Donegal Group Inc (DGICA) 2011 Q4 法說會逐字稿

Good morning. My name is Jaime and I will be your conference operator today. At this time, I would like to welcome everyone to the fourth-quarter 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.

Mr. Miller, you may begin your conference.

Thank you. Good morning everyone and welcome to the Donegal Group conference call for the fourth quarter and year ended December 31, 2011. I am Jeff Miller, Chief Financial Officer. I'll begin the conference call by discussing a number of financial highlights and providing commentary on the quarterly and full-year results. Don Nikolaus, President and Chief Executive Officer, will then provide additional comments on the quarter and give an update on our business and prospects for 2012.

Certain statements made in our news release and in this conference call are forward-looking in nature and involve a number of risks and uncertainties. Please refer to our news 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 on the report -- in the report on Form 10-K that we submit 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. We plan to file our 2011 Form 10-K within the next few weeks.

Our fourth quarter was difficult from an underwriting perspective and we posted a net loss of $879,000, or $0.03 per share, for reasons that I will cover today. Investment income, realized gains and an income tax benefit provided a substantial offset to the underwriting loss we incurred for the quarter.

On the positive side, we achieved significant growth in premiums, primarily as the result of our Michigan acquisition and continuing success in growing our Commercial Lines of business. Don will provide more commentary on our premium growth in a few minutes.

On the other hand, we were disappointed that our fourth-quarter losses incurred continued to reflect the effects of severe weather that we experienced during the first nine months of the year.

In a moment, I'll provide more details on fourth-quarter events, but let me focus first on the cat development that we announced last week. We preannounced that we incurred development of the $7.1 million from catastrophe event earlier in 2011, including a $2.4 million provision for claims that we project will be reported in 2012. Our catastrophe reinsurance program is conservatively structured with $130 million of coverage above our $5 million retention for any one event, and is based on the model possibility of extreme catastrophe events.

In terms of probable maximum loss estimates, the coverage represents close to a 1 in 250 year event. So in the case of a very large catastrophe event, we would be covered up to $135 million in total losses. You might think of that as coverage for severity as opposed to frequency.

I should add that the largest single cat event that we've ever experienced generated claims in the $15 million range. Our program is structured in four layers and each layer contains annual limits to the coverage that layer provides. During 2011, the first layer provided $10 million of coverage in excess of our $5 million retention and provided for one reinstatement of the $10 million coverage for total coverage in the first layer of $20 million during 2011.

Prior to 2011, we have never had more than two catastrophe events that exceeded our retention. In 2011, however, there were five major catastrophes events, and that unprecedented frequency resulted in our utilization of the full $20 million of coverage under the first layer of our catastrophe reinsurance program, as all five events exceeded $5 million in losses but none of the five events exceeded $15 million. Therefore, although we would've been covered from a severity perspective if any of the five events had pierced the first layer, the unusual frequency of events that fell within that $5 million to $15 million range resulted in approximately $7.1 million in claims that exceeded the first layer of coverage limit. As I mentioned, that amount includes $2.4 million of the IB&R which we believe will be adequate to cover any further development of claims related to these storms going forward.

Turning to fourth-quarter weather events, we incurred a fairly typical $5 million of weather related claims, including about $1 million from that very unusual snowstorm that hit the Northeast at the end of October and $1 million from a hailstorm in Tennessee that same month.

Before I leave the topic of weather and reinsurance, let me give some overall statistics for the full year of 2011. Our insurance subsidiaries incurred over $88 million in weather related losses during the year, which for us is a staggering number. Our reinsurance coverage with Donegal Mutual and external parties limited the net impact of our financial results to $52.6 million, which was more than double our previous five-year average weather losses of $23.3 million.

If we remove the impact of 19 catastrophe events from our numbers and included only what we would consider normal weather losses, our statutory combined ratio would've been 100.7% for 2011 compared to 100.3% on a similarly calculated basis for 2010. The impact of those 19 events to our full-year 2011 Class A earnings per share was approximately $0.88.

As we mentioned in the earnings announcement, for the full year, we had virtually no prior accident year reserve developments, which compares to $2.9 million of favorable development for 2010.

At this point, I'll make a few comments about investments and then turn the microphone over to Don. Our investment income showed a modest decline from the fourth quarter of 2010, but the decline had little to do with investment income and more to do with the low level of investment expenses in last year's fourth quarter because of a year-end true-up of an expense allocation.

More importantly, fourth-quarter 2011 net investment income was modestly higher than the amount we earned during the third quarter of 2011, reflecting our efforts to maintain the yield levels in our fixed maturity portfolio. As shown in our announcements our average yields have remained fairly constant in spite of the ongoing pressure on reinvestment yields in the current low rate environment.

The silver lining of the low rate environment is the resulting increase in the value of our bond portfolio and its impact on our book value per share, which was $15.01 at December 31, 2011, up from $14.86 at year-end 2010.

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

Thank you Jeff. Good morning to everyone and welcome to our earnings conference call. Jeff has done an excellent job of describing the history of the fourth quarter and the adverse weather and the resulting loss that he has indicated. What I am going to focus on is where we currently are and where are we going.

The year 2011 was a difficult year, not only for Donegal Group Inc. but for the property/casualty insurance industry as a whole, as you are all aware. However, we do believe that our company has achieved many very positive things in the year 2011, which we believe will position us well going forward.

Talking a little bit about premium, net written premium grew by 16% for the year, 14.2% for the fourth quarter. As Jeff has emphasized, we have had considerable success in growing over the last 18 months our Commercial book of business, which is our intent to have a greater percentage of our overall premiums, over time, come from commercial business.

Having said that, for the year, we had approximately 30% Commercial growth; 13% of that was organic, remembering that Michigan Insurance Company is included in the overall numbers. For the quarter, we had organic growth in Commercial of 17%, and about 30% overall. So needless to say, those are very positive from a premium standpoint.

Also in the year 2011, we integrated the largest acquisition to date for our company, a $100 million acquisition of Michigan Insurance Company. We made lots of progress doing that integration which we all know is one of the most important aspects of doing an acquisition. In the next week, we will be rolling them on going live with Michigan on our information systems, which will fairly well complete the integration process.

In 2011, we continued to invest considerable sums in our technology, both in Personal Lines, Commercial and Farm, and other aspects of our technology. We recognize, and I'm sure many of the folks on the line recognize, that you have to have the right technology in place because it's an element, a major element, of your competitive position within the industry.

We are also pleased to report that, yes; we did have lots of claims, well over 10,000 involving property risk in 2010 -- 2011 as a result of all the storms. The positive side of that is our claims department responded in an excellent way, and we are pleased to say that well over 98% of those claims are closed as of the end of 2011.

We grew our distribution system by appointing 50 agencies in the fourth quarter, bringing the total for the year-to-date to 210, a very strong number. We expanded organically into doing business in the state of Indiana, which is adding to our presence contiguous to the state of Ohio. We will grow there of course by appointing one agency at a time. It brings our total distribution system to 22 states, and somewhere between 2400-plus agencies.

We believe that we are very well-positioned for 2012. One of the areas that certainly is important to address is how are we going to improve on probability. It's clear that we have done well in growing premium in 2011. What we would like to talk a little bit about in 2012 is the result of the numerous rate increases in every line of business that we began to do in Personal Lines well over a year ago, and increased that in 2011, and as we move into 2012, all Commercial policies, we will be making a very serious effort to have premium increases in Commercial Lines anywhere from mid to upper single digits to as much as 7%, 8%, 9%, depending upon the particular class of business and depending upon the state in which it is located.

One of the interesting things about the property/casualty insurance industry at this point in time as the result of all the catastrophes in 2010 and 2011 is that the P&C industry does have a reasonable level of pricing power which many industries in our economy do not. We are finally seeing rates firming after four to five years of a very soft rate environment.

Our primary goal for 2012, which probably appears in numerous parts of our business plan for 2012, is underwriting profit. We are committed and have been committed to doing all the things necessary to achieve that, continued rate increases, reinspections of property, re-underwriting of business that doesn't have the acceptable losses. We are prepared to step away from business because, at this point, it's very essential that underwriting profit have the highest priority over all other aspects of how we are operating, of course all consistent with meeting all regulatory and statutory requirements in the respective states in which we are doing business.

We have begun our 28 agency meetings that we do in the spring, where we travel to some 12 to 14 states. Yesterday, we completed our sixth agency meeting. These would be meetings where anywhere from 50 to 150 agencies would attend in various cities throughout the regions in which we do business.

One of the concerns that we had is, with all the rate increases, all the underwriting action, how would agents perceive that? I am pleased to report that our sense from the process of meeting with the first six groups of agencies is that they are supportive, because they of course live on commission dollars, and they also have been adversely affected from all of the issues of the last three to four years. So we think that our distribution system is receptive, keeping in mind that they are the first line underwriters and having their full support for focusing on underwriting profitability as a key.

We think our business model and our strategy are right on. We believe that we are better positioned than we have ever been, and certainly compared to years when our underwriting profits and net income were significant. Our abilities and capabilities today are far better than what they would have been two, three, four, or five years ago.

Needless to say, in the fourth quarter, we did not have good results, but we also didn't try to pull any rabbits out of a hat to try to make it look good at the end of the year. We have tried to be conservative in our reserving estimates, and work on making sure that 2012 is the year that we all expect it to be. We can't control the weather, but we do know that there's lots of other aspects of our business that we do have control over, and that we are very focused. Everybody, whether you are in sales, underwriting, claims, financial, knows how important underwriting profitability and of course profitability from there.

We welcome the opportunity to answer questions. There's lots of things that we haven't covered, such as we have increased the quota share -- decreased the quota share on the Michigan Insurance Company book of business from 50% to 40%, which means that we will be taking that additional 10% into our 2012 premiums written, which provides additional amounts of premium. But there is certainly various other aspects that we would be pleased to answer if and when you have questions on those as we move into the question-and-answer session.

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

Thank you Don. Jaime, if you could open the lines for questions please.

(Operator Instructions). Matt Rohrmann, KBW.

Don, Jeff, good morning. I guess first question for Don. I noticed in the release you talk about focusing on newer agents less so and sort of refining your core team more. Just curious as to what's your -- the main drivers for your change of focus there a little bit. Then talking about the targeting price increases is great for 2012, but we've seen some companies sort of struggle with new business, even though they are getting rate on sort of their renewal book. I just want to get your thoughts there as well, thanks.

With regard to agencies, new appointments, we have made great progress in 2009, '10 and '11 in appointing additional new agencies. We're going to continue to do that to a degree in 2012, but our emphasis in 2012 will be to spend additional time working with the agencies that we appointed in 2009, '10 and '11, and making sure that they are producing the right business and that we are getting credible volume from them. So we are deemphasizing new appointments to a degree, but we will continue to do it.

With regard to rate increases and the ability to write new business, there certainly is a trade off. There is also a trade off with regard to existing businesses to what your tolerance for allowing business to run off if the insurer is not willing to accept your rate increases. At this point, we are seeing that Commercial new business is doing well. Personal Lines, our growth in Personal Lines will probably, organically, not be as strong. However, we don't believe that that's going to anywhere affect our premium growth. It's simply that our unit count will not necessarily be as strong in terms of growth.

Great. Then just two numbers questions for Jeff. What was the duration on the portfolio for the end of the year?

The duration is 4.5.

Okay.

So it's down (multiple speakers)

Then I know you guys repurchased just a few shares in the quarter. What was the price for those?

That price was $14.30.

Great. Thank you gentlemen.

(Operator Instructions).

While we wait to see if any callers have any questions, let me comment briefly on some reinsurance changes that became effective for the Donegal Insurance Group in 2012. We eliminated our multi-line excess of loss reinsurance contract, which in 2011 that contract provided coverage for any individual losses that exceeded $750,000 up to $1 million, at which point we have coverage under other reinsurance contracts. Therefore, for 2012, our per-risk retention is generally $1 million, although a few of our smaller city areas have separate reinsurance to lower their per-risk retentions.

It should come as no surprise that catastrophe reinsurance rates increased for our 2012 renewals. Netting the multi-line savings against the cat increases yields an overall increase in the reinsurance premiums of about $1.2 million or the year, and that's assuming the same premium base as 2011. We would certainly view that increase in reinsurance costs as modest in relation to the size of our book of business.

As Don mentioned, we did make a change in the external quota share that Michigan Insurance Company has, changing the percentage from 50% to 40%, which means that Michigan will retain an additional 10% of its net business, which translates to approximately $10 million in net written premium growth for us in 2012.

We did not make any change to the Donegal Mutual quota share, whereby Donegal Mutual assumes 25% of Michigan's business in places that into the pooling agreement. It's a little complex there, but the bottom line is that 55% of Michigan's underwriting results are in the Donegal Group results for 2012.

One of the things that I would emphasize is that we have not increased our retention on catastrophe coverage, so we think that is currently conservatively structured, and we wanted to keep it with that structure going forward.

Matt Rohrmann, KBW.

Sorry. One, I just want to follow up on one point from Jeff's comments. You obviously -- while he talked about the rate increases you expect for reinsurance, particularly the cat side, just curious to get your thoughts on obviously, for large severity driven events, the coverage is what it is. I was curious if you had looked at either this year or in prior years, and I'm curious to get your sense in terms of what the costs would be of more of a frequency driven type of plan, as I know others have said that it would be quite expensive. I'm curious to get sort of a feel, better feel, for the magnitude of what that kind of cost would be.

We have looked over the years at aggregates is basically what they are, and they are quite pricey. Certainly in the catastrophe reinsurance market, going into 2012, we believe that would have been a prohibitive cost. So it's -- the concept sounds nice, but in the markets over the last year, it would not have been, in our judgment, not advisable and not cost effective.

In terms -- I know it's not apples to apples by a long shot, but are plans such as those -- and I know it's obviously with the frequency of weather this past year and then pretty much from '08 on, are those type of plans two to three times more expensive of the bottom-line cost?

Our understanding -- we have not priced it in about three years. Our understanding is that it might be as much as 1.5 to 2 times.

Okay.

But certainly -- here is our view of it. That you want a reinsurance program to be in place for a longer period of time. If you have an aggregate in place, you're going to pay significantly higher costs every year. One of the attributes or one of the philosophies of reinsurance is that you're going to have claims over time and you want to ensure against the severe events, but you want to make sure that, over time, that you have a reasonable reinsurance cost. That's been our approach at least over the years.

Great, thanks very much guys.

Ron Bobman, Capital Returns.

I believe you touched on part of this. Could you talk about the rate movement in sort of the major lines that you write for the fourth quarter? Maybe you could compare them to what the rate movements were as compared to the third quarter of '11 and then correspondingly how retentions changed.

Let me address the rate part, and Jeff will talk about the retention. In Personal Lines, we of course have a schedule of the frequency with which we do rate reviews. So as an example, in a Homeowners line of business, you generally do an annual rate review. Our rate reviews, we take it by state, so it would've ranged anywhere from the first quarter of last year into the fourth quarter. As the year progressed, we would have, because of results, we would have had increased -- the indications would have increased significantly. As a result, we would have filed for higher percentage increases in the third and fourth quarter than compared to prior quarters.

On the Commercial -- and they could be anywhere, in Homeowners, anywhere as high as 12%, which is fairly significant. So we would have an automobile, private passenger automobile, they could range anywhere from 4% to 8%.

In Commercial, Commercial is more complex because, many times, your premium increases that you achieve have to do with how you deal with what are known as credits that you have by regulation, the ability to price up or down a risk off of a base rate. In our case, we would not, other than in Workers Comp, would not have filed a lot of base rate changes, but on the thousands of renewals, you have the ability legally to adjust the amount of credits or debits that you apply. That is the method by which you get your premium increases generally on Commercial Lines. You also can have base rate increases. We, in the fourth quarter, would have begun that process of increasing Commercial rates much more than we would have in the first three quarters of 2011.

We have, by product line and by state, a schedule that we are attempting to achieve. It would be anywhere from mid single digits to as high as 10% or 12%, depending upon the specific risk, but generally the increases in the case of risk without losses would be in the range of 5% to 7%. Any with losses could be as much as double digits or more, or potentially non-renewal. So that process is accelerating as we move into 2012.

Could you comment about January of 2012 please? It sounds like, if I understand your description right on the Commercial Lines, you were not effectively pushing for rate in the first three quarters, but you in earnest began in the fourth quarter. You gave us the ranges for the fourth quarter. I'm not sure what the average increase was, but anyway you gave us the ranges in the fourth quarter. Should we assume that, in the early parts of '12, the numbers for Commercial Lines are either at or greater than these ranges that you gave us? Just --?

It is fair to assume that those ranges for Commercial Lines in the first quarter would be very similar to the fourth quarter because they are part of the business plan.

Similar. Okay. How about retention, sir?

Sure. On the retention side, our Personal Lines attention -- both Personal Line and Commercial Lines retention rates have stayed fairly constant. In Personal Lines a year ago, we would have been around 89% policy retention, and through 2011, we were at like 88.5%, so it really didn't change a whole lot. Commercial Lines, it's mid 80s%, and Commercial Lines retention might be down a percentage point, but overall very consistent. We have not seen a significant decrease in retention as a result of the rate increases that we've taken throughout the year.

So I guess that emboldens you to stay the course with the rate increases.

It does indeed.

Exactly.

Okay. Great. Hope it continues. Best of luck.

(Operator Instructions). I am showing there are no further questions at this time.

We thank everyone for their participation on the call, and hope for a good 2012.

Thank you everyone.

Ladies and gentlemen, this concludes today's fourth-quarter 2011 earnings conference call. You may now disconnect.