Erie Indemnity Co (ERIE) 2003 Q4 法說會逐字稿

Hello and welcome to the Erie Indemnity Company fourth quarter and year-end earnings conference. At the request of Erie Indemnity this conference is being recorded for instant replay purposes. (OPERATOR INSTRUCTIONS). Now I would like to introduce your host for today's conference call, Karen Krauss Phillips, Vice President and Manager of Corporate Communications and Investor Relations. Please go ahead, Karen.

Good morning. We appreciate all of you joining us today. On today's call management will discuss our fourth quarter and year-end 2003 results. Joining me are Jeff Ludrof, President and CEO; Executive Vice President and Chief Financial Officer, Phil Garcia; and Jan Van Gorder, Senior Executive Vice President and General Counsel.

Today's prepared remarks will be approximately 30 minutes. Following those remarks we will open the call for questions. We would ask that you please keep to one question and a follow-up. We issued our earnings release and additional supplements yesterday afternoon. If you need a copy of the press release or any of the exhibits, you can find these in the Investor section of our website at erieinsurance.com. We also filed Form 8-K with the SEC. We will file the 10-K by March 4, 2004.

On today's call the management of Erie Indemnity Company will share important information about current and future initiatives being undertaken at the Company. As a result, certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 may be incorporated into their comments. These forward-looking statements reflect the Company's current views about future events and are based on assumptions subject to known and unknown risks and uncertainties. These risks and uncertainties may cause results to differ materially from those anticipated as described in those statements.

Many of the factors that will determine future events or achievements are beyond our ability to control or predict. For information on important factors that may cause such differences, please see the Safe Harbor statements in our latest 8-K filing with the SEC dated February 25, 2004, and in the related press release.

This call is being recorded and the recording is the property of Erie Indemnity Company. It is not intended for reproduction or rebroadcast by any other party without the prior consent of Erie Indemnity Company. A replay will be available on our website today at 12:30 Eastern time. Your participation on this call will constitute consent to the recording, publication, webcast, broadcast and use of your name, voice and comments by Erie Indemnity. If you do not future not agree with these terms, please disconnect at this time. Thank you.

I would now like to turn the call over to Erie's President and CEO, Jeff Ludrof.

Good morning everyone and thank you for joining us on today's call. As Karen said the earnings release was issued yesterday afternoon and indicates that Erie Indemnity Company had a good fourth quarter, with net income up by more than 27 percent to 61 cents per share. Overall for the year net income was up by 16 percent to $199.7 million, with net income per share increasing to $2.81 per share, a company record. And because of these results we were pleased that in December the Company's board elected to increase quarterly dividends to shareholders to 21.5 cents per share and authorized a substantial share repurchase program.

The Board also elected to lower the management fee from 24 percent to 23.5 percent beginning in January 2004. This action allows us to continue to balance the profitability of the Company with the financial strength of the exchange. Phil will get into the details and review the numbers for the comparable time frames in 2002. He will also explain the deferred acquisition costs and deferred income tax adjustments we recorded during the fourth quarter that affected our overall results by 12 cents per share. Both of these adjustments were onetime, non-cash charges.

Before Phil reviews the financials, I will talk about our continued focus on underwriting profitability during the fourth quarter and how that impacted our overall results. I will also share some thoughts on our key initiatives for 2004.

While Erie Indemnity Company shares only 5.5 percent of the Property Casualty Group's underwriting losses, the Company is dependent long-term on the Property Casualty group's underwriting performance. Our commitment to improved underwriting profitability showed promising results during the fourth quarter of 2003.

The Property Casualty Group's reported statutory combined ratio in the fourth quarter was 102.1. This result was due in part to a limited catastrophe impact of only 1.7 points in comparison to Property Casualty Group's third-quarter 2003 statutory combined ratio of 117, which was heavily impacted by Hurricane Isabel and included 12 points of catastrophe.

When adjusted for the profit component of the management fee, which puts our underwriting performance on the same level as our peers, the Property Casualty Group's statutory combined ratio was 96.4 for the fourth quarter, and 103.2 for the year. This is a significant improvement over the year-end 2002 reported statutory combined ratio of 118.5 with an adjusted year-end 2002 result of 111.2. Additionally, our 2003 calendar year results were not materially influenced by adverse development on prior year claims.

We're pleased with our progress to address underwriting profitability in the fourth quarter. We're taking this same approach to improving underwriting profitability as we do in managing the business overall, a thoughtful, deliberate, long-term approach. We have not put our cultural advantages at risk by abandoning markets or lines of business. Our business model remains simple and effective and is solidly based in the relationships we have with our agents, employees and our policyholders.

Our rates remain competitive, including our largest market, Pennsylvania, where the price gap has narrowed. As a result we have tempered some of our original rate increases for 2004 from the 343 million in anticipated additional written premium we announced at September 30, 2003 to $320 million in anticipated additional written premium today.

We're also seeing increased pressure on new policy production as our rates have increased. However, we continue to see pricing discipline in our markets which is encouraging for our focus on underwriting profitability. Our plan remains to balance our focus on underwriting profitability and quality growth.

We do expect our 2004 pricing increases, combined with our careful underwriting approach, to cause new business production to decline from the accelerated growth rates experienced in 2002 and early 2003. Our strategy to focus on core business strengths is starting to share results. Concentrating on re-underwriting fundamentals is beginning to to have an effect on our existing book of business, eliminating underperforming accounts and securing appropriate premium levels for those we retained.

And because of our thoughtful approach, because we place such high value on our people and the relationships we maintain, Erie can continue to provide exemplary service. There is evidence of this in our continued strong retention ratio, finishing the year at 90.2 percent, a number that most of our competitors find enviable.

At the outset of 2003 we told you to expect a drop in Erie's retention ratio, given our focus on improving risk selection, particularly in our commercial lines of business. Our 2003 year-end retention ratio represents a full point reduction from the 91.2 percent at year end 2002. We'll continue our re-underwriting efforts in 2004, and believe this will have a continued impact on our retention ratio.

At year end 2003 policies in force for the Property Casualty Group totaled more than 3.7 million, a 6.7 percent increase over year end 2002. Personal Lines policies were up by 6.6 percent year-over-year at December 31, 2003, with Commercial Lines policies increasing by 7.5 percent year-over-year.

We anticipate that the roll out in 2004 of ERIEConnection, our new agency interface system, may have a short-term impact on unit growth. As with any new system roll out, you can expect a ramp up period with consideration to training and orientation. Once agents become proficient ERIEConnection users the system will support their ongoing sales efforts.

This year we will continue to work to bring down our combined ratio, but our balanced approach involves concentrated efforts on both underwriting profitability and quality growth. We have revised our agent bonus program to incense truly profitable agencies that achieve quality growth targets. We have resumed agent recruitment efforts with plans to add approximately 50 new agencies this year, and continue to move forward with our efforts to obtain our license in Minnesota. We're also working closely with agents to identify other opportunities to enhance efforts to write quality business.

As you can see, we have maintained a disciplined focused approach for long-term growth. And as you'll hear from Phil, we have strengthened the Exchange surplus and positioned our companies for long-term success. Phil, I will turn it over to you to explain the details.

Good morning everyone. Before I discuss the quarter, I would like to talk about FIN 46 and explain why we have not consolidated the results of the Erie Insurance Exchange with the Company, as we indicated we would at the end of the third quarter.

As you know, the Company disclosed in its third quarter 2003 Form 10-Q that under Financial Accounting Standards Board, FASB, Interpretation Number 46, FIN 46, that the Erie Insurance Exchange was a variable interest entity or a VIE. We also stated that the Company was the the primary beneficiary of the Exchange under the interpretation, and must consolidate the financial results of the Exchange with those of the Company.

The Company reevaluated its position in response to a revision made by the FASB to FIN 46 in December, 2003. The FASB revised FIN 46 to provide that only the variability in decision maker fees should be included in the calculation of the primary beneficiary of a VIE. Prior to the change, FIN 46 required that the gross fees paid to the decision maker, Erie Indemnity, should be included in the expected residual returns computation when determining the primary beneficiary. As a result of our recomputation in accordance with revisions to FIN 46, we have concluded that the Company is not the primary beneficiary of the Exchange. Consequently, the results of the Exchange have not been consolidated with the results of the Company for 2003.

Now I would like to discuss the fourth quarter results. As Jeff remarked, fourth quarter was a strong one for Erie Indemnity Company. For the fourth quarter 2003 net income increased by 27.1 percent to $43.1 million or 61 cents per share compared to $33.9 million or 48 cents per share for the fourth quarter 2002. For the full year, net income increased 16 percent to $199.7 million or $2.81 per share compared to $172.1 million or $2.42 per share in 2002.

Net income, excluding the effects of net realized capital gains or losses on investments and related federal income taxes, rose 12.6 percent for the fourth quarter of 2003 to $40.1 million, up from $35.6 million for the same period one year ago. For the full year 2003 net income, excluding the effects of net realized capital gains or losses, on investment and related federal income taxes, grew 7.5 percent to $192.9 million.

The company's financial results were affected by two onetime non-cash charges recorded in the fourth quarter. The first, a charge of 7 cents per share reduces the company's deferred acquisition proposition cost, or DAC assets, recorded as part of the insurance underwriting segment of the Company's operation. Prior to the fourth quarter of 2003 the Company recorded as DAC the management fee paid to the Company by its wholly-owned Property Casualty subsidiaries through their assume share of the intercompany reinsurance pool. These costs were deferred at the full amount of the management fees, which included an intercompany profit component. During the fourth quarter 2003 the DAC was adjusted to reflect only the underlying policy acquisition costs of the Company, of the 5.5 percent pooled business.

The Company also recorded an adjustment for deferred income taxes during the fourth quarter. This non-cash charge reduced fourth quarter earnings by 5 cents per share. The adjustment was made to reflect future tax obligations that will arise when earnings from the Company's equity investment in Erie Family Life Insurance Company are distributed. The deferred tax provision was computed in accordance with GAAP assuming undistributed earnings of EFL would be distributed in the format of dividends.

As I review the management operations, you can refer to the Exhibit, Consolidated Statement of Operations Segment Basis, which was included in the supplemental data issued with the press release. First, I would like to discuss our performance in our Management Operations segment. Management fee revenue grew by 13.7 percent to $206.7 million for the fourth quarter 2003 compared to $181.8 million in the fourth quarter of 2002. For the twelve months ended December 31, 2003, management fee revenue increased 13.2 percent to $878.4 million from $775.7 million in 2002.

The fourth quarter to quarter comparison of management fee revenue was affected by the initial recording in the fourth quarter of 2002 of an allowance for returned management fees of $11.9 million. After factoring in the initial adjustment for recording an allowance for returned management fees, management fee revenue grew at a slower rate in the fourth quarter 2003 than the increase in premiums written.

This was due primarily to the action of our Board of Directors to reduce the fee rate from 25 percent to 24 percent beginning January 1, 2003. In December the Board of Directors approved a further reduction in the management fee rate beginning January 1, 2004, to 23.5.

Direct written premium in the fourth quarter grew by 11.3 percent, totaling $862.3 million compared to $774.8 million a year earlier, down from the 25.7 percent premium growth in the fourth quarter of 2002.

For the years ended December 31, 2003 and 2002 the Property and Casualty direct written premiums of the Erie Insurance Group totaled $3.7 billion and $3.2 billion respectively, an increase of 16.6 percent. The twelve-month policies in force growth rate was 6.7 percent at December 31, 2003, down from 9 percent at December 30th 2003. The year-over-year increase in average premium per policy was 9.3 percent.

In addition, our year-over-year policy retention ratio declined slightly to 90.2 at December 31, 2003 from 91.2 at December 31, 2002. As a consequence of our focus on underwriting profitability initiatives, written premium on new policies decreased by 32.8 percent overall in the fourth quarter, and 13.7 percent for the full year from the very high new policy premiums written in 2002.

Personal Lines new policy written premium decreased by 25.3 percent, while Commercial Lines new policy written premium decreased by 46.4 percent for the three months ended December 31, 2003 versus the same period in the prior year. This direction is in line with the necessary steps we have taken to pursue more profitable business.

Our rating actions in the latter part of 2003 and 2004 will partially offset the impact on premium volume related to these anticipated declines in new unit growth. As Jeff noted, expected rating actions will amount to approximately $320 million in anticipated additional written premium in 2004. At the end of the third quarter of 2003, we announced that rating actions anticipated filed and approved would amount to $343 million in anticipated additional written premiums. We have moderated some of our 2004 anticipated rate increases.

Service agreement revenue decreased for the fourth quarter of 2003 to $7.1 million and $7.4 million during the fourth quarter of 2002. For all of 2003 service agreement revenue totaled $27.1 million compared to $23.7 million for 2002. Included in the service agreement revenue are service charges the Company collects from policyholders who provide an extended payment plan on policies. The service charge revenue for the fourth quarter of 2003 increased 30 percent to $5.4 million compared to $4.2 million for the same quarter a year earlier.

Also included in service agreement revenues is the service fee income received from the Exchange as compensation to the management and administration of voluntary assumed reinsurance from nonaffiliated insurers. These fees decreased during the fourth quarter 2003 as a result of our action to exit the assumed reinsurance business by January 1, 2004. The reduction in service fee income on voluntary assumed reinsurance premiums written by the Exchange was down 48.6 percent to $1.7 million in the fourth quarter 2003 from $3.2 million in the fourth quarter of 2002. Voluntary assumed reinsurance premiums decreased to $27.6 million in the fourth quarter of 2003 from 46 million in the fourth quarter of 2002.

The cost of management operations increased by 15.9 percent in the fourth quarter to $158 million from $136.3 million for the same period in 2002. For the year, the cost of management operations increased to $652.3 million in 2003 compared to $557.4 million in 2002.

Commissions to our independent agency force account for the majority of these costs. Commission costs totaled $113.3 million for the fourth quarter of 2003, an 18.4 percent increase over the $95.7 million recorded for the fourth quarter of 2002. Commission costs in the fourth quarter of 2002 were affected by the initial recording of an allowance for returned management fees, which also required a reduction in commission expense on the returned fees. This reduction in commission expense in the fourth quarter of 2002 was $5.8 million. After adjusting for the returned commission in 2002, commission expense in the fourth quarter 2003 increased 11.7 percent over the fourth quarter of 2002.

We expect recently announced changes to commercial commission to reduce commercial commission expense by approximately $15 million annually based on 2003 commercial premiums written. The majority of these savings will be used to enhance the agency contingency bonus program. Even with the proposed changes to commercial commissions, Erie's commercial commission rates remain competitive. Changes to the agent bonus program will be effective in 2004. Commercial commission rate changes will be effective January 1, 2005.

Other operating expenses, excluding commissions, increased by 11.5 percent to $177.5 million compared to $159.1 million a year earlier. Personnel costs, including salaries and wages, employee benefits and payroll taxes which encompass the largest component of other operating expense increased 18.3 percent to $25.9 million for the fourth quarter of 2003 compared to $21.8 million for the same period in 2002. Salaries and wages rose 12.3 percent to $19.3 million in the fourth quarter 2003.

In anticipation of the projected efficiencies the Company will realize from ERIEConnection, combined with the production effect of our underwriting profitability strategy, we have substantially slowed hiring of personnel in 2004. The increase in personnel costs was driven by salary and wage growth, and increases in employee benefit expenses driven by higher medical and retirement benefit costs. The company self-insures its medical benefit plans for employees and experienced higher utilization rates and medical inflation during the quarter. The Company also experienced increased costs in its group life insurance and workers compensation benefits during the fourth quarter of 2003.

The Company continues to record increased costs for employee retirement benefits under its retirement plan due to a lower discount interest rate assumption. In the fourth quarter of 2003 retirement plan costs increased $800,000 to $1.8 million. For the full year 2003 retirement plan costs increased to $6.6 million compared to $3.5 million in 2002. We anticipate that retirement benefit costs for 2004 will increase by about $3.1 million over 2003 expense as a result of a still lower discount rate assumption for the pension plan. The gross margin for management operations was 26.1 percent for the fourth quarter and 28 percent for the full year 2003.

Next, I would like to discuss our insurance underwriting segment. As you know, the Erie Indemnity Company's Property and Casualty insurance subsidiaries retain a 5.5 percent share of the underwriting results for the Property and Casualty Group. Erie Indemnity Company's reported GAAP combined ratio for the fourth quarter was 115.8 compared to a GAAP combined ratio of 125.3 during the same period in 2002. Excluding the DAC adjustment, the GAAP combined ratio in the fourth quarter 2003 for the Company would have been 100.9.

In total, Erie Indemnity recorded underwriting losses on a net basis of $8 million in the fourth quarter of 2003 compared to losses of 11.2 million for the fourth quarter of 2002. For the year ended December 31, 2003, the underwriting loss totaled $24.9 million, an improvement from the underwriting loss of $27.1 million in 2002.

Investment operations recorded income of $21.8 million during the fourth quarter compared to $8 million for the same period in 2002. For the full year, income from investment operations totaled $74.2 million compared to $42.3 million in 2002. Net investment income increased by 3.7 percent to $15.3 million for the fourth quarter 2003 from $14.7 million for the fourth quarter of 2002. In 2003 net investment income improved to $58.3 million from $55.4 million in 2002.

The Company also recorded equity and losses from limited partnerships in the fourth quarter 2003 of $.6 million compared to losses of $4.8 million in the fourth quarter 2002. These losses for the year totaled $2 million compared to $3.7 million in 2002.

The company's earnings from its 21.6 percent equity ownership of Erie Family Life Insurance Company increased to $2.4 million in the fourth quarter of 2003 from $.6 million for the fourth quarter of 2002. The full year earnings from the Company's equity ownership of Erie Family Life totaled $7.4 million, a significant improvement from the 1.7 million recorded in 2002. Strong premium growth in our traditional life insurance product, increases in net investment income, and reduced levels of realized losses on investment contributed to this increase.

In the supplemental information provided with the press release we included selected financial data of the Erie Insurance Exchange. You'll note that the surplus of the Exchange grew 14.8 percent in 2003 to $2.4 billion from $2.1 billion at year end 2002, putting our premium to surplus ratio at 1.5 to 1, a number we're very comfortable with.

Additionally, as we spoke about in the previous quarters, we have reduced the common stock exposure in the Exchange investment portfolio from 2.2 billion at December 31, 2002 to $1.3 billion at December 31, 2003.

We have also completed the transition of investment managers from John Peterson, who retired his consulting position with the Company in 2003, to an initial group of new equity portfolio managers. Finally, as Jeff indicated earlier, the Board authorized the share repurchase program at its regular December, 2003 Board meeting. The Board authorized the repurchase of up to $250 million of the Company's class A common stock through December of 2006. The Company has repurchased shares in the first quarter of 2004.

That concludes our prepared remarks. Cynthia, if you'd could now open the call for questions from our phone audience.

(OPERATOR INSTRUCTIONS). Charlie Gates with Credit Suisse First Boston.

Two questions, one question and my follow-up. My first question, I don't understand the math where you say that the combined ratio of the Exchange would be some 19 percentage points lower if the accounting was similar to that of other property casualty companies. That is my first question.

My follow-up question, to the extent that you are -- you indicated that you were pressing for a lower level of rate increases than before for auto, I assumed, where do you think your auto insurance rates are now versus those of, say, Progressive for the Ultra Preferred Risk, because Progressive, to the best of my knowledge, isn't raising auto insurance?

Charlie, I will answer -- this is Phil. I will answer the first part of the question, and I let Jeff answer the second part. As to the adjustment that we're talking about, when you say a 19 point adjustment, I assume you are referring to the third quarter of 2003?

I thought somebody said that the combined ratio was 115, and that is for basically on a comparable basis might have been 96. That was where I was coming from.

What we said was first of all on a group basis our combined ratio was 1021, on a total group basis. All of our five property casualty insurers collectively had a fourth quarter statutory combined ratio of 1021. From that number you have to take the profit component that we pay Erie Indemnity Company, which is about 5.5 to 6 points. So that is how we get the 96 for the fourth quarter statutory combined.

Then when you look at the Insurance Underwriting segment of Erie Indemnity Company, we had that 1158 included in the acquisition costs in that number is this DAC adjustment we made in the fourth quarter. We increased our acquisition expenses by the $7 million DAC adjustment that we talked about in the release. When you adjust for that, that 1158 becomes 100.9.

Charlie, let me follow up on your question about auto competitiveness. The average rate changes we're making in automobile are about 7 to 8 percent. That enables us to continue to maintain a strong competitive position in each of our marketplace where we operate. In addition to our rate competitiveness, of course, we have a strong reputation for superior products, superior service, local professional and accessible independent agents backed by our employees. So we offer a very strong value proposition. And while that gap is certainly narrowing out there, we continue to maintain a very strong competitive position.

(OPERATOR INSTRUCTIONS). Charlie Gates.

The other question, how much stock did you guys buy back during the quarter?

We're going to disclose that at the end of the first quarter in our Q., Charlie.

That is for the fourth quarter. You'll disclose at the end of the first quarter?

No, the stock we bought --.

I thought that you announced a stock repurchase program last year. I'm sorry.

I'm sorry. Let me clarify. We did not buy any stock in the fourth quarter. Remember that the program was authorized by our Board at its meeting on December -- early December, I believe it was December 8th. So we did not buy any stock under that authorization in the fourth quarter of 2003. My comment referred to in the first quarter of 2004 we have repurchased shares. We will disclose those shares, that share repurchases, in the first quarter 10-Q.

My follow-up question, if you turn to the last page of your news release, which I guess fax copy number 815, you have this huge realized gain of $580 million. If you spoke to that during your prepared remarks, I missed. What is that?

Again, this last page of the press release is selective financial data of the Erie Insurance Exchange, so it is condensed. It is a condensed income statement for the Erie Insurance Exchange and a condensed balance sheet for the Erie Insurance Exchange. The Exchange, as we talked about in the call, had a large common stock element in its portfolio, in excessive of $2 billion.

We have talked about all year in 2003 about transitioning that common stock portfolio and making it a smaller portfolio, which we completed in the fourth quarter. And so to do that we sold quite a bit of our common stocks in the Exchange. A lot of those common stocks had embedded realized gains -- unrealized gains which we realized in the fourth quarter.

(OPERATOR INSTRUCTIONS). We have no additional questions at this time. Ms. Krause Phillips, I will turn the call back over to you for closing comments.

Thank you all so much for joining us this morning. That concludes the call. Again, a recording of the call will be posted on our website, erieinsurance.com after 12:30 PM Eastern time today. And if you have any questions at all, please feel free to call me at 814-870-4665. And thank you again, and have a great day.

Again, this does conclude today's conference call. We do thank you for your participation, and you may disconnect at this time.