Palomar Holdings, Inc. (PLMR)

What kind of company is Palomar?

Palomar Holdings is an insurance underwriter — it sells insurance policies to homeowners and commercial property owners, collects premiums, and pays claims when insured events occur. It is a specialty insurer, which means it focuses on market segments that larger, more diversified insurers have de-emphasized or largely abandoned. Palomar underwritten policies primarily in coastal areas exposed to hurricane risk and other high-hazard geographies where traditional insurers have pulled back or raised rates dramatically.

The company was founded in 2009, right after the financial crisis, and initially focused on homeowners insurance in Florida — a state that has historically been a difficult market, with major hurricanes creating large claims. Over time, Palomar has expanded into other high-risk homeowners markets and into commercial property insurance, and it has grown its presence in states like California where wildfire risk has made traditional coverage scarce or expensive.

Why would an insurance company choose to write risky policies?

The conventional assumption is that insurance companies should avoid risk, but the economics of specialty insurance are different. A major national insurer may decide that hurricane risk in Florida is too volatile relative to the premium it can charge, so it stops writing policies or writes very few. That creates an opportunity for a specialist: Palomar, or a competitor like Heritage Insurance, can write policies in those geographies and price them to reflect the risk.

This works because specialty insurers typically have lower expense ratios than large diversified insurers. They do not have a nationwide brand to support, do not have legacy administrative costs from decades of diverse operations, and can be laser-focused on what they underwrite. A specialty insurer writing nothing but homeowners policies in high-risk coastal states can be more efficient at that specific task than a massive national carrier managing homeowners, auto, commercial, life, and international exposures.

The second reason is expertise. Over years of writing policies in hurricane-prone Florida, Palomar has built actuarial models, claims experience, and relationships with local agents that let it price risk more accurately than a generalist insurer could. If Palomar’s models predict that a certain subset of Florida properties will average 0.8 claims per 100 policies per year, it can price accordingly. A large national insurer, applying a blunter pricing model, might charge too much (losing business to Palomar) or too little (losing money).

What determines whether a specialty insurer succeeds or fails?

Pricing and underwriting discipline are everything. An insurer that charges too little for the risk it is taking will eventually suffer claims that exceed premiums, eroding the business. One that charges too much will lose customers to competitors or see new capacity enter the market. The challenge is that an insurer may not know if its pricing is right until years of claims history are in the books.

Palomar’s success hinges on the accuracy of its underwriting. The company has to assess the risk of a given property — its construction quality, its age, its location relative to hazards, the owner’s claims history — and price a one-year or multi-year policy such that the premiums collected exceed claims and operating expenses. If the company is consistently underpricing risk, losses will eventually exceed premiums and the business will contract or become unprofitable. If it overprices, it will lose market share.

The other critical factor is capital. Insurance companies operate on negative float — they collect premiums upfront and pay claims later (sometimes much later in the case of catastrophic events). This means the company needs sufficient capital on hand to handle claims and to absorb unexpected losses when catastrophes strike. A specialty insurer in high-risk zones needs more capital relative to premiums than a diversified insurer, because the tail risk is heavier. Palomar must have enough equity capital to survive a major hurricane season without being forced into loss-making decisions or into raising expensive new capital.

What are the specific risks in Palomar’s business?

Catastrophic losses from hurricanes or wildfires are the most obvious. A severe hurricane season can generate thousands of claims in a single month, exceeding what the company has set aside. Palomar can reinsure — buy insurance from other insurers to cover losses above a threshold — but reinsurance is expensive, and if a catastrophe is severe enough or broad enough, the company may still face large losses.

A second risk is regulatory. Insurance is heavily regulated at the state level, and state insurance commissioners can limit how much an insurer can raise rates, deny rate increases, or restrict which lines of business a company can write. In Florida, for instance, regulators have historically resisted big rate increases even as catastrophe risk has risen, which can force insurers to choose between writing policies at inadequate rates or exiting the market.

A third risk is competition. If reinsurance becomes cheap (which happens in soft markets when large insurers are flush with capital), competitors can undercut Palomar’s pricing. Alternatively, large national insurers can re-enter markets Palomar dominates if they become willing to absorb more risk or if they develop better pricing models. The competitive moat in specialty insurance is not durable — it is based on current expertise and efficiency, not on structural barriers that a well-capitalized competitor cannot overcome.

A fourth risk is concentration. If most of Palomar’s portfolio is concentrated in a few geographies — say, coastal Florida and Southern California — then a geographically correlated catastrophe (a hurricane hitting Florida while wildfires rage in California) could create outsized losses that the company’s capital cannot absorb.

What would an investor research before buying Palomar?

Start with the composition of the portfolio: where are policies written, what types of properties, what is the concentration in high-risk zones. A 10-K (SEC CIK 0001761312) lays this out. Then look at the loss ratios — the percentage of premium dollars paid out as claims. A trending loss ratio shows whether the company’s underwriting is becoming more or less profitable. A stable or improving loss ratio means the company is pricing accurately or improving its underwriting discipline.

Watch the expense ratio — operating costs as a percentage of premiums. A rising expense ratio can signal inefficiency or indicate that the company is spending more on distribution or customer acquisition, which may be necessary to grow but can also be wasteful.

Monitor the capital adequacy and any changes to the reinsurance program. If Palomar is buying more reinsurance or if reinsurance costs are rising, that is a sign of higher perceived risk and lower profitability. If capital levels are declining relative to premiums, the company has less cushion against catastrophes.

Finally, pay attention to state regulatory changes. Rate increases or decreases, changes in underwriting rules, or shifts in the competitive environment can help forecast future profitability.