Skyward Specialty Insurance Group, Inc. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations The term “Skyward Specialty” as used below refers only to Skyward Specialty Insurance Group, Inc. and the terms “our Company,” “we,” “us,” and “our” as used below refer to Skyward Specialty Insurance Group and its consolidated subsidiaries. The term “first quarter” as used below refers to the three months ended March 31 for the time period then ended. We discuss certain key metrics which provide useful information about our business and the operational factors underlying our financial performance. Many of these metrics are generally standard among insurance companies and help to provide comparability with our peers. Select insurance, accounting, operating and financial terms for Skyward Specialty are defined in the sections entitled “Select Insurance and Financial Terms” and “Key Operating and Financial Metrics” included in our 2024 Form 10-K for the year ended December 31, 2024 (the “2024 Form 10-K”). The discussion and analysis below include certain forward-looking statements that are subject to risks, uncertainties and other factors described in “Risk Factors” in our 2024 Form 10-K. 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 months ended March 31, 2025 are not necessarily indicative of the results that may be expected for the full year ended December 31, 2025, 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 2024 Form 10-K. The accompanying condensed consolidated financial statements and related notes have been prepared in accordance with United States (“U.S.”) generally accepted accounting principles (“GAAP”). Overview Founded in 2006, Skyward Specialty is a specialty insurance holding company incorporated in Delaware. We have one reportable segment through which we offer a broad array of commercial property and casualty products and solutions on a non-admitted (or E&S) and admitted basis, predominantly in the United States. We focus our business on markets that are underserved, dislocated and/or for which standard insurance coverages are insufficient or inadequate to meet the needs of businesses, including our customers and prospective customers operating in these markets. Our customers typically require highly specialized, customized underwriting solutions and claims capabilities. As such, we develop and deliver tailored insurance products and services to address each of the niche markets we serve. During the first quarter of 2025, the Company updated its underwriting divisions to align with how management currently oversees the business, allocates resources and evaluates operating performance. The Company added a ninth division, Agriculture and Credit (Re)insurance, which includes the Global Agriculture unit, previously reported with Global Property, and the Mortgage and Credit units, and focuses on specialty classes for which reinsurance provides a more attractive market entry. The Industry Solutions division is now the Construction & Energy Solutions division and the Inland Marine unit is now included in the Transactional E&S division. Programs is now Specialty Programs. Prior reporting periods have been conformed to reflect the new presentation. All of our insurance company subsidiaries are group rated and have financial strength ratings of “A” (Excellent) with stable outlook from the A.M. Best Company. 27 Table of Contents Results of Operations The following table summarizes our results for the three months ended March 31, 2025 and 2024: Three months ended March 31, ($ in thousands) 2025 2024 Gross written premiums $ 535,326 $ 458,620 Ceded written premiums (192,055) (171,520) Net written premiums $ 343,271 $ 287,100 Net earned premiums $ 300,366 $ 236,342 Commission and fee income 1,976 2,026 Losses and LAE 187,309 143,914 Underwriting, acquisition and insurance expenses 86,551 69,774 Underwriting income (1) $ 28,482 $ 24,680 Net investment income $ 19,331 $ 18,297 Net investment gains $ 6,841 $ 8,303 Income before income taxes $ 51,435 $ 46,977 Net income $ 42,058 $ 36,784 Adjusted operating income (1) $ 37,321 $ 31,024 Loss and LAE ratio 62.4 % 60.9 % Expense ratio 28.1 % 28.7 % Combined ratio 90.5 % 89.6 % Annualized return on equity 20.5 % 21.7 % Annualized return on tangible equity (1) 22.9 % 25.0 % Annualized adjusted return on equity (1) 18.2 % 18.3 % Annualized adjusted return on tangible equity (1) 20.3 % 21.1 % (1) See “Reconciliation of Non-GAAP Financial Measures” in this Item 2 Reconciliation of Non-GAAP Financial Measures Adjusted Operating Income The following table provides a reconciliation of adjusted operating income to net income for the three months ended March 31, 2025 and 2024: Three months ended March 31, 2025 2024 ($ in thousands) Pre-tax After-tax Pre-tax After-tax Income as reported $ 51,435 $ 42,058 $ 46,977 $ 36,784 Less (add): Net investment gains 6,841 5,594 8,303 6,501 Net impact of LPT — — 241 189 Other income 13 11 — — Other expenses (1,061) (868) (1,188) (930) Adjusted operating income $ 45,642 $ 37,321 $ 39,621 $ 31,024 28 Table of Contents Underwriting Income The following table provides a reconciliation of underwriting income to income before federal income tax expense for the three months ended March 31, 2025 and 2024: Three months ended March 31, ($ in thousands) 2025 2024 Income before income taxes $ 51,435 $ 46,977 Add: Interest expense 1,834 2,727 Amortization expense 337 388 Other expenses 1,061 1,188 Less: Net investment income 19,331 18,297 Net investment gains 6,841 8,303 Other income 13 — Underwriting income $ 28,482 $ 24,680 Tangible Stockholders’ Equity The following table provides a reconciliation of tangible stockholders’ equity to stockholders’ equity for the periods ended March 31, 2025 and 2024: Three months ended March 31, ($ in thousands) 2025 2024 Stockholders’ equity $ 850,721 $ 692,272 Less: Goodwill and intangible assets 87,089 88,137 Tangible stockholders’ equity $ 763,632 $ 604,135 Annualized Adjusted Return on Equity The following table provides a reconciliation of annualized adjusted return on equity to annualized return on equity for the three months ended March 31, 2025 and 2024: Three months ended March 31, ($ in thousands) 2025 2024 Numerator: annualized adjusted operating income $ 149,284 $ 123,896 Denominator: average stockholders’ equity $ 822,360 $ 676,652 Annualized adjusted return on equity 18.2 % 18.3 % Annualized Return on Tangible Equity Annualized return on tangible equity for the three months ended March 31, 2025 and 2024 reconciles to annualized return on equity as follows: Three months ended March 31, ($ in thousands) 2025 2024 Numerator: annualized net income $ 168,232 $ 147,136 Denominator: average tangible stockholders’ equity $ 735,142 $ 588,366 Annualized return on tangible equity 22.9 % 25.0 % 29 Table of Contents Annualized Adjusted Return on Tangible Equity Annualized adjusted return on tangible equity for the three months ended March 31, 2025 and 2024 reconciles to annualized return on equity as follows: Three months ended March 31, ($ in thousands) 2025 2024 Numerator: annualized adjusted operating income $ 149,284 $ 123,896 Denominator: average tangible stockholders’ equity $ 735,142 $ 588,366 Annualized adjusted return on tangible equity 20.3 % 21.1 % Underwriting Results Premiums The following tables present gross written premiums by underwriting division for the three months ended March 31, 2025 and 2024: Three months ended March 31, ($ in thousands) 2025 2024 Change % Change Accident & Health $ 63,169 $ 40,901 $ 22,268 54.4 % Agriculture and Credit (Re)insurance 87,847 43,321 44,526 102.8 % Captives 68,401 68,408 (7) — % Construction & Energy Solutions 75,571 74,222 1,349 1.8 % Global Property 46,686 57,312 (10,626) (18.5 %) Professional Lines 41,166 42,239 (1,073) (2.5 %) Specialty Programs 62,675 52,178 10,497 20.1 % Surety 37,798 33,842 3,956 11.7 % Transactional E&S 52,006 46,232 5,774 12.5 % Total gross written premiums (1) $ 535,319 $ 458,655 $ 76,664 16.7 % (1) Excludes exited business The increase in gross written premiums for the first quarter of 2025, when compared to the same 2024 period, was driven by double-digit premium growth primarily from the agriculture and credit (re)insurance, accident & health and specialty programs divisions, partially offset by a decrease in gross written premiums in the global property division. Net written premiums for the first quarter of 2025 were $343.3 million, an increase of $56.2 million or 19.6%, when compared to $287.1 million for the same 2024 period. The increase in net written premiums was primarily driven by the same reasons that drove the increases in gross written premiums discussed above. Net earned premiums for the first quarter of 2025 were $300.4 million, an increase of $64.1 million or 27.1% when compared to $236.3 million for the same 2024 period. The increase in net earned premiums was primarily driven by the same reasons that drove the increases in gross written premiums discussed above. For additional information regarding our reinsurance programs, see the “Reinsurance” discussion included in this Item 2 . 30 Table of Contents Losses and LAE The following tables set forth the components of the loss and LAE ratios and adjusted loss and LAE ratios for the three months ended March 31, 2025 and 2024: Three months ended March 31, 2025 2024 ($ in thousands) Losses and LAE % of Net Earned Premiums Losses and LAE % of Net Earned Premiums Losses and LAE: Non-cat loss and LAE $ 180,809 60.2 % $ 143,155 60.6 % Cat loss and LAE (1) 6,500 2.2 % 1,000 0.4 % Prior accident year development - LPT — — % (241) (0.1)% Total losses and LAE $ 187,309 62.4 % $ 143,914 60.9 % (1) Current accident year The loss ratio for the first quarter of 2025 increased 1.5 points when compared to the same 2024 period, due to higher catastrophe losses, primarily from convective storms in the Midwest and the California wildfires. The improvement in the non-catastrophe loss and LAE ratio for the first quarter of 2025 when compared to the same 2024 period, was driven by the business mix shift. Expense Ratio The following tables set forth the components of the expense ratios for the three months ended March 31, 2025 and 2024: Three months ended March 31, 2025 2024 ($ in thousands) Expenses % of Net Earned Premiums Expenses % of Net Earned Premiums Net policy acquisition expenses $ 44,490 14.8 % $ 31,977 13.6 % Other operating and general expenses 42,061 14.0 % 37,797 16.0 % Underwriting, acquisition and insurance expenses 86,551 28.8 % 69,774 29.6 % Less: commission and fee income (1,976) (0.7 %) (2,026) (0.9 %) Total net expenses $ 84,575 28.1 % $ 67,748 28.7 % The expense ratio for the first quarter improved 0.6 points when compared to the same 2024 period primarily due to earnings leverage partially offset by higher acquisition costs due to the business mix shift. The expense ratios for the first quarters of 2025 and 2024 exclude the impact of IPO related stock compensation and secondary offering expenses, which are reported in other expenses in our condensed consolidated statements of operations and comprehensive income. 31 Table of Contents Investment Results The following table sets forth the components of net investment income and net investment gains (losses) for the three months ended March 31, 2025 and 2024: Three months ended March 31, $ in thousands 2025 2024 Short-term investments & cash and cash equivalents $ 4,041 $ 5,088 Fixed income 16,730 12,478 Equities 657 627 Alternative and strategic investments (2,097) 104 Net investment income $ 19,331 $ 18,297 Net unrealized gains on securities still held $ 5,491 $ 8,991 Net realized gains (losses) 1,350 (688) Net investment gains $ 6,841 $ 8,303 Net investment income for the first quarter of 2025 increased $1.0 million when compared to the same 2024 period. The increase in income from our fixed income portfolio for the first quarter of 2025, when compared to the same 2024 period, was due to (i) a larger asset base as we continued to increase our allocation to this part of our investment portfolio and (ii) a higher book yield of 5.2% at March 31, 2025 compared to 4.7% at March 31, 2024. The decrease in income from short-term investments for the first quarter of 2025 when compared to the same 2024 period, was due to a lower book yield. The losses from alternative and strategic investments for the first quarter of 2025 was driven by the decline in the fair value of limited partnership investments. When a fixed maturity has been determined to have an impairment, the impairment charge is separated into an amount representing the credit loss, which is recognized in earnings as a realized loss and on the balance sheet as an allowance for credit losses netted with the amortized cost of fixed maturities. Future increases in fair value, if related to credit factors, are recognized through earnings limited to the amount previously recognized as an allowance for credit losses. The amount related to non-credit factors is recognized in accumulated other comprehensive income and future increases or decreases in fair value, if not credit losses, are included in accumulated other comprehensive (loss) income. We reviewed our available-for-sale fixed maturities at March 31, 2025 and determined that no credit impairment existed in the gross unrealized holding losses. See Note 2, “Investments” to our condensed consolidated financial statements included in Item 1 of this Form 10-Q for additional information. Investments Composition of Investment Portfolio The following table sets forth the components of our investment portfolio at carrying value at March 31, 2025 and December 31, 2024: 2025 2024 ($ in thousands) Carrying Value % of Total Carrying Value % of Total Cash and cash equivalents $ 112,916 5.4 % $ 121,603 6.1 % Short-term investments 308,042 14.6 % 274,929 13.8 % Fixed income 1,413,520 67.1 % 1,318,708 66.2 % Equities 108,075 5.1 % 106,254 5.3 % Alternative and strategic investments 163,753 7.8 % 170,929 8.6 % Total portfolio $ 2,106,306 100.0 % $ 1,992,423 100.0 % 32 Table of Contents Fixed income Our fixed income portfolio primarily consists of investment grade fixed income securities, which are predominantly highly-rated and liquid bonds, and commercial mortgage loans. The following table sets forth the components of our fixed income securities at March 31, 2025 and December 31, 2024: 2025 2024 ($ in thousands) Carrying Value % of Total Carrying Value % of Total U.S. government securities $ 26,682 1.9 % $ 26,486 2.0 % Corporate securities and miscellaneous 490,850 34.7 % 425,628 32.3 % Municipal securities 85,831 6.1 % 84,716 6.4 % Residential mortgage-backed securities 402,397 28.5 % 393,833 29.9 % Commercial mortgage-backed securities 76,191 5.4 % 69,364 5.2 % Other asset-backed securities 315,557 22.3 % 292,191 22.2 % Total fixed income portfolio, available-for-sale 1,397,508 98.9 % 1,292,218 98.0 % Commercial mortgage loans $ 16,012 1.1 % $ 26,490 2.0 % Total fixed income portfolio $ 1,413,520 100.0 % $ 1,318,708 100.0 % The weighted average credit rating of our available-for-sale fixed income portfolio was “A+” by Standard & Poor’s Financial Services, LLC (“Standard & Poor’s”) at March 31, 2025 and “AA-” at December 31, 2024. The following table sets forth the credit quality of our available-for-sale fixed income portfolio at March 31, 2025 and December 31, 2024, as rated by Standard & Poor’s or equivalent designation: 2025 2024 ($ in thousands) Fair Value % of Total Fair Value % of Total AAA $ 479,479 34.2 % $ 483,099 37.3 % AA 158,996 11.4 % 141,177 10.9 % A 480,478 34.4 % 429,703 33.3 % BBB 255,335 18.3 % 216,602 16.8 % BB and Lower 23,220 1.7 % 21,637 1.7 % Total fixed income portfolio, available-for-sale $ 1,397,508 100.0 % $ 1,292,218 100.0 % Our commercial mortgage loans are primarily senior loans on real estate across the U.S. The average duration of our fixed income portfolio was approximately 4.29 years and 4.34 years, respectively, as of March 31, 2025 and December 31, 2024. Equities The equities portfolio primarily consists of domestic preferred stocks, common equities, exchange traded funds, limited partnerships, limited liability corporations and other types of equity interests, 100.0% of which are publicly traded. Alternative and strategic investments Alternative investments consists of promissory notes, limited partnerships, joint ventures and equity interests. The underlying investments are primarily floating rate senior secured loans, comprised of short duration, collateralized, asset-oriented credit investments. The limited partnerships and joint ventures are subject to future increases or decreases in asset value as asset values are monetized and the income is distributed. Strategic investments consists of equity interests in private entities within the insurance industry. Other Items Income Taxes Income tax expense for the three months ended March 31, 2025 was $9.4 million compared to $10.2 million for the same 2024 period. Our effective tax rate for the three months ended March 31, 2025 was 18.2%, compared to 21.7% for the same 2024 period. The effective tax rate for the three months ended March 31, 2025 was impacted by certain discrete tax items, primarily tax benefits from stock-based compensation, which reduced the effective tax rate by 3.9%. For 33 Table of Contents additional information, see Note 7 of our condensed consolidated financial statements included in Item 1 of this Form 10-Q. Liquidity and Capital Resources Sources and Uses of Funds Our most significant source of cash is from premiums received from our insureds, which, for most policies, we receive at the beginning of the coverage period, net of the related commission amount for the policies. Our most significant cash outflow is for claims that arise when a policyholder incurs an insured loss. Because the payment of claims occurs after the receipt of the premium, often years later, we invest the cash in various investment securities that generally earn interest and dividends. We also use cash to pay for operating expenses such as salaries, rent and taxes and capital expenditures such as technology systems. We use reinsurance to manage the risk that we take on our policies. We cede, or pay out, part of the premiums we receive to our reinsurers and collect cash back when losses subject to our reinsurance coverage are paid. The timing of our cash flows from operating activities can vary among periods due to the timing by which payments are made or received. Some of our payments and receipts, including loss settlements and subsequent reinsurance receipts, can be significant, and as a result their timing can influence cash flows from operating activities in any given period. Management believes that cash receipts from premiums and proceeds from investment income are sufficient to cover cash outflows in the foreseeable future. Our cash flows for the three months ended March 31, 2025 and 2024: ($ in thousands) 2025 2024 Cash and cash equivalents provided by (used in): Operating activities $ 96,760 $ 94,265 Investing activities (100,779) (69,866) Financing activities — (9,466) Change in cash and cash equivalents and restricted cash $ (4,019) $ 14,933 The increase in cash provided by operating activities in 2025 when compared to 2024 was primarily due to positive cash flow from our insurance operations. Cash from operations can vary from period to period due to the timing of premium receipts, claim payments and reinsurance activity. Cash flows from operations in each of the past two years were used primarily to fund investing activities. Net cash used in investing activities in 2025 and 2024 were primarily driven by purchases of fixed maturity securities and short-term investments. Net cash used in financing activities in 2024 was driven by net payments on debt. Credit Agreements FHLB Loan On August 30, 2024, we entered into a loan (the “FHLB Loan”) with the Federal Home Loan Bank of Dallas (the “FHLB”) pursuant to its Advances and Security Agreement. The FHLB Loan is a 4.5-year term loan in the principal amount of $57.0 million. The FHLB Loan provides for interest-only payments during its term, with principal due in full at maturity. The interest rate is fixed over the term of the loan at 4.00%. The FHLB Loan is fully secured by a pledge of specific investment securities of HSIC. We used the proceeds to fund the redemption of the March 15, 2024 draw on the Revolving Credit Facility and redeemed $7.0 million of the March 29, 2023 draw on the Revolving Credit Facility (see “Revolving Credit Facility” below for additional information regarding the redemption). Revolving Credit Facility On March 29, 2023, we entered into an unsecured revolving credit facility (the “Revolving Credit Facility”) with a syndicate of participating banks. The Revolving Credit Facility provides us with up to a $150.0 million revolving credit facility and a letter of credit sub-facility of up to $30.0 million. On March 14, 2024, we drew $50.0 million on the Revolving Credit Facility and used the proceeds and existing cash to fund the redemption of the Debentures (see “Debentures” below for additional information regarding the redemption). On August 30, 2024, we fully redeemed the March 15, 2024 draw on the Revolving Credit Facility and redeemed $7.0 million of the March 29, 2023 draw on the Revolving Credit Facility. As of March 31, 2025, we had $43.0 million outstanding under the Revolving Credit Facility with another $107.0 million of undrawn capacity. 34 Table of Contents Interest on the Revolving Credit Facility is payable quarterly. The interest rate on the Revolving Credit Facility is the SOFR plus a margin of between 150 and 190 basis points based on the ratio of debt to total capital and a credit spread adjustment of 10 basis points. At March 31, 2025, the six-month SOFR on the Revolving Credit Facility was 4.22%, plus a margin of 1.60%. We are subject to covenants on the Revolving Credit Facility based on minimum net worth, maximum debt to capital ratio, minimum A.M. Best Rating and minimum liquidity. As of March 31, 2025, we are in compliance with all covenants. Debentures In August 2006, we received $58.0 million of proceeds from a debenture offering through a statutory trust, Delos Capital Trust (the “Trust”). The sole asset of the Trust consists of Fixed/Floating Rate Junior Subordinated Deferrable Interest Debentures (the “Trust Preferred”) with a principal amount of $59.8 million issued by us and cash of $1.8 million from the issuance of Trust common shares purchased by us equal to 3% of the Trust capitalization. On March 15, 2024, the Company redeemed the Debentures and paid $1.4 million of accrued interest. Subordinated Debt In May 2019, we issued unsecured subordinated notes (the “Notes”) with an aggregate principal amount of $20.0 million. Interest on the subordinated notes is 7.25% fixed for the first eight years and 8.25% fixed thereafter. Early retirement of the debt ahead of the eight-year commitment requires all interest payments to be paid in full, as well as the return of all capital. Principal payment is due at maturity on May 24, 2039 and interest is payable quarterly. At March 31, 2025 the ratio of total debt outstanding, including the FHLB Loan, the Revolving Credit Facility and the Notes, to total capitalization (defined as total debt plus stockholders’ equity) was 12.3% and at December 31, 2024, the ratio of total debt outstanding, including the Term Loan, the Revolver, the Trust Preferred and the Notes, to total capitalization was 13.1%. Share Repurchase Program In October 2024, the Board of Directors approved a share repurchase program authorizing the repurchase of up to $50.0 million of our common stock. The shares may be repurchased from time to time in open market purchases, privately-negotiated transactions, block purchases, accelerated share repurchase agreements or a combination of methods, including through Rule 10b5-1 trading plans. The timing, manner, price and amount of any repurchases under the share repurchase program will be determined by us in our discretion. The share repurchase program does not require us to repurchase any specific number of shares, and may be modified, suspended or terminated at any time. As of March 31, 2025, no shares had been repurchased under this plan. Reinsurance We strategically purchase reinsurance from third parties which enhances our business by protecting capital from severity events (either large single event losses or catastrophes) and reducing volatility in our earnings. Our reinsurance contracts are predominantly one year in length and renew annually throughout the year, primarily in January and April. At each annual renewal, we consider several factors that influence any changes to our reinsurance purchases, including any plans to change the underlying insurance coverage we offer, updated loss activity, the level of our capital and surplus, changes in our risk appetite and the cost and availability of reinsurance treaties. We purchase quota share reinsurance, excess of loss reinsurance, and facultative reinsurance coverage to limit our exposure from losses on any one occurrence. The mix of reinsurance purchased considers efficiency, cost, our risk appetite and specific factors of the underlying risks we underwrite. • Quota share reinsurance refers to a reinsurance contract whereby the reinsurer agrees to assume a specified percentage of the ceding company’s losses arising out of a defined class of business in exchange for a corresponding percentage of premiums, net of a ceding commission. • Excess of loss reinsurance refers to a reinsurance contract whereby the reinsurer agrees to assume all or a portion of the ceding company’s losses for an individual claim or an event in excess of a specified amount in exchange for a premium payable amount negotiated between the parties, which includes our catastrophe reinsurance program. • Facultative coverage refers to a reinsurance contract on individual risks as opposed to a group or class of business. It is used for a variety of reasons, including supplementing the limits provided by the treaty coverage or covering risks or perils excluded from treaty reinsurance. For the three months ended March 31, 2025 our net retention on a written basis (calculated as net written premiums as a percentage of gross written premiums) was 64.1%, compared to 62.6% for the same 2024 period. 35 Table of Contents The following is a summary of our reinsurance programs as of March 31, 2025: Line of Business Maximum Company Retention Accident & Health $0.90 million per occurrence Commercial Auto (1) $1.00 million per occurrence Excess Casualty (1)(2) $1.69 million per occurrence General Liability (1) $1.68 million per occurrence Ocean Marine (2) $2.50 million per occurrence Professional Lines (2) $5.19 million per occurrence Property (3) $4.00 million per occurrence Representation and Warranty $5.00 million per occurrence Surety (2) $4.00 million per occurrence Workers’ Compensation (2) $2.33 million per occurrence (1) Legal defense expenses can force exposure above the maximum company retention for Excess Casualty, Commercial Auto and General Liability. (2) Reinsurance is subject to a loss ratio cap or aggregate level of loss cover that exceeds a modeled 1:250-year PML event. (3) Catastrophe loss protection is purchased up to $36.0 million in excess of $12.0 million retention, which provides cover for a 1:250-year PML event. Credit and Financial Strength Ratings On August 1, 2024, A.M. Best upgraded Skyward Specialty’s financial strength rating to A (Excellent) from A- (Excellent) and revised the outlook to stable from positive. Item 3. Quantitative and Qualitative Disclosures About Market Risk There have been no material changes in market risk from the information provided in our Annual Report on Form 10-K for the year ended December 31, 2024.