Business context and reporting period
Palomar Holdings, Inc. filed its Form 10-K for the fiscal year ended December 31, 2019. The company is a specialty property insurer focused on earthquake, wind, flood and other targeted risks, using granular underwriting analytics, multiple distribution channels and substantial reinsurance. Its common stock began trading on Nasdaq in April 2019.
The filing also reports unaudited quarterly results: fourth-quarter 2019 gross written premiums were $73.3 million, total revenues were $34.6 million and net income was $10.9 million.
Financial and operating performance
| Metric | FY 2019 | FY 2018 |
|---|---|---|
| Gross written premiums | $252.0 million | $154.9 million |
| Net written premiums | $143.6 million | $71.9 million |
| Net earned premiums | $100.2 million | $69.9 million |
| Total revenues | $113.3 million | $73.0 million |
| Underwriting income (non-GAAP) | $8.7 million | $19.8 million |
| Net income | $10.6 million | $18.2 million |
| Diluted EPS | $0.49 | $1.07 |
| Adjusted net income (non-GAAP) | $37.9 million | $19.8 million |
| Combined ratio | 91.3% | 71.6% |
| Adjusted combined ratio (non-GAAP) | 63.3% | 69.5% |
Gross written premiums grew 62.7%; net written premiums rose 99.6%, partly reflecting a lower cession rate (43.0% of gross written premiums versus 53.6% in 2018). Net earned premiums increased 43.4%. The loss ratio improved to 5.6% from 9.0%, while the expense ratio rose to 85.7% from 62.6%. Management reported adjusted return on equity of 24.1%, up from 22.7%.
Earthquake products were 67.2% of gross written premiums; residential business was 71%. California and Texas accounted for 56.3% and 17.5%, respectively. Overall average monthly premium retention was approximately 88%; residential earthquake retention was 94% and Hawaii hurricane retention was 97%.
Cash, investments and capital
Operating cash flow was $41.7 million, compared with $22.8 million in 2018. Investing activities used $80.6 million and financing activities provided $62.3 million, including $87.4 million net IPO proceeds, partly offset by debt redemption and a $5.1 million distribution to the former sole stockholder. Cash and cash equivalents were $33.1 million at year-end; investments totaled $239.5 million. The company reported $272.8 million of cash and investment securities available.
Total assets were $395.5 million, total liabilities $176.9 million and stockholders’ equity $218.6 million, compared with $231.1 million, $134.8 million and $96.3 million, respectively, at year-end 2018. Long-term debt was zero at December 31, 2019, following redemption of $20.0 million of floating-rate notes in May 2019. The fixed-maturity portfolio had a 2.9% book yield and 3.49-year weighted-average effective duration. Management said available resources and expected cash flows should meet liquidity needs for at least the next 12 months and beyond.
Material changes versus the prior comparable period
- Net income fell 41.7% despite strong premium growth. The main unusual expense was $24.1 million of stock-based compensation, including a $23.0 million charge from modifying the former parent’s management incentive plan; income tax expense also increased to $7.5 million from an immaterial benefit in 2018.
- Adjusted net income increased 91.1% to $37.9 million and adjusted combined ratio improved to 63.3%. These are non-GAAP measures and exclude specified items; they should be considered alongside GAAP results.
- Other underwriting expenses rose 185.7% to $51.3 million, reflecting compensation, technology and growth-related costs as well as one-time and equity-compensation charges. Excluding the company’s specified adjustments, those expenses were 11.6% of gross earned premiums versus 12.0% in 2018.
- Net investment income rose 84.5% to $6.0 million, and investment gains shifted from a $2.6 million loss to a $4.4 million gain, primarily reflecting better equity-security performance.
- Stockholders’ equity more than doubled, supported by IPO proceeds and stock compensation recorded in additional paid-in capital. The company completed its IPO and a selling-stockholder secondary offering in 2019; a January 2020 offering generated approximately $35.4 million of additional net proceeds for the company from its own shares sold.
Outlook, commentary and risks
The filing provides no quantified earnings or premium guidance. Management’s stated priorities are to grow in existing and new markets while maintaining disciplined pricing, underwriting, diversification and conservative reinsurance protection. New offerings in inland marine and assumed reinsurance launched in 2019. The company intends to retain no more than $5 million per earthquake or wind event under its stated program as of January 1, 2020; catastrophe coverage was up to $1.2 billion for earthquake and $514 million for wind, subject to terms and exclusions.
Key risks include severe catastrophe losses, climate and weather uncertainty, model limitations, reinsurance availability and counterparty nonpayment, and concentration in California and Texas. The company also relies substantially on a small number of program-administrator relationships: four programs represented 59.0% of 2019 gross written premiums. Residential flood losses are not covered under the catastrophe XOL treaty, though the company reported ceding 70% of flood risk up to a $75 million occurrence limit. Loss reserves require significant estimates; year-end gross reserves were $16.8 million and net reserves $3.9 million. Management reported $0.2 million of net favorable prior-year development in 2019.
Other notable considerations include extensive insurance regulation, dependence on the A.M. Best “A−” financial strength rating, investment-market risk, and restricted upstream dividends from insurance subsidiaries. The company does not expect to pay common-stock cash dividends in the foreseeable future. It reported no material litigation and no off-balance-sheet arrangements reasonably likely to have a material effect. Management concluded disclosure controls and internal control over financial reporting were effective at year-end; the auditor did not provide an internal-control attestation because the company was an emerging growth company. The financial statements received an unqualified audit opinion.
Important facts for investors to verify
- Reconcile GAAP net income of $10.6 million with adjusted net income of $37.9 million, especially the $24.1 million stock-compensation adjustment and the tax effects.
- Assess whether expense growth and the 85.7% expense ratio are sustainable as the business scales; distinguish reported combined ratio from the adjusted measure.
- Track catastrophe exposure, modeled PML, reinsurance renewals, coverage exclusions and reinsurer recoverability, including the $17.3 million reported aggregate reinsurance recoverable.
- Monitor geographic and distribution concentration, especially California, Texas and the program administrators responsible for a significant share of premiums.
- Review reserve development and claims emergence as newer product lines mature, and evaluate the assumptions underlying loss reserves.
- Confirm the effect of the January 2020 offering, subsidiary dividend restrictions and statutory capital requirements on parent-company liquidity and growth capacity.