Kinsale Capital
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Kinsale was started by Michael Kehoe right after the financial crisis, in 2009. The previous seven years, he was the CEO of James River, an excess and surplus (E&S) insurance company. Before that, his experience was also insurance. So Kehoe had been around the block.
The insight he had was that E&S could be some of the most profitable lines of insurance. Kinsale has a very strong actuarial team and they use technology to price and close business very quickly. This makes them an attractive underwriter for brokers like RSG Speciality, AmWINS, or CRC Commercial, which make up nearly half of Kinsale’s underwriting volume. These brokers have direct relationships with customers and get about a 15% commission of any written premiums and then Kinsale makes money from the rest of the premium and keeps whatever is left over after losses and expenses.
Before getting any further, we should talk about E&S insurance. It’s a type of property and casualty (P&C) insurance that is sometimes called non-admitted insurance. Basically, if there is a hard-to-price insurance opportunity, the admitted carriers might not be interested. Admitted carriers mean that the company providing the policy is regulated in that specific state. Non-admitted carriers are still licensed but they don’t necessarily have to comply with the specific state’s regulations. There are still regulations but they aren’t always as stringent. So, naturally, the next question is why would anyone want to be an admitted carrier? Well, mainly, consumers like it because the state will take over the claims process if the carrier goes bankrupt. Further, an admitted carrier can cut out the surplus broker middlemen. But the primary reason is the consumer confidence that an admitted carrier…for lack of a better word, carries.
But, sometimes, these admitted carriers simply think writing a specific policy is too risky so customers are forced to use non-admitted carriers. Think of situations like hurricane insurance on the coast of Florida or liability insurance for a marijuana dispensary – things like that. These hard-to-price risks are what E&S companies specialize in. And because the large, admitted carriers don’t want to price them, the competition is lower and premiums can be quite juicy.
Getting back to Kinsale, the company specializes in E&S policies for unique small businesses. For instance, that marijuana example wasn’t theoretical. Kinsale does quite a few of those policies for limiting legal liability. If a product causes someone to have a heart attack, someone might sue the dispensary, in which the casualty policy from Kinsale might come into effect. What’s really interesting is just how random some of these liability policies are. Kinsale covers mobile home parks, axe throwing venues, taxi cab businesses, security guard operations, equestrian stables, haunted attractions, martial arts studios, and much, much more. Basically, anything that has risk and not many other providers are willing to price, Kinsale may be interested in making money on that opportunity.
The company has done extremely well with this simple strategy. Gross written premiums have grown about 30% annually since the company’s IPO seven years ago. Meanwhile, net earned premiums have grown at roughly a 40% CAGR in the same period, as the company has gradually ceded less to reinsurers. There is an old saying about being wary of a fast-growing financial company but Kinsale seems to be immune in that regard. Loss ratios have been a hair under 60% and the business is run very efficiently so the combined ratio hovers just under 80%. That means that for every dollar of kept premium, the company makes 20% margins. And this is before counting any income from the float. So Kinsale routinely has higher than 25% margins, while growing 40% over the past seven years. These are just mind-blowing numbers for what seems like a sleepy insurance industry.
Crucially, about half of growth has been from volumes and half has been from price. Because these customers typically don’t have another option, Kinsale’s pricing power is quite strong. While E&S insurance only makes up about 9% of the total P&C market, the last few years have been an extremely “hard” market. Hard, if you’re an insurance company, is good. That means premium prices are going up. Hard, if you’re a buyer of insurance, is bad. There are various reasons why certain insurance markets go through hard and soft pricing but the inflation of the last few years helped E&S companies flex their pricing power. What is a go-karting operation going to do? Just not have insurance? No, they just can’t take that risk. And oftentimes, there is no one else to turn to besides Kinsale.
Kinsale has really taken the “riches in niches” thing seriously and has reaped the rewards. However, on the last few earnings calls, Kehoe has made it clear that the hard market won’t last forever. He said to expect more like 10-20% growth instead of the 40% that everyone has gotten used to. As inflation starts to subside, Kinsale just can’t raise prices forever. At some point, customers start to become upset. I mean, in a lot of cases, premiums have doubled over the past several years. At the same time, Kehoe strikes me as a conservative, expectation-setter. I wouldn’t be surprised to see Kinsale’s success continue because a lot of these customers have nowhere else to go. But where there are fat profits, capitalism does a great job of competing those away. Kehoe has made it clear that they are seeing a decent amount of competition entering the market because of the hard pricing. It’s similar to a stock market bubble – when people see prices go up, they want in, but that pushes prices up even further, and so a lot of companies go public to take advantage of the prices, and then there is too much supply for that last incremental dollar of demand and the bubble bursts. I’m not saying the dynamics are exactly the same, but the concept of supply and demand remains. When a lot of competition enters the market, that hurts pricing.
Kinsale has one of the lowest expense ratios in the business so that should insulate them from the incoming competition. The company can’t grow 40% forever but even with 15% growth and small improvements in profitability, the stock could continue to do well.
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The saying about being wary of fast growth in financials, esp. banks and insurers is very true.
So what if ER is a bit low(er) because the underwriting is done fast(er) without looking into risks in that much detail, leading to a) low ER and b) faster quoting which the brokers might prefer and thus deliver much business.
The low LR and thus low CR overall might be understated due to the high growth. So the moment the growth stops
1) investors might assign a lower multiple due to lower growth/reinvestment, and
2) a yet lower multiple due to higher LR/CR and thus lower roe
(That said, I play the pessimistic dude here but own another high growth insurer)
hard to outperform expectations of 40% growth for too long