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spk02: Good morning and welcome to the Palomar Holdings Inc. Second Quarter 2024 Earnings Conference Call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference line will be open for questions with instructions to follow. As a reminder, this conference call is being recorded. I would now like to turn the call over to Mr. Chris Uchida, Chief Financial Officer. Please go ahead.
spk03: Thank you, operator, and good morning, everyone. We appreciate your participation in our earnings call. With me here today is Mac Armstrong, our chairman and chief executive officer. Additionally, John Christensen, our president, is here to answer questions during the Q&A portion of the call. As a reminder, a telephonic replay of this call will be available on the investor relations section of our website through 1159 p.m. Eastern Time on August 13, 2024. Before we begin, let me remind everyone that this call may contain certain statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These include remarks about management's future expectations, beliefs, estimates, plans, and prospects. Such statements are subject to a variety of risks, uncertainties, and other factors that could cause actual results to differ materially from those indicated or implied by such statements. Such risks and other factors are set forth in our quarterly report on Form 10-Q filed with the Securities and Exchange Commission. We do not undertake any duty to update such forward-looking statements. Additionally, during today's call, we will discuss certain non-GAAP measures which we believe are useful in evaluating our performance. The presentation of this additional information should not be considered in isolation or as a substitute for results prepared in accordance with U.S. GAAP. A reconciliation of these non-GAAP measures to their most comparable GAAP measure can be found in our earnings release. At this point, I'll turn the call over to Mac.
spk05: Thank you, Chris, and good morning. I am very pleased with our second quarter results as we achieved record gross written premium and adjusted net income during the quarter and put ourselves in a position to accomplish the inaugural Palomar 2X fall of doubling 2021's adjusted underwriting income in three years. Our profitable growth remains robust with gross written premium and adjusted net income increasing 40% and 47% respectively year over year. The quarter's strong financial results and a host of associated accomplishments reflect the sustained execution of not only Palomar 2X, but 2024's four strategic imperatives, grow where we want, manage dislocation and diversification, provide consistent earnings, and scale the organization. Our first imperative is centered on achieving strong premium growth across the portfolio, with an emphasis on those segments that generate the strongest risk-adjusted returns. Our top-line growth of 40% was driven by solid execution across the book of business, highlighted by our earthquake franchise, which saw an acceleration in its year-over-year growth rate from the first quarter, and the continued strong growth in our casualty book. These two product categories helped drive profitable growth with limited volatility. Our second imperative requires navigating and managing the dislocation in the market while further diversifying our business. During the quarter, we successfully replaced our June 1st Excessive Loss Reinsurance Program. Not only did we complete the 6-1 of attractive rates that were well below our initial expectations, but we also procured incremental excess of loss limit to support our growth and reduced our non-earthquake occurrence retention. Separately, we signed an agreement to acquire First Indemnity of American Insurance Company, or FIA, a regionally focused surety insurer that will allow Palomar to enter an attractive business segment, further diversify our portfolio, and create a meaningful growth driver. Our third imperative is a steadfast commitment to the delivery of consistent earnings. This quarter we achieved adjusted net income growth of 47%, enabling us to raise our guidance once again this quarter and more progressively for the fifth consecutive quarter. Additionally, we delivered an adjusted return on equity of 24.7% with slightly elevated catastrophe losses in the quarter. The fourth imperative is scaling the organization and making the requisite investments to accomplish Palomar 2X. This effort starts with an investment in people, and I'm proud to say that we've recruited industry-leading talent to join the Palomar team this quarter. As previously announced, Tim Carter joined the Palomar team as our Chief People Officer, and Rudy Hervé has come on board as our Chief Operating Officer. Their expertise and leadership will be invaluable as we continue to grow and innovate. We're executing very well, and as I mentioned at the outset of the call, we are firmly on track to achieve the Palomar 2X goal of doubling our 2021 underwriting income in three years. Importantly, this strategy is ongoing as we work to continually plant the seeds for future growth and returns. The accomplishments of 2024 in the past several years undoubtedly helped lead to AMBEST upgrading their financial strength rate into an A from an A-. This upgrade underscores our financial stability, strategic success, and health as an insurer, counterparty, and trading partner. Long-term, it should create opportunities within our portfolio and beyond. I would now like to review the performance and market conditions of our five product categories. Firstly, our core earthquake franchise grew gross written premium 25%, representing a strong acceleration from the first quarter's 13% growth rate, which, as a reminder, was 18% on a same-store basis. Overall, we remain confident that earthquake premiums will grow in the high-teens 20% range in 2024, and this quarter's performance emboldens the stance. Residential earthquake business continues to generate consistent new business growth, highlighted by strong E&S productions. The E&S book saw 38% growth year-over-year as personalized business continues to flow into the non-admitted market in California. Additionally, our residential earthquake book saw decent traction from new partnerships with Cincinnati Financial and USAA. The earthquake market remains stable and attractive from a pricing perspective. Commercial rates averaged an increase of 11.7% this quarter as compared to 11.6% in the first quarter of 2024. The 10% inflation guards that our residential earthquake qualities contain are now providing a meaningful cushion above inflationary levels and provide annual increases regardless of market condition. Consistent with prior calls, our key portfolio metrics of average annual loss and the 250-year probable maximum loss to premium ratio remain at all-time best levels. This will translate into strong net and premium growth as the cost of excess of loss reinsurance is moderated from previous highs. We remain positive on the growth and profitability prospects of our Earthquake franchise. Our aluminum and other property products do 34% year-over-year, driven by our builders' risk, excess national property, and Hawaiian hurricane lines of business. Growth in this product set slowed from the first quarter's rate as we continue to focus on our mantra, grow where we want, and curtail exposure in hurricane-exposed regions of the country. Builders Risk, our largest in the marine product, and our excess national property line continue to experience robust premium and submission growth. During the quarter, we hired more regionally focused underwriters for both business lines to expand our addressable markets and sustain the growth in these businesses. Hawaiian Hurricane premiums grew 52% in the second quarter through a combination of rate increases, as an aside, we received an approval for a 23% increase at the end of the quarter, as well as an increased level of fee generating new business written through Laulima Reciprocal Exchange. Our all-risk business has seen rate increases flatten versus the 18% in the prior quarter. However, the underlying PML and AAL metrics, much like our earthquake business, are healthy, as is the profitability of the book. And as previously mentioned, we are not increasing exposure in this line. It is worth mentioning that we did see elevated CAT losses from Texas severe convective storm and tornado activity in our builder's risk book during this quarter. Fortunately, the losses were only modestly above what CRISP budgets for many cats this time of year. The limited impact of these losses on our quarterly results is a testament to our conservative underwriting. Our casualty products had another strong quarter with premiums increasing 281% over the previous year's second quarter. Excess liability led to growth as the investments made in talent and distribution over the course of 2023 allowed the book to grow five-fold year over year. Other standout performing lines in the quarter include niche segments like contractors, general liability, real estate errors and omissions, and environmental liability. Our contractor's GL book grew 122% over the prior year, real estate E&O grew 110%, and our nascent environmental liability book grew 120% on a sequential basis from the first to second quarter. We are growing our business through broadening our distribution footprint and increasing our submission activity. Our strong growth in casualty products, which now comprises 16% of our total book, remains anchored in a conservative approach to underwriting targeted niche segments of the market. We employ prudent risk management tactics such as modest gross and net line size, avoidance of heavy bodily injury and other high severity exposure, and conservative reinsurance to call our loss potential in the classes we write. As an example, the three lines I just highlighted above, real estate E&O, contractors GL, and environmental liability, have an average net line of 1.2 million. Additionally, we continue to see decent rate increases in excess of lost costs across the casualty book. Our professional liability products are a blended increase above 10% with real estate errors and omissions rates increasing 18%. The excess liability book was up over 20% and the contractors general liability books an increase of 8%. While there are certain pockets of our casualty book that are softer from a pricing perspective, Private company DNO was down 4.8%. We continue to believe our rates are more than adequate. For the quarter, the Capsule T-Books loss ratios remain at our conservative loss picks with reserves continuing to build due to the nascency of the book. We are optimistic that as the book seasons, reserves will develop favorably. Our fronting business grew premium 20% year over year. Fronting growth is primarily driven by a new fronting partner in the personal marine yacht sector. We also saw solid performance from our cyber cross-border trucking and Texas homeowners programs. Both our Texas homeowners and cyber fronting programs had successful reinsurance renewals in the quarter, seeing improved economics and reinsurance support. As previously indicated, we do expect our fronting segment to under-index the growth of our other business segments as we take a very selective approach to curating and managing our fronting partner portfolio. In the fourth quarter, fronting premium will decline as one of our key partners, Omaha National, an AM Best rated insurance company, secured the requisite license to do business in California without a front. Termination of the contract will impact our fronting segment's growth over the next several quarters as we work to replace the lost business with new partnerships. While we have a healthy pipeline of opportunities, we will be selective as we closely manage the risk in this segment. Turning to crop, we wrote $2.2 million in premium the second quarter, which is a seasonally low period. Year-to-date, we have written over $40 million in premium compared to $0.5 million the prior year. Overall, it has been a good planting season, and we remain confident in achieving or exceeding the full-year forecast of $125 million of gross written premium. As discussed, we see significant opportunity to build a large business in the crop market. To that end, we appointed James Long, EVP of Innovation and Head of Crop Insurance in July. James joins us from Renaissance Re, where he spent 15 years as a senior-level specialty reinsurance underwriter with a focus that included global crop insurance. James will work side-by-side with John Christensen, building his business and capitalizing on the large opportunity in the crop market, which, as an aside, continues to consolidate. The number of improved insurance providers stands at 12, following Farmers Mutual Hale's recent acquisition announcement of Global Ag from AxaXL. Turning to reinsurance, we successfully placed our 6-1 excess of loss reinsurance program at pricing and terms that were better than our expectations. We also procured approximately $400 million of incremental limit to support the growth of our earthquake franchise and issued our fifth Torrey Pines re-catastrophe bond. Our reinsurance coverage now extends to $3.06 billion for earthquake events, $735 million for Hawaii hurricane events, and $117.5 million for all other perils, including continental United States hurricanes. These levels all exceed our 101 and 250-year peak zone probable maximum loss. It is important to note that we did sacrifice some savings as we reduced our event retention to 15.5 million for non-earthquake catastrophe events, including hurricane and severe convective storm, from 17.5 million the previous year. We slightly increased our earthquake retention to 20 million. These are levels that continue to be meaningfully within our stated retention guideposts of less than one-quarter adjusted net income and less than 5% of Palomar's surplus on an after-tax basis. In the spirit of delivering consistent earnings, we felt sacrificing some savings for improved predictability was prudent. Overall, our reinsurance program is becoming increasingly attracted to reinsurance as the program becomes less exposed to continental U.S. and Hawaii hurricanes. Once all Hawaii hurricane policies are assumed by Laulima, our reinsurance program will be almost entirely single-parallel earthquake, This should afford us better pricing during next year's renewal, all as equal. In addition to the excess of loss renewal, we renewed 12 other reinsurance treaties, including large quota shares for flood and builders' risk and our cyber-fronting program. Overall, the renewals were favorable, with half seen improved economics at the renewal and only one seen negative economics. I want to discuss our proposed acquisition of First Indemnity of American Insurance Company, or FIA, which we are acquiring for 1.7 times closing book value. FIA is a New Jersey domiciled insurance carrier that specializes in the underwriting of contract surety bonds for small to medium-sized contractors, primarily in the Northeast United States. FIA writes approximately $10 million in premiums, is licensed in 16 states, and is rated A- by AMBEST. The company is led by Pat Lynch, Sr., and has an experienced team with a long record of profitable underwriting. FIA has delivered loss ratios that have outperformed the broader surety market over its history, and importantly, over the last five years. Surety is a very attractive specialty insurance market that we have analyzed for several years. Surety consistently outperforms the broader P&C market in terms of combined ratios and has an underwriting cycle that does not follow the general P&C cycle. In an atypical fashion, we decided it made more sense to enter Surety through an acquisition versus building the business from the ground up. We believe FIA is a great business and one that we can help grow significantly using Palomar's capital, distribution, and technology resources. FIA is led by talented market experts, and as such, we will maintain their underwriting and claims handling philosophy and strategies. Upon closing, we will invest resources toward the expansion of their distribution and geographic footprint and help them get federal T-listing. These efforts will meaningfully expand our market opportunity. FIA's strong team will enable Palomar to confidently and expertly build a national surety franchise in a business that can become a material contributor to Palomar's earnings base over the medium term. We expect to close the acquisition before year-end and do not expect consequential revenue earnings contribution in 2024. We do expect the transaction to be accretive to 2025 earnings. As I mentioned in my opening remarks, this quarter we recruited experienced industry veterans to help us further grow and scale Palomar. We recruited Tim Carter from LPL Financial to be our Chief People Officer in June. Tim brings more than 20 years of executive leadership in human resources operations and sales functions. Additionally, Rudy Hervéz joined us from SCORE to be our new Chief Operating Officer. Rudy is an experienced insurance executive who also has more than 20 years of experience across technology, operations, strategic transformations, and mergers and acquisitions. What sets these exceptional executives apart is their proven track record and their ability to build market leaders, whether it is by officially launching new products, recruiting best-in-class talent, or implementing innovative technologies. Their experience and expertise will be invaluable as we enter the next phase of our growth. To conclude, our business is performing well, and we are raising the guidance range for our full year 2024 adjusted net income to $124 million to $130 million from $122 million to $128 million. With that, I'll turn the call over to Chris to discuss our results, including guidance assumptions in more detail.
spk03: Thank you, Matt. Please note that during my portion, when referring to any per share figure, I'm referring to per diluted common share as calculated using the Treasury stock method. This methodology requires us to include common share equivalents, such as outstanding stock options during profitable periods, and exclude them in periods when we incur a net loss. For the second quarter of 2024, our adjusted net income was $32 million, or $1.25 per share, compared to adjusted net income of $21.8 million, or $0.86 per share, for the same quarter of 2023, representing adjusted net income growth of 47%, Our second quarter adjusted underwriting income was $32.9 million compared to $23.1 million last year. Our adjusted combined ratio was 73.1% for the second quarter compared to 72.2% in the second quarter of 2023. Excluding catastrophes, our adjusted combined ratio was 70.3% for the quarter compared to 69.6% last year. For the second quarter of 2024, our annualized adjusted return on equity was 24.7%. compared to 21.3% for the same period last year. The second quarter adjusted return on equity continues to validate our ability to maintain top-line growth with a predictable rate of return above our Palomar 2X target of 20%. Growth-ridden premiums for the second quarter were $385.2 million, an increase of 40% compared to the prior year's second quarter. Along with breaking out crop, we are also regrouping our written premium to align with our five key specialty insurance products. earthquake, in the marine and other property, casualty, fronting, and crop. It is important to remember the seasonality of our crop premium. Based on our current expectations, the majority of our crop premium will be written and earned in the third quarter of each year, with only a modest premium in the second and fourth quarters. The crop premium written and earned in the third quarter will have a seasonal effect on our ratios calculated as a percentage of gross earned premium in the third quarter. Specifically, the ratios for net earned premium, acquisition expense, and other underwriting expense. Since the majority of our crop business is seeded, the net impact to our financials will not change compared to our previously shared expectations. Net earned premiums for the second quarter were $122.3 million, an increase of 47% compared to the prior year's second quarter. For the second quarter of 2024, our ratio of net earned premiums as a percentage of gross earned premiums were 37.4%. compared to 34.3% in the second quarter of 2023, and compared sequentially to 35.6% in the first quarter of 2024. The year-over-year increase in this ratio is reflective of our higher growth rate of our non-fronting lines of business, including earthquake, that seed less premium. In addition, these results include the first month of our new excess of loss reinsurance placement that started June 1st. While the dollars associated with this placement are higher to facilitate continuing earthquake growth, the risk-adjusted rate online is lower than the previous year. With our excess of loss reinsurance in place and the majority of our crop premium, for which we currently feed about 95% written and earned during the third quarter, we still expect the third quarter to be the low point of our net earned premium ratio. From there, we expect the net earned premium ratio to increase the remainder of the reinsurance treaty in a similar pattern to last year. While there is some expected seasonality in our net earned premium ratio, We continue to expect strong net earned premium growth. Losses and loss-adjusted expenses for the second quarter were $30.4 million, comprised of $27 million of non-catastrophe attritional losses and $3.4 million of catastrophe losses from severe convective storm activity. The loss ratio for the quarter was 24.9%, compared to a loss ratio of 21.5% a year ago. For the second quarter, our attritional loss ratio was 22.1%, and our catastrophe loss ratio was 2.8%. During the quarter, we also experienced favorable prior year development from our property lines of business as we continue to maintain conservative casualty reserves. We expect our attritional loss ratio to be approximately 21 to 25% for the year, and our catastrophe loss ratio to be about 2 to 3% for the year. These expectations include our estimate of third quarter catastrophe losses from Hurricanes Beryl and Debbie of $5 to $7 million. Our acquisition expense as a percentage of gross earned premiums for the second quarter was 11% compared to 10.8% in last year's second quarter and sequentially to 10.5% in the first quarter of 2024. This percentage increased for the same reasons as our net earned premium ratio, strong growth from our non-funding lines of business, resulting in higher commission expense and less seating commission to offer our acquisition expense. Similarly, We expect third quarter crop written and earned premiums result in a higher seating commission, pushing this acquisition expense ratio a little lower in the third quarter. We expect this ratio to move up from the low point in the third quarter. The ratio of our other underwriting expenses, including adjustments to gross earned premiums in the second quarter was 7.3% compared to 6.9% in the second quarter last year, and compared sequentially to 6.8% in the first quarter of 2024. slightly higher this quarter from the performance-based accruals from our strong results, but in line with our expectations as we continue to invest in our organization as we continue to grow. We continue to expect long-term scale in this ratio, while we may see periods of sequential flatness as we continue to invest in scaling the organization. Crowd premium will have a similar seasonal impact on this ratio for the third quarter as it does with the acquisition expense ratio. Our net investment income for the second quarter was $8 million, an increase of 43.6% compared to the prior year's second quarter. The year-over-year increase was primarily due to higher yields on invested assets and a higher average balance of investments held during the three months ended June 30, 2024 due to cash generated from operations. Our yield in the second quarter was 4.3% compared to 3.6% in the second quarter last year. The average yield on investments made in the second quarter was 5.9%. We continue to conservatively allocate our positions to asset classes that generate attractive risk-adjusted returns. At the end of the quarter, our net room premium to equity ratio was 1.02 to 1, and our stockholders' equity has reached $532.6 million, a testament to our profitable growth. As Mac mentioned, we are raising our full year 2024 adjusted net income guidance range again. The increased guidance range includes $6.8 million of catastrophe losses incurred for the first half of the year and $5 to $7 million of additional catastrophe losses related to Hurricanes Beryl and Debbie incurred in the third quarter, but does not include any incremental income from the FIA acquisition if it closes this year. Based on our strong performance during the first half of the year, We are raising our full-year adjusted net income guidance range to $124 million to $130 million, implying 36% adjusted net income growth at the midpoint of the range, also implying that we will double our 2021 adjusted underwriting income in three years. With our sustained strong performance, we are confident in our ability to continue achieving our Palomar 2X goal of doubling adjusted underwriting income in three to five years while maintaining an ROE above 20%. With that, I'd like to ask the operator to open the line for any questions. Operator?
spk02: Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. Remember, star two if you would like to remove your questions from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the start keys. One moment, please, while we poll for questions. The first question comes from the line of Paul Newsome with Piper Sandler. Please go ahead.
spk10: Good morning. Congratulations on the quarter. I was hoping you could give us a little bit more of your thoughts on the topic of the quarter, which is casualty reserves and I think mainly concerns that the underlying inflation rate is rising in general for cashier rates. And just, you know, to the extent you're seeing it or not seeing it in your book of business, you're growing quite there, you know, how you feel you can be really comfortable in an environment that seems kind of uncertain. Any additional thoughts would be great, I think.
spk05: Yeah, Paul, this is Matt. Good to hear from you. Thanks for the question. I think it starts just with reinforcing what we're doing in casualty, and we're writing niche segments within the market. Real estate, contractors, GL, environmental liability, narrow professional lines like collection agencies. you know, in some miscellaneous professional lines broadly. But, you know, A, we're not weighed down by, you know, legacy books of business. So it really is a matter of us making sure that we feel very confident in our underwriting, our loss picks, and our line size in risk management. So just to give you a little bit of color, you know, on the risk selection side, you We're really avoiding severity-exposed classes, whether it's public DNO or large commercial auto fleets. We have really modest limits. Our max gross line is $5 million, but as I pointed out in the call, when you look at some of those niche segments, our net line is $1.2 million. On the high end, it's going to be $2 million on a net basis. So what we like about that is, A, it insulates us from a shock loss. B, it's not in the realm of litigation, finance, and social inflation. And then there's other underwriting controls. For contractors, GL, if we do have auto, we're trying to confine it to fleets that are less than 50 units of vehicles and minimizing the number of jobs that people are driving to on a daily basis. I think the other thing, though, is when you look at how we're managing the book relative vis-a-vis loss costs, we think we're getting rate right now. The excess liability, we had rates increases that were 20% plus. On the real estate agency, it was in the high teens. And I think when you look at that line, that's also a line that's really not too exposed to social inflation, right? It's really tied to, you know, transaction values in home sales. And if there's a loss of value in the home, well, you're covered by that because you underwrite it on the value of the home and the sales that the agency does. So, you know, what you're really looking at there is you know, social inflation or, excuse me, inflation exposure that's come down meaningfully because it's tied to property values. So we are very, very focused on making sure that we have rates in excess of lost costs. We're very, very focused on managing line size. And we have terrific people that are doing it, well-experienced industry veterans that are leading the books, leading and building great books of business. So hopefully that gives you some color, but we feel very confident, and we also feel very confident we haven't touched our reserves yet. So we're building up a big book of reserves that hopefully will favor lead it all.
spk10: That's great. Second question, maybe another broad one. Could you talk about the competitive environment from your perspective with your business mix? I think there's broader concerns that, you know, properties are moderating, it casually sort of not doing much, but your mix is pretty unique. So, you know, do you think it's, you know, the same, getting better, getting worse from a competitive environment?
spk05: Yeah. So, I mean, listen, I'm going to give it somewhat broadly because we do have a diverse book of business and I'll talk about it within our five product categories. Um, You know, in the circumstance of earthquake, we feel like it remains a very attractive, competitive environment for us. Our rates remain strong, up 10 to 12 percent, 11.6 percent, I think exactly. The CEA on the residential side continues to pull back its coverage. It actually now has a rate increase that will be going into place effective, I think, the start of the year. Commercial earthquake, there still is limited capacity, and we bought incremental reinsurance to support our growth. And I think you saw the growth in the first quarter. So that's broad brush, how I would describe that. In the marine and other property, this is where we say we're growing where we want to. Yet, I mean, there is a little bit of increased competition in the all-risk book. You can see that with our rates kind of flattening in the second quarter. capacity has come back into that market because the rates have been so strong. Our metrics are really strong there, but we're not looking to grow exposure. We're seeing in builders risk a little bit more competition, but for us, you know, we're more focused on building out a national footprint there. And so we've added underwriters to help us expand in the Midwest, to help us expand in the Northeast and, you know, the Western U.S. So that's probably the thing where I'd say we see the most competition in that inland marine and other property. Casualty, you touched upon it. We're right in niche lines. We feel like we're getting rate. We're coming into markets and expanding our distribution footprint, adding underwriting talent. So we feel like there's good growth there and not too much in the way of competitive impact that's going to slow down our growth plans. Crop is the fourth one. We've seen consolidation in that market. So we still think we're the new kid on the block there. So we think we can continue to take share and are well on our way to do. And then fronting is a bit of a mixed bag. As I said, we lost one large account. A good partner, highly rated and best rated company that now has the licenses that merits it getting rid of a front. So I'd say there's competition in that market as well. So if I had to sum it up, Inland Marine and other property and fronting is probably where we're seeing the most competition.
spk10: Great. Thank you. That's very helpful. Appreciate it, as always.
spk06: Thanks, Paul. Yeah, appreciate it.
spk02: Thank you. Next question comes from the line of Mark Hughes with Truth Securities. Please go ahead.
spk09: Yeah, thank you. Good morning. The ratio of earned premium to gross, Chris, I think you say will bottom out in the third quarter at a low point. Can you kind of say roughly where that number will? bottom out?
spk03: Yeah, thanks, Mark, for the question. You and I talk about net earn premium a lot, but yeah, we do expect the net earn premium ratio to be at its low point in the third quarter. There's two factors affecting that. The one that's consistently impacted it is excess of loss. The first full quarter of our new excess of loss will be the third quarter of this year, similar to last year. So that will put pressure on the ratio. We do by that premium or by the excess of loss to support our overall growth in the portfolio. So even though the rate was down approximately 5% on a rate online basis, the dollars we spend are still going to be up. So that increased dollars will put pressure on the ratio. The second factor that's going to affect it this year and in years to come is also the crop premium. The majority of the crop premium will be written and earned in the third quarter of this year. like years to come. And so that, and we still see about 95% of that premium. So that will also put additional pressure on that ratio. And I look at it in the third quarter. So when I look at it specifically, I would expect something similar to what you saw last year. I would expect low 30s type net earn premium ratio in the third quarter. And then moving up from there, I'd say the The down and the up will probably be a little bit steeper this year, but that's really driven by crop. While when you look at the net earn premium dollars, I expect to see continued sequential growth in the net earn premium dollars. When you look at Q1, Q2, and then into Q3, I still expect the net earn premium dollars to increase, but that ratio, we'll see a little bit more variability in the third quarter, and a lot of that driven from the crop premium that we're expecting.
spk09: Thanks for that detail. And then the impact of the lost fronting business, what is the dollar amount roughly?
spk03: Yeah, so the total portfolio for that book of business is right around $165 to $168 million. So that obviously is a significant chunk of business that we will be losing. We will start losing that, or we will start, call it, rolling that over in the second or the third quarter of this year. So we'll probably experience about half of it this year. The first quarter is the heaviest quarter for that. And then just trying to get to the number right now that we will see it's about 39 million of premium last year in the third quarter. So I would say think about that as half that we will not get this year. The fourth quarter of 23 was about $37 million of written premium. The first quarter of 24 was about $48 million of written premium. And Q2 of this year, this quarter, was about $44 million of written premium. So in total, that's about $168 million of funding premium that we will be rolling off of starting in the middle of the third quarter.
spk05: I think what I would add, Mark, is just importantly, you know, I think a couple things. One, this is a company that now has the requisite licenses needed. It's always had an AM best rating, so I think it speaks to the quality of the counterparty. Two is, you know, you look at fronting, it's a nice fee income stream, but it's a lower margin product for us, so we think we can certainly play through that next year. And then some, because we have a nice pipeline, and we added new clients in the quarter, and Furthermore, there's so many other growth factors we have. I mean, the beauty of our business is we can lose someone like this, and we have a great portfolio, and we still feel very good about the long-term growth prospects of the business.
spk09: Thank you for that. In California, in the personalized market, the dislocation, I think, has been helping from the Quake standpoint. I think you talked about more movement in the E&F was beneficial on the residential side. Is that continuing to pace? How do you see the trajectory in that? Is it still as dislocated, or is that slowing down a little bit?
spk05: Mark, good question. Yes, it's continuing to pace. You know, I mentioned 38% E&S growth in residential quake in the second quarter. We're seeing still steady new business in E&S as we sit here today. The admitted homeowners market remains as stable dislocated, discombobulated, and we don't expect that to remedy itself in the near term. So we think that's a nice tailwind for us. And the other thing I'd add is, you know, a lot of the partnerships we brought on, like Cincinnati Financial, that is with their E&S offering, their high-value E&S offering. So it's a natural conduit for E&S homeowners policies to come over to Quake.
spk06: Appreciate it. Thank you. Thanks, Mark.
spk02: Thank you. Next question comes from the line of David Mott-Maden with Evercore ISI. Please go ahead.
spk00: Thanks. Good morning. I had a question just on some of the loss ratio discussion. So it sounds like 21% to 25% attritional with two to three points of CAT losses for this year. So if I think about that, all-in loss ratio of about a 23 to a 28 for this year. I guess, how are you guys thinking about that as we head into next year given all the changes in the mix of business? Any sort of thoughts there would be helpful. Thank you.
spk03: Yeah, thanks, Dave. No, I think the loss ratio is moving up as we have kind of projected and expected, right? I think the one nice thing that we're seeing is that, you know, the lines of business that do have attritional losses casualty inland marine are growing at a very strong rate. Those are profitable lines of business but those lines of business also come with attritional losses which we expect. So that growth is kind of outpacing our expectations a little bit. So we think it's prudent to kind of push the loss ratio up a little bit. We've said that I wouldn't be surprised if it moves up you know a point each every quarter as these books mature and as that earned premium and growth comes on the books. So I think that's what we're seeing. That two to three points of cat loss that you talked about, that does reflect the losses that we've seen through the first half of the year, but also our projections, our estimates for losses from Beryl and Debbie that is still kind of impacting the U.S. right now. So we hope those estimates are conservative, but we do think that our loss ratio is moving as we would expect. The other thing that when you look at our loss ratio for the quarter, there was some favorable prior period development. We're happy to see that as always. That did come from our property line of business, specifically some of our larger builders risk where we were holding some conservative reserves. We were able to close out some claims during the quarter, so we felt comfortable taking those reserves down. Importantly, as Mac pointed out a little bit earlier, we are not touching our casualty reserves, right? The casualty book is a little newer for us. We are reserving that in our minds conservatively. And we're holding those reserves. So we have not taken those reserves down at this stage. And so we feel like we have a conservative position for our total reserve base. And we hope that proves out. But importantly, our book of business is maturing. Our mix is growing in lines of business outside of earthquake while earthquake still has strong growth. These other lines are going at a greater rate. So that greater rate is causing our attritional loss ratio to move up because while these businesses are still profitable, unfortunately, they're not a sub-20 loss ratio line of business. But they're still very profitable, and so we're happy to see the attritional loss ratio move up with the growth in those lines of business.
spk00: Got it. That's helpful. And I guess just on the CAT losses, so... If I look at year to date and include the barrel and Debbie losses, I guess around 13 to 14 million. Is that sort of what you would expect in terms of a cat load for a typical year, just given the mix shift in your business?
spk05: Yeah, Dave, I think it's directional. Candidly, I believe that, you know, the second quarter had elevated SES activity and we had, you know, a tornado loss that hit our builders risk book that probably disproportionately and unusually high. So I wouldn't expect that every year, but it's not a bad trajectory. The other thing is, you know, it was the first quarter, most of those cat losses were from the flood activity in California. And if we rotate out of an El Nino into a La Nina, there may be potentially lower rain activity in Southern California. I probably just jinxed myself, but nonetheless, you know, so it's a combination of cat lotus. It's from SCS flood and, you know, continental hurricane. That's not a bad directional target over the course of the year.
spk00: Great. Thank you. And then interesting to learn a little bit more about the surety deal for FIA. I guess our Are there any other lines you haven't spoken about where you're thinking of entering and where you're sort of weighing either building it yourselves, which is what we've seen you guys do in the past, versus acquiring something like you just did here?
spk05: Yeah, good question, Dave. And what I would say is, first and foremost, we still believe that we are an organic growth story. And it's... All of the growth that we've done to date has been organic, and the predominance will remain. So FIA was unique. It's a market that we really like, but there is an expertise that we thought we were better suited to buy than build. I think you should continue to consider us an organic growth story, but in the case of FIA, because we have market experts who have generated exceptional returns and better than industry returns for decades, we found a great partner. And what I think you'll probably see, though, is, as I mentioned, it's $10 million in a premium. Our goal is to build in multiples of that, so it will turn into an organic growth story once we bring it on board. But Consider us organic growth and an opportunistic acquirer, especially when you can buy a great franchise like FIA.
spk06: Got it.
spk00: Understood. Thank you.
spk06: Thanks, Dave.
spk02: Thank you. Next question comes from the line of Andrew Anderson with Jefferies. Please go ahead.
spk04: Hey, good morning. Any way to size the benefit or expand growth opportunity from the recent AM Best upgrade, and what would be the timeline to seeing any benefit there?
spk05: Hey, Andrew. Yeah, good question. We were thrilled to get that upgrade. It's hard for us to size it. I think there are segments of our book that will be more positively impacted than others, in particular professional lines and some of the niche casualty segments that we write in. I don't think it's going to be as pertinent to property But I think it does enhance us as a counterparty. It certainly enhances us as a trading partner. And, you know, it will open distribution sources. It will potentially open new lines of business. I also think it will probably help us recruit talent. But I don't want to give you, you know, some type of dollar impact. But we're going to use it to the best of our ability to market.
spk04: Understood. And then maybe on the earthquake side, the inflation guard has been pretty sticky. Should we think of that maybe reversing in 25? And then if you could also just touch on the commercial earthquake market where pricing has at least quarter over quarter remained relatively consistent.
spk05: Yeah, I'll let John Christensen speak to that. I'll say just on the inflation guard, and he should chime in. It's a locked-in underwriting guideline that we have filed, or underwriting rule, rather, that we have filed. So we have no intention to rescind it and change it. So it will be firm for 2025.
spk01: Yeah, and I'd add, you know, that's one thing that we watch those retention ratios very closely and how the inflation guard may impact a buyer's decision to renew a policy. And as of right now, we're seeing no change in buyer behavior. So like Max said, we're pleased to continue that conservative inflation approach that we've had employed here over the last couple of years. On the commercial earthquake, to your question, you know, that rating environment, you know, continues to be very strong, the strongest in our careers. And, you know, while there has been some decreases at Mac, mentioned or flattening, I should say, of the all-risk segment. We continue to see some appreciation in rate over the course of the second quarter in the commercial earthquake segment. So more opportunities in the market and pleased to see the rates hold up.
spk05: I think, Andrew, what I would add is two things. On respect to the residential earthquake, you know, in those retention rates and sustaining those, With the CEA pushing forth a rate increase that will be effective at the start of the year, that gives us a bit of competitive cover, so to speak. And then on just all of the earthquake, the fact that we were able to lock in our reinsurance at a 5% rate decline while maintaining that type of coverage. price integrity, whether it's the inflation guard or commercial rate increases, that does bode well for net-earned premium conversion slash margin expansion in that line of business.
spk06: Thank you.
spk02: Thank you. Next question comes from the line of Mayor Shields with KBW. Please go ahead.
spk08: Great. Thanks so much. A couple of questions probably all over the place. First, is there any overlap in FIA's agency network and the contractor-related liability lines that you're writing now?
spk05: Not a lot currently. There's potentially ways to cross-sell in time. I actually think there's probably a decent cross-sell, too, with some builders' risk. But as we sit here today, there's not much in the way of geographic or distribution overlap. FIA is Northeast heavy. Our contractors, GL, tends to be Western U.S. heavy. Okay, perfect.
spk08: And I'm assuming that just because of the size and presumably the insurance prices, we shouldn't expect this to impact acquisition expense ratios for 2025. For FIA? FIA? Yeah. FIA. Yeah. Oh, go ahead, Chris.
spk03: Yeah, no, I think obviously it's a smaller book of business than some of our other lines of business, so it will – have an impact, but I wouldn't expect anything material to change just on the overall weight, even in 2025. Weight of that book in 2025? From a ratio standpoint, sorry.
spk08: Right, no, no, understood. On the fronting side, I guess, the remaining books, in other words, outside of, I guess, Omaha Casualty, if I have the name right, is that business more permanent in nature, or are clients there also looking for licensing or distribution to sort of branch out on their own over time?
spk05: Yeah, Mayor, I would say it's more permanent in nature. The Omaha National, we knew that at some point they would no longer need a front. The other ones tend to be more either MGAs or reinsurers that don't have primary primary company access.
spk08: Okay, perfect. And the last question, if I can, on Omaha National, did you retain any of that underwriting risk?
spk05: We did, yes. It had been between 5% and 7%, but that will not go forward. Okay, perfect.
spk02: Thanks so much.
spk05: Thank you.
spk02: Thank you. A reminder to all the participants that you may press star and one to ask a question. Next question comes from the line of Pablo Singon with JPMorgan.
spk07: Please go ahead. Hi, good afternoon. I was a bit surprised by the sequential increase in the net earned premium ratio, right? So just given that we only have one month of, I guess, a rebase XLL cost here. Putting that aside, as you think about where you're growing, right, are there lines of business where you get the most leverage against, you know, a reinsurance budget that's flattened out? So, you know, as you think about Resi Earthquake, that's an obvious one. It runs on an XO program. But within, say, marine or property, which I think has grown the fastest for you, you know, year to date, are there lines there that, you know, benefit like Earthquake from an XO budget that's flattened out?
spk05: Yeah, all the property business. And, you know, even Laulima, where we're now an attorney and fact manager, you know, there's more margin for us to retain potentially there. So all of the property business from builder's risk to earthquake to Hawaiian hurricane and all risk, they benefit from decreasing reinsurance pricing.
spk07: Okay. It sounds like those lines are not heavily quota shared then, right? Is that correct?
spk05: Correct. Builders risk has a quota share, but it's for non-cap. And yeah, in excess national property, same. That tends to be more fact heavy, but yes. But Hawaii earthquake and all risk, that's where there's not much quota share we're using there.
spk03: Yeah, gotcha. Maybe I'll speak a little bit just to the sequential growth in the net earn premium ratio, which was a little unexpected when we go back to the Q1 results. But I think after the placement of the excess of loss, we did receive some benefit there. So those were, it was better than our expectations. You know, we had called single digits savings there versus we were expecting a rate increase. So that definitely impacted our expectations on the net earn premium ratio. And then just overall growth in lines of business that use what's called less reinsurance or quota share reinsurance than fronting, right? Fronting was probably the slower grower over the first half of the year. So the growth in lines like in the marine and casualty, even though they still use quota share, they don't use as much as fronting. So the growth in those lines of business was a little bit ahead of our expectations as well, helped increase that net earn premium ratio sequentially from Q1 to Q2. So that's something else that needs to be factored in when you think about it. While when we talked last time, we were probably expecting that ratio to be a little bit flatter for Q2. But still, we do expect that dip in the third quarter.
spk07: Yep. Okay. That makes sense. And then switching gears here, just on the ENS Resi product in California. So the high-value homeowner's customers you're getting, are these customers net new business for you? Or are you seeing some shift from, you know, admitted policies to the ENS side?
spk05: It's both. That's a good question, Pablo, and I'd say it's both. So, you know, I've highlighted again Cincinnati Financial. Those are going to be new business. There are others that are coming into the market to buy, and only the ENS is open to them. And then we have made a deliberate decision. renewal or migration, rather, of certain policies in peak zones in Southern California or Northern California, for that matter, that we want to have on E&S paper, whether we need to charge more for it to justify the reinsurance costs or just improve the spread of risk. And go ahead, John.
spk01: Yeah, Pablo, I'd also add that, you know, as we see changes in the personalized marketing in California associated with those carriers who are participating insurers of the California Earthquake Authority. As the California Earthquake Authority reduces its exposure, particularly to those that may be kind of a higher value profile of customer, we see that business coming to us. While they may be historically earthquake buyers, we see that business coming to us on the ENS side of the house as well.
spk07: Got it. That makes sense. And then just last for me on FIA, Mackie said that the aspiration is to grow a premium base of 10 million multiples of what it is now. The question for you is, what does FIA get by being part of the Palomar platform that you think will enable that growth? Is it distribution? Is it operations? How are you thinking about all those things?
spk05: Yeah, I mean, I think our objective is to export their excellence in surety, underwriting, and claims management to a broader geographic and distribution footprint. So we can bring capital, potentially keep a little more on the balance sheet. They write nice, modest limits that... wouldn't disproportionately impact our risk management targets. So we can give them capital to write more and keep more. We definitely can open up distribution for them. And we certainly, if we can, bring more resources to bear to help them expand their geographic footprint. What you won't see is a material change in the underwriting, appetite, and classes of business, nor their claims handling approach. They are excellent at that, and that's what we want to export.
spk07: Understood. Thank you so much.
spk06: Thanks, Pablo.
spk02: Thank you. Ladies and gentlemen, we have reached the end of question and answer session. I would now like to turn the floor over to Matt Armstrong for closing comments.
spk05: Thanks, operator, and thank you to everyone for participating today. In conclusion, we have another strong quarter where we executed our Palomar 2x strategy. I want to, as always, thank our talented team. For their hard work and dedication, our success is a reflection of their efforts. You know, looking at the second half of the year, we were optimistic of our ability to execute our plan and deliver profitable growth. Lastly, I look forward to welcoming the FIA team to Palomar upon the closing of the acquisition. I'm very excited about what we are going to accomplish together. So thank you all. Enjoy the rest of your day, and we'll talk to you next quarter.
spk02: Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.
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