Erie Indemnity Co (ERIE) 2004 Q2 法說會逐字稿

Good day everyone and welcome to the Erie Indemnity Company’s second quarter 2004 earnings conference call. At the request of Erie Indemnity this conference is being recorded for instant replay purposes. At this time all participants are in a listen-only mode. Following prepared remarks from management, we will open the call for questions and answers.

Now I’d like to introduce your host for today’s conference call, Karen Kraus Phillips, Vice President and Manager Corporate Communication and Investor Relations. Please go ahead.

Thank you Madania and good morning. We appreciate all of you joining us today. On today’s call management will discuss our second quarter 2004 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 remarks will be approximately 30 minutes. Following those remarks we will open the call for question, we’d 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 the Form 10Q with the SEC. 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 in their comment.

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 and 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 related 10-Q filing with the SEC dated July 28, 2004 and the related press release on 8-K.

In this call we will discuss some non-GAAP measures. You can find the reconciliation of those measures to GAAP measures in the press release and in the supplement posted on our investor website at erieinsurance.com. 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 after 12:30 p.m. eastern time. Your participation on this call will constitute consent of the recording publication, web cast broadcast and use of your name, voice and comments by Erie Indemnity. If you do not agree with these terms please disconnect at this time. And now I’d like to turn it over to Jeff Ludrof, Erie’s President and CEO. Jeff?

Thank you Karen and good morning everyone. As I was driving into the office today I was thinking about this call and reflecting on this past quarter. It’s been a good one, certainly one that has been not without challenges. Erie agents and employees have worked very hard and together we’ve worked the plan. We’re making progress and we’re effectively addressing our challenges. Today I’ll cover where we are on underwriting profitability. The management fee changed, we announced in the press release, Erie’s adoption of insurance scoring and our progress on Erie Connection. Phil will then provide more information on our financial results.

As I said overall it was a good quarter. Net income was up by 4.6% to $57m for the quarter ended June 30, 2004 as compared to $54.5m a year earlier. Net income per share was 81 cents for the quarter up from 77 cents per share for the second quarter for 2003. Direct written premium for the property and casuality group was nearly $1.1b for the quarter up, nearly 11% for the quarter ended June 30, 2003. This translated into management fee revenue for the Indemnity Company of $256.1m up 10% from the comparable quarter a year earlier.

The results of our focused efforts to improve underwriting profitability are having a positive effect. Tn property and casuality groups recorded statutory combined ratio for the second quarter of 2004 was 93.2 when adjusted for the profit paid to the Indemnity Company, the combined ratios falls to 87.3.

On direct business the adjusted statutory combined ratio for the P&C group was 88.3 for the second quarter. Due to the significant efforts by our agents and employees we are hopeful that we will continue this progress even with the approaching softer market and I’ll give you my thoughts on that in just a few minutes. Having the ability to raise and lower the management fee the exchange pays to Erie’s Indemnity Company allows us to balance the interest of our policy holders and our shareholders. Given our considerable progress on underwriting profitability and the related effect upon premium growth, the Board increased the management fee rate to 24% effective July 1, 2004. One of the expected challenges we’re faced with is something I have talked with you about before. A slow down in new written premium because we continue to concentrate on re-underwriting and risk selection. We continue to see moderation of new written premium.

For year ending June 30, 2004, new written premium growth was down 24.5% compared to a decrease of 30.1% for the year ending March 31, 2004. Total premium growth at the end of the second quarter was up by 10.7%. Our policies in force increased by 3.2% as of June 30th 2004, that’s down sequentially from 4.8% as of March 30th 2004 and 6.7% at December 31st 2003. To increase our affected net income and enhance our competitive position we have introduced insurance scoring as an underwriting tool. Agents will begin using insurance scores on August 2nd in most of our territories. We will use insurance scores in conjunction with agents front line underwriting. It will enable us to write business we might not have written all be it at a higher premium rate. We’re also developing segmented pricing models that incorporate insurance scores for private passenger auto and homeowners. We expect to implement these models into our rating plan for these two lines of business in 2005.

I mentioned the oncoming soft market a little earlier and you know that a significant part of our underwriting profitability recovery has been our ability to obtain rate increases. In the past few quarters we have been able to adjust our rate projections downward due in part to our improving loss experience. Last quarter we projected a rate change impact on written premium in 2004 to be $308m. We have adjusted that to $302m based on rates approved, filed and projected. The hard market is definitely waning, given the combined ratios the industry is experiencing and we can expect that pricing will continue to soften in 2005.

This is a cyclical industry, pricing trends tend to repeat themselves, but obviously there are significant differences facing the industry today than there were during the last soft market. Technology wasn’t as sophisticated, pricing models were not as advanced and the raging bull market overwhelmed the move to underwriting discipline. Industry analysts are saying insurers can no longer depend on the stock market to offset underwriting losses. The companies must adhere to underwriting discipline to achieve profitability in a soft market. How our competition will react this, I don’t know. What I can tell you is what Erie will do. We will focus on the fundamentals, maintain discipline in pricing and underwriting and support our agents to achieve quality growth. In essence we’ll stick with the Erie’s solid business model.

We continue to closely monitor our competitive position in all markets and while we remain strong in some markets and segments our position is challenged in others. We believe introducing insurance scoring will help to firm up our position overall, especially combined with our efforts to refine our segmented pricing. We continue to work with agent user groups in the development and deployment of Erie Connection, our new agent interface system. Through usability tests we are identifying system enhancements while a limited roll out continues. The system is now available to agents in Ohio, Indiana, Illinois and Wisconsin and is being used by nearly 1000 of our employees.

Our efforts to recruit new agents continue as well and we’re concentrating those efforts on start up or so called scratch agents. Recruiting scratch agents is typically more time intensive than bringing on established agencies. Therefore we expect to recruit about 40 agencies this year. As I’ve said before we take a balanced approach to underwriting profitability and quality growth. We continue to work with agents to develop effective marketing efforts that support production and retention and we’re evaluating new programs that we believe will have a favorable impact on our agents’ ability to attract the most desirable business.

We will continue to distinguish ourselves in the marketplace through our passion for providing outstanding service to Erie policyholders. We will build upon the strong relationships we have with our loyal Erie agents and continue to place great value on our effective and dedicated Erie employees. And now I’ll turn the call over to Phil

Thanks Jeff and good morning everyone. As Jeff indicated we made substantial strides in our efforts to improve underwriting profitability but we still have work to do as the progress our employees and agents have made in a very short time is remarkable. With the progress we have made we are planning to implement insurance scoring and further refinements of our pricing strategy. For the second quarter 2004, net income increased by 4.6% to $56m or 81 cents per share, compared to $54.5m or 77 cents per share for the second quarter 2003. Net income excluding the effects of net realized capital gains and income taxes on those gains rose 5.2% for the quarter to $55m or 78 cents per share, up from $52.2m or 74 cents per share for the same quarter in 2003. 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 in the press release.

First I would like to discuss the performance in our management operation segment. Management fee revenue grew by 10% to $256.1m for the second quarter 2004 compared to $232.7m in the second quarter of 2003. Management fee revenue grew at slower rate in the second quarter 2004 for two primary reasons, the reduction of the fee rate in 2004 and the reduced volume of the direct premiums written by the property casualties group. The 0.5% reduction in management fee rate represents $10.2 m less in revenue for the first 6 months of 2004, or a reduction in net income of 9 cents per share. If the management fee rates were equal for the comparable periods, the management fee revenue would have increased by 12.4 % during the second quarter 2004, rather than 10% and as you know the Board has revised the management fee rate back to 24% effective July 1st 2004.

Direct written premium of the group in the sarong quarter of 2004, grew by 10.7% totaling $1.1b compared to $973.9m a year earlier. Year over year policies and force growth was 3.2% a slower rate than the 4.8% at the end of March 2004, as our efforts to control exposure growth and approve risk selection has slowed our growth. For the first 6 months of 2004, direct written premiums of the property and casualty group increased 10.9% to $2b compared to $1.8b for the same period last year. The year over year increase in average premium per policy was 8.7% to $1,022 from $940 for the 12 months ended June 30th 2004. The year over year policy retention issue declined from 89.8 at March 31st 2004 to 89.2 at June 30th 2004. The lower retention rate is an expected result of our effort to mange our exposure growth. Another consequence of our focus on underwriting profitability, is a continued decline in new policy premiums, for the quarter new written premium decreased by 19% overall from the high levels of new policy premiums written in the second quarter 2003. Personal lines new written premium decreased by 10.5% while commercial lines new written premium decreased by 33.8% for the 3 months ended June 30th 2004 versus the same period last year. As Jeff indicated earlier, we are seeing a slow down in the rate of decline in both new written premiums and policies in force growth rate. Our underwriting profitability results have been positively impacted by the rating actions we have taken.

The increases in rated have also continued to partially offset the impact of premium volume related to declines in new unit growth. As Jeff mentioned, due to improving experience and ensure our competitive position, we have slightly modified our rate change of projections for 2004 from $308.3m an additional written premium at the end of the first quarter 2004, to a $303.2m estimate today.

Jeff also talks about the impact of the ensuing soft market. We expect an increase in average premium per policy in 2005 of about 5%. Half of which we expect from rate increases and half from higher exposure value. Our rate increase projections obviously may be tempered by market conditions.

Finally during the second quarter management fee revenue was affected by a change in the estimate of the allowance for return to management fee. This adjustment to the allowance resulted in a positive effect of 2nd quarter net income of $0.9m net of the corresponding commission adjustment or 1 cent per share.

Service agreement revenue decreased for the second quarter 2004 to $5.2m from $6.9m during the second quarter of 2003. Included in service agreement revenue is the service fee income received from the Erie insurance exchange, as compensation for the management and administration of voluntary assumed reinsurance of non-affiliated insurers. These fees decreased substantially during the 2nd quarter 2004 due to our winding down of the assumed reinsurance business, for that reason, assumed reinsurance premiums written by the exchange were negligible in the second quarter 2004 from $32.2m in the second quarter of 2003.

Also included in the service agreement revenue are service charges the company collects from policy holders for providing extended payment plans on policies. The service charge revenue from the 2nd quarter 2004 was $5.3m compared to revenues of $4.9m for the same quarter a year earlier up 6.5%.

The cost of management operations increased by 13.3% for the second quarter 2004 to $192.7m from $170.1m for the same period of 2003. Commissions paid to our independent agency force account for the majority of these costs. Commission costs totaled $146.1m for the 2nd quarter of 2004. The 16.6% increase over the $125.3m recorded for the second quarter of 2003.

Commission costs were affected during the 2nd quarter 2004, by charge of $11m for the agency contingency bonus program versus $5.3m in the 2nd quarter 2003. Due to the significant improvement in underwriting profitability.

For 2004, our current estimate is the annual agency contingency award results is an increase in expense of approximately $13m over 2003. This bonus is based upon the 36 month under-writing profitability of the direct business written by the property and casualty group.

Scheduled commissions increased to $129.2m in the quarter, driven primarily by the 10.7% increase in direct written premiums that I referenced earlier.

For 2005 our scheduled commissions will grow more slowly than the increase in direct written premium. This is due to commission reductions in some commercial lines, which we previously announced. This commission reduction will result in an increase in 2005, net income per share of approximately 19 cents.

Other operating expenses, excluding commissions increased by 4.1% to $46.6m, compared to $44.8m a year earlier.

Personnel costs, including salaries and wages, employee benefits and payroll taxes which encompass the largest component of other operating expenses, increased 3.7% to $27m for the 2nd quarter of 2004, compared to $26m for the same period in 2003.

The increase in personnel costs was driven by salary and wage growth of 5.3%.Employee benefit expenses in the second quarter 2004 decreased by 1.8%, compared to the 2nd quarter 2003.

In the second quarter of 2004, pension plan costs increased to $2.4m, from $1.5m in the second quarter of 2003, due to the change in the discount rate assumption within the plan. We expect pension plan costs to be about $0.8m higher per quarter in 2004, than in 2003.

The gross margin for management operations was 26.3% for the second quarter. If the management fee were consistent with last year’s rate, the gross margin would have been 27.8% at the end of the second quarter 2004, compared to 29% in the second quarter of 2003.

Now I’d like to walk you through the results of our insurance underwriting operations. As Jeff indicated, we continue to show significant improvement in the area of underwriting profitability. I must take a moment and congratulate the employees and the agents who have committed so fully to our peak performance plan this year.

Our insurers have depended on - - other insurers have depended on insurance scoring and pricing stratification to drive profitability. We turned to our people first. They have set the course and have opened the door for even greater future success.

Now, we can integrate those tools as a supplement to the initiative and skills of our agents and our employees. As you know, the Erie Indemnity company’s property and casualty insurance subsidiaries retain a 5.5% share of the underwriting results of the property and casualty group.

To give you a better view of our results, I’ll drill down on the statutory combined ratios by the line of business for the property and casualty group. These combined ratios are adjusted results and therefore exclude the profit component of the management fee paid to Erie Indemnity Company.

As we said previously, the reported statutory combined ratio for the property casualty group, was 93.2% for the second quarter of 2004 and when adjusted for the profit component of the management fee, the combined ratio is 87.3% for the quarter.

Our catastrophe experienced during the second quarter of 2004, added 2.2 points to the statutory combined ratio, up from 0.8 points in the first quarter 2004. We are also experiencing positive development on losses of prior accident years through the first six months of 2004, of approximately$100m. This is an early indication to us that the added claimed skill and process improvement efforts, we’ve implemented in the last 18 months, are having a positive.

For the quarter, the property and casualty groups personal lines have an adjusted statutory combined ratio of 87.2%. The group’s commercial line showed significant improvement in the quarter, with an adjusted statutory combined ratio of 91%.

Segmenting that further --in our group’s personal lines, voluntary private passenger auto, our largest line of business, recorded an adjusted statutory combined ratio of 91.3. Direct homeowners business produced an adjusted statutory combined ratio of 77. This is again, a dramatic improvement from 2003 results and is due to improvements in frequency, average premium per exposure and reduced catastrophe losses.

We see the same indications in our commercial lines combined ratios. Commercial auto had an 80.4 adjusted statutory combined ratio, while our commercial multi apparel and property coverages, Ultra Flex and Ultra Share for property owners had adjusted direct statutory combined ratios of 78.7 and 82.4 respectively.

The adjusted statutory combined ratio for workers compensation remained relatively flat from last quarter at 109 for the second quarter 2004.

Erie Indemnity Company has reported GAAP combined ratio for the second quarter was 109.5, compared to a GAAP combined ratio of 113.3 during the same period in 2003.

The underwriting results for the property and cash in the operations of Erie Indemnity Company were affected by a reversal of recoveries under the excessive loss reinsurance agreement with the Erie Insurance Exchange. This resulted in a charge of $4.9m.

In total Erie Indemnity Company recorded underwriting losses, on a net basis, of $4.9m in the second quarter of 2004, compared to losses of $6.3m for the second quarter of 2003.

Investment operations recorded income of $21.6m during the second quarter, compared to $17.9m for the same period in 2003. An increased of 20.8%. The increase was driven by increased net investment income and earnings in limited partnerships of $1.5m in the second quarter 2004, compared to losses and limited partnerships of $1.4m in the second quarter of 2003.

There were no impairment charges during the second quarters of 2004 or 2003. Net investment income increased by 9.48% to $15.6m for the second quarter 2004, from $14.2m for the second quarter of 2003.The company also recorded equity and earnings from limited partnerships in the second quarter 2004 of $1.5 million, compared to losses of $1.4 million in the second quarter 2003.

I would like to make comment regarding our share repurchase program, during the second quarter we accelerated our share repurchase activity, repurchasing479,000 shares at a cost of $22.1 million or an average cost per share of $46.11. For the first six months of 2004, the company has repurchased a total of 618,000 shares of its outstanding class-A stock at a total cost of $28.4 million. As you may recall, the plan allows the company to repurchase up to $250 million of its outstanding class-A common stock through December 31st 2006.

Erie’s second quarter 2004 results show me that our agents and employees are steadfast in their commitment to our company’s success. Because of their efforts we are meeting the goals we set out to achieve. Our underwriting results are improving; we are growing and growing profitably. Erie’s solid business model, which we refer to as our cycle of success continues to ground us in that balance and disciplined approach that is building long term value for all of our share holders.

Thank you, and now I would like to turn the call back over to Karen.

Karen Kraus Phillips Thanks Bill that concludes our prepared remarks, Madonia[ph], if you could now open the call for questions from our phone audience.

certainly, the question and answer session will be conducted electronically, if you would like to ask a question today, you may do so signaling – by pressing star one on your telephone keypad at this time. If you’re using a speakerphone, please make sure your mute button is released to allow your signal to reach our equipment. Once again, for a question please press star one, and we’ll pause for a moment to assemble the roster.

Our first question comes from Adam Bobber with Cochran Koruna (ph).

Good morning

Morning Adam

Morning

Several questions, number one, with the underwriting results turning around so quickly, does that mean the company can shift back to growth mode in 2005?

Well certainly as we’ve said repeatedly, we want to continue to balance under-writing profitability and quality growth so Adam, we’re looking to balance – throughout the remainder of 2004 and into 205.

What type of agency growth would you expect to see, could we expect to see in 2005?

We haven’t finalized our plans in there – on that yet Adam, so in the third quarter call we’ll give you a look at what we’re going do with the agency force in 2005, we’re still reporting on 2005 number which you saw in the Q was 40.

Right, Right okay. As far as the underwriting margin, again a big improvement this quarter, rate increases are still flowing through. Is there a target level you want to get to by next year?

A target level of..?

Combined ratio, sorry.

Combined ratio? We want to continue to improve our combined ratio, we still have some work to do in some of our commercial lines, particularly workers comp, we are going to introduce insurance scoring and some price segmentation next year, with the intent of continuing to improve all of our loss ratios. So we still think we need to improve them next year to maintain our competitive position

Okay and finally. What’s the agents view on moving to credit scoring?

Well I think the agents recognize that they want to maintain their judgment in the process and avail themselves of the tolls that are being used to successfully compete in the market place, so like us agents are a bit apprehensive about insurance scoring but recognizing the opportunities, particularly as we develop a segmented pricing model to successfully compete in the marketplace.

Thank you very much

Thanks Adam

And as a reminder, please press star one for a question. Our next question comes from Beth Malone from Advest Inc.

Thank you good morning.

Morning Beth.

Just a couple of quick questions when you talked about price increases at 5% I think you said for going forward is that sufficient to deal with loss cost inflation? Is that going to be an adequate rate increase for you and I think you said in 2005?

Well first of all Beth I said that the –we expect average premium movement of 5%. And I said about half of that would be in rate, the other half would be in what we call you know symbol creep and inflation adjustments on home owners and higher payrolls and in commercial lines. So really we’re talking about 2 to 2.5 next year. We need to keep working on severity. This year we’re expecting our pure premium to rise in the mid 3s and our average premium for exposure, earn premium for exposure is rising mid 6s. So we expect improvement in our combined ratio 3+ points this year. I’m speaking about on an accident year, non-Cap basis year.

So if we’re going to get I said 2, 2.5 and our pure premium is growing by 3, we’re going to lose a little ground or break even. So our challenge is to control our severity which we’re continuing to focus on in all lines of business and to keep our pure premium increases below that – those increases and rate.

Okay just switching gears a second you all have been working at changing managers and restructuring the investment portfolio, I guess which is most exposed on the property causality company, could you talk about where you are in that? In the past your company has been more sensitive to some of the higher Cap market as a result of your investments in that area and has that changed over the last year?

Well as you know we’ve reported it in the end of last year that we were going to take down our common stock exposure and switch managers – on the retirement of John Peterson at year end. We needed to obtain some new managers for the portfolio which we did. We went out and I think we’ve reported in one of our Qs that we appointed 8 equity managers in the first quarter of this year. We gave them cash from the proceeds of selling down our portfolio. All 8 of them out performed their bench mark in the second quarter, some of them by very light margin. So at least through 6 months we’re very pleased with our selections.

Do you think your switching does that reduce your sensitivity in the portfolio to the technology markets in that more volatile part of the market was that one of the intention and was that successful?

Yes we’re much more diversified than we were. We had a pretty concentrated portfolio. Now we are still managing as part of the portfolio internally we have approximately 15 investments. It’s fairly large positions --15 investment that we mange internally like I said that are basically in tech, drugs and in financials. We have a very low cost basis in these investments. It’s Microsoft, Intel, Mereck [ph], City Group those sorts of names. We have a very low cost basis as I said and so we’re continuing to manage those. We do still have some tech investment in there. But it’s a much more diversified portfolio than it was a year ago. And it does have some less exposure to technology.

Okay thank you.

Moving on we’ll hear from Mathew Roswell with Legg Mason.

Yes good morning a quick question on the insurance scoring, is that can be credit bases or loss experience or some blended average of the two?

It’s going to be a credit based insurance score Mat.

Okay thank you very much.

And there is a final reminder press star one for a question. It does appear we have no further questions at this time Mrs. Karen Kraus Phillips I’d like to turn the call back to you for any additional or closing comments.

Karen Kraus Phillips Thank you Madonia and thank you to every one on the call. That concludes our call today. Again a recording or the call will be posted on our web site Erieinsurance.com after 12:30 today eastern time. If you have any questions at all please call me at 814-870-4665, have a great day. Thank you.

That does conclude today’s conference call. We thank you for your participation, you may now disconnect.