Donegal Group Inc (DGICB) 2009 Q3 法說會逐字稿

Good morning. At this time, I would like to welcome everyone to the third quarter 2009 Donegal Group earnings conference call. All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions). Thank you.

Mr. Jeff Miller, Chief Financial Officer -- Sir, you may begin.

Thank you. Good morning, everyone, and welcome to the Donegal Group earnings release conference call for the third quarter ended September 30, 2009.

I am Jeff Miller, Chief Financial Officer, and I will begin the conference call by discussing financial highlights and commenting on the quarterly results. Don Nikolaus, President and Chief Executive Officer, will then provide his comments on the quarter and discuss current business trends.

Before we begin, we want to remind you that certain statements made in our earnings release and in this conference call are forward-looking in nature and involve a number of risks and uncertainty. 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 10K that we submitted to the SEC. You can find a copy of our Form 10K on the Investors portion of our Website under the SEC filing link.

Our net income for the third quarter of 2009 was $6.7 million or $0.27 per share of our Class A common stock, compared to $6.3 million or $0.25 per share of our Class A common stock for the third quarter of 2008. Our net income increased [53.7]% over the net income we reported for the second quarter of 2009.

Our total revenues for the third quarter of 2009 increased 2.3% to $94.9 million with net premiums earned, holding constant at $88 million. Net premiums written increased by 1.6% with personal lines increasing 6% and commercial lines decreasing 7.9%.

Sheboygan Falls Insurance Company, which was acquired in December of 2008, added $2.2 million to our net premiums written for the quarter.

Our investment income for the quarter was $5.1 million compared to $5.8 million for the third quarter of 2008. The decrease was once again driven by lower short-term interest rates during the period. We had no other than temporary impairment during the first nine months of 2009, underscoring the high quality of our investment portfolio.

Our loss ratio for the third quarter was 66.6%, compared to 62% for the third quarter of 2008. Our weather-related losses declined from what we had experienced in the first two quarters of 2009, but third quarter results were adversely impacted by a number of wind and hail events in the Midwest that collectively added up to about $2.4 million after reinsurance.

The total impact of weather claims was around $6 million for the quarter. So other than the Midwest events, the impact of weather during the quarter was within a normal range.

Also impacting the third quarter loss ratio was a modest $1.6 million of unfavorable loss reserve development from prior accident years. We were pleased to see our prior accident year reserve development stabilize from the amounts we incurred for the first half of the year when we had development from late reporting of 2008 hail losses in a few of our property lines.

We also saw improvement in development trends for the most recent prior accident year as reserve development for the 2008 accident year in our key casualty line improved as compared to the reserve development for the 2007 accident year experienced as of one year ago.

Our expense ratio was in line with our expectations at 32% for the third quarter of 2009, compared to 33% reported for the third quarter of 2008, with the decrease largely attributable to lower underwriting-based incentive costs due to the higher loss ratio in the quarter. Our combined ratio for the third quarter of 2009 was 98.9% compared to 95.5% for the third quarter of 2008.

Our book value per share increased significantly to $15.36 as of September 30, 2009, up 10.6% compared to $13.89 one year ago. Our prefab [115] book value per share as of September 30, 2009 was $14.45. Included in the third quarter increase in our book value were after-tax unrealized gains of 14.4 million in our bond portfolio as well as $1.4 million after-tax related to our common stock holdings of insurance services office that were converted to shares of [Barris Analytics] as part of its IPO on October 6.

Last week, our Board of Directors declared a cash dividends of $0.1125 per share of our Class A common stock and $0.10 per share of our Class B common stock, payable November 16 to stockholders of record as of the close of business on November 2.

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

Thank you, Jeff, and good morning to everyone. Thank you for joining our conference call.

Needless to say, we are pleased with the improvement in quarterly earnings over the third quarter of 2008, and particularly pleased with the significant improvement in quarterly results for the third quarter of 2009 -- over the second quarter of 2009.

Jeff has given you a thorough overview of many of the details of that. One of the areas that I would have some commentary on is that we have seen nice improvement in our combined ratios and lines of business such as homeowners that were certainly very elevated in the first two quarters of 2009, and for portions of 2008. Although as of 9/30/2009, our combined ratio for homeowners is 114 that, on the third quarter, it was much lower at 101.9.

So we are beginning to see a significant improvement in that line of business, which has been a major source of the loss activity in terms of combined ratios for the year.

In workers comp where, earlier in the year, we were seeing -- at the six months' level we were saying the combined ratio over 100% at 103. For nine months it is now 94.3 and for the third quarter was below 80%.

On the weather front, Jeff gave you the statistics on that. It continues to be a difficult year from the standpoint of weather events and, therefore, property type losses. Fortunately it was not as severe in the third quarter as it had been in some prior quarters.

One of the areas that we would continue to talk about in terms of Donegal Group's strength is its balance sheet strength. There is $20.1 million of net after-tax unrealized gain in the fair value of our investments. The increase in book value is at $15.36 which Jeff indicated is a 10.6% above September 30, 2008, and a 7.7% increase from the point in December 31 -- a reminder to everyone that we were one of the few companies in the property casualty industry or certainly among a minority that did not have a decline in book value at the end of 2008.

On the expense side, we continue to manage expenses, although the decline in the GAAP expense ratio has certainly been helped significantly as a result of the lower amount of incentive-based compensation. We also believe that we are making good strides in containing expenses.

From a rate-filing (technical difficulty) standpoint and underwriting integrity, I know that there are always questions with regard to rate increases. We have now exceeded 30 plus rate filings in various states since the beginning of the year where rate increases in personal lines, both homeowners and auto with most of the focus being on homeowners, but also in automobile and bureaus of the states in which we do business. As I would have reported at the end of the second quarter, we continued to take action with regard to our homeowners book. Because even though it is weather-related with regard to many of the losses, it has been our experience that you need to take a look at your homeowners book of business whenever you have a serious escalation of claims to make sure that your insurance -- the value is correct, to make sure that your underwriting requirements are where they need to be.

And in certain states where we have had the highest levels of homeowner losses, we have put into place and are putting into place programs to make sure that longer term, that we are having reasonable and more standard levels of profitability in that line of business.

I am pleased to emphasize that, in terms of the amount of growth, although growth is difficult in the environment that we are currently in, I am pleased to tell you that in personal lines that the Donegal Group had an increase of 6% for the quarter, and in commercial lines the decline was 7.9. However, compared to the second quarter where personal lines grew by 5.6, we can see that there has been some further increase there. But in the second quarter commercial lines had declined by 12.4.

So that you can see that there is a significant improvement, although still in the negative. And what we are attributing that to is we are seeing, both in personalized and certainly in commercial, an increasing amount of new business that we are writing, which has been very helpful. And we would attribute to an expansion of our distribution system which is always a factor; the rolling out of additional product; and the expansion of WriteBiz into additional states in which we had not previously been writing commercial.

We are not doing it through an electronic portal.

In that area of the growth of the distribution system, in the third quarter we had 48 mew agency appointments. We are up to 137 year to date. We would expect for the total year to be somewhere in the range of 180 to 190 new agencies.

From the competitiveness standpoint, personal lines is -- clearly as we have reported earlier is improving. We see numerous companies taking rate increases which means that the environment is more receptive for rate increases. Commercial lines continues to be quite competitive.

I'm also pleased to report that as part of our plan at acquiring Sheboygan Falls Insurance Company in Wisconsin that, two weeks ago, we had agency meetings throughout the state of Wisconsin and rolled out a full complement of commercial products for both Sheboygan Falls and for Donegal Mutual as well as our WriteBiz technology.

As a reminder, Sheboygan Falls was primarily and is primarily up to this point a personal lines company and it is our goal to have them become -- and for Donegal Mutual and the other affiliates -- to become major players in commercial lines in the state of Wisconsin.

The mention of Donegal Mutual, as you are familiar to the [point] agreement, 80% of whatever ends up being written by Donegal mutual flows through into the public company.

We also continue our initiatives in a competitive environment to make sure that our time service standards are at the first-class level in the industry, that we continue to look at further product enhancements that make good business sense as part of an organized approach to grow our top line.

In the merger and acquisitions front, we continue to see increased activity. We are pleased to report that we have more opportunities to talk to various companies. Meaning that there is -- I would describe it as a more receptive environment to other companies, considering that. And you know from a press release that we would have released several months ago, that Donegal Mutual Insurance Company had entered into an agreement to hopefully do a [surplus] note as well as a quota share reinsurance agreement with a fine company in Georgia by the name of Southern Mutual Insurance Company.

We attended the insurance department hearing on October 9. We, of course, have to await the Commissioner's review of that hearing and, hopefully, an approval. If that approval is received and hopefully in a timely manner, that the transaction would close and as a reminder that the quota share is 100% quota share and it would flow 80% into the public company's revenue stream.

From the standpoint of overall initiatives, we continue to look to manage the Company in a progressive way for profitable growth going forward, but always with the commitment to looking at what makes good sense and making sure that it is sound judgment and business strategy for the long term.

At this point I will turn it back to Jeff and we will be pleased to answer questions.

Okay. Thank you, Don. Mandy, if you would open a line for questions please.

(Operator Instructions). Michael Phillips with Stifel Nicolaus.

The comments on homeowners, Don, the improvements you made there and then your comment about getting it back, some programs that are going to get it back to more standard levels of profitability. How would you define that? What kind of combined ratio do you want to get through there?

We would traditionally be looking at mid-90s.

Okay and any thoughts on --? Is that an 18 month to a year, 10-year kind of program?

Well, sometimes we are very conservative about things and sometimes we are optimistic. I mean, needless to say, we can't control the weather patterns, but if they are not overly severe weather patterns we would hope that that is a 2010 event in terms of getting back to normal combined ratios.

We have put into effect in some states to separate rate increases, which as you know, it takes many months for rate increases to flow through into earned premium. And coupled with other actions we are basically trying to take steps to mitigate even some ongoing effect of weather. Because if there are going to be weather patterns, it is our belief that weather patterns that are somewhat adverse, it is our belief that we need to have higher levels of premiums for the exposures.

And we need to make sure that we have the best possible risk in place as it relates to the maintenance of dwellings and all of the elements that might go wrong with that.

The organizational structure changes that you have been making to presumably -- that will presumably help out your expense ratio. What -- where do you see that leveling off in the next couple of years? Is that low 30s? You've been 33-ish kind of range. Where do you want that to get to?

I think low 30s. Certainly, we would like to see it dip below 30, but that would require some additional premiums.

So in this current environment with premium growth being a challenge, I think we would say low 30s would be the goal going forward.

And then, last one for me here is on your acquisitions, anything out of either the order -- Le Mars or Sheboygan or even now with the one out of Georgia. I guess more so the first two -- Le Mars or Sheboygan -- that you look back and say you know we wish we could have seen this earlier or some things that out of those two specific acquisitions that you are visibly working on to change that maybe you didn't recognize out of the gate earlier?

No, matter-of-fact, in both of those transactions you may remember that they were both new mutuals, and there were surplus notes that were done with those when they were mutual. And we went through a period of time where whatever needed to be done, we felt that we did and then they were demutualized and were sold to the public company based upon a fairness opinion.

Both of those acquisitions, we think, have been just excellent. They have opened good markets for us in the Midwest. Excellent people who work at those companies for us. They are -- we have very strong promotional programs in place in terms of profitably growing in those states.

So no, we have done acquisitions years ago where we could've had Monday morning buyers remorse. But these are -- these are working very well.

Okay, great. Thank you, Don.

Joe DeMarino with Piper Jaffray.

Thank you. This is a follow-up from one of the earlier questions. Is there a certain loss ratio right now that you're pricing to? On -- that you're targeting to I guess on your business right now? As you set your lost [pics]?

I would say that that would vary by product line and certainly our actuaries are looking at the exposures and matching rates to the exposures. Target loss ratio would be -- to be in the low 60s. We're seeing this quarter we had 66.6 and certainly that is higher than we would hope for or target.

So I would say 60, low 60s would be the target we are trying to rate our products so that we can achieve.

So is the current rate action that you've taken you think -- and they've done what you're projecting loss experience is going to be going forward, you do think that it's adequate at this point to achieve the loss ratio target you just mentioned?

Yes. We would believe so. And that's an ongoing exercise to analyze rates and it's subject to competitive pressures and what other players are doing. But, yes, the rate actions that we are taking are designed to lower the loss ratios in some of the lines where we have seen elevated loss ratios in the past year or so.

But I would also add that rate is only one of the components. And the other component is the underwriting piece. And we always believe that we have been conservative underwriters.

But there is always merit in continuing to refine their process and making sure that either on existing book of business or new business that we are honing our skills in the selection and retention process as good as possible.

Thanks. That's helpful. Can you talk about pricing on renewals versus new business in both personal and commercial?

Well, clearly on personal the rate increases that we would be filing are not just for new business. They of course flow through where we -- current business as well.

On the commercial side, needless to say -- because it continues to be a competitive environment -- there are not I -- it would not be accurate to say that in any significant percentage of commercial policies that we are getting premium or rate increases. We are on some business. We try for a modest low single digit increase in a broad class of business, but because of competitive forces, many times that is not doable.

So there is not necessarily a lot of premium increases happening in commercial. However we have been encouraged that, based upon our present pricing policies in commercial, that, as I referred to earlier, that we had a better experience in the third quarter as compared to the second quarter in terms of writing a new business as well as the retention of existing business.

Okay. For commercial on that business that is I guess to underprice at this point that you may be walking away from, how far off is it in terms of pricing? Or how close is it to where you would like it to be or is it still a ways away?

Well, the business that we are either walking away from or someone is walking it away from us, you always will in our business here extremes where another competitor came in and took it for 20% less than what you are writing it for. But, those are examples of extremes.

As we have said in the last number of conference calls, we don't see the competitive environment in any way intensifying. It simply hasn't gotten much better in terms of the competitiveness of it. But it is not, at least our view of the world, it is not getting -- it is not deteriorating.

It is simply not improving as all of us and the industry would probably like to see it improve. Whether or not we are 5 or 10% away from the pricing level that we would like to see, you have to remember that each account has to be looked at on its own merit.

But clearly the pricing in commercial should be up another -- anywhere from high single digits to low double digits. And hopefully, when the world wakes up it will begin to head in that direction.

Thank you that is very helpful. And one last question.

I'm sure you said it, but what was the net favorable development in the quarter?

It was actually net unfavorable development. It was $1.6 million.

Was there a favorable development though?

There was favorable development in some lines and in some years, but on a net basis it was unfavorable. And as I said before, the 2008 accident year is actually developing better than the 2007 accident year was developing at this time last year.

So we are seeing some positive trends. And certainly the development in the third quarter is a big improvement over what we would have seen in the first two quarters of the year.

Great. Thanks.

Our next question is from the line of [Lee Feingold] with Fox-Pitt Kelton.

Thank you. Just following up the unfavorable development of $1.6 million. I was wondering if you could disclose what accident year and lines of business that was from?

Be glad to give some additional details on that. It's primarily in the 2008 accident year and in primarily -- as far as line of business, it would be private passenger auto liability. So in the bodily injury type of claim.

And although I -- what -- my statement earlier that we experienced 2008 was better than 2007 this time last year -- what that highlights is that we had more settlements and favorable development in older accident years in the third quarter of 2007 and our two -- I'm sorry, in the third quarter of 2008 that we had in the third quarter of 2009.

So that's what is contributing to a lesser amount of favorable development in the third quarter of '09 than we would've seen a year earlier.

Thank you for that. Then moving over to the investment side, that has been lower with interest rates being the way they are. I was wondering if you guys had any plans to reallocate your portfolio to increase the return there? Where you're putting new money?

At this point we have continued to concentrate on the tax exempt municipal bonds as we are shifting money out of short-term investments. As we see opportunities to do that, we have.

However, we continue to stay short in our durations, believing that interest rates are going to eventually rise. So we are being somewhat conservative there even though the yields aren't near what we would like them to be.

So we don't plan to do anything dramatic at this point. We are going to continue to stay the course and put money to work, as we see opportunities to do that.

Thanks for your time.

Matt Rohrmann with KBW.

Good morning. One quick question on the weather. Jeff, could you repeat what you said about the $6 million loss. The call kind of broke up. And then also do you have any state-specific numbers around the outside loss that you mentioned in the release?

The weather claims were around $6 million for the quarter and that included $2.4 million in the Midwest which would have been Iowa, Nebraska primarily; wind and hail events in those states.

So $6 million and that's actually down slightly from where we would've posted in the third quarter of 2008 when we had the remnants of Hurricane Ike that came through the Ohio and Western Pennsylvania. So -- but it is lower than what we experienced in the first two quarters. And I didn't quite catch your question on the States. Was there something (multiple speakers)?

Yes. I think you said $2.4 million was in Iowa and Nebraska?

Correct.

Okay. Great. Thanks very much.

(Operator Instructions). Michael Phillips with Stifel Nicolaus.

Thanks. Just one more on the competitive environment. Anything specific you could talk to on personal auto and your largest market in Pennsylvania? What you're seeing from the large competitors there?

Yes. We subscribe to a publication called the Pennsylvania Advisory and it is published monthly and it shows you the rate filing. It's all publicly available information of the rate filings. And the most recent two, three editions of that are showing that some of the major competitors have filed for rate increases in private passenger automobile. Some of them, significant. A few of them were actually double digits at 11%.

So we are clearly, even in our principal state, seeing a fair amount of rate activity and -- which is certainly encouraging to see.

Okay. Great. Thanks,

Joe DeMarino at Piper Jaffray.

What is the current statutory surplus number and then how much (technical difficulties) capital do you estimate you have right now?

The current statutory surplus was $347.3 million as of September 30. As far as excess capital, certainly we [wouldn't] say that we have a great deal of excess capital. We are looking to do acquisitions. We are going to preserve the capital that we have and look to capitalize on those types of opportunities.

I wouldn't see any significant returns of capital in the form of share repurchase is at this point. But we certainly believe our capital is adequate. We believe we are well-capitalized. We have very low debt levels and we feel like we are in a very good financial position.

Did you already comment as to what size acquisitions you might be looking at?

Well, we've -- I think we have historically said we looked at acquisitions anywhere from $10 million to $75 million, $80 million as far as premiums written and surplus levels. So those would be the types of acquisition candidates that we would be interested in looking at. Not looking to swallow a well, so anything that would be $100 million plus would likely be outside of our interest.

But looking at smaller, we look at mutual companies as well as stock companies. And we believe that there's a universe of companies out there that we will have opportunity to look at over the next couple of years.

Great. Thanks.

(Operator Instructions). Sir, at this time there are no further questions. Do you have further comments?

We want to thank everyone for their good questions and for their participation on the call this morning. Thank you very much.

Yes. Thank you, everyone.

Thank you for participating in today's third quarter 2009 Donegal Group earnings conference call. You may now disconnect.