Palomar Holdings, Inc. — Q3 2023 Form 10-Q
Reporting period: Three and nine months ended September 30, 2023; comparisons are with the same 2022 periods unless noted. Amounts below are in millions of dollars except per-share data and percentages. Palomar is a specialty property and casualty insurer, with a focus that includes earthquake coverage; it also writes fronting business, ceding most of the associated premium and risk.
Financial performance and position
| Metric | Q3 2023 | Q3 2022 | 9M 2023 | 9M 2022 |
|---|---|---|---|---|
| Gross written premiums | $314.0 | $253.1 | $838.4 | $642.8 |
| Net written premiums | $110.7 | $91.2 | $295.6 | $268.6 |
| Net earned premiums | $85.8 | $77.9 | $252.2 | $234.2 |
| Total revenue | $90.9 | $80.7 | $270.5 | $238.5 |
| Net investment income | $6.0 | $3.7 | $16.7 | $9.5 |
| Net income | $18.4 | $4.3 | $53.3 | $33.4 |
| Diluted EPS | $0.73 | $0.17 | $2.10 | $1.29 |
| Combined ratio | 75.8% | 94.8% | 77.6% | 82.1% |
| Operating cash flow | Not presented quarterly | Not presented quarterly | $93.8 | $94.5 |
- Growth and earnings: Q3 gross written premiums increased 24.0%, while net earned premiums rose 10.1%. Nine-month gross written premiums increased 30.4%, versus 7.7% growth in net earned premiums. Nine-month net income grew 59.5%.
- Underwriting: Q3 losses and loss adjustment expenses were $16.1 million, down from $30.9 million, including catastrophe losses of negative $0.5 million versus $12.5 million in Q3 2022. The Q3 catastrophe loss ratio was negative 0.6%. Nine-month catastrophe losses were $3.4 million versus $13.5 million; non-catastrophe losses increased 9.7% to $51.3 million. The nine-month loss ratio improved to 21.7% from 25.7%.
- Margins and non-GAAP measures: The combined ratio was below 100% in both comparison periods, indicating underwriting profit under the company’s definition. Adjusted combined ratio was 70.9% for Q3 and 72.1% for nine months (versus 90.3% and 77.1%); adjusted net income was $23.3 million and $65.5 million, respectively. These are company-defined non-GAAP measures and should be considered alongside GAAP results.
- Cash, investments and equity: At September 30, cash and cash equivalents were $53.0 million; total investments were $634.7 million, including $591.9 million of available-for-sale fixed maturities. Management reported $688.0 million of cash and investment securities available. Total assets were $1.626 billion and stockholders’ equity was $421.3 million, up from $384.8 million at year-end 2022. Nine-month operating cash flow was positive, while cash, cash equivalents and restricted cash decreased $14.9 million to $53.3 million.
- Investment valuation: Available-for-sale fixed maturities had amortized cost of $647.6 million and fair value of $591.9 million, a $55.3 million gross unrealized loss position. Accumulated other comprehensive loss was $43.2 million. Management attributed most fixed-maturity unrealized losses to interest rates, reported no intent or expected need to sell before cost recovery, and recorded credit-loss allowances on two securities.
- Debt and liquidity: Borrowings were $52.6 million under the collateralized FHLB line, at a 5.69% overnight rate; the $100 million U.S. Bank revolving facility had no borrowings. The company reported compliance with debt covenants. It stated that liquidity and expected cash sources should cover needs for the foreseeable future and at least the next 12 months, while noting catastrophe losses could affect cash flows.
Material changes and management commentary
- Premium growth was attributed to new business with existing partners, strong retention, broader distribution and new partnerships. Fronting premiums reached $278.5 million for nine months, up 80.6%, and represented 33.2% of gross written premiums. Ceded written premiums grew faster than gross premiums: 45.1% for nine months, with ceded premiums equal to 64.7% of gross written premiums versus 58.2% a year earlier. The net earned premium ratio consequently fell to 34.1% from 48.4%.
- Management said growth in fronting and quota-share business and higher exposure and reinsurance rates drove higher cessions and XOL costs. Underwriting changes to reduce continental U.S. hurricane exposure contributed to lower Commercial All Risk premiums. Specialty Homeowners premiums fell following the company’s decision to cease most of that business and convert Texas business to a fronting arrangement in 2022.
- Other underwriting expenses increased 24.8% for nine months, primarily from payroll, technology, stock-based compensation and professional fees. Acquisition expenses fell 6.2%, mainly due to higher ceding commissions and fronting fees.
- Interest income increased with a larger investment portfolio and higher yields. Fixed-income book yield rose to 3.90% from 3.30% at year-end 2022; weighted-average effective duration was 3.61 years. Investment risks include interest-rate, credit and equity-market exposure.
- The company repurchased 418,901 shares for $22.1 million during the first nine months; approximately $43.5 million remained under the $100 million authorization, which runs through March 31, 2024. No cash dividend is planned in the foreseeable future, and subsidiary distributions are subject to regulatory limits.
Outlook, risks and other disclosures
- Guidance: The filing provides no specific financial guidance or numerical forecast. Management states that interim results are not necessarily indicative of full-year results and expresses confidence in liquidity for the foreseeable future.
- Catastrophe and reinsurance exposure: Current event retention is $17.5 million for all perils; stated catastrophe reinsurance limits extend to $2.68 billion for earthquake, $900 million for Hawaii hurricane and $100 million for continental U.S. hurricane events. The company warns that losses can exceed coverage, reinsurance may become more expensive or unavailable, and reinsurers may fail to pay. Aggregate reinsurance recoverables were $280.2 million.
- Reserves: Gross reserves for losses and LAE were $324.3 million, with $232.2 million of recoverables on unpaid losses. Management reported adverse prior-year development of $1.0 million in Q3 and $3.7 million for nine months, primarily from higher-than-anticipated attritional loss severity, partly offset by lower catastrophe severity. The filing emphasizes that reserve estimates are uncertain and could materially change.
- Concentration and other risks: California represented 53.8% of nine-month gross written premiums; Texas represented 8.7%. Disclosed risks include catastrophe frequency and severity, climate-related weather changes, inflation in repair costs, reinsurance collectability and availability, reserve adequacy, reliance on major program administrators, regulation, competition, and investment-market volatility.
- Capital and regulatory constraints: Insurer subsidiary dividends are restricted by state and Bermuda rules. PSIC could pay up to $78.2 million in 2023 without regulatory approval under the stated formula; PESIC could not pay a 2023 dividend without Arizona approval; PSRE’s stated calculated 2023 capacity was approximately $3.9 million, subject to solvency requirements.
- Legal proceedings and controls: The company said ordinary-course legal matters were not expected to have a material adverse effect. Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether premium growth, particularly fronting growth, translates into durable net earned premium and underwriting returns as cessions and reinsurance costs rise.
- How much of Q3’s improved loss performance reflects favorable catastrophe development, and whether attritional loss severity or prior-year reserve development worsens.
- The adequacy and collectability of the $280.2 million in reinsurance recoverables and the availability, cost and terms of future catastrophe protection.
- The effect of California concentration, catastrophe exposure and interest rates on capital, investment fair values and liquidity; fixed maturities carried $55.3 million of gross unrealized losses.
- Use of remaining repurchase authorization, regulatory limits on subsidiary distributions, and compliance with debt covenants as borrowings and operating needs change.