Good morning. And welcome to the Palomar Holdings, Inc. Second Quarter 2023 Earnings Conference Call. During today’s presentation, all parties will be in a listen-only mode. Following the presentation, the conference call 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 conference call over to Mr. Chris Uchida, Chief Financial Officer. Chris, please go ahead, sir.

Thank you, Operator. Good morning, everyone. We appreciate your participation in our second quarter 2023 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 10, 2023. Before we begin, let me remind everyone that this call may contain certain statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These include remarks about management’s future expectations, beliefs, estimates, plans and prospects. Such statements are subject to a variety of risks, uncertainties and other factors that could cause actual results to differ materially from those indicated or implied by such statements. Such risks and other factors are set forth in our quarterly report on Form 10-Q filed with the Securities and Exchange Commission. We do not undertake any duty to update such forward-looking statements. Additionally, during today’s call, we will discuss certain non-GAAP measures, which we believe are useful in evaluating our performance. The presentation of this additional information should not be considered in isolation or as a substitute for results prepared in accordance with U.S. GAAP. A reconciliation of these non-GAAP measures to the 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. I am very pleased with the strong results of Palomar’s second quarter. Our team successfully executed our Palomar 2X strategy of profitable growth, even in the teeth of elevated catastrophe activity and a historically hard reinsurance market that significantly impacted the insurance industry. In the quarter, we focused our capital and resources towards targeted segments of our book of business, like Earthquake, Inland Marine and Casualty to maximize our risk adjusted returns, while we continue to reduce exposure to segments of our book that add volatility to our results. This prudent approach resulted in gross written premium growth of 25%. When excluding the drag from run-off and deemphasized products, this growth rate was an even more impressive 44%. Importantly, we delivered an adjusted return on equity of 21.3% in the second quarter. Beyond the strong financial results, the quarter featured several noteworthy accomplishments that position us well for near- and long-term success. Namely, we have successfully placed our 6/1 reinsurance program in line with our expectations and subsequently raised our adjusted net income guidance for the full year. We hired a team of professional liability underwriters to extend our Casualty franchise in attractive niches like real estate E&O. And lastly, in July, we received a revised positive outlook of our rating from A.M. Best. Over the course of the second quarter, we made incremental progress in 2023’s identified strategic objectives, sustaining profitable growth, managing the dislocation in the global insurance market, enhancing earnings predictability and scaling the organization. Looking forward, we will continue to execute these imperatives, but look to convey their progress through five key lines of business that will drive the value of Palomar over the medium-term. Those lines of business are Earthquake, Inland Marine and Other Property, Casualty, Fronting and…

Thank you, Mac. Please note that during my portion, when referring to any per share figure, I am 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 where we incur a net loss. As a reminder, beginning in the fourth quarter of 2022, we have modified our definition of adjusted net income, diluted adjusted EPS and adjusted ROE to adjust for net realized and unrealized gains and losses. We have modified the current and prior period figures accordingly. For the second quarter of 2023, our net income was $17.6 million or $0.69 per share, compared to net income of $14.6 million or $0.57 per share for the same quarter last year. Our adjusted net income was $21.8 million or $0.86 per share, compared to adjusted net income of $22.4 million or $0.87 per share for the same quarter of 2022. Our second quarter adjusted underwriting income was $23.1 million, compared to $24.8 million last year. Our adjusted combined ratio was 72.2% for the second quarter, compared to 69.1% in the second quarter of 2022. For the second quarter of 2023, our annualized adjusted return on equity was 21.3%, compared to 23.7% for the same period last year. The second quarter adjusted return on equity is further validation of our ability to maintain topline growth with a predictable rate of return above our Palomar 2X target of 20%, even during a quarter with very active severe convective storms and in a historically hard reinsurance market. Gross written premiums for the second quarter were $274.3 million, an increase of 25.4% compared to the prior year second quarter. Excluding deemphasized and current run-off products, our written premium…

Thank you. [Operator Instructions] Our first question is coming from Tracy Benguigui from Barclays. Your line is now live.

Thank you. Good morning or good afternoon. Your attritional loss ratio of 18.9% was below your guide of 22% to 24% for 2023. Could you unpack that a little bit?

Yeah. Thanks, Tracy. That’s a good question. When we look at our loss ratio for the quarter, obviously, we are happy with the results. The overall loss ratio was 21.5%. If you put back in the prior period development, that loss ratio moves up a little bit to 22.3% for the quarter, which I would say is, in the low range of the guidepost we gave out of 22% to 24%. Mini cats for us were elevated this quarter, causing us to put those losses or severity and magnitude of those events caused us to put some of those losses into catastrophes. As you saw that loss ratio for the quarter being about 2.6%. So, overall, we feel good about those results. The loss ratio was a little bit better. I think mini cats were a little bit higher, causing the loss ratio probably to be about 1.6 points higher than we would have expected. So still better than expected. But, overall, everything is in line with how we feel about the year. I think the one thing you will notice on the prepared remarks, we did call a decrease the bottom of the range for the full year. We went from 21% to 24%, reflecting what we have seen in the first half of the year, but still expecting those loss ratios to improve in the latter half of the year and then into Q1 next year.

Tracy, this is Mac.

Is that a function of pricing? Go ahead.

I think -- yeah. Tracy, this is Mac. I will -- I think pricing is contributing to that. I think it’s also part of our concerted efforts to run-off certain segments of the book and that’s why I know one of the things that you were focused on was the growth. We grew 44% in the areas that we are investing in and we are thrilled with that. But one of the benefits of running off some of these lines or deemphasizing some of these lines like All Risk is, is it does improve the loss ratio. Even in the second quarter, All Risk, which declined close to 40% year-over-year, it still had $1 million of cat loss and it has a higher attritional loss and certainly the 21% that we blend out to. So one of the positives and one of the reasons why we are running off some of these books that have higher volatility is that they also have higher loss ratios. So that’s also a meaningful contributor to why the loss ratio is was what it was this quarter and why we think -- and Chris has always said, we expect it to continue to go down somewhat over the course of this year and certainly into 2024.

Okay. My next question, I’d like to talk about the durability of your Fronting program in light of higher Reinsurance costs and increased market concern about Reinsurance counterparty risk, particularly on collateral?

Yeah. So I am happy to do so, Tracy, and it’s a timely and smart question. We are seeing strong growth from targeted Fronting partners. We have, as I mentioned in my remarks, we have seven of them. So we take a rifle shot approach, which allows us to manage these partners closely and frankly collaboratively. It’s more like an underwriting relationship. And we are -- so it’s a pillar and segment where we are seeing nice considerable growth, but that percentage of the premium that it can constitute is not the same from adjusted net income. So it’s a nice segment for us. It allows us to be disciplined and prudent with new partners and who we bring on, we can be very selective. I think the one thing that certainly with the shakeout of what’s happening in, in the Fronting market broadly with Vesttoo, our exposure is immaterial. We were able to get in front of this really quickly and we understand not just our exposure, but our remedies and those remedies are several. I think for us, we continue to look closely at how we manage these programs and how the industry will shakeout. Two, our Reinsurance programs for our Fronting partners renewed with increased capacity and support and consistent economics in the second quarter. We also had one successfully renewed at the first part of the third quarter, incepting in July 1. So I think there will be consequences. I think for us, though, it’s probably a net positive for Palomar because, first and foremost, we are an underwriting organization. We are already seeing submissions from program submissions from MGAs that are looking for potentially a new fronting partner. We are also seeking potentially more stable fronting partner. We have also seen submission flow uptick in a few Casualty lines from MGA back or rather renewals coming away from MGAs that have potential collateral exposure to us just in the open market with our Casualty segment. So, all in all, we won’t deviate from our Fronting strategy. If anything, our blended strategy and our targeted strategy is affirmed here and I think it also overall validates our models of reinsure, excuse me, as an underwriting organization.

Thank you.

Thank you. Next question today is coming from Mark Hughes from Truist Securities. Your line is now live.

Yeah. Thank you. Good afternoon. The earned premium, you alluded to the topline growth. You certainly were influenced this quarter by the run-off and deemphasized lines. What should the earned premium growth be given kind of your mix of Fronting versus underwritten business? How should the earned premium trajectory be?

Well, Chris, can chime in, Mark. What I -- this is Mac. And what I would say is that, you look at those kind of five segments that we have talked about. We see very strong sustained growth in Earthquake. It’s growing 20%. I think that’s a good rule of thumb for that line. And then I think when you look at Casualty and Inland Marine, there is considerable growth. Fronting, it’s hard to say, it’s going to sustain a 90% growth rate, but what we like is there is embedded growth with most of our partners here. Some are kind of hitting their critical mass in steady state, but that’s all right for us because there’s still a nice earned premium ramp for us. So long winded way of saying, I think, the growth is going to continue to be strong, expecting it to be 44% might be a bit ambitious, but we feel like that it’s a healthy growth vector when you look at the underlying contributors like Inland Marine, Casualty and obviously, Quake.

Yeah. And Mac talked about the topline growth of the written premium, obviously, that will influence how the gross earned premium grows. I talk about this a lot that the -- with the change in the mix of business with a lot of Fronting and business that uses quota share and with the increased excess of loss costs that we will see for the first full quarter in Q3 that the net earned premium ratio will continue to decrease. It was 34% in the second quarter, it’s going to get into the low-30%s for Q3 and potentially a little bit in Q4 as well, right? So I just want to make sure people think about that as they model it because the excess of loss Reinsurance costs that we have talked about before was up about 30%, which is as expected as we modeled into our guidance. But I want to make sure people are thinking about that and modeling it correctly when they think about our net earned premium ratio and the results that we are going to see in the second half of the year, right, Q3 will be the lowest point of that, and then we will start to scale more as we continue to grow the business, but the excess of loss cost is flat and in place until 6/1 of 2024.

When you look at the renewals that are coming up, you are describing about a 20-point differential between, what would have been other than the deemphasized and run-off business. What’s going to be the marginal impact in Q3 and Q4, if it was 20 points in Q2, how much of these risk management adjustments going to impact the second half?

I think it’s probably -- Mark, it’s in and around the difference between 14 -- maybe 10 points to 14 points overhang of the growth. Most of the specialty homeowners business will be out by the third quarter. The All Risk is over the course of the year.

Okay.

So if you look at All Risk, what we are really trying to solve for is getting the PML down to $100 million and it’s basically there. And at that level, we feel that it is a sustainable level where we can maintain a manageable reinsurance expense, it obviously was up meaningfully. And I think it’s one thing that I’d point out is if you look at the relative cost of all-peril and Wind Reinsurance versus Earthquake, it’s double. So we are focusing more of our cat dollars on earthquake. For Wind, we want to get it down to $100 million continental hurricane PML and I think at that point we can justify our retention. It’s a $4 million AAL at that level and it has minimal severe convective storm exposure. So that means that there is an opportunity for us to take rate and optimize that book continues to grow, but that’s really not going to start until the first quarter of 2024.

And then, finally, the Commercial Quake business, better pricing, but a little bit of deceleration at the topline -- deceleration -- from very strong growth. Anything noteworthy there?

No. That market -- and Jon Christianson can chime in. But I would say, I mean, it grew 30% or 29% in the quarter. We want to be mindful of where the reinsurance costs were going to shake out and that would inform the PML. And frankly, we want to make sure that we could procure the incremental $550 million of reinsurance support to support the growth that we are seeing. What I will tell you right now is our metrics have never been better. The capacity in the market is dwindling. So we feel very good about sustaining strong growth in Commercial Earthquake. But Jon, anything you would add?

Yeah. No. I agree with all that. I think we have seen now many quarters in a row of that strong rate appreciation in the Commercial Earthquake segment, and as we look forward to the next few quarters, there’s no signs that would suggest that it would decelerate.

Great. Thank you.

Thanks, Mark.

Thank you. Next question is coming from David Motemaden from Evercore ISI. Your line is now live.

Hi. Thanks. Just a question on the Crop opportunity. It sounds like you think that will start coming in, in the third quarter. I guess how big do you think that has the potential to be as another growth lever that we haven’t really seen here in the first half and then how should we think about the profitability profile of that business versus your existing business?

Dave, yeah, this is Mac. And again, I will let Jon speak to this. I think there are a few things that I would want to get across to you is, for this year, it’s really a startup. We will generate some premium in the third quarter and in the second -- or the second half of the year, but it’s more fronted, so it’s really going to be a fee generation product. For 2024, we think it can be a meaningful premium. It’s a $20 billion market. We are one of 13 approved insurance providers, we have terrific in-house expertise and a terrific distribution partner in Advanced AgProtection. So we are optimistic that it can become a large contributor to premium in due time, but in 2024, it has a chance to be high double-digit millions of premium.

Yeah. And with regard to the profitability aspect of the question, it is a historically profitable line, and importantly, it’s not correlated with our existing core lines and it has a short tail and a combined exposure period with strong Reinsurance support back in it. So from a profitability standpoint, we feel it folds in nicely with the other lines of business that we have.

I think the one thing that I would add to that, Dave, and I should have brought this up, next year, we expect -- we will take risk on it, but you are talking about, just call it, conservatively a 10% participation. So it’s still going to be a nice balance of fee and underwriting income like we have done with all of our new products. So we are not going to deviate from that strategy. So nice fee income stream, as well as a nice underwriting income component to it. So it may end up being like an 8% to 10% margin in that year.

Got it. Understood. That’s helpful. And then just on the Vesttoo, the one counterparty where you have exposure, was that something where it just -- it sounds like it’s immaterial in size. Was that something where you just absorbed the -- what you had reinsured or is that something where you just replaced the LOC in question?

So it’s for a prior, it’s sort of a treaty period that has expired and so we are looking at just what’s in trust and what would be our exposure if it goes beyond trust. And so if it goes beyond the trust, which we have full control of, that’s where our exposure would be, and again, it’s immaterial. For everything that’s in place right now, Vesttoo, there’s nothing -- Vesttoo is not an issue, they are not a reinsurer.

Got it. Thanks. And then maybe just finally, it sounds like capacity has definitely not been an issue for the seven programs, the existing programs, but just wondering on like the growth -- the future growth of adding new program partners. Is there just -- have you seen a slowdown in the conversations that you have been having with capacity providers? It sounds like MGAs want to partner with you guys, but are you able to secure the capacity on the back end for newer partners?

No. I mean I think for us we have been -- we have had successful Reinsurance renewals. We are being very selective in talking to potential new Fronting partners. Ultimately, we view these Fronting partners as people that we are going to take a risk on at some point in time. So we hold them to a different standard than maybe other markets do. So, as a result, we are getting a lot of inbounds. We expect that we will add to them in time, but it’s going to be a very deliberate addition. But I would say…

Okay. Thank you.

…on the deal of what’s been in the press the last week or a few weeks, we are seeing a lot more inbounds, but selectivity has not changed, if not increased.

Yeah. Understood. Thank you.

Thanks, Dave.

Thank you. [Operator Instructions] Our next question is coming from Andrew Andersen from Jefferies. Your line is now live.

Hey. Good afternoon. Just with regards to the Fronting program, Mac, I am not sure if I heard you mention cyber, but it seems from like industry pricing surveys, it’s kind of softening a bit. Can you just kind of talk about the appetite there for the Fronting program with regards to cyber?

Sure, Andrew. Yeah. Cyber is one of our large partners in the Fronting arena and that was the renewal that I referred to that was early third quarter, it’s 7/1. So that was successfully placed with great capacity support. We had taken modest risk participation there we have for the last two years. Yeah, we are watching the pricing. I think for that program, it’s one or that product in that Fronting relationship, we really do view that like we are the underwriter here. And so while it’s only a low mid-single digits participation, we manage it like something that we are taking 30%, 40%, 50% of. So on the whole, rates are certainly down from where they were two years, three years ago, but we feel good about the performance. We feel great about the Reinsurance support. They got the ability to grow from a revenue perspective or from a premium perspective, so the premium capital has increased. So on the whole, I think, it’s a line of business that is performing well. It certainly requires increasing diligence, because of the market conditions, but it’s a great partnership.

Okay. And on the Casualty business, you mentioned an uptick in submissions there. Should we really just think of that as some of the real estate E&O or is it perhaps some different lines, and can you remind us if that’s going to largely be on the E&S entity, which looked like the growth was a little bit slower in this quarter?

Yeah. Good question on the Casualty side. We are pleased with the growth there, it’s 92% and it’s now approaching -- it’s 4%-plus of the book. We are being deliberate here, though, too. We are using the E&S company for the predominance of it. We do have a handful of GL business that’s on the admitted company and that tends to be focusing on kind of small to mid-market commercial contractors, call it, $5 million to $20 million in annual, predominantly low and moderate hazard stuff. So think about like trade contractors or general contractors that are building schools. We really are trying to avoid classes that have severity on the admitted side or high severity exposure. What I will say is on the professional lines where that’s mostly E&S, it’s growing really nicely, but also deliberately. It’s targeted niches that we are going into, real estate E&O is the one you highlighted. But when we brought on some underwriters in the quarter, a lot of them, they spent the quarter ramping up and now we are starting to see them leverage their expertise, leverage their distribution relationships. Gerrit VandeKemp, who oversees our professional lines, I were talking recently about a collection agency program that he’s already starting to write with one of his underwriters that just -- is just coming on and has nice potential to be a great supplement to the E&O franchise, but very targeted and niche. That’s what we are looking to do. I think if we can take that deliberate approach from a reach and distribution and appetite perspective, the book not only will grow, but it will be profitable and predictable.

Great. Thank you.

Thank you.

Thank you. Next question today is coming from Pablo Singzon from JPMorgan. Your line is now live.

Hi. Thank you. So my first question is on guidance. You increased it twice over the past several months. I was hoping you could impact those changes a bit here. To what extent was the updated guidance based on your first half performance and to what extent is the reflection of what you think will happen in the second half of the year?

Pablo, I think, it’s a combination of the two. It’s a good question and thanks for asking it. What I would say is, the first guidance raise was potentially it was a little bit of a delay off of Q1, but we want to see where reinsurance pricing shook out and so that informed the raise that we did in June. This quarter on the heels of Q2, we raised guidance again to reflect the results in the first quarter, but also what we expect to see in the first half or the second half of the year. Chris pointed out, he’s taken down the loss ratio range. So that’s informing it. We are also -- again, the business that we are running off has -- you could argue that certainly some of it was unprofitable and certainly with the Reinsurance load that we are seeing on Wind business, it would have been unprofitable on a prospective basis if we had tested on. So long-winded way of saying it’s a combination of the two, but we feel like there’s great momentum in the business and our goal is to be in the race, that’s our operative focus.

Okay. And then second question maybe for Chris. I heard what you said about expense ratios going down on a gross basis, right? But if you look at the expense ratio against net earned premiums, I think, this is the first quarter over the past four or five where it actually went up year-over-year and that’s probably more a function of net earned going down. Do you see that trend persisting through the second half because of what you described, right, essentially the reinsurance costs kicking in, will that essentially inflate the expense ratio on a net earned basis as well for the second half of the year?

Yeah. So you pointed it out well, Pablo, right? When you think about the expense ratio, even the loss ratio on a net earned basis, it is severely impacted by the excess of loss, right? I don’t think that we -- my view is that combined ratio doesn’t do a good job of measuring those ratios when you have an excess of loss load like we do and seeing the excess of loss load going up by close to 30%, like, we have talked about, is going to impact that with really no overall change in potentially the expense ratio or the loss ratio. So it’s kind of why we take it out, especially on the expenses. We think about it on a gross basis. You can model a little bit easier, you can look at it and so when I look at the acquisition expense ratio, I see that continuing to tick down because of the mix change, whether it be Fronting things of that nature, but then the same with the expenses, right? It’s a little bit flatter, which we talked about and so it feels like everything is heading in the right direction and it kind of -- when I look at it on a gross basis, it takes out the noise of the excess of loss and that’s why when we talk about the gross earned premium ratio and think about that, we talk about that separately, so that you guys can think about how the excess of loss is going to impact it and that’s going to go from 34 down to the low-30s in the second half of the year. That’s how we think about it. But you are absolutely right. The modeling impact of those ratios and call it being a little bit higher this quarter is impacted by the excess of loss cost. And so, like I said, that cost is going to be higher in Q3, which is going to be the first full quarter with that loaded in.

Okay.

I think the other thing to add, Pablo, and Chris described it well. Just a reminder, we brought on a lot of underwriters in the second quarter. Great talent and claims professionals alike that will generate a return, whether it be topline or improving the bottomline through cost containment and loss management, but that will take a little bit of time. So there was a decent amount of some cost -- not some cost, but cost that should generate a return, certainly in 2024.

Okay. And then last question for you, Mac. So I heard your comments about disruption in the California Earthquake -- California market potentially being an opportunity for you to grow Earthquake. I guess the question is, just given what’s happening, right, like, in the amount of disruption. Is there a risk that the market gets overly disrupted where, for whatever reason, the uptick of Earthquake insurance goes down, right? And I am thinking of like massive withdraws capacity like more people going to the fewer client, for example, like if the disruption reaches that level, is that still good for your Earthquake business?

Yeah. Pablo and I will let Jon Christianson offer this, too. The disruption in the Earthquake market -- the homeowners market, I think, remains good for our business, whether it be the non-renewing policies that may have had an Earthquake endorsement or standalone companion policy attached to it. We get to compete on that, whether it be the CEA taking their deductibles up to 15% on anything over $1 million of Coverage A or reducing the amount of Coverage C, which is your personal property. Those are all good dynamics for us. And I don’t think we have reached a point where there’s a precipice that we have gone beyond. I think this is just a bit of kind of a slow burn change in the California market that we are going to be benefiting from.

Yeah. And I’d add with the disruption that we have seen to date in that homeowners market in California, it has not translated into anything unusual with our Residential Earthquake book. Our book has been very predictable and our partnerships remain very strong in the State of California. So we have not seen anything that would indicate a disruption to a very predictable and profitable line of business for us.

Okay. And even with the homeowners pricing going up double digits, it seems like from what you are saying there’s still appetite for earthquake insurance as a rider to the basic homeowners product, is that fair?

That’s fair. Yeah. I mean, again, our buyers tend to be mass affluent that have a lot of equity value in their home, so they are protecting an asset and we have not seen people reduce coverage. We offer multiple deductible options that hasn’t deviated where they move their deductible up to manage the expense. So we look at that, but if you look at just, A, the continued growth, 20% in Residential Quake, but also the increasing take-up in E&S, which frankly, E&S, on E&S, whereas EQ policy cost more on a per dollar basis or per dollar reinsurance basis than in the admitted side, I think, that’s a reflection of the appetite.

Okay. Thank you.

Thank you. We reached the end of our question-and-answer session. I’d like to turn the floor back over to Mac Armstrong for any further closing comments.

All right. Thank you very much, Operator, and thanks to all who joined this morning. We appreciate your participation, certainly, your questions and as well most of all your continued support. As always, I want to thank the great team here at Palomar for their diligent work and all that we accomplished this quarter and all the work that was done to further expand the franchise in the new specialty segments and further extend the Palomar 2X [Audio Gap]. And our earnings targets and we are raising guidance. We will look to continue to do this. But I think what we have in front of us is really exciting and we are going to continue to build an industry-leading franchise. So thanks very much and speak to you next quarter.

Thank you. That does conclude today’s teleconference. You may disconnect your line at this time and have a wonderful day. We thank you for your participation today.