Donegal Group Inc (DGICB) 2009 Q1 法說會逐字稿

Good morning. I will be your conference operator today. At this time I would like to welcome everyone to the first quarter, 2009 Donegal Group earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. (Operator Instructions). Thank you. I would now like to turn the call over to Mr. Jeff Miller, Chief Financial Officer. Sir, you may begin your call.

Good morning, everyone, and welcome to the Donegal Group earnings release conference call for the first quarter ended March 31st, 2009. I'm Jeff Miller, Chief Financial Officer and I will begin the conference call by discussing financial highlights and providing commentary on the quarterly results. Don Nikolaus, President and Chief Executive Officer will then provide his comments on the quarter, and discuss current business trends.

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. Further information on risk factors that could cause actual results to differ materially from those projected in the forward-looking statements, is available in the report on form 10-K that we submitted to the SEC. You can find a copy of our form 10-K on the investors portion of our website under the SEC filings link.

We encountered a number of challenges during the first quarter of 2009 that contributed to disappointing underwriting results. Increased claim activity from severe winter weather events and an unusually large number of fires throughout our operating regions led to a much higher loss ratio than we've historically experienced. On the positive side, we recognize no other than temporary impairments during the first quarter and the market values of our available for sale fixed income investments improved significantly contributing to an increase in our book value.

As our release this morning indicated. Our net income for the first quarter of 2009 was $169,804 or $0.01 cent per share of our class A common stock. Compared to $6.6 million or $0.26 per share of our class A common stock for the first quarter of 2008. Our total revenues for the first quarter of 2009 increased 6.3% to $95.5 million. With net premiums earned increasing 7.7% to $88.3 million. Largely due to the pooling change of March first of last year, and the acquisition of Sheboygan Falls Insurance Company in December.

It is somewhat difficult to make a true comparison of the net premiums written between the first quarter of 2009 and the year earlier quarter because of the pooling change that was effective March 1st, 2008. I'll list the number of components that contributed to the 11.7% decrease in net writings and I'll be glad to answer specific questions during the Q&A session if further clarification is needed. Comparing the two quarterly periods, there was a 13.7% reduction related to the one time unearned premium transfer in the first quarter of 2008. There was also a 4.6% increase related to the increased pooling allocation because of all three months of 2009 were at 80% versus only one month in the first quarter of 2008 at 80%. And finally we had a 2.6% decline in writings exclusive of the pooling change. The 2.6% decrease in organic writings was split between personal lines net premiums written, which increased 5.92% and commercial lines and net premiums written which decreased 11.1%.

So as you can see, there are a number of moving parts impacting the change in writings between the quarters. Our release mentioned our 2009 reinsurance program renewal which did not have a material impact on our change in writings. We expect our reinsurance costs to be relatively consistent with those of 2008 as a result of modest rate increases within several of our contracts, with those increases offset by savings realized by increasing our per loss retention from $600,000 to $750,000 effective January 1st, 2009.

I'm going to pause for a moment. I've been advised there's a problem with the web cast. And so I'll just pause for a moment and ask that Rodney, if you can check on that, and make sure that the web cast is functioning properly. Rodney, are you there?

Yes, sir. One moment.

Thank you. Hearing no update on that, I think we'll continue and if there is a problem with the web cast, they can hear the replay and hopefully those technical difficulties will be revolved.

Moving on to our investment income for the first quarter of 2009 was $5.4 million, a slight decrease from the $5.7 million reported for the first quarter much 2008, but virtually unchanged from the investment income reported for the fourth quarter of 2008. In the past several quarterly conference calls I've mentioned a number of factors that continue to impact our investment income. First, we've been fairly conservative with the proceeds from calls and maturities of higher yielding securities, holding increase levels of short term funds primarily in US Treasury securities where there's a high level of safety, but low investment yields.

Secondly we liquidated our preferred stock holdings during 2008, resulting in reductions in dividend income. And finally we paid off $15.5 million of trust deferred subordinated debentures in August of 2008 with the related decrease in investment income more than off set by the interest expense savings. We put some money to work late in the first quarter to improve our overall investment yield as indicated by the lower amount of short term investments on our quarter end balance sheet.

Shifting to the underwriting results, I mentioned the disappointing increase in our loss ratio to 74.7% compared to 65.6% for the first quarter of 2008. We incurred an unusually large number of fire losses in the first quarter of 2009. To give you a sense of the impact. We identified 45 fires that resulted in damages in excess of $50,000, collectively totaling nearly $7 million. In addition to the fire losses, we incurred claims from a number of severe weather events during the quarter. High winds and hail in the Midwest contributed to nearly triple the amount of first quarter losses incurred by our Le Mars subsidiary compared to the year earlier quarter.

High winds also swept across the Mid-Atlantic region in February, and a hail storm hit our local area of York and Lancaster counties just before the end of the quarter. When you also include the claims from a number of less severe storm events, our weather related losses for the quarter exceeded $7 million or approximately double the amount incurred in the first quarter of 2008.

Our expense ratio was 31% for the first quarter of 2009 compared to 31.9% reported for the first quarter of 2008 with the decrease largely attributable to lower underwriting based incentive costs, due to the higher claim activity. The accrual related to the contested premium tax issue that we discussed in our pre-announcement added approximately $381,000 to other underwriting expenses and approximately $974,000 to interest expense for the first quarter of 2009, explaining the unusual increase to the interest expense line item for the quarter. Summing up the parts, our combined ratio for the first quarter of 2009 was 105.9%, compared to the 97.8% posted in the first quarter of 2008.

As I mentioned at the beginning of my presentation, our book value increased as a result of unrealized gains in our bond portfolio, coming in at $14.47 per share as of March 31st, 2009. Comparing favorably to the $14.29 per share at December 31st, 2008 and $14.01 per share as of March 31st, 2008. Our pre FAS115 book value per share as of March 31st, 2009 was $14.23 compared to $13.88 one year earlier.

Last week our Board of Directors declared dividends of 11.25 cents per share of our class A common stock, and $0.10 per share of our class B common stock payable May 15th to stockholders of record as of the close of business on May 1st. These dividends represent increases in the 7% to 8% range. And speak to the confidence that we have in our ability to return more favorable results for the remainder of the year.

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

Thank you, Jeff. And good morning to everyone, thank you for joining our earnings conference call.

Needless to say, the earnings that we have announced this morning and did a pre-announcement on the 15th that they're certainly totally unacceptable to us. They're inconsistent with our traditional very good combined ratios and loss ratios. And we did clearly, as Jeff has spelled out, had considerable amount of weather claims and some very severe weather incidences. The reference that Jeff made to a hail storm in central Pennsylvania which is right where we are located, in my lifetime, I have not seen hail in this area to the extent that we had on that particular occasion. And also, there is -- as Jeff has indicated, there were a considerable number of fires.

The important item that I would like to cover is that we do not believe that there has been any shift or change in the quality of our book of business. We are certainly not able to determine whether some of the fires relate to the economic circumstances in the country. We have no clear indications of that. Needless to say, whenever we see a spike up in claims, even when they are weather related, it causes us to take a harder look at our book of business. We continue then to refocus to make sure that our underwriting is exactly where we want it to be. And we certainly are prepared to take all the necessary steps, although we do believe that the quarter is an aberration.

We are certainly pleased that again we are able to be announcing an increase in book value. And as you may remember at the end of 2008 we were able to announce an increase in book value, which was not certainly the norm in property casualty insurance companies in the United States. From the standpoint of underwriting integrity and rate adequacy, a continuation of what we would have said at the earnings call for the end of the year, that we have continued to make rate filings for personal lines rate increases in homeowners and auto. And we have now effected that in almost all of the states in which we do business, although some of the actual effective dates are in May and June. We have 90% of the filings we have made have been approved. And we are in the process or have already implemented them for the respective effective dates.

From the standpoint of our distribution system, we have appointed 44 new agencies during the first quarter, which is consistent with our goal for the year. We have rolled out WritePro in the state of Wisconsin as part of our Sheboygan Falls Insurance Company acquisition. And we are making great progress in converting them to our IT platform and systems. And we would look to be being aggressive in appointing new agencies in the Wisconsin state going throughout the rest of this year.

From the standpoint of competitiveness, which is always a topic that everyone is interested in hearing input on, personal lines clearly is firming in rates. Just as we have filed a significant number of rate filings, we can say to you that most of the major competitors have done the same, which indicates that there is an overall firming of rates in personal lines. On the commercial line side, continues to be quite competitive. There's no question about that, which is evidenced by the fact that we have a decline in net premiums written in commercial lines.

However, there is a -- there's certainly a point at which in any application or renewal where we are not prepared to sacrifice profitability, future profitability for premium. We have endeavored to try to have a fine line where we're not crossing over, where we're being reasonably competitive, but not doing things that are foolish and we believe that that's the correct approach. Going-forward, although we are certainly aggressive in trying to obtain new business and retaining our renewals, we are simply saying that we will not do anything just to write the piece of business.

We have recently, as of yesterday, completed doing 24 group agency meetings in ten states which started in mid January. And we completed it yesterday in South Dakota. And those meetings would be meetings with groups of agencies of anywhere between 40 agencies and 120 to 150 depending upon the particular location. It's a part of our major spring initiatives to get out and meet agents, tell our story, and basically ask for business. I can report to you that we have been very pleased with those meetings in almost all locations, very well attended. Very good interest in our companies and our products, and we believe that it will be helpful to us going-forward.

On the standpoint of business retention, we have taken a look at some initiatives to make sure that our retention levels stay where they are or hopefully improve. And we have initiated some claims, survey processes. I'm happy to report that 97% of those responding to our claims surveys are saying that they are very satisfied, and satisfied with our levels of claims service. And there's a significant connection between claims service and policy retention. We have also expanded our call center and making sure that we have as strong of a service level as part of trying to respond to whatever inquiries agencies and policyholders may have. So going-forward, we would hope to continue to have additional initiatives to work on policy retention and premium retention.

I can assure you that Donegal management and its personnel are working very aggressively to return to normal growth and the levels of profitability that we have historically reported. I can also tell you that we have an enhanced increasing outreach activity program to potential acquisition candidates, including visiting of companies that have expressed an interest. And although we do not have anything specific to report, that is certainly a part of our business agenda for the year 2009 as it has been in the past.

At this point I will turn it back to Jeff. And we'll move on to questions.

Thank you, Don. Rodney if you would open the line for questions, please.

(Operator Instructions). Your first question comes from the line of Joseph DeMarino with Piper Jaffray.

Good afternoon. Thank you. I'm wondering if you can help me understand the top line change a little bit better? I know you commented on it, could you just explain again the two percentage numbers you quoted, I think we're 13.7 and 4.7 related to the pooling?

Certainly, be glad to do that. As you recall, the first quarter of 2008 there was under premium transfer that was related to the pooling change. And that would have increased the net premiums written in the first quarter of 2008.

By 13.2 million?

Right. And so I think it was $13.6 million. ANd if you pull that out when you look at the difference in the writings between the first quarter of 2008 versus the first quarter of 2009 that represented a 13.7% reduction. The $4.6 million -- 4.6% increase relates to the additional allocation from the pooling agreement that Atlantic States received in the first quarter of 2009. And that would be related to the fact that there were three months at the new pooling percentage in the 2009 quarter versus only one month in the 2008 quarter.

And what is that dollar amount?

$4.6 million. Coincidentally the same as the percentage.

All right. Thanks.

Okay.

And then how about on the reinsurance? Have you -- do you guys have any type of aggregate reinsurance that you've looked at as opposed to just the per loss occurrence?

We do not have any aggregate reassurance in place, we did look at that a number of years ago, and found it not to be price effective. So that is not any -- no part of our reinsurance program includes an aggregate.

All right. And on the investment portfolio, I guess you're fixed assets increased in value, but what is the overall unrealized loss position on your fixed income securities?

We actually are in an unrealized gain position.

We don't believe in unrealized losses.

The balance sheet shows accumulated other comprehensive income of $6 million, which is an after tax number. And a substantial portion of that is related to the fixed income securities and I'm pulling up the number here, on a pretax basis it's $3.6 million unrealized gain.

Okay. I guess, what percent of your fixed income securities are in an unrealized loss position?

It is a -- there is a minor percentage of it, I don't think I have that at my fingertips. Certainly, that's in the 10Q. There's a disclosure to that effect. But it is a small portion of our overall portfolio.

Okay. And then I guess on pricing. On the commercial side, how much of an impact is the economy having versus just the overall competitiveness within commercial?

Well, the answer to that is, we -- I don't know that we can quantify it mathematically for you, but we can say this to you. That -- which I'm sure you're hearing from other carriers, that whether it be a new application or a renewal, where it's based upon payroll such as worker's comp, or whether it's based upon sales, that for liability coverages there certainly are fewer positive audits for expiring premiums. There are -- many times there might be credits, where the estimated premium might have exceeded the actual payroll levels. So we're seeing, we're certainly seeing some of that. So it clearly is a combination of decline in exposures as well as competitiveness.

Are you seeing any firming there, though?

I don't know that we can say commercially that we're seeing any firming, we can't see we see it getting any more intense. But I don't know that we can say to you that we can see any clear indications of firming. Now, having said that, we have some renewals that are going out with modest premium increases because we are trying where possible to get a 2%, 3%, 4% increase. However, there are other renewals that are going out somewhat less than the prior year. But it continues, the commercial side continues to be soft.

All right. Thank you.

You're welcome.

(Operator Instructions). Your next question comes from the line of Michael Phillips with Stifel Nicolaus.

Good morning. Guys, any comments on reserve development from prior years?

Sure. We tend not to focus on loss development in the first quarter. Simply because we are only three months into the year. But that being said, there were no reserve releases during the quarter. We experienced some modest adverse loss development in the first quarter of 2009 similar to what we experienced in 2008. And as we talked about, I think last year, we primarily attribute adverse loss development in the first quarter to normal claim life cycles for the most recent prior accident year. And what I mean by that is the reserves for claims reported late for the dissent year tend to increase after the occurrence date. And then as the year progresses, we normally see those developments improve as claims are settled within the reserves.

And as we look at 2009 the number is slightly higher than what it was in the first quarter of 2008. And we think that some of that might be due to the fact that we had a large number of property claims coming in, weather related claims that our staff was dealing with, which does impact our ability to concentrate on settling open claims. So there was some adverse development mainly in the 2008 accident year. Lines of business like private passenger auto, worker's comp. So it's our hope that as the year progresses, that our development would improve somewhat, but the numbers are fairly minor, about 2% of the reserves at the end of last year.

Okay. Thanks, Jeff that was helpful. You've talked -- and last quarter, I think especially about expense reductions and personnel related expense reductions. You you still see that going forward -- anything else behind your expense improvements, that you expect to see the rest of this year, maybe into 2010 besides personnel? Kind of what are you doing there?

We do expect the expenses to improve. And if you look at the first quarter of 2008 versus the first quarter of 2009, the numbers are somewhat misleading because again the pooling change was effective for all three months of the 2009 quarter versus only one month of the 2008. So the expense ratio is probably a better measurement. And that is somewhat offset by the lower organic premium writings. So there's some pressure on the expense ratio from the writing side, but certainly we believe that comparing our expenses in 2009 to those in 2008 that we would see some improvement as the year progresses. Some of that will be dependent upon the level of underwriting profitability and its impact on the underwriting base incentive costs.

Okay. Thanks. Finally two numbers if I can.

Sure.

What was your tax rate on net investment income in the quarter?

The effective tax rate in the quarter?

For just net investment income.

For net investment income. It was around 10%.

Okay. That's down a bit from prior quarters, is that right?

I believe that is correct. We continue to invest in tax exempt securities. Okay.

And then did you repurchase any shares?

We repurchased 3,000 shares in the quarter.

Okay. Thank you, I'm all set.

Your next question comes from the line of Dan Schlemmer from FPK.

Good morning. I have a couple questions from the introductory comments and I hope I got this right. I think you said 45 fires that were $50,000 or greater and $7 million total. Correct me if I'm wrong, but do you have any kind of a normalized level? Or I guess I'm just trying to quantify, is that twice as bad as a normal quarter or if you have -- if that's something you track separately?

Well, I tell you we don't normally track the fire losses because they generally are not a significant number as we would have seen in the first quarter. The $7 million-- you do have the numbers correct, it was -- collectively near $7 million, and that was 45 fires in excess of $50,000. A normal quarter would have maybe a quarter of that amount. We would normally see 15, 20 fires and see maybe $2 million of effect. But this quarter was just an unusually large number of fires that was spread across a number of our subsidiaries and operating regions.

Okay. That's helpful. Thank you. Can you also -- can you give a little more detail on the tax ruling issue? Just -- I don't know how specific you can get on that. But just what was the issue, what geographies and lines of business were impacted, et cetera?

It is only -- it is only one state. And it would, of course been premium taxes on whatever business is written on that particular state. And the issue goes to the fact in a one of our subsidiaries previously was domiciled there and we had merged it with one of the other subsidiaries. And it goes to an arcane issue having to do with the sites of the investment assets. And depending upon how that comes out, factually, there is a difference in the level of premium tax.

And we believed and continue believe that that particular insurance department was misapplying the formula, given our particular fact situation. And there are constitutional issues that we are arguing relative to the fact that it's not an equal application of the particular tax requirement. So we have it -- we have filed a petition [accertiare] to the Supreme Court of that state, and it is fully reserved and paid. And, of course, hopefully if we prevail, we will seek the appropriate refund.

Very helpful, thanks. The $1.4 million during this quarter, can you -- I guess don't know how much you can go into. I understand in affect it applies across multiple accident years and that's just the accrual during this quarter, whether there was already an impact. Can you quantify that down into the 2008 accident year, what the total costs of the premium tax under what you believe is correct versus what the state believes is correct? Or is there a way to quantify that?

There is. It's -- the liability dates back to 2002. And we had accrued various amounts over the years for the premium tax. Once we receive notification that there was a dispute, we started to accrue on a more conservative basis. The impact of 2008 we had fully accrued the premium tax. And there was a -- just a modest interest and penalty impact for that year from around $50,000. So most of the impact would have been for prior years.

Okay. So the 2008 -- I think what you're saying, the 2008 premium was actually already being calculated in accordance with what the state believes is correct, is that fair?

That is correct.

That is correct.

All right. Last question, and sort of changing gears, I think you said up 5.2% on personal lines of premium. Can you break that out in terms of rate versus organic? I'm sorry, rate versus exposure?

Yes, exactly.

Is how I meant to say it.

I would say that because most of our rate increases are taking effect April, May, June, July of this year, that probably only one, one and a half percent of that is rate.

Okay. Very helpful. Thank you.

(Operator Instructions). At this time you have a follow-up question from the line of Joseph DeMarino, Piper Jaffray.

Do you know your statutory capital level in the quarter?

I do. The surplus as of March 31st, was $324.6 million.

All right. And can you just briefly explain the higher interest expense again?

Sure. A great portion of that $1.4 million accrual related to the premium tax was for interest and penalties on the prior years. And so the $974,000 of the interest expense reported in the quarter was related to that particular accrual. So other than that, accrual number, the average interest expense for our subordinated trust preferreds was actually a decrease from the prior year.

Okay. So what is the -- I guess the run rate on that?

Well, if you pull $974,000 out of the number we reported, that would be a good run rate. Because our interest rates have been fairly constant on the trust preferreds, they're currently hovering in the 5% range.

So it's just the one time thing?

That's correct.

Thank you. That's all I had.

You're welcome.

And at this time, there are no further questions.

Okay, I think we're ready to close the call. We thank everyone for your participation today. And wish you a good day.

Thank you, everybody.

Ladies and gentlemen, this concludes today's first quarter 2009 Donegal Group earnings conference call. Thank you for your participation, and you may disconnect.