Donegal Group Inc (DGICB) 2005 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the fourth quarter 2005 Donegal Group earnings conference call. (OPERATOR INSTRUCTIONS). I would now like to turn the presentation over to your host for today's call, Mr. Jeff Miller, Chief Financial Officer. Please proceed sir.

Thank you. Good morning and welcome to the Donegal Group earnings release conference call for the fourth quarter and year ended December 31, 2005. I am Jeff Miller, Senior Vice President and Chief Financial Officer, and I will begin the conference call by providing some highlights and analysis of the quarterly and annual financial results. Don Nikolaus, President and Chief Executive Officer, will then provide commentary on our results and discuss the trends we are currently experiencing.

Also, present on today's call are Dan Wagner, Senior Vice President and Treasurer of the Company, and Matt Resch, Vice President of Investments and Investor Relations.

All statements made in this 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, severe weather, 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 of the forward-looking statements included herein to reflect future events or developments. Undue reliance should not be placed on any such forward-looking statements.

I'm pleased to report that Donegal Group's results in the fourth quarter were a continuation of the strong earnings posted throughout 2005, with the Company again experiencing excellent underwriting results, premium revenue growth, and increased investment income as compared to the fourth quarter of 2004. We posted record net income for the quarter, contributing to record full year net income in 2005 for the fourth straight year.

Our net income for the fourth quarter of 2005 increased 36.4% to $9.9 million, or $0.52 per share on a diluted basis, compared to $7.2 million, or $0.40 per share on a diluted basis, for the fourth quarter of 2004, after adjusting for the impact of 4 to 2 stock split in March of 2005. Total revenues for the fourth quarter of 2005 were $81.7 million, an increase of 8.3% over the total revenues of 75.5 million in the fourth quarter of 2004.

Premiums earned in the fourth quarter increased 7.2% to $74.7 million, compared to 69.7 million in the fourth quarter of 2004. Our investment income grew to 5.2 million in the fourth quarter of 2005, an increase of 20.9% over the 4.3 million in the fourth quarter of 2004.

As I mentioned in previous quarters, our tax-exempt interest income has increased steadily throughout the year as we shifted our invested asset mix to include a higher percentage of tax-exempt municipal bonds in our portfolio. Tax-exempt interest income as a percentage of total investment income was 52.8% in the fourth quarter of 2005 compared to 46.7% in the fourth quarter of 2004. We again continued to benefit from higher after-tax yields as a result of this shift. And we have been able to maintain approximately the same effective tax rate in spite of a 41% increase in pretaxed income for the year.

Focusing on our underwriting results for the fourth quarter, our loss ratio showed a slight increase to 60.4% compared to 59.6% that we reported in the fourth quarter of 2004. Our expense ratio decreased to 28.4% in the fourth quarter of 2005 compared to 32.5% in the fourth quarter of 2004. The slightly higher claim results contributed to the decrease in expenses, in that claims experienced directly impacted incentive compensation to our agents.

There were also some expense accruals adjustments in the fourth quarter of 2005. In particular, we received in late December a Pennsylvania guaranty fund assessment that was much lower than we had anticipated based upon assessments we received in the past several years. As a result, we recognized the benefit in the amount of approximately $1.3 million after-tax related to our reduced guaranty fund assessment.

Looking at the combination of our loss experience and expense details for the quarter, we posted very excellent underwriting results as reflected by our GAAP combined ratio of 89.4% compared to 92.7% for the fourth quarter of 2004.

Turning to the year as a whole, we had a very excellent year from a profitability standpoint, posting a record low combined ratio of 89.5% compared to 93.1% for the full year 2004. Our 2005 loss ratio was 56.9% compared to 61.7% in the prior year. The improvement in our loss ratio was attributable to our emphasis on premium rate adequacy, lower claim frequencies as a result of favorable weather conditions in our operating areas, and continuing favorable loss development trends in most of our lines of business.

Our net income for 2005 reached a record $36.9 million, an increase of 41.2% over the net income before extraordinary items of 26.2 million in 2004. Net income in 2004 included an extraordinary item of $5.4 million reported in the first quarter of 2004 related to an acquisition.

Earnings per share on a diluted basis for 2005 were $1.98 cents per share compared to $1.44 per share for 2004 prior to the effect of the extraordinary item. Our book value per share increased to $15.07 as of year end, and our return on average equity for the year was 14.2%.

At this point I will turn the call over to our President, Don Nikolaus, for his comments on results and the trends we are experiencing.

Good morning everyone. Thank you for joining our earnings conference call. As you can hear and see from the information that has been provided by Jeff, that we have experienced both an excellent fourth quarter, as well as an excellent entire 2005. We as a Company certainly are gratified by these excellent results, returning an 89.5% combined ratio certainly relative to the industry that we understand from AM Best will be somewhere between 101.8 and 102%. We are pleased with the performance in an absolute basis and certainly on a comparable basis relative to the industry as a whole.

If you take a look at, as an example, investment income, we certainly did not quite anticipate that we would be achieving that level of increase. But we will continue to invest our funds within the policy that we have established that we believe will continue to reflect very strong performance.

One of the areas that I would like to talk about today in telling you about some of the results, but also some of the initiatives going forward. We have been very active in the fourth quarter in rolling out our automated underwriting system for personal lines, called WritePro. It has certainly been very successful for us. We are in the process of rolling it out in the web-based technology. And the significance of WritePro is not only the ease of doing business and the efficient technology, but embedded in it are our best personal lines products. So that there is also very much a business result that comes from it.

We are also in the process of finalizing the development on the commercial side of a product we are identifying as [WriteBiz], which will be an automated underwriting system for commercial lines.

It is our projection and intention to make sure that our technology is comparable and on a level playing field with even the very largest national companies, because we recognize that as a regional Company, we have to have national capabilities when it comes to the day-to-day doing the business, ease of business, products, and pricing.

Also, I would like to talk a little bit about the management of catastrophe exposures because we're all certainly aware that follow the TNT industry, that Katrina, Rita, and Wilma certainly provided some extraordinary storms and losses to the industry as a whole. I would like to reconfirm, as I believe we did in the third quarter conference call, that our losses from the combination of those storms was very modest. In the range of -- somewhere in the range in 250 to $400,000. So a very modest sum of money.

What we attribute that to is an ongoing and historic management of our catastrophe exposures. We're not Johnny come lately to that. And we will continue to very much monitor and manage that whole process.

From the standpoint of the computer models we, like all other companies, come have run computer models over the years, and have subscribed to all the very best computer models. However, what we have done is we have -- from the reinsurance standpoint, we have placed our reinsurance on a conservative basis so that we are covering potential events of 500 to 1,000 years, and not relying upon being covered on a 100 to a 250 year event. In addition to a conservative management of our catastrophe exposures, we are also making sure that our reinsurance in place is certainly far and let's say very adequate for the exposures that we might have.

Everyone is always interested in talking about where we are in the pricing cycle. We are certainly focused as a Company on maintaining rate adequacy. And that is whether we are in a tight market or whether we are in a softening environment. That continues to be our philosophy and our discipline. I think we all recognize that the market is certainly less firm than it has been. There it is certainly somewhat of an increased level of competitiveness, but it is certainly not in any way irrational. And we believe that the triple storms of Katrina, Rita and Wilma will temper the price softening in most lines of business, particularly in any risks that are associated with property.

As you all realized that we had announced in the third quarter that we had entered into an agreement to do an acquisition right having to do with renewals of a book of business that one of the subsidiaries of Vesta Shelby Insurance Company had in three states in which we currently do business. I believe at the last conference call we indicated that we would give some indication of how that is proceeding.

We are quite pleased that from the standpoint of the day-to-day handling of the book transfer, that it has worked extremely well. It has been very automated. But at the same time we have underwritten each and every risk, and not just a portfolio transfer of the book of business. We are pleased to indicate that early returns, at least based upon numbers available to us at the end of January, which would have been the first full month of the business being written as part of this acquisition rights agreement, that we are retaining at least as of the early indication about 65% of the business that we are presenting offers for. And that is certainly within the range of expectations that we would have had going into this. So that we are certainly quite pleased with how that is proceeding. And in subsequent quarters we will keep you posted as to our results. We certainly are going to be continuing to monitor it, and certainly continue to look for other opportunities to do similar transactions.

A little bit more about WritePro and WriteBiz. What we believe WritePro and WriteBiz, in addition to the technology that we provide to our agents and the ease of doing business, we believe that it also will open for us, particularly in personal lines, increased opportunities to do a book roll of existing business within agencies, which is basically where an agency would suggest to us, or we would discuss with an agency, the possible rolling of a book of business that they might currently have with another carrier. We're looking for that technology to help us in that regard.

We never have these conference calls without talking about underwriting discipline. We continue to be emphasizing within our organization the importance of underwriting integrity, and the direct connection between excellent combined ratios and excellent loss ratios and the need to be conservative in the quality of the business that we write as a Company.

On the topic of acquisitions, we continue to have ongoing discussions with various parties. And it still is very much high on our priority list, but as we have said in the past, that we want to make sure that any acquisition is a good fit, and that it is appropriately priced, and that we believe that it can be successful going forward.

At this point I will turn it back to Jeff, and we will proceed to the question and answer session.

Thank you, Don. I believe we're ready for the question and answer session.

(OPERATOR INSTRUCTIONS). Eric Jackson of SunTrust Robinson Humphrey.

This is Eric Jackson calling in for David Lewis. Congratulations on a good quarter. I have two questions to start off with. The first one is kind of high level. It is sort of a broad question. We're hearing that AM Best, with them still trying to cipher through how they will view capital requirements for CAT exposed coverages going forward, many companies and regulators are kind of sitting on the sidelines being cautious in regards to rate hikes as they await more clarification from AM Best.

Consequently, we're hearing that many larger players are looking to raise rate in noncoastal property areas as a temporary offset to the CAT related pressure. If you are seeing this happen, do you as a regional focused Company with not a lot of direct coastal exposure, see this as an opportunity to gain market share with others potentially raising rates in markets you don't have to?

That's an excellent question. I just came back several weeks ago from AM Best's annual conference that they have for companies. Certainly, one of the topics of their discussion in those sessions related to their, I guess, ongoing process that they are doing in reviewing their models that they use to analyze the exposure of companies and what their revised capital requirements might be in what they call their [B card] formula.

It appears clear from those early indications that they will have -- they will develop more conservative capital requirements, particularly where there is CAT exposure. And also they will be focusing on what they call the second event. Because one of the things that certainly the industry and the regulators have realized that major storm events can occur in a close timetable. They will be setting additional stringent requirements for what capital has to be in place to protect against a second event within the same fiscal year.

If, in fact, larger national competitors do follow through to raise rates in noncoastal areas it clearly would benefit regional companies such as ourselves. And it would clearly be an opportunity for us to increase market share. We will certainly welcome that opportunity, and certainly will monitor those circumstances closely.

Number two, I'm not for sure if I missed this, but just a couple of thoughts on a few line items on today's report. With the premiums, you all had kind of guided toward 9% growth year-over-year for written in or premiums, and they both fell a little short of that for the quarter. I wanted to get your thoughts on that in case I missed it. If you can provide any guidance for the premium outlook for '06?

Generally -- first of all, generally we do not provide guidance. Historically we have not provided guidance. Although we have probably in various conference calls have given some range of where we might see growth to be.

If you look at the numbers for the year, I believe that you will find that our revenues increased by 11.1% and our premiums earned by 10.8. You are correct that the fourth quarter did not achieve those numbers for the quarter. In the quarter the revenues were up by 8.3.

However, I would hasten to say that what we have said historically over the last years that a range of 8 to 10% in revenue growth is certainly within the realm of reason, and we will continue to emphasize growth. However, we would prefer to grow at 8.3 and be extremely profitable than grow at 9.5 to 10 and sacrifice profitability. That is an ongoing issue in I would assume almost any property and casualty insurance company.

We continue to emphasize to where people that, yes, we would like to grow double digits. But we don't want to do that if that means that we are pricing business below adequacy, or if it means that we're writing business that would not fit our traditional targets in terms of what we want to write. It is an ongoing balancing act. But we certainly are poised to grow, want to grow, but we're going to make sure we do it in a profitable way.

Just lastly, the slight spike in the loss ratio for the fourth quarter, what do you all attribute that to?

That is an excellent question. We had -- fourth quarter is generally a quarter that we see an increase in our loss ratio. If you look at the fourth quarter of 2004 our loss ratio this year is just a few cents higher than what it would have been last year. That is typically a quarter where we see more fires, and we see auto accidents when roads get icy. We also saw some increase in our workers' comp -- some severity in the workers' comp, and auto liability lines in the fourth quarter compared to say the earlier quarters this year. It is kind of across a few of the lines of business, but not necessarily atypical for the fourth quarter.

Adam Klauber of Cochran, Caronia and Wallace.

Just to follow up on the last question. I think you mentioned severities were up a little. Do you think that is a bit of a blip? And could you give us some idea what the severity trend is? Also, are you still seeing relatively favorable frequencies in the auto line in particular?

Yes, we had very comparable loss experience in our core entities, and we are seeing a little bit of severity in some of our subsidiaries. So it does vary by geographic region. For instance, in the south we had some increase in severity in our auto liability, so there were some accidents. That is an area where if you have bad weather those accidents can occur, because people aren't used to driving in the bad weather.

Also in our Midwest operation we did see some increase in the casualty severity during the quarter, which we would not have seen -- we believe it is not necessarily a trend, but that there were some isolated instances of severe accidents or severe injuries on the workers' comp side. But generally at this point we are not seeing that it is a trend.

I know one of your larger regional competitors in Pennsylvania had been pretty quiet over the last year and half, but I think you have been getting more aggressive. Is that impacting your premiums writings at all?

I, of course, don't know whom you might be referring to, but I'm not aware of any specific regional carrier that is causing any particular competitive issue for us.

Chad Klatt of Piper Jaffray.

You mentioned the Shelby acquisition and the success rate you are having with that book. What portion of that book did you ultimately make offers to?

That's a good question. We ultimately made offers on approximately 65 to 70% of the policies that we had the opportunity to review.

Okay. Understood. And then could you just provide us with an update on the new agency appointments for the year?

Yes. New agency appointments for the year would have ranged somewhere in the neighborhood of over 100 agencies. At the end of the third quarter I would have reported that it was 79. And we would have added in our various regions -- we would have added approximately another 20 to 24 agencies. That would take it a little over 100.

Perfect. And then finally you mentioned the continued shift towards munis and the investment portfolio. What is the current allocation of munis, and then what is your targeted allocation?

Bare with us a second until we pull that information out. We are real close to a sort of 49, 50% allocation currently to munis. And we would see that increasing over the next year as we continue to evaluate our tax position. But at this point see no reason why that would not continue to increase gradually throughout the year.

(OPERATOR INSTRUCTIONS). Meyer Shields with Stifel Nicolaus.

Just briefly, was there any impact positive or negative from prior quarter or prior year reserve development?

Good question. And the answer is that we have seen a continuation of the development trends that we would have seen earlier in the year. As of the end of year our development was right around 5.5% of our beginning reserves. And that would be across each of the last five accident years, and across most of our lines of business. So we do not have any significant change in the fourth quarter related to our loss development.

Also, with regard to the regional companies that are -- with whom you are in discussions for mergers and acquisitions, are you seeing any trend in that more mutual companies or more stock companies are interested in that, or is it still fairly even?

We have discussions with both. I think that there are probably more opportunities on the mutual side. But having said that, we have had discussions in the last four or five months with two stock entities. Longer-term I think there will be more opportunities on the mutual side. As you probably are well aware, a lot of companies have had successful '04s and '05s, and sometimes they push the topic into the future. We think in time though increased opportunities will make themselves available.

If I could just follow up with the loss development question to make it clear that those loss developments we experienced throughout the year were favorable loss developments.

Eric Jackson, SunTrust Robinson Humphrey.

Just a couple of the number questions. Do you have the pre-FAS 115 book value? And also can you provide [B] loss rates, the personal line loss ratio and the commercial lines loss ratio?

Sure, I would be glad to do that. The pre-FAS book value at the end of the year was $14.93 per share. So there are $0.14 of net unrealized gains included in the equity. As far as the segment information you are requesting commercial versus personal. I have both -- I have combined ratios which may be more meaningful for the full year, commercial versus personal. The combined ratio on our commercial business was 86.2%. And the personal lines combined ratio was 91.6. We had slightly better performance in the commercial lines than the personal for the year.

(OPERATOR INSTRUCTIONS). At this time you had no further questions. I would like to turn the conference back to management for closing remarks.

I certainly want to thank everyone for participating on the conference call and for the good questions. And just as a reminder, a replay of this conference call will be available until March 6 by dialing 888-286-8010, pass code 27386733.

And once again we thank you for participating in the fourth quarter conference call.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a great day.