HCI US Equity☆

ITEM 1A –Risk Factors

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

Business and operational risks

Our historical revenue growth was derived primarily through policy assumptions and acquisitions. We cannot guarantee that future policy assumptions and acquisitions will be available to the extent they have in the past.

Substantially all of our historical revenue has been generated from policies assumed from Citizens, our acquisition of policies from one Florida insurance company and subsequent renewals of these policies. Our ability to grow our premium base may depend upon the availability of future policy assumptions and acquisitions upon acceptable terms. Opportunities to acquire large numbers of policies from Citizens meeting our strict underwriting criteria have diminished in recent years. We cannot provide assurance that such opportunities will arise in the future.

Although we began selling insurance products in other states, our insurance business is primarily in Florida. Thus, any catastrophic event or other condition affecting losses in Florida could adversely affect our financial condition and results of operations.

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

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

The insurance industry historically has been cyclical, characterized by periods of intense price competition due to excessive underwriting capacity, as well as periods when shortages of capacity permitted an increase in pricing and, thus, more favorable underwriting profits. As premium levels increase, there may be new entrants to the market, which could subsequently lead to a decrease in premium levels. Any of these factors could lead to a significant reduction in premium rates in future periods, less favorable policy terms and fewer opportunities to underwrite insurance risks, which could have a material, adverse effect on our results of operations and cash flows. In addition to these considerations, changes in the frequency and severity of losses suffered by insureds and insurers may affect the cycles of the insurance business significantly.

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

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

Our operations are highly dependent on the efforts of our senior executive officers, particularly our chief executive officer, Paresh Patel, as well as our chief financial officer, Mark Harmsworth, and the President of our Real Estate Division, Anthony Saravanos. The loss of their leadership, industry knowledge and experience could negatively impact our operations. However, we have management succession plans to lessen any such negative impact. Apart from Mr. Patel and Mr. Harmsworth, we have no employment agreements with any of our personnel nor do we offer any guarantee of any employee’s ongoing service. We maintain key-man life insurance on Mr. Patel although such policy may be insufficient to cover the damage resulting from the loss of Mr. Patel’s services.

Our information technology systems may fail or be disrupted, which could adversely affect our business.

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

The growth of our insurance business is dependent upon the successful development and implementation of advanced computer and data processing systems as well as the development and deployment of new information technologies to streamline our operations, including policy underwriting, production and administration and claim handling. The failure of these systems to function as planned could slow our growth and adversely affect our future business volume and results of operations.Additionally, our computer and data processing systems could become obsolete or could cease to provide a competitive advantage in policy underwriting, production and administration and claim handling which could negatively affect our future results of operations.

We conduct our business primarily from offices located in Tampa, Florida where tropical storms could damage our facilities or interrupt our power supply. The loss or significant impairment of functionality in these facilities for any reason could have a material, adverse effect on our business although we believe we have sufficient redundancies to replace our facilities if functionality is impaired. We contract with a third-party vendor to maintain complete daily backups of our systems, which are stored at the vendor’s facility in Atlanta, Georgia. We additionally use industry leading Internet cloud infrastructure providers to host some of our data processing systems. These cloud providers ensure redundancy across geographic regions with additional daily system backups. Access to these databases and hosted environments is strictly controlled and limited to authorized personnel. In the event of a disaster causing a complete loss of functionality at our Tampa locations, we plan to temporarily use our secondary office in Ocala, Florida to continue our operations.

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

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

HCPCI and TypTap have each obtained a Demotech rating of “A Exceptional,” which is accepted by major mortgage companies operating in the state of Florida and many other states. Mortgage companies may require homeowners to obtain property insurance from an insurance company with an acceptable A.M. Best rating, which we do not currently have. Such a requirement could prevent us from expanding our business unless we obtain such rating, which may in turn limit our ability to compete with large, national insurance companies and certain regional insurance companies. A downgrade or loss of our Demotech rating could result in a substantial loss of business in the event insureds move their business to insurers with a sufficient financial strength rating.

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

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

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

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

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

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

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

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

We rely on our claims personnel to accurately evaluate and pay the claims made under our policies. Many factors could affect our ability to accurately evaluate and pay claims, including the accuracy of our independent adjusters as they make their assessments and submit their estimates of damages; the training, background, and experience of our claims representatives; the ability of our claims personnel to ensure consistent claims handling given the input by our independent adjusters; the ability of our claims department to translate the information provided by our independent adjusters into acceptable claims settlements; and the ability of our claims personnel to maintain and update our claims handling procedures and systems as they evolve over time based on claims and geographical trends in claims reporting. Any failure to pay claims accurately could lead to material litigation, undermine our reputation in the marketplace, impair our corporate image and negatively affect our financial results.

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

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

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

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

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

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

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

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

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

• engaging in vigorous underwriting;

• carefully evaluating terms and conditions of our policies;

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

• ceding insurance risk to reinsurance companies.

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

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

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

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

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

The success of TypTap’s organic growth so far has been driven by selling our policies through independent agents. An inability to sell our products through independent agents would negatively affect our revenues.

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

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

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

• the availability of sufficient reliable data;

• the uncertainties that inherently characterize estimates and assumptions;

• our selection and application of appropriate rating and pricing techniques;

• legislatively imposed consumer initiatives.

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In addition, we could underprice risks, which would negatively affect our profit margins. We could also overprice risks, which could reduce our retention, sales volume and competitiveness. The foregoing factors could materially and adversely affect our profitability.

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

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

Financial risks

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

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

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

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

Our credit agreement contains restrictions that can limit our flexibility in operating our business.

The agreement governing our revolving credit facility contains various covenants that limit our ability to engage in certain transactions. These covenants limit our and our subsidiaries’ ability to, among other things:

• incur additional indebtedness;

• declare or make any restricted payments;

• create liens on any of our assets now owned or hereafter acquired;

• enter into certain transactions with our affiliates.

An increase in interest rates may negatively impact our operating results and financial condition.

Borrowings under our revolving credit facility have a variable rate of interest. An increase in interest rate would have a negative impact on our results of operations attributable to increased interest expense.

Investment risks

There may be limited markets for and restrictions on certain holdings in our investment portfolio.

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

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

A portion of our income is, and likely will continue to be, generated by the investment of our available cash. The amount of income so generated is a function of our investment policy, available investment opportunities, and the amount of available cash invested. Fluctuating interest rates and other economic factors make it difficult to estimate accurately the amount of investment income that will be realized. In fact, we have realized and may in the future realize losses on sales of our investments as well as credit losses on our investment holdings. Any unfavorable change to the fair value of our equity securities will also impact our financial results.

Our revenue from real estate investments may be affected by the success and economic viability of our anchor retail tenants. Our reliance on a single or significant tenant at certain properties may impact our ability to lease vacated space and adversely affect returns on the specific property.

At certain retail centers, we may have tenants, commonly referred to as anchor tenants, occupying all or a large portion of the gross leasable space. In the event an anchor tenant becomes insolvent, suffers a downturn in business, ceases its operations at the retail center, or otherwise determines not to renew its lease, any reduction or cessation of rental payments to us could adversely affect the returns on our real estate investments. A lease termination or cessation of operations by an anchor tenant could also lead to the loss of other tenants at the specific retail location. We may then incur additional expenses to make improvements and prepare the vacated space to be leased to one or more new tenants.

Similarly, the leases of some anchor tenants may permit the anchor tenant to transfer its lease to another retailer. The transfer to a new anchor tenant could cause customer traffic in the retail center to decrease and thereby reduce the income generated by that retail center. A lease transfer to a new anchor tenant could also allow other tenants to make reduced rental payments or to terminate their leases.

Our retail and other real estate properties may be subject to impairment charges which can adversely affect our financial results.

We periodically evaluate our long-lived assets and related intangible assets to determine if there has been any impairment in their carrying values. If we determine an impairment has occurred, we are required to record an impairment charge equal to the excess of the asset’s carrying value over its estimated fair value. As our real estate operations grow, there is an increased potential that the impairment of an asset could have a material adverse effect on our financial results. In addition, our fair value estimates are based on several assumptions that are subject to economic and market uncertainties including, but not limited to, demand for space, competition for tenants, changes in market rental rates and costs to operate each property. As these factors are difficult to predict and are subject to future events that may alter our assumptions, the future cash flows estimated in our impairment analysis may not be achieved.

Our ongoing investments in real estate and information technology businesses have inherent risks and could burden our financial and human resources.

We have invested and expect to continue to invest in real estate and information technology. Despite our due diligence, these investments may still involve significant risks and uncertainties, including distraction of management and employees from current operations, insufficient revenues to offset liabilities assumed and incurred expenses, inadequate return of capital, and failure to realize the anticipated benefits. There can be no assurance that such investments will be successful and will not adversely affect our financial condition and operating results.

Legal and regulatory risks

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

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

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

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

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outside of the ordinary course of business, certain management, service, and cost sharing agreements, reinsurance transactions, dividends, and consolidated tax allocation agreements.

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

Regulations may vary from state to state, and states occasionally may have conflicting regulations. Currently, the federal government’s role in regulating or dictating the policies of insurance companies is limited. However, Congress, from time to time, considers proposals that would increase the role of the federal government in insurance regulation, either in addition to or in lieu of state regulation. The impact of any future federal insurance regulation on our insurance operations is unclear and may adversely impact our business or competitive position.

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

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

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

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

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

• business operations and claims practices;

• approval of policy forms and premium rates;

• standards of solvency, including risk-based capital measurements;

• licensing of insurers and their products;

• restrictions on the nature, quality and concentration of investments;

• restrictions on transactions between insurance companies and their affiliates;

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

• requiring deposits for the benefit of policyholders;

• requiring certain methods of accounting;

• periodic examinations of our operations and finances;

• the level of reserves.

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

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In certain states including Florida, insurance companies are subject to assessments levied by the states where they conduct their business. While we can recover these assessments from Florida policyholders through policy surcharges, our payment of the assessments and our recoveries may not offset each other in the same reporting period in our consolidated financial statements and may cause a material, adverse effect on our cash flows and results of operations in a particular reporting period.

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

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

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

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

Security and fraud risks

An unauthorized disclosure or loss of policyholder or employee information or other sensitive or confidential information, including by cyber-attack or other security breach, could cause a loss of data, give rise to remediation or other expenses, expose us to liability under federal and state laws, and subject us to litigation and investigations, which could have an adverse effect on our business, cash flows, financial condition and results of operations.

As part of our normal operations, we collect, process and retain certain sensitive and confidential information. We are subject to various federal and state privacy laws and rules regarding the use and disclosure of certain sensitive or confidential information. Despite the security measures we have implemented to help ensure data security and compliance with applicable laws and rules, which include firewalls, regular penetration testing and other measures, our facilities and systems, and those of our third-party service providers and vendors, may be vulnerable to cyber-attacks, security breaches, acts of vandalism, computer viruses, theft of data, misplaced or lost data, programming and human errors, physical break-ins, or other disruptions. In addition, we cannot ensure that we will be able to identify, prevent or contain the effects of possible cyber-attacks or other cybersecurity risks in the future that may bypass our security measures or disrupt our information technology systems or business.

Noncompliance with any privacy or security laws and regulations, or any security breach, cyber-attack or cybersecurity breach, and any incident involving the misappropriation, loss or other unauthorized disclosure or use of, or access to, sensitive or confidential member information, could require us to expend significant capital and other resources to continue to modify or enhance our protective measures and to remediate any damage caused by such breaches. In addition, this could result in interruptions to our operations and damage to our reputation, and misappropriation of confidential information could also result in regulatory enforcement actions, material fines and penalties, litigation or other liability or actions which could have a material adverse effect on our business, cash flows, financial condition and results of operations. As the regulatory environment related to information security, data collection and use, and privacy becomes increasingly rigorous, with new and constantly changing requirements applicable to our business, compliance with those requirements could also result in additional costs.

We rely on service providers and vendors to provide certain technology, systems and services that we use in connection with various functions of our business, including PCI DSS (Payment Card Industry Data Security Standard) compliant credit card processing, and we may entrust them with confidential information. The information systems of our third-party service providers and vendors are also vulnerable to an increasing threat of continually evolving cybersecurity risks. Unauthorized parties may attempt to gain access to these systems or our information through fraud or other means of deceiving our associates, third-party service providers or vendors. Hardware, software or applications we obtain from third parties may contain defects in design or manufacture or other problems that could unexpectedly compromise information security. The methods used to obtain unauthorized access, disable or degrade service or sabotage systems are also constantly changing and evolving and may be difficult to anticipate or detect for long periods of time. Ever-evolving threats mean our third-party service providers and vendors must continually evaluate and adapt their own respective systems and processes, and there is no assurance that they will be adequate to safeguard against all data security breaches or misuses of data. Any future significant compromise or breach of our data security via a third-party service provider or vendor could result in additional significant costs, lost revenues, fines, lawsuits, and damage to our reputation.

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General risks

Our operations could be materially and adversely affected by measures implemented by federal, state and local governments to cope with public health issues such as the outbreak of COVID-19, resulting in a material impact to our financial position and results of operations.

On March 11, 2020, the World Health Organization (“WHO”) declared the outbreak of COVID-19 a pandemic. COVID-19 is a respiratory illness caused by a virus that can spread from person to person. To contain the spread of COVID-19 during the first half of 2020, measures were undertaken in the United States of America and elsewhere around the world. These measures included, but were not limited to, domestic and international travel restrictions, temporary closure of nonessential businesses, cessation of public activity, and work-from-home orders, which had led to significantly reduced economic activity. To prevent the U.S. economy from further deterioration, several state and local governments have relaxed or lifted some of these measures even though infection rates remain above five percent, the level at which the WHO recommends rates fall below for at least 14 days before reopening. In Florida where we are located, a statewide stay-at-home order was issued and later lifted in May 2020. In response to the pandemic, we temporarily closed our offices in Florida and India and asked employees to work from home. Since then, some employees who have gone through our health safety training are allowed to alternate their work location between home and office. As a provider of homeowners insurance, we continually prepare for disasters and catastrophic events, including events that could disrupt business continuity. As a result, we were able to quickly adjust our technologies and infrastructure to support a remote workforce and maintain business continuity.

In response to the pandemic, Congress had passed three stimulus bills intended to provide fast and direct economic assistance for American workers and families, small businesses, and to preserve jobs in American industries. In addition, the authorization for use and dissemination of COVID-19 vaccines in the U.S. has brought optimism to the business community for the economic outlook for 2021, contributing to a rebound in the financial markets. However, it is still uncertain when the U.S. economy will return to pre-COVID-19 levels.

Our insurance subsidiaries have not experienced and, at present, do not foresee a direct material impact from the outbreak of COVID-19 in terms of increased claims and losses. However, the resulting economic uncertainty adversely affected the results of our investment portfolios during the first half of 2020. Most of these investment portfolios have recovered. We generally hold or invest premiums collected from policyholders in the financial markets in order to earn income before claims need to be paid.

In addition, our insurance subsidiaries may experience difficulties collecting premiums from some policyholders. Policyholders with financial difficulties may decide not to renew insurance policies with us. At present, there is no material impact from uncollectibility of premium. Reinsurance companies with which we have contracted may also face liquidity issues and may not timely settle reinsurance balances that become due. Reinsurance costs have increased as reinsurers pay COVID-19 related claims worldwide and face the possibility of increases in the cost of capital needed to fund their operations.

Furthermore, due to the impact of the COVID-19 outbreak on retail business activities, rent payments due from our lessees may be delayed or not received. Some lessees, with the exception of all anchor tenants, have sought rent concessions in order to stay in business. In the near term, we determined there is no impairment to our real estate investments or intangible assets as the real estate market is inherently slower moving than equity and debt security markets.

It is difficult to predict when the overall economy will no longer need the intervention and support of the government. As of the date of issuance of this report, the extent to which the COVID-19 pandemic may materially affect our financial condition, liquidity, or results of operations in the long-term future remains uncertain and unquantifiable.

Changing climate conditions could have an adverse impact on our business, results of operations or financial condition.

There is an emerging scientific consensus on climate change, which may affect the frequency and severity of storms, floods and other weather events, and negatively affect our business, results of operations, and/or financial condition.

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

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

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ITEM 1B –Unresolved Staff Comments

Not applicable.

ITEM 2 – Properties

Real Estate Owned and Used in Operations

Tampa, Florida. The real estate consists of a two-story building with gross area of approximately 67,300 square feet and will be used as the second corporate office building in Tampa, Florida.

Ocala, Florida. The real estate consists of 1.6 acres of land and an office building with gross area of approximately 16,000 square feet. The facility is 100% designated for our insurance operations and will be used as an alternative location in the event a catastrophic event impacts our operations in Tampa, Florida.

Investment Real Estate

Treasure Island, Florida. The real estate consists of approximately 10 acres of waterfront property and land improvements, a restaurant and a marina facility. The marina facility is currently owned and operated by us. The company-operating restaurant was closed in October 2020 and the facility has been leased to an unrelated party that operates several restaurants in the area.

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, 49% of the retail space is leased to non-affiliates, and the remaining space is available for lease.

Riverview, Florida. The real estate consists of 2.57 acres of land, 1.27 acres of which is leased to Thorntons, LLC, a gas station and convenience store chain. Our retail structure with 8,400 square feet of net rentable space is situated on the remaining land. 100% of the rentable space is leased to non-affiliates.

Sorrento, Florida. The real estate includes 5.42 acres of outparcel land intended for ground lease or resale and a retail shopping center with 61,400 square feet of net rentable area. Approximately 74% of the rentable space is currently leased to Publix supermarket. Approximately 96% of the rentable space is leased to non-affiliates and the remaining space is available for lease.

Melbourne, Florida. The real estate includes 2.26 acres of outparcel land intended for ground lease, resale or future development and a retail shopping center with 49,995 square feet of rentable area. Approximately 42% of the rentable space is currently leased to Fresh Market supermarket. 100% of the rentable space is leased to non-affiliates.

Tampa, Florida. We own investment properties in two different locations. One real estate consists of 6.69 acres of land and an office building with gross area of 68,867 square feet. The building is 100% leased to Bank of America. Another is approximately 9 acres of undeveloped land that we acquired in February 2019.

Clearwater, Florida. The real estate consists of 6.08 acres of land and a retail building with approximately 57,000 square feet of rentable space. It is currently under redevelopment.

Leased Property

Tampa, Florida. We lease 122,000 square feet of office space and a four-level parking garage to serve as our headquarters and several subsidiaries’ offices.

Noida, India. We lease 15,000 square feet of office space for our information technology operations. The lease commenced in 2013 and has an initial term of nine years.

Miami Lakes, Florida. We lease approximately 5,600 square feet of office space for our claims related administration. The lease has an initial term of approximately three years.

Expense under all facility leases was $1,259,000, $456,000 and $407,000 during the years ended December 31, 2020, 2019 and 2018, respectively. Expense for 2019 reflects lease expense under a new lease accounting standard adopted on January 1, 2019.

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ITEM 3–Legal Proceedings

We are a party to claims and legal actions arising routinely in the ordinary course of our business. Although we cannot predict with certainty the ultimate resolution of the claims asserted against us, we do not believe that any currently pending legal proceeding to which we are a party will have a material, adverse effect on our consolidated financial position, results of operations or cash flows.

ITEM 4 –Mine Safety Disclosures

Not applicable.

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PART II

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

Markets for Common Stock

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

Common Stock

Price

High Low

Calendar Quarter—2020

Calendar Quarter—2019

Holders

As of February 26, 2021, the market price for our common stock was $57.87 and there were 275 holders of record of our common stock.

Dividends

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

Declaration Payment Date of Per Share

Date Date Record Amount

Under Florida law, a domestic insurer may not pay any dividend or distribute cash or other property to its stockholders unless certain requirements, which are discussed in Note 25 -- “Regulatory Requirements and Restrictions” to our consolidated financial statements under Item 8 of this Annual Report on Form 10-K, are met. Hence Florida law may limit the availability of cash from our insurance subsidiaries for the payment of dividends to our shareholders.

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Securities Authorized for Issuance Under Equity Compensation Plans

The following table summarizes our equity compensation plans as of December 31, 2020. We currently have no equity compensation plans not approved by our stockholders.

Performance Graph

The following graph compares the 5-year cumulative total dollar return to shareholders on our common stock relative to the cumulative total returns of the Russell 2000 Index and the NASDAQ Insurance Index. An investment of $100 (with reinvestment of all dividends) is assumed to have been made in our common stock and in each index on December 31, 2015 and its relative performance is tracked through December 31, 2020. The returns shown are based on historical results and are not intended to suggest future performance.

Recent Sales of Unregistered Securities

None.

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Issuer Purchases of Equity Securities

The table below summarizes the number of shares of common stock repurchased during the three months ended December 31, 2020 under the repurchase plan approved by our Board of Directors in March 2020 and also the number of shares of common stock surrendered by employees to satisfy minimum federal income tax liabilities associated with the vesting of restricted shares in December 2020 (dollar amounts in thousands, except share and per share amounts):

See Note 20 -- “Stockholders’ Equity” to our consolidated financial statements under Item 8 of this Annual Report on Form 10-K.

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ITEM 6 –Selected Financial Data

The following selected consolidated financial data should be read in conjunction with Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes appearing in Item 8 “Financial Statements and Supplementary Data” of this Annual Report on Form 10-K. The consolidated statements of income data for the years ended December 31, 2020, 2019, and 2018 and the consolidated balance sheet data at December 31, 2020 and 2019 are derived from our audited consolidated financial statements appearing in Item 8 of this Annual Report on Form 10-K. The consolidated balance sheet data at December 31, 2018 are derived from our audited consolidated financial statements that are not included in this Annual Report on Form 10-K. The historical results are not necessarily indicative of the results to be expected in any future period.

Years Ended December 31,

(Dollar amounts in thousands, except per share amounts)

Revenue

Net realized investment gains (losses) 1,000 (254 ) 6,183

Net other-than-temporary impairment losses — (289 ) (80 )

Credit losses on investments (611 ) — —

Gain on involuntary conversion 36,969 — —

Expenses

Loss on repurchases of convertible senior notes 150 — —

Loss on extinguishment of debt 98 — —

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As of or for the Years Ended December 31,

(Dollar amounts in thousands, except per share amounts)

Per Share Data:

Diluted earnings per share $ 3.49 $ 3.31 $ 2.34

Ratios to Net Premium Earned:

Ratios to Gross Premiums Earned:

Consolidated Balance Sheet Data:

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

The following discussion should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K.

Forward-Looking Statements

In addition to historical information, this Annual Report on Form 10-K contains forward-looking statements as defined under federal securities laws. Such statements, 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; the impact of the novel coronavirus (“COVID-19”) pandemic; and other risks and uncertainties and other factors listed under Item 1A -- “Risk Factors” and elsewhere in this Annual Report on Form 10-K and in our other Securities and Exchange Commission filings.

OVERVIEW

General

HCI Group, Inc. is a Florida-based company which through its subsidiaries is engaged in a variety of business activities, including property and casualty insurance, reinsurance, real estate and information technology. Its principal business is property and casualty insurance.

We began insurance operations by participating in a “take-out program” which is a legislatively mandated program designed to encourage private companies to assume policies from Citizens, a Florida state-sponsored insurance carrier. Opportunities to acquire large numbers of policies from Citizens meeting our strict underwriting criteria have diminished in recent years. We may, however, selectively pursue additional assumption transactions with Citizens.

Our general operating and growth strategies are to continually optimize our existing book of insurance business, organically expand our insurance business, manage our costs and expenses, diversify our business operations, develop and deploy new technologies to streamline operational processes, and maintain a strong balance sheet so we can quickly pursue accretive opportunities when they arise.

Recent Developments

On January 15, 2021, our Board of Directors declared a quarterly dividend of $0.40 per common share. The dividends are to be paid March 19, 2021 to stockholders of record on February 19, 2021.

On January 18, 2021, we entered into an agreement with United Insurance Holdings Corporation (“United”) for United’s primary insurance subsidiary, United Property & Casualty Insurance Company, to cede to us a portion of its personal lines insurance business in the states of Connecticut, New Jersey, Massachusetts and Rhode Island. Under the reinsurance agreement, we will provide 69.5% quota share reinsurance on all of United’s in-force, new and renewal policies in those states from December 31, 2020 through May 31, 2021. In exchange, we paid United an allowance of $4,400,000 towards already purchased catastrophe reinsurance and a provisional ceding commission of 25% of premium. That percentage could increase up to 31.5% depending on the direct loss ratio results from the reinsured business. Annual premiums from the assumed business approximate $125,000,000. We also entered into a renewal rights agreement with United in connection with the assumed business. Under the renewal rights agreement, we have the right to renew and/or replace United’s insurance policies at the end of their respective policy periods in the four states. Our ability to replace policies begins June 1, 2021 or at a later date as mutually agreed upon by both parties. The agreement also contains a non-compete clause that does not permit United to engage in marketing, selling, writing, renewing, or servicing any insurance contract in these states until July 1, 2024. In return, United received 100,000 shares of our common stock and a 6% commission on the aggregate replacement premium in excess of $80,000,000. The total commission will not exceed $3,100,000.

On February 26, 2021, TypTap Insurance Group, Inc. (“TTIG”), our wholly-owned subsidiary, completed an investment transaction with a fund associated with Centerbridge Partners, L.P. Under the agreement, TTIG issued 9,000,000 voting shares of its Series A-1 Preferred Stock and 1,000,000 non-voting shares of its Series A-2 Preferred Stock (together “Series A Preferred Stock”), $0.001 par value, at a price of $10 per share for total proceeds of $100,000,000 (which is based on TTIG’s pre-transaction valuation of $850,000,000). Cumulative dividends are payable semi-annually in cash or paid-in-kind at TTIG’s option. Cash dividend rates are $0.50 per share in Year 1, $0.60 per share in Year 2, $0.75 per share in Year 3, and $0.95 in Year 4 and thereafter. The rates for paid-in-kind are $0.60 per share in Year 1 and $0.70 per share in Year 2. The holders of the Series A Preferred Stock have the right to convert the stock at

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any time into shares of common stock with an initial conversion rate of 1 to 1. The conversion rate will be adjusted under certain conditions. Unless converted earlier, all shares of Series A Preferred Stock will be automatically converted into shares of TTIG’s common stock at the then-applicable conversion rate upon 1) a public offering of TTIG’s common stock with gross proceeds of not less than $250,000,000 with a price per share at least equal to 150% of the original purchase price of the shares, or 2) at the election of holders of a majority of the Series A Preferred Stock, whichever comes first. The holders of Series A Preferred Stock also have redemption rights and liquidation preference.

In connection with the transaction, the lead investor was granted warrants to purchase 750,000 shares of HCI with an exercise price of $54.40 per share. The warrants will be immediately exercisable and will expire on the fourth anniversary of the date of issuance.

On March 2, 2021, Gulf to Bay LM, LLC (“GTB”), our wholly-owned real estate subsidiary, received from The Kroger Co. approximately $3,100,000 in settlement of the lawsuit filed by GTB in April 2020 to enforce a guaranty of a commercial lease executed between GTB and Lucky’s Market Operating Company, LLC, which is currently in bankruptcy proceedings. After the settlement, GTB has assigned the lease to a new lessee.

On March 8, 2021, we repaid the outstanding balance of $23,750,000 on our revolving credit facility. The borrowing capacity of the facility is now $65,000,000.

RESULTS OF OPERATIONS

Comparison of the Year Ended December 31, 2020 with the Year Ended December 31, 2019

Our results of operations for the year ended December 31, 2020 reflect net income of $27,580,000, or $3.49 diluted earnings per share, compared with a net income of $26,576,000, or $3.31 diluted earnings per share, for the year ended December 31, 2019. The year-over-year increase was primarily attributable to a gain on involuntary conversion of $36,969,000 and an net increase in net premiums earned of $46,146,000, offset by an increase in losses and loss adjustment expenses of $52,522,000, a net decrease in income from our investment portfolio (consisting of net investment income and net realized and unrealized gains or losses) of $15,095,000, an increase in policy acquisition and other underwriting expenses of $11,362,000 and a $2,717,000 increase in payroll costs and other personnel expenses.

Revenue

Gross Premiums Earned for the years ended December 31, 2020 and 2019 were approximately $415,918,000 and $342,079,000, respectively. The increase in 2020 was primarily attributable to the policies transitioned from Anchor Property and Casualty Insurance Company (“Anchor”) and increased policies in force from the growth in TypTap’s business, offset by a normal decrease due to policy attrition. Gross premiums earned related to the Anchor policies and the growth in TypTap’s business during 2020 were approximately $27,765,000 and $47,900,000, respectively.

Premiums Ceded for the years ended December 31, 2020 and 2019 were approximately $153,458,000 and $125,765,000, respectively, representing 36.9% and 36.8%, respectively, of gross premiums earned. Our premiums ceded represent costs of reinsurance to cover losses from catastrophes that exceed the retention levels defined by our catastrophe excess of loss reinsurance contracts or to assume a proportional share of losses defined in a quota share arrangement. The rates we pay for reinsurance are based primarily on policy exposures reflected in gross premiums earned. The $27,693,000 increase was primarily attributable to increased reinsurance costs effective June 1, 2020 and a higher level of reinsurance coverage, offset by a reduction in premiums ceded attributable to retrospective provisions under one reinsurance contract. See “Economic Impact of Reinsurance Contracts with Retrospective Provisions” under “Critical Accounting Policies and Estimates.”

Net Premiums Written for the years ended December 31, 2020 and 2019 totaled approximately $350,696,000 and $239,190,000, respectively. Net premiums written represent the premiums charged on policies issued during a fiscal period less any applicable reinsurance costs. The increase in 2020 resulted primarily from an increase in gross premiums written from the growth of TypTap business of approximately $44,600,000, the transition of policies from Anchor of approximately $30,600,000, and the assumed business from United of approximately $44,600,000. HCPCI’s and TypTap’s gross premiums written were approximately $399,299,000 and $104,855,000, respectively, for 2020 compared with approximately $304,683,000 and $60,272,000, respectively, for 2019. We had approximately 154,000 policies in force at December 31, 2020 versus approximately 131,000 policies in force at December 31, 2019.

Net Premiums Earned for the years ended December 31, 2020 and 2019 were approximately $262,460,000 and $216,314,000, respectively, and reflect the gross premiums earned less reinsurance costs as described above.

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The following is a reconciliation of our Net Premiums Written to Net Premiums Earned for the years ended December 31, 2020 and 2019 (amounts in thousands):

Years Ended December 31,

Net Investment Income for the years ended December 31, 2020 and 2019 was approximately $4,564,000 and $13,642,000, respectively. The year-over-year decrease was primarily attributable to a decrease in income from limited partnership investments of approximately $2,771,000 and lower interest income from fixed-maturity securities and cash balances by approximately $5,533,000. See Note 5 -- “Investments” under Net Investment Income to our consolidated financial statements under Item 8 of this Annual Report on Form 10-K.

Net Realized Investment Gains for the year ended December 31, 2020 were approximately $1,000,000 versus net realized investment losses of approximately $254,000 for the year ended December 31, 2019. The gains in 2020 resulted primarily from sales of fixed-maturity securities.

Net Unrealized Investment Gains for the years ended December 31, 2020 and 2019 were approximately $679,000 and $7,950,000, respectively. Net unrealized investment gains or losses represent the net change in the fair value of equity securities. In addition to an overall improvement in the equity market, we sold securities with unrealized gain position during the first quarter of 2020. In contrast, securities with unrealized loss position were sold during 2019.

Gain on Involuntary Conversion for the year ended December 31, 2020 was approximately $36,969,000. This one-time gain resulted from the transaction with the FDOT. See Note 9 -- “Property and Equipment, Net” to our consolidated financial statements under Item 8 of this Annual Report on Form 10-K.

Expenses

Our Losses and Loss Adjustment Expenses amounted to approximately $160,036,000 and $107,514,000 for the years ended December 31, 2020 and 2019, respectively. The $52,522,000 increase was primarily attributable to $14,850,000 of losses from the addition of the Anchor policies, net losses after reinsurance recoverable for Hurricane Sally of $20,264,000 and $10,000,000 of losses specific to Tropical Storm Eta, offset by lower prior year development. See “Reserves for Losses and Loss Adjustment Expenses” under “Critical Accounting Policies and Estimates.”

Policy Acquisition and Other Underwriting Expenses for the years ended December 31, 2020 and 2019 were approximately $53,859,000 and $42,497,000, respectively, and primarily reflect the amortization of deferred acquisition costs such as commissions payable to agents for production and renewal of policies, and premium taxes. The increase was primarily attributable to higher agent commission rates, property inspection costs associated with the organic growth of TypTap business, and $1,411,000 of amortized transition costs related to Anchor policies.

General and Administrative Personnel Expenses for the years ended December 31, 2020 and 2019 were approximately $33,829,000 and $31,112,000, respectively. Our general and administrative personnel expenses include salaries, wages, payroll taxes, stock-based compensation expense, and employee benefit costs. Factors such as merit increases, changes in headcount, and periodic restricted stock grants, among others, cause fluctuations in this expense. In addition, our personnel expenses are decreased by the capitalization of payroll costs related to a project to develop software for internal use and the payroll costs associated with the processing and settlement of Hurricane Irma claims which are recoverable from reinsurers under reinsurance contracts. The year-over-year increase of $2,717,000 was primarily attributable to an increase in the headcount of temporary and full-time employees, merit increases for non-executive employees, higher stock-based compensation expense, and lower capitalized and recoverable payroll costs, offset by a decrease in employee incentive bonus.

Interest Expense for the years ended December 31, 2020 and 2019 was approximately $11,734,000 and $13,055,000, respectively. The decrease primarily resulted from the repayment of our 3.875% convertible senior notes in March 2019.

Income Tax Expense for the year ended December 31, 2020 was approximately $9,348,000 for federal, state, and foreign income taxes compared with income tax expense of approximately $9,517,000 for the year ended December 31, 2019, resulting in an effective tax rate of 25.3% for 2020 and 26.4% for 2019.

Ratios:

The loss ratio applicable to the year ended December 31, 2020 (losses and loss adjustment expenses incurred related to net premiums earned) was 61.0% compared with 49.7% for the year ended December 31, 2019. The increase was primarily due to a change in the mix of business and losses related to Hurricane Sally and Tropical Storm Eta.

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The expense ratio applicable to the year ended December 31, 2020 (defined as total expenses excluding losses and loss adjustment expenses related to net premiums earned) was 43.2% compared with 45.7% for the year ended December 31, 2019. The decrease in our expense ratio was primarily attributable to the increase in net premiums earned, offset bythe increases in policy acquisition expenses and general and administrative personnel expenses as described earlier.

The combined ratio is the measure of overall underwriting profitability before other income. Our combined ratio for the year ended December 31, 2020 was 104.2% compared with 95.4% for the year ended December 31, 2019. The increase was primarily attributable to the increase in losses and loss adjustment expenses combined with the increases in reinsurance costs and policy acquisition and other underwriting expenses.

Due to the impact our reinsurance costs have on net premiums earned from period to period, our management believes the combined ratio measured to gross premiums earned is more relevant in assessing overall performance. The combined ratio to gross premiums earned for the year ended December 31, 2020 was 65.8% compared with 60.3% for the year ended December 31, 2019. The increase in 2020 was primarily attributable to the increase in losses and loss adjustment expenses.

Comparison of the Year Ended December 31, 2019 with the Year Ended December 31, 2018

Our results of operations for the year ended December 31, 2019 reflect net income of $26,576,000, or $3.31 diluted earnings per share, compared with a net income of $17,725,000, or $2.34 diluted earnings per share, for the year ended December 31, 2018. The year-over-year increase was primarily attributable to an increase in net premiums earned of $2,892,000, a net increase in income from our investment portfolio (consisting of net investment income and net realized and unrealized gains or losses) of $8,776,000, and a $5,041,000 decrease in interest expense, offset by a $5,204,000 increase in payroll costs and other personnel expenses and an increase in policy acquisition and other underwriting expenses of $3,554,000.

Revenue

Gross Premiums Earned for the years ended December 31, 2019 and 2018 were approximately $342,079,000 and $343,065,000, respectively. The decrease in 2019 was primarily attributable to a net decrease in policies in force. Although the number of policies in force and gross premiums written from TypTap business have increased steadily, these premiums have yet to be earned over the term of the policies.

Premiums Ceded for the years ended December 31, 2019 and 2018 were approximately $125,765,000 and $129,643,000, respectively, representing 36.8% and 37.8%, respectively, of gross premiums earned. Our premiums ceded represent costs of reinsurance to cover losses from catastrophes that exceed the retention levels defined by our catastrophe excess of loss reinsurance contracts or to assume a proportional share of losses defined in a quota share arrangement. The rates we pay for reinsurance are based primarily on policy exposures reflected in gross premiums earned. The $3,878,000 decrease was primarily attributable to a $6,778,000 reduction related to retrospective provisions under one reinsurance contract as opposed to a net reduction of approximately $485,000 in 2018 under the same contract. See “Economic Impact of Reinsurance Contracts with Retrospective Provisions” under “Critical Accounting Policies and Estimates.” Premiums ceded in the prior year also included the recognition of additional premiums ceded of approximately $1,222,000 resulting from the termination of one reinsurance contract during the second quarter of 2018 (See Note 26 -- “Related Party Transactions” to our audited consolidated financial statements under Item 8 of this Annual Report on Form 10-K for additional information).

Net Premiums Written for the years ended December 31, 2019 and 2018 totaled approximately $239,190,000 and $206,813,000, respectively. Net premiums written represent the premiums charged on policies issued during a fiscal period less any applicable reinsurance costs. The increase in 2019 resulted primarily from an increase in gross premiums written from the growth in TypTap business combined with the decrease in premiums ceded as described above. HCPCI’s and TypTap’s gross premiums written were approximately $304,683,000 and $60,272,000, respectively, for 2019 compared with approximately $321,939,000 and $14,517,000, respectively, for 2018. We had approximately 131,000 policies in force at December 31, 2019 versus approximately 127,000 policies in force at December 31, 2018.

Net Premiums Earned for the years ended December 31, 2019 and 2018 were approximately $216,314,000 and $213,422,000, respectively, and reflect the gross premiums earned less reinsurance costs as described above.

The following is a reconciliation of our Net Premiums Written to Net Premiums Earned for the years ended December 31, 2019 and 2018 (amounts in thousands):

Years Ended December 31,

(Increase) Decrease in Unearned Premiums (22,876 ) 6,609

Net Investment Income for the years ended December 31, 2019 and 2018 was approximately $13,642,000 and $16,581,000, respectively. The year-over-year decrease was primarily attributable to a decrease in income from limited partnership investments of

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approximately $3,254,000. See Note 5-- “Investments” under Net Investment Income to our consolidated financial statements under Item 8 of this Annual Report on Form 10-K.

Net Realized Investment Losses for the year ended December 31, 2019 were approximately $254,000 versus net unrealized investment gains of approximately $6,183,000 for the year ended December 31, 2018. The gains in 2018 resulted primarily from sales intended to rebalance our investment portfolio to mitigate the impact from the rising interest rate trend and to decrease our holdings in municipal bonds as they become less attractive in a low tax rate environment.

Net Unrealized Investment Gains for the year ended December 31, 2019 were approximately $7,950,000 versus net unrealized investment losses of approximately $10,202,000 for the year ended December 31, 2018. Net unrealized investment gains or losses represent the net change in the fair value of equity securities. The increase in 2019 reflected an improvement in the fair value of equity securities compared with values prevalent during the general downturn in the securities markets in December 2018.

Expenses

Our Losses and Loss Adjustment Expenses amounted to approximately $107,514,000 and $109,328,000 for the years ended December 31, 2019 and 2018, respectively. Losses and loss adjustment expenses in 2019 included net losses related to a severe storm event in March 2019 of approximately $7,400,000 as well as adverse development related to Hurricane Matthew in 2016 of approximately $1,923,000 and adverse development related to non-catastrophe claims of approximately $9,100,000 primarily related to assignment of benefits litigation. During 2018, losses and loss adjustment expenses included net losses of approximately $16,520,000 for Hurricane Michael as well as adverse development related to Hurricane Matthew of approximately $2,100,000 and adverse development related to non-catastrophe claims of approximately $9,900,000 primarily related to assignment of benefits litigation. See “Reserves for Losses and Loss Adjustment Expenses” under “Critical Accounting Policies and Estimates.”

Policy Acquisition and Other Underwriting Expenses for the years ended December 31, 2019 and 2018 were approximately $42,497,000 and $38,943,000, respectively. The increase from 2018 was primarily attributable to the organic growth of TypTap business resulting in increased agent commissions and property inspection costs.

General and Administrative Personnel Expenses for the years ended December 31, 2019 and 2018 were approximately $31,112,000 and $25,908,000, respectively. The year-over-year increase of $5,204,000 was primarily attributable to an increase in the headcount of temporary and full-time employees, merit increases for non-executive employees effective in late March 2019, higher stock-based compensation expense, and an increase in employee incentive bonus.

Interest Expense for the years ended December 31, 2019 and 2018 was approximately $13,055,000 and $18,096,000, respectively. The decrease resulted from the repayment of our 3.875% convertible senior notes in March 2019.

Income Tax Expense for the year ended December 31, 2019 was approximately $9,517,000 for federal, state, and foreign income taxes compared with income tax expense of approximately $9,177,000 for the year ended December 31, 2018, resulting in an effective tax rate of 26.4% for 2019 and 34.1% for 2018. The decrease was primarily attributable to 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 occurred in 2018 and related to restricted stock awards with market conditions that were not 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).

Ratios:

The loss ratio applicable to the year ended December 31, 2019 was 49.7% compared with 51.2% for the year ended December 31, 2018. The decrease was primarily due to the increase in net premiums earned combined with the decrease in losses and loss adjustment expenses.

The expense ratio applicable to the year ended December 31, 2019 was 45.7% compared with 44.6% for the year ended December 31, 2018. The increase in our expense ratio was primarily attributable to the increases in policy acquisition expenses and other general and administrative personnel expenses, offset by the increase in net premiums earned as described earlier.

The combined ratio to net premiums earned for the year ended December 31, 2019 was 95.4% compared with 95.8% for the year ended December 31, 2018. The decrease was primarily to the increase in net premiums earned as described earlier.

The combined ratio to gross premiums earned for the year ended December 31, 2019 was 60.3% compared with 59.6% for the year ended December 31, 2018. The increase in 2019 was primarily attributable to the net increase in total expenses.

Seasonality of Our Business

Our insurance business is seasonal. Hurricanes and tropical storms affecting Florida, our primary market, typically occur during the period from June 1st through November 30th of each year. Winter storms in the northeast usually occur during the period between December 1st and March 31st of each year. Also, with our reinsurance treaty year typically effective on June 1st of each year, any variation in the cost of our reinsurance, whether due to changes in reinsurance rates or changes in the total insured value of our policy base, will occur and be reflected in our financial results beginning on June 1st of each year.

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LIQUIDITY AND CAPITAL RESOURCES

Throughout our history, our liquidity requirements have been met through issuances of our common and preferred stock, debt offerings and funds from operations. We expect our future liquidity requirements will be met by funds from operations, primarily the cash received by insurance operations from premiums written and investment income. We may consider raising additional capital through debt and/or equity offerings to support our growth and future investment opportunities.

Our insurance operations require liquidity and adequate capital to meet ongoing obligations to policyholders and claimants and to fund operating expenses. In addition, we attempt to maintain adequate levels of liquidity and surplus to manage any differences between the duration of our liabilities and invested assets. In the insurance industry, cash collected for premiums from policies written is invested, interest and dividends are earned thereon, and losses and loss adjustment expenses are paid out over a period of years. This period of time varies by the circumstances surrounding each claim. Substantially all of our losses and loss adjustment expenses, excluding litigated claims, are fully settled and paid within approximately 100 days of the claim receipt date. Additional cash outflow occurs through payments of underwriting costs such as commissions, taxes, payroll, and general overhead expenses.

We believe that we maintain sufficient liquidity to pay claims and expenses, as well as to satisfy commitments in the event of unforeseen events such as reinsurer insolvencies, inadequate premium rates, or reserve deficiencies. We maintain a comprehensive reinsurance program at levels management considers adequate to diversify risk and safeguard our financial position.

In the future, we anticipate our primary use of funds will be to pay claims, reinsurance premiums, interest, and dividends and to fund operating expenses and real estate acquisitions.

Revolving Credit Facility, Senior Notes, Promissory Notes, and Finance Leases

The following table summarizes the principal and interest payment obligations for our indebtedness at December 31, 2020:

Maturity Date Payment Due Date

4.25% Convertible Senior Notes* March 2037 March 1 and September 1

3.75% Callable Promissory Note Through September 2036 1st day of each month

3.90% Promissory Note Through April 2032 1st day of each month

4.55% Promissory Note Through August 2036 1st day of each month

Finance leases Through August 2023 Various

See Note 13 -- “Long-Term Debt” to our consolidated financial statements under Item 8 of this Annual Report on Form 10-K.

Limited Partnership Investments

Our limited partnership investments consist of five private equity funds managed by their general partners. Three of these funds have unexpired capital commitments which are callable at the discretion of the fund’s general partner for funding new investments or expenses of the fund. Under certain circumstances, we may be required to provide additional capital for one of the two funds with expired capital commitments. At December 31, 2020, there was an aggregate unfunded capital balance of $10,304,000. See Limited Partnership Investments under Note 5 -- “Investments” to our consolidated financial statements under Item 8 of this Annual Report on Form 10-K.

Real Estate Investment

Real estate has long been a significant component of our overall investment portfolio. It helps offset the volatility of other high-risk assets. Thus, we may consider expanding our real estate investment portfolio should an opportunity arise.

We currently have a 90% equity interest in FMKT Mel JV, LLC, a Florida limited liability company for which we are not the primary beneficiary. FMKT Mel JV’s real estate portfolio consists of outparcels for ground lease or sale. We have the option to take full ownership of these outparcels by acquiring the remaining 10% interest. Alternatively, we may sell these outparcels and allocate the profits from the sale before liquidating FMKT Mel JV.

Sources and Uses of Cash

Our cash flows from operating, investing and financing activities for the years ended December 31, 2020, 2019 and 2018 are summarized below.

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Cash Flows for the Year Ended December 31, 2020

Net cash provided by operating activities for the year ended December 31, 2020 was approximately $77,311,000, which consisted primarily of cash received from net premiums written and reinsurance recoveries of approximately $56,860,000 less cash disbursed for operating expenses, losses and loss adjustment expenses and interest payments. Net cash provided by investing activities of $143,215,000 was primarily due to the proceeds from sales of fixed-maturity and equity securities of $128,745,000, the proceeds from calls, redemptions and maturities of fixed-maturity securities of $84,459,000, $44,000,000 of compensation received for the property relinquished through eminent domain proceeding, and the distributions of $2,086,000 received from limited partnership investments, offset by the purchases of fixed-maturity and equity securities of $103,174,000, the purchases of property and equipment of $6,437,000, additional investments in limited partnership interests of $4,241,000, and the purchases of real estate investments of $3,020,000. Net cash used in financing activities totaled $16,705,000, which was primarily due to the repayment of long-term debt of $17,048,000, $6,708,000 used in our share repurchases, $4,459,000 used to repurchase a portion of our 4.25% convertible senior notes, and $12,388,000 of net cash dividend payments, offset by $14,000,000 of net borrowings from our revolving credit facility and the proceeds from issuance of a 3.90% promissory note of $10,000,000.

Cash Flows for the Year Ended December 31, 2019

Net cash provided by operating activities for the year ended December 31, 2019 was approximately $54,047,000, which consisted primarily of cash received from net premiums written and reinsurance recoveries of approximately $105,676,000 less cash disbursed for operating expenses, losses and loss adjustment expenses and interest payments. Net cash provided by investing activities of $50,459,000 was primarily due to the proceeds from sales of fixed-maturity and equity securities of $45,616,000, the proceeds from calls, redemptions and maturities of fixed-maturity securities of $59,343,000, the proceeds from sales, redemptions and maturities of short-term and other investments of $67,398,000, and the distributions of $2,121,000 from limited partnership investments, offset by the purchases of fixed-maturity and equity securities of $107,299,000, the purchases of real estate investments of $11,481,000, the purchases of property and equipment of $2,887,000, the purchases of short-term and other investments of $1,178,000, and the investments in limited partnership interests of $1,174,000. Net cash used in financing activities totaled $114,724,000, which was primarily due to the repayment of long-term debt of $91,318,000, $20,054,000 used in our share repurchases, and $12,706,000 of net cash dividend payments, offset by $9,750,000 of borrowings from our revolving credit facility.

Cash Flows for the Year Ended December 31, 2018

Net cash provided by operating activities for the year ended December 31, 2018 was approximately $28,595,000, which consisted primarily of cash received from net premiums written and reinsurance recoveries of approximately $128,300,000 less cash disbursed for operating expenses, losses and loss adjustment expenses and interest payments. Net cash used in investing activities of $17,678,000 was primarily due to the purchases of fixed-maturity and equity securities of $165,424,000, the purchases of short-term and other investments of $201,538,000, the purchases of real estate investments of $7,472,000, and the investments in limited partnership interests of $7,182,000, offset by the proceeds from sales of fixed-maturity and equity securities of $148,248,000, the proceeds from calls, redemptions and maturities of fixed-maturity securities of $82,177,000, and the proceeds from sales, redemptions and maturities of short-term and other investments of $135,256,000. Net cash used in financing activities totaled $27,288,000, which was primarily due to $21,166,000 used in our share repurchases, $10,351,000 of net cash dividend payments and the repayment of long-term debt of $1,127,000, offset by the proceeds from the issuance of a 4.55% promissory note of $6,000,000.

Investments

The main objective of our investment policy is to maximize our after-tax investment income with a reasonable level of risk given the current financial market. Our excess cash is invested primarily in money market accounts, certificates of deposit, and fixed-maturity and equity securities.

At December 31, 2020, we had $122,852,000 of fixed-maturity and equity investments, which are carried at fair value. Changes in the general interest rate environment affect the returns available on new fixed-maturity investments. While a rising interest rate environment enhances the returns available on new investments, it reduces the market value of existing fixed-maturity investments and thus the availability of gains on disposition. A decline in interest rates reduces the returns available on new fixed-maturity investments but increases the market value of existing fixed-maturity investments, creating the opportunity for realized investment gains on disposition.

In the future, we may alter our investment policy with regard to investments in federal, state and municipal obligations, preferred and common equity securities and real estate mortgages, as permitted by applicable law, including insurance regulations.

OFF-BALANCE SHEET ARRANGEMENTS

As of December 31, 2020, we had unexpired capital commitments for limited partnerships in which we hold interests. Such commitments are not recognized in the consolidated financial statements but are required to be disclosed in the notes to the consolidated financial statements. See Note 23 -- “Commitments and Contingencies” to our consolidated financial statements under Item 8 of this Annual Report on Form 10-K.

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CRITICAL ACCOUNTING POLICIES AND ESTIMATES

We have prepared our consolidated financial statements in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). The preparation of these consolidated financial statements requires us to make estimates and judgments to develop amounts reflected and disclosed in our consolidated financial statements. Material estimates that are particularly susceptible to significant change in the near term are related to our losses and loss adjustment expenses, which include amounts estimated for claims incurred but not yet reported. We base our estimates on various assumptions and actuarial data we believe to be reasonable under the circumstances. Actual results may differ materially from these estimates.

We believe our accounting policies specific to losses and loss adjustment expenses, reinsurance recoverable, reinsurance with retrospective provisions, deferred income taxes, and stock-based compensation expense involve our most significant judgments and estimates material to our consolidated financial statements.

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 and LAE reserves represent 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 and LAE reserves is complex and inherently imprecise, as it involves the estimation of the outcome of future uncertain events. The impact of both internal and external variables on ultimate losses and LAE costs is difficult to estimate. In determining loss and LAE reserves, we give careful consideration to all available data and actuarial analyses.

Currently, our estimated ultimate liability is calculated using the principles and procedures described in Note 15 -- “Losses and Loss Adjustment Expenses” to our consolidated financial statements under Item 8 of this Annual Report on Form 10-K, which are applied to the lines of business written. However, because the establishment of loss and LAE reserves is an inherently uncertain process, we cannot be certain that ultimate losses will not exceed the established loss and LAE reserves and have a material, adverse effect on our results of operations and financial condition. Changes in estimates, or differences between estimates and amounts ultimately paid, are reflected in the operating results of the period during which such adjustments are made.

Our reported results, financial position and liquidity would be affected by likely changes in key assumptions that determine our net loss reserves. Management does not believe that any reasonably likely changes in the frequency of claims would affect our loss and LAE reserves. However, management believes that a reasonably likely increase or decrease in the severity of claims could impact our net loss and LAE reserves. The table below summarizes the effect on net loss and LAE reserves and equity in the event of reasonably likely changes in the severity of claims considered in establishing loss and LAE reserves. The range of reasonably likely changes in the severity of our claims was established based on a review of changes in loss year development and applied to loss and LAE reserves as a whole. The selected range of changes does not indicate what could be the potential best or worst case or likely scenarios:

Change in Reserves Reserves Percentage Change in Equity, Net of Tax

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 Contract with Retrospective Provisions. One of our reinsurance contracts includes retrospective provisions that adjust premiums 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 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.

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For the year ended December 31, 2020, we accrued benefits of $15,120,000. For the year ended December 31, 2019, we accrued benefits of $6,344,000 and recognized a reduction in ceded premiums of $434,000.For the year ended December 31, 2018, we recognized a net increase in accrued benefits of $743,000 and a net increase in ceded premiums of $258,000.In combination, for the years ended December 31, 2020 and 2019, we recognized decreases in ceded premiums of $15,120,000 and $6,778,000, respectively.For the year ended December 31, 2018, we recognized a net reduction in ceded premiums of $485,000.

As of December 31, 2020, we had $10,920,000 of accrued benefits, the amount that would be charged to earnings in the event we experience a catastrophic loss that exceeds the coverage limit provided under such agreement. In June 2020, we received a $13,680,000 premium refund under the retrospective reinsurance contract that ended May 31, 2020. Accrued benefits related to this expired contract were $9,480,000 at December 31, 2019. We believe the credit risk associated with the collectability of these accrued benefits is minimal based on available information about the reinsurer’s financial position and the reinsurer’s demonstrated ability to comply with contract terms.

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

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

Limited Partnership Investments. The valuation of our limited partnership investments is prepared by the general partner of each fund. We use net asset value (“NAV”) provided by the general partner to estimate our share of the fair value of these investments. However, the timing of the delivery of the fund’s financial statements and NAV information is on a three-month lag which results in a three-month delay in the recognition of our share of the limited partnership’s earnings or losses. But because this is the best information available, we use it as an estimate for the fair value at our reporting dates, unless conditions have changed significantly in the economy or securities markets since the previous quarter due to an event such as the onset of the COVID-19 virus. In such case, we will adjust our estimate with the assistance from the general partner.

ITEM 7A Quantitative and Qualitative Disclosures About Market Risk

Our investment portfolios at December 31, 2020 included fixed-maturity and equity securities, the purposes of which are not for speculation. Our main objective is to maximize after-tax investment income and maintain sufficient liquidity to meet our obligations while minimizing market risk, which is the potential economic loss from adverse fluctuations in securities prices. We consider many factors including credit ratings, investment concentrations, regulatory requirements, anticipated fluctuation of interest rates, durations and market conditions in developing investment strategies. Our investment securities are managed primarily by outside investment advisors and are overseen by the investment committee appointed by our board of directors. From time to time, our investment committee may decide to invest in low risk assets such as U.S. government bonds.

Our investment portfolios are exposed to interest rate risk, credit risk and equity price risk. Fiscal and economic uncertainties caused by any government action or inaction may exacerbate these risks and potentially have adverse impacts on the value of our investment portfolios.

We classify our fixed-maturity securities as available-for-sale and report any unrealized gains or losses, net of deferred income taxes, as a component of other comprehensive income within our stockholders’ equity. As such, any material temporary changes in their fair value can adversely impact the carrying value of our stockholders’ equity. In addition, we recognize any unrealized gains and losses related to our equity securities in our statement of income. As a result, our results of operations can be materially affected by the volatility in the equity market.

Interest Rate Risk

Our fixed-maturity securities are sensitive to potential losses resulting from unfavorable changes in interest rates. We manage the risk by analyzing anticipated movement in interest rates and considering our future capital needs.

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The following table illustrates the impact of hypothetical changes in interest rates to the fair value of our fixed-maturity securities at December 31, 2020 (amounts in thousands):

Credit Risk

Credit risk can expose us to potential losses arising principally from adverse changes in the financial condition of the issuers of our fixed-maturity securities. We mitigate the risk by investing in fixed-maturity securities that are generally investment grade, by diversifying our investment portfolio to avoid concentrations in any single issuer or business sector, and by continually monitoring each individual security for declines in credit quality. While we emphasize credit quality in our investment selection process, significant downturns in the markets or general economy may impact the credit quality of our portfolio.

The following table presents the composition of our fixed-maturity securities, by rating, at December 31, 2020 (amounts in thousands):

Equity Price Risk

Our equity investment portfolio at December 31, 2020 included common stocks, perpetual preferred stocks, mutual funds and exchange traded funds. We may incur potential losses due to adverse changes in equity security prices. We manage the risk primarily through industry and issuer diversification and asset mix.

The following table illustrates the composition of our equity securities at December 31, 2020 (amounts in thousands):

Estimated Fair Value % of Total Estimated Fair Value

Stocks by sector:

Mutual funds and Exchange traded funds by type:

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

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Foreign Currency Exchange Risk

At December 31, 2020, we did not have any material exposure to foreign currency related risk.

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ITEM 8 –Financial Statements and Supplementary Data

Index to Financial Statements

Page

36

Report of Independent Registered Public Accounting Firm

Stockholders and the Board of Directors

HCI Group, Inc. and Subsidiaries

Opinion on the Consolidated Financial Statements

We have audited the accompanying consolidated balance sheets of HCI Group, Inc. and Subsidiaries (the “Company”) as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2020, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the Company’s internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated March 12, 2021 expressed an unqualified opinion thereon.

Basis for Opinion

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud.

Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

Critical Audit Matters

The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.

Reserves for Losses and Loss Adjustment Expenses

As described in Note 2 - Summary of Significant Accounting Policies and Note 15 - Losses and Loss Adjustment Expenses to the consolidated financial statements, the Company’s reserves for losses and loss adjustment expenses (“LAE”) reported in the consolidated balance sheet were $212.2 million at December 31, 2020. Reserves for losses and LAE reflect management’s best estimate regarding the Company’s ultimate losses, resulting in a liability for claims that have been incurred, but not yet paid, and claims that have been incurred but not yet reported. The reserves are based on the application of actuarial techniques and other projection methodologies, taking into consideration other facts and circumstances known at the balance sheet date. The methods used by management in determining the reserves for losses and LAE are complex and subjective with various key inputs and assumptions. Judgement is required to determine the inputs and assumptions used and these can significantly impact the reserves recognized. The most significant judgments include the choice of the appropriate standard actuarial reserving methods, the selection of loss development factors that place reliance on actual historical loss experience, current claim trends, and the prevailing social, economic and legal environments, and reserves derived specific to catastrophe events.

The principal considerations for our determination of the reserves for losses and LAE as a critical audit matter are the complexity and subjectivity of the estimates and assumptions that management utilized in determining their ultimate loss estimates, and the involvement of an actuarial specialist to assist in performing audit procedures. This required a high degree of effort and judgment in selecting the

37

auditor procedures to evaluate management’s estimates and assumptions as it relates to the reserves for losses and LAE, including the use of a specialist.

The primary procedures we performed to address this critical audit matter included:

Valuation of Limited Partnership Investments

As described in Note 2 - Summary of Significant Accounting Policies and Note 5 – Investments to the consolidated financial statements, the Company’s limited partnership investments reported in the consolidated balance sheet were $27.7 million at December 31, 2020. For the investments with ownership interest at five percent or less, the Company uses the net asset value method to estimate the fair value of these investments. Due to a reporting lag, the Company may record an adjustment to the Company’s most recent share of net asset value when the amount can be reasonably estimated and a significant adverse impact on the net asset value is expected as a result of a major economic event. The methods used by management in determining if an adjustment to the Company’s most recent share of net asset value is necessary are complex and subjective based on the judgement that is required to determine the key inputs and assumptions which can significantly impact the adjustments recognized.

The principal considerations for our determination of the valuation of limited partnership investments as a critical audit matter are the subjectivity of the inputs and assumptions that management utilized in determining the adjustment to the Company’s most recent share of net asset value, and the involvement of a valuation specialist to assist in performing audit procedures. This required a high degree of effort and judgment in selecting the auditor procedures to evaluate management’s estimates and assumptions as it relates to the valuation of limited partnership investments, including the use of a specialist.

The primary procedures we performed to address this critical audit matter included:

/s/ Dixon Hughes Goodman LLP

We have served as the Company’s auditor since 2013.

Tampa, Florida

March 12, 2021

38

Report of Independent Registered Public Accounting Firm on Internal Control

Stockholders and the Board of Directors

HCI Group, Inc. and Subsidiaries

Opinion on Internal Control Over Financial Reporting

We have audited HCI Group, Inc. and Subsidiaries (the “Company”)’s internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated financial statements of the Company for each of the three years in the period ended December 31, 2020, and our report dated March 12, 2021, expressed an unqualified opinion on those consolidated financial statements.

Basis for Opinion

The Company’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

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

Definition and Limitations of Internal Control Over Financial Reporting

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

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

/s/ Dixon Hughes Goodman LLP

Tampa, Florida

March 12, 2021

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HCI GROUP, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(Dollar amounts in thousands)

December 31,

Assets

Short-term investments, at fair value — 491

Limited partnership investments, at equity 27,691 28,346

Investment in unconsolidated joint venture, at equity 705 762

Accrued interest and dividends receivable 588 1,616

Reinsurance recoverable, net of allowance for credit losses:

Right-of-use assets - operating leases 4,002 484

(continued)

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HCI GROUP, INC. AND SUBSIDIARIES

Consolidated Balance Sheets – (Continued)

(Dollar amounts in thousands)

December 31,

Liabilities and Stockholders’ Equity

Assumed reinsurance balances payable 87 76

Lease liabilities - operating leases 4,014 513

Commitments and contingencies (Note 23)

Stockholders’ equity:

Additional paid-in capital — —

Accumulated other comprehensive income, net of taxes 1,544 2,178

Total liabilities and stockholders’ equity $ 941,313 $ 802,609

See accompanying Notes to Consolidated Financial Statements.

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HCI GROUP, INC. AND SUBSIDIARIES

Consolidated Statements of Income

(Dollar amounts in thousands, except per share amounts)

Years Ended December 31,

Revenue

Net realized investment gains (losses) 1,000 (254 ) 6,183

Net other-than-temporary impairment losses — (289 ) (80 )

Credit losses on investments (611 ) — —

Gain on involuntary conversion 36,969 — —

Expenses

Loss on repurchases of convertible senior notes 150 — —

Loss on extinguishment of debt 98 — —

Diluted earnings per share $ 3.49 $ 3.31 $ 2.34

See accompanying Notes to Consolidated Financial Statements.

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HCI GROUP, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income

(Amounts in thousands)

Years Ended December 31,

Other comprehensive (loss) income:

Change in unrealized gain (loss) on investments:

Net unrealized gains (losses) arising during the period 86 4,902 (3,137 )

Other-than-temporary impairment losses charged to income — 289 80

Credit losses charged to income 611 — —

Call and repayment gains charged to investment income (374 ) (141 ) (18 )

Reclassification adjustment for net realized gains (1,163 ) (218 ) (723 )

Net change in unrealized (losses) gains (840 ) 4,832 (3,798 )

Deferred income taxes on above change 206 (1,201 ) 963

See accompanying Notes to Consolidated Financial Statements.

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HCI GROUP, INC. AND SUBSIDIARIES

Consolidated Statements of Stockholders’ Equity

For the Year Ended December 31, 2020

(Dollar amounts in thousands, except per share amounts)

Shares Amount Capital Income Net of Tax Equity

Total other comprehensive loss, net of income taxes — — — — (634 ) (634 )

Cumulative effect on adoption of credit loss standard — — — (453 ) — (453 )

Exercise of common stock options 10,000 — 63 — — 63

Issuance of restricted stock 192,680 — — — — —

Forfeiture of restricted stock (18,852 ) — — — — —

Repurchase and retirement of common stock (33,633 ) — (1,547 ) — — (1,547 )

Common stock dividends ($1.60 per share) — — — (12,388 ) — (12,388 )

Stock-based compensation — — 8,133 — — 8,133

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HCI GROUP, INC. AND SUBSIDIARIES

Consolidated Statements of Stockholders’ Equity – (Continued)

For the Year Ended December 31, 2019

(Dollar amounts in thousands, except per share amounts)

Shares Amount Capital Income Net of Tax Equity

Total other comprehensive income, net of income taxes — — — — 3,631 3,631

Exercise of common stock options 10,000 — 63 — — 63

Issuance of restricted stock 180,404 — — — — —

Forfeiture of restricted stock (299,776 ) — — — — —

Repurchase and retirement of common stock (28,784 ) — (1,203 ) — — (1,203 )

Common stock dividends ($1.60 per share) — — — (12,706 ) — (12,706 )

Stock-based compensation — — 6,460 — — 6,460

Tax basis adjustment on equity method investment — — 132 — — 132

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HCI GROUP, INC. AND SUBSIDIARIES

Consolidated Statements of Stockholders’ Equity – (Continued)

For the Year Ended December 31, 2018

(Dollar amounts in thousands, except per share amounts)

Shares Amount Capital Income Net of Tax Equity

Total other comprehensive loss, net of income taxes — — — — (2,835 ) (2,835 )

Cumulative effect adjustments for adoption of new accounting standards:

Issuance of restricted stock 189,860 — — — — —

Forfeiture of restricted stock (56,637 ) — — — — —

Repurchase and retirement of common stock (27,281 ) — (1,151 ) — — (1,151 )

Purchase of noncontrolling interest — — (539 ) — — (539 )

Stock-based compensation — — 4,632 — — 4,632

See accompanying Notes to Consolidated Financial Statements.

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HCI GROUP, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(Amounts in thousands)

Years Ended December 31,

Cash flows from operating activities:

Net realized investment (gains) losses (1,000 ) 254 (6,183 )

Net unrealized investment (gains) losses (679 ) (7,950 ) 10,202

Other-than-temporary impairment losses — 289 80

Credit loss expense - investments 611 — —

Credit loss expense - reinsurance recoverable (368 ) — —

Loss (income) from unconsolidated joint venture 57 83 (304 )

Distribution received from unconsolidated joint venture — — 68

Loss on repurchases of convertible senior notes 150 — —

Loss on extinguishment of debt 98 — —

Gain on involuntary conversion (36,969 ) — —

Net loss (income) from limited partnership interests 1,595 (1,176 ) (4,430 )

Distributions received from limited partnership interests 1,215 4,176 2,345

Foreign currency remeasurement loss 32 57 135

Changes in operating assets and liabilities:

Accrued interest and dividends receivable 1,028 176 191

Assumed reinsurance balances payable 11 62 (1 )

Reinsurance recovered in advance on unpaid losses — — (13,885 )

(continued)

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HCI GROUP, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows – (Continued)

(Amounts in thousands)

Years Ended December 31,

Cash flows from investing activities:

Investments in limited partnership interests (4,241 ) (1,174 ) (7,182 )

Distributions received from limited partnership interests 2,086 2,121 158

Distribution from unconsolidated joint venture — — 695

Purchase of property and equipment (6,437 ) (2,887 ) (2,187 )

Purchase of intangible assets — — (409 )

Purchase of short-term and other investments (200 ) (1,178 ) (201,538 )

Cash flows from financing activities:

Net borrowing under revolving credit facility 14,000 9,750 —

Cash dividends received under share repurchase forward contract 306 306 967

Proceeds from exercise of common stock options 63 63 —

Proceeds from the issuance of long-term debt 10,000 — 6,000

Repurchases of convertible senior notes (4,459 ) — —

Purchase of non-controlling interest — — (539 )

Effect of exchange rate changes on cash 2 (22 ) (164 )

(continued)

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HCI GROUP, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows – (Continued)

(Amounts in thousands)

Years Ended December 31,

Supplemental disclosure of cash flow information:

Non-cash investing and financing activities:

Receivable from sales of equity securities $ 5,240 $ — $ —

Payable on purchases of equity securities $ 7 $ — $ —

Addition to property and equipment under finance lease $ — $ 18 $ 61

See accompanying Notes to Consolidated Financial Statements.

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HCI GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

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

Note 1 -- Nature of Operations

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”) 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 and has regulatory approval to underwrite residential property and casualty insurance in various other states. HCPCI has issued insurance policies in other states, however, Florida is still its primary market. TypTap offers standalone flood and homeowners multi-peril policies to Florida homeowners. In October 2020, TypTap began applying for approval to offer homeowners coverage in 23 states outside of Florida. Since then, TypTap has received approvals from ten states. The operations of both insurance subsidiaries are supported by HCI Group, Inc. and certain HCI subsidiaries. In particular, the Company is currently using internally developed technologies to collect and analyze claims and other supplemental data to generate savings and efficiency for the operations of the insurance subsidiaries. In addition, Greenleaf Capital, LLC, the Company’s real estate subsidiary, is primarily engaged in the businesses of owning and leasing real estate and operating marina facilities.

On February 5, 2020, HCPCI entered into a policy replacement agreement with Anchor Property & Casualty Insurance Company (“Anchor”). Under the agreement, Anchor cancelled all its policies as of April 1, 2020 and HCPCI offered short-term replacement policies to those policyholders, who were under no obligation to accept them. The replacement policies had substantially the same terms and rates as the cancelled policies and would expire on the same dates the cancelled policies would have expired had they not been cancelled. Upon expiration of the replacement policies, HCPCI will offer, but is not obligated to offer, renewals to those policyholders at its own rates and terms. Total replacement policies issued by the Company on April 1, 2020 approximated 40,000.

In December 2020, the Company reached an agreement in principle with United Insurance Holdings Corporation (“United”) for United’s primary insurance subsidiary, United Property & Casualty Insurance Company, to cede a portion of its personal lines insurance business in the states of Connecticut, New Jersey, Massachusetts and Rhode Island and subsequently sell its policy renewal rights to HCPCI. The agreement was later finalized on January 18, 2021. Under the reinsurance agreement, HCPCI will provide 69.5% quota share reinsurance on all of United’s in-force, new and renewal policies in those states from December 31, 2020 through May 31, 2021. In exchange, HCPCI paid United an allowance of $4,400 towards already purchased catastrophe reinsurance and a provisional ceding commission of 25% of premium. That percentage could increase up to 31.5% depending on the direct loss ratio results from the reinsured business. Annual premiums from the assumed business approximate $125,000. After the reinsurance agreement expires, the Company has the ability to renew and/or replace United’s insurance policies under a renewal rights agreement. See Note 28 -- “Subsequent Events” for information concerning the acquisition of the renewal rights from United.

Note 2 -- Summary of Significant Accounting Policies

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

Adoption of New Accounting Standards.

In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2016-13 (“ASU 2016-13”), Financial Instruments – Credit Losses (Topic 326), effective January 1, 2020. This update amends guidance on the recognition and measurement of credit losses for assets held at amortized cost and available-for-sale debt securities. For assets held at amortized cost, ASU 2016-13 eliminates the probable initial recognition threshold and, instead, requires credit losses to be measured using the Current Expected Credit Loss (“CECL”) model. The CECL model requires the measurement of all expected credit losses based on historical experience, current conditions, and reasonable and supportable forecasts which incorporate forward-looking information. The incurred loss model previously used to estimate credit losses is replaced with the CECL model for premiums receivable and reinsurance recoverable. For available-for-sale debt securities, credit losses will continue to be measured in a manner similar to the current standard. See also “Allowance for Credit Losses” within this note.

Effective January 1, 2020, the Company used a modified retrospective method for transition to the CECL model. The Company recognized a cumulative-effect adjustment of $453 related to reinsurance recoverable to beginning retained income with a corresponding entry to an allowance for credit losses account. Any subsequent changes to the expected credit losses will be recognized in the Company’s consolidated statement of income.

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HCI GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

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

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

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

Cash and Cash Equivalents. The Company considers all short-term highly liquid investments with original maturities of less than three months to be cash and cash equivalents. At December 31, 2020 and 2019, cash and cash equivalents consisted of cash on deposit with financial institutions and securities brokerage firms, and certificates of deposit.

Available-for-Sale Fixed-Maturity Securities. Fixed-maturity securities that are available for sale include debt securities and redeemable preferred stock. The Company’s available-for-sale securities are carried at fair value. Changes in the fair value of available-for-sale securities representing unrealized gains or losses, other than impairments, 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 impairment on a monthly basis. Effective January 1, 2020, net unrealized loss in the fair value of an available-for-sale fixed-maturity security is evaluated for impairment. When reviewing impaired securities, the Company considers its ability and intent to hold these securities and whether it is probable that the Company will be required to sell these securities prior to their anticipated recovery or maturity. For the fixed-maturity securities that the Company intends to sell or it is probable that the Company will have to sell before recovery or maturity, the unrealized losses are recognized currently as impairment losses in income.

Impaired securities where the Company has the ability and intent to hold until recovery and believes it is not probable that the Company will be required to sell these securities prior to their anticipated recovery or maturity, are evaluated for the existence of credit-related losses. 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, the failure of the issuer to make a scheduled payment, 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. If such credit-related losses exist, an allowance for credit losses is established with a charge in the statement of income. Subsequent changes in the allowance, whether favorable or unfavorable, are recorded on the statement of income. See additional information in the Allowance for Credit Losses section within this note. Any remaining impairment loss related to other non-credit factors such as changes in interest rates or market conditions is reflected as a component of accumulated other comprehensive income (loss).

Prior to January 1, 2020, when the fair value of any investment was lower than its cost, an assessment was made to determine whether the decline was temporary or other-than-temporary. If the decline was determined to be other-than-temporary, the investment was written down to fair value and an impairment loss was recognized in income in the period in which the Company made such determination. When reviewing impaired securities, the Company considered its ability and intent to hold these securities and whether it was probable that the Company would be required to sell these securities prior to their anticipated recovery or maturity. For the fixed-maturity securities that the Company intended to sell or it was probable that the Company would have to sell before recovery or maturity, the unrealized losses were recognized as other-than-temporary losses in income. In instances where there were credit-related losses associated with the impaired fixed-maturity securities for which the Company asserted that it did not have the intent to sell, and it was probable that the Company would not be required to sell until a market price recovery or maturity, the amount of the other-than-temporary impairment loss related to credit losses was recognized in income, and the amount of the other-than-temporary

51

HCI GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

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

impairment loss related to other non-credit factors such as changes in interest rates or market conditions was recorded as a component of accumulated other comprehensive income (loss).

Allowance for Credit Losses. Allowance for credit losses represents an estimation of potential losses that the Company may experience due to credit risk. The allowance for credit losses account is a contra account of a financial asset to reflect the net amount expected to be collected. Any increase or decrease in the allowance for credit losses related to investments is recognized and reflected as credit losses on investments in the Company’s consolidated statements of income. For all other financial assets, credit loss expense is included in other operating expenses. When the risk of credit loss becomes certain, the allowance for credit losses account will be written off against the financial asset. Under the CECL model, the Company measures all expected credit losses related to relevant financial assets based on historical experience, current conditions, and reasonable and supportable forecasts which incorporate forward-looking information. The Company primarily uses a discounted cash flow method and a rating-based method in estimating credit losses at a reporting date for financial assets under the scope of the CECL model. The discounted cash flow method is a valuation method used to estimate the value of a financial asset based on its future cash flows. The Company uses this method to determine the expected credit losses for available-for-sale fixed-maturity securities. In addition, the Company elected not to measure an allowance for credit losses for accrued interest receivable as any uncollectible amount is adjusted to interest income on a monthly basis.

For certain financial assets related to insurance business such as reinsurance recoverable and reinsurance receivable for premium refund, the Company uses a rating-based method, which is a modified version of the probability of default method. It requires two key inputs: a) the liquidation rate and b) the amount of loss exposure. The liquidation rate, which is published annually, is the ratio of impaired insurance companies that were eventually liquidated to the group of insurance companies considered by A.M. Best in its study. The amount of loss exposure represents the future billing balance, net of any collateral, spread over the projected periods that are based on the Company’s historical claim payment pattern. The rating-based method measures credit losses by multiplying the future billings grouped by insurance rating over the projected periods by their corresponding liquidation rates by insurance rating. At present, the exposure to credit losses for certain financial assets related to non-insurance business is considered immaterial to the Company’s financial position.

Equity Securities. Equity securities represent ownership interests held by the Company in entities for investment purposes. Unrealized holding gains and losses related to equity securities are reported in the consolidated statement of income as net unrealized investment gains and losses. Realized investment gains and losses from sales are recorded on the trade date and are determined using the FIFO method (see Equity Securities in Note 5 -- “Investments”).

Short-Term Investments. Short-term investments include certificates of deposit issued by financial institutions with original maturities of more than three months but less than one year at date of acquisition. These short-term investments are carried at cost or amortized cost, which approximates fair value.

Limited Partnership Investments. The Company has interests in limited partnerships that are not registered under the United States 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 uses the equity method to account for the investments with ownership interest greater than five percent. For the investments with ownership interest at five percent or less, the Company uses the net asset value method to estimate the fair value of these investments. The Company generally recognizes its share of the limited partnership’s earnings or losses on a three-month lag. Due to the lag, the Company may record an adjustment to the Company’s most recent share of net asset value when the amount can be reasonably estimated and a significant adverse impact on the net asset value is expected as a result of a major economic event.

Net investment income or loss from limited partnerships represents a net aggregate amount of operating results allocated to the Company based on the percentage of ownership interest in each limited partnership.

Pursuant to U.S. GAAP, these limited partnerships which are private equity funds must measure their investments at fair value and reflect the unrealized gains and losses in the fair value of their investments on their statement of income. As a result, the carrying value of limited partnership investments at each reporting date approximates their estimated fair value.

52

HCI GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

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

Investment in Unconsolidated Joint Venture. The Company has a 90% equity interest in a limited liability company (treated as a joint venture under U.S. GAAP) that owns land for lease or for sale. The joint venture was determined to be a variable interest entity as it lacks sufficient equity to finance its activities without additional subordinated financial support. Despite having a majority equity interest, the Company does not have the power to direct the activities that most significantly impact the economic performance of the joint venture and, accordingly, is not required to consolidate the joint venture as its primary beneficiary. As a result, the Company uses the equity method to account for this investment.