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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good afternoon, ladies and gentlemen, and welcome to the Palomar Holdings, Inc. First Quarter 2019 Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded.
I'd now like to turn the conference over to your host, Mr. Chris Uchida, Chief Financial Officer. Thank you. You may begin
Thank you, operator, and good afternoon, everyone. We appreciate your participation on our first quarter 2019 earnings call. With me here today is Mac Armstrong, our Chief Executive Officer and Founder.
As a reminder, the telephonic replay of this call will be available on the Investors section of our website through 11:59 p.m. Eastern Time on May 23, 2019.
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 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 the Form 10-Q that will be filed with the Securities and Exchange Commission on May 17, 2019. 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 a substitute for results prepared in accordance with U.S. GAAP. A reconciliation of these non-GAAP measures to the most comparable GAAP measures can be found in our earnings release.
At this point, I'll turn it -- turn the call over to Mac.
Thank you, Chris, and good afternoon, everyone. Before I get started, I would like to take a moment to thank all of those people who helped us through our initial public offering, which culminated in our first day of trading on the NASDAQ stock market on April 17, 2019. The hard work of our employees and advisers and the loyal support of our customers and partners contributed to the success of our offering. And as a result, we were able to raise approximately $87 million in net proceeds to support the strategic plan of the company. This capital infusion will allow Palomar to take full advantage of the numerous growth opportunities, including geographic expansion of our specialty property product footprint, entry into new specialty lines of insurance and stroke-of-the-pen measures, such as increasing our participation in selected existing lines of business. We see considerable whitespace for expansion and are excited by the opportunity that lies ahead.
Turning to today's call, I would like to provide a brief overview of our company and our growth strategy for those investors who were unable to hear our story during the IPO road show. I will then briefly review the highlights of our first quarter performance before handing the call over to Chris for a more detailed discussion of our results. From there, we will open the call for your questions.
To start, we founded Palomar in 2014 because we saw a unique opportunity to write profitable business in several speciality property insurance markets, including residential and commercial earthquake, Commercial All Risk and Hawaiian Hurricane. We believe that these markets were largely underserved, with few direct competitors focused exclusively on specialty property risk. In many instances, these incumbents were mispricing the risk and limiting the coverage available to insurers. As a result, we strongly believe that we would develop products to better meet the specific needs of both commercial and residential insurers and once we rolled out these products, we'd ultimately capture substantial market share.
To take advantage of this opportunity, we invested significant time and resources, both human and systems, in developing an analytically driven product framework that creates innovative and unique product offerings. We are licensed as an admitted insurer in all 25 states where we operate, allowing us to provide our customers the certainty of admitted insurance products, typically in the form of a state-guaranteed fund backstop, and to eliminate certain administrative requirements of our distribution producers. In addition, we offer specialty property products with flexible features, broad pricing capability and coverages that are not typical of standard products, but rather the E&S market.
By offering our customers the ability to choose deductibles and other à la carte coverage options, we believe we have created products that are attractive to not only those customers who have existing policies with our competitors, but also for those customers who have not historically bought insurance in our focus markets, most notably California earthquake, where we are currently the fifth-largest writer of business in the state. Importantly, our specialty property products have a strong competitive moat as they have been approved by individual state regulators and are supported by proprietary data analytics and pricing models.
We employ a highly granular and analytically driven underwriting process to assess and price each risk that we write. As part of our process, we have developed sophisticated, proprietary modeling tools that utilize extensive geospatial and actuarial data, enabling automated pricing of risk at the geocode location or ZIP Code level. As an example, our 2016 Residential Earthquake rate and policy form filing with the Washington state Department of Insurance had over 20,000 distinct pricing zones that take into account nuance regional differences in soil types, liquefaction potential and distance from known faults. In contrast, most competing earthquake insurance rate filings in Washington are based on broad territorial pricing zones that ignore the aforementioned earthquake risk characteristics. We believe our analytically driven underwriting process, combined with the decades of specialty property underwriting experience embedded within our management team, provide better oversight of our exposure and, ultimately, a competitive advantage. This competitive advantage should result in attractive underwriting margins and superior risk-adjusted returns for our shareholders as we continue to scale our business.
As we have our refined our product framework and underwriting process, we have made substantial progress diversifying our business by product, market and geography. As we launch new products, we look to borrow certain attributes of existing products, illustratively granular pricing, flexible coverage, distribution network or systems. In 2014, our first year of operation, all of our premiums related to earthquake insurance. For the year ended December 31, 2018, 67% of our gross written premiums were related to earthquake insurance. Additionally, we have looked to build a balanced portfolio of commercial and residential business to insulate us from shifting dynamics in the insurance market. At year-end 2018, 77% of our gross written premiums were attributable to residential business, and 23% of our gross written premiums were attributable to commercial business.
As our book of business grows and continues to diversify, we further use data analytics to manage risk at a portfolio level and inform our risk transfer strategy. Our risk transfer strategy is premised around 3 concepts: one, capping the loss potential from a major event; two, minimizing earnings volatility; and three, positioning the company to capitalize on post-event demand for our products.
To manage our exposure to catastrophe events, we utilize several risk mitigation strategies, most notably treaty and facultative reinsurance. Our reinsurance program enhances our business by reducing our exposure to potential catastrophe and shock losses, as well as reducing volatility in our underwriting performance, as we only retain $5 million of risk per catastrophic event. Importantly, our use of reinsurance not only provides loss protection, but also superior visibility into earnings.
Another critical component to our success in the market is our proprietary technology platform. One benefit of being a newly formed insurance company is the ability to build an operating platform that incorporates state-of-the-art technology and best practices derived from our team's extensive experience. Our technology philosophy is premised around providing ease of use to our distribution partners, portfolio management integration, knowing our risk as well, as scalability. Our internally developed Palomar Automated Submission System, known as PASS, acts as the point of sale interface for our products, enabling our distribution partners to rapidly quote and bind policies via automated processing. Of note, several of our products enable our distribution partners to quote, bind and issue policy in less than 1 minute. Our systems also permit us to run detailed portfolio analytics for internal and external constituents, including distribution partners, carrier partners and reinsurers. We believe that this real-time access to data and analytics offer advantages in distributing our products, managing our risk and purchasing reinsurance.
Importantly, we also pre-underwrite several of our products into our policy administration system, which allows us to minimize underwriting errors and scale these lines of business. Our technology platform has been a key factor in expanding our distribution network and, moreover, growing the company.
Our differentiated products and easy-to-use systems combine to generate high satisfaction from our producers and policyholders. This is demonstrated by our strong policy renewal rates, which offer visibility into future revenue. In 2018, our lines of business experienced average monthly premium retention of 84%, with our largest line, Residential Earthquake, above 93% and Hawaiian Hurricane line at 100%.
Looking forward, our growth strategy is to diversify our book of business by extending our geographic reach, broadening our distribution plan and expanding our product portfolio. Today, we are licensed in 25 states, with California and Texas representing our largest exposures of 56% and 19% of our gross written premiums, respectively, at quarter end. We also have applications for certificates of authority submitted in 3 states and have notable new geographic expansion initiatives underway, including the expansion of our specialty homeowners and flood products into several new states.
Our first quarter results provide further evidence of the successful execution of our growth strategy and the competitive advantages that Palomar possesses. During the first quarter, our gross written premiums grew approximately 59% year-over-year. This strong performance was paced by our Residential Earthquake products, which grew approximately 75% during the quarter, as well as our Commercial All Risk products, which grew approximately 158% for the same period. Other strong performing products included our Hawaii Hurricane, Flood and Commercial Earthquake lines.
One particular driver of growth in the first quarter was the continued success of our carrier partnership strategy. We work with over 20 other insurance companies who select Palomar to provide specialty property insurance products to their customer base. In the first quarter, we consummated a new partnership with a homeowners' carrier, whereby Palomar assumes a diversified book of residential earthquake business that fit our underwriting criteria via an assumed reinsurance agreement. The partnership added approximately $6.6 million of in-force premium in the first quarter.
Additionally, during the quarter, like others in the market, we saw an improving pricing environment in the commercial line segment of our business. On the whole, our average commercial account increased approximately 5% of renewal in the first quarter, thought it varied by product, geography and whether the account was loss affected. This healthy pricing environment translated into sequential improvement in our monthly premium retention for the commercial lines and the book of business on the whole.
Our Commercial Earthquake product saw average monthly premium retention of 80% in the first quarter, compared to 74% for full year 2018, and Commercial All Risk was 92% in the first quarter, compared to 81% in 2018. Average monthly premium retention in the first quarter across all lines of business was 86%, compared to 84% in 2018.
During the first quarter, we also made 2 strategic hires. As previously announced, we hired Robert Beyerle as Senior Vice President of Underwriting. Robert spent the last 16 years at Great American Insurance Group, most recently as Divisional Senior Vice President of company's property Inland Marine division. Robert is leading Palomar's new Inland Marine department, and his first product is a builder's risk program that we expect to have live in the second quarter. It will provide a new source of commercial lines growth and diversification, while at the same time, leveraging existing Palomar infrastructure.
The second key addition to our team, Jon Knutzen, joined Palomar as our new Chief Risk Officer subsequent to quarter end. Jon joined us from TigerRisk, where he was a partner, leading the firm's property specialty and reinsurance solutions practice. Jon will wear multiple hats for Palomar in his role as Chief Risk Officer, including contributions to the data analytics team and refining our assumed reinsurance strategy. The addition of both Robert and Jon further reinforce Palomar's commitment to growing our commercial specialty lines of business in a disciplined and analytics-informed fashion.
Lastly, we continue to generate high returns, as our business model is benefiting from scale. While the first quarter will show we generate an annualized return on equity of a negative 58.2%, that is primarily a function of the $23 million noncash, stock-based compensation charge that we incurred in the quarter related to our IPO. When adjusting for this onetime expense, we delivered an annualized first quarter adjusted ROE of 35.7%, which compares to an annualized 27.7% ROE for the first quarter of 2018.
Our results are a testament to our high-retention differentiated products, thoughtful risk transfer strategy, and our commitment to predictable earnings.
I would now like to turn the call over to Chris for a more detailed review of our financial results.
Thank you, Mac. During my portion we'll be referring to the per-share figure, I'm referring to per diluted common share, unless otherwise specifically noted. For the first quarter of 2019, our net loss was $14.4 million or a loss of $0.85 per share as compared to net income of $5.6 million or $0.33 per share for the same quarter in 2018.
For the first quarter of 2019, our adjusted net income was $8.8 million or $0.52 per share as compared to net income of $5.6 million or $0.33 per share for the same quarter of 2018. First quarter 2019 adjusted net income excludes the $23 million stock compensation charges that were incurred related to the IPO, as Mac discussed, plus other minor onetime items, including the tax effect of those items.
Our diluted book value per share at the end for the quarter was $5.99, which was an increase of $0.33 per share from December 31, 2018, and an increase of $1.11 per share from March 31, 2018. Our diluted tangible book value per share at the end of the first quarter was $5.95, which was an increase of $0.33 per share from December 31, 2018, and an increase of $1.11 per share from March 31, 2018.
Gross written premium for the first quarter were $54 million, representing an increase of 58.8%, as compared to the prior year's first quarter. This growth was driven by new business across multiple lines, strong policy retention rates and continued geographic expansion, as we are now an admitted insurance carrier in 25 states across the country. As Mac previously mentioned, our increase in gross written premiums was largely driven by the strong performance of our Residential Earthquake product, Commercial All Risk products, Specialty Homeowners products and the addition of new partnerships.
Ceded written premiums for the first quarter were $26.1 million, representing an increase of 89.7%, as compared to the prior year's first quarter. The increase in ceded written premiums was primarily due to increased ceding of written premium related to our Specialty Homeowners operations in the state of Texas. Ceded written premiums related to excess of loss reinsurance also increased based on higher exposure from the growth of our overall portfolio for the respective period.
Net earned premiums for the first quarter were $18.4 million, an increase of 2%, compared to the prior year's first quarter, due to the growth in earning of higher gross written premium, offset by the growth in earning of higher ceded written premiums.
Commission and other income for the first quarter was $586,000, an increase of 8.5%, compared to the prior year's first quarter, as we expanded our fee-related activities of underwriting on behalf of third-party capacity.
Our expense ratio for the first quarter of 2019 was 192.1%, compared to 61.5% at the end of the first quarter of 2018. The year-over-year increase is largely due to the stock compensation charges and onetime expenses related to our IPO, as Mac discussed. On an adjusted basis, our expense ratio reflected significant expenses related to building out our team and systems to capture the market opportunity in front of us, but track more in line with our historical average, at 65%.
We continue to believe our business will scale over the long term. The combined ratio from the first quarter was 193.8%, and compares to a combined ratio of 66.7% for the prior year's first quarter. The adjusted combined ratio, which we believe is a better assessment of our efforts during the quarter, was 66.7%, flat compared to the prior year's first quarter.
Losses and loss adjustment expenses incurred in the first quarter were $316,000, a decrease of 66.3%, compared to the prior year's first quarter. The decrease was driven by lower losses for the quarter, including modest prior year loss development compared to the amounts recorded through the end of 2018. The decrease in the loss ratio was driven by the improvement in the attritional losses for the period, including the transition of our Texas homeowners program to a fronting arrangement during the second quarter of 2018. As of the first of this year, we retained approximately $5 million of risk per cat event and have $850 million of per-event coverage in place. We continue to emphasize a conservative risk transfer strategy oriented toward limiting our exposure in the event of a major catastrophe and reducing volatility in earnings. Furthermore, we protect our balance sheet in order to capitalize on post-event market demand and dislocation.
Net investment income for the quarter was $1 million, an increase of 55.6%, compared to the prior year's first quarter. The increase was largely due to a higher average balance of investments during the first quarter of 2019. Importantly, we take a conservative approach as our funds are generally invested in high-quality securities, including government agency securities, asset and mortgage-backed securities and municipal and corporate bonds, which have an average credit quality of AA. The weighted average duration of our fixed maturity investment portfolio, including cash equivalents, was 3.9 years at quarter end and 3.9 years at December 31, 2018.
Cash and investment assets totaled $159.2 million at quarter end as compared to $156.9 million at December 31, 2018.
Effective January 1, 2018, the company adopted a new accounting standard, which prescribes several changes, including eliminating the available-for-sale classification of equity investments and requiring changes in unrealized gains and losses and the fair value of equity investments to be recognized in net income. For the first quarter, the company recognized realized and unrealized gain on investments in the consolidated statement of income of $2.4 million. The majority of the gains was monetized during the quarter through the sale of equity index fund and a rotation into index funds that invest solely in corporate debt and fixed income securities. At quarter end, we have no exposure to the traditional equity markets.
The effective tax rate for the 3 months ended March 31, 2019, was negative 1% and negative 0.1% for the comparable quarter -- for the 2018 comparable quarter. For the quarter ended March 31, 2019, the income tax expense increased $151,000 due to positive tax law income during the quarter that was partially offset by the benefit from the reduction of a valuation allowance on our deferred tax assets.
Following the completion of our IPO in mid-April, we had a total of 23,468,750 shares of common stock outstanding. Stockholders' equity was $101.9 million at March 31, 2019, compared to $96.3 million at December 31, 2018.
For the first quarter of 2019, annualized return on equity was a negative 58.2%, which compares to 27.7% for the prior year's first quarter. However, over the same period, annualized adjusted return on equity increased to 35.7% from 27.7%. The increase in the annualized adjustment return on equity was due to improvements in underwriting performance and higher returns on the investment portfolio.
And now I'd like to turn the call back to Mac for concluding comments.
Thank you, Chris. To include, we used an analytically driven framework that results in differentiated products and, ultimately, superior underwriting. This framework has enabled Palomar to rapidly grow premiums, capture market share, and, importantly, put us in position to scale the business. Our strategy is best validated by the strong market acceptance of our products in the associated 75% compound annual growth rate in gross written premium from 2014 through 2018. The first quarter further exemplified this dynamic, with gross written premium of approximately 59% year-over-year. Additionally, our analytically driven underwriting and risk transfer strategy helped drive our performance this past quarter. We believe it will continue to limit downside risk and provide strong visibility into future earnings growth going forward. Our team sees numerous opportunities for profitable growth and are excited by our future prospects.
With that, I'd like to ask the operator to open up the line for any questions. Thank you. Operator?
[Operator Instructions] Our first question here is from Mark Hughes from SunTrust.
Yes. Question on the other expenses, and, Chris, you might have touched on this. You clearly did very well at the top line. I think your other underwriting expenses were pretty similar to what you had discussed at the time of the IPO. If you continue to outperform at the top line, do you think the absolute level of expenses will kind of hold steady with what you thought previously? Or should we see some lift if you do get that faster top line growth?
Hey, Mark. Yes. This is Chris. No. That's a great question. When we look at our other operating expenses, obviously when you look at the quarter, there are 2 main things in that, that we need to back out. We need to back out the stock compensation expense and then also some of those onetime expenses related to the tax restructuring for the IPO. With that, I would say that we do expect the business to scale over time. We think that we've invested a lot in these systems and the people, and we think that those operating expenses, from a pure dollar standpoint, will definitely flatten out, definitely in comparison to the top line growth that we are seeing. So we're not giving specific guidance on where those numbers are going to go, but we definitely feel that we've built a business that's going to continue to scale over the long term.
Yes. Mark, this is Mac, and I would just add a little more color to what Chris has said, just maybe an -- better said, an anecdote. For instance, we brought on Robert Beyerle to lead our Inland Marine department, and he generated no written premium in the first quarter. He was really focusing on developing rates, developing products and investing in system infrastructure. So we're going to start to get a return, not just on the fixed cost, but they are also -- we've also made investments in revenue or premium generative items, too.
Understood. On the Commercial All Risk, that was a strong contributor to growth, is there some seasonality to that business and how much more momentum do you think you have? Where are we in terms of your kind of rollout on the Commercial All Risk?
Yes. Mark, this is Mac. That's a great question. Yes. We were very pleased with how that line of business performed. As Chris highlighted, it grew in excess of 150%. And I think it's good to just provide a little backdrop on what's driving that growth. As you may recall, in the end of the third quarter, we entered into a new partnership where we had 2 quota share reinsurers supporting us and taking 60% of the risk on. So the first quarter really reflected us being in the market broadly with those 2 quota share participants, Swiss Re and Ren Re, that offered us the ability to write larger limits, but not change our risk profile. So the first quarter kind of is emblematic of where we think the program kind of is and has the potential to even grow beyond as we broaden the distribution footprint and benefit from a higher financial size category post the IPO. So we're -- I don't think there's much seasonality that's driving it. I think it's really just reaping the benefit of the broader limit that we can put in the market as well as the broader distribution -- the bigger limit, rather, and the broader distribution.
And then a final quick one. On the investment gains, was the tax rate on that similar kind of flat, negative 1%? Or was there a different tax rate you might think about for the gains?
No. For those gains -- Mark, this is Chris again. Yes. We would say that the tax rate for the quarter reflects a couple of things. It reflects the release of the valuation allowance. The overall growth that we have in the first quarter allowed us to release the federal deferred tax asset valuation allowance. So that is obviously driving that rate down. We also have the stock compensation in there, so that's another big driver of the change in the rate. I would say that everything else on the book is probably averaging about 21% to 22% effective tax rate, if you back out those items. And there's a little more detail on that when you -- the full 10-Q comes out. We'll file it later today, but I don't think you guys will be able to see it until tomorrow.
Our next question here is from David Motemaden from Evercore.
Just was wondering if you have a view or what you guys are seeing in the reinsurance market because you have a few layers renewing on June 1. So just wondering what you're seeing in terms of rates on those -- on some of those treaties that are going to be renewing up here in the next few weeks.
Yes. Hey, Dave. This is Mac. Thanks for the question. I guess what I would tell you is we're not -- we can't offer perspective on what's going on right now in the market because we are in the midst of the market. We have 2 different kind of treaties renewing at 6/1. One is finalized. The other is near to finalization. And we would expect to issue an 8-K on the reinsurance placement once indeed it does come to completion.
What I would say is a good indicator in our eyes is to look to what happened at the 4/1 renewals, where you had a lot of loss-affected business and particularly in the Japanese market come up for renewal. And loss-affected business did see an increase, but non-loss-affected layers or lines of business were -- did not see much in the way of an increase, if maybe a modest one. And so I think that is a good indicator of what we would expect. I think it's worth reiterating, the majority of our program is very unique and distinct, and it's frankly non-loss impacted. So if you look at our -- what's up for renewal at 6/1, outside of our 10x of 5 layer, there is nothing that's been loss affected, and it's driven by Residential Earthquake and Hawaiian Hurricane. And again, we are really the only buyer of reinsurance that has prevailing -- which prevailing exposure is earthquake and Hawaiian Hurricane. So we feel 4/1 is a good indicator, and that's where I'd point you to for now, and we'll let you know as soon as it's wrapped up what we saw.
Okay. Great. And then there were a few severe weather events -- wind events in the Southeast U.S., Texas, Mississippi and Louisiana. Just wondering if you had any initial view in terms of any losses that you guys may have from those events.
Yes. David, this is Mac again. What I would tell you is nothing that's material at this point. It's -- and it's worth reiterating that in Texas, the majority of our book, we act as a front. So while there could have been hail damage in the residential segment of our book, we're really not on risk there because we do act as a front. But going back to it, the severe weather activity, we've been mindful of it. We've had claims, but nothing that's material.
And one thing I'd add is -- and Mac was talking about with the fronting arrangement that we put in place in Texas. You can see in the quarterly results that the losses for 2019 performed a lot better than the losses in 2018. I think if you even factor in the fact that in 2018, the first quarter loss results reflected a prior year benefit of about $1.5 million. So that Texas front and the reinsurance arrangements that we've put in place to minimize the volatility in earning really shows a lot more if you weigh that in. You're talking about a $300,000 number versus a number that's closer to $3.4 million with the $1.5 million added to it.
Okay. Great. And then just my last question. Just thinking about your rating at AM Best and just wondering, following the IPO, if you guys have any visibility in terms of when you think that might be changed at AM Best.
Hey, Dave. This is Mac. What I would say is we're focusing right now on the A- side -- 8 financial side category, so an A-8 rating. And that is really triggered by the size of your capital base in surplus. And so once the 10-Q is filed, we will have reached that threshold, which will put us in the A-8 rating.
As it relates to the long-term rating of the company, I think we want to continue to execute to put us in position for a change in outlook and then subsequently an upgrade in the rating. I think we'll try to get back to AM Best to walk them through the first half of the year's results in the summer and then go back for our annual review. But it's really the financial side category that's more germane to us, being able to write -- or opening up commercial distribution sources.
One quick correction. I said $3.4 million. It should be $2.4 million for the total losses in -- first quarter of 2018. Sorry about that.
Our next question here is from Jeff Schmitt from William Blair.
Question on the $8 million Residential Earthquake book that came over from a homeowner's carrier. Was that kind of a onetime thing? Or do you expect more premium from that relationship?
Hey, Jeff. It's Mac. Yes. That's a great question. I think that partnership, first and foremost, we were thrilled to bring that onto the books. We think it's a ringing endorsement of our partnership strategy. It's one that we had chased after for a long time, and it shows that people are coming to view us as a specialty property specialist, for lack of a better term.
But -- so embedded in the $8 million from that partnership is $6.5 million or $6.6 million of unearned premium that is onetime, but the delta in there is kind of recurring. And we believe that, that partnership, a good way to look at that is, if you take that unearned premium and double it, that's a good proxy for the recurring premium base associated with it.
And so -- and I think it's also worth pointing out that the Residential Earthquake business, it grew 74% in the first quarter. Even excluding the UEP pop, if you would, the unearned premium transfer pop, it grew 36%, so very healthy, organic same-store growth.
And are there other books that could come over from that relationship, I guess, what I meant more? Or is that just the book?
So that relationship is going through -- that is specifically a Residential Earthquake partnership. So that doubling the $6.6 million, that is kind of a good frame or reference for that specific partnership. We have partnerships with over 20 companies at this point. We continue to pursue incremental partnerships. It's been a great channel for us. We think it will remain a great channel. There are a lot more in our pipeline. They're very hard to handicap when they will come on because it is such a long sales cycle and then a long onboarding process. So there are multiples of them out there. We just don't predict when they come online.
Got it. Okay. And then looking at some of the smaller products, Hawaii Hurricane and Flood. Obviously, you're pretty early stage there. But do you expect to ramp those kind of like the Commercial All Risk? I mean, can they be ramped at that type of rate?
Yes. So this is Mac again, Jeff. So what I would tell you is the Hawaiian Hurricane grew approximately 38% quarter -- year-over-year, excuse me, in the first quarter. So we think that is a terrific growth rate. The one thing that will govern our ability to grow at the same risk -- rate as we did in the All Risk is just the size of that market, but we think we can continue to grow it at an attractive level.
The Flood, which grew in excess of 100% year-over-year in the first quarter, we think that one will continue to grow at a nice rate and could start -- the thing that we are excited about that product is you kind of have a bit of a regulatory option on it in the sense that we are growing that on a state-by-state basis, on an agent-by-agent basis, but there could be some type of a regulatory shift, which would allow great -- that would allow the NFIP to potentially re-underwrite its book, would allow greater options for banks who accept private market flood, and, particularly, Fannie and Freddie. So we like to view that as kind of a nice blocking-and-tackling product that's growing at a very nice rate, but has great upside potential if there is some type of regulatory change.
Okay. And then any update on new products in development, the Builder's Risk or Inland Marine?
Sure, Jeff. This is Mac again. What I would say the Builder's Risk and Inland Marine, we spent the first part of -- or the entirety of the first quarter working on rate filings, system development, distribution partnerships, building out a distribution network to then put us in a position where we think that we will write business in Q2. So we would expect the Builder's Risk to start to see some premium in the second quarter. And then Inland Marine, in particular, contractor's equipment and installation floaters and things of that sort, would follow from there. But we've got pretty good traction as it related to rate filings and state approvals and the like.
Our next question is from Meyer Shields from KBW.
Great. So 2 questions on acquisition expenses, if I can. The first is whether the unearned premium transfer or just the initiation of that relationship, does that involve any unusual level of acquisition expenses? And second, how should we think about that particular line item scaling or being affected by continued scale-up?
Yes. So I think the acquisition expense is, just specifically to that one partnership, the unearned premium transfer that comes on does have acquisition expense associated with it. For that, it is earned very similar to the premium. So let's call it a $1 of premium is earned, there's acquisition expense for a similar percentage of that to any other type of business. So whether it be -- if it's a 20% acquisition expense for a piece of business, that would be $20 of expense. It's earned pro rata, very similar to how that premium would be earned over time. So I wouldn't call it anything unusual or specific in nature that's going to cause a pop or a drop in acquisition expense. It should just be smooth as the earned premium is.
And Meyer, this is Mac. On the second question that you asked. I would say as we continue to grow the All Risk, that's going to help drive down the acquisition expense. You'll see in the 10-Q that the acquisition expense in the first quarter of '19 was 17.1% versus, I think, it was 23% in the first quarter of '18. That reflects the fact that we are getting ceding commissions from these quota share partners that we use as a contra expense to the acquisition expense. So that drive -- that will allow us to drive the acquisition expense down on a perspective basis as All Risk continues to grow and more of these quota share arrangements increases the percentage of the overall premium. And I think the other component is the acquisition expense on All Risk, as well as our Commercial Earthquake, can be a little bit lower. So as commercial business grows, we should see the acquisition expense tick down from that dynamic as well.
And the other big quota share that's in there is the Texas front. So this is -- or the first quarter 2019 compared to the first quarter 2018. That front was put in place in June -- on June 1 of 2018. So this is the first time you're seeing that show up. So that's also helping to drive the overall acquisition expense down as that includes the ceding commission from those quota share partners.
Okay. Fantastic. That's very helpful. And Chris, I didn't catch whether you disclosed the impact of prior period reserve developments on losses in the quarter?
We did not disclose that in the earnings release, but it will be in the Q. So the -- I can tell you that for 2019, it's a minimal increase in prior year reserves. I think it's about $38,000. But like I said earlier, really, if you look at comparing quarters, the 2018 quarter has about $1.5 million of beneficial development. So it's reduced by $1.5 million. So when you're comparing apples-to-apples, you can really see how well 2019 -- or how good 2019 looks compared to 2018, with those quota shares in place and minimizing the overall net losses that we have to recognize on our books.
Yes. This is Mac. The good thing about it being $38,000, we can tell you through the claims which one they were, and they were a handful. So it's a pretty modest amount, like Chris said.
Our next question is from Sue Lee from Barclays.
So how would you see your business mix and catastrophe exposure as well kind of evolving over time as you guys add these new products and expand into other states?
Sue, this is Mac. Yes, that's a good question. We continue to look at diversification as a sound strategy for several purposes: one, inflating us from swings in the broader insurance market; two, not being overly concentrated in a specific region or a product. So we're going to want to continue to espouse that philosophy.
I think kind of directionally, we've always said we want a balance of Commercial and Residential business. I'd like to see our Commercial business, especially with the current pricing environment, increase as a percentage of the total book of business. And I would expect that to happen, especially on the heels of us reaching a new financial size category, and rolling out new products like Builder's Risk and Inland Marine. So I'd like to see Commercial business increase as a percentage. Similarly, I think if we continue to look at other geographies, be it outside of California, and California is approximately, I think, 53% or so of our total business. We wouldn't mind seeing that come down. But at the same time, we love the fact that that's really Residential Earthquake. It's our bellwether programs or products, and we have a ton of conviction on what we're doing in that segment. But I'd like to see us diversify and California come down as a percentage of total business over the long term.
Great. And then would you guys envision any sort of change to your reinsurance strategy as you grow in scale?
So that's a terrific question as well. What I would say is there's some sacrosanct principles, and it starts with where we're projecting to. We want to make sure that we always have a cushion that is beyond the 1-in-250-year PML. And so that is something we will not deviate from. I think the one thing that we'll continue to look at as we grow capital through earnings, and certainly on the heels of the IPO, is just how we participate in the risk. And so that could inform how we participate in quota share reinsurance arrangements. It could inform how we participate in per risk reinsurance arrangements and then also what our retention is.
We like having the optionality that a bigger balance sheet affords us. So that will be a little more fluid, but again, fundamentally, and as I use the term the sacrosanct principle of maintaining the cushion above the 250, the 1-in-250-year PML, that is.
Great. And then if I can just sneak in one last one. Just in terms of that A- VIII category that you guys are looking to get from AM Best, any sense of how much additional distribution you could get through some of the big alphabet broker houses? And how you guys think about that?
Sue, this is Mac. That's a good question. What I would say is, it's a little too early to handicap. I can tell you, anecdotally, that we have some distribution sources that have been kind of nipping at our heels, asking about when that was going to be triggered. Others, we'd kind of let them know, and they're saying terrific, that's great.
But I think a good rule of thumb is just, if you look at the normal quoting process for our commercial business, it's anywhere from 60 to 75 days out for certain lines, and maybe a little bit inside of that for others. So I don't see us really reaping the benefit of broadening that distribution until, hopefully, the third quarter, but maybe even the fourth, because some of it is going to be incumbent upon us to go out and market to people too.
Our next question is from Paul Newsome from Sandler O'Neill.
I'm almost out of questions. The only follow-up I had was, is there any change in sort of how you think of the business mix perspectively with the new people on board? Does that change your plans? Or is it just kind of the same plans you had pre the IPO?
Yes. Paul, it's Mac. I would say, no, I don't think it's going to change, vis-à-vis, pre the IPO. As we get traction in Builder's Risk -- or we could pivot to different geographies based on what the distribution is telling us. But I don't think it's going to mean a departure from the specialty property focus.
[Operator Instructions] Our next question here is from Mark Hughes from SunTrust.
Any update on the Commercial Quake? Just sort of curious, that was -- you still got good growth there, but a little lower than your other lines, pricing, competition, demand?
So Mark, yes, you're right. It looks like -- this is Mac. It looks like it is lower growth. I think quarter-over-quarter, it points to 12%. But it's worth pointing out that in the first quarter of 2018, we terminated one distribution partnership that resulted in us non-renewing in Q1 '19 over $1 million of premium. So if you exclude that and kind of do it on a same-store basis, it's 26% growth, so pretty close to our other lines. And I will tell you, that's the line that we think there's the greatest potential upside for growth on the Commercial business because of the A- VIII financial size category. So I think we might see a bit of a lift. But I view it -- we did pretty well growing 26% on a same-store basis, if you would.
This concludes the question-and-answer session. I'd like to turn the floor back to Mr. Armstrong for any closing comments.
Terrific. So that concludes Palomar's inaugural earnings call. We hope you walked away with a keen sense of what we believe was a strong quarter. But moreover, we hope that you got a keen sense of how this quarter was emblematic of our near-term and long-term strategy.
The management team at Palomar is really excited about what the future holds. So with that, thank you, and see you next quarter.
This concludes today's teleconference. You may disconnect your lines at this time. Thank you, again, for your participation.