Donegal Group Inc (DGICB) 2010 Q1 法說會逐字稿

Good morning. My name is Carly and I will be your conference operator today. At this time I would like to welcome everyone to the Q1 2010 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. I would now like to turn the conference over to Mr. Jeff Miller, Chief Financial Officer. Mr. Miller, you may begin.

Thank you. Good morning and welcome to the Donegal Group earnings release conference call for the first quarter ended March 31, 2010.

I am 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 an update on 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.

Similar to the first quarter of 2009, we encountered a number of challenges during the first quarter of 2010 that produced disappointing underwriting results. Increased claim activity from severe winter weather events, including two major snowstorms in the mid-Atlantic region, and an unusually large number of fires throughout our operating regions led to an elevated loss ratio relative to our historic experience.

On the positive side, we reported a 5.6% increase in net premium writings as a result of both personal and commercial lines growth and an affiliation that became effective in the fourth quarter of 2009.

As we reported this morning, our net income for the first quarter of 2010 was $234,758 or $0.01 per share of our Class A common stock, compared to $169,804 or $0.01 per share of our Class A common stock for the first quarter of 2009. Our total revenues for the first quarter of 2010 increased 2.5% to $97.9 million, with net premiums earned increasing 3.4% to $91.4 million.

I mentioned that our net premiums written increased 5.6% over the first quarter of 2009. Organic writings increased 3%, attributable to a 2.4% increase in personal lines premiums and a 4.2% increase in commercial lines premiums. The remaining 2.6% net premiums written growth was related to an increase in pool premiums from Donegal Mutual's affiliation with Southern Mutual Insurance Company in the fourth quarter of 2009.

Our release mentioned that we made no significant changes to our 2010 reinsurance program, and we expect our reinsurance costs to be relatively consistent with those in 2009.

Our investment income for the quarter was $4.9 million, a decrease from the $5.4 million reported for the first quarter of 2009, but very comparable to the investment income reported for the fourth quarter of 2009. Our loss ratio for the first quarter of 2010 was 74.4%, very close to the 74.7% loss ratio for the first quarter of 2009.

We incurred claims from severe weather events during both quarterly periods. The major snowstorms in the mid-Atlantic region contributed to a record number of incoming property claims for any quarter in recent history. Our weather-related losses for the first quarter of 2010 totaled $9 million compared to $7 million for the first quarter of 2009, which was approximately double the amount incurred in the first quarter of 2008.

We also incurred an unusually large number of fire losses in the first quarters of both 2010 and 2009, resulting in claims in the amount of approximately $8 million in 2010 compared to nearly $7 million in 2009. We have historically incurred increased fire claims in the first and fourth quarters of the year, but our recent experience has exceeded historical norms. Harsh weather and the economic recession are clearly factors driving the increase in fire losses.

Although we tend not to focus heavily on prior accident year loss development in the first quarter, we are pleased that our prior year reserve development for the first quarter of 2010 was relatively flat, representing a substantial improvement from early 2009 when we experienced adverse development in a number of property lines of business, primarily from the reporting tail on 2008 hailstorms.

Our development trends improved as 2009 progressed, and we were pleased to see that improvement continue into the first quarter of 2010.

Our expense ratio was 31.4% for the first quarter of 2010, in line with the 31% reported for the first-quarter 2009, with both quarters' ratios reflecting lower underwriting-based incentive costs due to the higher claim activity. Our combined ratio for the first quarter of 2010 was 106.0%, virtually unchanged from the 105.9% posted in the first-quarter 2009.

Our book value remained constant at $15.11 per share as of March 31, 2010, compared to $15.12 at the end of 2009 and $14.47 as of March 31, 2009. Our pre-FAS 115 book value per share as of March 31, 2010, was $14.54, increasing 2.2% over $14.23 as of one year earlier.

Last week our Board of Directors declared dividends of $0.115 per share of our Class A common stock and $0.1025 per share of our Class B common stock, payable May 17 to stockholders of record as of the close of business on May 3. These dividends represent increases in the 2% range from the previous quarterly amounts.

Earlier this week, Donegal Financial Services Corporation announced the execution of an agreement with the Union National Financial Corporation, pursuant to which those two bank holding companies and their respective bank subsidiaries would merge. Donegal Financial Services Corporation is jointly owned by Donegal Mutual Insurance Company and Donegal Group Inc. The merger is subject to regulatory approval and the approval of Union National's shareholders. This transaction would add scale to our modest banking operations and enhance our ability to provide quality community banking services in our home area of Lancaster County, Pennsylvania.

Donegal Group Inc. and Donegal Mutual will proportionately contribute additional capital to Donegal Financial Services Corporation to effect the acquisition and mergers. And both entities will participate in the future earnings of the merged bank according to their respective ownership percentages.

While we look forward to the opportunities this acquisition will create, our banking operations will continue to represent a small component of our overall business plan and organizational structure.

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

Thank you, Jeff, and good morning to everyone. Thank you for joining our earnings conference call for the first quarter.

Needless to say, the first-quarter results are disappointing. However, there is a very strong explanation, as Jeff has indicated. The 2010 first quarter in terms of winter weather events has been the most severe for us since the 1994/1996, two years that were extreme.

Jeff has quoted the various numbers. To elaborate a little bit, we would have received about 6,400 reported property claims in the first quarter, with about 4,700 of those being in the mid-Atlantic states alone, and it's approximately about twice what we would have received in the prior year. So that is a substantial number of property claims.

Clearly, we cannot change what happens in terms of bad weather. We can, however, going forward take certain steps that arise out of whenever a company, or an industry in this case, severe loss ratios in property line.

So this will cause us to have a new round of rate increases for homeowners, which we see other companies beginning to do also. Because if there is going to be somewhat increased weather patterns, which we don't know whether that will be the case or not, we have to make sure that our rate adequacy is in place to anticipate potential increases in weather-related losses. So we will and have begun to do the various indications, and we will be making appropriate filings in many of the states in which we do homeowners business.

One of the positives that Jeff made reference to was the net premium growth. We think it's appropriate to highlight that because two parts of our strategy has been to grow the premium base and also to have very excellent underwriting profitability and profits in general.

Clearly in the first quarter, we didn't achieve the profitability part, but we have made very good progress in terms of net premium growth. Jeff has broken it down for you. It's probably one of the first quarters in some time that our commercial growth has been of any significance.

As you may remember, in 2009 in most quarters we would have been reporting that commercial premiums were down. Actually, we have about 4.25% increase in commercial premiums for this quarter.

What gives rise to all of this growth is a combination of an affiliation, which reflects the strength and the importance of doing reasonable acquisitions. But also it reflects the various activities that we have undertaken over the last several years to grow the distribution system, to expand products, which I think are now resulting in some very meaningful growth.

As far as the growth of the distribution system, we have added 41 agencies, which is about on target for what we would expect. Last year the same quarter we had about 45, so it's well within the range.

In the area of technology, which has been a significant help in terms of us projecting ourselves and taking advantage of potential enhancements of our franchise and growth of business, we continued throughout the first quarter to enhance our WritePro system and our WriteBiz system. We are now working on a new platform for the writing automatically in an electronic fashion of farm risk, and it will be called WriteFarm.

Another growth initiative. We are establishing a New England region, and the states involved will be Maine, Vermont, and New Hampshire. One of our subsidiary, Peninsula Insurance company, currently does business there. But we will be expanding our other companies, basically Donegal Mutual Insurance Company and Atlantic States, to begin to do business in those states.

We have hired an experienced sales executive to manage that region. And we would expect that later in 2010, probably by the fall of 2010, to have our other companies begin to do business there.

We gave a brief overview of the Southern Mutual affiliation. In addition to the premium growth that it is currently bringing, we are actively integrating their IT systems into the Donegal Insurance Group's IT system and also beginning to make all the necessary commercial filings so that they may begin to do commercial insurance, which would be another opportunity for us and them to expand our premiums.

We have just completed agency meetings in 12 states -- 28 meetings in which anywhere from 40 to 150 or 160 agency people would have attended. It is our major spring initiative for the marketing of our Company. We can report that our meetings were very well attended, high levels of enthusiasm, and we believe a good potential result for that early in the year kickoff of our marketing efforts.

We have reported previously that we initiated a call center for personal lines and for accounting information. We are about to expand that in June into a service center for those agencies that desire to be selling insurance and not taking care of the backend servicing of personal lines.

We will be offering that as an optional feature for agents. It is basically an effort to make sure that we are providing all of the potential services that any of our very large competitors would be providing.

Needless to say, the entire Donegal Insurance management is working aggressively to return to historic levels of profitability while at the same time pushing our growth initiatives.

In terms of affiliations and acquisitions, we continue to aggressively seek prudent acquisitions. We have named two of our Senior Vice Presidents to devote a defined portion of their time to M&A and assisting senior management in that regard.

As a little follow-up comment to Jeff Miller's reference to the Union National transaction, the Donegal Insurance Group -- a combination of Donegal Mutual and Donegal Group -- through Donegal Financial Services Corp. has owned Province Bank for approximately 10 years. The Union National transaction is a logical modest expansion of our investment into the banking industry. We would want to underscore that banking would continue to remain a small part of the principal business and focus of the Donegal Insurance Group.

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

Okay, thank you. Carly, if you would open the line for questions please.

(Operator Instructions) Michael Phillips, Stifel Nicolaus.

Thanks. Good morning, everybody. Jeff, you mentioned the first quarter -- or I guess, Don mentioned the number of property claims and pretty significant. Then Jeff started off with the adverse development in 1Q 09 because of the tail.

Any risk of that here in the next couple quarters because of the onslaught of claims that you're seeing from the property side?

That's a very good question, Mike, and we do not foresee a significant tail from these storms. The difference being that because of the magnitude of the storms we have exceeded the retentions on our intercompany reinsurance agreements, or we are right at the retentions.

So any additional development from those storms would be ceded to our reinsurers.

Okay, perfect. Then, Don mentioned the filings to kind of segue Southern into some commercial lines business. I guess two parts.

Is that a this-year kind of thing, or is that next year? And then any impact on the expense ratio because of that?

It is a this-year event. We expect to have the filings all made by May/June time frame and we would expect to be rolling it out to their agents probably by July, certainly by August.

In terms of the expense ratio, because of the way the agreement is structured with Southern Mutual, that there is a ceding commission. And the expenses associated with that new business is basically borne by the cedent. And the premium that comes to the Donegal Insurance Group is net.

Okay, so then no impact really for you guys. Correct?

No additional impact, other than (multiple speakers), correct.

Okay. I guess lastly, anything you can comment on what you are seeing maybe in Pennsylvania -- but I guess it's physically just the mid-Atlantic in general -- from personal auto rate filings from some of your larger competitors? The Travelers and State Farms of the world. Any more uplift from those guys than what you have seen in the past couple quarters?

I think that we saw more rate increases being filed in the fourth quarter in personal auto than we did in the first. But I wouldn't read anything into that, because generally companies are only making one rate filing a year, generally. They can try for two.

We would see that there is somewhat of a firming of rates in personal auto with the trend being towards the up side. So we would view it as a constructive pricing environment.

Don, follow-up on that then. If you think about just kind of macro for personal auto liability over the next three to five years, what is the biggest concern you have there that would affect trends from the liability loss cost for personal auto?

Anything? Changes in health or fee schedules from hospitals or anything like that? Kind of a macro level trend over the next couple years.

Well, as we all know, the national health bill is an unknown event in terms of how that may impact health costs. Certainly you read pros and cons in terms of what will happen to health costs.

But certainly that's something that could have some bearing on it. It could have a positive help, or it could create somewhat of a trend.

Needless to say, companies such as ourselves will be monitoring that, because if we see any indication of that it will simply cause us to make sure that our rates are adequately reflecting any changes in healthcare costs.

Okay, great. That's all for me now. Thanks.

(Operator Instructions) Dan Schlemmer, Macquarie Securities.

Hi, everybody. Good morning. Question on the bank. Can you give us some picture of what the timing will be for any regulatory approvals? Or is that something that is somewhat known, or is it just totally open for the regulators to control?

It's totally in the hands of the regulators. But we would anticipate that -- not to speak for them, but just based upon similar transactions -- that it would probably be a late third quarter, early fourth quarter type of an approval process.

Great, thanks. Then can you give us a little more color on just -- why does it make sense to get more heavily into a bank at this point?

Well, I think there are several good reasons. One of the things that we would want to point out, that the bank that is being acquired is also based totally here in Lancaster County. We have very good knowledge of this particular area, our Province Bank people do.

What it does -- it enhances the investment that we have already in the banking industry in Lancaster County and central Pennsylvania. So it enhances the investment that we currently have, because it adds some more critical mass to it. It makes it a more valuable asset.

And relative to our overall operations, it is not necessarily a significant part of what we do. And relative to all the other investments that we have, on a comparison, it's sort of a modest percentage.

Also as you would know, that the pricing of banking assets at this point in time are -- under the right circumstances can be a good time to be making such an increase in enhancing our current investment.

Great, thanks. Then sort of changing gears back to the insurance side, can you talk both on the -- you talked about Southern Mutual looking at commercial opportunities; and then you also talked about the New England states.

Can you, on both of those, just talk a little bit about what you see as the size of the opportunity maybe a year out, or more three to five years out on each of those?

Well, let's talk about New England, the executive that we have hired to run that region for us and is in the process currently of putting together an [elaborate] business plan that would go out three-plus years. We would hope over a -- and we generally try to look at things conservative until we have some real definitive numbers.

But we would look to that region, hopefully over a three-year period of time, to be maybe somewhere in the $10 million to $12 million range. Maybe it will be more aggressive than that, but we wouldn't want to overestimate.

Southern Mutual, we would expect that in 2011 that that might generate $3 million, $4 million of commercial premium.

Great. Thanks. Then two quick numbers questions. You said prior-year development was essentially flat. Was there any movement on an individual line or individual year? Or was it really just flat across everything was what you were seeing?

It goes across a number of lines. I would say we saw improvement in the private passenger auto lines; and workers comp was relatively similar to the prior year.

Where we are seeing significant improvement would be in those property lines where we had seen the tail from the 2008 storm. So the trends are looking much better than they would have a year ago. And it's a continuation, as I said, of the improving trends that we saw towards the end of 2009.

Great, thanks. Last question, real quick number. Don, you had in the last, in the Q4 call, you had thrown out 150 to 175 as new agencies in 2010. Is that still the target that you are looking at?

Yes, absolutely. We committed 41 for the first quarter, and we would expect that that will ramp up somewhat as we go out into better weather, because it was a tough time for our territorial sales managers to navigate in a lot of the geographic areas. So we expect that to increase as we are in better weather.

Good information. Thanks a lot.

Matt Rohrmann, KBW.

Don, Jeff, good morning. Just two questions. Jeff, I know I'd asked you the other day; I just wanted to see if you have any better handle on if there were going to be any parts to the loan portfolio on the Union National deal that you saw. Or is that still being worked out?

Well, we have done some initial due diligence on those, on looking at their loan portfolio. Certainly as part of the purchase accounting exercise there will be a lot of attention placed on them. So that really will kind of flesh itself out as we go through the purchase accounting.

The value that we eventually record during the asset on our books will reflect the adjustment of those loans to what we believe the fair value to be. So I don't know that we have a number that we could quote to you at this point, although that was factored into the price that we offered for the bank.

Okay, great. Then, Don, obviously you have had some good momentum with WritePro and WriteBiz. What kind of premium potential down the road do you see as you build out the WriteFarm product?

Well, we have been in the farming business for decades, and therefore we have a decent footprint in it. What we need to do is to make it an easier -- an ease of doing business type of approach.

So therefore we would expect that once we got WriteFarm live in many of our states that have good farm business, that we could probably over a period of years' time increase those premiums hopefully by somewhere in the $4-million-plus.

Okay. All right. Great. Thanks, gentlemen.

Ron Bobman, Capital Returns.

Hi. Thanks a lot. I had a question on a point you made earlier about the reinsurance coverage and how you're -- I think the words you used were if you have further development you will then have reinsurance recoverables to be a beneficiary of.

I was wondering. Are those -- is your reinsurance program a per-event? Or do you have some sort of aggregate cover where certain qualifying events and losses from them, once they aggregate and exceed a certain amount, you get coverage? Could you describe that, if I am explaining the question properly?

Certainly. You did explain it very clearly. We do not have any aggregate covers. All of our reinsurance is on an excess of loss or catastrophe excess of loss basis.

But the reinsurance that I was referring to would be on a per-event basis. As you know we had two major snowstorms here in the mid-Atlantic. One of those bumped right up against our retention from an intercompany standpoint with Donegal Mutual, so there won't be any further development from that event.

The second event is into our external reinsurance. Again, Donegal Mutual limits the impact to the Donegal Group subsidiaries. So any further development on event will also be ceded to the outside reinsurers.

We do have another subsidiary, Peninsula. It is in Salisbury. It has its separate reinsurance program. And in that, both of the events are very close to the reinsurance limit for that company as well.

So we would not expect to see significant development from those two events in the future quarters.

Let me add little flavor to it also. We believe strongly that the way we have our per-event retention is what we would call it, per event for cat, is conservatively written, meaning that we try to maintain it at the lowest level possible. We have an external retention of $3 million.

So given our capital and the size of our operation, that would be viewed a relatively conservative number. So we think it is well structured.

As Jeff is saying, if the 6,900 or 6,400 claims, or whatever the number is, for these various cat events -- that if they produce over time increases in losses, we will not relect that in our net results because it will have been ceded out as part of this reinsurance under the cat program.

Thanks for straightening me out. It's sort of a -- I think your answer is going to be no; but is this experience weather-wise and loss-wise this year alongside your current program going to prompt you to modify your program for next year? Or you think it's going to be -- you will try to largely structure it similarly?

I think it will be structured very similar because we think that it is the right structure. What we have to keep in mind is we all -- and I don't know where all you gentlemen might live -- but if you live in the Northeast, you know how extreme the winter was. If simply you have that kind of a winter and you are going to develop a lot of property losses, we don't necessarily believe that this past winter is going to necessarily repeat itself frequently.

And we don't think that we could structure our program any more conservatively. We could go and add in an aggregate. But an aggregate becomes a very expensive proposition that you pay for, and maybe in the next 10 years have relatively modest winters. So we think we have it structured correctly.

Understood. Thanks a ton for your thorough answer.

You bet.

There are no further questions at this time.

Well, we want to thank everyone for their good questions and participation this morning and wish you all a good day.

Thank you, everybody.

This does conclude today's conference. You may now disconnect.