Donegal Group Inc (DGICB) 2006 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q2 2006 Donegal Group earnings conference call. My name is Latasha and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to Mr. Jeff Miller, Chief Financial Officer. Please proceed, sir.

Good morning and thank you for participating in the Donegal Group earnings release conference call for the second quarter ended June 30, 2006. I am Jeff Miller, Chief Financial Officer, and I will begin the conference call by covering highlights and providing some analysis of the quarterly and six-month financial results.

I will then turn the call over to Don Nikolaus, President and Chief Executive Officer, for his perspective on the quarter and 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, our 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 involved 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 the main 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; the availability and cost of reinsurance; 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.

We're pleased to report that Donegal Group continued to experience excellent underwriting results and growth in investment income in the second quarter of 2006, driving our earnings to the highest level we have ever recorded in a quarterly period.

A four-for-three stock split of our Class A and Class B common stock was effective on April 26, 2006. Please note that all prior-year share and per share information presented in today's earnings release and discussed during today's conference call have been restated to reflect the effects of the stock split.

Our net income for the second quarter of 2006 increase 14.8% to $10.2 million or $0.40 per share on a diluted basis compared to 8.9 million or $0.36 per share on a diluted basis for the second quarter of 2005. Total revenues for the second quarter of 2006 were $81.9 million, an increase of 3% over the total revenues of $79.5 million in the second quarter of 2005.

Net premiums earned in the second quarter increased 2.2% to 75.1 million compared to 73.4 million in the second quarter of 2005. Growth in net premiums earned from premium production increases was partially offset by increased reinsurance costs, primarily due to increases in reinsurance rates effective January 1, 2006, and the purchase of additional reinsurance coverages at that time.

We continue to be encouraged by our personal lines premium growth in a number of states where our WritePro automated underwriting and policy issuance system is fully implemented, and also in those states where we acquired acquisition rights to policies previously written by Shelby Insurance Company. Our personal lines growth in those states was 6.8% on a direct basis, with growth of 11.6 in Pennsylvania, where WritePro utilization is the highest. We continue to roll out our WritePro system to additional agents and are actively promoting the use of this underwriting total based upon very positive feedback that we have received.

Our investment income increased $5.1 million in the second quarter of 2006, an increase of 16% over the 4.4 million posted in the second quarter of 2005, primarily due to an increase in invested assets and improvement in the interest rate environment in the past year.

In spite of the impact of a number of significant weather events in our operating areas, our recent trend of excellent underwriting results continued during the second quarter, as exhibited by our loss ratio of 54.3%, relatively unchanged from the record-low 54.2% we reported in the second quarter of 2005.

We incurred approximate $1 million of additional weather-related claims in the second quarter of 2006 compared to the second quarter of 2005, primarily from windstorms in the Midwest and storms in the last week of June that impacted the mid-Atlantic region.

Turning to the expense ratio, our ratio decreased to 33.5% in the second quarter of 2006 compared to 35% in the year-earlier period, with savings primarily coming from ongoing expense control initiatives and reductions in projected guaranty fund assessments from what we were anticipating to this point in 2005. The excellent loss ratio and improved expense ratio contributed to a record-low 88% combined ratio for the second quarter of 2006 compared to 89.6% for the second quarter of 2005.

Combining the strong underwriting results of two consecutive quarters, our net income for the six months ended June 30, 2006, was $19.4 million, an increase of 11.7% over net income of $17.3 million in the first six months of 2005.

Earnings per share on a diluted basis for the first six months of 2006 were $0.76 per share compared to $0.71 per share on a diluted basis for the first six months of 2005. Our six-month combined ratio for 2006 was 89.2% compared to 90.1% in the year-earlier period. The favorable results year to date have increased our book value per share to $11.85 as of the end of the quarter and have provided an annualized return on average equity for the first six months of 13.5%.

Our Board of Directors yesterday approved a quarterly cash dividend of $0.0825 per share of Class A common stock and $0.07 per share of Class B common stock. The dividend is payable August 15 to stockholders of record as of the close of business on August 1.

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

Thank you, Jeff, and good morning to everybody. Thank you for participating in our second-quarter earnings conference call. Needless to say, we are quite pleased with the record earnings for the quarter that have been announced that represents a 14.8% increase over the same period of 2005. Investment income, as Jeff has touched on, was up 16% for the quarter, the combined ratio a very, very excellent 88%.

So I think we can all identify that the Donegal Group and its subsidiaries, on an earnings basis, is certainly hitting on all cylinders. And it has, as you all know, it has been our policy and our strategy to focus very much on underwriting profit and growth of profitability. And I think that we continue to achieve that, as we know, and I think that we all know, in an increasing competitive marketplace in the P&C industry.

On the topic of pricing, certainly we see lines of business such as private [pensions] or automobile and commercial where rates are softening. And there are other lines such as homeowners and dwelling fire and others where rates are not necessarily soft. But certainly it is in a softer environment than what we have experienced over the last several years. However, having said that, we are certainly gratified by the fact that our profitability continues to hit on all cylinders, even in somewhat of a softening price market.

One of the topics I would like to talk about is growth of premium, because we would recognize that that would be an issue for which participants on the call would want to understand how we are addressing that and the fact that the present growth for the year is certainly not where we would want it to be, nor probably would have expected it to be when the year started.

Needless to say, it is a major topic that we are -- the management of the Company -- is addressing, because we recognize that going forward, we want to have reasonable growth so that longer term, our profitability grows along with the overall growth of the Company.

What I would like to do is identify for you some of the areas in which we -- the steps that we are taking to address premium growth. And one of the things that you will see in our strategy here is that it is targeted, it is focused on maintaining premium adequacy, and it is focused on underwriting integrity.

Some of the areas that are our initiatives we have been making and will continue to make -- certain filings to a number of our products, particularly in the personal lines arena, to distinguish our filings and our product from some of our competitors, because we think there is an opportunity to not just sell price, but also to sell the competitiveness from the standpoint of the product and the comprehensiveness of it.

We have stepped up appropriate agency incentives tied to production to address any production issues. We also are more aggressively rolling out our WritePro and our WriteBiz product because, as Jeff has indicated to you, such as in the state of Pennsylvania and several other states where we are further along in the rollout particularly of WritePro, we are getting some nice traction. So we accelerated our program of rolling it out, including more active meetings and contacts with agents to educate them and to promote its use.

Also, we are targeting commercial lines and those classes of business within commercial lines that we have historically found to be our niche and profitable, to sharpen our pencil somewhat because we do not want to lose quality business for a few percentages, in terms of pricing. So we have a more aggressive but selective approach to that.

Also, we are trying to identify books of business that might be available from other companies, and certainly are not able to discuss that publicly, but that is certainly -- we are pursuing that, because we have been pleased with the success that we have experienced with the Shelby book.

The Donegal companies recognize the growth issue. And we believe we have an ongoing strategy to try to improve on growth, but do it in a prudent and sensible way so that we can preserve the levels of profitability that we have historically been known for.

Speaking a little bit about Shelby, our ratio of percentage of accepted to total offered risk has improved somewhat from the first quarter. It was good then. It is up to about 69% year to date as compared to about 64% that I think that we announced at the end of the first quarter.

And also, in case any of you have read anything in any of the industry press about some rehabilitative action that is being taken against Shelby's parent and some of its subsidiaries, we do not believe, at the end of the day, that that will affect our ability to make offers to the remaining policyholders. We have issued renewals for what we are willing to offer new policies, up to September 19, which means we only have two and a half months approximately, three and a half months of the remaining 2006.

And we would anticipate that we will, certainly with approvals of the various insurance departments, accelerate the process by which we are issuing the remaining policies so that we can capture and garner as much of that as possible. We will certainly do whatever is legally appropriate. But we believe that that will work its way through.

And needless to say, to reemphasize, we have no legal connection with Shelby or any of its entities. We simply have a simple agreement to acquire to the extent we are willing to offer a renewal policy to an existing policyholder. And that is the extent of any connection or relationship.

On the topic of acquisitions, we recognize that we have not completed any in the last two years. But I think we all recognize that those are not something that you can budget or say we are going to do this year. We are actively talking to a number of companies, and I would be encouraged by that process.

Jeff, I will now turn it back to you for the question-and-answer process.

Okay, if you could please facilitate the question-and-answer session.

(OPERATOR INSTRUCTIONS). David Lewis, SunTrust Robinson Humphrey.

Kind of talking a little further about the top line, can you give us a little more detail about the pricing and whether the competitiveness in the marketplace has changed materially over the past three months? I think you indicated in the first-quarter call that it was competitive, but rational.

I think an accurate answer to that would be that we see more aggressive pricing and competition on the commercial side in the second quarter. We don't believe that there is any significant difference in the personal lines pricing as compared to the first quarter. Now, it was certainly more competitive in the first quarter than it was in '05, but we don't particularly see, at least in the jurisdictions that we are doing business, that that is necessarily intensified.

But on the commercial side, we do see that there are competitors that are being aggressive in pricing risk. Now, once again, you have to always be careful about the war stories about other competitors in the marketplace, because they may be war stories about business that we don't particularly target. And we do believe that the competition is keener and sharper the larger the risk might be. And although we're certainly far from immune from competition in the smaller to mid-sized accounts, we don't believe that it is as intensified there as it has for larger-type risk.

Having said that, it is more competitive in the second quarter than the first commercially. And that is why we have identified certain additional initiatives to deal with that.

Is it more competition from the nationals or the regionals? I would guess some of the nationals pulling back out of potentially cat-exposed areas going into the Midwest and up to the East Coast would probably be a little more competitive in trying to put their capital to work. Is that true?

Well, I believe that that is an accurate assessment. I think that the national companies are more aggressive. But there are so certainly some of the superregionals that are stepping more up to the plate. Dave, as you know, there's always some new player that's come in to a particular state that gets identified as a new player. So it is primarily large carriers, but there are regionals as well involved.

And shifting gears to WritePro and WriteBiz, can you give us an update on how many states you're in and where you think you might be by the end of the third quarter? And finally, any guidance on what you think net written premium growth might be for the second half of the year?

Well, with regard to WritePro and WriteBiz, we are currently live in eight states as we speak. Now, some of those -- several of those would have occurred towards the end of June and into July. But we would expect to be live in 12 states, 11 to 12 by the end of the third quarter, and corresponding the same with WriteBiz.

But just as important, we have found that it takes a number of months to get better traction in a state in which you have just introduced the system, because it is a matter of making sure that agents are well-trained, down to their CSR level. And sometimes you have to go -- not that our system is difficult; we think it is one of the best in the industry. But with anything new, you have to try to wean people off of their current habits to embrace yours. So sometimes it takes a couple of visits to get that accomplished. So there's a -- certainly a certain lifecycle to rolling it out.

As you know, we generally don't give guidance. But what I would say to you, Dave, is that we certainly plan on improving on our growth in the third quarter over the second quarter.

Ron Bobman, Capital Returns.

I had a handful of questions. Was there any favorable development in the quarter?

Sure, I'll address that, Ron. The development that we track a number of different ways, by line of business, by accident year, and generally what I try to do is compare that to where the development was in the prior year and prior quarter. And we would see very similar trends in 2006 to what we experienced in 2005. And I believe we were in the 5 to 5.5% range of positive development in 2005, and that would be as a percentage of net reserves.

So in 2006, all the indications are that we are experiencing very similar trends across all of our subsidiaries, as well as pretty much even the line of business are very closely aligned to what they would have shown a year ago. So there may be some slight improvements in different areas. And I think overall, I would say that the developments look slightly better than they did last year, but not seeing any inverse trends in that area.

And just so I understand, in order to ballpark the magnitude, so if I were to look at -- and again, it is just a rough estimate -- if I look at the beginning-of-quarter net loss reserves and I took a little bit more, or slightly better than 5 to 5.25%, and I took, then, 25% of that number, that would be the amount of ballpark favorable development recognized in the quarter?

Right. The only thing that I would add to your method that you just proposed is that you need to subtract off the reinsurance recoverable, which represents the ceded losses. So the reinsurance recoverable, reinsurance receivable on the asset side of the balance sheet needs to be reduced from the losses and loss expenses which are shown gross of reinsurance.

Right. No, I was -- I thought you were saying net reserves.

Correct. So if you take net reserves, yes, times that 5.5% times 25%, that would roughly be the impact in the current quarter.

And then I don't think you commented -- is it weighted more towards personal lines or commercial lines or evenly distributed by the relative size of those books?

Yes, it is fairly evenly distributed. Because our personal lines book is larger than our commercial lines book, there would be some weight to the personal lines. But there is not any significant shifting between the commercial and personal.

And could you -- I assume you already covered this in a previous call, but could you remind us how much cat cover you purchased and where that amount corresponds to -- sort of a one in 100, one in 250 -- I think in the past before models got reset, you were buying at a 1 in -- I think a 500-year number. I have it in my notes from some time ago.

Yes. Now, we've purchased catastrophe reinsurance by different subsidiaries. Some of our subsidiaries purchase it in their won program. But for the major subsidiaries, we are covered up to an $80 million event, and that would represent -- a 1 in 500-year event is well-covered by that 80 million.

Okay, so it is still 77 excess of 3?

That's correct.

For the major?

That's correct.

I was wondering how much of the -- you don't give us -- there's a lot you don't give us. And I could probably say that in all caps here, because the press release doesn't include a lot of detail. I am trying to understand the Shelby impact on premium growth in the quarter. Could you give us what direct writings were and then quarter over quarter, and what the Shelby component was?

Sure, I can give that to you. Because we are writing some of the premiums in the Donegal Mutual companies, only a portion of that transfers into the public entity. So the numbers I am going to give you are just the impact to the public entity.

The direct writings would have been 1.4 million in the second quarter. And after factoring in reinsurance, it would have been about 1.2 million to the net premiums written in the second quarter. So that would have been the Shelby impact.

And then what about by line of business? Obviously, Shelby is helping the personal lines book, I believe. But you didn't give us any sort of premiums insight as to what happened in the commercial book. And I think your prepared remarks, you commented on commercial lines as competitive. Is that across all three areas -- commercial auto, workers' comp and the C&P products? Or does it vary by line?

It is pretty much across the board in the commercial lines. It basically showed about, in the current quarter, a 6.4% decrease over the second quarter of 2005. And that is spread across all the -- the commercial auto, the workers' comp and the commercial multi-peril lines. Personal lines would have been up 3.5% for net premiums written.

You have all the info at your fingertips, but it didn't make its way into the press release.

We can work on improving that.

How much business do you do in Pennsylvania? That was my last question. If I have anything else, I will circle back. But I was interested to know your sort of mix by state.

I am thinking it is right around 50%, maybe a little higher than 50% -- the premiums that are coming into the public entity.

I'll circle back if I have anything else. Best of luck. Nice job.

Meyer Shields, Stifel Nicolaus.

It is Meyer Shields from Stifel Nicolaus. Let me start with this -- the expense ratio improved year over year, but it seems to bounce a lot from quarter to quarter. I'm trying to understand what drives that.

Certainly. Well, a large component of our expense ratio is related to incentive compensation of our agents. And as that loss ratio jumps up and down, we are adjusting what we think our annualized liability is going to be for those incentives.

And so to the extent that you have a low loss ratio in a certain quarter, generally you're going to see a higher expense ratio in that quarter. And then to the extent that you have a higher loss ratio in another quarter, then there is an adjustment there to the annualized incentive cost, and so you will see a lower expense ratio.

So unfortunately, we can't have nice, even losses across the year as weather events hits and various other severity trends can jump around from quarter to quarter. So it happens to be that as the loss ratios hit, that is how the expense ratio also gets impacted.

But the goal in every quarter is that quarter's contribution to an annual accrual. Is that right?

That's correct.

Am I correct in interpreting Don's comments about agency incentives as an increase in commission levels? Or is there something else going on there?

No, not increase in commission levels. We may run, as an example, one of the incentives that we put in place was for -- in commercial for BOP business in certain states. We put in a bonus commission for a fixed period of time, but of course, it expires and it's only based upon new business. Is not based upon renewals. We also have travel incentives if agents achieve a certain production of premium. So we have enhanced some of that. So that is what we're talking about.

That is helpful. I guess one other question -- you mentioned how it appears that commercial lines are becoming more competitive than personal lines. Near the end of the second quarter, obviously, Progressive said that they are going to revamp their pricing. It sounds like you haven't seen any signs of that. But I am just wondering how you are positioning yourself to respond to stuff that they might do?

Well, keep in mind that Progressive, although they do embrace the preferred and the standard market, they compete primarily, I would say, in most of our states against us sort of the nonstandard business, because most of our independent agencies, not all -- and I want to be careful about that -- but a lot of our independent agencies utilize Progressive primarily for their nonstandard products.

So they are certainly a major competitor. But we run across them more as it relates to our nonstandard We compete very effectively in most jurisdictions against them on their standard and preferred business. So from what I read about what they are doing in our preferred, superpreferred business, I don't know that we will be overly concerned about what they may be doing.

That is very helpful. Does Vesta's ongoing liquidation or receivership present any other opportunities for you to get books of business from them?

I would say no, because the books of business that we understood that represented their standard and preferred book were the Shelby business. And we, of course, acquire them in the states that we were interested. I believe most of their other books of business are business that we are not in or would not have interest in.

(OPERATOR INSTRUCTIONS). David Lewis, SunTrust Robinson Humphrey.

A couple of quick questions. First, what was that net written premiums in the second quarter?

The net written premiums in the second quarter were 80.091 million.

And I am not sure that I understood the answer to one of the previous questions. If I heard it correctly, commercial net earned premium was up 6.4% or down?

The net written premium was down 6.4% quarter over quarter.

I show no further questions in the queue at this time. I would now like to turn the call over for closing remarks.

Okay. We certainly thank everyone for their participation in the call and for the very good questions. And there is a replay available, and the instructions are included in the press release. So thank you, everyone, for participating, and have a nice day.

This concludes the presentation. You may all now disconnect. Good day.