Donegal Group Inc (DGICB) 2017 Q2 法說會逐字稿

Good morning. My name is Heidi, and I will be your conference operator today. At this time, I would like to welcome everyone to the Donegal Group Inc.'s Q2 2017 Earnings Conference Call. (Operator Instructions)

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

Thank you, Heidi. Good morning, everyone, and welcome to the Donegal Group Conference Call for the Second Quarter and First Half ended June 30, 2017. I will begin today's call with commentary on our quarterly financial results. Kevin Burke, President and Chief Executive Officer will then discuss our current business developments and growth initiatives. Following that, our Chairman, Don Nikolaus, will share his perspective on our ongoing business strategy before we open the line for questions.

You should 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. Please refer 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 available in the report on Form 10-K that we submitted to the SEC. You can find a copy of our Form 10-K in the Investors section of our website under the SEC filings link. Further reconciliation of non-GAAP information, as required by SEC Regulation G, was provided in our news release, which is also available in the Investors section of our website.

With that, let's move to a discussion on Donegal's operating results. Our second quarter was highlighted by 2 main themes. First, continued and balance premium growth in our core markets. This growth was driven by our commitment to leveraging our regional strategy to offer individuals and businesses a broad base of insurance products in the markets we know well. Second, a higher frequency of weather-related claims and higher-than-normal fire losses prevented us from reaching our profitability goals during the period. Kevin will go into greater detail on our top line growth, but let me provide additional color on the losses we incurred during the second quarter.

Our statutory combined ratio increased to 104.5% for the second quarter 2017 compared to 95% for the second quarter 2016. The main driver for that increase was the weather impact to our statutory loss ratio, which increased to 72.9% compared to 63.8% for the prior year quarter. Weather-related losses added approximately $20.1 million to our losses incurred for the second quarter 2017, including a provision of approximately $3.6 million for additional weather-related losses incurred, but yet -- not yet reported, and approximately $2.7 million from events that occurred during the first quarter.

The company's previous 5-year average for second quarter weather-related losses was $10.5 million. Weather-related losses contributed 11.5 percentage points to our loss ratio for the quarter compared to 6.9 points of our loss ratio for the second quarter of 2016. The losses resulted from numerous wind and hail events throughout the quarter and were not attributable to any one major storm event or a specific geographic region. In fact, none of the loss accumulations from any of these events exceeded or are projected to exceed our $5 million third-party catastrophe reinsurance retention.

Our homeowners line of business took the brunt of the weather loss impact during the quarter. And from a longer-term perspective, that line of business has performed well in recent years, and we continually review our property risk profile to ensure appropriate diversification of geographical risk and rate adequacy.

In addition to the weather impact, we incurred a higher-than-normal incidence of fire loss activity during the quarter. Large fire losses, which we define as individual fire losses in excess of $50,000, totaled $7.6 million for the second quarter of 2017 or 4.3 percentage points of our loss ratio. That amount was substantially higher than the fire losses of $3.7 million for the second quarter of 2016 or 2.3 percentage points of our loss ratio, with the increase primarily in our homeowners line of business.

We've reviewed the claims and we did not note any particular trend or pattern in the data. The causes range from typical electrical fires, cooking accidents and careless smoking, even to an unusual garage fire that resulted when a homeowner was attempting to smoke out groundhogs on his property. So the volume of fire losses we incur in any given quarter tends to fluctuate, and unfortunately the volume was higher than normal in the current quarter and comparatively higher than the prior year second quarter when our fire losses were below historic norms.

We were pleased that our workers' compensation line of business continued to perform well, while the decrease in net premiums written in that line reflected increased competition for quality accounts. On the other hand, commercial auto underperformance continued, driven primarily by reserve increases related to certain prior year liability losses, for which we received additional information during the second quarter and expect will ultimately cost more to settle than we had anticipated.

We've been working to improve the profitability of our commercial automobile line of business and we've implemented rate increases for that line in all of the states in which we conduct business, in addition to reviewing large claims and implementing enhanced underwriting procedures and controls.

Development of reserves for losses incurred in prior accident years added 3.3 percentage points to our loss ratio for the second quarter of 2017, compared to 2.3 percentage points of our loss ratio for the second quarter of 2016. In addition to the reserve increases for commercial automobile liability losses that I already mentioned, the development in the second quarter 2017 related to higher-than-anticipated severity in commercial multi-peril liability claims and modest increases in case reserves or personal automobile liability claims, primarily related to accident year 2016, offset by lower-than-anticipated severity in prior years' workers' compensation losses.

Our statutory expense ratio was 30.9% for the second quarter 2017, consistent with 30.7% for the second quarter 2016 and in line with our expectations.

I'll take just a moment to highlight our investment performance for the period. Net investment income increased 5.7%, largely due to an increase in average invested assets relative to the prior year second quarter. Net realized investment gains were $1.1 million for the second quarter 2017 compared to approximately $715,000 for the second quarter 2016.

Our yield and duration have remained consistent over the past several quarters. While we've benefited marginally from the higher short-term rates we're receiving on our cash and short-term investments, longer-term reinvestment yields for bonds remained lower than the yield to maturing bond investment.

As a result of the combination of various factors I highlighted, we had a net loss of $2.3 million or $0.08 per diluted Class A share for the second quarter of 2017 compared to net income of $8.6 million or $0.32 per diluted Class A share for the second quarter 2016.

At this point, I'll turn the call over to Kevin for his comments on the quarter.

Thank you, Jeff. Before I discuss the details of our quarterly results, it's important to acknowledge the hard work and dedication of our claim staff and our independent agents during periods like our second quarter. Providing exceptional claim service over a prolonged period of severe weather like Donegal experienced in the second quarter can often be more challenging in servicing one large event in a particular area. Because of our claims automation, we have the capability to balance incoming claim workloads among all of our regional claims operations. Our responsiveness to our policyholders and agents at the time of a claim is critically important, as we deliver on our promise to be there when it matters most. We have viewed the unfortunate weather-related issues as an opportunity to prove to our policyholders, agents and stockholders that Donegal delivers.

Turning to premium growth we achieved in the second quarter. We are pleased to report premium growth continued in both commercial lines and personal lines and the momentum we gained in the first quarter continued in the second quarter. We achieved a 7% increase in our net premiums written to $190.8 million for the quarter with 4.7% growth in our commercial lines and 8.9% in our personal lines.

We are actively monitoring our growth rates in both commercial lines and personal lines and making specific underwriting and rate adjustments to achieve the desired balance within our overall book of business. Balance is an ongoing strategic objective. As we continue to grow our market share, but at the same time recognize we need to take additional rate in certain lines such as personal auto, commercial auto, where our results have not met our expectations. While some of the quarterly premium growth came from rate increases, the majority of our growth was related to the writing of new accounts as our independent agents continue to increase their commitment to us.

Within the commercial segment, we are continuing to see opportunities to obtain modest renewal premium increases with increased competition for quality accounts. Our renewal premium increases during the second quarter generally range from 3% to 5%, which is consistent with the past several quarters.

Workers' compensation was the exception to that range, as various regulatory actions and competitive forces have put pressure on rates. We are taking action to maintain quality accounts in an increasingly competitive market for that profitable business. Our workers' compensation products, which we provide predominately for small-to-midsize businesses continue to perform very well in the second quarter and the first half of the year. We continue to benefit from continuing trend of lower claims frequency within indemnity and medical claims. We feel that our proactive approach to claims management has also had a positive impact on the results.

Our commercial lines retention levels remain strong through the first half of 2017. Our policy retention is in the mid-80% range, which has been our historical average and we believe we are in excellent position within the marketplace to continue to profitably grow our commercial lines.

In personal automobile, we have implemented and we'll continue to file rate increases in the mid- to upper single-digit range depending upon the state and subsidiary. Market condition support more aggressive automobile pricing, and we are being selective in the areas where we are taking rate increases. Personal lines retention levels remained strong with retention in the high 80% range.

Over the last few years, we invested considerably in technology that has both improved our agency-facing portals for quoting and underwriting our commercial and personal lines products as well as enhancing our claims management and billing activities.

Last quarter, I highlighted the implementation of our commercial auto predictive model, which specifically identifies predictive factors that correlate to higher loss ratios. We expanded the implementation during the second quarter to all states and expect to realize benefits from the underwriting enhancements in the coming months and quarters. We believe the combination of rate adequacy and underwriting refinements will begin to show tangible results through our Donegal's auto book in future periods.

We are pleased to announce that Donegal has expanded its geographical footprint with our entry into the State of Illinois. We recently entered the State of Illinois and have appointed 11 independent agents that will represent Donegal. We will take a conservative approach as we build the Illinois book of business, and believe that we have appointed agents that understand our underwriting appetite. Illinois will be part of our Ohio, Indiana region, and we look forward to the profitable growth opportunities this state will provide.

At this point, I'll turn the call over to Don Nikolaus for his comments before we open the lines for questions. Thank you.

Thank you, Kevin and Jeff. Good morning, everyone, and welcome to our earnings conference call.

Over several years, I have mentioned to our stockholders that one of our most important metrics is book value appreciation over time. At June 30, 2017, our book value per share increased to $16.23 compared to $16.21 at December 31, 2016. This is even in the face of a second quarter loss.

Unrealized gains within our available-for-sale investment portfolio increased modestly, and we believe that the premium growth that we have maintained reflects the appropriate combination of rate adequacy and new business.

We were pleased that during the first half of 2017, Donegal continued to increase book value in spite of the unusual weather-related and other loss factors that Jeff and Kevin discussed. We are committed to delivering underwriting results that outperform the insurance industry, and we, of course, have referenced that in the past.

Combined with solid investment returns, who help deliver our goal of superior book value appreciation over time. Needless to say, the insurance market with the weather conditions had some additional complexity, but we believe that we are well positioned going forward to take advantage of the circumstances. And in our business, as many of you know, weather is going to occur from time to time. And the important thing is not that the weather is bad in any one particular quarter, but whether the company from an underwriting standpoint is structured to handle it and how we respond to it.

At this point, we would be glad to respond to any questions that you might have.

(Operator Instructions) Your first question comes from the line of Christopher Campbell with KBW.

My first question is on DGI's premium growth, which was a little bit heavier in personal versus commercial lines than I would have expected. And Kevin, you had mentioned in the introductory comments about balance. So I'm just -- and historically, I think you guys have said that you want to be a little bit more focused on commercial lines growth. So just with the most recent data points, what are your current thoughts on the relative growth between the 2 segments?

Chris, thanks for the question. Absolutely, our goal is to really bring this entire book of business into balance, where we are split 50% commercial lines and personal lines. Given the second quarter results, including the first half of the year, the personal lines business has continued to grow. There's a number of reasons for it from our perspective. There has been some disruptive action in the marketplace. We have talked about that a little bit before. Whether it's a national or regional carrier taking very, very aggressive stance on rate taking. So we've also had some particular carriers remove themselves from various states. And what that has done is, it's created an opportunity where business is flowing our way probably at an accelerated rate that we didn't really anticipate. From our perspective, there is a silver lining to this. And that is, as we are aggressively taking rate in private passenger auto, in particular, we have taken rate anywhere from 2.5% up to 9%, given the various regions and locations. As that starts to filter through the book, we think that we will start to see a very nice lift from the rate taking from an earned premium standpoint. Ideally, Chris, we would like to see our commercial lines grow at a faster pace than it has. We've had a lot of success the last 2 years. And this past quarter with personal lines growing at the rate that it has, I think part of it is reflective of some of the disruption in the marketplace and agents are moving some of that business to Donegal.

Great. That's very helpful. And just kind of a follow-up question on the -- especially the personal auto. Is there -- so it sounds like there is more business that has come -- that Donegal is getting a chance to see. Is your conversion ratio changing? And what I mean by that is just the number of policies that you're buying versus what you quote? Is there any change in that metric as well?

There is not. And I think that's an important piece to remember. Despite maybe some of the disruptions that are happening in the marketplace, and again as it relates to private passenger auto, the Donegal process for underwriting an account, looking at it before we buying coverage has not changed. So it's important to recognize that we may have agents that come to us and say, particular national carrier maybe do something very aggressive or extreme, we're not interested in rolling a book of personal lines business into our portfolio. Our phrase is that, we're open for business. And so that book of business will be put through the same underwriting criteria and discipline that we would put a single account through. And so the uptick that you're seeing is not that we've changed anything in terms of our underwriting appetite or flexibility. We're underwriting to profitability, but we have seen that uptick and we believe that it's something that with our rate increases that we are going to continue to take that should level out over the next few quarters.

Great. Yes, just shifting to workers' comp. This quarter, the premium growth was negative and the staff combined ratio was up about 470 bps, which I guess includes the reserve -- the modest reserve benefit? Can we get more color what's driving the premium trends and then the lower underwriting profits? And then what would the workers' comps staff combined ratio have been, like excluding the reserve development?

From a premium standpoint, Jeff is going to talk a little bit about some of the loss ratio issues there in earnings. On the workers' comp, Chris, we're seeing competitive -- very aggressive competitiveness as it relates to the workers' comp business. As you can imagine, workers' comp line has been a very profitable line for many carriers for multiple quarters. And as a result, as various carriers are seeing some of the erosion in profitability whether it's commercial, auto or private passenger auto, they have ratchet it up the pressure in terms of some of the workers' comp. We believe that some of the lower numbers as it relates to that is some of the business we just simply, we're not going to price it at a lower rate. And so from an underwriting standpoint, we make sure that we had discipline. And that if there is a slight downward turn in workers' comp from a premium standpoint, we want to make sure that we're not necessarily chasing rate and underwriting a piece of business that we don't think is profitable. So it's increased pressure from a competitive standpoint.

Chris, this is Jeff. On the losses, the favorable development in the first quarter represented about 5.6 points on the loss ratio, so it would have reduced the overall combined ratio during the quarter by about 5.6 points. And the uptick relative to past periods is that, that favorable development was somewhat lower than what we would have seen in the first quarter of 2017. It's consistent. Actually, a little bit better than what we saw in the second quarter 2016. We've -- so we've seen favorable development pretty consistently in workers' comp over the past several quarters, but not quite as high in the second quarter 2017 as in the first quarter. So if you're looking at it on a comparative basis, quarter-over-quarter that would account for the difference in the loss ratio.

Right. So would it be fair to say that the core loss ratio, if we back out the 5.6%, that's increasing and that's as a result of just the increased competitiveness in the line?

I would say it hasn't changed significantly. The core loss ratio continues to be very good. We track large workers' comp losses, which again we would consider large loss over $50,000, and they were very consistent during the quarter. So the premium differential was on the written side, not necessarily on the earned side. So I think overall we would say the results are fairly consistent with the difference being the fluctuation in the prior year losses.

Okay. And then just one follow-up one for Kevin or Jeff. Just if there is lower workers' compensation because of increasing competitor -- or increasing aggressiveness in pricing from competitors? Is that going to hurt the -- given your account selling strategy, is that going to hurt any of the -- your selling efforts in auto or CMP?

We don't believe that it is. So I mean, it's a very valid point. We think that as we move forward, we're going to continue to sell and use it as an account writing. But I don't believe that it's going to be a major issue for us.

(Operator Instructions) Your next question comes from the line of Bob Farnam.

I kind of have a question on the technological advances that you guys have been working on over the last few years. And it's maybe difficult to answer, but I'm just curious if you've seen any benefits or fruits to your labor behind the scenes? I know the cat losses, the weather losses and development distort things, but I'm just curious if you starting to see any improvements because of the technology?

Bob, this is Kevin. Thank you for the question. We have. Let's talk specifically about private passenger auto since that is the area of focus of the industry and rightly so. Several years ago, we moved forward with, what we call, risk index scoring as a result of predictive analytics. And what we have done is number one, all of our new business has a scoring associated with it. And in the past 6 months, our personal lines underwriting department has really looked at the higher risk scores, what we would categorize as 9s and 10s. These are risk index scores, Bob, that tells us that we have perhaps underpriced that particular category of business. And so there's been really a deeper dive in the last couple of months by our entire personal lines underwriting department to look at those risk index scores of 9s and 10s. We think that it's relevant because we're really going to be able to start to hone in on may be some different business that either needs additional rate and/or needs a different -- needs to be driven to a different score level, where there would be rate attached to it. So we're starting to see some additional deeper dive, if you will, as it relates to predictive analytics. And we're -- our hope is, in combination with that and then being able to take additional rate with the market will bear, we think that over period of a number of quarters, we should start to see the result of that.

And I would assume since you're starting with the commercial auto side as well that you'd expect to start seeing some improvement there over the next few quarters?

Absolutely. The same process is being undertaken in commercial auto. In homeowners, as far as, again, the risk index scoring from predictive analytics as a result of that, is also in pilot. And so we're really looking to ratchet. The work that we put in over the last couple of years really putting it to tangible work, so we're starting to see the results from a profitability standpoint.

This is Don Nikolaus. Let me add a little bit of additional flavor to this. I think that what we are also seeing is that agents recognizing that our company has invested substantial amount in technology and that they are recognizing us as a company that is gaining and making progress with this technology. So at the end of the day, that's important because agents want to be associated with company that are in the forefront of technological advances. So I think we're getting some of the benefits of that and that will play out over time.

And there are no further questions in the queue.

All right. At this point, we'll thank everyone for your participation and talk to you next quarter.

Thank you, everybody.

Thank you.

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