HCI Group, Inc. 10-Q

ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our investment portfolios at September 30, 2020 included fixed-maturity and equity securities, the purposes of which are not for speculation. Our main objective is to maximize after-tax investment income and maintain sufficient liquidity to meet our obligations while minimizing market risk, which is the potential economic loss from adverse fluctuations in securities prices. We consider many factors including credit ratings, investment concentrations, regulatory requirements, anticipated fluctuation of interest rates, durations and market conditions in developing investment strategies. Our investment securities are managed primarily by outside investment advisors and are overseen by the investment committee appointed by our board of directors. From time to time, our investment committee may decide to invest in low risk assets such as U.S. government bonds. Our investment portfolios are exposed to interest rate risk, credit risk and equity price risk. Fiscal and economic uncertainties caused by any government action or inaction may exacerbate these risks and potentially have adverse impacts on the value of our investment portfolios. We classify our fixed-maturity securities as available-for-sale and report any unrealized gains or losses, net of deferred income taxes, as a component of other comprehensive income within our stockholders’ equity. As such, any material temporary changes in their fair value can adversely impact the carrying value of our stockholders’ equity. In addition, we recognize any unrealized gains or losses related to our equity securities in our statement of income. As a result, our results of operations can be materially affected by the volatility in the equity market. Interest Rate Risk Our fixed-maturity securities are sensitive to potential losses resulting from unfavorable changes in interest rates. We manage the risk by analyzing anticipated movement in interest rates and considering our future capital needs. The following table illustrates the impact of hypothetical changes in interest rates to the fair value of our fixed-maturity securities at September 30, 2020 (amounts in thousands): Hypothetical Change in Interest Rates Estimated Fair Value Change in Estimated Fair Value Percentage Increase (Decrease) in Estimated Fair Value 300 basis point increase $ 88,775 $ (3,968 ) -4.28 % 200 basis point increase 90,097 (2,646 ) -2.85 % 100 basis point increase 91,420 (1,323 ) -1.43 % 100 basis point decrease 93,562 819 0.88 % 200 basis point decrease 93,961 1,218 1.31 % 300 basis point decrease 94,237 1,494 1.61 % Credit Risk Credit risk can expose us to potential losses arising principally from adverse changes in the financial condition of the issuers of our fixed-maturity securities. We mitigate the risk by investing in fixed-maturity securities that are generally investment grade, by diversifying our investment portfolio to avoid concentrations in any single issuer or business sector, and by continually monitoring each individual security for declines in credit quality. While we emphasize credit quality in our investment selection process, significant downturns in the markets or general economy may impact the credit quality of our portfolio. 58 The following table presents the composition of our fixed-maturity securities, by rating, at September 30, 2020 (amounts in thousands): % of Total % of Total Amortized Amortized Estimated Estimated Comparable Rating Cost Cost Fair Value Fair Value AA+, AA, AA- $ 16,110 17.0 $ 16,455 17.0 A+, A, A- 43,952 48.0 44,743 48.0 BBB+, BBB, BBB- 20,011 22.0 20,876 23.0 BB+, BB, BB- 4,229 5.0 4,357 5.0 CCC+, CC and Not rated 6,864 8.0 6,312 7.0 Total $ 91,166 100.0 $ 92,743 100.0 Equity Price Risk Our equity investment portfolio at September 30, 2020 included common stocks, perpetual preferred stocks, mutual funds and exchange traded funds. We may incur losses due to adverse changes in equity security prices. We manage the risk primarily through industry and issuer diversification and asset mix. The following table illustrates the composition of our equity securities at September 30, 2020 (amounts in thousands): % of Total Estimated Estimated Fair Value Fair Value Stocks by sector: Financial $ 13,691 32 Technology 2,550 6 Consumer 4,151 10 Other (1) 4,517 10 24,909 58 Mutual funds and exchange traded funds by type: Debt 15,382 36 Equity 2,411 6 Total $ 42,702 100 (1) Represents an aggregate of less than 5% sectors. Foreign Currency Exchange Risk At September 30, 2020, we did not have any material exposure to foreign currency related risk. 59