You should read the following discussion in conjunction with our condensed
consolidated financial statements and related notes and other information
included elsewhere in this Quarterly Report on Form 10-Q and in our Annual
Report on Form 10-K for the year ended December 31, 2022 ("2022 Form 10-K").
Unless the context requires otherwise, as used in this Form 10-Q, the terms
"we", "us", "our", "the Company", "our Company", and similar references refer to
Heritage Insurance Holdings, Inc., a Delaware corporation, and its subsidiaries.
Overview
We are a super-regional property and casualty insurance holding company that
primarily provides personal and commercial residential insurance products across
our multi-state footprint. We provide personal residential insurance in Alabama,
California, Connecticut, Delaware, Florida, Georgia, Hawaii, Maryland,
Massachusetts, Mississippi, New Jersey, New York, North Carolina, Rhode Island,
South Carolina, and Virginia and commercial residential insurance in Florida,
New Jersey, and New York. We provide personal residential insurance in Florida
on both an admitted and non-admitted basis and in California on a non-admitted
basis. As a vertically integrated insurer, we control or manage substantially
all aspects of risk management, underwriting, claims processing and adjusting,
actuarial rate making and reserving, customer service, and distribution. Our
financial strength ratings are important to us in establishing our competitive
position and can impact our ability to write policies.
Recent Developments
Economic and Market Factors
We continue to monitor the effects of general changes in economic and market
conditions on our business. As a result of general inflationary pressures, we
have experienced, and may continue to experience, increased cost of materials
and labor needed for repairs and to otherwise remediate claims throughout all
states in which we conduct business. Additionally, we anticipate continued
rising costs and constrained availability of catastrophe reinsurance. We
mitigate these conditions by continued exposure management, implementation of
increased rates and the use of inflation guard, which increases the insured
value of a property to reflect the inflationary impact on costs to repair
properties.
The table below provides policy count, premiums-in-force, and TIV for Florida
and all other states as of March 31, 2023 and compares these metrics to the
first quarter of 2022. One of our goals has been to reduce personal lines
exposure in Florida, given historical abusive claims practices. Florida
policies-in-force declined from the prior year quarter by 15.6% with a 13.2%
increase in premiums-in-force, and a TIV increase of only 1.8%. The increase in
Florida premiums-in-force was driven by rate increases, organic growth of our
commercial residential business, and use of inflation guard, partly offset by
premium reductions associated with fewer policies. Use of inflation guard,
partly offset by fewer personal residential policies, also increased TIV from
the prior year quarter. Compared to the first quarter of 2022, premiums-in-force
for markets outside of Florida increased while the policy count decreased due to
rate actions and exposure management.
The Supplemental Information table demonstrates progress made compared to the
first quarter 2022.
Policies-in-force: Q1 2023 Q1 2022 % Change
Florida 172,425 204,406 (15.6 ) %
Other States 336,647 355,090 (5.2 ) %
Total 509,072 559,496 (9.0 ) %
Premiums-in-force:
Florida $ 624,931,522 $ 551,962,357 13.2 %
Other States 681,407,015 626,010,221 8.8 %
Total $ 1,306,338,537 $ 1,177,972,578 10.9 %
Total Insured Value:
Florida $ 104,735,498,939 $ 102,863,325,053 1.8 %
Other States 302,701,975,889 293,478,796,893 3.1 %
Total $ 407,437,474,828 $ 396,342,121,946 2.8 %
Strategic Profitability Initiatives
The following provides an update to our strategic initiatives that are expected
to enable us to achieve consistent long-term quarterly earnings and drive
shareholder value.
•
Generate underwriting profit through rate adequacy and more selective
underwriting.
22
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o
Continued significant rating actions throughout the book of business resulting
in an increase in average premium per policy throughout the book of 5.9% from
fourth quarter 2022, and 21.9% over first quarter 2022.
o
Premiums-in-force of $1.3 billion are up 10.9% from the prior year quarter,
while policy count is down 9.0%, resulting from prior underwriting efforts.
o
Continued focus on tightening underwriting criteria while also restricting new
business for policies written in over-concentrated markets or products.
•
Allocate capital to products and geographies that maximize long-term returns.
o
Increased commercial residential premiums-in-force by 69.6% over the prior year
quarter while total insured value ("TIV") only increased 39.9% and policies in
force increased by only 11.8%.
o
Reduction of policy count for the Florida personal lines product remains a key
focus and will continue until the positive impact of recent legislation to
reduce abusive claims practices is realized. Policy count for Florida personal
lines business intentionally declined by 16.8% as compared to the prior year
period.
o
Disciplined underwriting approach resulted in a policy count reduction of 5.2%
in other states while generating an 8.8% increase in premiums-in-force.
•
Maintain a balanced and diversified portfolio.
o
Even with the substantial increase in commercial business, no state represents
over 26% of the Company's TIV.
o
The top four states grew TIV by an average of 3.7% while the smallest five
states grew by 38.8%.
o
As a result of diversification efforts, the top five personal lines states
represented 71.5% of all TIV at first quarter 2023 compared to 73.3% of all TIV
at first quarter 2022.
o
Florida TIV increased 1.8% related to the use of inflation guard and growth of
the Company's commercial residential product.
o
TIV in other states increased 3.1% compared to the prior year period, largely
driven by inflation guard.
o
Excluding Florida, TIV represented 74.3% of the entire portfolio, compared to
74.0% as of the first quarter of 2022.
•
Provide coverage suitable to the market and return targets.
o
Expansion of Excess & Surplus lines ("E&S") premium-in-force in California and
Florida.
o
Continued plan to introduce E&S products in South Carolina during second quarter
of 2023.
o
Continue to evaluate other strategic states for E&S products.
Reinsurance Commutation
As further described in Note 17, Commitments and Contingencies, to the condensed
consolidated financial statements, our 2017 reinsurance agreement with the FHCF
requires a commutation no later than 60 months after the end of the contract
year, which commutation process is expected to begin in June 2023. As part of
this process, Heritage and FHCF will terminate the 2017 reinsurance agreement
and agree on the amount that FHCF will be required to pay to the Company to
settle all outstanding losses owed under the agreement related to losses from
Hurricane Irma. As such, this commutation process will ultimately result in a
final determination of and payment for known, unknown or unreported claims
relating to Hurricane Irma, with the potential for payment by the FHCF to
Heritage of a larger or lesser amount than would otherwise have been the FHCF's
responsibility if the commutation were not required by Florida statutes and the
contract terms. The commutation process has not yet begun, and the Company
cannot predict whether the loss estimates determined by Heritage and the loss
estimates determined by the FHCF will differ. As such, there is no assurance
that the reported reinsurance recoverable for Hurricane Irma losses from the
FHCF will differ from the final amount that will be paid by the FHCF. Further,
social inflation and the litigated claims environment in the State of Florida,
which affected Hurricane Irma claims could result in adverse development of
these claims which, create uncertainty as to the ultimate cost to settle of all
the remaining Hurricane Irma claims. Accordingly, the final amount that will be
paid by the FHCF could vary from the Company's current or future estimation of
losses to be recovered from the FHCF. The commutation process will be final and
binding on both parties once complete.
Overview of 2023 Financial Results
In the following section, we discuss our financial condition and results of
operations for the three months ended March 31, 2023 compared to the three
months ended March 31, 2022.
23
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The discussion of our financial condition and results of operations that follows
provides information that will assist the reader in understanding our
consolidated financial statements, the changes in certain key items in those
financial statements from year to year, including certain key performance
indicators such as net combined ratio, ceded premium ratio, net expense ratio
and net loss ratio, and the primary factors that accounted for those changes, as
well as how certain accounting principles, policies and estimates affect our
consolidated financial statements. This discussion should be read in conjunction
with our consolidated financial statements and the related notes included under
Item 1 of this Quarterly Report on Form 10-Q.
•
Net income for the three months ended March 31, 2023 was $14.0 million or $0.55
per diluted share, compared to a net loss of $30.8 million or ($1.15) per
diluted share in the prior year quarter.
•
Gross premiums written were $310.3 million, up 9.6% from $283.2 million in the
prior year quarter, reflecting higher average premium per policy throughout the
book of business, partly offset by intentional exposure management related
reductions in Florida personal lines business and business outside of Florida of
10.0% and 1.0%, respectively, and a strategic and substantial increase in
Florida commercial lines business.
•
Gross premiums earned of $317.0 million, up 10.3% from $287.4 million in the
prior year quarter, reflecting higher gross premiums written over the last
twelve months driven by a higher average premium per policy and organic growth
of our commercial residential business.
•
Net premiums earned of $166.0 million, up 8.6% from $153.0 million in the prior
year quarter, reflecting higher gross premium earned outpacing the increase in
ceded premiums for the quarter.
•
Losses and loss adjustment expenses ("LAE") incurred of $97.5 million, down
30.4% from $140.0 million in the prior year quarter. The decrease primarily
stems from significantly lower weather losses in the southeast. Net current
accident year weather losses were $12.8 million, down substantially from $63.8
million in the prior year quarter. Current accident year weather losses include
$5.0 million of net current accident quarter catastrophe losses, down from $45.0
million in the prior year quarter, and $7.8 million of other weather losses,
down from $18.8 million in the prior year quarter. Additionally, we experienced
$1.5 million of favorable prior year development compared to $2.4 million of
unfavorable prior year development in the prior year quarter.
•
Ceded premium ratio of 47.6%, up 0.8 points from 46.8% in the prior year quarter
driven by a higher cost of the 2022-2023 catastrophe excess of loss program,
stemming from both higher costs and higher TIV, partly offset by higher gross
premiums earned.
•
Net loss and LAE ratio of 58.7%, 32.9 points lower than the prior year quarter
of 91.6%, driven by lower losses incurred as described above.
•
Net expense ratio of 35.8%, down 2.1 points from the prior year quarter amount
of 37.9%, as slightly higher policy acquisition costs were more than offset by
the benefit of higher gross premiums earned over the prior year quarter.
•
Net combined ratio of 94.5%, down 35.0 points from 129.5% in the prior year
quarter, driven by lower net loss and net expense ratios as described above.
•
Effective tax rate was 18.6% compared to 25.7% in the prior year quarter, driven
by the impact of permanent differences in relation to the pre-tax income or loss
each quarter. In addition, the Company reduced its valuation allowance from
fourth quarter 2022 by $1.7 million, favorably impacting the effective tax rate
for the quarter. The valuation allowance relates to certain tax elections made
by Osprey Re, the Company's captive reinsurer domiciled in Bermuda.
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Results of Operations
Comparison of the Three Months Ended March 31, 2023 and 2022
Revenue
For the Three Months Ended March 31,
(Unaudited) 2023 2022 $ Change % Change
(in thousands)
REVENUE:
Gross premiums written $ 310,309 $ 283,196 $ 27,113 9.6 %
Change in gross unearned premiums 6,713 4,172 2,541 60.9 %
Gross premiums earned 317,022 287,368 29,654 10.3 %
Ceded premiums (150,993 ) (134,439 ) (16,554 ) 12.3 %
Net premiums earned 166,029 152,929 13,100 8.6 %
Net investment income 5,582 2,000 3,582 179.1 %
Net realized gains 1,898 (16 ) 1,914 NM
Other revenue 3,412 3,695 (283 ) (7.6 )%
Total revenue $ 176,921 $ 158,608 $ 18,313 11.5 %
NM= Not Meaningful
Gross premiums written
Gross premiums written were $310.3 million, up 9.6% from $283.2 million in the
prior year quarter, reflecting higher average premium per policy throughout the
book of business, partly offset by intentional exposure management related
reductions in Florida personal lines business and business outside of Florida of
10.0% and 1.0%, respectively, and a strategic increase in Florida commercial
lines business of 92.4%.
Premiums-in-force of $1.3 billion as of March 31, 2023, representing a 10.9%
increase from first quarter 2022, primarily due to continued proactive
underwriting and rate actions, despite a policy count reduction of approximately
50,000 policies. In addition, our intentional growth of the Company's commercial
product, and use of inflation guard, favorably impacted premiums-in-force.
Concurrently, TIV increased only 2.8%.
Gross premiums earned
Gross premiums earned of $317.0 million were up 10.3% from $287.4 million in the
prior year quarter, reflecting higher gross premiums written over the last
twelve months driven by a higher average premium per policy and organic growth
in our commercial residential business.
Ceded premiums
Ceded premiums were $151.0 million in first quarter 2023, up 12.3% from $134.4
million in the prior year quarter. The increase is attributable to an increase
in the cost of our catastrophe excess of loss reinsurance program driven by an
increase in TIV and higher reinsurance costs for the respective reinsurance
contract periods as well as a higher cost for our net quota share reinsurance
associated with premium growth in the northeast.
Net premiums earned
Net premiums earned were $166.0 million in first quarter 2023, up 8.6% from
$153.0 million in the prior year quarter. The increase primarily stems from
growth in gross premiums earned outpacing the increase in ceded premiums, as
described above.
Net investment income
Net investment income, inclusive of realized investment gains and unrealized
gains on equity securities, was $7.5 million in first quarter 2023, compared to
$2.0 million in the prior year quarter. The increase is primarily due to higher
yields on cash and invested assets associated with higher interest rates,
coupled with a gain on the sale of other investments.
Other revenue
Other revenue was $3.4 million in first quarter 2023, slightly down compared to
the prior year quarter, driven primarily by a reduction of policy fee income as
the policy count declined.
Total revenue
Total revenue was $176.9 million in first quarter 2023, up 11.5% from $158.6
million in the prior year quarter. The increase primarily stems from higher net
premiums earned and investment income as described above.
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For the Three Months Ended March 31,
(Unaudited) 2023 2022 $ Change % Change
OPERATING EXPENSES: (in thousands)
Losses and loss adjustment expenses 97,452 140,038 (42,586 ) (30.4 )%
Policy acquisition costs
40,324 38,257 2,067 5.4 %
General and administrative expenses 19,054 19,724 (670 ) (3.4 )%
Total operating expenses
156,830 198,019 (41,188 ) (20.8 )%
Losses and loss adjustment expenses
Losses and LAE were $97.5 million in first quarter 2023, down 30.4% from $140.0
million in the prior year quarter. The decrease stems from significantly lower
net weather losses, as described above. Refer to Note 17, Commitments and
Contingencies, to the condensed consolidated financial statements for discussion
related to the upcoming commutation of our 2017 reinsurance contract with the
FHCF.
Policy acquisition costs
Policy acquisition costs were $40.3 million in first quarter 2023, up 5.4% from
$38.3 million in the prior year quarter. The increase is primarily attributable
to growth in gross premiums written and is partly offset by higher ceding
commission income.
General and administrative expenses
General and administrative expenses were $19.1 million in first quarter 2023,
down 3.4% from the prior year quarter. The reduction was driven primarily by IT
costs and certain costs which vary with policy count, such as printing and
postage.
For the Three Months Ended March 31,
(Unaudited) 2023 2022 $ Change % Change
(in thousands, except per share amounts)
Operating income (loss) 20,091 (39,411 ) 59,502 (151.0 )%
Interest expense, net 2,881 1,972 909 46.1 %
Income (loss) before income taxes 17,210 (41,383 ) 58,593 (141.6 )%
Provision (benefit) for income taxes 3,202 (10,624 ) 13,826 (130.1 )%
Net income (loss)
$ 14,008 $ (30,759 ) $ 44,767 (145.5 )%
Basic earnings (loss) per share $ 0.55 $ (1.15 ) $ 1.70 (147.7 )%
Diluted earnings (loss) per share $ 0.55 $ (1.15 ) $ 1.70 (147.6 )%
Interest expense, net
Interest expense, net was $2.9 million in the first quarter of 2023, up 46.2%
from the prior year quarter and driven by higher variable interest rates on our
debt.
Provision (Benefit) for income taxes
The provision for income taxes was $3.2 million in first quarter 2023 compared
to a tax benefit of $10.6 million in the prior year quarter. The effective tax
rate was 18.6% compared to 25.7% in the prior year quarter, driven by the impact
of permanent differences in relation to the pre-tax income or loss each quarter.
In addition, the Company reduced its valuation allowance from fourth quarter
2022 by $1.7 million, favorably impacting the effective tax rate for the
quarter. The valuation allowance relates to certain tax elections made by Osprey
Re, the Company's captive reinsurer domiciled in Bermuda. The effective tax rate
can fluctuate throughout the year as estimates used in the quarterly tax
provision are updated with additional information.
Net income (loss)
First quarter 2023 net income was $14.0 million ($0.55 earnings per share), up
from net loss of $30.8 million or ($1.15 loss per share) in the prior year
quarter. The quarter-over-quarter change primarily stems from higher
underwriting income driven by higher rates and investment income and
significantly lower weather losses, as described above.
Ratios
For the Three Months Ended March 31,
(Unaudited) 2023 2022
Ceded premium ratio 47.6 % 46.8 %
Net loss and LAE ratio 58.7 % 91.6 %
Net expense ratio 35.8 % 37.9 %
Net combined ratio 94.5 % 129.5 %
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Ceded premium ratio
The ceded premium ratio was 47.6%, up 0.8 points from 46.8% in the prior year
quarter driven by a higher cost of the 2022-2023 catastrophe excess of loss
program and net quota share program, as described above, partly offset by higher
gross premiums earned.
Net loss and LAE ratio
The net loss and LAE ratio was 58.7% in first quarter 2023, down 32.9 points
from 91.6% in the prior year quarter, driven by significantly lower weather
losses compared to the prior year quarter, as described above, coupled with
higher net premiums earned.
Net expense ratio
The net expense ratio of 35.8%, down 2.1 points from the prior year quarter
amount of 37.9%, driven by higher policy acquisition costs from by the growth in
gross premiums written partly offset by lower general and administrative
expenses, and the benefit of higher gross premiums earned over the prior year
quarter.
Net combined ratio
The net combined ratio was 94.5% in first quarter 2023, down 35.0 points from
129.5% in the prior year quarter. The decrease primarily stems from lower net
loss and LAE and net expense ratios as described above.
Liquidity and Capital Resources
Our principal sources of liquidity include cash flows generated from operations,
existing cash and cash equivalents, our marketable securities balances and
borrowings available under our Credit Facilities. As of March 31, 2023, we had
$336.7 million of cash and cash equivalents and $629.0 million in investments,
compared to $287.6 million and $653.6 million, respectively, as of December 31,
2022. The increase in cash and cash equivalents was primarily due to strategic
investment of proceeds from investment maturities into short term treasury bills
to achieve a higher yield without increasing credit risk, and to increase
liquidity.
We generally hold substantial cash balances to meet seasonal liquidity needs
including amounts to pay quarterly reinsurance installments as well as meet the
collateral requirements of Osprey Re, our captive reinsurance company, which is
required to maintain a collateral trust account equal to the risk that it
assumes from our insurance company affiliates.
We believe that our sources of liquidity are adequate to meet our cash
requirements for at least the next twelve months.
We may increase capital expenditures consistent with our investment plans and
anticipated business strategies. Cash and cash equivalents may not be sufficient
to fund such expenditures. As such, in addition to the use of our existing
Credit Facilities, we may need to utilize additional debt to secure funds for
such purposes.
Cash Flows
For the Three Months Ended March 31,
2023 2022 Change
(in thousands)
Net cash provided by (used in):
Operating activities $ 14,946 $ (39,206 ) $ 54,152
Investing activities 36,525 (27,648 ) 64,173
Financing activities (2,379 ) (4,312 ) 1,933
Net increase (decrease) in cash and
cash equivalents $ 49,092 $ (71,166 ) $ 120,258
Operating Activities
Net cash provided by operating activities was $14.9 million for the three months
ended March 31, 2023 compared to net cash used in operating activities of $39.2
million for the comparable period in 2022. The increase in cash from operating
activities relates primarily to timing of cash flows associated with claim and
reinsurance payments as well as reinsurance reimbursements during the first
three months of 2023 compared to the first three months of 2022.
Investing Activities
Net cash provided by investing activities for the three months ended March 31,
2023 was $36.5 million as compared to net cash used in investing activities of
$27.6 million for the comparable period in 2022. The change in cash provided by
investing activities relates primarily to the timing of investment maturities
and related re-investment of proceeds into short-term treasury bills.
27
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Financing Activities
Net cash used in financing activities for the three months ended March 31, 2023
was $2.4 million, as compared to cash used in financing activities of $4.3
million for the comparable period in 2022. The change in net cash used in
financing activities relates primarily to the repurchase of $5 million in
treasury stock and a $15 million draw from our Revolving Credit Facility
(defined below) to purchase and retire $11.7 million of Convertible Notes
(defined below) during the first quarter of 2022, as described in Note 14 to the
condensed consolidated financial statements.
Credit Facilities
The Company is party to a Credit Agreement by and among the Company, as
borrower, certain subsidiaries of the Company from time to time party thereto as
guarantors, the lenders from time to time party thereto (the "Lenders"), Regions
Bank, as Administrative Agent and Collateral Agent, BMO Harris Bank N.A., as
Syndication Agent, Hancock Whitney Bank and Canadian Imperial Bank of Commerce,
as Co-Documentation Agents, and Regions Capital Markets and BMO Capital Markets
Corp., as Joint Lead Arrangers and Joint Bookrunners (as amended from time to
time, the "Credit Agreement").
The Credit Agreement, as amended, provides for (1) a five-year senior secured
term loan facility in an aggregate principal amount of $100 million (the "Term
Loan Facility") and (2) a five-year senior secured revolving credit facility in
an aggregate principal amount of $50 million (inclusive of a sublimit for the
issuance of letters of credit equal to the unused amount of the revolving credit
facility and a sublimit for swingline loans equal to the lesser of $25 million
and the unused amount of the revolving credit facility) (the "Revolving Credit
Facility" and together with the Term Loan Facility, the "Credit Facilities").
Term Loan Facility. The principal amount of the Term Loan Facility amortizes in
quarterly installments, which began with the close of the fiscal quarter ending
March 31, 2019, in an amount equal to $1.9 million per quarter, payable
quarterly, decreasing to $875,000 per quarter commencing with the quarter ending
December 31, 2021, and increasing to $2.4 million per quarter commencing with
the quarter ending December 31, 2022, with the remaining balance payable at
maturity. The Term Loan Facility matures on July 28, 2026. As of March 31, 2023,
there was $86.8 million in aggregate principal outstanding under the Term Loan
Facility.
Revolving Credit Facility. The Revolving Credit Facility allows for borrowings
of up to $50 million inclusive of a sublimit for the issuance of letters of
credit equal to the unused amount of the Revolving Credit Facility and a
sublimit for swingline loans equal to the lesser of $25 million and the unused
amount of the Revolving Credit Facility. As of March 31, 2023, the Company had
drawn $10.0 million under the Revolving Credit Facility and had unused letter of
credit of $10.0 million.
At our option, borrowings under the Credit Facilities bear interest at rates
equal to either (1) a rate determined by reference to SOFR, plus an applicable
margin (described below) and a credit adjustment spread equal to 0.10% or (2) a
base rate determined by reference to the highest of (a) the "prime rate" of
Regions Bank, (b) the federal funds rate plus 0.50%, and (c) the adjusted term
SOFR in effect on such day for an interest period of one month plus 1.00%, plus
an applicable margin (described below).
The applicable margin for loans under the Credit Facilities varies from 2.75%
per annum to 3.25% per annum (for SOFR loans) and 1.75% to 2.25% per annum (for
base rate loans) based on our consolidated leverage ratio ranging from 1.25-to-1
to greater than 2.25-to-1. Interest payments with respect to the Credit
Facilities are required either on a quarterly basis (for base rate loans) or at
the end of each interest period (for SOFR loans) or, if the duration of the
applicable interest period exceeds three months, then every three months. As of
March 31, 2023, the borrowings under the Term Loan Facility and Revolving Credit
Facility are accruing interest at a rate of 7.884% and 7.661% per annum,
respectively.
In addition to paying interest on outstanding borrowings under the Revolving
Credit Facility, we are required to pay a quarterly commitment fee based on the
unused portion of the Revolving Credit Facility, which is determined by our
consolidated leverage ratio.
We may prepay the loans under the Credit Facilities, in whole or in part, at any
time without premium or penalty, subject to certain conditions including minimum
amounts and reimbursement of certain costs in the case of prepayments of SOFR
loans. In addition, we are required to prepay the loan under the Term Loan
Facility with the proceeds from certain financing transactions, involuntary
dispositions or asset sales (subject, in the case of asset sales, to
reinvestment rights).
All obligations under the Credit Facilities are or will be guaranteed by each
existing and future direct and indirect wholly owned domestic subsidiary of the
Company, other than all of the Company's current and future regulated insurance
subsidiaries (collectively, the "Guarantors").
The Company and the Guarantors are party to a Pledge and Security Agreement, (as
amended from time to time the "Security Agreement"), in favor of Regions Bank,
as collateral agent. Pursuant to the Security Agreement, amounts borrowed under
the Credit Facilities are secured on a first priority basis by a perfected
security interest in substantially all of the present and future assets of the
Company and each Guarantor (subject to certain exceptions), including all of the
capital stock of the Company's domestic subsidiaries, other than its regulated
insurance subsidiaries.
The Credit Agreement contains, among other things, covenants, representations
and warranties and events of default customary for facilities of this type. The
Company is required to maintain, as of each fiscal quarter (1) a maximum
consolidated leverage ratio of
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2.50 to 1.00, stepping down to 2.25 to 1.00 as of the second quarter of 2024 and
2.00 to 1.00 as of the second quarter of 2025, (2) a minimum consolidated fixed
charge coverage ratio of 1.20 to 1.00 and (3) a minimum consolidated net worth
for the Company and its subsidiaries, which is required to be not less than $100
million plus 50% of positive quarterly net income (including its subsidiaries
and regulated subsidiaries) plus the net cash proceeds of any equity
transactions. Events of default include, among other events, (i) nonpayment of
principal, interest, fees or other amounts; (ii) failure to perform or observe
certain covenants set forth in the Credit Agreement; (iii) breach of any
representation or warranty; (iv) cross-default to other indebtedness; (v)
bankruptcy and insolvency defaults; (vi) monetary judgment defaults and material
nonmonetary judgment defaults; (vii) customary ERISA defaults; (viii) a change
of control of the Company; and (ix) failure to maintain specified catastrophe
retentions in each of the Company's regulated insurance subsidiaries.
Convertible Notes
On August 10, 2017, the Company and Heritage MGA, LLC (the "Notes Guarantor")
entered into a purchase agreement (the "Purchase Agreement") with Citigroup
Global Markets Inc., as the initial purchaser (the "Initial Purchaser"),
pursuant to which the Company agreed to issue and sell, and the Initial
Purchaser agreed to purchase, $125.0 million aggregate principal amount of the
Company's 5.875% Convertible Senior Notes due 2037 (the "Convertible Notes") in
a private placement transaction pursuant to Rule 144A under the Securities Act,
as amended (the "Securities Act"). The Purchase Agreement contained customary
representations, warranties and agreements of the Company and the Notes
Guarantor and customary conditions to closing, indemnification rights and
obligations of the parties and termination provisions. The net proceeds from the
offering of the Convertible Notes, after deducting discounts and commissions and
estimated offering expenses payable by the Company, were approximately $120.5
million. The offering of the Convertible Notes was completed on August 16, 2017.
The Company issued the Convertible Notes under an Indenture (the "Convertible
Note Indenture"), dated August 16, 2017, by and among the Company, as issuer,
the Notes Guarantor, as guarantor, and Wilmington Trust, National Association,
as trustee (the "Trustee").
The Convertible Notes bear interest at a rate of 5.875% per year. Interest is
payable semi-annually in arrears, on February 1 and August 1 of each year. The
Convertible Notes are senior unsecured obligations of the Company that rank
senior in right of payment to the Company's future indebtedness that is
expressly subordinated in right of payment to the Convertible Notes; equal in
right of payment to the Company's unsecured indebtedness that is not so
subordinated; effectively junior to any of the Company's secured indebtedness to
the extent of the value of the assets securing such indebtedness; and
structurally junior to all indebtedness or other liabilities incurred by the
Company's subsidiaries other than the Notes Guarantor, which fully and
unconditionally guarantee the Convertible Notes on a senior unsecured basis.
The Convertible Notes mature on August 1, 2037, unless earlier repurchased,
redeemed or converted.
Holders may convert their Convertible Notes at any time prior to the close of
business on the business day immediately preceding February 1, 2037, other than
during the period from, and including, February 1, 2022 to the close of business
on the second business day immediately preceding August 5, 2022, only under the
following circumstances: (1) during any calendar quarter commencing after the
calendar quarter ending on September 30, 2017, if the closing sale price of the
Company's common stock, for at least 20 trading days (whether or not
consecutive) in the period of 30 consecutive trading days ending on the last
trading day of the calendar quarter immediately preceding the calendar quarter
in which the conversion occurs, is more than 130% of the conversion price of the
Convertible Notes in effect on each applicable trading day; (2) during the ten
consecutive business-day period following any five consecutive trading-day
period in which the trading price for the Convertible Notes for each such
trading day was less than 98% of the closing sale price of the Company's common
stock on such date multiplied by the then-current conversion rate; (3) if the
Company calls any or all of the Convertible Notes for redemption, at any time
prior to the close of business on the second business day immediately preceding
the redemption date; or (4) upon the occurrence of specified corporate events.
During the period from and including February 1, 2022 to the close of business
on the second business day immediately preceding August 5, 2022, and on or after
February 1, 2037 until the close of business on the second business day
immediately preceding August 1, 2037, holders may surrender their Convertible
Notes for conversion at any time, regardless of the foregoing circumstances.
The conversion rate for the Convertible Notes was initially 67.0264 shares of
common stock per $1,000 principal amount of Convertible Notes (equivalent to an
initial conversion price of approximately $14.92 per share of common stock). The
conversion rate is subject to adjustment in certain circumstances and is subject
to increase for holders that elect to convert their Convertible Notes in
connection with certain corporate transactions (but not, at the Company's
election, a public acquirer change of control (as defined in the Convertible
Note Indenture)) that occur prior to August 5, 2022.
Upon the occurrence of a fundamental change (as defined in the Convertible Note
Indenture) (but not, at the Company's election, a public acquirer change of
control (as defined in the Convertible Note Indenture), holders of the
Convertible Notes may require the Company to repurchase for cash all or a
portion of their Convertible Notes at a fundamental change repurchase price
equal
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to 100% of the principal amount of the Convertible Notes to be repurchased, plus
accrued and unpaid interest to, but excluding, the fundamental change repurchase
date.
At any time prior to February 1, 2037, the Company may redeem for cash all or
any portion of the Convertible Notes, at the Company's option, at a redemption
price equal to 100% of the principal amount of the Convertible Notes to be
redeemed, plus accrued and unpaid interest to, but excluding, the redemption
date. No sinking fund is provided for the Convertible Notes, which means that
the Company is not required to redeem or retire the Convertible Notes
periodically. Holders of the Convertible Notes are able to cause the Company to
repurchase their Convertible Notes for cash on any of August 1, 2022, August 1,
2027 and August 1, 2032, in each case at 100% of their principal amount, plus
accrued and unpaid interest to, but excluding, the relevant repurchase date.
The Convertible Note Indenture contains customary terms and covenants and events
of default. If an Event of Default (as defined in the Convertible Note
Indenture) occurs and is continuing, the Trustee by notice to the Company, or
the holders of at least 25% in aggregate principal amount of the Convertible
Notes then outstanding by notice to the Company and the Trustee, may declare
100% of the principal of, and accrued and unpaid interest, if any, on, all the
Convertible Notes to be immediately due and payable. In the case of certain
events of bankruptcy, insolvency or reorganization (as set forth in the
Convertible Note Indenture) with respect to the Company, 100% of the principal
of, and accrued and unpaid interest, if any, on, the Convertible Notes
automatically become immediately due and payable.
In January 2022, the Company repurchased $11.7 million principal amount of
outstanding Convertible Notes. As of March 31, 2023, there was $885,000
principal amount of outstanding Convertible Notes, net of $21.1 million of
Convertible Notes held by an insurance company subsidiary.
As discussed above, holders of the Convertible Notes issued by the Company had
an optional put right, pursuant to the indenture governing the Convertible
Notes, to require the Company to repurchase the aggregate principal amount of
Convertible Notes that are validly tendered. The Company received notice from
the Depository for the Convertible Notes that, on July 29, 2022, $10.9 million
aggregate principal amount of the Convertible Notes has been validly tendered in
accordance with the terms of the indenture and the Company's notice with respect
to the optional put right of the Convertible Notes, and the Company has
requested that the Trustee cancel the Convertible Notes tendered. The
outstanding balance as of March 31, 2023 of non-affiliated Notes was $885,000.
On August 1, 2022, the Company made payments for the principal amount of the
Convertible Notes tendered and unpaid interest in the aggregate amounts of $10.9
million and $320,041, respectively. The Company has drawn $10.0 million from the
Revolving Credit Facility to replenish the cash used to pay the $10.9 million
for the purchase of the tendered Convertible Notes.
FHLB Loan Agreements
In December 2018, a subsidiary of the Company pledged U.S. government and agency
fixed maturity securities with an estimated fair value of $24.3 million as
collateral and received $19.2 million in a cash loan under an advance agreement
with the FHLB Atlanta. The loan originated on December 12, 2018 and bears a
fixed interest rate of 3.094% with interest payments due quarterly commencing in
March 2019. The principal balance on the loan has a maturity date of December
13, 2023. In connection with the agreement, the subsidiary became a member of
the FHLB. Membership in the FHLB required an investment in FHLB's common stock
which was purchased on December 31, 2018 and valued at $1.4 million. As of March
31, 2023, the common stock was valued at $1.2 million. The subsidiary is
permitted to withdraw any portion of the pledged collateral over the minimum
collateral requirement at any time, other than in the event of a default by the
subsidiary. The proceeds from the loan were used to prepay the Company's Senior
Secured Notes due 2023 in 2018.
Critical Accounting Policies and Estimates
When we prepare our condensed consolidated financial statements and accompanying
notes in conformity with U.S. generally accepted accounting principles (GAAP),
we must make estimates and assumptions about future events that affect the
amounts we report. Certain of these estimates result from judgments that can be
subjective and complex. As a result of that subjectivity and complexity, and
because we continuously evaluate these estimates and assumptions based on a
variety of factors, actual results could materially differ from our estimates
and assumptions if changes in one or more factors require us to make accounting
adjustments. We have made no material changes or additions with regard to those
policies and estimates as disclosed in our Annual Report on Form 10-K for the
year ended December 31, 2022.
Recent Accounting Pronouncements
The information set forth under Note 1 to the condensed consolidated financial
statements under the caption "Basis of Presentation and Significant Accounting
Policies" is incorporated herein by reference. We do not expect any recently
issued accounting pronouncements to have a material effect on our condensed
consolidated financial statements.
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