(1) Indicates non-GAAP financial measure; see “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Reconciliation of Non-GAAP Financial Measures” for a reconciliation of the non-GAAP financial measures to their most directly comparable financial measures prepared in accordance with GAAP.
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.
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 in our first year of operations to $354.4 million for the year ended December 31, 2020, which reflects a compound annual growth rate of approximately 66%. For the year ended December 31, 2020, we experienced average monthly premium retention rates above 93% for our Residential Earthquake and Hawaii Hurricane lines and approximately 87% overall across all lines of business, providing strong visibility into future revenue.
The COVID-19 Pandemic ("the Pandemic") continues to impact businesses, households, communities, and financial markets.
We have not seen a significant change in the growth rate of our gross written premiums since the beginning of the Pandemic. However, adverse events such as health-related concerns about working in our offices, the inability to travel, potential impact on our business partners and customers, and other matters affecting the general work and business environment could harm our business and impact the implementation of our business strategy. 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 could adversely impact our business in the future.
● 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;
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
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.
Net earned premiums represent the earned portion of our gross written premiums, less the earned portion that is ceded to third-party reinsurers under our reinsurance agreements. Our insurance policies generally have a term of one year and premiums are earned pro rata over the term of the policy.
• The geographic location and characteristics of the policies we underwrite;
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 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 certain 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 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.
Interest expense consists primarily of interest expense on our surplus notes through September 2018 and our Floating Rate Notes after September 2018. In addition, we incurred interest expense related to prepayment penalties on the payoff of our surplus notes in September 2018 and related to the redemption premium paid on our Floating Rate Notes in May 2019.
Underwriting income is a non-GAAP financial measure defined as income before income taxes excluding net investment income, net realized and unrealized gains and losses on investments and interest expense. See “Reconciliation of Non-GAAP Financial Measures” for a reconciliation of income before income taxes calculated in accordance with GAAP to underwriting income.
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.
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 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.
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:
During the fourth quarter of 2020, we ceased offering Commercial All Risk products on an admitted basis and will only offer them on an E&S basis going forward. This transition will impact the growth rate of our Commercial All Risk line in future periods. In addition, during the fourth quarter of 2020, we purchased the renewal rights of certain Hawaii Hurricane policies from another insurance company. We expect our Hawaii Hurricane written premiums to increase related to this purchase. However, there is no guarantee that policyholders will renew their policies with us and the ultimate impact to our future written premiums is uncertain.
Ceded written premiums increased $46.8 million, or 43.2 %, to $155.1 million for the year ended December 31, 2020 from $108.3 million for the year ended December 31, 2019. The increase was primarily due to increased excess of loss reinsurance (“XOL”) expense commensurate with growth in exposure. In addition, catastrophe losses occurring in the third and fourth quarters of 2020 caused us to fully utilize portions of our XOL coverage. As a result, we incurred charges of $7.0 million during the fourth quarter of 2020 related to the acceleration of XOL expenses and the purchase and utilization of a backup XOL layer.
Premiums ceded under quota share arrangements also increased due to the growth in written premium lines subject to quota share arrangements. Ceded written premiums as a percentage of gross written premiums slightly increased to 43.8% for the year ended December 31, 2020 from 43.0% for the year ended December 31, 2019. This increase was primarily due to increased XOL expense offset by changes in our quota share agreements in our Specialty
Homeowners and Commercial All Risk lines as we entered into new ceding arrangements on these lines which increased the percentage of premiums we retained.
Losses and loss adjustment expenses consisted of the following elements during the respective periods:
Other underwriting expenses decreased $17.2 million, or 33.6%, to $34.1 million for the year ended December 31, 2020 from $51.3 million for the year ended December 31, 2019. This decrease was primarily due to a decrease in expenses relating to unique items. During the prior year, the company incurred significant charges associated with an IPO, tax restructuring, secondary offerings, retirement of debt, and one-time incentive cash bonuses. The company also incurred a stock compensation charge of $23.0 million upon modification of its management incentive plan in the prior year.
Other underwriting expenses as a percentage of gross earned premiums were 11.3% for the year ended December 31, 2020 compared to 25.6% for the year ended December 31, 2019. Excluding the impact of expenses relating to our IPO, tax restructuring, secondary offerings, one-time incentive cash bonuses, stock-based compensation, retirement of debt, and catastrophe bonds, other underwriting expenses as a percentage of gross earned premiums were 10.2% for the year ended December 31, 2020 compared to 11.6% for the year ended December 31, 2019. This percentage decreased due to higher gross earned premiums without a proportional increase to expenses.
Net investment income increased $2.6 million, or 44.1%, to $8.6 million for the year ended December 31, 2020 from $6.0 million for the year ended December 31, 2019. The increase was primarily due to a higher average balance of investments during the year ended December 31, 2020 due primarily to proceeds from our January and June 2020 stock offerings. The increase from a higher average investment balance was partially offset by lower yields on investments due to a lower interest rate environment in 2020 versus 2019.
Net realized and unrealized gains on investments decreased $3.0 million, to a $1.5 million gain for the year ended December 31, 2020 from a $4.4 million gain for the year ended December 31, 2019. We had a higher balance of
The company had an immaterial income tax benefit for the year ended December 31, 2020 compared to a $7.5 million expense for the year ended December 31, 2019 primarily because of lower pre-tax income during the year ended December 31, 2020. During the year ended December 31, 2020, our income tax rate differed from the statutory rate of 21% due primarily to the tax impact of the permanent component of employee stock option exercises. For the year ended December 31, 2019, our income tax expense was significantly impacted by the reversal of our U.S. federal deferred tax valuation allowance in March 2019, offset by an addback related to a nondeductible stock compensation charge incurred upon the modification of our management incentive plan in March 2019.
Gross written premiums were $252.0 million for the year ended December 31, 2019 compared to $154.9 million for the year ended December 31, 2018, an increase of $97.1 million, or 62.7%. Premium growth was primarily
Approximately $19.4 million of the increase to Residential Earthquake premiums was due to a new partnership with a homeowners carrier in which we assumed $6.6 million of unearned premiums and wrote an additional $12.8 million in premiums.
Ceded written premiums increased $25.4 million, or 30.6%, to $108.3 million for the year ended December 31, 2019 from $82.9 million for the year ended December 31, 2018. The increase was primarily due to increased cessions to new quota share reinsurance partners in our Commercial All Risk line. We also incurred increased excess of loss reinsurance expense commensurate with growth in exposure. Ceded written premiums as a percentage of gross written premiums decreased to 43.0% for the year ended December 31, 2019 from 53.6% for the year ended December 31, 2018. The cession percentage was higher in the prior year due to an $11.8 million transfer of unearned premiums in June 2018 related to our entering into a fronting arrangement in our Specialty Homeowners line in the state of Texas. This fronting arrangement terminated in June 2019 in conjunction with the inception of our Specialty Homeowners Facility (“SHF”).
Losses and loss adjustment expenses decreased $0.7 million, or 10.9%, to $5.6 million for the year ended December 31, 2019 from $6.3 million for the year ended December 31, 2018.
Our non-catastrophe loss ratio was 5.6% for the year ended December 31, 2019 compared to 1.8% during the year ended December 31, 2018. Non-catastrophe losses increased due mainly to a higher percentage of business in lines subject to attritional losses such as Commercial All Risk, Specialty Homeowners, and Inland Marine and due to losses on our assumed reinsurance portfolio.
Acquisition expenses increased $9.1 million, or 32.0%, to $37.3 million for the year ended December 31, 2019 from $28.2 million for the year ended December 31, 2018. The primary reason for the increase was higher earned premiums which resulted in higher commissions and premium-related taxes. Acquisition expenses as a percentage of gross earned premiums were 18.6% for the year ended December 31, 2019 compared to 20.5% for the year ended December 31, 2018. Acquisition expenses as a percentage of gross earned premiums decreased due to higher earned ceding commissions related to our Specialty Homeowners and Commercial All Risk lines.
corporate bonds with the remainder of investments in equity securities. The following table summarizes the components of our investment income for the years ended December 31, 2019 and 2018:
Income tax expense increased to $7.5 million for the year ended December 31, 2019 from an immaterial amount for the year ended December 31, 2018 as a result of positive taxable income during the year ended December 31, 2019 occurring after our U.S. domestication in March 2019 partially offset by the benefit from the reduction of the valuation allowance on our federal deferred tax assets. For the year ended December 31, 2019, our income tax expense was significantly impacted by the reversal of our U.S. federal deferred tax valuation allowance in March 2019, offset by an addback related to a nondeductible stock compensation charge incurred upon the modification of our management incentive plan in March 2019.
We are subject to income taxes in certain jurisdictions in which we operate. Our U.S. subsidiaries are subject to federal and state income taxes. We earn income in Bermuda, a non-taxable jurisdiction, primarily as a result of quota share reinsurance agreements between our U.S. insurance subsidiary and PSRE, and the investment income earned in PSRE. Prior to July 1, 2019, our U.S. insurance subsidiary and PSRE were subject to a quota share reinsurance agreement under which the U.S. insurance subsidiary ceded 50% of the earthquake and Hawaii hurricane gross premiums earned as well as losses and loss adjustment expenses to PSRE in exchange for a 25% ceding commission.
Total revenue calculated in accordance with GAAP reconciles to underwriting revenue as follows:
We define underwriting income as income before income taxes excluding net investment income, net realized and unrealized gains and losses on investments, and interest expense. Underwriting income represents the pre-tax profitability of our underwriting operations and allows us to evaluate our underwriting performance without regard to investment income. 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:
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:
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.
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.
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.
Stockholders’ equity calculated in accordance with GAAP reconciles to tangible stockholders’ equity as follows:
Under California and Oregon 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 of December 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, under Oregon statute PSIC may only declare a dividend from earned surplus, which does not include contributed capital. Surplus arising from unrealized capital gains or revaluation of assets is not considered part of earned surplus. Based on the above restrictions, PSIC may pay a dividend or distribution of no greater than $11.3 million in 2021 without approval by the California and Oregon Insurance Commissioners.
Insurance companies in the United States are also required by state law to maintain a minimum level of policyholder’s surplus. State insurance regulators have a risk-based capital standard designed to identify property and casualty insurers that may be inadequately capitalized based on inherent risks of the insurer’s assets and liabilities and its mix of net written premium. Insurers falling below a calculated threshold may be subject to varying degrees of regulatory action. As of December 31, 2020 and December 31, 2019, the total adjusted capital of PSIC and PESIC were in excess of their respective prescribed risk-based capital requirements.
Under the Insurance Act and related regulations, our Bermuda reinsurance subsidiary is required to maintain certain solvency and liquidity levels, which it maintained as of December 31, 2020 and December 31, 2019.
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 our Bermuda reinsurance subsidiary 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 in Bermuda 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, our Bermuda reinsurance subsidiary 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.
Pursuant to Bermuda regulations, the maximum amount of dividends and return of capital available to be paid by a reinsurer is determined pursuant to a formula. Under this formula, the maximum amount of dividends and return of capital available from our Bermuda subsidiary during 2021 is calculated to be approximately $10.5 million. However, this dividend amount is subject to annual enhanced solvency requirement calculations. There were no dividends approved or paid in 2020 or 2019.
The following table summarizes our cash flows for the years ended December 31, 2020, 2019 and 2018:
Cash used in investing activities for each of the last three years related primarily to purchases of fixed income and equity securities in excess of sales and maturities.
Oregon Insurance Commissioners before such payments could be made. Such payments could only be made from surplus.
The Company incurred $1.1 million in interest expense related to the Floating Rate Notes for the year ended December 31, 2019 (inclusive of the $0.4 million redemption premium) and $0.6 million for the year ended December 31, 2018 and paid $1.2 million and $0.5 million for each period, respectively. The Company incurred and paid $1.2 million in interest expense related to the surplus notes for the year ended December 31, 2018.
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.
The following tables provide the credit quality of investment securities as of December 31, 2020 and December 31, 2019:
The amortized cost and fair value of our available-for-sale investments in fixed maturity securities summarized by contractual maturity as of December 31, 2020 were as follows:
Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations. See “Critical Accounting Policies and Estimates- Investment Valuation and Fair Value” for discussion of investment valuation considerations.
We identified the accounting estimates below as 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 which 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 consolidated financial statements. These judgments and estimates affect the reported amounts of assets, liabilities, revenue and expenses and the disclosure of material contingent assets and liabilities. Actual results may differ materially from the estimates and assumptions used in preparing the consolidated financial statements. We evaluate our estimates regularly using information that we believe to be relevant. For a detailed discussion of our accounting policies, see the Notes to Consolidated Financial Statements included in this Annual Report on Form 10-K.
We categorize our reserves for unpaid losses and loss adjustment expenses into two types: case reserves and reserves for incurred but not yet reported losses (“IBNR”). Through our third-party administrators (“TPAs”), we generally are notified of losses by our insureds or their agents or brokers. Based on the information provided by the TPAs, we establish initial case reserves by estimating the ultimate losses from the claim, including administrative costs associated with the ultimate settlement of the claim. Our personnel use their knowledge of the specific claim along with internal and external experts, including underwriters and legal counsel, to estimate the expected ultimate losses.
We establish IBNR reserves to provide for (i) the estimated amount of future loss payments on incurred claims not yet reported, and (ii) potential development on reported claims. IBNR reserves are estimated based on generally accepted actuarial reserving techniques that consider quantitative loss experience data and, where appropriate, qualitative factors. With the assistance of an independent actuarial firm, we use statistical analysis to estimate the cost of losses and loss adjustment expenses related to IBNR. Those estimates are based on our historical information, industry information and practices, and estimates of trends that may affect the ultimate frequency of incurred but not reported claims and changes in ultimate claims severity.
The following tables summarize our gross and net reserves for unpaid losses and loss adjustment expenses at December 31, 2020 and 2019.
The process of estimating the reserves for losses and loss adjustment expenses requires a high degree of judgment and is subject to several variables. On a quarterly basis, we perform an analysis of our loss development and select the expected ultimate loss ratio for each of our product lines by accident year. In our actuarial analysis, we use input from our TPAs and our underwriting departments, including premium pricing assumptions and historical experience. Multiple actuarial methods are used to estimate the reserve for losses and loss adjustment expenses. These methods utilize, to varying degrees, the initial expected loss ratio, detailed statistical analysis of past claims reporting and payment patterns, claims frequency and severity, paid loss experience, industry loss experience, and changes in market conditions, policy forms, exclusions, and exposures. The actuarial methods used to estimate loss and loss adjustment expenses reserves are:
● Reported and/or Paid Loss Development Methods-Ultimate losses are estimated based on historical reported and/or paid loss reporting patterns. Reported losses are the sum of paid and case losses. Industry development patterns are substituted for historical development patterns when sufficient historical data is not available.
● Reported Bornhuetter-Ferguson Severity Method-Under this method, ultimate losses are estimated as the sum of cumulative reported losses and estimated IBNR losses. IBNR losses are estimated based on expected average severity, estimated ultimate claim counts and the historical development patterns of reported losses.
During the year ended December 31, 2019, our gross incurred losses for accident years 2018 and prior developed favorably by $1.0 million. This favorable development was due to reported losses emerging at a lower level than expected, primarily in our Specialty Homeowners business, offset by higher frequency and severity of claims in our special property lines of business. The net favorable development of $0.2 million reflects the effect of ceding the gross favorability under our reinsurance program.
During the year ended December 31, 2018, our gross incurred losses for accident years 2017 and prior developed favorably by $3.2 million. This favorable development was due to reported losses emerging at a lower level than expected, primarily in our Specialty Homeowners business. The net favorable development of $1.9 million reflects the effect of ceding the gross favorability under our reinsurance program.
We invest in a variety of investment grade fixed maturity securities, including U.S. government issues, state government issues, mortgage and asset-backed obligations, and corporate bonds. All of our investments in fixed maturity securities and equity securities are carried at fair value, defined as the price that we would receive upon selling an investment in an orderly transaction to an independent buyer in the principal or most advantageous market of the investment. Market participants are assumed to be independent, knowledgeable, able and willing to transact an exchange and not acting under duress.
The Company adopted new accounting guidance beginning with this Annual Report on 10-K, and is now required to consider recognizing an allowance for credit losses on its financial assets, including its available-for-sale securities. All financial assets measured at amortized cost are required to be presented at the net amount expected to be collected by means of an allowance for credit losses that is included in net income. Credit losses relating to available-for-sale debt securities are also required to be recorded through a reversible allowance for credit losses, but the allowance is limited to the amount by which fair value is less than amortized cost. The previous accounting guidance delayed the recognition of credit losses until it was probable a loss had been incurred.
The Company also considers whether it intends to sell the security or if it is more likely than not that it will be required to sell the security before recovery of its amortized cost. When assessing whether it intends to sell a fixed-maturity security or if it is likely to be required to sell a fixed-maturity security before recovery of its amortized cost, the Company evaluates facts and circumstances including, but not limited to, decisions to reposition the investment
portfolio, potential sales of investments to meet cash flow needs, and potential sales of investments to capitalize on favorable pricing.
See “Note 2-Recent Accounting Pronouncements” in the Notes to Consolidated Financial Statements included in this Annual Report on Form 10-K for a discussion of accounting pronouncements recently adopted and recently issued accounting pronouncements not yet adopted and their potential impact to our financial statements.
Index to Audited Consolidated Financial Statements of Palomar Holdings, Inc. and Subsidiaries as of December 31, 2020 and 2019 and for each of the Three Years Ended December 31, 2020, 2019 and 2018
We have audited the accompanying consolidated balance sheets of Palomar Holdings, Inc. and Subsidiaries (the Company) as of December 31, 2020 and 2019, the related consolidated statements of income and comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2020, and the related notes and financial statement schedules listed in the Index at Item 15(a) (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020, in conformity with U.S. generally accepted accounting principles.
At December 31, 2020, the reserve for losses and loss adjustment expenses (LAE) is $129,036 thousand. As explained in Notes 2 and 9 to the consolidated financial statements, the reserve for losses and LAE represents management's best estimate for unpaid claims and claim adjustment expenses on reported losses and estimates of losses incurred but not reported (IBNR), net of salvage and subrogation recoveries. The liability is based on individual claims, case reserves and other estimates reported by policyholders, as well as management estimates of ultimate losses and loss adjustment expenses. Inherent in the
PSIC is a property and casualty insurance company domiciled in the state of Oregon. The Company’s core focus is on the residential and commercial earthquake markets in earthquake-exposed states such as California, Oregon, Washington, and states with exposure to the New Madrid Seismic Zone. The Company also offers products tailored to broader geographic regions and perils, including Hawaii residential hurricane, Specialty Homeowners, Inland Marine, and Flood products. PSIC is licensed to underwrite insurance on an admitted basis in 32 states in the United States, as of December 31, 2020, mainly through managing general insurance agencies, wholesale brokers, and independent agents.
PSRE is a Bermuda captive reinsurance company that has historically been used to reinsure certain premiums on a quota share basis exclusively for PSIC.
PGIA is a property and casualty general insurance agency for PSIC, PESIC, and unaffiliated insurance carriers. As a general insurance agency, PGIA assists in developing insurance products, underwriting insurance policies, and receiving and disbursing funds from premium and loss transactions under contracts on behalf of insurance companies. PGIA earns commissions from the product development, marketing, and servicing of the insurance companies’ programs. PGIA also earns fee income from policyholder transactions.
The Company operates as an insurance holding company system and is subject to the insurance holding company laws of the States of Oregon and Arizona, the states in which PSIC and PESIC are domiciled. The Company is also commercially domiciled in California, making it subject to California insurance holding company laws. These statutes require that each insurance company in the system register with the insurance department of its state of domicile and furnish information concerning the operations of companies within the holding company system that may materially affect the operations, management or financial condition of the insurers within the system and domiciled in that state.
The Company has a single operating segment, the property and casualty insurance business. While the Company’s chief operating decision-maker reviews the revenue streams attributable to individual products, operations are managed, resources are allocated, and financial performance is evaluated on a consolidated basis.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect amounts reported in the consolidated financial statements and accompanying notes. Such estimates and assumptions could change in the future as more information becomes known, which could impact the amounts reported and disclosed herein. All revisions to accounting estimates are recognized in the period in which the estimates are revised. Significant estimates reflected in the Company’s consolidated financial statements include, but are not limited to, reserves for losses and loss adjustment expenses, reinsurance recoverables on unpaid losses, and the fair values of investments.
All of the Company’s investments in fixed maturity securities are classified as available-for-sale and are carried at fair value.
Prior to the adoption of ASU 2016-13, the Company evaluated fixed maturity securities for credit losses and any losses were bifurcated into the credit-related loss and the loss related to all other factors. The credit-related impairment loss would have been recognized as a realized loss in the statement of income and comprehensive income and the cost basis of the security would have been reduced. The impairment related to other factors would have remained in accumulated other comprehensive income.
Level 2-Pricing inputs are quoted prices for similar investments in active markets; quoted prices for identical or similar investments in inactive markets; or valuation based on models where the significant inputs are observable or can be corroborated by observable market data.
The fair value of the Company’s investments in fixed maturity securities is estimated using relevant inputs, including available market information, benchmark curves, benchmarking of like securities, sector groupings, and matrix pricing. An Option Adjusted Spread model is also used to develop prepayment and interest rate scenarios. Industry standard models are used to analyze and value securities with embedded options or prepayment sensitivities. These fair value measurements are estimated based on observable, objectively verifiable market information rather than market quotes; therefore, these investments are classified and disclosed in Level 2 of the hierarchy.
Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of cash and cash equivalents, fixed maturity securities and reinsurance recoverables. The Company places its cash and cash equivalents with high credit quality financial institutions and its fixed maturity securities in securities of the U.S. government, U.S. government agencies, and high credit quality issuers of debt securities. The Company evaluates the financial condition of its reinsurers and reinsures its business with highly rated reinsurers and sometimes requires letters of credit or retains funds from reinsurers (see Note 10).
Prior to December 31, 2019, the Company did not have an allowance for uncollectable premiums. An initial allowance for uncollectable premiums of $0.2 million was established upon adoption of ASC 2016-13 on January 1, 2020 and the company recognized an immaterial amount of credit losses relating to uncollectable premiums during the year ended December 31, 2020.
The costs of successfully acquiring new business, principally commission expense and premium taxes, are deferred and amortized over the terms of the policies in force, net of any ceding commissions.
Costs associated with the implementation of certain internal systems are capitalized and carried at capitalized cost less accumulated amortization and are included as a component of prepaid expenses and other assets on the Company’s consolidated balance sheet. Costs capitalized include internal personnel costs, external developer costs, and interest. The implementation costs relate to systems built on software which the Company purchases under a cloud computing arrangement and accounts for as a service contract. As such, capitalized costs are amortized over the term of the service contract, which currently ends in December 2024.
the undiscounted cash flows expected to result from the use and eventual disposition of the asset or asset group. This assessment is based on the carrying amount of the asset or asset group at the date it is tested for recoverability. An impairment loss is measured as the amount by which the carrying amount of a long-lived asset or asset group exceeds its fair value. No impairments of long-lived assets were recognized for the years ended December 31, 2020, 2019 and 2018.
Reserves for IBNR are established in accordance with industry practice to provide for (i) the estimated amount of future loss payments on incurred claims not yet reported, and (ii) potential development on reported claims. IBNR reserves are estimated based on generally accepted actuarial reserving techniques that consider quantitative loss experience data and, where appropriate, qualitative factors.
The Company purchases excess of loss and quota share reinsurance to protect it against the impact of losses. Reinsurance premiums, commissions, ceded unearned premiums are accounted for on bases consistent with the underlying terms of the reinsurance contracts and in proportion to the amount of insurance protection provided. The Company receives ceding commissions in connection with quota share reinsurance. The ceding commissions are capitalized and amortized as a reduction of acquisition expenses. Amounts applicable to ceded unearned premiums are reported as assets in the accompanying consolidated balance sheets. Premiums earned and losses and loss adjustment expenses incurred are stated in the accompanying consolidated statements of income and comprehensive income net of amounts ceded to reinsurers.
Reinsurance recoverables represent balances due to the Company from its reinsurers for paid and unpaid losses and loss adjustment expenses. The Company is exposed to credit losses from reinsurers being unable to meet their obligations. The Company evaluates the financial condition of potential reinsurers and reinsures its business only with highly rated reinsurers with a rating of “A-“ (Excellent) (Outlook Stable) or better from A.M. Best. Reinsurers who do not meet the Company’s rating criteria are required to post collateral. The Company reviews credit quality of its reinsurers on a quarterly basis. The Company’s reinsurance contracts also include special termination provisions that allow the Company to cancel and replace any participating reinsurer that is downgraded below a rating of “A−” from A.M. Best, or whose surplus drops by more than 20%. Historically, the Company has not experienced any credit
losses from reinsurance recoverables and did not have an allowance for uncollectable reinsurance recoverables as of December 31, 2020 or December 31, 2019.
Basic earnings per share is calculated by dividing net income by the weighted-average common shares outstanding for the period. Diluted earnings per share reflects the dilution which could occur if equity-based awards are converted into common share equivalents as calculated using the treasury stock method. When inclusion of additional common share equivalents increases the earnings per share or reduces the loss per share, the effect on earnings per share is anti-dilutive, and the diluted net earnings or net loss per share is computed excluding these common share equivalents.
In February 2016, the Financial Accounting Standards Board (“FASB”) issued new guidance for accounting for leases, ASU 2016-02, Leases (Topic 842) and subsequently issued multiple clarifying updates to the guidance. This updated guidance requires the recognition of a right-of-use (“ROU”) asset and a corresponding lease liability, discounted to the present value, for all leases that extend beyond 12 months. Under the previous guidance, leases were only included on the balance sheet if the criteria to classify the agreement as a capital lease were met.
In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740) Simplifying the Accounting for Income Taxes. Among other things, ASU 2019-12 eliminates certain exceptions for recognizing deferred taxes for investments, performing intra-period tax allocation and calculating income taxes in interim periods. ASU 2019-12 also clarifies the accounting for transactions that result in a step-up in the tax basis of goodwill. ASU 2019-12 is effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. The Company will adopt this guidance in the first fiscal quarter of 2021 and does not expect adoption to have a material impact on its consolidated financial statements.
The aggregate fair value and gross unrealized losses of the Company’s investments aggregated by investment category and the length of time these individual securities have been in a continuous unrealized loss position as of December 31, 2020 and 2019, are as follows:
The amortized cost and fair value of fixed maturity securities at December 31, 2020, by contractual maturity, are shown below.
Proceeds from the sale of fixed maturity securities were $39.8 million, $46.3 million and $48.5 million for the years ended December 31, 2020, 2019 and 2018, respectively.
The Company places securities on statutory deposit with certain state agencies to retain the right to do business in those states. These securities are included in available-for-sale investments on the consolidated balance sheets. At December 31, 2020 and 2019, the carrying value of securities on deposit with state regulatory authorities was $7.5 million and $5.1 million, respectively.
The Company has operating leases for office space used to conduct its insurance operations and administration activities. Operating lease ROU assets are a component of prepaid expenses and other assets and operating lease liabilities are included in accounts payable and other accrued liabilities in the Company's consolidated balance sheets.
The Company determines whether an arrangement is a lease at its inception. Operating lease ROU assets and liabilities are recognized at the lease commencement date based on the estimated present value of lease payments over the lease term. To determine the present value of lease payments, the Company uses its incremental borrowing rate, which it calculates based on information available at the lease commencement date. For certain leases that contain options to extend, the options are included in lease liabilities only if the company is reasonably certain the option will be exercised. Variable lease costs such as parking are expensed in the period the obligation is incurred and are not included in the Company’s operating lease liability. The Company's lease agreements do not contain any residual value guarantees.
Loss and loss adjustment expenses reserves represent management’s best estimate of the ultimate cost of all reported and unreported losses incurred for the years ended December 31, 2020, 2019, and 2018. The Company does not discount loss and loss adjustment expense reserves. The reserves for unpaid losses and loss adjustment expenses are
In addition to case reserves, which are generally based on reported claims, the Company establishes reserves for incurred but not reported claims (“IBNR”). IBNR reserves are developed to provide for (i) the estimated amount of future loss payments on incurred claims not yet reported, and (ii) potential development on reported claims. IBNR reserves are estimated based on generally accepted actuarial reserving techniques that consider quantitative loss experience data and, where appropriate, qualitative factors. With the assistance of an independent, actuarial firm, the Company uses statistical analysis to estimate the cost of losses and loss adjustment expenses related to IBNR. Those estimates are based on historical information, industry information and practices, and estimates of trends that may affect the ultimate frequency of incurred but not reported claims and changes in ultimate claims severity.
Although considerable variability is inherent in such estimates, management believes the reserves for losses and loss adjustment expenses are adequate. The estimates are continually reviewed and adjusted as necessary as experience develops or new information becomes known. Any adjustments to estimates are recorded in the current period.
The foregoing reconciliation shows loss and loss adjustment expense reserve redundancies of $0.1 million, $0.2 million, and $1.9 million developed in 2020, 2019 and 2018, respectively. During 2020, this favorable reserve development related to lower than anticipated frequency and severity of claims in our homeowners and special property
As such, the following tables show the Company’s historical homeowner and special property incurred and cumulative paid losses and LAE development, net of reinsurance, as well as IBNR loss reserves and the number of reported claims on an aggregate basis as of December 31, 2020 for each of the previous two accident years.
in November 2020, which accounted for approximately $7.1 million in ceded written premiums for the year ended December 31, 2020. No other quota share program accounted for more than 10% of total ceded written premiums for those years.
The Company recognizes ceded unearned premiums related to quota share agreements as an asset on its consolidated balance sheets. As of December 31, 2020 and 2019, ceded unearned premiums totaled $35.0 million and $26.1 million, respectively. The increase was driven primarily by premium growth in lines subject to quota shares and the timing at which the Company entered quota share arrangements.
As part of its reinsurance program, in May 2017, the Company obtained catastrophe protection through a reinsurance agreement with Torrey Pines Re Ltd. (“TPRe”). In connection with the reinsurance agreement, TPRe issued notes to unrelated investors in an amount equal to the full $166 million of coverage provided under the reinsurance agreement covering a three-year period, ending May 31, 2020. At the time of the agreement, the Company performed an evaluation of TPRe to determine if it meets the definition of a variable interest entity (“VIE”). The Company concluded that TPRe is a VIE but it does not have a variable interest in the entity, as the variability in results is expected to be absorbed entirely by the investors in TPRe. Accordingly, TPRe is not consolidated in the Company’s financial statements. The premium ceded to TPRe for the year ended December 31, 2020 was approximately $5.0 million.
redemption premium was recognized as a component of interest expense and the $0.9 million issuance cost write-off was recognized as a component of other underwriting expenses in the Company’s consolidated statements of income and comprehensive income.
As of December 31, 2020 and December 31, 2019, the Company has 5,000,000 preferred shares authorized with a par value of $0.0001 and no preferred shares issued and outstanding. As of December 31, 2020 and December 31, 2019, the Company has 500,000,000 common shares authorized and 25,525,796 and 23,468,750 common shares issued and outstanding, respectively, with a par value of $0.0001. Additional paid in capital is $310.5 million as of December 31, 2020 and $180.0 million as of December 31, 2019.
On April 22, 2019, the Company completed its IPO with the sale of 6,468,750 shares of common stock at a price to the public of $15.00 per share. The Company received net proceeds of approximately $87.4 million, after deducting underwriting discounts and commissions and offering costs.
Common stock reserved for future issuance consists of the following as of December 31, 2020:
Stock-based compensation expense is recognized on a straight-line basis over the vesting period of awards. The Company does not apply a forfeiture rate to unvested awards and accounts for forfeitures as they occur. All stock-based
The total intrinsic value of stock options exercised during the year ended December 31, 2020 was $7.7 million. No options were exercised prior to 2020. As of December 31, 2020, the Company had approximately $3.7 million of total unrecognized stock-based compensation expense related to stock options expected to be recognized over a weighted-average period of 2.27 years.
The fair value of each option granted was estimated on the grant date using the Black-Scholes option pricing model with the following assumptions in each year presented:
(2) Determined based on analysis of the historical volatility of a peer group of publicly traded companies.
(3) Determined using the “simplified method” for estimating the expected option life, which is the average of the weighted-average vesting period and contractual term of the option as the Company does not have sufficient historical exercise data to provide a reasonable basis upon which to estimate expected term due to the limited period of time its common stock has been publicly traded.
The following table summarizes RSU transactions for the year ended December 31, 2020:
As of December 31, 2020, the Company had approximately $1.2 million of total unrecognized stock-based compensation expense related to RSUs expected to be recognized over a weighted-average period of 2.41 years.
On April 16, 2019, the Company's 2019 Employee Stock Purchase Plan (“the 2019 ESPP”) became effective. A total of 240,000 shares of common stock are initially authorized and reserved for issuance under the 2019 ESPP. In addition, the 2019 ESPP provides for annual increases in the number of shares available for issuance on January 1 of each year through 2029, equal to the smaller of 240,000 shares of the Company’s common stock or such other amount as may be determined by the board of directors.
Changes in accumulated other comprehensive income (loss) (“AOCI”) are as follows:
The Company has a single reportable segment and offers primarily earthquake, wind, and flood insurance products. Gross written premiums (“GWP”) by product are presented below:
Common share equivalents relate to outstanding stock options and RSUs under the 2019 Plan and unpurchased shares under the 2019 ESPP and are calculated using the treasury stock method.
Under the Bermuda Insurance Act, 1978 and related regulations, PSRE is required to maintain certain solvency and liquidity levels. The minimum statutory solvency margin required at December 31, 2020 and 2019 was approximately $1.2 million and $1.2 million, respectively. Actual statutory capital and surplus at December 31, 2020 and 2019 was $39.2 million and $38.3 million, respectively. PSRE had statutory net income of $0.9 million, $18.5 million and $17.3 million for 2020, 2019 and 2018, respectively.
PSRE had stockholder’s equity of $41.9 million and $39.7 million on a GAAP basis at December 31, 2020 and 2019, respectively. The principal difference between statutory capital and surplus and stockholder’s equity presented in accordance with GAAP are prepaid expenses, which are non-admitted assets for Bermuda statutory purposes.
PSRE maintains a Class 3A license and thus must maintain a minimum liquidity ratio in which the value of its relevant assets is not less than 75.0% of the amount of its relevant liabilities for general business. Relevant assets include cash and cash equivalents, fixed maturity securities, accrued interest income, premiums receivable, losses recoverable from reinsurers, and funds withheld. The relevant liabilities include total general business insurance reserves and total other liabilities, less sundry liabilities. As of December 31, 2020 and 2019, the Company met the minimum liquidity ratio requirement.
The Company’s U.S. insurance company subsidiaries, PSIC and PESIC are restricted by the statutes as to the amount of dividends that they may pay without prior approval by state insurance commissioners.
As of December 31, 2020, the Company has three irrevocable standby letters of credit for the benefit of ceding insurance companies to secure the unearned premium assumed by PSIC. The bank letters of credit amount to $1.5 million, $0.5 million and $0.4 million. The $1.5 million and $0.4 million letters of credit expire December 31, 2021 with no renewal terms. The $0.4 million letter of credit auto renews each year. The letters of credit are collateralized by $3.2 million of U.S. Treasury bonds which are included in available-for-sale investments on the consolidated balance sheets.
(1) Due to rounding differences, quarterly total revenues does not add up to the yearly total.
Preparation of the financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying disclosures. Those estimates are inherently subject to change, and actual results may ultimately differ from those estimates.