Kinsale Capital Stock: Reaping the Benefits of Excellent Execution (NYSE: KNSL)

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It is premature and hyperbolic to proclaim Capital of Kinsale (KNSL) the best that is or will be in over and over underwriting, but it is clear that management has found a winning formula as Kinsale has managed to raise premiums at a compound rate of over 36% over the last four years, while increasing underwriting income to almost 50% and has consistently shown a slightly positive reserve development. Best of all, the business is still a small fish in a big growing pond, and I don’t see much that could hurt Kinsale’s future growth rate.

Rating is tricky and I wouldn’t be surprised to see comments like “I would never pay 7 times for the book”. Given the potential for double-digit core earnings growth, however, I don’t think Kinsale is necessarily overvalued, and best-run companies have a way of making valuations that look expensive look cheaper with the retreat (cf. WR Berkeley (WRB)).

Prosper from the mistakes of others

Within a still tough general P&C market, excess and excess are holding up even better, and Kinsale is still one step ahead of that. Since many large insurance companies are experiencing reserve issues with business written in weaker markets (including Argo(ARGO) recent problems in its construction business), there is not much price competition yet, as many of these insurers need higher rates to fill the holes in their wallets.

Kinsale posted 36% growth in net written premiums in the last quarter, well ahead of expectations. Revenues were also strong, with 40% growth in net premiums earned resulting in reported revenue growth of 32%.

Underwriting results remain quite strong, with an almost stable loss ratio at 57%, a modest improvement in an already excellent expense ratio (from 22.8% to 21.4%), and another quarter of good development reserves (4.0%, in line with a long-term trend between 3% and 5% since 2018). With all of that, underwriting revenue nearly doubled (up 95% year-over-year), while operating profit was up 55%, beating 27%, and book value per share price increased by 21% compared to the previous year.

Kinsale management noted that the growth in submissions continued at the pace of teens, while average rates were up among teens. While some property and casualty insurance markets have started to soften, that hasn’t really been the case for overages and surpluses, with prices being helped not only by economic growth, but also by other challenges in the damage insurance sector. With past underwriting issues, some P&C companies have moved away from old lines of business (driving these clients into the E&S market), and within E&S, many competitors have also had issues with reserves . Referring to conversations with reinsurers, Kinsale management said there were “more issues ahead”, suggesting high pricing could sustain a tough E&S market at least until 2022.

Built to win

Even outside of a strong current price environment, I believe there are fundamental fundamentals that are helping Kinsale outperform and gain share in the growing E&S market.

To begin with, Kinsale is a relatively young company and has not looked to mergers and acquisitions to grow. Unlike older competitors, Kinsale does not operate a computer system assembled from multiple legacy systems and the company continues to reinvest in its computer capabilities to resolve claims, process submissions and effectively assess risk.

Where most competitors need days or even weeks to price business, Kinsale can often respond within hours and usually within 24 hours. Additionally, Kinsale can compete on price by offering closer coverage; the company’s risk assessment tools allow it to identify and price requested risks and ONLY requested risks – many rivals are less accurate and therefore push for wider and more expensive paper-based coverage compared to their risk assessment abilities less accurate.

On top of that, an efficient IT system supports a highly efficient operation, as Kinsale has one of the lowest expense ratios in the business. Not only does this help Kinsale earn better margins (because insurance is a commodity in some ways), it also allows the business to compete for business that others cannot profitably underwrite, including small businesses which have been a source of growth in recent years.

It’s at least somewhat speculative on my part, because management doesn’t really talk about it in those terms, but I also think Kinsale’s excellent risk modeling gives the company the same kind of flexibility that has long been at the heart of arch capital(ACGL) success. By understanding and properly pricing risk, Arch has been adept enough to move capital in and out of business lines based on potential returns; I note that Kinsale has significantly expanded areas such as Supplemental Accidents, Commercial Property, Product Liability and Allied Health in recent years, while reducing Construction, General Accidents, Energy Accidents and Professional Liability.

Perspectives

I don’t think double digit pricing can stay in place forever, but I would expect Kinsale to take advantage of this tough market to write some very profitable business. To that end, I’m a little surprised the loss rates aren’t a bit higher, as it would seem like a good opportunity to set some conservative loss picks for this new venture. Although capital is not a big constraint at this point, management has openly discussed the possibility of issuing debt to continue to fund the company’s growth.

Given the challenges in the market, including with many Lloyds underwriters, I believe Kinsale can and will continue to increase market share in the attractive E&S market. I realize that low to mid teen base earnings growth is hardly conservative in terms of modeling expectations/outcomes, but Kinsale has far exceeded my past expectations, and low to mid teen growth would still only mean about 2% share in the E&S market in 2031 if the E&S market is growing at about 4% per year (half its growth rate over the past 20 years).

The essential

If Kinsale can in fact deliver growth in low-to-mid-teenage base incomes over the next decade, the shares look somewhat undervalued today. Admittedly, the shares are quite expensive on P/E and P/BV by industry standards, but I would say Kinsale is not a normal company. Mean reversion is certainly a risk, and you can never completely rule out the risk of underwriting errors with an insurance company, but given Kinsale’s track record and the great untapped opportunities in the E&S market, I think that this is a case of more growth-oriented investors should take a closer look.

Sallie R. Loera