Donegal Group Inc (DGICB) 2007 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second quarter 2007 Donegal Group earnings conference call. My name is Dan, and I will be your operator for today. At this time, all participants are in a listen-only mode. We will conduct 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 call over to Mr. Jeff Miller, Senior Vice President and Chief Financial Officer. Please proceed, sir.

Thank you, Dan. Good morning, everyone, and welcome to the Donegal Group earnings release conference call for the second quarter ended June 30, 2007. I am Jeff Miller, Senior Vice President and Chief Financial Officer, and I will begin the conference call with a presentation of financial highlights, and analysis of the quarterly financial results. I will then turn the call over to Don Nikolaus, President and Chief Executive Officer for his comments on the quarter, and his perspective on the business trends we are currently experiencing.

Certain statements made in our earnings release and in 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.

We are pleased to announce that our results for the second quarter of 2007 reflected a return to the levels of underwriting and operating profitability that we enjoyed in 2006. Contrasted with the first quarter of 2007, when harsh winter weather impacted our results, a return to normal weather patterns in the second quarter contributed to near-record quarterly earnings.

Our net income for the second quarter of 2007 was $10.8 million, or $0.43 per share of Class A common stock on a diluted basis, compared to $10.2 million, or $0.41 per share of Class A common stock on a diluted basis for the second quarter of 2006. Total revenues for the second quarter of 2007 were $84.6 million, an increase of 3.4% over the total revenues of $81.9 million in the second quarter of 2006.

Net premiums earned for the second quarter increased 3.3% to $77.6 million, compared to $75.1 million for the prior-year period. Our net premiums written increased 3.7% for the second quarter of 2007 compared to the year-earlier period, with personal lines writings increasing 5.8%, and commercial lines writings virtually unchanged from the second quarter of 2006.

Our investment income was $5.6 million for the second quarter of 2007, an increase of 10% over the $5.1 million reported for the second quarter of 2006, with the increase primarily due to improvements in the interest rate environment. Our continuing shift to tax exempt municipal bond holdings has somewhat slowed the growth of our pretax investment income, but continues to benefit our net results by lowering our effective tax rate.

Our second quarter 2007 loss ratio was a record quarterly low 52.3%, compared to the 54.3% loss ratio that we reported for the second quarter of 2006. As I mentioned earlier, favorable weather conditions in our regions during the quarter contributed to the low loss ratio. Also, our prior accident year reserve development trends for the first six months of 2007 are outpacing the favorable trends we experienced during 2006, primarily the result of our continuing efforts to settle open claims.

Our expense ratio was 35.4% for the second quarter of 2007, compared to the 33.5% reported for the second quarter of 2006, with the change attributable to increased underwriting-based incentive costs, due to the favorable underwriting results.

Because of the significant fluctuation in underwriting results in the first and second quarters of 2007, the year-to-date expense ratio of 33.8% represents a more meaningful measurement of our current expense level relative to our premium base, with the year-to-date expense ratio being slightly higher than the expense ratio of 32.7% for the comparable period in 2006. The slight increase in the year-to-date expense ratio reflects additional expenses related to the production of growth in our new business premium writings, such as increases in advertising, underwriting reports, and sales personnel costs.

Looking at our underwriting results as a whole, our combined ratio for the second quarter of 2007 matched the record quarterly low of 88% posted in the second quarter of 2006, directly reflecting the favorable claims experience, and in spite of the catch-up in incentive costs during the quarter.

Our net income for the first six months of 2007 was $16.3 million, compared to net income of $19.4 million in the first six months of 2006. Earnings per share on a diluted basis for the first six months of 2007 were $0.65 per share Class A common stock on a diluted basis, compared to $0.77 per share of Class A common stock on a diluted basis for the first six months of 2006, and our combined ratio for the six months of 2007 was 93.2%, compared to 89.2% in the year-earlier period.

Our book value per share increased to $13.17 as a result of the favorable results during the quarter. We are pleased to announce that yesterday our Board of Directors declared dividends of $0.09 per share of our Class A common stock, and $0.0775 per share of our Class B common stock, payable August 15th to stockholders of record as of the close of business on August 1.

You will note that we presented our earnings per share data separately for Class A and Class B common stock in the earnings release table. Based upon our review of recent guidance concerning technical accounting pronouncements related to two-class common stock capital structures, we have determined that our EPS data should be reported using the two-class method, which is described in our earnings release. As we work through the calculations we filed with the EPS computed separately for Class A is comparable to the single EPS amounts we previously reported.

Should you desire to do so for comparability purposes, you can compute a single EPS amount, by dividing net income by the sum of the Class A weighted number of diluted shares outstanding and the Class B shares outstanding, as provided in the earnings release table. Our second quarter 10-Q will provide further details related to the two-class presentation method, including the various components of the EPS calculation.

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

Thank you, Jeff. Good morning, everyone. Thank you for joining us for our second quarter earnings call. Needless to say, we are quite pleased with the very favorable results. We did not, certainly, on the counterside, we did not certainly like the results that we announced for the first quarter, and we are pleased to see that our earnings have returned to what we have historically over the last several years been reporting.

A couple of the statistics that Jeff has announced, I would like to highlight because it ties into the environment that we see, and the successes that we are having within that environment. One of the statistics is that our personal lines growth was in excess of 5%, 5.8%, which we find very favorable, and I will talk a little bit about it in a moment. It is tied in directly to the successful rollout of our WritePro automation.

Another statistic, our investment income growing by 10%, the book value growing 11.2%, to $13.17 per share. Also, during the second quarter we appointed in our various regions, we appointed 60 new agencies, and that compares favorably to the 57 that we announced for the first quarter, and candidly the 60 is higher than we would have budgeted.

We are certainly pleased by that, because those of you who participated in the first quarter call, remember us saying, that we tried to get agency appointments as early in the year as possible, so that the orientation period, and getting the ramping up of activity can get an earlier start in the year. So we are certainly pleased by the 60 agency appointments during the quarter.

With regard to the whole issue of building our distribution system, we have added some additional resources to that initiative, including naming a new Vice President of Sales and Distribution, who will have as part of his responsibilities, focusing on the coordination of the building of our distribution system, in the various regions in which we do business. I know that you are all interested in hearing comments with regard to the competitive environment.

Our view of it is that it has remained very competitive, as has been discussed in prior quarters. We do not feel that it has necessarily intensified, but it is certainly a very keen competition out there, and I think that we have reasonably been successful in competing, and also being profitable in that level of competitive environment.

We also like to report on our WritePro and WriteBiz activity. If you may remember in the first quarter, we reported that for the first quarter over the fourth quarter of the prior year, that our quote activity in both WritePro and WriteBiz were up by substantial percentages. The quotation at that point was, that our WritePro quotes were up by 24% over the fourth quarter, and WriteBiz was up over 35% over the fourth quarter of '06.

But I am pleased to tell you, is that those same levels of quote activity have continued in the second quarter. Now what I mean by that is that they have not declined, and we are pleased that that significant increase over the end of 2006, that that level of quote activity has been able to be sustained. That from our view is important, because it was not just some flash in the pan.

Other strategies and competitive issues that we have been working on, we continue to work on enhancing our WritePro and WriteBiz technology. We are aggressively rolling out change processing, which means that agencies are able to, through our automated system without human intervention, upload and process endorsements to policies, which they incur thousands of them in a week and a month's time, and we are in the process, not completed, but we are in the process of rolling that technology out to various states.

We have also in the first six months, and certainly in the second quarter, worked on further enhancements to our commercial and personal lines products, so that they are distinguished from simply commodity products that may be offered in the industry. We have also been very active in branding our company through co-op advertising in conjunction with our agencies.

We have worked hard towards maintaining a disciplined underwriting process, because we recognize in a competitive environment, it is very easy to let down the guard for the sake of just writing business. But we recognize that profitability is the most important issue, but at the same time, we recognize that we all need to see good growth. We also continue to refine our predictive models, which is the manner in which subject to appropriate regulatory requirements, that we are able to refine the pricing of products on an ongoing basis, as is appropriate in terms of our underwriting appetite.

On the topic of acquisitions, although it is not a Donegal Group announcement, you may have seen that we announced in early June, that Donegal Mutual, our affiliate, did close on the contribution note agreement with Sheboygan Falls Mutual Insurance Company, and that company is now affiliated with our Mutual, and over time and in accordance with various regulatory approvals, we would at some point in the future hope to move forward to the next hopefully potentially demutualization, and we continue to look for similar opportunities to expand our distribution system, and our operations, into states that we believe will be providing a profitable and good regulatory climate.

At this time I will turn it back to Jeff, and we will open it up for questions.

Thank you, Dan. If we could begin the question-and-answer session now?

(OPERATOR INSTRUCTIONS) Your first question comes from the line of David Lewis from Raymond James. Please proceed, sir.

Good morning and thank you. A couple questions.

Hi, David.

First to clarify. Don, the WritePro and WriteBiz activity, does that mean it's flat with the robust levels you saw in quote activity in the first quarter of '07?

That is correct, but I would want to underscore that the fact that we have been able to maintain that significantly increased level of quote activity, we believe is very meaningful, because what can happen, as you roll out into different states, agents sometimes will try it and if they like it, then they stay with it. If they don't, then they fade off and maybe quote only occasionally. So we were encouraged to see that significant increase in quote activity was maintained. So it is basically flat, but that is not a negative. I view that as a positive.

I was just trying to clarify. Can you tell us with percentage of the markets have been rolled out for both WritePro and WriteBiz?

95% of our markets are live with WritePro, and about 75% for WriteBiz. We still have to roll out WriteBiz in the states of Iowa, Nebraska, and South Dakota.

Okay. Can you talk a little bit more about just some of the pricing trends in some of the individual lines, maybe a little workers' comp, small commercial, personal lines, just a little more detail there.

Sure.

Secondly, the competitive pressures still primarily on the regional side, or some of the nationals trying to come down into the smaller markets?

Well, let's start with the first, they are good questions. From the standpoint of individual product lines, as you see from other announcements from other companies, Progressive and All-State, companies of that large size, certainly private passenger automobile, has nationally become more competitive. And we are certainly experiencing and have experienced that. I think what we are seeing, is that it's not anymore competitive in the second quarter than it would have been in the fourth of '06, or the first quarter of '07.

With regard to homeowners, it is not as intense competition in that line of business, for all the reasons that I think everybody knows. On the commercial side, workers' comp is competitive, but it is not intensifying any more than it has been.

Clearly, larger accounts, the larger the account, whether it's in workers' comp or whether it is in packaged business or commercial auto, it is clearly much keener competition, because we don't play as much in the above-100,000 accounts. We are probably not seeing maybe as much intensity of competition as maybe those players are seeing.

In our space, yes, the Travelers and the Hartfords and all the nationals have come down into our space, but that is not new news. That would go back two, three years, and I think that we are effectively competing with them, since they have entered into our space.

With regard to going forward, it is all certainly going to be interesting to see whether the market's competitiveness does intensify or not. I think we have a strategy in place that hopefully will serve us well, and that we will be able to deal with it.

That is very helpful. I will come back with other questions. Thank you.

Okay.

Your next question comes from the line of Mr. Scott [Laure]. He is a private investor. Please proceed, sir.

Good morning, Scott.

Hey, Don. With our quote activity up 24% on the WritePro, and 35% on the WriteBiz, what percent are becoming Donegal policy holders?

Well, those are what we call hit ratios, and I will answer that generally, because that is somewhat proprietary from a competitive standpoint, because all kinds of people will listen to this call.

Sure.

Including our competitors. Generally, if you have a hit ratio of between 20 and 30% of the quotes that you are giving, you are generally pretty pleased about that. And if it is above 30, you are more than pleased. In some states, we are pleased, and in other states we are more than pleased.

Certainly, you understand we need to put this data into our model and that is the reason for the question. How many total commercial policies do you have in force, and also personal lines?

Well, we have that information available.

Where at. I can't find it?

Well, we have it available, we just haven't announced it because some of that we consider to be somewhat proprietary.

All right.

Needless to say, we have a substantial number.

All right. In March you announced a 500,000 share repurchase buyback program. How many shares did you repurchase this quarter?

We are reaching for that, but I think it is something like 135,000 shares.

This quarter?

Well, since the point that it was announced.

All right. Do you know the --

The bulk of that would have been in this quarter.

Do you know the average cost?

Well, you know how the, $15.40 something. $15 and 40-some cents, I believe.

It was a good rebound. I will get back in queue.

Okay.

Your next question comes from the line of Meyer Shields with Stifel Nicolaus.

Good morning, everybody.

Good morning.

In general, would you characterize the growth that you are seeing as deeper penetration in existing agents, or coming more proportionally from the newer agency you are appointing?

I think that it is a combination. Certainly, one of the reasons that we are making agency appointments is to broaden the scope of our distribution system, in many of the states in which we certainly could be well served by an increase of our distribution system.

But it is also with existing agencies, and that of course is important to us, because we want to increase in a good cross-section of agencies, the percentage of business that they have to offer so that we are developing, trying to develop stronger relationships with existing agencies, while at the same time bringing new ones on. So I think that it is two-fold.

Similar question I guess. Do you have any sense as to whether your growth is coming from policy holders that were formally with regional carriers, or with the national guys?

We have some statistics in the personal lines arena, and it is a cross-section that we are getting policies from the State Farms of the worlds, from All-State, Travelers, we are also getting them from regional companies. Which, of course, we think is important because it would demonstrate that we can effectively compete against not just regional carriers, but also against national carriers.

Okay. Is there any ballpark data, or numbers you can throw around that?

I don't have it in front of me, but I did see an internal report about a week ago, and that is what I am quoting from from memory, so I don't know that I would want to give the specific statistics, but I know that the listing of [some], was called prior carrier's report, and I was pleased that there was a good cross-section of both national, as well as regional companies on the report.

Okay. Just curious for a little bit, if you are seeing a 35% increase in quote activity from WriteBiz, and a hit ratio somewhere north of 20%, how does that translate into flat premium volumes year-over-year?

Well, first of all, we don't have flat premium volumes.

On the commercial side.

Oh, on the commercial side. Well, I think that is where the competitive nature of the business comes in, that if you look at many of the other announcements by other carriers, you will see that increase in new business is one element.

The other is the retention rates on commercial, because everybody is trying to get the other guy's renewal. So we are certainly not immune from all of that, but it is what it is, but I think that relative to other reports that I have seen, I think that our ability to effectively compete in this marketplace has been pretty good.

Okay, that is helpful. I am going to jump back in the queue. Thank you.

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

Good morning, gentleman. One follow-up question on the competitive environment, just in terms of your new business production. What do you attribute the wins to? Is it terms and conditions, pricing, is it all WritePro and WriteBiz? Can you comment on that?

Well, I would like to think that some of it is some effective execution on our strategy, that it is WriteBiz, it is WritePro, it is having production underwriters out in the field, calling on agencies in their office. I think it is very fast follow-up on quotations on the commercial side, there is still a role to be played with service. I think the slickness of the technology has been helpful, so I think it is a combination of things.

Also, on the product side, what we have tried to do is, and this is not new, this goes back a year, 18 months, we have tried to distinguish some of our products by putting on some additional coverages that are not necessarily going to break the bank, in terms of the loss side, but are nice-to-have type of coverages. You see on television where All-State advertises their first accident forgiveness, but my understanding of their product is that for most policies, there is a charge for it.

And the way we do it is, we do it depending upon whether you get into our preferred or superior tiers. And if you do, and you have a very good prior accident record, you don't pay an extra premium for it. It is part of the enhancements to our policy. That is an example of some of the things that we have tried to do, and in our marketing meetings that we had 29 of them throughout 12 states this spring, we tried to drill home to agents that they have to sell more than just price.

They have got to sell the product, that there is more to the product than just price, and that if we as a company present a product that has various enhancements, that they ought to consider, they ought to make sure that they are presenting that to their insurers. My answer to you is that it is a combination, but certainly we have structured our predictive model, so that we are competitive on the business we want to write, and we are not as competitive on the business that we are not anxious to write. So price is certainly a significant factor.

Okay, fair enough. Then you did speak, you started to talk about acquisitions a bit there, with the Sheboygan Falls. Maybe update us in terms of the current environment, the properties you are looking at right now?

Well, I can only say to you that we are receiving more phone calls, and talking to more people, than we would have had the opportunity to do a year ago. I am encouraged by that change, and if we all would understand that when the market gets more competitive, that companies may be more inclined to at least consider that alternative.

Also, a lot of smaller companies, it is not necessarily capital or profitability, it is whether they have a technology platform, and that has become a significant competitive advantage or disadvantage, and we are finding that that issue has opened up some opportunities for conversation.

So my answer to you is that we are seeing more opportunities to have discussions with people. But how long it takes to have that become reality, and when it does, all that is unpredictable. But I think the opportunities are better.

It so sounds like more opportunities than ever before. Would that be on the commercial lines or personal, or equally on both?

I would say it is equally on both. It generally depends upon what that particular company is in, but generally we are never talking to anybody that is in different businesses than we are. We are either talking to somebody who is in the personal lines business, or they are in small commercial, or they are in small commercial and personal lines. So we are looking for a fit with what we do, and how we go about it.

Okay, fair enough. Just a couple of other questions here. Jeff, can you provide us with reserve development in the quarter?

Reserve developments in the quarter, as I mentioned in my comments, were slightly better than what we would have experienced in the second quarter of 2006. Approximately, maybe about a $2 million increase is a rough number in the favorable development that we experienced in the second quarter of '07.

The trends look good, they look good across all of the accident years, and across all lines of business. So as we compare the trends from last year to this year, we are encouraged that the development we would have experienced in 2006, which was quite favorable, continues in 2007, and it is actually quite a bit better.

Just to clarify, it was $2 million in the quarter, in terms of favorable development?

Additional favorable development compared to 2006. As far as the bulk number in the second quarter, it is in the $5 million range.

And I would hasten to remind folks on the call that we are not talking about bulk takedowns of INBR, or bulk takedown of reserves. We are talking about favorable reserve development from the normal settlement and closing of cases and claims.

Okay, fair enough. Just what was the impact, if any, in the quarter on your losses or in loss rated, sorry-- On losses with regard to the nor'easter storms that occurred earlier in the spring? Was there anything at all?

We did have some impact from that, especially toward the further eastern part of our operating regions, and the storm loss activity that we incurred during the quarter was very similar to what we incurred in the second quarter of '06, that is why I didn't comment on it. There was no real change from what we had in the second quarter from a storm standpoint.

So although we did have some storm activity earlier in the quarter, and even in the beginning of June, we had some storms out in the Midwest, the level of activity and claims that we incurred from those storms was fairly minor, and comparable to what we would normally see in the second quarter.

Okay. Thank you.

Your next question comes from the line of Mr. David Lewis from Raymond James. Please proceed, sir.

Thank you. Don or Jeff, can you talk a little bit about frequency and severity trends, breaking that down broadly between commercial and personal? Also, do the same on retention rates.

Sure, David. I would be glad to do that. Our actuaries have put together some information for us on frequency and severity, and I would say across the board, we are seeing frequency staying very constant to what it has been the last couple of years, with some slight decreases in some areas, such as bodily injury claims on personal auto, actually the frequency has decreased somewhat.

On the severity side, we are seeing some modest increases on some of the lines. Other lines we are seeing that they are basically flat. Personal auto liability, bodily injury again the severity is pretty much comparable to where it would have been in 2006. That is pretty much the case across the board, even in commercial policies, we are seeing as frequency continues to be flat or decreasing slightly. In certain situations, certain lines of business, the severity is increasing slightly.

On the retention rates, we are seeing rates in personal lines in the high 80s, 88, 89%, and on the commercial lines, the high 70s to low 80s, depending on the region that we are talking about. Those are, on the personal line side, pretty comparable to what we have experienced in the past. Commercial is slightly less than what we would have experienced in the past.

And on the commercial side, is that just a couple points down or, do you have some magnitude?

Yes, just a couple points. When we are talking about high 70s to low 80s in the past, we would have been [inaudible] in the low 80s. So it is down a few points.

Lastly, any material weather issues in July that are worth noting?

None that we are aware of.

Great. Thanks very much.

You are welcome.

Your next question comes from the line of Mr. Meyer Shields from Stifel Nicolaus. Please proceed, sir.

Thanks. Just a really quick question, if I can. Reinsurance recoverables on unpaid losses?

Sure. It is around $91 million, I think it is rounded to $91 million.

Okay. Can you just remind me of the commission structure you have in place?

Well, the commission structure is a combination. There is the standard commission that we pay for each product line. Of course, it varies by product line. We have not changed our standard commission schedule for probably three years. We have contingent commissions that are paid. Of course, as you know, we believe in the independent agency system, they are regulatory and statutorily approved in the states in which we do business.

So there is a combination of a regular commission, a contingent commission, and we might from time to time, run some incentives based upon certain products, a certain amount of production that an agent in a quarter would get some additional levels of commission or so many dollars per policy, if they wrote so many policies in a quarter. Those are sort of specials that we might run from year-to-year in a particular period of time.

Okay.

Have I answered your question?

Yes. I was basically looking to see if you had changed the commission levels, but that was a helpful answer.

No.

Jeff, really quickly, did your comments on frequency and severity also hold for the property lines of business that you write?

Yes.

Okay. Thank you.

Your next question comes from the line of Mr. Mike Grasher from Piper Jaffray. Please proceed, sir.

Thanks. Just a couple more here. Jeff, on stat surplus, do you have that number available?

I do. It is 316.8 million.

Okay. Can you give us some information regarding your investment portfolio in terms of your exposure on mortgage-backed securities?

Yes. Thank you for that question. Of course, the subprime issue has gotten a lot of attention. We have no exposure whatsoever to subprime securities.

All of our mortgage-backed securities are very highly rated, and they are standard agency-typed mortgage-backed securities. So no exposure at all to the subprime.

Okay. There seems to be a lot of concern, just whether it is subprime or not, the vintage of the issue itself, in terms of 2005 and 2006 originations. Any exposure there?

No. We do not. Most of our mortgage-backed securities have been in our portfolio for many years.

Okay. Thank you very much.

You are welcome.

(OPERATOR INSTRUCTIONS) At this time, there are no further questions in the queue.

Okay. We certainly thank everyone for all of the good questions and participation, and thank you for joining the call.

Thank you, everybody.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day!