Palomar Holdings, Inc.

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

A specialty insurance company that provides property and casualty insurance products in industries and locations with unique risks, focusing on catastrophe-exposed markets such as earthquake, wind, and flood.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Palomar Holdings (PLMR) operates within the specialty insurance sector, a niche characterized by higher risks but potentially higher returns compared to standard insurance businesses. They primarily offer residential and commercial specialty insurance products, largely focusing on catastrophe-exposed markets like California, Florida, and Texas.

Business Overview

  • Targeted Insurance Products: Palomar specializes in catastrophe-exposed insurance, including earthquake, wind, and flood coverage. Their main products include:
    • Residential Earthquake: Palomar offers homeowners insurance policies, with a focus on areas at high risk of earthquakes, mainly in California.
    • Specialty Homeowners: Insurance policies, not just earthquake, that are focused on areas with high natural disaster risk.
    • Commercial Earthquake and All Risk: Policies focused on earthquake and other risks for commercial property.
    • Catastrophe Excess and Surplus Lines: Provides high-coverage insurance which includes the risk of all the above catastrophe.
  • Geographic Focus: The company’s major operations are centered around states with notable natural disaster exposure. California and Texas, and more recently, Florida and Hawaii, represent key markets for their specialized offerings.
  • Client Base:
    • Their main distribution comes from a mix of independent agents, wholesale brokers, and program administrators.

Industry Trends and Competitive Landscape

  • Increased Frequency of Natural Disasters: Extreme weather events and natural disasters are becoming more common and severe, and are increasingly shaping the insurance landscape. This creates a demand for robust insurance, but creates more uncertainty and risk for insurers.
  • Rising Prices: Catastrophe exposed markets are currently experiencing rising premiums for homeowners.
  • Consolidation: The market is highly fragmented with several small players and some large players. Competition is mainly driven by price and distribution network.
  • Technological Advancements: Companies are utilizing AI-powered data analysis to enhance loss assessments, customer management, and pricing strategy.

What Makes Palomar Different?

Palomar differentiates itself through its focus on specific niche markets rather than trying to be a general insurance provider, allowing it to specialize on risks others tend to avoid. Their key differentiators include:

  • Specialized Expertise: They focus on high-risk areas, allowing them to develop expertise and a better understanding of those risks.
  • Agile Approach: Their technology-driven approach enables them to evaluate risk efficiently, implement necessary changes, and have a better overall analysis of the market.
  • Data Analytics: Palomar uses extensive data to properly price risks and develop better policy management.

Financial Analysis

  • Revenue Distribution: The bulk of premiums are generated by California and Texas, with newer expansions in Florida and Hawaii.
  • Revenue Growth: The company has shown strong revenue growth but it also has very volatile earnings. As of the latest quarter ending September 2023, their gross written premium increased 31.3% to $444.5 million compared to $338.6 million, with net earned premiums increasing 34.7% to $211.6 million compared to $157 million.
  • Profit Margins: The company is susceptible to large losses due to the nature of their business. Their combined ratio has stayed above 90% for the past 3 years. And during the same time they have had negative annual earnings. This will likely increase in the future with more exposure. In the last quarter they have managed to bring up net income to 45.8 million which is a substantial improvement over previous results but still needs to be stabilized for better overall performance. This is driven mostly by a decrease in losses. However, their net income for the first nine months is still lower compared to the previous year mainly due to large catastrophes in the beginning of the year.
  • Expense Structure: Palomar’s main expenses are related to claims, policy acquisition, and operations which have grown considerably over the years, but also because of their expansions, their expense ratios are mostly on average compared to the industry.
  • Return on Capital: The return on equity (ROE) has mostly been very volatile. The most profitable it has ever been was 2019 when it gave shareholders an average ROE of 36%, however recent years have proven extremely volatile with a mix of high and negative returns which shows the instability of the financials of this company.

It’s important to mention the company was impacted heavily by hurricanes in the third quarter of 2022, which resulted in a net loss of $130 million, showing the volatility of their results as they are in a high-risk industry. There is no guarantee they won’t be affected similarly by future unforeseen events. However, management claims that they have improved their policy structure to reduce their exposure to such events and therefore their future performance is better.

Moat Assessment

While Palomar operates in a specialized market, its economic moat is relatively narrow, therefore rating it a 2/5. This is because:

  • Brand: While Palomar has developed a brand in the insurance industry, it is not nearly strong enough to give it a huge advantage.
  • Customer Switching Costs: High switching costs do exist because customers with existing policies tend to keep them due to inertia but they are still not strong enough to grant Palomar a huge competitive advantage.
  • Cost Advantage: Their process-based cost advantage through efficient technological tools is not yet proven to be a durable advantage and will probably be easily copied in the long term.
  • Intangible Assets: The only intangible asset comes from their data analytics software, which has potential but does not create a defensible moat.
  • Network Effect: The network effect is completely non-existent in this type of business.

Risks to the Moat and Business Resilience

Palomar faces several risks that could erode its moat and impact business resilience:

  • Competition: The insurance market is fiercely competitive and highly fragmented. Even small companies can make it into the market and therefore easily reduce Palomar’s advantages and margins.
  • Regulation: Due to the nature of their business, they are more prone to legislative and regulation changes such as rate hikes and limits on policy rates.
  • Technological Disruption: New technologies and a shift into digital distribution might reduce Palomar’s competitive advantage if they do not keep up.
  • Catastrophic Events: As their business is focused on natural disasters, their results and thus stock performance is highly volatile and subject to large losses.
  • Investment Portfolio: The company’s returns are highly correlated with the credit markets, and therefore are subject to volatility, as has been seen recently in their investment results.

Understandability Rating: 3/5

Palomar is relatively easy to understand as an insurance business, however, its exposure to specialty and catastrophe insurance and the underlying financial factors that create volatility increase the complexity making it a level 3 company to understand.

  • The business model is straightforward—writing insurance policies in specialized areas.
  • Their earnings and financials are volatile and affected by various factors which makes it harder to get the general picture of the company.
  • The specialized focus on niche insurance products does require a better knowledge of the overall insurance market.

Balance Sheet Health Rating: 4/5

Palomar’s balance sheet is generally healthy, but with some specific caveats.

  • Liquidity: The company has a strong liquidity. Cash and short-term investments were around $330 million at the end of the last quarter, which is almost half of their liabilities.
  • Debt: They have low-debt levels, with debt-to-equity ratio around 0.2.
  • Solvency: The company is currently stable and has positive free cash flows, but it is important to be aware of their volatility in results.
  • Capital: Although they have a solid capital base to withstand their large claims and expenses, they also have an active share repurchasing program, which should be closely watched to see if it’s done responsibly.
  • Overall, the balance sheet has improved in recent years and provides a solid cushion from any unforeseen market turbulence. But it is also highly dependent on the company’s management decisions and thus should be closely monitored.