HERITAGE INSURANCE HOLDINGS INC Sidoti Small-Cap Virtual Conference

Brendan, thank you. Good afternoon, everyone, and thank you for joining us. I'm Kirk Lusk, CFO of Heritage, and I'm going to take a few minutes to walk you through Heritage Insurance Holdings, what the company is today, what the second quarter looked like, and why we believe the positive trajectory of our business will continue for the next few years. Of course, what would a presentation be without the safe harbor? Heritage is a super regional property and casualty insurance holding company. We trade on the New York Stock Exchange, HRTG. We're headquartered in Florida, and we were established around 2012, went public in 2014, and have roughly 517 employees. At the end of the second quarter, we had $2.5 billion of total assets, $567 million of total equity, and book value of $19.09 per share.

We carry $1.4 billion of premium in force across 351,000 policies. The most important thing to understand about the exposure is where it sits. Nearly half, 47%, is in the Northeast, about 30% in the Southeast. The balance is spread across the Mid-Atlantic, the West, and the Pacific. Just over 70% of our insured value is outside Florida. As you can see, we are not just a Florida homeowners company, which provides us with significant advantage that I will touch on momentarily. Moving to the quarter. Let me go straight to the quarter because the numbers are the clearest validation of the argument. Second quarter net income was $16.7 million, or $2.05 per share. Earnings before taxes were $82 million, up $19.2 million from the prior quarter. The driver was margin, not volume. Our net combined ratio was 64.8%, an improvement of 8.1 points from 72.9% a year ago.

Essentially, all of that came from the loss ratio, which improved 8.1 points to 30.4%. The expense ratio was flat at 34%. Importantly, our top line was deliberately smaller. Gross premiums written were $388 million, down 5.5%. Gross premiums earned were $351 million, down slightly. But net premiums earned, what we keep after reinsurance, went up 2.4% to $201 million. More of every premium dollar is staying with us and less is going out the door to reinsurers. Premiums in force was $1.4 billion, down 1.4% year-over-year, and policy count was down 5%. I want to be direct about what sits inside those declines because there are two different stories. Personal residential premium was stable to modestly higher at $1.16 billion. The decline is mostly entirely commercial residential, where premium in force fell 12.7% to $237 million.

That reflects competitive pricing pressure in the commercial residential market, and our response has been to let business go rather than to match prices we don't think are adequate. We would rather shrink that book than write underwriting at a loss. To put the quarter in context, it helps to see the four-year arc. In 2022, we lost $154 million. That included $94 million of goodwill write-off and $40 million retained losses from Hurricane Ian. That year was the bottom and it forced a hard reset. We underwrote the entire portfolio, we filed for rate increases, we non-renewed business that didn't meet our standards, we stopped writing new personal lines across most of our territories, and we invested in analytics. Our strategic initiatives were designed to improve our profitability, and as a result, we have seen strong improvement each year. In 2023, we earned $45 million.

In 2024, net income was $61.5 million. In 2025, $195 million. Through the first half of this year, $98.2 million, with $36.5 million in the first quarter and $61.7 million in the second quarter. Importantly, the test we set for ourselves wasn't simply to be profitable in a quiet year, in other words, a year without catastrophes. It was to be profitable throughout catastrophes. In 2023, we had $40 million of retained loss from hurricanes Idalia and the Maui wildfires. 2024 had $105 million of retained losses, which included hurricanes Milton, Debby, and Helene. The first quarter of 2025 had $32 million from the California wildfires, and the first quarter of this year had $24 million associated with the Northeast winter storms. Most importantly, it demonstrates our ability to stay profitable even when events happen.

That's the difference between a company that earns well when the weather cooperates and one that treats catastrophes as a normal cost of doing business. As you can see, we are a very different company today than we were just a few years ago, and advantageously positioned to continue that trajectory. That brings us to our strategic shift that is currently underway at Heritage, which is a critical aspect of our discussion today. In December of 2022, we largely ceased writing new personal lines business in the Northeast and Florida because reinsurance was tightening, rates needed to increase, costs were climbing, and risk-adjusted return just wasn't there. That said, we made a deliberate choice at that time. We kept our infrastructure intact. We held onto our sales organization, the agency relationships, and the customer support functions.

Even while we were not writing business, we knew the market would turn, and we wanted to be ready. Three things have changed since 2022. Our rate and underwriting actions have worked, reinsurance pricing has stabilized, and the legislative reforms in Florida has changed the litigation environment we underwrite into. At the same time, there's real disruption across several of our markets, and that disruption is creating some opportunity. As such, we've reached an inflection point and are pivoting to a controlled growth strategy. We've opened up in almost all our markets for new business and have already started writing new personal lines business. We're also pursuing new geographies, specifically a planned entry into Texas on an E&S basis. The operative word here is controlled growth. We're filling capacity we have.

We're not loosening underwriting standards to do it, and we won't write policies we believe are underpriced. Geographic diversification and intelligent growth. The first, or actually, underneath, we have three disciplines that we'll continue to run through. The first is generating underwriting profit, rate adequacy, risk selection, restricting new business and markets or products where we're already concentrated with inflation guard, so insured values keep place with replacement cost. The second is managing portfolio diversity. No single state accounts for more than 29.6% of our total insured value. About 70%, as I mentioned, sits outside of the Southeast entirely. We're complementing admitted business with excess and surplus lines in several states, which gives us rate and filing flexibility, as we simply don't have on an admitted basis. Worth noting, Florida insured value was actually up 3.3% versus the second quarter of last year.

This is diversification achieved by growing elsewhere, not by retreating in Florida. Strategic profitability initiatives. The third is capital allocation, steering capital towards whichever segment is earning the best return. Commercial residential was that segment in 2023 and 2024. The competitive pricing we are now seeing there is precisely why capital is now rotating back to personal lines. We hold $439 million of combined statutory surplus, which is what funds our organic growth. On returning capital, our board evaluates dividend and repurchases quarterly. The current authorization is $50 million through the end of 2026. Through the end of June, we repurchased just over 1 million shares for $24.6 million. Of that, just $13 million applied to the new authorization, so that leaves us over $37 million available. We continue to see our shares trading below intrinsic value, and we aggressively through the first half of this year.

Now reinsurance, which for a coastal property insurer, this is not a line item, it is a core part of our business. We fully placed our 2026 Catastrophe Excess of Loss program in May. Three things about the renewal. First, cost. We achieved substantial adjusted savings in the favorable market this year. Actually, over $60 million worth of reinsurance savings with that placement. Second, structure. We placed a shared limit to protect each entity, $1.2 billion in the Northeast, $1.8 billion in the Southeast and $1 billion in Hawaii. There are no co-participations in the syndicated program. We are not retraining slices of layers we paid to cede. The entire program is indemnity-based, so we are covered for our actual losses rather than against an index that does not match them. First event retention is $50 million in the Southeast and in the Mid-Atlantic and Hawaii, and $38 million in the Northeast.

The third is capital markets. $55 million of this year's limit comes from catastrophe bonds issued through our special purpose vehicle, Citrus Re. This multiyear capacity that locks in terms and diversifies us from traditional reinsurance cycle. In addition, our panel is deep and highly rated. Swiss Re, Munich Re, Transatlantic Reinsurance Company, Arch Reinsurance Company, Hannover Re, Ariel Re Group, Odyssey Reinsurance Company, D. E. Shaw on a collateralized basis. These are just a few of the many reinsurers on our panel, but it demonstrates the strength of our reinsurance partners. Along with our income statement, the balance sheet has also been rebuilt along those earnings. Book value per share has gone from $5.13 at the end of 2022 to $19.09, up close to four times. Shareholders' equity has gone from $131 million to $567 million.

Cash and invested assets are just under $1.4 billion, and debt to capital has gone down from roughly 50% to about 11% over the same time period. The work we have done, including our debt facility, which has a $75 million term loan, $50 million revolver, and a $75 million deferred term loan. This gives us considerable financial flexibility going forward. The investment portfolio is deliberately conservative. It has very short duration, 3.4 years, average credit rating of A+ weighted towards municipals, corporates, and government paper. Book yield has been climbing as older positions roll off and we invest the funds into new maturities. Investment income was up $10.6 million in the quarter, up $700,000 year-over-year. We take underwriting risk, so from an enterprise risk standpoint, this portfolio exists to protect our claims-paying ability, not to generate excitement. Vertically integrated structure. We are vertically integrated.

Underwriting, actuarial, customer service, claims processing, and adjusting are all in-house, alongside a preferred contractor network through our mitigation and construction division. These parties are used as needed, not by default. That lowers costs, but more importantly, it gives us control and a hedge in catastrophe years. When the market price of adjusters and controllers spike, its meaningful part of our weight for earnings should be less volatile than the exposure alone would suggest. Technology. We are building a data foundation, a mature enterprise analytics platform used across product, sales, underwriting, claims, actuarial, and finance, with AI capabilities layered on top. We are near completion of the Guidewire conversion, which gives us policy administration, claims, and billing, which will be streamlined on how we can move rate and policy changes through the system.

We have an experienced management team that when you look at all the changes that have occurred over the last several years, this is the group that really led that transformation. Ernie has been CEO since 2020. I joined with the NBIC acquisition in 2018. Both Tim Moore and Tim Johns have been in their roles over 10 years. Let me close with the thesis in five lines. We are a geographically diversified super-regional property and casualty insurer with $1.4 billion of premium in force and the majority of our exposure is outside Florida. Our profitability initiatives worked. A 64.8% combined ratio and $98 million of first half earnings. We have demonstrated we can absorb cat losses and stay profitable in the quarter and in the year.