What changed in this filing

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Item 2. Management’s Discussion and Analysis

2021-05-07 compared with 2020-11-13 · 169 added, 377 removed, 352 unchanged (61% of the section changed)

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Our actual results could differ materially from those anticipated in these forward-looking statements as a result of many factors.

The results of operations for the three and nine months ended September 30, 2020 are not necessarily indicative of the results that may be expected for the full year ended December 31, 2020, or for any other future period.

The following discussion should be read in conjunction with the unaudited condensed consolidated financial statements and the notes thereto included in Part I, Item 1 of this Quarterly Report, and in conjunction with our audited consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K as filed with the SEC on February 28, 2020.

The results of operations for the three months ended March 31, 2021 are not necessarily indicative of the results that may be expected for the full year ended December 31, 2021, or for any other future period.

References to the "Company,"

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and its subsidiaries, unless the context otherwise requires.

We are a rapidly growing and profitable company focused on the provision of specialty property insurance.

We focus on certain markets that we believe are underserved by other insurance companies, such as the markets for earthquake, wind and flood insurance.

We provide specialty property insurance products in our target markets to both individuals and businesses.

We use proprietary data analytics and a modern technology platform to offer our customers flexible products with customized and granular pricing.

We provide most of our products on an admitted basis, while having the flexibility to provide certain products on a non-admitted basis.

We distribute our products through multiple channels, including retail agents, program administrators, wholesale brokers, and in partnership with other insurance companies.

Our business strategy is supported by a comprehensive risk transfer program with reinsurance coverage that we believe reduces earnings volatility and provides appropriate levels of protection in the event of a major catastrophe.

We are a rapidly growing and innovative insurer focused on providing specialty insurance to residential and commercial customers.

Our underwriting and analytical expertise allow us to concentrate on certain markets that we believe are underserved by other insurance companies, such as the markets for earthquake, hurricane and flood insurance.

We use proprietary data analytics and a modern technology platform to offer our customers flexible products with customized and granular pricing for both the admitted and excess and surplus lines (“E&S”) markets.

We provide admitted insurance products through our Oregon domiciled insurance company, Palomar Specialty Insurance Company (“PSIC”), and non-admitted insurance products through our Arizona domiciled surplus lines insurance company, Palomar Excess and Surplus Insurance Company (“PESIC”).

We distribute our products through multiple channels, including retail agents, program administrators, wholesale brokers, and partnerships with other insurance companies.

Our management team combines decades of insurance industry experience across specialty underwriting, reinsurance, program administration, distribution, and analytics.

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We have organically increased gross written premiums from $16.6 million for the year ended December 31, 2014, our first year of operations, to $354.4 million for the year ended December 31, 2020, a compound annual growth rate (“CAGR”) of approximately 66%.

For the nine months ended September 30, 2020, we experienced average monthly premium retention rates above 90% for our Residential Earthquake, Flood, and Hawaii Hurricane lines and approximately 90% overall across all lines of business, providing strong visibility into future revenue.

In February 2014, Palomar Specialty Insurance Company was awarded an “A−” rating from A.M.

For the three months ended March 31, 2021, we experienced average monthly premium retention rates above 90% for our Residential Earthquake, Commercial Earthquake, and Hawaii Hurricane lines and approximately 90% overall across all continuing lines of business, providing strong visibility into future revenue.

In February 2014, PSIC was awarded an “A−” rating from A.M.

Best Company (“A.M.

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In April 2020, A.M.

Best affirmed the “A−” rating for Palomar Specialty Insurance Company and affirmed our “A−” group rating for Palomar Holdings, Inc.

In July 2020, Palomar Excess and Surplus Lines Insurance Company was also awarded an “A−” rating by A.M.

Best affirmed the “A−” rating for PSIC and affirmed our “A−” group rating for Palomar Holdings, Inc.

In July 2020, PESIC was also awarded an “A−” rating by A.M.

These ratings reflect A.M.

Best’s opinion of our subsidiaries’ financial strength, operating performance, and ability to meet obligations to policyholders and are not an evaluation directed towards the protection of investors.

In April 2019, we closed our Initial Public Offering (“IPO”) and received net proceeds of approximately $87.4 million, after deducting underwriting discounts and commissions and offering costs.

On January 9, 2020, we, along with certain selling stockholders, sold 5,750,000 shares of common stock at a price of $49.00 per share in an underwritten public offering.

The offering was comprised of 5,000,000 shares sold by

certain selling stockholders and 750,000 shares sold by us.

We received net proceeds of approximately $35.5 million, after deducting underwriting discounts and commissions and offering costs.

On June 26, 2020, we sold 1,150,000 shares of common stock to the public at a price of $82.00 per share in an underwritten public offering.

We received net proceeds of approximately $90.1 million, after deducting underwriting discounts and commissions and offering costs.

During the second quarter of 2020, we capitalized and received regulatory approval for a newly formed surplus lines insurance company subsidiary named Palomar Excess and Surplus Insurance Company (‘‘PESIC’’).

We capitalized PESIC with approximately $100 million in initial surplus.

PESIC is domiciled in the State of Arizona and licensed in Arizona to transact across all our existing lines of business.

We believe that the underwriting acumen and market expertise we have established in the admitted insurance market is also applicable to the non-admitted, or surplus lines market, and that PESIC enables us to serve certain risks that our admitted products cannot currently satisfy.

We began writing surplus lines business, notably commercial earthquake, on a national basis during the third quarter of 2020 and have entered into several new partnerships which will enable us to write additional surplus lines business in the future.

Best’s opinion of our financial strength, operating performance, and ability to meet obligations to policyholders and are not an evaluation directed towards the protection of investors.

We believe that our market opportunity, distinctive products, and differentiated business model position us to grow our business profitably.

COVID-19 Pandemic and Impact on Palomar

The COVID-19 Pandemic ("The Pandemic") continues to impact financial markets, businesses, households, and communities.

The Pandemic has impacted our operations and we are taking several actions to protect the health of the public and our employees and comply with directives and advice of governmental and health authorities.

Since March 2020, the majority of our employees have been working from home and we have put all business travel on hold indefinitely.

We have implemented safeguards for employees in critical roles to ensure operational reliability and established protocols for employees who interact directly with the public.

COVID-19 Update

The COVID-19 Pandemic ("the Pandemic") continues to impact businesses, households, communities, and financial markets.

In response to the Pandemic, we have been taking several actions to protect the health of the public and our employees while serving our policyholders and ensuring business continuity.

Since March 2020, the majority of our employees have been working from home and we have implemented safeguards to ensure operational reliability and established safety protocols for employees who interact directly with the public.

We also provide employees a reimbursement to help manage incremental costs associated with remote work.

In addition, we are taking extra physical security and cybersecurity measures to further safeguard our systems to serve the operational needs of our remote workforce and ensure uninterrupted service to brokers and policyholders.

The initial economic impacts of the Pandemic, as well as the various stay at home orders and mandated closures of certain business, have caused a significant temporary slowdown in certain sectors of the economy and a corresponding increase in unemployment.

We have experienced an increase in the number of business interruption claims related to the Pandemic.

In addition, we are taking extra physical security and cybersecurity measures to safeguard our systems to serve the operational needs of our remote workforce and ensure uninterrupted service to our brokers and policyholders.

We have experienced business interruption claims related to the Pandemic.

Our All Risk and Commercial Earthquake (Difference in Conditions or “DIC”) policies offer business interruption coverage for insureds for a loss in business income caused by physical damage to the structure.

All of these policies are written on an admitted basis and all of our all risk policies have an Insurance Services Office (“ISO”) virus exclusion.

Each of our All Risk policies has a virus and/or communicable disease exclusion.

Our DIC policies require physical damage to the structure caused by the covered perils, whether it be an earthquake or flood.

We are acknowledging, investigating, assessing and adjudicating each of these claims and providing the policyholder requisite consideration.

We are acknowledging, investigating, assessing and adjudicating each claim received and providing the policyholder requisite consideration.

Our results of operations depend, in part, on the performance of our investment portfolio.

During 2020 we have experienced volatility in the fair value of our investment portfolio due to unrealized losses and gains on our fixed income securities.

Since the onset of the Pandemic, we have experienced volatility in the fair value of our investment portfolio due to unrealized losses and gains on our fixed income securities.

The economic impacts of the Pandemic could reduce our net investment income and result in realized investment losses in future periods.

We have not seen a significant change in the growth rate of our gross written premiums since the beginning of the Pandemic and related economic downturn.

However, adverse events such as health-related concerns about working in our offices, the inability to travel, potential impact on our business partners and customers, and other matters affecting the general work and business environment could harm our business and impact the implementation of our business strategy.

We cannot anticipate all the ways in which the Pandemic and financial market conditions could adversely impact our business in the future.

We have not seen a significant impact on the growth rate of our gross written premiums since the beginning of the Pandemic.

However, the macroeconomic effects of the Pandemic may persist for an indefinite period, even after the Pandemic has subsided and we cannot anticipate all the ways in which the Pandemic could adversely impact our business in the future.

Components of Our Results of Operations

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In periods where we modify a quota share agreement, ceded written premiums may increase or decrease significantly compared to prior periods and these fluctuations may not be indicative of future trends.

In addition, our XOL costs as a percentage of gross earned premiums vary over the life of XOL contracts due to changes of premium in force during the contract period.

In addition, our XOL costs as a percentage of gross earned premiums may vary each period due to changes of premium in-force during the XOL contract period or due to acceleration of XOL charges or the need to purchase additional reinsurance due to losses.

Net Earned Premiums

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Losses and Loss Adjustment Expenses

Losses and loss adjustment expenses represent the costs incurred for losses.

Losses and loss adjustment expenses represent the costs incurred for losses, net of any losses ceded to reinsurers.

These expenses are a function of the size and term of the insurance policies we write and the loss experience associated with the underlying coverage.

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Our losses and loss adjustment expenses are generally affected by:

● The occurrence, frequency and severity of catastrophe events in the areas where we underwrite polices relating to these perils;

● The occurrence, frequency and severity of catastrophe events in the areas where we underwrite policies relating to these perils;

● The occurrence, frequency and severity of non-catastrophe attritional losses;

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Other underwriting expenses represent the general and administrative expenses of our insurance operations including employee salaries and benefits, software and technology costs, office rent, stock-based compensation, licenses and fees, and professional services fees such as legal, accounting, and actuarial services.

Interest Expense

Interest expense consisted of interest expense on our Floating Rate Notes during the three and nine months ended September 30, 2019.

These notes were redeemed in May 2019 and we did not have any debt or incur any interest expense thereafter.

Net Investment Income

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Our invested assets are primarily comprised of fixed maturity securities, and may also include cash and cash equivalents, and equity securities.

The principal factors that influence net investment income are the size of our investment portfolio, the yield on that portfolio and expenses due to external investment managers.

As measured by amortized cost, which excludes changes in fair value, caused by changes in interest rates, the size of our investment portfolio is mainly a function of our invested equity capital along with premium we receive from our insureds, less payments on policyholder claims and other operating expenses.

The principal factors that influence net investment income are the size of our investment portfolio, the yield on that portfolio, and investment management expenses.

As measured by amortized cost, which excludes changes in fair value, caused by changes in interest rates, the size of our investment portfolio is mainly a function of our invested capital along with premium we receive from our insureds, less payments on policyholder claims and other operating expenses.

Our balance of invested capital may be impacted in the future by repurchases of shares of our common stock.

Net Realized and Unrealized Gains and Losses on Investments

Net realized and unrealized gains and losses on investments are a function of the difference between the amount received by us on the sale of a security and the security’s cost-basis, mark-to-market adjustments as well as any “other-than-temporary” impairments recognized in earnings.

Income Tax Expense

Currently our income tax expense consists mainly of federal income taxes imposed on our operations.

Our effective tax rates are dependent upon components of pretax earnings and the related tax effects.

Our effective tax rates are dependent upon the components of pretax earnings and the related tax effects.

Key Financial and Operating Metrics

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See “Reconciliation of Non-GAAP Financial Measures” for a reconciliation of total revenue calculated in accordance with GAAP to underwriting revenue.

Underwriting income is a non-GAAP financial measure defined as income before income taxes excluding net investment income, net realized and unrealized gains and losses on investments and interest expense.

Underwriting income is a non-GAAP financial measure defined as income before income taxes excluding net investment income and net realized and unrealized gains and losses on investments.

See “Reconciliation of Non-GAAP Financial Measures” for a reconciliation of income before income taxes calculated in accordance with GAAP to underwriting income.

Adjusted net income (loss) is a non-GAAP financial measure defined as net income excluding the impact of certain items that may not be indicative of underlying business trends, operating results, or future outlook, net of tax impact.

Adjusted net income is a non-GAAP financial measure defined as net income excluding the impact of certain items that may not be indicative of underlying business trends, operating results, or future outlook, net of tax impact.

We calculate the tax impact only on adjustments which would be included in calculating our income tax expense using the estimated tax rate at which the company received a deduction for these adjustments.

See “Reconciliation of Non-GAAP Financial Measures” for a reconciliation of net income calculated in accordance with GAAP to adjusted net income (loss).

See “Reconciliation of Non-GAAP Financial Measures” for a reconciliation of net income calculated in accordance with GAAP to adjusted net income.

Return on equity is net income expressed on an annualized basis as a percentage of average beginning and ending stockholders’ equity during the period.

Adjusted return on equity is a non-GAAP financial measure defined as adjusted net income (loss) expressed on an annualized basis as a percentage of average beginning and ending stockholders’ equity during the period.

Adjusted return on equity is a non-GAAP financial measure defined as adjusted net income expressed on an annualized basis as a percentage of average beginning and ending stockholders’ equity during the period.

See “Reconciliation of Non-GAAP Financial Measures” for a reconciliation of return on equity calculated using unadjusted GAAP numbers to adjusted return on equity.

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See “Reconciliation of Non-GAAP Financial Measures” for a reconciliation of combined ratio calculated using unadjusted GAAP numbers to adjusted combined ratio.

Diluted adjusted earnings per share is a non-GAAP financial measure defined as adjusted net income (loss) divided by the weighted-average common shares outstanding for the period, reflecting the dilution which could occur if equity-based awards are converted into common share equivalents as calculated using the treasury stock method.

Diluted adjusted earnings per share is a non-GAAP financial measure defined as adjusted net income divided by the weighted-average common shares outstanding for the period, reflecting the dilution which could occur if equity-based awards are converted into common share equivalents as calculated using the treasury stock method.

See “Reconciliation of Non-GAAP Financial Measures” for a reconciliation of diluted earnings per share calculated in accordance with GAAP to diluted adjusted earnings per share.

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See “Reconciliation of Non-GAAP Financial Measures” for a reconciliation of combined ratio calculated using unadjusted GAAP numbers to adjusted combined ratio excluding catastrophe losses.

Adjusted net income excluding catastrophe losses is a non-GAAP financial measure defined as adjusted net income (loss) excluding catastrophe losses, net of tax impact.

See “Reconciliation of Non-GAAP Financial Measures” for a reconciliation of income before income taxes calculated in accordance with GAAP to adjusted net income excluding catastrophe losses.

Tangible stockholders’ equity is a non-GAAP financial measure defined as stockholders’ equity less intangible assets.

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Results of Operations

Three months ended September 30, 2020 compared to three months ended September 30, 2019

The following table summarizes our results for the three months ended September 30, 2020 and 2019:

Three months ended March 31, 2021 compared to three months ended March 31, 2020

The following table summarizes our results for the three months ended March 31, 2021 and 2020:

Three months ended

September 30,

($ in thousands, except per share data)

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Other underwriting expenses

Underwriting income (loss) (1)

Underwriting income (1)

Net investment income

Net realized and unrealized gains on investments

Net realized and unrealized gains (losses) on investments

Income before income taxes

Income tax expense (benefit)

Net income (loss)

Expenses associated with IPO, tax restructuring, secondary offerings, and one-time incentive cash bonuses

Income tax expense

Expenses associated with transactions and stock offerings

Stock-based compensation expense

Adjusted net income (loss) (1)

Amortization of intangibles

Expenses associated with catastrophe bond, net of rebate

Adjusted net income (1)

Key Financial and Operating Metrics

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Adjusted combined ratio excluding catastrophe losses (1)

Adjusted net income excluding catastrophe losses (1) (2)

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see “Reconciliation of Non-GAAP Financial Measures” for a reconciliation of the non-GAAP financial measures to their most directly comparable financial measures prepared in accordance with GAAP.

(2) Catastrophe losses above are shown before their tax impact.

Adjusted net income excluding catastrophe losses excludes catastrophe losses net of the estimated tax effect on them.

Gross Written Premiums

Gross written premiums increased $36.8 million, or 55.4% to $103.0 million for the three months ended September 30, 2020 compared to $66.2 million for the three months ended September 30, 2019.

Premium growth was primarily due to an increased volume of policies written across our lines of business which was driven by new business generated with existing partners, strong premium retention rates for existing business, expansion of our products’ distribution footprint, and new partnerships.

Gross written premiums increased $32.1 million, or 44.9% to $103.6 million for the three months ended March 31, 2021 compared to $71.5 million for the three months ended March 31, 2020.

The following table summarizes our gross written premiums by line of business and shows each line’s percentage of total gross written premiums for each period:

Three Months Ended September 30,

Three Months Ended March 31,

($ in thousands)

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Total Gross Written Premiums

We experienced the largest percentage increase in our Inland Marine and Commercial Earthquake lines.

Other gross written premiums are comprised of various items including our Assumed Reinsurance program.

Changes to other gross written premiums may not be indicative of future trends.

During the three months ended March 31, 2021, PSIC accounted for $79.8 million or approximately 77% of our gross written premiums and PESIC accounted for $23.8 million or approximately 23% of our gross written premiums.

Ceded Written Premiums

Ceded written premiums increased $13.5 million, or 48.1%, to $41.6 million for the three months ended September 30, 2020 from $28.1 million for the three months ended September 30, 2019.

The increase was primarily due to an increase in excess of loss (“XOL”) reinsurance expense commensurate with growth in exposure.

In addition, we had increased quota share cession primarily in our specialty homeowners lines due to higher written premiums in those lines.

Ceded written premiums as a percentage of gross written premiums decreased to 40.4% for the three months ended September 30, 2020 from 42.4% for the three months ended September 30, 2019.

This decrease was primarily due to changes in our quota share agreements in our specialty homeowners and commercial all risk lines as we entered into new ceding arrangements on these lines which increased the percentage of premiums we retained.

Ceded written premiums increased $13.9 million, or 47.0%, to $43.4 million for the three months ended March 31, 2021 from $29.5 million for the three months ended March 31, 2020.

The increase was primarily due to an increase in excess of loss (“XOL”) reinsurance expense due to growth in exposure and additional charges resulting from Winter Storm Uri (“Uri”), which impacted our Specialty Homeowners and Commercial All Risk products.

Catastrophe losses from Uri caused us to utilize certain layers of our XOL program which increased our expense during the current quarter and will result in increased expense in the second quarter of 2021.

During the three months ended March 31, 2021, the Company incurred an additional $4.0 million of expense associated with the reinstatement of its reinsurance program.

The Company also expects to incur similar costs in the second quarter of 2021.

In addition to XOL increases, we had increased quota share cessions due to growth in the volume of written premiums subject to quota shares.

Ceded written premiums as a percentage of gross written premiums increased to 41.9% for the three months ended March 31, 2021 from 41.3% for the three months ended March 31, 2020.

This increase was primarily due to XOL charges and a higher proportion of our written premiums being subject to quota shares.

Net Written Premiums

Net written premiums increased $23.2 million, or 60.8%, to $61.4 million for the three months ended September 30, 2020 from $38.2 million for the three months ended September 30, 2019.

The increase was primarily due to an increase in gross written premiums, primarily in our commercial earthquake and specialty homeowners lines offset by increased ceded written premiums.

Net written premiums increased $18.2 million, or 43.4%, to $60.2 million for the three months ended March 31, 2021 from $42.0 million for the three months ended March 31, 2020.

The increase was primarily due to an increase in gross written premiums, primarily in our Commercial Earthquake and Residential Earthquake lines offset by increased ceded written premiums.

Net Earned Premiums

Net earned premiums increased $14.3 million, or 51.9%, to $42.0 million for the three months ended September 30, 2020 from $27.7 million for the three months ended September 30, 2019 due primarily to the earning of increased gross written premiums offset by the earning of ceded written premiums under reinsurance agreements.

Net earned premiums increased $12.2 million, or 35.2%, to $47.1 million for the three months ended March 31, 2021 from $34.8 million for the three months ended March 31, 2020 due primarily to the earning of increased gross written premiums offset by the earning of ceded written premiums under reinsurance agreements.

The table below shows the amount of premiums we earned on a gross and net basis and net earned premiums as a percentage of gross earned premiums in each period presented:

Three Months Ended

September 30,

($ in thousands)

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Commission and Other Income

Commission and other income increased $0.1 million or 15.1% to $0.8 million for the three months ended September 30, 2020 from $0.7 million for the three months ended September 30, 2019 due primarily to an increase in policy related fees associated with an increased volume of premiums written.

Commission and other income decreased by an immaterial amount and was approximately $0.7 million for each of the three months ended March 31, 2021 and March 31, 2020.

The decrease was due to decreased commission income on policies we write through our affiliated managing general agent.

This was offset by an increase in policy related fees associated with an increased volume of premiums written.

Losses and Loss Adjustment Expenses

Losses and loss adjustment expenses increased $38.7 million to $41.1 million for the three months ended September 30, 2020 from $2.4 million for the three months ended September 30, 2019.

Losses and loss adjustment expenses decreased $6.3 million to negative $4.4 million for the three months ended March 31, 2021 from $1.9 million for the three months ended March 31, 2020.

Losses and loss adjustment expenses consisted of the following elements during the respective periods:

Three Months Ended

September 30,

($ in thousands)

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Our catastrophe loss ratio was 86.9% during the three months ended September 30, 2020.

Catastrophe losses primarily included losses from Hurricanes Hanna, Isaias, Laura, Sally and Beta.

We did not experience any catastrophe losses during the three months ended September 30, 2019.

Our non-catastrophe loss ratio was 10.8% for the three months ended September 30, 2020 compared to 8.8% during the three months ended September 30, 2019.

Non-catastrophe losses increased due mainly to higher attritional loss activity on lines of business subject to attritional losses such as commercial all-risk, specialty homeowners, and inland marine.

Our catastrophe loss ratio was negative 20.5% during the three months ended March 31, 2021.

The negative catastrophe loss ratio was due to favorable development on catastrophe losses from 2020 Hurricanes and due to reinsurance recoveries.

We did not incur any catastrophe losses during the three months ended March 31, 2020.

Our non-catastrophe loss ratio was 11.1% for the three months ended March 31, 2021 compared to 5.4% during the three months ended March 31, 2020.

Non-catastrophe losses increased due mainly to higher attritional loss activity on lines of business subject to attritional losses such as Commercial All-Risk, Specialty Homeowners, Flood, and Inland Marine.

Acquisition Expenses

Acquisition expenses increased $7.8 million, or 75.5%, to $18.0 million for the three months ended September 30, 2020 from $10.2 million for the three months ended September 30, 2019.

Acquisition expenses increased $6.3 million, or 48.0%, to $19.3 million for the three months ended March 31, 2021 from $13.0 million for the three months ended March 31, 2020.

The increase was primarily due to higher earned premiums which resulted in higher commissions and premium-related taxes.

Acquisition expenses as a percentage of gross earned premiums were 22.6% for the three months ended September 30, 2020 compared to 19.2%

for the three months ended September 30, 2019.

Acquisition expenses as a percentage of gross earned premiums increased due primary to lower earned ceding commissions.

Earned ceding commissions decreased due to changes in our specialty homeowners and all risk ceding arrangements which increased the percentage of premiums we retained and decreased our ceding commissions.

Acquisition expenses as a percentage of

gross earned premiums were 21.2% for the three months ended March 31, 2021 compared to 20.1% for the three months ended March 31, 2020.

Acquisition expenses as a percentage of gross earned premiums increased due to changes in business mix and changes in our Specialty Homeowners ceding arrangements which increased the percentage of premiums we retained and decreased our ceding commissions.

Acquisition expenses as a percentage of gross earned premiums fluctuates based on mix of business produced and quota share arrangements in place.

Other Underwriting Expenses

Other underwriting expenses decreased $0.5 million, or 6.3%, to $7.8 million for the three months ended September 30, 2020 from $8.3 million for the three months ended September 30, 2019.

The decrease was primarily due to the company incurring significant expenses in the prior year quarter related to a stock offering and one-time incentive cash bonuses.

Other underwriting expenses as a percentage of gross earned premiums were 9.8% for the three months ended September 30, 2020 compared to 15.6% for the three months ended September 30, 2019.

Excluding the impact of expenses relating to stock offerings and one-time incentive cash bonuses and stock-based compensation, other underwriting expenses as a percentage of gross earned premiums were 9.1% for the three months ended September 30, 2020 compared to 10.5% for the three months ended September 30, 2019.

This percentage decreased due to higher gross earned premiums without a proportional increase to expenses.

Net Investment Income and Net Realized and Unrealized Gains on Investments

Net investment income increased $0.4 million, or 23.7%, to $2.1 million for the three months ended September 30, 2020 from $1.7 million for the three months ended September 30, 2019.

The increase was primarily due to a higher average balance of investments during the three months ended September 30, 2020 due primarily to proceeds from our January and June 2020 stock offerings and the investing of our cash generated from operations, partially offset by lower yields on investments due to a lower interest rate environment.

Net realized and unrealized gains on investments decreased $0.4 million, or 93.4%, to an immaterial amount for the three months ended September 30, 2020 from $0.4 million for the three months ended September 30, 2019 due to lower appreciation on our fixed income based equity securities during the period ended September 30, 2020.

Other underwriting expenses increased $6.3 million, or 79.2%, to $14.2 million for the three months ended March 31, 2021 from $7.9 million for the three months ended March 31, 2020.

The increase was primarily due to the company incurring higher payroll, technology, stock-based compensation, and professional fees expenses associated with growth of the Company.

In addition, during the first quarter of 2021, other underwriting expenses were significantly impacted by expenses associated with the issuance of a catastrophe bond.

Other underwriting expenses as a percentage of gross earned premiums were 15.6% for the three months ended March 31, 2021 compared to 12.2% for the three months ended March 31, 2020.

Excluding the impact of expenses relating to transactions and stock offerings, stock-based compensation, amortization of intangibles and catastrophe bonds, other underwriting expenses as a percentage of gross earned premiums were 11.9% for the three months ended March 31, 2021 compared to 11.2% for the three months ended March 31, 2020.

Other underwriting expenses as a percentage of gross earned premiums may fluctuate period over period based on timing of certain expenses relative to premium growth.

Net Investment Income and Net Realized and Unrealized Gains (Losses) on Investments

Net investment income increased $0.2 million, or 9.0%, to $2.2 million for the three months ended March 31, 2021 from $2.0 million for the three months ended March 31, 2020.

The increase was primarily due to a higher average balance of investments during the three months ended March 31, 2021 due primarily to proceeds from our June 2020 stock offering and the investing of our cash generated from operations, partially offset by lower yields on investments due to a lower interest rate environment.

Net realized and unrealized gains on investments decreased $1.2 million, or 268.0%, to a $0.7 million loss for the three months ended March 31, 2021 from a $0.4 million gain for the three months ended March 31, 2020 due to unrealized losses on our fixed income based equity securities during the period ended March 31, 2021.

Currently, we mainly invest in investment grade fixed maturity securities, including U.S.

2 unchanged sentences

Three Months Ended

September 30,

($ in thousands)

3 unchanged sentences

Net investment income

Net realized and unrealized gains on investments

Income Tax Expense (Benefit)

Income taxes decreased $8.2 million or 408.7% to $6.2 million of benefit for the three months ended September 30, 2020 from $2.0 million of expense for the three months ended September 30, 2019 as we had a pre-tax loss during the three months ended September 30, 2020.

During the three months ended September 30, 2020, our income tax rate differed from the statutory rate of 21% due primarily to the tax impact of the permanent component of employee stock option exercises.

During the three months ended September 30, 2019, our income tax rate was approximately equal to the statutory tax rate of 21%.

Nine months ended September 30, 2020 compared to nine months ended September 30, 2019

The following table summarizes our results for the nine months ended September 30, 2020 and 2019:

Nine months ended

September 30,

($ in thousands, except per share data)

Gross written premiums

Ceded written premiums

Net written premiums

Net earned premiums

Commission and other income

Total underwriting revenue (1)

Losses and loss adjustment expenses

Acquisition expenses

Other underwriting expenses

Underwriting income (loss) (1)

Interest expense

Net investment income

Net realized and unrealized gains on investments

Income before income taxes

Income tax expense

Net income (loss)

Expenses associated with IPO, tax restructuring, secondary offerings, and one-time incentive cash bonuses

Stock-based compensation expense

Expenses associated with retirement of debt

Expenses associated with catastrophe bond

Adjusted net income (1)

Key Financial and Operating Metrics

Annualized return on equity

Annualized adjusted return on equity (1)

Expense ratio

Combined ratio

Adjusted combined ratio (1)

Diluted earnings per share

Diluted adjusted earnings per share (1)

Catastrophe losses (2)

Catastrophe loss ratio (1)

Adjusted combined ratio excluding catastrophe losses (1)

Adjusted net income excluding catastrophe losses (1) (2)

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(1) Indicates non-GAAP financial measure;

see “Reconciliation of Non-GAAP Financial Measures” for a reconciliation of the non-GAAP financial measures to their most directly comparable financial measures prepared in accordance with GAAP.

(2) Catastrophe losses above are shown before their tax impact.

Adjusted net income excluding catastrophe losses excludes catastrophe losses net of the estimated tax effect on them.

Gross Written Premiums

Gross written premiums increased $79.7 million, or 44.6% to $258.3 million for the nine months ended September 30, 2020 compared to $178.6 million for the nine months ended September 30, 2019.

The following table summarizes our gross written premiums by line of business and shows each line’s percentage of total gross written premiums for each period:

Nine Months Ended September 30,

($ in thousands)

Residential Earthquake

Commercial Earthquake

Specialty Homeowners

Commercial All Risk

Inland Marine

Hawaii Hurricane

Residential Flood

Total Gross Written Premiums

NM- not meaningful

During the nine months ended September 30, 2019, we entered into a new Residential Earthquake partnership in which we assumed $6.6 million of unearned premiums.

Excluding the impact of this unearned premium assumption, our Residential Earthquake gross written premiums increased by $15.1 million, or 17.1%.

Other gross written premiums are comprised of various items including our Assumed Reinsurance program.

Changes to other gross written premiums may not be indicative of future trends.

Ceded Written Premiums

Ceded written premiums increased $22.5 million, or 28.5%, to $101.3 million for the nine months ended September 30, 2020 from $78.8 million for the nine months ended September 30, 2019.

The increase was primarily due to an increase in excess of loss (“XOL”) reinsurance expense commensurate with growth in exposure.

Ceded written premiums as a percentage of gross written premiums decreased to 39.2% for the nine months ended September 30, 2020 from 44.1% for the nine months ended September 30, 2019.

This decrease was primarily due to decreased quota share cession on our specialty homeowners and commercial all risk lines as we entered into new ceding arrangements on these lines which increased the percentage of premiums we retained.

Net Written Premiums

Net written premiums increased $57.2 million, or 57.3%, to $157.0 million for the nine months ended September 30, 2020 from $99.8 million for the nine months ended September 30, 2019.

The increase was primarily due to an increase in gross written premiums, primarily in our commercial all risk and commercial earthquake lines, offset by increased ceded written premiums.

Net Earned Premiums

Net earned premiums increased $46.9 million, or 67.8%, to $116.1 million for the nine months ended September 30, 2020 from $69.2 million for the nine months ended September 30, 2019 due primarily to the earning of increased gross written premiums offset by the earning of ceded written premiums under reinsurance agreements.

The table below shows the amount of premiums we earned on a gross and net basis and net earned premiums as a percentage of gross earned premiums in each period presented:

Nine Months Ended

September 30,

($ in thousands)

Gross earned premiums

Ceded earned premiums

Net earned premiums

Net earned premium ratio

Commission and Other Income

Commission and other income increased $0.5 million or 23.5% to $2.5 million for the nine months ended September 30, 2020 from $2.0 million for the nine months ended September 30, 2019 due primarily to an increase in policy related fees associated with an increased volume of premiums written.

Losses and Loss Adjustment Expenses

Losses and loss adjustment expenses increased $43.5 million to $46.9 million for the nine months ended September 30, 2020 from $3.4 million for the nine months ended September 30, 2019.

Losses and loss adjustment expenses consisted of the following elements during the respective periods:

Nine Months Ended

September 30,

($ in thousands)

Catastrophe losses

Non-catastrophe losses

Total losses and loss adjustment expenses

NM- not meaningful

Our catastrophe loss ratio was 31.4% during the nine months ended September 30, 2020.

Catastrophe losses primarily included losses from Hurricanes Hanna, Isaias, Laura, Sally and Beta.

We did not experience any catastrophe losses during the nine months ended September 30, 2019.

Our non-catastrophe loss ratio was 8.9% for the nine months ended September 30, 2020 compared to 4.9% during the nine months ended September 30, 2019.

Acquisition Expenses

Acquisition expenses increased $19.7 million, or 75.3%, to $45.9 million for the nine months ended September 30, 2020 from $26.2 million for the nine months ended September 30, 2019.

The primary reason for the increase was

higher earned premiums which resulted in higher commissions and premium-related taxes.

Acquisition expenses as a percentage of gross earned premiums were 21.3% for the nine months ended September 30, 2020 compared to 18.5% for the nine months ended September 30, 2019.

Acquisition expenses as a percentage of gross earned premiums increased due primary to lower earned ceding commissions.

Acquisition expenses as a percentage of gross earned premiums fluctuates based on mix of business produced and quota share arrangements in place.

Other Underwriting Expenses

Other underwriting expenses decreased $19.6 million, or 44.2%, to $24.7 million for the nine months ended September 30, 2020 from $44.3 million for the nine months ended September 30, 2019.

This decrease was primarily due to the company incurring significant charges during the prior year nine months associated with an IPO, tax restructuring, secondary offering, retirement of debt, and one-time incentive cash bonuses.

The company also incurred a stock compensation charge of $23.0 million upon modification of its management incentive plan in the prior year.

Other underwriting expenses as a percentage of gross earned premiums were 11.5% for the nine months ended September 30, 2020 compared to 31.3% for the nine months ended September 30, 2019.

Excluding the impact of expenses relating to stock offerings, tax restructuring, and one-time incentive cash bonuses, stock-based compensation, retirement of debt, and catastrophe bond, other underwriting expenses as a percentage of gross earned premiums were 10.3% for the nine months ended September 30, 2020 compared to 12.1% for the nine months ended September 30, 2019.

This percentage decreased due to higher gross earned premiums without a proportional increase to expenses.

Interest Expense

Interest expense decreased $1.1 million to zero for the nine months ended September 30, 2020 from $1.1 million for the nine months ended September 30, 2019.

Interest expense decreased as we did not have any debt during the nine months ended September 30, 2020 whereas we had outstanding Floating Rate Notes during a portion of the nine months ended September 30, 2019.

Net Investment Income and Net Realized and Unrealized Gains on Investments

Net investment income increased $2.1 million, or 50.7%, to $6.3 million for the nine months ended September 30, 2020 from $4.2 million for the nine months ended September 30, 2019.

The increase was primarily due to a higher average balance of investments during the nine months ended September 30, 2020 due primarily to proceeds from our April 2019 IPO, investing of cash generated from operations, and proceeds from our January 2020 and June 2020 stock offerings, partially offset by lower yields on investments due to a lower interest rate environment.

Net realized and unrealized gains on investments decreased $2.1 million, or 61.9%, to $1.2 million for the nine months ended September 30, 2020 from $3.3 million for the nine months ended September 30, 2019.

We had a higher balance of equity securities during the prior year period and saw appreciation on those equity securities during that period.

Currently, we mainly invest in investment grade fixed maturity securities, including U.S.

government issues, state government issues, mortgage and asset-backed obligations, and corporate bonds.

The following table summarizes the components of our investment income for each period presented:

Nine Months Ended

September 30,

($ in thousands)

Interest income

Dividend income

Investment management fees and expenses

Net investment income

Net realized and unrealized gains on investments

Net realized and unrealized gains (losses) on investments

Income Tax Expense

Income tax expense decreased $3.4 million or 86.7% to $0.5 million for the nine months ended September 30, 2020 from $3.9 million for the nine months ended September 30, 2019 as we had lower pre-tax income during the nine months ended September 30, 2020.

During the nine months ended September 30, 2020, our income tax rate differed from the statutory rate of 21% due primarily to the tax impact of the permanent component of employee stock option exercises.

For the nine months ended September 30, 2019, our income tax expense was significantly impacted by the reversal of our U.S.

federal deferred tax valuation allowance in March 2019, offset by an addback related to a nondeductible stock compensation charge related to the modification of our management incentive plan in March 2019.

Income taxes increased $0.1 million or 2.7% to $3.5 million for the three months ended March 31, 2021 from $3.4 million for the three months ended March 31, 2020 as we had higher pre-tax income during the three months ended March 31, 2021.

During the three months ended March 31, 2021, our income tax rate differed from the statutory rate of 21% due primarily to the tax impact of the permanent component of employee stock option exercises.

For the three

months ended March 31, 2020 the tax rate differs from the statutory rate of 21% due to miscellaneous differences between taxable income calculated under GAAP and IRS regulations.

Reconciliation of Non-GAAP Financial Measures

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We define underwriting revenue as total revenue excluding net investment income and net realized and unrealized gains and losses on investments.

Underwriting revenue represents revenue generated by our underwriting operations and allows us to evaluate our underwriting performance without regard to investment income.

Underwriting revenue represents revenue generated by our underwriting operations and allows us to evaluate our underwriting performance without regard to investment results.

We use this metric as we believe it gives our management and other users of our financial information useful insight into our underlying business performance.

2 unchanged sentences

Three Months Ended

Nine Months Ended

September 30,

(in thousands)

Total revenue

Net investment income

Net realized and unrealized gains on investments

Net realized and unrealized (gains) losses on investments

Underwriting revenue

Underwriting Income

We define underwriting income as income before income taxes excluding net investment income, net realized and unrealized gains and losses on investments, and interest expense.

Underwriting income represents the pre-tax profitability of our underwriting operations and allows us to evaluate our underwriting performance without regard to

investment income.

We define underwriting income as income before income taxes excluding net investment income and net realized and unrealized gains and losses on investments.

Underwriting income represents the pre-tax profitability of our underwriting operations and allows us to evaluate our underwriting performance without regard to investment results.

We use this metric as we believe it gives our management and other users of our financial information useful insight into our underlying business performance.

Underwriting income should not be viewed as a substitute for pre-tax income calculated in accordance with GAAP, and other companies may define underwriting income differently.

Income (loss) before income taxes calculated in accordance with GAAP reconciles to underwriting income as follows:

Income before income taxes calculated in accordance with GAAP reconciles to underwriting income as follows:

Three Months Ended

Nine Months Ended

September 30,

(in thousands)

Income (loss) before income taxes

Income before income taxes

Net investment income

Net realized and unrealized gains on investments

Interest expense

Underwriting income (loss)

Adjusted Net Income (Loss)

Net realized and unrealized (gains) losses on investments

Underwriting income

Adjusted Net Income

We define adjusted net income as net income excluding the impact of certain items that may not be indicative of underlying business trends, operating results, or future outlook, net of tax impact.

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Other companies may define adjusted net income differently.

Net income (loss) calculated in accordance with GAAP reconciles to adjusted net income (loss) as follows:

Net income calculated in accordance with GAAP reconciles to adjusted net income as follows:

Three Months Ended

Nine Months Ended

September 30,

(in thousands)

Net income (loss)

Expenses associated with IPO, tax restructuring, secondary offerings, and one-time incentive cash bonuses

Expenses associated with transactions and stock offerings

Stock-based compensation expense

Expenses associated with retirement of debt

Expenses associated with catastrophe bond

Adjusted net income (loss)

Amortization of intangibles

Expenses associated with catastrophe bond, net of rebate

Adjusted net income

Annualized Adjusted Return on Equity

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Three Months Ended

Nine Months Ended

September 30,

($ in thousands)

Annualized adjusted net income (loss)

Annualized adjusted net income

Average stockholders' equity

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Three Months Ended

Nine Months Ended

September 30,

($ in thousands)

Sum of losses and loss adjustment expenses, acquisition expenses, and other underwriting expenses, net of commission and other income

2 unchanged sentences

Adjustments to numerator:

Expenses associated with IPO, tax restructuring, secondary offerings, and one-time incentive cash bonuses

Expenses associated with transactions and stock offerings

Stock-based compensation expense

Portion of expenses associated with retirement of debt classified as other underwriting expenses

Expenses associated with catastrophe bond

Amortization of intangibles

Expenses associated with catastrophe bond, net of rebate

Adjusted combined ratio

5 unchanged sentences

Three Months Ended

Nine Months Ended

September 30,

(in thousands, except per share data)

Adjusted net income (loss)

Adjusted net income

Weighted-average common shares outstanding, diluted

Diluted adjusted earnings per share

(1) For the nine months ended September 30, 2019, we had a net loss on a GAAP basis.

Therefore, common share equivalents were not included in the denominator for calculating GAAP net loss per share as doing so would be anti-dilutive.

The common share equivalents are included in the above denominator as we had adjusted net income during that period.

Catastrophe Loss Ratio

5 unchanged sentences

Three Months Ended

Nine Months Ended

September 30,

($ in thousands)

Losses and loss adjustment expenses

7 unchanged sentences

Therefore, we are providing this metric because we believe it gives our management and other financial statement users useful insight into our results of operations and trends in our financial performance without the volatility caused by catastrophe losses.

Adjusted combined ratio excluding catastrophe losses should not be viewed as a substitute for combined ratio calculated in accordance with GAAP, and other companies may define adjusted combined ratio excluding catastrophe losses differently.

Adjusted combined ratio excluding catastrophe losses should not be viewed as a substitute for combined ratio calculated using unadjusted GAAP numbers, and other companies may define adjusted combined ratio excluding catastrophe losses differently.

Adjusted combined ratio excluding catastrophe losses is calculated as follows:

Three Months Ended

Nine Months Ended

September 30,

($ in thousands)

Sum of losses and loss adjustment expenses, acquisition expenses, and other underwriting expenses, net of commission and other income

2 unchanged sentences

Adjustments to numerator:

Expenses associated with IPO, tax restructuring, secondary offerings, and one-time incentive cash bonuses

Expenses associated with transactions and stock offerings

Stock-based compensation expense

Portion of expenses associated with retirement of debt classified as other underwriting expenses

Expenses associated with catastrophe bond

Amortization of intangibles

Expenses associated with catastrophe bond, net of rebate

Catastrophe losses

Adjusted combined ratio excluding catastrophe losses

Adjusted Net Income Excluding Catastrophe Losses

Adjusted net income excluding catastrophe losses is defined as adjusted net income excluding catastrophe losses, net of tax impact.

Although we are inherently subject to catastrophe losses, the frequency and severity of catastrophe losses is unpredictable and their impact on our operating results may vary significantly between periods and obscure other trends in our business.

Adjusted net income excluding catastrophe losses does not reflect the overall profitability of our business and should not be viewed as a substitute for net income calculated in accordance with GAAP.

Other companies may define adjusted net income excluding catastrophe losses differently.

Net income (loss) calculated in accordance with GAAP reconciles to adjusted net income excluding catastrophe losses as follows:

Three Months Ended

Nine Months Ended

September 30,

(in thousands)

Net income (loss)

Expenses associated with IPO, tax restructuring, secondary offerings, and one-time incentive cash bonuses

Stock-based compensation expense

Expenses associated with retirement of debt

Expenses associated with catastrophe bond

Catastrophe losses

Adjusted net income excluding catastrophe losses

Tangible Stockholders’ Equity

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Stockholders’ equity calculated in accordance with GAAP reconciles to tangible stockholders’ equity as follows:

September 30,

(in thousands)

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Consequently, our ability to pay dividends to stockholders and pay taxes and administrative expenses is largely dependent on dividends or other distributions from our subsidiaries and affiliates, whose ability to pay us is highly regulated.

Our insurance company subsidiaries, Palomar Specialty Insurance Company (“PSIC”), and Palomar Excess and Surplus Insurance Company (“PESIC”) are restricted by statute as to the amount of dividends that they may pay without the prior approval of the Arizona, Oregon and/or California Insurance Commissioners.

Generally, insurers may pay dividends without advance regulatory approval only from earned surplus and only to the extent that all dividends paid in the twelve months ending on the date of the proposed dividend do not exceed the greater of (i) 10% of their statutory policyholders’ surplus as of December 31 of the preceding year or (ii) 100% of their statutory net income for the calendar year preceding the year in which the value is being determined.

In addition, under Oregon Statute which governs PSIC, statutory net income must exclude realized investment gains and losses and a domestic insurer may only declare a dividend from earned surplus.

This does not include surplus arising from unrealized capital gains or revaluation of assets.

A domestic insurer may declare a dividend from other than earned surplus only if the Insurance Commissioner approves the declaration prior to payment of the dividend.

In the future, state insurance regulatory authorities may adopt statutory provisions more restrictive than those currently in effect.

The Company’s U.S.

insurance company subsidiaries, PSIC and PESIC are restricted by the statutes as to the amount of dividends that they may pay without prior approval by state insurance commissioners.

Under California and Oregon statute which govern PSIC, dividends paid in a consecutive twelve month period cannot exceed the greater of (i) 10% of an insurance company’s statutory policyholders’ surplus as of December 31 of the preceding year or (ii) 100% of its statutory net income for the preceding calendar year.

Any dividends or distributions in excess of these amounts would require regulatory approval.

In addition, under Oregon statute PSIC may only declare a dividend from earned surplus, which does not include contributed capital.

Surplus arising from unrealized capital gains or revaluation of assets is not considered part of earned surplus.

Based on the above restrictions, PSIC may pay a dividend or distribution of no greater than $11.3 million in 2021 without approval by the California and Oregon Insurance Commissioners.

Under Arizona statute which governs PESIC, dividends paid in a consecutive twelve month period cannot exceed the lesser of (i) 10% of an insurance company’s statutory policyholders’ surplus as of December 31 of the preceding year or (ii) 100% of its statutory net income for the preceding calendar year.

As such, PESIC is unable to pay a dividend or distribution in 2021 without the approval of the Arizona Insurance Commissioner as it had a statutory net loss in 2020.

State insurance regulators have broad powers to prevent the reduction of statutory surplus to inadequate levels, and there is no assurance that dividends up to the maximum amounts calculated under any applicable formula would be permitted.

In addition, state insurance regulators may adopt statutory provisions and dividend limitations more restrictive than those currently in effect in the future.

Bermuda regulations limit the amount of dividends and return of capital paid by a regulated entity.

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If a Class 3A insurer has failed to meet its minimum solvency margin on the last day of any financial year, it will also be prohibited, without the approval of the BMA, from declaring or paying any dividends during the next financial year.

Furthermore, the Insurance Act limits the ability of PSRE to pay dividends or make capital distributions by stipulating certain margin and solvency requirements and by requiring approval from the BMA prior to a reduction of 15% or more of a Class 3A insurer’s total statutory capital as reported on its prior year statutory balance sheet.

Furthermore, the Insurance Act limits the ability of PSRE to pay dividends or make capital distributions

by stipulating certain margin and solvency requirements and by requiring approval from the BMA prior to a reduction of 15% or more of a Class 3A insurer’s total statutory capital as reported on its prior year statutory balance sheet.

Moreover, an insurer must submit an affidavit to the BMA, sworn by at least two directors and the principal representative in Bermuda of the Class 3A insurer, at least seven days prior to payment of any dividend which would exceed 25% of that insurer’s total statutory capital and surplus as reported on its prior year statutory balance sheet.

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We use our cash flows primarily to pay reinsurance premiums, operating expenses, losses and loss adjustment expenses, and income taxes.

We also recently implemented a share repurchase plan and may use our cash to purchase outstanding shares of our common stock in the future.

Our cash flows from operations may differ substantially from our net income due to non-cash charges or due to changes in balance sheet accounts.

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Management believes that our current liquidity and cash receipts from written premiums, investment income, proceeds from investment sales and redemptions, and reinsurance recoveries, if necessary, are sufficient to cover cash outflows for each of the Company’s insurance subsidiaries in the foreseeable future.

The following table summarizes our cash flows for the nine months ended September 30, 2020 and 2019:

Nine months ended

September 30,

The following table summarizes our cash flows for the three months ended March 31, 2021 and 2020:

Three months ended

($ in thousands)

4 unchanged sentences

Change in cash, cash equivalents, and restricted cash

Our cash flow from operating activities has been positive in each period shown above.

Variations in operating cash flow between periods are primarily driven by variations in our gross and ceded written premiums and the volume and timing of premium receipts, claim payments, and reinsurance payments.

In addition, fluctuations in losses and loss adjustment expenses and other insurance operating expenses impact operating cash flow.

Cash used in investing activities for the nine months ended September 30, 2020 and 2019 related primarily to purchases of fixed income and equity securities in excess of sales and maturities.

Cash provided by financing activities for nine months ended September 30, 2020 was related to the receipt of $35.5 million in net proceeds from the January 2020 stock offering, the receipt of $90.1 million in net proceeds from the June 2020 stock offering, the receipt of $0.7 million in proceeds related to the issuance of common stock via our employee stock purchase plan, and the receipt of $1.7 million related to the issuance of common stock via stock option exercises.

Cash provided by financing activities for the nine months ended September 30, 2019 was related to the receipt of $87.4 million in net proceeds from our IPO in April 2019, offset by $20.0 million cash paid to redeem our Floating Rate Notes in May 2019 and a one-time cash distribution of $5.1 million to our then sole stockholder, GC Palomar Investor LP in March 2019.

Our cash flow from operating activities was negative during the three months ended March 31, 2021 due to an increase in net operating assets primarily related to payment on claims in excess of reinsurance recoveries.

Our cash flow from operating activities was positive during the three months ended March 31, 2020 due to net income and a decrease in net operating assets.

reinsurance recoveries on paid losses.

In addition, fluctuations in losses and loss adjustment expenses and other insurance operating expenses impact operating cash flows.

Cash provided by in investing activities for the three months ended March 31, 2021 related primarily to sales and maturities of fixed maturity and equity securities in excess of purchases.

Cash used in investing activities for the three months ended March 31, 2020 related primarily to purchases of fixed maturity and equity securities in excess of sales and maturities.

Cash provided by financing activities for three months ended March 31, 2021 was related to the receipt of $0.3 million in proceeds from the issuance of common stock via our employee stock purchase plan, and the receipt of $1.0 million from the issuance of common stock via stock option exercises.

Cash provided by financing activities for the three months ended March 31, 2020 was related to the receipt of $35.5 million in net proceeds from the January 2020 Secondary Offering and the receipt of $0.4 million in proceeds related to the issuance of common stock pursuant to our employee stock purchase plan.

We do not have any current plans for material capital expenditures other than current operating requirements.

1 unchanged sentence

The key factor that will affect our future operating cash flows is the frequency and severity of catastrophe losses.

To the extent our future operating cash flows are insufficient to cover our net losses from catastrophic events, we had $450.0 million in cash and investment securities available at September 30, 2020.

To the extent our future operating cash flows are insufficient to cover our net losses from catastrophic events, we had $436.7 million in cash and investment securities available at March 31, 2021.

We also have the ability to access additional capital through pursuing third-party borrowings, sales of our equity or debt securities or entrance into a reinsurance arrangement.

Notes Payable

In September 2018, the Company completed a private placement financing of $20.0 million floating rate senior secured notes (“Floating Rate Notes”).

These Floating Rate Notes were redeemed in May 2019 pursuant to their terms and the Company did not have any debt subsequent to May 2019.

Stockholders’ Equity

At September 30, 2020 total stockholders’ equity was $361.9 million and tangible stockholders’ equity was $361.2 million, compared to total stockholders’ equity of $218.6 million and tangible stockholders’ equity of $217.8 million as of December 31, 2019.

Stockholder’s equity increased primarily due to net income, receipt of proceeds from our January 2020 and June 2020 common stock offerings, and unrealized gains on fixed maturity securities.

It also increased due to issuance of common stock and stock-based compensation from our equity compensation plans.

At March 31, 2021 total stockholders’ equity was $376.4 million and tangible stockholders’ equity was $365.2 million, compared to total stockholders’ equity of $363.7 million and tangible stockholders’ equity of $352.2 million as of December 31, 2020.

Stockholder’s equity increased primarily due to net income, issuance of common stock and stock-based compensation from our equity compensation plans off set by unrealized losses on fixed maturity securities.

Tangible stockholders’ equity is a non-GAAP financial measure.

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Our cash and invested assets consist of cash and cash equivalents, fixed maturity securities, and equity securities.

As of September 30, 2020, the majority of our investment portfolio, or $390.8 million, was comprised of fixed maturity securities that are classified as available-for-sale and carried at fair value with unrealized gains and losses on these securities, net of applicable taxes, reported as a separate component of accumulated other comprehensive income.

As of March 31, 2021, the majority of our investment portfolio, or $402.3 million, was comprised of fixed maturity securities that are classified as available-for-sale and carried at fair value with unrealized gains and losses on these securities, net of applicable taxes, reported as a separate component of accumulated other comprehensive income.

Also included in our investment portfolio were $10.5 million of equity securities, primarily comprised of mutual funds that provide exposure to the U.S.

investment-grade bond market.

In addition, we maintained a non-restricted cash and cash equivalent balance of $14.0 million at September 30, 2020.

Our fixed maturity securities, including cash equivalents, had a weighted average effective duration of 4.06 and 3.49 years and an average rating of “A1/A” and “A1/A+” at September 30, 2020 and December 31, 2019, respectively.

Our fixed income investment portfolio had a book yield of 2.33% as of September 30, 2020, compared to 2.90% as of December 31, 2019.

At September 30, 2020 and December 31, 2019 the amortized cost and fair value on available-for-sale securities were as follows:

September 30, 2020

In addition, we maintained a non-restricted cash and cash equivalent balance of $23.6 million at March 31, 2021.

Our fixed maturity securities, including cash equivalents, had a weighted average effective duration of 3.97 and 3.96 years and an average rating of “A1/A” and “A2/A” at March 31, 2021 and December 31, 2020, respectively.

Our fixed income investment portfolio had a book yield of 2.24% as of March 31, 2021, compared to 2.27% as of December 31, 2020.

At March 31, 2021 and December 31, 2020 the amortized cost and fair value on available-for-sale securities were as follows:

March 31, 2021

($ in thousands)

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Total available-for-sale investments

The following tables provide the credit quality of investment securities as of September 30, 2020 and December 31, 2019:

September 30, 2020

The following tables provide the credit quality of investment securities as of March 31, 2021 and December 31, 2020:

March 31, 2021

($ in thousands)

1 unchanged sentence

($ in thousands)

The amortized cost and fair value of our available-for-sale investments in fixed maturity securities summarized by contractual maturity as of September 30, 2020 were as follows:

September 30, 2020

The amortized cost and fair value of our available-for-sale investments in fixed maturity securities summarized by contractual maturity as of March 31, 2021 were as follows:

March 31, 2021

($ in thousands)

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We use facultative reinsurance selectively to supplement limits or to cover risks or perils excluded from other reinsurance contracts.

During the second quarter of 2020, we procured approximately $200 million of incremental limit for California earthquakes, approximately $300 million of incremental limit for all earthquake zones, and approximately $80 million of incremental windstorm limit.

Effective June 1, 2020, our reinsurance coverage exhausts at $1.4 billion for earthquake events and $600 million for hurricane events, providing coverage in excess of our 1:250 year peak zone PML.

As of June 30, 2020, a modeled earthquake equivalent to the 1906 San Francisco or 1994 Northridge earthquake would generate a gross loss of $883 million or $848 million, respectively.

Our catastrophe event retention is currently $10 million for all perils and we retain $3 million as a vertical co-participation in selected layers of our reinsurance program that we believe to present a compelling risk adjusted return.

Our reinsurance panel includes approximately 90 reinsurers, all of which have an ‘‘A-’’ (Excellent) (Outlook Stable) or better financial strength rating from A.M.

We have a robust program utilizing a mix of traditional reinsurers and insurance linked securities.

We currently purchase reinsurance from over 90 reinsurers, who either have an “A−” (Excellent) (Outlook Stable) or better financial strength rating by A.M.

Best or post collateral.

We divide our catastrophe XOL treaty into multiple layers.

At each reinsurance treaty renewal, we consider any plans to change the underlying insurance coverage we offer, our current capital, our risk appetite, and the cost and availability of reinsurance coverage.

Many of our reinsurance contracts have additional features, such as expanded coverage windows for catastrophe events, that we believe provide us with significant protection and flexibility should market conditions change.

In the event of a catastrophe that impacts our reinsurance contracts, our contracts typically include prepaid reinstatements that limits our net loss to $10 million retention per event.

For layers that are not reinstateable (commonly known as “single shot”) we have arranged cascading coverage that drops down in order to eliminate any potential gap in coverage in the catastrophe program for subsequent event(s).

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements (as defined by applicable regulations of the SEC) that are reasonably likely to have a current or future material effect on our financial condition, results of operations, liquidity, capital expenditures or capital resources.

Our reinsurance contracts include special termination provisions that allow us to cancel and replace any participating reinsurer that is downgraded below a rating of “A−” (Excellent) (Outlook Stable) from A.M.

Best, or whose surplus drops by more than 20%.

In addition to reinsurance purchased from traditional reinsurers, we have historically incorporated collateralized protection from the insurance linked securities market (i.e.

catastrophe bonds).

During the first quarter of 2021, the Company closed a $400 million 144A catastrophe bond which will be effective June 1, 2021.

The catastrophe bond was completed through Torrey Pines Re Pte.

(“Torrey Pines Re”).

Torrey Pines Re.

is a special purpose insurer established in Singapore whereby Torrey Pines Re provides Palomar with indemnity-based reinsurance covering earthquake events.

Our catastrophe event retention is currently $10 million for all perils and we retain $1 million as a vertical co-participation in selected layers of our reinsurance program that we believe present a compelling risk adjusted return.

Our reinsurance coverage exhausts at $1.4 billion for earthquake events and $600 million for hurricane events, providing coverage in excess of our 1:250 year peak zone PML and in excess of our A.M.

Best requirement.

In addition, we maintain reinsurance coverage equivalent to or better than the 1 in 250 year PML for our other lines.

In the event that multiple catastrophe events occur in a period, many of our contracts include the right to reinstate reinsurance limits for potential future recoveries during the same contract year and preserve our limit for subsequent events.

This feature for subsequent event coverage is known as a “reinstatement.” In addition, to provide further coverage against the potential for frequent catastrophe events we have secured $25 million of aggregate XOL reinsurance limit effective April 1, 2021.

This coverage, applying within our per occurrence retention, has an attachment point of $30 million and applies across all perils including but not limited to earthquakes, hurricanes, convective storms, and floods above a qualifying level of $2.0 million in ultimate gross loss.

Critical accounting estimates

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We evaluate our estimates regularly using information that we believe to be relevant.

Our critical accounting policies and estimates are described in our annual consolidated financial statements and the related notes in our 2019 Annual Report on Form 10-K filed with the SEC on February 28, 2020.

Our critical accounting policies and estimates are described in our annual consolidated financial statements and the related notes in our 2020 Annual Report on Form 10-K.

There have been no significant changes in our critical accounting policies and estimates as compared to the critical accounting policies and estimates disclosed in Management’s Discussion and Analysis of Financial Condition and Operations included in our 2020 Annual Report on Form 10-K

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 2. Management’s Discussion and Analysis