Palomar Holdings Inc

NASDAQ:PLMR

Earnings Call Transcript 2022-Q1

[Operator]

Greetings and welcome to the Palomar Holdings Incorporated First Quarter 2022 Earnings Conference Call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference line will be open for questions with instructions to follow at that time. As a reminder, this conference is being recorded.

I would now like to turn the call over to Mr. Chris Uchida, Chief Financial Officer. Please go ahead sir.

[Chris Uchida, Chief Financial Officer]

Thank you, operator, and good morning, everyone. We appreciate your participation in our first quarter 2022 earnings call. With me here today is Mac Armstrong, our Chairman, Chief Executive Officer and Founder. As a reminder, a telephonic replay of this call will be available on the Investor Relation section of our website through 11:59 p.m. Eastern Time on May 12, 2022.

Before we begin, let me remind everyone that this call may contain certain statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These include remarks about management's future expectations, beliefs, estimates, plans and prospects. Such statements are subject to a variety of risks uncertainties and other factors that could cause actual results to differ materially from those indicated or implied by such statements, including, but not limited to risks and uncertainties related to the COVID-19 pandemic. Such risks and other factors are set forth in our annual report on Form 10-K filed with the Securities and Exchange Commission. We do not undertake any duty to update such forward-looking statements.

Additionally, during today's call, we will discuss certain non-GAAP measures, which we believe are useful in evaluating our performance. The presentation of this additional information should not be considered in isolation or as a substitute for results prepared in accordance with US GAAP. A reconciliation of these non-GAAP measures to their most comparable GAAP measure can be found in our earnings release.

At this point, I'll turn the call over to Mac.

[Mac Armstrong, Chairman, Chief Executive Officer & Founder]

Thank you, Chris, and good morning, everyone. Today, I'll provide review of our strong first quarter results and an update on the progress achieved executing our near and long-term strategic initiatives. Now if we put is a very good quarter for Palomar as our top line surged more than 60%. We earned $17.6 million of adjusted net income inclusive of a $1.3 million realized and unrealized loss from our equity holdings and generated an adjusted ROE of 18.1%. Obviously, Chris will review these results in more detail, but I wanted to cut the chase before I went into my remarks.

When we began the year, we outlined four strategic priorities for 2022. One, generating strong premium growth; two, monetizing the new investments made over the course of 2021; three, sustained delivery of consistent and predictable earnings; and four, scaling our organization. I'm quite happy to report that we made strong progress across all four initiatives during the quarter and I'd like to spend a few minutes updating you on each.

As it pertains to written premium growth, the first quarter is another stat example of our ability to sustain top line growth. In the first quarter, gross written premiums increased 65% as compared to the first quarter of 2021, driven by continued strength in residential and commercial earthquake as well as in our E&S business, Palomar Excess and Surplus Insurance Company.

Looking at our lines of business in more detail, I will start with our earthquake franchise. Our total earthquake book grew 24% in the first quarter with Commercial Earthquake growing 18% and residential earthquake, our largest line of business growing 29%. Several factors drove the growth in the residential earthquake line including, but not limited to a new partnership with Progressive the continued dislocation in the California homeowners' market and the California Earthquake Authority, officially stating they are reducing their reinsurance purchase by the equivalent of $1 billion.

These factors along with our existing marketing efforts led to record new business sales for residential earthquake in the first quarter. The partnership with Progressive is one I'm excited about, as it is a solution to provide progressive homeowners policyholders outside of California with a comprehensive earthquake solution be an assumed reinsurance arrangement. We're thrilled to partner with Progressive and optimistic on the potential for this relationship.

As it pertains to the CEA, we believe the continued uncertainty regarding their claims paying capacity provide considerable room for continued strong growth in this important and profitable line of business. Beyond earthquake, other product lines performing well in the first quarter include in the Marine which grew premiums 133% year-over-year and is now our fourth largest line. Commercial all risk grew 37% year-over-year with a large majority of the growth coming from rate increases as opposed to exposure. Flood premiums grew 31% year-over-year and National Flood Insurance programs Risk rating 2.0 starts to influence market conditions.

As previously discussed, the NFIP rating action will likely generate a material price increase in renewal, which we believe creates opportunity for Palomar to capture market share as we work through the year. As it pertains to our nascent casualty franchise, our real estate errors and emissions program is a standout as it continues to grow rapidly with year-over-year growth of 151%.

Shifting to our E&S business, Palomar Access and Surplus Insurance Company had another strong quarter generating $41 million of gross written premium representing 71% written premium growth year-over-year. Inclusive of our fronting business, the gross written premium was $67 million. PESIC's growth was primarily driven by its main products namely Commercial Earthquake, National Layered and Shared Commercial Property and builders risk. Our recently launched E&S products including professional liability, excess liability and contractors liability are beginning to ramp and we expect them to be significant contributors to our growth. PESIC continues to be an important growth driver for Palomar and we believe the business can become 50% of our premium over time.

Our second 2022 strategic priority is monetizing the investments made over the last year or so in new products and businesses. Along these lines, I'm very pleased with the initial success of Palomar Front. Launched in September, Palomar Front achieved almost $30 million in gross written premiums in the first quarter. One of its initial success story is a fronting program for an innovative cyber MGA in a world-class panel of reinsurers that have gained strong traction in the market and are taking advantage of the remarkably hard market pricing environment in the cyber market.

On the whole, our fronting programs are performing well from an underwriting and collateral perspective and we continue to believe that adding a fee-based revenue stream to our business will further fortify our earnings base. Given our strong start to the year, we remain confident in our goal building the fronting business to $80 million to $100 million of managed premiums this year.

We are also pleased with the progress that our newly hired underwriters are making as they build their franchises in segments like general, casualty, professional, liability and non-catastrophe exposed excess property. While still in the early stages of formation, these businesses will be important growth drivers for Palomar in the year ahead.

That said, our focus over the first half of 2022 is to thoughtfully build these businesses while the necessary talent, infrastructure and support to enable our underwriters to scale their franchises. During the quarter, considerable efforts were made in the procurement of quota share reinsurance, distribution network build-out and the development of systems forms and filed, while the premium generated in the first quarter was modest, we're encouraged with the quality of business bound.

The third strategic priority is focusing on earnings predictability and reducing volatility in our results. While growth is certainly a priority, we are also laser-focused on growing profitably and properly managing the risk in our portfolio. Along these lines, we took three important steps during the first quarter to achieve this goal.

First, we renewed our aggregate reinsurance program and in the process move the floor on our adjusted ROE from 10% to 14%. We believe this program creates real value for our shareholders by essentially coloring the downside of our financial results.

Second, we successfully placed new quota shares for our new professional lines and casualty products. These quota shares allow us to walk before we run as we conservatively build the books of business for these important new lines. They not only reduce our net limit exposed to an account and the impact of the shock loss on a nascent book, but also permit us to generate fee income.

The architecture of the quota shares enable us to proceed cautiously. And if we write to a 90 combined ratio, generate half of the products income from ceding commissions and half from underwriting, a further demonstration of our focus on fee income and earnings predictability. As an example, taking professional liability program where we assume 25% of the risk and see now 75%. We will earn a 10-point margin on 25% of risk that we underwrite assuming a 90% combined ratio. We will then earn a 5% override in excess of our costs on the 75% of ceded premium. So the majority of our profits come from ceding commission.

Third, we continue to reduce our continental wind exposure. Our non-Texas homeowners business is now officially in runoff and we are not growing the exposure of our national layered and shared commercial property business.

Our fourth strategic priority is scaling the organization. What makes our platform so attractive to new hires is that we can offer them industry-leading technology and infrastructure, combined with the wealth of talent and expertise that affords our new underwriters the opportunity to build a platform capable of delivering our products and services in the fastest most efficient way possible. Competitive advantage is a strong selling point to experience talent in our industry. Our insurance in the casualties being led by market experts with strong track records of success we saw Palomar as an attractive platform to build their business.

We continue to bolster the analytical actuarial technology and operating expertise to support our growth. Key hires this quarter included Eric Hennen, VP of Analytics who formally helped lead the property analytics team of a global reinsurance broker and Ben Markowski [ph] another actuarial fellow to augment our budding casualty franchise. As you can see we have made significant stride executing our strategic initiatives in the first quarter as we strive to position Palomar for sustainable growth, predictable earnings, and reduced volatility.

At this point, I'd like to spend a few minutes updating you on what we are seeing in the market. From a pricing standpoint, we are seeing sustained rate increases across all lines and pockets of business where rate increases are accelerating. In commercial earthquake, the average rate increase ticked up from the fourth quarter of 2021 as rate increases moved up from approximately 5% to 7% in the quarter. We expect further hardening for the next few quarters in this line of business.

As previously mentioned, we are not looking to grow the exposures in our wind-exposed national layered and shared commercial property business as we believe we can generate sufficient growth from rate. For this line of business, we experienced risk-adjusted rate increases of 22% year-over-year with over 14% risk-adjusted rate strengthening in Q1 alone. This market is becoming increasingly dislocated as the reinsurance market hardens and we are generally seeing continued rate increases combined with improved terms and conditions.

As it pertains to inflation in addition to the use of third-party license data, we can leverage our builders risk program that audits construction projects on a monthly basis to inform our perspective on the cost of materials and labor. We are incorporating these factors into our underwriting and marrying them with rate increases and higher inflation guards.

For personal lines like residential earthquake, we increased the inflation guards from our historical level of 5% to 8% this year. While our casualty lines remain in our infancy, and therefore, don't offer much in the way of renewal price increase commentary, we are getting rate increases of approximately 5% to 7% on expiring terms with certain segments of professional lines and general liability seeing greater increase.

Turning to our 6/1 reinsurance renewal. We are currently in the market placing our program and believe the combination of rate increases, and reduction in our continental hurricane exposure pretend to successful renewal. While it is undoubtedly a hard reinsurance market, our unique program that includes ILS market support remained appealing to reinsurers and ILS investors. We are more than 60% placed at this point, and expect to finalize the placement shortly. We will provide an update to the market when the placement is complete.

Turning to capital allocation. We will continue to see operating leverage in our business model and financial metrics, as we scale. Additionally, we are generating cash from operations, which provide sufficient capital to fund our growth initiatives while providing ample room to execute on our $100 million share repurchase program. As a result, we were active with our repurchase program as we saw and continue to see our shares at levels, we believe are undervalued especially, in light of the numerous growth vectors in our business and the adjusted ROE flow of 14%.

To conclude, we are very pleased with our results and the momentum in our business, as we look out to the remainder of the year. We are reiterating guidance for the full-year 2022 where we expect to generate between $80 million and $85 million of adjusted net income representing 54% year-over-year growth and an adjusted ROE of 19%. This range factors in the additional investments that we need to make in talent systems infrastructure, the current projected cost of reinsurance and the unrealized losses on equity securities in the quarter.

With that, I'll turn the call over to Chris, to discuss our results in more detail.

[Chris Uchida, Chief Financial Officer]

Thank you, Mac. Please note that during my portion when referring to any per share figure, I'm referring to per diluted common shares calculated using the treasury stock method. This methodology requires us to include common share equivalents such as outstanding stock options, during profitable periods and exclude them in periods when we incur a net loss. We have adjusted the calculations accordingly. For the first quarter of 2022, our net income was $14.5 million or $0.56 per share compared to net income of $16.6 million or $0.63 per share, for the same quarter in 2021.

Our adjusted net income was $17.6 million or $0.68 per share compared to adjusted net income of $19.3 million or $0.73 per share for the same quarter of 2021. As we compare to the prior year results, it is important to remember the impact Winter Storm Uri had on our results for the first and second quarters of 2021. While Uri resulted in favorable net losses in the first quarter of 2021 we did impair additional reinsurance expense or see written premiums, in the first and second quarters of 2021.

Gross written premiums for the first quarter were $170.9 million, an increase of 65% compared to the prior year's first quarter. This continued strong growth was driven by a combination of increases in premiums across our core products, as well as, gained momentum in our recently entered lines such as fronting. Ceded written premiums for the first quarter, were $89.6 million representing, an increase of 106.5% compared to the prior year's first quarter. This increase was primarily from quota share reinsurance from our new fronting business, as well as, increased catastrophe ex-oil reinsurance related to the exposure growth.

Ceded written premiums as a percentage of gross written premiums increased to 52.4% for the three months ended March 31st 2022, from 41.9% for the three months ended March 31st 2022. Our new fronting business was the primary driver of the increase in this percentage, slightly offset by the decrease in SLR [ph] percentage compared to last year that included the impact of Uri. We believe the ratio of net earned premiums to gross earned premiums, were a better metric for assessing our business versus the ratio of net written premiums to gross written premiums.

Net earned premiums for the first quarter were $76 million an increase of 61.6% compared to the prior year's first quarter. This increase is due to the growth in earning of higher gross written premiums offset by the growth in earning of IRC and written premiums under reinsurance agreements. For the first quarter of 2022, net earned premiums as a percentage of gross earned premiums were 54.7% compared to 51.5% in the first quarter of 2021 and compared sequentially to 55.2% in the fourth quarter of 2021.

As previously indicated, the launch and expected growth of our fronting business could push this ratio below 50%, on an annual basis that will add consistent fee income that will enhance our ROE and bottom line. Losses and loss adjustment expenses incurred for the first quarter, were $15 million due to attritional losses of $14.5 million and unfavorable prior year catastrophe loss development of $0.5 million. The loss ratio for the quarter was 19.7% comprised of an attritional loss ratio of 19.1% and a catastrophe loss ratio of 0.6%.

Our expense ratio for the first quarter of 2022 was 56.8% compared to 69.8% in the first quarter of 2021. On an adjusted basis, our expense ratio was 52.4% for the quarter compared to 62.7% in the first quarter of 2021 and compared to 55.7% sequentially, in the fourth quarter of 2021. Similar to our net earned premium ratio, we feel is a better representation of our business to look at our expense ratios, as a percentage of gross earned premium.

Our acquisition expense as a percentage of gross earned premiums for the first quarter of 2022, was 20.2% compared to 21.2% in the first quarter of 2021 and compared to 22.2% sequentially in the fourth quarter of 2020. The decrease was driven by additional ceding commission from our new fronting business, that is netted in acquisition expense and all overall changes in our mix of business. The ratio of other underwriting expenses including adjustments to gross earned premiums for the first quarter of 2022, was 9% an improvement compared to 11.9% in the first quarter of 2021 and compared to 9.2% sequentially in the fourth quarter 2021.

As we continue to invest in talent systems and our infrastructure, we expect our business to scale over the long-term. But I wouldn't be surprised, if this ratio was flatter in the coming quarters with those investments.

Our combined ratio for the first quarter was 76.5%, compared to 60.4% in the first quarter of 2021. Our adjusted combined ratio was 72.1% for the first quarter, compared to 53.3% in the first quarter of 2021, which included the unsustainable negative loss ratio in the first quarter of 2021 from Uri.

Net investment income for the first quarter was $2.6 million, an increase of 16.2% compared to the prior year's first quarter. The year-over-year increase was primarily due to a higher average balance of investments, held during the three months ended March 31, 2022, due to cash generated from operations and by slightly higher yields on our invested assets.

Our fixed income investment portfolio book yield during the first quarter was 2.34%, compared to 2.24% for the first quarter of 2021. The weighted average duration of our fixed maturity investment portfolio, including cash equivalents, was 4.17 years at quarter end. Cash and invested assets totaled $533.2 million as compared to $436.7 million at March 31, 2021.

For the first quarter, we recognized losses on investments in the consolidated statement of income of $1.3 million, compared to losses of $739,000 in the prior year's first quarter. We will continue to take a conservative investment approach, which may impact our recognized gains and losses from quarter-to-quarter.

Our effective tax rate for the first quarter was 23.8%, compared to 17.3% for the first quarter of 2021. For the first quarter of 2022, the tax rate differed from the statutory rate due to nondeductible executive compensation expense.

Our stockholders' equity was $380.4 million at March 31, 2022, inclusive of the share buyback and unrealized changes to our investment portfolio, compared to $394.4 million at December 31, 2021.

For the first quarter of 2022, annualized return on equity was 15% compared to 18% for the same period last year. Our annualized adjusted return on equity was 18.1% compared to 20.8% for the same period last year.

As of March 31, 2022, we had 25,817,059 diluted shares outstanding as calculated using the treasury stock method. We do not anticipate a material increase to this number during the year ahead.

Before 2022, we reiterate our previously provided adjusted net income guidance range of $80 million to $85 million, representing 54% year-over-year growth and adjusted ROE of 19% at the midpoint of the range. Consistent with previous guidance, these estimates do not include any losses from major catastrophic events.

As a reminder, we expect Continental US wind projected net average annual loss, or net AAL, of approximately $6 million as of September 30, 2022 the peak of wind season. This net AAL is an industry metric used to assess Continental Hurricane and severe convective storm exposure.

During the quarter we repurchased 219,061 shares, or $13 million worth of shares, under our previously announced two-year $100 million share repurchase program. We have approximately $87 million remaining under the authorized program.

While we are not pivoting from our established growth strategy, we view our current shares as undervalued and we will take an opportunistic approach to share repurchases under this program.

While our goal of investing for profitable growth remains our core focus, we believe the share repurchase program is an appropriate use of our capital in order to increase long-term shareholder value. This bifurcated capital allocation strategy reinforces our confidence in the strategic direction of the company for long-term growth.

With that, I'd like to ask the operator to open the line for any questions. Operator?

[Operator]

Thank you. We will now conduct a question-and-answer session. [Operator Instructions] Our first question comes from Matt Carletti with JMP. Please proceed.

[Matt Carletti, JMP]

Yes. Thanks. Good morning. Just, Mac, I wanted to -- first question, you made mentioned about the recent actions taken by the CEA, I was hoping you could expand on that.

One, I just want to make sure I'm understanding it right that, is the thought that by buying less reinsurance more assessment risks, just to the member companies, and therefore, they're going to be less eager to sell a CEA quake policy?

And two is, when I saw the news, it was rather late in the quarter. And so, how much of that are you seeing any of that yet, or is this something you expect to impact results as we go forward?

[Mac Armstrong, Chairman, Chief Executive Officer & Founder]

Hey, Matt. Good afternoon, good morning, depending which coast you're on. But, yes, it's a great question and I think, first and foremost, you're right, it was the actions of the CEA were later in the quarter.

And so, the declaration of the reduction of around $1.2 billion of claims paying capacity, really hadn't taken full root in the market in the first quarter. And I think the market frankly is still digesting it.

As it pertains to the participating insurers, I think what it does do is, create a circumstance where there is less claims paying capability, which means there is a higher potential assessment applied to them. And as you recall, that would mean that they had put more capital up, but also it means that they're likely to be more inclined to find alternatives to the CEA. And there was a decree in December, which did allow participating insurers to explore alternatives in conjunction with to the CEA and in conjunction with the mandatory offer.

So long story short, we think this is something that will really probably impact or extend the growth in this line on a prospective basis rest of this year into next year. And when you marry that with just overall dislocation in the California homeowners market, which we've talked about, it's a nice catalyst for extended growth into resi Q for an indefinite period of time.

[Matt Carletti, JMP]

Great. Yeah sure. Go ahead.

[Mac Armstrong, Chairman, Chief Executive Officer & Founder]

Sorry and I think the one thing also that the claims paying capacity does potentially impact is just the ratings of the CEA. And so, I think Fitch took some action there has not been others, but that could also lead to a bit more tumult too, sorry.

[Matt Carletti, JMP]

Thanks again. That's great. Then one quick just numbers follow-up maybe for Chris. I saw you broke out the Palomar front premiums as a separate line this quarter. Could you just remind us what -- I know I think last quarter Q4 was kind of it's first full quarter of operations. What was the gross written premium in Q4 for that business?

[Chris Uchida, Chief Financial Officer]

Yeah, it was modest in Q4. I don't think we've disclosed the exact number of what that was yet, but I would say less than $5 million in Q4 of last year and last year or in Q4 that was in the other bucket. So and it was modest yeah.

[Matt Carletti, JMP]

Okay. Great. Thank you for the answers. Appreciate it.

[Chris Uchida, Chief Financial Officer]

Thanks, Matt.

[Operator]

Our next question comes from Pablo Singzon with JPMorgan. Please proceed.

[Pablo Singzon, JPMorgan]

Hi. The uptick in the accident year loss ratio was a bit higher than I would have thought. And I assume a lot of that was driven by the new lines you're writing. Was there anything unique about this quarter? And are any of the -- are the losses on the new lines consistent with your expectations? And I guess, given that you're growing faster in those lines, I was hoping you could provide some perspective on how that loss ratio could progress over time? Thanks.

[Chris Uchida, Chief Financial Officer]

Thanks, Pablo. Yeah, that's a great question. When we look at the loss ratio, it's important to remember a few things. First and foremost, our business is still anchored by the binary lines, our Hawaii hurricane, our earthquake lines are relatively binary and obviously not contributing to the attritional loss ratio. If you exclude the fronting premium from that, that book has remained relatively consistent. About 55% of that premium is still from those binary lines and about 45% of the premium is from the lines of attritional loss. So it hasn't changed the dynamic too much. It's also important to remember, when you think about fronting, fronting does not add anything to the loss ratio or to the net earned premium. The only thing that really does is, it kind of reduces the acquisition expense.

And also, when we think about the loss ratio, it's important to note that these lines are still very profitable lines. These are lines that we are comfortable with. When you look at it, these obviously, we've said this before as long as there are several hundred, they are accretive to the ROE and the bottom line. But when you look at it on a gross basis and you look at Q4, these lines we're writing probably around a 40% loss ratio in total. So still very profitable lines of business.

Specifically, on the first quarter, obviously it is up a little bit from where it was in Q4. I think if you remember our adjusted number for Q4 was about 15.7%. I had indicated that I expect that to go, call it one to two points a quarter up. But on an annualized basis, they expect it to be around three to four points up for the year. This is well within that range. And so, we're very comfortable with where it's at. I do also want to reiterate that generally, the first and second quarter of the year, are a little bit heavier for us. We are exposed to tour hail and other exposures that definitely are higher in the first two quarters of the year. So it is potential for that number to decrease or stay flat for the year.

But when I look at it on an annualized basis, three to four points up is well within the range. It's probably a little higher sequentially than the call it one to two points that I'd indicated, but well within our comfort zone. So, with that, I don't expect it to move a ton for the remainder of the year, it could be lower, it could be higher, but I would expect that three to four points on an annualized basis to be a good target from a full year results.

[Mac Armstrong, Chairman, Chief Executive Officer & Founder]

Yeah Pablo, this is Mac and Chris described it well, but the only thing I would add is, if you look at the lines that are major contributors, it tends to be the specialty homeowners book. And as a reminder that a good portion of that specialty homeowners book is going into runoff. And so, when you combine the fact that it's going into runoff, I think that add some stability to what Chris is talking about and maintaining it in that plus or minus three to four points year-over-year. But then also, that is -- this is -- tends to be seasonally aberrant. There's higher PCS activity in the first and second quarters of the year. So, we think, it's well confined and moreover the newer lines casualty, real estate E&O and flood are within our targets and frankly performing better than income, the expected loss ratio.

[Pablo Singzon, JPMorgan]

Thank you for that. And my follow-up, a numbers question here. How much fee income did funding produced in the quarter? Thanks.

[Chris Uchida, Chief Financial Officer]

We haven't broken out specifically what that fee income is. Obviously, we wrote about $30 million. We are earning that premium and earning that fee. I would say, it's generally going to be plus or minus around that 5% range. So you can do the math on depending on when that came in the quarter and how you're earning it. But now so we'll take that let's call it 5% fee over the next two or 12 months from when it was read. But we haven't disclosed the specific number. But the one thing you can note when you look at it sequentially and you look at the acquisition expense on a gross earned basis it was about 22% in Q4 and that has decreased to about 20% in the first quarter of this year.

So you can kind of see that ceding commission or additional ceding commission run through and that's really driven by the fronting premium. There is a little bit of mix differential from quota shares on the other attritional lines of business but the main driver is that fronting premium or that fronting ceding commission, lowering the acquisition expense.

[Pablo Singzon, JPMorgan]

Got it. Thanks, Chris.

[Operator]

Our next question comes from Mark Hughes with Truist Securities. Please proceed.

[Mark Hughes, Truist Securities]

Yeah. Thank you. Could you talk about the capital situation? You talked about your bifurcated strategy. You're obviously growing very rapidly and buying back some stock. How much more room do you have in terms of your current capital base? Obviously with your returns being pretty high that's adding to it. So just some thoughts about your runway from here?

[Mac Armstrong, Chairman, Chief Executive Officer & Founder]

Sure, Mark. This is Mac, and I'll take the first crack and then Chris can chime in. I think in the first quarter we bought $13 million of stock back and that was in conjunction with the $100 million share repurchase program that we authorized. That's over a two-year period of time. So kind of on a $50 million run rate if you would but that's also a reflection of where the stock was trading and the value that we saw.

I think it's important to point out that holding aside the unrealized changes in the investment portfolio, we still generated increased surplus on a pure cash flow basis. Our net income was $17.6 million and we bought back $13 million of stock. So I think we're going to want to continue to build our surplus, opportunistically buy back stock as we see it present itself. And then where we are writing right now from a net premiums are in the surplus basis, we still feel that we have ample capital to do both those things. So there's certainly cushion to grow free cash flow buy back stock opportunistically and not our growth plans impeded at all.

[Chris Uchida, Chief Financial Officer]

And specifically on numbers that Matt was talking about on our ability to write premium on a trailing 12-month basis net written premium to ending capital was a little bit higher than it was last quarter. It's about 0.85 times right now but still well within the range. If we were purely a cat company, we have said that we were comfortable writing up to 1:1. So with the growth in the other lines that are not as cat exposed some of the attritional lines whether it be inland marine, whether it be the casualty lines that are longer – can have a longer tail we definitely feel comfortable going over that 1:1 ratio. So we still have ample capital room from a net written premium basis to grow the premium base and still look at buybacks opportunistically, as our share price look still as we feel a little undervalued.

[Mark Hughes, Truist Securities]

And then from the cyclical standpoint Mac you had pointed out that the pricing increases were sustained and accelerated in some cases. When you say sustained are you saying sustained at the same rate of increase, or are you seeing any kind of deceleration, there seems to be a bifurcated to use the word, a discussion about that whether there's some deceleration or sustained or acceleration a little more on that would be helpful?

[Mac Armstrong, Chairman, Chief Executive Officer & Founder]

Yeah absolutely. So again I think it is sustained or excuse me it's sustained in certain products it's accelerating others. It really is bifurcated. So the segments of our book where it's – you're still seeing rate increases call it 5% to 7% tends to be the newer lines like the casualty lines. That being said, there are within the casualty segment pockets where you're getting better increases in that 10% to 20% a GL package they may have some auto exposure for instance or sub-classes within there that's had higher loss activity.

For us where we're seeing it accelerate again is an earthquake and the commercial all risk so that what we call national layered and shared property program that's where we're seeing it accelerate. And then I think what you have in the residential business, earthquake we are increasing our inflation guards. We are using our E&S company more effectively, especially for higher value accounts where we can get again better risk-adjusted returns. So really is product specific, but we don't have any line within our portfolio where rate increases are flat. We are seeing it either up modestly at consistent levels or accelerating.

[Mark Hughes, Truist Securities]

And why the acceleration in Commercial Quake?

[Mac Armstrong, Chairman, Chief Executive Officer & Founder]

It's capacity there is a – it's a hardening reinsurance market. And so therefore there's capacity limitations or the cost of risk transfer is higher than the prior year. So that and it's probably more pronounced in kind of mid-size to large commercial accounts and there will probably be a catch-up in small commercial accounts that you'll see.

But as I mentioned on the call, we went from an average rate increase of 5% in the fourth quarter to 7% plus in the first quarter and that was a reversal of I guess, probably three, four quarters of decelerating rate increases. So and I don't think that's going to reverse back. I think we're going to continue to see acceleration of rate increase.

[Mark Hughes, Truist Securities]

Thank you very much.

[Operator]

Our next question comes from Dave Motemaden with Evercore ISI. Please proceed.

[Dave Motemaden, Evercore ISI]

Hi thanks. I just had a question just as a follow-up for Chris, on the attritional loss ratio, continuing to hold the outlook of it being up three to four points for full year 2022 versus 2021. I guess, could you just remind me, what base I should be using? Because I know there were some exited lines that were -- that are obviously gone now that impacted the ratio last year. So I wonder if you could, just help me out on that point.

[Chris Uchida, Chief Financial Officer]

Yeah. So the right way to think about the base or the way I think about the base is, when you look at the fourth quarter of last year, the blended or the adjusted loss ratio after you back out the admitted all-risk book that we were running off last year. And that we did still have some losses from in the fourth quarter. That blended loss ratio or the adjusted loss ratio, excuse me, was about 15.7%.

So for me that's my starting point, sequentially, as the book evolves and I think about where it's going to go for 2022. And so on an annualized basis, I think that's going to be up, three to four points for the full-year. And I previously had also said, and I'd say, if you and I think about that sequentially that could be one to two points a quarter.

But I think -- so that -- but also I'd also say is that could be plus one a quarter or minus one a quarter and still kind of be within that comfort range. I think the number this quarter was definitely within that range.

I'd say, it's a little bit higher than we'd like to see but well within the comfort zone, especially when you think about Q1 and Q2 being a little more volatile for our attritional alliance when you think about the torn hail season in Texas where we still have a large portion of our specialty homeowners book in La Marine.

It does also have a little bit of exposure in there. So nothing surprising in that number and I think definitely something that we can still feel comfortable about blending to that three to four points up from that 15.7%, when I talked about a little bit earlier for the year.

[Dave Motemaden, Evercore ISI]

Got it. Thanks. And Mac, I guess just a kind of a related question on just your loss trend assumptions, and if you made any changes in the quarter in response to the inflationary environment on some of the short-tail lines?

[Mac Armstrong, Chairman, Chief Executive Officer & Founder]

Yeah. So it's a good question Dave. And I think on the short-tail lines the loss trends we are -- we think we have a very good sense of inflation, whether it, be how we are incorporating our third-party data analytics with our frontline information that we're getting from our builders risk book.

What we are doing is, measuring and accurately gauging the IPB and making sure that the base level exposure is accurate. And that's where we use those data sources both third-party and proprietary and taking what we're seeing in builders' risk and using them for specialty homeowners, then we're overlaying an inflation guard, then we're overlaying rate increases. So it's kind of a three-prong approach.

So, I guess that's a long-winded way of saying that, we feel that we have the right loss picks in based on the utilization of those three tools. And then, as we look at things going forward we can continue to use the E&S Company for potential selected residential risk to be even more nimble, so to speak. And not be reliant on insurance department approval for certain rate changes. And that's probably most relevant for residential quake, Hawaiian Hurricane and those store-tail lines you're touching upon -- touch upon.

[Dave Motemaden, Evercore ISI]

Got it, okay. That's great color. Thanks, I appreciate that. And then, if I could just sneak one more in the adjusted expense ratio at 52.4% that was definitely better than I had thought. Just wondering, the sustainability and future improvement in that from these levels, I think Chris you made some comments that the underwriting -- the other underwriting expense ratio would be flattish for the rest of the year. But I guess how should I think about the acquisition ratio as you ramp up the fronting business over the course of the rest of the year?

[Chris Uchida, Chief Financial Officer]

No. That's a great question. And so when I think about the other underwriting expense, if you go back to my commentary in Q4 or for Q4 I definitely said that, it could potentially be flat to up. It improved a little bit this quarter. So we are still seeing some good dynamics there.

And like I said on the prepared remarks, I would be surprised if it was flattish for the near-term quarter, so maybe a quarter or two but I definitely expect it to still improve and definitely improve compared to last year.

And then, on a long-term basis I definitely feel that there is still plenty of potential in the other underwriting expenses for margin expansion and to scale the organization. But a good lead in into the near-term, I do expect to see more or faster improvement on the acquisition expense ratio and that is really driven by the fronting premium. You saw it this quarter especially compared to last year on a gross basis, I talked about a little bit earlier.

Acquisition expense in Q4 on a gross basis was 22%. It's 20% in Q1. I would expect that to continue to improve. So, I would expect to see continued improvement in the near-term from the printing business seating commission driving down acquisition expense and expect to see that throughout the remainder of the year especially as Mac talked about, we would like to get to $80 million to $100 million of printing premium.

We wrote 30% in the first quarter. So, I think we're on track for that. But with that premium, I expect the acquisition expense ratio to improve faster than the other run rate expenses, but you still expect long-term improvement in the underwriting expenses.

[Dave Motemaden, Evercore ISI]

Great. Thank you for the color.

[Chris Uchida, Chief Financial Officer]

Thanks Dave.

[Operator]

Our next question comes from Meyer Shields with KBW. Please proceed.

[Meyer Shields, KBW]

Great. Thanks very much for taking my question. Mac you talked about raising the inflation guards to 8%. Can you let us know I guess what the filing requirements and status of that is? And I guess second related question is the current environment at 8% level?

[Mac Armstrong, Chairman, Chief Executive Officer & Founder]

Hey Meyer, yeah, that's a great question. Fortunately, there's no filing requirement associated with -- or approvals associated with that, so we can implement it. I do think 8% is enough because you have to remember this is for like residential earthquake.

We have had a 5% inflation guard in place since we formed the company. And so if you think about a policy that was bound in year one of operations and we averaged 90%-plus policy retention for that line we would have something that since its initial bind the underlying TIV and the underlying exposure would have increased more than by more than 50%.

Furthermore, what we do is when we underwrite and price that risk, we take the greater of our estimate or the associated homeowners policy. So, we think -- we rely on the homeowners policy estimate or our own to determine what is the base TIV. And then we also again manage the portfolio, we're constantly looking at using a tool like that from CoreLogic and our own what the underlying replacement cost is in the market and overlaying that.

Again, that's how we come with our base level against the homeowners' policy to calibrate. So, it's a very long-winded way of saying we think the 8% inflation guard is sufficient, but this is a tool that we've had in place well before 2021 and 2022 inflationary pressures start to rerated.

[Meyer Shields, KBW]

No, that's okay. Look the answer is more than welcome. So, that's great. Next question I guess and I apologize if I missed it. Just I was hoping for an update on new money yields on the investment portfolio compared to book yield, particularly because I assume that most of your investment portfolio is fairly short tenure?

[Mac Armstrong, Chairman, Chief Executive Officer & Founder]

Yes, you're right. It is fairly short tail, especially, when you start to think about the growth from fronting premium just to grow the investment portfolio. The new yields that we're seeing right now are around 3.8% or so compared to historical yields of -- in a quarter. So, there is a pickup. And it's obviously -- it's not at the expense of security. So, the credit risk remains identical.

So, we think that is a good thing for us long-term, but Palomar makes the majority of its money through underwriting and it always will. But that's not a bad I guess tailwind to have.

[Meyer Shields, KBW]

Sorry to the down side. One last question if I can. You discussed how the fronting premium production in the first quarter compared to your expectation?

[Mac Armstrong, Chairman, Chief Executive Officer & Founder]

Sure. It exceeded our expectation. We said we wanted to do $80 million to $100 million and we feel very good about that number. As I mentioned in my remarks, we have one large deal with a very reputable and strong-performing Cyber MGA that has a terrific panel of reinsurers basically funding for those reinsurers. As you know Meyer the cyber market is very hard and so the rates that they are seeing they exceeded our initial expectations.

The one thing that I would temper that with is when we put a lot of these programs together we do put premium caps on them because we want to be mindful of collateral and not overextending our exposure. But when you have rates that are 50% to 100% up depending on the size of the account the underlying PIP is meaningfully less than we thought. So, that's a nice dynamic to have.

So, we are exceeding our projections on the fronting side and we have a nice pipeline of deals that we think will help us build this into a nice franchise.

[Meyer Shields, KBW]

Perfect. Thank you so much.

[Mac Armstrong, Chairman, Chief Executive Officer & Founder]

Thanks Meyer.

[Operator]

Our next question comes from Tracy Benguigui with Barclays. Please proceed.

[Tracy Benguigui, Barclays]

Hi. I'd like seeing the breakout in your disclosure of the subsidiary level premium. So, I noticed that E&S premiums now represent nearly 40% of your mix. And I'm just wondering, prospectively, how you think that could shift over time?

[Mac Armstrong, Chairman, Chief Executive Officer & Founder]

Yes, Tracy. Yeah, it's a good observation. We're pleased with how the E&S company is trending and it was 40%. We said that we think it can be 50% of the premium. Now the one thing that I would temper the 40% with is some of that is coming from fronting. So fronting, as I mentioned, the real number in the quarter on the E&S side was -- I can't remember actually, 50 million plus or minus or $40 million, excuse me, $41 million. So it's closer to 25%, 26% of the book when you exclude the fronting. When you include fronting, it was $67 million. So that gets you to that 40% number. So blog still means - we still believe that they can get to 50% and that's on the core business that we are underwriting and retaining risk on. The fronting will potentially inflate that as we use both the admitted and the E&S company.

[Tracy Benguigui, Barclays]

Got it. And then, looking at fronting business, I mean I recognize these days most reinsurers are hybrid. They also have primary operations. So what structurally do they need to get from you versus maybe writing this risk on their own paper and then maybe doing internal reinsurance back offshore?

[Mac Armstrong, Chairman, Chief Executive Officer & Founder]

Yeah. Tracy, it's really deal-specific. We have one deal that we are fronting for another insurance company that has a statutory limitation. We have another deal where -- that we just talked about where it's really an MGA that we have the relationship with, we bring them a panel of reinsurers.

So those reinsurers could potentially try to go and do it on a primary basis but they'd be dislocating the MGA or ourselves who are in the market. So that's the deal. The MGA deals, they need a primary front the reinsurers that we work with are the reinsurance business not in the primary business. And then, we have other deals where it maybe for another insurance company that doesn't have the requisite invest rating.

So, it's a hodgepodge of transactions that we'll do as a fronting carrier. And we also view fronting as a great R&D tool for us to learn about markets where we may end up taking some risk and time. And so in doing that we are -- the risk there or to some degree but really control the program and can steer the reinsurance as we deem fit.

[Tracy Benguigui, Barclays]

Great. Just maybe one other question. I remember years ago there was an issue in industry with reinsurance recoverable being a large part of balance sheet. And just given that, you do see a lot of your premiums is that a metric that you're watching?

[Mac Armstrong, Chairman, Chief Executive Officer & Founder]

Yeah, absolutely. I think -- we feel very good about the quality of our reinsurers. And we also feel very good that we have a rather diverse reinsurance panel that's over 60 panelists and no one's more than 6% to 7% of the total limit. We also have cat bonds where it's collateralized. So -- but that being said, we constantly look at the underlying credit ratings of our reinsurers. Our brokers have security panels that they report back to us on. We have provisions in our reinsurance contracts, that gives us the right to call, if someone is downgraded and force a redemption so to speak. So it's something that we actively look at. And fortunately, we have never had any issues to date with recoverables and I'll knock on wood in my head when I say that.

[Chris Uchida, Chief Financial Officer]

Yeah, and I'd say financially obviously we look at this from a CECL standpoint or a credit standpoint. And so, when we look at the activity that we had in 2020 and 2021, we did have some learning we still do have some reinsurance recoverables. We evaluate that on a quarterly basis to see if any changes have happened to our reinsurers and anything any action needs to be taken but we have not had to decrease our receivable or take a write-down on any of our receivables, because of credit quality specifically on the printing side depending on the quality of the reinsurer we run each of our counterparties through a collateral analysis to determine whether or not we need and how much collateral we need to collect.

We look at their size capital structure, history licensing and authorization to determine that type of capital. When we look at the unearned premium, we look at the expected losses. And then, depending on the counterparty, we could be collecting 100% to 150% of that required collateral from the reinsurer involved to make sure that we do have adequate capacity on high end and make sure that that is either in trust. We are either holding it in kind or looking at different types of arrangements to make sure that we do have that cash available. So, it's something that we are very focused on and make sure that we understand to make sure that there is no call it additional risk that we are taking from the reinsurance parties that are involved in these transactions.

[Tracy Benguigui, Barclays]

Okay. Thank you.

[Operator]

Thank you. At this time, I would like to turn the call back over to Mr. Armstrong for closing comments.

[Mac Armstrong, Chairman, Chief Executive Officer & Founder]

Terrific. Thank you operator, and thanks to all who were able to join. We appreciate your participation questions and importantly your support. I also want to thank our team at Palomar for their exceptional work and commitment they are instrumental in our success.

So to conclude, I'm proud of our results and the progress we made executing against our 2022 strategic initiatives during the quarter. We did indeed, delivered strong growth. We monetized or continue to monetize our new investments. We are enhancing our earnings predictability and we're scaling.

We do believe that we can continue to cultivate the new businesses, harvest the existing ones and attract outstanding talent to the company. And we have the foundation in place to deliver strong growth at a better than industry average ROE that will generate value for our investors and shareholders.

So along those lines, we are thrilled to announce that we'll be hosting an Investor Day on June 15th in New York City to discuss these topics in more detail. And we hope that you can join our full team and business heads for a deep dive into our strategic plan that we are calling Palomar 2x. We will be sharing further details on the event in coming days which will be posted to the IR section of our website. So, we look forward to seeing you in New York on June 15. Thank you again and enjoy the rest of your day. Take care.

[Operator]

Thank you. This does conclude today's teleconference and webcast. You may disconnect at this time and thank you for your participation. Have a great day.