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Palomar Holdings Inc (NASDAQ:PLMR)
Q4 2019 Earnings Call
Feb 19, 2020, 12:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Operator

Good morning, and welcome to the Palomar Holdings, Inc. fourth-quarter and full-year 2019 earnings conference call. [Operator instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to Mr.

Chris Uchida, chief financial officer. Please go ahead, sir.

Chris Uchida -- Chief Financial Officer

Thank you, operator, and good morning, everyone. We appreciate your participation in our fourth-quarter and full-year 2019 earnings call. With me here today is Mac Armstrong, our chief executive officer and founder. As a reminder, a telephonic replay of this call will be available on the investor relations section of our website through 11:59 p.m.

Eastern Time on February 26, 2020. 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 most recent periodic report and our prospectus filed with the Securities and Exchange Commission, January 10, 2020. We do not undertake any duty to update such forward-looking statements. Additionally, during today's call, we will discuss certain non-GAAP measures, which we believe are useful in evaluating our performance. The presentation of this additional information should not be considered in isolation or as a substitute for results prepared in accordance with U.S.

GAAP. A reconciliation of these non-GAAP measures to the most comparable GAAP measure can be found in our earnings release. At this point, I will turn the call over to Mac.

Mac Armstrong -- Chief Executive Officer and Founder

Thank you, Chris, and good morning, everyone. Over the course of 2019, Palomar executed on its mission to build a diversified book of specialty property business. We remain focused on developing a suite of distinctive and flexible products delivered via an easy to use and scalable platform that incorporates an analytics-driven underwriting and risk transfer framework. Our results over this past quarter and the full year of 2019 demonstrate that we are making progress on our mission and that our products are well received by the market.

But before we go into the quantitative highlights for the quarter and the year, I want to provide some qualitative perspective on 2019, as it was a momentous year. Selected accomplishments include expanding our geographic footprint into 27 states, consummating multiple new carrier partnerships, including the largest in our history; launching two new divisions of the company in the marine and assumed reinsurance; making significant investments in our human capital, with the notable hiring of a chief risk officer and an SVP people and talent; returning $345 million of incremental reinsurance limit to prudently support our growth; and lastly, our initial public offering in April, which catalyzed several growth drivers of the business. Turning to our results. Gross written premiums grew 68% year over year for the fourth quarter, and 63% year over year for the full year 2019.

Importantly, we generated strong growth across our expanding product portfolio, not just from a few standouts. 73% year-over-year growth of our earthquake products during the fourth quarter demonstrates that our earthquake franchise continues to gain traction and that we increasingly play a leadership role in the market segment. Our non-earthquake products grew 59% year over year in the fourth quarter, further proving that our product development strategy is exportable to other segments of the specialty property market. As a company, we remain focused on developing differentiated products to serve key market needs, and I'm pleased to report that the contribution from our newest product lines continue to grow.

Specifically, our residential club program grew 140% year over year in the fourth quarter, while our recently launched inland marine department continued to expand its geographic footprint, product offerings and distribution network. Overall, premiums for our non-earthquake products represented 30% of total gross written premiums during the quarter. In many cases, these products are in markets that are multiple times larger than the addressable earthquake market, and offer significant runway for future growth and broadening of our premium base. Additionally, we generated solid growth across both commercial and personal lines, exiting 2019 with a mix of 29% commercial and 71% personal lines.

An attractive rate environment and expanding distribution network led to 135% growth year over year in the fourth quarter for our commercial lines offerings. Our commercial lines experienced an average deposit renewal rate increase of 11.2% during the fourth quarter compared to 9% in the third quarter. Accelerated rate increases was most pronounced in our commercial earthquake line of business, which saw a deposit renewal rate increase of 13.8% versus 9.2% in Q3. Personal lines offerings exhibited continued momentum and grew 46% year over year in the fourth quarter.

We believe that there is no stronger endorsement of the unique value that we offer to our distribution partners, and ultimately, the end insures, than our strong premium retention rates. Average monthly premium retention across all lines of business was 89% during the quarter, up sequentially from 87% in the third quarter and compared to 83% during the fourth quarter of 2018. Notably, we saw retention rates above 92% for our All Risk, Hawaii Hurricane and Residential Earthquake business during the fourth quarter. The composition of our book of business minimizes our exposure to attritional loss and provide considerable earnings visibility.

However, we will experience some measure of loss on a quarterly basis, even when there isn't a major earthquake or hurricane in Hawaii. Fortunately, our commitment to managing loss exposure through market selection, underwriting and risk transfer confined attritional loss. So during the fourth quarter, we had loss and loss adjustment expense of $2.2 million, and Chris will provide more detail on the losses shortly. But I will point out that even with the modest amount of loss, our loss ratio was 5.6% for the full year 2019 compared to a loss ratio of 9% for the full year 2018.

Through this commitment to predictable and profitable underwriting, we were able to achieve a full-year adjusted combined ratio of 63.3% and an adjusted ROE of 24.1%. We believe these results reflect the uniqueness and capital efficiency of our model as we were able to achieve that ROE with a conservative net written premium to ending stockholders' equity ratio of 0.66. Risk management is a central pillar of our model, and the completion of our January 1 reinsurance renewal reflects our dedication to balancing the growth of our portfolio with conservative reinsurance protection. As previously disclosed, we renewed approximately $300 million of our core reinsurance program at rates flat to modestly up on an exposure-adjusted basis, and purchased $145 million of incremental limit to support the continued growth of our existing and new products.

As of January 1, our reinsurance program provides coverage up to $1.2 billion for California earthquake events. This coverage allows the company to maintain a cushion above the 100 and 250 year peak zone probable maximum loss, and significantly exceed simulated losses from any recorded historical event. Our per event retention remains $5 million through May 31, 2020. Looking ahead, we entered 2020 committed to our ongoing growth initiatives.

As previously mentioned, reaching an AM Best financial size Category 8 last year, unlocked new distribution sources for our commercial lines products and new carrier partnerships for our personal lines products. With the primary proceeds from our January 2020 follow-on offering, we are now in proximity to achieve $250 million in surplus in AM Best Financial Size Category 9, which should further unlock new growth opportunities. Our product suite remains relevant and attractive to the market. We are adding new states of operations and broadening our product offerings in existing ones.

We continue to invest in technology that offers distribution partners more streamlined access to our products and improves our ability to drive scale in our business. We are invigorated by the prospects of 2020, and believe that we can grow adjusted net income between 33% and 40% for the full year. With that, I would now like to turn the call over to Chris for a more detailed review of our financial results.

Chris Uchida -- Chief Financial Officer

Thank you, Mac. Please note that during my portion, when referring to any per share figure, I'm referring to per diluted common share as calculated using the treasury stock method. For the fourth quarter of 2019, our net income was $10.9 million or $0.45 per share compared to net income of $4.1 million or $0.24 per share for the same quarter in 2018. For the full year of 2019, our net income was $10.6 million or $0.49 per share compared to net income of $18.2 million or $1.07 per share in 2018.

For the fourth quarter of 2019, our adjusted net income was $11.5 million or $0.48 per share compared to adjusted net income of $4.6 million or $0.27 per share for the same quarter of 2018. Fourth-quarter 2019 adjusted net income excludes expenses related to the company's stock offerings, stock-based compensation and the tax impact of those expenses. In the fourth quarter of 2018, adjustments exclude the expenses associated with the company's IPO and tax restructuring. For the full year of 2019, our adjusted net income was $37.9 million or $1.73 per share compared to adjusted net income of $19.8 million or $1.17 per share in 2018.

Gross written premiums for the fourth quarter were $73.3 million, representing an increase of 68.4% compared to the prior year's fourth quarter. For 2019, gross written premiums were $252 million, growth of 62.7% compared to $154.9 million in 2018. As Mac indicated, this growth was driven by a combination of robust new business, rate increases and strong premium retention with contributions across our product portfolio. Ceded written premiums for the fourth quarter were $29.5 million, representing an increase of 35.8% compared to the prior year's fourth quarter.

Our risk transfer strategy remains a critical component of our business, especially as we demonstrate sustained topline growth. The increase was primarily driven by an increase in our excess of loss, or XOL reinsurance expense, commensurate with our growth, and our quota share reinsurance. We utilize quota share reinsurance to minimize the impact of attritional losses on our portfolio and to generate valuable fee income from ceding attractive risk to reinsurance partners. The increase in ceded written premium was in part due to increased ceding to the quota share reinsurance partners.

That said, while the total dollar amount of ceded written premium increased, ceded written premiums as a percentage of gross written premiums decreased to 40.3% for the three months ended December 31, 2019, from 49.9% for the three months ended December 31, 2018, due primarily to the increase in gross written premiums in our residential earthquake and commercial earthquake lines, which are not subject to quota share reinsurance agreements. This dynamic was also evident for the full year of 2019, as ceded written premiums as a percentage of gross written premiums decreased to 43% for the full year of 2019, from 53.6% for the full year of 2018. As we grow our business, we expect to incur additional excess of loss reinsurance expense as we maintain a conservative level of overall coverage. Due to the timing of our reinsurance places and the terms of our underlying contracts, there may be a lag between earned premium and a reinsurance placement or expense.

But over time, we expect the impact to smooth out and their trends that look the same. Our retention remains $5 million per earthquake or wind event, and we purchased $1.2 billion of total reinsurance coverage for California earthquake events. Net earned premiums for the fourth quarter were $31 million, an increase of 75.9% compared to the prior year's fourth quarter due to the growth in earning of higher gross written premiums offset by the growth in earning of higher ceded written premiums. Net earned premiums for 2019 were $100.2 million, an increase of 43.4% compared to 2018.

For the fourth quarter of 2019, ceded earned premiums as a percentage of gross earned premiums were 47.5% compared to 53.4% in the fourth quarter of 2018. For 2019, ceded earned premiums as a percentage of gross earned premiums were 50% compared to 49.3% in 2018. Commission and other income was approximately $0.7 million for the three months ended December 31, 2019, and $0.5 million for the same period in 2018. Commission and other income in 2019 was $2.7 million, and $2.4 million in 2018.

Losses and loss adjustment expense, or LAE, incurred in the fourth quarter were $2.2 million, an increase of $3 million compared to the prior year's fourth quarter. Our losses during the quarter included roughly $0.9 million of attritional losses equating to an attritional loss ratio of 2.5% for the quarter. In addition, we booked approximately $1.3 million of losses in LAE from Typhoon Hagibis, an unfavorable development from the events that occurred late in the third quarter, including Typhoon Faxai, Tropical Storm Imelda and Hurricane Dorian. Losses in LAE for the fourth quarter of 2018 included current year and prior year unfavorable development of $0.3 million and $0.5 million, respectively.

Combining the impact of attritional losses with major events, our loss ratio for the quarter was 7.1% compared to a negative 4.4% from the prior year's fourth quarter. As Mac mentioned earlier, our 2019 loss ratio was 5.6% compared to 9% in 2018. Our expense ratio for the fourth quarter of 2019 was 56% compared to 64.3% in the fourth quarter of 2018. We believe our business will continue to scale over the long term.

Our combined ratio for the fourth quarter was 63.1%. Adjusted combined ratio was 63.3% compared to 69.5% in 2018, demonstrating our ability to scale. Net investment income for the fourth quarter was $1.8 million, an increase of 75.6% compared to the prior year's fourth quarter. The increase was largely due to increased interest income generated by proceeds from our IPO in April.

We maintain a conservative investment strategy as our funds are generally invested in high-quality securities, including government agency securities, asset and mortgage-backed securities and municipal and corporate bonds, with an average credit quality of AA. The weighted average duration of our fixed maturity investment portfolio, including cash equivalents, was 3.49 years at quarter's end. Cash and invested assets totaled $272.8 million at quarter end as compared to $157.3 million at December 31, 2018. For the fourth quarter, we recognize realized and unrealized gains on investments in the consolidated statement of income of $1.2 million compared to $3.6 million loss in the prior year's fourth quarter.

The loss during last year's fourth quarter was principally due to a decline in the value of the company's equity securities. Our effective tax rate during the fourth quarter was 24.5% compared to 0.1% from the prior year's fourth quarter. The 2019 fourth-quarter tax rate includes an adjustment from prior periods of $0.4 million or approximately three points of the effective tax rate for the quarter. The increase in our effective tax rate is due to our restructuring in the early part of this year.

All of our operations are now taxable in the U.S., whereas in the prior periods, our Bermuda operations were not subject to U.S. taxes. Excluding any unforeseen events, we anticipate that our tax rate will settle around the 21% mark for the 2020 year. Our stockholders' equity was $218.6 million at December 31, 2019 compared to $96.3 million at December 31, 2018.

This increase was due to our earnings during the year, as well as the addition of IPO net proceeds, which will put downward pressure on our return on equity in the short-term, while providing capacity for continued growth over the long term. For the fourth quarter of 2019, annualized return on equity was 20.4% compared to 17.6% during the fourth quarter of 2018. Similarly, our annualized adjusted return on equity during the fourth quarter was 21.5% compared to 19.6% during the fourth quarter of 2018. Our adjusted return on equity for 2019 was 24.1% compared to 22.7% for 2018 with a lower capital base.

Looking ahead to 2020, we expect to generate adjusted net income between $50.5 million to $53 million, which equates to a growth rate of 33% to 40% on a year-over-year basis. As of December 31, 2019, we had 24,092,325 diluted shares outstanding, as calculated using the treasury stock method. Taking into account the 750,000 primary shares issued from the January 2020 secondary offering, there would be 24,842,325 diluted shares outstanding as of December 31, 2019. We do not anticipate a material increase to this number during the year ahead.

With that, I'd like to ask the operator to open up the line for any questions. Operator?

Questions & Answers:


Operator

[Operator instructions] Our first question is from Mark Hughes, SunTrust. Please proceed with your question.

Mark Hughes -- SunTrust Robinson Humphrey -- Analyst

Thank you very much. Good afternoon. On the earned premium, if I look at your trend in written premium in recent quarters, I might have expected a little more earned to flow through in the fourth quarter. Was more of that business signed near the end of the quarter? Or is there something in the ceded premium that influences that? Just anything about the timing of earned premium would be helpful.

Chris Uchida -- Chief Financial Officer

Hey Mark, it's Chris. Yes, I would say that there definitely was strong written premium to finish off the year. So a lot of that is going to help the prospects of 2020. Along with that, I think we have said in the past that the, call it, the 50% ratio for ceded earned premium to ceded gross earned premium is probably a better ratio than using the gross written premium to ceded written premium ratio.

That can get a little bit out of whack depending on what happened during the quarter, whether it be a large assumed deal or even significant growth. So some of that growth that you saw in Q3, and even in Q4, doesn't necessarily play out properly in the ratios. We think looking at the gross ceded earned is a better ratio to kind of pick when you're looking at modeling this out. So I think those two factors and just, as we talked about, the addition of some excess of loss during the year that needed to come off to help facilitate the growth probably started to play out a little bit in the fourth quarter.

But overall, we're happy with the projects, and we're happy with the gross written premium and how it's going to play out into 2020.

Mark Hughes -- SunTrust Robinson Humphrey -- Analyst

And then on the earthquake business, clearly, the California quake would seem like it was a catalyst. How have you seen trends as the year last year progressed, then as you said at the start of 2020?

Mac Armstrong -- Chief Executive Officer and Founder

Hey Mark, this is Mac. Let me answer that question. I'll bifurcate it into the two components of our earthquake business. First, our residential; and then secondly, our commercial.

And the Ridgecrest earthquake was a nice driver of new business growth, in particularly in the third quarter. In the fourth quarter, we continue to see strong new business, and that manifested itself in north of 55%, I think 58% growth in the residential earthquake business. But I think by the middle of the quarter, Ridgecrest was less of a driver. And I think the bigger driver, I think this is a net positive for us is the continued dislocation in the California homeowners market, driven by wildfires.

And you have admitted markets trying to nonrenew business on a consistent fashion. And I think you're talking about, as much as 10% of their book is being non-renewed. So that comes back into the primary market and kind of a jump ball and up for grabs dynamic. And so we get to compete on that.

And so I think that's a kind of a longer-term catalyst for growth in residential quake. Ridgecrest's, I don't know if it's dissipated, but because what you do have as a circumstance, we add new agents, and we did add new agents over the course of the fourth quarter. When you have, agent awareness is driven by awareness in the event itself. On the commercial side, I think, Ridgecrest is less of a driver of it.

I think, frankly, for us, what was the bigger driver is us getting access to new distribution sources. And that being a function of a larger financial size category, in this case, AM Best Size 8, and hopefully what will come to root when we get to AM Best Franchise Size 9. And I think just one thing to point out, if you look at the first part, and this is anecdotal, but our small commercial earthquake business, if you look at the first eight months of the year, our average monthly submission activity was just approximately 860 submissions a month. After August, so September through the end of the year, that submission activity nearly doubled.

It's closer to 1,600 submissions a month. And so I think that's a bigger driver of growth for us on the commercial side than the Ridgecrest earthquake, it just increased submission filing.

Mark Hughes -- SunTrust Robinson Humphrey -- Analyst

Thank you.

Operator

Our next question is from David Motemaden, Evercore ISI. Please proceed with your question. Our next question is from Paul Newsome, Sandler O'Neill. Please proceed with your question.

Paul Newsome -- Sandler O'Neill + Partners, L.P. -- Analyst

I was hoping you could give us a little bit more detail about the basic assumptions, not the details, but the basic assumptions underlying guidance for the year just in general? And then separately does that net guidance include some assumption for realized gains and losses?

Mac Armstrong -- Chief Executive Officer and Founder

Hey Paul, this is Mac. Let me answer your second question first. It does not assume any realized gains or losses on the investments. And I think, overarchingly, we feel good about the guidance that we are providing.

We're very comfortable with the range. And I think the key point to emphasize is the numbers that we put forth is based on existing products in the existing geographic footprint. There are no major leaps of faith. There is no assumptions on new products that aren't already in the market.

No new teams that are joining us. No major partnerships that we have not already consummated. So furthermore, no acceleration in pricing beyond levels where we are today, and therefore leaps of faith on premium retention. So we feel that we have a very good sense of what is required from our existing products to accomplish the range that we provided.

And I think what you'll also see is that, from a loss perspective, we feel good about the loss assumption there, and it's consistent with what we have done in the past where you have many cash and attrition loss contributing to it. So that's kind of the overarching tops-up approach that we've taken or bottom's up approach rather we have taken with the model, I think the one thing that I would add is that, we kind of view this guidance as an interim marker, it's no way an ultimate goal, it's a near term goal. And furthermore, while we've been somewhat conservative in the assumptions, it does not mean that we are not actively in new product development. We're not actively expanding our distribution print.

We're not trying to go deeper in existing geographies, nor are we not trying to drive new partnerships and expand our footprint in that regard. So that's really the overarching premise behind the guidance.

Paul Newsome -- Sandler O'Neill + Partners, L.P. -- Analyst

Well, that makes sense. And my second question is, if you could talk a little bit about capital adequacy levels. Obviously, you recently raised a little bit of capital, but you're also growing quite fast. Do you have any sense of assuming maybe the continued growth that we are seeing of late, how would the capital adequacy change over time?

Chris Uchida -- Chief Financial Officer

So we ended the year around 0.66 times ratio from a premium-to-surplus perspective. That was prior to the incremental, call it, $35 million of net capital that we brought on the balance sheet in January, that will push us probably closer to below 0.5 times. So we think that for the indefinite future, we are adequately capitalized. The combination of free cash flow will allow just in concert with organic growth, will allow us to kind of stay ahead of a ratio of 0.9 to 0.95 times, which is a number that we kind of think that we can get to on a steady-state basis.

And anything beyond that, that's when we probably look at incremental capital. But as long as we're below that 0.95, 0.9 times ratio, we think we're good.

Paul Newsome -- Sandler O'Neill + Partners, L.P. -- Analyst

Thank you. Congrats on the year.

Chris Uchida -- Chief Financial Officer

Thanks Paul.

Operator

Our next question is from David Motemaden, Evercore ISI.

David Motemaden -- Evercore ISI -- Analyst

Thanks. Good morning. Just a quick follow-up on the outlook for 2020. Are you guys assuming any catastrophe losses in there? Like a full retention loss? Or what is the assumption around cats in there?

Mac Armstrong -- Chief Executive Officer and Founder

Hey Dave, we are assuming kind of mini cats, so think about it as a similar type of loss profile to what you saw in 2019, there is not an assumption around a full retention loss. But if you look at 2019, we had losses from Tropical Storm Barry, Tropical Storm Imelda, Hurricane Dorian. So there are cats that influence it, and it's the mini-cat component to what we've seen historically, but no full retention loss.

David Motemaden -- Evercore ISI -- Analyst

Got it. Thanks. And Mac, just a follow-up on getting upgraded to AM Best Financial Size 9. Any sort of sense in terms of timing around that? And any other sort of initial thoughts or traction that you guys have seen from some of the larger brokers on the possibility of getting upgraded?

Mac Armstrong -- Chief Executive Officer and Founder

Yes, Dave. So the timing, the way that would work is, once we file our Q1 statutory and group financial statements in the Q, then we would automatically trigger it, because it's really just a mechanical process that they do once they import your financials into their system and then the financial size category is triggered. So you're talking about middle of the second quarter. And then over the course of the second half of that quarter and third quarter, is when it would probably really manifest itself in the market.

Going back to what I was talking about earlier on the call, we got the Financial Size Category 8 on the heels of the IPO and our first quarter results. And it really didn't start to bear fruit. Increased submission activity and the promulgation of a broader broker network until August, September time frame, so the latter half of the third quarter. Conservatively, I think the benefits of the Financial Size Category 9 would probably start to really, again, come to play at a similar time frame.

So third quarter, second half of the year.

David Motemaden -- Evercore ISI -- Analyst

Got it. And do you anticipate a similar type magnitude? Or I think you had said you got a doubling in submissions, when you got upgraded to AM Best Size 8?

Mac Armstrong -- Chief Executive Officer and Founder

I don't think it will be as pronounced as it was with AM Best Financial Size Category 8. I do think, though, it will help us in certain segments of commercial earthquake and commercial all risk, in particular, kind of layered and shared accounts, which candidly is an area where there's probably as much dislocation as anywhere in the property market, at least. So that should be helpful there. But I don't think it's going to be, again, as pronounced as it was in the conservative chance of going to financial size Category 8.

David Motemaden -- Evercore ISI -- Analyst

OK, got it. And if I could just sneak one more in. Just on the Japanese typhoon losses. Just sort of taking '19 and what happened with the losses in stride, does that change your approach at all to expanding into new lines going forward? And do you see making any changes to the assumed reinsurance book as a result of the experience?

Mac Armstrong -- Chief Executive Officer and Founder

So the assumed reinsurance strategy that we put in place is we hired Jon Knutzen to come be our chief risk officer, and in addition to overseeing our analytics department, he is looking to build out an assumed reinsurance product. And ultimately, what we're really trying to accomplish there is get access to certain geographies that have perils that we know well. So illustratively, northeast wind, where we're not licensed and actively writing business, or Canadian earthquake. That was what we were trying to do with assumed reinsurance.

And we've assembled a book that has exposure to those perils, plus some others, but all the business that we understand. Secondarily, we use it as a way to really kind of get a sense of the market on a global basis and a national basis to figure out where there are segments for us to potentially go into. So it's kind of a good tool for front-end R&D. So I think what I would say is I don't think the strategy is one that we're going to take our foot off the pedal on.

I think those same principles apply, as it gives us access to products or geographies where we can't access on a primary basis. It gives us a tool to do R&D. But at the same time, we hope that we can recoup some of the losses that we've incurred from that over the course of 2020. So I think the thesis remains solid, and it's one that we're going to continue to impart.

But hopefully get paid for the loss that we've incurred, and particularly from the Japanese storms.

David Motemaden -- Evercore ISI -- Analyst

OK great. Thank you.

Operator

Our next question is from Jeff Schmitt, William Blair. Please proceed with your question.

Jeff Schmitt -- William Blair -- Analyst

Hi. Good morning. A question on the attritional loss ratio. I think you had said it was around 2.5% excluding catastrophe events there.

How should we think about that going forward as the business mix changes? Obviously, it's probably going to go up, but can we get a sense of how you're looking at it from a degree perspective?

Chris Uchida -- Chief Financial Officer

Yes. Hey Jeff, that's correct. We said 2.5%, while backing out some of the assumed or some of the storm activity that we call mini-cats. We're not going to kind of a carve those out specifically.

We've kind of said in the past that we're only going to carve out full retention events that hit our books. So we view these, everything kind of on the attritional or mini cat, but we just want to make sure that people could see exactly what the more recurring or what we expect to be a little bit more recurring from a loss ratio standpoint. So that's why we disclosed that number. Like you said, as we grow into other lines of business, whether it be our all risk or inland marine, we would expect the loss ratio to just tick up naturally over time.

We think those lines of business do have attritional losses associated with them. They are going to have losses with them. We do use different types of quota shares to help minimize the impact that any of those losses can have on our book, but also helped generate fee income. That fee income will help to drive down our acquisition expense over time as well.

So we use a couple of different strategies to help those books, but they with the growth and with those becoming a larger component of our book, I would expect the loss ratio to tick up slightly over time. It's not going to jump, call it, five points to 7.5, but one point, 0.5 point over a quarter wouldn't surprise me.

Jeff Schmitt -- William Blair -- Analyst

OK. And then looking at that NPW to GPW retention. It was a bit higher than expected, close to 60%. Did you say that was kind of driven by that new assumed reinsurance business? And how should we think about that for 2020?

Chris Uchida -- Chief Financial Officer

Yes. So I'd say, for the fourth quarter, if I'm looking at that ratio, that's going to be driven by a lot of the growth that we've seen. Like I've said before, we buy excess of loss reinsurance in pieces, whether it be June 1 or January 1. So when you look at the excess of loss component of that, it's going to look a little bit more like a stair-step where you buy a piece of it, and then it's kind of set for five or six months, or three months, depending on how much growth we're seeing.

But when you look at the growth that we saw, so we bought excess of loss in June, then the growth on top of it, you're going to see a higher ratio that make the ceded written look a little bit lower. That's why I think it's more important from our standpoint to focus on the gross earned and the ceded earned, which is truly a more equivalent ratio of the risk that we're on and the excess of loss being amortized over the term of that excess of loss reinsurance. So like I said, for the year, it was right around 50%. I would expect that ratio to remain true in 2020 as well, assuming that there's no major shift in any of our lines of business or how we're doing quota share reinsurance.

The quota share reinsurance, kind of jumping around a little bit, is a lot more linear for the written and for the earning of it when you see it on our books. But as our mix stays the same, I would expect that 50% to be a better target when you look at the gross to ceded earned going forward.

Jeff Schmitt -- William Blair -- Analyst

Right. OK.

Operator

[Operator instructions] Our next question is from Meyer Shields, KBW. Please proceed with your question.

Meyer Shields -- KBW -- Analyst

Great. Thanks. Good morning. One of the themes that we heard from a number of reinsurers with regard to January 1, is that feeding commission rates were going down.

Are you seeing any of that in the quota share contracts that you're purchasing?

Mac Armstrong -- Chief Executive Officer and Founder

Hey Meyer, it's Mac. That's a good question. Fortunately, we have been able to maintain the economics on the quota shares that we put into place in the fourth quarter. And we didn't have much in the way of 1/1 coming up, but what we did renew, and particularly on the all risk side, was consistent with what we had expiring.

Meyer Shields -- KBW -- Analyst

OK, fantastic. And then I just want to touch a little bit more on Japan, because I think I understand that a little bit less. Are you writing that on a quota share or excess of loss basis yourself? And can you tell us what the reinsurance protections are for that particular business?

Mac Armstrong -- Chief Executive Officer and Founder

Sure. So we are writing that on an excess of loss basis. And the way we've done that is we have selectively partnered with existing reinsurers that we know well, that are big participants on our program. And so there's an inherent trust that we have with those reinsurers.

And there's an inherent familiarity that brings us a higher level of confidence. So what we are doing, though, is we are just taking a percentage of their excess of loss program, if you would. So we are attaching high up in depending on the reinsurers, but generally speaking, we're attaching pretty high up the PML, and as a result, like, you have the losses are fairly modest. So there's no first dollar exposure.

And I think it's worth pointing out that the losses that we have had, and Chris can chime in, it's an estimate right now. There have been no claims tendered. So we are just working in concert with our partners there.

Meyer Shields -- KBW -- Analyst

OK, fantastic. And then final question. I know the insurance commissioner in California is trying to sort of discourage nonrenewals. Is that impacting submission flow for California residential earthquake?

Mac Armstrong -- Chief Executive Officer and Founder

Yes, Meyer, that's a good question. What he certainly is the commissioner certainly is trying to discourage nonrenewals and has put a moratorium in place in selected areas. And I think that constituted roughly 800,000 homes in the state. So it was a small component of it, and frankly, they were areas that are probably most exposed to wildfire.

You're still seeing 10% of the average book of business, 10% of it being non-renewed. And I think that is a dynamic that, when you put into context of the total size of the book that an insurer has, even if they are into more 24 select segments, they can find another area to nonrenew. That probably doesn't meet their underwriting criteria at this point. So it's not impacting us, long-winded answer.

Meyer Shields -- KBW -- Analyst

OK. That's very helpful. Thank you so much.

Operator

Our next question is from Matt Carletti, JMP.

Matt Carletti -- JMP Securities -- Analyst

Thanks. Good morning, Chris. Actually, I want to follow-up on Jeff's question about kind of loss ratio progression as the book evolves. Is there any kind of corresponding expense ratio movement that we should expect in terms of whether it's kind of commissions paid with the smaller lines of business to start growing? And separately, just an expense ratio question generally is, as you kind of get to scale and kind of the target mix of business you're targeting, what's a good run rate expense ratio that the company can achieve?

Chris Uchida -- Chief Financial Officer

Yes. So on the acquisition expense for the lines of business that we're growing in, those will have a lower acquisition expense than our other lines of business. When you look at our residential earthquake business, it is driven by the MGA market, which has a higher acquisition expense. These other lines that we're looking at or that are growing right now, all risk, inland marine, are driven by the wholesale markets that just have a naturally lower acquisition expense than the MGA business.

As I mentioned, we also have quota shares for those lines of business. The ceding commission that we receive on the quota shares is netted against the commission expense, so that does help you drive down the acquisition expense a little bit more. So as those lines become a larger component of our overall book, I would expect the acquisition expense to also decrease, it's not going to drop similar to loss ratio, I don't expect it to jump up. I don't expect the acquisition expense to drop.

We have five points in the quarter, but I wouldn't be surprised to see it decrease slightly over a period of time. The other thing with that is, it's also on an earned basis, so it's going to take a little bit longer for that just to develop naturally through the book, but I would expect those lines to help push the acquisition expense down. Similarly, going to just the other operating expenses or the expense ratio in general, we have not provided any type of guidance on the expense ratio. But as we look at our book, as we look at the way we've built things for growth, whether it be on the residential lines or just the systems that we put in place, we would expect there to be more scale in the book as we continue to grow.

I think the top line growth that we're seeing should exceed any growth in expenses. That's not to say that we're not going to be prudent about adding people for technology, people for process improvement. But just naturally, the growth in the revenue is going to exceed the growth in the operating expenses. But we haven't provided specific guidance on the expense ratio is going to drop to 55 or anything like that.

We just think it's naturally going to go down over time.

Mac Armstrong -- Chief Executive Officer and Founder

And Matt, just to add a little more color. If you just look, to Chris' point, on the scale, the adjusted other operating expenses was 11.6% in the fourth quarter versus 12% in the same quarter to year prior, and that's with a lot more investment in headcount, technology and frankly, public company expenses. So I think that's illustrative of the scale that we are starting to achieve. So I think that's probably anecdotal support.

Matt Carletti -- JMP Securities -- Analyst

Great. And then if I could just sneak one more in. Mac, just a high-level question here. You've got a lot of kind of great opportunities ahead of you in very different kind of stages of growth and incubation.

As you kind of look out over the longer term, five years, whatever you want to define that as, which business do you see as the biggest opportunity for Palomar? Or potentially is the one that we haven't found out about yet and you guys have in the kind of an R&D and having, aren't public on?

Mac Armstrong -- Chief Executive Officer and Founder

Yes, good question, Matt. What I think just overarchingly right now, I think we're seeing more opportunity in the commercial side of our business. And within those lines that we have in commercial, it's called inland marine, commercial earthquake and all risk, there are different catalysts for each one. Commercial earthquake, not to beat a dead horse, but that was the prime beneficiary of our larger financial size category, and I think that's going to continue to be a driver of increased submission activity.

And then you couple that increased submission activity with a pretty attractive pricing environment, that leads to selectivity and growth and better margin. So I think we feel pretty good about the prospects there. The all risk side, that's in a much larger market than the earthquake market is. And while we're getting very good growth there, we still think we're in the early stages of that operation.

So I think there's a lot of promise there. And then inland marine is brand spanking new. Less than one year of operation, and we have some real talent in that organization. The leader of that department has now gotten his filings into all 27 states in which we are licensed.

He's increased his production count from the third to fourth quarter by over 140%. So he put a lot of infrastructure in place to really scale that organization. He's continuing to add talent. So I think that one, it's really just the tip of the iceberg.

So I think right now, we are probably seeing more growth in opportunity and promise in the commercial market. But we feel good about what we're doing also in the residential business and personal lines business.

Matt Carletti -- JMP Securities -- Analyst

Hey Mac, congrats on a first year as a public company, a strong one, and best of luck in 2020.

Mac Armstrong -- Chief Executive Officer and Founder

Thank you, Matt. Appreciate it. Thanks for your support.

Operator

Our next question is from Mark Hughes, SunTrust.

Mark Hughes -- SunTrust Robinson Humphrey -- Analyst

Mac, what was your comment on the pricing, residential versus commercial or different lines, what did you have to say? And then could you give us an update on where you kind of see things standing today?

Mac Armstrong -- Chief Executive Officer and Founder

Yes. So our residential business, we don't have the ability to take rate like we do in the commercial. And most of our products have what we call an inflation guard, which allows us to kind of take rate a little bit ahead of the cost of construction and the like. So those typically have a 5% automatic renewal increase on them.

And that's what we have in place right now for our personal business, personal lines of business. On the commercial side, our composite rate increase was right around 9%, 9.2% for the risk side, and then 13.4% for the commercial earthquake. So very strong. And I think we've touched upon it.

The rate increases accelerated from the third quarter versus the second quarter, and certainly did from the fourth quarter versus the third quarter. I think we feel very good about the ability to maintain rate through the course of 2020, and frankly, that is much informed by the continued pull back of capacity from some of our competitors, Lloyd's, in particular. I think there are another five syndicates that were wound down in the fourth quarter. I think there's very strong rate integrity on our distribution network.

It's all alignment there. And then larger riders continue to be mindful of their capacity, in particular, in larger property schedules. So we feel very good about the pricing dynamic that we're seeing today and that we saw in the fourth quarter and don't see a near-term catalyst that pushes it the other way.

Mark Hughes -- SunTrust Robinson Humphrey -- Analyst

How about the specialty homeowners? You've still got solid growth there, but being outstripped by other lines. How's the competitive environment or your appetite there?

Mac Armstrong -- Chief Executive Officer and Founder

What I would say, it's more our appetite, that's a nice line of business for us, and we put it into the specialty homeowners quota share facility. So it's a good driver of fee income for us. But it's also, in the circumstance of our Texas book, it's probably our most mature line of business. So we've kind of governed ourselves in terms of how much we're going to grow.

We will grow that as we extend our geographic footprint. In the fourth quarter, we started to bring on more business in North Carolina to balance what we're doing in Texas, Mississippi and Alabama, and there are other states that are on the horizon over the course of 2020. But that line of business won't grow as quickly as any of the commercial lines. It won't grow as quickly as flood, it's not going to grow as quickly as residential quake.

Operator

We have reached the end of the question-and-answer session, and I will now turn the call back over to Mac Armstrong for closing remarks.

Mac Armstrong -- Chief Executive Officer and Founder

Thank you, operator, and thank you all for your time this morning. This concludes Palomar's fourth-quarter and full-year earnings call. We appreciate the time, the questions and always, your support. We feel that 2019 was a milestone year for the company.

We entered several new lines of business, expanded our geographic footprint, we strengthened our team through the addition of several highly talented industry veterans, and we generated strong financial results. Hopefully that you will see that our 2019 accomplishments provide both motivation and invigoration for 2020. And hopefully, that the earnings guidance we provided you, you will feel very good about the prospects for 2020. Certainly, we do.

So we look forward to speaking with you after the first quarter, and thank you very much for your time. Have a great day.

Operator

[Operator signoff]

Duration: 52 minutes

Call participants:

Chris Uchida -- Chief Financial Officer

Mac Armstrong -- Chief Executive Officer and Founder

Mark Hughes -- SunTrust Robinson Humphrey -- Analyst

Paul Newsome -- Sandler O'Neill + Partners, L.P. -- Analyst

David Motemaden -- Evercore ISI -- Analyst

Jeff Schmitt -- William Blair -- Analyst

Meyer Shields -- KBW -- Analyst

Matt Carletti -- JMP Securities -- Analyst

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