The discussion and analysis below include certain forward-looking statements that are subject to risks, uncertainties and other factors described in "Risk Factors" in this Quarterly Report on Form 10-Q and in the Annual Report on Form 10-K for the year endedDecember 31, 2022 . Our actual results could differ materially from those anticipated in these forward-looking statements as a result of many factors. The results of operations for the three months endedMarch 31, 2023 are not necessarily indicative of the results that may be expected for the full year endedDecember 31, 2023 , or for any other future period. The following discussion should be read in conjunction with the unaudited condensed consolidated financial statements and the notes thereto included in Part I, Item 1 of this Quarterly Report, and in conjunction with our audited consolidated financial statements and the notes thereto included in the Annual Report on Form 10-K for the year endedDecember 31, 2022 .
References to the "Company," "Kinsale," "we," "us," and "our" are to
Overview
Founded in 2009, Kinsale is a specialty insurance company. Kinsale focuses exclusively on the excess and surplus lines ("E&S") market in theU.S. , where we use our underwriting expertise to write coverages for hard-to-place small business risks and personal lines risks. We market these insurance products in all 50 states, theDistrict of Columbia , theCommonwealth of Puerto Rico and theU.S. Virgin Islands , primarily through a network of independent insurance brokers. We have one reportable segment, ourExcess and Surplus Lines Insurance segment, which offers property and casualty ("P&C") insurance products through the E&S market. For the first three months of 2023, the percentage breakdown of our gross written premiums was 70% casualty and 30% property. Our commercial underwriting divisions include commercial property, excess casualty, small business casualty, construction, general casualty, allied health, products liability, professional liability, life sciences, energy, small property, entertainment, management liability, environmental, health care, inland marine, public entity, commercial auto, aviation, ocean marine and product recall. We also write a small amount of homeowners insurance in the personal lines market, which in aggregate represented 2% of our gross written premiums in the first three months of 2023 and is included within our personal insurance division.
Components of Our Results of Operations
Gross written premiums
Gross written premiums are the amounts received or to be received for insurance policies written or assumed by us during a specific period of time without reduction for policy acquisition costs, reinsurance costs or other deductions. The volume of our gross written premiums in any given period is generally influenced by:
•New business submissions;
•Conversion of new business submissions into policies;
•Renewals of existing policies; and
•Average size and premium rate of bound policies.
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We earn insurance premiums on a pro rata basis over the term of the policy. Our insurance policies generally have a term of one year. Net earned premiums represent the earned portion of our gross written premiums, less that portion of our gross written premiums that is ceded to third-party reinsurers under our reinsurance agreements. Ceded written premiums Ceded written premiums are the amount of gross written premiums ceded to reinsurers. We enter into reinsurance contracts to limit our exposure to potential large losses. Ceded written premiums are earned over the reinsurance contract period in proportion to the period of risk covered. The volume of our ceded written premiums is impacted by the level of our gross written premiums, any decision we make to increase or decrease retention levels and reinstatement premiums, if any.
Losses and loss adjustment expenses
Losses and loss adjustment expenses are a function of the amount and type of insurance contracts we write and the loss experience associated with the underlying coverage. In general, our losses and loss adjustment expenses are affected by:
•Frequency of claims associated with the particular types of insurance contracts that we write;
•Trends in the average size of losses incurred on a particular type of business;
•Mix of business written by us;
•Changes in the legal or regulatory environment related to the business we write;
•Trends in legal defense costs;
•Wage inflation
•Social inflation;
•Inflation in material costs, and
•Inflation in medical costs.
Losses and loss adjustment expenses are based on an actuarial analysis of the estimated losses, including losses incurred during the period and changes in estimates from prior periods. Losses and loss adjustment expenses may be paid out over a period of years.
Underwriting, acquisition and insurance expenses
Underwriting, acquisition and insurance expenses include policy acquisition costs and other underwriting expenses. Policy acquisition costs are principally comprised of the commissions we pay our brokers, net of ceding commissions we receive on business ceded under certain reinsurance contracts. Policy acquisition costs also include underwriting expenses that are directly related to the successful acquisition of those policies which are deferred. The amortization of policy acquisition costs is charged to expense in proportion to premium earned over the policy life.
Other underwriting expenses represent the general and administrative expenses of our insurance business such as employment costs, telecommunication and technology costs, and legal and auditing fees.
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Net investment income
Net investment income is an important component of our results of operations. We earn investment income on our portfolio of cash and invested assets. Our cash and invested assets are primarily comprised of fixed-maturity securities, and may also include cash equivalents, equity securities and short-term investments. The principal factors that influence net investment income are the size of our investment portfolio and the yield on that portfolio. As measured by amortized cost (which excludes changes in fair value), the size of our investment portfolio is mainly a function of our invested equity capital combined with premiums we receive from our insureds less payments on policyholder claims. Net investment income also includes rental income and depreciation expense from our real estate investment property.
Change in fair value of equity securities
Change in fair value of equity securities represents the increase or decrease in the fair value of equity securities held during the period.
Net realized investment gains (losses)
Net realized investment gains (losses) are a function of the difference between the amount received by us on the sale of a security and the security's amortized cost. Income tax expense Currently, substantially all of our income tax expense relates to federal income taxes. Our insurance subsidiary,Kinsale Insurance Company , is not subject to income taxes in the states in which it operates; however, our non-insurance subsidiaries are subject to state income taxes, but have not generated any material taxable income to date. The amount of income tax expense or benefit recorded in future periods will depend on the jurisdictions in which we operate and the tax laws and regulations in effect.
Key metrics
We discuss certain key metrics, described below, which we believe provide useful information about our business and the operational factors underlying our financial performance.
Underwriting income is a non-GAAP financial measure. We define underwriting income as net income, excluding net investment income, net change in the fair value of equity securities, net realized investment gains and losses, change in allowance for credit losses on investments, interest expense, other income, other expenses and income tax expense. See "-Reconciliation of Non-GAAP Financial Measures" for a reconciliation of net income in accordance with GAAP to underwriting income. Net operating earnings is a non-GAAP financial measure. We define net operating earnings as net income excluding the net change in the fair value of equity securities, after taxes, net realized investment gains and losses, after taxes and change in allowance for credit losses on investments, after taxes. See "-Reconciliation of Non-GAAP Financial Measures" for a reconciliation of net income in accordance with GAAP to net operating earnings.
Loss ratio, expressed as a percentage, is the ratio of losses and loss adjustment expenses to net earned premiums.
Expense ratio, expressed as a percentage, is the ratio of underwriting, acquisition and insurance expenses to net earned premiums.
Combined ratio is the sum of the loss ratio and the expense ratio. A combined ratio under 100% indicates an underwriting profit. A combined ratio over 100% indicates an underwriting loss. 28
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Return on equity is net income expressed on an annualized basis as a percentage of average beginning and ending total stockholders' equity during the period.
Operating return on equity is a non-GAAP financial measure. We define operating return on equity as net operating earnings expressed on an annualized basis as a percentage of average beginning and ending total stockholders' equity during the period. See "-Reconciliation of Non-GAAP Financial Measures" for a reconciliation of net income in accordance with GAAP to net operating earnings.
Net retention ratio is the ratio of net written premiums to gross written premiums.
Gross investment return is investment income from fixed-maturity and equity securities (and short-term investments, if any), before any deductions for fees and expenses, expressed as a percentage of the average beginning and ending book values of those investments during the period. 29
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Results of Operations
Three months ended
The following table summarizes our results of operations for the three months
ended
Three Months Ended March 31, ($ in thousands) 2023 2022 Change % Change Gross written premiums$ 357,588 $ 245,513 $ 112,075 45.6 % Ceded written premiums (58,558) (29,015) (29,543) 101.8 % Net written premiums$ 299,030 $ 216,498 $ 82,532 38.1 % Net earned premiums$ 237,158 $ 178,562 $ 58,596 32.8 % Losses and loss adjustment expenses 139,034 102,505 36,529 35.6 % Underwriting, acquisition and insurance expenses 46,545 38,545 8,000 20.8 % Underwriting income (1) 51,579 37,512 14,067 37.5 % Net investment income 20,695 9,088 11,607 127.7 % Change in fair value of equity securities 3,518 (7,751) 11,269 NM Net realized investment (losses) gains (4,652) 295 (4,947) NM Change in allowance for credit losses on investments (81) - (81) NM Interest expense (2,570) (253) (2,317) 915.8 % Other expense, net (96) (19) (77) 405.3 % Income before taxes 68,393 38,872 29,521 75.9 % Income tax expense 12,593 7,081 5,512 77.8 % Net income$ 55,800 $ 31,791 $ 24,009 75.5 % Net operating earnings (2)$ 56,760 $ 37,681 $ 19,079 50.6 % Loss ratio 58.6 % 57.4 % Expense ratio 19.6 % 21.6 % Combined ratio (3) 78.2 % 79.0 % Annualized return on equity 28.6 % 18.6 % Annualized operating return on equity (2) 29.1 %
22.1 %
NM - Percentage change not meaningful.
(1) Underwriting income is a non-GAAP financial measure. See "-Reconciliation of Non-GAAP Financial Measures" for a reconciliation of net income in accordance with GAAP to underwriting income. (2) Net operating earnings and annualized operating return on equity are non-GAAP financial measures. Net operating earnings is defined as net income excluding the net change in the fair value of equity securities, after taxes, net realized investment gains and losses, after taxes, and change in allowance for credit losses on investments, after taxes. Annualized operating return on equity is defined as net operating earnings expressed as a percentage of average beginning and ending total stockholders' equity during the period. See "-Reconciliation of Non-GAAP Financial Measures" for a reconciliation of net income in accordance with GAAP to net operating earnings.
(3) The combined ratio is the sum of the loss ratio and expense ratio as presented. Calculations of each component may not add due to rounding.
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Overview
Net income was$55.8 million for the three months endedMarch 31, 2023 compared to$31.8 million for the three months endedMarch 31, 2022 , an increase of 75.5%. The increase in net income for the first three months of 2023 over the same period last year was primarily due to a combination of strong growth in the business from favorable E&S market conditions and continued rate increases, higher returns on equity investments and an increase in investment income driven by higher investment balances and higher interest rates. Underwriting income was$51.6 million for the three months endedMarch 31, 2023 compared to$37.5 million for the three months endedMarch 31, 2022 , an increase of 37.5%. The corresponding combined ratios were 78.2% for the three months endedMarch 31, 2023 compared to 79.0% for the three months endedMarch 31, 2022 . The increase in underwriting income for the first three months of 2023 compared to the same period last year was due to a combination of premium growth, favorable loss experience, lower net commissions and scale.
Premiums
Our gross written premiums were$357.6 million for the three months endedMarch 31, 2023 compared to$245.5 million for the three months endedMarch 31, 2022 , an increase of$112.1 million , or 45.6%. The increase in gross written premiums for the first three months of 2023 over the same period last year was due to higher submission activity from brokers and higher rates across most lines of business, resulting from continued favorable conditions in the E&S market. The average premium on a policy written was$14,900 in the first three months of 2023 compared to$11,800 in the first three months of 2022. Excluding our personal lines insurance, which has a relatively low premium per policy written, the average premium on a policy written was$16,200 for the first three months of 2023 and$14,200 for the first three months of 2022. Net written premiums increased by$82.5 million , or 38.1%, to$299.0 million for the three months endedMarch 31, 2023 from$216.5 million for the three months endedMarch 31, 2022 . The increase in net written premiums for the first three months of 2023 compared to the same period last year was primarily due to higher gross written premiums. The net retention ratio was 83.6% for the three months endedMarch 31, 2023 compared to 88.2% for the same period last year. The decrease in the net retention ratio was due to higher premiums ceded under the new commercial property quota share reinsurance treaty, effectiveJune 1, 2022 , and a change in the mix of business. Net earned premiums increased by$58.6 million , or 32.8%, to$237.2 million for the three months endedMarch 31, 2023 from$178.6 million for the three months endedMarch 31, 2022 due to growth in gross written premiums.
Loss ratio
The loss ratio was 58.6% for the three months endedMarch 31, 2023 compared to 57.4% for the three months endedMarch 31, 2022 . The increase in the loss ratio in the first three months of 2023 compared to the first three months of 2022 was due primarily to lower net favorable development of loss reserves from prior accident years as a percentage of earned premiums and higher catastrophe losses incurred during the period. During the three months endedMarch 31, 2023 , prior accident years developed favorably by$9.0 million , of which$12.6 million was attributable to the 2021 and 2022 accident years due to lower emergence of reported losses than expected across most lines of business. This favorable development was offset in part by adverse development largely from the 2017 and 2019 accident years due primarily to long-tail property damage claims within our construction-related primary casualty business that are more exposed to the recent increase in inflation. On an inception-to-date basis, all prior accident years have developed favorably with the exception of the 2011 accident year. During the three months endedMarch 31, 2022 , prior accident years developed favorably by$8.3 million , of which$10.1 million was attributable to the 2020 and 2021 accident years due to lower than expected reported losses across 31
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most lines of business. This was offset by
The following table summarizes the loss ratios for the three months endedMarch 31, 2023 and 2022: Three Months Ended March 31, 2023 2022 Losses and Loss Losses and Loss Adjustment Adjustment ($ in thousands) Expenses % of Earned Premiums Expenses % of Earned Premiums Loss ratio: Current accident year before catastrophe losses$ 146,503 61.8 %$ 110,789 62.1 % Current year catastrophe losses 1,574 0.6 % 62 - % Effect of prior year development (9,043) (3.8) % (8,346) (4.7) % Total$ 139,034 58.6 %$ 102,505 57.4 % Expense ratio
The following table summarizes the components of the expense ratio for the three
months ended
Three Months Ended March 31, 2023 2022 Underwriting Underwriting ($ in thousands) Expenses % of Earned Premiums Expenses % of Earned Premiums
Net commissions incurred 26,610 11.2 % 22,122 12.4 % Other underwriting expenses 19,935 8.4 % 16,423 9.2 % Total$ 46,545 19.6 %$ 38,545 21.6 % The expense ratio was 19.6% for the three months endedMarch 31, 2023 compared to 21.6% for the three months endedMarch 31, 2022 . The decrease in the expense ratio was due to lower net commissions incurred and lower other underwriting expenses as a percentage of earned premiums. The decrease in net commissions incurred was due primarily to higher ceding commissions earned under the commercial property quota share treaty as a result of commercial property premium growth. Underwriting expenses relative to earned premium decreased as the Company continues to benefit from scale. Direct commissions paid as a percentage of gross written premiums was 14.4% and 14.6% for the three months endedMarch 31, 2023 and 2022, respectively. 32
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Investing results
The following table summarizes net investment income, change in the fair value
of equity securities and net realized investment (losses) and gains for the
three months ended
Three Months Ended March 31, ($ in thousands) 2023 2022 Change Interest from fixed-maturity securities$ 18,740 $ 8,652 $ 10,088 Dividends from equity securities 1,143 1,030 113 Cash equivalents and short-term investments 713 19 694 Real estate investment income 1,358 - 1,358 Gross investment income 21,954 9,701 12,253 Investment expenses (1,259) (613) (646) Net investment income 20,695 9,088 11,607 Change in fair value of equity securities 3,518 (7,751) 11,269 Net realized investment (losses) gains (4,652) 295 (4,947) Change in allowance for credit losses on investments (81) - (81) Net realized and unrealized investment losses (1,215) (7,456) 6,241 Total$ 19,480 $ 1,632 $ 17,848 Our net investment income increased by 127.7% to$20.7 million for the three months endedMarch 31, 2023 from$9.1 million for the three months endedMarch 31, 2022 . The increase in the first three months of 2023 compared to the same period last year was primarily due to growth in our investment portfolio largely generated from the investment of strong operating cash flows and higher interest rates relative to the prior year period. Our fixed-maturity investment portfolio, excluding cash equivalents and unrealized gains and losses, had an annualized gross investment return of 3.7% and 2.5% for the three months endedMarch 31, 2023 and 2022, respectively. During the first three months of 2023, the change in fair value of equity securities was comprised of unrealized gains related to exchange traded funds ("ETFs") of$2.7 million and unrealized gains related to non-redeemable preferred stock of$0.8 million . The change in unrealized gains during the first three months of 2023 attributable to ETFs reflected higher valuations in the broaderU.S. stock market during the period. During the first three months of 2022, the change in fair value of equity securities was comprised of unrealized losses related to exchange traded funds ("ETFs") of$4.5 million and unrealized losses related to non-redeemable preferred stock of$3.2 million . The change in unrealized losses during the first three months of 2022 attributable to ETFs was largely reflective of the broaderU.S. stock market. The change in unrealized losses during the first three months of 2022 attributable to non-redeemable preferred stock was reflective of a higher interest rate environment. Net realized investments losses were$4.7 million for the three months endedMarch 31, 2023 and were primarily related to disposing of securities issued by certain banking and financial institutions. We perform quarterly reviews of all available-for-sale securities within our investment portfolio to determine whether the decline in a security's fair value is deemed to be a credit loss. Based on our review, we recorded an allowance for credit losses of$0.4 million atMarch 31, 2023 . There were no credit losses recorded atMarch 31, 2022 . See Note 2 of the notes to the consolidated financial statements for further information regarding credit losses. 33
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Income tax expense
Our effective tax rate was 18.4% for the three months endedMarch 31, 2023 compared to 18.2% for the three months endedMarch 31, 2022 . The effective tax rate was lower than the federal statutory rate of 21% primarily due to the tax benefits from stock-based compensation and tax-exempt investment income.
Return on equity
Our annualized return on equity was 28.6% for the three months endedMarch 31, 2023 compared to 18.6% for the three months endedMarch 31, 2022 . Our annualized operating return on equity was 29.1% for the three months endedMarch 31, 2023 compared to 22.1% for the three months endedMarch 31, 2022 . The increase in annualized operating return on equity for the three months endedMarch 31, 2023 compared to the prior period was attributable largely to continued profitable growth in the business from continuing favorable market conditions and rate increases.
Liquidity and Capital Resources
Sources and uses of funds
We are organized as aDelaware holding company with our operations primarily conducted by our wholly-owned insurance subsidiary,Kinsale Insurance Company , which is domiciled inArkansas . Accordingly, we may receive cash through (1) loans from banks and other third parties, (2) issuance of equity and debt securities, (3) corporate service fees from our insurance subsidiary, (4) payments from our subsidiaries pursuant to our consolidated tax allocation agreement and other transactions, and (5) dividends from our insurance subsidiary. We may use the proceeds from these sources to contribute funds toKinsale Insurance Company in order to support premium growth, reduce our reliance on reinsurance, pay dividends and taxes and for other business purposes. We receive corporate service fees fromKinsale Insurance Company to reimburse us for most of the operating expenses that we incur. Reimbursement of expenses through corporate service fees is based on the actual costs that we expect to incur with no mark-up above our expected costs. InAugust 2022 , we filed a universal shelf registration statement with theSEC that expires in 2025. We can use this shelf registration to issue an unspecified amount of common stock, preferred stock, depositary shares and warrants. The specific terms of any securities we issue under this registration statement will be provided in the applicable prospectus supplements. InJuly 2022 , we entered into a Note Purchase and Private Shelf Agreement (the "Note Purchase Agreement"), which provides for the issuance of senior promissory notes with an aggregate principal amount of up to$150.0 million . Pursuant to the Note Purchase Agreement, onJuly 22, 2022 we issued$125.0 million aggregate principal amount of 5.15% senior promissory notes (the "Series A Notes"), the proceeds of which were used to fund surplus atKinsale Insurance Company , refinance indebtedness and for general corporate purposes. See Note 13 for further information regarding the Note Purchase Agreement. InJuly 2022 , we entered into an Amended and Restated Credit Agreement, which extended the maturity date toJuly 22, 2027 , and increased the aggregate commitment to$100.0 million , with the option to increase the aggregate commitment by$30.0 million , subject to certain conditions. Borrowings under the Amended and Restated Credit Agreement may be used for general corporate purposes (which may include, without limitation, to fund future growth, to finance working capital needs, to fund capital expenditures, and to refinance, redeem or repay indebtedness). See Note 13 for further information regarding the Amended and Restated Credit Agreement. 34
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Management believes that the Company has sufficient liquidity available both in Kinsale and in its insurance subsidiary,Kinsale Insurance Company , as well as in its other operating subsidiaries, to meet its operating cash needs and obligations and committed capital expenditures for the next 12 months.
Cash flows
Our most significant source of cash is from premiums received from our insureds, which, for most policies, we receive at the beginning of the coverage period. Our most significant cash outflow is for claims that arise when a policyholder incurs an insured loss. Because the payment of claims occurs after the receipt of the premium, often years later, we invest the cash in various investment securities that earn interest and dividends. We also use cash to pay commissions to insurance brokers, as well as to pay for ongoing operating expenses such as salaries, consulting services and taxes. As described under "-Reinsurance" below, we use reinsurance to manage the risk that we take related to the issuance of our policies. We cede, or pay out, part of the premiums we receive to our reinsurers and collect cash back when losses subject to our reinsurance coverage are paid. The timing of our cash flows from operating activities can vary among periods due to the timing by which payments are made or received. Some of our payments and receipts, including loss settlements and subsequent reinsurance receipts, can be significant, so their timing can influence cash flows from operating activities in any given period. Management believes that cash receipts from premiums, proceeds from investment sales and redemptions and investment income are sufficient to cover cash outflows in the foreseeable future.
Our cash flows for the three months ended
Three Months Ended March 31, 2023 2022 (in thousands) Cash and cash equivalents provided by (used in): Operating activities$ 197,604 $ 121,929 Investing activities (190,212) (135,710) Financing activities (5,018) (3,101) Change in cash and cash equivalents $
2,374
Net cash provided by operating activities was approximately$197.6 million for the three months endedMarch 31, 2023 , compared to$121.9 million for the same period in 2022. This increase was largely driven by higher premium volume, the timing of claim payments and reinsurance recoveries, offset in part by changes in operating assets and liabilities. Net cash used in investing activities was$190.2 million for the three months endedMarch 31, 2023 , compared to$135.7 million for the three months endedMarch 31, 2022 . Net cash used in investing activities during the first three months of 2023 included purchases of fixed-maturity securities of$258.2 million , which were comprised largely of asset-backed securities, corporate bonds, and to a lesser extent, municipal securities. During the first three months of 2023, we received proceeds of$49.2 million from sales of fixed-maturity securities, largely municipal securities and corporate bonds, and$26.1 million from redemptions and maturities of mortgage- and asset-backed securities and corporate bonds. For the three months endedMarch 31, 2023 , purchases of equity securities of$20.3 million consisted of common stocks. In addition, net sales of short-term investments of$15.1 million consisted ofU.S. Treasuries and corporate bonds. Net cash used in investing activities of$135.7 million for the three months endedMarch 31, 2022 included purchases of fixed-maturity securities of$226.5 million , which were comprised largely of corporate bonds, mortgage-backed securities, and to a lesser extent, asset-backed securities, sovereign and municipal securities. 35
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During the first three months of 2022, we received proceeds of$54.2 million from sales of fixed-maturity securities, largely corporate bonds and mortgage- and asset-backed securities, and$37.0 million from redemptions of asset- and mortgage-backed securities and corporate bonds. For the three months endedMarch 31, 2022 , purchases of ETFs were$0.5 million . During the first three months of 2023, cash used in financing activities reflected dividends paid of$0.14 per common share, or$3.2 million in aggregate. In addition, for the three months endedMarch 31, 2023 , payroll taxes withheld and remitted on restricted stock awards were$2.1 million , offset in part by proceeds received from our equity compensation plans of$0.3 million . During the first three months of 2022, cash used in financing activities reflected dividends paid of$0.13 per common share, or$3.0 million in aggregate. In addition, for the three months endedMarch 31, 2022 , payroll taxes withheld and remitted on restricted stock awards were$0.5 million , offset in part by proceeds received from our equity compensation plans of$0.4 million .
Reinsurance
We enter into reinsurance contracts primarily to limit our exposure to potential large losses. Reinsurance involves an insurance company transferring ("ceding") a portion of its exposure on a risk to another insurer, the reinsurer. The reinsurer assumes the exposure in return for a portion of the premium. Our reinsurance is primarily contracted under quota-share reinsurance treaties and excess of loss treaties. In quota-share reinsurance, the reinsurer agrees to assume a specified percentage of the ceding company's losses arising out of a defined class of business in exchange for a corresponding percentage of premiums, net of a ceding commission. In excess of loss reinsurance, the reinsurer agrees to assume all or a portion of the ceding company's losses, in excess of a specified amount. Under excess of loss reinsurance, the premium payable to the reinsurer is negotiated by the parties based on their assessment of the amount of risk being ceded to the reinsurer because the reinsurer does not share proportionately in the ceding company's losses. We renew our reinsurance treaties annually. During each renewal cycle, there are a number of factors we consider when determining our reinsurance coverage, including (1) plans to change the underlying insurance coverage we offer, (2) trends in loss activity, (3) the level of our capital and surplus, (4) changes in our risk appetite and (5) the cost and availability of reinsurance coverage. Effective with theJune 1, 2022 renewal, we entered into a new commercial property insurance quota share treaty in place of our previous property per-risk reinsurance treaty. To manage our natural catastrophe exposure, we use computer models to analyze the risk of severe losses. We measure exposure to these losses in terms of probable maximum loss ("PML"), which is an estimate of the amount of loss we would expect to meet or exceed once in a given number of years (referred to as the return period). When managing our catastrophe exposure, we focus on the 100-year and the 250-year return periods. 36
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The following is a summary of our significant reinsurance programs as of
Line of Business Covered Company Policy Limit Reinsurance Coverage Company Retention Property - commercial N/A 42.5% up to$93.3 million 57.5% of all commercial insurance (1) per catastrophe property losses Property - personal N/A 50% up to$35.5 million 50% of all personal insurance (2) per catastrophe property losses Property - catastrophe (3) N/A$75.0 million excess of$25.0 million per$25.0 million catastrophe Primary casualty (4) Up to$10.0 million per$8.0 million excess of$2.0 million per occurrence$2.0 million occurrence Excess casualty (5) Up to$10.0 million per Variable quota share$2.0 million per occurrence occurrence except as described in note (5) below (1) Our commercial property quota-share reinsurance reduces the financial impact of property losses on our commercial property, small property and inland marine policies. Reinsurance is not applicable to any individual policy with a limit of$2.0 million or less.
(2) Our personal insurance quota share reinsurance reduces the financial impact of property losses on our personal insurance policies.
(3) Our property catastrophe reinsurance reduces the financial impact of a catastrophe event involving multiple claims and policyholders. Our property catastrophe reinsurance includes a reinstatement provision which requires us to pay reinstatement premiums after a loss has occurred in order to preserve coverage. Including the reinstatement provision, the maximum aggregate loss recovery limit is$150 million and is in addition to the per-occurrence coverage provided by our treaty coverages.
(4) Reinsurance is not applicable to any individual policy with a
per-occurrence limit of
(5) For casualty policies with a per-occurrence limit higher than$2.0 million , the ceding percentage varies such that the retention is always$2.0 million or less. For example, for a$4.0 million limit excess policy, our retention would be 50%, whereas for a$10.0 million limit excess policy, our retention would be 20%. For policies for which we also write an underlying primary limit, the retention on the primary and excess policy combined would not exceed$2.0 million . Reinsurance contracts do not relieve us from our obligations to policyholders. Failure of the reinsurer to honor its obligation could result in losses to us, and therefore, we established an allowance for credit risk based on historical analysis of credit losses for highly rated companies in the insurance industry. In formulating our reinsurance programs, we are selective in our choice of reinsurers and we consider numerous factors, the most important of which are the financial stability of the reinsurer, its history of responding to claims and its overall reputation. In an effort to minimize our exposure to the insolvency of our reinsurers, we review the financial condition of each reinsurer annually. In addition, we continually monitor for rating downgrades involving any of our reinsurers. AtMarch 31, 2023 , all reinsurance contracts that our insurance subsidiary was a party to were with companies withA.M. Best ratings of "A-" (Excellent) or better. As ofMarch 31, 2023 , we recorded an allowance for credit losses of$0.5 million related to our reinsurance balances. 37
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Ratings
Kinsale Insurance Company has a financial strength rating of "A" (Excellent) with a stable outlook fromA.M. Best .A.M. Best assigns ratings to insurance companies, which currently range from "A++" (Superior) to "F" (In Liquidation). "A" (Excellent) is the third highest rating issued byA.M. Best . The "A" (Excellent) rating is assigned to insurers that have, inA.M. Best's opinion, an excellent ability to meet their ongoing obligations to policyholders. This rating is intended to provide an independent opinion of an insurer's ability to meet its obligation to policyholders and is not an evaluation directed at investors. The financial strength ratings assigned byA.M. Best have an impact on the ability of the insurance companies to attract and retain agents and brokers and on the risk profiles of the submissions for insurance that the insurance companies receive. The "A" (Excellent) rating obtained byKinsale Insurance Company is consistent with our business plan and allows us to actively pursue relationships with the agents and brokers identified in our marketing plan.
Financial Condition
Stockholders' equity
AtMarch 31, 2023 , total stockholders' equity was$815.7 million and tangible stockholders' equity was$812.9 million , compared to total stockholders' equity of$745.4 million and tangible stockholders' equity$742.7 million atDecember 31, 2022 . The increases in both total and tangible stockholders' equity over the prior year-end balances were due to profits generated during the period, an increase in the fair value of our fixed-maturity investments and net activity related to stock-based compensation plans, offset in part by payment of dividends. Tangible stockholders' equity is a non-GAAP financial measure. See "-Reconciliation of non-GAAP financial measures" for a reconciliation of stockholders' equity in accordance with GAAP to tangible stockholders' equity.
Investment portfolio
AtMarch 31, 2023 , our cash and invested assets of$2.4 billion consisted of fixed-maturity securities, equity securities, cash and cash equivalents, real estate investments and short-term investments. AtMarch 31, 2023 , the majority of the investment portfolio was comprised of fixed-maturity securities of$2.0 billion that were classified as available-for-sale. Available-for-sale investments are carried at fair value with unrealized gains and losses on these securities, net of applicable taxes, reported as a separate component of accumulated other comprehensive income. AtMarch 31, 2023 , we also held$171.4 million of equity securities, which were comprised of ETF securities, non-redeemable preferred stock and common stocks,$158.6 million of cash and cash equivalents,$76.5 million of real estate investments and$26.6 million of short-term investments. Our fixed-maturity securities, including cash equivalents, had a weighted average duration of 3.4 years and 3.5 years atMarch 31, 2023 andDecember 31, 2022 , respectively, and an average rating of "AA-" at bothMarch 31, 2023 andDecember 31, 2022 . 38
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At
March 31, 2023 December 31, 2022 Estimated Fair % of Total Fair Estimated Fair % of Total Fair Amortized Cost Value Value Amortized Cost Value Value ($ in thousands) Fixed-maturity securities:U.S. Treasury securities and obligations ofU.S. government agencies$ 17,940 $ 16,976 0.9 %$ 17,934 $ 16,741 1.0 % Obligations of states, municipalities and political subdivisions 206,449 185,803 9.4 % 230,746 204,632 11.6 % Corporate and other securities 1,008,098 939,031 47.6 % 909,285 832,892 47.3 % Asset-backed securities 484,384 478,511 24.3 % 361,248 353,006 20.1 % Residential mortgage-backed securities 341,064 291,891 14.8 % 349,066 293,962 16.7 % Commercial mortgage-backed securities 65,321 59,588 3.0 % 65,353 58,867 3.3 % Total fixed-maturity securities$ 2,123,256 $ 1,971,800 100.0 %$ 1,933,632 $ 1,760,100 100.0 % The table below summarizes the credit quality of our fixed-maturity securities atMarch 31, 2023 andDecember 31, 2022 , as rated byStandard & Poor's Financial Services, LLC ("Standard & Poor's"): March 31, 2023 December 31, 2022 Standard & Poor's or Equivalent Estimated Fair Estimated Fair Designation Value % of Total Value % of Total ($ in thousands) AAA$ 582,712 29.6 %$ 452,001 25.7 % AA 485,746 24.6 % 496,761 28.2 % A 514,876 26.1 % 434,388 24.7 % BBB 326,848 16.6 % 313,875 17.8 % Below BBB and unrated 61,618 3.1 % 63,075 3.6 % Total$ 1,971,800 100.0 %$ 1,760,100 100.0 % The amortized cost and estimated fair value of our fixed-maturity securities summarized by contractual maturity as ofMarch 31, 2023 andDecember 31, 2022 , were as follows: March 31, 2023 December 31, 2022 Amortized Estimated Fair % of Total Fair Amortized Estimated Fair % of Total Fair Cost Value Value Cost Value Value ($ in thousands) Due in one year or less$ 55,240 $ 54,255 2.8 %$ 15,133 $ 14,925 0.9 % Due after one year through five years 724,427 703,547 35.7 % 647,263 626,182 35.6 % Due after five years through ten years 214,934 189,970 9.6 % 245,670 213,539 12.1 % Due after ten years 237,886 194,038 9.8 % 249,899 199,619 11.3 % Asset-backed securities 484,384 478,511 24.3 % 361,248 353,006 20.1 % Residential mortgage-backed securities 341,064 291,891 14.8 % 349,066 293,962 16.7 % Commercial mortgage-backed securities 65,321 59,588 3.0 % 65,353 58,867 3.3 % Total fixed-maturity securities$ 2,123,256 $ 1,971,800 100.0 %$ 1,933,632 $ 1,760,100 100.0 % 39
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Actual maturities may differ from contractual maturities because some borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Restricted investments
In order to conduct business in certain states, we are required to maintain
letters of credit or assets on deposit to support state-mandated insurance
regulatory requirements and to comply with certain third-party agreements.
Assets held on deposit or in trust accounts are primarily in the form of
high-grade securities. The fair value of our restricted assets was
Reconciliation of Non-GAAP Financial Measures
Reconciliation of underwriting income
Underwriting income is a non-GAAP financial measure that we believe is useful in evaluating our underwriting performance without regard to investment income. Underwriting income is defined as net income excluding net investment income, the net change in the fair value of equity securities, net realized investment gains and losses, change in allowance for credit losses on investments, interest expense, other expenses, other income and income tax expense. We use underwriting income as an internal performance measure in the management of our operations because we believe it gives us and users of our financial information useful insight into our results of operations and our underlying business performance. Underwriting income should not be viewed as a substitute for net income calculated in accordance with GAAP, and other companies may define underwriting income differently.
Net income for the three months ended
Three Months Ended March 31, ($ in thousands) 2023 2022 Net income$ 55,800 $ 31,791 Income tax expense 12,593 7,081 Income before income taxes 68,393 38,872 Net investment income (20,695) (9,088) Change in the fair value of equity securities (3,518) 7,751 Net realized investment losses (gains) 4,652 (295) Change in allowance for credit losses on investments 81 - Interest expense 2,570 253 Other expenses (1) 402 143 Other income (306) (124) Underwriting income$ 51,579 $ 37,512
(1) Other expenses are comprised of corporate expenses not allocated to our insurance operations.
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Reconciliation of net operating earnings
Net operating earnings is defined as net income excluding the effects of the net change in the fair value of equity securities, after taxes, net realized investment gains and losses, after taxes, and the change in allowance for credit losses on investments, after taxes. We believe the exclusion of these items provides a useful comparison of our underlying business performance from period to period. Net operating earnings and percentages or calculations using net operating earnings (e.g., diluted operating earnings per share and annualized operating return on equity) are non-GAAP financial measures. Net operating earnings should not be viewed as a substitute for net income calculated in accordance with GAAP, and other companies may define net operating earnings differently.
Net income for the three months ended
Three Months Ended March 31, ($ in thousands) 2023 2022 Net income$ 55,800 $ 31,791 Adjustments: Change in the fair value of equity securities, before taxes (3,518) 7,751 Income tax (benefit) expense (1) 739 (1,628)
Change in the fair value of equity securities, after taxes
(2,779) 6,123 Net realized investment losses (gains), before taxes 4,652 (295) Income tax (benefit) expense (1) (977) 62 Net realized investment losses (gains), after taxes 3,675 (233)
Change in allowance for credit losses on investments, before taxes
81 - Income tax benefit (1) (17) - Change in allowance for credit losses on investments, after taxes 64 - Net operating earnings$ 56,760 $ 37,681 Operating return on equity: Average stockholders' equity (2)$ 780,590 $ 682,453 Annualized return on equity (3) 28.6 % 18.6 % Annualized operating return on equity (4) 29.1 % 22.1 %
(1) Income taxes on adjustments to reconcile net income to net operating earnings use an effective tax rate of 21%.
(2) Computed by adding the total stockholders' equity as of the date indicated to the prior quarter-end or year-end total, as applicable, and dividing by two.
(3) Annualized return on equity is net income expressed on an annualized basis as a percentage of average beginning and ending stockholders' equity during the period.
(4) Annualized operating return on equity is net operating earnings expressed on an annualized basis as a percentage of average beginning and ending stockholders' equity during the period.
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Reconciliation of tangible stockholders' equity
Tangible stockholders' equity is defined as total stockholders' equity less intangible assets, net of deferred taxes. Our definition of tangible stockholders' equity may not be comparable to that of other companies, and it should not be viewed as a substitute for stockholders' equity calculated in accordance with GAAP. We use tangible stockholders' equity internally to evaluate the strength of our balance sheet and to compare returns relative to this measure.
Stockholders' equity at
($ in thousands) March 31, 2023 December 31, 2022 Stockholders' equity $ 815,731 $ 745,449 Less: intangible assets, net of deferred taxes 2,795 2,795 Tangible stockholders' equity $ 812,936 $ 742,654 Critical Accounting Estimates We identified the accounting estimates which are critical to the understanding of our financial position and results of operations. Critical accounting estimates are defined as those estimates that are both important to the portrayal of our financial condition and results of operations and require us to exercise significant judgment. We use significant judgment concerning future results and developments in applying these critical accounting estimates and in preparing our condensed consolidated financial statements. These judgments and estimates affect our reported amounts of assets, liabilities, revenues and expenses and the disclosure of our material contingent assets and liabilities, if any. Actual results may differ materially from the estimates and assumptions used in preparing the condensed consolidated financial statements. We evaluate our estimates regularly using information that we believe to be relevant. Our critical accounting policies and estimates are described in our annual consolidated financial statements and the related notes in our Annual Report on Form 10-K for the year endedDecember 31, 2022 .
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