Kingstone Companies, Inc. (KINS) Q2 2019 Earnings Report, Transcript and Summary

Greetings. Welcome to Kingstone Companies 2019 Second Quarter Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note this conference is being recorded. I would now turn the conference over to Rich Swartz. Thank you. You may begin.

Thank you very much, Sherry, and good morning, everyone. Yesterday afternoon, the company issued a press release, detailing Kingstone’s 2019 second quarter results. On this call, Kingstone may make forward-looking statements regarding itself and its business. 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 the section entitled Factors That May Affect Future Results and Financial Conditions in Part I, Item 1A of the company’s Form 10-K for the year ended December 31, 2018, along with the commentary on forward-looking statements at the end of the company’s earnings release 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’d like to turn the call over to Kingstone’s CEO, Mr. Barry Goldstein. Please go ahead, Mr. Goldstein.

Great, and thanks, Rich. Good morning, everyone, and thanks for joining our second quarter 2019 conference call. As I’m sure most of you are aware, I returned as Kingstone’s CEO, following the departure of our prior CEO last month. I share your disappointment with our recent results. It’s my challenge to return Kingstone to those top-tier metrics that we delivered to so many years. I am excited to be back in the driver seat and begun to put in place plans and have started taking actions that were overdue. Our moratorium on writing new commercial lines business about a two months period in length was used to assess whether and how long it would take these very challenging and competitive small business risks to return to profitability. I decided that the cost and internal effort required would be too much. It would take too long and we’d risk absorbing heightened losses over an extended period, which is not the best use of shareholder capital. My first action was to announce the exit from all commercial lines other than our auto physical damage program. We immediately began the process of non-renewing our in-force book and expect all policies to be off the books before the fourth quarter of next year. Our continued growth in personal lines were more than offset the foregone premiums. Recently, it became clear that the long-tailed claims from commercial lines create volatile reserves that require an action plan. We are working now to see if we can on a cost effective basis, use reinsurance to contain the volatility or eliminate the uncertainty entirely. We are comfortable that the reserve actions already taken put us in a good position going forward. I’ll report back once decision is made as to the reinsurance. Now for personal lines, our core homeowners product is currently being distributed in six states. And our regional diversification footprint, which began in April 2017 is almost fully in place. We have only one state rollout remaining, which we hope to complete during the fourth quarter. In the second quarter, our total direct written premium reached $38 million, of which $6.3 million or 16% came from risks outside of New York State. As mentioned last quarter, our Cosi Agency business is also expanding. You may recall that Cosi was set up to manage a new distribution channel outside of our core independent agency business. Cosi has developed relationships with three of the nation’s top 10 carriers. And these partnerships along with other national and digital agency appointments are now becoming a material part of our business. While it will take some time for the book-to-bill than time for the premiums written to be earned, during the second quarter, as these relationships expanded in New York, Cosi added just under $1 million of written premium at 2.5% to the total. A better representation of the power of Cosi is that of the new business written in the second quarter, Cosi contributed over 8% of that total. So we expect the Cosi will continue to grow and will soon expand outside of New York. I’ll be sure to update you each quarter as to its progress. But profitability is our major focus. Yes, we’ve experienced weather losses that are outside of our control. But we’ve also seen a deterioration in profitability that requires us to move quickly on pricing, underwriting and expense actions. After many years of maintaining steady premium rates in New York, we are moving in earnest to increase rates. This is a process that will take time to manifest itself in our financials as it depends on timing of approved rate increases, which then must be rolled on to our renewal book and earned out over a one-year period. We are taking underwriting actions to call out the marginal risks from our new business written, and expect this too will help. But since the renewal business represents over three quarters of our total premiums, it is a base premium rate increase that is needed. With the expansion almost fully implemented, we expect that our expense ratio will continue to decline and hope to see that reduction down to 35% to 36% next year. Now, I’ll turn it over to our EVP and Chief Actuary, Ben Walden. Ben?

Thank you, Barry. Despite recent quarterly results, we remain very optimistic since our key profit drivers have not changed. Kingstone is in the middle of a long planned company transformation. Five years ago, we were a small single-state company with products and systems that fit a very narrow niche. Today, we are regional A-rated carrier competing with and taking business from the big players. Our products, pricing and systems require continuous adjustments in order to make this a successful transition. The first adjustment is to focus on risk segments with high profit margins and proven profitability. Over the last several quarters, we found that small commercial lines business in New York City is not one of those segments. Recent volatility and claim outcomes quickly led us to the conclusion that the business is not profitable and we are now exiting that market. The second adjustment is to focus on pricing of our personal lines business. In the five years I’ve been at Kingstone, rate actions have not been needed since the business has consistently run at a combined ratio in the low-80%s. Other non-rated carriers have priced their personal lines business below ours, yet we continue to grow and increase market share. The A-rating accelerated our momentum and allowed us to grow at an even quicker pace. However, we now see that growth has put some pressure on profitability. To address that, we have already taken a targeted rate increase for New York homeowners earlier this year. We plan on another more significant rate change by the end of the year. We are also taking significant rate in the expansion states in order to ensure their continued profitability. Finally, we are transforming our business through technology, so that we can remain nimble and proactive as we grow. We are in the process of consolidating our systems infrastructure from legacy systems to new platforms. These will support growth, reduce expenses and enhance our ability to quickly react to emerging trends. We recently updated our homeowners’ predictive model, and we are using that to target underwriting actions to further improve profitability. Along with these positive adjustments, it’s important to note that our underlying business remains profitable despite recent challenges. During the quarter, we recorded a combined ratio of 94%, inclusive of some unusual weather and continued volatility from our commercial lines book. Excluding the unusual items, we posted a quarterly combined ratio in the mid-80%s. As Barry noted, we are closely monitoring reserve levels with our internal and external actuarial teams. This is an ongoing process that we have followed each quarter since 2014. We will take the needed actions to contain the uncertainty arising from older commercial liability claims. Our book value at the end of the quarter is $8.14, which is now higher than our stock price. That is an interesting situation for an A-rated company with strong underlying profit, continued growth and many positive actions in the pipeline. Now, I’ll turn it back to Barry for some closing remarks. Barry?

Thanks, Ben. Again, I share with the entire board a disappointment in our recent results. We are deliberately moving on many fronts and hope you will show us the patience required as we rebuild shareholder value. We’ve decided to reduce the dividend to allow KICO, our operating entity, to retain more surplus, thus strengthening its already strong balance sheet. I have no intentions of leaving this job until it’s done. And quite frankly, no one I know will derive anywhere near as much benefit as I will from the actions that I’m taking. So with that, let me turn the call back to the operator and open it up for questions.

Thank you. [Operator Instructions] Our first question is from Paul Newsome with Sandler O’Neill. Please proceed.

Good morning. I want to ask about the rate need. Is the rate need driven by underlying claims inflation or is it the segmentation outside of the core New York book? Or is it some sort of new business penalty? Can you talk about just sort of what’s the underlying driver of the rate need?

Ben, you want to take that?

Sure. It’s Ben Walden. Yeah, most of the rate need right now is driven by a combination of increased claims severity, especially on water damage claims. We’re seeing some higher severity on those types of claims. So it’s really not driven by anything other than that. We are seeing increased – a little bit of an increase in reinsurance costs as well, which factors into the indication. But again, we haven’t taken a rate change in New York, since I’ve been here. So we’re at the stage where we do need to address some of these increasing severity trends and that’s the reason we are going to go at with further increases.

Let me add a little color to that also Paul. It’s – I’ve been very anxious to be a strong competitor. And our ability and our consistency to maintain rate with very, very little change is something that I was quite proud of. But things began to change. And probably, we should have been getting to taking these rate increases last year. So we’re a little late to the party, but we’re going to catch up here. I don’t think you’re going to see anything dramatic, but claims inflation does factor into it, no doubt, it’s just generation inflation. So I hope that addresses your question.

No. It does. Could we also talk about the dividend cutter? Are you targeting some sort of a payout ratio over time? Or how are you thinking about the dividend, both the new and going forward?

Typically, we looked at the dividend as being supported by our investment income, which by the way is immaculate. And as you know, with a book of almost exclusively, if not, fixed rate instruments that – certainly interest sensitive instruments, we’ve seen quite a good reaction in our portfolio recently. But just to be safe, just to be a little more cautious, I thought it was prudent to cut back on the dividend. And we’ll address that each quarter going forward as we have. But it’s really just a factor of trying to be a little more cautious and a little more conservative with how we’re handling the business going forward.

And then finally, could you talk about the components of the expense reduction? And that’s a pretty good cut you seem to be targeting for next year. Where exactly are those cuts coming from?

Well, it’s not so much of a cut. It’s the benefits with the heightened growth coupled with the unwinding of our quota share. If you recall, maybe we haven’t mentioned it, we did have a personal lines quota share treaty that we began – we thought we were going to be at 20%. One of our participants saw their fortunes change. So we asked them out of the treaty. We reduced it to 10% for the last year. And as of June 30, it’s all – so we have no further quota share. But the – we’ve seen the benefits of our expenses remaining close to level. But with our business growing – and we don’t see the need for the incremental costs to develop those are the states that we’ve had to experience. So I think what you’re going to see is just a maturity in the footprint and us getting the benefit of scale from it.

Great. Thank you all. I’ll let some folks ask questions. I appreciate it.

Okay. Thank you.

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

Yeah. Hi, there, and good morning. I think – I have a question on the Cosi Agency. It sounds like that’s going to be a pretty good driver of growth. And I wanted to get more information on how it works, who’s doing the underwriting? What paper it’s written on? I just want to make sure I understand how the underwriting is going to be for that business relative to the traditonal business?

Okay, sure, and thanks for the question. Yeah. So just to go back, Cosi is a subsidiary of the holding company, as is Kingstone Insurance Company. And the insurance company appointed Cosi to act as its general agent. So while Cosi has very similar underwriting guidelines as the independent agent channel would have, in more cases than not, where there’s a difference, it’s a restriction placed on Cosi. So these company employees, whether they’re Kingstone Insurance Company employees or Cosi Agency employees, who are underwriting the business using the same systems. And while – again, while there are certain nuances that make the underwriting for Cosi a little bit different, they’re almost exclusively more difficult than the independent agents would see. It’s really not all that much more different than that, Bob.

All right. So how is the business – how does the business come to you? Is it these partners are saying, hey, we want to write a package policy on the quota share, but we don’t want to take this particular risk, can you take that? I mean, I just – how is this sourced?

Okay. Okay. I’m sorry. I wasn’t clear with that. So, all of our business is written on Kingstone’s paper. So Cosi has appointed the general agencies of three of the very large national name-brand companies, who – at least for those three, all have a storefront offices or call center offices that originate business initially and were intending for the – that carriers’ book. But each of those carriers has different appetites than we do, have different restrictions than we do, whether we’re willing to write to a higher coverage A, we’re willing to write closer to water, whatever it is. So when the business that comes into these carriers, does it meet their appetite, it can move through Cosi and onto Kingstone. It’s really our same policy just being originated by a different group of agents. And while these three national carriers and a number of the digital and national agencies represent only a handful of relationships, frankly, it winds up more than a couple of hundred offices who are originating this. So, some of them are name-brand storefront offices. I’m not permitted at least at this point to use the name of the national carriers we’re doing business with. But I’m sure you’d find them to be recognizable.

All right. And so the benefit to these national carriers is that they will take the other pieces, perhaps the auto policy or the umbrella policies and that stuff, and you just take the homeowner risk?

Exactly. Exactly. And it’s not as though – this has only really gained traction. We started the major role out of this in the third week of March. So while I’m talking about this after another quarter, I think, you’re going to see a significant increase in the next quarter and the quarter after that as these individual offices were allocated codes and began doing business with us.

Right, right. Okay. I just wanted to at least make sure I understood what’s going with Cosi. So okay, thanks.

Thanks, Bob.

[Operator Instructions] Our next question is from Paul Newsome with Sandler O’Neill. Please proceed.

Yeah. Just one more kind of follow-up, as you – could you talk a little bit about the process in assessing the claims and reserves on the runoff book of commercial business? Are there a number of upcoming sort of second looks at it? And just trying to get a sense of whether or not we will see much activity on the actual reserve themselves, before there is a possible reinsurance situation?

Let me start that question, Ben, and we’re in two different places, Paul. So please understand that Ben chimes in after a couple of seconds. But yeah, so we did take a little further strengthening during the quarter little over $1 million. We did have an independent actuarial firm take a look at what we were doing. And when I said in my release and in my introduction earlier that we feel comfortable with where we are, it’s just that. I think we are in a good spot. The process in order to see if there is interest in and at what kind of rate a reinsurance transaction could be entered into requires this third-party actuarial assessment. And then it will be marketed to the various runoff type carriers that Aon is familiar with. We’ve had quite a lot of interest in this. Whether it will make sense for us given our comfort in the reserves to pay some sort of premium to either cap them off or to eliminate them entirely is really going to depend upon the market and the pricing. So we’ve started that process by having the third-party actuary take a look and we’ll move in earnest on it right now.

There is still other major reserve looks at it either outside or inside in the plans in the next near future?

When you say reserve looks, you’re speaking…

Yeah. Heightened level of reserve processing, reserve analysis, some companies do have a higher level of process that they’ll do maybe in the third or fourth quarter. Just…

Well, let me let Ben discuss how he normally goes about this and how he is worked with our outside actuary. Why don’t you give a little more color here, Ben?

Sure. So we do use an outside actuary to sign our statement of opinion. We do that annually so there is a full review done by them at year-end. Internally, we do a review every month and every quarter in detail. However, with the commercial lines volatility in the last few quarters, we’ve had our outside actuary take another look as of 6/30. And that is being used to support where our carried reserves are now. So we will continue to have them look as we get closer to year-end, but combination of their review and our review, we feel comfortable where the reserves are. And things change every quarter. We get new information. So we’ll continue to look at that and react to it as it comes in.

Great. Thank you.

Okay.

Our next question is from [Todd Blue] [ph], private investor. Please proceed.

Good morning.

Good morning.

Welcome back, Barry.

Thank you. Thanks very much. I didn’t get much time left, did I?

I was going to say, that was very short – a little short lived. You might not have knocked off all the buckets there.

Yeah.

Question about your underwriting ratio, it seems just back to the envelope for this year, you’re probably going to be pushing on that 1.5, wondering how you’re thinking about that capital-wise?

Yeah. I mean – and you are right. I mean, we are looking at that. And we’ll probably, because of the runoff of the commercial lines book, not see all that much increase to that leverage between now and the end of the year. No doubt, the heightened premium levels that are coming on now from some of the targeted areas in New York, where we took rate early this year will add premium. And on the other hand, that’s the – we don’t have any idea when the department will approve our rate increases for the rest of New York that we’re looking at. But I would say, we’ll be buttoned up to that 1.5 or pretty close to it by year end. And well before we get there, we’ll take a look at it. And if we need to do something to deal with that we will. And we’re quite familiar with the reinsurance solutions that are available to us.

Got you. Okay. Secondly, with the stock where it is, would the Board consider some repurchases?

Good question. And we’ve been struggling with this – I should say, I am struggling with answering the question, because the liquidity at the holding company is what would drive our ability to make share repurchases. We’ve had a number of parties come forth, offering us types of solutions. And seeing the stock trade at or below book is, obviously – makes for an interesting opportunity. On the other hand, it kind of sickens me to see how much work is going down the drain. But, yeah, as much as we’d like to do, I think the capital is precious at this time, trying to put any kind of strain on the company to take advantage of it. And I’m hoping it’s only a short-lived advantage. Our directors have all bought shares in the stock. And I don’t doubt there will be more purchases by insiders showing their – that what they believe of the company’s future. But right now, I don’t see any near-term share repurchases in a meaningful way.

Got you. Thanks a lot.

My pleasure.

This concludes the question-and-answer session of our conference. I would like to turn the conference back over to Barry Goldstein for closing remarks.

Great. Well, listen, thanks everybody for listening in. It’s been a short period of time that I was away from being the CEO and maybe a little bit longer period since I was responsible for the day-to-day efforts of the company. But I’m happy to be back, I’m happy doing the things that I think need to be done. Each of them has a targeted purpose. Each thing has been vetted and is sound in the way we’re going about it. They will take time to run through our financials. But please just keep track of the measures we are taking. And you’ll see that our goal to get us back to where we were, while it may take a little bit of time, is well within our reach. So thank you again all for listening in. And I look forward to chatting with you on our next call.

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

Thank you.