Earnings Call Transcript - KINS Q2 2022

Operator, Operator

Greetings, and welcome to the Kingstone Companies Second Quarter 2022 Earnings Conference Call. At this time, all participants are in listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host Ms. Amanda Goldstein, Investor Relations Director. Thank you, please go ahead.

Amanda Goldstein, Investor Relations Director

Thank you very much, and good morning, everyone. Yesterday afternoon, the company issued a press release detailing Kingstone's 2022 second quarter results. On this call, Kingstone may make forward-looking statements regarding itself and its business. The forward-looking events and circumstances discussed on this call may not occur and could differ materially as a result of known and unknown risk factors and uncertainties affecting Kingstone. For more information, please refer to the section entitled Factors that may affect future results and financial condition in Part 1, Item 1A of the company's Form 10-K for the year ended December 31, 2021, along with the commentary on forward-looking statements at the end of the company's earnings release issued yesterday. In addition, our remarks today include references to non-GAAP measures. For a reconciliation of our non-GAAP measures to the GAAP figures, please see the tables in our earnings release. With that, I'd like to turn the call over to Kingstone's CEO, Mr. Barry Goldstein. Please go ahead, Mr. Goldstein.

Barry Goldstein, CEO

Thanks, Amanda, and good morning, everyone. We're pleased that you can join us for this second quarter 2022 conference call as in our prior call, with the elephants still present in the room. At the end of our remarks, I will share what I can and hope you understand that what I say is limited as per an existing nondisclosure agreement. Today, as in our prior call, we will only accept questions from the analysts that cover this stock. But first let me talk about the state of Kingstone. Our focus remains squarely on returning Kingstone to profitability. It's not an overnight process, but much has already been done, and much is underway. I'd like to begin by reviewing the key changes we've made, and which we have focused on in order to improve our profitability. First, we have been and continue to take rate in all states. We're achieving this through a combination of rate filings, inflation-driven increases, and adjustments to coverage to properly reflect increased replacement costs. Second, through the introduction of our new select product suite, which better matches rate to risk, we are targeting more profitable risk profiles. Select is now live in over 85% of our footprint, which will increase to more than 90% when our next state goes live later this quarter. Third, we developed and have implemented a proprietary model to enable us to better identify currently insured risks that do not meet our profitability standards. Lastly, we've made numerous changes to reduce our expenses. I'm pleased to note that this effort has begun to bear fruit, as a result of Kingstone 2.0, and that'll be discussed by Meryl. But one last thing before Meryl reviews our operating results, I feel obligated to point out what many of you already know: Our premium rates are approved by the insurance departments of each state in which we operate and remain at that level until the next approved change. We cannot and do not flow through our increased costs as they occur, like so many other businesses can. Our loss and loss adjustment expenses are subject to inflation and supply chain issues that make repairs more difficult and make the repair processes take longer. So yes, we priced that in, but the rate impact is deferred. Our current results reflect the 9% to 10% inflation seen throughout our Northeast footprint. With that, let me turn it over to Meryl to review our operating results for the second quarter. Meryl, please go ahead.

Meryl Golden, CFO

Great, thanks, Barry. The company posted a second quarter net loss of $5.4 million and $0.51 per diluted share compared to net income of $1.3 million and $0.12 per diluted share for the same period last year. While approximately $0.33 per share of this decline was attributable to a spike in market interest rates and a decline in the value of our equities and other investments, I will tackle the operations portion and Barry will rejoin to go over the investment portfolio. Direct premiums for the quarter were up $5.2 million from the prior year to $49.8 million; most of this growth was due to rate increases. During the quarter, our written premium increased by 11.6%, while our policies in force grew only 3.3%. Similar to what we shared in the first quarter, we are adding premium at more than three times the rate that we are adding exposures. We expect this premium growth to continue, and the delta between premiums and expected losses to widen throughout the remainder of the year. While we have seen our rates increase, we have also seen our policyholder retention increase; our retention is up in every major line of business we write. This, along with a 20% increase in quota activity, gives you a sense of the favorable competitive environment we are operating in. Net written premiums declined versus last year due to our entering into a new 30% personal lines quota share treaty. The net loss and loss adjustment expense ratio was 66.9%, up 8.3 points from the prior year period. This increase from the prior year was attributable to two main items. First, we experienced an increase in fire severity due to some large fire claims, as well as the impact of inflation. While Q2 losses were elevated, I want to point out that our year-to-date fire loss experience is in line with historical averages. Second, non-weather water claims added approximately four points to the quarter's loss ratio relative to the prior year. I noted that several large carriers mentioned an increase in water claims this quarter. Our new Select product, which includes by-peril rating, prices the water peril more accurately. We are working hard to stay ahead of inflation and loss costs. In addition to inflation-driven rate increases, we are also adjusting replacement costs on policies at renewal. I also want to mention that one main driver of our high loss ratio for the 2021 accident year was high liability claim frequency for dwelling fire, particularly, which has not been a driver in 2022. We attributed this increase in frequency to COVID, and fortunately, we are now trending back to historical levels. For the current quarter, the net underwriting expense ratio decreased 5.4 points to 36.4%. Our expense reduction is driven by the quota share and corresponding seating commission, but also by multiple expense reduction initiatives from our Kingstone 2.0 strategy that are starting to take hold. Please take a look at the press release and you'll see that each of our captions expenses is down versus the prior year, or has grown far slower than direct written premium. As the quota share makes our expenses difficult to understand, let me share some interesting facts with you: our underwriting expense is now down to 14.1% of direct earned premium from 15.7% in the prior year period, and our total commission expense is down to 18% of direct earned premium compared to 19.4% for the prior period. Our legacy system conversion, one of our key Kingstone 2.0 initiatives, will be completed ahead of schedule in Q3 and will lead to an even greater expense reduction as we move forward. I want to thank all of our employees who have worked so hard to make this goal a reality. I look forward to seeing the benefit of our incredibly hard work in Kingstone's financial results, as we have done and continue to do all of the right things to return the company to profitability. Now, let me turn the call back over to Barry to discuss our investment results.

Barry Goldstein, CEO

Great, thanks, Meryl. I also need to address the portfolio. As you know, we've always invested primarily in highly rated limited duration fixed income securities and similar items that are meant to provide us with income while limiting our risk profile. Like all others, we have seen the dramatic rise in interest rates in the first and second quarters result in a decline in bond values, felt most profoundly in the shorter maturities that Kingstone holds. A portfolio realignment during late last year led us to holding better quality bonds and a more diversified portfolio, albeit at lower rates than previous and lower than available today. While these bond prices are down, we are required to reduce their values, mark them to market, and flow the change through our balance sheet as other comprehensive income. We have always invested with the intent of holding and not trading bonds. We fully expect that our A+ rated portfolio will pay off at par upon maturity, and the decline in other comprehensive income will be restored at that time, as rates have already begun to return and now are back to early Q2 levels. Book value per share suffered by $0.57 in the second quarter and $1.30 year-to-date. Also suffering declines were our preferred stocks and fixed income ETFs, both being bond surrogates that behave in a very similar way to changes in rates. As these equities decline, we record those changes in our income statement, reducing our earnings. Realized and unrealized changes in our equity portfolio have reduced per share earnings by $0.33 for the second quarter and $0.67 for this six-month period. Finally, I'd like to briefly address the business update we provided in our earnings release late yesterday afternoon. Our Board and Management team regularly review Kingstone's strategic, operational, and financial priorities. We do so in the context of the current operating environment, with the objective of driving shareholder value forward. Consistent with this, following our third quarter 2021 operational review, we shared with the Board and then engaged an independent financial advisor to aid in the exploration of a range of options that might have the potential for enhanced shareholder value creation. In May, we announced that Kingstone received a preliminary non-binding indication of interest with regard to an acquisition of all of the outstanding equity of the company. Last week, it was disclosed that following that third-party's substantial completion of its due diligence, Kingstone received the final non-binding indication of interest and agreed to extend the previously executed exclusivity agreement to further pursue the proposal. While no assurances can be given that the transaction will be consummated, the Kingstone Board of Directors is committed to acting in the best interest of the company and its stockholders, and we will continue to take actions consistent with that objective. We do not intend to comment further on this topic unless and until an agreement is reached or a disclosure becomes required. As such, I ask that you keep your questions today focused on our financial results and performance. With that operator, please take the analyst's questions.

Operator, Operator

Thank you. Our first question today is coming from Paul Newsome of Piper Sandler. Please go ahead.

Paul Newsome, Analyst

Good morning. Thanks for the call. I have a couple of questions here. I want to ask about the premium in force growth and retention. I'd like you to tie these thoughts and comments into what you're doing, or at least provide more details about what you're doing on the in-force book to essentially improve the profitability of that. Looking at the insured value and things of that nature, I was a little surprised that retention improved, because in your books you're not profitable. You generally want premium in-force growth to shrink. So could you talk about what you're doing to work that existing book into a more profitable state, besides just rolling it into the new product?

Barry Goldstein, CEO

Yes, so there are a few parts of that question. I'll try to handle them, Paul, and I'll let Meryl correct me or embellish upon what I say first. I mean, your statement that retention sounds as though you think retention is a bad thing when we're unprofitable. The fact of the matter is, in most sections of our book, we are profitable. It's those specific areas that have not proven to meet our requirements that we're targeting. I'm not going to tell you what our secret sauce is because I know we have competitors listening to this call. But at a minimum, we've eliminated our exposure to the high-value market. We no longer write high-value homes, and over time, we'll continue to eliminate those risks from our book. So that's the kind of thing I'm talking about. We have a lot of other pieces to that algorithm we've built, but again, I can't share that with you. In terms of Meryl, would you like to pick up anything here?

Meryl Golden, CFO

Sure, Paul, we're taking rate, we're non-renewing unprofitable segments, and we are working with unprofitable producers to move some of their business elsewhere. We're pulling updated replacement costs and ensuring that our book is insured to value. So it's a combination of all those factors and others.

Barry Goldstein, CEO

But Paul, I think the operative point here is we are selling new business. About 80% of our business still comes from New York. We are selling new business in New York and adding premium in force there while eliminating these unprofitable risks. So the small single-digit growth in the premium in force this quarter is the net of new business additions that are far better priced and underwritten, and the elimination of those risks that we're targeting. I hope that gives you a little color on what we're doing.

Paul Newsome, Analyst

It absolutely does. And then I want to ask about the net investment income level. Excluding the unrealized losses, which I think is pretty normal this quarter for insurers, the straight-up net investment income was a little bit lower than I expected. Is that due to the ETFs and other items that you mentioned?

Barry Goldstein, CEO

No, because we are not involved in that.

Paul Newsome, Analyst

Between stock market?

Barry Goldstein, CEO

Yes. I mean, we are going to publish our 10-Q due on Monday afternoon and we'll have that out timely. In that report, you'll see that in the quarter, we needed to make an adjustment and reduce our accrued interest receivable on a segment of Fannie Mae bonds. It was a result of our third-party software processor having an overall accrual. We rely upon their SOX-1 filing, but we had to take a one-time write-off of something north of $700,000 on a pre-tax basis. So you'll see that disclosed in the footnotes. But if you were to add back that charge, this quarter's investment income is pretty much where you'd expect it to be.

Paul Newsome, Analyst

Thank you. So that should snap back?

Barry Goldstein, CEO

Yes.

Paul Newsome, Analyst

To levels?

Barry Goldstein, CEO

It had nothing to do with 2022 at all.

Paul Newsome, Analyst

Right. Finally, can you add anything about the rest of the capital structure? You have some debt, this refinancing. I know there may be some limited comments you can make, but I'm getting a lot of questions about it.

Barry Goldstein, CEO

I'm sure you are. What I can assure you is that we're not just cognizant of it but are actively working on that. I hope to be able to share the progress we're making, but at this point, those bonds come due on December 30. We fully expect to pay off those bonds on time, and we do have an opportunity to pay them off early when the refinancing is done. However, the terms of those bonds make it prohibitively expensive because if we wanted to pay them off early, we'd still have to pay the interest through December 30 with a minor discount. The answer to your question is, we're aware of it. We're working on it. We've got several major activities going on at the same time. I believe there’s more than one challenge, but I have been discussing one. I hope the confidence our investors have had over the years will be restated, as we have discharged our obligations timely without fail. That's what's going to happen again.

Paul Newsome, Analyst

Thank you. I'll let other folks ask questions. Thank you for your help.

Barry Goldstein, CEO

Thank you.

Operator, Operator

Thank you. At this time, I'd like to turn the floor back over to Mr. Goldstein, President and Chief Executive Officer of Kingstone Companies for closing comments.

Barry Goldstein, CEO

Well, thank you, operator, and much appreciated. That concludes our call for today. Thank you all for listening in and I hope to speak with you all very soon. Bye-bye.

Operator, Operator

Ladies and gentlemen, thank you for your participation and interest in Kingstone Companies. You may disconnect your lines or log off the webcast at this time and enjoy the rest of your day.