Kinsale Capital Group, Inc. (NYSE:KNSL) Q4 2022 Earnings Call Transcript

Kinsale Capital Group, Inc. (NYSE:KNSL) Q4 2022 Earnings Call Transcript February 17, 2023

Operator: 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 fourth quarter results. Kinsale’s management may also reference certain non-GAAP financial measures in the call today.

A reconciliation of GAAP of 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. Brian Haney, Kinsale’s Chief Operating Officer, and Bryan Petrucelli, Chief Financial Officer, are both with me. Each of us will make a few comments and then we’ll move on to any questions that you may have for us. In the fourth quarter, Kinsale’s operating earnings per share increased by 48% and gross written premium grew by 45%. The company posted a 72.4% combined ratio for the quarter and an operating return on equity for all of 2022 of 25%. We believe these results are principally driven by Kinsale’s unique business model of disciplined underwriting and technology-driven low costs. The results are also boosted by the favorable E&S market, which continues to experience a strong inflow of new business that allows for meaningful rate increases and exposure growth.

Kinsale continues to raise rates above the loss cost trend as we have been doing for four years now. And we continue to establish reserves for future losses in a conservative fashion. Investors should have a high level of confidence in Kinsale’s balance sheet and reserve position. As an E&S company, part of Kinsale’s long-term success is reacting quickly to market disruptions and turning those disruptions into opportunities. Over the last couple of years and continuing even today, Kinsale is taking advantage of the disruption in the property market to grow our book of business at a rapid rate. As always, we are mindful of the volatility associated with property accounts, especially hurricane-exposed properties in the Southeastern United States.

Photo by Frans Ruiter on Unsplash

Although we are writing more property business than ever, we maintain strict limits on the geographic concentration of business, we model the portfolio regularly, we manage our policy limits carefully, we purchased a substantial reinsurance program, and most importantly, we are being well paid for the risks we’re taking. All of these steps allow us to write the business and capture an attractive return while continuing to limit the volatility of the book. In 2022, property amounted to just under 23% of our gross written premium, with below 10% of our overall gross written premium having any meaningful hurricane exposure. We announced in late December that Kinsale had acquired two office buildings and 29 acres of land for just over $76 million.

This property is adjacent to our existing headquarters building. One of the office buildings is subject to a long-term lease. The other is mostly vacant and we are planning to renovate that property. The purchase gives Kinsale expansion space next to our existing building and also provides an interesting investment opportunity, as we consider selling parts of that property to real estate developers over the next several years. Lastly, we continue to have an optimistic outlook for the market for the balance of 2023, at this point halfway through the first quarter. The property market is quite favorable, but we also see opportunities across our casualty product line as well. Regardless of where the market goes in the next couple of years and given Kinsale’s competitive advantages, we expect the company to continue to grow and generate best-in-class returns under any market conditions.

Now, I’ll turn the call over to Bryan Petrucelli.

Bryan Petrucelli: Thanks, Mike. Again, just a really strong quarter and close to the end of the year with a 45% growth in written premium, and net income and operating income increasing by 39% and 48%, respectively. 72.4% combined ratio for the quarter includes 3.3 points from net favorable prior year loss reserve development compared to 4 points last year and a negligible impact from cat losses in either period. Most of the improvement in the quarterly expense ratio, so the 19.9% this quarter compared to 21.4% last year, related to ceding commissions from the company’s casualty and commercial property proportional reinsurance agreements. Net investment income increased by 107% over the fourth quarter last year as a result of continued growth in the investment portfolio and higher interest rates, with a gross return of 3% for the year compared to 2.5% last year.

We’re investing new money in shorter-duration securities, with new money yields averaging close to 5% during the quarter and duration has decreased to 3.5 years, down from 4.3 years at the end of 2021. Book value was positively impacted in Q4 from a combination of net income, an increase in the fair value of our fixed income securities during the quarter, and the $47.5 million equity raise in November. Notwithstanding the positive fourth quarter movements, our fixed income portfolio continues to be an overall unrealized loss position, 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 that I just touched on.

As it relates to capital, as I mentioned, we raised approximately $47 million in our fourth quarter equity offering to fund the expected growth of the company. We continuously monitor our needs as market conditions change. Given the continued favorable market conditions and related premium growth, there’s always the possibility that we’ll need additional supporting capital. Support can come in the form of debt or equity with a bias towards debt, given our current modest debt-to-capital position. And lastly, diluted earnings per share was $2.60 per share for the quarter compared to $1.76 per share last year. And with that, I’ll pass it over to Brian Haney.

Brian Haney: Thanks, Bryan. As mentioned earlier, premium grew 45% in the fourth quarter, largely consistent with the first three quarters. Overall, the E&S market remains favorable, with strong growth across most of our product line. The property market continues to be hard and, in the wake of Hurricane Ian, the contraction in industry capacity has continued as we believed it would. In addition to our property divisions, we are seeing strong growth across most of our casualty divisions. Our energy, general casualty and entertainment divisions in particular continue to grow at a significant pace. There are some pockets of business that are more competitive and flat or slower growing, such as management liability and product liability.

Submission growth continues to be strong just under 20%, which represents a very slight deceleration from the previous quarter. We sell a wide array of products and the rates in those products don’t move in lockstep, but if we boil it all down to one number, we see real rates being up around 7% in the aggregate during the fourth quarter compared to 8% in the third quarter. The property market is certainly boosting that number. The rate changes for our property would be well higher than the average. The rate changes for the casualty divisions would vary greatly, but overall would be less than the average, but still positive, which indicates that the combination of rate change and the premium trend is exceeding loss cost trend. It is important to stress that rate change and rate adequacy are two different concepts.

Our rates are more than adequate. We are continually reviewing and adjusting our rates based on a number of considerations, such as our target combined ratio, our target return on equity, the market opportunity and shifts in the competition. We continue to keep an eye on inflation. We feel we’re in a good position because we’ve been achieving rate increases ahead of the loss cost trend for several years now, as Mike mentioned. These increases combined with our strategy of conservative reserving further protects us from the threat of inflation that some of our peers may be more exposed to. The market conditions are generally favorable across the board. We do still see a proliferation of MGAs and (ph) deals. We don’t delegate underwriting authority ourselves, but virtually all our competitors do in some fashion or another.

Some of these MGAs are being overly aggressive on rates and terms, not all, but some. But despite these new MGAs and new fronting deals, the market has not been too affected at this point. Overall, clearly, a good quarter, and we are happy with the results. And with that, I’ll hand it back over to Mike.

Michael Kehoe: Thanks, Brian. Operator, we’re ready for questions now.

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Q&A Session

Operator: And your first question comes from the line of Mike Zaremski from BMO. Your line is open.

Michael Kehoe: Good morning, Mike.

Mike Zaremski: Hey, good morning, everyone, and happy Friday. Maybe first touching on — it sounds like a continued more optimism a bit on the property growth front. And I think we can see that you’re ceding a bit more too, I believe, to reinsurers and just any — I’m assuming the math works right if you’re growing opportunistically into property versus higher reinsurance costs. Maybe you can update us whether we — how should we think — should think about the growth and whether we should think about any changes to the reinsurance — your reinsurance program throughout the year?

Michael Kehoe: Okay. Yes, this is Mike. So, we buy a lot of our reinsurance on our excess casualty book where we put up larger limits and on our property book. And so, yes, the growth in the property is going to result. I mean, that mix of business shift, both the growth in casualty and property, is going to result in a higher ceding ratio over time. The property is ceded on an earned premium basis. So, there’s a little bit of a lag between when we write the business and when we earn it. But in general, it would be reasonable to expect an incremental increase in the ceding ratio here for the near term.

Mike Zaremski: And I’m just thinking — should we be thinking at all about kind of IR reinsurance costs kind of impacting kind of how we should think about any of the ratios into ’23 or that will be kind of TBD as — this time as the year progresses?

Michael Kehoe: I don’t — it’s hard to say, right? Our program renews on 06/01. There’s been a lot of commentary about reinsurance costs are rising. And we would certainly expect that, that would be the case in our cat excess of loss treaty. That’s not an enormous cost for our company. We buy $75 million, (ph) $25 million today. So, on the proportional side, I think the largest contract there is our commercial property quota share, the results there have been quite favorable. So, we don’t expect any kind of dramatic change in economics on the renewal of that treaty, and likewise on the casualty side. I think we’ve ceded away very attractive returns to our reinsurers in general over the long term. And so, I think that’ll be reflected in the renewal pricing. But again, it’s a 06/01 treaty, so it’s a little bit speculative at this point.

Mike Zaremski: Okay. Understood. We, obviously, know that you’re (ph) more profitable than the industry, so maybe pricing for you guys is a bit better. Just thinking about your commentary about growth in the near term, I mean, is there enough line of sight into kind of new growth in the property side that we should be thinking about the gross premiums written growth rate kind of continuing near recent levels at least for the foreseeable future?

Michael Kehoe: The things we look at, I would say, if you look at the last four years, we’ve been growing either just below or just above that 40% rate. I would say that’s an extraordinary growth rate in our industry. It’s driven in part by some pretty dramatic increases in pricing. And it’s been driven in part by strong growth in exposure. I think Brian Haney commented that our flow of new business submissions continues around that 20% growth level. And we’ve always looked at that as a little bit of a leading indicator. And then, just some of the commentary again in the press and whatnot about distress in the reinsurance market. There’s been a little bit of commentary lately about reinsurers’ concern with adverse development across the industry for the ’15 to ’19 accident years on the casualty side.