Earnings Call Transcript
Palomar Holdings, Inc. (PLMR)
Earnings Call Transcript - PLMR Q4 2021
Operator, Operator
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 time 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.
Chris Uchida, CFO
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 PM Eastern Time on February 24, 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 the 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.
Mac Armstrong, CEO
Thank you, Chris. And good morning, everyone. Today, I'll 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 and '21, 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 apparel disproportionately impacted by climate change. While we're focused on delivering sustained revenue growth, that will not come at the expense of our bottom line. To support this over the course of the year, we completed the run-up of our property in Louisiana homeowners portfolios, shifted our commercial wind exposed property focus to a layered and shared model, mostly reduced our maximum limited lines side and took advantage of favorable market conditions to increase rates and improved 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 of Palomar going back to our founding eight years ago. During 2021, we continued to thoughtfully use the 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 reduced our maximum limit per risk and provided 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 in 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 by 35% and our value select residential earthquake product, our largest product growing by 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 the 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 in the California residential earthquake market which provides considerable room for continued strong growth in this important, 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've 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 builders' risk. During the year, we also launched several new E&S products, including professional liability, excess liability, and contractors liability. These products along with others will be significant contributors to our success in the 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 the Inland Marine, which grew 290% year-over-year and exited 2021 at a $72.8 million run rate, Hawaii Hurricane with 109% year-over-year growth and flood, which grew 32% year-over-year. Our first casualty product, Real Estate Errors and Omissions, continued to show great promise as it grew nearly nine-fold year-over-year. 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're pleased to report in the fourth quarter for all of 2021, frankly, we're able to marry the 50% plus top-line growth with a very strong bottom-line and 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 homeowner’s 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 of our results. Our strong results combined with the substantial investments in products, 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'm particularly excited about. Introduced in September, our team has quickly built a strong pipeline, has already executed three programs which are all fee-based and do not involve taking underwriting revenues. 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 to $100 million of managed premiums in 2022. We also recruited talented underwriters for 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 in our 2022 outlook, we are increasing our share and extending our TAM in the P&C market 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-teen rate increases in the fourth quarter and for 2022 we expect to see sustained price increases as well in light 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% to 10% on expiring terms, with certain segments like professional lines seeing greater upward movement. Our national layered and shared property program saw a rate increase in excess of 20% in the fourth quarter, with December increases over-indexing the quarterly average. A 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 exposure in 2022. All growth from that line will come from rate. On a related note, we are exiting the specialty homeowner’s 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 positions 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 a tie 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, and on January 1, 2022. We are renewing our loss free 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 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 0.78 ads. And we feel comfortable variety of business up to 1x of our cut exposed lines and higher for others. So 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% year-over-year growth and an adjusted ROE of 19% at the midpoint of the range. This range factors in additional investments that we'll make in talent, systems, infrastructure, and reinsurance because 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 would like to conclude with an update on the 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 Palomar’s ESG materials. We also released our annual sustainability report this month, providing an update on our progress related to specific ESG initiatives established in '21, as well as our initiatives and goals for the year ahead. One endeavor that I'm particularly excited about is Tamar protects, which is a charitable initiative that can reinvest earned premium back into communities to help them prepare or 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.
Chris Uchida, CFO
Thank you, Mac. Please note that during my portion when referring to any per share figure, I'm referring to per diluted common share as calculated using the treasury stock method. This methodology requires us to include common share equivalents such as outstanding stock options during profitable periods, and exclude them in periods when we incur a net loss. We have adjusted the calculations accordingly. For the fourth quarter of 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 an 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 an 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 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 sessions 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 31, 2021 from 56% for the three months ended December 31, 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 in earned premiums offset by the growth and earnings 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 premium to gross earned premium 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% to 55% on an annual basis, or 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 in 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 in 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 negative 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 at 15.6%. Our expense ratio for the fourth quarter of 2021 was 60% compared to 68.6% in the fourth quarter of 2020. 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 it's a better representation of our business to look at our expense ratio 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 year-over-year increase was primarily due to a higher average balance of investments held during the three months ended December 31, 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 $245,000 gain in the prior year's fourth quarter. The recognized gains were driven by dividend yielding equity index funds. And like the rest of our portfolio, we'll 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 ended December 31, 2021 was 19.8%. Our stockholder’s equity was $394.2 million at December 31, 2021, compared to $363.7 million at December 31, 2020. For the fourth quarter of 2021, annualized return on equity was 17.2% compared to negative 2% for the same period last year. Our annualized adjusted return on equity was 19.9% compared to a negative 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 31, 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're providing adjusted net income guidance range of $80 million to $85 million, representing 54% year-over-year 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're providing our continental U.S. wind projected net average annual loss or net AAL of approximately $6 million projected as of September 30, 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 repurchase authorization and no new shares have been purchased under the new authorization. Well, while we are not pivoting from our established growth strategy, we view our current shares are 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. But 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, Operator
At this time, we will begin the question-and-answer session. Please hold while we gather questions. Our first question comes from Mark Hughes with Truist Securities. You may proceed with your question.
Mark Hughes, Analyst
Thank you. Good morning.
Chris Uchida, CFO
Mark, how are you?
Mark Hughes, Analyst
I'm good. Still morning central time. In regards to the attritional losses and 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?
Chris Uchida, CFO
Thanks, Mark. That's a good question. We've discussed the loss ratio in recent quarters, and we've mentioned our expectation for it to increase due to changes in our business mix. You can see that trend this quarter. If we adjust the loss ratio for the historic all-risk book, which we have fully phased out by the end of the year, the loss ratio for Q4 was around 15.7%. This same factor accounted for about 1.7 points of our annual 2021 loss ratio, which suggests that the annual loss ratio is below 15% using that metric. We've communicated this expectation. We anticipate a slight increase in the loss ratio as we continue to adjust our business mix, potentially by another point per quarter. It's also worth noting that we utilize a significant amount of quota share, especially for our new business lines like casualty, Inland Marine, and national all-risk, which helps to manage the loss ratio. Our earthquake business and Hawaiian Hurricane business, which represent about 55% of our overall portfolio, contribute to maintaining a low loss ratio, though the mix is changing. Therefore, I expect the loss ratio to rise slightly, but it won't escalate rapidly. Regarding the expense ratio, I expect the fronting business, which has a seemingly higher commission, to be the main driver for changes over the next 12 months. I believe this will help reduce acquisition expenses. Long term, I expect the other underwriting expenses to achieve more scale, but in the short term, I anticipate more fluctuations in acquisition expenses, primarily due to fronting. This quarter, our ceded written premium was about 47%, an increase from 38% in Q3, mostly driven by quota share from the fronting business. These factors should contribute to a slight decline in the acquisition expense ratio as the year progresses. I also expect long-term improvements in other underwriting expenses. We continue to invest in our teams, systems, and organization to ensure we are positioned for success in fronting, casualty, core earthquake, and marine lines. Therefore, while I wouldn't be surprised if the ratio levels off or even increases slightly in Q1, I do expect it to improve over the full year. There are many elements at play here, and I wanted to ensure I addressed everything you were interested in.
Mark Hughes, Analyst
Yeah, I know that's great detail. The fronting premium, are you going to break that out that we know how much was attributable to that versus the other business?
Chris Uchida, CFO
I believe we will eventually break that out, although it's currently a small part of our portfolio and classified in the other premium category. Regarding the fronting premium, our net earned premium was approximately 55% at the end of the quarter. I anticipate that this will decrease, likely at a rate similar to our acquisition expenses. You'll be able to observe how our return on equity is affected as the fronting business evolves. It's important to note that this business is nearly risk-free, meaning we won't experience losses or shocks from it, and it will contribute positively to the long-term return on equity of the organization. Please continue.
Mac Armstrong, CEO
We are aiming for managed premium between $80 million and $100 million and believe we have a strong pipeline that could increase that figure. This is a solid target. Additionally, while the attritional loss ratio may rise slightly, all lines will contribute positively to the Return on Equity, provided they are writing below a 100 combined ratio. This is illustrated by our steady-state attritional loss ratio of 15% for the quarter, with our annualized ROE nearing almost 20%.
Mark Hughes, Analyst
Chris, you mentioned the $6 million number for a possible law, central law. Is that maybe a suggested or reasonable cat load for the business? Does that make sense?
Chris Uchida, CFO
Yes. I think that's a great question, Mark. No. So this is our continental U.S. wind net AAL and that is $6 million so that is what we believe if we were to put a bit of 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. So with all those other underwriting changes that we've made, you look at where it was last year that's still had our historic risk business in it. You think about the changes in Mac talked about with underwriting and reinsurance that we're making this year. That number is about 40% lower than it was last year. So we do believe that as a good metric or cat loads that people can use to think about our book of business going forward.
Mark Hughes, Analyst
Then one final question, the commercial quake pricing has been decelerating a bit. Mac, I think last quarter you said on a combined basis, third quake business could grow 20% for maybe an indefinite period. How do you see that now?
Mac Armstrong, CEO
As I mentioned during the call, we believe there are plenty of opportunities in the quake market, particularly in both the commercial and residential sectors, with a more significant potential in the residential sector. In the commercial market, while rates have slowed somewhat, there is still strong integrity, and we are seeing mid-single-digit increases. There's not an influx of new capacity, which presents a chance to expand our portfolio and gain market share. We see the most growth potential in the residential side, which is encouraging since it's our largest business segment. This growth is influenced by ongoing disruptions in the homeowner's market; for instance, AIG recently announced plans to withdraw from California's admitted homeowner's market due to wildfire disruptions. Additionally, the California Earthquake Authority is contributing to this landscape. All these factors are creating substantial opportunities for us. Notably, January 2022 was our best month ever for new business in our value select residential earthquake segment, indicating that our product is performing exceptionally well. This bodes well for continued strong growth in our earthquake segment.
Mark Hughes, Analyst
Thank you very much.
Operator, Operator
Our next question comes from the line of Matt Carletti with GMP Securities. You may proceed with your question.
Matt Carletti, Analyst
Good morning. Mark covered both what I had, but I guess a follow-up, Chris, for the conversation on fronting. With the right way to think about it, is it wrong to assume it’s a market-level five-ish percent fronting fee and if we use that against kind of the $80 million to a $100 million guide for '22 that's kind of the magnitude of impact in ratios that it might have on the acquisition ratio?
Chris Uchida, CFO
Yes, that's a reasonable evaluation, estimating between $80 million to $100 million. This amount will need to be accrued over the term, which I would expect to primarily be 12-month policies. The margin will range from 5 to 7, depending on the specific risk and type of business involved. This is the correct perspective to adopt. This aligns with the appropriate market considerations and addresses the need to reduce acquisition expenses.
Matt Carletti, Analyst
And then Mac do maybe just a follow-up on the color you gave there on kind of some things going on in the California market or quake in particularly the CEA. It seems like we’ve been waiting for a little while now for them to decide how they want to handle risk management going forward, is there a certain timeline around that by what you expect them to make a decision, or is it more of just a wait and see?
Mac Armstrong, CEO
I think there's a couple of things that I pointed out, Matt. First, they did put out in December a circular that did authorize the participating insurers to seek alternative solutions. So there is something definitive there. And that goes well for us because that 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. And in fact, in Q4 we did bring on a nice new partner in the California residential quake market. But beyond that, it's hard to say whether they're going to 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 anxiety amongst producers, it does create anxiety potentially amongst insureds, and certainly creates anxiety with participating insurers. So that's the type of dislocation that Palomar does well and it gives me the optimism that we all have about the growth in that line.
Matt Carletti, Analyst
Great. Well, thank you for the color and congrats on a strong end to the year.
Mac Armstrong, CEO
Thanks, Matt. Look forward to seeing you soon.
Operator, Operator
Our next question comes from the line of David Motemaden with Evercore ISI. You may proceed with your question.
David Motemaden, Analyst
Thank you. Good afternoon. I have a question regarding your outlook for 2022, specifically about your expectations for top line growth and gross premiums written in 2022. You mentioned exiting all homeowners insurance outside of Texas, and I wasn't entirely clear on your statement about not increasing exposure in the Southeast in 2022, with premium growth being driven solely by rate increases. I have a significant question, and I would appreciate it if you could elaborate on your projections for top line growth in 2022 and discuss some of the new changes you are implementing.
Mac Armstrong, CEO
Certainly, those are great questions. While we haven't provided specific top-line guidance, I want to express our confidence in the growth trajectory of the business. Last year, we experienced over 50% growth for the full year, and factoring in the runoff of the admitted all-risk business, it was closer to 70%. Although we don't anticipate maintaining that growth rate in 2022, we believe we can achieve strong, potentially industry-leading growth rates that will allow us to uphold our margin structure and combined ratio as we did this year while hitting our net income guidance range. It's important to note that the growth we are targeting in the top line and the more than 50% bottom line growth comes alongside the business we are further exiting, specifically the specialty homeowner's business outside Texas, which accounted for about 5% of our book last year. On a steady state basis, it likely has a combined ratio in the mid-eighties. Our aim is to exit this line of business since it offers reasonable pre-cat margins but comes with too much volatility for us. Consequently, the 80% to 85% combined ratio we are presenting has a significantly different volatility profile compared to last year and the year before. As for the shared national property program layer you mentioned, we are not looking to increase our exposure there. We believe it can grow but mainly due to rate adjustments. We've reduced our probable maximum loss by 40% over the year and expect it to be reduced by 60% by the peak of the wind season. This allows us to estimate that net AOL for Continental Hurricane is $6 million, which translates to 2-3 points of cat load. Therefore, the growth we are aiming for presents a different quality than in previous years; it is more predictable, more consistent, and has significantly lower cat exposure. We are focusing on income-driven initiatives for Palomar and new casualty-oriented lines of business that involve substantial quota share to mitigate our net line size and protect against shock losses. While that was a lengthy explanation, it’s crucial for us to convey to all investors that we are very optimistic about our growth and equally confident in the reduced volatility of our business portfolio, which will enable us to achieve 50% growth on the bottom line.
David Motemaden, Analyst
Got it. Thanks that makes sense. That makes sense and I guess with that $6 million AOL, is there going to be any change in the reinsurance program as a result of that? I think it's a $12.5 million or $12 million retentions right now on the per occurrence. And that is both earthquake and win. Are we going to change anything on the wind side, maybe bring down the retention or yes, I guess any outlook on that?
Mac Armstrong, CEO
Yeah, David, I think the retention of $12.5 million up until 6th of 2022 is $12.5 million. I think that's a directionally good target. It could pick up a million dollars 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, a quarter of earnings. So that's going to be our guideposts. I think the reduction in the exposure will help that being said, as I said at the outset, only 9% of our expected loss in the reinsurance tower is going to come from Continental Hurricane. That is the toughest segment to place in the market right now. And so we're going to need to be nimble there, but I don't think it's going to change materially from where it is today. And 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.
David Motemaden, Analyst
Got it. That makes sense. If I could ask one more question about share repurchases, it's good to see the $100 million authorization. You didn't use the previous $40 million authorization completely. I know it was over two years, but I believe you utilized about 40% of it. Do you plan to fully use the $100 million authorization? Could you explain how you are currently thinking about share buybacks?
Mac Armstrong, CEO
Yes, definitely, David. Thank you for the question. We plan to be strategic with our approach. We assess our current valuation in terms of price-to-earnings and price-to-earnings growth, and we're currently below benchmarks like the S&P and the Russell 2,000. This suggests to us that we should consider repurchasing our stock, especially since we have excess capital. In the fourth quarter, we would have liked to buy back shares, but we were constrained due to Chris establishing a credit facility that enhances our liquidity for potential stock repurchases in a leveraged manner. However, it's uncertain if we will fully utilize this opportunity, though we certainly plan to take advantage of it. It's also important to note that if we manage this effectively, we can improve our return on equity, which we have set a floor for this year at around 14%. By repurchasing shares, we could potentially increase that return for our shareholders while making better use of our cost of capital.
David Motemaden, Analyst
Got it. Thanks. That makes sense.
Operator, Operator
Our next question comes from the line of Tracy Benguigui with Barclays. You may proceed with your question.
Tracy Benguigui, Analyst
Thank you. I want to go back to your comment about exiting specialty homeowner’s business outside Texas to reduce your Continental Hurricane PML. So I get that you are only now going to grow on Re, but this is going to sound super basic. Won't that leave you proportionately more exposed to wind as Texas is highly exposed?
Mac Armstrong, CEO
Thank you for your question, Tracy. While Texas does have exposure, it is not as significant as the combined exposure of Texas along with Mississippi, Louisiana, Alabama, North Carolina, and South Carolina, which led us to simplify our targets. Additionally, our operations in Texas are located inland rather than on the coast, specifically in Tier two counties like Harris County and Houston. This geographic spread of risk allows us to manage catastrophic (CAT) risks more effectively compared to our other specialty homeowners lines that were primarily coastal. Our portfolio in Texas is substantial enough that it offers a quicker payback from CAT events than states like Mississippi or Alabama, where premiums are lower. Moreover, our decision to exit that line was influenced by our partnership with a reliable collaborator who maintained a solid attritional loss ratio. Unfortunately, the volatility became excessive. With a stable earnings foundation projected to generate between $80 million to $85 million next year, we believe it is not beneficial to risk a few million dollars during a CAT-free year, potentially incurring pre-tax losses of $10 million to $12.5 million.
Tracy Benguigui, Analyst
Okay. Very helpful that you clarified that your Texas exposure is away from the coast. Could you also discuss what drove the negative CAT losses from prior period development? And I guess one side just for that $1.7 million prior period development, it looks like you had zero CAT losses. Can you confirm that it is the case?
Chris Uchida, CFO
That is the case. Obviously, it's all going to the first part of the question. And the prior period development was storms from 2020, storms for 2021 that we could have favorable development. We've said this from the past. We try to have a conservative position when it comes to loss ratios, that goes for the cats, that goes through the attritional. So this is kind of moving in the direction that we would expect when we look at it. So just think about all the storms that we were exposed to in 2020, 2021 and just the favorable development there. These are mostly also calling 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. So that's where the favorable development came in on the CAT side. In thinking through what your other part also that is, yes, we did not have any major CATs in the fourth quarter. We do have smaller exposure to many CAT, things of that nature, but nothing that we would call a CAT and hit our portfolio.
Tracy Benguigui, Analyst
Okay. I guess what's interesting in taking that prior period development actions, it's like there's an overall concern about inflation, and I guess could you just comment that part of your thinking that wasn't as big of an issue in replacement calls?
Mac Armstrong, CEO
Sure. Tracy, inflation is a key concern for us and influences our underwriting, risk transfer, and claims processes. It definitely played a role in our evaluations. Much of the development we've seen was related to the conservative IBNR load on certain events, as Chris mentioned. We've successfully closed the majority of our outstanding claims, particularly in residential business for storms like Hana, Ida, Delta, and Data. However, we still face significant IBNR for storms, largely due to inflation and rising costs, such as lumber and staffing shortages, which affect business interruption coverages. Therefore, I wouldn't say we consider inflation to be a minor issue for us.
Tracy Benguigui, Analyst
All right. Thank you.
Operator, Operator
Our next question comes from the line of Paul Newsome with Piper Sandler. You may proceed with your question.
Paul Newsome, Analyst
Thanks. Good morning. Congratulations on the year and quarter. I have a couple of modeling questions. First, should we assume that with everything else being equal, top-line growth will be slightly lower than bottom-line growth due to the increased share of the business in fronting and its margins? Is that a fair assumption?
Chris Uchida, CFO
I just want to ensure I'm breaking this down correctly for you, Paul. So you're suggesting that bottom-line growth will exceed top-line growth. Are you referring to pure gross written premium? Because that includes the fronting. We do expect that to continue to grow. I would say that the net written or net earned from that, in dollar terms, should be zero, but the overall top-line gross written premium will increase. I just want to confirm if that's how you're viewing it.
Paul Newsome, Analyst
No, on a net basis, on what we see goes to the income.
Chris Uchida, CFO
If you focus solely on fronting in terms of net line exposure or net earned basis, the net earned or net written will essentially be zero, while our acquisition expenses will decrease. Therefore, if you incorporate fronting into the current book and add $80 million to $100 million of fronting premium, our bottom line would rise without any changes to our net written and net earned. So, you're considering this correctly.
Paul Newsome, Analyst
I've seen the accounting on both ways, so just trying to clarify.
Chris Uchida, CFO
Just want to make sure we have that's how we're showing it.
Paul Newsome, Analyst
Yes. Properly done. Difference in opinion at accounting. And then my second question has to do with the $6 million CAT mode. We are nearly we take essentially assume a CAT load for the companies that we cover, and it put that as part of our earnings estimate. But you're presenting it a little differently than others think. So could you just talk about the intellectual pros and cons to basically just taking the risk guidance that you gave us and then subtracting out $6 million, whether that makes sense or not makes sense I'm just why you think we should look at it either way. And maybe and just we're off, that's too simple, but your thoughts that would be great.
Mac Armstrong, CEO
I think we're trying to avoid using our hurricanes as a way to influence our results, but we do analyze everything and consider both stochastic and deterministic outcomes. This refers to the hurricane and convective storm projections for the upcoming U.S. period, where we anticipate most of our losses. We believe this is a valuable tool and may look to incorporate it going forward. As we navigate this transitional period, we see it as an important point of reference for you.
Meyer Shields, Analyst
Yes, thanks. I want to start by saying I really appreciate the tremendous amount of data you’re providing us. It’s very helpful. Is there any way to estimate the AAL with respect to the earthquake or the Hawaii Hurricane?
Mac Armstrong, CEO
No, we have not provided that information. I don't think it's relevant because the situation with the earthquake and the Hawaiian Hurricane does not involve SDS exposure. The market doesn't perceive it that way, and we don't factor in losses from an earthquake. This is how we would consider the CAT load if we were in your position.
Meyer Shields, Analyst
Okay. That's fair. Is that a one event CAT load?
Mac Armstrong, CEO
No. This isn't theoretically the average annual loss; this will be a multitude of events. This could be multiple storms. It could be multiple hail events; it just averages at all out.
Meyer Shields, Analyst
Okay. That's helpful. And one last question, if I can. I think about this, want to 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 true or low level coverage or aggregate cover that the 12.5 retention would have gone up over the course of this year when we head into June and it sounds like you're not that concerned about it. And you know more about this than I, I was hoping you could take us through your thoughts in terms of those two factors, the gross book growth and reinsurance, Edison's.
Mac Armstrong, CEO
Sure. So I think as it relates to the aggregate will actually finish our retention. Yes. 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 and I think if what you saw at 11 was a gravitation, five, the reinsurance market to those segments that are more remote and not subject to what's called secondary apparel, severe convective storm or Winter Storm like Uri and so I think that helps us stand out in uniquely positions us well, as it relates to the aggregates. We are in the market. We have a loss ROE renewal up and it's also dominated by those same perils. We have pulled out 60 +% of the wind exposure that they are 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 Hawaiian Hurricane and flood driven. So 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 forming.
Adam Klauber, Analyst
Good morning, guys. Thanks. Could you talk about the progression in your distribution? You did a fair amount of commercial earthquake this year, Inland Marine really picked up and clearly, some of the other categories, 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 give us some flavor there, that'd be great.
Mac Armstrong, CEO
Yeah. Sure, Adam. Yeah, I think our team did a great job broadening the distribution footprint. Total distribution across the company increased by 19%, Inland Marine grew 40 plus percent, distribution points and residential quake was up to 25%. I would just from a channel focus, I would say 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 is essentially more of the admitted company is going to be a mix of retailers and MGAs and wholesalers to a lesser degree. But Inland Marine is probably going to skew more wholesale with a small bit of retail distribution. And then 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 we now have the preferred hunting license to go train and get producing on our products. And then just because the commercial earthquake and some of the liability is that also more of a wholesale channel available plus sale, yet
Adam Klauber, Analyst
That's what I thought. Okay. Okay. Is it fair to say that in the wholesale channel you are bigger than you were a year ago, but you're still relatively early stage with the big producers in that channel.
Mac Armstrong, CEO
Yes. I believe we are still developing our presence in that area. We have strong relationships with wholesalers, but there is potential to strengthen our connections in specific offices. This varies by product. For earthquake coverage, we have solid coverage, and we are expanding in builders risk and inland marine. There is definitely more market potential to explore.
Operator, Operator
Our next question comes from Pablo Singzon with JP Morgan. You may proceed with your question.
Pablo Singzon, Analyst
Hi. Thanks. So first just in the fronting fees, will all of this call it $45 million based on the March premiums you provided appear in '22 or will it be spread out between 2023 based on that number that you gave? And when thinking about how this will affect earnings, will all of it fall to the bottom line or are there any associate expenses to think about?
Chris Uchida, CFO
Yes. To address your first question, this will be allocated over the next two years. We will recognize this in a manner similar to our typical acquisition expenses. These relate specifically to 12-month policies which will be recognized over the upcoming 12 months. The $80 to $100 million in written premium numbers means that $80 million will be recognized over the next two years, and the 5% to 8% fronting fee will also be recognized during that same timeframe. As for the other part of your question, let me think about that for a moment.
Mac Armstrong, CEO
There isn't much additional expense expected; it should align with the bottom line, Pablo. You're absolutely correct. We do not need to hire significantly more staff. We are utilizing our program team and other senior leaders effectively. Therefore, we anticipate a fairly strong margin.
Chris Uchida, CFO
But I will say we are adding some more infrastructure around that just to make sure that we do have the proper procedures in place to manage that. When we think about it, we still need to do premiums and claims audit, we're still looking at underwriting results, making sure that we're 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.
Pablo Singzon, Analyst
Yep. Understood. The second one I had just a quick numbers question. I was hoping you could provide color in some of the line items that will build up to adjusted net income in '22. So specifically I'm looking at add-backs for stock comp and amortization, as well as what you're assuming for net realized interim losses, because that does flow through your adjusted number and that was a little larger than usual in the fourth quarter. Thank you.
Chris Uchida, CFO
Yes. We do see an increase in stock compensation, particularly due to new arrangements made for the executive team in 2021. This stock compensation is a standard non-cash expense. For amortization, most of it relates to the Hawaii deal we completed last year, which will continue to amortize over the seven to ten-year period of that deal. Regarding your question about expenses related to transactions, those should be minimal, but we will consider certain aspects as we evaluate and add those back as well.
Pablo Singzon, Analyst
I'll clarify my question regarding investment gains or losses. Are you investing?
Chris Uchida, CFO
Yes. We've discussed that our equity exposure has evolved over time as we review our overall investments. We believe we have sufficient capital in place. Considering the duration and the changes in our mix, particularly related to casualty, we feel comfortable increasing our equity exposure in our portfolio to better manage our ability to realize gains. This exposure has indeed grown, although it wasn't evident in the fourth quarter. We anticipate some gains and potential losses as we progress, but we do not expect these to be significant. As we've stated previously, we see ourselves as underwriters rather than investment managers, yet we maintain a solid portfolio. Consequently, we have allocated a larger portion of our investments to equities, focusing on equity index funds rather than individual stock selections.
Pablo Singzon, Analyst
Got it. And are you able to provide a number on how much you're assuming that BD E5 is it zero or is there some small positive number or just any color there would be helpful. Thanks.
Mac Armstrong, CEO
Yes. Pablo, we are not assuming any equity gains or appreciation in there even if it is zero.
Operator, Operator
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.
Mac Armstrong, CEO
Great. Thank you, operator. And thank you to all for joining us this morning. We appreciate your participation, questions, and your support. I'd also want to thank the Palomar team for their hard work and commitment over the last year they are key to our success past, present, and future. To conclude, I'm very proud of our results in the position we're in as we begin 2022. 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% plus net income growth in 2022. And then lastly, we have meaningfully reduced the volatility in our portfolio and will continue to do so, which in turn generates consistent predictable growth. So hopefully you all get a sense and ascertain our enthusiasm for 2022 and hopefully 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.
Operator, Operator
This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation. Enjoy the rest of your day.