Kingstone Companies (KINS): A Homeowner’s Insurance Company Focused on Selling Through Agents in Downstate New York
From time-to-time, I research a company where I think I’ll do a write-up of the stock and then discover it isn’t as interesting a situation as what I first thought. That’s the case here. Kingstone (KINS) seemed fairly cheaply priced on the surface. And seemed like an easy enough business to understand. But, several of the things I found – while not individually all that serious – added up to a pass for me. Instead of writing about the company, the valuation, etc. in a lot of detail – I’ll just go over what I found that were hurdles I couldn’t clear.
We can start with valuation. Value investors are often attracted to insurers where the stock is trading below tangible book value. As of the last 10-Q, Kingstone had about $88 to $89 million in tangible equity. Shares outstanding are about 10.6 million. So, tangible book value is a bit north of $8.30 a share. The stock last traded at a price a bit below $7 a share. So, you are getting in at a discount of something like 15% of tangible book value.
There are two ways of looking at this.
One, it gives you upside. If a company can compound at 10% a year and you buy it below tangible book value – you can get an earnings yield higher than 10% a year and you can get an additional capital gain from the increase in the price-to-book multiple over the time you own it.
This is the “Davis Double Play”. You buy at say 8 times earnings. Earnings compound at 10% a year. After a number of years, you sell at 16 times earnings. Over 10 years, a doubling of the earnings multiple provides a 7% a year return. The business itself only has to grow at a “modest” 8% a year for this combination (7% plus 8%) to add up to a 15% a year return over 10 years. That’s a low-ish hurdle to clear for a very nice, very market beating return. So, that approach appeals to value investors.
Two, tangible book value can provide downside protection. An insurer could make an attractive acquisition target for another insurer if the price-to-book multiple of the acquired insurer is below that of the acquiring insurer and if it’s below book value. If paid in cash, an acquirer gets more assets by paying less than book value. If paid in shares, an acquirer gets more assets than it gives up because the shares it is giving up in itself have less asset backing than the shares it is acquiring.
There’s a third way of looking at it.
This is the “Buffett” approach. When Buffett bought National Indemnity (an insurer) for Berkshire Hathaway – he thought of his purchase price as only the amount he was paying over the investments held by the company. This is because he was going to own cash, stocks, and bonds anyway. And once he bought National Indemnity, he’d have control of the cash and stocks and bonds that company owned. He could re-allocate the capital. So, it was only the goodwill paid above book value that mattered.
On this score, Kingstone does well. It’d be a good target for someone interested in owning an insurer. Tangible book value is maybe $8.30 a share. Stock price is maybe $7 a share. But, investments per share are more like $18 a share. Investments are more than double equity. So, you know that a lot of investments are financed with something other than equity. That could be float. It could also be debt. Here, it’s mostly “float”. The company does have $30 million (around $9 a share) in debt on it too.
The cost of the equity, float, and debt financing the investment portfolio is not necessarily super low here though. That’s because the company’s combined ratio and its cost of borrowing may not be dependably all that low.
This brings us to the other way of thinking about an insurance company.
It’s my preferred way.
We can break an insurer into two parts. Part one is the immediate and direct results of underwriting. This is the front of the investment opportunity. Is underwriting on its own – absent the profits earned on float – money making, money losing, or break even? Then, we have the back end of the investment opportunity. How much cash is generated that can be invested? What is the size of the investment opportunity?
And now we have the debate every value investor looking at an insurer for the first time hears.
Should an insurer trade at tangible book value? Below? Above?
There’s conventional wisdom.
And then there’s whatever wisdom I can offer.
Here’s my thinking…
It depends primarily on the front part of the investment opportunity. Investable assets are sourced via underwriting. If this sourcing is consistently cheap – the securities portfolio is extra valuable. If this sourcing is consistently expensive – the securities portfolio is less valuable.
At an insurer – if the underwriting itself is consistently profitable, then whatever float is generated is better than cost free. So, you get an investment portfolio financed for less than zero percent. Even with regulations investment companies have to abide by for their portfolio composition, capital levels, etc. – and usually even with subpar and uninspired investment management by the company – a securities portfolio financed at less than zero percent must be worth more than an investment portfolio directly held by owners. In other words, if a company’s combined ratio is always under 100 then that company almost has to be worth more than its tangible book value. If the combined ratio is greater than 100 on average, it could be worth less. Simply put, it’s better to buy an investment portfolio indirectly through an insurer with a combined ratio below 100 when that insurer trades below book value then it is to buy an investment portfolio directly (buy stocks and bonds for your own brokerage account instead of the insurer’s common stock).
It’s unclear here that the combined ratio will come in below 100. Kingstone writes through agents. The business has historically been primarily for covering “personal lines” especially homeowners insurance in downstate New York. Operations are done more upstate and policyholders more downstate. There is very significant exposure to winter storms, a very occasional hurricane, etc. writing on coastal properties in states like New York. Properties have very high values. Losses could be large. There is significant noise from year-to-year weather related losses. Usually, there will be a series of small losses (lumpy, but expected). Sometimes, there will be one specific named storm (like Superstorm Sandy, for instance) that will cause major losses all on its own.
There’s nothing wrong with writing this kind of insurance. But, the way Kingstone does it exposes the company to some significant costs that could make it difficult to write at a low combined ratio. Basically, I’m not sure the company is really doing enough to extract value from the insurance process – it’s too much of a pure middleman.
Why do I say that?
The company does not sell policies directly under a strong brand name in the state of New York and nearby Northeastern states. Instead, it sells through independent agents (agents who can write for other insurers too). That comes with significant costs. If you are retaining these risks on your own balance sheet, you may still get to extract plenty of value. But, to a large extent, Kingstone is not doing this. It makes use of a lot of reinsurance. In the past, the company had consistently used reinsurance in two ways. It used “quota” reinsurance, which is more like splitting policies with a reinsurer. On average, who does this benefit? Kingstone? Or the reinsurer? The risk is that it only benefits Kingstone when reinsurance pricing is weak. Kingstone doesn’t have sufficient financial strength to continue writing policies at the same volume while staying out of the reinsurance market in years where reinsurance is priced strongly. The other way they use reinsurance is through catastrophe reinsurance. This is more typical and more necessary for a smaller insurer that takes on weather risk. I am referring to the company – as I did with Universal down in Florida – as mainly a homeowner’s insurance company, because I think those are the greatest risks and opportunities to consider as an investor in the company. It does write other business. It does property damage only (no liability) for “livery” (this can mean taxi, limo, van, bus, etc. – there is plenty of this needed in NYC). The company also writes an immaterial amount of canine liability insurance. Previously, it had written commercial policies for which it did not have reinsurance. Prior years have some run-off results from lines it no longer writes. Generally, these issues have been resolved.
This makes reserve development harder to evaluate. On a company-wide basis, it has not historically been what I’d say you want to see. However, the company recently changed almost everyone – except a major shareholder, and now CEO and Chairman (once again) – that matters to insurance decision making. This includes not just top executives but the head actuary. It’s a complete change at the top. And it’s hard to evaluate how much of this is for the better. It is not clear to me that problems in underwriting were related only to very recent years. What problems there were did happen under a top person at the company who is at the top now. So, it’s not like an outsider coming in and changing everything.
Kingstone’s reinsurance is with the usually expected reinsurers mostly. One reinsurer they use is not adequately reliable (in my opinion). However, that reinsurer does post collateral. So, they are fine there. Overall, I would be most worried about the possibility of reinsurance prices rising faster than the company can increase its policy pricing. This would lead to weaker results over time. Results at this company include some past years where I think reinsurance rates were not as high as they need to be long-term. They were cyclically low. And I wouldn’t count on the rates of 5 years ago or whatever being that kind of rates to expect indefinitely into the future. So, you can have a drag from reinsurance rates increasing faster than policy pricing. Same risk as at Universal. Of course, that’s just my totally speculative input. We don’t know if it’ll happen. The company might tell you reinsurance rates as a percent of premiums will turn down and stay down. I don’t know. But, you can find other insurers that aren’t so dependent on reinsurance.
Kingstone’s financial strength is mediocre. They warn in the 10-K that they lost their A.M. Best A- rating which is a requirement to be available on national insurance marketing platforms they had been using (they call this segment “Cosi” in their filings). The company also reduced its catastrophe coverage in a way that exposes it more to extremely bad but extremely rare weather years. As a result, existential risk to Kingstone is higher now than it had been a couple years ago. According to models, we are talking about a disaster year rarer than a COVID type pandemic. But, as we saw with COVID – somewhat rare but eventually bound to happen catastrophes do happen, and they are less covered now than previously. Also, models may not be able to distinguish between a one-in-50 and one-in-150 year event as well as they think. Life would be easier for the company if it had the larger reinsurance coverage and the better A.M. Best rating it used to. On the other hand, I suppose that leaves upside potential in a “turnaround” situation. A few years of very good underwriting, some investment gains, retaining earnings, etc. can get the company to a financial position that would make it better positioned for future growth.
Theoretically, this is an old company. It had been sort of a mutual company prior to about 10 years ago. However, in its current form – it’s a young company. The executives, executive compensation approach, etc. are unremarkable. The company could be run cheaper. But, incentives are mostly what you’ll see at a lot of insurers. They are tied to underwriting results instead of investing. They suggest ROEs in the 6-14% range (which is 10% plus or minus 4%) are the kind of targets the company is thinking about when setting compensation.
They have a couple somewhat large (5-9%) shareholders that are notable. The one that stands out is “Griffin Highline Capital” which focuses on insurance investments. The guy who runs that firm previously worked for a reinsurer and did investment banking among insurers before that.
This company does not have a history of earning and retaining earnings. The balance sheet consists mostly of capital contributed to the company. Retained earnings are just $16 million (less than 20% of total shareholder equity). For comparison, there are insurers out there that have been grown almost entirely organically through retained earnings such that equity is basically all formed from accumulated past earnings. This is just a simple point that illustrates the past history of the company is not long and not particularly impressive.
The stock is pretty cheap versus where it traded in the past. It was once priced at 3 times today’s level. However, the stock’s price versus its tangible book has been all over the place historically. I am not sure how other investors view the stock. It seems to have a history of trading on sentiment and speculation about near-term results much more than on a balance sheet focused valuation.
How cheap is it versus a good past year? Maybe somewhat cheap. The stock once earned over $1 a share. But, it doesn’t have a history of doing so. It might be trading at like 7-10x a good year of results. But, you could figure this out by just looking at price-to-book.
Kingstone stock may be cheap. However, I didn’t find much of anything special about this situation. And unless I learn more – it’s probably a pass even at somewhat lower prices. It might be fine as part of a basket. It is not the safest looking insurer I’ve ever seen.