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Operator
Good morning and welcome to HCI Group's second quarter 2022 earnings call. My name is Jenny and I will be your conference operator. 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 8, 2022, starting later today. The call is also being broadcast live via webcast and available via webcast replay until August 9, 2023. On the investor information section of HCI Group's website at www.hcigroup.com. I would now like to turn the call over to Matt Glover, Gateway Investor Relations. Matt, please proceed.
Jenny
Thank you, Jenny. This is Matt Glover from Gateway Investor Relations. Thank you and good morning. Welcome to HCI Group's second quarter 2022 earnings call. On today's call is Karen Coleman, HCI's Chief Operating Officer, Mark Harmsworth, HCI's Chief Financial Officer, and Parish Patel, HCI's Chairman and Chief Executive Officer. Following Karen's opening remarks, Mark will review our financial performance for the second quarter of 2022, and then Parish will provide an operational outlook. To access today's webcast, please visit the investor information section of our corporate website at hcigroup.com. Before we begin, I'd 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 risks or uncertainties develop into actual events, these developments should 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 Karen Coleman, Chief Operating Officer. Karen?
Jenny
Thank you, and good morning, everyone. The second quarter of 2022 marked another quarter of growth. Our insurance division growth premiums earned were up 30% and our national expansion continued with premium outside of Florida approaching a quarter of our business. There were two main items that impacted our financial results. First, investment income with unrealized losses were impacted by market decline. And second, we strengthened reserves in response to inflation and litigation. These two items resulted in an $8.5 million loss for the quarter. In strengthening reserves, it resulted in a 7.8% increase to our loss ratio. To offset this, we filed meaningful rate increases, 10% at Homeowner's Choice and 12% at TipTap. We also executed on a number of key items this quarter. First, we raised more than $170 million through issuance of convertible notes increasing our flexibility at a time when capital is scarce across our industry. Parrish will speak more to this in remarks. Second, we finalized our reinsurance with pricing and terms comparable to last year while maintaining a conservative program with modest retentions and substantial limits. With reinsurance in place, Deltek reaffirmed our A exceptional ratings at both homeowner's choice and TIP TAP. And third, we continue to optimize our balance sheet, repositioning our investment portfolio to generate income. Finally, we remain committed to returning capital to shareholders through dividends and share repurchases, and continue to view our stock as an attractive investment. During the quarter, we repurchased shares representing approximately 10% of the company, and we paid a dividend of 40 cents per share, our 47th consecutive quarterly dividend. In summary, we continue to position HCI to take advantage of the opportunities in front of us while managing the business to maximize return for our shareholders. And now I'll turn it over to Mark who will provide more detail on our financial results.
Mark
Mark? Thanks, Karen. In the second quarter last year, net income was $3.8 million. In the second quarter this year, we had a net loss of $8.5 million. Half of that change came from realized and unrealized changes in the value of equities in our investment portfolio. The overall market declined more than 16% in the quarter. The balance of the difference came from a higher loss ratio, which increased from 40.1% to 47.9%. There were three reasons for the increase. First, business mix simply relates to premium growth coming from lines with a higher loss ratio. The second reason was inflation. which resulted in us making higher current period loss selections. The third factor was adjustments we made to some prior period loss selections for inflation and some adverse litigation development. We continued to build reserves by expensing more than we were paying out in claims. In the first six months of this year, non-CAC claims paid were $30 million less than what we expensed. There were also a number of positive trends this quarter. First, the company continues to grow. Gross premiums earned were up 30% over the same quarter last year. Second, as Karen mentioned, we completed our reinsurance program for the new treaty year. Our net premiums seeded, assuming no storms, are expected to be $245 million for the treaty year that started June 1st, and we expect reinsurance as a percentage of premiums to continue to be lower this year than last. Policy acquisition expenses as a percentage of gross premiums earned are coming down because Tip-Tap is paying lower commissions. Fourth, investment income is going up. We kept cash on hand waiting for the interest rate environment to improve, and it has. So far this year, we have bought over $350 million of short-duration fixed-term securities, and as a result, investment income is increasing. Lastly, we're continuing to adjust rates to compensate for inflation. As Karen mentioned, in August, we implemented rate increases for Florida homeowners in both TIP TAP and Homeowners Choice. And as these higher rates are earned, we expect the loss ratio to start to improve. There have been a number of favorable developments on the balance sheet as well. In May, we closed on a new convertible debt issue. We set out to raise $150 million, and we were significantly oversubscribed. We raised gross proceeds of $172.5 million at a rate of 4.75%, maturing in June of 2042. We started this year in a solid liquidity position, and that position is even stronger now. Both of our insurance companies are in strong surplus positions, and we have significant dry powder at the holding company level. We have over $170 million of cash and investments at the holding company level, and full access to our credit line with Fifth Third Bank. This is almost twice as much liquidity as we started the year with. Just a couple of other quick points. Our share count for purposes of calculating book value per share and paying dividends is now $9,048,000. We used $67 million of the convert proceeds to buy back almost 10% of the company on a fully diluted basis. As of June 30th, our fully diluted share count was $11,300,000. In conclusion, this quarter we addressed our rate needs to combat inflationary pressures. We continued to build reserves. We secured our reinsurance program, and we bought back almost 10% of the company. We also significantly improved our liquidity position. We ended the quarter with close to a quarter of a billion dollars of liquidity at the holding company level. The actions taken this quarter put us in a strong financial position to execute on our strategy in the future. And with that, I'll turn it over to Parrish. Thanks, Mark.
Mark
As discussed by Karen and Mark, the main items affecting HCI Group in Q2 were inflation and volatility in equity markets. We have taken corrective measures and continue to execute our business strategy with the company growing 30% year over year. Our national expansion beyond Florida including the UPC transaction, continues as planned and the results are within expectations. However, we are aware of the turmoil in the Florida homeowners market. These pressures brought about by a combination of increased weather events, inflation, and litigation has and will continue to disrupt existing markets. This has resulted in the liquidation of some carriers this year and leaves many others facing rate and downgrades. We have a hard market and diminished competition. But our technology and our management team has shielded us from this turmoil. In fact, as a company that has successfully navigated the Florida market for 15 years, this turmoil provides a substantial opportunity. To take advantage of this opportunity, the first step was to ensure that we had ample capital. and we have completed that in Q2. In the coming weeks, we intend to apply to set up additional insurance carriers in the state of Florida. We expect these new carriers to begin writing business early next year. Why are we doing this? Basically, homeowners insurance is a product that is in high demand, and it will still be in high demand a decade from now. there is an opportunity here to pick up market share. Now, some are fearful due to present market conditions, but we have a track record that lets us navigate through these market conditions. And secondly, we are focused on the long-term opportunity and intend to capitalize on that opportunity. With that, we will open for questions. Operator, please give instructions.
Operator
Thank you, sir. Ladies and gentlemen, the floor is now open for questions. If you have any questions or comments, please press star one on your phone at this time. We ask that while posing your question, you please pick up your handset if listening on a speakerphone to provide optimum sound quality. Please hold whilst we poll for questions. Thank you. Your first question is coming from Matt Carletti of JMP. Matt, please ask your question.
Matt Carletti
Hey, thanks. Good morning. Good morning. Parrish, I just wanted to follow up on actually that last point you brought up about planning to set up some new companies and be ready to write business next year. How should we think about that opportunity? And at least as I think about kind of HCI as it stands today, you've got TipTap that's kind of organic growth, the independent agents. You've got Homeowner's Choice that has a history of being a bit more of a specialist doing book rolls and citizens takeouts and things like that. How do you see that opportunity unfolding? Will these new companies look like more one versus the other, or is it too early to tell?
Mark
Matt, it's a combination. They will look very similar or a hybrid of homeowner's choice and tip-tap, yet they will be different. That is why we set them up separately. It will evolve over the coming months, and we will provide more detail as... as events progress, yeah?
Matt Carletti
Okay. All right. Probably a question for Mark. You mentioned on the kind of the upward movement and the loss ratio, the seven or eight points or so, it was a few different things, kind of business mix, the impacts of inflation and prior period development. I was hoping you might be able to break those pieces out, you know, kind of how much of the movement relates to each one.
Mark
Sure. Hey, Matt. Yeah. So, so in terms of those percentages, so, so the loss ratio is up about, um, 7.8% from the second quarter of last year to the second quarter this year. Um, so about 1.8 of that is, uh, is the mix that I mentioned, um, about 3.3% of that is inflation and 2.7 is prior development. Okay. Very helpful.
Matt Carletti
And then one last one, if I could just sneak it in, Mark, also a numbers question. Just what is, at June 30, what is the tip-tap surplus?
Mark
Tip-tap surplus at the end of June is, just give me one second here, $90.2 million. Wonderful.
Matt Carletti
All right. Thank you very much.
Mark
Yep. Thanks, Matt.
Operator
ladies and gentlemen as a reminder if you wish to ask a question please press star 1 on your handset at this time your next question is coming from mark hughes from truest mark please ask your question yeah thank you good morning the uh part of your development was there any particular trigger for that there was some legislative action in florida was there a
Mark
last minute flurry of claims or was this something that's been building for some time?
Mark
So there's a couple of things going on in there and there's two or three sort of discrete items in there. So homeowner's choice, there was a couple of million dollars of adverse development in homeowner's choice and it relates to the anchor assumption from back in 2020 So, you know, it's a couple years back. You know, a lot's changed since then, but if we look back at that assumption in 2020, we tweaked that loss ratio up a bit. It's largely just related to increasing our litigation picks a little bit for there. The other thing that's going on is we've got, I think we've talked about it a couple times before, but Tropical Storm Ada from November of 2020 pretty significant difference between the number of lawsuits that we thought we'd get off of the, you know, 1,200 or 1,300 claims that are there than expected. So, you know, we've been increasing the ultimate selection, if you will, for ADA as a result of that. So, again, that's, you know, largely litigation driven. And then in TIPTAP, we've got a couple of a couple of accident quarters again from 2020 where we're adjusting up our litigation picks. So a lot of it, you know, as I mentioned, is litigation. So those are sort of the buckets of the adverse development. Just in terms of litigation trends generally, you know, litigation and the reported litigation in the second quarter of this year was significantly lower than it was in the second quarter of last year. But we do have, you know, just, you know, a few of these accident quarters from 2020 that we're going back and adjusting the initial litigation pick.
Mark
And then when we think about the inflation and mixed impacts, what is that, about five points? Does that persist? And I guess maybe just diminish over time as you get these rate increases. How should we think about that?
Mark
Yeah, good question. So assuming that we've got some rate increases that we mentioned, and inflation has been obviously higher than our rate increases. Assuming that the inflation, I don't think anyone's expecting prices to go down. They've gone up, but I don't think anyone's expecting them to go down. If they stay flat, sort of stay at these elevated levels, then as the rate increases work their way into the book, I would expect the loss ratio to drop a couple of points, you know, each quarter for the next couple of quarters.
Mark
So sequentially some improvement and maybe some improvement after that. Yeah. A couple of points sequentially.
Mark
Yeah. I mean, yeah, exactly. A couple of points in Q3 and Q4.
Mark
Yeah. Mark, as you know, the loss ratio ended immediately in the second quarter. The rate increases that we've put through, which are greater than the increase in the loss ratio, will take several months to earn in. And so consequently, as that happens, the loss ratio will drop. But it will be a multi-month process, yeah? Multi-quarter process.
Mark
Yep, understood. I think you mentioned TIPCAP paying lower commissions. Could you talk a little bit more about that? Is that across all states? Is that directed in Florida? Will that continue?
Mark
Yeah. Mark, we should clarify on that a little bit better. TIPCAP's business plan always has been that we pay higher commissions on new businesses and it crops at renewal. As more of the book renews, the blended commission rate comes down. So it's not necessarily that we are reducing commissions everywhere. We may be doing that in a couple of places, but not dramatically. Most of the effects you're seeing are mainly because renewal commissions are lower than new business commissions.
Mark
I understand. So you're kind of easing off during storm season means there's more concentration of renewals in the period and so it reduces the number.
Mark
And look, it's simple math in a weird way. It's in the sense of the first year when you write $100 million of business, it's all new business. Second year you write $100 million of new business, it's half of it's renewal, half of it's new business. Third year you write $100 million, it's $200 million of renewal business and only $100 million of new business. So the renewal rates tend to over time dominate the new business rates, yeah? It's a natural occurrence, unpredictable, yeah?
Mark
Yeah. I'll ask the question this way. I think you've done very well historically keeping losses under control, done substantially better than your peers. It's kind of the the appearance of inflation here, you know, Florida has been, and your competitors have been undergoing, you know, some stress for, for a while. You've seen some of it. What, what, why now? I think you've, you've touched on this, but I just wanted to kind of flesh it out a little more. If there's anything else to be said, you know, why the mix to understand the prior development makes sense to, Inflation, you know, having more of an incremental impact, you know, 330 points is, you know, meaningful. I'm just sort of curious why you think, why now?
Mark
Well, I think the second quarter was, you know, moved a lot from what people were believing in April versus what people believed by the end of June. And one of the big things was, and I'll quote, I think, the Federal Reserve Chairman, a shifting in belief that inflation is transitory to inflation is permanent, right? And if you remember Mark's earlier comments, Mark Homsworth's earlier comments, that he's not expecting prices to come down anytime soon, right? So now you have permanently elevated expenses. You should build that into your business. And we have obviously, by our actions, swiftly moved in that direction. So Once we came to that conclusion that prices are not coming down, we took decisive action. We can't always predict the future, but whenever the present becomes obvious, we take corrective action quickly and efficiently.
Mark
Fair enough. And then what's your appetite for growth in Florida once we get out of the storm season? How should we think about your growth posture come Q4, for instance?
Mark
Well, therein lies the comments on the question that Matt Carletti asked earlier. Because of the turmoil in Florida, we actually see a greater opportunity at this moment in time unfolding in the fourth quarter than maybe we saw six months ago. Now, we wanted to make sure that we communicated this clearly to everybody So, tip-tap insurance companies' plans and expansion plans outside Florida are going unabated, unchanged. We see an additional opportunity in Florida, and that's why we're setting up new carriers to take advantage of those new opportunities, yeah?
Mark
Yep, yep. Okay, thank you very much. Thanks, Mark.
Operator
At this time, this concludes our question and answer session. I would now like to turn the call back over to Paresh Patel, who has a few closing remarks.
Mark
Paresh Patel Okay. 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. While we talk about a lot of numbers, we never lose sight of the fact that our primary mission is that we are protecting a policyholder's most valuable asset, their home. With that, thank you very much and see you next quarter.
Operator
Thank you for joining us today for our presentation. This concludes today's call. You may now disconnect.
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