Donegal Group Inc (DGICB) 2006 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q4 2006 Donegal Group earnings conference call. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded for replay purposes. I would now like to turn the call over to Mr. Jeff Miller, Senior Vice President and Chief Financial Officer. Please proceed, sir.

Thank you, Francis. Good morning and thank you for participating in the Donegal Group earnings release conference call for the fourth quarter ended December 31, 2006.

I am 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 full-year financial results. I will then turn the call over to Don Nikolaus, President and Chief Executive Officer, for his comments on the quarterly and annual results and a discussion of overall business trends. Also present on today's call is Dan Wagner, Senior Vice President and Treasurer of the Company. Certain statements made in our earnings release and this conference call are forward-looking in nature and involve a number of risks and uncertainties. Please refer to our earnings release for more information about 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 effect of the four-for-three stock split of our Class A and Class B common stock that was effective on April 26, 2006.

We're pleased to report excellent underwriting results and record quarterly earnings for Donegal Group in the fourth quarter of 2006, which contributed to record earnings once again for the full year 2006. Our net income for the first quarter of 2006 was $11 million or $0.43 per share on a diluted basis, representing a 12.1% increase over the $9.9 million or $0.39 per share on a diluted basis that we posted for the fourth quarter of 2005. Total revenues for the fourth quarter of 2006 were $84.2 million, an increase of 3.1% over the total revenues of $81.7 million in the fourth quarter of 2005. Net premiums earned in the fourth quarter increased 2% to $76.2 million compared to $74.7 million in the fourth quarter of 2005. As noted in our conference calls throughout 2006, growth in net premiums earned from additional premium writing was partially offset by increased reinsurance costs that resulted from increases in reinsurance rates and the purchase of additional reinsurance coverage for 2006. During the fourth quarter we continue to achieve personal lines premium growth through increased usage of our WritePro automated underwriting and policy issuance system by our agents. WritePro is now in place in the vast majority of the states where we are actively writing business and we continue to be encouraged by the increased flow of business through WritePro. As we noted in the third-quarter conference call, the 2006 acquisition rights agreement with Shelby Insurance Company was completed in the third quarter. Therefore, we did not receive any premium growth as a result of that agreement in the fourth quarter of 2006.

On a direct basis in the fourth quarter of 2006, or personal lines writings increased 2.9% and commercial lines writings decreased 1.3%. However, in a number of states where WritePro is in widespread use, we're seeing increases of 10% and higher.

Our investment income grew to $5.9 million in the fourth quarter of 2006, an increase of 14.3% over the $5.2 million reported in the fourth quarter of 2005, primarily due to an increase in invested assets and improvements in the short-term interest rate environment throughout the past year.

Our fourth-quarter 2006 loss ratio was 54.9%, a significant improvement over the 60.4% loss ratio we reported in the fourth quarter of 2005. The improvement is attributable to a number of factors. Mild weather conditions and modest decreases in claims frequency contributed to lower levels of claim activity and provided an opportunity to reduce our inventory of open claims with an increased number of settlements contributing to favorable loss reserve development during the quarter.

Our expense ratio was 32.8% in the fourth quarter of 2006, comparable to the earlier quarterly periods of 2006 but an increase over the 28.4% reported for the fourth quarter of 2005 when we received the benefit of a reduction in guaranty funds assessments of approximately $2.0 million. Our combined ratio was 88.2% for the fourth quarter of 2006, representing the second lowest combined ratio we have ever reported for a quarterly period and improving upon the 89.4% posted in the fourth quarter of 2005.

Moving to the full year 2006 results, our net income for the year 2006 was a record $40.2 million, an increase of 8.8% over the net income of $36.9 million for 2005. We are pleased to report that 2006 represents the fifth straight year that we have achieved record earnings. Investment income for the full year 2006 increased 15.4% to $21.3 million compared to $18.5 million in 2005.

Earnings per share on a diluted basis for the full year 2006 were $1.57 per share on a diluted basis compared to $1.49 per share on a diluted basis for 2005. And our combined ratio for the year was 89%, outperforming the 89.5% that we posted in 2005. The excellent results and unrealized gains in our fixed maturities portfolio have increased our book value per share to $12.70 as of the end of the year and our return on average equity for 2006 was 13.4%.

At this point, I will turn to call over to our President, Don Nikolaus, for his comments on the quarterly and annual results. Don?

Thank you, Jeff, and good morning, everyone, and welcome to our earnings call. You of course have heard the good results that were announced by Jeff. We're pleased that we have had a historic quarter from the standpoint of earnings. And also for the year a combined ratio of 88.2 for the quarter. And approximately 89 for the entire year.

As we all know, financial results basically are the result of all the other activity that takes place within a company, whether it be in a given quarter or a given year. In 2006, the Donegal Group placed great emphasis on execution on our business strategy, with a lot of attention to detail and looking not only to produce good earnings and growth but to build our franchise going forward.

We're pleased to tell you that both WritePro and WriteBiz, which we have made reference to in prior calls, continue to experience very good traction. The usage by our agencies throughout the three regions in which we do business is continuing to escalate. Certainly, with importance, we continue to enhance it with adding new products such as recently we rolled out dwelling fire, which is a personal lines product that we have rolled out into WritePro. We anticipate within the forthcoming months of adding boat owners and personal umbrella to the WritePro system, as well as adding additional functionality because we have recognized that a significant part of our success in personal lines will come from our ability to deliver to our agents a very efficient, easy-to-use business friendly tool for them to write business. And it's our goal and I think that we have made excellent progress in that regard, to have the kind of technology and delivery system that is second to none, whether it be compared to other regional companies or very large national companies. We have continued over the year 2006 to continue to refine our predictive modeling within WritePro, as we try to target the most profitable risk as we also expand our total market interest in a broad cross range of applicants.

Certainly, on the commercial side, our WriteBiz similar technology -- we have rolled out in all of our states in which we write commercial lines. We are continuing to see increased usage of that system and we would hope in 2007 to build on that. One of the initiatives that we have been working on are book transfers within agencies from other franchises to our own. And we believe that we're making some headway there and gaining some traction.

One of the topics that I have spoken about at these various calls is the expansion of our agency distribution system. I'm pleased to tell you that all of our affiliates and subsidiaries in the fourth quarter appointed 24 new agencies, which brought the total for 2006 to 134. As I think we would all understand that in order to grow as a regional company, we need to be able to expand our distribution system, strengthen the existing distribution system and create a solid and growing of a premium base in all of our regions. And we certainly made some progress in that regard in 2006 with the 134 agency appointments.

As you know we have always in these calls spoken about our strategy for rate adequacy, underwriting discipline and also a goal to have a greater percentage of our agencies be actively providing new business to us. In that regard, we will be conducting over the next several months, probably about 2.5 months, over 28 agency meetings in 12 states. These are meetings where we would bring agency principles and their producers to meetings so that we might have in any one given city, we might have as much as 120 to 150 agency personnel in one of these meetings. And it's an opportunity to introduce what's new with the Donegal Group for the forthcoming year. They are basically sales meetings, basically trying to energize agencies to commit a greater percentage of their books of business to our Company. It's been part of our marketing tradition and it's been very helpful in the past and we will look forward to it going forward.

Certainly within the last quarter of '06, we continued to make additional commitments to technology in addition to WritePro and WriteBiz so that we would be staying on the cutting-edge of what can make us efficient, not only from the standpoint of doing business with agencies but, within our own operations.

We also have been placing a lot of emphasis on quality and timely claim service. We pride ourselves traditionally with having that kind of a reputation and we believe that there are results to be gained by continuing to improve on what is already a quality product because we recognize that not only attracting new business but retention of current policyholders depends upon how well we service them and deliver on the promise of paying claims for which insurers are taking out policies.

On the topic of acquisitions, Donegal Group itself has not entered into any acquisitions since the last earnings call. However, our affiliate, Donegal Mutual Insurance Company did announce that it was entering into an affiliation agreement with Sheboygan Falls Mutual Insurance Company in the state of Wisconsin. And the intended desire there is that the entire Donegal Insurance Group would have an entree into doing business in a new state. None of our companies currently do business in Wisconsin and we are looking forward to the potential of that opportunity.

We believe that we have a very well thought-through business strategy for 2007. And it would be our intention to continue to place emphasis on execution of that strategy in an effort to deliver the kind of results that we are pleased to be able to announce today. Jeff, we will turn it back to you.

Thank you, Don. Francis, if you would facilitate the question answer session at this time?

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

This is actually Eric Saxton calling for David. I have a few quick questions. To start off, can you provide us with your thoughts on increasingly competitive casualty environment and some of the pricing changes you noticed in the quarter?

Well as I -- I think, Eric, we all realized that there has been increasing softness in pricing and in casualty business. But we do not see any evidence of it intensifying?. Throughout all of all of '06, it has been a competitive environment. We would expect that to continue. But I don't know that we are seeing that there is any irrationality associated with it and we believe that we have been successful in effectively competing in that environment. And I guess I would want to emphasize that, yes, in personal lines auto there has been more competition -- from a pricing standpoint. But we think that our delivery system and our predictive modeling in WritePro has been able to effectively deal with that.

In commercial lines, there has been more competitiveness than in personal lines. But, one has to recognize that it's competitive in all areas of commercial but certainly in the larger accounts. And we certainly write what we call mid market accounts, which would be anywhere for us -- anywhere from about $30,000 to $40,000 up to $100,000 plus. But that is not a major part of our book of business. And we -- as I said, earlier, we are not necessarily seeing it intensifying any further than what we have seen throughout 2006.

What about your investment income and agent recruiting for '07? Can you provide any thoughts on that?

Well, I will handle the part about the development of the distribution system. We would anticipate being as aggressive in '07 as we were in '06 in terms of the appointment of additional agencies. And as I announced, we appointed 134 in all of our regions by all of our subsidiaries and affiliates and we would hope and expect to be able to achieve in excess of 100 appointments in '07 and hopefully maybe even exceed 134. The emphasis has to be on quality appointments that are going to produce business. You can always go out and appoint lots of agencies but you need to be careful that you are pointing them appointing them where it is going to do you good and also you don't want to overcrowd your distribution system in any given geographic area. So, the quality emphasis is important.

Eric, on the investment income side, our invested assets continued to increase throughout the year. We have a great deal of our portfolio or a larger portion of our portfolio in short-term investments due to the interest rate environment as it currently stands. We are looking for opportunities to purchase continued municipal bonds as we have in the last two years. As we find opportunities to find attractive after-tax yields we have purchased municipal bonds and we continue to look for those opportunities.

As far as what the investment income is going to do next year, we would hope that it would continue to increase and add a steady return to the bottom line.

And just one more data question and I will let others take questions. Any favorable development in 4Q '06? Favorable reserve development?

There was favorable reserve development in the quarter, as there was in every quarter throughout the year. However, the fourth quarter because we had an unusual number of settlements during the quarter, we reduced our inventory of open claims as I mentioned. And I would approximate that there is maybe $2.5 million pretax above the average development for the first three quarters of the year. So there was some additional reserve development in the fourth quarter.

Meyer Shields, Stifel Nicolaus.

Thanks, its Meyer Shields. If we apply a 35% tax rate to underwriting income and to capital gains, you have a little spike in the tax rate for investment income compared to earlier quarters. Is there anything driving that?

Well I'm looking at the after-tax yields and the tax related to those and I'm not seeing a spike there. There was not as much of an increase in tax-exempt interest income in the fourth quarter as maybe there was in the previous quarter so that maybe what's affecting your analysis. We have a greater percentage of short-term investment income than we would have in prior quarters.

Okay and that's not tax advantaged?

That's correct.

That's helpful. Thanks. Can you quantify at all the impact of last year's agency appointments on written premium in '06?

I don't believe that we can quantify that, keeping in mind that the -- anywhere between the first six plus months of an agency appointment is orientation -- them getting used to your systems, learning your products. And maybe for future quarterly reports we could give you some rundown on that. But we do not necessarily monitor that so much in the first six months to a year because there's a lot of effort being placed on getting it started and therefore we don't necessarily quantify it.

No, that's fair, that makes sense. One last question if I can. Don, you talked before about pursuing book rolls from your independent agents. Can you talk about the factors that are driving the agents away from some of your competitors towards Donegal?

Well, more than likely, they want to do business with Donegal but there are always in any agency distribution system that you have at a company, there are always opportunities as an example that and agent may want to get a certain critical amount of premium with a particular company; in this case, us. And in order to accomplish that, it might take us a longer period of time for it to be done with strictly new business. So they may look to remove a book of business. There are candidly -- there are in certain jurisdictions, some of our products are very favorably viewed. And one of the things that we have done is tried to distinguish -- at the moment I'm talking about personal lines -- trying to distinguish our products from our competitors by providing some enhanced coverages; by providing other features to it that are helpful to agents in terms of marketing our products. We also are providing co-op advertising in many of our regions and that has been helpful to co-brand not only ourselves but the agency. And we have tried to do a number of things that would hopefully distinguish us from many of the competitors that are out there. So, there's lots of factors that go into it. And it's something that we continually work at in terms of being able to attract agents to move books of business.

Jonathan [Glassy], Piper Jaffray.

Could you just speak in regards to the robustness of the pipeline compared with last quarter and just over the last 12 to 18 months?

Now you are talking about the pipeline of --?

Acquisitions.

Acquisitions. Well, we continue to have dialogue with various parties. And as you are I think probably aware, some of our dialogue is in conjunction with our mutual company into other mutual companies. Because a lot of our past acquisitions have started there. And, we think that there's a fair amount of potential going forward there. And as I've stated before, it all takes time. Companies on the other side of the discussions don't necessarily take action the first time you have a conversation with them. So, we would be encouraged that one of the positives, if you can say it that way, of a somewhat softening cycle and more competition, particularly for modest sized smaller companies, is that we believe there will be greater opportunities going forward and we continue to have that as part of our business strategy to go out and actively seek those kinds of dialogues that hopefully will lead us to affiliations. So, we are as active as we have been and we will want to continue to be.

Thank you. And some of these potential deals -- have you seen pricing decline over the last 12 to 18 months?

I can't say that I can say that pricing has declined.

Okay. And can you just give me an idea of pricing on average premium size -- or I'm sorry, pricing on premium size throughout the spectrum of your book? Like on larger accounts, are you seeing -- obviously probably seeing pricing decline? Are you seeing the same in smaller accounts?

Well I would say that where we see pricing particularly in commercial accounts declining, it's generally in the single digits and sometimes it's as low as 4% or 5%. Other times it can be 7%, 8%, 9% but I would not characterize across the board that it's any more dramatic than that.

And just for bookkeeping, do you have a statutory capital number for the quarter?

Yes, I do. The statutory capital was 299.9.

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

This is Eric Saxton again. Just a couple of data questions. Hopefully I didn't miss this before. Can you provide the combined ratio data for the personal lines and commercial lines as well as the net written premiums?

I can do that; certainly, Eric. The combined ratios for personal lines for the fourth quarter -- it was 93.7% on a statutory basis and commercial was 76.7%, again on a statutory basis. As far as net written premiums, for personal lines in the quarter, it was 45,017,000. And for commercial lines, 25,728,000.

[David Duesenbury], [Dulton Renier].

I'm not sure if I have this -- if I have remembered this correctly but, when you ruled out WritePro, you weren't able to put in your best pricing in there. I think you were going through approval process in each of the states or in some of the states. Can you just give me an update on that?

Yes, your memory is correct that we elected in many of the states to roll out the models that we currently had in effect at that point in time. And throughout '06, we have made numerous filings in various states in all of our personal lines products. And we probably have two or three states where we're still waiting for approvals and there's another two where we're in the process of finalizing the filing. But I would have to characterize that in the principal states in which we do business, those filings have been made, approved and are implemented at various times during the year, some of which would've been as late as fourth quarter

Okay, so we could see when you gave that kind of general 10% increase that you are seeing through WritePro related business, we could see that play out a little bit into the first part of '07.

We would certainly hope to see that, yes, David.

Adam Klauber, Cochran Caronia Waller.

Just to follow up on Dave's question, could you give us a picture overall of what the impact of auto rates and commercial rates were on premium growth in 2006? And overall, do you think the direction will be up or down in 2007 for those two major lines?

So your question is, what is the rate impact versus the number of new policies being issued?

Yes.

I don't know that we have that well quantified but I would say low single digits, somewhere, in terms of the pricing decreases that -- is that what you're saying?

Yes.

I would say in personal lines, it's somewhere in certainly in single digits -- I would say maybe high low single digits. And with regard to, on the commercial side, that may be a little bit more difficult to conclude. But I would say what I answered earlier that we have seen pricing effects in '06 of, depending upon the particular commercial product, anywhere from low single digits to mid-to upper single digits.

And Adam, another thing we've said in the past is that with these new systems we're able to really segment the risk characteristics of the business that we are writing. And so, although you may see some decreases in the overall rates, we believe that we are better able to segment those risks than get an appropriate rate for the risks that we're taking.

And as a follow-up to that, we've also many times said that there's more to being competitive than just price and that if you are selecting the right piece of business, many times you can be a little bit more price sensitive if you are getting the right business on the books. And of course, that's always the challenge.

Okay. And one follow-up, with rates coming down somewhat, do you think your accident year loss ratios will begin to move up in 2007 compared to 2006?

Well that's certainly possible that they will. Our actuaries are always doing projections of what they expect the loss ratios to be. Certainly price is one characteristic that affects the rates. The other is weather conditions, claims frequencies and severities. And we've continued to see decreases in the claims frequency as well as severity. So, we are hopeful that we can continue the very favorable underwriting results that we have posted in the last couple of years. But in a particular line of business, it would not be unexpected that the combined -- the accident year loss ratios would start to decline slightly.

Okay. And as far as the favorable frequency, are you seeing that on the commercial side as well as on the auto side?

It varies by line of business but on a general basis, we are seeing no increases in frequency. The frequency graphs that our actuaries prepare would show very flat to slight decreases throughout 2006.

There are no further questions at this time. I would like to turn the call back over to Mr. Jeff Miller for closing remarks.

Thank you and we want to thank everyone for their participation in the conference call and all the good questions that were asked and we appreciate your continued interest in Donegal and Group. Have a nice day.

Thank you, everybody.

Thanks for your participation in today's conference. This concludes the presentation and you may now disconnect. Good day.