Erie Indemnity Co (ERIE) 2006 Q2 法說會逐字稿

Hello and welcome to the Erie Indemnity Co. second quarter 2006 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'd like to introduce your host for today's conference call, Karen Kraus Phillips - Vice President and Manager of Corporate Communications and Investor Relations. Please go ahead.

Thanks, Katy, and good morning everyone. We appreciate all of you joining us today.

On today's call management will discuss our second quarter 2006 results. Joining me are Jeff Ludrof, President and CEO, Executive Vice President and Chief Financial Officer, Phil Garcia and Brian Bolash, Associate 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 our Form 10-Q with SEC.

On today's call, the management of the Erie Indemnity Co. 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 10-Q filing with the SEC dated August 2, 2006, 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 supplements posted on our investor website at erieinsurance.com.

This call is being recorded and the recording is the property of Erie Indemnity Co. It is not intended for reproduction or rebroadcast by any other party without the prior consent of Erie Indemnity Co. 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 use of your name, voice, and comments by Erie Indemnity. If you do not agree with these terms, please disconnect at this time.

Now Erie's President and CEO, Jeff Ludrof. Jeff.

Thank you, Karen, and good morning, everyone.

Based on your past feedback we will again keep our prepared remarks at a higher level rather than reread the many details contained in our 10-Q. We will provide financial highlights of our second quarter results, share information about our underlying trends, and provide insights into our strategies to enhance the Company's performance going forward.

As you know, net income decreased by 26.1% to $56.3 million from $76.2 million at June 30, 2005.

Net income per share decreased by 21.8% to $0.86 per share compared to $1.10 per share in the comparable quarter from 2005. Net income excluding net realized gains or losses on investments and related federal income taxes decreased by 19.3% to $56.7 million or $0.87 per share from $70.2 million or $1.01 per share for the same period one year ago.

Frankly our end results for the quarter don't provide an indication of the underlying growth trend we are seeing. While our average premium per policy is decreasing, which is expected during a softer market, the targeted rate interactions we put in place have advanced our competitive position.

During the quarter total Policies in Force increased by more than 20,000 units. This includes an increase in Private Passenger Auto Policies in Force, reversing the trend we have experienced. Our all lines retention ratio for the Property and Casualty Group has also moved upward from 88.5% at January 31, 2006 to 89% at June 30, 2006. For Private Passenger Auto, the retention ratio was 90.3 at June 30, 2006; and for homeowners it was 88.9 at the end of the second quarter 2006.

These indicators (technical difficulty) growth rates and stronger retention ratios have continued to improve through the beginning of the third quarter. We expect that our all lines retention ratio will move close to our historic average of 90.5 by year-end.

I have said to you before that it is our objective to achieve quality growth while maintaining underwriting profitability. This takes discipline and thoughtful planning. We have got to be smart about how we pursue growth. Some would assume, given our results, that we could cut our rates to spur rapid growth. If we did that we would find ourselves back in the position we were in 2002 - facing a combined ratio of 118% in the Property and Casualty Group and a GAAP-combined ratio of 116.5 in Erie Indemnity.

My commitment to you, our shareholders, to our employees, agents and - most fervently - our customers is not to be there again. In three short years we were able to turn our underwriting profitability results around and begin producing some of the best combined ratios in the history of our Company. Our underwriting discipline remains solidly in place as normalized underwriting results for the second quarter 2006 demonstrate.

Catastrophe losses contributed 5.8 points to the adjusted statutory combined ratio of the Property and Casualty Group, and 5.9 points to the Company's GAAP combined ratio, yielding combined ratios of 92.3 and 99.4, respectively.

This puts us in a good position to make rate adjustments, to enhance competitiveness where needed. That is our plan. It is working and the results are starting to bear out.

I also committed to you last quarter that through our cost management plan we would hold our noncommission expense rate to a 9% increase over 2005 levels for the Erie Indemnity Co., which equates to a 6% increase for the Erie Insurance Group of companies - or as we sometimes refer to it as - the Enterprisewide. We are on track to hit those numbers by year-end. For the second quarter 2006 our cost of operations for Erie Indemnity Co. - excluding commissions - was 5.4% over second quarter 2005 and 10.6% for the six months ended June 30, 2006.

For the Erie Insurance Group the increase was 5% over 2005 levels for the first half of 2006. Based on data published by A.M. Best from 2001 through 2005, when compared to major national carriers, Erie has consistently ranked third in its overall operating expense ratio just behind direct writers, Geico and USAA. Our low cost of operations is a competitive advantage and essential to our ability to remain competitive with our chosen business model, selling insurance through independent agents.

So what are we doing to support and encourage our agents' marketing efforts? I talked about the targeted rate reductions we put in place to improve competitiveness. We will continue to gather intelligence from the field to make additional adjustments as needed. We are confident in our core pricing model and will continue to go forward with our strategy to refine it as planned by adding new variables, discounts and secondary rating factors.

These changes are affected in most states on September 1 and in Pennsylvania on October 1.

For example, we enhanced our safe driver discount for new business, increasing it from 8% to 15%. We believe the increased discount, new rating factors and the new Private Passenger Auto growth incentive for agents will boost momentum in the new Private Passenger Auto unit growth. The incentive I referenced was announced on July 1 to all agents with the dual objective of stimulating greater Private Passenger Auto production and agent revenues.

Agents will receive $50 for each new Erie Private Passenger Auto application over an 18-month period. Going hand in hand with our pricing and sales promotion strategies is our overall Marketing Communications approach. Recently we completed a comprehensive customer segmentation study that we are using to refine our marketing strategy and shore up our brand positioning.

At the same time we are also continuing our marketing support to agents, by offering a variety of co-branded marketing materials as well as financial incentives to use these materials through our co-op marketing program. On the agency recruitment fund we have appointed 71 new agencies thus far this year, 49 agencies during the second quarter alone. We are finding agencies to be very receptive to Erie's value proposition and we are confident that we will reach our goal of 125 new agencies in 2006 as planned.

Improving our technology capabilities continues to be a priority focus for the Company. In June we rolled out a new online commercial system to our agency force. The objective is to give agents a user-friendly web-based commercial system to submit quotes, applications and eventually endorsements. The first products contained in the new front end system are fleet and non fleet commercial auto. Once all functionality has been released for fleet and non fleet commercial auto, additional lines of business will be added to the system. Agents agree that their overall experience with the system has been positive.

One final note regarding technology. Last week, we announced the addition of a new Chief Information Officer, Jeff Stempora. Jeff comes to Erie from Citigroup where he served in several capacities, including Executive Vice President and Global Head of Strategy and Strategic Initiatives for technology infrastructure. He has extensive insurance experience, holding leadership positions with top national, property and casualty insurance companies.

I'm confident in Jeff's ability to lead our technology strategy and implement solutions for both our agents and customers.

Now I'll turn it over to Phil to share second quarter financial highlights.

Thanks, Jeff, and good morning, everyone.

As Jeff pointed out for the second quarter of '06, our net income decreased 26.1% to $56.3 million from 76.2 million at June 30, 2005. Our operating income - which as you know is our net income excluding the effects of the realized capital gains on the income taxes on those gains - declined $0.87 per share from $1.01 per share from the same quarter in '05; and if you recall during the second quarter of '05 we made an adjustment of $9.4 million or $0.09 per share to record pre 2005 gains in earnings from limited partnership investments. That is reflected in the $1.01 per share in operating income in '05.

Our income for management operations for the second quarter of '06 decreased to 56.6 million from 61.6 million for the second quarter of '05, as a result of a decline in our direct written premiums for the property casualty group. Our management fee revenue decreased by only 1.3% because of a higher management fee rate of 24.75% versus 23.75% in 2005.

Management fee revenue was down primarily as a result of slower growth in premiums as the Property Casualty group direct written premiums, decreased 4.5% for the quarter.

The decline in written premium was caused by declines in the average written premium for policy. The declined in the average premium for policy is a result of our announced pricing actions, segment pricing refinements and a change in the mix of new and renewal business to lower-priced tiers for our auto and home business.

The declines in average premium for policy were partially offset by better new policy growth and an increase in the year-over-year retention rate to 89%.

As Jeff pointed out, our Policies in Force grew by over 20,000 policies in the quarter which included growth in our Private Passenger Auto Policies in Force.

In order to provide greater transparency around understanding the drivers of costs included in the cost of management operations, we've expanded the information provided in the 10-Q for the second quarter 2006 and in the related press release. Cost of management operations increased 1.5% in the second quarter, with overall commission costs consistent with the prior quarter and costs other than commission costs growing more slowly than the prior quarter at 5.4%.

In the second quarter of '06, the cost of agent bonuses increased 3.9%, while scheduled and accelerated commission counts decreased 3.9 million compared to the second quarter of '05. Our personnel costs increased 8.5%, primarily due to higher average pay rates and more information technology salaries being absorbed by the Company rather than being allocated amongst affiliated companies. We continue to make progress containing our employee benefit costs, recognizing a 1.1% increase in this area in the second quarter.

As you can see, we are now breaking out our survey in underwriting costs at our sales and policy issuance costs. Our survey in underwriting costs include the costs of outside underwriting reports, such as motor vehicle reports or MVRs and insurance scores, as well as board and bureau fees in the cost of third party policy audit services. There are no internal salary costs included in that category.

Survey and underwriting costs decreased due to insurance scoring costs, reflecting a more normalized level for this quarter, compared with the second quarter of '05.

Our sales and policy issue costs include the costs of postage and printing, office supplies and certain agency-related marketing sales and promotional expenses. As with the survey and underwriting category there are no salary costs included in this category. Overall, our sales and policy issue costs rose by 1.8% with increases and agency-related sales expenses offset by reduced printing and office supply costs.

Turning to the Company's insurance underwriting operations, the GAAP combined ratios were 99.4 and 90.9 for the quarters ended June 30, '06 and '05 respectively. The adjusted statutory combined ratio of our Property and Casualty Group for the second quarter '06 was 92.3 compared to 82.6 for the second quarter of '05.

Higher catastrophe losses during the second quarter '06 added 5.9 points to the GAAP combined ratio, and 5.8 points to the stat combined ratio. As compared to our very low cat losses of just .4 points in the second quarter of '05.

Company share of those catastrophe losses incurred as defined by the property casualty group amounted to 3.2 million and .2 million in the second quarters of '06 and '05, respectively. Also during the second quarter of ,'06 the property casualty group recorded an increase of about $32.5 million in reserves related to our second quarter '06 catastrophe losses, of which the Company share was about $1.8 million adding an additional 3.3 points to the GAAP combined ratio. And we did not include that reserve adjustment in our quarterly cat loss totals.

As we have discussed before, our underwriting losses are seasonally higher in the Company's second and fourth quarters; and as a consequence the Company's combined ratio generally increases as the year progresses. The second quarter of '06, the Company's share of the increase to reserves related to seasonality adjustments was $1.7 million or about 3.1 combined ratio points for the property casualty group.

In the first quarter of '06 the seasonality adjustment reduced the Company's share of incurred but not recorded reserves by $2.9 million.

Finally, included in our Private Passenger Auto combined ratio of 96 for the second quarter '06 was about six points of additional prior year loss development related to our quarterly review of our pre 1986 automobile catastrophe injury liability reserves.

And of course, you saw our homeowners' statutory combined ratio of 102 for the second quarter. It was influenced by more than 20 points of catastrophe losses.

The Company's investment operations recorded income of 29.5 million during the second quarter of '06 compared to 47.3 million for the same period of 2005. Funds used to repurchase Company stock amounted to $159.3 million in the second quarter of '06, compared to about $11.5 million in the second quarter of '05 which lowered the cash available for investments.

The net realized losses on investments in the second quarter of '06 resulted from a large number of fixed maturity securities, which were sold to fund the repurchase of Company stock in the second quarter '06.

Our equity in earnings and limited partnerships decreased $6.6 million partially due to the valuation adjustment of $9.4 million, related to years prior to 2005 which I mentioned previously.

During the second quarter of '06 the Exchange completed its tender offer and its short-term merger for all of the publicly held outstanding common stock of Erie Family Life. Exchange acquired the balance of the EFL's publicly held common stock at $32 per share, increasing its ownership percentage from 53.5 to 78.4 of the outstanding common stock of EFL at June 30. The aggregate consideration paid by the exchange for the outstanding EFL shares was $75.2 million. As you know, the Company's 21.6% stake in EFL was unaffected by this transaction.

During the second quarter of '06 the Company repurchased 2,891,565 shares of its outstanding classic common stock in conjunction with a continuation of the stock repurchase plan. As I mentioned previously the shares were purchased at a total cost of $159.3 million.

In February 2006 the Company's Board approved the continuation of the current stock program, allowing the Company to repurchase an additional 250 million of its Class A common stock through December 31, 2009. At June 30, 2006, the Company has about $147 million in a standing repurchase authority under the program.

Thanks for your attention. Now I will turn the call back over to Karen.

Thanks Bill. And that includes our prepared remarks. Jamie, if you could now open the call for questions from our phone audience.

(OPERATOR INSTRUCTIONS) Blake Phillips with Fox-Pitt Kelton.

Good morning. Do you have any indication of what the pickup is like for this new $50 bonus program in the Private Passenger Auto?

It's really too early to tell at this point, Blake. As you know it started July 1 and so we have seen some evidence of pickup but --

Has there been enthusiasm about the program or --?

I think it's fair to say that there is a mixed reaction to just about any announcement that you make. I think agents are interested in the opportunity for increasing revenues. One of the alternatives would have been to increase commissions and so there are agents who are embracing it with enthusiasm. There are agents who are mixed in their reaction to it.

I was wondering, could you give me a little more detail on the structure of the Founders Award bonus program as far as the premium growth and the profitability [like] requirements for each?

The way the Founders Award program works is, each agency has a breakeven loss ratio. That is based on the distribution of their mix of business. Because each line of business has a separate breakeven point. So at a high level - depending on their distribution of let's say personal versus commercial lines - if they have a higher percent of personal lines typically their breakeven loss ratio is going to be higher.

Once they establish -- once we establish with them - the breakeven loss ratio for the agency, they are able to earn a profit up to 20% of every dollar. Every profit dollar, they earn 20% of it. They also have the opportunity to earn growth bonuses. Once they qualify for the program. No scrub bonuses could add up to additional levels. New business commissions in the current year, up to a maximum of 5.25%.

There's also a Life Growth bonus and it falls into different levels - bronze, silver, gold and platinum.

Does that help?

Yes. And, is there -- I don't know if you have the numbers but what the breakout would look like, between the profitability versus the growth as far as commissions -- as the bonuses are paid out?

In terms of what percentage of the dollars are paid out in profitability versus the growth?

Yes. Correct.

I would say over 95% of it is paid out in profitability with a much smaller percent in the growth areas.

Great. Thanks a lot.

[Michael Phillips] with Stifel Nicolaus.

Good morning, everybody. A couple of questions. One, I believe it's true, correct me if I'm wrong - is that agents currently for personal lines don't have the ability to quote in the field. And if that's true what are your thoughts on that?

Is there any kind of detriment to that for you guys and when do you see some kind of Internet-based rating system for agents in the field for personal lines?

They absolutely have the opportunity to quote in the field.

They do?

Yes.

For personal lines?

Yes.

Okay. I guess I was under the assumption from the old system that you scrapped that was no longer true.

What we were working through of course with that system was to enhance functionalities, make it easier to do business. But they did have - with the prior system and the system that they are currently using - quote capabilities in the field.

Good. Can you talk about the -- I guess how you view your appetite for different types of commercial risk and what you are currently writing? Do you see yourself maybe getting into a different kind of commercial risk than what you are currently writing? I guess just what appetite there is.

In terms of the type of commercial that we write, we characterize it as small to medium commercial. Main Street commercial. Now admittedly small, medium, Main Street means a lot of different things to a lot of different people. But in working closely with our agents and the relationship that is strong that they have between themselves and our underwriters in commercial, we continue to have an appetite that focuses on this small to medium commercial marketplace.

Our appetite has not changed this year versus last year necessarily. With that said, we also have a new Senior Vice President of Commercial who brings a fresh perspective. I don't expect us to have a drastic change in our appetite for commercial. I do expect as with any change in leadership for there to be some change.

A lot of that has to do with how you look at commercial. For example, the current definition of small. What does that mean? Is it determined by payroll? Is it determined by a number of employees? I know - just from a conversation I had with him yesterday - those are conversations he is having with our entire underwriting staff. And so within the definition of small, I could see our appetite changing slightly.

I know that is a little bit vague but it is such a broad topic, Mike, that I think it's difficult. But don't expect us to be out there writing super large commercial to be extreme.

(technical difficulties) account is about $2500. So that's pretty small.

Yes it is.

Our average workers' comp is approximately $6,000. (MULTIPLE SPEAKERS) so that gives you a sense based on those numbers. That's not to say that we don't write $100,000 account or upwards of that. We certainly do. It represents a smaller part of our business; and it represents a long-term relationship with many of our customers who have grown from a much smaller premium base to be the successful companies that they are.

And there, since our average policy is about $3750 so that gives you kind of an impression that it is pretty small.

Those are business owner policies.

Appreciate it. Those are good thoughts.

Finally if I could switch gears, just for a second over to the life side. And I ask this simply because I have no clue on the answer to this at all. How does your commission rates for life policies compare competitively to other folks out there? I know you guys -- didn't you just recently start offering an Apartment Life policy pretty recently? I don't know how that pairs compares if it's different for permanent versus other type of life policies. Just kind of some general -- how your commission structure is different versus your competitors?

In general how it compares is we pay a little bit more over the long term, but other companies pay a little bit more sooner and we have an opportunity to take a look at that as well and have committed with our agents that we will work together with them through what we call our Agent Life Task Force to explore that.

But our commission levels, overall, are competitive assuming a long-term relationship. In fact in some cases I think they're better. But there is an opportunity to pay sooner so we are going to look at that with the agents.

(OPERATOR INSTRUCTIONS). Adam Klauber, CCW Investment Banking.

Good morning. Thank you. Very good to see that you are ramping up and appointing new agencies. Two questions along those lines. No. 1, are those de novo agencies or are those existing? And also could you give us an idea on a geographic basis where the growth in agency has been?

Let me start with the geographic. Fortunately I am pleased to tell you that it is happening everywhere. As I look across our 18 different branch offices, we have a distribution of new agents in every single one of them excluding our local office where, of course, we have the highest concentration of agents.

So it is coming from everywhere. In terms of the -- I believe your question goes to, are they existing agents or are they scratch agents. Our term scratch agents, newly starting agencies, and I would say it is about 50-50. So about 50% of them are coming from existing agencies and about 50% are coming to us scratch.

And in the agencies that are existing, have been up and running for some time, how long does it typically take for a good portion of those to roll over to Erie, using Erie products?

Typically, it takes about a year. If you think of it from a standpoint of the customer renewing and an agent having the opportunity to discuss with the customer at the renewal, the multiple opportunities that that agent has to offer.

There are some opportunities that we are exploring that might allow us to increase that opportunity.

Next question. It was good to see management expense growth at a relatively low level. What factors do you worry about over the next three to nine months that could change that expense growth, [make it go in] the wrong direction?

You saw that the expenses moderated considerably in the second quarter and to give you a little color on that. The biggest driver - other than commissions - is the personnel costs and through where we sit today our full-time employment Companywide - now I'm just not talking about indemnity, I'm talking about the whole group - it is down about 100 people.

So the split between indemnity and the claims function is about a third indemnity, a full of those 100 and two-thirds exchange or claims employees. So the single biggest driver is our rate of employment and whether we as people [attrit] out of our organization - we have a natural attrition of 2 to 300 people a year - taking a hard look at whether we should replace those people that leave. And that is probably the single biggest factor. And so far through the year as I say we are down 100 full-time people.

So that is probably the single biggest factor going forward. Now we are going to be monitoring our growth. As you see we had a pretty healthy growth in units of 20,000 units for the quarter. So that requires people in the underwriting areas and processing areas. So we are going to balance our workforce with our unit growth.

But we have enough people, even with the (indiscernible) growth we are experiencing and the 100 decline.

Finally, on the surface it sounds like you brought in a pretty big CIO, CTO. What are the first two or three initiatives that you envision we could see coming out of the new CIO?

Firstly I want the individual obviously to establish strong relationships. Relationships with obviously the leadership in our IT area. The senior leadership of our Company and the various dependencies that they represent and also our agency force. They represent some very important customers for us. We want to make it easy for them to do business with us.

We also want to have rapid application development. We know that there are numerous opportunities at all levels of our business, affecting all of our customers which include employees as well as policyholders as well as agents, in terms of providing additional functionality. So we see relationships focused on customers' rapid application development being very important right out of the gate.

Thank you very much.

Ladies and gentlemen, we are standing by. With no further questions at this time, I would like to turn the conference back over to Mr. Ludrof for any additional or closing comments.

Thank you. Thanks for our discussion today. As I noted earlier, based on the underlying trends - steady policies, enforced growth, rising retention ratios, effective cost management and stable underwriting results - I am optimistic about where we are headed in 2006 and into 2007. Our employees are fully engaged in executing on our strategy to build Erie into a regional gem. Simply the best insurer wherever we do business.

This customer-driven strategy is built on our philosophy of enhancing quality growth while maintaining underwriting profitability, an equation that will latest to strong results for the Erie Indemnity Co. and you, our shareholders.

Thank you for your time and we look forward to sharing our third quarter results with you in early November.

That concludes today's 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 at all please give me a call at 814-870-4665. Thank you again and have a great day.

Thank you. Once again, ladies and gentlemen, that concludes today's call. Thank you for your participation. You may disconnect at this time.