Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Unless the context otherwise requires, all references to “we,” “us,” “our,” and “Company” refer to Universal Insurance Holdings, Inc. (“UVE”) and its wholly-owned subsidiaries. You should read the following discussion together with our unaudited condensed consolidated financial statements (“Financial Statements”) and the related notes thereto included in “Part I, Item 1—Financial Statements,” and our audited condensed consolidated financial statements and the related notes thereto included in “Part II, Item 8—Financial Statements and Supplementary Data” in our Annual Report on Form 10-K for the year ended December 31, 2021. Operating results for any one quarter are not necessarily indicative of results to be expected for any other quarter or for the year.
Cautionary Note Regarding Forward-Looking Statements
In addition to historical information, this report may contain “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The forward-looking statements anticipate results based on our estimates, assumptions and plans that are subject to uncertainty. These forward-looking statements may be identified by their use of words like “plans,” “seeks,” “expects,” “will,” “should,” “anticipates,” “estimates,” “intends,” “believes,” “likely,” “targets,” and other words with similar meanings. These statements may address, among other things, our strategy for growth, catastrophe exposure and other risk management, product development, investment results, regulatory approvals, market position, expenses, financial results, litigation and reserves. We believe that these statements are based on reasonable estimates, assumptions and plans. However, if the estimates, assumptions or plans underlying the forward-looking statements prove inaccurate or if other risks or uncertainties arise, actual results could differ materially from those communicated in these forward-looking statements as a result of the risks set forth below, which are a summary of those set forth in our Annual Report on Form 10-K for the year ended December 31, 2021. We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events, or otherwise.
Risks and uncertainties that may affect, or have affected, our financial condition and operating results include, but are not limited to, the following:
•Unanticipated increases in the severity or frequency of claims, including those relating to catastrophes, severe weather events and changing climate conditions, which, in some instances, have exceeded, and in the future may exceed our reserves established for claims;
•Failure of our risk mitigation strategies, including failure to accurately and adequately price the risks we underwrite and to include effective exclusions and other loss limitation provisions in our insurance policies;
•Loss of independent insurance agents and inability to attract new independent agents;
•Reliance on models, which are inherently uncertain, as a tool to evaluate risks;
•The continued availability of reinsurance at current levels and prices, and our ability to collect payments due from our reinsurers;
•Changes in industry trends, including changes due to the cyclical nature of the industry and increased competition;
•Geographic concentration of our business in Florida and the effectiveness of our growth and diversification strategy in new markets;
•Loss of key personnel and inability to attract and retain talented employees;
•Failure to comply with existing and future guidelines, policies and legal and regulatory standards;
•The ability of our claims professionals to effectively manage claims;
•Litigation or regulatory actions that could result in significant damages, fines or penalties;
•A downgrade in our Financial Stability Rating® and its impact on our competitive position, the marketability of our product offerings, our liquidity and profitability;
•The impact on our business and reputation of data and security breaches due to cyber-attacks or our inability to effectively adapt to changes in technology;
•Our dependence on the returns of our investment portfolio, which are subject to market risk;
•Legal, regulatory or tax changes that increase our operating costs and decrease our profitability, such as limitations on rate changes or requirements to participate in loss sharing;
•Our dependence on dividends and permissible payments from our subsidiaries;
•The ability of our Insurance Entities to comply with statutory capital and surplus minimums and other regulatory and licensing requirements; and
•The ongoing impact of the COVID-19 pandemic on our business and the economy in general.
OVERVIEW
We are a vertically integrated holding company offering property and casualty insurance and value-added insurance services. We develop, market and underwrite insurance products for consumers predominantly in the personal residential homeowners’ line of business and perform substantially all other insurance-related services for our primary insurance entities, including risk management, claims management, and distribution. Our primary insurance entities, Universal Property & Casualty Insurance Company (“UPCIC”) and American Platinum Property and Casualty Insurance Company (“APPCIC” and together with UPCIC, the “Insurance Entities”), offer insurance products through both our appointed independent agent network and our online distribution channels across 19 states (primarily in Florida), with licenses to write insurance in two additional states. The Insurance Entities seek to produce an underwriting profit (defined as earned premium minus losses, loss adjustment expense (“LAE”), policy acquisition costs and other operating costs) over the long term; maintain a conservative balance sheet to prepare for years in which the Insurance Entities are not able to achieve an underwriting profit; and generate investment income on assets.
The following Management’s Discussion and Analysis (“MD&A”) is intended to assist in an understanding of our financial condition and results of operations. This MD&A should be read in conjunction with our Financial Statements and accompanying Notes appearing elsewhere in this Report (the “Notes”). In addition, reference should be made to our audited Consolidated Financial Statements and accompanying Notes to Consolidated Financial Statements and “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our Annual Report on Form 10-K for the year ended December 31, 2021. Except for the historical information contained herein, the discussions in this MD&A contain forward-looking statements that involve risks and uncertainties. Our future results could differ materially from those discussed herein. Factors that could cause or contribute to such differences include, but are not limited to, those discussed above under “Cautionary Note Regarding Forward-Looking Statements.”
Trends
Florida Trends
We are currently working through a cycle to improve long-term rate adequacy and earnings for the Insurance Entities by increasing rates and managing exposures, while taking advantage of what we believe to be opportunities in a dislocated market. The Florida personal lines homeowners’ market currently can be characterized as a “hard market”, where insurance premium rates are escalating, insurers are reducing coverages, and underwriting standards are tightening as insurers closely monitor insurance rates and manage coverage capacity. Due to conditions in the Florida market and factors more generally affecting the U.S. and global reinsurance markets, reinsurance capacity in recent years has also been subject to less favorable pricing and terms. These market forces decrease competition among admitted insurers, and ultimately result in the increased use of Citizens Property Insurance Corporation (“Citizens”), which was created to be the State’s residual property insurance market. In recent years, in response to adverse behaviors and conditions in the Florida residential market, most admitted market competitors have sought and often received approval for significant rate increases. Meanwhile, Citizens’ rate increases are limited by law, resulting in its policies, in a hard market, becoming priced lower than admitted market policies. This causes Citizens to become viewed as a desirable alternative to the admitted market as admitted market insurers manage through the hard market challenges. Our Insurance Entities likewise have taken and continue to take action to manage through this hard market by increasing rates and prudently managing exposures while also seeking to maintain their competitive position in the market and supporting our current policyholders and agents.
While addressing rate adequacy for the Insurance Entities, we continue to experience increased costs for losses and LAE in the Florida market, where an industry has developed around the solicitation, filing and litigation of personal residential claims. These dynamics have been made worse by the litigation financing industry, which in some cases, funds these actions. In addition, rising inflation, as seen in the cost of labor and material supplies, has further escalated costs associated with the settlement of claims. These behaviors and related rising repair costs are a chief contributing factor for the rate increases in this market. These behaviors result in a pattern of continued increases in year-over-year levels of represented claims, the increases in purported claim amounts, and increased demands for attorneys’ fees. Active solicitation of personal residential claims in Florida by policyholder representatives, remediation companies and repair companies has led to an increase in the frequency and severity of personal residential claims in Florida, exceeding historical levels and levels seen in other jurisdictions. Information prepared by the Florida Office of Insurance Regulation also shows that claims in Florida are litigated at a substantially disproportionate rate when compared to other states. This is largely due to a Florida statute providing a one-way right of attorneys’ fees against insurers which has, when coupled with certain other statutes and judicial rulings, produced a legal environment in Florida that encourages litigation, in many cases without regard to the underlying merits of the claims. The one-way right to attorneys’ fees essentially means that unless an insurer’s position is entirely upheld in litigation, the insurer must pay the plaintiff’s attorneys’ fees in addition to its own defense costs. This affects not only claims that are litigated to resolution, but also the settlement discussions that take place with nearly all litigated claims. This also affects a large number of claims from inception or during the adjusting process as a substantial and growing percentage of policyholders obtain representation early in the process, and sometimes even before notifying insurers of their claims. These market conditions also add, and will continue to add, complexity to efforts to efficiently and expeditiously adjust claims. This is due to an increasing number of policyholders who have one or more recent prior losses with the Insurance Entities or with other insurers, which then require evaluation during subsequent claims and determinations regarding whether property has been repaired consistently with the scope and amount of damage previously asserted.
The one-way right to attorney fees creates a nearly risk-free environment, and incentive, for attorneys to pursue litigation against insurers. The result has been a substantial increase in represented and litigated claims in Florida, far outpacing levels experienced in other states. In April 2021, the Florida legislature passed a bill intending to curtail the adverse claim trends impacting the Florida homeowners’ insurance market. Most provisions of the bill went into effect on July 1, 2021. Among its provisions, the bill
creates a new pre-suit notice requirement wherein an insured must make a formal monetary demand of a residential property insurer before commencing suit. The Company has established an internal team to review and respond to these pre-suit demands in a further effort to resolve disputes before litigation ensues. Another provision of the new law reduces the time period in which to file a new or reopened claim to two years following the date of loss. In light of the recent enactment of these reforms, it is premature to assess whether the reforms will have their intended effect. Whether these changes are beneficial to consumers, insurers, insurance company holding systems or the residential property insurance market as a whole may not be fully known for some time.
In a further effort to alleviate concerns in the Florida property insurance market, Florida’s Governor called a special session of the legislature in May 2022. The legislature passed, and the Governor promptly signed into law, several additional reforms intended to curtail litigation abuses. Among other things, the new law precludes the assignment of policyholders’ rights to attorneys’ fees, allows plaintiffs’ attorneys to receive fee multipliers only in rare and exceptional cases, and requires plaintiffs to establish breaches of the insurance policy before pursuing related bad faith actions. Because the new law only recently was adopted, its impact on claims and claims-related costs, including litigation, will not be fully known for some time.
Despite our initiatives, such as those mentioned above, our costs to settle claims in Florida have increased for the reasons noted herein. For example, the Company continues to adjust its estimate of expected losses and has increased its current year loss estimates and increased estimates associated with prior years’ claims. Over the past three years, even as we have increased our estimates of prospective losses each year, we have recorded adverse claim development on prior years’ loss reserves and further strengthened current year losses during the year to address the increasing impact Florida’s market disruptions, as well as the impact of rising costs of building materials and labor, have had on the claims process and the establishment of reserves for losses and LAE. The full extent and duration of these market disruptions and inflationary pressures are unknown and still unfolding, and we will monitor the impact of such disruptions on the recording and reporting of claim costs.
The Company has taken a series of steps over time to mitigate the financial impact of these negative trends in the Florida market. We also have closely monitored rate levels, especially in the Florida market, and have submitted rate filings based upon evolving data. However, because rate filings rely upon past loss and expense data and take time to develop, file and implement, we can experience significant delays between identifying needed rate adjustments, gaining approval of rate changes, and ultimately collecting and earning the resulting increased premiums. This is particularly the case in an era of rising costs such as the current Florida market, in which the costs of losses and loss adjustment expenses continue to increase due to Florida’s outsized claims litigation environment and inflationary pressure. In addition, the Company has implemented several initiatives in its claims department in response to the adverse market trends. We utilize our process called Fast Track, which is an initiative to handle straightforward, meritorious claims as promptly as possible to mitigate the adverse impacts that can be seen with claims that remain open for longer periods. In addition, we increased our emphasis on subrogation to reduce our net losses while also recovering policyholders’ deductibles when losses are attributable to the actions of others. We have an internal staff of trained water remediation experts to address the extraordinary number of purported water damage claims filed by policyholders and vendors. We developed a specialized in-house unit for responding to the unique aspects of represented claims, and we have substantially increased our in-house legal staff in an effort to address the increase in litigated or represented claims as cost-effectively as possible.
Additionally, we have taken steps to implement claim settlement rules associated with the Florida legislation passed in 2019 designed to reduce the negative effects of claims involving assignments of benefits (“AOB”). See “Part I— Item 1—Business—Government Regulation” in our Annual Report on Form 10-K for the year ended December 31, 2021. An AOB is a document signed by a policyholder that allows a third party to be paid for services performed for an insured homeowner who would normally be reimbursed by the insurance company directly after making a claim. Prior to the AOB reform legislation, the Company experienced an increase in AOB-related litigation initiated by vendors, in many cases unbeknownst to policyholders. Claims paid under an AOB often involve unnecessary litigation, with the Company required to pay both its own defense costs and those of the plaintiff, and, as a result, cost the Company significantly more than claims settled when an AOB is not involved. In 2019, the Florida legislature passed legislation designed to increase consumer protections against AOB abuses and reduce AOB-related litigation. The legislature added to these AOB-related reforms in the recently concluded 2022 special legislative session, during which it passed a new law precluding policyholders’ assignments of attorneys’ fees. Prior to the recent 2022 law change, the overall impact of the deterioration in claims-related tactics and behaviors, including other first-party litigation, continued to outpace benefits arising from the 2019 AOB reform legislation. Following recent 2022 special legislative session, the Company intends to adopt procedures reflecting the new AOB law and monitor its effects.
Following legislation adopted in Florida’s 2021 legislative session, we also have established procedures and dedicated personnel to a new pre-suit notice and offer process. The new process requires policyholders or their attorneys to notify insurers at least ten days before commencing litigation and allows insurers an opportunity to make pre-suit settlement offers. The policyholders’ ability to recover attorneys’ fees is determined according to a scale that compares the ultimate outcomes of the cases to the insurers’ pre-suit offers. Although this new process is intended to reduce claims litigation and encourage settlements, it is too early to evaluate whether it will be successful in limiting the types of settlement demands and litigation that have plagued the Florida market or in offsetting other factors adversely affecting the market such as increased costs of building materials and labor.
Impact of COVID-19
Subsequent to March 2020, we have not seen a direct material impact from COVID-19 on our business, our financial position, our liquidity, or our ability to service our policyholders and maintain critical operations. Indirectly, inflationary pressures, in part due to supply chain and labor constraints during the pandemic, have affected and continue to affect claims costs and, to a lesser degree, other expenses. As a provider of services that have been deemed essential under most directives and guidelines, we are confident in our ability to maintain consistent operations and believe we can continue to manage with our hybrid work
arrangement as a result of our disaster preparedness planning, with little impact on our business and service levels and our standards of care for both underwriting and claims. We continue to monitor local, state and federal guidance and will adjust workforce activities as appropriate. Although we have not experienced a direct material impact from COVID-19 since its onset in 2020, the ultimate impact of the COVID-19 pandemic, or future pandemics, on our business and on the economy in general cannot be predicted.
KEY PERFORMANCE INDICATORS
The Company considers the measures and ratios in the following discussion to be key performance indicators for its businesses. Management believes that these indicators are helpful in understanding the underlying trends in the Company’s businesses. Some of these indicators are reported on a quarterly basis and others on an annual basis.
These indicators may not be comparable to other performance measures used by the Company’s competitors and should only be evaluated together with our condensed consolidated financial statements and accompanying notes.
In addition to our key performance indicators and other financial measures presented in accordance with United States Generally Accepted Accounting Principles (“GAAP”). management also uses certain non-GAAP financial measures to evaluate the Company's financial performance and the overall growth in value generated for the Company’s common shareholders. Management believes that non-GAAP financial measures, which may be defined differently by other companies, help to explain the Company’s results to investors in a manner that allows for a more complete understanding of the underlying trends in the Company’s business. The non-GAAP measures should not be viewed as a substitute for those determined in accordance with GAAP. The calculation of these key financial measures including the reconciliation of non-GAAP measures to the nearest GAAP measure are found below under ― “Non-GAAP Financial Measures.”
Definitions of Key Performance Indicators and GAAP and Non-GAAP Measures
Adjusted book value per common share ― is a non-GAAP measure, that is calculated as adjusted common stockholders’ equity divided by common shares outstanding at the end of the period. Management believes this metric is meaningful, as it allows investors to evaluate underlying book value growth by excluding the impact of interest rate volatility.
Adjusted common stockholders' equity ― is a non-GAAP measure, that is calculated by GAAP common stockholders' equity, excluding accumulated other comprehensive income (loss). Management believes this metric is meaningful, as it allows investors to evaluate underlying growth in stockholders’ equity by excluding the impact of interest rate volatility.
Adjusted net income attributable to common stockholders ― is a non-GAAP measure, that is calculated by GAAP net income attributable to common stockholders, excluding net realized gains (losses) on investment and net changes in unrealized gains (losses) of equity securities, net of tax. Management believes this metric is meaningful, as it allows investors to evaluate underlying profitability and enhances comparability across periods, by excluding items that are heavily impacted by investment market fluctuations and other economic factors and are not indicative of operating trends.
Adjusted operating income ― is a non-GAAP measure, that is computed by GAAP operating income, excluding net realized gains (losses) on investment and net changes in unrealized gains (losses) of equity securities. Management believes this metric is meaningful, as it allows investors to evaluate underlying profitability and enhances comparability across periods, by excluding items that are heavily impacted by investment market fluctuations and other economic factors and are not indicative of operating trends.
Adjusted operating income margin ― is a non-GAAP measure, which is computed by adjusted operating income divided by core revenue. Management believes this metric is meaningful, as it allows investors to evaluate underlying profitability and enhances comparability across periods, by excluding items that are heavily impacted by investment market fluctuations and other economic factors and are not indicative of operating trends.
Adjusted return on common equity (Adjusted “ROCE”) ― is a non-GAAP measure, that is calculated by actual or annualized adjusted net income attributable to common stockholders divided by average adjusted common stockholders' equity, with the denominator excluding current period income statement net realized gains (losses) on investments and net changes in unrealized gains (losses) of equity securities, net of tax. Management believes this metric is meaningful, as it allows investors to evaluate underlying profitability and enhances comparability across periods, by excluding items that are heavily impacted by investment market fluctuations and other economic factors and are not indicative of operating trends.
Book Value Per Common Share ― total stockholders’ equity, adjusted for preferred stock liquidation, divided by the number of common shares outstanding as of a reporting period. Book value per common share is the excess of assets over liabilities at a reporting period attributed to each share of stock. Changes in book value per common share informs shareholders of retained equity in the Company on a per share basis which may assist in understanding market value trends for the Company’s stock.
Combined Ratio ― the combined ratio is a measure of underwriting profitability for a reporting period and is calculated by dividing total operating costs and expenses (which is made up of losses and LAE and general and administrative expenses) by premiums earned, net, which is net of ceded premiums earned. Changes to the combined ratio over time provide management with an understanding of costs to operate its business in relation to net premiums it is earning and the impact of rate, underwriting and other business management actions on underwriting profitability. A combined ratio below 100% indicates underwriting profit; a combined ratio above 100% indicates underwriting losses.
Core Loss Ratio ― a common operational metric used in the insurance industry to describe the ratio of current accident year expected losses and LAE to premiums earned. Core loss ratio is an important measure identifying profitability trends of premiums in force. Core losses consists of all other losses and LAE, excluding weather events beyond those expected and prior years’ reserve development. The financial benefit from the management of claims, including claim fees ceded to reinsurers, is recorded in the condensed consolidated financial statements as a reduction to core losses.
Core revenue ― is a non-GAAP measure, that is calculated by total GAAP revenue, excluding net realized gains (losses) on investments and net changes in unrealized gains (losses) of equity securities, Management believes this metric is meaningful, as it allows investors to evaluate underlying revenue trends and enhances comparability across periods, by excluding items that are heavily impacted by investment market fluctuations and other economic factors and are not indicative of operating trends.
Debt-to-Equity Ratio ― long-term debt divided by stockholders’ equity. This ratio helps management measure the amount of financing leverage in place in relation to equity and future leverage capacity.
Debt-to-Total Capital Ratio ― long-term debt divided by the sum of total stockholders’ equity and long-term debt (often referred to as total capital resources). This ratio helps management measure the amount of financing leverage in place (long-term debt) in relation to total capital resources and future leverage capacity.
Diluted adjusted earnings per common share ― is a non-GAAP measure, which is calculated by adjusted net income available to common stockholders divided by weighted average diluted common shares outstanding. Management believes this metric is meaningful, as it allows investors to evaluate underlying revenue trends and enhances comparability across periods, by excluding items that are heavily impacted by investment market fluctuations and other economic factors and are not indicative of operating trends.
Direct Premiums Written (“DPW”) ― reflects the total value of policies issued during a period before considering premiums ceded to reinsurers. Direct premiums written, comprised of renewal premiums, endorsements and new business, is initially recorded as unearned premium in the balance sheet which is then earned pro-rata over the next year or remaining policy term. Direct premiums written reflects current trends in the Company’s sale of property and casualty insurance products and amounts that will be recognized as earned premiums in the future.
DPW (Florida) ― includes only DPW in the state of Florida. This measure allows management to analyze growth in our primary market and is also a measure of business concentration risk.
Expense Ratio (Including Policy Acquisition Cost Ratio and Other Operating Cost Ratio) ― calculated as general and administrative expenses as a percentage of premiums earned, net. General and administrative expenses is comprised of policy acquisition costs and other operating costs, which includes such items as underwriting costs, facilities and corporate overhead. The expense ratio, including the sub-expense ratios of policy acquisition cost ratio and other operating cost ratio, are indicators to management of the Company’s cost efficiency in acquiring and servicing its business and the impact of expense items to overall profitability.
Losses and Loss Adjustment Expense Ratio or Loss and LAE Ratio ― a measure of the cost of claims and claim settlement expenses incurred in a reporting period as a percentage of premiums earned in that same reporting period. Losses and LAE incurred in a reporting period includes both amounts related to the current accident year and prior accident years, if any, referred to as development. Ultimate losses and LAE are based on actuarial estimates with changes in those estimates recognized in the period the estimates are revised. Losses and LAE consist of claim costs arising from claims occurring and settling in the current period, an estimate of claim costs for reported but unpaid claims, an estimate of unpaid claim costs for incurred-but-not-reported claims and an estimate of claim settlement expenses associated with reported and unreported claims which occurred during the reporting period. The loss and LAE ratio can be measured on a direct basis, which includes losses and LAE divided by direct earned premiums, or on a net basis, which includes losses and LAE after amounts have been ceded to reinsurers divided by net earned premiums (i.e., direct premium earned less ceded premium earned). The net loss and LAE ratio is a measure of underwriting profitability after giving consideration to the effect of reinsurance. Trends in the net loss and LAE ratio are an indication to management of current and future profitability.
Monthly Weighted Average Renewal Retention Rate ― measures the monthly average of policyholders that renew their policies over the period of a calendar year. This measure allows management to assess customer retention.
Premiums Earned, Net ― the pro-rata portion of current and previously written premiums that the Company recognizes as earned premium during the reporting period, net of ceded premium earned. Ceded premiums are premiums paid or payable by the Company for reinsurance protection. Written premiums are considered earned and are recognized pro-rata over the policy coverage period. Premiums earned, net is a measure that allows management to identify revenue trends.
Policies in Force ― represents the number of active policies with coverage in effect as of the end of the reporting period. The change in the number of policies in force is a growth measure and provides management with an indication of progress toward achieving strategic objectives. Inherent seasonality in our business makes this measure more useful when comparing each quarter’s balance to the same quarter in prior years.
Premium in Force ― is the amount of the annual direct written premiums previously recorded by the Company for policies which are still active as of the reporting date. This measure assists management in measuring the level of insured exposure and progress toward meeting revenue goals for the current year, and provides an indication of business available for renewal in the next twelve months. Inherent seasonality in our business makes this measure more useful when comparing each quarter’s balance to the same quarter in prior years.
Return on Average Common Equity (“ROCE”) ― calculated by actual or annualized net income attributable to common stockholders divided by average common stockholders' equity. ROCE is a capital profitability measure of how efficiently management creates profits.
Total Insured Value ― represents the amount of insurance limits available on a policy for a single loss based on all policies active as of the reporting date. This measure assists management in measuring the level of insured exposure.
Unearned Premiums ― represents the portion of direct premiums corresponding to the time period remaining on an insurance policy and available for future earning by the Company. Trends in unearned premiums generally indicate expansion, if growing, or contraction, if reducing, which are important indicators to management. Inherent seasonality in our business makes this measure more useful when comparing each quarter’s balance to the same quarter in prior years.
Weather events ― an estimate of losses and LAE from weather events occurring during the current accident year that exceed initial estimates of expected weather events when establishing the core loss ratio for each accident year. This metric informs management of factors impacting overall current year profitability.
REINSURANCE
Reinsurance enables our Insurance Entities to limit potential exposures to catastrophic events. Reinsurance contracts are typically classified as treaty or facultative contracts. Treaty reinsurance provides coverage for all or a portion of a specified group or class of risks ceded by the primary insurer, while facultative reinsurance provides coverage for specific individual risks. Within each classification, reinsurance can be further classified as quota share or excess of loss. Quota-share reinsurance is where the primary insurer and the reinsurer share proportionally or pro-rata in the direct premiums and losses of the insurer. Excess-of-loss reinsurance indemnifies the direct insurer or reinsurer for all or a portion of the loss in excess of an agreed upon amount or retention.
Developing and implementing our reinsurance strategy to adequately protect our balance sheet and Insurance Entities in the event of one or more catastrophes while maintaining efficient reinsurance costs has been a key strategic priority for us. In order to limit the Insurance Entities’ potential exposure to catastrophic events, we purchase significant reinsurance from third-party reinsurers and the Florida Hurricane Catastrophe Fund (“FHCF”). The Florida Office of Insurance Regulation (“FLOIR”) requires the Insurance Entities, like all residential property insurance companies doing business in Florida, to have a certain amount of capital and reinsurance coverage in order to cover losses upon the occurrence of a single catastrophic event and a series of catastrophic events occurring in the same hurricane season. The Insurance Entities’ respective 2022-2023 reinsurance programs meet the FLOIR’s requirements, which are based on, among other things, successfully demonstrating cohesive and comprehensive reinsurance programs that protect the policyholders of our Insurance Entities as well as satisfying a series of stress test catastrophe loss scenarios based on past historical events. Similarly, the Insurance Entities’ respective 2022-2023 reinsurance programs meet the stress test and review requirements of Demotech, Inc., for maintaining Financial Stability Ratings® of A (Exceptional).
We believe the Insurance Entities’ retentions under their respective reinsurance programs are appropriate and structured to protect policyholders. We test the sufficiency of the reinsurance programs by subjecting the Insurance Entities’ personal residential exposures to statistical testing using a third-party hurricane model, RMS RiskLink v18.1 (Build 1945). This model combines simulations of the natural occurrence patterns and characteristics of hurricanes, tornadoes, earthquakes and other catastrophes with information on property values, construction types and occupancy classes. The model outputs provide information concerning the potential for large losses before they occur, so companies can prepare for their financial impact. Furthermore, as part of our operational excellence initiatives, we continually look to enable new technology to refine our data intelligence on catastrophe risk modeling.
Effective June 1, 2022, the Insurance Entities entered into multiple reinsurance agreements comprising our 2022-2023 reinsurance program. See “Item 1—Note 4 (Reinsurance).”
UPCIC’s 2022-2023 Reinsurance Program
•First event All States retention of $45 million.
•All States first event tower extends to $3.161 billion with no co-participation in any of the layers, no limitation on loss adjustment expenses for the non-catastrophe bond Cosaint Re Pte. Ltd. traditional reinsurance and no accelerated deposit premiums.
•Assuming a first event completely exhausts the $3.161 billion tower, the second event exhaustion point would be $1.183 billion.
•Full reinstatement available on $1.138 billion of the $1.288 billion of non-FHCF first event catastrophe coverage for guaranteed second event coverage. For all layers purchased between $111 million and the projected FHCF retention, to the extent that all of our coverage or a portion thereof is exhausted in a catastrophic event and reinstatement premium is due, we have purchased enough reinstatement premium protection ("RPP") limit to pay the premium necessary for the reinstatement of these coverages.
•First event layer of 100% of $66 million in excess of $45 million established by UIH in captive insurance arrangement. While the Company retains the risk that otherwise would be transferred to third party-reinsurers for this layer, the
additional risk is substantially offset by the savings in premiums that would otherwise have been paid to third-party reinsurers.
•Specific 2nd event private market excess of loss coverage of $66 million in excess of $45 million sitting behind captive arrangement.
•Specific 3rd and 4th event private market catastrophe excess of loss coverage of $86 million in excess of $25 million provides frequency protection for multiple events during the treaty period including a $20 million reduction in retention for a 3rd and 4th event.
•For the FHCF Reimbursement Contracts effective June 1, 2022, UPCIC has continued the election of the 90% coverage level. We estimate the total mandatory FHCF layer will provide approximately $1.827 billion of coverage for UPCIC, which inures to the benefit of the open market coverage secured from private reinsurers and Cosaint Re Pte. Ltd.
•To further insulate for future years, UPCIC has secured $383 million of catastrophe capacity with contractually agreed limits that extend coverage to include the 2022 and 2023 wind seasons and $277 million of the $383 million extends through the 2024 wind season and is all capacity which sits below the Florida Hurricane Catastrophe Fund. UPCIC’s catastrophe bond, secured leading up to the 2021-2022 renewal, Cosaint Re Pte. Ltd, continues to provide one limit of $150 million in this year’s program and it may also include the 2023 wind season, depending on loss activity in the 2022 wind season.
Reinsurers
The table below provides the A.M. Best and S&P financial strength ratings for each of the largest rated third-party reinsurers in UPCIC’s 2022-2023 reinsurance program:
| | | | | | | | | | | | | | |
Reinsurer | | A.M. Best | | S&P |
Allianz Risk Transfer AG, Bermuda Branch | | A+ | | AA- |
Chubb Tempest Reinsurance Ltd. | | A++ | | AA |
Everest Re | | A+ | | A+ |
Munich Re | | A+ | | AA- |
Renaissance Re | | A+ | | A+ |
Various Lloyd’s of London Syndicates | | A | | A+ |
Florida Hurricane Catastrophe Fund (1) | | N/A | | N/A |
(1)No rating is available, because the fund is not rated.
APPCIC’s 2022-2023 Reinsurance Program
•First event All States retention of $3.5 million.
•All States first event tower of $54.85 million with no co-participation in any of the layers, no limitation on loss adjustment expenses and no accelerated deposit premiums.
•Full reinstatement available for all private market first event catastrophe layers for guaranteed second event coverage. For the layer purchased between $3.5 million and the projected FHCF retention, to the extent that all of our coverage or a portion thereof is exhausted in a catastrophic event and reinstatement premium is due, we have purchased enough RPP limit to pay the premium necessary for the reinstatement of this coverage.
•APPCIC also purchases extensive multiple line excess per risk reinsurance with various reinsurers due to the high-value risks it insures in both the personal residential and commercial multiple peril lines of business. Under this multiple line excess per risk contract, APPCIC has coverage of $8.5 million in excess of $500 thousand ultimate net loss for each risk and each property loss, and $1 million in excess of $0.3 million for each casualty loss. A $19.5 million aggregate limit applies to the term of the contract for property-related losses and a $2.0 million aggregate limit applies to the term of the contract for casualty-related losses. This contract also contains a profit-sharing feature if specific performance measures are met.
•For the FHCF Reimbursement Contracts effective June 1, 2022, APPCIC has continued the election of the 90% coverage level. We estimate the total mandatory FHCF layer will provide approximately $28.6 million of coverage for APPCIC, which inures to the benefit of the open market coverage secured from private reinsurers.
Reinsurers
The table below provides the A.M. Best and S&P financial strength ratings for each of the largest rated third-party reinsurers in APPCIC’s 2022-2023 reinsurance program:
| | | | | | | | | | | | | | |
Reinsurer | | A.M. Best | | S&P |
Chubb Tempest Reinsurance Ltd. | | A++ | | AA |
DaVinci Reinsurance Limited | | A | | A+ |
Lancashire Insurance Company Limited | | A | | A- |
Renaissance Reinsurance Ltd. | | A+ | | A+ |
Various Lloyd’s of London Syndicates | | A | | A+ |
Florida Hurricane Catastrophe Fund (1) | | N/A | | N/A |
(1)No rating is available, because the fund is not rated.
The cost of the 2022-2023 reinsurance programs for UPCIC and APPCIC is projected to be $696 million, representing approximately 37.6% of estimated direct premium earned for the 12-month treaty period for UPCIC and APPCIC.
RESULTS OF OPERATIONS AND ANALYSIS OF FINANCIAL CONDITION
Highlights for the quarter ended June 30, 2022
•The Insurance Entities successfully completed their 2022-2023 reinsurance programs providing a total limit protection of $3.2 billion to the Insurance Entities. The limits include expanded use of an internal captive insurance entity. The estimated cost to the Insurance Entities, as a percentage of direct earned premium, increased from 36.4% of estimated premiums to 37.6% for the 2022-2023 program.
•The Florida legislature, in a special session, enacted a law this quarter introducing new reforms intended to reduce the level of inflated and litigated claims and provide relief to consumers. These new reforms are on top of reforms enacted in 2019 and 2021 which have had some measured benefits. Management is optimistic these new reforms will be beneficial, but recognizes it will take time before the reforms are fully realized.
•Previously approved rate filings and inflation adjustments to policy insured values are increasing written and earned premium as they take effect and earn prospectively over the policy period.
•Management is continuing its efforts to prudently manage new business risk selection, improve risk exposure diversification and moderate new business growth rates, compared to prior years, while the above rate increases are taking effect to improve profitability. Renewal retention rates have declined year over year as consumers react to higher renewal premiums. As a result, the number of total policies in force is lower, notwithstanding increases in written premium.
•Recently approved rate increases for Florida (14.9%), Indiana (19.9%), Pennsylvania (12.0%), North Carolina (7.9%) and South Carolina (14.6%) went into effect this quarter.
•Net investment income increased as market interest rates rise, however the rising interest rates have lowered the market value of our investments resulting in unrealized losses.
•Losses and LAE, net were higher this quarter compared to the same period last year primarily due to a higher level of expected losses and LAE for this year (the 2022 accident year) as a result of increases in loss trends and higher claim inflation costs in Florida and other markets.
•Other expense and acquisition cost management efforts have lowered the expense ratio. In April 2021, the commission rate on policy renewals was reduced 2 percentage points and further reduced on May 1, 2022 by 2 percentage points in response to premium rate increases during the past year. The benefit of lower commission rates are realized over the next year as policies renew under this new commission rate structure.
•The company continued to return shareholder value with quarterly dividends and modest share repurchases.
Second quarter of fiscal 2022 results of operations comparisons are to second quarter of fiscal 2021 (unless otherwise specified).
Results of Operations — Three Months Ended June 30, 2022 Compared to Three Months Ended June 30, 2021
Net income for the three months ended June 30, 2022, was $7.4 million compared to $21.9 million for the same period in 2021. Weighted average diluted common shares outstanding for the three months ended June 30, 2022 were lower by 1.4% to 30.9 million shares from 31.3 million shares for the same period of the prior year. Diluted earnings per share for the three months ended June 30, 2022 was $0.24 compared to $0.70 for the same period in 2021. Benefiting the quarter were increases in premiums earned, net, an increase in commission revenue, and an increase in net investment income, partially offset by an increase in operating costs and expenses, and an increase in both realized and unrealized losses. Direct premium earned and premiums earned, net were up 9.2% and 8.2%, respectively, due to premium growth in 15 of the 19 states in which we are licensed and writing during the past 12 months as a result of rate increases implemented during 2021 and 2022. The net loss and LAE ratio was 72.3% for the three months ended June 30, 2022, compared to 65.3% for the same period in 2021 reflecting higher core losses partially offset by lower prior years’ reserve development. As a result of the above and further explained below, the combined ratio for the three months ended June 30, 2022 was 100.9% compared to 97.3% for the three months ended June 30, 2021. Also see the discussion above under “Overview—Trends.”
A detailed discussion of our results of operations follows the table below (in thousands, except per share data).
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | Change |
| 2022 | | 2021 | | $ | | % |
REVENUES | | | | | | | |
Direct premiums written | $ | 532,527 | | | $ | 473,627 | | | $ | 58,900 | | | 12.4 | % |
Change in unearned premium | (103,722) | | | (81,053) | | | (22,669) | | | 28.0 | % |
Direct premium earned | 428,805 | | | 392,574 | | | 36,231 | | | 9.2 | % |
Ceded premium earned | (151,744) | | | (136,402) | | | (15,342) | | | 11.2 | % |
Premiums earned, net | 277,061 | | | 256,172 | | | 20,889 | | | 8.2 | % |
Net investment income | 5,221 | | | 2,858 | | | 2,363 | | | 82.7 | % |
Net realized gains (losses) on investments | (725) | | | 496 | | | (1,221) | | | NM |
Net change in unrealized gains (losses) of equity securities | (8,884) | | | 1,229 | | | (10,113) | | | NM |
Commission revenue | 11,404 | | | 9,860 | | | 1,544 | | | 15.7 | % |
Policy fees | 5,940 | | | 6,575 | | | (635) | | | (9.7) | % |
Other revenue | 1,989 | | | 1,991 | | | (2) | | | (0.1) | % |
Total revenues | 292,006 | | | 279,181 | | | 12,825 | | | 4.6 | % |
OPERATING COSTS AND EXPENSES | | | | | | | |
Losses and loss adjustment expenses | 200,304 | | | 167,221 | | | 33,083 | | | 19.8 | % |
General and administrative expenses | 79,291 | | | 81,866 | | | (2,575) | | | (3.1) | % |
Total operating costs and expenses | 279,595 | | | 249,087 | | | 30,508 | | | 12.2 | % |
Interest and amortization of debt issuance costs | 1,731 | | | 35 | | | 1,696 | | | 4,845.7 | % |
| | | | | | | |
INCOME (LOSS) BEFORE INCOME TAXES | 10,680 | | | 30,059 | | | (19,379) | | | (64.5) | % |
Income tax expense (benefit) | 3,310 | | | 8,118 | | | (4,808) | | | (59.2) | % |
NET INCOME (LOSS) | $ | 7,370 | | | $ | 21,941 | | | $ | (14,571) | | | (66.4) | % |
Other comprehensive income (loss), net of taxes | (29,656) | | | 7,996 | | | (37,652) | | | NM |
COMPREHENSIVE INCOME (LOSS) | $ | (22,286) | | | $ | 29,937 | | | $ | (52,223) | | | NM |
DILUTED EARNINGS (LOSS) PER SHARE DATA: | | | | | | | |
Diluted earnings (loss) per common share | $ | 0.24 | | | $ | 0.70 | | | $ | (0.46) | | | (65.7) | % |
Weighted average diluted common shares outstanding | 30,883 | | | 31,310 | | | (427) | | | (1.4) | % |
| | | | | | | |
NM – Not Meaningful | | | | | | | |
Direct premiums written increased by $58.9 million, or 12.4%, for the quarter ended June 30, 2022, driven by premium growth within our Florida business of $52.8 million, or 13.2%, and premium growth in our other states business of $6.1 million, or 8.3%, as compared to the same period of the prior year. Rate increases approved in 2021 and 2022 for Florida and for certain other states, as discussed below, were the principal driver of higher written premiums. In total policies in force declined 48,975, or
5.2%, from 943,593 at December 31, 2021 to 894,618 at June 30, 2022. A summary of the recent rate increases which are driving increases in written premium are as follows:
•In May 2022, the Company filed a rate increase with the FLOIR for an overall 14.9% rate increase for UPCIC on Florida personal residential homeowners’ line of business which became effective June 1, 2022, for new business and November 4, 2022, for renewals. This filing was made on a “ Use and File” basis.
•In December 2021, the FLOIR approved an overall 3.9% rate increase for UPCIC on Florida personal residential homeowners’ line of business, effective January 2022 for new business and March 2022 for renewals.
•In September 2021, the FLOIR approved an overall 14.9% rate increase for UPCIC on Florida personal residential homeowners’ line of business, effective September 2021 for new business and November 2021 for renewals.
•In addition, during the past year, rate increases for UPCIC were approved in Alabama, Georgia, Indiana, Minnesota, North Carolina, South Carolina, Pennsylvania and Virginia.
These rate increases are applied on new business submissions and renewals from the effective date of their renewal and then are earned subsequently over the policy period. The recent rate increases in Florida are in response to rising claim costs driven by higher costs of material and labor associated with claims, the cost of weather events, the rising cost of catastrophe and other reinsurance protecting policyholders and, more importantly, the impact of “social inflation” on claims as claim settlements increasingly have involved inflated demands, representation, and litigation. In addition, the Insurance Entities’ policies provide for coverage limits to be adjusted at renewal based on third-party data sources that monitor factors such as changes in costs for residential building materials and labor.
During 2022, management continued efforts to prudently manage policy counts and exposures intended to slow the growth of written premiums relating to new business compared to prior years while the above rate increases are taking effect. Reduced new business writings, declines in renewal retentions during 2022 and the impact of selected policy non-renewals, have resulted in a decrease in policies in force during the quarter of 22,127, or 2.4%, from 916,745 at March 31, 2022 to 894,618 at June 30, 2022. Direct premiums written continue to increase across the majority of states in which we conduct business. As a result of our business strategy, policy premium rate increases, lower renewal retention, fewer new business policies written and disciplined underwriting initiatives, we have seen a decrease in policy count, but an increase in in-force premium and total insured value in a majority of states for the past three years. In total, we wrote policies in 19 states during both of the second quarters of 2022 and 2021. In addition, we are authorized to do business in Tennessee and Wisconsin and are proceeding with product filings in those states. At June 30, 2022, policies in force decreased 82,633 policies, or 8.5%; premium in force increased $148.0 million, or 9.1%; and total insured value increased $8.2 billion, or 2.6%, compared to June 30, 2021.
The following table provides direct premiums written for Florida and Other States for the three months ended June 30, 2022 and 2021 (dollars in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| For the Three Months Ended | | | | |
| June 30, 2022 | | June 30, 2021 | | Growth year over year |
State | Direct Premiums Written | | % | | Direct Premiums Written | | % | | $ | | % |
Florida | $ | 453,168 | | | 85.1 | % | | $ | 400,370 | | | 84.5 | % | | $ | 52,798 | | | 13.2 | % |
Other states | 79,359 | | | 14.9 | % | | 73,257 | | | 15.5 | % | | 6,102 | | | 8.3 | % |
Total | $ | 532,527 | | | 100.0 | % | | $ | 473,627 | | | 100.0 | % | | $ | 58,900 | | | 12.4 | % |
We seek to prudently grow and generate long-term rate adequate premium in each state where we offer policies. Our diversification strategy seeks to increase business outside of Florida and to improve geographical distribution within Florida. Premium growth outside Florida is a measure monitored by management in its efforts to meet that objective.
Direct premium earned increased by $36.2 million, or 9.2%, for the quarter ended June 30, 2022, reflecting the earning of premiums written over the past 12 months including the benefit of rate changes due to primary rate filings, filings to cover increased reinsurance costs as well as policy premium adjustments due to increases in insured values caused by inflation.
Reinsurance enables our Insurance Entities to limit potential exposures to catastrophic events and other covered events. Ceded premium represents premiums paid to reinsurers for this protection and is a cost which reduces net written and net earned premiums. Ceded premium earned increased $15.3 million, or 11.2%, for the quarter ended June 30, 2022, as compared to the same period of the prior year. The increase in reinsurance costs reflects an increase in the value of exposures we insure; increased pricing when compared to the expired reinsurance program; and differences in the structure and design of the respective programs. Reinsurance costs, as a percentage of direct premium earned, increased from 34.7% for the three months ended June 30, 2021 to 35.4% for the three months ended June 30, 2022. Reinsurance costs associated with each year’s reinsurance program are earned over the annual policy period which typically runs from June 1st to May 31st. See the discussion above for the Insurance Entities’ 2022-2023 reinsurance programs and “Item 1—Note 4 (Reinsurance).”
Premiums earned, net of ceded premium earned, grew by 8.2%, or $20.9 million, to $277.1 million for the three months ended June 30, 2022, reflecting an increase in direct premium earned partially offset by increased costs for reinsurance.
Net investment income was $5.2 million for the three months ended June 30, 2022, compared to $2.9 million for the same period in 2021, an increase of $2.4 million, or 82.7%. In the fourth quarter of 2021, we saw increases in investment yields as the Federal Reserve took action to address the market concerns of inflation and employment. As a result, liquidity generated by our portfolio from interest payments, principal repayments and new investments are being invested at higher rates, resulting in overall increased investment returns on our portfolio.
Total invested assets were $1,106.6 million as of June 30, 2022 compared to $1,093.7 million as of December 31, 2021. The increase is attributable to capital contributions from UIH, excess cash balances invested in the portfolio, receipt of interest payments partially offset by unrealized losses on available-for-sale debt securities. Unrealized losses reverse over time as debt instruments are generally held to maturity. Cash and cash equivalents were $317.0 million at June 30, 2022 compared to $250.5 million at December 31, 2021, an increase of 26.5%. This increase is largely attributable to changes in operational cash flows since year end. Cash and cash equivalents are invested short term until needed to settle loss and LAE payments, reinsurance premium payments and operating cash needs or until they are deployed by our investment advisors.
Yields from cash and cash equivalents, short-term investments and the available-for-sale debt portfolio are dependent on the composition of the portfolio, future market forces, monetary policy and interest rate policy from the Federal Reserve. During most of 2021, the Federal Reserve broadly maintained lower interest rates, which impacted the effective yields on newly purchased available-for-sale debt securities and overnight cash purchases and short-term investments. This overall trend changed in late 2021 and into 2022 as inflation worries began to impact the financial markets, including the markets’ concern over future Federal Reserve actions of rate hikes and other actions to address inflation concerns. As a result, we saw increased yields on securities purchased in late 2021 and 2022 and increased unrealized losses on our portfolio, reflected after-tax in the equity section of our balance sheet as increased market yields negatively impacted the fair value of much of our available-for-sale debt securities.
Although we generally hold the vast majority of debt securities to maturity, we sell investments, including securities, from our investment portfolio from time to time to meet our investment objectives or take advantage of market opportunities. During the three months ended June 30, 2022, sales of available-for-sale debt securities resulted in net realized losses of $0.9 million and sales of equity securities resulted in net realized gains of $0.2 million, generating total net realized losses of $0.7 million during the second quarter of 2022. During the three months ended June 30, 2021, sales of available-for-sale debt securities resulted in net realized losses of $0.2 million and sales of equity securities resulted in net realized gains of $0.7 million, in total generating net realized gains of $0.5 million. See “Item 1—Note 3 (Investments).”
There was an $8.9 million net unrealized loss in equity securities during the three months ended June 30, 2022, largely driven by macro inflationary pressures and the uncertain recessionary outlook, which put pressure on domestic equities broadly, compared to a $1.2 million net unrealized gain in equity securities during the three months ended June 30, 2021. Net change in unrealized gains or losses reflected on the income statement are the result of changes in the fair market value of our equity securities during the period for securities still held at the end of the reported period and the reversal of unrealized gains or losses for securities sold during the period. See “Item 1—Note 3 (Investments).”
Commission revenue is comprised principally of brokerage commissions we earn from third-party reinsurers (excluding the FHCF) on reinsurance placed for the Insurance Entities. Commission revenue is earned pro-rata over the reinsurance policy period which runs from June 1st to May 31st of the following year. For the three months ended June 30, 2022, commission revenue was $11.4 million, compared to $9.9 million for the three months ended June 30, 2021. The increase in commission revenue of $1.5 million, or 15.7%, for the three months ended June 30, 2022 was primarily due to increased commissions from third-party reinsurers earned on increased reinsurance premiums which is attributable to growth in our insured values for this year’s reinsurance program as well as the difference in pricing and structure associated with our reinsurance program when compared to the prior year.
Policy fees were $5.9 million for the three months ended June 30, 2022 compared to $6.6 million for the same period in 2021. The decrease of $0.6 million, or 9.7%, was the result of a decrease in the combined total number of new and renewal policies written during the three months ended June 30, 2022 compared to the same period in 2021 in states where we are permitted to charge this fee.
Other revenue, representing revenue from policy installment fees, premium financing and other miscellaneous income, was $2.0 million for the three months ended June 30, 2022 compared to $2.0 million for the same period in 2021.
Core revenue, representing total GAAP revenue, excluding net realized gains (losses) on investments and net changes in unrealized gains (losses) of equity securities, was $301.6 million for the three months ended June 30, 2022 compared to $277.5 million for the same period in 2021.
The following table presents losses and LAE incurred on a direct, ceded and net basis expressed in dollars and as a percent of the respective amounts of premiums earned. These amounts are further categorized as i) core losses, ii) weather events for the current accident year and iii) prior years’ reserve development (dollars in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended June 30, 2022 |
| Direct | | Loss Ratio | | Ceded | | Loss Ratio | | Net | | Loss Ratio |
Premiums earned | $ | 428,805 | | | | | $ | 151,744 | | | | | $ | 277,061 | | | |
| | | | | | | | | | | |
Loss and loss adjustment expenses: | | | | | | | | | | | |
Core losses | $ | 196,630 | | | 45.9 | % | | $ | 36 | | | — | % | | $ | 196,594 | | | 71.0 | % |
Weather events* | — | | | — | | | — | | | — | | | — | | | — | |
Prior years’ reserve development | 63,600 | | | 14.8 | % | | 59,890 | | | 39.5 | % | | 3,710 | | | 1.3 | % |
Total losses and loss adjustment expenses | $ | 260,230 | | | 60.7 | % | | $ | 59,926 | | | 39.5 | % | | $ | 200,304 | | | 72.3 | % |
| | | | | | | | | | | |
*Includes only current year weather events beyond those expected. |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended June 30, 2021 |
| Direct | | Loss Ratio | | Ceded | | Loss Ratio | | Net | | Loss Ratio |
Premiums earned | $ | 392,574 | | | | | $ | 136,402 | | | | | $ | 256,172 | | | |
| | | | | | | | | | | |
Loss and loss adjustment expenses: | | | | | | | | | | | |
Core losses | $ | 159,412 | | | 40.6 | % | | $ | (78) | | | (0.1) | % | | $ | 159,490 | | | 62.3 | % |
Weather events* | — | | | — | | | — | | | — | | | — | | | — | |
Prior years’ reserve development | 116,890 | | | 29.8 | % | | 109,159 | | | 80.0 | % | | 7,731 | | | 3.0 | % |
Total losses and loss adjustment expenses | $ | 276,302 | | | 70.4 | % | | $ | 109,081 | | | 80.0 | % | | $ | 167,221 | | | 65.3 | % |
| | | | | | | | | | | |
*Includes only current year weather events beyond those expected. |
See “Item 1—Note 6 (Liability for Unpaid Losses and Loss Adjustment Expenses)” for change in liability for unpaid losses and LAE.
Management looks at losses and LAE in three areas, as described below and represented in the tables above, each of which has different drivers that impact reported results. As a result, these components of losses and LAE are described separately. Overall losses and LAE, net of reinsurance recoveries, were $200.3 million resulting in a 72.3% net loss and LAE ratio for the quarter ended June 30, 2022. This compares to $167.2 million resulting in a 65.3% net loss and LAE ratio for the quarter ended June 30, 2021.
The Company continues to monitor and adjust its estimate of expected losses and has increased its current year loss estimates and increased estimates associated with prior years’ claims. Over the past three years, even as we have increased our estimates of prospective losses each year, we have recorded adverse claim development on prior years’ loss reserves and further strengthened current year losses during the year to address the increasing impact of Florida’s market disruptions, as well as the impact of inflation from building material costs and labor costs have on the reserving and claim settlement process. The full extent and duration of these market disruptions and inflationary pressures are unknown and still unfolding, and we continue to monitor the impact of such disruptions on the recording and reporting of claim costs. See the discussion above for the Insurance Entities’ 2022-2023 reinsurance programs and “Item 1 - Note 4 (Reinsurance).” Also see the discussion above under “Overview—Trends.”
The factors impacting losses and LAE are as follows:
•Core losses
◦Our core losses consist of all losses and LAE for the current accident year excluding both weather events for the current year beyond those anticipated in our regular accrual process and prior years’ reserve development. Core losses were 45.9% of direct premium earned for the quarter ended June 30, 2022 compared to 40.6% for the same period in 2021. During the quarter ended June 30, 2022 management increased the core loss ratio by one loss ratio point retroactive to January 1, 2022, with the cumulative impact being recorded in the quarter, as a result of worsening trends in overall weather not associated with named storms and in response to changes in estimated losses caused by deteriorating loss trends and higher repair costs as a result of material and labor inflation. The trend in core losses and LAE is increasing year over year as the claims environment in Florida continues to deteriorate and inflation continues to drive repair costs up. Also see the discussion above under “Overview—Trends.” Core losses also increase as premium volume increases year over year.
•Weather events beyond those expected
◦There were no weather events beyond those expected during the quarter ended June 30, 2022.
◦There were no weather events beyond those expected during the quarter ended June 30, 2021.
•Prior years’ reserve development
◦Two drivers influence the amounts recorded as prior years’ reserve development, namely: (i) changes to prior estimates of direct and net ultimate losses on prior accident years excluding major hurricanes and (ii) changes to prior estimates of direct and net ultimate losses on hurricanes.
▪During the quarter ended June 30, 2022, prior years’ reserve development totaled $63.6 million of direct losses and $3.7 million of net unfavorable loss development after the benefit of reinsurance.
•Prior years’ reserve development for the quarter ended June 30, 2022 was $63.6 million offset by ceded losses of $59.9 million resulting in net unfavorable development of $3.7 million. Prior year adverse development includes gross reserve development on Hurricane Irma of $39.3 million, of which $35.6 million was ceded, resulting in net development on Hurricane Irma of $3.7 million in the quarter. In addition to Hurricane Irma development, the Company concluded a commutation during the quarter, increasing ceded prior year loss payments which was offset by a provisory increase in direct prior year incurred but not reported (“IBNR”) amount, resulting in no net effect.
•Excluding hurricanes, there was no prior years’ reserve development for the quarter ended June 30, 2022.
▪For the quarter ended June 30, 2021, direct prior years’ reserve development of $116.9 million, less $109.2 million ceded, resulted in $7.7 million net development.
•For hurricanes, prior years’ reserve development for the quarter ended June 30, 2021 was the result of a direct increase in the ultimate losses for hurricanes of $109.1 million offset by ceded hurricane losses of $109.2 million resulting in net favorable development of $0.1 million. Direct losses increased for Hurricanes Irma, Sally, Michael and Matthew. Ceded losses benefited from changes to estimated non-Florida reinsurance coverage, which has a lower attachment point. As a result of ceded losses exceeding direct losses, net loss development on prior hurricanes was favorable during second quarter of 2021.
•Excluding hurricanes, there was $7.8 million of direct and net prior years’ reserve development for the quarter ended June 30, 2021. This development, from the 2019 and prior accident years, resulted from the settlement on litigated claims exceeding prior estimated amounts.
The financial impact generated by our claims adjusting affiliate from the management of claims, including claim fees ceded by our Insurance Entities to reinsurers, was an increase of $0.2 million for the three months ended June 30, 2022, compared to a benefit of $1.2 million during the three months ended June 30, 2021, driven by the recoveries from reinsurers and internal claim services. The impact was recorded in the condensed consolidated financial statements as a reduction or increase to losses and LAE.
For the three months ended June 30, 2022, general and administrative expenses were $79.3 million compared to $81.9 million during the same period in 2021, as follows (dollars in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended | | | | |
| June 30, | | Change |
| 2022 | | 2021 | | $ | | % |
| $ | | Ratio | | $ | | Ratio | | | | |
Premiums earned, net | $ | 277,061 | | | | | $ | 256,172 | | | | | $ | 20,889 | | | 8.2 | % |
General and administrative expenses: | | | | | | | | | | | |
Policy acquisition costs | 54,100 | | | 19.5 | % | | 56,766 | | | 22.2 | % | | (2,666) | | | (4.7) | % |
Other operating costs | 25,191 | | | 9.1 | % | | 25,100 | | | 9.8 | % | | 91 | | | 0.4 | % |
Total general and administrative expenses | $ | 79,291 | | | 28.6 | % | | $ | 81,866 | | | 32.0 | % | | $ | (2,575) | | | (3.1) | % |
|
General and administrative expenses decreased by $2.6 million, which was the result of a decrease in policy acquisition costs of $2.7 million offset by a slight increase in other operating costs of $0.1 million. The total general and administrative expense ratio was 28.6% for the three months ended June 30, 2022 compared to 32.0% for the same period in 2021.
•The decrease in policy acquisition costs of $2.7 million reflects a reduction in the commission rate paid to agents on the renewal of Florida policies which was reduced by 2 percentage points to 8% effective May 1, 2022, which will benefit future periods as the new rate structure applies prospectively. The decrease in policy acquisition costs as a percentage of premiums earned, net during the quarter is primarily due to the reduction in commissions paid to agents.
•The increase of other operating costs of $0.1 million was primarily higher salary and performance bonus expenses, mostly offset by lower stock-based compensation and policy related expenses. The other operating cost ratio was 9.1% for the three months ended June 30, 2022, compared to 9.8% for the same period in 2021. This reduction in the operating cost ratio reflects several factors including economies of scale as we continue to grow premium, and efficiencies gained from leveraging technology and spending discipline.
As a result of the above, the combined ratio for the second quarter ended June 30, 2022 was 100.9% compared to 97.3% for the same period in 2021. The increase was the result of a decrease in the general and administrative expense ratio offset by an increase in the loss and LAE ratio as described above.
Interest and amortization of debt issuance costs increased by $1.7 million for the three months ended June 30, 2022. The increase in interest and amortization of debt issuance costs is the result of an increase in the outstanding debt as a result of our fourth quarter of 2021 borrowing. See “Item 1—Note 7 (Long-term debt)” for additional details.
Income tax expense was $3.3 million for the quarter ended June 30, 2022 compared to an income tax expense of $8.1 million for the quarter ended June 30, 2021. Our effective tax rate (“ETR”) increased to 31.0% for the three months ended June 30, 2022, as compared to 27.0% for the three months ended June 30, 2021. The ETR increased as a result of a higher ratio of permanent items relative to the amount of income before taxes, principally non-deductible compensation, and a lower level of discrete tax benefits primarily due to an increase in stock forfeitures.
Other comprehensive loss, net of taxes for the three months ended June 30, 2022, was $29.7 million compared to other comprehensive income of $8.0 million for the same period in 2021, reflecting after-tax changes in fair value of available-for-sale debt securities held in our investment portfolio and reclassifications out of accumulated other comprehensive income for available-for-sale debt securities sold. See “Item 1—Note 11 (Other Comprehensive Income (Loss))” for additional information about the amounts comprising other comprehensive income (loss), net of taxes for these periods.
Adjusted operating income, representing GAAP operating income, excluding net realized gains (losses) on investment and net changes in unrealized gains (losses) of equity securities, was $22.0 million for the three months ended June 30, 2022 compared to $28.4 million for the same period in 2021.
Adjusted operating income margin, representing adjusted operating income divided by core revenue, was 7.3% for the three months ended June 30, 2022 compared to 10.2% for the same period in 2021.
Adjusted net income attributable to common stockholders, representing GAAP net income attributable to common stockholders, excluding net realized gains (losses) on investment and net changes in unrealized gains (losses) of equity securities, net of tax was $14.6 million for the three months ended June 30, 2022 compared to $20.6 million for the same period in 2021.
Diluted adjusted earnings per common share, representing adjusted net income available to common stockholders divided by weighted average diluted common shares outstanding, was $0.47 for the three months ended June 30, 2022 compared to $0.65 for the same period in 2021.
Results of Operations — Six Months Ended June 30, 2022 Compared to Six Months Ended June 30, 2021
Net income was $24.9 million for the six months ended June 30, 2022 compared to $48.3 million for the six months ended June 30, 2021. Weighted average diluted common shares outstanding for the six months ended June 30, 2022 were lower by 0.7% to 31.1 million shares from 31.3 million shares for the same period of the prior year. Diluted earnings per share for the six months ended June 30, 2022 was $0.80 compared to $1.54 in 2021. Benefiting the six months ended June 30, 2022 were increases in premiums earned, net, an increase in commission revenue, and an increase in net investment income partially offset by an increase in operating costs and expenses, and an increase in both the realized and unrealized losses and decreased revenue from policy fees and other revenue. Direct premium earned and premiums earned, net were up 9.8% and 9.3%, respectively, due to premium growth in 16 of the 19 states in which we are licensed and writing during the past 12 months as a result of rate increases implemented during 2021 and 2022, partially offset by higher costs for reinsurance flowing through to premiums earned, net. The net loss and LAE ratio was 70.6% for the six months ended June 30, 2022, compared to 62.3% for the same period in 2021 reflecting higher core net losses and an increase in excess weather events beyond those expected partially offset by lower prior years’ reserve development. As a result of the above and as further explained below, the combined ratio for the six months ended June 30, 2022 was 99.4% compared to 95.2% for the six months ended June 30, 2021. See “Overview - Trends.”
A detailed discussion of our results of operations follows the table below (in thousands, except per share data).
| | | | | | | | | | | | | | | | | | | | | | | |
| Six Months Ended June 30, | | Change |
| 2022 | | 2021 | | $ | | % |
REVENUES | | | | | | | |
Direct premiums written | $ | 929,008 | | | $ | 838,941 | | | $ | 90,067 | | | 10.7 | % |
Change in unearned premium | (85,600) | | | (70,761) | | | (14,839) | | | 21.0 | % |
Direct premium earned | 843,408 | | | 768,180 | | | 75,228 | | | 9.8 | % |
Ceded premium earned | (297,283) | | | (268,703) | | | (28,580) | | | 10.6 | % |
Premiums earned, net | 546,125 | | | 499,477 | | | 46,648 | | | 9.3 | % |
Net investment income | 9,263 | | | 5,844 | | | 3,419 | | | 58.5 | % |
Net realized gains (losses) on investments | (667) | | | 1,038 | | | (1,705) | | | NM |
Net change in unrealized gains (losses) of equity securities | (12,280) | | | 735 | | | (13,015) | | | NM |
Commission revenue | 22,565 | | | 18,986 | | | 3,579 | | | 18.9 | % |
Policy fees | 10,719 | | | 11,962 | | | (1,243) | | | (10.4) | % |
Other revenue | 3,763 | | | 3,896 | | | (133) | | | (3.4) | % |
Total revenues | 579,488 | | | 541,938 | | | 37,550 | | | 6.9 | % |
OPERATING COSTS AND EXPENSES | | | | | | | |
Losses and loss adjustment expenses | 385,410 | | | 311,184 | | | 74,226 | | | 23.9 | % |
General and administrative expenses | 157,588 | | | 164,289 | | | (6,701) | | | (4.1) | % |
Total operating costs and expenses | 542,998 | | | 475,473 | | | 67,525 | | | 14.2 | % |
Interest and amortization of debt issuance costs | 3,339 | | | 55 | | | 3,284 | | | 5970.9 | % |
INCOME BEFORE INCOME TAXES | 33,151 | | | 66,410 | | | (33,259) | | | (50.1) | % |
Income tax expense | 8,244 | | | 18,061 | | | (9,817) | | | (54.4) | % |
NET INCOME | $ | 24,907 | | | $ | 48,349 | | | $ | (23,442) | | | (48.5) | % |
Other comprehensive income (loss), net of taxes | (72,566) | | | (8,914) | | | (63,652) | | | 714.1 | % |
COMPREHENSIVE INCOME (LOSS) | $ | (47,659) | | | $ | 39,435 | | | $ | (87,094) | | | (220.9) | % |
DILUTED EARNINGS PER SHARE DATA: | | | | | | | |
Diluted earnings per common share | $ | 0.80 | | | $ | 1.54 | | | $ | (0.74) | | | (48.1) | % |
Weighted average diluted common shares outstanding | 31,060 | | | 31,292 | | | (232) | | | (0.7) | % |
| | | | | | | |
NM – Not Meaningful | | | | | | | |
Direct premiums written increased by $90.1 million, or 10.7%, for the six months ended June 30, 2022, driven by premium growth within our Florida business of $80.2 million, or 11.3%, and premium growth in our other states business of $9.8 million, or 7.5%, as compared to the same period of the prior year. Rate increases approved in 2021 and 2022 for Florida and for certain other states, as discussed below, were the principal driver of higher written premiums. In total, policies in force declined 48,975,
or 5.2%, from 943,593 at December 31, 2021 to 894,618 at June 30, 2022. A summary of the recent rate increases which are driving increases in written premium are as follows:
•In May 2022, the Company filed a rate increase with the FLOIR for an overall 14.9% rate increase for UPCIC on Florida personal residential homeowners’ line of business, effective June 1, 2022, for new business and November 4, 2022, for renewals. This filing was made on a “Use and File” basis.
•In December 2021, the FLOIR approved an overall 3.9% rate increase for UPCIC on Florida personal residential homeowners’ line of business, effective January 2022 for new business and March 2022 for renewals.
•In September 2021, the FLOIR approved an overall 14.9% rate increase for UPCIC on Florida personal residential homeowners’ line of business, effective September 2021 for new business and November 2021 for renewals.
•In December 2020, the FLOIR approved an overall 7.0% rate increase for UPCIC on Florida personal residential homeowners’ line of business, effective December 2020 for new business and March 2021 for renewals.
•In addition, during the past year, rate increases for UPCIC were approved in Alabama, Georgia, Indiana, Minnesota, North Carolina, South Carolina, Pennsylvania and Virginia.
These rate increases are applied on new business submissions and renewals from the effective date of their renewal, and then are earned subsequently over the policy period. The recent rate increases in Florida are in response to rising claim costs driven by higher costs of material and labor associated with claims, the cost of weather events, the rising cost of catastrophe and other reinsurance protecting policyholders and, more importantly, the impact of “social inflation” on claims as claim settlements increasingly have involved inflated demands, representation, and litigation. In addition, the Insurance Entities’ policies provide for coverage limits to be adjusted at renewal based on third-party data sources that monitor factors such as changes in costs for residential building materials and labor.
During 2022, management continued efforts to prudently manage policy counts and exposures intended to slow the growth of written premiums relating to new business compared to prior years while the above rate increases are taking effect. Reduced new business writings, declines in renewal retentions in 2022 and the impact of selected policy non-renewals, has resulted in a decrease in policies in force of 48,975, or 5.2%, during 2022 from 943,593 at December 31, 2021 to 894,618 at June 30, 2022. Direct premiums written continue to increase across the majority of states in which we conduct business. As a result of our business strategy, rate changes and disciplined underwriting initiatives, we have seen a decrease in policy count, but an increase in in-force premium and total insured value in a majority of states for the past three years. In total, we wrote policies in 19 states during each of 2022 and 2021. We actively wrote policies in 19 states during 2021 and 2022. In addition, we are authorized to do business in Tennessee and Wisconsin and are proceeding with product filings in those states. At June 30, 2022, policies in force decreased 82,633 policies, or 8.5%, premium in force increased $148.0 million, or 9.1%, and total insured value increased $8.2 billion, or 2.6%, compared to June 30, 2021.
The following table provides direct premiums written for Florida and Other States for the six months ended June 30, 2022 and 2021 (dollars in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| For the Six Months Ended | | | | |
| June 30, 2022 | | June 30, 2021 | | Growth year over year |
State | Direct Premiums Written | | % | | Direct Premiums Written | | % | | $ | | % |
Florida | $ | 787,605 | | | 84.8 | % | | $ | 707,381 | | | 84.3 | % | | $ | 80,224 | | | 11.3 | % |
Other states | 141,403 | | | 15.2 | % | | 131,560 | | | 15.7 | % | | 9,843 | | | 7.5 | % |
Total | $ | 929,008 | | | 100.0 | % | | $ | 838,941 | | | 100.0 | % | | $ | 90,067 | | | 10.7 | % |
| | | | | | | | | | | |
We seek to prudently grow and generate long-term rate adequate premium in each state where we offer policies. Our diversification strategy seeks to increase business outside of Florida and to improve geographical distribution within Florida. Premium growth outside Florida is a measure monitored by management in its efforts to meet that objective.
Direct premium earned increased by $75.2 million, or 9.8%, for the six months ended June 30, 2022, reflecting the earning of premiums written over the past 12 months including the benefit of rate changes due to primary rate filings, filings to cover increased reinsurance costs as well as policy premium adjustments due to increases in insured values caused by inflation.
Reinsurance enables our Insurance Entities to limit potential exposures to catastrophic events and other covered events. Ceded premium represents premiums paid to reinsurers for this protection and is a cost which reduces net written and net earned premiums. Ceded premium earned increased $28.6 million, or 10.6%, for the six months ended June 30, 2022 as compared to the same period of the prior year. The increase in reinsurance costs reflects an increase in the value of exposures we insure; increased pricing when compared to the expired reinsurance program and differences in the structure and design of the respective programs. Reinsurance costs, as a percentage of direct premium earned, increased from 35.0% in 2021 to 35.2% in 2022. Reinsurance costs associated with each year’s reinsurance program are earned over the annual policy period which typically runs from June 1st to
May 31st. See the discussion above for the Insurance Entities’ 2022-2023 reinsurance programs and “Item 1— Note 4 (Reinsurance).”
Premiums earned, net of ceded premium earned, grew by 9.3%, or $46.6 million, to $546.1 million for the six months ended June 30, 2022, reflecting an increase in direct premium earned offset by increased costs for reinsurance.
Net investment income was $9.3 million for the six months ended June 30, 2022, compared to $5.8 million for the same period in 2021, an increase of $3.4 million, or 58.5%. In the fourth quarter of 2021, we saw increases in investment yields as the Federal Reserve took action to address the market concerns of inflation and employment. As a result, liquidity generated by our portfolio from interest payments, principal repayments and new investments are being invested at higher rates, resulting in overall increased investment returns on our portfolio.
Total invested assets were $1,106.6 million as of June 30, 2022 compared to $1,093.7 million as of December 31, 2021. The increase is attributable to capital contributions from UIH, excess cash balances invested in the portfolio, receipt of interest payments partially offset by unrealized losses on available-for-sale debt securities. Unrealized losses reverse over time as debt instruments are generally held to maturity. Cash and cash equivalents were $317.0 million at June 30, 2022 compared to $250.5 million at December 31, 2021, an increase of 26.5%. This increase is largely attributable to changes in operational cash flows since year end. Cash and cash equivalents are invested short term until needed to settle loss and LAE payments, reinsurance premium payments and operating cash needs or until they are deployed by our investment advisors.
Yields from cash and cash equivalents, short-term investments and the available-for-sale debt portfolio are dependent on the composition of the portfolio, future market forces, monetary policy and interest rate policy from the Federal Reserve. During most of 2021, the Federal Reserve broadly maintained lower interest rates, which impacted the effective yields on newly purchased available-for-sale debt securities and overnight cash purchases and short-term investments. This overall trend changed in late 2021 and into 2022 as inflation worries began to impact the financial markets, including the markets’ concern over future Federal Reserve actions of rate hikes and other actions to address inflation concerns. As a result, we saw increased yields on securities purchased in late 2021 and 2022 and increased unrealized losses on our portfolio reflected after-tax in the equity section of our balance sheet as increased market yields negatively impacted the fair value of much of our available-for-sale debt securities.
We sell investments, including securities, from our investment portfolio from time to time to meet our investment objectives or take advantage of market opportunities. During the six months ended June 30, 2022, sales of available-for-sale debt securities resulted in a net realized losses of $1.2 million and sales of equity securities resulted in net realized gains of $0.5 million, generating total net realized losses of $0.7 million. During the six months ended June 30, 2021, sales of available-for-sale debt securities resulted in net realized losses of $0.5 million, sales of equity securities resulted in net realized gains of $1.1 million, and the sale of an investment real estate property resulted in a realized gain of $0.4 million, in total generating net realized gains of $1.0 million. See “Item 1—Note 3 (Investments).”
There was a $12.3 million net unrealized loss in equity securities during the six months ended June 30, 2022 compared to a $0.7 million net unrealized loss in equity securities during the six months ended June 30, 2021. Net change in unrealized gains or losses reflected on the income statement are the result of changes in the fair market value of our equity securities during the period for securities still held at the end of the reported period and the reversal of unrealized gains or losses for securities sold during the period. See “Item 1—Note 3 (Investments).”
Commission revenue is comprised principally of brokerage commissions we earn from third-party reinsurers (excluding the FHCF) on reinsurance placed for the Insurance Entities. Commission revenue is earned pro-rata over the reinsurance policy period which runs from June 1st to May 31st of the following year. For the six months ended June 30, 2022, commission revenue was $22.6 million, compared to $19.0 million for the six months ended June 30, 2021. The increase in commission revenue of $3.6 million, or 18.9%, for the six months ended June 30, 2022 was primarily due to increased commissions from third-party reinsurers earned on increased reinsurance premiums which is attributable to growth in our insured values as well as the difference in pricing and structure associated with our reinsurance program when compared to the prior year.
Policy fees for the six months ended June 30, 2022 were $10.7 million compared to $12.0 million for the same period in 2021. The decrease of $1.2 million, or 10.4%, was the result of a decrease in the combined total number of new and renewal policies written during the six months ended June 30, 2022 compared to the same period in 2021 in states where we are permitted to charge this fee.
Other revenue, representing revenue from policy installment fees, premium financing and other miscellaneous income, was $3.8 million for the six months ended June 30, 2022 compared to $3.9 million for the same period in 2021.
Core revenue, representing total GAAP revenue, excluding net realized gains (losses) on investments and net changes in unrealized gains (losses) of equity securities, was $592.4 million for the six months ended June 30, 2022 compared to $540.2 million for the same period in 2021.
The following table presents losses and LAE incurred on a direct, ceded and net basis expressed in dollars and as a percent of the respective amounts of premiums earned. These amounts are further categorized as i) core losses, ii) weather events for the current accident year and iii) prior years’ reserve development (dollars in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Six Months Ended June 30, 2022 |
| Direct | | Loss Ratio | | Ceded | | Loss Ratio | | Net | | Loss Ratio |
Premiums earned | $ | 843,408 | | | | | $ | 297,283 | | | | | $ | 546,125 | | | |
| | | | | | | | | | | |
Loss and loss adjustment expenses: | | | | | | | | | | | |
Core losses | $ | 376,580 | | | 44.7 | % | | $ | 80 | | | — | % | | $ | 376,500 | | | 69.0 | % |
Weather events* | 4,545 | | | 0.5 | % | | — | | | — | % | | 4,545 | | | 0.8 | % |
Prior years’ reserve development | 74,260 | | | 8.8 | % | | 69,895 | | | 23.5 | % | | 4,365 | | | 0.8 | % |
Total losses and loss adjustment expenses | $ | 455,385 | | | 54.0 | % | | $ | 69,975 | | | 23.5 | % | | $ | 385,410 | | | 70.6 | % |
| | | | | | | | | | | |
*Includes only current year weather events beyond those expected. |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Six Months Ended June 30, 2021 |
| Direct | | Loss Ratio | | Ceded | | Loss Ratio | | Net | | Loss Ratio |
Premiums earned | $ | 768,180 | | | | | $ | 268,703 | | | | | $ | 499,477 | | | |
| | | | | | | | | | | |
Loss and loss adjustment expenses: | | | | | | | | | | | |
Core losses | $ | 304,640 | | | 39.7 | % | | $ | (50) | | | — | % | | $ | 304,690 | | | 61.0 | % |
Weather events* | — | | | — | | | — | | | — | | | — | | | — | |
Prior years’ reserve development | 208,960 | | | 27.2 | % | | 202,466 | | | 75.3 | % | | 6,494 | | | 1.3 | % |
Total losses and loss adjustment expenses | $ | 513,600 | | | 66.9 | % | | $ | 202,416 | | | 75.3 | % | | $ | 311,184 | | | 62.3 | % |
| | | | | | | | | | | |
*Includes only current year weather events beyond those expected. |
See “Item 1—Note 6 (Liability for Unpaid Losses and Loss Adjustment Expenses)” for change in liability for unpaid losses and LAE.
Management looks at losses and LAE in three areas, as described below and represented in the tables above, each of which has different drivers that impact reported results. As a result, these components of losses and LAE are described separately. Overall losses and LAE, net of reinsurance recoveries, were $385.4 million resulting in a 70.6% net loss and LAE ratio for the six months ended June 30, 2022. This compares to $311.2 million resulting in a 62.3% net loss and LAE ratio for the six months ended June 30, 2021.
The Company continues to monitor and adjust its estimate of expected losses and has increased its current year loss estimates and increased estimates associated with prior years’ claims. Over the past three years, even as we have increased our estimates of prospective losses each year, we have recorded adverse claim development on prior years’ loss reserves and further strengthened current year losses during the year to address the increasing impact of Florida’s market disruptions, as well as the impact of inflation from building material costs and labor costs, have on the reserving and claim settlement process. The full extent and duration of these market disruptions and inflationary pressures are unknown and still unfolding, and we continue to monitor the impact of such disruptions on the recording and reporting of claim costs. See the discussion above for the Insurance Entities’ 2022-2023 reinsurance programs and “Item 1 - Note 4 (Reinsurance).” Also see the discussion above under “Overview—Trends.”
The factors impacting losses and LAE are as follows:
•Core losses
◦Our core losses consist of all losses and LAE for the current accident year excluding both weather events for the current year beyond those anticipated in our regular accrual process and prior years’ reserve development. Core losses were 44.7% of direct premium earned for the six months ended June 30, 2022 compared to 39.7% for the same period in 2021. During the quarter ended June 30, 2022, management increased the core loss ratio by one loss ratio point retroactive to January 1, 2022, with the cumulative impact being recorded in the quarter. This was done in response to worsening weather experience during the quarter. Management elected to address this through an increase in the current accident year loss pick rather than record specific weather events given the overall trends in recent years for weather not associated with named storms and in response to changes in estimated losses caused by deteriorating loss trends and higher repair costs as a result of material and labor inflation. The trend in core losses and LAE is increasing year over year as the claims environment in Florida
continues to deteriorate and inflation continues to drive repair costs up. Also see the discussion above under “Overview—Trends.” Core losses also increase as premium volume increases year over year.
•Weather events beyond those expected
◦There were $4.5 million of weather events beyond those expected and included in the core losses during the six months ended June 30, 2022.
◦There were no weather events beyond those expected and included in the core losses during the six months ended June 30, 2021.
•Prior years’ reserve development
◦Two drivers influence the amounts recorded as prior years’ reserve development, namely: (i) changes to prior estimates of direct and net ultimate losses on prior accident years excluding major hurricanes and (ii) changes to prior estimates of direct and net ultimate losses on hurricanes.
▪During the six months ended June 30, 2022, prior years’ reserve development totaled $74.3 million of direct losses and $4.4 million of net unfavorable loss development after the benefit of reinsurance.
•For hurricanes, prior years’ reserve development for the six months ended June 30, 2022 was the result of a direct increase in the ultimate losses for several hurricanes of $74.3 million offset by ceded hurricane losses of $69.9 million resulting in net unfavorable development of $4.4 million. Direct losses increased for Hurricanes Irma, Sally, Michael and Matthew. Prior year adverse development includes gross reserve development on Hurricane Irma of $49.8 million, of which $45.6 million was ceded, resulting in net development on Hurricane Irma of $4.2 million in the period. Additionally, the Company concluded a favorable commutation during the quarter, increasing ceded prior year loss payments which was offset by a provisory increase in direct prior year IBNR amount, resulting in no net effect. Hurricane Matthew direct and net losses increased $0.1 million.
•Excluding hurricanes, there was no direct and net prior years’ reserve development for the six months ended June 30, 2022.
▪For the six months ended June 30, 2021 prior years’ reserve development totaled $209.0 million of direct losses and $6.5 million of net losses after the benefit of reinsurance.
•For hurricanes, prior years’ reserve development for the six months ended June 30, 2021 was the result of a direct increase in the ultimate losses for hurricanes of $201.2 million offset by ceded hurricane losses of $202.5 million resulting in net favorable development of $1.3 million. Direct losses increased for Hurricanes Irma, Sally, Michael and Matthew. Ceded losses benefited from changes to estimated non-Florida reinsurance coverage, which has a lower attachment point. As a result of ceded losses exceeding direct losses, net loss development on prior hurricanes was favorable during the six months ended June 30, 2021.
•Excluding hurricanes, there was $7.8 million of direct and net prior years’ reserve development for the six months ended June 30, 2021. This development, from the 2019 and prior accident years, resulted from the settlement on litigated claims exceeding prior estimated amounts.
The financial benefit generated by our claims adjusting affiliate from the management of claims, including claim fees ceded by our Insurance Entities to reinsurers, was $1.9 million for the six months ended June 30, 2022, compared to $9.3 million during the six months ended June 30, 2021, driven by the recoveries from reinsurers and internal claim services. The benefit was recorded in the condensed consolidated financial statements as a reduction to losses and LAE.
General and administrative expenses were $157.6 million for the six months ended June 30, 2022, compared to $164.3 million during the same period in 2021, as follows (dollars in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Six Months Ended | | | | |
| June 30, | | Change |
| 2022 | | 2021 | | $ | | % |
| $ | | Ratio | | $ | | Ratio | | | | |
Premiums earned, net | $ | 546,125 | | | | | $ | 499,477 | | | | | $ | 46,648 | | | 9.3 | % |
General and administrative expenses: | | | | | | | | | | | |
Policy acquisition costs | 108,823 | | | 19.9 | % | | 113,224 | | | 22.7 | % | | (4,401) | | | (3.9) | % |
Other operating costs (1) | 48,765 | | | 8.9 | % | | 51,065 | | | 10.2 | % | | (2,300) | | | (4.5) | % |
| | | | | | | | | | | |
Total general and administrative expenses | $ | 157,588 | | | 28.8 | % | | $ | 164,289 | | | 32.9 | % | | $ | (6,701) | | | (4.1) | % |
| | | | | | | | | | | |
General and administrative expenses decreased by $6.7 million, which was the result of a decrease in policy acquisition costs of $4.4 million and other operating costs of $2.3 million. The total general and administrative expense ratio was 28.8% for the six months ended June 30, 2022 compared to 32.9% for the six months ended June 30, 2021.
•The decrease in policy acquisition costs of $4.4 million reflects a reduction in the commission rate paid to agents on the renewal of Florida policies which was reduced by 2 percentage points to 10% effective April 1, 2021. The commission rate paid to agents on the renewal of Florida policies was reduced by an additional 2 percentage points to 8% effective May 1, 2022, which will benefit future periods as the new rate structure applies prospectively. The decrease in policy acquisition costs as a percentage of premiums earned, net during the period is primarily due to the reduction in commissions paid to agents.
•The decrease in other operating costs of $2.3 million primarily reflects lower employee benefits, stock-based compensation, and performance bonus accruals. The other operating cost ratio was 8.9% for the six months ended June 30, 2022 compared to 10.2% in the six months ended June 30, 2021. This reduction reflects several factors including economies of scale as we continue to grow premium, and efficiencies gained from leveraging technology, and spending discipline.
As a result of the above, the combined ratio for the six months ended June 30, 2022 was 99.4% compared to 95.2% for the same period in 2021. The increase was the result of a decrease in the general and administrative expense ratio offset by an increase in the loss and LAE ratio as described above.
Interest and amortization of debt issuance costs increased by $3.3 million for the six months ended June 30, 2022. The increase in interest and amortization of debt issuance costs is the result of an increase in the outstanding debt as a result of our fourth quarter of 2021 borrowing. See “Item 1—Note 7 (Long-term debt)” for additional details.
Income tax expense was $8.2 million for the six months ended June 30, 2022, compared to income tax expense of $18.1 million for the six months ended June 30, 2021. Our ETR decreased to 24.9% for the six months ended June 30, 2022, as compared to 27.2% for the six months ended June 30, 2021. The ETR decreased as a result of a lower ratio of permanent items relative to the amount of income before taxes, principally non-deductible compensation, and a higher level of discrete tax benefits primarily due to an increase in the Florida corporate income tax rate enacted on January 1, 2022.
Other comprehensive loss, net of taxes for the six months ended June 30, 2022, was $72.6 million compared to other comprehensive loss of $8.9 million for the same period in 2021, reflecting after-tax changes in fair value of available-for-sale debt securities held in our investment portfolio and reclassifications out of accumulated other comprehensive income for available-for-sale debt securities sold. See “Item 1—Note 11 (Other Comprehensive Income (Loss))” for additional information about the amounts comprising other comprehensive income (loss), net of taxes for these periods.
Adjusted operating income, representing GAAP operating income, excluding net realized gains (losses) on investment and net changes in unrealized gains (losses) of equity securities, was $49.4 million for the six months ended June 30, 2022 compared to $64.7 million for the same period in 2021.
Adjusted operating income margin, representing adjusted operating income divided by core revenue, was 8.3% for the six months ended June 30, 2022 compared to 12.0% for the same period in 2021.
Adjusted net income attributable to common stockholders, representing GAAP net income attributable to common stockholders, excluding net realized gains (losses) on investment and net changes in unrealized gains (losses) of equity securities, net of tax, was $34.7 million for the six months ended June 30, 2022 compared to $47.0 million for the same period in 2021.
Diluted adjusted earnings per common share, representing adjusted net income available to common stockholders divided by weighted average diluted common shares outstanding, was $1.12 for the six months ended June 30, 2022 compared to $1.50 for the same period in 2021.
Analysis of Financial Condition—As of June 30, 2022 Compared to December 31, 2021
We believe that cash flows generated from operations will be sufficient to meet our working capital requirements for at least the next twelve months. We invest amounts considered to be in excess of current working capital requirements.
The following table summarizes, by type, the carrying values of investments as of the dates presented (in thousands):
| | | | | | | | | | | |
| As of |
| June 30, | | December 31, |
Type of Investment | 2022 | | 2021 |
Available-for-sale debt securities | $ | 1,021,006 | | | $ | 1,040,455 | |
| | | |
Equity securities | 79,844 | | | 47,334 | |
| | | |
Investment real estate, net | 5,798 | | | 5,891 | |
Total | $ | 1,106,648 | | | $ | 1,093,680 | |
See “Item 1—Condensed Consolidated Statements of Cash Flows” and “Item 1—Note 3 (Investments)” for explanations on changes in investments.
Restricted cash and cash equivalents increased by $17.5 million to $20.1 million as of June 30, 2022 as a result of collateral held by a reinsurance captive arrangement with one of the Insurance Entities reported as a Variable Interest Entities (“VIE”) in the condensed consolidated financial statements. See “Item 1—Note 14 (Variable Interest Entities)” for more information.
Prepaid reinsurance premiums represent the portion of unearned ceded written premium that will be earned pro-rata over the coverage period of our reinsurance program, which runs from June 1st to May 31st of the following year. The increase of $349.1 million to $590.1 million as of June 30, 2022 was primarily due to additional ceded written premium of $632.4 million recorded this quarter for the estimated reinsurance costs relating to our new 2022-2023 catastrophe reinsurance program beginning June 1, 2022, less amortization of ceded written premium for the reinsurance costs earned during the period.
Reinsurance recoverable represents the estimated amount of paid and unpaid losses, LAE and other expenses that are expected to be recovered from reinsurers. The decrease of $152.2 million to $33.3 million as of June 30, 2022 was primarily due to the collections of amounts recoverable from reinsurers relating to settled claims from hurricanes and covered by our reinsurance contracts and amounts received in connection with a commutation received by UPCIC this quarter.
Premiums receivable, net, represents amounts receivable from policyholders. The increase in premiums receivable, net of $14.4 million to $79.3 million as of June 30, 2022 relates to consumer payment behavior of our business. The amount of direct premiums written during a calendar year tends to increase just prior to the second quarter and tends to decrease approaching the fourth quarter.
Deferred policy acquisition costs (“DPAC”) increased by $2.2 million to $111.0 million as of June 30, 2022, which is consistent with the seasonal premium trends of written premium. In addition DPAC was impacted by the reduction to Florida renewal commissions implemented during 2022 and 2021 and other changes to the Company’s commission structure. See “Item 1—Note 5 (Insurance Operations)” for a roll-forward in the balance of our DPAC.
Income taxes recoverable represents the difference between estimated tax obligations and tax payments made to taxing authorities. As of June 30, 2022, the balance recoverable was $22.3 million, representing amounts due from taxing authorities at that date, compared to a balance recoverable of $16.9 million as of December 31, 2021. Income taxes recoverable as of June 30, 2022 will either be refunded or applied to future periods to offset future federal and state income tax obligations.
Deferred income taxes represent the estimated tax asset or tax liability caused by temporary differences between the tax return basis of certain assets and liabilities and amounts recorded in the financial statements. During the six months ended June 30, 2022, deferred tax assets increased by $13.9 million to $30.3 million primarily due to an increase in unrealized losses on investments and an increase in unearned premiums net of prepaid reinsurance premiums. Deferred income taxes reverse in future years as the temporary differences between book and tax reverse.
See “Item 1—Note 6 (Liability for Unpaid Losses and Loss Adjustment Expenses)” for a roll-forward in the balance of our unpaid losses and LAE. Unpaid losses and LAE decreased by $159.9 million to $186.3 million as of June 30, 2022. The majority of the decrease is from the settlement of losses from prior hurricanes and prior large weather events. Overall, unpaid losses and LAE decreased, as claim settlements exceeded new emerging claims. Unpaid losses and LAE are net of estimated subrogation recoveries.
Unearned premiums represent the portion of direct premiums written that will be earned pro-rata in the future. The increase of $85.6 million from December 31, 2021 to $943.4 million as of June 30, 2022 reflects the seasonality of our business, which varies from month to month.
Advance premium represents premium payments made by policyholders ahead of the effective date of the policies. The increase of $32.6 million to $86.3 million as of June 30, 2022 reflects customer payment behavior and the payment behavior of mortgage escrow service providers.
We maintain a short-term cash investment strategy sweep to maximize investment returns on cash balances. There were no book overdrafts as of June 30, 2022 compared to book overdrafts totaling $26.8 million as of December 31, 2021. The decrease of $26.8 million is the result of higher cash balances available for offset as of June 30, 2022 compared to December 31, 2021. See “—Liquidity and Capital Resources” for more information.
Reinsurance payable, net, represents the unpaid reinsurance premium installments owed to reinsurers, unpaid reinstatement premiums due to reinsurers and cash advances received from reinsurers, if any. On June 1st of each year, we renew our core catastrophe reinsurance program and record the estimated annual cost of our reinsurance program. These estimated annual costs are increased or decreased during the year based on premium adjustments or as a result of new placements during the year. The annual cost initially increases reinsurance payable, which is then reduced as installment payments are made over the policy period of the reinsurance, which typically runs from June 1st to May 31st. The balance increased by $449.2 million to $637.8 million as of June 30, 2022 as a result of the timing of the above items. See “—Liquidity and Capital Resources” for more information about timing of reinsurance premiums installment payments.
Other liabilities and accrued expenses increased by $5.9 million to $33.3 million as of June 30, 2022, primarily driven from an increase in other liabilities due to the timing of payments.
Capital resources, net, decreased by $63.7 million for the six months ended June 30, 2022, reflecting a net decrease in total stockholders’ equity and long-term debt. The change in stockholders’ equity was principally the result of increases coming from our 2022 net income and share-based compensation, offset by declines in the after-tax changes in the fair value of our available-for-sale debt securities, treasury share purchases and dividends to shareholders. Available-for-sale debt securities decline in fair value of $96.3 million (before tax) in the first half of 2022, caused the net unrealized loss position of $20.2 million at December 31, 2021 to increase to $116.5 million at June 30, 2022. Current market outlooks are signaling further Federal Reserve tightening which could continue to have a negative impact on the valuation of available-for-sale debt securities. See “Item 1—Condensed Consolidated Statements of Stockholders’ Equity” and “Item 1—Note 8 (Stockholders’ Equity)” for explanation of changes in treasury stock.
The reduction in debt of $0.7 million was the result of principal payments on debt during 2022. See “—Liquidity and Capital Resources” for more information.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity
Liquidity is a measure of a company’s ability to generate sufficient cash flows to meet its short and long-term obligations. Funds generated from operations have been sufficient and we expect them to be sufficient to meet our current and long term liquidity requirements.
The balance of cash and cash equivalents, excluding restricted cash, as of June 30, 2022 was $317.0 million, compared to $250.5 million at December 31, 2021. See “Item 1—Condensed Consolidated Statements of Cash Flows” for a reconciliation of the balance of cash and cash equivalents between June 30, 2022 and December 31, 2021. The increase in cash and cash equivalents was driven by cash flows generated from operating activities in excess of cash flows used in investing and financing activities. Our cash investment strategy at times includes cash investments where the right of offset against other bank accounts does not exist. A book overdraft occurs when aggregating the book balance of all accounts at a financial institution, for accounts which have the right of offset, and if the aggregation results in a net negative book balance, that balance is reclassified from cash and cash equivalents in our Condensed Consolidated Balance Sheet to book overdraft. Cash and cash equivalents balances are available to settle book overdrafts, and to pay reinsurance premiums, expenses and claims. Reinsurance premiums are paid in installments during the reinsurance policy period, which runs from June 1st to May 31st of the following year. The FHCF reimbursement premiums are paid in three installments on August 1st, October 1st, and December 1st, and third-party reinsurance premiums are generally paid in four installments on July 1st, October 1st, January 1st and April 1st, resulting in significant payments at those times. See “Item 1—Note 12 (Commitments and Contingencies)” and additional discussion below under the caption “—Material Cash Requirements” for more information.
The balance of restricted cash and cash equivalents as of June 30, 2022 and December 31, 2021 represents cash equivalents on deposit with certain regulatory agencies in the various states in which our Insurance Entities do business and, in 2022, restricted cash and cash equivalents also includes collateral held by a third party in a consolidated VIE, in support of the holding company’s reinsurance captive arrangement with UPCIC. The amount of collateral held was $17.5 million as of June 30, 2022. Previous years’ captive arrangements have included collateral posting by the holding company, which was either returned to the holding company before year end when there were no claims under the reinsurance protection with the VIE, or remitted to UPCIC under this arrangement in the form of VIE reinsurance settlements with UPCIC. See “Item 1—Note 14 (Variable Interest Entities)” for more information.
Liquidity is required at the holding company for us to cover the payment of holding company general operating expenses and contingencies, dividends to shareholders (if and when authorized and declared by our Board of Directors), payment for the possible repurchase of our common stock (if and when authorized by our Board of Directors), payment of our tax obligations to taxing authorities, settlement of taxes between subsidiaries in accordance with our tax sharing agreement, capital contributions to subsidiaries or surplus note contributions to the Insurance Entities, if needed, and interest and principal payments on outstanding debt obligations of the holding company. Effective in 2021 for UPCIC and 2022 for APPCIC, the holding company has put in place an ongoing surplus note arrangement with the Insurance Entities, which has been approved by the Florida Office of Insurance Regulation as the Insurance Entities’ domestic regulator. Surplus notes are unsecured debt issued by the Insurance Entities that is subordinated to all claims by policyholders and creditors, with interest and principal payments on the surplus notes to the holding company being made only upon the FLOIR’s express approval. Surplus notes are considered bonds in function and payout structure, but are accounted for as equity in the statutory reporting of the Insurance Entities. The holding company has outstanding with the Insurance Entities $134.0 million in surplus notes. Under the arrangement, interest accrues at a variable rate (currently 8.27%) on the outstanding surplus note balances and, if approved by the FLOIR is payable annually to the holding company. In 2022, UPCIC received approval from its Florida regulator to permit UPCIC to pay interest accruing from surplus notes outstanding during 2021. The declaration and payment of future dividends to our shareholders, and any future repurchases of our common stock, will be at the discretion of our Board of Directors and will depend upon many factors, including our operating results, financial condition, debt covenants and any regulatory constraints. New regulations or changes to existing regulations imposed on the Company and its affiliates may also impact the amount and timing of future dividend payments to the parent. Principal sources of liquidity for the holding company include dividends paid by our service entities generated from income earned on fees paid by the Insurance Entities to affiliated companies for general agency, inspections and claims adjusting services. Dividends are also paid from income earned from brokerage commissions earned on reinsurance contracts placed by our wholly-owned subsidiary, Blue Atlantic Reinsurance Corporation, and policy fees. We also maintain high quality investments in our portfolio as a source of liquidity along with ongoing interest and dividend income from those investments. As discussed in “Item 1—Note 5 (Insurance Operations),” there are limitations on the dividends the Insurance Entities may pay to their immediate parent company, Protection Solutions, Inc. (“PSI”, formerly known as Universal Insurance Holding Company of Florida).
The maximum amount of dividends that can be paid by Florida insurance companies without prior approval of the FLOIR is subject to restrictions as referenced below and in “Item 1—Note 5 (Insurance Operations).” Dividends from the Insurance Entities can only be paid from accumulated unassigned funds derived from net operating profits and net realized capital gains. Subject to such accumulated unassigned funds, the maximum dividend that may be paid by the Insurance Entities to PSI without prior approval (an “ordinary dividend”) is further limited to the lesser of statutory net income from operations of the preceding calendar year or statutory unassigned surplus as of the preceding year end. During the six months ended June 30, 2022 and the year ended December 31, 2021, the Insurance Entities did not pay dividends to PSI. As of June 30, 2022, the Insurance Entities did not have the capacity to pay ordinary dividends.
On November 23, 2021, we entered into Note Purchase Agreements with certain institutional accredited investors and qualified institutional buyers pursuant to which we issued $100 million of 5.625% Senior Unsecured Notes due 2026. We intend to use the net proceeds to support the Insurance Entities’ statutory capital requirements and for general corporate purposes. If necessary, the Company also has amounts available under our unsecured revolving loan as discussed in “Item 1—Note 7 (Long-term debt).”
Liquidity for the Insurance Entities is primarily required to cover payments for reinsurance premiums, claims payments including potential payments of catastrophe losses (offset by recovery of any reimbursement amounts under our reinsurance agreements), fees paid to affiliates for managing general agency services, inspections and claims adjusting services, agent commissions, premium and income taxes, regulatory assessments, general operating expenses, and interest and principal payments on debt obligations. The principal source of liquidity for the Insurance Entities consists of the revenue generated from the collection of premiums earned, net, interest and dividend income from the investment portfolio, the collection of reinsurance recoverable and financing fees.
Our insurance operations provide liquidity as premiums are generally received months or even years before potential losses are paid under the policies written. In the event of catastrophic events, many of our reinsurance agreements provide for “cash advance” whereby reinsurers advance or prepay amounts to us, thereby providing liquidity, which we utilize in the claim settlement process. In addition, the Insurance Entities maintain substantial investments in highly liquid, marketable securities, which would generate funds upon sale. The average credit rating on our available-for-sale securities was A+ as of June 30, 2022 and December 31, 2021. Credit ratings are a measure of collection risk on invested assets. Credit ratings are provided by third party, nationally recognized rating agencies and are periodically updated. Management establishes guidelines for minimum credit rating and overall credit rating for all investments. The duration of our available-for-sale securities was 4.4 years at June 30, 2022 compared to 4.4 years at December 31, 2021. Duration is a measure of a bond’s sensitivity to interest rate changes and is used by management to limit the potential impact of longer-term investments.
The Insurance Entities are responsible for losses related to catastrophic events in excess of coverage provided by the Insurance Entities’ reinsurance programs and retentions before our reinsurance protection commences. Also, the Insurance Entities are responsible for all other losses that otherwise may not be covered by the reinsurance programs and any amounts arising in the event of a reinsurer default. Losses or a default by reinsurers may have a material adverse effect on either of the Insurance Entities, on our business, financial condition, results of operations and liquidity.
Capital Resources
Capital resources provide protection for policyholders, furnish the financial strength to support the business of underwriting insurance risks and facilitate continued business growth. The following table provides our stockholders’ equity, total long-term debt, total capital resources, debt-to-total capital ratio and debt-to-equity ratio for the periods presented (dollars in thousands):
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| As of |
| June 30, | | December 31, |
| 2022 | | 2021 |
Stockholders’ equity | $ | 366,551 | | | $ | 429,702 | |
Total long-term debt | 103,161 | | | 103,676 | |
Total capital resources | $ | 469,712 | | | $ | 533,378 | |
| | | |
Debt-to-total capital ratio | 22.0 | % | | 19.4 | % |
Debt-to-equity ratio | 28.1 | % | | 24.1 | % |
The debt-to-total capital ratio is total long-term debt divided by total capital resources, whereas the debt-to-equity ratio is total long-term debt divided by stockholders’ equity. These ratios help management measure the amount of financing leverage in place in relation to equity and future leverage capacity.
Adjusted common stockholders’ equity, representing GAAP common stockholders' equity, excluding accumulated other comprehensive income (loss), was $454.6 million as of June 30, 2022, $486.3 million as of June 30, 2021 and $445.2 million as of December 31, 2021.
Adjusted book value per share common share, representing adjusted common stockholders’ equity divided by outstanding common shares at the end of the reporting period, was $14.80 as of June 30, 2022, $15.55 as of June 30, 2021 and $14.26 as of December 31, 2021.
Adjusted return on common equity representing actual or annualized adjusted net income attributable to common stockholders divided by average adjusted common stockholders' equity, with the denominator excluding current period income statement net realized gains (losses) on investments and net changes in unrealized gains (losses) of equity securities, net of tax, was 15.3% as of June 30, 2022, 20.2% as of June 30, 2021 and 4.3% as of December 31, 2021.
As described in our Annual Report on Form 10-K for the year ended December 31, 2021, UPCIC entered into a surplus note with the State Board of Administration of Florida under Florida’s Insurance Capital Build-Up Incentive Program on November 9, 2006. The surplus note has a twenty-year term, with quarterly payments of principal and interest that accrue per the terms of the note agreement. At June 30, 2022, UPCIC was in compliance with the terms of the surplus note. Total adjusted capital and surplus, which includes the surplus note, was in excess of regulatory requirements for both UPCIC and APPCIC.
As discussed in “Item 1—Note 7 (Long-term Debt),” we entered into a credit agreement and related revolving loan with JPMorgan Chase Bank, N.A. in August 2021 which makes available an unsecured revolving credit facility with an aggregate commitment not to exceed $35.0 million. Borrowings under the Revolving Loan mature 364 days after the date of the loan. The Revolving Loan contains customary financial covenants. As of June 30, 2022, the Company was in compliance with all applicable covenants, including financial covenants. We had not drawn any amounts under the Revolving Loan as of June 30, 2022. The revolving credit facility with JP Morgan Chase Bank, N.A. is subject to annual renewals each August.
In November 2021, we completed a private placement offering through which we issued and sold $100 million of 5.625% Senior Unsecured Notes due 2026 (the “Notes”) to certain institutional accredited investors and qualified institutional buyers. The Notes mature on November 26, 2026, at which time the entire $100 million of principal is due and payable. At any time on or after November 23, 2023, the Company may redeem all or part of the Notes. See “Item 1—Note 7 (Long-term debt)” for additional details. As of June 30, 2022, we were in compliance with all applicable covenants, including financial covenants of this note agreement.
We will also continue to evaluate opportunities to access the debt capital markets to raise additional capital. We anticipate any proceeds would be used for general corporate purposes, including investing in the capital and surplus of the Insurance Entities.
In addition to the liquidity generally provided from operations, we maintain a conservative, well-diversified investment portfolio, predominantly comprised of fixed income securities with an average credit rating of A+, that focuses on capital preservation and providing an adequate source of liquidity for potential claim payments and other cash needs. The portfolio’s secondary investment objective is to provide a total rate of return with emphasis on investment income. Historically, we have consistently generated funds from operations, allowing our cash and invested assets to grow.
Impact of the COVID-19 Pandemic
The impact of the COVID-19 pandemic on the economy and credit markets remains a key risk as the United States and the world continues to navigate its consequences and the efforts taken by governments to address financial recovery and economic stability. We remain in regular contact with our advisors to monitor the credit quality of the issuers of the securities in our portfolio and discuss appropriate responses to credit downgrades or changes in companies’ credit outlook. We believe these measures, when combined with the inherent liquidity generated by our business model and in our investment portfolio, will allow us to continue to meet our short- and long-term obligations.
Looking Forward
We continue to monitor a range of financial metrics related to our business. Although we have not yet experienced material adverse impacts on our business or liquidity, conditions are subject to change depending on the extent of the economic downturn and the pace and extent of an economic recovery. Significant uncertainties exist with the potential long-term impact of the COVID-19 pandemic, including unforeseen newly emerging risks that could affect us and future economic changes as the Federal Reserve addresses the emerging economic concerns of inflation, employment and recession. We will continue to monitor the broader economic impacts of the COVID-19 pandemic and its impact on our operations and financial condition including liquidity and capital resources.
Common Stock Repurchases
On November 3, 2020, we announced that our Board of Directors authorized a share repurchase program under which we may repurchase in the open market up to $20 million of outstanding shares of our common stock through November 3, 2022. We may repurchase shares from time to time at our discretion, based on ongoing assessments of our capital needs, the market price of our common stock and general market conditions. We will fund the share repurchase program with cash from operations.
During the six months ended June 30, 2022, we repurchased an aggregate of 603,080 shares of our common stock in the open market at an aggregate purchase price of $7.4 million. Also, see “Part II, Item 2—Unregistered Sales of Equity Securities and Use of Proceeds” for share repurchase activity during the three months ended June 30, 2022.
Off-Balance Sheet Arrangements
The Company does not have any off-balance sheet arrangements that are reasonably likely to have a material effect on the financial condition, results of operations, liquidity, or capital resources of the Company, except for multi-year reinsurance contract commitments for future years that will be recorded at the commencement of the coverage period. See “Item 1—Note 12 (Commitments and Contingencies)” for more information.
Cash Dividends
The following table summarizes the dividends declared by the Company in 2022:
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2022 | | Dividend Declared Date | | Shareholders Record Date | | Dividend Payable Date | | Cash Dividend Per Common Share Amount |
First Quarter | | February 10, 2022 | | March 10, 2022 | | March 17, 2022 | | $ | 0.16 | |
Second Quarter | | April 20, 2022 | | May 13, 2022 | | May 20, 2022 | | $ | 0.16 | |
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MATERIAL CASH REQUIREMENTS
The following table represents our material cash requirements for which cash flows are fixed or determinable as of June 30, 2022 (in thousands):
| | | | | | | | | | | | | | | | | | | | | |
| Total | | Next 12 Months | | Beyond 12 Months | | | | |
Reinsurance payable and multi-year commitments (1) | $ | 876,113 | | | $ | 703,841 | | | $ | 172,272 | | | | | |
Unpaid losses and LAE, direct (2) | 186,349 | | | 105,101 | | | 81,248 | | | | | |
Long-term debt (3) | 131,893 | | | 7,230 | | | 124,663 | | | | | |
Total material cash requirements | $ | 1,194,355 | | | $ | 816,172 | | | $ | 378,183 | | | | | |
(1)Amount represents the payment of reinsurance premiums payable under multi-year commitments. See “Item 1—Note 12 (Commitments and Contingencies).”
(2)There are generally no notional or stated amounts related to unpaid losses and LAE. Both the amounts and timing of future loss and LAE payments are estimates and subject to the inherent variability of legal and market conditions affecting the obligations and make the timing of cash outflows uncertain. The ultimate amount and timing of unpaid losses and LAE could differ materially from the amounts in the table above. Further, the unpaid losses and LAE do not represent all the obligations that will arise under the contracts, but rather only the estimated liability incurred through June 30, 2022. Unpaid losses and LAE are net of estimated subrogation recoveries. In addition, these balances exclude amounts recoverable from the Company’s reinsurance program. See “Item 1—Note 4 (Reinsurance).”
(3)Long-term debt consists of a Surplus note and 5.625% Senior unsecured notes. See “Item 1—Note 7 (Long-term debt).”
IMPACT OF INFLATION AND CHANGING PRICES
The financial statements and related data presented herein have been prepared in accordance with GAAP, which require 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 are monetary in nature. As a result, interest rates have a more significant impact on our performance than the effects of the general levels of inflation. Interest rates do not necessarily move in the same direction or with the same magnitude as the cost of paying losses and LAE.
Insurance premiums are established before we know the amount of loss 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 rates, we may be limited in raising premium levels for competitive and regulatory reasons. Inflation also affects the market value of our investment portfolio and the investment rate of return. Any future economic changes which result in prolonged and increasing levels of inflation could cause increases in the dollar amount of incurred loss and LAE and thereby materially adversely affect future liability requirements.
ARRANGEMENTS WITH VARIABLE INTEREST ENTITIES
We entered into a reinsurance captive arrangement with a VIE in the normal course of business, and consolidated the VIE since we are the primary beneficiary.
For a further discussion of our involvement with the VIE, see “Item 1—Note 14 (Variable Interest Entities).”
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
There have been no material changes during the period covered by this Quarterly Report on Form 10-Q to Critical Accounting Policies and Estimates previously disclosed in “Part II, Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our Annual Report on Form 10-K for the year ended December 31, 2021.
NON-GAAP FINANCIAL MEASURES
Non-GAAP financial measures should be considered in addition to, and not as a substitute for or superior to, financial measures presented in accordance with GAAP. For more information regarding our key performance indicators, please refer to the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Key Performance Indicators.”
The following table presents the reconciliation of GAAP revenue (total premiums earned and other revenues) to core revenue, which is a non-GAAP measure (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | Six Months Ended June 30, |
| 2022 | | 2021 | | 2022 | | 2021 |
GAAP revenue | $ | 292,006 | | | $ | 279,181 | | | $ | 579,488 | | | $ | 541,938 | |
less: Net realized gains (losses) on investments | (725) | | | 496 | | | (667) | | | 1,038 | |
less: Net change in unrealized gains (losses) of equity securities | (8,884) | | | 1,229 | | | (12,280) | | | 735 | |
Core Revenue | $ | 301,615 | | | $ | 277,456 | | | $ | 592,435 | | | $ | 540,165 | |
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The following table presents the reconciliation of GAAP income before income taxes to adjusted operating income, which is a non-GAAP measure (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | Six Months Ended June 30, |
| 2022 | | 2021 | | 2022 | | 2021 |
GAAP income before income taxes | $ | 10,680 | | | $ | 30,059 | | | $ | 33,151 | | | $ | 66,410 | |
add: Interest and amortization of debt issuance costs | 1,731 | | | 35 | | | 3,339 | | | 55 | |
GAAP operating income | 12,411 | | | 30,094 | | | 36,490 | | | 66,465 | |
less: Net realized gains (losses) on investments | (725) | | | 496 | | | (667) | | | 1,038 | |
less: Net changes in unrealized gains (losses) of equity securities | (8,884) | | | 1,229 | | | (12,280) | | | 735 | |
Adjusted operating income | $ | 22,020 | | | $ | 28,369 | | | $ | 49,437 | | | $ | 64,692 | |
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The following table presents the reconciliation of operating income margin to adjusted operation income margin, which is a non-GAAP measure (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | Six Months Ended June 30, |
| 2022 | | 2021 | | 2022 | | 2021 |
GAAP operating income | $ | 12,411 | | | $ | 30,094 | | | $ | 36,490 | | | $ | 66,465 | |
GAAP revenue | 292,006 | | | 279,181 | | | 579,488 | | | 541,938 | |
GAAP operating income margin | 4.3 | % | | 10.8 | % | | 6.3 | % | | 12.3 | % |
Adjusted operating income | 22,020 | | | 28,369 | | | 49,437 | | | 64,692 | |
Core revenue | 301,615 | | | 277,456 | | | 592,435 | | | 540,165 | |
Adjusted operating income margin | 7.3 | % | | 10.2 | % | | 8.3 | % | | 12.0 | % |
The following table presents the reconciliation of GAAP net income (loss) available to common stockholders to adjusted net income available to common stockholders, which is a non-GAAP measure (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | Six Months Ended June 30, |
| 2022 | | 2021 | | 2022 | | 2021 |
GAAP net income | $ | 7,370 | | | $ | 21,941 | | | $ | 24,907 | | | $ | 48,349 | |
less: Preferred dividends | 2 | | | 2 | | | 5 | | | 5 | |
GAAP net income (loss) available to common stockholders | 7,368 | | | 21,939 | | | 24,902 | | | 48,344 | |
less: Net realized gains (losses) on investments | (725) | | | 496 | | | (667) | | | 1,038 | |
less: Net changes in unrealized gains (losses) of equity securities | (8,884) | | | 1,229 | | | (12,280) | | | 735 | |
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add: Income tax effect on above adjustments | (2,329) | | | 413 | | | (3,138) | | | 424 | |
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Adjusted net income available to common stockholders | $ | 14,648 | | | $ | 20,627 | | | $ | 34,711 | | | $ | 46,995 | |
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Weighted average common shares outstanding - Diluted | 30,883 | | | 31,310 | | | 31,060 | | | 31,292 | |
Diluted earnings per common share | $ | 0.24 | | | $ | 0.70 | | | $ | 0.80 | | | $ | 1.54 | |
Diluted adjusted earnings per common share | $ | 0.47 | | | $ | 0.65 | | | $ | 1.12 | | | $ | 1.50 | |
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The following table presents the reconciliation of GAAP stockholders’ equity to adjusted stockholders’ equity and book value per common share to adjusted book value per common share, which is a non-GAAP measure (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | |
| As of |
| June 30, | | June 30, | | | | | | December 31, | | |
| 2022 | | 2021 | | | | | | 2021 | | |
Stockholders' equity | $ | 366,551 | | | $ | 480,842 | | | | | | | $ | 429,702 | | | |
less: Preferred equity | 100 | | | 100 | | | | | | | 100 | | | |
Common stockholders' equity | 366,451 | | | 480,742 | | | | | | | 429,602 | | | |
less: Accumulated other comprehensive income (loss) | (88,134) | | | (5,571) | | | | | | | (15,568) | | | |
Adjusted common stockholders' equity | $ | 454,585 | | | $ | 486,313 | | | | | | | $ | 445,170 | | | |
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Common shares outstanding | 30,716 | | | 31,269 | | | | | | | 31,221 | | | |
Book value per common share | $ | 11.93 | | | $ | 15.37 | | | | | | | $ | 13.76 | | | |
Adjusted book value per common share | $ | 14.80 | | | $ | 15.55 | | | | | | | $ | 14.26 | | | |
The following table presents the reconciliation of GAAP ROCE to adjusted ROCE, which is a non-GAAP measure (in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | Six Months Ended June 30, | | Year Ended December 31, |
| 2022 | | 2021 | | 2022 | | 2021 | | 2021 |
Actual or annualized net income available to common stockholders | $ | 29,472 | | | $ | 87,756 | | | $ | 49,804 | | | $ | 96,688 | | | $ | 20,397 | |
Average common stockholders' equity | 381,346 | | | 467,654 | | | 398,027 | | | 464,952 | | | 439,382 | |
ROCE | 7.7 | % | | 18.8 | % | | 12.5 | % | | 20.8 | % | | 4.6 | % |
Actual or annualized adjusted net income available to common stockholders | $ | 58,592 | | | $ | 82,508 | | | $ | 69,422 | | | $ | 93,990 | | | $ | 18,959 | |
Actual or adjusted average common stockholders' equity* | 458,292 | | | 476,567 | | | 454,782 | | | 465,392 | | | 444,775 | |
Adjusted ROCE | 12.8 | % | | 17.3 | % | | 15.3 | % | | 20.2 | % | | 4.3 | % |
| | | | | |
* | Adjusted average common stockholders’ equity excludes current period net realized gains (losses) on investments and |
| net changes in unrealized gains (losses) of equity securities, net of tax. |