Palomar Holdings, Inc. — Q2 2023 Form 10-Q
Business context and reporting period. Palomar is a specialty property and casualty insurer focused on selected markets, including earthquake insurance, and also writes fronting business. This unaudited filing covers the quarter and six months ended June 30, 2023; comparisons are with the corresponding 2022 periods. Interim results are not necessarily indicative of full-year results.
Financial and operating performance
| Metric | Q2 2023 | Q2 2022 | First half 2023 | First half 2022 |
|---|---|---|---|---|
| Gross written premiums | $274.3 million (+25.4%) | $218.7 million | $524.4 million (+34.6%) | $389.6 million |
| Net written premiums | $105.2 million (+9.5%) | $96.1 million | $185.0 million (+4.2%) | $177.4 million |
| Net earned premiums | $83.1 million (+3.5%) | $80.3 million | $166.3 million (+6.4%) | $156.3 million |
| Total revenue | $90.4 million (+13.5%) | $79.7 million | $179.6 million (+13.8%) | $157.8 million |
| Net income | $17.6 million (+20.4%); diluted EPS $0.69 | $14.6 million; diluted EPS $0.57 | $34.9 million (+19.7%); diluted EPS $1.37 | $29.1 million; diluted EPS $1.13 |
| Underwriting income (non-GAAP) | $17.4 million (-12.9%) | $20.0 million | $35.8 million (-5.5%) | $37.9 million |
| Adjusted net income (non-GAAP) | $21.8 million (-2.9%) | $22.4 million | $42.2 million (+2.9%) | $41.0 million |
| Combined ratio | 79.0%, versus 75.1% | 75.1% | 78.5%, versus 75.8% | 75.8% |
| Adjusted combined ratio (non-GAAP) | 72.2%, versus 69.1% | 69.1% | 72.8%, versus 70.5% | 70.5% |
Premium growth reflected new business through existing partners, retention, expanded distribution and new partnerships. Fronting premiums rose 90.3% in Q2 and 138.8% in the first half. However, ceded written premiums grew faster than gross premiums, reaching 61.7% and 64.7% of gross written premiums, respectively, as fronting and quota-share cessions expanded and excess-of-loss reinsurance costs increased. The resulting net earned premium ratio fell to 34.3% in Q2 and 35.6% in the first half. Fronting premiums generally cede most of the premium and risk; Palomar earns fronting fees.
Investment income increased to $5.5 million in Q2 and $10.7 million in the first half, attributed to larger average investments and higher yields. Net realized and unrealized investment gains were $1.1 million and $1.3 million, respectively, compared with losses of $4.7 million and $6.0 million in 2022, mainly reflecting equity-security performance. Other comprehensive income was $13.9 million in Q2 and $36.7 million for the first half; Q2 included a $3.7 million after-tax unrealized loss on available-for-sale securities.
Balance sheet, cash flow and liquidity
- At June 30, 2023, total assets were $1.546 billion, total liabilities $1.133 billion and stockholders’ equity $413.7 million, up from $384.8 million at year-end 2022. Tangible equity, a non-GAAP measure, was $400.6 million.
- Cash and cash equivalents were $58.3 million; total investments were $601.5 million, including $560.1 million of available-for-sale fixed maturities and $41.4 million of equity securities. Available-for-sale fixed maturities had $44.8 million of gross unrealized losses; management attributed most to interest rates and said it did not expect to be forced to sell before recovery of amortized cost.
- For the first half, operating cash flow was $23.2 million, down from $82.8 million. Investing used $52.9 million and financing provided $20.1 million; cash, cash equivalents and restricted cash declined $9.6 million to $58.6 million.
- Borrowings were $71.4 million under the collateralized FHLB line, at a reported overnight rate of 5.28%; there were no borrowings under the $100 million U.S. Bank revolver. The company reported compliance with debt covenants. Management cited $660.2 million of cash and investment securities available at quarter-end and said liquidity was sufficient for the foreseeable future.
- Management stated it expects cash flows to meet liquidity needs for at least the next 12 months and beyond. Insurance-subsidiary dividend capacity is regulated; PSIC’s stated 2023 ordinary dividend capacity was up to $78.2 million, PESIC could not pay a dividend without regulatory approval, and PSRE’s calculated capacity was approximately $3.9 million.
Material changes, outlook and risks
- Losses and loss adjustment expenses rose 24.4% in Q2 and 31.4% in the first half. Catastrophe losses were $2.2 million for Q2 and $4.0 million year to date, associated with severe convective storms and first-quarter floods. Non-catastrophe losses also rose, particularly in Commercial All Risk, Casualty and Inland Marine.
- The loss ratio increased to 21.5% in Q2 and 23.2% in the first half. Prior-year development was favorable by $0.6 million in Q2, but adverse by $2.7 million for the first half, primarily reflecting higher-than-anticipated attritional severity.
- Other underwriting expenses increased 22.8% in Q2 and 21.8% year to date, including higher payroll, technology and stock-based compensation costs. Acquisition expenses declined as higher ceding commissions and fronting fees offset higher commissions and premium-related taxes.
- Palomar issued a $200 million catastrophe bond effective June 1, 2023, providing earthquake reinsurance through June 1, 2026. Reported catastrophe retention was $17.5 million per event; stated coverage limits were $2.66 billion for earthquake, $900 million for Hawaii hurricane and $100 million for continental U.S. hurricane events.
- No specific full-year financial guidance was provided in the filing. Management said it expects to continue writing fronting premiums, while noting their volume may vary with partnership starts and terminations. It also reported underwriting changes to reduce continental U.S. hurricane exposure.
- Key exposures include catastrophe frequency and severity, climate and claims inflation, reserve-estimation uncertainty, reinsurance availability, cost and counterparty performance, and investment interest-rate, credit and equity-market risk. California represented 55.1% of first-half gross written premiums and Texas 9.2%; the two largest program administrators represented 31.3% and 14.7%.
- Subsequent to quarter-end, A.M. Best upgraded the company’s financial strength rating to A- with a Positive outlook on July 14, 2023. The filing reports effective disclosure controls and no material change in internal control over financial reporting during the quarter. Ordinary-course legal proceedings were not expected to have a material adverse effect.
Important facts for investors to verify
- Whether premium growth converts into sustained net earned premium and underwriting profit given rising cessions, reinsurance costs and the larger fronting mix.
- Loss-reserve adequacy and development trends, especially the first-half adverse prior-year development and increased attritional losses.
- Reinsurance renewal terms, recoverability and remaining protection against multiple or severe catastrophe events.
- Liquidity and capital flexibility, including collateral securing FHLB advances, regulatory limits on subsidiary dividends and the effect of share repurchases; $15.6 million was repurchased in the first half, with about $50.0 million remaining authorized.
- Investment portfolio sensitivity to interest rates and credit conditions, including the unrealized fixed-maturity losses and any need to sell securities to fund claims.
- The sustainability of growth and profitability in concentrated geographies and through major program administrators; non-GAAP adjusted measures should also be assessed alongside GAAP results.