Palomar Q3 2024 Earnings Call Transcript

Quartr
Provided by Quartr
November 5, 2024

There are 9 speakers on the call.

Operator

Good morning, and welcome to the Palomar Holdings, Inc. 3rd 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 opened for questions with instructions to follow. As a reminder, this conference call is being recorded.

Operator

I would now like to turn the call over to Mr. Chris Uchida, Chief Financial Officer. Please go ahead, sir.

Speaker 1

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 Christianson, our President, is here to answer questions during the Q and 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 November 12, 2024.

Speaker 1

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.

Speaker 1

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.

Speaker 1

At this point, I'll turn the call over to Mac.

Speaker 2

Thank you, Chris, and good morning. I'm very pleased with our Q3 results as they clearly demonstrate our successful efforts to deliver consistent earnings and returns. In a quarter that experienced a high level of cat activity, we delivered 39% adjusted net income growth, a 77% adjusted combined ratio and a 21% adjusted ROE. Our results further validate the concerted efforts that we have undertaken to diversify the business, reduce the volatilities in our earnings base and profitably grow. This quarter's strong financial results also reflect the sustained execution of our 2024 strategic imperatives, grow where we want, manage dislocation and diversification, provide consistent earnings and scale the organization.

Speaker 2

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. For the Q3, we delivered top line growth of 32% driven by solid execution across our book of business, highlighted by continued strong growth from our earthquake and casualty books of business as well as significant growth in our young crop book. It's worth noting that the same store sales growth was 38%. Our second strategic mandate requires navigating and capitalizing on dislocation in the market while further diversifying our business. During the quarter, we raised $160,000,000 to a primary equity issuance to help further diversify our specialty insurance franchise and strengthen our position in the existing classes of business where we see both opportunity and dislocation.

Speaker 2

We earmarked a portion of the proceeds to finance our acquisition of Surety Insurer, First Indemnity of American Insurance Company or FIA. Proceeds also strengthen the balance sheet to support our rapidly growing crop business. Lastly, we are using the remaining portion of the capital for organic growth and targeted increase in risk participation in lines like earthquake. Our third imperative is a steadfast commitment to delivering consistent earnings. As I mentioned, we achieved adjusted net income growth of 39% with an adjusted return on equity of 21% despite elevated catastrophe losses in the quarter.

Speaker 2

Steps taken to reduce the volatility in our portfolio is best exemplified by Palomar being a consensus for the 8th straight quarter even in a period of atypical hurricane activity and the associated catastrophe losses incurred. Separately, our crop business and the pending entry into the surety business will lead to earnings from products uncorrelated with the traditional P and C cycle. The 4th imperative is scaling the organization and making the requisite investments to accomplish our Palomar 2X objectives. This effort starts with an investment in people and I'm proud to say that we've continued to recruit industry leading talent to join Palomar this quarter. Notable additions to our team include David Sapia, Head of E and S Casualty Benson Latham, Head of Crop and Althea Garvey, Chief Claims Officer.

Speaker 2

In addition to our entrepreneurial and innovative culture, a key factor in attracting experienced industry veterans is the growth scale and reputation we'll have that Palomar is achieving, highlighted by AM Best upgrading our financial strength rating to an A from an A-. I'm humbled and thrilled by the talent that we've been able to recruit in 2024. I would now like to review the performance and market conditions of our 5 product categories. Firstly, our core earthquake franchise grew gross written premium 19%. Our residential earthquake business continued to generate strong new business growth and high policy retention.

Speaker 2

Additionally, our residential earthquake E and S book saw 74% growth year over year as personal lines business continues to flow into the non admitted market in California. It's worth noting that our E and S rates are considerably higher on a like for like basis. In peak zones like West Los Angeles, they are more than 50% higher. We feel that growth in residential earthquake business will sustain given the continued dislocation in the California homeowners market, combined with the CEA continuing to reduce their exposure and coverages. This can be seen by the CEA's decision not to renew $750,000,000 of expiring excess of loss reinsurance on October 1.

Speaker 2

As the CEA continues to reduce coverage and claims paying capacity, Palomar will remain the primary option in the California residential earthquake market. Our commercial earthquake business saw solid growth in the quarter. In the Q3, commercial rates did plateau as the average account renewed flat on a risk adjusted basis. Terms and conditions continue to improve and the underlying profitability metrics such as average annual loss to premium and 2 50 year probable max loss to premium are at the best levels in our company history. Current market conditions in earthquake affirms our strategy of adding both commercial and residential earthquake business to navigate any market cycle.

Speaker 2

The 10% inflation guard in our residential policies provides a meaningful cushion above inflationary levels and therefore enhances our margins in a flat to down reinsurance market. Our commercial book allows us to generate meaningful risk increases when market conditions permit or demand. Ultimately, the performance of our earthquake franchise remains strong and we are confident that earthquake premiums will grow in the high teens to 20% range for the full year 2024. Our inland marine and other property category, which consists of 7 property products, Builders Risk, Excess National Property, All Risk, Motor Truck Cargo Contractors Equipment, Hawaiian Hurricane and Residential Flood grew 22% year over year. As a reminder, this is a product category where we are investing in growth and reducing exposure as we continuously measure risk adjusted returns line by line.

Speaker 2

During the quarter, we saw strong performance from our excess national property and Hawaiian hurricane lines of business, whereas our all risk book continue to contract, a trend that we inspect in 2025 as well. The all risk book was the primary driver of catastrophe losses in the quarter and is expected to be the same for Hurricane Milton. The heels of this robust and active hurricane season, we continue to assess our options to reduce the potential losses from continental U. S. Windstorms.

Speaker 2

Builders Risk, our largest in the marine product and our excess national property line, which typically writes business in non catastrophe exposed regions, continued to experience robust premium and submission growth as well as higher regionally focused underwriters. During the quarter, we implemented a new facultative reinsurance treaty for the Excess National Property team that allows them to write large limits while keeping a small net line size and do so in an automated fashion. This new reinsurance agreement will enhance our servicing and quoting capabilities and ultimately production. Hawaii hurricane premiums grew 74% in the 3rd quarter as the 23 percent rate increase approved last quarter is now flowing through our renewals. We have rolled over 90% of our in force Palomar specialty insurance company policies onto our Laulima reciprocal.

Speaker 2

This effort meaningfully reduces Palomar's exposure to a large loss from a hurricane in Hawaii and enhances our fee income base. From a pricing standpoint, rate activity varies widely by region and product. For instance, our builders risk rate increases nationwide were flat, but in Texas, we're seeing increases of 5% to 10%. Hawaii hurricane as previously mentioned is up 23%. In the circumstance of flood, pricing was flat in California, although we are waiting on a rate increase approval, but in states impacted by Hurricane Helene, we are renewing policies up 10%.

Speaker 2

All risk policies were down 6.4% in the quarter, but that level of decline is likely to decelerate at least in Florida and Texas on the heels of losses from hurricanes Milton, Helene and Beryl. It really does vary product by product and territory by territory. Shifting to casualty, the product group had another strong quarter of growth with premiums increasing 91% over the previous year. Standout performers this quarter included niche casualty classes such as real estate errors and omissions, which grew 40%, commercial contractors general and excess liability and environmental liability, both of which grew greater than 100%. We're growing these lines of business in all casualty segments for that matter by adding underwriting talent, broadening our distribution footprint and increasing our submission intake and quoting activity.

Speaker 2

Our approach to the casualty market was now comprises 14% of our total book remains anchored in underwriting targeted niche segments of the market. We employ prudent risk management tactics such as modest gross and net line size, avoidance of heavily bodily injury and other high severity exposure and conservative reinsurance to call our loss potential in the classes we write. During the quarter, our average gross line for miscellaneous professional liability, contractors general liability, real estate environmental liability was $2,100,000 that netted down to $890,000 after the application of reinsurance. As it pertains to pricing and rate accuracy, we continue to see decent rate increases in excess of loss costs across the casualty book. Our miscellaneous professional liability products saw a blended increase of 7.6%, while real estate errors and omission rates increased 9%.

Speaker 2

The excess liability book was up 11% and the contractors general liability book saw an increase of 6% with those accounts that have auto coverage up 17%. Beyond the rate increases, we limit auto liability and include many exclusions in the policy language in both general and excess liability policies. For the quarter, the casualty book's loss ratio remained in line with our conservative loss picks with reserves continuing to build. It's worth noting that nearly 80% of our reserves are IBNR, which is higher than industry averages for casualty. At the same time, we are quick to recognize outsized large loss activity and we have experienced conservative reserve force view shock losses.

Speaker 2

We are optimistic that as the book seasons reserves will develop favorably. Lastly and most importantly on casualty in September, David Sapia joined Palomar as Head of E and S Casualty. David brings 30 years of casualty underwriting field management experience, most recently having run E and S casualty for Hanover Reeds HDI subsidiary. His strategic vision will not only bolster our current operations, but also fuel our growth initiatives. Turning to our fronting business, we experienced a net 11% decline in premiums given the separation from Omaha National.

Speaker 2

The termination of the contract will impede the Frontine Group's growth over the next several quarters as we work to replace the lost business with new partnerships. Our prospects are healthy with quality Frontine Partners in the pipeline. This quarter we forged a new partnership with an affiliate MGA of an international reinsurer. We will remain selective as we closely manage the risk of this segment though. On an exciting note, we turn to crop.

Speaker 2

We wrote 60,000,000 dollars in premium in the seasonally strong Q3. Year to date, we've written over $100,000,000 in premiums compared to just $12,100,000 last year. Overall, it has been a good planting season and market acceptance has been strong. During the Q3, we experienced product mix shift, which will move a portion of our production to crops that are planted in the Q4. This will result in a portion of our gross written premium shifting to the Q4 as well.

Speaker 2

We also plan to write livestock premium in the Q4 given our strong expertise in the sector and the availability of new capital to support this diversifying initiative. Additionally, I'm pleased to report that Benson Latham has joined Palomar's Executive Vice President and Head of Crop. An impressive 30 years in the crop industry, Benson brings a wealth of experience and expertise to our team. He is responsible for founding the Validus Insurance Group's agricultural practice and has held executive roles at ProAg, Crop Risk Services AIG and Great American Insurance Company. With Benson's addition to the team, there's even more conviction that Palomar will become a market leader in the $19,000,000,000 crop insurance market.

Speaker 2

Turning to reinsurance, the 3rd quarter is light from a placement standpoint, but we are pleased with the quarter's accomplishments and feedback received from our broad panel of reinsurers after several marketing trips. As previously mentioned, we successfully placed an automatic facultative reinsurance program for our excess national property line this quarter. Additionally, our real estate E and O quota shares treaty successfully renewed and improved economics. Lastly, we also put in place a quota share for a new E and S general liability program targeting security guards. Importantly, we were able to leverage the relationships with key trading partners to get support for our de novo casualty program at competitive economics.

Speaker 2

Palomar's stature in the global reinsurance market proved a competitive advantage in this instance. While it's only November and as such, we're more than 6 months away from the renewal of our XOL program, we do think it's worthwhile to offer our current views on the prospects for our renewal following the cat losses year to date. It's our expectation the catastrophe excess of loss pricing for Palomar should be flat to down next year. The reasons are several. 1, we currently are not putting any losses into our XOL program.

Speaker 2

2, we continue to reduce the hurricane exposure in the treaty and our expectation at sixone is that 97% of the treaty will be earthquake only. 3, the CA non renewing over $750,000,000 of earthquake excess of loss limit will create excess capacity that can conceivably support our growth. Fourthly, earthquake catastrophe bonds raised after Hurricane Milton were issued at prices down year over year. Again, these items are germane to Palomar's placement only in a form our view on Palomar's unique position at the sixone renewal. I also want to briefly discuss our pending acquisition of FIA, the contract surety insurer.

Speaker 2

We expect to receive regulatory approval by year end and close the acquisition in early 2025. As a result, we do not expect to receive any financial contribution in the Q4. Overall, FIA is performing very well and the integration should be straightforward. Chris will go into detail on our guidance for the remainder of the year, but it's important to point out that despite the catastrophe losses from this hurricane season, we not only beat consensus in the Q3, but also with our tightened guidance range of $124,000,000 to $128,000,000 of adjusted net income, we are affirming the low end of our guidance range. The consistency in our financial performance affirms our Palomar 2X strategy and the quality of our team and operation.

Speaker 2

With that, I'll turn the call over to Chris to discuss our financial results in more detail.

Speaker 1

Thank you, Mac. Please note that during my portion 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 Q3 of 2024, our adjusted net income was $32,400,000 or $1.23 per share compared to adjusted net income of $23,300,000 or $0.92 per share for the same quarter of 2023, representing adjusted net income growth of 39%. Our 3rd quarter adjusted underwriting income was $31,000,000 compared to $25,000,000 last year.

Speaker 1

Our adjusted combined ratio was 77.1% for the 3rd quarter compared to 70.9% in the Q3 of 2023. Excluding catastrophes, our adjusted combined ratio was 67.6 percent for the quarter compared to 71.5% last year. For the Q3 of 2024, our annualized adjusted return on equity was 21% compared to 22.3% for the same period last year. The 3rd quarter adjusted return on equity continues to validate our ability to maintain top line growth with a predictable rate of return above our Palomar QX target of 20%. Even in the face of elevated cat activity like what we experienced in the Q3 and with the additional capital raise during the quarter.

Speaker 1

Gross written premiums for the Q3 were $415,000,000 an increase of 32% compared to the prior year's Q3, 38% growth excluding runoff business. In the quarter, we have continued to regroup our written premium to align with our 5 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. The majority of our crop premium is written and earned in the Q3 of each year with only modest premium in the second and fourth quarters. That said, as Mac indicated, the market changes and as we write more livestock premium, we would expect to see a bit more premium written in the 4th quarter relative to our original expectations.

Speaker 1

Additionally, the crop premium written and earned in the Q3 has a seasonal effect on our ratios calculated as a percentage of gross earned premium in the Q3, specifically the ratios for net earned premium, acquisition expense and other underwriting expenses. Since the majority of our crop premium is ceded, the net impact to our financials has been small and will look similar to previously shared expectations. Net earned premiums for the Q3 were $135,600,000 an increase of 58% compared to the prior year's Q3. For the Q3 of 2024, our ratio of net earned premiums as a percentage of gross earned premiums was 34.3% compared to 31.6% in the Q3 of 2023 and compared sequentially to 37.4% in the Q2 of 2024. The year over year increase in this ratio is reflective of improved excess of loss reinsurance and of the higher growth rate of our non fronting lines of business including earthquake that seed less premium.

Speaker 1

These results include the 1st full quarter of new excess of loss reinsurance placement that started June 1. While the dollars associated with this placement are higher to facilitate continued 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 premiums written and earned during the Q3 for which we currently see about 95%, we expect the Q3 to be the low point of our net earned premium ratio. From there, we expect the net earned premium ratio to increase to 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 expect net earned premium to continue to grow.

Speaker 1

Losses and loss adjustment expenses for the Q3 were $40,300,000 comprised of $27,400,000 of non catastrophe attritional losses and $12,900,000 of catastrophe losses from Hurricanes Beryl, Debbie and Helene. The loss ratio for the quarter was 29.7 percent made up of an attritional loss ratio of 20.2% and a catastrophe loss ratio of 9.5%. As Mac indicated, we believe this quarter's results were a testament to our continued effort to de risk our portfolio over the past few years. Our acquisition expense as a percentage of gross earned premium for the Q3 was 10.5% compared to 9.9% in last year's Q3 and sequentially to 11% in the Q2 of 2024. This percentage decreased sequentially primarily from strong growth from crop that is primarily written and earned in the Q3.

Speaker 1

Most of the crop premium is seeded resulting in higher ceding commission and a lower acquisition expense ratio for the quarter. We expect this ratio to move up from the low point in the 3rd quarter. The ratio of other underwriting expenses including adjustments to gross earned premiums for the 3rd quarter was 5.9% compared to 6.7% in the Q3 last year and compared sequentially to 7.3% in the Q2 of 2024. As expected, the lower result for the quarter was influenced by the crop premium written in the quarter. As demonstrated by our new hires over the last 6 months, we are extremely committed to investing in all aspects of our organization as we continue to grow profitably.

Speaker 1

We continue to expect long term scale in this ratio while we may see periods of sequential flatness or increases as we continue to invest in scaling the organization within our Palomar 2x framework. Our net investment income for the Q3 was $9,400,000 an increase of 56% compared to the prior year's Q3. The year over year increase was primarily due to higher yields on invested assets and a higher average balance of investments held during the 3 months ended September 30, 2024 due to cash generated from operations. Our yield in the 3rd quarter was 4.6% compared to 3.9% in the 3rd quarter last year. The average yield on investments made in the 3rd quarter was 5.7%.

Speaker 1

We continue to conservatively allocate our positions to asset classes that generate attractive risk adjusted returns. Our stockholders' equity has reached $703,300,000 a testament to consistent profitable growth and the capital raise. At the end of the quarter, our net run premium to equity ratio was 0.84:1. Turning to our full year adjusted net income guidance. We initiated 2024 with a range of $110,000,000 to $115,000,000 at the beginning of the year.

Speaker 1

Given our strong performance and execution through the Q2, we increased that guidance range to $124,000,000 to $130,000,000 Now we are tightening our full year 2024 adjusted net income guidance to $124,000,000 to $128,000,000 including approximately $8,000,000 of catastrophe losses from Hurricane Milton in the 4th quarter, significantly ahead of our original full year guidance outlined in February that did not include any estimate catastrophe losses. The midpoint of our updated guidance range represents adjusted net income growth of 35% compared to 2023 and an adjusted ROE greater than 20%, including a capital raise in August, which puts us well on the path to achieving our Palomar 2x goal of doubling adjusted underwriting income in 3 years. With that, I'd like to ask the operator to open the line for any questions. Operator?

Operator

Thank you. We will now be conducting a question and answer session. Our first question comes from the line of Mark Hughes with Truist Securities. Please proceed with your question.

Speaker 3

Yes, thank you. Good morning, good afternoon.

Speaker 4

When we think about the quake business for next year, you talked about the

Speaker 3

earthquake authority not renewing a proportion of its reinsurance. What are the growth prospects next year, I guess, maybe thinking about commercial versus residential as well?

Speaker 2

Hey, Mark, this is Mac. Good question. And I think overall, we feel very good about the growth prospects for earthquake broadly. As I said in my remarks, we really like the fact that we have a balanced book of residential and commercial quake. So right now, it's probably about 55 residential, 45 commercial.

Speaker 2

We as I've mentioned, rates are plateauing in commercial, but the metrics still remain very attractive. So we want to continue to grow in commercial earthquake even if there is some degradation in rate because again the metrics are compelling. We do think that we can maintain high teens growth. What we said 18% to 20% for 24%, we think we sustain growth in the teens next year. We'll probably see a little more growth from residential on a relative basis versus commercial.

Speaker 2

But again, it will be a balanced approach. But I think the one thing that I want to emphasize is with Residential Quake, we have flat rates that renew with a 10% inflation guard, which again is covering inflation at this current day. So it's providing scale as reinsurance pricing is flat and certainly nice scale and quite elegant scale if reinsurance pricing declines. So we feel good about the prospects for Quake, like our balance book of residential and commercial, and you'll continue to see us invest, especially as you pointed out reinsurance capacity becomes even more available on the heels of the changes that the CA just made.

Speaker 3

And Chris, some nice improvement in the earned premium ratio, and you may have touched on this, but how much of that is mix of business versus pricing for your reinsurance? And how do we think about that on a go forward basis? If you've taken this kind of step up year over year and then it's going to continue to step up sequentially, Is that going to trend positively as we think through 2025, I won't go beyond that, but into 2025?

Speaker 1

Yes. Thanks, Mark. Great question. Obviously, we talk about net earned premium and there's just the growth in the dollars that we're seeing there from the overall performance of the business. When you get down to the overall fundamentals of what's underlying, right, it's kind of all of the above of what you talked about.

Speaker 1

It's going to be driven by rate, it's going to be driven by mix and then also driven by the strong performance that we saw in the excess of loss placement at 6.1 of 2024. So when I look at it, we've talked about it before that we do believe when we look at the net earned premium ratio that the low point will be Q3 of this year. When we went into this quarter, I would probably expect it to be a little bit lower than the 34% that we saw. So strong performance by the overall book did help that. I do expect Q3 still to be the low point.

Speaker 1

So incrementally, I expect it to continue to move up from this point in Q3 to Q4 and Q1 of next year and then reset a little bit at the next excess of loss renewal just with the normal placement where we buy to fund, let's call it, the growth in our cat exposed lines, primarily earthquake. But overall, we expect to see that same trend. But the tea leaves are showing strongly that we should see favorability and strong growth in our net and premium dollars as we go through the end of 'twenty four and through 2025.

Speaker 2

And Mark, this is Mac. One thing I would add and Chris talked about it, the fact that our fronting business now is growing slower than our other lines, that's going to also drive net earned premium growth. So that's one silver lining, so to speak, of the slowdown in fronting and the expiration of our 1 fronting partnership with Omaha National. So that's also a catalyst that is encouraging.

Speaker 3

Appreciate it. Thank you.

Speaker 2

Thanks, Mark.

Operator

Thank you. Our next question comes from the line of Paul Newsome with Piper Sandler. Please proceed with your question. And Paul, are you on mute?

Speaker 5

Hopefully, I'm not I'm coming through now. I was hoping to ask a little bit of a big picture question about your property businesses and not just like this quarter, but obviously they've been the main source of volatility, it's fairly natural. But if you look back over the period of time, have they been profitable over time and it's been that as you've reduced your exposures, it's more a matter of reducing volatility or has there or has it actually been something where it really hasn't been profitable and that's what you needed to deal with over time, not this last quarter.

Speaker 2

Yes, Mark, excuse me, Paul. We look at across the board, our property portfolio and casualty portfolio like to look at risk adjusted returns and the volatility that they can bring. And also in the case of property, what we call our cat payback. So how long would it take if there are losses severe or average from a catastrophe to recoup them through rate or underwriting changes. And so when we look at our portfolio, Hold Aside Earthquake, which has performed well of what we call our inland marine and other property products, that's 7 different products, builders risk, motor truck cargo, non cat exposed excess national property, Hawaiian hurricane, flood, commercial equipment and 17, all risk.

Speaker 2

And I think what you could say within any portfolio, you're going to have some strong performers and some that are under performing. Builders risk has been exceptional, excess national property exceptional. Hawaiian hurricane is now becoming more of a fee generator. So we're long that product so to speak. And then motor truck cargo is a consistent small limit performer as well.

Speaker 2

I think the ones that we are watching have been flood and the all risk book. And so flood has been profitable. It's been losses have been a bit amplified this year by the atmospheric rivers in California and then some of the storms. And then all risk is one that's been probably disproportionately volatile. And so we have done a very good job of reducing our limits in that line of business.

Speaker 2

For instance, if you look at Helene the average exposed net limit there was about $400,000 same for Hurricane Milton. So we're not taking big pops but if you get 40 claims and the average exposed limit is $400,000 it's a 50 percent damage ratio that's where you get the $8,000,000 of losses from Milton. So that puts a little bit of pressure on something that's only 3% of our premium or something along those lines. So long winded way of saying, generally speaking, the property book has been profitable and performed well. There are a couple of underperformers that we're continuing to look at and likely will pull back exposure to.

Speaker 5

Somewhat related, the crop business, is that a net diversifier for your P and Ls? Or is it additive to the property exposures?

Speaker 6

Paul, this is John Christianson. I can take that one. No, it's a great diversifier for us. So as you think about the types of impacts that can affect a negative crop year, it's really drought. And so that's an uncorrelated risk with as you think about the rest of the property book.

Speaker 6

So it's a really nice diversifier and a complement to everything that we've built over the past decade. So we have a lot of conviction in that line and believe that it will be a great source of diversification on a go forward basis.

Speaker 2

And I think the other thing that I would add to John's point is that it is uncorrelated and it's uncorrelated to P and C market cycles too. So it can be a nice steady contributor to earnings on a go forward basis. And on the heels of us raising capital in August, it is our intention starting oneone of 25 to take some more risk in that line. The balance sheet affords it. The team that we brought on has the competence and then some to do it.

Speaker 2

So we are again really enthused about what we can do in crop.

Speaker 5

Fantastic. Thank you very much. Appreciate the help as always.

Speaker 2

Thanks, Paul.

Operator

Thank you. Our next question comes from the line of David Motemaden with Evercore ISI. Please proceed with your question.

Speaker 7

Hey, thanks. Good afternoon. I had a question just on the catastrophe losses. It looks like this year it will sort of settle out in the 5 to 6 point of an impact on the combined ratio. Is that the sort of expected level that you guys would expect in a given year given the mix of business or any sort of commentary you could provide on the AAL or your expected cat load would be helpful because a lot of things have changed over the last several years in terms of your mix?

Speaker 2

Yes, Dave. It's a good question. And what I would say, it's a slightly elevated this year to what the AALs had, whether that was because of severe convective storm activity in Texas and really Torale loss that we was a 1 in 100 type of event and then a little bit of elevated flood losses. I think with the wind, what I would say is, all of these events have been well within our retention. So that's something that we feel good about from an ongoing capital or reinsurance support standpoint.

Speaker 2

But what it also means is that does it again generate the cat payback that we're looking for, the risk adjusted return. So I would expect us to pull back some of our Continental Hurricane PML over the course of 2025, and therefore bring down that cat load some. So I think if we've talked about it being 3 to 4 points, I think that's a good steady state number especially with some of the underwriting changes or yes, underwriting changes we expect to make.

Speaker 7

Got it. Thanks. That's helpful. And then Chris, on the other underwriting expense ratio at 5.9%, Obviously, a bunch of moving pieces this quarter. Could you just help us give us a sense of what's the sort of run rate underwriting expense ratio as we think about as the business scales and sort of adjusting for some of the mix impacts that may have flattered this quarter's result?

Speaker 1

Yes. No, good question. And we've talked about it. The crop premium that comes in, in the Q3 and when you look at the ratios, the expense ratios on a gross basis, there was call it max $60,000,000 of written premium almost all of that is earned during the quarter. So that does artificially push the underwriting expense ratio down a little bit, so 5.9%.

Speaker 1

I would expect it to be a little, call it, steadier in the mid-six percent to 7 percent, right? So that's probably the right way to think about it on a, call it, run rate basis. I'd say the one thing I would continue to emphasize is that we are adding talent, we are adding scale to the organization. So we are still building, right? So I am not beholden to try and hold the other underwriting expenses at a certain level to call it hit profitability.

Speaker 1

We are very profitable. We can afford to invest in all of our teams and our people. And so we will continue to do that. Overall, I still expect strong scale in the other underwriting expenses as we continue to grow over the long term. But we are not going to slow down in trying to build this organization to continue to grow and scale.

Speaker 1

So overall, it's performing well. It's performing within our expectations, but I will point out we will continue to invest. But I don't expect this ratio to jump to call it 10%, But it will call it vary and move around from quarter to quarter. But I'd say mid-6s to 7% is probably a good way to think about it as we continue to grow this organization.

Speaker 2

Yes. And just to add some color to Chris' comments, you bring someone on like a David Sapia. The great thing is that they are a player coach. They're producing business, but also going to be adding underwriters who can extend our footprint and our growth long term. So that's an investment that you're making upfront that you get great returns on long term.

Speaker 2

Same thing for Benson Latham. So like Chris is saying, we're not going to sacrifice the investment in long term growth in earnings to maintain that ratio in the short term, but it's not going to vacillate wildly. I think Chris has given very good direction on where it will go to.

Speaker 7

Great. That's helpful. Thanks and good to see some of that scale come through despite or considering the investments that you guys are making. Maybe just lastly, Mac, you spoke about just the market conditions and commercial earthquake. And I'm wondering if maybe you could provide a little bit more detail on where that incremental competition is coming from.

Speaker 7

We've heard the London market being a little bit more competitive. I know you guys don't directly write in the London market, but I know that that is another avenue for some of the commercial quake business. So I'm just wondering is that really driving that plateauing in the commercial earthquake rates?

Speaker 2

Yes. I think the plateauing in earthquake rates are driven by a few things. One is you've had 4 years of consecutive rate increases on loss free business. And so when you look at, let's call it a homeowners association in California, kind of a small, midsize account risk, they're getting what we call fatigue in terms of rate increases. And so what we'll do in many instances is sacrifice rate, but hold terms and conditions, move up deductibles or make it name peril of earthquake only as opposed to a DIC policy.

Speaker 2

So that's contributing to it somewhat. But yes, there has been new capacity that's come in. It's been a few MGAs that are broadening capacity. Lloyd's syndicates are indeed guilty in that instance of some of that new capacity. And then there's been some business in the D and F market that's been aggressive.

Speaker 2

But on the whole, the metrics and profitability of the line remain compelling. And as such, we're going to look to grow in commercial earthquake. I think we can grow in commercial earthquake next year. But it is a little bit more competitive than it's been the last year and a half.

Speaker 7

Got it. Understood. Thank you.

Operator

Thanks, Dave. Thank you. Our next question comes from the line of Andrew Anderson with Jefferies. Please proceed with your question.

Speaker 1

Hey, good afternoon. I think you had previously pointed to 125 to 150 crop premium for the year. I know you mentioned some shift to 4Q and some new products online, but do you still expect that to be the case for the full year?

Speaker 2

Hey, Andrew. Yes, I don't think we said 150, I think we said 100 and 25. If I said 150, that was maybe my bold ambition. But nonetheless, I think we feel good about getting to that close to that 120 number. And I think importantly, with the addition of Benson Latham and James Long, 2 terrific hires in the last quarter and a half, we feel very good about building it into a not $500,000,000 plus franchise in the next several years.

Speaker 2

We think we're going to be a market leader here.

Speaker 6

Yes. And Andrew, John Christianson here. One thing I'd add is, we are really proud of our achievements in crop year to date. Mac and Chris both talked about it, surpassing that milestone of $100,000,000 in the 9 months of first time of the calendar year, despite commodity prices being down year over year. And mentioned that we had some favorable, what I call favorable product mix shift throughout the year and as a result, we'll see a bit more in Q4 being written.

Speaker 6

But as it was mentioned before, just to reiterate, Q3 will remain the seasonally high quarter for crop followed by Q1 and Q4 and Q2 will make up the difference.

Speaker 1

Thanks. And then on excess liability, I think I heard 11 percent rate increase. It seems like a deceleration to the 20% in the prior quarter. Was that just mix shift or is there anything else going on there we should be thinking of?

Speaker 2

Well, it's a bit of mix shift, but it's also we've tightened terms and conditions and put in more policy exclusions. So I think when you look at the actual risk adjusted increase, we feel great about that. And I think the other thing too is we remain very tight on the excess liability keeping the auto either out of it altogether or tightly constrained from a fleet size and range of activity standpoint. So it's a combination of rate and then constriction of coverage, which is something that we and our reinsurance panel are strongly endorsing. Thank you.

Operator

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

Speaker 4

Great. Thanks so much. Really a couple of follow ups on earlier questions. One of the things we've heard over the course of this earning season is that rate trends for smaller commercial property risks are rising. Are you seeing that in the earthquake space too or is that just a different market?

Speaker 2

I would say that's a different market, Meyer. I think smaller risk and particularly our book are the ones that you're starting to run into budgetary constraints, especially in California where you also have fire premiums rising. So we are not seeing that in commercial earthquake.

Speaker 4

Okay. That's helpful. Thank you. So the attritional loss ratio in the 3rd quarter obviously fantastic and I think better than guidance. Does that have any impact on your expectations for 2025?

Speaker 1

I think that's a great question. First thing I'd point out is that yes, the attritional loss ratio performed very well this quarter. I'm very happy with the results. One thing and one key thing I'd point out there is that we are not touching any of our casualty reserves, right? So there is no, call it, takedown of any casualty reserves in there.

Speaker 1

This is really driven by strong performance in our property lines of business that had a very strong quarter, some minor prior period development in there. But overall, casualty loss ratios are being held steady as we continue to build on that book. So that's the first thing I'd point out. The other thing I'd point out is that we've talked about a little bit before our attritional loss ratio does have some mini cats in it. This quarter was obviously an elevated from a frequency and activity standpoint.

Speaker 1

So I would say that some of those cats were elevated or some of those mini cats were elevated into the cat category. So let's call it, took out maybe 1 to 2 points of our what would be attritional losses and moved it into the cat loss category. So that brings that loss ratio up a little bit. Overall, it is doing what we expected to do as the mix shift changes for the business, the loss ratio, the attritional loss ratio has continued to move up. I expect that trend to continue in 2025 as the mix in those lines of business continues to improve or it continues to diversify and so that we kind of move away from some of our lines that have no losses, earthquake in fronting or not move away from, but kind of diversify around those lines.

Speaker 1

So I expect it to still continue to move up. But again, still very highly profitable lines of business, still very strong overall combined ratio of lines of business.

Speaker 2

But Meyer, I would just add and I kind of want to make sure I give credit where credit is due to our underwriting team. If you look at just we are the attritional loss ratio year over year ticked up from 19.4% to 20.2%, while the casualty book grew 90% year over year. So I think that shows the quality of the underwriting in the property side, and with not touching reserves on the casualty side. So while Chris, as I agree with everything Chris said, it's going to tick up, it's not going to tick up like a step function. It's going to tick up very gradually and steadily.

Speaker 2

And I think this Q3 was a prime example of the great job our team did underwriting.

Speaker 3

Yes. No, that makes perfect sense.

Speaker 4

And then final question, I guess for you, Matt. Do you have any thoughts on the availability or ceding commissions on casualty reinsurance as we had in 2025?

Speaker 2

Well, I think I was just in Bermuda 2 weeks ago and saw about 20 reinsurers there. And I think on the whole, they continue to have capital. When I look at our casualty book, we're in the market now on 1 treaty. We got 2 done in the Q3 at expiring or improved economics. We got a de novo one done market consistent and frankly attractive economics to us.

Speaker 2

So we feel like there is capacity for niche casualty lines. And I think the other thing that we feel good about that's unique to Palomar is by being the stature of a buyer that we are now, on the XOL, Chris talks about it, we spent $265,000,000 just on our excess of loss costs. And we have over, I guess, now 100 reinsurers that we're working with. So our balance in the market certainly helps us feel good about strong support on the casualty side, 24 rest of 24 and into 25. We have not seen any pressure on our ceding commissions at this point.

Speaker 2

And so we feel good about our prospects individually. And I think the market on the whole, there is still ample capacity in capital, especially with Milton looking more like an earnings event and not a capital event by any stretch.

Speaker 4

Okay, fantastic. Thank you so much.

Speaker 2

Thanks, Meyer.

Operator

Thank you. And our next question comes from the line of Pablo Singzon with JPMorgan. Please proceed with your question.

Speaker 8

Hi, good afternoon guys. First question, could you offer your latest views and you sort of talked about this already, but something more specific, your latest views on how fast the official loss ratio will pick up over the next couple of years as you shift the business mix?

Speaker 1

Yes. No, I think I've talked about it, it would be call it 1 point to 2 points potentially a quarter. I think 2 is very aggressive. I'd say 1 is probably a little more consistent. So if we finish this year in the call it low 20s right, the guide points have been 21 to 25 based on this quarter's strong results.

Speaker 1

I'd probably say expect to see that on the lower end, let's call it the 22% to 23% range. So well within the guidepost, I would expect if they moved up a point, so 3 to 4 points by the end of next year would kind of be my expectation overall as we look at the growth rate. And the one caveat I always give to that is that that's with similar risk participation, right? We do have some new capital burning a little bit of hole in our pocket. So we may try and use that strategically on lines of business that we're really bullish on and have been performing really well.

Speaker 1

But overall, it doesn't change my overall expectations really on where that's going to move up to. I would expect it to be, call it, in that 26% to 28% type range by the end of next year as we think about the growth and the diversification of our lines of business. So overall, still feel very good about that. And that type of loss ratio still gets you into a sub-eighty combined ratio overall.

Speaker 8

Yes, that makes sense. Thanks for that Chris. And then second question, I think Mackie had mentioned how fast E and S Residential Earthquake is growing, right? And it was a big number. I think it's above 70.

Speaker 8

I don't remember the exact number. But how can you talk about the admitted side of the resi earthquake book? And you did mention there's an inflation guard. But apart from that, outside of that, how fast is that piece of the business growing? And then if you sort of take a step back, right, to what extent in your opinion is growth in resi earthquake being influenced by this, I'll just call it, like migration of risks from admitted to E and S on the personal line side, right?

Speaker 8

Like I think that's pretty well known at this point, you're benefiting from it. But in other words, like in a more normal market and who knows when that happens, do you think your growth profile will change? So there's a bunch in there, but hopefully

Speaker 2

Yes, Pablo, let me just kind of give you my views on growth in Residential Quake and I think we'll probably able to touch on it. I think 1st and foremost, we feel very good about the growth prospects for residential earthquake, both admitted and E and S. When we talk about E and S, outer bounds that can probably be about 20% of our book. It's going to be concentrated in higher value risk. It's going to be concentrated in selected geographic areas like West Los Angeles and certain pockets of the Bay Area, where the housing stock is expensive and the exposure is more pronounced.

Speaker 2

If you look at our just our new business right now, it is very consistent across both admitted and E and S. Now E and S, we're getting more risk adjusted rate. And so we'd like to continue to grow that like we did in the Q3. And think, but I don't want you to think that we are going to even as the market grows increasingly E and S in California, you're going to see us not write as much on just the standard residential earthquake side of the book. Additionally, we have benefited certainly from the dislocation in

Speaker 1

the California homeowners market and

Speaker 2

as well the changes in homeowners market where companies like State Farm are non renewing large swaths of their book, that means they have to leave the CEA and that means we get the chance to compete for them. So that's going to be standard policies. And again, a driver of the standard residential Value Select products growth. The other thing that we are cautiously optimistic about, which might be a 25% growth driver, might be 26% growth driver. As interest rates come down, we do expect to see housing sales and transaction activity pickup.

Speaker 2

And when that happens, that means you're going to see new buyers of Residential Quake come into the market. So and those will more than likely be on the standard side. So on the whole, we feel very good about the growth in Residential Quake. It was pretty close to the same level as commercial in this quarter. It's a high teens grower on a bigger base.

Speaker 2

And I think we feel that that is sustainable, especially when you do have a 10% inflation guard and policy retention in the high 80s, low 90s depending on the month.

Speaker 8

Yes, that makes sense, Mac. And then just last for me, as you're growing outside of EarthClick, I'd be curious to hear the investments you're making outside of underwriting. And basically what I have in mind is something like claims right as you write more cash flow business. Those types of policies or claims tend to get more litigated. So what's sort of happening outside of the new business underwriting functions?

Speaker 8

And if you could sort of speak to the investments you're making? Thank you.

Speaker 2

Yes. Great question and thanks for asking. It gives me a chance to do a little bit of a commercial for someone we just brought on. We just hired Althea Garvey as our new Chief Claims Officer. She will work alongside Angela Grant, our Chief Legal Officer on the claims side.

Speaker 2

So Althea has over 30 years of experience as both a litigator, insurance defense counsel and litigator, as well as running claims off property claims for large E and S companies like Lexington and AIG, and then also having run TPAs. So she's got a very holistic view of the claims process. And part of her charge will be not only management of TPAs that we work with, but also continuing to build our in house capabilities. That organization is growing. And there are certain areas that we will probably be leaning into and taking more active control of, especially on the casualty side.

Speaker 2

So good question. You'll probably be hearing more over the course of 2025 about the investments we're making on the claims side and certain actions that we're taking to further invest in loss management prevention and control.

Speaker 3

Thank you.

Speaker 4

Thank you. And there are

Operator

no further questions at this time. I would like to turn the floor back to Mac Armstrong for closing remarks.

Speaker 2

Great. Thanks, operator. To wrap the call, I'd like to start by thanking our talented team for their continued work in

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Earnings Conference Call
Palomar Q3 2024
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