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KINSALE CAPITAL GROUP, INC. – 10-Q – Management's Discussion and Analysis of Financial Condition and Results of Operations
The discussion and analysis below include certain forward-looking statements that are subject to risks, uncertainties and other factors described in "Risk Factors" in this Quarterly Report on Form 10-Q and in the Annual Report on Form 10-K for the year endedDecember 31, 2021 . Our actual results could differ materially from those anticipated in these forward-looking statements as a result of many factors. The results of operations for the three and nine months endedSeptember 30, 2022 are not necessarily indicative of the results that may be expected for the full year endedDecember 31, 2022 , or for any other future period. The following discussion should be read in conjunction with the unaudited condensed consolidated financial statements and the notes thereto included in Part I, Item 1 of this Quarterly Report, and in conjunction with our audited consolidated financial statements and the notes thereto included in the Annual Report on Form 10-K for the year endedDecember 31, 2021 .
References to the "Company," "Kinsale," "we," "us," and "our" are to
Capital Group, Inc.
Overview
Founded in 2009, Kinsale is a specialty insurance company. Kinsale focuses
exclusively on the excess and surplus lines ("E&S") market in the U.S. , where we
use our underwriting expertise to write coverages for hard-to-place small
business risks and personal lines risks. We market these insurance products in
all 50 states, the District of Columbia , the Commonwealth of Puerto Rico and the
U.S. Virgin Islands , primarily through a network of independent insurance
brokers.
We have one reportable segment, our Excess and Surplus Lines Insurance segment,
which offers property and casualty ("P&C") insurance products through the E&S
market. For the first nine months of 2022, the percentage breakdown of our gross
written premiums was 79% casualty and 21% property. Our commercial underwriting
divisions include commercial property, small business, excess casualty,
construction, general casualty, allied health, products liability, life
sciences, professional liability, energy, management liability, entertainment,
environmental, health care, inland marine, public entity, small property and
aviation. We also write a small amount of homeowners insurance in the personal
lines market, which in aggregate represented 3% of our gross written premiums in
the first nine months of 2022 and is included within our personal insurance
division.
COVID-19
Consistent with 2021, the Company's results of operations, financial position and cash flows were not materially impacted by COVID-19 and the related economic effects during the first nine months of 2022. For further discussion, see Part II, Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations" of our Annual Report on Form 10-K for the year endedDecember 31, 2021 .
Components of Our Results of Operations
Gross written premiums
Gross written premiums are the amounts received or to be received for insurance
policies written or assumed by us during a specific period of time without
reduction for policy acquisition costs, reinsurance costs or other deductions.
The volume of our gross written premiums in any given period is generally
influenced by:
•New business submissions;
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•Conversion of new business submissions into policies;
•Renewals of existing policies; and
•Average size and premium rate of bound policies.
We earn insurance premiums on a pro rata basis over the term of the policy. Our insurance policies generally have a term of one year. Net earned premiums represent the earned portion of our gross written premiums, less that portion of our gross written premiums that is ceded to third-party reinsurers under our reinsurance agreements. Ceded written premiums Ceded written premiums are the amount of gross written premiums ceded to reinsurers. We enter into reinsurance contracts to limit our exposure to potential large losses. Ceded written premiums are earned over the reinsurance contract period in proportion to the period of risk covered. The volume of our ceded written premiums is impacted by the level of our gross written premiums, any decision we make to increase or decrease retention levels and reinstatement premiums, if any.
Losses and loss adjustment expenses
Losses and loss adjustment expenses are a function of the amount and type of insurance contracts we write and the loss experience associated with the underlying coverage. In general, our losses and loss adjustment expenses are affected by:
•Frequency of claims associated with the particular types of insurance contracts
that we write;
•Trends in the average size of losses incurred on a particular type of business;
•Mix of business written by us;
•Changes in the legal or regulatory environment related to the business we
write;
•Trends in legal defense costs;
•Wage inflation; and
•Inflation in medical costs.
Losses and loss adjustment expenses are based on an actuarial analysis of the estimated losses, including losses incurred during the period and changes in estimates from prior periods. Losses and loss adjustment expenses may be paid out over a period of years.
Underwriting, acquisition and insurance expenses
Underwriting, acquisition and insurance expenses include policy acquisition costs and other underwriting expenses. Policy acquisition costs are principally comprised of the commissions we pay our brokers, net of ceding commissions we receive on business ceded under certain reinsurance contracts. Policy acquisition costs also include underwriting expenses that are directly related to the successful acquisition of those policies which are deferred. The amortization of policy acquisition costs is charged to expense in proportion to premium earned over the policy life.
Other underwriting expenses represent the general and administrative expenses of
our insurance business such as employment costs, telecommunication and
technology costs, and legal and auditing fees.
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Net investment income
Net investment income is an important component of our results of operations. We earn investment income on our portfolio of cash and invested assets. Our cash and invested assets are primarily comprised of fixed-maturity securities, and may also include cash equivalents, equity securities and short-term investments. The principal factors that influence net investment income are the size of our investment portfolio and the yield on that portfolio. As measured by amortized cost (which excludes changes in fair value), the size of our investment portfolio is mainly a function of our invested equity capital combined with premiums we receive from our insureds less payments on policyholder claims.
Change in fair value of equity securities
Change in fair value of equity securities represents the increase or decrease in
the fair value of equity securities held during the period.
Net realized investment gains (losses)
Net realized investment gains (losses) are a function of the difference between the amount received by us on the sale of a security and the security's amortized cost. Income tax expense Currently, substantially all of our income tax expense relates to federal income taxes. Our insurance subsidiary,Kinsale Insurance Company , is not subject to income taxes in the states in which it operates; however, our non-insurance subsidiaries are subject to state income taxes, but have not generated any material taxable income to date. The amount of income tax expense or benefit recorded in future periods will depend on the jurisdictions in which we operate and the tax laws and regulations in effect.
Key metrics
We discuss certain key metrics, described below, which we believe provide useful
information about our business and the operational factors underlying our
financial performance.
Underwriting income is a non-GAAP financial measure. We define underwriting income as net income, excluding net investment income, the net change in the fair value of equity securities, net realized investment gains and losses, interest expense, other expenses, other income and income tax expense. See "-Reconciliation of Non-GAAP Financial Measures" for a reconciliation of net income in accordance with GAAP to underwriting income. Net operating earnings is a non-GAAP financial measure. We define net operating earnings as net income excluding the net change in the fair value of equity securities, after taxes, and net realized investment gains and losses, after taxes. See "-Reconciliation of Non-GAAP Financial Measures" for a reconciliation of net income in accordance with GAAP to net operating earnings.
Loss ratio, expressed as a percentage, is the ratio of losses and loss
adjustment expenses to net earned premiums.
Expense ratio, expressed as a percentage, is the ratio of underwriting,
acquisition and insurance expenses to net earned premiums.
Combined ratio is the sum of the loss ratio and the expense ratio. A combined ratio under 100% indicates an underwriting profit. A combined ratio over 100% indicates an underwriting loss.
Return on equity is net income expressed on an annualized basis as a percentage
of average beginning and ending total stockholders' equity during the period.
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Operating return on equity is a non-GAAP financial measure. We define operating return on equity as net operating earnings expressed on an annualized basis as a percentage of average beginning and ending total stockholders' equity during the period. See "-Reconciliation of Non-GAAP Financial Measures" for a reconciliation of net income in accordance with GAAP to net operating earnings.
Net retention ratio is the ratio of net written premiums to gross written
premiums.
Gross investment return is investment income from fixed-maturity and equity
securities, before any deductions for fees and expenses, expressed as a
percentage of the average beginning and ending book value of those investments
during the period.
Results of Operations
Three months ended
The following table summarizes our results of operations for the three months
ended
Three Months Ended September 30,
($ in thousands) 2022 2021 Change % Change
Gross written premiums $ 284,111 $ 197,616 $ 86,495 43.8 %
Ceded written premiums (48,212) (26,939) (21,273) 79.0 %
Net written premiums $ 235,899 $ 170,677 $ 65,222 38.2 %
Net earned premiums $ 209,259 $ 156,871 $ 52,388 33.4 %
Losses and loss adjustment expenses 134,788 87,352 47,436 54.3 %
Underwriting, acquisition and insurance
expenses 40,145 31,465 8,680 27.6 %
Underwriting income (1) 34,326 38,054 (3,728) (9.8) %
Net investment income 13,858 8,095 5,763 71.2 %
Change in the fair value of equity
securities (6,095) (1,012) (5,083) 502.3 %
Net realized investment (losses) gains (173) 895 (1,068) (119.3) %
Interest expense (1,716) (243) (1,473) 606.2 %
Other expense, net (100) (110) 10 (9.1) %
Income before taxes 40,100 45,679 (5,579) (12.2) %
Income tax expense 7,116 9,054 (1,938) (21.4) %
Net income $ 32,984 $ 36,625 $ (3,641) (9.9) %
Net operating earnings (2) $ 37,936 $ 36,717 $ 1,219 3.3 %
Loss ratio 64.4 % 55.7 %
Expense ratio 19.2 % 20.0 %
Combined ratio 83.6 % 75.7 %
Annualized return on equity 21.1 % 22.7 %
Annualized operating return on equity (2) 24.2 %
22.8 %
(1) Underwriting income is a non-GAAP financial measure. See "-Reconciliation of
Non-GAAP Financial Measures" for a reconciliation of net income in accordance
with GAAP to underwriting income.
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(2) Net operating earnings and annualized operating return on equity are non-GAAP financial measures. Net operating earnings is defined as net income excluding the net change in the fair value of equity securities, after taxes, and net realized investment gains and losses, after taxes. Annualized operating return on equity is defined as net operating earnings expressed on an annualized basis as a percentage of average beginning and ending total stockholders' equity during the period. See "-Reconciliation of Non-GAAP Financial Measures" for a reconciliation of net income in accordance with GAAP to net operating earnings. Net income was$33.0 million for the three months endedSeptember 30, 2022 compared to$36.6 million for the three months endedSeptember 30, 2021 , a decrease of 9.9%. The decrease in net income for the third quarter of 2022 from the same period last year was primarily due to higher catastrophe losses incurred during the period and a decline in the fair value of our equity investment portfolio driven by adverse movements in the capital markets during the period. This decrease was largely offset by strong growth in the business from favorable E&S market conditions and continued rate increases and an increase in investment income quarter over quarter driven by higher investment balances. Underwriting income was$34.3 million for the three months endedSeptember 30, 2022 compared to$38.1 million for the three months endedSeptember 30, 2021 , a decrease of 9.8%. The corresponding combined ratios were 83.6% for the three months endedSeptember 30, 2022 compared to 75.7% for the three months endedSeptember 30, 2021 . The decrease in our underwriting income in the third quarter of 2022 compared to the third quarter of 2021 was largely due to higher catastrophe losses incurred during the period, offset in part by premium growth and favorable rate increases from a strong underwriting environment and lower levels of relative operating expenses. Net catastrophe losses incurred were$26.1 million during the third quarter of 2022 compared to$5.9 million during the third quarter of 2021. Premiums Our gross written premiums were$284.1 million for the three months endedSeptember 30, 2022 compared to$197.6 million for the three months endedSeptember 30, 2021 , an increase of$86.5 million , or 43.8%. The increase in gross written premiums for the third quarter of 2022 over the same period last year was due to higher submission activity from brokers and higher rates across most lines of business, resulting from continued favorable conditions in the E&S market. The average premium on a policy written was approximately$12,700 in the third quarter of 2022 compared to approximately$10,700 in the third quarter of 2021. Excluding our personal lines insurance, which has a relatively low premium per policy written, the average premium on a policy written was approximately$14,700 in the third quarter of 2022 compared to$13,000 in the third quarter of 2021. Net written premiums increased by$65.2 million , or 38.2%, to$235.9 million for the three months endedSeptember 30, 2022 from$170.7 million for the three months endedSeptember 30, 2021 . The increase in net written premiums for the third quarter of 2022 compared to the same period last year was primarily due to higher gross written premiums. The net retention ratio was 83.0% for the three months endedSeptember 30, 2022 compared to 86.4% for the three months endedSeptember 30, 2021 . The decrease in the net retention ratio was largely due to a combination of factors, including higher premiums ceded under the new commercial property quota share reinsurance treaty, effectiveJune 1, 2022 , a change in the mix of business quarter over quarter and higher reinstatement premiums related to the catastrophe reinsurance treaty during the quarter.
Net earned premiums increased by
the three months ended
months ended
written premiums.
Loss ratio
The loss ratio was 64.4% for the three months endedSeptember 30, 2022 compared to 55.7% for the three months endedSeptember 30, 2021 . The increase in the loss ratio in the third quarter of 2022 compared to the third quarter of 29
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2021 was due primarily to higher catastrophe losses incurred during the period
related to Hurricane Ian. Net catastrophe losses incurred during the third
quarter of 2021 were primarily attributable to Hurricane Ida.
During the three months endedSeptember 30, 2022 , prior accident years developed favorably by$11.0 million , of which$10.9 million was attributable to the 2020 and 2021 accident years due to lower than expected reported losses across most lines of business. During the three months endedSeptember 30, 2021 , prior accident years developed favorably by$9.2 million , of which$7.1 million was attributable to the 2020 accident year. The favorable development for the 2020 accident year reflected our improved outlook related to potential COVID-19 related claims as no significant claims had been reported to date. In addition, reported losses emerged at lower levels than expected across most lines of business.
The following table summarizes the loss ratios for the three months ended
Three Months Ended September 30,
2022 2021
Losses and Loss Losses and Loss
Adjustment Adjustment
($ in thousands) Expenses % of Earned Premiums Expenses % of Earned Premiums
Loss ratio:
Current accident year before
catastrophe losses $ 119,650 57.2 % $ 90,675 57.8 %
Current year catastrophe losses 26,130 12.5 % 5,882 3.8 %
Effect of prior year development (10,992) (5.3) % (9,205) (5.9) %
Total $ 134,788 64.4 % $ 87,352 55.7 %
Expense ratio
The following table summarizes the components of the expense ratio for the three
months ended
Three Months Ended
2022 2021
Underwriting Underwriting
($ in thousands) Expenses % of Earned Premiums Expenses % of Earned Premiums
Commissions incurred:
Direct $ 37,177 17.8 % $ 26,317 16.8 %
Ceding (12,939) (6.2) % (6,902) (4.5) %
Net commissions incurred 24,238 11.6 % 19,415 12.3 %
Other underwriting expenses 15,907 7.6 % 12,050 7.7 %
Underwriting, acquisition and
insurance expenses $ 40,145 19.2 % $ 31,465 20.0 %
The expense ratio was 19.2% for the three months ended September 30, 2022
compared to 20.0% for the three months ended September 30, 2021 . The decrease in
the expense ratio was due to lower net commissions and lower other underwriting
expenses as a percentage of earned premiums. The decrease in the net commissions
incurred ratio was mostly due to higher ceding commissions resulting from the
new commercial property quota share treaty, effective June 1, 2022 . The decrease
in the other underwriting expense ratio was primarily due to higher net earned
premiums, without a proportional increase in the amount of other underwriting
expenses, as a result of management's focus on controlling costs, and lower
variable compensation costs as a percentage of earned
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premiums. The decrease in variable compensation costs as a percentage of earned premiums was due to higher catastrophe losses incurred during the third quarter of 2022 compared to the same period last year. Direct commissions paid as a percent of gross written premiums was 14.6% for both the three months endedSeptember 30, 2022 and 2021.
Investing results
The following table summarizes net investment income, change in the fair value of equity securities and net realized investment (losses) gains for the three months endedSeptember 30, 2022 and 2021: Three Months Ended September 30, ($ in thousands) 2022 2021 Change Interest from fixed-maturity securities$ 12,890 $ 7,345 $ 5,545 Dividends from equity securities 1,085 979 106 Cash equivalents and short-term investments 475 1 474 Gross investment income 14,450 8,325 6,125 Investment expenses (592) (230) (362) Net investment income 13,858 8,095 5,763 Change in the fair value of equity securities (6,095) (1,012) (5,083) Net realized investment (losses) gains (173) 895 (1,068) Total$ 7,590 $ 7,978 $ (388) Our net investment income increased by 71.2% to$13.9 million for the three months endedSeptember 30, 2022 from$8.1 million for the three months endedSeptember 30, 2021 . This increase was primarily due to growth in our investment portfolio generated from the investment of strong operating cash flows sinceSeptember 30, 2021 and to a lesser degree, higher interest rates relative to the prior year period. Our investment portfolio, excluding cash equivalents and unrealized gains and losses, had an annualized gross investment return of 3.1% and 2.5% for the three months endedSeptember 30, 2022 and 2021, respectively. During the third quarter of 2022, the change in fair value of equity securities was comprised of unrealized losses related to exchange traded funds ("ETFs") of$5.6 million and unrealized losses related to non-redeemable preferred stock of$0.5 million . The change in unrealized losses during the third quarter of 2022 attributable to ETFs reflected lower valuations in the broaderU.S. stock market during the period. The change in unrealized losses during the third quarter of 2022 attributable to non-redeemable preferred stock reflected a higher interest rate environment.
During the third quarter of 2021, the change in fair value of equity securities
was comprised of unrealized losses related to ETFs of
unrealized losses related to non-redeemable preferred stock of
Income tax expense
Our effective tax rate was 17.7% for the three months endedSeptember 30, 2022 compared to 19.8% for the three months endedSeptember 30, 2021 . The effective tax rates were lower than the federal statutory rate of 21% due to the tax benefits from stock-based compensation and tax-exempt investment income. 31
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Nine months ended
2021
The following table summarizes our results of operations for the nine months
ended
Nine Months Ended September 30, ($ in thousands) 2022 2021 Change % Change Gross written premiums$ 806,625 $ 560,553 $ 246,072 43.9 % Ceded written premiums (111,885) (77,825) (34,060) 43.8 % Net written premiums$ 694,740 $ 482,728 $ 212,012 43.9 % Net earned premiums$ 577,979 $ 417,612 $ 160,367 38.4 % Losses and loss adjustment expenses 344,333 236,727 107,606 45.5 % Underwriting, acquisition and insurance expenses 117,662 89,490 28,172 31.5 % Underwriting income (1) 115,984 91,395 24,589 26.9 % Net investment income 33,540 22,466 11,074 49.3 % Change in fair value of equity securities (37,199) 13,644 (50,843) (372.6) % Net realized investment gains 1,535 2,397 (862) (36.0) % Interest expense (2,306) (752) (1,554) 206.6 % Other expense, net (140) (424) 284 (67.0) % Income before taxes 111,414 128,726 (17,312) (13.4) % Income tax expense 19,549 24,387 (4,838) (19.8) % Net income$ 91,865 $ 104,339 $ (12,474) (12.0) % Net operating earnings (2)$ 120,039 $ 91,666 $ 28,373 31.0 % Loss ratio 59.6 % 56.7 % Expense ratio 20.3 % 21.4 % Combined ratio 79.9 % 78.1 % Annualized return on equity 18.6 % 22.5 % Annualized operating return on equity(2) 24.3 %
19.8 %
(1) Underwriting income is a non-GAAP financial measure. See "-Reconciliation of Non-GAAP Financial Measures" for a reconciliation of net income in accordance with GAAP to underwriting income. (2) Net operating earnings and annualized operating return on equity are non-GAAP financial measures. Net operating earnings is defined as net income excluding the net change in the fair value of equity securities, after taxes, and net realized investment gains and losses, after taxes. Annualized operating return on equity is defined as net operating earnings expressed on an annualized basis as a percentage of average beginning and ending total stockholders' equity during the period. See "-Reconciliation of Non-GAAP Financial Measures" for a reconciliation of net income in accordance with GAAP to net operating earnings.
Overview
Net income was$91.9 million for the nine months endedSeptember 30, 2022 compared to$104.3 million for the nine months endedSeptember 30, 2021 , a decrease of 12.0%. The decrease in net income for the first nine months of 2022 from the same period last year was primarily due to a decline in the fair value of our equity investment portfolio driven by adverse movements in the capital markets during the period and higher catastrophe losses 32
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incurred during the period. This decrease was offset in part by strong growth in the business from favorable E&S market conditions and continued rate increases and an increase in investment income period over period driven by higher investment balances. Underwriting income was$116.0 million for the nine months endedSeptember 30, 2022 compared to$91.4 million for the nine months endedSeptember 30, 2021 , an increase of 26.9%. The corresponding combined ratios were 79.9% for the nine months endedSeptember 30, 2022 compared to 78.1% for the nine months endedSeptember 30, 2021 . The increase in underwriting income for the first nine months of 2022 compared to the same period last year was due to a combination of premium growth and favorable rate increases from a strong underwriting environment and lower levels of relative reported losses and operating expenses, offset in part by higher catastrophe losses incurred.
Premiums
Our gross written premiums were$806.6 million for the nine months endedSeptember 30, 2022 compared to$560.6 million for the nine months endedSeptember 30, 2021 , an increase of$246.1 million , or 43.9%. The increase in gross written premiums for the first nine months of 2022 over the same period last year was due to higher submission activity from brokers and higher rates across most lines of business, resulting from continued favorable conditions in the E&S market. The average premium on a policy written was$12,100 in the first nine months of 2022 compared to$10,100 in the first nine months of 2021. Excluding our personal lines insurance, which has a relatively low premium per policy written, the average premium on a policy written was$14,500 for the first nine months of 2022 and$12,700 for the first nine months of 2021. Net written premiums increased by$212.0 million , or 43.9%, to$694.7 million for the nine months endedSeptember 30, 2022 from$482.7 million for the nine months endedSeptember 30, 2021 . The increase in net written premiums for the first nine months of 2022 compared to the same period last year was primarily due to higher gross written premiums. The net retention ratio was 86.1% for both the nine months endedSeptember 30, 2022 and 2021. Net earned premiums increased by$160.4 million , or 38.4%, to$578.0 million for the nine months endedSeptember 30, 2022 from$417.6 million for the nine months endedSeptember 30, 2021 due to growth in gross written premiums.
Loss ratio
The loss ratio was 59.6% for the nine months endedSeptember 30, 2022 compared to 56.7% for the nine months endedSeptember 30, 2021 . The increase in the loss ratio in the first nine months of 2022 compared to the first nine months of 2021 was due primarily to higher catastrophe losses incurred during the period and lower net favorable development of loss reserves from prior accident years as a percentage of earned premiums. During the nine months endedSeptember 30, 2022 , current year incurred losses and loss adjustment expenses included$26.2 million of net catastrophe losses primarily related to Hurricane Ian. During the nine months endedSeptember 30, 2021 , current year incurred losses and loss adjustment expenses included$8.8 million of net catastrophe losses primarily attributable to Hurricane Ida and the winter storms inTexas . During the nine months endedSeptember 30, 2022 , prior accident years developed favorably by$28.9 million , of which$32.0 million was attributable to the 2020 and 2021 accident years due to lower than expected reported losses across most lines of business. This favorable development was offset in part by adverse development largely from the 2018 accident year due to routine variability in reported losses and modest adjustments in actuarial assumptions. On an inception-to-date basis, all prior accident years have developed favorably with the exception of the 2011 accident year. 33
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During the nine months endedSeptember 30, 2021 , prior accident years developed favorably by$25.4 million , of which$28.9 million was attributable to the 2020 accident year. The favorable development for the 2020 accident year reflected our improved outlook related to potential COVID-19 related claims as no significant claims had been reported to date. In addition, reported losses emerged at lower levels than expected across most lines of business. This favorable development was offset in part by adverse development, mostly attributable to the 2015-2018 accident years as a result of modest adjustments in actuarial assumptions based on observable trends.
The following table summarizes the loss ratios for the nine months ended
Nine Months Ended September 30,
2022 2021
Losses and Loss Losses and Loss
Adjustment Adjustment
($ in thousands) Expenses % of Earned Premiums Expenses % of Earned Premiums
Loss ratio:
Current accident year before
catastrophe losses $ 346,970 60.1 % $ 253,348 60.7 %
Current year catastrophe losses 26,213 4.5 % 8,792 2.1 %
Effect of prior year development (28,850) (5.0) % (25,413) (6.1) %
Total $ 344,333 59.6 % $ 236,727 56.7 %
Expense ratio
The following table summarizes the components of the expense ratio for the nine
months ended
Nine Months Ended
2022 2021
Underwriting Underwriting
($ in thousands) Expenses % of Earned Premiums Expenses % of Earned Premiums
Commissions incurred:
Direct $ 99,540 17.2 % $ 71,036 17.0 %
Ceding (30,069) (5.2) % (18,344) (4.4) %
Net commissions incurred 69,471 12.0 % 52,692 12.6 %
Other underwriting expenses 48,191 8.3 % 36,798 8.8 %
Underwriting, acquisition and
insurance expenses $ 117,662 20.3 % $ 89,490 21.4 %
The expense ratio was 20.3% for the nine months ended September 30, 2022
compared to 21.4% for the nine months ended September 30, 2021 . The decrease in
the expense ratio was due to lower net commissions incurred and lower other
underwriting expenses as a percentage of earned premiums. The decrease in the
net commissions incurred ratio was largely due to higher ceding commissions
resulting from the new commercial property quota share treaty, effective June 1,
2022 , and a change in the mix of business. The decrease in the other
underwriting expense ratio was primarily due to higher net earned premiums,
without a proportional increase in the amount of other underwriting expenses, as
a result of management's focus on controlling costs, and lower variable
compensation costs as a percentage of earned premiums. The decrease in variable
compensation costs as a percentage of earned premiums was due to higher
catastrophe losses incurred during the first nine months of 2022 compared to the
same period last year. Direct commissions paid as a percentage of gross written
premiums was 14.6% for both the nine months ended September 30, 2022 and 2021.
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Investing results
The following table summarizes net investment income, change in the fair value of equity securities and net realized investment gains for the nine months endedSeptember 30, 2022 and 2021: Nine Months Ended September 30, ($ in thousands) 2022 2021 Change Interest from fixed-maturity securities$ 31,573 $
20,992
Dividends from equity securities 3,208 2,801 407 Cash equivalents and short-term investments 598 11 587 Gross investment income 35,379 23,804 11,575 Investment expenses (1,839) (1,338) (501) Net investment income 33,540 22,466 11,074 Change in fair value of equity securities (37,199)
13,644 (50,843)
Net realized investment gains 1,535 2,397 (862) Total$ (2,124) $ 38,507 $ (40,631) Our net investment income increased by 49.3% to$33.5 million for the nine months endedSeptember 30, 2022 from$22.5 million for the nine months endedSeptember 30, 2021 . This increase in the first nine months of 2022 compared to the same period last year was primarily due to growth in our investment portfolio largely generated from the investment of strong operating cash flows sinceSeptember 30, 2021 and to a lesser degree, higher interest rates relative to the prior year period. Our fixed-maturity investment portfolio, excluding cash equivalents and unrealized gains and losses, had an annualized gross investment return of 2.7% and 2.5% for the nine months endedSeptember 30, 2022 and 2021, respectively. During the first nine months of 2022, the change in fair value of equity securities was comprised of unrealized losses related to exchange traded funds ("ETFs") of$28.6 million and unrealized losses related to non-redeemable preferred stock of$8.6 million . The change in unrealized losses during the first nine months of 2022 attributable to ETFs reflected lower valuations in the broaderU.S. stock market during the period. The change in unrealized losses during the first nine months of 2022 attributable to non-redeemable preferred stock reflected a higher interest rate environment. During the first nine months of 2021, the change in fair value of equity securities was comprised of unrealized gains related to ETF securities of$13.4 million and unrealized gains related to non-redeemable preferred stock of$0.2 million . The change in unrealized gains during the first nine months of 2021 attributable to ETF securities was largely reflective of gains in the broaderU.S. stock market. We perform quarterly reviews of all available-for-sale securities within our investment portfolio to determine whether the decline in a security's fair value is deemed to be a credit loss. Management concluded that there were no credit losses from available-for-sale investments for the nine months endedSeptember 30, 2022 or 2021.
Income tax expense
Our effective tax rate was 17.5% for the nine months endedSeptember 30, 2022 compared to 18.9% for the nine months endedSeptember 30, 2021 . The effective tax rate was lower than the federal statutory rate of 21% primarily due to the tax benefits from stock-based compensation and tax-exempt investment income. 35
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Return on equity
Our annualized return on equity was 18.6% for the nine months endedSeptember 30, 2022 compared to 22.5% for the nine months endedSeptember 30, 2021 . Our annualized operating return on equity was 24.3% for the nine months endedSeptember 30, 2022 compared to 19.8% for the nine months endedSeptember 30, 2021 . The increase in annualized operating return on equity for the nine months endedSeptember 30, 2022 compared to the prior period was attributable largely to growth in the business from continuing favorable market conditions and rate increases and lower average stockholders' equity, offset in part by higher catastrophe activity. The decrease in average stockholders' equity was largely due to the decline in the fair value of our investments, resulting from a higher interest rate environment and volatility in the capital markets.
Liquidity and Capital Resources
Sources and uses of funds
We are organized as aDelaware holding company with our operations primarily conducted by our wholly-owned insurance subsidiary,Kinsale Insurance Company , which is domiciled inArkansas . Accordingly, we may receive cash through (1) loans from banks and other third parties, (2) issuance of equity and debt securities, (3) corporate service fees from our insurance subsidiary, (4) payments from our subsidiaries pursuant to our consolidated tax allocation agreement and other transactions, and (5) dividends from our insurance subsidiary. We may use the proceeds from these sources to contribute funds toKinsale Insurance Company in order to support premium growth, reduce our reliance on reinsurance, pay dividends and taxes and for other business purposes. We receive corporate service fees fromKinsale Insurance Company to reimburse us for most of the operating expenses that we incur. Reimbursement of expenses through corporate service fees is based on the actual costs that we expect to incur with no mark-up above our expected costs. InAugust 2022 , we filed a universal shelf registration statement with theSEC that expires in 2025. We can use this shelf registration to issue an unspecified amount of common stock, preferred stock, depositary shares and warrants. The specific terms of any securities we issue under this registration statement will be provided in the applicable prospectus supplements. OnJuly 22, 2022 , we entered into a Note Purchase and Private Shelf Agreement (the "Note Purchase Agreement"), which provides for the issuance of senior promissory notes with an aggregate principal amount of up to$150.0 million . Pursuant to the Note Purchase Agreement, onJuly 22, 2022 we issued$125.0 million aggregate principal amount of 5.15% senior promissory notes (the "Series A Notes"), the proceeds of which were used to fund surplus atKinsale Insurance Company , refinance indebtedness and for general corporate purposes. See Note 12 for further information regarding the Note Purchase Agreement. OnJuly 22, 2022 , we entered into an Amended and Restated Credit Agreement, which extended the maturity date toJuly 22, 2027 , and increased the aggregate commitment to$100.0 million , with the option to increase the aggregate commitment by$30.0 million , subject to certain conditions. Borrowings under the Amended and Restated Credit Agreement may be used for general corporate purposes (which may include, without limitation, to fund future growth, to finance working capital needs, to fund capital expenditures, and to refinance, redeem or repay indebtedness). See Note 12 for further information regarding the Amended and Restated Credit Agreement. OnJuly 25, 2022 , a portion of the proceeds from the Series A Notes were used to pay off outstanding loans of$43.0 million , plus accrued interest, under our Amended and Restated Credit Agreement. Management believes that the Company has sufficient liquidity available both in Kinsale and in its insurance subsidiary,Kinsale Insurance Company , as well as in its other operating subsidiaries, to meet its operating cash needs and obligations and committed capital expenditures for the next 12 months. 36
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Cash flows
Our most significant source of cash is from premiums received from our insureds, which, for most policies, we receive at the beginning of the coverage period. Our most significant cash outflow is for claims that arise when a policyholder incurs an insured loss. Because the payment of claims occurs after the receipt of the premium, often years later, we invest the cash in various investment securities that earn interest and dividends. We also use cash to pay commissions to insurance brokers, as well as to pay for ongoing operating expenses such as salaries, consulting services and taxes. As described under "-Reinsurance" below, we use reinsurance to manage the risk that we take related to the issuance of our policies. We cede, or pay out, part of the premiums we receive to our reinsurers and collect cash back when losses subject to our reinsurance coverage are paid. The timing of our cash flows from operating activities can vary among periods due to the timing by which payments are made or received. Some of our payments and receipts, including loss settlements and subsequent reinsurance receipts, can be significant, so their timing can influence cash flows from operating activities in any given period. Management believes that cash receipts from premiums, proceeds from investment sales and redemptions and investment income are sufficient to cover cash outflows in the foreseeable future.
Our cash flows for the nine months ended
Nine Months Ended September 30,
2022 2021
(in thousands)
Cash and cash equivalents provided by (used in):
Operating activities $ 456,699 $ 301,881
Investing activities (519,851) (280,081)
Financing activities 68,325 (8,881)
Change in cash and cash equivalents $
5,173
Net cash provided by operating activities was approximately$456.7 million for the nine months endedSeptember 30, 2022 , compared to$301.9 million for the same period in 2021. This increase was largely driven by higher premium volume, the timing of claim payments and reinsurance recoveries, offset in part by changes in operating assets and liabilities. Net cash used in investing activities was$519.9 million for the nine months endedSeptember 30, 2022 , compared to$280.1 million for the nine months endedSeptember 30, 2021 . Net cash used in investing activities during the first nine months of 2022 included purchases of fixed-maturity securities of$599.7 million , which were comprised largely of corporate bonds, mortgage- and asset-backed securities, and to a lesser extent, municipal securities and sovereigns. During the first nine months of 2022, we received proceeds of$73.1 million from sales of fixed-maturity securities, largely corporate bonds and mortgage- and asset-backed securities, and$89.8 million from redemptions of mortgage- and asset-backed securities and corporate bonds. For the nine months endedSeptember 30, 2022 , we received proceeds of$4.0 million from sales of equity securities, which were comprised of$2.4 million from sales of ETFs and$1.6 million from calls of non-redeemable preferred stock. In addition, net purchases of short-term investments of$81.1 million consisted ofU.S. Treasuries and corporate bonds. Net cash used in investing activities of$280.1 million during the nine months endedSeptember 30, 2021 included purchases of fixed-maturity securities of$509.0 million , and were comprised primarily of corporate bonds, mortgage- and asset-backed securities, municipal securities and, to a lesser extent,U.S. Treasuries. During the first nine months of 2021, we received proceeds of$102.6 million from sales of fixed-maturity securities, largely corporate bonds, and$139.7 million from redemptions of asset- and mortgage-backed securities and corporate 37
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bonds. For the nine months ended
and non-redeemable preferred stock were
respectively.
During the first nine months of 2022, cash provided by financing activities reflected proceeds of$125.0 million from the issuance of the Series A Notes onJuly 22, 2022 , a portion of which were used to pay off the outstanding loans of$43.0 million under the Amended and Restated Credit Agreement onJuly 25, 2022 . Financing activities also reflected dividends paid of$0.39 per common share, or$8.9 million in aggregate. In addition, for the nine months endedSeptember 30, 2022 , payroll taxes withheld and remitted on restricted stock awards were$3.3 million , offset in part by proceeds received from our equity compensation plans of$0.9 million . Debt issuance costs of$2.4 million were paid in connection with the Note Purchase Agreement and Amended and Restated Credit Agreement previously discussed. During the first nine months of 2021, cash used in financing activities reflected dividends paid of$0.33 per common share, or$7.5 million in aggregate. In addition, payroll taxes withheld and remitted on restricted stock awards were$2.1 million , offset in part by proceeds received from our equity compensation plans of$0.7 million , for the nine months endedSeptember 30, 2021 .
Reinsurance
We enter into reinsurance contracts primarily to limit our exposure to potential
large losses. Reinsurance involves an insurance company transferring ("ceding")
a portion of its exposure on a risk to another insurer, the reinsurer. The
reinsurer assumes the exposure in return for a portion of the premium. Our
reinsurance is primarily contracted under quota-share reinsurance treaties and
excess of loss treaties. In quota-share reinsurance, the reinsurer agrees to
assume a specified percentage of the ceding company's losses arising out of a
defined class of business in exchange for a corresponding percentage of
premiums, net of a ceding commission. In excess of loss reinsurance, the
reinsurer agrees to assume all or a portion of the ceding company's losses, in
excess of a specified amount. Under excess of loss reinsurance, the premium
payable to the reinsurer is negotiated by the parties based on their assessment
of the amount of risk being ceded to the reinsurer because the reinsurer does
not share proportionately in the ceding company's losses.
We renew our reinsurance treaties annually. During each renewal cycle, there are
a number of factors we consider when determining our reinsurance coverage,
including (1) plans to change the underlying insurance coverage we offer, (2)
trends in loss activity, (3) the level of our capital and surplus, (4) changes
in our risk appetite and (5) the cost and availability of reinsurance coverage.
Effective with the June 1, 2022 renewal, we entered into a new commercial
property insurance quota share treaty in place of our previous property per-risk
reinsurance treaty.
To manage our natural catastrophe exposure, we use computer models to analyze
the risk of severe losses. We measure exposure to these losses in terms of
probable maximum loss ("PML"), which is an estimate of the amount of loss we
would expect to meet or exceed once in a given number of years (referred to as
the return period). When managing our catastrophe exposure, we focus on the
100-year and the 250-year return periods.
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The following is a summary of our significant reinsurance programs as of
Line of Business Covered Company Policy Limit Reinsurance Coverage Company Retention Property - commercial N/A 42.5% up to$93.3 million 57.5% of all commercial insurance (1) per catastrophe property losses Property - personal N/A 50% up to$35.5 million 50% of all personal insurance (2) per catastrophe property losses Property - catastrophe (3) N/A$75.0 million excess of$25.0 million per$25.0 million catastrophe Primary casualty (4) Up to$10.0 million per$8.0 million excess of$2.0 million per occurrence$2.0 million occurrence Excess casualty (5) Up to$10.0 million per Variable quota share$2.0 million per occurrence occurrence except as described in note (5) below
(1) Our commercial property insurance quota share reinsurance reduces the
financial impact of property losses on our commercial insurance policies.
Reinsurance is not applicable to any individual policy with a per-occurrence
limit of
(2) Our personal insurance quota share reinsurance reduces the financial impact
of property losses on our personal insurance policies.
(3) Our property catastrophe reinsurance reduces the financial impact of a catastrophe event involving multiple claims and policyholders. Our property catastrophe reinsurance includes a reinstatement provision which requires us to pay reinstatement premiums after a loss has occurred in order to preserve coverage. Including the reinstatement provision, the maximum aggregate loss recovery limit is$150 million and is in addition to the per-occurrence coverage provided by our treaty coverages.
(4) Reinsurance is not applicable to any individual policy with a
per-occurrence limit of
(5) For casualty policies with a per-occurrence limit higher than$2.0 million , the ceding percentage varies such that the retention is always$2.0 million or less. For example, for a$4.0 million limit excess policy, our retention would be 50%, whereas for a$10.0 million limit excess policy, our retention would be 20%. For policies for which we also write an underlying primary limit, the retention on the primary and excess policy combined would not exceed$2.0 million . Reinsurance contracts do not relieve us from our obligations to policyholders. Failure of the reinsurer to honor its obligation could result in losses to us, and therefore, we established an allowance for credit risk based on historical analysis of credit losses for highly rated companies in the insurance industry. In formulating our reinsurance programs, we are selective in our choice of reinsurers and we consider numerous factors, the most important of which are the financial stability of the reinsurer, its history of responding to claims and its overall reputation. In an effort to minimize our exposure to the insolvency of our reinsurers, we review the financial condition of each reinsurer annually. In addition, we continually monitor for rating downgrades involving any of our reinsurers. AtSeptember 30, 2022 , all reinsurance contracts that our insurance subsidiary was a party to were with companies withA.M. Best ratings of "A-" (Excellent) or better. As ofSeptember 30, 2022 , we recorded an allowance for credit losses of$0.4 million related to our reinsurance balances. 39
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Ratings
Kinsale Insurance Company has a financial strength rating of "A" (Excellent) with a stable outlook fromA.M. Best .A.M. Best assigns ratings to insurance companies, which currently range from "A++" (Superior) to "F" (In Liquidation). "A" (Excellent) is the third highest rating issued byA.M. Best . The "A" (Excellent) rating is assigned to insurers that have, inA.M. Best's opinion, an excellent ability to meet their ongoing obligations to policyholders. This rating is intended to provide an independent opinion of an insurer's ability to meet its obligation to policyholders and is not an evaluation directed at investors. The financial strength ratings assigned byA.M. Best have an impact on the ability of the insurance companies to attract and retain agents and brokers and on the risk profiles of the submissions for insurance that the insurance companies receive. The "A" (Excellent) rating obtained byKinsale Insurance Company is consistent with our business plan and allows us to actively pursue relationships with the agents and brokers identified in our marketing plan.
Financial Condition
Stockholders' equity
AtSeptember 30, 2022 , total stockholders' equity was$619.5 million and tangible stockholders' equity was$616.7 million , compared to total stockholders' equity of$699.3 million and tangible stockholders' equity$696.5 million atDecember 31, 2021 . The decreases in both total and tangible stockholders' equity over the prior year-end balances were due to an increase in unrealized losses on available-for-sale investments, net of taxes, and payment of dividends, offset in part by profits generated during the period and net activity related to stock-based compensation plans. Tangible stockholders' equity is a non-GAAP financial measure. See "-Reconciliation of non-GAAP financial measures" for a reconciliation of stockholders' equity in accordance with GAAP to tangible stockholders' equity.
Investment portfolio
AtSeptember 30, 2022 , our cash and invested assets of$1.9 billion consisted of fixed-maturity securities, equity securities, cash and cash equivalents and short-term investments. AtSeptember 30, 2022 , the majority of the investment portfolio was comprised of fixed-maturity securities of$1.6 billion that were classified as available-for-sale. Available-for-sale investments are carried at fair value with unrealized gains and losses on these securities, net of applicable taxes, reported as a separate component of accumulated other comprehensive income. AtSeptember 30, 2022 , we also held$133.7 million of equity securities, which were comprised of ETF securities and non-redeemable preferred stock,$126.2 million of cash and cash equivalents and$81.4 million of short-term investments.
Our fixed-maturity securities, including cash equivalents, had a weighted
average duration of 3.9 years and 4.3 years at
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At
fair value on fixed-maturity securities were as follows:
September 30, 2022 December 31, 2021
Estimated Fair % of Total Fair Estimated Fair % of Total Fair
Amortized Cost Value Value Amortized Cost Value Value
($ in thousands)
Fixed-maturity securities:
U.S. Treasury securities and
obligations of U.S. government
agencies $ 22,945 $ 21,598 1.4 % $ 6,936 $ 6,847 0.5 %
Obligations of states,
municipalities and political
subdivisions 230,156 202,667 12.6 % 216,375 228,045 16.4 %
Corporate and other securities 795,400 707,563 44.1 % 450,594 458,487 32.9 %
Asset-backed securities 323,601 315,143 19.6 % 299,810 301,775 21.7 %
Residential mortgage-backed
securities 356,947 299,236 18.6 % 340,804 337,685 24.3 %
Commercial mortgage-backed
securities 65,680 59,640 3.7 % 57,000 59,227 4.2 %
Total fixed-maturity securities $ 1,794,729 $ 1,605,847 100.0 % $ 1,371,519 $ 1,392,066 100.0 %
The table below summarizes the credit quality of our fixed-maturity securities
at
Financial Services, LLC
September 30, 2022 December 31, 2021
Standard & Poor's or Equivalent Estimated Fair Estimated Fair
Designation Value % of Total Value % of Total
($ in thousands)
AAA $ 416,950 26.0 % $ 375,579 27.0 %
AA 493,353 30.7 % 523,739 37.6 %
A 371,597 23.1 % 234,547 16.9 %
BBB 263,730 16.4 % 196,740 14.1 %
Below BBB and unrated 60,217 3.8 % 61,461 4.4 %
Total $ 1,605,847 100.0 % $ 1,392,066 100.0 %
The amortized cost and estimated fair value of our fixed-maturity securities
summarized by contractual maturity as of September 30, 2022 and December 31,
2021 , were as follows:
September 30, 2022 December 31, 2021
Amortized Estimated Fair % of Total Fair Amortized Estimated Fair % of Total Fair
Cost Value Value Cost Value Value
($ in thousands)
Due in one year or less $ 14,977 $ 14,823 0.9 % $ 6,742 $ 6,822 0.5 %
Due after one year through five years 531,759 506,959 31.6 % 185,273 189,497 13.6 %
Due after five years through ten
years 245,305 207,332 12.9 % 226,707 232,197 16.7 %
Due after ten years 256,460 202,714 12.6 % 255,183 264,863 19.0 %
Asset-backed securities 323,601 315,143 19.6 % 299,810 301,775 21.7 %
Residential mortgage-backed
securities 356,947 299,236 18.7 % 340,804 337,685 24.3 %
Commercial mortgage-backed securities 65,680 59,640 3.7 % 57,000 59,227 4.2 %
Total fixed-maturity securities $ 1,794,729 $ 1,605,847 100.0 % $ 1,371,519 $ 1,392,066 100.0 %
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Actual maturities may differ from contractual maturities because some borrowers
may have the right to call or prepay obligations with or without call or
prepayment penalties.
As of
ETFs. At
comprised of the following funds:
September 30, 2022 December 31, 2021
Fund Fair Value % of Total Fair Value % of Total
($ in thousands)
Domestic stock market fund $ 58,563 61.7 % $ 81,384 66.0 %
Dividend yield equity fund 36,335 38.3 % 42,005 34.0 %
Total $ 94,898 100.0 % $ 123,389 100.0 %
As of
non-redeemable preferred stock. A summary of these securities by industry
segment is shown below as of
September 30, 2022 December 31, 2021
Industry Fair Value % of Total Fair Value % of Total
($ in thousands)
Financial $ 35,514 91.4 % $ 45,331 92.1 %
Utilities 2,639 6.8 % 2,993 6.1 %
Industrials and other 684 1.8 % 898 1.8 %
Total $ 38,837 100.0 % $ 49,222 100.0 %
Restricted investments
In order to conduct business in certain states, we are required to maintain
letters of credit or assets on deposit to support state-mandated insurance
regulatory requirements and to comply with certain third-party agreements.
Assets held on deposit or in trust accounts are primarily in the form of
high-grade securities. The fair value of our restricted assets was
and
Reconciliation of Non-GAAP Financial Measures
Reconciliation of underwriting income
Underwriting income is defined as net income excluding net investment income,
the net change in the fair value of equity securities, net realized investment
gains and losses, interest expense, other expenses, other income and income tax
expense. The Company uses underwriting income as an internal performance measure
in the management of its operations because the Company believes it gives
management and users of the Company's financial information useful insight into
the Company's results of operations and underlying business performance.
Underwriting income should not be viewed as a substitute for net income
calculated in accordance with GAAP, and other companies may define underwriting
income differently.
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Net income for the three and nine months ended
reconciles to underwriting income as follows:
Three Months Ended September 30, Nine Months Ended September 30,
($ in thousands) 2022 2021 2022 2021
Net income $ 32,984 $ 36,625 $ 91,865 $ 104,339
Income tax expense 7,116 9,054 19,549 24,387
Income before income taxes 40,100 45,679 111,414 128,726
Net investment income (13,858) (8,095) (33,540) (22,466)
Change in the fair value of equity
securities 6,095 1,012 37,199 (13,644)
Net realized investment losses
(gains) 173 (895) (1,535) (2,397)
Interest expense 1,716 243 2,306 752
Other expenses (1) 212 145 521 482
Other income (112) (35) (381) (58)
Underwriting income $ 34,326 $ 38,054 $ 115,984 $ 91,395
(1) Other expenses are comprised of corporate expenses not allocated to our
insurance operations.
Reconciliation of net operating earnings
Net operating earnings is defined as net income excluding the effects of the net
change in the fair value of equity securities, after taxes, and net realized
investment gains and losses, after taxes. Management believes the exclusion of
these items provides a useful comparison of the Company's underlying business
performance from period to period. Net operating earnings and percentages or
calculations using net operating earnings (e.g., diluted operating earnings per
share and annualized operating return on equity) are non-GAAP financial
measures. Net operating earnings should not be viewed as a substitute for net
income calculated in accordance with GAAP, and other companies may define net
operating earnings differently.
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Net income for the three and nine months ended
reconciles to net operating earnings as follows:
Three Months Ended September 30, Nine Months Ended September 30,
($ in thousands) 2022 2021 2022 2021
Net income $ 32,984 $ 36,625 $ 91,865 $ 104,339
Adjustments:
Change in the fair value of equity
securities, before taxes 6,095 1,012 37,199 (13,644)
Income tax (benefit) expense (1) (1,280) (213) (7,812) 2,865
Change in the fair value of equity
securities, after taxes 4,815 799 29,387 (10,779)
Net realized investment losses
(gains), before taxes 173 (895) (1,535) (2,397)
Income tax (benefit) expense (1) (36) 188 322 503
Net realized investment losses
(gains), after taxes 137 (707) (1,213) (1,894)
Net operating earnings $ 37,936 $ 36,717 $ 120,039 $ 91,666
Operating return on equity:
Average stockholders' equity (2) $ 626,761 $ 644,401 $ 659,395 $ 617,702
Annualized return on equity (3) 21.1 % 22.7 % 18.6 % 22.5 %
Annualized operating return on equity
(4) 24.2 % 22.8 % 24.3 % 19.8 %
(1) Income taxes on adjustments to reconcile net income to net operating
earnings use an effective tax rate of 21%.
(2) Computed by adding the total stockholders' equity as of the date indicated
to the prior quarter-end or year-end total, as applicable, and dividing by two.
(3) Annualized return on equity is net income expressed on an annualized basis as a percentage of average beginning and ending stockholders' equity during the period.
(4) Annualized operating return on equity is net operating earnings expressed on
an annualized basis as a percentage of average beginning and ending
stockholders' equity during the period.
Reconciliation of tangible stockholders' equity
Tangible stockholders' equity is defined as total stockholders' equity less intangible assets, net of deferred taxes. Our definition of tangible stockholders' equity may not be comparable to that of other companies, and it should not be viewed as a substitute for stockholders' equity calculated in accordance with GAAP. We use tangible stockholders' equity internally to evaluate the strength of our balance sheet and to compare returns relative to this measure.
Stockholders' equity at
tangible stockholders' equity as follows:
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Table of Contents ($ in thousands) September 30, 2022 December 31, 2021 Stockholders' equity $ 619,455 $ 699,335 Less: intangible assets, net of deferred taxes 2,795 2,795 Tangible stockholders' equity $ 616,660 $ 696,540 Critical Accounting Estimates We identified the accounting estimates which are critical to the understanding of our financial position and results of operations. Critical accounting estimates are defined as those estimates that are both important to the portrayal of our financial condition and results of operations and require us to exercise significant judgment. We use significant judgment concerning future results and developments in applying these critical accounting estimates and in preparing our condensed consolidated financial statements. These judgments and estimates affect our reported amounts of assets, liabilities, revenues and expenses and the disclosure of our material contingent assets and liabilities, if any. Actual results may differ materially from the estimates and assumptions used in preparing the condensed consolidated financial statements. We evaluate our estimates regularly using information that we believe to be relevant. Our critical accounting policies and estimates are described in our annual consolidated financial statements and the related notes in our Annual Report on Form 10-K for the year endedDecember 31, 2021 .
Arthur J. Gallagher & Co. Announces Third Quarter 2022 Financial Results
Part I – Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
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