Good morning and welcome to the Palomar Holdings, Inc. Second Quarter 2022 Earnings Conference Call. [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.

Thank you, operator and good morning everyone. We appreciate your participation in our second quarter 2022 earnings call. With me here today is Mac Armstrong, our Chairman and Chief Executive Officer. 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 August 11, 2022. 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, including, but not limited to, risks and uncertainties related to the COVID-19 pandemic. 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 will turn the call over to Mac.

Thank you, Chris, and good morning, everyone. We are very proud of our strong second quarter results. The quarter highlighted by 69% gross written premium growth, adjusted net income of $18.7 million and an adjusted ROE of 19.7%. In addition to strong financial results, during the quarter, we introduced our investors in the market broadly to Palomar 2x. Our intermediate-term objective of doubling adjusted underwriting income and maintaining an adjusted ROE of 20% plus via organic growth. It’s also a philosophy that continually assesses our product suite to ensure there’s enough organic growth opportunity to double the adjusted underwriting business in an evergreen fashion. As a reminder, key principles of Palomar 2x include but are not limited to, profitable organic growth, a portfolio anchored by binary/non-attritional loss business, namely earthquake, continued reduction of non-binary catastrophe exposure, a conservative reinsurance strategy, fee income build-out, scaling the business with technology and process and a commitment to ESG. The second quarter results are a clear demonstration of executing on Palomar 2x and the four strategic initiatives that we outlined at the start of the year. We wake up everyday thinking about how we will double Palomar’s adjusted underwriting income. And I am pleased to say we are firmly on track to do so as our products continue to deliver strong growth and the investments that we have made in the new lines of business are ramping up as we look to the second half of the year and beyond. Turning to 2022 strategic priorities, we made significant progress across all four components in the second quarter. Our first priority, generating strong premium growth is abundantly clear and our record gross written premium of $218.7 million in the quarter, which equates to 69% growth over the prior year. Notably, premium in our earthquake business…

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 period and exclude them in periods when we incur a net loss. We have adjusted the calculations accordingly. For the second quarter of 2022, our net income was $14.6 million or $0.57 per share compared to net income of $12.3 million or $0.47 per share for the same quarter of 2021. Our adjusted net income was $18.7 million or $0.73 per share compared to adjusted net income of $13.2 million or $0.51 per share for the same quarter of 2021. As we compare to the prior year results, it’s important to remember the impact Winter Storm Uri had on our results for the first and second quarters of 2021. While Uri resulted in favorable net losses in the first quarter of 2021, we did incur additional reinsurance expense or ceded written premiums in the first and second quarters of 2021. Gross written premiums for the second quarter were $218.7 million, an increase of 69.1% compared to the prior year second quarter. Our consistent strong growth was driven by a combination of favorable rate environment and increases in volume across our products. Fee written premiums for the second quarter were $122.6 million, representing an increase of 137.8% compared to the prior year second quarter. This increase was primarily due to quota share reinsurance driven by the growth of our fronting business and lines of business subject to additional loss. Ceded written premiums as a percentage of gross written premium increased 56.1% for the 3 months ended June 30, 2022 from 39.9% from 3 months ended June…

Thank you. [Operator Instructions] Our first question comes from the line of Tracy Benguigui with Barclays. Please proceed with your question.

Thank you. Good morning. You reiterated your 2022 outlook of $80 million to $85 million of adjusted net income but if I look at the first half of this year, you achieved just over $36 million, so it seems to be tracking behind. So are you expecting the second half of the year to be better than the first half?

Hi, Tracy, this is Mac. Yes, I mean, this is the guidance that we put in place and we’ve hit our targets to date and exceeded them. There is obviously a lot of embedded growth, right, over the course of the year. So as the premiums earned and our expenses for things like reinsurance are locked in, we feel very good about hitting the $80 million to $85 million or the $85 to $90 million if you back out the unrealized losses from the securities. It’s just how the premium ramps and some seasonality.

Yes. The only thing I’d add to that, Tracy, right, when you look at that 36 and if you put the tax-affected unrealized losses back in, you’re around about $41 million, and you do the math on that, call it to the midpoint of either one of those ranges, depending on what your starting point is, it’s $46 million in the second half of the year. So we feel pretty good about those numbers, especially with the growth we’ve seen in the top line.

Got it. And you also raised your Palomar FRONT guide to $130 million to $160 million from $80 million to $100 million in premium. And I recognize this is a capital light line. Could more volume be accretive to your 19% ROE target or do you need more critical scale to revise your ROE guide?

Yes, Tracy. I mean I think as we outlined at Investor Day, we’re trying to maintain an ROE above 20%, and we are right there this quarter at 19.7%, Palomar FRONT and the growth that we have and that does indeed put us in a position to pass that threshold. And our goal is to adhere to that, if not continue to build from it. It is capital light. We think we’ve got very good visibility on the revised range that we provided, especially when you factor in a good portion of that uplift is coming from an existing book of business that is transitioning to a frontage relationship in the form of our Texas homeowners business. So long-winded way of saying, yes, I think it is accretive to the ROE, and we have very good visibility on the revised range that we provided to you.

Thank you.

Our next question comes from the line of Pablo Singzon with JPMorgan. Please proceed with your question.

Hi, thanks. So cap losses have been benign for you so far this year. Would it be reasonable to assume that the average loss SME that you had referenced, I think $6 million, is that materialized or should that be concentrated in hurricane season, so basically the second half of this year?

Yes. Pablo, that is the AAL is for Continental hurricane. So it would be during wind season that runs 6.1 to basically November 1 but it tends to be more in the third quarter. I think it’s important to point out the number that we give you is based on September 30, that’s the peak of wind season and that should be declining post that September 30 date because a lot of that comes from the specialty homeowners book that’s in runoff. So we have a schedule that looks policy by policy, state by state, how that comes down. And so that number actually will start to tick down October 1, December 1 and obviously into next year.

Got it. And just to follow-up on that comment, Mac. The Texas business is being fronted, would it go through the same dynamic, basically meaning that even though we attach everything June this year, it will take the entire year for you to be fully off the risk there? Is that how that book should work as well?

No, no, that’s a good question, and thank you for asking that, and it’s always worth us to clarify. Effective June 1, all risks are transitioned into the quota share. So we are ostensibly off-risk say, for above the reinsurance provided by that quota share facility, which we do have in our program. But we are, in theory, off risk effective June 1.

Got it. And the last one for me. I wanted to follow-up on your comment about the view of having a 19% loss ratio for the year. Obviously, the loss ratio this quarter is pretty good. And I think if you see 19% for the year, you’re implying a pickup in the second half. So I was just wondering if you could speak to your expectations there, what will drive that, I guess, sequential deterioration from here? Thank you.

Yes. No, I don’t view it as a deterioration. I think that’s kind of hitting the numbers on what we’ve kind of provided guidance for or guidepost for the beginning of the year. We’ve always said it’s going to be calling that 18% to 19% range. We’re obviously happy with a lower loss ratio this quarter. We hit 17%. Our book of business, the loss ratio is still anchored by the binary book of business and also now by the fronting book of business. That represents about 64% of our overall written premium. So we do see that developing nicely over the coming years and periods. But with the overall book and the runoff of some of the specialty homeowners’ book that’s non-Texas, we do expect the loss ratio to still hover around that 19%. So could it be 19.5% or 18%? Yes, that would be within our comfort range. So we don’t think it’s going to run away from us. We’ve said that a lot. But overall, we’re pretty comfortable with that pick that we gave out at the beginning of the year and sticking to that 19% for the remainder of 2022.

Thanks for the answers.

Thanks, Pablo.

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

Yes, thanks. Good afternoon. Mac, your point about the earthquake authority, I think you said you were not impacted by the CEA. Why not? And will you be impacted in the future?

Yes. Mark, it’s a great question. And the sum and substance of it is, the CEA has certainly gone out and put out public bulletins around the changes they’re making. They have stated that they are buying less reinsurance, moving it down from 1 in 400 to 1 in 350, which ostensibly is about a $1.2 billion reduction in P&L. That’s taking place kind of in real time. They’re letting that limit potentially expire as certain reinsurance programs renew. They have not yet put into place reductions in coverages, they have raised rates very modestly. And so when I say it’s not been impacting us, it’s a marketing catalyst for us but there hasn’t been a dynamic where now, okay, they are changing coverages or shedding policies. So frankly, it’s runway for us. What has been a bigger dynamic it has been the dislocation in the homeowners market. That is what you’re probably seeing that today, the continued wildfire activity in the state of California and the residual impact that has on the insurance market, that’s been a bigger catalyst. And I think the other big catalyst for us, frankly, is that we continue to build our distribution network. Our distribution network in residential quake was up over 20% year-over-year, 4% or 5% sequentially. Partnerships are getting further traction in California and outside. So I don’t want to diminish the potential changes from the CEA. I just would say that it has not been a material driver yet, which I think is a positive.

Okay. And then in the commercial weight business, you saw acceleration. Could you talk a little bit more about that, what’s going on in terms of capacity, competition, demand? What’s driving that?

Yes. So we did see some acceleration. Rates ticked up in large accounts, for instance, from 7% to 9%. There is some capacity limitation. The cost of reinsurance went up. Our rate increase on the reinsurance was up 9%. Now, if you isolate the quake, it was probably up closer to 5% to 6% but there is an emphasis, at least internally, for us, on trying to recover loss costs post June 1 in that renewal. And I think others are doing the same. So I think market-wide, there’s rate integrity and the need to recover loss costs. And especially if you’re buying your reinsurance on an all-perils basis, we have the luxury of the majority of our tower being quake your rate increase may be more than 9% even if it is loss-free like we were. So, I think there is rate integrity. There is capacity limitations or pull back and it’s created a circumstance where we think on the commercial side, we can grow and optimize the book at the same time, which is frankly a unique dynamic.

And Chris, did you report or disclose the fronting fees that you generated in the quarter?

Hey Mark. No, that is not something we have disclosed. We have talked about it on the calls previously, but generally speaking, the fronting fee is going to be about 5% of the fronting premium. We earned that similarly to all of our risk-bearing premium. And we always talk about the fact that we do net that fee as ceding commission through our acquisition expense. So, you can see that trend showing up in the acquisition expense this quarter with it continuing to go down. It was up 18% on a gross basis this quarter from about 20% in Q1. So, everything is operating as expected and the fronting fees and the ceding commission, even from our other lines of business with attritional losses where we still use heavy quotation reinsurance, that fee income is showing up and reducing our acquisition expense as we expected.

Mac, I liked your comment about how you are keeping an eye on the inflation in the construction area, auditing values and replacement costs on a monthly basis. When we look at excess liability, how do you keep an eye or try to get in front of potential inflation in that line of business?

Yes. Fortunately, we have got seasoned leadership that I think you have the chance to visit with at Investor Day, Mark. I think what we are really watching there is court activity and trying to see, as the court reopens, what that portends and how that informs pricing, how that informs loss costs and claims management frankly. It’s a small portion of what we do. And so that’s how we are approaching it from an underwriting standpoint. I think the other side that we, frankly, are using as a tool for risk management is the quota share reinsurance. So, for excess liability, if we are writing a $5 million line, we are, on average, around 25% depending on the program. So, we are either 25% or 30% of the risk. So, individually, in isolation, we are trying to manage it that way as well as get fee income and then there is also the underwriting tools and claims management tools that we just referred to. It’s certainly something that we need to keep an eye on as that book grows.

Thank you.

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

Hi. Thanks. Good afternoon. I had a follow-up on the attritional loss ratio of 17.2% in the quarter. Can you talk about the moving pieces there during the quarter that drove the favorability versus the roughly 19% level that you have guided to for the full year? And I guess I am wondering specifically in there, if there was any benefit – any tangible benefit from the one month that you had removed Texas or moved Texas to a fronting arrangement?

Yes, Dave, that’s a great question. The key components of that loss ratio are, I will call it, current year was about - the prior year development was about $0.5 million of favorable development. So, we have talked about in the past that we are always generally conservative on how we set up the loss ratios when we go into a period. So, we did have a little bit of favorability come back into it there. I wouldn’t call it a material amount, but it was about $500,000. So, let’s call it the current year loss ratio was a little bit higher than the 17.2%, let’s call it, 17.8%-ish was the current year loss ratio with that favorable development back out. So, I would say that’s in line with our expectations. As you did indicate, we do see a little bit of benefit from the Texas specialty homeowners book being turned into a front business. But for most of that quarter, that’s still in there and it’s still got some severe convective storm period in there, which is part of our heavier season for the Texas business. But again, quota shares operating as expected for the first two months and then moving all that book into a front is something that’s going to be able to deliver consistent profitable fee earnings over the next 12 months and into the future as that line. And then the other homeowners book is kind of fully run off.

But I think, David, it is an astute observation you make that really more for prospectively, that is that line of business at the end of ‘21, the specialty homeowners book was around $60 million of, call it, 12% of the book. And so it’s either winding down over the course of the year or it’s converted to a front. And that was a loss ratio that’s a little bit higher and obviously has the cap exposure. So, I think that just adds more stability and which in turn gives us more confidence on why we think we can maintain 19%. And hopefully, there is some positivity to the upside based on conservatism of prior year estimates.

Got it. Thanks. That’s helpful. And so yes, I guess the way I interpret that and I guess a follow-up question is the volatility is obviously removed from moving the Texas book to a fronting arrangement. But it feels like there might be somewhat of an attritional loss ratio benefit from that as well. Is that fair to assume?

Yes. It is.

Got it. Okay. And, sorry, the $500,000 favorable development that you had, that was on the attritional losses. Could you just elaborate where that was specifically, at what line?

Yes. No, I think it was on the attritional losses. So, we had 500 favorable on attritional and let’s call it, 500 unfavorable on the caps. So, those are the two components we look at it in the table. It’s almost a breakeven number for the quarter. From the attritional standpoint, there was really nothing that stood out on the capability. It was really across the board on all lines of business, whether it would be specialty homeowners, inland marine, flood, all the lines really performed well this quarter or developed well this quarter, so we are very happy with it. And I think it also sticks with our theme of being conservative upfront. So, we saw that kind of play out this quarter in the development. And then digging on the cap side, right, we did have a little bit of unfavorable development there. Nothing surprising on that or nothing I would call systemic or issues that are arising there. If you guys recall, from our standpoint, for a cap, it really has to be the smaller caps that impact our results because the larger events go into the reinsurance tower and so they move up or they move down, are not as impactful to our financial results. So, these are, call it, a small handful of claims that are getting closed out that developed poorly, but it’s not on large events and it’s not a giant move. This is just the smaller claims just getting closed out.

And Chris, if I am not mistaking, the majority of that 500, if not the totality of it was from the admitted RS book that is runoff.

That is correct. Yes.

Got it. That’s great color. Thanks for that. And then if I can just ask on the two fronting arrangements, the upsizing of Cowbell and then the California workers’ comp, have you guys decided to retain any of those two relationships? And I guess, maybe how you are thinking about that from a risk management standpoint, if so?

Yes. So, we are going to take 5% on the Cowbell program. And it’s a modest amount. We have – well, as I have said, since all along, like we have been able to basically do it, we use this as a form of due diligence, right. We have the ability to learn a segment as a fronting partner and then if there is a chance to take risk, we will elect to or not. So, we did elect to take 5% there. And then on the workers’ comp, it’s around a 4% participation as well.

Got it. Thank you.

Thanks David. Appreciate it.

Our next question comes from the line of Derek Han with KBW. Please proceed with your question.

Hi. Thanks. So, you had really strong growth in the quarter, but just curious if your growth rates are being impacted by personal carrier partners pulling back just because of poor results and can you also comment on the Insurtech side as they increasingly focus on profitability?

So, Derek, thanks for the question. I would say our personal lines carriers pulling back, I think it’s part of a broader theme of dislocation in the California homeowners’ market that we have talked about, so that’s certainly a contributor. What we are seeing is more and more homeowners businesses going in the E&S market, and that’s giving us the option or the ability to write E&S residential earthquake at a higher rate than we have historically as well. I would say it’s been more pronounced this quarter than it has been really over the last 2.5 years. And then on the Insurtech side, we are fortunate. We partner with some of the Insurtechs, and they are very good at customer acquisition, and we think we provide them a nice complementary product around out their suite. We have not seen anything yet in terms of them retrenching from a production standpoint. I can’t speak to how they are underwriting, but it’s been a good channel for us. So, the one thing that I will say around the partnerships is, we are continuing to execute with partnerships like Travelers as an example where we have performed in certain states and now are trying to broaden the relationship to move into states beyond the initial cohort. And we continue to have dialogue with other carriers who want to either enter the California market as an E&S rider or are trying to manage their exposure in the state. So, partnerships remains a pretty active channel for us.

Got it. That’s helpful. And then my second question is on inflation. It looks like you are largely maintaining your loss trend assumptions that you raised last quarter. So, how comfortable do you feel about that holding in the second half of this year as a lot of carriers have kind of raised their loss trend assumptions?

Yes. So, I think we feel comfortable with it, especially on the property side, which is the large predominance of the book. And I think it’s worth reiterating that we have taken somewhat of a three-pronged approach to inflation. It starts with the ITV and the inflation to value and making sure that we get the appropriate replacement cost per square foot. And that’s where, again, we have the luxury of leveraging a host of third-party tools plus what we do in our builders’ risk book where we have audit policies and we get a real-time assessment of the replacement cost. So, that’s one. Two is the inflation guard and then three would be a rate change. So, I will use the State of Hawaii as an example. We are obviously going through the ITV exercise and getting that right. And then secondly, we have now an 8% inflation guard on renewal policies. And then furthermore, we have a 6.85%, I will round up to 7% rate increase. So, it’s a multipronged approach that we have to stay on top of. Listen, we had a 9% rate increase on our reinsurance program. We need to cover that loss cost and then some to maintain our margins. And I think we are doing a good job of it, but we can’t take our eye off the ball.

Okay. Thank you for the detail.

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

Great. Well, thank you, everyone, and thank you, operator. We appreciate all that who are able to join us this morning. We appreciate your participation, questions and most of all your support. I want to continue – rather, I would like to thank all of our employees for their hard work and dedication as they really did a superb job of execution this quarter. To conclude, I am proud of our results in the second quarter and the progress on achieving our 2022 strategic initiatives. We have delivered consistent strong growth. We continue to monetize our new investments, enhance our earnings predictability and it made strides on scaling the organization. Furthermore, we remain very confident in our ability to execute Palomar 2x. The combination of the considerable organic growth and the investments we have made really do position us well to double the adjusted underwriting income of the business and deliver better-than-industry average ROE. And what that translates to is value for our shareholders. And I think that’s ultimately what you will see. So, thank you all, and enjoy the rest of the day, and we will speak to you next quarter.

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.