Donegal Group Inc (DGICA) 2014 Q2 法說會逐字稿

Good morning, my name is Gina and I will be your conference operator today. At this time I would like to welcome everyone to the Donegal Group Incorporated second-quarter 2014 earnings conference call.

(Operator Instructions).

I will now turn the call over to our host, Jeff Miller. Sir, you may begin.

Thank you. Good morning and welcome to the Donegal Group conference call for the second quarter ended June 30, 2014.

I am Jeff Miller, Chief Financial Officer and I will begin today's call with commentary on the quarterly financial results. Don Nikolaus, President and Chief Executive Officer, and Kevin Burke, Chief Operating Officer, are also on the call this morning and will provide additional comments on the quarter and an update on our current business trends and developments.

You should be aware that 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 in the report on Form 10-K that we submitted to the SEC. You can find a copy of our Form 10-K in the investors section of our website under the SEC filings link. Further reconciliation of non-GAAP information as required by SEC Regulation G was provided in our news release, which is also available in the investors section of our website.

Turning to the quarterly results, we continued to make progress on several key objectives especially related to our emphasis on expanding our commercial lines of business. However, second-quarter net income fell short of our expectations due to a number of factors that I will cover during my remarks this morning.

Our net premiums written grew by 7.7% for the quarter. As we've reported in the past, the growth was due to premium rate increases in most of our business lines, commercial lines, new business growth and an additional contribution from a reduction in Michigan Insurance Company's external quota share reinsurance.

Don and Kevin will talk more about our rate increases and premium growth initiatives in a few minutes. But we are committed to achieving consistent underwriting profitability and will continue to seek rate increases where needed to accomplish that key objective.

Our second-quarter profitability was impacted by unusual claim activity. I will provide some additional details for several of the key areas of impact.

Weather losses of $11.6 million were close to our average for second-quarter losses over the past five years. But they did exceed the $9.4 million of weather losses we incurred in the 2013 second-quarter.

Of the total $11.6 million, nearly $4 million was from designated catastrophe events, primarily wind and hail storms, including an unusually severe hailstorm that hit central and eastern Pennsylvania and three wind and hail events in the Midwest states. Our reinsurance arrangements with Donegal Mutual and third-party reinsurers served us well by limiting the net financial impact of the severe weather events. But those events account for the increase over the prior year second-quarter weather losses.

Large fire losses totaled $9.3 million, which was above our quarterly average over the past several years. Although homeowners fire losses were in line with our expectations, we experienced an unusual volume of large commercial fire losses in the current quarter. Five or six of these large commercial losses involve situations where our insureds' business was affected by a fire that started at a neighboring property, or was caused by another tenant inside our insureds' location.

Potentially these cases might present some opportunity for subrogation recoveries, as that would reduce the overall loss impact to our companies in the future. And all large property losses are thoroughly reviewed by our underwriting management and discussed with our underwriting and loss control teams to enhance their awareness with respect to the circumstances surrounding those losses. We have also taken or will take nonrenewal or rate increase actions where appropriate.

Our personal lines combined ratio improved over the prior-year quarter, coming in at 99.5%, which was a pleasant surprise in light of the weather activity. We attribute the improvement to the continuing benefits of cumulative rate increase activity over the past several years, the ongoing benefits of our reinspection efforts, and the lower incidence of large fire losses in our homeowners line of business as well as decreased frequency and severity of personal auto bodily injury liability losses. In fact, had it not been for the unusual hail activity, our second-quarter personal auto combined ratio would have come in below 100%.

Our commercial lines combined ratio rose to 105.8%. The large fire losses I mentioned earlier drove the increase in our commercial multi-peril combined ratio.

Our workers' compensation line of business performed well with an excellent 90.6% combined ratio for the quarter, even though we had a comparable level of large losses in the prior-year quarter. Total prior accident year loss reserve development added $6 million to our incurred losses in the quarter compared to $4.7 million in the second quarter of 2013.

The increase was primarily related to development in our commercial auto liability line of business accounting for the elevated combined ratio in that line of business. We had a handful of prior-year liability claims on which we received new information during the quarter that led to reserve adjustments to reflect our increased loss potential based on that new information.

Turning to the investment portfolio, investment income was down 1.2% for the quarter, which is a smaller decline than we have experienced in recent quarterly periods. An increase in average invested assets partially offset the impact of a lower average investment yield in our fixed maturity portfolio.

Net unrealized gains in our available for sale investment portfolio increased by approximately $7 million after-tax compared to year-end 2013. That increase was due to reduced market interest rates and contributed to an increase in our book value per share $15.25 at June 30, 2014, compared to $15.02 at year-end 2013.

Last Thursday our Board of Directors approved quarterly cash dividends of $0.1315 cents per share of our Class A common stock and $0.116 per share of our Class B common stock payable August 15 to stockholders of record as of August 1. And finally we did not repurchase any common stock during the quarter. At this point I will turn the call over to Don for his comments on the quarter.

Thank you, Jeff, and welcome, everyone, to our earnings conference call. Needless to say, the earnings for the quarter were not to our expectations or our business plan but reflect the results of weather and storms and also the higher-than-anticipated combined ratio in commercial property and commercial auto.

Needless to say, our reinsurance structure was beneficial to our overall results. And that is certainly part of the strategic arrangements that we have put together.

When we look at the personal lines combined ratio at 99.5%, homeowners combined ratio at 90.9%, it reflects the efforts that have been put into increasing rates, looking at underwriting quality of all personal lines business. In the worker's comp arena, a combined ratio of 90.6%, we are certainly pleased with that because needless to say that's very excellent, and we will continue to work to try to achieve those results.

As Jeff has indicated, premiums were up 7.7% and our book value grew to $15.25 per share. For the year to date we have appointed 93 new agencies, 44 in the second quarter. Needless to say we have a complete focus on underwriting profitability throughout the organization.

All of the storms provided -- they are something we would -- certainly would have preferred not to occur. But once they occurred it provided another opportunity to demonstrate superior claims service, and I think that our claims people did an absolutely excellent job.

As we have said in the past, the Donegal Insurance Group has a focused and dynamic business strategy for profitable growth and an expanding distribution system, with state-of-the-art technology and committed to shareholder value and success as an independent regional property and casualty insurance group. At this point I would like to turn it over to Kevin Burke, Executive Vice President and Chief Operating Officer, and he will give you some additional details on rate increases, etc.

Thank you, Don. Good morning. I will review commercial and personal lines underwriting segments of our business as well as touch base upon several technology initiatives.

We continue to focus on rate adequacy and achieving underwriting profitability levels in both commercial lines and personal lines. Despite the challenges we faced as a result of cat events and other unusual claims activity in the second quarter, our continued premium growth, attention to rate adequacy and appropriate levels of reinsurance has helped to mitigate the impact of the claim activity.

In commercial lines we continue to see strong premium growth, with the commercial lines book of business now rising to 44.43% of our total writings for the first half of the year. Commercial lines renewal premium increases were within the range of 6.5% to 6.75%. For the second quarter commercial lines net premiums written increased 11.8%.

We are making rate filings in various lines of commercial business with increases in the low to high single digits based upon the line of business and state in which we write. Rate filings for increases in commercial auto range from low single digits to 9% depending upon the state and subsidiary.

In rate filing increases and workers' compensation range from low single digits to 8% depending on the state and subsidiary. We continue to focus on expanding our commercial lines business in the appropriate -- and the appointment of additional agents with an increase in growing commercial lines with Donegal. We believe this increase in our agency distribution plan has created a good foundation for future growth in this line.

In personal lines we continue to assess rate adequacy in all lines of our personal lines business, and appropriate rate filings have been submitted. We continue to see progress towards our targeted profitability levels in personal lines.

Rate filing increases in homeowners are within the 4% to 9% range depending upon the state and subsidiary. Rate filing increases in automobile range from low single digits to 6%, again depending upon the state and subsidiary.

Net premiums written for the second quarter increased by 5% and retention levels remained strong in the high 80% range. We are encouraged by our pricing strategy, thorough underwriting discipline and effective loss control. And we feel that there is a sound foundation in place that will allow us to grow organically and achieve our underwriting profitability goals.

I would like to turn now to several technology initiatives that we have going on here at Donegal. Mobile application, mobile apps as we know them, we are pleased to report that Donegal's mobile application is now live in all the states in which we do business.

Functionality includes review your policy, report a claim, pay a bill, etc. The Donegal mobile app has been well received by our insureds and we continue to develop and enhance this technology.

We are implementing a new billing system. We are in the process of implementing this new billing system to replace the prior legacy system. We are pleased to report that the implementation of this new billing system is on target, with the new platform scheduled to be rolled out by the first quarter of 2015.

We have a new rating system that we are also implementing. The ability to make changes to our products in a fast, efficient manner will further enhance Donegal's ability to make changes quickly based on the market factors.

Our new rating system will go live in September of 2014 starting with Pennsylvania personal automobile. Our goal is to have all personal lines policies converted to this new rating system within the next 12 months.

Lastly, e-signature. We are currently piloting e-signature for personal lines new business and we anticipate a full rollout of e-signature in Pennsylvania within the next 30 to 60 days.

E-signature allows the insurer to sign and confirm the document electronically and it is recognized by the state as an original signature. Additional states will follow as we rollout e-signature for personal lines. At this point I will turn the call back over to Don Nikolaus for some final comments on the second-quarter results.

Well, thank you, Kevin. And needless to say, Kevin has just given a very thorough overview of rate changes, premium increases, technology and other initiatives. So at this point I will turn it back to Jeff and we can move on with questions.

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

(Operator Instructions). Vincent DeAugustino, KBW.

Thanks for taking the questions. I guess first on the subrogation for the large fire losses, I know this is early but I'm curious if you happen to have any thoughts on maybe what percentage of those as far as incurred losses might be coming back? Or maybe what percent at least of the large fire losses, regardless of the dollars -- just on the number of claims which were kind of initiated from not one of your insureds in maybe an adjacent property, just so we can get a sense for what the impact there might be.

Sure. It's a bit early to speculate on what recoveries we might be able to ultimately receive. But there were several large losses that had damages that were several hundred thousand up to $1 million dollars that were related to those fires that I had mentioned.

So it's going to take some time to develop the subrogation cases and those things tend to take quite a bit of time to resolve. So it's very difficult at this point to estimate what level of success we will have in recovering funds, but we are going to pursue them and expect to have some measure of recoveries from those specific losses.

And Vincent, let me add to that. We have a very experienced subrogation. It's a separate claims -- part of the claims department.

And every large claim is reviewed for subro possibility. And the claims that Jeff is referring to, needless to say you have to have engineers, investigators because you have to be able to identify the liability on the part of the other person.

That whole process is currently underway. And we do believe that there will be success, but it's very difficult early on to measure the degree of success given circumstances that might arise in the investigation.

Okay, and then just staying on this topic for hopefully just a moment longer. Just with your property inspections and loss mitigation efforts, I am curious if in -- for inspections, for example, if there has been an increased focus on sprinkler systems, or ancil systems, or perhaps in this case maybe adjacent properties that you are maybe a little suspect on? I am just curious if in that process, if these issues would be something that would be potentially being addressed already as you work through those?

Well, on an ongoing basis we always do an analysis of adjoining properties because there can be exposures because of the adjoining properties. That's an ongoing part of our inspection program, and needless to say, when losses occur we want to know what were the circumstances.

That is clearly part of our inspection process. And needless to say many times we will not write a risk because what is adjacent to what otherwise might be an acceptable risk.

Okay, got it. And then moving to the reserve side.

So the development trajectory has been looking pretty good there, and I'm curious if we can just sort of discuss the dynamics A) on the handful of commercial auto claims just maybe in terms of if this is a half-dozen claims, or if this is numbering more than that? And then kind of what the vintage is here in terms of it being really long dated or something from the last few accident years.

And then second, B), if we look at commercial auto outside of these claims, what was the reserve performance there? And then second, as far as other lines of business, again, how was the reserve performance there?

I'm just trying to get an idea of some of the development that we had seen was isolated to those claims and essentially everything outside of that is still on track? Or if there was any change in what we are seeing outside of commercial auto?

Certainly, Vincent. That's an excellent question. And certainly an area that we did quite a bit of research as we were preparing for the earnings release to determine what exactly are the underlying trends and where should we be focusing.

And I have an analysis that I prepared that compares the first six months of 2014 to the first six months of 2013 to get some sense of the underlying trends. And what I can tell you is that other than commercial auto, which I will address in a minute, virtually every other line of business the development trends are improving over what they would have looked like a year ago for the six-month period.

Worker's Comp, for example, has improved by over $1 million just comparing the six-month development to prior-year six-month development. And as well as the private passenger auto liability, as we are seeing improving trends there.

In the commercial auto line, as I mentioned, there were a handful of losses and a handful is actually five. There were five losses. Individually those five losses account for $1.2 million of the increase, which is really the entire increase for the first six months relative to the first six months of last year.

So had it not been for those five claims, the commercial auto liability development would have come right in almost exactly where it should have or at least where we would've expected it. Those five claims are all 2012 accident year claims, so outside of that particular accident year the other year's development looks very stable and favorable to very modestly adverse.

And when I say modestly, I am still talking about $100,000 -- again, the change this year's first six months relative to last year.

Those particular five claims, though -- one of them was a first notice of loss that we just received in May. Several of them we received information from Defense Counsel that were indicating that a claimant had now required surgery; or we received a packet of specials, what we call specials -- the medical reports that would give us a better indication of the severity of an injury.

In another case there was a new attorney that is representing the claimant and they submitted information that we were not able to gather in the past. So hopefully that gives you a little color that it was isolated in our view to a very small group of claims that in the absence of those claims all of our trends would have been favorable. And that gives us some measure of comfort that things are on the right track.

Okay, that's actually really helpful. And then just on the hail losses -- not so much an odd question, but I'm just curious; on these type of losses it's not an at-fault accident or anything of that nature.

So I'm just curious if we should think about if there's any type of rate recalibration or response to this activity? Or if this is just something that it happens and you just have to pay it and move on?

Well, clearly, Vincent, we will include all of that loss information as part of our next review of rate indications because it becomes part of the loss ratio. It will get factored in, so as you need to because you don't know if there's other occurrences in the future. So clearly it will be a factor that we will consider in the next rate increase.

Okay.

And Vincent, if I could add just to that, relating to the hail losses, we looked at our homeowners combined ratio and it was quite favorable. And one of the first things we looked at was, well how is that possible in light of all these hail losses.

And what we found is that although there were quite a number of homeowners losses related to those hailstorms, the auto losses were a large percentage of the hail claims. And those auto losses were reported very quickly and the homeowners claims tend to be reported somewhat slower.

And so as we are developing a cat event, the losses that make up the amount that we are retaining versus what we are reinsuring tended to be more heavily concentrated on the auto lines, specifically private passenger auto. So that is some explanation as to why homeowners actually performed very well in spite of those hail losses.

Okay, and so to that comment, it seems the implication is that you are anticipating some tail to the homeowner side and that is already baked into your incurred loss estimates? On the timing?

Well, that would be correct. And any tail that we experience would be ceded to outside reinsurers because we have exceeded our retentions on those particular events. So we would not expect any further net impact to our financial results from those hailstorms.

Okay, good to know. And then one last one for Kevin. Just on the rate increase side.

It actually seems like things are fairly stable there relative to the commentary last quarter and prior to that. So if we pair that with some of your non-rate-driven margin improvement initiatives, I was hoping if we could look bigger picture and think about what you are targeting as far as a combined ratio, or ROE, if we kind of assume more normalized fire, cat and reserve release performance?

Will, Vincent, obviously we have had a bit of a challenging first part of the year considering some of the weather-related issues and also some of the fires on the homeowner side. But Donegal's approach has always been and target is always to write below 100 combined.

With the first six months -- the challenges being in place, we also have to be sensitive to the rate filings and increases that we will be taking. They have to be measured. That's why one of the things that I reported on was the retention levels, particularly in personal lines, is in the higher 80%s, 80% range.

So our goal, Vincent, is to be a profitable company by the end of the year as far as a combined ratio being under 100 combined. We are working diligently to do that. But we're also taking a very measured approach to it so that our rate increases are appropriate and they follow a good business model.

Okay. Sounds good, and good core loss ratio performance, definitely nice to see that strong performance here in a couple of quarters in a row. So I look forward to talking to you guys soon and thanks.

(Operator Instructions).

No further questions in the queue. Gina, I think we are probably ready to close.

We appreciate everyone's participation on the call this morning and good questions from Vincent. And hope for better results to report to you as our core operations, as Vincent has mentioned, continue to perform very strongly. We hope for better results as the year progresses.

Thank you, everybody, for your participation.

Thank you.

This concludes today's conference call. Thank you for your participation. You may now disconnect.