Donegal Group Inc (DGICB) 2011 Q2 法說會逐字稿

Good morning. My name is [Kenya] and I will be your conference operator today. At this time, I would like to welcome everyone to the Q2 2011 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. Miller, you may begin your conference.

Thank you. Good morning and welcome to the Donegal Group earnings release conference call for the second quarter ended June 30, 2011. I'm Jeff Miller, Chief Financial Officer and I will begin the conference call by covering financial highlights and providing commentary on the quarterly results. Don Nikolaus, President and Chief Executive Officer, will then provide his comments on the quarter, market conditions we're experiencing, as well as an update on our current business initiatives and opportunities.

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. And 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've 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.

I'll cover a number of topics in my comments this morning, beginning with the weather impact to our results, which appears to be the main story line for the quarter for the whole industry. And then I'll touch briefly on the ongoing effect of acquisition accounting, discuss our underlying performance, and finally provide a quick review of our investments where we had a fairly significant realized gain during the quarter.

But first, some details about the weather impact. For the second quarter of 2011, we incurred $13.1 million of losses from 11 catastrophe events that we pre-announced and another $7.4 million in non-cat weather losses from smaller storm systems for total weather-related losses in the second quarter of $20.5 million. Our release provided some context for that $20 million figure. A year ago, we incurred $10 million of weather-related losses in the second quarter, which was then a record quarterly amount.

Our previous five-year average second quarter weather impact, including 2010, was $7.2 million. Therefore the $20 million we incurred in the second quarter of 2011 was twice our previous record quarterly weather loss amount and nearly three times our prior five-year average for the second quarter.

The increased weather losses added 8.5 percentage points to our combined ratio, compared to the second quarter of 2010 and represented an increase of 12.7 percentage points, compared to our five-year average. Roughly, 75% of these reported claims have been paid as of June 30 and we do not expect any significant impact from further development in the third quarter, because any additional losses reported would be fully offset by reinsurance recovery.

It might be helpful to explain the reason that we use the term weather-related losses versus catastrophe losses. Because we manage our catastrophe exposures and maintain relatively conservative reinsurance retentions for property cat events, our results are generally protected against the individual designated cat events that generate a significant number of claims for the industry.

Smaller weather events that are more localized might not generate enough claims to qualify as a national catastrophe. These smaller events can have as significant an impact on Donegal's results as a major cat event. Therefore we track all weather related claims rather than just those resulting from events that meet the national cat definition, because that statistic tends to be more relevant in comparing our underwriting results to prior quarterly periods.

You'll hear us talk about weather-related losses and by that term, we simply mean property and automobile comprehensive claims that were caused by weather. The weather impact masked a number of positive trends in our underlying results again this quarter as did the acquisition accounting adjustments related to Michigan Insurance Company that I described in detail during our first quarter call.

I won't repeat the theory details behind those adjustments, but I do want to point out that the majority of the acquisition accounting impact is now behind us.

To give just a quick overview, the largest of the amortization items resulted in a reduction of our earned premiums. In the first quarter that reduction was $1.8 million and in the second quarter the reduction was $1 million. We have only $500,000 remaining to be amortized, most of which will be recorded as reduction of earned premiums in the third quarter.

Another acquisition accounting adjustment related to deferred ceding commissions, that adjustment resulted in an increase to our GAAP underwriting expenses of about $700,000 in the first quarter and another $450,000 in the second quarter.

Summarizing the effect on second quarter results, the $1 million reduction in premiums and additional $450,000 in expense combined for a reduction in pre-tax income of $1.5 million, or approximately $1 million after tax. That translates to $0.04 per Class A share for the quarter and 1.5 points on our GAAP combined ratio.

Operationally, Michigan Insurance is contributing as we anticipated and it serves one of the few states that experienced more normal weather patterns in the second quarter. Don will give more details about the ongoing integration in Michigan Insurance Company into our operations in a few minutes.

Moving to our underlying results, we achieved a 15.2% increase in net written premiums, with about 12% coming from Michigan and 6% from organic growth within our other states of operation, which were offset by 3% from reinsurance reinstatement premiums related to the weather losses.

Our commercial premiums, exclusive of Michigan, grew by 10.2% as a result of growth in all of our operating regions. Our personal lines premiums, again exclusive of Michigan, grew by 3.2% with the majority of the growth coming from pricing increases, but that growth was fully offset by reinsurance reinstatement premiums, so that we have reinsurance coverage for the remainder of 2011.

Our statutory loss ratio for the first quarter of 2011 was 79.8%, compared to 73.8% for the second quarter of 2010. The additional weather losses are partially offset by fewer fire losses causing over $50,000 in damages. This is a continuing favorable trend with large fire losses adding only $1.7 million in the second quarter of 2011, compared to $6.1 million in the prior year quarter.

Our prior accident year reserve development for the second quarter of 2011 was modestly favorable and slightly more favorable than we experienced in the second quarter of 2010.

A few brief investment highlights. Fixed maturities made up 90% of our investment portfolio with 55.7% now invested in municipal bonds. In May, we completed the merger of Union National Financial Corporation with and into Donegal Financial Services Corporation. Our investment in affiliates reflects the $20.6 million additional investment in our expanded banking operations.

Investment income increased 9.1%, primarily because our portfolio is larger following the acquisition of Michigan Insurance. We also reported a realized gain of $4.3 million from the sale of an equity security for which a selling restriction expired in early April. The stock had previously represented our largest single investment holding and we made a portfolio risk management decision to reduce our holdings at what we considered a favorable valuation.

On an after-tax basis, the realized gain represented $0.11 for Class A share, compared to $0.05 per share of realized gains in the prior year quarter. We repurchased around 50,000 shares of our Class A stock during the second quarter and our book value per share was $14.97, up from $14.86 at year end due to increases in the unrealized gains in our bond portfolio.

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

Thank you, Jeff, and good morning to everyone, and welcome to our conference call. I'm going to cover a number of topics including our sense of market conditions, give an update on the Michigan Insurance consolidation and a review and overview of our organic growth strategies and the results.

But first, just little commentary about weather-re losses, as you know it was a record first half for industry-wide catastrophes. Despite the magnitude of our own cat losses, as we have been monitoring commentary across the industry, we continued to believe the steps that we have taken in recent years to raise rates in personal lines, particularly in homeowners, and manage our exposures in certain geographic areas, helped to mitigate the effects of the storms on Donegal's policyholders and contained our losses to some extent.

On a relative basis, we believe our quarterly results look favorable as compared to many of our peers and the industry results as a whole. In any cat event, claims handling is an important and interesting opportunity to demonstrate policyholder service. And as Jeff has referred to, approximately as of June 30, 75% of the claims arising out of those cats were settled by that point in time.

So we believe that although it's very devastating from the standpoint of the individuals that have experienced those claims, and the losses that we experienced it is an opportunity to demonstrate the abilities of our claims department.

Several other statistics, as Jeff has indicated, our stat combined ratio came in at 108.7%, which is certainly not a good combined ratio from a statutory standpoint, but certainly relative to what we are seeing as it relates to other companies in the industry in this quarter, we feel that that stands fairly well in comparison. Our book value increased to $14.97 and our stockholders' equity increased year-to-date.

With regard to market conditions and pricing environment, there has been some announcements by other companies that have indicated somewhat improved rate trends and we certainly in general can confirm that, what I'd like to do is cover it, sort of, by segment and by product line.

In commercial lines, in small to medium-size risk, which is what we basically write in commercial, there's generally some rate firming, although it is certainly not in any way significant.

In personal lines, there clearly is firming in most of the areas in which we do business in personal lines, particularly in private passenger automobile and homeowners.

In private passenger automobile, there are some states in the Midwest where it remains quite competitive.

As to homeowners, significant rate increases have been acted upon by many carriers and that certainly is our experience, which I will talk about.

From the standpoint of workers' comp premium audits, we're pleased to say that the negative trends that we saw in 2009 and 2010 have begun to rectify themselves and as of June 30, basically our audit premiums on workers' comp are generally flat to up very slightly.

What has to be understood when you do a comparison and analysis of workers' comp audit premium is a lot has to do with how good of a job an individual company does in identifying at the time the premium, the policy is written, accurate payroll estimates.

From the standpoint of the ability to take rate increases, certainly in homeowners we have had a number of rate filings over the last 12 months in almost all of the states in which we do homeowners business. And we are currently working on another round of rate increases that depending upon the state will range anywhere from 5% to 10%.

Agencies generally are acceptable of aggressive rate increases in homeowners. Commercial, it depends upon the size of the account. And in general, we are attempting to get somewhere between a 3% to 5% increase on individual commercial policies, needless to say, we don't always achieve that.

From the standpoint of our own book of business, commercial lines has grown nicely for us, 10.2%, not including the favorable impact of Michigan Insurance Company. From the standpoint of combined ratios on a statutory basis, our combined ratio for commercial lines came in at 93.9%, which is very favorable. And certainly in workers' comps, we are very pleased with our results there. Our combined ratios, on a statutory basis, are less than 90%.

Correspondingly though, in homeowners as an example for the quarter, our combined ratio, on a stat basis, 147%, which demonstrates the significant impact of weather on our property book of business.

Let's give you a little update on the Michigan Insurance acquisition, which as you know was the largest acquisition that we have done over the years, it is going quite well.

Michigan Insurance Company's second quarter stat combined ratio was 98%, which is very good. We are, I think, doing well in terms of continuing for Michigan to build relationships with its agency force. From the standpoint of the system integration, as far as the IT system, we have a very major project that we would have reported on at the end of the first quarter. And we are making excellent progress on that. We would expect by October to be generating all of their new business on our WritePro, WriteBiz and other systems.

As far as Michigan and what we are introducing there and what they are introducing, they took some rate increases in homeowners and auto in the last 45 days. And we will be working with them as part of the roll out of their company on to our systems, a new predictive modeling system for them, very much mirrored after the Donegal Insurance Group system.

Some business initiatives and other items outside of Michigan that we are doing, talking about retention rates. We're certainly very pleased to report that our retention rates on commercial lines is about 85%, 84.9%, personal lines, it's 89.3%, certainly favorable in this environment. We're also pleased to report that we have a significant increase in fee income for the quarter. It is up 37% over the same quarter a year ago.

From the standpoint of enhancing our overall technology in the second quarter, we have fairly well completed the roll out of change processing, which is basically processing all commercial endorsements on our WriteBiz system, which is a major enhancement. Many carriers do not have this functionality. And within the last 30 days, we have introduced auto prefill, which is a very slick addition to our WritePro where the agent knows the name, address of an applicant, but doesn't have, as an example, their cars or their drivers. We automatically, based upon the name, address can provide that information. It is very helpful to agencies in terms of the speed with which they can do a quote. And we are optimistic that it will help with our quote activity and we also believe with increased issuance.

New agency appointments in the quarter were 53, in the first quarter it was 52. So we continue a very positive trend there.

From the standpoint of acquisitions, as you know we have been an active Company in that regard over the last number of years. Our structure, basically of an affiliation with a mutual company, provides excellent flexibility and how we go about that. Needless to say, we are currently focusing on integrating Michigan and do not have any acquisitions that are well advanced, but we do have the capital and the capacity to acquire additional companies. And we are always in conversation, so that we build over time a pipeline in order to do what we think is an important part of our strategy.

At this point, I would like to turn it back to Jeff, and we will be pleased to respond to questions.

All right. Thank you, Don.

Kenya, if you would open the line for questions please?

(Operator Instructions). We have a question from the line of Matt.

Don, Jeff, good morning. Can you hear me?

Good morning.

Yes, good morning.

Okay, great. Couple of questions, I guess, obviously with all the weather and you guys fared much better than a lot of the other regional companies out there. Don, I was wondering if you could talk about your thoughts on, sort of, the reinsurance that not only that you have in place, but what you think the reinsurance landscape will look like coming next year and have you considered revising that, given the experience this year?

And then I also wanted to get your thoughts on, it seems like most regional companies that had business in the Midwest, obviously were hurt by the storms, but it wasn't necessarily the states' specific locations, it was more the concentrations within certain states. I'd like to hear your thoughts around limiting concentration, things like that for underwriting purposes?

Sure. Let's address first the reinsurance area. Needless to say, what transpires with the further cat in the continental United States throughout the rest of the year is going to have a major role in what happens in the renewal season for reinsurance.

And as you all know, we are just starting into the hurricane season. So depending upon what happens there, clearly, based upon the cats up to this point, I would have to conclude that there will probably be some firming in the reinsurance market. However, up to this point, I don't believe that it has been as significant of an event that it's going to materially impair the capital of any reinsurers or any significant number of reinsurers.

So my hope would be that there will not be, based upon this cat activity, significant rate increases from reinsurers.

From the standpoint of our own program, we believe that it is very well structured. As a reminder, we have a cat retention of $5 million and for any particular cat loss and relative to our capital and surplus, that's a relatively conservative number. And we would not have any plans, at this point in time, of increasing that.

We have in the last number of months, taken a look at Version 11 of one of the modeling companies, RMS, and we have increased the top layers of our reinsurance. However, we would not contemplate doing anything with the retention.

With regard to concentration, we are monitoring that very closely. We have the necessary access to software to monitor that. One of the things that is certainly happening as you aggressively raise homeowners' rates, it has a tendency to somewhat slow down the influx of new homeowners business, although, we continue to write our fair share of it.

We will continue to monitor it. As a reminder, we, for instance, recently notified the state of Oklahoma and our Oklahoma agents that we would no longer be writing property business in that state. We are, by intention, staying away from some of the most cat prone tornado, hail prone states such as Missouri, Oklahoma, Kansas, down into some of those areas. We are not at this point looking to significantly increase our property writings in states like Alabama. We exited North Carolina from property business, from homeowners' property business about two years ago.

So we are very on top of concentration.

Okay, great. And then, just -- notice you guys had bought back some shares, you hadn't done that for few years, is that something that we can expect to see, I guess, more of until the market kind of sells out after all these storms?

I would anticipate that based upon market conditions that we would again be somewhat more active in repurchasing our shares than we would have been in 2010.

Okay, great. Thank you, guys.

Thank you.

(Operator Instructions).

As we pause for a few minutes just to see if any other questions are queued. Just want to maybe give a little more color on those comments that Don made about the reinsurance change.

We did do an extensive analysis of the RMS Version 11, changes to their model and looked at the PMLs, which of course increased fairly significantly for companies that are doing business in the mid-Atlantic part of the country and the Southeast. And particularly these models, of course, projected higher losses in land and certainly because we do not do a lot of business along the coast that would impact our Company.

So after we reviewed that analysis we, like others, questioned somewhat the validity of the increased PMLs, but nevertheless decided that it would be prudent to purchase some additional coverage to maintain the same conservative or at least a conservative level of reinsurance limits relative to the average of the RMS Version 11 and the [AIR Version 12], which is another model that we use.

And so we added $35 million to the $95 million of coverage we previously had in place, which represents near a one in 250 year event, when averaging two models. So at that level our reinsurance continues to provide a conservative level of catastrophe coverage relative to rating agency expectations. And we believe exceeds the levels of coverage that are generally maintained throughout the industry.

So hopefully, that helps just to give some additional color on the reinsurance model changes and what we've done to address them.

Seeing no questions in the queue, Kenya, I believe, we're ready to wrap up the call.

Okay. At this time, there are no questions in queue.

Thank you, everybody.

We thank everyone for participating. Have a good day.

This concludes today's conference. You may now disconnect.