Kinsale Capital Group, Inc. Q1 FY2020 Earnings Call

Ladies and gentlemen, thank you for standing by and welcome to the First Quarter 2020 Kinsale Capital Group, Inc. Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. Before we get started, let me remind everyone that through the course of the teleconference, Kinsale's management may make comments that reflect their intentions, beliefs and expectations for the future. As always, these forward-looking statements are subject to certain risk factors which could cause actual results to differ materially. These risk factors are listed in the company's various SEC filings, including the first quarter 2020 quarterly report on Form 10-Q and the 2019 Annual Report on Form 10-K which should be reviewed carefully. The company has furnished a Form 8-K with the Securities and Exchange Commission that contains the press release announcing its first quarter results. Kinsale's management may also reference certain non-GAAP financial measures in the call today. A reconciliation of GAAP to these measures can be found in the press release, which is available at the company's website at www.kinsalecapitalgroup.com. I will now turn the conference over to Kinsale's President and CEO, Mr. Michael Kehoe. Please go ahead, sir.

Thank you very much operator, and good morning, and welcome to our call. We hope everyone participating on the call is staying well and we want to especially commend all the Kinsale employees for their hard work and flexibility during this crisis in adapting so quickly to our remote work arrangement and in continuing to deliver best-in-class service to our brokers around the country. Their efforts in particular have helped to distinguish Kinsale and to drive the superior performance we reported last night. Joining me on today's call are Bryan Petrucelli, Kinsale's CFO and Brian Haney, Kinsale's COO. Last night we reported a 19% increase in operating earnings per share compared to the first quarter of 2019, a 47% increase in written premium and a combined ratio of about 84%. Our annualized operating ROE was 17% for the first quarter. Bryan Petrucelli will provide some additional detail and color on our financial performance here in a moment. Kinsale's strategy of focusing on the E&S market, controlling our underwriting and claim handling operations absolutely and using technology to improve customer service and reduce costs served us well this quarter. When the virus hit and we needed to shift to a work from home model, we were able to do so quickly and with no loss in productivity or drop-off in service levels. As of now, 90% of our employees are working remotely, and our business is firing on all cylinders. There has been a considerable amount of commentary about the coronavirus and its impact on the P&C industry. This is an evolving topic and subject to some element of uncertainty. However, given what we know at this point, we do not believe the coronavirus will have a material impact on Kinsale’s profitability or growth. Specifically, Kinsale does not write any of the following lines of business that may have a heightened exposure to virus related losses. Event cancellation, work comp, surety, trade credit, mortgage insurance or reinsurance areas where we could be exposed to losses, include commercial property, premises liability, management liability and allied healthcare liability. I'll start with the commercial property. Kinsale’s property book focuses on industrial type exposures in general, processing facilities, recyclers, warehouses, vacant properties, et cetera. We generally avoid occupancies like restaurants, gyms, theaters, et cetera, that may be more exposed to government shutdown orders. We believe the overwhelming majority of our policyholders are still operating during this crisis. All of our policies require direct physical damage to trigger coverage, all include virus exclusions and all include an authorities exclusion, which specifically precludes coverage for claims arising from government shutdown orders. To date, we have received 17 commercial property claims. Eight of these involve policies that either do not have business income coverage at all or policies where the BI limit is below the attachment point of Kinsale’s excess policy. So, in effect, for those policies, there's zero exposure to our coverage. The remaining nine policies could possibly present exposure to loss subject to a complete investigation, subject to the terms and conditions of the policy and subject to a BI calculation that exceeds Kinsale’s attachment point, as these are mostly excess policies. We have not received any claims to date in the management liability, premises liability or the allied healthcare liability areas related to coronavirus. Again, we anticipate policy terms and conditions would preclude coverage for most claims. Specifically, the allied healthcare coverage excludes communicable disease on every policy. Our premises liability accounts both primary and excess, exclude viruses and our D&O book excludes bodily injury on every policy. Of course, upon receipt of any claim, we will conduct a thorough investigation and proceed appropriately given the coverage in place, the allegations and the circumstances. Regarding the impact on growth, a few thoughts. Kinsale grew 41% last year and 47% in the first quarter, principally due to dislocation within the broader P&C industry. After a long period of intense industry competition, many companies, standard and non-standard, are restructuring their books of business, running off underperforming lines, reducing capacity, raising prices and canceling programs, as a disciplined underwriting company that didn't lose its way during the soft period of the insurance cycle, Kinsale is not canceling or running off anything. We're working very hard to grow the business and expand our margins. Any slowdown in the P&C industry and specifically the E&S market due to an economic contraction, we expect to be offset by the continuing market dislocation. We expect this dislocation to continue for the remainder of 2020 and perhaps even into 2021. It's possible the coronavirus even adds to this level of dislocation. Time will tell. I'll now turn the call over to Bryan Petrucelli.

Thanks Mike. As Mike highlighted, we experienced a strong quarter and are pleased with the premium growth and profitability we've achieved, especially considering the effects of COVID-19 on the economy. Our objective is to consistently attain combined ratios in the mid-80s and operating returns on equity in the mid-teens. In the first quarter, we recorded an 84% combined ratio and a 17% annualized operating ROE, aligning with that target. The financial market volatility at the end of the quarter negatively impacted our net income and comprehensive income. However, the markets have recovered in April, and we've regained about three-quarters of the unrealized investment losses incurred in the first quarter. We reported net income of $5.1 million for Q1 2020, which is a 72.8% decrease from last year, noting that 2020 included around $16 million in pretax unrealized losses on our equity investments. Net operating earnings increased by 24.5%, reaching $17.2 million compared to $13.8 million in the same quarter last year. The company generated underwriting income of $14.4 million and a combined ratio of 83.9%, compared to $12 million and 80.3% last year. The combined ratio for Q1 2020 included 3.4 points from favorable prior year loss reserve development, while last year had 10.4 points. Although we haven't received many claims directly related to COVID-19, we noticed a slowdown in reported losses, likely due to courts operating at reduced capacity and other legal inefficiencies because of COVID-19. We incorporated some conservatism into our reserves, adding approximately $5.4 million in additional IBNR in Q1 to address uncertainties tied to COVID-19. Our effective income tax rate was a negative 1.1% for the quarter, in contrast to 17.9% last year. This negative rate was influenced by discrete tax benefits recognized from the exercise of stock options during the quarter and the impact of unrealized losses on our quarterly taxable income. Gross written premiums were $124 million, a 47% increase from last year, driven by the factors Mike mentioned, including ongoing market dislocation and sustained service levels. On the investment front, net investment income rose by about 32% year-over-year, reaching $6 million from $4.5 million last year due to continued growth in the investment portfolio. However, annual gross investment returns, excluding cash and cash equivalents, fell to 2.9% from 3.2% last year, mainly due to the lower interest rate environment in the first quarter. Diluted earnings per share for the quarter were $0.76, compared to $0.64 last year. If we normalize our effective tax rate, the $0.76 would have been reduced by approximately $0.03. With that, I'll hand it over to Brian Haney.

Thanks Bryan. As mentioned earlier, premium grew 47% in the first quarter. The highest growth rates were in our commercial property, allied healthcare, excess casualty, inland marine and management liability divisions. But, in general, we saw strong growth across the portfolio. Our spare business was up 29% for the quarter. We took significant rate actions in our personal insurance book, which as you will recall, is focused on manufactured housing in the coastal states. This has led to a more modest growth in item count, but at a more attractive margin. Pre-coronavirus submission growth was on track to be around 30% for the quarter. The first couple of weeks of the lockdown, the growth rate slowed to a single digit rate, but has recovered significantly to the low to mid-20 range in the last two weeks. Weekly numbers can be volatile, but we are encouraged by the bounce back. During that brief submission slowdown, we made the best of the situation by improving our customer service and quote ratios. As you know, we frequently count our technology as a competitive advantage. Sometimes, it's hard to put that in perspective for the investor, but this situation provides an excellent example of how we really are different. In a matter of about a week, we went from having a small percentage of our staff working from home to having more than 90% working from home. We have not missed a beat. Among our underwriting staff, we had one person working from home before COVID and more than 90% after. With one month's worth of data to look at, it is clear we are getting out more quotes per underwriter than we did previously. So, not only have we been able to smoothly transition to a work from home model, we've actually gotten better and more efficient. It's a testimony to the strength of our systems, the effectiveness of our IT team and how hardworking and diligent our employees are. So while submission growth has moderated in response to the COVID situation, quote growth has stayed high and combined with the rate increases, we've been able to continue to grow the premium at a healthy pace. The market dislocation we have discussed over the last year hasn't abated due to the virus. Accordingly, we continue to increase rates in response to market conditions. As a reminder, we have a very heterogeneous book of business, which complicates reducing all the rate movement to a single number. But that all being said, we see rates being up in the plus 10% to plus 12% range in the aggregate during the first quarter. And with that, I'll turn it back over to Mike.

Thanks, Brian. Operator, we're now ready for any questions that come in.

Certainly. And our first question comes from the line of Matt Carletti with JMP Securities.

Hey, good morning.

Good morning, Matt.

Got a couple of questions. First is just a clarification, just following on Brian's comments there. That, that commentary about the brief slowdown and then quickly responded to re-rebounded to the mid-20s. Is that submission count growth you're talking about and not a premium level, so not taking into account pricing or exposure, just the submission count?

Correct.

Can you provide some insight into the small amount of favorable prior period development this quarter? Is it related to specific accident years with significant fluctuations, or was it a minor adjustment across the board?

We don't have any specific info. I think it was generally across the board, Matt.

Okay. Great. Wonderful. That's all I got. Thank you very much and best of luck.

Thanks, Matt.

Thank you. And our next question comes from the line of Mark Hughes with SunTrust.

Yeah, thank you. Good morning.

Good morning, Mark.

Could you discuss what you have observed with small accounts? There is clearly a lot of concern regarding the overall business. What has been your experience thus far and what do you expect moving forward?

We, as a company, are certainly focused on small accounts. Our average premiums are typically around $10,000 per policy. There's significant dislocation in the economy right now, as reflected in the headlines. We've detailed what we're experiencing; there was a noticeable drop in submissions for a few weeks, but we've seen a solid rebound, although not back to the 30% level, but rather in the 20% range. Premium growth has been less affected, and part of that is due to rate increases, as well as our ability to quote a higher percentage of incoming submissions.

What about cancellations or mid-term premium adjustments? Are there any signs of that occurring?

Yeah, I mean, we're doing a lot of one-off accommodations. If someone calls and says, hey, my business has been shutdown for two months. Okay. Why don't we extend your expiration date by two months for no additional premium, right? And just kind of working those things out on a case by case basis.

And how material has that activity been?

It hasn't been overwhelming, but there's clearly, a number of transactions every day. I mean, keep in mind, we write tens of thousands of policies. We have hundreds of thousands of submissions. So, in the grand scheme of things, it hasn't been dramatic enough that it’s impacted our top line. But we're trying to do the right thing. This is an incredible crisis that's come up very suddenly, and we want to treat our policyholders fairly. And that's essentially what we're doing.

Bryan, you mentioned that you allocated $5.4 million in additional IBNR in the first quarter. Can you elaborate on that? Does this relate to the decrease in claims, considering the claims you would typically report resulted in lower losses, yet you increased the IBNR for the sake of conservatism?

Hey, Mark, this is Mike again. Yeah, we noticed a modest downtick in claim frequency. But the real driver is just kind of the general uncertainty created by this crisis. You can read all the commentary out there about its possible impact on the P&C industry. We feel that we're very well-positioned, but there's still a lot of uncertainty out there. And so, we're just trying to drive a little bit of additional conservatism in our IBNR.

So, you're suggesting that in other things being equal with the claims volume with the pricing, the loss pick might have been lower $5.4 million lower, but you added some additional conservatives?

Yeah.

The expense ratio was quite good, and it seems like you're achieving operating leverage. If I recall correctly, you mentioned that a figure around 25 or 26 is ideal. This current ratio is about 24. Should we anticipate that a lower figure will be sustainable?

Mark, I think, that 25% pick is probably a good number. We're obviously growing premium. We're adding staff in the underwriting areas and some of the IT areas. We're monitoring what's going on sort of with the premium and we'll add staff accordingly. But I think, just like we always have, I think we're very conscious on managing expenses to a reasonable level. What's going to ebb and flow a little bit, but I'd say the 24.5, 25 is probably a good place to look.

Do you have any comments on the pricing trends you've observed in April? Mike, I believe you mentioned that you expect the dislocation to persist throughout 2020, with no changes in the upward trend for April.

Yeah, this is Bryan. No. No change. We're still pushing rate. And we're going to change the trajectory.

I was curious if there have been any significant changes at Lloyd's. I noticed they seemed to reduce some of their exposure in California during the first quarter, but the latest data didn't indicate a decrease in their E&S business. Is there any information from Lloyd's, or perhaps a broader perspective on the dislocation?

Yeah. Mark, this is my Mike again. I don't think we want to comment on competitors. We'll let them speak for themselves. But in general, I think to Bryan's point, right? The dislocation in the market is continuing. We went through a long period of very intense price competition. I don't think it's unusual that it takes the industry a little bit of time to kind of get things on track. So, that's why we made that comment. Obviously, we're speculating. We don't know definitively how the year is going to unfold, but our general guess at this point is that the trading environment in terms of rate trends and reduction in capacity and all these restructurings that are ongoing, we think that's going to continue for the balance of the year.

Thank you.

Thank you. And our next question comes from the line of Ron Bobman with Capital Returns.

Hi, and thanks again for taking my questions. I'm wondering that without sort of addressing the competitive questions that were just asked, I'm wondering if you could sort of come at it from a different way. Are you seeing any change to your buying to quote ratio of late?

No.

There is a significant chance that certain business segments will experience more challenges due to the pandemic and the weakening economy. It is possible that some areas might reach a critical state where capacity becomes insufficient. Are there any potential opportunities on your radar for entering a new line if conditions worsen significantly?

I would say we're always looking for new opportunities and working on the incremental expansion of our product line. Keep in mind, we only operate in non-admitted or excess and surplus lines. Regarding the areas you mentioned, such as surety, you need to have licensed paper for that. So, the answer is yes. We're always seeking to expand, but in the near term, we're focusing on the E&S market.

Okay. Thanks a lot.

Thanks, Ron.

And I am showing no further questions at this time. So, with that, I'll turn the call back over to CEO, Michael Kehoe, for closing remarks.

Yeah, we'll take him. Do we have one more call operator or one more question?

Yes. I see we just had Sam Hoffman from Lincoln Square, queue up. Sir, your line is now open.

Good morning.

Good morning, Sam.

Thanks for taking my question. I'm just following up on Mark's question, where you said that the cancellations and mid-term premium adjustments were relatively minor at this point. To what extent do you believe that these are lagging indicators and that they should increase dramatically in the second corridor? Because I guess maybe your insurance company, you might be the last party that you would call at the beginning of the crisis. And so, have you think about that going forward in terms of your expectations to receive additional cancellations and mid-term adjustments?

As a company focused on small commercial buyers, we experience a high volume of cancellations every day under normal operating conditions. It's not uncommon for small businesses to delay premium payments, or for someone to purchase coverage because a contractor requires it for a job. Once the job is completed, which may be in three months, they often cancel the policy. We are currently about six to eight weeks into this process.

We're not noticing an increase in the requests. In fact, it's slightly decreasing, and I wouldn't describe it as significant at all.

So, it's possible that it picks up, but we feel pretty good about that that's not going to be a big problem for us.

Is this different from your experience in previous recessions, like the financial crisis or consistent?

I think, it's consistent. I mean, if you look back at the E&S market broadly during the 2008 recession, the E&S market did shrink a couple percentage points. But it's an industry where our customers are typically buying insurance, because it's compulsory, either their landlord or the general contractor requires it, or if you worked for the highway department, they require the coverage. If your product's being sold to a retail store, the retailer requires the coverage. So, you don't have wild swings in revenue volatility like you might have in other industries, like say, auto manufacturing. We're kind of insulated I think from some of that dynamic.

Okay. I missed the beginning of the call, but did you comment on your exposure to restaurants and bars and the retail and other types of industries that are shutdown and how that affects what we're talking about?

We did as respects the property book. Well, we write commercial property that was 8% of our premium volume last year. And our property book is skewed heavily in favor of a more industrial type exposure. So, warehouses and processing facilities, recyclers. We have very, very limited exposure to, I think, the type of occupancies you're talking about in our property book, restaurants, theaters, gyms, things like that. We think anecdotally that overwhelmingly our insureds continue to operate during this crisis. It's not to say universally, but most of them we think are. And that combined with our coverage limitations, we think put us in a very good spot in terms of exposure to COVID related claims.

Great. Thanks for taking my questions.

Okay. Thanks, Sam.

Thank you. I will now turn the call back over to CEO, Mr. Michael Kehoe, for closing remarks.

Thank you, operator. And thanks everybody for joining us on the call today, and stay well and we look forward to speaking with you again in a few months. Have a good day.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating and you may now disconnect.