Palomar Holdings, Inc. quarterly report, Q1 FY2019

Palomar Holdings, Inc. — Q1 2019 Form 10-Q

Reporting period: Three months ended March 31, 2019; comparative period is Q1 2018. Palomar is a specialty property insurer focused primarily on earthquake, wind and flood coverage. The company completed its IPO on April 22, 2019, after quarter-end.

Financial performance and key metrics

Metric	Q1 2019	Q1 2018
Gross written premiums	$54.0 million	$34.0 million
Net written premiums	$27.9 million	$20.3 million
Net earned premiums	$18.4 million	$18.0 million
Total revenue	$22.3 million	$18.5 million
Net investment income	$1.0 million	$0.6 million
Net investment gains (losses)	$2.4 million	($0.6 million)
Net income (loss)	($14.4 million)	$5.6 million
Diluted EPS	($0.85)	$0.33
Operating cash flow	$2.5 million	$8.4 million

• Gross written premiums grew 58.8%, led by residential earthquake and commercial all-risk business. Ceded premiums rose 89.7%; ceded premiums were 48.3% of gross written premiums versus 40.4% a year earlier. Consequently, net earned premiums grew only 2.0%.
• The reported loss ratio was 1.7%, expense ratio 192.1%, and combined ratio 193.8%, compared with 5.2%, 61.5%, and 66.7%, respectively, in Q1 2018. The expense increase chiefly reflects a $23.0 million stock-compensation charge; excluding specified IPO, tax-restructuring and incentive-plan expenses, the company reported adjusted net income of $8.8 million and an adjusted combined ratio of 66.7%. These are non-GAAP measures.
• At March 31, 2019, total assets were $246.2 million, total liabilities $144.3 million, and stockholders’ equity $101.9 million. Cash and cash equivalents were $10.5 million; including restricted cash, cash totaled $10.9 million. Investments were $148.7 million, and premium receivable was $24.3 million.
• Long-term notes had a $19.1 million balance-sheet carrying value; the notes’ principal was $20.0 million. Interest expense was $0.4 million. The company reported compliance with debt covenants.
• Invested assets included $126.9 million of available-for-sale fixed maturities and $21.8 million of equity securities. Fixed maturities had a 3.93-year weighted-average effective duration, 3.1% book yield and average rating of Aa3/A+. Net unrealized gains on available-for-sale securities lifted accumulated other comprehensive income by $2.2 million during the quarter.
• Cash increased $1.0 million in the quarter. Investing activities provided $3.6 million, while financing activities used $5.1 million for a one-time distribution to the then-sole stockholder.

Material changes and unusual items

• Other underwriting expenses rose to $28.9 million from $3.8 million, primarily because modification of the former parent’s management incentive plan accelerated vesting and triggered a $23.0 million stock-compensation charge. The charge was noncash and increased additional paid-in capital.
• In March 2019, Palomar domesticated from a Cayman Islands holding company to a Delaware corporation. The change brought Bermuda subsidiary income into the U.S. tax regime. Management released $1.7 million of federal deferred-tax valuation allowance, citing projected taxable income and the domestication; a $4.8 million tax expense related to nondeductible stock compensation offset that benefit in the tax reconciliation. Reported Q1 tax expense was $0.1 million.
• Prior-year reserve development was unfavorable by $0.04 million in Q1 2019, mainly from a Hurricane Michael claim, partly offset by favorable Texas homeowners development. The filing cautions that reserve estimates are inherently variable and could materially affect equity.
• After quarter-end, the IPO issued 6,468,750 shares at $15.00 each and generated approximately $86.7 million in net proceeds. The filing reports 23,468,750 shares outstanding at May 15, 2019.
• After quarter-end, Palomar gave notice to redeem its $20.0 million floating-rate notes on May 23, 2019. The stated payment is $20.7 million, including accrued interest; the company expected a $1.3 million charge for the redemption premium and write-off of unamortized issuance costs.

Outlook, liquidity and principal risks

Management gave no specific earnings or premium guidance. It described the business as positioned for profitable growth, citing product and geographic expansion, partnerships and premium retention. Management said available cash receipts, investment sales and reinsurance recoveries should meet foreseeable needs, and believed cash flows would satisfy liquidity requirements for at least the next 12 months. It cited $159.2 million of cash and investment securities available at March 31, 2019. The filing cautions that Q1 results are not necessarily indicative of full-year results.

• Catastrophe frequency and severity, climate and weather uncertainty, model limitations, and concentrations in California and Texas could drive losses, volatility and capital needs.
• Reinsurance reduces exposure but does not remove Palomar’s primary obligation to policyholders. Reinsurer nonpayment, coverage disputes, higher costs or reduced availability could increase net losses; stated retention was $5 million per earthquake or wind event, with earthquake coverage up to $850 million, subject to exclusions.
• Insurance regulation restricts subsidiary dividends. The U.S. insurance subsidiary could not pay a dividend to the holding company in 2019 without regulatory approval because of negative earned surplus at December 31, 2018. The filing also notes limits on access to subsidiary capital and the effects of regulation on solvency and liquidity.
• Other disclosed risks include investment market and credit risk, reliance on distribution partners, competition, operational and cyber risks, claims and reserve uncertainty, and public-company compliance costs. The company reported effective disclosure controls; 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 growth given rising ceded premiums and reinsurance costs.
• Underlying expense and underwriting performance after separating the one-time incentive-plan charge and other adjustments from GAAP results.
• Reserve adequacy, catastrophe exposure, and the collectability and continuing cost and availability of reinsurance.
• Post-IPO capitalization, actual use of IPO proceeds, and completion and accounting impact of the announced debt redemption.
• Realizability of deferred tax assets and the effects of U.S. taxation following domestication, as well as regulatory limits on cash distributions from insurance subsidiaries.