HCI Group, Inc (NYSE: HCI) Q1 2023 Earnings Call dated May. 09, 2023.
Corporate Participants:
Matt Glover — Investor Relations, Gateway Group, Inc.
Karin Coleman — Chief Operating Officer and President of Homeowners Choice Property and Casualty Insurance Company
Mark Harmsworth — Chief Financial Officer
Paresh Patel — Chief Executive Officer
Analysts:
Mark Hughes — Truist — Analyst
Matt Carletti — JMP — Analyst
Presentation:
Operator
Good afternoon, and welcome to HCI Group’s First Quarter 2023 Earnings Call. My name is John, and I will be your conference operator. [Operator Instructions] And will be available for replay through June 8, 2023, starting later today. The call is also being broadcast live via webcast and available via webcast replay until May 9, 2024, on the Investor Information section of HCI Group’s website at www.hcigroup.com.
I will now turn the call over to Matt Glover, Gateway Investor Relations. Matt, please proceed.
Matt Glover — Investor Relations, Gateway Group, Inc.
Thank you, John, and good afternoon, everyone. Welcome to HCI Group’s First Quarter 2023 Earnings Call. On today’s call is Karin Coleman, HCI’s Chief Operating Officer; Mark Harmsworth, HCI’s Chief Financial Officer; and Paresh Patel, HCI’s Chairman and Chief Executive Officer. Following Karin’s operational update, Mark will review our financial performance for the first quarter of 2023, and then Paresh will provide a strategic update. To access today’s webcast, please visit the Investor Information section of our corporate website at www.hcigroup.com.
Before we begin, I’d like to take this 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, 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 could have material adverse effects on the company’s business, financial conditions and results of operations. HCI Group disclaims all obligations to update any forward-looking statements.
Now with that, I’d like to turn the call over to Karin Coleman, Chief Operating Officer. Karin?
Karin Coleman — Chief Operating Officer and President of Homeowners Choice Property and Casualty Insurance Company
Thank you, Matt, and welcome, everyone. HCI Group reported a strong first quarter with pretax income of $23.1 million and diluted earnings per share of $1.54. Our Homeowners Choice, TypTap and Greenleaf subsidiaries all contributed to earnings with several noteworthy accomplishments during the quarter. TypTap Insurance Group, our insurance and technology subsidiary reached a milestone with its first quarter of profitability on a GAAP basis and more than $350 million of in-force premium. At both of our insurance companies, loss ratios improved from last quarter, driven by lower claim volumes partially due to legislative reforms enacted in Florida last year.
Our real estate division, Greenleaf Capital, earned over $9 million, reflecting gains on the sale of two properties disclosed on our last call. As a reminder, over the last three years, Greenleaf realized gross proceeds of close to $90 million and a gain of $60 million on just four transactions. And we believe there is still plenty of upside in our real estate portfolio. In addition, our investment portfolio earned $9 million during the quarter, with 90% of it coming from interest income alone. This is a result of steps we took to reposition the balance sheet into short-duration interest-earning assets over the last year.
We now have an investment portfolio capable of generating $30 million in interest income on an annualized basis with a low risk profile. We also continued to deliver on our commitment to shareholders, paying a $0.40 per share dividend, our 50th consecutive quarterly dividend. In summary, it was a solid profitable quarter with all three of our main divisions contributing to the success of the quarter.
And now I’ll turn it over to Mark, who will provide more detail on our financial results.
Mark Harmsworth — Chief Financial Officer
Thanks. As Karin mentioned, pretax income for the quarter was $23.1 million, and diluted earnings per share were $1.54, up from $0.09 in the first quarter of 2022. We discussed several positive trends over the past few quarters and those trends are translating into material, sustainable improvements in earnings. First, gross premiums earned are up despite policies in force being down, driven by rate adjustments made over the past few quarters. This means that while revenue is up, exposure is down. Second, investment income is going up.
As Karin mentioned, we had a gain from our real estate portfolio, but even if that is excluded, the remaining $8.8 million of investment income is more than 3 times what it was in the same quarter last year. This increase in investment income is being driven by steadily increasing interest income on our bond investments and on cash. When interest rates were low, we held on to our cash, and when they started to go up, we carefully invested some of that cash in bond. At the end of Q1, we have $500 million invested in fixed-term securities at an average yield of 3.7% compared to $150 million invested at 1.6% a year ago.
We have continued to manage the risk as well. Our average term to maturity in the bond portfolio was just over one year, and we still have over $300 million in cash. The third positive trend is that policy acquisition expenses are declining as a percentage of gross premiums earned. In Q1, policy acquisition expenses were 12.6% of gross premiums earned, down from 16.4% in the same quarter last year because of lower commissions and a change in the mix of new versus renewal business. This reduced expenses by more than $7 million for the quarter. I saved the last trend, declining loss expenses, for last as it deserves more explanation. In the first quarter, our consolidated loss ratio was 33%, down considerably from 40% in the same quarter last year.
The lower loss ratio was driven by higher average premium per policy, moderating claims severity as well as lower claim and litigation frequency, some of which is as a result of the legislative changes in Florida. I should note that we did not get to these lower loss ratios by reducing reserves. While we have slowed the pace of reserve increases, we have not yet started to reduce them. So stepping back, that’s four positive trends that I went through, and the combined impact of all of these trends is a material positive impact on the operating performance of the company as evidenced by the strong earnings in the quarter. These trends have also positively impacted our insurance and technology subsidiary, TypTap Insurance Group.
Higher average premium per policy, higher investment income and a lower loss ratio and a lower expense ratio led to TypTap Insurance Group being profitable for the quarter. Our real estate division also had another very strong quarter. As Karin mentioned, we sold two of our commercial properties for a gain of $8.9 million, another example of our opportunistic real estate strategy. Just a few other quick things. Consolidated cash flow from operations was $99 million or about $11 per share compared to $57 million in the same quarter last year. Book value per share increased to $20.97 from $18.91 during the quarter.
A quick comment on holding company liquidity. Cash and financial investments outside the insurance entities were $160 million at the end of the quarter, up from $145 million at the end — at the start of the quarter. Of course, this does not include the $120 million in value represented by our investments in real estate and Greenleaf. In summary, this was a strong quarter for us. Our operating strategies are paying off, the insurance market in Florida is improving, and we’ve positioned the business to deliver superior ongoing operating results.
And with that, I’ll hand it over to Paresh.
Paresh Patel — Chief Executive Officer
Thank you. Mark and Karin outlined our strong financial results for the quarter. We are seeing the benefits of the company’s underwriting and rate actions as well as the bold leadership provided by the Florida legislature in 2022. These benefits should continue in the upcoming quarters and provide a solid foundation for the future. Before talking about future prospects for HCI, I wanted to briefly comment on reinsurance. We are finishing up the placement for both of our insurance companies, and like prior years, we will provide full details when everything is finalized.
Our reinsurance program is progressing as expected. We came into the renewal with the majority of the program already set. Between the Florida Hurricane Cat Fund, the Reinsurance Assist Policyholders, or RAP program, and our multiyear contract, TypTap and Homeowners Choice had secured approximately 70% of their plan limit purchase. The remaining 30% is being placed in the pilot market now and where enough capacity is available. On a blended basis, we think the rates will be higher but the cost will be within expectations.
Now looking towards the future. Homeowners Choice continues to be regarded as one of the best performing homeowners carriers in Florida. And Greenleaf continues to prove its worth as a separate real estate division that delivers solid long-term returns. Both Homeowners Choice and Greenleaf at this point has solid proven track records on which we continue to build. Now let’s talk about TypTap Insurance Group. It made a GAAP profit in Q1 of this year. Last year, we talked about TypTap seeing periods of profitability. The first quarter of this year shows that we’re executing on that vision. But our work is not done. We continue to leverage our technology and optimize our book of business while maintaining strong retention ratios, and we plan to build on the current momentum in TTIG.
Finally, we continue to make progress on items we mentioned in previous calls. We had talked about setting up additional insurance companies. We are in the process of setting up two new carriers named Tailrow and Peril Risk. We still have work to do before these new companies write their first policies with progress being made. In closing, from our perspective, we are starting to see a turn in the operating environment in Florida. The underwriting actions we’ve taken over the past several months, along with the benefits of legislative reforms have started to show up in our Q1 results. On prior calls, we highlighted there will be an opportunity for us in the near future. We are seeing that opportunity unfold in front of us. The days ahead are even brighter.
With that, I’d like to open the call to questions. Operator?
Questions and Answers:
Operator
Thank you sir. [Operator Instructions] Our first question comes from Mark Hughes with Truist. Please proceed.
Mark Hughes — Truist — Analyst
Yes, thank you very much. Mark, you listed a number of drivers of the improvement in the loss ratio to 33% from 40%, higher premiums, and then you mentioned two or three other things. Could you repeat those? [Indecipherable] write them down.
Mark Harmsworth — Chief Financial Officer
Yes. So part of it is obviously higher average premium per policy. The other thing I mentioned is claims severity is kind of — is moderating. But really more importantly, claims frequency is declining and also litigation frequency is also declining. And those are the four drivers, number three and four probably being the most important.
Mark Hughes — Truist — Analyst
And how much of that do you attribute to the reform?
Mark Harmsworth — Chief Financial Officer
I mean, it’s hard to say for sure. I mean, we talked about it on the last call. Any comment I’d make about this, we’d sort of preface it by saying that it’s early. But we talked about the expectations that we had of what we thought would happen. We talked about the decline. We expect the declines in claim frequency of 15% to 20%. We talked about that on the last call. We talked about a decline in litigation frequency of about 30%. And like I said, it’s early but from what we have seen so far, it would indicate that those assumptions were pretty reasonable. So it’s definitely a significant part of it.
Mark Hughes — Truist — Analyst
Excellent. How much did the better weather help this quarter, do you think? It was probably was characterize.
Mark Harmsworth — Chief Financial Officer
Yes, it was a good question. A little bit, not a huge issue. You might recall in the first quarter of last year in Florida, we had more weather than you would normally see in a first quarter. So we had less weather in the first quarter this year than last year in Florida, but we had more weather-related expense — weather-related losses in the Northeast this quarter than the first quarter last year. So weather was not really a big factor. It was a little bit of the drop but not really a big one, just because of those things — those two things really sort of offset one another mostly.
Mark Hughes — Truist — Analyst
Then the setting up the two new carriers, I’m interested in kind of thoughts on your broader appetite for new business. The written premiums, if I’m looking at it properly, the pick-up definitely helped pretty meaningfully. What do you hope to capture with the two new carriers? Maybe refresh me on that.
Paresh Patel — Chief Executive Officer
Absolutely. Mark. Two things, in terms of just growing the top line, we can do that just within the two carriers that are already up and operating. The two new carriers are being set up because we are now starting to set up for the next phase of our growth. And while we haven’t disclosed how they fit into the group and what exactly they have been doing, we clearly are doing this to — in a manner where those two new carriers will be both expansive and complementary to the current two carriers that we have, yes?
Mark Hughes — Truist — Analyst
Yes. And then Mark, you had mentioned that you started to slow the pace of reserve increases. You hadn’t gone in the other direction though. Could you give us some dimension of magnitude of that? How much have you changed? How much are you still kind of working away at that quarter-to-quarter?
Mark Harmsworth — Chief Financial Officer
Yes. So we went through this period where — and we talked about it a lot where we were expensing more than we paid out and reserves were going up. A few reasons for that. We were growing, obviously. And also, the number of open lawsuits and expected lawsuits was going up. And so we were increasing out — we’re expensing more than we were paying out, and as a result, reserves were increasing.
In Q1 this year, net reserves were pretty flat. We didn’t really increase them. We didn’t decrease them. So our loss expense is pretty close to what the incurred loss expense was and what the paid losses were. So we haven’t really started to reduce them at this point. But given the trends and some of the numbers that we’re seeing, I think that’s a possibility for the future. That’s probably the next phase of this.
Mark Hughes — Truist — Analyst
Thank you very much.
Operator
[Operator Instructions] The next question comes from Matt Carletti with JMP. Please proceed.
Matt Carletti — JMP — Analyst
Hey, thanks, good afternoon. Just wanted to circle back on one of the questions Mark had there on weather, with kind of Florida being a little maybe below normal and Northeast a little above normal, netting out to sounds like pretty normal. Would that comment hold true for TypTap when we think about kind of it being GAAP profitable but it did so in kind of a normalized weather quarter or did it run a little hot or a little cool?
Mark Harmsworth — Chief Financial Officer
Yes, it was — I mean, that comment holds for both. I mean, it was less weather in Florida, more weather in the Northeast. But it’s — the improvement in the loss ratio, the biggest driver was the decrease in even weather-adjusted claims frequency was down considerably even if you take weather out of it. If you remove the weather claims in both quarters and just look at weather-adjusted frequency, it was down substantially more than we expected it to be. And that’s why that statement that we made on the last call about loss ratios, expecting them to be — I think I said 25%, Paresh mentioned from 40% down to 30%, what we saw in the first quarter would indicate that we’re definitely heading towards that.
Matt Carletti — JMP — Analyst
Okay. And then as we think about say, growth across the year, and not so much — more about exposure growth or kind of when you — as you start up, obviously, new companies or even within the existing companies, think about not just kind of rate growth, how should we think about that in terms of timing with when reinsurance incepts, when hurricane season might play into that, the reinsurance true-up later in the fall? Is it reasonable to think that, that might be a little more back-end weighted or am I thinking about that wrong?
Paresh Patel — Chief Executive Officer
Mike, you’re thinking about it exactly correctly. Growth will be back-end weighted in the context of count, yes?
Matt Carletti — JMP — Analyst
Yes, exactly. Okay, great. And then just a numbers question probably for Mark. You have the net written premiums for the quarter?
Mark Harmsworth — Chief Financial Officer
Yes, so it’s $129.4 million.
Matt Carletti — JMP — Analyst
Wonderful. Great, thanks so much.
Operator
[Operator Instructions] We have a follow-up coming from Mark Hughes with Truist. Mark, please proceed.
Mark Hughes — Truist — Analyst
The improvement in severity, any comment around inflation, building materials? Is that part of this? Is that moderating?
Mark Harmsworth — Chief Financial Officer
Yes. So good question. So I used the term moderating. And you might recall, inflation obviously was an issue, is an issue. I think it was probably the second quarter of last year where we really saw the — probably the biggest impact of that increase. But it started to kind of level out after that. And I think Paresh has mentioned it, we track the cost of those things, and I think it’s sort of been level since then. So if you look at claim severity in the first quarter of this year, it’s higher than the first quarter of last year. It is up. But it took that bump in Q2 of last year and since then, hasn’t moved a lot and that’s why I used that term moderating. So it’s higher than it was in the first quarter of last year, I think about 10% or so. But it’s not having the adverse effect that it was having in prior — in past quarters.
Mark Hughes — Truist — Analyst
So you essentially lapped that in the current quarter?
Paresh Patel — Chief Executive Officer
Yes, Mark, a different way of looking at this is in the second quarter last year, it was unknown whether severity increasing was going to be repetitive in that follow-through quarter after quarter after quarter. I think what Mark is saying and what we’re seeing is that the average severity very took a jump in Q2 of last year. So then it’s been flat since then. So it’s more of a step function, right, as opposed to an increasing ramp, which is obviously very good news.
Mark Hughes — Truist — Analyst
Yes, yes. Mark, any thoughts on loss ratio for the — maybe not for the year but kind of the underlying trend line? I think you’re suggesting that you’re seeing improvement but we’re not — we’re only on the way, but we’re at a 33% loss ratio, which is pretty darn good. And maybe not too much of influence on weather, where — what’s the right run rate?
Mark Harmsworth — Chief Financial Officer
Yes. So I’ll go back again to something that we said in the last earnings call, and I just mentioned that we felt that overall impact on the consolidated loss ratio is in the 25% range. Paresh talked about it going from 40% to 30%. And we still think that, that makes sense and that, that’s the ramp that we’re headed towards. Second quarter, that doesn’t necessarily say that, that’s going to happen every quarter.
Second quarter, I think everybody knows it’s sort of a quarter where there’s usually some weather. The loss ratio in the second quarter is usually a little higher than it is in the first quarter. But I think we’re headed back down toward that 30% range. I think we’ll see it. Again, it’s — you have to be careful because it’s only one quarter, right? And those trends that we’re seeing are good, but we need time to make sure that they settle in. So does that answer the question?
Mark Hughes — Truist — Analyst
It does. Have you seen any weather so far in the — I mean, we’re almost halfway through the first quarter, probably have April in hand. I know a lot of opportunity for other things to happen, but any reason to think so far?
Paresh Patel — Chief Executive Officer
Mark, it’s Paresh. Two things. Yes, we are picking up somewhere in the second quarter. But as Mark indicated, it’s what you normally expect in the second quarter. There’s been some — it’s been a choppy spring so there’s been some activity. But it’s not anything beyond what our expectations were, right? So from that sense, it’s very good. The other thing, I think, to summarize some of the stuff, your conversations back and forth with Mark, I think what’s being indicated is that movement from 40.6% last year to 33.6% this year, right, isn’t the result of a onetime windfall, whether it be reserve relief or onetime, one quarter where the weather was unusually benign, right?
There’s none of those kinds of things in Q1 numbers. It’s sort of telling you that a lower loss ratio is underway and is probably sustainable. It will fluctuate up and down a little bit second quarter because of weather might be slightly worse, it normally is. But you are clearly and solidly on a path to having improved loss ratios and actually improved combined ratios for that manner.
Mark Hughes — Truist — Analyst
Understood. And then, Paresh, you mentioned the 70% of the reinsurance program is already placed. And that’s — I think you said that — is it the Cat Fund, Florida Hurricane Cat Fund, the RAP program. What else did you mention in that?
Paresh Patel — Chief Executive Officer
Also our — we have one or two multiyear contracts so those rates were obviously set last year, yes?
Mark Hughes — Truist — Analyst
Yes. And then the 30% is being placed now. Any observations about the capacity or capital in the market? Any kind of recent shift in sentiment around — I’m thinking the ILS spreads have narrowed or there’s some maybe movement in that direction. Does that mean anything?
Paresh Patel — Chief Executive Officer
Mark, we’ve heard and said similar things that we see all that movement. The more important thing that we are usually focused at this point in time is can we get our program placed, right? And that, we feel confident about. And that’s really — we hear rumors and/or conversations about what’s happening in the industry as a whole. But at this point in time, we’ve become very narrowly focused on making sure our progress has completed.
Mark Hughes — Truist — Analyst
Yes, fair enough. Maybe just one more, the commission expense improved nicely. I think you mentioned some decline in commission rates, maybe mix. I assume if you’re not pursuing much new business in 2Q or 3Q, maybe the — it stays at the same rate, maybe the mix is consistent on new and renewal. Does it then pop back up in the fourth quarter? How much of this is going to stay with us versus perhaps temporary?
Mark Harmsworth — Chief Financial Officer
I think — I mean, it does depend a little bit on that mix. But I think it’s been coming down for a while and I think where it is now, I think it will probably decline a little bit more but not a lot. So if you’re modeling that, I think that rate that we’re at now is probably a pretty good number.
Mark Hughes — Truist — Analyst
And I’ll maybe ask one more, if I might. Anything in Greenleaf around some of these concerns around commercial real estate, the lending environment? Does that have any impact on valuations or liquidity in the market? I know [Indecipherable] is hot, but I’m just curious.
Paresh Patel — Chief Executive Officer
Mark, two things. One is all the real estate we own, we either have paid for in cash or where there is a loan, I think it’s — the mortgages are, by their very nature, long duration and fixed rate, right? So from our perspective, we don’t see any pressure on the — The other thing is it looks well executed. As Karin mentioned in her prepared comments, the four transactions over the last three years, right, has really — have really freed up a lot of capital for the HCI Group by selectively selling certain assets, including the latest two shopping plazas that we did, which freed up about $31 million of capital?
Mark Harmsworth — Chief Financial Officer
Yes. And Mark, I would just add one thing to that, that we’ve talked about this before, but there’s that very sizable delta between what we’ve got the real estate on the books for and what it appraises for — with bank appraisals or what we think it’s worth. And even as we’ve gone through some of these transactions, that number is not getting any smaller. It’s still — even if you look at bank appraisals, there’s still a $50 million difference between the bank appraised value of our real estate and what it’s on the books for. So we’ve got some really good quality properties and very unlevered. I think total debt on that $120 million of value is about $4.5 million. So good quality real estate in good markets. To this point, the value has been maintained. It’s very low leverage, and it’s been — Karin went through the numbers. It’s been a great investment for us.
Mark Hughes — Truist — Analyst
Okay, thank you for all the answers.
Operator
Thank you. At this time, this concludes our question-and-answer session. I would now like to turn the call over to Paresh Patel who has a few closing remarks.
Paresh Patel — Chief Executive Officer
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. Thank you.
Operator
[Operator Closing Remarks]