Tierra Verde, Florida. The real estate consists of 7.1 acres of waterfront property, a dry rack storage building with gross area of 57,500 square feet, and two buildings with retail space having an aggregate gross area of approximately 23,000 square feet. This marina facility is owned and operated by us. Approximately 5% of the available retail space is occupied by us, 65% of the retail space is leased to non-affiliates, and the remaining space is available for lease.
In addition to historical information, this annual report on Form 10-K contains forward-looking statements as defined under federal securities laws. Such statements, including statements about our plans, objectives, expectations, assumptions or future events, involve risks and uncertainties. These statements involve estimates, assumptions, known and unknown risks, uncertainties and other factors that could cause actual results to differ materially from any future results, performances or achievements expressed or implied by the forward-looking statements. Typically, forward-looking statements can be identified by terminology such as “anticipate,” “estimate,” “plan,” “project,” “continuing,” “ongoing,” “expect,” “believe,” “intend,” “may,” “will,” “should,” “could,” and similar expressions. The important factors that could cause actual results to differ materially from those indicated by such forward-looking statements include but are not limited to the effect of governmental regulation; changes in insurance regulations; the frequency and extent of claims; uncertainties inherent in reserve estimates; catastrophic events; changes in the demand for, pricing of, availability of or collectability of reinsurance; restrictions on our ability to change premium rates; increased rate pressure on premiums; and other risks and uncertainties and other factors listed under Item 1A - “Risk Factors” and elsewhere in this annual report on Form 10-K and in our other Securities and Exchange Commission filings.
On February 27, 2019, we acquired approximately nine acres of undeveloped land located near our current headquarters in Tampa, Florida for a purchase price of $8,500,000, which was primarily financed by our revolving credit facility. The land is a potential site for the construction of a new headquarters building. The transaction was accounted for as an asset acquisition. As such, all acquisition-related costs are capitalized.
Gross Premiums Earned for the years ended December 31, 2018 and 2017 were approximately $343,065,000 and $358,253,000, respectively. The decrease in 2018 was primarily attributable to a net decrease in policies in force offset by an increase in the average premium per policy.
Net Other-Than-Temporary Impairment Losses for the years ended December 31, 2018 and 2017 were approximately $80,000 and $1,467,000, respectively. During 2018, we recognized impairment loss on one fixed-maturity security versus impairment losses specific to four fixed-maturity securities and six equity securities during 2017.
Policy Acquisition and Other Underwriting Expenses for the years ended December 31, 2018 and 2017 were approximately $38,943,000 and $39,663,000, respectively. The decrease from 2017 was primarily attributable to decreased commissions and premium taxes resulting from the net decrease in policies in force.
Income Tax Expense for the year ended December 31, 2018 was approximately $9,177,000 for state, federal, and foreign income taxes compared with income tax benefit of approximately $8,731,000 for the year ended December 31, 2017, resulting in an effective tax rate of 34.1% for 2018 and 55.9% for 2017. The decrease was primarily attributable to the positive impact from a lower federal corporate income tax rate effective January 1, 2018, offset by the negative effect of the derecognition of deferred tax assets of approximately $1,825,000 and the nondeductible expense of approximately $1,887,000, both of which related to restricted stock awards with market conditions that will not be met. (see Restricted Stock Awards in Note 21 - “Stock-Based Compensation” to our consolidated financial statements under Item 8 of this Annual Report on Form 10-K).
The loss ratio applicable to the year ended December 31, 2018 (losses and loss adjustment expenses incurred related to net premiums earned) was 51.2% compared with 73.8% for the year ended December 31, 2017. The decrease was primarily due to the decrease in losses and loss adjustment expenses as described previously.
The expense ratio applicable to the year ended December 31, 2018 (defined as underwriting expenses, general and administrative personnel expenses, interest and other operating expenses related to net premiums earned) was 44.6% compared with 42.0% for the year ended December 31, 2017. The increase in our expense ratio was primarily attributable to the decrease in net premiums earned.
Comparison of the Year Ended December 31, 2017 with the Year Ended December 31, 2016
For the year ended December 31, 2017, premiums ceded included a net increase of approximately $5,740,000 related to retrospective provisions. For the year ended December 31, 2016, premiums ceded reflect a net reduction of approximately $12,677,000. See “Economic Impact of Reinsurance Contracts with Retrospective Provisions” under “Critical Accounting Policies and Estimates.”
Income Tax Benefit for the year ended December 31, 2017 was approximately $8,731,000 versus approximately $17,835,000 of income tax expense for the year ended December 31, 2016, resulting in an effective tax rate of 55.9% for 2017 and 38.1% for 2016. The year-over-year change was primarily attributable to our 2017 operating losses and the recognition of $1,400,000 in beneficial tax effects on our net deferred tax liabilities due to the lower future corporate income tax rates enacted by the 2017 Tax Act.
In the future, we anticipate our primary use of funds will be to pay claims, reinsurance premiums, interest, and dividends and to fund operating expenses and real estate acquisitions.
Furthermore, we will repay the holders of our 3.875% Convertible Senior Notes an aggregate amount of $89,990,000 on the maturity date, March 15, 2019, if the notes are not yet converted prior to March 14, 2019.
The following table summarizes the principal and interest payment obligations for our long-term debt at December 31, 2018:
See Note 14 - “Long-Term Debt” to our consolidated financial statements under Item 8 of this Annual Report on Form 10-K.
Net cash provided by operating activities for the year ended December 31, 2016 was approximately $88,275,000, which consisted primarily of cash received from net premiums written less cash disbursed for operating expenses, losses and loss adjustment expenses and interest payments. Net cash used in investing activities of $49,028,000 was primarily due to the purchases of fixed-maturity and equity securities of $107,964,000, $12,056,000 of net cash used in acquiring one business, and the limited partnership investments of $4,670,000, offset by the proceeds from sales of fixed-maturity and equity securities of $63,581,000 and the $10,200,000 proceeds from the acquisition, development and construction arrangement. Net cash used in financing activities totaled $26,157,000, which was primarily due to $11,347,000 used in the repurchases of our convertible senior notes, $20,026,000 used in our share repurchase plan and $11,691,000 of net cash dividend payments, offset by $18,200,000 in aggregate proceeds from the issuance of two promissory notes.
In addition, we had short-term investments of $66,479,000 at December 31, 2018. These investments consisted of certificates of deposit and zero-coupon commercial paper. Our shift toward more short-term investments during 2018 was primarily to reduce the impact of a rising interest rate environment.
In the future, we may alter our investment policy as to investments in federal, state and municipal obligations, preferred and common equity securities and real estate mortgages, as permitted by applicable law, including insurance regulations.
As of December 31, 2018, we had unexpired capital commitments for four limited partnership in which we hold interests. Such commitments are not recognized in the financial statements but are required to be disclosed in the notes to the financial statements. See Note 23 - “Commitments and Contingencies” to our consolidated financial statements under Item 8 of this Annual Report on Form 10-K and Contractual Obligations and Commitments below for additional information.
(1) Represents the lease for office space in Miami Lakes, Florida, and the lease and maintenance service agreement for office space in Noida, India. Liabilities related to our India operations were converted from India Rupees to U.S. dollars using the January 2, 2019 exchange rate, the first available rate subsequent to December 31, 2018, which was a non-business day.
(4) Amounts represent principal and interest payments over the lives of various long-term debt obligations. See Note 14 - “Long-Term Debt” to our consolidated financial statements under Item 8 of this Annual Report on Form 10-K.
Reserves for Losses and Loss Adjustment Expenses. We establish reserves for the estimated total unpaid costs of losses including loss adjustment expenses (LAE). Loss and LAE reserves reflect management’s best estimate of the total cost of (i) claims that have been incurred, but not yet paid in full, and (ii) claims that have been incurred but not yet reported to us (“IBNR”). Reserves established by us represent an estimate of the outcome of future events and, as such, cannot be considered an exact calculation of our liability. Rather, loss reserves represent, we believe, management’s best estimate of our company’s liability based on the application of actuarial techniques and other projection methodologies and taking into consideration other facts and circumstances known at the balance sheet date. The process of establishing loss reserves is complex and inherently imprecise, as it involves using judgment that is affected by many variables such as past loss experience, current claim trends and the prevailing social changes in our claims adjusting process, economic and legal environments. The impact of both internal and external variables on ultimate losses and LAE costs is difficult to estimate. Our exposure is impacted by both the risk characteristics of the physical locations where we write policies, such as hurricane and tropical storm-related risks, as well as risks associated with varying social, judicial and legislative characteristics in the locations in which we have exposure. In determining loss reserves, we give careful consideration to all available data and actuarial analyses.
When a claim is reported to us, our claims personnel establish a “case reserve” for the estimated amount of the ultimate amount payable to settle the claim. This estimate reflects an informed judgment based upon general insurance reserving practices and on the experience and knowledge of the claims adjuster. The individual estimating the reserve considers the nature and value of the specific claim, the severity of injury or damage, location, and the policy provisions relating to the type of loss. Case reserves are adjusted by us as more information becomes available. It is our policy to settle each claim as expeditiously as possible.
The paid loss development method is mechanically identical to the reported loss development method described above, but applied to loss payments only. The paid method does not rely on case reserves or claim reporting patterns in making projections.
While the property and casualty industry has incurred substantial aggregate losses from claims related to asbestos-related illnesses, environmental remediation, product and mold, and other uncertain or environmental exposures, we have not experienced significant losses from these types of claims. We have experienced material losses associated with sinkholes in past years, but the materiality of this hazard has decreased significantly since the passing of Florida Senate Bill 408. We continue to segregate this data in our derivation of estimated required reserves. While the losses we have experienced from exposures to catastrophes have not historically been material, we have experienced significant losses related to recent catastrophes. These losses have followed materially different development patterns than the balance of our experience. To address this situation, we separate this exposure from the remainder of the business and derive reserves specific to each catastrophe event. Total reserves are determined by adding the reserves related to each line of business.
Reinsurance Recoverable. Our reinsurance recoverable balance represents an estimate of the amount of paid and unpaid losses and loss adjustment expenses that is recoverable from reinsurers. This estimate is determined in a manner consistent with the terms of the applicable reinsurance contracts and based on the ultimate losses and loss adjustment expenses we expect to incur. Given the uncertainty of the ultimate amounts of losses and loss adjustment expenses, the estimate may vary significantly from the eventual outcome.
Economic Impact of Reinsurance Contracts with Retrospective Provisions. Certain of our reinsurance contracts include retrospective provisions that adjust premiums, increase the amount of future coverage, or result in profit commissions in the event losses are minimal or zero. In accordance with U.S. GAAP, we will recognize an asset in the period in which the absence of loss experience gives rise to an increase in future coverage or obligates the reinsurer to pay cash or other consideration under the contract. In the event that a loss arises, we will derecognize such asset in the period in which a loss arises. Such adjustments to the asset, which accrue throughout the contract term, will negatively impact our operating results when a catastrophic loss event occurs during the contract term.
Notes to Consolidated Financial Statements for the Years Ended December 31, 2018, 2017 and 2016
HCI Group, Inc., together with its subsidiaries (“HCI” or the “Company”), is primarily engaged in the property and casualty insurance business through two Florida domiciled insurance companies, Homeowners Choice Property & Casualty Insurance Company, Inc. (“HCPCI”), its principal operating subsidiary, and TypTap Insurance Company (“TypTap”). HCPCI is authorized to underwrite various homeowners’ property and casualty insurance products and allied lines business in the state of Florida. HCPCI also offers flood-endorsed and wind-only policies to Florida customers. During 2017, HCPCI received regulatory approval to write residential property and casualty insurance in the states of Arkansas, California, Maryland, North Carolina, New Jersey, Ohio, Pennsylvania, South Carolina and Texas. However, Florida is still HCPCI’s major market. TypTap primarily offers standalone flood and homeowners multi-peril policies to Florida homeowners. HCPCI’s and TypTap’s operations are supported by HCI Group, Inc. and certain HCI subsidiaries.
In addition, HCI includes various subsidiaries predominantly engaged in the businesses of owning and leasing real estate, operating marina facilities and one restaurant, and developing software products. See Note 17 - “Segment Information.”
The Company obtained a majority of its policies through participation in a “take-out program” with Citizens Property Insurance Corporation (“Citizens”), a Florida state supported insurer. Policies were obtained in separate assumption transactions with Citizens. The Company is required to offer renewals on the policies acquired for a period of three years subsequent to the initial expiration of the assumed policies. During the first full year after assumption, such renewals are required to have rates that are equivalent to or less than the rates charged by Citizens. Substantially all of the Company’s premium revenue since inception comes from these assumptions and one additional assumption through which the Company acquired the Florida policies of another Florida insurance carrier.
Accounting Standards Update No. 2014-09 (“ASU 2014-09”), Revenue from Contracts with Customers (Topic 606). The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The Company elected to use a modified retrospective method for transition to the new revenue recognition standard. The impact is limited to revenue from gift cards sold that is not material to the Company’s results of operations.
Accounting Standards Update No. 2016-18 (“ASU 2016-18”), Statement of Cash Flows (Topic 230): Restricted Cash. ASU 2016-18 amends guidance on the classification and presentation of restricted cash in the statement of cash flows. Upon adoption of this standard, restricted cash is now included with cash and cash equivalents when the Company reconciles the beginning-of-period and end-of-period total amounts shown on the consolidated statement of cash flows. In addition, the consolidated statement of cash flows for the prior period presented is retrospectively restated to comply with the new standard. This change in classification and presentation of restricted cash increases the previously reported cash flows from operating activities from $16,426 to $16,635 for the year ended December 31, 2017 and from $87,975 to $88,275 for the year ended December 31, 2016.
Accounting Standards Update No. 2017-09 (“ASU 2017-09”), Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting. ASU 2017-09 provides guidance about which changes to the terms or conditions of a share-based payment award require an application of modification accounting. The adoption of this standard had no impact on the current or prior financial statements and will impact the Company’s accounting for any future modification of its existing share-based awards.
After the adoption of Accounting Standards Update No. 2017-01 during the fourth quarter of 2017, the Company evaluates whether substantially all of the fair value of the gross assets acquired in a real estate transaction is concentrated in a single identifiable asset or group of similar identifiable assets. If such concentration is substantial, the transaction is accounted for as an asset acquisition. As a result, the cost of acquiring real estate is allocated to the individual assets based on the relative fair values of the individual assets. Acquisition related costs are capitalized and allocated among the assets acquired.
Cash and Cash Equivalents. The Company considers all short-term highly liquid investments with original maturities of less than three months to be cash and cash equivalents. At December 31, 2018 and 2017, cash and cash equivalents consisted of cash on deposit with financial institutions and securities brokerage firms, commercial paper, and certificates of deposit.
Available-for-Sale Fixed-Maturity Securities. Fixed-maturity securities include debt securities and redeemable preferred stock. The Company’s available-for-sale securities are carried at fair value. Temporary changes in the fair value of available-for-sale securities are excluded from net investment income and reported in stockholders’ equity as a component of accumulated other comprehensive income, net of deferred income taxes. Realized investment gains and losses from sales are recorded on the trade date and are determined using the first-in first-out (FIFO) method. Investment income is recognized as earned and discounts or premiums arising from the purchase of debt securities are recognized in investment income using the interest method over the estimated remaining term of the security. Gains and losses from call redemptions and repayments are charged to investment income.
The Company reviews fixed-maturity securities for other-than-temporary impairment on a monthly basis. When the fair value of any investment is lower than its cost, an assessment is made to determine whether the decline is temporary or other-than-temporary. If the decline is determined to be other-than-temporary, the investment is written down to fair value and an impairment loss is recognized in income in the period in which the Company makes such determination.
When determining impairment due to a credit related loss, the Company carefully considers factors such as the issuer’s financial ratios and condition, the security’s current ratings and maturity date, and overall market conditions in estimating the cash flows expected to be collected. The expected cash flows discounted at the effective interest rate of the security implicit at the date of acquisition is then compared with the security’s amortized cost at the measurement date. A credit loss is incurred when the present value of the expected cash flows is less than the security’s amortized cost. The Company considers various factors in determining whether an individual security is other-than-temporarily impaired (see Available-for-Sale Fixed-Maturity Securities in Note 5 - “Investments”).
Limited Partnership Investments. The Company has interests in limited partnerships that are not registered under the United Stated Securities Act of 1933, as amended, the securities laws of any state or the securities laws of any other jurisdictions. The partnership interests cannot be resold in the public market and any withdrawal is subject to the terms and conditions of the partnership agreement. The Company has no influence over partnership operating and financial policies. The Company did not elect the fair value option and, therefore, uses the equity method to account for these investments (see Limited Partnership Investments in Note 5 - “Investments”). The Company generally recognizes its share of the limited partnership’s earnings or losses on a three-month lag.
Deferred policy acquisition costs. Deferred policy acquisition costs (“DAC”) represent direct costs to acquire insurance contracts and consist of premium taxes and commissions paid to outside agents at the time of collection of the policy premium. DAC is amortized over the life of the related policy in relation to the amount of gross premiums earned.
Reinsurance Recovered in Advance on Unpaid Losses. Reinsurance recovered in advance on unpaid losses represents cash received in advance from reinsurers under reinsurance contracts to reimburse the Company’s losses and LAE. The Company is contractually permitted to apply these funds to offset the paid portion of reinsurance recoverable only.
Deferred income tax expense results from changes in deferred tax assets and liabilities between periods. Deferred tax assets are recognized if it is more likely than not, based on the technical merits, that the tax position will be realized or sustained upon examination. The term “more likely than not” means a likelihood of more than fifty percent; the terms “examined” and “upon examination” also include resolution of the related appeals or litigation processes, if any. A tax position that meets the more-likely-than-not recognition threshold is initially and subsequently measured as the largest amount of tax benefit that has a greater than fifty percent likelihood of being realized upon settlement with a taxing authority that has full knowledge of all relevant information. The determination of whether or not a tax position has met the more-likely-than-not recognition threshold considers the facts, circumstances, and information available at the reporting date and is subject to management’s judgment. Deferred tax assets are reduced by a valuation allowance if, based on the weight of evidence available, it is more likely than not that some portion or all of a deferred tax asset will not be realized. As of December 31, 2018, management is not aware of any uncertain tax positions that would have a material effect on the Company’s consolidated financial statements.
Fair Value of Financial Instruments. The carrying amounts for the Company’s cash and cash equivalents approximate their fair values at December 31, 2018 and 2017. Fair values for securities or financial instruments are based on the framework for measuring fair value established by U.S. GAAP (see Note 8 - “Fair Value Measurements”).
Accounting Standards Update No. 2018-13. In August 2018, the FASB issued Accounting Standards Update No. 2018-13 (“ASU 2018-13”), Fair Value Measurement (Topic 820): Disclosure Framework, which removes, modifies and adds certain disclosure requirements about recurring and nonrecurring fair value measurements. ASU 2018-13 is effective for the Company beginning with the first quarter of 2020. Early adoption is permitted. This guidance will impact the Company’s future fair value disclosures in the notes to the consolidated financial statements.
the length of time and the extent to which the market value of the security has been below its cost or amortized cost;
There was no activity related to cumulative credit losses during 2018. During 2017, the Company sold two fixed-maturity securities with cumulative credit losses totaling $475. The decision to sell these securities before their maturity was primarily driven by the impact of the Tax Cut and Jobs Act signed into law in 2017. Of two fixed-maturity securities with credit related losses existing at January 1, 2016, one matured with full payment of principal and interest and one was sold due to uncertainties surrounding the issuer’s restructuring plan during 2016.
Securities with gross unrealized loss positions at December 31, 2018 and 2017, aggregated by investment category and length of time the individual securities have been in a continuous loss position, are as follows:
At December 31, 2017, there were 77 securities in an unrealized loss position. Of these securities, 15 securities had been in an unrealized loss position for 12 months or longer.
Prior to the adoption of ASU 2016-01 as described in Note 2 - “Summary of Significant Accounting Policies,” equity securities classified as available-for-sale were evaluated for other-than-temporary impairment. When the impairment existed, an impairment loss was recognized in the consolidated statement of income. For the years ended December 31, 2017 and 2016, the Company recognized impairment losses of $1,039 and $917, respectively, related to available-for-sale equity securities.
(h) Expected to have a six-year term from the commencement date, which can be extended for up to two additional one-year periods with the consent of either the advisory committee or a majority of limited partners.
(i) Unless extended or terminated for reasons specified in the agreement, the capital commitment is expected to expire on December 1, 2019.
(j) Expected to have an eight-year term after the final fund closing date, which has yet to be determined.
During the year ended December 31, 2018, the Company received in cash a return on investment of $2,345 and a return of capital of $158. During the year ended December 31, 2017, the Company received total cash distributions of $12,639, representing $11,758 of returned capital and $881 of return on investment. Included in the return of capital was $11,626 from one limited partnership the Company withdrew from in February 2017. During the year ended December 31, 2016, the Company received in cash $544 of return on investment.
In January 2016, FMJV sold a portion of its outparcel land for gross proceeds of $829, of which $515 was used to repay a portion of the construction loan obtained for its real estate development project. FMJV recognized a $404 gain on the outparcel sale of which $383 was allocated to the Company in accordance with the profit allocation specified in the operating agreement. On December 15, 2016, FMJV distributed its entire equity interest in FMKT Mel Manager, LLC (“FMKT MGA”), its wholly owned subsidiary, to Melbourne FMA and the other member, each of which received 90% and 10%, respectively. In addition to operating a retail shopping center business, FMKT MGA owned land which included two outparcels. Melbourne FMA accounted for this transaction as a business step acquisition using the fair value method and, as a result, recognized a $4,005 gain on remeasurement of previously held interest. The gain represented the difference between the fair value of the 90% equity interest and its carrying value under the equity method. The fair value of the equity interest was comprised of the fair value of FMKT MGA’s underlying assets primarily determined by an independent appraiser offset by the fair value of liabilities assumed on the date of distribution. Inputs used by the appraiser included, but were not limited to, information about market and surrounding environments, demographics, and the sale or rent of similar types of property within the vicinity. Due to their short-term nature, the carrying value of current assets and assumed liabilities, including a variable interest rate revolving credit line, approximated fair value. See Pineda Landings - Melbourne, Florida in Note 7 - “Business Acquisitions” for additional information.
(a) Included in net investment income in the Company’s consolidated statements of income. Gain from the sale of the outparcel during 2017 was allocated in accordance with the method specified in the operating agreement.
Real estate investments include buildings with office and retail space for lease, outparcels, and one marina. Real estate investments consist of the following as of December 31, 2018 and 2017:
In November 2018, the Company reclassified a net carrying value of $9,810 from real estate investments to assets held for sale.
On June 13, 2018, the Company, through a wholly owned subsidiary, acquired commercial real estate in Clearwater, Florida, including assumed liabilities of $35, for a purchase price of $6,766. The real estate consisted of land, one in-place lease agreement which was recorded in intangible assets, and commercial structures that are currently under renovation. This transaction was accounted for as an asset acquisition.
Depreciation and amortization expense related to real estate investments was $1,536, $1,447 and $531, respectively, for the years ended December 31, 2018, 2017 and 2016.
The Company has a commercial property in Riverview, Florida which was developed by a limited liability company treated under U.S. GAAP as a joint venture. On January 26, 2018, the Company gained full ownership of this limited liability company by acquiring the noncontrolling interest for $539 which was reported in the Company’s consolidated statement of stockholders’ equity. Prior to the acquisition date, the Company already consolidated this limited liability company as its primary beneficiary. As a result, the acquisition was accounted for as an equity transaction. No gain or loss was recognized as there was no change in control. Real estate investments owned by this limited liability company primarily include a retail strip center with 8,400 square feet of net rentable space and an adjacent parcel of land which is currently leased in its entirety to a large gas station and convenience store chain. The following table summarizes the assets and liabilities related to this variable interest entity which are included in the accompanying consolidated balance sheets as of December 31, 2017.
On August 16, 2016, the Company’s wholly owned subsidiary, Greenleaf Capital, LLC, assigned the right to purchase the developed property to its subsidiary, Sorrento PBX, LLC. Sorrento PBX simultaneously exercised the purchase option and acquired the property from Sorrento Retail Investments, LLC. The acquired assets included a retail shopping center and appurtenant facilities in Sorrento, Florida as well as existing tenant lease agreements to use the property. The purchase price was $12,250, which was determined using a predetermined capitalization rate and the projected net operating income of the property. The Company recognized a $2,071 gain on bargain purchase, resulting primarily from a favorable fair value at the date of acquisition as compared with the Company’s purchase price. The Company relied on an independent appraisal report, which is based on the weighted results of two valuation approaches, in determining the estimated fair values of the significant assets acquired. This acquisition was financed in part by the proceeds from the issuance of a 3.75% promissory note. See Note 14 - “Long-Term Debt” for additional information.
Short-term investments consist of certificates of deposit and zero-coupon commercial paper with maturities of 91 to 365 days. Due to their short maturity, the carrying value approximates fair value.
Estimated fair values are determined in accordance with U.S. GAAP, using valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. Fair values are generally measured using quoted prices in active markets for identical securities or other inputs that are observable either directly or indirectly, such as quoted prices for similar securities. In those instances where observable inputs are not available, fair values are measured using unobservable inputs. Unobservable inputs reflect the Company’s own assumptions about the assumptions that market participants would use in pricing the security and are developed based on the best information available in the circumstances. Fair value estimates derived from unobservable inputs are significantly affected by the assumptions used, including the discount rates and the estimated amounts and timing of future cash flows. The derived fair value estimates cannot be substantiated by comparison to independent markets and are not necessarily indicative of the amounts that would be realized in a current market exchange.
There were no transfers between Level 1, 2 or 3 during the years ended December 31, 2018 and 2017.
The following tables present fair value information for assets and liabilities that are carried on the balance sheet at amounts other than fair value as of December 31, 2018 and 2017:
Recognized with the acquisitions of commercial real estate in 2018 and 2017 as described in Real Estate Investments in Note 5 - “Investments” were $409 and $636, respectively, of in-place leases. In connection with the 2016 business acquisitions described in Note 7 - “Business Acquisitions,” the Company recognized $5,199 of intangible assets. For the years ended December 31, 2018, 2017 and 2016, amortization expense associated with intangible assets was $604, $503 and $77, respectively. The remaining weighted-average amortization period as of December 31, 2018 was 15.1 years and 11.8 years for anchor tenant relationships and in-place leases, respectively, or a combined weighted average of 12.8 years.
In December 2018, the Company entered into a three-year secured revolving credit agreement (“Credit Agreement”) with Fifth Third Bank that expires on December 5, 2021. The Credit Agreement provides the Company with borrowing capacity of up to $65,000 and bears interest at an annual rate equal to monthly-determined LIBOR plus a margin based on the type of collateral used to secure each borrowing. The interest payment is due quarterly in arrears on January 1, April 1, July 1, and October 1. The Credit Agreement contains affirmative and negative covenants as well as customary events of defaults. Under the terms of the Credit Agreement, the Company must comply with certain financial and non-financial covenants and agree to pay a fee equal to the product of the unused line fee rate and the average of the daily unused available credit balances. The unused line fee rate is determined monthly based on the average daily deposit balances. At December 31, 2018, the Company was in compliance with all required covenants, and there were no outstanding loans.
In connection with FMJV’s December 15, 2016 distribution of its 90% ownership interest in FMKT MGA as described in Investment in Unconsolidated Joint Venture in Note 5 - “Investments,” the Company assumed a liability to repay $8,214 under a secured credit agreement. The agreement provided that the Company could borrow up to $9,550. The Company had an option to convert the outstanding balance at the initial maturity date into a three-year mortgage loan payable in 36 monthly installments at a fixed interest rate. On December 15, 2016, the Company drew an additional $1,193 from this credit line, which was used towards the purchase of the 10% noncontrolling interest as described in Pineda Landings - Melbourne, Florida in Note 7 - “Business Acquisitions.” In February 2017, the Company exercised the conversion option under the credit agreement. See 3.95% Promissory Note in Note 14 - “Long-Term Debt” for additional information. For the year ended December 31, 2016, interest expense for this revolving credit facility totaled $235, of which $11 related to the period from December 15 to 31, 2016.
The following table summarizes future maturities of long-term debt as of December 31, 2018, which takes into consideration the assumption that the 4.25% Convertible Senior Notes are repurchased at the earliest call date.
The Company’s Convertible Senior Notes consist of 3.875% Convertible Senior Notes due 2019 (“3.875% Convertible Notes”) and 4.25% Convertible Senior Notes due 2037 (“4.25% Convertible Notes”). The 3.875% Convertible Notes were issued in late 2013 in a private offering for an aggregate principal amount of $103,000. During the first quarter of 2016, the Company repurchased an aggregate of $13,010 in principal, thereby decreasing the aggregate principal balance of its 3.875% Convertible Notes to $89,990. On March 3, 2017, the Company issued 4.25% Convertible Notes in a private offering for an aggregate principal amount of $143,750. The net proceeds of the 4.25% Convertible Notes were $138,775 after $4,975 in related issuance and transaction costs. The following table summarizes the principal and interest payment terms of these Convertible Senior Notes:
The Convertible Senior Notes rank equally in right of payment to the Company’s existing and future unsecured and unsubordinated obligations. These Convertible Senior Notes do not contain any financial or operating covenants or restrictions on the payments of dividends, the incurrence of indebtedness or the issuance or repurchase of securities by the Company or any of its subsidiaries. The Convertible Senior Notes provide no protection to the note holders in the event of a fundamental change or other corporate transaction involving the Company except those described in each respective indenture. These Convertible Senior Notes do not require a sinking fund to be established for the purpose of redemption.
3.875% Convertible Notes. Since January 2015, the Company’s cash dividends on common stock have exceeded $0.275 per share, resulting in adjustments to the conversion rate of the 3.875% Convertible Notes. Accordingly, as of December 31, 2018, the conversion rate of the Company’s 3.875% Convertible Notes was 16.3645 shares of common stock for each $1 in principal amount, which was the equivalent of approximately $61.11 per share.
The note holders who elect to convert their Convertible Senior Notes in connection with a fundamental change as described in the indentures will be entitled to a “make-whole” adjustment in the form of an increase in the conversion rate. Upon conversion, the Company has options to satisfy its conversion obligation by paying or delivering cash, shares of its common stock or a combination of cash and shares of its common stock. As of December 31, 2018, none of the conditions allowing the holders of either class of the Convertible Senior Notes to convert had been met.
In connection with the business acquisition described in Note 7 - Business Acquisitions, Sorrento PBX, LLC entered into a 20-year secured loan agreement for gross proceeds of $9,000. The loan proceeds were used to finance the acquisition. The loan bears a fixed annual interest rate of 3.75% and is collateralized by the acquired property and the assignment of associated lease agreements. Approximately $53 of principal and interest is payable in 240 monthly installments. The promissory note may be repaid in full after September 1, 2017 as long as the Company provides at least 60 days’ written notice and pays a prepayment premium as specified in the loan agreement. In addition, the lender may require full payment of the outstanding principal and unpaid interest on September 1, 2031 provided a written notice of its intention to call the note is given at least six months in advance.
The Company remains liable for claims payments in the event that any reinsurer is unable to meet its obligations under the reinsurance agreements. Failure of reinsurers to honor their obligations could result in losses to the Company. The Company evaluates the financial condition of its reinsurers and monitors concentrations of credit risk arising from similar geographic regions, activities or economic characteristics of the reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. The Company contracts with a number of reinsurers to secure its annual reinsurance coverage, which generally becomes effective June 1st each year. The Company purchases reinsurance each year taking into consideration probable maximum losses and reinsurance market conditions.
Certain of the reinsurance contracts include retrospective provisions that adjust premiums, increase the amount of future coverage, or result in a profit commission in the event losses are minimal or zero. Due to the losses incurred by Hurricane Irma, the balances of previously accrued benefits and deferred reinsurance premiums were adjusted with the changes recognized in the consolidated statement of income as additional ceded premiums. For the year ended December 31, 2018, the Company recognized a net reduction in ceded premiums of $485 compared with a net increase in ceded premiums of $5,740 for the year ended December 31, 2017. Included in these adjustments attributable to the Company’s contract with Oxbridge for the years ended December 31, 2018 and 2017 were $448 and $933, respectively, of net increase in ceded premiums. These adjustments were reflected as a net reduction in premiums ceded of $12,677 for the year ended December 31, 2016, of which $1,929 related to the Company’s contract with Oxbridge.
In addition, adjustments related to retrospective provisions are reflected in other assets. At December 31, 2018 and 2017, other assets included $3,136 and $2,393, respectively, of which $0 and $479 related to the contract with Oxbridge. In June 2016, the Company received a total of $37,800 in cash benefits related to two retrospective reinsurance contracts that terminated May 31, 2016 of which $7,560 was received from Oxbridge. In September 2016, the Company received the final cash payment of $5,716 under the terms of the remaining retrospective reinsurance contract which terminated May 31, 2016. See Note 26 - “Related Party Transaction” regarding the termination of the Company’s reinsurance contract with Oxbridge. Management believes the credit risk associated with the collectability of these accrued benefits is minimal as the amount receivable is concentrated with one reinsurer and the Company monitors the creditworthiness of this reinsurer based on available information about the reinsurer’s financial condition.
The Company writes insurance primarily in the state of Florida, which could be exposed to hurricanes or other natural catastrophes. The occurrence of a major catastrophe could have a significant effect on the Company’s quarterly results and cause a temporary disruption of the normal operations of the Company. However, the Company is unable to predict the frequency or severity of any such events that may occur in the near term or thereafter.
The establishment of loss reserves is an inherently uncertain process and changes in loss reserve estimates are expected as these estimates are subject to the outcome of future events. Changes in estimates, or differences between estimates and amounts ultimately paid, are reflected in the operating results of the period during which such adjustments are adjusted. During the year ended December 31, 2018, the Company incurred approximately $16,520 of net losses related to Hurricane Michael and experienced unfavorable development of $12,468, of which $9,614 pertains to claims in the 2015 and 2016 loss years. The 2018 prior year development was driven by continued reserve strengthening in response to trends involving assignment of insurance benefits and litigation and a $2,101 increase in 2016 loss reserves related to Hurricane Matthew. Loss reserves for 2017 Hurricane Irma were increased during 2018 by $144 million, all of which is recoverable under reinsurance agreements.
(a)   Excludes losses from Wind-only insurance (2012 through 2018), any hurricane event prior to 2018 and Hurricane Michael (2018).
(b)   The cumulative number of reported claims is measured as the number of per-policyholder, per-event claims for all coverages regardless of whether the claim results in loss or expense to the Company.
The following is supplementary and unaudited information about average historical claims duration as of December 31, 2018:
The Company identifies its operating divisions based on organizational structure and revenue source. Currently, the Company has three reportable segments: insurance operations, real estate operations, and corporate and other. Due to their economic characteristics, the Company’s property and casualty insurance division and reinsurance division are grouped together into one reportable segment under insurance operations. The real estate operations segment includes companies engaged in operating commercial properties the Company owns for investment purposes or for use in its own operations. The corporate and other segment represents the activities of the holding companies, the information technology division, and other companies that do not meet the quantitative thresholds for a reportable segment. The determination of segments may change over time due to changes in operational emphasis, revenues, and results of operations. The Company’s chief executive officer, who serves as the Company’s chief operating decision maker, evaluates each division’s financial and operating performance based on revenue and operating income.
For the years ended December 31, 2018, 2017 and 2016, revenues from the Company’s insurance operations before intracompany elimination represented 95.0%, 96.2% and 95.5%, respectively, of total revenues of all operating segments. At December 31, 2018, 2017 and 2016, insurance operations’ total assets represented 85.9%, 87.1% and 87.9%, respectively, of the combined assets of all operating segments. See Note 1 - “Nature of Operations” for a description of the Company’s insurance operations. The following tables present segment information reconciled to the Company’s consolidated statements of income. Intersegment transactions are not eliminated from segment results. However, intracompany transactions are eliminated in segment results below.
(c) Represents amounts before reclassification to conform with an insurance company’s presentation.
The following table presents segment assets reconciled to the Company’s total assets in the consolidated balance sheets.
In July 2017, the Company received notice from the Internal Revenue Service stating the Company’s 2015 federal income tax return would be examined. In August 2018, the Internal Revenue Service notified the Company that the examination of the Company’s 2015 federal income tax return was completed with no change to the Company’s reported tax.
For the year ended December 31, 2018, the Company recorded approximately $9,177 of income taxes, which resulted in an effective tax rate of 34.1%. For the year ended December 31, 2017, the Company recorded approximately $8,731 of income tax benefits, which resulted in an effective tax rate of 55.9%. The decrease in the effective tax rate in 2018 as compared with the prior year was primarily attributable to the reduction of the federal corporate income tax rate from 35% to 21%, offset by the negative effect of the derecognition of deferred tax assets of $1,825 for restricted stock awards of which market conditions will not be met prior to their expiry date, the disallowance of the deductibility of the $1,887 expense representing dividends cumulatively paid on such restricted stock awards which were reclassified from retained income (see Restricted Stock Awards in Note 21 - “Stock-Based Compensation”), and an increase in nondeductible compensation expenses due to the elimination of the deductibility of most performance-based compensation.
*** Stock options and convertible senior notes were excluded due to antidilutive effect.
In December 2018, the Company’s Board of Directors authorized a plan to repurchase up to $20,000 of the Company’s common shares before commissions and fees. The repurchase plan allows the Company to repurchase shares from time to time through December 31, 2019. The shares may be purchased for cash in open market purchases, block transactions and privately negotiated transactions in accordance with applicable federal securities laws. The share repurchase plan may be modified, suspended, terminated or extended by the Company any time without prior notice.
For each of the last two years, the Company’s Board of Directors authorized a one-year plan to repurchase up to $20,000 of the Company’s common shares before commissions and fees. During the years ended December 31, 2018 and 2017, the Company repurchased and retired 511,628 and 433,175 shares, respectively, at weighted average prices per share of $39.09 and $34.94, respectively. The total costs of shares repurchased, inclusive of fees and commissions, during the years ended December 31, 2018 and 2017 were $20,015 and $15,155, respectively, or $39.12 and $34.98 per share, respectively.
In conjunction with the issuance of the 4.25% Convertible Notes as described in Note 14 - “Long-Term Debt” under Convertible Senior Notes, the Company used $20,345 of the net proceeds to repurchase and retire an aggregate of 413,600 shares of its common stock at a price of $49.19 per share from institutional investors.
The Company has one outstanding prepaid share repurchase forward contract entered into with Societe Generale, a forward counterparty. The Company entered into this forward contract in conjunction with the March 2017 issuance of the 4.25% Convertible Notes as described in Note 14 - “Long-Term Debt” under Convertible Senior Notes. Under the forward contract, the Company made an initial upfront payment of $9,400 in exchange for the future delivery of 191,000 shares of the Company’s common stock over a settlement period in 2022.
The forward contract is subject to early settlement, in whole or in part, at any time prior to the final settlement date at the option of the forward counterparty, as well as early settlement or settlement with alternative consideration in the event of certain corporate transactions. In the event the Company pays any cash dividends on its common shares, the forward counterparty will pay an equivalent amount to the Company. The shares to be purchased under the forward contract will be treated as retired for financial statement purposes as of the effective date of the forward contract, but will remain outstanding for corporate law purposes, including for purposes of any future stockholders votes.
The Company currently has outstanding stock-based awards granted under its 2007 Stock Option and Incentive Plan and 2012 Omnibus Incentive Plan. Only the 2012 Plan is active and available for future grants. With respect to the 2012 Plan, the Company may grant stock-based awards to employees, directors, consultants, and advisors of the Company. On March 17, 2017, the Company’s board of directors amended the 2012 Plan and reduced the number of shares reserved under the plan from 5,000,000 shares to 3,000,000 shares. At December 31, 2018, there were 1,752,432 shares available for grant.
For the years ended December 31, 2018, 2017 and 2016, the Company recognized $521, $306 and $0, respectively, of compensation expense which was included in general and administrative personnel expenses. Deferred tax benefits related to stock options were $79, $78 and $0 for the years ended December 31, 2018, 2017 and 2016, respectively. At December 31, 2018 and 2017, there was $1,359 and $941, respectively, of unrecognized compensation expense related to nonvested stock options. The Company expects to recognize the remaining compensation expense over a weighted-average period of 2.7 years.
The following table provides assumptions used in the Black-Scholes option-pricing model to estimate the fair value of the stock options granted during the years ended December 31, 2018 and 2017:
From time to time, the Company has granted and may grant restricted stock awards to certain executive officers, other employees and nonemployee directors in connection with their service to the Company. The terms of the Company’s outstanding restricted stock grants may include service, performance and market-based conditions. The fair value of the awards with market-based conditions is determined using a Monte Carlo simulation method, which calculates many potential outcomes for an award and then establishes fair value based on the most likely outcome. The determination of fair value with respect to the awards with only performance or service-based conditions is based on the market value of the Company’s stock on the grant date.
The Company recognized compensation expense related to restricted stock, which is included in general and administrative personnel expenses, of $4,111, $4,217 and $4,198 for the years ended December 31, 2018, 2017 and 2016, respectively. At December 31, 2018 and 2017, there was approximately $11,199 and $9,101, respectively, of total unrecognized compensation expense related to nonvested restricted stock arrangements. The Company expects to recognize the remaining compensation expense over a weighted-average period of 2.8 years. The following table summarizes information about deferred tax benefits recognized and tax benefits realized related to restricted stock awards and paid dividends, and the fair value of vested restricted stock for the years ended December 31, 2018, 2017 and 2016.
During the years ended December 31, 2018, 2017 and 2016, no awards were issued with other than service-based vesting conditions.
The Company has a 401(k) Safe Harbor Profit Sharing Plan (“401(k) Plan”) that qualifies as a defined contribution plan under Section 401(k) of the Internal Revenue Code. Under the 401(k) Plan, participating employees are eligible for company matching and discretionary profit sharing contributions. Plan participants may elect to defer up to one hundred percent of their pre-tax gross wages, subject to annual limitations. The Company matching contribution is limited to a maximum of four percent of the employee’s annual salary or wage and is fully vested when contributed. Eligibility and vesting of the Company’s discretionary profit sharing contribution is subject to the plan participant’s years of service. During the years ended December 31, 2018, 2017 and 2016, the Company contributed approximately $536, $560 and $415, respectively, in matching contributions, which are included in general and administrative personnel expenses. There has been no discretionary profit sharing contribution since the plan’s inception.
* Premiums payable after March 31, 2019 are estimated. See Note 15 - “Reinsurance” for additional information.
The Company leases 15,000 square feet of office space in Noida, India. The lease has an initial term of nine years. The monthly rental payment, exclusive of applicable service tax, has increased by five percent every year since the end of the first year of the lease term. In addition, the Company has a lease for office space in Miami Lakes, Florida for its claims related administration. The lease commenced on March 1, 2018 and has an initial term of approximately three years.
Rental expense under all facility leases was $407, $336 and $333, respectively, during the years ended December 31, 2018, 2017 and 2016.
In connection with the lease for office space in India as described in the “Lease Commitments” above, the Company signed a long-term contract with the landlord to receive maintenance and facility services. The agreement has the same initial term of nine years. The monthly payment, exclusive of applicable service tax, has also increased by five percent every year since the end of the first year of the lease term.
Provided the agreement is not early terminated, minimum future payments under the service agreement after December 31, 2018 are as follows:
The Company leases available space at the Company’s headquarters and at its various investment properties to non-affiliates at various terms. In addition, the Company leases boat slips and docks on a long-term basis. Expected annual rental income due under non-cancellable operating leases for all properties owned at December 31, 2018 is as follows:
The tables below summarize unaudited quarterly results of operations for 2018, 2017 and 2016.
* During the quarter ended September 30, 2017, the convertible senior notes and stock options were antidilutive.
The Code requires HCPCI to maintain capital and surplus equal to the greater of 10% of their respective liabilities or a statutory minimum as defined in the Code. TypTap, the Company’s insurance subsidiary organized in 2015, is subject to a consent order that requires TypTap to maintain minimum capital and surplus of $20,000 during each of the three years ending December 31, 2016, 2017, and 2018. At December 31, 2018, HCPCI was required to maintain minimum capital and surplus of $21,700. At December 31, 2017, HCPCI was required to maintain minimum capital and surplus of $25,900. HCPCI and TypTap were in compliance with these requirements at December 31, 2018 and 2017.
U.S. GAAP differs in certain respects from the accounting practices prescribed or permitted by insurance regulatory authorities (statutory-basis). These entities’ statutory-basis financial statements are presented on the basis of accounting practices prescribed or permitted by the FLOIR. The FLOIR has adopted the National Association of Insurance Commissioner’s (“NAIC”) Accounting Practices and Procedures Manual as the basis of its statutory accounting practices. At December 31, 2018, 2017 and 2016, HCPCI’s statutory-basis capital and surplus was approximately $149,000, $153,000 and $183,000, respectively. For the year ended December 31, 2018, HCPCI had a statutory-basis net income of approximately $20,700. For the year ended December 31, 2017, HCPCI had a statutory-basis net loss of approximately $10,500 as compared with a statutory-basis net income of approximately $5,900 for the year ended December 31, 2016. At December 31, 2018, 2017 and 2016, TypTap’s statutory-basis capital and surplus was approximately $26,000, $24,000 and $25,000, respectively. For the year ended December 31, 2018, TypTap had a statutory-basis net income of approximately $2,034 in contrast to statutory-basis net losses of approximately $797 and $364 for the years ended December 31, 2017 and 2016, respectively. Statutory-basis surplus differs from stockholders’ equity reported in accordance with U.S. GAAP primarily because policy acquisition costs are expensed when incurred. In addition, the recognition of deferred tax assets is based on different recoverability assumptions.
Since inception, HCPCI and TypTap have each maintained a cash deposit with the Insurance Commissioner of the state of Florida in the amount of $300 to meet regulatory requirements.
The Bermuda Monetary Authority requires Claddaugh Casualty Insurance Company, Ltd. (“Claddaugh”), the Company’s Bermuda domiciled reinsurance subsidiary, to maintain minimum capital and surplus of $2,000. At December 31, 2018 and 2017, Claddaugh’s statutory capital and surplus was approximately $45,000 and $63,000, respectively. For the years ended December 31, 2018 and 2017, Claddaugh reported statutory net losses of approximately $8,100 and $5,200, respectively, in contrast with a statutory net profit of approximately $13,200 for the year ended December 31, 2016. During 2018, Claddaugh made a return of capital distribution of $10,000 to the Company. During 2017, Claddaugh made a dividend payment of $20,000 to the Company. There were no cash dividends paid by Claddaugh during 2016.
In connection with the acquisition of Pineda Landings described in Note 7 - “Business Acquisition,” the Company incurred and paid $20 of legal fees in 2016 for services provided by a law firm that specializes in real estate transactions at which one immediate family member of the Company’s directors is employed.
On January 15, 2019, the Company granted 40,000 shares of restricted stock and 110,000 options to purchase the Company’s common shares at an exercise price of $53 per share to its chief executive officer, Paresh Patel. The options will expire on January 15, 2029. These share-based awards were granted pursuant to the 2012 Plan and will vest in equal annual installments over four years, so long as Mr. Patel remains employed by the Company. The grant date fair values of the restricted stock and options were $1,918 and $1,345, respectively.
On February 27, 2019, the Company acquired approximately nine acres of undeveloped land located near its current headquarters in Tampa, Florida for a purchase price of $8,500, which was primarily financed by the Company’s revolving credit facility. The land is a potential site for the construction of a new headquarters building. The transaction was accounted for as an asset acquisition. As such, all acquisition-related costs are capitalized.