HCI Group, Inc. 10-Q

ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our investment portfolios at March 31, 2021 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 March 31, 2021 (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 $ 56,807 $ (3,395 ) -5.64 % 200 basis point increase 57,939 (2,263 ) -3.76 % 100 basis point increase 59,070 (1,132 ) -1.88 % 100 basis point decrease 60,943 741 1.23 % 200 basis point decrease 61,355 1,153 1.92 % 300 basis point decrease 61,528 1,326 2.20 % 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. 55 The following table presents the composition of our fixed-maturity securities, by rating, at March 3 1 , 202 1 (amounts in thousands): % of Total % of Total Amortized Amortized Estimated Estimated Comparable Rating Cost Cost Fair Value Fair Value AA+, AA, AA- $ 13,738 23.0 $ 13,918 23.0 A+, A, A- 20,834 36.0 21,280 36.0 BBB+, BBB, BBB- 18,208 31.0 18,931 31.0 BB+, BB, BB- 1,967 3.0 2,172 4.0 CCC+, CC and Not rated 4,174 7.0 3,901 6.0 Total $ 58,921 100.0 $ 60,202 100.0 Equity Price Risk Our equity investment portfolio at March 31, 2021 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 March 31, 2021 (amounts in thousands): % of Total Estimated Estimated Fair Value Fair Value Stocks by sector: Financial $ 12,807 26 Technology 3,268 6 Consumer 3,808 8 Other (1) 5,669 11 25,552 51 Mutual funds and exchange traded funds by type: Debt 19,782 40 Equity 4,466 9 Total $ 49,800 100 (1) Represents an aggregate of less than 5% sectors. Foreign Currency Exchange Risk At March 31, 2021, we did not have any material exposure to foreign currency related risk. 56