Palomar Holdings, Inc. (NASDAQ:PLMR) Q1 2024 Earnings Call Transcript May 3, 2024
Palomar Holdings, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Good morning and welcome to the Palomar Holdings First Quarter 2024 Earnings Conference Call. During today’s presentation, all parties will be in a listen-only mode. Following the presentation, the conference line will be open for questions with instructions to follow. As a reminder, this conference call is being recorded. I would now like to turn the call over to Mr. Chris Uchida, Chief Financial Officer. Please go ahead, sir.
Chris Uchida: Thank you, operator, and good morning, everyone. We appreciate your participation in our earnings call. With me here today is Mac Armstrong, our Chairman and Chief Executive Officer. Additionally, Jon Christianson, our President, is here to answer questions during the Q&A portion of the call. 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 May 10, 2024. 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. Such risks and other factors are set forth in our quarterly report on Form 10-Q 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 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 Mac.
Mac Armstrong: Thank you, Chris, and good morning. During the first quarter, Palomar celebrated its 10th birthday, and this quarter is a terrific illustration of how much we’ve accomplished in our young history. We produced another quarter of profitable growth and again demonstrated our ability to grow where we want, while delivering predictable earnings. Five product categories generated gross written premium growth of 47.2%, with especially strong contributions from our Crop and Casualty products. Likewise, we delivered net earned premium growth of 30% in the first quarter, a nice increase from the 14% growth we achieved in the fourth quarter of 2023. Crop, Casualty and certain Other Property lines, combined with our market-leading Earthquake franchise, drove adjusted net income growth of 36% and an adjusted return on equity of 22.9%.
Another exciting result of our financial performance this quarter is our stockholders’ equity surpassed $500 million, moving us into AM Best Financial Size Category 10. This level should help us open new market segments, distribution channels and attract talent. The year is off to a strong start, and we are on track to achieve the Palomar 2X goal of doubling our adjusted net income over a three to five year period. This goal was first introduced at our Investor Day in June 2022, which means we are tracking towards the shorter end of the time frame objective. We remain steadfast in our commitment to maintain profitable growth with best-in-class risk-adjusted returns. First quarter puts us well on our way to attaining this objective in 2024 and beyond.
Before I dive into our results, I’d like to point out that this quarter and going forward, we will provide performance commentary, including but not limited to gross written premium and market conditions on our 5 product categories: earthquake, Earthquake, Inland Marine and Other Property, Casualty, Fronting, and Crop. We believe this will help our investors better understand how our portfolio of businesses are performing as we move forward. Starting with our Earthquake franchise, we grew premium 13% in the first quarter of 2024. It is important to point out that the first quarter of 2023 benefited from a nonrecurring premium transfer that came over in conjunction with the strategic carrier partnership. Excluding this onetime benefit, our Earthquake book grew 18% on a same-store basis.
We are confident that Earthquake premiums will grow in the high-teens to 20% in 2024. Our confidence stems from several factors, most notably a residential earthquake partnership with Cincinnati Financial, consummated in the fourth quarter of 2023 that did not go live until April, as well as new partnerships, one residential and one commercial, that should increase production in the second half of the year. The Earthquake market remains stable and attractive from a pricing perspective. Commercial rates increased 11.6% this quarter as compared to 18.9% in the fourth quarter. The 8% to 9% inflation guards of residential earthquake policies are now providing the cushion above inflationary levels and provide annual increases regardless of market condition.
While rate increases have moderated from 2023 levels, our key portfolio metrics, average annual loss and 250-year probable maximum loss to premium ratio, are at all-time best levels. This should translate into strong net earned premium growth as the cost of excess of loss reinsurance moderates from previous levels over the near term. Looking forward, we remain positive on the growth and profitability prospects of our Earthquake franchise. Our Inland Marine and Other Property products business grew 46% year-over-year, driven by our excess national property, Hawaii Hurricane and Builders Risk line of business. While growth in this product set has accelerated from the pace that we saw in recent quarters, I wanted to reiterate, this is a category that best typifies our grow where we want mantra and where we are judiciously managing, and in certain cases, reducing our exposure.
Specifically, we are not adding limit in continental hurricane-prone areas and reducing our balance sheet exposure in Hawaii as we transition our policies to our Laulima Reciprocal Exchange. Builders Risk, our largest in the Marine product, had 16% same-store growth in the quarter. Our excess national property line saw approximately 178% year-over-year growth and 6% rate increases in the quarter as our teams built a portfolio of non-cat-exposed property business. For both Builders Risk and excess national property, we hired experienced regionally-focused underwriters that we believe will sustain the growth in these lines of business for 2024. All Risk business grew 21%, while increasing rates 18%, down from 36% in the prior quarter. Flood written premium grew 18% year-over-year in the first quarter.
The growth was somewhat muted by new business moratoriums throughout the quarter in California due to the heightened rain and flood activity. Importantly, catastrophe losses associated with the major floods in California in January were in line with the estimate provided on last quarter’s call. Hawaii Hurricane premiums grew 30% in the first quarter, a combination of rate increases, our inflation guard and new business written on Laulima paper. Importantly, our policyholders are embracing Laulima with approximately 92% of policies converting from Palomar Specialty Insurance Company in the quarter. It is worth reiterating that the migration of policies to Laulima transitions our business model from one that is risk bearing to one that is fee generative.
Once complete, we will all but eliminate balance sheet exposure to hurricane losses in Hawaii. Our Casualty product set saw robust growth in the first quarter as premiums increased 327% over the previous year. Strong performing lines in the quarter were commercial contractors, general and excess liability, real estate errors and omissions, and miscellaneous professional liability. Excess liability particularly stood out as the investments made in talent and distribution over the course of 2023 allowed the book to grow fivefold year-over-year and 65% sequentially. Our contractor’s general liability book had close to an identical sequential growth rate of 64%, while growing 375% year-over-year. Our professional liability line grew premiums 81% year-over-year, while seeing a 28% sequential increase.
Our strong growth in Casualty products, which still comprise less than 15% of our total book, remains anchored in a conservative approach to our underwriting targeted niche segments of the market. We employ prudent risk management tactics such as modest gross and net line size, avoidance of heavy bodily injury and other high severity exposure, and conservative reinsurance to cover loss potential in the classes we write. Additionally, we continue to see decent rate increases across the Casualty book. Our professional liability products saw a blended increase of 6.5% with real estate errors and omissions rates increasing 10.6%. The excess liability book was up 6.7% in the contractor’s general liability book saw an increase of 9.9%. While there are certain pockets of our Casualty book that are softer from a pricing perspective, private company D&O was up 2.4%.
We continue to believe our rates are staying ahead of loss costs. For the quarter, the Casualty book’s loss ratio remained in line with our conservative loss picks. As the predominance of the book is less than two years old, we are focused on building a sizable reserve base that we believe will develop favorably over time. Our Fronting business modestly grew premiums 3% year-over-year in the first quarter. Growth in the quarter was impacted by a few things. First, our cyber fronting program continued to see heightened competition and soft pricing as its average renewal decreased 6.7%. Second, 2 new partnerships were slower to ramp than initially forecast. Lastly, while our pipeline is strong, we did not add any new clients this quarter. As a reminder, we take a very selective approach securing our Fronting partner portfolio to ensure comprehensive management of the programs and no surprises.
We do expect to bring on new Fronting relationships in the second half of the year, but this product set will experience slower growth in 2024 than the others. Conversely, our newest product group, Crop, had a very strong start to 2024, writing $38.7 million of premium in the first quarter. Our success in market acceptance are a function of our expertise and our strong partnership with advanced AgProtection. We successfully married Palomar’s data-driven risk management and underwriting model with advanced Advanced AgProtection’s longstanding market relationships, technology and customer service to assemble an attractive and geographically-diverse book this quarter. As a reminder, for 2024, our Crop business has a participatory front, where we are taking 5% risk.
The expectation is that we will take a more meaningful risk participation in 2025. Production exceeded our expectations, and we are now forecasting more than $125 million of premium in 2024, up from the previous guidance of more than $100 million. Also, Crop written premium is seasonal, so you should not expect much in the way of written premium next quarter. We are pleased with the traction to date and are confident that we will generate meaningful net earned premium in the years ahead. Turning to reinsurance, the first quarter is lighter in activity. That said, we were still engaged on several placements, including our June 1 core excess of loss placement and two quota sharing treaties, Casualty and Builders Risk. We are pleased that the ceding commission on the Casualty quota share renewed at slightly better terms than expiring, and we enhanced the treaty’s terms and conditions.
We also improved the economics on our Builders Risk quota share, while increasing our gross and net line capacity. We are amid the 6/1 core XOL placement, as well as marketing Torrey Pines Re, our fifth catastrophe bond. We are encouraged by the progress to date on both key endeavors. As we discussed last quarter, we had two earthquake treaties renewed on January 1 at risk-adjusted decreases of approximately 5%. As we sit here today, certain layers of our core tower are bound, and the implied risk-adjusted decrease is directionally similar to the earthquake treaties renewed on January 1. While most of the placement is still outstanding, we are encouraged with the results so far. It affords us confidence that we will meet or beat the 5% price increase embedded in our full year 2024 guidance.
To conclude, we are encouraged by the trends in our business and are raising the guidance range for our full year 2024 adjusted net income to $113 million to $118 million from $110 million to $115 million. And to reiterate, our guidance does assume a 5% risk-adjusted increase on our 6/1 core excess of loss program. Lastly, the midpoint of our guidance implies an adjusted ROE above our Palomar 2X target of 20%. With that, I’ll turn the call over to Chris to discuss our results in more detail.
Chris Uchida: 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. For the first quarter of 2024, our adjusted net income was $27.8 million or $1.09 per share compared to adjusted net income of $20.4 million or $0.80 per share for the same quarter of 2023, adjusted net income and earnings per share growth of 36%. Our first quarter adjusted underwriting income was $29.2 million compared to $22.2 million last year. Our adjusted combined ratio was 73% for the first quarter compared to 73.3% in the first quarter of 2023.
Excluding catastrophes, our adjusted combined ratio was 69.8% for the quarter compared to 71.2% last year. For the first quarter of 2024, our annualized adjusted return on equity was 22.9% compared to 20.7% for the same period last year. The first quarter adjusted return on equity continues to validate our ability to maintain top line growth with a predictable rate of return above our Palomar 2X target of 20%. Gross written premiums for the first quarter were $368.1 million, an increase of 47.2% compared to the prior year’s first quarter. Along with breaking out Crop, we also regrouped our written premium to align with our 5 key specialty insurance products: Earthquake, Inland Marine and Other Property, Casualty, Fronting and Crop. It is important to remember the seasonality of our Crop premium.
Based on our current expectations, the majority of our Crop premium will be written in the third quarter of each year, with only modest premium in the second and fourth quarters. The $38.7 million of crop premium written in the first quarter should represent about 30% of the premium expected for the year. Net earned premiums for the first quarter were $107.9 million, an increase of 29.6% compared to the prior year’s first quarter. For the first quarter of 2024, our ratio of net earned premiums as a percentage of gross earned premiums was 35.6% compared to 37% in the first quarter of 2023 and compared sequentially to 33.9% in the fourth quarter of 2023. The year-over-year decrease is reflective of our growth in Fronting and lines of business that use quota share reinsurance and the increased cost of our excess of loss reinsurance program that renewed last June.
With the mix of business maturing and our excess of loss reinsurance program in place, our net earned premium ratio has continued to increase from its low point in the third quarter of 2023. Based on our assumption that the excess of loss reinsurance costs will increase modestly, our risk-adjusted — on a risk-adjusted basis, we expect our net earned premiums ratio to follow a similar pattern as last year. We expect a slight decrease in the net earned premium ratio for the second quarter with the low point of this ratio in the third quarter, the first full quarter of our June 1 reinsurance renewal. From there, we expect the ratio to increase through the treaty year, similar pattern to what we have seen over the current treaty year. Losses and loss adjustment expenses for the first quarter were $26.8 million, comprised of $23.4 million of non-catastrophe attritional losses and $3.4 million of catastrophe losses from flood activity.
The loss ratio for the quarter was 24.9%, compared to a loss ratio of 24.8% a year ago. For the first quarter, our attritional loss ratio was 21.8% and our catastrophe loss ratio was 3.1%. We continue to expect our loss ratio to be approximately 21% to 25% for the year. Our acquisition expense as a percentage of gross earned premium for the first quarter was 10.5% compared to 11.4% in the first quarter last year and in line with the fourth quarter of 2023. Additional ceding commission and fronting fees continued to drive the year-over-year improvement. With our growth and mix of business, we expect this ratio to be flat for the full year with some potential for improvement. The ratio of other underwriting expenses including adjustments to gross earned premiums for the first quarter was 6.8%, the same as the first quarter last year and compared sequentially to 6.9% in the fourth quarter of 2023, in line with our expectations as we continue to invest in our organization as we continue to grow.
We continue to expect long-term scale in this ratio, while we may see periods of sequential flatness as we continue to invest in scaling the organization. Our investment income for the first quarter was $7.1 million, an increase of 39.4% compared to the prior year’s first quarter. The year-over-year increase was primarily due to higher yields on invested assets and higher average balance of investments held during the three months ended March 31, 2024 due to cash generated from operations. Our yield in the first quarter was 4.2%, compared to 3.4% in the first quarter last year. The average yield of investments made in the first quarter was 5.6% compared — we continue to conservatively allocate our positions to assets that generate attractive risk-adjusted return.
There were no shares repurchased during the quarter. While the previous plan has expired, as a matter of good corporate governance, we will be authorizing a new share repurchase program. At the end of the quarter, our net written premium to equity ratio was 0.94 to 1. Our stockholders’ equity has reached $501.7 million, a testament to our profitable growth. As Mac mentioned, we are raising our full year 2024 adjusted net income guidance to — range to $113 million to $118 million, implying 23.5% adjusted net income growth at the midpoint of the range. It’s important to remember that our loss estimate and guidance include our expectations of mini cat such as severe convective storm activity. For the year, we expect our loss ratio to be approximately 21% to 25%, including our estimate of mini cats, which represent approximately 2 points to 3 points of our expected loss ratio.
With that, I’d like to ask the operator to open the line for any questions. Operator?
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