PLMR - NASDAQ

Good morning, and welcome to the Palomar Holdings Inc.’s Second 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 open for questions with instructions to follow. 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 earnings call. With me here today is Mac Armstrong, our Chairman and Chief Executive Officer. Additionally, Jon Christianson, our President is here to answer questions during the Q&A portion of the call. As a reminder, a telephonic replay of call will be available on the Investor Relations section of our website through 11:59 p.m. Eastern Time on August 13, 2024. Before we begin, let me remind everyone that this call may contain certain statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These include remarks about management's future expectations, beliefs, estimates, plans and prospects. Such statements are subject to a variety of risks, uncertainties and other factors that could cause actual results to differ materially from those indicated or implied by such statements. Such risks and other factors are set forth in our quarterly report on Form 10-Q filed with the Securities and Exchange Commission. We do not undertake any duty to update such forward-looking statements. Additionally, during today's call, we will discuss certain non-GAAP measures, which we believe are useful in evaluating our performance. The presentation of this additional information should not be considered in isolation or as a substitute for results prepared in accordance with U. S. GAAP. A reconciliation of these non-GAAP measures to the most comparable GAAP measure can be found in our earnings release. At this point, I'll turn the call over to Mac.

Thank you, Chris, and good morning. I am very pleased with our second quarter results as we achieved record gross written premium and adjusted net income during the quarter and put ourselves in a position to accomplish the inaugural Palomar 2x goal of doubling 2021's adjusted underwriting income in three years. Our profitable growth remains robust with gross written premium and adjusted net income increasing 40% and 47% respectively year-over-year. The quarter's strong financial results and a host of associated accomplishments reflect the sustained execution of not only Palomar 2x, but 2024's four strategic imperatives: grow where we want; manage dislocation and diversification; provide consistent earnings and scale the organization. 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. Our top line growth of 40% was driven by solid execution across the book of business highlighted by our earthquake franchise, which saw an acceleration in its year over year growth rate from the first quarter and the continued strong growth in our casualty book. These two product categories help drive profitable growth with limited volatility. Our second imperative requires navigating and managing the dislocation in the market while further diversifying our business. During the quarter, we successfully placed our June 1 excess of loss reinsurance program. Not only did we complete the 6.1 at attractive rates that were well below our initial expectation, but we also procured incremental excess of loss limit to support our growth our and reduced our non-earthquake occurrence retention. Separately, we signed an agreement to acquire First Indemnity of American Insurance Company or FIA, a regionally focused surety insurer that will allow Palomar to enter an attractive business segment further diversify our portfolio and create a meaningful growth driver. Our third imperative is a steadfast commitment to the delivery of consistent earnings. This quarter, we achieved adjusted net income growth of 47% enabling us to raise our guidance once again this quarter and more aggressively for the fifth consecutive quarter. Additionally, we delivered an adjusted return on equity of 24.7% with slightly elevated catastrophe losses in the quarter. The fourth imperative is scaling the organization and making the requisite investments to accomplish Palomar 2x. This effort starts with an investment in people and I'm proud to say that we've recruited industry leading talent to join the Palomar team this quarter. As previously announced, Tim Carter joined the Palomar team as our Chief People Officer and Rudy Herve has come on board as our Chief Operating Officer. Their expertise and leadership will be invaluable as we continue to grow and innovate. We're executing very well and as I mentioned at the outset of the call, we are firmly on track to achieve the Palomar 2x goal of doubling our 2021 underwriting income in three years. Importantly, this strategy is ongoing as we work to continually plant the seeds for future growth and returns. The accomplishments of 2024 in the past several years undoubtedly helped lead to AM Best upgrading our financial strength rating to an A from an A minus. This upgrade underscores our financial stability, strategic success and health as an insurer counterparty and trading partner. Long term, it should create opportunities within our portfolio and beyond. I would now like to review the performance and market conditions of our five product categories. Firstly, our core Earthquake franchise grew gross written premium 25% representing a strong acceleration from the first quarter's 13% growth rate, which as a reminder was 18% on a same store basis. Overall, we remain confident that Earthquake premiums will grow in the high teens 20% range in 2024 and this quarter's performance in [indiscernible]. Residential earthquake business continues to generate consistent new business growth highlighted by strong E&S production. The E&S book saw 38% growth year-over-year as personal lines business continues to flow in a non-admitted market in California. Additionally, our residential earthquake book saw decent traction from new partnerships with Cincinnati Financial and USAA. The earthquake market remains stable and attractive from a pricing perspective. Commercial rates averaged an increase of 11.7% this quarter as compared to 11.6% in the first quarter of 2024. The 10% inflation guards at our residential earthquake polities contain are now providing a meaningful cushion above inflationary levels and provide annual increases regardless of market condition. Consistent with prior calls, our key portfolio metrics of average annual loss in the 250-year probable maximum loss to premium ratio remain at all time best levels. This will translate into strong net earned premium growth as the cost of excess of loss reinsurance has moderated from previous highs. We remain positive on the growth and profitability prospects of our earthquake franchise. Our Inland Marine and Other Property products grew 34% year-over-year driven by our builders risk, excess national property and Hawaiian hurricane lines of business. Growth in this product set slowed from the first quarter's rate as we continue to focus on our mantra grow where we want and curtail exposure in hurricane exposed regions of the country. Builders Risk, our largest Inland Marine product and our excess national property line continue to experience robust premium and submission growth. During the quarter, we hired more regionally focused underwriters for both business lines to expand our addressable markets and sustain the growth in these businesses. Hawaiian hurricane premiums grew 52% in the second quarter through a combination of rate increases as an aside we received an approval for a 23% increase at the end of the quarter as well as an increased level of fee generating new business written through Laulima Reciprocal Exchange. Our all-risk business has seen rate increases flatten versus the 18% in the prior quarter. However, the underlying PML and AAL metrics, much like our earthquake business, are healthy as is the profitability of the book. And as previously mentioned, we are not increasing exposure in this line. It is worth mentioning that we did see elevated cat losses from Texas severe convective storm and tornado activity in our builders risk book during this quarter. Fortunately, the losses were only modestly above our crisp budgets for mini cat this time of year. The limited impact of these losses on our quarterly results is a testament to our conservative underwriting. Casualty products had another strong quarter with premiums increasing 281% over the prior previous year's second quarter. Excess liability led the growth as the investments made in talent and distribution over the course of 2023 allowed the book to grow fivefold year-over-year. Other standout performing lines in the quarter include niche segments like Contractors, General Liability, Real Estate Errors and Omissions and Environmental Liability. Our contractors GL book grew 122% over the prior year. Real Estate E&O grew 110% and our nascent environmental liability book grew 120% on sequential basis from the first and second quarter. We are growing our business through broadening our distribution footprint and increasing our submission activity. Strong growth in casualty products which now comprises 16% of our total book remains anchored in a conservative approach to 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 collar loss potential in the classes we write. As an example, the three lines I just highlighted above Real Estate E&O, Contractors GL and Environmental Liability have an average net line of $1.2 million. Additionally, we continue to see decent rate increases in excess of loss costs across the casualty book. Our professional liability products are blended increased above 10% with real estate errors and omissions rates increasing 18%. The excess liability book was up over 20% and the contractor’s general liability book is an increase of 8%. While there are certain pockets of our casualty book that are softer from a pricing perspective, private company D&O was down 4.8%. We continue to believe our rates are more than adequate. For the quarter, the Casualty book’s loss ratios remained at our conservative loss picks with reserves continuing to build due to the nascency of the book. We are optimistic that as the book seasons, reserves will develop favorably. Our Fronting business grew premium 20% year over year. Fronting growth was primarily driven by a new fronting partner in the personal marine yacht sector. We also saw solid performance from our Cyber cross-border trucking and Texas Homeowners programs. Both our Texas Homeowners and Cyber Fronting programs had successful reinsurance renewals in the quarter seeing improved economics and reinsurance support. As previously indicated, we do expect our Fronting segment to under index the growth of our other business segments as we take a very selective approach to curating and managing our Fronting partner portfolio. In the fourth quarter, fronting premium will decline as one of our key partners Omaha National an AM Best rated insurance company secured the requisite license to do business in California without a front. Termination of the contract will impact our Fronting segment's growth over the next several quarters as we work to replace the lost business with new partnerships. While we have a healthy pipeline of opportunities, we will be selective as we closely manage the risk in this segment. Turning to Crop, we wrote $2,200,000 of premium in the second quarter, which is a seasonally low period. Year-to-date, we have written over $40 million of premium compared to $5 million in the prior year. Overall, it has been a good planting season and we remain confident in achieving or exceeding the full year forecast of $125 million of gross written premium. As discussed, we see significant opportunity to build a large business in the crop market. To that end, we appointed James Long, EVP of Innovation and Head of Crop Insurance in July. James joins us from RenaissanceRe where he spent 15 years as a senior level specialty reinsurance underwriter with a focus that included global crop insurance. James will work side by side with Jon Christianson building this business and capitalizing on the large opportunity in the crop market which as an aside continues to consolidate. The number of improved insurance providers stands at 12 following Farmers Mutual Hail's recent acquisition announcement of Global Ag from AXA XL. Turning to reinsurance, we successfully placed our 6/1 excess of loss reinsurance program and pricing in terms that were better than our expectations. We also procured approximately $400 million of incremental limit to support the growth of our earthquake franchise and issued our fifth Torrey Pines Re re-catastrophe bond. Our reinsurance coverage now extends to $3.06 billion for earthquake events, $735 million for Hawaiian hurricane events and $117.5 million for all other payrolls including Continental United States Hurricane. These levels all exceed our one in 250-year peak zone probable maximum loss. It is important to note that we did sacrifice some savings as we reduced our hurricanes event retention to $15.5 million for non-earthquake catastrophe events including hurricane and severe convective storm from $17.5 million the previous year. We slightly increased our earthquake retention to $20 million. These are levels that continue to be meaningfully within our stated retention guideposts less than one quarter's adjusted net income and less than 5% of Palomar's surplus on an after-tax basis. In the spirit of delivering consistent earnings, we felt sacrificing some savings for improved predictability was prudent. Overall, our reinsurance program has become increasingly attractive to program becomes less exposed to Continental U. S. And Hawaii hurricanes. Once all Hawaii hurricane policies are assumed by Laulima, our reinsurance program will be almost entirely single parallel earthquake. This should afford us better pricing during next year’s renewal all else equal. In addition to excess of loss renewal, we need 11 other reinsurance treaties including large quota shares for flood and builders risk and our cyber fronting program. Overall, the renewals were favorable with half seen improved economics of the renewal and only one seen negative economics. I want to discuss our proposed acquisition of First Indemnity of American Insurance Company or FIA, which we are acquiring for 1.7x closing book value. FIA is a New Jersey domicile insurance carrier that specializes in the underwriting of contract surety bonds small to medium sized contractors primarily in the Northeast United States. FIA writes approximately $10 million in premium in 16 states and is rated A minus by AM Best. This company is led by Pat Lynch Sr., and has an experienced team with a long track record of profitable underwriting. FIA has delivered loss ratios that have outperformed the broader surety market over its history and importantly over the last five years. Surety is a very attractive specialty insurance market that we have analyzed for several years. Surety consistently outperforms the broader P&C market in terms of combined ratios and has an underwriting cycle that does not follow the general P&C cycle. In an atypical fashion, we decided we made more sense to enter surety through an acquisition versus building the business from the ground up. We believe FIA is a great business and one that we can help grow significantly using Palomar's capital distribution and technology resources. FIA is led by a talented market expert and as such we will maintain their underwriting claims handling philosophy and strategies. Upon closing, we will invest resources toward the expansion of their distribution and geographic footprint and help them get federal T-Listing. These efforts will meaningfully expand our market opportunity. FIA's strong team will enable Palomar to confidently and expertly build a national Surety franchise in a business that could become a material contributor to Palomar's earnings base over the medium term. We expect to close the acquisition before year end and do not expect account much of revenue in our earnings contribution in 2024. We do expect this transaction to be accretive to 2025 earnings. As I mentioned in my opening remarks, this quarter we recruited experienced industry veterans to help us further grow and scale Palomar. We recruited Tim Carter from LPL Financial to be our Chief People Officer in June. Tim brings more than 20 years of executive leadership in human resources operations and sales functions. Additionally, Rudy Herve has joined us from SCOR to be our new Chief Operating Officer. Rudy is an experienced insurance executive who has also has more than 20 years of experience across technology, operations, strategic transformations and mergers and acquisitions. What sets these exceptional executives apart is a proven track record and their ability to build market leaders, whether it is by officially launching new products, recruiting best in class talent or implementing innovative technologies. Their experience and expertise will be invaluable as we enter the next phase of our growth. To conclude, our business is performing well and we are raising the guidance range for our full year 2024 adjusted net income to $124 million to $130 million from $122 million to $128 million. With that, I'll turn the call over to Chris to discuss our results including guidance assumptions in more detail.

Thank you, Mac. Please note that during my portion when referring to any per share figure, I'm referring to per diluted common share as calculated using the treasury stock method. This methodology requires us to include common share equivalents such as outstanding stock options during profitable periods and exclude them in periods when we incur a net loss. For the second quarter of 2024, our adjusted net income was $32 million or $1.25 per share compared to adjusted net income of $21.8 million or $0.86 per share for the same quarter of 2023, representing adjusted net income growth of 47%. Our second quarter adjusted underwriting income was $32.9 million compared to $23.1 million last year. Our adjusted combined ratio was 73.1% for the second quarter compared to 72.2% in the second quarter of 2023. Excluding catastrophes, our adjusted combined ratio was 70.3% for the quarter compared to 69.6% last year. For the second quarter of 2024, our annualized adjusted return on equity was 24.7% compared to 21.3% for the same period last year. The second quarter adjusted return on equity continues to validate our ability to maintain top line growth with a predictable rate of return above our Palomar 2x target of 20%. Gross written premiums for the second quarter were $385.2 million an increase of 40% compared to the prior year's second quarter. Along with breaking out crop, we are also regrouping our written premium to align with our five key specialty insurance products: Earthquake, Inland Marine and Other Property, Casualty, Fronting and Crop. It is important to remember the seasonality of our crop premium. Based on our current expectations, majority of our crop premium will be written and earned in the third quarter of each year with only a modest premium in the second and fourth quarters. The crop premium written and earned in the third quarter will have a seasonal effect on our ratios calculated as a percentage of gross earned premium in the third quarter. Specifically, the ratios for net earned premium, acquisition expense and other underwriting expense. Since the majority of our crop business is seeded, the net impact to our financials will not change compared to our previously shared expectations. Net earned premiums for the second quarter were $122.3 million an increase of 47% compared to the prior year's second quarter. For the second quarter of 2024, our ratio of net earned premiums as a percentage of gross earned premiums were 37.4% compared to 34.3% in the second quarter of 2023 and compared sequentially to 35.6% in the first quarter of 2024. The year-over-year increase in this ratio is reflective of our higher growth rate of our non-fronting lines of business including earthquake that seed less premium. In addition, these results include the first month of our new excess of loss reinsurance placement that started June 1. While the dollars associated with this placement are higher to facilitate continuing 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 premium for which we currently seed about 95% written and earned during the third quarter, we still expect the third quarter to be the low point of our net earned premium ratio. From there, we expect the net earned premium ratio to increase 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 continue to expect strong net earned premium growth. Losses and loss adjusted expenses for the second quarter were $30.4 million comprised of a $27 million of non-catastrophe attritional losses and $3.4 million of catastrophe losses from severe convective storm activity. The loss ratio for the quarter was 24.9% compared to a loss ratio of 21.5% a year ago. For the second quarter, our attritional loss ratio was 22.1% and our catastrophe loss ratio was 2.8%. During the quarter, we also experienced favorable prior year development from our property lines of business as we continue to maintain conservative casualty reserves. We expect our attritional loss ratio to be approximately 21% to 25% for the year and our catastrophe loss ratio to be about 2% to 3% for the year. These expectations include our estimate of third quarter catastrophe losses from hurricanes Beryl and Debbie of $5 million to $7 million. Our acquisition expense as a percentage of gross earned premiums for the second quarter was 11% compared to 10.8% in last year's second quarter and sequentially to 10.5% in the first quarter of 2024. This percentage increased for the same reasons as our net earned premium ratio, strong growth from our non-funding lines of business, resulting in higher commission expense and less ceding commission to offset our acquisition expense. Similarly, we expect third quarter crop written and earned premium to result in higher ceding commission pushing this acquisition expense ratio a little lower in the third quarter. We expect this ratio to move up from the low point in the third quarter. The ratio of our other underwriting expenses including adjustments to gross earned premiums in the second quarter was 7.3% compared to 6.9% in the second quarter last year and compared sequentially to 6.8% in the first quarter of 2024, slightly higher this quarter from the performance-based accruals from our strong results, but in line with our expectations as we continue to invest in our organization as we continue to grow. We continue to expect long term scale in this ratio while we may see periods of sequential flatness as we continue to invest in scaling the organization. Credit premium will have a similar seasonal impact on this ratio for the third quarter as it does with the acquisition expense ratio. Our net investment income for the second quarter was $8 million an increase of 43.6% compared to the prior year's second quarter. The year-over-year increase was primarily due to higher yields on invested assets and a higher average balance of investments held during the three months ended June 30, 2024 due to cash generated from operations. Our yield in the second quarter was 4.3% compared to 3.6% in the second quarter last year. The average yield on investments made in the second quarter was 5.9%. We continue to conservatively allocate our positions to asset classes that generate attractive risk adjusted returns. At the end of the quarter, our net written premium to equity ratio was 1.02 to 1 and our stockholders' equity has reached $532.6 million a testament to our profitable growth. As Mac mentioned, we are raising our full year 2024 adjusted net income guidance range again. The increased guidance range includes $6.8 million of catastrophe losses incurred for the first half of the year and $5 million to $7 million of additional catastrophe losses related to hurricanes Beryl and Debbie incurred in the third quarter, but does not include any incremental income from the FIA acquisition if it closes this year. Based on our strong performance during the first half of the year, we are raising our full year adjusted net income guidance range to $124 million to $130 million implying 36% adjusted net income growth at the midpoint of the range, also implying that we will double our 2021 adjusted underwriting income in three years. With our sustained strong performance, we are confident in our ability to continue achieving our Palomar 2x goal of doubling adjusted underwriting income in three to five years while maintaining an ROE above 20%. With that, I'd like to ask the operator to open the line for any questions. Operator?

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] The first question comes from the line of Paul Newsome with Piper Sandler. Please go ahead.

I was hoping you could give us a little bit more of your thoughts on the topic of the quarter, which is casualty reserves and I think mainly concerns that the underlying inflation rate is rising in general for cash in rates. And just to the extent you're seeing or not seeing it in your book of business growing quite there, and how you feel you can be really comfortable in an environment that seems kind of uncertain? Any additional thoughts would be great, I think.

Yes, Paul, this is Matt. Good to hear from you. Thanks for the question. I think it starts just with reinforcing what we're doing in casualty and we're writing these segments within the market. Real estate, E&O contractors GL, environmental liability, narrow professional lines like contractor excuse me, our collection E&O and some miscellaneous professional lines broadly. But, A, we're not weighed down by legacy books of business. So, really is a matter of us making sure that we feel very confident in our underwriting, our loss picks and our line size in risk management. So, just to give you a little bit of color, on the risk selection side, we're really avoiding severity exposed classes whether it's public D&O or large commercial auto fleets. We have really modest limits. Our max gross line is $5 million, but as I pointed out in the call, when you look at some of those niche segments, our net line is $1.2 million, on the high end, it's going to be $2 million on a net basis. So, what we like about that is A, it insulates us from a shock loss. B, it's not in the realm of litigation finance and social inflation. And then there's other underwriting controls like for contractors GL, if we do have auto, we're trying to confine it to fleets that are less than 50 units of vehicles and minimizing the number of jobs that people are driving to on a daily basis. I think the other thing though is when you look at how we're managing the book relative vis-à-vis loss cost, we think we're getting rate right now. The excess liability, we had rates increases that were 20% plus. On the real estate, E&O, it was in the high teens. And if we look at that line that's also a line that's really not too exposed to social inflation, right. It's really tied to transaction values and home sales. And if there's a loss of value in the home, well you're covered by that because you underwrite it on the value of the home and the sales that the agency does. So, what you're really looking at there is social inflation or excuse me, inflation exposure that's come down meaningfully because it's tied to property values. So, we are very, very focused on making sure that we have rates in excess of loss cost. We're very, very focused on managing line size and we have terrific people that are doing it, well experienced industry veterans that are leading the books leading and building great books of business. So, hopefully that gives you some color, but we feel very confident and we also feel very confident. We haven't touched our reserves yet. So, we're building up a good bit of reserves that hopefully will be able to lead it off.

Second question maybe another broad one. Could you please talk about the -- could you talk about the competitive environment from your perspective with your business mix? I think there's broader concerns that property is sort of moderating and casualty sort of not doing much, but your mix is pretty unique. So, do you think it's the same, getting better, getting worse from a competitive environment?

Yes. So, I mean, listen, I'm going to give it somewhat broadly because we do have a diverse book of business, and I'll talk about it within our five product categories. In the circumstance of earthquake, we feel like it remains a very attractive competitive environment for us. Our rates remain strong up 10% to 12%, 11.6% I think exactly. The CEA on the residential side continues to pull back its coverage. It actually now has a rate increase that will be going into place effective I think at the start of the year. Commercial earthquake, there still is limited capacity and we bought incremental reinsurance to support our growth and I think you saw the growth in the first quarter. So, that's broad brush how I would describe that. Inland Marine and Other Property, this is where we say, we're growing where we want to. Yes, I mean, there is a little bit of increased competition in the all-risk book. You could see that with our rates kind of flattening. In the second quarter, capacity has come back into that market because the rates have been so strong. Our metrics are really strong there, but we're not looking to grow exposure. We're seeing in builders risk a little bit more competition, but for us we're more focused on building out a national footprint there. And so, we've added underwriters help us expand in the Midwest, to help us expand in the Northeast and the Western U. S. So probably that's probably the segment where I'd say we see the most competition Inland Marine and Other Property. Casualty, you touched upon it, we're right in these lines, we feel like we're getting rate. We're coming into markets and expanding our distribution footprint, adding underwriting talent. So, we feel like there's good growth there and not too much in the way of competitive impact that's going to slow down our growth plans. Crop is the fourth one. We've seen consolidation in that market. So, we think we're the new kid on the block there. So, we think we can continue to take share and are well on our way to doing so. And then Fronting is a bit of a mixed bag. As I said, we lost one large account, a good partner, highly rated AM Best rated company that now has the licenses that merits getting rid of a front. So, I'd say there's competition in that market as well. So, if I had to sum it up, Inland Marine and Other Property and Fronting is probably where we're seeing the most competition.

Thank you. Next question comes from the line of Mark Hughes with Truist Securities. Please go ahead.

The ratio of earned premium to growth, Chris, I think you say will bottom out in the third quarter, the low point. Can you kind of say roughly where that number will bottom out?

Yes. Thanks, Mark, for the question. You and I talked about net earned premium a lot. But yes, we do expect the net earned premium ratio to be at its low point in the third quarter. There's two factors affecting that. The one that's consistently impacted it is excessive loss. The first full quarter of our new excess of loss will be the third quarter of this year similar to last year. So that will put pressure on the ratio. We do buy that premium or buy the excess of loss to support our overall growth in the portfolio. So even though the rate was down approximately 5% on a rate online basis. The dollars we spend are still going to be up. So that increased dollars will put pressure on the ratio. The second factor that's going to affect it this year and in years to come is also the crop premium. The majority of the crop premium will be written and earned in the third quarter of this year, like years to come. And so that and we still seed around 95% of that premium. So that will also put additional pressure on that ratio and look at it in the third quarter. So, when I look at it specifically, I would expect something similar to what you saw last year. I would expect low-30s type net earned premium ratio in the third quarter and then moving up from there. I'd say the down and the up will probably be a little bit steeper this year, but that's really driven by crop. While when you look at the net earned premium dollars, I expect to see continued sequential growth in the net earned premium dollars when you look at Q1, Q2 and then into Q3. I still expect the net earned premium dollars to increase, but that ratio will see a little bit more variability in the third quarter and a lot of that driven from the crop premium that we're expecting.

Thanks for that detail. And then the impact of the lost fronting business, what is the dollar amount roughly?

Yes. So, the total portfolio for that book of business is right around $165 million to $168 million. So that obviously is a significant chunk of business that we will be losing. We will start losing that or we will start, I call it, rolling that over in the second or the third quarter of this year. So we'll probably experience about half of it this year. The first quarter is the heaviest quarter for that. And then just trying to sorry, I get to the number right now that we will see it's about $39 million of premium last year in the third quarter. So, I would say think about that as half that we will not get this year. The fourth quarter of '23 was about $37 million of written premium. The first quarter of '24 was about $48 million of written premium and Q2 of this year, this quarter, was about $44 million of written premium. So, in total, that's about $168 million of fronting premium that we will be rolling off of starting in the middle of third quarter.

I think what I would add, Mark, is just importantly, I think there's a couple of things. One, this is a company that now has the requisite licenses needed. It's always had an AM Best rating. So, I think it speaks to the quality of the counterparty. Two is, if you look at fronting, it's a nice fee income stream, but it's a lower margin product for us. So, we think we can certainly play through that next year and then some because we have a nice pipeline and we added new clients in the quarter. And furthermore, there's so many other growth factors we have. I mean the beauty of our business is we can lose someone like this and we have a great portfolio and we still feel very good about the long-term growth prospects of the business.

Thank you for that. And then, in California, in the personal lines market, the dislocation, I think, has been helping from the quake standpoint. I think you talked about more movement into E&S was beneficial on the residential side. Is that continuing at pace? How do you see the trajectory in that? Is it still as dislocated? Or is that slowing down a little bit?

Mark, good question. Yes, it's continuing to pace. I mentioned 38% E&S growth in residential quake in the second quarter. We're seeing still steady new business in E&S as we sit here today. The admitted homeowners market remains as dislocated, discombobulated and we don't expect that to remedy itself in the near term. So, we think that's a nice tailwind for us. And the other thing I'd add is, a lot of the partnerships we brought unlike Cincinnati Financial that is with their E&S offering, their high value E&S offering. So, it's a natural conduit from E&S homeowner’s policy to come over to quake.

Thank you. Next question comes from the line of David Motemaden with Evercore ISI. Please go ahead.

I had a question just on the some of the loss ratio discussion. So, it sounds like 21% to 25% attritional with 2 to 3 points of cat losses for this year. So, if I think about that all-in loss ratio of about a 23 to a 28 for this year. I guess, how are you guys thinking about that as we head into next year given all the changes in the mix of business? Any sort of thoughts there would be helpful. Thank you.

Yes. Thanks, Dave. No, I think the loss ratio is moving up as we have kind of projected and expected, right? I think the one nice thing that we're seeing is that the lines of business that do have attritional losses, casualty, inland marine are growing at a very strong rate. Those are profitable lines of business, but those lines of business also come with attritional losses, which we expect. So, that growth is kind of outpacing our expectations a little bit. So, we think it's prudent to kind of push the loss ratio up a little bit. We've said that I wouldn't be surprised if it moves up a point-ish every quarter as these books mature and as that earned premium and growth comes on the books. So, I think that's what we're seeing. That 2 to 3 points of cat loss that you talked about, that does reflect the losses that we've seen through the first half of the year, but also our projections, our estimates for losses from Beryl and Debbie that is still kind of impacting the U.S. right now. So, we think those we hope those estimates are conservative, but we do think that our loss ratio is moving as we would expect. The other thing that when you look at our loss ratio for the quarter, there was some favorable prior period development. We're happy to see that as always. That did come from our property line of business, specifically some of our larger builders risk where we were holding some conservative reserves. We were able to close out some claims during the quarter, so we felt comfortable taking those reserves down. Importantly, as Mac pointed out a little bit earlier, we are not touching our casualty reserves, right? The casualty book is a little newer for us. We are reserving that in our minds conservatively and we're holding those reserves. So, we have not taken those reserves down at this stage. And so, we feel like we have a conservative position for our total reserve base and we hope that proves out. But importantly, our book of business is maturing. Our mix is growing in lines of business outside of earthquake. While earthquake still has strong growth, these other lines are growing at a greater rate. So, that greater rate is causing our attritional loss ratio to move up because while these businesses are still profitable, unfortunately, they're a sub-20% loss ratio line of business. But they're still very profitable and so we're happy to see the attritional loss ratio move up with the growth in those lines of business.

Got it. That's helpful. And I guess just on the cat losses, so if I look at year to date and include the Beryl and Debbie losses, it's I guess around $13 million to $14 million. Is that sort of what you would expect in terms of a cat load for a typical year just given the mix shift in your business?

Yes, Dave. I think it's directional. Candidly, I believe that the second quarter had elevated SCS activity and we had a tornado loss that hit our builders risk book that probably disproportionately and unusually high. So, I wouldn't expect that every year, but it's not a bad trajectory. The other thing is, so the first quarter most of those cat losses were from the flood activity in California. And if we rotate out of an El Nino into La Nina, there may be potentially lower rain activity in Southern California. I probably just jinxed myself, but nonetheless, so it's a combination of cat load. It's from SCS flood and Continental hurricane. That's not a bad directional target over the course of the year.

And then, interesting to learn a little bit more about the Surety deal for FIA. I guess, are there any other lines you haven't spoken about where you're thinking of entering and where you're sort of weighing either building it yourselves, which is what we've seen you guys do in the past versus acquiring something like you just did here?

Yes. Good question, Dave. And what I would say is, 1st and foremost, we still believe that we own an organic growth story. And it's we've all of the growth that we've done to-date has been organic and the predominance will remain. So, FIA was unique. It's a market that we really like, but there is an expertise that we thought we were better suited to buy than build. And so, I think you should continue to consider us an organic growth story, but in the case of FIA, because we have market experts who have generated exceptional returns and better than industry returns for decades. We found a great partner. And what I think you'll probably see though is, as I mentioned, it's $10 million of premium. Our goal is to build in multiples of that. So, it will turn into an organic growth story once we bring it on board. But consider us organic growth and an opportunistic acquirer especially when you could buy a great franchise like FIA.

Thank you. Next question comes from the line of Andrew Andersen with Jefferies. Please go ahead.

Any way to size the benefit or expand growth opportunity from the recent AM Best upgrade and what would be the timeline to seeing any benefit there?

Hey, Andrew. Yes, good question. We were thrilled to get that upgrade. It's hard for us to size it. I think there are segments of our book that will be more positively impacted than others in particular professional lines and some of the niche casualty segments that we ride in. I don't think it's going to be as pertinent to property, but I think it does enhance us as a counterparty. It certainly enhances us as a trading partner. And it will open distribution source, it will potentially open new lines of business. I also think it will probably help us recruit talent. But I don't want to give you some type of dollar impact, but we're going to use it to do the best of our ability to market.

Understood. And then maybe on the earthquake side, the inflation guard has been pretty sticky. Should we think of that maybe reversing in 2025? And then if you could also just touch on the commercial earthquake market where pricing has at least quarter over quarter remained relatively consistent?

Yes. I'll let Jon Christianson speak to that. I'll say just on the inflation guard and he should chime in. It's a locked in underwriting guideline that we have filed. So, they're underwriting rule rather that we have filed. So, we have no intention to rescind it and change it. So, it will be firm for 2025.

Yes. And I'd add that's one thing that we watch those retention ratios very closely and how the inflation guard may impact a buyer's decision to renew a policy. And as of right now, we're seeing no change in buyer behavior. So, like Mac said, we're pleased to continue that conservative inflation approach that we've had employed here over the last couple of years. On the commercial earthquake to your question, that rating environment continues to be very strong, the strongest in our careers. And while, there has been some decreases that Mac mentioned or flattening, I should say, of the al-risk segment, we continue to see some appreciation in rate over the course of the second quarter in the commercial earthquake segment. So, more opportunities in the market and pleased to see the rates hold up.

I think, Andrew, what I would add is two things. On respect to the residential earthquake, we again, those retention rates and sustaining those with the CEA pushing forth a rate increase that will again will be effective at the start of the year that gives us a bit of competitive cover so to speak. And then on just all of the earthquake the fact that we were able to lock in our reinsurance at a 5% rate decline, while maintaining that type of price integrity, whether it's the inflation guard or commercial rate increases that does bode well for net and premium conversion margin expansion in that line of business.

Thank you. Next question comes from the line of Meyer Shields with KBW. Please go ahead.

Great. Thanks so much. A couple of questions probably all over the place. First, is there any overlap in FIA's agency network and the contractor related liability lines that you're writing now?

Not a lot currently, there's potentially ways to cross sell in time. I actually think there's probably a decent cross sell to with some builders risk. But as we sit here today there's not much in the way of geographic or distribution overlap. FIA Northeast heavy, our contractors GL tends to be Western U. S. heavy.

Okay, perfect. And I'm assuming that just because of the size and presumably reinsurance plans, we shouldn't expect this to impact acquisition expense ratios for 2025.

For FIA?

Yes, in other words including FIA.

Yes. Go ahead, Chris.

Yes. No, I think obviously it's a smaller book of business than some of our other lines of business. So, it will have an impact, but I wouldn't expect anything material to change just on the overall weight even in 2025 weight of that book in 2025 from a ratio standpoint.

Right. No, no, understood. On the fronting side, I guess, the remaining books, in other words, outside of, I guess, Omaha Casualty, if I have the name right. Is that business more permanent in nature or are clients there also looking for licensing or distribution to sort of branch it on their own over time?

Yes, I would say it's more permanent in nature. Omaha National, we knew that at some point, they would no longer need a front. The other ones tend to be more either MGAs or reinsurers that don't have primary company access.

Okay, perfect. And then last question, if I can, on I'm sorry, Omaha National. Did you retain any of that underwriting risk?

We did. Yes. We had been between 5% and 7%, and so -- but that will not go forward.

Thank you. [Operator Instructions] Next question comes from the line of Pablo Singzon with JPMorgan. Please go ahead.

I was a bit surprised by the sequential increase in the net earned premium ratio, right? So just given that we only have one month of, I guess, a rebased XOL cost here. So, putting that aside, as you think about where you're growing, right, are there lines of business where you get the most leverage against, reinsurance budget that's flat and out? So, as you think about resi earthquake, that's an obvious one, it runs on an XOL program. But within same arena property, which I think has grown the fastest for you year to date, are there lines there that benefit like earthquake from an XOL budget that's flattened out?

Yes, all the property business. And even Laulima where we're now attorney in fact manager, there's more margin for us to retain potentially there. So, all of the property business from builders risk to earthquake to Hawaiian hurricane and all risk, they benefit from decreasing reinsurance pricing.

Okay. It sounds like those lines are not heavily quota share then, right? Is that correct?

Correct, builders risk has a quota share, but it's for non-cat and yes, in the excess national property, same. That tends to be more fact heavy, but yes. But Hawaii, earthquake and all risk is that's where you're there's not much quota share, we're using there.

Yes. Got you.

Pablo, maybe I'll speak a little bit just to the sequential growth in the net earned premium ratio, which was a little unexpected when we go back to the Q1 results. But I think after the placement of the excess of loss, we did receive some benefit there. So, those were -- it was better than our expectations. We had, call it, single digits savings there versus we were expecting a rate increase. So that definitely impacted our expectations on the net earned premium ratio. And then just overall growth in lines of business that use, let's call it, less reinsurance or quota share reinsurance than fronting, right? Fronting was probably the slower grower over the first half of the year. So, the growth in lines like inland marine and casualty, even though they still use quota share, they don't use much as fronting. So, the growth in those lines of business that was a little bit ahead of our expectations as well helped increase that net earned premium ratio sequentially from Q1 to Q2. So, that's something else that needs to be factored in when you think about it. While when we talked last time, we were probably expecting that ratio to be a little bit flatter for Q2. But still, we do expect that dip in the third quarter.

Yes. Okay. That makes sense. And then switching gears here, just on the E&S resi product California. So, the high-value homeowners customers you are getting, are these customers net new business for you? Or are you seeing some shift from a bit of volatility to the E&S side?

It's both. That's a good question, Pablo, and I'd say it's both. So, I've highlighted again, Cincinnati Financial those are going to be new business. There are others that are coming into the market to buy and only the E&S is open to them. And then we have made a deliberate renewal or migration rather of certain policies in peak zones in Southern California or Northern California for that matter that we want to have on E&S paper whether we need to charge more for it to justify the reinsurance costs or just improve the spread of risk. And go ahead,Jon.

Yes. And Pablo, I'd also add that as we see changes in the first line for market in California with associated with those carriers who are participating in insurance of the California Earthquake Authority, as the California Earthquake Authority reduces its exposure particularly to those that maybe kind of a higher value profile of customer, we see that business coming to us. While they may be historically earthquake buyers, we see that business coming to us on the E&S side of the house as well.

Got it. That makes sense. And then just last for me on FIA. Mac, you said that the aspiration is a growth premium base of $10 million multiples of what it is now. The question for you is, what does FIA get by being part of the Palomar platform that you think will enable that growth, right? Is it distribution? Is it operations? How are you thinking about all of those things?

Yes. I mean, I think our objective is to export their excellence in Surety underwriting and claims management to a broader geographic and distribution footprint. So, we can bring capital, potentially keep a little more on the balance sheet there right nice modest limits that wouldn't disproportionately impact our risk management targets. So, we can give them capital to write more and keep more. We definitely can open up distribution for them and we certainly, if we can bring more resources to bear to help them expand their geographic footprint. What you won't see is a material change in the underwriting appetite and classes of business nor their claims handling approach. They are excellent at that and that's what we want to export.

Thank you. Ladies and gentlemen, we have reached the end of question-and-answer session. I would now like to turn the floor over to Mac Armstrong for closing comments.

Thanks, operator, and thank you to everyone for participating today. In conclusion, we had another strong quarter where we executed our Palomar 2x strategy. I want to as always thank our talented team for their hard work and dedication. Our success is a reflection of that their efforts. Looking to second half of the year, we were optimistic of our ability to execute our plan and deliver profitable growth. Lastly, I look forward to welcoming the FIA team to Palomar upon the closing of the acquisition. I'm very excited about what we are going to accomplish together. So, thank you all. Enjoy the rest of your day and we'll talk to you next quarter.