Annual Statements Open main menu

Heritage Insurance Holdings, Inc. - Quarter Report: 2023 March (Form 10-Q)

10-Q

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON D.C. 20549

 

Form 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2023

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number

001-36462

 

Heritage Insurance Holdings, Inc.

(Exact name of Registrant as specified in its charter)

 

Delaware

 

45-5338504

(State of Incorporation)

(IRS Employer

Identification No.)

1401 N. Westshore Blvd

Tampa, FL 33607

(Address, including zip code, of principal executive offices)

(727) 362-7200

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Title of each class

Trading Symbol(s)

Name of each exchange on which registered

Common Stock, par value $0.0001 per share

HRTG

New York Stock Exchange

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer

Accelerated filer

Emerging growth company

Non-accelerated filer

Smaller reporting company

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No

The aggregate number of shares of the Registrant’s Common Stock outstanding on May 2, 2023 was 26,469,720.

 

 


HERITAGE INSURANCE HOLDINGS, INC.

Table of Contents

 

 

 

Page

PART I – FINANCIAL INFORMATION

 

 

Item 1 Unaudited Financial Statements

 

 

Condensed Consolidated Balance Sheets: March 31, 2023 (unaudited) and December 31, 2022

 

2

Condensed Consolidated Statements of Operations and Other Comprehensive Income (Loss): Three Months Ended March 31, 2023 and 2022 (unaudited)

 

3

Condensed Consolidated Statements of Stockholders’ Equity: Three Months Ended March 31, 2023 and 2022(unaudited)

 

4

Condensed Consolidated Statements of Cash Flows: Three Months Ended March 31, 2023 and 2022(unaudited)

 

5

Notes to Unaudited Condensed Consolidated Financial Statements

 

7

Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

22

Item 3 Quantitative and Qualitative Disclosures about Market Risk

 

31

Item 4 Controls and Procedures

 

31

PART II – OTHER INFORMATION

 

 

Item 1 Legal Proceedings

 

32

Item 1A Risk Factors

 

32

Item 2 Unregistered Sales of Equity Securities and Use of Proceeds

 

32

Item 5 Other Information

 

32

Item 6 Exhibits

 

32

Signatures

 

33

 

 

 

 


 

FORWARD-LOOKING STATEMENTS

Statements in this Quarterly Report on Form 10-Q (“Form 10-Q”) or in documents incorporated by reference that are not historical facts are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include statements regarding: (i) our core strategy and ability to fully execute our business plan; (ii) our growth, including by geographic expansion, new lines of business, additional policies and new products and services, competitive strengths, proprietary capabilities, processes and new technology, results of operations and liquidity; (iii) strategic initiatives and their impact on shareholder value; statements concerning projections, predictions, expectations, estimates or forecasts as to our business, financial and operational results and future economic performance; (iv) statements of management’s goals and objectives, including intentions to pursue certain business and the handling of certain claims; (v) projections of revenue, earnings, capital structure, reserves and other financial items; (vi) assumptions underlying our critical accounting policies and estimates; (vii) assumptions underlying statements regarding us and our business; (viii) statements regarding the impact of legislation; (ix) expectations regarding claims and related expenses, and our reinsurers’ obligations; (x) beliefs regarding pending legal proceedings and their effect on our financial position; and (xi) other similar expressions concerning matters that are not historical facts. These forward-looking statements are subject to risks and uncertainties that could cause actual results and events to differ. A detailed discussion of these and other risks and uncertainties that could cause actual results and events to differ materially from such forward-looking statements is included throughout this filing and particularly in Item 1A: "Risk Factors" set forth in our 2022 Annual Report on Form 10-K and Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” set forth in this quarterly report on Form 10-Q. All forward-looking statements included in this document are based on information available to us on the date hereof, and we assume no obligation to revise or publicly release any revision to any such forward-looking statement, except as may otherwise be required by law.

These statements are based on current expectations, estimates and projections about the industry and market in which we operate, and management’s beliefs and assumptions. Without limiting the generality of the foregoing, words such as “may,” “will,” “expect,” “believe,” “anticipate,” “intend,” “could,” “would,” “estimate,” or “continue” or the negative variations thereof or comparable terminology are intended to identify forward-looking statements. Forward-looking statements are not guarantees of future performance and involve certain known and unknown risks and uncertainties that could cause actual results to differ materially from those expressed or implied by such statements. The risks and uncertainties include, without limitation:

the possibility that actual losses may exceed reserves, which are based on estimates;
the concentration of our business in coastal states, which could be impacted by hurricane losses or other significant weather-related events such as northeastern winter storms;
our exposure to catastrophic weather events;
our failure to adequately assess and price the risks we underwrite;
the fluctuation in our results of operations, including as a result of factors outside of our control;
increased costs of reinsurance, non-availability of reinsurance, non-collectability of reinsurance and our ability to obtain reinsurance on terms and at a cost acceptable to us;
inherent uncertainty of our models and our reliance on such models as a tool to evaluate risk;
increased competition, competitive pressures, industry developments and market conditions;
continued and increased impact of abusive and unwarranted claims;
our inability to effectively manage our growth and integrate acquired companies;
our failure to execute our diversification strategy;
our reliance on independent agents to write insurance policies for us on a voluntary basis and our ability to attract and retain agents;
the failure of our claims department to effectively manage or remediate claims;
the failure of policy renewals to meet our expectations;
our inability to maintain our financial stability rating;
our ability to access sufficient liquidity or obtain additional financing to fund our operations and expand our business;
our inability to generate investment income;
effects of emerging claim and coverage issues relating to legal, judicial, environmental and social conditions;

 


 

the failure of our risk mitigation strategies or loss limitation methods;
lack of effectiveness of exclusions and loss limitation methods in the insurance policies we assume or write;
the regulation of our insurance operations;
changes in regulations and our failure to meet increased regulatory requirements, including minimum capital and surplus requirements;
climate change, health crisis, severe weather conditions and other catastrophe events;
litigation or regulatory actions;
regulation limiting rate increases or that require us to participate in loss sharing or assessments;
the terms of our indebtedness, including restrictions that limit our flexibility in operating our business, and our inability to comply with the financial and other covenants of our debt facilities;
our ability to maintain effective internal controls over financial reporting;
certain characteristics of our common stock;
failure of our information technology systems or those of our key service providers and unsuccessful development and implementation of new technologies;
a lack of redundancy in our operations; and
our failure to attract and retain qualified employees and independent agents or our loss of key personnel.

Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition or operating results. The forward-looking statements speak only as of the date on which they are made, and, except as required by law, we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrences of anticipated events. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in the forward-looking statements. Consequently, you should not place undue reliance on forward-looking statements.

 


 

PART I – FINANCIAL INFORMATION

Item 1 – Financial Statements

HERITAGE INSURANCE HOLDINGS, INC.

Condensed Consolidated Balance Sheets

(Amounts in thousands, except per share and share amounts)

 

 

 

March 31, 2023

 

 

December 31, 2022

 

ASSETS

 

(unaudited)

 

 

 

 

Fixed maturities, available-for-sale, at fair value (amortized cost of $671,018 and $705,548)

 

$

613,176

 

 

$

635,572

 

Equity securities, at fair value, (cost $1,495 and $1,514)

 

 

1,495

 

 

 

1,514

 

Other investments, net

 

 

14,283

 

 

 

16,484

 

Total investments

 

 

628,954

 

 

 

653,570

 

Cash and cash equivalents

 

 

329,965

 

 

 

280,881

 

Restricted cash

 

 

6,699

 

 

 

6,691

 

Accrued investment income

 

 

3,536

 

 

 

3,817

 

Premiums receivable, net

 

 

80,775

 

 

 

92,749

 

Reinsurance recoverable on paid and unpaid claims, net of allowance for credit losses of $197 and $45

 

 

681,844

 

 

 

805,059

 

Prepaid reinsurance premiums

 

 

188,760

 

 

 

306,977

 

Income tax receivable

 

 

4,264

 

 

 

12,118

 

Deferred income tax asset, net

 

 

17,962

 

 

 

16,841

 

Deferred policy acquisition costs, net

 

 

98,035

 

 

 

99,617

 

Property and equipment, net

 

 

27,603

 

 

 

25,729

 

Right-of-use lease asset, finance

 

 

19,490

 

 

 

20,132

 

Right-of-use lease asset, operating

 

 

7,563

 

 

 

7,335

 

Intangibles, net

 

 

47,987

 

 

 

49,575

 

Other assets

 

 

15,344

 

 

 

11,509

 

Total Assets

 

$

2,158,781

 

 

$

2,392,600

 

LIABILITIES AND STOCKHOLDERS' EQUITY

 

 

 

 

 

 

Unpaid losses and loss adjustment expenses

 

$

980,992

 

 

$

1,131,807

 

Unearned premiums

 

 

649,864

 

 

 

656,641

 

Reinsurance payable

 

 

95,900

 

 

 

199,803

 

Long-term debt, net

 

 

126,700

 

 

 

128,943

 

Advance premiums

 

 

39,642

 

 

 

26,516

 

Accrued compensation

 

 

5,349

 

 

 

6,594

 

Lease liability, finance

 

 

22,012

 

 

 

22,557

 

Lease liability, operating

 

 

8,890

 

 

 

8,690

 

Accounts payable and other liabilities

 

 

74,708

 

 

 

80,010

 

Total Liabilities

 

$

2,004,057

 

 

$

2,261,561

 

 

 

 

 

 

 

 

Commitments and contingencies (Note 17)

 

 

 

 

 

 

Stockholders’ Equity:

 

 

 

 

 

 

Common stock, $0.0001 par value, 50,000,000 shares authorized, 37,790,425 shares issued and 25,558,751 outstanding at March 31, 2023 and 37,796,107 shares issued and 25,539,433 outstanding at December 31, 2022

 

 

3

 

 

 

3

 

Additional paid-in capital

 

 

335,098

 

 

 

334,711

 

Accumulated other comprehensive loss, net of taxes

 

 

(44,295

)

 

 

(53,585

)

Treasury stock, at cost, 12,231,674 shares at each March 31, 2023 and December 31, 2022

 

 

(130,900

)

 

 

(130,900

)

Retained deficit

 

 

(5,182

)

 

 

(19,190

)

Total Stockholders' Equity

 

 

154,724

 

 

 

131,039

 

Total Liabilities and Stockholders' Equity

 

$

2,158,781

 

 

$

2,392,600

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

2


 

HERITAGE INSURANCE HOLDINGS, INC.

Condensed Consolidated Statements of Operations and Other Comprehensive Income (Loss)

(Unaudited)

(Amounts in thousands, except per share and share amounts)

 

 

 

For the Three Months Ended
March 31,

 

 

 

2023

 

 

2022

 

REVENUES:

 

 

 

 

 

 

Gross premiums written

 

$

310,309

 

 

$

283,196

 

Change in gross unearned premiums

 

 

6,713

 

 

 

4,172

 

Gross premiums earned

 

 

317,022

 

 

 

287,368

 

Ceded premiums

 

 

(150,993

)

 

 

(134,439

)

Net premiums earned

 

 

166,029

 

 

 

152,929

 

Net investment income

 

 

5,582

 

 

 

2,000

 

Net realized gains (losses)

 

 

1,898

 

 

 

(16

)

Other revenue

 

 

3,412

 

 

 

3,695

 

Total revenues

 

 

176,921

 

 

 

158,608

 

EXPENSES:

 

 

 

 

 

 

Losses and loss adjustment expenses

 

 

97,452

 

 

 

140,038

 

Policy acquisition costs, net of ceding commission income (1)

 

 

40,324

 

 

 

38,257

 

General and administrative expenses, net of ceding commission income(2)

 

 

19,054

 

 

 

19,724

 

Total expenses

 

 

156,830

 

 

 

198,019

 

Operating income (loss)

 

 

20,091

 

 

 

(39,411

)

Interest expense, net

 

 

2,881

 

 

 

1,972

 

Income (loss) before income taxes

 

 

17,210

 

 

 

(41,383

)

Provision (benefit) for income taxes

 

 

3,202

 

 

 

(10,624

)

Net income (loss)

 

$

14,008

 

 

$

(30,759

)

OTHER COMPREHENSIVE INCOME (LOSS)

 

 

 

 

 

 

Change in net unrealized gains (losses) on investments

 

 

12,143

 

 

 

(31,770

)

Reclassification adjustment for net realized investment losses

 

 

2

 

 

 

16

 

Income tax (expense) benefit related to items of other comprehensive income (loss)

 

 

(2,855

)

 

 

7,433

 

Total comprehensive income (loss)

 

$

23,298

 

 

$

(55,080

)

Weighted average shares outstanding

 

 

 

 

 

 

Basic

 

 

25,558,305

 

 

 

26,787,379

 

Diluted

 

 

25,617,568

 

 

 

26,787,379

 

Earnings (loss) per share

 

 

 

 

 

 

Basic

 

$

0.55

 

 

$

(1.15

)

Diluted

 

$

0.55

 

 

$

(1.15

)

 

(1)
Policy acquisition costs includes $12.9 million and $11.7 million of ceding commission income for the three months ended March 31, 2023 and 2022, respectively.
(2)
General and administration includes $4.3 million and $3.9 million of ceding commission income for the three months ended March 31, 2023 and 2022, respectively.

 

See accompanying notes to unaudited condensed consolidated financial statements.

3


 

HERITAGE INSURANCE HOLDINGS, INC.

Condensed Consolidated Statements of Stockholders’ Equity

(Unaudited)

(Amounts in thousands, except share amounts)

 

 

 

 

Common Shares

 

 

Par Value

 

 

Additional Paid-In Capital

 

 

Retained
Deficit

 

 

Treasury Shares

 

Accumulated Other Comprehensive Loss

 

 

Total
Stockholders'
Equity

 

Balance at December 31, 2022

 

 

25,539,433

 

 

$

3

 

 

$

334,711

 

 

$

(19,190

)

 

$

(130,900

)

 

$

(53,585

)

 

$

131,039

 

Net unrealized change in investments, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

9,290

 

 

 

9,290

 

Shares tendered for income taxes withholding

 

 

(4,200

)

 

 

 

 

 

(8

)

 

 

 

 

 

 

 

 

 

 

 

(8

)

Restricted stock vested

 

 

25,000

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Forfeiture on restricted stock

 

 

(1,482

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock-based compensation on restricted stock

 

 

 

 

 

 

 

 

395

 

 

 

 

 

 

 

 

 

 

 

 

395

 

Net Income

 

 

 

 

 

 

 

 

 

 

 

14,008

 

 

 

 

 

 

 

 

 

14,008

 

Balance at March 31, 2023

 

 

25,558,751

 

 

$

3

 

 

$

335,098

 

 

$

(5,182

)

 

$

(130,900

)

 

$

(44,295

)

 

$

154,724

 

 

 

 

 

 

 

Common Shares

 

 

Par Value

 

 

Additional Paid-In Capital

 

 

Retained
Earnings

 

 

Treasury Shares

 

Accumulated Other Comprehensive Loss

 

 

Total
Stockholders'
Equity

 

Balance at December 31, 2021

 

 

26,753,511

 

 

$

3

 

 

$

332,797

 

 

$

138,381

 

 

$

(123,557

)

 

$

(4,573

)

 

$

343,051

 

Net unrealized change in investments, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(24,321

)

 

 

(24,321

)

Shares tendered for income taxes withholding

 

 

(9,849

)

 

 

 

 

 

(89

)

 

 

 

 

 

 

 

 

 

 

 

(89

)

Restricted stock vested

 

 

25,000

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Issued restricted stock

 

 

397,176

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock-based compensation on restricted stock

 

 

 

 

 

 

 

 

505

 

 

 

 

 

 

 

 

 

 

 

 

505

 

Stock buy-back

 

 

(721,118

)

 

 

 

 

 

 

 

 

 

 

 

(5,000

)

 

 

 

 

 

(5,000

)

Cash dividends declared ($0.06 per common stock)

 

 

 

 

 

 

 

 

 

 

 

(1,621

)

 

 

 

 

 

 

 

 

(1,621

)

Net loss

 

 

 

 

 

 

 

 

 

 

 

(30,759

)

 

 

 

 

 

 

 

 

(30,759

)

Balance at March 31, 2022

 

 

26,444,720

 

 

$

3

 

 

$

333,213

 

 

$

106,001

 

 

$

(128,557

)

 

$

(28,894

)

 

$

281,766

 

 

 

 

 

 

 

 

 

 

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

4


 

HERITAGE INSURANCE HOLDINGS, INC.

Condensed Consolidated Statements of Cash Flows

(Unaudited)

(Amounts in thousands)

 

 

 

For the Three Months Ended March 31,

 

 

 

2023

 

 

2022

 

OPERATING ACTIVITIES

 

 

 

 

 

 

Net income (loss)

 

$

14,008

 

 

$

(30,759

)

Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:

 

 

 

 

 

 

Stock-based compensation

 

 

395

 

 

 

505

 

Bond amortization and accretion

 

 

(279

)

 

 

910

 

Amortization of original issuance discount on debt

 

 

117

 

 

 

521

 

Depreciation and amortization

 

 

2,127

 

 

 

2,047

 

Allowance for bad debt

 

 

27

 

 

 

(14

)

Expected credit allowance on reinsurance

 

 

152

 

 

 

 

Net realized investment gains

 

 

(1,898

)

 

 

16

 

Deferred income taxes

 

 

(3,976

)

 

 

(14,444

)

Changes in operating assets and liabilities:

 

 

 

 

 

 

Accrued investment income

 

 

281

 

 

 

(123

)

Premiums receivable, net

 

 

11,947

 

 

 

(2,573

)

Prepaid reinsurance premiums

 

 

118,217

 

 

 

87,308

 

Reinsurance recoverable on paid and unpaid claims

 

 

123,063

 

 

 

(19,388

)

Income taxes receivable

 

 

7,854

 

 

 

10,374

 

Deferred policy acquisition costs, net

 

 

1,582

 

 

 

3,240

 

Right of use leased asset

 

 

414

 

 

 

790

 

Other assets

 

 

(3,835

)

 

 

(1,042

)

Unpaid losses and loss adjustment expenses

 

 

(150,815

)

 

 

(1,746

)

Unearned premiums

 

 

(6,777

)

 

 

(4,183

)

Reinsurance payable

 

 

(103,903

)

 

 

(75,510

)

Accrued interest

 

 

(87

)

 

 

(342

)

Accrued compensation

 

 

(1,245

)

 

 

(2,244

)

Advance premiums

 

 

13,126

 

 

 

14,663

 

Operating lease liabilities

 

 

(345

)

 

 

(697

)

Other liabilities

 

 

(5,204

)

 

 

(6,515

)

Net cash provided by (used in) operating activities

 

 

14,946

 

 

 

(39,206

)

INVESTING ACTIVITIES

 

 

 

 

 

 

Fixed maturity securities sales, maturities and paydowns

 

 

145,070

 

 

 

22,132

 

Fixed maturity securities purchases

 

 

(110,251

)

 

 

(58,969

)

Sale on other investments and return of capital

 

 

4,119

 

 

 

9,368

 

Equity securities reinvestments of dividends

 

 

 

 

 

(2

)

Software in progress

 

 

(2,376

)

 

 

 

Cost of property and equipment acquired

 

 

(37

)

 

 

(177

)

Net cash provided by (used in) investing activities

 

 

36,525

 

 

 

(27,648

)

FINANCING ACTIVITIES

 

 

 

 

 

 

Repayment of term note

 

 

(2,375

)

 

 

(875

)

Mortgage loan adjustments (payments)

 

 

15

 

 

 

(81

)

Draw from revolver

 

 

 

 

 

15,000

 

Repurchase of convertible notes

 

 

 

 

 

(11,633

)

Purchase of treasury stock

 

 

 

 

 

(5,000

)

Tax withholdings on share-based compensation awards

 

 

(8

)

 

 

(89

)

Dividends paid

 

 

(11

)

 

 

(1,634

)

Net cash used in financing activities

 

 

(2,379

)

 

 

(4,312

)

Increase (decrease) in cash, cash equivalents, and restricted cash

 

 

49,092

 

 

 

(71,166

)

Cash, cash equivalents and restricted cash, beginning of period

 

 

287,572

 

 

 

364,752

 

Cash, cash equivalents and restricted cash, end of period

 

$

336,664

 

 

$

293,586

 

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

 

 

 

 

 

 

Income taxes (refund) paid

 

$

(676

)

 

$

 

Interest paid

 

$

2,376

 

 

$

1,578

 

 

5


 

Reconciliation of cash, cash equivalents, and restricted cash to condensed consolidated balance sheets.

 

 

March 31, 2023

 

 

December 31, 2022

 

 

 

(In thousands)

 

Cash and cash equivalents

 

$

329,965

 

 

$

280,881

 

Restricted cash

 

 

6,699

 

 

 

6,691

 

Total

 

$

336,664

 

 

$

287,572

 

 

Restricted cash primarily represents funds held to meet regulatory requirements in certain states in which the Company operates.

 

See accompanying notes to unaudited condensed consolidated financial statements.

6


 

HERITAGE INSURANCE HOLDINGS, INC.

Notes to Unaudited Condensed Consolidated Financial Statements

 

 

NOTE 1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The condensed consolidated financial statements include the accounts of Heritage Insurance Holdings, Inc. (together with its subsidiaries, the “Company”). These statements have been prepared in accordance with generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Certain financial information that is normally included in annual consolidated financial statements prepared in accordance with GAAP, but that is not required for interim reporting purposes, has been omitted. In the opinion of the Company’s management, all material intercompany transactions and balances have been eliminated and all adjustments consisting of normal recurring accruals which are necessary for a fair statement of the financial condition and results of operations for the interim periods have been reflected. The accompanying interim condensed consolidated financial statements and related footnotes should be read in conjunction with the Company’s audited consolidated financial statements and related footnotes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2022 filed on March 13, 2023 (the “2022 Form 10-K”).

Significant accounting policies

The accounting policies of the Company are set forth in Note 1 to the condensed consolidated financial statements contained in the Company’s 2022 Form 10-K.

Accounting Pronouncements not yet adopted

The Company has documented the summary of its significant accounting policies in its Notes to the Audited Consolidated Financial Statements contained in the Company’s 2022 Form 10-K. There have been no material changes to the Company’s accounting policies since the filing of that report.

No other new accounting pronouncements issued, but not yet adopted, have had, or are expected to have, a material impact on the Company’s results of operations or financial position.

NOTE 2. INVESTMENTS

Securities Available-for-Sale

The amortized cost, gross unrealized gains and losses, and fair value of the Company’s debt securities available-for-sale are as follows for the periods presented:

 

March 31, 2023

 

Cost or Adjusted /
Amortized Cost

 

 

Gross Unrealized
Gains

 

 

Gross Unrealized
Losses

 

 

Fair Value

 

Debt Securities Available-for-sale

 

(In thousands)

 

U.S. government and agency securities (1)

 

$

104,455

 

 

$

62

 

 

$

3,071

 

 

$

101,446

 

States, municipalities and political subdivisions

 

 

102,209

 

 

 

 

 

 

10,604

 

 

 

91,605

 

Special revenue

 

 

281,872

 

 

 

12

 

 

 

28,823

 

 

 

253,061

 

Industrial and miscellaneous

 

 

182,482

 

 

 

173

 

 

 

15,591

 

 

 

167,064

 

Total

 

$

671,018

 

 

$

247

 

 

$

58,089

 

 

$

613,176

 

(1)
Includes securities at March 31, 2023 with a carrying amount of $23.3 million that were pledged as collateral for the advance agreement entered into with a financial institution in 2018. The Company is permitted to withdraw or exchange any portion of the pledged collateral over the minimum requirement at any time.

 

December 31, 2022

 

Cost or Adjusted /
Amortized Cost

 

 

Gross Unrealized
Gains

 

 

Gross Unrealized
Losses

 

 

Fair Value

 

Debt Securities Available-for-sale

(In thousands)

 

U.S. government and agency securities (1)

 

$

121,811

 

 

$

24

 

 

$

4,093

 

 

$

117,742

 

States, municipalities and political subdivisions

 

 

104,361

 

 

 

 

 

 

12,734

 

 

 

91,627

 

Special revenue

 

 

284,946

 

 

 

1

 

 

 

34,817

 

 

 

250,130

 

Industrial and miscellaneous

 

 

194,430

 

 

 

90

 

 

 

18,447

 

 

 

176,073

 

Total

 

$

705,548

 

 

$

115

 

 

$

70,091

 

 

$

635,572

 

 

(1)
Includes securities at December 31, 2022 with a carrying amount of $24.3 million that were pledged as collateral for the advance agreement entered into with a financial institution in 2018. The Company is permitted to withdraw or exchange any portion of the pledged collateral over the minimum requirement at any time.

7


 

The Company’s unrealized losses on corporate bonds have not been recognized because the bonds are of a high credit quality with investment grade ratings. The average rating was an A+ for the three months ended March 31, 2023. The unrealized losses are deemed to be caused by interest rates rising after the bonds were purchased and no credit loss allowance was recorded for the three months ended March 31, 2023 or for the year ended December 31, 2022.

Net Realized Gains (Losses)

The following table presents net realized gains (losses) on the Company’s debt securities available-for-sale for the three months ended March 31, 2023 and 2022, respectively:

 

 

2023

 

 

2022

 

Three Months Ended March 31,

 

Gains
(Losses)

 

 

Fair Value at Sale

 

 

Gains
(Losses)

 

 

Fair Value at Sale

 

 

 

(In thousands)

 

Debt Securities Available-for-Sale

 

 

 

 

 

 

 

 

 

 

 

 

Total realized gains

 

$

 

 

$

 

 

$

7

 

 

$

910

 

Total realized losses

 

 

(2

)

 

 

356

 

 

 

(23

)

 

 

1,685

 

Net realized (losses) gains

 

$

(2

)

 

$

356

 

 

$

(16

)

 

$

2,595

 

The following table presents the reconciliation of net realized gains (losses) on the Company’s investments reported for the three months ended March 31, 2023 and 2022, respectively:

 

 

As of March 31,

 

 

 

2023

 

 

2022

 

 Gross realized gains on sales of available-for-sale securities

 

$

 

 

$

23

 

 Gross realized losses on sales of available-for-sale securities

 

 

(2

)

 

 

(39

)

 Gross realized gains on sale of other investments

 

 

1,900

 

 

 

 

 Net realized gains (losses)

 

$

1,898

 

 

$

(16

)

During the first quarter of March 31, 2023, the Company sold its investment in an Insurtech company for $4.0 million, resulting in a $1.9 million realized gain on the investment.

The table below summarizes the Company’s debt securities at March 31, 2023 by contractual maturity periods. Actual results may differ as issuers may have the right to call or prepay obligations, with or without penalties, prior to the contractual maturity of those obligations.

 

 

 

At March 31, 2023

 

 

 

Cost or Amortized Cost

 

 

Percent of Total

 

 

Fair Value

 

 

Percent of Total

 

Maturity dates:

 

 

 

 

 

 

 

(In thousands)

 

 

 

 

Due in one year or less

 

$

102,233

 

 

 

15.2

%

 

$

100,237

 

 

 

16.3

%

Due after one year through five years

 

 

336,998

 

 

 

50.2

%

 

 

311,151

 

 

 

50.7

%

Due after five years through ten years

 

 

171,332

 

 

 

25.5

%

 

 

146,215

 

 

 

23.8

%

Due after ten years

 

 

60,456

 

 

 

9.0

%

 

 

55,573

 

 

 

9.1

%

Total

 

$

671,018

 

 

 

100.0

%

 

$

613,176

 

 

 

100.0

%

Net Investment Income

The following table summarizes the Company’s net investment income by major investment category for the three months ended March 31, 2023 and 2022, respectively:

 

 

Three Months Ended March 31,

 

 

 

2023

 

 

2022

 

 

 

(In thousands)

 

Debt securities

 

$

3,023

 

 

$

2,275

 

Equity securities

 

 

33

 

 

 

 

Cash and cash equivalents

 

 

2,204

 

 

 

16

 

Other investments

 

 

730

 

 

 

230

 

Net investment income

 

 

5,990

 

 

 

2,521

 

Less: Investment expenses

 

 

408

 

 

 

521

 

Net investment income, less investment expenses

 

$

5,582

 

 

$

2,000

 

 

The following tables present, for all debt securities available-for-sale in an unrealized loss position (including securities pledged) and for which no credit loss allowance has been established to date, the aggregate fair value and gross unrealized loss by

8


 

length of time the security has continuously been in an unrealized loss position at March 31, 2023 and December 31, 2022, respectively:

 

 

 

Less Than Twelve Months

 

 

Twelve Months or More

 

March 31, 2023

 

Number of
Securities

 

 

Gross
Unrealized
Losses

 

 

Fair Value

 

 

Number of
Securities

 

 

Gross
Unrealized
Losses

 

 

Fair Value

 

Debt Securities Available-for-sale

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. government and agency securities

 

 

16

 

 

$

167

 

 

$

14,750

 

 

 

73

 

 

$

2,904

 

 

$

81,806

 

States, municipalities and political subdivisions

 

 

5

 

 

 

15

 

 

 

1,531

 

 

 

116

 

 

 

10,589

 

 

 

67,028

 

Special revenue

 

 

51

 

 

 

145

 

 

 

8,370

 

 

 

465

 

 

 

28,678

 

 

 

216,363

 

Industrial and miscellaneous

 

 

30

 

 

 

104

 

 

 

10,251

 

 

 

232

 

 

 

15,487

 

 

 

144,875

 

Total fixed maturity securities

 

 

102

 

 

$

431

 

 

$

34,902

 

 

 

886

 

 

$

57,658

 

 

$

510,072

 

 

 

 

 

 

Less Than Twelve Months

 

 

Twelve Months or More

 

December 31, 2022

 

Number of
Securities

 

 

Gross
Unrealized
Losses

 

 

Fair Value

 

 

Number of
Securities

 

 

Gross
Unrealized
Losses

 

 

Fair Value

 

Debt Securities Available-for-sale

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. government and agency securities

 

 

61

 

 

$

2,040

 

 

$

56,389

 

 

 

36

 

 

$

2,053

 

 

$

56,389

 

States, municipalities and political
   subdivisions

 

 

28

 

 

 

1,967

 

 

 

17,730

 

 

 

95

 

 

 

10,767

 

 

 

68,852

 

Special revenue

 

 

273

 

 

 

5,832

 

 

 

57,881

 

 

 

259

 

 

 

28,985

 

 

 

167,384

 

Industrial and miscellaneous

 

 

95

 

 

 

1,535

 

 

 

32,387

 

 

 

197

 

 

 

16,912

 

 

 

134,462

 

Total fixed maturity securities

 

 

457

 

 

$

11,374

 

 

$

164,386

 

 

 

587

 

 

$

58,717

 

 

$

427,087

 

 

The Company’s unrealized losses on corporate bonds have not been recognized because the bonds are of a high credit quality with investment grade ratings. The Company does not intend to sell and it is unlikely the Company will be required to sell the securities prior to their anticipated recovery, and the decline in fair value is deemed due to changes in interest rates and other market conditions. The debt issuers continue to make timely principal and interest payments on the bonds. After taking into account these and other factors previously described, the Company believes these unrealized losses generally were caused by a decrease in market interest rates since the time the securities were purchased and not as a result of credit losses.

Quarterly, the Company considers whether it intends to sell an available-for-sale security or if it is more likely than not that it will be required to sell the security before recovery of its amortized costs. In these instances, a decline in fair value is recognized in net income based on the fair value of the security at the time of assessment, resulting in a new cost basis for the security.

Other Investments

Non-Consolidating Variable Interest Entities (“VIEs”)

The Company makes passive investments in limited partnerships (“LPs”), which are accounted for using the equity method, with income reported in earnings. The Company also holds a passive investment in a Real Estate Investment Trust (“REIT”), which is accounted for using the measurement alternative method, and reported at cost less impairment (if any), plus or minus changes from observable price changes.

The following table summarizes the carrying value and maximum loss exposure of the Company’s non-consolidated VIEs at March 31, 2023 and December 31, 2022, respectively:

 

 

As of March 31, 2023

 

 

As of December 31, 2022

 

 

 

Carrying Value

 

 

Maximum Loss Exposure

 

 

Carrying Value

 

 

Maximum Loss Exposure

 

Investments in non-consolidated VIEs - Equity method

 

$

3,416

 

 

$

3,416

 

 

$

3,517

 

 

$

3,517

 

Investments in non-consolidated VIEs - Amortized cost

 

$

8,490

 

 

$

8,490

 

 

$

8,490

 

 

$

8,490

 

Investments in non-consolidated VIEs - Measurement alternative

 

$

2,377

 

 

$

2,377

 

 

$

4,477

 

 

$

4,477

 

Total non-consolidated VIEs

 

$

14,283

 

 

$

14,283

 

 

$

16,484

 

 

$

16,484

 

 

9


 

No agreements exist requiring the Company to provide additional funding to any of the non-consolidated VIEs in excess of the Company’s initial investment.

NOTE 3. FAIR VALUE OF FINANCIAL MEASUREMENTS

Fair value is determined based on the exchange price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date.

The Company is required to use an established hierarchy for fair value measurements based upon the inputs to the valuation and degree to which they are observable or not observable in the market. The three levels in the hierarchy are as follows:

Level 1 – Unadjusted quoted prices are available in active markets for identical assets/liabilities as of the reporting date.
Level 2 – Valuations based on observable inputs, such as quoted prices for similar assets or liabilities at the measurement date; quoted prices in the markets that are not active; or other inputs that are observable, either directly or indirectly.
Level 3 – Pricing inputs are unobservable and significant to the overall fair value measurement, and the determination of fair value requires significant management judgment or estimation.

The highest priority is assigned to Level 1 inputs and the lowest priority to Level 3 inputs. At March 31, 2023 and December 31, 2022, there were no transfers in or out of Level 1, 2, and 3.

The following table presents information about the Company’s assets measured at fair value on a recurring basis. The Company assesses the levels for the investments at each measurement date, and transfers between levels are recognized on the actual date of the event or change in circumstances that caused the transfer in accordance with the Company’s accounting policy regarding the recognitions of transfers between levels of the fair value hierarchy.

The tables below present the balances of the Company’s invested assets measured at fair value on a recurring basis:

 

March 31, 2023

 

Total

 

 

Quoted Prices in Active Markets for Identical Assets (Level 1)

 

 

Significant Other Observable Inputs (Level 2)

 

 

Significant Unobservable Inputs (Level 3)

 

Invested Assets:

 

(in thousands)

 

Debt Securities Available-for-sale

 

 

 

 

 

 

 

 

 

 

 

 

U.S. government and agency securities

 

$

101,446

 

 

$

 

 

$

101,446

 

 

$

 

States, municipalities and political subdivisions

 

 

91,605

 

 

 

 

 

 

91,605

 

 

 

 

Special revenue

 

 

253,061

 

 

 

 

 

 

253,061

 

 

 

 

Industrial and miscellaneous

 

 

167,064

 

 

 

 

 

 

167,064

 

 

 

 

Total investments

 

$

613,176

 

 

$

 

 

$

613,176

 

 

$

 

 

December 31, 2022

 

Total

 

 

Quoted Prices in Active Markets for Identical Assets (Level 1)

 

 

Significant Other Observable Inputs (Level 2)

 

 

Significant Unobservable Inputs (Level 3)

 

Invested Assets:

 

(in thousands)

 

Debt Securities Available-for-sale

 

 

 

 

 

 

 

 

 

 

 

 

U.S. government and agency securities

 

$

117,742

 

 

$

 

 

$

117,742

 

 

$

 

States, municipalities and political subdivisions

 

 

91,627

 

 

 

 

 

 

91,627

 

 

 

 

Special revenue

 

 

250,130

 

 

 

 

 

 

250,130

 

 

 

 

Industrial and miscellaneous

 

 

176,073

 

 

 

 

 

 

176,073

 

 

 

 

Total investments

 

$

635,572

 

 

$

 

 

$

635,572

 

 

$

 

Financial Instruments excluded from the fair value hierarchy

The carrying value of premium receivables, accounts payable, accrued expense, revolving loans and borrowings under the Company’s senior secured credit facility approximate their fair value. The rate at which revolving loans and borrowings under the Company’s senior secured credit facility bear interest resets periodically at market interest rates.

10


 

Non-recurring fair value measurements

Assets and liabilities that are measured at fair value on a non-recurring basis include intangible assets which are recognized at fair value during the period in which an acquisition is completed, from updated estimates and assumptions during the measurement period, or when they are considered to be impaired. For the three months ended March 31, 2023, there were no assets or liabilities that were measured at fair value on a non-recurring basis.

Certain of the Company's investments, in accordance with GAAP for the type of investment, are measured using methodologies other than fair value.

NOTE 4. OTHER COMPREHENSIVE INCOME (LOSS)

The following table summarizes other comprehensive income (loss) and discloses the tax impact of each component of other comprehensive income (loss) for the three months ended March 31, 2023 and 2022, respectively:

 

 

 

For the Three Months Ended March 31,

 

 

 

2023

 

 

2022

 

 

 

Pre-tax

 

 

Tax

 

 

After-tax

 

 

Pre-tax

 

 

Tax

 

 

After-tax

 

 

 

(in thousands)

 

Other comprehensive income (loss)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Change in unrealized gains (losses) on investments, net

 

$

12,143

 

 

$

(2,855

)

 

$

9,288

 

 

$

(31,770

)

 

$

7,437

 

 

$

(24,333

)

Reclassification adjustment of realized losses included in net income (loss)

 

 

2

 

 

 

 

 

 

2

 

 

 

16

 

 

 

(4

)

 

 

12

 

Effect on other comprehensive income (loss)

 

$

12,145

 

 

$

(2,855

)

 

$

9,290

 

 

$

(31,754

)

 

$

7,433

 

 

$

(24,321

)

 

NOTE 5. LEASES

The Company has entered into operating and financing leases primarily for real estate and vehicles. The Company will determine whether an arrangement is a lease at inception of the agreement. The operating leases have terms of one to ten years, and often include one or more options to renew. These renewal terms can extend the lease term from two to ten years and are included in the lease term when it is reasonably certain that the Company will exercise the option. The Company considers these options in determining the lease term used in establishing the Company’s right-of-use assets and lease obligations. The Company’s lease agreements do not contain any material residual value guarantees or material restrictive covenants.

Because the rate implicit in each operating lease is not readily determinable, the Company uses its incremental borrowing rate to determine present value of the lease payments. The Company used the implicit rates within the finance leases.

Components of the Company’s lease costs were as follows (in thousands):

 

 

 

For The Three Months Ended March 31,

 

 

 

2023

 

 

2022

 

Operating lease cost, included in General & Administrative expenses on the Consolidated Statements of Operations

 

$

393

 

 

$

353

 

Finance lease cost:

 

 

 

 

 

 

Amortization of assets, included in General & Administrative expenses on the Consolidated Statements of Operations

 

 

645

 

 

 

646

 

Interest on lease liabilities, included in Interest expense on the Consolidated Statements of Operations

 

 

227

 

 

 

249

 

Total finance lease cost

 

$

872

 

 

$

895

 

Variable lease cost, included in General & Administrative expenses on the Consolidated Statements of Operations

 

$

409

 

 

$

186

 

Short-term lease cost, included in General & Administrative expenses on the Consolidated Statements of Operations

 

$

30

 

 

$

32

 

 

Supplemental balance sheet information related to the Company’s operating and financing leases were as follows (in thousands):

 

 

 

 

Operating Leases

 

March 31, 2023

 

 

December 31, 2022

 

Right of use assets

 

$

7,563

 

 

$

7,335

 

Lease liability

 

$

8,890

 

 

$

8,690

 

Finance Leases

 

 

 

 

 

 

Right of use assets

 

$

19,490

 

 

$

20,132

 

Lease liability

 

$

22,012

 

 

$

22,557

 

 

11


 

Weighted-average remaining lease term and discount rate for the Company’s operating and financing leases for the periods presented below were as follows:

Weighted-average remaining lease term

 

March 31, 2023

 

 

December 31, 2022

 

 

Operating lease

 

 

6.31

 

yrs.

 

6.49

 

yrs.

Finance lease

 

 

7.90

 

yrs.

 

8.13

 

yrs.

Weighted-average discount rate

 

 

 

 

 

 

 

Operating lease

 

 

4.9

 

%

 

5.14

 

%

Finance lease

 

 

4.2

 

%

 

4.16

 

%

 

Maturities of lease liabilities by fiscal year for the Company’s operating and financing leases were as follows (in thousands):

 

 

Financing Lease

 

 

Operating Lease

 

2023

 

$

2,316

 

 

$

1,243

 

2024

 

 

3,101

 

 

 

1,656

 

2025

 

 

3,166

 

 

 

1,548

 

2026

 

 

3,197

 

 

 

1,558

 

2027

 

 

3,190

 

 

 

1,595

 

2028 and thereafter

 

 

10,920

 

 

 

2,846

 

Total lease payments

 

 

25,890

 

 

 

10,446

 

Less: imputed interest

 

 

(3,878

)

 

 

(1,556

)

Present value of lease liabilities

 

$

22,012

 

 

$

8,890

 

 

NOTE 6. PROPERTY AND EQUIPMENT, NET

Property and equipment, net consisted of the following at March 31, 2023 and December 31, 2022:

 

 

 

March 31, 2023

 

 

December 31, 2022

 

 

 

(In thousands)

 

Land

 

$

2,582

 

 

$

2,582

 

Building

 

 

9,599

 

 

 

9,599

 

Software in progress

 

 

9,260

 

 

 

6,884

 

Computer hardware and software

 

 

8,876

 

 

 

8,851

 

Office furniture and equipment

 

 

1,394

 

 

 

1,381

 

Tenant and leasehold improvements

 

 

10,485

 

 

 

10,485

 

Vehicle fleet

 

 

594

 

 

 

594

 

Total, at cost

 

 

42,790

 

 

 

40,376

 

Less: accumulated depreciation and amortization

 

 

(15,187

)

 

 

(14,647

)

Property and equipment, net

 

$

27,603

 

 

$

25,729

 

For the three months ended March 31, 2023, the Company invested $2.4 million for software development and implementation services for a new policy, billing and claims system for which one component is anticipated to be completed and placed in service during the second quarter of 2023 with the remaining components anticipated to be placed in service in early 2024.

Depreciation and amortization expense for property and equipment was approximately $539,000 and $459,000 for the three months ended March 31, 2023 and 2022, respectively. The Company owns real estate consisting of 13 acres of land, two buildings with a gross area of 88,378 square feet and a parking garage.

NOTE 7. INTANGIBLE ASSETS

At March 31, 2023 and December 31, 2022, intangible assets were $48.0 million and $49.6 million, respectively. The Company has determined the useful life of its intangible assets to range between 2.5-15 years. Intangible assets include $1.3 million relating to insurance licenses which is classified as an indefinite lived intangible and is subject to annual impairment testing.

The Company’s intangible assets consist of brand, agent relationships, renewal rights, customer relations, trade names, non-competes and insurance licenses.

Amortization expense of the Company’s intangible assets for each of the respective three month periods ended March 31, 2023 and 2022 was $1.6 million. No impairment in the value of amortizing or non-amortizing intangible assets was recognized during the three months ended March 31, 2023 or 2022.

12


 

Estimated annual pretax amortization of intangible assets for each of the next five years and thereafter is as follows (in thousands):

 

Year

 

Amount

 

2023 - remaining

 

$

4,763

 

2024

 

$

6,351

 

2025

 

$

6,315

 

2026

 

$

6,114

 

2027

 

$

5,917

 

Thereafter

 

$

17,212

 

Total

 

$

46,672

 

 

NOTE 8. EARNINGS (LOSS) PER SHARE

The following table sets forth the computation of basic and diluted earnings (loss) per share (“EPS”) for the periods indicated.

 

 

 

Three Months Ended March 31,

 

 

 

2023

 

 

2022

 

Basic earnings (loss) per share:

 

 

 

 

 

 

Net income (loss) attributable to common stockholders (000's)

 

$

14,008

 

 

$

(30,759

)

Weighted average shares outstanding

 

 

25,558,305

 

 

 

26,787,379

 

Basic earnings (loss) per share:

 

$

0.55

 

 

$

(1.15

)

 

 

 

 

 

 

 

Diluted earnings (loss) per share:

 

 

 

 

 

 

Net income (loss) attributable to common stockholders (000's)

 

$

14,008

 

 

$

(30,759

)

Weighted average shares outstanding

 

 

25,558,305

 

 

 

26,787,379

 

Weighted average dilutive shares

 

 

59,263

 

 

 

 

Total weighted average dilutive shares

 

 

25,617,568

 

 

 

26,787,379

 

Diluted earnings (loss) per share:

 

$

0.55

 

 

$

(1.15

)

The Company had 1,903,039 antidilutive shares for the period ended March 31, 2022. The convertible notes were excluded from the computations because the conversion price on these notes was greater than the average market price of the Company's common stock during each of the respective periods, and therefore, would be anti-dilutive to earnings per share under the "if converted" method under the guidance of ASU 2020-06, adopted by the Company on January 1, 2022.

NOTE 9. DEFERRED REINSURANCE CEDING COMMISSION

The Company defers reinsurance ceding commission income, which is amortized over the effective period of the related insurance policies. For the three months ended March 31, 2023 and 2022, the Company allocated ceding commission income of $12.9 million and $11.7 million to policy acquisition costs, respectively, and $4.2 million and $3.9 million to general and administrative expense, respectively.

The table below depicts the activity regarding deferred reinsurance ceding commission during the three months ended March 31, 2023 and 2022.

 

 

Three Months Ended March 31,

 

 

 

2023

 

 

2022

 

 

(In thousands)

 

Beginning balance of deferred ceding commission income

 

$

42,757

 

 

$

40,405

 

Ceding commission deferred

 

 

15,021

 

 

 

12,454

 

Less: ceding commission earned

 

 

(17,089

)

 

 

(15,614

)

Ending balance of deferred ceding commission income

 

$

40,689

 

 

$

37,245

 

Deferred ceding commission income is classified in “Accounts payable and other liabilities” on the Company’s condensed consolidated balance sheet.

NOTE 10. DEFERRED POLICY ACQUISITION COSTS

The Company defers certain costs in connection with written policies, called deferred policy acquisition costs (“DPAC”), which are amortized over the effective period of the related insurance policies.

The Company anticipates that its DPAC will be fully recoverable in the near term. The table below depicts the activity regarding DPAC for the three months ended March 31, 2023 and 2022.

13


 

 

 

 

Three Months Ended March 31,

 

 

 

2023

 

 

2022

 

 

(In thousands)

 

Beginning Balance

 

$

99,617

 

 

$

93,881

 

Policy acquisition costs deferred

 

 

53,180

 

 

 

49,992

 

Amortization

 

 

(54,762

)

 

 

(53,232

)

Ending Balance

 

$

98,035

 

 

$

90,641

 

 

NOTE 11. INCOME TAXES

For the three months ended March 31, 2023 and 2022, the Company recorded an income tax provision of $3.2 million and a tax benefit of $10.6 million, respectively, which corresponds to effective tax rates of 18.6% and 25.7%, respectively. Effective tax rates are dependent upon components of pre-tax earnings and the related tax effects. The effective tax rate for each period was affected by various permanent tax differences, including disallowed executive compensation deductions which was further limited in 2018 and future years upon the enactment of H.R.1, commonly referred to as the Tax Cuts and Jobs Act (“Tax Act”). Additionally, the state effective income tax rate can also fluctuate as a result of changes in the geographic dispersion of the Company’s business. The effective tax rate can fluctuate throughout the year as estimates used in the tax provision for each quarter are updated as more information becomes available throughout the year.

The table below summarizes the significant components of the Company’s net deferred tax assets:

 

 

 

March 31, 2023

 

 

December 31, 2022

 

Deferred tax assets:

 

(in thousands)

 

Unearned premiums

 

$

23,251

 

 

$

17,060

 

Unearned commission

 

 

9,566

 

 

 

10,053

 

Net operating loss

 

 

567

 

 

 

1,189

 

Tax-related discount on loss reserve

 

 

4,705

 

 

 

4,902

 

Stock-based compensation

 

 

386

 

 

 

297

 

Accrued expenses

 

 

997

 

 

 

1,016

 

Leases

 

 

892

 

 

 

885

 

Unrealized losses

 

 

14,131

 

 

 

16,987

 

Dual Consolidated loss limitation

 

 

6,960

 

 

 

9,740

 

Other

 

 

277

 

 

 

238

 

Total deferred tax asset

 

 

61,732

 

 

 

62,367

 

Valuation allowance

 

 

(4,712

)

 

 

(6,376

)

Adjusted deferred tax asset

 

 

57,020

 

 

 

55,991

 

Deferred tax liabilities:

 

 

 

 

 

 

Deferred acquisition costs

 

$

23,048

 

 

$

23,420

 

Prepaid expenses

 

 

256

 

 

 

180

 

Property and equipment

 

 

2,358

 

 

 

2,200

 

Note discount

 

 

290

 

 

 

290

 

Basis in purchased investments

 

 

26

 

 

 

28

 

Basis in purchased intangibles

 

 

10,823

 

 

 

11,178

 

Internal revenue code 481(a)

 

 

 

 

 

 

Other

 

 

2,257

 

 

 

1,854

 

Total deferred tax liabilities

 

 

39,058

 

 

 

39,150

 

Net deferred tax assets

 

$

17,962

 

 

$

16,841

 

 

14


 

The income tax (benefit) expense differs from the amounts computed by applying the U.S. federal income tax rate of as indicated below to pretax income as a result of the following (in thousands):

 

 

March 31, 2023

 

 

 

March 31, 2022

 

 

Change

 

 

Expected income tax expense at federal rate

 

 

21.0

 

%

 

 

21.0

 

%

 

0.0

 

%

Tax exempt interest

 

 

(0.3

)

%

 

 

0.1

 

%

 

(0.3

)

%

Executive compensation 162(m)

 

 

0.2

 

%

 

 

(0.2

)

%

 

0.4

 

%

Permanent items

 

 

1.1

 

%

 

 

(0.3

)

%

 

1.4

 

%

State tax expense

 

 

5.4

 

%

 

 

2.8

 

%

 

2.6

 

%

Prior period adjustment/penalties/interest

 

 

0.9

 

%

 

 

0.6

 

%

 

0.3

 

%

Valuation allowance

 

 

(9.7

)

%

 

 

0.0

 

%

 

(9.7

)

%

Non-deductible stock compensation

 

 

0.0

 

%

 

 

0.0

 

%

 

0.0

 

%

Goodwill impairment

 

 

0.0

 

%

 

 

1.7

 

%

 

(1.7

)

%

Reported income tax expense

 

 

18.6

 

%

 

 

25.7

 

%

 

(7.0

)

%

For the quarters ended March 31, 2023 and 2022, the effective tax rate was 18.6% and 25.7%, respectively. The 7.0 point change can be attributed to the impact of permanent differences to the pre-tax income or loss. For the quarter ended March 31, 2022, the effective tax rate was impacted primarily by the goodwill impairment and state taxes. For the three months ended March 31, 2023, the effective tax rate was impacted primarily by the valuation allowance that was reduced from $6.4 million to $4.7 million and state taxes, which had a favorable impact on the effective tax rate for the quarter.

The statute of limitations related to the Company’s federal and state income tax returns remains open from the Company’s filings for 2019 through 2022.

At March 31, 2023 and December 31, 2022, the Company had no significant uncertain tax positions or unrecognized tax benefits that, if recognized, would impact the effective income tax rate.

NOTE 12. REINSURANCE

Overview

In order to limit the Company’s potential exposure to individual risks and catastrophic events, the Company purchases significant reinsurance from third party reinsurers. Purchasing reinsurance is an important part of the Company’s risk strategy, and premiums ceded to reinsurers is one of the Company’s largest costs. The Company has strong relationships with reinsurers, which it attributes to its management’s industry experience, disciplined underwriting, and claims management capabilities. For each of the twelve months beginning June 1, 2021 and 2022, the Company purchased reinsurance from the following sources: (i) the Florida Hurricane Catastrophe Fund, a state-mandated catastrophe fund (“FHCF”) for Florida policies only, (ii) private reinsurers, all of which were rated “A-” or higher by A.M. Best Company, Inc. (“A.M. Best”) or Standard & Poor’s Financial Services LLC (“S&P”) or were fully collateralized, and (iii) the Company’s wholly-owned reinsurance subsidiary, Osprey Re Ltd. (“Osprey Re”). The Company also sponsored catastrophe bonds in 2022 through Citrus Re Ltd. In addition to purchasing excess of loss catastrophe reinsurance, the Company also purchased quota share, property per risk and facultative reinsurance. The Company’s quota share program limits its exposure on catastrophe and non-catastrophe losses and provides ceding commission income. The Company’s per risk programs limit its net exposure in the event of a severe non-catastrophe loss impacting a single location or risk. The Company also utilizes facultative reinsurance to supplement its per risk reinsurance program where the Company capacity needs dictate.

Purchasing a sufficient amount of reinsurance to cover catastrophic losses from single or multiple events or significant non-catastrophe losses is an important part of the Company’s risk strategy. Reinsurance involves transferring, or “ceding”, a portion of the risk exposure on policies the Company writes to another insurer, known as a reinsurer. To the extent that the Company’s reinsurers are unable to meet the obligations they assume under the Company’s reinsurance agreements, the Company remains liable for the entire insured loss.

The Company’s insurance regulators require all insurance companies, like the Company, to have a certain amount of capital and reinsurance coverage in order to cover losses and loss adjustment expenses upon the occurrence of a catastrophic event. The Company’s reinsurance program provides reinsurance in excess of its state regulator requirements, which are based on the probable maximum loss that it would incur from an individual catastrophic event estimated to occur once in every 100 years based on its portfolio of insured risks. The nature, severity and location of the event giving rise to such a probable maximum loss differs for each insurer depending on the insurer’s portfolio of insured risks, including, among other things, the geographic concentration of insured value within such portfolio. As a result, a particular catastrophic event could be a one-in-100-year loss event for one insurance company while having a greater or lesser probability of occurrence for another insurance company. The Company also purchases reinsurance coverage to protect against the potential for multiple catastrophic events occurring in the same year. The Company shares portions of its reinsurance program coverage among its insurance company affiliates.

15


 

For a detailed discussion of the Company’s 2022-2023 Reinsurance Program please Refer to Part II, Item 8, “Financial Statements and Supplementary Data” and “Note 12. Reinsurance” in the Company’s 2022 Form 10-K. Additionally, please refer to Note 17, Commitments and Contingencies, for discussion related to the upcoming commutation of the Company’s 2017 reinsurance contract with the FHCF.

Effect of Reinsurance

The Company’s reinsurance arrangements had the following effect on certain items in the condensed consolidated statement of income for the three months ended March 31, 2023 and 2022:

 

 

 

Three Months Ended March 31,

 

 

 

2023

 

 

2022

 

 

 

(In thousands)

 

Premium written:

 

 

 

 

 

 

Direct

 

$

310,309

 

 

$

283,196

 

Ceded

 

 

(32,776

)

 

 

(47,131

)

Net

 

$

277,533

 

 

$

236,065

 

Premiums earned:

 

 

 

 

 

 

Direct

 

$

317,022

 

 

$

287,368

 

Ceded

 

 

(150,993

)

 

 

(134,439

)

Net

 

$

166,029

 

 

$

152,929

 

Loss and Loss Adjustment Expenses

 

 

 

 

 

 

Direct

 

$

162,817

 

 

$

199,668

 

Ceded

 

 

(65,365

)

 

 

(59,630

)

Net

 

$

97,452

 

 

$

140,038

 

 

NOTE 13. RESERVE FOR UNPAID LOSSES

The Company determines the reserve for unpaid losses on an individual-case basis for all incidents reported. The liability also includes amounts which are commonly referred to as incurred but not reported, or “IBNR”, claims as of the balance sheet date. The Company estimates its IBNR reserves by projecting its ultimate losses using industry accepted actuarial methods and then deducting actual loss payments and case reserves from the projected ultimate losses.

The table below summarizes the activity related to the Company’s reserve for unpaid losses:

 

 

 

Three Months Ended March 31,

 

 

 

2023

 

 

2022

 

 

 

(In thousands)

 

Balance, beginning of period

 

$

1,131,807

 

 

$

590,166

 

Less: reinsurance recoverable on unpaid losses

 

 

759,682

 

 

 

301,757

 

Net balance, beginning of period

 

 

372,125

 

 

 

288,409

 

Incurred related to:

 

 

 

 

 

 

Current year

 

 

98,914

 

 

 

137,626

 

Prior years

 

 

(1,462

)

 

 

2,412

 

Total incurred

 

 

97,452

 

 

 

140,038

 

Paid related to:

 

 

 

 

 

 

Current year

 

 

30,374

 

 

 

39,628

 

Prior years

 

 

78,429

 

 

 

77,136

 

Total paid

 

 

108,803

 

 

 

116,764

 

Net balance, end of period

 

 

360,774

 

 

 

311,683

 

Plus: reinsurance recoverable on unpaid losses

 

 

620,218

 

 

 

276,737

 

Balance, end of period

 

$

980,992

 

 

$

588,420

 

 

The Company believes that the reserve for unpaid losses reasonably represents the amount necessary to pay all claims and related expenses which may arise from incidents that have occurred as of the balance sheet date.

As of March 31, 2023, the Company reported $360.8 million in unpaid losses and loss adjustment expenses, net of reinsurance which included $284.0 million attributable to IBNR net of reinsurance recoverable, or 78.7% of net reserves for unpaid losses and loss adjustment expenses.

Reinsurance recoverable on unpaid losses includes expected reinsurance recoveries associated with reinsurance contracts the Company has in place. The amount may include recoveries from catastrophe excess of loss reinsurance, net quota share reinsurance,

16


 

per risk reinsurance, and facultative reinsurance contracts. Refer to Note 17, Commitments and Contingencies, for discussion related to the upcoming commutation of the Company’s 2017 reinsurance contract with the FHCF.

NOTE 14. LONG-TERM DEBT

Convertible Senior Notes

In August 2017 and September 2017, the Company issued in aggregate $136.8 million of 5.875% Convertible Senior Notes (“Convertible Notes”) maturing on August 1, 2037, unless earlier repurchased, redeemed or converted. Interest is payable semi-annually in arrears, on February 1, and August 1 of each year. As of March 31, 2023, pursuant to the guidance of ASU 2020-06, the outstanding Convertible Notes would have been converted into 59,263 shares of the Company's common stock as they are dilutive and as such have been included in the Company's quarterly diluted earnings per share results. For the three months ended March 31, 2022, the Company was in a net loss position, therefore the diluted earnings per share would not be considered for the conversion as the Convertible Notes were anti-dilutive for that period.

As of March 31, 2023, the Company had approximately $885,000 of the Convertible Notes outstanding, net of $21.1 million of Convertible Notes held by an insurance company subsidiary. For each of the three-month periods ended March 31, 2023 and 2022, the Company made interest payments, net of affiliated Convertible Notes, of approximately $26,000 and $630,650, on the outstanding Convertible Notes, respectively.

In January 2022, the Company reacquired and retired $11.7 million of its outstanding Convertible Senior Notes. Payment was made in cash and the Convertible Notes were retired at the time of repurchase. In addition, the Company expensed $242,700 which was the proportionate amount of the unamortized issuance and debt discount costs associated with this repurchase.

Senior Secured Credit Facility

The Company is party to a credit agreement dated as of December 14, 2018 (as amended from time to time, the “Credit Agreement”) with a syndicate of lenders.

The Credit Agreement, as amended, provides for (1) a five-year senior secured term loan facility in an aggregate principal amount of $100 million (the “Term Loan Facility”) and (2) a five-year senior secured revolving credit facility in an aggregate principal amount of $50 million (inclusive of a sublimit for the issuance of letters of credit equal to the unused amount of the revolving credit facility and a sublimit for swingline loans equal to the lesser of $25 million and the unused amount of the revolving credit facility) (the “Revolving Credit Facility” and together with the Term Loan Facility, the “Credit Facilities”).

Term Loan Facility. The principal amount of the Term Loan Facility amortizes in quarterly installments, which began with the close of the fiscal quarter ending March 31, 2019, in an amount equal to $1.9 million per quarter, payable quarterly, decreasing to $875,000 per quarter commencing with the quarter ending December 31, 2021, and increasing to $2.4 million per quarter commencing with the quarter ending December 31, 2022, with the remaining balance payable at maturity. The Term Loan Facility matures on July 28, 2026. As of March 31, 2023, there was $86.8 million in aggregate principal outstanding under the Term Loan Facility and after giving effect to the additional term loan advance that was used to refinance amounts outstanding under the Revolving Credit Facility and to pay fees, costs and expenses related thereto, there was $10 million in aggregate principal outstanding under the Revolving Credit Facility.

For the three months ended March 31, 2023 and 2022, the Company made principal and interest payments of approximately $4.1 million and $2.6 million, respectively, on the Term Loan Facility.

Revolving Credit Facility: The Revolving Credit Facility allows for borrowings of up to $50 million inclusive of a sublimit for the issuance of letters of credit equal to the unused amount of the Revolving Credit Facility and a sublimit for swingline loans equal to the lesser of $25 million and the unused amount of the Revolving Credit Facility. As of December 31, 2022, we had $10.0 million in borrowings and $32.6 million letters of credit outstanding under the Revolving Credit Facility. In connection with the incurrence of additional amounts under the Term Loan Facility pursuant to a November 2022 amendment to the Credit Agreement, the borrowings under the Revolving Credit Facility were repaid in full. On December 23, 2022, the Company drew $10 million from the amended Revolving Credit Facility, resulting in an outstanding principal balance under the Revolving Credit Facility in the amount of $10 million. At December 31, 2022, the Company had multiple letters of credit that total $32.6 million outstanding under the Revolving Credit Facility. At January 31, 2023, $22.6 million of the letters of credit were terminated and at March 31, 2023, there remained a single letter of credit in the amount of $10 million and $10 million outstanding under the Revolving Credit Facility. For the three months ended March 31, 2023, the Company made interest payments in aggregate of approximately $188,670 on the Revolving Credit Facility.

At the Company's option, borrowings under the Credit Facilities bear interest at rates equal to either (1) a rate determined by reference to SOFR, plus an applicable margin and a credit adjustment spread equal to 0.10% or (2) a base rate determined by reference to the highest of (a) the “prime rate” of Regions Bank, (b) the federal funds rate plus 0.50%, and (c) the adjusted term SOFR in effect on such day for an interest period of one month plus 1.00%, plus an applicable margin.

17


 

At March 31 2023, the effective interest rate on for the Term Loan Facility and Revolving Credit Facility was 7.884% and 7.661%, respectively. The Company monitors the rates prior to the reset date which allows it to establish if the payment is monthly or quarterly payment based on the most beneficial rate used to calculate the interest payment.

Mortgage Loan

In October 2017, the Company and its subsidiary, Skye Lane Properties LLC, jointly obtained a commercial real estate mortgage loan in the amount of $12.7 million, bearing interest of 4.95% per annum and maturing on October 30, 2027. Pursuant to the terms of the mortgage loan, on October 30, 2022, the interest rate adjusted to an interest rate equal to the annualized interest rate of the United States 5-year Treasury Notes as reported by Federal Reserve on a weekly average basis plus 3.10%, which resulted in an increase of the rate from 4.95% to 7.42% per annum. The Company makes monthly principal and interest payments against the loan. For each of the three months ended March 31, 2023 and 2022, the Company made principal and interest payments of $223,212 on the mortgage loan, respectively.

FHLB Loan Agreements

In December 2018, a subsidiary of the Company received a 3.094% fixed interest rate cash loan of $19.2 million from the Federal Home Loan Bank (“FHLB”) Atlanta. In connection with the loan agreement, the subsidiary became a member of the FHLB. Membership in the FHLB required an investment in FHLB’s common stock which was purchased in December 2018 and valued at $1.4 million. Additionally, the transaction required the acquired FHLB common stock and certain other investments to be pledged as collateral. As of March 31, 2023, the fair value of the collateralized securities was $22.2 million and the equity investment in FHLB common stock was $1.2 million. For the three months ended March 31, 2023, and 2022, the Company made quarterly interest payments as per the terms of the loan agreement of approximately $148,500 and $150,160, respectively. As of March 31, 2023 and at December 31, 2022, the Company also holds other common stock from FHLB Des Moines and FHLB Boston for a combined value of $319,100, classified as equity securities and reported at fair value on the condensed consolidated financial statements.

The following table summarizes the Company’s long-term debt and credit facilities as of March 31, 2023 and December 31, 2022:

 

 

 

March 31, 2023

 

 

December 31, 2022

 

 

 

(in thousands)

 

Convertible debt

 

$

885

 

 

$

885

 

Mortgage loan

 

 

11,214

 

 

 

11,199

 

Term loan facility

 

 

86,750

 

 

 

89,125

 

Revolving credit facility

 

 

10,000

 

 

 

10,000

 

FHLB loan agreement

 

 

19,200

 

 

 

19,200

 

Total principal amount

 

$

128,049

 

 

$

130,409

 

Deferred finance costs

 

$

1,349

 

 

$

1,466

 

Total long-term debt

 

$

126,700

 

 

$

128,943

 

 

As of the date of this report, the Company was in compliance with the applicable terms of all its covenants and other requirements under the Credit Agreement, Convertible Notes, cash borrowings and other loans. The Company’s ability to secure future debt financing depends, in part, on its ability to remain in such compliance. The covenants in the Credit Agreement may limit the Company’s flexibility in connection with future financing transactions and in the allocation of capital in the future, including the Company’s ability to pay dividends and make stock repurchases, and contribute capital to its insurance subsidiaries that are not parties to the Credit Agreement.

The schedule of principal payments on long-term debt as of March 31, 2023 is as follows:

 

Year

 

Amount

 

 

 

(In thousands)

 

2023 remaining

 

$

26,679

 

2024

 

 

9,854

 

2025

 

 

9,874

 

2026

 

 

71,018

 

2027

 

 

414

 

Thereafter

 

 

10,210

 

Total

 

$

128,049

 

NOTE 15. ACCOUNTS PAYABLE AND OTHER LIABILITIES

Accounts payable and other liabilities consist of the following:

18


 

 

Description

 

March 31, 2023

 

 

December 31, 2022

 

 

 

(In thousands)

 

Deferred ceding commission

 

$

40,689

 

 

 

42,758

 

Accounts payable and other payables

 

 

16,454

 

 

 

17,660

 

Accrued dividends

 

 

61

 

 

 

72

 

Accrued interest and issuance costs

 

 

648

 

 

 

733

 

Other liabilities

 

 

468

 

 

 

229

 

Premium tax

 

 

2,129

 

 

 

1,001

 

Commission payables

 

 

14,259

 

 

 

17,558

 

Total other liabilities

 

$

74,708

 

 

$

80,010

 

 

NOTE 16. STATUTORY ACCOUNTING AND REGULATIONS

State laws and regulations, as well as national regulatory agency requirements, govern the operations of all insurers such as the Company’s insurance subsidiaries. The various laws and regulations require that insurers maintain minimum amounts of statutory surplus and risk-based capital, restrict insurers’ ability to pay dividends, restrict the allowable investment types and investment mixes, and subject the Company’s insurers to assessments.

The Company’s insurance subsidiaries Heritage Property & Casualty Insurance Company (“Heritage P&C)”, Narragansett Bay Insurance Company (“NBIC”), Zephyr Insurance Company (“Zephyr”), and Pawtucket Insurance Company (“PIC”) must maintain capital and surplus ratios or balances as determined by the regulatory authority of the states in which they are domiciled. Heritage P&C is required to maintain capital and surplus equal to the greater of $15.0 million or 10% of its respective liabilities. Zephyr is required to maintain a deposit of $750,000 in a federally insured financial institution. NBIC is required to maintain capital and surplus of $3.0 million. The combined statutory surplus for Heritage P&C, Zephyr, and NBIC was $260.5 million at March 31, 2023 and $276.3 million at December 31, 2022. State law also requires the Company’s insurance subsidiaries to adhere to prescribed premium-to-capital surplus ratios, and risk-based capital requirements with which the Company's insurance subsidiaries are in compliance. At March 31, 2023, the Company’s insurance subsidiaries met the financial and regulatory requirements of each of the states in which they conduct business.

NOTE 17. COMMITMENTS AND CONTINGENCIES

The Company is involved in claims-related legal actions arising in the ordinary course of business. The Company accrues amounts resulting from claims-related legal actions in unpaid losses and loss adjustment expenses during the period that it determines an unfavorable outcome becomes probable and it can estimate the amounts. Management makes revisions to its estimates based on its analysis of subsequent information that the Company receives regarding various factors, including: (i) per claim information; (ii) company and industry historical loss experience; (iii) judicial decisions and legal developments in the awarding of damages; and (iv) trends in general economic conditions, including the effects of inflation.

The Company’s Florida insurance company affiliate is required to enter into a reinsurance contract with the FHCF for a portion of its catastrophe risk transfer each year. Since the Company’s inception in 2012, few catastrophic events have resulted in losses which pierced the FHCF layer and resulted in reimbursements from the FHCF. To date, losses from only Hurricane Irma, which struck in 2017, and Hurricane Ian, which struck in 2022, have triggered the Company’s FHCF coverage. The Company’s 2017 reinsurance agreement with the FHCF is consistent among Florida insurance companies and requires a commutation no later than 60 months after the end of the contract year, which the commutation process is expected to begin in June 2023. This commutation represents an agreement between Heritage and the FHCF to terminate the 2017 reinsurance agreement and agree on the conditions under which all obligations for both parties are discharged. The terms of the 2017 reinsurance agreement with the FHCF provide for the commutation process as well as the process to settle any disagreements as to the present value of outstanding losses that will serve as the basis for determining the amount payable by FHCF upon termination of the reinsurance agreement. The commutation process has not yet begun, and the Company cannot predict whether the loss estimates determined by Heritage and the loss estimates determined by the FHCF will differ. As such, there is no assurance that the reported reinsurance recoverable for Hurricane Irma losses from the FHCF will differ from the final amount that will be paid by the FHCF. Further, social inflation and the litigated claims environment in the State of Florida, which affected Hurricane Irma claims could result in adverse development of these claims, which create uncertainty as to the ultimate cost to settle the remaining Hurricane Irma claims. Accordingly, the final amount that will be paid by the FHCF could vary from the Company’s current or future estimation of losses to be recovered from the FHCF. The commutation process will be final and binding on both parties once complete.

NOTE 18. RELATED PARTY TRANSACTIONS

From time to time the Company has been party to various related party transactions involving certain of its officers, directors and significant stockholders, including as set forth below. The Company has entered into each of these arrangements without obligation to continue its effect in the future and the associated expense was immaterial to its results of operations or financial position as of March 31, 2023 and 2022.

19


 

In July 2019, the Board of Directors appointed Mark Berset to the Board of Directors of the Company. Mr. Berset is also the Chief Executive Officer of Comegys Insurance Agency, Inc. (“Comegys”), an independent insurance agency that writes policies for the Company. The Company pays commission to Comegys based upon standard industry rates consistent with those provided to the Company’s other insurance agencies. There are no arrangements or understandings between Mr. Berset and any other persons with respect to his appointment as a director. For the three months ended March 31, 2023 and 2022, the Company paid agency commission to Comegys of approximately $90,511 and $458,645, respectively.

NOTE 19. EMPLOYEE BENEFIT PLANS

The Company provides a 401(k) plan for all qualifying employees. The Company provides a matching contribution of 100% on the first 3% of employees’ contribution and 50% on the next 2% of the employees’ contribution to the plan. The maximum match is 4%. For the three months ended March 31, 2023 and 2022, the contributions made to the plan on behalf of the participating employees were approximately $399,200 and $396,600, respectively.

Effective September 1, 2021, the Company enrolled in a flex healthcare plan which allows employees the choice of three medical plans with a range of coverage levels and costs. For the three months ended March 31, 2023 and 2022, the Company incurred medical premium costs including healthcare premiums of $1.5 million and $1.2 million, respectively.

NOTE 20. EQUITY

The total amount of authorized capital stock consists of 50,000,000 shares of common stock and 5,000,000 shares of preferred stock. As of March 31, 2023, the Company had 25,558,751 shares of common stock outstanding, 12,231,674 treasury shares of common stock and 622,011 unvested restricted common stock with accrued dividends reflecting additional paid-in capital of $335.1 million as of such date.

As more fully disclosed in the Company’s audited consolidated financial statements for the year ended December 31, 2022, as of December 31, 2022, there were 25,539,433 shares of common stock outstanding, 12,231,674 treasury shares of common stock and 648,493 unvested shares of restricted common stock with accrued dividends, representing $334.7 million of additional paid-in capital.

Common Stock

Holders of common stock are entitled to one vote for each share held on all matters subject to a vote of stockholders, subject to the rights of holders of any outstanding preferred stock. Accordingly, holders of a majority of the shares of common stock entitled to vote in any election of directors may elect all of the directors standing for election, subject to the rights of holders of any outstanding preferred stock. Holders of common stock will be entitled to receive ratably any dividends that the board of directors may declare out of funds legally available therefor, subject to any preferential dividend rights of outstanding preferred stock. Upon the Company’s liquidation, dissolution or winding up, the holders of common stock will be entitled to receive ratably the Company's net assets available after the payment of all debts and other liabilities and subject to the prior rights of holders of any outstanding preferred stock. Holders of common stock have no preemptive, subscription, redemption or conversion rights. There is no redemption or sinking fund provisions applicable to the common stock. All outstanding shares of the Company’s capital stock are fully paid and non-assessable.

Stock Repurchase Program

On December 15, 2022, the Board of Directors established a new share repurchase program plan to commence on December 31, 2022, for the purpose of repurchasing up to an aggregate of $10.0 million of common stock, through the open market or in such other manner as will comply with the terms of applicable federal and state securities laws and regulations, including without limitation, Rule 10b-18 under the Securities Act at any time or from time to time on or prior to December 31, 2023 (the "New Share Repurchase Plan").

At March 31, 2023, the Company has the capacity under the New Share Repurchase Plan to repurchase $10.0 million of its common stock until December 31, 2023.

Dividends

The declaration and payment of any future dividends will be subject to the discretion of the Board of Directors and will depend on a variety of factors including the Company’s financial condition and results of operations.

NOTE 21. STOCK-BASED COMPENSATION

 

Restricted Stock

The Company has adopted the Heritage Insurance Holdings, Inc., Omnibus Incentive Plan (the “Plan”) effective on May 22, 2014. The Plan authorized 2,981,737 shares of common stock for issuance under the Plan for future grants.

20


 

At March 31, 2023, there were 388,085 shares available for grant under the Plan. The Company recognizes compensation expense under ASC 718 for its stock-based payments based on the fair value of the awards.

For the performance-based restricted stock, the number of shares that will be earned at the end of the performance period is subject to decrease based on the results of the performance condition.

The Plan authorizes the Company to grant stock options at exercise prices equal to the fair market value of the Company’s stock on the dates the options are granted. The Company has not granted any stock options since 2015 and all unexercised stock options have since been forfeited.

 

 

 

Restricted stock activity for the three months ended March 31, 2023 is as follows:

 

 

 

 

 

Weighted-Average

 

 

 

 

 

 

Grant-Date Fair

 

 

 

Number of shares

 

 

Value per Share

 

Non-vested, at December 31, 2022

 

 

648,493

 

 

$

9.32

 

Granted - Performance-based restricted stock

 

 

 

 

 

 

Granted - Time-based restricted stock

 

 

 

 

 

 

Vested

 

 

(25,000

)

 

 

1.80

 

Canceled and surrendered

 

 

(1,482

)

 

 

6.77

 

Non-vested, at March 31, 2023

 

 

622,011

 

 

$

9.63

 

 

Awards are being amortized to expense over the two to five-year vesting period. The Company recognized $394,624 and $505,730 of compensation expense for the three months ended March 31, 2023 and 2022, respectively. For the three months ended March 31, 2023, 25,000 shares of restricted stock were vested and released, all of which had been granted to employees. Of the shares released to employees, 4,200 shares were withheld by the Company to cover withholding taxes of $7,560. For the comparable period of 2022, 25,000 shares of restricted stock were vested and released, of the shares released to employees, 9,849 shares were withheld by the Company to cover withholding taxes of $89,000.

At March 31, 2023, there was approximately $723,100 unrecognized expense related to time-based non-vested restricted stock and an additional $895,625 for performance-based restricted stock, net of expected forfeitures which is expected to be recognized over the remaining restriction periods as described in the table below. For the comparable period in 2022, there was in aggregate $3.3 million of unrecognized expense.

Additional information regarding the Company’s outstanding non-vested time-based restricted stock and performance-based restricted stock at March 31, 2023 is as follows:

 

Grant date

Restricted shares unvested

 

 

Share Value at Grant Date Per Share

 

 

Remaining Restriction Period (Years)

 

January 4, 2021

 

111,857

 

 

 

10.43

 

 

 

0.8

 

April 13, 2021

 

32,681

 

 

 

10.71

 

 

 

0.8

 

October 18, 2021

 

56,363

 

 

 

6.89

 

 

 

0.8

 

March 3, 2022

 

 

12,727

 

 

 

5.50

 

 

 

1.0

 

March 16, 2022

 

 

321,429

 

 

 

6.72

 

 

 

1.8

 

June 23, 2022

 

 

86,954

 

 

 

3.22

 

 

 

0.3

 

 

 

 

622,011

 

 

 

 

 

 

 

 

NOTE 22. SUBSEQUENT EVENTS

The Company performed an evaluation of subsequent events through the date the condensed consolidated financial statements were issued and determined there were no recognized or unrecognized subsequent events that would require an adjustment or additional disclosure in the condensed consolidated financial statements as of March 31, 2023.

 

 

21


 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

You should read the following discussion in conjunction with our condensed consolidated financial statements and related notes and other information included elsewhere in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the year ended December 31, 2022 (“2022 Form 10-K”). Unless the context requires otherwise, as used in this Form 10-Q, the terms “we”, “us”, “our”, “the Company”, “our Company”, and similar references refer to Heritage Insurance Holdings, Inc., a Delaware corporation, and its subsidiaries.

Overview

We are a super-regional property and casualty insurance holding company that primarily provides personal and commercial residential insurance products across our multi-state footprint. We provide personal residential insurance in Alabama, California, Connecticut, Delaware, Florida, Georgia, Hawaii, Maryland, Massachusetts, Mississippi, New Jersey, New York, North Carolina, Rhode Island, South Carolina, and Virginia and commercial residential insurance in Florida, New Jersey, and New York. We provide personal residential insurance in Florida on both an admitted and non-admitted basis and in California on a non-admitted basis. As a vertically integrated insurer, we control or manage substantially all aspects of risk management, underwriting, claims processing and adjusting, actuarial rate making and reserving, customer service, and distribution. Our financial strength ratings are important to us in establishing our competitive position and can impact our ability to write policies.

 

Recent Developments

Economic and Market Factors

We continue to monitor the effects of general changes in economic and market conditions on our business. As a result of general inflationary pressures, we have experienced, and may continue to experience, increased cost of materials and labor needed for repairs and to otherwise remediate claims throughout all states in which we conduct business. Additionally, we anticipate continued rising costs and constrained availability of catastrophe reinsurance. We mitigate these conditions by continued exposure management, implementation of increased rates and the use of inflation guard, which increases the insured value of a property to reflect the inflationary impact on costs to repair properties.

The table below provides policy count, premiums-in-force, and TIV for Florida and all other states as of March 31, 2023 and compares these metrics to the first quarter of 2022. One of our goals has been to reduce personal lines exposure in Florida, given historical abusive claims practices. Florida policies-in-force declined from the prior year quarter by 15.6% with a 13.2% increase in premiums-in-force, and a TIV increase of only 1.8%. The increase in Florida premiums-in-force was driven by rate increases, organic growth of our commercial residential business, and use of inflation guard, partly offset by premium reductions associated with fewer policies. Use of inflation guard, partly offset by fewer personal residential policies, also increased TIV from the prior year quarter. Compared to the first quarter of 2022, premiums-in-force for markets outside of Florida increased while the policy count decreased due to rate actions and exposure management.

The Supplemental Information table demonstrates progress made compared to the first quarter 2022.

 

Policies-in-force:



Q1 2023

 

 

Q1 2022

 

 

% Change

 

 

Florida



 

172,425

 



 

204,406

 



 

(15.6

)

%

Other States



 

336,647

 



 

355,090

 



 

(5.2

)

%

Total



 

509,072

 



 

559,496

 



 

(9.0

)

%





 

 



 

 



 

 



Premiums-in-force:



 

 



 

 



 

 



Florida

$

 

624,931,522

 

$

 

551,962,357

 



 

13.2

 

%

Other States



 

681,407,015

 



 

626,010,221

 



 

8.8

 

%

Total

$

 

1,306,338,537

 

$

 

1,177,972,578

 



 

10.9

 

%





 

 



 

 



 

 



Total Insured Value:



 

 



 

 



 

 



Florida

$

 

104,735,498,939

 

$

 

102,863,325,053

 



 

1.8

 

%

Other States



 

302,701,975,889

 



 

293,478,796,893

 



 

3.1

 

%

Total

$

 

407,437,474,828

 

$

 

396,342,121,946

 



 

2.8

 

%

 

Strategic Profitability Initiatives

The following provides an update to our strategic initiatives that are expected to enable us to achieve consistent long-term quarterly earnings and drive shareholder value.

Generate underwriting profit through rate adequacy and more selective underwriting.

22


 

o
Continued significant rating actions throughout the book of business resulting in an increase in average premium per policy throughout the book of 5.9% from fourth quarter 2022, and 21.9% over first quarter 2022.
o
Premiums-in-force of $1.3 billion are up 10.9% from the prior year quarter, while policy count is down 9.0%, resulting from prior underwriting efforts.
o
Continued focus on tightening underwriting criteria while also restricting new business for policies written in over-concentrated markets or products.
Allocate capital to products and geographies that maximize long-term returns.
o
Increased commercial residential premiums-in-force by 69.6% over the prior year quarter while total insured value (“TIV”) only increased 39.9% and policies in force increased by only 11.8%.
o
Reduction of policy count for the Florida personal lines product remains a key focus and will continue until the positive impact of recent legislation to reduce abusive claims practices is realized. Policy count for Florida personal lines business intentionally declined by 16.8% as compared to the prior year period.
o
Disciplined underwriting approach resulted in a policy count reduction of 5.2% in other states while generating an 8.8% increase in premiums-in-force.
Maintain a balanced and diversified portfolio.
o
Even with the substantial increase in commercial business, no state represents over 26% of the Company's TIV.
o
The top four states grew TIV by an average of 3.7% while the smallest five states grew by 38.8%.
o
As a result of diversification efforts, the top five personal lines states represented 71.5% of all TIV at first quarter 2023 compared to 73.3% of all TIV at first quarter 2022.
o
Florida TIV increased 1.8% related to the use of inflation guard and growth of the Company’s commercial residential product.
o
TIV in other states increased 3.1% compared to the prior year period, largely driven by inflation guard.
o
Excluding Florida, TIV represented 74.3% of the entire portfolio, compared to 74.0% as of the first quarter of 2022.
Provide coverage suitable to the market and return targets.
o
Expansion of Excess & Surplus lines (“E&S”) premium-in-force in California and Florida.
o
Continued plan to introduce E&S products in South Carolina during second quarter of 2023.
o
Continue to evaluate other strategic states for E&S products.

Reinsurance Commutation

As further described in Note 17, Commitments and Contingencies, to the condensed consolidated financial statements, our 2017 reinsurance agreement with the FHCF requires a commutation no later than 60 months after the end of the contract year, which commutation process is expected to begin in June 2023. As part of this process, Heritage and FHCF will terminate the 2017 reinsurance agreement and agree on the amount that FHCF will be required to pay to the Company to settle all outstanding losses owed under the agreement related to losses from Hurricane Irma. As such, this commutation process will ultimately result in a final determination of and payment for known, unknown or unreported claims relating to Hurricane Irma, with the potential for payment by the FHCF to Heritage of a larger or lesser amount than would otherwise have been the FHCF’s responsibility if the commutation were not required by Florida statutes and the contract terms. The commutation process has not yet begun, and the Company cannot predict whether the loss estimates determined by Heritage and the loss estimates determined by the FHCF will differ. As such, there is no assurance that the reported reinsurance recoverable for Hurricane Irma losses from the FHCF will differ from the final amount that will be paid by the FHCF. Further, social inflation and the litigated claims environment in the State of Florida, which affected Hurricane Irma claims could result in adverse development of these claims which, create uncertainty as to the ultimate cost to settle of all the remaining Hurricane Irma claims. Accordingly, the final amount that will be paid by the FHCF could vary from the Company’s current or future estimation of losses to be recovered from the FHCF. The commutation process will be final and binding on both parties once complete.

Overview of 2023 Financial Results

In the following section, we discuss our financial condition and results of operations for the three months ended March 31, 2023 compared to the three months ended March 31, 2022.

23


 

The discussion of our financial condition and results of operations that follows provides information that will assist the reader in understanding our consolidated financial statements, the changes in certain key items in those financial statements from year to year, including certain key performance indicators such as net combined ratio, ceded premium ratio, net expense ratio and net loss ratio, and the primary factors that accounted for those changes, as well as how certain accounting principles, policies and estimates affect our consolidated financial statements. This discussion should be read in conjunction with our consolidated financial statements and the related notes included under Item 1 of this Quarterly Report on Form 10-Q.

Net income for the three months ended March 31, 2023 was $14.0 million or $0.55 per diluted share, compared to a net loss of $30.8 million or ($1.15) per diluted share in the prior year quarter.
Gross premiums written were $310.3 million, up 9.6% from $283.2 million in the prior year quarter, reflecting higher average premium per policy throughout the book of business, partly offset by intentional exposure management related reductions in Florida personal lines business and business outside of Florida of 10.0% and 1.0%, respectively, and a strategic and substantial increase in Florida commercial lines business.
Gross premiums earned of $317.0 million, up 10.3% from $287.4 million in the prior year quarter, reflecting higher gross premiums written over the last twelve months driven by a higher average premium per policy and organic growth of our commercial residential business.
Net premiums earned of $166.0 million, up 8.6% from $153.0 million in the prior year quarter, reflecting higher gross premium earned outpacing the increase in ceded premiums for the quarter.
Losses and loss adjustment expenses ("LAE") incurred of $97.5 million, down 30.4% from $140.0 million in the prior year quarter. The decrease primarily stems from significantly lower weather losses in the southeast. Net current accident year weather losses were $12.8 million, down substantially from $63.8 million in the prior year quarter. Current accident year weather losses include $5.0 million of net current accident quarter catastrophe losses, down from $45.0 million in the prior year quarter, and $7.8 million of other weather losses, down from $18.8 million in the prior year quarter. Additionally, we experienced $1.5 million of favorable prior year development compared to $2.4 million of unfavorable prior year development in the prior year quarter.
Ceded premium ratio of 47.6%, up 0.8 points from 46.8% in the prior year quarter driven by a higher cost of the 2022-2023 catastrophe excess of loss program, stemming from both higher costs and higher TIV, partly offset by higher gross premiums earned.
Net loss and LAE ratio of 58.7%, 32.9 points lower than the prior year quarter of 91.6%, driven by lower losses incurred as described above.
Net expense ratio of 35.8%, down 2.1 points from the prior year quarter amount of 37.9%, as slightly higher policy acquisition costs were more than offset by the benefit of higher gross premiums earned over the prior year quarter.
Net combined ratio of 94.5%, down 35.0 points from 129.5% in the prior year quarter, driven by lower net loss and net expense ratios as described above.
Effective tax rate was 18.6% compared to 25.7% in the prior year quarter, driven by the impact of permanent differences in relation to the pre-tax income or loss each quarter. In addition, the Company reduced its valuation allowance from fourth quarter 2022 by $1.7 million, favorably impacting the effective tax rate for the quarter. The valuation allowance relates to certain tax elections made by Osprey Re, the Company’s captive reinsurer domiciled in Bermuda.

24


 

Results of Operations

Comparison of the Three Months Ended March 31, 2023 and 2022

Revenue

For the Three Months Ended March 31,

 

(Unaudited)

2023

 

2022

 

$ Change

 

% Change

 

 

 

(in thousands)

 

REVENUE:

 

 

 

 

 

Gross premiums written

$

310,309

 

 

$

283,196

 

 

$

27,113

 

 

 

9.6

%

Change in gross unearned premiums

 

 

6,713

 

 

 

4,172

 

 

 

2,541

 

 

 

60.9

%

Gross premiums earned

 

317,022

 

 

 

287,368

 

 

 

29,654

 

 

 

10.3

%

Ceded premiums

 

(150,993

)

 

 

(134,439

)

 

 

(16,554

)

 

 

12.3

%

Net premiums earned

 

166,029

 

 

 

152,929

 

 

 

13,100

 

 

 

8.6

%

Net investment income

 

5,582

 

 

 

2,000

 

 

 

3,582

 

 

 

179.1

%

Net realized gains

 

1,898

 

 

 

(16

)

 

 

1,914

 

 

NM

 

Other revenue

 

3,412

 

 

 

3,695

 

 

 

(283

)

 

 

(7.6

)%

Total revenue

$

176,921

 

 

$

158,608

 

 

$

18,313

 

 

 

11.5

%

 

NM= Not Meaningful

Gross premiums written

Gross premiums written were $310.3 million, up 9.6% from $283.2 million in the prior year quarter, reflecting higher average premium per policy throughout the book of business, partly offset by intentional exposure management related reductions in Florida personal lines business and business outside of Florida of 10.0% and 1.0%, respectively, and a strategic increase in Florida commercial lines business of 92.4%.

Premiums-in-force of $1.3 billion as of March 31, 2023, representing a 10.9% increase from first quarter 2022, primarily due to continued proactive underwriting and rate actions, despite a policy count reduction of approximately 50,000 policies. In addition, our intentional growth of the Company’s commercial product, and use of inflation guard, favorably impacted premiums-in-force. Concurrently, TIV increased only 2.8%.

Gross premiums earned

Gross premiums earned of $317.0 million were up 10.3% from $287.4 million in the prior year quarter, reflecting higher gross premiums written over the last twelve months driven by a higher average premium per policy and organic growth in our commercial residential business.

Ceded premiums

Ceded premiums were $151.0 million in first quarter 2023, up 12.3% from $134.4 million in the prior year quarter. The increase is attributable to an increase in the cost of our catastrophe excess of loss reinsurance program driven by an increase in TIV and higher reinsurance costs for the respective reinsurance contract periods as well as a higher cost for our net quota share reinsurance associated with premium growth in the northeast.

Net premiums earned

Net premiums earned were $166.0 million in first quarter 2023, up 8.6% from $153.0 million in the prior year quarter. The increase primarily stems from growth in gross premiums earned outpacing the increase in ceded premiums, as described above.

Net investment income

Net investment income, inclusive of realized investment gains and unrealized gains on equity securities, was $7.5 million in first quarter 2023, compared to $2.0 million in the prior year quarter. The increase is primarily due to higher yields on cash and invested assets associated with higher interest rates, coupled with a gain on the sale of other investments.

Other revenue

Other revenue was $3.4 million in first quarter 2023, slightly down compared to the prior year quarter, driven primarily by a reduction of policy fee income as the policy count declined.

Total revenue

Total revenue was $176.9 million in first quarter 2023, up 11.5% from $158.6 million in the prior year quarter. The increase primarily stems from higher net premiums earned and investment income as described above.

 

25


 

For the Three Months Ended March 31,

 

(Unaudited)

2023

 

2022

 

$ Change

 

% Change

 

OPERATING EXPENSES:

(in thousands)

 

Losses and loss adjustment expenses

 

 

97,452

 

 

 

140,038

 

 

 

(42,586

)

 

 

(30.4

)%

Policy acquisition costs

 

40,324

 

 

 

38,257

 

 

 

2,067

 

 

 

5.4

%

General and administrative expenses

 

 

19,054

 

 

 

19,724

 

 

 

(670

)

 

 

(3.4

)%

Total operating expenses

 

156,830

 

 

 

198,019

 

 

(41,188

)

 

(20.8

)%

 

Losses and loss adjustment expenses

Losses and LAE were $97.5 million in first quarter 2023, down 30.4% from $140.0 million in the prior year quarter. The decrease stems from significantly lower net weather losses, as described above. Refer to Note 17, Commitments and Contingencies, to the condensed consolidated financial statements for discussion related to the upcoming commutation of our 2017 reinsurance contract with the FHCF.

Policy acquisition costs

Policy acquisition costs were $40.3 million in first quarter 2023, up 5.4% from $38.3 million in the prior year quarter. The increase is primarily attributable to growth in gross premiums written and is partly offset by higher ceding commission income.

General and administrative expenses

General and administrative expenses were $19.1 million in first quarter 2023, down 3.4% from the prior year quarter. The reduction was driven primarily by IT costs and certain costs which vary with policy count, such as printing and postage.

 

 

 

For the Three Months Ended March 31,

 

(Unaudited)

 

2023

 

2022

 

$ Change

 

% Change

 

 

 

(in thousands, except per share amounts)

 

Operating income (loss)

 

20,091

 

 

 

(39,411

)

 

59,502

 

 

(151.0

)%

Interest expense, net

 

 

2,881

 

 

 

1,972

 

 

 

909

 

 

 

46.1

%

Income (loss) before income taxes

 

17,210

 

 

 

(41,383

)

 

58,593

 

 

(141.6

)%

Provision (benefit) for income taxes

 

 

3,202

 

 

 

(10,624

)

 

 

13,826

 

 

 

(130.1

)%

Net income (loss)

$

14,008

 

 

$

(30,759

)

$

44,767

 

 

(145.5

)%

Basic earnings (loss) per share

$

0.55

 

 

$

(1.15

)

$

1.70

 

 

(147.7

)%

Diluted earnings (loss) per share

$

0.55

 

 

$

(1.15

)

$

1.70

 

 

(147.6

)%

 

Interest expense, net

Interest expense, net was $2.9 million in the first quarter of 2023, up 46.2% from the prior year quarter and driven by higher variable interest rates on our debt.

Provision (Benefit) for income taxes

The provision for income taxes was $3.2 million in first quarter 2023 compared to a tax benefit of $10.6 million in the prior year quarter. The effective tax rate was 18.6% compared to 25.7% in the prior year quarter, driven by the impact of permanent differences in relation to the pre-tax income or loss each quarter. In addition, the Company reduced its valuation allowance from fourth quarter 2022 by $1.7 million, favorably impacting the effective tax rate for the quarter. The valuation allowance relates to certain tax elections made by Osprey Re, the Company’s captive reinsurer domiciled in Bermuda. The effective tax rate can fluctuate throughout the year as estimates used in the quarterly tax provision are updated with additional information.

Net income (loss)

First quarter 2023 net income was $14.0 million ($0.55 earnings per share), up from net loss of $30.8 million or ($1.15 loss per share) in the prior year quarter. The quarter-over-quarter change primarily stems from higher underwriting income driven by higher rates and investment income and significantly lower weather losses, as described above.

Ratios

For the Three Months Ended March 31,

 

(Unaudited)

2023

 

2022

 

 Ceded premium ratio

 

47.6

%

 

 

46.8

%

 

 

 

 

 

 

 

Net loss and LAE ratio

 

58.7

%

 

 

91.6

%

Net expense ratio

 

35.8

%

 

 

37.9

%

Net combined ratio

 

94.5

%

 

 

129.5

%

 

26


 

Ceded premium ratio

The ceded premium ratio was 47.6%, up 0.8 points from 46.8% in the prior year quarter driven by a higher cost of the 2022-2023 catastrophe excess of loss program and net quota share program, as described above, partly offset by higher gross premiums earned.

Net loss and LAE ratio

The net loss and LAE ratio was 58.7% in first quarter 2023, down 32.9 points from 91.6% in the prior year quarter, driven by significantly lower weather losses compared to the prior year quarter, as described above, coupled with higher net premiums earned.

Net expense ratio

The net expense ratio of 35.8%, down 2.1 points from the prior year quarter amount of 37.9%, driven by higher policy acquisition costs from by the growth in gross premiums written partly offset by lower general and administrative expenses, and the benefit of higher gross premiums earned over the prior year quarter.

Net combined ratio

The net combined ratio was 94.5% in first quarter 2023, down 35.0 points from 129.5% in the prior year quarter. The decrease primarily stems from lower net loss and LAE and net expense ratios as described above.

Liquidity and Capital Resources

Our principal sources of liquidity include cash flows generated from operations, existing cash and cash equivalents, our marketable securities balances and borrowings available under our Credit Facilities. As of March 31, 2023, we had $336.7 million of cash and cash equivalents and $629.0 million in investments, compared to $287.6 million and $653.6 million, respectively, as of December 31, 2022. The increase in cash and cash equivalents was primarily due to strategic investment of proceeds from investment maturities into short term treasury bills to achieve a higher yield without increasing credit risk, and to increase liquidity.

We generally hold substantial cash balances to meet seasonal liquidity needs including amounts to pay quarterly reinsurance installments as well as meet the collateral requirements of Osprey Re, our captive reinsurance company, which is required to maintain a collateral trust account equal to the risk that it assumes from our insurance company affiliates.

We believe that our sources of liquidity are adequate to meet our cash requirements for at least the next twelve months.

We may increase capital expenditures consistent with our investment plans and anticipated business strategies. Cash and cash equivalents may not be sufficient to fund such expenditures. As such, in addition to the use of our existing Credit Facilities, we may need to utilize additional debt to secure funds for such purposes.

Cash Flows

 

 

For the Three Months Ended March 31,

 

 

2023

 

 

2022

 

 

Change

 

 

 

(in thousands)

 

Net cash provided by (used in):

 

 

 

 

 

 

 

 

 

Operating activities

 

$

14,946

 

 

$

(39,206

)

 

$

54,152

 

Investing activities

 

 

36,525

 

 

 

(27,648

)

 

 

64,173

 

Financing activities

 

 

(2,379

)

 

 

(4,312

)

 

 

1,933

 

Net increase (decrease) in cash and cash equivalents

 

$

49,092

 

 

$

(71,166

)

 

$

120,258

 

 

Operating Activities

Net cash provided by operating activities was $14.9 million for the three months ended March 31, 2023 compared to net cash used in operating activities of $39.2 million for the comparable period in 2022. The increase in cash from operating activities relates primarily to timing of cash flows associated with claim and reinsurance payments as well as reinsurance reimbursements during the first three months of 2023 compared to the first three months of 2022.

Investing Activities

Net cash provided by investing activities for the three months ended March 31, 2023 was $36.5 million as compared to net cash used in investing activities of $27.6 million for the comparable period in 2022. The change in cash provided by investing activities relates primarily to the timing of investment maturities and related re-investment of proceeds into short-term treasury bills.

27


 

Financing Activities

Net cash used in financing activities for the three months ended March 31, 2023 was $2.4 million, as compared to cash used in financing activities of $4.3 million for the comparable period in 2022. The change in net cash used in financing activities relates primarily to the repurchase of $5 million in treasury stock and a $15 million draw from our Revolving Credit Facility (defined below) to purchase and retire $11.7 million of Convertible Notes (defined below) during the first quarter of 2022, as described in Note 14 to the condensed consolidated financial statements.

Credit Facilities

The Company is party to a Credit Agreement by and among the Company, as borrower, certain subsidiaries of the Company from time to time party thereto as guarantors, the lenders from time to time party thereto (the “Lenders”), Regions Bank, as Administrative Agent and Collateral Agent, BMO Harris Bank N.A., as Syndication Agent, Hancock Whitney Bank and Canadian Imperial Bank of Commerce, as Co-Documentation Agents, and Regions Capital Markets and BMO Capital Markets Corp., as Joint Lead Arrangers and Joint Bookrunners (as amended from time to time, the “Credit Agreement”).

The Credit Agreement, as amended, provides for (1) a five-year senior secured term loan facility in an aggregate principal amount of $100 million (the “Term Loan Facility”) and (2) a five-year senior secured revolving credit facility in an aggregate principal amount of $50 million (inclusive of a sublimit for the issuance of letters of credit equal to the unused amount of the revolving credit facility and a sublimit for swingline loans equal to the lesser of $25 million and the unused amount of the revolving credit facility) (the “Revolving Credit Facility” and together with the Term Loan Facility, the “Credit Facilities”).

Term Loan Facility. The principal amount of the Term Loan Facility amortizes in quarterly installments, which began with the close of the fiscal quarter ending March 31, 2019, in an amount equal to $1.9 million per quarter, payable quarterly, decreasing to $875,000 per quarter commencing with the quarter ending December 31, 2021, and increasing to $2.4 million per quarter commencing with the quarter ending December 31, 2022, with the remaining balance payable at maturity. The Term Loan Facility matures on July 28, 2026. As of March 31, 2023, there was $86.8 million in aggregate principal outstanding under the Term Loan Facility.

Revolving Credit Facility. The Revolving Credit Facility allows for borrowings of up to $50 million inclusive of a sublimit for the issuance of letters of credit equal to the unused amount of the Revolving Credit Facility and a sublimit for swingline loans equal to the lesser of $25 million and the unused amount of the Revolving Credit Facility. As of March 31, 2023, the Company had drawn $10.0 million under the Revolving Credit Facility and had unused letter of credit of $10.0 million.

At our option, borrowings under the Credit Facilities bear interest at rates equal to either (1) a rate determined by reference to SOFR, plus an applicable margin (described below) and a credit adjustment spread equal to 0.10% or (2) a base rate determined by reference to the highest of (a) the “prime rate” of Regions Bank, (b) the federal funds rate plus 0.50%, and (c) the adjusted term SOFR in effect on such day for an interest period of one month plus 1.00%, plus an applicable margin (described below).

The applicable margin for loans under the Credit Facilities varies from 2.75% per annum to 3.25% per annum (for SOFR loans) and 1.75% to 2.25% per annum (for base rate loans) based on our consolidated leverage ratio ranging from 1.25-to-1 to greater than 2.25-to-1. Interest payments with respect to the Credit Facilities are required either on a quarterly basis (for base rate loans) or at the end of each interest period (for SOFR loans) or, if the duration of the applicable interest period exceeds three months, then every three months. As of March 31, 2023, the borrowings under the Term Loan Facility and Revolving Credit Facility are accruing interest at a rate of 7.884% and 7.661% per annum, respectively.

In addition to paying interest on outstanding borrowings under the Revolving Credit Facility, we are required to pay a quarterly commitment fee based on the unused portion of the Revolving Credit Facility, which is determined by our consolidated leverage ratio.

We may prepay the loans under the Credit Facilities, in whole or in part, at any time without premium or penalty, subject to certain conditions including minimum amounts and reimbursement of certain costs in the case of prepayments of SOFR loans. In addition, we are required to prepay the loan under the Term Loan Facility with the proceeds from certain financing transactions, involuntary dispositions or asset sales (subject, in the case of asset sales, to reinvestment rights).

All obligations under the Credit Facilities are or will be guaranteed by each existing and future direct and indirect wholly owned domestic subsidiary of the Company, other than all of the Company’s current and future regulated insurance subsidiaries (collectively, the “Guarantors”).

The Company and the Guarantors are party to a Pledge and Security Agreement, (as amended from time to time the “Security Agreement”), in favor of Regions Bank, as collateral agent. Pursuant to the Security Agreement, amounts borrowed under the Credit Facilities are secured on a first priority basis by a perfected security interest in substantially all of the present and future assets of the Company and each Guarantor (subject to certain exceptions), including all of the capital stock of the Company’s domestic subsidiaries, other than its regulated insurance subsidiaries.

The Credit Agreement contains, among other things, covenants, representations and warranties and events of default customary for facilities of this type. The Company is required to maintain, as of each fiscal quarter (1) a maximum consolidated leverage ratio of

28


 

2.50 to 1.00, stepping down to 2.25 to 1.00 as of the second quarter of 2024 and 2.00 to 1.00 as of the second quarter of 2025, (2) a minimum consolidated fixed charge coverage ratio of 1.20 to 1.00 and (3) a minimum consolidated net worth for the Company and its subsidiaries, which is required to be not less than $100 million plus 50% of positive quarterly net income (including its subsidiaries and regulated subsidiaries) plus the net cash proceeds of any equity transactions. Events of default include, among other events, (i) nonpayment of principal, interest, fees or other amounts; (ii) failure to perform or observe certain covenants set forth in the Credit Agreement; (iii) breach of any representation or warranty; (iv) cross-default to other indebtedness; (v) bankruptcy and insolvency defaults; (vi) monetary judgment defaults and material nonmonetary judgment defaults; (vii) customary ERISA defaults; (viii) a change of control of the Company; and (ix) failure to maintain specified catastrophe retentions in each of the Company’s regulated insurance subsidiaries.

Convertible Notes

On August 10, 2017, the Company and Heritage MGA, LLC (the “Notes Guarantor”) entered into a purchase agreement (the “Purchase Agreement”) with Citigroup Global Markets Inc., as the initial purchaser (the “Initial Purchaser”), pursuant to which the Company agreed to issue and sell, and the Initial Purchaser agreed to purchase, $125.0 million aggregate principal amount of the Company’s 5.875% Convertible Senior Notes due 2037 (the “Convertible Notes”) in a private placement transaction pursuant to Rule 144A under the Securities Act, as amended (the “Securities Act”). The Purchase Agreement contained customary representations, warranties and agreements of the Company and the Notes Guarantor and customary conditions to closing, indemnification rights and obligations of the parties and termination provisions. The net proceeds from the offering of the Convertible Notes, after deducting discounts and commissions and estimated offering expenses payable by the Company, were approximately $120.5 million. The offering of the Convertible Notes was completed on August 16, 2017.

The Company issued the Convertible Notes under an Indenture (the “Convertible Note Indenture”), dated August 16, 2017, by and among the Company, as issuer, the Notes Guarantor, as guarantor, and Wilmington Trust, National Association, as trustee (the “Trustee”).

The Convertible Notes bear interest at a rate of 5.875% per year. Interest is payable semi-annually in arrears, on February 1 and August 1 of each year. The Convertible Notes are senior unsecured obligations of the Company that rank senior in right of payment to the Company’s future indebtedness that is expressly subordinated in right of payment to the Convertible Notes; equal in right of payment to the Company’s unsecured indebtedness that is not so subordinated; effectively junior to any of the Company’s secured indebtedness to the extent of the value of the assets securing such indebtedness; and structurally junior to all indebtedness or other liabilities incurred by the Company’s subsidiaries other than the Notes Guarantor, which fully and unconditionally guarantee the Convertible Notes on a senior unsecured basis.

The Convertible Notes mature on August 1, 2037, unless earlier repurchased, redeemed or converted.

Holders may convert their Convertible Notes at any time prior to the close of business on the business day immediately preceding February 1, 2037, other than during the period from, and including, February 1, 2022 to the close of business on the second business day immediately preceding August 5, 2022, only under the following circumstances: (1) during any calendar quarter commencing after the calendar quarter ending on September 30, 2017, if the closing sale price of the Company’s common stock, for at least 20 trading days (whether or not consecutive) in the period of 30 consecutive trading days ending on the last trading day of the calendar quarter immediately preceding the calendar quarter in which the conversion occurs, is more than 130% of the conversion price of the Convertible Notes in effect on each applicable trading day; (2) during the ten consecutive business-day period following any five consecutive trading-day period in which the trading price for the Convertible Notes for each such trading day was less than 98% of the closing sale price of the Company’s common stock on such date multiplied by the then-current conversion rate; (3) if the Company calls any or all of the Convertible Notes for redemption, at any time prior to the close of business on the second business day immediately preceding the redemption date; or (4) upon the occurrence of specified corporate events.

During the period from and including February 1, 2022 to the close of business on the second business day immediately preceding August 5, 2022, and on or after February 1, 2037 until the close of business on the second business day immediately preceding August 1, 2037, holders may surrender their Convertible Notes for conversion at any time, regardless of the foregoing circumstances.

The conversion rate for the Convertible Notes was initially 67.0264 shares of common stock per $1,000 principal amount of Convertible Notes (equivalent to an initial conversion price of approximately $14.92 per share of common stock). The conversion rate is subject to adjustment in certain circumstances and is subject to increase for holders that elect to convert their Convertible Notes in connection with certain corporate transactions (but not, at the Company’s election, a public acquirer change of control (as defined in the Convertible Note Indenture)) that occur prior to August 5, 2022.

Upon the occurrence of a fundamental change (as defined in the Convertible Note Indenture) (but not, at the Company’s election, a public acquirer change of control (as defined in the Convertible Note Indenture), holders of the Convertible Notes may require the Company to repurchase for cash all or a portion of their Convertible Notes at a fundamental change repurchase price equal

29


 

to 100% of the principal amount of the Convertible Notes to be repurchased, plus accrued and unpaid interest to, but excluding, the fundamental change repurchase date.

At any time prior to February 1, 2037, the Company may redeem for cash all or any portion of the Convertible Notes, at the Company’s option, at a redemption price equal to 100% of the principal amount of the Convertible Notes to be redeemed, plus accrued and unpaid interest to, but excluding, the redemption date. No sinking fund is provided for the Convertible Notes, which means that the Company is not required to redeem or retire the Convertible Notes periodically. Holders of the Convertible Notes are able to cause the Company to repurchase their Convertible Notes for cash on any of August 1, 2022, August 1, 2027 and August 1, 2032, in each case at 100% of their principal amount, plus accrued and unpaid interest to, but excluding, the relevant repurchase date.

The Convertible Note Indenture contains customary terms and covenants and events of default. If an Event of Default (as defined in the Convertible Note Indenture) occurs and is continuing, the Trustee by notice to the Company, or the holders of at least 25% in aggregate principal amount of the Convertible Notes then outstanding by notice to the Company and the Trustee, may declare 100% of the principal of, and accrued and unpaid interest, if any, on, all the Convertible Notes to be immediately due and payable. In the case of certain events of bankruptcy, insolvency or reorganization (as set forth in the Convertible Note Indenture) with respect to the Company, 100% of the principal of, and accrued and unpaid interest, if any, on, the Convertible Notes automatically become immediately due and payable.

In January 2022, the Company repurchased $11.7 million principal amount of outstanding Convertible Notes. As of March 31, 2023, there was $885,000 principal amount of outstanding Convertible Notes, net of $21.1 million of Convertible Notes held by an insurance company subsidiary.

As discussed above, holders of the Convertible Notes issued by the Company had an optional put right, pursuant to the indenture governing the Convertible Notes, to require the Company to repurchase the aggregate principal amount of Convertible Notes that are validly tendered. The Company received notice from the Depository for the Convertible Notes that, on July 29, 2022, $10.9 million aggregate principal amount of the Convertible Notes has been validly tendered in accordance with the terms of the indenture and the Company’s notice with respect to the optional put right of the Convertible Notes, and the Company has requested that the Trustee cancel the Convertible Notes tendered. The outstanding balance as of March 31, 2023 of non-affiliated Notes was $885,000. On August 1, 2022, the Company made payments for the principal amount of the Convertible Notes tendered and unpaid interest in the aggregate amounts of $10.9 million and $320,041, respectively. The Company has drawn $10.0 million from the Revolving Credit Facility to replenish the cash used to pay the $10.9 million for the purchase of the tendered Convertible Notes.

FHLB Loan Agreements

In December 2018, a subsidiary of the Company pledged U.S. government and agency fixed maturity securities with an estimated fair value of $24.3 million as collateral and received $19.2 million in a cash loan under an advance agreement with the FHLB Atlanta. The loan originated on December 12, 2018 and bears a fixed interest rate of 3.094% with interest payments due quarterly commencing in March 2019. The principal balance on the loan has a maturity date of December 13, 2023. In connection with the agreement, the subsidiary became a member of the FHLB. Membership in the FHLB required an investment in FHLB’s common stock which was purchased on December 31, 2018 and valued at $1.4 million. As of March 31, 2023, the common stock was valued at $1.2 million. The subsidiary is permitted to withdraw any portion of the pledged collateral over the minimum collateral requirement at any time, other than in the event of a default by the subsidiary. The proceeds from the loan were used to prepay the Company’s Senior Secured Notes due 2023 in 2018.

Critical Accounting Policies and Estimates

When we prepare our condensed consolidated financial statements and accompanying notes in conformity with U.S. generally accepted accounting principles (GAAP), we must make estimates and assumptions about future events that affect the amounts we report. Certain of these estimates result from judgments that can be subjective and complex. As a result of that subjectivity and complexity, and because we continuously evaluate these estimates and assumptions based on a variety of factors, actual results could materially differ from our estimates and assumptions if changes in one or more factors require us to make accounting adjustments. We have made no material changes or additions with regard to those policies and estimates as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2022.

Recent Accounting Pronouncements

The information set forth under Note 1 to the condensed consolidated financial statements under the caption “Basis of Presentation and Significant Accounting Policies” is incorporated herein by reference. We do not expect any recently issued accounting pronouncements to have a material effect on our condensed consolidated financial statements.

30


 

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

The duration of the financial instruments held in our portfolio that are subject to interest rate risk was 3.168 years and 3.758 years at March 31, 2023 and 2022, and 3.179 years at December 31, 2022. As interest rates rise, the fair value of our fixed rate debt securities are subject to decline. Credit risk results from uncertainty in a counterparty’s ability to meet its obligations. Credit risk is managed by maintaining a high credit quality fixed maturity securities portfolio. As of March 31, 2023, the estimated weighted-average credit quality rating of the fixed maturity securities portfolio was A+, at fair value, consistent with the average rating at March 31, 2022.

We have not experienced a material impact when compared to the tabular presentations of our interest rate and market risk sensitive instruments in our Annual Report on Form 10-K for the year ended December 31, 2022.

Item 4. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) that are designed to assure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures.

As required by Exchange Act Rule 13a-15(b), as of the end of the period covered by this Quarterly Report, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of our disclosure controls and procedures. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of March 31, 2023.

Changes in Internal Control over Financial Reporting

There has been no change in our internal controls over financial reporting during our most recent quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. There were no significant changes to our internal control over financial reporting for the period ending March 31, 2023.

31


 

PART II. OTHER INFORMATION

The Company is a party to claims and legal actions arising routinely in the ordinary course of our business. Although we cannot predict with certainty the ultimate resolution of the claims and lawsuits asserted against us, we do not believe that any currently pending legal proceedings to which we are a party will have a material adverse effect on our condensed consolidated financial position results of operations or cash flow.

Item 1A. Risk Factors

The Company documented its risk factors in Item 1A of Part I of its Annual Report on Form 10-K for the year ended December 31, 2022 filed on March 13, 2023. There have been no material changes to the Company’s risk factors since the filing of that report.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Not Applicable

Item 5. Other Information

Not Applicable

Item 6. Exhibits

The information required by this Item 6 is set forth in the Index to Exhibits accompanying this Quarterly Report on Form 10-Q.

Index to Exhibits

 

3.1

Certificate of Incorporation of Heritage Insurance Holdings, Inc. (incorporated by reference to Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q filed on August 6, 2014

3.2

By-laws of Heritage Insurance Holdings, Inc. (incorporated by reference to Exhibit 3.2 to the Company’s Quarterly

Report on Form 10-Q filed on August 6, 2014

4

Form of Stock Certificate (incorporated by reference to Exhibit 4.1 to the Company’s Registration Statement on Form S-1/A (File No. 333-195409) filed on May 13, 2014)

31.1*

Rule 13a-14(a)/15d-14(a) Certification of Principal Executive Officer as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2*

Rule 13a-14(a)/15d-14(a) Certification of Principal Financial Officer as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1**

Certification of Chief Executive Officer pursuant to 18 U.SC. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2**

Certification of Chief Financial Officer pursuant to 18 U.SC. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

101.INS*

 

Inline XBRL Instance Document (the Instance Document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document)

101.SCH*

 

Inline XBRL Taxonomy Extension Schema Document

101.CAL*

 

Inline XBRL Taxonomy Extension Calculation Linkbase Document

101.DEF*

 

Inline XBRL Taxonomy Extension Definition Linkbase Document

101.LAB*

 

Inline XBRL Taxonomy Extension Label Linkbase Data Document

101.PRE*

 

Inline XBRL Taxonomy Extension Presentation Linkbase Document

104

 

Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101)

 

 

 

* Filed herewith

** Furnished herewith

32


 

 

 

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934 as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

HERITAGE INSURANCE HOLDINGS, INC.

 

 

 

 

Date: May 8, 2023

By:

 

/s/ ERNESTO GARATEIX

 

 

 

Ernesto Garateix

 

 

 

Chief Executive Officer

(Principal Executive Officer and Duly Authorized Officer)

 

 

 

 

Date: May 8, 2023

By:

 

/s/ KIRK LUSK

 

 

 

Kirk Lusk

 

 

 

Chief Financial Officer

(Principal Financial Officer)

 

33