Palomar Holdings, Inc.

Good morning, and welcome to the Palomar Holdings, Inc. Third Quarter 2020 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 at that time. 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.

Thank you, operator, and good morning, everyone. We appreciate your participation in our third quarter 2020 earnings call. With me here today is Mac Armstrong, our chairman, chief executive officer, and founder. As a reminder, a telephonic replay of this call will be available on the investor relations section of our website through 1159 p.m. Eastern Time on November 18, 2020. 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 relating to the COVID-19 pandemic. Such risks and other factors are set forth in our quarterly report on Form 10-Q that will be 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 the 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.

Thank you, Chris, and good morning, everyone. I hope those of you with us today continue to be safe and healthy. Today, I'll speak to our third quarter results at a high level and speak to our operations before turning the call over to Chris to discuss the financial results in more detail. For the third quarter, end of September 30th, 2020, we experienced several notable achievements. First, the momentum of our business remained strong, as evident in our year-over-year gross rate and premium growth at 55.4%. A figure that included meaningful growth across several product lines as we have increased our position as a specialty insurance leader. Second, Palomar Access and Surplus Insurance Company, or PESIC, our newly established surplus lines insurer, launched in August and bound policies across several lines of business during the third quarter. We believe PESIC will only enhance our ability to pursue profitable growth and respond favorably to a further hardening rate environment. Third, during the quarter, we continue to expand our distribution network, executing several new partnerships in lines like residential earthquake and flood, and roll out new products to existing and new distribution partners. Fourth, we sustained our commitment to building a world-class team and grew our headcount by 10%. Among the key additions to our team, we welcomed Jason Sears, an experienced E&S casualty and programs insurance executive, as Senior Vice President of Programs to lead our program business as well as the scaling and diversification of PESIC. Lastly, and subsequent to quarter end, we formally launched our ESG Committee of the Board of Directors, which will not only help articulate and measure the company's values, but reinforce Palomar's reputation as a forward-thinking employer and partner. Turning the third quarter, our country experienced an unusual frequency of severe weather, from the Midwest derecho to an unprecedented windstorm season to the devastating wildfires in our home state of California. Palomar and our policyholders were impacted by the spate of hurricanes that made landfall in the United States including Hurricanes Hannah, Isaias, Laura, Sally, and Beta. I'm very proud of our team's rapid response as we work to help our policyholders and their communities recover from these damaging events. Our swift actions are best exemplified by the fact that at the time of this report, 87% of our specialty homeowners' claims from the aforementioned storms are closed or settled. Due in large part to the impact from losses associated with these events, During the third quarter, we reported a net loss of $15.7 million compared to net income of $7.5 million in the third quarter of 2019. This result is disappointing as it clouds the results of an otherwise strong quarter, more so for our lines of business not exposed to the Gulf of Mexico, approximately 80%. While we could go on about the incredibly low probability of the 2020 win season and how the hard market will allow us to take rate and recoup our losses, and that is something we intend to do, I want to discuss the improvements we have begun to execute. Palomar's culture is premised on continuous improvement, problem solving, and agility. It is also analytically driven. As such, we will apply the data we have gathered and lessons we have learned across our organization to enhance our underwriting, analytics, and risk transfer operations, and more overdrive consistency in results and predictability in earnings. As we learn and grow as a business, we will rigorously optimize our reinsurance program, product suite, and geographic mix in light of market opportunity, risk-adjusted return on capital, and payback analysis. With respect to Palmar's reinsurance program, we will look to implement new coverages that further protect the balance sheet and earnings stream from severe and frequent events. It is worth highlighting that Palmar secured incremental reinsurance coverage in October that preserved our $10 million per event retention through June 1st, 2021. As it pertains to underwriting and exposure management, in October we decided to exit commercial all-risk on an admitted basis in Alabama, Louisiana, and Mississippi, as well as specialty homeowners in Louisiana. Additionally, we are reducing our exposure to risk with a short proximity to the coast for commercial all-risk. These actions, among others, reflect our focus on remaining agile, preserving our ability to invest in our core markets and new initiatives like PESIC, and importantly, achieve the requisite payback from a catastrophe for Palomar, our investors, and our reinsurance partners. We feel the achievability of these measures are feasible in light of what we expect will be an incrementally harder insurance market. Operationally, we remain fairly insulated from COVID-19 and continue to believe the pandemic will not have a material impact on our profitability or growth. It is our belief that our exposure to business interruption remains negligible as our commercial property policies require a loss from physical damage to the property from the name peril and future virus exclusions. Turning to third quarter results, we experienced meaningful growth across several product lines as we expanded our position as a specialty insurance leader, driven specifically by our newer lines of business like Inland Marine, which experienced growth of 360% during the third quarter. Our builder's risk and motor truck cargo offerings continue to demonstrate strong traction and an encouraging market opportunity. Another major driver was our commercial earthquake business, which grew 115% compared to the prior year period. Commercial lines growth was a function of new distribution sources, expanded geographic footprint, incremental product traction, and most importantly, sustained pricing increases. Our third quarter commercial policy average rate increase on renewals was 14.1% versus 14.2 in the second quarter. With respect to our residential business, it is worth highlighting the growth of two products, flood and residential earthquake. Flood grew 50% year-over-year across 11 geographically diverse states, while residential earthquake grew 13% year-over-year across with a prior year comparable in the third quarter of 2019 that saw a large surge in new business following the Ridgecrest earthquakes in July of that year. During the third quarter, our book experienced premium retention rates of 90%, which increased from 88% achieved during the second quarter. Premium retention for our residential and commercial earthquake, Hawaii hurricane, and residential flood lines of businesses were all in excess of 92%. This continues to be a testament to the unique value our products offer insureds and distribution partners. Moving on to our newly launched ENS company, PESIC, we expect it will add an additional dimension of capability and growth for Palomar. As previously described, PESIC will also enable us to further leverage our analytically driven underwriting framework to write business on a national scale and to ensure certain risks that our admitted products cannot currently satisfy. For example, PESIC allows Palomar to compete in the layered and shared commercial property market, an area where there is currently a high level of market dislocation. In August, we entered into a new partnership with the Special Risk Underwriting Division of leading wholesaler Amwins to underwrite and produce layered and shared property business for PESIC. We certainly anticipate this partnership and PESIC on the whole will be a growth driver for 2021 and beyond. Expanding our distribution network remains a key priority and we are proud of the progress we made during the quarter. During the third quarter, our retail and wholesale active producers increased 6% sequentially from the second quarter. Carrier partnerships continue to be a differentiated channel for our business, and in the third quarter, we entered into multiple new partnerships, including another residential earthquake partnership motivated by the continued dislocation of the California homeowners market. Our flood business entered into a new partnership with Torrent Technologies, a flood insurance technology company and subsidiary of Marsh. The partnership will give Torrent's distribution access to our residential flood offering in the 11 states we currently write business. These relationships take time to develop, and we are proud to provide valuable solutions to other insurance carriers. Separately, we continue to execute our geographic expansion initiatives by growing the geographic footprint for our emitted carrier to 31 states across the nation. We are also excited to announce the launch of our new real estate errors and omissions product offering. This is a line of business that our team has extensive prior experience with, and we believe it will be a beneficial addition to our product suite. As we grow PESC in all of our business, we believe it is vital that we sustain investments, technology, analytics, and talent. I already mentioned the growth of our team in the addition of Jason Sears to spearhead the execution of our program and E&S efforts. The third quarter also included two developments within our existing leadership team that we believe reflect the ongoing evolution and focus of our business and strategy. In early August, John Christensen, our former Chief Operating Officer, took the role of Chief Underwriting Officer. In concert with his promotion, we subsequently promoted our Chief Technology Officer, Britt Morris, to assume the role of Chief Operating Officer. The vital role that technology plays across Palomar and BRIT's instrumental role in building out our technology team and platform made him a natural choice. We also expect to have BRIT's replacement of CTO in place by the end of the first quarter. Yesterday, we announced a renewal rights transaction with affiliates of Giovera Holdings, whereby Palomar will offer policies to all Giovera Hawaii residential hurricane policyholders upon renewal. This transaction will considerably increase our footprint in the state of Hawaii, a market we first entered into in 2015, and have actively looked to deepen our presence. Lastly, subsequent to quarter end, we formally launched our ESG and Diversity, Inclusion, Community Engagement and Equality, or DICE, committees, which will reaffirm and pursue our efforts and ongoing dedication to the environment, health and safety, corporate social responsibility, corporate governance, and sustainability. The ESG committee will meet on a quarterly basis, led by myself and board members Daryl Bradley and Martha Nateras. This committee will be responsible for holding the company and management accountable for our progress toward ESG goals, as established by Palomar Management and in consultation with our team members. We believe that diversity, equality, and inclusion yield greater organizational creativity and productivity, which helps us serve our customers and partners more effectively. Delivering on our diversity commitment returns greater value to our shareholders and ultimately makes a positive impact on the communities in which we do business. 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 exclude common share equivalents such as outstanding stock options during periods when we incur a net loss and include them in profitable periods. We have adjusted the calculations accordingly. As you have seen in the earnings release, we have added new metrics describing our results including and excluding catastrophe losses. We believe that this additional information provides better visibility into our business and results. Going forward, we will continue to show these metrics. For the third quarter of 2020, we reported a net loss of $15.7 million, or negative 62 cents per share, compared to net income of $7.5 million, or 31 cents per share for the same quarter in 2019. On an adjusted basis, excluding catastrophe losses, our net income for the third quarter was $13.7 million, or 52 cents per share, compared to $9.6 million, or $0.40 per share for the same quarter of 2019. Gross written premiums for the third quarter were $103 million, representing an increase of 55.4% compared to the prior year's third quarter. We continue to see healthy new business, rate increases, and strong retention with contributions across all of our product offerings. Seated written premiums for the third quarter were $41.6 million, representing an increase of 48.1%. compared to the prior year's third quarter. The increase was primarily due to increase in reinsurance expense commensurate with our growth. Our risk transfer strategy remains a critical component of our business, especially as we demonstrate sustained top-line growth. As we grow our business, we expect to incur additional excess of loss reinsurance expense as we maintain a conservative level of overall coverage. As of June 1st of this year, we retained $10 million per earthquake or wind event, and we purchased $1.4 billion in total reinsurance coverage for earthquake events. Additionally, after multiple hurricane events during the quarter, we purchased backup reinsurance coverage, maintaining our $10 million event retention. The additional expense of $6 million for this coverage began in the fourth quarter and will run through June 1st of 2021. Net earn premiums for the third quarter were $42 million, an increase of 51.9% compared to the prior year's third quarter. Our results improved primarily due to the earning of increased gross earned premiums offset by the earning of seeded written premiums under reinsurance agreements. For the third quarter of 2020, net earned premiums as a percentage of gross earned premiums were 52.9% compared to 51.8% in the third quarter of 2019. We believe the ratio of net earned premiums to gross earned premiums is a better metric for assessing our business versus the ratio of net written premiums to gross written premiums. As previously discussed last quarter, we expect that ratio to be around 53% to 54% on an annual basis, lower at the beginning of a new excess of loss treaty and higher at the end with our expected growth in earned premiums. This quarter's results are in line with that expectation, but the additional expense for the backup reinsurance layer will adjust the ratio slightly below the normalized level beginning in the fourth quarter. Commission and other income was $816,000 for the three months ended September 30th, 2020, compared to $709,000 from the same period in 2019. The increase was primarily due to an increase in policy-related fees associated with an increased volume of premiums written. Losses and loss adjustment expenses, or LAE, incurred in the third quarter were $41.1 million compared to $2.4 million in the prior year's third quarter. Our losses during the quarter were primarily the result of increased catastrophe activity from hurricanes Anna, Isaias, Laura, Sally, and Beta. We define catastrophe losses as certain losses resulting from events involving multiple claims and policyholders, including earthquakes, hurricanes, floods, convective storms, terrorist acts, or other aggregating events. This definition captures the catastrophe losses from this quarter and Hurricane Harvey in Florence from previous periods. We had catastrophe losses of $36.5 million for the third quarter of 2020 within the range provided in October. The catastrophe loss ratio of 86.9% compared to no catastrophe losses from the third quarter of 2019. Our loss ratio excluding catastrophe losses for the quarter was 10.8% compared to 8.8% in the third quarter of 2019. The increase in our nutritional loss ratio is in line with the expectation that our loss ratio would increase with our growth and as we diversify the book of business into lines like Inland Marine where there is attritional loss. Our expense ratio for the third quarter of 2020 was 59.4% compared to 64.6% in the same quarter of 2019. As we have previously discussed, we expected the expense ratio to increase 2 to 2.5 points sequentially compared to previous quarters from structural changes to our SHF and investments in PESIC. These changes will not have a material impact on net income, but do impact our ratios, such as the expense ratio, combined ratio, and net earned premium to gross earned premium ratio. The combined ratio for the third quarter was 157.1% compared to a combined ratio of 73.4% for the prior year's third quarter, excluding the catastrophe losses in the quarter. Our adjusted combined ratio was 68.9% for the third quarter, compared to 63.6% in the third quarter of 2019. We believe that given the unprecedented activity in the third quarter, this is a better measure of our results for comparison purposes and offers a better sense of our business on a steady state basis. Net investment income for the third quarter was $2.1 million, an increase of 23.7% compared to the prior year's third quarter. The increase was largely due to a higher average balance of investments during the three months ended September 30, 2020, due primarily to proceeds from our primary stock offerings during the period, as well as cash generated from operations. Funds are generally invested conservatively in high-quality securities, including government agency, asset, and mortgage-backed securities, municipal and corporate bonds with an average credit rating of A1A+. Our fixed income investment portfolio book yield during the third quarter was 2.33% compared to 2.9% for the third quarter of 2019. The weighted average duration of our fixed maturity investment portfolio, including cash or cobblets, was four years at quarter end. Cash and invested assets totaled $450 million at quarter end compared to $263.2 million at September 30th, 2019. For the third quarter, we recognize realized and unrealized gain on investments in the consolidated statement of income of $24,400 compared to $361,000 in the prior year's third quarter. Our effective tax rate for the third quarter of 2020 was 28.2% compared to 21.1% for the third quarter of 2019. Higher this quarter with the pre-tax loss in conjunction with the discrete tax deduction of stock-related compensation. This would decrease the effective tax rate in periods of pre-tax income. Excluding any unforeseen events, we anticipate our tax rate exclusive of discrete permanent items will settle around the 21% mark for the 2020 year. Our stockholders' equity was $361.9 million in September 30th, 2020, compared to $218.6 million at December 31st, 2019. For the third quarter of 2020, annualized return on equity was a negative 17% compared to 14.6% during the third quarter of 2019. Our annualized adjusted return on equity, excluding catastrophe losses during the third quarter, was 14.8% compared to 18.8% during the third quarter of 2019. The change in annualized return on equity and annualized adjusted return on equity, excluding catastrophe losses, reflects significant increase in the company's stockholders' equity primarily due to $125.5 million in capital raised across multiple stock offerings during 2020. Looking to the remainder of the year, given the heightened CAT activity during the third quarter and into the fourth quarter, we are adjusting our full-year 2020 outlook. We previously projected adjusted net income between $50.5 million and $53 million. This range did not assume any losses from major catastrophes as we defined them. We are now anticipating full-year adjusted net income, excluding catastrophe losses, between $51 million and $52 million, which equates to a growth rate of 35% to 37% year-over-year. These assumptions include the additional reinsurance purchased and assumed that there are no major losses from business interruption legislation. As of September 30, 2020, we had $26,271,000 615 diluted shares outstanding as calculated using the Treasury stock method. We do not anticipate a material increase to this number during the year ahead. With that, I'd like to ask the operator to open up the line for any questions. Operator?

Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star 1 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. Thank you. Our first question comes from the line of Matt Carletti with JMP Securities. Please proceed with your question.

Hey, thanks. Good morning. Matt, I was hoping you could maybe dive in a little bit deeper to your opening comments about some of the potential adjustments you know, making to the book, you know, kind of as you learn from the frequency of events that took place in the quarter. You know, I appreciate kind of the, you walked through a few lines and talking about kind of on the primary side exposure reduction. Can you talk a little bit about maybe some of the reinsurance tools that might be available to you to help cap that as well? And if those are things that you'd expect to kind of proceed with, or do you think that, you know, a lot of the actions you've taken on the inward side of the business will suffice?

Hey, Matt, great to hear from you, and thanks for the question. It's a great one. And I think the sum and substance of it is we need to do both. We need to take the underwriting actions that I can go into more detail on in addition to solve for the balance sheet protection. Because if we do the first, you know, the former, then we're going to be very successful in the latter. But we need to marry those two and put them together in concert. And I think it starts with when you look at our business, we have the luxury of certain lines having terrific margins and terrific growth opportunities and growth prospects in front of them. And when you marry that with our culture that's premised around problem solving, using data analytics to interpret data, I think what we try to do is be self-effacing and look to continuously improve. And when you have the win season like we did, it gives you a pretty big lens into how the book is performing. And so we have a target ROE on our individual products. It's an excess of what we deliver on an aggregated basis because it's based on a net basis and a dollar of capital is a dollar of capital. And so when you looked at the third quarter, What we saw in the commercial all-risk business, for instance, is that we were not going to hit the target ROE, certainly with the losses, but moreover, not going to hit a target ROE in those markets that would generate sufficient cap payback. And so if you think about it, if we have a target ROE of 20%, we need to make sure that we can get over time an average ROE of 20%. in a state like Louisiana, Mississippi, and Alabama. So when we applied that methodology, we just couldn't see a market opportunity that we could get enough rate and have enough premium in that segment to generate the cap payback. So that led us to take the steps that we've done, like exiting Mississippi, Alabama, and Louisiana on the commercial all-risk basis. commercial auto risk business, as well as exiting specialty homeowners in Louisiana. Turning to reinsurance, I think if we do that, we are going to materially reduce our exposure in areas where we've generated loss. We're going to, in theory, reduce potential exposure just generally for windstorms. And that will allow us to go down the path of not just buying reinsurance for severe events, but also protecting the balance sheet from multiple events. So what we will look to implement is either some type of an aggregate cover or a net quota share that really keeps losses from multiple events inside our retention. So as I said, what it's really incumbent upon is us doing the analytics and and making some tough choices, as well as making thoughtful, informed choices that will reduce our exposure, improve the underlying results from an underwriting standpoint, and then furthermore, protecting the balance sheet with new types of risk transfer that aren't just focused on major severe events, but also potentially more frequent events.

Great, and thank you for that. That's very well thought out, as usually is the case. Just one other quick one, if I could. You know, you mentioned a bit about buying the backup cover and keeping the, you know, the per event retention at 10 million or capping it at 10 million. Is that how we should think about Delta and Zeta and the potential impacts they might have in Q4? Or are there other items at work to that might not be just kind of, you know, 20 on the high side?

Yeah, so you should continue to assume that losses from a single event would be $10 million, and we have secured incremental coverage, as Chris and I both pointed out, and that is kind of locked in, and there is some incremental expense, but it's expense that we'll happily incur to maintain that level of protection. Great. Thank you for the answers, and best of luck. Thanks, Matt.

Our next question comes from the line of Paul Newsome with Piper Sandler. Please proceed with your question.

Good morning. I was hoping you could give us a little bit more detail on if there's any sort of numbers behind it, the expected growth rates of the firm, obviously quite stunning over the last couple of years. And then as part of that, I assume that the the runoff of the commercial all-risk and especially home insurances in those cap-prone lines will have at least some impact on premium growth perspective, but can you give us a sense of maybe how big that would be?

Sure, Paul. This is Mac. You know, what I would say is, first and foremost, you know, we were pleased with the growth that we achieved in the quarter and a growth in core lines like residential quake, commercial earthquake, newer lines like in the Merlene and flood. So we've – and, you know, we've also entered in some new partnerships and introduced some new products that are just getting off the ground. So we think there's considerable greenfield and growth in front of us that generate the target returns that we expect and that you all as investors expect from us, which candidly makes, while difficult, some of the decisions that we've made around shrinking the all-risk book for easier in some ways, as well as, you know, the small step that we're taking in exiting Louisiana in specialty homeowners. You know, I think, you know, it's really more of an effort to reduce exposure than reduce premium. Those markets were not that large in totality when you look at, you know, state-by-state details that's in our yellow book filings. So it will certainly, the all-risk line, the growth rate will come down, and that book certainly on the admitted side will contract, but there is ample growth in other segments, whether it's PESIC or the lines that I mentioned that will more than compensate for it. And I think it's also worth pointing out that, you know, while we took the decision to exit Louisiana on the specialty homeowners side of the business, The rest of that book is performing rather well. On a pre-capped basis, you know, Texas, Mississippi, Alabama, the Carolinas, the states in which we write that, has a combined ratio inside of 80%. And in certain states, it's less than 70%. So that book is well, and it grew rapidly in the third quarter. It's continuing to perform well. And it is generating the requisite payback that we need to see for cat exposure. So a long-winded way of saying, you know, I think there's adequate growth outside of all risk. That book will come down, but we still feel very good about the growth prospects for 21 and beyond.

Great. My second question, I think we all expected, as the book moved away from earthquake, that we would see the growth higher attritional ratios, loss ratios over time. But I don't think most of us built in really any material cat load, respectively. But as the business picks change, particularly with some of these new efforts, should we be thinking about some level of a cat load in our expectations in 2021, 2022?

Paul, I'll let Chris chime in. What I would say is, you know, the way we define capped, it's really going to be losses that are material and more than likely going to be results in reinsurance losses. And if you look in the third quarter of 2019, there were storms like Dorian, Marco, and others. So there will be capped that's in, you know, in PCS loss that is in our standard loss ratio. And that's reflected in the 10 plus percent that we incurred on kind of a normalized basis, on a steady state basis. So, you know, I think we still incur, you know, severe weather activity in our normal losses because of the exposures that we write. But, you know, a storm like Laura or Sally is a different animal. But, Chris, I'll let you offer your thoughts, too.

Yeah, so, Paul, we're not going to tell you exactly how to create your model. I think generally, obviously, we are hyper-focused on cats and trying to mitigate the risks that they can cause in our book. But we generally do not put it into our model, and it's also reflected in the way we give the guidance, is that we know that events happen, but we aren't going to become predictors of when they're going to happen and the severity that they're going to hit us at. So we do not usually think about large cats when we're doing our projections because I think it would provide too much noise and say, oh, we think a cat's going to happen in Q1 and it didn't happen, and then we outperform for that. That's not how we think about our book. We think about our book from an operational standpoint and make sure that the core is doing everything that it needs to do. And then we build the model with reinsurance, whether it be quota shares, excess of loss, and then strategically with underwriting to hope and to try and make sure that that minimizes the volatility that those losses will have on our book. So we think about it, but we don't try and put it into our model to predict when it's going to happen. But like Max said, we have included catastrophes this quarter. We've backed out some of them that are larger events, but the attritional loss ratio still does have losses from smaller events, whether it be the Earthquake in Utah, you know, crystal ball earlier this year. So there's other CAP type events that are still in the attritional loss ratio, but it's really just the what I'll call severe events that we've kind of separated from the rest of the book to kind of show that metric. But, you know, I think we have a lot of faith in what we're doing. And, you know, Mac talked about what we're adjusting to try and protect the book. But, you know, it's really the core operations that we try and focus on. and think about with all those metrics and then, you know, making sure that we're protected when a cat does happen.

And Paul, the only thing that I would add, and Chris describes that well, is that, you know, as we start to crystallize our thoughts on the net quota share or an aggregate, we will certainly inform you in terms of the cost of that may be incremental to what's in kind of our model right now, but then also what's the positive consequence of that in terms of potentially capping losses from a confluence of events like we went through in the third quarter. So I think that might be a better way for us to help manage on a go-forward basis is just what's the shifting cost of reinsurance and how much of that is associated with capping not just single event retention, but potentially some type of net quota share or aggregate solution that caps losses in totality from apparel.

Yeah, and just one, oh, sorry, Mac. So one other thing that I would add is that, you know, when we think about our historic numbers, the only other events, you know, would be Harvey and Florence that would be included in our CAT definition. So, you know, in 2019, there was no cats from the way we would define them that would go into our results.

Great. Thank you very much. I'll let some other folks ask questions, but appreciate the help. You got it.

Our next question comes from the line of Mark Hughes with Truist Securities. Please proceed with your question.

Thank you. Max, you say that the lines or the accounts you're exiting are not that large. Could you give us a specific number on that?

Well, I mean, I think they're large in terms of their TIV and their exposure. The total premium on a year-to-date kind of in-force basis for those states on a commercial basis is around $8.5 million. Mark? Okay.

Yeah, okay.

Now it's kind of in force at the end of September.

Eight and a half million in force at September.

Yep. And so, you know, these are admitted policies, so, you know, they will come up for non-renewal, and so they will wind down over the course of the year. I think, though, you know, the one thing that's a little bit nebulous, Mark, is just the impact that as we shift our appetite for riding certain risks on the coast and move further off the coast, that is not just limited to Mississippi, Alabama, and Louisiana. That's going to be in all states because what we saw from like a storm like Hurricane Sally where the expectation was that it wouldn't, whether it was intensify or just stall because it started moving basically at three miles per hour, so it stayed on the coast for an extended period of time. and did more damage from water than it did from wind, you know, that informs our underwriting perspective on coastal risk. And so coastal risk is, again, to all states in which we're writing in the southeast. We'll pull back from there. That's harder to gauge how much of that premium will be non-renewed because it's not state-specific.

And one thing I might add to that is, you know, Mark, you're focusing on the premium side of that. But we're thinking about this shift more from a profitability standpoint. So when we look at our target returns, we're taking out premium that is outside of our target returns. So hopefully when we do this move, it helps improve the overall net income and ROE of our current book. Yeah, very good point.

The moratorium in California homeowners, I think, I saw something on that the other day. I'm not sure how broad it is. Does that make it a little more difficult to sell residential quake if there's a non-renewal order in place?

Mark, that's a very good question. My short answer is it does not. Now, this is the second wave of moratoriums that California has put in place. The first one applied to, I think, around – You know, just under a million homes, I think around 850,000. This one's a little bit larger than that, or we're close to double that. But if you look at our new business over the course of 2020, we wrote, you know, more new business in 2020 for the first time this year than we did for 2019. And that's even with the big pop that we saw in the third quarter of 19 from the Ridgecrest earthquake. So I do not believe it's going to challenge our ability to sell residential earthquake in California. And frankly, the continued dislocation in the homeowner's market, whether there's a moratorium in certain segments, it's statewide. It's, you know, the wildfire season was longer. It was more dramatic and more pronounced and therefore more impactful on the at a minimum of homeowners insurers. So this location continues, and I think it's going to persist. And I think, again, look no further than the slew of partnerships that we continue to do in California with either new entrants on the ENS side or incumbents that are looking to pull back in the market.

The Giovera, why did they pursue a renewal rights Is there any rate action that you need to take when you take over that boat?

Mark, you know, I can't speak for Giovera's intention in their decision to exit the market. They were great to work with on this deal, and we left it the opportunity to further bolster our presence there. in the market of Hawaii. You know, it's one that we're now offering multiple products in Hawaiian hurricane most notably in flood and then some builders risking in the marine. This deal gives us true ballast and critical mass in the market. It gives us, you know, the ability to convert approximately $17 million of premium onto our book. It's in a line that does not have attritional loss, in a line that's a great diversifier from our core earthquake reinsurance program. So we're really excited about it. And then to answer your question specifically, the rates are very comparable. So we feel like we should have the ability to convert and feel that the risk is adequately priced.

Thank you very much. Thank you.

As a reminder, if you would like to ask a question, press star one on your telephone keypad. Our next question comes from the line of David Motemadden with Evercore. Please proceed with your question.

Hi, good morning. Matt, I appreciate the commentary you've made on the underwriting actions that you've taken in all risk and specialty home exiting in those states. And then also in I guess, writing further from the coast and the remaining exposure. I guess I'm wondering if there is any sort of rule of thumb or any indication about the reduction in the PMLs that this will result in or a reduction in TIV, just in terms of any sort of way that we from the outside can gauge just how much the exposure has been reduced.

Sure, Dave, and thanks for the questions. Those are good ones. You know, the PML that is going to come off from those states is, you know, it's not insignificant. It would probably constitute close to 15% of our total wind PML, but that would also, you know, and that's when you factor in Hawaii, Texas, and the Carolinas, so you now have a pretty good diverse and uncorrelated mix What it does do is it gets rid of PML and AL in a pretty correlated band. Mississippi, Alabama, and Louisiana tend to correlate. So we think that will allow us to, you know, reduce PML. It will reduce exposure. It will reduce correlated exposure. And additionally, you know, just simplistically, and I can tell that John Christensen and John Knutson will roll their eyes when I say this, but it just kind of reduces targets as well. And targets where we just don't think that there was a big enough market opportunity for us to generate the returns that we wanted. So, you know, if we have done like a kind of a roll forward, assuming kind of normal non-renewal cycles, you know, by the middle or the height of one season next year, we'll have less than a million of premium in force in those markets. Okay. on the all risk side. And there will still be some residential business there.

Got it. Okay. That's helpful. And I guess just thinking about, you know, obviously it sounds like the rate momentum, you know, has been sustained at around 14% rate increases on the commercial side. I guess I'm just wondering in terms of and I think you kind of alluded to this earlier, Mac, just in terms of the additional rate that you think you can get that would maybe offset the incremental cost of the reinsurance. And I say this because I'm just looking at the book of business and I see 45%-ish of it is in resi earthquake where that is capped in terms of how much rate you can take. And you obviously wouldn't be taking rate on that for wind risk in the Southeast US. So I guess that's a long way of asking, do you think that you can get incremental rate on the specialty home side or on the commercial or risk side that would offset the higher cost of reinsurance?

Yeah, Dave, another astute question. And what I would say, I'd like to answer it in a few different ways. First and foremost, with respect to all commercial all risk and the wind exposed across all states, we're pushing more right now than 14% on the heels of the storms and the continued dislocation in the property market, whether it's from wildfires to red shows or obviously this wind season. we're not renewing an account, you know, at less than 20%. Furthermore, we now have the E&S company, which allows us to be even more assertive, if you would, in our renewals. And that will allow us to further get more rate, provide more rate integrity, and or just – better terms and conditions. So I think we're going to see more rate. I think as it relates to, so that's on the one side of commercial earthquake, we're continuing to drive right there, 14, 15%. There's a derivative impact of rising reinsurance costs and market dislocation across property that will allow us to maintain that level of rate as well. And we're continuing to push mid-teens, high-teens rates on Quake. So we feel very good about the rates we're seeing in the commercial business. I think it's important, though, to come back to how we buy our reinsurance outside of the new changes that we'll put in around some type of aggregate or net quarter share. We buy a considerable amount of reinsurance to protect us from severe events. And this was a season of severe events, but it's worth emphasizing that Not a single event, the largest loss that we'll see as we currently have booked on a gross basis is not going to go beyond. It's only going into our second layer of reinsurance, and it's inside of 14%, 15% of our total win limit. So we buy copious amounts, and we'll continue to do so. But I think it's more important that it says that 85% of the tower is going to be renewing loss-free. Knock on wood. But right now, as we sit here today, it's loss-free. So I think that gives us ample cushion to endure rate increases, which, by the way, we already paid at 6-1. So we've kind of already bared the brunt of that. So the combination of having loss-free renewals, exposure that's come down because of the underwriting changes that we've made, and then a very, very conducive market to pushing rate in the primary side, makes us feel like we can handle the rate increases that we'll see at 6.1, especially, again, because a good portion of what is set to renew is indeed loss-free.

And one thing I might add, Mac, is, you know, David, you were talking about the residential earthquake, and I believe we've talked about this before. The residential earthquake book does have an inflation guard on it, and when you look at the overall retention above 90%, let's call it 90% of that book does get a 5% rate increase on an annual basis. So it's not a 0% rate increase anchor. There is still some rate that we're getting on the residential book, but like Max said, it is loss free when you look at it from the reinsurance side as well.

No, that's, that's great color. I really appreciate that guys. That's, that's helpful detail. Um, If I could just ask just a quick one on just overall growth continues to be very solid. I guess I'm wondering how much of a contribution the ENS business had to this quarter's growth, if any, if much at all.

Yeah, fair question, Dave. It was pretty modest. I think the ENS uh, premium was in and around $9 million. We didn't launch it until, um, uh, August. Uh, that's when we really were in the market. Um, and, um, uh, the majority of that was going, came from commercial quakes. So, you know, the new Amwins program that we talked about that went live effective, uh, one in theory, but you put that business, uh, pretty far out in advance. Um, some of the new, other um partnerships that we entered into or new producers that we appointed same thing applies so with the exception of really commercial earthquake everything else was really in its infancy and so we feel pretty good about the prospects uh for q4 and seeing you know the ens company get uh traction yeah no that that definitely sounds like there's a lot of momentum there um

So that's great. We'll stay tuned. Thanks a lot for the answers, guys.

Thank you. Our next question comes from the line of Meyer Shields with KBW. Please proceed with your question.

Great. Thanks. I guess the first question is I was hoping you could explain to me the mechanics of needing reinstatement premium. I guess naively I would have thought we would have to burn through, like, the whole $600 million one layer for that. So can you explain what I'm missing, please?

Uh, so maybe the way we, what we have is, um, we have prepaid reinstatements. Uh, so essentially, you know, we had, let's just use our, our 20 excess of 10 layer. We, if we burned through $20 million, excess of that 10 million for multiple events, we already had it reinstated. Um, so we basically had $40 million working for us, uh, excess of 10 million. to cover us from multiple events, and that certainly applied here, and we still have some of that limit in place for storms that have hit in the fourth quarter or earthquakes that just happen in the future. Plus then we procured another limit, which is 20 excess of 10, kind of back up to backfill that should that incremental 7 million, or excuse me, the incremental amount that's left in the 20 excess of 10, there's a $40 million blanket,

be totally subsumed. Okay, so we don't have the entire tower doesn't drop down or whatever. No, yeah, no, no.

We had two limits, yeah. So we have certain layers at the top of the program that cascade down, but what we've done is we have reinstatements for those two layers or those two limits, and then we've bought incremental limits to backfill the two limits that we were using.

Okay, that's helpful. I don't think I had a sophisticated enough understanding. Another naive question, I guess. Is it just unaffordable to maintain the pre-615 million dollar attachment for wind?

Mayor, candidly, yes. I mean, with the size of the book, you would more than likely be paying a rate online that's the equivalent to trading dollars. So I think we're better served putting in some type of a net quota share or an aggregate that caps losses from multiple events at a certain level. So that's certainly inside of what we experienced in third quarter. We could try to do it, but I just think the rate on lines would be pretty egregious.

Okay. No, that makes sense. And just finally, the reinstatement premium, did that impact written or earned premium at all in the third quarter, or is that all over the next three?

No, that's all over the next three. That was not placed until Q4. Okay, perfect.

All right, thanks so much for the help.

Our next question comes from the line of Adam Clover with William Blair. Please proceed with your question.

Thanks. Can we talk a bit more about the rollout of PESIC? Again, you mentioned that third quarter is just going to go in, fourth quarter is beginning to ramp up. Could you, just for perspectives, give an idea, you know, what submission levels you're seeing this quarter compared to last quarter?

Sure. Adam, you know, what I would tell you is that, you know, for one of our lines, we wrote more last week than we did in the totality of the quarter. So it's really starting to scale for those partnerships that we entered into in Q3 and towards the end of Q3. and there are several more that are forthcoming that will just be coming up and being brought online in Q4. So it's really, you know, submission count is somewhat negligible, but I think I could just give you kind of more anecdotal direction. You know, I would expect us to, you know, see pretty rapid sequential growth.

Okay. And which products are being sold through Press Academy?

Right now, we are writing commercial earthquake, national layered and shared property, which is wind, as well as quake, and then builder's risk. We have a couple of new programs that will be coming in line that will have a package, a property, and a casualty component to them. Um, but we'll give you more color, but right now, what's really, what we wrote business in is really more property, um, kind of right up the middle for what we've done. Quake, uh, builders risk and, um, kind of layered and shared wind and, uh, wind.

Okay. You mentioned the, um, the, the partnership or the deal with ambulance, which is great given the ambulance size. Now you were dealing with major wholesalers, ambulance, RT prior, but on an admitted basis. Now, obviously, you're much more in the mainstream. So, I guess, could you just give some perspective that what slice of the pie did you access before from those big wholesalers compared to what slice of the pie within your lines? Obviously, you're not doing casualty, but within your lines, what slice of the pie do you think you have now compared to when you were just dealing with them on an admitted basis?

You know, what I would say, Adam, is I'd really look at the wholesalers that we were working with kind of viewed us as a small to mid market account writer. And that's what we were doing in all risk. And that's what we were doing in commercial quake with the ENS deal. We can ENS company, we can write national schedules. We can write larger accounts where we're part of a, um, a slip, so to speak. So we're, we might be 10% of a hundred million dollar account. We might be 10% of a $50 million account. Um, when before we were only going to be, you know, they'd only come to us for 10 million, uh, as a primary layer or a standalone layer. So it, it not only gives us access to, you know, a market segment that's probably quintuple the size of where we have been in commercial quake or, um, national property. but it also allows us to kind of spread our limit more effectively, not be as concentrated as you are when you're running kind of primary risks.

Right, right, okay. And then as far as the ramp up, I mean, we talked about near term, third quarter, very, very little, fourth quarter, again, it's much more from a sequential standpoint. But, I mean, how many quarters does it really take to get deeper into, again, the AMLINs and RTs too? really begin to, you know, match with their distribution, which is quite sizable.

You know, Adam, that's a great question. I think it's also the nature, it's specific to the nature of the relationship, excuse me. So us going and doing a business arrangement partnership with SRU means that you start to come on to their in-force business, as well as seeing submissions from other offices that we're going to get directly to our commercial quake or our builder's risk team. So I think we can get scale with some partnerships quicker than getting just normal submission flow. So that's been kind of our strategy is let's get normal submission flow for our existing lines, but then let's enter into a handful of partnerships that can get us a percentage of an existing book of business. And that's why we're very excited about having someone like Jason Sears who come in to lead programs for us because that allows us to go into existing lines where there are books of business that can be moved over in addition or are dislocated in addition to kind of normal submission flow. And so that's what that anyways SRU deal does. Yeah, yeah, that makes sense.

And then this is sort of a bigger macro about the market, more ENF, but, you know, my sense is that the market had been more, unbundling versus bundling, meaning that, you know, pick a carrier that they throw in the wind, the earthquake, the flood, and often throw in some of those coverages for free. You know, I know in the last six, 12 months, what I've been hearing is that there's more of a nature to unbundle to separate those. So I guess two questions is, one, is that unbundling accelerating? And two, does that favor Palomar? And how does that favor Palomar?

Yes, that dynamic, Adam, that dynamic is existing. It's accelerating. It's favorable to Palomar. I look no further than the commercial earthquake. You know, we do 115% year over year. And a good reason for that is we're now able to go into layered and shared property accounts and um, that we previously did not have the ability to go into as an admitted insurer or were somewhat structurally limited in doing so. And so while we grew, you know, the growth in the third quarter is a lot faster or more pronounced than it was in the first half of the year. And when you look at losses from all the property losses in this quarter, wind, fire, um, Midwestern derechoes, it only further, um, sustain that dislocation and that unbundling and uncoupling.

Okay. Great. Thank you.

Thank you. We have no further questions at this time. Mr. Armstrong, I would now like to turn the floor back over to you for closing comments.

Great. Thank you, Operator, and thank you all for your time this morning. This concludes Palomar's third quarter earnings call. We appreciate the time and questions, and as always, your support. Although from a loss perspective, the third quarter was our toughest since inception, we did continue to experience very solid growth, and I believe as we apply the lessons learned from this storm season, we will emerge stronger and better positioned in which will in turn further enhance the growth opportunities for the business. We will continue to focus on profitably growing Palomar and scaling Palomar's capabilities as we expand our reach and our product footprint. We are on this journey with our investors and the team for the longer term, and Palomar remains focused on delivering for all stakeholders. Today is Veterans Day. I do want to thank all members of the armed forces for their service and all that they have done and continue to do for our country. So with that, I hope you all remain safe and healthy during this holiday season. Thanks very much, and we'll speak to you in the fourth quarter. Have a great day.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.