Kingstone Companies, Inc.
Q1 2015 Earnings Call Transcript

Published: 14 May 2015

[Operator:]

Greetings, and welcome to the Kingstone Companies, Inc. Kingstone Reports First Quarter 2015 Financial Results. At this time, all participants are in a listen-only mode. A brief 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, Adam Prior of The Equity Group. Thank you, Mr. Prior. You may begin.

[Adam Prior:]

Thank you very much Andrew, and good morning everyone. Yesterday afternoon, the company issued the announcement of Kingstone's 2015 First Quarter Results. We will be utilizing a slide show presentation as an accompaniment to this call. This presentation is available on Kingstone Companies' website at www.kingstonecompanies.com. While we will not be referring to the entire presentation slide by slide, the structure of the discussion will mirror that of the slide show. We welcome each of you to review this presentation, and follow along. 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 management of each entity. The words; anticipate, expect, believe, may, should, estimate, project, outlook, forecast, or 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 company, 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, 2014. No forward-looking statement can be guaranteed. Except as required by applicable securities laws, forward-looking statements speak only as of the date hereof which they are made, and the company and its subsidiaries undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. When discussing 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 would like to turn the call over to Mr. Barry Goldstein, Chairman and CEO of Kingstone. Please go ahead, Barry.

[Barry Goldstein:]

Yes thanks and good morning everyone. I am joined today by Victor Brodsky, Kingstone's Chief Financial Officer, as well as Ben Walden, our Senior Vice President and Chief Actuary. Before we begin I want to point out that there was a small error in our press release sent out yesterday afternoon. In the table on page one, the amount shown for the March 2014 book value per share was incorrect as was the percentage change just to its right. Corrections have been made and the as corrected release has been posted to the KINS website. KINS generated solid financial results in the first quarter of 2015. These results were dramatically impacted by the long harsh winter we experienced in downstate New York and elsewhere in the Northeast. Still we were able to achieve 23% direct return premium growth in our continuing lines of business and year-over-year improvements in net income and earnings per share. Our ex-catastrophe combined ratio was an excellent 70.6%, which is an improvement of three full percentage points over the first quarter of last year. I hate to complain about bad weather, but the bad winter weather this year and last led to heightened claim volumes. This year was more of an ice event, with February and March temperatures setting records and leading to higher severity pipe freezes and water damming claims, as compared to last year, where snow was a bigger contributor. Weather is a major consideration for all property and casualty carriers. This is something that we have to live with good or bad. I will begin today’s call with a discussion of what is driving Kingstone’s growth and the competitive elements within our target markets. Ben will detail for each of you the impact of the severe winter weather on our financials, and Victor will review some specifics of our financial results, and then I will return for a few closing remarks. We have a long history in the insurance industry going back to our founding in 1886. We have proven track record of consistently delivering underwriting profits from a growing premium base and an expanding investment portfolio. Referring to SNL.com’s analysis of 2014 results, our wholly owned subsidiary, Kingstone Insurance Company was ranked Number 24 in New York State when considering homeowner premiums written, up from Number 29 in 2013. Still our market share is but three quarters of 1%, showing the size of the opportunity we are presented with. Similarly looking at dwelling fire writings, we are ranked Number 20, up from Number 24 last year and with the market share above 1.2%. Looking now at the first quarter, our premium growth was driven by a 22.8% increase in our personal lines writings, which includes homeowners and dwelling fire policies. Our business is focused on the downstate New York market and we have increased our policies in force count by 20.6% over last year. We will soon file an updated rating plan for targeted counties in the Hudson Valley and believe that we can further diversify geographically by building a presence in our own backyard. Our applications to do business in four additional states are still pending, and as soon as I can give you more information on this I will, but I can share that we are interviewing for candidates to help us build out an agency only distribution network leveraging our stellar reputation within the New York independent [producer] community. In terms of competition in our downstate marketplace, for years we have seen larger national carriers lessen their exposure through the gradual non-renewal of policies. We have seen new competitors enter the marketplace and we expect more to follow. In spite of the perceived heightened competition, we are well equipped to continue growing again due to the excellent relationships we enjoy with our select producers. During the period, we continued to see rapid growth in livery physical damage policies we write, largely as a result of the widespread acceptance of transportation network companies, such as Uber. In past quarters, I have talked about profitability struggles with the commercial automobile line of business. I outlined that our overall premium growth rate would be lessened due to our decision to run off the commercial auto liability line. We seized writing new commercial auto policies on October 1 of last year, and made the decision to not renew existing commercial auto policies beginning with those effective May 1 of this year. At the end of Q1, commercial auto represented approximately 1.3% of our total policies in force, and by this time next year there will be none left. We are managing the claims run off aggressively and feel our reserves are adequate to satisfy the claims generated by this line. Now, I'll turn it over to Ben Walden, our Senior Vice President and Chief Actuary. Ben?

[Ben Walden:]

Thanks Barry. I will now take a few moments to discuss the loss ratio for the quarter. As Barry mentioned, the severe winter weather affected our results considerably, specifically in personal lines. Many of the winter losses were from claims due to frozen pipes and other winter related structural damage from snow and ice. Kingstone’s current catastrophe reinsurance treaty contains a provision that provides coverage for excessive winter weather losses. However, this provision was not triggered by the winter weather in the first quarter of 2015. The 2015 first-quarter net loss ratio improved to 68% from 73% in the prior year period. Beginning with first-quarter 2015 reporting, we specifically breakout the net loss ratio into its component parts. First the winter weather impact is determined as excess losses over and above an average winter season. The impact on our net loss ratio from the severe winter weather was 17.7% in the first quarter of 2015 compared to 15.9% in 2014. The second component is the impact on our net loss ratio from prior year loss and LAE development. This was 1% in the first quarter of 2015 compared to 3.4% in the first quarter of 2014. Finally, our core net loss ratio excludes the impact of severe winter weather and prior year loss and LAE development. The core net loss ratio improved to a healthy 49.3% in the first quarter of 2015 from 53.7% in the prior year period. The improvement in the core net loss ratio was driven by favorable results for commercial lines and a shift in the net earned premium mix towards lines of business that have a lower core loss ratio such as personal lines and livery physical damage. The company’s combined ratio was 97.9% in the first quarter of 2015, and 95.5% in the first quarter of 2014. Keep in mind the severe winter weather affects both the net loss ratio and the net underwriting expense ratio due to the impact that increased losses have on our contingent heating commissions. As a result, the total effect of the severe winter weather on the first quarter combined ratio was 27.3 percentage points in 2015, compared to 21.9 points in the prior year period. Excluding the impact of the severe winter weather, the first quarter combined ratio improved 3 points to 70.6 in 2015 from 73.6 in 2014. At this point, I will turn it over to Victor Brodsky, our CFO.

[Victor Brodsky:]

Thanks, Ben. I'd like to start off talking about our combined ratio. Our net combined ratio for the quarter was 97.7%. Components of the combined ratio are the net loss ratio, and net underwriting expense ratio. Ben has already discussed our losses to the quarter, and our 68% net loss ratio, which includes the effects of severe winter weather. Our net underwriting expense ratio was 29.9% this quarter compared to 22.5% in the first quarter of 2014. Comparison of net underwriting expense ratio between quarters is impacted by the reduction of quarterly share ceding rates on July 1, 2014. Reduction in quarterly share ceding rates increased our net earned premiums, which impacts net underwriting expense ratio by increasing the denominator of the ratio. The three components of the net underwriting expense ratio are, first, commissions paid to our select producers; second, other underwriting expenses, which are the overhead required to run our business; and last, the ceding commissions we receive from our quota share reinsurance partners. Commission expense as a percentage of premiums written remained fairly constant except the additional commissions we paid to our select producers as a bonus. This quarter, we increased the estimated bonus compared to the first quarter of last year. Other underwriting expenses include the costs related to the writing of insurance policies, regulatory fees, and overhead costs of running our business. Other underwriting expenses as a percentage of direct written premiums increased to 15.4% this quarter, from 14% in 2014. This is an unusual occurrence since we have always been reporting that our other underwriting expenses have been decreasing as a percentage of direct written premiums. The increase stems from employment costs, professional fees, and rate increase in state assessments and premium taxes. I would like to address some of these items individually. During the quarter, our salaries and other employment costs increased by 32% compared to the first quarter of 2014. The increase was due to the hiring of additional staff to service our current level of business and the anticipated growth to come. We believe that the experience our new hires bring to Kingstone will allow us to efficiently manage additional growth. In addition, there were annual rate increases in both salaries and cost of employee benefits. The first quarter of 2015 includes a large increase of professional fees. We are now recording these fees in the quarter in which the services are rendered. The final component is ceding commission revenue. These amounts are offset against the other underwriting expenses and reduced the net underwriting expense ratio. The reduction of quota share ceding rates results in lower ceding commission amount, further severe winter weather produced our [conventional] ceding commissions due to resulting increased loss ratio. Reduction in ceding commission [increased] the net underwriting expense ratio. Regarding investments our philosophy is very basic. We seek stable after-tax income in our portfolio. Kingstone's cash and invested holdings, at March 31, 2015, increased to $75 million. The vast majority of our investments are in investment grade fixed income securities. One trend worth noting that over the past several quarters we have successfully shortened the effective duration of the portfolio to a current 5.5 years. To summarize, the highlights of net income, our direct written premium growth, an increase of net written premiums due to new quota share agreements, along with increased investment income, led to the bottom line improvements despite the impact of the winter weather that [Indiscernible]. Kingston's net income for the quarter increased 16.8% from the prior period. Before I turn it back to Barry, I’m also very pleased to report that our board declared a dividend of $0.05 per share to be payable on June 15, 2015 to shareholders of record on June 1, 2015. This marked our 16th consecutive quarter of dividend distributions. With that I'll turn things back over to Barry for closing remarks.

[Barry Goldstein:]

Thank you, Victor. Our quarter was defined by the harsh winter storms that affected our markets. We explained in our last call that we anticipate that the winter’s impact to be similar to what we saw last year. In fact, the total winter losses incurred this year were greater than last year. However, due to changes in our quota share agreements and the change in the mix of business, the net loss ratio showed some improvement year-over-year. As previously discussed, Kingstone governs itself by adhering to a limited set of core values. One of these is the maintenance of a conservative operating leverage by trying to maintain a conservative ratio of net written premiums to surplus. Historically we have set this at 150% over the treaty term, which begins July 1. We will continue to utilize quota share reinsurance to allow us to take on the business and share the risks of doing so with others. But we will be reducing the ceding percentage in July based upon the volume of business we expect to write over the treaty term. Right now it appears that the current personal lines treaty, which carries a 55% ceding percentage will be reduced to 40%. While a final decision as to ceding percentage will be made in late June, I feel confident in saying that I expect Kingstone to stand on its own and eliminate the need for all quota share by July of 2017. Based on current favorable market conditions we also anticipate achieving better pricing and better terms on all of our reinsurance treaties. Operator, let's open it up for questions.

[Operator:]

Thank you. [Operator Instructions] First question comes from Paul Newsome with Sandler O'Neill. Please go ahead.

[Paul Newsome:]

Good morning and thank you for the conference call. I want to ask about the elimination of the quota share, and your goal to get rid of it entirely, could you talk about some of the pros and cons of that choice, certainly I understand that in the context that we have a pretty cheap reinsurance environment and there are some diversification [mismanagement] benefits to the quota share agreement?

[Barry Goldstein:]

Sure Paul. Basically it is a financial decision. Whatever we cede to our reinsurance partners is done understanding that they are generating a profit on the business, which otherwise would have [Indiscernible] to our benefit if we had the surplus to support it. Depending upon the type of agreement we enter into, we will either have a growth quota share treaty, which includes a proportionate share of our catastrophe needs, or a net quota share treaty, which will give us only a very limited amount of catastrophe coverage. So in the growth treaty, which is the way we have been doing it, the reinsurers have built in a margin for both the use of their balance sheet as well as the profit they hope to generate by providing us with the CAT cover. If you remember, and what sticks in my throat repeatedly, is that following super storm Sandy, our loss ratio went from an amount that otherwise would have given us the maximum possible benefit by that treaty to one in which we at least stood to lose money on every dollar we ceded to the reinsurance partners starting in November. So, that is not a result that I want to revisit. I certainly don’t believe that the likelihood of a major CAT event this year is heightened in any way. I mean reports are that the number of – estimated number of storms and the number of named storms that would hit the US is down versus prior year’s estimates, but I think the point is that the real need for leaning on someone else is because they have the surplus to help us support the spreading of the risk. So if we have our own surplus, we don’t need to rely on anybody else. And frankly, if they’re listening to Victor’s commentary and [Ben’s] trying to explain what the impact is on ceding commission, contingent ceding commission, underwriting expense ratio, change in quota share, I look forward to the day where I basically can cross that part out of that presentation. I hope that is responsive to what you were looking for.

[Paul Newsome:]

Absolutely, thank you very much. [Operator Instructions] The next question comes from Ken Billingsley of Compass Point. Please go ahead.

[Ken Billingsley:]

Good morning. Just wanted to verify you said that your statutory underwriting leverage target is 1.5 times, correct?

[Barry Goldstein:]

Generally that is true. The problem we have had it is easy to say that number, but we have to draw estimators to what we are actually going to write on a going forward basis, and now with the prospect of expanding our writings elsewhere in New York, as well as some type of roll-out in one, two, three or four more states over the treaty term it is a big guess. And in the past I have been ultraconservative. I think if you were to look our current trailing 12 months net leverage ratio is about 1.2 to 1. So we are not taking on as much risk as we can because of the conservative estimate I put in place last July. I am not saying I want to undo that because I can, but I’m going to be very – I will be a little less weary of taking a shot with our writings let us say.

[Ken Billingsley:]

And it doesn’t sound like the 1.5 is necessarily a ceiling, how much higher can you take that maybe temporarily if opportunities presented themselves?

[Barry Goldstein:]

If we went up to 1.7, 1.8 I wouldn’t be uncomfortable. I just find it is easier to gravitate towards a few core amounts, a few core metrics, and explain the way we conduct the business with our company around it. And maybe you will pardon me for sounding repetitive in these calls, but I know I can’t simply say the same few things. We only sell through independent agents. We try to be conservative, and we honor the way we do business over a long history, and I intend to someday although not anytime soon pass the baton onto a successor. So I want to leave it in a better position than I got it and gravitating around these few measures helps me to explain that.

[Ken Billingsley:]

Your delivery product, can you maybe discuss why – what makes your product attractive, considering is this property damage, is it because they are not required to have anything else with – and I’m speaking specifically to the Uber and Lyft purchasers, but why are they purchasing your product when I would imagine that they may need some additional liability coverage as well?

[Barry Goldstein:]

Well, they do need the liability coverage. Under New York rules and TLC regulations, there is a heightened amount of coverage that is required of a livery car owner in New York as compared to many other places. The question though is in addition to that liability coverage, who needs the physical damage coverage, where do they get it from and why are you guys doing so much of it. And I think it starts with the fact that we have an entrenched network of producers we have worked with on this line and other lines for many, many years. There are only a handful of livery liability writers who are operating in the New York Metropolitan area, and only a small number of those even offer the physical damage coverage. So when Uber requires drivers to have relatively new cars, where limousine bases trying to keep up with Uber are requiring their drivers to have new vehicles. Most of those vehicles or many of those vehicles I would say have a financing against them, where the lender or lessor requires physical damage coverage be put in place. So we have been the beneficiary of this new car surge, mostly triggered by Uber. There is nothing magical about our product. I think if there is any one thing I would point to apart from market conditions it is our ability to turn around claims faster than anybody in the area. We have got the experience. We have got the know-how. We have got the personnel. The drivers know that if they have a Kingstone policy and they get into a fender bender that car will get back on the road faster than any other carrier could do it, and we are very proud of that. I don’t like to say it too loudly to my claims department for they will ask for a little extra compensation.

[Ken Billingsley:]

Okay. what keeps the liability riders from writing the physical damage, especially if you are making money on it, they already have a captive audience right in the liability side, is there anything that keeps them from offering the product and packaging it up?

[Barry Goldstein:]

I think going back to the claim servicing I just said, we do a better job than they did when they wrote it. They are also kind of capital constrained as the growth of the number of cars on the road has surged. The amount of cover that they have to provide has gone up and the capitalization is limited. So by focusing more of their surplus towards handling the liability portion of the business that leaves the physical damage for us.

[Ken Billingsley:]

Just one more question, the adverse development in the quarter, can you just say, I don’t recall if you said where that was from and what years?

[Barry Goldstein:]

I think there was two points and I will let Ben chime in. first we had a 1% adverse development in the quarter, which was about a third of what we experienced last year. That 1% came almost entirely from fourth quarter late December claims that matured and were developed during the first quarter. So this is a normal occurrence I think for virtually all P&C carriers that you will see some development on fourth quarter amounts. Let me let Ben maybe give a little bit more to that.

[Ben Walden:]

Sure the development we saw in the quarter was really related to four larger claims. Three of those were from [actually] year 2014, so as Barry was saying we strengthened our reserves for that year a little bit just to be a little more conservative. We had some timing issues with those large claims getting reported just after year-end. So technically it is prior year development, but we increased the 2014 year a little bit, and in terms of lines of business it was coming from commercial lines and we had one commercial auto claim reported in December that caused us to increase our reserve for that year slightly.

[Barry Goldstein:]

Yes I think the takeaway though Ken is that we spent a lot of time and devoted a lot of effort towards strengthening our reserves over the past, I guess year and half that Ben has joined us [indiscernible] earlier today about the increase in our salaries and wages and the vast amount of the increase is attributable to our building, our claims department. We hired many more people. We didn’t do as good a job handling the claims and reserving for the claims as we did boarding the business on our books and we were very good in bringing the business in, but recording and servicing and analyzing claims, we were weak. I think we have solved that issue. I feel very comfortable in saying that we’re very proud that the adverse development in the first quarter was about 1% and we look forward to a nominal of any contribution from prior years to our loss ratio for the rest of 2015.

[Ken Billingsley:]

I guess there’s two other questions. I believe this one might be for Victor. I believe you said that the expense ratio was higher due to some accounting changes and the way you’re recording it and that it won’t repeat through the remainder of 2015, first of all, if I have that correct, then the next part is how much was that of an impact on the expense ratio this quarter?

[Victor Brodsky:]

It was about a 0.5% on the expense ratio. It was mostly due to the cost of 2014 audit and the actuary services but all those services rendered in the first quarter 2015 and once that’s over we just have just some nominal professional fees throughout the rest of the year and the actuary services really won’t begin again until next January, February.

[Barry Goldstein:]

It’s very much a timing difference Ken. We’re taking up a lot of professional fee [indiscernible] in Q1, but versus the prior year and a much lesser amount in Q2, Q3 and Q4.

[Ken Billingsley:]

And so I know that 0.5%if it really is the audit fee, it’s not necessarily related to the actual increase to change the way you did it or is it just strictly audit fees that we’ll see in 2015?

[Victor Brodsky:]

It’s the timing of it.

[Ken Billingsley:]

All right.

[Victor Brodsky:]

[Indiscernible] much, it’s just -- it was [indiscernible] during the first quarter because that’s when the services are rendered.

[Ken Billingsley:]

I understand, so there’s not -- it’s not – that won’t reoccur, it was just the timing I misread that then. And then the last question I have and this is probably maybe for you Barry is, so you talked about the four states and maybe this is my word not yours, but a delay in getting the approval, but is there been a delay in getting the approvals or is there anything that’s holding it up?

[Barry Goldstein:]

There’s nothing that’s holding it up. I guess this is kind of like that’s okay for government work type of stuff, but here’s really -- it’s out of our hands, we haven’t been confronted with any issues, there’s nothing that I’m aware of that made it slower. We’d like to see it happen, we’d like to see it happen tomorrow, but there’s really not much we can do. I’m not going to be visiting someone’s office and shaking them up. Let them do their work. We’ve been around since 1886, so we got plenty of time in front of us to get this.

[Operator:]

[Operator Instructions] The next question comes from Brad Nelson, a Private Investor. Please go ahead.

[Brad Nelson:]

Just one quick question, should we expect a smaller effect due to the severe winter storms on the June quarter?

[Barry Goldstein:]

Yes we have factored in ID&R for the remaining claims we expect to get in second quarter, so right now we don’t anticipate any future developments on the winter losses in future quarters.

[Operator:]

There are no further questions at this time. I would like to turn the floor back over to management for closing comments.

[Barry Goldstein:]

Okay great and it’s of course my pleasure to host calls like this. And I look forward to speaking with you all again. I will be sending out a release as soon as we have the final details with respect to our reinsurance placements. I’ll be heading to Bermuda to start it next month and maybe get a little sun at my face at the same time after this long winter, but as soon as I’ve got the information available, I’ll get it out to everybody. Again thanks very much for your time and talk to you soon.

[Operator:]

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