Palomar Holdings, Inc.

Good morning and welcome to the Palomar Holdings Inc. First Quarter 2021 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 this call over to Mr. Chris Fujita, Chief Financial Officer. Please go ahead, sir. Thank you. You may begin.

Thank you, Operator, and good morning, everyone. We appreciate your participation in our first quarter 2021 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 May 13th, 2021. Before we begin, let me remind everyone that this call may contain certain statements that constitute forward-looking statements within the meaning of 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 and implied by such statements, including, but not limited to, risk and uncertainties related to the COVID-19 pandemic. Such risks and other factors are set forth in our quarterly report on Form 10-Q, followed with the Securities 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.

Thank you, Chris, and good morning, everyone. Today, I'll speak to our first quarter results at a high level and then discuss ongoing efforts to expand our business and drive profitable growth. From there, I'll turn the call back to Chris to discuss our financial results in more detail. We had a strong first quarter. a quarter that generated solid financial results, and a quarter that puts us in a position to reap the long-term benefits of several key initiatives. Highlights of Q1 I'd like to emphasize are as follows. First, our strong growth trajectory not only continued but actually accelerated as our growth rate and premium increased by 45% during the quarter. We grew broadly across both new and existing offerings, including residential commercial earthquake, Hawaii hurricane, and in the marine. Second, Our E&S carrier, PESIC, continues to be an important driver of growth for existing products and diversification in the new lines of business. PESIC grew rapidly, approaching $100 million in annualized gross written premiums in just its second full quarter of operation. Third, we continue to refine our underwriting and risk transfer strategy while benefiting from sustained attractive pricing environment and dislocation in selected specialty insurance markets. We've spoken to this in great length on previous calls, but I'd like to emphasize that we are committed to the ongoing improvement of Palomar across all dimensions of our business and believe that our actions and results this quarter reflect this commitment and capability. Fourth, we remain focused on providing visibility into our earnings base and growth. I am very pleased that the $25 million of aggregate excess of loss reinsurance limit, which we refer to as the aggregate cover, that was secured in the first quarter will protect our balance sheet. Moreover, it establishes a floor for our earnings and return on equity. The aggregate cover is an actionable example of how we are proactively safeguarding our business and our results. Finally, our business model and strategy are architected to support continued profitable growth by addressing several attractive tailwinds and remain confident that Palomar is still in the early stages of executing upon our long-term plan and the associated market opportunities. The launch of two new products and three carrier partnerships this quarter are prime examples of this dynamic. Turning to our results in more detail, as previously mentioned, we delivered strong growth in premium growth, 45% in the first quarter. Overall, earthquake premium grew 44%, while non-earthquake premium increased 46%. Our commercial earthquake products grew up 96% in the quarter, driven by rate and distribution partners accessing PESIC. Our residential earthquake products grew 25%, Other strong contributors were Inland Marine and Hawaii Hurricane with 315% and 128% year-over-year growth, respectively. We've seen very good conversion rates on the book of business in Hawaii we acquired in late 2020. Newer products like our real estate errors and omissions program continue to gain traction and scale. Our commercial lines premiumed under 58% year-over-year during the quarter, a function of PESIX launch, new distribution sources, expanded geographic footprint, incremental product traction, and sustained pricing increases. This growth is more impressive when factoring in the runoff of our admitted all-risk policies, nearly a 7% offset to our premium growth rate. The average rate increase on renewals during the first quarter for our commercial earthquake policies was 18% versus 15% in the fourth quarter of 2020, demonstrating an ongoing hard market. We're seeing the strongest rate increases in the small to mid-sized accounts, with larger accounts showing some deceleration after an earlier dislocation. Our other commercial lines of business are also seeing state rate increases. In certain cases, like small account single-shot or large TID wood-framed builders' risk accounts, increases are well north of 20%. We also continue to use terms and conditions, as well as risk attachment points, to optimize our risk-adjusted returns. This has been most successful in our E&S All-Risk Program. Our premium retention exceeded 90% across our book during the first quarter, excluding the runoff-admitted all-risk business. Most notably, a residential earthquake, commercial earthquake, and Hawaii hurricane experienced retention rates above 93%. The continued high retention rates are a testament to the unique value our products offer insureds and distribution partners. Turning to our E&S company, PESIC, our conviction remains as strong as ever about the added dimension it will provide our business. EMS premiums in the quarter were $23.8 million, which constitutes 16% sequential growth from the fourth quarter of 2020. This considerable growth was driven by a combination of existing property lines of business, such as commercial earthquake, and new lines, such as layered and shared national property. In the quarter, we launched two new products, excess liability and national builder's risk, that while not meaningful in gross rate and premium contribution in the quarter, have meaningful prospects. The excess liability program is PESIC's first casualty line of business. The builder's risk product follows our tested playbook of launching a line of business with an initial focus on regional small commercial accounts and then expanding into national large account business with a well-respected partner. Both products are buttressed by strong quota share reinsurance programs to enable a successful and conservative launch. PESIC provides us with the flexibility to enter new market segments in an expedient fashion and serves as the logical extension of our commercial property franchise. Over the long term, we can see our E&S carrier approaching the size of our admitted carrier, as well as eventually housing the majority of our commercial business, given its superior ability to address changing market conditions. Insurance carrier partnerships continue to be a key growth driver for the company. During the first quarter, we launched a partnership with Travelers involving the marketing of Palomar's residential earthquake products to Travelers agency partners in Missouri, Indiana, and Utah. This partnership further expands our retail distribution footprint in these states and will help diversify our earthquake business. Separately, we consummated another earthquake partnership in the quarter that involved the assumption of an existing book of business via a reinsurance transaction. This new partnership provided a one-time transfer of $3.6 million of unearned premiums an inception as we stepped into the risk. We believe these partnerships deliver sustainable long-term growth and serve as an important point of how Palomar can collaborate and add value to our partners. As it pertains to reinsurance matters, there are two successful initiatives in the quarters worth highlighting. The aggregate cover in our Torrey Pines Re-Catastrophe bond specifically. The aforementioned $25 million of aggregate excess of loss reinsurance limit, effective April 1st of this year, will provide supplemental coverage against losses from multiple severe catastrophe events, including but not limited to earthquakes, hurricanes, convective storms, and floods. The aggregate coverage triggers after $30 million of pre-tax losses from qualifying events, a threshold that could be reached through full retention losses or a number of smaller events. We believe this aggregate cover further enhances visibility into our performance by providing a floor on our earnings and return on equity. At the end of the quarter, we successfully issued a $400 million 144A catastrophe bond. Torrey Pines RE is a multi-year reinsurance agreement whereby Palomar is provided with indemnity-based reinsurance covering earthquake events. It fits seamlessly into our existing traditional CAT reinsurance program. We are pleased to upsize the offering from $300 million to $400 million at compelling pricing and believe the success of the issuance reflects investor confidence in our ability to underwrite residential and commercial earthquake business effectively. The multi-year protection strengthens our robust reinsurance program, broadens our already extensive panel of reinsurance partners, and benefits policyholders, distribution, and investors by providing further transparency into our risk transfer program. As we speak here today, we are sensibly complete with our 6-1 reinsurance renewal. We are pleased with the outcome and greatly appreciate our reinsurance support, and moreover, their acceptance of the underwriting actions taken in 2020. We intend to release an 8 with more detail once all allocations, terms, and conditions are finalized. It is worth noting the cost of the 6 reinsurance renewal is reflected in our revised 2021 guidance. I want to take the opportunity to briefly touch on winter storm area. First, our thoughts remain with all those impacted by the storm, and we'd like to reiterate our commitment to supporting our affected policyholders. While Chris will provide more detail regarding the event and his remarks, I will reiterate that due to our conservative and thoughtfully designed reinsurance structure for events of this nature, our net loss from this event is approximately $1 million, in line with what was signaled on our Q4 2020 earnings call. We are hyper-focused on protecting our balance sheet from both shock attritional losses and catastrophe losses. URI proved to be the rare event where both risk transfer strategies were used simultaneously. I will also point out that Gary did not consume any of our Ag Recover. Finally, in late March, our board approved the share repurchase program effective March 31 of this year. The plan authorizes the repurchase of up to 40 million of our outstanding shares over a two-year period. This program provides the company with the flexibility to opportunistically deploy our capital in an accretive fashion when we believe our shares are underpriced and ultimately drive long-term value creation for our shareholders. That said, this program is opportunistic and does not diminish our growth strategy or our missions. We remain as energized as ever about the long-term opportunity ahead of us to bring unique products to market, to serve a growing footprint of customers, partners, and team members, and to deliver attractive results to our investors for years to come. With the strong start to the year, we are pleased to increase our adjusted net income guidance. For the fall year 2021, we believe that our adjusted net income will be between $64 and $69 million. Additionally, We believe that with our aggregate cover in place, we have established a full of approximately 10.5% adjusted return on equity and $41 million for adjusted net income for the year. 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 accordingly. For the first quarter of 2021, our net income was $16.6 million, or 63 cents per share, compared to net income of $11.8 million, or 48 cents per share for the same quarter of 2020. Our adjusted net income was $19.3 million, or 73 cents per share, compared to adjusted net income of $12.3 million or 50 cents per share for the same quarter of 2020. Gross written premiums for the first quarter were $103.6 million, representing an increase of 44.9% compared to the prior year's first quarter. As Mac indicated, this growth was driven by a combination of new products, sustained rate increases, expansion of our ENS footprint, and extension of our distribution networks. Seeded written premiums for the first quarter were $43.4 million, representing an increase of 47% compared to the prior year's first quarter. The increase was primarily due to increased excess of loss reinsurance related to our exposure growth. Additionally, our excess of loss costs were impacted by the acceleration of expenses and charges related to the reinstatement of our reinsurance program. Separately, we had increased quota share sessions due to the growth in the volume of written premiums subject to quota shares. Seeded written premiums as a percentage of gross written premiums increased to 41.9% for the three months ended March 31, 2021, from 41.3% for the three months ended March 31, 2020. This increase was primarily due to excessive loss charges and higher proportion of our written premiums being subject to quota shares. Net earned premiums for the first quarter were $47.1 million, an increase of 35.2% compared to the prior year's first quarter. due to the growth and earning of higher gross earned premiums offset by the growth and earning of higher seeded earned premiums that include the additional and accelerated reinsurance expense described earlier. For the first quarter of 2021, net earned premiums as a percentage of gross earned premiums were 51.5% compared to 53.6% in the first quarter of 2020. We believe the ratio of net earned premiums to gross earned premiums is a better metric for assessing the our business versus the ratio of net written premiums to gross written premiums. With the additional reinsurance expense impacting the first and second quarter of this year, we expect a similar gross earned premium ratio of 51.5% for the second quarter of 2021. After that, we expect this ratio to be around 52 to 54% on an annual basis, lower at the beginning of a new reinsurance placement and higher at the end with our expected growth in earned premiums. The expected net earned premium ratio contemplates the new aggregate cover that provides increased protection and improved earning visibility if we face multiple catastrophic events similar to what we saw in 2020. Losses and loss adjustment expense, or LIE, incurred in the first quarter were negative $4.4 million, made up of $5.2 million of attritional losses offset by $2.4 million of favorable prior year development on 2020 catastrophe losses, and Winter Storm Uri, which I'll describe a little more later. The loss ratio for the quarter was negative 9.4%, including an attritional loss ratio of 11.1% compared to a loss ratio of 5.4% during the same period last year comprised entirely of attritional losses. Non-catastrophe losses increased due to the growth of lines of business subject to attritional losses such as specialty homeowners, flood, and in the Marines. Due to Winter Storm URI in the first quarter, we incurred additional reinsurance charges related to the reinstatement of our reinsurance program. For the first half of 2021, URI will result in a net underwriting loss of approximately $1 million, comprised of approximately $4 million of additional reinsurance expense in the first quarter of 2021, and a similar additional reinsurance expense in the second quarter of 2021, partially offset by the negative net loss in the first quarter of 2021. Our expense ratio for the first quarter of 2021 was 69.8% compared to 58.2% in the first quarter of 2020. On an adjusted basis, our expense ratio was 62.7% for the quarter compared to 56.2% in the first quarter of 2021. The increased expense ratio was driven by additional reinsurance placements with increased seeded premiums and continued investment in PESIC. Our acquisition expense as a percentage of gross earned premiums for the first quarter of 2021 was 21.2% compared to 20.1% in the first quarter of 2020. The ratio of other underwriting expenses, including adjustments, to gross earned premiums for the first quarter of 2021 was 11.9% compared to 11.2% in the first quarter of 2020. Our combined ratio for the first quarter was 60.4% compared to 63.6% in the first quarter of 2020. Our adjusted combined ratio, which we believe is a better assessment of our efforts, was 53.3% during the first quarter compared to 61.6% in the prior year's first quarter. Net investment income for the first quarter was $2.2 million, an increase of 9% compared to the prior year's first quarter. The year-over-year increase was primarily due to a higher average balance of investments held during the three months ended March 31, 2021, offset by lower yields on invested assets. We maintain a conservative investment strategy as our funds are generally invested in high-quality securities, including government-aided securities, asset and mortgage-backed securities, and municipal and corporate bonds with an average credit quality of A1A. Our fixed income investment portfolio book yield during the first quarter was 2.24%, compared to 2.85% for the first quarter of 2020. The weighted average duration of our fixed maturity investment portfolio is including cash equivalents, was 3.97 years at quarter end. Cash and invested assets totaled $436.7 million as compared to $320.4 million at March 31, 2020. For the first quarter, we recognized losses on investments in the consolidated statement of income of $739,000 compared to a $440,000 gain in the prior year's first quarter. Our effective tax rate for the first quarter was 17.3% compared to 22.3% for the three months ended March 31st, 2020. For the current quarter, our income tax rate differed from the statutory rate due to the tax impact of the permanent component of employee stock options exercises. Our stockholders' equity was $376.4 million at March 31st, 2021 compared to $363.7 million at December 31, 2020. For the first quarter of 2021, annualized return on equity was 18% compared to 19.7% for the same period last year. Our annualized adjusted return on equity was 20.8% compared to 20.6% for the same period last year. As MAC indicated, looking ahead to 2021, we are increasing our adjusted net income guidance to between $64 to $69 million. This adjusted net income guidance considers the impact of Winter Storm URI in Texas. Additionally, with some of the moving pieces associated with Winter Storm URI described earlier, we are providing adjusted net income guidance for the first half of 2021 of between $31.5 million and $33 million. We believe the unique nature of Winter Storm URI's impact to our financial results over multiple quarters necessitates this additional guidance. While we believe that this additional guidance is warranted in the current situation, We will only provide this type of information in the future if we believe the facts warrant such disclosure. As of March 31, 2021, we had 26,198,960 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?

At this time, we will 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 sign will indicate your line is in the question queue. You may press star 2 to remove your question from the queue. For participants using speaker equipment, it may be necessary for you to pick up your handset before pressing the star key. One moment while we poll for questions. Our first question comes from Matt Carletti with J&P. You may proceed with your question.

Hey, thanks. Good morning. Just a couple of numbers questions for me. First is on the current year attritional loss ratio. Is there anything to note in that in terms of kind of one-timers one way or the other, or is that a good kind of starting point to think about kind of where the business is today? And I would presume as we go forward and some of the newer products, you know, grow at a faster rate than some of the earthquake products that slow drift higher.

Hey, Matt. This is Matt. Good to hear from you. Chris will chime in and have some thoughts on this as well, but what I would provide is when you look at the attritional loss ratio, there are a few things that I believe are worth highlighting. First is exactly what you touched upon in that it is a function of the growth of certain lines of business that have exposure to attritional loss. I'll pick on Inland Marine, for instance. It grew 315%. It has some attritional loss to it. Now, mind you, it's performing in line with expectation, but as that grows at a disproportionate level or over-indexes the rest of the book, that will move the loss ratio up significantly. Similarly, that's what you would see even with the new E&S all-risk line of business, which is one of the big drivers of the E&S growth. That does have attritional loss, so that outpaces the growth of maybe a residential earthquake, for instance, or you're going to see that attritional loss tick up. The other point that I would make, though, is, you know, we kind of guided folks towards a slow increase of that attritional loss ratio. You know, it was 11% in this quarter. That number is somewhat obfuscated by how URI is being accounted for with reinstatement premiums. a reinsurance expense as opposed to being captured in the loss ratio, that reduced our net premiums earned. So if you kind of normalize the 11% attritional loss ratio, it's closer to a 10%, which is just a subtle increase from the fourth quarter. So that's what I would point out, but I'm sure Chris has a few things to offer.

Yeah, no, thanks, Mac. I think you described it well, obviously. When you look at it compared to what we talked about before, we have indicated when you think about the end of 2020, the overall loss ratio for the year was about 8.5%. We had indicated that we do expect that to tick up. I think we indicated probably about two to three points for 2021. When you think about that, that's right in line with that, especially when you think about the higher seeded premium that kind of makes the ratio a little bit higher. You can adjust that out and think of it as more as 10%, I think, seasonally. Also, the first quarter is a little bit of a higher loss ratio month for us just naturally because of some of the exposure that we have in Texas and other states that kind of have some tour hail or even, you know, with events similar to URI, you know, when some of our other lines had higher exposure with whether it be motor truck cargo that was impacted by some of the icy roads that were out there. So just a little bit higher in nature. But overall, nothing that I would say is surprising and kind of in line with what we would expect to see based on the growth of the lines we talked about and then also some of the indications we gave to the market after following the year-end results.

Yeah, and just to piggyback on that seasonality point, you know, even like you look at a line like flood for us, you know, where we write flood, states like California and even in Hawaii, There's some seasonality to it, so we see a little bit higher loss in the first quarter of the year than we do the rest of the year, certainly in a state like California.

Okay, great. That's helpful. And then kind of the follow-up there, just speaking about that extra $4 million of a seeded premium, that will also impact Q2. All odds equal that 10 would look more like an 11 in Q2 as well, correct? And obviously I understand the seasonality could be different and mix the business different and so forth, but all odds equal. that would repeat itself in 2Q.

Yeah, that's correct.

Yeah, there will be incremental reinsurance expense associated with URI in the second quarter.

That's exactly right. All right, great. Wonderful. Thank you very much for the color. Appreciate it.

Our next question comes from the line of David Modemadden with Epicor ISI. You may proceed with your question.

Hi, thanks. Good morning. I just had a question, you know, good to see growth re-accelerate this quarter. I guess I'm wondering, you know, was there anything sort of one-off in the growth that you would call out or is this sort of a good indication of what we should expect to see from a growth standpoint over the course of the rest of the year?

Hey, Dave. Great question. We were thrilled to see the growth, and we expected it. And we touched upon it at the end of Q4 earnings call that we saw very good momentum in the business. And it did manifest itself in Q1, and we think it's going to manifest itself through the rest of the year. To your question on one-offs, as I mentioned in my remarks, there was $3.6 million of premium that was associated with the earthquake book, both commercial and residential, for a partnership that we stepped into that you could argue is one-off. But at the same time, there also was around seven points, call it $7 million of premium that was wound down from the all-risk book. So net, it washes. So I guess the best way to describe it is when it's all said and done in this quarter, there's nothing really one-off because there was one thing to the good and one thing that was probably 2x that to the bad. So we feel very good about the growth in this quarter and how we're positioned for Q2 and beyond.

Got it. Thanks for that. And just on the all-risk book that's winding down, the $7 million – of a headwind this quarter, the seven points. Is that going to remain around that level over the course of the year as that book non-renews? Or are there some chunkier pieces that are rolling off in subsequent quarters?

I think that should be a good rule of thumb for the year. It'll probably be less pronounced in Q4 because that's when we started to non-renew. So the majority of the policies will be coming off into the October timeframe, but I think that is a good rule of thumb. Now, the one thing that we have going for us is that the national accounts all-risk business, the layered and shared all-risk business that we're doing in concert with Amwins is growing. It's growing nicely. It's getting great returns. It's hitting our metrics, if not exceeding them, from an average annual loss. and a PML for the premium standpoint. So we're encouraged with that. So that mitigates that decline and will continue to drive growth beyond 2021. But I do think that, you know, there's that seven points of headwind associated with the wind down of the admitted book that we'll see over the course of the next, certainly the next Q2 and Q3, and it might be a little bit less in Q4.

Got it. That makes sense. And then I guess on the other side, obviously the E&S book continues to ramp up. You know is it I guess maybe could you just quantify sounds like 25 million a court this quarter of gross premiums I believe it was 21 million last quarter so you know Ramping up on an annualized basis by a decent amount I guess if we sort of reached You know, you know, do you expect to see a continued sequential acceleration in that or we kind of hit a the capacity now of where you think it kind of can, like, obviously still very good year-over-year growth, but, you know, maybe it slows down a bit more sequentially.

Yeah, Dave, you know, I don't want to give guidance on sequential growth, but what I would say is there's very good momentum in the E&S company right now, and it's coming from commercial earthquake, it's coming from national property accounts. There are also new programs that we launched in the second quarter, as I said, that were not meaningful contributors. In particular, a builder's risk partnership for national builder's risk accounts, our excess liability program. All of those have great potential, terrific market conditions to be participating in or capturing or taking advantage of, rather. great distribution partners that can drive production, some cases an existing book of business that we can slot into. So I would say there's terrific momentum in the lines that we launched in Q3 and Q4 of 20. There's a lot of terrific potential in products that are just getting off the ground in Q1. And then lastly, we're not done. There are several more that are in various stages of R&D, so to speak. So I think you'll see more products in the E&S market come online from us this year, which gives us the conviction to say that in time, the majority of our commercial business could be ENS, as well as it has the potential to be the same size as the emitted company.

Got it. Great. Thanks for the color.

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

Congratulations from the quarter. I just have one remaining question, and I apologize. This may just be confusing, but a negative loss ratio is an amazing thing. I don't think I've seen it once in my career. But what's interesting to me is the current year was a negative number, not just the prior year development. Could you talk about how that just mechanically works from an accounting perspective, how you get to a negative note for the current, because current year is just this last month. Is that a function of the insurance, or is there something else going on?

Hey, Paul, it's Chris. Let me respond to your question. Yeah, it's a good thing. You pointed it out. Yeah, it is a little bit of something that is unusual to see. I think it just naturally happened that way. based on the way that our reinsurance is structured. Obviously, we've talked about this before. We use quota share reinsurance for a lot of our attritional lines of business, and then we buffer that with excess of loss. This just happened to be an attritional loss that went into our cat tower as well. These contracts or these reinsurance relationships do not inure to the benefit of each other, so I think that's one thing to point out when we look at it. You know, we think of the negative loss as being offset by the seeded premium that is related to reinstatement of the reinsurance layers. I think when you look at it in Q4, that was about $4 million. This is going to probably be a similar amount in Q2, just because of the way the reinsurance is expensed through seeded premium. So if we were to combine those numbers, I think we talked about it on the prepared remarks, we think that is a negative $1 million. So for us, it's really You know, the accounting treatment kind of shows it in two different lines, but we think of it as a combined loss. And, you know, one example or maybe an analogy that we think of is, you know, think of this as we used our reinsurance structure with a reinstatement premium function to it so that when the event happened, you know, we were able to recover 100% of loss and then offset that with a reinstatement premium. We could have also structured this with a co-participation, where instead of recovering 100%, we only recovered the net amount. So in that scenario, our loss would have been about the same, a million dollar loss. You just would have seen it all through the loss line versus us. We used reinstatement premium for our structure. And so you can see it in the seeded premium and in the loss numbers. So that's kind of the, I'll call it, a little bit of the nuts and bolts about the accounting treatment and why it's in different lines you know, and why it's showing up over multiple quarters. And that also reiterates the reason why we gave, you know, on the call, we gave a half or a full, the first half year guidance because, you know, with the ups and downs caused by that reinsurance charge, we wanted to make sure the market had a better view of how we were thinking about the first half of 2021 impacted by those reinsurance charges.

Yeah, Chris describes it well, Paul. Ultimately, it is a negative number in that loss, but it ultimately ends up collectively being, when you factor in reinstatements and the like, a loss of $1 million, a positive loss, so to speak.

An actual loss. That makes a ton of sense. Thank you. That was very helpful, actually. Appreciate it.

Our next question comes from Mark Hughes with Truist. You may proceed with your question.

Yeah, thank you. Good afternoon and good morning. Can you talk about capital, kind of where you sit? Obviously, PESIC is ramping up pretty quickly. How much more runway do you have with your current balance sheet?

Yeah, Mark, this is Mac. It's a very good question. And what I would say is we have ample capital to support the growth that we have in front of us. You know, we right now are in and around a 0.5 net premiums earned to surplus ratio. Our long-term target on that is 0.9 to 1. In fact, that target could actually be moving up somewhat because of the complexion of the book as we write some casualty business that has a longer tail to it. So as a result, we think we are adequately capitalized and then some to go execute on the plan that we've put in place. I also think it's the impetus behind why we authorize a stock buyback because we think that we can be opportunistic in how we deploy capital. We can be opportunistic to go out and do an acquisition like we did in Hawaii and acquire a book of business which we're doing an excellent job of bringing on to our paper. We could go out and buy back our stock and acquire our currency at what we think is a very attractive valuation and get an ROE that's in the mid-teens. Or we can continue to invest it in the business where we could bring on new teams or enter into new lines of business. And fortunately, the capital position that we are in right now really affords us the chance to do all of those. So we think that we can be very effective in how we deploy capital over the next several quarters and generate attractive ROEs in several different fashions.

Thank you for that. Then the excess liability book, how are you approaching it from an underwriting perspective? What expertise have you brought in-house? What is informing your judgment about what the pieces of business you should write?

Yeah, that's a very good question, Mark. And what I will tell you is we have brought in a leader in Jason Sears who's overseeing all of our program business, but he's a long-standing casualty underwriter. And we have selected a partner who he has a long-standing history with to help us build out the excess liability franchise. I think overarchingly what we are doing in excess liability is very similar to what we've done with all lines of business that we've gone into that are not earthquake or not Hawaiian hurricane. It might be viewed as a little further afield. And that is be very deliberate in terms of how much we want to write in year one, very conservative in how much limit we're willing to write, and then also very conservative in how we use reinsurance to support it. So in this circumstance, We will write no more than a $5 million gross line, but we're taking around 22.5% of that. So our net position is around a $1.1 million line. And we are attaching it in excess position. in a market that is very hard right now. We think we have the potential to build a nice book of business there. It's with a production plant that we have great history with in the property arena, but what we're trying to do now is get them familiar with our philosophy and strategy in this segment and Casualty generally. But I think there's great promise there. But it's not a circumstance where we're going to turn around and write $50 million of excess liability in year one. It's going to be modest, but it does have the potential maybe in year two, year three to be, you know, a sizable book.

Thank you.

Our next question comes from the line of Tracy Benguigui with Barclays. You may proceed with your question.

Thank you. I just wanted to follow up on some comments you made about the buyback authorization. I totally get that you're not trying to signal that you're not constructive about growth. But just help me think about how that may be attractive to you because usually you tend to see companies want to buy back more stock when they're trading below or near book value and you're well above that. So if you could just help me understand the framework you have in mind.

Yeah, sure, Tracy. This is Mack, and it's a fair question to ask. I think for our board and us as a management team, we look at our earnings growth potential and all the steps that we've taken to provide consistency and stability in the earnings, whether it's with the aggregate cover, whether it's with even the cap bond, and certainly with all the underwriting changes. We have considerable conviction in the visibility that we have in the business, That's why we took guidance up. And we think that when you look at our, you know, my background as a former reform private equity investor is we look at earnings growth and the price of earnings growth, and we think that is pretty compelling at this level. It's materially below our earnings growth trajectory. And so that's part of the impetus, and that's why our board has gotten comfortable with the buyback.

Okay, excellent. That was very helpful. You're growing in so many different areas, but if I could just take you home to your earthquake risk. I know it is particularly within commercial that's grown pretty substantially, and I'm just wondering if others just don't have the appetite now, like what you're seeing in terms of competition and risk appetite in that space.

Sure, Tracy. I think an earthquake, a commercial earthquake, the one that you specifically called out, it did have terrific growth in excess of 90 plus percent, like 96 percent. That was as much of us being able to continue to take rate, especially in our small commercial earthquake franchise, but also opening up the E&S company to our long-standing distribution partners. So that's allowed us to get under risk that we previously didn't have as much access to. Call it mid-size or large account business where our admitted offering really was not acceptable or not permissible just because of forms and coverages and rigidity of such. So I think that's what's allowed us to come on and build a business show very strong growth in Q1 in the commercial quake. Competition-wise, I think there is competition in that market, but generally speaking, there is very good rate integrity. I actually touched upon it in large accounts. We're probably seeing a little pullback in the rate increases and the acceleration of rates. Small account, you're still seeing very good rates. So, overarching, I think we've got, you know, very good runway in commercial quake. I'm not saying that 96% is sustainable, but I do believe that the market condition certainly is amenable to us as a new entrant, so to speak, on the ENS side, as well as a longstanding entrant on the admitted side or a longstanding participant on the admitted side continuing to take, share, and drive terms and conditions.

Thank you. Very comprehensive answer. I really appreciate it.

No, thanks.

Our next question comes from the line of Mayor Shields with KBW. You may proceed with your question.

Great, thanks. I had a couple of numbers questions first and then one bigger picture question. So, yes, I'm going to direct this to Chris. If we take out the $3.3 million of adjustments, then we get underlying operating expenses at just under $11 million. Is that a good run rate for the year?

yeah thanks man no i would say that that's a decent run rate i think as we projected before we did expect call it q1 from a percentage standpoint to be up to flat compared to where it was last year so i think you know that's a pretty good run rate i do expect let's call it with the growth and earn premium the scale to be more in the latter half of 2021 and from there on but no i i don't I wouldn't shy away from that run rate from a materiality standpoint. I think it's a good point to pick off of. Okay.

Perfect. And then on the reinstatement premiums, I just want to make sure that only impacts the, I guess, seeded earned premium, seeded written, seeded earned premium, right? That doesn't impact the actual operating expenses.

That is correct. It does not impact the actual operating expenses. It's only seeded written and seeded earned premiums. But it does impact the ratios because it decreases the denominator that those ratios are calculated off of. So that's why we were kind of doing a little bit of math earlier to help break that out. But, yeah, it's not in any of the operating expense dollars. It is just in the debtor premium, basically.

Okay. No, that's perfect. Thank you. And then that bigger question, I know there's a lot of conversation about construction material cost inflation. How quickly can you incorporate? I mean, if you assume that that inflation will persist, how quickly can it be incorporated in pricing? And should we worry that we're seeing the larger properties rate increases decelerate at the same time as maybe inflation getting worse?

Hey, Mayor, yeah, it is interesting. And, you know, there have been certain cases where we've had estimates move up because of the cost of lumber and the like. And so that's being factored into the underwriting. And that is, you know, everything that we do from underwriting at the risk level or modeling at the portfolio level and the reinsurance, we always throw demand surge on. for expected loss and average annual loss. And so that should be captured in how we price a risk again at the portfolio or at the individual level. So what I would tell you is we should be staying ahead of that and having the ENS company is allowing us to do it. I go to what I mentioned on the call, I'll pick on or highlight our builder's risk. That's where you would most directly feel the cost day-to-day and just in terms of your projects, building them and bringing them up the ground or replacing them and approving them on the heels of a loss. We're seeing as much as 30% rate increases for large account and certainly north of 20 for single-shot small account business, which is definitely keeping pace with the rising cost of goods in that regard. But we're watching it, and it is something that I think the whole industry... is focused on. We're also focused on, frankly, the potential labor shortage driven by it as well, you know, with the demand for new build or in areas that were, you know, materially impacted like, you know, Lake Charles, Louisiana. It's not just the cost, it's the labor. So we have to factor that in as well. Okay. That's perfect.

Thank you.

Our next question comes from the line of Adam Klamber with William Blair. You may proceed with your question.

Hi. Can you talk on the sales support or field network? As you go into new products, have you been expanding that? Excuse me. How big is that today versus a year ago?

Adam, this is Mac. Just to clarify, you're asking about the sales support in our production plant and the like, or are you talking here? Your field, you know, your field sales. Yep, yeah, no, great question. So if you look at just year over year, our distribution footprint grew by 22%. And, you know, a line like in the marine that grew 300%, the distribution footprint was up 63%. residential earthquake was up 25% year-over-year. These are metrics that we track very closely because they are leading indicators of future growth as well as existing growth. I'll highlight residential earthquake. For instance, we added on a sequential basis a couple hundred producers from Q4 to Q1 And that was driven as much by new partnerships. So the Travelers Partnership, we were able to appoint new producers. Now, did they all start sending over a ton of submissions and did we bind a ton of policies? No, that wasn't the case, but it's a good leading indicator for what the potential can be. So we are definitely expanding our distribution network. The combination of partnerships, new products and obviously just opening up PESIC, the ENS company, to either existing or new distribution sources is the contributing factor to that.

Okay, thanks. And then as far as the excess of loss and the builder's risk, are those programs and who are the distribution partners on those programs?

Yeah, the access liability is a program, and that's with K2, an MGA we've known for a long time. The leadership there, a lot of us, well, the entire management team has worked with the leadership team there. And then the builder's risk is with True Technical Risk Underwriters, which is part of RSG. And what we've done there is it's very similar to what we've done in Kuwait, where we have Our in-house builder's risk team, led by Robert Byerly, who's built our inland marine department, he oversees that program while he's also writing it day-to-day on a small commercial or mid-size account basis. It's a tried-and-true formula that we've gone for a large account business we're going to work with. a partner that can use our capacity to support a layered and shared strategy while writing it in-house for small single accounts or mid-sized accounts. And that's what we've done in Quake. That's what we have done in Builders Risk. And we've done, to a lesser degree, in All Risk as well.

Great. And then as far as end of April, there were some, I think, some bad storms in the south. Does your first half guidance, I guess, include those storms? And do you think those storms for you will have a bigger or lower impact than you saw with URI?

Adam, good question. First half guidance definitely incorporates thoughts on losses from those storms, and it will not look like URI. Okay.

And then last question. I'm sorry if you said this. As you're renewing your main cat tree for the end of the year, what's your limit going to be, your retention? Is it still going to be $10 million, or is that being pushed up?

So what I can tell you is we've actually finalized the placement yesterday after the earnings went out, and we were pleased with the outcome and the support that we received from our reinsurers. And what I'll tell you right now is while we're kind of dotting I's, crossing T's, and getting all the paperwork put together, we procured more limit to support our growth, and this will all be out in an 8K. We basically maintained the retention in line with what it was in 2020. The complexion is going to be a little bit different, you know, but it's going to be basically the same number, if not a little bit less. And we've also incorporated all of the rate changes, including those from loss-impacted layers, into our guidance. So, you know, long story short, the sixth one went how we had hoped. And we also were able to go out and secure an aggregate and place a cap bond in addition to that, which gives us even more conviction on stability and predictability in the earnings. Great. Okay. Thank you. Thank you very much.

Our last question comes from the line of Pablo Singsong with J.P. Morgan. You may proceed with your question.

Hi. Can you hear me?

Yep. Loud and clear, Pablo.

Yep. Perfect. So I just wanted to follow up on your net income guidance, which increased by 2 million at both ends of the range. Did the favorable PYD factor into this at all, which I think was a little over 2 million in the first quarter, or did you have other considerations when you raised the range?

Yeah, Pablo, what I'd say is, you know, as we raised the range, you know, we factored in Q1 and from the positive development from URI to the, excuse me, positive development from prior quarter storms. We've also factored in the impact of URI in the first two quarters, and then also the strong growth. So we feel very good about the guidance that we've pushed up. You know, we think that the range we provided is achievable, you know, and also ambitious. There's just great momentum in the business. And ultimately, you know, there's some favorable development Q2. You know, that's a nice dynamic to have. Or Q1, excuse me, that's a nice dynamic to have. We're not going to hang our hat on that every quarter. So we've just assumed that everything else remains flat for the course of the year in terms of development, that is. And if we get continued favorable development, that's icing on the cake.

Understood. Second question. So you're clearly benefiting from pricing on the ENF side. Can you talk about the pricing dynamic in admitted earthquakes? How does pricing there tend to move in relation to the broader P&T market? And maybe if you can distinguish between commercial, which is, I guess, at this point, very less admitted, and residential, which is admitted.

Yeah, so residential earthquake, the rates are not changing beyond an inflation guard that we have on the product. And we have not put a rate filing in place to change rates since we've started the business. Our results have been strong. So... The residential market rates are not changing on an admitted basis. Now, we are writing E&S business on residential earthquake, and that tends to be more high value, and therefore it's a different underwriting because of the content exposure, the cost of reconstruction, labor demand, all those questions that were asked. previously of us, and there I would say you're looking at rate increases and rate activity that's more similar to the commercial. So I would almost placate it between ENS and admitted, and residential ENS looks a lot like commercial ENS. Admitted, more standard business. You are kind of governed by what the state permits, and we're not taking rate based on the historical action and the performance of the book.

Got it. And my last question, is there sort of a high-level way to think about the mix of commercial and residential earthquake in your book? So clearly commercial is growing much faster. I'm not sure if it makes sense to sort of look at where your book could end up by essentially looking at, you know, where the overall earthquake market is right into the share. Or do you think at some point, you know, just because ENS is growing so fast that maybe commercial will become a bigger book than residential? Just sort of, you know, high-level thoughts on how that book could develop over time.

Yeah, at a high level, we want to maintain earthquake at 50% of our business on the whole. Yeah, I mean, I think commercial is ultimately a bigger problem. and market, and as our balance sheet grows and as the E&S company gets traction, I think the delta in terms of percentage mix between commercial and residential could close down. But even if you just look at where we exited the quarter, there's still a pretty decent head start that residential has, and residential is still growing at a pretty good clip at 25% in the quarter. So I think the gap will shrink, but it's still 50% more. So I think there's a ways to go.

Okay. Thanks for your answers.

Ladies and gentlemen, we have reached the end of today's question and answer session. I would like to turn this call back over to Mr. Mack Armstrong for closing remarks.

Great, thank you, operator, and thank you all for your time this morning. This concludes Palomar's first quarter earnings call. We appreciate your participation and questions and always your support. We are pleased with our first quarter results, and more importantly, I think we're very enthusiastic about our growth prospects on a go-forward basis. We executed across all facets of our plan during this strong quarter. illustratively our strong premium growth laid the ground for continued momentum in existing franchises as well we have new lines of business that could provide incremental growth that are just getting off the ground where new partnerships and new geographies that we have entered into we've also made meaningful progress on enhancing the predictability of our results so as such we raised our guidance and And we hope you can sense our enthusiasm for what lays ahead of us and hopefully share it. So thanks, everyone. We look forward to speaking to you after the second quarter. Have a great day.

You may now disconnect your lines at this time. Thank you for your participation. Enjoy the rest of your day.