TIP804: Kinsale Capital Stock Deep Dive w/ Clay Finck & Daniel Mahncke

26:08So this means really good underwriting is essential. One of the things that is unique about Kinsale is that they keep all of their underwriting in-house. And they have this culture of continuous improvement. So they are constantly monitoring industry trends and trying to improve that underwriting. The pricing of risk, it's always a moving target. So really the work is never finished on this front and there's always room for improvement. On the other hand, many of the other excess and surplus insurers outsource their underwriting to what are referred to as MGAs. So let's imagine you're a small ENS carrier, maybe you're a new entrant to the industry, it probably makes sense to outsource the underwriting because you might not have the industry expertise required to do appropriate underwriting.

26:57But outsourcing this critical function can also lead to several key issues. There's a fundamental misalignment of interest for MGAs because they're responsible for determining an appropriate premium level for each risk, but they aren't responsible for the risk itself. and it's the classic principal agent problem. The MGAs tend to be paid based on premium volume, while the insurer cares most about long-term underwriting profitability. So the incentives are not well aligned here. This could lead to the MGA either being incentivized to try and get more business to be written, or it could lead to them recommending or pricing these riskier policies than what might appear on the surface.

27:40So to use an analogy, it would be like you paying me for me to give you stock ideas to invest in, but me taking none of the downside risk should those ideas turn out to be poor investments. So in the case of Kinzale, again, they're doing all of the underwriting themselves. Based on my understanding, they would never outsource this key function. So they have every incentive to turn down business that they know is unprofitable, quote premiums that generate their profitability targets, and avoid business that they just deem too risky. Maybe they don't have the data, they don't have the experience with those types of risks.

28:15Kinsale's in-house underwriters are incentivized first to underwrite for a profit and second to grow the business. So at the end of the day, Kinsale lives or dies based on how well they underwrite in this market. And they don't necessarily rely on the kindness of strangers. Now also think about how that dynamic might change from the standpoint of innovation. MGAs, they may or may not innovate, and the insurer may or may not benefit from such innovations. Whereas at Kinsale, if they improve their underwriting processes, then they only stand to benefit from those improvements. I don't think this would be a surprise to anyone, but I, again, just want to highlight just how slow-moving and resistant to change the insurance industry can be.

29:02So many of the largest P &C insurers are still operating on legacy technology systems that were built decades ago. And modernizing these systems is just incredibly difficult. It's very costly. It's very time consuming to just overhaul and modernize these systems or bring underwriting in-house, for example. At my previous job, I actually worked at an insurer here in Lincoln. And I remembered just how big of a deal it was for them to switch one of their IT systems. It involved countless people. It led to countless headaches. And because of how cumbersome and time-consuming it is, I wouldn't say that the employees overall are too excited about making such a change.

29:44Follow the incentives and I'll show you the outcome. They'd probably just rather keep their existing legacy systems that require all these manual processes that are just inefficient, but it gives them something to do day to day. And because insurance is fundamentally about managing risk, the culture of the industry tends to be very conservative as well. So most insurers prioritize stability, they prioritize avoiding mistakes rather than pushing for innovation, which means the pace of technological improvement is often pretty slow. This environment creates an interesting opportunity for a company like Kinsale though, because most players are just resistant to that change in innovation, but Kinzale embraces it.

30:27And once a company gains a big operational lead in a slow-moving industry like insurance, it can take a long time for competitors to catch up. In one of the CEO's presentations, I heard a Michael Kehoe. He was talking about how they lost one of their larger accounts a few years ago. So the account was coming up on its renewal period. And Kinzale had quoted them a renewal premium of$170 ,000. And they ended up losing that account because an MGA misclassified the business and unwrote a premium of just$57 ,000. So we're going to talk about this later, but oftentimes these insureds are mainly shopping based on price.

31:07So the MGA quoted a price that was one third that of Kinzale's, but the lower premium was not due to the MGA pricing the risk more appropriately, but it was actually due to them classifying the business as a sporting goods distributor instead of a firearms manufacturer. So that's just one example that illustrates how Kinzale, I think they tend to do a better job in their underwriting for the risks that they're taking on. And they've put together the systems, the expertise, the processes, and the right team to accurately price these risks and do so very efficiently. When you talk about the headaches of changing an IT system at an insurance company, that gives me immediate flashbacks to all of our Constellation software discussions.

31:51It always seems so straightforward to just go with the new shiny product. Currently, it's AI. But in reality, keeping what works is often the best solution. And that's the switching cost mode that CSU is so often talking about. And insurance is generally quite an interesting field because insurers are literally selling a product without knowing the underlying cost of what it actually is that they're selling. So when you look at practically any business, it generally knows what its costs are going to be with a high degree of certainty. So I mean, take Coca-Cola as an example. Let's say they charge$1.50 for a bottle of Coke.

32:27So that is sold to a retailer. They can then look at their expenses and say, well, this much went into purchasing the syrup, this much for the bottle and this much to transfer the bottle of Coke and all of that stuff. But insurance companies, they don't have that luxury, right? I mean, if an insurer sells a whole life insurance policy with, let's say, a million dollar face value, the insurer doesn't know whether they will need to pay out that million dollars in a month from now, in 10 years, in 30 years, or at any point in the next 50, 60 years. So that's what makes the accounting so tricky when it comes to insurers, because they need to set aside reserves.

33:01And those reserves make actual assumptions on when and at what level of claims will be paid out over time. And Buffett has cautioned investors that some insurers might appear to have a cost advantage with the way that they basically set reserves and handle their accounting. And it's kind of like having a self-graded exam in class. I think we all still know how they turned out most of the time. And if an insurer understates the level of claims they need to pay, it might appear on the surface as if it's this well-run and more profitable company than it actually is for a while. And this is particularly true of all these long-tail risks, where claims may be paid out many, many years or even decades into the future after a policy is actually written.

33:46So I think Kinsel has actually shared that they are very conservative in setting reserves, but I think about any insurer would tell you that they operate very conservatively. But insurers are required to disclose how reserves are adjusted over time. And historically, at least, Kinsale has consistently overestimated their reserves, which shows that they actually do, or historically have been taking a fairly conservative approach and not trying to mislead their investors. I don't expect them to get this perfect, certainly, as surprises can and often do happen in insurance, but generally, they've been pretty conservative with their reserving methodology.

34:27Another way that Kinzale limits the level of risk that they're taking is, I hit on this a little bit earlier, but just simply diversifying their exposure base. So instead of being concentrated in one industry or one geography, they do a pretty good job of spreading out their bets across uncorrelated end markets. In the reports, they share several lines of business they have exposure to, which includes things like commercial property, excess casualty, construction, allied health, entertainment, and energy. With this diversification though, almost all of their lines of business share three key features.

35:00They tend to be commercial rather than personal. They involve non-standard risks and they require specialized underwriting judgment. So given that Kinsale is trying to keep the costs as low as possible, how does their expense structure compare against these other insurance companies? So it's funny. Last May, we were in Omaha together for the Berkshire meeting. And on Sunday, we attended the Markel brunch. At that event, Markel, they put together this investor presentation and they take questions from the audience. So Markel does this presentation and they highlight how they seek to be a market leader in each of their pursuits.

35:39The irony is that I think they did a pretty good job of highlighting just how special of a business Kinsale is. They had a slide there that showed the combined ratio for several excess and surplus insured. So for those not familiar with this insurance terminology, the combined ratio is a measure that helps show how profitable an insurance company is. So the lower the combined ratio, the better. So in 2024, Markel's combined ratio was 95%. This means that for every$100 in premium that they're collecting, they get to keep roughly$5 as profit after paying expenses and paying out claims. Markel also showed the combined ratio for their competitors.

36:21Several competitors had a combined ratio that was lower than Markel's, including Chubb and RLI Specialty Insurance, but nobody had anywhere near the combined ratio that Kinzale Capital had. Kinsale's combined ratio in 2024 was 76%, and they consistently keep that ratio below 80%. RLI was the next close competitor on that slide. They were at 86%. While RLI keeps around$14 out of every$100 they take in, Kinsale is keeping around$24. So nobody in the ENS or the PNC industry for that matter is in the same league as Kinsale. While their combined ratio is around 76%, The industry average is around 91%.

37:05So within a given year, Kinsale is sending more than 400 ,000 quotes to insurance brokers and closing business on more than 40 ,000 of those quotes. So other insurers really struggle to do that level of volume in the ENS market. And again, this ties directly into their culture of operating with a high level of efficiency and automating as much as possible. Kinsale is able to do all of this with just 700 employees, which I thought was pretty impressive. Another reason that Kinsale's margins are significantly better is because most of their competitors are going to be outsourcing that underwriting of the policy.

37:44So when a broker requests a quote for a potential customer, it's Kinsale themselves that is determining what the premiums should be. So their competitors are also inherently just giving up some level of margin by paying somebody else to be generating that quote for them. It's pretty remarkable, actually, what Kinsel has been able to do because insurance, again, tends to be one of the most commoditized industries out there. I recently put together an episode on MS for our intrinsic value podcast. And it's just incredible how some people will buy a$40 ,000 MS bag because it is MS and actually because it costs$40 ,000.

38:21And in insurance, as we all know, you have the opposite dynamic where business owners purchase insurance, not because they want to, but because they have to. And most people purchasing insurance, they just want the coverage that costs the least. And usually what that means is there's not a lot of pricing power. And we've looked at so many businesses. And what we find is that if you're a good business, but in a bad industry, usually that means your business won't be doing that well either. But there are some companies for which that doesn't seem to be the case. And Kinzale is one of those. What you just highlighted, I think, is a reason to even be skeptical at Kinzale.

38:54Really dig into the details and really understand what sort of advantages they might have. And I can certainly attest to that, the pricing power within insurance. When I pay for an insurance premium, I tend to think of it as just throwing money down the drain. I like my Geico auto coverage because I think their premiums are very reasonable. And if they were to hike my premium enough times, that would likely take one or two hours to get my coverage switched. I have no brand loyalty to any auto insurer for the record. The last thing I want to do is overpay for insurance because as Buffett said, at the end of the day, this is a commodity.

39:30And most of the time, customers tend to highly prioritize the price they're quoted. And Kinsley knows that having a low expense structure and competitive premiums is essential to succeed in this business. So their expense ratio is something like 21%, while their competitors will have an expense ratio of 35 % and some actually have one as high as 40%. And as you highlighted earlier, I think it illustrates just how slow these legacy insurance companies can be to adapt. I think it almost seems that the only way one can get an expense ratio or structure as low as Kinsel has it is if you basically start out from scratch, instead of trying to modernize the systems at these larger insurance companies, which, as you said, can be even difficult to do if it's just the software that you want to exchange.

40:15And in an interview with CEO Michael Kehoe, he even compared what Kinsel is doing today, what Geico and Progressive have done in the personal auto industry. And for decades, they basically made technology one of their core competencies, not only to deliver strong returns, but also to grow their market share significantly. I mean, for example, in 1990, Progressive had a market share of around one to 2%. And today they have a market share of around 16 % of the auto insurance market. And with that said, Kinsale has already had an incredible run over the past decade. So do you still see them going the way of progressive and continuing to steal share?

40:55Or are we close to the maximum that they can reach? Yeah. So the ENS market, it's estimated to do around$115 billion in written premium. So that's around 10 % of the broader P &C market. And Kinzale has less than 2 % of the market in the ENS space. So since Kinzale has been growing revenues north of 30 % for several years in the past, they've of course been increasing that market share. And I think it's clear that there's still room for them to continue to grow that market share in the future. One of the reasons that Kinzale is able to steal market share is because they have that sole focus on the ENS industry.

41:35So when you look at competitors like Chubb, AIG, Travelers. These are large insurers with several different divisions. And due to Kinzale's focus, they're able to have more underwriting expertise. They have the processes in place that are optimized for that one industry. And most of their management team has 20, 30 plus years experience in the industry. And I think part of their advantage over these bigger players is the speed at which they're able to work with brokers. So insurance tends to be distributed through brokers. So they ultimately decide which insurer is getting the business. As a result, speed and reliability tend to matter a lot.

42:14So Kinsale has this proprietary technology that has allowed them to issue quotes fast, which is an important innovation given that they are getting requests for these hard to place risks. So if Kinsale is getting right back to the broker with a quote, but other insurers might be taking days or weeks to run the quote, then brokers may increasingly choose to select Kinsale in writing the business. And not only is Kinsale stealing share in the E &S market, but the E &S market itself is growing at a fairly rapid rate as well. So for commercial lines from 2010 to 2023, the standard P &C market, it grew by 4.6 % per year, so slightly faster than the broader economy, while the ENS market grew by 10.5 % per year.

43:01So in starting Kinzale in 2009, I think it's pretty clear that Kehoe recognized the trends that were playing to his favor at the time. Yeah. I mean, as Charlie Munger said, and you also early in this episode, show me the incentive and I will show you the outcome. And we all know that brokers earn commissions when actually selling insurance. So that is obviously a benefit if you're just faster than competitors. So how do Kinsales Commission compare to those of the other insurers? Commissions do certainly play a big role in determining which policies are sold and which insurers the brokers want to select.

43:37And this was actually really interesting to research. And management has a lot of experience in this industry and is very shareholder focused. So I would expect them to try and find the right balance of compensating brokers enough, but not being overly generous in the commissions they're handing out. So Kinzale, they pay an average commission of around 14 to 15 % of gross written premiums, but the commission isn't the sole consideration by the broker. They're also considering the price that the insured is paying and the service and expertise offered by the carrier when determining where to place their business.

44:13So you can imagine if you're a broker and you get two quotes from the insurers, let's say Kinsale's is$15 ,000 premium, the other insurer's a$16 ,000 premium. Well, it's in the broker's best interest to give the insured the best deal instead of giving them the spiel of why they should pay more for coverage that is essentially the same. So Kinsale believes that their commission rates are slightly lower than that of their competitors, but they're able to make up for that through their high degree of service, and their rapid response time. So if they can help make the broker's lives easier, then that's a win-win for everyone, even if they're paying a slightly lower commission rate than the next carrier.

44:53As I already highlighted, due to the high level of automation in Kinsale's workflows, they're able to provide these quotes at a faster pace than their competitors. And most people just don't view shopping for insurance as a very pleasant experience. So they tend to just want to take care of it as soon as possible. And sometimes speed is actually a necessity in getting coverage. So for example, a lender might require proof of general liability coverage before releasing funds, or a contractor might not be able to start work until they've gotten coverage. So in these types of situations, speed is of utmost importance, which Kinsale is very well positioned to deliver on.

45:34Furthermore, I was speaking with a member of our community who happened to meet with Kinzale's CFO. And the member was telling me that since the brokers don't make much money on these smaller ENS policies, they tend to just view them as a headache. So once a customer comes in wanting that type of policy, the broker tends to just want to get it off their plate. They probably have bigger issues to deal with and bigger accounts to service. And I think that's yet another reason why Speed plays so into Kinzale's favor. Let's take a quick break and hear from today's sponsors. Ever wanted to explore the world of online trading but haven't dared try?

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49:41Digging into this sort of made my head spin a bit because soft markets and hard markets have different implications for different insurers, depending if you're very disciplined like Kinzale or your standard insurer out there. So the hard versus soft market terminology is essentially getting to the underlying market dynamics. It reminds me of how in real estate, agents will talk about how we're either in a buyer's market or a seller's market. For example, in a buyer's market, the buyer tends to have the upper hand in the negotiation. So in insurance, a hard market occurs when insurance becomes more expensive or harder to obtain.

50:18So in other words, the insurer has the upper hand at the table. A hard market leads to rising premium rates, stricter underwriting standards, less coverage capacity, and more exclusions and restrictions in the policies. This type of environment, it tends to happen after the industry experiences some losses. So that means claims are rising faster than initially expected, or there are capital shortages among insurers. You can imagine that if you were an insurer and your financial position was getting pretty tight, then naturally you would want to increase your premium rates and limit the amount of risk that you're taking.

50:55Whereas in a soft market, things are going well. Premiums might be declining or flat, more insurers are competing for business, and broader coverage is offered to try and capture more shares. So this tends to happen when insurers are in a much better financial situation. Since insurance is a commodity, it makes sense that the industry would go through these cycles of hard and soft markets. And coming out of the early 2000s, the industry was in a hard market. This was driven by 9-11 losses, a surge in claims, and a brutal bear market hitting investment portfolios. Then interest rates rose sharply and underwriting tightened significantly with insurers focused on restoring that profitability.

51:36But hard markets don't last forever. As results improved and new capital entered the space, the market began softening. And this is a trend that deepened steadily from roughly 2010 through 2017. Carriers were cutting rates, they were loosening their terms, and they were chasing premium volumes at the expense of underwriting discipline. So in a soft market, the insurer effectively sets the price without too much of a consideration for how profitable that price will be long-term. And soft markets are a really difficult environment for Kinsale, whose model is built around pricing each risk accurately and walking away when the numbers just don't work.

52:15So the tide started to turn around 2017, 2018. Years of inadequate pricing combined with back-to-back catastrophic loss years, it began exposing how poorly reserved many insurance carriers were. So insurers, they started to suffer the consequences of their short-term decisions of the past, which helped give Kinzale more pricing power. And insurers in the standard market, they were really dialing back their coverage, which pushed a lot of business into the ENS market, which really benefited Kinzale. And somewhat ironically, when the standard market does tighten, the ENS market is expanding to fill the gaps in the market.

52:54So that's what I'm talking about when I mentioned my head sort of spinning of all these good for one carrier, not so good for another carrier. There's a lot to wrap your mind around here. So the resulting hard market, it lasted around six years, far longer than the three to four year average seen since the 1980s. And it featured a more gradual sustained elevation of rates rather than the sharp spikes and drops of prior cycles. So moving into 2025, the market began to soften again in certain lines, and Kinsale has started to see that pressure. Their response, as always, will be to hold the line on price and accept slower growth rather than chasing premium volume at inadequate margins, which is exactly what their model is designed to do.

53:37When we look at the growth in Kinsale's business over time, this is really what we're seeing when we look at the market's dynamics over time. So growth really took off in 2019 as the market was hardening. They entered 2019 with just over$200 million in premium volume. And today they do over$1.6 billion in premiums on an annual basis. So however, the market environment has normalized as it's softened. And we're seeing that in the growth figures as premium growth in 2025 was around 18%, while premium grew on average by 36 % annualized in the five years prior. However, 18 % premium growth is still very good for an insurance company.

54:20If the insurance industry continues to soften, then we could see Kinsale's growth potentially continue to slow. I think the most important takeaway is that the ENS market is cyclical, but it's still a market with structural long-term growth. And it's also important to keep in mind that the ENS market got that significant boost post-COVID. So it's important for investors not to get too tied or too anchored to the growth rates that we saw for Kinsale from 2019 to 2024 due to the unique market environment during that period. I think one of the other really interesting things about Kinsale is just how the management team just truly takes ownership of the company they're running.

55:02I mean, they take pride in the fact they've built really a best-in-class insurer. And the management team also owns sizable portions of stock as well. As you know, I like to look at management compensation and how management is incentivized. Because if you look at so many companies, one common denominator is just that people actually are incentivized to go in the right direction, right? I mean, that's so important for all the companies we look at. And Kinsale's CEO, for example, he owns shares worth about$350 million. The COO has$64 million stake, and the CFO has a stake of about$24 million. So for a company that's worth more than about$8 billion right now, this might not seem significant, but what matters more is not necessarily the value of the holdings relative to the size of the company, but actually relative to their own net worth.

55:49And when taking a look at the salaries of the management team, the salaries are relatively modest, which can help us further put into perspective how management is incentivized. I mean, these top managers can clearly increase their net worth much more by providing value to shareholders and increasing the stock price rather than making money just from a high salary. And Michael Kehoe, for example, he had about$1.2 million in salary in 2024, and he earned, I think, about$6.7 million in total compensation, which is relatively modest compared to his share ownership that is worth hundreds of millions of dollars.

56:25Yeah, I do agree with you that the incentives do seem pretty well aligned. And on that note, one of the things that I picked up in listening to Kehoe is just how passionate he is about this business. He knows the business from top to bottom. And he comes across to me as someone who treats his role at Kinzale very, very seriously and treats the company like it's his baby. And just again, this company was started in 2009 as nothing, and today it's worth$8 billion. So over the years, he's done several things that can just be incredibly difficult to do, such as attracting high quality talent, learning how to motivate them and retain them, and continue to encourage that culture of innovation.

57:06You and I sort of touched on this, but he seems like a value investor in the insurance space. And that's sort of what you can see in any industry. You did your episode on Constellation, Mark Leonard, he's been a value investor in the software space for years. And I think you can find that in a lot of great companies. And Kehoe, he especially knows the importance of having great people. And he knows that if there's a legacy insurer that just has a somewhat, let's say, mediocre culture or mediocre environment, mediocre growth outlook, then their top performers are going to want to be at a company that is a top performing company.

57:42And Kehoe knows how to attract some of that talent. Most importantly, retain them for the long term. And one of the other things that stood out to me about Kehoe is just how humble he is. He's certainly not looking to pump his stock price based on what I can tell. All he seems to care about is delivering results and being a good steward of shareholder capital. When I first started looking at these larger companies, I always felt like talking about culture seems so wonky. What exactly is culture actually meaning? But I think if you look at these companies, you look at their financials, you look at how management speaks, you will actually see and figure out for each company individually, what culture actually means.

58:21And I mean, listen to some interviews of Michael Kehoe, and you will understand how much he cares about the business. And then you will understand why he is so much more long-term focused than so many other companies in the space. And that's really something that you see in all the successful management teams, and therefore also in all the successful companies that you will look at. And I mean, when we look at the incentive structure for Kinsale. I mean, management's incentive plan is based primarily on company financial performance metrics, and only then adjusted for individual performance. So the three business metrics that make the most impact on the bonus include return on equity, operating profit, and of course, the combined ratio, which, in my opinion, is just an excellent combination, because it encourages the management to both pursue growth, but not at the expense of the return on equity or the combined ratio.

59:08And therefore, it kind of discourages pursuing reckless premium growth or underpricing any risks. So when Kinsella is operating in a soft market, which you just explained in a very good way so that even I understood it, it might be more difficult for them to get as much business as they otherwise would. So perhaps they might not get much benefit in terms of operating profit growth. But if they are disciplined in their underwriting, they can still earn part of their bonus just by generating a solid return on equity. And then the restricted stock awards, I think they're vests over a period of one to four years.

59:42They have similar performance metrics attached to those as well, which is one of those things that is always driving Sean crazy when he sees these stock awards vesting and you don't have to do anything but just staying at the company level. This is something that you don't see here. And just to repeat myself, I have looked at dozens of companies for our intrinsic value show, and you would be surprised how many bad incentive programs are out there. I mean, compared to those, I would think I would judge Kinsale's incentive structure as pretty much excellent. I mean, given that the management team is heavily invested in shares and gets compensated based on incentives that are, again, well aligned with long-term shareholders, that's just fantastic to see.

1:00:20And management definitely seems to be one of the high points in looking at this business. Many of the executives have most of their net worth invested in the company. And as a result, But they've built a wonderful business over the past 17 years. And with Michael Kehoe being around 60 years old today, I think I would expect him to be running this business for about as long as he can. And it always is difficult to look at companies that are operating in industries that you don't understand that well. And then even more important it is to kind of just take this sidecar approach where you know the management team is incentivized just as you are.

1:00:54Then it just makes it a lot easier for you to fall asleep at night. And maybe with that said, Clay, where do you see the business going from here? Clayton Yeah, I would first just like to reiterate what you said about fully appreciating what Kinzell's management team has built over the years. They understand at the end of the day, building a great company comes down to having those great people. And he's built a culture that understands how to create long-term value for shareholders. And it's something that for us is really difficult to communicate. Every company will tell you their culture is great.

1:01:26But the important thing is to figure out which companies truly have a great culture and truly have a culture that can endure for the long term. So I would say the people at Kinzale are data-driven, they're well-incentivized, and they have a culture of ownership as more than 50 % of employees do own shares in the company and everyone is paid bonuses based on underwriting profits. So the employee base understands the value of controlling costs and maximizing profits. To your question on where the business goes from here, that really is the key question. To try and understand and answer that, let's take a look at just their growth formula and the variables that play into how Kinzale grows.

1:02:06So Kinzale's business model is optimized to underwrite and ensure a large number of policies with these lower premium amounts. The size of their business is of course a function of gross written premium volumes. And the gross written premium volumes, this is a factor of four things. You have the number of inquiries for new policies. These are coming in from the brokers. You have the conversion rate of those inquiries that end up being insured by Kinzale. You have the renewal rate of their existing policies, and then you have the average premium per policy. So again, the number of submissions or inquiries for new policies comes from the brokers, and this number has grown at a fast clip year after year.

1:02:48And then a small portion of these will end up being insured by Kinzale. So looking at 2024, they received over 880 ,000 new business submissions, but just 7.3 % of those, or 64 ,000, end up converting as business for Kinzale. So the conversion rate, it's pretty consistent over time, and it tends to grow slightly each year as well. For example, the conversion rate back in 2019 was 6.6%. And then the retention rate is also important. So if they have a lot of policies that are churning out in one or two years, then they're on this hamster wheel of each year needing to replace the policies that dropped off just to maintain their business.

1:03:27So I was actually pretty surprised to find that a lot of their policies actually do churn out rather quickly. So for example, 2024, they issued 64 ,000 policies, but they also saw 43 ,000 policies lapse without renewal. So when you look at the renewal rate for policies that are set to expire, around 70 % of policies are renewed, meaning that around 30 % churn out. So that is one metric I would probably keep an eye on. If they're seeing that churn rate increase, then it's going to be more difficult for them to continue to grow. And then for premium volume, I highlighted that the average premium is around$15 ,000.

1:04:05Since their focus is on these smaller policies, I would not expect this metric to change significantly, at least in the near term. And then in terms of profitability, management does see room for the expense ratio to continue to decline as they increasingly use automation and spread out their fixed costs over a larger base of premiums. And as that gap between revenue and expenses widens, it also gives Kinzale the opportunity to push prices lower and potentially generate even more premium volume. So you can think of the scale of premiums and the amount of business they're going to end up getting.

1:04:40The higher they set premiums, the lower the conversion rate they'll probably see. The lower they set premiums, since the insured is very price sensitive, the more conversions I think you'll see for Kinsale. It's kind of like the Costco model. The lower that Costco lowers their prices, the more they'll see customers walking into their stores. However, I don't think we should expect top line growth of 20 % or more going forward. And I think the market is starting to recognize that reality as we've seen the price to book ratio re-rate from 10 or 11 just two years ago to around four and a half times book today.

1:05:14But even at four and a half times book, it certainly is not your typical insurance company when you're comparing it to other insurers. Through the cycle, I think it would be reasonable to assume that Kinsdale can grow somewhere in the 10 to 20 % range. They don't provide guidance. They don't necessarily know how fast they're going to be able to grow since there's sick locality, there's competitors that they're always going head to head with. But at a high level, the P &C industry, it grows at around the rate of the broader economy. The E &S industry, it tends to grow at a multiple of that. And I think that Kinsale is well-positioned to continue to steal share in the market.

1:05:53So that gives us, let's say, 6 % to 7 % plus for the E &S growth of just the market overall growing. And then Kinsale, I would expect them to be growing at some rate faster than that, right? Because they are well-positioned to continue to capture share. So through the cycle, let's call it seven to 12 years, I think premium growth of at least 10 % on the lower end is certainly reasonable. So given that Kinsale has less than 2 % share in the market today, I see ample opportunity for them to continue to steal share in this$100 billion ENS market. Lastly, part of their growth algorithm is simply a factor of how many quotes they can push out to brokers.

1:06:32And that's just a function of their headcount. For the time being, AI, at least Kinsale says, is not going to replace underwriters. And Kehoe, he's actually highlighted the importance of keeping human underwriters, which I believe currently account for roughly half of their workforce. So as they continue to hire more underwriters, it's only logical to assume that this will help support continued growth. We've already talked some numbers now, but I think it's kind of time to get to the part that Sean and I always look forward to the most in our stock breakdowns. And that's the valuation. So we know that the valuation of insurance companies is often judged based on price to book.

1:07:11But this metric would have been practically useless for a company like Kinsale. So what is actually the best way to go about valuing this company? I almost feel like I want to give a management response and cop out on the answer because we just don't know what the future holds. but I'll try and share some helpful information that I can because insurers are certainly tricky to value because it's difficult to determine what the normalized earnings are. One insurer can look cheap because they've been under-reserving for years and they have a lot of big claims coming up just around the corner, while a more conservative company might look a bit expensive because they've been very prudent with the way they're setting reserves.

1:07:49So the quality of the management team and the way they handle the underwriting and setting reserves, it just can't be understated. We're sitting at around$360 a share here towards the end of March, 2026. Their price to book, again, is four and a half times. The PE is 17 or 18. And we haven't seen a PE ratio this low for quite a while. And it's actually since the IPO. But the question is whether the business's future prospects justify the lower PE. So the trouble with using price to book for Kinzale is that the book value is just growing so fast. So investors might've looked at a price to book of five in 2018 and immediately just said, that's ridiculous.

1:08:32And since then, the book value has increased by more than seven times. So today's price to book ratio is much lower than where it's historically traded, but still it's much higher than traditional insurers. So most traditional insurers are treated like commodity-like businesses because that's what they are. and they tend to be businesses with low growth and low ROE. But in my opinion, Kinsale should not be closely compared to these other insurers given their track record of achieving high growth alongside high return on equity. And just to give a frame of reference, while Kinsale compounded their book value at 33 % since 2018, Berkshire Hathaway compounded their book value at 10 % over the same period.

1:09:14Finally, the business's growth has started to slow over the past one to two years. And that's led many growth investors exiting and bringing the stock price down pretty significantly. So Kinzale's PE, it was over 40 just three years ago. And now it's been more than cut in half. The stock market tends to reward this smooth, predictable growth, and it dislikes surprises. And Kinzale had this strong, fairly consistent growth for several years during the hard market. And as the market softened, you saw that growth decelerate. So the market has this distaste for lumpy or more cyclical growth, and that can serve as an opportunity for investors who are more patient in letting the business continue to compound through the cycle and over time.

1:10:00Where the stock price goes from here will largely depend on the return on equity and the rate at which they can continue to reinvest earnings to pursue new opportunities in the E &S market. So over Kinzale's history, the vast majority of its earnings have been reinvested in the business, which has helped propel the exponential growth in book value that we've seen. So when I look at some other comps in the insurance industry, the growth rate and the ROE for other insurers, it just doesn't compare to Kinsale. So the only way I could see the valuation further compressing is if growth continues to decelerate or we see that return on equity coming down.

1:10:39If that does happen, I would expect it to be more due to the tightening of competition, competitors entering and really trying to compete with Kinsale on price rather than mismanagement of the business. And amazingly, again, book value is compounded at a very good clip. And even if that book value growth slows from say 30 % to 10 % to 15%, I would still expect the intrinsic value of this business to coincide with that growth in book value. And investors don't need all of the growth to come in the form of premium volumes, because this is a business that does experience some operating leverage due to their increased use of technology.

1:11:18So one would expect that profits are going to continue to compound faster than revenues and premium volumes. I'm actually glad that this time it was you having to make the valuation because it really can be difficult at times, right? And again, I mean, we emphasized on this before, but for a business like this, it really comes down to whether you trust the people at the helm of the company. And then you can look at the track record, which has been phenomenal, but also growth is slowing down. It's very difficult to assess, especially for cyclical companies, where the bottom of that is. So that's why I'm saying, you either decide to go with the management team and say you double down on a company that has phenomenal people at the helm, plus the track record to clearly be better than the average company in the space.

1:11:59But then there are also risks that are involved. And we didn't really talk about them yet too much. But cyclicality is a clear risk that stands out to me. I mean, Kinsale is, to some extent at least, still at the whims of what is happening around them and how their competitors are behaving. And as you mentioned, I mean, the cyclical nature of the industry, it does also have an impact on the stock price as well. When Kinsale is firing on all its cylinders, growth investors, they tend to hop on board and push the stock to elevated levels. And then when the cycle turns, they will push the stock price to the other direction.

1:12:31This obviously is also a chance. And we have this company today because we believe we might be at that point. But there are also other risks that come to my mind. And one of them is competition. Because one thing that you usually see in capitalistic systems is that strong profitability coupled with high growth rarely goes unnoticed. And that's why the market gave 40 times PE to this company a couple of years ago. So it does seem like it's only a matter of time before strong competitors will enter the market. And at the end of the day, Kinsale still sells a commodity product. So it seems that it's only a matter of time before the high returns normalize.

1:13:07But the question really is then, when is that actually happening? Yeah, you're certainly right that at the end of the day, Kinsale is still a commodity business that has sort of been an anomaly with its track record. But I would also say that it will not be easy for a competitor to replicate their strategy. Legacy players are bogged down by outdated technologies and inefficient workflows, but that doesn't mean that they can't compete with Kinzale more closely, even if it means poor returns for them, which might mean that Kinzale brings their prices down even further, which could mean lower but still strong returns on equity.

1:13:46Think ROE of say 15 % to 20 % instead of 25 % to 30%. So I'll highlight a few other risks for investors. So Kinsale operates in the ENS industry, which by definition, it contains these risks that can be difficult to assess. Although their history of pricing these risks is sullen, there's always the risk that this changes as they continue to grow and ensure all sorts of different types of risks in the industry. If underwriting discipline were to weaken or if certain risk classes were mispriced, the impact on loss ratios could be severe. And on a related note, the reality of the insurance industry is you sort of need to be prepared for the unexpected.

1:14:30So if a catastrophic event happens, for example, a hurricane impacts several of their properties that they've insured, then this could negatively impact Kinzale. And we haven't really touched on this, but insurance companies, they tend to get what's referred to as reinsurance. So reinsurers are insurance for the insurance companies. And this helps protect them against these catastrophic events that are really tail risks that have a very low probability of happening. But once or twice every 100 years, they tend to still happen. The next risk I'll highlight is broker concentration. So Kinsel, they distribute their products through 180 or so brokers, but the top five brokers account for more than half of their premium volume.

1:15:13So this level of concentration isn't unusual in the industry, but if they were to lose just one of these brokers, whether due to relationship changes or strategic shifts, then that could meaningfully impact Kinzale in the short run. However, they help mitigate this risk by building a reputation for the responsiveness and reliability, which has helped contribute to a steadily rising flow of submissions. There's also investment risk. So Kinsale earns a pretty considerable amount of interest income through their fixed income security. So if interest rates were to decline, for example, then Kinsale would be receiving much less income through their investments.

1:15:53And the last risk I would highlight is key person risk or the erosion of the culture. So Michael Kehoe, he is key to what has made Kinsale the great company it is today. if he were to step away for any reason, then that could impact the business pretty significantly. We'll mention Constellation here, for example. Many people expected Mark Leonard to be around the rest of his life, perhaps a decade or more. But things can happen that are just totally unpredictable and lead to changes at the company and who's leading them. So if that innovative culture of Kinsale started to erode, then the gap between them and their competitors, it would probably gradually close over time.

1:16:32Constellation is actually such a good example for that because it's probably one of the most decentralized companies out there. And still, you had this key man risk, which also to some extent played out. But yeah, I would say that's about it for today. I very much appreciate you joining me to break down Kinsale Capital today, Clay. This is a company that so many of our listeners have talked to us about. Oftentimes, we need to cover this and always felt like the insurance industry is just so difficult to understand. So it's perfect that you were able to join us today. And it's just always interesting to dive into these best-in-class businesses that operate in industries that many investors just tend to shy away from.

1:17:10So Sean and I have looked at many such companies on our show as well. And after studying enough of these businesses, you just start to see some patterns emerge. I mean, you often have these ambitious founders at the helm, which is also the case here with Kinsell. You have a great culture, which again, is the case here with Kinsell. And you just have these lean cost structures that tend to bring higher margins and managers with skin in the game. And I think that Kinsel just fits every single one of those categories. And I actually look forward to seeing how their story continues to unfold because it seems to me that they are, you know, there's still very early innings of where they're heading to.

1:17:45Even if you just look at the market share and you say it's about 2%, it seems like there's a lot of runway left. So yeah, I think it's a good place to wrap up the episode. So again, thanks for joining me, Clay. and I really enjoyed this discussion. Excellent. Thanks a lot, Danielle. Thanks for listening to TIP. Follow We Study Billionaires on your favorite podcast app and visit theinvestorspodcast.com for show notes and educational resources. This podcast is for informational and entertainment purposes only and does not provide financial, investment, tax or legal advice. The content is impersonal and does not consider your objectives, financial situation or needs.

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