Palomar Holdings, Inc. — Q2 2022 Form 10-Q
Reporting period: Three and six months ended June 30, 2022; comparative periods ended June 30, 2021. Palomar is a specialty insurer focused on earthquake, hurricane, inland marine, flood and related products, and also writes fronting business.
Financial results and key metrics
| Metric | Q2 2022 | Q2 2021 | Six months 2022 | Six months 2021 |
|---|---|---|---|---|
| Gross written premiums | $218.7m | $129.4m | $389.6m | $232.9m |
| Net earned premiums | $80.3m | $54.2m | $156.3m | $101.3m |
| Total revenue | $79.7m | $57.7m | $157.8m | $107.0m |
| Income before taxes | $18.3m | $15.5m | $37.4m | $35.6m |
| Net income | $14.6m | $12.3m | $29.1m | $29.0m |
| Diluted EPS | $0.57 | $0.47 | $1.13 | $1.11 |
| Combined ratio | 75.1% | 76.0% | 75.8% | 68.7% |
Q2 underwriting income, a company-defined non-GAAP measure, increased 53.6% to $20.0m; adjusted net income rose 41.3% to $18.7m. For the first half, underwriting income increased 19.7% to $37.9m and adjusted net income rose 11.5% to $36.3m. GAAP total revenue includes investment results; it was reduced by net realized and unrealized investment losses of $4.7m in Q2 and $6.0m in the first half.
Q2 loss ratio was 17.9% versus 13.3%, while the expense ratio improved to 57.1% from 62.6%. For the first half, the loss ratio rose to 18.8% from 2.8%, and the combined ratio increased to 75.8% from 68.7%. The 2021 comparison benefited from favorable catastrophe-loss development; 2022 included higher attritional losses and adverse prior-year development.
Six-month operating cash flow was $82.8m, compared with cash used of $7.1m in 2021. Investing activities used $101.5m, primarily for net purchases of securities; financing provided $4.8m. Cash and restricted cash ended the period at $36.5m, down from $50.4m at year-end 2021.
At June 30, total assets were $1.051bn, total liabilities $673.1m and stockholders’ equity $378.1m, down from $394.2m at year-end. AOCI moved from positive $5.3m to negative $27.2m, principally reflecting unrealized fixed-maturity losses. Fixed maturities had $35.0m of gross unrealized losses, which management attributed primarily to interest rates rather than issuer credit quality; the company said it did not intend, and was not likely to be required, to sell them before recovery.
Debt included $23.0m of FHLB overnight borrowings at 1.67%; there were no borrowings under the separate $100m U.S. Bank revolving facility, which matures in 2026. The company reported compliance with debt covenants. Cash and investment securities available totaled $552.5m. Management said liquidity and expected cash sources were sufficient for the foreseeable future and liquidity requirements for at least the next 12 months and beyond.
Material changes and management commentary
- Gross written premiums grew 69.1% in Q2 and 67.3% in the first half, driven by new business, existing-partner production, retention, expanded distribution and new partnerships. Ceded premiums grew faster, reflecting fronting and quota-share cessions and greater reinsurance costs.
- Fronting premiums were $42.2m in Q2 and $72.0m for the first half; the fronting business launched in Q4 2021. Palomar writes the premium and cedes most of the premium and risk in exchange for a fronting fee. Management expects to continue fronting, while noting volumes can vary with partner timing.
- Palomar stopped writing Specialty Homeowners outside Texas and converted Texas business to a fronting arrangement effective June 1, 2022. Specialty Homeowners gross written premiums fell 27.4% in Q2 year over year.
- Investment income increased, but equity-market losses weighed on earnings. Higher interest rates also drove substantial unrealized losses on fixed-maturity securities through other comprehensive income.
- Palomar closed a $275m earthquake catastrophe bond effective June 1, 2022, in addition to a $400m bond effective in 2021. Reported catastrophe retention was $12.5m per event, with reinsurance protection up to $2.08bn for earthquakes and $900m for hurricanes.
- A.M. Best affirmed the subsidiaries’ “A−” financial strength ratings in June 2022. Management cited average monthly premium retention above 93% in certain earthquake and Hawaii Hurricane lines.
Outlook, risks and contingencies
The filing provides no specific earnings or premium guidance. Management cautioned that interim results are not necessarily indicative of full-year results. It identified catastrophe frequency and severity, reinsurance availability and collectability, reserve estimates, investment-market movements, inflation and construction costs, and business concentration in California and Texas as important risks. Reinsurance recoverables totaled $132.6m; Palomar remains primarily liable to policyholders if reinsurers fail to pay.
Management noted considerable uncertainty in loss and LAE reserves; changes to ultimate liabilities could materially affect equity. Prior-year development was adverse by $1.6m for the first half of 2022, compared with favorable development of $3.1m in the prior-year period. The company also identified pandemic-related economic and investment uncertainty, broker and program-administrator concentration, competition, and regulatory and operational risks. Ordinary-course legal proceedings were not expected to have a material adverse effect. Disclosure controls were assessed as effective, with no material change in internal control over financial reporting reported.
Important facts for investors to verify
- Whether premium growth, particularly fronting and E&S growth, translates into durable net earned premium and underwriting profitability after cessions and fees.
- How loss trends and reserve development evolve, including the effect of attritional claims, catastrophe exposure and prior-year estimates.
- Reinsurance renewal terms, counterparty credit quality, recoverable collection and the protection available relative to modeled catastrophe exposures.
- Whether investment valuations recover or further affect earnings, AOCI, capital and liquidity; distinguish equity-security losses in earnings from fixed-maturity losses in AOCI.
- Liquidity and capital effects of the $23m FHLB borrowing, share repurchases, and any constraints on distributions from regulated subsidiaries. The $100m repurchase program had $79.7m remaining at June 30, 2022.