Kingstone Companies, Inc. (KINS) Q2 2017 Earnings Report, Transcript and Summary

Greetings, and welcome to the Kingstone Companies' Second Quarter 2017 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Amanda Goldstein, Investor Relations Director. Thank you. You may begin.

Thank you, Jess, and good morning, everyone. Yesterday afternoon, the company issued a press release detailing Kingstone's 2017 second quarter results. We posted a PowerPoint presentation on the company website that acts as an accompaniment to this call. The speakers will not be referring to the slides, but we hope they assist in the discussion. Please review the presentation and follow along if you can. On this call, Kingstone may make forward-looking statements regarding the company, its subsidiaries and businesses. Such statements are based on the current expectations of the management of each entity. The words anticipate, expect, believe, may, should, estimate, project, outlook, forecast or other similar words are used to identify such forward-looking information. The forward-looking events and circumstances discussed on this call may not occur and could differ materially as a result of known and unknown risk factors and uncertainties affecting the companies, including risks regarding the insurance industry, economic factors, and the equity markets generally, and the risk factors discussed in the Risk Factors section of its Form 10-K for the year ended December 31, 2016. No forward-looking statement can be guaranteed. Except as required by applicable securities laws, forward-looking statements speak only as of the date on which they are made, and the company and its subsidiaries undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise. When discussing our business operations, we may use certain terms of ours which are not defined under U.S. GAAP. In the event of any unintentional difference between the presentation materials and our GAAP results, investors should rely on the financial information in our public filings. With that, I'd like to turn the call over to Kingstone's Chairman and CEO, Mr. Barry Goldstein. Please go ahead, Mr. Goldstein.

Thanks, Amanda, and good morning, everyone. Today, I'm joined by Ben Walden, Kingstone's Executive Vice President and Chief Actuary; as well as our Chief Financial Officer, Victor Brodsky. We're going to update you on our quarterly results for the period ended June 30, 2017, as well as other items that have occurred since the close of Q2. We'll begin with a discussion -- we'll begin our discussion with a recap of some of our achievements since the last conference call on May 12. I'll review the impact of the improved A.M. Best rating and the implications for the future. Ben will discuss loss ratios and reserves. Then, Victor will follow with a review of the quarter's financial metrics and highlights. Finally, we will open it up for Q&A. To recount 2 of our accomplishments since our last call, I would first point to being accepted as a member of the Federal Home Loan Bank of New York, something that would not ever happened without the A.M. Best rating of A-. We've moved sufficient collateral to the Federal Home Loan Bank and can receive a same-day advance of more than $5 million should a catastrophe occur requiring immediate liquidity. Second, we have strengthened the company's board by adding two world-class insurance executives, Ms. Carla D'Andre and Mr. Dale Thatcher. I look forward to working with them, learning from them and collaborating with the rest of the board to continue our company on its profitable growth path. We set out in Q4 2016 with a plan to improve upon our A.M. Best rating. Our goal was to achieve a financial strength rating of A- Excellent for our insurance subsidiary, KICO. The plan, which was centered on strengthening and protecting our balance sheet required us to raise a significant amount of capital through a follow-on offering that occurred in January and February. We contributed the vast majority of the proceeds to KICO on March 1, 2017, the date we were committed to do so by the New York State Department of Financial Services. We then negotiated a reduction to our quota share reinsurance by half, from 40% to 20% in personal lines, effective July 1, 2017. Finally, also on -- as of July 1, we broadened and strengthened our catastrophe reinsurance coverage. The impact of the reduced quota share will be seen on our net written and net earned premiums beginning in Q3. With a long-stated goal to totally eliminate quota share, we are well on our way. We enjoyed a highly successful reinsurance placement. In spite of adding significant additional limit and purchasing far more reinstatement premium protection, there will be no negative impact on our profitability going forward. The cost of the increased amount of coverage we secured was offset in whole by premium rate declines. Our overriding goal is and has always been to improve our company and to improve the products distributed exclusively by Kingstone's appointed agents and brokers, never direct. We've mentioned how, without an A rating, the doors to many of the larger agencies were closed to Kingstone. No more. Contracts and leases requiring an A rating by the contractor or lessee meant we were excluded from competing to provide coverage. No more. Trying to distribute our products in the geographies that are more competitive with a large number of A-rated carriers presented a very difficult problem. We've solved it with the A- rating. But on our existing business, we always believe that our offering of products and services was already A class. Yet we were repeatedly told by our agents and brokers in New York that if only we had an A rating, they could give us more business. The A.M. Best rating is an important factor for the insurance professional to consider. It's not just price but quality and consistency that matters to the professional insurance broker and agent. What would the rating upgrade mean to our core business? This was a topic we didn't discuss with you in the past. There was no material we could find that examined a change at similar carriers. While we expected a positive impact from the rating change to our existing business, we had nothing but subjective statements to go on. All Ben, Victor, and I had were guesses. What happened is that the headwinds of heightened competition, particularly felt in personal lines over the past 3 quarters, have been offset and then some by our rating improvement. We have successfully separated KICO from the Demotech-only, single-product carriers. We are now seeing the results of a better-rated and more highly regarded carrier. Simply stated, new business is accelerating at a rapid rate. Personal lines quoting increases in May, June, and July following the rating upgrade in mid-April were well beyond what any of us dared to guess. June was the first full month, which reflected the practicality of quoting in an average 2-week delay until a policy is bound. We keep detailed records and analyses of quoting and binding data. After making the adjustments to our quote-bind data so as to be as close to apples-to-apples as possible in order to isolate the ratings impact, quoting in the past three months has increased by more than 25%. The number of new policies issued has grown by more than 30%, while our average premium is virtually flat. This is what I call our A.M. Best effect. The report for Q2's direct written premiums only reflects a portion of this A.M. Best effect. Please note that during the prior 3 quarters, those where we spoke of heightened competition, in fact from some of those listening in on today's call, year-over-year quarterly growth rates in personal lines were 11.6%, 10%, and 11.6%. But in Q2, we grew personal lines by 17.5%. Yesterday afternoon, we filed our 2017 Form 10-Q for the period ending June 30. The results for the quarter were excellent with a combined ratio of 78%, which we are very happy with. I'm going to turn the call over to Ben now, so he can give a little more detail as our -- as to our underwriting results in Q2. Ben?

Thank you, Barry. We're very pleased with the continued strong results achieved this quarter. Second quarter is typically a good quarter due to the reduced level of fires and weather-related claims compared to winter months. However, although we posted a loss ratio in the 40s and a combined ratio in the 70s, we were not quite able to match the stellar second quarter of a year ago. The 2017 second quarter net loss ratio was 44.0% compared to 38.6% in 2016 second quarter, an increase of 5.4 points. The higher loss ratio is explained by random fluctuation in the impact of fire claims year-over-year. The PowerPoint contains a chart showing this effect. Due to our focus on homeowners insurance, fire claims have a significant impact on our bottom line results but can be random in nature. In fact, one of our larger claims this quarter was the random result of a lightning strike. Our long-term average frequency of fire claims per policy is less than 1 in 500, but the random nature of when they occur can affect quarterly comparisons. This quarter, the impact of fires on our personal lines loss ratio was 5.7 points higher than an average second quarter and 7.7 points higher than 2Q 2016. We do not see any particular trend or change in mix of business that is responsible for this quarterly variance in fire frequency. As Barry noted, we are very happy to see new business growth accelerate following our A.M. Best upgrade. Growth may increase further as we begin to leverage new agents seeking an A-rated carrier for the niche businesses we write. The rating upgrade is allowing us to overcome recent growth challenges due to heightened competition from nonrated carriers. Turning to the new state expansion, our New Jersey Homeowners product was launched in May. The mix of business is developing as we expected, and we are encouraged by the quality of coastal risks written so far. We are seeing higher-than-expected coverage amounts and average premiums. This aligns with our product pricing and design, which was tailored to a more preferred risk type. We aim to fill a niche between the national carriers writing a broad spectrum of risks and the high-end carriers specializing in the most affluent ones. Last week, we filed rates in our next target state, Rhode Island, and plan to be open there by the end of the year. We are now moving on to develop and file our Connecticut homeowners product as well as additional product lines in New Jersey and Rhode Island. On the claims side, there was favorable prior year development of 1.2 points recorded this quarter. Most of the recent prior year adjustments relate to commercial liability, and this is the line of business where there's the most uncertainty in ultimate claims outcome. The processes we put into place starting in 2015 are resulting in better-than-expected loss development for the more recent accident years. During the quarter, we also closed 6 more commercial auto claims and have 23 still open. We remain very confident in our overall reserve adequacy given our strong claims staff and new processes. To conclude, our 81.4% combined ratio through the first half of 2017 continues us on the track to another record year. We are happy that our numbers continue to speak for themselves. One of the challenges of being a highly successful company is that we cannot always perform better than our average or better than a prior quarter. That said, we are pleased to continue posting results consistent with our historical success. We will gladly accept combined ratios in the 70s on increasing volume. Our long-term strategy continues to play out as planned despite minor short-term fluctuations. With another outstanding quarter in the books, we continue to be in great position to deliver sustainable, long-term value to our shareholders. Our dedicated employees and independent agent partners continue to work together to drive our success. With that, I will turn it over to Victor for some more of our financial highlights. Victor?

Good morning. To start, we are pleased to announce our 25th consecutive quarterly dividend in the amount of $0.08 per share to be paid on September 15 to holders of record on August 31. During the second quarter, our book value increased to $8.50 per share, a 2.5% increase over the first quarter. This increase is primarily due to profitable underwriting results for the quarter, along with $542,000 of other comprehensive income, partially offset by our dividend payment of $850,000. Turning to our financial highlights. Quarterly net income per share on a diluted basis was $0.23 on quarterly net income of just over $2.5 million. Net income per share compared to last year was affected by the 2.7 million shares issued in a public offering during the first quarter of this year. As Ben discussed, we had an excellent quarter posting another combined ratio in the 70s at 77.6%. Our year-to-date net income has increased nearly 18% compared to 2016. The statutory surplus of KICO at June 30 stands at $75.8 million, an increase of $1.8 million relative to March 31. As of June 30, the leverage ratio was 0.932:1, about the same as the 0.92 as of March 31. The leverage ratio will move back to our historical norms as new business builds. In addition, the reduction of our quota share reinsurance rate to 20% on July 1 will cause a spike in net premiums written due to the increased retention and return of previously ceded unearned premiums. Ben has reviewed the changes to our net loss ratio. The other component of our combined ratio is net underwriting expense ratio. With no change in quota share rates between Q2 2017 and Q2 2016, a meaningful comparison of expenses between quarters can been made by using the traditional measure of expenses to net earned premiums. The underwriting expense ratio for Q2 2017 was 33.6%, a 1.5 decrease from 35.1% in Q2 of 2016. The decrease was driven by increases in earned premiums and ceding commission revenue for the quarter. Partially offsetting this are the expenses related to our state expansion initiatives. Although we started writing business in New Jersey in May, there's not yet a material impact in earned premiums to offset the start-up costs. As premiums accelerate and begin to earn into our results, the impact of a new state expansion on our expense ratio should lessen in future quarters. We also expect to achieve more economies of scale related to systems and infrastructure costs as we scale up into additional states. Expenses at our holding company are included in other operating expenses, which is not included in the combined ratio. During the second quarter, other operating expenses increased by $500,000 over the second quarter of 2016. Approximately $300,000 is from the accrual of a long-term bonus pursuant to Barry's three-year employment agreement, which was effective as of January 21, 2017. His prior employment agreement did not include any long-term bonus compensation. If anyone is interested in how the three-year bonus path is calculated, you can find the employment agreement as an exhibit to the 8-K filed on January 23, 2017. Now I'll turn it back to Barry for some concluding remarks.

Thanks, Victor. As mentioned, we began selling our homeowners product in New Jersey during May. We've written a modest amount through June. And with our distribution network there being built out now, we're confident that, by year-end, New Jersey writings will become something we can then discuss in detail. We filed a similar product in Rhode Island on August 4 and hope to begin writing there by the end of the year. Our new A- rating will allow us to be more easily accepted in Rhode Island, where coastal competitors are typically Demotech only or not admitted. I have been and remain very excited about our future prospects, and I'm having a great time adding the people and skills to our company, preparing to become, if not the biggest northeast regional underwriter, the best one. I look forward to keeping you informed as things progress. With that, operator, let's open the line for questions.

Thank you. Ladies and gentlemen, at this time we'll be conducting a question-and-answer session. [Operator instructions] Our first question is coming from the line of Ken Billingsley with Compass Point.

Good morning, and thanks for taking my questions. I have three in particular I wanted to focus on. One, the growth expectations from the new agency appointments, which you said you really had not implemented here that are going to target the rating upgrade. Can you talk about -- two parts to that: One, is this going to come more from commercial or personal line side? Which side do you see will drive the most growth on a percentage basis and then on a dollar basis? And then what kind of growth would we -- should we be modeling given the fact that you had surprise uplift from the rating upgrade this last quarter?

Is that just one question or three, Ken?

Well, I hope that counts as 1.

Well, let me talk for a second. The -- again, we hadn't included anything with regards to new agencies being added, and what I gave you before were the percentage increases we experienced at the in-place agents and those who had been in place for at least a year so to make a fair comparison. The growth will be primarily personal lines. The larger agencies control the larger volume of high-valued homes. We've actually started our first division of Kingstone, a high-valued homes division and will soon be announcing the woman that will lead our efforts in that regard in New York. But I would say, while I can't give you nor would I -- I haven't given forward-looking statements in the past, and I really hesitate to try to do your job for you, I can tell you that I would expect this to become something meaningful within the first couple of years. I'm not in any hurry to do it. It's writing $1 million to $5 million homes, which we now have the capability of doing with our new reinsurance treaty. It's a different sort of business. It requires a different type of claims handling, a different type of inspection, different outlook towards the business, and we're setting it up as a division just for that reason. So, I guess in answer to the questions, it would be highly personal versus commercial, but I won't answer as to dollar amounts.

I appreciate that. The 5 million to 10 million homes targeted now, this compares -- what's the average home value currently?

Right now, our average -- this is Ben Walden. Our average building coverage amount in New York is about $450,000 for homeowners. We expect that would increase over time as we write more of these high-end risks.

And Ben, while I have you. Next question is on the fire side. I believe there was mention that random events like the lightning strike, when did these -- were these multiple events? And were they whole home loss write-offs? Or were -- was it partial losses and there was higher number frequency? And when did they occur? Were they later in the quarter?

It was relatively spread out throughout the quarter. And I would say most of them were actually midsized fire claims. We didn't see any that were above our excess of loss reinsurance retention. So, a lot of them were related to either older homes or lower-coverage-amount homes, where we typically do see a higher fire frequency, although this quarter was a little bit of an aberration compared to prior quarters.

Yes. We've seen this. I guess, it was a couple of years ago that we had a similar type of situation. I mean, it's not something we like to call out to point the finger at any one thing that causes it. But like Ben said, given how infrequent these things occur and how random they are, when you get a higher density of them in any one short time frame, it sticks out, and that's why we're calling it out.

Sure. And so, were there multiple lightning strikes? Or is that just an example of just the randomness of what causes it?

That was just an extreme example of the randomness. We actually have not seen very many lightning strikes in our history. This was unusual. Fortunately, there were a few people in the house that did get out without being injured, so we're happy about that. We think -- go ahead.

Sorry. I believe you'd commented that -- sorry, I was trying to focus on what you were saying there. But on the homes, themselves, were these homes that they had previously been insured? I think you had said before that there really wasn't any adjustment to mix of business. And so, I'm assuming these weren't -- it wasn't like new customers or new expansions, this is just your core group and just older homes.

Yes, there was no pattern that we saw. Again, the relative number of claims is very small. There's no pattern to be seen. One of the homes was insured with us for over 10 years, so it's just a matter of random fluctuation, I believe, for the quarter.

And last question I have for Victor is with the quota share reduction, do you have any color or guidance on -- from an unearned premium standpoint, what kind of spike we may see once the quota share adjusts a dollar-amount base now that the quarter's closed?

We're calculating and checking out numbers for submission till we finish our total review process, but it'll be several millions of dollars and as we expect.

Well, I mean, Ken, and I know this has become -- this is a -- one of the reasons I want to eliminate the quota share is having to explain things like this. I've saddled Victor with this responsibility for a long time, and I'm sure he's anxious to get off of it. But for all intents and purposes, our quota share partners will be returning to us later this month about half of the unearned premium they had on hand as of June 30. We will return to them that portion of the ceding commission we previously received but not earned -- well, actually half of that. So, in balance, we're talking -- I mean, on a net basis, something less than $5 million between the net of the returned premiums that we'll receive versus the return commissions that we'll lay out.

That's correct.

Great. Thanks.

But on a quarterly basis, it creates a spike, and that's why we wanted to call it out.

Perfect. Thank you.

My pleasure.

Thank you. The next question is coming from the line of Bob Farnam with Boenning, Scattergood. Please proceed with your question.

Yeah. Hi there. Good morning. My question is related to capital. So how much room do you have to grow? And it sounded like with the Federal Home Loan Bank, you're only using it for emergencies. Is that what I got out of the commentary?

Well, Bob, let me address the capital issue. So, we needed to raise the amount of capital we did in order to reach this threshold required by Best, raising out of a cost score to a level that would put us in line for the A.M. Best rating. Victor talked previously about how our leverage, which we used to target what we had targeted, adds up to 1.5 to 1, where we felt comfortable, as we're -- was still something less released as of June 30. We were still less than 1:1. So, we do have significant runway, but that's going to be quickly eaten up as we grow in New York at the accelerated rate we talked about, we grow outside New York as well as change our business mix towards bringing in those larger-size brokers. So, we have enough capital, I believe, to get us to and through the early to mid- part of next year. But we have no plans to raise any additional capital. If anything, given the debt markets that are available today, that's where we would seek to participate, where interest rates for seven to 10-year paper for a investment-grade company -- investment-grade-rated company like Kingstone, would bring that rate to under 6% annually. And as I'm sure you realize that, while it would be -- we would contribute from the holding company, the proceeds of that borrowing to the insurance company, the cost of capital using debt rather than equity is probably less than one third. So, I guess, in answer to your question, we're good through the middle part of next year. If anything, if we see a heightened growth, we would access the debt markets, and that may be sooner rather than later depending upon market conditions. I hope that answers your question.

Yes, agreed.

Now with regard to the Federal Home Loan Bank, we gave an example of what we already have in place today. I mean, I'm very proud of my Kingstone staff for turning around an application and getting us approved as a member faster than it's ever been done at the Federal Home Loan Bank. They called us out for that. But while it's important that we have access to that capital in an emergency, what that's really saying is, if there's an emergency, we don't either have to sell investments to create liquidity nor do we have to leave an excessive amount of cash on the sidelines just in case. That was just one example we gave. But the opportunity for a participant -- or a P&C carrier participant with the Federal Home Loan Bank is to take advances on a fully secured basis using our in-place mortgage loans that we already own and borrow at a rate below 1.5%. So that's the initial opportunity for us. As we grow, and we may be able to access more of their programs, that's a good thing. And finally, the ability to leave our excess cash on deposit with the home loan bank is a far better idea than leaving it with our commercial bank, who pays us, at best, just a few basis points in interest.

All right, okay. That's good. And last question from me, so any change in the business plan because of the proposed acquisition in Narragansett by Heritage? I don't know how that impacts you guys.

Well, I mean, it impacts me on an intellectual level, I can tell you that. But on a business level, it's no change for us. We've competed with Narragansett. They're a fine company. They do a great job. Their CEO has, I think, done an excellent job since he took over. And of course, the valuations ascribed to a company like they are flatters the valuation of my company. But the answer is, whoever owns Narragansett won't change our business attitude, our prospects nor the processes we're undertaking now. So, no change for us.

All right, thanks Barry.

My pleasure.

Thank you. [Operator instructions] Our next question is coming from the line of [Andrew with Kenny Capital]. Please procced with your question.

Hi. Good morning. Thanks for taking my question. And I was interested to hear about the voluntary flood product you announced a few months back. And after Hurricane Sandy, New York received billions of dollars in claims from the National Flood Insurance Program, which is many times the amount of policies that they collect every year. And so, I was wondering how -- if you all felt you could offer a competing product with a favorable risk profile given this history?

Well, thanks for participating, [Andrew]. I appreciate it. And yes, what we did was announce the introduction of a very limited product in the New York market, and that would only be where homes located in the X zone for flood coverage, which is homes that are really not subject to coastal storm surges are located. It's a -- our first in what we hope to be a three-part package of flood offerings. But the answer to your question is, we don't intend to compete with the NFIP coverage that's out there today. We watch what's going on in Washington very carefully because that does impact us. I live right off the water, so it impacts me in particular. But the answer to your question is, no, we don't intend to compete with the NFIP.

Okay. Is it more of just an additional feature of the policies that you can offer your customers?

Exactly, Andrew. It's something that we offer that is very uncommon. I think it's certainly not found elsewhere in the admitted market in New York, or at least the last time we looked it wasn't. But we're trying to separate Kingstone, first, as I talked about from a rating agency perspective, separate us from the competition. We're not Travelers or The Hartford. We're not Chubb or PURE. We're not the Demotech-only or single-product companies. We stake -- we want to stake out our own ground. And by having this product and by ultimately introducing the other two features we're talking about, Kingstone will be able to settle a claim, like 1 of the 3,400 we saw from Superstorm Sandy with one adjustor rather than two and sometimes three that many carriers experience. The objective is to make our product better, make the experience better, even in the worst-case analysis for the homeowner. Our job is, unlike some of my competitors seem to think, it's not just find a way to collect premiums from people. It's to have the ability to pay claims fairly and quickly and be able to respond in a top-shelf fashion. So, think about Kingstone in that way. But thank you for your question.

Yes. Yes. If I could just have one more follow-on, I appreciate that response. Do you see being able to introduce that in other states as you move into other states as well?

Yes. I mean, we're giving consideration to that. Like I responded before, one of our challenges is adding high-shelf, high-class, highly skilled people. We've got a lot of ideas, but between me and Ben and Victor and the rest of our team, we'd have to ultimately do things sequentially where we should be doing things contemporaneously. So, by building out our staff and the accelerating growth in our premiums will allow us to keep our expense ratio contained while we do that, we'll have the ability to accelerate our process as we go forward. I hope that responds to what you're looking for.

Yes. Thank you so much.

Thank you. It appears we have no additional questions at this time, so I'd like to pass the floor back over to Mr. Goldstein for any additional concluding comments.

Great. Thanks, everyone, for taking the time to listen. For my entire team, we're pleased and proud to have delivered these outstanding results and look forward to continuing our buildout of Kingstone to a multistate, multiline carrier. Have a great day.

Ladies and gentlemen, this does conclude today's teleconference. Again, we thank you for your participation, and you may disconnect your lines at this time.