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, 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 in the 2017 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 the GAAP to these measures can be found in the press release, which is available at the company's website at www.kinsalecapitalgroup.com. I would now like to turn the conference over to Kinsale's President and CEO, Mr. Michael Kehoe.
Please go ahead, sir.
Good morning, everyone. Thank you for joining us today. With me are Bryan Petrucelli, Kinsale's Chief Financial Officer, and Brian Haney, Chief Operating Officer. After a few introductory comments by me, Bryan Petrucelli will review Kinsale's financial highlights for the quarter. Brian Haney is going to provide some commentary on our quarterly performance and discuss our market outlook. After that, we'll follow up with any questions you may have. Just as a reminder, the Kinsale strategy combines disciplined underwriting and claim handling with technology-enabled low costs to deliver attractive returns and growth. We focus on smaller and sometimes hard-to-place accounts within the excess and surplus lines market. Unlike competitors, we maintain absolute control over the underwriting and the claim management process and do not outsource those functions to external parties. We believe these strategies help Kinsale drive attractive loss ratios.
Further, Kinsale uses proprietary technology and automation combined with an owner-operator business culture to operate at a significant expense advantage over many larger competitors. The combination of disciplined underwriting with low costs is an end-game winner every time. For the fourth quarter, Kinsale posted strong growth and profitability. With a combined ratio of 87.1% for the quarter and 85.3% for the year, we generated a 15.4% operating return on equity for the year 2018. As a reminder, our forward guidance is a mid-80s combined ratio and a mid-teens operating return on equity. The 87.1% combined ratio for the fourth quarter was slightly elevated by the $5 million pre-tax loss on Hurricane Michael in October. We had previously estimated this loss as $4 million pre-tax. It developed slightly higher since we issued that estimate in early November.
Gross written premiums grew by almost 27% for the fourth quarter and by 23.5% for the full year. This strong growth rate is driven by the strength of Kinsale's business model and by the ongoing dislocation within the excess and surplus lines market. We expect this dislocation to continue for the near term. With that, I'm going to turn it over to Bryan Petrucelli.
Thanks, Mike. The results for the fourth quarter and the full year were strong and generally in line with expectations. We continue to generate market-leading combined ratios and believe it demonstrates the strength of our low-cost model irrespective of market conditions. We reported net income of $4.5 million for the fourth quarter of 2018, down slightly from $5.9 million for the fourth quarter of last year. That's due primarily to Hurricane Michael, as Mike just mentioned, and the impact from unrealized losses related to our equity securities that are now reported through the income statement as a result of a GAAP accounting rule change in 2018. The decrease was mitigated somewhat by a lower effective tax rate in 2018 and a charge in 2017 related to the enactment of the Tax Reform Act.
Net operating earnings increased by 29.8% to $10.1 million, compared to $7.8 million in the fourth quarter of last year. The increase in operating earnings was largely driven by the lower effective tax rate in 2018 and the tax charge last year that I just mentioned. Our effective income tax rate was 16.5% for the full year of 2018, compared to 35.4% last year, and lower primarily due to the Tax Reform Act and tax benefits from the exercise of stock options and interest on our tax-exempt investments. The company generated underwriting income of $7.7 million and a combined ratio of 87.1%, compared to $8 million and 83.1% for the fourth quarter of last year. The combined ratio for the fourth quarter of 2018 included 2.2 points from net favorable prior year loss reserve development, compared to 1.1 points from net unfavorable prior year loss reserve development last year.
Cat activity this quarter contributed 8.7 points to the combined ratio, compared to 1.8 points in the fourth quarter of 2017. The year-to-date combined ratio of 85.3% included 2.7 points from cat losses and benefited from 3.3 points of net favorable prior year loss reserve development, compared to a combined ratio of 84% last year that included 5.1 points from cat losses and 6.4 points from net favorable prior year loss reserve development. Annualized operating return on equity of 15.5% for the fourth quarter of 2018 and 15.4% for the full year of 2018 was in line with our mid-teens guidance compared to 13.2% for the fourth quarter and 11.9% for the full year last year. Gross written premiums were $72.1 million, representing 27% over the fourth quarter of 2017. Year to date, as Mike mentioned, written premiums have increased 23.5% over last year.
Increases continue to be generated from an overall increase in underwriting activity across most lines of business and due to the reasons Mike Kehoe mentioned previously, including improved market conditions. Brian Haney will get into this in a little more detail here shortly. On the investment side, no significant change in strategy. Net investment income increased by 48.8% over the fourth quarter of last year to $4.6 million, up from $3.1 million last year, as a result of just continued growth in the investment portfolio and rising interest rates. Gross investment returns increased to 3% from 2.4% last year. Basic and diluted operating EPS were $0.20 and $0.40 per share, respectively, for the fourth quarter 2018, compared to $0.27 and $0.36 per share last year. With that, I'll pass it over to Brian Haney.
Thanks, Bryan. As mentioned earlier, premium grew 27% in the fourth quarter, which is the highest rate of any quarter for the year and the highest growth rate in nearly five years. Our Allied Health, Commercial Property, and management liability divisions continue to grow nicely, as does our inland marine division. Aspera 41% for the quarter. Overall, submissions continue to increase at a strong pace. Submissions in the fourth quarter were up 22% over the fourth quarter of 2017. We look at submissions as a good leading indicator for growth rates going forward, and the vast majority of our 17 divisions have had and continue to have positive growth in submissions. The growth rates in premium and submissions have encouraged us to be more assertive in pushing for rate increases.
We have a very heterogeneous mix of business, so it is difficult to boil all the various rate movement down to one single number. If we had to do that, we'd say the rate increase was somewhere in the 3%-5% range and gradually accelerating. Certain lines, like property, have much stronger rate increases. We expect to keep pushing bigger rate increases going forward. While it is tough for us to know exactly what is driving the increased flow of business, I suspect that the announcement from many competitors of scaling back on certain programs or exiting certain programs altogether has had something to do with it. As a reminder, we don't give out the pen to third parties. When competitor programs are falling apart, we do tend to see a rush of submissions.
Accounts which would previously not have been shopped due to the presence of an easily accessible, often underpriced program, will tend to be shopped aggressively when the cheap insurance is no longer available. I've said in the past that I suspect we would continue to see more poor results coming out of the programs in the next few years. That's exactly what we've been seeing, and I suspect we are not done seeing it. We feel optimistic about the state of things. The acceleration of submission growth shows no signs of abating. Our simple yet effective business model, combined with our excellent systems, has well-positioned us to take full advantage of the opportunities we are now seeing. We have a great team that is working hard to deliver superior returns to our investors, and I think the future seems very bright for us.
With that, I'll turn it over to Mike.
Thanks, Brian. Operator, we're now ready to field any questions in the queue.
Thank you. Ladies and gentlemen, if you have a question at this time, please press star and then one on your touch tone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. To prevent any background noise, we ask you mute your line once your question has been stated. Our first question comes from Mark Hughes from SunTrust. Your line is now open.
Thank you very much. Good morning.
Good morning, Mark.
The ceded premiums this quarter were down a bit sequentially. They were kind of steady year-over-year, the ratio was. I think usually the property has higher ceded premiums, if I remember correctly. It sounds like you did well on Commercial Property in terms of top-line growth, but still your ceded premiums were down. Was that more of a seasonal issue, or is there some other mix going on there?
I think the ratio of ceded premiums is going to fluctuate almost exclusively with the mix of business. Our primary casualty business, we don't have any reinsurance on that book. The excess casualty, depending on the limits, we cede a very high percentage, and the property's in the middle. The mix of business is going to cause a little bit of a fluctuation there.
Okay. Understood. The dislocation, does that include Lloyd's? Are you seeing movement there?
Absolutely. Lloyd's and AIG, I think have been the two big
E&S writers. If you look at Lloyd's collectively, I think it was 23% market share in 2017. The 2018 statistics haven't been published yet. AIG has always been the second largest writer of recent years, and they're both going through a lot of restructuring. It's not limited to those two entities. There's all sorts of activity that you see in the trade press of companies trying to triage their books of business to improve profitability. I think that's, for a healthy company that's been disciplined in its underwriting, it's a pretty favorable opportunity to not just grow the business but expand margins at the same time.
Your current accident year losses really took a nice decline this quarter. I know in the past you've had a pattern of sort of being conservative up front and seeing how the year develops. When you think about 2018, was this a function of better loss experience, or the better pricing kicking in that gave you that gain, or was that your conservatism kind of playing out for the full year?
I think it's mostly attributable to just the normal variability that you're going to have in reported losses. I think we're clearly focused on being conservative in how we reserve our book of business. That's a very explicit goal for us as a company. We want to set our reserves in a conservative fashion so that they're likely to develop favorably in the years ahead. If you look at our track record now over nine accident years, all of our accident years have developed favorably except for the 2011 year, which was a very modest size year. It was our first full year in business. No change in our strategy of being conservative. I think any kind of variation from quarter to quarter or even year to year would just be kind of within the normal bounds of variability.
Final quick one. Bryan, what's the best tax rate to use for 2019?
Yeah, Mark. It's a little tough to tell because what really drives that variability from quarter to quarter is the volume of stock options that are exercised during any period. I think what you typically see is that there tends to be more activity in the second half of the year than the first. I think the best way to look at it is to look at that annual rate and stick with that. I think it's going to bounce around from quarter to quarter just based on what I just said.
Thank you very much.
Thanks, Mark.
Thank you. Our next question comes from Jeff Schmitt from William Blair. Your line is now open.
Hi. Good morning, everyone. I believe you said growth of Aspera was 41%. Could you maybe discuss where you're seeing that growth and sort of what your outlook is for 2019?
We're seeing that through some geographic expansion. We've entered a few new states recently. We're also seeing that expansion from getting into more commercial products. The bulk of what we write now is personal lines, but we do have the capability to write commercial lines within Aspera, and that has been growing as well. It's really a combination of geographic expansion into a few new states and expansion of the commercial product line.
What type of commercial products oh, I'm sorry.
I was just going to say, I think we view that as part of our growth story. Over the years ahead, it's grown from zero to, I think, slightly below 5% of our total volume over the last couple of years. We would expect that trajectory to continue.
What type of commercial products are going through there?
It's similar to what we write on the individual risk side within the other divisions. I would say they're smaller, though. If you were to look at what the small business division within the rest of the company is most similar to what Aspera writes on the commercial side.
Cash and cash equivalents continues to be pretty high, I think around $75 million. What's the strategy there? Are you thinking of M&A opportunities, or why wouldn't that be put to work in the investment portfolio?
No, I think it's just holding onto it, looking for the best investment opportunities we can have. We have no expectation of M&A in the foreseeable future.
Yeah, our strategy-- this is Mike Kehoe, Jeff. Our strategy is to grow organically. We think we've got a very competitive model with our expense advantage, with our focus on a fairly defined niche, use of automation to drive kind of best-in-class service levels. We think we can grow at a healthy clip without any kind of deal-making.
Okay. Thank you.
Thank you. As a reminder, if you have a question, please press star then one. Our next question comes from Scott Heleniak from RBC Capital Markets. Your line is now open.
Thanks. Good morning. The first question, I want to follow up a little bit on the dislocation that you're seeing. If you could talk a little bit more about some of the specific areas. I know you mentioned Lloyd's and AIG, are there any particular lines that come to mind that sort of stick out there? Did you see a big change in that, an increase in the dislocation in Q4 versus Q3?
This is Brian Haney. I would say in our Allied Health lines, we're definitely seeing an uptick in the last 12 months. I would say versus last quarter, it's similar.
Okay.
Versus last year, I think it's much more favorable for us. Commercial Property, I think, still is continuing to benefit from the effects of all the catastrophes. Again, that's one where it's no more dislocated, if you will, than it was last quarter, a lot more so than it would have been a year and a half ago. Those are really the ones that jump to mind, the biggest ones.
One thing I can think of is there was a headline a month or so ago where AIG announced they were going to discontinue about half their program book, that probably covers a whole range of different coverages and lines of business. I think it's a broad reassessment of profitability across the industry, it's a good tailwind for a company like Kinsale.
Yep. Is your appetite a little bit bigger now on the property side, just given kind of the change in market conditions than it was maybe a few years ago, and just on the pricing side and the dislocation that you're seeing?
Yeah, I would say our appetite is not any bigger. It's probably smaller. It's just we're seeing a lot more opportunities and getting a lot more quotes out, and just writing a lot more. Yeah, we're not getting more expansive in what we are willing to write.
Right. Okay. I wanted to follow up on a comment, Brian, you made a couple quarters ago about some opportunities to write some larger account business than you had seen before. I was wondering if you, I know you didn't mention it in Q3, but wondering if you saw that again in Q4 and that's some of the growth drivers is also just seeing the bigger premium accounts than maybe you had a few years ago.
Yeah. Keep in mind, large accounts are a small percentage of what we do.
The bread and butter of what we do is always going to be small accounts. That being said, we have seen a trend that there's just a lot more of those accounts available. We're very selective when we look at large accounts because they still tend to draw irrational competition. That all being said, fourth quarter of 2018 was better for us in terms of premium on large accounts than fourth quarter of 2017.
Okay. Yep, that's fair. Then I guess the last question I had was just the, you have the 17 divisions now, is there any plans to expand that into some new areas for 2019 or 2020? I know there's probably not anything to announce, but anything you can share on that front or just keep growing in the lines you're in right now?
I think part of being an E&S company is you're always looking for new opportunities. I mean, it's a very dynamic market in which we work and focus. Given the strong top-line growth across our portfolio, there's probably a slightly more focus on just growing the business that we're already targeting. We're also putting a lot of effort into system development and process improvement, that's an area of emphasis that's not so much expanding the product line, it's just being more efficient and smarter about how we handle the current business. That's kind of our near-term focus.
Got you. Okay. That makes sense. All right. Thanks a lot.
Okay. Thank you.
Thank you. I'm not showing any further questions. I will now return the call back to President and CEO, Mr. Michael Kehoe, for any further remarks.
Okay. Thank you, operator. Thanks everybody for joining us, and we look forward to speaking with you again in a few months after the first quarter. Have a good day.
Ladies and gentlemen, thank you for your participation in today's conference. This concludes today's program. You may all disconnect. Everyone, have a great day.