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Kinsale Capital Group, Inc. (NASDAQ:KNSL)
Q3 2019 Earnings Call
Nov 1, 2019, 9:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Before we get started, let me remind everyone that through the course of the teleconference, Kinsale's management may make comments that reflect their intentions, beliefs and expectations for the future. As always, these forward-looking statements are subject to certain risk factors, which could cause actual results to differ materially.

These risk factors are listed in the Company's various SEC filings, including the 2018 Annual Report on Form 10-K, which should be reviewed carefully. The Company has furnished a Form 8-K with the Securities and Exchange Commission that contains the press release announcing its third quarter results.

Kinsale's management may also reference certain non-GAAP financial measures in the call today. A reconciliation of GAAP to these measures can be found in the press release, which is available at the Company's website at www.kinsalecapitalgroup.com.

I will now turn the conference over to Kinsale's President and CEO, Mr. Michael Kehoe. Please go ahead, sir.

Michael P. Kehoe -- Chief Executive Officer and President

Thank you, operator, and good morning, everyone. Joining me today are Bryan Petrucelli, Kinsale's CFO; and Brian Haney, Kinsale's Chief Operating Officer.

We're going to follow a similar format today that we've had on our prior conference calls. I'll begin with some quick introductory comments and then Bryan Petrucelli will review our financial results, followed by Brian Haney who will discuss Kinsale's underwriting results and provide some market commentary. And then we're going to follow up with any questions.

As a reminder, Kinsale combines disciplined underwriting and claim handling with technology-enabled low costs to deliver attractive returns and growth. We focus on smaller and sometimes hard-to-place accounts within the excess and surplus lines market. And unlike competitors, excuse me, we maintain absolute control over the underwriting and the claim management process and we do not outsource those functions to external parties. We use proprietary technology and automation to operate at a significant expense advantage over many larger competitors. And this combination of disciplined underwriting and low costs is a winner every time.

The third quarter saw a continuation of Kinsale's profitability and growth from the first half of the year. The combined ratio for the quarter was 86.9%. Through nine months, the annualized operating return on equity was 15.9%. These numbers are consistent with our forward guidance of a mid-teens return on equity and a mid-80s combined ratio. Premium growth for the quarter, 40.9%, was up from 36% in the second quarter and 32% in the first. The growth we experienced in the third quarter was driven by Kinsale's business strategy combined with a trading environment that is not only favorable, but improving.

As we've discussed on prior calls, this improving trading environment is driven by dislocation within the broad P&C market and that includes both standard lines and E&S companies, wherein companies are reducing capacity, withdrawing from certain lines of business, canceling some delegated programs, and generally becoming more discriminating about risk in their underwriting process.

And now I'm going to turn the call over to Bryan Petrucelli for the financial report.

Bryan P. Petrucelli -- Senior Vice President and Chief Financial Officer

Thanks, Mike. Kinsale had another strong quarter and we are encouraged by the premium growth and improved market conditions. We reported net income of $13 million for the third quarter of 2019, an increase of 9% when compared to $11.9 million for the third quarter of 2018, and due primarily to growth in the business. Net operating earnings increased by 20% to $12.6 million, compared to $10.6 million in the third quarter of last year.

The Company's generating underwriting income of $9.5 million and a combined ratio of 86.9%, compared to $8.4 million and 84.6% last year. Cat activity contributed 1.2 points to the third quarter 2019's combined ratio, and was less than 1 point last year. The combined ratio for the third quarter of 2019 included 0.7 points from net favorable prior-year loss reserve development, compared to 4 points from net favorable prior-year loss reserve development last year, and was lower largely as a result of lengthening of actuarial loss development factors in an effort to add a modest amount of conservatism to our IBNR reserves for certain prior accident years.

Our effective income tax rate was 16.6% for the first nine months of 2019, compared to 17.1% last year and lower due to the tax benefits from the exercise of a larger amount of stock options this year. Annualized operating return on equity was 15.9% for the first nine months of this year and in line with our mid-teens guidance.

Gross written premiums of $97.9 million, represented a 41% increase over last year. And as Mike mentioned, growth continues to be generated from an increased submission flow from our brokers and firmer pricing driven by market dislocation. Brian Haney will get into this a little more detail here shortly.

On the investment side, net investment income increased by 29% or so over the third quarter 2018 to $5.3 million from $4 million last year as a result of continued growth in the investment portfolio. Annualized gross investment returns increased to 3.1% from 2.9% for the first half of the year. Diluted operating EPS was $0.58 [Phonetic] per share for the third quarter of 2019, compared to $0.55 per share last year, and $1.77 for the first nine months of 2019, compared to $1.32 last year.

With that, I'll pass it over to Brian Haney.

Brian D. Haney -- Senior Vice President and Chief Operating Officer

Thanks, Bryan. As mentioned earlier, premium grew 41% in the third quarter. Our commercial property business grew significantly, driven by a surge in submissions, significant rate increases and a focus on improving internal processes to get to more of the submissions as quickly as humanly possible. We're also seeing strong growth in our management liability, product liability and environmental divisions, but the growth is widespread across many different divisions and classes of business.

Our Aspera's units were up 40% for the quarter, in line with the rest of the Company. Submission growth was 35% for the third quarter. We continue to see substantial across the board increases in submission volume in most divisions. We feel we are doing well to keep up our service levels, but some areas are seeing inflows of submissions of such magnitude and servicing them all becomes a challenge at times.

We are becoming more and more assertive in seeking rate increases. As a reminder, we have a very heterogeneous book of business which complicates reducing all the rate movement to a single number, but that all being said, we see rates up being in the plus 8% to plus 10% range in the aggregate. We are seeing higher rate increases for property business and lower increases for professional lines. At this point, the rate increases are starting to contribute materially to the premium growth. I did want to address the topic of social inflation, which several other insurers have commented on recently.

With the book as relatively small as ours and with as diverse a book of business as we have, it is not always easy for us to discern certain changes in trends using only our own data. We tend to rely on publicly available third-party information when developing our views on loss trends. So while we haven't seen anything in our own data that would suggest a significant uptick in social inflation, we have been revisiting the available third-party data and have been revising some of the trend assumptions used in our pricing models where appropriate.

It is worth keeping in mind that we write very little commercial auto, we write mostly $1 million limits or lower and focus on smaller accounts. All three of those facts, we feel would make us less exposed to any social inflation the industry has seen.

Lastly, and as a reminder, while the market has definitively moved in our favor recently in terms of pricing and market opportunity and while we are growing at a very strong rate at the moment, investors should not expect that this extraordinary growth rate will continue forever. We don't know how long it will last, but the market moves in cycles and at some point in the future, we expect to see a return to more normal growth rate.

Bryan P. Petrucelli -- Senior Vice President and Chief Financial Officer

Yeah, this is Bryan Petrucelli. Just to clarify one thing, diluted operating EPS was $0.50 per share for the quarter -- $0.57 per share for the quarter, it was $0.58 just on a diluted earnings per share basis.

Michael P. Kehoe -- Chief Executive Officer and President

And operator, we're now ready for any questions.

Questions and Answers:

Operator

[Operator Instructions] Your first question comes from the line of Mark Hughes with SunTrust.

Michael P. Kehoe -- Chief Executive Officer and President

Good morning, Mark.

Mark Hughes -- SunTrust -- Analyst

Yeah. Thank you. Good morning. Just to clarify, you say the lengthened reserve development is not something you're seeing in your own data, but rather the third-party data is motivating you to make the change?

Michael P. Kehoe -- Chief Executive Officer and President

No. Brian was talking about some of the commentary we've seen on other company's conference calls or earnings releases where they're talking about social inflation impacting their financial results. And so we're -- we just wanted to -- we anticipated a question, and we're just trying to get ahead of that. You know...

Mark Hughes -- SunTrust -- Analyst

So that -- when we look at the 70 basis points of favorable development versus what 4 points last year, just to clarify is that based on your book of business or is that -- are you saying that that's -- just taking a more conservative approach based on what you're seeing across the industry?

Bryan P. Petrucelli -- Senior Vice President and Chief Financial Officer

Right. So if you're talking about our quarterly results, yes. I would say in terms of the amount of favorable development that was impacted by our reserve position. I think we talked about on our last conference call three months ago that we had lengthened our reporting patterns, which has the effect of slowing down the release of IBNR, injecting a little bit more conservatism into our reserve position. And then a lot of it was just loss activity in the quarter. No trends of any concern, but just the normal loss variability that you get in a 90-day period of time.

Mark Hughes -- SunTrust -- Analyst

And then on the investment income, is there anything that was non-recurring, anything unusual would bump that up, that wouldn't be recurring next quarter?

Bryan P. Petrucelli -- Senior Vice President and Chief Financial Officer

No, Mark.

Michael P. Kehoe -- Chief Executive Officer and President

It's mostly just -- it's the assets growing with the book of business.

Mark Hughes -- SunTrust -- Analyst

Understand. Thank you.

Michael P. Kehoe -- Chief Executive Officer and President

Thanks, Mark.

Operator

Your next question comes from the line of Rowland Mayor with RBC Capital Markets.

Rowland Mayor -- RBC Capital Markets -- Analyst

Hi, good morning. Sticking on the investments, the portfolio duration got a bit longer in the quarter and it looked like the new money from the capital is on a fixed income as opposed to equity. So I was wondering if there was a change in thinking there? Or how we should think about that going forward?

Bryan P. Petrucelli -- Senior Vice President and Chief Financial Officer

No, there is no change. I think we're -- on the equity side, we're just legging into the market over time. But I think our allocation is pretty steady here recently.

Rowland Mayor -- RBC Capital Markets -- Analyst

Okay. Got it. And then you mentioned the new headquarter construction in the press release. I was wondering if there is a timeline on that [Indecipherable] incorporate any additional operating expenses of the project?

Michael P. Kehoe -- Chief Executive Officer and President

The timeline -- the building is under construction today. We expect to occupy half the building in September of 2020. And then we expect to lease out the balance of that building to other tenants. So that's the general timeline.

Rowland Mayor -- RBC Capital Markets -- Analyst

Got it. Yeah, those were my only two real questions. Thank you.

Michael P. Kehoe -- Chief Executive Officer and President

Okay.

Operator

[Operator Instructions] At this time, there are currently no further questions in the queue.

Michael P. Kehoe -- Chief Executive Officer and President

Okay. Well, I just want to thank everybody for participating, and we look forward to speaking with you again here in another three months. Have a good day.

Operator

[Operator Closing Remarks].

Duration: 14 minutes

Call participants:

Michael P. Kehoe -- Chief Executive Officer and President

Bryan P. Petrucelli -- Senior Vice President and Chief Financial Officer

Brian D. Haney -- Senior Vice President and Chief Operating Officer

Mark Hughes -- SunTrust -- Analyst

Rowland Mayor -- RBC Capital Markets -- Analyst

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