Donegal Group Inc (DGICA) 2003 Q2 法說會逐字稿

Good day ladies and gentleman and welcome to the Donegal Group second quarter earnings call. At this time, all participants are in a listen-only mode. My name is Mike and I will be your conference coordinator today. If at any time during the call you require assistance, please press star followed by zero and a conference coordinator will be happy to assist you. As a reminder, this conference is being recorded. I would now like to turn the program over to your host for today's conference, Chief Financial Officer, Mr. Ralph Spontak, please proceed sir.

Thank you very much. Good morning everyone, and welcome to the Donegal Group, Inc. earning release conference call, for the second quarter of 2003. I am Ralph Spontak, Chief Financial Officer of the company and I will be starting the conference call by reviewing some of the key financial components of the quarterly results. Don Nikolaus, President and Chief Executive Officer of the company will then, as usual, discuss some of the current trends we are experiencing.

Just as a reminder, all statements contained in this conference call that are not historic facts are based on current expectations. Such statements are forward-looking in nature and involve a number of risks and uncertainties. Actual results may vary materially. The factors that could cause actual results to vary materially include the ability of the company to maintain profitable operations, the adequacy of the company's reserve for loss and loss-adjusting expense, business and economic conditions in the company's primary operating areas, competition from various insurance and non-insurance businesses, changes in regulatory requirements, and other risks that may be described from time to time in reports Donegal is required to file with the Securities and Exchange Commission. Undue reliance should not be placed on any such forward-looking statements.

Second quarter saw the favorable underwriting trends we began to experience in 2002 and continued experiencing in the first quarter of this year to continue and improve even further as the effects of pricing increases, underwriting discipline, and expense control, all contributed to the strong results for the quarter. Net income for the second quarter of 2003 increased 66% over the second quarter of 2002 with record net income of $5,268,953 or $0.56 per common share on a diluted basis for the second quarter of 2003 compared to $3,178,834 or $0.35 per share on a diluted basis for the second quarter of 2002. Operating income for the second quarter of 2003 was $5,128,313 or $0.54 per common share on a diluted basis. Net income for the first six months of 2003 increased 70% over the first half of 2002, once again with record net income of $9,113,385 or $0.97 per common share on a diluted basis compared to the first half of 2002, which posted net income of $5,359,550 or $0.59 per share on a diluted basis. The annualized return on equity for the first half of 2003 was 13%.

As mentioned, the second quarter marked a continuation of the trends we saw in 2002 and earlier in this year towards strong underwriting results with the company posting an excellent GAAP combined ratio of 92.3% for the second quarter ended June 30, 2003. That compares to 99.3% combined ratio that we posted in the second quarter of 2002. The GAAP combined ratio for the year-to-date was 94.7 compared to 100.5 for the first half of 2002 with the company's loss ratio improving to 63.8% for the first half of this year compared to 69.3% in the first half of 2002. The company's combined ratio continues to benefit from improvements in operating expenses and increases in efficiencies with the company's GAAP expense ratio being at 30.6% during the second quarter. This is somewhat higher than we would have anticipated and a large part of that is due to incentives that were tied to the fine underwriting results. The company's book value per common share, once again increased significantly during the quarter, ending up at June 30, 2003 at $15.49.

Total revenues in the second quarter increased 4.1% with premiums earned increasing 5%. The company continues to have its premiums earned somewhat depressed as the result of some mergers of subsidiaries that took place during 2002 whose premium income is now pooled with that of Atlantic States and Donegal Mutual. The effects of that change should pretty much be over at the end of this quarter. As a more interesting comparison, the direct premiums written, of Donegal Mutual and Atlantic States, as pooled results, actually increased 6.3% during the second quarter and the pool direct business written increased 9.38% for the year-to-date.

At this point, I will be turning things over to Don Nikolaus, President and Chief Executive Officer of the Donegal Company. Don?

Thank Ralph. Good morning everybody and welcome as you have realized from reading the press release and from listening to Ralph's presentation, it was an excellent quarter for Donegal Group and we are particularly pleased because I think that it reflects well on the underwriting and pricing discipline that we have been focusing on over the last two years and I would have to say that it is a combination of the two, we have been aggressive over the last two years in bringing a rate in premium increases, but at the same time, in a tight market and with the ability to obtain rate in premium increases, we have also taken the opportunity over that two year period to refine our book of business and to refine our underwriting appetite because moving forward, we wanted to make sure that we had the best quality book of business that would be possible and at times, that may have meant that certain business that we previously had on the books, that was acceptable premium at the time, but under new underwriting standards no longer met this stiff criteria that we were putting in place.

I am pleased to say that we are also, in the year 2003, able to make additional rate increase filings, particularly in product lines such as homeowners that we have obtained approvals in states such as Pennsylvania and Ohio and several other states where we have significant books of homeowner business and intend to continue to monitor premium adequacy to make sure that our rates are appropriate and will return the kind of ROE that we are interested in achieving.

From the standpoint of business opportunities, we had mentioned on prior calls that we are working on increasing our distribution system and year-to-date have appointed approximately 45 to 50 new agencies in the various states in which we do business. And, we would anticipate going forward that over a reasonable period of time that those new agency appointments will begin to contribute towards growth opportunities.

For the year 2003, we have also put in place incentive programs for our agents in various states including travel incentives, and certain commission, bonus incentives based upon a certain quantity of business being submitted in a quarterly period. We believe that the combination of those incentives coupled with the fact that we do have some very quality strong underwriting that we are attracting quality business to our company. Although our gross percentages reflected in this quarter do not reflect high growth rates, we believe that through the balance of the year that we will begin to see higher rates of growth reflected from a combination of factors.

We see that our new business submission, particularly in the commercial area have increased nicely and that we would anticipate that that trend should continue forward throughout the rest of the year. We in general, our observation is that many of our large national competitors continue to take rate increases which is always helpful to regional companies because it provides us certainly the environment within which to be attracted to various businesses opportunities, as well as the environment that allows us to continue to moderately increase our rates along with the rest of those industry players.

We would at this point be very interested in entertaining questions from the various participants so that we can respond to any inquiries you have both as to the quarter and to other matters relating to our operations.

Ladies and gentlemen, if you wish to ask a question, please press star one on your telephone. If your question has been answered or you wish to withdraw your question, please press star two. Questions will be taken in the order they are received. Again that's star one to ask a question. And our first question comes from David Lewis (ph) with SunTrust Robinson Humphrey, please proceed.

Thank you and good morning. Congratulations on a fabulous quarter.

Thank you Dave.

I guess I want to talk a little bit about claim trends. First, just kind of noting this is probably the best loss ratio we have ever seen at your company, since I covered it a fair number of years? Are there any reserve releases from any of the other areas that might have benefited the quarter, or was that just a fabulous weather-related quarter?

No. There were no reserve releases at all during the quarter Dave.

And Dave, I would say to you that weather is certainly a factor, but we would think -- we would take the position that weather is only one of the factors. We think that the profitability that has reflected is primarily from the fact that we've been able to increase rate adequacy and also we have been refining our underwriting quality.

Let's talk a little bit about that and if you look in the first quarter, you guys generated a loss ratio of 66.5% and if I recall correctly, you had pretty decent weather related losses in the first quarter. I know the first quarter has got a little bit of weather in there and then you're down to 61.2% in the second quarter, and what should I assume in the second half if we anticipate more normalized weather, is it a 65% loss ratio or is it a 63% loss ratio under a normalized kind of weather pattern?

Well as you know, we generally aren't in the business of predicting exactly where our specific loss ratios will be. We would -- it would be our expectation that we will continue to have very good results through the remainder of the year. As you know, it is very difficult to say that we will be able to repeat as good of a loss ratio in the third and fourth quarter as we had in the second. That is very possible, but we certainly are not in the position to predict that. Certainly, weather is always an issue and the third quarter can have as much weather issues as the second quarter does. So, weather certainly is a component, but in the absence of any really severely bad weather, we would expect that we would continue to have very good results whether it's the loss ratio of the first quarter or the loss ratio of the second quarter, or somewhere in between. We would expect it to be within that range.

I would tend to echo Don's comments. Also Dave, any time that you post what is most probably our record low loss ratio, it is hard to say that you are going to do that again the next quarter. There are a lot of factors that impact the summer loss ratios including a great deal of increased driving for the summer months, which does tend to impact the loss ratio in the automobile lines and of course the unpredictability of weather is always in there. As Don said, our most likely scenario would be somewhere between the current quarter and the first quarter. That would be our best bet.

And as you know Dave, an issuance company's book of business, the quality of it has a lot to do with what the longer-term trends are in terms of loss ratio, and we think that traditionally we have always had a good book of business and reasonably priced. We think that certainly over the last six months to a year that, that quality of that book of business has improved and certainly the pricing has improved nicely. So, we think that we have a very good foundation to move forward that we are not dealing with the book of business; it has a lot of ifs in it.

I understand. Maybe Don, you can talk a little bit about the pricing environment and may be give us a little more detail than you did in you initial remarks possibly even breaking out the pricing between workers comp, one, other commercial, and then personal lines? And then, to draw on that, you indicated that the price increases will help you to achieve a homeowner ROE target, if you could maybe tell us what that target is versus where it is running right now?

Yes, we will certainly try to do that. With regard to the various lines of business, certainly in the workers comp line, we continue to try to get anywhere between 8% and 12% increases on accounts. Certainly, where that is warranted, that varies from jurisdictions and that certainly has been our practice over the last couple of years, certainly in 2002, it would have been a higher percentage. In other commercial lines, we are seeking increases depending upon the product line, for instance, in commercial auto, it would be anywhere between 6% and 10%, in package business both tops (ph) and CPTs (ph), it would be anywhere between 5% and 10% depending upon the particular jurisdiction.

Certainly in commercial lines, as I am sure, you may be hearing from others, there is still a very firm market depending upon certain areas there may be a little bit more price sensitivity than there has been over the last two and a half years. But, it certainly is not problematic, but competition is still alive and well in our industry.

On the personal line side, we are certainly more aggressive currently in rate increases in homeowners than we are in private passenger automobile. We have raised in 2003 private passenger on the bill rates anywhere from 5% to 9%. We have also, on a very, and I want to emphasis this on a very selective basis, we have identified certain geographic areas in our super preferred products where we want to be a bit more competitive, where on a very select basis, we have refined some rates. But, in general private passenger automobile rates have been growing -- continue to go up.

In homeowners, we, as an example, in the state of Ohio, we raised homeowner rates approximately 9%. In Pennsylvania we raised them 4.5% and that is after raising them probably double that in the three prior years. And in terms of ROE, we are certainly recognizing the overall ROE in our industry, and in a line like homeowners, we would like to get it to the point where hopefully we are getting an ROE of somewhere from 10% to 12%. We are probably not there in homeowners, but we want to work in that direction.

Great. Thank you very much.

And our next question comes from Beth Malone (ph) with Advest (ph), please proceed.

Okay, thank you. Good morning, congratulations on the quarter. I just like to follow up on a couple of things that that David mentioned. One, with the loss ratio being at these record low levels for your company, is there any thought or incentive when you see the top line growth to start to be to - it's probably below your targeted level, and so I am wondering is there any chance that you would review some of your pricing, and that you are actually getting more-- better pricing than you thought so that there might be an incentive to ease up on the pricing a little bit to get the loss ratio a little bit more inline with targeted and grow the top line a little more?

Well, I think that's an excellent question. Let me address it in a - from a number of standpoints. As you know I placed some emphasis on the fact that over the last two years we've taken the opportunity to refine our book of business, and very candidly, we like any other company in that process would have identified some business that no longer met our criteria. And in the second quarter as an example, there were a number of large commercial accounts that no longer met our criteria, and we probably moved away either our action or because of our pricing action probably moved away from five or six large accounts that would have maybe moved the growth for at least the month of June may have moved it by two percentage points. Now, we think that we are probably through all of that but it goes back to the fact that we are prepared to have underwriting discipline and not just to keep an account to say that we write some large accounts. We are primarily a writer of small to medium sized commercial accounts anywhere from $1,000 to $75,000, but we do have a certain part of our book to business for larger accounts.

Having said all of that, we are encouraged by the fact that our amount of new business that we are seeing opportunities on and righting is fairly significant and therefore we don't think that our pricing is out of line. What we are seeing is that maybe certain existing business that was on the book was not priced adequately and in the process over the last two years of getting that up to speed, some of that renewal business has moved off the book. And we think that that's part of refining the book of business.

So, we are encouraged by the fact that we are seeing good opportunities to write new business and that our new business is ahead of budget, and that we would expect that trend to continue. I believe and this is not a prediction but I believe that our third quarter results will show more top line growth. We clearly have our profitability and pricing under control. We recognize that we now need to spend some more time focusing on top line. So, that's one of the marching orders that we are sending out, but we would want to underscore that we will not want to do that by compromising either pricing to any significant degree, or comprising our underwriting standards.

In order to encourage some top line growth that's why we did do on a surgical basis, we did do some refining of our rates in our super preferred auto products, which represents probably only about 20% of our automobile business but what we are attempting to do there is on the very select business to be a bit more competitive because we may have over the last two years increased rates in that product line a little more than we needed to, and we are seeing nice improvement in our profitability there. So, we have taken some limited steps to refine some of our more select private passenger automobile products, so that we can grow the top line in that product line.

Okay. Also on the side of the balance sheet, is there as you -- if you focus on this top line growth a little bit more, is there any capital constraint or was the capital you've raised earlier this year going to be more than adequate based on your goals?

I think it's clear that we have no capital constraints and the capital that we raised in the trust preferred is primarily - certainly for general corporate purposes, some of the money may find its way into some of the insurance subsidiaries, but it's primarily for the purpose of potential acquisitions.

Beth Malone Okay. All right, well thank you.

You are welcome.

And, our next question comes from Eric Avickser (ph) with Rubicon (ph) Partners. Please proceed.

Yes. Hi. Congratulations on a good quarter. I'd like to know if possibly the adjustment to reserves that were done possibly in the first quarter. You did answer about the second quarter and if you could tell us what the comparables were on the first and second quarter of last year, loss adjustments to reserve?

Loss adjustment to reserves -- Let me grab those numbers, we will be right back to you.

Thank you.

Maybe we can move onto the next quarter, while we get those numbers together. To the next question.

Actually, I just have another question. It had to do with the last remark about the acquisitions. Are these to be made from the mutual or are there external to it?

Well, we because of our unique structure, we have the ability to do acquisitions by the Mutual and also by the public company. Certainly I was answering that question in the context of a public company. And, the capital that would have been raised by the public company would be used only for acquisitions by the public company. But, we also have the opportunity through the Mutual to do mutual affiliation and then eventually to demutualize it and then historically what we have done is then to sell that entity to the public company. So, --

My question had to do really with whether there is any potential of doing acquisitions from the mutual to the public company at this point?

Well, are you saying to acquire?

Was there already a company? I think I remember something about the Mutual already acquiring another small Mutual and getting it in shape. I am just wondering if the potential acquisition had to do with [inaudible] at specific entities from the Mutual to the public company?

The answer to that is that there is an entity that the Mutual has done an affiliation with, in the Mid West and that company is in the process of going through the re-underwriting process and yes there is a possibility that, that company would be demutualized and that our public company might very well acquire that at the appropriate point, yes. That's a distinct possibility.

Great. I think that's good news.

In answer to the question about the amount of loss development included in the financials, Dan Wagner, our Treasurer is getting the numbers for the first quarter, but through the first six months of this year, we have favorable development approximately $640,000 that would have compared to adverse development a year-ago of $2.9m. So, you can see that the loss reserving that we had done a year ago was very strong and that the $640,000 of favorable reserve development is pretty flat. It's about as flat as you can get in a year.

Right. And, that's probably done on the first quarter of this year, right because the comment was that on second quarter there were no release of reserves?

That is exactly correct. Now, to be honest even a six-month period is still a pretty short period to be doing any detailed analysis of loss development. But, that's our best estimate at this point.

I am sure. Thank you very much.

And, our next question comes from David Lewis with SunTrust Robinson Humphrey. Please proceed.

Thank you. Can we talk a little bit about the expense ratio, if you had a more normalized loss ratio in the 65% area; it's just a point. Where do you think that expense ratio would have been running, would it have been closer to 29.5%, do you think it will be closer to 30%, I guess I am trying to figure out the incentives. How much impact did that have on the expense ratio in the quarter?

Dave, I think it would be closer to 30%, maybe just under.

Okay. So, if we assume something more normal moving forward, your target might be closer to that 30% range on a GAAP basis?

On a GAAP basis, I think that's fair.

Okay. That's helpful. And, talking about the top line, [inaudible] in premium, the comparisons were a bit more difficult in the first half then they are on the second half and I know you had some of the pooling issues there, but based on my model, which you hit almost dead on in second quarter, we are kind of looking for something in the 8% total net written premium growth in the second half of '03? Do you feel that, that's unrealistic and I know you don't make predictions, but maybe any thought process would be helpful?

No. I think that's very realistic Dave. I think that's right in the range.

Something comparable maybe 6% to 8% or something in that range in '04 ought to be reasonable assuming that the cycle continues at the kind of levels we think today?

Again, I think we would very much agree with those levels.

Okay. And then, talking about net investment income, I assume there has not been any change in the portfolio strategy obviously keeping pretty short portfolio, are you starting to push that out a little bit?

We have not started to push that out at this point. We are still trying to stay pretty short, as we all know, interest rates are down pretty substantially. If you look at our balance sheet you actually see that our short-term investments increased pretty significantly from the end of the year, end of 2002 to the end of June. Basically, what we've done is taken the additional operating cash that has been generated from the underwriting side and kept it real short. So, we've done nothing with our mix of business, investment portfolio at this point.

And, Dave as you know what's happened to the bond market over the last three weeks, it appears that the bond market believes that rates will trend up and they certainly have been trending up since the end of June. So, we were reluctant to go out very far in the yields curve, at the very low rates that were available.

I understand. So, we are probably looking at even on the sequential net investment income probably something roughly flat to modestly even down in the second half of the year on a quarter-by-quarter basis?

Yeah. I think modestly down is not unrealistic.

Okay. And, given the new tax law changes, is there any anticipation of a change in dividends payouts to shareholders?

Well, we did just last quarter increase the normal quarterly dividend from $0.10 for the Class A to $0.11 and from $0.09 on the Class B to $0.10. So, this is only the second quarter the announcement that we just made today of the -- this quarter dividends. Only the second quarter with those higher dividend levels. I think at this point, we'd not anticipate an increase in the immediate future anyway.

And, as you are aware our payouts as a percentage has certainly been fairly high relative to many other common stocks. So, we think we are providing a healthy dividend to our shareholders and we think that we are at an appropriate level at this point in time.

Based upon the current market values, the dividend is still running about 3.3% to 3.5% of the current market values. So, we feel it's pretty strong.

Most definitely. Final question Ralph. Do you know what the statutory capital level was at June 30th and I assume that included the preferred offering?

The statutory capital at the end of June 30th was a $129.859m and that would not include the $15m of the trust preferred, because at June 30th that was all still sitting up at the holding company level.

Okay, so that's $15m trust preferred held at the holding company which could obviously will be dividend down some point if needed.

It could be right.

Right, thanks very much.

You're welcome.

Once again ladies and gentlemen, if you wish to ask a question, please press star one. And that's star one to ask a question. And there are no further questions at this time Mr. Spontak.

Okay, just like to thank everybody for joining us today. We appreciate your participation. If you have any further questions, please don't hesitate a hold of me and we’ll answer those as best a possible. Once again thank you all for participating in our conference call. Good bye.

This concludes your conference call. Thank you for your participation today. You may now disconnect.