Palomar Holdings, Inc.
Q4 2020 Earnings Call Transcript

Published: 27 Feb 2021

[Operator:]

Good morning, and welcome to the Palomar Holdings, Inc. Fourth Quarter and Full Year 2020 Earnings Conference Call. During today’s presentation, all parties will be in a listen-only mode. Following the presentation, the conference line will be opened up for questions with instructions to follow at that time. As a reminder, this conference call 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:]

Thank you, operator, and good morning, everyone. We appreciate your participation in our fourth quarter and full year 2020 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 Relations section of our website through 11

[Mac Armstrong:]

Thank you, Chris, and good morning, everyone. Today, I will speak to our fourth quarter results at a high level and then discuss our initiatives to expand our business and drive profitable growth before turning the call back to Chris to discuss our financial results in more detail. During the fourth quarter, we executed upon several notable initiatives that further position Palomar for consistent earnings growth in the years ahead. First, we grew gross written premium 31% and including growth across existing and new product lines, expanding our position as a specialty insurance leader. Second, our newly launched E&S carrier, which we refer to as PESIC, accelerated its traction in the fourth quarter. Our efforts with PESIC represent a logical extension of our business and enable us to address a large and attractive market opportunity. Third, we consummated seven new partnerships during the quarter, most notably, a Residential Earthquake partnership with the Travelers company. Partnerships like these continue to be a meaningful source of growth for Palomar as well as an important validation of the value that we provide to the market. Fourth, we acquired the renewal rights to GeoVera’s book of Hawaiian residential hurricane business. This transaction allowed us to solidify our position in an attractive market where we already provide our producers and carrier partners a differentiated product, technology platform and financial stability.

[Chris Uchida:]

Thank you, Mac. Please note that during my portion, when referring to any per share figure, I’m referring to per diluted common share as 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 fourth quarter of 2020, our net loss was $1.8 million or $0.07 per share compared to net income of $10.9 million or $0.45 per share for the same quarter in 2019. For the full year of 2020, our net income was $6.3 million or $0.24 per share compared to net income of $10.6 million or $0.49 per share in 2019. The gross written premiums for the fourth quarter were $96.1 million, representing an increase of 31% compared to the prior year’s fourth quarter. For 2020, our gross written premiums were $354.4 million, growth of 40.6% compared to $252 million in 2019. As Mac indicated, this growth was driven by a combination of new products, accelerated rate increases, expansion of our E&S footprint and extension of our distribution networks. Ceded written premiums for the fourth quarter were $53.8 million, representing an increase of 82.3% compared to the prior year’s fourth quarter.

[Operator:]

Thank you. We’ll now be conducting a question-and-answer session. Our first questions come from the line of Matt Carletti with JMP. Please proceed with your questions.

[Matt Carletti:]

Hey, thanks. Good morning. Just a couple of questions. Mac, maybe start with one centered on growth. I appreciate your comments about seven new partnerships being signed in the quarter. And really, my question is, could you help us kind of gauge your excitement or optimism for the growth path going forward? Specifically, kind of what’s the potential for those new partnerships? How should we think about the timing and the ramp of those? And then really, with kind of the bottom line question of, as you look at 2020 and what was a very strong kind of 40% or so gross written premium growth rate, do you feel that’s sustainable? Do you feel that’s something that can be built upon? Or is the model maturing a bit and there’ll still be strong growth, but maybe we shouldn’t think about those numbers?

[Mac Armstrong:]

Yes, Matt. That’s good to hear from you, and thanks for the question. Definitely want to address this because I think it’s important to say that we feel very good about our growth prospects into 2021 and beyond. When you look at our growth over the course of 2020, it was strong, but with the addition of new products, the new carrier and new partnerships, which you’ve touched upon, we do believe that a growth rate that’s – and we don’t – we’re not going to provide premium guidance per se, but we do think that our growth rate that we achieved in 2020 is sustainable. So we think that, that is directionally very achievable. And I wouldn’t mind just giving just a little more color on the fourth quarter top line growth because ultimately, when we went through the exercises and the underwriting changes that we put into place in the fourth quarter, we focused on profitability. And as a result, we made changes that would have slowed the growth in certain lines of business. So clearly, Commercial All Risk, exiting that business in the middle of the quarter on an admitted basis and pivoting to the E&S layered and shared focus, exiting Specialty Homeowners in Louisiana, that – you could argue, that sacrificed seven points of growth from just what our average new business was in a month, but it also took away the potential losses of – 70% of our losses that we incurred from the wind season of 2020. We also looked at certain of our lines, like Commercial Earthquake, to make sure we were getting the same targeted return. Even with earthquake where you have a circumstance where you see no attritional loss, you do have underlying target metrics. And there were certain accounts that we opted to walk away from, that weren’t going to achieve our targeted returns. And so if you compartmentalize that, that was probably around seven points of growth within Commercial Earthquake. And then just one little nuance on Commercial Earthquake is that there is around $1.2 million of premium that’s tied to national property in the E&S book that is earthquake premium. That could have been reconstituted and would have pushed up the earthquake growth rate to closer to – commercial quake closer to 23%. And the only thing I would highlight, too, is on Residential Earthquake, our same-store growth was 15%. Our largest product, Value Select was north of 20% in the fourth quarter. So it’s a long-winded way of saying, when you look at just the underlying trends in earthquake plus factor in the growth from the E&S company; new partnerships that we have in Builders Risk, certainly for national property; some of our new casualty lines; the real estate agents E&O; the new earthquake partnerships with someone like Travelers; our flood partnership with Torrent; and then also the Hawaiian Hurricane renewal rights deal, which didn’t kick in until the first quarter because there is a lag I think on – from the timing of the deal to when you actually deliver the renewal notice. There are multiple growth drivers that gives us very good confidence about sustaining growth equivalent to that of 2020 for the full year in 2021. And the only other – the last point I’d make is we’re two months into the year, and we’re seeing very good growth, earthquake, Hawaii, you name the line.

[Matt Carletti:]

Great. That’s very helpful. Thank you. And then just one other question, kind of a – more of an underwriting approach question. Particularly as we think about some of the newer partnerships that have been announced. So I’m thinking of things that have a little larger limits to them, like the excess liability partnership or the Builders Risk partnership. Can you just give us a little inside baseball on how you approach kind of those sorts of partnerships where maybe there’s – in some of those, there’s a little more tail involved. There’s a little larger limits involved. I’m sure reinsurance is probably part of the answer as well as just old-fashioned underwriting. But any color you could give there would be great. Thank you.

[Mac Armstrong:]

Yes, absolutely. And so – well, first off, we want to underwrite it on a net line basis, so we’re looking at what is the unit-level profitability irrespective of reinsurance. Because if you do it that way, you have the ability to supplement your risk and your underwriting appetite with reinsurance. And so those lines that you touched upon, the newer partnerships and Builders Risk, the new partnership that we’ve done in the casualty arena, those have quota share reinsurance supporting them. So typically, we would only end up being 20% to 25% of the risk, much like we’ve done with all of our attritional loss lines, and that’s why we have the confidence that we do around the results in Texas. We have underlying quota shares working side-by-side with us. So those new partnerships, we’re going to wade into those markets, have a very disciplined underwriting appetite, have incremental reinsurance supporting us, and doing it in a market that is conducive to naming your terms and conditions. It is still a very favorable market from a pricing and terms and condition standpoint.

[Matt Carletti:]

Great. Thank you for the color and best of luck in 2021.

[Mac Armstrong:]

Thanks, Matt.

[Operator:]

Thank you. Our next questions come from the line of David Motemaden with Evercore ISI. Please proceed with your questions.

[David Motemaden:]

Hi, thanks. Good morning. I had a question, Mac, just on – just a bit more on the growth during the quarter. And specifically, the Residential Earthquake growth where it slowed a bit. And I think I caught that you had said 14% to 15% same-store growth in Residential Earthquake, and you guys have historically had very good retention in this line. So I guess I’m just wondering maybe if you could touch on new business trends. And was that just running a little bit light in 4Q? That it seems like it might be temporary based on the comments that you just made. But wondering if you could just expand a bit on the Residential Earthquake growth of about 6% year-over-year in the quarter.

[Mac Armstrong:]

Yes, absolutely, Dave. And again, what I would say is that the same-store growth was 15%, and our largest product, Value Select, grew 20% in the quarter. There’s really two specific things that influenced or impacted the growth. And it wasn’t new business, it was actually some of our assumed reinsurance partnerships. We had one partnership with a carrier that exited the line in Utah that we stopped doing business with that actually in the fourth quarter gave us a little bit of a onetime unit unearned premium bump. So that was roughly a four-point kind of aberration in the fourth quarter of 2019. And then the other thing was we had one other assumed reinsurance relationship with a homeowners provider in California that has materially changed its appetite due to wildfire. We have supported them on the earthquake side, and they’re still a very good partner, but they have changed the size of the risk they want, they’re not renewing policies because of the wildfire exposure in the state of California. So what I look to, again, is our core products, Value Select, Heritage, Flex Choice, those grew 20-plus percent. You had two legacy partnerships, for lack of a better term, that have been kind of wound down or one was wound down, one has come back some considerably. And then, again, as I said, if you look at the start of this year, new business is strong. We feel very good about sustaining the growth rate that you saw, 15-plus percent in 2020 on the Residential Earthquake side in 2021.

[David Motemaden:]

Great. Thanks. That’s really helpful. And then maybe a quick follow-up on that. Great to hear about the partnerships, adding seven in the quarter, and great to hear about the Travelers partnership in Missouri, Indiana and Utah. I guess I’m just wondering if you have any line of sight into expanding that relationship to include some other states like California, Washington, Oregon. I guess, is that an ongoing conversation that you guys are having?

[Mac Armstrong:]

Those are ongoing conversations. I think what we’re focused on right now is executing in those first three states, getting our systems well integrated with their agents, getting our marketing team to train their marketing reps as well as their producers on the products themselves. But yes, we entered into this arrangement with the hopes of expanding it well beyond those three states. So I hope to report that there is expansion over the course of 2021, but we’re going to walk before we run and get it right because this is an important deal for us.

[David Motemaden:]

Got it. That makes sense. Thanks. And then I guess just shifting over to reinsurance. It was great to see the aggregate that you guys put in place earlier this month. I’m wondering if you could maybe just touch on other parts of the program? And just on the reinsurance renewals at 1/1, what sort of rate increases you guys experienced? And then also maybe just give your outlook on how you expect the reinsurance rates to progress over 2021. Especially now, it sounds like the Specialty Home facility is clearly working as you guys had intended, but I believe that renews at 6/1 and that’s – so just wondering, I guess, as well, specifically on the specialty home facility, how you’re thinking about the renewal on that.

[Mac Armstrong:]

Sure. So what I would tell you, David, so we did not have any reinsurance renewing at 1/1. The majority of the program renews at 6/1, but we did go out and place the aggregate earlier this year, and it incepts at 4/1 and it was a – we did it in January, as you know. And we had a good experience. We have some great reinsurers supporting us. It was priced kind of in line with our expectations. And as it relates to 6/1, the broader cat program renews. We are in the market now. We have a terrific panel of reinsurers that the strong majority of which will not have incurred losses. So I think we feel good about the placement. The guidance that we put in place reflects some rate increase, and it’s a digestible rate increase when looking at the primary market and what we can get there. On the Specialty Homeowners facility, I think that first and foremost, what it starts with is we need to do a very good job of servicing our policyholders, one, to make sure that they’re not disrupted in their homes, and are back in their homes with full utility; two that we’re responsive and also not putting ourselves in a position where there’s leakage from a claims handling expense or just overall malaise in servicing the business. And if we do a good job of that, we feel that we have – we will be able to successfully renew the Specialty Homeowners facility at 6/1. Up until this month, that program had done very well, and it has done very well historically. We’ve got a great group of reinsurers supporting us. And so we think we’ll be able to get it placed. We’re very confident in that. And we take around 22.5% of the risk there. We might be able to dial that up or down some. But I think what it first comes down to is just being very transparent with our reinsurers, being very responsive to our policyholders and getting these claims serviced and closed as quick as possible.

[David Motemaden:]

Okay, great. Thanks. That makes sense.

[Operator:]

Thank you. Our next questions come from the line of Mark Hughes with Truist. Please proceed with your questions.

[Mark Hughes:]

Yes. Thank you. I know you’ve said that Texas was not material, but in thinking about your guidance, the $62 million to $67 million, I do wonder whether there might be $1 million or $2 million that you assume from the winter storms in that guidance. I think you said it was inclusive of Texas. Is Texas zero? Or is it perhaps a couple million?

[Mac Armstrong:]

Yes, Mark, this is Mac. And it’s a fair question. I mean we’ll have some loss. It’s going to be on the lower end. It will be within that range. If I had to handicap right now, it will be within that range that you specified. And so that’s why we feel that it’s immaterial, but it’s still too early to tell. But the guidance that we put out there reflects the losses from Texas. And that’s kind of all we can say because it is early stages. Certainly in terms of adjudication, the volume of claims is dissipating some, but we’re still seeing them. So until we get our true hands around that, like the range of the net is kind of what you outlined.

[Chris Uchida:]

The one thing I’d add around that guidance as well is that we talked about it on the call and mentioned earlier this year is that, that also includes the new cost of the aggregate, which is new to our program but will definitely help create more visibility and consistency of earnings, but also, as Mac mentioned in his prepared remarks, create more of a floor for what our adjusted net income will be for 2021. So I think that will just help prepare. But there is additional costs associated with that included in that guidance that we are providing.

[Mark Hughes:]

Mac, you gave some numbers talking about that floor specifically. I think the 10% ROE, 80% adjusted combined ratio. Did I hear that properly? And then I think you provided a third metric that I did not get.

[Mac Armstrong:]

Yes, yes. The numbers were approximately a 10% – the floor, this is, again, the floor, 10% ROE, 80% adjusted combined ratio and adjusted net income of $39 million. For what it’s worth, if based on the underwriting changes that we’ve made, if 2020 were to repeat itself again with the same type of storm, same location, the range that we would have, the floor wouldn’t be $39 million. It would be closer to $41 million, $46 million. But the full utilization of the aggregate would be a $39 million adjusted net income.

[Mark Hughes:]

Understood. And then PESIC, I think you mentioned 128% sequential growth. You might have given the 3Q number last quarter. But what was that contribution in the fourth quarter just from a written standpoint?

[Mac Armstrong:]

It was – in terms of the gross written premium?

[Mark Hughes:]

Yes.

[Mac Armstrong:]

Yes, sure. It was – in – let me give you the exact number. It was in and around $21 million.

[Mark Hughes:]

And then what do you think about the ramp on that? Obviously, 128% sequential, where is that going? Yes, what kind of ramp should we anticipate on that roughly?

[Mac Armstrong:]

I think long-term, we think the premium in PESIC could be equivalent to what we have in the admitted company. We have internal targets. We’re not going to guide to them this year. But we – the new partnerships that we’ve announced and Builders Risk, in excess liability, those are E&S. There’s great momentum with what we’re doing with Amwins as well as on the national property as well as in commercial quake. So there’s a lot of – and there’s a lot of things in the hopper. So we feel very good about the long-term prospects. And I don’t know if we’re going to grow sequentially 130% a quarter, but we’re going to grow pretty nicely in the E&S company.

[Mark Hughes:]

Thank you.

[Operator:]

Thank you. Our next questions come from the line of Jeff Schmitt with William Blair. Please proceed with your questions.

[Jeff Schmitt:]

Hi, good morning. The Commercial All Risk book that you exited, I think in the past, you said that was about a $9 million book and – but it costs you sort of seven points of overall growth in the quarter, I believe, which implies maybe it was a bit larger. So I guess, what was the size of that book? And will that come out fairly evenly this year as policies non-renew?

[Mac Armstrong:]

Yes. Jeff, it’s Mac. I think it was 9% of total premium, not $9 million. So the – but what I would tell you is, sequentially, we – that book of business declined from, call it, $12.5 million or so in the third quarter, it declined probably about by about 50% so it’s going – on a sequential basis. It’s going to wind down ratably over the course of the year. It’s going to be offset by growth on national property and the E&S company. So that – it will probably end up being looking slightly flat to down modestly as categorized as Commercial All Risk, but it will be all E&S versus the admitted. So we’re kind of rolling off close to 8% to 10% a month. And the limit comes down commensurately as well. And I think a good indicator of that is if you just look in the fourth quarter, and we disclosed this, how much of our Texas premium declined sequentially. And that was a function of the Commercial All Risk being wound down in that state – the admitted Commercial All Risk being wound down in the state. And then the only thing that I would add is just if you look at the business that we’re bringing on, on the layered and shared national property business, the metrics are considerably better, not necessarily from a pure rate perspective. But from a pure premium perspective in the AAL to premium and some of the other metrics that we track, it’s considerably better. It’s close to 38% better from a theoretical or underlying profitability standpoint. So it will help with our margins. It will reduce our cost of reinsurance, and it will enhance our spread of risk.

[Jeff Schmitt:]

Got it. Okay. Yes, that’s great color. And then looking at the other line in premium, it’s actually ramping faster than flood, almost as fast as Builders Risk. Is that all the real estate E&O product? Or I thought that was newer, I guess, what is in that? And sort of what are the growth prospects of that?

[Mac Armstrong:]

Yes. So there’s a few things in there. There is – there’s real estate E&O. There are some new E&S assumed reinsurance relationships. We are starting to write kind of non-property assumed quota share reinsurance with the team that’s long-standing market experts. And so that’s another component to it. And that could be for a line like mostly casualty. And then – so the other right now is going to be really more of our casualty business, and so we’ve got a good start in ramping that up.

[Jeff Schmitt:]

Is that casualty in terms of like with a property, like a commercial property, kind of a commercial package product?

[Mac Armstrong:]

Yes, some of it could be – yes. Some of it could be packaged. Some of it could be just a pure liability product. Some of it could be like the real estate agency. It’s a professional line.

[Jeff Schmitt:]

Got it, okay. Thanks for the answers.

[Operator:]

Thank you. Our next questions come from the line of Tracy Benguigui with Barclays. Please proceed with your questions.

[Tracy Benguigui:]

Thank you. Just want to circle back to Uri. There are a lot of estimates that seem to be pretty varied, and the largest vendor catastrophe modeling firms haven’t provided their view yet. So I’m just wondering as you’re thinking about your outlook for the year, it seems to be in a tight range, how you think about the industry loss size of this event? And if you could also just walk us through the mechanics your reinsurance because I realize it’s not linear. Or maybe I could follow-up on that question.

[Mac Armstrong:]

Well, what I would tell you, Tracy – and we can follow-up on it. And I think we’ve talked about, since we’ve been public that we use four attritional loss lines like Texas homeowners or our Specialty Homeowners facility, we use quota share reinsurance. And so we’re taking 22.5% of the risk with recoveries on a first dollar basis. But we have quota shares in place for the Specialty Homeowners business. We have them in place for the all risk business as well as Builders Risk and Inland Marine. So we have three separate quota shares in place to support us from an attritional loss standpoint. So those are inside of our retention. And then once above 10 – once the aggregate loss is above $10 million, that’s when it’s triggered by our cat program. So we have the ability to recover from multiple vehicles

[Tracy Benguigui:]

Yes. I guess you’ve previously mentioned 22.5% for Specialty Homeowners. But if you could walk us through what your retention is for commercial property. And also if your estimate take a view that you will blow through your occurrence tower?

[Mac Armstrong:]

We will not blow through our occurrence tower. This will not – we will not have $600-plus million of loss from Uri. It will be nowhere near that. We – it could go into the first layer of our reinsurance program. It’s still early to tell. As I said earlier, the claims have dissipated or the pace of claims tendering has dissipated considerably over the last few days. So it’s a manageable, identifiable number. And so our all risk, on average, we’re taking about 20% of the attritional loss and same thing on the Builders Risk and it’s 22.5% on the Specialty Homeowners.

[Tracy Benguigui:]

Okay. Appreciate you laying that all out. And then, I guess, there was a lot of discussion on growth. Maybe on the flip side, you had mentioned, I guess, reiterated, not new news on some businesses that you have exited. I’m wondering if there’s any other areas where you’re not meeting your risk return – risk-adjusted returns on capital that may look less attractive right now that you’re revisiting.

[Mac Armstrong:]

Right now, beyond the Commercial All Risk and the Specialty Homeowners in Louisiana, we look at it on a state-by-state and account-by-account basis. So we – and that’s the beauty of having an E&S company or having the ability to modify rates even on the admitted side. So no, there’s no line of business. There could be ZIP codes, there could be certain classes that we’re going to take rate on, but that’s just good underwriting. But so there’s nothing, no broad brush.

[Tracy Benguigui:]

Thank you.

[Operator:]

Thank you. Our next questions come from the line of Meyer Shields with KBW. Please proceed with your questions.

[Meyer Shields:]

Great, thanks. So first, I think, Mac, you mentioned seven new deals. Should we think of those, outside of Travelers, as being the typical earthquake hotspots?

[Mac Armstrong:]

Yes, that’s fair, Meyer. Yes. It’s going to mirror where we have filings in place, existing presence in distribution, but that’s right.

[Meyer Shields:]

Okay. And those are also up and running as of January 1?

[Mac Armstrong:]

They are – yes, in varying degrees. Some of them are in pilot phases, some of them are in training phases in a single state. So there’s a lot more to come in terms of penetration, training and adoption.

[Meyer Shields:]

Okay. That’s helpful. And second, I was hoping you could just go through the reinsurance program associated with the growth in Florida, just because it’s been a tricky state in the past.

[Mac Armstrong:]

Sure. So the reinsurance, so we have a separate tower, it’s the North Atlantic hurricane tower that is – that covers us for the Florida exposure. And some of the Florida exposure that we brought on was part of – is motor truck cargo, some of it is the assumed reinsurance that doesn’t have cat exposure. So the new Florida business that we brought on that’s tied to our layered and shared property. There is a stand-alone facility that we have that, that attaches at $10 million. And then at some point, the broader cat program, it will inure to the benefit of the broader cat program. But our PMLs in Florida right now are very modest.

[Meyer Shields:]

Okay. And then I’m assuming it was in accidental, but I was wondering whether you’ve given any thought to disclosing how Palomar looks at AAL.

[Mac Armstrong:]

In terms of how we look at our average annual loss? We look at...

[Meyer Shields:]

Yes. In other words, how we should build it?

[Mac Armstrong:]

Well, I think I wouldn’t – I mean, the average annual loss that we built – AAL, our reinsurance program is priced at a multiple of the AAL, the same way we price our premium. I think if you’re trying to figure out like what a cat load is, what we have – I think our best offering to you is we have put the aggregate in place that puts a floor. If there are three retentions, after three retentions, it goes into the aggregate. So there is – a lot would have to happen, and we saw it happen in 2020. But 2020 is going to look very different than 2021 just because of our underwriting appetite. So the cat load, if it’s one event, if it’s – that would be – I don’t know how you want to do that, Meyer. I think when we look at AAL, we use it to look at the underlying pricing and how we pay for our reinsurance. And the lower the AAL, the cheaper our reinsurance is and so that the higher the – our net earned premium is.

[Meyer Shields:]

No. Understand. I know it’s not a question you can answer. I mean that’s something for the model.

[Mac Armstrong:]

Yes.

[Operator:]

Thank you. Our next questions come from the line of Paul Newsome with Piper Sandler. Please proceed with your questions.

[Paul Newsome:]

Thank you, and good morning. I was hoping you could talk a little bit about the outlook for the attritional layer loss ratio. Obviously, you have a business mix change happening with the new E&S business, which I assume would have higher attritional losses, but there’s been a lot of changes in both reinsurance and pricing. So do we – should we continue to expect sort of, I guess, a gradual increase in the attritional loss ratio? Or should just – how should we think about that? And how that may be changing in the last three, six months?

[Chris Uchida:]

Yes. No, I can handle that one, Mac. But I think you described it well. I think there’s really no change in the philosophy that we’ve kind of been giving really over the last year. That we do expect the attritional loss ratio to continue to tick up, as you can see for the full year of 2020. It didn’t jump. We went from 5.6% for 2019 to about 8% for 2020 – or excuse me, 8.5% for 2020. Some of that is also a little inflated just because of the amount of additional reinsurance expense that we had to take in the fourth quarter. So that pushed the loss ratio up slightly. But these are all in line with our expectations through the year that it was going to go up. Obviously, we are still expanding some of those lines. The Specialty Homeowners line is still growing. As Mac mentioned, we are rotating out of our admitted all risk but going into another all risk or a layered and shared all risk program. I will say that the attritional loss profile of that book is a little bit better than our historic book or historic admitted book. So we do expect to see some improvement there. But there are lines expanding, such as Inland Marine, all risk. I think the layered and shared all risk, the Specialty Homeowners will still have attritional losses. So we expect it still to tick up. But like I’ve said before, it’s not turning into the 20% overnight. This is going to be 8.5%, moving up to maybe 9% next quarter or things of that nature. But it’s – as you know, loss ratios aren’t perfect. They are a little bit seasonal. So there’s going to be some bumps and valleys in that. But on an annual basis, we don’t expect it to jump to 20% or anything like that, maybe a point or two each quarter or over an annual period.

[Mac Armstrong:]

And I think just what I would add, Paul, is if you look at the fourth quarter, it was 7%. It was flat year-over-year. So again, to Chris’s point, it’s very gradual.

[Paul Newsome:]

That’s great. And then on the reinsurance side use of quota share, are there any products where you are either expanding or contracting the use of quota share that might affect sort of net to gross, respectively, over the next year or two?

[Mac Armstrong:]

Not in a material fashion. Our participation in our flood product has ticked up modestly over the last few years. But it’s – so no, it’s not like we’re going to start to take 100% of that book. We’re still ceding out 60% of it.

[Chris Uchida:]

Yes. And like I said, obviously, when we talked about it on the call or on the prepared remarks on the call, I indicated that our net earned premium should remain around that 52% to 54% mark. That includes our thoughts on our participation in the quota shares, the increased expense of the Ag and then also obviously, any reinsurance that we place at the June 1 renewal.

[Paul Newsome:]

Great. Thank you very much.

[Mac Armstrong:]

Thanks, Paul.

[Operator:]

Thank you. Our next questions come from the line of Adam Klauber with William Blair. Please proceed with your questions.

[Adam Klauber:]

Hi, a couple of questions. On the expense ratio, quarter-over-quarter, obviously, jumps up. Went from – sorry, year-over-year, 54% to almost 67%. How much of that is the reinsurance?

[Chris Uchida:]

Yes, there is a significant amount of that, that is being driven by reinsurance. When you think about how that ratio is calculated, it probably, let’s call it, about a 12% hit to those ratios. So when I look at the expense ratio, it was 56% last quarter, on an adjusted basis, 53.6% to 54%. And it’s now, adjusted, it’s about 66.7%. If you were to back out some of those reinsurance charges for the year, that gets you below 60%. So when we do – the reinsurance charge I’m talking about is the expense acceleration of $4.1 million and then the reinstatement of the backup layer, about $760,000. You take those out of your net earned – or add those back into your net earned, that lowers the ratio to be within our expectations for the year or for the quarter where we did talk about the fact that as we changed the quota shares back in Q2, we increased our participation and then also changed the structure where we had a lower ceding commission. But that also helped drive up the improved net earned premium. But the expense ratio definitely is inflated. I’d call it about 7.5 to 8 points gets inflated from purely from the acceleration in additional reinsurance in the quarter.

[Adam Klauber:]

Okay. So that’s helpful. So this is more directional than exact. But so, 2019, the expense ratio was 57%. 2020, up to 59%, but again, had a lot more reinsurance expense. As we think about 2021, again, you got the aggregate coming in, you got some of the additional reinsurance costs. So are we looking at that sort of higher level to – not asking for exact, but 59%? Or with the additional reinsurance, could be going up from what we saw in 2020?

[Chris Uchida:]

Yes. No, I think it should. I think one thing we’ve talked about is the investment we’re making in PESIC. I think over the last couple of quarters, we’ve said that the expenses or the ratios will probably flatten out in a little bit over Q4 and then into Q1 of this year. So I think it’s going to stay at that level, let’s call it, for maybe a quarter or two. But then we do expect, let’s call it, by the end of – or probably the second half of 2021, that we will start seeing that scale come back into the model as some of those investments take hold. I think Mac talked about we’re continuing the investment in people. Talked about Angela Grant and other folks that have joined the team. We’re continuing to invest there and then also on some of the other things that help – will help PESIC grow. But that scale, we do expect to continue to be in there. And I think you can even see it when you look at the other underwriting expenses on a gross basis. I mean compared to gross earned, if you look at the other underwriting expenses with the adjustments included, last year, it was 10.5%, and this year was 10%. So there is still improvement in those layers or in those ratios as we look at on a gross basis, which is generally how we look at it internally. Because it takes out the noise that any type of reinsurance expense is going to put into those ratios.

[Adam Klauber:]

Okay, okay, thanks. And then going back to some of the premium growth, again, the Commercial All Risk will be a bit of a drag. It sounds like more in the first half. How big is the Louisiana homeowners that you’re running off? And then also on the Commercial Earthquake, sounded like you did some reunderwriting in the fourth quarter. Is there any of that going forward? Or is that probably more of a – just a fourth quarter-type hit?

[Mac Armstrong:]

Adam, this is Mac. Good questions. First on the Louisiana homeowners, it’s very modest. It’s plus or minus $1 million, $1.5 million. So that will not have much of an impact, if any. On the commercial quake, I would say, it was specific to the fourth quarter. As I said, we’re seeing very good growth to start the year. And what I would add is we’re seeing very good growth to start the year with our target metrics being hit. So we’re getting rate increases. We’re improving terms and conditions. So we feel very good about Commercial Earthquake growth at this point.

[Adam Klauber:]

And then, sorry, a similar question on residential. I think you said one of your partners is not doing well in California. I think one other thing depressed that somewhat growth in the fourth quarter. Will we see some of that carry over in the first half? Or is that more of a fourth quarter issue?

[Mac Armstrong:]

That was a fourth quarter issue. There – one was a onetime unearned premium bump that we received. And those can happen as we bring on new partnerships, but that was a partnership that was dissolved fairly quickly after a short-term arrangement. And then the other one is – it kind of run itself over the course of 2020. So they’ve stabilized what they want in California homeowners.

[Adam Klauber:]

Okay, okay. And then more of an overall on the E&S and PESIC bit. Yes. I mean again, still very new, two quarters in, you’re building up some partnerships there. Is the momentum in that property market still building as much as you saw through six months ago? Or is there any, I guess planning out or flattening of that momentum?

[Mac Armstrong:]

No. We’re still continuing to see rate increases, and we feel good about that for the remainder of the year. I mean in the fourth quarter, our average rate increase was around 16%. I don’t know if I want to say that for the rest of the year, we’ll average a 60% rate increase, but we will get rate. And it’s rate on top of rate at this point, which is a good thing. So – and in some of the – yes, so I think we feel very good about the rate environment and it being sustained, certainly, in a positive fashion through the rest of this year and probably into the early part of next year, too.

[Adam Klauber:]

And how about the level of opportunities come in the door. You had over 100% sequential growth. Do you see any change in that environment anytime soon?

[Mac Armstrong:]

No. I mean we’re seeing a lot of different new partnerships, new markets to enter. We have to be somewhat mindful of bandwidth and how we allocate our time and resources and making sure that these new arrangements can hit our target returns, but yes, there’s no shortage of opportunities out there in this market.

[Adam Klauber:]

Okay, great. Thanks a lot.

[Operator:]

Thank you. There are no further questions at this time. I would like to turn the call back over to Mac Armstrong for any closing comments.

[Mac Armstrong:]

Great. Thanks, operator, and thank you to all for your time this morning. This concludes Palomar’s fourth quarter earnings call. We appreciate your participation, the questions and certainly, your support. We believe 2020 was a significant year in our company’s short history. We launched a new E&S platform. We grew in both new and existing lines. We added terrific talent to our team. And also, and most importantly, we adapted swiftly to market conditions and challenges. Looking ahead, we really are excited about the opportunity ahead of us in 2021. We think we’ll be – we will showcase our efforts and our growth initiatives in a very good fashion and, moreover, provide strong, consistent earnings over the course of 2021. So with that, I hope everyone remains safe and healthy. Thanks so much, and we’ll speak to you after the first quarter. Have a great day.

[Operator:]

Thank you for your participation. This does conclude today’s teleconference. You may disconnect your lines at this time. Have a great day.