Yep, it is afternoon. I'll kick off the session, Adam Klauber, Insurance Analyst at William Blair. Please look at our website for disclosures. This session is with Palomar. We have the Founder and CEO, Mac Armstrong, joining us. I'll just say two words and kick it over to Mac. Palomar is probably, you know, or some of you know, is one of our favorite companies. It is our top pick this year. We're not just saying that. It is our top pick. It's relatively unique. There's a lot of, having followed this industry for a while, there's a fair amount of specialty companies, and if you can execute in the specialty business, it's a good business model. Palomar is really a much, much different company. They're a specialty, which is great, but it's really how the company is constructed, how they go about the markets.
It really is materially different. I appreciate you here listening to the company. Mac?
Thanks, Adam. Great to be here. I want to thank William Blair for having us. This is one of our favorite events, if not our favorite event of the year, and we appreciate William Blair's support of our business since actually before we went public, but certainly since we went public in 2019. You can read that disclaimer in your spare time as well. Like Adam said, it's on our website. Just quickly, a summary of our business. I think to piggyback on what Adam described, this overview is really intended to impress upon you what makes us different. We are a specialty insurer. We are one full stop. We don't try to be all things to all people. What we want to do is focus on markets where our data analytics, our underwriting acumen, and our risk transfer expertise give us a structural edge.
What we call it is really being a one of one specialty insurer that can find niches where the standard market or the E&S market isn't equipped to serve and then build leadership positions there. We are an AM Best A-rated company, A- or A11, soon to be A12 with over $1 billion of GAAP equity in our sights. I think a prime example of what we do has really been in the earthquake market, and we'll talk a bit more about earthquake. We are the third largest writer of earthquake insurance in the U.S., and we write both residential and commercial, and we write it both on an admitted and an E&S basis. That model has been exported into five other product categories, or four other product categories, excuse me: in the marine and other property, casualty, crop, and now surety and credit.
Again, what we're trying to do is leverage data analytics, underwriting, technology, and existing relationships to build market leadership positions through both an admitted and an E&S offering. What's critical to our success is a couple other components, and that is, one, our distribution strategy. We say we're distribution agnostic, depending on the line of business, we could work with a wholesaler, a retailer, and another insurance company to generate business for us. We are flexible. If a risk fits our box, we don't care how it's originated for us. Certain products tend to be loyal to certain channels, generally speaking, we are going to find the risk, and we are somewhat indifferent to how it arrives on our desk. Then lastly, risk transfer, reinsurance. That is one of our true differentiators as well.
We are premised around using reinsurance to limit exposure to major events and reduce earnings volatility. I think what that ultimately does is lead to predictability and consistency in the results, and we will talk more about that as well today. How we have incorporated this portfolio into an operational or strategic mantra is really what we call Palomar 2X. We launched this in 2022, and it's really our commitment to double adjusted net income in an intermediate timeframe, so think three - five years, while maintaining adjusted ROE above 20%. Core tenets of this strategy certainly stems from profitable growth. Our growth has been almost entirely organic. We've done one major acquisition and a couple smaller tuck-ins. Really central to Palomar 2X has been the organic growth that stemmed from initially the earthquake business, which has provided an anchor to us.
It's a high margin, low frequency, but high severity line that can generate a combined ratio in the mid-60s. What that allows us to do is complement, and this is what we've done over the last 12, 13 years, is complement the earthquake with lower volatility specialty lines of business, whether it be crop or surety or inland marine and builders risk and the casualty franchise. What we ultimately are also doing to ensure there's that low volatility is the comprehensive use of reinsurance to smooth out the earnings base and preserve our strong margins. That can be protecting us from a severe event like an earthquake or a hurricane, or managing the casualty book from a shock loss standpoint, or not a disproportionate amount of exposure from a gross and net limit standpoint.
Since we've introduced the Palomar 2X concept, we have achieved the target of doubling adjusted net income in less than three years. Importantly, we are not deviating from this philosophy. We think that this is achievable for the indefinite future. We have levers that allow us to do that, whether that is indeed managing our gross and net line sizes up. In the case of property, we'll increase our line size. In the case of casualty, we're going to continue to keep it very modest. We also have the ability to use the reinsurance to potentially flex up and down how much limit we have protecting us, how much we're willing to expose to a given large event. That also provides us leverage. Lastly, with the investment portfolio becoming an increasingly meaningful contributor to our bottom line, we have investment leverage.
We have been over-capitalized, so to speak. We think we remain so. As the complexion of the book has changed, the investment portfolio will drive incremental leverage. The combination of those will allow us to sustain our strong net income growth objectives. In this year, what we're really looking to do at a strategic level is continue to leverage our scale, whether that be increasing our line sizes in areas like property or potentially managing the risk from a session percentage in our crop book, like leverage the scale the balance sheet affords us. Second, we are curating this portfolio to really navigate any market cycle. The combination or the complexion of the book, whether it's the combination of admitted and E&S, can allow us to endure a soft or a hard market if you are susceptible to that.
Thirdly, we're going to continue to deepen and unlock existing markets. The Gray Surety acquisition is a prime example of this. We believe the surety market is a very complementary one to the other four segments of the book from a margin standpoint, as well as from an uncorrelation standpoint. It's complementary in the sense that it has its own market nuance and cycle. It's additive, so we're going to continue to unlock opportunities there and expand existing footprints in existing markets as well as new. We'll continue to integrate and operate and optimize the business, and that's really focused on leveraging investments we've made in people, process, and systems.
As I look forward, you'll start to see operating leverage kick in from what's already a healthy margin space, but really in 2027, 2028, and beyond as we monetize the investments made over the last few years. Turning to the next slide, this just gives you a little more color around the portfolio. We feel that thoughtful and deliberate diversification will drive the successful execution of Palomar 2X for the intermediate, if not indefinite, future. Since our formation, we really have tried to intentionally diversify into what we think are adjacent markets, where we see a compelling opportunity to certainly generate attractive risk-adjusted returns, but also leverage existing resources, whether that be people, distribution, reinsurance, data, and technology. The intentional diversification within specialty insurance, again, is premised around us navigating any market cycle.
A generationally hard property market like we saw in 2023, or now what has been a softening property cat market in 2026 in current. It's important to point out that we are seeing opportunities across the portfolio. We grew 43% in the first quarter, and it was across earthquake casualty, surety crop, and in the marine. The growth rates are different, but the balance in the book is affording us the ability to continue to grow even where there is more pronounced softening. When you look at the mix in earthquake, we have a strong combination of both residential and commercial earthquake business. Commercial business is under some pressure from a pricing standpoint, and particularly in the large segment, whereas our residential earthquake business, which is roughly 60% of the earthquake book, has an average rate increase of around 10% and ±90% policy retention.
Very sticky. The complement of the two is allowing us to grow in the earthquake market. In the marine and property, what you have here is around eight different products. It's a combination of commercial and residential business as well as admitted and E&S. Like earthquake, you can play through pockets of softness and have good growth drivers, and particularly in the residential component like we're seeing in flood as well as Hawaiian hurricane, and then our residential builders risk business. Builders risk is the largest component of that in the marine and property franchise. The casualty book is niche lines of business like environmental liability, contractors, general liability, real estate E&O, and other E&S lines. Majority of this business is written on an E&S basis, you're seeing stable rates.
There are pockets where there is some rate pressure, like in the property segment, we know where to lean in, and like healthcare liability or contractors GL, and know where to pull back, like in this case right now, cyber, and certain classes of professional liability. Crop is our fastest growing line of business. We are one of 12 approved insurance providers, which means we get to access the Federal Crop Insurance Corporation and cede business to the FCIC through the standard reinsurance agreement they put in place with the 12 approved insurance providers. Which is important because the crop business is one where the federal government sets the pricing. You're differentiating via service claims handling and technology. We have grown rapidly.
We expect to grow 35% this year off of a base around a quarter billion dollars and do think that in the near term, we can get that over half a billion. In long term, that should be a billion-dollar line of business. Lastly, the surety and credit segment is our newest class of business, and that is one that we think has both attractive margins and is also compelling because it is uncorrelated to the traditional P&C market cycle. You can see again just the mix of the business and how much of it is E&S versus admitted and how much is this commercial versus residential. I think that balance really affords us the ability to sustain our bottom line growth in any market cycle. This next slide just shows how the book has evolved, but the consistency of the margins remained.
Actually give credit to Adam because this is an analysis that piggybacks off of something he pulled together. Concerns that some investors have had is that the diminution of the earthquake book as a percentage of the total would potentially degrade our margins some. What you can see here is that's not the case because, in fact, as earthquake has shrunk, certainly the bottom line has grown meaningfully. It's grown nearly four-fold from 2021 -2 227 on an LTM basis. The combined ratio hasn't changed. The combined ratio is still in the mid-70s, still what we would consider is best in class. Furthermore, the ROEs actually improved. The lines of business that we have gone into are not consuming capital away from our high margin lines.
In many ways, we are over-capitalized. That affords us the ability to go into an area like crop that's not capital intensive, but is certainly uncorrelated with earthquake and leverage that capital and make it accretive to the ROE. This slide just is a simple summation of the continued execution that we've had through the first quarter of this year. I think what I would probably prefer to highlight is just the sustained growth and the sustained profitability in there. Gross written premiums were up 40-plus% in the first quarter. The adjusted net income was up 24%, and the adjusted ROE was approaching 27%. This is a nice combination, a very compelling combination of growth and profitability, and the Q1 was actually our 14th consecutive quarter of beating consensus EPS. The top line growth was broad-based. It wasn't just a one-trick pony, so to speak.
Casualty grew 55%. The surety and credit, obviously the addition of Gray to supplement that grew 130%. Crop grew 82%. Even in the teeth of a softening commercial property market, we saw growth in quake and the marine and other property. I think the other thing that I would point out too is when you look at the composition of the returns, that 27% of return on equity, investment income was call it $18 million of a $61 million total. A nice contributor, but the predominance of our results and our returns comes from the underwriting side. We are an underwriting organization, and the returns demonstrate as much. I talked about initially just how we use data analytics and technology to separate ourselves from our competition. This is something that Adam and I have talked about even before we went public.
We think that we can use technology and data to ultimately out-compete in the market and differentiate ourselves to our distribution partners. We've built a company to scale. A lot of our core systems enable straight-through processing. Residential earthquake, Hawaiian hurricane do not require human interaction. You enter in seven or eight attributes, you can get a quote. On the back end, we use technology to enhance the portfolio and optimize the reinsurance spend through data analytics and third-party and proprietary systems. Additionally, we continue to invest in our systems, whether that's leveraging new technologies that are AI enabled on both a policy administration standpoint or a claims management standpoint, but also incorporating AI to help us from a productivity, whether that be in service or in underwriting or risk selection.
Ultimately, we think we can use AI right now to enhance the customer experience, to improve our risk selection, and drive down costs both operationally as well as from a ceded and premium standpoint. We want to continue to invest in that to make sure that we don't fall behind, but rather use it as a competitive differentiator. The other true competitive differentiator for Palomar is our comprehensive and sophisticated use of reinsurance. Our leadership team, the good portion of them, cut their teeth in the reinsurance space. When we launched the company, we knew that we could use reinsurance to generate consistent returns and protect our balance sheet in a way that was unique to the market. It's been central since we started the company in 2014, and it really has credentialized us. We have a reinsurance panel that's over 100 strong.
No single reinsurer constitutes more than 2.5% of our XOL limit. They importantly support us across multiple treaties, whether it's property XOL or casualty quota share, or in the ILS market. It's not just a risk management tool for us. It's really a competitive differentiator, and I think it's best illustrated in the fact that we use reinsurance for a single product. In many instances, four different types of reinsurance will touch a single line in how it supports it. If you look at earthquake or builder's risk, we will have an excess of loss treaty working for us. We could have a cap on working for us. We would have facultative reinsurance, so that's individual risk protection, and then a quota share treaty, which is more pro rata support and risk transfer. Ultimately, what we are trying to do is provide consistent earnings.
We want to protect the balance sheet from a severe event. We want to make sure that we're not overextended from a gross and net limit standpoint, so a shock loss throws off a quarter. I think our recent consistency or our longstanding consistent results demonstrate the sophistication and the utilization of reinsurance. Just to give a quick update on the recent reinsurance market, we have been active, and we are constantly in the market, but it's been across the portfolio. In the Q1 alone, we completed six different treaties, three property and three casualty. All of those renewed at improved economics relative to the expiring terms. In the circumstance of the casualty treaties, we kept our sessions, so how much we cede off to the reinsurers flat, but they paid us more for what we ceded off to them.
I think that's a testament to the solid underwriting, especially for younger lines of business, as much as it is the market cycle. As it relates to the property side, similarly had quota shares renew at attractive economics where we were getting a higher cede. We were potentially retaining more by getting more third-party capacity to support our growth. For builders risk, we actually took our program up from $30 million to $50 million of support so we can write larger limits. We're getting paid more for the larger limits that we write on behalf of our reinsurers, we're retaining more, but not disproportionate to the growth of our balance sheet. With our core excess of loss program, we now buy nearly $4 billion of ground-up earthquake protection.
That is commensurate with the growth in the earthquake and property book, as well as the increase in the exposure base, so both premium and exposure growth. We did it at rates that were close to 20% down year-over-year. I think the other thing that's important to point out was that we maintained our event retention. What is our exposure from a single hurricane or earthquake at the expiring level, despite the growth in the balance sheet? When we went public, our earthquake retention was $15 million on a surplus base that was $200 million in an earnings base that was close to $30 million. We sit here today, midpoint of the guidance is $273 million, and our earthquake retention is $20 million.
It's gone from a quarter plus of earnings to a matter of weeks of earnings is how much we would lose from an earthquake in a matter of days in the circumstance of a hurricane. It was a great outcome for us, it was a further testament to our ability to maintaining consistent earnings, raising guidance, on the heels of this reinsurance placement, we did raise our guidance another time, which dovetails into the next slide. We enter 2026 with the initial net income guidance of $260 million-$275 million. Following a strong Q1 , we raised that to $262 million-$278 million, now taking it up to $266 million-$280 million. That midpoint implies a 26% adjusted net income growth for the year.
It also includes $8 - $12 million of catastrophe losses. The midpoint of that guidance, this circles back to this Palomar 2X concept that we manage our business to, shows a doubling of the net income from 2024 in two years. This would be the second year in which the Palomar 2X cohort is doubled inside of two years. As we think about our long-term growth trajectory, we're not deviating from Palomar 2X, and I think the sustained profitable growth is something that all investors should hold us accountable to. This slide just further hammers the point home. We have beat guidance 12x . Excuse me, we've raised guidance 12x since 2023. The net income in that same timeframe has grown 43% annually. The initial guidance has been far exceeded over the course of the year.
2025 alone, we beat the initial guidance by 16%. As we sit here in early June, we've already raised guidance by two percent for 2026. I would be remiss if I didn't point out that despite our strong net income growth and profitability, we are certainly under-indexed from a valuation perspective compared to specialty peers. We have top-tier profitability and net income growth, return on equity, and combined ratio. We think it's best in class in both growth and capital efficiency. Yet, we don't think that's fully reflected in our valuation. As a result, we have put in place a new stock buyback where we have bought, excuse me, we bought $25 million back in the Q1 , and now we have a new $200 million buyback in place.
In the Q1 , we were trading higher than where we are today, so you should assume that we are buying back our stock in a meaningful fashion as we sit here in June of 2026. With that, this slide just is our management team. We've been doing it for a long time, but I'll hand it over to Adam for questions.
Great. Thank you, Mac. Any questions from the audience? If not, I'll chime in. Your second-to-last chart says a lot that your combined ratio in the last couple years, three, four, five years, has averaged mid-70s, whereas good players in the industry tend to be 90, 95, the industry being overall P&C. If I look, the industry would be somewhere between 95%-100%. 20 points, that's a lot. What would you say are the two reasons you are that much better?
Besides management? No. I would say it would be the lines of business that we go into have very strong risk-adjusted return opportunities if you are thoughtful in how you use reinsurance and technology and data. I think really it comes down to our ability to select risk and select markets that can generate attractive returns while ensuring that you achieve those attractive returns with thoughtful and comprehensive risk transfer. I think that's really what's allowed us to have the results. We could buy less reinsurance for earthquake and the margins would be better, but we sleep a lot better at night knowing that a large event is really a very modest earnings event and a great marketing opportunity for us.
I think a concern, and this is for the group as well as Palomar, the P&C market is clearly softer today than it was one year ago. We'll see what happens with 2027, but 2026 is softer. How are you maintaining higher levels of growth and still a very favorable margin gap even though the market is soft?
Yeah. It really comes down to two things. One, we've designed the business to navigate any market cycle. Right now, if the market's softening in commercial property, we have a lot of residential property where the rates are stable, if not increasing. Leaning in more towards those market segments and knowing when to pull back in others, like in the commercial property side. Having growth vectors in front of us like crop. We are well on our way, but we are still in the early stages of building a billion-dollar franchise, and we're continuing to make considerable investments in that market. I think our ability to sustain the growth is a function of the composition of the book, the vectors that we have, and then again, how we manage the capital both on the asset and the liability side, for that matter.
Okay. Great. Yeah.
In something like surety, how much do you guys focus on performance bonds versus sort of scalable bonds?
The predominance is contract surety bonds. We did just get Palomar Specialty T-listed, which should open up more treasury bond and federal government opportunity. The strong majority of it is contract surety bonds, so thinking performance or completion work.
Yeah. as that line grows, kind of overall, is that beneficial to loss ratio?
It should be, yeah. It's a high expense ratio, low loss ratio business. Yeah. Again, ultimately, crop's a higher loss ratio line, lower expense ratio, which should all balance out in the complexion, and that's why we think we can sustain our margins, keep the combined ratio under 80, and certainly keep that ROE well above 20.
Mac, we have one more, and then we'll have to-
Sure.
obviously, crazy weather affects financials. What happens when an El Niño year happens and the weather is going great? Does that affect things?
Yeah. again, the good thing about an El Niño can impact our business in multiple ways, but the breadth of the portfolio on the property side, you could argue a super El Niño bodes well for a pretty light hurricane season. it could be active in Hawaii, which we watch, but we have a $2.5 million retention in Hawaii, and we also run a reciprocal as opposed to have it on our balance sheet. I think it could lead to more rain the second part of the year on the crop side, which is never a bad thing. Anything that offsets droughts is good for us there. on the whole, we've built a broad enough property and crop portfolio that any weather cycle, we should be, no pun intended, hedged against.
Great. With that, thank you, Mac.
Thank you, Adam. Thanks, everyone.