What changed in this filing

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Item 2. Management’s Discussion and Analysis

2023-05-08 compared with 2022-11-03 · 105 added, 288 removed, 460 unchanged (46% of the section changed)

2 unchanged sentences

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, 2022 are not necessarily indicative of the results that may be expected for the full year ended December 31, 2022, 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 24, 2022.

The results of operations for the three months ended March 31, 2023 are not necessarily indicative of the results that may be expected for the full year ended December 31, 2023, or for any other future period.

References to the "Company,"

8 unchanged sentences

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”).

Each of our insurance company subsidiaries as well as our holding company, Palomar Holdings Inc., carry an “A-“ rating from A.M.

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.

1 unchanged sentence

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

Due to our participation in lines of business such as earthquake insurance and the fronting market, a significant portion of our gross written premium does not expose us to the risk of attritional losses.

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 from catastrophic events.

3 unchanged sentences

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 underwriting 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.

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, Professional 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 have established protocols designed to ensure operational reliability and employee safety.

In addition, we have taken extra physical security and cybersecurity measures to safeguard our systems, 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 peril, whether it be an earthquake or flood.

We do not expect additional business interruption claims from the Pandemic and have acknowledged and adjusted 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 and equity securities.

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

18 unchanged sentences

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 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.

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.

27 unchanged sentences

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

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

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.

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

We earn fronting fees consistent with how we earn premiums on the underlying insurance policies, on a pro rata basis over the terms of the policies.

Other Underwriting Expenses

1 unchanged sentence

Interest Expense

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.

Interest expense consists of interest incurred on borrowings from our U.S.

Bank credit agreement and FHLB line of credit and the unused line fee and amortization of the commitment fee on our U.S.

Bank credit agreement.

Net Investment Income

18 unchanged sentences

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.

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.

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.

20 unchanged sentences

Results of Operations

Three months ended September 30, 2022 compared to three months ended September 30, 2021

The following table summarizes our results for the three months ended September 30, 2022 and 2021:

Three months ended March 31, 2023 compared to three months ended March 31, 2022

The following table summarizes our results for the three months ended March 31, 2023 and 2022:

Three months ended

September 30,

($ in thousands, except per share data)

6 unchanged sentences

Losses and loss adjustment expenses

Acquisition expenses

Acquisition expenses, net of ceding commissions and fronting fees

Other underwriting expenses

Underwriting income (loss) (1)

Underwriting income (1)

Interest expense

Net investment income

Net realized and unrealized losses on investments

Net realized and unrealized gains (losses) on investments

Income before income taxes

Income tax expense (benefit)

Income tax expense

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

Expenses associated with transactions

1 unchanged sentence

Amortization of intangibles

Expenses associated with catastrophe bond

Adjusted net income (1)(2)

10 unchanged sentences

Adjusted combined ratio excluding catastrophe losses (1)

Adjusted underwriting income (loss) (1)

Adjusted underwriting income (1)

NM - not meaningful

1 unchanged sentence

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) We now include 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 increased $100.8 million, or 66.2% to $253.1 million for the three months ended September 30, 2022 compared to $152.3 million for the three months ended September 30, 2021.

Gross written premiums increased $79.2 million, or 46.3% to $250.1 million for the three months ended March 31, 2023 compared to $170.9 million for the three months ended March 31, 2022.

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 distribution footprint, and new partnerships.

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)

3 unchanged sentences

Inland Marine

Hawaii Hurricane

Commercial All Risk

Hawaii Hurricane

Residential Flood

1 unchanged sentence

Total Gross Written Premiums

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During the fourth quarter of 2021, we launched our fronting business, known as PLMR-FRONT.

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.

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

We have subsequently entered several fronting partnerships which drove the above increase in premiums.

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

These underwriting changes caused the decline in Specialty Homeowners premiums and contributed to the increase in Fronting premiums shown above.

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

Three Months Ended September 30,

Three Months Ended March 31,

($ in thousands)

1 unchanged sentence

Ceded Written Premiums

Ceded written premiums increased $103.9 million, or 178.8%, to $161.9 million for the three months ended September 30, 2022 from $58.1 million for the three months ended September 30, 2021.

Ceded written premiums increased $80.8 million, or 90.2%, to $170.3 million for the three months ended March 31, 2023 from $89.6 million for the three months ended March 31, 2022.

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 three months ended September 30, 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 $1.3 million of expense associated with the acceleration of XOL expense and reinstatement of our reinsurance program.

We expect to incur an additional $1.8 million of ceded premium to be recognized ratably from October 1, 2022 to May 31, 2023.

Ceded written premiums as a percentage of gross written premiums increased to 64.0% for the three months ended September 30, 2022 from 38.1% for the three months ended September 30, 2021.

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

Ceded written premiums as a percentage of gross written premiums increased to 68.1% for the three months ended March 31, 2023 from 52.4% for the three months ended March 31, 2022.

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

Net Written Premiums

Net written premiums decreased $3.1 million, or 3.2%, to $91.2 million for the three months ended September 30, 2022 from $94.3 million for the three months ended September 30, 2021.

The decrease was due to higher XOL expense due to growth in exposure and growth in lines of business subject to a quota share, such as Inland Marine, Casualty and Commercial Earthquake.

Net written premiums decreased $1.6 million, or 2.0%, to $79.8 million for the three months ended March 31, 2023 from $81.4 million for the three months ended March 31, 2022.

The decrease was primarily due to increased ceded written premiums from growth in lines of business subject to a quota share, such as Inland Marine, Casualty, and Commercial Earthquake.

In addition, ceding increased due to the conversion of our Texas Specialty Homeowners business to a fronting arrangement beginning June 1, 2022.

XOL reinsurance expense also increased due to growth in exposure.

Net Earned Premiums

Net earned premiums increased $13.2 million, or 20.4%, to $77.9 million for the three months ended September 30, 2022 from $64.7 million for the three months ended September 30, 2021 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 $7.2 million, or 9.5%, to $83.2 million for the three months ended March 31, 2023 from $76.0 million for the three months ended March 31, 2022 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)

4 unchanged sentences

Commission and Other Income

Commission and other income increased $0.3 million to $1.3 million for the three months ended September 30, 2022 from $1.0 million for the three months ended September 30, 2021.

The balance increased due to an increase in policy related fees associated with an increased volume of premiums written.

Commission and other income decreased $0.1 million to $0.7 million for the three months ended March 31, 2023 from $0.8 million for the three months ended March 31, 2022.

The balance decreased due to a decrease in

commissions from a lower volume of policies written through our internal managing general agency, Palomar Insurance Agency.

Losses and Loss Adjustment Expenses

Losses and loss adjustment expenses increased $2.4 million, or 8.5% to $30.9 million for the three months ended September 30, 2022 from $28.5 million for the three months ended September 30, 2021.

Losses and loss adjustment expenses increased $5.7 million, or 38.1% to $20.7 million for the three months ended March 31, 2023 from $15.0 million for the three months ended March 31, 2022.

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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Total losses and loss adjustment expenses

Our catastrophe loss ratio was 16.0% during the three months ended September 30, 2022.

Catastrophe losses were related to losses from Hurricane Ian which primarily impacted our Commercial All Risk line of business.

Our catastrophe loss ratio was 27.0% during the three months ended September 30, 2021.

Catastrophe losses included losses from Hurricanes Ida and Nicholas which impacted our Commercial All Risk and Specialty Homeowners lines of business and a single loss from an excess liability indemnity policy covered by PESIC.

Our non-catastrophe loss ratio was 23.6% for the three months ended September 30, 2022 compared to 17.0% during the three months ended September 30, 2021.

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

Our catastrophe loss ratio was 2.2% during the three months ended March 31, 2023.

Catastrophe losses were primarily related to flood losses, offset by favorable development on prior year catastrophe events.

Our catastrophe loss ratio was 0.6% during the three months ended March 31, 2022.

Catastrophe losses were related to unfavorable development on prior year catastrophe events.

Our non-catastrophe loss ratio was 22.6% for the three months ended March 31, 2023 compared to 19.1% during the three months ended March 31, 2022.

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

Acquisition Expenses

Acquisition expenses increased $0.8 million, or 3.0%, to $27.2 million for the three months ended September 30, 2022 from $26.4 million for the three months ended September 30, 2021.

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 14.6% for the three months ended September 30, 2022 compared to 22.5% for the three months ended September 30, 2021.

Acquisition expenses decreased $2.3 million, or 8.5%, to $25.7 million for the three months ended March 31, 2023 from $28.0 million for the three months ended March 31, 2022.

The decrease was primarily due to higher earned ceding commissions and fronting fees due to an increase in premiums subject to a quota share or fronting agreement.

This was partially offset by higher earned premiums which resulted in higher commissions and premium-related taxes.

Acquisition expenses as a percentage of gross earned premiums were 11.4% for the three months ended March 31, 2023 compared to 20.2% for the three months ended March 31, 2022.

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 resulting from changes in mix of business produced.

Other Underwriting Expenses

Other underwriting expenses increased $4.5 million, or 35.3%, to $17.1 million for the three months ended September 30, 2022 from $12.6 million for the three months ended September 30, 2021.

Other underwriting expenses increased $3.3 million, or 20.7%, to $19.2 million for the three months ended March 31, 2023 from $15.9 million for the three months ended March 31, 2022.

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 9.2% for the three months ended September 30, 2022 compared to 10.8% for the three months ended September 30, 2021.

Excluding the impact of expenses relating to transactions, stock-based compensation, and amortization of intangibles, other underwriting expenses as a percentage of gross earned premiums were 7.3% for the three months ended September 30, 2022 compared to 9.4% for the three months ended September 30, 2021.

Other underwriting expenses as a percentage of gross earned premiums were 8.5% for the three months ended March 31, 2023 compared to 11.5% for the three months ended March 31, 2022.

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 6.8% for the three months ended March 31, 2023 compared to 9.0% for the three months ended March 31, 2022.

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

1 unchanged sentence

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

Net investment income increased $1.5 million, or 67.4%, to $3.7 million for the three months ended September 30, 2022 from $2.2 million for the three months ended September 30, 2021.

The increase was primarily due to a higher average balance of investments during the three months ended September 30, 2022 and higher yields on invested assets.

The Company incurred $2.4 million of net realized and unrealized losses on investments for the three months ended September 30, 2022 compared to $0.3 million of net realized and unrealized losses for the three months ended September 30, 2021 due to higher unrealized losses on our equity securities during the period ended September 30, 2022.

Net investment income increased $2.5 million, or 98.5%, to $5.1 million for the three months ended March 31, 2023 from $2.6 million for the three months ended March 31, 2022.

The increase was primarily due to a higher average balance of investments during the three months ended March 31, 2023 and higher yields on invested assets.

The Company incurred $0.1 million of net realized and unrealized gains on investments for the three months ended March 31, 2023 compared to $1.3 million of net realized and unrealized losses for the three months ended March 31, 2022 due primarily to lower unrealized losses on our equity securities during the period ended March 31, 2023.

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

1 unchanged sentence

Three Months Ended

September 30,

($ in thousands)

6 unchanged sentences

Income Tax Expense

Income tax expense increased $1.0 million to $0.9 million of expense for the three months ended September 30, 2022 from a benefit of $0.1 million for the three months ended September 30, 2021 due to higher pre-tax income for the period ended September 30, 2022.

During the three months ended September 30, 2022, our income tax rate of 17.5% was lower than 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, 2021, our income tax rate of negative 101.6% differed from the statutory rate of 21% due primarily to the tax impact of the permanent component of employee stock option exercises.

The tax rate was also impacted by the Company’s pre-tax income being close to break-even.

Results of Operations

Nine months ended September 30, 2022 compared to nine months ended September 30, 2021

The following table summarizes our results for the nine months ended September 30, 2022 and 2021:

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 (1)

Interest expense

Net investment income

Net realized and unrealized losses on investments

Income before income taxes

Income tax expense

Expenses associated with transactions

Stock-based compensation expense

Amortization of intangibles

Expenses associated with catastrophe bond, net of rebate

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

Catastrophe loss ratio (1)

Adjusted combined ratio excluding catastrophe losses (1)

Adjusted underwriting income (1)

NM- not meaningful

(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.

Gross Written Premiums

Gross written premiums increased $257.5 million, or 66.8% to $642.8 million for the nine months ended September 30, 2022 compared to $385.3 million for the nine months ended September 30, 2021.

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

Fronting Premiums

Commercial Earthquake

Inland Marine

Commercial All Risk

Specialty Homeowners

Hawaii Hurricane

Residential Flood

Total Gross Written Premiums

NM- not meaningful

During the fourth quarter of 2021, we launched our fronting business, known as PLMR-FRONT.

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.

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

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

Nine Months Ended September 30,

($ in thousands)

Total Gross Written Premiums

Ceded Written Premiums

Ceded written premiums increased $221.1 million, or 144.5%, to $374.1 million for the nine months ended September 30, 2022 from $153.0 million for the nine months ended September 30, 2021.

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 nine months ended September 30, 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 $1.3 million of expense associated with the reinstatement of our reinsurance program.

We expect to incur an additional $1.8 million of ceded premium to be recognized ratably from October 1, 2022 to May 31, 2023.

During the nine months ended September 30, 2021, our XOL reinsurance expense was impacted by Winter Storm Uri (“Uri”).

Catastrophe losses from Uri caused us to utilize certain layers of our XOL program causing us to 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 58.2% for the nine months ended September 30, 2022 from 39.7% for the nine months ended September 30, 2021.

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

Net Written Premiums

Net written premiums increased $36.4 million, or 15.7%, to $268.6 million for the nine months ended September 30, 2022 from $232.3 million for the nine months ended September 30, 2021.

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

Net Earned Premiums

Net earned premiums increased $68.3 million, or 41.1%, to $234.2 million for the nine months ended September 30, 2022 from $166.0 million for the nine months ended September 30, 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 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 by $0.4 million, or 14.4%, to $3.1 million for the nine months ended September 30, 2022, from $2.7 million for the nine months ended September 30, 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 increased $29.0 million, or 92.6%, to $60.3 million for the nine months ended September 30, 2022 from $31.3 million for the nine months ended September 30, 2021.

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

Our catastrophe loss ratio was 5.8% during the nine months ended September 30, 2022.

Catastrophe losses were primarily related to losses from Hurricane Ian which primarily impacted our Commercial All Risk line of business.

Our catastrophe loss ratio was 4.0% during the nine months ended September 30, 2021.

Catastrophe losses included losses from Hurricanes Ida and Nicholas and Winter Storm Uri.

These events impacted our Commercial All Risk and Specialty Homeowners lines of business.

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

These losses were partially offset by favorable development on catastrophe losses from 2020 Hurricanes and reinsurance recoveries.

Our non-catastrophe loss ratio was 19.9% for the nine months ended September 30, 2022 compared to 14.8% during the nine months ended September 30, 2021.

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

Acquisition Expenses

Acquisition expenses increased $15.8 million, or 23.2%, to $83.9 million for the nine months ended September 30, 2022 from $68.1 million for the nine months ended September 30, 2021.

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 17.3% for the nine months ended September 30, 2022 compared to 21.9% for the nine months ended September 30, 2021.

Other Underwriting Expenses

Other underwriting expenses increased $11.8 million, or 29.9%, to $51.2 million for the nine months ended September 30, 2022 from $39.4 million for the nine months ended September 30, 2021.

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 10.6% for the nine months ended September 30, 2022 compared to 12.7% for the nine months ended September 30, 2021.

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 8.2% for the nine months ended September 30, 2022 compared to 10.7% for the nine months ended September 30, 2021.

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

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 $2.8 million, or 42.3%, to $9.5 million for the nine months ended September 30, 2022 from $6.6 million for the nine months ended September 30, 2021.

The increase was primarily due to a higher average balance of investments during the nine months ended September 30, 2022 and higher yields on invested assets.

The Company incurred $8.4 million of net realized and unrealized losses on investments for the nine months ended September 30, 2022 compared to $0.8 million of net realized and unrealized losses for the nine months ended September 30, 2021 due to higher unrealized losses on our equity securities during the period ended September 30, 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:

Nine Months Ended

September 30,

($ in thousands)

Interest income

Dividend income

Investment management fees and expenses

Net investment income

Net realized and unrealized gains (losses) on investments

Income Tax Expense

Income tax expense increased $2.6 million or 40.3% to $9.2 million for the nine months ended September 30, 2022 from $6.5 million for the nine months ended September 30, 2021 due to higher pre-tax income and a higher effective tax rate during the nine months ended September 30, 2022.

During the nine months ended September 30, 2022, our income tax rate of 21.5% was higher than the statutory rate of 21% due primarily to non-deductible executive compensation expense.

During the nine months ended September 30, 2021, our income tax rate of 18.3% was lower than the statutory rate of 21% due primarily to the tax impact of the permanent component of employee stock option exercises.

Income tax expense increased $0.8 million, or 16.9% to $5.3 million for the three months ended March 31, 2023 from $4.5 million for the three months ended March 31, 2022 due to higher pre-tax income for the period ended March 31, 2023.

During the three months ended March 31, 2023, our income tax rate of 23.5% was higher than the statutory rate of 21% due primarily to non-deductible executive compensation expense.

During the three months ended March 31, 2022, our income tax rate of 23.8% was higher than the statutory rate of 21% also due primarily to non-deductible executive compensation expense .

Reconciliation of Non-GAAP Financial Measures

6 unchanged sentences

Three Months Ended

Nine Months Ended

September 30,

(in thousands)

Total revenue

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Three Months Ended

Nine Months Ended

September 30,

(in thousands)

Income before income taxes

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Amortization of intangibles

Expenses associated with catastrophe bond, net of rebate

Expenses associated with catastrophe bond

Adjusted underwriting income

7 unchanged sentences

Three Months Ended

Nine Months Ended

September 30,

(in thousands)

Net realized and unrealized (gains) losses on investments

Expenses associated with transactions

1 unchanged sentence

Amortization of intangibles

Expenses associated with catastrophe bond, net of rebate

Expenses associated with catastrophe bond

Adjusted net income

5 unchanged sentences

Three Months Ended

Nine Months Ended

September 30,

($ in thousands)

Annualized adjusted net income

7 unchanged sentences

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

5 unchanged sentences

Amortization of intangibles

Expenses associated with catastrophe bond, net of rebate

Expenses associated with catastrophe bond

Adjusted combined ratio

5 unchanged sentences

Three Months Ended

Nine Months Ended

September 30,

(in thousands, except per share data)

Adjusted net income

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Three Months Ended

Nine Months Ended

September 30,

($ in thousands)

Losses and loss adjustment expenses

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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

5 unchanged sentences

Amortization of intangibles

Expenses associated with catastrophe bond, net of rebate

Expenses associated with catastrophe bond

Catastrophe losses

5 unchanged sentences

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

September 30,

(in thousands)

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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 pay a dividend or distribution of no greater than $4.1 million in 2022 without approval of the Arizona Insurance Commissioner.

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.

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.

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

One of our insurance company subsidiaries, PSIC, is a member of the Federal Home Loan Bank of San Francisco (FHLB).

Membership allows PSIC access to collateralized advances, which may be used to support and enhance liquidity management.

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

Our primary sources of cash flow are written premiums, investment income, reinsurance recoveries, sales and redemptions of investments, and proceeds from borrowings on our lines of credit.

6 unchanged sentences

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, 2022 and 2021:

Nine months ended

September 30,

The following table summarizes our cash flows for the three months ended March 31, 2023 and 2022:

Three months ended

($ in thousands)

4 unchanged sentences

Change in cash, cash equivalents, and restricted cash

Our cash flow from operating activities was positive during the nine months ended September 30, 2022 and 2021 due to net income and a decrease in net operating assets in each period.

Our cash flow from operating activities was positive during the three months ended March 31, 2023 and 2022 due to net income and a decrease in net operating assets in each period.

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, reinsurance payments, and reinsurance recoveries on paid losses.

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

Cash used in investing activities for the nine months ended September 30, 2022 and 2021 related primarily to purchases of fixed maturity securities in excess of sales and maturities in each period.

Cash provided by financing activities for nine months ended September 30, 2022 was related to $26.4 million in borrowings from our FHLB line of credit, the receipt of $2.2 million in proceeds from stock option exercises and the

receipt of $0.8 million in proceeds from our employee stock purchase plan, offset by the repurchase of $23.3 million of our common stock.

Cash used in financing activities for nine months ended September 30, 2021 was related to the repurchase of $15.8 million of our common stock offset by the receipt of $1.8 million from the issuance of common stock via stock option exercises and the receipt of $0.7 million in proceeds related to the issuance of common stock via our employee stock purchase plan.

Cash used in investing activities for the three months ended March 31, 2023 and 2022 related primarily to purchases of fixed maturity securities in excess of sales and maturities in each period.

Cash provided by financing activities for three months ended March 31, 2023 was related to $35.0 million in borrowings from our lines of credit, the receipt of $0.1 million in proceeds from stock option exercises and the receipt of $0.4 million in proceeds from our employee stock purchase plan, offset by the repurchase of $6.8 million of our common stock .

Cash provided by financing activities for three months ended March 31, 2022 was related to $15.0 million in borrowings from our FHLB line of credit, the receipt of $0.1 million in proceeds from stock option exercises and the receipt of $0.3 million in proceeds from our employee stock purchase plan, offset by the repurchase of $13.0 million of our common stock.

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 $541.8 million in cash and investment securities available at September 30, 2022.

To the extent our future operating cash flows are insufficient to cover our net losses from catastrophic events, we had $674.2 million in cash and investment securities available at March 31, 2023.

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.

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Under our current share repurchase program, shares may be repurchased from time to time in the open market or negotiated transactions at prevailing market rates, or by other means in accordance with federal securities laws.

We purchased 399,198 shares for $23.3 million under this program during the nine months ended September 30, 2022 and $76.7 million remains available for future repurchases.

We purchased 134,680 shares for $6.8 million under this program during the three months ended March 31, 2023 and $58.8 million remains available for future repurchases.

Credit Agreements

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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.

As of September 30, 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.

As of March 31, 2023, we had $35.0 million of borrowings outstanding through the Credit Agreement.

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

2 unchanged sentences

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

As of September 30, 2022, the Company had $26.4 million of borrowings outstanding through the FHLB line of credit.

As of March 31, 2023, we had $36.4 million of borrowings outstanding through the FHLB line of credit.

Stockholders’ Equity

At September 30, 2022 total stockholders’ equity was $367.8 million and tangible stockholders’ equity was $359.3 million, compared to total stockholders’ equity of $394.2 million and tangible stockholders’ equity of $384.7 million as of December 31, 2021.

Stockholder’s 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.

At March 31, 2023 total stockholders’ equity was $404.6 million and tangible stockholders’ equity was $396.7 million, compared to total stockholders’ equity of $384.8 million and tangible stockholders’ equity of $376.5 million as of December 31, 2022.

Stockholder’s equity increased primarily due to net income earned for the period, activity related

to stock-based compensation, and unrealized gains on fixed maturity securities and was partially offset by share repurchases made during the period.

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

6 unchanged sentences

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

As of September 30, 2022, the majority of our investment portfolio, or $476.8 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, 2023, the majority of our investment portfolio, or $554.5 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 $39.4 million of equity securities.

In addition, we maintained a non-restricted cash and cash equivalent balance of $29.5 million at September 30, 2022.

Our fixed maturity securities, including cash equivalents, had a weighted average effective duration of 4.03 and 3.99 years and an average rating of “A1/A+” and “A1/A” at September 30, 2022 and December 31, 2021, respectively.

Our fixed income investment portfolio had a book yield of 2.83% as of September 30, 2022, compared to 2.23% as of December 31, 2021.

At September 30, 2022 and December 31, 2021 the amortized cost and fair value on available-for-sale securities were as follows:

September 30, 2022

In addition, we maintained a non-restricted cash and cash equivalent balance of $80.3 million at March 31, 2023.

Our fixed maturity securities, including cash equivalents, had a weighted average effective duration of 3.93 and 3.81 years and an average rating of “A1/A+” and “A1/A+” at March 31, 2023 and December 31, 2022, respectively.

Our fixed income investment portfolio had a book yield of 3.40% as of March 31, 2023, compared to 3.30% as of December 31, 2022.

At March 31, 2023 and December 31, 2022 the amortized cost and fair value on available-for-sale securities were as follows:

March 31, 2023

($ in thousands)

15 unchanged sentences

Total available-for-sale investments

The following tables provide the credit quality of investment securities as of September 30, 2022 and December 31, 2021:

September 30, 2022

The following tables provide the credit quality of investment securities as of March 31, 2023 and December 31, 2022:

March 31, 2023

($ 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, 2022 were as follows:

September 30, 2022

The amortized cost and fair value of our available-for-sale investments in fixed maturity securities summarized by contractual maturity as of March 31, 2023 were as follows:

March 31, 2023

($ in thousands)

30 unchanged sentences

This catastrophe bond was completed through Torrey Pines Re Ltd., a Bermuda-domiciled special purpose insurer that provides indemnity-based reinsurance covering earthquake events through June 1, 2025.

The Company is currently seeking to expand its catastrophe XOL coverage through a catastrophe bond offering, which is expected to close in the second quarter of 2023, and may seek similar catastrophe bond offerings in the future.

There can be no assurances that the catastrophe bond offering will close in the expected timeline, on acceptable terms, or at all.

Our catastrophe event retention is currently $12.5 million for all perils.

Our reinsurance coverage exhausts at $2.08 billion for earthquake events, $900 million for Hawaii hurricane events, and $250 million for continental U.S.

Our reinsurance coverage exhausts at $2.15 billion for earthquake events, $1.01 billion for Hawaii hurricane events, and $250 million for continental U.S.

hurricane events , providing coverage in excess of our 1 in 250 year peak zone PML and in excess of our A.M.

2 unchanged sentences

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, the Company has historically obtained aggregate reinsurance coverage.

Beginning April 1, 2021 and renewing on April 1, 2022, we have secured $25 million of aggregate XOL reinsurance limit.

This feature for subsequent event coverage is known as a “reinstatement.”

In addition, to provide further coverage against the potential for frequent catastrophe events, the Company has historically obtained aggregate reinsurance coverage.

During the three months ended March 31, 2023 and 2022, we maintained $25 million of aggregate XOL reinsurance limit.

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 net loss.

Based on our strategic plan to reduce volatility and contract our exposure to continental U.S.

hurricane risk, we made the decision not to renew this aggregate cover after it expires on March 31, 2023 as we believe its utility has diminished.

We intend to pursue alternative forms of risk transfer that provide protection from multiple severe events.

Subsequent to March 31, 2023, we secured $187.5 million of incremental XOL limit from a syndicated panel of long-term trading partners which will incept between April 1, 2023 and June 1, 2023 and provide coverage through June 1, 2024.

Critical Accounting Estimates

8 unchanged sentences

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