Palomar - Q2 2023
August 3, 2023
Transcript
Operator (participant)
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 line 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, the 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 10th, 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 their most comparable GAAP measure can be found in our earnings release. At this point, I'll turn the call over to Mac.
Mac Armstrong (Chairman and CEO)
Thank you, Chris, and good morning, everyone. I'm 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 teeth 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 de-emphasized 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've 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 into 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 on 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 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. 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 exodus 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%-10% rate increases and expanded its quota share support, allowing us to write larger limits without taking on disproportionate risk, as well as add incremental ceding commission. Our excess property line saw 10% rate increases and over 600% year-over-year growth as it built 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, flying hurricane, and flood, we're 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 PMO to $100 million. This effort led to a 45% reduction in premium year-over-year. However, commercial all risk policies that remain on our books renewed an average increase of 60%, that 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 professional liability. During the quarter, we integrated our tuck-in acquisition, XCO 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 that involves hiring underwriting talent with long-standing 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 risks has enabled this performance. Our thoughtful underwriting approach was validated with approved 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 on the lines of business to further our diversification into 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 on 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 organizations and our prospects of building a meaningful presence in crop insurance. Two members of our executive management team, John Christensen and John Knudsen, have extensive experience in the crop market. Upon confirmation of the deal, John Christensen 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, and that crop insurance will be a significant contributor 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 is now exhausted, $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 more than 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 of Palomar and our subsidiaries to a positive outlook by A.M. Best. Lastly, we are upseating our 2023 adjusted net income guidance to $89 million-$93 million. This updated guidance reflects catastrophe losses incurred in the first and second quarter of approximately $4 million. With that, I'll turn the call over to Chris to discuss our results in more detail.
Chris Uchida (CFO)
Thank you, Mac. Please note that during my portion, when referring to any per share figure, I'm referring to per diluted common shares 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 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 top-line 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's second quarter. Excluding de-emphasized 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's 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, compared sequentially 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%-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 sequentially to 11.4% in the first quarter of 2023.
Additional ceding commission and fronting fees continued 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, 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 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 0.88-1 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-$93 million, an increase from $88 million-$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, 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. Based on the current market, our effective tax rate for the year may remain elevated between 22%-24%. Before opening the call for questions, I would like to note that John Christensen, President of Palomar, will be joining the question and answer session of this call.
With that, I'd like to ask the operator to open the line for any questions. Operator?
Operator (participant)
Thank you. We'll now be conducting a question and answer session. If you'd like to be placed into the question queue, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you'd like to remove your question from the queue. One moment please, while we pull for questions. Our first question is coming from Tracy Benguigui from Barclays. Your line is now live.
Tracy Benguigui (Director)
Thank you. Good morning, or good afternoon. Your attritional loss ratio of 18.9% was below, your guide of 22%-24% for 2023. Could you unpack that a little bit?
Chris Uchida (CFO)
Yeah, thanks, Tracy. That's a good question. You know, when we look at our loss ratio for the quarter, obviously we're 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%-24%. Mini cats for us were elevated this quarter, causing us to put those losses or the severity and magnitude of those events caused us to put some of those losses into catastrophes. As you saw, saw that loss ratio for the quarter being about 2.6%. Overall, we feel good about those results.
You know, the loss ratio was a little bit better. I think mini caps are a little bit higher, causing the loss ratio probably to be about 1.6 points higher than we would have expected. Still better than expected, but overall, everything's in line with how we feel about the year. I think the one thing you'll notice on the prepared remarks, we did call it decrease the bottom of the range for the full year. We went to 21%-24%, reflecting, you know, what we've seen in the first half of the year, but still expecting, you know, those loss ratios to improve in the latter half of the year and then into Q1 next year.
Mac Armstrong (Chairman and CEO)
Tracy, this is Mac-
Tracy Benguigui (Director)
Go ahead.
Mac Armstrong (Chairman and CEO)
I think, Tracy, this is Mac. I think pricing is contributing to that. I think it's also part of our concerted efforts to run off certain segments of the book, you know, and that's why, you know, I know one of the things that you were focused on was the growth. We grew 44% in the areas that we are investing in, and we're thrilled with that. One of the, the benefits of running off some of these lines or de-emphasizing some of these lines, like all risks, is that it does improve the loss ratio.
You know, even in the second quarter, all risk, which declined, you know, close to 40% year-over-year, you know, it still had a $1 million of cat loss, and it has a higher attritional loss than certainly the 21% that we blend out to. One of the positives and one of the reasons why we are running off some of these books that have higher volatility, is that they also have higher loss ratios. That's also a meaningful contributor to why the loss ratio was what it was this quarter, and why we think, and Chris has always said, we expect it to continue to go down somewhat over the course of this year and certainly into 2024.
Tracy Benguigui (Director)
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 risks, particularly on collaterals.
Mac Armstrong (Chairman and CEO)
Yeah. I, I'm happy to do so, Tracy. It's, it's a, it's a timely and smart question. You know, we're, we're seeing strong growth from targeted fronting partners. We have, as I mentioned in my remarks, we have seven of them. We take a rifle shot approach, which allows us to manage these partners closely and frankly, collaboratively. It's more like an underwriting relationship and more. It's, it's a, it's a pillar and segment where we're seeing nice, considerable growth. That percentage of the premium that it can constitute is not the same from adjusted net income. It's a nice segment for us. It allows us to be disciplined and prudent with new partners and who we bring on. You know, we can be very selective.
you know, I think the one thing that certainly with the shakeout of what's happening in the fronting market broadly with Vesttoo, you know, our exposure is immaterial. We were able to get in front of this really quickly, and we understand not just our exposure, but our remedies, and those remedies are several. I think for us, you know, we continue to look closely at how we manage these programs, and how the industry will, you know, shake out. Two of our reinsurance programs, four of our fronting partners renewed with increased capacity and support and consistent economics in the second quarter. We also had one successfully renewed at the first part of the third quarter, accepting in July 1. I think there will be consequences.
I think for us, though, it's probably a net positive for Palomar, because first and foremost, we're an underwriting organization. We're already seeing submissions from program submissions from MGAs that are looking for potentially a new fronting partner. We're also in seeking potentially a more stable fronting partner. We've also seen submission flow uptick in a few Casualty lines from, from MGA-backed, or rather, renewals coming away from MGAs that have potential collateral exposure to us, just in the open market with our Casualty segment. All in all, we won't deviate from our fronting strategy. If anything, our blended strategy and our targeted strategy is affirmed here. I think it also overall validates our model as a, an underwriting organization.
Tracy Benguigui (Director)
Thank you.
Operator (participant)
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, you alluded to the top line, top line growth. You, you certainly were influenced this quarter by, the run-off and de-emphasized lines. What should the earned premium growth be given and that your mix of fronting versus, you know, underwritten business? How, how should the earned premium trajectory be?
Mac Armstrong (Chairman and CEO)
Well, I, Chris can chime in, Mark, but I... This is Mac, and what I would say is that you know, you look at those kind of five segments that we've talked about, you know, we see very strong, sustained growth in earthquake. It's growing 20%. I think that's a good, good rule of thumb for that line. Then I think when you look at Casualty and Inland Marine, there is considerable growth. Fronting, you know, it's, it's, it's hard to say it's going to sustain a 90% growth rate, but what we like is there is embedded growth with most of our partners here. Some are kind of hitting their critical mass in steady state. That's all right for us because there's still a nice earned premium ramp for us.
long winded way of saying, you know, I think the growth is going to continue to be strong. you know, expecting it to be 44% might be a bit ambitious, but we feel like that it's a, it's a healthy growth vector when you look at the underlying contributors like Inland Marine, Casualty, and obviously quake.
Chris Uchida (CFO)
Yeah, and Mac talked about the top line growth of the written premium, and obviously that will influence how the gross written premium grows. I talk about this a lot, that the, you know, 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 written premium ratio will continue to decrease. You know, it was 34% in the second quarter. It's going to get into the low 30s, you know, for Q3, and potentially a little bit in Q4 as well, right?
I just wanna make sure people think about that as they model it, because the excess of loss reinsurance cost that we've talked about before, was up about 30%, which is as, as expected as we modeled into our guidance. I wanna make sure people are thinking about that and modeling it correctly when they think about our net and premium ratio and the results that we're gonna see in the second half of the year, right? Q3 will be the lowest point of that, and then we'll 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, the renewals that are coming up, you're describing about a 20-point differential between what would have been other than the de-emphasized and run-off business. What's gonna be the marginal impact in Q3 and Q4? If it was 20 points in Q2, how, how much are these, you know, these risk management adjustments gonna impact the second half?
Mac Armstrong (Chairman and CEO)
You know, I think it's probably markets in and around, you know, the difference between, you know, 14, maybe it's 10-14 points overhang of the growth. You know, the most of the specialty homeowners business will be out by the third quarter. You know, the all risk is over the course of the year.
Mark Hughes (Analyst)
Okay.
Mac Armstrong (Chairman and CEO)
If you look at all risk, you know, what we're really trying to solve for is getting the PML down to $100 million, and it's basically there. At that level, you know, we feel that it is a sustainable level, where we can maintain a manageable reinsurance expense. It obviously was up meaningfully, I think is 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 2x. We're focusing more of our cat dollars on earthquake. For wind, we want to get it down to $100 million of 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.
That means that there is an opportunity for us to take rate and optimize that book and get it to grow, but that's really not gonna start until the first quarter of 2024.
Mark Hughes (Analyst)
Finally, the commercial Earthquake business, better pricing, but a little bit of deceleration at the top line, deceleration, you know, from very strong growth, strong growth. Anything noteworthy there?
Mac Armstrong (Chairman and CEO)
No, that market's, and John Christensen can chime in, but I would say, I mean, through 30% or 29% in a quarter, you know, we wanted to be mindful of where reinsurance costs were going to shake out, and that would inform the PML. Frankly, you know, we wanna make sure that we could procure the incremental $550 million of reinsurance support to support the growth that we're seeing. What I'll tell you right now is our metrics have never been better. The capacity in the market is dwindling, so, we feel very good about sustaining strong growth in commercial earthquake. John, anything you'd add?
John Christensen (President)
Yeah. No, I agree with all that, and I think we've seen now, many quarters in a row of that strong rate appreciation in the commercial earthquake segment. As we look forward to the next few quarters, there's no signs that would suggest that it would decelerate.
Mark Hughes (Analyst)
Great. Thank you.
Mac Armstrong (Chairman and CEO)
Thanks, Mark.
Operator (participant)
Thank you. Next question is coming from David Motemaden from Evercore ISI. Your line is now live.
David Motemaden (Managing Director and Senior Equity Research Analyst)
Hi, thanks. Just a question on the crop opportunity. It sounds like you think that'll start coming in in the third quarter. I guess how big do you think that has, you know, the potential to be as another growth lever that we haven't really seen here in the first half? Then how should we think about the profitability profile of that business versus your existing business?
Mac Armstrong (Chairman and CEO)
Dave, yeah, this is Mac, and again, I'll, I'll let John speak to this. I think there are a few things that I would wanna get across to you is, you know, for this year, it's, it's really a startup. We will generate some premium in the third quarter and in the second, or the second half of the year, but it's more fronted, so it's really gonna be a fee generation product. For 2024, we think it can be a meaningful premium. You know, it's, it's a $20 billion market. We're one of 13 approved insurance providers. We have terrific in-house expertise and a terrific distribution partner in Advanced AgProtection.
You know, we are optimistic that it can become, you know, a large contributor to premium in due time, but in 2024, like, it, it has a chance to, you know, be high, high double-digit millions of premium.
John Christensen (President)
Yeah, with regard to the, the profitability aspect of the question, you know, it is a historically profitable line, and importantly, it's uncorrelated with our existing core lines. It has a short tail and a combined exposure period with strong reinsurance support backing it. From a profitability standpoint, we feel it pulls in nicely with the other lines of business that we have.
Mac Armstrong (Chairman and CEO)
I think the one thing that I would add to that, Dave, and I should have brought this up. You know, next year we expect we'll, we'll take risk on it, but, you know, you're talking about just call it conservatively, a 10% participation. It's still gonna be a nice balance of fee and underwriting income, like we've done with all of our new products, so we're not gonna deviate from that strategy. You know, nice fee income stream, as well as a nice underwriting income component to it. You know, it, it may end up being like an 8%-10% margin in that year.
David Motemaden (Managing Director and Senior Equity Research Analyst)
Got it. Understood. That's helpful. Then just on, you know, on the, on the Vesttoo, the, the one counterparty where you have exposure, was that something where it just... You know, it sounds like it's immaterial in size. Was that something where you just absorbed the, what you had reinsured, or is that something where you just replaced the, the LOC in question?
Mac Armstrong (Chairman and CEO)
It's, it's for a prior, it's for a treaty period that has expired. We're looking at just what's our-- what's in trust and what would be our exposure if it goes beyond trust. If it goes beyond the trust, which we have full control of, you know, that's, that's where our exposure would be, and again, it's immaterial. You know, for everything that's in place right now, Vesttoo is-- there's nothing. Vesttoo is not an issue. They're not a reinsurer.
David Motemaden (Managing Director and Senior Equity Research Analyst)
Got it. Thanks. Then maybe just finally, it sounds like capacity has definitely not been an issue for the seven programs, the existing programs, but just wondering on, like, you know, the future growth of adding new program partners. Is, is there just, you know, have you seen a slowdown in the conversations that you've been having with capacity providers? It sounds like, you know, MGAs want to partner with you guys, but are you able to, you know, secure the capacity on the back end for, for newer partners?
Mac Armstrong (Chairman and CEO)
No, I mean, I think for us, we've had successful reinsurance renewals. We're being very selective in, in talking to potential new fronting partners. You know, ultimately, we view these fronting partners as people that we're going to take a risk on at some point in time. We hold them to a different standard than maybe other markets do. As a result, you know, 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. I would say, you know, on the heels of what, what's been in the press the last week or, or a few weeks, we're seeing a lot more inbounds, but selectivity has not changed, if not increased.
David Motemaden (Managing Director and Senior Equity Research Analyst)
Yep, understood. Thank you.
Mac Armstrong (Chairman and CEO)
Thanks, Dave.
Operator (participant)
Thank you. As a reminder, that's star 1 to be placed into question queue. Our next question is coming from Andrew Anderson from Jefferies. Your line is now live.
Andrew Anderson (SVP of Equity Research)
Hey, good afternoon. Just with regards to the fronting program, Mac, I'm 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, the fronting program with regards to cyber?
Mac Armstrong (Chairman and 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 a 7/1. That was successfully placed with great capacity support. We had taken modest risk participation there, we have for the last two years. Yeah, we're watching the pricing. I think for that program, it's one, or that product and that fronting relationship, we really do view that like we are, you know, the underwriter here. While it's only a, you know, low, mid-single digits participation, we manage it like something that we're taking 30%, 40%, 50% of. On the whole, rates are certainly down from where they were two, three years ago.
We're 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, the premium cap was increased. 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, it's a, it's a great partnership.
Andrew Anderson (SVP of Equity Research)
Okay. 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? 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 (Chairman and CEO)
Yeah, Andrew, good question on the Casualty side. You know, we're, we're pleased with the growth there. It's 92%, and it's now approaching, you know, it's 4%+ of the book. We're being deliberate here, though, too. We are using the E&S company for the predominance of it. We do have a handful of GL business that's on the admitted company, and that tends to be focusing on kind of small to mid-market commercial contractors. Call it $5 million-$20 million in annual repeat and pre-predominantly low and moderate hazard stuff. So think about like trade contractors or general contractors that are building schools. We really are trying to avoid classes that have severity on the admitted side or high severity exposure.
What I will say is on, on the professional lines, where that's mostly ENS, it's growing, really nicely, but also deliberately. It's targeted niches that we're going into. Real Estate E&O is the one you highlighted, but, you know, when we brought on some underwriters in the quarter, a lot of them, you know, they spent the quarter ramping up, and now we're starting to see them leverage their expertise, leverage their distribution relationships. Garrett Vande Kamp, who oversees our professional alliance, when I were talking recently about a, a collection agency E&O program that he's already starting to write with one of his underwriters that is just coming on and has nice potential to be a great supplement to the E&O franchise, but very targeted and niche. That's what we're looking to do.
I think if we can take that deliberate approach from a re- reach, and distribution and appetite perspective, the book not only will grow, but it'll be profitable and predictable.
Andrew Anderson (SVP of Equity Research)
Great. Thank you.
Mac Armstrong (Chairman and CEO)
Thank you.
Operator (participant)
Thank you. Next question today is coming from Pablo Singzon from JPMorgan. Your line is now live.
Pablo Singzon (Executive Director)
Hi, thank you. My first question is on guidance. You increased it twice over the past several months. I was hoping you could unpack those changes a bit here. To what extent was the upgraded guidance based on your first half performance, and to what extent is it a reflection of what you think will happen in the second half of the year?
Mac Armstrong (Chairman and CEO)
Pablo, I think it's a combination of the two. It's a good question, and thanks for asking it. What I would say is, you know, the first guidance raise was potentially was a little bit of a delay off of Q1, but we wanted to see where reinsurance pricing shook out. That informed the raise that we did in June. This quarter, or on the heels of Q2, we raised guidance again to reflect the results in the first quarter, but also what we expect to see in the first half-- the second half of the year. Chris pointed out he's taken down the loss ratio range. That's informing it.
We're also, you know, again, the business that we're running off has, you know, could you could argue that certainly some of it was unprofitable, and certainly with the, the reinsurance load that we're seeing on web business, it would have been unprofitable on a prospective basis if we had kept stayed on. Long-winded way of saying it's a combination of the two, but we feel like there's great momentum in the business. Our goal is to, you know, beat and raise. That's, that's our operative focus.
Pablo Singzon (Executive Director)
Okay. Second question, maybe for Chris. Heard what you said about expense ratios going down on a gross basis, right? 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 cost kicking in. Will that essentially inflate, you know, the expense ratio on a net earned basis as well, through the second half of the year?
Chris Uchida (CFO)
You pointed it out well, Pablo, right? When you think about the ratio, even the loss ratio on a net earned basis, it is severely impacted by the excess of loss, right? I don't think that my view is the combined ratio doesn't do a good job of measuring those ratios when you have an excess of loss load like we do, and seeing the excess of loss load going up by, you know, close to 30%, like we've talked about, is going to impact that with really no overall change in potentially the expense ratio or the loss ratio. It's kind of why we take it out, especially on the expenses. We think about it on a gross basis. You can model a little bit easier, you can look at it.
When I look at the acquisition expense ratio, I see that continuing to tick down because of the mix change, whether it be fronting, things of that nature, but then the same with the expenses, right? It's a little bit flatter, which we've talked about, it feels like everything is heading the right direction. When I look at it on a gross basis, it takes out the noise of the excess of loss. That's why when we talk about the gross earn premium ratio and think about that, we talk about that separately, so that you guys can think about how the excess of loss is going to impact it, and that's going to go from 34, you know, down to the low 30s in the second half of the year.
That's how we think about it, but you're absolutely right. The modeling impact of those ratios, and call it being a little bit higher this quarter, is impacted by the excess of loss costs. Like I said, that cost is going to be higher in Q3, which is going to be the first full quarter with that loaded in.
Mac Armstrong (Chairman and CEO)
I think the only thing that I would add, Pablo, just. Chris described it well. Just a reminder, you know, we brought on a lot of underwriters in the second quarter, great talent, and claims professionals alike that will generate a return, whether it be top line or improving the bottom line, through cost containment and loss management. That'll take a little bit of time. There was a decent amount of sunk costs, not sunk costs, but costs that should generate a return, certainly 2024.
Pablo Singzon (Executive Director)
Okay. Then last question, for you, Mac. Heard your comments about disruption in the California earthquakes or California market potentially being an opportunity for you to grow earthquake. I, I guess the question is just given, given what's happening, right, like, and the amount of disruption, is there a risk that the market gets overly disrupted where, you know, for whatever reason, the uptick of earthquake insurance goes down, right? I'm thinking of, like... you know, massive withdrawals capacity, like more people going to the, the FEAR plan, for example. Like if the disruption reaches that level, is that still good for your earthquake business?
Mac Armstrong (Chairman and CEO)
Yeah, I, Pablo, and I'll let John Christensen offer this too. You know, the disruption in the earthquake market, the homeowners market, I think it remains good for our business, whether it be the non-renewing policies that may have had an earthquake endorsement or subsidy or a standalone companion policy attached to it. We get to compete on that, whether it be the CEA taking their deductibles up to 15% on anything over $1 million of coverage A, or reducing the amount of covered C, which is your personal property. Those are all good dynamics for us. I don't think we've reached a point where any there's a precipice that we've gone beyond. I think this is just a bit of kind of a, a slow burn change in the California market that we are going to be benefiting from.
John Christensen (President)
Yeah, I'd, I'd add with the disruption that we've seen to date in that homeowners market in California, it has not translated into anything unusual with our residential Earthquake book. Our, our book has been very predictable, and our partnerships remain very strong in the state of California. We've not seen anything that would indicate a disruption to a very predictable and profitable line of business for us.
Pablo Singzon (Executive Director)
Okay. Even with the homeowners pricing going up double digits, it seems like from what you're saying, there's still appetite for earthquake insurance as a rider to the basic homeowners product. Is that fair?
Mac Armstrong (Chairman and 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're 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. You know, we, we look at that, but if you look at just the continued growth, 20% in residential earthquake, but also the increasing take-up in E&S, which frankly, E&S, on E&S, whereas earthquake policy costs more on a per dollar basis or per dollar of insurance basis than the admitted side. I think that's a reflection of the appetite.
Pablo Singzon (Executive Director)
Okay, thank you.
Operator (participant)
Thank you. We've 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 (Chairman and CEO)
Thank you very much, operator, and thanks to all who joined this morning. We appreciate your participation, certainly your questions, and 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 strategic initiative. You know, listen, we are growing where we want to. We are hitting our ROE targets and our earnings targets, and we're raising guidance. We'll look to continue to do this, but I think, you know, what we have in front of us is really exciting, and we are gonna continue to build an industry-leading franchise. Thanks very much, and speak to you next quarter.
Operator (participant)
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.