Hello, and thank you for standing by. My name is Regina, and I will be your conference operator today. At this time, I would like to welcome everyone to Kinsale Capital Group, Inc.'s third quarter 2022 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star then the number one on your telephone keypad. To withdraw your question, press star one again. 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 third quarter results. Kinsale's management may also reference certain non-GAAP financial measures in the call today. A reconciliation of GAAP to these measures can be found in the press release, which is available on 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, operator, and good morning, everyone. Bryan Petrucelli, Kinsale's CFO, and Brian Haney, Kinsale's COO, are joining me this morning. Our third quarter conference call will follow our usual format. Each of us will make a few comments, and then we'll move on to any questions you may have. Kinsale's operating earnings for the third quarter of 2022 increased by 3.3% over the same quarter in 2021. The gross written premium was up 44% for the quarter. The company posted an 83.6% combined ratio for the quarter and an 80% combined ratio for the nine months. The annualized operating ROE for the first nine months of the year was 24.3%. The previously mentioned 3.3% growth in operating earnings was more muted than recent history because of losses from Hurricane Ian in Southwest Florida.
A few comments on Kinsale's property insurance strategy and Hurricane Ian. Through nine months of 2022, Kinsale's premium was split about 21% property and 79% casualty. For comparison purposes, the overall E&S market is about 1/3 property, 2/3 casualty. Slightly less than half of that 21% property premium has some sort of exposure to hurricane losses. The balance does not. Kinsale writes catastrophe-exposed property business because the profit margins are compelling. We are mindful, however, of the volatility associated with this type of business and use a variety of strategies to control it, specifically a disciplined underwriting approach, regular modeling of individual risks and the property portfolio, limits on the concentration of business, and a robust reinsurance program.
Regarding Hurricane Ian in particular, our gross loss is estimated at $67.5 million, and our net after-tax loss is $20.6 million. About 80% of these gross losses arose from our modestly sized book of personal lines business. As this amount exceeded some of our underwriting and pricing assumptions, we're making a variety of adjustments to reduce volatility in this area. With about 20% of our gross loss from Ian coming from our commercial lines book, this book significantly outperformed our underwriting and pricing expectations, which of course is encouraging. Beyond Hurricane Ian, the quarter was a continuation of the trends we had experienced over the last several years. A relatively hard market with a strong growth in submissions, strong top-line growth in premium, and favorable profit margins on our underwriting.
This strong business performance, combined with Kinsale's low-cost operating model, allowed us to absorb the storm losses and still produce a quarterly sub 84% combined ratio and a nine-month operating ROE above 20%. We continue to raise rates above loss cost trend in the quarter, and we continue to establish reserves for future losses in a conservative fashion. This, combined with the unique nature of our business model, should provide our investors with confidence in our balance sheet and our prospects for future growth and profitability. We continue to have an optimistic outlook for the E&S market for the balance of 2022 and for 2023. Beyond next year, our view of the market becomes a little bit less certain.
With our model of disciplined underwriting and technology-driven low costs, we expect to grow our business, take market share from less efficient competitors, and produce best-in-class returns for the foreseeable future under any market conditions. Now I'll turn the call over to Bryan Petrucelli.
Thanks, Mike. Again, just another really strong quarter from an operating income perspective, even in light of catastrophic losses from Hurricane Ian.
Although net income was down around 9.9% compared to Q3 2021 as a result of the higher cat activity and a decline in the fair value of our equity investments during the quarter. Operating earnings, which excludes the impact from fluctuations in equity values, did increase by approximately 3.3% over the same period last year. The 83.6% combined ratio for the quarter included 5.3 points from net favorable prior year loss reserve development compared to 5.9 points last year, and cat losses contributed 12.5 points this quarter compared to 3.8 points last year.
With respect to expenses, we continue to achieve some economies of scale as our earned premium continues to grow at a faster clip than our operating expenses, as reflected in the 19.2% expense ratio that we reported for Q3 of this year compared to 20% last year. A portion of this decrease related to slightly lower relative variable compensation given a higher cat activity this year. Additionally, we entered into a quota share reinsurance agreement on our commercial property business at June 1 of this year that includes some ceding commission, that did not exist last year and shows up as a reduction to our commission expense. Book value decreased by 2.3% in the quarter, primarily due to unrealized losses on our investment portfolio as a result of higher interest rates and volatility in the equity markets.
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. 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 3.9 years, down from 4.3 years at the end of 2021. Net investment income increased by 71% over the third quarter last year as a result of continued growth in the investment portfolio, and as we start to recognize some effects from the higher interest rate environment. Lastly, diluted operating earnings per share was $1.92 per share for the quarter compared to $1.28 per share last year.
With that, I'll pass it over to Brian Haney.
Thanks, Brian. As mentioned earlier, premium grew 44% in the third quarter, largely consistent with the first two quarters. Overall, the E&S market remains favorable with strong gross growth across most of our product line. The property market continues to be hard, and in the wake of Hurricane Ian, we expect contraction in industry capacity, which will prolong the hard market. In addition to our property divisions, we are seeing continued strong growth across most of our casualty divisions. Our energy, general casualty, and entertainment divisions in particular have been growing at a significant pace. Submission growth continues to be strong, a little over 20%, which represents a slight acceleration from the first two quarters. We sell a wide array of products, and the rates in those products don't move in lockstep.
If we boil it all down to one number, we see real rates being up around 8% in the aggregate during the third quarter. Hurricane Ian happened late in the quarter, so we haven't seen any rate effects from it yet. We believe it will lead to further firming in the property market and perhaps in the overall market as well as reinsurers and other capital providers' tolerance for loss wanes. We are continuing to keep an eye on inflation. We feel we're in a good position because we have been achieving rate increases ahead of loss cost trend for several years now. These increases, combined with our strategy of conservative reserving, further protect the company 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 see a proliferation of MGAs and other delegated underwriting authority arrangements. We do not delegate underwriting authority ourselves, but virtually all our competitors do. Although there are certainly some well-managed MGAs in the market, we consider this dramatic proliferation to be a harbinger of undisciplined market behavior to come in the long run in the form of overly aggressive pricing and lax underwriting. At this point, it is not affecting the market much because many of the new entrants are just beginning to ramp up, and because MGAs typically rely heavily on reinsurers whose enthusiasm for aggressive expansion will be curbed by their significant losses in Hurricane Ian. As for Kinsale, the fact that we are able to deliver results like these, even with a significant catastrophe in the quarter, is a testament to the hard work of our people and the soundness of our business plan.
Our disciplined underwriting and technology-enabled low costs have allowed us to deliver superior returns to our investors, even in a difficult quarter for the industry. With that, I'll hand it back over to Mike.
Just one correction. The diluted operating earnings per share for the quarter was actually $1.64.
Okay. Operator, we're ready for any questions that come in.
As a reminder to ask a question, simply press star followed by the number one on your telephone keypad. Again, that is star one for any questions. Our first question will come from the line of Mark Hughes with Truist Securities. Please go ahead.
Yeah, thank you. Good morning.
Good morning, Mark.
The ceded premium ratio was up a bit in the quarter. You'd mentioned you entered into a quota share June 1. Was that it? Should we assume that I'm seeing kind of a 17% ceded premium. Should it continue at that level, go higher, go back lower?
Yeah. Yeah, Mark, this is Brian. That was the primary driver. There was a little bit of reinstatement premium in there as well. You should see that retained premium sort of at a lower level than we have seen historically. Yeah.
Back to kind of the low mid-teens, is that what you're saying?
I think that's a good estimate, yeah.
Okay. Then you said the personal lines underperformed. I assume that's manufactured housing. Did you just happen to have a concentration where the storm hit or do you think it's a broader issue than that?
Hey, Mark. Good morning. This is Mike. Yeah, we certainly write a lot of business in Florida, so we had you know, plenty of accounts in that area. I would just phrase it as you know, the frequency and the severity of the storm, we're just reconciling that with some of the underwriting and pricing assumptions. Like we do with all of our business, hey, we have to react where the business didn't perform as well as we anticipated. You know, that involves underwriting, pricing, concentration issues, reinsurance and the like. You know, we are long-term committed to the homeowner space. We do see that as a long-term opportunity to grow the business. I would say right now it's not so material to the company.
It's probably about 3% of our overall business. We're optimistic about getting that on track and continuing to grow.
How would you characterize your appetite for the coastal property? That's 10% or so of your book that's exposed to coastal. I assume that's going up, because I assume the pricing will be pretty attractive. You tell me, and then how much higher would you be willing to take that?
You know, we don't really have a macro ceiling that we manage to. It's really more of a bottom-up strategy depending on, you know, we have very strict limits on concentration, right? That's always a constraint on growth, especially when you get into urban areas like, South Florida or Houston and the like. I would say in general, our commercial property book performed exceptionally well in the storm. For a number of years now, it's generated very significant returns for the company, in a way that doesn't create a lot of volatility in our results. We are looking to incrementally grow that business.
You know, if 10% of our book today is some sort of hurricane-exposed property, you know, certainly that could go up a few points, but I wouldn't expect it to be, you know, dramatically higher than that.
Thank you very much.
You bet.
Your next question will come from the line of Casey Alexander with Compass Point. Please go ahead.
Yeah. Hi, good morning. A couple questions. One, first of all, my estimate for the quarter was way off the mark, and I wholly overestimated the losses that would result from Ian. I sort of apologize for that. It wasn't my intention to raise alarm bells or to distort consensus. More trying to figure out how I could be as far off the mark as I was. I compared your losses to, given the magnitude of Ian, to the loss ratio that you had in 2020. Is the difference between the two, the fact that 2020 had multiple events that dug into your retention in multiple ways compared to Ian, which was much greater magnitude storm, but only one event that only dug into your retention one time?
Casey, this is Mike. It may be best to take that question offline. I don't know that we have information in front of us to do a detailed comparison with 2020 and 2022. You know, we're happy to go back and talk to you about maybe the reinsurance structure we had two years ago versus today. That's all public information.
Okay.
That probably contributed to a lot of the difference.
Okay. Well, secondly, there have been a number of reports out recently that market participants can expect significantly reinsurance renewal cost increases, including increased retention. How does that contour your strategy going forward in this Southeast markets, and how might those changes in the reinsurance renewal and retention impact your margins?
Well, I would say this. You know, we are and always have been interested in managing volatility in our business. We do that in part through our reinsurance purchases. That's an important part of how we manage volatility, but also with our own underwriting decisions. What limits do we put out? What concentration of business do we allow in a specific area? How do we price the risk that we take onto our books? We just renewed our reinsurance program a couple months ago, so we'll have the better part of a year to look at the way the reinsurance market develops. You know, as I mentioned a few minutes ago, we're already proactively making some adjustments on our own.
I would say in general, our reinsurance partners have made a lot of money on Kinsale over the years. We're a valuable client. I think that puts us probably in a little bit of a different position than some competitors, but it probably varies company by company. You know, I think the short answer is it's a little bit early to speculate, but you know, certainly we're aware of those headlines and the like as well.
All right, great. Thank you for taking my questions. I appreciate it.
You bet.
Your next question will come from the line of Pablo Singzon with JPMorgan. Please go ahead.
Hi, good morning. First one, I just wanted to follow up on the, I believe I heard 8% pricing improvement you mentioned. Is that comparable to the low double-digit range you've been mentioning for the past couple of years? Or is there an inflation adjustment to be considered there? Because I believe you also mentioned the term real in your remarks. I just wanted to sort of make sure I'm comparing apples to apples here.
Okay. You're correct. This is Brian Haney. In the past, we've stated nominal rate increases. This quarter we pivoted to real rate increases, which are adjusted for the loss cost trend and premium trend. We find that's a clearer view of the movement in the rate adequacy and the margin.
Okay. If you sort of make it apples to apples, it seems like in an inflation mid-single, you'll probably be back to low double digits, right? No material change there. That's sort of the bottom line, right? Correct?
Well, yes.
Okay. Got it. The second question I had, so, you know, negative surprise on the personal property side, but, I guess, Mike, your comment on outperforming on commercial property, I was wondering if you could sort of talk through the elements there in your underwriting approach that enable that, right? Is most of your coverage there, like, named perils versus all risk or, you know, was there an element of geographic spread? Just sort of your thoughts and, you know, why that part of your book outperformed expectations.
Well, I mean, it's you know, there's a lot of things that go into it, Pablo. Certainly the limits that we put up when there's a pronounced hurricane exposure tend to be smaller rather than larger. How we price that risk, you know, we've achieved, and candidly, the market has allowed us to achieve over the last couple of years very significant rate increases. You know, partly we use coverage to drive a more accurate underwriting process. We control our own underwriting. We think that gives us a little bit better result. We have strict limits on concentration. We buy a lot of reinsurance in that area, so you know, lots of things go into it.
You know, the general takeaway is the bulk of our property business comes through that commercial property division, and it's an outperformer, even in the face of a you know, pretty significant hurricane in Florida. Again, we find it very encouraging.
Got it. I had a couple more. Maybe the next one's for Bryan Petrucelli. I think E&S losses were a negative surprise this quarter at least versus my number. But you put up a pretty strong accident year loss ratio at about 57%, right? Year-over-year, roughly consistent, but then sequentially, that's a pretty significant improvement. I was just wondering if you'd help us think about how that might evolve going forward, right? Whether, you know, there was something one-off this quarter. Was it the renewal of business you wrote last year? Sort of any commentary and, you know, that could help us think about how that ratio could evolve going forward.
No, I think as you mentioned, it's pretty consistent with where we were last year in the third quarter. I think if you look, you know, going back in the years, that loss ratio has a tendency to drift down throughout the year from quarter to quarter. I think if you look at Q2 of last year to Q3 of last year, the movement there relative to Q2 this year to Q3 this year, I think it's a fairly similar trend. Nothing unusual to comment on.
Is the downward drift because of the business that renews in the second half of the year? Or, you know, is there a change in loss picks throughout the year? Sort of any color you could provide on why that pattern exists in the first place?
Yeah, Pablo, this is Mike again. I would just attribute it to our generally conservative approach to reserving, right? Each sequential quarter across the calendar year, you have a little bit more information, and you have a little more confidence in where the losses are going to trend. I think you see, you know, some of that show up in the loss pick. You know, it's higher in the first quarter, tends to be lower in the second half of the year.
Okay. Thanks. Makes sense. The last one for me, I was looking at Stamping Office data, and it seems like premium growth in California was actually negative this quarter. Obviously, didn't detract from the overall premium growth number, but I was just curious to hear, you know, any commentary on what's happening there and I guess the opportunities you see in California versus other geographies. Thanks.
Yeah. This is Mike again. I would just attribute that to normal, you know, volatility when you get down to a state-specific number like that. I think with the stamping offices as well, sometimes there can be maybe a slight lag in reporting that causes that number to vary month by month. In general, I think, you know, Brian Haney commented, we've seen very robust growth across, you know, the quarter and across our whole portfolio.
All right. Thank you.
Again, for any questions, please press star one. Your next question will come from the line of Scott Heleniak with RBC Capital Markets. Please go ahead.
Yes, good morning. Just wanted to ask a quick question on, you know, we've heard this earnings season a few of the specialty insurers talk about a little more competition in a few areas, you know, typically liability lines where some of the rates may be drifting down a little bit. It sounds like you're really not seeing that much at all. But just, I wondered if you had any comments on what you're seeing versus the past couple quarters. Then also the submission counts, how they're sort of trended, you know, during the quarter, whether those strengthened toward the end of the quarter and into October.
Yeah, this is Brian Haney. We see in our market things pretty stable. Now, keep in mind, we focus on smaller accounts than a lot of our peers, so it wouldn't surprise me if the people that focus on larger accounts are seeing a little bit more competition. We certainly don't see places where, you know, you're getting rate decreases. We might be seeing some where the rate increases are less than the market average. Excess casualty is still pretty firm relative to casualty. Property is obviously the firmest. Some of the professional lines are probably some of the least firm, but everything seems to be going in a positive direction. We don't really pay a lot of attention to movement month by month in submissions, but I mean, it tends to be pretty stable.
The submission rate has been pretty consistent all year. It's just been on this very slight upward accelerating trajectory.
Yeah. It sounds like it was pretty close to what you saw in the second quarter. Maybe a little bit better on the submissions, but definitely very strong.
If I could expound my answer on one thing. When I talk about the MGAs, those new startup MGAs tend to focus on larger deals, so that's why we're not seeing a big effect from them in particular right now.
Okay. Yeah, makes sense. I was just curious. You mentioned some of the growth areas that you saw in the quarter and you know the casualty, energy, entertainment. Just wondering if you see any new growth areas or initiatives you have kind of planned for 2023? Is it just continue to build out you know with existing products, new hires, new expanding distribution? You know, how you kind of see that you know over 2023? 'Cause it sounds like you're pretty optimistic on the market itself, so I'd imagine you're preparing for growth there.
Yeah, Scott, this is Mike. I would just say yes to the optimism, both because of the market conditions and because we think our business model is a little bit different and we think that helps quite a bit as well. In terms of the product line, we're always working on incremental expansion. That's been going on for years. You know, certainly it's gone on this year, and we'll continue into next. That's, that'll be part of the growth story. I think if you look at how we roll out new products, they tend to be very incremental. It's, you know, it's a small part of the growth story in any given year, but over a long period of time, it's very meaningful.
Yeah. Okay. Just a question on the July 1 reinsurance renewals. I mean, you entered the quota share, but was there anything notable, any notable changes there versus, you know, what you had previously? I was also wondering if you could quantify the ceding commission benefit that you saw in the third quarter versus before you had the quota share, the new quota share treaty.
You know, I'll let Brian handle the ceding commission question. You know, the big shift was we moved away from a excess of loss approach on our commercial property business to a quota share approach. You know, the effect of that is, hey, it does generate a little bit of ceding commission, whereas the excess of loss approach, those treaties were net. They had the effect of actually, I don't know if artificially is the right word, but they had the effect of pushing up your expense ratio. The ceding commission pushes it down slightly. I don't know if we can quantify it on this call.
Yeah.
Okay.
Yeah. It had about a 0.1-point impact on our expense ratio.
One. Okay. Yeah. All right. That's perfect. Thanks a lot.
Okay. Thank you.
Our next question is a follow-up from Mark Hughes with Truist Securities.
Yeah. Anything from an economy standpoint, any slowdown in business, exposure units, that sort of thing, payrolls you're seeing among your customer base?
Yeah, Mark, this is Brian Haney. We're seeing the very early signs of that in some of the construction-related business, but honestly, it's a pretty broad product line, and across most of it, we're not seeing that yet. But if we were seeing it anywhere, we're seeing it in the construction-related accounts.
Understood. I don't know whether Mike or Brian, you had mentioned the possibility that this hard market and reinsurance could extend the casualty lines. I wonder if you could just expand on that a little bit. Is that something you've seen in the past? How likely is that in your judgment?
You know, look, we're just speculating, Mark. I wouldn't go too far with that. You know, when there's a big cat, sometimes, you know, that can bleed over into other lines beyond property in terms of reduced capacity. I think the bigger issue in casualty historically has been reserve adequacy. If you talk to a lot of reinsurers, some indicate that they suspect that the industry, I'm not talking about Kinsale, but for the industry, that there are some accident years where perhaps reserves aren't as robust as they need to be. That certainly can prolong a more favorable, you know, hard market, if you will.
I always like to reiterate, hey, we at Kinsale really strive to establish conservative reserves, and people, investors in particular, should have a lot of confidence in our balance sheet. Maybe for the broader industry, some companies, yes, some companies, no.
Understood. Thank you.
Our next question is a follow-up from the line of Pablo with JPMorgan.
Hi, thanks for taking my follow-up. First one is, I have is for Michael. Just based on your experience with past pricing cycles and I guess looking out further into the future, do you think that all this business that's moved from admitted to E&S remains in E&S, or would it be reasonable to assume some amount of give back, you know, at some point in the future when the cycle does turn?
I think it's good to keep in mind, Pablo, how dynamic the E&S market is even today when it's growing. I think E&S grew last year, the whole industry grew by 25%. Even in a boom year like that, you've constantly got business moving back and forth from standard to non-standard. I just think of like an example would be a new business would start out in the non-standard market many times. Couple years later, if they've had favorable loss history, they'll probably go to the standard side. That back and forth goes on all the time. I would say the long-term trend, if you look back 30 years, is the E&S market growing from 3% of the P&C industry. I think last year was 10.5%.
Not every year does it grow. I think, in the Great Recession back in 2007, 2008, there were like four or five years in a row where the E&S market actually shrank relative to the standard market. Typically by like 1% or 2% each year. It can ebb and flow, but the long-term trend we think is likely to continue, where E&S continues to grow at the expense of the standard market.
Got it. Just a quick follow-up on the question on construction exposure. I think, based on the notes I have, it seems like your exposure to construction is probably like less than 20% of the overall premium book. Is that? Does that sound right?
I don't have the exact numbers in front of me, but that's probably relatively close.
Okay. All right. Thank you.
We have no further questions at this time. I'll turn the call back over to Michael Kehoe for any closing remarks.
Okay. Thank you, operator, and thank you everyone for participating today, and we look forward to speaking with you again in three months. Have a great day.
Ladies and gentlemen, that concludes today's call. Thank you all for joining. You may now disconnect.