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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON D.C. 20549

 

 

Form 10-K

 

 

 

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

For the fiscal year ended December 31, 2014

OR

 

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

Commission File Number

001-34126

 

 

HCI Group, Inc.

(Exact name of Registrant as specified in its charter)

 

 

 

Florida   20-5961396
(State of Incorporation)  

(IRS Employer

Identification No.)

5300 West Cypress Street, Suite 100

Tampa, FL 33607

(Address, including zip code of principal executive offices)

(813) 849-9500

(Registrant’s telephone number, including area code)

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

 

Title of Each Class

 

Name of Each Exchange on Which Registered

Common Shares, no par value   New York Stock Exchange
Preferred Share Purchase Rights   New York Stock Exchange
8.00% Senior Notes due 2020   New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act: None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

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  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files).    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

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

 

Large accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨    Smaller reporting company   ¨

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

The aggregate market value of the common stock held by non-affiliates of the registrant as of June 30, 2014, computed by reference to the price at which the common stock was last sold on June 30, 2014, was $379,970,934.

The number of shares outstanding of the registrant’s common stock, no par value, on March 2, 2015 was 10,761,107.

DOCUMENTS INCORPORATED BY REFERENCE

The information required by Part III of this Form 10-K is incorporated by reference from the registrant’s definitive proxy statement which will be filed not later than 120 days after the end of the fiscal year covered by this Form 10-K.

 

 

 


Table of Contents

HCI GROUP, INC. AND SUBSIDIARIES

TABLE OF CONTENTS

 

         Page  
  PART I:   

Item 1

 

Business

     2-11   

Item 1A

 

Risk Factors

     11-23   

Item 1B

 

Unresolved Staff Comments

     23   

Item 2

 

Properties

     24   

Item 3

 

Legal Proceedings

     25   

Item 4

 

Mine Safety Disclosures

     25   
  PART II:   

Item 5

 

Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

     26-29   

Item 6

 

Selected Financial Data

     30   

Item 7

 

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

     31-46   

Item 7A

 

Quantitative and Qualitative Disclosures About Market Risk

     46-48   

Item 8

 

Financial Statements and Supplementary Data

     49-107   

Item 9

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

     108   

Item 9A

 

Controls and Procedures

     108-109   

Item 9B

 

Other Information

     109   
  PART III:   

Item 10

 

Directors, Executive Officers and Corporate Governance

     110   

Item 11

 

Executive Compensation

     110   

Item 12

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

     110   

Item 13

 

Certain Relationships and Related Transactions, and Director Independence

     110   

Item 14

 

Principal Accounting Fees and Services

     111   
  PART IV:   

Item 15

 

Exhibits, Financial Statement Schedules

     112-119   

Signatures

    

Certifications

    


Table of Contents

PART I

ITEM 1 – Business

General

HCI Group, Inc. is a Florida-based company owning subsidiaries primarily engaged in the property and casualty insurance business. HCI was incorporated in 2006. References to “we,” “our,” “us,” “the Company,” or “HCI” in this Form 10-K generally refer to HCI Group, Inc. and its subsidiaries. Our principal executive offices are located at 5300 West Cypress Street, Suite 100, Tampa, Florida 33607, and our telephone number is (813) 849-9500.

Over the years, we have broadened and diversified our business portfolio through acquisitions to include information technologies and investment real estate. Based on the organizational structure, revenue sources, and evaluation of financial and operating performances by management, we manage our operations under one business segment, which includes the following operations:

 

  a) Insurance Operations

 

    Property and casualty insurance

 

    Reinsurance

 

  b) Other Operations

 

    Information technology

 

    Real estate

Insurance Operations

Property and Casualty Insurance

Our principal operating subsidiary, Homeowners Choice Property & Casualty Insurance Company, Inc. (“HCPCI”), was incorporated and began operations in 2007. Through HCPCI, we currently provide property and casualty insurance to homeowners, condominium owners and tenants residing in Florida. HCPCI’s operations are supported by certain of HCI’s wholly owned subsidiaries as well as HCI Group, Inc.:

 

    Homeowners Choice Managers, Inc. – acts as managing general agent and provides marketing, underwriting, claims settlement, accounting and financial services to HCPCI; and

 

    Southern Administration, Inc. – provides policy administration services to HCPCI.

HCPCI began operations by participating in a “take-out program” through which we assumed insurance policies held by Citizens Property Insurance Corporation (“Citizens”), a Florida state-supported insurer. The take-out program is a legislatively mandated program designed to

 

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reduce the State’s risk exposure by encouraging private companies to assume policies from Citizens. We have assumed policies in eleven separate transactions, which took place from July 2007 through December 2014 and included the most recent assumption of primarily wind-only policies in December 2014. In addition, we completed a transaction with HomeWise Insurance Company (“HomeWise”) in November 2011 through which we acquired its Florida policies. Substantially all of our premium revenue since inception has come from the policies acquired in these assumption transactions and subsequent renewals. Through the Citizens assumptions and HomeWise policies, we have increased our geographic diversification within the state of Florida. Following the December 2014 assumption, we have approximately 175,000 policies in force and approximately $435 million in annualized gross premiums.

Citizens has historically required us to offer renewals on the policies we acquire in the take-out program for a period of three years subsequent to the initial expiration of the assumed policies. The policyholders have the option to renew with us or they may place their coverage with another insurance company. Policyholders also have the option to opt out of the assumption and return to Citizens. With respect to our November 2013 and December 2014 assumptions, the opt-out provision was limited to the thirty-day period preceding and following the assumption date. We strive to retain these policies by offering competitive rates and exceptional service to our policyholders. We may selectively pursue additional assumption transactions with Citizens in the future.

We face various challenges to implementing our operating and growth strategies. Since we currently write policies that cover Florida homeowners, condominium owners, and tenants, we cover losses that may arise from, among other things, catastrophes, which could have a significant effect on our business, results of operations, and financial condition. To mitigate our risk of such catastrophic losses, we cede a portion of our exposure to reinsurers under contracts called catastrophe excess of loss reinsurance and quota share treaties. Even without catastrophic events, we may incur losses and loss adjustment expenses that deviate substantially from our estimates and that may exceed our reserves, in which case our net income and capital would decrease. Our operating and growth strategies may also be impacted by regulation of our business by the State of Florida, which must approve our policy forms and premium rates as well as monitor HCPCI’s compliance with financial and regulatory requirements. Additionally, we may compete with large, well-established insurance companies, possessing greater financial resources, larger agency networks, and greater name recognition. See Item 1A, “Risk Factors,” below.

In addition, HCPCI began writing flood coverage in January 2014 in response to the demand for an alternative to the Federal National Flood Insurance Program for Florida homeowners. The flood coverage is offered on a limited basis as a policy endorsement to eligible new and pre-existing Florida customers who are likely most impacted by the significant rate increases that may result from the Biggert-Waters Flood Insurance Reform and Modernization Act of 2012.

 

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We seek opportunities to enter the property and casualty insurance market and establish our presence in other states. In August 2013, our subsidiary, Homeowners Choice Assurance Company, Inc., was approved and licensed by the Alabama Department of Insurance.

Competition

We operate in highly competitive markets where we face competition from national, regional and residual market insurance companies. We believe that we have approximately 20 significant competitors writing homeowners’ property and casualty insurance in the state of Florida. Since beginning business in 2007, we have grown our business to become the third largest provider of homeowners’ property and casualty insurance in the state of Florida based on September 30, 2014 annualized premiums written data from the Florida Office of Insurance Regulation.

Many of our competitors have larger financial capacities, greater resource availability, and more diversification in terms of insurance coverage. Our competitors include companies which market their products through agents, as well as companies which sell insurance directly to their customers. Large national insurers may have certain competitive advantages such as increased name recognition, increased loyalty of their customer base, and reduced policy acquisition costs. We may also face competition from new or temporary entrants in our niche markets. In some cases, such entrants may, because of inexperience, desire for new business, or other reasons, price their insurance products below ours. Although our pricing is inevitably influenced to some degree by that of our competitors, we believe that it is generally not in our best interest to compete solely on price.

Our competitive strategies focus on the following key areas:

 

    Exceptional service – We are committed to maintaining superior service to our policyholders and agents.

 

    Claims settlement practices – We focus on fair and timely settlement of policyholder claims.

 

    Disciplined underwriting – We analyze exposures and utilize available underwriting data to ensure policies meet our selective criteria.

 

    Effective and efficient use of technology – We strive to add or improve technology that can effectively and efficiently enhance service to our policyholders and agents. For instance, we currently use our internally developed application, Exzeo, to increase the efficiency of our claims processing and settlement.

 

    New product offerings – In addition to our flood-endorsed policies and wind-only program, we may cross-sell additional insurance products to our existing policyholders in order to broaden our lines of business and product mix or identify other lines of insurance to offer.

 

    Geographical expansion – We continue to seek opportunities to expand our business within the state of Florida and perhaps into other states to increase overall geographic diversification.

 

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Seasonality of Our Business

Our insurance business is seasonal as hurricanes and tropical storms typically occur during the period from June 1 through November 30 each year. With our reinsurance treaty year effective on 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.

Government Regulation

We are subject to the laws and regulations in any state in which we conduct our insurance business. The regulations cover all aspects of our business and are generally designed to protect the interests of insurance policyholders as opposed to the interests of shareholders. Such regulations relate to a wide variety of financial and non-financial matters including:

 

    authorized lines of business;

 

    capital and surplus requirements;

 

    approval of allowable rates and forms;

 

    approval of reinsurance contracts;

 

    investment parameters;

 

    underwriting limitations;

 

    transactions with affiliates;

 

    dividend limitations;

 

    changes in control; and

 

    market conduct.

Our failure to comply with certain provisions of applicable insurance laws and regulations could have a material, adverse effect on our business, results of operations or financial condition.

Regulatory Uncertainty

Certain states including Florida have adopted laws or are considering proposed legislation which, among other things, limits the ability of insurance companies to effect rate increases or to cancel, reduce or non-renew insurance coverage with respect to existing policies. The Florida legislature continuously considers bills affecting the Florida residential property insurance market. Current law penalizes insurers for noncompliance with the insurance code, establishes a private cause of action relating to claims payment practices, extends the notice period applicable to non-renewals of certain residential policies, prevents non-renewals and cancellation except for material misrepresentation and non-payment of premium and establishes procedures governing rate filings. Any changes in such laws and regulations could materially and adversely affect our operations or our ability to expand.

 

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State Licensure and Approval

Most states, including Florida, require licensure and regulatory approval prior to the marketing of insurance products. Typically, licensure review is comprehensive and includes a review of a company’s business plan, solvency, reinsurance, rates, and forms, the character of its officers and directors and other of its financial and non-financial aspects. The regulatory authorities may not allow entry into a new market by not granting a license. In addition, regulatory authorities may preclude or delay our entry into markets by disapproving or withholding approval of our product filings.

Statutory Reporting and Examination

All insurance companies must file quarterly and annual statements with certain regulatory agencies and are subject to regular and special examinations by those agencies. The National Association of Insurance Commissioners mandates that all insurance companies be examined once every five years. However, the FLOIR has the authority to conduct an examination of HCPCI whenever it is deemed appropriate. HCPCI’s latest FLOIR financial examination related to the year ended December 31, 2010.

Liability for Losses and Loss Adjustment Expenses

Our liability for losses and loss adjustment expenses represents our estimate of the total cost of (i) claims that have been incurred, but not yet paid (case reserves), (ii) claims that have been incurred but not yet reported (“IBNR”), and (iii) loss adjustment expenses (“LAE”) which are intended to cover the ultimate cost of settling claims, including investigation and defense of lawsuits resulting from such claims. We base our estimates on various assumptions and actuarial data we believe to be reasonable under the circumstances. The process of estimating the liability is inherently subjective and is influenced by many variables such as past loss experience, current claim trends and the prevailing social, economic and legal environments.

Significant time can elapse between the occurrence of an insured loss, the reporting of the loss to us and our payment of that loss. Our liability for losses and LAE, which we believe represents the best estimate at a given point in time based on facts, circumstances and historical trends then known, may necessarily be adjusted to reflect additional facts that become available during the loss settlement period.

For a discussion and summary of the activity in the liability for losses and LAE for the years ended December 31, 2014, 2013 and 2012, see Note 11 — “Losses and Loss Adjustment Expenses” to our consolidated financial statements under Item 8 of this Annual Report on Form 10-K.

 

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Loss Development

Our liability for losses and LAE represent estimated costs ultimately required to settle all claims for a given period. The following table illustrates development of the estimated liability for losses and LAE for the years 2007 (inception) through 2014 (amounts in thousands):

Schedule of Loss Development

 

     Years Ended December 31,  
     2007      2008      2009      2010     2011     2012      2013     2014  

Original liability for losses and LAE1

   $ 1,688       $ 14,763       $ 19,178       $ 22,146      $ 27,424      $ 41,168       $ 43,686      $ 48,908   

Re-estimated losses and LAE2 as of:

                    

1 year later

     1,412         10,879         18,399         26,776        27,309        38,712         47,344     

2 years later

     1,236         10,991         19,866         26,003        28,536        40,015        

3 years later

     1,268         11,661         19,361         27,226        28,499          

4 years later

     1,327         11,528         19,617         26,544            

5 years later

     1,330         11,424         18,969               

6 years later

     1,330         11,361                  

7 years later

     1,330                     

Cumulative redundancy (deficiency)3

     358         3,402         209         (4,398     (1,075     1,153         (3,658  

Cumulative amount of liability paid as of:

                    

1 year later

     760         7,725         10,481         16,833        15,652        22,365         26,595     

2 years later

     1,108         9,229         15,336         20,708        21,707        31,824        

3 years later

     1,108         10,339         17,065         23,732        25,350          

4 years later

     1,327         10,947         17,992         25,063            

5 years later

     1,330         11,121         18,375               

6 years later

     1,330         11,167                  

7 years later

     1,330                     

Gross premiums earned

   $ 9,546       $ 61,925       $ 110,011       $ 119,757      $ 143,606      $ 233,607       $ 337,113      $ 365,488   

 

1 Represents management’s original estimated liability for (i) unpaid claims, (ii) IBNR, and (iii) loss adjustment expenses.
2 Represents the re-estimated liabilities in later years for unpaid claims, IBNR and loss adjustment expenses for each of the respective years.
3 Represents the difference between the latest re-estimate and the original estimate. A redundancy indicates the original estimate is higher than the current estimate whereas a deficiency indicates the original estimate is lower than the current estimate.

 

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For the years ended December 31, 2014, 2013 and 2012, revenues from property and casualty insurance operations represented 96.1%, 95.0% and 93.0%, respectively, of total revenues of all operating segments. As a result, our property and casualty insurance operations are our only reportable operating segment.

Reinsurance

We have a Bermuda domiciled wholly owned reinsurance subsidiary, Claddaugh Casualty Insurance Company Ltd., which participates in HCPCI’s reinsurance program and uses cash as collateral for its loss exposure.

Other Operations

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 India and in Tampa, Florida, are focused on developing cloud-based, innovative products or services that can be marketed to the public in addition to providing affiliates with back-office technology support services that can facilitate and improve ongoing operations. Some of the technologies originally developed in-house for our own insurance operations have been launched for use by third parties. These products include the following.

ExzeoTM

Exzeo is a cloud application available at Exzeo.com that provides automation and intelligence across multiple business processes. The product offers a highly customizable environment for businesses to integrate existing applications and develop new ones to address their unique business needs.

PropletTM

We introduced to a selected group of independent insurance agents our new web-based tool called Proplet. Agents can search a property’s insurance-related information such as wind mitigation reports, inspection reports, claims activity reports or flood zone areas by name, address or by dropping a pin on a specific location on a map interface. In addition, agents can get an instant insurance quote from HCPCI through the use of Proplet. We plan to improve this technology continually as part of our commitment to exceptional service to policyholders and agents.

 

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Atlas Viewer

Atlas Viewer is our new interactive cloud-based data mapping and visualization platform. Atlas Viewer allows users to upload, view and securely share data feeds on a customized map. Atlas Viewer, an industry agnostic data visualization product, allows users to combine data from multiple sources and leverage location coordinates to make more informed business decisions. Atlas Viewer is offered as a subscription-based service.

Real Estate

Our real estate operations consist of several properties we own including our headquarters building in Tampa, Florida and a secondary insurance operations site in Ocala, Florida. In addition, the Ocala location serves as our alternative site in the event we experience any significant disruption at our headquarters building. We also own investment real estate in Treasure Island, Florida and Tierra Verde, Florida with a combined 20 acres of waterfront property.

With the exception of the Ocala location, we lease office or retail space at each location to non-affiliates on various terms. In addition, we own and operate one full-service restaurant and two marinas that we acquired in connection with our purchase of the waterfront properties. The combined marina facilities offer to the general public: a) one dry-stack boat storage facility with capacity for 305 boats; b) 64 wet slips; c) two fuel facilities; and d) open areas for parking and storage. Dry-stack boat storage space is generally rented on a monthly or annual basis while the wet slips are rented on a daily or monthly basis.

In June 2014, we entered into an Acquisition, Development and Construction loan arrangement (“ADC Arrangement”) under which it agreed to provide financing for up to a maximum of $9.8 million for the acquisition, development and construction of a retail shopping center and appurtenant facilities. Greenleaf Capital has an option to purchase the property when the construction project is completed contingent upon tenant rental commitments for at least 90% of rentable space being secured by the developer. We believe this opportunity will enable us to grow our real estate portfolio and diversify our future sources of income. See Note 4 — “Investments” under ADC Arrangement to our consolidated financial statements under Item 8 of this Annual Report on Form 10-K for additional information.

In September 2014, we entered into a joint venture agreement with FMKT Sponsor, LLC. The joint venture plans to acquire land and construct a retail shopping center for lease or for sale in Melbourne, Florida. See Investment in Joint Venture under Note 4 — “Investments” to our consolidated financial statements under Item 8 of this Annual Report on Form 10-K for additional information.

 

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Financial Highlights

The following table summarizes our financial performance during the years ended December 31, 2014, 2013 and 2012:

 

(Amounts in millions except per share amounts)                     
     2014      2013      2012  

For the year ended December 31:

        

Net premium earned

   $ 252.1       $ 234.2       $ 157.7   

Total revenue

   $ 266.1       $ 241.1       $ 163.1   

Losses and loss adjustment expenses

   $ 79.5       $ 65.1       $ 66.3   

Income before income taxes

   $ 101.0       $ 106.5       $ 49.6   

Net income

   $ 62.7       $ 65.6       $ 30.2   

Income available to common stockholders

   $ 62.7       $ 65.5       $ 29.8   

Earnings per share of common stock:

        

Basic

   $ 5.90       $ 5.82       $ 3.45   

Diluted

   $ 5.36       $ 5.63       $ 3.02   

Dividends per common share

   $ 1.10       $ 0.95       $ 0.88   

Net cash provided by operating activities

   $ 88.7       $ 55.5       $ 106.3   

Cash dividends paid on common stock

   $ 11.7       $ 10.8       $ 8.1   

At December 31:

        

Total investments

   $ 168.8       $ 146.0       $ 60.9   

Cash and cash equivalents

   $ 314.7       $ 293.4       $ 230.2   

Total assets

   $ 602.2       $ 526.0       $ 338.3   

Total stockholders’ equity

   $ 182.6       $ 160.5       $ 121.3   

Common shares outstanding (in millions)

     10.2         10.9         10.9   

Environmental Matters

Our subsidiaries that own waterfront property, including marina facilities, are subject to regulation under various federal, state, and local laws concerning the environment, including laws addressing the discharge of pollutants into the air and water and the management and disposal of hazardous substances and wastes and the cleanup of contaminated sites.

Employees

As of February 20, 2015, we employed approximately 200 full-time individuals working primarily from our corporate offices in Florida and approximately 80 employees located in India. In addition, our real estate operations have approximately 70 employees leased through professional employer organizations.

 

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Available Information

We file annual, quarterly, and current reports with the U.S. Securities and Exchange Commission (“SEC”). These filings are accessible free of charge on our website, www.hcigroup.com (click “SEC filings” at the “Investor Information” tab), as soon as reasonably practicable after they have been electronically filed with or furnished to the SEC. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers, which can be accessed via the SEC’s website at www.sec.gov. In addition, these filings are accessible at the SEC’s Public Reference Room, which is located at 100 F Street, NE, Washington, DC 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330.

ITEM 1A – Risk Factors

Our business is subject to a number of risks, including those described below, which could have a material effect on our results of operations, financial condition or liquidity and, additionally, could cause our operating results to vary significantly from period to period.

Although we plan to enter the insurance market in other states, our insurance business is currently in Florida only. Thus, any single catastrophic event or other condition affecting losses in Florida could adversely affect our financial condition and results of operations.

A single catastrophic event, a destructive weather pattern, a general economic trend, regulatory developments or other conditions specifically affecting the state of Florida could have a disproportionately adverse impact on our business, financial condition, and results of operations. While we actively manage our exposure to catastrophic events through our underwriting process and the purchase of reinsurance, the fact that our business is concentrated in the state of Florida subjects it to increased exposure to certain catastrophic events and destructive weather patterns such as hurricanes, tropical storms, and tornados. Changes in the prevailing regulatory, legal, economic, political, demographic and competitive environment, and other conditions in the state of Florida could also make it less attractive for us to do business in Florida and would have a more pronounced effect on our business than it would on other insurance companies that are geographically diversified. Since our business is concentrated in this manner, the occurrence of one or more catastrophic events or other conditions affecting losses in the state of Florida could have an adverse effect on our business, financial condition, and results of operations.

Our results may fluctuate based on many factors including cyclical changes in the insurance industry.

The insurance business historically has been a cyclical industry characterized by periods of intense price competition due to excessive underwriting capacity, as well as periods when shortages of capacity permitted an increase in pricing and, thus, more favorable underwriting profits. As premium levels increase, there may be new entrants to the market, which could then lead to a decrease in premium levels. Any of these factors could lead to a significant reduction in premium rates, less favorable policy terms and fewer opportunities to underwrite insurance risks, which could

 

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have a material, adverse effect on our results of operations and cash flows. In addition to these considerations, changes in the frequency and severity of losses suffered by insureds and insurers may affect the cycles of the insurance business significantly.

We cannot predict whether market conditions will improve, remain constant or deteriorate. Negative market conditions may impair our ability to write insurance at rates that we consider appropriate relative to the risk assumed. If we cannot write insurance at appropriate rates, our business would be materially and adversely affected.

Our business could be harmed if we lose the services of our key personnel.

Our operations are highly dependent on the efforts of our senior executive officers, particularly our chief executive officer, Paresh Patel, as well as our chief financial officer, Richard Allen, and HCPCI’s president, Scott Wallace. The loss of their leadership, industry knowledge and experience could negatively impact our operations. However, we have management succession plans to lessen any such negative impact. With the exception of Mr. Patel, Mr. Allen and Mr. Wallace, we have no employment agreements with any of our personnel nor do we offer any guarantee of any employee’s ongoing service. We maintain key-man life insurance on Mr. Patel although such policy may be insufficient to cover us for the damage resulting to our company from the loss of Mr. Patel’s services.

Our information technology systems may fail or suffer a loss of security, which could adversely affect our business.

Our insurance business is highly dependent upon the successful and uninterrupted functioning of our computer and data processing systems. We rely on these systems to perform actuarial and other modeling functions necessary for writing business, as well as to handle our policy administration process (i.e., the printing and mailing of our policies, endorsements, renewal notices, etc.). The successful operation of our systems depends on a continuous supply of electricity. The failure of these systems or disruption in the supply of electricity could interrupt our operations and result in a material, adverse effect on our business.

The development and expansion of our insurance business is dependent upon the successful development and implementation of advanced computer and data processing systems. Because HCPCI intends to expand its writing of voluntary policies, we are enhancing our information technology systems to handle and process an increased volume of voluntary policies. The failure of these systems to function as planned could slow our growth and adversely affect our future business volume and results of operations.

In addition, a security breach of our computer systems could damage our reputation or result in liability. We retain confidential business and policyholder information in our computer systems. We may be required to spend significant capital and other resources to protect against security breaches or to alleviate problems caused by such breaches. It is critical that these facilities and infrastructure remain secure. Despite the implementation of security measures, this infrastructure may be vulnerable to physical break-ins, computer viruses, programming errors, attacks by third parties or similar disruptive problems. In addition, we could be subject to liability if hackers were able to penetrate our network security or otherwise misappropriate confidential information.

 

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We conduct our business primarily from offices located in Tampa, Florida where tropical storms could damage our facilities or interrupt our power supply. The loss or significant impairment of functionality in these facilities for any reason could have a material, adverse effect on our business although we believe we have sufficient redundancies to replace our facilities if functionality is impaired. We contract with a third party vendor to maintain complete daily backups of our systems, which are stored at the vendor’s facility in Atlanta, Georgia. Access to these databases is strictly controlled and limited to authorized personnel. In the event of a disaster causing a complete loss of functionality at our Tampa location, we plan to use temporarily the secondary office in Ocala, Florida to continue our operations.

Increased competition, competitive pressures, industry developments, and market conditions could affect the growth of our business and adversely impact our financial results.

The property and casualty insurance industry in Florida is cyclical and highly competitive. We compete not only with other stock companies but also with mutual companies, other underwriting organizations and alternative risk sharing mechanisms. Our principal lines of business are written by numerous other insurance companies. Competition for any one account may come from very large, well-established national companies, smaller regional companies, other specialty insurers in our field, and new entrants to the Florida market. Many of these competitors have greater financial resources, larger agency networks and greater name recognition than our company. We compete for business not only on the basis of price, but also on the basis of financial strength, types of coverage offered, availability of coverage desired by customers, commission structure, and quality of service. We may have difficulty continuing to compete successfully on any of these bases in the future. Competitive pressures coupled with market conditions may affect our rate of premium growth and financial results.

Our ability to compete in the property and casualty insurance industry and our ability to expand our business may be negatively affected by the fact that we are not a long-established company. HCPCI has obtained a Demotech rating of “A Exceptional,” which is accepted by major mortgage companies operating in the state of Florida and many other states. Mortgage companies may require homeowners to obtain property insurance from an insurance company with an acceptable A.M. Best rating. Such a requirement could prevent us from expanding our business, which may in turn limit our ability to compete with large, national insurance companies and certain regional insurance companies. We currently do not have an A.M. Best rating but may seek to obtain such a rating. A downgrade or loss of our Demotech rating could result in a substantial loss of business in the event insureds move their business to insurers with a sufficient financial strength rating.

 

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There are inherent limitations and risks related to our projections and our estimates of claims and loss reserves. If our actual losses exceed our loss reserves, our financial results, our ability to expand our business, and our ability to compete in the property and casualty insurance industry may be negatively affected. In addition, industry developments could further increase competition in our industry. These developments could include —

 

    an influx of new capital in the marketplace as existing companies attempt to expand their businesses and new companies attempt to enter the insurance business as a result of better pricing and/or terms;

 

    new programs or changes to existing programs in which federally or state-sponsored entities provide property insurance in catastrophe-prone areas or other alternative markets;

 

    changes in Florida or any other states’ regulatory climate; and

 

    the enactment of federal proposals for an optional federal charter that would allow some competing insurers to operate under regulations different or less stringent than those applicable to our insurance subsidiaries.

These developments and others could make the property and casualty insurance marketplace more competitive by increasing the supply of insurance available.

If competition limits our ability to write new business at adequate rates, our future results of operations would be adversely affected.

If our actual losses from claims exceed our loss reserves, our financial results would be adversely affected.

Our objective is to establish loss reserves that are adequate and represent management’s best estimate; that is, the amounts initially recorded as reserves should approximate the ultimate cost to investigate and settle a specific claim. However, the process of establishing adequate reserves is complex and inherently uncertain, and the ultimate cost of a claim may vary materially from the amounts reserved. We regularly monitor and evaluate loss and loss adjustment expense reserve development to determine reserve adequacy.

Due to these uncertainties, the ultimate losses may vary materially from current loss reserves which could have a material, adverse effect on our future financial condition, results of operations and cash flows.

Our failure to pay claims accurately could adversely affect our insurance business, financial results and capital requirements.

We rely on our claims personnel to accurately evaluate and pay the claims made under our policies. Many factors could affect our ability to accurately evaluate and pay claims, including the accuracy of our external independent adjusters as they make their assessments and submit their estimates of damages; the training, background, and experience of our claims representatives; the ability of our claims personnel to ensure consistent claims handling given the input by our external

 

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independent adjusters; the ability of our claims department to translate the information provided by our external independent adjusters into acceptable claims settlements; and the ability of our claims personnel to maintain and update our claims handling procedures and systems as they evolve over time based on claims and geographical trends in claims reporting. Any failure to pay claims accurately could lead to material litigation, undermine our reputation in the marketplace, impair our corporate image and negatively affect our financial results.

The effects of emerging claim and coverage issues on our business are uncertain.

As industry practices and legal, judicial, social and other environmental conditions change, unexpected and unintended issues related to claims and coverage may emerge. These issues may adversely affect our business by either extending coverage beyond our underwriting intent or by increasing the number or size of claims. In some instances, these changes may not become apparent until sometime after we have issued insurance contracts that are affected by the changes. As a result, the full extent of liability under our insurance contracts may not be known for many years after a contract is issued and renewed, and our financial position and results of operations may be adversely affected.

If we are unable to expand our business because our capital must be used to pay greater than anticipated claims, our financial results may suffer.

Our future growth will depend on our ability to expand the number of insurance policies we write, to expand the kinds of insurance products we offer, and to expand the geographic markets in which we do business, all balanced by the insurance risks we choose to assume and cede. Our existing sources of funds include possible sales of our securities and our income from operations and investments. Unexpected catastrophic events in our market areas, such as hurricanes, may result in greater claims losses than anticipated, which could require us to limit or halt our growth while we redeploy our capital to pay these unanticipated claims unless we are able to raise additional capital.

HCI Group, Inc. depends on the ability of its subsidiaries to generate and transfer funds to meet its debt obligations.

HCI Group, Inc. does not have significant revenue generating operations of its own. Our ability to make scheduled payments on our debt obligations depends on the financial condition and operating performance of our subsidiaries. If the funds we receive from our subsidiaries are insufficient to meet our debt obligations, we may be required to raise funds through the issuance of additional debt or equity securities, reduce or suspend dividend payments, or sell assets.

 

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We may require additional capital in the future which may not be available or may only be available on unfavorable terms.

Our future capital requirements depend on many factors, including our ability to write new business successfully and to establish premium rates and reserves at levels sufficient to cover losses. To the extent that our present capital is insufficient to meet future operating requirements or to cover losses, we may need to raise additional funds through financings or curtail our growth. Based on our current operating plan, we believe current capital together with our anticipated retained income will support our operations. However, we cannot provide any assurance in that regard, since many factors will affect our capital needs and their amount and timing, including our growth and profitability, and the availability of reinsurance, as well as possible acquisition opportunities, market disruptions and other unforeseeable developments. If we require additional capital, it is possible that equity or debt financing may not be available at all or may be available only on terms unfavorable to us. Equity financings could result in dilution to our shareholders, and in any case such securities may have rights, preferences and privileges that are senior to those of existing shareholders. If we cannot obtain adequate capital on favorable terms or at all, our business, financial condition or results of operations could be materially affected.

Limited markets for and restrictions on certain holdings in our investment portfolio.

Certain holdings in our investment portfolio include limited partnership interests, a construction loan (which is referred to herein as the ADC Arrangement) and one real estate joint venture. We also plan to increase our holdings in these types of investments in the near future. These investments may be illiquid in the near term as they are privately placed and are subject to certain restrictions or conditions that may limit our ability to immediately dispose of the investment. If it becomes necessary to sell any of these investments at a time when the fair market value is below our carrying value, we may incur significant losses which could have a material adverse effect on our net income and financial position.

Our financial results may be negatively affected by the fact that a portion of our income is generated by the investment of our available cash.

A portion of our income is, and likely will continue to be, generated by the investment of our available cash. The amount of income so generated is a function of our investment policy, available investment opportunities, and the amount of available cash invested. We may alter our investment policy to accept higher levels of risk with the expectation of higher returns. Fluctuating interest rates and other economic factors make it impossible to estimate accurately the amount of investment income that will be realized. In fact, we may realize losses on our investments.

 

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Reinsurance coverage may not be available to us in the future at commercially reasonable rates or at all and we risk non-collectability of reinsurance amounts due us from reinsurers with which we have contracted.

Reinsurance is a method of transferring part of an insurance company’s liability and premium under an insurance policy to another insurance company, or reinsurer. We use reinsurance arrangements to limit and manage the amount of risk we retain, to stabilize our underwriting results and to increase our underwriting capacity. The cost of such reinsurance is subject to prevailing market conditions beyond our control, such as the amount of capital in the reinsurance market and natural and man-made catastrophes. We cannot be assured that reinsurance will remain continuously available to us in the amounts we consider sufficient and at prices acceptable to us. As a result, we may determine to increase the amount of risk we retain or look for other alternatives to reinsurance, which could in turn have a material, adverse effect on our financial position, results of operations and cash flows.

With respect to the reinsurance treaties we currently have in effect, our ability to recover amounts due from reinsurers is subject to the reinsurance company’s ability and willingness to pay and to meet their obligations to us. We attempt to select financially strong reinsurers with an A.M. Best rating of “A-” or better or we require the reinsurer to fully collateralize its exposure. While we monitor from time to time their financial condition, we rely principally on A.M. Best, our reinsurance broker, and other rating agencies in determining their ability to meet their obligations to us. Any failure on the part of any one reinsurance company to meet its obligations to us could have a material, adverse effect on our financial condition or results of operations.

We have exposure to unpredictable catastrophes, which can materially and adversely affect our financial results.

We write insurance policies that cover homeowners, condominium owners, and tenants for losses that result from, among other things, catastrophes. We are therefore subject to losses, including claims under policies we have written, arising out of catastrophes that may have a significant effect on our business, results of operations, and financial condition. A significant catastrophe could also have an adverse effect on our reinsurers. Catastrophes can be caused by various events, including hurricanes, tropical storms, tornadoes, windstorms, earthquakes, hailstorms, explosions, power outages, fires and man-made events. The incidence and severity of catastrophes are inherently unpredictable. The extent of losses from a catastrophe is a function of both the total amount of insured exposure in the area affected by the event and the severity of the event. Our policyholders are currently concentrated in Florida, which is especially subject to adverse weather conditions such as hurricanes and tropical storms. Therefore, although we attempt to manage our exposure to catastrophes through our underwriting process and the purchase of reinsurance protection, an especially severe catastrophe or series of catastrophes could exceed our reinsurance protection and may have a material, adverse impact on our results of operations and financial condition.

 

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Industry trends, such as increased litigation against the insurance industry and individual insurers, the willingness of courts to expand covered causes of loss, rising jury awards, and the escalation of loss severity may contribute to increased costs and to the deterioration of the reserves of our insurance subsidiary.

Loss severity in the property and casualty insurance industry may increase and may be driven by larger court judgments. In the event legal actions and proceedings are brought on behalf of classes of complainants, this may increase the size of judgments. The propensity of policyholders and third party claimants to litigate and the willingness of courts to expand causes of loss and the size of awards may render our loss reserves inadequate for current and future losses.

The failure of the risk mitigation strategies we utilize could have a material, adverse effect on our financial condition or results of operations.

We utilize a number of strategies to mitigate risk exposure within our insurance business, which include:

 

    engaging in vigorous underwriting;

 

    carefully evaluating terms and conditions of our policies;

 

    focusing on our risk aggregations by geographic zones and other bases; and

 

    ceding insurance risk to reinsurance companies.

However, there are inherent limitations in all of these tactics. We cannot provide assurance that an event or series of unanticipated events will not result in loss levels which could have a material, adverse effect on our financial condition or results of operations.

The failure of any of the loss limitation methods we employ could have a material, adverse effect on our financial condition or our results of operations.

Our insurance underwriting process is generally designed to limit our exposure to known and manageable risks. Various provisions of our policies, such as limitations or exclusions from coverage, which have been negotiated to limit our risks, may not be enforceable in the manner we intend.

In addition, the policies we issue contain conditions requiring the prompt reporting of claims to us and our right to decline coverage in the event of a violation of that condition. While our insurance product exclusions and limitations reduce the loss exposure to us and help eliminate known exposures to certain risks, it is possible that a court or regulatory authority could nullify or void an exclusion or legislation could be enacted modifying or barring the use of such endorsements and limitations in a way that would adversely affect our loss experience, which could have a material, adverse effect on our financial condition or results of operations.

 

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In the future, we may rely on independent agents to write our insurance policies, and if we are not able to contract with and retain independent agents, our revenues would be negatively affected.

Although voluntary policies comprise a small percentage of our business, we expect to increase the number of voluntary policies we write as our business expands. An inability to sell our products through independent agents would negatively affect our revenues.

We must compete with other insurers for independent agents’ business. Our competitors may offer a greater variety of insurance products, lower premiums for insurance coverage, or higher commissions to their agents. If our products, pricing and commissions do not remain competitive, we may find it more difficult to attract business from independent agents to sell our products. A material reduction in the amount of our products that independent agents sell could negatively affect our revenues.

Our success depends on our ability to accurately price the risks we underwrite.

The results of our operations and our financial condition depend on our ability to underwrite and set premium rates accurately for a wide variety of risks, including risks associated with new product offerings. Rate adequacy is necessary to generate sufficient premiums to pay losses, loss adjustment expenses, and underwriting expenses and to earn a profit. In order to price our products accurately, we must collect and properly analyze a substantial amount of data; develop, test and apply appropriate rating formulas; closely monitor and timely recognize changes in trends; and project both severity and frequency of losses with reasonable accuracy. Our ability to undertake these efforts successfully, and as a result price our products accurately, is subject to a number of risks and uncertainties, some of which are outside our control, including —

 

    the availability of sufficient reliable data;

 

    the uncertainties that inherently characterize estimates and assumptions;

 

    our selection and application of appropriate rating and pricing techniques;

 

    changes in legal standards, claim settlement practices, and restoration costs; and

 

    legislatively imposed consumer initiatives.

In addition, we could underprice risks, which would negatively affect our profit margins. We could also overprice risks, which could reduce our retention, sales volume and competitiveness. In any event, our profitability could be materially and adversely affected.

Use of current operating resources may be necessary to develop future new insurance products.

We may expand our product offerings by underwriting additional insurance products and programs. Claddaugh may offer reinsurance products to unaffiliated insurance companies. Expansion of our product offerings will result in increases in expenses due to additional costs incurred in actuarial rate justifications, software and personnel. Offering additional insurance products will also require regulatory approval, further increasing our costs and potentially affecting the speed with which we will be able to pursue new market opportunities. We cannot assure you that we will be successful bringing new insurance products to markets.

 

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Use of current operating resources may be necessary to expand our insurance business geographically.

Although we currently conduct our homeowners’ insurance business in Florida, we plan to enter the homeowners’ insurance markets in other states. Geographic expansion of our insurance business will result in increases in expenses due to additional costs incurred in actuarial rate justifications, software, personnel and regulatory compliance. Although we plan to enter other states judiciously with attention to profitability, we cannot assure you that our entry into other states will be successful.

As an insurance holding company, we are currently subject to state regulation and in the future may become subject to federal regulation.

All states regulate insurance holding company systems. State statutes and administrative rules generally require each insurance company in the holding company group to register with the department of insurance in its state of domicile and to furnish information concerning the operations of the companies within the holding company system that may materially affect the operations, management or financial condition of the insurers within the group. As part of its registration, each insurance company must identify material agreements, relationships and transactions with affiliates, including without limitation, loans, investments, asset transfers, transactions outside of the ordinary course of business, certain management, service, and cost sharing agreements, reinsurance transactions, dividends, and consolidated tax allocation agreements.

Insurance holding company regulations generally provide that transactions between an insurance company and its affiliates must be fair and equitable, allocated between the parties in accordance with customary accounting practices, and fully disclosed in the records of the respective parties. Many types of transactions between an insurance company and its affiliates, such as transfers of assets among such affiliated companies, certain dividend payments from insurance subsidiaries and certain material transactions between companies within the system may be subject to prior approval by, or prior notice to, state regulatory authorities. If we are unable to obtain the requisite prior approval for a specific transaction, we would be precluded from taking the action, which could adversely affect our operations. In addition, state insurance regulations also frequently impose notice or approval requirements for the acquisition of specified levels of ownership in the insurance company or insurance holding company.

HCPCI is approved as an admitted carrier in Florida and as a non-admitted carrier in Maryland, New Jersey, South Carolina and Virginia. In addition, our Alabama subsidiary is approved as an admitted carrier to write insurance products in Alabama. We may in the future seek authorization to transact business in other states as well. We will therefore become subject to the laws and regulatory requirements of those states. These regulations may vary from state to state, and states occasionally may have conflicting regulations. Currently, the federal government’s role in regulating or dictating the policies of insurance companies is limited. However, Congress, from time to time, considers proposals that would increase the role of the federal government in insurance regulation, either in addition to or in lieu of state regulation. The impact of any future federal insurance regulation on our insurance operations is unclear and may adversely impact our business or competitive position.

 

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Our insurance subsidiaries are subject to extensive regulation, which may reduce our profitability or limit our growth. Moreover, if we fail to comply with these regulations, we may be subject to penalties, including fines and suspensions, which may adversely affect our financial condition and results of operations.

The insurance industry is highly regulated and supervised. Our insurance subsidiaries are subject to the supervision and regulation of the states in which they are domiciled and the states in which they transact insurance business. Such supervision and regulation is primarily designed to protect our policyholders rather than our shareholders. These regulations are generally administered by a department of insurance in each state and relate to, among other things —

 

    the content and timing of required notices and other policyholder information;

 

    the amount of premiums the insurer may write in relation to its surplus;

 

    the amount and nature of reinsurance a company is required to purchase;

 

    participation in guaranty funds and other statutorily created markets or organizations;

 

    business operations and claims practices;

 

    approval of policy forms and premium rates;

 

    standards of solvency, including risk-based capital measurements;

 

    licensing of insurers and their products;

 

    restrictions on the nature, quality and concentration of investments;

 

    restrictions on the ability of insurance company subsidiaries to pay dividends to insurance holding companies;

 

    restrictions on transactions between insurance companies and their affiliates;

 

    restrictions on the size of risks insurable under a single policy;

 

    requiring deposits for the benefit of policyholders;

 

    requiring certain methods of accounting;

 

    periodic examinations of our operations and finances;

 

    the form and content of records of financial condition required to be filed; and

 

    the level of reserves.

The FLOIR and regulators in other jurisdictions where we may become licensed and offer insurance products conduct periodic examinations of the affairs of insurance companies and require the filing of annual and other reports relating to financial condition, holding company issues and other matters. These regulatory requirements may adversely affect or inhibit our ability to achieve some or all of our business objectives. These regulatory authorities also conduct periodic examinations into insurers’ business practices. These reviews may reveal deficiencies in our insurance operations or non-compliance with regulatory requirements.

HCPCI is subject to assessments levied by the Florida Insurance Guaranty Association, Inc. While we can recover these assessments from policyholders through policy surcharges, our payment of the assessments and our recoveries may not offset each other in the same reporting period in our financial statements and may cause a material, adverse effect on our results of operations in a particular reporting period.

 

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In addition, regulatory authorities have relatively broad discretion to deny or revoke licenses for various reasons, including the violation of regulations. In some instances, we follow practices based on our interpretations of regulations or practices that we believe may be generally followed by the industry. These practices may turn out to be different from the interpretations of regulatory authorities. If we do not have the requisite licenses and approvals or do not comply with applicable regulatory requirements, insurance regulatory authorities could preclude or temporarily suspend us from carrying on some or all of our activities or otherwise penalize us. This could adversely affect our ability to operate our business.

Finally, changes in the level of regulation of the insurance industry or changes in laws or regulations themselves or interpretations by regulatory authorities could adversely affect our ability to operate our business, reduce our profitability and limit our growth.

Our real estate operations include owning marina operations, which are subject to regulation under various federal, state, and local laws concerning the environment.

Our marina operations are subject to regulation under various federal, state, and local laws concerning the environment, including laws addressing the discharge of pollutants into the air and water and the management and disposal of hazardous substances and wastes and the cleanup of contaminated sites. We could incur substantial costs, including remediation costs, fines and civil or criminal sanctions and third-party damage or personal injury claims, if in the future we were to violate or become liable under environmental laws relating to our marina operations.

Our real estate operations include owning restaurant operations, which expose us to additional risks, which could negatively impact our operating results and financial condition.

Our restaurant operations expose us to unique business risks. For example, restaurant operations are dependent in large part on food, beverage, and supply costs that are not within our control. Also, the restaurant industry is affected by changes in consumer preferences and discretionary spending patterns that could adversely affect revenues from restaurant operations. Moreover, the restaurant industry is affected by litigation and publicity concerning food quality, health, and other issues which can cause guests to avoid restaurants and that can result in liabilities. Any one of these risks, among others, could negatively impact our operating results and financial condition.

Our operations in India expose us to additional risks, which could negatively impact our business, operating results, and financial condition.

Our India operations expose us to additional risks including currency exchange rate fluctuations and risks related to other challenges caused by distance, language, and compliance with Indian labor laws and other complex foreign and U.S. laws and regulations that apply to our India operations. These numerous and sometimes conflicting laws and regulations include anti-corruption laws, such as the Foreign Corrupt Practices Act, and other local laws prohibiting corrupt payments to governmental officials, among others. Violations of these laws and regulations could result in fines and penalties, or criminal sanctions against us, our officers, or our employees. Although policies and procedures are designed to ensure compliance with these laws and regulations, there can be no assurance that our employees, contractors, or agents will not violate our policies.

 

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Unintended consequences of the anti-takeover provisions of our shareholder rights agreement.

Our shareholder rights agreement is intended to deter coercive or unfair takeover tactics and to protect our shareholders’ interests by encouraging anyone seeking control of our company to negotiate with our board of directors. However, these rights may discourage, delay or prevent a tender offer or takeover attempt, including offers or attempts that could be beneficial to our shareholders. In addition, the rights agreement may deter investors from participating in any future equity offerings we propose.

ITEM 1B – Unresolved Staff Comments

Not applicable.

 

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ITEM 2 – Properties

Real Estate Owned and Used in Operations

Tampa, Florida. The real estate consists of 3.5 acres of land, a building with gross area of 122,000 square feet, and a four-level parking garage. This facility is used by us and our U.S. subsidiaries and serves as our headquarters. In addition, we lease an aggregate of approximately 42,500 square feet to non-affiliates.

Ocala, Florida. The real estate consists of 1.6 acres of land and an office building with gross area of approximately 16,000 square feet. The facility is designated for our insurance operations and will be used as an alternative location in the event a catastrophic event impacts our operations in Tampa, Florida.

Investment Real Estate

Treasure Island, Florida. The real estate consists of approximately 10 acres of waterfront property and land improvements, a restaurant and a marina facility. The marina facility and the restaurant are currently operated by us.

Tierra Verde, Florida. The real estate consists of 7.1 acres of waterfront property, a dry rack storage building with gross area of 57,500 square feet, and three buildings with retail space having an aggregate gross area of 28,893 square feet. This marina facility is operated by us. Approximately 49% of the available retail space is leased to non-affiliates.

Leased Property

Noida, India. We lease 15,000 square feet of office space for our information technology operations. The lease commenced January 15, 2013 and has an initial term of nine years. We are permitted to terminate the lease after the 36-month period following the commencement date by providing 3 months’ written notice to the landlord.

Rental expense under all facility leases was $222,000, $248,000 and $527,000 during the years ended December 31, 2014, 2013 and 2012, respectively. The 2012 expense included $179,000 related to our former corporate headquarters.

 

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ITEM 3 – Legal Proceedings

We are 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 asserted against us, we do not believe that any currently pending legal proceeding to which we are a party will have a material, adverse effect on our consolidated financial position, results of operations or cash flows.

ITEM 4 – Mine Safety Disclosures

Not applicable.

 

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PART II

ITEM 5 – Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Markets for Common Stock

Our common stock is trading on the New York Stock Exchange under the symbol “HCI.” The following table represents the high and low sales prices for our common stock as reported by the New York Stock Exchange for the periods indicated:

 

     Common Stock  
     Price  
     High      Low  

Calendar Quarter - 2014

     

First Quarter

   $ 52.07         35.92   

Second Quarter

   $ 41.41         34.24   

Third Quarter

   $ 43.35         35.99   

Fourth Quarter

   $ 50.84         35.36   

Calendar Quarter - 2013

     

First Quarter

   $ 27.25         20.16   

Second Quarter

   $ 35.21         24.66   

Third Quarter

   $ 41.66         29.99   

Fourth Quarter

   $ 53.50         37.79   

Holders

As of February 27, 2015, the market price for our common stock was $47.32 and there were 21 holders of record of our common stock.

 

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Dividends

The declaration and payment of dividends is at the discretion of our board of directors. Our ability to pay dividends depends on many factors, including the Company’s operating results, financial condition, capital requirements, and legal and regulatory constraints and requirements on the payment of dividends and such other factors as our board of directors deems relevant. The following table represents the frequency and amount of all cash dividends declared on common equity for the two most recent fiscal years:

 

Declaration
Date
    Payment
Date
    Date of
Record
    Per Share
Amount
 
  1/22/2013        3/15/2013        2/15/2013      $ 0.225   
  4/8/2013        6/21/2013        5/17/2013      $ 0.225   
  7/16/2013        9/20/2013        8/16/2013      $ 0.225   
  10/18/2013        12/20/2013        11/15/2013      $ 0.275   
  1/27/2014        3/21/2014        2/21/2014      $ 0.275   
  3/17/2014        6/20/2014        5/16/2014      $ 0.275   
  6/26/2014        9/19/2014        8/15/2014      $ 0.275   
  10/21/2014        12/19/2014        11/21/2014      $ 0.275   

Under Florida law, a domestic insurer such as HCPCI may not pay any dividend or distribute cash or other property to its stockholders unless certain requirements, which are discussed in Note 19 — “Regulatory Requirements and Restrictions” to our consolidated financial statements under Item 8 of this Annual Report on Form 10-K, are met.

In the first quarter of 2015, we increased cash dividends on our common stock from 27.5 cents per share to 30 cents per share, although we are not obligated to do so and may discontinue cash dividends or change the cash-dividend rate on our common stock at any time and for any reason.

Securities Authorized for Issuance Under Equity Compensation Plans

The following table summarizes our equity compensation plans as of December 31, 2014. We currently have no equity compensation plans not approved by our stockholders.

 

     (a)      (b)      (c)  

Plan Category

   Number of Securities
To be Issued Upon
Exercise of
Outstanding Options
     Weighted-Average
Exercise Price of
Outstanding Options
     Number of Securities
Remaining Available
for Future Issuance
under Equity
Compensation Plans

(Excluding Securities
Reflected in Column (a))
 

Equity Compensation Plans Approved by Stockholders

     230,000       $ 3.00         4,246,470   
  

 

 

       

 

 

 

 

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Performance Graph

The following graph compares the 5-year cumulative total dollar return to shareholders on our common stock relative to the cumulative total returns of the Russell 2000 Index and the NASDAQ Insurance Index. An investment of $100 (with reinvestment of all dividends) is assumed to have been made in our common stock and in each index on December 31, 2008 and its relative performance is tracked through December 31, 2014. The returns shown are based on historical results and are not intended to suggest future performance.

 

LOGO

 

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Recent Sales of Unregistered Securities

All information related to sales of unregistered securities had been reported in a current report on Form 8-K.

Issuer Purchases of Equity Securities

The table below summarizes the number of common shares repurchased under a share repurchase plan and also the number of shares of common stock surrendered by employees to satisfy their minimum federal income tax liability associated with the vesting of restricted shares during the three months ended December 31, 2014 (dollar amounts in thousands, except share and per share amounts):

 

For the Month Ended

   Total Number
of Shares

Purchased
     Average
Price Paid
Per Share
     Total Number of
Shares Purchased as
Part of Publicly
Announced Plans
or Programs (a)
     Approximate Dollar
Value of Shares That
May Yet Be
Purchased Under
The Plans
or Programs (b)
 

October 31, 2014

     81,020       $ 39.83         81,020       $ 8,972   

November 30, 2014

     153,949       $ 42.05         153,402       $ 2,526   

December 31, 2014

     21,355       $ 40.31         21,355       $ 1,666   
  

 

 

       

 

 

    
  256,324    $ 41.20      255,777   
  

 

 

       

 

 

    

 

(a) In March 2014, our Board of Directors approved a one-year plan to repurchase up to $40 million of common shares. See Note 14 — “Stockholders’ Equity” to our consolidated financial statements under Item 8 of this Annual Report on Form 10-K.
(b) Represents the balances before commissions and fees at the end of each month.

 

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ITEM 6 – Selected Financial Data

The following selected consolidated financial data should be read in conjunction with Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes appearing in Item 8 “Financial Statements and Supplementary Data” of this Annual Report on Form 10-K. The consolidated statements of income data for the years ended December 31, 2014, 2013, and 2012 and the consolidated balance sheet data at December 31, 2014 and 2013 are derived from our audited consolidated financial statements appearing in Item 8 of this Annual Report on Form 10-K. The consolidated statements of income data for the years ended December 31, 2011 and 2010, and the consolidated balance sheet data at December 31, 2012, 2011, and 2010, are derived from our audited consolidated financial statements that are not included in this Annual Report on Form 10-K. The historical results are not necessarily indicative of the results to be expected in any future period.

 

     As of or for the Years Ended December 31,  
     2014     2013     2012     2011     2010  
     (Dollar amounts in thousands, except per share amounts)  

Operating Revenue

          

Gross premiums earned

   $ 365,488      $ 337,113      $ 233,607      $ 143,606      $ 119,757   

Premiums ceded

     (113,423     (102,865     (75,939     (55,525     (57,322
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net premiums earned

  252,065      234,248      157,668      88,081      62,435   

Net investment income

  4,781      1,469      980      2,061      1,962   

Policy fee income

  2,820      3,098      2,538      1,438      1,464   

Net realized investment gains

  4,735      80      276      290      2,003   

Gain on bargain purchase

  —        —        179      936      —     

Other income

  1,707      2,193      1,424      1,003      751   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating revenue

  266,108      241,088      163,065      93,809      68,615   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating Expenses

Losses and loss adjustment expenses

  79,468      65,123      66,310      48,243      37,667   

Policy acquisition and other underwriting expenses

  37,952      31,619      25,930      18,129      14,878   

Salaries and wages

  16,483      14,714      10,545      4,916      3,066   

Interest expense

  10,453      3,607      —        —        —     

Goodwill impairment loss

  —        —        161      —        —     

Other operating expenses

  20,790      19,572      10,539      6,116      4,418   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

  165,146      134,635      113,485      77,404      60,029   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

  100,962      106,453      49,580      16,405      8,586   

Income tax expense

  38,298      40,891      19,423      6,441      3,164   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

$ 62,664    $ 65,562    $ 30,157    $ 9,964    $ 5,422   

Preferred stock dividends

  4      (104   (322   (815   —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income available to common stockholders

$ 62,668    $ 65,458    $ 29,835    $ 9,149    $ 5,422   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Per Share Data:

Basic earnings per common share

$ 5.90    $ 5.82    $ 3.45    $ 1.49    $ 0.88   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Diluted earnings per common share

$ 5.36    $ 5.63    $ 3.02    $ 1.34    $ 0.81   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Dividends per common share

$ 1.10    $ 0.95    $ 0.88    $ 0.53    $ 0.30   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ratios to Net Premium Earned:

Loss Ratio

  31.53   27.80   42.06   54.77   60.33

Expense Ratio

  33.99   29.67   29.92   33.11   35.82
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Combined Ratio

  65.52   57.47   71.98   87.88   96.15
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ratios to Gross Premiums Earned:

Loss Ratio

  21.74   19.32   28.39   33.59   31.45

Expense Ratio

  23.45   20.62   20.19   20.31   18.67
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Combined Ratio

  45.19   39.94   48.58   53.90   50.12
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Consolidated Balance Sheet Data:

Total investments

$ 168,799    $ 146,028    $ 60,916    $ 58,759    $ 43,481   

Total cash and cash equivalents

$ 314,716    $ 293,398    $ 230,214    $ 100,355    $ 54,849   

Total assets

$ 602,210    $ 526,316    $ 338,288    $ 214,818    $ 140,948   

Total stockholders’ equity

$ 182,585    $ 160,521    $ 121,253    $ 63,830    $ 46,629   

 

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ITEM 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this annual report on Form 10-K. All dollar amounts, except per share amounts, stated in this Management’s Discussion and Analysis of Financial Condition and Results of Operations are in thousands unless specified otherwise.

Forward-Looking Statements

In addition to historical information, this annual report on Form 10-K 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. 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 effect of governmental regulation; changes in insurance regulations; the frequency and extent of claims; uncertainties inherent in reserve estimates; catastrophic events; a change 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; and other risks and uncertainties and other factors listed under Item 1A - “Risk Factors” and elsewhere in this annual report on Form 10-K and in our other Securities and Exchange Commission filings.

OVERVIEW

General

HCI Group, Inc. is a Florida-based holding company primarily providing property and casualty insurance to homeowners, condominium owners, and tenants in the state of Florida through its subsidiaries. We offer insurance products at competitive rates, while pursuing profitability using selective underwriting criteria.

We began operations in 2007 by participating in a “take-out program” which is a legislatively mandated program designed to encourage private companies to assume policies from Citizens, a Florida state sponsored insurance carrier. Our growth since inception has resulted primarily from a series of policy assumptions from Citizens and one assumption transaction with HomeWise Insurance Company. This growth track has been beneficial to us in terms of reduced policy acquisition costs and, depending on the timing of the transaction, temporarily lower reinsurance costs. Even though expanding our policyholder base through opportunistic assumptions may continue to be a part of our growth plan, we will also seek opportunities to expand and to provide new product offerings such as our flood product, which we began offering as an endorsement in January 2014, and our wind-only policies, which we assumed from Citizens in December 2014.

 

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Recent Developments

On January 19, 2015, our Board of Directors declared a quarterly dividend of $0.30 per common share. The dividends will be paid March 20, 2015 to stockholders of record on February 20, 2015.

RESULTS OF OPERATIONS

Comparison of the Year Ended December 31, 2014 to the Year Ended December 31, 2013

Our results of operations for the year ended December 31, 2014 reflect income available to common stockholders of $62,668, or $5.36 earnings per diluted common share, compared with income available to common stockholders of $65,458, or $5.63 earnings per diluted common share, for the year ended December 31, 2013.

Revenue

Gross Premiums Earned for the years ended December 31, 2014 and 2013 were $365,488 and $337,113, respectively. The increase in 2014 was primarily attributable to revenue from the Citizens assumptions completed in November 2013 and December 2014.

Premiums Ceded for the years ended December 31, 2014 and 2013 were $113,423 and $102,865, respectively. Our premiums ceded represent amounts paid to reinsurers to cover losses from catastrophes that exceed the retention levels defined by our catastrophe excess of loss reinsurance treaties. During the years ended December 31, 2014 and 2013, premiums ceded reflect net reductions of $23,543 and $12,521, respectively, that relate to certain provisions under certain reinsurance contracts. See “Economic Impact of Reinsurance Contracts with Retrospective Provisions” under “Critical Accounting Policies and Estimates.” Our reinsurance rates are based primarily on policy exposures reflected in gross premiums earned. Premiums ceded were 31.0% and 30.5% of gross premiums earned during the years ended December 31, 2014 and 2013, respectively.

Net Premiums Written during the years ended December 31, 2014 and 2013 totaled $294,230 and $251,906, respectively. Net premiums written represent the premiums charged on policies issued during a fiscal period less any applicable reinsurance costs.

Net Premiums Earned for the years ended December 31, 2014 and 2013 were $252,065 and $234,248, respectively, and reflect the gross premiums earned less reinsurance costs as described above.

 

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The following is a reconciliation of our total Net Premiums Written to Net Premiums Earned for the years ended December 31, 2014 and 2013:

 

     Years Ended
December 31,
 
     2014      2013  

Net Premiums Written

   $ 294,230       $ 251,906   

Increase in Unearned Premiums

     (42,165      (17,658
  

 

 

    

 

 

 

Net Premiums Earned

$ 252,065    $ 234,248   
  

 

 

    

 

 

 

Net Investment Income for the years ended December 31, 2014 and 2013 was $4,781 and $1,469, respectively. The increase in 2014 is primarily due to the increase in late 2013 in our investments in available-for-sale securities that comprise the majority of our investment portfolio and the change in the mix of our available-for-sale investments during 2014. See Note 4 — “Investments” under Net Investment Income (Loss) to our consolidated financial statements under Item 8 of this Annual Report on Form 10-K.

Policy Fee Income for the years ended December 31, 2014 and 2013 was $2,820 and $3,098, respectively. The decrease in 2014 is primarily due to the change in the fourth quarter of 2013 in the method of recognizing policy fees, which are recognized ratably over the policy coverage period.

Net Realized Investment Gains for the years ended December 31, 2014 and 2013 was $4,735 and $80, respectively. The increase in 2014 is due to sales of fixed-maturity securities primarily in the third quarter of 2014.

Expenses

Our Losses and Loss Adjustment Expenses amounted to $79,468 and $65,123, respectively, during the years ended December 31, 2014 and 2013. See “Reserves for Losses and Loss Adjustment Expenses” under “Critical Accounting Policies and Estimates.”

Policy Acquisition and Other Underwriting Expenses for the years ended December 31, 2014 and 2013 were $37,952 and $31,619, respectively, and primarily reflect the amortization of deferred acquisition costs, commissions payable to agents for production and renewal of policies, and premium taxes and brokerage fees. The increase in 2014 is primarily attributable to commissions and premium taxes related to the policies assumed from Citizens in 2013 that have renewed and are included in 2014 direct written premiums.

Salaries and Wages for the years ended December 31, 2014 and 2013 were $16,483 and $14,714, respectively. The $1,769 increase in 2014 was primarily attributable to an increase in employee headcount. As of December 31, 2014, we had 200 employees located at our headquarters in Florida compared with 177 employees as of December 31, 2013. We also had 79 employees located in Noida, India at December 31, 2014 versus 67 at December 31, 2013.

 

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Interest Expense for the years ended December 31, 2014 and 2013 were $10,453 and $3,607, respectively. The increase in 2014 was primarily the result of the 3.875% convertible debt offering completed in December 2013.

Other Operating Expenses for the years ended December 31, 2014 and 2013 were $20,790 and $19,572, respectively. The $1,218 increase in 2014 was primarily attributable to a $3,383 increase in stock-based compensation and employee benefit expenses offset by a decrease in other general expenses such as professional service fees, director fees, and charitable contributions.

Income Tax Expense for the years ended December 31, 2014 and 2013 was $38,298 and $40,891, respectively, for state, federal and foreign income taxes resulting in an effective tax rate of 37.9% for 2014 and 38.4% for 2013.

Ratios:

The loss ratio applicable to the year ended December 31, 2014 (losses and loss adjustment expenses related to net premiums earned) was 31.5% compared with 27.8% for the year ended December 31, 2013. (See Gross Premiums Earned and Losses and Loss Adjustment Expenses above).

The expense ratio applicable to the year ended December 31, 2014 (defined as underwriting expenses, salaries and wages, interest and other operating expenses related to net premiums earned) was 34.0% compared with 29.7% for the year ended December 31, 2013. The increase in our expense ratio is primarily attributable to the increase in 2014 specific to interest expense and compensation and related costs.

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 year ended December 31, 2014 was 65.5% compared with 57.5% for the year ended December 31, 2013. Our combined ratio was negatively impacted by an increase in interest expense and compensation and related costs and, also, the increase in 2014 in our losses and loss adjustment expenses.

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 year ended December 31, 2014 was 45.2% compared with 39.9% for the year ended December 31, 2013.

 

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Comparison of the Year Ended December 31, 2013 to the Year Ended December 31, 2012

Our results of operations for the year ended December 31, 2013 reflect income available to common stockholders of $65,458, or $5.63 earnings per diluted common share, compared with income available to common stockholders of $29,835, or $3.02 earnings per diluted common share, for the year ended December 31, 2012.

Revenue

Gross Premiums Earned for the years ended December 31, 2013 and 2012 were $337,113 and $233,607, respectively, and primarily reflect the revenue from policies acquired from HomeWise and Citizens and subsequent renewals. The increase in 2013 was primarily attributable to revenue from the Citizens assumptions completed in November 2013 and 2012.

Premiums Ceded for the years ended December 31, 2013 and 2012 were $102,865 and $75,939, respectively. Our premiums ceded represent amounts paid to reinsurers to cover losses from catastrophes that exceed the retention levels defined by our catastrophe excess of loss reinsurance treaties. During the year ended December 31, 2013, premiums ceded reflect a net reduction of $12,521 related to the provisions under certain reinsurance contracts. Our reinsurance rates are based primarily on policy exposures reflected in gross premiums earned. Premiums ceded were 30.5% and 32.5% of gross premiums earned during the years ended December 31, 2013 and 2012, respectively.

Net Premiums Written during the years ended December 31, 2013 and 2012 totaled $251,906 and $203,240, respectively. Net premiums written represent the premiums charged on policies issued during a fiscal period less any applicable reinsurance costs.

Net Premiums Earned for the years ended December 31, 2013 and 2012 were $234,248 and $157,668, 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 years ended December 31, 2013 and 2012:

 

     Years Ended
December 31,
 
     2013      2012  

Net Premiums Written

   $ 251,906       $ 203,240   

Increase in Unearned Premiums

     (17,658      (45,572
  

 

 

    

 

 

 

Net Premiums Earned

$ 234,248    $ 157,668   
  

 

 

    

 

 

 

Net Investment Income for the years ended December 31, 2013 and 2012 was $1,469 and $980, respectively. The increase in 2013 is primarily due to higher returns on our investment portfolio, which has grown from $44,829 in 2012 to $129,800 in 2013, and lower operating losses related to certain of our real estate investments.

Policy Fee Income for the years ended December 31, 2013 and 2012 was $3,098 and $2,538, respectively, and reflects the policy fee income we earn with respect to our issuance of renewal policies.

 

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Other Income for the years ended December 31, 2013 and 2012 was $2,193 and $1,424, respectively. The increase in other income in 2013 is primarily due to the recognition of income related to the Aon Benfield settlement.

Expenses

Our Losses and Loss Adjustment Expenses amounted to $65,123 and $66,310, respectively, during the years ended December 31, 2013 and 2012. During the year ended December 31, 2013, we experienced favorable development of $2,456 with respect to our net unpaid losses and loss adjustment expenses established as of December 31, 2012, which contributed to the overall favorable variance of $1,187 with respect to the total losses and loss adjustment expenses incurred in 2013 as compared with 2012. In addition, our losses and loss adjustment expenses for the year ended December 31, 2012 included approximately $3,500 related to claims from Tropical Storm Debby and Tropical Storm Isaac, which occurred in June and August 2012, respectively.

Policy Acquisition and Other Underwriting Expenses for the years ended December 31, 2013 and 2012 were $31,619 and $25,930, respectively, and primarily reflect the amortization of deferred acquisition costs, commissions payable to agents for production and renewal of policies, and premium taxes, marketing costs and policy fees. The increase in 2013 is primarily attributable to an increase in commissions and premium taxes related to the increase in policy renewals in 2013, the effect of which is offset by a one-time charge of $1,210 in 2012 resulting from a change in accounting standards with respect to deferred acquisition costs.

Salaries and Wages for the years ended December 31, 2013 and 2012 were $14,714 and $10,545, respectively. The $4,169 increase in 2013 was primarily attributable to increases in employee headcount and cash bonus expense. As of December 31, 2013, we had 177 employees located at our offices in Florida compared with 145 employees as of December 31, 2012. We also had 67 employees located in Noida, India at December 31, 2013 versus 62 at December 31, 2012.

Interest Expense totaled $3,607 for the year ended December 31, 2013 and relates to the two debt offerings we completed during 2013. See Note 9 — “Long-Term Debt” to our consolidated financial statements under Item 8 of this Annual Report on Form 10-K.

Other Operating Expenses for the years ended December 31, 2013 and 2012 were $19,572 and $10,539, respectively. The $9,033 increase was primarily attributable to a $5,127 increase in stock-based compensation and employee benefit expenses. The remaining increase of $3,906 relates to charitable contributions of $1,066 and other administrative costs, which include a variety of professional service fees, corporate insurances, information system expense, and other general expenses of $2,840.

 

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Income Tax Expense for the years ended December 31, 2013 and 2012 was $40,891 and $19,423, respectively, for state, federal and foreign income taxes resulting in an effective tax rate of 38.4% for 2013 and 39.2% for 2012.

Ratios:

The loss ratio applicable to the year ended December 31, 2013 was 27.8% compared with 42.1% for the year ended December 31, 2012. Our loss ratio was positively impacted by a significant increase in our net premiums earned during 2013 combined with favorable development in claim trends for frequency and severity and favorable development of reserves for prior accident years (see Gross Premiums Earned and Losses and Loss Adjustment Expenses above).

The expense ratio applicable to the year ended December 31, 2013 was 29.7% compared with 29.9% for the year ended December 31, 2012.

The combined ratio is the measure of overall underwriting profitability before other income. Our combined ratio for the year ended December 31, 2013 was 57.5% compared with 72.0% for the year ended December 31, 2012. Our combined ratio was positively impacted by a significant increase in our net premiums earned during 2013 (see Gross Premiums Earned above) and, also, by continued favorable trends in 2013 related to our losses and loss adjustment expenses.

The combined ratio to gross premiums earned for the year ended December 31, 2013 was 39.9% compared with 48.6% for the year ended December 31, 2012.

Seasonality of Our Business

Our insurance business is seasonal as hurricanes and tropical storms typically occur during the period from June 1 through November 30 each year. With our reinsurance treaty year effective on 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

Over the years, our liquidity requirements have been met through issuance 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 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 main insurance subsidiary, Homeowners Choice Property & Casualty Insurance Company, Inc., requires 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,

 

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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. A substantial portion of our losses and loss adjustment expenses are fully settled and paid within 90 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.

In the future, we anticipate our primary use of funds will be to pay claims, reinsurance premiums, interest, and dividends and also to fund operations. In addition, we intend to increase the size of our portfolios of limited partnership investments and real estate investments in order to maximize returns during 2015.

Senior Notes

Our long-term debt at December 31, 2014 consisted of 8% Senior Notes due 2020 and 3.875% Senior Convertible Notes due 2019, which were issued during 2013 for gross proceeds of $40,250 and $103,000, respectively. We make quarterly interest payments of $805 on the senior notes due 2020 with quarterly payments due on January 30, April 30, July 30 and October 30. We make semiannual interest payments of approximately $1,996 on the convertible notes with payments due in arrears on March 15 and September 15 of each year. See Note 9 — “Long-term debt” to our consolidated financial statements under Item 8 of this Annual Report on Form 10-K.

Share Repurchase Plan

On March 18, 2014, our Board of Directors approved a one-year plan to repurchase up to $40,000 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 14 — “Stockholders’ Equity” to our consolidated financial statements under Item 8 of this Annual Report on Form 10-K.

Limited Partnership Investment

We entered into a subscription agreement to invest up to a maximum of $12,500 for a 16.5% interest in a limited partnership. The partnership which was approved to operate as a small investment company in October 2014 aims to provide direct lending to private U.S. lower-middle-market companies. At December 31, 2014, there is an unfunded capital balance of $9,860. See Limited Partnership Investment under Note 4— “ Investment” to our consolidated financial statements under Item 8 of this Annual Report on Form 10-K.

 

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ADC Arrangement

In June 2014, we entered into an ADC Arrangement under which we agreed to provide financing up to a maximum of $9,785 for the acquisition, development and construction of a retail shopping center and appurtenant facilities. At December 31, 2014, $6,981 of the commitment is available and unused. See Note 4 — “Investments” under ADC Arrangement to our consolidated financial statements under Item 8 of this Annual Report on Form 10-K.

Cash Flows

Our cash flows from operating, investing and financing activities for the years ended December 31, 2014, 2013 and 2012 are summarized below.

Cash Flows for the Year ended December 31, 2014

Net cash provided by operating activities for the year ended December 31, 2014 totaled $88,729, which consisted primarily of cash received from net written premiums less cash disbursed for operating expenses, losses and loss adjustment expenses and interest payments. Net cash used in investing activities of $18,652 was primarily due to the purchases of available-for-sale securities of $127,622, the funding of the ADC Arrangement of $2,803 and the $4,500 cash contribution to a joint venture, offset by redemptions and repayments of fixed-maturity securities of $4,603, and the proceeds from sales of available-for-sale securities of $115,175. Net cash used in financing activities totaled $48,730, which was primarily due to $38,354 used in our share repurchase plan and $11,670 of net cash dividend payments.

Cash Flows for the Year ended December 31, 2013

Net cash provided by operating activities for the year ended December 31, 2013 was $55,472, which consisted primarily of cash received from net written premiums less cash disbursed for operating expenses, reinsurance premiums and losses and loss adjustment expenses. Net cash used in investing activities of $90,040 was primarily due to the purchases of available-for-sale securities of $94,215, the purchase of $3,433 in property and equipment and the purchase of $565 in other investments offset by redemptions and repayments of fixed-maturity securities of $3,607, and the proceeds from sales of available-for-sale securities of $4,558. Net cash provided by financing activities totaled $97,752, which was primarily due to $143,250 from the issuance of long-term debt offset by $4,770 of related underwriting and issuance costs, $10,902 of cash dividend payments, and $30,886 of payments to repurchase common stock.

Cash Flows for the Year ended December 31, 2012

Net cash provided by operating activities for the year ended December 31, 2012 was $106,266, which consisted primarily of cash received from net written premiums less cash disbursed for operating expenses and losses and loss adjustment expenses. Net cash used in investing activities amounted to $1,211 and was primarily due to $8,157 used to complete our business acquisitions in 2012, $16,538 used for the purchases of fixed-maturity and equity securities, and $2,796 used for the

 

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purchases of property, equipment and other investments offset by $10,726 from the proceeds from sales of fixed-maturity and equity securities, $3,127 of proceeds from calls, repayments, and maturities of fixed-maturity securities and $12,427 from time deposit redemptions. Net cash provided by financing activities totaled $24,799, which was primarily due to $20,082 from the issuance of common stock, $12,152 related to the exercise of stock options and warrants and $1,161 excess tax benefit from stock options exercised offset by $8,561 in cash dividends paid.

Investments

The main objective of our investment policy is to maximize our after-tax investment income with a minimum of risk given the current financial market. Our excess cash is invested primarily in money market accounts and available-for-sale investments.

At December 31, 2014, we had $142,634 of available-for-sale 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.

With the exception of large national and regional banks, it is our current practice not to maintain cash deposits of more than an aggregate of $5,500 in any one bank at any time. From time to time, we may have in excess of $5,500 of cash available for investment and on deposit at a single national brokerage firm. 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.

OFF-BALANCE SHEET ARRANGEMENTS

As of December 31, 2014, we are contractually committed to provide financing for the acquisition, development and construction of one real estate property and to provide a capital contribution for a limited partnership interest (which are referred to herein as the ADC Arrangement and the Limited Partnership Investment, respectively). Such commitments are not recognized in the financial statements but are required to be disclosed in the notes to the financial statements. See Note 17 — “Commitments and Contingencies” to our consolidated financial statements under Item 8 of this Annual Report on Form 10-K and Contractual Obligations and Commitments below for additional information. As of December 31, 2013, we had no off-balance sheet arrangements as defined in Item 303(a)(4) of SEC Regulation S-K.

 

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CONTRACTUAL OBLIGATIONS AND COMMITMENTS

The following table summarizes our material contractual obligations and commitments as of December 31, 2014:

 

     Payment Due by Period (in thousands)  
     Total      Less than
1 Year
     1-3 Years      3-5 Years      More than
5 Years
 

Operating lease (1)

   $ 958         118         253         279         308   

Service agreement (1)

     172         21         46         50         55   

Reinsurance contracts (2)

     89,440         66,451         22,989         —           —     

Acquisition, development and construction loan commitment (3)

     6,981         6,981         —           —           —     

Unfunded capital commitment (4)

     9,860         9,860         —           —           —     

Long-term debt obligations (5)

     178,116         7,211         14,423         115,427         41,055   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

$ 285,527      90,642      37,711      115,756      41,418   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Represents the lease and maintenance service agreement for office space in Noida, India. Liabilities were converted from India Rupee to U.S. dollars using the December 31, 2014 exchange rate.
(2) Represents the minimum payment of reinsurance premiums under multi-year reinsurance contracts.
(3) Represents the unused portion of our commitment related to the ADC Arrangement. See Note 17 — “Commitments and Contingencies” under Financing Commitment to our consolidated financial statements under Item 8 of this Annual Report.
(4) Represents the unfunded balance of capital commitment under the subscription agreement related to one limited partnership.
(5) Amounts represent principal and interest payments over the life of the senior notes due January 30, 2020 and the convertible notes due March 15, 2019.

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. 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 with retrospective provisions, deferred income taxes, and stock-based compensation expense involve our most significant judgments and estimates material to our consolidated financial statements.

 

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Reserves for Losses and Loss Adjustment Expenses. We establish reserves for the estimated total unpaid costs of losses including LAE. We believe reserves reflect management’s best estimate of the total cost of (i) claims that have been incurred, but not yet paid, and (ii) claims that have been incurred but not yet reported. Reserves established by us represent an estimate of the outcome of future events and, as such, cannot be considered an exact calculation of our liability. Rather, loss reserves represent, we believe, management’s best estimate of our company’s liability based on the application of actuarial techniques and other projection methodologies and taking into consideration other facts and circumstances known at the balance sheet date. The process of establishing loss reserves is complex and inherently imprecise, as it involves using judgment that is affected by many variables such as past loss experience, current claim trends and the prevailing social, economic and legal environments. The impact of both internal and external variables on ultimate losses and LAE costs is difficult to estimate. Our exposure is impacted by both the risk characteristics of the physical locations where we write policies, such as hurricane and tropical storm-related risks, as well as risks associated with varying social, judicial and legislative characteristics in the states in which we operate. In determining loss reserves, we give careful consideration to all available data and actuarial analyses. This process involves significant judgment.

Reserves represent estimates of the ultimate unpaid cost of all losses incurred, including losses for claims that have not yet been reported to our insurance company. The amount of loss reserves for reported claims consist of case reserves (based on a case-by-case evaluation of the kind of risk involved, knowledge of the circumstances surrounding each claim and the insurance policy provisions relating to the type of loss) and bulk reserves for additional growth on carried case reserves on known claims (based on historical patterns of development on aggregate claims grouped by loss date). The amounts of reserves for unreported claims and LAE (incurred but not reported claims, or IBNR) are determined using historical homeowners insurance information as adjusted to current conditions. Inflation is ordinarily implicitly provided for in the reserving function through analysis of costs, trends and reviews of historical reserving results over multiple years.

Reserves are closely monitored and are recalculated periodically using the most recent information on reported claims and a variety of actuarial techniques. Specifically, claims management personnel complete weekly and ongoing reviews of existing case reserves, new claims, changes to existing case reserves, and paid losses with respect to the current and prior years. As we develop historical data regarding paid and incurred losses, we use this data to develop expected ultimate loss and loss adjustment expense ratios. We then apply these expected loss and loss adjustment expense ratios to earned premium to derive a reserve level for our homeowners line of business. In connection with the determination of these reserves, we will also consider other specific factors such as recent weather-related losses, trends in historical paid losses, and legal and judicial trends regarding liability. Most of our business was assumed from Citizens and HomeWise. Therefore, we use the loss ratio method, among other methods, to project an ultimate loss expectation, and then the related loss history must be regularly evaluated and loss expectations updated, with the possibility of variability from the initial estimate of ultimate losses.

When a claim is reported to us, our claims personnel establish a “case reserve” for the estimated amount of the ultimate payment. This estimate reflects an informed judgment based upon general insurance reserving practices and on the experience and knowledge of the estimator. The individual estimating the reserve considers the nature and value of the specific claim, the severity of

 

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injury or damage, location, and the policy provisions relating to the type of loss. Case reserves are adjusted by us as more information becomes available. It is our policy to settle each claim as expeditiously as possible.

We maintain IBNR reserves to provide for claims that have been incurred but have not been reported and subsequent development on reported claims. The IBNR reserve is determined by estimating our insurance company’s ultimate net liability for both reported and unreported claims and then subtracting the case reserves and payments made to date for reported claims.

Loss Reserve Estimation Methods. We apply the following general methods in projecting loss and LAE reserves:

 

    Reported loss development;

 

    Paid loss development;

 

    Reported Bornhuetter-Ferguson method;

 

    Paid Bornhuetter-Ferguson method;

 

    Loss ratio method; and

 

    Frequency-Severity method.

Selected reserves are based on a review of the indications from these methods as well as emergence since the most recent evaluation and number of open claims for a given accident period.

Description of Ultimate Loss Estimation Methods. The reported loss development method relies on the assumption that, at any given state of maturity, ultimate losses can be predicted by multiplying cumulative reported losses (paid losses plus case reserves) by a cumulative development factor. The validity of the results of this method depends on the stability of claim reporting and settlement rates, as well as the consistency of case reserve levels. Case reserves do not have to be adequately stated for this method to be effective; they only need to have a fairly consistent level of adequacy at all stages of maturity. Because of our limited loss experience, we select loss development factors based on industry data found in current A.M. Best’s Aggregates and Averages – Property/Casualty – United States & Canada. We assume that our loss development patterns will be reasonably consistent with industry averages, and use the selected factors to assist in the projection of the ultimate losses.

The paid loss development method is mechanically identical to the reported loss development method described above. The paid method does not rely on case reserves or claim reporting patterns in making projections.

The validity of the results from using a loss development approach can be affected by many conditions, such as internal claim department processing changes, a shift between single and multiple claim payments, legal changes, or variations in our mix of business from year to year. Also, since the percentage of losses paid for immature years is often low, development factors are volatile. A small variation in the number of claims paid can have a leveraging effect that can lead to significant changes in estimated ultimate losses. Therefore, ultimate values for immature loss years are often based on alternative estimation techniques.

 

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The loss ratio method used by us relies on the assumption that remaining unreported losses are a function of the total expected losses rather than a function of currently reported losses. The expected loss ratio is multiplied by earned premium to produce ultimate losses. Reported incurred losses are then subtracted from this estimate to produce expected unreported losses.

The loss ratio method is most useful as an alternative to other models for immature loss years. For these immature years, the amounts reported or paid may be small and unstable, and therefore, not predictive of future development. Therefore, future development is assumed to follow an expected pattern that is supported by more stable historical data or by emerging trends. This method is also useful when variations in reporting or payment patterns distort the historical development of losses.

The paid and reported Bornhuetter-Ferguson methods are a weighting of the loss ratio method and the corresponding development method. Outstanding reserves or IBNR reserves are derived by applying the loss ratio estimate to the estimated unpaid or unreported percent of losses based on the development patterns from the development methods.

Finally, we employ the frequency/severity method. We segregate our claims according to when they were incurred and conduct a detailed review in order to estimate average future development of open claims and average projected loss on IBNR claims. We combine this estimate with our open claims in order to derive an estimate of expected unreported losses. Paid losses are added to this estimate in order to derive an estimate of ultimate losses. This method is based on the assumption that future unreported claims and the average severity of open claims and unreported claims can be reasonably estimated from the experience available.

While the property and casualty industry has incurred substantial aggregate losses from claims related to asbestos-related illnesses, environmental remediation, sinkholes, product and mold, and other uncertain or environmental exposures, we have not experienced significant losses from these types of claims. However, we have experienced losses from exposures (sinkholes and catastrophes) that follow materially different loss patterns than the balance of our experience. To address this situation, we separate these exposures from the remainder of the business and derive reserves specific to each of these exposures. Total reserves are determined by adding the reserves related to each segment of business.

Currently, our estimated ultimate liability is calculated monthly using these principles and procedures applied to the lines of business written. However, because the establishment of loss reserves is an inherently uncertain process, we cannot be certain that ultimate losses will not exceed the established loss reserves and have a material, adverse effect on our results of operations and financial condition. Changes in estimates, or differences between estimates and amounts ultimately paid, are reflected in the operating results of the period during which such adjustments are made.

Our reported results, financial position and liquidity would be affected by likely changes in key assumptions that determine our net loss reserves. Management does not believe that any reasonably likely changes in the frequency of claims would affect our loss reserves. However, management believes that a reasonably likely increase or decrease in the severity of claims could impact our net loss reserves. The table below summarizes the effect on net loss reserves and equity in the event of reasonably likely changes in the severity of claims considered in establishing loss and loss adjustment expense reserves. The range of reasonably likely changes in the severity of our claims

 

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was established based on a review of changes in loss year development and applied to loss reserves as a whole. The selected range of changes does not indicate what could be the potential best or worst case or likely scenarios:

 

Year Ended December 31, 2014  
Change in Reserves     Reserves     Percentage
change in
equity, net of tax
 
  -10.0     44,017        1.65
  -7.5     45,240        1.23
  -5.0     46,463        0.82
  -2.5     47,685        0.41
  Base        48,908        —     
  2.5     50,131        -0.41
  5.0     51,353        -0.82
  7.5     52,576        -1.23
  10.0     53,799        -1.65

Economic Impact of Reinsurance Contracts with Retrospective Provisions. Certain of our reinsurance contracts include retrospective provisions that adjust premiums, increase the amount of future coverage, or result in profit commissions in the event losses are minimal or zero. In accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”), we will recognize an asset in the period in which the absence of loss experience gives rise to an increase in future coverage or 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 should a catastrophic loss event occur during the contract term.

For the years ended December 31, 2014 and 2013, we accrued benefits of $20,794 and $8,815, respectively, and deferred recognition of $2,749 and $3,706, respectively, in ceded premiums for total reductions in ceded premiums of $23,543 and $12,521, respectively. As of December 31, 2014, we have accrued a benefit of $28,123 and deferred recognition of $6,456 in ceded premiums, amounts that would be charged to earnings in the event we experience a catastrophic loss that exceeds the coverage limits provided under such agreements and in the period that the increased coverage is applicable, respectively. At December 31, 2013, we had $8,815 of accrued benefits and $3,706 of ceded premiums deferred related to these agreements. In June 2014, we received $1,485 under the terms of one retrospective reinsurance contract, which terminated May 31, 2014.

Income Taxes. We account for income taxes in accordance with U.S. GAAP, resulting in two components of income tax expense: current and deferred. Current income tax expense reflects taxes to be paid or refunded for the current period by applying the provisions of the enacted tax law to the taxable income or excess of deductions over revenues. We determine deferred income taxes using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is based on the tax effects of the differences between the book and tax bases of assets and liabilities, and enacted changes in tax rates and laws are recognized in the period in which they occur. Valuation allowances are provided against assets that are not likely to be realized, if any. We have elected to classify the related interest and penalties, if any, as income tax expense as permitted by current accounting standards.

 

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Stock-Based Compensation. We account for our stock option and incentive plan under the fair value recognition provisions of U.S. GAAP, which requires the measurement, and recognition of compensation for all stock-based awards made to employees and non-employee directors including stock options and restricted stock issuances based on estimated fair values. We recognize stock-based compensation in the consolidated statements of income on a straight-line basis over the vesting period. We use the Black-Scholes option-pricing model, which requires the following variables for input to calculate the fair value of each stock award on the option grant date: 1) expected volatility of our stock price, 2) the risk-free interest rate, 3) expected term of each award, 4) expected dividends, and 5) an expected forfeiture rate. For restricted stock awards with market-based conditions, we estimate their fair values by using a Monte Carlo simulation model, which requires the following variables for input: 1) expected dividends per share, 2) expected volatility, 3) risk-free interest rate, 4) estimated cost of capital, and 5) expected term of each award.

ITEM 7A – Quantitative and Qualitative Disclosures About Market Risk

Our investment portfolios at December 31, 2014 included fixed-maturity and equity securities, the purposes of which are not for trading or speculation. Our main objective is to maximize after-tax investment income and maintain sufficient liquidity to meet policyholder 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 investment companies and are overseen by the investment committee appointed by our board of directors.

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 and equity 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.

 

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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 December 31, 2014 (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

   $ 85,196       $ (11,888      (12.25 )% 

200 basis point increase

     89,159         (7,925      (8.16 )% 

100 basis point increase

     93,121         (3,963      (4.08 )% 

100 basis point decrease

     101,035         3,951         4.07

200 basis point decrease

     104,697         7,613         7.84

300 basis point decrease

     107,242         10,158         10.46

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 and by diversifying our investment portfolio to avoid concentrations in any single issuer or business sector.

The following table presents the composition of our fixed-maturity securities, by rating, at December 31, 2014 (in thousands):

 

Comparable Rating

   Amortized
Cost
     % of
Total
Amortized
Cost
     Estimated
Fair Value
     % of
Total
Estimated
Fair Value
 

AAA

   $ 2,287         2       $ 2,293         2   

AA+, AA, AA-

     16,984         18         17,106         18   

A+, A, A-

     32,072         33         32,784         34   

BBB+, BBB, BBB-

     31,996         33         32,386         33   

BB+, BB, BB-

     6,254         7         5,974         6   

Not rated

     6,570         7         6,541         7   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

$ 96,163      100    $ 97,084      100   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Equity Price Risk

Our equity investment portfolio at December 31, 2014 included common stocks, perpetual preferred stocks, mutual funds and exchange traded funds (“ETF”). We may incur potential losses due to adverse changes in equity security prices. We manage the risk primarily through industry and issuer diversification and asset allocation techniques.

The following table illustrates the composition of our equity securities at December 31, 2014 (in thousands):

 

     Estimated
Fair Value
     % of Total
Estimated
Fair Value
 

Stocks by sector:

     

Financial

   $ 29,361         64   

Energy

     3,003         7   

Consumer

     4,047         9   

Other (1)

     294         1   
  

 

 

    

 

 

 
  36,705      81   
  

 

 

    

 

 

 

Mutual funds and ETF by type:

Debt

  7,550      17   

Equity

  1,295      2   
  

 

 

    

 

 

 
  8,845      19   
  

 

 

    

 

 

 

Total

$ 45,550      100   
  

 

 

    

 

 

 

 

(1) Represents an aggregate of less than 5% sectors.

Foreign Currency Exchange Risk

At December 31, 2014, we did not have any material exposure to foreign currency related risk.

 

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ITEM 8 – Financial Statements and Supplementary Data

Index to Financial Statements

 

     Page  

Reports of Independent Registered Public Accounting Firm:

  

Reports of Dixon Hughes Goodman LLP, Independent Registered Public Accounting firm

     50-51   

Report of Hacker, Johnson & Smith PA, Independent Registered Public Accounting firm

     52   

Consolidated Balance Sheets at December 31, 2014 and 2013

     53   

Consolidated Statements of Income for the Years Ended December 31, 2014, 2013 and 2012

     54   

Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2014, 2013 and 2012

     55   

Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2014, 2013 and 2012

     56-58   

Consolidated Statements of Cash Flows for the Years Ended December 31, 2014, 2013 and 2012

     59-60   

Notes to the Consolidated Financial Statements for the Years Ended December 31, 2014, 2013 and 2012

     61-107   

 

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Report of Independent Registered Public Accounting Firm

Board of Directors and Stockholders of

HCI Group, Inc. and Subsidiaries:

We have audited the accompanying consolidated balance sheets of HCI Group, Inc. and Subsidiaries (the “Company”) as of December 31, 2014 and 2013, and the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows for each of the years in the two-year period ended December 31, 2014. The Company’s management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of HCI Group, Inc. and Subsidiaries as of December 31, 2014 and 2013, and the results of its operations and its cash flows for each of the years in the two-year period ended December 31, 2014, in conformity with accounting principles generally accepted in the United States of America.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 10, 2015, expressed an unqualified opinion.

 

/s/ Dixon Hughes Goodman LLP
Clearwater, Florida
March 10, 2015

 

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Report of Independent Registered Public Accounting Firm on Internal Control

To the Board of Directors and Stockholders of

HCI Group, Inc. and Subsidiaries

We have audited HCI Group, Inc. and Subsidiaries’ (the “Company”) internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, HCI Group, Inc. and Subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets and the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows of HCI Group, Inc. and Subsidiaries, and our report dated March 10, 2015, expressed an unqualified opinion on those consolidated financial statements.

 

/s/ Dixon Hughes Goodman LLP
Clearwater, Florida
March 10, 2015

 

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Report of Independent Registered Public Accounting Firm

Board of Directors and Stockholders

HCI Group, Inc.

Tampa, Florida:

We have audited the consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows of HCI Group, Inc. and Subsidiaries (the “Company”) for the year ended December 31, 2012. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated results of the Company’s operations, comprehensive income and cash flows for the year ended December 31, 2012, in conformity with accounting principles generally accepted in the United States of America.

 

/s/ Hacker, Johnson & Smith PA
HACKER, JOHNSON & SMITH PA
Tampa, Florida

March 10, 2015

 

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HCI GROUP, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(Dollar amounts in thousands)

 

     December 31,  
     2014      2013  

Assets

     

Fixed-maturity securities, available for sale, at fair value (amortized cost: $96,163 and $110,738, respectively)

   $ 97,084       $ 112,151   

Equity securities, available for sale, at fair value (cost: $45,387 and $17,248, respectively)

     45,550         17,649   

Limited partnership investment, at equity

     2,550         —     

Investment in joint venture, at equity

     4,477         —     

Real estate investments

     19,138         16,228   
  

 

 

    

 

 

 

Total investments

  168,799      146,028   

Cash and cash equivalents

  314,716      293,398   

Accrued interest and dividends receivable

  1,059      1,133   

Income taxes receivable

  2,624      —     

Premiums receivable

  15,824      14,674   

Prepaid reinsurance premiums

  34,096      28,066   

Deferred policy acquisition costs

  15,014      14,071   

Property and equipment, net

  12,292      13,132   

Deferred income taxes, net

  2,499      —     

Other assets

  35,287      15,814   
  

 

 

    

 

 

 

Total assets

$ 602,210    $ 526,316   
  

 

 

    

 

 

 

Liabilities and Stockholders’ Equity

Losses and loss adjustment expenses

$ 48,908    $ 43,686   

Unearned premiums

  214,071      171,907   

Advance premiums

  4,380      4,504   

Assumed reinsurance balances payable

  218      4,660   

Accrued expenses

  4,826      4,032   

Dividends payable

  —        19   

Income taxes payable

  —        543   

Deferred income taxes, net

  —        2,740   

Long-term debt

  129,539      126,932   

Other liabilities

  17,683      6,772   
  

 

 

    

 

 

 

Total liabilities

  419,625      365,795   
  

 

 

    

 

 

 

Commitments and contingencies (Note 17)

Stockholders’ equity:

7% Series A cumulative convertible preferred stock (liquidation preference $10.00 per share), no par value, 1,500,000 shares authorized, 0 and 110,684 shares issued and outstanding in 2014 and 2013, respectively

  —        —     

Series B junior participating preferred stock (no par value, 400,000 shares authorized, no shares issued or outstanding)

  —        —     

Preferred stock (no par value, 18,100,000 shares authorized, no shares issued or outstanding)

  —        —     

Common stock (no par value, 40,000,000 shares authorized, 10,189,128 and 10,939,268 shares issued and outstanding in 2014 and 2013, respectively)

  —        —     

Additional paid-in capital

  20,465      48,966   

Retained income

  161,454      110,441   

Accumulated other comprehensive income, net of taxes

  666      1,114   
  

 

 

    

 

 

 

Total stockholders’ equity

  182,585      160,521   
  

 

 

    

 

 

 

Total liabilities and stockholders’ equity

$ 602,210    $ 526,316   
  

 

 

    

 

 

 

See accompanying Notes to Consolidated Financial Statements.

 

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HCI GROUP, INC. AND SUBSIDIARIES

Consolidated Statements of Income

(Dollar amounts in thousands, except per share amounts)

 

     Years Ended December 31,  
     2014     2013     2012  

Revenue

      

Gross premiums earned

   $ 365,488      $ 337,113      $ 233,607   

Premiums ceded

     (113,423     (102,865     (75,939
  

 

 

   

 

 

   

 

 

 

Net premiums earned

  252,065      234,248      157,668   

Net investment income

  4,781      1,469      980   

Policy fee income

  2,820      3,098      2,538   

Net realized investment gains

  4,735      80      276   

Gain on bargain purchase

  —        —        179   

Other

  1,707      2,193      1,424   
  

 

 

   

 

 

   

 

 

 

Total revenue

  266,108      241,088      163,065   
  

 

 

   

 

 

   

 

 

 

Expenses

Losses and loss adjustment expenses

  79,468      65,123      66,310   

Policy acquisition and other underwriting expenses

  37,952      31,619      25,930   

Salaries and wages

  16,483      14,714      10,545   

Interest expense

  10,453      3,607      —     

Goodwill impairment loss

  —        —        161   

Other operating expenses

  20,790      19,572      10,539   
  

 

 

   

 

 

   

 

 

 

Total expenses

  165,146      134,635      113,485   
  

 

 

   

 

 

   

 

 

 

Income before income taxes

  100,962      106,453      49,580   

Income tax expense

  38,298      40,891      19,423   
  

 

 

   

 

 

   

 

 

 

Net income

$ 62,664    $ 65,562    $ 30,157   

Preferred stock dividends

  4      (104   (322
  

 

 

   

 

 

   

 

 

 

Income available to common stockholders

$ 62,668    $ 65,458    $ 29,835   
  

 

 

   

 

 

   

 

 

 

Basic earnings per common share

$ 5.90    $ 5.82    $ 3.45   
  

 

 

   

 

 

   

 

 

 

Diluted earnings per common share

$ 5.36    $ 5.63    $ 3.02   
  

 

 

   

 

 

   

 

 

 

Dividends per common share

$ 1.10    $ 0.95    $ 0.88   
  

 

 

   

 

 

   

 

 

 

See accompanying Notes to Consolidated Financial Statements.

 

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HCI GROUP, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income

(Dollar amounts in thousands)

 

     Years Ended December 31,  
     2014     2013     2012  

Net income

   $ 62,664      $ 65,562      $ 30,157   
  

 

 

   

 

 

   

 

 

 

Other comprehensive (loss) income:

Change in unrealized (loss) gain on investments:

Net unrealized gain (loss) arising during the period

  3,870      (767   2,571   

Other-than-temporary impairment loss charged to investment income

  107      —        —     

Call and repayment losses charged to investment income

  28      24      3   

Reclassification adjustment for net realized gain

  (4,735   (80   (276
  

 

 

   

 

 

   

 

 

 

Net change in unrealized (loss) gain

  (730   (823   2,298   

Deferred income taxes on above change

  282      317      (886
  

 

 

   

 

 

   

 

 

 

Total other comprehensive (loss) income, net of income taxes

  (448   (506   1,412   
  

 

 

   

 

 

   

 

 

 

Comprehensive income

$ 62,216    $ 65,056    $ 31,569   
  

 

 

   

 

 

   

 

 

 

See accompanying Notes to Consolidated Financial Statements.

 

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HCI GROUP, INC. AND SUBSIDIARIES

Consolidated Statements of Stockholders’ Equity

For the Year Ended December 31, 2014

(Dollar amounts in thousands)

 

     Series A Preferred Stock      Common Stock      Additional
Paid-In
    Retained     Accumulated
Other
Comprehensive
Income, Net
    Total
Stockholders’
 
     Shares     Amount      Shares     Amount      Capital     Income     of Tax     Equity  

Balance at December 31, 2013

     110,684      $ —           10,939,268      $ —         $ 48,966      $ 110,441      $ 1,114      $ 160,521   

Net income

     —          —           —          —           —          62,664        —          62,664   

Total other comprehensive loss, net of income taxes

     —          —           —          —           —          —          (448     (448

Conversion of preferred stock to common stock

     (107,298     —           107,298        —           —          —          —          —     

Issuance of restricted stock

     —          —           108,720        —           —          —          —          —     

Exercise of common stock options

     —          —           50,000        —           125        —          —          125   

Forfeiture of restricted stock

     —          —           (10,840     —           —          —          —          —     

Repurchase and retirement of common stock

     —          —           (14,617     —           (643     —          —          (643

Repurchase and retirement of common stock under share repurchase plan

     —          —           (990,701     —           (38,354     —          —          (38,354

Redemption of Series A preferred stock

     (3,386     —           —          —           (34     —          —          (34

Deferred taxes on debt discount

     —          —           —          —           215        —          —          215   

Common stock dividends

     —          —           —          —           —          (11,655     —          (11,655

Derecognition of preferred stock dividends payable

     —          —           —          —           —          4        —          4   

Tax benefits on stock-based compensation

     —          —           —          —           2,080        —          —          2,080   

Stock-based compensation

     —          —           —          —           8,110        —          —          8,110   
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Balance at December 31, 2014

  —      $ —        10,189,128    $ —      $ 20,465    $ 161,454    $ 666    $ 182,585   
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

 

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HCI GROUP, INC. AND SUBSIDIARIES

Consolidated Statements of Stockholders’ Equity – (Continued)

For the Year Ended December 31, 2013

(Dollar amounts in thousands)

 

     Series A Preferred Stock      Common Stock      Additional
Paid-In
    Retained     Accumulated
Other
Comprehensive,
Net of
    Total
Stockholders’
 
     Shares     Amount      Shares     Amount      Capital     Income     Tax     Equity  

Balance at December 31, 2012

     241,182      $ —           10,877,537      $ —         $ 63,875      $ 55,758      $ 1,620      $ 121,253   

Net income

     —          —           —          —           —          65,562        —          65,562   

Total other comprehensive loss, net of income taxes

     —          —           —          —           —          —          (506     (506

Conversion of preferred stock to common stock

     (130,498     —           130,498        —           —          —          —          —     

Issuance of restricted stock

     —          —           612,000        —           —          —          —          —     

Forfeiture of restricted stock

     —          —           (29,670     —           —          —          —          —     

Repurchase and retirement of common stock

     —          —           (28,346     —           (963     —          —          (963

Repurchase of common stock under prepaid forward contract

     —          —           (622,751     —           (29,923     —          —          (29,923

Equity component on 3.875% convertible senior notes (net of offering costs of $557)

     —          —           —          —           15,900        —          —          15,900   

Deferred taxes on debt discount

     —          —           —          —           (6,348     —          —          (6,348

Common stock dividends

     —          —           —          —           —          (10,775     —          (10,775

Preferred stock dividends

     —          —           —          —           —          (104     —          (104

Tax benefits on stock-based compensation

     —          —           —          —           1,060        —          —          1,060   

Stock-based compensation

     —          —           —          —           5,365        —          —          5,365   
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Balance at December 31, 2013

  110,684    $ —        10,939,268    $ —      $ 48,966    $ 110,441    $ 1,114    $ 160,521   
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

 

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HCI GROUP, INC. AND SUBSIDIARIES

Consolidated Statements of Stockholders’ Equity – (Continued)

For the Year Ended December 31, 2012

(Dollar amounts in thousands)

 

     Series A Preferred Stock      Common Stock      Additional
Paid-In
     Retained     Accumulated
Other
Comprehensive
Income, Net
     Total
Stockholders’
 
     Shares     Amount      Shares     Amount      Capital      Income     of Tax      Equity  

Balance at December 31, 2011

     1,247,700      $ —           6,202,485      $ —         $ 29,636       $ 33,986      $ 208       $ 63,830   

Net income

     —          —           —          —           —           30,157        —           30,157   

Total other comprehensive income, net of income taxes

     —          —           —          —           —           —          1,412         1,412   

Exercise of common stock options

     —          —           340,000        —           283         —          —           283   

Shares surrendered upon exercising common stock options

     —          —           (72,592     —           —           —          —           —     

Exercise of common stock warrants

     —          —           1,314,806        —           11,869         —          —           11,869   

Excess tax benefit from stock options exercised

     —          —           —          —           1,161         —          —           1,161   

Conversion of preferred stock to common stock

     (1,006,518     —           1,006,518        —           —           —          —           —     

Issuance of restricted stock

     —          —           246,320        —           —           —          —           —     

Issuance of common stock (net of offering costs of $220)

     —          —           1,840,000        —           20,082         —          —           20,082   

Common stock dividends

     —          —           —          —           —           (8,063     —           (8,063

Preferred stock dividends

     —          —           —          —           —           (322     —           (322

Stock-based compensation

     —          —           —          —           844         —          —           844   
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Balance at December 31, 2012

  241,182    $ —        10,877,537    $ —      $ 63,875    $ 55,758    $ 1,620    $ 121,253   
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

See accompanying Notes to Consolidated Financial Statements.

 

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HCI GROUP, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(Amounts in thousands)

 

     Years Ended December 31,  
     2014     2013     2012  

Cash flows from operating activities:

      

Net income

   $ 62,664      $ 65,562      $ 30,157   

Adjustments to reconcile net income to net cash provided by operating activities:

      

Stock-based compensation

     8,110        5,365        844   

Net amortization of discounts and premiums on investments in fixed-maturity securities

     782        336        279   

Depreciation and amortization

     4,958        2,103        1,591   

Deferred income tax (benefit) expense

     (4,742     557        (2,366

Net realized investment gains

     (4,735     (80     (276

Other-than-temporary impairment charge

     107        —          —     

Income from real estate investments

     (85     —          —     

Loss from joint venture

     23        —          —     

Loss from limited partnership interest

     90        —          —     

Gain on bargain purchase

     —          —          (179

Goodwill impairment loss

     —          —          161   

(Gain) loss on sale of real estate investment

     (1     20        —     

Loss on disposal of real estate investment

     —          6        —     

Foreign currency remeasurement loss

     29        69        23   

Changes in operating assets and liabilities:

      

Premiums and reinsurance receivable

     (1,150     (4,032     3,267   

Advance premiums

     (124     475        1,897   

Prepaid reinsurance premiums

     (6,030     (18,954     5,057   

Accrued interest and dividends receivable

     74        (758     33   

Other assets

     (19,845     (9,728     (803

Assumed reinsurance balances payable

     (4,442     3,283        1,377   

Deferred policy acquisition costs

     (943     (4,039     2,289   

Losses and loss adjustment expenses

     5,222        2,518        13,744   

Unearned premiums

     42,164        17,658        45,572   

Income taxes

     (3,167     (8,270     3,857   

Accrued expenses and other liabilities

     9,770        3,381        (258
  

 

 

   

 

 

   

 

 

 

Net cash provided by operating activities

  88,729      55,472      106,266   
  

 

 

   

 

 

   

 

 

 

Cash flows from investing activities:

Cash consideration paid for acquired business, net of cash acquired

  —        —        (8,157

Investment in real estate under acquisition, development, and construction arrangement

  (2,803   —        —     

Investment in limited partnership interest

  (2,640   —        —     

Investment in joint venture

  (4,500   —        —     

Purchase of property and equipment

  (453   (3,433   (1,196

Purchase of real estate investments

  (413   (565   (1,600

Purchase of fixed-maturity securities

  (83,365   (82,907   (10,128

Purchase of equity securities

  (44,257   (11,308   (6,410

Proceeds from sales of fixed-maturity securities

  98,365      1,749      8,991   

Proceeds from calls, repayments and maturities of fixed-maturity securities

  4,603      3,607      3,127   

Proceeds from sales of equity securities

  16,810      2,809      1,735   

Proceeds from sales of property and equipment

  —        1      —     

Proceeds from sales of real estate investments

  1      7      —     

Time deposits, net

  —        —        12,427   
  

 

 

   

 

 

   

 

 

 

Net cash used in investing activities

  (18,652   (90,040   (1,211
  

 

 

   

 

 

   

 

 

 

 

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HCI GROUP, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows – (Continued)

(Amounts in thousands)

 

     Years Ended December 31,  
     2014     2013     2012  

Cash flows from financing activities:

      

Net proceeds from the issuance of common stock

     —          —          20,082   

Proceeds from the exercise of common stock options

     125        —          283   

Proceeds from the exercise of common stock warrants

     —          —          11,869   

Proceeds from the issuance of long-term debt

     —          143,250        —     

Cash dividends paid

     (12,355     (10,902     (8,561

Cash dividends received under share repurchase forward contract

     685        —          —     

Repurchases of common stock

     (643     (30,886     —     

Repurchases of common stock under share repurchase plan

     (38,354     —          —     

Redemption of Series A preferred stock

     (34     —          —     

Debt issuance costs

     (234     (4,770     (35

Tax benefits on stock-based compensation

     2,080        1,060        1,161   
  

 

 

   

 

 

   

 

 

 

Net cash (used) provided by financing activities

  (48,730   97,752      24,799   
  

 

 

   

 

 

   

 

 

 

Effect of exchange rate changes on cash

  (29   —        5   
  

 

 

   

 

 

   

 

 

 

Net increase in cash and cash equivalents

  21,318      63,184      129,859   

Cash and cash equivalents at beginning of year

  293,398      230,214      100,355   
  

 

 

   

 

 

   

 

 

 

Cash and cash equivalents at end of year

$ 314,716    $ 293,398    $ 230,214   
  

 

 

   

 

 

   

 

 

 

Supplemental disclosure of cash flow information:

Cash paid for income taxes

$ 43,902    $ 47,435    $ 16,710   
  

 

 

   

 

 

   

 

 

 

Cash paid for interest

$ 6,258    $ 2,531    $ —     
  

 

 

   

 

 

   

 

 

 

Non-cash investing and financing activities:

Unrealized (loss) gain on investments in available-for-sale securities, net of tax

$ (448 $ (506 $ 1,412   
  

 

 

   

 

 

   

 

 

 

Conversion of Series A preferred stock to common stock

$ 972    $ 1,170    $ 9,121   
  

 

 

   

 

 

   

 

 

 

See accompanying Notes to Consolidated Financial Statements.

 

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HCI GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share amounts, unless otherwise stated)

Note 1 — Nature of Operations

HCI Group, Inc. together with the insurance and non-insurance subsidiaries (“HCI” or the “Company”), is primarily engaged in the property and casualty insurance business through Homeowners Choice Property & Casualty Insurance Company, Inc. (“HCPCI”), its principal operating subsidiary. HCPCI is authorized to underwrite various homeowners’ property and casualty insurance products in the state of Florida. HCPCI’s operations are supported by the following HCI subsidiaries:

 

    Homeowners Choice Managers, Inc. – acts as managing general agent and provides marketing, underwriting, claims settlement, accounting and financial services to HCPCI;

 

    Southern Administration, Inc. – provides policy administration services to HCPCI; and

 

    Claddaugh Casualty Insurance Company, Ltd. – participates in the reinsurance program to HCPCI.

Homeowners Choice Assurance Company, Inc. was organized and was approved and licensed by the Alabama Department of Insurance in August 2013. During 2014, HCPCI was also approved to underwrite excess and surplus lines insurance products in Maryland, New Jersey, South Carolina, and Virginia.

In addition, HCI has various subsidiaries primarily engaged in the businesses of owning and leasing real estate, operating marina facilities and one restaurant, and developing software.

The Company reports its operations under one business segment.

The Company obtained a majority of its policies through participation in a “take-out program” with Citizens Property Insurance Corporation (“Citizens”), a Florida state supported insurer. Policies were obtained in eleven separate assumption transactions with Citizens that took place from July 2007 through December 2014. The Company is required to offer renewals on the policies acquired for a period of three years subsequent to the initial expiration of the assumed policies. During the first full year after assumption, such renewals are required to have rates that are equivalent to or less than the rates charged by Citizens. The Company’s premium revenue since inception comes from these assumptions and one additional assumption from HomeWise Insurance Company (“HomeWise”) in November 2011 through which the Company acquired the Florida policies of HomeWise.

 

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HCI GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share amounts, unless otherwise stated)

 

Note 2 — Summary of Significant Accounting Policies

Basis of Presentation. The accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”).

Principles of Consolidation. The accompanying consolidated financial statements include the accounts of HCI and its majority-owned and controlled subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. In addition, the Company evaluates its relationships or investments for consolidation pursuant to authoritative accounting guidance related to the consolidation of variable interest entities (“VIE”) under the Variable Interest Model prescribed by the Financial Accounting Standards Board (“FASB”). A VIE is consolidated when the Company has the power to direct activities that most significantly impact the economic performance of the VIE and has the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE. When a VIE is not consolidated, the Company uses the equity method to account for the investment. Under this method, the carrying value is generally the Company’s share of the net asset value of the unconsolidated entity, and changes in the Company’s share of the net asset value are recorded in net investment income.

Use of Estimates. The preparation of the consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as well as the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results may differ materially from these estimates. Material estimates that are particularly susceptible to significant change in the near term are primarily related to losses and loss adjustment expenses, reinsurance with retrospective provisions, deferred income taxes, and stock-based compensation expense.

Cash and Cash Equivalents. The Company considers all short-term highly liquid investments with original maturities of less than three months to be cash and cash equivalents. At December 31, 2014 and 2013, cash and cash equivalents consist of cash on deposit with financial institutions and securities brokerage firms and also includes a $300 statutory deposit held by the State of Florida for the benefit of all policyholders.

Investments in Available-for-Sale Securities. Investments consist of fixed-maturity and equity securities. Fixed-maturity securities include debt securities and redeemable preferred stock. Securities may be classified as either trading, held to maturity or available-for-sale. The Company’s available-for-sale securities are carried at fair value. Temporary changes in the fair value of available-for-sale securities are excluded from net investment income and reported in stockholders’ equity as a component of accumulated other comprehensive income, net of deferred income taxes. Realized investment gains and losses from sales are recorded on the trade date and are determined using the first-in first-out (FIFO) method. Investment income is recognized as earned and discounts or premiums arising from the purchase of debt securities are recognized in investment income using the interest method over the estimated remaining term of the security. Gains and losses from call redemptions and repayments are charged to investment income.

 

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HCI GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share amounts, unless otherwise stated)

 

The Company reviews all securities for other-than-temporary impairment on a quarterly basis and more frequently when economic or market conditions warrant such review. When the fair value of any investment is lower than its cost, an assessment is made to determine whether the decline is temporary or other-than-temporary. If the decline is determined to be other-than-temporary, the investment is written down to fair value and an impairment charge is recognized in income in the period in which the Company makes such determination. For a debt security that the Company does not intend to sell nor is it more likely than not that the Company will be required to sell before recovery of its amortized cost, only the credit loss component of the impairment is recognized in income, while the impairment related to all other factors is recognized in other comprehensive income. The Company considers various factors in determining whether an individual security is other-than-temporarily impaired (see Note 4 — “Investments”).

Limited Partnership Investment. The Company has interest in a limited partnership that is not registered under the United Stated Securities Act of 1933, as amended, the securities laws of any state or the securities laws of any other jurisdictions. The partnership interest cannot be resold in the public market and any withdrawal is subject to the terms and conditions of the partnership agreement. The Company has no influence over partnership operating and financial policies. The Company did not elect the fair value option and, therefore, uses the equity method to account for this investment (see Note 4 — “Investments”). The Company will generally recognize its share of the limited partnership’s earnings on a three- to six-month lag.

Investment in Joint Venture. The Company has a 90% equity interest in a joint venture that was organized to acquire and develop land on which the joint venture partners plan to construct a retail shopping center (see Note 4 — “Investments”) for lease or for sale. The joint venture was determined to be a variable interest entity as it lacks sufficient equity to finance its activities without additional subordinated financial support. Despite having a majority equity interest, the Company does not have a controlling financial interest and, accordingly, is not required to consolidate the joint venture as its primary beneficiary.

In addition, the joint venture agreement contains an embedded purchase option the Company can exercise to purchase the entire interest of the other party to the joint venture after the expiration of a restricted period. The Company determined the embedded purchase option is not required to be bifurcated and fair value accounting at each reporting date is not applicable. Due to the lack of a controlling financial interest and until the embedded purchase option becomes exercisable, the Company uses the equity method rather than consolidation to account for its investment in the joint venture.

Real Estate Investments. Real estate investments consist of an acquisition, development and construction loan agreement (“ADC Arrangement”) and also real estate and the related assets purchased for investment purposes (see Note 4 — “Investments”).

Under the ADC Arrangement, the Company provides financing to a property developer for the acquisition, development, and construction of a retail shopping center. The Company also expects to participate in the residual profit resulting from the ultimate sale or other use of the property. Classification and accounting for the ADC Arrangement as a loan, an investment in real estate, or a joint venture is determined by the Company’s evaluation of the characteristics and the risks and rewards of

 

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HCI GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share amounts, unless otherwise stated)

 

the ADC Arrangement. If the Company expects to receive more than 50% of the residual profit from the ADC Arrangement and it has characteristics similar to a real estate investment, the costs of the real estate project will be capitalized and interest will be recognized in net investment income.

In addition, the Company considers any rights or features embedded in the ADC Arrangement that may require bifurcation and derivative accounting. Due to its participation in the expected residual profit, which is deemed a variable interest, the Company evaluates its involvements in the design and essential activities of the entity to which the Company provides financing for possible consolidation as the primary beneficiary under the Variable Interest Model.

Any subsequent changes in terms, rights or the developer’s equity interest that may result in a reclassification or a change in the accounting treatment of the ADC Arrangement will be evaluated. The Company will continually assess the collectability of principal, accrued interest and fees.

Real estate and the related depreciable assets are carried at cost, net of accumulated depreciation, which is included in net investment income and allocated over the estimated useful life of the asset using the straight-line method of depreciation. Real estate is evaluated for impairment when events or circumstances indicate the carrying value of the real estate may not be recoverable.

Deferred policy acquisition costs. Deferred policy acquisition costs (“DAC”) primarily represent commissions paid to outside agents at the time of collection of the policy premium and premium taxes and are amortized over the life of the related policy in relation to the amount of gross premiums earned.

The method followed in computing DAC limits the amount of such deferred costs to their estimated realizable value, which gives effect to the gross premium earned, related investment income, unpaid losses and LAE and certain other costs expected to be incurred as the premium is earned.

DAC is reviewed to determine if it is recoverable from future income, including investment income. If such costs are determined to be unrecoverable, they are expensed at the time of determination. The amount of DAC considered recoverable could be reduced in the near term if the estimates of total revenues discussed above are reduced or permanently impaired as a result of the disposition of a line of business. The amount of amortization of DAC could be revised in the near term if any of the estimates discussed above are revised.

Property and Equipment. Property and equipment is stated at cost less accumulated depreciation and amortization, which is included in other operating expenses. Depreciation is calculated on a straight-line basis over the estimated useful lives as follows: building 39 years; computer hardware and software 3 years; office and furniture equipment 3 to 7 years. Leasehold improvements are amortized over the shorter of the lease term or the asset’s useful life. Expenditures for improvements are capitalized to the property accounts. Replacements and maintenance and repairs that do not improve or extend the life of the respective assets are expensed as incurred.

Impairment of Long-Lived Assets. Long-lived assets, such as property and equipment, are reviewed for impairment annually or whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. The Company assesses the recoverability of long-lived

 

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HCI GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share amounts, unless otherwise stated)

 

assets by determining whether the assets can be recovered from undiscounted future cash flows. Recoverability of long-lived assets is dependent upon, among other things, the Company’s ability to maintain profitability, so as to be able to meet its obligations when they become due. In the opinion of management, based upon current information and projections, long-lived assets will be recovered over the period of benefit.

Long-Term Debt. Long-term debt is generally classified as a liability and carried at amortized cost, net of any discount. At issuance, a debt instrument with embedded features such as conversion and redemption options is evaluated to determine whether bifurcation and derivative accounting is applicable. If such instrument is not subject to derivative accounting, it is further evaluated to determine if the Company is required to separately account for the liability and equity components.

To determine the carrying values of the liability and equity components at issuance, the Company measures the fair value of a similar liability, including any embedded features other than the conversion option, and assigns such value to the liability component. The liability component’s fair value is then subtracted from the initial proceeds to determine the carrying value of the debt instrument’s equity component, which is included in additional paid-in capital.

Any embedded feature other than the conversion option is evaluated at issuance to determine if it is probable that such embedded feature will be exercised. If the Company concludes that the exercisability of that embedded feature is not probable, the embedded feature is considered to be nonsubstantive and would not impact the initial measurement and expected life of the debt instrument’s liability component.

Transaction costs related to issuing a debt instrument that embodies both liability and equity components are allocated to the liability and equity components in proportion to the allocation of the proceeds and accounted for as debt issuance costs and equity issuance costs, respectively. Debt issuance costs are recognized in other assets. Both debt discount and deferred debt issuance costs are amortized to interest expense over the expected life of the debt instrument using the effective interest method. Equity issuance costs are a reduction to the proceeds allocated to the equity component.

Prepaid Share Repurchase Forward Contract. A prepaid share repurchase forward contract is generally a contract that allows the Company to buy from the counterparty a specified number of common shares at a specific time at a given forward price. The Company entered into such a contract in December 2013 and evaluated the characteristics of the forward contract to determine whether it met the definition of a derivative financial instrument pursuant to U.S. GAAP. The Company determined the forward contract is an equity contract on the Company’s common shares requiring physical settlement in common shares of the Company. As such, the transaction is recognized as a component of stockholders’ equity with a charge to additional paid-in capital equal to the prepayment amount, which represents the cash paid to the counterparty. There will be no recognition in earnings for changes in fair value in subsequent periods.

Losses and Loss Adjustment Expenses. Reserves for losses and loss adjustment expenses (“LAE”) are determined by establishing liabilities in amounts estimated to cover incurred losses and LAE. Such reserves are determined based on the assessment of claims reported and the development of pending claims. These reserves are based on individual case estimates for the reported losses and LAE and estimates of such amounts that are incurred but not reported. Changes in the estimated liability are charged or credited to income as the losses and LAE are settled.

 

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HCI GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share amounts, unless otherwise stated)

 

The estimates of unpaid losses and LAE are subject to trends in claim severity and frequency and are continually reviewed. As part of the process, the Company reviews historical data and considers 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 LAE. 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.

Advance Premiums. Premium payments received prior to the policy effective date are recorded as advance premiums. Once the policy is in force, the premiums are recorded as described under “Premium Revenue” below.

Reinsurance. In the normal course of business, the Company seeks to reduce the loss that may arise from catastrophes or other events that cause unfavorable underwriting results by reinsuring certain levels of risk in various areas of exposure with other insurance enterprises or reinsurers. The Company contracts with a number of reinsurers to secure its annual reinsurance coverage, which generally becomes effective June 1st each year. The Company purchases reinsurance each year taking into consideration probable maximum losses and reinsurance market conditions. Amounts recoverable from reinsurers would be estimated in a manner consistent with the applicable reinsurance contract(s). Reinsurance premiums and reserves related to reinsured business are accounted for on a basis consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts. Premiums ceded to other companies have been reported as a reduction of gross premiums earned. Prepaid reinsurance premiums represent the unexpired portion of premiums ceded to reinsurers.

Certain of the Company’s current contracts contain retrospective provisions including terms and conditions that adjust premiums, increase the amount of future coverage, or result in profit commissions based on the loss experience under the contracts. In such cases, a with-and-without method is used to estimate the asset or liability amount to be recognized at each reporting date. The amount of the estimate is the difference between the net contract costs before and after the loss experience under the contract. Estimates related to premium adjustments, profit commissions and coverage changes are recognized in ceded premiums earned. These estimates are reviewed monthly based on the loss experience to date and as adjustments become necessary. Such adjustments are reflected in the Company’s current operations and recorded in other assets until received upon the expiration of the contracts.

Premium Revenue. Premium revenue is earned on a daily pro-rata basis over the term of the policies and is included in gross premiums earned. Unearned premiums represent the portion of the premium related to the unexpired policy term. The Company reviews its policy detail and establishes an allowance for any amount outstanding for more than 90 days. As of December 31, 2014 and 2013, there was no allowance required.

 

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HCI GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share amounts, unless otherwise stated)

 

Policy Fees. Policy fees represent nonrefundable fees for insurance coverage, which are intended to reimburse a portion of the costs incurred to underwrite the policy. Effective October 1, 2013 on a prospective basis, policy fees are recognized ratably over the policy coverage period. Prior to October 1, 2013, the fees were recognized in income when the policy was written on the basis that the revenues were appropriately matched to the Company’s incremental direct costs related to policy underwriting.

Florida Insurance Guaranty Association Assessments. The Company may be assessed by the state guaranty association. The assessments are intended to be used for the payment of covered claims of insolvent insurance entities. The assessments are generally based on a percentage of premiums written during or following the year of insolvency. Liabilities are recognized when the assessments are probable to be imposed on the premiums on which they are expected to be based and the amounts can be reasonably estimated. The Company is permitted by Florida statutes to recover the entire amount of assessments from in-force and future policyholders through policy surcharges. U.S. GAAP provides that the Company should record an asset based on the amount of written or obligated-to-write premiums and limited to the amounts recoverable over the life of the in-force policies.

Foreign Currency. The functional currency of the Company’s Indian subsidiary is the U.S. dollar. As such, the monetary assets and liabilities of this subsidiary are remeasured into U.S. dollars at the exchange rate in effect on the balance sheet date. Non-monetary assets and liabilities are remeasured using historical rates. Expenses recorded in the local currency are remeasured at the prevailing exchange rate. Exchange gains and losses resulting from these remeasurements are included in other operating expenses.

Income Taxes. The Company files consolidated federal and state income tax returns and allocates taxes among its wholly owned subsidiaries in accordance with a written tax-allocation agreement.

The Company accounts for income taxes in accordance with U.S. GAAP, resulting in two components of income tax expense: current and deferred. Current income tax expense reflects taxes to be paid or refunded for the current period by applying the provisions of the enacted tax law to the taxable income or excess of deductions over revenues. The Company determines deferred income taxes using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is based on the tax effects of the differences between the book and tax bases of assets and liabilities, and enacted changes in tax rates and laws are recognized in the period in which they occur.

Deferred income tax expense results from changes in deferred tax assets and liabilities between periods. Deferred tax assets are recognized if it is more likely than not, based on the technical merits, that the tax position will be realized or sustained upon examination. The term “more likely than not” means a likelihood of more than fifty percent; the terms “examined” and “upon examination” also include resolution of the related appeals or litigation processes, if any. A tax position that meets the more-likely-than-not recognition threshold is initially and subsequently measured as the largest amount of tax benefit that has a greater than fifty percent likelihood of being realized upon settlement with a taxing authority that has full knowledge of all relevant information. The determination of whether or not a tax position has met the more-likely-than-not recognition threshold considers the facts, circumstances,

 

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HCI GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share amounts, unless otherwise stated)

 

and information available at the reporting date and is subject to management’s judgment. Deferred tax assets are reduced by a valuation allowance if, based on the weight of evidence available, it is more likely than not that some portion or all of a deferred tax asset will not be realized. As of December 31, 2014, management is not aware of any uncertain tax positions that would have a material effect on the Company’s consolidated financial statements.

Fair Value of Financial Instruments. The carrying amounts for the Company’s cash and cash equivalents approximate their fair values at December 31, 2014 and 2013. Fair values for securities are based on the framework for measuring fair value established by U.S. GAAP (see Note 5 — “Fair Value Measurements”).

Stock-Based Compensation. The Company accounts for stock-based compensation under the fair value recognition provisions of U.S. GAAP which requires the measurement and recognition of compensation for all stock-based awards made to employees and directors including stock options and restricted stock issuances based on estimated fair values. In accordance with U.S. GAAP, the fair value of stock-based awards is generally recognized as compensation expense over the requisite service period, which is defined as the period during which an employee is required to provide service in exchange for an award. The Company uses a straight-line attribution method for all grants that include only a service condition. The Company’s restricted stock awards include service, market and performance conditions. As a result, restricted stock grants with market condition are expensed over the derived service period for each separately vesting tranche. For awards with performance conditions, the Company recognizes compensation expense over the requisite service period when it is probable that the performance condition will be achieved. Compensation expense related to all awards is included in other operating expense.

Basic and diluted earnings per common share. Basic earnings per common share is computed by dividing net income attributable to common stockholders by the weighted-average number of common shares outstanding for the period. U.S. GAAP requires the inclusion of restricted stock as participating securities since holders of the Company’s restricted stock have the right to share in dividends, if declared, equally with common stockholders. During periods of net income, participating securities are allocated a proportional share of net income determined by dividing total weighted-average participating securities by the sum of total weighted-average common shares and participating securities (the “two-class method”). Diluted earnings per common share reflect the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted as well as participating equities. See Note 13 — “Earnings Per Share” for potentially dilutive securities at December 31, 2014, 2013 and 2012.

Reclassifications. Certain reclassifications of prior year amounts have been made to conform to the current year presentation.

Note 3 — Recent Accounting Pronouncements

Accounting Standards Update No. 2014-15. In August 2014, the FASB issued Accounting Standards Update No. 2014-15 (“ASU 2014-15”), Presentation of Financial Statements – Going Concern (Subtopic 205-40). The purpose of this update is to provide guidance about management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a

 

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HCI GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share amounts, unless otherwise stated)

 

going concern and to provide related footnote disclosures. ASU 2014-15 applies to all reporting entities and is effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter. Early adoption is permitted. Adoption of this guidance is expected to have no effect on the Company’s consolidated financial statements.

Accounting Standards Update No. 2014-12. In June 2014, the FASB issued Accounting Standards Update No. 2014-12 (“ASU 2014-12”), Compensation – Stock Compensation (Topic 718). ASU 2014-12 applies to all reporting entities that grant employees share-based payments in which the terms of the award provide that a performance target affecting vesting could be achieved after the requisite service period. ASU 2014-12 is effective for all entities for reporting periods beginning after December 15, 2015. Early adoption is permitted. Entities may apply the amendments in this Update either (a) prospectively to all awards granted or modified after the effective date or (b) retrospectively to all awards with performance targets that are outstanding as of the beginning of the earliest annual period presented in the financial statements and to all new or modified awards thereafter. Although the Company has share-based awards with performance targets, such awards do not permit vesting when a performance target is achieved after termination of an employee’s service. Adoption of this guidance had no effect on the Company’s consolidated financial statements.

Accounting Standards Update No. 2014-09. In May 2014, the FASB issued Accounting Standards Update No. 2014-09 (“ASU 2014-09”), Revenue from Contracts with Customers (Topic 606). The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 supersedes the revenue recognition requirements in Topic 605, Revenue Recognition, and most industry-specific guidance throughout the Industry Topics of the Codification. ASU 2014-09 also amends the existing requirements for the recognition of a gain or loss on the transfer of nonfinancial assets that are not in a contract with a customer to be consistent with the guidance in this ASU. ASU 2014-09 is effective for public entities for reporting periods beginning after December 15, 2016. Early adoption is not permitted. While the guidance specifically excludes revenues from insurance contracts, investments and financial instruments from the scope of the new guidance, the guidance will be applicable to the Company’s other forms of revenue not specifically exempted from the guidance. The adoption of this guidance is not expected to have a material effect on the Company’s consolidated financial statements.

 

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HCI GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share amounts, unless otherwise stated)

 

Note 4 — Investments

The Company holds investments in fixed-maturity securities and equity securities that are classified as available-for-sale. At December 31, 2014 and 2013, the cost or amortized cost, gross unrealized gains and losses, and estimated fair value of the Company’s available-for-sale securities by security type were as follows:

 

     Cost or
Amortized
Cost
     Gross
Unrealized
Gain
     Gross
Unrealized
Loss
     Estimated
Fair

Value
 

As of December 31, 2014

           

Fixed-maturity securities

           

U.S. Treasury and U.S. government agencies

   $ 3,747       $ 9       $ (8    $ 3,748   

Corporate bonds

     24,342         57         (430      23,969   

Mortgage-backed securities

     2,138         4         (3      2,139   

State, municipalities, and political subdivisions

     56,336         1,205         (38      57,503   

Redeemable preferred stock

     9,433         178         (54      9,557   

Other

     167         1         —           168   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

  96,163      1,454      (533   97,084   

Equity securities

  45,387      1,694      (1,531   45,550   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available-for-sale securities

$ 141,550    $ 3,148    $ (2,064 $ 142,634   
  

 

 

    

 

 

    

 

 

    

 

 

 

As of December 31, 2013

Fixed-maturity securities

U.S. Treasury and U.S. government agencies

$ 4,549    $ 37    $ (22 $ 4,564   

Corporate bonds

  25,139      484      (219   25,404   

Mortgage-backed securities

  10,929      499      (96   11,332   

State, municipalities, and political subdivisions

  69,715      917      (181   70,451   

Redeemable preferred stock

  406      5      (11   400   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

  110,738      1,942      (529   112,151   

Equity securities

  17,248      920      (519   17,649   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available-for-sale securities

$ 127,986    $ 2,862    $ (1,048 $ 129,800   
  

 

 

    

 

 

    

 

 

    

 

 

 

At December 31, 2014 and 2013, $113 and $105, respectively, of U.S. Treasury securities relate to a statutory deposit held in trust for the Treasurer of Alabama.

Expected maturities will differ from contractual maturities as borrowers may have the right to call or prepay obligations with or without penalties. The scheduled contractual maturities of fixed-maturity securities at December 31, 2014 and 2013 are as follows:

 

     December 31,  
     2014      2013  
     Amortized
Cost
     Estimated
Fair
Value
     Amortized
Cost
     Estimated
Fair

Value
 

Available-for-sale

           

Due in one year or less

   $ 715       $ 721       $ 2,366       $ 2,381   

Due after one year through five years

     25,973         26,093         24,829         25,145   

Due after five years through ten years

     57,157         57,560         59,083         59,582   

Due after ten years

     10,180         10,571         13,531         13,711   

Mortgage-backed securities

     2,138         2,139         10,929         11,332   
  

 

 

    

 

 

    

 

 

    

 

 

 
$ 96,163    $ 97,084    $ 110,738    $ 112,151   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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HCI GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share amounts, unless otherwise stated)

 

Sales of Available-for-Sale Securities

Proceeds received, and the gross realized gains and losses from sales of available-for-sale securities, for the years ended December 31, 2014, 2013 and 2012 were as follows:

 

     Proceeds      Gross
Realized
Gains
     Gross
Realized
Losses
 

Year ended December 31, 2014

        

Fixed-maturity securities

   $ 98,365       $ 4,096       $ (98
  

 

 

    

 

 

    

 

 

 

Equity securities

$ 16,810    $ 1,372    $ (635
  

 

 

    

 

 

    

 

 

 

Year ended December 31, 2013

Fixed-maturity securities

$ 1,749    $ 92    $ (4
  

 

 

    

 

 

    

 

 

 

Equity securities

$ 2,809    $ 155    $ (163
  

 

 

    

 

 

    

 

 

 

Year ended December 31, 2012

Fixed-maturity securities

$ 8,991    $ 421    $ (6
  

 

 

    

 

 

    

 

 

 

Equity securities

$ 1,735    $ 91    $ (230
  

 

 

    

 

 

    

 

 

 

Other-than-temporary Impairment

The Company regularly reviews its individual investment securities for other-than-temporary impairment. The Company considers various factors in determining whether each individual security is other-than-temporarily impaired, including:

 

    the financial condition and near-term prospects of the issuer, including any specific events that may affect its operations or earnings;

 

    the length of time and the extent to which the market value of the security has been below its cost or amortized cost;

 

    general market conditions and industry or sector specific factors;

 

    nonpayment by the issuer of its contractually obligated interest and principal payments; and

 

    the Company’s intent and ability to hold the investment for a period of time sufficient to allow for the recovery of costs.

 

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HCI GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share amounts, unless otherwise stated)

 

Securities with gross unrealized loss positions at December 31, 2014 and 2013, aggregated by investment category and length of time the individual securities have been in a continuous loss position, are as follows:

 

     Less Than Twelve Months      Twelve Months or
Greater
     Total  
     Gross
Unrealized
Loss
    Estimated
Fair

Value
     Gross
Unrealized
Loss
    Estimated
Fair
Value
     Gross
Unrealized
Loss
    Estimated
Fair
Value
 

As of December 31, 2014

              

Fixed-maturity securities

              

U.S. treasury and U.S. government agencies

   $ (8   $ 2,485       $ —        $ —         $ (8   $ 2,485   

Corporate bonds

     (428     12,929         (2     998         (430     13,927   

Mortgage-backed securities

     (3     1,018         —          —           (3     1,018   

State, municipalities, and political subdivisions

     (19     3,144         (19     202         (38     3,346   

Redeemable preferred stock

     (54     2,586         —          —           (54     2,586   
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total fixed-maturity securities

  (512   22,162      (21   1,200      (533   23,362   

Equity securities

  (1,449   18,848      (82   4,619      (1,531   23,467   
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total available-for-sale securities

$ (1,961 $ 41,010    $ (103 $ 5,819    $ (2,064 $ 46,829   
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

At December 31, 2014, there were 94 securities in an unrealized loss position. Of these securities, 9 securities had been in an unrealized loss position for 12 months or greater.

 

     Less Than Twelve Months      Twelve Months or
Greater
     Total  
     Gross
Unrealized
Loss
    Estimated
Fair

Value
     Gross
Unrealized
Loss
    Estimated
Fair
Value
     Gross
Unrealized
Loss
    Estimated
Fair
Value
 

As of December 31, 2013

              

Fixed-maturity securities

              

U.S. treasury and U.S. government agencies

   $ (22   $ 3,291       $ —        $ —         $ (22   $ 3,291   

Corporate bonds

     (212     9,502         (7     230         (219     9,732   

Mortgage-backed securities

     (96     2,179         —          —           (96     2,179   

State, municipalities, and political subdivisions

     (181     20,233         —          —           (181     20,233   

Redeemable preferred stock

     (11     239         —          —           (11     239   
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total fixed-maturity securities

  (522   35,444      (7   230      (529   35,674   

Equity securities

  (273   10,742      (246   1,069      (519   11,811   
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total available-for-sale securities

$    (795 $ 46,186    $ (253 $ 1,299    $ (1,048 $ 47,485   
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

At December 31, 2013, there were 100 securities in an unrealized loss position. Of these securities, 8 securities had been in an unrealized loss position for 12 months or greater.

Based on the review, the Company believes the unrealized losses on investments in fixed-maturity securities were caused by interest rate changes. Because the decline in fair value is attributable to changes in interest rates or market conditions and not credit quality, and because the Company has the ability and intent to hold these securities and it is not more likely than not that the Company will be required to sell these securities until a market price recovery or maturity, the Company does not consider any of its fixed-maturity securities to be other-than-temporarily impaired at December 31, 2014 and 2013.

 

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HCI GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share amounts, unless otherwise stated)

 

In determining whether equity securities are other than temporarily impaired, the Company considers its intent and ability to hold a security for a period of time sufficient to allow for the recovery of cost. In the fourth quarter of 2014, the Company determined that one equity security was other-than-temporarily impaired after considering the length of time this security had been in an unrealized loss position, the extent of the decline and its near term prospect of recovery. As a result, the Company recognized an impairment charge of $107 in net investment income.

Limited Partnership Investment

During the fourth quarter of 2014, the Company entered into a subscription agreement to invest up to a maximum of $12,500 for a 16.5% limited partnership interest. The primary investment strategy of the partnership is to invest in senior secured loans and, to a limited extent, in other debt and equity securities of private U.S. lower-middle-market companies. Except under certain circumstances, the Company is not permitted to withdraw any amount of its capital investment for a minimum of 10 years. The Company’s involvement is limited to that of a passive investor. As such, the Company is not the primary beneficiary and does not consolidate the partnership. For the year ended December 31, 2014, the Company recognized a $90 investment loss in net investment income. At December 31, 2014, the Company’s contributed capital to the partnership is $2,640 and its carrying value and maximum exposure to loss is $2,550.

Investment in Joint Venture

In September 2014, Melbourne FMA, LLC, a wholly owned subsidiary, entered into a joint venture agreement with FMKT Sponsor, LLC to organize FMKT Mel JV, LLC (“FMJV”), a Florida limited liability company. Melbourne FMA and FMKT Sponsor contributed cash of $4,500 and $500, respectively, for equity interests in FMJV of 90% and 10%, respectively. The joint venture will acquire and develop land on which the joint venture partners plan to construct a retail shopping center for lease or for sale in Melbourne, Florida. FMJV is deemed a VIE due to its lack of sufficient equity to finance its operations without direct or indirect additional financial support from parties to the joint venture. Although Melbourne FMA holds a majority interest in FMJV, certain major economic decisions specified in the agreement are not under Melbourne FMA’s control. As a result, Melbourne FMA is not the primary beneficiary and is not required to consolidate FMJV.

In addition, FMJV is contractually required to engage affiliates of FMKT Sponsor to manage and develop the project, and also operate the property while the joint venture agreement is in effect. The agreement includes FMKT Sponsor’s right of sale and first offer as well as an embedded option under which Melbourne FMA can purchase the entire interest of FMKT Sponsor. Under the right of sale and first offer, Melbourne FMA can either choose to purchase the interest of FMKT Sponsor in the developed property or approve the sale of the developed property to a third party buyer. Either party can initiate these provisions after the expiration of a restricted period.

 

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Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share amounts, unless otherwise stated)

 

At December 31, 2014, the Company’s maximum exposure to loss relating to the VIE was $4,477 representing the carrying value of the investment. At December 31, 2014, an undistributed $23 loss from equity method investees was included in consolidated retained income. The joint venture partners received no distributions during 2014. The following tables provide summarized operating results and the financial position of FMJV:

 

     Year Ended
December 31, 2014
 
     (Unaudited)  

Operating results:

  

Revenue

   $ —     

Operating expenses

     25   
  

 

 

 

Net loss

$ (25
  

 

 

 

Melbourne FMA’s share of net loss*

$ (23

 

* Included in net investment income in the Company’s consolidated statements of income.

 

     December 31,
2014
 
     (Unaudited)  

Balance Sheet:

  

Construction in progress - real estate

   $ 3,612   

Cash

     1,323   

Other

     40   
  

 

 

 

Total assets

$ 4,975   
  

 

 

 

Other liabilities

  —     

Members’ capital

  4,975   
  

 

 

 

Total liabilities and members’ capital

$ 4,975   
  

 

 

 

Investment in joint venture, at equity

$ 4,477   

Real Estate Investments

Real estate investments consist of the ADC Arrangement and the Company’s real estate portfolio and the related assets of the marina and restaurant facilities. Operating activities related to the Company’s real estate investments include leasing of office and retail space to tenants, wet and dry boat storage, a restaurant, and fuel services with respect to marina clients and recreational boaters.

 

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Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share amounts, unless otherwise stated)

 

Real estate investments consist of the following as of December 31, 2014 and 2013:

 

     December 31,  
     2014      2013  

Land

   $ 11,476       $ 11,299   

Land improvements

     1,425         1,351   

Building

     3,097         3,022   

Other

     1,359         1,262   
  

 

 

    

 

 

 

Total, at cost

  17,357      16,934   

Less: accumulated depreciation and amortization

  (1,107   (706
  

 

 

    

 

 

 

Real estate, net

  16,250      16,228   

ADC Arrangement classified as real estate investment

  2,888      —     
  

 

 

    

 

 

 

Real estate investments

$ 19,138    $ 16,228   
  

 

 

    

 

 

 

Depreciation and amortization expense for other investments was $402, $388 and $279, respectively, for the years ended December 31, 2014, 2013 and 2012.

ADC Arrangement

In June 2014, the Company’s wholly owned subsidiary, Greenleaf Capital, LLC, entered into an ADC Arrangement under which it agreed to provide financing up to a maximum of $9,785 for the acquisition, development and construction of a retail shopping center and appurtenant facilities. Greenleaf Capital has an option to purchase the property when the construction project is completed contingent upon tenant rental commitments for at least 90% of rentable space being secured by the developer. The purchase price is calculated at maturity of the loan using a predetermined capitalization rate and the projected net operating income of the developed property. The loan has an initial term of 24 months and can be extended for an additional 12 months if the purchase option is not exercised by Greenleaf Capital. Prepayment is not permitted while the ADC Arrangement is in effect. The loan bears a fixed annual interest rate of 6% due monthly in arrears. The loan agreement is secured by a) a first mortgage on the land and improvements, b) assignment of all leases, rents, issues, and profits from the land and improvements, and c) personal guarantees.

Under this ADC Arrangement, Greenleaf Capital will provide substantially all necessary funds to complete the development and Greenleaf Capital will receive the entire residual profit of the developed property if it exercises the purchase option. The developer may make multiple draws on the credit facility as the construction progresses. Based on the characteristics of this ADC Arrangement which are similar to those of an investment, combined with the expected residual profit being greater than 50%, the arrangement is accounted for and reported in the balance sheet as a real estate investment. All project costs associated with the ADC Arrangement are capitalized. The loan commitment fee received by Greenleaf Capital is deferred and recognized in investment income on a straight-line basis over the term of the loan agreement.

Because of the purchase option and the substantial financial support provided by Greenleaf Capital, the developer who has no equity interest in the property is a VIE. However, Greenleaf Capital’s involvement is solely as the lender on the mortgage loan with protective rights as the lender. Greenleaf Capital does not have power to direct the activities that most significantly impact economic performance of the VIE. As a result, Greenleaf Capital is not the primary beneficiary and is not required to consolidate the VIE. At December 31, 2014, the Company’s maximum exposure to loss relating to the VIE was $2,888 representing the carrying value of the ADC Arrangement.

 

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HCI GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share amounts, unless otherwise stated)

 

In addition, Greenleaf Capital determined that the option to purchase the entire developed property is not a derivative financial instrument pursuant to U.S. GAAP. As such, the embedded feature is not required to be bifurcated and the fair value accounting for the embedded feature at each reporting date is not applicable.

Net Investment Income (Loss)

Net investment income (loss), by source, is summarized as follows:

 

     Years Ended December 31,  
     2014      2013      2012  

Available-for-sale securities:

        

Fixed-maturity securities

   $ 3,339       $ 1,868       $ 1,464   

Equity securities

     2,364         499         492   

Other-than-temporary impairment charge

     (107      —           —     

Investment expense

     (436      (210      (150

Limited partnership investment

     (90      —           —     

Time deposits

     —           —           357   

Real estate investments

     (955      (1,045      (1,334

Cash and cash equivalents

     666         357         151   
  

 

 

    

 

 

    

 

 

 
$ 4,781    $ 1,469    $ 980   
  

 

 

    

 

 

    

 

 

 

At December 31, 2014, $234,025 or 74.4% of the Company’s cash and cash equivalents were deposited at three national banks and included $48,674 in three custodial accounts. At December 31, 2013, $241,378 or 82.3% of the Company’s cash and cash equivalents were deposited at three national banks and included $22,252 in two custodial accounts.

Note 5 — Fair Value Measurements

The Company records and discloses certain financial assets at their estimated fair value. The fair value hierarchy prioritizes the inputs to valuation techniques used to measure fair value into three broad levels as follows:

Level 1 – Unadjusted quoted prices in active markets for identical assets.

Level 2 – Other inputs that are observable for the asset, either directly or indirectly.

Level 3 – Inputs that are unobservable.

Valuation Methodology

Cash and cash equivalents

Cash and cash equivalents primarily consist of money-market funds. Their carrying value approximates fair value due to the short maturity and high liquidity of these funds.

 

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HCI GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share amounts, unless otherwise stated)

 

Available-for-sale securities

Estimated fair values of the Company’s available-for-sale securities are determined in accordance with U.S. GAAP, using valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. Fair values are generally measured using quoted prices in active markets for identical securities or other inputs that are observable either directly or indirectly, such as quoted prices for similar securities. In those instances where observable inputs are not available, fair values are measured using unobservable inputs. Unobservable inputs reflect the Company’s own assumptions about the assumptions that market participants would use in pricing the security and are developed based on the best information available in the circumstances. Fair value estimates derived from unobservable inputs are significantly affected by the assumptions used, including the discount rates and the estimated amounts and timing of future cash flows. The derived fair value estimates cannot be substantiated by comparison to independent markets and are not necessarily indicative of the amounts that would be realized in a current market exchange.

The estimated fair values for securities that do not trade on a daily basis are determined by management, utilizing prices obtained from an independent pricing service and information provided by brokers. Management reviews the assumptions and methods utilized by the pricing service and then compares the relevant data and pricing to broker-provided data. The Company gains assurance of the overall reasonableness and consistent application of the assumptions and methodologies and compliance with accounting standards for fair value determination through ongoing monitoring of the reported fair values.

ADC Arrangement Classified as Real Estate Investment

As described in Note 4 — “Investments” under ADC Arrangement, the ADC Arrangement represents a financing agreement with a purchase option between Greenleaf Capital and a property developer. Based on the characteristics of this ADC Arrangement which are similar to those of an investment, combined with the expected residual profit being greater than 50%, the arrangement is included in real estate investments at its carrying value in the balance sheet. Projected future cash inflows at maturity are discounted using a prevailing borrowing rate to estimate its fair value that relies on Level 3 inputs.

Limited Partnership Investment

As described in Note 4 — “Investments” under Limited Partnership Investment, the Company entered into a subscription agreement to invest up to a maximum of $12,500 for a 16.5% limited partnership interest. The initial contribution was made in December 2014. Valuation of the Company’s limited partnership interest will be based upon the net asset value provided by the fund manager. The net asset value will be on a three- to six-month lag and was not available as of December 31, 2014 as the partnership was newly formed during the quarter ended December 31, 2014.

 

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HCI GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share amounts, unless otherwise stated)

 

Long-term debt

Long-term debt includes the Company’s 8% senior notes due 2020 and 3.875% convertible senior notes due 2019. The 8% senior notes were initially sold to the public in January 2013 and trade on the New York Stock Exchange. The estimated fair value of the 8% senior notes is based on the closing market price on December 31, 2014. The 3.875% convertible senior notes were sold in a private offering completed on December 30, 2013. The fair value of the 3.875% convertible senior notes is estimated using a discounted cash flow method that relies on Level 3 inputs.

Assets Measured at Estimated Fair Value on a Recurring Basis:

The following tables present information about the Company’s financial assets measured at estimated fair value on a recurring basis. The table indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value as of December 31, 2014 and 2013:

 

     Fair Value Measurements Using         
     (Level 1)      (Level 2)      (Level 3)      Total  

As of December 31, 2014

           

Financial Assets:

           

Cash and cash equivalents

   $ 314,716       $ —         $ —         $ 314,716   
  

 

 

    

 

 

    

 

 

    

 

 

 

Fixed-maturity securities:

U.S. Treasury and U.S. government agencies

  1,069      2,679      —        3,748   

Corporate bonds

  22,274      1,695      —        23,969   

Mortgage-backed securities

  —        2,139      —        2,139   

State, municipalities, and political subdivisions

  —        57,503      —        57,503   

Redeemable preferred stock

  9,557      —        —        9,557   

Other

  —        168      —        168   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total fixed-maturity securities

  32,900      64,184      —        97,084   

Equity securities

  45,550      —        —        45,550   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available-for-sale securities

  78,450      64,184      —        142,634   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

$ 393,166    $ 64,184    $ —      $ 457,350   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     Fair Value Measurements Using         
     (Level 1)      (Level 2)      (Level 3)      Total  

As of December 31, 2013

           

Financial Assets:

           

Cash and cash equivalents

   $ 293,398       $ —         $ —         $ 293,398   
  

 

 

    

 

 

    

 

 

    

 

 

 

Fixed-maturity securities:

U.S. Treasury and U.S. government agencies

  3,520      1,044      —        4,564   

Corporate bonds

  24,476      928      —        25,404   

Mortgage-backed securities

  —        11,332      —        11,332   

State, municipalities, and political subdivisions

  —        70,451      —        70,451   

Redeemable preferred stock

  400      —        —        400   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total fixed-maturity securities

  28,396      83,755      —        112,151   

Equity securities

  17,649      —        —        17,649   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available-for-sale securities

  46,045      83,755      —        129,800   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

$ 339,443    $ 83,755    $ —      $ 423,198   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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HCI GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share amounts, unless otherwise stated)

 

There were no transfers between Level 1, 2 or 3 during the year ended December 31, 2014. During the second quarter of 2013, the Company analyzed its investment portfolio and determined the municipal bonds, which were previously classified as Level 1, should be classified as Level 2 based on the inputs used to measure fair value and the level of market activity in those instruments. As such, transfers into Level 2 from Level 1 were $10,684 during the year ended December 31, 2013.

Assets and Liabilities Carried at Other Than Fair Value

The following tables present fair value information for assets and liabilities that are carried on the balance sheet at amounts other than fair value as of December 31, 2014 and 2013:

 

     Fair Value Measurements Using         
     (Level 1)      (Level 2)      (Level 3)      Total  

As of December 31, 2014

           

Financial Assets:

           

ADC Arrangement classified as real estate investment

   $ —         $ —         $ 2,835       $ 2,835   

Financial Liabilities:

           

Long-term debt:

           

8% Senior notes

   $ —         $ 42,955       $ —         $ 42,955   

3.875% Convertible senior notes

     —           —           93,367         93,367   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total long-term debt

$ —      $ 42,955    $ 93,367    $ 136,322   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     Fair Value Measurements Using         
     (Level 1)      (Level 2)      (Level 3)      Total  

As of December 31, 2013

           

Financial Liabilities:

           

Long-term debt:

           

8% Senior notes

   $ —         $ 43,390       $ —         $ 43,390   

3.875% Convertible senior notes

     —           —           86,630         86,630   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total long-term debt

$ —      $ 43,390    $ 86,630    $ 130,020   
  

 

 

    

 

 

    

 

 

    

 

 

 

Note 6 — Deferred Policy Acquisition Costs

The following table summarizes the activity with respect to deferred policy acquisition costs:

 

     December 31,  
     2014      2013  

Beginning balance

   $ 14,071       $ 10,032   

Policy acquisition costs deferred

     33,861         31,097   

Amortization

     (32,918      (27,058
  

 

 

    

 

 

 

Ending balance

$   15,014    $   14,071   
  

 

 

    

 

 

 

The amount of policy acquisition costs amortized and included in policy acquisition and other underwriting expenses for the years ended December 31, 2014, 2013 and 2012 was $32,918, $27,058 and $18,273, respectively.

 

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Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share amounts, unless otherwise stated)

 

Note 7 — Property and Equipment, net

Property and equipment, net consists of the following:

 

     December 31,  
     2014      2013  

Land

   $ 1,642       $ 1,642   

Building

     7,622         7,596   

Computer hardware and software

     1,617         1,486   

Office furniture and equipment

     1,647         1,407   

Tenant and leasehold improvements

     3,093         3,093   

Other

     691         629   
  

 

 

    

 

 

 

Total, at cost

  16,312      15,853   

Less: accumulated depreciation and amortization

  (4,020   (2,721
  

 

 

    

 

 

 

Property and equipment, net

$   12,292    $   13,132   
  

 

 

    

 

 

 

In February 2013, the Company purchased real estate in Ocala, Florida for a total purchase price of $2,002. At acquisition, the real estate consisted of 1.6 acres of land and a vacant office building with rentable area of approximately 16,000 square feet. The facility is currently used by the Company’s insurance operations and, also, as an alternative location in the event a catastrophic event impacts the Company’s home office and other support operations.

Depreciation and amortization expense under property and equipment was $1,304, $1,151 and $848, respectively, for the years ended December 31, 2014, 2013 and 2012.

Note 8 — Other Assets

The following table summarizes the Company’s other assets:

 

     December 31,  
     2014      2013  

Benefits receivable related to retrospective reinsurance contracts

   $ 28,123       $ 8,815   

Deferred costs related to retrospective reinsurance contracts

     473         194   

Deferred offering costs on senior notes issued in 2013

     3,653         4,305   

Prepaid expenses

     1,444         771   

Other

      1,594          1,729   
  

 

 

    

 

 

 

Total other assets

$   35,287    $   15,814   
  

 

 

    

 

 

 

In June 2014, the Company received $1,485 under the terms of one of the retrospective reinsurance contracts, which terminated May 31, 2014.

 

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Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share amounts, unless otherwise stated)

 

Note 9 — Long-Term Debt

The following table summarizes the Company’s long-term debt:

 

     December 31,  
     2014      2013  

8% Senior Notes, due January 30, 2020

   $ 40,250       $ 40,250   

3.875% Convertible Senior Notes, due March 15, 2019*

      89,289          86,682   
  

 

 

    

 

 

 

Total long-term debt

$ 129,539    $ 126,932   
  

 

 

    

 

 

 

 

* net carrying value

8% Senior Notes

On January 17, 2013, the Company completed the sale of unsecured senior notes in a public offering for an aggregate principal amount of $35,000. In addition, effective January 25, 2013, the Company received an aggregate principal amount of $5,250 pursuant to the underwriters’ exercise of the over-allotment option. The offering was made pursuant to the Company’s effective registration statement on Form S-3, as amended (Registration Statement No. 333-185228) and the prospectus supplement dated January 10, 2013. The combined net proceeds were $38,690 after underwriting and issuance costs of approximately $1,560, of which $1,525 was paid during the year ended December 31, 2013. The notes will mature on January 30, 2020 and bear interest at a fixed annual rate of 8% payable quarterly on January 30, April 30, July 30 and October 30, commencing on April 30, 2013. The notes may be redeemed, in whole or in part, at any time on and after January 30, 2016 upon not less than 30 or more than 60 days’ notice. The redemption price will be equal to 100% of the principal amount redeemed plus accrued and unpaid interest. Additionally, the Company may, at any time, repurchase the senior notes at any price in the open market and may hold, resell or surrender the notes for cancellation.

The senior notes rank on parity with all of the Company’s other existing and future senior unsecured obligations. In addition, to the extent the senior notes are unsecured, they also rank junior in right of payment to any secured debt that the Company may have outstanding to the extent of the value of the assets securing such debt.

The senior notes contain customary restrictive covenants relating to merger, modification of the indenture, subordination, issuance of debt securities and sale of assets, the most significant of which include limitations with respect to certain designated subsidiaries on the incurrence of additional indebtedness or guarantees secured by any security interest on any shares of their capital stock. The senior note covenants also limit the Company’s ability to sell or otherwise dispose of any shares of capital stock of such designated subsidiaries. The senior note covenants do not contain any restrictions on the Company’s payment or declaration of dividends nor require a sinking fund to be established for the purpose of redemption.

Interest expense with respect to the senior notes was approximately $3,403 and $3,228, respectively, for the years ended December 31, 2014 and 2013 and included amortization of debt issuance costs of approximately $182 and $159, respectively. The effective interest rate, taking into account the stated interest expense and amortization of debt issuance costs, approximates 8.7%.

 

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Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share amounts, unless otherwise stated)

 

3.875% Convertible Senior Notes

On December 11, 2013, the Company issued 3.875% Convertible Senior Notes (the “Convertible Notes”) in a private offering for an aggregate principal amount of $100,000. In addition, pursuant to the over-allotment option exercised by the underwriters, the Company received an aggregate principal amount of $3,000 on December 30, 2013. The aggregate net proceeds of the Convertible Notes were $99,514, after $3,486 in related issuance and transaction costs. The Convertible Notes rank equally in right of payment to the Company’s existing and future unsecured and unsubordinated obligations. The Convertible Notes bear interest at a rate of 3.875% per year, payable semiannually in arrears on March 15 and September 15 of each year. The Convertible Notes will mature on March 15, 2019 unless repurchased or converted prior to such date. The Company may not redeem the Convertible Notes prior to maturity unless requested by the note holders under certain events specified in the indenture.

The Convertible Notes do not contain any financial or operating covenants or restrictions on the payments of dividends, the incurrence of indebtedness or the issuance or repurchase of securities by the Company or any of its subsidiaries. The Convertible Notes provide no protection to the note holders in the event of a fundamental change or other corporate transaction involving the Company except those described in the indenture to the Convertible Notes. The Convertible Notes do not require a sinking fund to be established for the purpose of redemption.

In conjunction with the issuance of the Convertible Notes, the Company entered into a prepaid stock repurchase forward contract and used $29,923 of the net proceeds from the Convertible Notes offering to repurchase the Company’s common stock. See Note 14 — “Stockholders’ Equity” for the effect of the repurchase forward contract on earnings per share.

For the years ended December 31, 2014 and 2013, interest expense applicable to the Convertible Notes included the contractual interest coupon, discount amortization and amortization of allocated issuance costs aggregating $7,050 and $379, respectively, the amounts of which included non-cash interest expense of $3,070 and $164. The effective interest rate, taking into account both cash and non-cash components, approximates 8.3%. As of December 31, 2014, the remaining amortization period of the debt discount was expected to be 4.2 years.

The following table summarizes information regarding the equity and liability components of the Convertible Notes:

 

     December 31,  
     2014      2013  

Principal amount

   $ 103,000       $ 103,000   

Unamortized discount

     (13,711      (16,318
  

 

 

    

 

 

 

Liability component – net carrying value

$ 89,289    $ 86,682   
  

 

 

    

 

 

 

Equity component – conversion, net of offering costs

$ 15,900    $ 15,900   
  

 

 

    

 

 

 

 

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Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share amounts, unless otherwise stated)

 

Embedded Conversion Feature

Each $1 of principal of the Convertible Notes will initially be convertible into 16.0090 shares of common stock, which is the equivalent of approximately $62.47 per share, subject to adjustment upon the occurrence of specified events but will not be adjusted for any accrued and unpaid interest. The note holders may convert all or a portion of their Convertible Notes during specified periods as follows: (1) during any calendar quarter commencing after the calendar quarter ending on March 31, 2014, if the last reported sale price of the Company’s common stock for at least 20 trading days during the period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter is greater than 130% of the conversion price on each applicable trading day; (2) during the five business-day period after any ten consecutive trading-day period in which the trading price per $1 principal amount of the Convertible Notes is less than 98% of the product of the last reported sale price and the conversion rate on each such trading day; (3) if specified corporate events, including a change in control, occur; or (4) at any time on or after January 1, 2019.

The note holders who elect to convert their Convertible Notes in connection with a fundamental change as described in the indenture will be entitled to a “make-whole” adjustment in the form of an increase in the conversion rate. Upon conversion, the Company has options to satisfy its conversion obligation by paying or delivering cash, shares of its common stock or a combination of cash and shares of its common stock. As of December 31, 2014, none of the conditions allowing the note holders to convert had been met.

The Company determined that the embedded conversion feature is not a derivative financial instrument but rather is required to be separately accounted for in equity because the Company may elect to settle the conversion option entirely or partially in cash. At issuance, the Company accounted for the equity component of the embedded conversion feature, which amounted to $16,457, as a reduction in the carrying amount of the debt and an increase in additional paid-in capital. The increase in additional paid-in capital was offset in part by $557 in related transaction costs.

Embedded Redemption Feature

The note holders also have the right to require the Company to repurchase for cash all or any portion of the Convertible Notes at par prior to the maturity date should any of the fundamental change events described in the indenture occur. The Company concluded that the embedded redemption feature is not a derivative financial instrument and that it is not probable at issuance that any of the specified fundamental change events will occur. Therefore, the embedded redemption feature is not substantive and will not affect the expected life of the liability component.

Note 10 — Reinsurance

The Company cedes a portion of its homeowners insurance exposure to other entities under catastrophe excess of loss reinsurance treaties. The Company remains liable with respect to claims payments in the event that any of its reinsurers are unable to meet their obligations under the reinsurance agreements. Failure of reinsurers to honor their obligations could result in losses to the Company. The Company evaluates the financial condition of its reinsurers and monitors concentrations of credit risk

 

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Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share amounts, unless otherwise stated)

 

arising from similar geographic regions, activities or economic characteristics of the reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. The Company contracts with a number of reinsurers to secure its annual reinsurance coverage, which generally becomes effective June 1st each year. The Company purchases reinsurance each year taking into consideration maximum projected losses and reinsurance market conditions.

The impact of the catastrophe excess of loss reinsurance treaties on premiums written and earned is as follows:

 

     Years Ended December 31,  
     2014      2013      2012  

Premiums Written:

        

Direct

   $ 341,685       $ 315,695       $ 205,839   

Assumed

     65,968         39,076         73,340   
  

 

 

    

 

 

    

 

 

 

Gross written

  407,653      354,771      279,179   

Ceded

  (113,423   (102,865   (75,939
  

 

 

    

 

 

    

 

 

 

Net premiums written

$ 294,230    $ 251,906    $ 203,240   
  

 

 

    

 

 

    

 

 

 

Premiums Earned:

Direct

$ 332,175    $ 273,037    $ 168,937   

Assumed

  33,313      64,076      64,670   
  

 

 

    

 

 

    

 

 

 

Gross earned

  365,488      337,113      233,607   

Ceded

  (113,423   (102,865   (75,939
  

 

 

    

 

 

    

 

 

 

Net premiums earned

$ 252,065    $ 234,248    $ 157,668   
  

 

 

    

 

 

    

 

 

 

During the years ended December 31, 2014, 2013 and 2012, there were no recoveries pertaining to reinsurance contracts that were deducted from losses incurred. There were 28 reinsurers at December 31, 2014 and 27 reinsurers at December 31, 2013, respectively, participating in the Company’s reinsurance program. There were no amounts receivable with respect to reinsurers at December 31, 2014 and 2013. Thus, there were no concentrations of credit risk associated with reinsurance receivables and prepaid reinsurance premiums as of December 31, 2014 and 2013. The ratio of assumed premiums earned to net premiums earned for the years ended December 31, 2014, 2013 and 2012 were 13.2%, 27.4%, and 41.0%, respectively.

Certain of the reinsurance contracts include retrospective provisions that adjust premiums, increase the amount of future coverage, or result in profit commissions in the event losses are minimal or zero. These adjustments are reflected in the statements of income as net reductions in ceded premiums of $23,543, $12,521 and $0, respectively, for the years ended December 31, 2014, 2013 and 2012. At December 31, 2014 and 2013, other assets included $28,596 and $9,009, respectively, and prepaid reinsurance premiums included $5,983 and $3,512, respectively, which are related to these adjustments.

Note 11 — Losses and Loss Adjustment Expenses

The liability for losses and loss adjustment expenses (“LAE”) is determined on an individual case basis for all claims reported. The liability also includes amounts for unallocated expenses, anticipated future claim development and losses incurred, but not reported.

 

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Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share amounts, unless otherwise stated)

 

Activity in the liability for losses and LAE is summarized as follows:

 

     Years Ended December 31,  
     2014      2013      2012  

Balance, beginning of year

   $ 43,686       $ 41,168       $ 27,424   
  

 

 

    

 

 

    

 

 

 

Incurred related to:

Current year

  75,810      67,579      66,425   

Prior years

  3,658      (2,456   (115
  

 

 

    

 

 

    

 

 

 

Total incurred

  79,468      65,123      66,310   
  

 

 

    

 

 

    

 

 

 

Paid related to:

Current year

  (47,650   (40,240   (36,914

Prior years

  (26,596   (22,365   (15,652
  

 

 

    

 

 

    

 

 

 

Total paid

  (74,246   (62,605   (52,566
  

 

 

    

 

 

    

 

 

 

Balance, end of year

$ 48,908    $ 43,686    $ 41,168   
  

 

 

    

 

 

    

 

 

 

The establishment of loss reserves is an inherently uncertain process and changes in loss reserve estimates are expected as such estimates are subject to the outcome of future events. Changes in estimates, or differences between estimates and amounts ultimately paid, are reflected in the operating results of the period during which such adjustments are made. During the year ended December 31, 2014, the Company experienced unfavorable development of $3,658 with respect to its net unpaid losses and loss adjustment expenses established for the year ended December 31, 2013. Factors attributable to this unfavorable development include a higher severity of claims and increased frequency of reported claims.

The Company writes insurance in the state of Florida, which could be exposed to hurricanes or other natural catastrophes. The occurrence of a major catastrophe could have a significant effect on the Company’s yearly results and cause a temporary disruption of the normal operations of the Company. However, the Company is unable to predict the frequency or severity of any such events that may occur in the near term or thereafter.

Note 12 — Income Taxes

A summary of income tax expense is as follows:

 

     Years Ended December 31,  
     2014      2013      2012  

Current:

        

Federal

   $ 36,651       $ 34,372       $ 18,484   

State

     6,222         5,844         3,168   

Foreign

     167         118         137   
  

 

 

    

 

 

    

 

 

 

Total current taxes

  43,040      40,334      21,789   
  

 

 

    

 

 

    

 

 

 

Deferred:

Federal

  (4,060   514      (1,986

State

  (678   43      (380

Foreign

  (4   —        —     
  

 

 

    

 

 

    

 

 

 

Total deferred taxes

  (4,742   557      (2,366
  

 

 

    

 

 

    

 

 

 

Income tax expense

$ 38,298    $ 40,891    $ 19,423   
  

 

 

    

 

 

    

 

 

 

 

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Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share amounts, unless otherwise stated)

 

The reasons for the differences between the statutory Federal income tax rate and the effective tax rate are summarized as follows:

 

     Years Ended December 31,  
     2014     2013     2012  
     Amount     %     Amount     %     Amount      %  

Income taxes at statutory rate

   $ 35,337        35.0      $ 37,258        35.0      $ 17,353         35.0   

Increase (decrease) in income taxes resulting from:

             

State income taxes, net of federal tax benefits

     3,601        3.6        3,802        3.6        1,799         3.6   

Other

     (640     (0.7     (169     (0.2     271         0.6   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Income tax expense

$ 38,298      37.9    $ 40,891      38.4    $ 19,423      39.2   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

The Company has no uncertain tax positions or unrecognized tax benefits that, if recognized, would impact the effective income tax rate. The tax years ending December 31, 2013, 2012, and 2011 remain subject to examination by the Company’s major taxing jurisdictions. The Company elected to classify, if any, interest and penalties arising from uncertain tax positions as income tax expense as permitted by current accounting standards. There have been no material amounts of interest or penalties for the years ended December 31, 2014 and 2013. Effective October 20, 2014, the Internal Revenue Service notified the Company that the examination of the Company’s 2011 federal income tax return was completed with no change to the Company’s reported tax. In addition, as of April 18, 2014, the Florida Department of Revenue completed an audit of the state income tax returns filed for 2010, 2011, and 2012. The audit resulted in no material changes to the state income taxes originally reported.

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.

 

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Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share amounts, unless otherwise stated)

 

Significant components of the Company’s net deferred income tax (liabilities) assets are as follows:

 

     December 31,  
     2014      2013  

Deferred tax assets:

     

Unearned premiums

   $ 11,718       $ 8,829   

Losses and loss adjustment expenses

     866         885   

Organizational costs

     83         95   

Stock-based compensation

     3,081         2,026   

Accrued expenses

     175         163   

Deferred expenses

     —           —     

Unearned revenue

     381         52   

Bad debt reserve

     10         5   
  

 

 

    

 

 

 

Total deferred tax assets

  16,314      12,055   
  

 

 

    

 

 

 

Deferred tax liabilities:

Property and equipment

  (1,604   (1,748

Deferred policy acquisition costs

  (5,959   (5,600

Unrealized net gain on securities available-for-sale

  (418   (700

Basis difference related to convertible senior notes

  (5,110   (6,295

Prepaid expenses

  (464   (296

Other

  (260   (156
  

 

 

    

 

 

 

Total deferred tax liabilities

  (13,815   (14,795
  

 

 

    

 

 

 

Net deferred tax assets (liabilities)

$ 2,499    $ (2,740
  

 

 

    

 

 

 

A valuation allowance is established if, based upon the relevant facts and circumstances, management believes any portion of the deferred tax assets will not be realized. Although realization of deferred income tax assets is not certain, management believes it is more likely than not that deferred tax assets will be realized. As a result, the Company did not have a valuation allowance established as of December 31, 2014 or 2013.

Note 13 — Earnings Per Share

U.S. GAAP requires the Company to use the two-class method in computing basic earnings per share since holders of the Company’s restricted stock have the right to share in dividends, if declared, equally with common stockholders. These participating securities effect the computation of both basic and diluted earnings per share during periods of net income.

 

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Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share amounts, unless otherwise stated)

 

A summary of the numerator and denominator of the basic and fully diluted earnings per common share is presented below:

 

     Income
(Numerator)
     Shares
(Denominator)
     Per Share
Amount
 
Year Ended December 31, 2014         

Net income

   $ 62,664         

Less: Preferred stock dividends

     4         

Less: Income attributable to participating securities

     (4,318      
  

 

 

       

Basic Earnings Per Share:

Income allocated to common stockholders

  58,350      9,888    $ 5.90   
        

 

 

 

Effect of Dilutive Securities:

Stock options

  —        137   

Convertible preferred stock

  (4   20   

Convertible senior notes

  4,343      1,649   
  

 

 

    

 

 

    

Diluted Earnings Per Share:

Income available to common stockholders and assumed conversions

$ 62,689      11,694    $ 5.36   
  

 

 

    

 

 

    

 

 

 
Year Ended December 31, 2013

Net income

$ 65,562   

Less: Preferred stock dividends

  (104

Less: Income attributable to participating securities

  (3,213
  

 

 

       

Basic Earnings Per Share:

Income allocated to common stockholders

  62,245      10,691    $ 5.82   
        

 

 

 

Effect of Dilutive Securities:

Stock options

  —        163   

Convertible preferred stock

  104      178   

Convertible senior notes

  237      90   
  

 

 

    

 

 

    

Diluted Earnings Per Share:

Income available to common stockholders and assumed conversions

$ 62,586      11,122    $ 5.63   
  

 

 

    

 

 

    

 

 

 
Year Ended December 31, 2012

Net income

$ 30,157   

Less: Preferred stock dividends

  (322

Less: Income attributable to participating securities

  (488
  

 

 

       

Basic Earnings Per Share:

Income available to common stockholders

  29,347      8,497    $ 3.45   
        

 

 

 

Effect of Dilutive Securities:

Stock options

  —        220   

Convertible preferred stock

  322      655   

Warrants

  —        441   
  

 

 

    

 

 

    

Diluted Earnings Per Share:

Income available to common stockholders and assumed conversions

$ 29,669      9,813    $ 3.02   
  

 

 

    

 

 

    

 

 

 

 

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Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share amounts, unless otherwise stated)

 

Note 14 — Stockholders’ Equity

Common Stock

Effective March 18, 2014, the Company’s Board of Directors authorized a plan to repurchase up to $40,000 of the Company’s common shares before commissions and fees. The repurchase plan allows the Company to repurchase shares from time to time through March 31, 2015. The shares may be purchased for cash in open market purchases, block transactions and privately negotiated transactions in accordance with applicable federal securities laws. The share repurchase plan may be modified, suspended, terminated or extended by the Company any time without prior notice. During the year ended December 31, 2014, the Company repurchased and retired a total of 990,701 shares at a weighted average price per share of $38.69 under this authorized repurchase plan. The total costs of shares repurchased, inclusive of fees and commissions, during the year ended December 31, 2014 were $38,354, or $38.71 per share. At December 31, 2014, a total of $1,666 is available in connection with this plan.

Series B Junior Participating Preferred Share Purchase Right

On October 17, 2013, the Company’s Board of Directors declared a dividend of one preferred share purchase right (“Right”) for each outstanding share of its common stock to shareholders of record at the close of business on November 15, 2013. Each Right entitles the common shareholder to purchase from the Company one one-hundredth of a share of Series B Junior Participating Preferred Stock, no par value, at a price of $125.00 per one one-hundredth of such preferred share, subject to adjustment for certain events. The Right is intended to prevent any unsolicited takeover attempt that is unfair and unfavorable to the Company’s shareholders. The Right will not interfere with any merger approved by the Company’s Board of Directors.

The Right will not be exercisable until ten days following a public announcement that a person or group has acquired beneficial ownership of 10% or more of the Company’s common stock or until ten business days after a person or group begins a tender or exchange offer that would result in beneficial ownership of 10% or more of the Company’s common stock. The Right may be redeemed or exchanged by the Company for $0.001 per Right at any time until the Right’s expiration date on October 18, 2018.

Prepaid Share Repurchase Forward Contract

Effective December 11, 2013, in conjunction with the issuance of the Convertible Notes, the Company entered into a prepaid share repurchase forward contract (the “forward contract”) with Deutsche Bank AG, London Branch (the “forward counterparty”). Pursuant to the forward contract, the Company prepaid $29,923 of the net proceeds of the offering to repurchase 622,751 shares of the Company’s common stock under which the shares will be delivered over a settlement period in 2019. The forward contract is subject to early settlement, in whole or in part, at any time prior to the final settlement date at the option of the forward counterparty, as well as early settlement or settlement with alternative consideration in the event of certain corporate transactions. In the event the Company pays any cash dividends on its common shares, the forward counterparty will pay an equivalent amount to the Company. The shares to be purchased under the prepaid forward contract will be treated as retired as of the effective date of the forward contract, but will remain outstanding for corporate law purposes, including for purposes of any future stockholders votes.

 

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Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share amounts, unless otherwise stated)

 

The Company determined that the forward contract does not meet the characteristic of a derivative instrument and, as such, the transaction resulted in an immediate reduction of the outstanding shares used to calculate the weighted-average common shares outstanding for both basic and diluted earnings per share.

Preferred Stock

Series A Cumulative Convertible Preferred Stock (“Series A Preferred”)

On February 4, 2014, the Company announced its Board of Directors fixed April 1, 2014 as the cancellation date for the conversion rights on its 7% Series A cumulative convertible preferred stock. The Company later extended the conversion privilege in April 2014. On June 2, 2014, 3,386 shares of Series A Preferred were redeemed at $10 per share, resulting in the derecognition of $4 in dividends payable. During the years ended December 31, 2014 and 2013, holders of 107,298 and 130,498 shares of Series A Preferred converted their Series A Preferred shares to 107,298 and 130,498 shares of common stock, respectively. As of December 31, 2014, no shares of Series A Preferred were outstanding.

Series B Junior Participating Preferred Stock (“Series B Preferred”)

On October 17, 2013, in connection with the declaration of the Right dividends, the Company’s Board of Directors established and fixed the rights and preferences of the Series B Preferred. Of the authorized shares, the Company designated 400,000 shares as Series B Preferred. Each Series B Preferred will be entitled to a minimum preferential quarterly dividend payment of $1.00 per share but will be entitled to an aggregate dividend of 100 times the dividend declared per common share of the Company. In the event of liquidation, the holders of the Series B Preferred will be entitled to a minimum preferential liquidation payment of $100 per share but will be entitled to an aggregate payment of 100 times the payment made per common share. Each Series B Preferred will have 100 votes per share, voting together as one class on all matters submitted to a vote of shareholders of the Company. Finally, in the event of any merger, consolidation or other transaction in which common shares are exchanged, each Series B Preferred will be entitled to receive 100 times the amount received per common share. The aforementioned rights of Series B Preferred are protected by customary anti-dilution provisions. As of December 31, 2014 and 2013, there were no Series B Preferred issued or outstanding.

Undesignated Preferred Stock

The Company is authorized to issue up to an additional 18,100,000 shares of preferred stock, no par value. The authorized but unissued and undesignated preferred stock may be issued in one or more series and the shares of each series shall have such rights as determined by the Company’s Board of Directors subject to the rights of the holders of the Series A Preferred and Series B Preferred.

 

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Notes to Consolidated Financial Statements

(Dollar amounts in thousands, except per share amounts, unless otherwise stated)

 

Note 15 — Stock-Based Compensation

Incentive Plan

The Company currently has outstanding stock-based awards granted under the 2007 Stock Option and Incentive Plan and the 2012 Omnibus Incentive Plan. Only the 2012 Plan is available for future grants as the 2007 Plan was terminated in 2012. With respect to the 2012 Plan, the Company may grant stock-based awards to employees, directors, consultants, and advisors of the Company. At December 31, 2014, there were 4,246,470 shares available for grant under the 2012 Plan.

Stock Options

Stock options granted and outstanding under the incentive plan vest over periods ranging from immediately vested to five years and are exercisable over the contractual term of ten years.

A summary of the stock option activity for the years ended December 31, 2014, 2013 and 2012 is as follows (option amounts not in thousands):

 

     Number of
Options
     Weighted
Average
Exercise
Price
     Weighted
Average
Remaining
Contractual
Term
   Aggregate
Intrinsic
Value
 

Outstanding at January 1, 2012

     620,000       $ 2.97       5.7 years    $ 3,122   

Exercised

     (340,000    $ 3.03         
  

 

 

          

Outstanding at December 31, 2012

  280,000    $ 2.91    4.9 years $ 5,007   
  

 

 

          

Outstanding at December 31, 2013