Donegal Group Inc (DGICA) 2010 Q3 法說會逐字稿

Good morning. My name is Josh and I will be your conference operator today. At this time, I would like to welcome everyone to the Q3 Donegal Group earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions). I will now turn the call over to Mr. Jeff Miller. Sir, you may begin your conference.

Thank you. Good morning and welcome to the Donegal Group earnings release conference call for the third quarter ended September 30, 2010. I am Jeff Miller, Chief Financial Officer and I will begin the conference call by discussing financial highlights and commenting on the quarterly results. Don Nikolaus, President and Chief Executive Officer, will then provide his comments on the quarter and an update on our business initiative.

Certain statements made in our earnings release and in this conference call are forward-looking in nature and involve a number of risks and uncertainties. Please refer to our earnings release for more information about forward-looking statements. Further information on risk factors that could cause actual results to differ materially from those projected in the forward-looking statements is available in the report on Form 10-K that we submitted to the SEC. You can find a copy of our Form 10-K on the Investors portion of our website under the SEC Filings link.

Our net income for the third quarter 2010 was $4.9 million, or $0.20 per share of our class A common stock compared to $6.7 million, or $0.27 per share of our class A common stock for the third quarter of 2009. Our net income for the third quarter of 2010 represents a significant improvement over our results for the first and second quarters of the year.

Our total revenues for the third quarter of 2010 increased 9.3% to $103.8 million with net premiums earned increasing 7.9% to $94.9 million. Our net premiums written increased 8.8% over the third quarter of 2009. Organic writings increased 6.5%, attributable to a 5.1% increase in personal lines premiums and a 10.1% increase in commercial lines premiums. The remaining 2.3% net premiums written growth was related to an increase in pooled premiums from Donegal Mutual's affiliation with Southern Mutual Insurance Company in the fourth quarter of 2009.

Our investment income for the quarter was $4.7 million, a decrease from the $5.1 million reported for the third quarter of 2009 as a result of lower investment yields. We reported $2.4 million in net realized investment gains that resulted from the sales of bonds and equity securities during the quarter.

Our loss ratio for the third quarter of 2010 was 71% compared to 66.6% for the third quarter of 2009. We incurred weather-related claims that totaled approximately $9.9 million in the third quarter 2010 compared to $5.9 million in the third quarter of 2009.

From a catastrophe perspective, there were a number of smaller wind and hail events that impacted our Midwestern subsidiaries that collectively added up to an impact of $2.5 million after reinsurance. In both quarterly periods, we incurred claims for multiple non-cat weather events that did not lead to volumes of claims that triggered reinsurance recoveries, but contributed to loss ratios that exceeded our historical experience.

We incurred a reduced number of fire losses during the third quarter 2010 compared to the first and second quarters of this year, but the fire losses we incurred during the third quarter were approximately $2.5 million in excess of the year earlier quarter.

We also mentioned increased casualty claims severity in our press release as we noted an increased number of larger dollar workers' compensation and bodily injury claims that added approximately $4 million to our quarterly losses compared to the impact of similar types of claims incurred in the third quarter of 2009.

I would want to point out that our workers' compensation line of business has performed well in the first nine months of 2010 with a combined ratio of 99.6%.

Offsetting the increased claim activity, we were again pleased to see significant improvement in our prior accident year loss reserve development trends. The improving trends began in the first quarter of 2010 and continued through the third quarter. Our prior accident year reserve development through nine months was modestly favorable compared to $8.4 million of unfavorable loss reserve development from prior accident years that we experienced in the first nine months of 2009.

Our expense ratio held constant at 32% for the third quarters of 2010 and 2009, reflecting lower underwriting-based incentive costs due to the higher claim activity in both periods. Our combined ratio for the third quarter of 2010 was 103.2% compared to 98.9% for the third quarter of 2009 and comparing favorably to the 106.2% combined ratio for the first six months of 2010.

Our book value per share increased to $15.46 as of September 30, 2010 compared to $15.12 at December 31, 2009. Yesterday, our Board of Directors declared dividends of $0.115 per share of our class A common stock and $0.1025 per share of our class B common stock, payable November 15 to stockholders of record as of the close of business on November 1. Our dividend yield based on the current trading price for our class A stock is in excess of 3%. At this point, I will turn the call over to our President, Don Nikolaus, for his comments.

Thank you, Jeff and good morning to everybody. Thank you for joining our call. Jeff has given you a very good overview of the results for the third quarter. Needless to say, we were pleased to see the improvement in the third quarter over the first and second quarter. As we all know, it has been a challenging environment because of adverse weather losses and an increase in fire losses over the last nine months. But we did very much appreciate the fact that we began to see a better overall result.

We continue to focus on balance sheet strength because we recognize that that is extremely important criteria going forward. Our book value having increased to $15.46 certainly reflects the increase in market value of securities as the result of primarily reduced interest rates in the current environment.

Certainly one of the strengths of the quarter and the year to date is the premium growth that we have experienced. And in a minute, I'm going to talk about some of the reasons for that growth, which we think are very positive reasons. We also are beginning to see concrete signs of rate activity, meaning rate increase activity, by a number of the competitors in the various markets in which we compete. And we believe that to be a positive sign in that clearly there are -- in our industry, the pricing is certainly too thin and needs to increase and it is always nice to see that others are identifying the same issue and are prepared to take actions with regard to it.

Some of the reasons for our growth, some of this is similar to what I would have reported to you at the second-quarter conference call, but certainly is still applicable. For instance, our 8.8% net premium written growth, which is certainly very good in this environment, is partially a result of acquisitions that we have done in the past over the last three years. Sheboygan Falls, Southern Mutual Insurance Company basically producing results in terms of growth within those market areas.

We have put a lot of emphasis on providing the best possible superior service because we think competition means more than just price. It is the way that you are dealing with your customer. In our case, we believe we have two -- the policyholder, as well as the agent -- because we distribute solely through the independent agency system. The rollout and enhancements to our WritePro and WriteBiz systems into other states that, up until the beginning of this year, we may not have had those systems live and we now have them live with the various acquisitions that we have made over the last number of years. And I am pleased to say that in October, we have gone live with WritePro and WriteBiz for Southern Mutual Insurance Company. And as a reminder, we have a 100% quota share reinsurance agreement in place and 80% of that through the pooling agreement comes to our public company.

We have also expanded our commercial lines into states that we were not previously doing commercial business in and that was primarily as the result of prior acquisitions of personal lines companies and now through that distribution system, we have rolled out commercial lines.

In addition, we have had a nice growth of agency appointments in the last three years and within this quarter, we have appointed 50 new independent agencies that brings the total for the year to date to 133.

I would also like to give you a little bit of update on our Michigan Insurance Company acquisition. We believe that the approval process we believe is moving along as planned. As a reminder, this is a company that has $106 million of premium. They have a history of underwriting profit and I can tell you from our own first-hand experience in August when we did agency meetings along with Michigan Insurance Company in Michigan and met over 95% of their agencies, they have a very strong agency plan.

We do expect to close the transaction sometime within the next 60 days. We are actively in the transition planning process, which is normal for when you are about to do an acquisition. So we are looking forward to that as being an event that will have been completed in this, the fourth quarter.

On another aspect of all this, I can say to you that in addition to rate increases that we are taking and one of the things I would want to point out is that, in the year 2010, in the first 9.5 months, we have made over 30 rate increase filings in personal lines in auto and homeowners. In almost every state in which we do business, we have made 15 such rate increase filings in the last three months. There are some jurisdictions in which we are filing rate increases in homeowners that would be anywhere from the 9% to 12% because we are taking a very proactive view that we must make money in the underwriting of insurance and that is a line of business that we believe needs to have additional rate given the weather patterns of the last number of years.

We have also, as a preventive measure, begun a very comprehensive reinspection program of thousands of homeowner policies to make sure that we have the correct amount of coverage A, meaning that it is proper insurance to value, that there are not issues with any of the properties. As we all know, properties necessarily over time can show signs of needing repairs, whatever it might be, and we are being proactive to make sure that we remain only on risk that show pride of ownership as we move forward.

As an overall plan, we have a comprehensive profit improvement plan that we have put into effect that is focused on disciplined underwriting and profit through either re-underwriting books of business or (technical difficulty) through the appropriate rate increases. We are also in some states taking action with regard to commercial lines where we are re-inspecting books of business where we may be seeing some loss ratio issues that we don't find acceptable. And I would emphasize that most of all of it is in property lines of business.

At this point, I will turn it back to Jeff and we will certainly look forward to your questions.

Thank you, Don. Josh, if you would open the line for questions, please?

(Operator Instructions). At this time, there are no questions from the phone lines.

We would be pleased to answer questions. Are we sure that the Q&A is operating?

(Operator Instructions). [Bill Broomall].

Hi, yes, can you here me?

Yes, Bill.

Great. Good morning. I was wondering maybe if you could talk about reserve releases year to date, what lines are in or what trends you are seeing there?

Sure. I would be glad to do that. We don't have any material reserve releases to report. What we have talked about in past quarters has been the reserve development for prior accident years and (inaudible) some histories. In 2009, we had some adverse loss development as a result of property claims. It was basically a tail on hail claims that was higher than we expected.

We have not seen any of those trends in 2010. In 2010, we have seen -- overall, we have seen favorable loss development and the lines of business that are most favorable would be in our private passenger and commercial auto liability. We are seeing favorable loss reserve development on prior accident years in those lines. Workers' comp has developed slightly adverse, mostly in one accident year of 2008, but other than that accident year, all of the others look very good.

We have seen not near to the extent of last year, but just a slight unfavorable loss reserve development in homeowners, which is a continuation of some of that tail on the property losses, but not anywhere close to the extent we would've seen in the prior year.

So the casualty lines are looking pretty good. Workers' comp, like I said, is acceptable, but not overly favorable. When you roll everything together, we are seeing favorable development, somewhere around $700,000 for the first nine months.

And Bill, this is Don Nikolaus. As a follow-up to Jeff's explanation, none of that favorable development involves some taking down of some bulk type of reserves. The way we measure and have measured it for years is it is based upon cases that are and files that are closed and paid, not some type of bulk adjustment that we take down.

Okay, perfect. All right, that makes sense. And then I guess my second question is, for the rate increases in the personal lines, you said 30 year to date and 15 in the last three months. Is there anything going on? Half of them seem to be in the last three months. Is there something going on in the last three months that has caused you to increase it compared to the first -- the prior six months before that?

Well, I think that's a very good question. Basically what we have done is it takes time to do rate indications. You want to make sure that you have thorough and complete actuarial work to justify the increase to the respective insurance departments. And once we saw the first-quarter results and the second-quarter results, it became clear to us that weather patterns had definitely taken their toll on loss ratios and that it was appropriate that we be aggressive in increasing rates.

So it is basically that once we saw the first quarter and the second quarter, we, of course, had our actuarial people do thorough analysis towards the latter part of the second quarter into the middle of the third quarter. And then as a result, we began to make rate increase filings primarily in homeowners, but also in private passenger automobile. So it is simply we believe the appropriate kind of management response to seeing not favorable loss reserves and loss ratios in the first two quarters of the year.

Got it. And I don't know if you break it -- what states -- I don't know if you go into that much detail -- what states are you seeing the most increases or do you need to apply the biggest increases?

Well, candidly, it is very simple. Where there has been the greatest amount of storm activity and hail and tornado and that would be in the Midwestern states and it would be in the Southern states. We have taken rate increases in Mid-Atlantic too, but the higher rate increases and the more focus has been where that storm activity has been most apparent.

Got it. All right, great. Well, thank you very much.

Gerry Heffernan.

Good morning, gentlemen. I hope you are all doing well today.

Yes, thank you.

I would like you to address the discussion of loss cost inflation. I believe that we had talked about it not too long ago and I was surprised to hear that your view was that loss costs are, despite housing prices falling and things of the sort, that loss costs were still inflating at a pretty good clip. And I would like you to contrast that with comments from Travelers indicating that loss cost inflation is benign.

Well, let me try to address that. Certainly if we gave you an overimpression at the last conference call that we thought that they were escalating, my recollection of it is it is twofold, that I think we all recognize that medical costs are not benign, with all due respect to the other company that you mentioned, that healthcare costs are not necessarily benign. And then secondly that, in the property area, particularly where you have catastrophe, it is called demand surge where if you have tornadoes and you have hailstorms, you basically have aggressive pricing by contractors because they have more demand for their work than they have the ability to do in a short period of time. So that is what we would be talking about.

And we would agree that in other aspects of claims that it is benign. But where you -- for instance, in a workers' comp where you definitely have a medical component, a health cost component of healthcare, which is clearly a component of that, there clearly continues to be not what it would have been maybe two years ago, but there continues to be increases there and this demand surge that I am referring to when you have property catastrophes, which is basically the origin of many of the property losses. That is what we would be referring to.

I appreciate that. Most of what I was referring to involved the property aspect. And is that because of the size of the respective portfolios, the cat aspect would dominate your results more so than a similar size group?

Correct.

Okay. In regards to premium policy price increases, to what extent are you taking advantage of where you are mispriced to the market, where others have applied for price increases as opposed to the market is just able to take a price increase?

Well. I would say that -- I would say two things. One that I don't think we have been behind the curve in terms of following what others have done that we would be catching up on rate increases. I think that we are in a set of circumstances where it is a market, particularly in property risk, where you can get the increases and there are lots of companies filing property rate increases because the wind and hail doesn't discriminate as to which company is affected. So there is a lot of rate filings being made and so that -- we view that positively, as I said earlier, because the more that it builds some momentum, it is better for the property/casualty insurance industry, which is in this very soft market as a whole.

That's great. If we could just take that one step further, what is going on in the reinsurance market as far as yourselves and all of your competitors to the extent that they use reinsurance? Are the reinsurers hiking rates to you, which, in past cycles, has been an impetus to press the whole group to start raising rates?

Well, candidly, I would view that as one of the silver linings for primary companies that, as you know, the reinsurers have had a very favorable, relatively favorable two-year period as far as major cats and keeping in mind that reinsurers are primarily, particularly those in the property cat area, are talking about hurricanes and giant storms. And they have had a very mild season and also last year. So our intelligence out there tells us that it will be a competitive market, meaning that it should be a reasonable market for primary companies in terms of property cat costs.

And the other thing, Gerry -- this is Jeff -- our book of business looks very favorable to reinsurers because of our very conservative underwriting and staying away from areas that are prone to the large cats. We believe we will have a fairly reasonable renewal season when we go to renew our reinsurance, which most of our reinsurance renews as of January 1.

Okay. And I guess one last question, just in the M&A world, anything new and different going on there? Anybody more or less reasonable in terms of price or more or less willing in terms of doing a transaction?

Well, here is where we would be on that. We have tried to be consistent and disciplined and do one property and casualty acquisition at a time. We have continued to talk to various people and candidly, we would have some other opportunities if we were pressing them at this point and proceeding to try to energize those opportunities. But we have -- we are waiting until we complete the Michigan transaction so that we can say that we have appropriately handled that, put that to bed, so to speak and then we can begin to actively engage in other potential discussions.

We think there are opportunities out there in the space that we deal in, which are the modest sized companies and as you have known from some other conference calls, we think that we have a unique approach to how we do these acquisitions and we think that, going forward, we can be quite successful. But we also want to be disciplined about it and do one transaction at a time.

That's great. Thank you very much for your time today.

You are welcome.

(Operator Instructions). At this time, there appears to be no questions.

Okay, well, we thank you for your participation in today's call and wish you a good day.

Thank you, everybody. We appreciate your participation.

This does conclude today's conference call. You may now disconnect.