Erie Indemnity Co (ERIE) 2005 Q3 法說會逐字稿

Hello and welcome to the Erie Indemnity Company third-quarter 2005 earnings conference. 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 would like to introduce your host for today's conference call, Karen Kraus Philips, Vice President and Manager of Corporate Communications and Investor Relations.

Thank you, Peter and good morning, everyone. We appreciate all of you joining us today. On today's call, management will discuss our third-quarter 2005 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 ask that you please keep to one question and a follow-up. We issued our earnings release and additional supplements yesterday afternoon. We also filed Form 10-Q 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 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 statement in our latest 10-Q filing with the SEC dated November 2, 2005 and in the related press release and 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 PM Eastern time.

Your participation on this call will constitute consent to the recording, publication, webcast, broadcast and the 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 Erie's President and CEO, Jeff Ludrof.

Good morning and thank you for joining us. Before I turn things over to Phil to talk about the financial details of the quarter, I want to touch on a few key highlights. First our underwriting profitability results, second our competitive position and what we are doing to enhance growth and third provide some insight into where we are going in 2006.

Let's start by looking at some top-level results. Net income decreased by 9.5% to $53 million for the quarter ended September 30, 2005 as compared to $58.6 million a year earlier. Net income per share was $0.76 (ph) for the quarter, down from $0.83 per share for the third quarter 2004. Direct written premium, for the Property and Casualty group, was $1 billion for the quarter, down slightly from the quarter ended September 30, 2004. This translated into management fee revenue for the Erie Indemnity Company of $241.6 million, which was off 1.9% from the same quarter a year earlier.

Underwriting profitability continues to be a primary focus for us and we continue to produce favorable results in this area. For the third quarter of 2005, the Property and Casualty groups reported statutory combined ratio was 90.5 compared to 88.6 a year ago. As a result of the Property and Casualty group's underwriting performance, the property casualty subsidiaries of the Erie Indemnity Company continue to report favorable GAAP combined ratio finishing the quarter at 96.9. Our underwriting result showed minimal impact from catastrophes with catastrophe losses adding only 0.5 points to the Property and Casualty group's combined ratio during the third quarter 2005.

Being a regional company, we did not have losses from Hurricanes Katrina or Rita during the third quarter or from Hurricane Wilma in October. While Erie had no direct losses from these storms, our agents and employees demonstrated their compassion toward others in this time of great need. Erie employees, agents, members of the Board of Directors and the Company joined together to contribute over $330,000 to support the Red Cross hurricane relief efforts. Even before we announced our formal fundraising plan, groups of employees and agents were already organizing events and raising money throughout our territories.

In addition to raising funds, they collected food and clothing and many traveled to the disaster area to distribute items directly to hurricane victims. We're told our combined contribution will help nearly one million families. Prior to Katrina, Rita and now Wilma, prices from competitors were relatively stable with slight increases from many of the largest competitors. State Farm however took rates down and because of our improved underwriting results we too took rates down. We also introduced segmented pricing during the first quarter of 2005 and since doing so, we have seen positive changes in the distribution of our new business with a growing percentage being written in our best price tiers.

The shift of business by tiers demonstrates that the overall quality of our book of business is improving and confirms our concern that we were being adversely selected against. This also positions us to make additional changes to improve our competitive position. For example, on July 1, we initiated a safe driver discount of 8% in most of our states, 6% in West Virginia and Tennessee. Since the introduction, the majority of our new policyholders have qualified for the discount. Our plan is to continue adopting these kinds of targeted rate reductions into 2006 to enhance our competitiveness for the most desirable customers.

We have taken similar actions in our homeowners line of business. We estimate that all rate reductions filed, approved and projected will have a rate change impact on written premium in 2005 of a $10 million decrease. For 2006, we estimate that the rate reduction impact will be a decrease of $87 million from the rate changes predominantly from additional refinements in segmented pricing for our private passenger auto line. We are taking these actions to improve our competitiveness and enhance unit growth throughout all lines of business.

Like last quarter, we continue to see an upward trend in policies-in-force for homeowners and in our commercial lines. This is not yet moved to our private passenger auto business. We expect to see unit growth gains in private passenger auto following the introduction of the new pricing variables in early 2006. January 1 for new business and March 1 for renewal.

Companywide, during the third quarter 2005, our all lines policy-in-force grew by about 1300. Just as we indicated last quarter, our all lines retention ratio remains stable at 88.4 at the end of the third quarter 2005. This is up sequentially from 88.3% at June 30, 2005.

In addition to pricing actions, we have initiated a number of sales promotion efforts at the onset of the third quarter 2005. These efforts include a sales incentive contest for our independent agents. Unlike previous contests, this sales incentive incorporates all lines of business Erie sells. It runs for one year from July 2005 through June 2006. We expect to see sales of private passenger auto accelerate with the January 1 pricing reductions I discussed earlier.

Expanding our distribution channel of independent agencies within our existing territories has been part of our strategy during 2005. To date, we have appointed 55 agencies and expect that number to grow to 68 by year end. And while I don't have a specific number yet for 2006, I expect that number to exceed our 2005 result.

I have always said that complacency is the biggest threat to Erie's ongoing success. In order to grow our business, we must continuously pursue new ideas and we are doing that through a disciplined, strategic planning process to evaluate our business practices and explore new opportunities. You'll hear more about this effort at our year-end earnings call in February 2006. We are continuing to make targeted investments in our competitive position, technology and marketing. Investments that will firmly position Erie as the number one insurer in our agents' offices and in the minds of our policyholders. Now I'll turn the call over to Phil to share more financial details.

Thank you, Jeff. Good morning to everybody. As Jeff stated, we continue to see consistent improvement in our underwriting profitability, which positions us well as we move forward into 2006. For the third quarter 2005, our net income decreased by 9.5% to $53 million or $0.76 per share compared to $58.6 million or $0.83 per share for the third quarter 2004. Our net income, excluding the effects of net realized capital gains and income taxes on those gains, decreased 10.6% for the quarter to $51.9 million or $0.74 per share from $58 million or $0.82 per share for the same quarter in 2004.

First, I would like to discuss the performance in our management operations segment and 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. As you know, management fee revenue is based on the management fee rate established by our Board and the direct written premiums of the Property and Casualty group. Management fee revenue decreased by 1.9% to $241.6 million for the third quarter 2005 compared to $246.4 million in the third quarter of 2004.

The decrease is attributable to the lower management fee rate in 2005 and lower direct written premiums of the Property Casualty group. The lower management fee rate in 2005 of 23.75% compared to 24% in the third quarter of 2004. That resulted in $2.6 million less of management fee revenue for the quarter ended September 30, 2005 or a decrease in our diluted net income per share of about $0.02.

Direct written premium of the Property Casualty group decreased 2.1% in the third quarter 2005 to $1.02 billion from $1.05 billion in the third quarter 2004. While policies-in-force continue to grow modestly by slightly more than 1300 policies in the third quarter 2005, the average premium per policy declined during the third quarter 2005 as compared to the third quarter of 2004 contributing to lower direct written premium.

Overall, policies-in-force were down 0.5% on a year-over-year basis with the average premium per policy increasing by 1.2% for the twelve months ended September 30, 2005 from $1042 to $1055. The year-over-year policy retention ratio improved to 88.4% at September 30, 2005 from 88.3% at June 30, 2005.

Another consequence of our focus on underwriting profitability coupled with more competitive market conditions and our resulting pricing actions in personal lines is the continued decline in new policy premium. For the quarter, new written premium decreased by 2.9% to $100.7 million from $103.6 million in the third quarter of 2004. Personal lines new written premium decreased by 5.4% to $70.6 million from $74.6 million for the third quarters of 2005 and 2004 respectively.

Commercial lines new written premium increased by 3.4% to $30 million for the three months ended September 30, 2005 versus $29 million during the same period last year. The private passenger auto new business premium written decreased to $42 million from $46.8 million for the third quarters of '05 and '04 respectively. And as Jeff indicated, we introduced some new pricing variables during the third quarter of 2005 to enhance our competitive position for the most desirable customers in both private passenger auto and homeowners.

As we have noted in prior calls each quarter, we record an estimated allowance for management fees returned to the exchange for mid-term policy cancellations. The third quarter of 2005 and 2004 revenues were reduced by $1.6 million and $4.6 million respectively due to changes in the allowance, which were partially offset by an adjustment for returned commissions. The cost of management operations increased by 3.6% for the third quarter of 2005 to $194.8 million from $188 million for the same period in 2004.

Commissions paid to our independent agency force account for the majority of these costs. Commission costs totaled $140.3 million for the third quarter of 2005, a slight increase over the $140.2 million reported for the third quarter of 2004. For the third quarter of 2005, our estimate for the annual agency contingency award resulted in an expense increase of about $5.6 million over the third quarter of 2004. The bonus estimate has increased due to improved underwriting results in '05 versus '04. And as you know, the bonus is based on an estimate of our 36-month underwriting profitability of the direct business written within our Property Casualty group.

As we have reported, our scheduled commissions are growing more slowly than the change in direct written premium due to commission reductions in some commercial lines. Commission expense was also affected by a reduction in the credit for returned commissions related to the mid-term policy cancellation allowance. As a result of the reduced credit for returned commissions, commission expense was $1.6 million more in the third quarter 2005 than the third quarter of 2006.

Our other operating expenses, excluding the commissions, increased by 14% to $54.5 million for the quarter compared to $47.8 million a year earlier. The increase was due primarily to personnel costs, including increased consulting fees for information technology projects and increased survey and underwriting costs associated with our use of insurance scoring. Personnel costs, including salaries and wages, employee benefits and payroll taxes, which encompassed the largest component of other operating expenses, increased 14.4% to $33.6 million for the third quarter of 2005 compared to $29.4 million for the same period of 2004. Contributing to these increase costs were consulting fees for our IT projects, which increased about $1.1 million in the third quarter of 2005 versus the third quarter of 2004 and increases in the expense of about $1 million related to the Company's long-term incentive plan for executives.

The gross margin for management operations decreased to 21.1% for the third quarter of 2005 compared to 25.3% last year. Next I will review the results of our insurance underwriting operations. But before I do that, I'd just like to remind you about the supplement we provide regarding our underwriting results. We have provided detailed statutory results of the Property and Casualty group's underwriting pool along with a reconciliation of those results with the GAAP insurance underwriting results of the Erie Indemnity Company. We believe this information will be very useful to investors in gaining a better understanding of our property and casualty underwriting results.

We have also provided quarterly adjusted statutory combined ratio data by line of business. As Karen mentioned, the supplement is also available on the Investor Relations section of our website. As you know, the Erie Indemnity Company's property casualty insurance subsidiaries retain a 5.5% share of underwritings relative to the Property Casualty group. Erie Indemnity Company recorded underwriting gains on a net basis of $1.7 million in the third quarter of '05 compared to gains of 2.9 million for the third quarter of '04.

Erie Indemnity Company's reported GAAP combined ratio for the third quarter was 96.9 compared to a GAAP combined ratio of 94.5 during the same period in 2004. Underlying the Company's results were the underwriting results of the Property and Casualty group. As we said previously, the reported statutory combined ratio for the Property Casualty group was 90.5% for the third quarter of 2005 compared to 88.6 in the third quarter of 2004. These ratios do not exclude the profit component of the management fee paid to Erie Indemnity Company and are therefore not apples-to-apples comparisons with the industry.

The profit component accounts for about 4.6 points of the reported statutory combined ratio for the third quarter of 2005. Therefore, the adjusted statutory combined ratio drops to 85.9% for the quarter. For the first nine months of 2005, the adjusted statutory combined ratio was 83.3 versus 88.3 for the same period in 2004. As Jeff indicated, Erie experienced no catastrophe losses from Hurricanes Katrina and Rita during the quarter and no losses from Hurricane Wilma in October of 2005. Our catastrophe experience during the third quarter of 2005 added 0.5 points to our reported statutory combined ratio.

Reflected in these third-quarter results were material changes to several reserve reestimates for the Property Casualty group. During the third quarter, reserve evaluation, reserves for pre-1986 automobile catastrophe injury liability reserves were increased by $47 million. That is net of our ceded recoveries. The reserve reestimates took into account updated trends with respect to ongoing attendant care costs for claimants on these claims.

The Company will continue to closely monitor these pre-'86 automobile catastrophe injury claims reserve estimates. Additionally, the assumed loss and loss adjustment expense reserves related to our World Trade Center reserves were reduced in the third quarter of 2005 by $42 million decreasing the Property Casualty group's statutory combined ratio by 4.2 points.

While the Company's GAAP combined ratio was impacted by these reserve adjustments, a reduction in the World Trade Center assumed loss and loss adjustment expense reserves triggered a reduction in previously recorded recoveries under the intercompany aggregate excess of loss reinsurance arrangement in the third quarter of '05, which offset the reduction in assumed reserves. As a result, reinsurance charges of $2.2 million occurred in the third quarter of 2005 versus $1.2 million in the third quarter of 2004.

For the quarter, the Property and Casualty group's personal lines have an adjusted statutory combined ratio of 90.5 and the group's commercial lines adjusted statutory combined ratio for the quarter was 92.6. Segmenting that a little further, our direct private passenger auto, our largest line of business, recorded an adjusted statutory combined ratio of 97.6%, which was adversely affected by the increase in the reserve reestimates for the pre-'86 automobile catastrophe injury reserves.

Our direct homeowners business produced an adjusted statutory combined ratio of 71.5. Our investment operations recorded income of $25.1 million during the third quarter compared to $21.2 million for the same period in 2004, an increase of 18.7%. Impairment charges recorded in the nine months ended September 30, 2005 were $1.4 million on some of our equity securities and $2.1 million on some of our fixed maturities. Net investment income was $14.8 million for the third quarters of both '05 and '04. And the equity in earnings of limited partnerships totaled $8 million in the third quarter of 2005 compared to $3.8 million in the third quarter of 2004.

During the third quarter of 2005, the Company recorded earnings from one partnership of $4.4 million in the form of a distribution. During the third quarter of 2005, the Company repurchased 395,445 shares of outstanding Class A common stock in conjunction with the stock repurchase plan that was authorized in December 2003. The shares were purchased at a total cost of $20.8 million for an average price per share of $52.54. That we reported incorrectly in our Q and our press release as $51.90, which was the year-to-date number and we will issue an amended filing today to correct that. So it is $52.54 was the average price during the quarter of shares repurchased.

As you may recall, the plan allows the Company to repurchase up to $250 million of its outstanding Class A common stock through December 31, 2006. Our remaining authorization is $149 million at September 30, 2005. Thank you for your attention. Now I will turn the call back over to Jeff.

Thanks, Phil. Just to wrap up before we move on to your questions. Again, our underwriting result for the quarter was positive and as you know, that is an anchor to our business model. We now have a stronger foundation on which to grow profitably. In 2005, we introduced new pricing and marketing initiatives like segmented pricing to help us achieve this goal. It will take time for these to take hold but we are beginning to see positive unit growth in homeowners and commercial. Because of our underwriting performance, we are able to take rating actions that will enhance our competitive position and help our agents attract desirable customers. We believe these rating actions coupled with marketing initiatives we have employed will turn our unit growth around in private passenger auto. Now Phil and I would be happy to take your questions.

(OPERATOR INSTRUCTIONS). Meyer Shields, Legg Mason.

Good morning. A couple of brief questions. First of all, do you know yet what the cost of the agency incentive program will be? Is it just a question of who gets it or is the cost not yet determined?

You're talking about our incentive bonus that we pay our agents?

That's right.

We report that in the Q. We report what we have accrued to date in our financial statement.

Right. But there's no forecast for going forward is there?

For '06?

Right.

No, we don't provide that. Remember it is a three-year rolling average. So right now we are working with '03 '04 '05. So our '06 forecast, we're going to drop out '03 and have to add in '06.

Okay. Moving to a slightly different topic. Can you talk about the trends in lost costs? I'm thinking specifically for personal lines, whether they are still favorable and whether they are matching your expectations.

Let's talk about frequency first. Our frequency continues to be favorable and in line with our pricing assumptions and the same with our severity. Our severity is in line with our pricing expectations in both private passenger auto and homeowners and so we are happy with the results in both frequency and severity for the quarter and for the year.

That's great. Thanks so much.

(OPERATOR INSTRUCTIONS). Adam Klauber, Cochran Caronia.

Good morning, thank you. Could you maybe illuminate a little on the competitive environment? You are getting much more aggressive in the market or more aggressive sorry in the market now that underwriting is in good shape. Are you seeing competitors become more aggressive also on the rate side or are they pretty much standing pat?

Adam, good morning. This is Jeff. What we're seeing, and we use Pennsylvania private passenger auto as an example, as a proxy. As you know, that is our largest line of business in our biggest state. What we're seeing there is we are seeing competitors take increases. A lot of the national competitors have taken several increases. As I mentioned, State Farm though took some decrease and we of course have taken some decreases and we will continue to be able to take decreases with our improved underwriting performance.

Generally, we are seeing a relatively stable marketplace in terms of rate changes. Still very competitive out there but generally speaking there is some stability in the pricing changes that are being taken.

Thank you. On the commercial side, we have heard a little that some of these large commercial players are getting more nervous about their coastal exposures and might be getting more aggressive in non-coastal exposures such as a Pennsylvania. Are you seeing any evidence of that on the commercial side?

We are not seeing any significant shifts at this time. We have heard of that type of statement. I think it is a little easier said than done. Probably won't see those types of shifts in any short period of time.

Okay. Another topic. Switching to growth in the agency force next year. I know in some of the newer states, as you restructured or changed your underwriting, you held back growth in those states. Do you foresee in '06 and moving to '07 that you'll start to expand the agency plan in some of the newer Midwestern states going forward?

We will expand our agency force in our existing states and certainly in the newer states in our Midwest area that you referred to. Over the last several years, we had the greatest opportunity for expansion. So the numbers will be increasing more dramatically there.

And finally on your move to add price to your underwriting, do you think at this point agents are comfortable and had there been an adoption period with the agents, is that adoption period over or is it going to take the agents awhile to get used to it?

Generally speaking I think they are becoming more comfortable in understanding the use of a tiering model. However, we are introducing additional interactions, which creates an added opportunity for additional understanding as we see different outcomes as a result of putting these interactions in. As I mentioned, beginning January 1, we will have additional interactions built into our pricing models. So there will be a continuous learning that will need to take place throughout the Company at the agency level as well.

And Ms. Kraus Phillips, there are no further questions at this time. I would like to turn the call back over to you for any additional or closing remarks.

I just want to thank you all for listening in today. 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. If you have any questions, as always, you can call me at 814-870-4665. Thank you again and have a great day.

Again, this does conclude today's conference call. Thank you for your participation. You may now disconnect.