Palomar Holdings, Inc. (NASDAQ:PLMR) Q4 2023 Earnings Call Transcript
Palomar Holdings, Inc. (NASDAQ:PLMR) Q4 2023 Earnings Call Transcript February 15, 2024
Palomar Holdings, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Good morning, and welcome to Palomar Holdings, Inc. Fourth Quarter and Full Year 2023 Earnings Conference Call. During today’s presentation, all parties will be in a listen-only mode. [Operator Instructions] 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.
Chris Uchida : Thank you, operator, and good morning, everyone. We appreciate your participation in our earnings call. With me here today is Mac Armstrong, our Chairman and Chief Executive Officer. Additionally, Jon Christianson, our President is here to answer questions during the Q&A portion of the call. As a reminder, a telephonic replay of this call will be available on the Investor Relations section of our website through 11:59 PM Eastern Time on February 22, 2024. Before we begin, let me remind everyone that this call may contain certain statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These include remarks about management's future expectations, beliefs, estimates, plans and prospects.
Such statements are subject to a variety of risks, uncertainties and other factors that could cause actual results to differ materially from those indicated or implied by such statements. Such risks and other factors are set forth in our quarterly report on Form 10-Q filed with the Securities and Exchange Commission. We do not undertake any duty to update such forward-looking statements. Additionally, during today's call, we will discuss certain non-GAAP measures, which we believe are useful in evaluating our performance. The presentation of this additional information should not be considered in isolation or as a substitute for results prepared in accordance with U.S. GAAP. A reconciliation of these non-GAAP measures to their most comparable GAAP measure can be found in our earnings release.
At this point, I'll turn the call over to Mac.
Mac Armstrong : Thank you, Chris, and good morning. Fourth quarter provided a strong end to what was a stellar 2023. The quarterly results included record gross written premium and adjusted net income, premium adjusted net income growth of 27% and 33%, respectively, and importantly, an adjusted return on equity of 25%. When looking at the full year, we're equally proud of record gross written premium and adjusted net income, strong top and bottom line growth and numerous initiatives that led to diversification and reduced earnings volatility. We introduced multiple new lines of business, namely Crop, Environmental Liability and Assumed Reinsurance. This robust and disciplined growth translated into an adjusted return on equity well above the 20% benchmark levels passed in our Palomar 2X strategic plan.
Before I go into the detail on the fourth quarter, I want to take a moment to recap the accomplishments of our terrific 2023. At the beginning of last year, we outlined 4 strategic objectives for the year: one, sustained strong growth; two, managed dislocation; three, enhance earnings predictability; and fourthly, scale the organization. I'm pleased to report we execute on all of these objectives and the execution not only led to record gross written premium and earnings but also put us in a position for long-term success. The highlights of 2023 are numerous, but selected achievements include 29.4% gross written premium growth that is closer to 40% when excluding deemphasized or discontinued lines of business. The successful navigation of the generationally hard property catastrophe reinsurance market in which we renewed our reinsurance program in line with the expectations implied in our full year 2023 earnings guidance, and procured more excess of loss to support our growth in earthquake.
The completion of a multiyear effort to reduce our continental wind and severe convective storm exposure that resulted in reduced volatility in our earnings base. This is best exemplified by our minimal catastrophe losses this year. As an inside, if the 2020 wind season were to happen again, our total losses from the cohort of storms will be less than $10 million on a net basis. The introduction of 3 new lines of business in Crop Insurance, Environmental Liability and Assumed Reinsurance and incremental traction in newer lines like excess property and casualty. These nascent products will enhance our specialty insurance franchise and create shareholder value. The addition of best-in-class underwriting reinsurance data actuarial and technology talent to our team, A.M. Best changing the outlook in their rating of Palomar to positive from stable.
Last but not least, the successful beaten raise of our quarterly adjusted net income targets every quarter of the year. These accomplishments allow us to exit the year energized by our prospects for profitable growth in 2024 and beyond. With that, I would like to discuss our fourth quarter results and our 2024 strategic priorities for our 5 product categories. Overarchingly, the quarter saw a robust growth with gross written premium increasing 27% year-over-year, a nice sequential acceleration from 24% gross written premium growth delivered in the third quarter. Excluding the emphasized lines of business, gross written premiums increased 32%. Likewise, net earned premiums grew 14% in the fourth quarter, which is an acceleration from the 10% that we delivered in the third quarter of 2023.
Chris will discuss the net earned premium trend for 2024. Looking at our 5 key business lines in more detail. Our core earthquake franchise grew 29% in the fourth quarter, up from 23% in the 2023 third quarter. The residential earthquake book grew 18% and our commercial earthquake grew a healthy 44%. The growth in Q4 for commercial earthquake favorably compared to the third quarter's growth of 35% and the second quarter's growth of 29%. Our residential earthquake portfolio remains our largest single line of business and a consistent performer. The market backdrop is still attractive as California homeowners market dislocation persists, existing California earthquake authority policyholders are seeing reduced coverage offered at renewal, and an increasing amount of historically standard lines businesses moving to Excess and Surplus [indiscernible].
At quarter end, our E&S premium was 9% of total California residential earthquake premium. We believe high-teens growth is sustainable in the year ahead and that a new partnership with the top 25 insurance brand, offering earthquake insurance to their E&S policyholders to provide a further catalyst for sustained profitable growth. During the quarter, commercial earthquake conditions remained attractive as we achieved rate increases of approximately 26% on a risk-adjusted basis and record best levels for average annual loss and 250-year probable maximum loss of premium. Our most important portfolio management metrics, we did see the level of rate increases start to moderate from the prior year and expect that to be the case in 2024. This dynamic is more pronounced in large layered and shared accounts than it is in the middle market.
We remain positive on the growth and profitability prospects of our earthquake franchise as we enter 2024. Our Inland marine and our other property products were 8% year-over-year, as this remains our product segment where we are judiciously managing and in certain cases reducing our exposure. It is the product group that best typifies our grow where we want mantra. We continue to invest in lines that hold attractive risk-adjusted returns like Builder's Risk, excess property and flood. Builder's Risk, our largest Inland marine product, exited the year with over $115 million of in-force premium and added several new underwriters to help expand our geographic reach and distribution footprint in the quarter. We are confident the investments in Builder's Risk infrastructure will sustain the growth of the business through 2024.
Our excess property line saw approximately 5% rate increases in the quarter and 136% year-over-year growth, as it builds a portfolio of non-cat exposed property business. Like Builder's Risk, the excess property line is adding talent and infrastructure to profitably grow in 2024. Flood written premium grew 25% year-over-year in the fourth quarter and 38% for the full year, as we continue to expand the products geographic footprint. We've now reduced our continental hurricane probable maximum loss to $100 million and the average annual loss to $4 million. This concerted effort meaningfully lowered the volatility in our book but did lead to the decline in our commercial all risk premium by 13% year-over-year. Importantly, the remaining commercial all risk book of business is attractive, with policies renewing at an average increase of more than 30% in the fourth quarter.
As we have completed the triage to the book, we expect commercial all risk premium to grow in 2024, albeit it will come exclusively through rate increases. Hawaii Hurricane premiums grew 13% in the fourth quarter with most of that growth from rate increases and our inflation guard. As we discussed last quarter, we have formed Laulima Exchange fully licensed for reciprocal insurer for which we serve as the attorney and fact manager. This new vehicle allows us to transition our business model for the Hawaiian Hurricane product from one -- that is risk bearing to one that is fee generative. We are in the process of rolling our policies and the Laulima to expect to have this completed by the fourth quarter of 2024. Our customers have been receptive to the Laulima transition, with 90% of our policies successfully converting.
Once this transition is completed, we will all but eliminate balance sheet exposure to win losses from hurricane hit in Hawaii. Turning to our casualty business, we are pleased to see premiums grew 165% year-over-year. Production was highlighted by strong growth from our excess liability, professional liability lines as well as our first premium from our recently hired environmental liability team. During the quarter, the book saw a blended rate increase of approximately 5% year-over-year, with rates skewing a bit higher in excess liability. Importantly, we continue to take a surgical approach to the build-out of our casualty business, where we focus on niche segments of the market that offer healthy risk-adjusted returns and [combination of] exposure to social inflation.
We employ prudent risk management tactics such as modest growth and net line size, avoidance of heavy bodily injury exposure and conservative reinsurance to minimize loss potential in the classes we write. Few of our approach of bringing on subject matter experts who are comfortable walking before they run will build a well underwritten book of business with limited exposure to large shock loss and significant adverse court rooms. For the quarter, the casualty book loss ratio remained in line with our conservative loss pick. As the predominance of the book is less than 2 years old, we are focused on building a sizable reserve base that we expect to favorably develop over time. We expect our casualty business to be a meaningful contributor to premium growth in 2024, primarily driven by our real estate E&O, excess liability and professional lines.
Our fronting business outperformed our expectations in 2023, growing premium 63% to $364 million and delivered 24% year-over-year growth in the fourth quarter. We also finalized 2 new fronting programs in the quarter, and recognize a modest level of premium from these new deals and are optimistic about their potential for 2024. As we said on past calls, our goal in fronting is to provide fee-generative services to a select group of MGAs, carriers and reinsurers, writing specialty lines of business and industry segments where we have a developed investment thesis and some measure of domain expertise. We actively manage the compliance oversight reinsurance and collateral of our fronting partners and maintain a risk participation in certain instances.
The current maximum participation of 8%. We remain selective of our strong fronting partners and apply that selectivity to our healthy pipeline of prospects. We continue to be very optimistic about the potential for our newest product group, crop insurance. As a reminder, Palomar's leadership team has extensive experience in the crop insurance market and we are now 1 of only 13 approved insurance provider or AIPs in the $20 billion industry. Our strategic partner, Advanced AgProtection, has extensive sector experience and a distinct technology that allows it to target risk at the producer and regional level, more importantly, compete effectively even without immediate scale. We are targeting business throughout the Midwest and a variety of crossed with the goal of minimizing exposure to a single event or heavy accumulation of losses in any one region.
Fourth quarter is a seasonally light period for crop insurers and one of which most AIPs, Palomar included, right negligible premium. During the quarter, we focused on generating premiums that will be booked at the start of the year. Thus far, the market's receptivity is encouraging, and we now expect to deliver more than $100 million of premium in 2024. Chris will provide more detail on the seasonality of the business. As it pertains to our reinsurance program, we are pleased with the outcome for our reinsurance treaties renewing January 1. While only a few treaties renewed at 1/1, we did have a commercial earthquake quota share, a small earthquake-only excess of loss layer and a casualty quota share renewed at the start of the year. So while limited compared to what renews June 1, these renewals offered a decently brought perspective on the market.
The earthquake quota share renewed and improved economics with an increased ceding commission that implies a risk-adjusted decrease of approximately 5%. The XOL layer renewed at a similar, if not slightly better risk-adjusted decrease. The casualty quota share renewed with improved economics and our seating commission increased from the expiring level. While the outlook for reinsurance has certainly improved from a year prior, we are conservatively budgeting for modest price increases in our June 1 renewal. We are confident the apex of a historically hard market is behind us, which bodes well for net earned premium growth and margin expansion. To conclude, 2023 has been a banner year of profitable growth and consistent earnings for Palomar.
We continue to invest in both our core lines as well as new lines of business to ensure we are positioned to achieve our Palomar 2X goals, notably doubling our underwriting income over a 3 to 5 year period, while delivering adjusted return on equity above 20%. As we set our sights on 2024, our steadfast commitment to profitable growth remains unwavering. Our strategic imperatives in many ways, emulate those of 2023, affording us conviction in their executability. High-level strategic imperatives for 2024 are summarized in the following 4 rubrics: one, grow where we want; two, manage dislocation and diversification; three, provide consistent earnings; and four, scale of the organization. As considerable progress has commenced across these directives, we are pleased to offer full year 2024 adjusted net income guidance of $110 million to $115 million.
Importantly, this range includes losses incurred in the first quarter from California flooding of approximately $3.5 million as well as full year loss estimates for severe convective storm and mini cat events. Our guidance does assume a low single-digit risk-adjusted increase on our XOL renewal at 6/1. The midpoint of our guidance implies an adjusted ROE of 21%, level above our Palomar 2X target. With that, I will turn the call over to Chris to discuss our results in more detail.
Chris Uchida : Thank you, Mac. Please note that during my portion, when referring to any per share figure, I'm referring to per diluted common share as calculated using the treasury stock method. This methodology requires us to include common share equivalents such as outstanding stock options during profitable periods and exclude them in periods we incur a net loss. For the fourth quarter of 2023, our adjusted net income was $28 million or $1.11 per share, compared to adjusted net income of $21.1 million or $0.82 per share for the same quarter of 2022. Our fourth quarter adjusted underwriting income was $29.3 million compared to $23.5 million last year. Our adjusted combined ratio was 68.8% for the fourth quarter compared to 71.4% in the fourth quarter of 2022.
For the fourth quarter of 2023, our annualized adjusted return on equity was 25.1% compared to 22.4% for the same period last year. The fourth quarter adjusted return on equity continues to validate our ability to maintain top line growth with a predictable rate of return above our Palomar 2X target of 20%. Gross written premiums for the fourth quarter were $303.2 million, an increase of 26.8% compared to the prior year's fourth quarter. Excluding deemphasized products, our written premium growth rate was 31.7% for the quarter. It is important to remember the seasonality of our crop premium. As anticipated, we did not have any crop written premium in the fourth quarter. Based on our current book, the majority of our crop premium will be written in the third quarter of each year followed by the first quarter, which should see about 1/4 of the year's premium.
The second and fourth quarters will see only modest premiums. As our crop premiums grow through the year, we plan on splitting out our crop premium into its own category and will provide an update on our first quarter's earnings call. Net earned premiums for the fourth quarter were $93.7 million, an increase of 14% compared to the prior year's fourth quarter. For the fourth quarter of 2023, our ratio of net earned premiums as a percentage of gross earned premiums was 33.9% compared to 38.9% in the fourth quarter of 2022, and compared sequentially to 31.6% in the third quarter of 2023. The year-over-year decrease is reflective of our growth in fronting and lines of business that use quota share reinsurance and the second full quarter with our renewed excess of loss reinsurance program.
With the mix of business maturing and our excess of loss reinsurance program are in place, our net earned premium ratio was at its low point in the third quarter of 2023 and increased in the fourth quarter. We continue to expect a slight improvement in this ratio for the first part of the year and relatively consistent patterns for 2024. Losses and loss adjustment expenses for the fourth quarter were $17.9 million, comprised almost entirely of non-catastrophe attritional losses. The loss ratio for the quarter was 19.1%, which compares to a loss ratio of 22.4% a year ago in the fourth quarter, which was comprised of a catastrophe loss ratio of 2.3% and an attritional loss ratio of 20.1%. For the full year, our loss ratio was 21%, in line with our previously expected range and which compares to 24.9% in 2022.
Based on our mix of business and growth, we expect our loss ratio to move up incrementally from the 2023 levels. Our acquisition expense as a percentage of gross earned premium for the fourth quarter was 10.5% compared to 12.7% in the fourth quarter last year, and compared sequentially to 9.9% in the third quarter of 2023. Additional ceding commission and fronting fees continue to drive the year-over-year improvement. The acquisition expense ratio may be flat to modestly up in future quarters as our business mix matures. This quarter, our acquisition expense was a little higher but was completely offset by a higher commission and other income for the quarter both related to our crop business. The ratio of other underwriting expenses, including adjustments to gross earned premiums for the fourth quarter was 6.9% compared to 6.9% in the fourth quarter last year, and compared to sequentially to 6.7% in the third quarter of 2023/ In line with our expectation as we continue to invent our organization as we continue to grow.
We continue to expect long-term scale in this ratio, while we face periods of sequential flatness as we continue to invest in scaling the organization. Our net investment income for the fourth quarter was $7 million, an increase of 58.9% compared to the prior year's fourth quarter. The year-over-year increase was primarily driven by a higher average balance of investments held during the 3 months ended December 31, 2023, and a mix shift of invested assets from lower-yielding investment assets into higher-yield investment assets with a similar credit quality. Our yield in the fourth quarter was 4.1% compared to 3.3% in the fourth quarter last year. The average yield on investments made in the fourth quarter was 5.9%. We continue to conservatively allocate our positions to asset classes that generate attractive risk-adjusted returns.
During the quarter, there were no share repurchases and we have $43.5 million of our authorized share repurchase program remaining as of December 31, 2023, that we will continue to use opportunistically. At the end of the quarter, our net written premium to equity ratio was 0.87 to 1. For the year, our strong top line performance continued to translate to the bottom line. Our adjusted net income grew 31% to $93.5 million. Our adjusted EPS grew 33.5% to $3.69. Our adjusted combined ratio was 71.2% made up of a loss ratio and an expense ratio of 21% and 50.2%, respectively, both improvements from 2022, ultimately resulting in an ROE of 21.9%. Our adjusted underwriting income grew 29.1% to $99.5 million, positioning us to achieve our Palomar 2X objective from 2021 in less than 4 years.
As Mac mentioned, we are initiating our full year 2024 adjusted net income guidance of $110 million to $115 million, implying 20% adjusted net income growth at the midpoint of the guidance. This range includes our current estimate of the catastrophic California flood losses incurred in the first quarter of approximately $3.5 million. It is important to remember that our loss estimates and guidance include our expectations of mini cats such as severe convective storm activity. For the year, we expect our loss ratio to be approximately 21% to 25% and including the first quarter flood losses incurred to date and our estimate of mini cats, which represents approximately 2 to 3 points of our expected loss ratio. With that, I'd like to ask the operator to open the line for any questions.
Operator?
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