Good day, ladies and gentlemen. Before we get started, let me remind everyone that through 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 contains the press release announcing fourth quarter and year-end results. Kinsale management may make reference 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 operation and is derived by subtracting losses and loss adjustment expenses and underwriting, acquisition, and insurance expenses from net earned premiums. The Form 8-K contains reconciliation between net income and underwriting 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 very much for that. Good morning, everyone. Thanks for joining us. I'm the CEO of Kinsale, after my introduction, I'm going to turn things over to Bryan P. Petrucelli, who is the Chief Financial Officer, to provide some additional financial results. After that, Brian D. Haney, Chief Operating Officer of Kinsale, will provide some color on Kinsale's operations and the market in which we compete. Last night, Kinsale reported favorable results for the fourth quarter, the highlights of which include the following. Net income of $6.9 million, up 49% over the prior fourth quarter 2015, annualized ROE of 13.1%, combined ratio of 75.3%, underwriting profit of $9.5 million, and premium growth of 5.1%. Kinsale's strategy combines disciplined underwriting and claim handling with a technology-enabled low-cost operation.
We think this is a powerful model in any market, but it's especially so during a highly competitive point in the insurance cycle like we're in today. Kinsale's customers demand competitively priced insurance policies, and the company is in a position to offer such terms without compromising its profit margin. Its costs range from 20%-40% lower than many of its competitors. With that, I'll turn it over to Bryan P. Petrucelli.
Thanks, Mike. As Mike noted, the fourth quarter was another good quarter for Kinsale. As a reminder, the company's goal is to consistently generate a mid-80s or lower combined ratio and to produce a return on equity in the mid-teens over the long term. For the fourth quarter, the company generated underwriting income of $9.5 million on a combined ratio of 75.3% and an annualized ROE of 13.1%. Underwriting income benefited from $3.8 million in net favorable prior year loss development for the quarter. That amount is $5.1 million after excluding the effects of our quota share. Gross written premiums were $47.5 million, representing a 5.1% increase over the fourth quarter of 2015. For the full year, gross premiums grew by 6.5%.
Premium growth continues to be generated from an overall increase in 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 96% fixed income allocation, a double A average credit rating, and a weighted average duration of 3.7 years. Investment income did increase by 29.8% over the fourth quarter 2015 as a result of growth in the investment portfolio. Gross investment returns continue to be in the low 2% range. For the fourth quarter, basic and diluted EPS was $0.33 and $0.32 per share, respectively. As we discussed last quarter, the 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.
On a normalized basis, assuming the company's current capital structure was in place for the entire year, basic and diluted EPS would have been $1.25 and $1.23 per share, respectively, for the year. With that, I'll pass it over to Brian Haney.
Thanks, Brian. As Brian just noted, premium grew 5.1% in the fourth quarter. The submission growth rate was in the mid-teens. Over the long run, we expect submission growth and premium growth to track more closely. Although the market is still highly competitive, we have noticed pockets in the industry where some of our competitors are pulling back due to adverse experience. The fact that some competitors are reporting stress in their results will be a positive for the trading environment if it were to continue or accelerate. Turning to product development, we feel that we already have a pretty broad product offering for a small boutique insurance company, but we are always looking for ways to expand what we offer. Late last year, we launched a private company D&O product in our management liability division and an educational institution liability product in our public entity division.
We also developed a med mal product for Pennsylvania and launched a small business commercial liability product for California in our Aspera unit. Moving on to rates. In the fourth quarter, our technical rates were essentially flat. I'd like to touch briefly on a few current topics facing the industry. commercial auto is an area that has posed problems for some insurers. I'd just like to point out that we write an immaterial amount of commercial auto, less than 3% of our total volume. For what it's worth, the experience on that small amount of business has been excellent. We also don't write business through delegated underwriting authority arrangements, what some people call programs. This is another area where some competitors have seen adverse experience.
When carriers pull back from the program space, as some have recently, we tend to see an uptick in opportunity as those accounts look for new homes. It's also worth noting, we are still 100% surplus lines. We don't write any admitted business, which is why we don't write any workers' comp. Lastly, we did have some property exposure in Hurricane Matthew. At this point, it appears that losses will come in below $1 million pre-tax. We feel pretty good about how the property portfolio performed. With that, I'll turn it back to Mike.
Thanks, Brian. One final topic, then we can move on to questions. There was a steady rollout of newly completed technology projects in the fourth quarter, including some of the new product offerings that Brian just spoke about a moment ago. Perhaps the most significant IT project that's been completed recently was just rolled out here earlier in the first quarter of 2017, it's the completion of the Kinsale Enterprise system. With the release of our new policy booking system earlier this quarter, Kinsale now operates a completely proprietary end-to-end enterprise system that saves the company time and expense in processing its business, in developing new system features and functions and applications, in the maintenance of the system over time, of course, in licensing fees.
Completing the Kinsale Enterprise system will accelerate the rollout of new IT projects as we move forward, we believe it augments Kinsale's technology competitive advantage in a material fashion. Operator, with that, we're ready to take any calls that are pending.
Ladies and gentlemen, at this time, if you have a question, please press star then one on your touch-tone telephone. If the question has been answered or you wish to remove yourself from the queue, please press the pound key. Our first question comes from Mark Hughes from SunTrust. Your line is now open.
Yeah, thank you. Good morning.
Good morning.
Am I correct in thinking, I think your other expenses category is $1.1 million. Is that largely non-recurring? What is in that bucket?
Yeah, Mark. Those were the costs that we incurred associated with our secondary offering.
Right. You might say non-recurring would be the other expenses plus the Hurricane Matthew.
Yeah, I would think that would be accurate, Mark.
The commercial auto, is that something you would be comfortable pursuing? It sounds like your experience is good. Rates are presumably going up. Would you look to increase your exposure there?
It's tough for us to write much commercial auto because we write all non-admitted. If you have to write primary commercial auto, for the most part, you have to be admitted. We would look to expand into it to the extent that we could do so non-admitted.
Okay.
I'll just add one more comment on that. If rates were to continue to trend upward, we would probably see an uptick in how much excess auto we write. It is possible for future expansion, depending on how the market develops. Right now, we're still taking a very cautious view given where prices are.
You talked about submission growth in the mid-teens. Refresh me, is that an acceleration lately, or do you think you'll be able to have an increasing rate of success with the submissions you're getting in?
That's consistent with what we saw in the third quarter, and for much of last year in terms of the growth rate. I do think eventually we're going to see more success from those submissions. It's probably worth noting we're quoting a lot more of the submissions that do come in. The growth rate in the quotes is well ahead of mid-teens.
Right. Why are you quoting more now? Is that a systems issue? Appetite?
It's mainly process improvements and system work. We're trying to get more quotes out faster. The system and our technology is allowing us to do that.
Final question on your investments, your yields, low twos. Do you feel like it's a time where you might take a little more risk in the investment portfolio, still have a conservative balance sheet, but maybe go out a little more on duration or a little higher risk?
Yeah. Mark, I think there's a potential of doing that. I think we're comfortable with our conservative approach to investments right now. We constantly reevaluate where we are. There's the potential we could go out a little further on the duration, but I wouldn't expect anything significant here in the near term.
Thank you.
Our next question comes from Sarah DeWitt from JPMorgan. Your line is now open.
Hi, good morning.
Good morning.
I just wanted to ask on the ROE. It slipped a bit in the quarter to 13%, as expected, given the IPO proceeds, and just wanted to get your latest thoughts on how long you think it could take to deploy the proceeds and get back to a run rate of about 15%.
Sarah, this is Mike Kehoe. Our long-term guidance, of course, is mid-teens ROE or better. Right now we've got a little bit of a lag with the primary proceeds coming out of the IPO. The work we've done on broadening our product line, I think the work we've done on improving our service standards, I think our low-cost platform, all those things give us confidence that over time we are definitely going to take market share and grow our business. Last year was mid-single-digit growth rate. I think we ended up the year at 6.5%. Our guidance always focuses on mid-teens ROE or better, mid-80s combined ratio or lower. We're focused there obviously on the profitability of the business. That's something we have a lot of confidence in. It's a little bit tougher to predict short-term growth rates because they are subject to some volatility.
Two-thirds of the way through the first quarter, I would say that growth's picked up a little bit, I think we've been saying that after several quarters, we'll be able to put that capital to work, I think we're still in that mode of thinking. Growth principally is how we're going to get back to an efficient use of capital and then revert to the mid-teens ROE or better.
Okay, great. You mentioned submission growth and premium growth would track over time. What's driving the divergence right now? Could you just elaborate on that, and how long would it take for those two factors to converge?
One is a shift in the mix of business towards smaller account divisions. Our personal insurance and our small business divisions write smaller average premium, and they're growing pretty well. I'd say in the first quarter, we've seen the numbers track more closely.
I think in general, too, there is some volatility around the growth rate. We're in an intensely competitive market where you have to proceed carefully. Sometimes competition gets in the way of writing a piece of business, and you have to move on to the next one. We did see some roll-off of some larger accounts last year. I guess it was starting in late 2015, ending in mid to late 2016. We moved away from some hospitality business that we felt like we couldn't get the right price for. Offset in part with growth in other areas. As Brian just said, our personal lines unit was up a very healthy % last year. When you net it all out, it ended up being mid-single-digit growth rate. Longer term, we're very confident around growth. Short term, it gets a little bit more speculative.
As I said a minute ago, two-thirds of the way through the first quarter 2017, hey, growth has picked up a bit. I guess that's where we stand.
Okay, great. Thanks for the answers.
Okay.
Our next question comes from Mark Dwelle from RBC Capital Markets. Your line is now open.
Yeah, good morning. A few of the questions have already been covered, but on the expense ratio, you commented in the release a little bit on what drove that. I guess what I was trying to get a sense of is to the extent you have incremental public company costs, et cetera, how does that shake out across the expectations for the expense ratio going forward? Would we expect to stay around the 27 level, or are some of those sufficiently temporary or timing-oriented that it'll level out over the course of the coming year?
Hey, good morning, Mark. It's Mike Kehoe. I would say, just as a reminder, our focus on expenses is really fundamental to our business plan. The 27 handle on that expense ratio, I think that goes back to the third quarter last year, fourth quarter. It's principally driven by the public company expenses. We're obviously working very hard to manage costs given that we operate in a commodity business and our customers expect that of us. I think the growth is going to solve some of that. Over time, we would expect that number to drift back down. The expectation is we would do better than 27. It might be a couple quarters till we get there.
Okay. That's helpful. The second question on the investment portfolio. The duration was up. I assume that's just continuing to put cash to work and rebuilding your duration. What would you expect is sort of your, I'll call it normalized duration, given how you have your liability stacked and so forth?
Well, I think the average duration on our liability side is 3-4 years. I think we'd look to match our investment duration in that same range.
You're fairly close then, I guess.
Yeah
The bottom line of that. Okay, that's helpful. Lastly, and this was kind of referred to a little bit, I guess, in your last answer to Sarah's question, but I guess if you distill out the businesses that you had been exiting, like hospitality and a couple of the others that you mentioned, is there a way to see kind of what the ongoing growth rate is? Obviously, it'd be a little bit higher than the 6.5% for the full year. Is it closer to 9% or 10% or is that not readily calculable?
Well, we still write a lot of hospitality business. It was just some segment within that broader book that we rolled off. I'm not sure that you could actually look at it that way, in a way that would really be helpful and meaningful. I think the best news on the growth is, hey, we've kicked off 2017. We're two-thirds of the way through the quarter, and the growth rate has picked up. Long term, we're very confident in growth given our low costs. We can price our business slightly more aggressively than some of our higher-cost competitors and still have more margin in that business, right? That puts us in, I think, a very attractive position. Short term, in a three-month period, it's just difficult to predict and accurately prognosticate where growth's going to be, especially when you're in a very competitive market like we are today.
I don't know if that really answers the question.
No, that's helpful. I understand where you're coming from on that, and I appreciate the answers. Thanks.
Okay.
Our next question comes from Adam Klauber from William Blair. Your line is now open.
Good morning, everyone. Couple different questions. The accident year loss ratio really trended better in the second half of the year versus the first half. Is that a result that you set your picks pretty conservatively, and then you saw the business flow in, and that was just more where the business was coming in?
We haven't changed how we've approached reserves. All that is a function of, it was just better experience in the second half than the first.
Yeah. Okay.
There's no conscious change in the reserving methodology as a result of what we've seen.
Sure.
It's been pretty consistent.
Yeah, just a normal volatility and how the claims come in and that type of thing.
Right. As we think about 2017, should we think about potential accident year more in line with 2016, more in line with the first half of 2016? Just directionally, how should we think about it?
I would think it would be pretty consistent. Rates are basically flat. Trends still pretty modest.
Yeah. One caveat there is I think our guidance is an 85% combined ratio.
Yeah.
I think that assumes a little bit of a higher loss ratio than what we experienced in 2016, right? We're trying to be cautious in how we offer guidance to the future. Just, hey, it's a volatile business. Not everything's completely predictable, and we try to be a little bit conservative in the guidance we offer.
Okay. As far as, you had a decent amount of favorable development really throughout the year. Is that evenly spread throughout the past years? Is that more some of the 2012, 2013, 2014? Are there certain products or lines you're seeing more favorable come through?
All our lines had favorable development for the quarter and the year.
Okay.
It's coming from most accident years, basically 2012 through 2016.
Okay.
I'm sorry, 2015 and prior.
Okay, that's helpful. Sounds like experience doing well. Can you say how big is that business, and what was the growth rate of that unit on an annual basis, quarterly or annual basis?
Yeah. I think as a percentage of our company, it's still very modest.
Yeah.
I think it was just under 4% of our premium.
The growth rate was just below 50%. It's growing at a healthy clip. We see that continuing in the years to come. We're working hard to expand our personal lines business into new states, new geographies, and there's different ideas we're working on around product expansion.
Okay
The like. We see that as being a bigger percentage of our book going forward.
Great. You mentioned some new products coming online as we go into this year. I guess two questions. One, did you bring on teams of underwriters with those new products? Of those, which one or two do you think could be more incremental in 2017 versus going out a couple of years?
I would say most of the hiring we do is in-house, right? We like to promote from within.
Okay.
Every now and again, we'll bring somebody in. The individual that runs our inland marine division moved from out of town to Richmond to take that role at Kinsale, and the individual that runs our management liability division, same thing. In general, in terms of impact on growth, I think we've done a lot of work in the new product area. There's a lot of new products out there. A lot of them are enhancements to existing products. I think it's making a material contribution to our growth rate. I don't know that we can quantify it on the call, though.
Yeah, I don't think we can.
Okay. No, that's fine. When we think about, I guess, some market trends overall, how are you seeing the legal environment? Would you say it's steady with a couple of years, or better or worse from your perspective?
This is kind of anecdotal, but I would say it's probably deteriorating.
Okay.
That's very anecdotal, right?
Sure.
Just interaction with our claims team in terms of individual cases that we're either litigating or settling, what have you. I think there's a general consensus that there has been a deterioration. I think if you read some of the commentary from different insurance companies that have reported some stress in their business, a lot of it is tied back to things like auto. Sometimes it's program business. I think AIG had some problems with workers' compensation. A lot of it goes back to increases in severity. There's a perpetual upward pressure in terms of jury verdicts and the like. In general-
Okay
I think it's deteriorated.
Yep. Okay. Yeah, that's what we're seeing too. Okay, thanks a lot, Mike.
Okay, Adam.
Thank you. We also have a follow-up question coming from Mark Hughes from SunTrust. Your line is now open.
Curious if you have any observations on the macro environment, small business confidence, small business startups, anything there that might be contributing to the submission growth?
I think we're going to see that. It's kind of tough to tell. I'd say submission growth has been consistent quarter-to-quarter. I would be surprised if we didn't see more of that because of the relaxed regulatory environment is going to mean a lot more business in things like coal mining, for example. I expect we'll be seeing it, but I think what we've been seeing so far is just an organic pickup in our business.
Thank you.
At this time, I'm showing no further questions.
Okay. Well, with that, I just want to say a special thank you to all the Kinsale employees for the hard work that went into the results that we posted last night. Thank you for everyone listening to the call, and we'll talk to you again next quarter.
Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. You may now all disconnect. Everyone, have a great day.