HERITAGE INSURANCE HOLDINGS, INC. – 10-Q – Management's Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion in conjunction with our condensed
consolidated financial statements and related notes and other information
included elsewhere in this Quarterly Report on Form 10-Q and in our Annual
Report on Form 10-K for the year ended
Unless the context requires otherwise, as used in this Form 10-Q, the terms
"we", "us", "our", "the Company", "our Company", and similar references refer to
Overview
insurance holding company that primarily provides personal and commercial
residential insurance products across its multi-state footprint. We provide
personal residential insurance in sixteen states and commercial residential
insurance in three of those states, while maintaining licenses in one additional
state. As a vertically integrated insurer, we control or manage substantially
all aspects of underwriting, customer service, actuarial analysis, distribution
and claims processing and adjusting. Our financial strength ratings are
important to the Company in establishing our competitive position and can impact
our ability to write policies.
The discussion of our financial condition and results of operations that follows
provides information that will assist the reader in understanding our
consolidated financial statements, the changes in certain key items in those
financial statements from year to year, and the primary factors that accounted
for those changes, as well as how certain accounting principles, policies and
estimates affect our consolidated financial statements. This discussion should
be read in conjunction with our consolidated financial statements and the
related notes that appear elsewhere in this document.
Recent Developments
COVID-19 and Other Matters
We continue to monitor the short- and long-term impacts of the COVID-19 virus
and its variants. For the quarter ended
to our business. As a residential property insurer, we view our business as
somewhat insulated because property owners and renters generally view our
products as a necessity. The majority of our gross and net premiums written are
from renewals of expiring policies. New business, which accounts for a smaller
portion of our revenue, may be impacted if consumers are not buying as many new
homes in our geographies, but this could be partially or fully offset by
increased retention in our renewal portfolio. We could experience disruptions to
our independent agency distribution channel, which may have a negative impact on
our revenues and financial condition. Changes in the cost of materials and labor
for home repairs can influence our loss costs associated with claims.
While we acknowledge uncertainties associated with future economic conditions,
we do not expect a material impact to our business going forward. We will
continue to monitor economic conditions and, in the case of a prolonged economic
slowdown as a result of COVID-19, will take necessary actions to mitigate any
negative impacts to our business, operations or financial results.
Financial Results for the first quarter of 2022
•
Net loss for the quarter was
of
•
Book value per share of
31, 2021
quarter 2022 coupled with unrealized losses on the Company's available-for-sale
fixed income securities portfolio. The unrealized losses were unrelated to
credit risk but were primarily due to the sharp first-quarter decline in bond
prices in a higher interest rate environment.
•
Gross premiums earned of
prior year quarter, reflecting higher gross premiums written over the last
twelve months.
•
Gross premiums written of
with intentional exposure-management and re-underwriting efforts resulting in a
4.0% reduction in
•
Premiums in force of
•
Net current accident year weather losses of
include
from
losses, up from
•
Total capital returned to shareholders of
share regular quarterly dividend and repurchase of 721,118 shares of stock.
23
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Results of Operations
Comparison of the Three Months Ended
Revenue
For the Three Months Ended March 31,
(Unaudited) 2022 2021 $ Change % Change
(in thousands)
REVENUE:
Gross premiums written $ 283,196 $ 274,181 $ 9,015 3.3 %
Change in gross unearned premiums 4,172 (3,770 ) 7,942 (210.7 )%
Gross premiums earned 287,368 270,411 16,957 6.3 %
Ceded premiums (134,439 ) (128,212 ) (6,227 ) 4.9 %
Net premiums earned 152,929 142,199 10,730 7.5 %
Net investment income 2,000 1,293 707 54.7 %
Net realized gains (16 ) 80 (96 ) NM
Other revenue 3,695 3,671 24 0.7 %
Total revenue $ 158,608 $ 147,243 $ 11,365 7.7 %
NM= Not Meaningful
Gross premiums written
Gross premiums written were
4.0% intentional exposure management related reduction in
offset by11.4% growth in other states. Rate increases meaningfully benefited
written premiums throughout the book of business. The reduction in
written premium reflects our strategy to manage our
value ("TIV") and attritional loss ratios by controlling renewals and new
business written.
Premiums-in-force were
quarter 2021, while policies-in-force were down 5.5%, with the delta largely
stemming from rate increases. Policies-in-force were 559,496, a 5.5% reduction
from 591,924 policies at first quarter 2021. The reduction in policies in force
from the second quarter of 2021 reflects our exposure management initiatives.
Gross premiums earned
Gross premiums earned were
premiums written over the last twelve months.
Ceded premiums
Ceded premiums were
million
in the cost of our catastrophe excess of loss reinsurance program driven by an
increase in TIV for the respective reinsurance contract periods.
Net premiums earned
Net premiums earned were
growth in gross premiums earned outpacing the increase in ceded premiums, as
described above.
Net investment income
Net investment income, inclusive of realized investment gains and unrealized
gains on equity securities, was
balances in our fixed income portfolio than the prior year quarter.
Other revenue
Other revenue was
compared to the prior year quarter.
Total revenue
Total revenue was
million
premiums earned, as described above.
24
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For the Three Months Ended March 31,
(Unaudited) 2022 2021 $ Change % Change
OPERATING EXPENSES: (in thousands)
Losses and loss adjustment expenses 140,038 97,909 42,129 43.0 %
Policy acquisition costs 38,257 35,366 2,891 8.2 %
General and administrative expenses 19,724 19,800 (76 ) (0.4 )%
Total operating expenses 198,019 153,075 44,944 29.4 %
Losses and loss adjustment expenses
Losses and loss adjustment expenses ("LAE") were
2022, up 43.0% from
from higher net weather losses, as described above.
Policy acquisition costs
Policy acquisition costs were
to growth in gross premiums written and is partially offset by higher ceding
commission income.
General and administrative expenses
General and administrative expenses were
relatively flat when compared to the prior year quarter.
For the Three Months Ended March 31,
(Unaudited) 2022 2021 $ Change % Change
(in thousands, except per share amounts)
Operating loss (39,411 ) (5,832 ) (33,579 ) 575.8 %
Interest expense, net 1,972 1,878 94 5.0 %
Loss before income taxes (41,383 ) (7,710 ) (33,672 ) 436.8 %
Benefit for income taxes (10,624 ) (2,562 ) (8,062 ) 314.6 %
Net loss $ (30,759 ) $ (5,148 ) $ (25,611 ) 497.5 %
Basic net loss per share $ (1.15 ) $ (0.19 ) $ (0.96 ) NM
Diluted net loss per share $ (1.15 ) $ (0.19 ) $ (0.96 ) NM
Interest expense, net
Net interest expense was
flat quarter-over-quarter.
Benefit for income taxes
Benefit for income taxes was
first quarter 2022, 7.6 points below the prior year quarter's 33.2% rate. The
lower effective tax rate relates to the impact of permanent tax differences on
projected results of operations for the calendar year. The effective tax rate
can fluctuate throughout the year as estimates used in the quarterly tax
provision are updated with additional information.
Net loss
First quarter 2022 net loss was
net loss of
year-over-year change primarily stems from a larger underwriting loss driven by
significantly higher weather losses, which was partly offset by growth in net
earned premium, as described above.
Ratios
For the Three Months Ended March 31,
(Unaudited) 2022 2021
Ceded premium ratio 46.8 % 47.4 %
Net loss and LAE ratio 91.6 % 68.9 %
Net expense ratio 37.9 % 38.8 %
Net combined ratio 129.5 % 107.7 %
Ceded premium ratio
The ceded premium ratio was 46.8% in first quarter 2022, down 0.6 points from
47.4% in the prior year quarter, reflecting the growth in gross premiums earned
outpacing the growth in ceded premiums.
25
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Net loss and LAE ratio
The net loss and LAE ratio was 91.6% in first quarter 2022, up 22.7 points from
68.9% in the prior year quarter, driven by higher weather losses compared to the
prior year quarter, which was partly offset by the 7.5% increase in net premiums
earned.
Net expense ratio
The net expense ratio was 37.9% in first quarter 2022, relatively flat compared
to 38.8% in the prior year quarter.
Net combined ratio
The net combined ratio was 129.5% in first quarter 2022, up 21.8 points from
107.7% in the prior year quarter. The increase primarily stems from a higher net
loss and LAE ratio with a relatively flat net expense ratio.
Liquidity and Capital Resources
Our principal sources of liquidity include cash flows generated from operations,
existing cash and cash equivalents, our marketable securities balances and
borrowings available under our credit facilities. As of
compared to
2021
of reinsurance payments for our catastrophe excess of loss ("XOL") program.
We generally hold substantial cash balances to meet seasonal liquidity needs
including amounts to pay quarterly reinsurance installments as well as meet the
collateral requirements of Osprey, our captive reinsurance company, which is
required to maintain a collateral trust account equal to the risk that it
assumes from our insurance company affiliates.
We believe that our sources of liquidity are adequate to meet our cash
requirements for at least the next twelve months.
We may continue to pursue the acquisition of complementary businesses and make
strategic investments. We may increase capital expenditures consistent with our
investment plans and anticipated growth strategy. Cash and cash equivalents may
not be sufficient to fund such expenditures. As such, in addition to the use of
our existing Credit Facilities, we may need to utilize additional debt to secure
funds for such purposes.
Cash Flows
For the Three Months Ended March 31,
2022 2021 Change
(in thousands)
Net cash provided by (used in):
Operating activities $ (39,206 ) $ 39,227 $ (78,433 )
Investing activities (27,648 ) (73,664 ) 46,016
Financing activities (4,312 ) (3,749 ) (563 )
Net (decrease) increase in cash and
cash equivalents $ (71,166 ) $ (38,186 ) $ (32,980 )
Operating Activities
Net cash used in operating activities was
ended
operating activities relates primarily to timing of cash flows associated with
claim and reinsurance payments as well as reinsurance reimbursements during the
first three months of 2022 compared to the first three months of 2021.
Investing Activities
Net cash used in investing activities for the three months ended
was
million
activities relates primarily to allocations of funds for investment in each
period. Strategic sales of investments to yield realized gains in 2020 produced
proceeds which were invested in early 2021.
Financing Activities
Net cash used in financing activities for the three months ended
was
million
activities was relatively flat from the prior year quarter, we drew
from our Revolving Credit Facility (defined below) to purchase and retire
million
as described in Note 14.
26
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Credit Facilities
The Company is party to a Credit Agreement by and among the Company, as
borrower, certain subsidiaries of the Company from time to time party thereto as
guarantors, the lenders from time to time party thereto (the "Lenders"),
Bank
Syndication Agent,
as Co-Documentation Agents, and
Corp.
time, the "Credit Agreement").
The Credit Agreement, as amended, provides for (1) a five-year senior secured
term loan facility in an aggregate principal amount of
Loan Facility") and (2) a five-year senior secured revolving credit facility in
an aggregate principal amount of
for the issuance of letters of credit and a
loans) (the "Revolving Credit Facility" and together with the Term Loan
Facility, the "Credit Facilities").
Term Loan Facility. The principal amount of the Term Loan Facility amortizes in
quarterly installments, which began with the close of the fiscal quarter ending
quarterly, decreasing to
quarter ending
maturity. The Term Loan Facility matures on
there was
Facility.
Revolving Credit Facility. The Revolving Credit Facility allows for borrowings
of up to
letters of credit and a
31, 2022
outstanding under the Revolving Credit Facility.
At our option, borrowings under the Credit Facilities bear interest at rates
equal to either (1) a rate determined by reference to LIBOR (based on one, two,
three or six-month interest periods), adjusted for statutory reserve
requirements, plus an applicable margin or (2) a base rate determined by
reference to the greatest of (a) the "prime rate" of
federal funds rate plus 0.50%, and (c) the LIBOR index rate applicable for an
interest period of one month plus 1.00%, plus an applicable margin. The Credit
Agreement provides for mechanisms for the transition away from LIBOR as a
benchmark interest rate and replacement of LIBOR with an alternative benchmark
rate.
The applicable margin for loans under the Credit Facilities varies from 2.5% per
annum to 3.0% per annum (for LIBOR loans) and 1.5% to 2.0% per annum (for base
rate loans) based on our consolidated leverage ratio ranging from 1.25-to-1 to
greater than 2.25-to-1. Interest payments with respect to the Credit Facilities
are required either on a quarterly basis (for base rate loans) or at the end of
each interest period (for LIBOR loans) or, if the duration of the applicable
interest period exceeds three months, then every three months. As of
2022
of 3.0 % per annum.
In addition to paying interest on outstanding borrowings under the Revolving
Credit Facility, we are required to pay a quarterly commitment fee based on the
unused portion of the Revolving Credit Facility, which is determined by our
consolidated leverage ratio.
We may prepay the loans under the Credit Facilities, in whole or in part, at any
time without premium or penalty, subject to certain conditions including minimum
amounts and reimbursement of certain costs in the case of prepayments of LIBOR
loans. In addition, we are required to prepay the loan under the Term Loan
Facility with the proceeds from certain financing transactions, involuntary
dispositions or asset sales (subject, in the case of asset sales, to
reinvestment rights).
All obligations under the Credit Facilities are or will be guaranteed by each
existing and future direct and indirect wholly owned domestic subsidiary of the
Company, other than all of the Company's current and future regulated insurance
subsidiaries (collectively, the "Guarantors").
The Company and the Guarantors are party to a Pledge and Security Agreement, (as
amended from time to time the "Security Agreement"), in favor of
as collateral agent. Pursuant to the Security Agreement, amounts borrowed under
the Credit Facilities are secured on a first priority basis by a perfected
security interest in substantially all of the present and future assets of the
Company and each Guarantor (subject to certain exceptions), including all of the
capital stock of the Company's domestic subsidiaries, other than its regulated
insurance subsidiaries.
The Credit Agreement contains, among other things, covenants, representations
and warranties and events of default customary for facilities of this type. The
Company is required to maintain, as of each fiscal quarter (1) a maximum
consolidated leverage ratio of 2.50 to 1.00 (2) a minimum consolidated fixed
charge coverage ratio of 1.20 to 1.00 and (3) a minimum consolidated net worth
for the Company and its subsidiaries. Events of default include, among other
events, (i) nonpayment of principal, interest, fees or other amounts; (ii)
failure to perform or observe certain covenants set forth in the Credit
Agreement; (iii) breach of any representation or warranty; (iv) cross-default to
other indebtedness; (v) bankruptcy and insolvency defaults; (vi) monetary
judgment defaults and material nonmonetary judgment defaults; (vii) customary
ERISA defaults; (viii) a change of control of the Company; and (ix) failure to
maintain specified catastrophe retentions in each of the Company's regulated
insurance subsidiaries.
27
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Convertible Notes
On
entered into a purchase agreement (the "Purchase Agreement") with
Global Markets Inc.
pursuant to which the Company agreed to issue and sell, and the Initial
Purchaser agreed to purchase,
Company's 5.875% Convertible Senior Notes due 2037 (the "Convertible Notes") in
a private placement transaction pursuant to Rule 144A under the Securities Act,
as amended (the "Securities Act"). The Purchase Agreement contained customary
representations, warranties and agreements of the Company and the Notes
Guarantor and customary conditions to closing, indemnification rights and
obligations of the parties and termination provisions. The net proceeds from the
offering of the Convertible Notes, after deducting discounts and commissions and
estimated offering expenses payable by the Company, were approximately
million
The Company issued the Convertible Notes under an Indenture (the "Convertible
Note Indenture"), dated
the Notes Guarantor, as guarantor, and
as trustee (the "Trustee").
The Convertible Notes bear interest at a rate of 5.875% per year. Interest is
payable semi-annually in arrears, on
Convertible Notes are senior unsecured obligations of the Company that rank
senior in right of payment to the Company's future indebtedness that is
expressly subordinated in right of payment to the Convertible Notes; equal in
right of payment to the Company's unsecured indebtedness that is not so
subordinated; effectively junior to any of the Company's secured indebtedness to
the extent of the value of the assets securing such indebtedness; and
structurally junior to all indebtedness or other liabilities incurred by the
Company's subsidiaries other than the Notes Guarantor, which fully and
unconditionally guarantee the Convertible Notes on a senior unsecured basis.
The Convertible Notes mature on
redeemed or converted.
Holders may convert their Convertible Notes at any time prior to the close of
business on the business day immediately preceding
during the period from, and including,
on the second business day immediately preceding
following circumstances: (1) during any calendar quarter commencing after the
calendar quarter ending on
Company's common stock, for at least 20 trading days (whether or not
consecutive) in the period of 30 consecutive trading days ending on the last
trading day of the calendar quarter immediately preceding the calendar quarter
in which the conversion occurs, is more than 130% of the conversion price of the
Convertible Notes in effect on each applicable trading day; (2) during the ten
consecutive business-day period following any five consecutive trading-day
period in which the trading price for the Convertible Notes for each such
trading day was less than 98% of the closing sale price of the Company's common
stock on such date multiplied by the then-current conversion rate; (3) if the
Company calls any or all of the Convertible Notes for redemption, at any time
prior to the close of business on the second business day immediately preceding
the redemption date; or (4) upon the occurrence of specified corporate events.
During the period from and including
on the second business day immediately preceding
immediately preceding
Notes for conversion at any time, regardless of the foregoing circumstances.
The conversion rate for the Convertible Notes was initially 67.0264 shares of
common stock per
initial conversion price of approximately
conversion rate is subject to adjustment in certain circumstances and is subject
to increase for holders that elect to convert their Convertible Notes in
connection with certain corporate transactions (but not, at the Company's
election, a public acquirer change of control (as defined in the Convertible
Note Indenture)) that occur prior to
Upon the occurrence of a fundamental change (as defined in the Convertible Note
Indenture) (but not, at the Company's election, a public acquirer change of
control (as defined in the Convertible Note Indenture), holders of the
Convertible Notes may require the Company to repurchase for cash all or a
portion of their Convertible Notes at a fundamental change repurchase price
equal to 100% of the principal amount of the Convertible Notes to be
repurchased, plus accrued and unpaid interest to, but excluding, the fundamental
change repurchase date.
Except as described below, the Company may not redeem the Convertible Notes
prior to
2037
Notes, at the Company's option, at a redemption price equal to 100% of the
principal amount of the Convertible Notes to be redeemed, plus accrued and
unpaid interest to, but excluding, the redemption date. No sinking fund is
provided for the Convertible Notes, which means that the Company is not required
to redeem or retire the Convertible Notes periodically. Holders of the
Convertible Notes are able to cause the Company to repurchase their Convertible
Notes for cash on any of
each case at 100% of their principal amount, plus accrued and unpaid interest
to, but excluding, the relevant repurchase date.
28
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The Convertible Note Indenture contains customary terms and covenants and events
of default. If an Event of Default (as defined in the Convertible Note
Indenture) occurs and is continuing, the Trustee by notice to the Company, or
the holders of at least 25% in aggregate principal amount of the Convertible
Notes then outstanding by notice to the Company and the Trustee, may declare
100% of the principal of, and accrued and unpaid interest, if any, on, all the
Convertible Notes to be immediately due and payable. In the case of certain
events of bankruptcy, insolvency or reorganization (as set forth in the
Convertible Note Indenture) with respect to the Company, 100% of the principal
of, and accrued and unpaid interest, if any, on, the Notes automatically become
immediately due and payable.
In
outstanding Convertible Notes. As of
principal amount of outstanding Convertible Notes.
FHLB Loan Agreements
In
fixed maturity securities with an estimated fair value of
collateral and received
with the FHLB Atlanta. The loan originated on
fixed interest rate of 3.094% with interest payments due quarterly commencing in
13, 2023
FHLB. Membership in the FHLB required an investment in FHLB's common stock which
was purchased on
permitted to withdraw any portion of the pledged collateral over the minimum
collateral requirement at any time, other than in the event of a default by the
subsidiary. The proceeds from the loan was used to prepay the Company's Senior
Secured Notes due 2023 in 2018.
Critical Accounting Policies and Estimates
When we prepare our condensed consolidated financial statements and accompanying
notes in conformity with
we must make estimates and assumptions about future events that affect the
amounts we report. Certain of these estimates result from judgments that can be
subjective and complex. As a result of that subjectivity and complexity, and
because we continuously evaluate these estimates and assumptions based on a
variety of factors, actual results could materially differ from our estimates
and assumptions if changes in one or more factors require us to make accounting
adjustments. During the three months ended
critical accounting policies and estimates as disclosed within our 2021 Annual
Report on Form 10-K.
Seasonality of our Business
Our insurance business is seasonal; hurricanes typically occur during the period
from
fourth quarters each year. With our catastrophe reinsurance program effective on
changes to reinsurance rates or changes in the total insured value of our policy
base will occur and be reflected in our financial results beginning
each year, subject to certain adjustments.
Recent Accounting Pronouncements
The information set forth under Note 1 to the condensed consolidated financial
statements under the caption "Basis of Presentation and Significant Accounting
Policies" is incorporated herein by reference. We do not expect any recently
issued accounting pronouncements to have a material effect on our condensed
consolidated financial statements.
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