Heritage Insurance Holdings, Inc.

Good morning and welcome to the Heritage Insurance Holdings Third Quarter 2020 Financial Results Conference Call. My name is Cole and I will be the operator for today. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. Please note this event is being recorded. I would now like to turn the conference over to Arash Soleimani, Executive Vice President at Heritage. Please go ahead.

Good morning and thanks for joining us today. we invite you to visit the investor section of our website, investors.heritagepci.com, where the earnings release and our earnings call will be archived. These materials are available for replay or review at your convenience. Today's call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are based on management's current expectations and are subject to uncertainty and changes in circumstances. In our earnings press release and in our SEC filings, we detail material risks that may cause our future results to differ from our expectations. Our statements are as of today, and we have no obligation to update any forward-looking statements we may make. For a description of the forward-looking statements and risks that could cause our results to differ materially from those described in the forward-looking statements, please refer to our annual report on Form 10-K, earnings release, and other SEC filings. With us on the call today are Bruce Lucas, our Chairman and Chief Executive Officer, and Kirk Lusk, our Chief Financial Officer. I will now turn the call over to Bruce.

Thank you, Arash. I would like to welcome all of you to our third quarter 2020 earnings call. Before we begin the call, I'd like to thank all our employees for their dedication to our company. The third quarter was challenging only because we experienced record catastrophe losses related to Hurricane Isaias and Sally, in addition to elevated non-cat weather losses. Despite elevated weather losses, the core fundamentals of the company continue to improve year over year and quarter over quarter. Over the past year, I've commented that new business has and will continue to accelerate as we launch new states, new partnerships, and develop additional revenue channels in our existing states. This trend has been remarkably strong and has continued in the third quarter as new business sales set a fifth consecutive quarterly record and gross premiums written increased 17% year over year. During the quarter, we launched operations in Delaware and anticipate launching Maryland in the fourth quarter, which will add additional revenue growth in 2021. I've been very focused on growing our national partnerships, which I believe sets us apart from our peers and will continue to add to our record growth. There are several more partnerships and expansions of existing partnerships that I believe will be announced in the near future. This is truly an exciting time for the company, and I don't see any material impediments to our growth for the foreseeable future. Equally important is that our loss reserves continue to develop favorably. The third quarter marks the ninth consecutive quarter of favorable reserve development. This is an incredible achievement given recent market conditions and is a testament to our conservative approach toward loss reserves. Our increasing sales and favorable reserve development have resulted in meaningful gains to our book value per share, which had solid growth year over year despite the weather losses in the third quarter. Additionally, the employment contracts for me, our President Richard Whitacombe, and our Chief Operating Officer Ernie Garite expire on November 4th. The Board of Directors offered new contracts for all of us that I believe are fair and strike an appropriate balance for shareholders. After a lot of consideration, I have decided to retire from Heritage by the end of November and promote Ernie Garrett to Chief Executive Officer. Ernie has been an integral part of Heritage's executive team since the company's inception and has tremendous experience across product management, underwriting, claims, analytics, and systems. As a founder of the company, it was important for me to pick the next CEO, and I'm pleased to name Ernie as my successor. Our co-founder, Richard Whitacombe, will continue to serve as president and chairman of the board. Even though I'm retiring from Heritage, I'll continue to serve the company as an executive consultant through 2021, and shareholders should expect a seamless transition. New agreements reflecting these changes will be filed as soon as they are completed, and I am confident that our executive compensation expenses will be significantly lower in 2021 and will provide a meaningful boost to our earnings per share. As many of you know, I'm a serial entrepreneur and love the challenge of creating new companies from the ground up. I have started several companies over the years, with Heritage being my most successful venture to date. It was important to me to stay with the company until the business plan I developed was fully implemented. Since inception, we grew from a single-state homeowners insurer in Florida to a top-20 homeowner writer in the United States that's actively writing in 15 states with over a billion of in-force premiums. We have developed an impressive double-digit organic growth engine, including a vast independent agency network and multiple national partnerships with some of the top insurance companies in the U.S. Over the past five years or so, we've de-risked roughly $23 billion of Tri-County Florida TIV, diversified the company's footprint, and reduced Florida TIV from 100% of the total company to just 31%. Our in-force premiums have nearly doubled and are growing at record levels. Our reserving has significantly improved and is arguably the strongest in the peer group as demonstrated by our ninth consecutive quarter of favorable prior year reserve development. We've been profitable every full year of our existence, even during the toughest periods of the assignment of benefits crisis in Florida and through extremely active storm years, which is the exception among our peers. Since inception, we've grown book value at an impressive 22% compounded annual growth rate, and we've returned almost $150 million to shareholders through dividends and share repurchases. Our new business sales have set new records each of the past five quarters and are up over 100% year over year. I am extremely proud of our operating results during my tenure as CEO, and the timing of my retirement felt right. as I believe we successfully navigated through some very difficult times, established ourselves as a meaningful competitor in the property insurance sector, and are in a position of strength relative to our peers. I trust Ernie's judgment and ability to execute a very successful business plan, and I look forward to supporting Ernie as he makes a seamless transition to his new role. I'd like to close by thanking our employees, directors, partners, and shareholders for their support over the past eight years. I did not build this company alone. It was a team effort and I am forever grateful for your contributions to our company. Thank you for all the amazing memories and for making Heritage a best-in-class company. I will now turn the call over to Kirk to provide more details on our financials.

Thank you, Bruce. Good morning. We have been very fortunate that COVID-19 has had virtually no impact on our business and much of that has to do with the efforts of our employees. Productivity remains high and we continue to provide our policyholders and distribution partners with the service they have come to expect from Heritage. I would like to thank our employees once again for their continued flexibility, dedication, and customer focus. The weather has been a challenge in 2020, starting in the second quarter and continuing into the third. Despite the second quarter having an unprecedented 13 PCS events and net weather losses of 26.8 million, the weather losses of 47.3 million in the third quarter surpassed the second quarter weather losses by over 20 million on a net basis. The net loss ratio of 86.6 was significantly impacted by hurricane and non-hurricane CAT losses of 24.5 million, which added 17.8 points to the net loss ratio and non-CAT weather losses of 22.8 million, which added another 16.5 points to the net loss ratio. The ex-weather net loss ratio was also impacted by higher current accident year losses, which we believe to be an anomaly. Despite having favorable prior year development of $5.8 million in the quarter, with the weather losses just mentioned, the company had a net loss for the quarter of $5.2 million, or $0.19 per diluted share. Growth premiums written for the quarter were $278.2 million, up $40.9 million, or 17.3% from the prior year quarter. The increase reflects growth outside of Florida of 18.1% and growth in Florida of 16.3%. Compared to the third quarter of 2019, the company has added written premium in the states of California, Delaware, and Mississippi. With the increased growth, we continue to evaluate our portfolio to ensure that we are getting the type of policies that will contribute to our long-term profitability. Along with the premium growth, we are focused on making an underwriting profit and obtaining adequate rates. The 17.3% year-over-year written premium increase outpaced our policy-enforced growth of 7.6%. The seeded premium ratio was 45.8% in the third quarter, down 0.7 points year-over-year, and down from the second quarter 46.6%. The decrease year-over-year reflects the increase in seeded premiums of 8.3%, which was more than offset by the increase in gross earned premium of 10.1%. 2020 third quarter net premiums earned were up 14.4 million, or 11.6%, reflecting higher gross premiums earned and partially offset by an increase in seeded premiums. Regarding our investment portfolio, during the third quarter, we experienced stable to slightly positive market spreads and strong demand in the secondary markets, allowing us to take 20.4 million of investment gains during the quarter. This will impact future yields in the short term, but was opportunistic for our insurance companies and we remain committed to maintaining a low-duration portfolio so that we can benefit when yields rise. The net expense ratio is 36.1% and down from 38.9% during the third quarter of 2019. The ratio reflects reduced compensation expense, technology equipment, and travel-related costs. The net combined ratio for the third quarter of 2020 was 122.6, which is up from 94.5% in the prior year period, reflecting a higher net loss ratio. Interest expense is down slightly, reflecting a decreased LIBOR rate relative to last year. Despite the loss in the quarter, book value per share is up by over 30 cents for the year. In closing, I'd like to comment on our focus going forward. In 2019, we focused on our capital structure and continuing to refine our exposures in Florida and expanding our footprint into other states. In 2020, the growth of the top line was a result of those efforts, and now we are focused on getting the bottom line to expand in line with the increase in the top line. As mentioned, we are focused on riding business where we think we can make a profit and obtain adequate rates. We will take the rates needed to achieve adequate margins. Bruce and I are now available to take your questions.

And at this time, we will begin the question and answer session. To ask a question, you may press star then 1 on your telephone keypad. If you're using a speaker phone, please pick up your handset before pressing the keys. To withdraw your question, please press star then 2. Once again, that is star then 1 to ask a question. Our first question today will come from Paul Newsome with Piper Sandler. Please go ahead.

Good morning. Congratulations to everyone on the change in the position. I WAS HOPING TO ASK A LITTLE BIT ABOUT THE CAPITAL POSITION AND HOW YOU FEEL FROM A CAPITAL PERSPECTIVE AS WELL AS MAYBE AN UPDATE AS TO HOW YOU THINK ABOUT CAPITAL ALLOCATION PERSPECTIVELY.

I'LL TAKE A STAB AND LET KIRK JUMP IN. WE THINK WE HAVE A VERY STRONG CAPITAL POSITION RIGHT NOW. WE'VE GOT PLENTY OF CASH ON THE BALANCE SHEET. We are in a position of strength with respect to capital, and we're happy with where we are in this position in terms of capital allocation going forward. Obviously, we keep some dry powder back to participate in reinsurance contracts and maintain appropriate RBC ratios, et cetera, but we do feel like the balance sheet has a lot of capital on it right now that we could use, and the number one target for us for use of that would be share repurchases. So we look at where we're trading right now and the discount to book value and then I kind of compare that to the fundamentals of the company. When you have the exceptional growth that we've shown and you have the favorable reserve trends for over two years now, that's a great combination for profitability. Our forward book value projections are significantly higher than where they are now. A good reuse of that capital is to return it to shareholders via share repurchases.

Great. Obviously, the balance sheet and reserves have been a huge focus for you guys for the last several years. It looked like there was a little mention of a little inter-year reserve changes and developments. Can you maybe talk about what that was, just so we have a sense of how the pieces are moving?

Yeah, I mean, a lot of that had to do with the number of PCS events we had in the first and second quarter and just the weather events. We did have a number of, you know, kind of companion claims that were associated with the CAT claims. You know, at this point, you know, we haven't really, you know, determined that those are, you know, COVID related or have any relationship to that. But it did spike a little bit in the third quarter. And that's why we do consider it to be somewhat of an anomaly. We just haven't seen, you know, that type of ramp up before. And that really was the cause of that.

And, Paul, you know, we take a very conservative approach to lost reserves, obviously, with nine consecutive favorable quarters. So whenever we see any type of trend, we err on the side of caution. We put up the additional capital. And what usually happens is we end up releasing it. And we think that gives shareholders a lot of confidence that we are reserving appropriately and there aren't any surprises on the horizon in terms of adverse development. We think that's very important.

Fantastic. I want some other folks to ask questions. Appreciate the answers, and congratulations to everybody.

Great. Thank you, Paul.

And once again, if you would like to ask a question, please press star then 1. Our next question will come from Marla Backer with the DOTI. Please go ahead.

Thank you. So I'm wondering a little bit more color, if you could, on the geographic diversification efforts So you moved into Delaware in the quarter to further expand your footprint. But in the past, we've also seen you take moves that were away from the East Coast to California, Hawaii. Any other potential more far-flung expansion that you're looking at or thinking about right now?

Yeah, it's a great question. So we did launch Delaware in the third quarter. In the fourth quarter, we plan to launch Maryland. We are currently evaluating approximately 15 to 20 additional states for licensure. So we're still in the due diligence process there. We can tell you, more importantly, where we won't be. We will not be in Louisiana, and we will not be in Texas. That is not In our business plan, we have never really been bullish on those two markets. And the big difference maker for us in the third quarter vis-a-vis our peer groups that have significantly elevated catastrophe losses than us is the fact that we don't have a presence in those two Gulf Coast states. So we're going to hold the line there. We like our portfolio. We have such tremendous runway ahead of us. We're growing top line at an incredible clip right now, up 17% year over year. And we have signed multiple deals to acquire tens of millions of dollars of additional premium that haven't even flown through our top line numbers yet. So I do think that you're going to see some pretty expansive growth in the company at profitable rates, but mainly within the existing footprint that we have today.

Okay, thanks. And then in terms of the partnerships, obviously, you know, that's been an important part of the strategy, the bundling opportunities. And if you already spoke to this, I apologize. I jumped on a couple of minutes late. Can you give us at least directionally some sense of, you know, to what extent that had an impact on the strong growth you saw in new business in the quarter?

Yeah, I mean partnerships are very critical for us and we've got multiple national partners in our portfolio right now that is truly unique among our peer group. I'm not aware of anyone that has the breadth of partnerships that we have here at Heritage and we've got several more on the horizon that I believe will be announced in the near term. We cannot comment on what those numbers are per partner. We have very clear agreements with all of them that we will not disclose financials and what that premium volume looks like. But it's safe to say that our biggest producers are the national partners that we have. So it is impacting our growth rate. But, you know, I'd say 90% of what we're producing right now is coming from independent agents and probably 10% of it's coming from the national partnerships. But I do expect those numbers at the national level to start growing just because we've signed all of these other deals to acquire tens of millions in premium that haven't even run through the top line enforced premium numbers yet. Okay. Thank you. Thank you.

And our next question will come from Bill Broomall with Dowling and Partners. Please go ahead. Great.

Thank you very much. If I could just switch to Florida. Have you seen any run-up in IRMA claims coming up on the three-year statute? Any trends that you've kind of observed?

Yeah, that's a great question, Bill. Not really. I mean, we saw a little bit of elevation in some claims that kind of came in the last, call it 30 days or so, but nothing that wasn't already fully accounted for, plus some in our IBNR numbers. So we didn't see anything. In fact, I was very surprised that the run-up was as low as it was. I know other insurance carriers in Florida have had significantly worse run-up numbers as you approach the deadline, but that's mainly because they have a big footprint in Tri-County where you see a lot of the – a lot of this is called social inflation claims. We just don't have that book of business. And so it's a little different for us vis-à-vis them. We think we're in a pretty good spot, and we didn't really get any surprises out of Irma as we approached the statutory deadline.

Great. Thank you. And, you know, we know Florida, there's a lot of companies under stress. You know, you talked about being in a position of strength. Is there any interest on your part in maybe participating if there is some dislocation in Florida, potentially picking up policies and filling in, you know, where other companies might be stop writing in the state because they have RBC issues and you can step in at maybe a more appropriate rate? And not just Tri-County, but maybe other parts of the state as well. Does that interest you at all?

Yeah, there's always opportunities there, Bill. And I think you really touched upon the hot topic in Florida right now. I think there's a fair number of players right now who are under pretty severe financial distress. And whenever there's chaos like that in the market, usually there's some really wonderful opportunities that come out of that. We're going to be opportunistic. We're not really looking to grow the Florida footprint right now. But if there's an opportunistic play within Florida that will generate huge returns for the company, we're absolutely going to take a look at it. And I can tell you that we're usually the first company that these guys call. just based on our track record of M&A activity both inside and outside of Florida.

Yeah, I'd say one of the things, you did mention a very key aspect of that, though, is at the right rate. So, you know, are we willing to just kind of go in and take portfolios that we think are underpriced? No, but, you know, at the right price, right rate, definitely, you know, we would look at it. Perfect.

That's helpful. Thank you. And I The cash on your balance sheet is definitely growing pretty significantly. Is there any way you can maybe help us think about what kind of cash you have at the Holdco?

We have a little over $40 million at the Holdco as of third quarter.

Did you downstream any capital to support the growth that you've been seeing? Not at this point. That's great. Thanks. And then maybe the last one. Bruce, hopefully you might be able to help me think about the topic of we've seen some press reports talking about the OIR looking at MGA relationships and affiliated partnership, yeah, internally affiliated kind of relationships. Can you just help us maybe frame out what's going on? I don't know if I kind of fully appreciate all the issues.

Yeah, the MGA structure in Florida is unique vis-a-vis a lot of other states, and that's really a structure that was designed and has been maintained to attract capital to the Florida marketplace with a way to generate some type of yield to the investors. I've heard this topic come up multiple times over the years, and I'm not really sure if what the breadth of that review is right now. I can tell you that I haven't seen anything negative or contrary to the current MGA structure at all. I think it would probably be something, if I'm going to guess, something that probably happens to some of the more financially strapped companies that are having a hard time meeting minimum RBCs, et cetera. I could see that as being a pressure point for them, but For the companies who have good solvency and good underwriting portfolios, et cetera, like us, I'd be very surprised to see any pushback on MGA fees.

Great. Thank you very much. I think that's all I had. And congratulations to everyone. Appreciate it. Thank you.

And once again, if you would like to ask a question, please press stars and one. And this will conclude our question and answer session. I'd like to turn the conference back over to Bruce Lucas for any closing remarks.

I would just like to thank everyone for participating in our third quarter 2020 earnings call.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect your lines at this time.