Greetings and welcome to Kingstone Companies Q1 2020 earnings call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Amanda Goldstein, Kingstone Companies Investor Relations.
Thank you very much, Brock, and good morning, everyone. Yesterday afternoon, the company issued a press release detailing Kingstone's 2020 first quarter results. On this call, Kingstone may make forward-looking statements regarding itself and its business. The forward-looking events and circumstances discussed on this call may not occur and could differ materially as a result of known and unknown risk factors and uncertainties affecting Kingstone.
For more information, please refer to the section entitled, "Factors That May Affect Future Results and Financial Condition," in Part I, Item 1A of the company's Form 10-K for the year ended December 31st, 2019, along with a commentary on forward-looking statements at the end of the company's earnings release issued yesterday. In addition, our remarks today include references to non-GAAP measures. As a reconciliation of our non-GAAP measures to our GAAP figures, please see the tables in our earnings release. With that, I'd like to turn the call over to Kingstone's CEO, Mr. Barry Goldstein. Please go ahead, Mr. Goldstein.
Thanks, Amanda, and good morning. We're pleased that you can join us on this, our first quarter 2020 conference call. The first one ever where I wasn't wearing a suit and tie. Our last call took place on March the 12th. I haven't been back to the office since. It's telling just how seamless it was for almost our entire staff to begin working from home just two business days later on Monday, March 16th. I'll give an immense amount of credit to the New York Department of Financial Services for that. Following Superstorm Sandy over seven years ago, there were a lot of regulations that the DFS implemented and which resulted in Kingstone being well prepared for this pandemic. So kudos to the New York Department for their foresight and their leadership. From an operating standpoint, we didn't miss a beat.
We're in regular contact with our producers, and while most are trying to work from home, the business has slowed materially. Our first quarter was most notable by what it didn't feature. No bad weather to speak of. No adverse development to record. This is our second quarter without any adverse development, and we're confident that that issue is behind us. Together, these items contributed to a terrible start to last year, and without them, we're off to a great start this year. On top of that, I'm very pleased to report that this year we saw our first quarter underlying loss ratio improve by more than five points versus last year. Total improvement amounts to a total of over 37 points. Ben will give more color on that in a few minutes. While losses were down materially, we also had a quarterly decline in net earned premiums of 9%.
This is the direct result of actions that we chose to take. We chose to reduce the volatility of our earnings from weather catastrophes. We chose to exit from the commercial liability lines of business where we determined that a capital allocation was no longer warranted. This is our focusing on profitability, which by its very nature will slow growth and which has led to the planned decline in net earned premium. So please take time to go through the schedules attached to yesterday's press release, as that will allow for a better understanding of much of what we are discussing today. I hope you'll recall from our last call that we entered into a 25% personal lines quota share treaty in the fourth quarter of last year. Previous to that, we had a 10% treaty in force.
The benefits of this new quota share treaty were a reduction in our premium leverage, maintaining a sensible level of risk-taking, a reduction of catastrophe retention, and all of which led to an improvement in our A.M. Best B++ score. The increase in personal lines premiums that get ceded to our reinsurance partners results in a decrease to our net written premiums and the 3.5% reduction to net earned premiums from personal lines were about $800,000. The decision to exit the volatile commercial liability lines of business last August resulted in a decline of net earned premiums of $1.9 million. We expect that we will enter the fourth quarter of this year with no remaining active commercial liability policies. Ben will soon discuss how this exit is going and how well the 2019 reserve strengthening is holding up.
In addition, we are now seeing the impact on new business from the rate increases we took and the underwriting actions taken, all of which were done to improve profitability. Most particularly, our New York homeowners rate increases began in November for new business and on December 15th of last year for renewal business. We've raised our rates outside of New York as well. These actions will take some time to be fully reflected in our financial statements, and they have slowed down our growth. With the reduction to net earned premiums as discussed before, our net expense ratio was also impacted. While we do receive ceding commissions from reinsurers, which serves to offset our underwriting expenses, the decline in net earned premium outpaced the decline in underwriting expenses and thus increased the expense ratio.
We had an operating loss in the first quarter of 2019 of almost $8.9 million, and an operating loss in the first quarter of 2018 of $2.3 million. This year, we all but broke even with an operating loss of about $300,000. A break-even winter quarter in our Northeast business is very satisfying. What I would normally say is this sets us up very nicely for the rest of the year, and it does. But the pandemic has filled our lives with uncertainty. It seems like most every morning we're taking a step forward in conquering or better dealing with the disease, but by the end of the day, there's something new and nasty to consider.
What I know is that at Kingstone, because of where we do business, each and every employee, agent, and insured is at the epicenter of the disaster, a war zone of sorts, with New York City and Long Island being ground zero. We see this from the comfort of our TV sets and our internet feeds. But the hospital personnel and first responders are on the battlefield. They are our heroes. Just as the soldiers afforded certain benefits when sent off to war where their wages aren't taxed, I feel the same should be true of all hospital workers at every level, all first responders who are putting themselves at risk to keep us safe. I've got a few additional points to go through which I think are of interest.
First, with regard to the dividend, the board has decided to reduce the quarterly dividend from $0.0625 to $0.04 beginning in the June quarter. This puts us in line with our peer group at about a 3% yield. Preserving capital and improving holding company liquidity makes sense at this time. We did buy back some shares in the first quarter, and building cash at the holding company will allow for us to act opportunistically when the situations present themselves. Every day, I see our shares trading so materially below book value, and with confidence in the future, I see the buyback as a great tool to increase shareholder value because I firmly believe that Kingstone 2.0 is on track to bring us to a higher level of profitability.
As we put up those more profitable numbers quarter- after- quarter, our share price will be reflective and no longer be in the bargain basement. Next item is investments. The quarterly decline in book value was entirely due to the payment of the dividend coupled with the decline in market value of securities that had not yet been sold. As mentioned in yesterday's press release, we've already recovered more than half of that decline. Next item relates to COVID-19. You may have heard a lot about business interruption claims and conversations around the country about that. Again, we chose to exit writing business owners' policies last year, and we haven't written a new one in over a year.
But there is proposed legislation in New York that could require Kingstone to provide this business interruption coverage in spite of the fact that our policies first require that there be a loss to covered property, which there is not. The passage of a law would effectively be retroactive coverage. The U.S. Constitution specifically precludes the passage of any ex post facto legislation. Common sense says, "Carriers have never priced into the typical business policies to include this as a covered cause of loss." Needless to say, we are closely monitoring but have faith in the law. We do not have cause to reserve for this possibility at this time, but we are closely monitoring the situation. At this point, let me turn the call over to Ben to review the first quarter's loss and reserve results. Please go ahead, Ben.
Thank you, Barry. The first quarter typically runs at a much higher loss ratio than other quarters because of winter weather and large fire claims. This quarter, we were fortunate as it was a very mild winter season. For the first quarter 2020, the overall loss ratio declined from 98.4% to 60.8%, an improvement of 37.6 points. The impact from winter CAT events was minimal, with only 0.7 points of CAT loss recorded this quarter. This compares to a CAT impact of 17.1 points a year ago and a 24.3 point impact in first quarter 2018. The core loss ratio, excluding commercial lines, improved 6.2 points from 63.3 in first quarter 2019 to 57.1 in first quarter 2020. We observed a lower claim frequency in both our personal lines and auto physical damage business, which drove the improvement.
Large fire claim activity this quarter was in line with the prior period. As Barry noted, we continue to observe stable prior year loss development. During the quarter, there were favorable outcomes on several large commercial liability claims from older years. This is a very encouraging result. For the quarter, we recorded 0.5 points of favorable prior year development compared to 15.3 points of adverse development in first quarter 2019. Our internal actuarial review continues to apply conservative assumptions for the more recent accident years. We will continue this more conservative reserving approach until claims handling improvements made over the past year are realized in the data. By line of business, the underlying loss ratio trends for the quarter were favorable. The personal lines underlying loss ratio, excluding CATs and prior year development, improved just over five points compared to first quarter 2019.
We saw much lower non-CAT claim frequency due to the mild winter. We are also starting to see the benefit of higher average premiums earning in as a result of the recent homeowners' rate increase. There was a sharp decline in auto physical damage claim frequency starting in mid-March, and this is reflected in the first quarter loss ratio. The commercial lines business that was placed into runoff last July is now a much smaller percentage of our books. As of March 31st, less than 3,000 policies remain on the books. Commercial lines represented only 6% of our total net earned premium for the quarter. We do expect that commercial lines will continue to run at high loss ratios until it is fully run off later this year. With that, I will turn it over to Meryl for an update on operations. Meryl?
Thanks, Ben. Good morning, everyone. I want to give a quick update on our efforts to modernize the company, Kingstone 2.0. As reported on the last call, we've completed the hiring of our team and have added tremendous depth and experience to the company. During the quarter, we made great progress on a few initiatives that I'm delighted to highlight. We are in the initial stages of core system replacement for both policy management and claims.
For policy management, we just started the conversion of our New York homeowners' product to a new system, and it's going well. We have a long road to go and look forward to streamlining our processing and ultimately retiring our legacy system. We are also in the process of designing a new producer interface. This new interface will have a more modern look and feel and will automate many of the processes that are performed manually today.
The implementation of our new claim system is also going well, and we're on target to start taking new claims on it by July 1st. We also continue to make headway on our new product development efforts. Overall, we remain confident that we're making the right investments and that they will lead to sustained improvement in the company's performance. On that note, I'd like to turn the call back to the operator so that we can answer any questions that you have. Operator, please pause for questions.
Thank you. At this time, we'll be conducting a question and answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Our first question today is from Paul Newsome of Piper Sandler. Please proceed with your question.
Good morning. Glad to hear everyone's safe and healthy. Could you talk about the outlook for the expense ratio prospectively? Is this kind of the appropriate level today given the changes in the reinsurance plus what you're investing in the systems?
Yeah. Paul, this is Barry, and thank you. Yeah, I think this is probably appropriate for the short term. Again, with not trying to focus on growth and seeing the commercial lines continue to run off, that net earned premium is really what's driving the percentage. We've had a moderate amount of increased expenses to support Kingstone 2.0, but really nothing unusual there. So this is being driven just by our goal towards getting more profitable.
I know this is a very small part of your book, but on the business owners' policies, did you have a separate virus exclusion as well as the definition of the loss having to be a property loss?
Hey, Meryl, you want to comment on that?
Sure, so we do not have a separate exclusion, but as Barry said during the call, we only cover those losses if there's a covered loss, a damage to property, and certainly, the pandemic is not that.
Yeah. Well, our forms that we use and most every other company that uses standardized forms, they're structured the same way.
But it didn't include the ISO, the standard ISO virus exclusions, is what you're telling us?
We don't have a specific exclusion.
Okay. Thank you. Fantastic. Appreciate it. Thank you very much.
My pleasure. Thank you.
The next question is from Scott Preston of Maven Group. Please proceed with your question.
Hi, good morning. Barry, I have a couple of questions. I'll just ask them all and then let you guys ask them all at once here. First, on the buyback, good to see that at roughly 60% of book. Is there an amount you have for that? That's my first question. Second, on the investments, was there anything that was permanently impaired in kind of those investment losses, or would you expect that kind of that normalized back to where it was over time? And then two more on the do you know the amount of the commercial claims standing, how many you have, and then if you're still kind of assessing options with that book? And then finally, as far as the 25% ceding of business, how long does that run before you might start to lower that? And that's all I have.
You done?
Yeah.
Okay. So I'm going to take numbers one, two, and four, and then I'll let Ben talk to the commercial claims that you asked about. First, we don't have a specific dollar amount. We've talked before that the repurchase of shares must come through the holding company, and the holding company's liquidity is we don't keep a great amount of liquidity there. The money that had been raised through our two prior public offerings, the debt offering, almost all of that money was contributed directly to the surplus of the insurance company. So on a regular basis, there is a dividend paid from the insurance company to the holding company. That money is used to pay dividends to service debt and holding company expenses. And when there's money left over to the extent that it makes sense, we would buy back shares.
Certainly, in the last quarter, as the price to book has gotten worse, the opportunity was there, and we took advantage of it to the extent that we could. But we don't have, at this point, a particular way to access additional holding company liquidity without challenging our leverage ratio and putting ourselves at rating risk. Finally, it makes no sense to me to go out and raise any money in the equity markets, or at least in a traditional sense, when the stock is trading at such a cheap value. So I hope that's responsive to what you're looking for. With regard to investments, is to permanent impairments?
No. In fact, I think on an overall basis, the valuation of our fixed income holdings is all but somewhere between 15%-10%, or 15%-20%, I should say, of the decline is still in force. We've gotten back more than 80% of the decline. So we're in real good shape there. I wrote down what the first part of that question was, and I can't read my handwriting. So you asked about, I guess, permanently impaired was all there was. Is that what you were looking for?
Yes, that's right.
Okay. And the last thing was the 25% quota share, which started December 15th of last year, extends through December 31st of this year. And certainly, on our radar, will be sometime towards the end of the third quarter. We'll decide whether we're going to keep or change that quota share. It's something I've always been opposed to. We do have, or at least we had, a far stronger balance sheet before 2019 than we have today. Just to take advantage of the market and give us that opportunity to work through these rate changes and not run the risk of having a bad winter again kind of blow us up.
That's why we put that quota share in place. But I see us generating more surplus from our operations this year, rebuilding back our surplus. So I'm feeling good that whatever we do towards the end of this year won't be under the stresses that we faced last year. Ben, I think what you were looking for, Scott, was some kind of claim count regarding the commercial policies?
That's right. Yeah.
Great. Ben, you want to take that?
Sure. So as of March, we have 227 open commercial lines claims, which is about 25% of our total claims inventory. Does make up a bigger portion of our total reserve, but as we noted, the development for the quarter was very favorable, and we'll continue to monitor that over time.
Okay.
That's all I have.
Yeah. Let me just expand on that just a little bit because we put, obviously, an immense amount of work went into having us put up the amount of reserve strengthening we did last year. And while much of it with regards to these commercial liability cases was done in the first and the second quarters, we're carefully monitoring each of those enhanced reserves. And what we'd said in the press release and what you'll see in the Q is that as time's gone on, we've been able to run off something about half these claims now, Ben?
Yeah. Out of the ones that were open at June 2019, we've closed about half of those. Yes.
They've closed favorably overall?
Yes. The amount paid on those claims was approximately 10% lower than the reserve that was in place, which is a much better result than we had been seeing previously.
We're no longer exploring as a result of that, we're no longer exploring the use of any reinsurance to protect us on that. We feel comfortable in the level of reserves. The amount that's run through is statistically significant, as I understand it. It's just a matter of time till they work their way out of our reserves. I hope that answers your question there, Scott.
Yeah. Yeah. Thank you and a good quarter and stay healthy.
Thank you. You too.
As a reminder, if you would like to ask a question, please press star one on your telephone keypad. Our next question is from Bob Farnham of Boenning & Scattergood. Please proceed with your question.
Hi there, and good morning. I have a question on it. It's kind of a disconnect. You had no storms, no severe storms. You had no adverse reserve developments. You had no reserves set up for COVID-19 claims. You had fire activity in line. You still came up with a 100 or so combined ratio and a slight operating loss for the quarter. So what's the difference in there?
Thank you for that, and I hope everything's well at Boenning.
It is.
But no, I think you should focus your attention not on the expense or the combined ratio. As I said, just the balance sheet restructuring through the use of quota share is impacting the expense ratio in an unfavorable way. But look at just the loss ratio. So yeah, we didn't have the bad weather this year, and yeah, we didn't have any adverse development this year. But what we like to look at is our core loss ratio has improved materially. And then when you take out the effect of the commercial lines loss ratio, which is still at a very elevated level, it's down even more.
So I think what you're going to see, while it does add up to 100, if we were allowed on the GAAP, I guess, to strip out a lot of the things and come with a direct computation, you'd see it was a far more profitable quarter than what looking at 100 combined gives you. And maybe we can take this conversation offline to work through the quota share accounting if you'd like.
Sure. Okay, so going forward, obviously, there's still an impact of the commercial lines book with a higher loss ratio. So, if I'm looking at a kind of a normalized current accident year loss ratio, you had like 60%-61% around that this quarter, what should we be expecting going forward?
I'm going to let Ben try to answer that, but let me just preface this that as a CEO, I've never been one to try to give guidance. I like to let the numbers speak for themselves, but I think your question's legitimate, and Ben, if you could give some color as to given how moderate the winter was and the lack of reserve influence over the loss ratio, can you give a little bit of color as to what you see the full year loss ratio would look like?
Sure. So our first quarters typically do run much higher than other quarters. And the reason for that is typically winter weather. Now, we didn't have any winter weather this quarter, but we do always have a higher claim frequency on the fire side. And that makes up typically between 10 points and 15 points of the loss ratio for first quarter. So the fact that this quarter was higher than a normal quarter is not unusual for us. Going forward, we do have this homeowners rate increase, which will be flowing through. And we anticipate that that will improve our loss ratio from 19 to 20 by about four to five points as it earns through. So we should see an improvement this year due to improved rate levels and also due to the fact that first quarter has come in much better than a typical first quarter would.
Right. Okay. In terms of obviously, all your business or vast majority of business comes through your independent agents, and they're at home. Just you mentioned maybe having some issues with trying to get new business in the door. What is your feel for expectations in terms of new business going forward?
Let me start that off. Meryl maybe can pick up a little bit. I mean, so the independent agents are more like storefront retail store owners in that many of them are just totally shut, and the ones that were better prepared continue to do business both online and over the phone, but there are quite a few that are neighborhood-type operations who just have seen their business all but stop, so we're compromised on that level. Meryl, do you want to talk a little bit about what you're seeing, what we saw during the first quarter, and what we're looking at going forward with COVID?
Sure. So we have seen a slowdown in our business from our independent agents. The line of business, though, most severely impacted by COVID has been our physical damage product for livery drivers. Obviously, there's no business for them as everyone shelters in place. So we've seen a very significant drop-off in that line of business. But in general, new business makes up a smaller portion of our total premium. And fortunately, we've not seen any impact on retention, and that's the majority of our premium. So I totally applaud our producers for helping us retain customers. And so while we do think new business will be slower, especially in Q2, we're thinking that it won't be that significant because new business is such a small portion of our total premium.
Right. And it looks like you grew the homeowners book, at least on the direct basis in the expansion states. Was there any states in particular that grew more than others?
Yes. So when you compare to last quarter last year, we hadn't yet entered Massachusetts or Connecticut. So those states certainly are driving some of our growth. But all of our four new states, all of them grew significantly versus first quarter of last year.
Okay. Great. Thank you.
Okay. There are no additional questions at this time. I would like to turn the call back to Barry Goldstein for closing remarks.
Thanks very much, everybody, for joining. I think we're off to a great start. The numbers are all over the place. It's going to take a lot of working through for you to see that. We're very hopeful. We're certain that the actions we've taken are having the intended effects. We do live in an environment right now where seeing the future is obviously out of the question. At this point, let's just say I'm feeling very good about the direction we're going in. I hope that everybody on the call has stayed safe, stayed sheltered, and we'll look forward to a safe reopening of our economy. Thank you all so very much. Bye now.
This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.