Kingstone Companies, Inc. (KINS) Q3 2017 Earnings Report, Transcript and Summary

Greetings, and welcome to Kingstone Companies' Third Quarter 2017 Financial Results. At this time, participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] I would now like to turn the conference over to your host, Amanda Goldstein. Thank you. You may begin.

Thank you very much, Sherrie, and good morning everyone. Yesterday afternoon, the company issued a press release detailing Kingstone's 2017 third quarter results. We've posted a PowerPoint presentation on the company Web site that acts as an accompaniment to this call. The speakers will not be referring to the slides, but we hope the ordering of the slides will follow the discussion. Please review the presentation and follow along if you can. On this call, Kingstone may make forward-looking statements regarding itself and its businesses. 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 Kingstone. For more information, please refer to section entitled Factors that May Affect Future Results and Financial Condition in Item 7 of the company's Form 10-K for the year ended 12-31-'16, along with a commentary on forward-looking statements at the end of the company's earnings release that was issued yesterday. In addition, our remarks today include references to non-GAAP measures. For a reconciliation of our non-GAAP measures to the GAAP figures please see the tables in our earnings release. With that, I would 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. Joining me today are Ben Walden, our Chief Actuary; and Victor Brodsky, our CFO. I'd like to change up our historical call format. Instead of me beginning by calling out what we've done and how the results for the quarter and the year-to-date stack up, instead I'm going to give you some of my impressions of the current insurance marketplace, how it affects Kingstone, and the things I'm thinking about and issues I see impacting us one way or another. The numbers speak for themselves. We had a great quarter on many counts, and I'll let Ben and Victor review them with you. First, our growth has accelerated at a pace we did not anticipate. As mentioned in our last call we've prepared for and were rewarded with increased activity in commercial lines, and we understood the possible changes to our distribution that an A rating could bring. But the degree to which this change would impact our core personal lines business was unclear, and in actuality was far more than any of us thought. Our new business volumes are surging, but with new business being only a small portion of the overall, the incremental gains to our earned premium levels will take time to be fully reflected. We anticipate the growth to continue with leverage at the insurance company increasing. So what am I thinking about? Our plans call for maintaining a conservative risk-adjusted capitalization of not more than 1.5 to 1. In the past, to match the premium growth with available surplus and stay under 1.5 to 1 we used a lot of quota share reinsurance, relying on the balance sheets of our reinsurer partners to support our organic growth. Addressing the concerns about our seeming over-reliance on reinsurance, we did two follow-on offerings and one private placement beginning in December, 2013. Surplus at KICO increased via capital being down-streamed from the holding company, allowing us to reduce our quota share. This had the short-term effect of dulling our returns, which I was willing to deal with as the long-term benefit of a better capitalized company were far more important, and I had the utmost faith in our ability to continue to grow. So what's on my mind? With the statutory surplus of KICO now at $76.8 million, and the current leverage ratio at 1.12 to 1, we need to address the expected increase in leverage as new business growth continues. At this point, we are planning on the use of debt for the first time. Kingstone has no outstanding debt obligations, but we are planning to access the debt markets, and will soon file a shelf offering dealing only with debt securities, no stock will be offered. This will limit the cost of bringing new surplus to KICO. Taking advantage of our investment-grade rating, we will not materially be diluting our shareholders, yet we will accomplish our objective. Second item, the recent catastrophe activity of hurricanes Harvey, Irma, and Maria, along with the California wildfires have taken a terrible human toll. Insured lost estimates of $100 billion and more are being discussed. It seems most every day another reinsurer is calling for rate increases, and without a doubt there will be increases particularly on those accounts where losses occurred. In my opinion, I would not be at all surprised to see many of the Florida carriers be forced to deal with significant increases in rate. At the same time that these Florida carriers are attempting to cope with the assignment of benefits issue, and seeing their attritional non-catastrophe loss ratios increase significantly, profitability has been in decline there for over a year; and now this. How will they handle the upcoming reinsurance increases, and that will be interesting. So why am I talking about the Florida guys, what am I thinking about? Well, the heightened competition in New York over the past two years has come most particularly from the Demotech-only rated companies. Our head-to-head New York and New Jersey competitors are now owned or soon to be owned by Florida-based carriers. How will the heightened costs [ph] they will be saddled with impact their competitive position elsewhere? Will they attempt to pass on the increased reinsurance costs on the Northeast policy holders as they are doing with the assignment of benefits in Florida? We will see. But Kingstone is not standing still. We are preparing for the use of catastrophe bonds for a portion of our July 2018 renewal. We will be ready to go if market forces favor the use of bonds instead of traditional reinsurance, which we have always relied upon and for good reason. At the same time, we are monitoring the progress of tax reform as we consider the impact on offshore captives, another tool we are contemplating. The third and final item I want to discuss is corporate income taxes. There's a proposal to reduce the corporate rate from 35% to 20%. My opinion on the likelihood, extent, and timing of this isn't worth your consideration, but the impact could be profound. On a pro forma basis, if the reduction to 20% was effective on July 1 of this year, our earnings for this quarter would've been $0.50 instead of the $0.38 that was posted at the 35% rate. Deferred tax liabilities set up at the higher rate would be taken down along with the impact of lower rates on pretax income. And as others have said, we expect the benefits to fall to the bottom line, retaining more, and thus needing less outside investment to support our growth. I'm going to turn the call over to Ben now so he can give a little more detail as to our underwriting results in the third quarter. Ben?

Thank you, Barry. Again, this quarter the numbers speak for themselves. We posted another record year for underwriting profits. This quarter's results highlights the consistent profitability that we worked hard to achieve. We were fortunate to have favorable weather patterns, and our results were not affected by any major storms. As Barry noted, we also saw a full quarter's impact from growth spurred by the A.M. Best rating upgrade in April. Increased growth opportunities, combined with superior underwriting performance puts us in an ideal situation to seize upon market conditions. Consistency shows through in all of the standard financial metrics this quarter. The 2017 third quarter net loss ratio of 32.9 was just 0.10 different than the ratio for 2016 third quarter. Fire and large claim activity was in line with historical averages for the third quarter. Reserve adequacy remained strong and prior year loss development was consistent with recent quarters. This quarter, we recorded another 0.2 points of favorable prior year loss development. Our strong claims team led by Jeanette Lobosco has greatly improved our confidence in the company's reserves since he joined us in 2014. This quarter marked the first full quarter of results since A.M. Best upgrade. Direct written premiums surged particularly for New York Homeowners ' line where we have seen the biggest impact from Demotech rated carrier. For the quarter, personal lines direct written premium grew by over 25%. We are optimistic that further growth opportunities will be realized as a consequence of our A rating. Our new state expansion continues right on track. The New Jersey Homeowners ' product continues to be well received as we expand our agent force. The mix of business and quote conversion ratios continue to be in line with expectations. Last month, we received approval for our new home owner's product in Rhode Island and expect to be writing policies by the end of this year. We will be competing against many of the same Demotech rated carriers that we see in New York and New Jersey. We anticipate that our A.M. Best A rating will provide a strong competitive advantage in coastal areas that many larger carriers still shy away from. We also received preliminary license approval in Massachusetts and are targeting the home owner's market in that state for our next product launch. In conclusion, our 69.8 combined ratio for the third quarter marks the second quarter in the last five that we have posted a result in the 60s. It also makes six consecutive quarters with combined ratios under 90. This brings our year-to-date combined ratio to 76.8, over 2 points lower than 2016 and on pace for another record year. Unlike some other carriers, we don't need to remove the impact of catastrophes and prior year loss development to explain away actual performance. These items we control through proper reserving and solid reinsurance. Our results are not a fluke. And there are now opportunities to make them even better. This is a very exciting time to be part of the Kingstone team. We are extremely pleased with the consistency of our financial results and look forward to adding long-term value for our shareholders in years to come. Now I'll turn it over to Victor for some more details behind our results. Victor?

Good morning. As discussed in the previous call, results for the third quarter include the impact from July 1 reduction of the ceding rate in our personal lines quota share treaty. The ceding rate was reduced to 20% from the previous rate of 40%. We received $7.1 million return on unearned premiums from our reinsurers that were previously ceded under the expired quota share treaty. Remember to keep this mind when comparing net written premiums between Q3 and other periods, the increased retention of earned premiums after July 1 make it difficult to compare the net underwriting expense ratio between periods. Any comparison using this metric for the third quarter is more meaningful when viewed on a direct basis. Our direct written premiums grew by 20.9% this quarter compared to last year. There is delay before this growth is fully realized in the form of higher earned premiums. Therefore, it is more appropriate to measure our expenses as ratio to direct written premiums. Our underwriting expenses exclusive of commissions increased by only 10.8%, roughly half of the increase in direct written premiums; the ratio of our underwriting expenses to direct written premiums was 13.6%, a reduction of 1.3% from Q3 2016. Despite incurring expenses related to expansion in other states, we are showing more efficiency in our expense management as we grow. Our growth and continued profitability brings with it more regulatory responsibilities. We are now required to act and accelerate SEC file beginning with our 2017 Form 10-K filing. And now are subject additional procedures. We have already expanded our staff and have incurred additional professional fees in order to meet these requirements. Cyber security is another area we have been focusing on. We have incurred expenses to be properly protected and in compliance with new regulations with emerging risk. Despite the lag in our earned premiums, about 20.9% growth in direct written premiums, net income for the quarter increased by 17.7% compared to Q3 2016. Coincidentally, our annualized ROE for the quarter was also 17.7%, showing greater returns in the capital that we raised earlier this year. Now, I'll turn it back to Barry for some concluding remarks.

Thanks, Victor. As mentioned, we're now an A rated carrier with the goal of becoming a premier Northeast writer of personal and commercial lines sold exclusively through independent agents and brokers. Now, up and running in New Jersey with our homeowner's product, we are preparing to add more lines to serve our core, small neighborhood agencies in the same manner as we've done in New York for so long. Rhode Island is next, beginning there before the end of the year. At this time I'd like to call out David Delaney, our Head of Business Development, and now the proud father of two beautiful girls, as he as been at the helm of our expansion and has done an exceptional job. With that, operator, let's open it up for some questions.

Thank you. At this time we'll be conducting a question-an-answer session. [Operator Instructions] Our first question is from Ken Billingsley with Compass Point. Please state your question.

Good morning. I wanted to just ask a question from a growth perspective, and this is two parts. One, what percent of growth is going to be coming out of New York versus the other states? Obviously the top line growth was better than expected on a core basis. So as the A- rating is filtered out there to your agents, do you expect New York to be 70% to 80% of the growth at least in the near term, or do you see these other states picking up a larger piece of that?

Let me let Ben answer that one.

Yes, in the near-term it's going to be mostly New York. In fact practically all of our growth this quarter was from agents we already have in New York. But we do expect by the end of next year to have a significant portion coming from these other states, particularly New Jersey. We think Massachusetts is another big market that we can take advantage of, but that will probably come later on down the line.

And can you give an update maybe on how many new agents you've been able to assign and bring onboard?

I mean, we've signed people up in New Jersey for a number, maybe 30 or so. Each one of these is hand-selected. David Delaney goes through a rigorous process to determine who he wants to do business with and how. This not the accelerated plan, so many of our competitors try to use. We don't appoint MGA's to just run up the numbers. We feel like we've got a long-term plan in mind and we're going to take the time to execute on it properly. Hope that answers your question.

It does. And then part two of that is I was reading from the press release, you talked about expenses and leveraging them down as you grow your business. Essentially how much more can you grow with the current workforce before you need to hire and expand? I see that you acquired the building next to you or property next to you for that expansion down the road, but how much more premium can you write on your existing footprint?

Well, I think in terms of the efficiency of our staff, I mean, it's kind of heartening to know that as much as we grew -- I mean, new business is what takes time. Much easier for us to handle are renewal piece of business than new. And we do have a hands-on approach to underwriting. I'm hesitant to disclose data particularly -- well, for some reason because some of my competitors listen in, I would tell them, by the way, that this call is recorded. So instead of wasting time listening live, they might be better served doing their work to try to catch up with us when they can. But, no, we -- the growth in volume and new business, you don't see it yet. You see that on our direct written premiums in personal lines were up 25%, but the incremental amount of earned premium increase is nominal compared to that. In order to do that we added two underwriting assistants for the quarter, and we can keep doing this. I mean, we have excellent systems. And I think Victor pointed out that as quick as we are growing, with such a heavy fixed asset load already having been covered, we can continue to drive down the expense ratio. It's just hard to see when you've got these quota share changes, crazy accounting. And hopefully, in the future, we can give a little more clarity as we exit the use of quota share reinsurance.

Great. Just two more questions. One, your core business on the personal lines you've discussed pretty well. So I just want to move on to delivery business. I saw that it declined this quarter, and it wasn't the highest loss ratio pick, but it had gone up over the prior two. Anything going on there specifically that made you pull back? Was it because of something you were seeing on the loss side or is there something else that was driving that decision?

We didn't pull back voluntarily. We did see a little bit of increased competition starting in August in that line. As far as the loss ratio goes, third quarter is usually a higher loss ratio quarter for that line due to higher claim frequency. But we have taken some actions recently that should improve the loss ratio. However, as I said, we are seeing a little more competition there.

Okay. And the last question I have is just on the increased audit expenses as you become an accelerated filer. You said you've already hired those people. Is that in the numbers now or is there someplace where we should see some incremental uptick still because those were recent hires.

No, it's in the numbers now. We knew this was going to be happening. It was based on our market cap at June 30, so we saw it coming, we're prepared for it. We've already started -- this is the first year we have the internal control audit. We can't wait till the end of the year to do it; it's been ongoing throughout the year. So we're very well prepared for this.

In fact, we're holding the call at a date earlier than we need to but a date that would be required when we become that accelerated filer.

Very good. Thank you for taking my questions.

Great, Ken. Nice talking to you.

Our next question is from Paul Newsome with Sandler O'Neill. Please state your question.

Good morning.

Good morning.

I think I know how this is going to work, but I just want to make certain. If you are growing organically faster than you expected, and are going to use debt to fund that growth, which makes sense, does that push out -- does the faster growth push out the timing of when you might essentially get rid of all the quota share piece?

I mean, good question, Paul. And the planning now is for us to do a debt offering to yield enough additional proceeds to the company that we can contribute enough down to Kingstone Insurance and eliminate the remaining quota share at June 30th, in next year. So the answer to your question is if we didn't take the options to buttress the surplus of the insurance company out leverage would get heightened by the middle of next year beyond the 1.5 we target. And at the same time, if we wanted to cut off the quota share that is. And I want to eliminate it. It's hard to see the quality of our numbers when we're constantly having to explain how quota share cutoff works.

No, that makes sense. Is there any chance that the cat reinsurance costs are materially higher given the environment in your opinion?

Well, I'd hate to guess how it's going to affect us. What we're seeing now are some indications from the January 1, National Company renewals, Farmers had a release on it, and some other companies are talking about it. The next in line following January that'll affect us will be the June renewals for the Florida riders. And so we come after that in July. I'm not assuming that we're going to continue to see the level of declines we've achieved in the prior years. But I'm also not expecting to see a material change in our pricing. I do expect the Florida hard-hit -- those bonds and programs that were hardest hit I think we'll all acknowledge will see the heaviest increase in pricing. The interesting thing for Kingstone is there are few, if any, Northeast riders that buy to the high limit the way we do. So we become a diversification opportunity for either the cat bond investors, primarily from Florida, or the program riders. And that's one of the reasons we're focusing on getting ready to write a cat bond. So that may be the cheapest source of our reinsurance going forward. I'm sure it will be, but we want to be prepared for it. I hope that answers your question.

Yes, absolutely. And congratulations on the quarter.

Thank you.

[Operator Instructions] Our next question is from Bob Farnam with Boenning & Scattergood. Please state your question.

Yes, hi there. Good morning. Continuing on the reinsurance theme, since your growth has been a lot stronger than you expected I assume that it's stronger than the business plan you gave A.M. Best. Are you likely going to need to buy more reinsurance because of the excess growth that you planned versus what you told A.M. Best you were going to do?

Well, we will be buying more, and we planned on buying more. The extent of the additional purchase that's going to be triggered by our excess growth is a fact of life. And yes, so we'll be buying far more limit at July of 2018 than we did at '17. We're looking at perhaps an additional limit of up to $100 million.

Okay, all right. And one other question I had, was how many agents do you intend to appoint in Rhode Island, and how are you find them? Are you cold calling them or you're being introduced by your current agency force or whatnot. I'm just kind of curious how that process works.

That's a good question. I mean, I'm hesitant to disclose the count. But I will tell you the process that David has taken is to identify those agencies that fit the mould of the best that Kingstone has in New York, those are family-owned long-term professional agencies, typically with a half-a-dozen or fewer employees. That's one sector. The sector, and perhaps just as important, is to make sure that the people we align ourselves with are those that are active in the industry trade organizations, those that take an active interest in how they do business. Before we opened in New Jersey -- well before we opened in New Jersey, a few of us traveled down and addressed their PIA meeting or two meetings of their PIA to let them know who we were, why we were coming, the opportunities we saw, and to build those relationships. What David did is take it to the next step, and allow those producers who we identified to test our product before we went live. We take the input of our partners. They truly are our partners. And I think that the give and take between us has led to a reputation that Kingstone enjoys that, quite honestly, I don't know other companies have today. Hope that answers your question, Bob.

Yes, that's great. Thanks for the color, Barry.

My pleasure.

Our next question is from Andrew Balkam with Canny Capital Management. Please state your question.

Andrew? I guess he dropped off.

Andrew, please check and see if your phone is muted?

Hello. Sorry.

Good morning, Andrew.

Good morning. How are you?

Good. Thank you.

Barry, you were mentioning that you could have some competitors listening in. And it occurred to me that I think some of your competition these days could be ROBO insurers and maybe you don't see that competition as much, but I just wanted to share your input on that side of kind of the FinTech world creeping into the insurance industry?

Yes, I've been -- and that's very good point to bring up. It's something where we are cognizant of, we read like everybody else does. At this point, so much effort in the FinTech world is placed on displacing our distribution channel, trying to make more efficient this process of acquiring insurance. And Kingstone stands firmly against that. We do not -- you need, if you want to insure the single biggest asset you have, your house; if you want to rely on some ROBO app to make decisions for you that are not nearly -- which you're far, far more complex than when you insure your car, frankly, good luck to you. And it's silly. We are dealing with people who understand not just the acquisition of the policy, but how the policy has to react when there is a claim. The nature of insurance is we sell and collect premium from a lot. So, we can return to the people who moves, who suffer a lot, and do it properly. When there is a ROBO or BOT [ph] or whatever you call this fancy technological terms, that can deal with a claimant after their house got a fire or something like that, well, they not pay real serious attention to that. And until then I wish them good luck and we're monitoring their progress.

Okay, this sounds good. And the other question I had was -- I have been pleased to see that you've had a pretty long-term paucity of paying dividends to your shareholders, and that's increased over time. Do you have a specific guideline in your own head about how that increases as your earnings increased, or do you have a stated policy that where we should be aware of?

I think, you know, frankly we look at our investment income as a source of funding dividends. And as the investment income grows, as the portfolio has grown, it affords us more of an opportunity to distribute dividends, but we're constantly looking at that. And one of the prime topics is conversation at the Board meetings, but we think that a balanced carrier, who returns a dividend to its shareholder, is a proper way to go, but in limited quantity. We don't pay out a high. We're never going to be a high-yielding company, but we think it's important to do that.

Yes, I agreed. Although if your stock goes down, then you will be higher yielding, so…

Well, thank you for pointing that out.

Okay.

Thank you so much.

And now we have a follow-up question from Ken Billingsley with Compass Point. Please state your question.

Thank you. I just wanted to ask about on the surplus side, I think you gave a number for [indiscernible] is that $76.8 million as of third quarter?

I think that was the number. Yes. That's the statutory surplus.

Correct. Okay, and then, so in -- my question is the issuance of debt in the plan, and you talked about by the end of '18 on the current path you would exceed the 1.5 times leverage. I want to make sure that we are on the same -- using the same math; that 1.5 time, is that net premiums written to statutory surplus?

Correct.

So based on that, obviously you think growth would be really strong going into 2018. And I just wanted to get an understanding, to hit that 1.5 level that you think you could get to, and you need to address, is that just through core organic growth that you already have in place, or is that assuming the reduction of the quota share or a combination of both?

It's a combination. We are assuming the elimination of the quota share in total [ph] at the middle of the year. And combining that with the heightened activity we've seen and the premiums coming from that, well, actually we think we're going to be above 1.5 to 1 in the middle of next year. So that's why we're taking these actions now. We are looking forward to filing our shelf offerings very soon. We are looking at various options in terms of maturity levels and costs. This is still a very low cost environment, and to allow us to fix in a rate, we are effectively adding capital to the insurance company without having to dilute the shareholders as we have in the past. We want to take advantage of that, not wait around.

Very good, thank you.

Okay.

[Operator Instructions] Ladies and gentlemen, we have reached the end of the question-and-answer session. I would like to turn the call back to management for closing remarks.

Great, and thanks everybody for taking the time to listen from the entire team in Kingstone. We are pleased and proud to have delivered these outstanding results, and we look forward to continuing to build out of Kingstone to a multi-state, multi-lined agent-only carrier. Have a great day.

Thank you. This concludes today's conference. You may disconnect your lines at this time. And thank you for your participation.