Donegal Group Inc (DGICA) 2005 Q1 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the Donegal Group earnings conference call. My name is Candace, and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be presenting a question-and-answer session towards the end of today's conference. If at any time during the call you require assistance, please press star followed by zero, and a coordinator will be happy to assist you. 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, Senior Vice President and Chief Financial Officer Mr. Ralph Spontak. Please proceed, sir.

Thank you and good morning, everybody. I'm Ralph Spontak, chief financial officer and senior vice president of Donegal Group, and I will be starting the conference call off by reviewing some of the key financial components of the first quarter results. When I have completed, Don Nikolaus, president and chief executive officer will then discuss, as usual, some of the current trends we are experiencing.

Just as a reminder, all statements contained 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 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 reserve for losses and loss adjustment expenses, severe weather, business, and economic conditions in the company's primary operating areas, competition from various insurance and non-insurance businesses, terrorism, legal and judicial developments, changes in regulatory requirements, and other risks that are described from time to time in periodic reports that the company files with the Securities and Exchange Commission. In light of the significant uncertainties inherent in forward-looking statements, the inclusion of such statements should not be regarded as a representation by the company or any other person. The company disclaims any obligation to update such statements or to announce publicly the results of any revisions to any forward-looking statements including herein to reflect future events or developments. Undo reliance should not be placed on any such forward-looking statements.

With that, I'll get into the first quarter operating results. The company's results in the first quarter continued the string of strong financial results that was set during 2004. The earnings are characterized by strong underwriting results and solid premium growth. Net income for the first quarter of 2005 was $8,417,088, or $0.46 per common share on a diluted basis compared to income before extraordinary items of $6,286,636, or $0.35 on a diluted basis for the first quarter of 2004. Just a reminder that the net income for the first quarter of 2004 was $11,732,000, which included an extraordinary gain of $5.4 million related to one of the acquisitions completed in that quarter.

Also for informational purposes, all 2004 per-share information has been restated to reflect a 4-for-3 stock split in the form of a 33 1/3% stock dividend issued to shareholders on March 28, 2005, to stockholders of record as of March 1, 2005. The company's excellent underwriting results continued during the first quarter of this year, with the company posting a GAAP combined ratio of 90.6% for the first quarter of 2005 compared to 92.7% for the first quarter of 2004. Results for both the commercial and personalized were excellent with both segments showing improvement in their combined ratios over the results of the year earlier.

The company's total revenues in the first quarter of '05 increased 14.8% over the same period in '04 to $78,079,058. The company's premiums earned in the first quarter of 2005 were $71,762,000. These represented an increase of 14.8% over the premiums earned in the first quarter of 2004. Just a reminder again that the earned premiums in the first quarter of '04 were reduced by $1.7 million related to the purchase accounting for the acquisitions in that quarter. Excluding the impact of this purchase accounting, premiums earned would have shown an increase of 11.5%.

The company's investment income in the first quarter of '05 increased 16.6% to $4,407,468 as the company continues to reduce its short-term investments and increase its percentage of its portfolio in tax-exempt securities. Tax-exempt income represented 39% of total investment income in the first quarter of '05 compared to just 30% in the first quarter of 2004.

The company's GAAP expense ratio in the first quarter of 2005 was 32.2% continuing to reflect higher levels of incentive expenses due to low loss ratios and increased profitability compared to one year earlier. The expense ratio was, however, slightly lower than the expense ratio of 32.5 incurred in the fourth quarter of '04.

Loss reserves continue to look solid, although one quarter is not a sufficient time period to adequately measure reserve developments from the end of 2004. However, initial indications are that the favorable loss development trends that we saw during the calendar year 2004 are continuing.

The company's book value per share increased during the quarter to $13.81 per common share at March 31, 2005.

Also, yesterday, the company's board of directors approved an increase in the company's cash dividend declaring a cash dividend of 10 cents per Class A common share and 8.5 cents per Class B common share payable May 16, 2005, to shareholders of record as of May 2, 2005.

At this point, I'd like to turn the call over to Don Nikolaus, president and chief executive officer of the Donegal Companies. Donald?

Thank you, Ralph, good morning, everyone. Thank you for joining our call. I'm sure that you would recognize that the company is certainly quite pleased with the results that we have been able to deliver for the first quarter of 2005. I won't repeat the many things that Ralph has just discussed but would like, certainly, to highlight both the combined ratio came in at historic levels, and the growth that we have experienced, we are certainly quite pleased with, as Ralph has indicated, that it would have been 11.5% after allocation or taking into account the accounting recognition in the prior year for the acquisition. We are experiencing in the marketplace growth opportunities. We continue to pursue those but always consistent with our focus on profitable growth and underwriting integrity. But we do see the opportunities for both the new agency appointments in those geographic areas in which we want to accelerate our growth, also to the book transfers of books of business from other companies within agencies in which we are currently doing business.

With regard to some of the other initiatives that the company has underway, in late October we introduced a new software delivery system for personal lines, which we have given the name of WritePro [ph]. It's a system in which agents can automatically rate, tier, and automatically upload personal alliance policies. It has all of the most sophisticated current tier segmentations that you might be familiar with from some of the large companies. We have rolled that out in the state of Pennsylvania, and it's about to be introduced into the states of Virginia and shortly into Georgia, and our goal would be, before the year is over, to have introduced it into a high percentage of the states in which we do business.

On the acquisition front, we continue to pursue those opportunities, have conversations with various companies that might look to be doing affiliations, and that we would anticipate, going forward, that we would have successful opportunities as has been demonstrated in '04 when we did two acquisitions both Peninsula and Le Mars.

At this point, I would like to turn it back to Ralph, and we will pursue the question-and-answer session.

Candace, we're ready for the question-and-answer session, if you'd open it up for that, please.

[OPERATOR INSTRUCTIONS] Mike Grasher, Piper Jaffray.

Good morning, gentlemen, and congratulations on a nice quarter. Could you give us an overview in terms of what pricing is like right now -- if you could walk through personal versus commercial and maybe even tough on workers' comp?

Sure, I'd be pleased to do that. Let's start with personal line. In homeowners there continues to be an opportunity to take modest rate increases -- modest being defined somewhere, depending upon the particular state, somewhere in the 3% to 6% range. Not necessarily in all jurisdictions, but there remains a constructive environment there, certainly, with the hurricanes of last year, although we did not write in states that are primarily affected by that. It does tend to provide an environment that is more conducive to rate increases because other companies seem to need or want to have rate increases in that line of business.

In private passenger automobile, there is somewhat of a more competitive environment. However, our approach to it has been to do more tier segmentation and refine competitiveness within the introduction of those types of tiered products rather than look to have rate reductions across any broad line of business. As a general proposition, we would be saying that although private passenger automobile does seem somewhat more competitive, we are not seeing anyone doing any wild things. As a matter of fact, we are seeing some companies continue to file rate increases. So I would conclude that in the markets that we're doing business in, at least at this point, it seems to be a fairly constructive marketplace.

In commercial lines, I think it depends upon whether you are a writer at larger risk or whether you're a writer of small to medium-size risk, and the reason for that distinction is that we do understand that in larger accounts, the competition and competitive posture is certainly heating up. We have seen some of that in the small to mid-market accounts that we write but, once again, we're not seeing anything dramatic. So we, I think, are comfortable with the rate environment.

Workers' comp -- we have continued to take selected rate increases in '05 in workers' comp, and it would range anywhere between 4% and 8%, depending upon what lost costs have been approved in the respective jurisdictions. Hopefully, that's helpful.

Yes, very much so. Where does your average policy size stand today in terms of the commercial?

I would say the average policy, as distinguished from account -- but I would say the average policy is probably somewhere in the $2,000 to $4,000 range. Now, the average account might be more like $8,000 to $10,000.

Okay, thank you for that. And then just one question on the acquisitions -- has it been a pricing issue or has it been a cultural issue or is it just a matter of not really finding the right book yet?

Well, we do have a select -- sort of a selective approach to what we are doing. I can't say that it's always priced. There are many times other factors, whether a potential acquisition meets the appetite that we have. As an example, we might get calls and someone is telling us about a company that has programs in commercial lines of business that we don't write or that the company writes homeowners in Florida or it's in a jurisdiction that we don't want to do business in. So there's a culling-out process. So it's like anything else that you do in the way of acquisitions or new opportunities. Sometimes you sort through a number of them, and a fair amount of time goes by, and then sometimes you get a couple of them that come together. So we think that the environment for acquisitions is probably improving, as there is somewhat of a tendency for the market in P&C to be a little bit more competitive. It generally is a time when you see more M&A activity as compared to when companies, regardless of what their circumstances, are able to see increasing results. So we think it's a good environment for M&A, going forward.

[OPERATOR INSTRUCTIONS] David Lewis, SunTrust Robinson Humphrey.

A couple of questions -- let's first talk about the premium growth outlook. I guess we probably should look at it as kind of an ongoing start -- the 11.5% growth rate -- from an earned premium perspective. Gross advanced 9%, so I would guess that as we kind of progress through the year, unless we get a spike in production, we're probably going to see somewhere in the 10% range for the balance of the year on earned?

Yes, I think that's fair, which is consistent with what our sorts of ranges are that we have been talking about.

But following up on Mike's question on the pricing side, you're really not getting significant price advantages. Some of that continuing to come off of 2004, so you must actually be able to find a reasonable amount of new business. Is that because of some of the new marketing relationships or just digging in a little harder?

Well, I think it's a combination of things. I believe that over the last two to three years that we have begun to build momentum in various markets in which we do business, and you have to -- I'm sure you do -- recognize that as you build relationships with agencies, you can tend to increase the flow of business.

Also to be kept in mind is on the property side of business that you can be receiving increases in premiums in addition to what you might be expecting in rate increases because if you have automatic inflation provisions within your policy and your rating system, that you are keeping the insurance to value current, which means on the same risk that you insured in the prior year, you are now getting more money for insuring that risk, although your coverage may be increased, but that only really comes into play if you have a total loss -- so that some of the increase in premium that you're getting is simply because you are increasing the coverage base based upon inflationary factors. So we are very focused, over the years, in making sure that we have accurate insurance to value which can, at least sometimes, many companies overlook as a source of additional reven on a per-policy basis.

That's helpful. I'm sure you don't track it this way, but do you have any sense of what -- let's say the 10% is the right number from an earned perspective or even a gross perspective, but would you say that maybe we're getting a third of the growth coming from units, a third from inflationary factors, a third from pricing?

I would characterize it a little differently. I think maybe as much as 20% might be coming from changes on existing policies in addition to inflation on buildings, which everybody understands. Also, there is a factor there, as people exchange newer cars for older cars and upgrade, you also end up with premium there. And my estimate would be that somewhere around 20% of that is probably -- of that 10%, say, 2% of the 10 would be coming from those types of factors.

Of the remaining 8%, it's always difficult. We always look at around a 50-50 split between that, although my guess would be that new policy production might be just slightly more than the 50% at this point.

Okay, that's helpful. Let's talk a little more about the tier segmentation that you've put into Pennsylvania and you'll expand in the other markets. Do you anticipate that that will have any favorable impact on the profitability or the underwriting profit, or is it allowing you to probably more adequately and more competitively price for the risks that you're receiving that might be a greater benefit to the top line?

Well, I think it's a component of both, Dave. One of the reasons, not the sole reason, but one of the reasons for introducing segmentation in the tiering is that our major competitors in personal lines have begun to do that, and that we would want to be avoiding any adverse selection so that we want our shot at the best business, and we want to make sure that the less favorable business is more accurately priced. So there are a number of things going on there. It's a way of trying to target the better business and to more accurately price what we'll call more standard business. But it's also a way in which we call our WritePro system, that we're able to write more of the business because today agents are looking for ease of doing business, and the process, how the business is submitted and rated, becomes very important to us -- to them. So it is also a way of making ourselves more attractive to agents so that we are in a position to be one of the preferred companies in their agencies.

That's helpful, and kind of to switch gears to the acquisitions of Peninsula and Le Mars. Are you finding now that you've owned those for 12 months that you might be cultivating some better growth opportunities out of those two acquisitions -- to your total book?

We are beginning to make progress in that direction. Certainly, the primary focus in the first year of ownership is to make sure that everything is as profitable as possible, and that expenses are under control. And we are now beginning to address the growth of those companies in their respective markets so that we would anticipate, as an example, that Le Mars would begin to make progress in growing in those states in the Midwest. Peninsula has had a nice growth rate, but I believe that their momentum will begin to build there also.

Okay, and final two quick questions -- Do you have the pre-FAS 115 book value and, Ralph, also, do you have an outlook for the expense ratio for the balance of the year? Shall we assume something in the low 32% range?

Sure, I have both of those. The pre-FAS 114 would be $13.73. There's an 8-cent unrealized gain in the $13.81 number. As far as expense ratio, I would say that we're hopeful we could get the expense ratio down under 32%. There were a number of factors in the first quarter including some increased expenses related to the Sarbanes-Oxley process, and although that's going to continue to be a significant process, we believe that the costs that we incur this year will not be duplicated in the coming year. So we're hopeful that going into the second and future quarters, we could drive that expense ratio down below the 31 -- excuse me, below 32 into the 31.

Adam Klauber, Cochran Caronia.

Could you give us an idea -- the loss ratio continues to improve on a sequential basis. How much of that is market factor such as frequency improving; how much of that is pricing; and do you expect that improvement to continue, going forward, or do you expect it to bottom at some point in the near future?

Well, let me try to address that for you, Adam. I think that a lot of our success in combined ratios per product line and combined ratios collectively is certainly partially a function of rate increases, over time, and rate adequacy. And it would certainly be our intention to continue to make sure that we have rate adequacy.

However, I think sometimes that what is lost in the -- by some not by all -- in the analysis of company results, is what is the underwriting process? Pricing of a book of business is only one of the components in determining whether or not that book of business is going to be profitable. Correspondingly, a very important part is what is the underwriting process? What is the underwriting selection process and what is the quality of the book of business that you were putting on?

And I would argue that you can have a stable pricing environment -- not an increasing one or not one where rates are decelerating at any extensive rate, but in a stable one, even to a slightly down rate environment, that if you had the right underwriting disciplines you can continue to do quite well simply by the process that you follow as a company.

Thank you. So if I understand, you're saying it's not just pricing. You've actually been underwriting a better book of business. Is that correct?

That's correct.

Okay, and do you think that is a continuing phenomenon, where, as you continue, especially with your tiered pricing, to maybe better select risks? Can we anticipate further improvement in the loss ratio or do you think we've seen most of the improvement?

Well, I don't know that we want to be predicting where our combines and loss ratios will be heading. Our focus has always been a longer-term focus to consistently make sure that we have rate adequacy and to be consistent in our underwriting disciplines.

What I think I would say to you, that, as we all know, things are relative, somewhat, in our industry, and I am suggesting that maybe because that there is less, at times, of a constructive pricing environment in the industry, maybe some companies' results would deteriorate as the result of that, while other companies would have a much more constructive, positive result and, therefore, the relative relationship of results, even though loss issues might trend slightly higher, might tend to be better than peers.

[OPERATOR INSTRUCTIONS] Beth Malone, Advest.

Thank you, good morning, and congratulations on the quarter. Most of my questions have been answered, but I was wondering -- are you all having any changes in your investment portfolio relative to the current market conditions that would have an impact on the way you're pricing your products or on what we can expect in investment income, going forward?

I think, Beth, historically, we have had a fairly stable investment philosophy, as you probably know. We do not have very much of a percentage of our portfolio invested in equity. Although the market was up yesterday very nicely, the market, on the equity side, has certainly been very sloppy since the very beginning of the year. So we're not really much affected by what's going on in the equity market as a relative matter to our portfolio.

On the fixed income side, we try not to be guessing where interest rates are going to go, because it would appear as if all the geniuses out there haven't been correct. So we certainly have a fixed-income portfolio that's affected by interest rates like anyone else's, but we're investing on a consistent manner and would expect to have our results mirror how they have resulted in the past. So unless there would be some very dramatic shift in one end or another of interest rates, we would not expect to have any major shift in our results from an investment standpoint.

Gentlemen, there are no further questions in queue. Please proceed to your closing remarks.

Okay, those were excellent questions. I'd like to thank everybody for joining us today and particularly those that asked questions. We greatly appreciate your participation. Thank you all very much.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect, have a great day.