Good morning, Welcome to Palomar Holdings, Inc. fourth quarter 2022 earnings conference call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference lines will be open 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.
Thank you, operator. Good morning, everyone. We appreciate your participation in our fourth quarter 2022 earnings call. With me here today is Mac Armstrong, our Chairman and Chief Executive Officer. 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 23rd, 2023. Before we begin, let me remind everyone 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 US GAAP. A reconciliation of these non-GAAP measures to their most comparable GAAP measure can be found in our earnings release. At this point, I'll turn the call over to Mac.
Thank you, Chris. Good morning, everyone. Very pleased to report our strong results for the fourth quarter and the full year of 2022. I'm proud of our team's achievements over the past year, most notably delivering record gross written premium growth of 65%, record adjusted net income of $71.3 million, and an adjusted ROE of 18.3%, even with the negative impact of Hurricane Ian. The full year results reflect stellar execution of Palomar 2X, our strategy to profitably grow the company, deliver predictable earnings, and achieve an ROE in excess of 20% while maintaining industry-leading profit margins.
Over the course of the year, we made demonstrable progress in achieving the long-term objectives of Palomar 2X as we enhanced our position in existing products, launched new lines of business, and invested in underwriting, technology, actuarial, and data analytics infrastructure to both sustain and catalyze our growth. Our revision remains unchanged as we strive to build premier specialty insurance company. Our vision is reinforced by the growing team of 195 professionals who continue to operate at an incredibly high and productive level. Turning to the fourth quarter, our strong results were highlighted by 60% written premium growth, a 22.4% loss ratio, and an adjusted ROE of 22.4%. Importantly, our premium growth was strong across all products, property, casualty, and fronting.
Our core earthquake business grew 40%, with residential earthquake growing 26% and commercial earthquake products growing 66%. The continued dislocation in the earthquake market has been amplified by the hard reinsurance market, which affords us the ability to both grow and optimize our book of business with rate increases and improved terms and conditions. Beyond our earthquake franchise In land marine grew 82% as compared to the fourth quarter of 2021, largely driven by our builder's risk products. Our recently launched excess property book grew 60% sequentially as it constructed an attractive book of business with negligible catastrophe exposure. Similar to our property products, our casualty business saw strong growth in the quarter.
Casualty lines grew 147% year-over-year, highlighted by 233% growth in our newly launched professional liability lines and 35% growth in excess liability. All the casualty products are performing in line with our expectations from a loss perspective. We are thrilled with the success of the Palomar FRONT business. During the quarter, it generated $69 million of premium versus $11.5 million the prior year. Palomar FRONT delivered $223 million in managed premium in 2022, well in excess of the original guidance of $125 million-$145 million provided a year ago. The managed premium from Palomar FRONT offers an attractive and growing fee income stream as we move into 2023.
Beyond the sound financial results generated during the fourth quarter, our team successfully navigated the choppy waters of the global insurance market as the industry digested the impact of inflation. We can balance sheets in Hurricane Ian. From an underwriting standpoint, we continue to find balance between exposure growth, rate increases, and enhanced terms and conditions for all products, but most notably our property book of business. Our E&S all risk book saw an average rate increase of 40%, with exposures decreasing approximately 35% year-over-year. Our Inland marine books saw regional variance in pricing with builders risk accounts seeing new projects priced 15% above the prior year. Our growing casualty books saw exposure growth with disciplined rate action. For instance, our most mature casualty line, real estate agents E&O, saw eight and a half percent rate increase in the fourth quarter.
As it pertains to earthquake, we continue to focus on taking advantage of the opportunities in the residential earthquake market, as well as the emerging capacity limitations in the commercial earthquake market. To that end, we successfully renewed our commercial earthquake quota share, modestly increasing the session percentage, and locked in an incremental $52.5 million of California earthquake limit to support growth in the quarter. The risk-adjusted pricing on these reinsurance buys was approximately 30% above the expiring terms. While the pricing certainly reflects a hard reinsurance market, this increase favorably compares to those seen in headlines or other lines of business and reflects the quality of our reinsurance program, both the exposure and reinsurer panel. Importantly, this purchase allows us to sustain our strategic focus of profitable growth in the earthquake market.
In an effort to keep pace with the increased cost of reinsurance, we'll continue to push rate on our commercial book beyond the 16% we saw in the fourth quarter, increase our inflation guards, which now stand at 10%, and further utilize our E&S company for residential earthquake. We will look to strike diversifying and reinsurance efficient partnerships such as the recently consummated deal with Bear River Mutual, where we are assuming ex-California earthquake risk on behalf of a regional carrier in Utah. Looking to the year ahead, we remain focused on executing Palomar 2X. First off, though, let me state that we believe that the cost of our core excess of loss reinsurance renewal will be manageable.
It will be up year-over-year, likely at levels similar to what we saw in December and January, but the capacity is there to support our growth. As such, we will continue to grow in the earthquake market. We have also identified four key strategic initiatives in 2023 that are central to Palomar 2X. One, sustain our strong profitable growth trajectory. Two, manage the dislocation in the global insurance market. Three, deliver predictable earnings. Four, scale the organization. I'm pleased to report that we are already making strong progress on all these initiatives. Selected examples include the January announcement of a new fronting partnership with Advanced AgProtection, a leading crop MGA, following the United States Department of Agriculture naming Palomar only the fourteenth approved crop reinsurer in the country. Looking ahead, we believe this could be a sizable business for Palomar in the long term.
Separately, in addition to the incremental reinsurance limit to support our growth in earth-earthquake, we put in place a new quota share for our Motor Truck Cargo product, a non-catastrophe exposed property line at attractive economics from a blue-chip reinsurance partner. Additionally, we are supporting a handful of outbound reinsurance treaties with a few long-standing trading partners and continue to look at ways to find mutually beneficial ways to work with our reinsurance panel. We are further reducing our continental wind exposure, and we are working to get the 250-year probable maximum loss below $100 million this year. This effort will help mitigate rising reinsurance costs and volatility in the earnings base. Lastly, we continue to make additions to our terrific team of professionals in areas such as casualty underwriting, data analytics, and treasury and investments.
We will continue to balance our capital allocation with a focus on investing in our growth initiatives and remaining opportunistic with our share repurchase program when our shares trade at a level we feel undervalues the business. As a result, we repurchased 222,217 shares at a total cost of $11 million in the fourth quarter, and a further 79,469 shares at a total cost of $3.8 million thus far in 2023. Turning to our full year 2023 guidance, we expect to generate adjusted net income of $86 million-$90 million, which includes $2.5 million of net catastrophe losses from recent California flooding. 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 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 where we incur a net loss. Additionally, beginning in the fourth quarter of 2022, we have modified our definitions of adjusted net income, diluted adjusted EPS, and adjusted ROE to adjust for net realized and unrealized gains and losses. We have modified the current and prior period figures accordingly. For the fourth quarter of 2022, our net income was $18.8 million or $0.73 per share, compared to net income of $16.6 million or $0.64 per share for the same quarter last year.
Our adjusted net income was $21.1 million or $0.82 per share, compared to adjusted net income of $17.6 million or $0.68 per share for the same quarter of 2021. For the full year of 2022, our adjusted net income grew to $71.3 million or $2.77 per share, compared to adjusted net income of $52.4 million or $2.01 per share last year. Our fourth quarter adjusted underwriting income, which we believe is the best financial indicator for evaluating Palomar 2X, was $23.5 million, compared to $19.9 million last year. Our full year 2022 adjusted underwriting income grew 37.8% to seventy-seventh point one million dollars, compared to $55.9 million last year.
For the fourth quarter of 2022, our annualized adjusted return on equity was 22.4%, compared to 18.2% for the same period last year. We remain confident in our strategy to achieve long-term growth and a predicted, predictable rate of return. Even with a full retention catastrophe loss, our adjusted ROE was 18.3% for the full year of 2022. Gross written premiums for the fourth quarter were $239.1 million, an increase of 59.5% compared to the prior year's fourth quarter. For the full year, gross written premiums increased 64.8% to $881.9 million.
Net earned premiums for the fourth quarter were $82.2 million, an increase of 21.2% compared to the prior year's fourth quarter. For the fourth quarter of 2022, our ratio of net earned premiums as a percentage of gross earned premiums was 38.9% compared to 55.2% in the fourth quarter of 2021, and compared sequentially to 41.7% in the third quarter of 2022. Decreasing as expected from the overall growth of fronting and lines of business that use quota share reinsurance. For the full year of 2022, our ratio of net earned premiums as a percentage of gross earned premiums was 45.5%, in line with our expectations based on the strong performance of our fee-based fronting business.
Losses and loss adjustment expenses incurred for the fourth quarter were $18.4 million, made up of attritional losses of $16.6 million and $1.8 million of prior period catastrophe loss development, primarily Hurricane Hanna and Winter Storm Uri. The loss ratio for the quarter was 22.4%, comprised of an attritional loss ratio of 20.1% and a catastrophe loss ratio of 2.3%. Attritional losses for the quarter include many catastrophe events such as Hurricane Nicole and Winter Storm Elliott. The loss ratio for the year was 24.9%, comprised of an attritional loss ratio of 20% and a catastrophe loss ratio of 4.9%.
Our acquisition expense as a percentage of gross earned premium for the fourth quarter was 12.7% compared to 22.2% in the fourth quarter last year, and compared sequentially to 14.6% in the third quarter of 2022. Additional ceding commission and fronting fees drove the improvement. The ratio of other underwriting expenses, including adjustments to gross earned premiums for the fourth quarter was 6.9% compared to 9.2% in the fourth quarter last year, and compared sequentially to 7.3% in the third quarter of 2022. Our adjusted combined ratio was 71.4% for the fourth quarter compared to 70.7% in the fourth quarter of 2021. Our adjusted combined ratio for 2022 was 75.6% compared to 76.1% last year.
Excluding catastrophe losses, it was 70.8% compared to 73.9%. Net investment income for the fourth quarter was $4.4 million, an increase of 81.6% compared to the prior year's fourth quarter. The year-over-year increase was primarily due to a higher average balance of investments held during the three months ended December 31, 2022, due to cash generated from operations and by deliberately shifting invested assets from lower yielding investment assets into higher yielding investment assets. Our yield in the fourth quarter was 3.3% compared to 2.2% in the fourth quarter last year. Our yield on investments made in the fourth quarter was above 5%.
During the quarter, we repurchased 222,217 shares of our stock for a total of $11.1 million under our 2-year $100 million share repurchase program. We have approximately $65.6 million remaining under the authorized program. For the full year of 2023, we are providing an adjusted net income guidance range of $86 million-$90 million. This range includes approximately $25 million of net catastrophe losses resulting from the recent California flooding events, does not include any additional catastrophe losses for the year. On a gross earned premium basis, we expect our net earned premium ratio and acquisition expense ratio to continue to decrease in 2023 from where they were in the fourth quarter of 2022.
With that, I'd like to ask the operator to open the line for any questions. Operator?
Thank you. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press Star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Our first question comes from Mark Hughes with Truist Securities. Please proceed.
Thanks, good morning. Good afternoon. Chris, you mentioned you expect the earned to written to continue to decrease from the fourth quarter level. Any guidance on what that might look like for 2023?
Hi, Mark. No, great question. As we've said, and we've really said for 2022 as well, we do expect the net earned premium ratio to continue to decrease. It was 38.9% in Q4. With the growth in fronting and other lines of business subject to quota share, we do expect that ratio to keep going down. I would expect, you know, for the year, that's probably gonna be within the mid-thirties, but it's just gonna go down sequentially. You know, that takes into account the quota share business, but also the additional excess of loss reinsurance cost that we'll be expecting at June 1 of this year.
Appreciate that. Then the quake business. How are you balancing the reinsurance by here? Clearly, you have some view on how much capacity you'll need to support growth. Presumably you could grow even faster, depending on how you approach the reinsurance market. Do you have kind of your vision of what the growth is going to be already dialed in, Mac?
Hey, Mark. Yeah, that's a great question, and it's something that we are really acutely focused on. I think stepping back, as I mentioned in my remarks, there is dislocation in the earthquake market, both residential and commercial. We are taking advantage of that. Taking advantage of it through rate, through enhanced terms and conditions, whether that's deductibles or attachment. Furthermore, further utilization of the E&S company and particularly on the admitted side of the business. The guidance that we provided does reflect solid growth in earthquake. It could be a lot more, but we do wanna balance reinsurance capacity availability.
What we have seen, as 1/1 unfolded and as the year 2023 has commenced, is there is capacity to support at least the growth that we are forecasting. You know, there was a lot of talk in the fourth quarter about the CEA and their reinsurance renewal. Frankly, I think that was something that we think that they are telegraphing. They had communicated that they were gonna buy less limit at a board meeting in the fourth quarter, and that did come to fruition. I think it was roughly $1 billion of less limit that was procured. That was part of their focus on bringing their capacity down to the one in 350 from their previous levels. That is freed up capacity that we can take advantage of.
There have been a few earthquake programs that were rolled into all perils programs, so that also frees up capacity. There have been some large national programs that had underlying quake in them that were non-renewed or delayed. We do feel that there is ample quake capacity to support our growth. Our guidance reflects pricing that is up along the lines of what we saw when we bought incremental limit in the fourth quarter in January. It is there to support our growth at a healthy level. Again, we're gonna continue to take rate and enhance terms and conditions and use the E&S Company to make sure we're getting the rising reinsurance costs covered.
Understood. One quick one, if I might. Chris, the attritional losses came in better than last quarter, and I think better than you might have guided to in your commentary within the quarter. Could you talk about that?
Yeah. Thanks, Mark. Obviously, we are happy with a better loss ratio, and it is a little bit better than we expected when we kind of projected out in the middle of December. When we looked at the numbers in October and November, you know, there was some frequency and severity that was coming in. Fortunately, December came in a lot better than we expected and was now able to kind of bring that loss ratio back down to what we would expect a normalized loss ratio for the year. It doesn't change our view on guidance. We still expect a loss ratio, let's call it 22%-24%, for 2023, with hopefully that tailing off at the end of the year and into 2024.
No real changes there, but like you, we're happy with a good loss ratio, it's within the parameters that we would expect.
Thank you.
Mm-hmm.
Thanks, Mark.
Our next question is from Paul Newsome with Piper Sandler. Please proceed.
Mac Armstrong, just a quick follow-up on your comment on reinsurance and earthquake. Just to make sure I understood this. There is If you wanted to grow an earthquake faster, you think there's capacity beyond what you are currently contemplating, or is there some essentially kind of limit given the capacity out there that if you really wanted to grow faster in earthquake? I just got myself a little confused there.
Sure, Paul. Just to elaborate on it, we have obviously forecasted growth in earthquake this year, and there is capacity to support that growth. We do not want to overstep into the market because we obviously want to maintain the guidepost that we always have with respect to earthquake and making sure that we keep our tower in line, if not above the 250-year peak zone PML, which is California quake. We also don't, you know, sacrifice too much margin for the sake of bringing on business that may not be generating the right risk-adjusted return.
That being said, in a market like this, you know, our underwriting expertise, the vehicles that we have, whether it's the E&S Company or the standard company, both commercial and residential appetite, we wanna maintain a leadership position. Market cycles change. This is what some are calling the hardest reinsurance market, since Hurricane Andrew, maybe it's been Hurricane Katrina, Hurricane Rita, Hurricane Wilma. We can navigate it, and it's gonna position us well in the long term to have a market leadership spot in quake. We're gonna grow in quake. We're not gonna grow egregiously, but we think we can grow and maintain the same type of reinsurance that we've always had in place.
That makes sense. Sorry about the confusion on my part.
No, it's a good question. It's one we wanna make sure people understand.
Any thoughts about the sort of non-attritional losses, the cat loss exposures prospectively, in addition to what you've already said? You know, it sounds like you're trying to pull the PML down, but the business is also growing. Just anything that'd be helpful as we think about
Happy to elaborate on that as well. With respect to the continental hurricane exposure, we are gonna bring the PML down from $250 million at the peak of wind season in 2022 to $100 million at the peak of wind season in 2023, and we are well underway. We've also made underwriting changes that are, you know, reducing our line size, and avoiding concentrations in county levels, and obviously on a regional basis as well, and putting AAL caps in at a county level basis. What that is going to allow us to do is, you know, manage the reinsurance costs for all perils, which frankly is the most expensive in Catastrophe XOL right now.
It's going to also add predictable earnings, in the sense that our AAL is going to meaningfully come down too. We are getting rate, which will help with the attritional loss ratio for that line of business. As I mentioned, it was, you know, in excess of 40% in the fourth quarter, and it's moving higher in the first quarter of this year. All that growth is going to come from in that line of business with that all risk business, is going to come from rate, with commensurate exposure reduction.
How should we think about any potential retention changes on the cap as well?
With respect to the retention, Paul, I think the fact that we are reducing our PML meaningfully on the all peril side, that will help with the retention. We've always said that we want to keep the retention and the parameters of our retention less than 5% of surplus and meaningfully less than a quarter of pre-tax earnings. Maybe call it 1.5 months or two months of pre-tax earnings. The reduction in the PML will allow us to maintain that. One guidepost that we've seen in the market is having a retention or the reinsurers want to see a retention that's equivalent to a one in 10-year event or in line with the 10-year event on the exceedance probability curve.
That correlates to around a $15 million-$17.5 million level as we currently sit right now. We'll see how that's priced out and whether or not we want to trade dollars. I think that's a good construct to operate from now.
Great. I have some other questions, but I want other people to ask questions too. Thanks for all the help. Really appreciate it.
No, thanks, Paul. Good questions.
Our next question is from Tracy Benguigui with Barclays. Please proceed.
Thank you. You know, when I hear commentary by our competitors, the outlook on casualty is pretty cautious, I realize this is a greenfield operation, so you're not a huge piece. You are making notable strides on growth. It was up 147% in the quarter. With that backdrop, do you think 2023 is the year to grow casualty? If so, what parts of the casualty market do you think you can grow and achieve attractive risk-adjusted return?
Hey, Tracy. Yeah, that's a good question. We, we do think we can grow in casualty, but like you allude to, it's got to be in specific targeted segments. I highlighted on the call real estate E&O. We like that line of business. We have a long-standing history that frankly predates Palomar in that market, and we did see rate there. It was up 8.5% in the fourth quarter. You know, on the other side of the equation, we do have a D&O book, and it's not a large book, but we are writing some there, and we're focusing more on private company D&O, where you're still seeing, you know, 5% up on renewals, at least that's what we saw in the fourth quarter, versus the public side, which is, you know, 5% down.
We want to be targeted there in, so professional liability, miscellaneous professional liability, general casualty, which is kind of flat to +5%. That's what we saw in the fourth quarter. Those are probably the segments that we're going to go deeper in. We are talking to a handful of underwriters that can help broaden the franchising casualty. It might be like a new segment that we enter into, but it will be very specific.
Great. When I think about your fronting business, an important piece of achieving the fee income is the ceding commission. Are you ceding compression on ceding commissions, and would that compression limit your growth trajectory for fronting business?
Tracy, that's a good question. You know, we are consistently renewing our fronting programs throughout the year. You know, ultimately, the pressure on the ceding commissions might fall back more on the distribution partner, not on the fee that we get. You know, we get a 5%-7% fee that's based on us taking potentially some tail risk. Obviously, lending our balance sheet from a collateral and managing collateral, and then also the licensing associated with a given product. We have not seen any pressure on our structure. I think the fact that most of our fronting business is non-property also lends itself well to sustainability of that margin. You know, on the whole, the fronting business has terrific visibility on growth into 2023.
We added a new partnership in Advanced Ag, and we believe that we should sustain the margins and have a nice visible fee income stream to grow in 23.
Just a quick follow-up question on that. You said tail risk. I thought you ceded 100% of those premiums. Are you assuming any tail risk or this is just helping, you know, MGAs manage tail risk?
It's, it's ultimately, you know, we have the specialty homeowners business that is all reinsured out and they buy beyond the 250-year PML. We do put some excess amount into our program just for conservatism's sake. There is tail risk there.
Got it. Thank you.
Our next question is from David Motemaden with Evercore ISI. Please proceed.
Hey, good afternoon. First question I have is just on the AAL expectation for 2023. If I think about, you know, peak wind season, if I recall, I think it was like $6 million in the third quarter of 2022, but it sounds like you guys are reducing the PML pretty substantially, you know, well over 50% is what it sounds like for third quarter 2023. Any color you could provide there on what the AAL is as we head into 2023?
Great question, Dave. No, obviously, Mac talked about it. We are meaningfully decreasing our PML. We are going to see a requisite reduction in our AAL expectations as well, based on a like-for-like view of our reinsurance structure. You know, that number would be in the force when we project out to, you know, September of 2023. You are seeing a requisite reduction in that average annual loss calculation. We like what we're seeing there, you know, and we hope that reduces the overall volatility and the catastrophe exposure that we have.
Got it. Thanks. Maybe following up on that. I think the cat loss was obviously a bit higher in the third quarter of 2022 from Hurricane Ian, which, you know, wasn't a normal year. When you guys look at that loss, you know, is that, you know, sort of like a one in 50 year event for you guys or one in 200 year event? Like, you know, I'm just trying to get a gauge for, you know, just triangulating with what you're doing with PMLs going forward and sort of what a, you know, sort of Hurricane Ian-like event would mean going forward as well.
Yeah. Ian was, Dave, you know, a one in 50 year, if not a little bit above one in 50, on our modeled results in EP curve. I think that Ian is developing in line with our original ultimate, if not, you know, some cautious optimism that it will come in below that. The one thing that I'll say is the underwriting actions that we have taken and the reduction to PML puts Ian well below, you know, the 50 years, much lower today than what it was in September, and it'll be much lower in September of 2023 than what it is. You know, I think what you would see is Ian like for like would be, you know, equivalent from a retention perspective, if not lower at the end of 2023.
Got it. Okay. That's helpful. Chris, I just wanted to follow up a little bit on the attritional loss ratio outlook for 23. You know, I mean, I don't want to be splitting hairs here, but I think it was 23%-24% on the attritional loss ratio when you spoke about it last quarter. Now it sounds like you guys are calling for 22%-24%, so maybe a little bit better on the low end. Maybe just talk about, you know, has your view changed at all, just given the commentary that you made? It sounds like it may have, but just wanted to double-check.
I think there's, you know, obviously this quarter showed that there's a little more favorability there, but you are correct. We did say 23- 24. I just didn't say 22- 24. I'd say no material change in that outlook, right? I think when people look at us from a quarterly standpoint, there is concern when it moves around a point or two. I did want to give a little bit of a leeway there, right? Remember, when for a quarter, a point of loss ratio is only about $800,000 in net loss, not a big number in the grand scheme of things. I want to make sure that people are considering that on a quarterly basis.
That annual target for us when we think about it is still call it 22%-24%, which is well within the same guidepost, I would say, that we talked about before.
Got it. Okay. Still the view is that could drift up a little bit as we head into 24?
No, I would say the other way around. I expected 23. It's going to obviously go up from where it was in 2022. I would expect by the end of 23 that there is going to be favorable pressure to push that loss ratio down by the end of the year.
Got it. Okay. Thank you for that.
As a reminder, just star one on your telephone keypad if you would like to ask a question. Our next question is from Andrew Andersen with Jefferies. Please proceed.
Hey, good afternoon. Some pickup this quarter in residential earthquake growth, and I think in the past you mentioned you haven't seen the proposed changes at the CEA really earn into results. Do the changes made in the last quarter with their reinsurance program give any greater clarity to the timing of that impact? Would any impact from CEA business be included in the guidance for 2023?
Andrew, yeah, that's a great question. You know, the actions the CEA took or the actions taken following, you know, the market downgrade, specifically AM Best downgrading them, didn't impact the fourth quarter. I think it has the potential to be a nice catalyst for sustained growth into 2023 and to 2024. Ultimately, you know, what we are seeing right now is improved production from CEA member companies that also have a trading relationship with us, like an Allstate, or a Farmers. We are also starting to have conversations with other participating insurers that are exploring their options for alternative solutions. It's helping us in the high-value segment as the CEA is further sub-limiting high-value accounts.
The good thing about that is those high-value accounts are now moving more to our E&S company, which gets a better risk-adjusted return at a higher rate than what it does in the standard market. CEA action is definitely informing the confidence that we have in the growth that's in the guidance for 23, but there's no kind of step change function like a large matriculation out of the CEA by a participating insurer that we pick up from.
Got it.
That business from
Inland marine growth this quarter picked up again pretty strong. Can you kind of help us think about the growth profile in this business? It sounds like builders risk. I guess I would have thought perhaps in, like, a tougher economic backdrop, it could be a bit more pressured, but maybe this isn't the case with anything you're currently seeing in results.
Andrew, it's astute that you would think that builders risk because it is tied to homebuilders would have some pressure on it in this environment. I think the one thing that's offsetting that, or there's a few things that are offsetting that, rather. One is we continue to expand geographically, whether it's through hiring new underwriters that have regional focuses, or it's broadening distribution into, in the states that we had not been as active in. Furthermore, a lot of what we're writing there is niche segments, really like multifamily. We're still seeing growth in multifamily, especially in a state like Texas. Again, this is in non-cat exposed segments of Texas, or Arizona, and even to a degree in California. You know, the multifamily market remains pretty robust.
We do look at the economic impact or potential economic impact on that line of business, probably as close as anyone that we have. It's performing pretty well as you can see by the growth.
Thanks. Maybe one last quick one. Sounded like the reinsurance announcement you made in December, risk-adjusted pricing was up 35%. Just wanna make sure I heard that right. That's kind of the same expectation into mid-year, but sounds like if you use the E&S carrier a bit more, you'll be able to push some right through and get inflation adjustments on that as well to offset.
Yeah, Andrew. It was 30%, just to clarify. That informs us. Now, you know, yeah, that is definitely informing us. I think there's cautious optimism that 6/1 might not be as draconian as 1/1, you know, that we're not gonna hang our hat on that right now. You're absolutely right. We do have levers. The E&S company, clearly on the commercial quake side, also on the admitted, the home, homeowner side, the residential side, we can use the E&S company, we are in an increasing fashion. Just as an aside, in the first part of this year, about 20% of our new business on residential earthquake is E&S. That lever is being used in an increasing fashion.
Got it. Thanks for the help.
No, good questions. Thanks.
Our next question is from Meyer Shields with KBW. Please proceed.
Thanks. Just a bunch of, I guess, random questions. First, Mac, can you talk about the distribution force that you have for agriculture?
Sure. The crop deal, we are working with Advanced AgProtection that, which is run by 2 long-standing crop executives, they are acting as the MGA. They are handling the claims as well too. Ben Latham, who's the president there, has been in this market for 30-plus years. He has distribution touch points throughout, you know, the Dakotas, Illinois, Iowa, Tennessee, and Ohio, you know, focusing on farmers and introducing brokers to farmers that write crop insurance like soybeans and some wheat, but more the beans and corn. It's going to be, you know, through an MGA with regional producers in those local markets.
Okay. We can think of, it sounds like if I'm interpreting that correctly, we can expect a fairly rapid ramp-up in premiums because of their existing relationships.
They should have existing relationships. You know, we've not forecasted a ton of growth in 23. We think it has great promise, 23, 24 and beyond. You know, they just got approval from the RMA and the USDA. Right now is when there is, you know, the majority of the business written up until about March 15th. They are bringing business on. I think it's really going to be a meaningful contributor in 24. I think it's important to point out that this is a fronted deal. We are going to get smarter in the market. Jon Christianson, our President, and Jon Knutzen, our Chief Risk Officer, have long-standing history in the market. They were both crop reinsurance brokers prior to their time with Palomar.
This is going to be purely fee generative, certainly in 23.
Okay. No, that's very helpful. Second question, when you talk about the PMLs coming down, does that have any impact on your need or desire to renew the aggregate cover?
Yeah, Meyer, that's a good question. Thanks for asking. I think to me, it makes the aggregate all that more appealing to our existing reinsurance partners there. You know, the aggregate fundamentally is designed around protection from a frequency of severe property cat events and then obviously providing an ROE floor. By reducing the wind PML, you are reducing the continental wind exposure that's in that aggregate and really making it look more like a third or fourth event cover for Hawaiian hurricane or earthquake. The reinsurers that have made money to date in it, I think they find it more attractive by the underwriting changes and the change in the book of business. We are in the market on that and underway with discussions.
I think we believe that we can get it done at economically compelling levels. If that's not the case, there are alternative structures that we could put in place that serve the purpose of protection from multiple severe events and ostensibly put that ROE floor on. It may not be an aggregate, though. We will let our investors in the market know as we get closer to 4/1.
Okay. That's very helpful. Then final question. I don't know how this works from a rating agency perspective. Does the changing reinsurance market have any impact on your targeted net written premium to equity or net written premium to surplus goals?
Chris.
No, it does not. You know, our view is still the same. Obviously, we use a heavy amount of excess of loss. Really I feel that that ratio is more pertinent to quota share, even though we do use it for the cat business. We still feel comfortable with the net written ratios targets for catastrophe being one-to-one, and then for the newer lines of business that are subject to more attritional and less cat exposed, such as the casualty lines and the, you know, inland marines builders risk type lines, you know, getting that ratio up to, like, a 1.5-to-1 type ratio. We still feel very good about those ratios. There has not been any pressure or view change from our standpoint on how those are viewed.
Yeah. Just to echo what Chris is saying, you know, if you look at just our BCAR scores from Best, they are well above our A-minus level. They're closer to an A-plus level. More excess of loss actually helps the BCAR, too. You know, ultimately, we're gonna manage, you know, the ratios what we feel Best and others are comfortable with, from a long-term perspective. If there's some deviation in the short term, it's practically, frankly, gonna be additive to how much premium we could write.
Okay, perfect. Thank you so much for all the information.
Thanks, Meyer.
Our next question is from Pablo Singzon with JP Morgan. Please proceed.
Hi. Thank you. I had a couple. Mac, you touched on this already, but I just wanted to get more color on your line of sight and comfort on the reinsurance costs you're embedding in the guidance, given that, you know, you don't renew your main programs till midyear, but it seems like you're, you know, in discussions in the market. You've obviously did the quota share early this year. Just sort of like, you know, your confidence and comfort level in getting the reinsurance costs that you're sort of embedding in your expectations.
Yeah, Pablo, you're absolutely right. We are focused on it right now. You know, we were in London 2 weeks ago. I'm heading to Europe next week to meet with the host of our continental European reinsurers. You know, Jon Knutzen and Chris Sabal and Jon Christianson and I are spending a lot of time on it. We feel very good about the reinsurance assumptions that are in the guidance that we've provided. Like I said, and like you just touched upon, it is informed by what we procured and paid at 1/1.
Again, we feel that we have a lot of different ways to play the reinsurance market, and manage the cost, but we're not gonna deviate from the guideposts of the 250-year PML retentions inside of 5% of surplus and, you know, less than a quarter or half a quarter of pre-tax earnings or something in that level. We feel very good that the capacity is there and the assumptions that are in the guidance are achievable.
Got it. Thanks. Then second one for Chris. The 22%-24% guidance on the loss ratio, I just wanted to confirm that that includes first the higher reinsurance costs you're gonna pay this year, right? So half a year of higher reinsurance costs through the ceding. Then I think in the past, you've also talked about some books you're trying to run off that might produce, you know, elevated claims. I just want to confirm that the 22-24 is an all-in view incorporating those two items.
Yeah, no, that's a very good view on the loss ratio. Obviously, there is pressure on the loss ratio because of the excess of loss costs, of the quota share. Obviously, that impacts the denominator in that calculation. Yeah, our target of 22%-24% does contemplate that type of change and that type of pressure, right? As the excess loss changes, it does push up the loss ratio with actually not changing any of the net dollars. No, that is a very astute view on that, but we do contemplate that and do contemplate that obviously, especially in the second half of the year.
Okay. Just to follow up on that comment, Chris Uchida, and maybe this question is for Mac Armstrong as well. As we think about... So you sort of provided your view for 2023, right? As we sort of think about 2024 and 2025, 2024 will essentially have a full year of higher reinsurance costs. It seems like, at least based on, you know, the numbers you gave, you think you can hold the line in 2023. In 2024, like, do you see that gap? You know, do you see yourself holding the line or is that gap gonna increase or... Obviously, the, you know, you sort of have to think about reinsurance versus what you're doing on the primary side, right?
Is there any thoughts on how, you know, one full year of higher reinsurance pricing might compare against what you're doing on the primary side, when thinking about 2024?
Yeah, Pablo, thinking out to 2024, I actually think, you know, you're gonna have only five months of the 2023 costs. My expectation is 2024 will start to rationalize a little bit. I'm not gonna make a call that the hard market will end, but I don't think the rate increases will be as pronounced. We've seen some snippets of some capital coming in or more retro support than what was initially expected, and that's a positive certainly for the primary industry, and I think it's a positive for the industry broadly. I think as it relates to 2024, we feel there's no need for us to deviate from what we're doing in 2023, and 2024 would look a lot similar from a complexion and mix of excess of loss versus non-excess of loss business.
Hold aside that there might be a little more rapid growth from some of the casualty lines or fronting lines.
Okay. Then last for me, the AAL that you offered, the $4 million, that doesn't include the two and a half flood loss in California, right? That's more.
That's right.
exposure type number. Okay. All right. Thank you. Thank you, guys.
Thanks, Pablo.
Our final question is from Mark Hughes with Truist Securities. Please proceed.
Mac, when you look at the profit on your new quake business, is it as profitable, say, as it was last year before the reinsurance costs went up? You know, obviously with the business you'd written on older pricing, as you pay higher reinsurance costs, that's gonna have some impact on your bottom line. Is the new business with updated pricing, with using the E&S company more frequently, is it as profitable as what you were writing last year?
Mark, it won't be as profitable as what we were writing last year. Some of that's frankly driven by the fact that the good portion of our residential book is in the standard market. It's written on admitted paper, so we're getting a 10% renewal in, for, or automatic increase due to the inflation guard. We can only use the E&S company for a portion of that, where you can recoup those rising loss costs. In the commercial, you can recoup a good portion of those rising loss costs. New business that we write this year will not have the same margin as new business that we wrote in 2023. I think, though, it's important for us to reiterate, we wanna maintain a market leadership position in an earthquake. It's still a very profitable line of business.
Market cycles change. There could be a point where reinsurance pricing could conceivably decline, and then you're gonna see some pretty elegance in the margins. On the whole, you know, we're taking a long-term view. We think that this year or for 2023, we're projecting 23.5% net income growth at the midpoint of the guidance with, you know, a very hard reinsurance market. We'll still generate a 20+ ROE and have a combined ratio that's in the low 70s. We wanna maintain a leadership position in the quake market because it's still gonna contribute to those numbers that I just gave you.
Chris, what's a good tax rate for 2023?
Yeah, good question, Mark Hughes. Obviously tax rate is higher this quarter and higher for the year than we've kind of talked about at 21%. The big driver of that, we do add back executive comp that exceeds the maximums provided by the IRS. You know, in Q4, it was driven by the fact that stock options, not many stock options were exercised, so it drove a little bit higher. I think if that trend continues, I expect the tax rate to trend a little bit higher as well. I think, you know, if we go with that trend, it's probably gonna be in the 22%-23% range. If, call it, stock price, does what we want it to do, then I think options come back into the table, and it can push it back down to 21%.
I would probably say today 22% is probably a good target for 2023.
Thank you very much.
You're welcome.
Thanks, Mark.
We have reached the end of our question and answer session. I would like to turn the conference back over to Mac for closing comments.
Thank you very much, operator. Thank you to all who were able to join us this morning. We appreciate your questions and your continued support. As always, I wanna thank the team at Palomar, who remain instrumental into our short and long-term success, and their productivity is industry leading. To conclude, we had a great year in 2022. We produced record premium, record earnings, and an adjusted ROE of 18.3%. You know, the results demonstrate the durability of the business model. I think the durability of the business model is even further evidenced in the guidance that we're giving for 2023.
You know, we are confident that we will navigate this hard reinsurance market, and we will be able to generate strong net income growth, an adjusted return on equity of 21%, and more importantly, execute on Palomar 2X, and deliver predictable earnings growth for the long term. Thank you very much and enjoy the rest of your day. Take care.
Thank you. This does conclude today's conference. You may disconnect your lines at this time. Thank you for your participation.