Kinsale Capital Group Inc (KNSL) 2016 Q3 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the Kinsale Capital Group Incorporated Q3 2016 earnings conference call. (Operator Instructions)

Before we get started, let me remind everyone that throughout the course of the teleconference Kinsale 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 second-quarter 2016 Form 10-Q, which should be reviewed carefully. The Company has furnished a Form 8-K with the Securities and Exchange Commission that consists of the press release announcing their third-quarter results.

Kinsale management may make references during the call to underwriting income, which is a non-GAAP financial measure of financial results. Kinsale's underwriting income represents the pre-tax profitability of the Company's insurance operations and is derived by subtracting losses and loss adjustments and expenses and underwriting acquisitions and insurance expenses from the net earned premiums.

Kinsale uses underwriting income as an internal performance measure in the management of its operations because the Company believes that gives management and users of the Company's financial information useful insight into the Company's results of operations and underlying business performance, but may not be comparable to other companies' definition of underwriting income. The Form 8-K contains a reconciliation between underwriting income and net income. The Form 8-K and press release are 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, Kevin. Good morning, everyone, and thank you for joining us this morning. I'm going to begin the call with a brief introduction, and then I am going to pass over to Bryan Petrucelli, Chief Financial Officer, who will comment on our financial results for the third quarter. And then Brian Haney, the Chief Operating Officer, will provide some comments on the operating environment and provide a little bit of color on our underwriting operations in the quarter.

Last night, Kinsale reported favorable financial results for the third quarter, the highlights of which includes the following: net income of $8 million, up 36% from the third quarter 2015; annualized ROE of 18.8%; a combined ratio of 67.5%; underwriting profit of $10.7 million; and premium growth of 4.4%.

The Kinsale business model is built on disciplined underwriting and claim handling, combined with a 20% to 40% expense advantage over the competition. It's a powerful model in any market, but it's especially so in a period of intense competition like we are in currently. And we believe the third-quarter results speak to the soundness of the plan.

As a relatively new public Company, we thought a quick overview of our business strategy made sense. First, Kinsale only writes business in the excess and surplus lines market, which historically has provided better margins to the risk bearer than has the broader standard market.

Two, the Company maintains absolute control over both underwriting and claims management process and, unlike its competitors, does not contract out those functions to third parties.

Three, Kinsale generally focuses on smaller accounts, which we believe offer better rate integrity than do larger policies, again, especially in a competitive market.

Four, Kinsale operates at a dramatic cost advantage, thanks in part to its advanced and proprietary information technology platform, which yields an advantage in terms of efficiency, the accuracy of our business process, the level of customer service we can provide and the breadth of the amount of data we are able to collect at the transaction level.

And finally, Kinsale has a business culture that's heavily influenced by the fact that we are an owner-operator. Many employees and all senior managers have invested considerable amounts of their life savings in the business, and we think the alignment of interests between our management and employees on the one hand and our investors on the other is superior to that of many of our competitors. As we say, it doesn't guarantee a favorable outcome, but it certainly improves the odds.

And with that, I'm going to turn it over to Bryan Petrucelli.

Thanks, Mike. As Mike noted, the third quarter was a good one for Kinsale. The Company's goal is to consistently generate mid-80s or lower combined ratio and produce a return on equity in the mid-teens over the long-term.

For the third quarter, the Company generated underwriting income of $10.7 million on a combined ratio of 67.5% and an annualized ROE of 18.8%. The combined ratio was 71.8% after adjusting for the effect of the Company's quota share reinsurance agreement. Underwriting income benefited from $3.5 million of net favorable prior-year loss reserve development for the quarter. That amount is $5 million after excluding the effects of the quota share.

Gross written premiums were $47.8 million, representing a 4.4% increase over the third quarter of 2015. Premium growth is being generated from an overall increase of policy count, primarily from the small business division, personal lines and some of the Company's new product offerings such as management liability, inland marine and public entity.

We continue to be conservative on the investment side with an approximately 95% fixed income allocation, and at a AA average credit rating and a weighted average duration of three years. However, net income did increase by 31.9% in the third quarter of 2015 as a result of growth in the investment portfolio. Gross investment returns continue to be in the low 2% range.

Just a couple quick comments on earnings per share. Both the third-quarter and year-to-date EPS metrics are a bit difficult to interpret, as GAAP accounting rules require that we recognize the capital structures in place before and after the IPO. Essentially, it requires the income attributable to those periods be allocated and the weighted average share count be computed for each respective period.

Ignoring all of that GAAP accounting craziness, and to get an idea of what EPS would be if the Company's current capital structure was in place for the entire quarter and year, we can simply divide the quarterly and year-to-date net income by the basic and diluted weighted average shares outstanding at September 30, both disclosed in the 10-Q. On a normalized basis, then: basic and diluted EPS, or $0.39, and $0.93 for the quarter and year to date, respectively.

With that, I'll pass it over to Brian Haney.

Thanks, Brian. This quarter, we continue to see a strong flow of new business submissions. Our submission counts grew by double digits, as did quotes and binders. These growth rates are driven in part by superior customer service. Our customers really appreciate our turnaround time on quotes.

The expansion of our product line over the last year or two has contributed as well, as has our broad risk appetite, where we purposely target hard-to-place accounts. This growth in submissions, quotes and binders gives us confidence in our growth prospects despite the competitive nature of the current market.

This year, we have increased our technical rates in the aggregate by a very low single-digit amount. In some areas, we have become modestly more competitive, while in other areas we have taken modest rate increases. The overall effect has been to be slightly better than flat on rates.

The P&C market remains intensely competitive. There's a lot of pressure on rates as well as terms and conditions. We are maintaining our underwriting discipline, and our underwriters are working hard to find growth opportunities. As a small insurer with limited market share, we are still able to find good business even in these market conditions.

Premium growth for the quarter lagged growth in submissions, quotes and binders. A big reason for this is that we had written a small number of larger deals -- and by larger, I mean $100,000 or more in premium -- in the third quarter of last year. And a lot of those deals moved away from us this quarter. Because of how those deals were priced, we think losing them made sense.

The good news is that this trend has mostly run its course. Looking forward, the Kinsale model of disciplined underwriting and claim handling combined with low cost should allow us to grow at a more robust rate.

With that, I will turn it over to Mike.

Okay, and that's the end of our prepared comments. So, we will turn it back to you, Kevin, if there are any questions from participants on the call.

(Operator Instructions) Sarah DeWitt, JPMorgan.

Congrats on a good quarter. First, I just wanted to get your latest thoughts on how fast you think you can deploy the IPO proceeds and the opportunities you are seeing there.

We commuted our structured reinsurance contract at 10/1. That put some of the proceeds to work immediately, if you will, by replacing the reinsurance capital with some of the equity, the primary proceeds from the IPO. The rest we think we are going to put to work over the next year or so, just with growth in the business. And we don't have a specific timeline to do that. I will tell you that, as a management team, we are very focused on capital efficiency. So we don't want to have fallow capital lying around; we want to put it to work and maintain very solid returns on equity.

Okay, great. And then secondly, on the reserve releases, could you just talk about what drove that in the quarter and how we should think about that trend going forward?

Yes. We had a better than expected loss experience. Nothing in particular drove it other than just not a lot of claims. So we strive to maintain conservative reserves. I would say it would be our hope that reserves would more frequently develop favorably than adversely, and that has been our mantra since we started.

And I would add just a second comment to that. The guidance we like to offer is that we are guiding toward a mid-80% -- mid-80%s combined ratio, which would essentially involve a slightly higher loss ratio. So I think we outperformed this quarter. But our guidance would be a little bit more cautious and conservative going forward.

Okay, great. And then finally, if I could, I'd just be curious on your thoughts of the election results and what the implications are for the US P&C insurance industry as well as Kinsale. Do you have any early thoughts at this point?

Let's see. (Laughs) I think, to the extent that the Trump administration implements a lot of pro-growth economic policies -- tax reform and regulatory reform and the like -- I think that could be therapeutic. P&C is a big, mature industry that tends to grow with the economy.

I think, as an E&S writer, the last couple decades the E&S market has grown at a much more rapid clip. It grows organically with the economy, but it has also taken market share from the standard lines side of the industry. And we would expect that trend to continue independently of public policy.

I don't know if you guys have got anything else.

I would just reiterate the point about tax reform. A lot of our competitors operate with a tax advantage that comes from having offshore entities that they cede business to. So if there was some sort of significant tax reform, it probably would benefit us relative to our offshore competitors.

Right. Okay, great. Thank you.

Mark Dwelle, RBC Capital Markets.

Just a couple questions. The growth rate in the quarter was maybe a little bit lower than we might have expected. Anything in the pricing environment or just business mix that maybe was different than what your expectations were?

I would say, when we think about growth, obviously we are in a competitive market where our underwriters have to work very hard to find good opportunities to write.

Beyond that, I do think the growth rate, especially when you talk about a 90-day period of time, it is going to ebb and flow a little bit over time. When you think about -- when we think about growth in our internal operations, our low-cost platform gives us, I think, a material advantage.

I think Brian Haney mentioned before the work we've done over the last year or two to broaden our product line. I think that plays into our growth story as well. We talked about the growth rate in submissions for the quarter. And sometimes we look at that as kind of a very loose leading indicator as to where the business might be going. We think about the pockets of stress in the industry. We are not a transportation writer. But that's a good example of stress in the broader standard market that sometimes creates E&S opportunities.

So when you put those things together -- the risk appetite, the customer service, the low cost -- we are cautiously optimistic on growth. And this quarter was a little bit lighter than we would have liked, but we would anticipate a more robust growth rate going forward.

Okay. Thanks for that. You guys had announced a little bit earlier this week a new product in the private D&O market. Can you talk about that a little bit and maybe how large of a potential opportunity you might see that as being over a multi-year period?

It was an incremental -- it was a product that we rolled out within our management liability division, which itself was new, I guess, about a year and a half ago. So I would expect it to be like all new products: we get it in and we grow very modestly. So in and of itself it's maybe not that material immediately. But, again, you are adding that to many other products we've rolled out in the near term that, in the aggregate, helps drive the top line.

Okay. And then just one last question. It looks like all of the proceeds of the IPO were pretty fully deployed in the fairly short time that you had them. Anything else to do there? Or the investment portfolio going forward, you'd probably expect to see what we see is what we get for the near term.

I think that's correct, Mark. The funds have been fully deployed. We still hold a little bit of cash that we can invest and will invest here over the near term. But for the most part it has been deployed.

Okay. Thanks for that.

(Operator Instructions) Adam Klauber, William Blair.

A couple different questions. Looking at the loss ratio, if you look at your accident year it's better than the last couple quarters. And I know this can bounce around, but is it seasonally better than the third quarter, or was it just some unique aspects about the quarter that drove it lower compared to the first half? And I'm looking at it on an adjusted basis.

There's no pronounced seasonal effect in our book. So it's just sort of random variation.

Okay. So don't read too much into it. Should we look -- as we think about modeling and forecasting, should we look at more the year-to-date average than this quarter, I take it?

Yes.

Okay. In the development -- again, I realize there's variation, and given the nature of the book there's probably more variation than average. But would you say more of the development was from the last year or two, or was it just spread pretty evenly across the years?

Because of the way we've grown the business from scratch, those first several years were very small books of business. So invariably it's going to be a little bit more weighted toward the more recent years.

Okay. And are you saying --

Because there's so much more premium in those years.

But in general, are you seeing any classes develop better than others? Or is it, again, just more across the book?

I think there's always going to be a lot of variation. We write, again, a broad product line, Adam. And so there's a lot of different lines of business. And then, of course, even though we are a new Company now, this is our seventh accident year in business. So inevitably you are going to see variation in results, and that would be very normal.

Okay. And then switching to the growth side, Brian, I think you said submissions are up low double digits, which is very strong. Compared to when I talk with other people in the industry, that's materially better. Do you think that's driven by your expansion to other product classes? Is that getting deeper into the wholesalers? What do you think is driving that high submission level?

I think both of those are responsible. I think that we are still a small Company. So there's still a lot of business that to us would be new that we haven't seen in the past. We have appointed new brokers. We have expanded in areas like for-profit D&O. There have been other areas were we had been in the past and we just -- we are growing more. So our environmental line, which had been small -- we put a special effort into growing that.

And then one big thing is just customer service. One thing we found is just that the better customer service we can give to our brokers, the more they respond by sending us more business.

Right. That makes sense. How is the personal lines effort going? Is that helping the submission level?

It is. But the growth rate -- that strong growth rate would be -- even if you excluded personal lines, it would still be up double digits.

Okay. Okay. And as long as we're on the topic, I know you guys are a very small writer of property. But did you have any losses or much in the way of losses from Hurricane Matthew?

Yes, I think just as a reminder, Adam, property premiums currently make up about 7% of the Kinsale book. We had originally thought it would be a little bit more -- a little bit larger than that. But given the competitive nature of that market it has just grown a little bit more slowly.

But, yes, currently around 7% of the book.

We did have exposure in the Southeast. And I think our losses as of today -- recognizing that these claims are still works in progress, the after-tax costs I would peg below $1 million. So it was a very, very modest loss, if you will, coming out of the hurricane.

Okay. And then finally, more of an industry question. How is the tug-and-pull going with these standard carriers? Have they become increasingly more aggressive pulling business out of the E&S market as the year has gone?

I don't know that it's gotten worse, but it certainly remains highly competitive. Competition from standard companies, but also competition within the ENF market. And, again, in this kind of intensely competitive environment, we sometimes think that the Kinsale business model shines brightest. Right? The fact that we maintain such control over the underwriting and the claims management; the fact that we operate with a material cost advantage where we can offer a little bit more value to the buyer in the form of a lower price and yet still capture an attractive return for our stockholders. So, hence our cautious optimism, I guess.

Okay. I apologize, but one more question. The adjusted expense ratio came in at 27%. And this is splitting hairs, but it looks like it has bounced a little between 26% to 27%. Are you more comfortable at either one, or should we just split the difference?

Yes. I would just say, Adam, I would look at what we're doing on an annual basis. In any given quarter you are going to have some lumpiness. We did have some deal cost there in the third quarter that probably elevated it a little bit. But I would look at the year-to-date number as a better gauge.

Okay. Thanks a lot, guys.

I'm not showing any further questions at this time. I would like to turn the conference back over to our hosts.

Okay. Well, thank you, everybody, for participating. And we look forward to speaking to you again in three months. Have a good day.

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect, and have a wonderful day.