HCI Group, Inc.

Good afternoon and welcome to HCI Group's second quarter 2020 earnings call. My name is Christy and I will be your conference operator this afternoon. At this time, all participants will be in a listen-only mode. Before we begin today's call, I would like to remind everyone that this conference call is being recorded and will be available for replay through September 5, 2020, starting later this evening. The call is also being broadcast live via the webcast and available via webcast replay until August 6, 2021, on the Investor Information section of HCI Group's website at www.hcigroup.com. I would now like to turn the call over to Rachel Swansinger, Investor Relations for HCI. Rachel, please proceed.

Thank you and good afternoon. Welcome to HCI Group's second quarter 2020 earnings call. With me on today's call is Parish Patel, our Chairman and Chief Executive Officer, and Mark Harmsworth, our Chief Financial Officer. Following Parish's opening remarks, Mark will review our financial performance for the second quarter of 2020, and then turn the call back to Parish for an operational update and business outlook. Finally, we will take your questions. To access today's webcast, please visit the investor information section of our corporate website at www.hcigroup.com. Before we begin, I would like to take the opportunity to remind our listeners that today's presentation and responses to questions may contain forward-looking statements made pursuant to the Private Securities Litigation Reform Act of 1995. Words such as anticipate, estimate, expect, intend, plan, and project and other similar words and expressions are intended to signify forward-looking statements. Forward-looking statements are not guarantees of future results and conditions, but rather are subject to various risks and uncertainties. Some of these risks and uncertainties are identified in the company's filings with the Securities and Exchange Commission. Should any risk or uncertainties develop into actual events, these developments could have material adverse effects on the company's business, financial conditions, and results of operations. HCI Group disclaims all the obligations to update any forward-looking statements. Now with that, I would like to turn the call over to Parish Patel, our Chairman and CEO. Parish?

Thank you, Rachel, and welcome everyone. I hope everyone is healthy and staying safe. First, very quickly, a comment about Hurricane Isaias. Isaias stayed off the coast of Florida, therefore we've had very few claims and we don't expect many. Also, as I've stated before, HCI's operations have not been materially impacted by the COVID-19 pandemic, and we continue to do business normally. Now, on to our second quarter results. It was a solid quarter. Our fully diluted, unadjusted earnings per share were $1.08. Highlights for the second quarter include growth rate and premiums that were up 29% over the same quarter last year. Net income was up 18%. We paid 40 cents per share dividend, our 38th consecutive quarterly dividend, and based on today's share price, our stock has a yield of 3.4%. Also, we completed integration of the policies we transitioned from anchor property and casualty, and retention of that book has been as expected. And finally, we also completed our catastrophic reinsurance program for the 2020 hurricane season. We increased our first event coverage tower from $960 million to almost $1.4 billion. We believe the additional limit better positions the company for the 2020 hurricane season. And although there was a higher expense incurred for the higher limit, we determined that it was most important to protect the business enterprise over maximizing short-term profit margins. I will now turn the call over to our CFO, Mark Harmsworth, who will walk us through our financial performance for the second quarter. Mark.

Thanks, Parish. The second quarter was another good one for us. On a GAAP basis, diluted earnings per share were $1.08, On an adjusted basis, diluted earnings per share were 86 cents, which was up from 81 cents in the second quarter last year. For the first six months, adjusted earnings per share were $1.41, up from $1.15 from the first six months of last year. As you know, we've been talking about growth for a number of quarters now, and that upward trend has continued. Gross written premiums were up 29% over the same quarter last year, and up 24% year-to-date. The increase is being driven by the continued growth of TIP TAP, as well as the transition of policies from anchor property and casualty. Gross earned premiums were also up 29% this quarter and 21% year-to-date. Again, driven by the growth in TIP TAP, as well as the transition of business from anchor. Back in June, we announced our new reinsurance arrangement for June 2020 to May 2021. We purchased significantly higher limits, and the net premiums for that are estimated to be $44 million per quarter, up from $31 million from the previous treaty year. Reinsurance expense this quarter reflects two months at the old rate and one month at the new rate. As in the past few quarters, there were some significant changes within investment income. While total investment income was about the same as last year, there were some shifting around within the components of it. Net investment income was down, driven by lower limited partnership income and lower yields on cash, but both realized and unrealized investment gains were up substantially as the equity markets recovered, and we also sold some fixed-term securities at a gain. Loss expense was up about $15 million over the same quarter last year. This was largely driven by the increase in gross premiums earned and a change in the mix of business. but it was also impacted by some weather in the quarter and then offset somewhat by lower prior year development. To be more specific, about $13 million of the increase was driven by growth in earned premium and exit business. We booked about $6 million of weather-related losses, and then these two increases were offset somewhat by lower prior year development, which was about $4 million less than the same quarter last year. Before turning to the balance sheet, just two other quick things in the income statement. During the quarter, we repurchased a small amount of our converts. While we bought these at a discount to par value, because of the way that the accounting is done for converts, we booked a small loss of $150,000. One last thing, you may notice that the effective tax rate is a little low this quarter at about 24%, driven by a couple of unusual windfalls, and we expect that to return to the normal 27%. Now to the balance sheet. Our cash and cash flow remains strong. In the first six months, cash flow from operations was well over $100 million, driven by increases in unearned premiums and an increase in reserves. As the book is growing, we are setting aside a considerable amount of money in reserves to pay claims that may eventually come. To the end of June, we have increased non-CAT reserves by just over $26 million. In other words, our loss expense for the first six months is $26 million higher than we have paid out in claims. This continues our conservative stance on reserving. Speaking of a strong balance sheet, yesterday we announced something that will strengthen it further. As stated in the press release, we closed on the agreement to sell our Cypress Commons property. Since this closed in July, it is not reflected in our second quarter financials. When it is recorded in the third quarter, it will increase earnings per share, book value per share, and cash. We have mentioned many times that our book value is understated because our real estate portfolio is reflected on a cost basis. While this transaction will significantly boost book value per share, there are still significant unrealized gains in our real estate portfolio that effectively understate book value even after this one transaction closes. A few things on capital management. As you know, in June we paid a dividend of $0.40 per share. although the amount per share was constant, the total amount of just over $3 million in cash was 7% less than the same quarter last year due to the decrease in the number of shares outstanding. You may recall that we announced a $20 million buyback plan for this year. In the second quarter, we bought back 51,834 shares at an average price of $40.48. The total shares bought back so far this year on the 2020 plan are 102,844 shares at an average price of $38.64. At the end of June, there is about $16 million available under the 2020 plan. Just one other quick number, book value per share at the end of the quarter was $23.75. Again, this is before the recognition of the gain on Cypress Commons. In summary, this is another good quarter for us. Written premiums are growing, earned premiums are growing, cash flow is growing, and the balance sheet remains strong and is getting stronger. And with that, I'll turn it back to Parish.

Thanks, Mark. Obviously, we are very pleased with our second quarter performance. Our results demonstrate that HCI has entered a period of growth, and for reasons I'll explain here, we expect the growth to accelerate. Our engine for growth and profitability is the TipTap Insurance Company, our technology-based insurance company. Eight years ago, we began investing in technology with a mission to develop software, data analytics, and artificial intelligence to simplify the insurance experience for agents and prospective policyholders, while at the same time improving profitability. TipTap embodies the technologies we developed. It uses our innovative proprietary online platform to code and bind policies quickly and efficiently. Agents and prospective policyholders answer a few simple questions and receive quick responses. TipTap uses powerful algorithms designed to identify policies that deliver profitable results while mitigating risk. And, as everyone knows, TipTap has grown rapidly and organically over the last four years, and also over the last four quarters, as agents and prospective policyholders discover its simplicity, ease of use, and speed. Premiums in force at the end of second quarter exceeded $75 million, three times the size it was a year ago. And we expect that they will reach $100 million before the end of the year. And as we announced this morning, we plan on expanding TipTap's footprint nationwide. If fully realized, this expansion plan will lead to an increase in TipTap's addressable market by nearly 10 times, from approximately $10 billion within Florida to more than $105 billion nationwide. While experiencing premium growth, TipTap has been consistently profitable. Its analytics and policy selection technologies have led to industry-leading combined underwriting ratios. All of this while operating in Florida, a very challenging litigation and hurricane-prone market. TipTap has survived profitably despite several hurricanes and a dangerous climate. So, in summary, we believe that at this point, TipTap is a proven platform that has industry-leading technology, analytics, growth, and profitability. Our goal at this point is to maximize the value of TipTap for our shareholders, all of you on this call. And we plan to do this through continued organic growth and expanding into additional states. Additionally, we will be exploring strategic opportunities which could include outside investment, joint ventures, licensing, or even a spinoff. With that, we are ready to open the call to your questions. Operator, please provide the appropriate instructions.

Thank you, sir. The floor is now open for questions. If you do have a question, please press star then one on your telephone keypad at this time. If you're using a speaker phone, please pick up your handset to provide the best sound quality. Again, ladies and gentlemen, if you would like to ask a question, it is star then one on your telephone keypad. And our first question comes from Matt Carletti with JMP Securities.

Good afternoon. Parish, I was hoping to follow on kind of that last line of commentary that you had and focus more on the future than what happened in the quarter. You know, a high-level question, what are some of the lessons learned? You know, you've kind of refined tip-tap. You know, you've been in the market in Florida for a few years. Strong growth, strong returns. It was kind of how you built the company. What lessons have you learned as you've done that that will kind of make the expansion nationwide, A, successful, and B, probably I would imagine you could do it a bit quicker than it took you in Florida because you had to learn on the fly the first time, and now you know how to do it.

Thanks, Matt. It's a great question. The lessons we've learned along the way, and this is why it's taken us, we waited patiently for the four years to prove that what we thought was going to happen was actually happening, and we had the results to back it up. But fundamentally, there's a couple of things. One is we have shown that we know how to organically grow a business very quickly. TipTap has tripled in size in a year. So you've got to be able to produce business. But more importantly, it's not just about producing business, it's can you actually do it profitably? And in the slide deck we put up, we showed you our loss ratios compared to the industry average. So you not only have to grow fast, But if you really have something of value, it should do it at a better result than the average industry average. And we have proven both of those things, and we've done it consistently across two product lines, both flood and wind homeowners insurance. So having done that, we know we have the techniques, the algorithms down as to how to grow into other states and grow there as well. So we are now about to embark on that journey.

expansion journey at this point having proven the the platform okay and then in terms of kind of the behind the scenes stuff i mean i know it took you you know you you built kind of the the the database the algorithms and everything behind it there's a lot of proprietary data there and you did it for i think five and a half million homes or how many however many are in florida Can you talk a little bit about kind of that process as you expand outside of Florida, how it might be kind of how we might look at the timing and how we might think of you adding states that imagine it's not 49 all at once, but they might come regionally or a few at a time?

Yes, Matt. What we've done is we've sort of divided into phase one, phase two. Phase one, we're going to expand to 20 additional states, and phase two will be the balance of the states. Now, obviously, for those that are aware of this, insurance is regulated on a state-by-state basis, so we will be applying to each of these 20 states, and they will take their appropriate amount of time in granting us a license for us to get operations running. All 20 states will not come online immediately. They will come on one after the other as the application process completes itself, and then we set up operations. So this is a, not a short-term journey, but more of a medium-term journey that we will be on, and we're just making every note that where we're going to go over the next decade, and that's really the item that we're on here, yeah?

Right. And then last question on TipTap. I know in Florida you found, you know, while it can be direct-to-consumer, you found that the agents really love it for the ease of use and how fast it is. Do you think it'll be a similar approach as you go into these new states? Do you expect it to be more of a tool agents fall in love with and get you in the door there? Or are you thinking about ways you could do more kind of direct-to-consumer marketing or otherwise to kind of go right to the end customer?

Good question. You know, the biggest thing we think about in the other states is agents are agents, policyholders are policyholders, behavior, human behavior tends to be the same. Floridians are not that different from Texans or, you know, New Yorkers for that matter, right? Not that those are new expansion states, but just as an example. A lot of the stuff, I think, will behave similarly. And as far as, you know, are we talking about going direct-to-consumer? Probably not, because I think the agents do control most of the business. And we've tried to make this thing agent-friendly and actually consumer-friendly as well, because when the agents recommend it to the consumer, they have to like it as well. So the best way of looking at what we've done over the last four years, why we've sort of stayed focused in Florida, is we sort of said, let's make sure you build the first state correctly and that you prove that this stuff works. Then it's almost like franchising going to all the other states. You're just replicating your winning formula over and over again. So this is why we didn't suddenly expand to 50 states four years ago, even though we might have been able to do that. A number of other people took that approach. We want to get one right first and then expand, and that's what we're doing now. That's why we're really excited, because we know we have something that works.

Right. Makes sense. One last one, just a quick one for Mark, and I apologize if I missed it, but net written premiums in the quarter, if you have it. Sure. Yeah, it's $137.5 million for Q2. Wonderful. All right. Thank you very much for the answers, and best of luck with the expansion. Thank you. Thanks, Matt.

And our next question comes from Mark Hughes with Truth Securities. Please proceed.

Thank you. Mark, how much did Anchor contribute to the gross written premium in the quarter?

About $42.5 million. And some of that is renewal.

Understood. Parrish, you talked about maybe pursuing or exploring strategic opportunities, and it sounded like you were painting a fairly broad brush there. Are there any relationships, associations, or partnerships that can help facilitate help with the national expansion, and I wonder if you could just expand on what sort of things you have in mind.

Mark, great question, and it's a broad question, right? I think my written comments were, my prepared comments, were more to do with the capital structure of the company in terms of how we would grow tip-top. I think the nature of your question could also apply to would we be using third-party distribution networks, et cetera, to sell our products, et cetera, and or partner with incumbent insurance companies in various states. And, yes, we are open to those possibilities as well. The key item to take away from my prepared remarks is we are on a mission to maximize the value of tip-tap to the shareholders, and we will do what's prudent to make that happen.

And am I hearing you that you're thinking about the potential that the growth is as attractive as you might like that might put a capital strain on the company, and so you're contemplating how to handle that? Is that what you're saying?

A little bit, yes. Up to now, if you can imagine what we've done with TipTap, it has entirely been paid for by the capital structure of the HCI group. In the initial phases of expansion, we can continue to have enough cash to continue the growth. You have to contemplate the possibility that if you've got additional capital in, you might be able to grow at a much faster rate because we have to balance our capital with our growth. So why wouldn't you consider partnerships in that fashion, yeah?

Yeah. In looking at your presentation, you highlight some attractive loss numbers for TipTap. Could you kind of give us a sense of what you think the run rate, you know, what this platform could do outside of Florida?

Yes. Just to put some of these numbers into perspective, on a nationwide basis, The homeowners insurance business is $105 billion in premium, and I think in 2018, which is the last year we actually had numbers for, it ran a combined, 103% combined. Putting it differently, the industry took in $105 billion, and when all the expenses were paid, it probably cost them like $106 or $107 billion. It's not exactly the highest margin business. What we are looking to do is, you know, carve out a $5 billion book out of that, but one that runs probably more like a 90 combined, not 103. That 13 points is a big deal when you're talking about $5 billion, yeah?

Yeah. Anything you would anticipate in kind of the near-term ramp-up expenses as you're Looking to expand into other states, obviously there's some groundwork that needs to be done. How much should we think about the magnitude of that?

Actually, Mark, I think the biggest magnitude of that are the items that we've already talked about in our prepared remarks. Because we were talking about growth and everything else, we went and took a more conservative stance in buying reinsurance this year in the size of the tower we bought, right, just because we didn't want to be distracted should there be an active hurricane season. On the other hand, also from Mark's prepared remarks, what you saw was we've taken a much more conservative stance in terms of the money we're setting aside in reserves for non-CAT claims. So these are really the biggest capital items that we're doing in terms of actually applying to states, et cetera. That isn't as expensive as opposed to the steps we've already taken. The operational expenses increase will be very minimal going forward.

Understood. Thank you very much.

Thank you.

And our next question comes from Bill Broomall with Dell Lingen Partners. Please proceed.

Great, thank you. If I could just follow up on the expansion plans. Looking at your phase one states, is there a certain reason why you might go to certain states first? Because it looks like it doesn't, you have a couple of states in the southeast, but it's in the middle of the country. on the coastal areas, so I was just wondering if you could help us understand how you got to the different states in phase one. What kind of attracted you to those first?

Simple answer I will give you, Bill, analytics. We sort of went looking at all the other 49 states, and we looked at a number of different factors as to what would make sense as to what sequence to go after them. When you actually did the analytics, it took us to the set of states that you're looking at currently. And we did that because it made sense. And ultimately, think of it this way. If you are going to be nationwide, you have to go to all 49 states. You're just debating the order in which you're going to go do them. And we wanted to make sure that we picked the states we liked first. And secondly, the item was we wanted to clearly communicate that we are talking about going national, not we're going to be regional in the southeast or we're going to be a coastal writer or anything else of that nature.

Understood. And when you think about the analytics and using your technology, in Florida, I would think you'd have a lot of data from your operations that you could then use to kind of help your models. I was wondering how you plan to handle the data and getting the necessary information you need to input into your models to properly underwrite in other states. Is it third party? You know, it's going to be a lot of third party data, but any thoughts on that? getting the data necessary to do this expansion would be helpful.

Okay, yeah. Let me answer the question in a slightly different way in terms of what's really involved in this expansion, or to do it in Florida, for that matter. There's one part where you need to get the raw data, and when we started doing this in Florida all those years ago, that raw data wasn't available, so we actually created it all ourselves. In this day and age, raw data is available much more readily available throughout the country. So the value of creating your own data has somewhat decreased over time. And we can use third-party data sources. But more importantly is what we did over the last four years is we built an algorithm that works, that knows how to process that data, digest it, and make smart decisions very, very quickly. That algorithm doesn't really change as you go from state to state. It adapts. And given that we already have this, this is what makes this so much easier to do. Now, yes, we use data to learn all these techniques over the last four years. But once you learn to hit a golf ball straight down the middle of the fairway, it doesn't matter which golf course you're playing on. It's the technique that counts. Bad analogy, but you get the idea.

Yeah, I know that. It does. It does. And kind of one of the questions that does come up when you think about using technology to underwrite with a focus on maybe homeowners and no floods in there, too, as well, Due to national expansion, you think the customers that you're going after have a home and a car. And you think about a lot of the national carriers who are out there, you know, they might be able to write both. And I was wondering how you kind of attack the problem of customer acquisition knowing that, you know, some people, a lot of people out there will bundle home and auto together.

Look, again, it's a great question, and it sort of goes back in the shades of the question Mark asked earlier about partnerships and so on. And clearly, that would be an advantage. Fortunately, one of the things that's happened over the years is there are a lot of auto carriers, InsurTech auto carriers, and they're just on the auto side. They might want to partner with somebody on the homeowner's side. and there's very few guys who have our capability to partner with them. So we have been working on the problem, and we have some interesting thoughts that we would do. I don't want to get into it too much, but it's clearly both a problem but also an opportunity.

Right, right. Okay, thanks. And one last number of questions. What was The in-force premium was a little over 75 at Q2. What was the in-force at Q1 for TipTap?

I don't have it at the time.

I could follow up later. It's not a problem.

Yeah, sorry. I don't have it right here. I've got it at the year end, but I don't have it for Q1.

Yeah, Bill, we know it's got to be somewhere north of 60, somewhere in the high 60s kind of range. The only reason I say that is because, as you know, we sort of slowed down in the second quarter a little bit, and we were well north of 50 by the end of 2019 anyway, yeah? Right.

Yeah, and Just to follow up on that, you talked about reaching 100 by the end of the year, I believe, in your prepared remarks. Does that mean, you know, that you slowed down, but now you're kind of returning to maybe focusing on growth a little bit more again just to get there? Yeah.

Yes, to some degree.

I guess my question is, you know, you pulled back. Are you kind of opening up the spigot again, maybe a little bit more than you were?

We're loosening the spigot a little bit. And, look, one of the other things that we've sort of clearly established, and it's good to do it in both directions, that we can turn the spigot off and drive growth to basically zero. And equally well, we can turn this figure on and drive growth to whatever we want it to be. So that degree of pinpoint control is amazing. Because I can tell you, I tried to do this at Homeowners Choice. It's very difficult doing a traditional insurance company. But TipTap does it so easily. It's incredible. But yeah, so at this point, really the plan between here and the end of the year is probably to... maybe grow a little bit during hurricane season, but then really accelerate in the fourth quarter as the hurricane season ends and try to make that $100 million mark by the end of the year.

Hey, Bill and Mark, to answer your question, oh, sorry, I was just going to jump in. It was a little over $71 million at the end of Q1, tip-top consolidated.

Perfect. Thank you. Thank you for that commentary. That was exactly, I was trying to figure out the timing of this hurricane season, but that was helpful. Thank you.

Yeah.

At this time, this concludes our question and answer session. I would now like to turn the call back over to Rachel Swampfinger, who has a few closing remarks.

On behalf of the entire management team, I would like to thank our shareholders, employees, agents, and most importantly, our policyholders for their continued support. We look forward to updating you on our progress in the near future.

Thank you for joining us today for our presentation. This concludes today's call. You may now disconnect.