Erie Indemnity Co (ERIE) 2006 Q3 法說會逐字稿

Hello and welcome to the Erie Indemnity Third Quarter 2006 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 would like to introduce your host for today's conference call, Mr. Mark Dombrowski from Erie Indemnity Company Corporate Communications Department. Please go ahead sir.

Thank you, and good morning. We appreciate all of you joining us today.

On today's call, management will discuss our third quarter 2006 results. Joining me are Jeff Ludrof, President and CEO, Executive Vice President and Chief Financial Officer, Phil Garcia, Jan Van Gorder, Senior Executive Vice President and General Counsel, and Tom Morgan, Executive Vice President.

Today's prepared remarks will be approximately 20 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. We also filed Form 10Q with the SEC. On today's call, the management of the Erie Indemnity Company will share important information about current and future initiatives being undertaken by 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 last 10-Q filing with the SEC dated November 1, 2006, and in the related press release and 8-K.

In this call, we will discuss some non-GAAP measures. You can find a 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 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 Chief Executive Officer, Jeff Ludrof.

Good morning, everyone and thank you for joining us on today's call.

In the press release highlights and investors' supplements, you can see that Erie Indemnity had a solid third quarter, with 2 of our 3 business segments, management operations and underwriting operations, generating positive results. The lower result during the quarter in our investment operations reflects the effects of our capital management strategy as we continue our share repurchase program..

Phil will provide specific details on the third quarter performance of each segment.

This morning, I'm going to talk about 3 critical areas of the Company and of great importance to you; growth, operating expenses, and strategic direction.

So let's talk about growth, starting with the competitive environment. No doubt you're hearing from others during this reporting season that competitive rate environment continues to soften and private-passenger auto is leading the way. This continues to put pressure on the growth of direct-written premium of Erie's Property and Casualty Group, which in turn affects the revenue of the Indemnity Company that they earn from the management fee. With our latest pricing changes introduced this fall, our year-over-year average premium per policy on new business dropped 3% to $845. With this change, however, agents are telling us our competitive position is strong, with evidence coming from continued unit growth and a strengthening retention rate.

At the end of the third quarter, for the Property and Casualty Group lines of business, total yea-rover-year new policies in-force grew by 1.7%, and the total line's retention rate grew to 89.2%. Our private-passenger auto line saw a 3% increase in new policies in-force from a year earlier on an over 5% increase in submitted applications. And our private-passenger auto retention ratio increased to 90.5%.

As it relates to pricing, I want to reiterate what I've said many times before. We take a disciplined approach in managing rates, and we'll continue to balance growth and underwriting profitability.

The Property and Casualty Group's adjusted combined ratio for the third quarter 2006 was 83.7%. The GAAP combined ratio for the Erie Indemnity Company was 89.2%, generating underwriting gain of $5.7 million during the third quarter of 2006.

In addition to rate actions, the private-passenger incentive, we introduced to agents in July that runs through December 2007 contributed to the increase in new private-passenger business. Agents receive $50 for every eligible new to Erie private-passenger auto policy they convert. For the third quarter, private-passenger applications were up over 8%. And while the incentive has helped us spur growth, agents are continuing to actively market Erie and are embracing co-branded marketing materials and programs we introduced earlier this year. Those programs include shared media buys that have helped to build greater brand awareness for both Erie and our agencies at the local level.

Erie has a great story to tell, and our agents are proficient story tellers. Enhanced brand awareness will support their abilities to convert prospects into policy holders.

Emphasis on new agent recruitment in 2006 continues and recruitment efforts are strong throughout all of Erie's territories. Our goal for 2006 is 125 new agencies, and by mid-October, we had surpassed the 100 mark.

Now let's turn to operating expenses. At the onset of the second quarter, we stated a goal of holding the increase in non-commission operating expenses to 6% in the Property and Casualty Group, and 9% in the Indemnity Company. I'm please to say that we're on track to meet of exceed those goals by year-end. For the third quarter, non-commission expenses grew by 2.8% in the Erie Indemnity Company; excluding the effect of lower accruals for management incentive bonuses, non-commission expenses grew 6.9% for the quarter.

For the third quarter of 2006, the Erie Indemnity Company gross profit margin for management operations stood at 20.5%. For the first 9 months of 2006, our gross profit margin stands at 20.7%. We are making good progress in our efforts to manage costs and maintain our low-cost advantage. At the same time, we are making targeted investments to growth the Company that are consistent with our regional [GEM] strategy. The primary focus of our strategy is creating a customer-centric organization; understanding the needs, behaviors, and attitudes of customers is central to the work we're doing to build our regional GEM.

Our customer research is telling us that despite the increasing number of online purchases, there are significant numbers of people who prefer to buy their insurance in person from an agent. These target customers expect personal service, and that's exactly what being a regional GEM is all about.

Our intent is to truly differentiate ourselves through personal service and to accomplish that, we know we need to understand what personal service means to our customers. For example, some of our target customers, personal service means having access to online services and information, as well as an agent to help guide through their purchase. We know we need to develop our online capabilities to fully engage these customers, and we're doing just that with our regional GEM 24/7 sales and service initiative.

This fall, we began talking with our agents about an online quoting capability for personal auto insurance as a way for the se targeted customers to access information easily on our public website, and drive these prospects to a local Erie agent. This online capability will be available later this month.

My vision is that we differentiate ourselves through personal service. I see real opportunity for us to shine by delivering unmatched personal service every chance we get. That's a great advantage in a market where other companies offer more generic products and services. Personal service has become a rarity any more, and yet at Erie, it remains a strategic advantage.

Now let me turn it over to Phil to provide more details on our financial results.

Thanks, Jeff; good morning everybody.

As Jeff pointed out, this was a solid quarter for the Erie Indemnity Company. Our net income per share increased 7.9% to $0.82 per share in the third quarter of '06, compared to $0.76 in the third quarter of '05. And in the third quarter 2006 net income was $52.8 million, down slightly from $53 million in 2005.

Our operating income increased to $53.4 million from $51.9, and on a per share basis, that operating income represents a 12.2% increase to $0.82 per share from the $0.74 per share for the same quarter in 2005.

I'll take a few moments to explain more of the details driving our third quarter results, starting with the management operations segment. Our management fee revenue increased by 1.3% during the third quarter of '06 even with the rate actions we took, which resulted in a lower direct-written premium for the Property and Casualty Group. Our improved retention and a higher management fee rate of 24.75 compared to 23.75 last year contributed to the result.

Efforts to enhance our competitive position resulted in a decline in written premium, and the average written premium per policy. Our all-lines average premium declined $44 per policy from a year ago. A third of that decline during this past quarter with additional rate reductions.

Another impact was the change in the mix of the renewal business to lower price tiers for auto and home. Our lower premium rates were partially offset by better new policy growth and an increase in our year-over year retention to 89.2%. Our policies in-force grew by almost 12,000 policies in the quarter, and over 30,000 policies since last December. And as Jeff noted, our largest line of business, private-passenger auto saw a 3% increase in new policies in-force for the quarter, which resulted in part from our private-passenger auto incentive.

The total payout for the $50 bonus program was $1.4 million during the quarter, which should approximate the average run rate for the rest of the year.

Overall, commission costs increased 3% during the third quarter 2006 with the cost of agent bonuses, which have growth and profitability components increasing $5.3 million when compared to the third quarter of '05. Our improved underwriting result of the Property and Casualty Group was the primary driver of the commission cost increase, from increases in our estimate for agent bonuses. The normal and the accelerated schedule commission cost to agents, however, declined by $3.6 million during the quarter, which reflects the decline in the direct-written premiums of the Group.

As Jeff noted earlier, excluding an adjustment for reductions for the estimated executive incentive plan payout, our operating costs other than commissions increased 6.9% in the third quarter. Other operating costs contained 2 categories of expense trends worth noting; our personnel costs increased 8.3%, excluding the executive incentive plan adjustment, and our survey and underwriting costs increased 24.6% during the quarter due to an increase in submitted applications and a more normalized level of insurance scoring costs when compared with the third quarter of '05.

Turning to the Company's insurance underwriting operations, the GAAP combined ratios were 89.2 and 96.9 for the quarters ended September '06 and '05 respectively. Contributing to that result are higher catastrophe losses during the quarter, which as we said are offset by favorable development of prior accident-year reserves.

Our catastrophe losses contributed $0.9 million, or 1.6 points of the GAAP combined ratio during the third quarter of '06, compared to 0.5 points during the third quarter of '05. And through the 9 months, the catastrophe losses contributed 3.7 points compared to 0.5 points for the same period.

The development of our prior accident-year losses also positively impacted our underwriting results. The Company share of this development amounted to about $2 million, or 3.8 point reduction in the GAAP combined ratio. We attribute this to improving severity from enhanced claims handling. We've provided you with a line of business analysis of prior-year reserve development in our information release, that's new for the quarter.

Results from investment operations for the third quarter 2006 were 8.9% lower as compared to the same quarter in '05. This reflects our use of capital to fund our stock repurchase program during the year. During the third quarter of '06, the Company repurchased about 329,000 share of its outstanding Class-A common stock, and those shares were repurchased at a cost of about $16.5 million, or an average of $50.03 per share.

In 2006 for the year, the Company has repurchased almost 4 million shares at a cost of almost $216 million. And at September 30, 2006 the Company had $130 million in outstanding repurchase authority remaining under the plan.

Thanks for your attention. I'll turn the call back over to Jeff.

Before we open the line for questions, I wanted to touch on the topic of technology. Last quarter we talked about Erie bringing on a new head of IT, our new CIO Jeff Stempora. He's been on board now for about 10 weeks, and he continues to complete a 100-day analysis of our IT operation. His outlook is very customer and agent focused, and he's committed to delivering new functionality to all key groups every 90 days. He's been out in the field visiting agents to gain a clearer understanding of their needs and priorities and is working with our newly-formed agent technology task force.

His plans going forward include creating an agent innovation lab, reconstructing the agent and customer experience. This test lab supports our intense focus on our customer and on our vision for unprecedented personal service.

So I thought I'd share that with you and now let's open it up for questions.

[OPERATOR INSTRUCTIONS].

Michael Phillips, Stifel Nicolaus.

Hey good morning everybody; how are you? Couple questions; one on the expenses; your goal is to keep it under the non-commission expenses less than 9% for '06. How do you think about that going into '07? I mean are you going to lower that goal or what does that goal look like for '07?

Well, we're currently putting our budget plans together with our senior management team for '07, so obviously, we want to keep our expenses in line with our revenues, as close as possible, so we're putting together our revenue budgets and our expense budgets, so we don't have much visibility around that, but our goal is to continue to work on closing the gap between our revenue and expense growth rate. And so that's all we can say at this point.

But let me talk a little bit about the quarter, what happens because I know you guys at Stifel kind of had a lower margin, and so let's go through the expenses a little bit. I talked a little bit about the personnel expenses, and you know the big thing there is the adjustment for a couple million dollars for our incentive plan and the fact that that accrual came down. So that's something, it's really around our long-term incentive plan where the accruals came down, which is a plan that looks at our performance in terms of combined ratio, premium growth, and return on invested assets against a peer group of companies. And so the accruals came way down for that plan because we're growing slower than the industry. Our combined ratio is better but they're closing the gap.

So what happens with that plan going forward is a relative thing regarding our performance in the peer group.

Our sales and policies issues costs came down 6.6% for the quarter. We have been aggressively managing our printing and postage costs. I think you're going to see going forward modest increases in those costs; our printing costs were down 14% for the quarter; our postage costs were down about 4% or 5%. We're aggressively managing both printing and postage, and we think we're going to have going forward small decreases, single-digit decreases in those numbers.

Hey Phil, could I cut in? That's one point I really didn't understand. How does the insurance scoring, with I think you talked about in the Q, how does that tie into that component of the expense? I just don't understand that.

Well, that's in our survey and underwriting cost line we talked about in the Q. So I was talking about the sales and policy issuance costs, which is composed --.

Sorry, [inaudible].

Yes, so again going back to the sales and policy issuing costs, our printing and postage are in there, agent related costs are from advertising and sales expense costs, and we've been aggressively managing down the printing and postage components of those, and that's why you see a decrease, a 6.6% decrease as we manage those down.

Our other operating expenses only went up 2.2%; there are a bunch of things in there; the single biggest things are travel, telephone, our IT, some of our IT costs, and professional fees. The couple of things that really moderated the growth there we are aggressive managing our telephone expenses down, and our travel is down. So those were down about 30% each. So that's moderating what's happening with total other operating costs in that line.

And I think you can expect that the telephone and the travel will continue to be down, but I don't think you can expect the 2.2% going forward; I think that's unreasonable to expect in that line item.

The survey and underwriting costs, they're up 24.6%; our apps were only up 3%. What's going on there is in the third quarter of '05, we were having a tough time getting transparency around how many survey and underwriting reports we were ordering, and we kind of under-accrued in the September '05 quarter, so there's a large adjustment in that quarter to kind of depress that number.

So I think you can expect survey and underwriting costs to go up consistent with -- now that we're kind of at a normalized level of ordering credit scores -- they're about $1 million a quarter, the credit scores, and we're kind of on a normalized run rate there. So you're not going to see a 24.6% increase on survey and underwriting costs; it's going to moderate.

Okay perfect, I appreciate all the details. One more I guess on the expenses, just want to understand how it ties in with the retiree health benefit plan. I guess that was terminated in the second quarter of '06, correct?

Right, that was terminated in the second quarter of '06.

Any idea, I guess can you share with us the dollar impact that it had on the second quarter and the third quarter?

Off the top of my head, I don't remember how it affected the second quarter. You can go back and look at the second quarter Q and I think we said what that change was. Going forward, it's going to be normalized at around I believe the expense is going to be about $600,000 a year going forward for the cost in the post-retirement benefit.

Okay good, thank you; I appreciate all the details there. And second question if I could throw out on I guess the growth on the policies in-force in autos specifically, and I think Jeff mentioned kind of moving into a bit of a lower-price tier for auto and home, and the agent bonus obviously is helping with that. How do you think about, I guess first what is the agent's role, I guess tied into auto, what is the agent's role with the credit scoring and how that applies to your rating? Does the agent have a role in that or is that more of an automated process?

Well, the agent has the opportunity up front to meet directly with the prospect and gather the information. And they provide that information directly into the systems that ultimately calculate the tier, the go off and do the appropriate credit scoring and the other aspects of ultimately arriving at the rate. So the agent has that opportunity, or course, to be sitting down with that customer to not only attain that rate but to help them understand what their choices are, what coverage options they have. Too often customers don't understand the coverage that they have; until an agent sits down and explains to them the various coverages available to them, they don't know.

The agent cannot manipulate the insurance score or tier. They provide the information and the pricing model ultimately calculates the price.

Okay right, so the whole pricing module is the automated part then. How do you, as you move into the I guess the lower tier -- the lower-priced tiers -- and continue to do so I assume, how do you get comfort on the fact that that part of your business has historically been a little bit of experience has been more towards the better price, the more higher price against the better credit score type folks out there, and as you move into the lower priced where I guess the experience is a little bit thinner, how do you comfort in the ability of that system to price that accurately with a little less experience that you have?

Well, one thing I want to say is that we know that lower-tiered business in our model has a lower loss ratio. But we also would expect that our model would provide an adequate price at all tier points, so we have an opportunity to write business not just at the lower tiers. If we could completely control and had enough volume, having all of our business to be extreme at the lowest tier with the lowest loss ratio at a competitive and adequate price, that would be very desirable. That's the most desirable business from the standpoint of loss ratio.

But our goal is to have the lowest-priced and a competitive price and an adequate price at all tier levels. We also know that lower tiers have higher retention ratios. So there's another attribute of why having a mix of your business with those lower tiers is beneficial.

Adam Klauber, CCW.

Good morning, thank you; I also have a question about the tiering and pricing. You've obviously been putting the system for a while now, and for some customers as you put in the tiering probably shows that you need less price, they were probably overpriced, but for some customers it probably shows you need more price. At what point in time can you go back to the regulators and say, "This base of customers is probably under-priced and we'd like to get more rates"?

Well it's a constant opportunity Adam for us to evaluate attributes that affect loss experience. And that's not unique to the Erie. Competitors are focusing on many different attributes that can be integrated with a tiering model that in part is driven by credit score, loss experience, usage of vehicles, and other factors that have been more traditionally used in the auto business.

So I don't think that it reaches a point where you're going to the regulator at -- and here's the change that's going to occur and that's going to be it. I think it's going to continue to evolve, and I think that each and every company is going to continue to try and develop what they view as factors that drive loss experience.

Okay thank you; given the rate actions you've been taking, would you say that you are at the mid-range price-wise above or below the average competitor in the market right now?

Speaking specifically of private-passenger auto?

I'm sorry Jeff, I meant in auto.

And I assumed as much, but just for everybody's benefit, just thinking of that line of business, our agents with our recent rate changes have indicated to us that it has had a very positive effect on our competitive position. So I would call our competitive position strong out there in the marketplace right now.

Okay; looking at the workers' comp line, that's not a large line for you, but it's probably had, continues to have the most significant reduction. Is that just a very competitive market right now?

It is very competitive; the other factor is that our average size of our commercial workers' comp has gone down in the last 3 or 4 years, it's gone down significantly. That's part of focusing on our appetite for specific commercial so that we can control our loss ratio, and as you know that has improved dramatically in workers' comp and in other lines.

Thank you very much.

[OPERATOR INSTRUCTIONS].

Blake Phillips, Fox-Pitt Kelton.

Good morning; will you guys, did you make a conscious decision to lower the amount of repurchase in the quarter? I mean because at the lower average price it seems like you lowered it pretty significantly from previous 3 quarters, 4 quarters even.

Yes, if you go back and look at the price movement during mid to late August into September, you see the stock price moved up pretty strongly. As we've said before, we're pretty opportunistic in this repurchase program, and the stock moved up pretty strongly on its own. So we stepped away in late August and early September. We also didn't have -- that's our, kind of what I call our [Safe Harbor] program, our market program; we, as we discussed before too we're kind of at the mercy of blocks coming to us, and we didn't have any blocks coming to us during that period of time; so again, being opportunistic with the repurchase program in late August and early September due to the strength of its own in the market.

Okay; and then did you guys have a yield dip in the quarter on your investment portfolio? It seems, I mean your invested assets were pretty flat; it seems like new money yield therefore, didn't really do that --?

No the yield didn't change much, but we lost a lot of assets in the second quarter with our repurchase program because we had large repurchase in the second quarter, and so we sold down a fair block of our fixed income portfolio in the second quarter to fund those repurchases. And that's why you're seeing the investment income coming down. It's not yield-based.

Okay, and the 98 agencies added in '06 thus far through the end of the third quarter, those are net adds?

No that's a gross add.

Gross add; do you have that on the net basis?

I don't think -- about 25 or 30 less on a net basis. Okay 25 to 30 on a net basis addition because a lot of our agencies there's a lot of combinations of agencies where agent one buys agent two, so you've got to be careful of the net number because it sounds like those are agents that parted company with us and are not writing any more, but in fact, in our book of business, we have quite a few that agent A buys agent B, so we have one less agency, but we're not losing that book of business.

Okay, and then finally I know it's probably a bit early with the hot issue coming out of nowhere the last quarter, but it's considered about an $11,000 fine and potential actual damages, do you have any kind of estimate what that could cost if you get an adverse ruling?

We really don't; we think the likelihood of any material impact is remote.

Okay, great; thanks a lot guys.

Michael Phillips.

One more; on the agency appointments, how much of that is current territories versus maybe expansion into new states, either through this quarter, or I guess the plan for '06?

I'm pleased to say it's very well distributed throughout the Company; certainly in the newest territories or States like Wisconsin and Illinois, we have greater opportunity and we've seen larger numbers than the more established States, but we've had nice growth in all of our territories in new agent appointments.

Okay, thank you very much.

And at this time, we have no further questions in the queue. I'll turn the conference back over the Mr. Dombrowski for any additional or closing remarks.

Thank you all for joining us today. That concludes today's call. Again, a recording of the call will be posted on our website erieinsurance.com after 12:30 p.m. Eastern Time today.

If you have any questions, please call me at 814/870-2285. Thank you again and have a great day.

That does conclude today's conference call. You may disconnect at this time.