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PALOMAR HOLDINGS, INC. – 10-Q – Management's Discussion and Analysis of Financial Condition and Results of Operations
The discussion and analysis below includes certain forward-looking statements that are subject to risks, uncertainties and other factors described in part II, item 1A of this Quarterly Report. 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 endedSeptember 30, 2021 are not necessarily indicative of the results that may be expected for the full year endedDecember 31, 2021 , 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 theSEC onMarch 9, 2021 .
References to the "Company," "
Holdings, Inc.
Overview
We are a rapidly growing and innovative insurer focused on providing specialty
insurance to residential and commercial customers. Our underwriting and
analytical expertise allow us to concentrate on certain markets that we believe
are underserved by other insurance companies, such as the markets for
earthquake, hurricane and flood insurance. We use proprietary data analytics and
a modern technology platform to offer our customers flexible products with
customized and granular pricing for both the admitted and excess and surplus
lines ("E&S") markets.
We provide admitted insurance products through our Oregon domiciled insurance
company, Palomar Specialty Insurance Company ("PSIC"), and non-admitted
insurance products through our Arizona domiciled surplus lines insurance
company, Palomar Excess and Surplus Insurance Company ("PESIC"). We distribute
our products through multiple channels, including retail agents, program
administrators, wholesale brokers, and partnerships with other insurance
companies. Our 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. Our
management team combines decades of insurance industry experience across
specialty underwriting, reinsurance, program administration, distribution, and
analytics.
Founded in 2014, we have significantly grown our business and have generated
attractive returns. We have organically increased gross written premiums from
$16.6 million for the year ended December 31, 2014 , our first year of
operations, to $354.4 million for the year ended December 31, 2020 , a compound
annual growth rate ("CAGR") of approximately 66%. For the nine months ended
September 30, 2021 , we experienced average monthly premium retention rates above
90% for our Residential Earthquake and Hawaii Hurricane lines and approximately
87% overall across all continuing lines of business, providing strong visibility
into future revenue.
In February 2014 , PSIC was awarded an "A-" rating from A.M. Best Company ("A.M.
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. Best . 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 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.
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In response to the Pandemic, we have been taking several actions to protect the
health of the public and our employees while serving our policyholders and
ensuring business continuity. We have implemented safeguards to ensure
operational reliability and established safety protocols for employees who
interact directly with the public. We also provide employees a reimbursement to
help manage incremental costs associated with remote work. In addition, we are
taking extra physical security and cybersecurity measures to 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 are acknowledging, investigating, assessing and
adjudicating each claim received and providing the policyholder requisite
consideration.
Our results of operations depend, in part, on the performance of our investment
portfolio. 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. We have not seen a significant impact on the growth
rate of our gross written premiums since the beginning of the Pandemic. However,
the macroeconomic effects of the Pandemic may persist for an indefinite period,
even after the Pandemic has subsided and we cannot anticipate all the ways in
which the Pandemic or other similar global health crises could adversely impact
our business in the future.
Components of Our Results of Operations
Gross Written Premiums
Gross written premiums are the amounts received or to be received for insurance policies written or assumed by us during a specific period of time without reduction for policy acquisition costs, reinsurance costs or other deductions. The volume of our gross written premiums in any given period is generally influenced by: ? Volume of new business submissions in existing products or partnerships;
? Binding of new business submissions in existing products or partnerships into
policies;
? Entrance into new partnerships or the offering of new types of insurance
products;
? Renewal rates of existing policies; and
? Average size and premium rate of bound policies.
Our gross written premiums are also impacted when we assume unearned in-force
premiums due to new partnerships or other business reasons. In periods where we
assume a large volume of unearned premiums, our gross written premiums may
increase significantly compared to prior periods and the increase may not be
indicative of future trends.
Ceded Written Premiums
Ceded written premiums are the amount of gross written premiums ceded to
reinsurers. 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.
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.
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
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the XOL contract period or due to acceleration of XOL charges or the need to
purchase additional reinsurance due to losses.
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.
Commission and Other Income
Commission and other income consist of commissions earned on policies written on behalf of third party insurance companies where we have no exposure to the insured risk and certain fees earned in conjunction with underwriting policies. Commission and other income are earned on the effective date of the underlying policy.
Losses and Loss Adjustment Expenses
Losses and loss adjustment expenses represent the costs incurred for losses, net of any losses ceded to reinsurers. These expenses are a function of the size and term of the insurance policies we write and the loss experience associated with the underlying coverage. 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. 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. Our losses and loss adjustment expenses are generally affected by:
? The occurrence, frequency and severity of catastrophe events in the areas where
we underwrite policies relating to these perils;
? The occurrence, frequency and severity of non-catastrophe attritional losses;
? The mix of business written by us;
? The reinsurance agreements we have in place at the time of a loss;
? The geographic location and characteristics of the policies we underwrite;
? Changes in the legal or regulatory environment related to the business we
write;
? Trends in legal defense costs; and
? Inflation in housing and construction costs.
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. Losses and loss adjustment expenses may be paid out over multiple years. 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 related to each policy we write are deferred and expensed pro rata over the term of the policy.
Other Underwriting Expenses
Other underwriting expenses represent the general and administrative expenses of
our insurance operations including employee salaries and benefits, software and
technology costs, office rent, stock-based compensation, licenses and fees, and
professional services fees such as legal, accounting, and actuarial services.
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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. The principal factors that influence net investment income are the size of our investment portfolio, the yield on that portfolio, and investment management expenses. As measured by amortized cost, which excludes changes in fair value, caused by changes in interest rates, the size of our investment portfolio is mainly a function of our invested capital along with premium we receive from our insureds, less payments on policyholder claims and other operating expenses. Our balance of invested capital may be impacted in the future by repurchases of shares of our common stock.
Net Realized and Unrealized Gains and Losses on Investments
Net realized and unrealized gains and losses on investments are a function of the difference between the amount received by us on the sale of a security and the security's cost-basis, mark-to-market adjustments, and credit losses recognized in earnings.
Income Tax Expense
Currently our income tax expense consists mainly of federal income taxes imposed on our operations. Our effective tax rates are dependent upon the components of pretax earnings and the related tax effects.
Key Financial and Operating Metrics
We discuss certain key financial and operating metrics, described below, which
provide useful information about our business and the operational factors
underlying our financial performance.
Underwriting revenue is a non-GAAP financial measure defined as total revenue, excluding net investment income and net realized and unrealized gains and losses on investments. See "Reconciliation of Non-GAAP Financial Measures" for a reconciliation of total revenue calculated in accordance with GAAP to underwriting revenue. Underwriting income is a non-GAAP financial measure defined as income before income taxes excluding net investment income and net realized and unrealized gains and losses on investments. See "Reconciliation of Non-GAAP Financial Measures" for a reconciliation of income before income taxes calculated in accordance with GAAP to underwriting income. Adjusted net income is a non-GAAP financial measure defined as net income excluding the impact of certain items that may not be indicative of underlying business trends, operating results, or future outlook, net of tax impact. We calculate the tax impact only on adjustments which would be included in calculating our income tax expense using the estimated tax rate at which the company received a deduction for these adjustments. See "Reconciliation of Non-GAAP Financial Measures" for a reconciliation of net income calculated in accordance with GAAP to adjusted net income.
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. See "Reconciliation of Non-GAAP Financial Measures" for a reconciliation of return on equity calculated using unadjusted GAAP numbers to adjusted return on equity.
Loss ratio, expressed as a percentage, is the ratio of losses and loss
adjustment expenses, to net earned premiums.
Expense ratio, expressed as a percentage, is the ratio of acquisition and other
underwriting expenses, net of commission and other income to net earned
premiums.
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Combined ratio is defined as the sum of the loss ratio and the expense ratio. A
combined ratio under 100% generally indicates an underwriting profit. A combined
ratio over 100% generally indicates an underwriting loss.
Adjusted combined ratio is a non-GAAP financial measure defined as the sum of
the loss ratio and the expense ratio calculated 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 combined ratio calculated using unadjusted GAAP numbers
to adjusted combined ratio.
Diluted adjusted earnings per share is a non-GAAP financial measure defined as
adjusted net income divided by the weighted-average common shares outstanding
for the period, reflecting the dilution which could occur if equity-based awards
are converted into common share equivalents as calculated using the treasury
stock method. See "Reconciliation of Non-GAAP Financial Measures" for a
reconciliation of diluted earnings per share calculated in accordance with GAAP
to diluted adjusted earnings per share.
Catastrophe loss ratio is a non-GAAP financial measure defined as the ratio of
catastrophe losses to net earned premiums. See "Reconciliation of Non-GAAP
Financial Measures" for a reconciliation of loss ratio calculated using
unadjusted GAAP numbers to catastrophe loss ratio.
Adjusted combined ratio excluding catastrophe losses is a non-GAAP financial
measure defined as adjusted combined ratio excluding the impact of catastrophe
losses. 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.
Tangible stockholders' equity is a non-GAAP financial measure defined as
stockholders' equity less intangible assets. See "Reconciliation of Non-GAAP
Financial Measures" for a reconciliation of stockholders' equity calculated in
accordance with GAAP to tangible stockholders' equity.
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Results of Operations
Three months ended
30, 2020
The following table summarizes our results for the three months endedSeptember 30, 2021 and 2020: Three months ended September 30, 2021 2020 Change % Change ($ in thousands, except per share data) Gross written premiums$ 152,332 $ 102,967 $ 49,365 47.9 % Ceded written premiums (58,073) (41,570) (16,503) 39.7 % Net written premiums 94,259 61,397 32,862 53.5 % Net earned premiums 64,720 42,020 22,700 54.0 % Commission and other income 1,018 816 202 24.8 %
Total underwriting revenue (1) 65,738 42,836 22,902 53.5 % Losses and loss adjustment expenses 28,475 41,060 (12,585) (30.7) % Acquisition expenses 26,412 17,976 8,436 46.9 % Other underwriting expenses 12,652 7,805 4,847 62.1 % Underwriting loss (1) (1,801) (24,005) 22,204 (92.5) % Net investment income 2,236 2,138 98 4.6 % Net realized and unrealized gains (losses) on investments (313) 24 (337) NM Income (loss) before income taxes 122
(21,843) 21,965 (100.6) % Income tax expense (124) (6,158) 6,034 (98.0) % Net income (loss)$ 246 $ (15,685) $ 15,931 (101.6) % Adjustments:
Stock-based compensation expense 1,525
551 974 176.8 % Amortization of intangibles 115 - 115 NM Tax impact (166) (101) (65) NM
Adjusted net income (loss) (1)$ 1,720 $ (15,235) $ 16,955 (111.3) % Key Financial and Operating Metrics Annualized return on equity 0.3 % (17.0) % Annualized adjusted return on equity (1) 1.8 %
(16.5) % Loss ratio 44.0 % 97.7 % Expense ratio 58.8 % 59.4 % Combined ratio 102.8 % 157.1 % Adjusted combined ratio (1) 100.2 % 155.8 % Diluted earnings per share$ 0.01 $ (0.62)
Diluted adjusted earnings per share (1)$ 0.07
$ (0.60) Catastrophe losses$ 17,487 $ 36,512 Catastrophe loss ratio (1) 27.0 % 86.9 %
Adjusted combined ratio excluding catastrophe losses (1) 73.2 %
68.9 % NM- not meaningful
Indicates non-GAAP financial measure; see "Reconciliation of Non-GAAP
(1) 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 $49.3 million , or 47.9% to $152.3 million for
the three months ended September 30, 2021 compared to $103.0 million for the
three months ended September 30, 2020 . Premium growth was primarily due to an
increased volume of policies written across our lines of business which was
driven by new business
25
generated with existing partners, strong premium retention rates for existing
business, expansion of our distribution footprint, and new partnerships. The
following table summarizes our gross written premiums by line of business and
shows each line's percentage of total gross written premiums for each period:
Three Months Ended September 30,
2021 2020
($ in thousands)
% of % of %
Amount GWP Amount GWP Change Change
Product
Residential Earthquake $ 50,075 32.9 % $ 40,507 39.3 % $ 9,568 23.6 %
Commercial Earthquake 27,433 18.0 % 18,061 17.5 % 9,372 51.9 %
Specialty Homeowners 19,881 13.1 % 17,048 16.6 % 2,833 16.6 %
Inland Marine 19,532 12.8 % 4,406 4.3 % 15,126 343.3 %
Hawaii Hurricane 8,996 5.9 % 4,360 4.2 % 4,636 106.3 %
Commercial All Risk 6,867 4.5 % 12,467 12.1 % (5,600) (44.9) %
Residential Flood 3,228 2.1 % 2,170 2.1 % 1,058 48.8 %
Other 16,320 10.7 % 3,948 3.9 % 12,372 313.4 %
Total Gross Written Premiums $ 152,332 100.0 % $ 102,967 100.0 % $ 49,365 47.9 %
During the fourth quarter of 2020, we made significant underwriting changes to
our Commercial All Risk program including ceasing to write policies on an
admitted basis. The majority of prior year Commercial All Risk policies were
written on an admitted basis and these changes significantly impacted the growth
rate shown above.
The following table summarizes our gross written premiums by insurance
subsidiary:
Three Months Ended September 30,
2021 2020
($ in thousands)
% of % of %
Amount GWP Amount GWP Change Change
Subsidiary
PSIC $ 110,875 72.8 % $ 93,987 91.3 % $ 16,888 18.0 %
PESIC 41,457 27.2 % 8,980 8.7 % 32,477 361.7 %
Total Gross Written Premiums $ 152,332 100.0 % $ 102,967 100.0 % $ 49,365 47.9 %
NM- not meaningful
Ceded Written Premiums
Ceded written premiums increased$16.5 million , or 39.7%, to$58.1 million for the three months endedSeptember 30, 2021 from$41.6 million for the three months endedSeptember 30, 2020 . The increase was primarily due to excess of loss ("XOL") reinsurance expense due to growth in exposure and increased quota share cessions due to growth in the volume of written premiums subject to quota shares. Ceded written premiums as a percentage of gross written premiums decreased to 38.1% for the three months endedSeptember 30, 2021 from 40.4% for the three months endedSeptember 30, 2020 . This decrease was primarily due to lower XOL expense as a percentage of gross written premiums.
Net Written Premiums
Net written premiums increased$32.9 million , or 53.5%, to$94.3 million for the three months endedSeptember 30, 2021 from$61.4 million for the three months endedSeptember 30, 2020 . 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. 26 Net Earned Premiums
Net earned premiums increased$22.7 million , or 54.0%, to$64.7 million for the three months endedSeptember 30, 2021 from$42.0 million for the three months endedSeptember 30, 2020 due primarily to the earning of increased gross written premiums offset by the earning of ceded written premiums under reinsurance agreements. The table below shows the amount of premiums we earned on a gross and net basis and net earned premiums as a percentage of gross earned premiums in each period presented: Three Months Ended September 30, 2021 2020 Change % Change ($ in thousands) Gross earned premiums$ 117,276 $ 79,428 $ 37,848 47.7 % Ceded earned premiums (52,556) (37,408) (15,148) 40.5 % Net earned premiums$ 64,720 $ 42,020 $ 22,700 54.0 % Net earned premium ratio 55.2% 52.9%
Commission and Other Income
Commission and other income increased by$0.2 million , or 24.8%, to$1.0 million for the three months endedSeptember 30, 2021 , from$0.8 million for the three months endedSeptember 30, 2020 . 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$12.6 million , or 30.7% to$28.5 million for the three months endedSeptember 30, 2021 from$41.1 million for the three months endedSeptember 30, 2020 . Losses and loss adjustment expenses consisted of the following elements during the respective periods: Three Months Ended September 30, 2021 2020 Change % Change ($ in thousands) Catastrophe losses$ 17,487 $ 36,512 $ (19,025) (52.1) % Non-catastrophe losses 10,988 4,548
6,440 141.6 %
Total losses and loss adjustment expenses
Our catastrophe loss ratio was 27.0% during the three months endedSeptember 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 catastrophe loss ratio was 86.9% during the three months endedSeptember 30, 2020 . Catastrophe losses primarily included losses from Hurricanes Hanna, Isaias, Laura, Sally and Beta and impacted primarily our Commercial All Risk and Specialty Homeowners lines of business. Our non-catastrophe loss ratio was 17.0% for the three months endedSeptember 30, 2021 compared to 10.8% during the three months endedSeptember 30, 2020 . Non-catastrophe losses increased due mainly to higher attritional losses on lines of business subject to attritional losses such as Commercial All Risk, Specialty Homeowners, Flood, and Inland Marine. 27 Acquisition Expenses
Acquisition expenses increased$8.4 million , or 46.9%, to$26.4 million for the three months endedSeptember 30, 2021 from$18.0 million for the three months endedSeptember 30, 2020 . The increase was primarily due to higher earned premiums which resulted in higher commissions and premium-related taxes. Acquisition expenses as a percentage of gross earned premiums were 22.5% for the three months endedSeptember 30, 2021 compared to 22.6% for the three months endedSeptember 30, 2020 . Acquisition expenses as a percentage of gross earned premiums fluctuates based on mix of business produced and quota share arrangements in place.
Other Underwriting Expenses
Other underwriting expenses increased$4.8 million , or 62.1%, to$12.6 million for the three months endedSeptember 30, 2021 from$7.8 million for the three months endedSeptember 30, 2020 . The increase was primarily due to the company incurring higher payroll, technology, stock-based compensation, and professional fees expenses associated with growth of the Company. Other underwriting expenses as a percentage of gross earned premiums were 10.8% for the three months endedSeptember 30, 2021 compared to 9.8% for the three months endedSeptember 30, 2020 . Excluding the impact of expenses relating to stock-based compensation and amortization of intangibles, other underwriting expenses as a percentage of gross earned premiums were 9.4% for the three months endedSeptember 30, 2021 compared to 9.1% for the three months endedSeptember 30, 2020 . Other underwriting expenses as a percentage of gross earned premiums may fluctuate period over period based on timing of certain expenses relative to premium growth.
Net Investment Income and Net Realized and Unrealized Gains (Losses) on
Investments
Net investment income increased$0.1 million , or 4.6%, to$2.2 million for the three months endedSeptember 30, 2021 from$2.1 million for the three months endedSeptember 30, 2020 . The increase was primarily due to a higher average balance of investments during the three months endedSeptember 30, 2021 , partially offset by lower yields on recently invested funds. Net realized and unrealized gains on investments decreased$0.3 million to a$0.3 million loss for the three months endedSeptember 30, 2021 from an immaterial gain for the three months endedSeptember 30, 2020 due to unrealized losses on our equity securities during the period endedSeptember 30, 2021 . Currently, we mainly invest in investment grade fixed maturity securities, includingU.S. government issues, state government issues, mortgage and asset-backed obligations, and corporate bonds with a small portion of our portfolio in equity securities. The following table summarizes the components of our investment income for each period presented: Three Months Ended September 30, 2021 2020 Change % Change ($ in thousands) Interest income$ 2,254 $ 2,149 $ 105 4.9 % Dividend income 104 109 (5) (4.6) %
Investment management fees and expenses (122) (120) (2) 1.7 % Net investment income 2,236 2,138 98 4.6 % Net realized and unrealized gains (losses) on investments (313) 24 (337) (1,404.2) % Total$ 1,923 $ 2,162 $ (239) (11.1) % Income Tax Expense
Income taxes increased$6.0 million or 98.0% to$0.1 million of benefit for the three months endedSeptember 30, 2021 from$6.2 million of benefit for the three months endedSeptember 30, 2020 due to higher pretax income during the three months endedSeptember 30, 2021 . During the three months endedSeptember 30, 2021 , our income tax rate of negative 101.6% differed from the statutory rate of 21% due primarily to the tax impact of the permanent component of 28 employee stock option exercises. The tax rate was also impacted by the Company's pre-tax income being close to break-even. For the three months endedSeptember 30, 2020 our income tax rate of 28.2% differed from the statutory rate of 21% also due primarily to the tax impact of the permanent component of employee
stock option exercises.
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Nine months ended
2020
The following table summarizes our results for the nine months endedSeptember 30, 2021 and 2020: Nine months ended September 30, 2021 2020 Change % Change ($ in thousands, except per share data) Gross written premiums$ 385,267 $ 258,268 $ 126,999 49.2 % Ceded written premiums (153,005) (101,264) (51,741) 51.1 % Net written premiums 232,262 157,004 75,258 47.9 % Net earned premiums 165,988 116,145 49,843 42.9 % Commission and other income 2,735 2,492 243 9.8 %
Total underwriting revenue (1) 168,723 118,637 50,086 42.2 % Losses and loss adjustment expenses 31,288
46,901 (15,613) (33.3) % Acquisition expenses 68,150 45,909 22,241 48.4 % Other underwriting expenses 39,438 24,732 14,706 59.5 % Underwriting income (1) 29,847 1,095 28,752 NM Net investment income 6,649 6,287 362 5.8 %
Net realized and unrealized gains (losses) on investments (752)
1,243 (1,995) (160.5) % Income before income taxes 35,744 8,625 27,119 314.4 % Income tax expense 6,529 523 6,006 NM Net income$ 29,215 $ 8,102 $ 21,113 260.6 % Adjustments:
Expenses associated with transactions and stock offerings 411 708 (297) NM Stock-based compensation expense 3,370 1,457 1,913 131.3 % Amortization of intangibles 704 - 704 NM Expenses associated with catastrophe bond, net of rebate 1,698
399 1,299 NM Tax impact (1,156) (534) (622) NM Adjusted net income (1)$ 34,242 $ 10,132 $ 24,110 238.0 % Key Financial and Operating Metrics Annualized return on equity 10.5 % 3.7 % Annualized adjusted return on equity (1) 12.3 %
4.7 % Loss ratio 18.8 % 40.4 % Expense ratio 63.2 % 58.7 % Combined ratio 82.0 % 99.1 % Adjusted combined ratio (1) 78.3 % 96.8 % Diluted earnings per share$ 1.12 $ 0.32
Diluted adjusted earnings per share (1)$ 1.31
$ 0.40 Catastrophe losses$ 6,719 $ 36,512 Catastrophe loss ratio (1) 4.0 % 31.4 %
Adjusted combined ratio excluding catastrophe losses (1) 74.2 %
65.4 % NM- not meaningful
Indicates non-GAAP financial measure; see "Reconciliation of Non-GAAP
(1) 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 $127.0 million , or 49.2%, to $385.3 million for
the nine months ended September 30, 2021 compared to $258.3 million for the nine
months ended September 30, 2020 . Premium growth was primarily due to an
increased volume of policies written across our lines of business which was
driven by new business
30
generated with existing partners, strong premium retention rates for existing
business, expansion of our distribution footprint, and new partnerships. The
following table summarizes our gross written premiums by line of business and
shows each line's percentage of total gross written premiums for each period:
Nine Months Ended September 30,
2021 2020
($ in thousands)
% of % of
Amount GWP Amount GWP Change Change
Product
Residential Earthquake $ 128,165 33.3 % $ 103,503 40.1 % $ 24,662 23.8 %
Commercial Earthquake 66,052 17.1 % 40,727 15.8 % 25,325 62.2 %
Specialty Homeowners 53,018 13.8 % 38,461 14.9 % 14,557 37.8 %
Inland Marine 39,047 10.1 % 9,747 3.8 % 29,300 300.6 %
Commercial All Risk 30,032 7.8 % 39,765 15.4 % (9,733) (24.5) %
Hawaii Hurricane 22,921 5.9 % 10,296 4.0 % 12,625 122.6 %
Residential Flood 8,377 2.2 % 5,728 2.2 % 2,649 46.2 %
Other 37,655 9.8 % 10,041 3.8 % 27,614 275.0 %
Total Gross Written Premiums $ 385,267 100.0 % $ 258,268 100.0 % $ 126,999 49.2 %
During the fourth quarter of 2020, we made significant underwriting changes to
our Commercial All Risk program including ceasing to write policies on an
admitted basis. The majority of prior year Commercial All Risk policies were
written on an admitted basis and these changes significantly impacted the growth
rate shown above.
The following table summarizes our gross written premiums by insurance
subsidiary:
Nine Months Ended September 30,
2021 2020
($ in thousands)
% of % of %
Amount GWP Amount GWP Change Change
Subsidiary
PSIC $ 285,991 74.2 % $ 249,288 96.5 % $ 36,703 14.7 %
PESIC 99,276 25.8 % 8,980 3.5 % 90,296 NM %
Total Gross Written Premiums $ 385,267 100.0 % $ 258,268 100.0 % $ 126,999 49.2 %
NM- not meaningful
Ceded Written Premiums
Ceded written premiums increased$51.7 million , or 51.1%, to$153.0 million for the nine months endedSeptember 30, 2021 from$101.3 million for the nine months endedSeptember 30, 2020 . The increase was primarily due to excess of loss ("XOL") reinsurance expense due to growth in exposure and additional charges resulting from Winter Storm Uri ("Uri"), which impacted our Specialty Homeowners and Commercial All Risk products 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 nine months
ended
associated with the reinstatement of our reinsurance program.
In addition to XOL increases, we had increased quota share cessions due to
growth in the volume of written premiums subject to quota shares.
31
Ceded written premiums as a percentage of gross written premiums increased to 39.7% for the nine months endedSeptember 30, 2021 from 39.2% for the nine months endedSeptember 30, 2020 . This increase was primarily due to XOL charges and a higher proportion of our written premiums being subject to quota shares.
Net Written Premiums
Net written premiums increased$75.3 million , or 47.9%, to$232.3 million for the nine months endedSeptember 30, 2021 from$157.0 million for the nine months endedSeptember 30, 2020 . The increase was primarily due to an increase in gross written premiums, primarily in our Commercial Earthquake, Inland Marine, and Residential Earthquake lines offset by increased ceded written premiums.
Net Earned Premiums
Net earned premiums increased$49.9 million , or 42.9%, to$166.0 million for the nine months endedSeptember 30, 2021 from$116.1 million for the nine months endedSeptember 30, 2020 due primarily to the earning of increased gross written premiums offset by the earning of ceded written premiums under reinsurance agreements. The table below shows the amount of premiums we earned on a gross and net basis and net earned premiums as a percentage of gross earned premiums in each period presented: Nine Months Ended September 30, 2021 2020 Change % Change ($ in thousands) Gross earned premiums$ 311,088 $ 215,266 $ 95,822 44.5 % Ceded earned premiums (145,100) (99,120) (45,980) 46.4 % Net earned premiums$ 165,988 $ 116,146 $ 49,842 42.9 % Net earned premium ratio 53.4% 54.0%
Commission and Other Income
Commission and other income increased by$0.2 million , or 9.8% to$2.7 million for the nine months endedSeptember 30, 2021 from$2.5 million for the nine months endedSeptember 30, 2020 . 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$15.6 million or 33.3% to$31.3 million for the nine months endedSeptember 30, 2021 from$46.9 million for the nine months endedSeptember 30, 2020 . Losses and loss adjustment expenses consisted of the following elements during the respective periods: Nine Months Ended September 30, 2021 2020 Change % Change ($ in thousands) Catastrophe losses$ 6,719 $ 36,512 $ (29,793) (81.6) % Non-catastrophe losses 24,569 10,389
14,180 136.5 %
Total losses and loss adjustment expenses
Our catastrophe loss ratio was 4.0% during the nine months endedSeptember 30, 2021 . Catastrophe losses included losses from Hurricanes Ida and Nicholas and Winter Storm Uri. These events impacted our Commercial All 32 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 catastrophe loss ratio was 31.4% during the nine months endedSeptember 30, 2020 . Catastrophe losses primarily included losses from Hurricanes Hanna, Isaias, Laura, Sally and Beta. Our non-catastrophe loss ratio was 14.8% for the nine months endedSeptember 30, 2021 compared to 8.9% during the nine months endedSeptember 30, 2020 . Non-catastrophe losses increased due mainly to higher attritional loss activity on lines of business subject to attritional losses such as Commercial All Risk, Specialty Homeowners, Flood, and Inland Marine.
Acquisition Expenses
Acquisition expenses increased$22.2 million , or 48.4%, to$68.1 million for the nine months endedSeptember 30, 2021 from$45.9 million for the nine months endedSeptember 30, 2020 . The increase was primarily due to higher earned premiums which resulted in higher commissions and premium-related taxes. Acquisition expenses as a percentage of gross earned premiums were 21.9% for the nine months endedSeptember 30, 2021 compared to 21.3% for the nine months endedSeptember 30, 2020 . Acquisition expenses as a percentage of gross earned premiums increased due to changes in business mix and changes in our Specialty Homeowners ceding arrangements which increased the percentage of premiums we retained and decreased our ceding commissions. Acquisition expenses as a percentage of gross earned premiums fluctuates based on mix of business produced and quota share arrangements in place.
Other Underwriting Expenses
Other underwriting expenses increased$14.7 million , or 59.5%, to$39.4 million for the nine months endedSeptember 30, 2021 from$24.7 million for the nine months endedSeptember 30, 2020 . The increase was primarily due to the Company incurring higher payroll, technology, stock-based compensation, and professional fees expenses associated with growth of the Company. In addition, during the first quarter of 2021, other underwriting expenses were significantly impacted by expenses associated with the issuance of a catastrophe bond. Other underwriting expenses as a percentage of gross earned premiums were 12.7% for the nine months endedSeptember 30, 2021 compared to 11.5% for the nine months endedSeptember 30, 2020 . Excluding the impact of expenses relating to transactions and stock offerings, stock-based compensation, amortization of intangibles and catastrophe bonds, other underwriting expenses as a percentage of gross earned premiums were 10.7% for the nine months endedSeptember 30, 2021 compared to 10.3% for the nine months endedSeptember 30, 2020 . Other underwriting expenses as a percentage of gross earned premiums may fluctuate period over period based on timing of certain expenses relative to premium growth.
Net Investment Income and Net Realized and Unrealized Gains (Losses) on
Investments
Net investment income increased$0.3 million , or 5.8%, to$6.6 million for the nine months endedSeptember 30, 2021 from$6.3 million for the nine months endedSeptember 30, 2020 . The increase was primarily due to a higher average balance of investments during the nine months endedSeptember 30, 2021 due primarily to proceeds from ourJune 2020 stock offering and the investing of our cash generated from operations, partially offset by lower yields on recently invested funds. 33
Net realized and unrealized gains on investments decreased$2.0 million , or 160.5%, to a$0.8 million loss for the nine months endedSeptember 30, 2021 from a$1.2 million gain for the nine months endedSeptember 30, 2020 due to unrealized losses on our equity securities during the period endedSeptember 30, 2021 . Currently, we mainly invest in investment grade fixed maturity securities, includingU.S. government issues, state government issues, mortgage and asset-backed obligations, and corporate bonds with a small portion of our portfolio invested in equity securities. The following table summarizes the components of our investment income for each period presented: Nine Months Ended September 30, 2021 2020 Change % Change ($ in thousands) Interest income$ 6,755 $ 6,242 $ 513 8.2 % Dividend income 261 354 (93) (26.3) %
Investment management fees and expenses (367) (309) (58) 18.8 % Net investment income 6,649 6,287 362 5.8 % Net realized and unrealized gains (losses) on investments (752) 1,243 (1,995) (160.5) % Total$ 5,897 $ 7,530 $ (1,633) (21.7) % Income Tax Expense
Income taxes increased by$6.0 million to$6.5 million for the nine months endedSeptember 30, 2021 from$0.5 million for the nine months endedSeptember 30, 2020 . During the nine months endedSeptember 30, 2021 , our income tax rate of 18.3% differed from the statutory rate of 21% due primarily to the tax impact of the permanent component of employee stock option exercises. For the nine months endedSeptember 30, 2020 our income tax rate of 6.1% differed from the statutory rate of 21% also due primarily to the tax impact of the permanent component of employee stock option exercises.
Reconciliation of Non-GAAP Financial Measures
Underwriting Revenue
We define underwriting revenue as total revenue excluding net investment income
and net realized and unrealized gains and losses on investments. Underwriting
revenue represents revenue generated by our underwriting operations and allows
us to evaluate our underwriting performance without regard to investment
results. We use this metric as we believe it gives our management and other
users of our financial information useful insight into our underlying business
performance. Underwriting revenue should not be viewed as a substitute for total
revenue calculated in accordance with GAAP, and other companies may define
underwriting revenue differently.
Total revenue calculated in accordance with GAAP reconciles to underwriting
revenue as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
2021 2020 2021 2020
(in thousands) (in thousands)
Total revenue $ 67,661 $ 44,998 $ 174,620 $ 126,167
Net investment income (2,236) (2,138) (6,649) (6,287)
Net realized and unrealized (gains) losses on
investments 313 (24) 752 (1,243)
Underwriting revenue $ 65,738 $ 42,836 $ 168,723 $ 118,637
Underwriting Income
We define underwriting income as income before income taxes excluding net
investment income and net realized and unrealized gains and losses on
investments. Underwriting income represents the pre-tax profitability of our
underwriting operations and allows us to evaluate our underwriting performance
without regard to investment results.
34
We use this metric as we believe it gives our management and other users of our
financial information useful insight into our underlying business performance.
Underwriting income should not be viewed as a substitute for pre-tax income
calculated in accordance with GAAP, and other companies may define underwriting
income differently.
Income before income taxes calculated in accordance with GAAP reconciles to
underwriting income as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
2021 2020 2021 2020
(in thousands) (in thousands)
Income (loss) before income taxes$ 122 $ (21,843) $ 35,744 $ 8,625 Net investment income (2,236) (2,138) (6,649) (6,287) Net realized and unrealized (gains) losses on investments 313 (24) 752 (1,243) Underwriting income (loss)$ (1,801) $ (24,005)
$ 29,847 $ 1,095
Adjusted Net Income (loss)
We define adjusted net income as net income excluding the impact of certain
items that may not be indicative of underlying business trends, operating
results, or future outlook, net of tax impact. 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. We use adjusted net income 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 net income does not reflect the
overall profitably of our business and should not be viewed as a substitute for
net income calculated in accordance with GAAP. Other companies may define
adjusted net income differently.
Net income calculated in accordance with GAAP reconciles to adjusted net income
as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
2021 2020 2021 2020
(in thousands) (in thousands)
Net income (loss) $ 246 $ (15,685) $ 29,215 $ 8,102
Adjustments:
Expenses associated with transactions and stock
offerings - - 411 708
Stock-based compensation expense 1,525 551 3,370 1,457
Amortization of intangibles 115 - 704 -
Expenses associated with catastrophe bond, net
of rebate - - 1,698 399
Tax impact (166) (101) (1,156) (534)
Adjusted net income (loss) $ 1,720 $ (15,235) $ 34,242 $ 10,132
Annualized Adjusted Return on Equity
We define adjusted return on equity as adjusted net income expressed on an
annualized basis as a percentage of average beginning and ending stockholders'
equity during the period. 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.
35
Annualized adjusted return on equity is calculated as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
2021 2020 2021 2020
($ in thousands) ($ in thousands)
Annualized adjusted net income$ 6,880 $ (60,940) $ 45,656 $ 13,509 Average stockholders' equity$ 377,260 $ 368,568 $ 370,745 $ 290,225 Annualized adjusted return on equity 1.8 % (16.5) %
12.3 % 4.7 % Adjusted Combined Ratio We define adjusted combined ratio as the sum of the loss ratio and the expense ratio calculated excluding the impact of certain items that may not be indicative of underlying business trends, operating results, or future outlook. We use adjusted combined ratio 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 combined ratio should not be viewed as a substitute for combined ratio calculated using unadjusted GAAP numbers, and other companies may define adjusted combined ratio differently.
Adjusted combined ratio is calculated as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
2021 2020 2021 2020
($ in thousands) ($ in thousands)
Numerator: Sum of losses and loss adjustment
expenses, acquisition expenses, and other
underwriting expenses, net of commission and
other income $ 66,521 $ 66,025 $ 136,141 $ 115,050
Denominator: Net earned premiums $ 64,720 $ 42,020 $ 165,988 $ 116,145
Combined ratio 102.8 % 157.1 % 82.0 % 99.1 %
Adjustments to numerator:
Expenses associated with transactions and
stock offerings $ - $ - $ (411) $ (708)
Stock-based compensation expense (1,525) (551) (3,370) (1,457)
Amortization of intangibles (115) - (704) -
Expenses associated with catastrophe bond,
net of rebate - - (1,698) (399)
Adjusted combined ratio 100.2 % 155.8 % 78.3 % 96.8 %
Diluted Adjusted Earnings Per share
We define diluted adjusted earnings per share as adjusted net income divided by
the weighted-average common shares outstanding for the period, reflecting the
dilution which could occur if equity-based awards are converted into common
share equivalents as calculated using the treasury stock method. We use diluted
adjusted earnings per share 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. Diluted adjusted earnings per share should not be viewed
as a substitute for diluted earnings per share calculated in accordance with
GAAP, and other companies may define diluted adjusted earnings per share
differently.
36
Diluted adjusted earnings per share is calculated as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
2021 2020 2021 2020
(in thousands, except per share data) (in thousands, except per share data)
Adjusted net income (loss) $ 1,720 $ (15,235) $ 34,242 $ 10,132 Weighted-average common shares outstanding, diluted$ 26,043,680 25,492,274 26,133,664 25,384,518 Diluted adjusted earnings per share $ 0.07 $
(0.60) $ 1.31 $ 0.40 Catastrophe Loss Ratio
Catastrophe loss ratio is defined as the ratio of catastrophe losses to net earned premiums. Although we are inherently subject to catastrophe losses, the frequency and severity of catastrophe losses is unpredictable and their impact on our operating results may vary significantly between periods and obscure other trends in our business. Therefore, we are providing this metric because we believe it gives our management and other financial statement users useful insight into our results of operations and trends in our financial performance without the volatility caused by catastrophe losses. Catastrophe loss ratio should not be viewed as a substitute for loss ratio calculated using unadjusted GAAP numbers, and other companies may define catastrophe loss ratio differently
Catastrophe loss ratio is calculated as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
2021 2020 2021 2020
($ in thousands) ($ in thousands)
Numerator: Losses and loss adjustment expenses$ 28,475 $ 41,060 $ 31,288 $ 46,901 Denominator: Net earned premiums$ 64,720 $ 42,020
$ 165,988 $ 116,145 Loss ratio 44.0 % 97.7 % 18.8 % 40.4 % Numerator: Catastrophe losses$ 17,487 $ 36,512 $ 6,719 $ 36,512
Denominator: Net earned premiums$ 64,720 $ 42,020
$ 165,988 $ 116,145 Catastrophe loss ratio 27.0 % 86.9 % 4.0 % 31.4 %
Adjusted Combined Ratio Excluding Catastrophe Losses
Adjusted combined ratio excluding catastrophe losses is defined as adjusted
combined ratio excluding the impact of catastrophe losses. Although we are
inherently subject to catastrophe losses, the frequency and severity of
catastrophe losses is unpredictable and their impact on our operating results
may vary significantly between periods and obscure other trends in our business.
Therefore, we are providing this metric because we believe it gives our
management and other financial statement users useful insight into our results
of operations and trends in our financial performance without the volatility
caused by catastrophe losses. Adjusted combined ratio excluding catastrophe
losses should not be viewed as a substitute for combined ratio calculated using
unadjusted GAAP numbers, and other companies may define adjusted combined ratio
excluding catastrophe losses differently.
37
Adjusted combined ratio excluding catastrophe losses is calculated as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
2021 2020 2021 2020
($ in thousands) ($ in thousands)
Numerator: Sum of losses and loss
adjustment expenses, acquisition expenses,
and other underwriting expenses, net of
commission and other income $ 66,521 $ 66,025 $ 136,141 $ 115,050
Denominator: Net earned premiums $ 64,720 $ 42,020 $ 165,988 $ 116,145
Combined ratio 102.8 % 157.1 % 82.0 % 99.1 %
Adjustments to numerator:
Expenses associated with transactions and
stock offerings $ - $ - $ (411) $ (708)
Stock-based compensation expense (1,525) (551) (3,370) (1,457)
Amortization of intangibles (115) - (704) -
Expenses associated with catastrophe bond,
net of rebate - - (1,698) (399)
Catastrophe losses (17,487) (36,512) (6,719) (36,512)
Adjusted combined ratio excluding
catastrophe losses 73.2 % 68.9 % 74.2 % 65.4 %
Tangible Stockholders' Equity
We define tangible stockholders' equity as stockholders' equity less intangible
assets. Our definition of tangible stockholders' equity may not be comparable to
that of other companies, and it should not be viewed as a substitute for
stockholders' equity calculated in accordance with GAAP. We use tangible
stockholders' equity internally to evaluate the strength of our balance sheet
and to compare returns relative to this measure.
Stockholders' equity calculated in accordance with GAAP reconciles to tangible
stockholders' equity as follows:
September 30, December 31,
2021 2020
(in thousands)
Stockholders' equity $ 377,777 $ 363,713
Intangible assets (10,512) (11,512)
Tangible stockholders' equity $ 367,265 $ 352,201
Liquidity and Capital Resources
Sources and Uses of Funds
We operate as a holding company with no business operations of our own. Consequently, our ability to pay dividends to stockholders and pay taxes and administrative expenses is largely dependent on dividends or other distributions from our subsidiaries and affiliates, whose ability to pay us is highly regulated.
The Company's
restricted by the statutes as to the amount of dividends that they may pay
without prior approval by state insurance commissioners.
UnderCalifornia andOregon statute which govern PSIC, dividends paid in a consecutive twelve month period cannot exceed the greater of (i) 10% of an insurance company's statutory policyholders' surplus as ofDecember 31 of the preceding year or (ii) 100% of its statutory net income for the preceding calendar year. Any dividends or distributions in excess of these amounts would require regulatory approval. In addition, underOregon statute PSIC may only declare a dividend from earned surplus, which does not include contributed capital. Surplus arising from unrealized 38 capital gains or revaluation of assets is not considered part of earned surplus. Based on the above restrictions, PSIC may pay a dividend or distribution of no greater than$11.3 million in 2021 without approval by theCalifornia andOregon Insurance Commissioners.
Under
twelve month period cannot exceed the lesser of (i) 10% of an insurance
company's statutory policyholders' surplus as of
preceding year or (ii) 100% of its statutory net income for the preceding
calendar year. As such, PESIC is unable to pay a dividend or distribution in
2021 without the approval of the Arizona Insurance Commissioner as it had a
statutory net loss in 2020.
State insurance regulators have broad powers to prevent the reduction of statutory surplus to inadequate levels, and there is no assurance that dividends up to the maximum amounts calculated under any applicable formula would be permitted. In addition, state insurance regulators may adopt statutory provisions and dividend limitations more restrictive than those currently in effect in the future.Bermuda regulations limit the amount of dividends and return of capital paid by a regulated entity. A Class 3A insurer is prohibited from declaring or paying a dividend if it is in breach of its minimum solvency margin, its enhanced capital requirement, or its minimum liquidity ratio, or if the declaration or payment of such dividend would cause such a breach. If a Class 3A insurer has failed to meet its minimum solvency margin on the last day of any financial year, it will also be prohibited, without the approval of the BMA, from declaring or paying any dividends during the next financial year. Furthermore, the Insurance Act limits the ability of PSRE to pay dividends or make capital distributions by stipulating certain margin and solvency requirements and by requiring approval from the BMA prior to a reduction of 15% or more of a Class 3A insurer's total statutory capital as reported on its prior year statutory balance sheet. Moreover, an insurer must submit an affidavit to the BMA, sworn by at least two directors and the principal representative inBermuda of the Class 3A insurer, at least seven days prior to payment of any dividend which would exceed 25% of that insurer's total statutory capital and surplus as reported on its prior year statutory balance sheet. The affidavit must state that in the opinion of those swearing the declaration of such dividend has not caused the insurer to fail to meet its relevant margins. Further, under the Companies Act, PSRE may only declare or pay a dividend, or make a distribution out of contributed surplus, if it has no reasonable grounds for believing that: (1) it is, or would after the payment be, unable to pay its liabilities as they become due or (2) the realizable value of its assets would be less than its liabilities.
Cash Flows
Our primary sources of cash flow are written premiums, investment income, reinsurance recoveries, sales and redemptions of investments, and proceeds from offerings of equity securities. We use our cash flows primarily to pay reinsurance premiums, operating expenses, losses and loss adjustment expenses, and income taxes. We also have implemented a share repurchase plan and have used and may use our cash in the future to purchase outstanding shares of our common stock. The program authorizes the repurchase by us of up to$40 million of our outstanding shares of common stock through the period ending onMarch 31, 2023 . We purchased 239,096 shares for$15.8 million under this program during the nine months endedSeptember 30, 2021 .
Our cash flows from operations may differ substantially from our net income due
to non-cash charges or due to changes in balance sheet accounts.
The timing of our cash flows from operating activities can also vary among
periods due to the timing by which payments are made or received. Some of our
payments and receipts, including loss settlements and subsequent reinsurance
receipts, can be significant. Therefore, their timing can influence cash flows
from operating activities in any given period. The potential for a large claim
under an insurance or reinsurance contract means that our insurance subsidiaries
may need to make substantial payments within relatively short periods of time,
which would have a negative impact on our operating cash flows.
39
Management believes that our current liquidity and cash receipts from written
premiums, investment income, proceeds from investment sales and redemptions, and
reinsurance recoveries, if necessary, are sufficient to cover cash outflows for
each of the Company's insurance subsidiaries in the foreseeable future.
The following table summarizes our cash flows for the nine months ended
September 30, 2021 and 2020:
Nine months ended
September 30,
2021 2020
($ in thousands)
Cash provided by (used in):
Operating activities $ 33,418 $ 44,170
Investing activities (12,193) (191,351)
Financing activities (13,377) 128,028
Change in cash, cash equivalents, and restricted cash
Our cash flow from operating activities was positive during the nine months
ended
operating assets.
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 endedSeptember 30, 2021 and 2020 related primarily to purchases of fixed maturity and equity securities in excess of sales and maturities. Cash used in financing activities for nine months endedSeptember 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 provided by financing activities for nine months endedSeptember 30, 2020 was related to the receipt of$35.5 million in net proceeds from theJanuary 2020 stock offering, the receipt of$90.1 million in net proceeds from theJune 2020 stock offering, the receipt of$0.7 million in proceeds related to the issuance of common stock via our employee stock purchase plan, and the receipt of$1.7 million related to the issuance of common stock via stock option exercises. We do not have any current plans for material capital expenditures other than current operating requirements. We believe that we will generate sufficient cash flows from operations to satisfy our liquidity requirements for at least the next 12 months and beyond. 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$467.0 million in cash and investment securities available atSeptember 30, 2021 . We also have the ability to access additional capital through pursuing third-party borrowings, sales of our equity or debt securities or entrance into a reinsurance arrangement.
Stockholders' Equity
AtSeptember 30, 2021 total stockholders' equity was$377.8 million and tangible stockholders' equity was$367.3 million , compared to total stockholders' equity of$363.7 million and tangible stockholders' equity of$352.2 million as ofDecember 31, 2020 . Stockholder's equity increased primarily due to net income, issuance of common stock and stock-based compensation from our equity compensation plans offset by unrealized losses on fixed maturity securities and repurchases of shares of our common stock.
Tangible stockholders' equity is a non-GAAP financial measure. See
"Reconciliation of Non-GAAP Financial Measures" for a reconciliation of
stockholders' equity in accordance with GAAP to tangible stockholders' equity.
40
Investment Portfolio
Our primary investment objectives are to maintain liquidity, preserve capital
and generate a stable level of investment income. We purchase securities that we
believe are attractive on a relative value basis and seek to generate returns in
excess of predetermined benchmarks. Our Board of Directors approves our
investment guidelines in compliance with applicable regulatory restrictions on
asset type, quality and concentration. Our current investment guidelines allow
us to invest in taxable and tax-exempt fixed maturities, as well as publicly
traded mutual funds and common stock of individual companies. Our cash and
invested assets consist of cash and cash equivalents, fixed maturity securities,
and equity securities. As of September 30, 2021 , the majority of our investment
portfolio, or $408.0 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 $17.4 million of equity securities. In addition,
we maintained a non-restricted cash and cash equivalent balance of $41.4 million
at September 30, 2021 . Our fixed maturity securities, including cash
equivalents, had a weighted average effective duration of 4.04 and 3.96 years
and an average rating of "A2/A" and "A2/A" at September 30, 2021 and
December 31, 2020 , respectively. Our fixed income investment portfolio had a
book yield of 2.19% as of September 30, 2021 , compared to 2.27% as of
December 31, 2020 .
At
available-for-sale securities were as follows:
Amortized Fair % of Total
September 30, 2021 Cost or Cost Value Fair Value
($ in thousands)
Fixed maturities:
U.S. Governments $ 18,965 $ 19,311 4.7 %
States, territories, and possessions 6,171 6,401 1.6 %
Political subdivisions 1,494 1,588 0.4 %
Special revenue excluding mortgage/asset-backed securities 43,376 44,430 10.9 %
Corporate and other 248,480 255,100 62.5 %
Mortgage/asset-backed securities 79,469 81,216 19.9 %
Total available-for-sale investments $ 397,955 $ 408,046 100.0 %
Amortized Fair % of Total
December 31, 2020 Cost or Cost Value Fair Value
($ in thousands)
Fixed maturities:
U.S. Governments $ 16,308 $ 17,059 4.3 %
States, territories, and possessions 6,208 6,636 1.7 %
Political subdivisions 2,027 2,152 0.5 %
Special revenue excluding mortgage/asset-backed securities 39,704 41,227 10.4 %
Corporate and other 234,049 245,360 61.6 %
Mortgage/asset-backed securities 82,983 85,553 21.5 %
Total available-for-sale investments $ 381,279 $ 397,987 100.0 %
41
The following tables provide the credit quality of investment securities as of
Estimated % of
September 30, 2021 Fair Value Total
($ in thousands)
Rating
AAA $ 82,447 20.2 %
AA 55,101 13.5 %
A 165,302 40.5 %
BBB 91,426 22.4 %
BB 10,097 2.5 %
NR 3,673 0.9 %
$ 408,046 100.0 %
Estimated % of
December 31, 2020 Fair Value Total
($ in thousands)
Rating
AAA $ 91,156 22.9 %
AA 54,342 13.7 %
A 149,977 37.7 %
BBB 88,817 22.3 %
BB 11,425 2.9 %
NA/NR 2,270 0.5 %
$ 397,987 100.0 %
The amortized cost and fair value of our available-for-sale investments in fixed maturity securities summarized by contractual maturity as ofSeptember 30 ,
2021
were as follows:
Amortized Fair % of Total
September 30, 2021 Cost Value Fair Value
($ in thousands)
Due within one year $ 27,733 $ 27,927 6.8 %
Due after one year through five years 134,550 137,757 33.8 %
Due after five years through ten years 112,259 116,275 28.5 %
Due after ten years 43,944 44,871 11.0 %
Mortgage and asset-backed securities 79,469 81,216 19.9 %
$ 397,955 $ 408,046 100.0 %
Expected maturities may differ from contractual maturities because borrowers may
have the right to call or prepay obligations.
Reinsurance
We purchase a significant amount of reinsurance from third parties that we
believe enhances our business by reducing our exposure to potential catastrophe
losses, limiting volatility in our underwriting performance, and providing us
with greater visibility into our future earnings. Reinsurance involves
transferring, or ceding, a portion of our risk exposure on policies that we
write to another insurer, the reinsurer, in exchange for a premium. To the
extent that our reinsurers are unable to meet the obligations they assume under
our reinsurance agreements, we remain liable for the entire insured loss; see
"Risk Factors-Risks Related to Our Business and Industry-We may be unable to
purchase third-party reinsurance or otherwise expand our catastrophe coverage in
amounts we desire on commercially acceptable terms or on terms that adequately
protect us, and this inability may materially adversely affect our business,
financial condition and results of operations."
42
We use treaty reinsurance and, on a limited basis, facultative reinsurance
coverage. Treaty coverage refers to a reinsurance contract that is applied to a
group or class of business where all the risks written meet the criteria for
that class. Our treaty reinsurance program primarily consists of catastrophe
excess of loss ("XOL") coverage, in which the reinsurer(s) agree to assume all
or a portion of the ceding company's losses relating to a group of policies
occurring in relation to specified events, subject to customary exclusions, in
excess of a specified amount. Additionally, we buy program specific reinsurance
coverage for specific lines of business on a quota share, property per risk or a
facultative basis. In quota share reinsurance, 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. Property per risk coverage is similar to catastrophe XOL
coverage except that the treaty applies in individual property losses rather
than in the aggregate for all claims associated with a single catastrophic loss
occurrence. Facultative coverage refers to a reinsurance contract on individual
risks as opposed to a group or class of business. We use facultative reinsurance
selectively to supplement limits or to cover risks or perils excluded from other
reinsurance contracts.
We have a robust program utilizing a mix of traditional reinsurers and insurance
linked securities. We currently purchase reinsurance from over 90 reinsurers,
who either have an "A-" (Excellent) (Outlook Stable) or better financial
strength rating by A.M. Best or post collateral. Our reinsurance contracts
include special termination provisions that allow us to cancel and replace any
participating reinsurer that is downgraded below a rating of "A-" (Excellent)
(Outlook Stable) from A.M. Best , or whose surplus drops by more than 20%.
In addition to reinsurance purchased from traditional reinsurers, we have
historically incorporated collateralized protection from the insurance linked
securities market (e.g. catastrophe bonds). During the first quarter of 2021,
the Company closed a $400 million 144A catastrophe bond which became effective
June 1, 2021 . The catastrophe bond was completed through Torrey Pines Re Pte.
Ltd. ("Torrey Pines Re"). Torrey Pines Re. is a special purpose insurer
established in Singapore whereby Torrey Pines Re provides Palomar with
indemnity-based reinsurance covering earthquake events.
Our catastrophe event retention is currently $12.5 million for all perils. Our
reinsurance coverage exhausts at $1.68 billion for earthquake events and $700
million for hurricane events, providing coverage in excess of our 1:250 year
peak zone PML and in excess of our A.M. Best requirement. In addition, we
maintain reinsurance coverage equivalent to or better than the 1 in 250 year PML
for our other lines.
In the event that multiple catastrophe events occur in a period, many of our
contracts include the right to reinstate reinsurance limits for potential future
recoveries during the same contract year and preserve our limit for subsequent
events. This feature for subsequent event coverage is known as a
"reinstatement." In addition, to provide further coverage against the potential
for frequent catastrophe events we have secured $25 million of aggregate XOL
reinsurance limit effective April 1, 2021 . This coverage, applying within our
per occurrence retention, has an attachment point of $30 million and applies
across all perils including but not limited to earthquakes, hurricanes,
convective storms, and floods above a qualifying level of $2.0 million in
ultimate gross loss.
Critical accounting estimates
We identified the accounting estimates which are critical to the understanding of our financial position and results of operations. Critical accounting estimates are defined as those estimates that are both important to the portrayal of our financial condition and results of operations and require us to exercise significant judgment. We use significant judgment concerning future results and developments in applying these critical accounting estimates and in preparing our condensed consolidated financial statements. These judgments and estimates affect our reported amounts of assets, liabilities, revenues and expenses and the disclosure of our material contingent assets and liabilities. Actual results may differ materially from the estimates and assumptions used in preparing the condensed consolidated financial statements. We evaluate our estimates regularly using information that we believe to be relevant. Our critical accounting policies and estimates are described in our annual consolidated financial statements and the related notes in our 2020 Annual
Report on Form 10-K.
43
There have been no significant changes in our critical accounting policies and estimates as compared to the critical accounting policies and estimates disclosed in Management's Discussion and Analysis of Financial Condition and Operations included in our 2020 Annual Report on Form 10-K
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