Donegal Group Inc (DGICB) 2010 Q4 法說會逐字稿

Good morning. My name is Janika and I will be your conference operator today. At this time I would like to welcome everyone to the Donegal Group quarter four 2010 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).

I would now like to turn the call over to Mr. Jeff Miller. You may begin.

Thank you and. Good morning and welcome to the Donegal Group earnings release conference call for the fourth quarter and year ended December 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 and full-year results. Don Nikolas, President and Chief Executive Officer, will then provide his comments on the quarter and an update on the business trends and development.

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 were disappointed that our net income for the fourth quarter and full-year 2010 lagged our historical experience and targeted profit objectives. I will provide some detail in a few minutes to further explain our loss trends for the quarter.

Although our commercial lines underwriting experience was favorable during the fourth quarter our personal lines underwriting experience was impacted by weather conditions and moderate increased severity of bodily injury claims. As we discussed in our third-quarter conference call, we filed numerous personal lines rate increases throughout 2010. As those rate increases work their way into our earned premiums over the course of the next year we expect our personal lines underwriting experience to improve.

We do have a lot of favorable news to share with you this morning, including solid organic premium growth and improving trends that are embedded in our loss data and the completion of the largest insurance acquisition we have done to date. Our net premiums earned increased 8.3% for the fourth quarter and 6.5% for the full year. We've provided detailed information with respect to our net premiums written for the quarter and full year in our release this morning, and I won't take the time to go over all of those details on the call. We are pleased with the organic growth in commercial lines where our underwriting results have been favorable historically and in this past year. In fact our statutory combined ratio for commercial lines was 93.6% for the year and around 90% for the fourth quarter. We are pleased to see growth in the commercial lines segment of our business.

While it had minimal impact on our premiums earned for the fourth quarter our acquisition of Michigan Insurance Company effective December 1 provided additional premium writings in the quarter and will be a source of net premium written growth in 2011. Because the acquisition was effected December 1 we included only one month of Michigan's results of operations in our consolidated 2010 results and the one-month results were immaterial to the fourth quarter and full year. Our year-end consolidated balance sheet includes the balance sheet of Michigan and you will notice a significant impact because of Michigan's reinsurance receivables. However we would hasten to point out that the vast majority of the additional reinsurance balances related to the obligations of Michigan's former majority owner West Bend Mutual Insurance Company, and as part of our purchase agreement West Bend agreed to place assets in a trust account for the benefit of Michigan in an amount equal to West Bend's net obligations under the historical reinsurance agreement between those two companies.

We had initially expected acquisition to be accretive to our earnings in 2011, but as we worked through the details of the purchase accounting rules we determined that a fair value adjustment with respect to Michigan's unearned premium reserve will result in a reduction of Michigan's premium revenue that we will earn in 2011. Mainly as a result of the impact of that adjustment, the effect of the acquisition will likely be earnings neutral to slightly dilutive in 2011 depending on the level of Michigan's underwriting profitability. Application of the accounting rules is a bit complicated and has nothing to do with the operations or underlying economics of the company. I will be glad to respond to any questions if there is further interest on the topic.

From a big picture perspective, the acquisition of Michigan provides opportunities for future growth and significant cost savings over time, particularly in IT cost savings as Michigan's systems are converted to our technology. I will let Don provide further comments on the acquisition, but it clearly was a highlight for Donegal Group in 2010 and we're excited about the future opportunities it affords to us.

Turning back to the quarterly results our loss ratio for the fourth quarter of 2010 was 71.3% compared to 70.6% for the fourth quarter of 2009. To provide additional details around the loss trend, we incurred weather-related claims that totaled approximately $4.1 million in the fourth quarter of 2010 compared to $2.8 million in the fourth quarter 2009. We did not incur a significant number of claims from a single catastrophe event, but multiple smaller storms generated moderate property losses and an increased number of auto accidents.

We incurred a reduced number of fire losses during the fourth quarter of 2010 compared to the year-earlier quarter, so that was a positive trend. However we did have an increased number of fire losses relative to other quarters of the year.

We also had increased personal auto liability claims severity which offset most of the improvement in the fire losses. We saw consistent improvement in our prior accident year loss reserve development trends throughout 2010 and they continued in the fourth quarter. Our prior accident year reserve development for the year 2010 was $2.9 million favorable compared to $9.8 million of unfavorable loss development from prior accident years that we experienced for the full-year 2009 for a year-over-year improvement of $12.7 million.

Although we were not pleased with our 2010 accident year loss ratio, the favorable loss reserve development was a significant improvement over the trends we experienced in 2009.

Our book value per share decreased slightly to $14.86 as of December 31, 2010 compared to $15.12 at December 31, 2009. The decrease was attributable to reduced unrealized gains within our available-for-sale bond portfolio. Excluding the FAS 115 affect of our unrealized gains, our book value was exactly the same at December 31, 2010 as it was at December 31, 2009, which reflected the cash dividend we paid to our stockholders during 2010.

There's been a lot of press related to municipal bond investments over the past few months and I will make a few comments relative to our municipal bond holdings. We intentionally reduced the percentage of our total investments that were invested in municipal bonds to 61.7% of our total investments at the end of the year. Our municipal bond portfolio is very clean with 80% general obligation bonds and 20% essential service revenue bonds.

The portfolio was trading above book value at year-end, is geographically diverse and 98% is rated A or higher. We've continued to reduce the percentage we invested in munis in early 2011 and we're confident in our portfolio and we tend to agree with many of the financial experts that have suggested the potential crisis in this sector has been exaggerated.

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

Thank you Jeff. Good morning everyone, thank you for joining the call. Needless to say, the earnings for the quarter are certainly not at acceptable levels but, as Jeff has pointed out, we believe we saw some very positive trends in the fourth quarter of 2010. We continued to experience good growth. Net premiums written increased by 7.2%, net premiums earned increased by 8.3%, commercial premiums written grew by over 20%, investment income increased 9%, new agency appointments were 28 for a total of 161 for the year to date which represents a continued growth of our distribution system. As Jeff pointed out, our commercial combined ratio for the quarter was -- for the year was 93.6 and for the fourth quarter was 90%.

Needless to say, all of that is very favorable. Additional rate increases in personal lines were taken. We continued as we reported at the third-quarter earnings call, at that point we had made over 30 rate filings. We continued to accelerate those and implement those and we will begin to see the effect through the flow-through of the earned premium as we go into 2011.

In the quarter we rolled out a very sophisticated [WriteFarm] system for quoting farms, which we have talked about in the past. We completed the rollout of our technology for several of the affiliates that we own or affiliate with, which was a nice accomplishment from the technology standpoint. We continued to work on making sure that our balance sheet is strong.

And what I would like to talk about next is the acquisition of Michigan Insurance Company. As you are aware, if you have followed us that it's the largest acquisition we have done to date -- $100 million of direct written premiums, a great agency distribution system, experienced management and a history of underwriting profitability. What has taken place since December 1 is that we have begun the integration process of assisting them in being integrated into our information services system. That has only begun. It will take quite a few months in 2011, but that process has begun. We have, of course, begun to provide various resources to them -- investment management, actuarial services, rate filing services, all of the accounting oversight and functions that need to be done. We believe that it will be a successful acquisition and we're looking forward to our increased representation in the Midwest.

One of the areas that I would like to talk about this morning is the multiyear process that we have undertaken over the last two to three years in terms of growing our regional companies and also improving in terms of what we are as a Company. We have completed three acquisitions and affiliations in the last three years. We had a significant expansion of our regional footprint and lots more geography than previously. We think that we have continued to build best-in-class technology and have emphasized profitable growth going forward.

We have also brought to the Company and have promoted up from within a fair number of people in new positions as we have grown and acquired companies so that we have the human resources in order to do the things that we know that we need to do in order to be competitive and to be a major force in the market place.

We have certainly focused on disciplined underwriting and all that is associated with that, including making sure that we have rate adequacy.

We also have made sure that we have the best claim service that we possibly can. We have done a satisfaction survey or two in 2010 and we have satisfaction rates of between 95% and 98%. We have worked very diligently on controlling expenses and making sure that we have a comprehensive program for improving profitability.

The sum of all of this, we believe that we are -- without any guidance -- we believe that we are poised to provide significantly better results going forward and we believe our strategy is very well thought out, very strong and we look forward to future quarters and these earnings conference calls.

We will turn it back to Jeff for questions.

Okay, Janika, if you would open the line up for questions, please.

[Matt] Rohrmann.

A couple of numbers questions, Jeff -- what was the actual number of favorable development accrued in the fourth quarter?

The fourth quarter favorable development -- I thought I had that number at my fingertips, but I do not. It was 2.9 million for the year.

Yes.

Let us pull that out, Matt.

Okay. I guess, next question, just curious if there was any update on the Union National transaction?

Yes. We are optimistic that we will receive approval for the transaction prior to the end of the first quarter, and we of course still need the approval of the OTS, but we are optimistic that we will receive that and are optimistic that the transaction will close before the end of the first quarter. That is no guarantee because we need to await for their decision, but we aware that they have deemed our application as being complete, which is a major step.

Okay, great. And then, Don, just a last question -- I would love to hear your thoughts on the workers comp business right now. The reason I ask is, there's a company not too far down the road from you kind of effectively pulled out of that business more or less; I'd just like to hear your thoughts on where you think that line of business stands?

Well, our view of workers comp is a reasonably constructive one. What we are seeing in some states, we are seeing the loss costs being developed by either their state ratings bureau or the NCCI with some modest increases, and we have also taken what are known as increases in loss cost multipliers.

Also, we think that it all depends upon the underwriting process and the classes within workers comp that you are writing, and we have a favorable view of it. And also, although we do write some monoline work comp, we are primarily account writers. And we think that that's an important component because it can be volatile. But we don't have negative feelings with regard to it.

Certainly, inflation can have an effect on it. The recession certainly had an effect because it is more difficult to get people back to work in a recession. But as we know, we're all beginning to see some improvements in the economy, and we think that there will be benefits there also.

Okay, great. Thank you very match, gentlemen, I appreciate it.

Sure, Matt, just to respond to your earlier question, the development was fairly flat at the end of the third quarter, so about $2 million in the fourth quarter of favorable development.

Okay, all right, great. Thanks Jeff.

(Operator Instructions).

Well, while we're waiting to see if there any other questions, one additional piece of information that we wanted to share with you is related to our 2011 reinsurance program, and I will cover that and then respond to any additional questions that might be queued.

We made a number of changes to our reinsurance program for 2011 and achieved some economies of scale by combining selective coverages for a number of our subsidiaries. The most significant change was to increase our catastrophe loss retention for an external reinsurance purposes from $3 million to $5 million for most of our subsidiaries. We considered increasing that external retention for several years as our Company has grown in size and because of rate pressures that resulted from cat loss activity in our operating region.

The $5 million retention level remains very conservative relative to our premium base and surplus level and we continue to purchase reinsurance that limits the various models would indicate represent conservative coverage levels.

Based on individual surplus levels and exposures of our subsidiaries, we have reduced the external $5 million retention further by entering into separate external reinsurance agreements for several of our subsidiaries and intercompany agreements with Donegal Mutual for the others.

So, as a result, the catastrophe retentions for our insurance subsidiaries now range from as low as $200,000 for Sheboygan Falls to $1 million for Le Mars and Peninsula, $1.5 million for Southern, $2 million for Atlantic States. Michigan has a $2.5 million cat retention prior to the quota share, and of course we have the 50% external quota share that would come into play after that catastrophe reinsurance.

So the bottom line of that is, we've taken slightly higher levels of catastrophe risk to keep our reinsurance premium costs in line, but we continue to believe that our reinsurance program is conservative and comprehensive.

So that gives you a little bit of an update on 2011 reinsurance.

Seeing no further questions in the queue, I believe we will wrap up the call. We appreciate your participation this morning and look forward to better results in 2011.

Thank you, everybody, for joining the call.

Thank you for participating in today's conference call. You may now disconnect.