Kinsale Capital Group, Inc. Q1 FY2022 Earnings Call

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 2021 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. I will now turn the conference over to Kinsale's President and CEO, Mr. Michael Kehoe. Please go ahead, sir.

Thank you, operator. And good morning, everyone. Welcome to our first quarter conference call. As you know, both Bryan Petrucelli, Kinsale's CFO; and Brian Haney, Kinsale's COO are joining me. They will each make a few comments on the quarter and then proceed to any questions that you may have. Kinsale's operating earnings for the first quarter 2022 increased by 47% over the same quarter in 2021, and gross written premium was up 45%. The company posted a 79% combined ratio for the quarter and an annualized operating return-on-equity of 22.1%. The performance of the business in the first quarter of 2022 is really a continuation of what we have been seeing for the last couple of years. A favorable and growing E&S market is creating a tailwind for Kinsale, in particular, by allowing us to raise rates and grow our premium at an unusually high level. Adding to this tailwind is our own unique business strategy, expert underwriting and claim handling, together with a technology-driven low-cost operation, the combination of which creates a powerful opportunity to deliver best-in-class profit and growth in the years ahead. We remain confident that the E&S market environment will remain favorable and allow for further rate increases and strong premium growth over the course of the next year. Beyond that, we have a little less visibility on the broader market, but we do have visibility on our competitive advantages which we believe have real durability to them, specifically controlling our own underwriting and not contracting that out to third parties; and secondly, building a core competency around technology, just like we do underwriting and claim handling, owning our own core systems and not relying on external parties for that function contributes to our highly automated business process and all the various benefits that flow from it, productivity gains, superior customer service, more robust and accurate data, and of course, it's driving our low expense ratio and boosting our returns. I'll now turn the call over to Bryan Petrucelli.

Thanks, Mike. The business continues to perform at a very high level with gross written premiums growing by 45% due to the continual favorable market conditions Mike just mentioned. We reported net income of $31.8 million for the first quarter of 2022, down slightly from $32.1 million last year, due primarily to unrealized losses on our equity portfolio. Net operating earnings, which excludes the impact from fluctuations in equity values increased by approximately 48%, up to $38 million from $26 million last year. The company generated underwriting income of $38 million and a combined ratio of 79% for the quarter compared to $25 million and 80% last year. The combined ratio for the first quarter of 2022 included 4.7 points from net favorable prior year loss reserve development compared to 5.7 points last year, with cap losses being negligible in both periods. We have a 21.6% expense ratio for the quarter that continues to benefit from some economies of scale with earned premiums that are growing faster than our operating expenses. Operating return-on-equity was approximately 22% for the year, and again, ahead of our mid-teens guidance. Book value decreased by 4.8% for the quarter, primarily due to unrealized losses on our fixed income securities resulting from the higher interest rate environment. The company continues to generate strong positive operating cash flows which gives us the ability to hold these securities to maturity, and the higher interest rate environment allows us to invest new money at better yields; this ultimately benefits the company over the long-term. Net investment income increased by 31% over the first quarter last year up to $9 million from $7 million last year as a result of continued growth in the investment portfolio. Annual gross investment returns excluding cash and cash equivalents was 2.5% for the quarter compared to 2.6% last year. Lastly, diluted operating earnings per share was $1.63 per share for the quarter compared to $1.11 per share last year. With that, I'll pass it over to Brian Haney.

Thanks, Bryan. As mentioned earlier, premium grew 45% in the first quarter, up from 36% in the fourth quarter. We saw further hardening in the property market, particularly in hurricane exposed areas in the Gulf and Atlantic states. Beyond that, we are seeing gradual acceleration in submission growth; in the first quarter, it was in the high teens. Exposure bases are going up, driven by economic activity and by inflation. Growth was particularly strong in our commercial property and inland marine divisions. Also, our general casualty book grew significantly helped by the reopening of the economy. We saw rates up in the low double digits in the aggregate during the first quarter, generally consistent with the past several quarters. The reason that the overall rate change is not moderating as has been reported by some other carriers is that we are growing fastest in the areas where rates are increasing the fastest, which tends to raise the weighted average. We are carefully monitoring inflation and loss cost trend and being cautious in our approach. Clearly, earlier prognostications in the press that inflation would be transitory do not pan out. The effects of the abrupt massive increase in the money supply may take a longer time to work through the economy than many people had thought and will likely cause disruption and pain in the insurance industry, which will serve to prolong the hard market. Kinsale, with our low expense ratio and higher margins and more nimble efficient processes is in a better position to navigate the current economic situation than many of our competitors. Also, it's worth noting that we have been achieving rate increases ahead of loss cost trend for several years now. These increases combined with our strategy of conservative reserving further protect the company from the threat of inflation that some of our peers are more exposed to. The fact that we write 100% of our business in the E&S market means that we are in a position to react much more quickly to events than our peers that have significant admitted business. With our control over the underwriting, as well as our superior technology, we have the necessary data to understand what is going on in our book, much more so than our competitors who delegate underwriting authority or who rely on antiquated technology. Again, it was a good quarter, and again, we are happy with the results. And with that, I'll hand it back over to Mike.

Thanks, Brian. Operator, we're ready for any questions in the queue.

Our first question comes from Mark Hughes from Truist. Please go ahead with your question.

Yes, thank you. Good morning.

Good morning, Mark.

Anything on the average policy size, have you seen much change there?

I think our average premium size is around 11,600 or something like that; it may be up very modestly. In general, our strategy is still to target the small to medium-sized accounts, depending on the mix of business in any quarter that could shift a little bit, but clearly, rate is helping as well.

Yes. The ceded premiums, just the ratio down a few points year-over-year; You mentioned how property is a focus for you; I don't know whether that impacts the ceded premium or is there an issue of excess versus primary that's influencing that?

Yes, yes. The mix of business; we see it off more in the excess than the primary casualty policies we just keep that. So the mix is going to impact that. If you're comparing year-over-year, our retentions have incrementally increased. So...

Yes. And I think there were some reinstatement premiums last year in the first quarter that we booked too, Mark.

Okay. And so you say your retentions have increased, just keeping more of the business yourself. Is that the way to think about it?

If you reflect back several years, you will see that there have been gradual changes in our retention. Therefore, the variations in retention, the composition of our business, and the reinstatement premium from last year can complicate your year-over-year comparison.

Yes. Brian, did you mention a gradual acceleration in submissions?

Yes.

Okay. And so that's kind of through the first quarter, you continue to see acceleration?

Yes. About the growth rate in the first quarter in submissions was marginally higher than the growth rate in the fourth quarter.

Yes. Regarding the end markets or lines you mentioned, such as commercial property, marine, and general casualty, do you have any additional observations about your strategy to pursue these businesses and the relevance of obtaining increased rates? Could you provide more details on that?

I would say that the growth is widespread. Most of our divisions have been experiencing growth during these quarters. There may be some areas that grow at different rates, but the overall growth we achieve is very consistent.

And that's been consistent, really, Mark, the last couple of years now.

Yes, and one more thing: regarding claims frequency and severity, you've mentioned inflation and how it extends the hard market. Are you noticing any signs of inflation in your operations? Yes.

Yes. The two trends I'd comment on are; yes, we do see inflation, right, especially when we're adjusting property claims, the cost of building materials and whatnot; I mean that's all being factored in settlement. So yes, the inflation is real. I would say, the more interesting trend at the moment, which again has continued now throughout COVID is that reported losses have come in slower than we would have expected. And we continue to offset those lower reported losses with higher IBNR because there's a real question around whether the trends in the reported losses are being driven principally by disruption in the core system. If that's the case, and the courts have now largely reopened and they're trying to probably play a little catch up; I think there's a question as to whether those loss trends kind of revert to the mean. And so we're prepared for them to do that. If they don't, in the future, then some of that extra redundancy will kind of waterfall out year after year. But I think we always like to reiterate with our investors that we take a very conservative approach to reserving, and we should have a lot of confidence in our balance sheet.

Thank you very much.

Thanks, Mark.

Thank you. Our next question comes from the line of Pablo Singzon from JPMorgan. Your question, please.

Hello. So your gross premium growth rate was one of the highest in our recent history; I think it's close to $80 million on an absolute basis versus last year. Was there anything unusual about the business you booked this quarter? Or do you see that type of growth continuing with a similar pace through the remainder of the year, whether measured in absolute terms or in terms of percentage?

Pablo, this is Mike. I would say that Brian highlighted a couple of the divisions where we're seeing a little bit stronger growth; property in the Marine, our general casualty area, where we write a lot of hospitality and apartment-type business, premises liability, but we're seeing good growth across the portfolio. If you look back the last several quarters, you're going to see that the growth rate does have a little bit of volatility to it. And we don't really forecast growth specifically but obviously, we've made some very optimistic comments about the market overall, and we feel very positive about the next several quarters; I'm trying to remember our growth rate in the fourth quarter, I think it was in the 30s.

36%.

Yes, so we grew at 36% in the fourth quarter, 45% in the first. I think you have to allow for a little bit of volatility like that, but in general, these are really extraordinary times in the E&S market and we're working really hard to take advantage of them.

Understood. Regarding your margins, there was a noticeable quarterly pattern in the accident year loss ratio in 2021, where the loss ratio was lower in the second half compared to the first half. A similar trend was also seen in 2020, though it was somewhat less pronounced. Do you anticipate a similar pattern this year, potentially influenced by the business renewing in specific quarters?

There are several factors that can influence the loss ratio throughout the year, such as reported losses and catastrophic events. Generally, we take a more conservative approach at the start of the year. Since it’s a new accident year and the policies have just been issued, we don’t have concrete data yet and are primarily relying on actuarial assumptions at this point. As the year progresses, we can respond to the reported loss activity, and this becomes increasingly significant in the second, third, and fourth years.

Yes. So in other words, Mike, there's more flexibility to potentially adjust your loss picks for accidental losses later in the year, is that what you're implying? Is that fair?

Yes. We projected a conservative loss pace, assuming the losses occur as anticipated, which I believe is highly probable or possibly even better than expected. At the beginning of the year, we're a bit more cautious compared to the latter part of the year.

Okay, understood. And then I have two more here. I think as you mentioned pricing increasing low double digits. Given the environment today, any change in where you see loss trends moving, I guess, versus a quarter or two quarters ago?

I believe that the underlying inflation will take some time to adjust. Currently, I would estimate a trend of about 4% to 6%, factoring in exposure-based trends, which account for rising prices and the products we are covering. Therefore, I still believe we are achieving rate increases that exceed the trends in loss costs.

We have been in a comfortable position regarding inflation for several years now, but it is an ongoing concern, and we are closely monitoring it.

Got it. Lastly, regarding submissions, I noticed in your K disclosure that submissions have been increasing, but at a slower pace. In 2019, the growth was 30% year-over-year, while in 2021 it dropped to 13%. However, based on your comments, it appears they're growing in the high teens in the first quarter. Do you anticipate this growth rate will change this year? What factors are contributing to this growth; are there new lines that weren't growing as much previously?

We really don't like prognosticate submission growth going forward. If I was to speculate what happened, I think that the COVID and the lockdown created this ripple effect where we actually got in some areas, a lot more submissions and so that when that kind of settled out, I think our submission growth kind of bottomed out in the low teens. But now you start to see the economy and the industry is returning a little bit more to normal, and so you're seeing kind of what I'd say is probably the more expected run rate where we're getting past the effect of COVID and the lockdown and all of that; so that will be my guess.

But it wouldn't be unprecedented to see some volatility in that number either, it does bounce around.

Yes, that's right.

Got it. Okay. Thanks for your answers.

Thanks, Pablo.

Our next question comes from the line of Casey Alexander from Compass Point. Your question, please.

Good morning. I have a question that might seem a bit niche, and you may not have the answer right now, but if that's the case, feel free to get back to me later. I would like to know what percentage of the fixed maturity portion of the portfolio is classified as available-for-sale. Additionally, for that available-for-sale portion, do you know the average price in relation to par?

To answer the first part is 100% of it is available for sale. I have to get back to you on the second question. I do not have that in front of me.

Okay, great. Thank you. That's my only question. Thanks very much.

Thanks, Casey.

Thank you. Our next question is a follow-up from the line of Mark Hughes from Truist. Your question, please. Mark, you might be on mute.

Yes, I'm sorry. I was on mute, apologize. Any observations about Lloyd's competitive behaviors or also in the past, Mike, you've talked about some of your program competitors being a little too aggressive and maybe there's going to be a reckoning on that front. Any updates on either topic would be helpful.

Yes, there are no updates, other than we are currently in a market phase where a lot of delegated underwriting authority business is being conducted, and there is significant growth in the number of fronting companies that support this. In the past, I've mentioned that many of these delegated underwriting programs have been successful for a long time, but there are also many that are not. This creates a certain level of volatility in the market, as programs can emerge and disappear rapidly. However, there has been no real change over the last year. We compete with a lot of MGAs, but that has always been the case, so it's business as usual to some extent.

You mentioned that the reported losses came in slower than expected. Could you walk us through how the frequency declined during COVID in 2020? As we consider how that progressed in 2021 and 2022, are we still operating at a depressed level? I would appreciate your perspective on that trajectory.

I believe the best way to understand this, Mark, is to refer to our statutory statement and examine our Schedule P information. You'll notice that for most lines of business, our IBNR is a higher percentage of the total incurred loss in the more recent accident years. This indicates that as the reported loss component has decreased, the IBNR has increased. I want to emphasize that we are not yet benefiting from this slowdown in reported losses; it might be temporary, or it might not. At this moment, we aren’t certain, but I believe we are well positioned if the loss activity increases for those accident years. If it does not, then some of the redundancy will gradually be realized in the coming years.

Is 2022 starting out to be at least similar to what you saw in 2021 on that front?

Yes. I think 2022 is similar to what we've seen in the last '21 and '20.

Okay. Thank you very much.

Thanks, Mark.

Thank you. Our next question is a follow-up from the line of Pablo Singzon from JPMorgan. Your question, please.

Hi, thanks for taking my follow-up. So, are you able to offer some estimate of how much your net investment income could benefit from higher interest rates, I guess, over the next several years? It seems like your new money yield is already higher than where your portfolio yield is.

Yes. What I would say, I think in the fourth quarter, Pablo, I think our new money yield was somewhere in the 3% range, and it's probably closer to 4.5% now.

Got it. Okay. And I guess the benefit will just sort of trickle in. I think your duration is about 4 to 5 years, right? So assuming no change...

Right.

Okay. And then last one for me. Just from a capital perspective, is the plan still to issue debt later this year to fund growth? I suppose interest rates will be a little higher now, but I don't think it will be material to you, but if you can just sort of confirm your thinking on the capital. Thanks.

Pablo, I don't think we got that. Did you ask...

Sorry?

Okay, I'm sorry, we got distracted with your...

Yes.

Can you just do me a favor and repeat the question?

Oh, yes, I'm not sure what happened there. From a capital perspective, is the plan still to issue debt later this year to fund growth? I suppose interest rates are higher now, but I don't think it will be significant for you. If you could confirm that, I would appreciate it.

Okay.

Thank you. Our next question comes from the line of Roland from RBC Capital Markets. Your question, please.

Hi, good morning. I saw the duration of the portfolio was extended to 4.6 years from 4.3 years at year-end. I just wanted to ask if there was anything to read into that or is that just, of course, the investments took in the quarter?

Yes, I think I wouldn't read a lot into it. If anything, I'd expect it to come in a little bit just with the uncertain interest rate environment right now.

And then within that portfolio, can you break up the percentage that has a maturity of less than one year? I'm just trying to get an understanding of how much of the portfolio could turn over in the next year at higher rates?

It's probably, I would guess, around 10%. But I think the one thing to kind of positively affects that is we've got a very strong flow of cash. I think last year, our cash flow was a little bit over $400 million, which is a big number relative to the size of the portfolio. And I think given the premium growth this year, we would expect that number to grow at a pretty good clip. So it's the new money plus the maturities and paydowns and like. Thanks a lot.

Thank you. This does conclude the question-and-answer session of today's program. I'd like to hand the program back to Michael Kehoe for any further remarks.

Okay. Thanks, operator. Thank you, everybody, for joining us, and we look forward to speaking with you again here in a few months.

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.