Good morning, and welcome to the Palomar Holdings, Inc. fourth quarter and full year 2021 earnings conference call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference line will be open for questions with instructions to follow at that time. As a reminder, this conference is being recorded. I would now like to turn the call over to Mr. Chris Uchida, Chief Financial Officer. Please go ahead, sir. You may begin.
Thank you, operator, and good morning, everyone. We appreciate your participation in our fourth quarter 2021 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 11:59 P.M. Eastern Time on February 24th, 2022. Before we begin, let me remind everyone that this call may contain certain statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These include remarks about management's future expectations, beliefs, estimates, plans, and prospects. Such statements are subject to a variety of risks, uncertainties, and other factors that could cause actual results to differ materially from those indicated or implied by such statements, including, but not limited to, risks and uncertainties related to the COVID-19 pandemic.
Such risks and other factors are set forth in our quarterly report on Form 10-Q filed with the Securities and Exchange Commission. We do not undertake any duty to update such forward-looking statements. Additionally, during today's call, we will discuss certain non-GAAP measures which we believe are useful in evaluating our performance. The presentation of this additional information should not be considered in isolation or as a substitute for results prepared in accordance with U.S. GAAP. A reconciliation of these non-GAAP measures to their most comparable GAAP measure can be found in our earnings release. At this point, I'll turn the call over to Mac.
Thank you, Chris, and good morning, everyone. Today, I will speak to our fourth quarter and full year results, our progress on strategic initiatives implemented in 2021, and our continued efforts to drive and sustain profitable growth. From there, I'll turn the call back to Chris to review our financial results in more detail. To start, I am very pleased with not only our results in the fourth quarter in 2021, but also the significant steps that we took throughout the year to position Palomar for long-term growth and predictable earnings in the years ahead. Highlights for the year include strong top-line growth as Palomar's gross written premiums increased by 56% for the fourth quarter and 51% for the full year 2021.
This strong growth was driven by our core products, including earthquake and Hawaii hurricane, combined with the successful scaling of our E&S business, Palomar Excess and Surplus Insurance Company, PESIC. PESIC grew its gross written premium an impressive 158% year over year in the fourth quarter. Second, we continue to invest in our business and plant the seeds for future growth. Notable accomplishments in 2021 include the recruitment of talented underwriters to build our casualty, professional liability, and excess property franchises, as well as the launch of the fee-generating PLMR-FRONT in September. Third, we took considerable underwriting actions to improve our portfolio and reduce our catastrophe exposure to perils disproportionately impacted by climate change. While we are focused on delivering sustained revenue growth, it will not come at the expense of our bottom line.
To support this, over the course of the year, we completed the runoff of our admitted all risk in Louisiana homeowners' portfolios, shifted our commercial wind-exposed property focus to a layered and shared model, meaningfully reduced our maximum limit and line size, and took advantage of favorable market conditions to increase rates and improve terms and conditions. These actions helped reduce our continental hurricane probable maximum loss by approximately 40% from its apex in 2020 and eliminated a primary driver of our attritional loss ratio. Fourth, minimizing volatility in our business and protecting capital has been a constant theme at Palomar going back to our founding eight years ago. During 2021, we continued to thoughtfully use risk transfer to protect our balance sheet and deliver consistent earnings.
Highlights of these efforts include the placement of a multi-year catastrophe bond, Torrey Pines Re 2.0, the placement of multiple quota shares that reduce our maximum limit per risk and provide fee income, and the purchase of aggregate reinsurance. The aggregate not only protects our business from losses generated by multiple severe catastrophic events, but also puts a floor on our adjusted ROE. Fifth, our board of directors authorized a $100 million share repurchase program last month that affords us the ability to opportunistically deploy capital and buy back our shares at levels that we believe are meaningfully undervalued. Importantly, we continue to believe stock repurchase will not impede our ability to capitalize on the open-ended growth opportunity that we see before us. We believe the buyback notably demonstrates the conviction we have in our long-term strategic plan and the optimism in the future of Palomar.
Lastly, we launched our ESG portal in 2021 and released our annual sustainability and citizenship report last month. We are very pleased with the progress that we have achieved in our ESG initiatives as well as the associated commitment to our employees, the environment, and the communities we serve that these initiatives demonstrate. Turning to our results in more detail, we delivered strong premium growth through the fourth quarter as we experienced momentum across all lines of our business. Our earthquake franchise saw growth of 21% in the fourth quarter and 31% for the full year, with commercial earthquake growing 35% and our Value Select residential earthquake product, our largest product, growing 26% in the quarter.
As we have discussed on previous calls, opportunity in the earthquake market remains abundant, whether it be from dislocation in the homeowners market or the California Earthquake Authority advocating a potential reduction in coverage, the shedding of limit, or the permission of participating insurers to seek alternative earthquake insurance solutions. We have less than a 6.2% share on the California residential earthquake market, which provides considerable room for continued strong growth in this important and profitable line of business. Shifting to PESIC, we launched the business in August of 2020 and have been extremely pleased with how quickly our operations have scaled as we have delivered $152 million in premium for the full year 2021 as compared to $29 million in 2020.
This growth was driven by PESIC's main products, which include commercial earthquake, national layered and shared commercial property and builder's risk. During the year, we also launched several new E&S products, including professional liability, excess liability, and contractor's liability. These products, along with others, will be significant contributors to our success and bottom line in the years to come. Needless to say, PESIC will remain an important growth driver for Palomar, and we believe the business can become 50% of our premiums over time. Other strong performing product lines in the fourth quarter included Inland Marine, which grew 290% YoY and exited 2021 at a $72.8 million run rate. Hawaii hurricane with 109% YoY growth and flood, which grew 32% YoY.
Our first casualty product, real estate errors and omissions, continues to show great promise as it grew nearly nine-fold YoY. While the strong top-line growth is and will continue to be a significant driver of our success as an organization, Palomar is keenly focused on profitable growth. We are pleased to report in the fourth quarter for all of 2021, frankly, we're able to marry the 50%+ top-line growth with a very strong bottom line in return on equity. We generated adjusted net income of $19.2 million and $53.4 million for the fourth quarter and full year 2021 respectively, which translated to an adjusted ROE of 19.9% and 14.1% for the same periods. Additionally, during the fourth quarter, we completed the aforementioned runoff of the admitted all-risk in Louisiana homeowners books of business.
These lines contributed 61% of our catastrophe losses in 2021. We believe exiting these businesses not only reduces our catastrophe exposure, but also improves the predictability in our results. Our strong results, combined with the substantial investments in product systems and talent, provide confidence in our positive outlook for growth in the years ahead. Over the course of 2021, we launched several new businesses and products to further fuel our growth in the medium term. PLMR-FRONT is one that I am particularly excited about. Introduced in September, our team has quickly built a strong pipeline and has already executed three programs which are all fee-based and do not involve us taking underwriting risk.
Adding a fee-based revenue stream to our business further fortifies our earnings base, and I believe we will build the fronting business to $80 million-$100 million in managed premiums in 2022. We also recruited talented underwriters to our team in the third and fourth quarters who are in the early stages of building their franchises in segments like general casualty, professional liability, and excess property. Palomar is an attractive company for experienced underwriters given that we have the technology, distribution relationships, reinsurance, and analytics acumen, as well as back office operations to rapidly scale the business. Our expectation is that the underwriting leaders will build their businesses over the course of 2022 and meaningfully contribute to our premium growth and bottom line in 2023.
Turning to the market and our 2022 outlook, we are increasing share and extending our TAM in a P&C market that remains conducive to rate increases and improved terms and conditions. During the fourth quarter, we saw rate increases in the mid-single digits on our commercial earthquake book and expect that dynamic to persist in 2022. The builders risk segment of our Inland Marine franchise saw low teens rate increases in the fourth quarter. For 2022, we expect to see sustained price increases as well as an informed sense of insurance to value and the impact of inflation on loss costs. While our casualty lines are nascent and therefore don't offer much in the way of renewal price increase commentary, we are targeting rate increases of 5%-10% on expiring terms with certain segments of professional lines seeing greater upward movement.
Our national layered and shared property program saw rate increases in excess of 20% in the fourth quarter, with December increases over-indexing the quarterly average. Pullback of capacity in the market will allow rate increases at this level to persist into 2022. As we look to manage volatility and reinsurance costs, we do not expect to increase our commercial wind exposure in 2022. All growth from that line will come from rate. On a related note, we are exiting specialty homeowners business outside of the state of Texas to further reduce our continental hurricane exposure, probable maximum loss, and steady state reinsurance expense. We believe the combination of rate increases and reduction in continental hurricane exposure portends for a successful reinsurance renewal.
The runoff of the admitted all risk in non-Texas homeowners business and the capping of commercial hurricane exposure reduces our continental hurricane probable maximum loss by 60% from its high point in 2020. Importantly, these efforts result in only 9% of the expected loss in our excess of loss catastrophe tower coming from continental hurricane, the segment of the property catastrophe reinsurance industry facing the most price pressure. Our program, dominated by earthquake and Hawaiian hurricane, is truly a differentiator and a diversifier for reinsurers. The uniqueness of the reinsurance program is best exemplified by a recent renewal of a commercial earthquake quota share, where renewal pricing improved from the prior year, January 1, 2022. We are renewing our loss ratio aggregate program, and we look forward to providing our shareholders with an update upon its completion.
We are confident that the aggregate will provide the same utility in 2022 that it did in 2021. While there are likely to be increases in our cost of reinsurance at June 1 this year, we believe it will be manageable and our program will be in high demand. Turning to matters of capital allocation and return, we expect to see operating leverage in our business model and financial metrics. Importantly, we have excess capital put to work as our net written premium to ending equity is at 0.78x, and we feel comfortable writing business up to 1x for our CAT exposed lines and higher for others. As we start new lines and build our fronting business, we will see our return on equity increase from already compelling levels.
Additionally, when we renew our aggregate, we will continue to have a floor on our ROE that minimizes volatility, ensures predictable results, and consistently builds our surplus. As our shares have come under pressure and we believe are trading below fair value, our board of directors authorized a new two-year, $100 million share buyback plan that replaces our original $40 million plan. Looking forward, we have sufficient capital resources to invest in our numerous growth initiatives as well as fully fund our buyback. We have more than enough capital to execute our strategy for the intermediate future. Turning to our guidance for the full year 2022, we expect to generate between $80 million and $85 million of adjusted net income, representing 54% YoY growth and an adjusted ROE of 90% at the midpoint of the range.
This range factors in the additional investments that we'll make in talent, systems infrastructure, and reinsurance as we continue to position Palomar for the future. Assuming full utilization of the current aggregate reinsurance program, our adjusted ROE has a floor of 14%. Before turning the call to Chris, I'd like to conclude with an update on the many ESG initiatives we have underway. Of note, we launched our ESG portal on our corporate website that details our efforts and acts as a central repository for all of Palomar's ESG materials. We also released our annual citizenship and sustainability report this month, providing an update on our progress related to specific ESG initiatives established in 2021, as well as our initiatives and goals for the year ahead.
One endeavor that I'm particularly excited about is Palomar Protects, which is a charitable initiative that reinvests earned premium back into communities to help them prepare and recover from natural disasters. As we move forward, our ESG program will continue to be an area of focus for us, and I look forward to updating you on future initiatives. With that, I'll turn the call over to Chris to discuss our results in more detail.
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 adjusted the calculations accordingly. For the fourth quarter of 2021, our net income was $16.6 million or $0.64 per share, compared to a net loss of $1.8 million or $0.07 per share in the same quarter of 2020. Our adjusted net income was $19.2 million or $0.74 per share, compared to adjusted net loss of $1.3 million or $0.05 per share for the same quarter of 2020.
For the full year of 2021, our adjusted net income was $53.4 million or $2.05 per share, compared to adjusted net income of $8.9 million or $0.35 per share in 2020. Gross written premiums for the fourth quarter were $149.9 million, an increase of 56% compared to the prior year's fourth quarter. In the full year of 2021, our gross written premiums were $535.2 million, representing growth of 51% compared to $354.4 million in 2020. As Mac indicated, this growth was driven by a combination of strong performance by our core products and new initiatives gaining traction in the market.
Ceded written premiums for the fourth quarter were $70.4 million, representing an increase of 30.8% compared to the prior year's fourth quarter. The increase was primarily due to increased catastrophe excess of loss, reinsurance expense related to exposure growth, and increased quota share cessions due to a greater volume of written premiums subject to quota shares. Ceded written premiums as a percentage of gross written premiums decreased to 47% for the three months ended December 31st, 2021, from 56% for the three months ended December 31st, 2020. The decrease in this percentage was primarily driven by a higher reinsurance expense in the fourth quarter of 2020.
You will recall that with the storm activity in the second half of 2020, we accelerated reinsurance expense, incurred reinsurance reinstatement premium, and purchased backup reinsurance, resulting in a higher percentage of ceded written premiums in the fourth quarter of 2020. Net earned premiums for the fourth quarter were $67.8 million, an increase of 74.3% compared to the prior year's fourth quarter. This increase is due to the growth and earning of higher gross written premiums, offset by the growth and earning of higher ceded written premiums under reinsurance agreements and the higher ceded earned premium in the fourth quarter of 2020 as described earlier. For the fourth quarter of 2021, net earned premiums as a percentage of gross earned premiums were 55.2% compared to 45.2% in the fourth quarter of 2020.
The increase in this percentage is primarily the result of the additional reinsurance expense in the fourth quarter of 2020 described earlier that reduced the ratio for that quarter. Net earned premiums for 2021 were $233.8 million, an increase of 50.8% compared to 2020. For 2021, net earned premiums as a percentage of gross earned premiums were 53.9% compared to 51.4% in 2020. We believe the ratio of net earned premiums to gross earned premiums is a better metric for assessing our business versus the ratio of net written premiums to gross written premiums. As previously mentioned, as part of the June 1 reinsurance renewal, we adjusted our participation in the attritional quota share arrangements.
With these changes, we expect this ratio to be around 53%-55% on an annual basis for our core historic business, lower at the beginning of a new reinsurance placement and higher at the end with our expected growth in earned premium. The launch and expected growth of our fronting business could push this ratio below 50% on an annual basis, though we'll add consistent fee income that will enhance our ROE and bottom line. We will continue to monitor this ratio and update the market based on our new business. Losses and loss adjustment expenses incurred for the fourth quarter were $10.2 million due to attritional losses of $11.9 million, slightly offset by favorable catastrophe loss development of $1.7 million.
The loss ratio for the quarter was 15%, comprised of an attritional loss ratio of 17.5% and a catastrophe loss ratio of -2.5%. Approximately 10% or 1.7 points of the attritional loss ratio for the quarter was from a line of business we have fully exited as of the end of the year. The attritional loss ratio would have been 15.7% if we excluded those losses. Our 2021 loss ratio was 17.7%, comprised of a catastrophe loss ratio of 2.1% and an attritional loss ratio of 15.6%. Our expense ratio for the fourth quarter of 2021 was 60% compared to 68.6% in the fourth quarter of 2020.
On an adjusted basis, our expense ratio was 55.7% for the fourth quarter compared to 56.3% sequentially in the third quarter of 2021. Similar to our net earned premium ratio, we feel there's a better representation of our business to look at our expense ratios as a percentage of gross earned premium. Our acquisition expense as a percentage of gross earned premiums for the fourth quarter of 2021 was 22.2%, slightly higher compared to 21% in the fourth quarter of 2020, driven by the changes in our mix of business. The ratio of other underwriting expenses, including adjustments to gross earned premiums for the fourth quarter of 2021 was 9.2%, a sequential improvement compared to 9.4% in the third quarter of 2021.
As we continue to invest in talent, systems, and our infrastructure, we expect our business to scale over the long term. Our combined ratio for the fourth quarter was 75% compared to 112.8% from the fourth quarter of 2020. For 2021, our combined ratio was 80% compared to 102.5% in 2020. Our adjusted combined ratio was 70.7% for the fourth quarter compared to 111% in the fourth quarter of 2020. For 2021, our adjusted combined ratio was 76.1% compared to 100.4% in 2020. Net investment income for the fourth quarter was $2.4 million, an increase of 4.6% compared to the prior year's fourth quarter.
The YoY increase was primarily due to higher average balance of investments held during the three months ended December 31st, 2021, offset by slightly lower yields on invested assets. Our fixed income investment portfolio yield during the fourth quarter was 2.2% compared to 2.3% for the fourth quarter of 2020. The weighted average duration of our fixed maturity investment portfolio, including cash equivalents, was 3.99 years at quarter end. Cash and invested assets totaled $516.3 million as compared to $456.1 million at December 31st, 2020. For the fourth quarter, we recognized gains on investments in the consolidated statement of income of $2 million compared to a $245,000 gain in the prior year's fourth quarter.
The recognized gains were driven by dividend yielding equity index funds that like the rest of our portfolio will continue to be conservatively invested, but may impact our recognized gains and losses from quarter to quarter. Our effective tax rate for the fourth quarter was 22.3% compared to 23.1% for the fourth quarter of 2020. For the fourth quarter of 2021, the tax rate differed from the statutory rate due to the non-deductible executive compensation expense. For the fourth quarter of 2020, our income tax rate differed from the statutory rate due to the tax impact of the permanent component of employee stock option exercises. Our tax rate for the full year ending December 31st, 2021 was 19.8%.
Our stockholders' equity was $394.2 million at December 31st, 2021 compared to $363.7 million at December 31st, 2020. For the fourth quarter of 2021, annualized return on equity was 17.2% compared to -2% for the same period last year. Our annualized adjusted return on equity was 19.9% compared to -1.4% for the same period last year. Our adjusted return on equity for 2021 was 14.1% compared to 3% for 2020. As of December 31st, 2021, we had 25,982,568 diluted shares outstanding as calculated using the treasury stock method. We do not anticipate a material increase in this number during the year ahead.
Looking ahead to 2022, we are providing adjusted net income guidance range of $80 million-$85 million, representing 54% YoY growth and an adjusted ROE of 19% at the midpoint of the range. With this guidance, it is worth reminding everyone about the impact Winter Storm Uri had on our results for the first and second quarter of last year. As you look at future periods, we believe the fourth quarter of 2021 is a better starting point for estimating our future results. Additionally, consistent with previous guidance, these estimates do not include any losses from major catastrophic events. As such, we are providing our continental U.S. wind projected net average annual loss, or net AAL, of approximately $6 million projected as of September 30th, 2022, the peak of wind season.
This net AAL is an industry metric used to assess continental hurricane and severe convective storm exposure. The projected net AAL is approximately 40% lower than the peak of wind season for 2021 and incorporates the underwriting and reinsurance changes mentioned by Mac earlier as we continue our commitment to consistent and predictable earnings. In January, we announced a new two-year share repurchase program with authorization to repurchase up to $100 million in shares. This program replaces our previous $40 million program. We did not repurchase any of our shares during the fourth quarter related to the previous $40 million share purchase authorization, and no shares have been purchased under the new authorization.
While we are not pivoting from our established growth strategy, we view our current shares as trading at a discount, and we will take an opportunistic approach to share repurchases under this program. Thus, we remain mindful of our goal of investing for profitable growth and are not deviating from that strategy. We believe the share repurchase program is another capital allocation tool we can leverage to increase long-term shareholder value. With that, I'd like to ask the operator to open the line for any questions. Operator?
At this time, we'll be conducting a question-and-answer session. If you would like to ask a question please press star one on your telephone keypad a confirmation tell more indicate your line is in a question queue, you may press star too to remove your question from the queue. For the participant using speaker equipment and maybe necessary or pick up your hands before pressing star keys. One moment while we poll for questions. Our first question comes from the line of Mark Hughes with Truist. You may proceed with your question.
Yeah, thank you. Good morning.
Mark, how are you?
I'm good. Still morning, Central Time. Chris, when we think about the progression, when you look at attritional losses in the expense ratio relative to your mix of business, obviously that's been migrating over time. How do you see that playing out in 2022?
Yeah. Thanks, Mark. Good question. Obviously, we've talked about the loss ratio over the last couple of quarters, and we have indicated that we did expect it to start going up as the mix of business has changed. I think you're seeing that this quarter. When we adjust that loss ratio a little bit for the historic all risk book that we have now, fully run off as of the end of the year, that loss ratio for Q4 was closer to 15.7%. It's also about the same factor. About 1.7 points of our full year 2021 loss ratio was about 1.7 points as well from that historic all risk book. That puts the annual loss ratio below 15% if you use that metric.
We believe that, you know, we've telegraphed that a little bit. As we also said, we do expect that to continue to tick up slightly as we continue to change our mix of business. I wouldn't be surprised to see that go up another 1 point quarter as that continues to evolve. It's also important to point out that we still use a lot of quota share, especially for the new lines of business, the casualty lines, the Inland Marine, and then our national all risk business that we have. We are still using that. That is going to help make sure that loss ratio does not run away from us. We're continuing to do that.
These are all very profitable lines, and that loss ratio is still anchored by our earthquake business and our Hawaii hurricane business that is very binary. That is still about 55% of our overall book. Those are all things that, you know, help make sure that loss ratio stays low. The mix is evolving, and so I do expect it to tick up slightly. It's not going to run away from us, but it will tick up a little bit from there. Moving on to the other piece, the expense ratio. I'd say the biggest driver that I expect to see from that over the next 12 months is gonna be from the fronting. The fronting business, obviously, as you are aware, does come with a ceding commission.
That ceding commission over the next 12 months, I expect to drive down the acquisition expense. Historically, I've said that I expect more scale from the other underwriting expense. I'd say that is still true on a long-term basis, but I think in the near term, I would expect to see a little more movement in the acquisition expense, and that's really from the fronting. You can kind of see that fronting premium in our net written for this year or for this quarter. The ceded written premium for the quarter was about 47%, which is up from Q3 of about 38%. You can kind of see that we are ceding a little bit more. Most of that is driven from quota share, which is from the fronting business.
I think those two factors are going to push the acquisition expense ratio down a little bit as the year continues. Other underwriting, I talked about that a little bit. I do expect that to improve over the long term, but we are continuing to invest in teams. We are continuing to invest in systems and people and our organization to make sure that we have all the right pieces in place to be successful in the fronting, in the casualty, and in our core earthquake and inland marine lines that we've been building over time. I wouldn't be surprised if that ratio flattens or is even potentially a little bit up in Q1. Over the full year, I do expect that ratio to improve. A lot of pieces there.
I just want to make sure I hit everything that you were looking for.
Yeah. No, that's great, the detail. The fronting premium, are you gonna break that out so we know how much is attributable to that versus the other business?
Yeah, I think over time we will. It was still a very small component of our book, so that right now is sitting in the other premium. Over time, we will probably start breaking that out. I think one other thing I'd add about the fronting premium, and Mark, you and I have spent a lot of time on this topic, is when you think about our net earned premium, at the end of the quarter, it was sitting at about 55%, or for the quarter it was sitting about 55%. With the fronting business, I do expect that to tick down. It's probably gonna tick down at a similar rate that our acquisition expense also ticks down.
You'll be able to, you know, see how that ROE or how the gains on ROE are running through the business as that fronting business comes through. Obviously, as you're aware, that business is almost risk-free. You know, we're not gonna have losses from that book of business. You know, we're not gonna have any shocks from it. It's just gonna help improve the long-term ROE of the organization.
Mark, this is Mac. I just-[crosstalk]
Yeah, please go ahead.
I would add two things. One on the fronting. As a reminder, I did say that we're targeting between $80 million and $100 million of managed premium there, and think we have a very robust pipeline that could push that higher, but that's a good directional target. And then secondly, all of these lines, while the, you know, while the attritional loss ratio may move up some, they're all accretive to the ROE, assuming that they're riding below a 100 combined. I think that's best evidenced, you know, we had a, you know, a steady state 15% loss ratio, attritional loss ratio in the quarter, and our annualized ROE was, you know, pushing 20%, almost 20%.
Yep. Chris, you mentioned a $6 million number for possible loss, potential loss. Is that a maybe a suggested or reasonable CAT load for the business? Does that make sense?
Yeah, no, I think that's a great question, Mark. No, this is our continental U.S. wind net AAL, and that is $6 million. That is what we believe if we were to put a metric out there, a good CAT load estimate for 2022 based on our current book of business, and that's projected as of the peak of wind season. With all those other underwriting changes that we've made, you know, you look at where it was last year that still had our historic all risk business in it, you think about the changes that Mac talked about with underwriting and reinsurance that we're making this year, that number is about 40% lower than it was last year.
We do believe that is a good metric or a CAT load that people can use to think about our book of business going forward.
One final question. The commercial quake pricing has been decelerating a bit. Mac, I think last quarter you said on a combined basis you thought the quake business could grow 20% for maybe an indefinite period. How do you see that now?
Yeah. As I said on the call, Mark, we think the quake market remains kind of abundant with opportunity. I would say that it's both in the commercial and the residential market, and probably even more pronounced in the residential market. On the commercial market, rates have decelerated some, but there's rate integrity, and you are seeing mid-single digit increases. I think that you know, there's not a surge of new capacity in that market, so there's an opportunity to grow that book and continue to take share. I think it's on the residential side that we feel that there is the most runway for growth. That's great because that's our largest line of business. You know, whether that's driven by you know, continued dislocation in the homeowners market.
I know AIG came out at the end of the fourth quarter and talked about pulling out of California admitted homeowners, further wildfire dislocation, and then also what I referred to with the California Earthquake Authority. I think all of that is creating a lot of opportunity and considerable runway, and I would say that, you know, just as an aside, January of 2022 was our highest new business month ever for our Value Select residential earthquake product. I think that's a nice harbinger for, you know, continued strong growth in the earthquake line.
Thank you very much.
Our next question comes from the line of Matt Carletti with JMP Securities. You may proceed with your question.
Hey, good morning.
Hey, Matt.
Mac covered most of what I had, but I guess a follow-up, Chris, for the conversation on fronting. You know, would the right way to think about it would we be wrong to assume it's kind of a kind of a market you know level you know 5%-ish kind of fronting fee, and if we use that against kind of the $80 million-$100 million guide for 2022, that's kind of the magnitude of impact in rough strokes that it might have on the acquisition ratio?
Yeah, that's a fair assessment that, you know, call it $80 million-$100 million, that's the written number. So obviously this will have to be earned over the term of those treaties.
Mm-hmm.
Most of these, I would assume, are gonna be 12-month policies, so you'll have to earn that out. Yeah, that's the right way to think about it. The margin's gonna be between, you know, call it 5%-7% on all these, depending on the type of risk that we're looking at and the type of business that we're using. Yeah, that's the right way to think about it. That is going to, that's the right marker, as you said to use, to start pushing down that acquisition expense.
Okay. Matt, maybe just a follow-up on the color you gave there on kind of some things going on in the California market for quake and particularly the CEA. It seems like we've been waiting for a little while now for them to kind of decide kind of how they want to handle, you know, risk management, you know, going forward. Is there a certain timeline around that by which you expect them to make a decision, or is it more of just a kind of a wait and see and they'll act when they're ready?
Yeah, I think there's a couple things that I'd point out, Matt. First, they did put out in December a circular that did authorize the participating insurers to seek alternative solutions. So there's something definitive there, and that bodes well for us because that, you know, potentially opens up new partnerships. As you know, carrier partnerships have been a nice driver of growth for us and a nice unique distribution channel for us. In fact, in Q4, we did bring on a nice new partner in the California residential quake market. But beyond that, you know, it's hard to say whether they're gonna go down the path of shedding limit or whether they're going to go down the path of buying less reinsurance or reducing coverages.
All that said, though, that is a nice dynamic for us to market against. It does create agita amongst producers. It does create agita potentially amongst insureds, and certainly creates agita with participating insurers. You know, that's the type of dislocation that Palomar does well in. You know, it gives me the optimism that we all collectively have around the growth in that line.
Great. Well, thank you for the color, and congrats on a strong end to the year.
Thanks, Matt. I look forward to seeing you soon.
Our next question comes from the line of David Motemaden with Evercore ISI. You may proceed with your question.
Thanks. Good afternoon. Just a question on, you know, as part of the outlook for 2022. I'm just wondering if you could just talk about your view on top line growth, gross premiums written growth in 2022. Maybe just a little bit more color. I think you mentioned that you are exiting all homeowners outside of Texas. I wasn't quite clear on the statement you made about not growing exposure in the Southeast in 2022, and it would just be rate driving the premium growth.
Yeah.
Kind of a big question, but wondering, yeah, what you're assuming for top line in 2022, if you could elaborate on that, and also just some of the new changes that you're talking about.
Sure, Dave. Yeah, all good questions and happy to expound upon that. You know, I think we haven't given top-line guidance, but what I would say is that we feel very good about the growth trajectory of the business. You know, you know, last year we grew 50+% for the full year. When you factor in the runoff of the admitted all risk business, it's actually closer to 70%. Now, I don't think we're going to grow at that rate in 2022, but what I will say is that we think that we can maintain you know, pretty strong, if not industry-leading growth rates that allows us to maintain our margin structure in the combined ratio like we have this year and achieve that net income guidance range.
I think it's important to point out that the growth that we will achieve from a top-line perspective and the 50%+ bottom line growth that we're targeting is coming with the business that we are running off further, and that is the specialty homeowners' business outside of Texas. That was around 5% of the book last year. On a steady-state basis ex cat, it's probably a mid-80s% combined ratio. What we are looking to do is exit a line of business that could give us good pre-cat margin, but does have too much volatility for us. You know, I think it's important to point out that the 80%-85% that we're giving you is a very different volatility profile than what we had last year and certainly what we had the year before.
I think that's also, you know, exemplified by the fact that layered and shared national property program, the question you asked, we are not looking to grow our exposure there. We think we can grow that line, but it's going to come purely from rates. That allows us to say we've reduced our PML by 40% over the course of the year, but we think it'll actually be by the peak of wind season reduced by 60%. It's allowing us to say that net AAL is $6 million for continental hurricane, which is, you know, 2-3 points of CAT load. The growth that we are targeting is a different complexion than what we had in years past. It's more predictable, it's more consistent, it's much less cat exposed. It's fee income from Palomar front.
It's new lines of business that are casualty oriented, that have considerable amount of quota share to reduce our net line size and insulate us from a shock loss. It's a different complexion. I think that's a long-winded explanation, but I do think it's really important for us to get across to all of our investors that the growth we have considerable confidence in the growth, but we're also very confident in the reduced volatility in that book of business that will give us, you know, 50% bottom line growth.
Got it. Thanks. That makes sense. I guess with that $6 million AAL, is there gonna be any change in the reinsurance program as a result of that? I think it's a $12.5 million or $12 million retention right now on the per occurrence. That is, you know, both earthquake and wind. Are you going to change anything on the wind side, maybe bring down the retention? Or yeah, I guess any outlook on that?
Yeah, David, I think the retention up until 6/1/2022 is $12.5 million. I think that's a directionally good target. It could tick up, you know, $1 million or so, depending on market conditions and what we're comfortable with. We obviously have always wanted to keep our retention inside of 3% of surplus, and well inside now at this point, you know, a quarter of earnings. So that's gonna be our guidepost. I think the reduction in the exposure will help. That being said, you know, as I said at the outset, you know, only 9% of our expected loss in the reinsurance tower is gonna come from Continental Hurricane. That is the toughest segment to place in the market right now. We're gonna need to be nimble there.
I don't think it's gonna change materially from where it is today. I think the actions that we're taking that will run its course over 2022 will allow us to maintain that, on a prospective basis as well.
Got it. Okay. That makes sense. Then maybe if I could just sneak one more in on share repurchases and, you know, good to see the authorization out, the $100 million authorization. You didn't utilize the prior $40 million authorization. I know it was over two years. You had used, I think it was 40% of it. Is this something you intend to exhaust the $100 million? Or, I guess, yeah, maybe just a little bit more on how you're thinking about, you know, share buybacks now.
Yes, absolutely. Dave, thanks for the question. You know, I think for us, you know, we will be opportunistic. You know, we do look at where we're valued now from a PE standpoint, from a price to earnings growth standpoint, and it's below the S&P, it's below the Russell 2000. That to us says that we should be thinking about buying back our stock, especially when we have excess capital. In the fourth quarter, we would have liked to potentially bought back stock, but we were restricted because Chris was putting in place a credit facility, which frankly provides us liquidity or incremental liquidity to potentially buy back our stock on a levered fashion. You know, we will be opportunistic.
I'm not sure if we will fully exhaust that, but we certainly intend to use it. I think the other thing that's worth pointing out, you know, is if we use it well, we can juice our ROEs, and we already put a floor on the ROE with our aggregate that this year was targeting around 14%. If we buy back our stock, we can actually move that up and get a better return on the equity for our shareholders, and, you know, leverage the cost of capital even more usefully.
Got it. Thanks. That makes sense.
Our next question comes to the line of Tracy Benguigui with Barclays. You may proceed with your question.
Thank you. I wanted to go back to your comment about exiting specialty homeowners business outside Texas to reduce your continental hurricane PML. I get you're only now going to grow on rate, but this is going to sound super basic. Wouldn't that leave you proportionally more exposed to wind as Texas is highly exposed?
Tracy, thanks for the question. Texas is exposed, but it's not as exposed as Texas plus Mississippi, plus Louisiana, plus Alabama, plus North Carolina, and South Carolina. We reduce vis-à-vis, simplistically, we reduce the target, so to speak. Furthermore, what we write in Texas is not on the coast, it's in tier two counties. Think Harris County in Houston and then up in the state. We have a better dispersion of risk in that state, which allows us to finance a cat more effectively than we did with other specialty homeowners lines, where it was purely coastal. I think, and it's a big enough book that it has a faster cat payback than a state that, you know, a Mississippi or an Alabama, where there's just not as much premium.
We, you know, our choice to exit that line, we had a great partner that was very good at what they did. They had a good attritional loss ratio. It just unfortunately brought too much volatility. When we have a stable earnings base that you know, that should generate $80 million-$85 million next year, we feel like it's not worth adding a couple million dollars on a cat-free year that could turn around and generate $10 million-$12.5 million of pre-tax loss.
Okay. Very helpful that you clarify that your Texas exposure is away from the coast.
Yeah.
Could you also discuss what drove the negative CAT losses from prior period development? I guess once I adjust for that $1.7 million prior period development, it looks like you had zero CAT losses. Can you confirm that is the case?
That is the case. Obviously, going to the first part of the question, the prior period development was, you know, storms from 2020, storms from 2021 that we had, that we could have favorable development. We've said this in the past. We try and have a conservative position when it comes to loss ratios. That goes for the cats, that goes for the attritional. This is kind of moving the direction that we would expect when we look at it. You know, just think about all the storms that we were exposed to in 2020 and 2021, and just the favorable development there. These are mostly also call it probably some of the smaller ones. These are within the retention changes, so not a lot of things that are happening above our prior retention.
That's kind of where the favorable development came in on the CAT side. Thinking through, you know, what the other analysts said is, yeah, we did not have any major CATs in the fourth quarter. You know, we do have, you know, small exposure to mini-cats, things of that nature, but nothing that we would call a CAT that hit our portfolio.
Okay. I guess what's interesting in taking that prior period development actions is, like, there's an overall concern about inflation and, you know, I guess could you just comment if part of your thinking was that wasn't as big of an issue in replacement cost?
Sure. Tracy Benguigui, I would say inflation is front and center for us. It's front and center in how we are underwriting. It's front and center in how we are transferring risk. It's front and center in how we're handling claims. No, inflation certainly did factor in. I think with a lot of the development that we had was just the IBNR load that we had on certain of these events was conservative, like Chris said, and we got through and closed down the majority of our outstanding claims certainly on residential business for a storm like Hanna, a storm like Ida, Delta and Zeta, unfortunately, there's a lot of them.
I think it's worth, you know, we still have very high IBNR for storms that's driven by inflation and the rising costs of things like lumber or staffing shortages that informs business interruption coverages and the like. I wouldn't say that, you know, we're making a call on inflation not being a persistent nuisance here.
Got it. Thank you.
Our next question comes from the line of Paul Newsome with Piper Sandler. You may proceed with your question.
Good morning. Congrats on the year and quarter. A couple of modeling questions. The first is, if we should assume that essentially all things being equal, the top line growth will be a little less than the bottom line growth because of the increased proportion of the business in fronting and the margins thereof? Is that fair?
I'm trying to make sure I'm bifurcating this the right way for you, Paul. You're saying the bottom line growth is gonna be higher than top line growth. Are you talking about pure gross written premium? The gross written premium will include the fronting. We do continue to expect that to grow. I'd say the net written on that or the net earned on that, let's call it from a dollar standpoint, should be zero. The overall pure top line gross written premium will increase. I just wanna make sure. Is that the way you're thinking about it?
No, on a net basis, you know, what we see goes through the income statement.
Yeah. If you just look at pure fronting from that standpoint on a net written or a net earned basis, right, the net earned or net written on that is going to essentially be zero, but our acquisition expense will be going down, so yes, we will. It will look like if you just added fronting to the current book today and added, you know, $80 million-$100 million of pure fronting premium, then yes, our bottom line would increase with our net written and net earned not changing. Yes, you're thinking about that the right way.
You're netting out the fronting fees and running it through the expense line as a contra expense as opposed to putting it through the top line.
Correct. That is going through and reducing acquisition expense as ceding commission. Our acquisition expense was on a gross basis 22% this quarter. I would expect that to start going down from the additional ceding commission on the fronting side.
I've seen the accounting done both ways, so I'm just trying to clarify.
No, absolutely.
But-
Just wanna make sure. Yeah, that's how we're showing it.
Yeah. Properly done. It's a difference in opinion. It's accounting opinion.
Mm-hmm.
My second question has to do with the $6 million CAT sort of load. You know, ordinarily we take, you know, we essentially assume a CAT load for the companies that we cover, and put that as part of our earnings estimate. But you're presenting it a little differently than others do. You know, could you just talk about sort of the intellectual, you know, pros and cons to, you know, basically just taking the earnings guidance that you gave us and then subtracting out $6 million? I mean, you know, whether that makes sense or not makes sense and just kind of why you think we should look at it either way.
We're off, that's too simple, but your thoughts there would be great.
No, I think, Paul, we are trying to. You know, we're not, and maybe it's superstition, maybe it's not, we're not trying to load in, you know, a hurricane to come through and hit our book. We do think we obviously model everything out and look at the stochastic and deterministic results, and this is the hurricane AAL and it's the severe convective storm AAL for the continental U.S., and that's where we've had the majority of our losses. We think that's a good tool. You know, it may be something that we start to incorporate in on a go-forward basis, but as we are in kind of a transitional period, we think this is a great guidepost for you.
No, it's certainly helpful. Thank you.
Our next question comes from the line of Meyer Shields with KBW. You may proceed with your question.
Yeah. Thanks. I should start by saying you're giving a tremendous amount of data, and I really appreciate it. It's very helpful. Is there any way of sort of ballparking the AAL from either West Coast earthquake or a Hawaii hurricane?
No, we have not given that. I just don't think that's relevant, Meyer, because it's earthquake and Hawaiian hurricane, it doesn't have this SCS exposure. The market doesn't look at it that way. You know, we don't price in, you know, loss from an earthquake. I think this is how we would think about CAT load if we're in your shoes.
Okay, that's fair. Is that a one event CAT load?
No. I mean, this isn't theoretical, it's the averaging a loss, so this would be a multitude event. This could be multiple storms, it could be multiple hail events. It just averages it all out.
Okay. No, that's helpful. One last question if I can, because I think I got this. When I think about this, probably directionally too conservative, but I would assume that the combination of a growing earthquake book and some hesitation on the part of reinsurers, whether it's too low level coverage or aggregate cover, that the 12.5 retention would've gone up over the course of this year when we head into June. It sounds like you're not that concerned about it, and you know a lot more about this than I do. I was hoping you could take us through your thoughts in terms of those two factors, the gross book growth and reinsurance attitudes.
Sure. I think you know, as it relates to the aggregate. Well, actually, let me start with retention. Yeah, I mean, I think we feel like the retention at $12.5 million or directionally close to that is doable. I think it starts with the fact that the majority of the exposure now is going to be Hawaiian hurricane and earthquake. So that remains a great diversifier for reinsurers. I think if what you saw at 1/1 was a gravitation by the reinsurance market to those segments that are more remote and not subject to what's called secondary peril, think severe convective storm or a winter storm like Uri. I think that helps us stand out and uniquely positions us well.
As it relates to the aggregate, you know, we are in the market, we have a loss ratio renewal up, and it's also driven by those same perils. You know, we have pulled out 60+% of the wind exposure that they were on risk for last year, and they were loss-free on, and now we're coming to them with something that's more quake and Hawaii hurricane and flood driven. We feel very good about that because of the uniqueness of the program, because of the improvements in the program, and the results that we've generated for them.
Okay, fantastic. Thank you so much.
Thanks, Meyer.
Our next question comes from the line of Adam Klauber with William Blair. You may proceed with your question. Adam, you may proceed with your question.
Oh, good morning, guys. Thanks. Could you talk about?
Hey, Adam.
... the progression in your distribution? You did a fair amount of commercial earthquake this year, and Inland Marine really picked up, and clearly some of the other categories, some of the, you know, some of the newer liability coverages. Is a lot of that going through the wholesale channel? Is some of it going through other channels? If you could give us some flavor there, that'd be great.
Yeah, sure, Adam. I mean, I think our team did a great job broadening the distribution footprint. You know, total distribution across the company increased 19%. Inland Marine grew 40+% , these are distribution points, and residential quake was up 25%. From a channel focus, I would say like PESIC, the E&S company, is going to be very wholesale driven, and that will be the majority of what we do through the E&S company. The residential business, which tends to be more of the admitted company, is going to be a mix of retailers and MGAs and wholesalers to a lesser degree. You know, Inland Marine is probably gonna skew more wholesale, with a small bit of retail distribution.
The residential quake, a lot of that growth was driven by the carrier partners, which opened up individual producers that were either captive to them or were appointed by them that, you know, we now have the proverbial hunting license to go train and get producing on our products.
Just because the commercial earthquake and some of the liability, is that also more of a wholesale channel or?
Wholesale
other channel?
Yeah. Wholesale.
Yeah. That's what I thought. Okay. Okay. And is it fair to say that in the wholesale channel you're bigger than you were, you know, a year ago, but you're still at the relatively early stage with, you know, with the big producers in that channel?
Yeah. I mean, I think we're still, you know, building out our franchise there. You know, we've got great relationships with the wholesalers, but we can go deeper in certain offices, and I think it varies by product. I think as it relates to earthquake, we have pretty good coverage. You know, builders risk in Inland Marine, it's extending. So yeah, I think it's. There's a lot more TAM to address there.
Okay, thank you. As far as, you know, the loss profile, you know, greatly reducing exposures with the liability programs, what's the retention on those?
You know, given that they have a tail, what sort of loss picks are you putting up on those? Not looking for exact, but just some idea would be great.
Yeah. I think, you know, on the casualty and the longer tail business, what we are targeting from a net line exposure is $1 million-$1.5 million. Hopefully, we can put a gross quota share that allows us to do $5 million. For that's what we're doing on the casualty side. On the loss picks, it varies, but you know, it's going to be anywhere from, you know, if it's a really good line, you know, mid- to low 40s% pushing up to kind of high 50s%. But I think that's directionally where we'll be. Again, we want to be conservative out of the gates here. We have terrific leadership in those segments that have long-standing histories in those markets.
You know, our actuaries and those leaders are probably being conservative, and that's fine by us.
Okay. Thank you. As far as the fronting business, you know, I would assume those are generally, you know, sort of one-off, you know, one-off sort of deals. How are those deals being generated? Is it contacts in the market or you and your team? Are they being funneled through reinsurance brokers? What's the process to build up that book of business?
Yeah, you touched on several of the channels, Adam. We have, you know, our program team led by Jason Sears is overseeing the fronting effort as well. They have terrific distribution or excuse me, reinsurance relationships. They have relationships with other, you know, non-rated or lower rated insurance companies. Then we also have, you know, Jon Christianson and I have brought a couple deals to the table through relationships we have. I think it's all of the above. Like you said, it's elephant hunting there. You can kind of know when to really lean in and go after something and you don't have to, you know, turn over too many stones.
Okay. Thank you very much.
As a reminder, if you would like to ask a question, please press star one on your telephone keypad. One moment while I poll for questions. Our next question comes to the line of Pablo Singzon with JP Morgan. You may proceed with your question.
First, just in the fronting fees, will all of this call it $4 million-$5 million based on the matched premiums you provided appear in 2022, or will it be spread out between 2022 and 2023 just based on that number that you gave? If when thinking about how this will affect earnings, will all of it fall to the bottom line or are there any associated expenses to think about?
Yeah. Tackling the first question, this will be spread over the next two years, right? We will earn this very similar to our normal acquisition expense. This will basically just, you know, for 12-month policies be earned over the next 12 months. That $80 million-$100 million that Matt talks about, that is the full year written premium number. That $80 million-$100 million will be earned over the next two years. That, call it 5%-8% fronting fee, will be earned over the same period. Going to the other part of your question. When we think about that a little bit. Sorry.
There's not much incremental expense.
Yeah.
It should fall to the bottom line, Pablo. Yeah. You know, you're exactly right. We don't need to add a lot of headcount. As I said, we're leveraging our programs team and other senior leaders, so it should be a pretty good margin.
I will say we are adding.
And then la-la-
some more infrastructure around that just to make sure that we do have the proper procedures in place to manage that. You know, when we think about it.
Sure
...we still need to do premiums and claims audits. We're still looking at underwriting results, making sure that we're, you know, looking at the collateral of all the partners that we're dealing with to make sure that we have the right people in place to manage that.
Yep. Understood. The second one I had just a quick numbers question. I was hoping you could provide color on some of the line items that will build up to adjusted net income in 2022. Specifically, I'm looking at add backs for stock comp and amortization as well as what you're assuming for net realized gains or losses, because that does flow through your adjusted number, and that was a little larger than usual in the fourth quarter. Thank you.
Yeah. Stock comp, we do see that going up. Obviously, we did talk about some of the new arrangements that were done during 2021 for the executive group. The stock comp is going up. Obviously, that is a standard non-cash expense. Amortization, most of that amortization is part of the Hawaii deal that we did last year, and that will continue to run off over the term of that deal. I believe that is in a call it a 7- to 10-year amortization period. Then the last piece of your question. When we think about that, the expenses associated with the, as you think the transactions, those should be minimal. You know, as certain things approach us, we will be looking at those and adding those back as well.
Oh, yeah. Just to clarify, Chris, I was asking about investment gains or losses. I think.
Sorry. Yes. Sorry. The investment gains and losses for-
Yeah.
Yeah. We've talked about that. The equity exposure that we do have has changed over time. When we look at our overall investments, we think about those, and we feel like we do have adequate capital in place. We look at the duration and the changes that are mixed. The casualty we talked about a little bit earlier.
Longer tail, so that we do feel that we can take a little bit more equity exposure in our portfolio to help manage some of the abilities to collect gains. So that has increased. You did see that in the fourth quarter. So we do expect to have some gains and potentially losses from those as we continue to move on, but we do not expect that to be material. As we've said in the past, we do view ourselves as underwriters, not investment managers, but we do have, obviously, an adequate portfolio to play with. We have taken a larger portion of our book into the equities, but these aren't, call it, pure individual stock plays. These are more index, equity index funds that we're investing in.
Got it. Are you able to provide a number on how much you're assuming in that 80-85? Is that zero or is that some small positive number or just any color that would be helpful? Thanks.
Yeah. Pablo, we are not assuming any equity gains or appreciation in there. That is zero.
All right. Thank you.
Ladies and gentlemen, we have reached the end of today's question and answer session. I would like to turn this call back over to Mr. Mac Armstrong for closing remarks.
Great. Thank you, operator, and thank you to all who joined us this morning. We appreciate your participation, questions, and your support. I'd also wanna thank the Palomar team for their hard work and commitment over the last year, as they are key to our success, past, present, and future. To conclude, I'm very proud of our results and the position we are in as we begin 2022. You know, our core products are benefiting from a strong market, which is driving both volume and price. Regulatory tailwinds and dislocation in the selected markets look like they'll present further opportunities over the course of the year. Our new businesses and existing products are scaling, and they should drive 50%+ net income growth in 2022.
Then lastly, we have meaningfully reduced the volatility in our portfolio, and we'll continue to do so, which should, in turn, generate consistent, predictable growth. Hopefully you all get a sense and ascertain our enthusiasm for 2022 and hopefully you share it. We look forward to speaking with you at the end of the first quarter. Thank you, and enjoy the rest of your day. Take care.
This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation. Enjoy the rest of your day.