP measures to provide greater transparency and a more meaningful, efficient comparison to prior year's results. Our non-GAAP and reconciliations from the GAAP measures to the non-GAAP measures are available in our earnings release. Statements in this conference call that are not historical facts are forward-looking statements. Words such as anticipate, estimate, expect, predict, project, and other similar words or phrases are intended to identify forward-looking statements. The matters discussed on this call that are forward-looking statements are are based on current management expectations involving risks and uncertainties that may result in these expectations not being realized. Actual events, outcomes, and results may differ materially from what is expressed or forecasted in forward-looking statements made on this call due to numerous risks and uncertainties, including but not limited to the risks and uncertainties described in this conference call our press release issued yesterday, and other filings made by the company with the SEC from time to time. Forward-looking statements made during this conference call speak only as of today's date, and FedNAT specifically disclaims any obligation to update or revise any forward-looking statements to reflect new information, future events, or circumstances or otherwise. Now I will turn the call over to FedNAT's Chief Executive Officer, Mike Braun.
spk05: Thank you. Good morning, and welcome to our third quarter 2021 conference call. Ron Jordan, our chief financial officer, and Eric Fernandez, our chief accounting officer, are on the call with me today. After my remarks, Ron will go into more detail on the financial results of the quarter, and then we will take questions. Before I review our third quarter results, I want to discuss the shift in FedNet strategy that we announced yesterday. We announced our intent to refocus our operations on the Florida property market, which has been our historical focus since the company's founding in 1992. The geographic expansion strategy that was launched in 2013 to write homeowners insurance in coastal markets outside of Florida and then accelerated in 2019 was well-intended given the challenges we were facing in the Florida homeowners market. The acquisition of Mason Insurance To a lesser extent, the expansion of FNIC's non-Florida book ended up being poorly timed due to the unprecedented number of catastrophe weather events that have affected our Texas and Louisiana books of business. The impact of these catastrophic weather losses put a strain on FedNet's capital position and further action was necessary. We are therefore exiting the non-Florida markets and refocusing our efforts on the improving Florida homeowners market, where we believe pricing is the most appropriate relative to increased costs that we have seen in a number of years. In conjunction with the decision to focus on Florida, Fed Nat has elected to commence an orderly runoff of Mason's insurance operations. Mason will be filing appropriate documentation with its insurance regulators in Louisiana, Florida, and Texas concerning a withdrawal plan, which is subject to regulatory review. We expect to begin non-renewing Mason's Louisiana policies on the expiration dates of each appropriate policy beginning in January 2022, and Mason's Texas policies beginning in February 2022. The non-renewal of Mason's Florida policies is expected to begin in June 2022. FNIC's non-Florida book has been written through our third party managing general underwriter, Sadeshore, and Sadeshore owns the renewal rights to these policies. After careful coordination and collaboration with Sadeshore, we expect that in December 2021, Sadeshore will begin making offers of coverage to FNIC policyholders to renew policies on alternative insurance carrier partners of Sadeshore. in Texas and Louisiana that are not affiliated with the company. FNIC policies in South Carolina, Alabama, and Mississippi that were written through Sadeshore will continue to be renewed by FNIC until such time as Sadeshore's affiliates obtain the necessary licensing in those states, possibly in the second quarter of 2022. We expect the transition to be smooth, though obviously subject to appropriate regulatory approvals. We expect the process of running off the Mason book and transferring the Sage Shore policies to take approximately 18 months to complete. Our commitment to honoring all existing policies remains the same, and all policyholders and agents will receive the same professional service they've always received from FedNet. Upon completion of the transition, we expect FedNet to be right-sized to our current capital position and therefore a financially stronger company. We anticipate that we will have approximately $450 million of in-force premiums exclusively in Florida with less exposure to weather frequency and therefore less volatility in our underwriting results. We expect the benefits of the transition to begin to materialize immediately in the form of lower capital requirements and lower exposure to catastrophe weather losses. Over the past five years, we have taken dramatic action to shrink our Florida homeowner's books until rates more accurately reflect the increase of doing business, including attritional losses, weather events, and higher reinsurance costs. Our exposure management efforts have reduced our Florida book by over a third from 272,000 policies in force in 2017 to 168,000 at the end of the third quarter. At the same time, we have increased FNIC's rates by almost 70% cumulatively, In that time period, restoring rate adequacy in our book. Insurance reform legislation in recent years, including AOB reform legislation passed in 2019 and SB 76 that went into effect in July, have also provided some help improving our attritional loss ratios. So we believe now is the right time to refocus on our historical roots in Florida, where FedNet continues to have significant market share, strong underwriting and claims processing capabilities, and strong agent relationships. Turning now to our third quarter results, we reported a net loss of $24.8 million, or $1.42 per share, in the third quarter of 2021, compared to $20.7 million, or $1.51 in the third quarter last year. This year's quarterly results were impacted by approximately 20 million of catastrophe weather events, including Hurricane Ida, and other smaller nanostorms that impacted Louisiana, Texas, and Florida. The claims handling infrastructure we have in place has performed admirably to handle the massive influx of claims from Ida and other events, and has also generated organic capital and liquidity that helps soften the blow of these storms to FedMed on a consolidated basis. Ron will provide more details on the impact of the catastrophe events in his remarks. Looking at the Florida homeowners market, The environment continues to have its challenges, though we are pleased with the trends we are seeing in improved nutritional losses in both our new and renewal business as they renew at increased rates. These increases include a 6.7% increase that took effect in March and a 9% increase that was implemented in April. We have a 5.7% increase pending that is expected to take effect in November. As a result of these initiatives, FNIC's average premium per policy increased by $109 in the third quarter compared to the second quarter of 2021 and $482 higher than the third quarter of 2020. This increase translated into approximately $74 million more in premiums on the 154,000 FNIC policies enforced in the third quarter of 2021 compared to last year with decreased risk. Importantly, the end result of these increases is that the attritional loss ratio in FNIC's Florida book dropped to approximately 39% for the third quarter of 2021 as compared to 44% a year ago, demonstrating why we are much more comfortable with the Florida market now than we were just a few quarters ago. We remain cautiously optimistic about potential benefits from portions of SB76 reform legislation that became effective on July 1 We are pleased with portions of the legislation, such as measures to reduce the time limits for filing claims from three years to two years, and to better control plaintiff attorney fees, which are significant issues driving increased costs. At the same time, we believe the significant rate increases that have rolled into our book reflect these increased costs and have enabled us to achieve an improved attritional loss ratio. We have maintained appropriate capital positions at FedNet Insurance Company and Monarch National Insurance Company with a capital infusion into FNIC of $20 million as of September 30th. FedNet elected to not infuse any additional surplus into Mason in the third quarter, and we do not anticipate needing to make any capital infusions in the future. We continue to maintain approximately $40 million in liquidity at the holding company level heading into the fourth quarter. As you know, last November, a board of directors formed a special board committee to oversee a review of strategic alternatives, including exploring options to strengthen the company's capital position. The work of the committee is ongoing, and the committee continues to work with Piper Sandler as its financial advisor. Now I'll turn the call over to Rob for more details on the third quarter results.
spk02: Thanks, Mike, and good morning, everyone. As Mike mentioned, our third quarter 2021 results were impacted by significant CAT losses from several named storms, including Hurricane Ida and other smaller events, including Elsa, Fred, and Nicholas. In total, our third quarter net income was reduced by approximately $20 million, or $1.15 per share, net of all reinsurance recoveries and affiliated fees. Because we are not recognizing any tax benefits from our deferred tax assets here in 2021, the impact of the cap losses in the third quarter was the same on both a pre-tax and an after-tax basis. Aggregate gross losses from these third quarter events are estimated at approximately $599 million, $575 of which is attributable to Hurricane Ida. These gross losses were reduced by seeded losses of approximately $562 million, consisting of $558 million under our excess of loss reinsurance treaties and $4 million under quota share treaties. The resulting $37 million of retained catastrophe losses within our insurance subsidiaries was partially offset by the accrual of $17 million of earnings from related claims handling and other revenues in affiliated entities, driven by the significant size of IDA. Net of the related affiliated claims handling fees, these CAT events added approximately 38 points to our loss ratio and combined ratio in the quarter. If one were to adjust our third quarter operating loss for the impact of the CAT events and then apply the federal tax rate, it indicates that FedNAT's adjusted operating loss in the quarter would have been approximately $4.4 million, or $0.26 per share. With the change in our strategy Mike just described to refocus on our Florida markets, and with the approved and pending rate increases that are rolling into our book, we expect FedNet to achieve ex-cat earnings improvement in 2022. To illustrate the future benefits of the strategy shift, I would point out that since the beginning of 2020, our non-Florida business has contributed almost 70% of our net catastrophe losses before fee offsets, despite representing less than 40% of our in-force premium. Going forward, we will continue to work to achieve low double-digit ROEs in years where catastrophe losses approximate the models, with higher ROEs attainable when CAT losses come in favorably as compared to the models. We continue to make strong progress in reducing the size of our book and the related total insured value, which enabled us to reduce our total catastrophe reinsurance costs for the 21-22 treaty year. Our Florida policy count at September 30 is down almost 7% sequentially from June 30 and down almost 23% from September 30 of 2020. The total insured value of our Florida book at September 30, is down over 17% from a year ago. We have continued to manage our exposure in Florida over the past few years until rates adequately reflected our cost of doing business. Importantly, we think we have largely accomplished that objective and now expect to begin bearing the fruit of our disciplined approach. Other than normal, ongoing exposure management pruning, we expect our Florida policy count to level out and perhaps increased slightly, such that in the coming quarters, rate increases will begin to add to our gross written premium rather than, in air quotes, funding exposure management initiatives as they have done in recent years. Despite the intentional shrinking of our policy count, gross earned premiums declined less than 3% from last year's third quarter due to the strong growth in average premium per policy resulting from our rate increases. Net premiums earned in the third quarter declined to $54 million from $83 million in the prior year, due entirely to a $24 million increase in seeded premiums, driven by increases in the percentages of quota share reinsurance in effect. As communicated in previous earnings calls, this reduction in net earned premiums is largely offset by corresponding reductions in loss and LAE in commission expense. Our net loss ratio, net expense ratio, and combined ratio are, of course, elevated by the higher level of seeded premiums, so it's worth pointing out that our gross expense ratio continues to perform well at less than 26%. Turning now to our balance sheet and capital position, we continue to maintain surplus in FedNet Insurance Company and Monarch National, consistent with RBC ratios of 300% or above. We made a capital infusion to FNIC of approximately $20 million, effective as of September 30. We also maintained our commitment to having appropriate liquidity at the holding company, and we currently estimate that holding company liquidity is approximately $40 million heading into the fourth quarter. As Mike discussed, we elected to not make any capital infusion into Maison in the third quarter, and we do not anticipate needing to make future capital contributions to Maison. Nissan's capital, of course, remains part of the FedNet consolidated group and will be redeployed within our structure at the appropriate time, subject to regulatory approval. At the end of the third quarter, we held total investments of approximately $355 million. In addition, we ended the quarter with total cash and equivalents of approximately $167 million. We continue to maintain our discipline to invest in higher quality liquid bonds and a handful of preferred securities. with no common stock exposure in the portfolio. Overall, the portfolio has a duration of 3.9 and a composite credit rating of A-. And with that, I'll turn the call back over to Mike. Great.
spk05: Thank you, Ron. Operator, with that, we'll go ahead and take any questions if there's an analyst that has a question for us.
spk01: As a reminder, to ask a question, you will need to press star 1 on your telephone. To withdraw your question, press the pound key. Please stand by while we compile the Q&A roster. Our first question comes from the line of Paul Newsome with Piper Sandler. Your line is open.
spk04: Good morning. I was hoping you could help me with some modeling questions related to the expense levels, prospectively, given the runoff. Are there expenses that we will incur that are related to the runoff itself that could be elevated in the short term? And if we think about the longer term, Where do you expect things like your general administrative expenses and sort of commission-level type expenses to run, respectively, given the runoff and the focus in the Florida business?
spk05: Yeah, hey, good morning, Paul. This is Mike. Ron can go a little deeper on the math, but I don't think there's going to be any significant cost to exit the market. As you know, in our business, the vast majority of our expenses are variable expenses. So acquisition and overhead, that's commissions to agents as well as commissions to our managing company to run the business. There's attritional losses. So as the book decreases, those attritional losses would obviously decrease proportionately. And then there's also the weather, net weather retained. And once again, I would say those would be in line. The only fixed cost would be reinsurance, what we call XOL, excessive loss. That is a variable expense, but it's kind of locked in for a period of time. And what that means is that September 30, that we did lock in that expense. So we do anticipate that the book will gradually shrink in the beginning of 2022, but I don't think it will significantly affect our expense ratio for the seated premium. And then just to clarify in terms of staffing, We have about 360 employees and do not see much, if any, change on our staffing levels. And what I mean by that is with Mason, that book of business is handled organically and we're pretty mean and lean with our staffing. I'll put it that way. And any folks that have been specifically committed to the Mason business could easily transition over to the other business that we have, both with FNIC as well as MNIC. And in addition, the same is true for the folks in claims. And obviously all the other departments within the company really support all functions, IT, HR, accounting, and so on. So I'm not sure, Ron, if you want to go deeper on the math there, but really most of our expenses are variable expenses.
spk02: Yeah, I guess just a couple things to add. In terms of the commission and acquisition costs, one thing I will say is that with the SageSure book, acquisition costs have been higher there given that we, of course, pay an MGA fee over to SageSure. So I do think as that book becomes a smaller percentage of our total, our overall acquisition you know, weighted average commission and other underwriting expenses would trend down to be more in line with just the Florida marketplace. I think that's probably the only additive comment.
spk04: With the general and administrative expenses have been running sort of 23, 24 million a year, is that a good run right prospectively?
spk02: Yeah, it really is. Those costs really did not go up as we increased in size very much at all, and I really don't expect them to come down too much as we contract a little bit outside of Florida, consistent with the remarks that Mike just made.
spk04: Great. I'll let somebody else ask their questions. Appreciate the help and the insights.
spk05: Yeah, I absolutely appreciate that.
spk01: Again, to ask a question, you will need to press star one on your telephone. To withdraw your question, press the pound key.
spk05: Yeah, operator, while we're waiting to see if anyone else joins, any other analysts join the queue, I just did want to share an email from the long-term shareholder, Doug Ruth, who's not able to get on the call. He was just asking for an update on the Florida marketplace. So I just want to elaborate a little bit. I have said repeatedly over the last, three, four years that, uh, we have no desire to write the Florida business, grow the Florida business until our rates more accurately, uh, reflect our increased cost of doing business. Uh, so why the change of heart in Florida? And the answer is our costs are up 70%. Um, I, I don't think, I don't say that, um, that's a good thing to our policy holders, to all the hard working people throughout the state of Florida. But it's a reality that their rates had to go up because of the operating environment in which we are operating in. So we do feel that we're doing the correct service to our policyholders. It's unfortunate rates had to go up like that. Hopefully there'll be more reforms at the state level to bring those costs down. But with those elevated costs, we feel that rates are now more accurate than they have been in a number of years. And we're seeing that Florida is a hard market. It's a difficult market that a lot of not carriers are writing. However, we're seeing signs that things are going to be changing in the near future. I encourage people to look at Barry Gilway. He runs Citizens Property Insurance Corporation. He did a presentation to the Banking and Insurance Commission at the Senate, Florida Senate. And he talked about numerous investors trying to get into Florida, numerous investors, and how one company in particular tried to take policies out of citizens, about 23,000, and only got about 10,000 of those. So I think the Florida market's changing. I think the rates are more accurate. I think AOB reform has taken a small bite of the apple. I think SB 76 has taken a small bite of the apple. But the truth is rates have really changed materially to reflect these increased costs. So I just want to stress that. And then the other question that Doug had sent over via the email was separate from the Florida marketplace is the non-Florida market. Our thoughts on the non-Florida market. I think the expansion into other states with the same lines of business and the same risks was appropriate at the time. Our Florida market was really under attack with increased costs. So once again, we were still exposed to homeowner-type policies in coastal states. And the last 15 months has been absolutely brutal. I've been doing this for 20-plus years, and that was off the charts, what we saw. So we do have a new capital position, and we do need to respond appropriately. So I think that shrinking that non-Florida book, the Sage Shore book, and they've been a very good partner, but once again, the weather has been very unkind to that book. And also with Mason, the weather has been very unkind. We have to respond. So those two books of business represent approximately $270 million of premium, and that would reduce us down to the $450 million, much more appropriate for our capital base. So with that, I'll return it back to the operator to see if we have any analyst questions.
spk01: Yes, we do have another question from the line of Paul Newsome with Piper Sandler. Your line is now open.
spk04: I apologize for another modeling question, but other income has been an important component of your revenue and is a little bit more difficult, I think, for outsiders to model. Could you talk about sort of what the outlook is for that and it will continue to be an important component of your profitability.
spk05: Yeah, absolutely, Paul. So Florida is an MGA state, and what that means is, as opposed to Andrew, the way the regulators in the state of Florida attracted capital was to create this MGA model, where not only do you have a carrier, where you have affiliates, and these affiliates perform work. So we have always had an MGA within our business model since we've been writing property, And I can tell you that what we have found is that our policyholders are best service when we have our folks handling these claims and doing as much as possible. So what we do is we do charge fees for those services, and they're based on market pricing, what we see that others would get. So fortunately, I do believe obviously there's some financial benefit on a consolidated basis. But I truly believe there's a significant benefit to our policyholders and all of our partners to make sure that we can handle these claims as quickly as possible, with the goal being to hand it off as little as possible. One of the challenges in Florida is when you have smaller companies, when there's multiple people handling a claim. So we're trying to get out to the policyholder as quick as possible when they have a claim, primarily a weather claim, help with remediating that. We've done an incredible amount of tarping after Ida. And then doing whatever we can to move that claim through our process and try to get that policyholder whole as quick as possible, back to their original position. So that's the intent. In terms of specifics on modeling that, It's tough because it's really dependent on weather, but obviously I defer to Ron on best ways to communicate that.
spk02: And I'll just add on a few remarks there. Another one of the notable contributors, Paul, through the other income line specifically is brokerage income that we earn from our internal reinsurance broker that's involved with the placement of our XOL tower each year. and certainly that will continue to be a meaningful income stream. Certainly over time our XOL spend will come down as we become Florida-centric, and so brokerage income would come down with that. Brokerage income was particularly elevated, as you'll recall, during the treaty year that ended June 30 because we had a lot of backup purchases, and additional seeded XOL premium, and that contributed to elevated brokerage income, particularly in the first half of 2021. You know, it kind of reset as of July 1 along with the new reinsurance tower. And so, you know, Q3 is certainly much more indicative of the run rate currently based on the current, you know, treaty year that we're in. Paul, also, there's a table in our 10-Q that you'll be able to look at with respect to other income to get a little detail into that number.
spk04: Great. Thank you very much.
spk05: Thank you, Paul.
spk01: I'm showing no further questions at this time. I would now like to turn the conference back to Mike Vaughn.
spk05: Thank you very much. Thank you all for participating on today's call. Before we close, I want to recognize our FedNet team who continue to provide exceptional service to our policyholders and partner agents, particularly in their times of need. The dedication and hard work of our team has enabled FedNet to maintain our high-quality reputation for close to 30 years. And we look forward to continuing to meet the highest standards of customer service as we refocus on our historical home market in Florida. So with that, I just want to thank everyone once again. And if there's follow-up questions, please reach out to myself, Ron, or Bernie. And everyone have a great day. Thank you.
spk01: This concludes today's conference call. Thank you for participating. You may now disconnect.
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