Palomar Holdings, Inc. — 2019 Q3 Form 10-Q
Reporting period: Three and nine months ended September 30, 2019, compared with the same 2018 periods. Palomar is a specialty property insurer focused mainly on earthquake, wind and flood coverage. Amounts below are in millions of dollars unless stated otherwise.
Financial performance and position
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Gross written premiums | $66.2 | $40.0 | $178.6 | $111.3 |
| Net earned premiums | $27.7 | $16.0 | $69.2 | $52.3 |
| Total revenue | $30.5 | $18.9 | $78.7 | $57.3 |
| Income before taxes | $9.4 | $1.6 | $3.7 | $14.1 |
| Net income (loss) | $7.5 | $1.6 | $(0.3) | $14.1 |
| Adjusted net income (non-GAAP) | $9.6 | $2.7 | $26.4 | $15.2 |
| Combined ratio | 73.4% | 100.2% | 103.9% | 76.4% |
| Adjusted combined ratio (non-GAAP) | 63.6% | 94.0% | 64.5% | 74.5% |
Gross written premiums rose 65.6% in Q3 and 60.4% year to date, reflecting policy growth, expanded products and distribution, new partnerships and retention. Net written premiums increased 98.6% in Q3 and 99.1% year to date. Residential earthquake was the largest product, representing 53.2% of year-to-date written premiums. California accounted for 55.7% and Texas 18.3% of year-to-date written premiums.
Q3 underwriting improved, with the combined ratio declining to 73.4%, while lower weather-related loss severity contributed to reduced claims; the prior-year quarter included a $5 million Hurricane Florence loss. Year-to-date GAAP results were weighed down by expenses, especially a $23.0 million stock-compensation charge from modifying the former parent’s management incentive plan. Total stock-based compensation was $23.7 million. The company’s adjusted measures exclude specified items and are non-GAAP.
Net investment income was $1.7 million in Q3 and $4.2 million year to date, up from $0.9 million and $2.2 million, respectively. Net realized and unrealized investment gains were $0.4 million in Q3 and $3.3 million year to date. The nine-month effective tax expense was $3.9 million; results reflect U.S. taxation following the March 2019 domestication, release of part of the federal deferred-tax valuation allowance, and a tax expense related to nondeductible stock compensation.
- Cash flow: Nine-month operating cash flow was $35.7 million, versus $15.8 million in 2018; investing cash flow was $(91.0) million and financing cash flow was $62.3 million. Ending cash, cash equivalents and restricted cash were $16.9 million.
- Balance sheet and liquidity: At September 30, total assets were $372.8 million and stockholders’ equity was $208.5 million, versus $231.1 million and $96.3 million at year-end 2018. Investments totaled $246.3 million. Management cited $263.2 million of cash and investment securities available and said it expected cash flows to meet liquidity needs for at least 12 months.
- Debt: No long-term debt remained at September 30. The $20.0 million floating-rate notes were redeemed in May 2019, with a $1.3 million charge for the redemption premium and unamortized issuance costs.
Material changes and unusual items
- The April 2019 IPO generated approximately $87.4 million in net proceeds and contributed to the increase in equity and investment assets.
- A one-time $5.1 million distribution was paid to the then-sole stockholder in March 2019.
- On September 30, selling stockholders completed a secondary offering of 6.04 million shares at $36.50 per share. Palomar received no proceeds and recorded $0.8 million of related transaction costs; incentive bonuses and offering-related costs also contributed to Q3 expenses.
- The company domesticated from a Cayman Islands holding company to a Delaware corporation in March 2019. Its Bermuda subsidiary’s income became subject to U.S. federal income tax in 2019.
- Available-for-sale fixed maturities had $7.4 million of net unrealized gains at September 30, compared with $0.7 million of net unrealized losses at December 31, 2018; the company reported no other-than-temporary impairment.
Outlook, commentary and risks
Palomar gave no specific numerical earnings or premium guidance. Management said it believed its business model and market opportunities could support profitable growth, and reported average monthly premium retention above 93% in residential earthquake and Hawaii hurricane and approximately 87% overall for the first nine months. It cautioned that interim results are not necessarily indicative of full-year results.
Management described reinsurance as central to limiting catastrophe exposure: stated retention was $5 million per earthquake or wind event, with earthquake coverage up to $1.05 billion, subject to customary exclusions. The filing also warns that catastrophe losses may exceed modeled expectations or reinsurance limits, and that reinsurers may fail to pay or pay late. Other material risks include reliance on California and Texas, distribution partners, reserve-estimation uncertainty, investment-market movements, regulatory constraints on subsidiary dividends, and dependence on key personnel. Management reported 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 and retention persist, particularly given geographic concentration and reliance on key program administrators.
- How catastrophe exposure, reinsurance renewals, recoverability and exclusions affect net losses under severe events.
- Whether reported profitability is sustainable after separating recurring operating results from the large incentive-plan compensation charge and other transaction-related expenses.
- How U.S. taxation, deferred-tax asset realizability and future tax expense affect earnings after domestication.
- Whether insurance-subsidiary capital, regulatory requirements and restrictions on dividends support holding-company liquidity and growth.