Donegal Group Inc (DGICA) 2003 Q4 法說會逐字稿

Good day, ladies, and welcome to the Q4 2003 Donegal Group earnings conference call. My name is Kristen (ph) and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's call, Ralph Spontak, Chief Financial Officer. Please proceed, sir.

Thank you very much. Good morning, everyone, and welcome to the Donegal Group Inc. earnings release conference call for the fourth quarter and year ended December 31st, 2003. I'm Ralph Spontak, Chief Financial Officer, and I will be starting the conference call off by reviewing some of the key financial components of the quarterly results. Don Nikolaus, President and Chief Executive Officer of the Donegal Companies, will then, as usual, discuss some of the current trends we are experiencing.

Remember that all statements contained in this conference call that are not historic facts are based upon current expectations. Such statements are forward-looking in nature and involve a number of risks and uncertainties. Actual results could vary materially. Among 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 reserves for losses and loss adjustment expenses; business and economic conditions in the Company's primary operating areas; competition from various insurance and noninsurance businesses; terrorism, legal and judicial developments; changes in regulatory requirements; and other risks that are described from time to time in the periodic reports the Company files with the Securities and Exchange Commission. Undue reliance should not be placed on any such forward-looking statements.

On to the fourth quarter results. the Company's strong financial results for the first three quarters of this year continued through the fourth quarter, with the Company's underwriting results improving even further over the underwriting results for the first three quarters. Net income for the fourth quarter of 2003 was $5,179,206, or 47 cents per share on a diluted basis. That compares to $3,627,496, or 39 cents per share on a diluted basis, for the fourth quarter of 2002. This represents a 43 percent increase in net income when compared to the prior-year numbers. Net income for the year ended December 31st, 2003, increased 52 percent over the full year 2002, with net income of $18,293,976, or $1.85 per common share on a diluted basis, compared to $12,002,722, or $1.31 per share on a diluted basis, for the full year 2002. The return on average equity for the Company was 12.2 percent for the full year 2003, and 12.4 percent on an annualized basis in the fourth quarter of 2003.

The Company posted an excellent GAAP combined ratio of 93.8 percent for the fourth quarter of 2003, compared to 97.9 percent in the fourth quarter of 2002. The GAAP combined ratio for the full year 2003 was also an excellent 95.0 percent, compared to a 99.6 percent combined ratio for the full year 2002. Loss developments continue to be almost right on the mark, with a positive loss development in the fourth quarter of approximately $125,000 and a positive loss development of approximately $400,000 for the full year 2003. The Company's total revenues in the fourth quarter of 2003 increased 7.2 percent over the same period in 2002.

The Company's GAAP expense ratio in the fourth quarter of this year was 29.8 percent, compared to 27.2 percent for the fourth quarter of 2002, with almost the entire increase coming from additional agent incentives that were based upon the Company's excellent underwriting profitability. The Company's effective tax rate in the fourth quarter was 29.8 percent, which was up slightly from the effective tax rate of 27.4 percent that we experienced through the first three quarters. This was due, once again, to the higher levels of underwriting profitability in the fourth quarter. The effective tax rate for the entire year 2003 was 28.1 percent.

The Company's book value per common share increased to $16.29 per share at December 31, 2003. As a result of the company's stock offering that was completed late in 2003, we estimate that the Company's fully-diluted shares outstanding in the first quarter of 2004 will be between 13.6 million shares and 13.7 million shares. Again, that's our estimate of fully diluted shares outstanding in the first quarter of 2004. At this point, I would like to turn the call over to Don Nikolaus, President and Chief Executive Officer of the Donegal Companies. Don?

Thank you, Ralph. Good morning, everyone. We are pleased to have you join us in this webcast and telephone conference with regard to our quarterly and year-end results. In a way, the financial results speak for themselves. We certainly have enjoyed the most successful year in many, if not all, of the measurements financially of an insurance holding company.

We are particularly pleased that two of those measurements -- the return on average equity, achieved 12.2 percent for the year, and I'm sure all of you realize that within the property and casualty industry, that is certainly on the high end of the range of return on average equity. Our combined ratio for the year of 95 percent and 93.8 percent certainly represent historic results for us. And we are certainly pleased with the result of all of that.

What I would like to do is to report on a number of aspects of our operations, including bringing you up-to-date on some of the information that would have been made public as part of the prospectus in connection with our offering. As you know, we were scheduled to close on two acquisitions, Peninsula Insurance Group and Le Mars Insurance Company. Le Mars closed on January 1, 2004, as expected. Peninsula closed five days later, on January 6, 2004. We are of course beginning the process of fully integrating those -- to the extent that was previously disclosed, integrating those into our operations and to working with the management of those subsidiaries to achieve the kind of results that we would expect and our investor group would also expect.

We also infused $10 million, as indicated in the prospectus, into our subsidiaries. Five million was invested in Southern Insurance Company, and 5 million was invested in Atlantic States Insurance Company. On the strictly operational side, we have continued to grow our distribution system since the latter part of the year. To this point in time, we would have appointed approximately 20 new agencies throughout the states, the traditional states, in which we have done business, which would be approximately 14 states, that we continue to see market opportunities in some territories to a greater extent than in others, but we see market opportunities as a result of a number of factors, including the possibility that some other companies might be somewhat stepping away from a particular market or a particular product, or that our presence is becoming more of a factor.

We continue to emphasize throughout our operations the need to have underwriting and pricing discipline, because we believe there is a close connection between our underwriting results -- the 95 combined and the 12.2 return on average equity (technical difficulty) and underwriting and pricing disciplines. Early in 2004, we have taken action to look at those rates and service charges, and we have made filings in all states where it is legally permissible to increase rate -- late fees on the payments of installments from $10 to $15, and that would go across both personal lines and commercial lines. We have also increased our installment service charge on commercial lines only from $7 to $10 per installment. This is all part of a long-term strategy to increase as much as practical and where good judgment indicates the service fee income that we can make available to ourselves.

We've also been active as appropriate in making rate filings. Of course, we are only early in the year. We generally have products on a cycle of which products get reviewed at which time of year. Generally, workers' comp is one of the early ones because the various workers' comp rating bureaus come out with their lost cost indications generally early in the year or very late in the prior year. And to give you an example, in workers' comp, we will have an effective increase, both a combination of what the workers' comp rating bureau would do and any increases we would have made to our lost cost multipliers. In Tennessee, we would have a rate increase of 10 percent; North Carolina 7 percent; Pennsylvania 8.2 percent on average, although we have a number of programs there; Virginia on average about 8.5 percent; Maryland 5 percent; and I believe one of the states, Delaware, is actually a modest decrease, I believe, of 2 percent. That gives you some indication. We are not suggesting that all of our product lines throughout the year might not necessarily have the opportunity to have the same level of rate increases, but certainly in a line such as workers' comp, that is certainly a welcome change, a welcome increase.

In homeowners, which is probably next on the timing cycle, we have recently filed a rate increase in Maryland for homeowners which has been approved, of 7.9 percent. We would anticipate doing reviews for various other states to determine whether we think rate increases in homeowners is appropriate. We would anticipate in most states that we would make filings that are responsive to the need for rate adequacy, but do not overstate the case to the point that we would cause ourselves market issues.

At this time, I would like to certainly open it up to questions for both Ralph and myself. There are certainly lots of other things that we could talk about, but my assumption is that maybe the question-and-answer session will bring out some of the additional issues that you may want some input on.

Maybe I can share some other general information that may be of interest to you. One of the things that we, like many companies, do annually is to develop a corporate business plan. And I would just want to say to you that in the development in late '03 of our 2004 corporate business plan, that we certainly have embedded in that business plan broad targets that we have indicated, when we are on our roadshow, as to the kind of criteria that we would expect to set out in terms of goals that we would try to achieve.

And when we were on the roadshow, we had indicated publicly that our financial goals were to try to attain internal growth in '04 of somewhere between 8 and 10 percent, combined ratios of 94 to 98 percent, and return on equity in the range of 11 to 14 percent, and those were certainly generally longer long-term goals, but certainly applicable to 2004. We have in -- each and every department in the Company has developed their internal departmental business plan, which has been, of course, incorporated into an overall corporate plan, all focused on underwriting discipline, premium adequacy, expense control, meeting return on GAAP equity targets, making sure that our technology is as comparable to the very large companies and making sure that our scheduled roll-out of technology is as aggressive as possible, but at the same time, making sure that it is effective technology. Certainly, putting in place the necessary procedures to both encourage and monitor the growth of the distribution system, not only the appointment of new agencies, but making sure that agencies that have written business with us, either as new agencies in '03 or more legacy agencies, that we are getting to levels of production that we should.

We have put in place a number of incentive programs for our agencies in the various jurisdictions in which we do business that are focused on the growth of new business, as well as we have confirmed -- reconfirmed -- our commitment to our profit commission and contingent commission programs, which incent agents to provide us with profitable business because their potential participation in profitability is based upon the loss ratio of their particular book of business. We are certainly trying to instill and probably expand on managing at all levels of the organization to achieve a results-driven business culture, which we think is certainly a necessary component as we would move forward.

On the acquisition front, we certainly don't have any new acquisitions to announce, but as we have indicated historically and that we would have indicated on the roadshow, that we continue to avail ourselves of opportunities to learn more about companies that may have an interest in the future or currently in affiliating with another company. Certainly, we are going through a screening process to try to identify future companies that we might hook up with. So we are certainly beginning to become, and as we have been in the past, active in that regard. Not sure that we have our technical problems solved at this point, and we will come back to you shortly.

(OPERATOR INSTRUCTIONS) David Lewis, SunTrust Robinson.

Thank you and good afternoon. I have a number of questions. I will just hit on a couple first and I'll come back if the others don't get answered. But first of all, on the acquisitions -- one, how much cash do you have at the holding company you could utilize for acquisitions looking forward? And Don, I know you indicated previously with your remarks you didn't have anything you could announce now, but could you maybe talk a little bit about the pipeline? That's one.

Two, the combined ratio outlook that is kind of your longer-term goal of 94 to 98 percent, basically on 2004 earnings means that is about a 50+ cent kind of swing factor. Assuming normalized weather patterns, don't you think it would probably be in the 94 to 95 range? And then finally, off of that, if that's accurate, can you give us any guidance kind of in the operating EPS outlook? My guess is we are probably in the $1.95, $2 range. Thank you.

Dave, let's start with the acquisition. As you know, the first pass is to make sure that we do a solid job in bringing the two acquisitions into the holding company and that they're functioning the way they should be functioning, and that we are making whatever changes, if any, that might be required. So that certainly has been the first order of business as it relates to acquisitions.

You also may be aware that when you're doing acquisitions, you start to talk to people maybe two, three years ago, and that those kinds of discussions either lead nowhere or over time they may evolve into something more concrete. So we are really basically continuing on the kind of dialogue and reaching out to various entities that we are aware may have some interest. So we basically are continuing to do what we have historically done, and which resulted in '03, closed in '04, with two acquisitions. So we are certainly talking to mutual companies and we also are trying to identify smaller stock subsidiaries, maybe of some larger companies. So it is sort of the same process that we have proceeded on in the past.

With regard to the range of combined ratios, as you are aware, we had indicated on the roadshow that our combined ratio goal was in the 94 to 98 range, and certainly we would very much like to be able to achieve in '04 the 95 percent that we achieved in '03, or possibly even better. But for purposes of an indication to investors, I think we need to stick with a range, but we recognize that we need to certainly try to hit the lower end of the range.

With regard to EPS guidance, you realize that we do not give EPS guidance and don't think that that's appropriate for us to start doing. I guess our position on it is that our results in the past should speak for themselves, and we need to make sure in the current year we are doing everything to return the best EPS that we possibly can. But we do not want to necessarily be giving guidance in that regard.

As far as your question about how much cash remains at the public holding company level, we currently have about $12 million. We also, of course, had established a new line of credit for 35 million, and at this point, that is totally available to the public company. We had paid off the old line of credit and have not drawn down anything at all. So the 12 million of cash is actual cash being held at the public company level.

Thanks very much.

Adam Klauber, Cochran, Caronia.

Good afternoon. Several questions. Will the premiums from both acquisitions start hitting the income statement in the first quarter? Number one. Number two, will the acquisitions change the loss or expense dynamics materially from what we've seen in the last two quarters of the existing book of business?

Sure, let me take each of those. The answer to the first question is yes, both acquisitions will be effective as of the first of the year, so that the earned premiums from both Le Mars and Peninsula will hit the public company's earnings stream immediately starting the first day of the first quarter. They will have an entire quarter's worth of operating results included in the consolidated results of Donegal Group in 2004.

As far as the other questions, we don't imagine that there will be a significant effect on either the loss ratio or the expense ratio. In the case of Peninsula, the Peninsula Group, they actually had an expense ratio slightly better than Donegal Group had been running at; in the case of Le Mars, it was slightly worse. So given that scenario and the fact that they still were relatively small compared to the existing organization, we don't see much significant fluctuation in the expense ratio as a direct result of those acquisitions.

Also, on the loss side, their mix of businesses do tend to be somewhat similar to our own, and we believe that pretty quickly, since our underwriting results, we believe, will reflect, particularly in the case of Le Mars, some of the underwriting that we have put in place over the last year, that the loss ratios will also tend to mimic those of Donegal Group. And again, because they don't represent a huge percentage of Donegal Group, it wouldn't overly influence it one way or the other.

Thank you. A follow-up question. As far as your auto insurance loss trends, we have seen in other parts of the industry loss trends have been favorably affected by frequency trends. Are you seeing those frequency trends in your book of business and can you give us any idea of what you’re pricing for in 2004, given the frequency trends?

As far as the pricing in 2004, we would see that pricing will remain firm. We don't see that there will be softness in the market; we don't see that there will be rate decreases. I think on the upside -- in private passenger automobile now is what we are talking about, I would say that the environment still will permit modest rate increases. They won't be dramatic, but we don't also see that there's necessarily going to be pressure on the downside. I think that our results in '03 would have reflected some improvement on frequency. As you probably realize, in the private passenger automobile sector of the business, that industry trends in that line of business, that most companies will generally experience what the industry trends seem to be. So we have experienced some improvement in frequency.

I would also like to add that the combined ratio for the automobile line of business for 2003 would have been about a 9 percentage point improvement over what we would have seen in 2002. And that trend pretty much continued through the whole year, with the fourth-quarter results having almost identical results to the full year.

Thank you very much.

(OPERATOR INSTRUCTIONS) Gentlemen, you have no questions at this time. One last question. A follow-up question from David Lewis of SunTrust Robinson.

Thank you. A couple more questions. Ralph, can you tell us what pre-FAS-115 book value adjustment is, and also the outlook for tax rate for 2004?

Sure. The FAS-115 effect was 41 cents per share, so the pre-FAS 115 unadjusted book value would have been $15.88. I think the effective tax rate should be fairly close to what we were projecting for the entire year, which was about 28 percent. The fourth quarter did have a slight uptick -- it was at 29.8, but we think 28 percent is a good effective tax rate to use for the full year 2004.

Don, can you maybe comment a little bit on the workers' comp business. How much of your premiums now come from workers' comp, and are you still anticipating -- I think you indicated some rate increases still coming out of that side of the business, and how it is performing.

Yes, the workers' comp in the public company represents about 12 to 13 percent of the premium. We think that's a very reasonable level; it's not an overly significant percentage of our overall book of business. Workers' comp on a GAAP combined ratio -- stack combined ratio was 83.6 in year 2003. We have seen improvement in our results in workers' comp, but we all know that it's a line that you have to continually to be vigilant on, and we are certainly very encouraged by our combined ratio in 2003. However, we had the opportunity to take additional rate increases on workers' comp -- I reflected that in my presentation -- and generally are not hesitant to take advantage of those opportunities because it's a line of business where you have to stay ahead of the loss trends.

The ratios of workers' comp business that Don just gave you would have been prior to our acquisitions. They would have been our historic numbers. So that number would drop slightly as we add the premiums of the other two organizations in, because their workers' comp premium would represent a much smaller percentage.

Right. And what was that 83.6 percent stack combined in '03 compared to in '02, please?

'02, it was approximately 97 percent.

Okay. And the strong performance, is that why we saw a tick-up in the dividend ratio in the fourth quarter?

Yes, there is a direct relationship between policyholder dividends and the results in workers' comp. Yes.

Thanks very much and great quarter.

Thank you.

Adam Klauber of Cochran, Caronia.

Thank you. Could you give us an idea of the competitive landscape in the personal lines market in Pennsylvania. Is State Farm still being relatively disciplined?

I would say that from all indications State Farm is remaining fairly disciplined. And you can pretty well judge that by their advertising, at least in Pennsylvania. They're not advertising anything to do with property and casualty business; it is either long-term care, it's bank products, it's annuities. Our understanding is that there is still a significant number of their agents that are on certain restrictions that they can only write so many policies of this product line or that product line. So I think they are remaining somewhat disciplined and we would view that has an opportunity.

Thank you.

(OPERATOR INSTRUCTIONS) You have no questions at this time.

Thank you very much. Again, I very much appreciate your patience, putting up with the technical glitch that we encountered today and very much appreciate you staying with us and your interest in Donegal Group. Thank you all very much. Bye-bye.