Good morning and welcome to the Palomar Holdings, Inc. third quarter 2019 earnings conference call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference lines will be open for questions with instructions to follow at that time. As a reminder, this conference call is being recorded. I would now like to turn the call over to Mr. Chris Uchida, Chief Financial Officer. Please go ahead, sir.

Thank you operator and good morning everyone. We appreciate your participation in our third quarter 2019 earnings call. With me here today is Mac Armstrong, our Chief Executive Officer and Founder. As a reminder, a telephonic replay of this call will be available on the Investor Relations section of our website through 11:59 P.M. Eastern Time on November 12, 2019. 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 and will be filed with the Securities and Exchange Commission today, November 5, 2019. 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 the results prepared in accordance with U.S. GAAP. A reconciliation of these non-GAAP measures to the most comparable GAAP measures can be found in our earnings release. At this point, I will turn the call over to Mac.

Thank you Chris and good morning everyone. Our third quarter results demonstrate the successful execution of Palomar's strategy and focus on profitable growth. We continued to enhance our product portfolio and expand our geographic footprint in the markets where we can deliver differentiated products that serve the needs of our customers and generate attractive underwriting income. This is best evidenced in the third quarter by our year-over-year gross written premium growth of 65.6% and our adjusted net income of $9.6 million and net income of $7.5 million. Our residential earthquake products, which comprised 53.9% of our gross written premium, generated 66.2% growth compared to the third quarter of last year. As discussed on our second quarter call, the Ridgecrest earthquake in Southern California in July, a third quarter event, caused a surge in demand for our residential earthquake products, a phenomenon that is common after earthquake events. In the third quarter, California residential earthquake new business policy count was 62.5% higher than the second quarter of 2019 and overall third quarter new residential earthquake policies increased 50.4% sequentially. Third quarter residential earthquake new business policies increased 87.6% over the prior year. This increase in demand is typically most pronounced in the first few months after an event but also historically established a higher new normal level of production as we appoint additional agents. During the quarter, our commercial earthquake business grew 73% year-over-year. Our sustained growth in this business is due to a combination of a stronger rate environment with an average rate increase of 9.2% during the quarter as well as expanding distribution on the heels of our achievement of our A.M. Best Financial Size Category VIII. Our wind-exposed business also demonstrated continued strong growth during the quarter, led by our Commercial all risk division. The all risk division…

Thank you Mac. During my portion, when referring to any per share figure, I am referring to the per fully diluted common share, unless otherwise specifically noted. For the third quarter of 2019, our net income was $7.5 million or $0.31 per share, compared to net income of $1.6 million or $0.09 per share for the same quarter in 2018. For the third quarter of 2019, our adjusted net income was $9.6 million or $0.40 per share, compared to net income of $2.7 million or $0.16 per share for the same quarter of 2018. Third quarter 2019 adjusted net income excludes expenses related to our company's IPO, the September secondary offering, one-time incentive cash bonuses, tax restructuring, stock-based compensation and the tax impact of those expenses. The third quarter of 2018 adjustments exclude the expenses associated with the company's IPO, tax restructuring and the retirement of debt. Gross written premiums for the third quarter were $66.2 million, representing an increase of 65.6% compared to the prior year third quarter. As Mac indicated, this growth was driven by strong premium retention and new business across our product portfolio as well as by an improving price environment, specifically for our commercial lines product, which saw an average rate increase of 9% during the quarter. Ceded written premiums for the third quarter were $28.1 million, representing an increase of 35.1% compared to the prior year's third quarter. Our risk transfer strategy remains a critical component to our business, especially as we demonstrated a sustained topline growth. The increase was primarily driven by an increase in our excess of loss or XOL reinsurance expense, commensurate with our growth in our quota share reinsurance. We utilize quota share reinsurance to minimize the impact of attritional losses on our portfolio and to generate valuable fee income…

Thank you Chris. To conclude, we are pleased with the results of the third quarter, especially the strong topline performance of all of our products in a sustained increasing price environment for commercial specialty property lines. Despite the losses associated with the heightened weather activity in the third quarter, we were able to still generate a compelling adjusted ROE of 18.8%. Lastly, we would like to thank all of the investors, new and existing, that participated in our successful secondary offering in September. We appreciate your support and endorsement and we will continue to execute our strategic plan on your behalf. With that, I would like to ask the operator to open up the line for any questions. Thank you. Operator?

[Operator Instructions]. Our first question comes from the line of Mark Hughes with SunTrust. Please proceed with your question.

Thank you. Did I hear you properly, the losses from the Ridgecrest and main storms was $1.8 million?

That is correct, Mark. You did hear us. That's $1.8 million, including IBNR from those events for the quarter.

And then you talked about the commercial retention being 91% this quarter versus 75% a year ago. Did I hear that properly? And that's a pretty meaningful change. Any detail you can give on that?

Sure. Mark, this is Mac. You did hear it correctly. It's 91%. And again, that is premium retention. So that reflects the improving rate environment that we are in right now. As I said on the call, the composite rate increase across all commercial lines was 9%. So the combination of better policy retention, which was driven by the overall competitive environment in the market in combination with the improving rate environment has allowed us to materially increase our retention.

The underwriting and other expenses were very good in the quarter. Were there any one-timers helping out there?

One-time like, I guess, you are talking benefits in the quarter that drove that down? No, there was no one-time benefits. Obviously, in the adjustments, we have listed the items that we take out of that to kind of get a more of a baseline, quarterly expense ratio or quarterly expense dollar amount. So I think, as long as you remove those, all one-time expenses should be removed and that's a good baseline for the quarter. And I would say, probably a better Q3 and Q4 of this year are going to be a better reflection of our current run rate based on the size and operations that we have right now.

Just to echo what Chris is saying, I think we have tried to say that by the time we got to the third and certainly into the fourth quarter, we should be at pretty decent steady state, barring any major investments and new lines of business and things of that sort. So we are hoping to really start to generate decent operating leverage.

And then the ceded written premiums relative to gross written, 42% in the last couple of quarters. Is that a reasonable way to look at it? Does that ratio hold steady? Or how much of that is influenced by seasonality perhaps on the written premium?

Yes. So I would definitely say that there is a little bit of seasonality in the written premium. Not necessarily, I will call it, by season, but definitely by events that have been impacting our book this quarter and historically. So if you look at Q3, the Ridgecrest event obviously happened early in the quarter. That helped with the overall growth for the quarter. So when you think about the gross to net premium ratio, there is a little bit of seasonality and I will call it noise in that ratio. And that can be from two things, it can be from a significant portion of growth in the quarter or it could also be from assumed deals. If you think back to the first quarter of this year where we had an assumed deal come on the books with about $6 million of additional written premium at that point in time, that can make the written premium look a little bit lumpier compared to the ceding out on the excess of loss or on the quota share side. So a couple of things that we would like to note and make sure that you guys are aware of. When we think about it, we think that the net to gross earned ceded premium and earned premium is a better way to look at our business because that has been smoothed out for any lumpiness for seasonality or for assumed deals that may come into our portfolio. And that number right now, you will see it in the Q, is hovering just below 50%. And we think that is probably a better indication of what the long term run rate will be or at least the current run rate based on our mix of business.

But I do think, just to echo what Chris is saying, I do think, what's driving it in the third quarter in a more pronounced fashion is just the composition of the mix of business. Earthquake actually over indexed the growth rate for the quarter. And earthquake does not have a quota share component to it. It's all excess of loss. And so therefore, there's a lower ceded premium amount. So if earthquake continues to grow at this rate, that could lower that ceded premium conversion, if you would. So it is a function of mix. And in this quarter, we benefited from a very strong growth in the earthquake business.

Thank you.

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

Hi. Thanks. Good morning. Just have a question. I just wanted to talk a bit about the continued penetration in some of the new distribution channels in the commercial business. I was wondering if you could just break down maybe how much of the growth that we saw within commercial quake and commercial all risk is being driven by some of these new relationships versus existing relationships and how you expect that to proceed as we head into 2020?

Hi Dave. It's Mac. I don't think we can break down how much was from existing distribution partners, how much was from new distribution partners because a lot of times, our commercial business, we generate through wholesale distribution. And so we would need to understand who the underlying potential retail originator is. So we can't tell you if something came from, for instance, A.M. wins, if it came from a retailer that we were not cleared by the Security Committee versus one that we previously were. But what I can say is, it grew 73% in the quarter. It was a combination of us writing new distribution sources through all different channels, whether it is retail or other carrier partners. So the commercial earthquake and commercial all risk is just growing through a combination of broadened distribution, opening up new distribution sources, having a bigger appetite on the heels of a larger balance sheet and now having access to new channels that we previously couldn't access because of our financial size category.

Got it. Thanks. And just to follow up on that, would you say we are still pretty early days in terms of those access to those new channels? Like do we have any more additional ones that could be brought online within the next few quarters?

Yes. I would say that we are still very, very focused on broadening our distribution for all of our commercial products, but commercial earthquake and all risk specifically. There's a lot of runway for growth there. So I think it's early stages, yes.

Okay. Great. And then just a question on the reinsurance purchasing and sort of buying additional limit for earthquake, just given the growth that we have seen, just wanted to get a sense for where are we and just how you are thinking about pricing for reinsurance at 1/1 renewals?

Yes. Dave, it's a good question. So what I would say is, we say it every quarter, one of our guiding principles is staying, keeping our reinsurance limit well above that 250-year PML and maintaining adequate cushion above that. Because of the growth that we saw in the third quarter and particularly in residential earthquake, we will be buying more limit in short order to again maintain that buffer. Our expectation is that we will be in the market in the fourth quarter and then at 1/1, we have $305 million of limit that's up for renewal that is all loss-free business. Our expectation is the market is going to look pretty similar to 6/1. We think loss-free business will be flat to maybe modestly up like it was at 6/1. And we think our portfolio remains very distinct in the sense that we are a great diversifier. We are at an excess of loss program that's dominated by earthquake and the secondary peril is Hawaiian hurricane. So we are very appealing, not only to the primary reinsurers, but even those in the retro market that are potentially pulling back their capacity. They like the fact that we are a way for them to access earthquake.

Great. Thanks for the answers.

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

Great. Thanks so much. Two really quick modeling questions. First, were there any prior period reserved developments in the quarter?

Yes. So we had a favorable development in the quarter of about $200,000 from the prior year.

Okay. Fantastic. Going forward, should we be modeling non-cash compensation at around the levels we have seen in the second and third quarter? Is that a recurring expense that will then be adjusted out?

Are you talking about the stock-comp, about, I think, $400,000 for the quarter?

Yes.

Yes. I think that's the right current level. I think over time, obviously, as we add resources to support the technology and the growth of the company, we will probably have additional options granted to those folks. So the comp will probably tick up in relationship to the overall addition of those folks. But I wouldn't expect a material movement over time. I think that's a good, yes, this is the first full quarter for the stock compensation, so I think that is a good marker for the near term.

Okay. Yes. I just wanted to make sure that that should be included. And then final question. When we look at other underwriting expenses, I appreciate your comments on the run rate going forward. Do you have any expectations or estimate about what the annual inflation is associated with that component, the inflation rate associated with that group of expenses?

We haven't provided any type of guidance on what we expect from that. I will say that, as we look at the business, we do think that there is going to be additional scale that occurs over time. With that, we are still going to continue in important parts of our business to make sure that the growth and the efficiency of the business continues. And so that's going to be technology. It's going to be some underwriting in relationship to the commercial lines. And then also, just some public company expenses that are required as we continue to grow. But I wouldn't expect that line to grow at a rate similar to the topline growth. So I do expect the margin and the scale to continue over the long term. But we haven't provided any specific guidance on it's going to go up 5% or 10% in the next quarter or year.

Meyer, this is Mac. And this might be a bit of overkill, but I think it's worth reiterating, just that the composition of the book of business and the fact that it's roughly 6.55% to 7% residential and personal lines business really does allow us to scale. And so if you think about it just on the heels of the third quarter with what we saw in residential earthquake, we not only saw the growth of 65% in that line of business. We also saw the number of agents that we have appointed increase by 12%. And for us to do that, we don't need to add bodies. We can appoint them on a one-time basis and then they are transacting within the system. So we can scale very nicely. And so I do think it's worth pointing that out. As Chris says, we will invest, but it's going to be selective and it's certainly nowhere near a circumstance where you have an investment that's a step-function to keep up with the growth on the topline.

Yes. Completely understood. Thank you so much. It's very helpful.

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

Good morning. Thanks for the call. Any update on product roll-up and how that may change the mix respectively?

Paul, yes. What I would say is, we are continuing to introduce new lines of business. We were pleased in the third quarter with the traction that we got in the recently launched inland marine division as well as our assumed reinsurance divisions. The inland marine right now, it's really focusing on builder's risk and we will start to move into other lines like contractors, equipment and installations. But it's still early stages in the sense that what we are trying to get is get our rates approved, get approved and producers appoint it across basically a national geographical footprint. Right now, we are writing business in five states out of a target of 26, so a long way to go. I think what you will see, though is, while the third quarter, we have said that we want to get to a 50-50 mix between other perils and earthquake, the third quarter, ultimately, we didn't reduce earthquake as a percentage of the overall book. That's actually a good thing because of the growth. But we are trying to continue to build around the earthquake and with a particular emphasis on these commercial lines. So I think you will see commercial business increase as a percentage and I think you will see commercial products outside of earthquake increase as a percentage as well.

And how should we think about the moves to the loss ratio of the expense ratio with that mix change?

Yes. Paul, it's a good question and Chris has talked about it in the past that you would likely see the loss ratio tick up some. But at the end of the day, right now, 72% of our business, it has zero. If things go as we hope and we expect that's a 0% loss ratio at the end of the quarter. And that's earthquake, both commercial and residential and Hawaiian hurricane. So as we grow, even if it grows at 100% year-over-year, like in the circumstance of builder's risk or flood or even all risk, it's not going to move it too materially. It's going to be pretty subtle on how it goes up.

And just to add to that a little more, I guess, context around the loss ratio and the acquisition expense. Those lines that we are expanding into obviously do have an attritional loss component to it. So that's usually the lines that we are going to look at using some sort of quota share to help minimize the volatility those losses will have on the book. So that's going to help keep the loss ratio lower. We do expect, obviously, that it will tick up just naturally as it becomes a larger component of the book. The other nice thing about the quota shares though, is it also helps with the acquisition expense. Those lines naturally have a lower acquisition expense than some of our other lines of business. But additionally, the acquisition expense will be offset by a ceding commission anytime we have a quota share in place. So that will also help to minimize or lower the acquisition expense as those lines of business expand.

Thank you very much.

Thanks Paul.

[Operator Instructions]. Our next question comes from the line of Adam Klauber with William Blair. Please proceed with your question.

Thanks. Good morning guys. Are you still seeing the demand surge carry into this quarter in California earthquake that you saw last quarter?

Hi Adam. What I would say is, what we have been looking at is the demand is persisting. It does dissipate, as we talked about. It does come down immediately following the event. But in the metrics that we try to track that we think gives us an indication of this new normal of new business is the number of agents that we appoint, not just the number of policies that we write in a quarter. So as I just said, we did increase our agent footprint by 12% on a sequential basis from Q2 to Q3 on the heels of the Ridgecrest earthquake. And we think that's a great indicator because what that means is those agents can now offer earthquake alongside all of their homeowners renewals when they come up. So it opens up the market. It kind of hopefully level sets the new business production for a period of time. And then when you combine that with a product that's got north of 90% premium retention, it offers a nice bit of visibility. So we are optimistic that we can see this persist for the immediate future.

Great. And just following up on that. I am not sure if you are going to answer this, but the way I think about it, you sort of have three different types of distribution. You have got retail agents. You have got MGA and wholesalers. And then you have got partnerships with insurance companies. Can you rank them, even if it's just on a rough basis, which ones actually are producing the fastest level of growth?

Right now, I would say the fastest level of growth right now is probably going to be the MGA and wholesale, because if you look at just certainly, in aggregate, because if you look at the third quarter, specifically, there was very strong growth in commercial all risk and commercial earthquake that's wholesale and/or MGA-driven. Residential quake, it's kind of a combination of all of the above. So I would say the MGA and wholesale is probably the fastest grower. But in terms of potential, it's going to be a combination of probably wholesale and retail that drives the future growth.

Okay. That's helpful.

The carrier partners are harder. They are a great channel for us. They are just harder to predict. They are lumpier. We saw a good traction from Liberty Mutual and Allstate, but they are still early in the third quarter. Those were both newly launched initiatives. Great promise, but it's from a sitting start.

Great. And then as we look at the commercial all risk and probably the commercial earthquake, are you benefiting and it may be early, but are you benefiting, to some extent, from unbundling of the major carriers? In other words, in the past, maybe an AIG or a Zurich would throw in a flood or throw in the earthquake along with their property coverage. But today versus a year ago, they are probably less likely to just give away those coverages. Are you seeing an impact from that?

Yes. Adam, that's a great observation. We are. But I would say, we are probably not seeing it in as pronounced fashion as others. You have to remember, we are an A-8 company. Those circumstances that you just outlined where a large national carrier was bundling in the flood or throwing in the quake with an all risk schedule, that's probably a national schedule. That's a $500 million of TIV or a couple of hundred million dollars of TIV. We traffic more in the sub-$50 million. Now we have a smattering of risk where we are going to be a $10 million, part of $100 million or $10 million, part of $200 million. But more often than not, we are going to be kind of a mid-market account. But that is a dynamic that is persisting in the market and that's allowing us to see our rates go up by 9% in the quarter and seeing them accelerate from up 5% in the second quarter to up 9% in the third. And frankly, it's something that is dynamic that we don't think is going to change in the immediate future.

Okay. Thank you. That's very helpful.

Our next question is a follow-up question from the line of Mark Hughes with SunTrust. Please proceed with your question.

Thanks. Did you mention the average pricing on residential quake?

Hi. Mark, this is Mac. Are you referring to what's the average premium point or average premium for an account? Or what the adverse rate increase is?

Yes. You got it. I am sorry. It's the average rate increase is my question.

So we have this inflation guard, which basically locks in an increase of approximately 5% on an annual basis. So that's a good rule of thumb that's going to renew up 5% year-over-year. Now it doesn't mean, so that's also tied to the exposure increasing somewhat as well, but it's an annual 5% premium renewal increase.

Thank you.

There are no further questions in the queue. I would like to hand the call back to Mac Armstrong for closing remarks.

Thank you very much operator. So that does conclude Palomar's third quarter earnings call. We thank you for your time, your questions and moreover, your support. We remain focused on the execution of our strategic plan and we look forward to speaking with you after the fourth quarter. All the best. Thanks very much.

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