UNIVERSAL INSURANCE: Management report and analysis of the financial situation and operating results (form 10-Q)
Unless the context otherwise requires, all references to "we," "us," "our," and "Company" refer to
Universal Insurance Holdings, Inc.and its wholly-owned subsidiaries. You should read the following discussion together with our unaudited condensed consolidated financial statements ("Financial Statements") and the related notes thereto included in "Part I, Item 1-Financial Statements," and our audited condensed consolidated financial statements and the related notes thereto included in "Part II, Item 8-Financial Statements and Supplementary Data" in our Annual Report on Form 10-K for the year ended December 31, 2020. Operating results for any one quarter are not necessarily indicative of results to be expected for any other quarter or for the year. Cautionary Note Regarding Forward-Looking Statements In addition to historical information, this report may contain "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). The forward-looking statements anticipate results based on our estimates, assumptions and plans that are subject to uncertainty. These forward-looking statements may be identified by their use of words like "plans," "seeks," "expects," "will," "should," "anticipates," "estimates," "intends," "believes," "likely," "targets," and other words with similar meanings. These statements may address, among other things, our strategy for growth, catastrophe exposure and other risk management, product development, investment results, regulatory approvals, market position, expenses, financial results, litigation and reserves. We believe that these statements are based on reasonable estimates, assumptions and plans. However, if the estimates, assumptions or plans underlying the forward-looking statements prove inaccurate or if other risks or uncertainties arise, actual results could differ materially from those communicated in these forward-looking statements as a result of the risks set forth below, which are a summary of those set forth in our Annual Report on Form 10-K for the year ended December 31, 2020. We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events, or otherwise. Risks and uncertainties that may affect, or have affected, our financial condition and operating results include, but are not limited to, the following: •Unanticipated increases in the severity or frequency of claims, including those relating to catastrophes, severe weather events and changing climate conditions, which, in some instances, have exceeded, and in the future may exceed our reserves established for claims; •Failure of our risk mitigation strategies, including failure to accurately and adequately price the risks we underwrite and to include effective exclusions and other loss limitation methods in our insurance policies; •Loss of independent insurance agents and inability to attract new independent agents; •Reliance on models, which are inherently uncertain, as a tool to evaluate risks; •The continued availability of reinsurance at current levels and prices, and our ability to collect payments due from our reinsurers; •Changes in industry trends, including changes due to the cyclical nature of the industry and increased competition; •Geographic concentration of our business in Floridaand the effectiveness of our growth and diversification strategy in new markets; •Loss of key personnel and inability to attract and retain talented employees; •Failure to comply with existing and future guidelines, policies and legal and regulatory standards; •The ability of our claims professionals to effectively manage claims; •Litigation or regulatory actions that could result in significant damages, fines or penalties; •A downgrade in our Financial Stability Rating® and its impact on our competitive position, the marketability of our product offerings, our liquidity and profitability; •The impact on our business and reputation of data and security breaches due to cyber-attacks or our inability to effectively adapt to changes in technology; •Our dependence on the returns of our investment portfolio, which are subject to market risk; •Legal, regulatory or tax changes that increase our operating costs and decrease our profitability, such as limitations on rate changes or requirements to participate in loss sharing; •Our dependence on dividends and permissible payments from our subsidiaries; •The ability of our Insurance Entities to comply with statutory capital and surplus minimums and other regulatory and licensing requirements; and •The ongoing impact of the COVID-19 pandemic on our business and the economy in general. 31 --------------------------------------------------------------------------------
Table of Contents OVERVIEW We are a vertically integrated holding company offering property and casualty insurance and value-added insurance services. We develop, market and underwrite insurance products for consumers predominantly in the personal residential homeowners line of business and perform substantially all other insurance-related services for our primary insurance entities, including risk management, claims management, and distribution. Our primary insurance entities,
Universal Property & Casualty Insurance Company("UPCIC") and American Platinum Property and Casualty Insurance Company("APPCIC" and together with UPCIC, the "Insurance Entities"), offer insurance products through both our appointed independent agent network and our online distribution channels across 19 states (primarily in Florida), with licenses to write insurance in two additional states. The Insurance Entities seek to produce an underwriting profit (defined as earned premium minus losses, loss adjustment expense ("LAE"), policy acquisition costs and other operating costs) over the long term; maintain a conservative balance sheet to prepare for years in which the Insurance Entities are not able to achieve an underwriting profit; and generate investment income on assets. The following Management's Discussion and Analysis ("MD&A") is intended to assist in an understanding of our financial condition and results of operations. This MD&A should be read in conjunction with our Financial Statements and accompanying Notes appearing elsewhere in this Report (the "Notes"). In addition, reference should be made to our audited Consolidated Financial Statements and accompanying Notes to Consolidated Financial Statements and "Item 7-Management's Discussion and Analysis of Financial Condition and Results of Operations" included in our Annual Report on Form 10-K for the year ended December 31, 2020. Except for the historical information contained herein, the discussions in this MD&A contain forward-looking statements that involve risks and uncertainties. Our future results could differ materially from those discussed herein. Factors that could cause or contribute to such differences include, but are not limited to, those discussed above under "Cautionary Note Regarding Forward-Looking Statements." Trends - Impact of the COVID-19 Pandemic The global COVID-19 pandemic has had a profound worldwide effect on social interactions and on the global, national and local economies. Since the first week of engaging our work from home strategy, nearly all aspects of our business have been, and continue to be, conducted remotely while striving to maintain the quality of our service standards. Subsequent to March 2020, we have not seen a material impact from COVID-19 pandemic on our business, our financial position, our liquidity, or our ability to service our policyholders and maintain critical operations. As a provider of services that have been deemed essential under most directives and guidelines, we are confident in our ability to maintain consistent operations and believe we can continue to manage with our remote workforce, with little impact on our business and service levels and our standards of care for both underwriting and claims. We continue to monitor local, state and federal guidance and will adjust workforce activities as appropriate. Although we have not experienced an adverse material impact from the COVID-19 pandemic, the ultimate impact of the pandemic on our business and on the economy in general cannot be predicted. Court systems in key markets in which we operate, including Florida, have been impacted by the COVID-19 pandemic. This has led to changes in certain court procedures and, in many cases, to delays in our ability to resolve contested claims. In our experience, delays in court proceedings can increase the amounts of judgements, settlements and related costs. In addition, delays in the judicial system could affect our ability to pursue subrogation actions in a timely and cost-effective manner. As a result, as the effects of the COVID-19 pandemic evolve, continuing periods of judicial delays and revised procedures could have an adverse effect on our litigation outcomes. Our level of direct premiums written during the three months ended March 31, 2021was strong and outperformed the same period in the prior year. We are cautiously optimistic in our belief that our customers and agent force will continue to renew and place business with us, especially our customers in hurricane-exposed states. In the event there is a slow-down in the production and/or collection of premiums, we intend to take measures to maintain liquidity while continuing to protect our capital and policyholders. See "-Liquidity and Capital Resources." KEY PERFORMANCE INDICATORS The Company considers the measures and ratios in the following discussion to be key performance indicators for its businesses. Management believes that these indicators are helpful in understanding the underlying trends in the Company's businesses. Some of these indicators are reported on a quarterly basis and others on an annual basis. These indicators may not be comparable to other performance measures used by the Company's competitors and should only be evaluated together with our condensed consolidated financial statements and accompanying notes.
Definitions of key performance indicators
Book Value Per Common Share - total stockholders' equity, adjusted for preferred stock liquidation, divided by the number of common shares outstanding as of a reporting period. Book value per common share is the excess of assets over liabilities at a reporting period attributed to each share of stock. Changes in book value per common share informs shareholders of retained equity in the Company on a per share basis which may assist in understanding market value trends for the Company's stock. Combined Ratio - the combined ratio is a measure of underwriting profitability for a reporting period and is calculated by dividing total operating costs and expenses (which is made up of losses and LAE and general and administrative expenses) by premiums earned, net, which is net of ceded premiums earned. Changes to the combined ratio over time provide management with an understanding of costs to operate its business in relation to net premiums it is earning and the impact of rate, underwriting and other business management actions on underwriting profitability. A combined ratio below 100 indicates underwriting profit; a combined ratio above 100 indicates underwriting losses. 32 --------------------------------------------------------------------------------
Table of Contents Core Loss Ratio - a common operational metric used in the insurance industry to describe the ratio of current accident year expected losses and LAE to premiums earned. Core loss ratio is an important measure identifying profitability trends of premiums in force. Core losses consists of all other losses and LAE, excluding weather events beyond those expected and prior years' reserve development. The financial benefit from the management of claims, including claim fees ceded to reinsurers, is recorded in the condensed consolidated financial statements as a reduction to core losses.
Debt ratio – long-term debt divided by equity. This ratio helps management measure the amount of funding leverage in place versus equity and future leverage capacity.
Total debt-to-capital ratio – long-term debt divided by the sum of total equity and long-term debt (often referred to as total capital resources). This ratio helps management measure the amount of funding leverage in place (long-term debt) versus total capital resources and future leverage capacity.
Direct Premiums Written ("DPW") - reflects the total value of policies issued during a period before considering premiums ceded to reinsurers. Direct premiums written, comprised of renewal premiums, endorsements and new business, is initially recorded as unearned premium in the balance sheet which is then earned pro-rata over the next year or remaining policy term. Direct premiums written reflects current trends in the Company's sale of property and casualty insurance products and amounts that will be recognized as earned premiums in the future.
Expense Ratio (Including Policy Acquisition Cost Ratio and Other Operating Cost Ratio) - calculated as general and administrative expenses as a percentage of premiums earned, net. General and administrative expenses is comprised of policy acquisition costs and other operating costs, which includes such items as underwriting costs, facilities and corporate overhead. The expense ratio, including the sub-expense ratios of policy acquisition cost ratio and other operating cost ratio, are indicators to management of the Company's cost efficiency in acquiring and servicing its business and the impact of expense items to overall profitability. Losses and Loss Adjustment Expense Ratio or Loss and LAE Ratio - a measure of the cost of claims and claim settlement expenses incurred in a reporting period as a percentage of premiums earned in that same reporting period. Losses and LAE incurred in a reporting period includes both amounts related to the current accident year and prior accident years, if any, referred to as development. Ultimate losses and LAE are based on actuarial estimates with changes in those estimates recognized in the period the estimates are revised. Losses and LAE consist of claim costs arising from claims occurring and settling in the current period, an estimate of claim costs for reported but unpaid claims, an estimate of unpaid claim costs for incurred-but-not-reported claims and an estimate of claim settlement expenses associated with reported and unreported claims which occurred during the reporting period. The loss and LAE ratio can be measured on a direct basis, which includes losses and LAE divided by direct earned premiums, or on a net basis, which includes losses and LAE after amounts have been ceded to reinsurers divided by net earned premiums (i.e., direct premium earned less ceded premium earned). The net loss and LAE ratio is a measure of underwriting profitability after giving consideration to the effect of reinsurance. Trends in the net loss and LAE ratio are an indication to management of current and future profitability. Monthly Weighted Average Renewal Retention Rate - measures the monthly average of policyholders that renew their policies over the period of a calendar year. This measure allows management to assess customer retention. Premiums Earned, Net - the pro-rata portion of current and previously written premiums that the Company recognizes as earned premium during the reporting period, net of ceded premium earned. Ceded premiums are premiums paid or payable by the Company for reinsurance protection. Written premiums are considered earned and are recognized pro-rata over the policy coverage period. Premiums earned, net is a measure that allows management to identify revenue trends. Policies in Force - represents the number of active policies with coverage in effect as of the end of the reporting period. The change in the number of policies in force is a growth measure and provides management with an indication of progress toward achieving strategic objectives. Inherent seasonality in our business makes this measure more useful when comparing each quarter's balance to the same quarter in prior years. Premium in Force - is the amount of the annual direct written premiums previously recorded by the Company for policies which are still active as of the reporting date. This measure assists management in measuring the level of insured exposure and progress toward meeting revenue goals for the current year, and provides an indication of business available for renewal in the next twelve months. Inherent seasonality in our business makes this measure more useful when comparing each quarter's balance to the same quarter in prior years. Return on Average Equity ("ROAE") - calculated by dividing earnings (loss) per common share by average book value per common share. Average book value per common share is computed as the sum of book value per common share at the beginning and the end of a period, divided by two. ROAE is a capital profitability measure of how effectively management creates profits per common share. Total Insured Value - represents the amount of insurance limits available on a policy for a single loss based on all policies active as of the reporting date. This measure assists management in measuring the level of insured exposure. 33 --------------------------------------------------------------------------------
Table of Contents Unearned Premiums - represents the portion of direct premiums corresponding to the time period remaining on an insurance policy and available for future earning by the Company. Trends in unearned premiums generally indicate expansion, if growing, or contraction, if reducing, which are important indicators to management. Inherent seasonality in our business makes this measure more useful when comparing each quarter's balance to the same quarter in prior years. Weather events - an estimate of losses and LAE from weather events occurring during the current accident year that exceed initial estimates of expected weather events when establishing the core loss ratio for each accident year. This metric informs management of factors impacting overall current year profitability.
Reinsurance enables our Insurance Entities to limit potential exposures to catastrophic events. Reinsurance contracts are typically classified as treaty or facultative contracts. Treaty reinsurance provides coverage for all or a portion of a specified group or class of risks ceded by the primary insurer, while facultative reinsurance provides coverage for specific individual risks. Within each classification, reinsurance can be further classified as quota share or excess of loss. Quota-share reinsurance is where the primary insurer and the reinsurer share proportionally or pro-rata in the direct premiums and losses of the insurer. Excess-of-loss reinsurance indemnifies the direct insurer or reinsurer for all or a portion of the loss in excess of an agreed upon amount or retention. Developing and implementing our reinsurance strategy to adequately protect our balance sheet and Insurance Entities in the event of one or more catastrophes while maintaining efficient reinsurance costs has been a key strategic priority for us. In order to limit the Insurance Entities' potential exposure to catastrophic events, we purchase significant reinsurance from third-party reinsurers and the
Florida Hurricane Catastrophe Fund("FHCF"). The Florida Office of Insurance Regulation("FLOIR") requires the Insurance Entities, like all residential property insurance companies doing business in Florida, to have a certain amount of capital and reinsurance coverage in order to cover losses upon the occurrence of a single catastrophic event and a series of catastrophic events occurring in the same hurricane season. The Insurance Entities' respective 2020-2021 reinsurance programs meet the FLOIR's requirements, which are based on, among other things, successfully demonstrating cohesive and comprehensive reinsurance programs that protect the policyholders of our Insurance Entities as well as satisfying a series of stress test catastrophe loss scenarios based on past historical events. We believe the Insurance Entities' retentions under their respective reinsurance programs are appropriate and structured to protect policyholders. We test the sufficiency of the reinsurance programs by subjecting the Insurance Entities' personal residential exposures to statistical testing using a third-party hurricane model, RMS RiskLink v18.1 (Build 1945). This model combines simulations of the natural occurrence patterns and characteristics of hurricanes, tornadoes, earthquakes and other catastrophes with information on property values, construction types and occupancy classes. The model outputs provide information concerning the potential for large losses before they occur, so companies can prepare for their financial impact. Furthermore, as part of our operational excellence initiatives, we continually look to enable new technology to refine our data intelligence on catastrophe risk modeling. Effective June 1, 2020, the Insurance Entities entered into multiple reinsurance agreements comprising our 2020-2021 reinsurance program. See "Item 1-Note 4 (Reinsurance)." UPCIC's 2020-2021 Reinsurance Program •First event All States retention of $43 million; first event Non-Florida retention of $15 million. •All States first event tower extends to $3.36 billionwith no co-participation in any of the layers, no limitations on loss adjustment expenses and no accelerated deposit premiums. •Assuming a first event completely exhausts the $3.36 billiontower, the second event exhaustion point would be $1.343 billion. •Full reinstatement available for all private market first event catastrophe layers for guaranteed second event coverage. For all layers purchased between $90 millionand the projected FHCF retention, to the extent that all of our coverage or a portion thereof is exhausted in a catastrophic event and reinstatement premium is due, UPCIC has purchased enough reinstatement premium protection ("RPP") limit to pay the premium necessary for the reinstatement of these coverages. •Effective September 1, 2020, UPCIC purchased RPP limit for the layer attaching at $45 million. Combined with the RPP limit purchased at June 1, 2020, UPCIC has purchased enough RPP limit to pay for the premium necessary for the reinstatement of all catastrophe layers between $45 millionand the projected FHCF retention. •Specific 3rd and 4th event private market catastrophe excess of loss coverage of $76 millionin excess of $35 millionprovides frequency protection for a multiple event storm season. •For the FHCF Reimbursement Contracts effective June 1, 2020, UPCIC has continued the election of the 90% coverage level. We estimate the total mandatory FHCF layer will provide approximately $2.008 billionof coverage for UPCIC, which inures to the benefit of the open market coverage secured from private reinsurers. •Secured $197 millionof new catastrophe capacity with contractually agreed limits that extend coverage to include the 2021 and 2022 wind seasons. In total, UPCIC has $420 millionof multi-year capacity with coverage extending to include the 2021 wind season or beyond. 34 --------------------------------------------------------------------------------
Table of Contents In
March 2021, UPCIC completed its first catastrophe bond transaction. Effective March 26, 2021, UPCIC entered into a three-year reinsurance agreement with Cosaint Re Pte. Ltd., a special purpose reinsurance vehicle incorporated in Singaporethat correspondingly issued notes in a Rule 144A offering to raise proceeds to collateralize its obligations under this agreement. The reinsurance agreement provides UPCIC with a single limit of $150Mof collateralized protection for named windstorm events.
The table below provides the
A.M. Bestand S&P financial strength ratings for each of the largest third-party reinsurers in UPCIC's 2020-2021 reinsurance program: Reinsurer A.M. Best S&P Allianz Risk Transfer A+ AA- Arch Reinsurance Limited A+ A+ Chubb Tempest Reinsurance Ltd. A++ AA Munich Re A+ AA- Renaissance Re A+ A+ Various Lloyd's of London Syndicates A A+
(1) No rating is available because the fund is not rated.
APPCIC's 2020-2021 Reinsurance Program •First event All States retention of
$3 million. •All States first event tower of $43.6 millionwith no co-participation in any of the layers, no limitation on loss adjustment expenses and no accelerated deposit premiums. •Full reinstatement available for all private market first event catastrophe layers for guaranteed second event coverage. For the layer purchased between $3 millionand the projected FHCF retention, to the extent that all coverage or a portion thereof is exhausted in a catastrophic event and reinstatement premium is due, APPCIC purchased enough RPP limit to pay the premium necessary for the reinstatement of this coverage. •APPCIC also purchases extensive multiple line excess per risk reinsurance with various reinsurers due to the high-value risks it insures in both the personal residential and commercial multiple peril lines of business. Under this multiple line excess per risk contract, APPCIC has coverage of $8.5 millionin excess of $0.5 millionultimate net loss for each risk and each property loss, and $1 millionin excess of $0.3 millionfor each casualty loss. A $19.5 millionaggregate limit applies to the term of the contract for property-related losses and a $2 millionaggregate limit applies to the term of the contract for casualty-related losses. This contract also contains a profit-sharing feature if specific performance measures are met. •For the FHCF Reimbursement Contracts effective June 1, 2020, APPCIC has continued the election of the 90% coverage level. The total mandatory FHCF layer is estimated to provide approximately $22.5 millionof coverage for APPCIC, which inures to the benefit of the open market coverage secured from private reinsurers. Reinsurers The table below provides the A.M. Bestand S&P financial strength ratings for each of the largest third-party reinsurers in APPCIC's 2020-2021 reinsurance program: Reinsurer A.M. Best S&P Chubb Tempest Reinsurance Ltd. A++ AA Lancashire Insurance Company Limited A A- Various Lloyd's of London Syndicates A A+
(1)No rating is available, because the fund is not rated. The total cost of the 2020-2021 reinsurance programs for UPCIC and APPCIC is projected to be
$499.8 million, representing approximately 34.0% of estimated direct premium earned for the 12-month treaty period. 35 --------------------------------------------------------------------------------
Table of Contents RESULTS OF OPERATIONS AND ANALYSIS OF FINANCIAL CONDITION Financial and Business Highlights First quarter of fiscal 2021 results of operations comparisons are to first quarter of fiscal 2020 (unless otherwise specified). •Direct premiums written overall grew by
$30.8 million, or 9.2%, to $365.3 million. •Policies in force at March 31, 2021were 976,250 compared to 984,830 at December 31, 2020, a decline of 0.9% from year end. •In Florida, direct premiums written grew by $28.5 million, or 10.2%, and in our other states, direct premiums written grew by $2.3 million, or 4.0%. •Premiums earned, net, grew by $22.5 million, or 10.2%, to $243.3 million. •FLOIR approved an overall 7.0% rate increase in December 2020for UPCIC on Floridapersonal residential homeowners line of business, effective December 2020for new business and March 2021for renewals. •Net investment income was $3.0 millioncompared to $6.8 millionin the first quarter of 2020. •Total revenues increased by $27.5 million, or 11.7%, to $262.8 million. •Net loss and LAE ratio was 59.2% as compared to 61.2%. •Diluted earnings per common share ("EPS") increased by $0.23, or 37.7%, to $0.84compared to $0.61. •Weighted average diluted common shares outstanding were lower by 4.4% to 31.3 million shares compared to 32.7 million shares. •Book value per share increased by $0.13, or 0.9%, to $14.56at March 31, 2021from $14.43at December 31, 2020. •Declared and paid dividends of $5.0 million, or $0.16per common share, in the first quarter of 2021. •Contributed $77 millionof capital to UPCIC during the first quarter of 2021 to support insurance operations. 36 --------------------------------------------------------------------------------
Table of Contents Results of Operations - Three Months Ended
March 31, 2021Compared to Three Months Ended March 31, 2020Net income was $26.4 millionfor the three months ended March 31, 2021, compared to net income of $20.1 millionfor the same period in 2020. Weighted average diluted common shares outstanding for the three months ended March 31, 2021were lower by 4.4% to 31.3 million shares from 32.7 million shares for the same period of the prior year. Benefiting the quarter were increases in premiums earned, net, improvements in both realized and unrealized gains and losses and an increase in commission revenue, offset by a decrease in net investment income, policy fees and other revenue and an increase in operating costs and expenses. Direct premium earned and premiums earned, net were up 15.2% and 10.2%, respectively, due to growth in all states in which we are licensed and writing during the past 12 months and rate increases implemented during 2020 and 2021, offset by higher costs for reinsurance flowing through to premiums earned, net. The net losses and LAE ratio was 59.2% for the three months ended March 31, 2021, compared to 61.2% for the same period in 2020 reflecting benefits from prior years' development and a decrease in weather events partially offset by higher core net losses when compared to the prior year quarter. A detailed discussion of our results of operations follows the table below (in thousands, except per share data). Three Months Ended March 31, Change 2021 2020 $ % PREMIUMS EARNED AND OTHER REVENUES Direct premiums written $ 365,314 $ 334,553 $ 30,7619.2 % Change in unearned premium 10,292 (8,602) 18,894 NM Direct premium earned 375,606 325,951 49,655 15.2 % Ceded premium earned (132,301) (105,122) (27,179) 25.9 % Premiums earned, net 243,305 220,829 22,476 10.2 % Net investment income 2,986 6,834 (3,848) (56.3) % Net realized gains (losses) on investments 542 299 243 81.3 % Net change in unrealized gains (losses) of equity securities (494) (8,024) 7,530 (93.8) % Commission revenue 9,126 7,015 2,111 30.1 % Policy fees 5,387 5,540 (153) (2.8) % Other revenue 1,905 2,782 (877) (31.5) % Total premiums earned and other revenues 262,757 235,275 27,482 11.7 % OPERATING COSTS AND EXPENSES Losses and loss adjustment expenses 143,963 135,048 8,915 6.6 % General and administrative expenses 82,443 72,643 9,800 13.5 % Total operating costs and expenses 226,406 207,691 18,715 9.0 % INCOME BEFORE INCOME TAXES 36,351 27,584 8,767 31.8 % Income tax (benefit) expense 9,943 7,517 2,426 32.3 % NET INCOME $ 26,408 $ 20,067 $ 6,34131.6 % Other comprehensive income (loss), net of taxes (16,910) (8,946) (7,964) 89.0 % COMPREHENSIVE INCOME $ 9,498 $ 11,121 $ (1,623)(14.6) % DILUTED EARNINGS PER SHARE DATA: Diluted earnings per common share $ 0.84 $ 0.61 $ 0.2337.7 % Weighted average diluted common shares outstanding 31,277 32,731 (1,454) (4.4) % NM - Not Meaningful 37
Table of Contents Direct premiums written increased by
$30.8 million, or 9.2%, for the quarter ended March 31, 2021, driven by growth within our Floridabusiness of $28.5 million, or 10.2%, and growth in our other states business of $2.3 million, or 4.0%, as compared to the same period of the prior year. Rate increases approved in 2020 in Floridaand in certain other states were the principal driver of higher written premiums despite a lower level of new writings and slightly lower renewal retention compared to the same period of the prior year. During the first quarter of 2021, management implemented efforts to prudently manage its exposures while rate increases take effect, which has slowed the growth of written premiums when compared to prior years. Policies in force declined from 984,830 at December 31, 2020to 976,250 at March 31, 2021as a result of management's effort to reduce new business exposures. Policies in force declined in 11 out of the 19 states that the Insurance Entities write in as a result of management's actions. We actively wrote policies in 19 states during 2021 compared to 18 states at March 31, 2020. In addition, we are authorized to do business in Tennesseeand Wisconsinand are proceeding with product filings in those states. Policies in force, premium in force and total insured value increased as of March 31, 2021when compared to March 31, 2020. The following table provides direct premiums written for Floridaand Other States for the three months ended March 31, 2021and 2020 (dollars in thousands): For the Three Months Ended Growth March 31, 2021 March 31, 2020 year over year Direct Direct Premiums State Premiums Written % Written % $ % Florida $ 307,01184.0 % $ 278,51183.2 % $ 28,50010.2 % Other states 58,303 16.0 % 56,042 16.8 % 2,261 4.0 % Total $ 365,314100.0 % $ 334,553100.0 % $ 30,7619.2 % We seek to grow and generate long-term rate adequate premium in each state where we offer policies, including Florida. Diversified sources of business are an important objective and premium growth outside Floridais a measure monitored by management toward meeting that objective. Direct premium earned increased by $49.7 million, or 15.2%, for the quarter ended March 31, 2021, reflecting the earning of premiums written over the past 12 months including positive changes in rates and policies in force during that time. Reinsurance enables our Insurance Entities to limit potential exposures to catastrophic events and other covered events. Ceded premium represents amounts paid to reinsurers for this protection. Ceded premium earned increased $27.2 million, or 25.9%, for the quarter ended March 31, 2021, as compared to the same period of the prior year. The increase in reinsurance costs reflects an increase in costs associated with the increase in exposures we insure, increased pricing when compared to the expired reinsurance program and differences in the structure and design of the respective programs. Reinsurance costs, as a percentage of direct premium earned, increased from 32.3% for the three months ended March 31, 2020to 35.2% for the three months ended March 31, 2021. Reinsurance costs associated with each year's reinsurance program are earned over the annual policy period which typically runs from June 1st to May 31st.. See the discussion above for the Insurance Entities' 2020-2021 reinsurance programs and "Item 1-Note 4 (Reinsurance)." Premiums earned, net of ceded premium earned, grew by 10.2%, or $22.5 million, to $243.3 millionfor the three months ended March 31, 2021, reflecting an increase in direct premium earned offset by increased costs for reinsurance. Net investment income was $3.0 millionfor the three months ended March 31, 2021, compared to $6.8 millionfor the same period in 2020, a decrease of $3.8 million, or 56.3%. This decrease is largely attributable to significantly lower yields on the reinvested portfolio following the sale of a majority of securities in the portfolio that were in an unrealized gain position in the third and fourth quarters of 2020. Market rates in the second half of 2020 were considerably lower than the book yields of the portfolio prior to the sale. Additionally, income from cash investing was down $0.8 millionin the first quarter of 2021 as compared to the same period of the prior year due to significantly lower yields on cash sweep and short-term cash investing. Total invested assets were $1,017.3 millionas of March 31, 2021compared to $919.9 millionas of December 31, 2020. Cash and cash equivalents were $90.8 millionat March 31, 2021compared to $167.2 millionat December 31, 2020, a decrease of 45.7%. Cash and cash equivalents are invested short term until needed to settle loss and LAE payments, reinsurance premium payments and operating cash needs or until they are deployed by our investment advisors. Yields from cash and cash equivalents, short-term investments and the available-for-sale portfolio are dependent on future market forces, monetary policy and interest rate policy from the Federal Reserve. The Federal Reservehas broadly been lowering and maintaining lower interest rates, which has impacted the effective yields on new available-for-sale portfolio and overnight cash purchases and short-term investments. The overall trend has been lower interest rates on new purchases of securities over the past year and lower returns on cash and cash equivalents and short-term investments. As discussed below, due to the significant sale of securities during the third and fourth quarters of 2020, it is expected that future portfolio returns will reflect lower book yields based on current market conditions. 38 --------------------------------------------------------------------------------
Table of Contents We sell investments, including securities, from our investment portfolio from time to time to meet our investment objectives or take advantage of market opportunities. During the three months ended
March 31, 2021, sales of equity securities resulted in net realized gain of $0.3 million, sales of available-for-sale debt securities resulted in net realized losses of $0.2 millionand the sale of an investment real estate property resulted in a realized gain of $0.4 million, in total generating net realized gain of $0.5 million. During the three months ended March 31, 2020, sales of available-for-sale debt securities resulted in net realized gains of $0.3 millionSee "Item 1-Note 3 (Investments)." There was a $0.5 millionnet unrealized loss in equity securities during the three months ended March 31, 2021compared to an $8.0 millionnet unrealized loss during the three months ended March 31, 2020following the onset of the COVID-19 pandemic. Unrealized gains or losses reflected on the income statement are the result of changes in the fair market value of our equity securities during the period for securities still held and the reversal of unrealized gains or losses for securities sold during the period. See "Item 1-Note 3 (Investments)." During 2020, the COVID-19 pandemic disrupted the financial markets. In the first quarter of 2020, our investment portfolio was adversely impacted, but has since substantially recovered. We took advantage of the recovery with the realization of gains on our available-for-sale debt securities discussed above. We believe the adverse impact to our investment portfolio was minimized in part during this COVID-19 pandemic-induced market dislocation as a result of our conservative investment strategy's focus on capital preservation and adequate liquidity to pay claims. We believe the high credit rating and shorter duration foundation of our portfolio and portfolio diversification will help us weather these difficult market conditions, thereby limiting the impact of future economic financial market downturns on the portfolio. Recent market yields have been lower when compared to prior years and we expect the trend in lower interest income to continue as long as we compare current yields to yields on the portfolio before it was sold in 2020. We will continue to monitor the impact of the COVID-19 pandemic on our portfolio and the impact of the expected economic recovery. Significant uncertainties and emerging risks still exist regarding the potential long-term impact of the COVID-19 pandemic on the credit markets and our investment portfolio. Commission revenue is comprised principally of brokerage commissions we earn from third-party reinsurers (excluding the FHCF) on reinsurance placed for the Insurance Entities. Commission revenue is earned pro-rata over the reinsurance policy period which runs from June 1st to May 31stof the following year. For the three months ended March 31, 2021, commission revenue was $9.1 million, compared to $7.0 millionfor the three months ended March 31, 2020. The increase in commission revenue of $2.1 million, or 30.1%, for the three months ended March 31, 2021was primarily due to increased commissions from third-party reinsurers earned on increased reinsurance premiums due to growth in our exposures, as well as the difference in pricing and structure associated with our reinsurance program when compared to the prior year. Policy fees for the three months ended March 31, 2021were $5.4 millioncompared to $5.5 millionfor the same period in 2020. The decrease of $0.2 million, or 2.8%, was the result of a decrease in the total number of new and renewal policies written during the three months ended March 31, 2021compared to the same period in 2020. The following table presents losses and LAE incurred on a direct, ceded and net basis expressed in dollars and as a percent of the respective amounts of premiums earned. These amounts are further categorized as 1) core losses, 2) weather events for the current accident year and 3) prior years' reserve development (dollars in thousands):
Three months ended
Direct Loss Ratio Ceded Loss Ratio Net Loss Ratio Premiums earned
$ 375,606 $ 132,301 $ 243,305Loss and loss adjustment expenses: Core losses $ 145,22838.7 % $ 28- % $ 145,20059.7 % Weather events* - - % - - % - - % Prior years' reserve development 92,070 24.5 % 93,307 70.5 % (1,237) (0.5) % Total losses and loss adjustment expenses $ 237,29863.2 % $ 93,33570.5 % $ 143,963
* Only includes weather events for the current year beyond those expected.
39 -------------------------------------------------------------------------------- Table of Contents Three Months Ended March 31, 2020 Direct Loss Ratio Ceded Loss Ratio Net Loss Ratio Premiums earned
$ 325,951 $ 105,122 $ 220,829Loss and loss adjustment expenses: Core losses $ 129,72839.8 % $ 21- % $ 129,70758.7 % Weather events* 1,000 0.3 % - - % 1,000 0.5 % Prior years' reserve development 42,515 13.0 % 38,174 36.3 % 4,341 2.0 % Total losses and loss adjustment expenses $ 173,24353.2 % $ 38,19536.3 % $ 135,048
* Includes only weather events of the current year beyond those expected.
See "Item 1-Note 6 (Liability for Unpaid Losses and Loss Adjustment Expenses)" for change in liability for unpaid losses and LAE. Management looks at losses and LAE in three areas, as described below and represented in the tables above, each of which have different drivers which impact reported results. As a result, these components of losses and LAE are described separately. Overall losses and LAE, net of reinsurance recoveries, were
$144.0 millionresulting in a 59.2% net loss and LAE ratio for the quarter ended March 31, 2021. This compares to $135.0 millionresulting in a 61.2% net loss and LAE ratio for the quarter ended March 31, 2020.
Factors affecting losses and AEL are as follows:
•Core losses •Our core losses consist of all other losses and LAE, current year strengthening and excludes weather events beyond those expected and prior years' reserve development. Core losses were 38.7% of direct premium earned for the quarter ended
March 31, 2021compared to 39.8% for the same period in 2020. These losses and loss ratios benefit from the profitable impact of ceded claim fees, which are described below, reducing core losses. The core loss ratio for 2020 and 2021 reflects trends we have seen in higher expected costs to settle claims in the Floridamarket, specifically in response to increased trends in litigated and represented claims. Core losses also increase as premium volume increases year over year. Although the Insurance Entities received rate increases in Floridaand certain other states, management has elected to keep the core loss ratio in line with the prior year until management sees loss costs stabilize in Floridaand certain other states. The core loss ratio, net is also negatively impacted in 2021 by a proportionally greater spend on reinsurance which increases the net loss ratio. See the discussion above for the Insurance Entities' 2020-2021 reinsurance programs and "Item 1-Note 4 (Reinsurance)." •Weather events beyond those expected •There were no weather events above plan during the quarter ended March 31, 2021. •During the quarter ended March 31, 2020, weather events totaled $1.0 milliondirect and net, principally for weather events beyond those expected. •Prior years' reserve development •Management identifies two drivers which influence amounts recorded as prior years' reserve development, namely: (i) changes to prior estimates of direct and net ultimate losses on prior accident years excluding major hurricanes and (ii) changes in prior estimates of direct and net ultimate losses on hurricanes. During the quarter ended March 31, 2021, prior years' reserve development totaled $92.1 millionof direct losses and $1.2 millionof net favorable loss development after the benefit of reinsurance. ?Prior years' reserve development for the quarter ended March 31, 2021was the result of a gross increase in the ultimate losses for Hurricane Sally of $92 million. Changes to ceded reserves on prior years' hurricanes exceeded gross development by $1.2 million, resulting in net favorable development on prior years' reserve development. There was an increase in ceded reserves on Hurricane Sally as a result of recoveries on losses outside of Florida, which have a lower attachment point, offset by a reduction in Hurricane Irma recoveries representing previously ceded losses not subject to recovery. As a result, net prior years' reserve development was favorable. ?Excluding hurricanes, there was no prior years' reserve development for the quarter ended March 31, 2021. ?For the quarter ended March 31, 2020, direct prior years' reserve development of $42.5 milliongross, less $38.2 millionceded, resulting in $4.3 millionnet development. The direct and net prior years' reserve development was principally due to increased ultimate direct losses and LAE for Hurricane Irma. 40 --------------------------------------------------------------------------------
Table of Contents The net loss and LAE ratio for the quarter ended
March 31, 2021was 59.2% compared to 61.2% in the first quarter of the prior year. The decrease of 2.0 loss ratio points was a result of: (1) favorable prior years' reserve development on prior years' losses and LAE reserves (2.5 loss ratio points); (2) decreased weather (0.5 loss ratio points); and (3) increased estimated core losses and LAE ratio and strengthening for the current year (4.1 loss ratio points, which include 4.1 loss ratio points as a result of higher reinsurance costs). The increase was partially offset by higher financial benefit from the management of claims, including claims fees ceded to reinsurers (3.1 loss ratio points). The Company continues to experience inflated costs for losses and LAE in the Floridamarket where an industry has developed around the solicitation, filing and litigation of personal residential claims, resulting in a pattern of continued increased year over year levels of represented claims, inflation of purported claim amounts, and increased demands for attorneys' fee. Active solicitation of personal residential claims in Floridaby policyholder representatives, remediation companies and repair companies has led to an increase in the frequency and severity of personal residential claims in Floridaexceeding historical levels and levels seen in other jurisdictions. A Floridastatute providing a one-way right of attorneys' fees against insurers, coupled with other adverse statutes and judicial rulings, have further produced a legal environment in Floridathat encourages litigation, in many cases without regard to the underlying circumstances of the claims. The market trends in losses and LAE led us to file in February 2020for an overall 12.4% rate increase in Florida, which was approved effective May 18, 2020for new business and July 7, 2020for renewals. In addition we filed and received approval on December 31, 2020to further increase our rates in Floridaby an additional 7.0% in response to higher reinsurance costs associated with the reinsurance program we put into effect June 1, 2020. This rate change was effective December 31, 2020for new business and March 1, 2021for renewal business. In addition, we implemented changes to certain new business underwriting guidelines, reduced new business writings in certain Floridacounties and developed and implemented specialized claims and litigation management efforts to address market trends which we believe are driving up claim costs. The financial benefit from the management of claims, including claim fees ceded to reinsurers, was $8.1 millionfor the three months ended March 31, 2021, compared to $0.3 millionduring the three months ended March 31, 2020, driven primarily by the recoveries from reinsurers in excess of costs and the financial impact of internal claim services on the expected core loss ratio. The benefit was recorded in the condensed consolidated financial statements as a reduction to losses and LAE. General and administrative expenses were $82.4 millionfor the three months ended March 31, 2021, compared to $72.6 millionduring the same period in 2020, as follows (dollars in thousands): Three Months Ended March 31, Change 2021 2020 $ % $ Ratio $ Ratio Premiums earned, net $ 243,305 $ 220,829 $ 22,47610.2 % General and administrative expenses: Policy acquisition costs 56,458 23.2 % 46,864 21.2 % 9,594 20.5 % Other operating costs (1) 25,985 10.7 % 25,779 11.7 % 206 0.8 % Total general and administrative expenses $ 82,44333.9 % $ 72,64332.9 % $ 9,80013.5 %
(1) Other operating costs include
General and administrative expenses increased by
$9.8 million, which was the result of increases in policy acquisition costs of $9.6 million, primarily due to commissions associated with increased premium volume and an increase in other operating costs of $0.2 million. The expense ratio as a percentage of premiums earned, net increased from 32.9% for the three months ended March 31, 2020to 33.9% for the same period in 2021. The increase in policy acquisition costs as a percentage of premiums earned, net increased during the quarter as a result of bonus payouts to agents exceeding previous estimates, higher premium tax rate and the ratio impact of higher reinsurance costs than previous years reducing premiums earned, net. The commission rate paid to agents on the renewal of Floridapolicies was reduced 2 percentage points effective April 1, 2021. Other operating cost ratio for the three months ended March 31, 2021was 10.7% compared to 11.7% in the first quarter of 2020, reflecting lower advertising costs and performance bonuses in 2021 and continued economies of scale as other operating costs did not increase at the same rate as premiums earned, net. Income tax expense was $9.9 millionfor the quarter ended March 31, 2021compared to income tax expense of $7.5 millionfor the quarter ending March 31, 2020. Our effective tax rate ("ETR") increased to 27.4% for the three months ended March 31, 2021, as compared to 27.3% for the three months ended March 31, 2020. The ETR increased as a result of a higher ratio of permanent items relative to the amount of income before taxes, principally non-deductible compensation, and a lower level of discrete tax benefits. Other comprehensive loss, net of taxes for the three months ended March 31, 2021, was $16.9 millioncompared to other comprehensive loss of $8.9 millionfor the same period in 2020, reflecting reclassifications out of cumulative other comprehensive income for available-for-sale debt securities sold and after-tax changes in fair value of available-for-sale debt securities held in our investment portfolio. See "Item 1-Note 11 (Other Comprehensive Income (Loss))" for additional information about the amounts comprising other comprehensive income for these periods. 41 --------------------------------------------------------------------------------
Table of Contents Analysis of Financial Condition-As of
March 31, 2021Compared to December 31, 2020We believe that cash flows generated from operations will be sufficient to meet our working capital requirements for at least the next twelve months. We invest amounts considered to be in excess of current working capital requirements. The following table summarizes, by type, the carrying values of investments as of the dates presented (in thousands): As of March 31, December 31, Type of Investment 2021 2020
Debt securities available for sale
Equity securities 91,291 84,887 Assets held for sale 6,855 - Investment real estate, net 6,027 15,176 Total
$ 1,017,304 $ 919,924See "Item 1-Condensed Consolidated Statements of Cash Flows" and "Item 1-Note 3 (Investments)" for explanations on changes in investments. Prepaid reinsurance premiums represent the portion of unearned ceded written premium that will be earned pro-rata over the coverage period of our reinsurance program, which runs from June 1st to May 31stof the following year. The decrease of $115.5 millionto $100.2 millionas of March 31, 2021was due to the amortization of ceded written premium for the reinsurance costs relating to our 2020-2021 catastrophe reinsurance program earned during the period. Reinsurance recoverable represents the estimated amount of paid and unpaid losses, LAE and other expenses that are expected to be recovered from reinsurers. The increase of $57.2 millionto $217.6 millionas of March 31, 2021was primarily due to increased estimates of amounts recoverable from reinsurers relating to settled claims from hurricanes and other events covered by our reinsurance contracts. Premiums receivable, net, represents amounts receivable from policyholders. The decrease in premiums receivable, net, of $4.4 millionto $62.5 millionas of March 31, 2021relates to a slight decrease in direct premium written during the quarter ended March 31, 2021compared to the quarter ended December 31, 2020and consumer payment behavior of our business. The amount of direct premiums written during a calendar year tends to increase just prior to the second quarter and tends to decrease approaching the fourth quarter. Income taxes recoverable represents the difference between estimated tax obligations and tax payments made to taxing authorities. As of March 31, 2021, the balance recoverable was $14.7 million, representing amounts due from taxing authorities at that date, compared to a balance recoverable of $30.6 millionas of December 31, 2020. Income taxes recoverable as of March 31, 2021will either be refunded or applied to future periods to offset future federal and state income tax obligations. Deferred income taxes represent the estimated tax asset or tax liability caused by temporary differences between the tax return basis of certain assets and liabilities and amounts recorded in the financial statements. During the three months ended March 31, 2021, deferred income tax asset, net increased by $11.2 millionto $17.5 million. Deferred income taxes reverse in future years as the temporary differences between book and tax reverse. See "Item 1-Note 6 (Liability for Unpaid Losses and Loss Adjustment Expenses)" for a roll-forward in the balance of our unpaid losses and LAE. Unpaid losses and LAE decreased by $6.7 millionto $315.8 millionas of March 31, 2021. The reduction in unpaid losses and LAE was principally due to the settlement of claims from previous hurricane and storm events, as more claims from those events concluded during the three months ended March 31, 2021. Overall unpaid losses and LAE decreased, as claim settlements exceeded new emerging claims. Unpaid losses and LAE are net of estimated subrogation recoveries. Unearned premiums represent the portion of direct premiums written that will be earned pro-rata in the future. The decrease of $10.3 millionfrom December 31, 2020to $772.8 millionas of March 31, 2021reflects the seasonality of our business, which varies from month to month. Advance premium represents premium payments made by policyholders ahead of the effective date of the policies. The increase of $24.2 millionto $73.7 millionas of March 31, 2021reflects customer payment behavior and the seasonality of our business. We exclude net negative cash balances, if any, from cash and cash equivalents that we have with any single financial institution based on aggregating the book balance of all accounts at the institution which have the right of offset. If the aggregation results in a net negative book balance, that balance is reclassified from cash and cash equivalents in our Condensed Consolidated Balance Sheet to book overdraft. These amounts represent outstanding checks or drafts not yet presented to the financial institution in excess of amounts on deposit at the financial institutions. We maintain a short-term cash investment strategy sweep to maximize investment returns on cash balances. There were no book overdrafts as of March 31, 2021compared to book overdrafts totaling $59.4 millionas of December 31, 2020. 42 --------------------------------------------------------------------------------
Table of Contents Reinsurance payable, net, represents the unpaid reinsurance premium installments owed to reinsurers, unpaid reinstatement premiums due to reinsurers and cash advances received from reinsurers, if any. On
June 1stof each year, we renew our core catastrophe reinsurance program and record the estimated annual cost of our reinsurance program. These estimated annual costs are increased or decreased during the year based on premium adjustments or as a result of new placements during the year. The annual cost initially increases reinsurance payable, which is then reduced as installment payments are made over the policy period of the reinsurance, which typically runs from June 1st to May 31st. The balance increased by $14.2 millionto $24.5 millionas of March 31, 2021as a result of a new reinsurance placement during the quarter ended March 31, 2021and the timing of the above items. Other liabilities and accrued expenses decreased by $11.2 millionto $41.1 millionas of March 31, 2021, primarily driven from the timing of payments and payables relating to purchases of securities for our investment portfolio that settled after December 31, 2020. Capital resources, net, increased by $5.0 millionfor the three months ended March 31, 2021. The increase in stockholders' equity was principally the result of our 2021 net income and share-based compensation, offset by declines in the after-tax changes in the fair value of our available-for-sale debt securities, treasury share purchases and dividends to shareholders. See "Item 1-Condensed Consolidated Statements of Stockholders' Equity" and "Item 1-Note 8 (Stockholders' Equity)" for explanation of changes in treasury stock. The reduction in long-term debt of $0.4 millionwas the result of principal payments on debt during 2021. See "-Liquidity and Capital Resources" for more information. LIQUIDITY AND CAPITAL RESOURCES Liquidity Liquidity is a measure of a company's ability to generate sufficient cash flows to meet its short and long-term obligations. Funds generated from operations have been sufficient and we expect them to be sufficient to meet our current and long term liquidity requirements. While we have not experienced an adverse impact on our liquidity as a result of the COVID-19 pandemic, we will continue to monitor liquidity as the economic consequences of the COVID-19 pandemic continue to unfold. See discussion below regarding the COVID-19 pandemic's impact. Also see the discussion above under "Overview-Trends-Impact of the COVID-19 Pandemic" regarding our response to the COVID-19 pandemic, the financial impact to us in 2020, our general outlook and plans to monitor the economic consequences of the COVID-19 pandemic. The balance of cash and cash equivalents, excluding restricted cash, as of March 31, 2021was $90.8 million, compared to $167.2 millionat December 31, 2020. See "Item 1-Condensed Consolidated Statements of Cash Flows" for a reconciliation of the balance of cash and cash equivalents between March 31, 2021and December 31, 2020. The decrease in cash and cash equivalents was driven by cash flows used in investing and financing activities in excess of cash flows generated from operating activities. We have not experienced an adverse impact on our liquidity as a result of the COVID-19 pandemic. Our cash investment strategy at times includes cash investments where the right of offset against other bank accounts does not exist. A book overdraft occurs when aggregating the book balance of all accounts at a financial institution, for accounts which have the right of offset, and if the aggregation results in a net negative book balance, that balance is reclassified from cash and cash equivalents in our Condensed Consolidated Balance Sheet to book overdraft. Cash and cash equivalents balances are available to settle book overdrafts, and to pay reinsurance premiums, expenses and claims. Reinsurance premiums are paid in installments during the reinsurance policy period, which runs from June 1st to May 31stof the following year. The FHCF reimbursement premiums are paid in three installments on August 1st, October 1st, and December 1st, and third-party reinsurance premiums are generally paid in four installments on July 1st, October 1st, January 1stand April 1st, resulting in significant payments at those times. See "Item 1-Note 12 (Commitments and Contingencies)" and "-Contractual Obligations" for more information. The balance of restricted cash and cash equivalents as of March 31, 2021and December 31, 2020represents cash equivalents on deposit with certain regulatory agencies in the various states in which our Insurance Entities do business and, in 2021, restricted cash and cash equivalents also includes collateral held by a reinsurance captive arrangement with one of the Insurance Entities reported as a variable interest entity ("VIE") in the condensed consolidated financial statements. The amount of collateral held was $10.1 millionas of March 31, 2021. See "Item 1-Note 14 (Variable Interest Entities)" for more information. Liquidity is required at the holding company for us to cover the payment of general operating expenses and contingencies, dividends to shareholders (if and when authorized and declared by our Board of Directors), payment for the possible repurchase of our common stock (if and when authorized by our Board of Directors), payment of income taxes, net of amounts received from affiliates, capital contributions to subsidiaries, if needed, and interest and principal payments on outstanding debt obligations of the holding company, if any. See "Item 1-Note 5 (Insurance Operations)." The declaration and payment of future dividends to our shareholders, and any future repurchases of our common stock, will be at the discretion of our Board of Directors and will depend upon many factors, including our operating results, financial condition, debt covenants and any regulatory constraints. Principal sources of liquidity for the holding company include dividends paid by our service entities generated from income earned on fees paid by the Insurance Entities to affiliated companies for general agency, inspections and claims adjusting services. Dividends are also paid from income earned from brokerage commissions earned on reinsurance contracts placed by our wholly-owned subsidiary, Blue Atlantic Reinsurance Corporation, and policy fees. We also maintain high quality investments in our portfolio as a source of liquidity along with ongoing interest and dividend income from those investments. As discussed in "Item 1-Note 5 (Insurance Operations)," there are limitations on the dividends the Insurance Entities may pay to their immediate parent company, Protection Solutions, Inc.("PSI", formerly known as Universal Insurance Holding Company of Florida). 43 --------------------------------------------------------------------------------
Table of Contents The maximum amount of dividends that can be paid by
Floridainsurance companies without prior approval of the FLOIR is subject to restrictions as referenced below and in "Item 1-Note 5 (Insurance Operations)." The maximum dividend that may be paid by the Insurance Entities to PSI without prior approval is limited to the lesser of statutory net income from operations of the preceding calendar year or statutory unassigned surplus as of the preceding year end. During the three months ended March 31, 2021and the year ended December 31, 2020, the Insurance Entities did not pay dividends to PSI. Liquidity for the Insurance Entities is primarily required to cover payments for reinsurance premiums, claims payments including potential payments of catastrophe losses (offset by recovery of any reimbursement amounts under our reinsurance agreements), fees paid to affiliates for managing general agency services, inspections and claims adjusting services, agent commissions, premium and income taxes, regulatory assessments, general operating expenses, and interest and principal payments on debt obligations. The principal source of liquidity for the Insurance Entities consists of the revenue generated from the collection of premiums earned, net, interest and dividend income from the investment portfolio, the collection of reinsurance recoverable and financing fees. Our insurance operations provide liquidity as premiums are generally received months or even years before potential losses are paid under the policies written. In the event of catastrophic events, many of our reinsurance agreements provide for "cash advance" whereby reinsurers advance or prepay amounts to us, thereby providing liquidity, which we utilize in the claim settlement process. In addition, the Insurance Entities maintain substantial investments in highly liquid, marketable securities, which would generate funds upon sale. The average credit rating on our available-for-sale securities was A+ as of March 31, 2021and December 31, 2020. Credit ratings are a measure of collection risk on invested assets. Credit ratings are provided by third party nationally recognized rating agencies and are periodically updated. Management establishes guidelines for minimum credit rating and overall credit rating for all investments. The duration of our available-for-sale securities was 4.5 years at March 31, 2021compared to 4.0 years at December 31, 2020. Duration is a measure of a bond's sensitivity to interest rate changes and is used by management to limit the potential impact of longer-term investments. The Insurance Entities are responsible for losses related to catastrophic events in excess of coverage provided by the Insurance Entities' reinsurance programs and retentions before our reinsurance protection commences. Also, the Insurance Entities are responsible for all other losses that otherwise may not be covered by the reinsurance programs and any amounts arising in the event of a reinsurer default. Losses or a default by reinsurers may have a material adverse effect on either of the Insurance Entities, on our business, financial condition, results of operations and liquidity. Capital Resources Capital resources provide protection for policyholders, furnish the financial strength to support the business of underwriting insurance risks and facilitate continued business growth. The following table provides our stockholders' equity, total long-term debt, total capital resources, debt-to-total capital ratio and debt-to-equity ratio for the periods presented (dollars in thousands): As of March 31, December 31, 2021 2020 Stockholders' equity $ 454,665 $ 449,262Total long-term debt 8,088 8,456 Total capital resources $ 462,753 $ 457,718Debt-to-total capital ratio 1.8 % 1.8 % Debt-to-equity ratio 1.8 % 1.9 % The debt-to-total capital ratio is total long-term debt divided by total capital resources, whereas debt-to-equity ratio is total long-term debt divided by stockholders' equity. These ratios help management measure the amount of financing leverage in place in relation to equity and future leverage capacity. As described in our Annual Report on Form 10-K for the year ended December 31, 2020, UPCIC entered into a surplus note with the State Board of Administration of Floridaunder Florida'sInsurance Capital Build-Up Incentive Program on November 9, 2006. The surplus note has a twenty-year term, with quarterly payments of principal and interest that accrue per the terms of the note agreement. At March 31, 2021, UPCIC was in compliance with the terms of the surplus note. Total adjusted capital and surplus, which includes the surplus note, was in excess of regulatory requirements for both UPCIC and APPCIC. In addition to the liquidity generally provided from operations, we maintain a conservative, well-diversified investment portfolio, predominantly comprised of fixed income securities with an average credit rating of A+, that focuses on capital preservation and providing an adequate source of liquidity for potential claim payments and other cash needs. The portfolio's secondary investment objective is to provide a total rate of return with emphasis on investment income. Historically, we have consistently generated funds from operations, allowing our cash and invested assets to grow. We have not had to liquidate investment holdings to fund either operations or financing activities. 44 --------------------------------------------------------------------------------
Table of Contents Impact of the COVID-19 Pandemic There has been significant recovery in the fair value of invested assets since the low point on or about
March 23, 2020and in the third and fourth quarters of 2020 the Company sold many of its securities in an unrealized gain position to take advantage of the recovery in asset values. The proceeds from the sales of available-for-sale debt securities in the third and fourth quarters of 2020 have been fully reinvested. The sales took advantage of increased market prices occurring on our available-for-sale debt investment portfolio. As a result of the sales and reinvestment of available-for-sale debt securities, it is expected that future portfolio investment income will be lower, as reinvestment rates reflected market rates which were below the book yields of the securities sold. The impact of the COVID-19 pandemic on the credit markets remains a key risk as the world continues to navigate the consequences of the COVID-19 pandemic and efforts taken by governments to accelerate and stimulate a financial recovery. Our concern is that individual companies within our portfolio experience business declines as a result of the COVID-19 pandemic's adverse impact on their business which impacts their credit rating, reducing the market value of their securities. We remain in regular contact with our advisors to monitor credit of the issuers of our securities and discuss appropriate responses to credit downgrades or changes in companies credit outlook. We believe these measures, when combined with the inherent liquidity generated by our business model and in our investment portfolio, will allow us to continue to meet our short- and long-term obligations. We implemented certain premium payment grace periods in Floridaand other states to assist policyholders affected by the COVID-19 pandemic. In addition, we have waived late payment fees that otherwise would apply to those policyholders. To date we have not seen significant use of these grace periods. We are not able at this time to estimate the number of policyholders who might avail themselves of an extended grace period. Generally, a significant number of our policies are subject to payment by mortgage companies, which are likely to continue remitting payments as scheduled. Our collection experience since March 2020was consistent with our average experience. This reflects on the nature of homeowners' insurance and the priority that mortgage companies and policyholders place on maintaining coverage for insured properties. We will monitor this as the impact of the COVID-19 pandemic and its economic consequences are felt by our policyholders.
Looking forward to
We continue to monitor a range of financial metrics related to our business. Although we have not yet experienced material adverse impacts on our business or liquidity, conditions are subject to change depending on the extent of the economic downturn and the pace and extent of an economic recovery. Significant uncertainties exist with the potential long-term impact of the COVID-19 pandemic, including unforeseen newly emerging risks that could affect us. We will continue to monitor the broader economic impacts of the COVID-19 pandemic and its impact on our operations and financial condition including liquidity and capital resources. Common Stock Repurchases On
November 3, 2020, we announced that our Board of Directors authorized a share repurchase program under which we may repurchase in the open market up to $20 millionof outstanding shares of our common stock through November 3, 2022. We may repurchase shares from time to time at our discretion, based on ongoing assessments of our capital needs, the market price of our common stock and general market conditions. We will fund the share repurchase program with cash from operations. During the three months ended March 31, 2021, we repurchased an aggregate of 15,444 shares of our common stock in the open market at an aggregate purchase price of $0.2 million. Also, see "Part II, Item 2-Unregistered Sales of Equity Securitiesand Use of Proceeds" for share repurchase activity during the three months ended March 31, 2021. Off-Balance Sheet Arrangements The Company does not have any off-balance sheet arrangements that are reasonably likely to have a material effect on the financial condition, results of operations, liquidity, or capital resources of the Company, except for multi-year reinsurance contract commitments for future years that will be recorded at the commencement of the coverage period. See "Item 1-Note 12 (Commitments and Contingencies)" for more information. Cash Dividends The following table summarizes the dividends declared by the Company: Cash Dividend Dividend Shareholders Dividend Per Common Share 2021 Declared Date Record Date Payable Date Amount First Quarter March 1, 2021 March 11, 2021 March 18, 2021 $ 0.16 Second Quarter April 22, 2021 May 14, 2021 May 21, 2021 $ 0.16 45
Table of Contents CONTRACTUAL OBLIGATIONS The following table represents our contractual obligations for which cash flows are fixed or determinable as of
March 31, 2021(in thousands): Less than Over Total 1 year 1-3 years 3-5 years 5 years Reinsurance payable and multi-year commitments (1) $ 252,342 $ 152,817 $ 99,525$ - $ - Unpaid losses and LAE, direct (2) 315,780 191,363 91,576 24,947 7,894 Long-term debt 8,304 1,157 4,550 2,597 - Total contractual obligations $ 576,426 $ 345,337
(1)The amount in less than 1 year includes reinsurance payable reflected in the Condensed Consolidated Balance Sheet and reinsurance premiums payable under multi-year commitments. The 1-3 years solely represents the payment of reinsurance premiums payable under multi-year commitments. See "Item 1--Note 12 (Commitments and Contingencies)." (2)There are generally no notional or stated amounts related to unpaid losses and LAE. Both the amounts and timing of future loss and LAE payments are estimates and subject to the inherent variability of legal and market conditions affecting the obligations and make the timing of cash outflows uncertain. The ultimate amount and timing of unpaid losses and LAE could differ materially from the amounts in the table above. Further, the unpaid losses and LAE do not represent all the obligations that will arise under the contracts, but rather only the estimated liability incurred through
March 31, 2021. Unpaid losses and LAE are net of estimated subrogation recoveries. In addition, these balances exclude amounts recoverable from the Company's reinsurance program. See "Item 1-Note 4 (Reinsurance)."
Agreements with variable interest entities
We entered into a captive reinsurance arrangement with a VIE in the normal course of business and consolidated the VIE as we are the primary beneficiary.
For a further discussion of our involvement with the VIE, see "Item 1-Note 14 (Variable Interest Entities)." CRITICAL ACCOUNTING POLICIES AND ESTIMATES There have been no material changes during the period covered by this Quarterly Report on Form 10-Q to Critical Accounting Policies and Estimates previously disclosed in "Part II, Item 7-Management's Discussion and Analysis of Financial Condition and Results of Operations" included in our Annual Report on Form 10-K for the year ended
December 31, 2020. Item 3. Quantitative and Qualitative Disclosures about Market Risk Market risk is the potential for economic losses due to adverse changes in fair market value of available-for-sale debt securities, equity securities ("Financial Instruments") and investment real estate. We carry all of our Financial Instruments at fair market value and investment real estate at net book value in our statement of financial condition. Our investment portfolio as of March 31, 2021is comprised of available-for-sale debt securities and equity securities, carried at fair market value, which expose us to changing market conditions, specifically interest rates and equity price changes. The primary objectives of the investment portfolio are the preservation of capital and providing adequate liquidity for potential claim payments and other cash needs. The portfolio's secondary investment objective is to provide a total rate of return with an emphasis on investment income. None of our investments in risk-sensitive Financial Instruments were entered into for trading purposes. See "Item 1-Note 3 (Investments)" for more information about our Financial Instruments. 46 --------------------------------------------------------------------------------
Table of Contents Interest Rate Risk Interest rate risk is the sensitivity of the fair market value of a fixed rate Financial Instrument to changes in interest rates. Generally, when interest rates rise, the fair value of our fixed rate Financial Instruments declines. The following tables provide information about our fixed income Financial Instruments as of
March 31, 2021compared to December 31, 2020, which are sensitive to changes in interest rates. The tables present the expected cash flows of Financial Instruments based on years to effective maturity using amortized cost compared to fair market value and the related book yield compared to coupon yield (dollars in thousands): March 31, 2021 2021 2022 2023 2024 2025 Thereafter Other Total Amortized cost $ 19,275 $ 59,504 $ 132,369 $ 100,014 $ 224,708 $ 395,139 $ 165 $ 931,174Fair market value $ 19,357 $ 59,620 $ 132,676 $ 99,622 $ 221,455 $ 380,204 $ 197 $ 913,131Coupon rate 3.31 % 1.61 % 1.97 % 3.09 % 2.62 % 2.29 % 7.50 % 2.39 % Book yield 2.26 % 0.69 % 0.91 % 1.01 % 1.07 % 1.68 % 6.31 % 1.31 %
* Years until effective maturity – 6.3 years
December 31, 2020 2021 2022 2023 2024 2025 Thereafter Other Total Amortized cost
$ 31,333 $ 58,790$
$ 815,647Fair market value $ 31,578 $ 58,868 $ 108,412 $ 180,111 $ 134,740 $ 306,041 $ 211 $ 819,961Coupon rate 2.75 % 1.88 % 2.15 % 3.12 % 2.51 % 2.41 % 7.50 % 2.52 % Book yield 2.12 % 0.59 % 0.84 % 0.71 % 1.07 % 1.59 % 6.31 % 1.16 %
* Years until effective maturity – 5.4 years
All securities, except those with perpetual maturities, were categorized in the tables above utilizing years to effective maturity. Effective maturity takes into consideration all forms of potential prepayment, such as call features or prepayment schedules, that shorten the lifespan of contractual maturity dates. Equity Price Risk Equity price risk is the potential for loss in fair value of Financial Instruments in common stock and mutual funds and other from adverse changes in the prices of those Financial Instruments. The following table provides information about the Financial Instruments in our investment portfolio subject to price risk as of the dates presented (in thousands): March 31, 2021 December 31, 2020 Fair Value Percent Fair Value Percent
Equity Securities: Common stock $ 6,2256.8 % $ 2,435 2.9 % Mutual funds and other 85,066 93.2 % 82,452 97.1 % Total equity securities $ 91,291100.0 % $ 84,887 100.0 % A hypothetical decrease of 20% in the market prices of each of the equity securities held at March 31, 2021and December 31, 2020would have resulted in a decrease of $18.3 millionand $17.0 million, respectively, in the fair value of those securities. The COVID-19 pandemic presents uncertainty to the financial markets. See further discussion in "Item 2- Management's Discussion and Analysis of Financial Condition and Results of Operations." 47 --------------------------------------------------------------------------------
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