As a reminder, this conference call is being recorded. Before we get started, let me remind everyone that through the course of the teleconference, Kinsale management may make comments that reflect our intentions, beliefs, and expectations for the future. As always, these forward-looking statements are subject to certain risk factors, which could cause the actual results to differ materially. These factors are listed in the company's various SEC filings, including the 2016 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 a press release announcing the first quarter results. Kinsale management may make reference during the call to underwriting income, which is a non-GAAP financial measure for our financial results. Kinsale's underwriting income represents the pre-tax profitability of the company's insurance operations.
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, operator. Good morning, everyone. I'm Michael Kehoe, CEO of Kinsale. I'm going to give a brief intro. Then I'm going to turn the floor over to Bryan P. Petrucelli, who's the Chief Financial Officer of the company. Bryan P.'s going to provide some additional financial results, after which Brian Haney, our Chief Operating Officer, will provide some color on Kinsale's operations and the market in which we compete. Last night, Kinsale reported favorable results for the first quarter, the highlights of which include the following. Net income of $6.3 million. That's up 19.5% over the first quarter of 2016. Annualized ROE of 11.8%, a combined ratio of 82.6%, underwriting profit of $7 million. Premium growth of just under 23%. Just as a recap, Kinsale's strategy combines disciplined underwriting and claim handling with a technology-enabled low-cost operation.
Kinsale's expenses run anywhere from 20%-40% lower than most of our competitors. Kinsale writes exclusively in the E&S market, where returns have historically been superior to the broader standard market. Unlike all of our competitors, Kinsale never delegates underwriting or claims authority to outside parties. We maintain absolute control over the underwriting and the claims management to drive better results. We really maintain an owner/operator business culture, where most of our employees and all of our senior managers are heavily invested in the company, creating an unusual alignment of interest between the management and the stockholders. We think our model creates a powerful competitive advantage that should allow us to continue to deliver both profit and growth over the long term, even in the face of the type of intense competition like we face today.
With that, I'm going to turn things over to Bryan Petrucelli.
Thanks, Mike. As Mike noted, the first quarter was another solid 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. We reported net income of $6.3 million for the first quarter of 2017, representing an increase of 19 and a half % over the first quarter of 2016. The company generated underwriting income of $7 million on a combined ratio of 82.6%, an increase of 12.9% from the first quarter of 2016. Underwriting income in the first quarter benefited from $5.1 million of net favorable prior year loss reserve development and an annualized ROE of 11.8% for the quarter.
We continue to expect ROE to meet our mid-teens goal as we absorb the new capital from last year's IPO and are encouraged by the growth in premium here in the first quarter. Gross written premiums were $52.9 million, representing a 22 and a half % increase over the first quarter of 2016. Premium growth continues to be generated from an overall increase in underwriting activity, including submissions, quotes, and binds. No significant changes on the investment side. Approximately 95% of total investments are in fixed income securities with a double A average credit rating and a weighted average duration of approximately 3.6 years. Investment income increased by 36.4% over the first quarter of 2016 as a result of continued growth in the investment portfolio. Gross investment returns continue to be in the low 2% range.
Basic and diluted EPS were $0.30 and $0.29 per share, respectively, and in line with our expectations. With that, I'll pass it over to Brian Haney.
Thanks, Brian. As Brian noted, premium grew 23% in the first quarter, which is significantly faster than the growth rate in the fourth quarter of last year. New business submissions were up around 15%, which we see as a good leading indicator. Product expansion over the last two years, improved customer service, geographic expansion of personal insurance, and pockets of dislocation have all contributed to the growth. Growth was widely spread, with most divisions showing significant increases year-over-year. One thing that hasn't changed is our underwriting philosophy. We are still writing business with the same approach. We focus on hard-to-place business, paying very careful attention to coverage, making sure that we understand the risks we are taking, and that we are appropriately paid for taking them. Overall, the market is still very competitive.
Although we have seen a number of competitors experience adverse results in a few specific areas, there is still, overall, plenty of excess capacity in the market. When a particular competitor gets overly aggressive, that invariably leads to them experiencing some adverse results later, which in turn forces them to pull back. When that happens, sometimes there will be another competitor willing to take on that same business at the same inadequate prices, but at other times, there's not. Hence, we see small pockets of dislocation modestly helping our growth rate. Eventually, market forces will dictate that prices will appropriately reflect the risk. Some of the behavior we are still seeing in the market is unsustainable and will have to be corrected at some point. This leads me to conclude that we will see more dislocation in the market in the future, which we regard as a good thing.
One last comment about growth. We're obviously quite pleased with 23% growth, but investors should remember that given our size, the growth rate will naturally have some variability in it, and it would be a mistake to conclude that 23% growth is the new normal based solely on one quarter's results. In any given quarter, we can't know for certain what the growth rate will be. Longer term, given the advantages of our business model, we are confident we will grow the business and take market share from our competitors. Now, moving on to rates. We did not make any changes to technical rates in the first quarter. We anticipate we will make changes selectively beginning in the second quarter. I would expect the overall effect of our rate changes this year to be very modestly upward, low single digits.
That will depend on how experience develops and what trends we see in the market. With that, I'll turn it back over to Mike.
Thanks, Brian. Operator, we're now ready for questions.
Thank you. Ladies and gentlemen, if you have a question at this time, please press star, then the 1 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. Our first question comes to the line of Sarah DeWitt from JPMorgan. Ma'am, your line is now open.
Hi, good morning. My first question is just on the combined ratio in the quarter. I know it's within your target of mid-to-low 80s, but it is up a bit from where you've been running the past couple of quarters. Just wanted to know if you expect that to trend down as the year progresses, or if there was anything unusual in there, or perhaps it reflected some sort of new business penalty given how much business you're writing.
Thank you, Sarah. Good morning. This is Mike Kehoe. I would say two things about the loss ratio for the quarter. One, if you look at the current accident year number, given our conservative approach to reserving, it would not be unusual to see that number start out a little bit higher and then drift down a little bit over the course of the next several quarters. In addition, there's also going to be just some natural variability in the number. We're still a small company, and just a normal variance in loss activity could cause it to move up or down. In the past, we've offered guidance around, I guess, mid-80s, 85% combined ratio. We think that's a conservative number that we're reasonably confident we're going to hit or exceed. I think the last two quarters of last year put us in the mid-to-upper 70s.
Again, we're just seeing a slight variance because of just the variability of the claims and then again, the conservatism on the current accident year at the beginning of the year versus subsequent quarters.
Okay, great. Thank you. Then just on the ROE in the quarter of 12%, I know it's still being dragged down by some of the capital that you raised. Given you're now seeing some faster growth and some more opportunity to deploy that, could we just get your latest thoughts on how long you think it'll take to get back to your mid-teens target?
I would hope a few more quarters, we would start to see a reversion to our mid-teens target. Obviously, the 23% growth is going to allow us to put that extra capital from the IPO to work quite a bit more quickly than the 6.5% growth that we posted in 2016. I think it's encouraging from that regard.
Okay, great. Thank you.
Our next question comes from the line of Mark Hughes from SunTrust. Sir, your line is now open.
Thank you. Good morning.
Good morning, Mark.
Can you talk about the expense ratio is 26%, 27%. Do you think that'll be something we'll see in coming quarters, or is it a little higher this quarter? Any one-timers?
Yes. First I'd say, hey, that expense ratio is a very fundamental part of our business plan. The fact that we operate at dramatically lower costs than a lot of our competitors, we think, is of paramount importance, and it's something we focus on constantly. The 27.9% is a little bit higher than we'd like. Part of that drift upward over the last three quarters has resulted from some public company expenses. As the business grows, we realize some modest economies of scale. We think that'll drift down. There's also a little bit of seasonality with some concentration of expenses in the first quarter. We would hope that the 27.9% is kind of the high watermark for the year, and we'd like to see that drift down over the balance of 2017.
When you think about the rate increase, I think you'd mentioned low single digits perhaps is what you'd be anticipating. Do you think that'll keep ahead of loss trends within your book?
This is Brian Haney. I think that we look at each individual division separately. For some of the divisions, it will be at or ahead of loss trend. For some of them, it might be a little bit below it. If we intentionally pick a rate change that's lower than trend, it's because we're doing very well in that division and don't particularly need the rate. I would assume overall, it's probably going to be pretty close to trend.
Thank you.
Our next question comes from the line of Adam Klauber from William Blair. Sir, your line.
Thanks. Good morning, guys.
Good morning.
A couple of different questions. How was the level of submissions this quarter compared to a year ago?
New business was up 15%.
In the first quarter.
In the first quarter. That's a little faster than the growth rate in the fourth quarter.
Okay.
Very little.
Great. How's Aspera doing? That's coming from a small base, but can you give us an idea of how quickly that's growing?
Yeah. Aspera, obviously, a small part of our business, but that's principally personal lines right now. It grew pretty dramatically last year. I think it's close to that growth rate in the first quarter, and that's partially due to a big geographic expansion into new states, the appointing of new brokers, pretty robust marketing effort. We think that'll continue to expand at a good clip.
Okay. Then you started some newer lines in the last 12 months, I think, environmental, one or two others. Then you've got your usual strongholds construction. Would you say more of that above extra growth came from the core lines, or is that more of a reflection of some of the new lines getting traction, or is it really both together?
It's really both. We're really seeing pretty widespread growth.
Okay. That's great.
It always ebbs and flows a little bit, division by division. In general, as Brian said, it's pretty widespread. The other things Brian highlighted earlier in his comments, I think, are important too. It's the new products. It's the pockets of dislocation in the industry that create little opportunities here and there. It's the geographic expansion of the personal lines. It's the improved customer service, which has helped, I think, in any business, right? The better the service to the customer, that can drive growth, too.
Right. Okay. You mentioned, obviously that's going to move up and down a little quarter-to-quarter. It's not exactly linear. Were there any big policies or anything unusual that really drove the GPW up this quarter?
No. Most of our policies are small, and there was no individual big policy driving it.
Okay. Just following up on the expense ratio, that makes sense. You have somewhat more cost now. To the extent that ratio can trend down, should that be sort of linear as you ramp up your premiums?
Yeah. I think if you look at where we were last year, I think we were like at 26.5% GAAP expense ratio. If you eliminated the multi-line quota share, that would be kind of our near-term target to get back to that level. I think longer term, we could probably do slightly better than that. I don't think it's going to be a dramatic reduction, I think I'd definitely like to see a 26 handle versus a 27 in the near term.
Okay. That's helpful. As far as on the loss side, how are legal trends today compared to maybe a year or two years ago? Are they any different, around the same?
Adam, that's always going to be difficult to nail down with certainty because we operate in 50 states, a lot of the tort system, of course, is based on state law. There's going to be some variability state by state. In general, I think you'd say there is some adverse trend in terms of jury verdicts and the like. I think with some of the headlines around the industry related to transportation and commercial auto, obviously, there have been some pernicious trends from the risk-bearer standpoint in terms of frequency and severity. If there's bad trends in auto, it wouldn't be unusual that those trends would jump to other lines of business at some point. Right? If you have a car wreck and somebody's driving a vehicle on their job, hey, that's going to start to impact workers' compensation results and the like.
It's something we look at and evaluate on a regular basis. I think we do a good job of staying ahead of that, it is a perpetual business challenge.
Okay. Thanks a lot.
You bet.
Our next question comes from the line of Mark Dwelle from RBC Capital Markets. Sir, your line is now open.
Yeah, good morning. Just a couple of questions.
Good morning.
In the 10-Q, you commented related to the reserve releases that those came mainly from the 2015 and 2016 accident year. Could you just describe a little bit on the review process on that is, are you able to take those reserves because you're mainly claims-made policies, you set the catastrophe reserve, when the claim doesn't happen, do you have that much more room to quickly take those reserves back, or is it more complicated than that?
I think it's a little more complicated than that. I would just say that in our models, we tend to assume that a lot more is going to come in early on than does. What you're seeing is when those early years come down, we were expecting to see more losses and just didn't. Rather than just keep those reserves up, we want to be guarding against being too conservative in the reserves. It's basically that we expect to see a certain amount of losses come in in those first few years after the accident year ends, and we don't.
Yeah. In terms of expectations for how quickly losses are reported, obviously, that varies by line of business. We write property, which tends to report very quickly. We write excess casualty, which tends to be much more of a slower report, and then we write a lot of business in between. Certainly, the claims-made where the policyholder can't report losses after the expiration of the contract is going to have a quicker development or a quicker reporting pattern than occurrence business. All those factors are taken into account. The general takeaway is we try to be conservative in our reserving. The goal is to set reserves over the years that are more likely to develop favorably, and we think that puts us in a great position.
Okay. That's helpful. Can you remind me, as we head into tornado and hurricane season, what states you have the most exposure to on the personal lines book?
Yeah. Florida is our biggest state, we're also spreading out along the Gulf. We have very little exposure in which we consider the southern Tornado Alley. Most of what we write in the Gulf, and let's say Mississippi, Louisiana, or Alabama would be in the southern sort of beach areas. We don't write in northern Alabama. The bulk of our exposure is in Florida and then extending out along the Gulf Coast.
Yeah. It's a southeastern focus on the coast, and that kind of dovetails with our focus on a preferred occupant, if you will. You have an anomaly where the closer you get to the ocean or the Gulf of Mexico, the more expensive the land. There's a trade where bigger cat exposure, but lower attritional loss exposure. We're trying to balance those two.
I see. Plausibly, ultimately, more exposure on a hurricane type event, less exposure on tornadic kind of events.
That's right.
I see. Got it. Last question, this is probably just a timing thing, it looked like the level of cash that you were holding was a little bit elevated. Was that just timing, or was there some more conscious decision behind that?
I think that's just a measure of conservatism on the part of our fixed income manager. We've got a healthy allocation to municipal bonds. There's some issues around munis with tax reform on the horizon. It's just, again, it kind of reiterates the conservatism of our strategy on the investment side. We really focus on risk-taking in our insurance business. A little more caution on the investment side.
Okay, great. That's all my questions. Thanks.
I am showing no further questions. I'd now like to turn the call back to Mr. Michael Kehoe for any further remarks.
Okay. Well, we'll go ahead and wrap up. I want to thank certainly all the Kinsale employees for another strong effort. They're certainly the ones responsible principally for the great results we're posting. I want to thank our investors for their confidence in the Kinsale team, and thank all the participants on the call. Have a good day.
Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program, and you may all disconnect. Everyone have a great day.