S-1 1 d667216ds1.htm FORM S-1 Form S-1
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As filed with the Securities and Exchange Commission on April 21, 2014

Registration No. 333-            

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form S-1

REGISTRATION STATEMENT

Under

The Securities Act of 1933

 

Heritage Insurance Holdings, LLC*

(Exact name of Registrant as specified in its charter)

 

Delaware   6331   45-5338504

(State or other jurisdiction of

incorporation or organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(IRS Employer

Identification No.)

 

Heritage Insurance Holdings, LLC

2600 McCormick Drive, Suite 300

Clearwater, Florida 33759

 

(Address, including zip code, and telephone number, including area code, of Registrant’s principal executive offices)

 

Bruce Lucas

Chairman & Chief Investment Officer

Heritage Insurance Holdings, LLC

2600 McCormick Drive, Suite 300

Clearwater, Florida 33759

(727) 362-7202

 

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 

Please send copies of all communications to:

 

Steven J. Gavin, Esq.

Karen A. Weber, Esq.

Winston & Strawn LLP

35 West Wacker Drive

Chicago, Illinois 60601

(312) 558-5600

 

Edward S. Best, Esq.

John P. Berkery, Esq.

Mayer Brown LLP

71 South Wacker Drive

Chicago, Illinois 60606

(312) 782-0600

 

Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this Registration Statement.

 

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act, check the following box:  ¨

 

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

 

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

 

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   x  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

 

CALCULATION OF REGISTRATION FEE

 

Title of Each Class of Securities to be Registered  

Proposed

Maximum

Aggregate

Offering

Price(1)(2)

 

Amount of

Registration

Fee

Common Stock, $0.0001 par value per share

  $100,000,000   $12,880

 

 

 

(1)   Estimated solely for the purpose of computing the amount of the registration fee pursuant to Rule 457(o) under the Securities Act of 1933, as amended.
(2)   Includes additional shares that the underwriters have the option to purchase.

 

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission acting pursuant to said Section 8(a) may determine.

 

*   Heritage Insurance Holdings, LLC, the registrant whose name appears on the cover of this registration statement, is a Delaware limited liability company. Prior to the effectiveness of this registration statement, Heritage Insurance Holdings, LLC will be converted into a Delaware corporation and renamed Heritage Insurance Holdings, Inc. Shares of the common stock of Heritage Insurance Holdings, Inc. are being offered by the prospectus. Except as disclosed in the prospectus, the consolidated financial statements and selected historical consolidated financial data and other financial information included in this registration statement are those of Heritage Insurance Holdings, LLC and its subsidiaries and do not give effect to the corporate conversion.


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The information in this preliminary prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.

 

 

SUBJECT TO COMPLETION, DATED APRIL 21, 2014

 

PRELIMINARY PROSPECTUS

 

LOGO

 

             Shares

 

Heritage Insurance Holdings, Inc.

 

Common Stock

 

$         per share

 

 

 

This is the initial public offering of our common stock. Prior to this offering, there has been no public market for our common stock. We are selling              shares of our common stock. We currently expect the initial public offering price to be between $         and $         per share of our common stock.

 

We have granted the underwriters an option to purchase up to              additional shares of our common stock to cover over-allotments.

 

We have applied to have the common stock listed on the              under the symbol “        .”

 

We are an “emerging growth company” as defined under the federal securities laws and are eligible for reduced public company reporting requirements.

 

 

 

Investing in our common stock involves risks. See “Risk Factors” beginning on page 13.

 

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

 

 

 

     Per Share      Total  

Public Offering Price

   $                    $               

Underwriting Discount

   $         $    

Proceeds to Us (before expenses)

   $         $    

 

The underwriters expect to deliver the shares to purchasers on or about                     , 2014 through the book-entry facilities of The Depository Trust Company.

 

 

 

Sole Book-Running Manager

 

Citigroup

SunTrust Robinson Humphrey

   

Sandler O’Neill + Partners, L.P.

Dowling & Partners Securities LLC

      JMP Securities   Willis Capital Markets & Advisory

 

 

 

                    , 2014


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We are responsible for the information contained in this prospectus and in any free-writing prospectus we have authorized. We have not authorized anyone to provide you with different information, and we take no responsibility for any other information others may give you. We are not, and the underwriters are not, making an offer to sell these securities in any jurisdiction where the offer or sale is not permitted. You should not assume that the information contained in this prospectus is accurate as of any date other than its date.

 

 

 

TABLE OF CONTENTS

 

     Page  

Prospectus Summary

     1   

Risk Factors

     13   

Forward-Looking Statements

     33   

Industry and Market Data

     34   

Use of Proceeds

     34   

Dividend Policy

     36   

Capitalization

     37   

Dilution

     38   

Selected Consolidated Financial Data

     40   

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     42   

Business

     59   

Management

     74   

Executive Compensation

     78   

Certain Relationships and Related Party Transactions

     90   

Security Ownership by Certain Beneficial Owners and Management

     92   

Description of Capital Stock

     93   

Shares Eligible for Future Sale

     96   

Underwriting

     98   

Material U.S. Federal Income Tax Considerations to Non-U.S. Holders

     103   

Legal Matters

     107   

Experts

     107   

Where You Can Find More Information

     107   

Index to Consolidated Financial Statements

     F-1   


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PROSPECTUS SUMMARY

 

This summary highlights information that we present more fully in the rest of this prospectus and does not contain all of the information you should consider before investing in our securities. You should read this entire prospectus carefully, including the “Risk Factors” section and our consolidated financial statements and related notes. Prior to the consummation of this offering, we intend to convert from a limited liability company to a corporation as discussed below in “—Reorganization Transactions.” Unless the context requires otherwise, as used in this prospectus, the terms “we,” “us,” “our,” “the Company,” “our company,” and similar references refer to Heritage Insurance Holdings, LLC, together with its subsidiaries, prior to our conversion to a corporation and Heritage Insurance Holdings, Inc. and its consolidated subsidiaries on and after such conversion. References in this prospectus to “stockholders” and “stockholders’ equity” refer to members and members’ equity, respectively, prior to our conversion to a corporation. References to “pro forma stockholders’ equity” or “after giving effect to this offering” mean after giving effect to this offering, assuming the sale of              shares at a public offering price of $         per share, the midpoint of the price range set forth on the cover page of this prospectus, after deducting the underwriting discounts and commissions and estimated offering expenses payable by us.

 

Our Business

 

We are a property and casualty insurance holding company headquartered in Clearwater, Florida and, through our subsidiary, Heritage Property & Casualty Insurance Company (“Heritage P&C”), we provide personal residential insurance for single-family homeowners and condominium owners in Florida. We are vertically integrated and control or manage substantially all aspects of insurance underwriting, actuarial analysis, distribution and claims processing and adjusting. We are led by an experienced senior management team with an average of 26 years of insurance industry experience. We began operations in August 2012, and in December 2012 we began selectively assuming policies from Citizens Property Insurance Corporation (“Citizens”), a Florida state-supported insurer, through participation in a legislatively established “depopulation program” designed to reduce the state’s risk exposure by encouraging private companies to assume insurance policies from Citizens. We also write policies outside the Citizens depopulation program, which we refer to as voluntary policies. Heritage P&C is currently rated “A” (“Exceptional”) by Demotech, Inc. (“Demotech”), a rating agency specializing in evaluating the financial stability of insurers.

 

As of December 31, 2013, we had approximately 128,000 policies in force, approximately 91% of which were assumed from Citizens. For the year ended December 31, 2013, we had gross premiums written of $218.5 million and net income of $34.2 million. At December 31, 2013, we had total assets of $282.0 million, total stockholders’ equity of $80.0 million and pro forma stockholders’ equity, after giving effect to this offering, of $         million.

 

As of December 31, 2013, Citizens had approximately one million insurance policies, of which approximately 766,000 were personal residential policies. We selectively assumed personal residential policies from Citizens in six separate assumption transactions between December 2012 and December 2013, and substantially all of our revenue since our inception has come from these policies. We intend to continue assuming policies from Citizens that meet our assumption strategy and underwriting criteria.

 

In order to assume a policy from Citizens, we must obtain the prior approval of the insurance agent that wrote the policy. With respect to policies written by agents that are affiliated with an insurance company or agency, we must also obtain the approval of the insurance company or agency. Currently, four large national insurance companies or agencies permit us to assume policies from Citizens that have been written by their agents—State Farm, Allstate, Brown & Brown and AAA (formerly the American Automobile Association). In an effort to increase the pool of Citizens policies that we may assume, we are seeking similar advance approvals from other insurance companies and agencies.

 

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We currently have advance approvals covering more than 4,500 agents. These agents were responsible for writing more than 85% of the approximately 766,000 personal residential insurance policies held by Citizens as of December 31, 2013.

 

We market and write voluntary policies through a network of approximately 1,100 independent agents. Of these agents, approximately 46% are affiliated with nine large agency networks with which we have entered into master agency agreements. We recently entered into an agreement with FAIA Member Services (“FMS”), the in-house, for-profit managing general agency division of the Florida Association of Insurance Agents, which gives us access to several hundred additional agents throughout the state. We intend to pursue additional voluntary business from agents in our existing independent agent network, expand our independent agent network and seek additional opportunities to use insurer-affiliated agents to offer our personal residential policies in Florida. While we had 11,159 voluntary policies (9% of our total policies in force) as of December 31, 2013, during the three months ended December 31, 2013, we wrote an average of 1,700 new voluntary policies per month. The voluntary market is a significant component of our growth strategy.

 

We seek to underwrite a diverse mix of geographic risks within Florida to manage the potential impact of a catastrophic event and reduce our per policy reinsurance costs. As of December 31, 2013, the geographic distribution of our policies in force and total insured values were as follows (figures may not sum to totals due to rounding):

 

     As of December 31, 2013  
     (Total Insured Value in Millions)  
      Policy
Count
     %      Total
Insured Value
     %  

South Florida Counties

           

Broward

     16,522         12.9%       $ 4,198         12.5%   

Miami-Dade

     10,634         8.4%         2,969         8.9%   

Palm Beach

     15,629         12.2%         3,647         10.9%   
  

 

 

    

 

 

    

 

 

    

 

 

 

South Florida exposure

     42,785         33.5%       $ 10,814         32.3%   

Other Significant Counties(1)

           

Pinellas

     22,722         17.8%       $ 6,135         18.3%   

Hillsborough

     16,753         13.1%         4,949         14.8%   

Pasco

     13,536         10.6%         3,539         10.6%   

Hernando

     4,581         3.6%         1,370         4.1%   

Lee

     3,457         2.7%         903         2.7%   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total other significant counties

     61,049         47.8%       $ 16,897         50.5%   

Summary for all of Florida

           

South Florida exposure

     42,785         33.5%       $ 10,814         32.3%   

Total other significant counties

     61,049         47.8%         16,897         50.5%   

Other Florida counties

     23,950         18.7%         5,778         17.3%   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     127,784         100.0%       $ 33,488         100.0%   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1)   Significant counties are defined as those counties with a policy count or total insured value greater than 2.5% of our 127,784 total policy count or $33.5 billion total insured value as of December 31, 2013.

 

In order to limit our potential exposure to individual risks and catastrophic events, we purchase significant reinsurance from third party reinsurers. Purchasing reinsurance is an important part of our risk strategy, and premiums paid (or ceded) to reinsurers is our single largest cost. We have strong relationships with reinsurers

 

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which we believe are a result of our management’s industry experience and reputation for selective underwriting. For the twelve months ending May 31, 2014, we purchased reinsurance from the following sources: (i) the Florida Hurricane Catastrophe Fund, a state-mandated catastrophe reinsurance fund (“FHCF”), (ii) 13 private reinsurers, all of which were rated “A-” or higher by A.M. Best Company, Inc. (“A.M. Best”) or Standard & Poor’s Financial Services LLC (“S&P”), (iii) two private reinsurers that have provided collateral to fully cover their exposure, and (iv) our wholly-owned reinsurance subsidiary, Osprey Re Ltd. (“Osprey”).

 

The Florida Office of Insurance Regulation (“FLOIR”) requires all insurance companies, like us, to have a certain amount of capital reserves and reinsurance coverage in order to cover losses upon the occurrence of a catastrophic event. Our reinsurance program for the twelve months ending May 31, 2014 provides reinsurance in excess of FLOIR’s requirements, which are based on the probable maximum loss that we would incur from an individual catastrophic event estimated to occur once every 100 years based on our portfolio of insured risks. We also purchase reinsurance coverage to protect against the potential for multiple catastrophic events occurring in the same year.

 

We test the sufficiency of our reinsurance program by subjecting our personal residential exposures to statistical testing using the AIR U.S. Hurricane Model, which replicates the most severe hurricanes to have occurred historically in Florida, individual storms of severity in excess of such historical levels, and the historical calendar years in which the most severe multiple catastrophic events occurred in Florida. In this regard, the 2004 calendar year, in which four large catastrophic hurricanes made landfall in Florida, is considered to be the worst catastrophic year in Florida’s recorded history. Assuming the reoccurrence of the 2004 calendar year events, the probable maximum net loss to us in 2013 would have been $10.3 million (after tax, net of all reinsurance recoveries and including our retention through Osprey). This loss would have represented 12.9% of our stockholders’ equity at December 31, 2013 and     % of our pro forma stockholders’ equity at December 31, 2013, after giving effect to this offering.

 

We closely manage all aspects of our claims adjustment process. Claims are initially reviewed by our managers and staff adjusters, who determine the extent of the loss and the resources needed to adjust each claim. In the case of a catastrophic event, we have contracted with four large national claims adjusting firms to assist our adjusters with the increased volume of claims and ensure timely responses to our policyholders. We utilize our wholly-owned subsidiary, Contractors’ Alliance Network, LLC (“Contractors’ Alliance”), to manage mitigation and restoration services for our customers. Contractors’ Alliance primarily handles water damage-related claims, which comprised approximately 68% of our losses and loss adjustment expenses through December 31, 2013. In March 2014, we completed the acquisition of the assets and personnel of our main water mitigation services vendor. We believe this acquisition will allow us to better service our customers and expand our mitigation and restoration services. In addition, all of our voluntary policies and renewed Citizens policies are enrolled in our Platinum Preferred Savings Program (the “Platinum Program”). Under the Platinum Program, customers receive a 10% discount on their claim deductible, and we obtain control over inspection, claims adjusting and repair services. We believe our approach to claims handling results in a higher level of customer service and reduces our losses and loss adjustment expenses. As a result of our efforts, our gross loss ratio, which expresses our losses and loss adjustment expenses as a percentage of gross earned premiums, was 27.5% for the year ended December 31, 2013.

 

Our Market

 

According to the U.S. Census Bureau, at July 1, 2013, Florida was the fourth largest U.S. state with an estimated population of approximately 20 million people. The University of Florida Bureau of Economic and Business Research estimates that Florida is expected to reach a population of approximately 26 million people by 2040, an increase of 36% percent from 2010. Property ownership and development represent key drivers of the Florida economy.

 

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Because of its location, Florida is exposed to an increased risk of hurricanes during the entire six months of Atlantic hurricane season, which spans from June 1 through November 30. While a significant hurricane has not made landfall in Florida since 2005, eight hurricanes in 2004 and 2005, including Hurricanes Charley, Katrina, Rita and Wilma, caused a combined estimated property damage of over $110 billion, a significant portion of which occurred in Florida. As a result, personal residential insurance and claims servicing are vitally important to Florida residents.

 

The Florida personal residential insurance market is highly fragmented and dominated by in-state insurance companies, including Citizens. Significant dislocation in the Florida property insurance market began following Hurricane Andrew in 1992 and accelerated following the 2004 and 2005 hurricane seasons. In total, national and regional insurers reduced their share of the market in Florida from 84% in 1999 to 26% in 2012. As national and regional insurance companies reduced their exposure in Florida, Citizens increased efforts to provide affordable personal residential insurance to those residents unable to obtain coverage in the private market. As a result, Citizens’ policy count grew from roughly 810,000 policies in 2005 to a peak level of approximately 1.5 million policies in late 2011. To reduce Citizens’ risk exposure, beginning in 2010, Florida elected officials encouraged Citizens to focus on reducing the size of its portfolio by returning policies to the private market. In response, Citizens instituted a number of measures to incentivize the private sector to participate in the depopulation program. Some of these initiatives include increased inspections, improved underwriting, reductions in coverage and annual rate increases.

 

In May 2013, Florida passed legislation to facilitate the reduction of Citizens’ policy count and establish the Property Insurance Clearinghouse (the “Clearinghouse”), which launched in January 2014. The Clearinghouse makes new and renewal business ineligible for Citizens if a participating insurance company is willing to extend comparable coverage at prescribed rates. On March 31, 2014, Heritage P&C was approved to participate in the Clearinghouse.

 

According to data compiled by FLOIR, Citizens was the largest personal residential insurance carrier in Florida for the nine months ended September 30, 2013, with a market share of approximately 23.5% based on total in force direct premiums written for personal and commercial residential insurance. As of the same date, we ranked 14th in Florida within this market, with a market share of approximately 1.5%. Assuming further access to capital and reinsurance support, we believe we have the opportunity to significantly expand the size of our personal residential insurance business in Florida and explore the expansion of our business into other complementary business lines and states.

 

In recent years, the property and casualty insurance market has experienced a substantial increase in the availability of property catastrophe reinsurance resulting from the increased supply of capital from non-traditional insurance providers, including private capital and hedge funds. This increased capital supply, coupled with a lack of recent significant catastrophic storm activity in Florida, has reduced the cost of property catastrophe reinsurance, directly benefitting purchasers of this reinsurance, including us. We believe this market trend will continue for the foreseeable future.

 

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Our Strategy

 

Since our inception, substantially all of our revenue has come from policies we assumed from Citizens, with the balance of our revenue generated from renewal of these assumed policies and from voluntary policies. Building on these successful transactions, we intend to continue to grow profitably by undertaking the following:

 

Increase Our Policies in Force in Florida Through Strategic Policy Assumptions and Expansion of Our Voluntary Market Share

 

We intend to continue assuming policies from Citizens that meet our assumption strategy and underwriting criteria. Additionally, we intend to increase our policy count by participating in the Clearinghouse. We will also pursue opportunities to increase the number of our voluntary policies by expanding our independent agent distribution network, as well as obtaining approval from national insurance companies to allow their agents to offer our personal residential policies in Florida. Our recent affiliation with FMS gives us access to several hundred additional agents throughout the state and should assist us in our effort to attract high-quality agents. We also intend to increase our advertising, which we believe will allow us to more effectively penetrate areas of the state where we are not currently writing significant new business.

 

Opportunistically Diversify Product Offerings

 

We will continue to focus on writing personal residential policies, but will opportunistically expand into complementary product lines we believe we can effectively and profitably underwrite. New product lines may include commercial residential and manufactured housing policies, as well as additional non-residential coverage, such as general liability insurance. In January 2014, we hired two individuals with significant experience in Florida commercial residential insurance sales and underwriting, who will assist us in developing this new product line.

 

Optimize Our Reinsurance Program

 

We will continue to obtain what we believe to be the most appropriate levels and sources of reinsurance. We believe that the significant additional capital entering portions of the reinsurance market provides us with the opportunity to obtain favorable pricing and contract terms and conditions, including the potential for multi-year commitments. In April 2014, we entered into a fully collateralized catastrophe reinsurance agreement funded through the issuance of $150.0 million principal amount of catastrophe bonds, and we will continue evaluating such cost-efficient alternatives to traditional reinsurance. See “—Recent Developments.” Additionally, we will continue to meet certain of our reinsurance needs through the use of our reinsurance subsidiary, Osprey, which mitigates our reinsurance expense and reduces our reliance on third party reinsurance.

 

Efficiently Manage Losses and Loss Adjustment Expenses

 

We are committed to proactively managing our losses and loss adjustment expenses through prudent underwriting and the use of internal claims adjustment and repair services. In March 2014, we acquired the largest vendor in the Contractors’ Alliance network, which we believe will allow us to expand our in-house mitigation and restoration services. We also intend to license our Contractors’ Alliance employees as adjusters, which we believe will reduce our loss adjustment expenses and shorten the length of time required to resolve claims.

 

Expand to New Geographic Markets

 

We intend to explore opportunities to enter other coastal states where we believe the market opportunity is most similar to Florida and where we can utilize our underwriting and claims expertise to attract and manage

 

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profitable business. We believe further increasing our geographic diversification is an important factor in reducing our potential risk of loss from any catastrophic event, reducing our per policy reinsurance costs and providing an additional area for future growth beyond our expansion in Florida.

 

Our Competitive Strengths

 

We believe that our rapid growth to date and our ability to capitalize on our future growth prospects are a result of the following competitive strengths of our business:

 

Experienced Management Team With a Long History in the Florida Personal Residential Insurance Market

 

We have a deep and experienced management team led by Bruce Lucas, Chairman and Chief Investment Officer, Richard Widdicombe, Chief Executive Officer and President, Stephen Rohde, Chief Financial Officer, Melvin Russell, Chief Underwriting Officer, Kent Linder, Chief Operating Officer, Ernesto Garateix, Executive Vice President, and Paul Nielsen, Vice President of Claims, most of whom have been with Heritage since inception. Our management team, which averages 26 years of insurance industry experience, has extensive experience in the Florida personal residential insurance market, has built longstanding relationships with key participants in the insurance industry and is supported by a group of highly qualified individuals with industry expertise, including a Chief Actuary with more than 34 years of industry experience.

 

Strong, Conservative Capital Structure

 

As of December 31, 2013, we had stockholders’ equity of $80.0 million and pro forma stockholders’ equity, after giving effect to this offering, of $         million. As of December 31, 2013, Heritage P&C had policyholder surplus of $63.1 million. We believe that this level of surplus places us among the best capitalized insurance companies focusing primarily on the Florida personal residential insurance market and is significantly in excess of the minimum capital levels required by FLOIR and Demotech for similarly rated in-state insurance companies. In addition, unlike many of our in-state competitors, we have relied almost exclusively upon common equity to provide our capital.

 

Selective Underwriting and Policy Acquisition Criteria

 

We believe our proprietary data analytics capabilities and underwriting processes allow us to better select the insurance policies we are willing to assume from the Citizens depopulation program, leading to strong profitability and reduced risk. In addition, we choose to minimize our exposure to or avoid certain types of coverage if we believe there is significant risk of loss, including coverage for sink-hole related losses in high-risk areas. As a result of our efforts, our gross loss ratio was 27.5% for the year ended December 31, 2013.

 

Unique Claims Servicing Model and Superior Customer Service

 

We believe that the vertical integration of our claims adjustment and repair services provides us with a competitive advantage. Because we manage both claims adjusting and repair services, we are generally able to begin the adjustment and mitigation process much earlier than our competitors, thus reducing our loss adjustment expenses and ultimate loss payouts. We expect that, in the near future, a significant number of our repair technicians will participate in training and certification programs to become licensed claims adjusters, allowing us to capture additional efficiencies. We also believe our unique model provides a superior level of customer service for our policyholders, enhancing our reputation and increasing the likelihood that our policyholders will renew their policies with us.

 

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Relationships with Highly Rated Reinsurers

 

We manage our exposure to catastrophic events through, among other things, the purchase of reinsurance. Our relationships with highly rated reinsurers have been developed as a result of our management team’s industry experience and reputation for selective underwriting. Our financial strength, underwriting results and the long-term relationships between our management team and our reinsurance partners help improve the cost-effectiveness of our reinsurance program.

 

Relationships with Independent Agents and National Underwriters

 

We have developed relationships with a network of approximately 1,100 independent insurance agents. We believe we have been able to build this network due to our reputation for financial stability, commitment to the Florida market and integrity in the underwriting and claims process. We are also exploring relationships with additional large national insurers and agencies that no longer write substantial personal residential insurance in Florida, which would give us access to their network of Florida agents.

 

Risks Associated with Our Business

 

As part of your evaluation of our company, you should take into consideration the following risks that we face in implementing or executing our growth strategies and maintaining our profitability:

 

   

We have an operating history of less than two years, which makes it difficult to evaluate our business and prospects.

 

   

If claims exceed our loss reserves, our financial results could be adversely affected.

 

   

Our only line of business is personal residential insurance in Florida, which exposes us to a significant risk of loss from hurricanes and other catastrophic events, which typically occur from June 1 through November 30 each year.

 

   

A single catastrophic event or series of catastrophic events or other conditions effecting losses in Florida could adversely affect our financial condition and results of operations because our business is concentrated in Florida.

 

   

Our results of operations may fluctuate significantly due to the cyclical nature of the insurance business and our participation in the Citizens depopulation program.

 

   

To date, we have been dependent on the Citizens depopulation program for the majority of our business and we may be unable to assume further policies from Citizens on attractive terms.

 

   

In the event that the reinsurance we purchase is inadequate or a reinsurer is unable or unwilling to make timely payments, our operating results would be adversely affected.

 

   

We compete with large, well-established insurance companies, as well as other specialty insurers, some of which possess greater financial resources, larger agency networks and greater name recognition than we do.

 

   

If we are unable to underwrite and set premium rates accurately, our results of operations and financial condition will be adversely affected.

 

   

A failure to effectively manage and remediate claims could lead to material litigation, undermine our reputation in the marketplace and negatively affect our financial results.

 

   

If we are unable to maintain our financial stability rating, which is important in establishing our competitive position, the marketability of our product offerings, and our liquidity, operating results and financial condition may be materially adversely affected.

 

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We do not anticipate paying any dividends on our common stock in the foreseeable future.

 

   

The insurance industry is highly regulated and our failure to fully comply with these regulations could have an adverse effect on our business. Changes to the statutes and rules governing the insurance industry could have an adverse effect on our business.

 

See “Risk Factors” beginning on page 12 of this prospectus for a more detailed discussion of these and other risks we face.

 

Recent Developments

 

On April 17, 2014, Heritage P&C entered into a catastrophe reinsurance agreement with Citrus Re Ltd., a newly-formed Bermuda special purpose insurer. The agreement provides for three years of coverage from catastrophe losses caused by certain named storms, including hurricanes, beginning on June 1, 2014. The limit of coverage of $150 million is fully collateralized by a reinsurance trust account for the benefit of Heritage P&C. Heritage P&C pays a periodic premium to Citrus Re during this three-year risk period. Citrus Re Ltd. issued $150 million of principal-at-risk variable notes due April 18, 2017 to fund the reinsurance trust account and its obligations to Heritage P&C under the reinsurance agreement. The maturity date of the notes may be extended up to two additional years to satisfy claims for catastrophic events occurring during the three-year term of the reinsurance agreement.

 

Reorganization Transactions

 

Warrant Exercise.    Certain of our current stockholders also hold warrants to purchase an aggregate of 3,019 shares of the Company at an exercise price of $15,000 per share. Prior to the consummation of this offering, warrants to purchase an aggregate of 2,974 shares will be exercised (the “Warrant Exercise”), including warrants to purchase an aggregate of              shares to be exercised on a cashless basis. Pursuant to the cashless exercise provisions of the warrants, each warrant holder will pay the exercise price by surrendering to the Company an amount of shares having a value equal to the aggregate exercise price of the warrants being exercised. The terms of the warrants provide that the value ascribed to each share that will be surrendered to the Company as payment for the exercise price will be equal to the initial public offering price per share of our common stock in this offering. As a result, the actual number of shares that will be issued upon the Warrant Exercise is dependent upon the initial public offering price per share of our common stock in this offering. Assuming an initial public offering price of $         per share, the midpoint of the price range set forth on the cover of this prospectus, an aggregate of              shares will be issued in connection with the Warrant Exercise. A $1.00 increase (decrease) in the assumed initial public offering price of $         per share would increase (decrease) the number of shares that will be issued in connection with the Warrant Exercise by              shares. Following the Warrant Exercise, we expect that there will remain outstanding warrants to purchase an aggregate of              shares at an exercise price of $         per share.

 

Conversion.    Following the Warrant Exercise and prior to the consummation of this offering, we will convert from a Delaware limited liability company into a Delaware corporation (the “Conversion”), and all outstanding shares of the limited liability company will be converted into shares of common stock of the Company on a one-for-one basis and all outstanding warrants to purchase shares of the limited liability company will convert into warrants to purchase shares of common stock of the Company on a one-for-one basis. Prior to the Conversion, we anticipate distributing an aggregate amount of $         in cash to our stockholders to satisfy such stockholders’ tax obligations (the “Tax Distribution” and, together with the Warrant Exercise and the Conversion, the “Reorganization Transactions”).

 

Corporate Information

 

Our principal executive offices are located at 2600 McCormick Drive, Suite 300, Clearwater, Florida 33759, and our telephone number is 727-362-7200. Our website is www.heritagepci.com. Information contained on our website is not incorporated by reference into this prospectus, and such information should not be considered to be part of this prospectus.

 

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THE OFFERING

 

Common Stock Offered

             shares

 

Common Stock to be Outstanding After This Offering

             shares

 

Underwriters’ Option to Purchase Additional Shares

We have granted the underwriters the right to purchase up to              additional shares of common stock within 30 days of the date of this prospectus.

 

Use of Proceeds

We estimate that our net proceeds from the sale of the common stock that we are offering will be approximately $        , assuming an initial public offering price of $         per share, which is the midpoint of the price range on the cover page of this prospectus, and after deducting underwriting discounts and commissions and offering expenses payable by us. We intend to use a portion of the net proceeds from this offering to increase our statutory capital and surplus to enable us to write additional policies and to fund collateralized reinsurance through Osprey, our reinsurance subsidiary. We intend to use the remainder of the net proceeds to fund the growth of our business and for general corporate purposes. See “Use of Proceeds.”

 

Proposed              Symbol

We intend to apply to list our common stock on the              under the symbol “        .”

 

Risk Factors

You should read the “Risk Factors” section of this prospectus for a discussion of facts to consider carefully before deciding to invest in shares of our common stock.

 

Dividend Policy

We do not anticipate paying any dividends on our common stock in the foreseeable future. Any future determinations relating to our dividend policies will be made at the discretion of our board of directors and will depend on various factors. See “Dividend Policy.”

 

Directed Share Program

At our request, the underwriters have reserved up to       % of the shares of common stock for sale at the initial public offering price to persons who are directors, officers, employees and other parties associated with us through a directed share program. The number of shares of common stock available for sale to the general public will be reduced by the number of directed shares purchased by participants in the program. Any directed shares not purchased will be offered by the underwriters to the general public on the same basis as all other shares of common stock offered. We have agreed to indemnify the underwriters against certain liabilities and expenses, including liabilities under the Securities Act of 1933, as amended (the “Securities Act”), in connection with the sales of the directed shares. Individuals who purchase shares in the directed share program will be subject to a 180-day lock-up period, as described in “Shares Eligible for Future Sale—Lock-Up Agreements.”

 

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Unless otherwise indicated, all information in this prospectus relating to the number of shares of common stock to be outstanding immediately after this offering:

 

   

gives effect to the completion of the Reorganization Transactions prior to the completion of this offering as described in “—Reorganization Transactions;”

 

   

assumes no exercise by the underwriters of their option to purchase up to              additional shares from us;

 

   

excludes an aggregate of              shares of common stock issuable upon the exercise of warrants at an exercise price of $             per share that will remain outstanding following the consummation of this offering; and

 

   

excludes an aggregate of              shares of our common stock reserved for issuance under the Heritage Insurance Holdings, Inc. Omnibus Incentive Plan (the “Plan”) that we intend to adopt in connection with this offering.

 

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SUMMARY CONSOLIDATED FINANCIAL DATA

 

The following tables set forth our summary consolidated historical financial data for the periods presented and pro forma balance sheet information as of December 31, 2013. You should read the information set forth below in conjunction with “Use of Proceeds,” “Capitalization,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and notes thereto included elsewhere in this prospectus. The statements of income (loss) data for the period ended December 31, 2012 and the year ended December 31, 2013 are derived from our audited consolidated financial statements included elsewhere in this prospectus. The statements of income (loss) data for the three months ended March 31, 2013, June 30, 2013, September 30, 2013 and December 31, 2013 set forth below are derived from our unaudited quarterly consolidated financial statements not included in this prospectus and contain all adjustments, consisting of normal recurring adjustments, that management considers necessary for a fair presentation of our financial position and results of operations for the periods presented. See “Index to Consolidated Financial Statements.”

 

Statement of Operations Data

(in thousands except share and per
share data)

  August 7, 2012
(inception) to
December 31, 2012
    Three Months Ended     Year Ended
December 31,
2013
 
    March 31, 2013     June 30, 2013     September 30,
2013
    December 31,
2013
   

Revenue:

           

Gross premiums written

  $ 43,384      $ 16,349      $ 81,049      $ 37,176      $ 83,963      $ 218,537   

Gross premiums earned

    5,719        20,324        28,040        41,506        50,089        139,959   

Ceded premiums

    (120     (358     (6,415     (19,702     (18,325     (44,800
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net premiums earned

    5,599        19,966        21,625        21,804        31,764        95,159   

Retroactive reinsurance income(1)

    —          —          26,072        —          (26     26,046   

Net investment income

    27        211        124        304        410        1,049   

Net realized losses

    —          (2     (46     (123     (152     (323

Other revenue

    4        167        826        795        1,113        2,901   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

  $ 5,630      $ 20,342      $ 48,601      $ 22,780      $ 33,109      $ 124,832   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Expenses:

           

Losses and loss adjustment expenses

    1,402        5,279        7,869        9,998        15,355        38,501   

Policy acquisition costs

    84        115        866        1,739        3,430        6,150   

General and administrative expenses

    7,922 (2)      3,986        5,582        3,372        11,764        24,704   

Interest expense

    829        4        6        6        —          16   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

    (4,607     10,958        34,278        7,665        2,560        55,461   

Provision for income taxes

    859        3,899        13,263        2,340        1,746        21,248   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

  $ (5,466   $ 7,059      $ 21,015      $ 5,325        814      $ 34,213   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Basic earnings (loss) per share(3)

  $ (2,219   $ 1,672      $ 3,525      $ 890      $ 130      $ 6,095   

Diluted earnings (loss) per share (3)

  $ (2,219   $ 1,672      $ 3,525      $ 890      $ 125      $ 6,028   

Basic weighted average shares outstanding(3)

    2,463        4,221        5,962        5,982        6,257        5,613   

Diluted weighted average shares outstanding(3)

    2,463        4,221        5,962        5,982        6,507        5,676   

 

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    Three Months Ended     Year  Ended
December 31,
2013
 
    March 31, 2013     June 30, 2013     September 30,
2013
    December 31,
2013
   

Selected Other Data

         

Book value per share(3)(4)

  $ 11,641      $ 14,850      $ 15,755      $ 15,742      $ 15,742   

Growth in book value per share(4)

    34.9     27.6     6.1     (0.1 )%      82.4

Return on average equity(4)

    58.8     107.2     23.2     3.3     45.0

Selected ratios(5)

         

Ratios to gross premiums earned

         

Gross loss ratio

    26.0     28.1     24.1     30.7     27.5

Ceded premium ratio

    1.8     22.9     47.5     36.6     32.0

Gross expense ratio

    20.2     23.0     12.3     30.3     22.0

Combined ratio

    47.9     73.9     83.9     97.6     81.6

Ratios to net premiums earned

         

Net loss ratio

    26.4     36.4     45.9     48.3     40.5

Net expense ratio

    20.5     29.8     23.4     47.8     32.4

Combined ratio

    47.0     66.2     69.3     96.2     72.9

 

     December 31, 2013
Consolidated Balance Sheet Data (in thousands)    Actual      Pro Forma(6)    Pro Forma  As
Adjusted(7)

Cash, cash equivalents and investments

   $ 201,236         

Total assets

   $ 281,978         

Unpaid losses and loss adjustment expenses

   $ 19,344         

Unearned premiums

   $ 116,243         

Total liabilities

   $ 181,073         

Redeemable equity(8)

   $ 20,921         

Total stockholders’ equity

   $ 79,984         

 

(1)   Retroactive reinsurance income of $26.0 million during the year ended December 31, 2013 represents premiums earned, net of losses, for the period from January 1, 2013 through May 31, 2013 from a retroactive reinsurance agreement entered into in connection with our assumption of approximately 39,000 policies from Citizens in June 2013. See Note 2 to our consolidated financial statements for the year ended December 31, 2013 included elsewhere in this prospectus.
(2)   General and administrative expenses for the period ended December 31, 2012 includes $5.5 million of stock-based compensation.
(3)   Share and per share data for the periods presented does not give retroactive effect to the Reorganization Transactions.
(4)   Includes the value, as of the end of each period, of the redeemable equity described in footnote 8 below. See “Selected Consolidated Financial Data.”
(5)   The ratios presented do not reflect the impact of the retroactive reinsurance income described in footnote 1 above. For a definition of each of the ratios presented, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Key Components of Our Results of Operations—Ratios.”
(6)   The pro forma balance sheet data gives effect to the Reorganization Transactions.
(7)   The pro forma as adjusted balance sheet data gives further effect to (i) the issuance of              shares of common stock in this offering and (ii) our receipt of the estimated net proceeds from the sale of shares of common stock offered by us in this offering at an assumed initial public offering price of $         per share, the midpoint of the price range set forth on the cover of this prospectus, after deducting the underwriting discounts and commissions and estimated offering expenses payable by us.
(8)   Represents equity held by certain members of our management which was redeemable at the option of the holder upon termination of their employment. Effective February 5, 2014, this redemption right was terminated, and this equity was reclassified as stockholders’ equity.

 

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RISK FACTORS

 

An investment in our common stock involves a high degree of risk and many uncertainties. You should carefully consider the specific factors listed below together with the other information included in this prospectus before purchasing our common stock in this offering. If any of the possibilities described as risks below actually occurs, our operating results and financial condition would likely suffer and the trading price of our common stock could fall, causing you to lose some or all of your investment. The following is a description of what we consider the key challenges and material risks to our business and an investment in our common stock.

 

Risks Related to Our Business

 

We have a limited operating history, and our business and future prospects are difficult to evaluate.

 

We began operations in August 2012 and wrote our first policy in November 2012. Due to our limited operating history, our ability to execute our business strategy is materially uncertain and our operations and prospects are subject to all risks inherent in a developing business enterprise. Our limited operating history also makes it difficult to evaluate our long term commercial viability. As a new business, we must work to establish and develop successful operating procedures, hire staff, tailor and fine-tune our information management and other systems, maintain adequate control of our expenses, develop business relationships, implement our marketing strategies (and adapt and modify them as needed), establish a positive image and reputation in the community, and take any other steps necessary to conduct our business. As a result of these challenges, it is possible that we may not be successful in implementing our business strategy or completing the development of the infrastructure necessary to expand our business.

 

Our loss reserves are estimates and may be inadequate to cover our actual liability for losses, causing our results of operations to be adversely affected.

 

We maintain reserves to cover our estimated ultimate liabilities for losses and loss adjustment expenses, also referred to as loss reserves. As a new company, we have a limited operating history and a limited loss history which may negatively impact our ability to accurately establish loss reserves. Our current loss reserves are based primarily on industry historical data and statistical projections of what we believe the resolution and administration of claims will cost based on facts and circumstances then known to us. As a new company, our claims experience and our experience with the risks related to certain claims is inherently limited, and we must rely heavily on industry historical data, which may not be indicative of future periods. As a result, our projections and our estimates may be inaccurate, which in turn may cause our actual losses to exceed our loss reserves. If our actual losses exceed our loss reserves, our financial results, our ability to expand our business and to compete in the property and casualty insurance industry may be negatively affected.

 

Factors that affect unpaid losses and loss adjustment expenses include the estimates made on a claim-by-claim basis known as “case reserves” coupled with bulk estimates known as “incurred but not yet reported” (or “IBNR”). Periodic estimates by management of the ultimate costs required to resolve all claims are based on our analysis of historical data and estimations of the impact of numerous factors such as (i) per claim information; (ii) industry and company historical loss experience and development patterns; (iii) legislative enactments, judicial decisions, legal developments in the awarding of damages and changes in political attitudes; and (iv) trends in general economic conditions, including the effects of inflation. Management revises its estimates based on the results of its analysis. This process assumes that past experience, adjusted for the effects of current developments and anticipated trends, is an appropriate basis for estimating the ultimate resolution of all claims. There is no precise method for subsequently evaluating the impact of any specific factor on the adequacy of the reserves, because the eventual redundancy or deficiency is affected by multiple factors.

 

Because of the inherent uncertainties in the reserving process, we cannot be certain that our reserves will be adequate to cover our actual losses and loss adjustment expenses. If our reserves for unpaid losses and loss adjustment expenses are less than actual losses and loss adjustment expenses, we will be required to increase

 

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our reserves with a corresponding reduction in our net income in the period in which the deficiency is identified. Future loss experience substantially in excess of our reserves for unpaid losses and loss adjustment expenses could substantially harm our results of operations and financial condition.

 

Because we conduct our business in Florida only, any single catastrophic event, or a series of such events, or other condition affecting losses in Florida could adversely affect our financial condition and results of operations.

 

We currently conduct our insurance business in Florida only. The distribution of our policies is generally consistent with that of Florida’s population and is therefore more concentrated in densely-populated coastal areas. A single catastrophic event, or a series of such events, destructive weather pattern, general economic trend, regulatory development or other condition specifically affecting Florida, particularly the more densely populated areas of the state, could have a disproportionately adverse impact on our business, financial condition and results of operations. While we actively manage our exposure to catastrophic events through our underwriting process and the purchase of reinsurance, the fact that our business is concentrated in Florida subjects us to increased exposure to certain catastrophic events and destructive weather patterns such as hurricanes, tropical storms and tornadoes. Changes in the prevailing regulatory, legal, economic, political, demographic and competitive environment, and other conditions in Florida could also make it less attractive for us to do business in Florida and would have a more pronounced effect on our business than it would on other insurance companies that are more geographically diversified than we are. Since our business is concentrated in this manner, the occurrence of one or more catastrophic events or other conditions affecting losses in Florida could have an adverse effect on our business, financial condition and results of operations.

 

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

 

We write insurance policies that cover homeowners and condominium owners for losses that result from, among other things, catastrophes. We are therefore subject to losses, including claims under policies we have assumed or written, arising out of catastrophes that may have a significant effect on our business, results of operations and financial condition. A significant catastrophe, or a series of catastrophes, could also have an adverse effect on our reinsurers. Catastrophes can be caused by various events, including hurricanes, tropical storms, tornadoes, earthquakes, hailstorms, explosions, power outages, fires and by man-made events, such as terrorist attacks. The incidence and severity of catastrophes are inherently unpredictable. The extent of losses from a catastrophe is a function of both the total amount of insured exposure in the area affected and the severity of the event. Our policyholders are currently concentrated in Florida, which is especially subject to adverse weather conditions such as hurricanes and tropical storms. Therefore, although we attempt to manage our exposure to catastrophes through our underwriting process and the purchase of reinsurance protection, an especially severe catastrophe or series of catastrophes could exceed our reinsurance protection and may have a material adverse impact on our results of operations and financial condition. In total, for the period from June 1, 2013 through May 31, 2014, we have purchased $721.0 million of reinsurance coverage, including our retention, for multiple catastrophic events. We are in the process of placing our reinsurance program for the period from June 1, 2014 through May 31, 2015, which will include our catastrophe reinsurance agreement with Citrus Re Ltd. and its issuance of $150.0 million of catastrophe bonds. See “Business—Reinsurance—2014-2015 Reinsurance Program.” Our ability to access this coverage, however, is subject to the severity and frequency of such events. As of December 31, 2013, our total insured value was $33.5 billion, and we may experience significant losses and loss adjustment expenses in excess of our retention.

 

Our results of operations may fluctuate significantly based on industry factors as well as our participation in the Citizens depopulation program.

 

The insurance business historically has been a cyclical industry characterized by periods of intense price competition due to excess underwriting capacity, as well as periods when shortages of capacity permitted an increase in pricing. As premium levels increase, there may be new entrants to the market, which could then lead to increased competition, a significant reduction in premium rates, less favorable policy terms and fewer opportunities to underwrite insurance risks, which could have a material adverse effect on our results of

 

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operations and cash flows. In addition to these considerations, changes in the frequency and severity of losses suffered by insureds and insurers, including changes resulting from multiple and/or catastrophic hurricanes, may affect the cycles of the insurance business significantly. We cannot predict whether market conditions will improve, remain constant or deteriorate. Negative market conditions may impair our ability to write insurance at rates that we consider appropriate relative to the risk assumed. If we cannot write insurance at appropriate rates, our business would be materially and adversely affected.

 

In addition, the uncertainties inherent in the reserving process, together with the potential for unforeseen developments, including changes in laws and the prevailing interpretation of policy terms, may result in losses and loss adjustment expenses materially different from the reserves initially established. Changes to prior year reserves will affect current underwriting results by increasing net income if the prior year reserves prove to be redundant or by decreasing net income if the prior year reserves prove to be insufficient. We are not allowed to record contingency reserves to account for expected future losses. As a result, we expect volatility in operating results in periods in which significant loss events occur because generally accepted accounting principles do not permit insurers or reinsurers to reserve for loss events until they have occurred and are expected to give rise to a claim. We anticipate that claims arising from future events may require the establishment of substantial reserves from time to time.

 

Our results of operations may also vary based on our continued participation in the Citizens depopulation program. As part of a typical assumption transaction with Citizens, we acquire the unearned premium associated with the assumed policies, which, depending on the size of the transaction, may cause significant variability in our financial results from period to period. In June 2013, we entered into a retroactive quota share reinsurance agreement with Citizens that resulted in our recognition of $26.0 million of retroactive insurance income for the year ended December 31, 2013, as we realized income equal to the earned premiums, net of associated losses and loss adjustment expenses, from such policies for the period from January 1, 2013 through May 31, 2013 with no corresponding reinsurance cost. We do not expect to enter into similar retroactive arrangements in connection with future policy assumptions from Citizens. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Key Components of Our Results of Operations—Retroactive reinsurance income.”

 

Our successful participation in the Citizens depopulation program depends on the continuation of such program and our ability to select favorable policies to assume.

 

An important element of our growth strategy involves continued participation in the Citizens depopulation program. As of December 31, 2013, approximately 91% of our 128,000 policies in force were assumed from Citizens. Our ability to participate in this program is subject to a variety of factors, including continuation of the program. There can be no assurance that Citizens will decide to continue the depopulation program for a significant period of time, or at all. In addition, the establishment of the Clearinghouse, which launched in January 2014 and makes certain new or renewed business ineligible to be underwritten by Citizens, may substantially reduce Citizens’ policy count and, in particular, the number of policies we would like to assume. Any efforts by the Florida legislature or Citizens to curtail the depopulation program, materially modify the terms of the program as it relates to personal residential policies, or restrict our participation in the program would hurt our growth prospects and will adversely impair our financial condition and results of operations. When we enter into an assumption transaction with Citizens, we have the opportunity to review information about the policies available for assumption. We undertake a robust selection process in which we analyze various aspects of each policy’s risk profile and, based on the results, select the policies we would like to assume. Our successful participation in the depopulation program depends on our ability to select policies that will be accretive to our financial results. However, our selection process involves many different considerations, and there can be no assurances that we will appropriately assess the risks associated with each policy. As a result, we may select unfavorable policies that could result in substantial losses, which may in turn adversely impact our financial condition and results of operations.

 

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We may not be able to collect reinsurance amounts due to us from the reinsurers with which we have contracted.

 

Reinsurance is a method of transferring part of an insurance company’s risk under an insurance policy to another insurance company. To the extent that our reinsurers are unable to meet the obligations they assume under our reinsurance agreements, we remain liable for the entire insured loss. We use reinsurance arrangements to limit and manage the amount of risk we retain, to stabilize our underwriting results and to increase our underwriting capacity. Our ability to recover amounts due from reinsurers under the reinsurance treaties we currently have in effect is subject to the reinsurance company’s ability and willingness to pay and to meet its obligations to us. We attempt to select financially strong reinsurers with an A.M. Best or S&P rating of “A-” or better or we require the reinsurer to fully collateralize its exposure. While we monitor from time to time their financial condition, we also rely on our reinsurance broker and rating agencies in evaluating our reinsurers’ ability to meet their obligations to us.

 

Our reinsurance coverage in any given year may be concentrated with one or a limited group of reinsurers. For the twelve months ending May 31, 2014, Allianz Risk Transfer (AG) Limited reinsures 75% of each layer of our reinsurance coverage up to the $401.5 million level and 90% and 100%, respectively, of our first and second aggregate layers. Any failure on the part of any one reinsurance company to meet its obligations to us could have a material adverse effect on our financial condition or results of operations.

 

All residential and commercial insurance companies that write business in Florida, including us, are required to obtain reinsurance through FHCF, and this coverage comprises a substantial portion of our reinsurance program. The limit and retention of the FHCF coverage is subject to upward or downward adjustment based on, among other things, submitted exposures to FHCF by all participants. We have purchased private reinsurance alongside our FHCF layer to fill in gaps in coverage that may result from the adjustment of the limit or retention of our FHCF coverage; however, such reinsurance would not cover any losses we may incur as a result of FHCF’s inability to pay the full amount of our claims. If a catastrophic event occurs in Florida, FHCF may not have sufficient funds to pay all of its claims from insurance companies in full or in a timely manner. This could result in significant financial, legal and operational challenges to our Company. In the event of a catastrophic loss, FHCF’s ability to pay may be dependent upon its ability to issue bonds in amounts that would be required to meet its reinsurance obligations. There can be no assurance that FHCF will be able to do this. While we believe FHCF currently has adequate capital and financing capacity to meet its reinsurance obligations, there can be no assurance that it will be able to meet its obligations in the future, and any failure to do so could have a material adverse effect on our liquidity, financial condition and results of operations.

 

Reinsurance coverage may not be available to us in the future at commercially reasonable rates or at all.

 

The cost of reinsurance is subject to prevailing market conditions beyond our control such as the amount of capital in the reinsurance market, as well as the frequency and magnitude of natural and man-made catastrophes. We cannot be assured that reinsurance will remain continuously available to us in the amounts we consider sufficient and at prices acceptable to us. As a result, we may determine to increase the amount of risk we retain or look for other alternatives to reinsurance, which could in turn have a material adverse effect on our financial position, results of operations and cash flows.

 

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

 

The property and casualty insurance industry in Florida is cyclical and, during times of increased capacity, highly competitive. We compete not only with other stock companies, but also with Citizens, mutual companies, other underwriting organizations and alternative risk sharing mechanisms. Our principal lines of business are written by numerous other insurance companies. Competition for any one account may come from very large, well-established national companies, smaller regional companies, other specialty insurers in our field and other companies that write insurance only in Florida. Some of these competitors have greater financial resources, larger agency networks and greater name recognition than we do. We compete for business not only on the basis

 

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of price, but also on the basis of financial strength, types of coverages offered, availability of coverage desired by customers, commission structure and quality of service. We may have difficulty continuing to compete successfully on any of these bases in the future. Competitive pressures coupled with market conditions may affect our rate of premium growth and financial results.

 

In addition, industry developments could further increase competition in our industry. These developments could include:

 

   

an influx of new capital in the marketplace as existing companies attempt to expand their businesses and new companies attempt to enter the insurance business as a result of better premium pricing and/or policy terms;

 

   

an increase in programs in which state-sponsored entities provide property insurance in catastrophe-prone areas;

 

   

changes in Florida’s regulatory climate; and

 

   

the passage of federal proposals for an optional federal charter that would allow some competing insurers to operate under regulations different or less stringent than those applicable to Heritage P&C.

 

These developments and others could make the property and casualty insurance marketplace more competitive by increasing the supply of insurance available. If competition limits our ability to write new business at adequate rates, our future results of operations would be adversely affected.

 

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

 

Our results of operations and financial condition depend on our ability to underwrite and set premium rates accurately for a wide variety of risks. Rate adequacy is necessary to generate sufficient premiums to pay losses, loss adjustment expenses, reinsurance costs and underwriting expenses and to earn a profit. In order to price our products accurately, we must collect and properly analyze a substantial amount of data; develop, test and apply appropriate rating formulas; closely monitor and timely recognize changes in trends; and project both severity and frequency of losses with reasonable accuracy. Our ability to successfully perform these tasks, and as a result price our products accurately, is subject to a number of risks and uncertainties, some of which are outside our control, including:

 

   

the availability of sufficient reliable data and our ability to properly analyze available data;

 

   

regulatory delays in approving filed rate changes;

 

   

the uncertainties that inherently characterize estimates and assumptions;

 

   

our selection and application of appropriate rating and pricing techniques;

 

   

changes in legal standards, claim resolution practices, and restoration costs; and

 

   

legislatively imposed consumer initiatives.

 

In addition, we could underprice risks, which would negatively affect our profit margins. We could also overprice risks, which could reduce the number of policies we write and our competitiveness. In either event, our profitability could be materially and adversely affected.

 

The inherent uncertainty of models and our reliance on such models as a tool to evaluate risk may have an adverse effect on our financial results.

 

We license analytic and modeling software from third parties to facilitate our pricing, assess our risk exposure and determine our reinsurance needs. Given the inherent uncertainty of modeling techniques and the application of such techniques, these models and databases may not accurately address the emergence of a variety of matters which might impact our exposure to losses. Accordingly, these models may understate the exposures we are assuming and our financial results may be adversely impacted, perhaps significantly.

 

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The failure of our claims department to effectively manage or remediate claims could adversely affect our insurance business, financial results and capital requirements.

 

We rely on our claims department to facilitate and oversee the claims adjustment process for our policyholders. Many factors could affect the ability of our claims department to effectively manage claims by our policyholders, including:

 

   

the accuracy of our adjusters as they make their assessments and submit their estimates of damages;

 

   

the training, background and experience of our claims representatives;

 

   

the ability of our claims department to ensure consistent claims handling;

 

   

the ability of our claims department to translate the information provided by adjusters into acceptable claims resolutions; and

 

   

the ability of our claims department to maintain and update its claims handling procedures and systems as they evolve over time based on claims and geographical trends in claims reporting.

 

Any failure to effectively manage the claims adjustment process, including failure to pay claims accurately, could lead to material litigation, undermine our reputation in the marketplace, impair our corporate image and negatively affect our financial results.

 

Additionally, in the final stage of the claims process, we leverage Contractors’ Alliance’s vendor network to provide repair and remediation services to the policyholder. If such services are not performed properly, we may face liability. Although we maintain professional liability insurance to cover losses arising from our repair and remediation services, there can be no assurances that such coverage is adequate. In addition, our failure to timely and properly remediate claims, or the perception of such failure, may damage our reputation and adversely affect our ability to renew existing policies or write new policies.

 

If actual renewals of our existing contracts do not meet expectations, our premiums written in future years and our future results of operations could be materially adversely affected.

 

Our insurance policies are written for a one-year term. We make assumptions about the renewal of our prior year’s contracts, including for purposes of determining the amount of reinsurance we purchase. If actual renewals do not meet expectations or if we choose not to write on a renewal basis because of pricing conditions, our premiums written in future years and our future operations would be materially adversely affected, and we may purchase reinsurance beyond what we believe is the most appropriate level.

 

Our participation in the new Clearinghouse may not result in an increase in our premium revenue.

 

Part of our growth strategy includes participating in the Clearinghouse. On March 31, 2014, we were approved to participate in the Clearinghouse, but there can be no assurance that our policy count or gross premiums will increase as a result of our participation in the Clearinghouse because our premiums may not be below the threshold required by Citizens, other carriers participating in the Clearinghouse may be willing to offer similar policies for lower premiums, or we may decide to not provide a quote on these policies if they do not meet our underwriting guidelines.

 

We may not be able to effectively execute our growth strategy.

 

As part of our growth strategy, we may broaden our service offerings in order to more efficiently serve our customers and manage the claims process. We are currently in negotiations to acquire the largest vendor in the Contractors’ Alliance network, a water remediation company, which we believe will allow us to expand our mitigation and restoration services. As part of this expansion strategy, we may enter into new lines of business or offer new products and services within existing lines of business. For example, in January 2014, we hired two individuals with experience in commercial residential insurance sales and underwriting who will assist us in

 

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developing this new product line. There are substantial risks and uncertainties associated with these efforts. We may invest significant time and resources to develop and market new lines of business and/or products and services and we may not achieve the return on our investment that we expect. Initial timetables for the introduction and development of new lines of business and/or new products or services may not be achieved and price and profitability targets may not prove feasible. External factors, such as compliance with regulations, competitive alternatives, and shifting customer preferences may also impact the successful implementation of a new line of business or a new product or service. Such external factors and requirements may increase our costs and potentially affect the speed with which we will be able to pursue new market opportunities. There can be no assurance that we will be successful bringing new insurance products to our marketplace. Additionally, any new line of business and/or new product or service could have a significant impact on the effectiveness of our system of internal controls. Failure to successfully manage these risks could have a material adverse effect on our business, results of operations and financial condition.

 

Our growth strategy may also involve expansion of our business to states outside of Florida. Geographic diversification may be hindered by the fact that we are a new company with a limited operating history, and we may be unable to satisfy requirements imposed by state regulators and other third parties.

 

If we are unable to expand our business because our capital must be used to pay greater than anticipated claims, our financial results may suffer. Further, we may require additional capital in the future which may not be available or may only be available on unfavorable terms.

 

Our future growth and future capital requirements will depend on our ability to expand the number of insurance policies we assume or write in Florida, to expand the kinds of insurance products we offer and to expand the geographic markets in which we do business, all balanced by the business risks we choose to assume and cede. All of these growth initiatives require capital. Our existing sources of funds include possible sales of common or preferred stock, incurring debt and our earnings from operations and investments. Unexpected catastrophic events in our coverage areas, such as the hurricanes experienced in Florida in the past decade, may result in greater claims losses than anticipated, which could require us to limit or halt our growth while we redeploy our capital to pay these unanticipated claims unless we are able to raise additional capital.

 

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

 

Our information technology systems may fail or suffer a loss of security which could adversely affect our business.

 

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

 

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The development and expansion of our insurance business is dependent upon the successful development and implementation of advanced technology, including modeling, underwriting and information technology systems. Because we intend to expand our business by writing additional voluntary policies and entering into new lines of business, we are enhancing our information technology systems to handle and process an increased volume of policies. The failure of these systems to function as planned could slow our growth and adversely affect our future business volume and results of operations. In addition, we have licensed certain systems and data from third parties. We cannot be certain that we will have access to these, or comparable systems, or that our technology or applications will continue to operate as intended. Moreover, we cannot be certain that we would be able to replace these systems without slowing our underwriting response time. A major defect or failure in our internal controls or information technology systems could result in management distraction, harm to our reputation, a loss or delay of revenues or increased expense.

 

In addition, a security breach of our computer systems could damage our reputation or result in liability. We retain confidential business and policyholder information in our computer systems. We may be required to spend significant capital and other resources to protect against security breaches or to alleviate problems caused by such breaches. It is critical that our facilities and infrastructure remain secure. Despite the implementation of security measures, our infrastructure may be vulnerable to physical break-ins, computer viruses, programming errors, attacks by third parties or similar disruptive problems. In addition, we could be subject to liability if hackers were able to penetrate our network security or otherwise misappropriate confidential information.

 

The development and implementation of new technologies will require an additional investment of our capital resources in the future.

 

Frequent technological changes, new products and services and evolving industry standards are all influencing the insurance business. We believe that the development and implementation of new technologies will require additional investment of our capital resources in the future. We have not determined, however, the amount of resources and the time that this development and implementation may require, which may result in short-term, unexpected interruptions to our business, or may result in a competitive disadvantage in price and/or efficiency, as we endeavor to develop or implement new technologies.

 

We do not have significant redundancy in our operations.

 

We conduct our business primarily from offices located on the west coast of Florida where hurricanes could damage our facilities or interrupt our power supply. The loss or significant impairment of functionality in these facilities for any reason could have a material adverse effect on our business, as we do not have significant redundancies to replace our facilities if functionality is impaired. We contract with a third party vendor to maintain complete daily backups of our systems, however, we have not fully tested our plan to recover data in the event of a disaster.

 

We may be unable to attract and retain qualified employees.

 

We depend on our ability to attract and retain experienced underwriting talent and other skilled employees who are knowledgeable about our business. If the quality of our underwriters and other personnel decreases, we may be unable to maintain our current competitive position in the specialized markets in which we operate and be unable to expand our operations, which could adversely affect our results.

 

Because we began operations in August 2012 and have relatively few employees, the loss of, or failure to attract, key personnel could have a more significant impact on our business as compared to some of our competitors that are larger or have longer operating histories. We believe that our ability to grow and fully execute our business plan will depend in large part on our ability to attract and retain additional skilled and qualified personnel and to expand, train and manage our employees. We may not be successful in doing so, because the competition for experienced personnel in the insurance industry is intense.

 

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We are dependent on key executives, the loss of whom could adversely affect our business.

 

Our future success depends to a significant extent on the efforts of our senior management. We believe there are only a limited number of available and qualified executives with substantial experience in our industry. Accordingly, the loss of the services of one or more of the members of our senior management could delay or prevent us from fully implementing our business strategy and, consequently, significantly and negatively affect our business.

 

Currently, we only maintain key man life insurance with respect to Bruce Lucas, our Chairman and Chief Investment Officer. If any other member of senior management dies or becomes incapacitated, or leaves the company to pursue employment opportunities elsewhere, we would be solely responsible for locating an adequate replacement for such senior management and for bearing any related cost. To the extent that we are unable to locate an adequate replacement or are unable to do so within a reasonable period of time, our business may be significantly and negatively affected.

 

Our financial results may be negatively affected by the fact that a portion of our income is generated by the investment of our company’s capital, premiums and loss reserves.

 

A portion of our income is, and likely will continue to be, generated by the investment of our capital, premiums and loss reserves. The amount of income so generated is a function of our investment policy, available investment opportunities and the amount of available cash invested. We are also constrained by investment limitations contained in the Florida Insurance Code. At December 31, 2013, approximately 68% of our available cash was invested in fixed-maturity and equity securities and mortgage loans with the balance in cash and cash equivalents. We may, under certain circumstances, be required to liquidate our investments in securities at prices below book value, which may adversely affect our financial results. We currently hold all of our cash in accounts with three financial institutions and, as a result of this concentration, a portion of the balances in such accounts exceeds the FDIC insurance limits. While we monitor and adjust the balances in our accounts as appropriate, these balances could be impacted if any of these financial institutions fail and could be subject to other adverse conditions in the financial markets.

 

We may alter our investment policy to accept higher levels of risk with the expectation of higher returns. Fluctuating interest rates and other economic factors make it impossible to estimate accurately the amount of investment income that will be realized. In fact, we may realize losses on our investments.

 

Our inability to maintain our financial stability rating may have a material adverse effect on our competitive position, the marketability of our product offerings, and our liquidity, operating results and financial condition.

 

Financial stability ratings are important factors in establishing the competitive position of insurance companies and can have a significant effect on an insurance company’s business. Many insurance buyers, agents, brokers and secured lenders use the ratings assigned by rating agencies to assist them in assessing the financial stability and overall quality of the companies from which they are considering purchasing insurance or in determining the financial stability of the company that provides insurance. We currently have a Demotech rating of “A” (“Exceptional”). This is the third highest financial stability rating of the six financial stability ratings utilized by Demotech. These financial stability ratings provide an objective baseline for assessing solvency and should not be interpreted as (and are not intended to serve as) an assessment of, a recommendation to buy, sell, or hold, any securities of an insurance company or its parent holding company, including the shares of our common stock being offered by this prospectus.

 

On an ongoing basis, rating agencies review the financial performance and condition of insurers and can downgrade or change the outlook on an insurer’s ratings due to, for example, a change in an insurer’s statutory capital, a reduced confidence in management or a host of other considerations that may or may not be under the

 

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insurer’s control. All ratings are subject to continuous review; therefore, the retention of these ratings cannot be assured. A downgrade in any of these ratings could have a material adverse effect on our competitive position, the marketability of our product offerings and our ability to grow in the marketplace.

 

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

 

Loss severity in the property and casualty insurance industry has continued to increase in recent years, principally driven by larger court judgments. In addition, many legal actions and proceedings have been brought on behalf of classes of complainants, which can increase the size of judgments. The propensity of policyholders and third party claimants to litigate and the willingness of courts to expand causes of loss and the size of awards may render the loss reserves of our insurance subsidiary inadequate for current and future losses. In addition, as industry practices and social and other environmental conditions change, unexpected and unintended issues related to claims and coverage may emerge. These issues may adversely affect our business by either extending coverage beyond our underwriting intent or by increasing the number or size of claims. In some instances, these changes may not become apparent until some time after we have issued insurance policies that are affected by the changes. As a result, the full extent of liability under our insurance policies may not be known at the time such policies are issued or renewed, and our financial position and results of operations may be adversely affected.

 

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

 

We utilize a number of strategies to mitigate our risk exposure including:

 

   

employing proper underwriting procedures;

 

   

carefully evaluating the terms and conditions of our policies;

 

   

geographic diversification; and

 

   

ceding insurance risk to reinsurance companies.

 

However, there are inherent limitations in all of these tactics. No assurance can be given that an event or series of unanticipated events will not result in loss levels which could have a material adverse effect on our financial condition or results of operations.

 

Lack of effectiveness of exclusions and other loss limitation methods in the insurance policies we assume or write could have a material adverse effect on our financial condition or our results of operations.

 

Various provisions of our policies, such as limitations or exclusions from coverage which are designed to limit our risks, may not be enforceable in the manner we intend. In addition, the policies we issue contain conditions requiring the prompt reporting of claims to us and our right to decline coverage in the event of a violation of that condition. While our insurance product exclusions and limitations reduce the loss exposure to us and help eliminate known exposures to certain risks, it is possible that a court or regulatory authority could nullify or void an exclusion or limitation, or legislation could be enacted modifying or barring the use of such endorsements and limitations in a way that would adversely affect our loss experience, which could have a material adverse effect on our financial condition or results of operations.

 

We rely on independent agents to write voluntary insurance policies for us, and if we are not able to attract and retain independent agents, our revenues would be negatively affected.

 

We write voluntary insurance policies through a network of independent agents. Of our network of approximately 1,100 independent agents, approximately 46% are affiliated with nine large agency networks with which we have entered into master agency agreements. As of December 31, 2013, voluntary policies written through independent agents constituted approximately 9% of our total policies in force and represented

 

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approximately $17.7 million in annualized premiums. We expect to increase the number of voluntary policies we write as our business expands, which will further increase our reliance on our network of independent agents. In fact, in the future, we may rely on independent agents to be the primary source for our property insurance policies. If any of our independent agents cease writing policies for us, or if any of our master agency agreements are terminated, we may suffer a reduction in the amount of products we are able to sell, which would negatively impact our results.

 

Many of our competitors also rely on independent agents. As a result, we must compete with other insurers for independent agents’ business. Our competitors may offer a greater variety of insurance products, lower premiums for insurance coverage, or higher commissions to their agents. If our products, pricing and commissions do not remain competitive, we may find it more difficult to attract business from independent agents to sell our products.

 

Changing climate conditions may adversely affect our financial condition, profitability or cash flows.

 

Climate change, to the extent it produces extreme changes in temperatures and changes in weather patterns, could affect the frequency or severity of weather events. Further, it could reduce the affordability and availability of personal residential insurance, which could have an effect on pricing. Changes in weather patterns could also affect the frequency and severity of other natural catastrophe events to which we may be exposed.

 

We identified material weaknesses in our internal controls over financial reporting. If we are unable to implement and maintain effective internal controls over financial reporting in the future, investors may lose confidence in the accuracy and completeness of our financial reports and the market price of our common stock may be negatively affected.

 

As a public company, we will be required to maintain internal controls over financial reporting and to report any material weaknesses in such internal controls. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of a company’s annual or interim financial statements will not be prevented or detected on a timely basis. Section 404 of the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”) requires that we evaluate and determine the effectiveness of our internal controls over financial reporting and, beginning with our annual report for the fiscal year ending December 31, 2015, provide a management report on the internal controls over financial reporting. If we have a material weakness in our internal controls over financial reporting, we may not detect errors on a timely basis and our financial statements may be materially misstated. We are in the process of designing and implementing the internal controls over financial reporting required to comply with this obligation, which process will be time consuming, costly, and complicated.

 

In connection with the preparation of our financial statements for the period ended December 31, 2012 and the year ended December 31, 2013, we identified material weaknesses in our internal control over financial reporting related to, among other things, accounting for stock based compensation, equity transactions and income taxes. With the oversight of senior management, we have taken steps and plan to take additional measures to remediate the underlying causes of these material weaknesses, primarily through the development and implementation of formal policies, improved processes, as well as the hiring of additional finance personnel. Although we plan to complete this remediation process as quickly as possible, we cannot at this time estimate how long it will take, and our initiatives may not prove to be successful in remediating these material weaknesses.

 

The occurrence of any of the following may cause investors to lose confidence in the accuracy and completeness of our financial reports and could negatively impact the price of our common stock:

 

   

our inability to remediate the material weaknesses discussed above;

 

   

identification of additional material weaknesses in our internal controls over financial reporting;

 

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our inability to comply with the requirements of Section 404 of the Sarbanes-Oxley Act in a timely manner;

 

   

our inability to assert that our internal controls over financial reporting are effective; or

 

   

our independent registered public accounting firm’s inability to express an opinion as to the effectiveness of our internal controls over financial reporting.

 

If any of the foregoing occur, we may also become subject to investigations by the stock exchange on which our common stock is listed, the Securities and Exchange Commission (“SEC”) or other regulatory authorities, as well as lawsuits by private plaintiffs.

 

We will incur significantly increased costs and devote substantial management time as a result of operating as a public company.

 

As a public company, we will incur significant legal, accounting and other expenses that we did not incur as a private company. For example, we will be subject to the reporting requirements of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and will be required to comply with the applicable requirements of the Sarbanes-Oxley Act and the Dodd-Frank Wall Street Reform and Consumer Protection Act, as well as rules and regulations subsequently implemented by the SEC and the                 , including the establishment and maintenance of effective disclosure and financial controls and changes in corporate governance practices, including the establishment and maintenance of a majority independent board of directors and required committees. We expect that compliance with these requirements will increase our legal and financial compliance costs and will make some activities more time consuming and costly. In addition, our management team and board of directors have limited experience implementing public company compliance requirements, and therefore we expect that our management and other personnel will need to divert attention from operational and other business matters to devote substantial time to such efforts. In particular, we expect to incur significant expenses and devote substantial management effort toward ensuring compliance with the requirements of Section 404 of the Sarbanes-Oxley Act, which will increase when we are no longer an emerging growth company, as defined in The Jumpstart Our Business Act of 2012 (the “JOBS Act”). We will need to hire additional accounting and financial staff with appropriate public company experience and technical accounting knowledge and may need to establish an internal audit function. We cannot predict or estimate the amount of additional costs we may incur as a result of becoming a public company or the timing of such costs. We also expect that operating as a public company will make it more difficult and significantly more expensive for us to obtain director and officer liability insurance.

 

We are an “emerging growth company” and we cannot be certain if the reduced disclosure and other requirements applicable to emerging growth companies will make our common stock less attractive to investors.

 

We are an “emerging growth company,” as defined in the JOBS Act, and we intend to take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not “emerging growth companies” including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act with respect to our internal control over financial reporting, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved. We may take advantage of these provisions for up to five years or such earlier time that we are no longer an “emerging growth company.” We would cease to be an “emerging growth company” upon the earliest to occur of: (i) the last day of the fiscal year in which we have more than $1.0 billion in annual revenues; (ii) the date we qualify as a “large accelerated filer,” with at least $700 million of equity securities; (iii) the issuance, in any three-year period, by our company of more than $1.0 billion in non-convertible debt securities held by non-affiliates; and (iv) the last day of the fiscal year ending after the fifth anniversary of this offering. We may choose to take advantage of some but not all of these reduced reporting and other burdens. To the extent we take advantage of

 

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any of the reduced reporting burdens in this prospectus or in future filings, the information that we provide our security holders may be different than you might get from other public companies in which you hold equity interests. We cannot predict if investors will find our common stock less attractive because we may rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our stock price may be more volatile.

 

In addition, Section 107 of the JOBS Act provides that an “emerging growth company” can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards. In other words, an “emerging growth company” can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. We are choosing to “opt- out” of such extended transition period, however, and, as a result, we will comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for non-emerging growth companies. Section 107 of the JOBS Act provides that our decision to opt-out of the extended transition period for complying with new or revised accounting standards is irrevocable.

 

Risks Related to Regulation of our Insurance Operations

 

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

 

We are subject to extensive state regulation. Heritage P&C is subject to supervision and regulation that is primarily designed to protect our policyholders rather than our stockholders, and such regulation is imposed by both the state in which it is domiciled (Florida) and the states in which it does business (currently only Florida). These regulations relate to, among other things, the approval of policy forms and premium rates, our conduct in the marketplace, our compliance with solvency and financial reporting requirements, transactions with our affiliates, and limitations on the amount of business we can write, the amount of dividends we can pay to stockholders, and the types of investments we can make. Insurance holding company regulations generally provide that transactions between an insurance company and its affiliates must be fair and reasonable, and must be clearly and accurately disclosed in the records of the respective parties, with expenses and payments allocated between the parties in accordance with customary accounting practices. Many types of transactions between an insurance company and its affiliates, such as transfers of assets, loans, reinsurance agreements, service agreements, certain dividend payments by the insurance company and certain other material transactions, may be subject to prior approval by, or prior notice to, state regulatory authorities. If we are unable to obtain the requisite prior approval for a specific transaction, we would be precluded from taking the action, which could adversely affect our operations. These regulatory requirements may adversely affect or inhibit our ability to achieve some or all of our business objectives. In addition, regulatory authorities also may conduct periodic examinations into insurers’ business practices. These reviews may reveal deficiencies in our insurance operations or differences between our interpretations of regulatory requirements and those of the regulators.

 

State insurance regulations also frequently impose notice or approval requirements for the acquisition of specified levels of ownership in the insurance company or insurance holding company. For example, Florida law requires that a person may not, individually or in conjunction with any affiliated person of such person, acquire directly or indirectly, conclude a tender offer or exchange offer for, enter into any agreement to exchange securities for, or otherwise finally acquire 5% or more of the outstanding voting securities of a Florida domiciled stock insurer or of a controlling company, unless it is in compliance with certain notice and approval requirements. Such restriction may inhibit our ability to grow our business or achieve our business objectives.

 

Further, regulatory authorities have relatively broad discretion to deny or revoke licenses for various reasons, including the violation of regulations. In some instances, we follow practices based on our interpretations of regulations or practices that we believe may be generally followed by the industry. These practices may turn out to be different from the interpretations of regulatory authorities. If we do not have the requisite licenses and approvals or do not comply with applicable regulatory requirements, insurance regulatory

 

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authorities could preclude or temporarily suspend us from carrying on some or all of our activities or otherwise penalize us. This could adversely affect our ability to operate our business.

 

Heritage P&C is subject to additional regulation imposed by consent orders entered into with FLOIR in connection with our formation.

 

In addition to compliance with statutes and regulations, Florida routinely places additional restrictions on new insurers as a condition of receiving their certificate of authority. These restrictions are typically memorialized in a consent order entered into between FLOIR and the insurer applying for a certificate of authority. We are subject to such a consent order. We have, in certain cases, agreed to higher or more stringent restrictions than are otherwise required under Florida law. The material restrictions we have agreed to include:

 

   

Florida law requires a residential property writer to maintain surplus of the greater of $15.0 million or 10% of its liabilities. Pursuant the consent order, we agreed to establish a minimum capital and surplus of $18.0 million.

 

   

Florida law restricts the ratio of premiums written to policyholder surplus to 10 to 1 on a gross basis and 4 to 1 on a net of reinsurance basis. Pursuant to the consent order, we agreed to not exceed the projected premiums in the plan of operation submitted with our original application for licensure without the prior written approval of FLOIR during 2012, 2013 and 2014. As part of the FLOIR approval process for the various Citizens assumption transactions in which we have participated, we have received approval to exceed these projected premiums.

 

   

Florida law places no restrictions on the parent of an insurer, or other upstream entities, with regard to the payment of dividends. Pursuant to the consent order, we agreed to not make any distributions to stockholders prior to July 31, 2015, except such distributions as are required to offset stockholders’ tax obligations resulting from the ownership of our equity or such distributions as may be approved by FLOIR in advance and in writing.

 

   

Florida law allows an insurer to pay certain dividends to stockholders without approval of FLOIR. Pursuant to the consent order, we agreed that, until July 31, 2017, Heritage P&C would pay only those dividends that have been approved in advance and in writing by FLOIR.

 

In addition, we are subject to several consent orders setting conditions upon FLOIR’s approval of the various Citizens assumption transactions in which we have participated. For example, beginning with our June 2013 assumption transaction, we are required to offer to renew each assumed policy for a minimum of three years and limit rate increases to the higher of those offered by Citizens for comparable risks or 10%.

 

In the event we are unable to comply with the additional regulation imposed by these consent orders, it may adversely affect our ability to operate our business.

 

Changes in regulation may reduce our profitability and limit our growth.

 

We are subject to extensive regulation in Florida, the only state in which we currently conduct business. The National Association of Insurance Commissioners (“NAIC”) and state insurance regulators are constantly reexamining existing laws and regulations, generally focusing on modifications to holding company regulations, interpretations of existing laws and the development of new laws. For example, in 2013 FLOIR asked the Florida legislature to amend the Florida Insurance Code in conformity with the latest amendments to the NAIC Model Holding Company System Regulatory Act. Among other things, such amendments would require the ultimate controlling person of any Florida insurance company to file an annual report identifying the material risks within the insurance holding company system that could pose enterprise risk to the insurance company. The proposed legislation was not enacted in 2013, but is expected to be reintroduced and eventually enacted into law.

 

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From time to time, states consider and/or enact laws that may alter or increase state authority to regulate insurance companies and insurance holding companies. States also consider and/or enact laws that impact the competitive environment and marketplace for property and casualty insurance. Our insurance company subsidiary currently transacts insurance only in Florida, where the recent political environment has led to aggressive regulation of property and casualty insurance companies. We expect this to continue for the foreseeable future. For example, in 2007, Florida enacted legislation that led to rate levels in the private insurance market that we believe, in many instances in the past, were inadequate to cover the related underwriting risk. This same legislation required Citizens to reduce its premium rates and begin competing against private insurers in the Florida residential property insurance market. Florida lawmakers may continue to enact or retain legislation that suppresses the rates of Citizens, further adversely impacting the private insurance market and increasing the likelihood that it must levy assessments on private insurance companies and ultimately on Florida consumers. These and other aspects of the political environment in jurisdictions where we operate may reduce our profitability, limit our growth, or otherwise adversely affect our operations.

 

During the past several years, various regulatory and legislative bodies have adopted or proposed new laws or regulations to address the cyclical nature of the insurance industry, catastrophic events and insurance capacity and pricing. These regulations include (i) the creation of “market assistance plans” under which insurers are induced to provide certain coverages, (ii) restrictions on the ability of insurers to rescind or otherwise cancel certain policies in mid-term or to nonrenew policies at their scheduled expirations, (iii) advance notice requirements or limitations imposed for certain policy non-renewals, (iv) limitations upon or decreases in rates permitted to be charged, (v) expansion of governmental involvement in the insurance market and (vi) increased regulation of insurers’ policy administration and claims handling practices.

 

Currently, the federal government does not directly regulate the insurance business. However, in recent years the state insurance regulatory framework has come under increased federal scrutiny. Congress and some federal agencies from time to time investigate the current condition of insurance regulation in the United States to determine whether to impose federal regulation or to allow an optional federal charter, similar to banks. In addition, changes in federal legislation and administrative policies in several areas, including changes in the Gramm-Leach-Bliley Act, financial services regulation and federal taxation, can significantly impact the insurance industry and us.

 

We cannot predict with certainty the effect any enacted, proposed or future state or federal legislation or NAIC initiatives may have on the conduct of our business. Furthermore, there can be no assurance that the regulatory requirements applicable to our business will not become more stringent in the future or result in materially higher costs than current requirements, or that creation of a federal insurance regulatory system will not adversely affect our business or disproportionately benefit our competitors. Changes in the regulation of our business may reduce our profitability, limit our growth or otherwise adversely affect our operations.

 

Our insurance subsidiary is subject to minimum capital and surplus requirements, and our failure to meet these requirements could subject us to regulatory action.

 

Our insurance subsidiary is subject to risk-based capital standards and other minimum capital and surplus requirements imposed under applicable state laws, currently the laws of Florida. The risk-based capital standards, based upon the Risk-Based Capital Model Act adopted by the NAIC, require our insurance subsidiary to report its results of risk-based capital calculations to FLOIR and the NAIC. These risk-based capital standards provide for different levels of regulatory attention depending upon the ratio of an insurance company’s total adjusted capital, as calculated in accordance with NAIC guidelines, to its authorized control level risk-based capital. Authorized control level risk-based capital is determined using the NAIC’s risk-based capital formula, which measures the minimum amount of capital that an insurance company needs to support its overall business operations.

 

An insurance company with total adjusted capital that is less than 200% of its authorized control level risk-based capital is at a company action level, which would require the insurance company to file a risk-based capital plan that, among other things, contains proposals of corrective actions the company intends to take that

 

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are reasonably expected to result in the elimination of the company action level event. Additional action level events occur when the insurer’s total adjusted capital falls below 150%, 100%, and 70% of its authorized control level risk-based capital. The lower the percentage, the more severe the regulatory response, including, in the event of a mandatory control level event (total adjusted capital falls below 70% of the insurer’s authorized control level risk-based capital), placing the insurance company into receivership. As of December 31, 2013, Heritage P&C’s risk-based capital ratio was 357%.

 

In addition, our insurance subsidiary is required to maintain certain minimum capital and surplus and to limit its written premiums to specified multiples of its capital and surplus. The insurance subsidiary could exceed these ratios if its volume increases faster than anticipated or if its surplus declines due to catastrophe or non-catastrophe losses or excessive underwriting and operational expenses.

 

Florida law requires a residential property writer to maintain surplus of the greater of $15.0 million or 10% of its liabilities. Pursuant to the consent order we entered into in connection with receiving our certificate of authority, we agreed to establish a minimum capital and surplus of $18.0 million. As of December 31, 2013, our insurance subsidiary held surplus of $63.1 million. Florida law also restricts the ratio of premiums written to policyholder surplus to 10 to 1 on a gross basis and 4 to 1 on a net of reinsurance basis. As of December 31, 2013, our insurance subsidiary’s gross and net writing ratios were 3.5 to 1 and 2.2 to 1, respectively. Pursuant to the consent order, we agreed to not exceed the projected premiums in the plan of operation submitted with our original application for licensure without the prior written approval of FLOIR during 2012, 2013, and 2014. As part of the FLOIR approval process for the various Citizens assumption transactions in which we have participated, we have received approval to exceed these projected premiums.

 

Any failure by our insurance subsidiary to meet the applicable risk-based capital or minimum statutory capital requirements or the writings ratio limitations imposed by the laws of Florida (or other states where we may eventually conduct business) could subject it to further examination or corrective action imposed by state regulators, including limitations on our writing of additional business, state supervision or liquidation.

 

Any changes in existing risk-based capital requirements, minimum statutory capital requirements, or applicable writings ratios may require us to increase our statutory capital levels, which we may be unable to do.

 

Regulation limiting rate increases and requiring us to participate in loss sharing may decrease our profitability.

 

From time to time, political dispositions affect the insurance market, including efforts to effectively suppress rates at a level that may not allow us to reach targeted levels of profitability. Despite efforts to remove politics from insurance regulation, facts and history demonstrate that public policymakers, when faced with untoward events and adverse public sentiment, can act in ways that impede a satisfactory correlation between rates and risk. Such acts may affect our ability to obtain approval for rate changes that may be required to attain rate adequacy along with targeted levels of profitability and returns on equity. Our ability to afford reinsurance required to reduce our catastrophe risk may be dependent upon the ability to adjust rates for our cost.

 

Additionally, we are required to participate in guaranty funds for insolvent insurance companies. The funds periodically assess losses against all insurance companies doing business in the state. Our operating results and financial condition could be adversely affected by any of these factors.

 

Risks Relating to Ownership of Our Common Stock

 

There is no existing market for our common stock, and we do not know if one will develop to provide you with adequate liquidity to sell our common stock at prices equal to or greater than the price you paid in this offering.

 

Prior to this offering, there has not been a public market for our common stock. We cannot predict the extent to which investor interest in our company will lead to the development of an active trading market on the

 

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                                         or otherwise or how liquid that market might become. If an active trading market does not develop, you may have difficulty selling any of our common stock that you buy. The initial public offering price for the common stock will be determined by negotiations between us and the representatives of the underwriters and may not be indicative of prices that will prevail in the open market following this offering. Consequently, you may not be able to sell our common stock at prices equal to or greater than the price you paid in this offering, or at all.

 

The price of our common stock may fluctuate significantly, and you could lose all or part of your investment.

 

Volatility in the market price of our common stock may prevent you from being able to sell your shares at or above the price you paid for them. The market price for our common stock could fluctuate significantly for various reasons, including:

 

   

our operating and financial performance and prospects;

 

   

our quarterly or annual earnings or those of other companies in our industry;

 

   

the public’s reaction to our press releases, our other public announcements and our filings with the SEC;

 

   

changes in, or failure to meet, earnings estimates or recommendations by research analysts who track our common stock or the stock of other companies in our industry;

 

   

the failure of research analysts to cover our common stock;

 

   

general economic, industry and market conditions;

 

   

strategic actions by us, our customers or our competitors, such as acquisitions or restructurings;

 

   

new laws or regulations or new interpretations of existing laws or regulations applicable to our business;

 

   

changes in accounting standards, policies, guidance, interpretations or principles;

 

   

material litigation or government investigations;

 

   

changes in general conditions in the U.S. and global economies or financial markets, including those resulting from war, incidents of terrorism or responses to such events;

 

   

changes in key personnel;

 

   

sales of common stock by us, our principal stockholders or members of our management team;

 

   

termination of lock-up agreements with our management team and principal stockholders;

 

   

the granting or exercise of employee stock options;

 

   

volume of trading in our common stock; and

 

   

impact of the facts described elsewhere in “Risk Factors.”

 

In addition, in recent years, the stock market has regularly experienced significant price and volume fluctuations. This volatility has had a significant impact on the market price of securities issued by many companies, including companies in our industry. The changes frequently appear to occur without regard to the operating performance of the affected companies. Hence, the price of our common stock could fluctuate based upon factors that have little or nothing to do with us and these fluctuations could materially reduce our share price.

 

If you purchase shares of our common stock in our initial public offering, you will experience substantial and immediate dilution.

 

If you purchase shares of our common stock in our initial public offering, you will experience substantial and immediate dilution in the pro forma net tangible book value per share because the price that you pay will be

 

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substantially greater than the pro forma net tangible book value per share of the common stock that you acquire. This dilution is due in large part to the fact that our earlier investors paid substantially less than the initial public offering price when they purchased their shares of our capital stock. You will experience additional dilution upon exercise of outstanding warrants to purchase our common stock or if we issue restricted stock to our employees under our equity incentive plan.

 

We do not currently intend to pay dividends on our common stock following the offering.

 

We do not anticipate paying any cash dividends on our common stock for the foreseeable future. Instead, we intend to retain future earnings to fund our growth. In addition, as a holding company, our ability to pay dividends will depend on amounts that our subsidiaries are able to pay us. We have agreed to refrain from making distributions to our equity holders through July 31, 2015, except for such distributions as are required to offset holders’ tax obligations or as may be approved by FLOIR in advance and in writing. Further, for a five-year period beginning on July 31, 2012, Heritage P&C, as a newly licensed insurer in Florida, is precluded from paying dividends unless approved by FLOIR. There is no guarantee that we or Heritage P&C will elect to pay dividends when permitted to do so. Finally, business and regulatory considerations may impact the amount of dividends actually paid, and prior approval of dividend payments may be required. Therefore, you may not receive a return on your investment in our common stock by receiving a payment of dividends. See “Dividend Policy.”

 

The issuer of common stock in this offering does not conduct any substantive operations and, as a result, its ability to pay dividends will be dependent upon the financial results and cash flows of its operating subsidiaries and the distribution or other payment of cash to it in the form of dividends or otherwise. The direct and indirect subsidiaries of the issuer are separate and distinct legal entities and have no obligation to make any funds available to the issuer.

 

In addition, the declaration and payment of dividends will be at the discretion of our board of directors and will be dependent upon the profits and financial requirements of our company and other factors, including legal and regulatory restrictions on the payment of dividends, general business conditions and such other factors as our board of directors deems relevant.

 

Future sales of our common stock, or the perception in the public markets that these sales may occur, may depress our stock price.

 

Sales of substantial amounts of our common stock in the public market after this offering, or the perception that these sales could occur, could adversely affect the price of our common stock and could impair our ability to raise capital through the sale of additional shares. Upon completion of this offering, there will be             shares of our common stock outstanding. Of these, the shares being sold in this offering (or             shares if the underwriters exercise their option to purchase additional shares in full) will be freely tradable immediately after this offering (except for any shares purchased by affiliates, if any) and approximately             shares may be sold upon expiration of lock-up agreements 180 days after the date of this prospectus (subject in some cases to volume limitations).

 

We also intend to register all common stock that we may issue under the Plan, as described in “Executive Compensation—Heritage Insurance Holdings, Inc. Omnibus Incentive Plan.” Effective upon the completion of this offering, an aggregate of shares of our common stock will be reserved for future issuance under the Plan. Once we register these shares, which we plan to do shortly after the completion of this offering, they can be freely sold in the public market upon issuance, subject to the lock-up agreements referred to above. If a large number of these shares are sold in the public market, the sales could reduce the trading price of our common stock.

 

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We have broad discretion in the use of the net proceeds from our initial public offering and may not use them effectively.

 

We cannot specify with any certainty the particular uses of the net proceeds that we will receive from our initial public offering. We will have broad discretion in the application of the net proceeds, including working capital, possible acquisitions, and other general corporate purposes, and we may spend or invest these proceeds in a way with which our stockholders disagree. The failure by our management to apply these funds effectively could adversely affect our business and financial condition. Pending their use, we may invest the net proceeds from our initial public offering in a manner that does not produce income or that loses value. These investments may not yield a favorable return to our investors.

 

Certain provisions of our certificate of incorporation and our bylaws may make it difficult for stockholders to change the composition of our board of directors and may discourage hostile takeover attempts that some of our stockholders may consider to be beneficial.

 

Certain provisions of our certificate of incorporation and bylaws may have the effect of delaying or preventing changes in control if our board of directors determines that such changes in control are not in the best interests of us and our stockholders. The provisions in such certificate of incorporation and bylaws will include, among other things, the following:

 

   

the ability of our board of directors to issue shares of preferred stock and to determine the price and other terms, including preferences and voting rights, of those shares without stockholder approval;

 

   

stockholder action can only be taken at a special or regular meeting and not by written consent;

 

   

advance notice procedures for nominating candidates to our board of directors or presenting matters at stockholder meetings;

 

   

removal of directors only for cause; and

 

   

allowing only our board of directors to fill vacancies on our board of directors.

 

We will elect in our certificate of incorporation not to be subject to Section 203 of the DGCL, an anti-takeover law. In general, Section 203 prohibits a publicly held Delaware corporation from engaging in a business combination, such as a merger, with a person or group owning 15% or more of the corporation’s voting stock for a period of three years following the date the person became an interested stockholder, unless (with certain exceptions) the business combination or the transaction in which the person became an interested stockholder is approved in a prescribed manner. Accordingly, we will not be subject to any anti-takeover effects of Section 203.

 

While these provisions have the effect of encouraging persons seeking to acquire control of our company to negotiate with our board of directors, they could enable the board of directors to hinder or frustrate a transaction that some, or a majority, of the stockholders might believe to be in their best interests, including an acquisition that would result in a price per share at a premium over the market price, and, in that case, may prevent or discourage attempts to remove and replace incumbent directors.

 

These provisions may frustrate or prevent any attempts by our stockholders to replace or remove our current management by making it more difficult for stockholders to replace members of our board of directors, which is responsible for appointing the members of our management. For more information, see “Description of Capital Stock.”

 

Applicable insurance laws may make it difficult to effect a change of control of our company.

 

State insurance holding company laws require prior approval by the state insurance department of any change of control of an insurer that is domiciled in that respective state. “Control” is generally defined as the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a

 

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company, whether through the ownership of voting securities, by contract or otherwise. Control is generally presumed to exist through the direct or indirect ownership of 10% or more of the voting securities of a domestic insurance company or any entity that controls a domestic insurance company. Because Heritage P&C is domiciled in Florida, we are subject to Florida law, which prohibits any person from acquiring 5% or more of our outstanding voting securities without the prior approval of FLOIR. However, a party acquiring more than 5% but less than 10% of our voting securities that does not otherwise exercise control may make such acquisition without prior approval by filing a disclaimer of affiliation and control with FLOIR. These laws may discourage potential acquisition proposals and may delay, deter or prevent a change of control of us, including through transactions, and in particular unsolicited transactions, that some or all of our stockholders might consider to be desirable.

 

Any issuance of preferred stock could make it difficult for another company to acquire us or could otherwise adversely affect holders of our common stock, which could depress the price of our common stock.

 

Upon completion of this offering, our board of directors will have the authority to issue preferred stock and to determine the preferences, limitations and relative rights of shares of preferred stock and to fix the number of shares constituting any series and the designation of such series, without any further vote or action by our stockholders. Our preferred stock could be issued with voting, liquidation, dividend and other rights superior to the rights of our common stock. The potential issuance of preferred stock may delay or prevent a change in control of us, discouraging bids for our common stock at a premium over the market price, and adversely affect the market price and the voting and other rights of the holders of our common stock.

 

Our business and stock price may suffer as a result of our lack of public company operating experience. In addition, if securities or industry analysts do not publish research or publish inaccurate or unfavorable research about our business, our stock price and trading volume could decline.

 

We are a privately-held company. Our lack of public company operating experience may make it difficult to forecast and evaluate our future prospects. If we are unable to execute our business strategy, either as a result of our inability to effectively manage our business in a public company environment or for any other reason, our business, prospects, financial condition and results of operations may be harmed. In addition, as a new public company we do not currently have and may never obtain research coverage by securities and industry analysts. If no securities or industry analysts commence coverage of our company, the trading price for our stock would be negatively impacted. If we obtain securities or industry analyst coverage and if one or more of the analysts who covers us downgrades our stock or publishes inaccurate or unfavorable research about our business, our stock price would likely decline. If one or more of these analysts ceases coverage of us or fails to publish reports on us regularly, demand for our stock could decrease, which could cause our stock price and trading volume to decline.

 

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FORWARD-LOOKING STATEMENTS

 

This prospectus contains forward-looking statements that involve risks and uncertainties, such as statements about our plans, objectives, expectations, assumptions, or future events. In some cases, you can identify forward-looking statements by terminology such as “anticipate,” “estimate,” “plan,” “project,” “continuing,” “ongoing,” “expect,” “believe,” “intend,” “may,” “will,” “should,” “could,” and similar expressions. Examples of forward-looking statements include, without limitation:

 

   

statements regarding our growth and other strategies, results of operations or liquidity;

 

   

statements concerning projections, predictions, expectations, estimates or forecasts as to our business, financial and operational results and future economic performance;

 

   

statements of management’s goals and objectives;

 

   

projections of revenue, earnings, capital structure and other financial items;

 

   

assumptions underlying statements regarding us or our business; and

 

   

other similar expressions concerning matters that are not historical facts.

 

Forward-looking statements should not be read as a guarantee of future performance or results, and will not necessarily be accurate indications of the times at, or by, which such performance or results will be achieved. Forward-looking statements are based on information available at the time those statements are made or management’s good faith belief as of that time with respect to future events, and are subject to risks and uncertainties that could cause actual performance or results to differ materially from those expressed in or suggested by the forward-looking statements. Important factors that could cause such differences include, but are not limited to, factors discussed under the headings “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and “Business.”

 

Forward-looking statements involve estimates, assumptions, known and unknown risks, uncertainties and other factors that could cause actual results to differ materially from any future results, performances, or achievements expressed or implied by the forward-looking statements. These risks include, but are not limited to, those listed below and those discussed in greater detail under the heading “Risk Factors” above:

 

   

our limited operating history;

 

   

the possibility that actual losses may exceed reserves;

 

   

the concentration of our business in Florida;

 

   

our exposure to catastrophic events;

 

   

the fluctuation in our results of operations;

 

   

the discontinuation of the Citizens depopulation program and our inability to select favorable Citizens policies to assume;

 

   

increased costs of reinsurance, non-availability of reinsurance, and non-collectability of reinsurance;

 

   

increased competition, competitive pressures, and market conditions;

 

   

our failure to accurately price the risks we underwrite;

 

   

inherent uncertainty of our models and our reliance on such model as a tool to evaluate risk;

 

   

the failure of our claims department to effectively manage ore remediate claims;

 

   

low renewal rates and failure of such renewals to meet our expectations;

 

   

unsuccessful participation in the Clearinghouse;

 

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our failure to execute our growth strategy;

 

   

failure of our information technology systems and unsuccessful development and implementation of new technologies;

 

   

we do not have significant redundancy in our operations;

 

   

our failure to attract and retain qualified employees and independent agents or our loss of key personnel;

 

   

our inability to generate investment income;

 

   

our inability to maintain our financial stability rating;

 

   

effects of emerging claim and coverage issues relating to legal, judicial, environmental and social conditions;

 

   

the failure of our risk mitigation strategies or loss limitation methods; and

 

   

changes in regulations and our failure to meet increased regulatory requirements.

 

Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition or operating results.

 

The forward-looking statements speak only as of the date on which they are made, and, except as required by law, we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. Consequently, you should not place undue reliance on forward-looking statements.

 

INDUSTRY AND MARKET DATA

 

This prospectus includes industry data, forecasts and information that we have prepared based, in part, upon data, forecasts and information obtained from independent industry publications and surveys and other information available to us. Some data is also based on our good faith estimates, which are derived from management’s knowledge of the industry and independent sources. Industry publications and surveys and forecasts generally state that the information contained therein has been obtained from sources believed to be reliable, but there can be no assurance as to the accuracy or completeness of included information. We have not independently verified any of the data from third-party sources nor have we ascertained the underlying economic assumptions relied upon therein. Statements as to our market position are based on market data currently available to us. While we are not aware of any misstatements regarding the industry data presented herein, our estimates involve risks and uncertainties and are subject to change based on various factors, including those discussed under the heading “Risk Factors” in this prospectus. Similarly, we believe our internal research is reliable, even though such research has not been verified by any independent sources.

 

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USE OF PROCEEDS

 

We estimate that the net proceeds from our issuance and sale of              shares of common stock in this offering will be approximately $         million, assuming an initial public offering price of $         per share, which is the midpoint of the price range listed on the cover page of this prospectus, and after deducting underwriting discounts and commissions and offering expenses payable by us.

 

A $1.00 increase (decrease) in the assumed initial public offering price of $         per share would increase (decrease) our net proceeds from this offering by approximately $         million, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the underwriting discounts and commissions and offering expenses payable by us.

 

If the underwriters exercise their option to purchase additional shares in full, we estimate that the net proceeds from this offering will be approximately $         million, assuming an initial public offering price of $         per share, which is the midpoint of the price range listed on the cover page of this prospectus, and after deducting underwriting discounts and commissions and estimated offering expenses payable by us.

 

We intend to use a portion of the net proceeds from this offering to increase our statutory capital and surplus to enable us to write additional policies and to fund collateralized reinsurance through Osprey, our reinsurance subsidiary. We intend to use the remainder of the net proceeds to fund the growth of our business and for general corporate purposes. We may use a portion of the net proceeds from this offering to pursue expansions of the insurance products that we offer in existing and new markets. We have no commitments with respect to any such investments, and we are not currently involved in any negotiations with respect to any such investments. As a result, our management will retain broad discretion over the allocation of a portion of the net proceeds from this offering.

 

Pending use of the proceeds from this offering, we intend to invest the proceeds in a variety of capital preservation investments, including short-term, investment-grade and interest-bearing instruments.

 

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DIVIDEND POLICY

 

Following the consummation of this offering, we do not plan to pay a regular dividend on our common stock for the foreseeable future. The declaration and payment of all future dividends, if any, will be at the discretion of our board of directors and will depend upon, among other things, our financial condition, earnings and contractual obligations. Moreover, our ability to pay dividends if and when our board of directors determines to do so, may be restricted by regulatory limits on the amount of dividends Heritage P&C is permitted to pay to us. We have agreed to refrain from making distributions to our equity holders through July 31, 2015, except for such distributions as are required to offset members’ tax obligations or as may be approved by FLOIR in advance and in writing. Further, until July 31, 2017, Heritage P&C has agreed to pay only those dividends that have been approved in advance and in writing by FLOIR. Heritage P&C has not paid, and has not sought approval from FLOIR to pay, any dividends to date. Prior to the Conversion, we expect to effect the Tax Distribution. See “Prospectus Summary—Reorganization Transactions.”

 

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CAPITALIZATION

 

The following table sets forth our cash and cash equivalents and capitalization as of December 31, 2013:

 

   

on an actual basis;

 

   

on a pro forma basis to give effect to the Reorganization Transactions; and

 

   

on a pro forma as adjusted basis to give further effect to (i) the issuance of              shares of common stock in this offering and (ii) our receipt of the estimated net proceeds from the sale of shares of common stock offered by us in this offering at an assumed initial public offering price of $         per share, the midpoint of the price range set forth on the cover of this prospectus, after deducting the underwriting discounts and commissions and estimated offering expenses payable by us, and the application of the net proceeds as described in “Use of Proceeds.”

 

This information should be read in conjunction with “Use of Proceeds,” “Selected Consolidated Financial and Operating Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the historical consolidated financial statements and related notes appearing elsewhere in this prospectus.

 

     As of December 31, 2013  
     Actual      Pro  Forma(1)      Pro Forma
As  Adjusted(1)(2)
 
     (dollars in thousands)  

Cash and cash equivalents

   $ 65,059       $                    $     
  

 

 

    

 

 

    

 

 

 

Redeemable equity(3)

   $ 20,921       $ —         $ —     
  

 

 

    

 

 

    

 

 

 

Stockholders’ equity:

        

Contributed members’ capital

   $ 62,850       $         $     

Preferred stock, par value $0.0001 per share; no shares authorized, issued or outstanding, actual; 5,000,000 shares authorized, no shares issued or outstanding, pro forma and pro forma as adjusted

     —           —           —     

Common stock, par value $0.0001 per share; no shares authorized, issued or outstanding, actual; 50,000,000 shares authorized pro forma and pro forma as adjusted,              shares issued and outstanding, pro forma and              shares issued and outstanding, pro forma as adjusted

     —           

Additional paid-in capital

     —           

Retained earnings

     17,924         

Accumulated other comprehensive loss

     (790)         
  

 

 

    

 

 

    

 

 

 

Total members’/stockholders’ equity

     79,984         
  

 

 

    

 

 

    

 

 

 

Total capitalization

   $ 79,984       $         $                
  

 

 

    

 

 

    

 

 

 

 

(1)   Assuming an initial public offering price of $         per share, the midpoint of the price range set forth on the cover of this prospectus, an aggregate of              shares will be issued in connection with the Warrant Exercise. A $1.00 increase (decrease) in the assumed initial public offering price of $         per share would increase (decrease) the number of shares that will be issued in connection with the Warrant Exercise by              shares. Following the Warrant Exercise, we expect that there will remain outstanding warrants to purchase an aggregate of              shares at an exercise price of $         per share.

 

(2)   A $1.00 increase or decrease in the assumed initial public offering price of $         per share, the midpoint of the price range set forth on the cover of this prospectus, would result in an approximately $         million increase or decrease in each of cash and cash equivalents, additional paid-in capital, total stockholders’ equity and total capitalization, assuming that the number of shares offered by us set forth on the cover of this prospectus remains the same, and after deducting the underwriting discounts and commissions and estimated offering expenses payable by us. Each 1.0 million increase or decrease in the number of shares offered by us would increase or decrease each of cash and cash equivalents, additional paid-in capital, total stockholders’ equity and total capitalization by approximately $         million, assuming the initial public offering price of $         per share, the midpoint of the price range set forth on the cover of this prospectus, remains the same, and after deducting the underwriting discounts and commissions and estimated offering expenses payable by us. The as adjusted information discussed above is illustrative only and will change based on the actual initial public offering price and other terms of this offering.

 

(3)   Represents equity held by certain members of our management which was redeemable at the option of the holder upon termination of their employment. Effective February 5, 2014, this redemption right was terminated and this equity was reclassified as stockholders’ equity.

 

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DILUTION

 

If you purchase our common stock in this offering, your ownership interest will be immediately diluted to the extent of the difference between the initial public offering price per share of our common stock and the pro forma net tangible book value per share of our common stock after this offering. Dilution results from the fact that the initial public offering price per share of our common stock is substantially in excess of the pro forma book value per share of common stock attributable to the existing stockholders for the currently outstanding shares of common stock.

 

Our pro forma net tangible book value as of              was $         million, or $         per share of common stock. Pro forma net tangible book value per share represents the amount of our total tangible assets less total liabilities, divided by the number of shares of common stock that will be outstanding immediately prior to the completion of the offering after giving effect to the Reorganization Transactions.

 

After giving effect to the sale of the              shares of common stock offered by us in this offering at an assumed initial public offering price of $         per share, the midpoint of the price range set forth on the cover of this prospectus, less estimated underwriting discounts and commissions and estimated offering expenses payable by us, our pro forma as adjusted net tangible book value as of              would have been approximately $         million, or $         per share of common stock after giving effect to this offering. This represents an immediate increase in pro forma net tangible book value to our existing stockholders of $         per share and an immediate dilution to purchasers in this offering of $         per share. The following table illustrates this per share dilution to new investors purchasing shares in this offering.

 

Assumed initial public offering price per share

   $                

Pro forma as adjusted net tangible book value per share as of             

  

Increase per share attributable to investors in this offering

  

Pro forma as adjusted net tangible book value per share after giving effect to this offering

  
  

 

 

 

Dilution in per share to investors in this offering

   $     
  

 

 

 

 

A $1.00 increase or decrease in the assumed initial public offering price of $         per share, the midpoint of the price range set forth on the cover of this prospectus, would increase or decrease pro forma net tangible book value by $         million, or $         per share, and would increase or decrease the dilution per share to investors in this offering by $        , based on the assumptions set forth above.

 

The following table summarizes as of             , on a pro forma as adjusted basis, the number of shares of common stock purchased, the total consideration paid and the average price per share paid by investors in this offering, based upon an assumed initial public offering price of $         per share, the midpoint of the range set forth on the cover page of this prospectus, and before deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us:

 

     Shares purchased     Total consideration        
      Number    Percent     Amount      Percent     Average price
per share
 

Existing stockholders

                       $                                     $                

New investors

            
  

 

  

 

 

   

 

 

    

 

 

   

 

 

 

Total

        100        100   $     
  

 

  

 

 

   

 

 

    

 

 

   

 

 

 

 

Except as otherwise indicated, the discussion and tables above assume no exercise of the underwriters’ option to purchase additional shares and no exercise of any outstanding options. If the underwriters’ option to purchase additional shares is exercised in full, our existing stockholders would own approximately     % and

 

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investors in this offering would own approximately     % of the total number of shares of our common stock outstanding after this offering. If the underwriters exercise their option to purchase additional shares in full, the pro forma as adjusted net tangible book value per share after this offering would be $         per share, and the dilution per share to investors in this offering would be $         per share.

 

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SELECTED CONSOLIDATED FINANCIAL DATA

 

The following tables set forth our consolidated historical financial data. You should read the information set forth below in conjunction with “Use of Proceeds,” “Capitalization,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and notes thereto included elsewhere in this prospectus. The statements of income (loss) data for the period ended December 31, 2012 and the year ended December 31, 2013 and the balance sheet data as of December 31, 2012 and 2013 are derived from our audited consolidated financial statements included elsewhere in this prospectus. The statements of income (loss) data for the three months ended March 31, 2013, June 30, 2013, September 30, 2013 and December 31, 2013 and the balance sheet data as of March 31, 2013, June 30, 2013 and September 30, 2013 set forth below are derived from our unaudited quarterly consolidated financial statements not included in this prospectus and contain all adjustments, consisting of normal recurring adjustments, that management considers necessary for a fair presentation of our financial position and results of operations for the periods presented. See “Index to Consolidated Financial Statements.”

 

Consolidated Statement of
Operations Data

(in thousands except share and per
share data)

  August 7, 2012
(inception) to

December 31, 2012
    Three Months Ended     Year  Ended
December 31,
2013
 
    March 31, 2013     June 30, 2013     September 30,
2013
    December 31,
2013
   

Revenue:

           

Gross premiums written

  $ 43,384      $ 16,349      $ 81,049      $ 37,176      $ 83,963      $ 218,537   

Gross premiums earned

    5,719        20,324        28,040        41,506        50,089        139,959   

Ceded premiums

    (120     (358     (6,415     (19,702     (18,325     (44,800
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net premiums earned

    5,599        19,966        21,625        21,804        31,764        95,159   

Retroactive reinsurance income(1)

    —          —          26,072        —          (26     26,046   

Net investment income

    27        211        124        304        410        1,049   

Net realized losses

    —          (2     (46     (123     (152     (323

Other revenue

    4        167        826        795        1,113        2,901   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

  $ 5,630      $ 20,342      $ 48,601      $ 22,780      $ 33,109      $ 124,832   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Expenses:

           

Losses and loss adjustment expenses

    1,402        5,279        7,869        9,998        15,355        38,501   

Policy acquisition costs

    84        115        866        1,739        3,430        6,150   

General and administrative expenses

    7,922 (2)      3,986        5,582        3,372        11,764        24,704   

Interest expense

    829        4        6        6        —          16   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

    (4,607     10,958        34,278        7,665        2,560        55,461   

Provision for income taxes

    859        3,899        13,263        2,340        1,746        21,248   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

  $ (5,466   $ 7,059      $ 21,015      $ 5,325        814      $ 34,213   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Basic earnings (loss) per share(3)

  $ (2,219   $ 1,672      $ 3,525      $ 890      $ 130      $ 6,095   

Diluted earnings per share(3)

  $ (2,219   $ 1,672      $ 3,525      $ 890      $ 125      $ 6,028   

Basic weighted average shares outstanding(3)

    2,463        4,221        5,962        5,982        6,257        5,613   

Diluted weighted average shares outstanding(3)

    2,463        4,221        5,962        5,982        6,507        5,676   

 

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    Three Months Ended     Year
Ended
December 31,
2013
 
    March 31, 2013     June 30, 2013     September 30,
2013
    December 31,
2013
   

Selected Other Data

         

Book value per share(3)(4)

  $ 11,641      $ 14,850      $ 15,755      $ 15,742      $ 15,742   

Growth in book value per share(4)

    34.9     27.6     6.1     (0.1 )%      82.4

Return on average equity(4)

    58.8     107.2     23.2     3.3     45.0

Selected ratios(5):

         

Ratios to gross premiums earned

         

Gross loss ratio

    26.0     28.1     24.1     30.7     27.5

Ceded premium ratio

    1.8     22.9     47.5     36.6     32.0

Gross expense ratio

    20.2     23.0     12.3     30.3     22.0

Combined ratio

    47.9     73.9     83.9     97.6     81.6

Ratios to net premiums earned

         

Net loss ratio

    26.4     36.4     45.9     48.3     40.5

Net expense ratio

    20.5     29.8     23.4     47.8     32.4

Combined ratio

    47.0     66.2     69.3     96.2     72.9

 

Consolidated Balance Sheet Data (in
thousands):
   December 31, 2012      March 31, 2013      June 30, 2013      September 30,
2013
     December 31,
2013
 

Cash, cash equivalents and investments

   $ 76,940       $ 113,259       $ 104,778       $ 179,456       $ 201,236   

Total assets

     81,864         121,584         272,039         264,745         281,978   

Unpaid losses and loss adjustment expense

     1,393         4,973         9,493         12,366         19,344   

Unearned premiums

     37,665         33,689         86,698         82,369         116,243   

Total liabilities

     53,745         53,679         183,060         170,343         181,073   

Redeemable equity(6)

     —           6,220         7,775         8,217         20,921   

Total stockholders’ equity

     28,119         61,683         81,204         86,185         79,984   

 

(1)   Retroactive reinsurance income of $26.0 million during the year ended December 31, 2013 represents premiums earned, net of losses, for the period from January 1, 2013 through May 31, 2013 from a retroactive reinsurance quota share agreement entered into in connection with our assumption of approximately 39,000 policies from Citizens in June 2013. See Note 2 to our consolidated financial statements for the year ended December 31, 2013 included elsewhere in this prospectus.
(2)   General and administrative expenses for the period ended December 31, 2012 includes $5.5 million of stock-based compensation.
(3)   Share and per share data for the periods presented does not give retroactive effect to the Reorganization Transactions.
(4)   Includes the value, as of the end of each period, of the redeemable equity described in footnote 6 below.
(5)   The ratios presented do not reflect the impact of the retroactive reinsurance income described in footnote 1 above. For a definition of each of the ratios presented, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Key Components of Our Results of Operations—Ratios.”
(6)   Represents equity held by certain members of our management which was redeemable at the option of the holder upon termination of their employment. Effective February 5, 2014, this redemption right was terminated, and this equity was reclassified as stockholders’ equity.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion and analysis of our financial condition and results of operations is intended to help prospective investors understand our business, results of operations, liquidity and capital resources and should be read in conjunction with our consolidated financial statements and related notes appearing elsewhere in this prospectus. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including, but not limited to, those which are not within our control. We began operations in August 2012 and wrote our first policy in November 2012. Accordingly, results of operations for the period from August 7, 2012 to December 31, 2012 are not representative of future periods, and this discussion will not contain period-over-period comparative analysis.

 

Overview

 

We are a property and casualty insurance holding company headquartered in Clearwater, Florida and, through our insurance subsidiary, Heritage P&C, we provide personal residential insurance for single-family homeowners and condominium owners in Florida. We began operations in August 2012 and wrote our first policy in November 2012. In December 2012, we began selectively assuming policies from Citizens through participation in a legislatively established depopulation program, which is designed to reduce the state’s risk exposure by encouraging private insurance companies to assume Citizens’ policies. Once Citizens informs us which policies we may assume, we notify each policyholder of our offer to assume their policy, the amount of their estimated premium upon renewal and their right to elect not to participate in, or “opt-out” of, the assumption transaction. Citizens transfers to us the unearned premiums as of the effective date of the assumption transaction for the policies that have not opted out of such transaction. A policyholder may also opt-out during the 30-day period following the effective date of the assumption transaction. If a policyholder opts-out during such period, we return the applicable unearned premiums to Citizens. See “Business—Citizens Assumption Transactions.”

 

On December 4, 2012, we entered into our first assumption transaction with Citizens, resulting in our assumption of approximately 37,000 policies and assumed premiums written of approximately $43.4 million. We entered into five additional assumption transactions during the year ended December 31, 2013 (one in the first quarter of 2013 and two in each of the second and fourth quarters of 2013), resulting in our assumption of an aggregate of approximately 90,000 additional policies and assumed premiums written of approximately $97.6 million. We intend to continue assuming policies from Citizens that meet our assumption strategy and underwriting criteria.

 

In connection with our assumption of 39,000 policies in June 2013, we entered into a retroactive quota share reinsurance agreement with Citizens that resulted in our recognition of $26.0 million of retroactive reinsurance income, representing the earned premium, net of associated losses and loss adjustment expenses, from such policies for the period from January 1, 2013 through May 31, 2013. We do not expect to enter into similar retroactive arrangements with Citizens in connection with future policy assumptions.

 

During 2013, we implemented a number of initiatives to grow our voluntary program, including establishing a network of independent agents throughout Florida, offering competitive pricing and focusing on superior customer service. As a result of these efforts, we had 11,159 voluntary policies in force as of December 31, 2013, compared to 145 voluntary policies in force as of December 31, 2012.

 

Our wholly-owned subsidiary, Contractors’ Alliance, manages repair and mitigation services provided to our customers. In March 2014, we completed the acquisition of the assets and personnel of the largest vendor in the Contractors’ Alliance network, SVM Restoration Services, Inc., for $2.5 million. See “Certain Relationships and Related Party Transactions—Relationship with SVM Restoration Services.”

 

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In April 2013, we purchased a two-building, 13-acre campus located in Clearwater, Florida for aggregate consideration of $9.8 million in cash and contributed the property to our wholly-owned subsidiary, Skye Lane Properties, LLC (“Skye Lane”). We established our operating headquarters on this site in March 2014. The property is primarily occupied by unaffiliated tenants, and we expect to make further investments in the property in connection with a long-term lease that has been secured for a substantial portion of the remainder of the property. See “—Liquidity and Capital Resources—Investing Activities.”

 

In May 2013, we capitalized our wholly-owned reinsurance subsidiary, Osprey, with $1.7 million in cash. Osprey secures its reinsurance obligations to Heritage P&C with a $5.0 million irrevocable letter of credit. This letter of credit is in turn collateralized with our otherwise unencumbered real estate in Clearwater, Florida. We utilize Osprey to mitigate our reinsurance expense and reduce our reliance on third party reinsurance.

 

Key Components of Our Results of Operations

 

Revenue

 

Gross premiums written.    Gross premiums written represent, with respect to a fiscal period, the sum of assumed premiums written (premiums from policies that we assumed from Citizens, net of opt-outs) plus direct premiums written (premiums from subsequent renewals of Citizens’ policies and voluntary policies written during the period, net of any midterm cancellations), in each case prior to ceding premiums to reinsurers.

 

Gross premiums earned.    Gross premiums earned represent the total premiums earned during a fiscal period from policies assumed from Citizens, subsequent renewals of such policies and voluntary policies. Premiums associated with assumed policies are earned ratably over the remaining term of the policy and premiums associated with voluntary and renewal policies are earned ratably over the twelve-month term of the policy.

 

Ceded premiums.    Ceded premiums represent the cost of our reinsurance during a fiscal period. We recognize the cost, excluding premiums ceded to Osprey, of our reinsurance program ratably over the twelve month term of the arrangement—June 1, 2013 through May 31, 2014.

 

Net premiums earned.    Net premiums earned reflect gross premiums earned less ceded premiums during the fiscal period.

 

Retroactive reinsurance income.    Retroactive reinsurance income represents the income, net of associated losses and loss adjustment expenses, arising from the retroactive reinsurance agreement we entered in connection with our assumption of approximately 39,000 policies from Citizens in June 2013. Under this retroactive reinsurance agreement, we realized income equal to the earned premiums, net of associated losses and loss adjustment expenses, from such polices for the period from January 1, 2013 through May 31, 2013 with no corresponding reinsurance costs. The earned premiums for the period from June 1, 2013 through June 27, 2013 are included in gross premiums written for the three months ended June 30, 2013. See Note 2 to our consolidated financial statements for the year ended December 31, 2013 included elsewhere in this prospectus. The retroactive reinsurance agreement, which was a key element of our decision to enter into an assumption transaction at the outset of hurricane season, is not typical of our assumption transactions with Citizens. The typical assumption transaction with Citizens provides for the assumption of unearned premiums as of the effective date of the transaction, and does not result in the transfer of earned premiums and losses and loss adjustment expenses for prior periods. We do not expect to enter into similar retroactive arrangements with Citizens in connection with future policy assumptions.

 

Net investment income.    Net investment income represents interest earned from fixed maturity securities, short term securities and other investments, dividends on equity securities, and the gains or losses from the sale of investments.

 

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Other revenue.    Other revenue represents rental income due under non-cancelable leases for space at our commercial property in Clearwater, Florida that we acquired in April 2013, and all policy and pay-plan fees. Florida law allows insurers to charge policyholders a $25 policy fee on each policy written; these fees are not subject to refund, and we recognize the income immediately when collected. We also charge pay-plan fees to policyholders that pay their premium in more than one installment and record the fees as income when collected.

 

Expenses

 

Losses and loss adjustment expenses.    Losses and loss adjustment expenses reflect losses paid, expenses paid to resolve claims, such as fees paid to adjusters, attorneys and investigators, and changes in our reserves for unpaid losses and loss adjustment expenses during the fiscal period, in each case net of losses ceded to reinsurers. Our reserves for unpaid losses and loss adjustment expenses represent the estimated ultimate cost of resolving all reported claims plus all losses we incurred related to insured events that we assume have occurred as of the reporting date, but that policyholders have not yet reported to us (which are commonly referred to as incurred but not reported, or “IBNR”). We estimate our reserves for unpaid losses using individual case-based estimates for reported claims and actuarial estimates for IBNR losses. We continually review and adjust our estimated losses as necessary based on industry development trends, our evolving claims experience and new information obtained. If our unpaid losses and loss adjustment expenses are considered deficient or redundant, we increase or decrease the liability in the period in which we identify the difference and reflect the change in our current period results of operations.

 

Policy acquisition costs.    Policy acquisition costs consist of the following items: (i) commissions paid to outside agents at the time of policy issuance, (ii) policy administration fees paid to a third-party administrator at the time of policy issuance, (iii) premium taxes and (iv) inspection fees. We recognize policy acquisition costs ratably over the term of the underlying policy. Until renewed, policies assumed from Citizens have no associated policy acquisition costs.

 

General and administrative expenses.    General and administrative expenses include compensation and related benefits, professional fees, office lease and related expenses, information system expenses, corporate insurance, and other general and administrative costs.

 

Provision for income taxes.    Provision for income taxes generally consists of income taxes payable by our subsidiaries that are taxed as corporations. In connection with this offering, we will convert from a limited liability company to a corporation. Once we are treated as a corporation for tax purposes, we will be subject to typical corporate U.S. federal and state income tax rates which we expect to result in a statutory tax rate of approximately 37.6% under current tax law.

 

Ratios

 

Ceded premium ratio.    Our ceded premium ratio represents ceded premiums as a percentage of gross premiums earned.

 

Gross loss ratio.    Our gross loss ratio represents losses and loss adjustment expenses as a percentage of gross premiums earned.

 

Net loss ratio.    Our net loss ratio represents losses and loss adjustment expenses as a percentage of net premiums earned.

 

Gross expense ratio.    Our gross expense ratio represents policy acquisition costs and general and administrative expenses as a percentage of gross premiums earned.

 

Net expense ratio.    Our net expense ratio represents policy acquisition costs and general and administrative expenses as a percentage of net premiums earned.

 

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Combined ratios.    Our combined ratio on a gross basis represents the sum of ceded premiums, losses and loss adjustment expenses, policy acquisition costs and general and administrative expenses as a percentage of gross premiums earned. Our combined ratio on a net basis represents the sum of losses and loss adjustment expenses, policy acquisition costs and general and administrative expenses as a percentage of net premiums earned.

 

The combined ratio is the key measure of underwriting performance traditionally used in the property and casualty industry. A combined ratio under 100% generally reflects profitable underwriting results. A combined ratio over 100% generally reflects unprofitable underwriting results.

 

Due to the impact our reinsurance costs have on net premiums earned from period to period, our management believes the combined ratio on a gross basis is more relevant in assessing overall performance.

 

Highlights for the Year Ended December 31, 2013

 

   

Approximately 128,000 policies in force at December 31, 2013, of which approximately 91.3% were assumed from Citizens

 

   

Gross premiums written of $218.5 million and total revenue of $124.8 million

 

   

Net premiums earned of $95.2 million

 

   

Net income of $34.2 million

 

   

Combined ratio of 81.6% on a gross basis; combined ratio of 72.9% on a net basis

 

   

Cash, cash equivalents and investments of $201.2 million

 

Results of Operations

 

Year Ended December 31, 2013

 

Revenue

 

Gross premiums written.    Gross premiums written for the year ended December 31, 2013 were $218.5 million. Of our gross written premiums for this period, $120.9 million represents direct premiums written and $97.6 million represents assumed premiums written, including earned premium for the period from June 1, 2013 to June 27, 2013 with respect to the approximately 39,000 policies we assumed from Citizens on June 28, 2013. Renewals of policies previously assumed from Citizens accounted for $102.8 million, while voluntary business accounted for $18.1 million.

 

Gross premiums written for the three months ended March 31, June 30, September 30 and December 31, 2013 were $16.3 million (including $11.6 million of direct premiums written and $4.7 million of assumed premiums written), $81.0 million (including $28.2 million of direct premiums written and $52.8 million of assumed premiums written), $37.2 million (including $36.2 million of direct premiums written and $1.0 million of assumed premiums written) and $84.0 million (including $44.9 million of direct premiums written and $39.1 million of assumed premiums written), respectively. The significant increase in gross premiums written for the three months ended June 30, 2013 as compared to the three months ended March 30, 2013 was a result of two assumption transactions with Citizens during the three months ended June 30, 2013, which resulted in our assumption of approximately 43,000 policies from Citizens. During the three months ended December 31, 2013, we also participated in two assumption transactions with Citizens, resulting in a significant increase during the period as compared to the three months ended September 30, 2013.

 

Gross premiums earned.    Gross premiums earned for the year ended December 31, 2013 were $140.0 million.

 

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Gross premiums earned for the three months ended March 31, June 30, September 30 and December 31, 2013 were $20.3 million, $28.0 million, $41.5 million and $50.1 million, respectively. From December 31, 2012 to December 31, 2013, policies in force grew by approximately 246%, favorably impacting our gross premiums earned throughout 2013.

 

Ceded premiums.    Ceded premiums for the year ended December 31, 2013 were $44.8 million.

 

Ceded premiums for the three months ended March 31, June 30, September 30 and December 31, 2013 were $0.4 million, $6.4 million, $19.7 million and $18.3 million, respectively. The increase beginning in the three months ended June 30, 2013 reflects the commencement of our annual catastrophe reinsurance program effective June 1, 2013. Prior to June 1, 2013, our reinsurance costs were significantly lower because we purchased reinsurance limited to non-hurricane related losses through May 31, 2013.

 

Net premiums earned.    Net premiums earned for the year ended December 31, 2013 were $95.2 million.

 

Net premiums earned for the three months ended March 31, June 30, September 30 and December 31, 2013 were $20.0 million, $21.6 million, $21.8 million and $31.8 million, respectively.

 

Retroactive reinsurance income.    Retroactive reinsurance income of $26.0 million for the year ended December 31, 2013 represents premiums earned, net of losses and loss adjustment expenses, for the period from January 1, 2013 through May 31, 2013 from a retroactive reinsurance agreement entered in connection with our assumption of approximately 39,000 policies in June 2013. This income, which had no corresponding reinsurance costs, is excluded from our premiums and losses. Beginning June 1, 2013, premiums and losses associated with these polices are included in our underwriting results. See Note 2 to our consolidated financial statements for the year ended December 31, 2013 included elsewhere in this prospectus.

 

Net investment income.    Net investment income was $1.0 million for the year ended December 31, 2013. Our average investable assets for the year ended December 31, 2013 were $135.8 million, and our average net return on investment for such period was 0.7%. Our net investment income was impacted by large cash balances and low interest rates on fixed maturity securities during the period.

 

Net investment income for the three months ended March 31, June 30, September 30 and December 31, 2013 was $0.2 million, $0.1 million, $0.3 million and $0.4 million, respectively.

 

Other revenue.    Other revenue for the year ended December 31, 2013 was $2.9 million.

 

Other revenue for the three months ended March 31, June 30, September 30 and December 31, 2013 was $0.2 million, $0.8 million, $0.8 million and $1.1 million, respectively. The increase in other revenue commencing with the three months ended June 30, 2013 is primarily related to purchase of our commercial property in Clearwater, Florida in April 2013 and the rental income received pursuant to non-cancelable leases for such property. Policy fees generated by our growing portfolio of new and renewed policies also contributed to the increase in other revenue.

 

Total revenue.    Total revenue for the year ended December 31, 2013 was $124.8 million.

 

Total revenue for the three months ended March 31, June 30, September 30 and December 31, 2013 was $20.3 million, $48.6 million, $22.8 million and $33.1 million, respectively. The increase in revenue for the three months ended June 30, 2013 was primarily attributable to retroactive reinsurance income recognized in connection with the retroactive reinsurance agreement we entered into in June 2013. The increase in revenue for the three months ended December 31, 2013 as compared to the prior period was due primarily to the significant Citizens assumption transaction in November 2013.

 

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Expenses

 

Losses and loss adjustment expenses.    Losses and loss adjustment expenses for the year ended December 31, 2013 were $38.5 million. Losses and loss adjustment expenses for this period include losses paid of $20.6 million and a $17.9 million increase in unpaid losses and loss adjustment expenses, including the addition of $10.0 million of IBNR reserves. As of December 31, 2013, we reported $19.3 million in unpaid losses and loss adjustment expenses which included $11.0 million (57%) attributable to IBNR.

 

Losses and loss adjustment expenses for the three months ended March 31, June 30, September 30 and December 31, 2013 were $5.3 million, $7.9 million, $10.0 million and $15.4 million, respectively. The increase in losses and loss adjustment expenses resulted primarily from an increase in the number of policies in force in each period.

 

Policy acquisition costs.    Policy acquisition costs were $6.2 million for the year ended December 31, 2013 and related to approximately 61,000 voluntary and renewed policies. We expect these costs to increase as we renew additional policies assumed from Citizens and pursue our strategy to increase the number of voluntary policies.

 

For the three months ended March 31, June 30, September 30 and December 31, 2013, policy acquisition costs were $0.1 million (related to an aggregate of 5,997 voluntary and renewed policies), $0.9 million (related to an aggregate of 13,676 voluntary and renewed policies), $1.7 million (related to an aggregate of 17,781 voluntary and renewed policies) and $3.4 million (related to an aggregate of 23,803 voluntary and renewed policies), respectively.

 

General and administrative expenses.    General and administrative expenses were $24.7 million for the year ended December 31, 2013.

 

For the three months ended March 31, June 30, September 30 and December 31, 2013, general and administrative expenses were $4.0 million, $5.6 million, $3.4 million and $11.8 million respectively. The increase in general and administrative expenses in the second and fourth quarters of 2013 is primarily related to an accrual for cash and equity bonuses payable to directors, officers and certain employees based on earnings. The bonuses paid during the three months ended December 31, 2013 exceeded the amount accrued as of the date of payment, resulting in an increase in general and administrative expenses during the period.

 

Interest expense.    Interest expense was $16,000 for the year ended December 31, 2013.

 

Provision for income taxes.    Provision for income taxes was $21.2 million for the year ended December 31, 2013, and our effective tax rate for such period was 38.3%.

 

Ratios

 

Ceded premium ratio.    Our ceded premium ratio for the year ended December 31, 2013 was 32.0%.

 

For the three months ended March 31, June 30, September 30 and December 31, 2013, our ceded premium ratio was 1.8%, 22.9%, 47.5% and 36.6% respectively. The increase in our ceded premium ratio reflects the commencement of our annual reinsurance program effective June 1, 2013 as described above. The decrease in the ceded premium ratio for the three months ended December 31, 2013 resulted from the assumed premiums for the policies we assumed from Citizens during the fourth quarter of 2013, for which there was no incremental reinsurance cost.

 

Gross loss ratio.    Our gross loss ratio for the year ended December 31, 2013 was 27.5%.

 

For the three months ended March 31, June 30, September 30 and December 31, 2013, our gross loss ratio was 26.0%, 28.1%, 24.1% and 30.7%, respectively.

 

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Net loss ratio.    Our net loss ratio for the year ended December 31, 2013 was 40.5%.

 

For the three months ended March 31, June 30, September 30 and December 30, 2013, our net loss ratio was 26.4%, 36.4%, 45.9% and 48.3% respectively. The increase in our net loss ratio during the second half of the year reflects the increase in ceded premium in connection with the commencement of our twelve month reinsurance program on June 1, 2013. Prior to June 1, 2013, our reinsurance costs were significantly lower because we purchased reinsurance limited to non-hurricane related losses through May 31, 2013.

 

Gross expense ratio.    Our gross expense ratio for the year ended December 31, 2013 was 22.0%. Our gross expense ratio was favorably impacted by the assumption of policies from Citizens, which have no policy acquisition costs until renewed.

 

For the three months ended March 31, June 30, September 30 and December 31, 2013, our gross expense ratio was 20.2%, 23.0%, 12.3% and 30.3%, respectively. The increase in our gross expense ratio for the three months ended December 31, 2013 resulted primarily from the cash and equity bonuses paid to directors, officers and employees during the period.

 

Net expense ratio. Our net expense ratio for the year ended December 31, 2013 was 32.4%. Our relatively low net expense ratio is due in part to the assumption of policies from Citizens, which have no policy acquisition costs until renewed.

 

For the three months ended March 31, June 30, September 30 and December 31, 2013, our net expense ratio was 20.5%, 29.8%, 23.4% and 47.8%, respectively. The increase in our net expense ratio for the three months ended December 31, 2013 resulted primarily from the payment of bonuses described above.

 

Combined ratio.    Our combined ratio on a gross basis for the year ended December 31, 2013 was 81.6% and on a net basis was 72.9%.

 

For the three months ended March 31, June 30, September 30 and December 31, 2013, our combined ratio on a gross basis was 47.9%, 73.9%, 83.9% and 97.6%, respectively, and on a net basis was 47.0%, 66.2%, 69.3% and 96.2% respectively. The increase in the combined ratios beginning during the three months ended June 30, 2013 was a result of the commencement of our annual reinsurance program effective June 1, 2013 and the payment of bonuses described above.

 

Period from August 7, 2012 (inception) to December 31, 2012

 

Revenue

 

Gross premiums written.    Gross premiums written for the period ended December 31, 2012 were $43.4 million and primarily related to our assumption of approximately 37,000 policies from Citizens in December 2012.

 

Gross premiums earned.    Gross premiums earned for the period ended December 31, 2012 were $5.7 million and primarily related to our December 2012 assumption transaction with Citizens.

 

Ceded premiums.    Ceded premiums during the period ended December 31, 2012 were $0.1 million.

 

Net premiums earned.    Net premiums earned for the period ended December 31, 2012 were $5.6 million.

 

Net investment income.    Net investment income was $27,000 for the period ended December 31, 2012.

 

Total revenue.    Total revenue for the period ended December 31, 2012 was $5.6 million.

 

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Expenses

 

Losses and loss adjustment expenses.    Losses and loss adjustment expenses for the period ended December 31, 2012 were $1.4 million and reflect our brief period of operations. No meaningful conclusions relating to trends or variance from expectations can be drawn from the very few reported losses during the period. Consequently, we established IBNR reserves to complement our limited paid and reserved loss experience consistent with the risk characteristics related to the exposures drawn from our assumption of policies from Citizens in December 2012.

 

Policy acquisition costs.    Policy acquisition costs were $84,000 for the period ended December 31, 2012 and related to an insignificant number of voluntary and renewed policies.

 

General and administrative expenses.    General and administrative expenses were $7.9 million for the period ended December 31, 2012 and primarily related to stock-based compensation of $5.5 million and start-up expenses.

 

Interest expense.    Interest expense was $0.8 million for the period ended December 31, 2012 and related to the payment of a 20% fee payable upon the exchange of $3.9 million aggregate principal amount of notes for equity.

 

Provision for income taxes.    Provision for income taxes was $0.9 million for the period ended December 31, 2012. Heritage P&C had taxable income for the period ended December 31, 2012, while our limited liability company subsidiaries sustained losses. Such losses were passed through to our equity holders and were not available to offset Heritage P&C’s taxable income.

 

Liquidity and Capital Resources

 

As of December 31, 2013, we had $65.1 million in cash and cash equivalents, which primarily consisted of cash and money market accounts. We intend to maintain substantial cash balances during hurricane season to meet seasonal liquidity needs relating to potential catastrophic losses.

 

We generate cash through premium collections, investment income and the sale or maturity of invested assets. During our start-up phase, we funded our working capital requirements primarily through private sales of equity. We received net proceeds of approximately $60.9 million primarily from four equity issuances through December 31, 2013. See “—Equity Issuances.” We use our cash to pay reinsurance premiums, losses and loss adjustment expenses, policy acquisition costs, salaries and employee benefits, other expenses, as well as to purchase investments.

 

Although we can provide no assurances, we believe that the net proceeds from this offering, together with our available cash and cash equivalents balance and cash generated from operations, should be sufficient to meet our working capital requirements and other capital expenditures for the next twelve months.

 

Operating Activities

 

For the year ended December 31, 2013, our operations generated cash of $105.1 million primarily from the transfer of unearned premiums associated with assumption transactions with Citizens and the retroactive reinsurance agreement effected during the period, as well as premiums associated with renewals of Citizens policies and voluntary policies. Our cash flows from operating activities generally represent the difference between: (l) premiums collected, net of reinsurance paid, and investment earnings realized and (2) losses and loss adjustment expenses paid and underwriting and other expenses paid.

 

Investing Activities

 

For the year ended December 31, 2013, we deployed approximately $136.5 million of our liquid resources, including $125.6 million, net of sales or maturities, to acquire investment securities and other invested assets,

 

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$9.7 million to acquire the commercial property in Clearwater, Florida, $0.9 million to effect real estate improvements and $0.3 million to acquire office equipment. We expect to make capital expenditures of approximately $4.0 million relating to improvements on the Clearwater property during 2014. We will continue to position our investment funds to achieve a prudent balance between current yield, conservation of investment capital and the immediate liquidity requirements of our operation.

 

In addition to maintaining a $300,000 cash deposit with FLOIR to meet regulatory requirements, at December 31, 2013, we held significant cash balances reflecting the receipt of premiums associated with significant assumption and retroactive reinsurance transactions with Citizens, limited attractive investment opportunities and our seasonal liquidity objective as we neared the end of the Florida hurricane season.

 

Financing Activities

 

During the year ended December 31, 2013, we raised $33.6 million through equity issuances. We satisfied a $1.0 million note payable to a financial institution that had been in place since our formation.

 

Seasonality of our Business

 

Our insurance business is seasonal as hurricanes typically occur during the period from June 1 through November 30 each year. With our reinsurance program effective on June 1 each year, any variation in the cost of our reinsurance, whether due to changes to reinsurance rates or changes in the total insured value of our policy base, will occur and be reflected in our financial results beginning June 1 of each year, subject to certain adjustments.

 

Equity Issuances

 

Historically, we have funded our working capital requirements primarily through private issuances of our equity. The equity issuances described below resulted in an aggregate of 6,410 shares (5,493 equity shares and 917 redeemable shares classified as temporary equity) and 3,019 warrants outstanding as of December 31, 2013, reflecting total paid in capital of $62.9 million as of such date, exclusive of the effects of issuing redeemable shares. Prior to the consummation of this offering,              of our outstanding warrants will be exercised for              shares of common stock of the Company, assuming an initial public offering price of $         per share, the midpoint of the range set forth on the cover of this prospectus. An additional              shares of common stock of the Company will be issued in connection with such exercise for every $1.00 increase in the public offering price in this offering. See “Prospectus Summary—Reorganization Transactions.”

 

In 2012, we initially raised an aggregate of $23.3 million from the sale of 2,329 shares at a price of $10,000 per share. We sold these shares to directors, certain members of senior management and a select group of initial investors. The price per share was established to achieve the desired capital in the formation of our Company and reflect the progress made by the Company towards the licensure of Heritage P&C.

 

In the fourth quarter of 2012, we issued $3.9 million aggregate principal amount of notes to certain members, including directors and members of senior management, to raise additional capital required by Heritage P&C. The notes provided for a 20% fee due upon repayment. Following the issuance of these notes, we determined that debt would not allow us to achieve our desired financial stability rating and exchanged the notes and the right to receive the accompanying 20% fee for equity in the form of investment units, with each investment unit comprised of one share and one warrant to purchase a share. Based on a value of $12,500 per investment unit, we issued 398 investment units in exchange for the notes. Certain investors, including directors and members of our senior management, who received fractional investment units upon the exchange of their notes, paid in $95,000 in cash in order to receive whole investment units. Additionally, in connection with the exchange of the notes, certain members of senior management received, in the aggregate, $200,000 in stock-based compensation in the form of investment units. The warrants are exercisable at any time at a strike price of

 

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$15,000 until their expiry at March 31, 2018. The value of $12,500 per investment unit was based on share sales to unrelated parties and the value inherent in the option to purchase shares represented by the warrant.

 

Also in the fourth quarter of 2012, we issued 532 shares to certain members of senior management and a select group of initial investors and recognized $5.3 million of compensation expense at $10,000 per share, which was based upon recent sales of investment units to unrelated parties after eliminating the consideration payable in respect of the warrants. These shares were distributed in connection with the successful execution of our initial assumption transaction with Citizens.

 

On January 1, 2013, we reclassified 415 equity shares to redeemable shares classified as temporary equity upon entering into employment agreements with certain members of management.

 

In the first quarter of 2013, we raised an additional $32.7 million through the issuance of 2,618 investment units to certain investors, including each member of our management team, at a price of $12,500 per investment unit. The warrants issued in this transaction are exercisable at any time at an exercise price of $15,000 per share until their expiry at March 31, 2018. The 2,618 investment units consisted of 2,511 equity shares, 107 redeemable shares classified as temporary equity and 2,618 warrants to purchase one share per warrant.

 

Also in the first quarter of 2013, certain members of management were given an opportunity to purchase, in the aggregate, 115 shares (15 equity shares and 100 redeemable shares classified as temporary equity) at $5,000 per share. Each member of management exercised his option to purchase the shares pursuant to this grant. We also established a reserve in order to reimburse management for their personal tax consequences of the stock grant in the amount of $318,000. We assigned a fair value to these stock grants of $10,000 per share, based upon recent sales of investment units to unrelated parties after reduction to eliminate the consideration payable in respect of the warrants, and recognized $893,000 compensation expense as a result of this grant.

 

In the fourth quarter of 2013, the Board resolved to award $5.1 million of equity compensation to our directors and certain members of our senior management and staff based upon a value per share as of October 31, 2013. We engaged an independent valuation specialist to perform a valuation of our shares, which value was approximately $13,125 per share as of October 31, 2013. Consistent with the valuation, we awarded 389 shares (97 equity shares and 292 redeemable shares classified as temporary equity) to our directors, members of senior management and staff valued at $13,125 per share. The independent valuation specialist’s valuation was based on various assumptions and considerations, which were evaluated by management, including a liquidity discount customarily associated with a private company.

 

Redeemable Equity

 

We have issued 917 shares to certain members of our management which were redeemable at the option of the holder upon termination of their employment. As of December 31, 2013, such shares were valued at $20.9 million. Effective February 5, 2014, this redemption right was terminated, and this equity was reclassified as stockholders’ equity.

 

Taxation

 

Deferred Tax Asset and Current Tax Liability

 

We report a deferred tax asset arising from the portion (20%) of unearned premiums that are recognized as taxable income in advance of being earned and recognized as income for financial reporting purposes. Accordingly, our income taxes currently paid and payable also reflect this temporary difference between taxable income and earned income reported in our financial statements. The increases in our deferred tax asset from December 31, 2012 through December 31, 2013 reflect the significant unearned premiums arising from our assumption transactions and the additional resulting temporary differences due to certain amounts being taxable in advance of being recognized as earned for financial reporting purposes.

 

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Conversion to a Corporation

 

In connection with this offering, we will convert from a limited liability company to a corporation. Because we are currently treated as a partnership for tax purposes, we are not subject to entity-level federal or state income taxation. Our income tax provision generally consists of income taxes payable by our separate subsidiaries that are taxed as corporations. As such, our current effective tax rate is driven primarily by the taxable income recognized with respect to gross premiums written as described above. Once we are treated as a corporation for tax purposes, we will be subject to typical corporate U.S. federal and state income tax rates which we expect to result in a statutory tax rate of approximately 37.6% under current tax law.

 

Off-Balance Sheet Arrangements

 

We obtained a $5.0 million irrevocable letter of credit from a financial institution to secure Osprey’s obligations arising from our reinsurance program. We collateralized this letter of credit facility with otherwise unencumbered real estate.

 

Quantitative and Qualitative Disclosures about Market Risk

 

Our investment portfolios at December 31, 2013 included fixed-maturity and equity securities, the purposes of which are not for trading or speculation. Our main objective is to maximize after-tax investment income and maintain sufficient liquidity to meet policyholder obligations while minimizing market risk which is the potential economic loss from adverse fluctuations in securities’ prices. We consider many factors including credit ratings, investment concentrations, regulatory requirements, anticipated fluctuation of interest rates, durations and market conditions in developing investment strategies. Investment securities are managed by a group of nationally recognized asset managers and are overseen by the investment committee appointed by our board of directors. Our investment portfolios are primarily exposed to interest rate risk, credit risk and equity price risk. We classify our fixed-maturity and equity securities as available-for-sale and report any unrealized gains or losses, net of deferred income taxes, as a component of other comprehensive income within our stockholders’ equity. As such, any material temporary changes in their fair value can adversely impact the carrying value of our stockholders’ equity.

 

Interest Rate Risk

 

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

 

The following table illustrates the impact of hypothetical changes in interest rates to the fair value of our fixed-maturity securities at December 31, 2013 (in thousands):

 

Hypothetical Change in Interest Rates

   Estimated
Fair Value
After Change
     Change in
Estimated
Fair Value
    Percentage
Increase
(Decrease) in
Estimated
Fair Value
 

300 basis point increase

   $ 91,128       $ (13,540     (12.9 )% 

200 basis point increase

     95,640         (9,028     (8.6 )% 

100 basis point increase

     100,153         (4,515     (4.3 )% 

100 basis point decrease

     109,067         4,399        4.2

200 basis point decrease

     112,426         7,758        7.4

300 basis point decrease

     114,252         9,584        9.2

 

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Credit Risk

 

Credit risk can expose us to potential losses arising principally from adverse changes in the financial condition of the issuers of our fixed-maturity securities. We mitigate the risk by primarily investing in fixed-maturity securities that are rated “BBB” or higher and diversifying our investment portfolio to avoid concentrations in any single issuer or business sector. Pursuant to our investment policy, only $1 million may be invested in below investment grade bonds. The following table presents the composition of our fixed-maturity securities, consisting of bonds and redeemable preferred stocks, by rating, at December 31, 2013 (in thousands):

 

Comparable Rating

   Amortized
Cost
     % of
Total
Amortized
Cost
    Estimated
Fair Value
     % of
Total
Estimated
Fair Value
 

AAA

   $ 3,967         3.7   $ 3,914         3.7

AA+

     14,384         13.6     14,188         13.6

AA

     20,148         19.0     19,855         19.0

AA-

     11,788         11.1     11,706         11.2

A+

     10,891         10.3     10,774         10.3

A

     11,895         11.2     11,780         11.3

A-

     10,863         10.3     10,761         10.3

BBB+

     9,059         8.5     8,978         8.6

BBB

     11,318         10.7     11,216         10.7

BBB-

     608         0.6     522         0.5

BB+

     719         0.7     668         0.6

BB

     60         0.1     50         0.0

B+

     183         0.2     183         0.2

B-

     72         0.1     73         0.1
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 105,955         100.0   $ 104,668         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

 

Equity Price Risk

 

Our equity investment portfolio at December 31, 2013 primarily consisted of non-redeemable preferred stocks and interests in publicly traded limited partnerships. We may incur potential losses due to adverse changes in equity security prices. We manage the risk primarily through industry and issuer diversification and asset allocation techniques.

 

The following table illustrates the composition of our equity securities at December 31, 2013 (in thousands):

 

     Estimated Fair Value      % of Total
Estimated Fair Value
 

Stocks by sector:

     

Financial

   $ 2,326         9.2

Energy

     5,125         20.1

Utility

        0.0

Other

     2,929         11.5
  

 

 

    

 

 

 

Subtotal

     10,380         40.8
  

 

 

    

 

 

 

Mututal Funds and ETF By type:

     

Debt

     15,000         58.9

Equity

     66         0.3
  

 

 

    

 

 

 

Subtotal

     15,066         59.2
  

 

 

    

 

 

 

Total

   $ 25,446         100.0
  

 

 

    

 

 

 

 

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Foreign Currency Exchange Risk

 

At December 31, 2013, we did not have any material exposure to foreign currency related risk.

 

Critical Accounting Policies and Estimates

 

Preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions about future events. These estimates and the underlying assumptions affect the amounts of assets and liabilities reported, disclosures about contingent assets and liabilities and reported amounts of revenues and expenses. We believe that the accounting estimates discussed below represent the accounting estimates requiring the exercise of judgment where a different set of judgments could result in the greatest changes to reported results. Our current critical accounting policies and estimates are as follows:

 

Premiums.    We record direct and assumed premiums written as revenue, net of ceded amounts, on a daily pro rata basis over the contract period of the related policies that are in force. For any portion of premiums not earned at the end of the reporting period, we record an unearned premium liability.

 

Premiums receivable represents amounts due from our policyholders for billed premiums and related policy fees. We perform a policy-level evaluation to determine the extent to which the balance of the premium receivable exceeds the balance of the unearned premium. We then age any resulting exposure based on the last date the policy was billed to the policyholder, and we establish an allowance account for credit losses for any amounts outstanding for more than 90 days. When we receive payments on amounts previously charged off, we credit bad debt expense in the period we receive the payment. Balances in premiums receivable and the associated allowance account are removed upon cancellation of the policy due to non-payment. We did not record an allowance for uncollectible premiums at December 31, 2013 or December 31, 2012.

 

When we receive premium payments from policyholders prior to the effective date of the related policy, we record an advance premium liability. On the policy effective date, we reduce the advance premium liability and record the premiums as described above.

 

Reserves For Unpaid Losses and Loss Adjustment Expenses.    Reserves for unpaid losses and loss adjustment expenses, also referred to as loss reserves, represent the most significant accounting estimate inherent in the preparation of our financial statements. These reserves represent management’s best estimate of the amount we will ultimately pay for losses and loss adjustment expenses and we base the amount upon the application of various actuarial reserve estimation techniques as well as considering other material facts and circumstances known at the balance sheet date.

 

We establish two categories of loss reserves as follows:

 

   

Case reserves—When a claim is reported, we establish an initial estimate of the losses that will ultimately be paid on the reported claim. Our initial estimate for each claim is based upon the judgment of our claims professionals who are familiar with property and liability losses associated with the coverage offered by our policies. Then, our claims personnel perform an evaluation of the type of claim involved, the circumstances surrounding each claim and the policy provisions relating to the loss and adjust the reserve as necessary. As claims mature, we increase or decrease the reserve estimates as deemed necessary by our claims department based upon additional information we receive regarding the loss, the results of on-site reviews and any other information we gather while reviewing the claims.

 

   

IBNR reserves—Our IBNR reserves include true IBNR reserves plus “bulk” reserves. True IBNR reserves represent amounts related to claims for which a loss occurred on or before the date of the financial statements but which have not yet been reported to us. Bulk reserves represent additional amounts that cannot be allocated to particular claims, but which are necessary to estimate ultimate losses on known claims. We estimate our IBNR reserves by projecting our ultimate losses using industry

 

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accepted actuarial methods and then deducting actual loss payments and case reserves from the projected ultimate losses. We review and adjust our IBNR reserves on a quarterly basis based on information available to us at the balance sheet date.

 

When we establish our reserves, we analyze various factors such as the evolving historical loss experience of the insurance industry as well as our experience, claims frequency and severity, our business mix, our claims processing procedures, legislative enactments, judicial decisions and legal developments in imposition of damages, and general economic conditions, including inflation. A change in any of these factors from the assumptions implicit in our estimates will cause our ultimate loss experience to be better or worse than indicated by our reserves, and the difference could be material. Due to the interaction of the foregoing factors, there is no precise method for evaluating the impact of any one specific factor in isolation, and an element of judgment is ultimately required. Due to the uncertain nature of any projection of the future, the ultimate amount we will pay for losses will be different from the reserves we record.

 

We determine our ultimate loss reserves by selecting a point estimate within a relevant range of indications that we calculate using generally accepted actuarial techniques. Our selection of the point estimate is influenced by the analysis of our paid losses and incurred losses since inception, as well as industry information relevant to the population of exposures drawn from Citizens. At our current level of experience, industry information strongly influences the basis for estimates of claims related factors. We expect that our loss experience will be of growing significance in future periods.

 

Our independent actuary evaluated the adequacy of our reserves as of December 31, 2013 and concluded that total reserves ranging from a low of $17.0 million to a high of $20.8 million would meet the requirements of the insurance laws of Florida, be consistent with reserves computed in accordance with accepted loss reserving standards and principles, and make a reasonable provision for all unpaid loss and loss adjustment expense obligations under the terms of our contracts and agreements. In addition to $7.6 million of recorded case reserves, we recorded $11.0 million of IBNR reserves as of December 31, 2013 to achieve overall reserves of $18.6 million, plus an additional $783,000 attributable to reinsurance claims payable.

 

The process of establishing our reserves is complex and necessarily imprecise, as it involves using judgment that is affected by many variables. We believe a reasonably likely change in almost any of the factors we evaluate as part of our loss reserve analysis could have an impact on our reported results, financial position and liquidity.

 

The following table quantifies the impact of changes in our loss reserves on our net income, stockholders’ equity and liquidity as of and for the year ended December 31, 2013.

 

(dollars in thousands)    Actual     Low
Estimate
     %
Change
from
Actual
    High
Estimate
     %
Change
from
Actual
 

Loss Reserves

   $ 18,561 (1)    $ 16,992         $ 20,786      

Impact on:

            

Net income

   $ 34,213      $ 35,154         2.8   $ 32,878         (3.9 )% 

Stockholders’ equity

   $ 79,984      $ 80,925         1.2   $ 78,649         (1.7 )% 

Cash, cash equivalents and investments

   $ 201,236      $ 201,236              $ 201,236           

Adjusted cash, cash equivalents and investments(2)

   $ 190,099      $ 191,041         0.5   $ 188,764         (0.7 )% 

 

(1)   

Does not include $783,000 attributable to reinsurance claims payable.

(2)   

Adjusted cash, cash equivalents and investments is intended to present a measure of future liquidity and consists of cash, cash equivalents and investments, less loss reserves, net of taxes, assuming a 40% tax rate.

 

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Policy Acquisition Costs.    We incur policy acquisition costs that vary with, and are directly related to, the production of new business. Policy acquisition costs consist of the following four items: (i) commissions paid to outside agents at the time of policy issuance, (ii) policy administration fees paid to a third-party administrator at the time of policy issuance, (iii) premium taxes and (iv) inspection fees. We capitalize policy acquisition costs to the extent recoverable, then we amortize those costs over the contract period of the related policy.

 

At each reporting date, we determine whether we have a premium deficiency. A premium deficiency would result if the sum of our expected losses, deferred policy acquisition costs and policy maintenance costs (such as costs to store records and costs incurred to collect premiums and pay commissions) exceeded our related unearned premiums plus investment income. Should we determine that a premium deficiency exists, we would write off the unrecoverable portion of deferred policy acquisition costs.

 

Reinsurance.    We follow industry practice of reinsuring a portion of our risks. Reinsurance involves transferring, or “ceding,” all or a portion of the risk exposure on policies we write to another insurer, known as a reinsurer. To the extent that our reinsurers are unable to meet the obligations they assume under our reinsurance agreements, we remain liable for the entire insured loss.

 

Our reinsurance agreements are short-term, prospective contracts. We record an asset, prepaid reinsurance premiums, and a liability, reinsurance payable, for the entire contract amount upon commencement of our new reinsurance agreements. We amortize our prepaid reinsurance premiums over the 12-month contract period.

 

In the event that we incur losses recoverable under our reinsurance program, we record amounts recoverable from our reinsurers on paid losses plus an estimate of amounts recoverable on unpaid losses. The estimate of amounts recoverable on unpaid losses is a function of our liability for unpaid losses associated with the reinsured policies; therefore, the amount changes in conjunction with any changes to our estimate of unpaid losses. Though an estimate of amounts recoverable from reinsurers on unpaid losses may change at any point in the future because of its relation to our reserves for unpaid losses, a reasonable probability exists that an estimated recovery may change significantly in the near term from the amounts included in our consolidated financial statements.

 

We estimate uncollectible amounts receivable from reinsurers based on an assessment of factors including the creditworthiness of the reinsurers and the adequacy of collateral obtained, where applicable. We recorded no amounts recoverable under our reinsurance program or bad debt expense related to reinsurance during the year ended December 31, 2013 or the period ended December 31, 2012.

 

Investments.    We currently classify all of our investments in fixed maturity securities and equity securities as available-for-sale, and report them at fair value. We currently classify our investments in mortgage loans as held to maturity and report them at amortized cost. Subsequent to our acquisition of available-for-sale securities, we record changes in value through the date of disposition as unrealized holding gains and losses, net of tax effects, and include them as a component of other comprehensive income. We include realized gains and losses, which we calculate using the specific-identification method for determining the cost of securities sold, in net income. We amortize any premium or discount on investments over the remaining maturity period of the related investments using the effective interest method, and we report the amortization in net investment income. We recognize dividends and interest income when earned.

 

Quarterly, we perform an assessment of our investments to determine if any are “other-than-temporarily” impaired. An investment is impaired when the fair value of the investment declines to an amount less than the cost or amortized cost of that investment. As part of our assessment process, we determine whether the impairment is temporary or “other-than-temporary”. We base our assessment on both quantitative criteria and qualitative information, considering a number of factors including, but not limited to: how long the security has been impaired; the amount of the impairment; whether, in the case of equity securities, we intend to hold, and have the ability to hold, the security for a period sufficient for us to recover our cost basis, or whether, in the case of debt securities or mortgage loans, we intend to sell the investment or it is more likely than not that we will

 

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have to sell the investment before we recover the amortized cost; the financial condition and near-term prospects of the issuer; whether the issuer is current on contractually-obligated interest and principal payments; key corporate events pertaining to the issuer and whether the market decline was affected by macroeconomic conditions.

 

If we were to determine that an equity security has incurred an “other-than-temporary” impairment, we would permanently reduce the cost of the security to fair value and recognize an impairment charge. If a debt security or mortgage loan is impaired and we either intend to sell the security or mortgage loan or it is more likely than not that we will have to sell the security or mortgage loan before we are able to recover the amortized cost, then we would record the full amount of the impairment in our net income.

 

A large portion of our investment portfolio consists of fixed maturity securities and a mortgage loan, which may be adversely affected by changes in interest rates as a result of governmental monetary policies, domestic and international economic and political conditions and other factors beyond our control. A rise in interest rates would decrease the net unrealized holding gains of our investment portfolio, offset by our ability to earn higher rates of return on funds reinvested. Conversely, a decline in interest rates would increase the net unrealized holding gains of our investment portfolio, offset by lower rates of return on funds reinvested.

 

Fair Value.    Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants (an exit price). When reporting the fair values of our financial instruments, we prioritize those fair value measurements into one of three levels based on the nature of the inputs, as follows:

 

   

Level 1—Valuations based on quoted prices in active markets for identical assets and liabilities;

 

   

Level 2—Valuations based on observable inputs that do not meet the criteria for Level 1, including quoted prices in inactive markets and quoted prices in active markets for similar, but not identical instruments; and

 

   

Level 3—Valuations based on unobservable inputs, which are based upon the best available information when external market data is limited or unavailable.

 

We estimate the fair value of our investments using the closing prices on the last business day of the reporting period, obtained from active markets. For securities for which quoted prices in active markets are unavailable, we use observable inputs such as quoted prices in inactive markets, quoted prices in active markets for similar instruments, benchmark interest rates, broker quotes and other relevant inputs. We do not have any investments in our portfolio which require us to use unobservable inputs. Our estimates of fair value reflect the interest rate environment that existed as of the close of business on December 31, 2013 and December 31, 2012. Changes in interest rates subsequent to December 31, 2013 may affect the fair value of our investments.

 

The carrying amounts for the following financial instruments approximate their fair values at December 31, 2013 and December 31, 2012 because of their short-term nature: cash and cash equivalents, accrued investment income, premiums receivable, reinsurance payable, and accounts payable and accrued expenses.

 

Stock-Based Compensation.    We account for stock-based compensation under the fair value recognition provisions of U.S. GAAP which requires the measurement and recognition of compensation for all stock-based awards made to employees and directors based on estimated fair values. In accordance with U.S. GAAP, the fair value of stock-based awards is amortized over the requisite service period, which is defined as the period during which an employee is required to provide service in exchange for an award. We use a straight-line attribution method for all grants that include only a service condition.

 

Income taxes.    We file as a consolidated partnership along with our limited liability company affiliates, Heritage MGA, LLC, Contractors’ Alliance, First Access Insurance Group, LLC and Heritage Insurance Claims, LLC. The limited liability companies are not required to provide for federal income taxes. As such, taxable

 

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income, losses, deductions and credits pass through to members for them to report on their respective income tax returns. Our insurance subsidiary, Heritage P&C, writes policies only in Florida and files a federal and Florida state income tax return. Our reinsurance subsidiary, which is based in Bermuda, plans to make an irrevocable election under Section 953(d) of the U.S. Internal Revenue Code of 1986, as amended, to be treated as a domestic insurance company for U.S. federal income tax purposes. As a result of this election, our reinsurance subsidiary will be subject to United States income tax on its worldwide income as if it were a U.S. corporation.

 

We recognize deferred tax assets and liabilities for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. We measure deferred tax assets and liabilities using enacted tax rates expected to apply to taxable income in the years in which we expect to recover or settle those temporary differences. Should a change in tax rates occur, we recognize the effect on deferred tax assets and liabilities in operations in the period that includes the enactment date. Realization of our deferred income tax assets depends upon our generation of sufficient future taxable income.

 

We recognize the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit. For tax positions meeting the more likely than not threshold, the amount recognized in the consolidated financial statements is the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement with the relevant taxing authority.

 

We record any income tax penalties and income tax-related interest as income tax expense in the period incurred. We did not incur any material tax penalties or income tax-related interest during the year ended December 31, 2013 or the period ended December 31, 2012.

 

Recent Accounting Pronouncements

 

We determined that all recently issued accounting pronouncements will not have a material impact on our consolidated financial position, results of operations and cash flows, or do not apply to our operations.

 

 

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BUSINESS

 

Our Business

 

We are a property and casualty insurance holding company headquartered in Clearwater, Florida and, through our subsidiary, Heritage P&C, we provide personal residential insurance for single-family homeowners and condominium owners in Florida. We are vertically integrated and control or manage substantially all aspects of insurance underwriting, actuarial analysis, distribution and claims processing and adjusting. We are led by an experienced senior management team with an average of 26 years of insurance industry experience. We began operations in August 2012, and in December 2012 we began selectively assuming policies from Citizens, a Florida state-supported insurer, through participation in a legislatively established “depopulation program” designed to reduce the state’s risk exposure by encouraging private companies to assume insurance policies from Citizens. We also write policies outside the Citizens depopulation program, which we refer to as voluntary policies. Heritage P&C is currently rated “A” (“Exceptional”) by Demotech, a rating agency specializing in evaluating the financial stability of insurers.

 

As of December 31, 2013, we had approximately 128,000 policies in force, approximately 91% of which were assumed from Citizens. For the year ended December 31, 2013, we had gross premiums written of $218.5 million and net income of $34.2 million. At December 31, 2013, we had total assets of $282.0 million, total stockholders’ equity of $80.0 million and pro forma stockholders’ equity, after giving effect to this offering, of $         million.

 

As of December 31, 2013, Citizens had approximately one million insurance policies, of which approximately 766,000 were personal residential policies. We selectively assumed personal residential policies from Citizens in six separate assumption transactions between December 2012 and December 2013, and substantially all of our revenue since our inception has come from these policies. We intend to continue assuming policies from Citizens that meet our assumption strategy and underwriting criteria.

 

In order to assume a policy from Citizens, we must obtain the prior approval of the insurance agent that wrote the policy. With respect to policies written by agents that are affiliated with an insurance company or agency, we must also obtain the approval of the insurance company or agency. Currently, four large national insurance companies or agencies permit us to assume policies from Citizens that have been written by their agents—State Farm, Allstate, Brown & Brown and AAA (formerly the American Automobile Association). In an effort to increase the pool of Citizens policies that we may assume, we are seeking similar advance approvals from other insurance companies and agencies. We currently have advance approvals covering more than 4,500 agents. These agents were responsible for writing more than 85% of the approximately 766,000 personal residential insurance policies held by Citizens as of December 31, 2013.

 

We market and write voluntary policies through a network of approximately 1,100 independent agents. Of these agents, approximately 46% are affiliated with nine large agency networks with which we have entered into master agency agreements. We recently entered into an agreement with FMS, the in-house, for-profit managing general agency division of the Florida Association of Insurance Agents, which gives us access to several hundred additional agents throughout the state. We intend to pursue additional voluntary business from agents in our existing independent agent network, expand our independent agent network and seek additional opportunities to use insurer-affiliated agents to offer our personal residential policies in Florida. While we had 11,159 voluntary policies (9% of our total policies in force) as of December 31, 2013, during the three months ended December 31, 2013, we wrote an average of 1,700 new voluntary policies per month. The voluntary market is a significant component of our growth strategy.

 

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We seek to underwrite a diverse mix of geographic risks within Florida to manage the potential impact of a catastrophic event and reduce our per policy reinsurance costs. As of December 31, 2013, the geographic distribution of our policies in force and total insured values were as follows (figures may not sum to totals due to rounding):

 

     As of December 31, 2013  
     (Total Insured Value in Millions)  
      Policy
Count
     %     Total Insured Value      %  

South Florida Counties

          

Broward

     16,522         12.9   $ 4,198         12.5

Miami-Dade

     10,634         8.4     2,969         8.9

Palm Beach

     15,629         12.2     3,647         10.9
  

 

 

    

 

 

   

 

 

    

 

 

 

South Florida exposure

     42,785         33.5   $ 10,814         32.3

Other Significant Counties(1)

          

Pinellas

     22,722         17.8   $ 6,135         18.3

Hillsborough

     16,753         13.1     4,949         14.8

Pasco

     13,536         10.6     3,539         10.6

Hernando

     4,581         3.6     1,370         4.1

Lee

     3,457         2.7     903         2.7
  

 

 

    

 

 

   

 

 

    

 

 

 

Total other significant counties

     61,049         47.8   $ 16,897         50.5

Summary for all of Florida

          

South Florida exposure

     42,785         33.5   $ 10,814         32.3

Total other significant counties

     61,049         47.8     16,897         50.5

Other Florida counties

     23,950         18.7     5,778         17.3
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

     127,784         100.0   $ 33,488         100.0
  

 

 

    

 

 

   

 

 

    

 

 

 

 

(1)   Significant counties are defined as those counties with a policy count or total insured value greater than 2.5% of the 127,784 total policy count or $33.5 billion total insured value as of December 31, 2013.

 

In order to limit our potential exposure to individual risks and catastrophic events, we purchase significant reinsurance from third party reinsurers. Purchasing reinsurance is an important part of our risk strategy, and premiums paid (or ceded) to reinsurers is our single largest cost. We have strong relationships with reinsurers which we believe are a result of our management’s industry experience and reputation for selective underwriting. For the twelve months ending May 31, 2014, we purchased reinsurance from the following sources: (i) FHCF, a state-mandated catastrophe reinsurance fund, (ii) 13 private reinsurers, all of which were rated “A-” or higher by A.M. Best or S&P, (iii) two private reinsurers that have provided collateral to fully cover their exposure, and (iv) our wholly-owned reinsurance subsidiary, Osprey.

 

FLOIR requires all insurance companies, like us, to have a certain amount of capital reserves and reinsurance coverage in order to cover losses upon the occurrence of a catastrophic event. Our reinsurance program for the twelve months ending May 31, 2014 provides reinsurance in excess of FLOIR’s requirements, which are based on the probable maximum loss that we would incur from an individual catastrophic event estimated to occur once every 100 years based on our portfolio of insured risks. We also purchase reinsurance coverage to protect against the potential for multiple catastrophic events occurring in the same year.

 

We test the sufficiency of our reinsurance program by subjecting our personal residential exposures to statistical testing using the AIR U.S. Hurricane Model, which replicates the most severe hurricanes to have occurred historically in Florida, individual storms of severity in excess of such historical levels, and the historical

 

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calendar years in which the most severe multiple catastrophic events occurred in Florida. In this regard, the 2004 calendar year, in which four large catastrophic hurricanes made landfall in Florida, is considered to be the worst catastrophic year in Florida’s recorded history. Assuming the reoccurrence of the 2004 calendar year events, the probable maximum net loss to us in 2013 would have been $10.3 million (after tax, net of all reinsurance recoveries and including our retention through Osprey). This loss would have represented 12.9% of our stockholders’ equity at December 31, 2013 and     % of our pro forma stockholders’ equity at December 31, 2013, after giving effect to this offering.

 

We closely manage all aspects of our claims adjustment process. Claims are initially reviewed by our managers and staff adjusters, who determine the extent of the loss and the resources needed to adjust each claim. In the case of a catastrophic event, we have contracted with four large national claims adjusting firms to assist our adjusters with the increased volume of claims and ensure timely responses to our policyholders. We utilize our wholly-owned subsidiary, Contractors’ Alliance to manage mitigation and restoration services for our customers. Contractors’ Alliance primarily handles water damage-related claims, which comprised approximately 68% of our losses and loss adjustment expenses through December 31, 2013. In March 2014, we completed the acquisition of the assets and personnel of our main water mitigation services vendor. We believe this acquisition will allow us to better service our customers and expand our mitigation and restoration services. In addition, all of our voluntary policies and renewed Citizens policies are enrolled in our Platinum Program. Under the Platinum Program, participating customers receive a 10% discount on their claim deductible, and we obtain control over inspection, claims adjusting and repair services. We believe our approach to claims handling results in a higher level of customer service and reduces our losses and loss adjustment expenses. As a result of our efforts, our gross loss ratio, which expresses our losses and loss adjustment expenses as a percentage of gross earned premiums, was 27.5% for the year ended December 31, 2013.

 

Our Market

 

According to the U.S. Census Bureau, at July 1, 2013, Florida was the fourth largest U.S. state with an estimated population of approximately 20 million people. The University of Florida Bureau of Economic and Business Research estimates that Florida is expected to reach a population of approximately 26 million people by 2040, an increase of 36% percent from 2010. Property ownership and development represent key drivers of the Florida economy.

 

Because of its location, Florida is exposed to an increased risk of hurricanes during the entire six months of Atlantic hurricane season, which spans from June 1 through November 30. While a significant hurricane has not made landfall in Florida since 2005, eight hurricanes in 2004 and 2005, including Hurricanes Charley, Katrina, Rita and Wilma, caused a combined estimated property damage of over $110 billion, a significant portion of which occurred in Florida. As a result, personal residential insurance and claims servicing are vitally important to Florida residents.

 

The Florida personal residential insurance market is highly fragmented and dominated by in-state insurance companies, including Citizens. Significant dislocation in the Florida property insurance market began following Hurricane Andrew in 1992 and accelerated following the 2004 and 2005 hurricane seasons. In total, national and regional insurers reduced their exposure in Florida from 84% in 1999 to 26% in 2012. As national and regional insurance companies reduced their share of the market in Florida, Citizens increased efforts to provide affordable personal residential insurance to those residents unable to obtain coverage in the private market. As a result, Citizens’ policy count grew from roughly 810,000 policies in 2005 to a peak level of approximately 1.5 million policies in late 2011. To reduce Citizens’ risk exposure, beginning in 2010, Florida elected officials encouraged Citizens to focus on reducing the size of its portfolio by returning policies to the private market.

 

In response, Citizens instituted a number of measures to incentivize the private sector to participate in the depopulation program. Some of these initiatives include increased inspections, improved underwriting,

 

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reductions in coverage and annual rate increases. In May 2013, Florida passed legislation to facilitate the reduction of Citizens’ policy count and establish the Clearinghouse, which launched in January 2014. The Clearinghouse makes new business ineligible for Citizens if a participating insurance company is willing to extend similar coverage at a price that is no more than 15% above the price of a Citizens’ policy. Similarly, existing Citizens policies will not be eligible for renewal with Citizens if a participating insurance company is willing to afford similar coverage at no additional cost over the price of a Citizens policy. The Clearinghouse will allow potential new and renewal policies of Citizens to be comparatively shopped by participating private market insurers before becoming, or remaining, Citizens policies. On March 31, 2014, Heritage P&C was approved to participate in the Clearinghouse.

 

According to data compiled by FLOIR, Citizens was the largest personal residential insurance carrier in Florida for the nine months ended September 30, 2013, with a market share of approximately 23.5% based on total in force direct premiums written for personal and commercial residential insurance. As of the same date, we ranked 14th in Florida within this market, with a market share of approximately 1.5%. Assuming further access to capital and reinsurance support, we believe we have the opportunity to significantly expand the size of our personal residential insurance business in Florida and explore the expansion of our business into other complementary business lines and states.

 

In recent years, the property and casualty insurance market has experienced a substantial increase in the availability of property catastrophe reinsurance resulting from the increased supply of capital from non-traditional insurance providers, including private capital and hedge funds. This increased capital supply, coupled with a lack of recent significant catastrophic storm activity in Florida, has reduced the cost of property catastrophe reinsurance, directly benefitting purchasers of this reinsurance, including us. We believe this market trend will continue for the foreseeable future.

 

Our Strategy

 

Since our inception, substantially all of our revenue has come from policies we assumed from Citizens, with the balance of our revenue generated from renewal of these assumed policies and from voluntary policies. Building on these successful transactions, we intend to continue to grow profitably by undertaking the following:

 

Increase Our Policies in Force in Florida Through Strategic Policy Assumptions and Expansion of Our Voluntary Market Share

 

We intend to continue assuming policies from Citizens that meet our assumption strategy and underwriting criteria. Additionally, we intend to increase our policy count by participating in the Clearinghouse. We will also pursue opportunities to increase the number of our voluntary policies by expanding our independent agent distribution network, as well as obtaining approval from national insurance companies to allow their agents to offer our personal residential policies in Florida. Our recent affiliation with FMS gives us access to several hundred additional agents throughout the state and should assist us in our effort to attract high-quality agents. We also intend to increase our advertising, which we believe will allow us to more effectively penetrate areas of the state where we are not currently writing significant new business.

 

Opportunistically Diversify Product Offerings

 

We will continue to focus on writing personal residential policies, but will opportunistically expand into complementary product lines we believe we can effectively and profitably underwrite. New product lines may include commercial residential and manufactured housing policies, as well as additional non-residential coverage, such as general liability insurance. In January 2014, we hired two individuals with significant experience in Florida commercial residential insurance sales and underwriting, who will assist us in developing this new product line.

 

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Optimize Our Reinsurance Program

 

We will continue to obtain what we believe to be the most appropriate levels and sources of reinsurance. We believe that the significant additional capital entering portions of the reinsurance market provides us with the opportunity to obtain favorable pricing and contract terms and conditions, including the potential for multi-year commitments. In April 2014, we entered into a fully collateralized catastrophe reinsurance agreement funded through the issuance of $150.0 million principal amount of catastrophe bonds, and we will continue evaluating such cost-efficient alternatives to traditional reinsurance. See “Prospectus Summary—Recent Developments.” Additionally, we will continue to meet certain of our reinsurance needs through the use of our reinsurance subsidiary, Osprey, which mitigates our reinsurance expense and reduces our reliance on third party reinsurance.

 

Efficiently Manage Losses and Loss Adjustment Expenses

 

We are committed to proactively managing our losses and loss adjustment expenses through prudent underwriting and the use of internal claims adjustment and repair services. In March 2014, we acquired the largest vendor in the Contractors’ Alliance network, which we believe will allow us to expand our in-house mitigation and restoration services. We also intend to license our Contractors’ Alliance employees as adjusters, which we believe will reduce our loss adjustment expenses and shorten the length of time required to resolve claims.

 

Expand to New Geographic Markets

 

We intend to explore opportunities to enter other coastal states where we believe the market opportunity is most similar to Florida and where we can utilize our underwriting and claims expertise to attract and manage profitable business. We believe further increasing our geographic diversification is an important factor in reducing our potential risk of loss from any catastrophic event, reducing our per policy reinsurance costs and providing an additional area for future growth beyond our expansion in Florida.

 

Our Competitive Strengths

 

We believe that our rapid growth to date and our ability to capitalize on our future growth prospects are a result of the following competitive strengths of our business:

 

Experienced Management Team With a Long History in the Florida Personal Residential Insurance Market

 

We have a deep and experienced management team led by Bruce Lucas, Chairman and Chief Investment Officer, Richard Widdicombe, Chief Executive Officer and President, Stephen Rohde, Chief Financial Officer, Melvin Russell, Chief Underwriting Officer, Kent Linder, Chief Operating Officer, Ernesto Garateix, Executive Vice President, and Paul Nielsen, Vice President of Claims, most of whom have been with Heritage since inception. Our management team, which averages 26 years of insurance industry experience, has extensive experience in the Florida personal residential insurance market, has built longstanding relationships with key participants in the insurance industry and is supported by a group of highly qualified individuals with industry expertise, including a Chief Actuary with more than 34 years of industry experience.

 

Strong, Conservative Capital Structure

 

As of December 31, 2013, we had stockholders’ equity of $80.0 million and pro forma stockholders’ equity, after giving effect to this offering, of $         million. As of December 31, 2013, Heritage P&C had policyholder surplus of $63.1 million. We believe that this level of surplus places us among the best capitalized insurance companies focusing primarily on the Florida personal residential insurance market and is significantly in excess of the minimum capital levels required by FLOIR and Demotech for similarly rated in-state insurance companies. In addition, unlike many of our in-state competitors, we have relied almost exclusively upon common equity to provide our capital.

 

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Selective Underwriting and Policy Acquisition Criteria

 

We believe our proprietary data analytics capabilities and underwriting processes allow us to better select the insurance policies we are willing to assume from the Citizens depopulation program, leading to strong profitability and reduced risk. In addition, we choose to minimize our exposure to or avoid certain types of coverage if we believe there is significant risk of loss, including coverage for sink-hole related losses in high-risk areas. As a result of our efforts, our gross loss ratio was 27.5% for the year ended December 31, 2013.

 

Unique Claims Servicing Model and Superior Customer Service

 

We believe that the vertical integration of our claims adjustment and repair services provides us with a competitive advantage. Because we manage both claims adjusting and repair services, we are generally able to begin the adjustment and mitigation process much earlier than our competitors, thus reducing our loss adjustment expenses and ultimate loss payouts. We expect that, in the near future, a significant number of our repair technicians will participate in training and certification programs to become licensed claims adjusters, allowing us to capture additional efficiencies. We also believe our unique model provides a superior level of customer service for our policyholders, enhancing our reputation and increasing the likelihood that our policyholders will renew their policies with us.

 

Relationships with Highly Rated Reinsurers

 

We manage our exposure to catastrophic events through, among other things, the purchase of reinsurance. Our relationships with highly rated reinsurers have been developed as a result of our management team’s industry experience and reputation for selective underwriting. Our financial strength, underwriting results and the long-term relationships between our management team and our reinsurance partners help improve the cost-effectiveness of our reinsurance program.

 

Relationships with Independent Agents and National Underwriters

 

We have developed relationships with a network of approximately 1,100 independent insurance agents. We believe we have been able to build this network due to our reputation for financial stability, commitment to the Florida market and integrity in the underwriting and claims process. We are also exploring relationships with additional large national insurers and agencies that no longer write substantial personal residential insurance in Florida, which would give us access to their network of Florida agents.

 

Underwriting

 

Our underwriters evaluate and select only those risks that they believe will enable us to achieve an underwriting profit. In order to achieve underwriting profitability on a consistent basis, we focus on (1) the suitability of the risk to be assumed or written, (2) the adequacy of the premium with regard to the risk to be assumed or written and (3) the geographic distribution of existing policies within Florida.

 

All of our underwriting is done internally under the supervision of our Chief Underwriting Officer with input from our Chief Actuary. Our underwriters use our proprietary data analytics capabilities, which include a number of automated processes, to analyze a number of risk evaluation factors, including the age, construction, location and value of the residence and the premiums to be received from insuring the residence. New technological advances in computer generated geographical mapping afford us an enhanced perspective as to geographic concentrations of policyholders. When considering the geographic distribution of existing policies, our underwriters may consider the number of other residences we insure within the same region, county, city and zip code. We also consider the cost of reinsurance when assessing the adequacy of the premium with regard to the risk to be assumed or written. In particular, because we assume policies from Citizens in large quantities, we must evaluate the aggregate impact of the assumed policies on our reinsurance program. The underwriting criteria that we consider will continue to evolve as our business grows and expands.

 

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We also review our expiring policies to determine whether those risks continue to meet our underwriting guidelines. If a given policy no longer meets our underwriting guidelines, we will take appropriate action regarding that policy, including raising premium rates or, to the extent permitted by applicable law and our assumption agreements with Citizens, not offering to renew the policy.

 

Policy Administration

 

We have engaged West Point Underwriters, Inc. (“West Point”), a provider of web-based software solutions and insurance personnel, to provide us with policy administration services, including processing, billing and policy maintenance. West Point’s software is able to adapt to a variety of forms and rates, handle the administration of an increasing number of policies as our Company grows and expands, and provide detailed information about our book of business to our internal underwriters so that they can adjust our underwriting criteria as necessary. West Point’s software provides us with daily updates regarding the insurance policies that we have issued. The system also allows us to provide renewal notices, late payment notices, cancellation notices, endorsements and policies to our policyholders in a timely fashion.

 

The term of our current agreement with West Point extends until September 2015. Pursuant to this agreement, we pay West Point a fixed fee for each policy for which it provides services.

 

Claims Administration

 

We closely manage all aspects of the claims process, from processing the initial filing to providing remediation services through our wholly-owned subsidiary, Contractors’ Alliance. When a policyholder contacts us to report a claim, members of our claims department create a claim file and aggregate the appropriate supporting documentation. Claims are then reviewed by our managers and staff adjusters, who assess the extent of the loss, including through on-site investigations, and determine the resources needed to adjust each claim. Our claims are generally adjusted by our staff claims professionals, except in the case of a catastrophic event for which we have contracted with four large national claims adjusting firms to assist our adjusters with the increased volume of claims and ensure timely responses to our policyholders. In the final stage of the claims process, we leverage Contractors’ Alliance’s vendor network to provide repair and remediation services to the policyholder.

 

We perform or supervise the services rendered to our policyholders at all stages of the claims process, which we believe allows us to reduce cost and provide a high level of customer service to our policyholders. To encourage our policyholders to allow us to manage their claims from beginning to end, we developed our Platinum Program. Under the Platinum Program, participating customers receive a 10% discount on their claim deductible, and we obtain control over inspection, claims adjusting and repair services, with the repair services being managed by either Contractors’ Alliance or one of our contracted vendors. If the policyholder elects to use a different vendor to provide repair services, we will resolve the claim for the amount we would have paid had Contractors’ Alliance or one of our contracted vendors performed the work. In March 2014, we acquired the largest vendor in the Contractors’ Alliance network, which we believe will allow us to expand our in-house mitigation and restoration services.

 

Citizens Assumption Transactions

 

As of December 31, 2013, we have assumed an aggregate of approximately 127,000 policies through participation in the Citizens depopulation program. Citizens generally offers depopulations on a monthly basis. Our practice is generally not to assume additional policies during hurricane season, and therefore we typically participate in assumption transactions during the first and fourth quarters of the year.

 

In order to be eligible to participate in an assumption transaction, we first apply to FLOIR for approval to assume a specified number of policies. We prepare and submit a report showing the cumulative pro forma

 

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financial impact of assuming all policies for which we have applied and all policies we have been previously approved to assume. Once we have received FLOIR approval indicating the maximum number of policies we may assume, Citizens provides us with a list of policies eligible for assumption and the relevant policy data. We evaluate these policies using our proprietary data analytics capabilities and submit to Citizens a list of policies we would like to assume. Citizens then compares our list of preferred policies with those of other private insurance companies participating in the depopulation and informs us which policies will be assigned to us.

 

Once Citizens informs us which policies we may assume, we notify each policyholder of our offer to assume their policy, the amount of their estimated premium upon renewal and their right to opt-out of the assumption transaction. We believe we were the first insurance carrier in Florida to inform holders of their estimated renewal premium prior to the assumption of their policies from Citizens and that this practice has led to an increase in the number of policyholders accepting, or not “opting-out” of, our offer of assumption. On the effective date of such transaction, Citizens transfers to us the unearned premiums for the policies that have not opted out of the assumption transaction. A policyholder may also opt-out during the 30-day period following the effective date of the assumption transaction. If a policyholder opts-out during such period, we return the applicable unearned premiums to Citizens.

 

Under the terms of our typical assumption agreement with Citizens, we assume all liability and obligation for losses under the assumed policies arising on or after the effective date of the assumption transaction, and we directly service all policyholder claims related to such losses. All terms and conditions of the assumed policies, including coverage and rates, remain unchanged for the remainder of the policy term. Citizens remains liable for all losses under the assumed policies arising prior to the effective date of the assumption transaction and is solely responsible for servicing all policyholder claims related to such losses.

 

Our current assumption agreement with Citizens requires us to offer renewals on the policies that we assume in the depopulation program for a period of three years subsequent to the initial expiration of the policies, during which time our rates may not exceed the greater of 110% of the previous rate or the renewal rate charged by Citizens for such policy. We strive to retain these policies by offering competitive rates and efficient claims handling to our policyholders. Through December 31, 2013, we renewed approximately 84% of the policies we assumed from Citizens upon their initial expiration.

 

Loss Development

 

Our losses and loss adjustment expenses represent estimated costs ultimately required to settle all claims for a given period. The following table illustrates, as of December 31, 2013, development of the estimated liability for losses and loss adjustment expenses from August 7, 2012 through December 31, 2012 (dollars in thousands):

 

     August 7, 2012
(inception) through

December 31, 2012
 

Original estimated losses and loss adjustment expense liability(1)

   $ 1,393   

Re-estimated losses and loss adjustment expense liability(2) as of:

  

One year later

     926   

Cumulative redundancy (deficiency)(3)

     467   

Cumulative amount of liability paid off as of:

  

One year later

     549   

Gross premiums earned

   $ 5,719   

 

(1)   Represents management’s original best estimated liability of (i) unpaid claims, (ii) IBNR and (iii) loss adjustment expenses.
(2)   Represents the re-estimated liabilities in later years of unpaid claims, IBNR and loss adjustment expenses in the respective years
(3)   Represents the difference between the latest re-estimate and the original estimate. A redundancy means the original estimate is higher than the current estimate whereas a deficiency means that the original estimate is lower than the current estimate.

 

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Technology

 

Our business depends upon the use, development and implementation of integrated technology systems. These systems enable us to provide a high level of service to agents and policyholders by processing business efficiently, communicating and sharing data with agents, providing a variety of methods for the payment of premiums and allowing for the accumulation and analysis of information for our management. We believe the availability and use of these technology systems has resulted in improved service to agents and customers, increased efficiencies in processing Heritage P&C’s business and lower operating costs.

 

We also license software from third parties, including West Point and AIR Worldwide, Inc. (“AIR”). AIR’s catastrophe modeling software enables us to optimize our insurance portfolio to reduce our reinsurance costs. We also own or license other technology systems used by Heritage P&C. These technology systems consist primarily of an integrated central processing computer, a series of server-based computer networks, a back-up server and various Internet-based communications systems.

 

Reinsurance

 

In order to limit our potential exposure to catastrophic events, we purchase significant reinsurance from third party reinsurers. Purchasing reinsurance is an important part of our risk strategy, and premiums paid (or ceded) to reinsurers is our single largest cost. Reinsurance involves transferring, or “ceding”, a portion of the risk exposure on policies we write to another insurer, known as a reinsurer. To the extent that our reinsurers are unable to meet the obligations they assume under our reinsurance agreements, we remain liable for the entire insured loss. See “Risk Factors—We may not be able to collect reinsurance amounts due to us from the reinsurers with which we have contracted.”

 

Our reinsurance agreements are short-term, prospective contracts. We record an asset, prepaid reinsurance premiums, and a liability, reinsurance payable, for the entire contract amount upon commencement of our new reinsurance agreements. We amortize our reinsurance premiums over the 12-month contract period, which is June 1 through May 31.

 

In the event that we incur losses and loss adjustment expenses recoverable under our reinsurance program, we record amounts recoverable from our reinsurers on paid losses plus an estimate of amounts recoverable on unpaid losses. The estimate of amounts recoverable on unpaid losses is a function of our liability for unpaid losses associated with the reinsured policies; therefore, the amount changes in conjunction with any changes to our estimate of unpaid losses. As a result, a reasonable possibility exists that an estimated recovery may change significantly in the near term from the amounts included in our consolidated financial statements.

 

FLOIR requires all insurance companies, like us, to have a certain amount of capital and reinsurance coverage in order to cover losses and loss adjustment expenses upon the occurrence of a catastrophic event. Our reinsurance program for the twelve months ending May 31, 2014 provides reinsurance in excess of FLOIR’s requirements, which are based on the probable maximum loss that we would incur from an individual catastrophic event estimated to occur once in every 100 years based on our portfolio of insured risks. The nature, severity and location of the event giving rise to such a probable maximum loss differs for each insurer depending on the insurer’s portfolio of insured risks, including, among other things, the geographic concentration of insured value within such portfolio. As a result, a particular catastrophic event could be a one-in-100 year loss event for one insurance company while having a greater or lesser probability of occurrence for another insurance company. We also purchase reinsurance coverage to protect against the potential for multiple catastrophic events occurring in the same year.

 

During the second quarter of 2013, we placed our reinsurance program for the period from June 1, 2013 through May 31, 2014. Our reinsurance program, which is segmented into layers of coverage, protects us for excess property catastrophe losses and loss adjustment expenses. Our current reinsurance program incorporates the mandatory coverage required by law to be placed with FHCF. We also purchase private reinsurance below,

 

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alongside and above the FHCF layer, as well as aggregate reinsurance coverage. The following describes the various layers of our reinsurance program.

 

   

Our Retention. For the first catastrophic event, we have a primary retention on the first $9.0 million of losses and loss adjustment expenses, of which our reinsurance subsidiary, Osprey, is responsible for $3.0 million. For a second and third catastrophic event, Heritage P&C’s primary retention decreases to $3.0 million per event. To the extent that there is reinsurance coverage remaining, Heritage P&C has no primary retention for events beyond the third catastrophic event. Osprey has no primary retention beyond the first catastrophic event.

 

   

Layers Below FHCF. Immediately above our retention, we have purchased $94.0 million of reinsurance from third party reinsurers and Osprey. Through Osprey, we retain an aggregate participation in this coverage of $3.5 million, comprised of a 3% participation of $31.0 million of losses and loss adjustment expenses in excess of $9.0 million, or $0.9 million, and a 4% participation of $63.0 million of losses and loss adjustment expenses in excess of $40.0 million, or $2.5 million. Through the payment of a reinstatement premium, we are able to reinstate the full amount of this reinsurance up to two times. To the extent that $94.0 million or a portion thereof is exhausted in a first catastrophic event, we have purchased reinstatement premium protection insurance to pay the required premium necessary for the first reinstatement of this coverage.

 

   

FHCF Layer. Our FHCF coverage includes an estimated maximum provisional limit of 90% of $270.0 million, or $243.0 million, in excess of our retention and private reinsurance of $103.0 million. The limit and retention of the FHCF coverage is subject to upward or downward adjustment based on, among other things, submitted exposures to FHCF by all participants. We have purchased coverage alongside and above the FHCF layer from third party reinsurers. The layer alongside is in the amount of $27.0 million and the layer immediately above is in the amount of $28.5 million. This private reinsurance will generally adjust to fill in gaps in the FHCF coverage. Through the payment of a reinstatement premium, we are able to reinstate the full amount of this private reinsurance up to two times. To the extent that all or a portion of either of these private layers is exhausted in a first catastrophic event, we have purchased reinstatement premium protection insurance to pay the required premium necessary for the first reinstatement of this coverage. The FHCF coverage cannot be reinstated once exhausted, but it does provide coverage for multiple events.

 

   

Aggregate Coverage. In addition to the layers described above, we have also purchased $170.0 million of aggregate reinsurance coverage for losses and loss adjustment expenses in excess of $401.5 million for a first catastrophic event. To the extent that this coverage is not fully exhausted in the first catastrophic event, it provides coverage commencing at our reduced retention levels for second and subsequent events and where underlying coverage has been previously exhausted. There is no reinstatement of the aggregate reinsurance coverage once exhausted, but it does provide coverage for multiple events.

 

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For a first catastrophic event, our reinsurance program provides coverage for $571.5 million of losses and loss adjustment expenses, including our retention, and we are responsible for all losses and loss adjustment expenses in excess of such amount. For subsequent catastrophic events, our total available coverage depends on the magnitude of the first event, as we may have coverage remaining from layers that were not previously fully exhausted. We have also purchased reinstatement premium protection insurance to provide an additional $149.5 million of coverage. Our aggregate reinsurance layer also provides coverage for second and subsequent events to the extent not exhausted in prior events. In total, we have purchased $721.0 million of potential reinsurance coverage, including our retention, for multiple catastrophic events. Our ability to access this coverage, however, is subject to the severity and frequency of such events. As of December 31, 2013, our total insured value was $33.5 billion, and we may experience significant losses and loss adjustment expenses in excess of our retention. The chart below provides a graphic illustration of the structure and operation of our current reinsurance program.

 

LOGO

 

We test the sufficiency of our reinsurance program by subjecting our personal residential exposures to statistical testing using the AIR U.S. Hurricane Model, which replicates the most severe hurricanes to have

 

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occurred historically in Florida, individual storms of severity in excess of such historical levels, and the calendar years in which the most severe multiple catastrophic events occurred in Florida. In this regard, the 2004 calendar year, in which four large catastrophic hurricanes made landfall in Florida, is considered to be the worst catastrophic year in Florida’s recorded history. Assuming the reoccurrence of the 2004 calendar year events, the probable maximum net loss to us in 2013 would have been $10.3 million (after tax, net of all reinsurance recoveries and including our retention through Osprey). This loss would have represented 12.9% of our stockholders’ equity at December 31, 2013 and             % of our pro forma stockholders’ equity at December 31, 2013, after giving effect to this offering. We estimate that, based on our portfolio of insured risks as of December 31, 2013, the 2004 calendar year events would represent, in the aggregate, a catastrophic event likely to occur approximately once every 164 years and would have exhausted approximately 14% of our total reinsurance coverage.

 

Assuming the reoccurrence of Hurricane Andrew, which is considered to be the most catastrophic single event in Florida’s recorded history, the probable maximum net loss to us in 2013 would have been $7.2 million (after tax, net of all reinsurance recoveries and including our retention through Osprey). This loss would have represented 9.0% of our stockholders’ equity at December 31, 2013 and             % of our pro forma stockholders’ equity at December 31, 2013, after giving effect to this offering. We estimate that, based on our portfolio of insured risks as of December 31, 2013, Hurricane Andrew would represent a catastrophic event likely to occur approximately once every 37 years and would have exhausted approximately 34% of our total reinsurance coverage.

 

For the twelve months ending May 31, 2014, we purchased reinsurance from the following sources: (i) FHCF, (ii) 13 private reinsurers, all of which were rated “A-” or higher by A.M. Best or S&P, (iii) two private reinsurers that have provided collateral to fully cover their exposure, and (iv) our wholly-owned reinsurance subsidiary, Osprey. Allianz Risk Transfer (AG) Limited reinsures 75% of each layer of our reinsurance coverage up to the $401.5 million level and 90% and 100%, respectively, of our first and second aggregate layers. The chart below lists our third-party reinsurers with A.M. Best and S&P ratings:

 

Reinsurer

   A.M. Best Rating    S&P Rating

ACE Tempest Reinsurance Ltd.

   A+    AA-

Allianz Risk Transfer (AG) Limited

   N/A    AA-

Alterra Bermuda Limited

   A    AA

Arch Reinsurance Ltd.

   A+    A+

Lloyd’s Underwriter Syndicate No. 0958

   A    A+

Lloyd’s Underwriter Syndicate No. 1955

   A    A+

Lloyd’s Underwriter Syndicate No. 2001

   A+    A+

Lloyd’s Underwriter Syndicate No. 4444

   A    A+

Montpelier Reinsurance Ltd.

   A    A-

Partner Reinsurance Ltd.

   A+    A+

S.A.C. Re, Ltd.

   A-    N/A

Tokio Millennium Reinsurance Limited

   A++    AA-

XL Re Ltd.

   A    A

 

2014-2015 Reinsurance Program

 

We are in the process of placing our reinsurance program for the 2014 hurricane season, which will be effective from June 1, 2014 through May 31, 2015. On April 17, 2014, Heritage P&C entered into a catastrophe reinsurance agreement with Citrus Re Ltd., a newly-formed Bermuda special purpose insurer. The agreement provides for three years of coverage from catastrophe losses caused by certain named storms, including hurricanes, beginning on June 1, 2014. The limit of coverage of $150 million is fully collateralized by a reinsurance trust account for the benefit of Heritage P&C. Heritage P&C pays a periodic premium to Citrus Re during this three-year risk period. Citrus Re Ltd. issued $150 million of principal-at-risk variable notes due April 18, 2017 to fund the reinsurance trust account and its obligations to Heritage P&C under the reinsurance agreement. The maturity date of the notes may be extended up to two additional years to satisfy claims for

 

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catastrophic events occurring during the three-year term of the reinsurance agreement. By accessing catastrophe reinsurance coverage through capital markets vehicles like Citrus Re Ltd., we aim to diversify our sources of reinsurance capacity in a cost-effective manner given current market conditions.

 

We are in the process of evaluating the remaining sources of our reinsurance for the 2014 hurricane season.

 

Investments

 

Our investments are managed by third-party asset managers. We have designed our investment policy to provide a balance between current yield, conservation of capital and the liquidity requirements of our operations. As such, our investable assets are primarily held in cash and bonds with relatively short durations. Our investment policy sets guidelines that provide for a well-diversified investment portfolio that is compliant with Florida statutes that emphasizes quality and preservation of capital. The policy limits investments in common and preferred stocks to 15% of Heritage P&C’s admitted assets, with no more than 10% in either class. Our bond portfolio must have a minimum weighted average portfolio quality of A, with only $1 million invested in below investment grade bonds. No more than 2% of admitted assets can be invested in any one issuer, excluding government-related securities. Investments in commercial mortgages cannot exceed 10% of admitted assets. Prohibited investments include short sales and margin purchases, oil gas, mineral or other types of leases, speculative uses of futures and options, unrated corporate securities, non-US denominated securities, convertible securities high risk CMO instruments, repurchase agreements, securities lending transactions and speculative foreign currency valuation transactions. Our investment policy, which may change from time to time, is approved by our Investment Committee and is reviewed on a regular basis in order to ensure that our investment policy evolves in response to changes in the financial market. See Note 3 to our consolidated financial statements for the year ended December 31, 2013 included elsewhere in this prospectus.

 

As of December 31, 2013, we held $65.1 million in cash and cash equivalents and $136.2 million in securities, which were comprised of $102.5 million in bonds, $7.1 million in preferred stocks, $20.5 million in common stock and $6.1 million in mortgage loans.

 

Government Regulation

 

The insurance industry is extensively regulated. Heritage P&C is subject to the laws and regulations of Florida and any other state where we may seek to do business. Florida’s insurance regulatory regime provides for regulation of virtually all aspects of Heritage P&C’s business. Florida, like many states, has adopted several model laws and regulations as promulgated by the NAIC. State statutes and administrative rules generally require each insurance company that is part of a holding company group to register with the department of insurance in its state of domicile and to furnish information concerning the operations of the companies within the holding company system which may materially affect the operations, management or financial condition of the insurers within the group. As part of its registration, each insurance company must identify material agreements, relationships and transactions with affiliates, including without limitation loans, investments, asset transfers, transactions outside of the ordinary course of business, certain management, service, and cost sharing agreements, reinsurance transactions, dividends and consolidated tax allocation agreements. In many instances, Florida’s insurance laws and regulations are even more stringent that those promulgated by the NAIC or other states.

 

As an initial matter, Florida routinely places additional restrictions on new insurers as a condition of receiving a certificate of authority. These restrictions are typically memorialized in a consent order entered into between FLOIR and the insurer applying for a certificate of authority. We are subject to such a consent order in which we have agreed to higher or more stringent restrictions than are otherwise required under Florida law. The material restrictions we have agreed to include:

 

   

Florida law requires a residential property writer to maintain surplus of the greater of $15.0 million or 10% of its liabilities. Pursuant to the consent order, we agreed to establish a minimum capital and surplus of $18.0 million. As of December 31, 2013, our insurance subsidiary held surplus of $63.1 million, in full compliance with Florida law and the consent order.

 

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Florida law restricts the ratio of premiums written to policyholder surplus to 10 to 1 on a gross basis and 4 to 1 on a net of reinsurance basis. As of December 31, 2013, Heritage P&C’s gross and net writing ratios were 3.5 to 1 and 2.2 to 1, respectively. Pursuant to the consent order, we also agreed to not exceed the projected premiums in the plan of operation submitted with our original application for licensure without the prior written approval of FLOIR during 2012, 2013 and 2014. As part of the FLOIR approval process for the various Citizens assumption transactions in which we have participated, we have received approval to exceed these projected premiums. We are in full compliance with these provisions of the consent order.

 

   

Florida law places no restrictions on the parent of an insurer, or other upstream entities, with regard to the payment of dividends. Pursuant to the consent order, we agreed to not make any distributions to stockholders prior to July 31, 2015, except such distributions as are required to offset stockholders’ tax obligations resulting from the ownership of our equity or such distributions as may be approved by FLOIR in advance and in writing. We are in full compliance with this provision of the consent order.

 

   

Florida law allows an insurer to pay certain dividends to stockholders without approval of FLOIR. Pursuant to the consent order, we agreed that, until July 31, 2017, Heritage P&C would pay only those dividends that have been approved in advance and in writing by FLOIR. Our insurance subsidiary has paid no stockholder dividends since its inception and is in full compliance with this provision of the consent order.

 

We are also subject to consent orders setting conditions for FLOIR’s approval of the Citizens assumption transactions in which we have participated. We are required by consent order to comply with the assumption agreements entered into with Citizens at the time of each assumption transaction, which requires that for the assumed policies, we must offer to renew each policy for a minimum of three years and limit rate increases to the higher of those approved by FLOIR for Citizens for comparable risks or 10%. We are in full compliance with all consent orders issued with regard to Citizens’ depopulation program.

 

Additionally, we are subject to regulations administered by a department of insurance in each state in which we do business (currently, only Florida). These regulations relate to, among other things:

 

   

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

 

   

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

 

   

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

 

   

participation in guaranty funds and other statutorily created markets or organizations;

 

   

business operations and claims practices;

 

   

approval of policy forms and premium rates;

 

   

standards of solvency, including risk-based capital measurements;

 

   

licensing of insurers and their products;

 

   

restrictions on the nature, quality and concentration of investments;

 

   

restrictions on the ability of insurance company subsidiaries to pay dividends to insurance holding companies;

 

   

restrictions on transactions between insurance companies and their affiliates;

 

   

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

 

   

requiring deposits for the benefit of policyholders;

 

   

requiring certain methods of accounting;

 

   

periodic examinations of our operations and finances;

 

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the form and content of records of financial condition required to be filed; and

 

   

requiring reserves.

 

FLOIR and regulators in other jurisdictions where we may become licensed and offer insurance products conduct periodic examinations of the affairs of insurance companies and require the filing of annual and other reports relating to financial condition, holding company issues and other matters. These regulatory authorities also conduct periodic examinations into insurers’ business practices. Additionally, as an insurance company operating in Florida, Heritage P&C is subject to assessments levied by Citizens, the Florida Insurance Guaranty Association and the FHCF.

 

Employees

 

As of March 31, 2014 we had 90 employees, all of whom are full time employees. We are not a party to any collective bargaining agreement and have not experienced any work stoppages or strikes as a result of labor disputes. We consider relations with our employees to be satisfactory.

 

Facilities

 

In April 2013, we purchased a two-building 13-acre campus located in Clearwater, Florida for aggregate consideration of $9.8 million and contributed the property to our wholly-owned subsidiary, Skye Lane. We established our operating headquarters on this site in March 2014. Approximately 88% of the property will be occupied by unaffiliated tenants.

 

Legal Proceedings

 

We are subject to routine legal proceedings in the ordinary course of business. We believe that the ultimate resolution of these matters will not have a material adverse effect on our business, financial condition or results of operations.

 

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MANAGEMENT

 

Executive Officers and Directors

 

The following table provides information with respect to our directors and executive officers as of April 1, 2014:

 

Name

   Age     

Position

Richard Widdicombe

     55       President, Chief Executive Officer and Director

Bruce Lucas

     42       Chairman and Chief Investment Officer and Director

Stephen Rohde

     62       Chief Financial Officer, Treasurer and Secretary

Melvin (Mel) Russell

     59       Executive Vice President, Chief Underwriting Officer and Director of Sales & Marketing

Kent Linder

     52       Chief Operating Officer

Ernesto (Ernie) Garateix

     42       Executive Vice President

Paul Neilson

     58       Vice President Claims

Panagiotis (Pete) Apostolou

     39       Director

Trifon Houvardas

     47       Director

James Masiello

     73       Director

Nicholas Pappas

     39       Director

Joseph Vattamattam

     37       Director

Vijay Walvekar

     67       Director

 

Executive Officers

 

Richard Widdicombe.    Mr. Widdicombe has served as our President and Chief Executive Officer since August 2012. Prior to joining the Company, Mr. Widdicombe served as Risk Manager of Homeowners Choice Property & Casualty Insurance Company (NYSE: HCI) from November 2009 to September 2011. Prior to that, Mr. Widdicombe served as President of People’s Trust Insurance Company from July 2007 to February 2009. Mr. Widdicombe brings to the board of directors an in-depth knowledge of the insurance industry gained from his years of leadership experience at multiple insurance carriers.

 

Bruce Lucas.    Bruce Lucas has served as our Chairman and Chief Investment Officer since August 2012. Prior to joining the Company, from January 2012 to August 2012, Mr. Lucas served as the Managing Member of IIM Holdings, II, LLC, an investment company. Prior to that, Mr. Lucas served as Chief Executive Officer of Infinity Investment Funds, a hedge fund, from April 2009 to December 2011. Mr. Lucas brings to the board of directors a critical link to management’s perspective in board discussions regarding the business and strategic direction of the Company.

 

Stephen Rohde.    Mr. Rohde has served as our Chief Financial Officer, Treasurer and Secretary since August 2012. Prior to joining the Company, Mr. Rohde served as Chief Financial Officer and Treasurer of People’s Trust Insurance Company from April 2008 to July 2012. Mr. Rohde serves on the board of directors of Lion Insurance Company.

 

Mel Russell.    Mr. Russell has served as our Executive Vice President, Chief Underwriting Officer and Director of Sales & Marketing since August 2013. Prior to joining the Company, Mr. Russell served as President, Chief Underwriting Officer, Corporate Secretary and Executive Vice President of United Insurance Holdings Corporation (NASDAQ: UIHC) beginning in January 2009.

 

Kent Linder.    Mr. Linder has served as our Chief Operating Officer since August 2012. Prior to joining the Company, Mr. Linder served in the business development department of SVM Restoration Services, Inc. beginning in February 2006. Prior to joining SVM Restoration Services, Mr. Linder served as Chief Operating Officer of Federated National Holding Company (NASDAQ: FNHC) from September 2003 to February 2006.

 

Ernie Garateix.    Mr. Garateix has served as our Executive Vice President since August 2012. Prior to joining the Company, Mr. Garateix served as Vice President for American Integrity Insurance Group beginning in October 2007.

 

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Paul Neilson.    Mr. Neilson has served as our Vice President Claims since September 2012. Prior to joining the Company, Mr. Neilson served as the Manager, Claim Quality Assurance for Citizens Property Insurance Corporation from September 2011 to August 2012. Prior to that, from August 2010 to August 2011, Mr. Neilson served as the Director of Claims Management for Homeowners Choice Property & Casualty Insurance Company (NYSE: HCI). From April 1996 to August 2010, Mr. Neilson served in various capacities at First Floridian Auto & Home / Travelers of Florida, an affiliate of The Travelers Indemnity Company.

 

Pete Apostolou.    Mr. Apostolou has served on our board of directors since August 2012. Mr. Apostolou is the owner of Central Cleaning Services and Central Parking Services, which he founded in 2010. He is also a real estate broker and owner of Alexa Realty of St. Petersburg, which he founded in 2004. Mr. Apostolou also serves as a manager and owner of several other commercial real estate companies. Mr. Apostolou brings to the board of directors an in-depth knowledge of the Florida commercial and residential real estate market.

 

Trifon Houvardas.    Mr. Houvardas has served on our board of directors since August 2012. Mr. Houvardas has been involved in the real estate industry since 1992 and currently manages all aspects of three real estate businesses, Foresight Property Services, Foresight Holding Inc. and Fasco Investments Inc. Mr. Houvardas serves as a director of First Home Bank, LLC. Mr. Houvardas possesses particular knowledge and experience in real estate and complex transactions that strengthen the board’s collective qualifications, skills and experience.

 

James Masiello.    Mr. Masiello has served on our board of directors since April 2014. Mr. Masiello founded Alliance Holdings, Inc., the parent company of Strategic Independent Agency Alliance, Inc. (SIAA), a national alliance of insurance agents, in 1994 and has served as its Chairman and Chief Executive Officer since that time. Mr. Masiello brings to the board of directors extensive operational and executive leadership experience in the insurance industry.

 

Nicholas Pappas.    Mr. Pappas has served on our board of directors since April 2014. Mr. Pappas is the President and owner of FlameStone American Grill and Besa Grill, restaurants in the Tampa area that opened in 2007 and 2011, respectively. Mr. Pappas also owns or serves on the executive team of several commercial real estate holding companies with properties in the Tampa and Jacksonville, Florida areas. Mr. Pappas brings to the board of directors an entrepreneurial and executive management background, as well as a strong knowledge of the Florida commercial real estate market.

 

Joseph Vattamattam.    Mr. Vattamattam has served on our board of directors since April 2014. Mr. Vattamattam is the Chief Executive Officer of HealthMap Solutions, a provider of technology and consulting services to healthcare organizations, a position he has held since July 2013. Prior to that, Mr. Vattamattam served as Vice President of Medical Economics at CareCentrix, Inc., a provider of home health solutions, from August 2010 to July 2013 and as Area Vice President, Operations from January 2010 to August 2010. Prior to that, Mr. Vattamattam held several positions at WellCare Health Plans, a provider of managed care services, from June 2007 to December 2009, most recently as Director, Health Services. Mr. Vattamattam previously held positions at Wachovia Securities and PricewaterhouseCoopers LLP. Mr. Vattamattam brings to the board executive management and leadership skills, as well as an in-depth knowledge of capital markets and financial analysis.

 

Vijay Walvekar.    Mr. Walvekar has served on our board of directors since August 2012. Mr. Walvekar currently serves as Vice President of Central Home Health Care, Inc., a position he has held since January 1985. Mr. Walvekar also serves as President or Managing Member of several real property holding companies owning real estate in Florida and Michigan. Mr. Walvekar also serves as Managing Director of Control-Touch Electronics (Poona) Pvt. Ltd., an Indian technology company. Mr. Walvekar possesses knowledge and experience in real estate, strategic planning and leadership.

 

Board Composition

 

Our certificate of incorporation, which will be in effect prior to the completion of this offering, will provide that, subject to any rights applicable to any then outstanding preferred stock, our board of directors shall consist of such number of directors as determined from time to time by resolution adopted by a majority of the total

 

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number of authorized directors whether or not there exist any vacancies in previously authorized directorships. Initially, our board of directors will consist of              directors. Subject to any rights applicable to any then outstanding preferred stock, any additional directorships resulting from an increase in the number of directors may only be filled by the directors then in office unless otherwise required by law or by a resolution passed by the board of directors. The term of office for each director will be until his or her successor is elected at our annual meeting or his or her death, resignation or removal, whichever is earliest to occur.

 

Our board of directors has affirmatively determined that each of              and              will be an “independent director,” as defined under the rules of                             .

 

Committees of the Board of Directors

 

We expect that, immediately following this offering, the standing committees of our board of directors will consist of an Audit Committee, a Compensation Committee and a Corporate Governance and Nominating Committee. Each of the committees will report to the board of directors as they deem appropriate and as the board may request. The expected composition, duties and responsibilities of these committees are set forth below.

 

Audit Committee

 

The Audit Committee will be responsible for, among other matters: (1) appointing, retaining and evaluating our independent registered public accounting firm and approving all services to be performed by them; (2) overseeing our independent registered public accounting firm’s qualifications, independence and performance; (3) overseeing the financial reporting process and discussing with management and our independent registered public accounting firm the interim and annual financial statements that we file with the SEC; (4) reviewing and monitoring our accounting principles, accounting policies, financial and accounting controls and compliance with legal and regulatory requirements; (5) establishing procedures for the confidential anonymous submission of concerns regarding questionable accounting, internal controls or auditing matters; and (6) reviewing and approving related person transactions.

 

Upon the completion of this offering, our audit committee will consist of             ,              and             . We believe that each of             ,              and              meets the definition of “independent director” for purposes of serving on an audit committee under Rule 10A-3 and              rules. In addition, our board of directors has determined that              qualifies as an “audit committee financial expert,” as such term is defined in Item 407(d)(5) of Regulation S-K. Our board of directors will adopt a new written charter for our audit committee, which will be available on our corporate website at www.heritagepci.com upon the completion of this offering. The information on our website is not part of this prospectus.

 

Compensation Committee

 

The Compensation Committee will be responsible for, among other matters: (1) reviewing key employee compensation goals, policies, plans and programs; (2) reviewing and approving the compensation of our directors, chief executive officer and other executive officers; (3) reviewing and approving employment agreements and other similar arrangements between us and our executive officers; and (4) administering our stock plans and other incentive compensation plans.

 

Immediately following this offering, our Compensation Committee will consist of             ,              and             . Our board of directors will adopt a written charter for the Compensation Committee in connection with this offering, which will be available on our corporate website at www.heritagepci.com upon the completion of this offering. The information on our website is not part of this prospectus.

 

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Corporate Governance and Nominating Committee

 

Our Corporate Governance and Nominating Committee will be responsible for, among other matters: (1) identifying individuals qualified to become members of our board of directors, consistent with criteria approved by our board of directors; (2) overseeing the organization of our board of directors to discharge the board’s duties and responsibilities properly and efficiently; (3) identifying best practices and recommending corporate governance principles; and (4) developing and recommending to our board of directors a set of corporate governance guidelines and principles applicable to us.

 

Immediately following this offering, our Corporate Governance and Nominating Committee will consist of             ,              and             . Our board of directors will adopt a written charter for the Corporate Governance and Nominating Committee in connection with this offering, which will be available on our corporate website at www.heritagepci.com upon the completion of this offering. The information on our website is not part of this prospectus.

 

Compensation Committee Interlocks and Insider Participation

 

None of our executive officers has served as a member of the board of directors or compensation committee of another entity that had one or more of its executive officers serving as a member of our board of directors.

 

Other Committees

 

Our board of directors may establish other committees as it deems necessary or appropriate from time to time.

 

Risk Oversight

 

Our board of directors will oversee the risk management activities designed and implemented by our management. The board of directors will execute its oversight responsibility for risk management both directly and through its committees. The full board of directors will also consider specific risk topics, including risks associated with our strategic plan, business operations and capital structure. In addition, the board of directors will receive detailed regular reports from members of our senior management and other personnel that include assessments and potential mitigation of the risks and exposures involved with their respective areas of responsibility.

 

Our board of directors will delegate to the audit committee oversight of our risk management process. Our other board committees will also consider and address risk as they perform their respective committee responsibilities. All committees will report to the full board of directors as appropriate, including when a matter rises to the level of a material or enterprise level risk.

 

Family Relationships

 

Mr. Vattamattam, one of our directors, is the brother-in-law of Mr. Lucas, our Chairman and Chief Investment Officer. There are no other family relationships among any of our executive officers, directors or any of the persons to be nominated as our directors prior to the consummation of this offering.

 

Code of Ethics

 

We intend to adopt a Code of Ethics that will apply to all of our employees, including our chief executive officer, chief financial officer and principal accounting officer. Our Code of Ethics will be available on our website at www.heritagepci.com by clicking on About Heritage and then Code of Ethics. If we amend or grant a waiver of one or more of the provisions of our Code of Ethics, we intend to satisfy the requirements under Item 5.05 of Item 8-K regarding the disclosure of amendments to or waivers from provisions of our Code of Ethics that apply to our Chief Executive Officer and Chief Financial Officer by posting the required information on our website at the above address. Our website is not part of this prospectus.

 

Director Compensation

 

See “Executive Compensation—Director Compensation.”

 

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EXECUTIVE COMPENSATION

 

Summary Compensation Table

 

The following Summary Compensation Table discloses the compensation information for fiscal year 2013 for our principal executive officer (“PEO”) and the two most highly compensated executive officers other than the PEO who were serving as executive officers at the end of the last completed fiscal year. Certain updated 2014 compensation and other information is provided in the narrative sections following the Summary Compensation Table.

 

Name and Principal

Position

   Year      Salary
($)(1)
     Bonus
($)(2)
     Stock Awards
($)(3)
    All Other
Compensation
($)(4)
     Total
($)
 

Richard Widdicombe

     2013        413,333         861,186         1,116,250        167,577         2,558,346   

President and Chief Executive Officer

                

Bruce Lucas

     2013        317,500         2,390,268         1,929,375        22,291         4,659,434   

Chairman and Chief Investment Officer

                

Kent Linder

     2013        335,417         688,948         1,286,875        159,835         2,471,075   

Chief Operating Officer

                

 

(1)   The amount for Mr. Widdicombe includes $383,333 for base salary and an additional $30,000 in fees earned pursuant to his service as a director on our Board. The amount for Mr. Lucas includes $287,500 for base salary and an additional $30,000 in fees earned pursuant to his service as a director on our Board.
(2)   Amounts disclosed in the Bonus column represent discretionary bonus amounts earned under the Company’s annual cash incentive program.
(3)   The amounts disclosed above represent the grant date fair value of vested Company shares granted by the Company during 2013 computed in accordance with FASB ASC Topic 718. Grant date fair value was determined by multiplying the number of vested Company shares granted by the market value of shares as determined by an independent third party, less any amounts paid to the Company to acquire such shares. The amount for Mr. Widdicombe includes a January 1, 2013 award of vested Company shares with a grant date fair value of $250,000 and an October 31, 2013 award of vested Company shares with a grant date fair value of $866,250. The amount for Mr. Lucas includes only an October 31, 2013 award of vested Company shares with a grant date fair value of $1,929,375. The amount for Mr. Linder includes a January 1, 2013 award of vested Company shares with a grant date fair value of $250,000 and an October 31, 2013 award of vested Company shares with a grant date fair value of $1,036,875.
(4)   Each of Messrs. Widdicombe, Lucas and Linder received a $10,800 automobile allowance during 2013. In addition, in connection with their January 1, 2013 awards of vested Company shares, Messrs. Widdicombe and Linder are receiving amounts of $138,204 and $138,205, respectively, in the first quarter of 2014 to reimburse them for personal income taxes resulting from such awards. The amounts disclosed above also include the excess portion of the employer share of premiums offered to our named executive officers with respect to the following benefits: health insurance, dental insurance, life insurance, long-term disability insurance (Mr. Widdicombe only) and HSA account contributions.

 

Base Salaries

 

Our named executive officers were entitled to the following annual base salaries pursuant to their employment agreements:

 

Named Executive Officer

   2013 Base  Salary
(Effective January 1, 2013)
     2014 Base  Salary
(Effective January 1, 2014)
 

Richard Widdicombe

   $ 400,000       $ 680,000   

Bruce Lucas

   $ 300,000       $ 680,000   

Kent Linder

   $ 350,000       $ 600,000   

 

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Annual Incentive Awards

 

Each year, the Board establishes a bonus pool in its discretion, based on the Company’s EBITDA performance. Annual incentive awards for 2013 for our named executive officers were determined in the Board’s discretion, subject to the minimum bonus entitlements specified in the named executive officers’ employment agreements, as described below. The Board did not establish preset performance goals with respect to 2013 annual incentive awards. In the Board’s discretion, annual incentive awards may be paid in cash and/or vested Company shares, as described below.

 

Award of Vested Company Shares

 

On January 1, 2013, we granted vested Company shares to certain of our employees, including 50 shares to each of Messrs. Widdicombe and Linder. Messrs. Widdicombe and Linder each invested $5,000 per share in exchange for shares with a fair market value of $10,000 per share, resulting in each individual receiving $250,000 of compensation. In addition, Messrs. Widdicombe and Linder received additional compensation of $138,204 and $138,205, respectively, in the form of tax allowances intended to cover their federal income taxes pursuant to such awards.

 

On October 31, 2013, we granted vested Company shares, free of any purchase price, to certain of our employees, including 66 shares to Mr. Widdicombe, 147 shares to Mr. Lucas and 79 shares to Mr. Linder. Our named executive officers did not receive tax allowances pursuant to the October 31, 2013 awards.

 

Severance and Change of Control Agreements

 

Our named executive officers are not parties to any separate severance or change of control agreements. As described below, our named executive officers are entitled to certain severance and change of control payments and benefits pursuant to their employment agreements.

 

Employee Benefits

 

Our named executive officers participate in other employee benefit plans generally available to all employees on the same terms, such as medical, dental, life, disability insurance programs and a 401(k) plan. In 2013, we provided nonelective contributions to the 401(k) accounts of all our employees, including our named executive officers, equal to 3% of our his or her annual compensation, subject to applicable IRS limitations. We do not provide our named executive officers with significant perquisites or similar personal benefits.

 

Mr. Widdicombe’s Employment Agreement

 

Effective January 1, 2014, Mr. Widdicombe entered into an employment agreement with us to serve as our President and Chief Executive Officer for a term of five years. The agreement provided for an initial base salary of $680,000 per year beginning January 1, 2014 and, if the Company achieves $25 million in EBITDA on a consolidated basis during 2014, his base salary would increase to $750,000 per year beginning on January 1, 2015 and remain at this level for the balance of the term of the agreement. In addition, Mr. Widdicombe is entitled to participate in the annual bonus pool in an amount not less than 10% of the bonus pool, subject to the discretion of the Chairman of the Board.

 

Mr. Widdicombe would be entitled to his base salary for the remainder of the employment term in the event he is terminated by us without “Cause,” which is defined as (i) a breach of the employment agreement or (ii) any fraud, breach of fiduciary duty, gross negligence, embezzlement or misappropriation against the Company. If Mr. Widdicombe’s agreement expires without the Company offering him a new employment agreement with compensation levels similar to those offered under this agreement in the last year of its term, then he would be entitled to severance equal his annual base salary in the final year of the agreement. If Mr. Widdicombe dies during the term of the agreement, his estate would be entitled to 50% of his base salary for the remainder of the employment term. Mr. Widdicombe may resign upon giving no less than 90 days’ notice.

 

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In the event of a “change of control” (as defined in the agreement), Mr. Widdicombe would be entitled to continue receiving, through the remainder of the term of the agreement, (i) his base salary as in effect on the change of control date, (ii) his annual bonuses in amounts no less than those paid in the preceding 12 months and (iii) employee benefits as in effect on the change of control date.

 

Mr. Widdicombe is subject to certain restrictive covenants, including non-competition and non-solicitation of Company employees obligations for a period of two years following any termination of his employment with the Company.

 

Mr. Widdicombe previously was a party to an employment agreement with us dated January 1, 2013. This agreement contained terms substantially similar to his agreement dated January 1, 2014, except that it provided for an initial base salary of $400,000 per year, subject to 10% annual increases (up to a maximum of $500,000) in the event the Company achieves $5 million in EBITDA on a consolidated basis during the preceding year.

 

Mr. Lucas’ Employment Agreement

 

Effective January 1, 2014, Mr. Lucas entered into an employment agreement with us to serve as our Chairman of the Board and Chief Investment Officer for a term of five years. The agreement provided for an initial base salary of $680,000 per year beginning January 1, 2014 and, if the Company achieves $25 million in EBITDA on a consolidated basis during 2014, his base salary would increase to $750,000 per year beginning on January 1, 2015 and remain at this level for the balance of the term of the agreement. In addition, Mr. Lucas is entitled to participate in the annual bonus pool in an amount not less than 30% of the bonus pool, as determined by the current Chairman of the Board and the Chief Executive Officer.

 

Mr. Lucas would be entitled to his base salary for the remainder of the employment term in the event he is terminated by us without “Cause,” which is defined as (i) a breach of the employment agreement or (ii) any fraud, breach of fiduciary duty, gross negligence, embezzlement or misappropriation against the Company. If Mr. Lucas’ agreement expires without the Company offering him a new employment agreement with compensation levels similar to those offered under this agreement in the last year of its term, then he would be entitled to severance equal his annual base salary in the final year of the agreement. If Mr. Lucas dies during the term of the agreement, his estate would be entitled to 50% of his base salary for the remainder of the employment term. Mr. Lucas may resign upon giving no less than 90 days’ notice.

 

In the event of a “change of control” (as defined in the agreement), Mr. Lucas would be entitled to continue receiving, through the remainder of the term of the agreement, (i) his base salary as in effect on the change of control date, (ii) his annual bonuses in amounts no less than those paid in the preceding 12 months and (iii) employee benefits as in effect on the change of control date.

 

Mr. Lucas is subject to certain restrictive covenants, including non-competition and non-solicitation of Company employees obligations for a period of two years following any termination of his employment with the Company.

 

Mr. Lucas previously was a party to an employment agreement with us dated January 1, 2013. This agreement contained terms substantially similar to his agreement dated January 1, 2014, except that (i) it provided for an initial base salary of $300,000 per year, subject to 20% annual increases (up to a maximum of $500,000) in the event the Company achieves $5 million in EBITDA on a consolidated basis during the preceding year and (ii) Mr. Lucas was previously required to pay the cash surrender value, if any, of any life insurance policy he chooses to have assigned to him upon his termination for any reason.

 

Mr. Linder’s Employment Agreement

 

Effective January 1, 2014, Mr. Linder entered into an employment agreement with us to serve as our Chief Operating Officer for a term of five years. The agreement provided for an initial base salary of $600,000 per year

 

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beginning January 1, 2014 and, if the Company achieves $25 million in EBITDA on a consolidated basis during 2014, his base salary would increase to $700,000 per year beginning on January 1, 2015 and remain at this level for the balance of the term of the agreement. In addition, Mr. Linder is entitled to participate in the annual bonus pool in an amount not less than 10% of the bonus pool, subject to the discretion of the Chairman of the Board.

 

Mr. Linder would be entitled to his base salary for the remainder of the employment term in the event he is terminated by us without “Cause,” which is defined as (i) a breach of the employment agreement or (ii) any fraud, breach of fiduciary duty, gross negligence, embezzlement or misappropriation against the Company. If Mr. Linder’s agreement expires without the Company offering him a new employment agreement with compensation levels similar to those offered under this agreement in the last year of its term, then he would be entitled to severance equal his annual base salary in the final year of the agreement. If Mr. Linder dies during the term of the agreement, his estate would be entitled to 50% of his base salary for the remainder of the employment term. Mr. Linder may resign upon giving no less than 90 days’ notice.

 

In the event of a “change of control” (as defined in the agreement), Mr. Linder would be entitled to continue receiving, through the remainder of the term of the agreement, (i) his base salary as in effect on the change of control date, (ii) his annual bonuses in amounts no less than those paid in the preceding 12 months and (iii) employee benefits as in effect on the change of control date.

 

Mr. Linder is subject to certain restrictive covenants, including non-competition and non-solicitation of Company employees obligations for a period of two years following any termination of his employment with the Company.

 

Mr. Linder previously was a party to an employment agreement with us dated January 1, 2013. This agreement contained terms substantially similar to his agreement dated January 1, 2014, except that it provided for an initial base salary of $350,000 per year, subject to 10% annual increases (up to a maximum of $450,000) in the event the Company achieves $5 million in EBITDA on a consolidated basis during the preceding year.

 

Outstanding Equity Awards at 2013 Fiscal Year-End

 

     Stock Awards(1)  

Name

   No. of shares that have
not vested (#)
     Market value of  shares
that have not vested ($)
 

Richard Widdicombe

     —           —     

Bruce Lucas

     —           —     

Kent Linder

     —           —     

 

(1)   As of December 31, 2013, none of our named executive officers held any options or unvested equity awards.

 

Director Compensation

 

As described more fully below, the following table summarizes the annual compensation for our non-employee directors during 2013.

 

2013 DIRECTOR COMPENSATION

 

Name(1)

   Fees Earned or
Paid in Cash
($)(2)
     Stock Awards
($)(3)(4)
     Total
($)
 

Pete Apostolou

     135,000        105,000         240,000   

Trifon Houvardas

     230,000         —           230,000   

Vijay Walvekar

     30,000        210,000         240,000   

 

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(1)   Two of our named executive officers, Messrs. Widdicombe and Lucas, are also directors. In accordance with SEC rules, we have omitted them from this table because their compensation is disclosed in the Summary Compensation Table and described in the accompanying narrative.
(2)   Messrs. Apostolou and Houvardas received annual cash bonuses in connection with their provision of services to the Board during 2013. The amount disclosed above for Mr. Apostolou includes $30,000 for his annual cash retainer and a $105,000 cash bonus. The amount disclosed above for Mr. Houvardas includes $30,000 for his annual cash retainer and a $200,000 cash bonus. The amount disclosed above for Mr. Walvekar includes only his $30,000 annual cash retainer.
(3)   The amounts disclosed above represent the grant date fair value of vested Company shares granted during 2013, computed in accordance with FASB ASC Topic 718. Grant date fair value was determined by multiplying the number of vested Company shares granted by the market value of shares as determined by an independent third party. Messrs. Apostolou and Walvekar received vested Company shares of 8 and 16 shares, respectively, on October 31, 2013 in connection with their provision of services to the Board during 2013.
(4)   During 2013, we granted the following vested Company shares to our directors: Mr. Lucas: 147 shares, Mr. Widdicombe: 116 shares, Mr. Apostolou: 8 shares, Mr. Houvardas: 0 shares, and Mr. Walvekar: 16 shares. As of December 31, 2013, none of our directors held any unvested shares or option awards.

 

Narrative to Director’s Compensation Table

 

The table above describes the compensation earned by our directors (other than Messrs. Widdicombe and Lucas, whose compensation is described in the Summary Compensation Table and accompanying narrative) in 2013. Our processes and procedures for considering and determining the amount of compensation we pay our non-employee directors consist of a periodic review of director compensation by the Board.

 

In 2013, each director earned an annual cash retainer of $30,000. We do not pay meeting fees or provide additional compensation for participation in Board committees. We provide discretionary bonuses in the form of cash and/or equity awards to directors pursuant to their services provided to the Board, as determined in the discretion of the Board based on the Company’s EBITDA performance. The Board did not establish preset performance goals with respect to 2013 annual incentive awards. In 2013, the Board approved the following bonuses for our non-employee directors: Mr. Apostolou received a cash bonus of $105,000 and 8 vested Company shares with a value of $105,000, Mr. Houvardas received a $200,000 cash bonus and Mr. Walvekar received 16 vested Company shares with a value of $210,000. We reimburse our directors for their travel expenses related to attending Board and committee meetings.

 

2014 Updates to Director Compensation Program

 

Effective January 1, 2014, the Company revised its compensation program for its non-employee directors by increasing the annual cash retainer from $30,000 to $40,000.

 

Heritage Insurance Holdings, Inc. Omnibus Incentive Plan

 

Our board of directors intends to adopt the Heritage Insurance Holdings, Inc. Omnibus Incentive Plan (the “Plan”) before the effective date of this offering. The Plan described below is filed as an exhibit to the registration statement of which this summary forms a part and the following description is qualified by reference to the Plan document in all respects. Capitalized terms used herein which are not otherwise defined shall have the meaning assigned to such terms in the Plan, unless clearly stated otherwise.

 

Purpose of the Plan

 

The purpose of the Plan is twofold: (1) it enables us to attract and retain individuals who are expected to make important contributions to our business, and (2) it increases stockholder value by aligning the interests of such persons with our stockholders.

 

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Effective Date

 

The Plan will become effective on, and awards may be granted under the Plan on and after, the date of the consummation of this offering.

 

Participants

 

The Plan permits us to grant certain stock-based and other incentive awards to any of our or our affiliates’ officers, employees or other service providers, any individual that we or an affiliate has engaged to become an officer or employee, or any non-employee director.

 

Administration

 

The Administrator will be the Compensation Committee of the Board or such other committee designated by the Board of Directors to administer the Plan. Our Chief Executive Officer may act as the Administrator with respect to awards granted to employees other than executive officers or employees who are not subject to Section 162(m) of the Internal Revenue Code of 1986, as amended (the “Code”). Subject to any limitations contained in the Plan, the Administrator will have the authority to designate those eligible individuals who will become participants and determine the type of awards to be granted to each participant and the number, terms and conditions of such awards, as well as establish, adopt or revise any rules and regulations as it may deem advisable to administer the Plan.

 

Awards

 

The Administrator may grant the following types of awards to any eligible individual it selects:

 

   

Stock Options.    A stock option permits the award holder to purchase shares of our common stock in the future at a fixed price. Two types of stock options may be granted: incentive (or qualified) stock options, which may only be granted to our employees (or those of any of our subsidiaries), and nonqualified stock options. A stock option must have an exercise price at least equal to the fair market value of a share of our common stock as determined on the date of grant. The date of grant may not be a date prior to the date the Administrator takes action to approve the option. For purposes of the Plan, fair market value means the closing price of a share of our common stock as reported on the                              on the relevant date, or if no sales occur on such date, on the last preceding date on which a sale occurred on such market. A stock option must expire no later than the tenth anniversary of its grant date.

 

   

Stock Appreciation Rights (“SARs”).    A SAR gives the award holder the right to receive the difference between the fair market value per share of our common stock on the date of exercise over the grant price. Similar to stock options, a SARs grant must be price at least equal to the fair market value of a share of our common stock as determined on the date of grant, and the date of grant may not be a date prior to the date the Administrator takes action to approve the SAR. A SAR must expire no later than the tenth anniversary of its grant date.

 

   

Restricted Stock.    A holder of a restricted stock award immediately receives shares of our common stock, which shares are subject to restrictions on transferability and subject to forfeiture based on certain conditional events.

 

   

Restricted Stock Units or Deferred Stock Rights.    These units/rights provide the award holder the right to receive shares of our common stock (or an equivalent value in cash or other property, as specified in the award agreement) in the future, based upon the attainment of stated vesting or performance criteria.

 

   

Performance Awards (Performance Shares or Performance Units).    These awards entitle the holder to a payment in stock or cash upon the attainment of one or more specified performance goals.

 

   

Annual or Long-Term Incentive Awards.    These awards entitle the holder to a payment in cash based on the attainment of one or more specified performance goals.

 

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Dividend Equivalent Units.    These units entitle the award holder to payments (or an equivalent value payable in stock or other property) equal to any dividends paid on the shares of stock underlying such award.

 

   

Other Stock-Based Awards.    The Administrator may grant other types of stock-based awards that are payable in stock or cash.

 

Subject to the limitations of the Plan, the Administrator has discretion to determine the terms and conditions of the awards, including: (1) whether the award will be subject to a vesting schedule, (2) when the award will be cancelled, and (3) what happens to the award when a participant stops providing services to us and our affiliates.

 

Shares Available for Awards

 

Subject to adjustment as provided in the Plan, the aggregate number of shares of our common stock reserved and available for issuance pursuant to awards granted under the Plan is the amount equal to ten percent (10%) of all our issued and outstanding shares of common stock (on a fully-diluted basis) as of the effective date of the Plan. Only an amount equal to five percent (5%) of all our issued and outstanding shares of common stock (on a fully-diluted basis) as of the effective date of the Plan may be issued upon the exercise of incentive stock options.

 

If (i) a Plan award lapses, expires, terminates or is cancelled without the issuance of shares under such award, (ii) it is determined during or at the conclusion of the term of an award that all or some portion of the shares with respect to which the Award was granted will not be issuable, (iii) shares subject to an award are forfeited or (iv) shares subject to an award are reacquired by us pursuant to rights reserved upon the issuance of such shares, then such shares shall be recredited to the Plan’s reserve and may again be used for new Plan awards. Any such shares recredited under clause (iv) may not, however, be issued pursuant to incentive stock options. In no event, however, will shares tendered in payment of the exercise price of an option, shares withheld to satisfy federal, state or local tax withholding obligations, or shares purchased by us using proceeds from option exercises be recredited back to the Plan reserve.

 

To the extent that Code Section 162(m) applies to us (see “Code Section 162(m)” below for more information), the maximum aggregate limits applicable to awards made to any participant during any fiscal year are as follows:

 

Type of Award

  

Limit

Options and Stock Appreciation Rights    2% of all issued and outstanding shares (on a fully-diluted basis) as of the effective date of the Plan
Restricted Stock (including any dividends paid thereon) and Restricted Stock Units (including any associated Dividend Equivalent Units) and Deferred Stock Rights (including any associated Dividend Equivalent Units)    2% of all issued and outstanding shares (on a fully-diluted basis) as of the effective date of the Plan
Performance Shares or Performance Units the value of which is based on the fair market value of shares of common stock    2% of all issued and outstanding shares (on a fully-diluted basis) as of the effective date of the Plan
Performance Units, the value of which is not based on the fair market value of shares of common stock    $5,000,000
Other Stock-Based Awards    2% of all issued and outstanding shares (on a fully-diluted basis) as of the effective date of the Plan
Annual Incentive Awards    $5,000,000
Long-Term Incentive Awards    $5,000,000

 

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Performance Goals

 

For any awards made under the Plan that are intended to meet the requirements of Section 162(m) of the Code, the grant or vesting of such awards may be based upon one or more performance goals that apply to the specified participant, one or more of our business units, or us as a whole. The categories of performance goals (defined as “Performance Goals” under the Plan) on which performance goals intended to qualify compensation as performance-based compensation for purposes of Code Section 162(m) may be based are:

 

•Our basic earnings per common share on a consolidated basis

 

•Our diluted earnings per common share on a consolidated basis

 

•Total stockholder return

 

•Fair market value of shares

 

•Net sales Non-catastrophic claims incurred

 

•Cost of sales

 

•Gross profit

 

•Selling, general and administrative expenses

 

•Operating income

 

•Earnings before interest and the provision for income taxes (EBIT)

 

•Earnings before interest, the provision for income taxes, depreciation, and amortization (EBITDA)

 

•Net income

 

•Accounts receivable

 

•Gross premiums earned

 

•Inventories

 

•Trade working capital

 

•Return on equity

 

•Return on assets

 

•Return on invested capital

 

•Reinsurance costs

 

•Return on sales

 

•Economic value added, or other measure of profitability that considers the cost of capital employed

 

•Free cash flow

 

•Net cash provided by operating activities

 

•Net increase (decrease) in cash and cash equivalents

 

•Customer satisfaction

 

•Market share

 

•Quality

 

The Administrator may designate other categories with respect to awards under the Plan that are not intended to qualify as performance-based compensation within the meaning of Code Section 162(m) or to the extent that the application of such categories results in a reduction of the maximum amount otherwise payable under the award.

 

Termination of Employment

 

Generally, a participant’s employment, retention, change of control, severance or similar agreement with us will control if such agreement discusses the treatment of awards upon a termination of employment. Otherwise, unless otherwise specified in a participant’s award agreement, the following provisions will apply.

 

If a participant is terminated for Cause or due to Inimical Conduct, all vested and unvested awards are automatically cancelled and forfeited.

 

All unvested and/or unexercisable stock options, SARs, restricted stock, restricted stock units and deferred stock rights (in each case, other than performance awards) will automatically be cancelled and forfeited upon termination of employment for any reason. If the participant terminates employment due to Retirement, death or Disability, all vested stock options and SARs will remain exercisable until the earlier of the end of the term of such award or the date that is one year following the date of such termination. The post-termination exercise

 

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period for vested stock options and SARs described in the preceding sentence is reduced to 30 days if the participant terminates employment for any reason other than due to Retirement, death, Disability or for Cause or Inimical Conduct.

 

Subject to the exceptions described below, all awards other than stock options, SARs, restricted stock, restricted stock units and deferred stock rights will be automatically cancelled and forfeited upon any termination of employment. Upon a termination of employment due to Retirement, (i) all performance awards outstanding will be paid in shares of our common stock or cash, as applicable, following the end of the performance period and based on the achievement of the performance goals as though the termination had not occurred, and (ii) all incentive awards shall be cancelled in exchange for a cash payment following the end of the performance period based on the achievement of the performance goals but prorated based on the number of days in the performance period that had passed prior to such termination of employment. Upon a termination of employment due to death or Disability, (i) all performance awards outstanding will be paid in shares of our common stock or cash, as applicable, following the end of the performance period and based on the achievement of the performance goals as though the termination had not occurred, but prorated based on the number of days in the performance period that had passed prior to such termination of employment, and (ii) all incentive awards shall be cancelled in exchange for a cash payment following the end of the performance period based on the achievement of the performance goals but prorated based on the number of days in the performance period that had passed prior to such termination of employment.

 

Limitations on Transfer

 

No award (other than unrestricted shares) will be assignable or transferable by a participant other than by will or the laws of descent and distribution, unless and to the extent the Administrator allows a participant to designate, in writing, a beneficiary to exercise the award after the participant’s death or to transfer an award.

 

Treatment of Awards upon a Change of Control

 

Generally, a participant’s employment, retention, change of control, severance or similar agreement with us, if applicable, will control if such agreement discusses the treatment of awards upon a Change of Control. Otherwise, unless otherwise specified in a participant’s award agreement or by the Administrator prior to the Change of Control, the following provisions will apply.

 

Upon a Change of Control, the successor entity in the transaction may assume all of our outstanding awards or replace such awards with similar awards. However, to the extent awards are not assumed or replaced, then all outstanding stock-based awards will vest immediately prior to the date of the Change of Control and (unless otherwise determined by the Administrator) (i) all stock options and SARs will be cancelled and paid out in cash and (ii) all earned but unpaid performance and incentive awards would be cancelled in exchange for a cash payment based on the maximum value payable to the participant under such award, but prorated based on the number of days in the performance period that had passed prior to such Change of Control.

 

If a participant who receives a replacement award by the successor entity in the transaction is terminated without cause (or the participant terminates employment for “good reason” under an agreement with us that contemplates such termination) within twelve months following a change of control, then the participant’s awards will be vested in full, or on a prorated basis if the award is subject to the attainment of performance goals (based on the maximum value payable to the participant under such award) and shall be cancelled in exchange for shares of the successor entity’s common stock or other securities or a cash payment to the participant.

 

Adjustments

 

In the event we enter into a transaction that causes the per-share value of the common stock to change (including, without limitation, any stock dividend, stock split, spin-off, rights offering or large nonrecurring cash

 

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dividend), the Administrator will make such adjustments to the number and type of shares subject to the Plan and outstanding awards, the grant, purchase or exercise price with respect to any award or the performance goals of an award (limited by the Code Section 162(m) rules, to the extent applicable) as the Administrator may deem equitable to prevent dilution or enlargement of the benefits or potential benefits intended to be made available under the Plan.

 

In no event, however, may we, the Administrator or any other person amend an option or SAR to reduce the exercise or grant price, cancel an option or SAR in exchange for a similar award with a lower exercise or grant price, or cancel an out-of-the-money option or SAR for a cash payment or other consideration.

 

Termination and Amendment

 

The Administrator may, at any time and from time to time, terminate or amend the Plan, but an amendment will require stockholder approval if (i) it is required by the Securities Exchange Act of 1934, as amended, the listing requirements of any principal securities exchange or market on which our shares of common stock are then traded, or any applicable law; or (ii) the amendment increases the number of shares reserved under the Plan or the individual participant share or payment limits set forth in the Plan, expands the group of individuals that may become participants, or diminishes the protections afforded by the anti-repricing provisions of the Plan.

 

In no event, however, may we, the Administrator or any other person amend an option or SAR to reduce the exercise or grant price, cancel an option or SAR in exchange for a similar award with a lower exercise or grant price, or cancel an out-of-the-money option or SAR for a cash payment or other consideration.

 

Code Section 162(m)

 

Section 162(m) of the Code generally limits the deduction companies can take for compensation paid to the chief executive officer and the four other highest paid officers other than the chief financial officer (determined as of the end of each year) to $1,000,000 per year per individual.

 

However, performance-based compensation that meets the requirements of Section 162(m) does not have to be included as part of the $1,000,000 limit. The Plan is designed so that awards granted to the covered individuals may meet the Section 162(m) requirements for performance-based compensation, if applicable.

 

Under a Section 162(m) transition rule for compensation plans of corporations that are privately held and that become publicly held in an initial public offering, the Plan will not be subject to Section 162(m) until a specified transition date, which is the earlier of:

 

   

the material modification of the Plan;

 

   

the issuance of all of the shares of our common stock reserved for issuance under the Plan

 

   

the expiration of the Plan; or

 

   

the first meeting of our stockholders at which members of our board of directors are to be elected that occurs after the close of the third calendar year following the calendar year in which our initial public offering occurs.

 

United States Federal Income Tax Consequences

 

The following discussion is only a summary of certain of the United States federal income tax consequences of awards under the Plan.

 

Nonqualified Stock Options

 

A participant subject to United States income tax will not recognize income at the time of grant of a nonqualified stock option and we will not be entitled to a deduction at that time. When the nonqualified stock

 

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option is exercised, the participant will recognize ordinary income equal to the difference, if any, between the aggregate exercise price paid and the fair market value, as of the date the nonqualified stock option is exercised, of the shares received. The participant’s tax basis in the exercised shares will equal the exercise price paid plus the amount recognized by the participant as ordinary income. We will generally be entitled to a United States federal income tax deduction, in the tax year in which the nonqualified stock option is exercised, equal to the ordinary income recognized by the participant at exercise. The gain or loss a participant realizes when he or she later sells shares that were acquired by exercising a nonqualified stock option may be a capital gain or loss for United States income tax purposes. The participant’s holding period for shares he or she acquires by exercising a nonqualified stock option will generally begin on the date of exercise.

 

Incentive Stock Options

 

The participant will not recognize income under United States federal income tax law at the time of grant of an incentive stock option and we will not be entitled to a deduction at that time. If the incentive stock option is exercised during employment, or within three months thereafter (or one year in the case of a permanently and totally disabled employee), the participant will not recognize any income and we will not be entitled to a deduction. The excess of the fair market value of the shares on the exercise date over the exercise price, however, is includible in computing the participant’s alternative minimum taxable income.

 

Generally, if the participant disposes of shares acquired by exercising an incentive stock option within either two years after the date of grant or one year after the date of exercise, the participant will recognize ordinary income, and we will be entitled to a deduction, equal to the excess of the fair market value of the shares on the date of exercise (or the sale price, if lower) over the exercise price. The balance of any gain or loss will be treated as a capital gain or loss to the participant. If the shares are disposed of after the two year and one year periods described above, we will not be entitled to any deduction, and the entire gain or loss for the participant will be treated as a capital gain or loss.

 

SARs

 

A participant will generally not recognize income, and we will not be entitled to a deduction from income, at the time of grant of a SAR. When the SAR is exercised, the participant will recognize ordinary income equal to the difference between the aggregate grant price and the fair market value, as of the date the SAR is exercised, of the our common stock. The participant’s tax basis in the shares acquired upon exercise of a stock-settled SAR will equal the amount recognized by the participant as ordinary income. We will generally be entitled to a United States federal income tax deduction, in the tax year in which the SAR is exercised, equal to the ordinary income recognized by the participant as described above. If the participant holds shares acquired through exercise of a stock-settled SAR for more than one year after the exercise of the SAR, the capital gain or loss realized upon the sale of those shares will be a long-term capital gain or loss. The participant’s holding period for shares acquired upon the exercise of a stock-settled SAR will begin on the date of exercise.

 

Restricted Stock Units and Deferred Stock Rights

 

Restricted stock units and deferred stock rights generally are subject to United States federal income tax at the time of payment and we will have a corresponding deduction when the participant recognizes income.

 

Other Awards

 

The current United States federal income tax consequences of other awards authorized under the Plan are generally as follows:

 

   

Restricted stock subject to a substantial risk of forfeiture results in income recognition equal to the excess of the fair market value of the shares over the purchase price (if any) only at the time the restrictions lapse (unless the recipient elects to accelerate recognition as of the date of grant);

 

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Performance shares, performance units, dividend equivalent units and other cash awards generally are subject to United States federal income tax (as ordinary income) at the time of payment.

 

In each of the foregoing cases, we will generally have a deduction equal to the amount of income the participant recognizes, at the same time as the participant recognizes it.

 

Payment with Shares

 

When shares subject to an award are used to satisfy any minimum required United States federal income tax withholding, the participant will recognize gain or loss on those shares. In this situation, the participant will recognize a capital gain or loss, as the case may be, equal to the difference between the amount of the minimum required United States federal income tax withholding satisfied by the shares over the participant’s tax basis, if any, in those shares.

 

If shares owned by the participant are used to pay, in whole or part, the exercise price of a stock option, no gain or loss will be recognized on those shares. In this situation, however, the United States federal income tax basis of the shares received upon exercise will be the tax basis of the shares delivered as payment, share for share, to the extent the number of shares received equals the number of shares delivered as payment. The United States federal income tax basis in shares received in excess of the number of shares delivered by the participant will be equal to the sum of the amount of the exercise price paid in cash or by check, if any, plus any amount the participant is required to recognize as income as a result of the exercise. However, if the holder of an incentive stock option pays the exercise price of that stock option with shares acquired through earlier exercise of an incentive stock option, and the shares used for payment have not been held for the required holding period discussed above, payment in shares will result in the participant recognizing ordinary income.

 

Code Section 409A

 

Any deferral of compensation may be subject to the requirements of Code Section 409A. Several forms of compensation allowed under the Plan, including, but not limited to, any grants of restricted stock units may constitute deferred compensation. Notwithstanding any of the preceding tax discussions, any deferred compensation under Plan awards that do not satisfy the requirements of Code Section 409A will, upon vesting, be currently taxable to participants and will be subject (in addition to normal income taxes) to a 20 percent excise tax plus interest. The Committee has established rules and procedures regarding deferred compensation that are meant to comply with the requirements of Code Section 409A. However, there is no guarantee that the rules and procedures comply with such requirements.

 

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CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS

 

The following is a description of transactions since our inception to which we have been a party in which the amount involved exceeded or will exceed $120,000 within any fiscal year and in which any of our directors, executive officers, beneficial holders of more than 5% of our capital stock or entities affiliated with them had or will have a direct or indirect material interest.

 

Relationship with SVM Restoration Services

 

In March 2014, we acquired the assets and personnel of SVM Restoration Services, Inc., a company that provides water mitigation and repair services to the Company’s policyholders, for $2.5 million in cash. The spouses of Messrs. Widdicombe and Linder, two of our executive officers, founded SVM Restoration Services, Inc. in 2003 and each held 33.3% of its outstanding equity interests. For the year ended December 31, 2013, we paid SVM Restoration Services, Inc. approximately $818,000 for services rendered.

 

Property Ownership, Management and Construction

 

The building in which our former St. Petersburg, Florida headquarters is located is owned by The Arc Group, Inc. One of our directors, Pete Apostolou, and his father collectively own 22.5% of the outstanding equity interests of The Arc Group, Inc. For the years ended December 31, 2012 and 2013, we made rent payments to The Arc Group, Inc. of approximately $65,000 and $488,000, respectively.

 

Further, in November 2013, Skye Lane entered into a Property Management Agreement with Central Management, Inc., a company owned by Mr. Apostolou, for the management of the 13-acre campus in Clearwater, Florida. Pursuant to this agreement, Skye Lane has agreed to pay an annual management fee of $100,000.

 

We have entered into an agreement with George Apostolou Construction, a company owned by the father of Mr. Apostolou, for the construction of a parking facility for our Clearwater property. In February 2014, we made a payment of approximately $82,000 for engineering and architectural services, and we expect to pay an aggregate of approximately $2.4 million in connection with this construction project.

 

Consulting Agreement with Infinity Investment Funds

 

Mr. Lucas, one of our executive officers, holds 50% of the outstanding equity interests of Infinity Investment Funds, LLC, a company that provides the Company with consulting services related to the evaluation of potential strategic acquisitions. We entered into a consulting agreement with Infinity Investment Funds, LLC on December 1, 2013, which is subject to termination at any time. In connection with the provision of these consulting services, we paid Infinity Investment Funds, LLC a non-recurring flat fee of $500,000 in December 2013.

 

Sales of our Equity Securities

 

We sold shares of the Company to our directors and officers and their respective affiliates in private transactions on the dates set forth below.

 

Subscriber

   Date of Purchase      Number of
Shares
     Number of
Warrants
     Aggregate
Purchase Price
 

Richard Widdicombe

     Third quarter of 2012         25         —         $ 250,000   
     Fourth quarter of 2012         38         15         417,500   
     First quarter of 2013         24         24         300,000   

Bruce Lucas

     Third quarter of 2012         122         —         $ 1,220,000   
     Fourth quarter of 2012         168         80         1,880,000   
     First quarter of 2013         48         48         600,000   
     Second quarter of 2013         46