What changed in this filing

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Item 7. Management’s Discussion and Analysis

2023-03-01 compared with 2022-02-25 · 148 added, 146 removed, 551 unchanged (35% of the section changed)

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Forward-looking statements in this Annual Report on Form 10-K are based on information available to us as of the date hereof, and we assume no obligation to update any such forward-looking statements.

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, inland marine, and flood insurance.

We are a specialty insurance company that provides property and casualty insurance products to individuals and businesses.

We use our underwriting and analytical expertise to provide products for select markets that we believe are underserved by other insurance companies, including the market for earthquake 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 provide admitted insurance products through our Oregon domiciled insurance company, Palomar Specialty Insurance Company (“PSIC”), and E&S insurance products through our Arizona domiciled surplus lines insurance company, Palomar Excess and Surplus Insurance Company (“PESIC”).

Each of our insurance company subsidiaries as carries an “A-“ rating from A.M.

Best Company (“A.M.

Best”), a leading rating agency for the insurance industry.

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

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We have organically increased gross written premiums from $16.6 million in our first year of operations to $881.9 million for the year ended December 31, 2022, which reflects a compound annual growth rate of approximately 64%.

For the year ended December 31, 2021, 55% of our gross written premiums were generated by our Residential Earthquake, Commercial Earthquake and Hawaii Hurricane lines of business, all of which are not subject to attritional losses.

We experienced average monthly premium retention rates above 89% overall for these 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.

Best”), a leading rating agency for the insurance industry.

An “A−” rating is categorized by A.M.

Best as an excellent rating and indicates a stable outlook.

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

In May 2021, A.M.

Best affirmed the “A−”rating of PSIC and PESIC.

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.

We received regulatory approval for PESIC during the second quarter of 2020 and 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 market (also known as the “surplus lines” or “E&S” market), and that PESIC enables us to serve certain risks that our admitted products cannot currently satisfy.

We began writing E&S business on a national basis during the third quarter of 2020.

We have also been profitable since 2016 and our net income growth since 2016 reflects a compound annual growth rate of 41%.

We seek to continuously grow our income by developing product offerings for lines of business that harness our core competencies and where we believe we can generate attractive risk adjusted returns.

Since 2021, we have introduced several new products including General Casualty, Fronting, Excess Liability, and Excess Property to diversify our book of business and broaden our product portfolio.

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

COVID-19 Update

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

Since the beginning of the Pandemic, our focus has been to protect the health of the public and our employees while serving our policyholders and ensuring business continuity.

We recently began allowing all employees to return to our offices on a voluntary basis, with established protocols to ensure operational reliability and employee safety.

In addition, we have been taking extra physical security and cybersecurity measures to safeguard our systems to serve the operational needs of our 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.

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 do not expect additional business interruption claims from the Pandemic and have acknowledged and adjudicated each claim received.

The Pandemic’s ultimate impact on our results of operations remains uncertain.

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.

Additional financial volatility caused by the Pandemic may have a negative impact on our investment portfolio and results of operations.

Inflationary pressures caused by the Pandemic may increase our operating expenses and the average size of our loss claims.

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

However, the Pandemic continues to impact many aspects of the economy and society and the macroeconomic effects of the Pandemic may persist for an indefinite period, even after the Pandemic has subsided.

We cannot anticipate all the ways in which the Pandemic or other similar global health crises could adversely impact our business in the future.

Components of Our Results of Operations

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● Entrance into new partnerships or the offering of new types of insurance products;

● Exits from existing partnerships or reducing or ceasing to offer existing insurance products;

● Renewal rates of existing policies;

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We enter into reinsurance contracts to limit our exposure to potential losses and to provide additional capacity for growth.

We cede premiums primarily through excess of loss (“XOL”) agreements and quota share agreements.

We cede premiums through excess of loss (“XOL”) agreements, quota share agreements, and fronting agreements.

Ceded written premiums are earned pro-rata over the period of risk covered.

The volume of our ceded written premiums is impacted by the amount of our gross written premiums and our decisions to increase or decrease limits or retention levels in our XOL agreements and co-participation levels in our quota share agreements.

The volume of ceded written premiums is also impacted by the amount of premium we write under fronting agreements.

Our ceded written premiums can be impacted significantly in certain periods due to changes in quota share agreements.

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 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.

Our XOL costs as a percentage of gross earned premiums also 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.

In addition, the volume of premiums ceded in fronting agreements each period may vary due to the timing of entering new fronting partnerships and terminations of fronting partnerships.

Net Earned Premiums

Net earned premiums represent the earned portion of our gross written premiums, less the earned portion that is ceded to third-party reinsurers under our reinsurance agreements.

Our insurance policies generally have a term of one year and premiums are earned pro rata over the term of the policy.

The majority of our insurance policies have a term of one year and premiums are earned pro rata over the terms of the policies.

Commission and Other Income

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Certain policies we write subject us to attritional losses such as building fires.

In addition, most of the policies we write subject us to catastrophe losses.

In addition, many of the policies we write subject us to catastrophe losses.

Catastrophe losses are certain losses resulting from events involving multiple claims and policyholders, including earthquakes, hurricanes, floods, convective storms, terrorist acts or other aggregating events.

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● Inflation in housing and construction costs;

● Increases in amounts awarded by courts and juries.

Losses and loss adjustment expenses are based on an actuarial analysis of the estimated losses, including losses incurred during the period and changes in estimates from prior periods.

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Acquisition Expenses

Acquisition expenses are principally comprised of the commissions we pay retail agents, program administrators and wholesale brokers, net of ceding commissions we receive on business ceded under quota share reinsurance contracts.

In addition, acquisition expenses include premium-related taxes and other fees.

Acquisition expenses are principally comprised of the commissions we pay retail agents, program administrators and wholesale brokers, net of ceding commissions and fronting fees we receive on business ceded under quota share and fronting reinsurance agreements.

In addition, acquisition expenses include premium-related taxes and

Acquisition expenses related to each policy we write are deferred and expensed pro rata over the term of the policy.

We earn fronting fees in a manner consistent with the recognition of the earned premiums on the underlying insurance policies, on a pro rata basis over the terms of the policies.

Other Underwriting Expenses

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Interest Expense

For the year ended December 31 2021, interest expense consists of the unused line fee and amortization of the commitment fee on our credit agreement.

We did not incur any interest expense during the year ended December 31, 2020.

Interest expense consists of the unused line fee and amortization of the commitment fee on our credit agreement with U.S.

Bank National Association and interest incurred on borrowings from our FHLB line of credit.

Net Investment Income

We earn investment income on our portfolio of invested assets.

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

We invest primarily in investment grade fixed maturity securities, including U.S.

government issues, state government issues, mortgage and asset-backed obligations, and corporate bonds with a small portion of our portfolio in equity securities and cash and cash equivalents.

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.

As measured by amortized cost, which excludes fair value fluctuations from changes in interest rates or other factors, the size of our investment portfolio is mainly a function of our invested capital along with premiums 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 or borrowings under our credit agreements.

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, and credit losses recognized in earnings.

Unrealized gains and losses on fixed maturity securities are recognized as a component of other comprehensive income and do not impact our net income.

Income Tax Expense

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

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

Annualized 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 excluding catastrophe losses.

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

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

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

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Other underwriting expenses

Underwriting income (loss) (1)

Underwriting income (1)

Interest expense

Net investment income

Net realized and unrealized gains on investments

Net realized and unrealized (losses) gains on investments

Income before income taxes

Income tax expense (benefit)

Expenses associated with transactions and stock offerings

Income tax expense

Net realized and unrealized losses (gains) on investments (2)

Expenses associated with transactions

Stock-based compensation expense

Amortization of intangibles

Expenses associated with catastrophe bond

Expenses associated with catastrophe bond, net of rebate

Adjusted net income (1) (2)

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Adjusted combined ratio excluding catastrophe losses (1)

Adjusted underwriting income (1)

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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) Beginning with this Annual Report on Form 10-K, we are including the impact of net realized and unrealized losses and gains on investments as an adjustment to our net income.

As this balance is primarily driven by equity market fluctuations rather than our underlying business performance, we believe adding this adjustment provides a more meaningful comparison of our performance.

We have also changed the prior year adjusted net income to conform to this presentation.

Gross Written Premiums

Gross written premiums were $881.9 million for the year ended December 31, 2022 compared to $535.2 million for the year ended December 31, 2021, an increase of $346.7 million, or 64.8%.

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’ geographic and distribution footprint, and new partnerships.

For commercial products, substantial rate increases also contributed to premium growth.

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Commercial Earthquake

Specialty Homeowners

Inland Marine

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Hawaii Hurricane

Specialty Homeowners

Residential Flood

Total Gross Written Premiums

During the fourth quarter of 2020, we ceased offering Commercial All Risk products on an admitted basis and only offered them on an E&S basis during 2021.

This transition caused a decline in premium in our Commercial All Risk line.

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During the fourth quarter of 2021, we launched our fronting business, known as PLMR-FRONT and fronting premium was responsible for a significant portion of our growth in the current year.

In a fronting agreement, we write the premium and then cede the majority of the premium and risk in exchange for a fronting fee, which is our primary source of profit in the arrangement.

We expect to continue to write fronting premiums for the foreseeable future.

The volume of fronting premiums written each period may vary due to the timing of entering new fronting partnerships and terminations of fronting partnerships.

During the second quarter of 2022, we ceased writing Specialty Homeowners business outside of Texas and converted our Texas Specialty Homeowners business to a fronting arrangement beginning June 1, 2022.

These underwriting changes caused the decline in Specialty Homeowners premiums shown above.

The following table summarizes our gross written premiums by insurance subsidiary:

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Ceded written premiums increased $301.1 million, or 134.8%, to $524.6 million for the year ended December 31, 2022 from $223.4 million for the year ended December 31, 2021.

The increase was primarily due to increased quota share ceding due to growth in written premium lines subject to quota shares.

In addition, XOL reinsurance expense increased due to growth in exposure and additional charges from Winter Storm Uri (“Uri”), which impacted our Specialty Homeowners and Commercial All Risk lines during the first quarter of 2021.

Catastrophe losses from Uri caused us to utilize certain layers of our XOL program which increased our XOL reinsurance expense.

During the year ended December 31, 2021, we incurred an additional $7.9 million of expense associated with the reinstatement of our reinsurance program as a result of Winter Storm Uri.

During 2020, we also incurred specific XOL expenses resulting from castastrophe events.

As a result of hurricanes occurring in the third and fourth quarters of 2020, we fully utilized portions of our XOL coverage and incurred charges of $7.0 million related to the acceleration of XOL expenses and the purchase and utilization of a backup XOL layer.

Ceded written premiums as a percentage of gross written premiums slightly decreased to 41.8% for the year ended December 31, 2021 from 43.8% for the year ended December 31, 2020.

This decrease was primarily due to gross written premiums growing at a faster rate than ceded written premiums.

The increase was primarily due to increased premiums ceded under quota share and fronting agreements due to growth in the volume of written premiums subject to quota share or fronting agreements.

In addition, we incurred increased excess of loss (“XOL”) reinsurance expense due to growth in exposure.

During the year ended December 31, 2022, our XOL reinsurance expense was impacted by Hurricane Ian.

Catastrophe losses from Ian caused us to utilize certain layers of our XOL program and incur approximately $2.0 million of expense associated with the acceleration of XOL expense and the reinstatement of our reinsurance program.

We also will incur an additional $1.9 million of XOL expense in 2023 related to the reinstatement of our reinsurance program due to Ian related Catastrophe losses.

During the year ended December 31, 2021, our XOL reinsurance expense was significantly impacted by Winter Storm Uri (“Uri”).

Catastrophe losses from Uri caused us to utilize certain layers of our XOL program and incur approximately $7.9 million of expense associated with the reinstatement of our reinsurance program.

Ceded written premiums as a percentage of gross written premiums increased to 59.5% for the year ended December 31, 2022 from 41.8% for the year ended December 31, 2021.

This increase was primarily due to increased quota share and fronting cessions as previously described.

Net Written Premiums

Net written premiums increased $45.6 million, or 14.6%, to $357.3 million for the year ended December 31, 2022 from $311.7 million for the year ended December 31, 2021.

The increase was primarily due to higher gross written premiums, primarily in our Earthquake and Inland Marine lines, offset by increased ceded written premiums.

The increase was primarily due to an increase in gross written premiums, partially offset by increased ceded written premiums.

Net Earned Premiums

Net earned premiums increased $78.7 million, or 50.8%, to $233.8 million for the year ended December 31, 2021 from $155.1 million for the year ended December 31, 2020 due primarily to the earned portion of the higher gross written premiums offset by the earned portion of the higher ceded written premiums.

Net earned premiums increased $82.6 million, or 35.3%, to $316.5 million for the year ended December 31, 2022 from $233.8 million for the year ended December 31, 2021 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 for each period presented:

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Commission and Other Income

Commission and other income increased $0.3 million, or 9.5%, to $3.6 million for the year ended December 31, 2021 from $3.3 million for the year ended December 31, 2020 due primarily to an increase in policies written through our internal managing general agency, Palomar Insurance Agency.

Commission and other income increased $0.7 million, or 18.4%, to $4.3 million for the year ended December 31, 2022 from $3.6 million for the year ended December 31, 2021.

This was due 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 decreased $22.6 million, or 35.3%, to $41.5 million for the year ended December 31, 2021 from $64.1 million for the year ended December 31, 2020.

During the year ended December 31, 2021, losses were primarily attributable to attritional losses and catastrophe losses from Hurricanes Ida and Nicholas and Winter Storm Uri which impacted our Specialty Homeowners and Commercial All Risk lines of business.

We also experienced a single castastrophe loss from an excess liability indemnity policy covered by PESIC .

During the year ended December 31, 2020, losses were primarily attributable to catastrophe events occurring during the third and fourth quarters in our Specialty Homeowners and Commercial All Risk lines of business.

Losses and loss adjustment expenses increased $37.2 million, or 89.8%, to $78.7 million for the year ended December 31, 2022 from $41.5 million for the year ended December 31, 2021.

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

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Total losses and loss adjustment expenses

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Our catastrophe loss ratio was 2.1% during the year ended December 31, 2021.

Catastrophe losses primarily included losses from losses from Hurricanes Ida and Nicholas, Winter Storm Uri, and a single loss from an excess liability indemnity policy covered by PESIC .

Our catastrophe loss ratio was 32.9% during the year ended December 31, 2020.

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

Our non-catastrophe loss ratio was 15.6% for the year ended December 31, 2021 compared to 8.5% during the year ended December 31, 2020.

Non-catastrophe losses increased due mainly to a higher percentage of business in lines subject to attritional losses such as Specialty Homeowners, Inland Marine, Flood, and assumed reinsurance.

Catastrophe loss ratio

Non-catastrophe loss ratio

Catastrophe losses during the year ended December 31, 2022 were primarily related to losses from Hurricane Ian which primarily impacted our Commercial All Risk line of business.

Catastrophe losses during the year ended December 31, 2021 primarily included losses from Hurricanes Ida and Nicholas, Winter Storm Uri, and a single loss from an excess liability indemnity policy covered by PESIC.

Non-catastrophe losses and loss ratio increased during the year ended December 31, 2022 due mainly to growth on lines of business subject to attritional losses such as Inland Marine, Commercial All Risk, and Casualty.

Acquisition Expenses

Acquisition expenses increased $15.3 million, or 16.1%, to $110.8 million for the year ended December 31, 2022 from $95.4 million for the year ended December 31, 2021.

The primary reason for the increase was increased commissions due to higher earned premiums, offset by increased ceding commissions from quota share arrangements.

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

The higher commissions and premium-related taxes were partially offset by higher earned ceding commissions and fronting fees due to an increase in premiums subject to a quota share or fronting agreement.

Acquisition expenses as a percentage of gross earned premiums were 15.9% for the year ended December 31, 2022 compared to 22.0% for the year ended December 31, 2021.

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.

Acquisition expenses as a percentage of gross earned premiums decreased due to the recognition of higher ceding commission and fronting fee income as a percentage of gross earned premiums due to changes in mix of business produced and growth in fronting premiums.

Other Underwriting Expenses

Other underwriting expenses increased $15.5 million, or 28.8%, to $69.2 million for the year ended December 31, 2022 from $53.7 million for the year ended December 31, 2021.

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

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

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

Other underwriting expenses as a percentage of gross earned premiums were 10.0% for the year ended December 31, 2022 compared to 12.4% for the year ended December 31, 2021.

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 10.3% for the year ended December 31, 2021 compared to 10.2% for the year ended December 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.

Excluding the impact of expenses relating to transactions, stock-based compensation, amortization of intangibles, and catastrophe bonds, other underwriting expenses as a percentage of gross earned premiums were 7.8% for the year ended December 31, 2022 compared to 10.3% for the year ended December 31, 2021.

This percentage decreased due to an increase in earned premiums without a corresponding increase in operating expenses.

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

Net investment income increased $4.8 million, or 52.8%, to $13.9 million for the year ended December 31, 2022 from $9.1 million for the year ended December 31, 2021.

The increase was primarily due to a higher average balance of

investments during the year ended December 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 recently invested funds.

Net realized and unrealized gains on investments decreased $0.2 million, to a $1.3 million gain for the year ended December 31, 2021 from a $1.5 million gain for the year ended December 31, 2020.

This change was due to fluctuations in performance of equity securities held.

The increase was primarily due to a higher average balance of investments during the year ended December 31, 2022 and higher yields on invested assets.

The Company incurred $7.5 million of net realized and unrealized losses on investments for the year ended December 31, 2022 compared to a $1.3 million gain for the year ended December 31, 2021 due to higher realized losses on fixed maturity securities and unrealized losses on our equity securities held during the period ended December 31, 2022.

Unrealized gains and losses on fixed maturity securities are recognized as a component of other comprehensive income and do not impact our net income.

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

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Net investment income

Net realized and unrealized gains on investments

Income Tax Expense (Benefit)

Income tax expense increased to $11.3 million for the year ended December 31, 2021 versus an immaterial benefit during the year ended December 31, 2020.

For the year ended December 31, 2021, the difference between our tax rate and the 21% statutory rate relates primarily to a benefit from the permanent component of employee stock option exercises and charges related to state tax accruals.

For the year ended December 31, 2020, the difference relates primarily the permanent component of employee stock option exercises.

Net realized and unrealized (losses) gains on investments

Income Tax Expense

Income tax expense increased $4.1 million, or 36.2%, to $15.4 million for the year ended December 31, 2022 compared to $11.3 million during the year ended December 31, 2021.

For the year ended December 31, 2022 our effective tax rate was 22.8% and the difference between our tax effective tax rate and the statutory rate of 21% relates primarily to non-deductible executive compensation expense and state taxes, offset by the permanent component of employee stock options.

For the year ended December 31, 2021, our effective tax rate was 19.8% and the difference between our tax rate and the statutory rate of 21% relates primarily to a benefit from the permanent component of employee stock option exercises and charges related to state tax accruals, offset by the non-deductible executive compensation expense.

Reconciliation of Non-GAAP Financial Measures

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Net investment income

Net realized and unrealized gains on investments

Net realized and unrealized losses (gains) on investments

Underwriting revenue

Underwriting Income

Underwriting Income and adjusted 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.

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

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

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.

Adjusted underwriting income should not be viewed as a substitute for pre-tax income calculated in accordance with GAAP.

Other companies may define adjusted underwriting income differently.

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

(in thousands)

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Net investment income

Net realized and unrealized gains on investments

Net realized and unrealized losses (gains) on investments

Interest expense

Underwriting income (loss)

Underwriting income

Expenses associated with transactions

Stock-based compensation expense

Amortization of intangibles

Expenses associated with catastrophe bond, net of rebate

Adjusted underwriting income

Adjusted Net Income

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(in thousands)

Expenses associated with transactions and stock offerings

Net realized and unrealized losses (gains) on investments

Expenses associated with transactions

Stock-based compensation expense

Amortization of intangibles

Expenses associated with catastrophe bond

Expenses associated with catastrophe bond, net of rebate

Adjusted net income

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We use adjusted return on equity as an internal performance measure in the management of our operations because we believe it gives our management and financial statement users useful insight into our results of operations and our underlying business performance.

Adjusted return on

equity should not be viewed as a substitute for return on equity calculated using unadjusted GAAP numbers, and other companies may define adjusted return on equity differently.

Adjusted return on equity should not be viewed as a substitute for return on equity calculated using unadjusted GAAP numbers, and other companies may define adjusted return on equity differently.

Adjusted return on equity is calculated as follows:

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Adjusted net income

Average stockholder’s equity

Average stockholders' equity

Adjusted return on equity

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Adjustments to numerator:

Expenses associated with transactions and stock offerings

Expenses associated with transactions

Stock-based compensation expense

Amortization of intangibles

Expenses associated with catastrophe bond

Expenses associated with catastrophe bond, net of rebate

Adjusted combined ratio

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Adjustments to numerator:

Expenses associated with transactions and stock offerings

Expenses associated with transactions

Stock-based compensation expense

Amortization of intangibles

Expenses associated with catastrophe bond

Expenses associated with catastrophe bond, net of rebate

Catastrophe losses

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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 $45.7 million in 2022 without approval by the California and Oregon Insurance Commissioners.

Under Arizona statute with 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.

Based on the above restrictions, PESIC may pay a dividend or distribution of no greater than $4.1 million in 2022 without approval of the Arizona Insurance Commissioner.

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 $78.2 million in 2023 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.

Based on the above restrictions, PESIC may not pay a dividend or distribution in 2023 without approval of the Arizona Insurance Commissioner due to incurring a statutory net loss in 2022.

In addition to the above limitations, any dividend or distribution declared is also subject to state regulatory approval prior to payment.

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However, this dividend amount is subject to annual enhanced solvency requirement calculations.

During the year ended December 31 2021, PSRE paid

dividends of $15.0 million and $10.0 million to the Company.

During the year ended December 31 2021, PSRE paid dividends of $15.0 million and $10.0 million to the Company.

These dividend payments were approved by the BMA.

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The amount of advances that may be taken is dependent on statutory admitted assets.

As of December 31, 2021 and 2020, there are no advances outstanding under the FHLB facility.

Our primary sources of cash flow are written premiums, investment income, reinsurance recoveries, sales and redemptions of investments, and proceeds from offerings of debt and equity securities.

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

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

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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Our cash flow from operating activities has been positive in each of the last two years.

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 each of the last two years related primarily to purchases of fixed income and equity securities in excess of sales and maturities.

Cash provided by financing activities for the year ended December 31, 2022 related to $36.4 million in proceeds from our FHLB line of credit and $3.0 million in proceeds from common stock issued via stock option exercises and our employee stock purchase plan, offset by the repurchase of $34.4 million of our common stock.

Cash used in financing activities for the year ended December 31, 2021 related to the repurchase of $15.9 million of our common stock offset by $2.8 million in proceeds from common stock issued via stock option exercises and our employee stock purchase plan.

Cash provided by financing activities for year ended December 31, 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 $2.0 million related to the issuance of common stock via stock option exercises.

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

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During the year ended December 31, 2021, our Board of Directors authorized a $40 million share repurchase program and we repurchased $15.9 million of shares under this program in 2021.

Subsequent to December 31, 2021, our Board of Directors approved a new share repurchase program, replacing the existing program and authorizing the repurchase by the Company of up to $100 million of our outstanding shares of common stock over the period ending on March 31, 2024 .

Through this program, we may use our capital to repurchase our shares in the future.

On January 24, 2022, our Board of Directors approved a new share repurchase program, replacing the existing program and authorizing the repurchase by the Company of up to $100 million of our outstanding shares of common stock over the period ending on March 31, 2024 .

We purchased 621,415 shares for $34.4 million under this program during the year ended December 31, 2022 and $65.6 million remains available for future repurchases.

The timing and amount of future share repurchases will depend on several factors, including our stock price performance, ongoing capital planning considerations, general market conditions, and applicable legal requirements.

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Bank National Association which provides a revolving credit facility of up to $100 million through December 8, 2026.

Interest on the credit facility accrues on each SOFR rate loan at the applicable SOFR (as defined in the Credit Agreement) plus 1.75% and on each base rate loan at the applicable Alternate Base Rate (as defined in the Credit Agreement) plus 0.75%.

may be either a SOFR rate loan or a base rate loan, at our discretion.

Outstanding amounts under the Credit Agreement may be prepaid in full or in part at any time with no prepayment premium and may be reduced in full or in part at any time upon prior notice.

Interest on the credit facility accrues on each SOFR (as defined in the Credit Agreement) rate loan at the applicable SOFR (as defined in the Credit Agreement) plus 1.75% and on each base rate loan at the applicable Alternate Base Rate (as defined in the Credit Agreement) plus 0.75%.

A loan may be either a SOFR rate loan or a base rate loan, at our discretion.

amounts under the Credit Agreement may be prepaid in full or in part at any time with no prepayment premium and may be reduced in full or in part at any time upon prior notice.

As of December 31, 2022 we do not have any outstanding borrowings under the Credit Agreement, but we may seek to borrow under the Credit Agreement in the future.

Our PSIC subsidiary is a member of the Federal Home Loan Bank of San Francisco (“FHLB”).

Membership in the FHLB provides PSIC access to collateralized advances, which can be drawn for general corporate purposes and used to enhance liquidity management.

All borrowings are fully secured by a pledge of specific investment securities of PSIC and the borrowing capacity is equal to 10% of PSIC’s statutory admitted assets.

All advances have predetermined term and the interest rate varies based on the term of the advance.

As of December 31, 2022, the Company had $36.4 million of borrowings outstanding through the FHLB line of credit.

Financial Condition

Stockholders’ Equity

At December 31, 2021 total stockholder’s equity was $394.2 million and tangible stockholders’ equity was $384.7 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 and due to issuance of common stock and stock-based compensation expense from our equity compensation plans, offset by unrealized losses on our fixed income securities and company repurchases of our common stock.

Stock-based compensation expense is treated as an additional paid-in-capital and increases stockholder’s equity.

At December 31, 2022 total stockholders’ equity was $384.8 million and tangible stockholders’ equity was $376.5 million, compared to total stockholders’ equity of $394.2 million and tangible stockholders’ equity of $384.7 million as of December 31, 2021.

Stockholders’ equity decreased primarily due to unrealized losses on fixed maturity securities and repurchases of shares of our common stock and was partially offset by the net income we earned for the period and activity related to stock-based compensation.

Stock-based compensation expense is treated as an additional paid-in-capital and increases stockholders’ equity.

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

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Loss Adjustment Expense reserves are estimated based on the ratio of paid loss adjustment expense to paid loss, which is estimated separately by line of business as well as split by hurricane and excluding hurricane.

We then apply

this ratio to our estimated unpaid loss, by multiplying the ratio times 50% of loss case reserves and 100% of loss IBNR reserves.

We then apply this ratio to our estimated unpaid loss, by multiplying the ratio times 50% of loss case reserves and 100% of loss IBNR reserves.

This is applied by line of business and accident year to arrive at estimated unpaid loss adjustment expense on a gross basis.

We then add the estimated unpaid loss adjustment expense on a gross basis to the paid loss adjustment expense to calculate estimated ultimate loss adjustment expense.

On a quarterly basis, the leaders of our executive management, accounting, actuarial, and claims teams meet to review the recommendations made by the independent actuarial consultant and use their best judgment to determine the best estimate to be recorded for the reserve for losses and loss adjustment expenses on our balance sheet.

On a quarterly basis, the leaders of our executive management, accounting, actuarial, and claims teams meet to review the recommendations made by our actuarial team and use their best judgment to determine the best estimate to be recorded for the reserve for losses and loss adjustment expenses on our balance sheet.

Our reserves are driven by several important factors, including litigation and regulatory trends, legislative activity, climate change, social and economic patterns and claims inflation assumptions.

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The amount by which estimated losses differ from those originally reported for a period is known as “development.” Development is unfavorable when the losses ultimately settle for more than the amount reserved or subsequent estimates indicate a basis for reserve increases on unresolved claims.

Development is favorable when losses ultimately settle for less than the amount reserved, or subsequent estimates indicate a basis for reducing loss reserves on

unresolved claims.

Development is favorable when losses ultimately settle for less than the amount reserved, or subsequent estimates indicate a basis for reducing loss reserves on unresolved claims.

We reflect favorable or unfavorable development of loss reserves in the results of operations in the period the estimates are changed.

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(in thousands)

During the year ended December 31, 2022, our total gross incurred losses for accident years 2021 and prior developed unfavorably by $0.3 million.

The gross unfavorable development was due primarily to losses on certain 2020 Hurricanes emerging at a higher severity than expected, primarily in our special property lines of business.

This was offset by favorable development on 2021 attritional and catastrophe losses.

On a net basis, the development was unfavorable by $2.4 million due to the effect of ceding under our reinsurance program.

The favorable 2021 development was subject to a higher amount of ceding versus the unfavorable 2020 development resulting in the net unfavorable development being higher than the gross amount.

During the year ended December 31, 2021, our gross incurred losses for accident years 2020 and prior developed unfavorably by $28.7 million.

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The net favorable development of $0.1 million reflects the effect of ceding the gross favorability under our reinsurance program.

During the year ended December 31, 2019, our gross incurred losses for accident years 2018 and prior developed favorably by $1.0 million.

This favorable development was due to reported losses emerging at a lower level than expected, primarily in our Specialty Homeowners business, offset by higher frequency and severity of claims in our special property lines of business.

The net favorable development of $0.2 million reflects the effect of ceding the gross favorability under our reinsurance program.

Although we believe that our reserve estimates are reasonable, it is possible that our actual loss experience may not conform to our assumptions.

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Equity securities are carried at fair value with unrealized gains and losses included as a component of net income on the Company’s consolidated statement of income.

Prior to 2018, unrealized gains and losses on equity securities were included in accumulated other comprehensive income as a separate component of stockholders’ equity.

All financial assets measured at amortized cost, including available-for-sale securities are required to be presented at the net amount expected to be collected by means of an allowance for credit losses that is included in net income.

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Deferred tax assets and liabilities are measured by applying enacted tax rates in effect for the years in which such differences are expected to reverse.

Our deferred tax assets result from temporary differences primarily attributable to unearned premiums and net operating losses (“NOLs”).

Our deferred tax liabilities result primarily from deferred acquisition costs and unrealized gains in the investment portfolio.

Our deferred tax assets result from temporary differences primarily attributable to unearned premiums, net operating losses (“NOLs”) and unrealized losses on investments.

Our deferred tax liabilities result primarily from deferred acquisition costs, internally developed software, and unrealized gains in the investment portfolio.

We recognize deferred tax assets when we determine that such assets are more-likely-than-not to be realized in future periods.

In making such a determination, we consider all available evidence, including future reversals of existing taxable temporary differences, tax-planning strategies, projected future taxable income, projected future tax rates, and results of recent operations.

On a quarterly basis, we review our deferred tax assets and, if we determine that it is more likely than not that some portion or all of the deferred tax assets will not be realized, we reduce our deferred tax asset with a valuation allowance.

The assessment requires significant judgement and review of all positive and negative evidence to reach a conclusion that it is more likely than not that all or some of portion of the deferred tax asset will not be realized.

We consider multiple factors, including the nature and amount of the deferred tax asset, the expected timing of when an asset will be used, and the historical profitability of our entities.

The assessment requires significant judgement and review of all positive and negative

evidence to reach a conclusion that it is more likely than not that all or some of portion of the deferred tax asset will not be realized.

In assessing the need for a deferred tax asset valuation allowance, we are required to make certain judgments and assumptions about our future operations based on historical experience and information regarding reversals of existing temporary differences, carryback capacity, future taxable income and tax planning strategies.

Recent events, including changes in market interest rates and significant financial market volatility have caused us to incur unrealized losses on investments which contributes to us having a net capital deferred tax asset in the amount of $11.0 million at December 31, 2022, as compared to a net capital deferred tax liability of $0.3 million at December 31, 2021.

We are currently utilizing tax planning strategies in our assessment of the realizability of a portion of our net capital deferred tax asset at December 31, 2022.

These tax planning strategies include the holding of fixed maturity and equity securities that are currently in a net unrealized loss position for tax purposes until recovery or maturity, if needed, to avoid future expiring capital loss carryforwards.

As of December 31, 2022, we had a valuation allowance of $3.0 million relating to our state net operating loss carryforwards and the remainder of our deferred tax assets did not require a valuation allowance.

Recent Accounting Pronouncements

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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-K

Item 7. Management’s Discussion and Analysis