What changed in this filing

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Item 1A. Risk Factors

2020-11-13 compared with 2020-08-05 · 72 added, 61 removed, 510 unchanged (21% of the section changed)

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Additional risks and uncertainties of which we are unaware, or that we currently deem immaterial also may become important factors that affect us.

Summary Risk Factors

Our business is subject to numerous risks and uncertainties, these risks include, but are not limited to, the following:

● We and our customers could be negatively and adversely impacted by the Pandemic, which may result in a decline in demand for our products, a decrease in underwriting income and a decrease in the value of our investment portfolio.

● Claims arising from unpredictable and severe catastrophe events, including those caused by global climate change, could reduce our earnings and stockholders' equity, and limit our ability to underwrite new insurance policies;

● The inability to purchase third-party reinsurance or otherwise expand our catastrophe coverage in amounts we desire on commercially acceptable terms or on terms that adequately protect us;

● Our risk management and loss limitation methods, including estimates and models, may fail to adequately manage our exposure to losses from catastrophe events and our losses could be materially higher than our expectations;

● A decline in our financial strength rating may adversely affect the amount of business we write;

● In the event that the reinsurance we purchase is inadequate or a reinsurer is unable or unwilling to make timely payments, our operating results and liquidity would be adversely impacted;

● Our business is concentrated in California and Texas and we are exposed more significantly to California and Texas loss activity and regulatory environments;

● The potential loss of one or more key executives or an inability to attract and retain qualified personnel could adversely affect our results of operations;

● We rely on a select group of brokers and program administrators to manage the distribution of a significant portion of our Residential Earthquake, Commercial Earthquake, Specialty Homeowners and Hawaii Hurricane products.

Two program administrators with which we have long-standing relationships represented

approximately 54.4% of our gross written premiums for the nine months ended September 30, 2020, and such relationships may not continue;

● Unexpected changes in the interpretation of our coverage or provisions, including loss limitations and exclusions, in our policies could have a material adverse effect on our financial condition or results of operations;

● There is intense competition for business in our industry;

● The failure of our information technology and telecommunications systems could adversely affect our business;

● Any failure to protect our intellectual property rights could impair our ability to protect our intellectual property, proprietary technology platform and brand, or we may be sued by third parties for alleged infringement of their proprietary rights;

● We incur significant costs as a result of operating as a public company, and our management is required to devote substantial time to complying with public company regulations;

● Our operating results and stock price may be volatile, or may decline regardless of our operating performance, and holders of our common stock could lose all or part of their investment.

Risks Related to Our Business and Industry

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Furthermore, the actual occurrence, frequency and magnitude of such events are uncertain.

While there can be no certainty surrounding the timing and magnitude of

earthquakes, some observers believe that significant shifts in the tectonic plates, including the San Andreas Fault, may occur in the future.

While there can be no certainty surrounding the timing and magnitude of earthquakes, some observers believe that significant shifts in the tectonic plates, including the San Andreas Fault, may occur in the future.

Over the past several years, changing weather patterns and climatic conditions, such as global warming, have added to the unpredictability and frequency of natural disasters in certain parts of the world, including the markets in which we operate.

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Claims from catastrophe events could reduce our earnings and cause substantial volatility in our results of operations for any fiscal quarter or year, which could materially adversely affect our financial condition, possibly to the extent of eliminating our total stockholders’ equity.

For example, Hurricane Harvey in August 2017 caused our gross losses and loss adjustment expenses to increase 66% from the prior year.

For example, Hurricane Harvey in August 2017 caused our gross losses and loss adjustment expenses to increase significantly from the prior year and catastrophe losses from multiple storms during the third quarter of 2020 also caused our gross loss and loss adjustment expenses to increase significantly from the prior year.

Our ability to underwrite new insurance policies could also be materially adversely impacted as a result of corresponding reductions in our capital.

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Furthermore, our earthquake policies do not provide coverage for fire damage arising from an earthquake.

While we believe this risk transfer program insulates us from volatility in our earnings, one or more severe catastrophe events could result in claims that substantially exceed the limits of our reinsurance coverage.

While we believe this risk transfer program reduces volatility in our earnings, one or more severe catastrophe events could result in claims that substantially exceed the limits of our reinsurance coverage.

Our reinsurers may not pay claims on a timely basis, or at all, which may materially adversely affect our business, financial condition and results of operations.

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For example, the Pandemic has put financial pressure on the insurance market due to several factors, including the inability of customers to pay premiums and increased claims for business interruption.

Increased claim demands for business interruption has put substantial financial pressure on the insurance and reinsurance market which may lead to court action and impact the ability of insurers and reinsurers to satisfy the liability under their policies.

Increased claim demands for business interruption has put substantial financial pressure on the insurance and reinsurance

market which may lead to court action and impact the ability of insurers and reinsurers to satisfy the liability under their policies.

In addition, reinsurers may default in their financial obligations to us as the result of insolvency, lack of liquidity, operational failure, fraud, asserted defenses based on agreement wordings or the principle of utmost good faith, asserted deficiencies in the documentation of agreements or other reasons.

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If a catastrophic event were to occur and our reinsurers were unable to satisfy their commitments to us, we may be unable to satisfy the liability to our policyholders.

We evaluate each reinsurance claim based on the facts of the case, historical experience with the

reinsurer on similar claims and existing case law and consider including any amounts deemed uncollectible from the reinsurer in a reserve for uncollectible reinsurance.

As of June 30, 2020, we had $24.7 million of aggregate reinsurance recoverables.

We evaluate each reinsurance claim based on the facts of the case, historical experience with the reinsurer on similar claims and existing case law and consider including any amounts deemed uncollectible from the reinsurer in a reserve for uncollectible reinsurance.

As of September 30, 2020, we had $103.0 million of aggregate reinsurance recoverables.

These risks could cause us to incur increased net losses, and, therefore, adversely affect our financial condition.

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If we are unwilling to bear an increase in loss exposure, we could have to reduce the level of our underwriting commitments, both of which could materially adversely affect our business, financial condition and results of operations.

Many reinsurance companies have begun to exclude certain coverages from, or alter terms in, the reinsurance contracts we enter into with them.

Many reinsurance companies have begun to exclude certain coverages from, or alter terms in, our reinsurance contracts with them.

As a result, we, like other insurance companies, write insurance policies which to some extent do not have the benefit of reinsurance protection.

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We manage our exposure to catastrophe losses by analyzing the probability and severity of the occurrence of catastrophe events and the impact of such events on our overall underwriting and investment portfolio.

We monitor and mitigate our exposure through a number of methods designed to minimize risk, including underwriting specialization, modeling and data systems, data quality control, strategic use of policy deductibles and regular review of aggregate exposure and probable maximum loss reports, which report the maximum amount of losses that one would expect based on computer or actuarial modeling techniques.

We monitor and mitigate our exposure

through a number of methods designed to minimize risk, including underwriting specialization, modeling and data systems, data quality control, strategic use of policy deductibles and regular review of aggregate exposure and probable maximum loss reports, which report the maximum amount of losses that one would expect based on computer or actuarial modeling techniques.

These estimates, models, data and scenarios may not produce accurate predictions;

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Changes in these estimates or assumptions or the use of inaccurate third-party data could cause our actual losses to be materially higher than our current expectation of losses generated by modeled catastrophe scenarios, which in turn could materially adversely affect our business, financial condition, and results of operations.

We run many model simulations in order to understand the impact of these assumptions on a catastrophe’s loss potential.

We run many model simulations to understand the impact of these assumptions on a catastrophe’s loss potential.

Furthermore, there are risks associated with catastrophe events, which are either poorly represented or not represented at all by catastrophe models.

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The models may not accurately reflect the impact on the economy of the area affected or the financial, judicial, political, or regulatory impacts on insurance claim payments during or following a catastrophe event.

Our investment portfolio may be adversely impacted by ratings downgrades, increased bankruptcies and credit spread widening in distressed industries, such as energy, gaming, lodging and leisure, autos, airlines and retail due to the Pandemic.

Further disruptions in global financial markets due to the continuing impact of the Pandemic could result in potential impairments in our fixed income portfolio.

In addition, declines in fixed income yields would result in decreases in net investment income from future investment activity, including re-investments.

As a result of these factors and contingencies, our reliance on assumptions and data used to evaluate our entire risk portfolio and specifically to estimate a probable maximum loss is subject to a high degree of uncertainty that could result in actual losses that are materially different from our probable maximum loss estimates and our financial results could be adversely affected.

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Best has assigned a financial strength rating of “A−” (Excellent) (Outlook Stable) to us.

Best assigns ratings that are intended to provide an independent opinion of an insurance company’s ability to meet its obligations to policyholders and such ratings are not evaluations directed to investors and are not a recommendation to buy, sell or hold our common stock or any other securities we may issue.

Best’s analysis includes comparisons to peers and industry standards as well as assessments of operating

plans, philosophy and management.

Best’s analysis includes comparisons to peers and industry standards as well as assessments of operating plans, philosophy and management.

Best periodically reviews our financial strength rating and may revise it downward or revoke it at A.M.

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economies and financial markets, and may further disrupt our operations and the operations of our insureds, agents, and third parties upon which we rely.

The current Pandemic health emergency has caused significant disruption in the global and U.S.

The current Pandemic has caused significant disruption in the global and U.S.

economies and financial markets.

On March 11, 2020, the World Health Organization formally declared the COVID-19 outbreak to be a pandemic.

The spread of COVID-19 has caused illness, quarantines, cancellation of events and travel, business and school shutdowns, reduction in business activity, widespread unemployment, supply chain interruptions, and overall economic and financial market instability.

There continue to be significant reported cases of infected individuals throughout the United States.

states, including California and Texas, where we generated more than one-half of our gross written premiums for the six months ended June 30, 2020, have declared states of emergency.

The spread of COVID-19 has caused illness, quarantines, cancellation of events and travel, business and school closures, reduction in business activity, increased unemployment, supply chain interruptions, and overall economic and financial market instability.

There continue to be significant reported cases of infected individuals throughout the United States and globally.

Impacts to our business could be widespread and material impacts may result, including but not limited to, the following:

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● unavailability of key personnel necessary to conduct our business activities;

● unprecedented volatility in financial markets that could materially affect our investment portfolio valuations and returns;

● volatility in financial markets that could materially affect our investment portfolio valuations and returns;

● government mandates and/or legislative changes, including premium grace periods and presumed Pandemic compensability for all or certain insured groups;

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Our business is concentrated in California and Texas and, as a result, we are exposed more significantly to California and Texas loss activity and regulatory environments.

Our policyholders and insurance risks are currently concentrated in California and Texas, which generated 56% and 19% of our gross written premiums, respectively, for the year ended December 31, 2019 and 46% and 22% of our gross written premiums, respectively, for the six months ended June 30, 2020.

Our policyholders and insurance risks are currently concentrated in California and Texas, which generated 56% and 19% of our gross written premiums, respectively, for the year ended December 31, 2019 and 48.1% and 21.3% of our gross written premiums, respectively, for the nine months ended September 30, 2020.

We are exposed to business, economic, political, judicial and regulatory risks due to this concentration that are greater than the risks faced by insurance companies that conduct business over a more extensive geographic area.

Any single, major catastrophe event, series of events or other condition causing significant losses in California or Texas could materially adversely affect our business, financial condition and results of operations.

Additionally, unfavorable business, economic or regulatory conditions in these states may result in a significant reduction of our premiums or increase our loss exposure.

Accordingly, the loss environment and unfavorable business, economic, demographic, natural perils, competitive, and regulatory conditions in California and Texas, including the impacts of the ongoing Pandemic, could negatively impact our business We are exposed to business, economic, political, judicial and regulatory risks due to this concentration that are greater than the risks faced by insurance companies that conduct business over a more extensive geographic area.

Changes in California or Texas political climates could result in new or changed legislation affecting the property and casualty insurance industry in general and insurers writing residential earthquake and wind coverage in particular.

Changes in California or Texas political climates could result in new or changed legislation affecting the property and casualty insurance industry in general which could have a negative impact on our business.

We could be adversely affected by the loss of one or more key executives or by an inability to attract and retain qualified personnel.

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Even if the relationships do continue, they may not be on terms that are profitable for us.

We distribute a significant portion of our Residential Earthquake, Commercial Earthquake, Specialty Homeowners and Hawaii Hurricane products through longstanding relationships with two program administrators.

We distribute a significant portion of our Residential

Earthquake, Commercial Earthquake, Specialty Homeowners and Hawaii Hurricane products through longstanding relationships with two program administrators.

Each of the four products managed by the program administrators operates as a separate program that is governed by an independent, separately negotiated agreement with unique terms and conditions, including geographic scope, key person provisions, economics and exclusivity.

These programs also feature separate managerial oversight and leadership, policy administration systems and retail agents originating policies.

In total, these four products accounted for $148.6 million or 59.0% of our gross written premiums for the year ended December 31, 2019 and $80.9 million or 52.1% for the six months ended June 30, 2020.

In total, these four products accounted for $148.6 million or 59.0% of our gross written premiums for the year ended December 31, 2019 and $140.4 million or 54.4% for the nine months ended September 30, 2020.

This amount includes our Value Select Residential Earthquake program, which represents the majority of our Residential Earthquake premium and is administered through a mutually exclusive program administrator agreement with Arrowhead for the states of California, Oregon and Washington.

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Furthermore, it may be difficult or prohibitively expensive for us to implement technology systems and processes that are competitive with the systems and processes of these larger companies.

In particular, competition in the insurance industry is based on many factors, including price of coverage, the general reputation and perceived financial strength of the company, relationships with brokers, terms and conditions of products offered, ratings assigned by independent rating agencies, speed of claims payment and reputation, and the

experience and reputation of the members of our underwriting team in the particular lines of insurance and reinsurance we seek to underwrite.

In recent years, the insurance industry has undergone increasing consolidation, which may further increase competition.

A number of new, proposed or potential industry or legislative developments could further increase competition in our industry.

Certain new, proposed or potential industry or legislative developments could further increase competition in our industry.

These developments include:

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Recently, the majority of our employees have been working outside of our primary offices as a result of the Pandemic.

We believe this additional remote work increases the need for our information technology and

telecommunications systems to work properly and creates additional operational risk and difficulty should these systems fail.

We believe this additional remote work increases the need for our information technology and telecommunications systems to work properly and creates additional operational risk and difficulty should these systems fail.

Any failure to protect our intellectual property rights could impair our ability to protect our intellectual property, proprietary technology platform and brand, or we may be sued by third parties for alleged infringement of their proprietary rights.

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Because the possibility of these events occurring depends in large part upon the financial condition and internal operations of our brokers, we monitor broker behavior and review financial information on an as-needed basis.

unable to collect premiums from our brokers in the future, our underwriting profits may decline and our financial condition and results of operations could be materially and adversely affected.

If we are unable to collect premiums from our brokers in the future, our underwriting profits may decline and our financial condition and results of operations could be materially and adversely affected.

Our failure to accurately and timely pay claims could materially and adversely affect our business, financial condition, results of operations, and prospects.

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We anticipate that we will continue to rely on such third- party software in the future.

Although we believe that there are commercially reasonable alternatives to the third-party software we currently license, this may not always be the case, or it may be difficult or costly to replace.

In addition, integration of new third-party software may require significant work and require substantial investment of our time and resources.

Integration of new third-party software or modifications to our existing third-party software may require significant work and require substantial investment of our time and resources.

Our use of additional or alternative third-party software would require us to enter into license agreements with third parties, which may not be available on commercially reasonable terms or at all.

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In an economic downturn, our customers may have less need for insurance coverage, cancel or cease payment on existing insurance policies, modify their coverage, or not renew the policies they hold with us.

Existing policyholders may exaggerate or even falsify claims to obtain higher claims

Existing policyholders may exaggerate or even falsify claims to obtain higher claims payments.

These outcomes would reduce our underwriting profit to the extent these factors are not reflected in the rates we charge.

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These securities are carried on the balance sheet at fair market value and are subject to potential losses and declines in market value.

Our equity invested assets totaled $37.6 million as of June 30, 2020.

Risks for all types of securities are managed through the application of our investment policy, which establishes investment parameters that include but are not limited to, maximum percentages of investment in certain types of securities and minimum levels of credit quality, which we believe are within applicable guidelines established by the National Association of Insurance Commissioners (“NAIC”), the Oregon Division of Financial Regulation and the California Department of Insurance.

Our equity invested assets totaled $45.0 million as of September 30, 2020.

Although we seek to preserve our capital, we cannot be certain that our investment objectives will be achieved, and results may vary substantially over time.

In addition, although we seek to employ investment strategies that are not correlated with our insurance and reinsurance exposures, losses in our investment portfolio may occur at the same time as underwriting losses and, therefore, exacerbate the adverse effect of the losses on us.

Further disruptions in global financial markets due to the continuing impact of the Pandemic could result in additional net realized investment losses, including potential impairments in our fixed income portfolio.

Our investment portfolio could also be adversely impacted by ratings downgrades, increased bankruptcies and credit spread widenings caused by economic downturns from pandemics or other events.

Severe economic downturns could cause impairments in our fixed income portfolio.

In addition, declines in fixed income yields would result in decreases in net investment income from future investment activity, including re-investments.

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Consequently, we seek to manage the duration of our investment portfolio based on the duration of our losses and loss adjustment expense reserves to provide sufficient liquidity and avoid having to liquidate investments to fund claims.

Risks such as inadequate losses and loss adjustment reserves or unfavorable trends in litigation could potentially result in the need to sell investments to fund these liabilities.

Risks such as inadequate losses and loss adjustment reserves or unfavorable trends in litigation could potentially result in

the need to sell investments to fund these liabilities.

We may not be able to sell our investments at favorable prices or at all.

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These practices may turn out to be different from the interpretations of regulatory authorities.

If we do not have

the requisite licenses and approvals or do not comply with applicable regulatory requirements, state insurance regulators could preclude or temporarily suspend us from carrying on some or all of our activities or could otherwise penalize us.

If we do not have the requisite licenses and approvals or do not comply with applicable regulatory requirements, state insurance regulators could preclude or temporarily suspend us from carrying on some or all of our activities or could otherwise penalize us.

This could adversely affect our ability to operate our business.

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It identifies property and casualty insurers that may be inadequately capitalized by looking at certain inherent risks of each insurer’s assets and liabilities and its mix of net written premium.

Insurers falling below a calculated threshold may be subject to varying degrees of regulatory action, including supervision, rehabilitation or liquidation.

Insurers falling below a calculated threshold may be subject to varying degrees of regulatory action, including

supervision, rehabilitation or liquidation.

Failure by any of our U.S.

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This in turn may negatively impact our growth in these markets if there is lower demand in the housing market as a consequence of the Tax Act.

If states increase the assessments that Palomar Specialty Insurance Company is required to pay, our business, financial condition and results of operations would suffer.

Certain jurisdictions in which Palomar Specialty Insurance Company is admitted to transact business require property and casualty insurers doing business within that jurisdiction to participate in insurance guaranty associations.

If states increase the assessments that we are required to pay, our business, financial condition and results of operations would suffer.

Certain jurisdictions in which PSIC is admitted to transact business require property and casualty insurers doing business within that jurisdiction to participate in insurance guaranty associations.

These organizations pay contractual benefits owed pursuant to insurance policies issued by impaired, insolvent or failed insurers.

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States may also assess admitted companies in order to fund their respective department of insurance operations.

Some states permit member insurers to recover assessments paid through full or partial premium tax offset or in limited circumstances by surcharging policyholders.

Palomar Specialty Insurance Company is licensed to conduct insurance operations on an admitted basis in 27 states and has applied for state approval for licenses in additional states.

As Palomar Specialty Insurance Company grows, our share of any assessments in each state in which it underwrites business on an admitted basis may increase.

We paid assessments of $1.1 million in 2018, $14,750 in 2019 and have paid $0.3 million during the six months ended June 30, 2020.

permit member insurers to recover assessments paid through full or partial premium tax offset or in limited circumstances by surcharging policyholders.

PSIC is licensed to conduct insurance operations on an admitted basis in 27 states and has applied for state approval for licenses in additional states.

As PSIC grows, its share of any assessments in each state in which it underwrites business on an admitted basis may increase.

PSIC paid assessments of $1.1 million in 2018, $14,750 in 2019 and have paid $0.3 million during the nine months ended September 30, 2020.

The increase in assessments paid during 2018 was primarily amounts assessed by the Texas Windstorm Insurance Association and Texas Fair Plan Association relating to Hurricane Harvey, with such amounts recovered from our reinsurers.

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If we are unable to successfully scale our new excess and surplus insurance company, our business and future prospects may be harmed.

We intend to launch our excess and surplus lines insurance product offerings via our recently formed surplus lines subsidiary, PESIC.

We recently launched our excess and surplus lines insurance product offerings via our recently formed surplus lines subsidiary, PESIC.

The excess and surplus market is highly competitive and many of our competitors are better capitalized and have a longer history in the market.

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We must maintain accounting and financial staff and consultants with appropriate public company reporting, technical accounting, and internal control knowledge to satisfy the ongoing requirements of Section 404 and provide internal audit services.

The Sarbanes-Oxley Act and the Dodd-Frank Act, as well as new rules subsequently implemented by the SEC and Nasdaq, have increased regulation of, and imposed enhanced disclosure and corporate governance requirements on,

public companies.

Our efforts to comply with these evolving laws, regulations and standards increases our operating costs and divert management’s time and attention from revenue-generating activities.

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We may not be successful in complying with these requirements, and compliance with them could materially adversely affect our business.

The increased costs decrease our net income and may require us to reduce costs in other areas of our business or increase the prices of our products or services.

These requirements increase our costs and may cause us to reduce costs in other areas of our business or increase the prices of our products or services.

For example, these rules and regulations to make it more difficult and more expensive for us to obtain director and officer liability insurance.

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If we do not implement the required controls in a timely manner or with adequate compliance, we may be subject to sanctions or investigation by regulatory authorities, such as the SEC or Nasdaq.

Any such action could harm our reputation and the confidence of investors in, and clients of, our company and could negatively affect our business and cause the price of our shares of common stock to decline.

Any such action could harm our reputation and the confidence of our investors and customers and could negatively affect our business and cause the price of our shares of common stock to decline.

We are required by Section 404 of the Sarbanes-Oxley Act to evaluate the effectiveness of our internal control over financial reporting.

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As a public company with SEC reporting obligations, we are required to document and test our internal control procedures to satisfy the requirements of Section 404(b) of the Sarbanes- Oxley Act, which requires annual assessments by management of the effectiveness of our internal control over financial reporting.

Although we currently qualify as an emerging growth company, we expect we will become a large accelerated filer on December 31, 2020.

Although we currently qualify as an emerging growth company, we will become a large accelerated filer on December 31, 2020.

As such, our auditor will be required to attest to the effectiveness of our internal control over financial reporting beginning with our 2020 Annual Report on form 10-K.

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We may not be able to conclude on an ongoing basis that we have effective internal control over financial reporting in accordance with Section 404(b) of Sarbanes-Oxley.

If we conclude that our internal control over financial reporting is not effective, we cannot be certain as to the timing of completion of our evaluation, testing and remediation actions or their effect on our operations.

If we conclude that our internal control over financial reporting is not effective, the cost and scope of remediation actions and their effect on our operations may be significant.

Moreover, any material weaknesses or other deficiencies in our internal control over financial reporting may impede our ability to file timely and accurate reports with the SEC.

Any of the above could cause investors to lose confidence in our reported financial

information or our common stock listing on Nasdaq to be suspended or terminated, which could have a negative effect on the trading price of our common stock.

Any of the above could cause investors to lose confidence in our reported financial information or our common stock listing on Nasdaq to be suspended or terminated, which could have a negative effect on the trading price of our common stock.

We qualify as an emerging growth company, and any decision on our part to comply with reduced reporting and disclosure requirements applicable to emerging growth companies could make our common stock less attractive to investors.

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The trading market for our common stock depends, in part, on the research and reports that securities or industry analysts publish about us or our business and our industry.

If one or more of the analysts who cover us downgrades our common stock or publishes inaccurate or unfavorable research about our business, our stock price would likely decline.

If one or more of the analysts who cover us downgrades our common stock or publishes inaccurate or unfavorable research about our business, our stock price

would likely decline.

If one or more of these analysts ceases coverage of us or fails to publish reports on us regularly, demand for our common stock could decrease, which could cause our stock price and trading volume to decline.

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 1A. Risk Factors