Aug 1, 2013
Executives
Les Holland – Investor Relations Paresh Patel – Chairman and Chief Executive Officer Richard R. Allen – Chief Financial Officer Scott R.
Wallace – Division President - Property and Casualty
Analysts
Casey J. Alexander – Gilford Securities, Inc.
Cliff Orr – Privet Fund Management LLC Carson L. Yost – Yost Capital Management LLC Edward Paul Hemmelgarn – Shaker Investments, L.L.C.
Operator
Good afternoon. Welcome to the HCI Group’s Second Quarter 2013 Earnings Call.
My name is Lotanya and I will be your conference operator this afternoon. Before we begin today’s call, I would like to remind everyone that this conference call is being recorded and will be available for replay through August 9 stating later this evening.
I would now like to turn the call over to Les Holland, Investor Relations at HCI Group. Sir, please proceed.
Les Holland
Thank you, and good afternoon. Welcome to HCI Group’s second quarter 2013 earnings call.
With me today are Paresh Patel, our Chairman and Chief Executive Officer; Richard Allen, our Chief Financial Officer; and Scott Wallace, President of our Insurance Division. Richard will review our financial performance for the second quarter and first six months of the year.
Paresh will give a brief update. Finally, we will open the call to your questions.
To access today’s webcast, please visit the Investor Relations’ section of our corporate website at www.hcigroup.com. Before we begin, I would like to take the opportunity to remind our listeners that today’s presentation and responses to questions may contain forward-looking statements made pursuant to the Private Securities Litigation Reform Act of 1995.
Words such as anticipate, estimate, expect, intend, plan and project and similar words and expressions are intended to signify forward-looking statements. Forward-looking statements are not guarantees of future results and conditions, but rather are subject to various risks and uncertainties.
Some of these risks and uncertainties are identified in the Company's filings with the Securities and Exchange Commission. Should any risks or uncertainties develop into actual events, these developments could have material adverse effects on the Company's business, financial conditions, and results of operation.
HCI Group Inc. disclaims all obligations to update any forward-looking statements.
Now, I will turn the call over to Richard Allen, our Chief Financial Officer, Richard?
Richard R. Allen
Thank you, Les and good afternoon everyone. For the second quarter of 2013, income available to common stockholders totaled $16.2 million or $1.40 diluted earnings per common share.
This compares to $7.2 million or $0.74 diluted earnings per common share for the same quarter of 2012. For the first six months of 2013, income available to common stockholders totaled $36.6 million or $3.20 diluted earnings per common share.
This compares with $14 million or $1.60 diluted earnings per common share in the first six months of 2012. Gross premiums earned in the second quarter of 2013 increased 52.4% to $82 million from $53.8 million in the same quarter of 2012.
For the first six months of 2013, gross premiums earned increased 51.7% to $164.5 million from $108.5 million in the first half of 2012. This increase was primarily due to revenue from policies acquired from Citizens in November of 2012.
Net premiums earned for the second quarter of 2013 increased 54.7% to $57.3 million, from $37.1 million in the same year ago period. For the first six months of 2013 net premiums earned increased 52.1% to $117.9 million, compared with $77.5 million for the same period of 2012.
Premiums ceded in the second quarter of 2013 were 34% of our gross premiums earned, compared with 31.1% in the second quarter of 2012. For the six months period ended June 30, 2013, premiums ceded were 28.3% of gross earned premiums, compared to 28.6% in the same period a year ago.
For the quarter ended June 30, 2013 net investment income was $295,000 compared to $302,000 in the same period of 2012. For the first six months of 2013, net investment income was $434,000 compared to $824,000 a year ago.
Losses and loss adjustment expenses in the second quarter of 2013 totaled $17.4 million compared with $16.2 million in the same period a year ago. For the first six months of 2013, losses and loss adjustment expenses totaled $33.3 million.
This compares with $35.4 million in the first half of 2012. Other operating expenses, which include a variety of general and administrative expenses, totaled $7.4 million during the second quarter of 2013.
This compares with $4.4 million in the second quarter of 2012. For the six months ended June 30, 2013, other operating expenses totaled $13.5 million versus $8.7 million for the comparable period of 2012.
Turning to our financial ratios; our loss ratio applicable to the second quarter of 2013, which we define as losses and loss adjustment expenses related to net premiums earned was 30.4% compared with 43.7% in the second quarter of 2012. For the first six months of 2013, the loss ratio was 28.2% compared with 45.6% in the same year ago period.
We are constantly monitoring claim activities for development of trends and frequency, severity and causes of loss for the potential impact on incurred losses and loss adjustment expenses, [within this] use of data to refine and improve our underwriting guidelines. The expense ratio applicable to the second quarter of 2013, which we define as underwriting expenses, interest and other operating expenses related to net premiums earned totaled 27% compared to 28.7% in the same year-ago period.
The expense ratio applicable to the six months ended June 30, 2013 was 24% compared to 28.1% in the same period of 2012. Expressed as a total of all expenses related to net premiums earned, the combined loss and expense ratio to net premiums earned in the second quarter of 2013 was 57.4% compared with 72.4% in the same year-ago period.
For the first six months of 2013, the combined loss and loss expense ratio to net premiums earned was 52.2% compared with 73.7% in the same period of 2012. Now, turning to the balance sheet, our cash and cash equivalents at the quarter-end totaled $296.8 million compared with $230.2 million at December 31, 2012.
Unearned premiums at June 30, 2013 were $191.4 million compared to $154.2 million at December 31, 2012. Our reserves for losses and loss adjustment expenses totaled $44.7 million at June 30, 2013 compared with $41.2 million at December 31.
As you can see, we have added successful underwriting results thus far in 2013 with continued strengthening of our balance sheet. And, now I’d to turn the call over to Paresh.
Paresh Patel
Thank you, Richard. Yesterday, July 31, 2013, marked the fifth anniversary of HCI being a publicly traded company.
Over that time, our diligent commitments; underwriting, expense management as well as opportunity expansion has propelled the company from being a startup to being one of the top P&C insurance providers in the state of Florida. Looking at the highlights for the quarter, as we improved our shareholders in May, we began doing business under the name HCI Group.
This name more actively represents the future of the company given our diverse yet compliment business activities which include property and casualty insurance, information technology, real estate and reinsurance. The rebranding also helps avoid confusion between our largest subsidiary, Homeowners Choice Property & Casualty Insurance Company and our other non-property casualty insurance enterprises.
Our overall strategic focus, however, does remain insurance, but having said that, we are equally excited about the future and our other enterprises like Exzeo and Greenleaf Capital. Looking forward, I would like to read the following statement.
Subsequent to the end of the quarter we filed an 8-K that outlined our 2013, 2014 reinsurance program. The gross premium cost of the program to the HCI Group is approximately $134 million.
However, because of special provisions in certain of the reinsurance agreements, which include premium and coverage estimate in the event losses are minimal or zero. We expect to recognize net reinsurance premiums needed of approximately $113 million from June 1, 2013 through May 31, 2014, assuming no losses occur during that period.
The difference between the gross and net amount is recognized as a benefit over the three-year and will be reversed and charged to earnings. In the event we experienced a catastrophic loss that exceeded that coverage limit provided under the related agreement.
As of June 30, 2013, we have recognized a benefit of approximately $1.3 million in connection with these agreements. With that, I will turn for additional questions and comments.
Thank you.
Les Holland
Go ahead.
Operator
Thank you, sir. We will now be conducting a question-and-answer session.
(Operator Instructions) Our first question comes from Casey Alexander with Gilford Securities. Please proceed with your question.
Casey J. Alexander – Gilford Securities, Inc.
Hi. I have a few questions.
First of all, in relation to the reinsurance, you said received the benefit already of $1.3 million in the June quarter. Where does that show up in the income statement?
Does that show up as a reduction of premiums ceded, in others words would premium ceded have been $25.9 million had do you not had this arrangement?
Richard R. Allen
Correct, Casey.
Casey J. Alexander – Gilford Securities, Inc.
Okay. And so, would the difference between the $134 million and $113 million sort of show up ratably month by month over the course of the year assuming that there are no catastrophic losses?
And then that, if there was a catastrophic loss that 1.3 million would be recaptured by the reinsurance company.
Paresh Patel
Casey, the reason I brought that this thing up in the conference call et cetera is just to make sure everybody understands how these things works, and I’ll try to answer the question because it’s taken Richard and the Finance Department several hours to explain to me, and so I could translate this hopefully into non-accounting terminology, okay. Here’s the simplest way of looking at this thing.
We spent $134 million in cash just going to go out for reinsurance over the course of the year, right. Given the provision in some of the contracts, if there are no losses, which you people will think about the last five years, there has been no losses and no (inaudible).
If no losses occur hypothetically, this is exactly what the agreement says, but if it was just all over one year would mean that the end of the year the reinsurer was $21 million back. Call it reduced premium, call it corporate commission, call it whatever you want, but in effect $21 million will be coming back, right.
So the question is at that point going forward I look at $113 million of $134 million of expenses. There is an accounting provision, which basically says that you cannot assume a catastrophe is going to happen before it happens.
So therefore you have to presume that you are going to have this upcoming year would be event free up to and until the day that event occurs, yeah. So consequently you could only book the contact in your accounting as if no losses are going to occur until a loss occurs in which case at that point you reverse out – you pull it up as such.
Casey J. Alexander – Gilford Securities, Inc.
Right.
Paresh Patel
So just to put this in simple terms, if a storm had happened on June 30, we could have reverse out our possibility of getting that $21 million back, right. What would happen at that point is we would basically take that extra $1.3 million charge because of money we’ve already accrued, plus going forward.
We’d amortize $134 million as opposed to $113 million.
Casey J. Alexander – Gilford Securities, Inc.
Okay.
Paresh Patel
Again it gets a little bit messy, but it’s that’s why we are not going to put up both the gross numbers and net number and also how much we will accrue to-date, yeah.
Casey J. Alexander – Gilford Securities, Inc.
So it sounds like there is a difference between the GAAP accounting on this (inaudible) and the cash accounting as it reaches the company.
Paresh Patel
Yes.
Casey J. Alexander – Gilford Securities, Inc.
For Richard, [Audio Gap] because it more just way to – because for modeling purposes it make you quite difficult. The proceeds from the Aon Benfield, are those arrive in this quarter or are they arriving in some future quarter?
Paresh Patel
The case is still under appeal. When this will be settled we will receive the cash.
Casey J. Alexander – Gilford Securities, Inc.
Okay, so no cash has been received from that. Is there any companies real estate portfolio, are there been any new developments during this quarter that are material to the company?
Paresh Patel
I don’t think well, I think when we close in the – yeah, so, general answer is no.
Casey J. Alexander – Gilford Securities, Inc.
Okay. See you haven’t closed the back up building in (inaudible)?
Richard R. Allen
Yes. that if I remember that was closed in the first quarter.
Casey J. Alexander – Gilford Securities, Inc.
That was closed in the previous quarter. Okay, that’s fine.
Richard R. Allen
Yeah.
Casey J. Alexander – Gilford Securities, Inc.
Yeah, you continue to have versus historical benchmarks of very low loss in loss adjustment expense ratio in policy acquisition. Our ratio is a percent of growth than that premiums.
It’s low enough that almost required as a function of diligence to ask, is that sustainable and for how long, because the number is well below what would be continued to historical benchmarks of Florida Homeowners Insurance Company. Can you give me some color on that?
Paresh Patel
Sure, thanks. I’ll talk about the loss ratios, I’ll let Richard talk about the acquisition cost part of it.
Casey J. Alexander – Gilford Securities, Inc.
Okay, great.
Paresh Patel
Some of the loss ratios, and as Richard said in his comment. We continue to look at this thing to see, if we ever see return going the other way in terms of development becoming adverse.
Because we have been focused as to why is this happening this way, for some time as well. And what fundamentally we seem to be noticing is there has been a material business in the mix of claims and consequently therefore the average cost per plain comes down and that very quickly starts multiplying.
And really it’s the new with the, what was all – half a couple of years ago about the (inaudible) problem even that, I think SB 408 all those kinds of things, what’s down a couple of years ago, you are now starting to see the effect of that grow through people’s (inaudible) up here. So that’s what’s causing the claims mix differences what causes the loss ratio to come down.
Again we are equally diligent in terms of keeping an eye on it, because we want to make sure that it’s not anything other than that’s causing it, yeah.
Casey J. Alexander – Gilford Securities, Inc.
Right. And Richard the policy acquisition costs?
Richard R. Allen
The policy acquisition costs Casey that you remember that in the prior calls we discussed the earned premiums related to the November takeout.
Casey J. Alexander – Gilford Securities, Inc.
Right.
Richard R. Allen
We are not subject to any acquisition costs, as those policies renew under Homeowners Choice policies, the acquisition costs will increase accordingly.
Casey J. Alexander – Gilford Securities, Inc.
So on that line we could expect after the policies have aged a year to start to see that move back, the policy acquisition cost move back towards more normal historical levels?
Richard R. Allen
Yes.
Casey J. Alexander – Gilford Securities, Inc.
Okay.
Richard R. Allen
And you got to remember too that January of last year we changed the recognition of policy acquisition costs, and deferral or you can confirm just commissions and premium taxes. Prior to that there were some expenses involved.
Casey J. Alexander – Gilford Securities, Inc.
Okay.
Richard R. Allen
Today that is lowered from 2011 levels, 2012 moving forward will be lower than those prior years.
Casey J. Alexander – Gilford Securities, Inc.
Okay. Paresh, it seems pretty clear based on everything that would be rather Citizens approach to how they offer policy take downs has changed.
Could you discuss how our HCI’s approach to, in terms of how they look at deals with citizens may or may not have changed as a result of that?
Paresh Patel
Casey, when you say that Citizens takedown has changed. Are you talking about this one-off deals that we’ve been doing in the early part of this year.
Casey J. Alexander – Gilford Securities, Inc.
Yeah.
Paresh Patel
Yeah, we speaking about that, I mean we’ve seen that et cetera and unfortunately, the companies that have done that have also had all kinds of ad works, publicity et cetera that have occurred with that. So we’ve seen all those things going on.
From our perspective, we seem to do quite well just with the programs that have been in place for the last six years. So, it doesn’t really become material for us to one that to be a different change, et cetera.
I think the special deals and stuff, I think there maybe actually at this point coming to an end, because I think even Citizens have taken a lot of negative threats on the matter.
Casey J. Alexander – Gilford Securities, Inc.
All right, yeah. Without getting into specifics, I know that you have the cash set aside for special opportunities have and obviously we wouldn’t talk about (inaudible), but have any acquisition opportunity has been presented to the Company and anything that you at least have under consideration?
Paresh Patel
Okay, I’m going to – answer to that question in two parts in terms of how things presented to us, I think a week doesn’t go by without something being presented to us either within Florida or outside Florida that kind of thing. Having said that, obviously we are not announcing closing on anything at this point, yeah.
Casey J. Alexander – Gilford Securities, Inc.
Okay. All right, well thank you for taking my questions in a very good quarter.
Congratulations.
Richard R. Allen
Thank you.
Paresh Patel
Thank you, Casey.
Operator
(Operator Instructions) Our next question comes from Cliff Orr with Privet Fund Management. Please proceed with your question.
Paresh Patel
Hi, there, Chris.
Operator
Cliff, your line is live. You can speak.
Cliff Orr – Privet Fund Management LLC
Good afternoon, gentlemen. Thanks very much for taking my call.
I’d love to hear you talk a little bit about the top line moving forward with the clearinghouse coming into effect in early January 2014, I mean, I think there are questions surrounding how that’s going to be implemented and executed, but, I mean, the general understanding that I’ve received is that all new policies were willing to sort of a system through which participating carriers can bid on that policy for about 48-hour period and then only if the quotes are not within 15% of Citizens, would go to Citizens? And I was just trying to think about the increase transparency associated with that and how that may ultimately affect a number of policies that Citizens holds and then next derivative of how many take-outs they maybe able to conduct at that point, and the profitability associated with those takeouts?
How are you thinking about that and maybe altering the policy generation business model, if at all, given the changing dynamics with respect to Citizens?
Paresh Patel
Okay, a number of questions in that. I’ll start with the last part first, the thing about policy generally, business generation et cetera.
We are at this point having $140,000 give or take a little bit number of policies that we have. We are as much focused on retaining the policies we’ve got as opposed to having to keep getting new ones, et cetera, because we have a recurring revenue stream here as well.
So we do that from a different position than we would have looked at this has this occurred, say five years ago when you were still ramping up. So one aspect that’s unique to us in this matter.
The other side of this in terms of the Citizens on the clearinghouse and everything else, I think that while this train is leaving the station and is going down that path there are a couple of big variables that are unknown and it’s how things will pass, because I think the clearinghouse was designed to the concept to give Citizens the ability to say no to a policy, right, which is not entirely the same and therefore somebody is going to step up and take that policy. So how all of this plays out and how this plays out in the political world remains to be seen, especially as we still have a hurricane season to go through before we get to that point.
So, we continue to monitor it and watch and we talk to the Citizens, speak about it regularly. But we are really, at this point, taking a wait-and-see attitude because usually when these things occur the – how people will perceive that was going to turn out versus how it actually turns out tends to be slightly different, historically.
Yes.
Cliff Orr – Privet Fund Management LLC
Okay. Great.
Relatively with these more recent takedowns or take outs over the past several months, curious if you perceive any change in Citizens’ preferred method for depopulation. By that, I mean, I it appears they are trying to jettison policies prior to hurricane season rather than perhaps after hurricane season once that catastrophe risk is passed.
Is that a fair assessment or do you have a different view?
Paresh Patel
I have a different view. I think in defense of the Citizens’ folks, I think they’ve been on a mission to reduce the size of Citizens for about 18 months to two years now and I think they are looking at any and every way they can think of to reduce the size of Citizens, right.
I’m not here to tell you whether that’s good public policy or bad public policy. I’m just telling you that seems to be the policy that seems to be coming out of Citizens at this point.
They are encouraging anything and everything they can think of to reduce the policy [accounting by] Citizens. And I think they’re agnostic as to which time of the year the reduction occurs.
Les Holland
Okay. Who’s next?
Cliff Orr – Privet Fund Management LLC
Okay. Thanks very much.
I appreciate the commentary.
Les Holland
Thank you.
Operator
Our next question comes from Carson Yost with Yost Capital. Please proceed with your question.
Carson L. Yost – Yost Capital Management LLC
Hi there, Paresh. I just had a quick question on number of policies in force at the end of the quarter.
It’s the first question. And second question is, can you just talk about return on both the newly acquired policies and pre-existing policies?
Thanks.
Paresh Patel
Okay. Scott is sending me a piece of paper, so I’ll just tally from that.
I think the…
Scott Wallace
Can I help you? As far as my (inaudible) book I’ve sent to you, by the way, most important…
Carson L. Yost – Yost Capital Management LLC
I did.
Scott Wallace
Pretty good.
Paresh Patel
In terms of our policy count, we are in that part of the year where our policy counts were going down month after month. I think I knew second quarter we were below 140,000, probably about – between 135,000-140,000 and it’s the decreasing cycling.
In terms of retention rate et cetera, I think we are right around 90%. It’s good as it’s ever been and I think we’re getting retention both in that splendid 90%.
So that tells us that both the take-out and the renewal polices are all basically staying with us. I’m very happy on that obviously.
Carson L. Yost – Yost Capital Management LLC
Great.
Les Holland
Go ahead.
Operator
(Operator Instructions) Our next question comes from Edward Hemmelgarn with Shaker Investments. Please proceed with your question.
Edward Paul Hemmelgarn – Shaker Investments, L.L.C.
Yeah thanks. There are a couple of questions.
One, you talked about a 90% policy retention rate. What kind of organic new policy outside of purchasers and Citizens is occurring?
Paresh Patel
We continue to write policy. I think what we tend to find is that organic growth is more a function of how hard we want to push to get new business and that is done over the year.
Now that we’re in lean season, et cetera, in hurricane season we tend not to want to grow the business between now and probably the end of September, end of October kind of timeframe. The question you’re asking if I just sort of told you, we are writing very little organic new business, sounds you’re like, Oh My God, how can you do this?
Well, the reality of this is we’re writing very little, because it’s not trying to write a lot. If we tried, if it’s actually did try to write a lot, I suspect we could do that as well.
Edward Paul Hemmelgarn – Shaker Investments, L.L.C.
I just wonder, another question is, what would you over the last 12 months or so in the cycle, what was your outside of the Citizens peak out, what was your organic new policy growth rate?
Paresh Patel
Not much. Probably in the region of about 4,000 or 5,000.
Edward Paul Hemmelgarn – Shaker Investments, L.L.C.
Okay. Would you expect that to change as you mature as a company, I mean, given then and there is the opportunity to, I suspect at some point in time, the opportunities take out from Citizens will decrease to balance out the losses that you’re having from and to start growing?
Paresh Patel
Well, I think the way we’ve always stated this thing and we’ve got five years of doing this at this point is that we usually set out setting a target size of the business that we want to get to and then we’d say, what is the ideal of getting there and usually there’s three ways of getting there. You either get there by being a take out, you can do that by organic growth or you can get there by doing an acquisition.
And a number of people look at all of these things and have some [doubt in mind] to which is a preferred method and which is better or which is worse. We’ve always looked at it to which is the most cost efficient method of getting to that number we want to get to and that’s the path we take.
We had grown into expand the organic growth business a couple of years ago, but then in late 2011, as everybody knows because the HomeWise acquisition were just that acquisition pur more policies in one cell roof on the books, then years of organic growth would have done. So we had to go, digest that.
Then last year was the take out, which is the opportunistic way of growing for this year and that’s what we did. So in terms of which capacity would use next year it’s really a function of what’s available to us.
Edward Paul Hemmelgarn – Shaker Investments, L.L.C.
Okay. That’s a good answer.
Second then is, in terms of the $21 million difference, is that just would you – would that be retained by the reinsurance if there was just one event?
Richard R. Allen
No, there is actually, that $21 million is based on how many events or how many years kind of think it’s a multiyear contract, which will grow forward year-to-year. So…
Edward Paul Hemmelgarn – Shaker Investments, L.L.C.
Numerous contracts.
Richard R. Allen
Yeah, as numerous contracts you should see our reinsurance contracts. It’s been like a stack of them at this point.
Paresh Patel
Size of a…
Edward Paul Hemmelgarn – Shaker Investments, L.L.C.
Yeah, okay. Graham, you told me that they overlapped.
Okay, so we really won’t know exactly what that number will be until the season is over and you can tell us.
Paresh Patel
It may actually be into multiple years because, yes, and that’s why it’s going forward we are going to tell you what that accrual number is.
Edward Paul Hemmelgarn – Shaker Investments, L.L.C.
Okay.
Paresh Patel
Let me elaborate on this a little bit further that at this point. The real reason that we’ve gone into these complicated contracts is everybody tries to insurance on an expected loss basis, right and so consequently one hurricane every three years and here is the price for reinsurance for that.
Where we’ve taken this in next step is to say okay, we will pay you that but if the losses don’t occur, we want to have provision thereby some of the money comes back, okay. It seems like a rational thing to do given how many years, we’ve paid reinsurance and how little we have collected back, which actually to-date is zero.
Edward Paul Hemmelgarn – Shaker Investments, L.L.C.
Yes.
Paresh Patel
So, that’s why we’ve got these clauses in there, but unfortunately accounting wise, they wanted us to book the lower number, I mean it is what the GAAP says, yeah.
Edward Paul Hemmelgarn – Shaker Investments, L.L.C.
But, you obviously you got a recapture on if there in none, but there is unlimited reinsurance has uncap exposure if there is multiple feedbacks. There is no upper limit?
Richard R. Allen
It’s between the 134 versus 113 yeah midterm.
Edward Paul Hemmelgarn – Shaker Investments, L.L.C.
No, no, no. I mean every reinsurance is available, there is one or 10 events.
Paresh Patel
It depends on what 3D is involved.
Richard R. Allen
Yeah, I mean, we’ve got three-year 3Ds with four events, we’ve got five year 3Ds with aggregate limits on them and two event hurry at base and we’ve got single year single shot 3D, so each 3D has its own, it’s almost like, we’re putting the reinsurance tower like a Mosaic together at this point, yeah.
Edward Paul Hemmelgarn – Shaker Investments, L.L.C.
Okay. All right.
Lastly, what is your, what in the event of, let’s say hurricane, but what is your, is there a maximum exposure you have?
Richard R. Allen
Well, I think the usual number that’ll be referred to is what your retention before the reinsurance has extend and at this point, it’s $11 million is what the retention number is.
Edward Paul Hemmelgarn – Shaker Investments, L.L.C.
Okay.
Richard R. Allen
Okay. And that’s a general $11 million per event.
Paresh Patel
In general, yes. By the time we get to the third event, it sort of all depends on what the first two events where, yeah.
Edward Paul Hemmelgarn – Shaker Investments, L.L.C.
Okay. All right, that’s reasonable.
All right thanks.
Operator
Our next question comes from (inaudible). Please proceed with your question.
Unidentified Analyst
Yeah thank you. Just a follow-up on that, the $21 million differential that is over a number of years, and I hearing that right, so you would not recognize that if there is not events, you would not recognize that.
This year there only be a portion of it, this year and if it roll forward, is that right. So it’s rolled from behind too, right.
Paresh Patel
I think it’s $21 million for this year.
Richard R. Allen
$21 million is just for the year.
Unidentified Analyst
This year, okay, so when this year is done and say there is no event or a partial or whatever comes out that will be recognized and then we’ll go forward sort of on a new basis, and none of that $21 million will fall carry forward?
Richard R. Allen
Some of it may carryforward because of the…
Paresh Patel
Per year.
Richard R. Allen
Nature of the contracts, what happens is that if we go this year event some of that $21 million be used actually provide additional reinsurance for us next year.
Unidentified Analyst
(inaudible) we’ll recognize the user I understand.
Richard R. Allen
Yes, that kind of thing. As a thing rolls out what it does, it basically take out reinsurance costs for several years down the road, because one of the things that everybody has always been worried about the business is the volatility year-to-year of whatever the rates are for reinsurance, yes.
Unidentified Analyst
Are you thinking of I mean, obviously every year is a new year, but are you rethinking your reinsurance strategy anyway, and should we expect changes there may be within the next year or two or it’s kind of going to be on the same basis going forward?
Paresh Patel
Great, this is why I like having questions for me, you set him up so beautifully. What’s coloring our thinking where we are now, right is when we start out as a public company five years ago et cetera.
There used to be lots of concern that if there was an event normally would you have, would you be making any money for the year you’d have losses for the year plus you would possibly have a balance sheet event on your hand in terms of how much your capital will be reduced et cetera. As we’ve grown and matured we sort of gone for and retained less risks we sort of eliminated that balance sheet risk to a great degree, and then we were trying to sort of stay, it’s quite an event we would like to make sure that we will be profitable for the year.
Well, that's now evolved that if you kind of look at what our quarterly earnings seem to be pre-tax, you could probably take those single events and maybe even stay profitable for the quarter, so we sort of built modes around the business so to speak, and what your are seeing and this is why unfortunately this reinsurance stuff is getting complicated we are trying to hedge away the fact that if there is a event this year reinsurance rates next year could be much greater or something of that nature that's why we're getting to these multi-year contracts and we have the profit potential if there were no losses et cetera. So that we know that the business has a fixed expense component and not variable if you wanted to what the reinsurance markets are doing.
That makes sense.
Unidentified Analyst
Yes, sense. But I mean, the point, so your overall strategy, I mean that’s evolved and that’s you’re not going to do anything different in terms of, I know you’ll work with the some companies in offshore certainly.
Paresh Patel
Yeah, absolutely, I mean we are developing and growing those relationships just to ensure that we’ve some (inaudible) possible quarters. I would do anything to risk that, yeah.
Unidentified Analyst
Okay. And then, you mentioned Exzeo.
Maybe I missed it, but how is that? That’s a longer term idea.
What’s the progress there and what should we be hearing about now?
Paresh Patel
It’s actually progressing as expected,, which is going to take a little while. We’ll start to use the Exzeo software within the insurance operation for the company and made it available to a lot of the vendors and other parties that we deal with.
So it’s slowly gaining traction out there in the marketplace. These things take a little bit of time to get there.
Yeah.
Unidentified Analyst
Right. Okay, but it’s progressing on and are you taking losses or are there expenses there?
I mean, is there a breakeven period or anything?
Paresh Patel
I think it’s not a question of breakeven or in that sense because the whole way the software business works, it tends to be more of a payoff than a multiple valuation kind of thing as opposed to cash flow. The cash flow that it is consuming hasn’t materially changed over the last 18 months or so.
So the cash requirements of Exzeo have been baked into our earnings and balance sheet for 18 months at this point. It’s just a normal part of our operating expenses.
Unidentified Analyst
It’s okay. All right.
Thank you. Thank you very much.
Operator
Our next question comes from Andrew Shapiro with Lawndale Capital. Please proceed with your question.
Andrew E. Shapiro – Lawndale Capital Management LLC
Hi, a few follow-ups on the clearinghouse thing and also in the nature of your business and these policies. So first off, of the policies you’ve looked to acquire is there a bias for profitability and that you selected you can choose and do choose, let’s say fewer larger value homes versus many lower value homes.
Are those policies because of dollars, per dollar value the single policy are those policies more profitable for you up front and in terms of loss ratios?
Paresh Patel
Andrew, I don’t think that, clearly we select the profitability and really the way of looking at that is that was called underwriting, right. You’re basically selecting to say what’s risk represent and as you presented and as you look at them provide you enough premium to be compensated for the risk you are taking.
Andrew E. Shapiro – Lawndale Capital Management LLC
Right.
Paresh Patel
We obviously do that and we look at any number of criteria to try and screen policies to make sure that whatever we take on, and actually by the way this applies regardless of whether we do a takeout, whether we do an acquisition or whether we do organic policy growth. We’ll make sure everything we add to the book passes a stringent test that tells us that we have a profitable policy on the books.
The criteria is nothing to do with just– it’s when totally into do just with the size of the house. It also depends on where it is construction type, any number of other things.
So consequently, it’s not just the dollar figure that makes the difference here.
Andrew E. Shapiro – Lawndale Capital Management LLC
Right, but do you, in general do you find the policies on a $2 million home to be more profitable than policies on a $1 million home?
Paresh Patel
Well, let me just help you out with that, right. We have limitations that we don’t actually write homes that has coverage a lot, above $1 million and the sweet spot of our book is that I think the average exposure we have on our 803, is around $300,000.
Andrew E. Shapiro – Lawndale Capital Management LLC
Okay, well, that’s good because obviously one of the terms of the clearinghouse is that they are going to be dumping out the homes in excess of $1 million. The second thing is, do you have plans, as this clearinghouse kicks in, you presently don’t, you have these really low policy acquisition ratios, because I am assuming you just run really lean and mean, and new policy development or marketing infrastructure because you have this one very large seller, where you’re getting a lot of policies as and if the clearinghouse evolves where Citizens shrinks or the policies left within Citizens aren’t, what you’re looking for, is your internal strategy, your business plan, your strategic plan to build or acquire a new policy acquisition infrastructure and how much might that cost?
Richard R. Allen
Okay. As far as the policy acquisition infrastructure, I think, we all actually have it.
We’ve had it and to my earlier answer, to the answer for an earlier question. We’ve always had the – we’ve had this thing, we develop it over the years whether we actually use it or not, is a different question and historically in the last couple of years, we’ve not pointed to its test, and put it out there because we haven’t had the need to do so.
I’ll give you another example of how we look at that differently. We’ve done takeouts in the fall in every year, and I just don't think except for 2011.
Why didn’t we do a takeouts in 2011 because we did the acquisition of HomeWise and that was the method of growth that year. That's why we weren’t having an opinion as to whether takeouts were good or bad, we just had a better opportunity and that's were we went after.
And what we’ve done in terms of takeout, I think you will see that there over years where we did very small takeouts and other years where we did large ones. And what all of those variables are is just because you can do a takeout, doesn't mean that the opportunity is there and the profitability is going to be there in acquiring those policies.
So the growth of the shrinking of the business is more focused on the market dynamics and we have multiple levels with which to pull in which direction we want to go to. Another factor to that point that I can point to is I think if you look at our policy counts by January of 2009, who about November 2011.
The policy count didn’t materially go up very much. However, our profitability went up tremendously, because those are other things that we do.
It’s not entirely always about growth and policy counts, it’s also about optimizing your book, improving the book finding the bottom price percent of your policyholders and replacing them with 5% new policyholders which will not increase your policy count or your exposure, but could have a marked improvement on your profitability. So this is a lot more involved than just what the top line number.
Yeah.
Andrew E. Shapiro – Lawndale Capital Management LLC
Yeah. And finally is there another clearinghouse kind of a question, as the policies now that are considered for citizens will go into kind of like an auction or into the clearinghouse.
Do you anticipate HCI potentially evaluating bidding and participating during that 48-hour period for those policies or only looking at these policies that remain in citizens as that kind of passthrough the clearinghouse process?
Paresh Patel
Okay. Let me answer the question this way.
This whole idea of the clearinghouse, right? And a lot of people obviously citizens, legislators, et cetera have put a lot of effort into coming up with the concept of implementing a mechanism for doing that thing.
But there is interesting observation in the sense of, if these policies were so wonderful, right, why didn’t they take them out of citizens in November this year or November last year, or November the year before? Okay.
There is a presumption that when you put them up for auction, all these new policies, all these new insurers would show up and say, hey I’ve got to take this policy. Now as I was totally unaware that policy existed before you put it up in the clearinghouse.
The reality of this is, I think most of these policies are known to most of the insurers and has been for several years. So it's not entirely a given packet, as soon as they put up the clearinghouse, these policies will certainly find a new home, it may not occur.
Andrew E. Shapiro – Lawndale Capital Management LLC
Oh yeah, I understand. You’re talking about the focus inside of citizens already when come up for renewal, right?
Richard R. Allen
Yeah, (inaudible) isn’t there for renewal and….
Andrew E. Shapiro – Lawndale Capital Management LLC
I understand the point you’re making there. How about with new policies where historically the state farm agent basically shops this, he says that the brokers whoever have the best deals with the broker shows the home owner this policy and then their citizens.
And they don’t otherwise generally shop as in the clearinghouses obviously going to mandate much more of a shopping situation for new policies. Would you – bidding for those or you would just wait and see if stay within and stick with citizens?
Paresh Patel
Let me make a generic statement whenever we see an opportunity to take good policy in whatever message we always do, right. And the clearinghouse is all opens yet another method of doing, so if it were to come to that.
As far as that state farm agents that the safe farm agents, policy into citizens, just little bit of color on this seen that we have done at this point nine takeouts and that urban legend that you know the state farm agents have busily dumping policies into citizens. While when you bring a takeout in November like we did last year, one would logically go look at those policies.
And say let me takes those out mainly because we’ve got two-thirds state farm agents under contract. So we can take those policies out.
I just got to tell you when I was looking them last year, those policies weren’t there. I don’t know why, but they aren’t there.
So consequently this whole idea that these captive agents have dumping policies into citizens that other people would take. I believe that once upon a time as well, I’m on looking for the evidence and I don’t find the evidence.
It’s an interesting dilemma, I’m sure we’ll discover the fact of this starting of the New Year.
Andrew E. Shapiro – Lawndale Capital Management LLC
Okay.
Paresh Patel
Thank you.
Operator
Our next question comes from Cliff Orr with Privet Fund Management. Please proceed with your question.
Cliff Orr – Privet Fund Management LLC
Thanks for taking my follow-up gentlemen. I had a question related to reinsurance and sort of how you think about capital allocation.
I was curious, I saw on the 8-K release on the reinsurance program that the capital reinsurance company exceeding little over $9 million of premium to management owned entities and just from sort of a parent company perspective to the extent that management clearly views that as attractively price to risk, why not given the excess liquidity as a parent, repaying that attractively priced risk for the benefit of shareholders versus management owned entities. Just trying to think about and would like to hear how you sort of balance that consideration versus the ROI for liquidity as a parent company.
Thanks very much.
Paresh Patel
Okay. Great question I think slightly off target a little bit in the sense of let’s separating the two items in terms of risk retention by the HCI Group and then we’ll talk about the management, well let’s talk about the management entity.
The management entities are basically entities who set up because we keep telling that you couldn’t do reinsurance at the prices that were there and we’ve kept these things up and actually do have an effect of providing downward pressure on our reinsurance costs. The reason for that being is that because of these entities, we are buying less in the open market and these entities do not get a better deal than anybody else in the open market, inside they get it slightly worst deal that consequently is beneficial to the HCI group, okay.
Having said that in terms of risk retention how much we’re retaining, very simple way to explain this, there was a time when HCI used to say for sake of argument make $7 million a year per-tax income. You could at that point, risk $7 million of capital in the captive and earn $3 million more in profit, by using reducing the premium pay out to third party.
So now instead of making $7 million pre-tax you’re making $10 million pre-tax, a beautiful increase in profitability and but you’re risking $7 million of capital in case an event were to occur. That was then, where we are now if you are looking at $70 million of pre-tax income, does it make sense to risk another $7 million to go from $70 million to $73 million.
So that simple logic and rationale has meant that even though as we’ve increased more and more capital the risk that is retained by Claddaugh has been flat or increasing very, very small year-over-year. Claddaugh’s lack of growth is not because “their management entities that are taking that risk”.
Claddaugh’s lack of growth is because we just look at opportunity and the risk reward profile and we are more and more looking at what we have here as a wonderful business that’s functioning perfectly and why would you over leverage it. Does that help?
Cliff Orr – Privet Fund Management LLC
I understand what you’re saying. I’m just trying to think about, I guess, I think of it less in terms of the scale of earnings and the lower effect given our earnings are now higher as I do, each incremental investment decision should stand on its own sort of irrespective of the scale of overall earnings.
Paresh Patel
I think premium is there, right, because through this way we could have – if you look at those revenues that were spent given a feeling that $113 million amortization, but let’s see the $134 million, the higher number. You could have reduced that by $20 million or $30 million by retaining additional risk inside that, right.
However, because we have that $40 million money that we’ve raised in the bond offering in January, which has been untouched we could have quite happily retained that and made that number less. However, we would much rather conserve that cash, because one of these days there will be an event and the greatest opportunity that we are going to have is to be financially strong the day after the event, because look at it on a different level.
We talk about clearinghouse and things going over in that way. Nobody is out about hurricanes in the state of Florida.
And when the next hurricane hits there will be tremendous opportunity for those people that have financial wherewithal to pick up growth like you don’t believe. So we are as much thinking about those things and putting out that in a conservative stance ready for that day.
It may come this year, it may come three years from now, but that day will come.
Cliff Orr – Privet Fund Management LLC
So, essentially you’re saying you feel like the potential return on that cash is higher, waiting on inevitable event become rather than retaining incremental risk for this year.
Paresh Patel
Yeah.
Cliff Orr – Privet Fund Management LLC
Okay what percent do you – thanks for the results on this year.
Operator
Our last question comes from Casey Alexander with Gilford Securities please proceed with your question.
Paresh Patel
Casey?
Operator
We had some musical, so and we have no more further questions in the queue so I’ll turn it back over to you closing comments.
Les Holland
Okay. Thank you all for participating in the conference and I apologize once again for making our research programs and things so complicated.
But we’re doing this because we’re trying at this point to ensure that this company keeps that streak of profitable quarters going as far into the future as we can. Whether we succeed or not, we are definitely going to try to make sure we keep this streak going.
Thank you.
Paresh Patel
Thank you Les Holland, at this time we’ll be closing down.
Operator
This concludes today’s teleconference. You may disconnect your lines at this time.
And thank you for your participation.