Donegal Group Inc (DGICB) 2014 Q4 法說會逐字稿

Good morning. My name is Tanya, and I will be your conference operator today. At this time, I would like to welcome everyone to the Donegal Group Inc. quarter-four 2014 earnings conference call.

(Operator Instructions)

Thank you. Jeff Miller, Chief Financial Officer, you may begin your conference.

Thank you. Good morning, everyone, and welcome to the Donegal Group conference call for the fourth quarter and year ended December 31, 2014. As introduced, I'm Jeff Miller, Chief Financial Officer, and I will begin today's call by discussing highlights of our quarterly and full-year financial results.

Kevin Burke, Chief Operating Officer and Acting Chief Executive Officer, joins me on the call this morning. Kevin will provide additional commentary on the quarter and an update on our current business trends. Don Nikolaus, our President and Chairman, while officially on a medical leave of absence as CEO, is back in the office regularly now, and we're pleased to have him joining us on the call today as well.

Please be aware that certain statements made in our news release and in this conference call are forward-looking in nature and involve a number of risks and uncertainties. We refer you to our news 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 included in our 2013 Form 10-K, which is available on our website under the SEC filings link. We plan to file our 2014 Form 10-K within the next few weeks.

Reconciliation of non-GAAP information, as required by SEC regulation G, was provided in our news release, which we've also made available in the Investor section of our website.

Turning to our fourth-quarter results, we had $4.5 million in net income, and $3.9 million in operating income. With a 101.8% statutory combined ratio for the quarter, our underwriting results did not meet our expectations. And I will provide more details about the increased non-weather claims activity as compared to the prior-year quarter in just a moment.

For the full year of 2014, our net income was $14.5 million. And our statutory combined ratio was 100.5%. Catastrophe losses and reinstatement premiums from weather events in the first half of the year contributed 2.6 percentage points to our 2014 combined ratio. And it accounted for most of the increase from our 97.4% statutory combined ratio for 2013.

Turning back to the fourth quarter, from a revenue perspective, earned premiums grew by 8.4% and net premiums written grew by 9.4%. We continued to benefit from premium rate increases, new commercial lines business growth, and the additional contribution from a reduction in Michigan Insurance Company's external quota share reinsurance. Kevin will talk in a few minutes about our growth initiatives and our ongoing marketing efforts across our operating regions.

Let's walk through some of the loss trend details for the fourth quarter. Beginning with weather losses, we incurred $4 million of weather-related losses during the quarter. That amount was less than the $4.6 million of weather losses we incurred during the prior-year fourth quarter, and reflected the absence of catastrophe weather events in our operating areas.

The fourth quarter is typically quieter for our operating regions from a weather perspective, and we were pleased that trend continued again this year. Large fire losses were $7.1 million for the quarter. And that was in line with the prior-year quarter as well, with $5 million in our homeowners line of business, and $2.1 million in our commercial property line.

We typically see a modest increase in fire losses as the heating season begins, but fire losses fell within our expectations for the current quarter. Our homeowners results were favorable, with relatively calm weather and the continuing benefit of premium rate increases and other underwriting actions contributing to a 93.4% combined ratio in that line.

But our personal lines combined ratio rose to 106.5% for the quarter, as a result of unfavorable personal auto results, which we attribute to an increase in personal auto liability loss severity that exceeded our expectations. The largest component of the severity was due to increases in case reserves during the quarter on a number of 2013 and 2012 claims, spread across several of our insurance subsidiaries and geographic regions.

While the increased reserve activity contributed to a disappointing increase in our personal auto combined ratio, we continue to see improving loss reporting trends within that line of business, including a meaningful reduction in the number of reported bodily injury claims during 2014, which provides a level of optimism as we move into 2015, since there are fewer claims to develop. But we'll be monitoring the reserve activity closely to ensure that we are responding appropriately to any trend indications.

Our commercial lines combined ratio was favorable at 95.1%, even with an uptick in the commercial auto combined ratio that reflected increased severity in that line of business as well. The increased severity in commercial auto was weighted to a handful of current-quarter claims rather than the development of previously reported losses.

For both auto lines, we will continue to increase premium rates and take other appropriate underwriting actions to restore those lines to profitability. And as we continue to utilize and enhance our predictive modeling tools, we expect to heighten our ability to identify specific products, tiers and geographic areas that warrant underwriting adjustments or rate actions.

We saw a continuation of positive trends in our other commercial lines of business through the fourth quarter, with workers' compensation posting an 86.6% combined ratio for the fourth quarter, and a solid 91.1% combined ratio for the full-year 2014. Likewise, we achieved an excellent 88.7% quarterly combined ratio in our commercial and multi-peril line.

While we had hoped for a stronger finish to the year, especially in light of the weather challenges we faced in the first half, we are optimistic as we move into 2015, and believe that we're in a stronger position to generate underwriting profits. As you may remember, we began 2014 with unprecedented freezing weather claim activity in early January, which created a significant obstacle to overcome from a financial performance perspective.

We are pleased to report that our January 2015 claim experience was quite favorable, with limited weather impact. We write a limited amount of business in New England, with no Massachusetts exposure, so the extreme snowfalls in that region will not impact us. However, as we speak, much of the eastern part of the country is enduring record-low temperatures, and the winter is far from over. Nevertheless, we're certainly pleased that the year 2015 has begun on a much more positive note than 2014, from a claims perspective.

And just a few comments on the investment portfolio. Our fourth-quarter net investment income increased by 2.8% over the fourth quarter of 2013, largely due to an increase in dividend income, as we have allocated a higher percentage of the portfolio to equity securities.

For the full-year, net investment income was down 2.4%, which is an improvement over the 7% decline we experienced in 2013. The slowing decline for the year and modest increase in investment income for the fourth quarter both reflect the benefits of our strategy to stay as fully invested as possible and to act on investment opportunities in our targeted asset classes that the market presents from time to time.

Our book value per share increased to $15.40 at December 31, 2014, from $15.02 at the prior year-end, primarily as a result of our increased net unrealized gains in our securities portfolio. We declared regular cash dividends in October and December, consistent with our past practice, and we did not repurchase any shares in the quarter.

I'll now turn the call over to Kevin for his comments on our premium growth and ongoing marketing efforts. Kevin?

Thanks, Jeff. Good morning, everyone. I will review commercial and personal lines underwriting segments of our business, as well as touch upon our expanding agency distribution system, and provide a brief update on the technology enhancements we look forward to implementing in the coming months.

Overall, we are pleased with the continuation of 2014, of the premium growth we have achieved in recent years. The full-year net premiums written increased 8.6% as compared to 2013. The fourth quarter's net premiums written grew by 9.4% as compared to the fourth quarter in 2013. This increase represented a combination of 16.7% growth in commercial lines and 4.8% in personal lines.

We are optimistic as we move forward into 2015 that our continuing premium growth will enhance our potential to generate a higher level of underwriting profitability. We routinely review rate indications market data as we focus on rate adequacy and quality underwriting to achieve our target of profitability levels in both commercial lines and personal lines.

As Jeff has mentioned, our commercial lines business performed well in the fourth quarter, achieving a combined ratio of 95.1%. In personal lines, we did not achieve the underwriting profitability level we expect. Jeff already covered the underlying reasons for the increase in our personal lines combined ratio for the fourth quarter.

I would like to highlight the fact that we have seen a decline in the frequency of private passenger automobile bodily injury claims during 2014. We have implemented and will continue to file rate increases where necessary. And we will enhance our utilization of predictive modeling tools to refine our pricing and underwriting tiers. We are optimistic that we will begin to see a return to more favorable results in this line of business as a result of these underwriting initiatives.

To give you a sense of recent rate filing activity in personal lines, we continue to file rate increases in homeowners in the 3% to 5% range, depending upon the state and subsidiary. Rate increases in personal automobile range in the low single-digits, depending upon the state and subsidiary. Net premiums written for the fourth quarter increased by 4.8%, with a large percentage of that increase representing increases in rate, versus increases in exposures. In commercial lines, renewal premium increases during the fourth quarter generally ranged from 5% to 7%.

We are continuing to see opportunities to obtain favorable renewal premium increases. We will be closely monitoring our competitiveness within our regional commercial markets. As I had mentioned earlier, we achieved strong growth in commercial lines during the fourth quarter, with net premiums written increasing to 16.7%. We remain committed to sound underwriting principles and loss control initiatives as we move into 2015.

Turning to our marketing efforts, I wanted to highlight the continued expansion of our independent agency distribution system. We continue to identify and appoint new high-quality agents throughout all of our operating areas, placing emphasis on appointing agents that have a commercial lines focus. This ongoing initiative has contributed greatly to the increase in commercial lines premium growth we achieved in 2014. And our expectation is that this will continue into 2015.

In the fourth quarter, we appointed 40 new agents. And for 2014 in total, 163 new agents were appointed. In addition to the appointment of new agencies, we've been working diligently to obtain further growth by enhancing our market position within our existing independent agencies. As a key component of our 2014 and 2015 business plans, we established specific goals to enhance the level of premium written in each of our appointed agents.

As we move agents from their current level or premium strata to the next higher level, we further enhance the overall business relationship between the agent and Donegal. And we have seen the quality and frequency of submissions improve as agencies commit a greater percentage of their business to Donegal.

Moving into 2015, we have started to conduct our annual agency sales meetings, and have recently completed meetings in Georgia, Tennessee and Virginia. We are pleased to report that we had excellent attendance at each of these meetings. Our agency sales meetings vary in size, from 50 to 160 agents attending each of these meetings, based on the various regions. We plan to host 28 agency meetings over the course of the next few months.

We continue to view these meetings as great opportunities to update our agents on product and technology enhancements -- but more importantly, opportunities for our agents to interact with Donegal management and the marketing and underwriting personnel. Those opportunities are invaluable as we promote Donegal to our newer agents and strengthen long-standing business and working relationships.

I would like to just spend a few minutes to discuss a number of technology enhancements Donegal is working on as part of our commitment to leverage best-in-class technology to ensure ease of doing business with our agents and policy holders. We're excited to announce shortly the introduction of WriteBiz 2.0 to our agents. WriteBiz is Donegal's agency interface for quoting our commercial lines business.

As a result of feedback we have received from our agents and focus groups, we have made extensive enhancements to this newest version of our WriteBiz system. The new version is very closely aligned, from a technology standpoint, with our WritePro personal lines system that has been extremely well received by our agents. We will be piloting the new release of WriteBiz with select agents in the coming weeks and anticipate a full rollout in the second quarter of 2015.

We are making great progress on the development of our new billing system, which will ultimately replace our legacy billing applications and provide enhanced opportunities to serve the billing needs of our customers. We expect to gradually roll this new system out to select states beginning in the second quarter of 2015.

We have a mobile application that is currently available in all of the states in which we do business. We are working on phase 2 of our mobile app, which is geared towards the independent agents. When an agent logs in to our mobile app, they will have enhanced abilities to view their book of business, follow up on the status of an insured's claim, obtain billing information, et cetera, all through their mobile devices. We're adding this functionality as a direct result of agent feedback, with a rollout planned in the second quarter of 2015.

At this point, I'll turn the call over to Don Nikolaus before we open the line for questions.

Thank you, Kevin. Good morning, everyone. Jeff and Kevin have given you a very good overview and summary. My comments will be therefore brief. Needless to say, as Jeff has indicated, 2014 did not produce the results that were planned or anticipated. But we are reasonably optimistic that 2015 will be a good year, assuming reasonable weather-related losses.

We feel that all of the actions that we have taken over the last two to three years, whether it be in technology, whether it be in product, the expansion of greater commercial lines exposure; whether it be enhancements to existing products, the distribution system and underwriting action, that we are well-poised. Needless to say, we have a very strong and capable management team, down at the very first level of management. And we have a very dedicated staff of people. All of the aspects of our operations, we believe, are functioning effectively and strategically.

As we have said in the past, the Donegal Insurance Group has a focused and dynamic business strategy for profitable growth, and an expanding distribution system with state-of-the-art technology and committed to shareholder value and success as an independent regional property and casualty insurance group.

One of the other aspects of what we have said is that with the various rate increases that we have continued to take, the underwriting action, we believe that we are well-poised for a successful future.

We'll turn it back to Jeff to begin the question-and-answer session.

Thank you, Don. Tanya, if you would of the line for questions, please?

(Operator Instructions)

Vincent DeAugustino, KBW.

Good morning, everyone.

Good morning, Vincent.

First, welcome back, Don. I hope you're doing well.

Thank you.

To start with, with Kevin, just on one of your points from the prepared remarks, on growing share of wallet with agents. With that resulting in some higher-quality business submissions, should we think about there being any loss ratio improvement lift from that, or is this more of an ancillary side-effect?

I think, Vince -- it's an excellent question.

I think that that's what is expected; that's what is anticipated. The hope is, again, we have not -- what's important is we have not left what we're most comfortable with from an underwriting standpoint. When we look at the growth of the book, we're comfortable with what we're underwriting. And I think that maybe some of the size of the accounts -- our appetite is growing in terms of being able to write some larger accounts. But it's not doing different type of underwriting or getting into different classes of business.

The expectation is, as we go into 2015, those accounts that we are very familiar with and we're comfortable with and that lift should be able to provide some increased profitability for 2015.

Okay. And then you opened up a little bit of a segue into my next question, which was really on the commercial auto side. You mentioned it here. But just curious -- in some of the reviews, looking back at the commercial auto book, if you found that any of that business, retrospectively, has been a little bit heavier, or a little bit more of a specialty flair to it than you originally thought? Or if there was any deviation -- it doesn't sound like it -- but any deviation from that underwriting target?

As you can imagine, when we have a particular line of business that isn't performing to our expectations, we'll spend a lot of time digging into the claims. One of the things that we have not found is that there is any consistency in terms of trends that causes major concern. In terms of -- when you talk about commercial auto, obviously we're looking at rate adequacy. But when we look at any losses within that line or other lines, we're not seeing any trend that causes us concern that maybe we're writing business that we're not typically used to.

So again, we're optimistic there when we look at that -- that the book of business is a book of business that we're very familiar with. And our hope is that some profitability in a couple of those lines will start to come through for 2015.

Vincent, this is Jeff.

If I could add to that -- one of the things we have done in just the last couple of months is to form what we call a commercial auto profit improvement team. It's following a similar model that we had followed a number of years ago when we had some elevated losses in our workers' compensation line, where we had an explicit team that just gets together -- it's a multi-disciplinary team; it has claims people as well as underwriting people, just to make sure we have open communications. They review some of the larger losses, review the classes and products of business where our loss ratios are exceeding our targets, and just making sure that we tighten up any underwriting areas that might need to be tightened up. But there's a lot of analysis and ongoing communication going on in that particular area.

Okay. Thank you very much for that, Jeff. That's helpful. You're right -- on the workers' comp side, the results have been quite good recently. So appreciate that.

This is really small potatoes, but on the DFSC side, with the lease terminations, relative 2015 versus 2014, what should we be thinking about on the cost savings?

Cost savings going forward to the bank are approximately $300,000 a year. Donegal Group Inc.'s percentage of that is 48.2%. So there will be some ongoing cost savings. It won't be material to the results that Donegal Group is posting. But there were some legacy issues there that predated our acquisition of Union, and so we were pleased to have the opportunity to extricate ourselves from some of those lease obligations that were in effect. Going forward, it cleans up not only the expense side of their books, but also removes from their obligations some ongoing lease-type things.

So it was a good move from them. It was a one-time hit to the financial results. But going forward, it will save us some money.

And Vincent, we think that it was a very good decision to do what was done. And it will clearly have positive aspects going forward.

Okay, good deal. And then just a last one from me.

On the M&A front, some of the transactions we've seen in the space -- almost all of them have had some type of expense synergy aspect to them. And we look at their earnings levers for insurers -- 10-year -- struggling always to stay above 2, getting a lot of pressure there. Clearly, insurance rates increases are decelerating. For a sub-scale insurer, you'd start to feel the pain on the expense structures more and more.

So I'm just curious if you're seeing any of that play out, and the M&A pipeline maybe getting a little bit more robust?

To this point, we have not seen a lot of activity in the pipeline. You're seeing a lot of M&A transactions on the reinsurance side; not as many on the primary side. So it's an area of our strategy that we continue to focus on. We are interested in doing further acquisitions as opportunities might arise. And we continue to look and talk to various companies. But I would say that that's not a real active discussion at this point.

We really view our opportunities as we go into 2015 on the organic side. We have a lot of momentum with our agencies, as Kevin talked about, in building books of business with commercially focused agents. And really moving them into that next strata, whether they're writing $0.5 million with us and moving to $750,000; they're writing a $750,000 moving to $1 million -- and just really getting that increased loyalty from our existing agents. We see a lot of opportunity there. But will continue to look for opportunities and explore any opportunities that are presented to us on the acquisition front.

Okay, thank you very much, everyone. Take care.

(Operator Instructions)

Well, while we're waiting to see if there is any other questions, let me just give a quick follow-up commentary here on our reinsurance renewal for 2015 -- something that would be of interest to our stockholders. We're pleased to report that we renewed our external reinsurance program for 2015 with relatively favorable terms compared to those in place for 2014. We've locked in the rates for a number of our programs for two years in 2014, so those rates have continued into 2015. And there's no major changes in coverage or reinsurance costs anticipated for those external agreements.

There's one notable exception to that statement, and that is that we've, over the past several years, incrementally reduced the level of Michigan Insurance Company's quota share reinsurance with external parties, with the percentage reduced to 20% for policies effective in 2014. For 2015, we've eliminated Michigan's external quota share reinsurance. And the financial impact of that change is an increase of about $20 million to our 2015 net premiums written. So that means that our consolidated underwriting results will include 95% of Michigan's underwriting results for policies effective in 2015.

And that marks the completion of the growth strategy we had outlined when we acquired Michigan in late 2010, underscoring our confidence in the management and underwriting activities of that major subsidiary. I just wanted to give you that update as we go into 2015.

Vincent DeAugustino, KBW.

Good morning again. Thank you for taking the follow-up.

Jeff, on the reinsurance renewals, just two quick questions. In your mention of favorable terms, was there any CAT hour extension on that as well, or no?

The CAT program -- we had actually negotiated a two-year CAT program on 70% of our program in 2014. We only renewed 30% of the CAT program, which was very helpful, because we obviously had a number of CAT losses during 2014. So that particular element helped us, as far as keeping the rate increases to a minimum. But all of the casualty side and the workers' comp we were able to renew at favorable terms, relatively similar to 2014, with some modest rate reductions in some of the contracts where we'd had favorable loss activity.

But I think part of your question is, were we able to extend the 72-hour to 96 hours?

You got it, yes.

And we were, in a number of the contracts.

Okay. Were those contracts -- I mean, here I'm honestly just thinking about the winter weather impact, and the longer the hour window for winter losses with ice damming and things like that, that's when you see the biggest delays. Is that by geography in Northeast on the contracts, or does it not work that way?

It does not work geographically.

No, the 96 hours is a windstorm window. So that would be for hurricane, for windstorm, hail, that type of loss. But we have actually a -- I believe it's a seven-day window for freezing-type claims.

Seven day, yes. But there is no geographic limitation.

That's correct.

Okay, all right, good to know on the freeze. And I think that wraps me up. So thank you very much, guys. Take care.

Thank you, Vincent.

There are no further questions at this time. I turn the call back over to the presenters.

Thank you. At this point, we're ready to wrap up the call. We appreciate everyone's participation this morning. And we'll talk to you at the end of the first quarter. Thank you.

Thank you, everybody.

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