Durability of Kinsale’s growth

Can it grow at >20% over the next 3-5 years?

Jan 19, 2024

In this piece, I attempt to examine in more detail whether my initial 20% growth estimates are reasonable, which is in line with the longer-term guidance of 15-20% provided by Michael Kehoe (CEO).

At the end of this article, I will also share an updated valuation for new investors who are considering initiating a position at current prices $397.43 (18 Jan 2024) as the stock has traded up by 18.55% since the last post.

Lets jump in.

Can Kinsale grow at 20% moving forward?

Relative to the past 5 years, 20% growth is considered a huge slowdown in top line growth for Kinsale (vs 40% average). However, we have to keep in mind that this growth was only possible as it coincided during the ‘Golden Age’ of the E&S industry over the past 4-5 years, which has seen above-average growth at 15-20%/year.

During this period Kinsale has outperformed the industry’s growth by a factor of 2-3x and grew EPS by more than 6x from $1.6 in FY18 to as estimated $12 for FY23.

In my projections for top-line growth, I used (1) Total net written premiums in E&S industry x (2) Kinsale market share% to estimate.

Assumptions

E&S indsutry grows at 8% per year (slowdown from 16.8% 5Y CAGR)
Kinsale captures +0.15% of market share YoY (in line with past 5 years)

Under these 2 key assumptions, I came to an average of 23.3% over the next 4 years (see table below):

I believe these assumptions to be fair for a base case scenario or Kinsale and the E&S market.

Assumption 1:
E&S Industry – Is 8% growth per year fair outlook?

Property Lines: Much of the growth in the E&S market over the past few years can be attributed to huge price jumps in CAT-related property coverage both on commercial and personal lines as the sector struggled to meet capacity demands due to large standard insurers drastically reducing their limits allocated to CAT related events. State Farm General Insurance Co. announced at the end of May 23 that it stopped accepting new policy applications for property/casualty insurance in California quoting risks such as wildfires and inflation. The decision followed a similar move by Allstate Corp. last year.

This development has resulted in a record-breaking seller’s environment for E&S players like Kinsale who were the only ones who could fill the gap from the loss of large players in the property lines, namely California and Florida. Looking forward, the US property market will still be operating in a hard environment as the hole left by the departure of standard insurers especially in the CAT-exposed states cannot be adequately filled by the E&S market.
Casualty & General Liability: On the liability front, there has also been an increased demand for customised solutions, especially for new risks that aren’t readily available on the admitted market such as artificial intelligence (AI), biometrics, social inflation and cyber risk — particularly ransomware — and PFAS.

These risks are often too complex for standard P&C insurers to underwrite since they are regulated by the different states they operate in, which makes it a lengthy and hard process for them to adjust prices of their offered coverages dynamically to factor in the newer and more complex risks.

As specialty insurers like Kinsale are unregulated, they have full freedom of how they set prices and the type of coverage they are willing to underwrite. This adaptability gives them first mover advantage to a market where demand far exceeds what carriers can provide.

I believe 8% to be conservative enough if you factor in twin engine of growths:

(1) Near-to-mid term spillover from a $1 trillion P&C industry, increased proportion % of non-admitted vs admitted lines;
(2) Organic growth within the non-standard lines.

Assumption 2:
Can Kinsale grow its market share at +0.15%/year? (Competitive Advantages)

Unlike Hermes or Ferrari where people are willing to pay a huge premium to be associated/identified with those brands, consumers/clients for P&C coverage will almost always choose the lowest cost provider for an identical coverage.

Because the insurance product is commoditised, the durability of an insurance provider lies primarily in how it maintains its expense advantage. The leaner their cost structure, the more savings they can pass off in its pricing = more customers = higher market share.

While most of the E&S insurance providers have an expense ratio closer to 30-35%, Kinsale operates at the low 20%.

How does Kinsale keep expenses ratio low?

Technology → Revenue/Headcount, Volume = Quality of cases, Speed

Technology was one of the founding core competency during the inception of the company in 2014, with around 120 out of the 540 staff in the IT department purely focused on developing new features, functions and improving current processes through heavy automation. All of Kinsale’s software is built in house + having in-house tech support, which is contrary to other insurance companies that tend to outsource their tech requirements to tech consulting companies and use external vendors for their software needs that can often be legacy softwares that are 10 years outdated from what is possible today.

Revenue/Headcount: By using technology to prioritise submissions and prequalify accounts, Kinsale has shown to be far more efficient in how they operate vs the industry, as shown by how can handle over 600k new business submission with only 540 employees (Revenue/Headcount ratio). Of the 600k submissions, they are able to submit 400-450k, and bind 40-50k of the cases on top of 50k of renewal policies in a year. This is especially important when handling the small-mid sized market where the sheer volume of applications coming are often too much for smaller E&S players to meaningfully handle with a limited headcount and sub-optimal softwares.
Volume = Quality of Cases: By considering a larger pool of cases eg. 600k vs 50k, Kinsale is able to be more selective with the pricing for the same amount of risk taken as they are way less desperate to close a case as compared to a company that only responds to 50k business submissions per year. This shows up in a huge way over the long run, as evident through consistently better loss ratios and profitability.
Speed: Kinsale is able respond in a more timely manner, within 24 hours vs 1-2 weeks for their competitors, which allows them to often enjoy better pricing from the wholesale brokers who brings them the cases. As Kinsale helps them close a case fast through their responsiveness, it results in better bargaining terms with the brokers. Kinsale’s underwriting expense to wholesale brokers are 2-3% lower at 15% vs industry average of 17.5-18%, which goes a long way in a commoditised industry.

Operational efficiency

Centralised office location: Only one location offices location in Richmond Virginia with lower rental costs as compared with multiple office locations, paying high rent in New York etc.
Lower Rental Costs
No WFH: Leaders are made to lead by example and come to the office for work - not running their business out of their vacation home in Jackson Hole Wyoming or Florida and flying in private jets once a week. Sets the tone for all employees that they are in growth mode and everyone should take their job seriously. Moved all the people back in Oct 2022 to work from office to facilitate communication and improve team productivity, especially for handling claims, underwriting which is a collaborative process. Good training culture for all their new hires.
Lower business expenses, higher output/productivity

How does Kinsale’s loss ratio remain low?

Blue Ocean Strategy vs Red Ocean strategy: Kinsale focuses on smaller accounts <$15k within the E&S market as competition grows for larger accounts (>$100k) are usually more competitive, which often results in lower profitability margins for the risk taken on. As it is hard to build a meaningful book size off small accounts only so the larger players avoid it. This niche allows Kinsale to set more restrictive terms with many case by case exclusions and charge higher prices to protect themselves especially since they are operating within providing coverage to a risker class of customer segment within the P&C industry.
100% In-House underwriting: Most E&S insurers operate under the traditional model where underwriting is outsource to MGA/specialty brokers. Brokers are paid a sales commission % on the total $ of premiums written, not profitability of premiums written. This results in a misalignment of interest which might lead to unanticipated and worse loss ratio few years down the road. Kinsale has said that it will never outsource the underwriting aspect as they believe in controlling the accounts they take on and ensuring that they are paid a more than fair price for the risk they put in their books.
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I believe these factors of (1) speed, (2) technology, (3) operational efficiency, (4) 100% in-house underwriting and (5) focusing on the smaller clients to be the competitive advantages of Kinsale that has allowed it to grow at an accelerated pace relative to peers with best in industry combined ratio levels.

With higher profitability, I believe they will build up their financial position to stand strong in tough claims environment, and also share these savings with customers to capture market share gradually in a highly fragmented E&S space with over 180 players.

Closing Thoughts

The CEO has brought up that GEICO and Progressive are the role models for them in the private auto insurance space that they are trying to emulate within the E&S market. Since the 2000s GEICO and Progressive grown their market share by +0.4 - 0.5%~ per year from 5% to around 15% today.

This was achieved through their relentless efforts to be the low-cost provider option in the auto space and being consistent in keeping loss ratios low through good underwriting of risks. Kinsale has demonstrated signs of this, which gives me a lot of confidence that a quality specialty insurer like Kinsale can gain market share of +0.15% per year.

Currently, Kinsale’s is ranked 21, with slightly over 1% of market share. I believe Kinsale has an extended runway for continued growth in a growing E&S market.

Zooming out and looking 10 years ahead, if Kinsale does indeed manage to go from being a 1.2% -> 5% market share player, doing some napkin math:

$200b E&S market (7% CAGR industry growth~)
Net margins of 20% = $2b profits/year
FY23 EPS $12 to grow 6x to FY33 EPS $80~ (Outstanding shares 23.9m > 25m)

This works out to a 21% forward IRR over 10 years which is an amazing result that I am excited to see play out.

To put things into perspective, we can look at the returns of PGR 0.00%↑ and $BRK.B to give us a glimpse of what $KNSL could replicate if it executes well. Time will tell if $KNSL can be a 7x bagger in 10 years out.

That being said, I am wary that the extended “Golden Age” of double digit growth and high profitability will not remain for an indefinite period of time. E&S specialty insurers have been fortunate to enjoy a period where standard P&C players have been cutting back on their exposure in various categories, allowing speciality insurers to operate in an environment of excess customer demand with a lack of supply. Should standard insurers start to be more risk seeking, especially in a lower interest rate environment where risk capital flows back into the harder to place risks, we could see top-line challenge as the market softens.

Until then…… make hay while the sun is shining.

I will continue to watch Kinsale’s progress, especially on its (1) Combined ratio vs competitors and (2) Market share %. As long as the business performs well on both ends, I am happy to let compounding do its magic.

Valuation (Updated)

Based on my earlier assumptions for industry growth of 8% per year and market share growth of +0.15% per year, my base case is 23.3% revenue growth over the next 3-5 years.
I have lowered net income margin down from 24.68% to 20% to add some buffer in case loss claims come up in the coming few years.
EPS is expected to grow from FY23 $12 to $22 by FY27, or a CAGR of 20.8%/year
P/E under base case is assumed to be 32x vs 34x as of today’s price

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