HCI Group Inc (NYSE:HCI) Q4 2022 Earnings Call dated Mar. 09, 2023.
Corporate Participants:
Matt Glover — Senior Managing Director
Karin Coleman — Chief Operating Officer and President of Homeowners Choice Property & Casualty Insurance Co.
Mark Harmsworth — Chief Financial Officer
Paresh Patel — Chief Executive Officer
Analysts:
Mark Hughes — Truist Securities — Analyst
Matt Carletti — JMP Securities — Analyst
Casey Alexander — Compass Point — Analyst
Presentation:
Operator
Good afternoon, and welcome to HCI Group’s Fourth Quarter 2022 earnings call. [Operator Instructions].
I would now like to turn the call over to Matt Glover, Gateway, Investor Relations. Matt. Please proceed.
Matt Glover — Senior Managing Director
Thank you, John, and good afternoon, everyone. Welcome to HCI Group’s fourth quarter 2022 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 fourth quarter of 2022 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 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 risks or uncertainties develop into actual results, 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 would like to turn the call over to Karin Coleman, Chief Operating Officer, Karin.
Karin Coleman — Chief Operating Officer and President of Homeowners Choice Property & Casualty Insurance Co.
Thank you, Matt and welcome everyone. HCI Group reported net income of $2.6 million and diluted earnings per share of $0.18 for the fourth quarter, an improvement over last year and last quarter. Let me start with our insurance division. Results in our insurance subsidiaries benefited from three factors. First prior rate actions. Second, a decline in our gross loss ratio to 39.4%. The 39.4% includes costs associated with Hurricane Nicole and winter storm Elliot. Third, investment income nearly tripled over Q4 last year as we put our balance sheet to work at yields over 4%, while maintaining short duration and ample liquidity.
As for Hurricane Ian, the claims received from Homeowners Choice and TypTap Insurance totaled just over 13,000. We continue to support policyholders impacted by Hurricane Ian, leveraging our technology and resources to expedite the claims handling process. Mark will provide more detail in his remarks.
On the legislative front, in December, the Florida Legislature passed Senate Bill 2A which squarely addresses the rising cost of litigation and social inflation in the Florida property insurance market. The provisions of this law build on Senate Bill 2D passed in May and represent substantial changes to the laws governing the litigation of property insurance claims in Florida. Provisions in this landmark Bill include three main items. It eliminates one-way attorney fee provisions related to property claims. It abolishes assignment of benefit. And it reduces the filing deadline to one year for policyholders reporting a claim.
Mark will detail the favorable impact we’re seeing in our business. We have heard some industry experts projecting a reduction to loss expense on the order of 25% to 40%. Obviously the level of improvement will vary from company to company, but we expect to see a significant change in litigation costs when the challenges take full — when the changes take full effect. We commend Governor DeSantis and the Florida Legislature for taking decisive action to stabilize the property insurance market in Florida.
Now moving to our real estate subsidiary, Greenleaf Capital. We will disclose in our 10-K that we are under contract to sell two of our retail shopping center investment properties for gross proceeds of more than $31 million. Similar to the sale of the Cypress property in 2020, and the Century Park right of way in 2022, these transactions highlight our ability to capitalize on the strength in the Florida real estate market. We plan to provide more detail on these transactions on our next call.
Finally, a word on capital. In a difficult year for the industry, HCI continued to return capital to our shareholders through dividends and share repurchases. During the quarter we repurchased nearly 3% of outstanding shares at an average cost of $37 per share and paid our 49th consecutive quarterly dividend to shareholders at $0.40 per share. These actions underscore the strength of our balance sheet and the commitment we have to our shareholders.
Now I will turn it over to Mark, who will provide more detail on our financial results.
Mark Harmsworth — Chief Financial Officer
Thanks, Karin. So as Karin mentioned net income this quarter was $2.6 million or $0.18 per share. Net income includes a small revaluation gain of about $800,000 related to the UPC book and loss expense includes $7.5 million for the combined cost of Hurricane Nicole and winter storm Elliot. Even with these storm losses included, the fourth quarter consolidated loss ratio was 39.4%, which is the lowest of the year and a point lower than the fourth quarter last year.
There are a number of reasons, a number of things, helping to lead to a lower loss ratio. First claim frequency has been declining. In the second half of 2012, claim frequency was 12% less than the second quarter — sorry — than the second half of 2021. Second, while the average premium per policy is going up, claim severity has started to level-off. Loss severity climbed steadily from the first quarter of 2021 to the second quarter of 2022. It has not changed much since then.
Third litigation frequency has started to moderate. For the full year, litigation frequency was only down slightly, but in the fourth quarter of 2022, litigation frequency was 15% less than the fourth quarter of 2021.
Looking ahead, we are confident that the downward trajectory of the consolidated loss ratio will continue. As Karin mentioned the Florida Legislature has passed legislation that should further reduce loss expenses as follows. First, because 15% to 20% of our total claims are AoB claims, we expect claims to dropped by a similar percentage. Second, because the average severity of an AoB claim is higher than a non-AoB claim we also expect claims severity to decline.
Third with the abolishment of the one way legal fees statute and AoBs being unenforceable we expect loss frequency to drop by 30% or more. In terms of the overall impact on loss expense we’ve seen models showing a 25% to 40% decrease in loss expense. And while we are modeling at the lowerend of that range we expect this to have a material positive impact on loss expense.
There are a couple of other trends in the business that I also wanted to point out. As you can see Investment income was about three times what it was in the fourth quarter last year. When interest rates were low, we kept most of our investable assets in cash that we can capitalize when interest rates increase, as they have.
At the end of last year, we had $40 million in fixed income investments and at the end of this year, we had over $480 million invested, which combined with higher rates is driving higher investment income. Another positive trend is policy acquisition expenses. Gross premiums earned were up 17% from the fourth quarter last year to the fourth quarter of this year, yet policy acquisition expenses are slightly lower because of the mix of renewals versus new business, lower commission and lower costs related to the UPC business.
Now I wanted to move over to a couple of things on the balance sheet. As you know, Hurricane Ian landed in Florida, right at the end of the third quarter. Since then, we’ve had time to evaluate the claim development and we have adjusted the ultimate down by about 15%. This of course has no impact on the income statement, but it is important. We are getting more comfortable that the impact of this storm is significantly less than expected.
In terms of non-CAT claims, I mentioned that the loss ratio was down, but we didn’t get thereby decreasing reserves. In fact, we have been increasing them. During the year daily loss expense was about $40 million higher than losses paid. And reserves are 25% higher at the end of this year, then they were at the start. This is significant because it means that loss ratios are going down, even as we have increased loss reserves.
Just a few other things. We’re in a good surplus position with each of our underwriters with RBC ratios over 330% for both. In terms of holding company liquidity we have just under $150 million of cash and financial investments at the holding company levels. And our $50 million credit facility with (Indecipherable].
Karin mentioned it, that we completed our share buyback program in the fourth quarter. The total dollar amount bought back under that program was $17 million for the year and when combined with the shares bought back as part of our convert offering the total number of shares bought back in the year with over $1.4 million or about 14% of the shares outstanding at the start of the year.
So in summary, average premium per policy is going up, loss ratios are coming down, profitability is improving, legislative changes should lead to further improvement and if you own a share of HCI stock at the beginning of the year you own 60% more of the company than you did a year-ago.
And with that, I’ll hand it over to Paresh.
Paresh Patel — Chief Executive Officer
Thank you, Mark. I want to begin with a reflection on our history and then discuss the future. We have a track-record of being good allocators of capital and doing what we thought was best for shareholders, even if it seemed counter to industry views. For example, we’ve patiently maintained our large cash position when interest rates were at record lows for several years. Now we are seeing a significant increase in investment income. We have deployed the cash in short-term treasuries and the full impact of our decisions will flow through over-time.
Second, we are leveraging our investment in technology to change how underwriting is done. TypTap has now grown to have $320 million of enforced premium and is writing business in 13 states. This is up from just $100 million in premium and only operating in one state, two short years ago. TypTap is just getting started and we will continue its geographic expansion.
Last May we saw an opening to raise capital at attractive terms, and executed on that opportunity. Because of this, we have tremendous amount of liquidity at the holding company, and this gives us the flexibility to execute on any new opportunities that may arise. And as Karin highlighted Greenleaf is trading assets now, both buying and selling real estate and creating tremendous value for the parent company.
But looking to the future, we want to build-on that track record and deliver consistent profitability and strong returns for our shareholders. And in 2023, there is an opportunity we think to do both. Let me provide some context and color. Florida is an overlooked opportunity. Putting it simply, look at where the industry is today versus where it was a year ago.
In 2022, because of actual inflation as well as social inflation the industry was playing catch-up raising rates in order to bring back sound operational margins. Those rate actions are now coming through because there’s a lag on their implementation. But the elimination of one-way attorney’s fees and AoBs will lead to improved loss trends. And as Mark highlighted, we are already seeing improvement in our gross loss ratios.
A year-ago reinsurance costs were increasing and there were some concerns about the availability of reinsurance. This year for the upcoming June 1 renewal, we expect reinsurance cost to increase. It’s normal given that was a loss. However it appears to be just a cost issue, not an availability issue, which is fantastic, and this is something that we can handle.
A year ago operational and G&A costs were increasing due to inflation and a very tight labor market. This year those costs have stabilized. And given our disciplined approach to managing our investment portfolio, our investment in investment income is increasing this year versus last year. So when you combine all of these different inputs. For the first time in several years there are more tailwinds than headwinds for the Florida insurance industry. The decisions that we’ve made over the last several years have positioned us for this day.
And with the improving operating environment in Florida the moment has arrived.
And with that. I will open it up for questions. Operator, please provide instructions.
Questions and Answers:
Operator
Thank you sir. [Operator Instructions]. And our first question comes from Mark Hughes with Truist. Mark, please proceed.
Mark Hughes — Truist Securities — Analyst
Yeah, thanks, good afternoon.
Paresh Patel — Chief Executive Officer
Good afternoon, Mark.
Mark Hughes — Truist Securities — Analyst
On the reinsurance outlook you say it’s not availability, but cost. Any way to frame that up a bit? It seems like folks have talked about 30% to 50% increases. What do you think?
Paresh Patel — Chief Executive Officer
Sure thing, Mark. Yeah. I think some of the rates could go up that much, but it’s also a question of we will be paying that across every single dollar reinsurance spend. To put this into perspective, for both companies about 60% of the reinsurance limit is purchased from the Florida Hurricane Cat Fund. And while that is expected to go up a little, but it’s not going to be 30% to 50%.
Secondly, both of our underwriters, both Homeowners Choice and TypTap deferred the RAP layer from last year. So those layers will be now provided in 2023 and they come at zero cost. So that actually can drag down the cost of reinsurance for us. The private market reinsurance will go up. And to some of the numbers you talked about, but we also have Homeowners Choice, which has a large section, the bottom of the reinsurance program placed on a multi-year basis with fixed renewal terms.
So given all of these things, yes, it will go up, but it won’t be the headline, 30% to 50% that you’re looking at, yeah, that you’ve alluded to.
Mark Hughes — Truist Securities — Analyst
Yeah, how much of the program is exposed to more private market adjustments.
Paresh Patel — Chief Executive Officer
Well, for Homeowners Choice, very little, I’d say. And I’m ad-libbing here a little bit, maybe about $150 million of private market limit out of $900 million tower. TypTap, I think is a similar number, but TypTap doesn’t have the benefit of the one multi year deal that Homeowners Choice does, yeah.
Mark Hughes — Truist Securities — Analyst
Yeah, okay. Was there any reserve development in the quarter?
Mark Harmsworth — Chief Financial Officer
Yeah. I mean that’s something that is — as you know we’ve done consistently over the last couple of years. It’s not — it’s pretty similar to what it was in the fourth quarter of last year, pretty similar. And if you look at the full year, it’s pretty similar to what it was for the full year. So no real significant changes there.
Mark Hughes — Truist Securities — Analyst
What was it in the fourth quarter last year?
Mark Harmsworth — Chief Financial Officer
I think it was about $12.5 million something like that, $10 million, $12 million similar this year.
Paresh Patel — Chief Executive Officer
I think it’s included in the $39.5 million.
Mark Harmsworth — Chief Financial Officer
Yeah, of course. Yeah, yeah, it’s all included in there, yeah.
Mark Hughes — Truist Securities — Analyst
Okay, yeah. And then you mentioned the $800,000 gain, that’s separate from the $3 million remeasurement items in the income statement. Are those separate and could you explain both of those?
Mark Harmsworth — Chief Financial Officer
Yeah, it’s — there was sort of two things that happened at the same time. So we had to adjust the valuation on the UPT, how that was originally booked and what happened is there’s two pieces to it. It was an asset that we set up and that asset was reduced by a couple of million dollars. So that was an expense. And then we also reduced the contingent liability, because we had a contingent liability for commissions that were only [Phonetic] over a certain size. So the contingent liability comes down and the asset also went down. And those two sort of offset one another.
The net is about $800,000 or $900,000. But they show-up in two different lines. That’s why you see that $3 million in the revenue line.
Mark Hughes — Truist Securities — Analyst
Yeah, okay. You mentioned you think of potential for losses to improve 25% to 40% when fully implemented. When do you think that will be, when — I think you said you are modeling kind of at the lower end of that improvement range. But when does that fully kick-in do you think?
Mark Harmsworth — Chief Financial Officer
Well I mean, it’s a little hard to say because these things are going to transition, right. So when we talk about the low end of that range, say 25%, I think it’s probably going to take a couple of years. It could potentially take a couple of years to fully get to that, as some of AoB, for example, transition through. But you’ll see significant improvement obviously in 2023. So I think that will — we have talked before about the loss ratios coming down over time, and I think that that will continue through 2023 and 2024, as that sort of transitions through the book.
Mark Hughes — Truist Securities — Analyst
And then final question, your growth, presumably you’re modulating your growth depending on what you see here in the market. It looks like you are little more restrained in the fourth quarter. Correct me, you see it differently. How do you see that stacking up in 2023, your enthusiasm about growing the topline?
Paresh Patel — Chief Executive Officer
So I think, Mark, it’s similar to the questions that we already sort of — what I said in my statements. We have a lot more tailwinds than headwinds. But the one headwind that is there is the cost of reinsurance. And we do live in a cat country at the moment. So given both of those things, we are both energized about growing, but making sure we grow at the right time in the right way. So you’ll — we’ve passed deals to grow already in the last few months, because it wasn’t the right deal at the right time.
So it’s opportunities as they arise and executing on them when they do it, yeah.
Mark Harmsworth — Chief Financial Officer
Hey, Mark, it’s Mark, just one thing, I just wanted to add in there. I know you embedded in your question there, I think you were probably referring to the gross written premium number in Q4, which is down.
Mark Hughes — Truist Securities — Analyst
Yes.
Mark Harmsworth — Chief Financial Officer
Yeah, yeah. So part of that is a bit of an anomaly there in the way that the UPC quota share agreements are accounted for. So in the fourth quarter of last year, we signed a fourth UPC quota share agreement. And the way those are booked is when you set up the quota-share you book all of the unearned premium that gets booked to written premium. And then the offset is in unearned premium. So that was $35 million in the fourth quarter of last year.
And then there is the written premium you see in the fourth quarter this year is just sort of as the book renews. So you have to sort of factor that out. And if you do that, gross written premium’s up about 7% quarter-over quarter and premiums in-force, which you could argue maybe a better way to look at it, premiums in-force have continued to grow throughout the year. So that drop that you see in the fourth quarter is a little impacted by that, just that UPC thing. That makes sense?
Mark Hughes — Truist Securities — Analyst
Sure does, yeah. Thank you very much.
Operator
[Operator Instructions]. The next question is coming from Matt Carletti with JMP. Please proceed.
Matt Carletti — JMP Securities — Analyst
Hey, good afternoon.
Paresh Patel — Chief Executive Officer
Good afternoon, Matt.
Matt Carletti — JMP Securities — Analyst
If I try to put it all together, kind of, a lot of what has been talked about in terms of the — Mark, you talked about the magnitude, the impact just from some of the models on the reforms and the timing. And we think about, obviously reinsurance costing more, you guys doing a good job of taking rate and inflation guard and things like that. When we get to kind of say that two years that Mark was talking about, what do you think combined ratios look like? Are we, do you think it’s back in kind of the 85% to 90% world, that I think of as kind of your HCI putting up over the long run? Or where do you think you can get to?
Paresh Patel — Chief Executive Officer
Okay, great question that. So let me try to answer this question in a couple of items. And by the way, one of the things that we’ve been very careful in doing and I should speak a little bit on Mark’s behalf here, when we do loss provisioning for a quarter, we do it in the quarter. So we already have set money aside for losses, with the data loss in Q1 2022, for example, even though the claim may come in the summer.
So we put those money aside. What we seeing already in Q1, et cetera is that the claims now are dropping off. They not coming in as fast. And why that becomes important? The claim doesn’t come in. Then later on there can be a lawsuit that would come in. So the claim frequency goes down, the loss frequency goes down. And where this is ultimately going to lead to is the money we have to reserve for each quarter is going to improve as we go forward. It will take a while for it to roll through, but some of that is also important to know that each quarter we sort of start from fresh to say what will it eventually cost.
But to your bigger question, this is — the importance of why you’ve got to have a healthy Florida insurance industry is because we took along with the rest of industry, pick a number between $20 billion and $30 billion expenses in and that was all done through private insurance and reinsurance. And we thank the legislature and the governor for passing the reform which is going to give us a better outcome. Here’s what the numbers now look like.
So if a year ago you took a one dollar of premium, you’re probably looking at — and I’m just approximating numbers here, so don’t try to reconcile them, but it’s pretty reasonably accurate. A year ago you took a dollar of premium. You spent about $0.36, $0.38 on reinsurance. You may have got a penny of investment income because interest rates were so low. You also had about $0.40 of attritional or non-CAT losses. And then you had policy acquisition costs, corporate overhead, et-cetera, around $0.23, all of which would basically leave you with a very — a 1% margin shall we say here.
Here’s what’s happening as this thing breaks through. Because of the rate increases — actually let’s go the other way around. So let’s start from the bottom. The corporate overhead, which is about $0.23 is going to stay roughly about the same. Mark’s earlier comments, what we’ve seen in attritional losses because of legislation passed is probably likely to go from $0.40 to maybe around $0.30.
Now offsetting that, the reinsurance cost will go up, but it will go up from like $0.38 to say $0.45. So it will go up some pennies there. But if you had your investment portfolio well positioned. Instead of making a penny, you’re going to make about three pending. So all of these pennies add-up. But the biggest item that will also happen is because rates went up, you would make about $1.20 in premium. Take a while, but that’s where you’re going to get to. And so therefore, your margins will increase substantially. And that is what will be needed to replenish surplus and create a healthy Florida industry.
So the steps that have been taken will eventually lead to that outcome. And that is a very, very, very positive outcome and that’s what keeps us very excited, in terms of if you add up those numbers, as to what it does to margins, yeah.
Matt Carletti — JMP Securities — Analyst
Very helpful and very easily way to think about it, so thank you. One other, if I could, just a quick one. You mentioned Greenleaf selling or entering an agreement to sell the two retail properties. I think I heard $31 million of gross proceeds. What are those carried at in terms of book value today and any guidance you can give on when you think that transaction might close?
Paresh Patel — Chief Executive Officer
Yeah, hey Matt, look. We wanted to make sure we mentioned it because it’s in our 10-K and not everybody reads our 10-K and subsequent events and everything. So the three properties are under contract, they haven’t closed. And we tend not to add up the number, add the dollars till we actually have in our hands. We already mentioned it, because we want full disclosure to everybody, yeah. And that’s why we will and as Karin alluded to, we will talk further about it at the next earnings call when we hope to report that we’ve actually sold two properties, yeah.
Matt Carletti — JMP Securities — Analyst
Fair enough, sounds great. Thank you for the color. Appreciate it.
Operator
[Operator Instructions]. The next question comes from Casey Alexander with Compass Point. Please proceed.
Casey Alexander — Compass Point — Analyst
Yeah, hi, good afternoon. A lot of my questions have been answered, but I do have one question. The expected 25% improvement in loss expenses, would really only apply to those expenses that come from the State of Florida, if I understand it correctly. So as you look forward and the expansion of the book, including TypTap outside the State of Florida, what percentage of your losses would you be expecting to come from the State of Florida as opposed to that percentage that you would expect to be coming from outside the State of Florida?
Mark Harmsworth — Chief Financial Officer
Yeah, so it’s Mark. So yeah, you’re right. So the 25% or so that we talked about is on the Florida loss expense. So Florida is about 80% of our book. So that 25% drop is not going to be on the non-Florida. But there’s other things going on that are already affecting the loss ratio as well. Rate, drop in frequency that we are already starting to see even before the legislation. And so when we talk about the consolidated loss ratio going, let’s say from 40 down to 30, we’re sort of looking at that 25% drop on the 80% of the book that’s Florida.
That also, I think the loss ratio in Florida will drop more than that when you take into account some of those other things. And that will get us to — that will get us to, I think to 25% on the full, on the consolidated loss ratio even though, to your point 20% of the book is outside of Florida.
Casey Alexander — Compass Point — Analyst
Yeah, okay. That’s the only question I had left. Thank you.
Mark Harmsworth — Chief Financial Officer
Thank you.
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.
Paresh Patel — Chief Executive Officer
Yeah. 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. As we end this call I want to summarize my earlier comments. There is an increasing demand for our product and the realization of the importance of a healthy insurance market. We have all the pieces in-place to benefit from a tremendous opportunity in front of us. And we have the right management team to execute on this opportunity.
We look forward to providing you with an update on our progress on our next earnings call. Thank you very much. [Operator Closing Remarks].