Donegal Group Inc (DGICB) 2009 Q4 法說會逐字稿

Good morning. My name is Rebecca, and I will be your conference operator today. At this time, I would like to welcome everyone to the quarter four 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 today's conference over to Jeff Miller, Chief Financial Officer. Please go ahead.

Thank you. Good morning and welcome to the Donegal Group earnings release conference call for the fourth quarter and year ended December 31st, 2009.

I am Jeff Miller, Chief Financial Officer, and I will begin the conference call by discussing key financial highlights, and providing commentary on the quarterly and annual financial results. I will then turn the call over to Don Nikolaus, President and Chief Executive Officer, for his comments on the fourth quarter, as well as the business trends we are currently experiencing.

We 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 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 Investor's portion of our website under the SEC filings link.

Our focus throughout 2009 was on balance sheet strength, and we finished the year in excellent financial condition, although our underwriting results for the fourth quarter and full year did not track with our historical experience.

There were a number of factors that impacted our quarterly results. We reported an increase in net income for the quarter compared to the year earlier period, with a portion of the increase related to realized gains on sales of securities.

Our net premiums written increased during the quarter, even after normalizing for a one-time unearned premium transfer described in the earnings release. We received a significant number of fire claims across several of our regions, impacting our loss and combined ratios.

Taking a step back and looking at the big picture, we were pleased that our book value increased 5.8% during the year, which continues to be one of our primary long-term goals.

Today's release discussed the impact of Donegal Mutual's affiliation with Southern Mutual Insurance Company, which includes a quota share reinsurance agreement, pursuant to which Donegal Mutual assumes 100% of the net business of Southern Mutual, and then places that business into the pooling agreement with Atlantic States Insurance Company, which is our primary insurance subsidiary.

The end result is that our consolidated results include 80% of Southern Mutual's underwriting activities since November 1st, 2009. The impact of the two months Southern Mutual activity on our operating results was not material, but we anticipate this affiliation will provide approximately $9 million in net premium revenue to us in 2010.

Our fourth quarter net income was $7.5 million, or $0.30 per share of Class A common stock on a diluted basis, compared to $6.4 million or $0.26 per share of Class A common stock on a diluted basis for the fourth quarter of 2008.

Our total revenues for the fourth quarter of 2009 were $101.5 million, an increase of 5.9%, which was attributable to a 2.3% increase in net premiums earned, and realized gains on the sale of [various] common stock, as well as fixed income securities, that had appreciated significantly as of the end of the third quarter.

Our net premiums written increased 12% for the fourth quarter of 2009, including a one-time $5.4 million transfer of unearned premiums from Southern Mutual. Excluding the one-time transfer, our personal lines writings increased 8.2%, and commercial lines writings decreased 2.1%, for a combined 5.1% increase over our net writings for the fourth quarter of 2008. Our investment income for the quarter was $4.9 million, a decrease from $5.5 million for the year earlier period.

We are continuing to maintain liquidity in the form of US government securities funds that carry low yields, and as higher yielding fixed investments mature in this lower interest rate environment, we are reinvesting those funds at lower yields, putting pressure on our investment income.

We are continuing to focus on investment quality, and are selectively taking opportunities to put funds to work in a laddered approach, with an emphasis on both taxable and tax exempt municipal bonds, high quality corporate debt and US Treasury securities, staying relatively short on the curve, except for municipal bonds, where we have been buying in the 8- to 15-year range, to obtain more favorable yields.

Moving to underwriting results our fourth quarter 2009 loss ratio was a disappointing 70.6%, compared to 66.8% for the fourth quarter of 2008. As I mentioned previously, we had a significant number of fire claims in the fourth quarter of 2009, adding up to an $8 million impact to our quarterly losses. Our loss ratio also included the effect of approximately $1.8 million of unfavorable prior accident year reserve development, primarily in our worker's compensation line of business for accident year 2008.

On the positive side, our quarterly reserve development represented an improvement from the amount we experienced in the fourth quarter of 2008, and from the average quarterly development for the first three quarters of 2009.

Our expense ratio was 31.2% for the fourth quarter of 2009, in-line with the 30.9% reported for the fourth quarter of 2008, and 31.3% for the first nine months of 2009. Our combined ratio for the fourth quarter of 2009 was 102.1%, compared to 98% posted in the fourth quarter of 2008, with the increase reflecting the higher loss ratio in the current quarter.

Our net income for the full year 2009 was $18.8 million, down from net income of $25.5 million for the full year 2008, reflecting the impact of increased weather and fire claim activity throughout the year, and additional unfavorable prior accident year reserve development as compared to the prior year.

Our total revenues for 2009 increased 3.8% to $386.7 million, with net premiums written increasing 1.8% for the full year, after adjusting for one-time unearned premium transfers in both years.

Earnings per share for full year 2009 were $0.76 per share of Class A common stock on a diluted basis, compared to $1.02 for the full year 2008, and our combined ratio for 2009 was 102.2%, compared to 97.2% for 2008. Our pre-FAS 115 book value per share as of December 31, 2009, was $14.53, reflecting a 2.2% increase over the $14.22 pre-FAS 115 book value one year earlier and that is after paying $11.2 million in cash dividends to our stockholders during 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. I simply would like to review some of the highlights as I see it from the standpoint of the fourth quarter, the year, and some preliminary thoughts as we move forward into 2010.

As Jeff has indicated, we continued to place emphasis on balance sheet strength, as many of you will remember in 2008, we had very excellent results in that our surplus during a very difficult time in the financial markets did not decline, in fact it increased. And then again in 2009 our book value increased by 5.9%, and we believe our portfolio is quite pristine.

We believe the significance of all of that is that it puts us in a position both in the regular day-to-day operation of our companies, but also from the standpoint of looking to do additional affiliations and acquisitions.

There were no Other Than Temporary Impairments in the fourth quarter, and as Jeff has indicated, our fourth quarter revenues increased by 5.9%, and our net premiums written increased 5.1%. And what I would like to point out is that the growth of 5.1% of net premiums written relative to what we see in our review of other companies is fairly good, and it reflects in our judgment three components.

It includes the fact that we did in 2008 a transaction in which the public company acquired Sheboygan Falls Insurance Company, the Mutual company in November of 2009; did the affiliation with Southern Mutual Insurance Company, and through the pooling agreement, 80% of those premiums are recognized by the public companies principal subsidiary; and thirdly, I think we have made some progress in growing our distribution system, and also seeing some improvement in the flow of commercial new business, which I will talk about in a moment.

In the fourth quarter, our distribution system grew by the appointment of 35 new agents, which brought the total for the year to 172, which we think was a good result in a recessionary environment. And yes, we did have our share of fire losses, both in commercial and homeowners in the fourth quarter of 2009. I think we are all pleased that the year 2009 is behind us.

Talking about rate adequacy and underwriting integrity, we continue to make filings for rate increases in various states in homeowners; in some cases it would be our second increase in a 12-month period in some states.

Homeowners, as many of you know, is a line of business that with all of the weather conditions of the last several years has proven to be a line of business where companies need to be vigilant as to the rate adequacy, and we as well as other companies have not been bashful in terms of making filings in that regard.

Even in a soft insurance market and a soft economy, we have continued to focus on the quality of underwriting. We have not hesitated to re-underwrite certain books of business, whether it be in a particular agency, or whether it be a particular line of business in a particular state. We think that that is appropriate to maintain the highest quality that we can, even with the pressures of a soft insurance market and a down economy.

As I indicated earlier, in the quarter our premiums grew; personal lines were up 8.2%; commercial was down 2.1%, and that would be compared to commercial being down 7.9% in the third quarter of '09, which would indicate that we have been successful in being able to attract, in our judgment, additional amounts of profitable new business.

On the technology side, in the fourth quarter we continued to roll out WriteBiz and WritePro, those are our electronic delivery systems for agents. We rolled those out into, particularly WriteBiz for Wisconsin for Sheboygan Falls, where in the fourth quarter we began our initiative to write commercial lines in that state, and we are encouraged by our initial reception in that state.

Talking a little bit about other initiatives that began in the fourth quarter, but will clearly continue in the first quarter of 2010, we have developed a greater focus on how to retain existing customers; policy retentions are very important, and we have enhanced our call center for personal lines.

We would expect by the early part of the second quarter of 2010, to have up and live a service center for personal lines, for agencies that prefer just to sell, and do not want to service their book of business, that we would offer that service to agencies. It is done on a reduced commission basis, and all of that is in an effort to make sure that we have all of the facilities available that any of our largest competitors might also have.

Our subsidiary, Peninsula Insurance Company, has been doing business in the states of Vermont, Maine, and New Hampshire, and as a result of their entree into those states, the Donegal Insurance Group will also be bringing other products to other subsidiaries to those three states in New England.

As a result in 2010 we will officially set up a New England region, to begin to do business in those identified states, as we believe that they will be states that will be potentially profitable states, and we will look to grow additional premium there.

From the arena of mergers and acquisitions as I know it doesn't come as a surprise to you folks that we continue to have conversations with companies. We try to expand our dialogue; as a matter of fact, we have asked two of our executives to spend additional portions of their time in assisting with those initiatives, because we want to broaden our outreach in that regard.

As we begin 2010, we believe the year has more potential for profitable growth than the year 2009. I think that we are encouraged by some of the early signs that we see. As many of you know, we do agency meetings beginning in January through the end of April, in about 30 locations across the country. We have already done about seven of those. We are pleased by the reception that we have received, and we believe that that will be helpful as always in forwarding our marketing efforts.

So at this point I will turn it back to Jeff.

Thank you, Don. Rebecca, if you could open the line for questions, please.

(Operator Instructions) And you do have a question from Michael Phillips with Stifel Nicolaus.

Hi, guys. Thanks, good morning.

Good morning.

Question, Don, on your comments on kind of the turn here in the commercial lines growth and tracking new profitable business. It seems like that can't be coming from offering better rates, though maybe I am wrong there. But can you talk about how you are getting that business?

Yes, I would be pleased to, because I think that does maybe need some clarification. I want to assure you that we are not out being the fastest gun in the marketplace.

Several aspects to it. We have begun to write in a new state, Wisconsin. Secondly, we have enhanced a number of our products, our commercial products, and are offering some additional coverages that some of our larger competitors have been offering in the past.

We have hired some additional field production underwriters, because what we have learned is that other companies have been aggressive, in terms of having people on the street in the sense of being in agencies, commercial production underwriters, that we have hired an additional four or five production underwriters to actually be in agencies' offices, because it is a matter sometimes of the ease of doing business.

If you have your people there, they are doing the quoting for the agency, on either a renewal or a new piece of business. So I think that we are being more proactive, and not necessarily in any way suggesting that we are being more aggressive on the pricing side.

Okay. Great, thanks. This is kind of actually a little follow-up to that answer then, with what you mentioned with the service center maybe coming up in 2010 in New England, and these things in the new coverages and hiring some folks, any pressure on expense ratio because of all these initiatives?

No, I don't believe so. The production underwriters are all ready to reflect it in the fourth quarter expenses. There will be some additional expenses but the way we have our budgeted plan, we don't believe that we will have an uptick in our expense ratio. We expect to balance it off with responsible premiums, so that there will not be a ratchet up in the expense ratio.

Okay. Thanks. And then lastly for me, you are getting 80% of the Southern Mutual net business, does that mean there might be a change to their external reinsurance business that they look at?

As far as their external reinsurance, we have left their reinsurance in place. So our net is net of their reinsurance, because needless to say, as a new affiliation we as a first step wanted to leave their reinsurance in place, because we think at this point that is appropriate.

Yes, I guess that is what I'm getting at, you don't expect to see them to have any changes to their reinsurance?

No, matter of fact, we worked with them in negotiating their renewal, and matter of fact, they were able to do it on favorable terms.

Okay, great. Thank you, Don.

You bet.

Your next question comes from the line of Dan Schlemmer with Macquarie Securities.

Hi, good morning. I was hoping you could talk a little bit more about just the $8 million in fire losses that you disclosed? Can you -- how many claims are we talking about here? Is it just a handful of claims, or is there a big rash coming through? And if it is possible, can you sort of normalize that relative to what is excess versus just a normal quarter?

Sure, Dan. Let me give you some additional information on that. There were somewhere in the neighborhood of 50 claims, 50 fires that exceeded $50,000, so that gives you kind of a handle on how many number of claims that we are dealing with. They were the usual cold weather related causes, from heating systems, we had some chimney fires, a handful that were caused by supplemental heating devices, electrical origin, several large commercial building fires.

So a logical question would be, is the recession causing some of that fire activity, to which we would answer we have not seen clear evidence that there is a trend toward increased fraudulent claims, but we are cognizant of that possibility, and do certainly have a very robust investigative unit that looks into all of those types of things.

As far as normalizing a quarter, a normal quarter might have in the $2 million range, $2 million to $3 million in fire losses, so $8 million is clearly at least $5 million in excess of what we would think of in a typical quarter.

Now as follow-up to that, I would want to add that the fourth quarter of almost every year has an increase in fire losses relative to the -- as compared to the third quarter and the second quarter, and sometimes the first quarter has somewhat elevated fire losses, but the worst quarter of the year is generally the fourth quarter.

And as Jeff is saying, whether some of this is recession related, things not being maintained as an example, which is not necessarily a fraudulent claim, it is simply that there may not be as close of maintenance. Also, a couple of these losses that fall into this $8 million were commercial losses, so at least two of them were over $1 million commercial losses. Our hope and expectation; that it was an aberration. Needless to say we monitor this very closely, looking for any kind of trends.

Very helpful, thank you. And sort of disappointed in myself that I am obviously so predictable, because fraud was the follow-up question. I guess rather predictable.

Separately, you talked in the prepared comments about homeowners' rates. One thing we have seen if you look at the industry over a long period of time, cat losses is really -- the big names are Andrew and Katrina and Northridge, and not very relevant for your company. But in the last few years we have seen an increase in some snowstorms and hail in some areas that actually would impact Donegal.

Is that something that you are taking into account, and is that what is driving the homeowners' rate increases you were talking about? Or is it really more just the general losses, and both interested in what you are choosing to do and also what you are seeing, both from regulators or competitors on that front? Is the increase in those types of cat losses driving significant rate behavior?

Well, it certainly varies from state to state, but clearly weather conditions, whether they be hail, tornado, winter storms, they are all components that we take a serious look at. I would say to you that, for instance, if we are talking about states in the Midwest, hail and tornado, and a certain amount of winter storms, are causing rate increases in those type of states. So it can vary from state to state but those are clearly part of it.

And as -- I think if you follow the weather patterns there have been in the last two to three years more hail storms, tornado events, in sometimes states that normally haven't had quite that severity of experience, that were not built into homeowner rates in our judgment, to the extent that maybe they needed to be, and that certainly is part of what we are looking at, and of course, the usual type of losses, fire and similar type of events. But I think you are on the right track there. And we believe we are seeing the same kind of reaction by other competitive companies.

And then just staying with that theme, sort of the competitive dynamic then, if you talk about rate increases in personal lines in particular and homeowner, are you seeing a shift in your retention or in your new business opportunities, or is it fair to say that the market is moving up, and your position is staying relatively static?

I think our position is static to positive. It is not dramatically increasing new business as an example in homeowners. But I think that there are some positive trends, and sometimes it can be whether your competitor has filed their rate increases earlier, or it can simply be that your overall marketing efforts are improving things. But what we call our hit ratios -- our hit ratios in homeowners are about on average by state what they have been, although there is probably some minor positive indicator there.

Thanks a lot. And last question real quick, you said 172, I think if I heard you right, 172 new agencies in 2009. Do you have a target for 2010?

Yes, we would expect in 2010 to be somewhere between 150 and 175.

Great, thanks.

(Operator Instructions) Mr. Miller, we have no questions at this time.

Okay. We thank everyone for their participation, and this will conclude our conference call for today.

Thank you, everybody.

Thank you for participating. You may disconnect at this time.