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FEDNAT HOLDING CO – 10-Q – Management's Discussion and Analysis of Financial Condition and Results of Operations
Overview
The following discussion and analysis should be read in conjunction with our unaudited consolidated financial statements and notes thereto included under Part I, Item 1 of this Quarterly Report on Form 10-Q (the "Form 10-Q"). In addition, please refer to our audited consolidated financial statements and notes thereto and related "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in our most recent Annual Report on Form 10-K for the year endedDecember 31, 2021 (the "2021 Form 10-K"). Unless the context requires otherwise, as used in the remainder of this Form 10-Q, the terms "FNHC," "Company," "we," "us" and "our" refer toFedNat Holding Company and its consolidated subsidiaries. Below, in addition to providing consolidated revenues and net income (loss), we also provide adjusted operating revenues and adjusted operating income (loss) because we believe these performance measures that are notUnited States of America generally accepted accounting principles ("GAAP") measures allow for a better understanding of the underlying trend in our business, as the excluded items are not necessarily indicative of our operating fundamentals or performance. Non-GAAP measures do not replace the most directly comparable GAAP measures and we have included a detailed reconciliation thereof in "Results of Operations" below.
We exclude the after-tax (using our prevailing income tax rate) effects of the
following items from GAAP net income (loss) to arrive at adjusted operating
income (loss):
•Net realized and unrealized investment gains (losses); •Gains (losses) associated with early extinguishment of debt; •Merger and acquisition, integration and other strategic costs, and the amortization of specifically identifiable intangibles (other than value of business acquired); •Impairment of intangibles; •Income (loss) from initial adoption of new regulations and accounting guidance; and •Income (loss) from discontinued operations.
We also exclude the pre-tax effect of the first bullet above from GAAP revenues
to arrive at adjusted operating revenues.
Forward-Looking Statements
This Form 10-Q or the documents that are incorporated by reference into this Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. These statements are therefore entitled to the protection of the safe harbor provisions of these laws. These statements may be identified by the use of forward-looking terminology such as "anticipate," "believe," "budget," "contemplate," "continue," "could," "envision," "estimate," "expect," "forecast," "guidance," "indicate," "intend," "may," "might," "outlook," "plan," "possibly," "potential," "predict," "probably," "pro-forma," "project," "seek," "should," "target," "will," "would," "will be," "will continue" or the negative thereof or other variations thereon or comparable terminology. We have based these forward-looking statements on our current expectations, assumptions, estimates and projections. While we believe these expectations, assumptions, estimates and projections are reasonable, such forward-looking statements are only predictions and involve a number of risks and uncertainties, many of which are beyond our control. These and other important factors may cause our actual results, performance or achievements to differ materially from any future results, performance or achievements expressed or implied by these forward-looking statements. Management cautions that the forward-looking statements contained in this Form 10-Q are not guarantees of future performance, and we cannot assume that such statements will be realized, or the forward-looking events and circumstances will occur. Factors that might cause such a difference include, without limitation, the risks and uncertainties discussed under Item 1. Business - "Going Concern" and Item 1A. "Risk Factors" in our 2021 Form 10-K, and discussed from time to time in our other reports filed with theSecurities and Exchange Commission ("SEC"), including this Form 10-Q. -29- -------------------------------------------------------------------------------- Given these risks and uncertainties, you are cautioned not to place undue reliance on such forward-looking statements. The forward-looking statements included or incorporated by reference into this Form 10-Q are made only as of the date hereof. We do not undertake and specifically decline any obligation to update any such statements or to publicly announce the results of any revisions to any such statements to reflect future events or developments. GENERAL The Company is a regional insurance holding company that controls substantially all aspects of the insurance underwriting, distribution and claims processes through our subsidiaries and contractual relationships with independent agents and general agents. We, through our wholly owned subsidiaries, are authorized to underwrite, and/or place homeowners multi-peril ("homeowners"), federal flood and other lines of insurance inFlorida and other states. We market, distribute and service our own and third-party insurers' products and other services through a network of independent and general agents.FedNat Insurance Company ("FNIC"), our largest wholly-owned insurance subsidiary, is licensed as an admitted carrier to write homeowners property and casualty insurance by the state insurance departments inFlorida ,Louisiana ,Texas ,South Carolina ,Alabama ,Georgia andMississippi .Maison Insurance Company ("MIC" or "Maison"), an insurance subsidiary, is licensed as an admitted carrier to write homeowners property and casualty insurance as well as wind/hail only exposures by the state insurance departments inLouisiana ,Texas andFlorida . Refer to Overview of Insurance Lines of Business - Non-Florida below for information regarding the Company's plan to execute an orderly runoff of MIC's insurance operations.
Monarch National Insurance Company ("MNIC"), an insurance subsidiary, is
licensed to write homeowners property and casualty insurance in
Through our wholly-owned subsidiary,FedNat Underwriters, Inc. ("FNU"), we serve as managing general agent for FNIC, MIC and MNIC.ClaimCor, LLC ("ClaimCor"), a wholly-owned subsidiary, is a claims solutions company that processes claims for FNIC, MIC and MNIC.
Material Distribution Relationships
We are a party to an insurance agency master agreement withIvantage Select Agency, Inc. ("ISA"), an affiliate of Allstate Insurance Company ("Allstate"), pursuant to which we have been authorized by ISA to appoint Allstate agents to offer our FNIC homeowners insurance products to consumers inFlorida . We are a party to a managing general underwriting agreement withSageSure Insurance Managers, LLC ("SageSure") in which they underwrite our FNIC homeowners business outside ofFlorida . Refer to Overview of Insurance Lines of Business - Non-Florida below for information regarding the Company's plan to execute an orderly runoff of insurance policies in our non-Florida market.
Going Concern
Refer to in "Part 1, Item 1, Business" and "Part I, Item 1A., Risk Factors" of our 2021 Form 10-K and "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations, Liquidity and Capital Resources" of this Form 10-Q for information with respect to the Company's going concern status.
Overview of Insurance Lines of Business
Homeowners Property and Casualty Insurance FNIC, MIC and MNIC underwrite homeowners insurance inFlorida and FNIC and MIC also underwrites homeowners insurance inLouisiana andTexas , while FNIC also underwrites homeowners inSouth Carolina ,Alabama andMississippi . Homeowners insurance generally protects an owner of real and personal property against covered causes of loss to that property. As ofMarch 31, 2022 , the total homeowners policies in-force was 248,000, of which 152,000 were inFlorida and 96,000 were outside ofFlorida . As ofDecember 31, 2021 , the total homeowners policies in-force was 280,000, of which 160,000 were inFlorida and 120,000 were outside ofFlorida . Refer to Overview of Insurance Lines of Business - Non-Florida below for information regarding the Company's plan to execute an orderly runoff of our non-Florida insurance operations.
Our homeowners insurance products provide maximum dwelling coverage of
approximately
approximately
million
-30- -------------------------------------------------------------------------------- aggregate total insured value of$6.5 million . We continually review and update these limits. The typical deductible is either$2,500 or$1,000 for non-hurricane-related claims and generally 2% of the coverage amount for the structure for hurricane-related claims. Premium rates charged to our homeowners insurance policyholders are continually evaluated to assure that they meet the expectation that they are actuarially sound and produce a reasonable level of profit (neither excessive, inadequate or discriminatory). Premium rates inFlorida and other states are regulated and approved by the respective states' office of insurance regulation. We continuously monitor and seek appropriate adjustment to our rates in order to remain competitive and profitable.
Through MIC, we have assumed
The following are our recent approved rate actions that we have taken across our
three insurance subsidiaries:
•In 2020, FNIC received approval from theFlorida Office of Insurance Regulations ("OIR") for a statewide-average rate increase of 6.7% forFlorida homeowners multiple-peril insurance policies, which became effective for new policies onFebruary 8, 2021 and for renewal policies onMarch 30, 2021 . •In 2020, FNIC received OIR approval for a statewide-average rate increase of 8.3% forFlorida dwelling fire insurance policies, which became effective for new policies onFebruary 2, 2021 and for renewal policies onMarch 30, 2021 . •In 2020, MIC received OIR approval for a statewide-average rate increase of 15.0% forFlorida manufactured home insurance policies, which became effective for new policies onMarch 10, 2021 . •In 2021, FNIC received OIR approval for a statewide-average rate increase of 9.0% forFlorida homeowners multiple-peril insurance policies, which became effective for new policies onMarch 1, 2021 and for renewal policies onApril 15, 2021 . •In 2021, MIC received OIR approval for a statewide-average rate increase of 14.8% forFlorida takeout wind only policies, which became effective onAugust 1, 2021 . •In 2021, MIC filed for a statewide-average rate increase of 14.9% forFlorida manufactured home insurance policies, which became effective for new and renewal policies onAugust 15, 2021 . •In 2021, FNIC received approval from the OIR for a statewide-average rate increase of 0.9% forFlorida homeowners multiple-peril insurance policies, which became effective for new policies onSeptember 1, 2021 and for renewal policies onOctober 15, 2021 . •In 2021, FNIC received approval from the OIR for a statewide-average rate increase of 5.7% forFlorida homeowners multiple-peril insurance policies, which became effective for new policies onOctober 15, 2021 and for renewal policies onNovember 22, 2021 . •In 2021, FNIC received OIR approval for a statewide-average rate increase of 6.7% forFlorida dwelling fire insurance policies, which became effective for new policies onOctober 15, 2021 and for renewal policies onNovember 22, 2021 . •In 2021, MIC received OIR approval for a statewide-average rate increase of 14.9% forFlorida takeout wind only policies, which became effective onDecember 25, 2021 . •In 2021, MIC received OIR approval for a statewide-average rate increase of 14.9% forFlorida voluntary wind only policies, which became effective onFebruary 7, 2022 . •In 2022, FNIC received approval from the OIR for a statewide-average rate increase of 6.0% forFlorida homeowners multiple-peril insurance policies, which became effective for new policies onJanuary 15, 2022 and for renewal policies onMarch 3, 2022 . •In 2022, FNIC received OIR approval for a statewide-average rate increase of 8.9% forFlorida dwelling fire insurance policies, which became effective for new policies onJanuary 15, 2022 and for renewal policies onMarch 3, 2022 . •Other rate filings have been filed with the OIR and are pending approval.
Non-
Our FNIC non-
partnership with SageSure, provide maximum dwelling coverage "A" up to
million
million
non-hurricane-related claims and generally 2% of the coverage amount for the
structure for hurricane-related claims.
EffectiveJuly 1, 2020 , FNIC entered into a quota-share treaty withAnchor Re, Inc. ("Anchor Re"), anArizona captive that is an affiliate of SageSure, the non-affiliated managing general underwriter that writes FNIC's non-Florida homeowners business. The treaty provided 50% quota-share reinsurance protection on claims incurred subsequent toJuly 1, 2020 on in-force, new and renewal business throughJune 30, 2021 , subject to certain limitations. The treaty was fully collateralized through Anchor Re. OnNovember 3, 2020 , FNIC increased its cession percentage in this treaty from 50% to 80%, effectiveDecember 1, 2020 , on claims incurred subsequent toDecember 1, 2020 on in-force, new and renewal basis. EffectiveJanuary 31, 2021 , the Company -31- -------------------------------------------------------------------------------- terminated its then-existing quota-share reinsurance treaty with Anchor Re and commuted the agreement. Immediately after the commutation, the Company entered into an 80% quota-share treaty with Anchor Re onFebruary 1, 2021 on an in-force, new and renewal basis, which covered the thirteen month period throughFebruary 28, 2022 , subject to certain limitations. The treaty arrangement was fully collateralized through Anchor Re. EffectiveDecember 31, 2021 , the Company terminated its existing 80% quota-share reinsurance treaty with Anchor Re and commuted the agreement. Immediately after the commutation, the Company entered into a 100% quota-share treaty with Anchor Re onDecember 31, 2021 on an in-force, new and renewal basis, which covers the six month period throughJune 30, 2022 , subject to certain limitations which include limits on the net losses that Anchor Re can realize during the treaty year. The new treaty excludes catastrophe losses, involves a funded trust and is fully collateralized through Anchor Re.
Our MIC non-
manufactured home insurance and dwelling fire insurance. MIC writes both full
peril property policies as well as wind/hail only exposures.
The following are our recent approved rate actions that we have taken across our
insurance subsidiaries that do business outside of
•In 2021, FNIC applied for a statewide-average rate increase of 8.4.% forMississippi homeowners insurance policies, which was approved by the respective regulatory agency and became effective for new policies onJanuary 17, 2022 and for renewal policies onMarch 1, 2022 . •In 2021, MIC applied for a statewide-average rate increase of 24.6% forLouisiana voluntary dwelling insurance policies, which was approved by the respective regulatory agency and became effect for new policies onMarch 15, 2021 and for renewal policies onApril 15, 2021 . •In 2021, FNIC applied for a statewide-average rate increase of 5.0% forAlabama homeowners insurance policies, which was approved by the respective regulatory agency and became effective for new policies onApril 1, 2021 and for renewal policies onMay 1, 2021 . •In 2021, FNIC applied for a statewide-average rate increase of 6.9% forSouth Carolina homeowners insurance policies, which was approved by the respective regulatory agency and became effective for new policies onApril 1, 2021 and for renewal policies onMay 1, 2021 . •In 2021, FNIC applied for a statewide-average rate increase of 9.0% forTexas homeowners insurance policies, which was approved by the respective regulatory agency and became effective for new policies onApril 8, 2021 and for renewal policies onMay 1, 2021 . •In 2021, FNIC applied for a statewide-average rate increase of 9.5% forTexas homeowners insurance policies, which was approved by the respective regulatory agency and became effective for new policies onAugust 16, 2021 for renewal policies onNovember 1, 2021 . •In 2021, FNIC applied for a statewide-average rate increase of 15.0% forTexas homeowners insurance policies, which was approved by the respective regulatory agency and became effective for new policies onNovember 1, 2021 and for renewal policies onDecember 16, 2021 . •In 2021, MIC applied for a statewide-average rate increase of 11.1% forLouisiana homeowners insurance policies, which was approved by the respective regulatory agency and became effective for new policies onMay 15, 2021 and for renewal policies onJuly 1, 2021 . •In 2021, MIC applied for a statewide-average rate increase of 11.0% forLouisiana takeout insurance policies, which was approved by the respective regulatory agency and became effective for new and renewal policies onJuly 1, 2021 . •In 2021, FNIC applied for a statewide-average rate increase of 11.0% forLouisiana homeowners insurance policies, which was approved by the respective regulatory agency and became effective for new and renewal policies onJuly 1, 2021 . In 2021, MIC applied for a statewide-average rate increase of 25.7% forTexas voluntary wind only insurance policies, which was effective for new and renewal policies onJuly 15, 2021 . •In 2021, MIC applied for a statewide-average rate increase of 9.5% forTexas takeout wind only insurance policies, which was effective for new and renewal policies onJuly 15, 2021 . •In 2021, MIC applied for a statewide-average rate increase of 22.6% forTexas manufactured home insurance policies, which was effective for new and renewal policies onAugust 15, 2021 . •In 2021, FNIC applied for a statewide-average rate increase of 15.0% forLouisiana homeowners insurance policies, which was approved by the respective regulatory agency and became effective for new policies onOctober 25, 2021 and for renewal policies onDecember 1, 2021 . -32- -------------------------------------------------------------------------------- •In 2021, MIC applied for a statewide-average rate increase of 19.0% forLouisiana takeout insurance policies, which was approved by the respective regulatory agency and became effective for new and renewal policies onNovember 25, 2021 . •In 2021, MIC applied for a statewide-average rate increase of 8.6% forLouisiana manufactured home insurance policies, which was approved by the respective regulatory agency and became effective for new and renewal policies onNovember 25, 2021 . •In 2021, MIC applied for a statewide-average rate increase of 23.1% forTexas homeowners insurance policies, which was effective for new policies onDecember 1, 2021 and effective for renewal policies onJanuary 1, 2022 . •In 2021, MIC applied for a statewide-average rate increase of 18.9% forLouisiana homeowners insurance policies, which was approved by the respective regulatory agency and became effective for new and renewal policies onDecember 3, 2021 . •In 2021, FNIC applied for a statewide-average rate increase of 20.0% forSouth Carolina homeowners insurance policies, which was approved by the respective regulatory agency and became effective for new policies onApril 1, 2022 and for renewal policies onMay 1, 2022 . •Additional rate filings have been applied for by FNIC and MIC and are pending to be approved by the respective regulatory agency. InNovember 2021 , the Company announced its plan to re-focus its operations on theFlorida market, which has been the Company's historical focus. In conjunction with this shift in strategy, the Company commenced an orderly runoff of MIC's insurance operations. In that regard, MIC filed appropriate documentation with its insurance regulators inLouisiana ,Florida andTexas concerning MIC's withdrawal plan. We began non-renewing MIC'sLouisiana policies on their anniversary dates inJanuary 2022 . Non-renewal of MIC'sTexas policies began inMarch 2022 , and the non-renewal of MIC'sFlorida policies is expected to begin inJuly 2022 . With respect to FNIC'sTexas andLouisiana books, the Company and SageSure (the third-party MGU that underwrote the business and owns the renewal rights thereof) began transferring policies onto alternative SageSure insurance carrier partners inDecember 2021 , by virtue of making offers of coverage to FNIC policyholders. FNIC policies inSouth Carolina ,Alabama andMississippi are expected to continue to be renewed by FNIC up throughJune 30, 2022 . SageSure has begun offering renewals inTexas andLouisiana from alternative SageSure insurance carrier partners and we expect they will do the same inSouth Carolina ,Alabama andMississippi byJuly 2022 . Non-renewals of FNIC's policies produced by SageSure beganApril 30, 2022 forTexas andLouisiana and subject to regulatory approvals of our withdrawal plans will beginMay 31, 2022 forAlabama andMississippi , andJune 30, 2022 inSouth Carolina . The non-renewal of all existing policies is governed by the appropriate regulatory requirements of each state in which the property insured by the policy is located. In conjunction with the 100% quota-share treaty and the in-process transfer of the book discussed above, effectiveFebruary 1, 2022 , claims handling for the SageSure book was transferred to an affiliate of SageSure. Other Lines of Business Flood: FNIC writes flood insurance through the National Flood Insurance Program ("NFIP"). We write the policy for the NFIP, which assumes 100% of the flood risk while we retain a commission for our service. FNIC offers this line of business inFlorida ,Louisiana ,Texas ,Alabama ,South Carolina andMississippi . FNIC plans to file an admitted flood endorsement as an alternative to the NFIP program. UntilDecember 2021 , MIC wrote flood insurance through a partnership withBintech Partners, Inc. who assumes 100% of the risk, inLouisiana only.
See the discussion in Item 1: "Business" in our 2021 Form 10-K, for additional
information with respect to our business.
Regulation
All insurance companies must file quarterly and annual statements with certain regulatory agencies and are subject to regular and special examinations by those agencies. We may be the subject of additional special examinations or analysis. These examinations or analysis may result in one or more corrective orders being issued by the OIR orLouisiana Department of Insurance ("LDI"), our primary regulators. Refer to "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations, Liquidity and Capital Resources" for discussion of OIR consent orders and the Company's action plans with respect thereto. -33-
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RESULTS OF OPERATIONS
Operating Results Overview - Three Months Ended
Three Months Ended
The following overview does not address all of the matters covered in the other
sections of Management's Discussion and Analysis of Financial Condition and
Results of Operations or contain all of the information that may be important to
our shareholders or the investing public. This overview should be read in
conjunction with the other sections of Management's Discussion and Analysis of
Financial Condition and Results of Operations herein and in our 2021 Form 10-K.
The following table sets forth results of operations for the periods presented:
Three Months Ended
March 31,
2022 % Change 2021
(Dollars in thousands)
Revenues:
Gross premiums written $ 137,892 (20.8) % $ 174,207
Gross premiums earned 164,328 (8.2) % 179,002
Ceded premiums (118,343) (15.0) % (139,257)
Net premiums earned 45,985 15.7 % 39,745
Net investment income 1,264 (24.5) % 1,674
Net realized and unrealized gains (losses) (15,053) NCM 92
Direct written policy fees 2,613 (21.2) % 3,315
Other income 7,426 (6.3) % 7,922
Total revenues 42,235 (19.9) % 52,748
Costs and expenses:
Losses and loss adjustment expenses 58,783 22.4 %
48,016
Commissions and other underwriting expenses 19,107 (9.1) %
21,031
General and administrative expenses 6,997 15.3 % 6,066 Interest expense 2,300 19.4 % 1,926 Total costs and expenses 87,187 13.2 % 77,039 Income (loss) before income taxes (44,952) 85.1 % (24,291) Income tax expense (benefit) (1,038) (78.9) % (4,910) Net income (loss)$ (43,914) 126.6 %$ (19,381) Ratios to net premiums earned: Net loss ratio 127.8 % 120.8 % Net expense ratio 56.8 % 68.2 % Combined ratio 184.6 % 189.0 % (1)Net loss ratio is calculated as losses and loss adjustment expenses ("LAE") divided by net premiums earned. (2)Net expense ratio is calculated as all operating expenses less interest expense divided by net premiums earned. (3)Combined ratio is calculated as the sum of losses and LAE and all operating expenses less interest expense divided by net premiums earned. -34- -------------------------------------------------------------------------------- The following table sets forth a reconciliation of GAAP to non-GAAP measures: Three Months Ended March 31, 2022 2021 (Dollars in thousands) Revenue Total revenues$ 42,235 $ 52,748 Less: Net realized and unrealized investment gains (losses) (15,053) 92 Adjusted operating revenues$ 57,288 $ 52,656 Net Income (Loss) Net income (loss)$ (43,914) $ (19,381) Less: Net realized and unrealized investment gains (losses) (15,053)
73
Acquisition and strategic costs -
(9)
Amortization of identifiable intangibles -
(30)
Adjusted operating income (loss)$ (28,861)
Income tax rate assumed for reconciling items above - %
21.00 %
Our first quarter of 2022 reported results onMay 9, 2022 , did not include an impairment loss of$12.6 million , which is included above. This impairment loss was precipitated by the OIR approval of the mid-term cancellation pursuant to the Company's action plan, which occurred onMay 13, 2022 . Total shareholders' equity was not impacted by such charge; however, the Company's net loss for three months endedMarch 31, 2022 worsened and other comprehensive income improved by$12.6 million in offsetting amounts. Refer to Note 2 of the notes to our Consolidated Financial Statements for additional information.
Revenue
Total revenue decreased$10.5 million or 19.9%, to$42.2 million for the three months endedMarch 31, 2022 , compared with$52.7 million for the three months endedMarch 31, 2021 . The decrease was driven primarily by lower net realized gains, gross premiums, direct written policy fees, net investment income and other income, partially offset by a decrease in ceded premiums, all of which are discussed in further detail below.
Gross Premiums Written
The following table sets forth the gross premiums written for the periods
presented:
Three Months Ended
March 31,
2022 2021
(In thousands)
Gross premiums written:
Homeowners Florida $ 116,159 $ 111,969
Homeowners non-Florida 17,317 57,909
Federal flood 4,481 4,389
Non-core (1) (65) (60)
Total gross premiums written $ 137,892 $ 174,207
(1)Reflects exited lines of business.
Gross premiums written decreased$36.3 million , or 20.8%, to$137.9 million in the quarter compared with$174.2 million for the same three-month period last year, driven by a reduction in our policies-in-force and exposure in non-Florida states, as a result of -35- --------------------------------------------------------------------------------
the orderly runoff of MIC and the transfer-upon-renewal of FNIC's non-
business to alternative insurance carrier partners of SageSure.
Gross Premiums Earned
The following table sets forth the gross premiums earned for the periods
presented:
Three Months Ended
March 31,
2022 2021
(In thousands)
Gross premiums earned:
Homeowners Florida $ 105,138 $ 109,426
Homeowners non-Florida 53,939 64,923
Federal flood 5,316 4,713
Non-core (1) (65) (60)
Total gross premiums earned $ 164,328 $ 179,002
(1)Reflects exited lines of business.
Gross premiums earned decreased$14.7 million , or 8.2%, to$164.3 million for the three months endedMarch 31, 2022 , as compared to$179.0 million for the three months endedMarch 31, 2021 , driven primarily by the same reasons as the decrease in gross premiums written, discussed above.
Ceded Premiums Earned
Ceded premiums earned decreased$21.0 million , or 15.0%, to$118.3 million in the quarter, compared to$139.3 million in the same three-month period last year. The decrease was driven by approximately$15 million lower catastrophe reinsurance spend due to additional purchases of supplemental coverage in the 2020-2021 catastrophe excess of loss reinsurance program to backfill layers and gaps in coverage stemming from the non-cascading portion of our reinsurance tower, following the six retention catastrophe events that occurred during that treaty year. Additionally, there was approximately$6 million of lower quota-share ceded premium associated with lower gross premiums earned discussed above which was largely offset by corresponding increases in net loss and LAE, and commission and other underwriting expenses when comparing the periods. Refer to Note 5 of the notes to our Consolidated Financial Statements for additional information regarding these quota-share treaties.
Net Investment Income
Net investment income decreased$0.4 million , or 24.5%, to$1.3 million during the three months endedMarch 31, 2022 , as compared to$1.7 million during the three months endedMarch 31, 2021 . This decrease was driven by a smaller fixed income portfolio as we have been impacted by several catastrophes, hail and wind-related severe weather events and private reinsurers have raised the cost of their coverages.
Net Realized and Unrealized Gains (Losses)
Net realized and unrealized gains (losses) decreased$15.2 million , to$(15.1) million for the three months endedMarch 31, 2022 , compared to$0.1 million the prior year period. Refer to Note 2 of the notes to our Consolidated Financial Statements for information about the Company recognition of an impairment loss of$(12.6) million . We also recognized$(0.6) million and less than$(0.1) million in unrealized investment gains (losses) for equity securities during these respective periods. Our current and prior year net realized investment gains on sales are primarily associated with our portfolio managers, under our control, moving out of positions due to both macro and micro conditions, a typical practice in most quarters.
Direct Written Policy Fees
Direct written policy fees decreased$0.7 million , or 21.2%, to$2.6 million for the three months endedMarch 31, 2022 , compared with$3.3 million for the three months endedMarch 31, 2021 . The decrease is primarily driven by a reduction in our policies in-force in the state ofFlorida , as a result of our rigorous exposure management in response to the challenging litigation environment and the orderly exit of the non-Florida business. -36- --------------------------------------------------------------------------------
Other Income
Other income included the following for the periods presented:
Three Months Ended
March 31,
2022 % Change 2021
(Dollars in thousands)
Other income:
Commission income $ 1,280 35.7 % $ 943
Brokerage 5,796 (11.8) % 6,575
Financing and other revenue 350 (13.4) % 404
Total other income $ 7,426 (6.3) % $ 7,922
The decrease in other income was primarily driven by lower brokerage revenue.
The brokerage revenue decrease is the result of lower excess of loss reinsurance
spend from the reinsurance programs in place, including reinstatement premiums
and/or additional purchases, during first quarter of 2022 as compared to the
first quarter of 2021.
Expenses
Losses and LAE
Losses and LAE incurred, net of reinsurance, included the following for the
periods presented:
Three Months Ended
March 31,
2022 2021
Net Loss Net Loss
Amount Ratio Amount Ratio
(In thousands)
Current accident year, excluding catastrophes:
Homeowners $ 26,063 56.7 % $ 34,395 86.4 %
Non-core (1) - - % - - %
Total current accident year, excluding
catastrophes 26,063 56.7 % 34,395 86.4 %
Current year catastrophes (2):
Florida 19,219 41.8 % 166 0.4 %
Texas 6,458 14.0 % 10,396 26.2 %
Louisiana 2,670 5.8 % 2,531 6.4 %
Other states 901 2.0 % - - %
Total current year catastrophes 29,248 63.6 % 13,093 33.0 %
Prior year loss development (redundancy):
Homeowners 3,543 7.7 % 624 1.6 %
Non-core (1) (71) (0.2) % - - %
Ceded losses subject to offsetting experience
account adjustments (3) - - % (96) (0.2) %
Total prior year loss development (redundancy) 3,472 7.5 % 528 1.4 %
Total net losses and LAE $ 58,783 127.8 % $ 48,016 120.8 %
(1)Reflects exited lines of business.
(2)Includes Property Claims Services ("PCS") weather events and other events
impacting multiple insureds for which the Company's insurance carriers
established catastrophe event codes, net of the benefit of claims handling
services. These catastrophe events are typically wind, hail and tornado related
weather events. Any individual catastrophe event with gross losses greater than
$20 million , on a pre-tax basis, are considered significant and specifically
addressed in the commentary below. Excludes any catastrophe related activity
recorded in other financial statement line items, outside of loss and loss
adjustment expenses.
-37-
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(3)Reflects homeowners losses ceded under retrospective reinsurance treaties to
the extent there is an offsetting experience account adjustment, such that there
is no impact on pre-tax net income (loss).
Losses and LAE increased $10.8 million , or 22.4%, to $58.8 million for the three
months ended March 31, 2022 , compared to $48.0 million for 2021. The net loss
ratio increased 7.0 percentage points, to 127.8% in the current quarter, as
compared to 120.8% in the first quarter of 2021. The higher loss expense and
corresponding ratio were primarily driven by larger net catastrophe losses and
prior year development as well as lower ceded losses under quota-share
reinsurance treaties attributable to lower gross premiums earned, partially
offset by lower gross attritional losses in the current quarter. Refer to Gross
Premiums Earned above for additional information.
The current quarter included approximately $29.2 million of catastrophe losses,
net of reinsurance and claims handling fee income, driven primarily by eleven
notable events (including one wildfire) that impacted Florida , Texas , Louisiana
and South Carolina . Approximately $10 million of these net catastrophe losses
are related to books of business that the Company is in the process of running
off, including FNIC's non-Florida book as well as MIC's book of business. In
addition, the Company recorded approximately $2 million of net adverse reserve
development in the quarter related to Hurricane Laura, which hit Louisiana in
August 2020 . By comparison, the first quarter of 2021 catastrophe net losses
were $13.1 million , net of reinsurance, primarily by Winter Storm Uri, which
caused heavy residential damage in Texas , primarily associated with freezing
temperatures causing widespread instances of burst water pipes.
Commissions and Other Underwriting Expenses
The following table sets forth the commissions and other underwriting expenses
for the periods presented:
Three Months Ended
March 31,
2022 2021
(In thousands)
Commissions and other underwriting expenses:
Homeowners Florida$ 10,682 $ 12,399 All others 13,233 11,691 Ceding commissions (18,051) (19,460) Total commissions 5,864 4,630 Fees 993 1,335 Salaries and wages 2,511 3,572
Other underwriting expenses 9,739
11,494
Total commissions and other underwriting expenses
Commissions and other underwriting expenses decreased$1.9 million , or 9.1%, to$19.1 million for the three months endedMarch 31, 2022 , compared with$21.0 million for the three months endedMarch 31, 2021 . This decrease was due to lower acquisition and underwriting expenses due to lower policies-in-force, offset by lower ceding commission as a result of higher catastrophe costs, which has the affect of reducing the ceded commissions in the quarter. The net expense ratio decreased 11.4 percentage points to 56.8% in the first quarter of 2022, as compared to 68.2% in the first quarter of 2021 due primarily to higher ceded reinsurance premiums in 2021 Our gross expense ratio was 26.9% during the three months endedMarch 31, 2022 , as compared to 26.0% during the three months endedMarch 31, 2021 , due primarily to inflation, partially offset by the Company's continued focus on expense control.
General and Administrative Expenses
General and administrative expenses increased$0.9 million , or 15.3%, to$7.0 million for the three months endedMarch 31, 2022 compared to$6.1 million in the first quarter of 2021, due primarily to investments in employees, which are critical to accomplishing our corporate goals, including providing service to our insureds. -38- --------------------------------------------------------------------------------
Interest Expense
Interest expense increased$0.4 million , or 19.4%, to$2.3 million for the three months endedMarch 31, 2022 compared to$1.9 million for the three months endedMarch 31, 2021 . The increase was primarily attributable to debt issued onApril 20, 2021 . Refer to Note 10 of the notes to our Consolidated Financial Statements set forth in Part II, Item 8. Financial Statements and Supplementary Data of our 2021 Form 10-K, for additional information.
Income Taxes
Income tax expense (benefit) decreased$3.9 million , to$(1.0) million for the three months endedMarch 31, 2022 , compared to$(4.9) million for the three months endedMarch 31, 2021 . Refer to Note 9 of the notes to our Consolidated Financial Statements for information related to our valuation allowance and our effective income tax rate.
Consolidated Company Outlook - Potential Changes in Financial Trends
See "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations, Liquidity and Capital Resources," for discussion of the action plan the Company has submitted to the OIR. If approved and implemented the plan would materially impact forward-looking expectations with respect to financial trends. Such impacts with respect to the Company's business include, but are not limited to: •Declines in net written and gross earned premiums; •Declines in loss and loss adjustment expenses as well as in commissions and other underwriting expenses; •Declines in exposure to catastrophe weather losses; •Declines in the expected cost of excess of loss reinsurance coverages over the runoff period; and •Reduced need or potential need for surplus infusions into FNIC and MIC, and corresponding reductions in the Company's overall capital needs. Overall, the Company anticipates lower consolidated earnings. However, if catastrophe losses were to continue at the elevated levels experienced in the past twenty one months, it is expected that the reduction of ourFlorida book of business and the orderly exit of the non-Florida business will have proven beneficial to the Company's earnings over the runoff period.
LIQUIDITY AND CAPITAL RESOURCES
Overview
Our primary sources of funds are gross written premiums, ceding of claims payments pursuant to reinsurance treaties, investment income, commission income and fee income. Our primary uses of funds are the payment of claims, catastrophe and other reinsurance premiums and operating expenses. As ofMarch 31, 2022 , on a consolidated basis, the Company held$87.4 million in cash and cash equivalents and$275.6 million in investments. As ofDecember 31, 2021 , on a consolidated basis, the Company held$83.5 million in cash and cash equivalents and$333.4 million in investments. Total shareholders' equity decreased$45.3 million , to$14.1 million as ofMarch 31, 2022 , compared with$59.4 million as ofDecember 31, 2021 due primarily to a net loss and unrealized losses on our bond portfolio. The Company believes it has adequate holding company liquidity to accommodate its potential second quarter catastrophe losses, and to maintain regulatory minimum RBC ratios throughout 2022. As described in Going Concern in "Part I, Item I. Business, Insurance Operations and Related Services" of our 2021 Form 10-K, the Company believes there is substantial doubt regarding its ability to continue as a going concern. Demotech currently rates FNIC "S" and MNIC "A". The Company believes FNIC's Demotech rating will adversely impact our ability to obtain excess-of-loss reinsurance for coverage beginningJuly 1, 2022 . Absent such coverage, the Company will not be in compliance with requirements communicated by theOffice of Insurance Regulation of the state ofFlorida regarding such coverage, which could ultimately result in the Company being placed into receivership. The Company has submitted a proposed action plan to the OIR. A portion of the action plan has been approved by the OIR, and consists of the mid-term cancellation, effectiveJune 29, 2022 , of approximately 68,200Florida policies currently in force on FNIC, MNIC and Maison, as requested by the Company. Such cancellations will require the refund of approximately$126 million of unearned premium to the impacted policyholders and result in the Company becoming much smaller, with significantly fewer policies in force. The refund of these unearned premiums will require the liquidation of a substantial portion of our insurance carriers' portfolios of fixed income securities. Because of this near-term liquidity need, unrealized losses on our investment portfolio have been recognized as realized losses for the three months endedMarch 31, 2022 . Additional portions of the Company's action plan continue to be subject to approval by the OIR and regulatory authorities in other states, including mid-term cancellations in non-Florida states, as well as reinsurance and capital raising options. More specifically, the Company is seeking to fully exit all non-Florida states as of an approved date. Concurrently, the Company is seeking additional capital investments into the holding company or directly into an insurance carrier, specifically MNIC. The Company's requests -39- -------------------------------------------------------------------------------- would bring its overall book of business to a more manageable size, consistent with its capital position and increase the likelihood of success with multiple stakeholders, including its regulators, rating agency, shareholders and its remaining policyholders. The proposed action plan would be expected to enable the Company to obtain excess-of-loss reinsurance on a smaller,Florida -only book of business. There can be no assurance such approvals will be obtained or that these plans can be effectively implemented. The Company has outstanding$100 million of 2029 Notes ("2029 Notes"), which bear interest at the annual rate of 7.75%. The 2029 Notes mature onMarch 15, 2029 and the indenture covenants allow for a maximum debt-to-capital ratio applicable to the incurrence of debt to 60% and a maximum debt-to-capital ratio applicable to restricted payments, including cash dividends on our common stock, to 20%. The Company has outstanding$21 million of Convertible Senior Unsecured Notes due 2026 ("2026 Notes"), which bear interest at the annual rate of 5.0%. The 2026 Notes are convertible in part or in whole at the option of the holders at any time until the close of business on the second trading day prior to the maturity date onApril 19, 2026 ("Maturity Date") into shares of the Company's common stock at an initial conversion rate of 166.6667 shares of the Company's common stock per$1,000 principal amount of the 2026 Notes (equivalent to an initial conversion price of$6.00 per share), subject to customary adjustments in certain circumstances. The Company will not have the right to redeem the 2026 Notes prior to the Maturity Date. Holders of the 2026 Notes may require the Company to purchase their 2026 Notes upon a change of control at a purchase price equal to 101% of the principal amount thereof, plus accrued and unpaid interest to, but excluding, the date of purchase. Refer to Note 10 of the notes to our Consolidated Financial Statements set forth in Part II, Item 8. Financial Statements and Supplementary Data of the 2021 Form 10-K, for additional information regarding the 2029 Notes and 2026 Notes. InMay 2022 , due primarily to the delay in the filing of the Company's Form 10-K for the year endedDecember 31, 2021 ,Egan Jones' rating on the Company's outstanding senior notes expired such that our notes are not currently rated. The lack of a rating, if not remediated within 30 days from receipt of notice as provided in the note indentures, has the potential to result in an Event of Default under the note indentures. The Company intends to use its best efforts to secure such a rating as soon as reasonably practicable. If the Company fails to secure such a rating, is placed into receivership or fails to obtain excess-of-loss reinsurance, such conditions, if not timely cured, could result in acceleration of repayment of our debt. The Company does not have adequate liquidity to repay this debt without replacement borrowings, which may not be available. We cannot provide any assurance that we will be able to comply with certain covenants in our senior note indentures or to make satisfactory alternative arrangements in the event we cannot do so.
The Company's actual debt to capital ratio as of
approximately 89.4%.
Historically, we have met our liquidity requirements primarily through cash generated from operations. Beginning in 2020, property and casualty businesses, including FNHC's insurance carriers, have been materially adversely impacted by multiple catastrophes, hail, and wind-related severe weather events and private reinsurers have tightened coverage provisions and raised the cost of their coverages. As a result, sales of our portfolio of fixed income securities was a significant source of liquidity for the Company. Quota-share reinsurance treaties are another liquidity management tool, via the ceding commission the Company receives upon inception and the related reduction to statutory surplus requirements. New quota-share treaties entered or increased were responsive to these purposes, as well as to reduce the Company's exposure to non-named storm catastrophes. Certain of the Company's quota-share treaties contain provisions that give the reinsurer the option to terminate the treaty in the event that our Demotech rating is downgraded or that we are placed into receivership. The termination of any of our quota-share treaties would place additional strain on our statutory surplus. Management continually monitors and adjusts its liquidity and capital plans for FNHC and its subsidiaries in light of the aforementioned challenges to ensure that we have adequate liquidity and capital. The Company's Board and management continue to explore all options to strengthen the Company's capital position. Management is pursuing various financing alternatives to augment our capital and liquidity, including possible equity or debt financings (consistent with our indentures) and possible sales of non-core assets. Continuing occurrences of severe weather events and the current significant economic uncertainty and volatility in the credit and capital markets may impair our ability to raise additional capital. We may not be able to raise sufficient additional capital to support the Company's action plan, and our other efforts to improve our profitability may not succeed.
As described more fully in Part I, Item 1. Business, Regulation of our 2021 Form 10-K, the Company's insurance operations are subject to the laws and regulations of the states in which we operate. The OIR and their regulatory counterparts in other states utilize theNational Association of Insurance Commissions ("NAIC") risk-based capital ("RBC") requirements, and the resulting RBC ratio, as a key metric in the exercise of their regulatory oversight. The RBC ratio is a measure of the sufficiency of an insurer's statutory capital and surplus. In addition, the RBC ratio is used by insurance industry ratings services in the determination of the financial strength ratings (i.e., claims paying ability) they assign to insurance companies. Our rating agency for our insurance carriers, -40- --------------------------------------------------------------------------------Demotech, Inc. requires a minimum RBC ratio of 300%, among other metrics, for a carrier to maintain a Demotech rating. As ofMarch 31, 2022 andDecember 31, 2021 , FNIC's statutory surplus, which includes MNIC, was$73.2 million and$99.4 million , respectively. In addition, FNIC's surplus includes a surplus note receivable due from MIC, carried at$17.3 million as ofMarch 31, 2022 , which matures inDecember 2022 . As ofMarch 31, 2022 andDecember 31, 2021 , MIC's statutory surplus was$30.2 million and$30.8 million , respectively. In conjunction with the Company'sNovember 2021 decision to re-focus on itsFlorida homeowners business as discussed under Overview of Insurance Lines of Business - Non-Florida above in "Part I, Item 1. Business, Insurance Operations and Related Services" of this Annual Report, the Company is in the process of executing an orderly runoff of MIC's business. The Company remains committed to maintaining statutory surplus in MIC that satisfies minimum regulatory requirements through the runoff period. As a result of the Company's decision to support MIC to the level of minimum regulatory capital but not to a 300% RBC level, Demotech has withdrawn its rating of MIC. The ratings of FNIC and MNIC remain in place at "S" and "A", respectively, and are independent of this action. Adjusted for the intercompany impacts of the surplus note referenced above, the combined statutory surplus of our insurance carriers is approximately$86.1 million . As ofMarch 31, 2022 , the Company has approximately$47 million of liquidity in its holding company and non-regulated subsidiaries (collectively referred to "holding company liquidity") that is available for general corporate purposes, including supporting the capital requirements of its insurance subsidiaries. Based on RBC requirements, the extent of regulatory intervention and action increases as the ratio of an insurer's statutory surplus to its ACL, as calculated under the NAIC's requirements, decreases. The first action level, the Company Action Level, requires an insurer to submit a plan of corrective actions to the insurance regulators if statutory surplus falls below 200% of the ACL amount. The second action level, the Regulatory Action Level, requires an insurer to submit a plan containing corrective actions and permits the insurance regulators to perform an examination or other analysis and issue a corrective order if statutory surplus falls below 150% of the ACL amount. The third action level, ACL, allows the regulators to rehabilitate or liquidate an insurer in addition to the aforementioned actions if statutory surplus falls below the ACL amount. The fourth action level is the Mandatory Control Level, which requires the regulators to rehabilitate or liquidate the insurer if statutory surplus falls below 70% of the ACL amount. Based upon the 2021 statutory financial statements for FNIC, MIC and MNIC, statutory surplus exceeded the regulatory action levels established by the NAIC's RBC requirements. FNIC, MIC and MNIC had ratios of statutory surplus to its ACL of 313%, 305% and 1,152%, respectively, as ofDecember 31, 2021 . As described above, the Company intends to maintain no less than the minimum required regulatory capital within FNIC and MIC, but does not intend to maintain a 300% RBC ratio. The Company will continue to closely coordinate with all applicable state insurance departments with respect to its plan of operation throughout the runoff period. Refer to "Part I, Item 1A., Risk Factors" of our 2021 Form 10-K for more information on how over time, additional weather-related events and actions by reinsurers, including loss limitations in reinsurance treaties and our ability to renew existing reinsurance treaties, could adversely affect the Company's ability to maintain a 300% RBC ratio in MNIC (which is critical to maintaining a Demotech rating and to the Company's proposed action plan) and minimum required regulatory capital in FNIC and MIC or FNHC's ability to contribute necessary capital. In addition, because of the valuation allowance on the Company's deferred tax assets, the insurance carriers will not benefit from immediate tax benefits of any future quarterly losses they incur. As such, any surplus infusions required will be larger than they would have been if our net deferred tax assets were deemed fully realizable.
Cash Flows Discussion
We currently believe that existing cash and investment balances, when combined with anticipated cash flows, will be adequate to meet our expected liquidity needs in both the short-term and the reasonably foreseeable future, including maintaining regulatory minimum capital levels in our insurance carriers. However, our ability to maintain 300% RBC levels in MNIC (which is critical to maintaining a Demotech rating) may be dependent on our ability to raise additional capital in the future. There can be no guarantee additional capital will be available to the Company, if needed. Future strategies and catastrophe events would require additional external financing and we may from time to time seek to obtain external financing. We cannot assure that additional sources of financing will be available to us on favorable terms, or at all, or that the terms of any such financing would not negatively impact our results of operations.
Operating Activities
Net cash provided by (used in) operating activities was$(37.0) million in the three months endedMarch 31, 2022 compared to$(110.1) million in the same period in 2021. This change primarily reflects lower reinsurance spend and lower expenses from losses and LAE, primarily from reinsurance recoveries, partially offset by lower gross premiums. -41- --------------------------------------------------------------------------------
Investing Activities
Net cash provided by (used in) investing activities was$40.9 million in the three months endedMarch 31, 2022 , as compared to$62.1 million in the three months endedMarch 31, 2021 . The change primarily reflects lower purchases of debt and equity investment securities of$27.4 million for the three months endedMarch 31, 2022 , as compared to$56.1 million for the three months endedMarch 31, 2021 , partially offset by lower sales, maturities and redemptions of our debt and equity investment securities of$68.3 million in 2022 as compared to$118.4 million in 2021. Financing Activities Net cash provided by (used in) financing activities for the three months endedMarch 31, 2022 of$0.0 million as compared to$15.4 million for the three months endedMarch 31, 2021 . The change primarily reflects no proceeds from the issuance of shares of our common stock in 2022 as compared to$15.4 million in 2021.
Impact of Inflation and Changing Prices
The consolidated financial statements and related data presented herein have been prepared in accordance with GAAP, which requires the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. Our primary assets and liabilities are monetary in nature. As a result, interest rates have a more significant impact on performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or with the same magnitude as the inflationary effect on the cost of paying losses and LAE. Insurance premiums are established before we know the amount of losses and LAE and the extent to which inflation may affect such expenses. Consequently, we attempt to anticipate the future impact of inflation when establishing rate levels. While we attempt to charge adequate premiums, including the use of third-party vendor "replacement cost estimator" tools when establishing coverage limits on policies we issue, we may be limited in raising premium levels for competitive and regulatory reasons. Inflation may also affect the market value of our investment portfolio and the investment rate of return. Any future economic changes that result in prolonged and increasing levels of inflation could cause increases in the dollar amount of incurred losses and LAE and thereby materially adversely affect future liability requirements.
Critical Accounting Policies
We prepare our consolidated financial statements in conformity with accounting principles generally accepted inthe United States ("GAAP"), which requires us to make estimates and assumptions about future events that affect the amounts reported in the financial statements and accompanying notes. Future events and their effects cannot be determined with absolute certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results may materially differ from those estimates. We believe our most critical accounting estimates inherent in the preparation of our financial statements are: (i) fair value measurements of our investments; (ii) accounting for investments; (iii) premium and unearned premium calculation; (iv) reinsurance contracts; (v) the amount and recoverability of deferred acquisition costs; (vi) reserve for loss and losses adjustment expenses; and (vii) income taxes. The accounting estimates require the use of assumptions about certain matters that are highly uncertain at the time of estimation. To the extent actual experience differs from the assumptions used, our financial condition, results of operations, and cash flows would be affected.
There have been no significant changes to our critical accounting estimates
during the three months ended
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Critical Accounting Estimates" included in our 2021 Form 10-K for a
more complete description of our critical accounting estimates.
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