Kinsale Capital Group, Inc. (NYSE:KNSL) Q3 2023 Earnings Call Transcript

Kinsale Capital Group, Inc. (NYSE:KNSL) Q3 2023 Earnings Call Transcript October 27, 2023

Operator: Ladies and gentlemen, thank you for standing by. My name is Brent, and I will be your conference operator today. At this time, I would like to welcome everyone to the Third Quarter 2023 Kinsale Capital Group, Inc. Earnings Conference Call. [Operator Instructions] 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 2022 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 third 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.

Michael Kehoe : Thank you, operator, and good morning, everyone. Bryan Petrucelli, our CFO; and Brian Haney, our COO; and I will each make a few comments and then move on to any questions that you may have. In the third quarter 2023, Kinsale’s operating earnings per share increased by 103.6% and gross written premium grew by 33% over the third quarter 2022. For the quarter, the company posted a combined ratio of 74.8% and it posted an operating ROE of 32.1% for 9 months. The company’s strategy of disciplined E&S underwriting and technology-enabled low costs drive these results and allows us to generate attractive returns and take market share from competitors at the same time. We believe these advantages have real durability to them, and consequently, we’re optimistic about future prospects for both profitability and growth.

The E&S market continues to benefit from the inflow of business from standard companies and from rate increases driven by inflation and tighter underwriting conditions. Brian Haney will offer some commentary on underwriting conditions in a moment, but on the topic of top line premium growth, I’ll note that the fluctuation in our growth rate from the second to the third quarter this year was due to normal quarterly variability and also due to a change in the flow of Southeastern wind-driven property accounts from the second to the third quarter. Our growth rate through 9 months of almost 46% this year is largely consistent with what we’ve experienced for the last 5 years, kind of plus or minus 40% growth year-over-year. Our near-term view of the E&S market continues to be bullish.

Of course, we also like to remind investors that extraordinary growth rates that we’ve experienced for the last 5 years are an anomaly in a mature industry like property casualty insurance. Although we are optimistic about E&S market conditions for the balance of 2023 and heading into 2024, we believe the longer-term growth rate for Kinsale will moderate to the 10% to 20% range as market competition returns to normal in the years ahead. [indiscernible] should always be a concern for investors in a P&C insurance company. And as we have stated in the past, at Kinsale, we strive to set reserves for future claims in a conservative fashion so that we are more likely to have set aside more than enough and are likely to see a steady flow of reserve redundancy as claims are resolved over the years ahead.

This focus on conservative reserving is especially important in a time of high inflation which can stress prior year reserve adequacy, as we’ve experienced a bit in our 2016 to 2018 accident years on some of our longer tail lines of business. We believe Kinsale’s reserves are more conservatively positioned now than at any time in our company’s history, and investors should have a high level of confidence in the Kinsale balance sheet. Finally, a quick update on our real estate project. As you recall, we purchased 2 office buildings and vacant land adjacent to our existing headquarters building for $77.5 million in December of 2022. We closed on the sale of 1 of those 2 buildings in the third quarter for $62 million, realizing a small gain in the process.

We will begin renovations on the other largely-vacant building soon and expect to occupy that within 2 years. Additionally, we expect to sell other development sites on the adjacent property over the next several years, generating additional return on our investment. And with that, I’ll turn the call over to Bryan Petrucelli.

Bryan Petrucelli : Thanks, Mike. Another solid quarter with 33% growth in written premiums, very low cat activity, and net income and net operating earnings increasing by 130.8% and 103.6%, respectively. Mike commented on the 32.1% operating return on equity for the 9 months. We do have around $155 million in unrealized losses net of taxes on a fixed income portfolio generated from the higher interest rate environment, and that temporarily reduces our cap equity. Operating return on equity is 27.4% for the 9 months when holding our fixed income investments at cost. Again, as we stated in the past, we intend to and have the ability to hold our fixed income investments to maturity. The 74.8% combined ratio for the quarter included 3.2 points from net favorable prior year loss reserve development compared to 5.1 points last year, with less than 0.5 point coming from cat losses this quarter compared to 12.2 points in the third quarter of last year, primarily from Hurricane Ian.

The 20.9% quarterly expense ratio continues to benefit from higher ceding commissions from the company’s casualty and commercial property proportional reinsurance agreements as a result in growth in both of those areas. This benefit was offset slightly by higher variable compensation accruals during the quarter. To support the continued strong top line growth, we secured an additional $50 million in fixed rate debt during the quarter. That will be used as capital at the insurance company level. This should put us in a good capital position for the remainder of 2023 and into 2024. Additionally, we used the proceeds from the real estate sale that Mike previously mentioned to pay down a good chunk of our revolving credit facility. As a result, our debt to total cap ratio decreased to approximately 17.8% from approximately 21% at the end of 2022.

On the investment side, net investment income increased by 95.5% over the third quarter last year as a result of continued growth in the investment portfolio and higher interest rates, with a gross return of 3.9% for the year to date so far compared to 2.7% last year. We’re continuing to invest new money in shorter duration securities, with new money yields averaging between 5.5% and 6%, and duration decreasing slightly to 2.9 years, down from 3.5 years at the end of 2022. And lastly, diluted operating earnings per share continues to improve, and was $3.31 per share for the quarter compared to $1.64 per share last year. And with that, I’ll pass it over to Brian Haney.

Brian Haney : Thanks, Bryan. As Mike mentioned earlier, premium grew 33% in the third quarter and 46% year-to-date. Also, the growth rate for the quarter was affected by seasonality in the market for hurricane-exposed property. Insurers tend to avoid effective dates during wind season if they’re major exposures to hurricane. That being said, the E&S market remains favorable with strong growth across much of our product line. In addition to our Commercial Property division, we are seeing strong growth in our Entertainment, General Casualty, Excess Casualty and Commercial Auto divisions. Products liability and management liability lagged somewhat partly due to more intense competition, particularly from MGAs and partly due to the effects of the economy and higher interest rates.

Submission growth continues to be strong, again, in the low 20% range, slightly higher than the first and second quarters. We’ve used submissions as a leading indicator of growth, so we see that submission growth rate as a positive signal. We sell a wide array of products and the rates on those products don’t move in lockstep, but if we boil it down to 1 number, we see real rates being up around 6%. The property market is still boosting the overall number. The rate changes for property would be well higher than average. Rate changes for the casualty divisions vary, but overall, would be above flat. It’s important to stress the rate adequacy and rate change are 2 different things. As our results demonstrate, our rates are more than adequate.

We are continually reviewing our rates and adjusting them based on a number of considerations such as our target return on equity, the market opportunity and shifts in the competition. In any event, we feel the business we’re putting on the books today is the most accurately priced business we’ve seen in our history. Inflation has moderated somewhat, which has good and bad side effects. Good in that lower inflation makes it easier to achieve a goal of conservative reserves that are more likely to develop favorably than adversely, the bad in that it reduces the tailwinds we get from higher underlying exposures and higher audit premiums. We feel good about the market conditions through the end of the year and into 2024. After that, we expect at some point, the market will revert more to normal.

However, we believe our unique model will continue to drive superior returns in any market, hard, soft, or in between. Overall, a good quarter, and we are happy with the results. And with that, I’ll hand it back to Mike.

Michael Kehoe : Thanks, Brian. Operator, we’re now ready for any questions in the queue.

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Q&A Session

Operator: [Operator Instructions] Your first question comes from the line of Bill Carcache with Wolfe Research.

Bill Carcache : I wanted to follow up on the decline in your loss ratio. Do you see room for favorable development tailwinds relating to that 2021, ’22 accident years to persist? Just wondering how much benefit is left if those lower loss emergence trends continue?

Michael Kehoe : Yes. Bill, this is Mike. I think the big shift in loss ratio from this quarter to the third quarter of last year was the absence of a major catastrophe. I think in general, we booked a slightly higher loss ratio if you look at it on an ex-cat basis, and I think that’s just a little bit of perspective additional conservatism, especially thinking about inflation in the economy and its unpredictability. But yes, we are very confident in terms of future redundancy that should come out over the years ahead as we incrementally adjust losses on these accident years.

Bill Carcache : Understood. That’s helpful. And separately, can you give us a little bit more color on your view of pricing adequacy in the industry versus the loss cost trends that we’re seeing? I think you previously suggested that the combination of inflationary pressures and the historical underpricing in standard lines could potentially extend the hard market as some carriers seek to course correct their pricing. Just your updated thoughts around those dynamics would be helpful.

Michael Kehoe : Yes. I think we’ve talked in the past about there’s a lot of conversation, especially among reinsurers, that tend to see a broad array of ceding company business that there’s a reserve adequacy issue for the industry on the casualty side, right? So we’re just kind of repeating commentary we get from others. We’re very confident in our own reserve position, and in terms of pricing adequacy across the industry, I would just note that it’s a very large industry. There are a lot of players in it. We see some competitors that are very disciplined and smart about how they manage their businesses, and we see a lot that are quite reckless.

Brian Haney : I would echo those comments. I would say, I don’t think we’ve seen all the pain there is for the industry, and it would shock me if there weren’t a few more competitors that were going to run into some sort of difficulty with their reserves at some point. But like Mike said, we feel great about ours.

Bill Carcache : That’s helpful. If I could squeeze in 1 last one. There’s been some chatter surrounding unfavorable experiences that some carriers have had recently with delegated underwriting authority. Without citing anything specific, can you speak to what you’re seeing in the marketplace and whether you expect any kind of changes in the proliferation of MGAs based on some of what we’re seeing?

Michael Kehoe : Yes. I would just say, I think our investors understand that we’re a bit contrarians on that topic. We think underwriting should be a core competency of an insurance company, and so we’re not believers in outsourcing that to external parties. As we’ve said in the past, there are some delegated arrangements that have been around for decades that are well-managed and quite profitable. But there’s been an unusual explosion, if you will, in the number of delegated authorities, the number of fronting companies that have been created in the last 5 or 7 years. And invariably, some of that new capacity is probably not well managed, and there could be issues with profitability on that. I mean we see a lot of bad behavior in the marketplace, I would just say anecdotally, on a regular basis.

Operator: Your next question is from the line of Mark Hughes with Truist Securities.

Mark Hughes : Yes. Thank you very much. Brian Haney, you had mentioned that one impact of lower inflation is the less exposure growth. Do you think that had any impact in the quarter? What’s the magnitude of that effect?