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Edited Transcript of KNSL earnings conference call or presentation 2-Mar-17 2:00pm GMT

Thomson Reuters StreetEvents

Q4 2016 Kinsale Capital Group Inc Earnings Call

Mar 2, 2017 (Thomson StreetEvents) -- Edited Transcript of Kinsale Capital Group Inc earnings conference call or presentation Thursday, March 2, 2017 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Michael Kehoe

Kinsale Capital Group Inc - CEO, President

* Bryan Petrucelli

Kinsale Capital Group Inc - SVP, CFO

* Brian Haney

Kinsale Capital Group Inc - SVP, COO

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Conference Call Participants

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* Mark Hughes

SunTrust - Analyst

* Sarah DeWitt

JPMorgan - Analyst

* Mark Dwelle

RBC Capital Markets - Analyst

* Adam Klauber

William Blair - Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen. Before we get started, let me remind everyone that through the course of the teleconference Kinsale Management may make comments that reflect their intentions, beliefs and expectations for the future. As always, these forward-looking statements are subject to certain risk factors which could cause actual results to differ materially.

These risk factors are listed in the Company's various SEC filings including the second quarter 2016 Form 10-Q, which should be reviewed carefully. The Company has furnished a Form 8-K with the Securities and Exchange Commission that contains the press release, announcing fourth-quarter and year-end results. Kinsale Management may make reference during the call to underwriting income which is a non-GAAP financial measure of financial results.

Kinsale's underwriting income represents the pretax profitability of the Company's insurance operation and is derived by subtracting losses and loss adjustment expenses and underwriting, acquisition and insurance expenses from net earned premiums. The Form 8-K contains reconciliation between net income and underwriting income. The Form 8-K and press release are available at the Company's website at www.KinsaleCapitalGroup.com.

I will now turn the conference over to Kinsale's President and CEO, Mr. Michael Kehoe. Please go ahead, sir.

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Michael Kehoe, Kinsale Capital Group Inc - CEO, President [2]

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Thank you very much for that. Good morning, everyone. Thanks for joining us. I'm the CEO of Kinsale and after my introduction I'm going to turn things over to Bryan Petrucelli, who is the Chief Financial Officer, to provide some additional financial results and after that, Brian Haney, Chief Operating Officer of Kinsale, will provide some color on Kinsale's operations and the market in which we compete.

Last night, Kinsale reported favorable results for the fourth quarter, the highlights of which include the following. Net income of $6.9 million up 49% over the prior fourth quarter of 2015; annualized ROE of 13.1%, combined ratio of 75.3%; underwriting profit of $9.5 million and premium growth of 5.1%. Kinsale's strategy combines disciplined underwriting and claims handling with a technology-enabled, low-cost operation. And we think this is a powerful model in any market, but it's especially so during a highly competitive point in the insurance cycle, like we're in today.

Kinsale's customers demand competitively priced insurance policies and the Company is in a position to offer such terms without compromising its profit margin. Its costs are -- range from 20% to 40% lower than many of its competitors. With that I'll turn it over to Bryan Petrucelli.

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Bryan Petrucelli, Kinsale Capital Group Inc - SVP, CFO [3]

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Thanks, Mike. As Mike noted, the fourth-quarter was another good quarter for Kinsale. As a reminder, the Company's goal is to consistently generate a mid-80s or lower combined ratio and to produce a return on equity in the midteens over the long-term.

For the fourth quarter, the Company generated underwriting income of $9.5 million on a combined ratio of 75.3% and an annualized ROE of 13.1%. Underwriting income benefited from $3.8 million of net favorable prior-year loss development for the quarter, that amount is $5.1 million after excluding effects of our quota share. Gross written premiums were $47.5 million representing a 5.1% increase over the fourth quarter of 2015. For the full year, gross premiums grew by 6.5%.

Premium growth continues to be generated from an overall increase in policy count primarily from the small business division, personal lines and some of the Company's new product offerings such as management liability, inland marine and public entity. We continue to be conservative on the investment side with an approximately 96% fixed income allocation, a AA average credit rating and a weighted average duration of 3.7 years. Investment income did increase by 29.8% over the fourth quarter 2015 as a result of growth in the investment portfolio. Our gross investment returns continue to be in the low 2% range.

For the fourth-quarter, basic and diluted EPS was $0.33 and $0.32 per share, respectively. As we discussed last quarter, the year-to-date EPS metrics are a bit difficult to interpret as GAAP accounting rules require that we recognize the capital structures in place before and after the IPO. On a normalized basis, and assuming the Company's current capital structure was in place for the entire year, basic and diluted EPS would have been $1.25 and $1.23 per share, respectively, for the year.

With that I'll pass it over to Brian Haney.

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Brian Haney, Kinsale Capital Group Inc - SVP, COO [4]

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Thanks, Bryan. As Bryan just noted, premium grew 5.1% in the fourth-quarter. The submission growth rate was in the midteens. Over the long run we expect submission growth and premium growth to track more closely. Although the market is still highly competitive we have noticed pockets in the industry where some of our competitors are pulling back due to adverse experience. The fact that some competitors are reporting stress in their results will be a positive for the trading environment if it were to continue or accelerate.

Turning to product development, we feel that we already have a pretty broad product offering for a small boutique insurance company, but we're always looking for ways to expand what we offer. Late last year we launched a private company D&O products in our management liability division and an educational institutional liability product in our public entity division. We also developed a med mal product for Pennsylvania and launched a small business commercial liability product for California in our (inaudible) unit.

Moving on to rates, in the fourth-quarter, our technical rates were essentially flat. Now I'd like to touch briefly on a few current topics facing the industry. Commercial auto is an area that has posed problems for some insurers. I would just like to point out that we write an immaterial amount of commercial auto; less than 3% of our total volume, and for what it's worth, the experience on that small amount of business has been excellent. We also don't write business through delegated underwriting authority arrangements, what some people call programs. This is another area where some competitors have seen adverse experience.

When carriers pullback from the program space, as some have recently, we tend to see an uptick in opportunity as those accounts look for new homes. And it's also worth noting we are still 100% surplus lines; we don't write any admitted business, which is why we don't write any workers comp. And lastly, we did have some property exposure in Hurricane Matthew. At this point, it appears that losses will come in below $1 million pretax so we feel pretty good about how the property portfolio performs.

And with that I'll turn it back to Mike.

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Michael Kehoe, Kinsale Capital Group Inc - CEO, President [5]

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Thanks, Brian. One final topic and then we can move on to questions. There was a steady rollout of newly completed technology projects in the fourth quarter including some of the new product offerings that Bryan just spoke about a moment ago. Perhaps the most significant IT project that's been completed recently was just rolled out here earlier in the first quarter of 2017 and it's the completion of the Kinsale enterprise system.

With the release of our new policy booking system earlier this quarter, Kinsale now operates a completely proprietary, end-to-end enterprise system that saves the Company time and expense in processing its business, in developing new system features and functions and applications, in the maintenance of the system over time and of course, in licensing fees. Completing the Kinsale enterprise system will accelerate the rollout of new IT projects as we move forward and we believe it augments Kinsale's technology competitive advantage in a material fashion.

So, operator, with that, we're ready to take any calls that are pending.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Mark Hughes, SunTrust.

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Mark Hughes, SunTrust - Analyst [2]

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Yes, thank you. Good morning. Am I correct in thinking -- -- I think your other expenses category is $1.1 million. Is that largely nonrecurring? What is in that bucket?

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Bryan Petrucelli, Kinsale Capital Group Inc - SVP, CFO [3]

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Yes, Mark. Those were the cost that we incurred associated with our secondary offering.

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Mark Hughes, SunTrust - Analyst [4]

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Right, so you might say nonrecurring would be the other expenses plus Hurricane Matthew?

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Bryan Petrucelli, Kinsale Capital Group Inc - SVP, CFO [5]

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Yes, I would think that would be accurate, Mark.

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Mark Hughes, SunTrust - Analyst [6]

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The commercial auto, is that something you would be comfortable pursuing? Sounds like your experience is good; rates are presumably going up. Would you look to increase your exposure there?

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Brian Haney, Kinsale Capital Group Inc - SVP, COO [7]

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It's tough for us to write commercial auto, much commercial auto because we write all not admitted, and much of that -- like you have to write primary commercial auto. For the most part, you have to be admitted. So we would look to expand into it, to the extent we could do so not admitted.

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Mark Hughes, SunTrust - Analyst [8]

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Okay.

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Brian Haney, Kinsale Capital Group Inc - SVP, COO [9]

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I'll just add one more comment on that. If rates were to continue to trend upward, we would probably see an uptick in how much excess auto we write. So -- it is possible for future expansion depending on how the market develops. Right now we're still taking a very cautious view given where prices are.

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Mark Hughes, SunTrust - Analyst [10]

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You had talked about submission growth in the midteens. Refresh me, is that an acceleration lately or do you think you will be able to have an increasing rate of success with the submissions you're getting in?

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Brian Haney, Kinsale Capital Group Inc - SVP, COO [11]

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So that is consistent with what we saw in the third quarter and for much of last year in terms of the growth rate. I do think eventually we're going to see more success from those submissions. It's probably worth noting we are quoting a lot more of the submissions that do come in. So the submission growth -- the growth rate in the quotes is well ahead of midteens.

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Mark Hughes, SunTrust - Analyst [12]

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Right, and why are you quoting more now? Is that a systems issue? Appetite?

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Brian Haney, Kinsale Capital Group Inc - SVP, COO [13]

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Like, it's mainly process improvements and system work. We're trying to get more quotes out faster and the system and our technology is allowing us to do that.

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Mark Hughes, SunTrust - Analyst [14]

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And then, final question on the -- your investments, your yields, low 2s. Do you feel like it's a time where you might take a little more risk in the investment portfolio, still have a conservative balance sheet but maybe go out a little more on duration, or a little higher risk?

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Brian Haney, Kinsale Capital Group Inc - SVP, COO [15]

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Yes, Mark, I think there is a potential of doing that. I think we're comfortable with our conservative approach to investments right now. But, you know, we constantly reevaluate where we are, so there is the potential we could go out a little further on the duration, but I wouldn't expect anything significant here in the near term.

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Mark Hughes, SunTrust - Analyst [16]

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Thank you.

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Operator [17]

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Sarah DeWitt, JPMorgan.

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Sarah DeWitt, JPMorgan - Analyst [18]

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Hi, good morning. First just wanted to ask on the ROE, it slipped a bit in the quarter to 13%, as expected, given the IPO proceeds and just wanted to get your latest thoughts on how long you think it could take to deploy the proceeds and get back to a run rate above 15%?

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Michael Kehoe, Kinsale Capital Group Inc - CEO, President [19]

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I think -- Sarah, this is Mike Kehoe. Our long-term guidance, of course, is midteens ROE or better, and right now we've got a little bit of a lag with the primary proceeds coming out of the IPO. The work we've done on broadening our product line, I think the work we've done on improving our service standards, I think our low-cost platform, all those things give us confidence that over time we're definitely going to take market share and grow our business.

Last year was mid single-digit growth rate. I think we ended up the year at 6.5%. Our guidance always focuses on midteens combine -- I'm sorry, midteens ROE or better, mid-80s combined ratio or lower. We're focused there, obviously, on the profitability of the business. That is something we have a lot of confidence in. It's a little bit tougher to predict short-term growth rates because they are subject to some volatility.

Two-thirds of the way through the first quarter, I would say that growth has picked up a little bit and so I think we've been saying that after several quarters we will be able to put that capital to work and I think we're still kind of in that mode of thinking. But growth principally is how we're going to get the ROE -- get back to an efficient use of capital and then revert to the midteens ROE or better.

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Sarah DeWitt, JPMorgan - Analyst [20]

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Okay, great. And then you mentioned submission growth and premium growth would track over time. What's driving the divergence right now? Could you just elaborate on that? And how long would it take for those two factors to converge?

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Brian Haney, Kinsale Capital Group Inc - SVP, COO [21]

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One is, we are -- a shift in the mix of business towards smaller account divisions, so our Personal Insurance and our small business division writes smaller average premiums and they are growing pretty well. I would say in the first quarter we've seen the numbers track more closely, so --.

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Michael Kehoe, Kinsale Capital Group Inc - CEO, President [22]

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I think in general, too, it's just -- there is some volatility around the growth rate and we're in an intensely competitive market where you have to proceed carefully, and sometimes competition gets in the way of writing a piece of business and you have to move onto the next one.

We did see some roll off of some larger accounts last year. I guess it was starting in late 2015, ending in mid to late 2016. We moved away from some hospitality business that we felt like we couldn't get the right price for, offset in part with growth in other areas. As Brian just said, our Personal Lines unit was up a very healthy percent last year. But you know, when you net it all out, it ended up being mid single-digit growth rate.

Longer term, we are very confident around growth. Short-term it gets a little bit more speculative. As I said a minute ago, two-thirds of the way through the first quarter 2017, growth has picked up a bit. So -- I guess that's where we are stand.

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Sarah DeWitt, JPMorgan - Analyst [23]

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Okay, great. Thanks for the answers.

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Operator [24]

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Mark Dwelle, RBC Capital Markets.

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Mark Dwelle, RBC Capital Markets - Analyst [25]

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Yes, good morning. A few of the questions have already been covered, but on the expense ratio, you commented in the release a little bit on what drove that. I guess I was trying to get a sense of is -- to the extent you have incremental public company costs, etc., how does that shake out across the expectations for the expense ratio going forward? Would we expect to stay around the 27 level or is that -- are some of those kind of sufficiently temporary or timing oriented that it will level out over the course of the coming year?

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Michael Kehoe, Kinsale Capital Group Inc - CEO, President [26]

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Hey, good morning, Mark; it's Mike Kehoe. I would say, just as a reminder, our focus on expenses is really fundamental to our business plan. The 27 handle on that expense ratio, I think that goes back to the third quarter last year, fourth quarter. It's principally driven by the public company expenses and we are obviously working very hard to manage costs given that we operate in a commodity business and our customers expect that of us. And I think the growth is going to solve some of that. Over time we would expect that number to drift back down. So the expectation is we will do better than 27. It might be a couple quarters until we get there.

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Mark Dwelle, RBC Capital Markets - Analyst [27]

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Okay, that's helpful. The second question on the investment portfolio. The duration was up. I assume that is just putting the original cash -- continuing to put cash to work and rebuilding your duration. What would you expect to sort of your -- I will call it normalized duration, given how you have your liabilities stacked and so forth?

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Brian Haney, Kinsale Capital Group Inc - SVP, COO [28]

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Well, think the average duration on our liability side is 3 to 4 years, so I think we've looked to match our investment duration in that same range.

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Mark Dwelle, RBC Capital Markets - Analyst [29]

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So you are fairly close then, I guess, is the bottom line? Okay. That's helpful. And then lastly, and this was kind of referred to a little bit I guess in your last answer to Sarah's question, but I guess if you distill out the businesses that you had been exiting, like hospitality and a couple of the others that you mentioned, is there a way to see what the, call it the ongoing growth rate is? Obviously, it would be a little bit higher than 6.5 for the full year. Is it closer to 9 or 10 or is that not readily calculable?

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Michael Kehoe, Kinsale Capital Group Inc - CEO, President [30]

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Well, the hospitality -- we still write a lot of hospitality business it was just some segment within that broader book that we rolled off. I'm not sure that you could actually look at it that way, in a way that would really be helpful and meaningful. I think the best news on the growth is, hey, we've kicked off 2017. We are two-thirds of the way through the quarter and the growth rate has picked up. And long-term we're very confident in growth given our low-cost.

We can price our business slightly more aggressively than some of our higher cost competitors and still have more margin in that business, right? That puts us in a, I think, a very attractive position. But, short-term on a three-month period, it's just difficult to predict and accurately prognosticate where growth is going to be, especially when you're in a very competitive market like we are today. So -- I don't know if that really answers the question, but --.

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Mark Dwelle, RBC Capital Markets - Analyst [31]

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No, it's helpful. I mean I understand where you're coming from on that and appreciate the answers. Thanks.

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Operator [32]

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Adam Klauber, William Blair.

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Adam Klauber, William Blair - Analyst [33]

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Good morning, everyone. A couple different questions. The accident year loss ratio really trended better in the second half of the year versus the first half. Is that a result that you set your picks pretty conservatively and then you saw the business flow in and that was just more where the business was coming in?

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Bryan Petrucelli, Kinsale Capital Group Inc - SVP, CFO [34]

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We haven't changed how we approach reserves, so all that is a function of just better experience in the second half than the first.

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Adam Klauber, William Blair - Analyst [35]

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Okay.

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Bryan Petrucelli, Kinsale Capital Group Inc - SVP, CFO [36]

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There's no conscious change in the reserving methodology as a result of what we've seen. It's been pretty consistent.

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Michael Kehoe, Kinsale Capital Group Inc - CEO, President [37]

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Yes, just the normal volatility in how the claims come in and that type of thing.

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Adam Klauber, William Blair - Analyst [38]

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Right. So as we think about 2017, should we think about potential accident year more in line with 2016, more in line with the first half of 2016? Just directionally, how should we think about it?

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Brian Haney, Kinsale Capital Group Inc - SVP, COO [39]

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I would think it would be pretty consistent. I mean rates are basically flat. Trends still pretty modest.

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Michael Kehoe, Kinsale Capital Group Inc - CEO, President [40]

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One caveat there is I think our guidance is an 85% combined ratio, and so I think that assumes a little bit higher loss ratio than what we experienced in 2016. Right? So we're trying to be cautious in how we offer guidance for the future, just, hey, it's a volatile business. Not everything is completely predictable and we try to be a little bit conservative in the guidance we offer.

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Adam Klauber, William Blair - Analyst [41]

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Okay, and then as far as -- you had a decent amount of favorable development really throughout the year. Is that coming from -- is that evenly spread throughout the past years or is that more some of the 2012, 2013, 2014? Just given -- and are there certain products or lines you are seeing more favorable come through?

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Brian Haney, Kinsale Capital Group Inc - SVP, COO [42]

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All our lines had favorable development for the quarter and the year and it's coming from most accident years, basically 2012 through 2016.

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Adam Klauber, William Blair - Analyst [43]

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Okay.

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Brian Haney, Kinsale Capital Group Inc - SVP, COO [44]

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I'm sorry, 2015 and prior year.

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Adam Klauber, William Blair - Analyst [45]

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Okay, that's helpful. Sounds like (inaudible) is doing well. Can you say how big is that business and what was the growth rate of that unit on an annual basis, quarterly or annual basis?

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Bryan Petrucelli, Kinsale Capital Group Inc - SVP, CFO [46]

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Yes, -- I think as a percentage of our Company, it's still very modest. I think it was just under 4% of our premium. The growth rate was just below 50%, so it's grown at a healthy clip. We see that continuing in the years to come. I mean we're working hard to expand our personal lines business into new states, new geographies and there's different ideas we're working on around product expansion.

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Adam Klauber, William Blair - Analyst [47]

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Okay.

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Bryan Petrucelli, Kinsale Capital Group Inc - SVP, CFO [48]

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-- and the like, so we see that as being a bigger percentage of our book going forward.

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Adam Klauber, William Blair - Analyst [49]

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Great. And you mentioned some new products coming in line as we go into this year. I guess two questions. One, did you bring on teams of underwriters with those new products? And of those, which one or two do you think could be more incremental in 2017 versus going out a couple years?

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Michael Kehoe, Kinsale Capital Group Inc - CEO, President [50]

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I would say most of the hiring we do is in-house, right? We like to promote from within, but every now and again, bring somebody in -- there's -- the individual that runs our inland marine division moved from out of town to Richmond to take that role at Kinsale and the individual that runs our management liability division, same thing. But, in general, in terms of impact on growth, I think it's -- we've done a lot of work in the new product area. There is a lot of new products out there. A lot of them are enhancements to existing products, and so I think it's material -- it's making a material contribution to our growth rate. I don't know that we can quantify it on the call, but --.

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Brian Haney, Kinsale Capital Group Inc - SVP, COO [51]

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No, I don't think we can.

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Adam Klauber, William Blair - Analyst [52]

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Okay, that's fine. That's fine. But when we think about the -- I guess some market trends overall, how are you seeing the legal environment? Would you say it's steady with a couple years or better or worse from your perspective?

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Michael Kehoe, Kinsale Capital Group Inc - CEO, President [53]

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I mean this is kind of anecdotal but I would say it's probably deteriorating.

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Adam Klauber, William Blair - Analyst [54]

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Okay.

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Michael Kehoe, Kinsale Capital Group Inc - CEO, President [55]

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I mean that is very anecdotal, right? It's just interaction with our claims team in terms of individual cases that we're either litigating or settling, what have you. But I think there is a general consensus that there has been a deterioration. I think if you read some of the commentary from different insurance companies that have reported some stress in their business, a lot of it is tied back to things like auto. Sometimes it's program business. I think AIG had some problems with workers comp, but a lot of it goes back to increases in severity. There's perpetual upward pressure in terms of jury verdicts and the like. But in general I think it's deteriorated.

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Adam Klauber, William Blair - Analyst [56]

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Yes, yes, okay. That's what we're seeing too. So -- okay. Thanks a lot, Mike.

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Operator [57]

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Mark Hughes, SunTrust.

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Mark Hughes, SunTrust - Analyst [58]

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Curious if you have any observations on the macro environment, small business confidence, small business startups, anything that is there that might be contributing to the submission growth?

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Michael Kehoe, Kinsale Capital Group Inc - CEO, President [59]

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No, I mean I think we're going to see that. It's kind of tough to tell. I would say submission growth has been consistent quarter to quarter. I would be surprised if we didn't see more of that because of the relaxed regulatory environment is going to mean a lot more business in things like coal mining, for example. So I expect we will be seeing it, but I think what we've been seeing so far is just an organic pick up in our business.

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Mark Hughes, SunTrust - Analyst [60]

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Thank you.

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Operator [61]

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And at this time I'm showing no further questions.

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Michael Kehoe, Kinsale Capital Group Inc - CEO, President [62]

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Okay, well with that, I just want to say a special thank you to all the Kinsale employees for the hard work that went into the results that we posted last night. And thank you for everyone listening to the call and we will talk to you again next quarter.

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Operator [63]

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Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. You may all now all disconnect. Everyone have a great day.