Earnings Call Transcript
Palomar Holdings, Inc. (PLMR)
Earnings Call Transcript - PLMR Q2 2022
Operator, Operator
Good morning and welcome to the Palomar Holdings, Inc. Second Quarter 2022 Earnings Conference Call. As a reminder, this conference call is being recorded. I would now like to turn the call over to Mr. Chris Uchida, Chief Financial Officer. Please go ahead.
Chris Uchida, CFO
Thank you, operator, and good morning, everyone. We appreciate your participation in our second quarter 2022 earnings call. With me here today is Mac Armstrong, our Chairman and Chief Executive Officer. As a reminder, a telephonic replay of this call will be available on the Investor Relations section of our website through 11:59 p.m. Eastern Time on August 11, 2022. Before we begin, let me remind everyone that this call may contain certain statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These include remarks about management’s future expectations, beliefs, estimates, plans, and prospects. Such statements are subject to a variety of risks, uncertainties, and other factors that could cause actual results to differ materially from those indicated or implied by such statements, including, but not limited to, risks and uncertainties related to the COVID-19 pandemic. Such risks and other factors are set forth in our quarterly report on Form 10-Q filed with the Securities and Exchange Commission. We do not undertake any duty to update such forward-looking statements. Additionally, during today’s call, we will discuss certain non-GAAP measures, which we believe are useful in evaluating our performance. The presentation of this additional information should not be considered in isolation or as a substitute for results prepared in accordance with U.S. GAAP. A reconciliation of these non-GAAP measures to their most comparable GAAP measure can be found in our earnings release. At this point, I will turn the call over to Mac.
Mac Armstrong, CEO
Thank you, Chris, and good morning, everyone. We are very proud of our strong second quarter results. The quarter was highlighted by 69% gross written premium growth, adjusted net income of $18.7 million, and an adjusted ROE of 19.7%. In addition to strong financial results, during the quarter, we introduced our investors and the market broadly to Palomar 2x. Our intermediate-term objective is to double adjusted underwriting income and maintain an adjusted ROE of 20% plus via organic growth. This philosophy continually assesses our product suite to ensure there’s enough organic growth opportunity to double the adjusted underwriting business in an evergreen fashion. Key principles of Palomar 2x include, but are not limited to, profitable organic growth, a portfolio anchored by binary/non-attritional loss business, namely earthquake, continued reduction of non-binary catastrophe exposure, a conservative reinsurance strategy, fee income build-out, scaling the business with technology and process, and a commitment to ESG. The second quarter results clearly demonstrate execution on Palomar 2x and the four strategic initiatives that we outlined at the start of the year. We wake up every day thinking about how we will double Palomar’s adjusted underwriting income. I am pleased to say we are firmly on track to do so as our products continue to deliver strong growth and the investments we have made in new lines of business ramp up as we look to the second half of the year and beyond. Turning to our 2022 strategic priorities, we made significant progress across all four components in the second quarter. Our first priority, generating strong premium growth, is abundantly clear with our record gross written premium of $218.7 million in the quarter, which equates to a 69% growth over the prior year. Notably, premium in our earthquake business grew 47%, an accelerated pace from Q1. We saw continued record new business in our largest residential earthquake product and increased demand for our commercial quick offerings. It is important to highlight that the strong organic growth achieved in our residential earthquake line was not the result of changes at the California Earthquake Authority. Looking forward, we continue to believe that the residential earthquake production will remain strong as the California homeowners market remains dislocated and as the CEA ultimately reduces their exposure in the market. Turning to our commercial earthquake product, the hardening reinsurance market has led to capacity pullback and accelerating rate increases. As we procured incremental reinsurance limit at June 1, we are well positioned to take advantage of the capacity constraints in the market while also optimizing our book to cover the incremental reinsurance expenses and maintain our margins. The strength in the top line was broad-based. Our Inland Marine product grew 98% year-over-year. Commercial all-risk grew 42% year-over-year with nearly all of this growth coming from rate increases and portfolio optimization rather than exposure additions. Our newly launched casualty franchise continues to build with our professional liability lines growing 36% sequentially and 225% year-over-year. PESIC, our E&S business, increased premiums 200% year-over-year with a total of $102.4 million. PESIC’s growth was primarily driven by its main products, including commercial earthquake, commercial all-risk, and builders risk. Palomar FRONT also generated a meaningful amount of premium through PESIC; excluding Palomar FRONT, PESIC premiums still grew impressively by 107% year-over-year. Palomar FRONT is the best testament to the success we have achieved on our second priority: monetizing investments made over the course of 2021. Palomar FRONT recorded $42.2 million in gross written premiums in the second quarter and is tracking well ahead of our 2022 target of $80 million to $100 million in gross written premium. Importantly, this target includes only a modest amount of premium from our Texas homeowners product in the quarter, a product that was converted to a FRONT team program on June 1. We have been both impressed and encouraged by the response and interest we’ve received from reinsurers, MGAs, and other carriers since Palomar FRONT’s launch in September 2021. Beyond the strong premium in the second quarter, we had a couple of notable accomplishments that will drive further growth for the remainder of the year and beyond. We successfully expanded our program partnership with CyberInsurer Cowbell, doubling the reinsurance capacity available to our program. In addition to the expanded partnership with Cowbell, we recently announced a partnership with Omaha National, a leader in the workers’ compensation market. This program should provide a nice driver of incremental fee income in 2023. These two new arrangements firmly position Palomar FRONT to trend well ahead of initial expectations. As we continue to grow Palomar FRONT, we remain disciplined in evaluating our individual fronting agreements to ensure they perform well from an underwriting and collateral perspective. I’m pleased to note that we’re trending well ahead of our previously announced plan to generate between $80 million to $100 million of managed premium. We now believe we can generate $130 million to $160 million of managed premiums this year, inclusive of the Texas homeowners business, which adds approximately $45 million of fee-generating premium over the next 12 months. Moving on to our third strategic priority, delivering consistent and predictable earnings. We remain confident that the foundation built from the underwriting actions implemented over the past two years will ensure this directive. In the second quarter, we further reduced the risk profile of Palomar by transitioning the aforementioned Texas specialty homeowners business to a fronting arrangement, transferring the in-force premium to a fully reinsured fronted quota share facility. Additionally, we successfully completed our June 1 reinsurance placement. Reinsurance is a critical component of our business model and our Palomar 2x framework, and we are pleased to supplement our expiring program with the risk capital crucial to support our premium and exposure growth. To recap our June 1 renewal, we experienced an approximate 9% rate increase on a risk-adjusted basis compared to our 2021 program. While the pricing exceeded our expectations, the outcome was favorable as we successfully maintained our $12.5 million per occurrence retention while securing $430 million of incremental earthquake limit compared to our program that accepted June 1, 2021. These accomplishments are even more impressive considering the challenging 61-T renewal period with DMAs in the market. Despite encountering the headwinds of a hard market driven by industry losses and the associated impact of broad cost inflation, Palomar’s strong results and efforts to realign its portfolio by reducing exposure to continental U.S. hurricane and other secondary perils have been well received by our reinsurance partners. The hard reinsurance market provides for reciprocal industry action to increase premium rates accordingly to cover loss costs and maintain profit margins. While we have historically received attractive rates on our specialty lines portfolio broadly, we have utilized the reinsurance price increase to drive rate increases on renewals and filed rate increases across our business. Our fourth strategic priority is scaling our organization. We made considerable progress with key hires as noted in our last quarterly earnings call, and we continue developing our platform to attract the analytical, actuarial technology, and operating expertise to support our growth drive. As we further enhance our infrastructure by adding notable talent and expertise, our industry-leading technology has consistently provided a competitive advantage to Palomar by offering new underwriters an entrepreneurial atmosphere that fosters innovative development tactics to further benefit our platform and efficiently deliver our products and services. At this point, I’d like to spend a few minutes updating you on what we are seeing in the market from a pricing standpoint. We continue to view rates increasing across all lines, with specific lines of business sequentially accelerating the levels of increase. In commercial earthquake, the average rate for large accounts increased to 9% on a composite basis compared to 7% in the first quarter of 2022. We expect further hardening in this line of business for the remainder of 2022. As previously conveyed, we are not looking to grow the exposures in our E&S all-risk business, as we are generating significant growth from rate. For this line of business, we experienced a composite rate increase of greater than 30% in the quarter. We continue to see a dislocation in the property market broadly as the hard reinsurance market persists, and we expect continued rate increases combined with improved terms and conditions will, at a minimum, cover any increase in loss costs for the foreseeable future. As it pertains to inflation, in addition to the use of third-party license data, we leverage our builders risk program that audits construction projects on a monthly basis to rapidly inform our perspective on the cost of materials and labor. We have incorporated these factors into our underwriting to produce accurate insurance to value and appropriate rate increases to accommodate inflation levels. For residential earthquake, we have swiftly increased the inflation guard from a historical level of 5% to 8% this year. We’ve also secured a 7% base rate increase in our Hawaii Hurricane product approved by the insurance department in the state, which is in addition to an inflation guard that is now 8%. Again, we remain acutely focused on covering our loss cost and incorporating inflation into our underwriting. Our casualty lines remain in a nascent development stage and therefore don't provide pricing commentary similar to that of our property business. But generally speaking, we’re receiving rate increases of approximately 3% to 10% for casualty lines, with excess liability having the highest average increase. Turning to capital allocation, we remain confident that the cash we’re generating from our robust premium earnings growth provides adequate liquidity for our two-pronged capital deployment: one, strategically utilizing our $100 million share repurchase program; and two, funding our multiple growth initiatives. During the quarter, we purchased approximately 128,000 shares at a total cost of $7.3 million. To conclude, the progress made in the second quarter firmly positions the company as we look to the second half of the year on the path of Palomar 2x. We are reiterating guidance for the full year 2022, where 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 the additional investments in talent, systems, infrastructure, the current projected cost of reinsurance, and importantly, $5.9 million of unrealized losses on equity securities year-to-date. The maintenance of guidance at this level implies a range of $85 million to $90 million when excluding unrealized loss on equity. Essentially, the reiterated range is actually a raise of $5 million from the guidance offered in Q1. With that, I will 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 second quarter of 2022, our net income was $14.6 million or $0.57 per share compared to net income of $12.3 million or $0.47 per share for the same quarter of 2021. Our adjusted net income was $18.7 million or $0.73 per share compared to adjusted net income of $13.2 million or $0.51 per share for the same quarter of 2021. As we compare to the prior year's results, it’s important to remember the impact Winter Storm Uri had on our results for the first and second quarters of 2021. While Uri resulted in favorable net losses in the first quarter of 2021, we did incur additional reinsurance expense and ceded written premiums in the first and second quarters of 2021. Gross written premiums for the second quarter were $218.7 million, an increase of 69.1% compared to the prior year’s second quarter. Our consistent strong growth was driven by a combination of a favorable rate environment and increases in volume across our products. Fee written premiums for the second quarter were $122.6 million, representing an increase of 137.8% compared to the prior year’s second quarter. This increase was primarily due to quota share reinsurance driven by the growth of our fronting business and lines of business subject to additional loss. Ceded written premiums as a percentage of gross written premium increased 56.1% for the three months ended June 30, 2022, from 39.9% for the three months ended June 30, 2021. As anticipated, our fronting business was the primary catalyst of this increase, slightly offset by the decrease in low percentage compared to last year that included the impact of Europe. We believe the ratio of net earned premiums to gross earned premiums is a better metric for assessing our business versus the ratio of net written premiums to gross written premiums. Net earned premiums for the second quarter were $80.3 million, an increase of 48% compared to the prior year’s second quarter. This increase was due to the growth in earning of higher gross written premiums, offset by the growth in earning of higher ceded written premiums under reinsurance agreements. For the second quarter of 2022, net earned premiums as a percentage of gross earned premiums were 50.8% compared to 52.9% in the second quarter of 2021 and compared sequentially to 54.7% in the first quarter of 2022. As previously indicated, the launch and expected growth of our fronting business could push this ratio below 50% on an annual basis, especially with the transition of our Texas specialty homeowners book to the fronting model, though we will add consistent fee income that will enhance our ROE and bottom line. Losses and loss adjustment expenses incurred for the second quarter were $14.4 million, consisting of attritional losses of $13.9 million and unfavorable prior period catastrophe loss development of $548,000. The loss ratio for the quarter was 17.9%, comprised of an attritional loss ratio of 17.2% and a catastrophe loss ratio of 0.7%. The loss ratio for the quarter is in line with our expectations and the evolution of the overall book of business. We continue to believe that the attritional loss ratio should be around 19% for the year. Our expense ratio for the second quarter of 2022 was 57.1% compared to 62.6% in the second quarter of 2021. On an adjusted basis, our expense ratio was 51.2% for the quarter, compared to 60.5% in the second quarter of 2021 and compared to 52.4% sequentially in the first quarter of 2022. Similar to our net earned premium ratio, we believe it’s a better representation of our book of business to look at our expense ratios as a percentage of gross earned premiums. Our acquisition expense as a percentage of gross earned premiums for the second quarter of 2022 was 18.1% compared to 21.9% in the second quarter of 2021 and compared to 20.2% sequentially in the first quarter of 2022. The decrease was driven by additional ceding commission or funding fees from our new funding business that are netted within acquisition expenses and overall changes in our mix of the business. The ratio of other underwriting expense, excluding adjustments to gross earned premiums for the second quarter of 2022 was 8.5%, an improvement compared to 11.1% in the second quarter of 2021 and compared to 9% in the first quarter of 2022. As we continue to invest in talent, systems, and our infrastructure, we expect our business to scale over the long term. However, those investments may result in a flattening of the reverse ratio in the coming quarters. Our combined ratio for the second quarter was 75.1% compared to 76% in the second quarter of 2021. Our adjusted combined ratio was 69.1% for the second quarter compared to 73.8% in the second quarter of 2021. Reflecting on the Palomar 2x philosophy shared at Investor Day, we are introducing a new metric that represents the dollar inverse of our adjusted combined ratio. That metric is adjusted underwriting income. We calculate adjusted underwriting income similarly to adjusted combined ratio. We start with the underwriting income and back out adjustments that may not be indicative of our underlying business trends, operating results, or future outlook. We believe that adjusted underwriting income is the most comparable financial metric for evaluating Palomar 2x. Our second quarter adjusted underwriting income was $24.8 million compared to $14.2 million last year. Our year-to-date adjusted underwriting income was $46 million compared to $36.2 million last year. Net investment income for the second quarter was $3.1 million, an increase of 43.1% compared to the prior year second quarter. The year-over-year increase was primarily due to the higher average balance of investments held during the three months ended June 30, 2022, due to cash generated from operation and by slightly higher yields on the invested assets. Our fixed income investment portfolio's book yield during the second quarter was 2.61% compared to 2.24% for the second quarter of 2021. The weighted average duration of our fixed maturity investment portfolio, including cash equivalents, was 4.18 years at quarter end. Cash and invested assets totaled $552.5 million as compared to $427.8 million at June 30, 2021. For the second quarter, we recognized losses on investments in the consolidated statement of income of $4.7 million compared to gains of $300,000 in the prior year second quarter. We will continue to take a conservative investment approach which may impact our recognized gains and losses from quarter to quarter. Exclusive of gains and losses, we expect our investment portfolio yield to improve in the foreseeable quarters based on the current market conditions. Our yield on investments made in the second quarter exceeded our overall blended yield for the quarter. Our effective tax rate for the second quarter was 20.2% compared to 20.5% for the second quarter of 2021. For the second quarter of 2022, the tax rate differed from the statutory rate due to the exercising of stock options during the quarter, partially offset by non-deductible executive compensation expense. During the quarter, we purchased 127,952 shares for a total of $7.3 million under our previously announced 2-year $100 million share repurchase program. We have approximately $79.7 million remaining under the authorized program. While we continue to view our current share price as trading at a discount and will take an opportunistic approach to share repurchases under this program, we remain focused on investing in and supporting the growth of our business lines as we strive to progress and execute on the framework we provided to deliver Palomar 2x. We are confident in our strategy to achieve long-term growth, sustainable and predictable earnings. Our stockholders’ equity was $378.1 million at June 30, 2022, inclusive of the share buyback and unrealized changes to our investment portfolio, compared to $394.2 million at December 31, 2021. For the second quarter of 2022, annualized return on equity was 15.4% compared to 13.1% for the same period last year. Our annualized adjusted return on equity was 19.7% compared to 14.1% for the same period last year. As of June 30, 2022, we had 25,737,899 diluted shares outstanding as calculated using the treasury stock method. We do not anticipate a material increase to this number during the remainder of the fiscal year. For 2022, we are reiterating our previously provided adjusted net income guidance range of $80 million to $85 million, including $5.9 million of pre-tax unrealized losses on the equity security holdings. This range is equivalent to adjusted net income of $85 million to $90 million, excluding unrealized gains and losses for the year, representing 64% year-over-year growth at the midpoint of the range. Consistent with previous guidance, these estimates do not include any losses from major catastrophic events. As a reminder, we expect a continental U.S. unprojected net average annual loss, or net AAL, of approximately $6 million as of September 30, 2022. The net AAL industry metric is needed to assess continental hurricane and severe convective storm exposure. The updated adjusted net income guidance and AAL reflect our recently completed reinsurance placement and the conversion of our Texas specialty homeowners business to our fronting business model. With that, I’d like to ask the operator to open the line for any questions.
Operator, Operator
Thank you. Our first question comes from the line of Tracy Benguigui with Barclays. Please proceed with your question.
Tracy Benguigui, Analyst
Thank you. Good morning. You reiterated your 2022 outlook of $80 million to $85 million of adjusted net income but if I look at the first half of this year, you achieved just over $36 million, so it seems to be tracking behind. So are you expecting the second half of the year to be better than the first half?
Mac Armstrong, CEO
Hi, Tracy, this is Mac. Yes, I mean, this is the guidance that we put in place, and we’ve hit our targets to date and exceeded them. There is obviously a lot of embedded growth over the course of the year. As the premiums earned and our expenses for things like reinsurance are locked in, we feel very good about hitting the $80 million to $85 million, or the $85 to $90 million if you back out the unrealized losses from the securities. It’s just how the premium ramps up and some seasonality.
Chris Uchida, CFO
Yes. The only thing I’d add to that, Tracy, is when you look at the $36 million and if you put the tax-affected unrealized losses back in, you’re around $41 million, and you do the math on that; call it to the midpoint of either one of those ranges, depending on your starting point, it’s $46 million in the second half of the year. So we feel pretty good about those numbers, especially with the growth we’ve seen in the top line.
Tracy Benguigui, Analyst
Got it. You also raised your Palomar FRONT guide to $130 million to $160 million from $80 million to $100 million in premium. I recognize this is a capital-light line. Could more volume be accretive to your 19% ROE target or do you need more critical scale to revise your ROE guide?
Mac Armstrong, CEO
Yes, Tracy. I believe as we outlined at Investor Day, we’re trying to maintain an ROE above 20%, and we are right there this quarter at 19.7%. Palomar FRONT and the growth that we have does indeed put us in a position to surpass that threshold. Our goal is to adhere to that, if not continue building from it. It is capital-light. We think we’ve got good visibility on the revised range that we provided, especially when you factor in that a good portion of that uplift comes from an existing book of business transitioning to a fronting relationship in the form of our Texas homeowners business. In short, yes, I think it is accretive to the ROE, and we have very good visibility on the revised range that we provided to you.
Tracy Benguigui, Analyst
Thank you.
Operator, Operator
Our next question comes from the line of Pablo Singzon with JPMorgan. Please proceed with your question.
Pablo Singzon, Analyst
Hi, thanks. Cap losses have been benign for you so far this year. Would it be reasonable to assume that the average loss SME that you referenced, I think $6 million, is that materialized or should that be concentrated in hurricane season, basically the second half of this year?
Mac Armstrong, CEO
Yes. Pablo, that AAL is for Continental hurricane. So it would be during the wind season that runs June 1 to basically November 1, but tends to be more concentrated in the third quarter. It’s essential to point out that the number we give you is based on September 30; that’s the peak of wind season, and it should begin to decline after that date since much of that comes from the specialty homeowners book that’s in runoff. We have a schedule that outlines the policy by policy, state by state, how that comes down. So that number will start to decrease after October 1, December 1, and into next year.
Pablo Singzon, Analyst
Got it. To follow up on that, Mac, the Texas business being fronted, would it go through the same dynamic? Is it correct that it will take the entire year for you to be off the risk there?
Mac Armstrong, CEO
No, that's a good question, and it’s worth clarifying. Effective June 1, all risks are transitioned into the quota share. We are effectively off the risk, save for above the reinsurance provided by that quota share facility, which we have in our program. But in theory, we are off risk effective June 1.
Pablo Singzon, Analyst
Got it. The last one for me. I wanted to follow-up on your comment about having a 19% loss ratio for the year. The loss ratio this quarter is strong; if you anticipate that ratio, are you implying a pickup in the second half? What drives that sequential deterioration?
Chris Uchida, CFO
No, I don’t view it as a deterioration. I think that’s kind of hitting the numbers we've provided guidance for at the beginning of the year. We’ve always stated it’s going to hover around 18% to 19% range. We’re happy with a lower loss ratio this quarter at 17%. Our book of business, the loss ratio is still anchored by the binary business and now the fronting business that represents about 64% of our overall written premium. We see that developing nicely over the coming years. However, with the overall book and the runoff of some of the specialty homeowners’ book that’s non-Texas, we expect the loss ratio to hover around that 19%. So, could it be 19.5% or 18%? Yes, that would be within our comfort range. So, we don’t think it’s going to run away from us. We’ve expressed that a lot. But overall, we’re confident in that prediction at the beginning of the year and sticking to the 19% for the remainder of 2022.
Pablo Singzon, Analyst
Thanks for the answers.
Mac Armstrong, CEO
Thanks, Pablo.
Operator, Operator
Our next question comes from the line of Mark Hughes with Truist. Please proceed with your question.
Mark Hughes, Analyst
Yes, thanks. Good afternoon. Mac, your point about the earthquake authority, I think you said you were not impacted by the CEA. Why not? And will you be impacted in the future?
Mac Armstrong, CEO
Yes. Mark, it’s a great question. The core of it is that the CEA has put out public bulletins around the changes they’re making. They have stated that they are buying less reinsurance, moving it down from 1 in 400 to 1 in 350, which represents about a $1.2 billion reduction in P&L. That’s taking place in real-time. They’re allowing that limit to potentially expire as certain reinsurance programs renew. They have not yet put into place reductions in coverage; they have raised rates very modestly. So when I say it hasn’t impacted us, it’s a marketing catalyst for us, but there hasn’t been a dynamic where they are changing coverages or shedding policies. It’s frankly runway for us. A bigger dynamic has been the dislocation in the homeowners market. That’s what you’re likely seeing today – the continued wildfire activity in California and the residual impact on the insurance market. That has been a more significant catalyst. Another big catalyst is that we are continuing to build our distribution network, with our distribution network in residential quake increasing over 20% year-over-year, and a 4% to 5% sequential improvement. Partnerships are gaining traction in California and outside. While I don’t want to undermine the potential changes from the CEA, it has not been a material driver yet, which I consider a positive.
Mark Hughes, Analyst
Okay. Could you discuss the acceleration you saw in your commercial quake business in terms of capacity, competition, and demand? What’s driving that?
Mac Armstrong, CEO
Yes. We did see some acceleration. Rates increased in large accounts from 7% to 9%. There is some capacity limitation. The cost of reinsurance went up. Our rate increase on reinsurance was up 9%. If you isolate the earthquake, it was probably closer to 5% to 6%. There is a focus on recovering loss costs post June 1 in that renewal, and I believe others are doing the same. Market-wide, there’s rate integrity and the need to recover loss costs. If you’re buying your reinsurance on an all-perils basis – we are fortunate to have a majority of our tower being quake; your rate increase may exceed 9%, even if you’re loss-free like we were. There’s rate integrity and then capacity limitations have created an environment where we believe we can grow and optimize the book, which is honestly a unique dynamic.
Mark Hughes, Analyst
Chris, did you report or disclose the fronting fees generated in the quarter?
Chris Uchida, CFO
Hey Mark. No, that is not something we have disclosed. We’ve talked about it on previous calls, but generally speaking, the fronting fee is going to be about 5% of the fronting premium. We earn that similarly to all of our risk-bearing premium. This fee is also netted as ceding commission through our acquisition expense. You can see that trend reflected in the acquisition expense this quarter with it continuing to decline. It was up 18% on a gross basis this quarter from about 20% in Q1. Everything is operating as expected, and the fronting fees, and the ceding commission from our other lines of business with attritional losses where we still use heavy quota share reinsurance, that fee income is showing up and reducing our acquisition expense as we anticipated.
Mark Hughes, Analyst
Mac, I liked your comment about how you are keeping an eye on inflation in the construction area, auditing values, and replacement costs monthly. When looking at excess liability, how do you monitor or anticipate potential inflation in that line of business?
Mac Armstrong, CEO
Yes. Fortunately, we have seasoned leadership that I think you had the chance to meet at Investor Day. We monitor court activity and derive insights as the court reopens to inform pricing, loss costs, and claims management. It’s a small portion of our business, so that’s how we approach it from an underwriting perspective. Another tool for risk management is the quota share reinsurance. For excess liability, if we write a $5 million line, we’re generally around 25% to 30% of the risk, so we manage it that way while also seeking fee income. There are also underwriting and claims management tools referenced earlier that we find valuable. It’s something we need to watch as that book grows.
Mark Hughes, Analyst
Thank you.
Operator, Operator
Our next question comes from the line of David Motemaden with Evercore. Please proceed with your question.
David Motemaden, Analyst
Hi. Thanks. Good afternoon. I had a follow-up on the attritional loss ratio of 17.2% in the quarter. Can you discuss the components that drove the favorability compared to the approximately 19% level you have guided for the full year? Specifically, was there any tangible benefit from the one month you removed Texas or moved Texas to a fronting arrangement?
Chris Uchida, CFO
Yes, Dave, that’s a great question. The key components of that loss ratio revealed that the prior year development was about $500,000 of favorable development. We’ve previously discussed that we generally take a conservative approach when we set the loss ratios. So, we did experience a little favorability; I wouldn’t call it a material amount, but it was around $500,000. That said, let’s call it the current year loss ratio was a bit higher than the 17.2% figure; approximately 17.8% represents the unadjusted current year loss ratio. I would say that’s in line with our expectations. As you indicated, we do see a little benefit from converting the Texas specialty homeowners book into the front business. For most of the quarter, that’s still in there, and we still faced severe convective storm periods, which is part of our heavier season for the Texas business. However, the quota shares operated as expected for the first two months, and then moving that entire book into a front should create consistent profitable fee earnings over the next 12 months and into the future as that line continues.
Mac Armstrong, CEO
David, it is an astute observation. For prospectively, the specialty homeowners book at the end of 2021 was approximately $60 million, representing about 12% of the book. It’s either winding down this year or transitioning to a front. This line historically had a higher loss ratio and exposure to catastrophe, which adds stability, granting us more confidence in maintaining our 19% target, potentially with some positive variability to the upside based on conservative prior year estimates.
David Motemaden, Analyst
Got it. It seems the volatility is reduced from moving Texas book to fronting arrangement, along with some attritional loss ratio benefit as well - is that a fair assumption?
Mac Armstrong, CEO
Yes, that’s correct.
David Motemaden, Analyst
Thanks for the detail. I wanted to also ask about the two fronting arrangements, the upsizing of Cowbell and then the California workers’ comp. Have you decided to retain any of those two relationships? And how do you evaluate those from a risk management standpoint?
Mac Armstrong, CEO
Yes. We are going to retain 5% on the Cowbell program, which is a modest amount. As we have always said, we can basically utilize this as due diligence; we can learn a segment as a fronting partner and choose whether we wish to take on the risk. We have chosen to take 5% there. On the workers’ comp, it is around a 4% participation as well.
David Motemaden, Analyst
Got it. Thank you.
Mac Armstrong, CEO
Thanks David. I appreciate it.
Operator, Operator
Our next question comes from the line of Derek Han with KBW. Please proceed with your question.
Derek Han, Analyst
Hi. Thanks. You had strong growth in the quarter; however, I’m curious if your growth rates are affected by personal carrier partners pulling back due to poor results. Additionally, can you comment on the Insurtech side as they shift focus to profitability?
Mac Armstrong, CEO
So, Derek, thanks for your question. I would say that personal line carrier pullbacks relate to a broader theme of dislocation in the California homeowners’ market we've discussed before. That’s certainly a contributor. We see more homeowners businesses migrating to the E&S market, allowing us to write E&S residential earthquake at higher rates than historically. This trend has become more pronounced this quarter compared to the previous two and a half years. Regarding Insurtech, we are fortunate to partner with some of them, as they excel in customer acquisition, and we provide complementary products to their suite. We haven’t yet seen any pullbacks on their production side, but it seems to be a good channel for us. Our continued partnerships serve as an active channel for business, including travelers who we have performed well with in certain states and are broadening our initiative into new states.
Derek Han, Analyst
That’s helpful. As a secondary question on inflation, it looks like you are maintaining your loss trend assumptions that you raised last quarter. How comfortable do you feel that will hold in the second half of this year as many carriers have raised their loss trend assumptions?
Mac Armstrong, CEO
Yes. We feel comfortable with it, particularly on property, which comprises a significant part of our book. It’s worth reiterating that we have taken a three-pronged approach to address inflation, starting with the ITV, ensuring the correct replacement cost per square foot. We have third-party tools plus our builders’ risk book to perform monthly audits and gain timely insights on replacement costs. Secondly is the inflation guard, and thirdly is the rate change. For example, in Hawaii, we’re conducting the ITV exercise and have established an 8% inflation guard for renewal policies along with a 7% rate increase. It’s a multifaceted approach we implement to stay ahead. Our reinsurance program faced a 9% rate increase, which we need to cover loss costs and enhance our margins. We’re executing that effectively and must remain vigilant.
Derek Han, Analyst
Okay. Thank you for the detail.
Operator, Operator
There are no further questions in the queue. I would like to hand the call back over to Mac Armstrong for closing remarks.
Mac Armstrong, CEO
Great. Well, thank you everyone, and thank you, operator. We appreciate all who were able to join us this morning. Your participation and questions mean a lot, as does your support. I want to thank all of our employees for their hard work and dedication; they did a superb job in executing this quarter. To conclude, I feel proud of our second-quarter results and the progress made on achieving our 2022 strategic initiatives. We have shown consistent strong growth, continued monetization of our new investments, enhancements to our earnings predictability, and strides in scaling our organization. Furthermore, we remain confident in our ability to execute Palomar 2x. The combination of significant organic growth and the investments we’ve made position us well to double our adjusted underwriting income and provide better-than-industry average ROE. Essentially, that means value for our shareholders, and that’s ultimately what you will see. Thank you all, enjoy the rest of your day, and we look forward to speaking with you in the next quarter.
Operator, Operator
Ladies and gentlemen, this does conclude today’s teleconference. Thank you for your participation. You may disconnect your lines at this time and have a wonderful day.