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
39
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.
42
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.
43
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.
46
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)
47
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.
When evidence indicates an impairment may occur, the Company evaluates whether a decline in value is other than temporary. Evidence may include continuing operating losses of the joint venture, a declining occupancy rate, a decrease in real estate value, and an oversupply of rental property in close vicinity to the investment property. Should available evidence indicate the recovery of the initial investment is less likely, the Company would compare the carrying value of the investment with its expected residual value and recognize an impairment loss in earnings.
Assets Held for Sale. Assets held for sale are valued at the lower of the carrying value or fair value less costs to sell. Assets are classified as held for sale when the following criteria are met: (i) management has the authority and commits to a plan to sell the asset; (ii) the asset is available for immediate sale in its present condition; (iii) there is an active program to locate a buyer and the plan to sell the asset has been initiated; (iv) the sale of the asset is probable within one year; (v) the property is being actively marketed at a reasonable sale price relative to its current fair value; and (vi) it is unlikely that the plan to sell will be withdrawn or that significant changes to the plan will be made.
In determining the fair value of the assets less costs to sell, the Company primarily relies on the value determined by an independent appraiser. If the estimated fair value less costs to sell is less than the carrying value of the asset, the asset is written down to its estimated fair value less costs to sell and an impairment loss is recognized in the consolidated statement of income. Depreciation is not recorded while assets are classified as held for sale.
Real Estate Investments. Real estate investments include real estate and the related assets purchased for investment purposes (see Note 5 -- “Investments”). Real estate and the related depreciable assets are carried at cost, net of accumulated depreciation, which is included in net investment income and allocated over the estimated useful life of the asset using the straight-line method of depreciation. Land is not depreciated. Real estate is evaluated for impairment when events or circumstances indicate the carrying value of the real estate may not be recoverable.
Deferred Policy Acquisition Costs. Deferred policy acquisition costs (“DAC”) represent direct costs to acquire insurance contracts and consist of premium taxes and commissions paid to outside agents at the time of collection of the policy premium. DAC also includes a cash bonus and other related expenses in association with the successful transition of policies from Anchor for the replacement policies and issuance of renewal policies under the Company’s own rates and terms. DAC is amortized over the life of the related policy in relation to the amount of gross premiums earned. Ceding commission and related costs paid to United under the quota share reinsurance agreement are also deferred and amortized over the life of the reinsurance agreement.
The method followed in computing DAC limits the amount of such deferred costs to their estimated realizable value, which gives effect to the gross premium earned, related investment income, unpaid losses and loss adjustment expenses and certain other costs expected to be incurred as the premium is earned.
DAC is reviewed to determine if it is recoverable from future premium income, including investment income. If such costs are determined to be unrecoverable, they are expensed at the time of determination. The amount of DAC considered recoverable could be reduced in the near term if the estimates of total gross premium earned are reduced or permanently impaired as a result of the disposition of a line of business. The amount of amortization of DAC could be revised in the near term if any of the gross premium earned estimates discussed above are revised.
Property and Equipment. Property and equipment is stated at cost less accumulated depreciation and amortization, which is included in other operating expenses. Depreciation is calculated on a straight-line basis over the estimated useful lives as follows: building, 39 years; computer hardware and software, three years; and furniture and office equipment, three to seven years. Leasehold improvements are amortized over the shorter of the lease term or the asset’s useful life. Land is not depreciated. Expenditures for improvements are capitalized to the property accounts. Replacements and maintenance and repairs that do not improve or extend the life of the respective assets are expensed as incurred. The Company capitalizes both internal and external costs for internally developed software during the application development stage. During the preliminary project and post-implementation stage, internal-use software development costs are expensed as incurred. Capitalized software costs are depreciated on a straight-line basis over the estimated useful life of seven years.
53
HCI GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Amounts in thousands, except share and per share amounts, unless otherwise stated)
Impairment of Long-Lived Assets. Long-lived assets, such as property and equipment, are reviewed for impairment annually or whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. The Company assesses the recoverability of long-lived assets by determining whether the assets can be recovered from undiscounted future cash flows. Recoverability of long-lived assets is dependent upon, among other things, the Company’s ability to maintain profitability so as to be able to meet its obligations when they become due. In the opinion of management, based upon current information and projections, long-lived assets will be recovered over the period of benefit.
Intangible Assets. Intangibles consist of the value attributable to the acquired in-place leases and the primary, or anchor, tenant relationships. The value attributable to the anchor tenant relationship represents the economic benefits of having a nationally recognized retailer as the lead tenant, which draws consumer traffic and other tenants to the retail center. These intangibles are amortized to expense over the related lease term. Amortization of the intangibles related to real estate investments is reflected in net investment income in the consolidated statement of income. The Company reviews these intangible assets for impairment annually or when events or changes in circumstances indicate the carrying value may not be recoverable. In the event the Company determines the carrying value is not recoverable, an impairment loss is recorded in the Company’s consolidated statement of income.
Leases.The Company leases office equipment, storage units, and office space from non-affiliates under terms ranging from one month up to ten years. In assessing whether a contract is or contains a lease, the Company first determines whether there is an identified asset in the contract. The Company then determines whether the contract conveys the right to obtain substantially all of the economic benefits from use of the identified asset or the right to direct the use of the identified asset. The Company elects not to record any lease with a term of 12 months or less on the consolidated balance sheet. For such short-term leases, the Company recognizes the lease payments in expense on a straight-line basis over the lease term.
If the contract is or contains a lease and the Company has the right to control the use of the identified asset, the right-of-use (“ROU”) asset and the lease liability is measured from the lease component of the contract and recognized on the consolidated balance sheet. In measuring the lease liability, the Company uses its incremental borrowing rate for a loan secured by a similar asset that has a term similar to the lease term to discount the lease payments. The contract is further evaluated to determine the classification of the lease as to whether it is finance or operating. If the lease is a finance lease, the ROU asset is depreciated to depreciation expense over the shorter of the useful life of the asset or the lease term. Interest expense is recorded in connection with the lease liability using the effective interest method. If the lease is an operating lease, the ROU asset is amortized to lease expense on a straight-line basis over the lease term. For the presentation of finance leases on the Company’s consolidated balance sheet, ROU assets and corresponding lease liabilities are included with property and equipment, net, and long-term debt, respectively. For the presentation of operating leases on the Company’s consolidated balance sheet, ROU assets are presented as right-of-use assets – operating leases and corresponding lease liabilities are reflected as lease liabilities – operating leases.
The Company as a lessor leases its commercial and retail properties, boat slips, and docks to non-affiliates at various terms. If the contract gives the Company’s customer the right to control the use of the identified asset, revenue is recognized on a straight-line basis over the lease term. Initial direct costs incurred by the Company are deferred and amortized on a straight-line basis over the lease term. The Company also records an unbilled receivable, which is the amount by which straight-line revenue exceeds the amount billed in accordance with the lease.
Lease Acquisition Costs. Lease acquisition costs represent capitalized costs of finding and acquiring tenants such as leasing commissions, legal, and marketing expenses. The costs are included in other assets on the consolidated balance sheet. The Company amortizes these costs in other operating expenses on a straight-line basis over the term of a lease.
Long-Term Debt. Long-term debt includes debt instruments and finance lease obligations. A debt instrument is generally classified as a liability and carried at amortized cost, net of any discount and issuance costs. At issuance, a debt instrument with embedded features such as conversion and redemption options is evaluated to determine whether bifurcation and derivative accounting is applicable. If such instrument is not subject to derivative accounting, it is further evaluated to determine if the Company is required to separately account for the liability and equity components.
To determine the carrying values of the liability and equity components at issuance, the Company measures the fair value of a similar liability, including any embedded features other than the conversion option, and assigns such value to the liability component. The liability component’s fair value is then subtracted from the initial proceeds to determine the carrying value of the debt instrument’s equity component, which is included in additional paid-in capital.
54
HCI GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Amounts in thousands, except share and per share amounts, unless otherwise stated)
Any embedded feature other than the conversion option is evaluated at issuance to determine if it is probable that such embedded feature will be exercised. If the Company concludes that the exercisability of that embedded feature is not probable, the embedded feature is considered to be non-substantive and would not impact the initial measurement and expected life of the debt instrument’s liability component.
Transaction costs related to issuing a debt instrument that embodies both liability and equity components are allocated to the liability and equity components in proportion to the allocation of the proceeds and accounted for as debt issuance costs and equity issuance costs, respectively. Debt issuance costs are capitalized and presented as a deduction from the carrying value of the debt. Both debt discount and deferred debt issuance costs are amortized to interest expense over the expected life of the debt instrument using the effective interest method. Equity issuance costs are a reduction to the proceeds allocated to the equity component.
Prepaid Share Repurchase Forward Contract. A prepaid share repurchase forward contract is generally a contract that allows the Company to buy from the counterparty a specified number of common shares at a specific time at a given forward price. The Company entered into such a contract and evaluated the characteristics of the forward contract to determine whether it met the definition of a derivative financial instrument pursuant to U.S. GAAP. The Company determined the forward contract is an equity contract on the Company’s common shares requiring physical settlement in common shares of the Company. As such, the transaction is recognized as a component of stockholders’ equity with a charge to additional paid-in capital equal to the prepayment amount, which represents the cash paid to the counterparty. There will be no recognition in earnings for changes in fair value in subsequent periods.
Losses and Loss Adjustment Expenses. Reserves for losses and loss adjustment expenses (“LAE”) are determined by establishing liabilities in amounts estimated to cover incurred losses and LAE. Such reserves are determined based on the assessment of claims reported and the development of pending claims. These reserves are based on individual case estimates for the reported losses and LAE and estimates of such amounts that are incurred but not reported. Changes in the estimated liability are charged or credited to income as the losses and LAE are settled.
The estimates of unpaid losses and LAE are subject to trends in claim severity and frequency and are continually reviewed. As part of the process, the Company reviews historical data and considers various factors, including known and anticipated regulatory and legal developments, changes in social attitudes, inflation and economic conditions. As experience develops and other data becomes available, these estimates are revised, as required, resulting in increases or decreases to the existing unpaid losses and LAE. Adjustments are reflected in the results of operations in the period in which they are made and the liabilities may deviate substantially from prior estimates. Losses and LAE ceded to or recovered from reinsurers are recorded as a reduction to losses and LAE on the consolidated statement of income.
Advance Premiums. Premium payments received prior to the policy effective date are recorded as advance premiums. Once the policy is in force, the premiums are recorded as described under “Premium Revenue” below.
Premium Receivable. Premium receivable represents the amount of premiums due from policyholders for insurance coverage. Premiums are recorded as receivable in the Company’s general ledger on the effective date of the policy. Premiums are billed to the policyholder 45-60 days in advance of the effective date. The policyholder is given a 30-day grace period after the effective date to pay the premium before the insurance coverage is cancelled. If the policyholder does not pay the premium, the Company can cancel the policy and has no obligation to provide insurance coverage. Unpaid renewal policies are cancelled at midnight on the last day of the period for which the policyholder has paid. The unearned premium liability for the cancelled policy is reversed along with the premium receivable balance. Therefore, there is no unpaid earned premium and credit loss associated with the cancelled policy.
However, when the 30-day grace period falls between two reporting periods, the premium receivable balance at the end of the first reporting period may potentially be overstated for not considering the policy that is subsequently cancelled during the following reporting period. To mitigate the overstatement issue, the Company estimates the monetary impact from the subsequent policy cancellation by multiplying the historical cancellation rate to the premium receivable balance at the reporting date. The premium receivable balance, together with the unearned premium liability, is then reduced by the computed amount.
At December 31, 2020 and 2019, allowances for uncollectible premiums were $2,053 and $528, respectively.
55
HCI GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Amounts in thousands, except share and per share amounts, unless otherwise stated)
Reinsurance. In the normal course of business, the Company seeks to reduce the loss that may arise from catastrophes or other events by reinsuring certain levels of risk in various areas of exposure with other insurance enterprises or reinsurers. The Company contracts with a number of reinsurers to secure its annual reinsurance coverage, which generally becomes effective June 1st of each year. The Company purchases reinsurance each year taking into consideration probable maximum losses and reinsurance market conditions. Amounts recoverable from reinsurers are estimated in a manner consistent with the applicable reinsurance contract or contracts. Reinsurance premiums and reserves related to reinsured business are accounted for on a basis consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts. Premiums ceded to other companies have been reported as a reduction of gross premiums earned. Prepaid reinsurance premiums represent the unexpired portion of premiums ceded to reinsurers.
One of the Company’s current reinsurance contracts contains retrospective provisions including terms and conditions that adjust premiums based on the loss experience under the contracts. In such cases, a with-and-without method is used to estimate the asset or liability amount to be recognized at each reporting date. The amount of the estimate is the difference between the net contract costs before and after the loss experience under the contract. Estimates related to premium adjustments are recognized in ceded premiums earned. These estimates are reviewed monthly based on the loss experience to date and as adjustments become necessary. Such adjustments are reflected in the Company’s current operations and recorded in other assets until received upon the expiration of the contracts.
The Company receives ceding commissions from ceding gross written premiums to a third-party reinsurer under one flood quota share reinsurance contract. The ceding commissions represent the reimbursement of the Company’s policy acquisition, underwriting and other operating expenses. Ceding commissions received cover a portion of premium taxes and agent commissions capitalized by the Company and a portion of non-capitalized acquisition costs and other underwriting expenses. Ceding commissions are recognized as income on a pro-rata basis over the terms of the policies reinsured, the amount of which is included in policy acquisition and other underwriting expenses in the consolidated statement of income. The unearned portion of ceding commissions that represents recovery of capitalized acquisition costs is classified as a reduction of DAC whereas the remaining unearned balance is classified as deferred revenue in other liabilities.
Premium Revenue. Premium revenue is earned on a daily pro-rata basis over the term of the policies and is included in gross premiums earned. Unearned premiums represent the portion of the premiums attributable to the unexpired policy term. The Company reviews its policy detail and establishes an allowance for any amount outstanding for more than 90 days.
Policy Fees. Policy fees represent nonrefundable fees for insurance coverage, which are intended to reimburse a portion of the costs incurred to underwrite the policy. Policy fees are recognized ratably over the policy coverage period.
Insurance Guaranty Association Assessments. The Company’s insurance subsidiaries may be assessed by state associations such as the Florida Guaranty Association. The assessments are intended to be used for the payment of covered claims of insolvent insurance entities. The assessments are generally based on a percentage of premiums written during or following the year of insolvency. Liabilities are recognized when the assessments are probable to be imposed on the premiums on which they are expected to be based and the amounts can be reasonably estimated. An insurer is generally permitted to recover the entire amount of assessments from in-force and future policyholders through policy surcharges. U.S. GAAP provides that the Company should record an asset based on the amount of written or obligated-to-write premiums and limited to the amounts recoverable over the life of the in-force policies.
Foreign Currency. The functional currency of the Company’s Indian subsidiary is the U.S. dollar. As such, the monetary assets and liabilities of this subsidiary are remeasured into U.S. dollars at the exchange rate in effect on the balance sheet date. Non-monetary assets and liabilities are remeasured using historical rates. Expenses recorded in the local currency are remeasured at the prevailing exchange rate. Exchange gains and losses resulting from these remeasurements are included in other operating expenses.
Income Taxes.The Company files consolidated federal and state income tax returns and allocates taxes among its wholly owned subsidiaries in accordance with a written tax-allocation agreement.
The Company accounts for income taxes in accordance with U.S. GAAP, resulting in two components of income tax expense and benefit: current and deferred. Current income tax expense and benefit 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. The Company determines 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.
56
HCI GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Amounts in thousands, except share and per share amounts, unless otherwise stated)
Deferred income tax expense and benefit results from changes in deferred tax assets and liabilities between periods. Deferred tax assets are recognized if it is more likely than not, based on the technical merits, that the tax position will be realized or sustained upon examination.The term “more likely than not” means a likelihood of more than fifty percent; the terms “examined” and “upon examination” also include resolution of the related appeals or litigation processes, if any.A tax position that meets the more-likely-than-not recognition threshold is initially and subsequently measured as the largest amount of tax benefit that has a greater than fifty percent likelihood of being realized upon settlement with a taxing authority that has full knowledge of all relevant information. The determination of whether or not a tax position has met the more-likely-than-not recognition threshold considers the facts, circumstances, and information available at the reporting date and is subject to management’s judgment. Deferred tax assets are reduced by a valuation allowance if, based on the weight of evidence available, it is more likely than not that some portion or all of a deferred tax asset will not be realized. As of December 31, 2020, management is not aware of any uncertain tax positions that would have a material effect on the Company’s consolidated financial statements.
Fair Value of Financial Instruments. The carrying amounts for the Company’s cash and cash equivalents approximate their fair values at December 31, 2020 and 2019. Fair values for securities or financial instruments are based on the framework for measuring fair value established by U.S. GAAP (see Note 7 -- “Fair Value Measurements”).
Stock-Based Compensation. The Company accounts for stock-based compensation under the fair value recognition provisions of U.S. GAAP which requires the measurement and recognition of compensation for all stock-based awards made to employees and directors based on estimated fair values. In accordance with U.S. GAAP, the fair value of stock-based awards is generally recognized as compensation expense over the requisite service period, which is defined as the period during which a recipient is required to provide service in exchange for an award. Forfeitures of the Company’s stock-based awards are accounted for as they occur. The Company uses a straight-line attribution method for all grants that include only a service condition. The Company’s outstanding stock-based awards include stock options and restricted stock awards with service conditions. Compensation expense related to all awards is included in general and administrative personnel expenses. The Company receives a windfall tax benefit for certain stock option exercises and for restricted stock awards if these awards vest at a higher value than the value used to recognize compensation expense. In the event the restricted stock awards vest at a lower value than the value used to recognize compensation expense, the Company experiences a tax shortfall. The Company recognizes tax windfalls and shortfalls in the consolidated statement of income.
Basic and Diluted Earnings Per Common Share. Basic earnings per common share is computed by dividing net income attributable to common stockholders by the weighted-average number of common shares outstanding for the period. U.S. GAAP requires the inclusion of restricted stock as participating securities since holders of the Company’s restricted stock have the right to share in dividends, if declared, equally with common stockholders. In addition, the intrinsic value of restricted stock declines when the Company experiences operating losses. As a result, holders of the Company’s restricted stock are allocated a proportional share of net income and loss determined by dividing total weighted-average shares of restricted stock by the sum of total weighted-average common shares and shares of restricted stock (the “two-class method”). Diluted earnings per common share reflect the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted as well as participating equities. During loss periods, common stock equivalents such as stock options and convertible debt are excluded from the calculation of diluted loss per share, as the inclusion would have an anti-dilutive effect. See Note 19 -- “Earnings Per Share” for potentially dilutive securities at December 31, 2020, 2019 and 2018.
Statutory Accounting Practices. The Company’s U.S. insurance subsidiaries comply with statutory accounting practices prescribed by the National Association of Insurance Commissioners. There are no state prescribed or permitted practices that have been adopted by the Company’s U.S. subsidiaries. In addition, the Company’s Bermuda insurance subsidiary prepares and files financial statements in accordance with the prescribed regulatory accounting practices of the Bermuda Monetary Authority.
Reclassification. Certain prior year amounts have been reclassified to conform to the current year presentation. ROU assets and corresponding lease liabilities - operating leases were reclassified out of other assets and other liabilities, respectively, at December 31, 2019.
Note 3 -- Recent Accounting Pronouncements
Accounting Standards Update No. 2020-01. In January 2020, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2020-01 (“ASU 2020-01”) Investments - Equity Securities (Topic 321), Investments - Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815) - Clarifying the Interactions between Topic 321, Topic 323, and Topic 815. This update, among others, clarifies the interaction of the accounting for equity securities under Topic 321 and investments under the equity method of accounting in Topic 323 when there is a change in level of ownership or degree of influence. ASU 2020-01 is effective for the Company beginning with the first quarter of 2021 and will be applied prospectively. Early adoption is permitted. This guidance will not have a material impact on the Company’s consolidated financial statements.
57
HCI GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Amounts in thousands, except share and per share amounts, unless otherwise stated)
Accounting Standards Update No. 2020-06. In August 2020, the FASB issued Accounting Standards Update No. 2020-06 (“ASU 2020-06”) Debt - Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging - Contracts in Entity’s Own Equity (Subtopic 815-40). ASU 2020-06 removes certain bifurcation models for convertible debt instruments and convertible preferred stock. Therefore, the embedded conversion features no longer are separated from the host contract for convertible instruments with conversion features that are not required to be accounted for as derivatives under Topic 815, Derivatives and Hedging, or that do not result in substantial premiums accounted for as paid-in-capital. The amendments also remove three settlement conditions that are required for equity contracts to qualify for the derivative scope exception and amend the derivative scope exception guidance for contracts in an entity’s own equity. In addition, the amendments expand disclosure requirements for convertible instruments and simplify areas of the guidance for diluted earnings-per-share calculations that are impacted by the amendments.
ASU 2020-06 is effective for public companies beginning with the first quarter of 2022 and shall be applied prospectively. Early adoption is permitted. The Company will early adopt this update in the first quarter of 2021 using the modified retrospective method. The adoption of this update will increase long-term debt by $4,000 and simultaneously decrease beginning retained income and deferred income tax liabilities by $3,019 and $981, respectively.
Accounting Standards Update No. 2020-08. In October 2020, the FASB issued Accounting Standards Update No. 2020-08 (“ASU 2020-08”) Codification Improvements to Subtopic 310-20, Receivables – Nonrefundable Fees and Other Costs. ASU 2020-08 states that an entity should reevaluate whether a callable debt security that has multiple call dates is within the scope of ASC 310-20-35-33 for each reporting period. Securities within the scope are those that have explicit, noncontingent call options that are callable at fixed prices and on preset dates at prices less than the amortized cost basis of the security. ASC 310-20-35-33 requires that for each reporting period, to the extent the amortized cost basis of an individual callable debt security exceeds the amount repayable by the issuer at the next call date, the excess should be amortized to the next call date, unless the guidance in ASC 310-20-35-26 applies. ASU 2020-08 is effective for the Company beginning with the first quarter of 2021 and will be applied prospectively. Early adoption is not permitted. This guidance will not have a material impact on the Company’s consolidated financial statements.
Note 4 -- Cash, Cash Equivalents, and Restricted Cash
The following table provides a reconciliation of cash, cash equivalents, and restricted cash reported within the Company’s consolidated balance sheets that sum to the total of the same such amounts shown in the consolidated statements of cash flows.
December 31,
At December 31, 2020, $317,420 or 73.6% of the Company’s cash and cash equivalents were deposited at six national banks and included $141,481 in two custodial accounts. At December 31, 2019, $126,347 or 55.1% of the Company’s cash and cash equivalents were deposited at three national banks and included $12,188 in two custodial accounts. At December 31, 2020 and 2019, the Company’s cash deposits at any one bank generally exceed the Federal Deposit Insurance Corporation’s $250 coverage limit for insured deposit accounts.
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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 5 -- Investments
a) Available-for-Sale Fixed-Maturity Securities
The Company holds investments in fixed-maturity securities that are classified as available-for-sale. At December 31, 2020 and 2019, the cost or amortized cost, gross unrealized gains and losses, and estimated fair value of the Company’s available-for-sale securities by security type were as follows:
Cost or Amortized Allowance for Gross Unrealized Gross Unrealized Estimated Fair
Cost Credit Loss Gain Loss Value
U.S. Treasury and U.S. government agencies $ 13,759 $ — $ 210 $ (1 ) $ 13,968
State, municipalities, and political subdivisions 3,023 — 60 (2 ) 3,081
Redeemable preferred stock 35 — — — 35
U.S. Treasury and U.S. government agencies $ 26,220 $ 78 $ (3 ) $ 26,295
State, municipalities, and political subdivisions 7,763 149 — 7,912
Redeemable preferred stock 118 5 — 123
Expected maturities will differ from contractual maturities as borrowers may have the right to call or prepay obligations with or without penalties. The scheduled contractual maturities of fixed-maturity securities at December 31, 2020 and 2019 are as follows:
December 31,
Cost or Estimated Cost or Estimated
Amortized Fair Amortized Fair
Cost Value Cost Value
Available-for-sale
Sales of Available-for-Sale Fixed-Maturity Securities
Proceeds received, and the gross realized gains and losses from sales of available-for-sale fixed-maturity securities, for the years ended December 31, 2020, 2019 and 2018 were as follows:
Gross Gross
Realized Realized
Proceeds Gains Losses
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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)
Gross Unrealized Losses for Available-for-Sale Fixed-Maturity Securities
Securities with gross unrealized loss positions at December 31, 2020 and 2019, aggregated by investment category and length of time the individual securities have been in a continuous loss position, are as follows:
Less Than Twelve Months Twelve Months or Longer Total
U.S. Treasury and U.S. government agencies $ (1 ) $ 1,337 $ — $ — $ (1 ) $ 1,337
States, municipalities, and political subdivisions (2 ) 1,268 — — (2 ) 1,268
Exchange-traded debt (5 ) 336 — — (5 ) 336
Total available-for-sale securities $ (25 ) $ 6,026 $ — $ — $ (25 ) $ 6,026
Less Than Twelve Months Twelve Months or Longer Total
U.S. Treasury and U.S. government agencies $ (3 ) $ 2,292 $ — $ — $ (3 ) $ 2,292
Total available-for-sale securities $ (21 ) $ 7,234 $ — $ — $ (21 ) $ 7,234
At December 31, 2020 and 2019, there were twelve and eight securities, respectively, in an unrealized loss position.
Allowance for Credit Losses of Available-for-Sale Fixed-Maturity Securities
The Company regularly reviews its individual investment securities for credit impairment. The Company considers various factors in determining whether a credit loss exists for each individual security, including-
The table below summarized the activity in the allowance for credit losses of available-for-sale fixed-maturity securities for the year ended on December 31, 2020:
Balance at January 1 $ —
Credit loss expense 611
Reductions for securities sold (23 )
Balance at December 31 $ 588
For the year ended December 31, 2020, the Company recognized $611 of credit loss expense on two fixed-maturity securities in the consolidated statement of income compared with $289 of credit-related impairment loss on one fixed-maturity security for the year ended December 31, 2019. The Company recognized $80 of non-credit related impairment loss pertaining to one fixed-maturity security for the year ended December 31, 2018. At December 31, 2019 and 2018, the Company had cumulative credit loss balances of $289 and $0, respectively.
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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)
b) Equity Securities
The Company holds investments in equity securities measured at fair values which are readily determinable. At December 31, 2020 and 2019, the cost, gross unrealized gains and losses, and estimated fair value of the Company’s equity securities were as follows:
Gross Unrealized Gross Unrealized Estimated Fair
Cost Gain Loss Value
The table below presents the portion of unrealized gains and losses in the Company’s consolidated statements of income related to equity securities still held.
Years Ended December 31,
Net unrealized gains (losses) recognized $ 679 $ 7,950 $ (10,202 )
Sales of Equity Securities
Proceeds received, and the gross realized gains and losses from sales of equity securities, for the years ended December 31, 2020, 2019 and 2018 were as follows:
Gross Realized Gross Realized
Proceeds Gains Losses
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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)
c) Limited Partnership Investments
The Company has interests in limited partnerships that are not registered or readily tradeable on a securities exchange. These partnerships are private equity funds managed by general partners who make decisions with regard to financial policies and operations. As such, the Company is not the primary beneficiary and does not consolidate these partnerships. The following table provides information related to the Company’s investments in limited partnerships:
Carrying Unfunded Carrying Unfunded
Investment Strategy Value Balance (%) (a) Value Balance (%) (a)
(i) The capital commitment has expired in December 2020.
(j) Expected to have an eight-year term from November 27, 2019.
The following is the summary of aggregated unaudited financial information of limited partnerships included in the investment strategy table above, which in certain cases is presented on a three-month lag due to the unavailability of information at the Company’s respective balance sheet dates. The financial statements of these limited partnerships are audited annually.
Years Ended December 31,
Operating results:
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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)
December 31,
Balance sheet:
For the year ended December 31, 2020, the Company recognized net investment loss of $1,595 compared with the investment income of $1,176 and $4,430 for the years ended December 31, 2019 and 2018, respectively, for these investments. At December 31, 2020 and 2019, the Company’s net cumulative contributed capital to the partnerships existing at each respective balance sheet date totaled $29,272 and $27,117, respectively, and the Company’s maximum exposure to loss aggregated $27,691 and $28,346, respectively.
During the year ended December 31, 2020, the Company received in cash a return on investment of $1,215 and a return of capital of $2,086 compared with a return on investment of $4,176 and a return of capital of $2,121 during the year ended December 31, 2019. During the year ended December 31, 2018, the Company received total cash distributions of $2,503, representing $2,345 of return on investment and $158 of returned capital.
d) Investment in Unconsolidated Joint Venture
Melbourne FMA, LLC, a wholly owned subsidiary, currently has an equity investment in FMKT Mel JV, a Florida limited liability company treated as a joint venture under U.S. GAAP.At December 31, 2020 and 2019, the Company’s maximum exposure to loss relating to this variable interest entity was $705 and $762, respectively, representing the carrying value of the investment. At December 31, 2020, 2019 and 2018, there was no undistributed income from this equity method investment.
For the years ended December 31, 2020 and 2019, the Company did not receive any cash distributions. For the year ended December 31, 2018, the Company received a cash distribution of $763, representing a combined distribution of $68 in earnings and $695 in capital.The following tables provide FMJV’s summarized unaudited financial results and the unaudited financial positions:
Years Ended December 31,
Operating results:
Total revenues $ — $ 2 $ 438
Net (loss) income $ (64 ) $ (91 ) $ 338
The Company’s share of net (loss) income* $ (57 ) $ (83 ) $ 304
December 31,
Balance sheet:
Property and equipment, net $ 705 $ 741
Other liabilities $ 5 $ —
Total liabilities and members’ capital $ 788 $ 847
Investment in unconsolidated joint venture, at equity** $ 705 $ 762
** Includes the 90% share of FMKT Mel JV’s operating results.
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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)
e) Assets Held for Sale
On April 9, 2020, Greenleaf Capital, LLC decided to offer for sale its investment property in Riverview, Florida. The proceeds from the sale are expected to exceed the property’s carrying value of $4,519 and, accordingly, no impairment loss was recognized on the classification of this property as held for sale. Although this property has drawn interest from several potential buyers since the listing, the Company has yet to receive an offer with acceptable terms. The Company will continue to market the property but can no longer reasonably assume a sale will occur within a year. Accordingly, in December 2020 the property was reclassified back to real estate investments at its carrying value before it was classified as held for sale. The carrying value of $4,748, including additional improvement costs of $229, was then adjusted for catch-up depreciation expense of $68, which is included in net investment income in the Company’s consolidated statement of income.
f) Real Estate Investments
Real estate investments include land, buildings with office and retail space for lease, outparcels, and marinas. Real estate investments consist of the following as of December 31, 2020 and 2019:
December 31,
Tenant and leasehold improvements 1,487 1,487
Less: accumulated depreciation and amortization (8,581 ) (6,717 )
In July 2020, a portion of undeveloped land with a carrying value of $443 was acquired by the Florida Department of Transportation (“FDOT”) as part of the agreement described in Note 9 -- “Property and Equipment, Net.”
Depreciation and amortization expense related to real estate investments was $1,864, $1,782 and $1,536, respectively, for the years ended December 31, 2020, 2019 and 2018 and was included in net investment income on the consolidated statements of income.
g) Net Investment Income
Net investment income (loss), by source, is summarized as follows:
Years Ended December 31,
Available-for-sale fixed-maturity securities $ 4,252 $ 6,506 $ 5,097
(Loss) income from unconsolidated joint venture (57 ) (83 ) 304
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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 6 -- Comprehensive Income (Loss)
Comprehensive income (loss) includes net income (loss) and other comprehensive income or loss, which for the Company includes changes in unrealized gains or losses of investments carried at fair value and changes to the credit losses related to these investments. Reclassification adjustments for realized (gains) losses are reflected in net realized investment gains (losses) on the consolidated statements of income. The components of other comprehensive income or loss and the related tax effects allocated to each component were as follows:
Before Tax Income Tax Effect Net of Tax
Unrealized gain arising during the period $ 86 $ 21 $ 65
Call and repayment gains charged to investment income (374 ) (92 ) (282 )
Reclassification adjustment for realized gains (1,163 ) (285 ) (878 )
Total other comprehensive loss $ (840 ) $ (206 ) $ (634 )
Income Tax
Before Tax Effect Net of Tax
Unrealized gain arising during the period $ 4,902 $ 1,219 $ 3,683
Other-than-temporary impairment loss 289 71 218
Call and repayment gains charged to investment income (141 ) (35 ) (106 )
Reclassification adjustment for realized gains (218 ) (54 ) (164 )
Income Tax
Before Tax Effect Net of Tax
Unrealized loss arising during the period $ (3,137 ) $ (795 ) $ (2,342 )
Other-than-temporary impairment loss 80 20 60
Call and repayment losses charged to investment income (18 ) (5 ) (13 )
Reclassification adjustment for realized gains (723 ) (183 ) (540 )
Total other comprehensive loss $ (3,798 ) $ (963 ) $ (2,835 )
Note 7 -- Fair Value Measurements