Federated National Holding Company's (FNHC) CEO Michael Braun on Q2 2014 Results - Earnings Call Transcript

Jul.29.14 | About: Federated National (FNHC)

Federated National Holding Company (NASDAQ:FNHC)

Q2 2014 Earnings Conference Call

July 29, 2014 10:00 AM ET

Executives

Michael Braun – President and CEO

Pete Prygelski – CFO and Treasurer

Analysts

Arash Soleimani – KBW

William Meyers – Miller Asset Management

Ron Bobman – Capital Returns

Samir Khare – Capital Returns Management

Doug Ruth – Lenox Financial

Rich Wilson – Private Investor

Operator

Good afternoon, and welcome to Federated National Holding Company’s Second Quarter 2014 Financial Results Conference Call. My name is Sam, and I will be the operator for today. Please note that today’s call is being recorded. At this time, all participant are in a listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions).

Statements in this conference call that are not historical facts are forward-looking statements. Without limiting the generality of the foregoing words such as anticipate, believe, budget, contemplate, continue, could, envision, estimate, expect, guidance, indicate, intend, may, might, plan, possibly, potential, predict, probably, pro forma, project, seek, should, target or will or the negative thereof or other variations thereon and similar words or phrases or comparable terminology are intended to identify forward-looking statements.

The matters discussed on this call that are forward-looking statements are based on current management expectations involving risks and uncertainties that may result in these expectations not being realized. Actual events, outcomes and results may differ materially from what is expected or forecasted in forward-looking statements made on this call, due to numerous risks and uncertainties including, but not limited to the risks and uncertainties described in this conference call or press release issued today and other filings made by the company with the SEC from time-to-time.

Forward-looking statements made during this presentation speak only as of the date on which they are made and Federated National Holding Company specifically disclaims any obligation to update or revise any forward-looking statements to reflect new information, future events or circumstances or otherwise.

Now at this time, I would like to turn the conference over to Mr. Michael Braun, Chief Executive Officer, and President of Federated National Holding Company. Please go ahead, sir.

Michael Braun

Good morning. Thank you for joining us today to discuss Federated National Holding Company’s second quarter 2014 financial results. I’m joined on the call by Pete Prygelski, our Chief Financial Officer. Our financial results for the quarter can be found in our earnings press release.

Highlights as measure against the same three-month period last year include 228% increase in basic earnings per share, 117% increase in net premiums earned, 109% increase in revenue, 82% growth in Florida homeowner policy account to approximately 152,600, and a 54% increase in gross premiums written.

We are pleased to announced strong earnings, which reflects the hard work of everyone associated with our organization from the team that works for our company to our partners, the agents, the vendors and our re-insurers. We remain committed to the service that has enabled us to achieve this success and the discipline of underwriting quality business.

With that, we are glad to open up the call to your questions.

Question-and-Answer Session

Operator

(Operator Instructions). And I’m showing our first question is from Arash Soleimani from KBW. Your line is now open.

Arash Soleimani – KBW

Hi, good morning.

Michael Braun

Good morning.

Arash Soleimani – KBW

And congrats on the quarter. Just had a couple of questions here. In terms of the growth you had, how much of that came from the Allstate program this quarter?

Michael Braun

We wrote approximately $50 million of new in the quarter – new homeowners’ premium that is. And we do approximately $1 million a week within the Allstate agencies. So roughly you can say around $13 million just off the top of my head of the $50 million.

We’re committed to all of our independent agents, the majority of the business is from the independent agents, as well as our commitment to the Allstate agents.

Arash Soleimani – KBW

Okay, great. And was there anything else that drove some of the growth within the independent agent network or was it just kind of the same reasons we saw last quarter?

Michael Braun

Yes, I don’t think there was anything unusual in the marketplace that transpired in the second quarter. In the third quarter we’re writing around $3 million a week of new business right now. Third quarter tends to be the slower of the quarters in terms of opportunities to write new business but that’s where we’re at right now.

Arash Soleimani – KBW

Okay. And is your appetite I guess, I guess a bit less during hurricane season to write new business?

Michael Braun

No, actually we have a very robust reinsurance program. We’ve bought the limit that we have based on the projections that we have of writing through wind season. So our appetite is not any different. It’s just traditionally insurers write lots of business during the third quarter.

So, therefore there is lots of renewals, lots of expirations of existing business out there. So, it’s more organic of policies that are perhaps home to being purchased and so on. But we continue to write voluntary business that’s our focus and that’s what we’ll continue to do.

Arash Soleimani – KBW

Sure. And switching to Monarch, I think you had mentioned before on your last call that part of the logic there was that you could get the rate levels that you consider adequate by going through Monarch.

So, with that said, would that imply to some of your other competitors in Florida wouldn’t be able to get those higher rate levels either? And then, if so to what extent does that impact your I guess competitive position when going to get some of those policyholders? Would your prices be significantly or materially above the rest of the market in that sense or?

Michael Braun

Sure. I think that we operate in a very granular manner. Our underwriting is very specific. And I think it’s been very successful. The concern is the trajectory within Federated National at some point will slow the growth. And there is so much opportunity outside of the niche that we’re in that we’re looking to write business.

There is a lot of quality business out there, outside of our niche within the Florida market that we want to go after. We think Monarch enables us to do that. And we’re very hopeful that we anticipate in the application to the Office of Insurance Regulation here very soon. And we’re hopeful that we get approval and can be up and running by January 1.

But I think those rates will be very competitive just like the rates within Federated National are very competitive. And that requires when you have competitive rates you need to be a disciplined underwriter. And we would be using the exact same approach in that regard to be writing business that we believe is sustainable.

Arash Soleimani – KBW

Okay, great. Thank you so much.

Michael Braun

Thank you.

Operator

And our next question comes from the line of William Meyers from Miller Asset Management. Your line is now open.

William Meyers – Miller Asset Management

Hi, congrats on the quarter. My question is, your cash and total investments it looks like from your balance sheet went up $88 million in the six months. And during that six months I think you reported about $20 million of net income. Could you walk me through the difference between how much cash is coming in and what your net income is reported?

Pete Prygelski

Sure, William. When we write the policies we’re collecting the full premium. So all that basically becomes unearned premium which is a liability on the balance sheet and you’re only earning it one-365th per day. So, your total investment portfolio is going to continue to go up ahead of the earnings. Because a lot of that’s parked on the balance sheet as unearned premium until we can earn it over the course of the policy period.

William Meyers – Miller Asset Management

Okay. And then, in a similar light, and maybe you just answered this. You list total liabilities of $279 million, is that primarily the sum, this unearned premium or is that broken down into some other large chunks?

Pete Prygelski

No, I mean, if you look at our balance sheet as of 6/31, the unearned premium is $178 million of that number. So, the growth on our balance sheet, the total liability is going up is a directly correlates to all the business we’re writing.

William Meyers – Miller Asset Management

Okay. So, I can fill in the sense with those liabilities, that part of the liabilities comes down as those policies are recognized?

Michael Braun

Exactly.

Pete Prygelski

No, exactly. If we didn’t write another policy today over 12 months that $178 million would go to zero. But of course we’re writing additional policies. So as we are recognizing the revenue, we’re still building that – we’re still in a growth mode so that balance is not going to probably not going to come down. But if we stop writing today you’re exactly right. In 12 months that would be zero.

William Meyers – Miller Asset Management

Okay, great. That helps me understand. Thank you very much.

Pete Prygelski

Thank you.

Operator

Our next question comes from the line of Ron Bobman from Capital Returns. Your line is now open.

Ron Bobman – Capital Returns

Good morning, and fine job this quarter. Also I like the way you didn’t waste our time really in the press release like 99 – what 99% everyone else does. So, congrats again on a good quarter.

I just had a question about the agent environment and sort of the competitive landscape on the front-end, currently obviously it’s been a handful of new entrants, lower reinsurance cost. So I imagine it’s a little bit of a changing dynamic from what it was a few years ago. Could you talk about sort of what the agency and production environment is? And maybe also talk about sort of the retention of renewal policies? Thanks a lot guys.

Michael Braun

Yes, thank you. In terms of the agents, that’s the backbone of our business. Without our agents our business plan doesn’t work. And we continue to build on that model and continuously service the business that comes in. The agent has to feel comfortable where they’re placing that business. They want to know that he policies are going to be renewed that questions are going to be answered timely. That policies will not have additional premiums, things like that.

So, we’ve really established a lot of trust with our agents in terms of claims. That’s why we are in the business as taking the claims. And agents want to make sure that that’s done timely. So I think the good will that we have with our agents is significant. New entrants in the market, it will take them time to establish that good will. But I think also people are targeting different parts of the market.

So I think that you’re going to continue to see us writing voluntary business. As I’ve indicated we’re doing approximately $3 million a week right now. In the third quarter the market can change at any point. But of course people can lower their rates to grab market share or change commission structures to whatever it may be.

Our interest is to write sustainable quality business. If someone feels that they can undercut us, we’re not going to match it and write something that we don’t believe to be profitable. So, we don’t see that happening in the marketplace right now. But we will continue to stay focused on our agents and underwrite quality business and write business that we believe to be profitable.

Ron Bobman – Capital Returns

And what’s retention like, is Florida a market into itself as far as the retention ratios, renewal retentions ratios that you run because of what the state experienced in the past?

Michael Braun

Yes, generally ours runs approximately 88%. And that includes that’s new business this year versus the prior year. So, you do lose some policies throughout the year. Maybe someone sold their house and so on. But I think that I find that a lot of the business that we write is coming from other carriers.

So, I won’t necessarily classify that we are grabbing business from citizens as they downsize. I think people are specifically targeting citizens as a competitor. That’s not how we look at it. I think citizens as out there, it’s a residual market. And that’s certain carriers that’s what they’re specifically targeting.

But I think what we’re finding is most of ours is coming from other carriers, that we’re just beating in the marketplace, either our rates are slightly better or the same but people are, the agents are placing just because of their confidence in us.

Ron Bobman – Capital Returns

Okay, gentlemen. Thanks again. See you soon.

Michael Braun

Thank you.

Operator

Our next question comes from the line of Samir Khare from Capital Returns Management. Your line is now open.

Samir Khare – Capital Returns Management

Hi, gentlemen. (Inaudible), Capital Returns. I just wanted to get some more questions out of the way. The realized capital gains, any difference in investment strategy that is resulting in elevated capital gains there?

Pete Prygelski

I think on the last call Samir, I might have mentioned and I’m pretty sure I mentioned that we were trying to reduce the equity in our investment portfolio. It had gotten up to like 16% to 20%, just because of market appreciation. And now we can have it down to about the quarter closed at like 10.5%. So, all the way from 20% down to 10.5%.

So, in April, we sold some equities and rebalanced the portfolio. And we continue to take new cash that we receive and put it into fixed income. So, all that was, was in April, we sold some equities to rebalance the portfolio and it resulted in, I think it was $1.3 million after tax.

Samir Khare – Capital Returns Management

Okay. And any reserve development in the loss ratio or either way?

Pete Prygelski

No, no.

Samir Khare – Capital Returns Management

Okay. And what is your surplus now?

Pete Prygelski

Approximately $92 million.

Samir Khare – Capital Returns Management

Okay. And what is your cash balance at hold at 6/30?

Pete Prygelski

As of – about $16.5 million.

Samir Khare – Capital Returns Management

Okay. And just talking about the Monarch strategy a little bit, does that have the potential to increase the submission flow from all your agents and as well as the stickiness?

Pete Prygelski

Absolutely Samir. Not only does it – it makes us, I think we’re very relevant with our agents. It makes us even more relevant. Because people tend to know the niche that we’re looking for. And maybe they’re not looking at us in other circumstances when they should be.

So, yes, being able to say yes more frequently for our partner agents, I think that creates a lot of value in our relationship.

Samir Khare – Capital Returns Management

Okay, great. And then, given the trajectory of submission flow right now, and your current rate plans, I know there was some talk about different rate plans with what you think you’re going to do with Monarch versus Federated. Could you see the $3 million to $4 million per week of new business that you’ve seen in the first six months? Could you see that increasing or you think that we’re in kind of in a steady state now?

Pete Prygelski

Obviously we can’t predict the future. However, I think that trajectory has been fairly solid for a period of time. And we have no reason to believe that will change. It can change obviously with anything that happens in the market.

Federated National Insurance Company just recently we took a 3% overall average rate decrease that goes into effect in September. But I think that I don’t think that Monarch will really cannibalize much of Federated National’s business. At least that’s what we’re intending before we get our rate filings into the state.

We’re really targeting a specific niche. So I think that Federated niche will remain healthy. But there is just so much business out there that we’re just not able to get. And in many cases, agents do want to place it with us. Our rates are very competitive.

But we don’t believe the rate is sufficient for that individual risk not that that’s not a good risk. But the cost associated with that risk, number one is our reinsurance expense and number two, what we – what our data tells us would be our ALP or all of apparel losses. So that’s why we’re looking for this flexibility to have the second carrier.

Samir Khare – Capital Returns Management

Okay, okay. Just a few questions on the reinsurance program, the quarter share specifically. What are the feeding commissions you guys got on the quarter share?

Pete Prygelski

25%.

Samir Khare – Capital Returns Management

Okay. And where will that show up on the income statement, with up the other income or?

Pete Prygelski

No, it won’t. It will be part – it will reduce our deferred policy acquisition costs. So it will be netted against commissions we owe agents. So it just goes into the part of bit lower the (inaudible) balance. And then statutorily it lowers our commission expense.

Samir Khare – Capital Returns Management

Okay.

Pete Prygelski

Yes.

Samir Khare – Capital Returns Management

And then the profit commissions on the quarter share, when are those calculated and payable? And where in the income statement will those show up?

Pete Prygelski

They are payable at the end of the contract which is June 30, 2016 assuming certain conditions are met which are no-storms or no storms over certain dollar amount. And hitting some all other apparel loss ratios which basically good to say under 30%. So, that’s when it’s payable.

How we’re accounting for it is we are looking at the probabilities of there being no storms in two years based on air enormous, data provided by Aon. We’re looking at our probability of being under 30% ALP that’s the gross earn, not the net. And based on weighted averages, we’ve determined that we’re going to begin the book $14 million over the next 24 months.

So, in the next quarter, and it will be pretty clear on our press release and in the Q that we have booked approximately $1.6 million of income in the quarter that is contingent on us hitting these directional at the end of the contract period.

So, we’re footnoting it because it could be reversed right. If there is a storm or if our book runs hotter, then we anticipate that income could be reversed so that’s the way we’re going to book it.

Samir Khare – Capital Returns Management

Okay. And that shows up in other income or?

Pete Prygelski

Yes, we haven’t decided how – it’s going to be able to show up in other income or contingent income, we’ll come up with some. But it will be clear and on the conference call, Mike and I will make it clear where that is. And we will footnote it that it could be reversed if these conditions aren’t met.

Samir Khare – Capital Returns Management

Okay. And just on the quarter share of percentage, can you help me understand the justification of that actually during the quarter share, why do it now, why 30%?

Pete Prygelski

Yes, Samir. The driving factor behind that was, obviously the reinsurance market is abundant, the capital in the market. And there was an appetite from some of our reinsurance partners that wanted to be on our program. And it would be more efficient for them to do it via quarter share.

So, as you can see, we haven’t done quarter share on our homeowner’s book really since inception for the last 15 years, never had it. And I’m not necessarily a fan of quarter share. However, we saw the opportunity to protect our shareholders and policyholders by actually saving money day one. And on top of that if there is no storms and our ALP performs as we expect that there could even be more of a bonus associated with it.

So, it’s hard not to take that opportunity with some of our quality re-insurers to just structure our program a little differently. And like I said the focus is protecting policyholder surplus and our shareholders. And I think we think that, while saving even more money.

Samir Khare – Capital Returns Management

Okay. And can you help me understand why 30%? I was going to say in the context of a $40 million equity raise, predictive view, you’ve done a larger quarter share and raised less, can you help me understand that balance?

Pete Prygelski

Well, basically the 30% just came from the quarter share is stepping in and helping us not only with our retention but primarily layer one. Layer one going up to $100 million. So, the quarter share affords protection for two events up to $100 million year one, two events up to $100 million year two.

So, where I guess the inflexion point with layer one of where excess of loss worked better and where the quarter share worked better, that’s where we’re most comfortable. But we absolutely had flexibility that we could have done more or less quarter share obviously.

Separately the capital raise, our intention is to make sure that we always have sufficient capital well on hand to support our insurance carrier. Even though quarter share can give you a statutory surplus can give relief on statutory surplus. It’s our intention to always have capital on-hand, in case that quarter share needs to be unwound for any reason that we are comfortable with all of our ratios.

Samir Khare – Capital Returns Management

Great. And just on the capital raise, what do you guys think of the timing of it and how much do you intend to push down to the subs?

Pete Prygelski

There is not a lot that we can add to that. We think that we’re really executing on our plan. We think that Federated National has growth that is demonstrated and opportunities in front of it. We think we’re very hopeful that we can get Monarch up and running with regulatory approval writing business to continue growing our company and protect our policyholder surplus and protect our shareholders with.

Operator

(Operator Instructions). Our next question comes from the line of Doug Ruth from Lenox Financial. Your line is now open.

Doug Ruth – Lenox Financial

Hi, congrats, on the beautiful report.

Pete Prygelski

Thank you.

Michael Braun

Thank you.

Doug Ruth – Lenox Financial

Is there any change as far as who the core customer is for you in the third quarter of 2014?

Michael Braun

No, Federated National, we’ve really targeted in within the Florida property market and that remains (inaudible) the expiration of policies within Florida as we said a little earlier but for domestic carriers in Florida to write new business. But we’re still targeting the same.

Doug Ruth – Lenox Financial

And how do you describe the relationship with offset (ph), does this appear to be stable at this point?

Michael Braun

Absolutely. We’re very fortunate to – five actually six carriers that are in the state that were invited to present, into Orlando to Jacksonville and then Fort Myers, Miami. And then into plantation. And to deepen our relationship and deepen the understanding of how in their Allstate corporation as well as how they can give us the business that we’re targeting.

The process works in an Allstate agency that they see up their in-house carrier which is called Castle Key will take the risk, which in most cases does not. Then it goes into the I-Vantage platform which is their general agency, Allstate’s general agency.

And that’s where – as long as there was admitted markets will take the risk, the process stops and the agent will place it there. If no one will take the risk, it then goes into citizens which then would go through this clearing house process where the other carriers in the state have an opportunity to get the business at that point.

But that clearing house mechanism comes after the first level and the second level, the first level being Castle Key looking at the risk and the second level being the I-Vantage partners looking at the risk. So, I think we have a great relationship, not only with the Corporation of Allstate but also with their agents. And I think it’s a successful partnership.

Doug Ruth – Lenox Financial

Sounds terrific. Could you talk about the employee count now and what you think – are you hiring additional people at this point?

Michael Braun

Yes, absolutely. We’re up to around 210 people. And we’re continuously hiring quality folks. Retention is not a challenge, always bringing in quality people is not as easy as it sounds. But I would say that we are staffed where we need to be. However to stay current and ahead of the trajectory, we continue to staff up.

Majority of the growth in personnel comes on the underwriting side/customer service and processing as well as on the adjusting side. We continue to add not only desk adjusters but field adjusters. But we have sufficient office space, our IT infrastructure, everything that we need to do to run our business we feel is there in place.

Doug Ruth – Lenox Financial

And then, is there any additional changes planned for the investment portfolio now or do you like your – the portfolio with the stock in bank composition?

Pete Prygelski

Doug, I think that we’re going to continue to focus on lessening the equity portion of the portfolio and try to get that around down to 7% to 8% of the portfolio. And we continue to stay short in duration, only because it’s inevitable. I think that rates are going to go up and we want to be in a position that we’re not too far out on the curve that we get killed with bombs that are dropping in value because rates are going up.

So we continue to monitor the duration of the portfolio to keep it under three and half years. And we look to lessen the equity position.

Doug Ruth – Lenox Financial

I like the strategy.

Pete Prygelski

Okay.

Doug Ruth – Lenox Financial

Could you talk some about citizens and where you think they are in the industry at this point?

Michael Braun

Yes, citizens peaked at around just about 1.5 million to 1.6 million policies. The last number that I have are little over 900,000. And Mr. Gilway who runs that and as I’ve spoken, that he like to get it down to in the 500,000 range. I don’t know if he’ll be successful in getting it down there, we’ll see. But there is clearly that effort and I think that’s admirable.

In terms of the growth of citizens, policies, before they can go into citizens have to go through this clearing house mechanism. And I think it’s great. What it does is it ensure that risk that are can be placed in the voluntary market don’t go into citizens.

But I think this mechanism has worked a little differently than originally expected. Because it’s such a process, my understanding is that quote can take 30 minutes as much as 40 minutes. It’s having the desire to outcome of limiting citizens growth because the agents can be a frustrated trying to get a quote to go into citizens and the clearing house mechanism.

So, I don’t think that citizens will grow and I think they’ll continue to downsize. I just don’t know how low they’ll get. Perhaps they can shed another 100,000 policies by not being written organically or through depots (ph) I’m not sure. Maybe it is another 300,000, 400,000 or 500,000, time will tell.

Doug Ruth – Lenox Financial

Okay. Could you share your vision like how could Federated look in, one two five years, what size could the company be and how much of the market could you possibly have somewhere in the future?

Michael Braun

Well, I’m always reluctant to make those strong forward-looking statements. But I think that Federated National and hopefully soon, Monarch National, I think we’re really poised for success.

I think our overhead is lower than most. Our expense is lower than most. Even our general agent’s commission that our MGA and what we pay the agent is significantly less than our competitors. That instantaneously gives us a cost advantage. I think our ALP program and our claims process is strong. And we pay promptly, fairly and quickly which will continue to keep our ratios in line.

And I think we do a very good job modeling our reinsurance program. I think there was an opportunity for Federated National to grow significantly. We’re only at 2.6% of the market. And I get that question all the time. And I don’t know if Federated National can grow to 3%, 4%, 5%, 6%, 7%, 8% of the market. But somewhere in that range I believe that we can get to at some point.

Anything can happen, circumstances can change in the market, new entrants, competitors and so on. I believe Monarch can have the similar success because I believe we’re going to – that’s going to be well received by our agents. It’s going to be run professionally. And everyone can expect the same level of service. And as long as we can get our rate structure where we think we can grow the business, I think there is a tremendous opportunity.

And once again, we don’t know how big that can get but I think there is a great opportunity for us to grow both of these companies in the foreseeable – like you said three to five years.

Doug Ruth – Lenox Financial

Okay.

Michael Braun

But I want to make sure where everyone understands, there is no race, there is no mandate that we need to grow. Our growth will only come if we believe it’s sustainable and it’s profitable. So if we can get to that size that’s great. But we are focused on the bottom-line earnings of the company and the ability to have an underwriting profit.

Doug Ruth – Lenox Financial

I like it. Thank you for answering my questions. And congratulations again on a great quarter.

Michael Braun

Thank you, Doug.

Operator

And our next question comes from the line of Arash Soleimani from KBW. Your line is now open.

Arash Soleimani – KBW

Thanks. I had a couple of follow-ups. Can you provide net premiums written for the quarter, please?

Pete Prygelski

Net premiums written?

Arash Soleimani – KBW

Yes.

Pete Prygelski

Well, growth premiums written for the quarter was $107 million. So, net premiums earned was $51 million. So, I don’t think – I think you meant gross premiums, do you mean gross premiums earned or written because?

Arash Soleimani – KBW

No, I meant net premiums written, I don’t think I saw that one?

Pete Prygelski

Net premiums written, well you don’t write, it’s written premium minus you see gets to your net premiums written. So net – so we don’t really track that so we have gross premiums written, gross premiums earned back out the ceiling. And you come to net premiums earned. So you won’t see net premiums written.

Arash Soleimani – KBW

Okay. Because I’ve seen them in the last few press releases, it wasn’t in there this time. I think you guys had gross premiums written, minus gross premiums seeded and then net premiums written?

Pete Prygelski

Well, it became – that became a little confusing to a lot of people with the prepaid reinsurance and everything else. So now it’s more streamlined, it’s just – here is gross premiums written, gross premiums earned, net premiums earned. The difference between the gross premiums earned and net premiums earned is what we seeded for CAT reinsurance and other reinsurance programs we have.

Arash Soleimani – KBW

Okay, that’s fair. I like it that way better to be honest, so I appreciate that change. I just wanted to confirm, I think you said on the duration that you try to keep it under 3.5 years, do you have – I guess some more specific, is 3.5 the right number to use for your duration or is it actually left on the?

Pete Prygelski

It is about – its exactly 3.49 years.

Arash Soleimani – KBW

3.49, okay perfect. Thank you. And just in terms of your looking this quarter year-over-year, both your loss ratio and expense ratio had improved. So, I guess, I’m just trying to get a grasp on what is it that drove some of that improvement, how should we kind of think about that going forward? Are there certain factors in play that should continue to benefit that ratio is that sort of lumpiness, just trying to make sure I understand the progress there?

Pete Prygelski

I think Mike can add to this. Quarter-to-quarter there can always be a large claim in the given three-month period. But what you see is anywhere between that 47 and 52 is where we bounced around the last couple of years. Why it’s come down recently and Mike can talk to this more than I. I mean, we have less concentration in South Florida which is more public adjusted. I’ll let Mike comment on that.

Michael Braun

Yes, the other thing you got to know is, with our rapid growth we really went to great lengths to make sure our shareholders understood that we’re getting, I guess you could call it a tailwind of sorts where reinsurance was locked in for the prior four quarters. So, last year’s program of $68 million for our CAT program, $68 million so let’s call that $17 million a quarter.

Arash Soleimani – KBW

Right.

Michael Braun

And now you see that we’ve – we have our new reinsurance program which is $117 million. So you’ll see that that came online partially June 1 but really July 1. So, you’ll see that reinsurance expense, let’s call it $120 million for easy math. So you’re talking $30 million of expense that we’ll have in third quarter versus the $17 million.

And we’re really strong advocates of reinsurance and sustainability. Our reinsurance program has over $1 billion of single-event limit and $1.5 billion of aggregate. And that’s imperative. And yes, we haven’t had any claims on that since 2005. But we’re very happy to have that protection in place. And to be able to have those partners step in when needed.

This most recent quarter a large loss, a fire that we had was about $1.7 million and because of our reinsurance program, we took around – we $500,000 of its net. So, we’re all about sustainability. And sometimes that’s easy to say why do, you spend so much on this or that, the reinsurance included. But we are here for the long-haul. And there is going to be events that happen to an insurance company and we want to be covered to make sure that we can pay our policyholders as quickly as possible.

Arash Soleimani – KBW

Okay, great. In terms of your expense ratio, I know you’ve mentioned 40% through the number there I mean, is that – do you think too conservative of an estimate because that also looks like it’s been relatively trending down?

Pete Prygelski

Well, just to piggyback on what Mike said, you got to remember, we’ve grown significantly. So, the numerator had stayed at $17 million and the denominator is growing because we’re writing a lot. So, a bit part of that expected – the dropdown, the 30% is because our reinsurance, the numerator has stayed at $17 million while we continued to write business which has caused earned premium to grow quarter-over-quarter.

So, now that we’re into this new reinsurance tree starting third quarter, I think you’re going to see that number come back up, not the 40% because as Mike said, our fixed cost is relatively low. We run an efficient operation. So our fixed costs are going to remain pretty low. What’s going to change in the numerator is the reinsurance is now $117 million divided by 12 months. And then all of our other costs are variable as we write business.

So, is 42 conservative perhaps is 30% wish, continued at 30% I think that’s wishful thinking so somewhere in the middle.

Arash Soleimani – KBW

But should seeded as a percentage of gross earned go down because it’s cheaper or?

Pete Prygelski

Well, we also, we did by more coverages here. So you’re saying seeded reinsurance versus earning premium?

Arash Soleimani – KBW

I’m saying if you look at the seeded premiums earned divided by gross premiums earned. Should that start to go down since your 2014-2015 program?

Pete Prygelski

Actually, generically speaking, the way we look at Florida is our CAT program, reinsurance typically should be let’s say, 40%, 42% in that range, percentage of premium, maybe 42.5%. Sometimes it’s been higher than in the past because of volatility, pricing and so on. We’re clearly below that. And that’s assisted in part because of our growth.

So, in a more – it should trend back higher as growth slows at some point or the $3 million, if we continue doing $3 million a week of new, that becomes less of a growth as a percentage of growth premium. It’s less impact on the future. So I think you’re going to see it ends somewhat.

And as you saw on our last press release released in the first quarter we said that all the – you got to remember, all the business that we wrote in the fourth quarter of ‘13 and the first quarter of ‘14, all that business that we wrote, that we were getting some earned premium on, there was no reinsurance on that business because we wrote it no reinsurance expense because the business was written after September 30.

So now, so we got earnings on what we wrote in the past six months with no reinsurance expense associated with it. And beginning July 1, there is a reinsurance expense associated with it. So, you won’t – you’re not going to see the ratio stay at 30%. And I don’t think you’re going to see it at 40%.

Arash Soleimani – KBW

Okay, okay. And would you say that for an insurer such as yourself that purchases so much reinsurance. Does it make sense to say that book-value maybe sort of artificially depressed since the GAAP reserves are gross as opposed to net?

Michael Braun

That’s up to you to decide and all the other shareholders. We’re here to run a business that we think will be here for the long-term. And that includes buying a lot of reinsurance. And that’s what we’re going to do. But for the valuation, that’s something that you’re going to have on your side.

Pete Prygelski

Yes. We’re very conservative, I mean, our reinsurance purchase, our retention is 8.6% of June 30 shareholder equity, 8.6%, extremely conservative. So Mike’s point, we’re building this company for the long-term viability and we’re protecting the balance sheet. 8.6% is an extremely and probably one of the lowest in Florida, retention compared to shareholder equity.

Arash Soleimani – KBW

I totally agree with that. I wasn’t questioning that at all. I was just trying to ask if, if just from an accounting point of view that makes sense, not better than plays anything else about the stability or?

Pete Prygelski

Yes.

Michael Braun

Yes.

Pete Prygelski

I mean, as Mike said, we’re not going point on that.

Arash Soleimani – KBW

That’s fine, okay. And then, I think you mentioned to one of the prior, in response to one of the prior questions, you said, you could get market share anywhere from the neighborhood of 3% to 8% over the next three to five years, depending on what market trends and fundamentals are looking like. So, and then you said that Monarch, did you say Monarch would have a similar opportunity or would that 3% to 8% include Monarch or Monarch have a separate kind of goal in your head?

Pete Prygelski

To clarify on that we don’t have a specific trajectory maps out. It’s impossible to know. However, currently Federated National is at 2.6%. I don’t know where – how big we can get it. Clearly, we’re not going to get to 50% of the market or 25% of the market or whatever with one single set of rate of rules, one single set of rate rules and forums.

So, there is no hard number on there. It’s – there is market out there that we’re trying to grow into. So, we don’t know where we’re going to wind up. But clearly, we think there is potential for us to continue growing the company, not only in Federated National but alongside of that Monarch National.

Arash Soleimani – KBW

Okay, great. Thank you for all the answers.

Pete Prygelski

Thank you.

Operator

And our final question comes from the line of Rich Wilson, private investor. Your line is now open.

Rich Wilson – Private Investor

Hi, I’d like to extend on a question that the previous gentleman asked and perhaps asked an additional one. I think it might be helpful if you basically breakdown your business model into the composite elements. And what I mean by that is if you start with gross premiums being 100% and then you said reinsurance cost, typically 40% to 42.5%. Can you then tell us what you envision loses in LAE (ph) and then administrative cost to be?

Pete Prygelski

Yes, we target around 28% to 30% for loss in LAE and 42% for reinsurance. Yes, and the other acquisitions, you can say it’s going to be in the low 20s. And this is all…

Rich Wilson – Private Investor

For basic avenues?

Pete Prygelski

That’s all statutory which translates into GAAP but there is other moving pieces because of our MGA and our ability to earn fees.

Rich Wilson – Private Investor

Okay, that’s very helpful. And can you tell me is that basic model any different with the new policies that you’re writing than the existing book?

Michael Braun

No, it’s similar. And basically it’s not a hard rule, so let me clarify reinsurance along the coast is a bigger part of the premium than reinsurance when you get inlands towards Orlando. If you call Orlando inland, it’s only 50 miles in. Reinsurance is a bigger part of the premium in Southern Florida, Miami-Dade, Broward and Palm Beach than what you’ll have up in the Northern Part of the State such as Jacksonville.

So, we speak in generic terms. However, we operate far more granular because it varies by county, it varies by territory. It varies by distance to coast, there are so many variables. But we’re just giving you a rough statement, generic to Florida.

Rich Wilson – Private Investor

I understand. That’s very helpful. Okay. In addition to that, can you talk in a little more granularity about commissions and your average commissions and do you – the commissions that you pay in different areas any different from what others pay?

Michael Braun

Generally, our commissions, the last number I had averaged 11.6%. Those are very competitive. There is a lot of different things that people do with commissions. Some of them may have lower and certain parts of the state higher elsewhere. Ours tend to be more simplified so that our agents understand what they’re going to be paid to produce that business.

But we believe we’re competitive in the commissions. We believe our prices are competitive and our services is really what differentiates us.

Rich Wilson – Private Investor

Okay. Thank you.

Michael Braun

Thank you.

Operator

There are no further questions at this time.

Michael Braun

Well, Pete and I would like to thank everyone for dialing in. And those were some great questions that we really appreciated so that we can tell you more about Federated National. And primarily where we operate, we’re just Florida. So, if there is, questions in the future, please don’t hesitate to reach out to us. And have a great day.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the program. You may now disconnect.

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