Item 2. Management’s Discussion and Analysis
ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion under this Item 2 in conjunction with our consolidated financial statements and related notes and information included elsewhere in this quarterly report on Form 10-Q and in our Form 10-K filed with the Securities and Exchange Commission (“SEC”) on March 6, 2020. Unless the context requires otherwise, as used in this Form 10-Q, the terms “HCI,” “we,” “us,” “our,” “the Company,” “our company,” and similar references refer to HCI Group, Inc., a Florida corporation incorporated in 2006, and its subsidiaries. All dollar amounts in this Management’s Discussion and Analysis of Financial Condition and Results of Operations are in whole dollars unless specified otherwise.
Forward-Looking Statements
In addition to historical information, this quarterly report contains forward-looking statements as defined under federal securities laws. Such statements involve risks and uncertainties, such as statements about our plans, objectives, expectations, assumptions or future events. These statements involve estimates, assumptions, known and unknown risks, uncertainties and other factors that could cause actual results to differ materially from any future results, performances or achievements expressed or implied by the forward-looking statements. Typically, forward-looking statements can be identified by terminology such as “anticipate,” “estimate,” “plan,” “project,” “continuing,” “ongoing,” “expect,” “believe,” “intend,” “may,” “will,” “should,” “could,” and similar expressions. The important factors that could cause actual results to differ materially from those indicated by such forward-looking statements include but are not limited to the effects of governmental regulation; changes in insurance regulations; the frequency and extent of claims; uncertainties inherent in reserve estimates; catastrophic events; changes in the demand for, pricing of, availability of or collectability of reinsurance; restrictions on our ability to change premium rates; increased rate pressure on premiums; the severity and impact of the novel coronavirus (“COVID-19”) pandemic; and other risks and uncertainties detailed herein and from time to time in our SEC reports.
OVERVIEW – General
HCI Group, Inc. is a Florida-based InsurTech company that, through its subsidiaries, is engaged in property and casualty insurance, reinsurance, real estate and information technology. Based on our organizational structure, revenue sources, and evaluation of financial and operating performances by management, we manage the following operations:
a)
Insurance Operations
▪
Property and casualty insurance
▪
Reinsurance
b)
Real Estate Operations
c)
Other Operations
▪
Information technology
▪
Other auxiliary operations
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For the three months ended June 30 , 20 20 and 201 9 , revenues from insurance operations before intracompany elimination represented 96.2 % and 95.2 %, respectively, of total revenues of all operating segments. For the six months ended June 30, 20 20 and 201 9 , revenues from insurance operations before intracompany elimination represented 95.5 % and 94.9 %, respectively, of total revenues of all operating segments. At June 30 , 20 20 and December 31, 201 9 , insurance operations’ total assets represented 85.9 % and 85. 5 %, respectively, of the combined assets of all operating segments. See Note 1 5 - - “Segment Information” to our unaudited consolidated financial statements under Item 1 of this Quarterly Report on Form 10-Q for additional information.
Insurance Operations
Property and Casualty Insurance
Our insurance business is operated through two insurance subsidiaries: Homeowners Choice Property & Casualty Insurance Company, Inc. (“HCPCI”), our principal operating subsidiary, and TypTap Insurance Company (“TypTap”). We provide various forms of residential insurance products such as homeowners insurance, fire insurance, flood insurance and wind-only insurance. We are authorized to write residential property and casualty insurance in the states of Arkansas, California, Florida, Maryland, North Carolina, New Jersey, Ohio, Pennsylvania, South Carolina and Texas. Currently, Florida is our primary market.
In February 2020, HCPCI entered into a policy replacement agreement with Anchor Property & Casualty Insurance Company (“Anchor”). Under the agreement, HCPCI offered short-term replacement policies for all policies cancelled by Anchor as of April 1, 2020. The replacement policies had substantially the same terms and rates as the cancelled polices and will expire on the same dates the cancelled policies would have expired had they not been cancelled. Upon expiration of the replacement policies, HCPCI may offer renewals to those policyholders at its own rates and terms but has no obligation to do so. In connection with the agreement, we received $30,000,000 on February 13, 2020 representing an estimate of unearned premium on policies to be replaced.
TypTap has been the primary source of our organic growth in gross written premium since 2018. TypTap’s policies in force have increased from 6,721 in January 2018 to 31,715 at June 30, 2020. TypTap has been successful in using internally developed proprietary technology to underwrite, select and write policies efficiently in Florida. In addition to the expansion in TypTap business, we expect the Anchor transaction will contribute to our future growth.
Reinsurance
We have a Bermuda domiciled wholly-owned reinsurance subsidiary, Claddaugh Casualty Insurance Company Ltd. We selectively retain risk in Claddaugh, reducing the cost of third-party reinsurance. Claddaugh fully collateralizes its exposure to our insurance subsidiaries by depositing funds into a trust account. Claddaugh may mitigate a portion of its risk through retrocession contracts. Currently, Claddaugh does not provide reinsurance to non-affiliates.
Real Estate Operations
Our real estate operations consist of properties we own and use for our own operations and multiple properties we own and operate for investment purposes. Properties used in operations consist of two Tampa office buildings and a secondary insurance operations site in Ocala, Florida. Our investment properties include one full-service restaurant, retail shopping centers, one office building, two marinas, and undeveloped land near our headquarters in Tampa, Florida.
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Other Oper ations
Information Technology
Our information technology operations include a team of experienced software developers with extensive knowledge in developing web-based products and applications for mobile devices. The operations, which are in Tampa, Florida and Noida, India, are focused on developing cloud-based, innovative products or services that support in-house operations as well as our third-party relationships with our agency partners and claim vendors. These products include SAMS TM , Harmony, and ClaimColony ® .
Impact of COVID-19 on Our Business
As of the date of this filing, the COVID-19 pandemic is likely to continue causing significant economic disruption and negatively affect almost every industry directly or indirectly. The long-term impact of the COVID-19 pandemic on our financial condition, results of operations and cash flows is difficult to predict (also see Risks and Uncertainties Caused by COVID-19 in Note 1 -- “Nature of Operations” to our unaudited consolidated financial statements under Item 1 of this Quarterly Report on Form 10-Q) as this global health crisis is still evolving. The severity of the impact of the COVID-19 pandemic on our business will depend on a number of factors, including, but not limited to, the duration and severity of the pandemic, the containment measures, the extent and severity of the impact on our patrons and business partners, and the size and effectiveness of the state and federal government’s relief programs, of which we expect more to follow. With the use of our existing technologies and infrastructure, a majority of our workforce can work from home without significant disruptions to our operations. At present, we have no plan to reduce our workforce. At June 30, 2020, the impact on our financial statements of COVOD-19 consists primarily of unrealized losses on our portfolio of investment securities and material losses from limited partnership investments. However, we may experience further material economic impacts in other areas of our business, such as in our real estate operations, in future periods.
Recent Events
On July 2, 2020, our Board of Directors declared a quarterly dividend of $0.40 per common share. The dividends are payable on September 18, 2020 to stockholders of record on August 21, 2020.
On July 24, 2020, the Florida Department of Transportation (“FDOT”) exercised the power of eminent domain under the Florida Constitution in order to acquire for a highway expansion project the property in Tampa, Florida where our headquarters is located for compensation of $47,500,000. Under the terms of the agreement, the FDOT assumed all contracts associated with this property, including the leases with existing tenants. In addition, we agreed to donate a small portion of a separate tract of nearby undeveloped land we own to the FDOT for the same expansion project. We will have no later than July 24, 2023 to vacate the property. In connection with this transaction, we recognized a net gain from involuntary conversion of approximately $37,000,000.
On July 29, 2020, we made an early repayment of our 4% Promissory note, which was collateralized by our Tampa, Florida headquarters.
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RESULTS OF OPERATIONS
The following table summarizes our results of operations for the three and six months ended June 30, 2020 and 2019 (dollar amounts in thousands, except per share amounts):
Three Months Ended
Six Months Ended
June 30,
June 30,
2020
2019
2020
2019
Operating Revenue
Gross premiums earned
$
107,803
$
83,315
$
200,168
$
165,912
Premiums ceded
(34,354
)
(31,317
)
(65,073
)
(62,730
)
Net premiums earned
73,449
51,998
135,095
103,182
Net investment income
1,604
4,226
1,412
7,504
Net realized investment gains (losses)
1,435
(133
)
(809
)
(505
)
Net unrealized investment gains (losses)
2,884
1,326
(1,921
)
6,619
Credit losses on investments
(87
)
—
(526
)
—
Policy fee income
847
800
1,676
1,595
Other income
585
413
1,170
869
Total operating revenue
80,717
58,630
136,097
119,264
Operating Expenses
Losses and loss adjustment expenses
39,843
24,293
67,921
51,289
Policy acquisition and other underwriting expenses
12,991
10,077
24,817
19,750
General and administrative personnel expenses
9,731
7,998
18,098
15,362
Interest expense
3,020
2,884
5,990
7,221
Loss on repurchase of convertible senior notes
150
—
150
—
Other operating expenses
3,159
3,063
6,641
6,044
Total operating expenses
68,894
48,315
123,617
99,666
Income before income taxes
11,823
10,315
12,480
19,598
Income tax expense
2,887
2,762
2,997
5,307
Net income
$
8,936
$
7,553
$
9,483
$
14,291
Ratios to Net Premiums Earned:
Loss Ratio
54.25
%
46.72
%
50.28
%
49.71
%
Expense Ratio
39.55
%
46.20
%
41.23
%
46.88
%
Combined Ratio
93.80
%
92.92
%
91.51
%
96.59
%
Ratios to Gross Premiums Earned:
Loss Ratio
36.96
%
29.16
%
33.93
%
30.91
%
Expense Ratio
26.95
%
28.83
%
27.82
%
29.16
%
Combined Ratio
63.91
%
57.99
%
61.75
%
60.07
%
Earnings Per Share Data:
Basic
$
1.16
$
0.93
$
1.23
$
1.75
Diluted
$
1.08
$
0.90
$
1.23
$
1.72
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Comparison of the Three Months ended June 30 , 2020 to the Three Months ended June 30 , 2019
Our results of operations for the three months ended June 30, 2020 reflect income available to common stockholders of approximately $8,936,000 or $1.08 earnings per diluted common share, compared with approximately $7,553,000, or $0.90 earnings per diluted common share, for the three months ended June 30, 2019. The quarter-over-quarter increase in pre-tax income was primarily due to a net increase in net premiums earned of $21,451,000, an increase in income from our investment portfolio (consisting of net investment income/loss and net realized and unrealized gains/losses) of $504,000, offset by an increase in policy acquisition and underwriting expenses of $2,914,000, an increase in losses and loss adjustment expenses of $15,550,000, and increased payroll costs of $1,733,000.
Revenue
Gross Premiums Earned for the three months ended June 30, 2020 and 2019 were approximately $107,803,000 and $83,315,000, respectively. The quarter-over-quarter increase was primarily attributable to the policies transitioned from Anchor and increased policies in force from the growth in TypTap’s business. Gross premiums earned related to the Anchor policies were approximately $14,220,000 for the quarter.
Premiums Ceded for the three months ended June 30, 2020 and 2019 were approximately $34,354,000 and $31,317,000, respectively, representing 31.9% and 37.6%, respectively, of gross premiums earned. The $3,037,000 increase was primarily attributable to increased reinsurance costs effective June 1, 2020 and a higher level of reinsurance coverage, offset by a reduction in premiums ceded attributable to retrospective provisions under one reinsurance contract.
Our premiums ceded represent costs of reinsurance to cover losses from catastrophes that exceed the retention levels defined by our catastrophe excess of loss reinsurance contracts or to assume a proportional share of losses as defined in a quota share agreement. The rates we pay for reinsurance are based primarily on policy exposures reflected in gross premiums earned. For the three months ended June 30, 2020, premiums ceded included a decrease of approximately $3,240,000 related to retrospective provisions compared with a net reduction of approximately $1,226,000 for the three months ended June 30, 2019. See “Economic Impact of Reinsurance Contracts with Retrospective Provisions” under “Critical Accounting Policies and Estimates.”
Net Premiums Written for the three months ended June 30, 2020 and 2019 totaled approximately $137,527,000 and $102,124,000, respectively. Net premiums written represent the premiums charged on policies issued during a fiscal period less any applicable reinsurance costs. The increase in 2020 resulted from an increase in gross premiums written from the growth of TypTap business and the transition of policies from Anchor. We had approximately 164,000 policies in force at June 30, 2020 as compared with approximately 124,000 policies in force at June 30, 2019.
Net Premiums Earned for the three months ended June 30, 2020 and 2019 were approximately $73,449,000 and $51,998,000, respectively, and reflect the gross premiums earned less reinsurance costs as described above.
The following is a reconciliation of our total Net Premiums Written to Net Premiums Earned for the three months ended June 30, 2020 and 2019 (amounts in thousands):
Three Months Ended
June 30,
2020
2019
Net Premiums Written
$
137,527
$
102,124
Increase in Unearned Premiums
(64,078
)
(50,126
)
Net Premiums Earned
$
73,449
$
51,998
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Net Investment Income for the three months ended June 30 , 2020 and 2019 was approximately $ 1,604,000 and $ 4,226 ,000 , respectively . The $ 2,622,000 decrease was primarily attributable to lower income from limited partnership investments and cash equivalent instruments .
Net Realized Investment Gains for the three months ended June 30, 2020 were approximately $1,435,000 versus approximately $133,000 of net realized investment loss for the three months ended June 30, 2019. The gains in 2020 resulted primarily from sales intended to rebalance our investment portfolio and manage overall portfolio risk.
Net Unrealized Investment gains for the three months ended June 30, 2020 and 2019 were approximately $2,884,000 and $1,326,000, respectively, reflecting an increase in the fair value of equity securities resulting from an improved economic outlook since the shock caused by COVID-19.
Expenses
Our Losses and Loss Adjustment Expenses amounted to approximately $39,843,000 and $24,293,000 for the three months ended June 30, 2020 and 2019, respectively. The $15,550,000 increase primarily resulted from the increase in gross premiums earned, change in premium mix and reserves for weather-related losses in the quarter, offset by a reduction in loss reserves related to 2019 loss year. See “Reserves for Losses and Loss Adjustment Expenses” under “Critical Accounting Policies and Estimates.”
Policy Acquisition and Other Underwriting Expenses for the three months ended June 30, 2020 and 2019 were approximately $12,991,000 and $10,077,000, respectively, and primarily reflect the amortization of deferred acquisition costs such as commissions payable to agents for production and renewal of policies, and premium taxes. The $2,914,000 increase was primarily attributable to higher agent commission rates and property inspection costs associated with the organic growth of TypTap business.
General and Administrative Personnel Expenses for the three months ended June 30, 2020 and 2019 were approximately $9,731,000 and $7,998,000, respectively. Our general and administrative personnel expenses include salaries, wages, payroll taxes, share-based compensation expenses, and employee benefit costs. Factors such as merit increases, changes in headcount, and periodic restricted stock grants, among others, cause fluctuations in this expense. In addition, our personnel expenses are decreased by the capitalization of payroll costs related to a project to develop software for internal use and the payroll costs associated with the processing and settlement of certain catastrophe claims which are recoverable from reinsurers under reinsurance contracts. The period-over-period increase of $1,733,000 was primarily attributable to higher share-based compensation expense and employee incentive bonus, an increase in the headcount of temporary and full-time employees, and merit increases for non-executive employees effective in late February 2020, and lower capitalized and recoverable payroll costs.
Income Tax Expense for the three months ended June 30, 2020 and 2019 was approximately $2,887,000 and $2,762,000, respectively, for state, federal, and foreign income taxes resulting in an effective tax rate of 24.4% for 2020 and 26.8% for 2019. The decrease in the effective tax rate was primarily due to the recognition of 2018 Florida income tax refund and the reduced Florida corporate income tax rate effective in September 2019.
Ratios:
The loss ratio applicable to the three months ended June 30, 2020 (losses and loss adjustment expenses incurred related to net premiums earned) was 54.2% compared with 46.7% for the three months ended June 30, 2019. The increase was primarily due to the increase in losses and loss adjustment expenses, offset in part by the increase in net premiums earned.
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The expense ratio applicable to the three months ended June 30, 2020 (defined as underwriting expenses, general and administrative personnel expenses , interest and other operating expenses related to net premiums earned) was 39.6 % compared with 4 6 . 2 % for the three months ended June 30, 2019 . The de crease in our expense ratio was primarily attributable to the increase in net premiums earned, offset by the increase in losses and loss adjustment expense s and the increase in policy acquisition, underwriting and personnel expenses .
The combined ratio (total of all expenses in relation to net premiums earned) is the measure of overall underwriting profitability before other income. Our combined ratio for the three months ended June 30, 2020 was 93.8% compared with 92.9% for the three months ended June 30, 2019.
Due to the impact our reinsurance costs have on net premiums earned from period to period, our management believes the combined ratio measured to gross premiums earned is more relevant in assessing overall performance. The combined ratio to gross premiums earned for the three months ended June 30, 2020 was 63.9% compared with 58.0% for the three months ended June 30, 2019. The increase in 2020 was attributable to the factors described above.
Comparison of the Six Months ended June 30, 2020 to the Six Months ended June 30, 2019
Our results of operations for the six months ended June 30, 2020 reflect income available to common stockholders of approximately $9,483,000, or $1.23 earnings per diluted common share, compared with approximately $14,291,000, or $1.72 earnings per diluted common share, for the six months ended June 30, 2019. The period-over-period decrease was primarily due to a net decrease in income from our investment portfolio of $14,936,000, an increase in losses and loss adjustment expenses of $16,632,000, an increase in policy acquisition and other underwriting expense of $5,067,000, and an increase in general and administrative personnel expenses of $2,736,000, offset by an increase net premiums earned of $31,913,000, which contributed to a decrease in pre-tax income of $7,118,000.
Revenue
Gross Premiums Earned for the six months ended June 30, 2020 and 2019 were approximately $200,168,000 and $165,912,000, respectively. The $34,256,000 increase in 2020 compared with the corresponding period in 2019 was primarily attributable to a net increase in policies in force as described earlier.
Premiums Ceded for the six months ended June 30, 2020 and 2019 were approximately $65,073,000 and $62,730,000, respectively, representing 32.5% and 37.8%, respectively, of gross premiums earned. The $2,343,000 increase was primarily attributable to increased reinsurance cost per coverage limit effective June 1, 2020 and a higher level of reinsurance coverage, offset by a reduction in premiums ceded attributable to retrospective provisions under one reinsurance contract.
For the six months ended June 30, 2020, premiums ceded included a reduction of approximately $5,760,000 related to retrospective provisions. For the six months ended June 30, 2019, premiums ceded included a net reduction of approximately $1,738,000 related to retrospective provisions. See “Economic Impact of Reinsurance Contracts with Retrospective Provisions” under “Critical Accounting Policies and Estimates.”
Net Premiums Written for the six months ended June 30, 2020 and 2019 totaled approximately $183,326,000 and $138,321,000, respectively. The $45,005,000 increase in 2020 resulted primarily from the factors described earlier.
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Net Premiums Earned for the six months ended June 30, 20 20 and 201 9 were approximately $ 135,095,000 and $10 3 , 182 ,000, respectively, and reflect gross premiums earned less reinsurance costs as described above.
The following is a reconciliation of our total Net Premiums Written to Net Premiums Earned for the six months ended June 30, 2020 and 2019 (amounts in thousands):
Six Months Ended
June 30,
2020
2019
Net Premiums Written
$
183,326
$
138,321
Increase in Unearned Premiums
(48,231
)
(35,139
)
Net Premiums Earned
$
135,095
$
103,182
Net Investment Income for the six months ended June 30, 2020 and 2019 was approximately $1,412,000 and $7,504,000, respectively. The $6,092,000 decrease was primarily attributable to a loss of $2,747,000 from limited partnership investments in 2020 as opposed to income of $832,000 in 2019. In addition, interest income from cash, cash equivalents, and short-term investments was lower by $1,627,000 in 2020 compared with 2019 due to a lowering of investment yields, particularly on cash.
Net Unrealized Investment Losses for the six months ended June 30, 2020 were approximately $1,921,000 versus net unrealized investment gains of approximately $6,619,000 for the six months ended June 30, 2019, reflecting a deterioration in the fair value of equity securities caused by COVID-19 pandemic.
Expenses
Our Losses and Loss Adjustment Expenses amounted to approximately $67,921,000 and $51,289,000 for the six months ended June 30, 2020 and 2019, respectively. The $16,632,000 increase was primarily attributable to the increase in gross premiums earned, change in premium mix and reserves for weather-related losses, offset by lower prior year development. See “Reserves for Losses and Loss Adjustment Expenses” under “Critical Accounting Policies and Estimates.”
Policy Acquisition and Other Underwriting Expenses for the six months ended June 30, 2020 and 2019 were approximately $24,817,000 and $19,750,000, respectively. The $5,067,000 increase was primarily attributable to the factors described earlier.
General and Administrative Personnel Expenses for the six months ended June 30, 2020 and 2019 were approximately $18,098,000 and $15,362,000, respectively. The period-over-period increase of $2,736,000 was primarily attributable to higher share-based compensation expense and merit increases for non-executive employees, and lower capitalized and recoverable payroll costs.
Interest Expense for the six months ended June 30, 2020 and 2019 was approximately $5,990,000 and $7,221,000, respectively. The decrease resulted from the repayment of our 3.875% Convertible Senior Notes in March 2019.
Income Tax Expense for the six months ended June 30, 2020 and 2019 was approximately $2,997,000 and $5,307,000, respectively, for state, federal, and foreign income taxes resulting in an effective tax rate of 24.0% for 2020 and 27.1% for 2019. The decrease was primarily attributable to the recognition of windfall tax benefits related to share-based awards in addition to the factors described previously.
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Ratios:
The loss ratio applicable to the six months ended June 30, 2020 was 50.3% compared with 49.7% for the six months ended June 30, 2019.
The expense ratio applicable to the six months ended June 30, 2020 was 41.2% compared with 46.9% for the six months ended June 30, 2019. The decrease in our expense ratio was primarily attributable to the increase in net premiums earned.
The combined ratio is the measure of overall underwriting profitability before other income. Our combined ratio for the six months ended June 30, 2020 was 91.5% compared with 96.6% for the six months ended June 30, 2019. The decrease was attributable to the increase in net premiums earned, offset in part by the increase in losses and loss adjustment expenses as described above.
Due to the impact our reinsurance costs have on net premiums earned from period to period, our management believes the combined ratio measured to gross premiums earned is more relevant in assessing overall performance. The combined ratio to gross premiums earned for the six months ended June 30, 2020 was 61.8% compared with 60.1% for the six months ended June 30, 2018. The increase in 2020 was primarily attributable to the increase in losses and loss adjustment expenses, offset by the increase in gross premiums earned.
Seasonality of Our Business
Our insurance business is seasonal as hurricanes and tropical storms affecting Florida typically occur during the period from June 1 through November 30 each year. Also, with our reinsurance treaty year typically effective June 1 each year, any variation in the cost of our reinsurance, whether due to changes in reinsurance rates or changes in the total insured value of our policy base, will occur and be reflected in our financial results beginning June 1 each year.
LIQUIDITY AND CAPITAL RESOURCES
Throughout our history, our liquidity requirements have been met through issuances of our common and preferred stock, debt offerings and funds from operations. We expect our future liquidity requirements will be met by funds from operations, primarily the cash received by our insurance subsidiaries from premiums written and investment income. We may consider raising additional capital through debt and equity offerings to support our growth and future investment opportunities.
Our insurance subsidiaries require liquidity and adequate capital to meet ongoing obligations to policyholders and claimants and to fund operating expenses. In addition, we attempt to maintain adequate levels of liquidity and surplus to manage any differences between the duration of our liabilities and invested assets. In the insurance industry, cash collected for premiums from policies written is invested, interest and dividends are earned thereon, and losses and loss adjustment expenses are paid out over a period of years. This period of time varies by the circumstances surrounding each claim. Substantially all of our losses and loss adjustment expenses are fully settled and paid within 100 days of the claim receipt date. Additional cash outflow occurs through payments of underwriting costs such as commissions, taxes, payroll, and general overhead expenses.
We believe that we maintain sufficient liquidity to pay claims and expenses, as well as to satisfy commitments in the event of unforeseen events such as reinsurer insolvencies, inadequate premium rates, or reserve deficiencies. We maintain a comprehensive reinsurance program at levels management considers adequate to diversify risk and safeguard our financial position.
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In the future, we anticipate our primary use of funds will be to pay claims, reinsurance premiums, interest, and dividends and to fund operating expenses and real estate acquisitions .
Revolving Credit Facility, Senior Notes, Promissory Notes, and Finance Leases
The following table summarizes the principal and interest payment obligations of our indebtedness at June 30, 2020:
Maturity Date
Interest Payment Due Date
4.25% Convertible senior notes
March 2037
March 1 and September 1
4% Promissory note
Through February 2031
1 st day of each month
3.75% Callable promissory note
Through September 2036
1 st day of each month
4.55% Promissory note
Through August 2036
1 st day of each month
3.90% Promissory note
Through April 2032
1 st day of each month
Finance leases
Through August 2023
Various
Revolving credit facility
Through December 2021
January 1, April 1, July 1, October 1
See Note 12 -- “Long-Term Debt” to our unaudited consolidated financial statements under Item 1 of this Quarterly Report on Form 10-Q.
Share Repurchase Plan
On March 13, 2020, the Board approved a plan for 2020, effective March 16, 2020, to repurchase up to $20,000,000 of common shares under which we may purchase shares of common stock in open market purchases, block transactions and privately negotiated transactions in accordance with applicable federal securities laws. See Note 19 -- “Stockholders’ Equity” to our unaudited consolidated financial statements under Item 1 of this Quarterly Report on Form 10-Q for more information.
Limited Partnership Investments
Our limited partnership investments consist of five private equity funds managed by their general partners. Three of these funds have unexpired capital commitments which are callable at the discretion of the fund’s general partner for funding new investments or expenses of the fund. Although capital commitments for the remaining three funds have expired, the general partners may request additional funds under certain circumstances. At June 30, 2020, there was an aggregate unfunded capital balance of $13,660,000. See Limited Partnership Investments under Note 5 -- “Investments” to our unaudited consolidated financial statements under Item 1 of this Quarterly Report on Form 10-Q for additional information.
Real Estate Investments
Real estate has long been a significant component of our overall investment portfolio. It diversifies our portfolio and helps offset the volatility of other higher-risk investments. Thus, we may consider increasing our real estate investment portfolio should an opportunity arise.
We currently have a 90% equity interest in FMKT Mel JV, LLC, a Florida limited liability company for which we are not the primary beneficiary. FMKT Mel JV’s real estate portfolio consists of outparcels for ground lease or sale. We have the option to take full ownership of these outparcels by acquiring the remaining 10% interest. Alternatively, we may sell these outparcels and allocate the profits from the sale before liquidating FMKT Mel JV.
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Sources and Uses of Cash
Cash Flows for the Six Months Ended June 30, 2020
Net cash provided by operating activities for the six months ended June 30, 2020 was approximately $109,988,000, which consisted primarily of cash received from net premiums written, reinsurance recoveries (of approximately $32,597,000) and $28,745,000 of net cash receipts from Anchor less cash disbursed for operating expenses, losses and loss adjustment expenses and interest payments. Due to the inclusion of the cash receipt from Anchor, net cash provided by operating activities was higher than usual. Net cash provided by investing activities of $85,995,000 was primarily due to the proceeds from sales of fixed-maturity and equity securities of $90,641,000, and the proceeds from redemptions and maturities of fixed-maturity securities of $52,594,000, offset by the purchases of fixed-maturity and equity securities of $48,673,000, the purchase of real estate investments of $2,522,000, limited partnership investments of $1,470,000, and the purchases of property and equipment of $5,349,000. Net cash used in financing activities totaled $2,686,000, which consisted of $9,496,000 used to repay a 3.95% promissory note, $6,162,000 of net cash dividend payments, $4,459,000 used to repurchase our 4.25% convertible senior notes, and $6,467,000 used in our share repurchases, offset by the proceeds from issuance of a 3.90% promissory note of $10,000,000 and draws from our revolving credit facility of $14,000,000.
Cash Flows for the Six Months Ended June 30, 2019
Net cash provided by operating activities for the six months ended June 30, 2019 was approximately $28,834,000, which consisted primarily of cash received from net premiums written as well as reinsurance recoveries (of approximately $45,832,000) less cash disbursed for operating expenses, losses and loss adjustment expenses and interest payments. Net cash provided by investing activities of $45,836,000 was primarily due to the proceeds from sales of fixed-maturity and equity securities of $35,826,000, the proceeds from redemptions and maturities of fixed-maturity securities of $47,788,000, and the proceeds from sales and maturities of short-term and other investments of $69,897,000, offset by the purchases of fixed-maturity and equity securities of $91,505,000, the purchase of real estate investments of $9,892,000, and limited partnership investments of $1,751,000. Net cash used in financing activities totaled $97,000,000, which was primarily due to the repayments of long-term debt of $90,647,000, $6,428,000 of net cash dividend payments, and $9,029,000 used in our share repurchases, offset by $9,500,000 of borrowings from our revolving credit facility.
Investments
The main objective of our investment policy is to maximize our after-tax investment income with a reasonable level of risk given the current financial market. Our excess cash is invested primarily in money market accounts, certificates of deposit, and fixed-maturity and equity securities.
At June 30, 2020, we had $139,302,000 of fixed-maturity and equity investments, which are carried at fair value. Changes in the general interest rate environment affect the returns available on new fixed-maturity investments. While a rising interest rate environment enhances the returns available on new investments, it reduces the market value of existing fixed-maturity investments and thus the availability of gains on disposition. A decline in interest rates reduces the returns available on new fixed-maturity investments but increases the market value of existing fixed-maturity investments, creating the opportunity for realized investment gains on disposition. To maximize the gains from fixed-maturity investments in a low interest rate environment, we have decreased our holdings in fixed-maturity securities since the beginning of 2020.
In the future, we may alter our investment policy as to investments in federal, state and municipal obligations, preferred and common equity securities and real estate mortgages, as permitted by applicable law, including insurance regulations.
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OFF-BALANCE SHEET ARRANGEMENTS
As of June 30, 2020, we had unexpired capital commitments for limited partnerships in which we hold interests. Such commitments are not recognized in the financial statements but are required to be disclosed in the notes to the financial statements. See Note 21 -- “Commitments and Contingencies” to our unaudited consolidated financial statements under Item 1 of this Quarterly Report on Form 10-Q and Contractual Obligations and Commitment below for additional information.
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
The following table summarizes our material contractual obligations and commitments as of June 30, 2020 (amounts in thousands):
Payment Due by Period
Less than
More than
Total
1 Year
1-3 Years
3-5 Years
5 Years
Operating leases (1)
$
374
$
277
$
97
$
—
$
—
Service agreement (1)
37
24
13
—
—
Unfunded capital commitments (2)
13,660
13,660
—
—
—
Revolving credit facility
23,750
23,750
—
—
—
Long-term debt obligations (3)
191,970
8,795
150,675
5,337
27,163
Total
$
229,791
$
46,506
$
150,785
$
5,337
$
27,163
(1)
Represents a lease for office space in Miami Lakes, Florida, a lease and maintenance service agreement for office space in Noida, India, and leases for office equipment and storage space. Liabilities related to our India operations were converted from Indian Rupees to U.S. dollars using the June 30, 2020 exchange rate.
(2)
Represents the unfunded balance of capital commitments under the subscription agreements related to limited partnerships in which we hold interests.
(3)
Amounts represent principal and interest payments over the lives of various long-term debt obligations. See Note 12 -- “Long-Term Debt” to our unaudited consolidated financial statements under Item 1 of this Quarterly Report on Form 10-Q.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
We have prepared our consolidated financial statements in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). The preparation of these consolidated financial statements requires us to make estimates and judgments to develop amounts reflected and disclosed in our financial statements. Material estimates that are particularly susceptible to significant change in the near term are related to our losses and loss adjustment expenses, which include amounts estimated for claims incurred but not yet reported. We base our estimates on various assumptions and actuarial data we believe to be reasonable under the circumstances. Actual results may differ materially from these estimates.
We believe our accounting policies specific to losses and loss adjustment expenses, reinsurance recoverable, reinsurance with retrospective provisions, deferred income taxes, and stock-based compensation expense involve our most significant judgments and estimates material to our consolidated financial statements.
Reserves for Losses and Loss Adjustment Expenses
Our liability for losses and loss adjustment expense (“Reserves”) is specific to property insurance, which is our insurance division’s only line of business. The Reserves include both case reserves on reported claims and our reserves for incurred but not reported (“IBNR”) losses. At each period end date, the balance of our Reserves is based on our best estimate of the ultimate cost of each claim for those known cases and the IBNR loss reserves are estimated based primarily on our historical experience. Changes in the estimated liability are charged or credited to operations as the losses and loss adjustment expenses are adjusted.
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The IBNR represents our estimate of the ultimate cost of all claims that have occurred but have not been reported to us, and in some cases may not yet be known to the insured, and future development of reported claims. Estimating the IBNR component of our Reserves involves considerable judgment on the part of management. At June 30, 2020 , $ 166,238,000 of the total $ 211,162,000 we have reserved for losses and loss adjustment expenses is attributable to our estimate of IBNR. The remaining $ 44,924,000 relates to known cases which have been reported but not yet fully settled in which case we have established a reserve based on currently available information and our best estimate of the cost to settle each claim. At June 30, 2020 , $ 32,393,000 of the $ 44,924,000 in reserves for known cases relates to claims incurred during prior years.
Our Reserves decreased from $214,697,000 at December 31, 2019 to $211,162,000 at June 30, 2020. The $3,535,000 decrease is comprised of reductions in our Reserves of $28,490,000 specific to Hurricane Irma in 2017 and Hurricane Michael in 2018 and reductions in our non-catastrophe Reserves of $14,324,000 for 2019 and $11,203,000 for 2018 and prior loss years, offset by $50,483,000 in reserves established for 2020 loss year. The $50,482,000 in Reserves established for 2020 claims is primarily driven by an allowance for those claims that have been incurred but not reported to the company as of June 30, 2020. The decrease of $54,017,000 specific to our 2019 and prior loss-year reserves is due to settlement of claims related to those loss years.
Based on all information known to us, we consider our Reserves at June 30, 2020 to be adequate to cover our claims for losses that have occurred as of that date including losses yet to be reported to us. However, these estimates are continually reviewed by management as they are subject to significant variability and may be impacted by trends in claim severity and frequency or unusual exposures that have not yet been identified. As part of the process, we review historical data and consider various factors, including known and anticipated regulatory and legal developments, changes in social attitudes, inflation and economic conditions. As experience develops and other data becomes available, these estimates are revised, as required, resulting in increases or decreases to the existing unpaid losses and loss adjustment expenses. Adjustments are reflected in the results of operations in the period in which they are made, and the liabilities may deviate substantially from prior estimates.
Economic Impact of Reinsurance Contracts with Retrospective Provisions
One of our reinsurance contracts includes retrospective provisions that adjust premiums in the event losses are minimal or zero. In accordance with accounting principles generally accepted in the United States of America, we will recognize an asset in the period in which the absence of loss experience obligates the reinsurer to pay cash or other consideration under the contract. In the event that a loss arises, we will derecognize such asset in the period in which a loss arises. Such adjustments to the asset, which accrue throughout the contract term, will negatively impact our operating results when a catastrophic loss event occurs during the contract term.
For the three months ended June 30, 2020 and 2019, we accrued benefits of $3,240,000 and $1,026,000, respectively. For the three months ended June 30, 2020, there was no adjustment in ceded premiums whereas we recognized a reduction in premiums ceded of $200,000 for the three months ended June 30, 2019. In combination, for the three months ended June 30, 2020 and 2019, we recognized decreases in ceded premiums of $3,240,000 and $1,226,000, respectively.
For the six months ended June 30, 2020 and 2019, we accrued benefits of $5,760,000 and $1,304,000, respectively. There was no adjustment in ceded premiums for the six months ended June 30, 2020. For the six months ended June 30, 2019, we recognized a decrease in premiums ceded of $434,000. In combination, for the six months ended June 30, 2020 and 2019, we recognized decreases in ceded premiums of $5,760,000 and $1,738,000, respectively.
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As of June 30, 2020, we had $1,560,000 of accrued benefits, the amount that would be charged to earnings in the event we experience a catastrophic loss that exceeds the coverage limit provided under such agreement. In June 2020, we received a $13,680,000 premium refund under the retrospective reinsurance contract that ended May 31, 2020. Accrued benefits related to this expired contract w ere $9,480,000 at December 31, 2019. We believe the credit risk associated with the collectability of these accrued benefits is minimal based on available information about the reinsurer’s financial position and the reinsurer’s demonstrated ability to comply with contract terms .
The above and other accounting estimates and their related risks that we consider to be our critical accounting estimates are more fully described in our Annual Report on Form 10-K, which we filed with the SEC on March 6, 2020. For the six months ended June 30, 2020, there have been no material changes with respect to any of our critical accounting policies.
RECENT ACCOUNTING PRONOUNCEMENTS
For information with respect to recent accounting pronouncements and the impact of these pronouncements on our consolidated financial statements, see Note 3 to our Notes to Unaudited Consolidated Financial Statements.
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