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 owned and operated by us. In November 2018, this property was listed for sale.
Sorrento, Florida. The real estate includes 5.42 acres of outparcel land intended for ground lease or resale and a retail shopping center with 61,400 square feet of net rentable area. Approximately 74% of the rentable space is currently leased to a large, well-known grocery retailer. Approximately 94% of the rentable space is leased to non-affiliates and the remaining space is available for lease.
Clearwater, Florida. The real estate consists of 5.33 acres of land and a vacant building with approximately 56,000 square feet of rentable space under redevelopment. Approximately 50% of the building is preleased to a large, well known grocery retailer and the remaining space will be available for multiple retailers.
Noida, India. We lease 15,000 square feet of office space for our information technology operations. The lease commenced in 2013 and has an initial term of nine years.
Miami Lakes, Florida. We lease approximately 5,565 square feet of office space for our claims related administration. The lease commenced March 1, 2018 and has an initial term of approximately three years.
Rental expense under all facility leases was $407,000, $336,000 and $333,000 during the years ended December 31, 2018, 2017 and 2016, respectively.
On January 15, 2019, we granted 40,000 shares of restricted stock and options to purchase 110,000 of our common shares at an exercise price of $53 per share to our chief executive officer, Paresh Patel. The options will expire on January 15, 2029. These share-based awards were granted pursuant to our 2012 Omnibus Incentive Plan and will vest in equal annual installments over four years, so long as Mr. Patel remains employed by us. The grant date fair values of the restricted stock and options were approximately $1,918,000 and $1,345,000, respectively.
Premiums Ceded for the years ended December 31, 2018 and 2017 were approximately $129,643,000 and $133,635,000, respectively, representing 37.8% and 37.3%, respectively, of gross premiums earned. The $3,992,000 decrease was primarily attributable to an unfavorable adjustment of $12,465,000 to premiums ceded in connection with retrospective provisions under certain reinsurance contracts due to losses incurred by Hurricane Irma during the third quarter of 2017, offset by the recognition of additional premiums ceded of approximately $1,222,000 resulting from the termination of one reinsurance contract during the second quarter of 2018 (See Note 17 - “Related Party Transactions” to our audited consolidated financial statements under Item 8 of this Annual Report on Form 10-K for additional information) and an increase in premiums ceded attributable to a lower retention level for the reinsurance contract year 2019/20.
Our premiums ceded represent costs of reinsurance to cover losses from catastrophes that exceed the retention levels defined by our catastrophe excess of loss reinsurance contracts or to assume a proportional share of losses defined in a quota share arrangement. The rates we pay for reinsurance are based primarily on policy exposures reflected in gross premiums earned. For the year ended December 31, 2018, premiums ceded included a net decrease of approximately $485,000 versus a net increase of approximately $5,740,000 for the year ended December 31, 2017 related to retrospective provisions. See “Economic Impact of Reinsurance Contracts with Retrospective Provisions” under “Critical Accounting Policies and Estimates.”
Net Unrealized Investment Losses for the year ended December 31, 2018 were approximately $10,202,000 versus approximately $92,000 of net unrealized investment gains for the year ended December 31, 2017. Net unrealized investment gains or losses represent the net change in the fair value of equity securities. The decrease in 2018 primarily resulted from the adoption of the new accounting standard with regard to equity securities as described in Note 2 - “Summary of Significant Accounting Policies” to our audited consolidated financial statements under Item 8 of this Annual Report on Form 10-K, combined with a general downturn in the U.S. securities markets in December 2018.
Our Losses and Loss Adjustment Expenses amounted to approximately $109,328,000 and $165,629,000 for the years ended December 31, 2018 and 2017, respectively. During 2018, loss and loss adjustment expenses included net losses of approximately $16,520,000 for Hurricane Michael as well as adverse development related to Hurricane Matthew of approximately $2,100,000 and adverse development related to non-catastrophe claims of approximately $9,900,000 primarily related to assignment of benefits litigation. Loss and loss adjustment expenses in 2017 included net losses related to Hurricane Irma of approximately $54,000,000 as well as adverse development related to Hurricane Matthew of approximately $2,500,000 and adverse development related to non-catastrophe claims of approximately $16,200,000 primarily related to assignment of benefits litigation. See “Reserves for Losses and Loss Adjustment Expenses” under “Critical Accounting Policies and Estimates.”
General and Administrative Personnel Expenses for the years ended December 31, 2018 and 2017 were approximately $25,908,000 and $25,127,000, respectively. Our general and administrative personnel expenses include salaries, wages, payroll taxes, share-based compensation expenses, and employee benefit costs. Factors such as merit increases, changes in headcount, and periodic restricted stock grants, among others, cause fluctuations in this expense. In addition, our personnel expenses are decreased by the capitalization of payroll costs related to a project to develop software for internal use and the payroll costs associated with the processing and settlement of Hurricane Irma claims which are recoverable from reinsurers under reinsurance contracts. The year-over-year increase of $781,000 was primarily attributable to the recognition of approximately $1,505,000 of cumulative dividends paid on unvested restricted stock awards of which market conditions will not be met and an increase of approximately $606,000 in employee incentive bonus, offset by an increase in recoverable Hurricane Irma payroll costs of $1,231,000 and lower share-based compensation expense during 2018.
Interest Expense for the years ended December 31, 2018 and 2017 was approximately $18,096,0000 and $16,767,000, respectively. The increase primarily resulted from the 4.25% convertible debt offering completed in March 2017.
The combined ratio is the measure of overall underwriting profitability before other income. Our combined ratio for the year ended December 31, 2018 was 95.8% compared with 115.8% for the year ended December 31, 2017. The decrease was primarily to the decrease in losses and loss adjustment expenses as described earlier.
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, 2018 was 59.6% compared with 72.6% for the year ended December 31, 2017. The decrease in 2018 was primarily attributable to the decrease in losses and loss adjustment expenses.
Our results of operations for the year ended December 31, 2017 reflect net loss of $6,893,000, or $0.75 loss per common share, compared with net income of $29,021,000, or $2.92 earnings per diluted common share, for the year ended December 31, 2016. The year-over-year decline was primarily attributable to a $40,962,000 increase in losses and loss adjustment expenses primarily from Hurricane Irma, a decrease in gross premiums earned of $20,425,000 and an increase in interest expense of $5,688,000 resulting from the issuance of long-term debt in March 2017. These factors contributed to $15,624,000 pre-tax operating losses in 2017 and, as a result, we recognized $8,731,000 of income tax benefit, the amount of which included net positive tax effects of approximately $1,400,000 due to the 2017 Tax Act.
Net Investment Income for the years ended December 31, 2017 and 2016 was approximately $11,439,000 and $9,087,000, respectively. The increase in 2017 was primarily due to year-over-year increases in income from limited partnership investments and fixed-maturity securities. See Note 5 - “Investments” under Net Investment Income to our consolidated financial statements under Item 8 of this Annual Report on Form 10-K.
Our Losses and Loss Adjustment Expenses amounted to approximately $165,629,000 and $124,667,000 for the years ended December 31, 2017 and 2016, respectively. Our 2017 losses and loss adjustment expenses included approximately $54,000,000 of net losses related to Hurricane Irma and additional losses of approximately $2,500,000 related to Hurricane Matthew. In addition, our losses and loss adjustment expenses included approximately $16,200,000 of additional losses, which reflected the continuation of reserve strengthening in response to trends involving assignment of insurance benefits and related litigation. Our losses and loss adjustment expenses were also impacted by weather-related events. 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, 2017 and 2016 were approximately $39,663,000 and $42,642,000, respectively. The decrease from 2016 was primarily attributable to decreased commissions and premium taxes resulting from policy attrition and the effect of the rate decrease.
The loss ratio applicable to the year ended December 31, 2017 was 73.8% compared with 51.2% for the year ended December 31, 2016. The increase was primarily attributable to losses related to Hurricane Irma combined with the decrease in net premiums earned which was driven in large part by the increase in ceded premiums due to the aforementioned adjustments.
The expense ratio applicable to the year ended December 31, 2017 was 42.0% compared with 38.1% for the year ended December 31, 2016. The increase in our 2017 expense ratio was primarily attributable to the decrease in 2017 net premiums earned, an increase in interest expense, and the loss on repurchases of our senior notes, as described above.
Our combined ratio for the year ended December 31, 2017 was 115.8% compared with 89.3% for the year ended December 31, 2016. Our combined ratio was negatively impacted by increased expenses for losses and loss adjustment expenses, increased interest expense, the loss on repurchases of our senior notes and a reduction in 2017 net premiums earned.
Our insurance business is seasonal as hurricanes and tropical storms affecting Florida typically occur during the period from June 1 through November 30 each year. Also, with our reinsurance treaty year typically effective 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.
In December 2018, our Board of Directors approved a one-year plan for 2019 under which we may purchase up to $20,000,000 of our common shares in open market purchases, block transactions and privately negotiated transactions in accordance with applicable federal securities laws. The approved amount excludes brokerage fees. See Note 20 - “Stockholders’ Equity” to our consolidated financial statements under Item 8 of this Annual Report on Form 10-K.
Our limited partnership investments consist of four private equity funds managed by their general partners. These funds have unexpired capital commitments which are callable at the discretion of the fund’s general partner for funding new investments or expenses of the fund. At December 31, 2018, there was an aggregate unfunded capital balance of $16,304,000. See Limited Partnership Investments under Note 5 - “Investment” to our consolidated financial statements under Item 8 of this Annual Report on Form 10-K.
We currently have a 90% equity interest in FMKT Mel JV, LLC, a Florida limited liability company for which we are not the primary beneficiary. FMKT Mel JV’s real estate portfolio consists of outparcels for ground lease or sale, the values of which have increased since the opening of an adjacent retail shopping center which we acquired in December 2016. We have the option to take full ownership of these outparcels by acquiring the remaining 10% interest. Alternatively, we may sell these outparcels and allocate the profits from the sale before liquidating FMKT Mel JV.
Our cash flows from operating, investing and financing activities for the years ended December 31, 2018, 2017 and 2016 are summarized below.
Net cash provided by operating activities for the year ended December 31, 2017 was approximately $16,635,000, which consisted primarily of cash received from net premiums written and reinsurance recoveries less cash disbursed for operating expenses, losses and loss adjustment expenses and interest payments. Net cash used in investing activities of $80,164,000 was primarily due to the purchases of fixed-maturity and equity securities of $165,196,000, the limited partnership investments of $4,226,000, and the real estate investments of $11,878,000, offset by the proceeds from sales of fixed-maturity and equity securities of $77,041,000, the distributions of $11,758,000 from limited partnership investments and the redemptions and repayments of fixed-maturity securities of $14,897,000. Net cash provided by financing activities totaled $39,030,000, which was primarily due to the proceeds from issuance of 4.25% Convertible Senior Notes of $143,750,000, offset by $40,250,000 used in the repurchases of our 8% senior notes, $4,975,000 of related underwriting and issuance costs, $45,872,000 used in our share repurchases and $12,833,000 of net cash dividend payments.
The main objective of our investment policy is to maximize our after-tax investment income with a reasonable level of risk given the current financial market. Our excess cash is invested primarily in money market accounts, certificates of deposit, and fixed-maturity and equity securities.
At December 31, 2018, we had $223,866,000 of fixed-maturity and equity investments, which are carried at fair value. Changes in the general interest rate environment affect the returns available on new fixed-maturity investments. While a rising interest rate environment enhances the returns available on new investments, it reduces the market value of existing fixed-maturity investments and thus the availability of gains on disposition. A decline in interest rates reduces the returns available on new fixed-maturity investments but increases the market value of existing fixed-maturity investments, creating the opportunity for realized investment gains on disposition.
The following table summarizes our material contractual obligations and commitments as of December 31, 2018 (amounts in thousands):
(2) Represents the minimum payment of reinsurance premiums under one multi-year reinsurance contract. Reinsurance premiums payable after March 31, 2019 are estimated and subject to subsequent revision as the premiums are determined on a quarterly basis based on the premiums associated with the applicable flood total insured value on the last day of the preceding quarter.
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 reserves for losses and LAE:
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 reasonably predicted by multiplying cumulative reported losses (paid losses plus case reserves) by a cumulative development factor derived from development patterns observed in the historical reported data. 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 for the historical experience that is considered. In order to derive loss development patterns that are predictive for our business, we compile and review loss development triangles of our experience on an accident quarter basis, and select loss development factors based on indications from this analysis of our data. We also consider industry data found in SNL Financial - Property/Casualty Insurance as a reasonability measure for these selected development patterns.
Finally, we employ the frequency/severity method for exposures that do not tend to follow historical payment and reported patterns, such as catastrophes. For such exposures, we estimate future development of reported claims and average severities 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.
For the year ended December 31, 2018, we recognized a net increase in accrued benefits of $743,000 and a net increase in ceded premiums of $258,000. In contrast, for the year ended December 31, 2017, we derecognized $3,413,000 of net accrued benefits. We also recognized ceded premiums of $2,327,000, including the reversal of the majority of previously deferred reinsurance costs. The adjustments made in 2017 were attributable to the impact of Hurricane Irma. For the year ended December 31, 2016, we accrued benefits of $13,610,000 and recognized net ceded premiums of $933,000, representing amortization of $1,219,000 of previously deferred reinsurance costs for increased coverage offset by $2,152,000 of ceded premiums deferred for the period. In combination, for the year ended December 31, 2018, we recognized a net reduction in ceded premiums of $485,000 as opposed to a net increase in ceded premiums of $5,740,000 for the year ended December 31, 2017. For the year ended December 31, 2016, we recognized a net reduction in ceded premiums of $12,677,000.
As of December 31, 2018, we had $3,136,000 of accrued benefits, the amount that would be charged to earnings in the event we experience a catastrophic loss that exceeds the coverage limits. As of December 31, 2017, we had $2,393,000 of accrued benefits related to these agreements.
Consolidated Statements of Comprehensive Income (Loss) for the Years Ended December 31, 2018, 2017 and 2016
Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2018, 2017 and 2016
Consolidated Statements of Cash Flows for the Years Ended December 31, 2018, 2017 and 2016
We have audited the accompanying consolidated balance sheets of HCI Group, Inc. and Subsidiaries (the Company) as of December 31, 2018 and 2017, the related consolidated statements of income, comprehensive income (loss), stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2018, and the related notes (collectively referred to as the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2018, 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) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2018, 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 8, 2019 expressed an unqualified opinion.
We have audited HCI Group, Inc. and Subsidiaries’ (the Company’s) internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control-Integrated Framework (2013) issued by COSO.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements of the Company as of December 31, 2018 and 2017, and for each of the three years in the period ended December 31, 2018, and our report dated March 8, 2019, expressed an unqualified opinion on those consolidated financial statements.
The Company adopted the following accounting standards effective January 1, 2018.
Accounting Standards Update No. 2016-01 (“ASU 2016-01”), Financial Instruments-Overall (Subtopic 825-10). ASU 2016-01 amends the accounting for equity investments, financial liabilities under the fair value option, and the presentation and disclosure requirements for financial instruments. ASU 2016-01 requires all equity investments other than those accounted for under the equity method of accounting or those that result in consolidation of the investee to be measured at fair value with changes in the fair value recognized through income. ASU 2016-01 also supersedes the guidance that requires classification of equity securities with readily determinable fair values into either “trading” or “available-for-sale.” Upon adoption of this standard, the after-tax net unrealized holding gains of $4,168 in accumulated other comprehensive income at December 31, 2017, which pertain to available-for-sale equity securities and represent a cumulative-effect amount, were reclassified to beginning retained income. Any subsequent changes in the fair value of equity securities have now been recognized in the Company’s consolidated statement of income rather than in accumulated other comprehensive income. In addition, previously reported available-for-sale and trading equity securities of $58,911 and $1,045, respectively, at December 31, 2017 are combined and presented as equity securities on the consolidated balance sheet. Certain prior-period disclosures related to equity securities are reorganized to conform with current period presentation.
Equity Securities. Equity securities represent ownership interests held by the Company in entities for investment purposes. Prior to January 1, 2018, these equity securities were classified as either available-for-sale or trading and were carried at fair value on the Company’s consolidated balance sheet. Unrealized holding gains and losses from the changes in the fair values of available-for-sale equity securities were reported in accumulated other comprehensive income. Effective January 1, 2018, after adoption of ASU 2016-01, unrealized holding gains and losses are reported in the consolidated statement of income as net unrealized investment gains and losses. As a result, other-than-temporary impairments will no longer be considered for equity securities. Realized investment gains and losses from sales are recorded on the trade date and are determined using the first-in first-out method (see Equity Securities in Note 5 - “Investments”).
When evidence indicates an impairment may occur, the Company evaluates whether a decline in value is other than temporary. Evidence may include continuing operating losses of the joint venture, a declining occupancy rate, a decrease in real estate value, and an oversupply of rental property in close vicinity to the investment property. Should available evidence indicate the recovery of the initial investment is less likely, the Company would compare the carrying value of the investment with its expected residual value and recognize an impairment loss in earnings.
Assets Held for Sale. Assets held for sale are valued at the lower of the carrying value or fair value less costs to sell. Assets are classified as held for sale when the following criteria are met: (i) management has the authority and commits to a plan to sell the asset; (ii) the asset is available for immediate sale in its present condition; (iii) there is an active program to locate a buyer and the plan to sell the asset has been initiated; (iv) the sale of the asset is probable within one year; (v) the property is being actively marketed at a reasonable sale price relative to its current fair value; and (vi) it is unlikely that the plan to sell will be withdrawn or that significant changes to the plan will be made.
Lease Acquisition Costs. Lease acquisition costs represent capitalized costs of finding and acquiring tenants such as leasing commissions, legal, and marketing expenses. The costs are included in Other assets in the consolidated balance sheet. The Company amortizes these costs in other operating expenses on a straight-line basis over the term of a lease.
Long-Term Debt. Long-term debt is generally classified as a liability and carried at amortized cost, net of any discount and issuance costs. 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.
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 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.
Certain of the Company’s current reinsurance 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.
The Company receives ceding commissions from ceding gross written premiums to a third-party reinsurer under one flood quota share reinsurance contract. The ceding commissions represent the reimbursement of the Company’s policy acquisition, underwriting and other operating expenses. Ceding commissions received cover a portion of premium taxes and agent commissions capitalized by the Company and a portion of non-capitalized acquisition costs and other underwriting expenses. Ceding commissions are recognized to income on a pro-rata basis over the terms of the policies reinsured, the amount of which is included in policy acquisition and other underwriting expenses in the consolidated statement of income. The unearned portion of ceding commissions that represents recovery of capitalized acquisition costs is classified as a reduction of deferred policy acquisition costs whereas the remaining unearned balance is classified as deferred revenue in other liabilities.
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 premiums attributable to the unexpired policy term. The Company reviews its policy detail and establishes an allowance for any amount outstanding for more than 90 days. At December 31, 2018 and 2017, there was no allowance required.
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.
Basic and diluted earnings (loss) per common share. Basic earnings (loss) per common share is computed by dividing net income (loss) 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. In addition, the intrinsic value of restricted stock declines when the Company experiences operating losses. As a result, holders of the Company’s restricted stock are allocated a proportional share of net income and loss determined by dividing total weighted-average shares of restricted stock by the sum of total weighted-average common shares and shares of restricted stock (the “two-class method”). Diluted earnings (loss) 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. During loss periods, common stock equivalents such as stock options and convertible debt are excluded from the calculation of diluted loss per share, as the inclusion would have an anti-dilutive effect. See Note 19 - “Earnings Per Share” for potentially dilutive securities at December 31, 2018, 2017 and 2016.
Reclassifications. Certain reclassifications of prior year amounts have been made to conform to the current year presentation. For example, certain payroll-related costs such as share-based compensation expense, payroll taxes and employee benefits, which were previously reported in other operating expenses totaling $7,163 for the year ended December 31, 2016 were reclassified to general and administrative personnel expenses to conform with the 2018 and 2017 presentation.
In February 2016, the FASB issued Accounting Standards Update No. 2016-02 (“ASU 2016-02”), Leases (Topic 842). The guidance establishes new principles that lessees and lessors will apply to report useful information to users of financial statements about the amount, timing, and uncertainty of cash flows arising from a lease. ASU 2016-02 supersedes accounting for leases prescribed in Topic 840, Leases. ASU 2016-02 leaves lessor accounting substantially unchanged. The key change affecting the Company is the requirement that operating leases be recorded on the balance sheet. The Company was initially required to use a modified retrospective method and apply this standard at the beginning of the earliest comparative period presented in the financial statements. The FASB later issued Accounting Standards Update No. 2018-11, Transition and Lessor Improvements, which provides a new alternative transition method. Under the alternative transition method, the Company is permitted to apply this standard at the beginning of the adoption period. The Company has identified lease contracts that will be affected by this standard and chosen to apply the practical expedients related to the identification and classification of leases that commenced before the effective date, initial direct cost for leases that commenced before the effective date, and the ability to use hindsight in evaluating lessee options to extend or terminate a lease. The Company has elected to use the alternative transition method. In 2019, ASU 2016-02 will result in the Company recording right-of-use assets of approximately $755 and lease liabilities of approximately $796. As such, the Company does not anticipate a material impact on its financial position.
Restricted cash primarily represents funds held by certain states in which the Company’s insurance subsidiaries conduct business to meet regulatory requirements. In August 2018, a $109 deposit related to a mortgage loan with one regional bank was released to the Company.
The Company holds investments in fixed-maturity securities that are classified as available-for-sale. At December 31, 2018 and 2017, 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:
Proceeds received, and the gross realized gains and losses from sales of available-for-sale fixed-maturity securities, for the years ended December 31, 2018, 2017 and 2016 were as follows:
The following table presents a rollforward of the cumulative credit losses in other-than-temporary impairments recognized in income for available-for-sale fixed-maturity securities:
* Unrealized holding gains and losses for the comparative years in 2017 and 2016 were reported in accumulated other comprehensive income. See Adoption of New Accounting Standards in Note 2 - “Summary of Significant Accounting Policies” for additional information.
Proceeds received, and the gross realized gains and losses from sales of equity securities, for the years ended December 31, 2018 and 2017 were as follows:
The Company has interests in limited partnerships that are not registered or readily tradeable on a securities exchange. These partnerships are private equity funds managed by general partners who make decisions with regard to financial policies and operations. As such, the Company is not the primary beneficiary and does not consolidate these partnerships. In February 2018, the Company entered into a subscription agreement to invest $5,000 with a limited partnership specializing in real estate private equity funds and portfolios. Subsequently, in September 2018, the Company increased its aggregate investment commitment with this limited partnership to $10,000. The following table provides information related to the Company’s investments in limited partnerships:
(c) Expected to have a ten-year term and the capital commitment is expected to expire on September 3, 2019.
(f) Expected to have a ten-year term and the capital commitment is expected to expire on June 30, 2020.
(g) With the consent of a supermajority of partners, the term of the fund may be extended for up to three additional one-year periods.
The following is the aggregated summarized unaudited financial information of limited partnerships included in the investment strategy table above, which in certain cases is presented on a three-month lag due to the unavailability of information at the Company’s respective balance sheet dates. In applying the equity method of accounting, the Company uses the most recently available financial information provided by the general partner of each of these partnerships. The financial statements of these limited partnerships are audited annually.
For the years ended December 31, 2018, 2017 and 2016, the Company recognized net investment income of $4,430, $2,334 and $1,207, respectively, for these investments. At December 31, 2018 and 2017, the Company’s cumulative contributed capital to the partnerships existing at each respective balance sheet date totaled $28,354 and $21,172, respectively, and the Company’s maximum exposure to loss aggregated $32,293 and $23,184, respectively.
In March 2017, FMJV sold a portion of its outparcel land for gross proceeds of $825 and recognized a $331 gain on sale of which $199 was allocated to the Company in accordance with the profit allocation specified in the operating agreement. During 2017, FMKT MGA was merged with Melbourne FMA, LLC. In June 2018, FMJV sold one of its outparcels for $849 and recognized a gain of $438.
In 2017, FMJV decided to terminate its development plan for nearby land, thereby expensing $382 of deferred costs associated with the land feasibility study. FMJV’s assets at December 31, 2018 and 2017 included primarily outparcels for sale or lease which have increased in value since the adjacent retail shopping center was completed. The Company determined that there was no impairment loss associated with these assets for the years ended December 31, 2018 and 2017.
On November 5, 2018, Greenleaf Capital, LLC, the Company’s wholly-owned subsidiary, listed its 10-acre waterfront property in Treasure Island, Florida for sale. The property primarily consists of land, commercial and marina buildings. This property, which is owned by the real estate division, was reclassified from real estate investments to assets held for sale in the Company’s consolidated balance sheet. The recording of depreciation on the buildings ceased November 5, 2018 resulting in a $34 decrease in depreciation expense in 2018 compared with 2017.
On October 17, 2017, the Company, through a wholly owned subsidiary, acquired commercial real estate in Tampa, Florida for a purchase price of $9,100. The acquired assets primarily consisted of land, building and in-place lease agreements. The Company incurred approximately $115 of acquisition-related costs and accounted for this transaction as an asset acquisition in accordance with ASU 2017-01 which the Company early adopted in the fourth quarter of 2017. As a result, all transaction-related costs were allocated among the assets acquired.
At December 31, 2018, $180,508 or 75.4% of the Company’s cash and cash equivalents were deposited at three national banks and included $73,511 in two custodial accounts. At December 31, 2017, $87,092 or 34.1% of the Company’s cash and cash equivalents were deposited at three national banks and included $38,543 in three custodial accounts. At December 31, 2018 and 2017, the Company’s cash deposits at any one bank generally exceed the Federal Deposit Insurance Corporation’s $250 coverage limit for insured deposit accounts.
Comprehensive income (loss) includes net income (loss) and other comprehensive income or loss, which for the Company includes changes in unrealized gains or losses of investments carried at fair value and changes in the other-than-temporary impairment losses related to these investments. Reclassification adjustments for realized (gains) losses are reflected in net realized investment gains (losses) on the consolidated statements of income. The components of other comprehensive income or loss and the related tax effects allocated to each component were as follows:
With regard to the 90% equity interest in FMKT MGA distributed by FMJV as described in Investment in Unconsolidated Joint Venture in Note 5 - “Investments,” the transaction was accounted for as a business step acquisition resulting in the assets acquired and liabilities assumed being recorded at fair value. Immediately following FMJV’s distribution of the 90% equity interest, the Company elected to purchase the remaining 10% noncontrolling interest from the other member and pay $2,064 in cash in 2016, plus an additional $200 in January 2017 upon the execution of one lease agreement. The Company funded the consideration paid with $871 of its own cash and $1,193 of additional borrowing from FMKT MGA’s revolving credit facility.
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, 2018 and 2017:
Depreciation and amortization expense under property and equipment was $1,370, $1,237 and $1,272, respectively, for the years ended December 31, 2018, 2017 and 2016.
Amortization expense for intangible assets after December 31, 2018 is as follows:
(Amounts in thousands, except share and per share amounts, unless otherwise stated)
The note holders have the right to require the Company to repurchase for cash all or any portion of the Convertible Senior Notes at par prior to the maturity date should any of the fundamental change events described in the indentures occur. The Company concluded that this 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, this embedded redemption feature is not substantive and will not affect the expected life of the liability component.
At the option of the holders of the 4.25% Convertible Notes, the Company is required to repurchase for cash all or any portion of the 4.25% Convertible Notes at par on March 1, 2022, March 1, 2027 or March 1, 2032. The Company concluded that this embedded feature is not a derivative financial instrument. In addition, based on economic factors at the time when the 4.25% Convertible Notes were issued, the Company determined it is probable that the note holders will exercise this option. Thus, the Company amortizes the liability component and related issuance costs associated with the 4.25% Convertible Notes over the period from March 3, 2017 to March 1, 2022.
The effective interest rates for the 3.875% Convertible Notes and the 4.25% Convertible Notes, taking into account both cash and non-cash components, approximate 8.3% and 7.6%, respectively. Had a 20-year term been used for the amortization of the liability component and issuance costs of the 4.25% Convertible Notes, the annual effective interest rate charged to earnings would have been decreased to approximately 5.4%. As of December 31, 2018, the remaining amortization periods of the debt discounts were expected to be 2.5 months for the 3.875% Convertible Notes and 3.2 years for the 4.25% Convertible Notes.
During the year ended December 31, 2018, ceded losses of $149,120 were recognized as a reduction in losses and LAE compared with ceded losses of $214,082 during the year ended December 31, 2017, $7,400 of which related to Oxbridge Reinsurance Limited, a related party. For 2018, ceded losses related to Hurricane Irma and Hurricane Michael were $143,890 and $5,230, respectively. For 2017, the reduction in losses and LAE entirely related to Hurricane Irma. During the year ended December 31, 2016, there were no recoveries pertaining to reinsurance contracts that were deducted from losses incurred. At December 31, 2018 and 2017, there were 38 and 37 reinsurers, respectively, participating in the Company’s reinsurance program. Amounts receivable with respect to reinsurers at December 31, 2018 and 2017 were $123,911 and $103,104, respectively. Approximately 29.1% of the reinsurance recoverable balance at December 31, 2018 was concentrated in two reinsurers. Based on the insurance ratings, the payment history and the financial strength of the reinsurers, management believes there was no significant credit risk associated with its reinsurers’ obligations to perform on any prepaid reinsurance contract and to fund any reinsurance recoverable balance as of December 31, 2018. The ratio of assumed premiums earned to net premiums earned for the years ended December 31, 2018, 2017 and 2016 was 0.98%, 4.9%, and 2.5%, respectively.
* Net balance represents beginning-of-period liability for unpaid losses and LAE less beginning-of-period reinsurance recoverable for unpaid losses and LAE.
The following is information about incurred and paid claims development as of December 31, 2018, net of reinsurance, as well as cumulative claim frequency and the total of incurred-but-not-reported liabilities plus expected development on reported claims included within the net incurred claims amounts. The information about incurred and paid claims development for the years ended December 31, 2015 to 2012 is presented as supplementary information and is unaudited.
(a)   Excludes losses from multi-peril and dwelling fire insurance (2012 through 2018), any hurricane event prior to 2018 and Hurricane Michael (2018).
The Company has no uncertain tax positions or unrecognized tax benefits that, if recognized, would impact the effective income tax rate. The tax returns filed for the years ending December 31, 2017, 2016, and 2015 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, 2018, 2017 and 2016.
On December 22, 2017, the Tax Cuts and Jobs Act (the “2017 Tax Act”) was passed and signed into law. Key components of the 2017 Tax Act are: a permanent reduction to the federal corporate income tax rate from a bracket system with a top tax rate of 35% to a flat rate of 21% beginning on January 1, 2018; implementation of a territorial tax system; an amendment to Internal Revenue Code Section 965 that requires U.S. shareholders (10% or greater) of controlled foreign corporations and other specified foreign corporations to include in income, for the last taxable year of such foreign corporation beginning before January 1, 2018, such U.S. shareholder’s pro rata share of a deemed repatriation amount; and changes to carryback and carryforward rules for net operating losses arising after December 31, 2017. Under U.S. GAAP, the tax effects of changes in tax laws or rates need to be recognized in the period in which the law is enacted.
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. Thus, the Company did not have a valuation allowance established as of December 31, 2018 or 2017.
A summary of the numerator and denominator of the basic and fully diluted earnings (loss) per common share is presented below:
* Loss attributable to participating securities included the reclassification of cumulative dividends paid on certain restricted stock with market based vesting conditions from retained income to expense. See Restricted Stock Awards in Note 21 - “Stock-Based Compensation” for additional information.
At December 31, 2018 and 2017, there were no Series A Cumulative Convertible Preferred Stock issued or outstanding.
At December 31, 2018 and 2017, there were no Series B Preferred issued or outstanding.
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 Cumulative Convertible Preferred Stock and Series B Preferred.
A summary of the stock option activity for the years ended December 31, 2018, 2017 and 2016 is as follows (option amounts not in thousands):
The following table summarizes information about options exercised for the years ended December 31, 2018, 2017 and 2016 (option amounts not in thousands):
During 2018, the Company reclassified from retained income dividends of $1,887 cumulatively paid on unvested restricted stock awards with market based vesting conditions to general and administrative personnel expenses for $1,346 and to other operating expenses for $541. These awards, of which the market conditions will not be met, were granted to the Company’s employee and nonemployee directors during 2013. The awards will lapse in May and November 2019. Any future dividend payment associated with these awards will be expensed when declared. As a result, for the year ended December 31, 2018, the Company recognized dividends of $195 related to these awards in general and administrative personnel expenses for $159 and in other operating expenses for $36.
The Company also maintains benefit plans for its employees in India including a statutory post-employment benefit plan, or gratuity plan, providing defined, lump-sum benefits. The Company’s liability for the gratuity plan reflects the undiscounted benefit obligation payable as of the balance sheet date, which was based upon the employees’ salary and years of service. At December 31, 2018 and 2017, the amounts accrued under the gratuity plan were $72 and $58, respectively. In addition, the Company provides matching contributions with respect to two defined contribution plans; the Provident Fund and the Employees State Insurance Fund, both of which are available to qualifying employees in India. Expense recognized by the Company for all benefit plans in India was $14, $17 and $14, respectively, for the years ended December 31, 2018, 2017 and 2016.
Provided the leases are not early terminated, minimum future rental payments under operating leases after December 31, 2018 are as follows:
* During the quarter ended December 31, 2018, the convertible senior notes and stock options were antidilutive.
The Company has no restrictions on the payment of dividends to its shareholders except those restrictions imposed by the Florida Business Corporation Act and those restrictions imposed by insurance statutes and regulations applicable to the Company’s insurance subsidiaries. As of December 2018, without prior regulatory approval, $90,561 of the Company’s consolidated retained earnings was free from restriction under the insurance statutes and regulations and available for the payment of dividends in 2019. The following briefly describes certain related and other requirements and restrictions imposed by the states or jurisdiction in which the Company’s insurance subsidiaries are incorporated.
Under Florida law, a domestic insurer may not pay any dividend or distribute cash or other property to its stockholders except out of that part of its available and accumulated capital and surplus funds which is derived from realized net operating profits on its business and net realized capital gains. A Florida domestic insurer may not make dividend payments or distributions to stockholders without prior approval of the FLOIR if the dividend or distribution would exceed the larger of (1) the lesser of (a) 10.0% of its capital surplus or (b) net income, not including realized capital gains, plus a two year carry forward, (2) 10.0% of capital surplus with dividends payable constrained to unassigned funds minus 25% of unrealized capital gains or (3) the lesser of (a) 10.0% of capital surplus or (b) net investment income plus a three year carry forward with dividends payable constrained to unassigned funds minus 25% of unrealized capital gains.
As a result, HCPCI was qualified to make dividend payments at December 31, 2018, 2017 and 2016.
HCPCI and TypTap are subject to risk-based capital (“RBC”) requirements as specified by the NAIC. Under those requirements, the amount of minimum capital and surplus maintained by a property and casualty insurance company is to be determined based on the various risks related to it. Pursuant to the RBC requirements, insurers having less statutory capital than required by the RBC calculation will be subject to varying degrees of regulatory action, depending on the level of capital inadequacy. At December 31, 2018 and 2017, the Company’s insurance subsidiaries individually exceeded any applicable minimum risk-based capital requirements and no corrective actions have been required. As of December 31, 2018, the combined statutory capital and surplus and minimum capital and surplus of the Company’s U.S. insurance subsidiaries were approximately $175,077 and $41,700, respectively.
At December 31, 2018 and 2017, restricted net assets represented by the Company’s insurance subsidiaries amounted to $181,571 and $180,286, respectively.
Claddaugh had a reinsurance agreement with Oxbridge Reinsurance Limited (“Oxbridge”) whereby a portion of the business assumed from the Company’s insurance subsidiary, HCPCI, was ceded by Claddaugh to Oxbridge. On May 28, 2018, Claddaugh terminated its multi-year reinsurance contract with Oxbridge, effective June 1, 2018. Upon termination, Claddaugh agreed to pay Oxbridge a settlement fee of $600 and derecognized the benefits accrued in connection with retrospective provisions. The settlement fee and the derecognition of the $622 of accrued benefits were recorded in premiums ceded. With respect to the period from June 1, 2016 through May 31, 2017, Oxbridge assumed $6,000 of the total covered exposure for approximately $3,400 in premiums. With respect to the period from June 1, 2017 through May 31, 2018, Oxbridge assumed $7,400 of the total covered exposure for approximately $3,400 in premiums. See Note 15 - “Reinsurance” - which includes the amounts due from and paid by Oxbridge during the years ended December 31, 2017 and 2016 with respect to benefits accrued in connection with the Oxbridge agreements. The premiums charged by Oxbridge were at rates which management believed to be competitive with market rates available to Claddaugh. Oxbridge had deposited funds into trust accounts to satisfy certain collateral requirements under its reinsurance contract with Claddaugh. Trust assets could be withdrawn by Claddaugh, the trust beneficiary, in the event amounts were due under the Oxbridge reinsurance agreement. Among the Oxbridge shareholders are Paresh Patel, the Company’s chief executive officer, who is also chairman of the board of directors for Oxbridge, and members of his immediate family and three of the Company’s non-employee directors including Sanjay Madhu who serves as Oxbridge’s president and chief executive officer.
During the first quarter of 2018, the Company purchased six-month certificates of deposit totaling approximately $15,094 from First Home Bank, a local bank in the Tampa Bay area where two of the Company’s directors are members of the bank’s board of directors. These certificates of deposit had a fixed interest rate of 1.95% with interest payable at maturity. The interest rate and terms of the certificates were comparable to those offered to other clients of the bank. In May 2018, the Company moved the entire funds from a certificate of deposit account to a money market account.
During 2016 and January 2017, one of the Company’s directors was a partner at a law firm that performs certain of the Company’s corporate legal matters. He retired from the practice of law on January 31, 2017. Fees incurred with respect to this law firm for the month ended January 31, 2017 and year ended December 31, 2016 were approximately $6 and $32, respectively.
On January 14, 2019, the Company’s Board of Directors declared a quarterly dividend of $0.40 per common share. The dividends are scheduled for payment on March 15, 2019 to stockholders of record on February 15, 2019.