Donegal Group Inc (DGICB) 2006 Q3 法說會逐字稿

Good day, ladies and gentlemen and welcome to the third quarter, 2006 Donegal Group earnings conference call. I will be your coordinator for today. [OPERATOR INSTRUCTIONS] I would now like to turn the call over to Mr. Jeff Miller, Chief Financial Officer. Please proceed, sir.

Thank you. Good morning everyone, and thank you for participating in the Donegal Group earnings release call for the third quarter ended September 30, 2006. As introduced, I'm Jeff Miller, Senior Vice President and Chief Financial Officer. And I will begin the conference call by providing highlights and analysis of the quarterly and nine months financial results. I will then turn the call over to Don Nikolaus, President and Chief Executive Officer, for his comments on the quarter and perspective on the business trends we are experiencing. Also present on today's call is Dan Wagner, Senior Vice President and Treasurer of the Company.

All statements made 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, severe weather, business and economic conditions in the Company's primary operating areas, competition from various insurance and non-insurance 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. Please also 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 affect of a 4-for-3 stock split of our Class A and Class B common stock that was effective on April 26, 2006.

We are pleased to report the Donegal Group once again experienced excellent underwriting results and investment income growth in the third quarter of 2006, sustaining the pattern of earnings performance that has developed throughout the past two years. Our net income for the third quarter of 2006 was $9.818 million or $0.38 per share on a diluted basis, compared to the $9.777 million or $0.39 per share on a diluted basis for the third quarter of 2005. Total revenues for the third quarter of 2006 were $82.6 million, an increase of 2.5% over the total revenues of $80.6 million in the third quarter of 2005.

Net premiums earned in the third quarter increased 1.5%, to $75.7 million, compared to $74.6 million in the third quarter of 2005. As in the first half of the year, growth in net premiums earned from additional premium writings was partially offset by increased reinsurance costs that resulted from increases in reinsurance rates and the purchase of additional reinsurance. We continue to see gains in personal lines premium growth through increased usage of our WritePro automated underwriting and policy issuance system and also through the additional policies obtained as a result of the acquisition rights agreement we executed with Shelby Insurance Company for 2006.

Our personal lines growth for WritePro and the Shelby agreement contributed additional premiums was 10.1% on a direct basis. And we obtained additional growth in the third quarter from an acceleration of the issuance of all remaining Shelby policies under the acquisition rights agreement, as a result of regulatory actions related to Shelby's parent Company. The premiums acquired from the Shelby policies added $1.9 million from the net premiums written in the third quarter and the book transfer was completed in the third quarter. Our investment income grew $5.4 million in the third quarter of 2006, an increase of 18.4% over the $4.5 million reported in the third quarter of 2005. Primarily due to an increase in invested assets and improvements in the overall interest rate environment throughout the past year.

Our third quarter 2006 loss ratio was 56.2%, slightly higher than the 55.1% loss ratio we reported in the third quarter of 2005. We incurred approximately $2 million of additional weather-related claims in the third quarter 2006 compared to the year earlier period, primarily from storms that impacted the mid-Atlantic and to a lesser extent the southeast region. Including approximately $1 million in claims from tropical storm Ernesto that came through our operating areas in late August. Our expense ratio held steady at 32.6% in the third quarter of 2006 and 2005. Our combined ratio was 89.5% for the third quarter of 2006, up slightly from the 88.5% from the third quarter of 2005, primarily again as a result of the increased weather-related claims activity.

Turning to our results for the nine months ended September 30. Our net income for the first nine months of 2006 was $29.2 million, an increase of 7.6% over net income of $27.1 million in the first nine months of 2005. Earnings per share on a diluted basis for the first nine months of 2006 were $1.14 per share, compared to $1.10 per share for the first nine months of 2005. And our combined ratio for the nine months of 2006 was 89.3%, slightly better than the 89.5% posted in the year earlier period. The favorable results year-to-date and unrealized gains in our fixed maturity portfolios have increased our book value per share to $12.39 as of the end of the quarter. And our annualized return on average equity for the first nine months of 2006 was 13.2%.

Yesterday, our Board of Directors 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 November 15 to stockholders of record as of the close of business on November 1. At this point, I will turn the call over to our President, Don Nikolaus for his comments on the quarterly results. Don?

Thank you, Jeff. Good morning, everyone, and welcome to our earnings conference call. We are certainly pleased to be able to report the earnings that Jeff has just reviewed with you, and as contained in the press release. Jeff pointed out that it was a quarter in which we had an increase of over $2 million of weather-related claims over the prior third quarter of 2005. And certainly, it would represent the most weather-related claims of any quarter in 2006. So, we are certainly pleased with those earnings results.

The combined ratio coming in at 89.5, and the increase in investment income of $18.4 all reflect that the business strategy of the Donegal Group is continuing to be executed and providing the results that I think both we and our shareholders anticipate. When the -- in the area of premium growth, Jeff indicated that our net premiums written increased by 3.6%, with the personal lines increasing by 6.5%. I'm going to talk in a little bit about how we believe that fits in to where we are headed in terms of going into the subsequent fourth quarter, and how we believe there are strategies in place that will hopefully continue to provide increases in premiums written.

I would like to talk a little bit about our WritePro and WriteBiz systems. To refresh your recollections, WritePro is our personal lines automated underwriting system available to our agents now in 12 states. We have been very aggressive in the rollout of that program. And what I would hasten to mention is that as we roll it out in states, we also simultaneously work on developing filings for our personal lines product that will continue to add additional segmentation that will provide competitiveness in those classes of business and to profile certain risks that we would consider to be the potentially most profitable. And we are in the process of continuing to enhance our products that are utilized and written through WritePro.

WriteBiz, of course, is the corresponding technology on the commercial side. We now have it live in nine states and are certainly pleased at this point with the usage. Although, we continue to aggressively promote it among our agencies. So that going forward, that we can enhance our growth of commercial lines that are written through that platform, which we believe enables us to not only be competitive but provide ease of doing business with a -- we think a lower expense cost, because of the automation.

In the areas of growth of premium, as reported at the time of the second quarter call, we talked about the fact that we were in the process of stepping up certain incentives that we make available to agencies, based upon profitable production, and more aggressive rollout of both WritePro and WriteBiz to which I have just referred. We have over the last quarter, I think, executed fairly effectively on a targeted approach to commercial lines pricing and not just some broad based reduction of premiums in order to deal with the competitive environment.

In the area of other growth initiatives, we have certainly begun to try to identify additional books of business, either similar to Shelby, or books of business that agencies may have interest in transferring to us. And we continue to be active in agency appointments with approximately 20 new agencies appointed in the third quarter throughout our distribution system in the states in which we do business.

With regard to the Shelby acquisition rights transaction, we have successfully completed that in the third quarter, as Jeff alluded to. We believe that it was quite successful, from several standpoints. It gave us an opportunity to have access to a bulk of business over a period of nine plus months. But also secondly, it enabled us to develop a new skill set in how to be able to aggressively and timely underwrite that quantity of policies. Keeping in mind that we underwrote each and every policy, and did not just roll the business. Our acceptance rate was in excess of 67% of the policies that we offered and we were quite pleased with those results.

With regard to going forward and I know there will be questions about pricing. We would probably be inclined to conclude that pricing circumstances are similar to what they would have been at the time of the second quarter conference call. That personal lines remains competitive but rational. In the commercial area, certainly larger accounts over $100,000, certainly are quite competitive. But that's not an arena that is our primary focus. The rest of commercial is competitive, however I think that we are, and have been addressing that satisfactorily. Because we are, as you know, always focused on underwriting profitability and rate adequacy.

And we are and have been working on strategies to make sure that we are competitive but at the same time, not discounting our premiums across the board. We think there's an intelligent way to compete and we are certainly committed to doing that. At this point, I will turn it back over to Jeff and we can begin the question and answer session.

If you would coordinate the question and answer session now please.

[OPERATOR INSTRUCTIONS] Your first question comes from the line of David Lewis with SunTrust Robinson Humphrey. Please proceed.

The first question is on the service fees and other income. They are only up, if my numbers are correct here, $200,000 or so in the quarter. It's been running pretty steady in the $1 million, $1.1 million range. What's happening there?

Well, part of the reason for the increase over the last number of years were the changes that we made to our fee structure, where we increased some installment charges and implemented a late fee. And we did some things to reduce the charges that some of our service providers charge us that get netted from those fees. And a lot of those initiatives have been baked in and we are seeing those things stabilize. So, we are not seeing the increase to the extent that we would have maybe a year ago. But those -- as our premium base has somewhat stabilized, so is our installment fee income.

So is the $200,000 or so an abnormally low number or is that kind of a run rate moving forward?

I would say that's probably typical of what we'll see going forward, in the absence any changes in our premium growth rates.

So that includes the other income. So 2004, full year, you had $3.7 million, in 2005, you had $4.1 million. So are we saying you have a run rate to $800,000? That's a pretty big change.

That's been what we are experiencing there. I don't expect that to change materially.

So just to clarify, we are going to go from $4.1 million in '05, to roughly $800,000 maybe or so in '07? Is that a better run rate for total --?

The increase would be --.

Not increase but total service fees and other income?

I'm not sure I'm following you David. Which numbers are you looking at on this?

I was just looking on our model, the way we break it out but it says -- we're showing total service fees and other income had been running $1.1 million. We may have a glitch here.

Yes, our -- because I'm looking at the nine months, even the three month numbers, our installment payment fees are $1.1 million, versus $1.132 million versus $1.066 million in the three months of --.

I'm sorry, we got a wrong number in here. I apologize.

Yes, they are trending upward somewhere in the neighborhood of 7%, 8% [plus] 10%.

Okay. All right.

As a matter of fact, David, over the years and currently, we have been pleased with the growth of our service fees.

Good. All right. Don, you want to talk a little bit about any pricing changes you see out there from a numbers standpoint? I know you said the personal lines is competitive. And then secondly, do you think the WritePro product is actually allowing you to add a greater number of agencies than you might have been able to otherwise?

Well, I -- first of all, with regard to try to respond to your question on pricing, I don't know that we can quantify it in terms of percentages but there's no question, the market has become more competitive. The cycle has certainly softened. But I -- that's one of the reasons we are certainly, particularly pleased that our profitability continues to be sustained.

From the standpoint of WritePro, we think that it's an excellent platform. We think that it's as good of a technology as very large carriers that we compete against. So we believe that we have a very excellent product and we are utilizing it in selling Donegal to new agency appointments. So, yes, we believe that it will help us in attracting an increase in our distribution system.

Okay. Just on -- Jeff, what was the commercial line net written premium growth, and were there any redundant reserve releases in the quarter?

Okay. On the commercial net premiums written, the commercial lines, the net premiums written were down in the third quarter, 1.4%. And if you recall, that same number at the end of the second quarter, I think the second quarter reduction was 6.4%. So, we're seeing improvement there, although it's still less than it would have been in the third quarter of '05. Certainly, the extent to which those premiums were dropping off earlier in the year has stabilized.

So -- and I think I mentioned the personal lines was up 6.5% for a 3.6 overall increase for the quarter. On the subject of reserve releases, we do not have any long tail releases that some of the larger carriers would talk about releasing reserves in the quarter. We do continue to see favorable loss development as we settle claims. And those trends would be very similar to last year and in line with what we talked about at the second quarter conference call, where we mentioned a 5% favorable development as a percentage of overall net reserves. So, that would be holding steady through the third quarter.

David, with regard to the commercial lines growth of premium or lack thereof, we are pleased with the trend from the second quarter to the third quarter. And we think that it underscores that some of the initiatives that we have taken to boost our commercial production have begun to get some traction.

Very good. Thank you.

Your next question comes from the line of Mike Grasher with Piper Jaffray. Please proceed.

A couple of questions. Jeff, housekeeping-wise, what is stat. capital at the end of the quarter?

Statutory capital, I will pull that out, Mike.

Okay. And I will go on to Don. What is the average tail now for your portfolio product?

The average tail of our portfolio product? Explain that question a little bit. What are you referring to?

Let me back up a step. With Shelby now fully in the mix, can you give us an update between personal and commercial lines in terms of your total mix of business?

The total mix of business. The total mix of business remains close to 60/40. It may be 61/39 but it's close in that.

Okay.

Which, of course, heavier on the personal lines side.

Okay. So with the change --?

It's not shifted things materially.

Great. Okay. And then with your commercial lines, what is your best guess in terms of your average tail?

Well, 3 to 5.

Okay. And with the commercial lines, your average premium size?

Well, our average premium size over a three to five year time span has increased significantly. Today, our average premium is probably somewhere in the $5,000 to $6,000 range.

Okay. Any change in the competitors that you see in your space, with sort of the change in pricing that we've witnessed over the last 18 months? Anyone new coming in or going away?

Well, let me first go back and clarify something on the premium side. We have a substantial number of small policies commercially, because that's been one of our areas of expertise.

Absolutely.

We do write a lot of larger policies but when you start averaging it all in, it comes down to that $5,000 to $6,000 range. But the -- which we think is certainly part of our success. But with regard to other product areas, as an example, the -- we're seeing a sort of a uniform growth and competitiveness within the various commercial lines of business. So that we're not seeing necessarily that there's more stringent competitiveness in some of the lines of business, it seems to be fairly uniform.

As far as new carriers are concerned, I think we reported on it at the last conference call. There are some of the large carriers that have affiliates that are coming into our space, and the carriers like Allied, which is an affiliate of Nationwide. They certainly would stand out as a name. But I don't know that we can say that there's a lot of entrants into the states in which we do business. I think it's a more a matter that some carriers that may be in the past were not as active and have gotten more active.

Mike, I have the statutory surplus number for you, for the group, it's around $294 million.

Okay. Thanks very much.

You're welcome.

Your next question comes from the line of Adam Klauber with CCW.

Good morning. Could you give us an idea of how robust you think your acquisition pipeline is? And then to the extent that you can, how comfortable do you feel that you will do more or less acquisitions in 2007 than you did in 2006?

Well, as we have always said, and it's been an accurate statement, we continue to talk to a broad range of people in the industry that we think may have some interest, either currently or in the future. And I would say that over the last six to nine months, we have spoken to more people than probably in the prior 18 months. And those have been conversations where it appeared to us that the other party may have some interest at the appropriate time. So, we think that the activity has increased.

Now we also recognize there have not been a significant number of M&A deals done in '06 and '05. At least the ones that we are aware of. What we -- what I think we all recognize is that with some of the capital assistance programs, whether they be surplus notes or whether they be trust preferreds, that have been actively marketed, that has tended to prop up some companies that otherwise may have been looking for affiliation. We also know with the cycle being as profitable as it was over the last three to four years, that companies generally -- most companies have done well. And therefore, they haven't felt as much of a need to look at alternative options.

As the cycle appears to be softening, we think that probably there will be an increased opportunities that present themselves and we are patient about it. As you know, we have always said that we don't just want to do acquisitions for the sake of doing them. They have to make good sense and they have got to be at a decent price. So, I would say that we're encouraged by the circumstances currently.

Good. That's good to hear. One follow-up question. If you haven't mentioned it, what were your frequency and severity in the auto line? And have you seen much change in the last three months compared to the first six -- half of this year? And do you see anything in the pipeline where you would see a change in frequency and severity in your auto line?

We have done some analysis of that, Adam, and at this point, we continue to see frequency declines in the auto, as far as auto liability line is concerned. I know we have read some things that other carriers saying they are starting to see some increases in frequency. We have not yet seen any of those trends in our book of business. We will continue to see some modest declines in the frequency rates.

Thank you very much.

[OPERATOR INSTRUCTIONS] Your next question comes from the line of Michael Phillips with Stifel Nicolaus.

Jeff, just real quick, you mentioned something and I just didn't catch your number. You said 10.1% for personal lines WritePro at the beginning. Can you say again what that was?

Sure, that was the direct premium growth in the states where WritePro is active, as well as the states where we were doing the Shelby transfer. So in the third quarter, in that select group of states, we would have seen a personal lines increase of 10.1% on a direct basis.

Okay. Thanks. Can you give us your overall combined ratio split for personal line versus commercial lines?

Yes, I can. These statutory, because with the segment data that we produce is on a statutory basis. But the statutory combined ration for commercial was 74.7% in the quarter and 95.1% for personal lines. So the personal lines, with the storm losses, we saw a little uptick there but certainly very profitable on the commercial lines.

Okay. Perfect. And speaking of the weather, you mentioned it was up $2 million over the last year, can you give us the total dollar amount for this quarter for that?

What we are tracking there, is we're tracking storm-related losses. And how we define that is any cause of loss code that would be caused by weather events. And the second -- in the third quarter, we would have been looking at about $5.6 million of storm losses and that would compare to the third quarter 2005, about $4.5 million.

Okay. Thanks. And then finally, Don, you mentioned, as you implement the WritePro, you are also doing some attendance filings for increased segmentation as you do the WritePro. And are you at the same time filing for decreases at the same time or are they coming into play right now or not?

Well, it varies, Mike, depending upon the states. What we try to do is whenever we are taking a look at our products, we try to do a thorough, competitive analysis. And as you know, base rates are different depending upon the ratings territory within a given state. So, what we try to do is to drill down and understand our profitability within rating territories. As an example, Pennsylvania we might have over 70 different rating territories and it will -- that will vary, of course, depending upon the size of the state.

So that in making these refinements and segmentations, we also do go take a look at the specific territory and make sure that our historic rate structure has been accurate, as it relates to how others in the industry are looking at it. So, there certainly would be some great base rate decreases by territory. But generally, we have tried to stay away from any across the board base rate reductions. We have more tended to do it within what we call XL tiers and XL factors based upon a combination of underwriting criteria. And try to target our discounts or our more competitive pricing on a very refined basis depending upon the application that's presented to us.

Okay. Thanks. That was helpful. That's all I have.

Mike, just a correction there. I gave you a bad number. $5.6 million for the storm losses in the third quarter of '06. $3.6 million for '05.

I was trying to get to that but I figured --.

Sorry about that. My math is bad.

Okay. Thanks, Jeff.

At this time, there are no further questions in queue. I would now like to turn the call over to Mr. Jeff Miller for closing remarks.

Well, we thank everyone for participating on the conference call, and for all the very good questions. And we wish everyone a good day. Thank you very much.

Thank you, everyone.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect and have a great day.