Earnings Call Transcript
Palomar Holdings, Inc. (PLMR)
Earnings Call Transcript - PLMR Q2 2023
Operator, Operator
Good morning. And welcome to the Palomar Holdings, Inc. Second Quarter 2023 Earnings Conference Call. During today’s presentation, all parties will be in a listen-only mode. Following the presentation, the conference call will be open for questions with instructions to follow at that time. As a reminder, this conference call is being recorded. I would now like to turn the conference call over to Mr. Chris Uchida, Chief Financial Officer. Chris, please go ahead, sir.
Chris Uchida, CFO
Thank you, Operator. Good morning, everyone. We appreciate your participation in our second quarter 2023 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 10, 2023. 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. 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 the 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. I am very pleased with the strong results of Palomar’s second quarter. Our team successfully executed our Palomar 2X strategy of profitable growth, even in the face of elevated catastrophe activity and a historically hard reinsurance market that significantly impacted the insurance industry. In the quarter, we focused our capital and resources towards targeted segments of our book of business, like Earthquake, Inland Marine, and Casualty to maximize our risk-adjusted returns, while we continue to reduce exposure to segments of our book that add volatility to our results. This prudent approach resulted in gross written premium growth of 25%. When excluding the drag from run-off and deemphasized products, this growth rate was an even more impressive 44%. Importantly, we delivered an adjusted return on equity of 21.3% in the second quarter. Beyond the strong financial results, the quarter featured several noteworthy accomplishments that position us well for near- and long-term success. Namely, we have successfully placed our 6/1 reinsurance program in line with our expectations and subsequently raised our adjusted net income guidance for the full year. We hired a team of professional liability underwriters to extend our Casualty franchise in attractive niches like real estate E&O. Lastly, in July, we received a revised positive outlook of our rating from A.M. Best. Over the course of the second quarter, we made incremental progress in 2023’s identified strategic objectives, sustaining profitable growth, managing the dislocation in the global insurance market, enhancing earnings predictability, and scaling the organization. Looking forward, we will continue to execute these imperatives but will look to convey their progress through five key lines of business that will drive the value of Palomar over the medium term. Those lines of business are Earthquake, Inland Marine, and Other Property, Casualty, Fronting, and Crop, our newest product. So with that, I’d like to walk through each business, beginning with our Earthquake franchise, which I expect to remain our largest line of business. Our core Earthquake franchise grew 24% in the second quarter as our Residential Earthquake book grew 20%, in line with the first quarter, and our Commercial Earthquake book grew 29%. The dislocation in the Earthquake market, whether it be a function of rising reinsurance costs, reductions in claims paying capacity, and coverage at the CEA or the exit of homeowners markets from California, is becoming more pronounced, which continues to afford Palomar the opportunity to both grow and optimize its book of business. During the quarter, we saw commercial accounts renewed at a risk-adjusted increase of 24%, which was a 25% sequential increase from the prior quarter. Additionally, our E&S Residential Earthquake business grew 75% year-over-year. At the end of the second quarter, E&S policies constituted a total of 8.8% of in-force California Residential Earthquake premium. We expect this environment to remain a tailwind for our business through the second half of this year and into next year. Lastly, in the quarter, we entered into a partnership with USAA, who will now offer our Residential Earthquake products in California. This new arrangement not only expands our reach but also validates our Residential Earthquake franchise. Turning to Inland Marine and Other Property products, Inland Marine experienced growth of 54% year-over-year through a combination of rate increases and new underwriters allowing us to expand our regional and distribution footprint. Builders Risk, our largest Inland Marine product, saw 7% to 10% rate increases and expanded its quota share support, allowing us to write larger limits without taking on disproportionate risks, as well as add incremental ceding commission. Our Excess Property line saw 10% rate increases and over 600% year-over-year growth as it builds a niche of non-cat exposed property business. Importantly, both these products are core to our strategy of maximizing our margins and using prudent risk management to achieve favorable loss ratios. As it pertains to other property products such as Commercial All Risk, Hawaii Hurricane, and Flood, we are hyper-focused on exposure management and contracting the existing book where necessary. In the case of Commercial All Risk, we made significant progress reducing our continental hurricane PML to $100 million, which led to a 45% reduction in premium year-over-year. However, Commercial All Risk policies that remain on our books renewed at an average increase of 60% and allowing us to recoup the rising cost of reinsurance. Turning to our Casualty business. We grew this segment 92% year-over-year, highlighted by strong premium growth in professional liability. During the quarter, we integrated our tuck-in acquisition, XEO Insurance Services, and hired a group of experienced underwriters and claim professionals to help extend the real estate E&O and miscellaneous professional liability franchises. Taking a surgical approach to the build-out of the Casualty business involves hiring underwriting talent with longstanding history and expertise in targeted niches and geographies. From an underwriting standpoint, the Casualty book’s loss performance continues to remain stable. Our focus on limit management and avoiding severity-exposed risk has enabled this performance. Our thoughtful underwriting approach was validated with improved terms and conditions at the renewal of our 4/1 Casualty quota share treaty. Turning to Palomar Front, we grew this business at a strong pace, delivering 82% growth over the prior year. During the second quarter, two of our Fronting programs renewed their reinsurance with incremental capacity support, a demonstration of their quality and sound underwriting performance. While our growth from Fronting is favorable, we want to reiterate our strategic approach to Fronting detailed last quarter. The goal of our Fronting effort is to provide services to a select group of MGAs, carriers, and reinsurers while we can gain experience in the lines of business to further our diversification in the specialty markets. We closely manage the compliance oversight, reinsurance, and collateral of our seven Fronting partners. This is a focus and strategic approach. We maintain a risk participation in selected partners with the current maximum participation of 5%. Our approach has allowed us to quickly assess and limit our counterparty exposure to potentially fraudulent letters of credit and transactions arranged by Vesttoo. Fortunately, our exposure is limited to a single counterparty and is immaterial. Our foray into the Crop market was via a Fronting arrangement with Advanced AgProtection, a leading crop MGA. As I mentioned last quarter, this is a partnership that we are particularly excited about. At this time, we are finalizing a strategic investment in Advanced AgProtection that further aligns our organization and our prospects for building a meaningful presence in Crop insurance. Two members of our executive management team, Jon Christianson and Jon Knutzen, have extensive experience in the Crop market. Upon consummation of the deal, Jon Christianson will join the Board of Directors of Advanced AgProtection. Palomar is now one of only 13 approved insurance providers with access to the $20 billion insured Crop marketplace. We expect to generate Crop written premium in the third quarter to our growth in 2024 as we generate a combination of both fee and underwriting income. Our goal is for Crop to prove a core pillar of Palomar 2X. Turning to our Reinsurance program. As announced in June, we successfully completed our 6/1 core Reinsurance program renewal. Pricing was in line with our expectations, and we were able to preserve event retentions and exhaustion points at historic levels that we view as sacrosanct. Our retention of $17.5 million remains less than one quarter’s earnings and less than 5% of the company’s surplus. Coverage now exhausts at $2.68 billion for earthquake events, $900 million for Hawaii Hurricane events, and $100 million for all continental United States Hurricane events. The $550 million of incremental Reinsurance limit procured over the course of 2023 provides ample capacity for our growth in the subject business line, as well as coverage to a level exceeding Palomar’s one in 250-year peak zone probable maximum loss. Importantly, our XOL program is in place until June 1, 2024. The Reinsurance placement, combined with our strong first-half results led to the recent upgrade at Palomar and our subsidiaries to a positive outlook by A.M. Best. Lastly, we are updating our 2023 adjusted net income guidance to $89 million to $93 million. This updated guidance reflects catastrophe losses incurred in the first quarter and second quarter of approximately $4 million.
Chris Uchida, CFO
Thank you, Mac. Please note that during my portion, when referring to any per share figure, I am referring to per diluted common share as calculated using the treasury stock method. This methodology requires us to include common share equivalents such as outstanding stock options during profitable periods and exclude them in periods where we incur a net loss. As a reminder, beginning in the fourth quarter of 2022, we have modified our definition of adjusted net income, diluted adjusted EPS, and adjusted ROE to adjust for net realized and unrealized gains and losses. We have modified the current and prior period figures accordingly. For the second quarter of 2023, our net income was $17.6 million or $0.69 per share, compared to net income of $14.6 million or $0.57 per share for the same quarter last year. Our adjusted net income was $21.8 million or $0.86 per share, compared to adjusted net income of $22.4 million or $0.87 per share for the same quarter of 2022. Our second quarter adjusted underwriting income was $23.1 million, compared to $24.8 million last year. Our adjusted combined ratio was 72.2% for the second quarter, compared to 69.1% in the second quarter of 2022. For the second quarter of 2023, our annualized adjusted return on equity was 21.3%, compared to 23.7% for the same period last year. The second quarter adjusted return on equity is further validation of our ability to maintain topline growth with a predictable rate of return above our Palomar 2X target of 20%, even during a quarter with very active severe convective storms and in a historically hard reinsurance market. Gross written premiums for the second quarter were $274.3 million, an increase of 25.4% compared to the prior year second quarter. Excluding deemphasized and current run-off products, our written premium growth rate was 44% for the quarter. Net earned premiums for the second quarter were $83.1 million, an increase of 3.5% compared to the prior year second quarter. For the second quarter of 2023, our ratio of net earned premiums as a percentage of gross earned premiums was 34.3%, compared to 50.8% in the second quarter of 2022 and compared sequencially to 37% in the first quarter of 2023. These results reflect the expected decrease due to our growth of lines of business that use quota share reinsurance, including Fronting, and the increased cost of our excess of loss reinsurance. Losses and loss adjustment expenses for the second quarter were $17.9 million, including $2.2 million of catastrophe losses from severe convective storms during the quarter, slightly offset by favorable prior year catastrophe development. The loss ratio for the quarter was 21.5%, comprised of an attritional loss ratio of 18.9% and a catastrophe loss ratio of 2.6%. Based on our year-to-date loss ratio of 23.2%, we expect a loss ratio of 21% to 24% for the year, including the catastrophe loss from the first half of the year. The expected range excludes large catastrophe events in the second half of the year, but includes many catastrophes and aligns with how we provide our adjusted net income guidance. Our acquisition expense as a percentage of gross earned premium for the second quarter was 10.8%, compared to 18.1% in the second quarter last year and compared sequencially to 11.4% in the first quarter of 2023. Additional ceding commission and Fronting fees continue to drive the improvement. The ratio of other underwriting expenses, including adjustments to gross earned premiums for the second quarter, was 6.9%, compared to 8.5% in the second quarter last year and compared sequentially to 6.8% in the first quarter of 2023. Continued improvement compared to last year and in line with our go-forward sequential expectations as we invest in underwriting through people and operations. We continue to expect long-term scale in this ratio. Our net investment income for the second quarter was $5.5 million, an increase of 76.5% compared to the prior year’s second quarter. The year-over-year increase was primarily due to a higher average balance of investments held during the three months ended June 30, 2023, due to cash generated from operations and a mix shift of invested assets from lower yielding investment assets into higher yielding investment assets with a similar credit quality. Our yield in the second quarter was 3.61%, compared to 2.61% in the second quarter last year. The average yield on our investments made in the second quarter remains above 5%. Our commercial real estate exposure in our investment portfolio is minimal at less than 3% of our portfolio and does not include any direct loans. We continue to conservatively allocate our positions to asset classes that generate attractive risk-adjusted returns. During the quarter, we repurchased 166,482 shares of our stock for a total of $8.7 million under our two-year $100 million share repurchase program. As of the end of the quarter, we had $50 million of our authorized share repurchase remaining that we will continue to use opportunistically as we view our share price as undervalued. At the end of the quarter, our net written premium to equity ratio was 0.88 times to 1 times. We are well capitalized and have ample capital to support our Palomar 2X organic growth objectives and opportunistically buy back shares. As Mac mentioned, we are updating our 2023 adjusted net income guidance range to $89 million to $93 million, an increase from $88 million to $92 million. This range includes approximately $4 million of net catastrophe losses incurred during the first half of the year but does not include additional catastrophe losses for the remainder of the year. On a gross earned premium basis, we expect our net earned premium ratio and acquisition expense ratio to continue to decrease in the second half of 2023 from the levels reflected in our second quarter results. After our recent successful reinsurance placement, our net earned premium ratio should be at its lowest point in the third quarter, the first full quarter under the new reinsurance placement. Additionally, based on the current market, our effective tax rate for the year may remain elevated between 22% to 24%. Before opening the call for questions, I would like to note that Jon Christianson, President of Palomar, will be joining the question-and-answer session of this call.
Operator, Operator
Thank you. Our first question is from Tracy Benguigui from Barclays. Your line is now live.
Tracy Benguigui, Analyst
Thank you. Good morning or good afternoon. Your attritional loss ratio of 18.9% was below your guide of 22% to 24% for 2023. Could you unpack that a little bit?
Chris Uchida, CFO
Yeah. Thanks, Tracy. That’s a good question. When we look at our loss ratio for the quarter, obviously, we are happy with the results. The overall loss ratio was 21.5%. If you put back in the prior period development, that loss ratio moves up a little bit to 22.3% for the quarter, which I would say is in the low range of the guidepost we gave out of 22% to 24%. Mini cats for us were elevated this quarter, causing us to put those losses or severity and magnitude of those events caused us to put some of those losses into catastrophes. As you saw that loss ratio for the quarter being about 2.6%. Overall, we feel good about those results. The loss ratio was a little bit better. I think mini cats were a little bit higher, causing the loss ratio probably to be about 1.6 points higher than we would have expected. So still better than expected. But overall, everything is in line with how we feel about the year. I think the one thing you will notice on the prepared remarks, we did call a decrease in the bottom of the range for the full year. We went from 21% to 24%, reflecting what we have seen in the first half of the year, but still expecting those loss ratios to improve in the latter half of the year and then into Q1 next year.
Mac Armstrong, CEO
Tracy, this is Mac. I believe pricing is playing a role here, along with our focused efforts to reduce certain segments of our portfolio. One of your main interests was in our growth. We experienced a 44% increase in the areas where we are making investments, which we are very pleased about. A benefit of decreasing some of these lines, such as All Risk, is that it helps improve the loss ratio. In the second quarter, All Risk, which saw a nearly 40% decline year-over-year, still had $1 million in catastrophe losses and has a higher attritional loss ratio compared to the 21% average we report. A key reason for winding down these volatile books is their higher loss ratios. This is a significant factor in this quarter's loss ratio and supports our expectation, which Chris has stated, that we anticipate a gradual decline throughout this year and into 2024.
Tracy Benguigui, Analyst
Okay. My next question, I’d like to talk about the durability of your Fronting program in light of higher reinsurance costs and increased market concern about reinsurance counterparty risk, particularly on collateral?
Mac Armstrong, CEO
I'm happy to answer that, Tracy. It's a relevant and insightful question. We are experiencing strong growth from our targeted Fronting partners. As I mentioned earlier, we have seven of them. We adopt a focused approach, allowing us to manage these partners closely and collaboratively, akin to an underwriting relationship. This segment is seeing significant growth, but the percentage of premium it constitutes differs from our adjusted net income. It represents a strong segment for us, enabling us to be disciplined and selective in choosing new partners. Despite the ongoing challenges in the broader Fronting market, particularly with Vesttoo, our exposure is minimal. We've addressed this situation promptly and have a clear understanding of our exposure and remedies, which are multiple. We continue to monitor how we manage these programs and the overall market dynamics. Additionally, our reinsurance programs for Fronting partners have been renewed with increased capacity and consistent support in the second quarter, and we successfully renewed one at the start of the third quarter as well. While there may be consequences, we believe this will be net positive for us because we are fundamentally an underwriting organization. We're already seeing submissions from MGAs seeking new Fronting partners and are pursuing more reliable options. Additionally, we've noticed an uptick in submissions for certain Casualty lines from MGA renewals that present potential collateral exposure. Overall, we remain committed to our Fronting strategy, and if anything, our blended and targeted strategy is reinforced, further validating our model as an underwriting organization.
Tracy Benguigui, Analyst
Thank you.
Operator, Operator
Thank you. Next question today is coming from Mark Hughes from Truist Securities. Your line is now live.
Mark Hughes, Analyst
Yeah. Thank you. Good afternoon. The earned premium, you alluded to the topline growth. You certainly were influenced this quarter by the run-off and deemphasized lines. What should the earned premium growth be given kind of your mix of Fronting versus underwritten business? How should the earned premium trajectory be?
Mac Armstrong, CEO
Well, Chris can join in, Mark. This is Mac. What I want to emphasize is that if you look at the five segments we've discussed, we see strong and sustained growth in Earthquake, which is growing at 20%. That's a good benchmark for that line. When examining Casualty and Inland Marine, there's significant growth there as well. It's hard to predict whether Fronting will maintain a 90% growth rate, but we're pleased that there's embedded growth with most of our partners. Some are reaching their critical mass in steady state, but that works for us because we still have a nice ramp in earned premium. So, to summarize, while expecting growth to be 44% might be a bit optimistic, we believe it will continue to be strong, especially when considering key contributors like Inland Marine, Casualty, and Quake.
Chris Uchida, CFO
Yeah. And Mac talked about the topline growth of the written premium, obviously, that will influence how the gross earned premium grows. I talk about this a lot that with the change in the mix of business with a lot of Fronting and business that uses quota share and with the increased excess of loss costs that we will see for the first full quarter in Q3 that the net earned premium ratio will continue to decrease. It was 34% in the second quarter; it’s going to get into the low-30s for Q3 and potentially a little bit in Q4 as well. So I just want to make sure people think about that as they model it because the excess of loss reinsurance costs that we have talked about before was up about 30%, which is as expected as we modeled into our guidance. But I want to make sure people are thinking about that and modeling it correctly when they think about our net earned premium ratio and the results that we are going to see in the second half of the year. Q3 will be the lowest point of that, and then we will start to scale more as we continue to grow the business, but the excess of loss cost is flat and in place until 6/1 of 2024.
Mark Hughes, Analyst
When you look at the renewals that are coming up, you are describing about a 20-point differential between what would have been other than the deemphasized and run-off business. What’s going to be the marginal impact in Q3 and Q4? If it was 20 points in Q2, how much of these risk management adjustments going to impact the second half?
Mac Armstrong, CEO
I think it’s around the difference between 10 points to 14 points regarding the growth. Most of the specialty homeowners business will be out by the third quarter. The All Risk is spread out over the course of the year.
Mark Hughes, Analyst
Okay.
Mac Armstrong, CEO
So if you look at All Risk, what we are really trying to solve for is getting the PML down to $100 million and it’s basically there. At that level, we feel that it is a sustainable level where we can maintain a manageable reinsurance expense, it obviously was up meaningfully. And I think it’s one thing that I’d point out is if you look at the relative cost of all-peril and Wind Reinsurance versus Earthquake, it’s double. So we are focusing more of our cat dollars on earthquake. For Wind, we want to get it down to $100 million continental hurricane PML, and I think at that point we can justify our retention. It’s a $4 million AAL at that level and it has minimal severe convective storm exposure. So that means that there is an opportunity for us to take rate and optimize that book continues to grow, but that’s really not going to start until the first quarter of 2024.
Mark Hughes, Analyst
In the Commercial Quake business, we have seen better pricing; however, there has been a slight slowdown in top-line growth from very strong growth. Is there anything noteworthy in this regard?
Mac Armstrong, CEO
No. That market is growing at about 30% or 29% in the quarter. We need to be aware of how the reinsurance costs will impact the PML. Additionally, we want to ensure that we can secure the extra $550 million in reinsurance support to facilitate our growth. I can tell you that our metrics have never been better. The capacity in the market is decreasing, so we feel optimistic about maintaining robust growth in Commercial Earthquake. But Jon, do you have anything to add?
Jon Christianson, President
Yeah. No. I agree with all that. I think we have seen now many quarters in a row of that strong rate appreciation in the Commercial Earthquake segment, and as we look forward to the next few quarters, there’s no signs that would suggest that it would decelerate.
Mac Armstrong, CEO
Thanks, Mark.
Operator, Operator
Thank you. Next question is coming from David Motemaden from Evercore ISI. Your line is now live.
David Motemaden, Analyst
Hi. Thanks. Just a question on the Crop opportunity. It sounds like you think that will start coming in, in the third quarter. I guess how big do you think that has the potential to be as another growth lever that we haven’t really seen here in the first half and then how should we think about the profitability profile of that business versus your existing business?
Mac Armstrong, CEO
Dave, yeah, this is Mac. And again, I will let Jon speak to this. I think there are a few things that I would want to get across to you is, for this year, it’s really a startup. We will generate some premium in the third quarter and in the second half of the year, but it’s more fronted, so it’s really going to be a fee generation product. For 2024, we think it can be a meaningful premium. It’s a $20 billion market. We are one of 13 approved insurance providers, we have terrific in-house expertise and a terrific distribution partner in Advanced AgProtection. So we are optimistic that it can become a large contributor to premium in due time, but in 2024, it has a chance to be high double-digit millions of premium.
Jon Christianson, President
Yeah. And with regard to the profitability aspect of the question, it is a historically profitable line, and importantly, it’s not correlated with our existing core lines and it has a short tail and a combined exposure period with strong reinsurance support back in it. So, from a profitability standpoint, we feel it folds in nicely with the other lines of business that we have.
Mac Armstrong, CEO
I think I should mention that next year, we expect to take on some risk, but conservatively, we are talking about a 10% participation. This will allow us to maintain a balance of fee and underwriting income like we have done with our new products. We will stick to this strategy, which means a solid stream of fee income alongside a good component of underwriting income. In that year, it may result in an 8% to 10% margin.
David Motemaden, Analyst
Got it. Understood. That’s helpful. Regarding Vesttoo, the one counterparty where you have exposure, is that something that seems immaterial in size? Did you just absorb what you had reinsured, or did you replace the letter of credit in question?
Mac Armstrong, CEO
We are reviewing a previous treaty period that has ended and assessing what is held in trust and our potential exposure if we exceed that trust. Our exposure would come from anything beyond the trust, which we fully control, and it is not significant. Currently, Vesttoo is not a concern; they do not function as a reinsurer.
David Motemaden, Analyst
Got it. Thanks. Finally, it seems that capacity has not been a concern for the seven existing programs, but I am curious about the potential growth in adding new program partners. Have you noticed any slowdown in discussions with capacity providers? It appears that MGAs are interested in partnering with you, but are you able to secure the necessary capacity for new partners?
Mac Armstrong, CEO
No. I mean I think for us, we have had successful reinsurance renewals. We are being very selective in talking to potential new Fronting partners. Ultimately, we view these Fronting partners as people that we are going to take a risk on at some point in time. So we hold them to a different standard than maybe other markets do. As a result, we are getting a lot of inbounds. We expect that we will add to them in time, but it’s going to be a very deliberate addition. But I would say, regarding what’s been in the press the last week or a few weeks, we are seeing a lot more inbounds, but selectivity has not changed, if not increased.
David Motemaden, Analyst
Yeah. Understood. Thank you.
Mac Armstrong, CEO
Thanks, Dave.
Operator, Operator
Thank you. Our next question is coming from Andrew Andersen from Jefferies. Your line is now live.
Andrew Andersen, Analyst
Hey. Good afternoon. Just with regards to the Fronting program, Mac, I am not sure if I heard you mention cyber, but it seems from like industry pricing surveys, it’s kind of softening a bit. Can you just kind of talk about the appetite there for the Fronting program with regards to cyber?
Mac Armstrong, CEO
Sure, Andrew. Yeah. Cyber is one of our large partners in the Fronting arena, and that was the renewal that I referred to that was early third quarter, it’s 7/1. So that was successfully placed with great capacity support. We had taken modest risk participation there over the last two years. Yeah, we are watching the pricing. I think for that program, it’s one that we really do view as we are the underwriter here. And so while it’s only a low mid-single digits participation, we manage it like something that we are taking 30%, 40%, 50% of. So on the whole, rates are certainly down from where they were two years, three years ago, but we feel good about the performance. We feel great about the reinsurance support. They got the ability to grow from a revenue perspective or from a premium perspective, so the premium capital has increased. So on the whole, I think, it’s a line of business that is performing well. It certainly requires increasing diligence, because of the market conditions, but it’s a great partnership.
Andrew Andersen, Analyst
Okay. And on the Casualty business, you mentioned an uptick in submissions there. Should we really just think of that as some of the real estate E&O, or is it perhaps some different lines, and can you remind us if that’s going to largely be on the E&S entity, which looked like the growth was a little bit slower in this quarter?
Mac Armstrong, CEO
We are pleased with the growth in the Casualty sector, reaching 92%, which is now nearly 4% of our total book. However, we are being intentional about our approach. Most of this growth is coming from our E&S company, although we have some general liability business in our admitted company that focuses on small to mid-market commercial contractors with annual revenues between $5 million and $20 million, primarily in low and moderate hazard areas, such as those building schools. We aim to avoid higher severity classes on the admitted side. In our professional lines, which are mostly E&S, we are seeing solid and intentional growth in targeted niches, including real estate E&O. Recently, we onboarded some underwriters who have been ramping up their efforts, and we are beginning to see them utilize their expertise and distribution connections. For instance, Gerrit VandeKemp, who leads our professional lines, discussed a new collection agency program that one of our underwriters is starting to develop, which has significant potential to enhance our E&O franchise in a focused manner. Our goal is to maintain this deliberate strategy in reaching and distributing our offerings, which we believe will result in a growing, profitable, and predictable book.
Andrew Andersen, Analyst
Great. Thank you.
Mac Armstrong, CEO
Thank you.
Operator, Operator
Thank you. Next question today is coming from Pablo Singzon from JPMorgan. Your line is now live.
Pablo Singzon, Analyst
Hi. Thank you. So my first question is on guidance. You increased it twice over the past several months. I was hoping you could impact those changes a bit here. To what extent was the updated guidance based on your first half performance and to what extent is the reflection of what you think will happen in the second half of the year?
Mac Armstrong, CEO
It's a combination of the two. It's a great question, and I appreciate you asking it. I would say the first increase in guidance was possibly a bit delayed from Q1, as we wanted to assess how reinsurance pricing turned out, which informed the adjustment we made in June. Following Q2, we raised guidance again to account for the results in the first quarter and our expectations for the second half of the year. Chris noted that he has lowered the loss ratio range, which plays a part in this decision. Additionally, the business we've been operating has had its challenges; some aspects were unprofitable, and given the reinsurance impact on our Wind business, it would have been unprofitable going forward if we had evaluated it at that time. So, in short, it's a mix of both factors, but we believe there is strong momentum in the business, and our focus is on staying competitive.
Pablo Singzon, Analyst
Okay. And then second question maybe for Chris. I heard what you said about expense ratios going down on a gross basis, right? But if you look at the expense ratio against net earned premiums, I think this is the first quarter over the past four or five where it actually went up year-over-year and that’s probably more a function of net earned going down. Do you see that trend persisting through the second half because of what you described, right, essentially the reinsurance costs kicking in, will that essentially inflate the expense ratio on a net earned basis as well for the second half of the year?
Chris Uchida, CFO
You made a good point, Pablo. When considering the expense ratio and the loss ratio on a net earned basis, both are significantly affected by the excess of loss. I believe that the combined ratio fails to accurately reflect these ratios when there is a significant excess of loss, such as we are experiencing. The increase in the excess of loss load by nearly 30% will affect this without necessarily changing the expense or loss ratios overall. This is why we prefer to evaluate it on a gross basis, which simplifies modeling. I expect the acquisition expense ratio to continue decreasing due to changes in mix, like Fronting, while expenses will remain relatively flat. Overall, it seems everything is moving in a positive direction. When examining our performance on a gross basis, it eliminates the distractions caused by the excess of loss. That's the reason we discuss the gross earned premium ratio separately, allowing you to consider the impact of excess loss, which we anticipate will decrease from 34 to the low 30s in the latter half of the year. You are correct that the modeling impact from these ratios this quarter is affected by the excess of loss costs, which are expected to be higher in Q3 as this will be the first complete quarter reflecting that cost.
Pablo Singzon, Analyst
Okay.
Mac Armstrong, CEO
I want to add that we brought on many talented underwriters and claims professionals in the second quarter. They will help us generate returns, whether through increased revenue or improved profitability via cost containment and loss management, but this will take some time. As a result, we incurred costs that should yield returns, especially in 2024.
Pablo Singzon, Analyst
Okay. And then last question for you, Mac. I heard your comments about disruption in the California market potentially being an opportunity for you to grow your Earthquake business. Given the current situation and the level of disruption, is there a risk that the market could become overly disrupted, leading to a decrease in the demand for Earthquake insurance? I'm considering scenarios like people withdrawing from the market and more providers competing for fewer clients. If the disruption reaches that level, would that still be beneficial for your Earthquake business?
Mac Armstrong, CEO
Yeah. Pablo, and I will let Jon Christianson share his insights as well. The disruption in the Earthquake market, particularly the homeowners market, continues to be advantageous for our business, whether it involves non-renewing policies with an Earthquake endorsement or standalone policies. We have the opportunity to compete in that space. With the CEA raising their deductibles to 15% on coverage over $1 million or reducing the amount of personal property coverage, these factors create favorable conditions for us. I don't believe we have reached a critical tipping point. Instead, this seems to be a gradual change in the California market from which we will benefit.
Jon Christianson, President
Yeah. And I’d add with the disruption that we have seen to date in that homeowners market in California, it has not translated into anything unusual with our Residential Earthquake book. Our book has been very predictable, and our partnerships remain very strong in the State of California. So we have not seen anything that would indicate a disruption to a very predictable and profitable line of business for us.
Pablo Singzon, Analyst
Okay. And even with the homeowners pricing going up double digits, it seems like from what you are saying there’s still appetite for Earthquake insurance as a rider to the basic homeowners product, is that fair?
Mac Armstrong, CEO
That’s fair. Yeah. I mean, again, our buyers tend to be mass affluent that have a lot of equity value in their home, so they are protecting an asset. We have not seen people reduce coverage. We offer multiple deductible options that hasn’t deviated where they move their deductible up to manage the expense. So we look at that, but if you look at just A, the continued growth, 20% in Residential Quake, but also the increasing take-up in E&S, which frankly, on E&S, whereas EQ policy costs more on a per dollar basis or per dollar reinsurance basis than in the admitted side, I think that’s a reflection of the appetite.
Operator, Operator
Thank you. We reached the end of our question-and-answer session. I’d like to turn the floor back over to Mac Armstrong for any further closing comments.
Mac Armstrong, CEO
All right. Thank you very much, Operator, and thanks to all who joined this morning. We appreciate your participation, certainly, your questions, and as well most of all your continued support. As always, I want to thank the great team here at Palomar for their diligent work and all that we accomplished this quarter and all the work that was done to further expand the franchise in the new specialty segments and further extend the Palomar 2X strategy. Our earnings targets are being raised, and we will look to continue to do this. But I think what we have in front of us is really exciting, and we are going to continue to build an industry-leading franchise. So thanks very much and speak to you next quarter.
Operator, Operator
Thank you. That does conclude today’s teleconference. You may disconnect your line at this time and have a wonderful day. We thank you for your participation today.