Palomar Holdings, Inc. — Q2 2020 Form 10-Q
Reporting period: Three and six months ended June 30, 2020; comparisons are with the same 2019 periods. Amounts are in U.S. dollars. The filing was signed August 5, 2020.
Business context
Palomar is a specialty property insurer focused primarily on earthquake, wind and flood coverage for individuals and businesses. It distributes through agents, program administrators, brokers and insurance-company partners, and uses reinsurance to manage catastrophe exposure. It reported one business segment.
Financial performance
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Total revenue | $43.1 million | $25.9 million | $81.2 million | $48.2 million |
| Net earned premiums | $39.3 million | $23.2 million | $74.1 million | $41.6 million |
| Gross written premiums | $83.8 million | $58.3 million | $155.3 million | $112.4 million |
| Net income (loss) | $12.0 million | $6.7 million | $23.8 million | ($7.7 million) |
| Diluted EPS | $0.48 | $0.30 | $0.95 | ($0.40) |
| Net investment income | $2.1 million | $1.5 million | $4.1 million | $2.4 million |
Q2 underwriting income, a company-defined non-GAAP measure, was $12.4 million versus $7.2 million; six-month underwriting income was $25.1 million versus a $10.1 million loss. GAAP combined ratios were 68.4% for Q2 versus 69.2%, and 66.1% for the half year versus 124.2%. Adjusted combined ratios were 65.1% and 63.4%, respectively, versus 63.8% and 65.1%. A ratio below 100% generally indicates underwriting profit.
Premium growth reflected more policies through existing and new partners, strong retention and expanded distribution. Commercial All Risk, Commercial Earthquake and Specialty Homeowners grew notably. Ceded premiums rose more slowly than gross premiums; ceded written premiums were 36.0% of gross in Q2 versus 42.2% and 38.4% for the half versus 45.1%, reflecting lower quota-share cessions in certain lines and increased retention.
Balance sheet, liquidity and capital
- At June 30, 2020, total assets were $584.1 million, including $109.3 million cash and cash equivalents and $320.5 million investments. Total liabilities were $208.8 million and stockholders’ equity was $375.2 million, compared with $395.5 million, $176.9 million and $218.6 million, respectively, at December 31, 2019.
- Cash, cash equivalents and restricted cash increased to $109.9 million from $33.3 million at year-end. First-half operating cash flow was $24.5 million, investing cash flow was negative $75.1 million and financing cash flow was positive $127.2 million.
- The company had no debt at June 30, 2020; its $20 million floating-rate notes were redeemed in May 2019. Management said liquidity was sufficient for the foreseeable future and expected cash flows to meet requirements for at least 12 months.
- Equity increased substantially, primarily from net income, unrealized investment gains and two 2020 stock offerings: $35.5 million net proceeds in January and $90.2 million in June. Shares outstanding were 25,468,321 at June 30.
- Available-for-sale fixed maturities had fair value of $282.9 million and unrealized net gains of $12.0 million at quarter-end. The portfolio’s weighted-average effective duration was 4.00 years, average rating was A1/A+, and book yield was 2.83%.
Material changes, outlook and risks
- For the six months, net income improved from a prior-year loss. The prior-year period included $23.0 million of stock-based compensation from modifying the former management incentive plan, as well as debt-retirement costs and unusual tax effects. In Q2 2020, other underwriting expenses included $399,000 of catastrophe-bond-related expense.
- Palomar capitalized and received regulatory approval for surplus-lines subsidiary PESIC, with approximately $100 million of initial surplus. It intended to begin writing mainly Commercial Earthquake and Commercial All Risk nationally in the second half of 2020. July 2020 brought an A.M. Best A- rating for PESIC; PSIC’s A- rating was affirmed in April.
- Effective June 1, reinsurance coverage extended to $1.4 billion for earthquake and $600 million for hurricane events, with a stated $10 million catastrophe retention and $3 million vertical co-participation in selected layers. Management reported adding approximately $200 million of California earthquake, $300 million of all-zone earthquake and $80 million of windstorm limits in Q2. Reinsurance does not remove Palomar’s primary liability to policyholders, and recoveries depend on reinsurer performance.
- COVID-19 created uncertainty around premium collections, demand, investment values and business-interruption claims. The company reported more business-interruption claims, while stating its all-risk policies included an ISO virus exclusion and its DIC policies required physical damage from covered perils. It was assessing claims individually and had implemented premium grace periods. Management said it had not seen a significant reduction in premium growth through the reporting period.
- Other key risks include catastrophe frequency and severity, model uncertainty, reserve estimation, investment and credit-market volatility, reinsurance availability and collectability, concentration in California and Texas, and dependence on distribution partners. The company reported favorable prior-year reserve development of $0.22 million for the first half, but adverse development of $0.09 million in Q2; management cautioned reserve variability could materially affect equity.
- The filing provides no formal earnings or premium guidance. Management noted interim results are not necessarily indicative of full-year results. It expected to become a large accelerated filer at year-end 2020 and cease emerging-growth-company status.
Most important facts for investors to verify
- Whether premium growth and retention persist, particularly as the business mix shifts toward lines where Palomar retains more risk.
- Whether loss experience, reserves and reinsurance recoverables remain consistent with assumptions; review catastrophe exposure, treaty exclusions, limits and counterparty credit.
- How COVID-related business-interruption claims, premium grace periods and any legal or regulatory developments affect claims, collections and underwriting results.
- Whether PESIC launches as planned and scales profitably, and whether the $100 million initial surplus and regulatory capital remain adequate.
- Investment portfolio sensitivity to credit spreads, interest rates and distressed industries, alongside the contribution of investment gains to reported results.
- Effects of the 2020 stock offerings and higher share count on per-share results; distinguish GAAP results from management’s non-GAAP adjusted measures.