Heritage Insurance (HRTG) - 2018 Q4 - Annual Report

Part I Business The company is a vertically integrated property and casualty insurer specializing in residential property insurance across 11 coastal states - The company is a property and casualty insurance holding company providing personal and commercial residential property insurance in 11 coastal states, including Florida, Hawaii, and several northeastern states, through its subsidiaries: Heritage P&C, NBIC, and Zephyr[15][20] Financial Strength Ratings of Key Subsidiaries | Subsidiary | Demotech Rating | KBRA Rating | KBRA Investment Rating | | :--- | :--- | :--- | :--- | | Heritage P&C | A | BBB+ | N/A | | Zephyr | A' | BBB+ | N/A | | NBIC | A | A- | N/A | | Heritage Insurance | N/A | N/A | BBB | Key Financial and Operational Metrics (as of and for the year ended Dec 31, 2018) | Metric | Value | | :--- | :--- | | Policies in Force | 515,686 | | Annualized Premium | $923.7 million | | Gross Premiums Written | $923.3 million | | Operating Income | $69.5 million | | Total Assets | $1.8 billion | | Total Stockholders' Equity | $425.3 million | - The company's core strategy is to grow and geographically diversify its property insurance operations to mitigate risk from catastrophic weather events, enhance relationships with reinsurers, and optimize reinsurance pricing[22] - A key competitive advantage is the vertical integration of its claims model, using subsidiaries CAN and BRC for claims adjustment, water mitigation, and repair services, which was expanded to North Carolina, Hawaii, and New York in 2018[30][41] - The company utilizes a substantial reinsurance program to limit exposure to catastrophic events, purchasing coverage from the FHCF, over 50 private reinsurers, and through catastrophe bonds sponsored by its subsidiary, Citrus Re Ltd[39][79] Risk Factors The company faces significant risks primarily related to its business operations, the regulatory environment, and common stock ownership - A primary risk is that loss reserves are estimates and may be inadequate to cover actual liabilities for losses, which could adversely affect results of operations[94] - The business is highly concentrated in coastal states, making it disproportionately vulnerable to single or multiple catastrophic events like hurricanes and winter storms[97][98] - The company is heavily reliant on reinsurance to manage catastrophic risk, with availability and cost subject to market conditions and a risk of non-payment by reinsurers, including the state-run Florida Hurricane Catastrophe Fund (FHCF)[101][103][104] - Operational risks include potential failures of IT systems, data breaches, cyber-attacks, and the inability to attract and retain qualified employees and key executives[127][129][136][138] - Insurance operations are subject to extensive state regulation covering premium rates, solvency, capital requirements, and affiliate transactions, which may reduce profitability or limit growth[152][162] - Risks for common stock owners include significant price volatility, no guarantee of future dividends, and anti-takeover provisions in corporate bylaws and state insurance laws that could deter a change of control[173][174][177][181] Unresolved Staff Comments The company reports no unresolved staff comments from the Securities and Exchange Commission - None[184] Properties The company owns its corporate headquarters, a restoration center, and two operational facilities, while leasing office space in Honolulu, Hawaii Summary of Company Offices and Locations | Location | Business Use | Square Footage | Ownership | | :--- | :--- | :--- | :--- | | Clearwater, Florida | Corporate Headquarters | 75,736 | Company owned | | Safety Harbor, Florida | Restoration Center | 16,367 | Company owned | | Honolulu, Hawaii | Insurance Company HI Operations | 4,405 | Leased | | Pawtucket, Rhode Island | Insurance Company NE Operations | 15,321 | Company owned (Held for sale) | | Pawtucket, Rhode Island | Insurance Company NE Operations | 22,520 | Company owned | Legal Proceedings The company is involved in routine legal proceedings not expected to materially affect its financial condition or results of operations - The company is subject to routine legal proceedings in the ordinary course of business, which are not expected to have a material adverse effect[186] Mine Safety Disclosures This item is not applicable to the company - Not applicable[187] Part II Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities The company's common stock is listed on the NYSE, with quarterly cash dividends paid since Q4 2015, and a stock repurchase program authorized - The company's common stock is listed on the NYSE under the symbol "HRTG", with 30,360,758 shares outstanding held by approximately 32 stockholders of record as of March 8, 2019[189][190] - The company has paid a quarterly cash dividend since Q4 2015, but future dividends are not guaranteed and depend on various factors[174][191] - A stock repurchase program authorizing up to $50 million in repurchases was authorized on August 1, 2018, effective through December 31, 2020[175] Selected Financial Data The company's five-year financial data shows significant growth in gross premiums written and total assets, with volatile but recovering net income and an improving combined ratio Selected Statements of Operations Data (2014-2018) | (In thousands, except per share data) | 2018 | 2017 | 2016 | 2015 | 2014 | | :--- | :--- | :--- | :--- | :--- | :--- | | Gross premiums written | $923,349 | $625,565 | $626,704 | $586,098 | $436,407 | | Total revenue | $480,171 | $406,623 | $438,958 | $394,792 | $233,820 | | Net income (loss) | $27,155 | $(1,119) | $33,865 | $92,512 | $47,097 | | Diluted earnings (loss) per share | $1.04 | $(0.04) | $1.14 | $3.05 | $1.82 | | Net loss ratio | 52.3% | 53.1% | 58.0% | 37.5% | 40.1% | | Combined ratio (net) | 90.4% | 94.1% | 92.8% | 65.0% | 71.4% | Selected Balance Sheet Data (2014-2018) | (In thousands) | 2018 | 2017 | 2016 | 2015 | 2014 | | :--- | :--- | :--- | :--- | :--- | :--- | | Total Assets | $1,768,713 | $1,771,210 | $1,033,244 | $837,398 | $615,031 | | Long-term debt, net | $148,794 | $184,405 | $72,905 | $— | $— | | Total Liabilities | $1,343,380 | $1,391,394 | $675,285 | $480,845 | $359,942 | | Total Stockholders' Equity | $425,333 | $379,816 | $357,959 | $356,553 | $255,089 | Management's Discussion and Analysis of Financial Condition and Results of Operations Management's discussion highlights the impact of the NBIC acquisition, return to profitability, challenges from hurricanes, and debt refinancing, with loss reserves remaining a critical accounting estimate Overview, Acquisitions, and Recent Developments This section covers the company's strategic acquisitions, including NBIC, the impact of 2018 hurricanes, and significant debt refinancing activities to enhance capital structure - The acquisition of NBIC Holdings, Inc. on November 30, 2017, for approximately $250 million ($210M cash and $40M stock), was a key strategic move for geographic diversification[207] - In 2018, the company incurred estimated consolidated retention losses of $16.5 million from Hurricane Florence and $16.0 million from Hurricane Michael[213][214] - In December 2018, the company enhanced its capital structure by entering a new five-year, $125.0 million secured credit facility, using proceeds to redeem $79.5 million in senior notes and repurchase $72.7 million in convertible senior notes[215] Results of Operations For 2018, the company saw a 48% increase in gross premiums written and a return to profitability, driven by NBIC's full-year operations and an improved combined ratio Consolidated Results of Operations (2018 vs. 2017) | (in thousands) | 2018 | 2017 | $ Change | % Change | | :--- | :--- | :--- | :--- | :--- | | Gross premiums written | $923,349 | $625,565 | $297,784 | 48% | | Net premiums earned | $454,182 | $379,564 | $74,618 | 20% | | Losses and LAE | $237,425 | $201,482 | $35,943 | 18% | | Operating income | $69,536 | $49,535 | $20,001 | 40% | | Net income (loss) | $27,155 | $(1,119) | $28,274 | N/A | - The increase in 2018 gross premiums written and earned was primarily due to the inclusion of a full year of operations from NBIC, which was acquired on November 30, 2017[233][234] - Ceded premiums increased 79% in 2018 due to a full year of NBIC's reinsurance program, which includes extensive quota share reinsurance designed to mitigate non-catastrophe losses[235] - The company's retained hurricane losses for 2018 were $32.9 million for Hurricanes Lane, Florence, and Michael, with an additional $1.7 million recorded for 2017's Hurricane Irma[242] - Losses incurred in 2018 included $13.3 million of adverse prior year development, primarily due to Florida litigated claims and Assignment of Benefits (AOB) abuse[243] Key Ratios (2018 vs. 2017) | Ratio | 2018 | 2017 | | :--- | :--- | :--- | | Ceded premium ratio | 51.0% | 41.0% | | Net loss ratio | 52.3% | 53.1% | | Net operating expense ratio | 38.1% | 41.0% | | Net combined ratio | 90.4% | 94.1% | Liquidity and Capital Resources The company's liquidity is strong, with significant cash from operations and investments, further enhanced by a new $125 million credit facility in late 2018 to refinance existing debt - As of December 31, 2018, the company held $250.1 million in cash and cash equivalents and $526.1 million in investments[288] Summary of Cash Flows (in thousands) | Activity | 2018 | 2017 | 2016 | | :--- | :--- | :--- | :--- | | Net cash from Operating activities | $95,428 | $7,489 | $82,955 | | Net cash from (used in) Investing activities | $24,365 | $(7,242) | $(249,416) | | Net cash (used in) from Financing activities | $(31,953) | $47,556 | $43,826 | - In December 2018, the company entered into a new five-year, $125 million credit agreement, consisting of a $75 million term loan and a $50 million revolving credit facility, with proceeds used to refinance existing debt[297][299] - During 2018, the company repurchased or exchanged a total of $83.3 million principal amount of its Convertible Notes, leaving $23.4 million outstanding as of Q1 2019[318] - In November 2018, a subsidiary obtained a $19.2 million loan from the Federal Home Loan Bank (FHLB), collateralized by $31.0 million in U.S. government securities[326] Contractual Obligations as of December 31, 2018 (in thousands) | Obligation | Total | Less Than 1 Year | 1-3 Years | 3-5 Years | More than 5 Years | | :--- | :--- | :--- | :--- | :--- | :--- | | Note payable | $117,588 | $12,929 | $24,552 | $80,107 | $— | | Convertible debt | $49,663 | $1,652 | $3,427 | $3,427 | $41,157 | | Mortgage loan | $21,280 | $893 | $1,786 | $1,786 | $16,815 | | FHLB agreement | $22,215 | $604 | $1,206 | $20,405 | $— | | Lease agreements | $11,215 | $922 | $2,743 | $2,687 | $4,863 | | Total | $221,881 | $17,900 | $33,714 | $108,412 | $62,835 | Critical Accounting Policies and Estimates The company's critical accounting estimates include loss reserves, reinsurance, policy acquisition costs, investment valuation, stock-based compensation, and income taxes, with new accounting standards adopted in 2018 - Reserves for unpaid losses and loss adjustment expenses represent the most significant accounting estimate, requiring management to project the ultimate cost of settling all reported and incurred but not yet reported (IBNR) claims[333] - As of December 31, 2018, gross reserves totaled $432.4 million, comprising $135.1 million in case reserves and $297.2 million in IBNR reserves[337] - Policy acquisition costs are capitalized to the extent recoverable and amortized over the policy period, with a premium deficiency test performed each reporting period to ensure recoverability[339][340] - Investments in fixed maturity and equity securities are classified as available-for-sale and reported at fair value, with unrealized gains and losses on fixed maturities recorded in other comprehensive income and changes in equity securities recorded in net income[345] - The Tax Cuts and Jobs Act, enacted December 22, 2017, reduced the corporate federal income tax rate from 35% to 21%, resulting in a tax benefit of approximately $21.3 million at December 31, 2017[365] Quantitative and Qualitative Disclosures About Market Risk The company's primary market risks are interest rate, credit, and equity price risks, managed through investment strategies focused on capital preservation and diversification - The company's main market risks are interest rate risk, credit risk, and equity price risk, managed by a committee-led investment strategy focused on maximizing income while preserving capital and liquidity[373] Interest Rate Sensitivity of Fixed-Maturity Securities (as of Dec 31, 2018) | Hypothetical Change in Interest rates | Change In Estimated Fair Value (in thousands) | % Change in Estimated Fair Value | | :--- | :--- | :--- | | 100 basis point increase | $(17,709) | (3)% | | 100 basis point decrease | $17,710 | 3% | - Credit risk is mitigated by investing in a diversified portfolio of fixed-maturity securities that are generally investment grade, with 94% of the portfolio rated BBB- or higher as of December 31, 2018[376][377] Financial Statements and Supplementary Data This section presents the company's audited consolidated financial statements for 2016-2018, including balance sheets, income statements, equity changes, and cash flows, along with detailed notes Consolidated Financial Statements The audited financial statements show total assets of $1.77 billion and total liabilities of $1.34 billion as of December 31, 2018, with $27.2 million net income for the year Consolidated Balance Sheet Highlights (as of Dec 31, in thousands) | Account | 2018 | 2017 | | :--- | :--- | :--- | | Total investments | $526,105 | $567,013 | | Cash and cash equivalents | $250,117 | $153,697 | | Total Assets | $1,768,713 | $1,771,210 | | Unpaid losses and LAE | $432,359 | $470,083 | | Unearned premiums | $472,357 | $475,334 | | Long-term debt, net | $148,794 | $184,405 | | Total Liabilities | $1,343,380 | $1,391,394 | | Total Stockholders' Equity | $425,333 | $379,816 | Consolidated Statement of Operations Highlights (Year ended Dec 31, in thousands) | Account | 2018 | 2017 | 2016 | | :--- | :--- | :--- | :--- | | Gross premiums earned | $926,326 | $643,304 | $640,518 | | Net premiums earned | $454,182 | $379,564 | $411,721 | | Total revenues | $480,171 | $406,623 | $438,958 | | Losses and LAE | $237,425 | $201,482 | $238,862 | | Operating income | $69,536 | $49,535 | $56,765 | | Net income (loss) | $27,155 | $(1,119) | $33,865 | Notes to Consolidated Financial Statements The notes detail accounting policies and financial results, including the NBIC acquisition, investment portfolio, goodwill, reinsurance program, loss reserves, and 2018 debt refinancing activities - The company completed the acquisition of NBIC Holdings, Inc. on November 30, 2017, for $250 million ($210M cash and $40M stock), resulting in goodwill of $106 million[479] - The 2018-2019 reinsurance program provides first event coverage up to $1.6 billion for Heritage P&C, $801 million for Zephyr, and $1.0 billion for NBIC, with an estimated net cost of approximately $252.0 million[518][522] Reserve for Unpaid Losses Activity (in thousands) | | 2018 | 2017 | 2016 | | :--- | :--- | :--- | :--- | | Net balance, beginning of period | $154,730 | $139,548 | $83,722 | | Incurred related to current year | $224,080 | $188,914 | $220,071 | | Incurred related to prior years | $13,345 | $12,567 | $18,791 | | Total paid | $(210,303) | $(221,823) | $(183,033) | | Net balance, end of period | $181,852 | $154,730 | $139,551 | - In December 2018, the company entered a new $125M credit facility and used proceeds to prepay its $79.5M Senior Secured Notes and repurchase a portion of its Convertible Notes[561][578] - As of December 31, 2018, the company's insurance subsidiaries had a combined statutory surplus of $375.1 million and met all minimum capital and risk-based capital requirements[597][600] Changes in and Disagreements with Accountants on Accounting and Financial Disclosure The company reports no changes in or disagreements with its accountants on accounting and financial disclosure - Information regarding changes in and disagreements with accountants on accounting and financial disclosure is none[641] Controls and Procedures The company's CEO and CFO concluded that disclosure controls and internal control over financial reporting were effective as of December 31, 2018, with no material changes during the quarter - Management, including the CEO and CFO, evaluated and concluded that disclosure controls and procedures were effective as of December 31, 2018[642] - Management assessed and concluded that internal control over financial reporting was effective as of December 31, 2018, based on the COSO 2013 framework[646] - There were no changes in internal control over financial reporting during the most recent quarter that materially affected internal controls[647] Other Information This item is not applicable - Not applicable[648] Part III Directors, Executive Officers and Corporate Governance Information on directors, executive officers, and corporate governance is incorporated by reference from the company's 2019 Proxy Statement - Information regarding directors, executive officers, and corporate governance is incorporated by reference from the company's Proxy Statement[650][651] Executive Compensation Information on executive compensation is incorporated by reference from the company's 2019 Proxy Statement - Information regarding executive compensation is incorporated by reference from the company's Proxy Statement[652] Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Information on security ownership of beneficial owners and management is incorporated by reference from the company's 2019 Proxy Statement - Information regarding security ownership is incorporated by reference from the company's Proxy Statement[653] Certain Relationships and Related Transactions, and Director Independence Information on certain relationships, related transactions, and director independence is incorporated by reference from the company's 2019 Proxy Statement - Information regarding related transactions and director independence is incorporated by reference from the company's Proxy Statement[653] Principal Accountant Fees and Services Information on principal accountant fees and services is incorporated by reference from the company's 2019 Proxy Statement - Information regarding principal accountant fees and services is incorporated by reference from the company's Proxy Statement[654] Part IV Exhibits, Financial Statement Schedules This section lists the consolidated financial statements, financial statement schedules, and exhibits filed or incorporated by reference as part of the Form 10-K - This section contains the list of financial statements, financial statement schedules, and exhibits filed with the Form 10-K[656] Form 10-K Summary No summary is provided in this section of the Form 10-K - None[661]