Kinsale Capital Group CEO Michael Kehoe at the 30th Annual Baron Investment Conference

Thanks Josh, good morning everybody. It's great to be with you. As Josh said, Kinsale insures businesses that other insurance companies don't want to handle. So I'm going to explain with a little bit of background information first. The property casualty industry in the United States is a large, mature industry. It's about a trillion dollars of premium that will change hands this year, 2023. That market is dominated by all the name brand insurance companies we're all familiar with: State Farm, Allstate, Travelers, Hartford, Liberty Mutual, etc. But about 11% of that $1 trillion, so about $115 billion, falls into what's known as the specialty market. Sometimes it's called the non-standard market or the excess and surplus lines or E&S market. Essentially, it's a market that exists specifically to handle risks that can't find a home amongst those standard lines companies. You've got your standard companies that focus on writing what we would call preferred business, low-risk or good business. Anything that qualifies as more high-risk, high hazard, they typically don't want it, and it drops into the non-standard market where Kinsale competes. When you insure high-risk business, we have to get paid for that risk we take. The things that make an account high risk are pretty varied. It could be a brand new business that doesn't have the requisite track record of careful management. It could be a business that's located in a litigious venue. Companies like Kinsale tend to write a disproportionate amount of our business in states like New York that tend to be much more litigious than other states. California, Texas, Florida, these are all big states because they tend to be a little bit more litigious than some other states. It can be a business that manufactures a high-hazard product, power tools, or maybe you import children's furniture from China, or maybe you manufacture a pharmaceutical or a nutrition related product that if it goes bad could injure somebody. A lot of times it's just businesses that have a poor loss history, they just present too many claims and so they get expelled out of the standard market. But whatever the rationale, companies like Kinsale use our freedom of rate and form to offset the hazard level by charging a higher price and offering more restrictive coverage. The freedom of rate and form is just one little regulatory piece that's interesting. Standard companies are subject to a tremendous amount of regulation at the state level. Typically they have to file rates and forms with the state. If they want to change their pricing, they have to make new filings. Whereas E&S companies like Kinsale operate in more of a free market environment. We can charge what the market will bear and we can adjust coverage on a case-by-case basis. That allows us to handle a very heterogeneous mix of business. It's not always predictable the things we have to entertain. We recently wrote professional liability on a dentist that had been accused of sexual misconduct with his patients. He was a talented dentist notwithstanding his personal problems. We have to structure coverage in a way that we're going to insure you if you make a mistake in providing dental care, that's predictable, something we can price for, but we can't cover any kind of intentional misconduct. We'll use that freedom of rate and form to adjust the coverage to make sure there's no way we're going to get dragged into a claim related to sexual misconduct. Even though we write high-risk business, Kinsale has a lot of competitors. I think there's about 75 or so companies that compete in our space. All the big companies like AIG, Chubb, Liberty Mutual, they have subsidiaries dedicated to this market. There's a lot of little boutique insurance companies that we compete with. The largest of all would be Lloyds of London. Lloyds, I think, gets credited for creating insurance maybe back in the 1600s. Last year, Lloyds wrote about 16% of all the business in the United States E&S market, so they're a big competitor as well. I figured it might be appropriate at this point to just go through a few of the attributes of our business that we think set us apart from the pack a little bit and go a long way to explaining the financial results we've been able to achieve over the last four years. We were a private company for a number of years and then as Josh said, we went public back in 2016. Our business strategy starts with a focus on the E&S market. That's all we write, and I think we're the only company that has that kind of focus in the marketplace. The interesting thing you should know about E&S, even though we write high-risk business, historically the profit margins have been superior to the broader standard market, and likewise the growth prospects have been superior. We live in a litigious world, the tort system is always changing, and E&S companies are a little bit better equipped to change with the marketplace to provide a good service to our customers in the form of competitively priced insurance, but at the same time making sure we're delivering a strong margin for our company. We focus on small accounts really for a similar reason. There's this inexorable tendency for insurance company underwriters to want to focus on large transactions. The reality is, as the account gets larger, the competition gets more intense and the margins for the risk bearer get squeezed. We're very comfortable focusing on that small transaction. We average today about $155,000 per policy, and we think that's a very nice safe harbor. The last several years we've been in what we call a hard market, where insurance companies actually have a little bit of pricing power. Before that, we were in a very competitive market, we call that a soft market. But hard or soft market, focusing on that small E&S account gives us a perpetual opportunity to serve our customers and generate attractive profits at the same time. The second point here is maintain control over the underwriting and the claims management process. I think it's a little bit underappreciated outside the P&C industry how much insurance companies rely on external parties to underwrite their business. This is especially true for small accounts because the volume of transactions is tremendous. I look at Kinsale as a kind of boutique insurance company. Last year we wrote $1.1 billion of premium and we had over 600,000 submissions that came in from our brokers around the United States asking us to quote the insurance on a specific risk. We sent out over 400,000 quotes. We ended up binding 40 or 50,000 of those new business policies. We bound another 50,000 or so renewal policies, and then several tens of thousands of additional transactions like policy changes, inspections, audits, cancellations, reinstatements. We get in thousands of claims every year that have to be investigated, negotiated, and resolved. We finished 2022 with 457 employees. I would argue, just anecdotally, that's a relatively modest headcount given the volume of work that's underway at our company. I think that's the crux of why so many of our competitors outsource the small account underwriting. We think on its face it doesn't make sense. What is the core competency, or what should be the core competency, of an insurance company? It's to segment and price risk. That's an expertise that you never actually achieve. You're always looking to improve, you're always reacting to claim trends or inflation in the marketplace or new industries that come up, like the vape business. The electronic cigarettes, they didn't exist 10 or 12 years ago, right now they're ubiquitous. Insurance companies that are good are constantly pouring effort into getting better at the underwriting. But if you contract that out to specialty brokers called managing general agents, MGAs, if you contract out the underwriting to an external party, it would almost prevent you from this continuous improvement. It also introduces an important misalignment of interest. These MGAs, these specialty brokers that underwrite on behalf of insurance companies, get paid based on premium volume. They're sales organizations. The sales function is critical in insurance, but we don't pay our underwriters based on volume. Their number one job is to underwrite to a profit, and their second job is to grow the business. We see a tremendous amount of inaccuracy in the insurance procurement process that we think stems in part from this misalignment of interest. We see nightclubs trying to buy insurance as though they're fine dining restaurants. We see businesses that have been in operation for a number of years that have a poor loss history pretending to be new businesses so they can expunge that loss history. We lost an account earlier this year. It was a very tough products liability account, it was a firearms manufacturer. We quoted the renewal policy at $170,000 premium. For us, that's a big account. We lost that to an MGA that wrote it for $57,000, so one third of our pricing. But importantly, they wrote it at the low price because they misclassified it. They considered it a sporting goods distributor instead of what the business actually did, which was manufacture firearms. It creates a question. Number one, if you charge the wrong risk, you're not going to generate an adequate return for your investors. But beyond that, you also have the challenge of how do you manage profitability if you don't even know what you're insuring? It's a real challenge for the industry. It goes back to these massive volumes of transactions. I had a competitor tell me a number of years ago, we can't afford to underwrite $10,000 policies. Of course, you can't afford not to. But I think what he meant was we don't have the technology, the business process, the personnel, the systems to handle that massive flow of work without an enormous headcount. In this day and age, you have to be automated in how you operate your business if you're going to be competitive. It segues into the third thing. When we started Kinsale 14 years ago, we decided that our core competencies as a business are going to be underwriting and claim handling, but we added technology to that. Technology is changing so many things about our society. It changes how we communicate with each other, it clearly changes how businesses process and accomplish work, it changes how businesses communicate with their customers. Given how data centric an insurance company is, we felt that was imperative for us. We've built a tremendously talented group of IT professionals. Our headcount today is about 545 full-time employees. About 120 of that 545 work in our IT shop. A few of them are focused on network security, desktop support, but the bulk of the headcount is focused on constantly innovating and rolling out new features and functions, taking manual tasks, pushing them into the software, doing all the things we have to do to innovate and get better with how we run our business. Most insurance companies take the opposite tact. They outsource the technology. It's a complex function to manage inside an insurance company, but once you build it, it provides some very powerful competitive advantages. Just a quick anecdote. We had a young woman who was a claims examiner in our office. We're based down in Richmond, Virginia. She left our company to go to one of our competitors in town. She still has friends at Kinsale, and she was having lunch with them and complaining about the new company she went to. The systems are a disaster. She has to go in and out of six or eight different systems all day long to accomplish her job, whereas at Kinsale she had one integrated system. It's just a reminder that for old line insurance companies that have been around a long time, most of them have been built in part through acquisition of other insurance companies. They're all dragging along legacy software, not one system but in some cases dozens and dozens of legacy systems that go back 20, 30, 40, 50 years. Kinsale has no legacy software. We do have some software that's dated, but it goes back 10 or 12 years, not 30 or 40. We're constantly rewriting our system to improve it. The small account E&S focus is really a positive indicator for profit and growth. Adding in the fact that we control our own underwriting is another competitive advantage that I think has real durability to it. We get there through technology. It took us 7 years to build our own enterprise system. This is the main workhorse system that we use to operate our business. I'm sure other people can do it, maybe they could do it in six years, but they can't do it in two or three. It's a massively complex undertaking. I think the technology also creates a durable competitive advantage. That segues into the fourth bullet, which is this idea of taking a quantitative approach to the business. There is so much folklore and whatnot that governs how insurance companies are managed. Just one example of how we use data to manage the business. About seven or eight years ago, one of the actuaries or quantitative type analysts in our company was doing some analysis of when we bind a piece of business. You're sending out hundreds of thousands of quotes. We're looking to get smarter about when we bind versus when someone else does. One thing that leaped out of the data was the quicker you offer the broker the terms, the higher the probability of a bind order. But that flew in the face of the P&C tradition, which is allowing each underwriter in the building to take his or her time to quote what they want when they want. This evolved very quickly into a complete change in how we service our brokers. We put enormous emphasis on quoting the highest volume of submissions that come in, as long as they fit our risk appetite, and then we quote them as fast as we can. The brokers love it. We are the only company in our industry, in this E&S market, that provides a level of service that we do. The beauty of it is we can then be more aggressive in pushing up our prices slightly higher. We can push the broker commissions we pay to our brokers down slightly. We pay a little bit less commission than all of our competitors in many cases. We can offer slightly more restrictive coverage, which helps us drive a more predictable loss ratio, all because we give our customer, the broker in this case, a more pleasant experience. It's a very contrarian approach to the business. It's hard to execute. It took us a number of years to change people's behavior, but it's a powerful driver along with these other elements in helping us reach the goals that we have.

This slide just kind of reiterates some of the things we've talked about, the focus on the E&S market and some of the main elements of our business strategy. One thing we haven't talked about is business culture. Culture is something that, I think Jack Welch, the old CEO of General Electric, used to call it social software. It really does contribute enormously to how people behave in an organization, but it's admittedly hard to reduce it to a few metrics where you can compare us to our competitors. I would tell you that Kinsale is an entrepreneurial startup company, even though we've been in business now 14 years. We consider ourselves owner operators. Certainly the leadership team, but many of the rank and file employees have invested very significant amounts of our net worth in the business. We consider it our money and we manage the company that way. I think it's a big contributor to the success we've been able to achieve over the years. This slide just kind of captures the fact that there's a lot of diversification in our book of business. We service the small E&S marketplace. We've got 23 verticals or underwriting divisions within our underwriting department. The idea of getting our underwriters to focus on either an industry segment or a coverage helps ensure that we're driving a lot of expertise at the transaction level. We talked about technology and how important that is to us. Over 20% of our headcount is focused in the tech area. One last thing that the technology provides is an opportunity to operate at a much lower cost structure than our competitors. If you're familiar with the personal auto space, we all get carpet bombed with ads. Geico and Progressive are the two low cost leaders in personal auto. For 25 or 30 years in a row, they've been delivering good returns and taking market share from their competitors. 25 years ago, they were each about 2% of the personal auto market. Now they're about 14%. Kinsale is executing a very similar strategy in the E&S market, not personal auto. Last quarter, I think our expense ratio, so that's all the expenses we have to operate the business excluding losses, our expense ratio is just right around 21%. Most of our competitors that focus on the small account market are in the mid-30s. I think Lloyds on its small account business may be above 40%. It's almost an unbelievable advantage. In a commodity business like insurance, I promise your customers care about cost more than anything. To have a low cost structure means we can offer more competitive pricing to the business owner, but at the same time deliver better returns to our stockholders. The last slide here is just a look back at our operating return on equity over the last several years. You can see that gradual increase in the profitability of the company. That's really reflective of the Kinsale model, but also the marketplace we've been operating in. There's been a rise in dislocation, financial distress amongst some of our competitors, and it's given us an opportunity to push up pricing, to charge our customers a little bit more, to grow our business a little bit more quickly. You can see the elevated returns there. We've had a lot of inflation the last couple years. That can be painful to an insurance company because insurance companies collect the premium today and we pay the claims out over a couple year period of time. At Kinsale, we're well protected against that because we always set aside a lot of what we would call a conservative level of reserves to pay future claims. Sometimes our competitors aren't so cautious. It's really given us a nice opportunity in the last few years, and we continue to be quite optimistic. Josh, that's the end of my prepared remarks.

I think the principal reason is loss costs are rising. The United States has a state-based tort system. In general, the tort system grows a little bit faster than the economy every year, and it grows in a fairly predictable fashion. It allows insurance companies to very accurately and moderately increase pricing to make sure they're covering their costs and generating a return. COVID was a wild event from an insurance standpoint in terms of upturning predictability. The whole economy, I mean a dramatic slowdown in the economy. People stopped driving to work, the number of miles driven just collapsed. The tort system also saw an incredible reduction in the number of lawsuits filed. People stopped going to the doctor for elective procedures. Then as things opened, there's a rebound effect that was equally unpredictable. When you add in the fact that we've had this rise in inflation the last couple years, I would really attribute the discombobulation in the industry to that. Insurance rates are rising for individuals. Keep in mind, for Kinsale that's good news obviously. For consumers it's not. There's also a last element which is related to the weather. Depending on where you live, if you buy a homeowners insurance policy and you happen to live on the Gulf Coast or in the southeast United States where there's a pronounced exposure to hurricane, there has been a big uptick in hurricane activity since about 2016. Multiple storms in Texas, Florida, Louisiana, and they can be wildly expensive for the industry, tens of billions of dollars, and they come all at once. A lot of insurance companies lost money in this uptick in natural catastrophes. You have a similar phenomenon out west with wildfires. Americans like to live on the hill looking out over Los Angeles. It's a beautiful view, but it comes with a lot of risk. The insurance companies in a lot of ways are playing catch up from some of these trends.

Candidly, there are a million lessons learned. As you operate a business, you're constantly looking for ways to improve what you do. I would say one of the more interesting challenges of being a business manager is how you interact with people. People are ultimately the foundation of a successful business. You have to recruit and retain good quality people that share your commitment to building a great business, serving the customers, etc. There's an interesting balance. You have to treat people with respect, you have to be kind, I think you have to be patient, but you also have to hold people accountable. There's an interesting balance there. I'm not sure there's a bright line rule you can reference to say this is the right way to balance the accountability with the patience. I do think it's something that over time you get better at. Sometimes people are in the wrong jobs, and we've got to take somebody out of that job, but we really like the individual and that person has a family and maybe that's the principal breadwinner in the family. There's always a lot of rationale to go slowly, which is appropriate. But at some point, you have a tremendous responsibility as a CEO of a company. You're the steward of other people's money, and you can't be too myopic about just looking at the individual and forgetting your broader responsibility. Not to say I forgot it at James River or one of these prior companies, just that the experience of working at one E&S company and then going to another and then another, I think you just learned some great lessons in how to better manage people.

I'm going to start in reverse first order here. We're doing a lot of experimenting with AI. There's some interesting and dangerous exposures that AI brings to network security. Someone could make a video, a fake video of Ron Baron telling Josh to wire money to a nefarious account, and it may look like Ron on the video or the voicemail, but it's really an impostor. The network security guys are very concerned about AI and what that can do to fraudsters. We're using AI in our product development area. We have a lot of quants that we employ at Kinsale, and they're using AI to test various forms of third-party data that we purchase from other companies to see if it's predictive of loss or not. Ultimately, the underwriting function where you look at a business and you classify the risk, AI will have a more prominent role in that. I think it's all coming in the future and gradually over time, but clearly we're doing a lot of work to be innovative in that area. In terms of health insurance, the insurance industry broadly divides into two buckets: health and life, and property casualty. We're on the P&C side. Health insurance has its own challenges around third party payers, the person paying the bills not the person consuming the service. I think that gives rise to a misalignment of interest. Obviously new technology and new pharmaceuticals are just tremendous in being able to improve human welfare, but sometimes they come at just staggering costs. Society has to work through how those technologies will be made available broadly. Lots of challenges there, but candidly I'm just a consumer on the health side.

The network security guys are hard at work on that as we speak. I think right now the videos are primitive enough that you would be able to tell, but they won't be for long. The fraudsters are becoming more convincing and they're using AI as a tool to do that. I think companies, not just insurance companies but all companies, need to obviously be vigilant and work on staying abreast of the threats and making sure that they're contained. It's a little bit of an arms race.

We don't set the stock price of course. I would say this. The business, we're executing the same plan today that we started with 14 years ago. Obviously it evolves continuously. We've broadened the product line, we deploy more technology today than ever. The results have continued more or less in a similar trajectory. We've grown the business at a good clip, we've produced best-in-class returns. The stock has run up quite a bit this year. I think even with the selloff in the last week or so, we're still up somewhere in the mid-30% range year to date. That's a lot of price appreciation. I don't know, maybe Josh has a better opinion, but guys have been executing well. I'm happy with 30%.

I think part of it is we manage our capital very carefully. We really serve two masters when it comes to capital. One, we have to have enough to satisfy state regulators. The more onerous capital standard comes from a company called AM Best, which is the principal rating agency for the insurance industry. AM Best has a complex capital model. They look at your reserves, your premium, your investments, your growth, and all sorts of things, and come up with an amount of capital that you have to have to protect the policyholders. We always make sure we have more than enough, but only a little bit more than enough. A lot of our competitors have a real abundance of capital beyond what they need to operate their businesses. I think in some ways, that price to book value can be an apples and oranges comparison. The other thing is Kinsale has generated very attractive returns and a very good growth profile for a long time now. I think the marketplace is rewarding us for that. The last comment I'd make is if you look at Kinsale's price as a multiple of earnings, of prospective earnings, I think you would find that we don't trade anywhere near as high. We still trade at a high multiple, but nowhere near four or five times what other companies are.

No, the homeowners are not out of luck. Generally speaking, it's just the cost of that risk transfer is going up dramatically. There is a segment of homeowner, if you live in a very old house, I'm thinking of Fort Myers, Florida right now. You had a devastating storm. You had a very old housing stock. Older homes perform very poorly in high wind speeds. High wind speeds result in catastrophic damages, the home is effectively destroyed. Florida has dramatically improved its building codes over the years. They're the best in the whole country by far. But those building codes are a lot more expensive than what it cost to build these older homes. There's a situation where a lot of those homeowners are effectively being pushed out of their homes. They can't afford to rebuild, in part because the insurance costs are dramatically higher and in part because the building costs are dramatically higher. There is a market for the insurance. It's just for the consumers, I think it looks absurd. I was paying $3,000 and now somebody wants to charge me $15,000. It looks like just outrageous price gouging. What the consumer forgets is these insurance companies, some of them have become insolvent. If they didn't manage that cat exposure, we call it cat, natural catastrophe exposure, carefully, it will bankrupt the company. Even if the company's not bankrupted, a lot of companies in Florida lost a fortune. You're our stockholders. We serve you. You've invested with Kinsale because you're counting on us to be smart business people and to operate at a profit. It's just a real challenge for homeowners in places like Florida if they're in close proximity to the beach, but there is a market.