Q3 2022 Palomar Holdings Inc Earnings Call
Good morning, and welcome to the Palomar Holdings, Inc. Third quarter 2022 earnings conference call.
During todays presentation, all parties will be in a listen only mode.
Following the presentation. The conference line will be opened for questions with instructions to follow at that time.
As a reminder, this conference is being recorded.
I would now like to turn the call over to Mr. Chris Your Cheetah Chief Financial Financial Officer. Please go ahead Sir.
Thank you operator, and good morning, everyone. We appreciate your participation in our third quarter 2022 earnings call with me here today is Mac Armstrong, our chairman and Chief Executive Officer.
As a reminder, a telephonic replay of this call will be available on the Investor Relations section of our website through 11 59 P. M. Eastern time on November 10th 2022.
Before we begin let me remind everyone that this call may contain certain statements that constitute forward looking statements within the meaning of the private Securities Litigation Reform Act of 1995.
These include remarks about management's future expectations beliefs estimates plans and prospects.
Such statements are subject to a variety of risks uncertainties and other factors that could cause actual results to differ materially from those indicated or implied by such statements, including but not limited to risks and uncertainties related to the COVID-19 pandemic such risks and other factors are set forth in our quarterly report on Form 10-Q.
You filed with the Securities and Exchange Commission, we do not undertake any duty to update such forward looking statements. Additionally, during today's call. We will discuss certain non-GAAP measures, which we believe are useful in evaluating our performance. The presentation of this additional information should not be considered in isolation or as a substitute.
For results prepared in accordance with U S. GAAP a reconciliation.
The Asian of these non-GAAP measures to their most comparable GAAP measure can be found in our earnings release at this point I'll turn the call over to Max.
Yes.
Thank you, Chris and good morning, everyone.
I'm very proud of our third quarter results as they are further testament to our commitment to profitable growth in our execution of Palomar to ask our intermediate term strategic plan of doubling our adjusted underwriting income, while achieving a 20% adjusted return on equity.
We grew the gross written premium of the business, 66% highlighted by sustained earthquake growth and incremental progress on newer lines of business, such as inland Marine and casualty.
We made incremental traction in our nascent Palomar front in excess property franchises amongst others, we added new talent throughout the organization and the underwriting actuarial and technology Department.
The most significant even with a full retention loss from hurricane Ian a major catastrophe that severely impacted our entire industry.
We generated adjusted combined ratio of approximately 90% as well as an adjusted ROE of 10%, when adding back realized and unrealized gains and losses from our investment portfolio.
We further validated the resilience in our model as adjusted net income grew over 328% year over year again with the fall event retention loss.
Taken together our continued strong momentum through the third quarter provides a clear line of sight to doubling our adjusted underwriting income and in an intermediate fashion and at a pace that has accelerated from where the concept was first introduced in June of this year.
Turning to our financial results and strategic priorities in more detail during the quarter. We made strong progress executing on all four components of our 2022 strategic plan.
Okay.
Our first priority is focused on generating strong and profitable premium growth, which we accomplished once again this quarter, having increased gross written premiums 66% to $253 1 million.
Our earthquake business grew 19% led by strength in our residential earthquake products, which continues to benefit from our marketing and product development efforts combined with the dislocation in the California homeowners market.
There's healthy dynamic is best exemplified by the fact that third quarter of 2022 like the first and second quarters of the year saw record quarterly new business sales.
Importantly, the market opportunities related to the proposed changes to the California earthquake authority, whether it be coverage offerings or reduction in claims paying capacity have yet to come to fruition and as such are not provided meaningful growth catalysts for Palomar products.
Yeah.
We remain excited at the prospects for the residential earthquake market ended the year ahead.
California, we continue to broaden our residential earthquake partnerships like whether it be through the addition of three new states to our travelers partnership or the addition of a new relationship that will increase our presence in Utah at the start of 2023.
While these smaller market opportunities. These partnerships will be additive to growth in the year ahead.
Our commercial earthquake business continue to grow through a combination of exposure growth and rate increase while improving its underlying metrics through enhanced terms and conditions.
<unk>, it's an inter quarter rate increased acceleration to levels above, 10%, which more than offset loss cost increases tied to our June 1st reinsurance renewal.
We believe the impact of Hurricane Ian most notably capacity constraints in the broader U S property insurance market will impact the commercial earthquake market and therefore provide the opportunity for further rate increases and portfolio optimization in the fourth quarter of 2022 and into 2023.
Beyond our earthquake franchise, we achieved strong growth across our entire portfolio of products highlighted by our inland marine products, which grew 58% year over year and our commercial all risk products, which grew 34% year over year with nearly all of the growth due to rate increases and portfolio optimization as opposed to exposure.
The in the Marine Department continues to perform very well across multiple segments, including both commercial and residential builders risk and motor truck cargo.
Additionally, our newly launched casualty franchise grew 350% year over year.
Our real estate you know in miscellaneous professional liability segments, our standout performers as they continue to add conservatively underwritten low volatility rest of the portfolio.
Overall, we encourage with the launch and ramp of our casualty business and the traction that our team is achieving.
Palomar front. It was also a significant contributor generating 32% of our premium this quarter.
I'll discuss Palomar front in a bit more detail when reviewing some of our new initiatives later in the call.
Combination of our growth in commercial lines, whether it be earthquake builder's risk or select casualty segments Palomar Friday.
Helped drive considerable growth and Palomar excess and surplus insurance company, our E&S business Pathic increased its gross written premiums of 181% year over year to $163 million as compared to the third quarter of 2022.
The accelerating growth in our non catastrophe exposed lines of business, whether it be casualty or Palomar fun.
Provide diversification and business mix and business model.
Through fee income across our portfolio and ultimately will lead to further predictability in our earnings base.
As such their success and our execution toward their success are key elements of our second strategic priority.
Monetizing the capital investments we made in 2021.
During the third quarter Palomar front recorded $82 2 million of gross written premium, which I. Previously stated was 33% of total gross written premium in the quarter.
Okay.
We have ramped our Palomar front.
Business very quickly since launching it in the fourth quarter of 2021.
The business line has already generated premiums of $154 million year to date, which is at the high end of our previously updated guidance range of $130 million to a $160 million of managed premiums for the full year.
As a reminder, our updated guidance range includes our Texas homeowners business, which adds approximately $45 million of fee generating premium to the base.
Based on the year to date results and the overall strong performance of Palomar front, we believe we can achieve $180 million to $200 million for the full year.
The growth in managed premium from Palomar front offers an attractive run rate of fee income as we moved into 2023.
As well as a modicum of underwriting income for the two programs, where we retain a small amount of risk.
Importantly, as we continue to expand through Palomar front, we remain disciplined through our conservative underwriting and collateral requirements to mitigate risk.
I've already mentioned the solid performance of our new casualty lines in the quarter, but I'd also like Yoko success of our excess property division.
This line of business is led by a terrific experienced underwriter and <unk>.
And it concentrates on writing excess property business risk and non catastrophe exposed regions.
Well, it's off a small base, we are pleased to see the premium triple sequentially.
As the North American property market remains dislocated, we expect this line of business to do quite well.
Progress in the outperformance of our new initiatives has put us in a position where we believe we are meaningfully ahead of our Palomar to X intermediate plan.
Even if the growth may push our attritional loss ratio slightly up.
The fee income generated by our fronting business has a meaningful lever of stability.
That we've created in our portfolio to generate predictable earnings which is not only a core principle of Palomar to act, but also our third strategic priority delivering consistent and predictable earnings.
Over the last few years, we've put into place multiple underwriting portfolio management and risk transfer programs to reduce volatility and enhance our risk adjusted returns.
These efforts were most pronounced without and impacted our results relative to the insurance industry broadly.
Over the last few years, we have considerably reduced our continental hurricane exposure as such our gross in ultimate loss from Hurricane Ian should under indexed the industry due to the underwriting portfolio management actions taken since 2020.
Our exposure was limited to a commercial property products that are national scope with an emphasis on layered in shared accounts with limited geographic concentration.
While a full retention loss of $12 5 million is not ideal and find some source that we have an adjusted ROE.
When excluding the impact of unrealized gains and losses of 10% for the quarter at approximately 17% year to date.
The diversification and profitable growth from lines of business without kind of a hurricane risk is now providing a considerable earnings base that enables us to have an adjusted combined ratio of 90% and adjusted ROE, excluding unrealized and realized gains and losses of 10% in a quarter, where we incur a full retention loss.
This favorably compares to the third quarter of 2021 and catastrophe losses led to an adjusted combined ratio of 100% and adjusted ROE, excluding realized and unrealized gains and losses of 2%.
Additionally, we are continually improving our underwriting and risk management controls to ensure that we are in an appropriate risk adjusted return for the higher volatility businesses that we continue to write.
This approach will result in further adjustments as the market the reinsurance market, especially absorbs the impact of Hurricane Dorian.
Our fourth strategic priority is scaling the organization, where we have invested in technology and infrastructure that provides a dynamic platform.
For product innovation as well as new business development.
This is very attractive to experienced underwriters, who would like to build a new business as can be seen in our newer lines of business like builders rescue in the marine and professional liability and excess property.
During the quarter, we bolstered our underwriting ranks.
Each of these product lines with the hiring of several industry veterans with proven track Records. We also to continue to attract analytics technology and actuarial professionals to the team.
Before we dive into the financials I'd like to offer a bit of commentary on the market and particularly the property segment, which has entered a new stage of dislocation due to hurricane Ian.
The hardware reinsurance market persists continued rate increases combined with improved terms and conditions will require renewals to cover any increase in loss costs at a minimum.
As it relates to our current cotton hurricane exposure, we've already reduced our PMA all by more than 60% over the last few years and still have some exposure in run off what we are left with is a national focus portfolio property risks with wind exposure. That's on average rate in excess of 30% in the third quarter and that was prior to and making landfall.
The storm along with other factors such as inflation bond portfolio losses in other industry losses will result in a significant capacity reduction for not just Florida, but throughout the southeast.
If the magnitude of the capacity pullback will be difficult to assess until the January one reinsurance renewals complete but our expectation is that rates for south East and Florida wind will move up commensurately for inflation reinsurance cost and supply.
The capacity, we commit to our E&S commercial all risk business, we'll take advantage of the market in a disciplined fashion with a refreshed risk adjusted return target.
Counts don't hit those thresholds, where five pulling back because we have numerous growth vectors.
As I mentioned earlier, we believe the commercial earthquake market. We'll also see a level of dislocation, albeit not like that of Florida and the rest of the southeast.
The 10% rate increase we saw at the end of the third quarter will increase in the fourth quarter and into 2023.
In terms of conditions, whether it be deductibles or attachments should also improve property capacity is going to be a scarce commodity in 2023, and we will judiciously use it in the primary market.
As it pertains to reinsurance we renewed our program at June 1st with pricing higher by 9% on a risk adjusted basis.
We do not have excess of loss treaties renew a January one.
Our expectation is that post in the hard reinsurance market will indeed persist.
In that backdrop informs our approach and maintain our growth and profitability targets in the year ahead.
It is imperative for all of our property products E&S and admitted commercial and residential to cover their loss costs through a combination of rate increase inflation guard, our terms and conditions.
Importantly, it is worth reiterating that we were already reducing our exposure to continental U S Hurricane and other secondary pair off before the store.
And our core earthquake business is a unique line of business for reinsurers given its non correlated risk.
We think the confluence of those factors along with a large private bank. We have built up with our reinsurance panel will help us navigate this cycle.
Yeah.
Turning to capital allocation, despite the cat losses that impacted our results this quarter remain well capitalized.
And in a healthy position to fund future growth as well as opportunistically repurchase shares.
During the quarter, we bought over 52000 shares at a total cost of $3 million.
To conclude this quarter demonstrated further execution of the Palomar to X strategic plan.
We meaningfully grew written premium we saw considerable progress and new products that add diversification vacation.
It is based on portfolio.
And we demonstrated the resiliency of our model is a full event retention did not preclude us from generating compelling return on equity.
While the quarter's losses were elevated we are encouraged by two factors, 129% of the loss in the quarter were from lines that are in run off for being restructured into a good portion of the quarterly loss was driven by product written premium outperformance and inline target rate loss ratios.
Chris will provide more detail on both of these items.
For the full year, we now expect to generate adjusted net income between $82 million and 85 million a 48% increase from 2021.
This range includes additional reinsurance expense related resulting from hurricane in incurred in the fourth quarter and excludes catastrophes in unrealized and realized gains and losses.
With that I'll turn the call over to Chris to discuss our results in more detail.
Thank you Mac. Please note that during my portion when referring to any per share figure I'm, referring to per diluted common share as calculated using the treasury stock method. This methodology requires us to include common share equivalents, such as outstanding stock options during profitable periods and exclude them in periods. When we incur a net loss we have adjusted the calculations.
Certainly.
For the third quarter of 2022, our net income was $4 $3 million or <unk> 17 per share compared to net income of $2 million or <unk> 10 per share for the same quarter in 2021, our adjusted net income was $7 $4 million or 29 cents per share compared to adjusted net income of $1 <unk>.
$7 million or <unk> <unk> per share for the same quarter of 2020 towards 2021.
Our adjusted net income, excluding net realized and unrealized losses was $9 2 million or <unk> 36 per share compared to $2 million or <unk> <unk> per share last year.
Gross written premiums for the third quarter were $253 1 million, an increase of 66, 2% compared to the prior year's third quarter, Arkansas.
Our consistent strong growth was driven by a combination of favorable rate acceleration and an increases in volume across our products.
Ceded written premiums for the third quarter were $161 9 million, representing an increase of 178, 8% compared to the prior year's third quarter. This increase was primarily due to quota share reinsurance driven by the growth of our fronting business lines of business subject to attritional losses, and additional excess of loss reinsurance.
To facilitate growth and the impact from Hurricane Ian.
Ceded written premiums as a percentage of gross written premiums increased to 64% for the three months ended September 32022 from 38, 1% for the three months ended September 32021.
As anticipated our fronting business was the primary catalyst for this of this increase slightly offset by a decrease in the ex oil percentage compared to last year.
Net earned premiums for the third quarter were $77 $9 million, an increase of 24% compared to the prior year's third quarter. This increase is due to the growth in earning of higher gross written premiums offset by the growth in earning of higher ceded written premiums in our reinsurance agreements for the third quarter of 2022 net earned premiums as a percentage of gross earned premiums were.
<unk> 41, 7% compared to 55, 2% in the third quarter of 2021 and compared sequentially to 58% in the second quarter of 2022.
As a reminder, we have indicated that the expected growth of our fronting business would push this ratio below 50% on an annual basis, especially with the transition of our Texas, especially homeowners book to our fronting model.
It will add consistent fee income that will enhance our ROE and bottom line.
Year to date, our net earned premiums as a percentage of gross earned premiums ratio was 48, 4% in line with our expectations based on the strong performance of our fee based printing business.
Losses and loss adjustment expenses incurred for the third quarter were $30 9 million made up of Attritional losses of $18 $4 million and $12 $5 million of the catastrophe losses from hurricane in the.
The loss ratio for the quarter was 39, 6% comprised of an attritional loss ratio of 23, 6% and our catastrophe loss ratio of 16%.
Approximately $5 3 million or 29% of your Attritional losses for the quarter were from lines of business in runoff or restructured.
Additionally, these lines of business exceeded their plan losses for the quarter by about $2 million that in conjunction with the success of lines of business key to Palomar to X were the primary contributors to the elevated losses and loss ratio for the quarter. The results for the quarter a firm our decision to exit or restructure certain lines and focus.
On business essential to Paolo about UX.
Considering those factors, we believe the loss ratio for the year will be between 20 and 21%.
Our expense ratio for the third quarter of 2022 was 55, 1% compared to 58, 8% in the third quarter of 2021 on adjusted basis, our expense ratio was 57% for the quarter compared to 56, 3% in the third quarter of 2021 and compared to 51, 2% sequential.
In the second quarter of 2022.
Our acquisition expense as a percentage of gross earned premiums for the third quarter of 2022 was 14, 6% compared to 22, 5% in the third quarter of 2021 and compared to 18, 1% sequentially in the second quarter of 2022. The improvement was driven by additional ceding commission or fronting fees from our new fronting.
That are netted within acquisition expense and overall changes in our mix of business the ratio of our other underwriting expenses, excluding adjustments to gross earned premiums for the third quarter of 2022 was seven 3% compared to nine 4% in the third quarter of 2021 and compared to eight 5% in the second quarter of 2020.
Two.
Our combined ratio for the third quarter was 94, 8% compared to 102, 8% in the third quarter of 2021.
Our adjusted combined ratio was 93% for the third quarter compared to 102% in the third quarter of 2021.
As a brief reminder, in concert with our Palomar to X strategy, we introduced the metric of adjusted underwriting income we calculate adjusted underwriting income Similarly to adjusted combined ratio, we start with underwriting income and back out the adjustments that may not be indicative of our underlying business trends operating results our future outlook.
We believe that the adjusted underwriting income is the most comparable financial metric for evaluating Palomar to UX, our third quarter adjusted adjusted underwriting income was $7 $5 million.
Compared to a loss of <unk> $2 million last year.
Our year to date adjusted underwriting income was $53 6 million compared to $36 million last year growth of 48, 7%.
Net interest net investment income for the third quarter was $3 $7 million, an increase of 67, 4% compared to the prior year's third quarter.
The year over year increase was primarily due to higher average balance of investments held during the three months ended September 32022 did your cash generated from operations and by slightly higher yields on investments.
Our fixed income investment portfolio book yield during the third quarter was $2 eight 3% compared to $2 one 9% in the third quarter of 2021, our book yield on investments made during the third quarter was above four 5% trending higher at the end of the quarter.
The weighted average duration of our fixed maturity investment portfolio, including cash equivalents was 4.0 to three years at the end of the quarter cash.
Cash and invested assets totaled $541 $8 million as compared to $467 million at September 32021.
For the quarter, we recognized realized and unrealized losses on investments of $2 4 million as compared to realized and unrealized losses and zero point $3 million in the prior year's third quarter.
Crucible of gains and losses, we do expect our investment portfolio yield to improve in the foreseeable quarters based on the current market conditions.
Our effective tax rate for the third quarter was 17, 5% compared to negative 101, 6% for the third quarter of 2021.
For the third quarter of 2022, the tax rate differed from the statutory rate due to the impact of the permanent component of employee stock option exercises.
During the quarter, we purchased 52185 shares for a total of $3 million under the previously announced two year $100 million share repurchase program.
We have approximately $76 $7 million remaining under the authorized program.
We will continue to take an opportunistic approach to share repurchases under this program when we view our stock trading at a discounted valuation we remain focused on investing in and supporting the growth of our business lines as we strive to progress and execute on the framework provided to deliver Palomar two weeks or.
Our stockholders' equity was $367 8 million at September 32022.
Inclusive of the share buyback and realized and unrealized changes to our investment portfolio compared to $394 2 million at December 31, 2021.
For the third quarter of 2022 annualized return on equity was four 6% compared to 3% for the same period last year.
Our annualized adjusted return on equity equity was seven 9% compared to one 8% from the same period last year.
We remain confident in our strategy strategy to achieve long term growth with sustainable and predictable earnings even with a full retention catastrophe loss our year to date adjusted ROE was 15, 3% and approximately 17%, excluding net realized and unrealized losses for the year.
For the full year of 2022, we are providing adjusted net income guidance range of $82 million to $85 million, including additional reinsurance expenses, resulting from hurricane Ian and excluding catastrophes, and unrealized and realized gains and losses.
With that I'd like to ask the operator to open the line for any questions operator.
Okay.
Thank you at this time, we'll be conducting a question and answer session.
If you would like to ask a question. Please press star one on your telephone keypad.
A confirmation tone will indicate your line is in the question queue.
You May press Star two if you would like to remove your question from the queue.
For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys.
One moment, please while we poll for questions.
Our first question today is from Mark Hughes of Truest. Please proceed with your question.
Yeah. Thank you good morning, and good afternoon.
Great.
Specialty homeowners business, you wrote 14 million in TQ and zero and re queue.
What impact would that have on our end.
Yeah, Michael Great question, when you think about it from a gross earned standpoint, obviously the impact was minimal right, let's let's talk about the specialty homeowners book, just a little bit there's two pieces of that there's the Texas portion that we have put into a full fronting model effective six one of this year. There is the non text, especially homeowners that is.
And run off obviously, we did not write any more business in Q3, the Texas business is now in the fronting model already is on our funding model. So generating a consistent fee income, but that move obviously has moved the written premium out of especially the homeowners line and we've now included in the fronting line from a net.
And then just standpoint, obviously there is an impact there was some of that impact was felt in Q2, but there was only one month of that impact.
Third quarter is the first full quarter, where you see the full impact of that net earned especially from the Texas, especially homeowners book being moved to the fronting model. When you think about that from a headwind standpoint, that's probably $3 million to $4 million.
Ceded earned premium that is now.
Moved out of the net earned premium because that is in the fronting model. Obviously, we do receive receive a little bit of benefit of that in the losses, but also you see that in the acquisition expense, but when youre thinking about the top line the revenue line or the net earned premium yes. There is a little headwind from that but that's as expected moving that and also obviously to get that.
Fee income.
Thanks for that you I think your guidance for the non cat.
Loss ratio for the full year was 20% to 21%.
How do you see the trajectory of that as we think about the <unk>.
Emerging through the development of the 2.0, you know what is what do we think about next year specifically.
No. It's a good question obviously the loss ratio for the quarter was higher than we would like to see it.
Some of that is due to the strong growth of our lines of business are key to Palomar <unk>, whether it be inland marine casualty those grew faster than we expected definitely faster than we expected when we presented Palomar to accident at Investor Day. So we're happy about that and that was taken into the thesis when we've said all along that.
The loss ratio was going to continue to tick up because of the growth in some of these lines and the overall change in the mix of business and it's also relevant when we talk about the lines of business that we're running off of those lines of business, obviously contributed a little bit more than we would have liked this quarter those lines will mostly be run off in the first.
Half of next year, but let's call it mostly fully run off by the end of next year. So there is still some of that is going to be running through there. We still expect from a mixed standpoint, but the loss ratio will continue to tick up but when you think about it a little bit longer term or intermediate term and you think about it in 2024 or 2025, when you think about the.
<unk> bottle and what we presented.
So assuming quota shares the same mix of business is the same as we presented we would expect that loss ratio to continue to go down from where it was so yes. It could go up too.
324% in the more near term, but I do expect over the more intermediate term of let's call. It two to three years, what that loss ratio will continue to tick down as the mix of business improves some of those lines of business are fully run off and we get a little more consistent.
Earnings and predictable earnings from some of the casualty lines, but also some of the lines subject to you our attritional quota share. So overall I expect it to improve but there is going to be a little bit of increase and then a decrease let's call. It hopefully, we'll see that starting to come up.
End of next year, but early in 2024, Mark This is Matt what I would add is that it.
Those lines.
Whether it's casualty or in the marine did outpaced the growth and that's a positive thing for us, but like Chris said that means that you pulled forward a little bit the timing on the attritional loss ratio ticking up so net net we are accelerating the pace of Palomar works because of the performance of both fee generative business.
And Palomar Friday and those lines.
That are expected to grow at a quicker rate than.
Stork, all binary lines like Hawaii and earthquake.
So that is a positive in the sense that I think that it will allow us to get to the inflection point, where the loss ratio does start to tick down at a quicker.
[noise] pace than initially forecast so that is something that I'm actually encouraged by.
Mac you say a proposed changes with the.
California earthquake authority have not yet been a catalyst.
Quake business can you.
Elaborate on that why not and when if they if they are going to be a catalyst.
Yeah, I I see share market and that's a good question as well I think ultimately you know.
The California earthquake authority has not come to a conclusive decision on the majority of the changes that they're wrestling with they have another a governing body meeting in.
In December and the topics on the table include a reduction in coverages, especially the non structure limits. There's also discussion of them potentially going back to the traditional many policy. So.
The changes in coverage there continues to be a little bit of a kicking the can down the line.
<unk> allows us to market against this but it doesn't drive something conclusive, but there would be from the participating insurers that are members of the <unk> or some of our distribution partners. They still have business that they send out there, especially something that's a more full coverage policy.
Secondly, as it relates to the reduction in claims paying capacity. They have stated that they are buying less reinsurance.
It's to the tune of $1 billion to 1 billion three that's just going to come up as it did as it renews and so that's the dynamic that we actually look.
Opportunistically upon is there might be limit that can be redeployed to our program that allows us.
To grow.
Efficiently from a reinsurance standpoint and support the growth in the premium base.
And frankly, it will allow reinsurers to get I participation.
More attractive in a better returning book of business. So.
What I would say is the coverages, it's fluid I would expect something will shake out over the course of 'twenty three the reinsurance and claims paying capacity, which is a catalyst for the participating insurers as well as us as a buyer of reinsurance that will take course over the course of the year as their program or news and they've been a lot of different treaty dates.
I appreciate it thank you.
The next question is from David Maiden of Evercore ISI. Please proceed with your question.
Hi, Thanks.
Good afternoon, or good morning for you guys.
Just start.
Question on <unk>.
How we should think about the reinsurance costs I know you guys. When you a lot of your well I think the aggregate renews on four one and the the rest of the program or news on six one next year.
Obviously hearing about the dislocation I think you guys had a 9% increase last year in your reinsurance costs.
So I guess I'm wondering it's two part question what are you guys expecting for your reinsurance cost increase this year just given everything that's happened in the market.
And second part do you think you'll be able to increase your pricing on a consolidated basis.
Considering the residential earthquake book as well will you be able to increase your price.
By enough to offset the cost of reinsurance.
Hey, Dave Yeah. This is Mac.
That's a good question and it's something that we are you know.
Very focused on and taking stock of this reinsurance market, we've actually been in Bermuda with and we get down to Bermuda and get to London cut on and off cycle basis, just to catch up and give people a holistic view of all of the Palomar is doing and it has afforded us the chance to get a sense of this market I mean, it is a desk.
Located market and there is pull back.
From reinsurers or are retrenching of their property cat appetite I think it's important though for us to reiterate a few kind of key themes.
One is the the property cat perils that are in the crosshairs for the majority of rate increase is going to be southeast wind, which obviously, we have some exposure to but I'll come back to that because it's a very.
Decreasing our book a bit or is it decreasing book of business and then those that have secondary apparel think about tornado hail duray show or Midwest wind.
And then a deliberate kind of unexpected losses, so for us and even if you look at and that was not an unexpected loss, but for as it relates to us we feel that we're in a very solid position, we have meaningfully reduced our <unk> in continental hurricane exposure, it's more than 60% since 2020, we actually.
With the run off a bit books that we have in place that we put into place at the start of this year, there's another 20% reduction in our P. M L.
And so as we think about what comes up for renewal at six one it's really going to be a single apparel or single uncorrelated apparel renewal and if you talk to reinsurance that's what they're focused on from a property cat standpoint. So they are focused on trying to confine their losses to what they are.
What they've historically been in business for and Thats earthquake that could be Hawaiian hurricane. It's the unexpected loss of winter storm or a again a direct Joe in the Midwest that puts the burden on the market and put a burden on the cost of capital. So what that means for us is as it becomes increasingly more single pair.
Oh and uncorrelated with the market's peak zone I think we feel very good about the.
The prospects for our renewal at six one and with the aggregate cause the same logic applies to the aggregate the aggregate.
<unk> has really mostly Hawaiian hurricane and earthquake in it.
It's easier to model and get their hands around and there's less of the death by 1000 cuts scenario.
So what does that mean.
We're going to take stock of the renewals at one one we've always we haven't put out guidance for 2023 at.
But we have all of our internal models for over the last several years are baked in increases.
In this market because we thought that the hard market would persist. So we feel very good that we can continue to operate grow profitably and add.
You know a good combination of earthquake and to a lesser degree wide hurricane to the book next year.
As it relates to your second question I mean, I think we can get the rate that's needed.
Got in the third quarter on the southeast wind you know a 30% rate up.
That is going to accelerate its guy to accelerate to keep up with potential loss cost inflation.
On the quake side.
We were seeing double digit rate increases now and as I sit here in the fourth quarter that picking up.
Yes.
And Moreover, as capacity pulls back whether it be MGA driven capacity or.
No insurers that are putting more of their historical binding authority capacity back into reinsurance will be able to drive terms and conditions.
As well as rate so overarching we I think we can get the right too.
Keep up with loss costs as it relates to the admitted side of the book you know the one thing that we do have and particularly in high net worth segment and we can change the cutoff in the parameters for high net worth in residential earthquake, we can use our E&S company more and we've been doing.
That and we can continue to do so and that's where you can recover the rates that's beyond the 8% inflation guard that we put in place on the residential quake and I think the I think that would add on Hawaii, we have not only an 8% inflation guard, but we did get a 9% rate increase.
We can and frankly, we can get more rate and potentially could get more rate next year. There. So I think the combination of having a balance of commercial and residential business affords us the ability to pass on the cost.
I think the overall quality of our book makes us feel like that we will be able to grow.
And maintain you know certainly directionally maintain our margins.
Got it. Thanks, I appreciate that answer and maybe just a follow up there I mean are you hearing.
From Reinsurer, you know we've been hearing just a broader retrenchment away from property lines, which I would you know I I don't know if that includes earthquake or not are you are you seeing just less capacity just full stop across property perils.
Reinsurance side.
We're not hearing a full stop so you know again, we don't have anything renewing at one one, but obviously we're talking to reinsurance.
Probably between 30 reinsurance over the last month or so.
Marketing trip, those actually established beforehand, but nonetheless.
No I mean, I think it's a matter of what their cost of capital is and what they're targeting I think every reinsurer is looking as earthquake as a bit of a safe Haven, it's not climate change impacted.
Impacted.
It's uncorrelated from their peak zone.
So oh.
The way South Eastern wind is a little bit of a different story and so that's why we feel good about the actions that we've taken over the last two years and that will have probably when its all said and done less than $200 million of southeastern wind P. M. L that we're buying limit for.
Which on a which is less than 10% of our total program. So.
Hum.
You know when you can bundle south eastern wind with earthquake and then the other thing too is as we've grown and diversified we can bring more casualty opportunities to reinsurance. So theres more that we can trade with from a broad relationship standpoint.
We feel that we are.
Uniquely positioned in that regard.
Yeah, and the only other thing I'd add is David.
We have built up a very significant book with our reinsurers they made money with us a lot of money with us.
So I think that counts for something to you.
Got it thanks.
And then you know I guess just on the just that the Attritional loss ratio I guess now we're thinking 'twenty three 'twenty four.
<unk> percent I think you were originally talking about a 21% to 22%.
If I recall for for next year.
Is that.
Is that really is that all driven by mix, where you're having just a greater portion of your of your net earned premiums that are just coming from these other lines, which I think you guys had outlined have a 57% attritional loss ratio and it's just.
Surely mix or is that 57% loss ratio that you guys laid out in the Palomar two axes that has that changed at all.
No. That's a good question and obviously that has not changed our view of Mac talked about it our view on the lines of business that are fundamental to Palomar chew bags in the marine casualty and alike. Those loss picks haven't changed those lines performed as expected. This quarter. So we're very happy with that but the written premium and earned premium associate.
With it have accelerated and so for where we were at.
June and we are in a different spot that has accelerated so has brought some of that loss ratio call. It forward a little bit and so when we look at it we think about 2023, yes that does push the loss ratio up but the one thing I'd also say is that we.
We've always had this run off in our expectations and so we knew that that part of the mix was in there when we've talked about this ticking up.
If we can fast forward and get this out of our book I still expect the loss ratio in total.
Thing I'll always caveat this with the same quota shares they mix to be below 20%.
So if we can do things faster and get that mix of the right spot by the end of 2023, maybe that happens faster or maybe maybe something one of those lines decelerates a little bit in another line goes faster and so maybe it stays a little higher a little bit longer, but that's a little bit harder to predict but overall this mix.
New business that we're writing is performing as expected. It's what we like to see we're very happy with it we're very happy with the growth trajectory and I think when you look at it in a long term basis and when it's call. It the mix is a little more mature we still expect that loss ratio to be below 20, but.
There is still going to be some increases in a little more of a short term. So the one thing I would say is I don't want people to front run the comments, where we say that.
$5 3 million or 29% of the loss ratio for the quarter is from these lines of business. These lines aren't necessarily gone in Q4, theyre going to take a little bit of time, but most of it the majority of it will be gone by the first half of next year.
Got it thanks and is there like a because you guys obviously disclose on.
The gross basis gross written basis the next.
Back of the envelope I'm calculating like roughly 40% of your mix will be from these.
[noise] Attritional loss lines is is that the right.
Like level the mix to think about and is that sort of a stable level or you know.
Would you I guess it sounds like you would think it would stay at a 40% mix and and it's sort of it's gonna be tapped out there.
Yeah, I think I heard you're doing that ex fronting anything because as youre thinking about <unk> I mean, we go in with let's call. It comparing to your earthquake in Hawaii kind of binary lines and yes, I think 40% is probably the right mix there.
Said for a while excluding fronting that at some point in time, there's probably going to be a 50 50 mix between earthquake and other lines I would say in that commentary that Hawaii is probably under a little bit as well, but no I think if that those lines are at let's call it 40% to 50% of the non fronting mix and I think that's a good mix for us.
But obviously everything still has to continue to grow which we are.
Watching as well and making sure that we're fundamentally strong earthquake growth will continue and is a key fundamental to how we're operating the business.
Great and earthquake and good growth.
As we sit here today all right.
Great. Thank you.
The next question is from Pablo Singsong of J P. Morgan. Please proceed with your question.
Hi, Good afternoon. The first question I had is.
Could you speak to the slowdown in Grimsby and growth are binary of lines in the quarter I think based on my math you grew about 33% in the first half and in the third quarter, you're greeting percent.
It seems like from your comments you expect growth to accelerate once disruption from the biggest to play out also can you comment on any impact you're seeing from each other writers splitting out of California, I think I'll state the day analysis stopped writing new business.
Hey, Pablo this is Matt yes, it's a good question I'm happy you brought it up.
We are the.
The growth did slow down.
Sequentially from the second quarter, the third quarter for earthquake and Hawaiian Hurricane lines I would point out that the third quarter is our largest and so it's a tougher comp.
But what I would tell you is that as we sit here today the growth year over year.
The early part of the fourth quarter is has accelerated some of that's a function of on the residential side.
E&S opportunities that we're seeing and the ability to get rate. There. Some of that is some partnerships that are getting more and more traction.
On the commercial side, it's right and.
Dislocation or better said capacity pullback so well it was earthquake did grow 20, just under 20% in the third quarter, we expect that to sustain if not grow.
Faster.
For the remainder of the year.
Our Hawaii, we were waiting in the third quarter, we were not actively looking to grow our exposure. There we were waiting on the approval of a rate increase and an inflation guard. So we did get both those approved in August .
Typically our quoting 45, if not 60 days out ahead. So what we're seeing there is again a reacceleration of growth in those in that binary segments. So.
We feel very good about the growth prospects for our residential earthquake and then even Hawaii, Hawaii, we're not going to be growing exposure, we're gonna be growing more just from pure rate.
But.
I would expect.
A sustained level of growth in those lines that well.
We have a nice anchor going forward.
Got it and then just a follow up on the reinsurance discussion.
How how much of your residential earthquake book has admitted versus CNS and how fast do you think you can shift your mix there right I guess the context of the question that you know recognizing all these pricing levers you have at the end of the day your biggest exposure.
California earthquake right, but it's mostly admitted in.
These subjects that are in there that's not granting any price increases.
Yeah, No I mean, we do have an inflation guard right. So that's picking up 8% a year on the admitted side, but the E&S book is around 10% right now.
Remind us and.
I think.
Probably closer to 8% right now, but nonetheless, we do have the ability to increase that.
That channel in particular, as we look at high value.
Thresholds and once eligible for the traditional automated versus E&S from a high value standpoint, we can look at certain produce producer channels. We can also look at geographic concentrations to manage that so.
Be admitted side does not afford the latitude we can use the E&S company the inflation guard gives us a decent cushion as well.
Placing guard is frankly, keeping up just done just about with the risk adjusted increase.
On the.
Six one renewal so.
The rest of it will be subsidized by the commercial.
Got it.
And then just switching to the results of this quarter and maybe for Chris how.
How how much earned premiums were associated with the run off book in the third quarter I'm, just trying to get a sense of the <unk> loss ratio ex those losses.
I guess can you talk about the drivers of claims here you know I think the main reason for.
You know your decision to exit certain lines with their exposure to cat risk, but it seems like official factors drove the loss of this quarter.
Yeah, No. That's a fair statement right. Obviously, you look at this quarter I mean somebody who's lines.
Most of these lines don't have.
A ton of cat that you have a little bit of a cat in there so some of that.
Was felt but no. These the attritional losses were the reason in that call. It if they work together when you look at the cat payback, but nutritional loss was the main reason we made the decision to exit these lines. When you look back in Q2, obviously, we had these lines and they were performing better but there is some reading of the tea leaves and we thought that this may be in there.
This definitely affirms our decision to exit those lines. These lines in total obviously, we haven't given out the breakout of the earned premium but in total it's probably good to think about these lines even with this loss ratio operating in the 90% to 95% combined range. So that's probably a good way to think about it but no. It's there.
I drove some of the results this quarter and something that we thought could happen and really did drive the reasoning behind we wanted to exit these lines and so that's what we started doing earlier this year and that's why the majority of it will be out by the middle of next year. So.
Happy with that decision, we just wish.
Some other people that it was out sooner, but it doesn't take away from the good results. We're having on all the other lines of business and the growth that we're seeing is a binary lines the growth that we're seeing and the lines are key to the Palomar <unk> and the fee income that we're seeing on fronting as well. So we feel good about all of those things also.
And are these lines non tech, especially homeowners or are they something else.
There's there's a specialty homeowners, especially homeowners. There's also an assumed reinsurance relationship which is a it's a it's a homeowner stocked renters product.
And and then there is one.
Commercial prop.
Property program that we are.
Again restructuring running off.
Okay, and then last for me just giving your cat experience. This year do you think that 6 million average annual loss estimate you offered before for cats still stands and.
I guess you know just given what happened with Ian could you talk about your appetite for raising rates in Florida, and Florida, given that you weren't in that market in any meaningful way a couple of years ago.
Sure. So I think Theres a couple of things in there the $6 million is the average annual loss.
And was not an average storm. This was I don't know if it's a warning 40 or 150 or.
130 year event, but so that's.
So it's going to.
An event like that will over index the average annual loss.
That all said as I mentioned earlier, we still have line of sight on a incremental 20 plus percent reduction to our exposure.
And kind of a hurricane which will.
Push down that al and also the run off which is a function of the runoff of that continental Hurricane exposure plus then.
One of the things that a <unk>.
Hard market affords us the ability to look at your book and drive further optimization. So we have rate targets, we have the ability to.
Contracted our line sizes, we have the ability to look at occupancy eligibility in an age of construction. So all of those will also help VA al.
Our ability to our retention whatever it might be so.
Al will actually come down if you roll forward to next year's wind season.
Two previously identified initiatives and then ongoing initiatives that we have right now on managing our wind exposure and taken advantage of rate and the like we'll push it down further.
And then again just to reiterate and that was not an average event that was a cat four cat five southwestern Florida.
I think we feel very good about our losses only been.
3% on a pre tax basis of our surplus.
Fair enough thanks, Matt.
The next question is from young Li of K B W. Please proceed with your question.
Hi, this is <unk>.
Thank you for taking my questions.
My first question.
So.
Any changes.
Changes on the current inflation.
Great.
Kind of a level.
Yeah. So on the inflation guards, we did increase them from 5% to 8% on our admitted our residential book.
Book, So residential earthquake and.
Admitted Hawaiian Hurricane I think we continue to look at not just the inflation guard, but the underlying insurance to value and the ITV for all of our portfolio. So we use that to look at when a policy is submitted for new business or renewals to make sure.
That the estimate on the replacement cost does factor in.
The a true sense of inflation right now we also have the ability to leverage our builders' risk business, which has what's called Auditable policies that you can see what the project is completed what was the ultimate cost and how does that compare to the original estimate and so if that was 10 or 12%.
Not only the premium adjusted but we can use that on a regional basis to inform what we think the replacement cost should be across all of our portfolio on a state by state basis. So.
Right now we think it's adequate that doesn't mean that we won't potentially bumped them up and hopefully as the fed gets.
Inflation under control there will start to be a cushion.
That would be above and below the 8%.
Got it thank you.
My second question is on the right.
<unk> premiums so funding premiums for this quarter continued to be strong.
Is there any updated thoughts for 2020.
And the.
This year and and going forward in 'twenty two 'twenty three.
Yes. So you are right. The fronting was strong this quarter and then has exceeded our expectations. This year and I think that gives us great visibility on a nice fee income stream into 2023, we did.
Take up the range from 100 to $180 million to $200 million this quarter from 100.
Ah 60 on the high end.
That we gave at the end of Q2, so that gives us good momentum into 2003, we have not given a target for 'twenty three what I will say is that we have a nice.
Pipeline of prospects for the fronting business.
The existing clients are performing well, we've been able to bring incremental capacity to support their growth.
Through our reinsurance relationships we have been.
<unk> been able to help them execute on a host of ways. So that gives us very nice conviction on.
The fronting opportunity in 'twenty three and beyond.
Got you. Thank you for the color.
Thank you.
The next question is from Tracy Bank weekly of Barclays. Please proceed with your question.
Thank you.
You've mentioned that you exhausted your problem.
Catastrophe retention any alcohol team in Shanghai.
Premium.
Can you highlight what the reinsurance or coffee, Israel gross losses, where I'm trying to get at is I'm, just trying to figure out how foreign.
Program, you might have had some losses and then just.
Adding back to that discussion.
Reinsurance capacity you know you had a view of how those reinsurance would feel about renewing with you.
At Hudson Laughing.
Yeah, Hey, Tracy this is Mac thats a good question.
So.
Just as a reminder, we do have prepaid reinstatement. So we have a 12 and a half million dollars retention loss from this event and then whatever is impacted in those lower layers of our reinsurance program are reinstated and so come back online that we have not.
Disclosed R R.
Our gross right now right as of yet.
We're seeing claims come in what I will tell you is this is.
And materially up our program now that being said for those reinsurers that are in our first layer of the program.
It's in the first layer and ticks up into the second we want to be mindful of their losses, and there will need to be payback there, but this is.
This is well within the first two layers of our reinsurance program and hopefully.
Really just closer to the.
The first layer.
Okay, No that's definitely helpful and I totally get your commentary earlier.
Okay.
Well talking only in China, but just thinking you know.
All right.
We are in the dangers I don't think you'd be interim Bob Rae.
Retention, calling charlene.
You know, maybe reducing top line or I mean, how how do you think about.
If you had a stretch.
What would be the minimum.
They think about insurance not reinsurance protection.
Hey, Tracy that that we are looking at the market closely and I think we look at our retention because that is frankly, where.
There will be a.
Losses into that first layer because of Ian and so do we have to take our retention up.
$3 million $5 million, we will see how that goes maybe we'll do it vertically through a co participation in that first layer.
Obviously, you don't want to get to a point, where we're trading dollars. So the rate online is a 100% that doesn't make a whole lot of sense for us.
I think in that.
I think there's a couple of themes that I that I want to impress upon you, though as you think about stress scenarios.
Again, I made the point around earthquake being a nice diversified.
I'll make the point again that we have a substantial bank built with those reinsurers. So we've made them money, but the one thing that you are hearing from reinsurers is they want to see retention go up but they also are moving up programs and so for us as you get above.
Our forecast at $175 million of limit you go into really only binary exposures or single payroll exposures and Thats, where property reinsurers are looking to go they want to go to single payer also if they take a loss or an earthquake thats what they are in business for its not a circumstance where theyre, taking a loss in the layer that they thought it was only.
Earthquake exposed and then Theres a winter storm that hit it so what youre seeing is reinsurance moving up in the mid working levels of programs and there is actually a scenario I mean this is my rose tinted view that we're going to have excess demand in the middle of our program because it will have an attractive rate online and it'll be single apparel.
So I think that's a dynamic that will play itself out whether its excess demand or what the prices. It will be manageable for us, but I do think that its not a circumstance, where we have midwestern toward hail exposure, Florida exposure all the way through our program. So we're scratching decline for limit, we're actually going to be bring.
<unk> something to them that's involved with the property reinsurance market I think the other thing that I need to reiterate we have a $2 $1 billion program $675 million of that is in cap ons that has multi year. So those are those are not they're not renewing right now so they are locked in.
2024 or 2025.
So I think that also like you think about those stress scenarios. We don't have the totality of the programming program renewing the majority of the program is single apparel.
And the strong majority of the program doesn't have any secondary apparel exposure.
Okay.
We have a follow up question from Mark Hughes of Truest. Please proceed with your question.
Yeah, Chris what would you say is a good ratio we should be thinking about in terms of earned premium relative to written and I think.
This quarter was a little lower because of that.
New reinsurance quota share.
When we think about Q4 or maybe.
And go forward a few quarters, what's a bad ratio look like.
Yeah, I think it's the best way to think about it is it's going to continue to decrease right I think as we transition some of our business over to fee based business like fronting or even some of the new clients that have attritional exposure will use a heavy amount of quota share to protect our risking.
Minimal help.
To help deliver more consistent earnings that the net earned premium is growing the net earned premium ratio is going to continue to go down. So at the end of this quarter. It was let's call it 42% and.
48% for the full year.
I think I've said, all along that I expected to devote be below 50 for the full year that trend is happening right and so could that full year number be $45 46, or potentially even lower maybe but I think that trend. When you think out to 'twenty. Three is going to continue fronting has been strong we expect that trend to continue back obviously.
It <unk> take up.
The range on where we perform there.
Growth in the lines of business.
To Palomar <unk> casualty in the marine have been strong those have quota shares with them that's going to increase and you can actually see that even on the net written side right. We did see a significant portion of our written premium this quarter to reinsure some of that obviously as <unk> talked about we did have some cost increases there also.
If you'll remember ex ol.
The first quarter that you have a full quarter of excess of loss is your heaviest quarter as a percentage goes because you are paying the same rate for the next 12 months, even though we are planning on growing our book and we buy to be able to facilitate that growth so extra wells a little bit higher but if the quota shares is going to drive the largest amount of that differential into.
In future quarters, when you think about the matter and so I continue to expect it to continue to decrease on the other side of that the fee side of that I expect the acquisition expense, especially as a percentage of gross earned to continue to decrease as well you saw that trend continue.
Q2 to Q3 of this year. So it's down to 14, 6% that trend is what we expected as well so it's still going the right direction.
And so I think that's what I continue to expect with network I'm not going to give out a specific target for.
Next year at this stage, but no I do you expect it to keep going down.
Thank you.
Are going to be more consistent fee income from that but also just strong performance in those lines of business is what youre seeing and what Youre seeing go through our net earned premium ratio right now.
Okay.
Thank you I appreciate it.
Welcome.
Yes.
There are no additional questions at this time I'd like to turn the call back to Mac Armstrong for closing remarks.
Great. Thanks, operator, and thanks, all were able to join we appreciate your participation questions and your support.
I'd also be remiss, if I didn't thank all of our team at Palomar for their dedication to the business.
And as well as all of our customers and partners for what they do and they are critical to our success.
To conclude we do think that this quarter really was a demonstration of the meaningful strides, we're making on our path to Palomar <unk>. We reached record growth in gross written premium we monetize and continue to monetize our capital investments made over last year and the early part of this year and we really did demonstrate the increasing resilience in our business model.
Overall, we have line of sight and our ability to execute <unk> and we look forward to delivering considerable value to our shareholders as we do.
Do do indeed achieved those milestones. So thank you very much enjoy the rest of your day and we will talk to you next quarter.
Okay.
This concludes today's conference you may disconnect your lines at this time. Thank you for your participation.
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