Donegal Group Inc (DGICB) 2004 Q2 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the Donegal Group second quarter earnings release conference call.

My name is Bill and I will be your coordinator for today.

At this time all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of this 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 your host for today's call, Mr. Ralph Spontak, Chief Financial Officer. Please proceed, sir.

Good morning everyone and welcome to the Donegal Group Bank, Inc. earnings release conference call for the second quarter ended June 30th, 2004. I am Ralph Spontak, Chief Financial Officer, and I will be starting off the conference call by reviewing some of the key financial components of the quarterly results. Don Nikolaus, President and Chief Executive Officer of the Donegal Companies, will then, as usual, discuss some of the current trends we are experiencing.

Before getting started, I need to read our forward-looking statement. All statements contained in the conference call 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 reserves for losses and loss adjustment expenses; business and economic conditions in the company's primary operating areas; competition from various insurance and noninsurance businesses; terrorism; legal and judicial developments; changes in regulatory requirements; and other risks that are described from time to time in the 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 revision to any forward-looking statements included herein to reflect future events or developments. Undue reliance should not be placed on such forward-looking statements.

Now to the discussion of the second quarter results. Net income for the second quarter of 2004 was $6,770,000 or 50 cents per common share on a diluted basis. Compared to $5,268,000 or 56 cents per share on a diluted basis for the second quarter of 2003. These results were achieved despite property claims from a severe weather event in the midwest that totalled approximately $1 million and reduced net income by $650,000 or 5 cents per share on a diluted basis.

Even with the impact of the midwest weather, the company's recent excellent underwriting results continued during the second quarter of 2004 with the company posting a GAAP combined ratio of 91.8% for the second quarter of 2004, compared to 92.3% for the second quarter of 2003. Net income for the year to date for 2004 is $18,502,000 or $1.36 per share on a diluted basis. The year to date figure includes an extraordinary gain that was taken in the first quarter of $5.4 million or 40 cents per common share on a diluted basis.

The extraordinary gain, just to remind everybody, was the result of GAAP purchase accounting for unallocated goodwill from the LeMars acquisition. And again, that was again in the first quarter. The company's combined ratio for the first six months of 2004 was 92.2%, compared to 94.7% for the first half of 2003.

The company's total revenues in the second quarter of 2004 increased 33.8% over the same period of 2003 to $70,692,000. Excluding the two acquisitions that took place early this year, the company's premiums earned increased 9.5% in the second quarter. Premiums written ,also excluding the two acquisitions, grew at a rate of 10.8% in the second quarter of 2004. Overall premium growth was 35.2% including the two acquisitions in the second quarter of 2004 compared to the second quarter of 2003.

The company's GAAP expense ratio in the second quarter of 2004 was 30.7%, compared to 30.6% in the second quarter of 2003. This expense ratio reflects lower operating expenses that were offset by higher levels of an incentive expenses due to the increased profitability of the company in the fine operating - - underwriting results.

Loss developments continue to be good with the company's reserves from the end of 2003 showing a slight redundancy through six months of this year. That of course would exclude the two acquisitions. The company's book value per share increased during the quarter to $17.23 per common share at June 30th, 2004. The company's board of directors declared a cash dividend of 12 cents per share per class A common share, and 10.5 cents per class B common share, payable August the 16th to shareholders of record August the 2nd. That was declared at last Thursday's board meeting.

At this point, I would like to turn the call over to Don Nikolaus, President and Chief Executive Officer of the Donegal Companies. Don.

Thank you, Ralph.

Good morning everyone. Thank you for joining our earnings conference call.

Needless to say, we are quite pleased with the results for the second quarter. And as Ralph has reviewed with you the various statistics, I won't repeat those. However, on the underwriting side, the combined ratio, we'd like to emphasize that we believe that this, of course, demonstrates the disciplined underwriting philosophy that our company has certainly fostered and promoted over a good number of years. And we're pleased that we have been able to deliver a combined ratio as low as 91.8%.

Even with that combined, as Ralph has indicated to you, there was a major storm in the Nebraska/Iowa portion of our territory, that we now participate in, that produced in excess of $1 million of storm losses in one event. And we're certainly pleased that our losses in that regard were not higher, but certainly are also pleased that we were able to absorb that and return such an excellent combined ratio. From the standpoint of growth, we have seen net written premiums accelerate somewhat in the second quarter. The earnings announcement indicates that in the core companies, meaning the subsidiaries prior to the two acquisitions, their net written premium was up 10.8% for the quarter, which is quite good and is a greater percentage that it would have been in the first quarter.

We're also pleased to report that Peninsula Insurance Group would have also grown by approximately the same percentage in the neighborhood of 10 to 12%, and LeMars would have grown slightly lower percentage, somewhere in the 7 to 8% for the quarter. The importance in all of it is that all of our entities have an emphasis on profitable growth and we believe that we are experiencing that, and our hope would be that that would accelerate further into the year.

From the standpoint of fee income, in the second quarter, we would have fully implemented all of the increases in late fees and installment charges that we would have filed and received regulatory approval for and certainly in the amounts and to the extent that each of the state regulatory entities would have approved, so that is starting to flow into the income stream. If you compare the service fee income, you will see that there is a nice growth there and we are not, of course, totally focused on fee income, but we believe it can be an additional source of revenue that flows very much to the bottom line.

Our distribution system, I am pleased to report, that as of June 30th, we would have appointed 62 new agencies to represent our various companies in the various geographic area. We are therefore, well on target to exceed 100 new agency appointments in the year 2004. And as we have discussed before, part of our growth strategy is not only organic growth, but it's certainly acquisitions, but it's also growing our distribution system within the states and territories in which we currently do business.

Other initiatives in the second quarter from an operational standpoint, we continue to make rate increase filings where appropriate. As an example in the second quarter, we would have made increased filings for many of our commercial products, in many of the states in which we do business, and they would have been in certainly the more moderate range as compared to prior years, but they would have been anywhere from 4 to 8%.

We are also in the process of expanding certain product lines, specifically in personal line, by introducing additional tiers in both homeowners and automobile in various states. The purpose of this is to exprand - - expand the breadth of our market and also to make sure that we have products that are as comprehensive as some of our very largest competitors.

We are also very close to rolling out some new technology that we call phase three upload, which is basically an automated underwriting system for personal lines that further enhances our technology. We would look forward to, in the third quarter of, beginning a very rapid rollout of that technology in some of our core states and later in the year, in the early part of '05, would expect to roll it into most of the remaining states. We believe that there are certainly other areas within the company that have certainly contributed to these fine results for the second quarter, but I think that covers many of the highlights, both in what Ralph and I have presented.

And I'll turn it back to Ralph and we'll move on to questions.

Yes, at this point, I'd ask that the operator please open things up for the Q and A period.

Thank you very much, sir. Ladies an gentlemen, if you wish to ask a question, please key star, one on your touch-tone telephone. If your question has been answered or you wish to withdraw your question, please key star, two. Questions will being taken in the order they are received. Please key star one now to begin.

And our first question comes from Eric Saxon of SunTrust Robinson Humphrey. Please proceed.

Good morning. I'm calling in today for David Lewis. Congratulations on a good quarter. Just had a few brief questions.

One, on the investment income line, see it came in lower than what we were expecting for the second quarter. Would you say the down side still reflects the reinvestments of the acquisition income? And how do you feel about the second half of '04 regarding investment income?

Sure, Eric. I'll take that. Yeah, I think as we discussed during the first quarter conference call, we are in the process of trying to invest quite a bit of our short-term money at that point. We believe that rates were poised to start increasing and had first started to show that around the time of the conference call. We did get in excess of $20 million of our short-term - - short-term investments invested into longer-term, more permanent type of invests, but that is still an ongoing process.

At the end of -- at the end of June, we still had in excess of $37 million in short-term investments in cash, although that was done considerably from a number that was almost $60 million at the end of June. So it's been a difficult rate environment to try to find good investments with higher yields to help bolster the income. But certainly with the movement in the last 90 days in interest rates, I believe holding off a little bit as we have will benefit us longer term. We are continuing to work very diligently to get all of that short-term money invested as quickly as we can. There are is also a movement on our part, because of our high levels of tax stability to shift some of our portfolio into municipals, tax frees, to try to take advantage of the full tax stability of Donegal Group at this time and end up with a little bit more flowing to the bottom line.

Okay. Can you give us an updates on your meetings with agencies? I think it was 13 of your states, the type of feedback you're hearing?

I would be pleased to talk about that. First of all, let me just follow up a little bit on the investment income. I think Ralph has covered that very- - very- - in a very comprehensive way. But one of the things I would like to add is that bottom line, we would expect that investment income will trend upward in the last six months of the year. But also, because of the analysis that we have done having to do with the need for additional tax exempt securities, that there will be a certain amount of tradeoff between investment income and lower taxes. So that's sort of a balancing that we will need to do based upon the relative relationship of taxables and tax exempts.

With regard to your about the agency meetings, we have completed 25 agency meetings in 13 states or 14 states, whichever the number is, and we would say that they were a very successful group of agency meetings. We are done agency meetings for over 20 years, and certainly, we compare year to year. And we felt that these particular series of meetings, our message was well received, agents seemed to be enthusiastic about our company in a broad range of areas, whether it be in product, whether it be in technology, in competition, so we felt quite good about it. It is always been a major part of our marketing strategy in the beginning of the year and certainly into the spring to get out and sort ever rally the troops to hopefully focus more of the percentage of their business to our companies as compared to our competitors.

Well, good. Thank you. I might come back for more questions.

Thank you very much, sir. Ladies and gentlemen, your next question comes from Beth Malone of Advest. Please proceed.

Okay. Thank you. Good morning and congratulations on the quarter.

Thank you.

Just a couple of follow-up questions. Your combined ratio was impacted by catastrophic losses in the midwest, but it certainly benefited from a lack of weather on the east coast. Could you -- is there a way to quantify how much of the combined ratio you set aside for expected, you know, weather worse than what we did have? I mean, is it like -- is there a way to look at that?

This is Ralph Spontak.

Beth, we generally do not set aside or try to calculate what would be considered catastrophic losses in any particular quarter. It is certainly difficult, particularly with the history in the east coast where storms and catastrophic events tend to hit more on every few year basis than every few quarters. So when your' looking at events that only hit every couple of years, it's very difficult to try to work something like that into the projected combined ratios. I think, certainly, companies that have a much heavier concentration in the midwest, you see more likely for those types of companies to include in their projections what I would describe as more normal weather activity. Because as we know, the midwest will have certain level of storm activity in the late spring and early summer. But with that representing such a low percentage of our overall book at this point, I don't think it would be appropriate for us to try to include an overall percentage for storm activity.

I'd like to add something to that answer to that question, Beth. Although there were no catastrophes in the east, it has to be understood that in every given year, every season, there for instance, in the second quarter there would have been certainly a fair number of thunderstorms in the east and there would have been certain mild hail storms. They simply did not rise to the level that we would have identified them as catastrophes. So the weather was simply more normal and was not outside of the range of normalcy.

Okay. Thank you.

Ralph, could you quantify, what was the unrealized gain or loss in the quarter?

The unrealized loss for the quarter was $4.7 million.

Okay. And did that -- that swung from the first quarter then?

It's - - it did. Hold on one second. I've got the first quarter here, I believe.

Well' have that for you in a second, Beth.

Okay. Great. I guess while you're getting that, when you look at your market in general, and the market in particular for the personal lines, are you seeing - - is there more disruption or changes among your competitors than you've seen in other times in the last couple of years, with the consolidations, and companies getting downgraded, and those kind of things, do you see more activity that way than you've seen in the past?

I would say, Beth, that there is some of that. And yes, it really, many times is geographic in the sense that you might see patterns of that in one of your regional areas, but in another it might be business as usual. So, yes, we have seen some of that. And we're - - you know, we're not sure where that goes going forward, but I don't know that at least in the six - - the last six months that we have seen a lot of disruption in the marketplace in personal lines.

Correspondingly, I don't see that there has been a lot of negatives either from a lot of increase in competitiveness. So we - - we're not seeing any wide fluctuations either in competitiveness or disruption in the marketplace, at least up to this six-month period.

Beth, getting back to the question about the unrealized gain, in the first quarter, we would have had an unrealized gain of just under $900,000. So again, unrealized gain of $900,000 in the first quarter, unrealized loss of a little bit over $4.5 million in the second quarter.

Okay. All right. And that's due primarily just to interest rate changes?

Almost exclusively.

Okay.

And one last question, on the - - as you expand your product base, as you start to offer a more different tiers of (INAUDIBLE). Does that suggest that you are starting to write more business that is less than preferred?

No, not at all. Let me sort of clarify that.

A number of the very large national carriers have begun in the last year to bring to the market numerous tiers that attempt to segment the business to a greater degree. And it does not necessarily mean for them, or for us, that we would be looking to write more nonstandard business or less than preferred. What it - - what we will be focusing on is how we can segment the more preferred business so that we have adequate number of tiers that we are on a competitive basis with some of the larger carriers, who, for instance in their preferred programs might have 5 tiers or 10 tiers, whereas currently we might have 3. So we don't want to surrender in anyway, or diminish our potential for writing the better business, so that we are making sure that we are staying current with the very large personal lines writers that we have the same kind of tier segmentation that they're attempting to do.

Okay. Is this development, is this all part of the increased technical capabilities that the Company - - that you're able - - that even the larger companies, as well as yourself, is able to slice and dice, you know, the market a lot more with a lot more detail than in the past?

It is, because without technology, it would be very difficult for an agent and an underwriter to be able to manually determine which tier something, they could do it, but it would be quite time-consuming. So all of this is enhanced. Your terminology of slice and dice, it is enhanced by more technology. It is enhanced by the use of data mining, of knowing what segment and what smaller segments of certain profiles of business are going to be more profitable. So it is driven by both of those and we have recognized that it's incumbent upon us to stay very current with all of that, because competition today is not just measured in price. It is measured in price, product, ease of doing business and technology.

Okay.

And finally, if - - if that's the market that you're competing in, do you think it's going to be much more difficult for your smaller, less well-funded companies to compete in that market? And do you see that leading to more opportunities for you to make acquisitions?

Well, we have a general view that - - and we have had that for some time, that the market and the environment in the P&C industry will, in general, over time be more and more difficult for smaller companies. And whether that's because of rating pressures, whether that's topics such as we're talking about, the ability to bring to market sophisticated technology and products. So yes, in answer to your question is yes. We just think it's more of the same theme that we have been talking about. And why we believe over time that there will be acquisition opportunities as we have certainly availed ourselves over the prior years.

Okay. Great. Thank you very much.

You're welcome.

Thank you very much, ma'am. Ladies and gentlemen, your next question is from Mike Paisan of Legg Mason. Please proceed.

Yeah, hi. Good morning everybody.

I just want to sart of break down the premium growth, and your overall growth a little bit more. If you could break it down a little bit into how much of that was pricing and how much of that was units. I would assume that some of the unit growth was from some of the new agents have been assigned or have been assigned. I was wondering if you could maybe even further funnel that down into what, I guess, would be in the retail sector, the same store sales? Meaning how much of your existing agency has produced that unit growth, trying to get some idea as o your existing penetration in your existing distribution prior to the addition of the assigned agents in the quarter.

To answer - - take the first part of that, Mike. The breakdown between new business and rate increases, I would say that roughly half of that growth is coming from new business and about half from rate increases. Always a difficult number to get a firm handle on, but that's a pretty good estimate, I think. So in the second quarter, we're looking at between 10 and 11% net premium growth. I think that's fair to split that down the middle between those 2 components.

Okay. Thank you.

One other - - I had one thing, Mike, with regard to the new agency appointments. I would say that, in the second quarter, it would not be a significant amount of growth that would have come from new agency appointments. It generally takes anywhere from 3 to 5 months to get agents oriented in your products, get their people up to speed in terms of how you do businesses and what your expectations are. So yes, there is and I don't know that we're able to quantify that, but it's is certainly something that, going forward, we'll make an effort to try to quantify.

Okay.

But I would not say it's a material dollar amount or percentage based upon the agencies that would have come on line in the last 3 to 5 months.

Okay. That's very helpful.

Thank you very much. Thank you very much, sir. Ladies and gentlemen, your next question comes from Adam Klauber of Cochran, Caronia. Please proceed.

Good morning. Thank you. Could you give us an idea of premium growth and combined ratio trends by product line: auto; homeowners; and commercial lines?

Certainly. As far as premium growth, breaking it down between commercial and personal lines, commercial continues to grow at a rate almost twice that of personal lines. I'll have - - for one second I'll have the actual premium growth for you.

As far as combined ratios and actual results, commercial results continue, as measured by combined ratio, to do better than personal lines although both sectors did very well in the second quarter even with the effect of the storm losses out in the midwest. The combined ratio for commercial lines in the second quarter was 80.7%. That's an improvement over a year earlier where the second quarter combined would have been 84.8%. But it's also an improvement over the first quarter of this year where the commercial combined ratio was 87.7%.

For personal lines, the combined ratio, because of the effects of that million dollars in storm losses, is somewhat lower than both a year ago, and the first quarter, but still very strong at 94.1% for the personal lines. Just as a good measurement, the combined ratio for those lines in the first quarter of this year would have been 92.9%.

Breaking both of those down to an actual by line number, commercial multi-peril business continues to have the best combined ratio within our commercial lines for the first - - for the second quarter at 75.8%. But workers comp continues to do better showing a marked improvement over the first quarter, coming in with a combined of 92.4%.

Within the personal lines, as mentioned, and is not - - it won't be any great shock, that homeowners did not do as well in the second quarter as compared to any personal, automobile. The homeowners individual line item combined ratio was 98.2% in the second quarter, compared to 94.2% for automobile in the second quarter. So automobile would have shown a modest improvement from the first quarter of this year. Homeowners, once again, because of the storm activity, would have shown a decline. The combined ratio for homeowners in the first quarter was 90.7%.

Now, if you calculate out the million dollars of losses, it equates to about 9 percentage points on the combined, so the homeowners combined of 98.2% almost the - - not almost, the entire increase in that during the second quarter was related to that one storm event.

I believe Don has some numbers here breaking the premium growth down for both personal and commercial lines.

These are - - and we certainly could get back to you about those, Adam. We don't have it broken down exactly, but we can certainly calculate that. However, commercial lines would have grown by a greater percentage, somewhere ,probably somewhere in the neighborhood of 12 to 14%, and personal lines would have grown somewhere in the - -and we're talking about in the quarter - - somewhere in the 6 to 7%, but we can certainly refine those numbers a little further.

Okay. That helps.

A follow up, in your auto book, are you still seeing - - did you still see favorable frequency trends in the second quarter?

Definitely. Frequency continues to be down from a year earlier. Fairly substantially, and that's a trend, really that we've seen now for the second consecutive year.

Okay. Different question. How is the pipeline for new acquisitions?

Well, we're continuing to be contacted and have put in front of us a number of potential acquisitions. To this point, we have not seen one that quite meets our criteria that we would like to pursue. But I would say, as measured by the sheer number of potential candidates out there, it continues to be very high. My own belief is that, with the market rate, rating market ,having been firm here for some period of time now, that many of these smaller companies that were trying to hang on, recognize that, although they're doing okay today, the prospects for their longer-term success is not great. Particularly in view of the investment in technology they with have to make, which Don discussed a little earlier, and also reinsurance costs continue to be very difficult for the smaller companies. So we think it's an excellent environment to do acquisitions and affiliations.

Follow up to that, Adam, we have, as Ralph has indicated, we have taken a look at information on a number of companies. We probably took a closer look in the last six months at 2 of them, but very candidly, we have certainly tried to remain disciplined about it and we don't want to do acquisitions for acquisition's sake. So we chose not to move forward on 2 that just, as Ralph said, didn't meet the kind of criteria that we have in doing acquisitions, but we're certainly optimistic that, if we're patient that we will, we will get our shots. If you have any bring, them to us.

Okay. Finally, as far as competition, in the last 3 months have you seen State Farm, AllState, Progressive, become more competitive, lower rates?

Well, let's take State Farm. I think it's clear that State Farm's own results are better in the last year and a half and as a result, in some markets they have become somewhat more competitive. In others, they have not. And Progressive, I mean, you watch television - - the same television commercials that I do. They are - - they are certainly actively promoting their business.

But whatever any of those large carriers are doing up to this point, we don't believe that - - that it has detracted from the opportunities that we believe that we have available to us in the independent agency system. And in many states we compete very effectively with various of our products against both of them. Not necessarily every day in every quote, but particularly in the better quality business, we would compete effectively as I've indicated in most states. So we're -- we're not feeling any adverse impact from those companies.

Thank you very much.

Thank you very much, sir. Again, ladies and gentlemen, if you wish to ask a question, please key star, one on your touch-tone telephone. Our next comes from - - is a follow up from Eric Saxon from Suntrust Robinson Humphrey. Please proceed.

Hello, I just had a quick number question. Do you have the preferred book value for 2Q '04?

We do. The pre-FAS book value would be $17.12.

Okay. As far as excess capital, do you think it's still around $12 million?

Yeah, I think that's a good estimate at this point.

Okay.

Just to remind everyone, we also have in - a totally unused $35 million line of credit at this point also.

Okay. Thank you.

Thank you very much, sir. Again, ladies and gentlemen, to ask a question, it is star, one.

At this time, we have no further questions. I'd like to turn the call back over to Mr. Spontak for his closing remarks. Please proceed.

Okay. Just like to thank everybody for participating in our conference call today. I think we had some very good questions and hopefully we've been able to add some clarity to our numbers. If have you any further questions, please don't hesitate to contact me. Again, thank you all for participating in our conference call. Good-bye.

Thank you very much, ladies and gentlemen, for your participation in today's presentation. This concludes the conference call. You may now disconnect. Have a good day.