Donegal Group Inc (DGICA) 2011 Q3 法說會逐字稿

Good morning. My name is Lashanna and I will be your conference operator today. At this time I would like to welcome everyone to the Donegal Group's Q3 2011 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) Thank you.

I would now like to turn the call over to Mr. Jeff Miller. Sir, you may begin.

Thank you, Lashanna. Good morning, everyone, and welcome to the Donegal Group earnings release conference call for the third quarter ended September 30, 2011.

I will begin the conference call by covering financial highlights and providing commentary on the quarterly results. Don Nikolaus, President and Chief Executive Officer, will then provide additional comments on the quarter and an update on our business initiatives.

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 filing link.

I'll cover several topics in my comments this morning, beginning with the quarterly underwriting results including the effect of weather and other factors. I will then spend a few minutes on our investment operations and how we are positioned in the current yield environment.

Let's begin by looking at our third-quarter underwriting results, as positive news is that our premiums continued to grow as a result of both organic and acquisition growth. Don will talk more about the sources of our premium growth and the outlook for future periods.

I am going to focus my commentary on the combined ratio, where four separate elements had an impact. These four different elements are weather-related losses, non-weather loss activity, prior-accident-year reserve development, and our expense ratio.

Weather-related losses were a large factor once again this quarter, with Hurricane Irene, Tropical Storm Lee, and three smaller Midwest wind and hail storms accounting for $6.2 million of the third quarter weather impact. Adding in non-cat weather, we incurred a total of $12.6 million in weather-related losses compared to $9.9 million of weather-related losses in the third quarter of 2010.

Our previous five-year average third-quarter weather loss impact including 2010 was $6.8 million. So the $12.6 million we incurred in the current quarter was nearly twice our previous five-year average amount.

Our third-quarter weather losses were fully attributable to events occurring within the quarter, as we had virtually no development during the quarter from prior-period storm losses. Most of the weather impact was within our personal lines, and we continue to believe that the steps we have taken to raise rates in those lines and to manage our exposures in certain geographies have helped to mitigate the weather impact of our results versus the impact to many of our peers.

Nevertheless, our weather losses in 2011 have reached unprecedented levels, accounting for $1.07 per share for the first nine months of 2011, compared to $0.76 per share for the first nine months of 2010. Don will provide an update on our continuing rate increases and other initiatives to offset the impact of severe weather.

Moving to non-weather losses, there were a number of moving parts. We saw an increase in large fire losses, which we define as greater than $50,000 in damages. Our year-to-date trend remains favorable, with $13.1 million in large fire losses in 2011 compared to $18.5 million for the first nine months of 2010.

However, our results for the third quarter of 2011 included $7.5 million of fire losses versus $4.5 million in the third quarter of 2010. Of that $3 million increase, about $2 million was related to commercial properties and the remaining $1 million increase was in homeowners.

Along with the increase in large fires, we incurred higher casualty loss ratios in our personal and commercial automobile lines of business during the third quarter as compared to the year-earlier quarter. We spent a fair amount of time analyzing the underlying loss data, and we did not identify any concentrations or common factors that led us to believe the increase represented any specific trend or indicated underwriting deficiencies.

Rather, we believe the increase represented normal fluctuations in claim activity. Or more specifically, we attribute the increase to the fact that we were comparing the current quarter to very favorable non-weather loss ratios in several of our lines of business in the prior-year quarter. An exception to that statement would be workers compensation, where our third quarter of 2011 loss ratio actually improved by 18 percentage points compared to the prior-year quarter, when we incurred a handful of severe workers compensation claims that inflated that loss ratio.

As we mentioned in the earnings announcement, we had slightly adverse prior-accident-year reserve development of approximately $600,000 for the third quarter of 2011 compared to slightly favorable development of $800,000 for the third quarter of 2010. Year to date, we had favorable reserve development of approximately $2.5 million, representing an improvement over the $700,000 favorable development we experienced for the first nine months of 2010. Relative to our $225 million in net loss reserves, we believe these modest development numbers demonstrate a significant level of stability within our reserves.

Our expense ratio was 30% for the third quarter compared to 32% for the prior-year quarter. Both periods reflect lower levels of underwriting-based incentive compensation.

In the first and second quarters of this year, I discussed the effect on our various ratios of the Michigan Insurance Company purchase accounting adjustment. I am pleased to say that the remainder of those adjustments had minimal effect on our third-quarter results and ratios and will have virtually no impact to our fourth-quarter results.

I'm going to shift gears now and talk briefly about our investments. Our investment income increased 7.1% in the current quarter, primarily because our portfolio is larger following the acquisition of Michigan Insurance in December of last year.

In reviewing the overall structure of our investment portfolio, we believe we are adequately prepared for the likelihood of a sustained low rate environment. We have followed a laddering approach with call protection to provide evenly distributed cash flows from expected prepayments and maturities. In spite of lower reinvestment rates, we have been fairly successful at maintaining the overall yield of our portfolio.

Our average tax-equivalent yield is 3.8% at September 30, 2011, compared to 4% at December 31, 2010. Our duration was slightly down at 4.4 years versus 5.1 at December 31. We have no exposure to Eurozone debt; very little exposure to the equity markets; and we continue to invest conservatively, focusing on quality agency mortgage-backed securities and municipal bonds where the yields have held up relative to many other asset classes.

We have harvested some realized gains have resulted from the decline in market interest rates, and we are actively managing the portfolio to generate a steady flow of investment income even though reinvestment rates are somewhat constrained and are likely to remain that way for some time.

We repurchased around 65,000 shares of our Class A stock during the third quarter. Our book value per share was $15.19, up from $14.86 at year-end due primarily to unrealized gains in our bond portfolio.

At this point I will turn the call over to Don for his comments on the quarter. Don?

Thank you, Jeff. Good morning, everyone, and welcome to our earnings conference call. I will cover a number of specific points that I think will cover areas of some interest to those on the call.

Needless to say, as usual weather and cat events are one of the highlights of the quarter, unfortunately. But we think that despite the magnitude of those losses, as we have monitored commentary across the industry and earnings releases to date, we continue to believe that the steps that we have taken in recent years to raise rates -- in personal lines particularly in homeowners -- and manage our exposures in certain geographic areas -- including substantial number of reinspections of properties -- have helped to contain our losses, including the fact that we believe that our reinsurance program is appropriately structured, which helps in these unfortunate weather-related events.

One of the things that Jeff has talked about is -- certainly a topic I would want to emphasize is book value growth. Although we have experienced significant cat and weather-related losses and our earnings per share for the quarter are not strong -- certainly they are weak at $0.03 per share -- we have had book value growth. Book value is at $15.19, which has grown from $14.86 at the end of December of 2010. So, although the weather and other loss events have impacted earnings, it has not been a capital or surplus event or events for us.

When we take a look at cat losses and all the travail that it brings to all of our policyholders, it is an excellent opportunity to demonstrate the quality of our claims operations and our focus on customer service. We believe that we will have probably 90% of the various weather-related claims and cat events closed by the end of October. We continue to make every effort to make sure that our policyholders receive the level of service and also to make sure it that we bring closure to those as soon as possible.

Clearly the primary emphasis at the Donegal Group and the various Donegal Insurance Companies is on underwriting profitability and book value growth. Needless to say, in these unusual times for property casualty insurance industry, we need to be focusing on what it is that is important in terms of changing those dynamics even though we don't have any particular control over weather.

Talking a little bit about rate increases, needless to say not only us but the industry has an environment in which it is certainly doable to take property rate increases in 10% or more, particularly in a line like homeowners. And we are doing that in many of the states in which we do business.

What I would emphasize is that rate increases are not the whole story. But what we see and what we are doing are raising, for instance, the minimum deductibles allowed for new business.

In our case, we are also significantly expanding our reinspection program to make sure that we know the quality of the business that we would have put on the books some years ago. We think that we are probably more proactive in that regard than maybe some of our peers.

We believe there is significant value in that because, as we all know, property -- whether it is homeowners or commercial property -- does not necessarily get better with time. The property may have been totally fine when it was underwritten. We need to make sure that on an ongoing basis that we have a program to stay on top of that.

Also, from the standpoint of agents, agents understand the need for increases in property exposures in terms of rate. There is an acceptance of what needs to take place, and that is certainly helpful to the overall environment.

Some of the business initiatives, as I have said earlier, underwriting profitability is very key. We also are focusing on increasing our commercial lines as a percentage of our overall written premiums. As I believe that Jeff has pointed out and the earnings release focused on is that our organic growth of commercial lines, without the addition of the commercial premium for Michigan Insurance Company acquisition, organically we have grown in the quarter 12.1% in commercial lines.

I would want to mention to you that our statutory combined ratio for commercial lines is 101.4%, compared to 110% for the overall operation. In commercial, we enjoy about an 85% retention ratio, which we think is quite good in our industry today.

What we also would want to talk about is the Michigan acquisition. In the third quarter we were pleased to report that their statutory combined was 100.8%, which is significantly lower than the combined ratio for the companies as a whole. Fortunately, in the state of Michigan, where they primarily do business, there have not been the number of weather events and cats.

As we have reported in prior earnings calls, that we are introducing our WritePro and WriteBiz technology to Michigan Insurance Company. The commercial lines should be rolled out on that within the next 30 to 45 days; and the personal lines will be placed on to that program early in 2012.

On to personal lines. From a Company standpoint, we enjoy about an 89% retention rate in personal lines. We have certainly in the homeowners area, we have continued to, as we've as stated earlier, have significant rate increases.

A significant portion of our growth in premium in homeowners comes from rate increases and not by increased exposures. We are not necessarily looking to increase the size of our homeowners book of business in terms of exposures. We are more interested in making sure that it returns to profitability.

In other areas of what we are working on, we continue to enhance commercial products in a number of the states that we have recently introduced commercial products to. We have fully rolled out commercial change processing as an automatic feature in the vast percentage of our states.

In terms of new agency appointments in the third quarter we appointed 59 new agencies. As you know, we have had a proactive program for appointing new agencies over the last several years. Year-to-date, we have about 160 new appointments.

We also have in the quarter moved actively to begin doing business in the state of Indiana. We did start that in the second quarter, but we are certainly more proactive as the third quarter unfolded.

Turning to capital management, we would just like to emphasize that we have -- as appropriate and depending upon the conditions in the investment market, we have repurchased about 65,000 shares. We continue to have a very strong dividend; at current market price it's approximately 3.8%.

On the acquisition front, as you know, we have been a very active acquirer of property casualty insurance companies over the last five years. We continue to have dialogue with various companies that may be candidates for potential acquisitions and we do see increased opportunities in that area over time.

At this point we will turn it back to Jeff for the question-and-answer session.

Okay. Thank you, Don. Lashanna, if you would open the line for questions, please.

(Operator Instructions) Matt Rohrmann, Keefe, Bruyette & Woods.

Don, and Jeff, good morning. Don, first question, just back to the M&A side. Obviously, a peer company of yours not too far down the road had a notable deal just a short while ago. Have you noticed any interest from potential buyers contacting you? Any increase since that announcement?

No, we have not. No. The answer to that, no, we have not. We are certainly fully aware of the Harleysville transaction. But no, we have not had any contact.

Okay. Then the second question, just obviously the weather is what it is; and the last couple of quarters been particularly rough for everybody in P&C.

But I wanted to just get a better idea on the fire losses. I know that you guys have been working on improving results there.

What has -- has the typical fire loss been more on the homeowners side or on the commercial side? Are there any particular segments within either of those lines that you have made more or less changes to, in terms of how you underwrite those?

Well, I think, certainly the quantity of fire losses would be homeowners. I believe we also had several commercial losses in CPP, the comprehensive policy.

But most of the losses would relate to homeowners, and as we have indicated, we continue to have aggressive reinspection programs. What we also do in -- when we have cat events and we are out adjusting a claim, our claims department cooperates fully with the underwriting department. And if they see circumstances about a property that they believe underwriting should take a look at, they take pictures and do some write-ups.

So we have a sort of a very high vigilance as part of the claims process, even on smaller claims, to be looking for issues that might be -- have potential for more serious losses. So we have a very proactive program.

Okay, great. Then questions for Jeff. Jeff, on the tax adjustment, how much room is there for any further tax adjustments going forward?

Well, the current quarter reflects basically an adjustment to our year-to-date tax provision on an actual basis. So where in prior quarters we would have used more of a projection of the expected annual taxes, and then backed into an effective tax rate to apply to the current quarter income, we have shifted that to an actual calculation because of the projected tax loss.

So for the fourth quarter, I think last year in the fourth quarter we would have reported a tax benefit as we trued up our estimates; and we would not expect that in the fourth quarter of 2011. Fourth-quarter tax expense should represent the tax expense that is related to that quarter's income.

Okay. Then just, obviously, great to see the buyback continue. How much today do you have remaining? And what was the average price that you were able to buy the shares back at?

We have that data here. We have purchased 132,000, almost 133,000, of the 300,000 that we have available. The average, I want to say was in the $11 to $12 -- $12.36 was the average price of the repurchases in the third quarter.

Obviously the market is headed back up hopefully for a while. But do you expect that type of pace to continue in the coming quarters?

Well, we will certainly monitor the market price of our stock, and we will be opportunistic about it. As you know we don't necessarily give guidance as to the number of shares and so forth that we might purchase; but we certainly will be monitoring it closely.

One of the things, Matt, I would like to do is to circle back to your first question with regard to the announced acquisition by Nationwide of Harleysville. We believe that our business strategy is such that we have demonstrated that we are a strong acquirer of companies. And we think that our business strategy will have lots of opportunities.

So that we clearly are a Company that believes that we can grow both organically as we have demonstrated in the last number of quarters, but also by doing acquisitions. We think we are uniquely positioned to be able to do that because we believe that companies that we approach in terms of doing acquisitions like the approach that we take and how we structure it and continue to co-brand them over time.

So that we believe that we have a very bright and strong future as a regional Company. As you would know, whenever an agency-based company is acquired by a direct writer, that also provides opportunities to other regional agency type of distribution companies. So we think that there are lots of opportunities going forward.

Okay, great. Don, Jeff, thanks. Very helpful. Appreciate it.

You're welcome, Matt. Thank you for those questions.

(Operator Instructions)

While we pause to see if there are any other questions, let me comment briefly on an accounting change for deferred acquisition costs that is becoming effective in 2012 and starting to attract some increased attention across the industry. Just make a few comments on that.

We have historically followed a conservative accounting policy in terms of acquisition cost that we defer and then amortize across the terms of our insurance policies. Because the vast majority of our deferred acquisition costs consist of commissions and premium taxes, we do not expect that rule change to have a significant impact on us. A relatively small component of our deferred acquisition cost that we will be analyzing between now and year-end to determine how much of that component will continue to qualify for deferral under the new rules. But again, we do not expect the impact of that accounting change to be material to our book value or our prospective results.

Seeing no other questions in the queue, we appreciate your participation this morning on our call and wish you a good day. Lashanna, I think we are ready to wrap things up.

Ladies and gentlemen, this does conclude today's conference. You may now disconnect.