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 2018 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 second 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 at the company's website at www.kinsalecapitalgroup.com. I will now turn the call over to Kinsale's President and CEO, Mr. Michael Kehoe.
Please go ahead, sir.
Thank you, operator, and thank you everyone for joining us this morning. Joining me today are both Bryan Petrucelli, Chief Financial Officer for Kinsale, and Brian Haney, Chief Operating Officer. I'll begin the call with some introductory comments. Bryan Petrucelli will follow with our financial results. Brian Haney will follow him with a discussion of Kinsale's underwriting results and provide some market commentary. We will then follow up with any questions you may have. As a reminder, Kinsale 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 claim management process, and we do not outsource those functions to external parties.
We use proprietary technology and automation to operate at a significant expense advantage over many larger competitors. As we like to say, the combination of disciplined underwriting and low costs is an end game winner every time. For the second quarter, Kinsale posted strong profitability and growth. The combined ratio for the quarter was 84.8%, and the annualized operating return on equity for the quarter was 16.7%. These numbers are consistent with our forward guidance of a mid-teens return on equity and a mid-eighties combined ratio. Premium growth for the quarter was 35.7%. The growth we experienced in the second quarter was driven by Kinsale's business strategy, in addition to the rising level of dislocation within the excess and surplus lines market.
For comparison purposes, the 35.7% second quarter growth was up from 32.5% growth in the first quarter and 27% growth in the fourth quarter of 2018. If the improving pricing environment and growth prospects continue, in order for us to capitalize on these robust growth trends, there's a possibility we could raise a modest amount of equity capital before year-end. I'll turn the call over to Bryan Petrucelli for the financial report.
Thanks, Mike. We had another strong quarter, we continue to generate market-leading combined ratios and returns for our investors. We reported net income of $13.8 million for the second quarter of 2019, an increase of 36% when compared to $10.1 million for the second quarter of 2019, due primarily to growth in the business and increases in the fair value of our equity investments. Net operating earnings increased by 26% to $12.4 million compared to $9.9 million in the second quarter of last year. Our effective income tax rate was 17.4% for the first half of 2019, compared to 18.2% last year.
The company generated underwriting income of $10.1 million and a combined ratio of 84.8% compared to $8.4 million and 83.5% last year. The combined ratio for the second quarter of 2019 included 2.2 points from net favorable prior year loss reserve development, compared to 4.4 points from net favorable prior year loss reserve development last year. Cat activity contributed one point to the second quarter 2019's combined ratio and was negligible last year. Annualized operating return on equity was 16.7% for the second quarter and 18.4% on an annualized year-to-date basis. Gross written premiums were $94.9 million representing a 36% increase over last year.
Increases continue to be generated from an overall increase in underwriting activity across most lines of business due to the reasons Mike already mentioned, including continued improvement in market conditions. Brian Haney will get into a little more detail here in a bit. On the investment side, net investment income increased by 27% or so over the second quarter of 2019 to $4.8 million from $3.8 million last year as a result of continued growth in the investment portfolio. Gross investment returns increased to 3.2% from 2.9% for the first half of the year. Diluted operating EPS was $0.57 per share for the second quarter of 2019, compared to $0.46 per share last year, and $1.21 per share for the first half of 2019, compared to $0.83 last year. With that, I'll pass it over to Brian Haney.
Thanks, Brian. As mentioned earlier, premium grew 36% in the second quarter. Most of our divisions grew. Our Commercial Property business, comprising the Commercial Property and Inland Marine divisions, was up 83% for the quarter off of a relatively small base. We are seeing a significant uptick in the market opportunity in that area. We are pushing rates up materially in property, and we are making an effort to get more quotes out and get them out faster. We are also seeing strong growth in our Allied Health, Management Liability, and Environmental divisions, but the growth is widespread across many different divisions and classes of business. Our spare units were up 83% for the quarter. I'm sorry, 38% for the quarter. Submission growth was 28% for the second quarter. We continue to see substantial across-the-board increases in submission volume in most divisions.
We are doing our best to keep up with the flow of submissions while keeping up our customer service levels, and for the most part, we are succeeding. In some areas, the increase in submissions has been so dramatic that understandably, our capacity to get to all the submissions in our usual speedy manner has been affected. We continue to be assertive in seeking rate increases. As a reminder, we have a very heterogeneous book of business, which complicates reducing all the rate movement to a single number. All that being said, we see rates being up in the +5% to +7% range in the aggregate. We are seeing higher rate increases for property and lower increases for some professional lines. With that, I'll turn it back over to Mike.
Thanks, Brian. Operator, we're now ready to field any questions that are in the queue.
Ladies and gentlemen, if you have a question at this time, please press the star and the one key on your touchtone 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 that you please press your line number once your question has been stated. Our first question comes from the line of Mark Hughes with SunTrust. Your line is now open.
Yeah. Thank you very much. Good morning.
Good morning, Mark.
The development this quarter, two points. You had more last quarter, obviously. Any observations about the pace of development, maybe touching on any inflation in costs, frequency, severity? Was this just normal volatility, or how should we look at it?
Yeah, I would not look at that as any kind of secular trend. I think it was really just the normal volatility you get in a 90-day period in a smaller company.
Is the kind of a dislocation, did that have to do with any acceleration in losses?
No. When we talk about dislocation, I think what we're talking about is some of the headlines you see in the trade press where companies are reacting to poor financial results by revising underwriting strategies, in some cases reducing capacity, in some cases stepping back from certain lines of business, in some cases raising prices. You see some delegated underwriting arrangements under stress. That kind of dislocation, really, is the best word I can think for it, right, is pretty therapeutic for an E&S company. I don't know. Brian Haney, do you have anything you want to add to that?
No, I would just sort of echo your comment. It's dislocation in other people's books of business that's kind of leading to what we're seeing. What you saw in the losses was not dislocation coming out of our book.
Thank you very much.
Thanks, Mark.
As a reminder, if you would like to ask a question, please press the star and the one key on your touchtone telephone. Our next question comes from the line of Jeff Schmitt with William Blair. Your line is now open.
Hi. Good morning, everyone.
Good morning.
Looking at the adverse development, it looks to be about $6 million in the first half for kind of strengthening 2011 through 2016, I guess taking a more conservative approach. You'd referenced kind of an emergence of loss trends there. Can you maybe discuss what you're seeing there and why you did that?
Yeah. This is Mike Kehoe. I would say for a couple of years in a row now, we have gradually lengthened our reporting patterns to allow for a slower release of IBNR. Essentially, we're injecting a little bit of additional conservatism in how long we anticipate losses to emerge. When we change those estimates, it has the effect of showing up as adverse development on some of those older accident years in the quarter. Essentially, what it is, I think maybe the best way to describe it is just adding a little bit of conservatism. It's probably prudent to remind everybody that on an inception-to-date basis, all of our accident years have developed favorably except one. It's the 2011 year. It was our first full year in business, obviously, it was a very small year. We definitely strive to be conservative in how we reserve.
The goal is to set reserves that are more likely to develop favorably than unfavorably. In general, I think we've achieved that level of success, we're constantly reacting to current results and adjusting reserves to, I think, maintain that level of conservatism.
Mm-hmm. Okay. Looking at, obviously, submission growth is really high right now. In looking at your average premium per policy, it's still actually staying flat. I guess, is this dislocation really as some of the big guys pull back? Are competitors just moving upmarket and just leaving that much opportunity on the smaller accounts?
This is Brian Haney.
Brian, do you want to take that?
Yeah. I would characterize it differently. I would say a lot of the divisions that are growing the fastest at our company are the smaller divisions, the divisions that focus on smaller accounts. Your hypothesis that it might be people moving upmarket is not unreasonable either. I think it's more just a function of which divisions are growing rather than us focusing on smaller accounts.
Okay. Obviously, the property lines in particular, are doing really well. You had talked about both commercial property and Aspera. How much of that is rate? What type of rate are you getting there?
It's really tough to boil that small a book down to one number, but I would say those rates are well into the double digits rate increases.
Got it.
The commercial property book grew 83%, so most of it is not rate, but the rate increase is very significant.
Is that the same for Aspera, too?
Yeah. Aspera took a very large high teens, probably around 20%, I think, rate increase a while back. Probably more of their growth is rate than would be the case for commercial property.
Got it. Okay. Thank you.
Thank you. Our next question comes from the line of Adam Klauber with William Blair. Your line is now open.
Good morning. Just a follow-up or two on the growth. I know you probably won't know exactly, but how much, just ballpark, is most of the new business coming from prior E&S market? Or is a good chunk of it coming from business that used to be in the standard market that switched over to the E&S market?
This is Brian Haney. It would be very tough for us to know that, but I think most of it is either business that was previously E&S or business that was previously written through a program or some binding authority. I don't think a typical account came to us from a standard lines company, let's say, like Travelers.
Okay. Thanks.
Maybe just one follow-up on that, Adam, would be that I think the E&S market is growing at a really healthy rate right now. Some of that's going to be just economic growth in the economy. Some of that's going to be standard business coming over to the E&S side.
This is Brian Haney again. I should qualify that. A lot of the business comes to us because it's experienced losses. In that case, it could very well have been from a standard lines company.
Right. I know you don't know exactly, but that's helpful. On property, are you writing generally more in one region? Is it more Texas, more Florida, more California, or is it pretty well spread out?
The commercial property is pretty well spread out. I would say we're underweight in quake and on the West Coast in particular, but it's pretty widespread. On the Aspera side, on the personal insurance within Aspera, we write in 10 states. Most of that's going to be Southeast Gulf Coast exposure.
Okay. As far as competition, obviously Lloyd's and AIG are having a really positive impact on the market. Are you seeing any new competitors pop up in the last three, six months or so?
This is Brian Haney. I would say we're not seeing anybody making a noticeable splash. I think we've heard of a few people either starting up or considering a new deal, we haven't seen an effect from that in the market yet.
Okay. Thanks a lot, guys.
Thanks, Adam.
Thank you. Our last question comes from the line of Mark Dwelle with RBC Capital Markets. Your line is now open.
Hey. Good morning. Looks a lot of my questions have kind of already been covered. With the growth in the property, what % of your overall book of business is property now?
I think commercial property is around 5%. Aspera as a whole is around 6%, and most of that is property related personal insurance.
10-ish, 11-ish, somewhere in there. Got it. As far as on the investment portfolio, new money yields, how are those tracking? I know you keep a pretty short duration, so it's probably not that challenging. Any pressure there?
No, this is Bryan Petrucelli. New money yields are right around 3%, Mark.
Okay. Good job on the quarter. I think those are all my questions. Thanks.
Thanks, Mark.
All right. We do have a follow-up question with the line of Mark Hughes with SunTrust. Your line is now open.
Yeah. Thank you. Refresh me on what your underwriting leverage multiple kind of a target or bogey might be. You talked about the perhaps the need to raise capital or look to raise capital later in the year. Where are you comfortable, and beyond what level would that become more of a necessity?
We have an A-minus rating from AM Best, and that's the capital level we manage to. We need to protect that rating. That's very important to us as a business. Bryan Petrucelli, I think we're running currently around a 1.2 to 1 net written premium to stat surplus.
Yeah, that's correct.
We probably have a little bit of room above that. I think the issue with capital is we're in this very attractive trading environment where we're not only able to grow at kind of an exaggerated rate, but we're also able to push up our prices. We're expanding margins. We're growing at a really healthy clip. Our goal is to always be capital efficient, but we also want to have enough capital, if you will, enough dry powder that we can execute our business plan and operate our business and maintain some degree of financial flexibility. That was the gist of my comments in the introductory section of our call today. We had said in the past that we were looking more toward 2020 for an equity raise. We've kind of reconsidered that and advanced that to be something we're considering this year.
Commercial auto, I think I've heard you comment on pricing relative to what you would think would be adequate. Is that getting any closer these days?
Well, clearly, commercial auto pricing has risen dramatically. It's still a very modest kind of 1%-2% of our book of business. It's essentially within our excess casualty unit, is where we write some excess commercial auto. Brian Haney, I think maybe you could comment on our appetite there.
I think we're going to look at it. I don't know if the rates are where they need to be yet, but it's something we're going to take a harder look at.
Very good. Thank you.
Thanks, Mark.
Thank you. That does conclude today's question and answer session. I would now like to turn the call back to Kinsale's President and CEO, Mr. Michael Kehoe, for any further remarks.
Okay. Thank you, operator, for handling today's call. Thanks for everybody for participating. We look forward to speaking with you again here in next quarter. Have a good day.
Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone, have a great day.