Kinsale Capital: Underwriting Excellence In E&S (NYSE:KNSL)
Kinsale Capital Group (NYSE:KNSL) is a rapidly growing specialty insurer focused exclusively on the Excess & Surplus (E&S) market in the United States. The company’s disciplined underwriting approach, facilitated by its proprietary technology platform, coupled with a focus on small, hard-to-place risks, has resulted in industry-leading combined ratios and returns on equity.
Following a recent selloff, we think KNSL currently trades at an attractive valuation relative to its strong fundamentals and growth prospects. Moreover, we believe the company is well-positioned to continue gaining market share in the high growth E&S market.
As such, we’re initiating coverage on KNSL with a Buy rating.
Company & Industry Overview
Founded in 2009 by current Chairman and CEO Michael Kehoe, Kinsale is a specialty insurance company focused exclusively on E&S insurance. The E&S market serves clients with complex or unique risks that standard insurance carriers are unwilling or unable to underwrite. For example, the list below includes examples of what Kinsale can insure within their Entertainment category.
KNSL benefits from the fact that the E&S market has grown significantly faster than the overall property and casualty insurance industry in recent years, and is expected to continue growing at a rapid clip for years to come. According to a study by McKinsey, the E&S market grew by three times as much as the admitted market (where pricing is subject to greater regulation and where risk is easier to underwrite, like auto, home, life insurance, etc.) between 2016 and 2021.
According to S&P Global, the E&S market grew by 20% in 2022, reaching $75.5 billion in premiums, as shown in the chart below.
Looking ahead, Allied Market Research forecasts the E&S market to grow at a compound annual growth rate (CAGR) of more than 15% from 2020 through 2027.
A number of factors are driving the growth of the E&S market. Capacity constraints in the admitted market, particularly for property catastrophe risks, have pushed more business into the E&S space. Additionally, rising claim costs due to weather events, social inflation (increased litigation costs), and supply chain disruptions have also led admitted carriers to reduce their appetite for certain risks. The increased prevalence of more complicated risks, like cybersecurity, has also increased demand for the specialized products offered by E&S insurers.
Overall, the E&S market is benefiting from its ability to adapt and meet the needs of insureds in an evolving and increasingly complicated risk environment.
With respect to KNSL, the company is divided into two segments: Commercial and Personal. The Commercial segment offers a variety of coverages including Commercial Property, Excess Casualty, General Casualty, Energy, Professional Liability, and Management Liability. The Personal segment consists of personal and property coverage, primarily for high-net-worth individuals.
As outlined in the chart below, KNSL has consistently grown its market share within the attractive E&S market.
As we discuss later, we think KNSL is poised to continue taking share and benefiting from attractive long-term growth tailwinds in the E&S market.
Recent News
On April 26, 2024, Kinsale reported strong Q1 2024 results. Here were the highlights:
- Gross written premiums increased 25.5% YoY to $448.6 million
- Net investment income increased 59.1% YoY to $32.9 million
- Diluted EPS increased 76.7% YoY to $4.24
- Combined ratio of 79.5%, with a 58.8% loss ratio and a 20.7% expense ratio for Q1 2024
- Annualized operating return on equity of 28.9% for Q1 2024
Despite these impressive results, KNSL’s share price declined by more than -20% in the days following the earnings release. We think the share price pressure was likely driven by concerns around a potential slowdown in the E&S market. On the Q1 2024 earnings call, management noted that growth in gross written premiums decelerated from 33.8% in Q4 2023 to 25.5% in Q1 2024, primarily driven by a return to more normal levels of competition in the property market following the dislocation seen in 2022 and early 2023.
Despite this short-term slowdown, we’re encouraged that management remains optimistic about the E&S market, highlighting that the casualty market is steady to slightly improving and noting continued strong submission growth (which management views a leading indicator of growth) in the low 20% range. Management also highlighted higher interest rates, inflation, and the potential for increased adverse reserve development among competitors as factors that could support further growth in E&S going forward.
In our view, the recent deceleration in growth of gross written premiums appears to be largely driven by one segment (property) and doesn’t reflect any deterioration in KNSL’s overall competitive positioning or underwriting discipline.
Importantly, KNSL exhibits industry-leading combined ratios and returns on equity, as outlined in the charts below.
With all this in mind, we view the recent pullback in KNSL as a buying opportunity. We think the company’s underlying fundamentals remain strong, and we believe KNSL is well-positioned to continue gaining share in the attractive E&S market.
KNSL: A Competitively Advantaged E&S Insurer
So what makes KNSL special?
We think KNSL has several key competitive advantages which have enabled the business’ significant growth while supporting best-in-class combined ratios and returns on equity.
The company differentiates itself by focusing exclusively on small, complex risks that are often overlooked or too complex for larger, less specialized insurers to underwrite. We think KNSL’s focus on this niche has allowed the company to develop deep expertise in underwriting and pricing E&S lines, resulting in the company’s superior risk and profitability profile. Additionally, KNSL manages all of its claims in-house, as opposed to delegating claims authority to third parties, which the company believes (and we agree) results in more favorably outcomes and a higher degree of reserve accuracy, supporting the company’s superior profitability and returns on equity.
KNSL’s proprietary technology platform, described in the slide below, is another key competitive advantage. The platform was built from the ground up by KNSL’s management team (so it’s relatively new since the company was founded in 2009), leveraging their experience in the E&S market to create a tech stack tailored to support the company’s unique business model.
The platform integrates all aspects of the underwriting process, from submission intake to policy issuance, and includes a data warehouse that systematically collects and analyzes a wide array of statistical data. This data-driven approach allows the company to make faster, more informed underwriting decisions while operating with a lower expense ratio than its peers.
The company’s experienced management team is another key competitive advantage. The team has extensive experience in the E&S market, with a track record of successfully building and growing specialty insurance businesses. Before founding KNSL, Kehoe was the President and CEO of James River Insurance Company (JRVR) from 2002 to 2008. And prior to joining KNSL, President and COO Brian Haney was JRVR’s Chief Actuary Officer from 2002 to 2009.
In our view, the experience of KNSL’s senior management team, including Kehoe and Haney’s six years working together to lead JRVR prior to founding KNSL in 2009, has been instrumental to Kinsale’s success. We think management has created a culture at KNSL grounded in an approach to underwriting that is both disciplined and customer-centric. And we think this shows up in the numbers.
By leveraging its focus on small, complex risks, coupled with its proprietary technology platform, experienced management team, and disciplined underwriting approach, KNSL has consistently outperformed its peers in terms of growth, profitability, and returns on equity.
We think these sustainable competitive advantages, combined with the favorable tailwinds driving the expansion of the E&S market, will enable KNSL to continue delivering superior results and creating long-term value for shareholders.
Valuation
At its current price, KNSL trades at an approximately 25x NTM P/E multiple. While this may appear optically expensive on an absolute basis, we believe it’s justified given KNSL’s strong fundamentals. Relative to its historical valuation, KNSL looks more attractive – with its NTM P/E multiple currently hovering below -1 standard deviation from its three-year average, and its LTM P/B multiple just above -1 standard deviation from its respective three-year average.
The company has grown total revenue at a 10-year CAGR of almost 40%, and has maintained a sub-80% combined ratio in each of the last three years, as outlined in the charts below.
Looking at the chart below, which shows KNSL’s valuation relative to peers, the stock might also look expensive on a comparables basis at first glance.
However, it’s important to contextualize these numbers. While KNSL has compounded operating revenue at near-40% clip over the last 10 years, its competitors have grown at around a mid-to-high-single-digit rate over the same period.
We think KNSL’s premium multiple relative to peers is more than justified given its far superior growth rate.
Using what we think are fairly conservative assumptions, KNSL currently trades at forward 5-year IRR north of our 15% hurdle. We assume annual revenue and EBITDA growth of 20% and 25%, respectively, through 2028. We also assume some dilution, and we don’t factor in any multiple expansion from current levels. With these assumptions, outlined in the table below, we think KNSL’s share price can more than double over the next 5 years, generating a 5-year IRR of 17.7% over the period.
Risks
While we believe KNSL is a competitively advantaged business currently trading at an attractive valuation, there are several risks to our investment thesis worth noting.
We recognize that increased competition in the E&S market could lead to pricing pressure and slower growth. However, we believe KNSL’s specialized focus, proprietary technology platform, experienced management team, and disciplined underwriting approach create a strong moat for the business that should help mitigate this risk. And in an effort to bake in some conservatism, the growth assumptions we use in our projected 5-year IRR for KNSL assume a 50% haircut to KNSL’s 5-year revenue and EBITDA CAGRs.
However, given Kinsale’s focus on complex, hard-to-place risks, the company is exposed to greater underwriting risk relative to insurers operating in more standardized lines. However, we think the company has a strong track record of conservative reserving practices – resulting in an industry-leading combined ratio over the last three years – which helps mitigate this risk. Given the complexity of the risks KNSL insures, a continued adherence to the company’s historically disciplined underwriting approach is critical to our investment thesis.
Additionally, KNSL’s reliance on wholesale brokers, with its top three brokers accounting for approximately 50% of gross written premiums in 2023, creates supplier concentration risk and could negatively impact our investment thesis if any of these key relationships deteriorate. However, we think KNSL’s strong reputation for service, speed, and reliability mitigates this risk.
While we believe KNSL’s current valuation is attractive relative to its growth prospects and competitive advantages, we also recognize that the stock trades at a premium to most of its peers in the E&S space. If KNSL’s growth slowed materially, the stock could experience significant multiple compression. That said, we still see a path to attractive returns for shareholders even if KNSL’s growth over the next 5 years ends up being 50% lower than its average over the last 5 years. So we think we have a sufficient margin of safety at the stock’s current valuation.
KNSL Earns Our Buy Rating
In short, we think KNSL presents an attractive opportunity to own a best-in-class insurer in the fast-growing E&S market.
The company’s specialized focus, proprietary technology, experienced management, and disciplined underwriting have driven industry-leading growth, profitability, and returns.
Despite the risks we outlined above, we think KNSL’s strong competitive advantages and attractive valuation following a recent selloff present a compelling buying opportunity.
We will continue to monitor the business for any changes to our investment thesis, but everything we’ve seen thus far suggests KNSL meets our high bar and is well-deserving of our Buy rating.