Market volatility has been high for months now. With rising inflation and interest rates, investors are operating in an economic environment not seen for 40 years.
The prudent investing path to follow in such a situation is to seek out solid companies that can withstand inflationary pressures. One company that could perform well is Kinsale Capital Group (KNSL 3.42%). The company operates in the insurance industry -- which Berkshire Hathaway CEO and Chairman Warren Buffett loves -- and has displayed a strong history of measuring its risks to achieve stellar results.
Making money from hard-to-place risks
Kinsale Capital Group is a property and casualty (P&C) insurance company with a niche focus in the excess and surplus (E&S) insurance market. E&S insurance is a particular type of insurance for harder-to-place risks in the traditional insurance market.
Kinsale writes a range of insurance coverage, with its largest being in construction, small business, and excess casualty lines of coverage. One aspect that makes Kinsale attractive is its focus on serving the E&S insurance market only. The E&S market is growing at a faster pace than the broader P&C market, and it has been doing so for the last decade.
E&S policies can be attractive due to their lower loss ratios, leading to higher profit margins. Because these policies are on hard-to-place risks, many insurance companies choose not to pursue them. This provides an excellent opportunity for an insurer that can adequately measure risks in these unusual or high-risk situations -- which is where Kinsale thrives.
Kinsale is highly selective on policies it will accept
Kinsale capital receives hundreds of thousands of submissions for insurance annually. Last year, the company received 520,000 submissions and issued 347,000 quotes. Of these quotes, only 36,000 new policies were created, or 6.9% of total submissions. This intense scrutiny and aggressive pricing by Kinsale are why the company has such good risk management.
One way insurance companies measure their risk management is the combined ratio. The combined ratio is simply the losses plus expenses incurred by an insurer, divided by the total premiums earned. A ratio under 100% is ideal, as that means the company is writing profitable policies, and the lower the ratio the better. Since going public in 2016, Kinsale's combined ratio has averaged 82% compared to the P&C industry average of about 99%.
How Kinsale could benefit from inflation
In the first quarter, Kinsale saw its net earned premiums grow 45% from last year, while its combined ratio came in at a solid 79%. The company was boosted by the reopening of the economy and inflationary pressures, which resulted in higher premiums.
According to Kinsale's Chief Operating Officer Brian Haney, "The effects of the abrupt massive increase in money supply may take a longer time to work through the economy that many people had thought and will likely cause disruption and pain in the insurance industry, which will serve to prolong the hard market."
When Haney talks about a hard market, he's talking about the current phase of the insurance market. Insurance markets go through soft and hard market phases. In a soft market, insurers compete for business, and premium growth tends to be low. This type of environment would hurt an E&S insurer like Kinsale. In a hard market, insurers tighten underwriting standards, and premiums rise -- which can benefit Kinsale.
An expensive stock that's worth the price tag
Investors should be aware that Kinsale Capital sports a price-to-earnings ratio of 30. This is on the high end among insurance industry stocks but is a testament to the company's rapid growth and high margins.
Over the last five years, Kinsale has grown its underwriting income by over 31% compounded annually. It has done a stellar job of managing its risks in the niche E&S market, helping it deliver higher profit margins when compared with traditional P&C insurers. Over the last five years, Kinsale's average profit margin was 18.1%, ahead of Chubb's 13.6% and Progressive's 8.9%.
We are currently experiencing a hardened insurance market due to increased weather-related events, elevated claims from the pandemic, and inflationary pressures. This hard market should continue to be a tailwind for Kinsale -- making the company worthy of a spot in any investor's portfolio -- even at today's high valuation.