Erie Indemnity Co (ERIE) 2007 Q1 法說會逐字稿

Please stand by. Hello and welcome to the Erie Indemnity Company's first quarter 2007 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.

Thank you, [Leeana] and good morning. We appreciate all of you joining us today. On today's call management will discuss our first quarter 2007 results. Joining me are Jeff Ludrof, President and CEO, Executive Vice President and Chief Financial Officer, Phil Garcia, and Jim [Tanith], Secretary and General Counsel.

Today's prepared remarks will be approximately 30 minutes. Following those remarks we will open the call for questions. 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 Relations section of our website at erieinsurance.com. 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 as a company. As a result, certain forward-looking statements 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 difference please see the Safe Harbor Statements in the latest 10Q filing with the SCC dated May 2, 2007 and in the related press release [inaudible].

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 investors 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. The replay will be available on our website today at 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.

And now Erie's President and CEO, Jeff Ludrof. Jeff.

Thank you, Karen. Good morning and thanks for joining us today. This morning Phil and I will make some brief remarks about our first quarter 2007 results, and then we'll get to your questions.

Before I start into our discussion of the first quarter I want to thank those of you who could attend our annual shareholders meeting held here at our home office on April 17. I know many of you attempted to be here but couldn't due to some terrible weather on the east coast.

For your information we've posted Phil and my remarks with the slides on the investment section of our public website erieinsurance.com. Now to our discussion of the first quarter results.

I would describe the Company's overall first quarter performance as showing steady progress. Our underwriting results are positive, our investment performance was stellar, and in our core P&C business policies in force and retention are up.

The combination of strong investment and underwriting results produced outstanding first quarter results for the Company, strengthening out net income by 13.9% and our net operating income per share by nearly 19% to $0.86 per share.

Drilling down into our management operations segment you'll note a continued decline in management fee revenue which is driven by the lower direct rate and premiums of the Property and Casualty Group. Yet underlying those results are increases in new written premium, policies in force and retention.

Our agents continue to make in-roads by bringing on new policy holders despite the increasingly competitive environment. We added 13,500 new policies to our book of business during the first quarter 2007 continuing the momentum we saw during the latter part of 2006. Year over year we've added 50,000 new policies.

Our retention ratio also ticked upward moving from 89.5 at the end of 2006 to 89.7 at the end of the first quarter. This tells me that our competitive position in the marketplace is holding steady and that the rate reductions we've taken are having the expected affect. That's not to say it isn't tough out there. I know it is.

Given Erie's strong service reputation and the quality and dedication of Erie employees and agents we believe we have a solid foundation to continue to expand policies and grow our retention of existing policies. Frankly, we've earned a few bragging rights.

Year after year the number one customer research company in America ranks Erie Insurance as the top independent agent carrier in the country. Our own recent customer study mirrors those results. Nearly 20,000 policyholders responded to our customer survey, and 95% of them said they'd recommend Erie to family and friends. They say the same about their Erie agent.

We've earned our customers' trust, and that's a rare thing for a company to claim today, and, yet, Erie insurance has been able to make that claim throughout its history.

On April 20 we celebrated 82 years in business. Throughout those 82 years we've held true to our founding purpose, our mission to provide as near perfect protection, as near perfect service as is humanly possible and to do so at the lowest possible cost. That's why the Erie Insurance Group of businesses, which included the Erie Indemnity Company, the Property and Casualty Group and Erie Family Life Company, has grown from the initial $31,000 in start-up capital to nearly $6 billion in capital, and we've done this primarily through word of mouth.

Inherent in our mission created by our founder H.O. Hirt in 1925 is a perfect balance of the interest of our policyholders and our shareholders. We strive to give our policyholders superior service above all, while at the same time we manage our operating costs to enhance competitiveness and shareholder returns. Our first quarter results amplify our efforts to do this.

During the first quarter we were able to decrease our cost of management operations. We initially projected that these costs, excluding commissions, would increase by 9% in 2007. Given our first quarter result, we're lowering that estimate to 6%. We view our low cost of operations as a distinct, strategic advantage we must sustain.

Consequently, we're taking a highly disciplined approach to target our spending in areas that will produce greater effectiveness and efficiencies, including key investments in technology. And while technology is a focus for us, it makes up only part of the initiatives we've undertaken to move our regional gem strategy forward.

Grounded in our founding mission, our regional gem strategy compels us to be the best insurance company wherever we do business, delivering personalized service above all. This charges motivating action throughout our entire organization.

Of primary interest to you is what we're doing to enhance growth. A renewed emphasis was placed on agency recruitment in 2006. We ended the year with 139 newly appointed agencies, ahead of our goal of 125. In 2007 we upped the recruitment goal to 200 agencies, and right out of the shoot we're off to the best recruitment year in our history with 66 appointments at the end of the first quarter. As of today we've made 89 agency appointments.

If you're not familiar with our recruitment process you may not fully understand the magnitude of this achievement. We take great care in selecting who represents the Company to potential buyers and within the communities we serve. It's not a simple, convenient process, nor is it truncated to expedite the achievement of goals.

It's like everything else we do at Erie, grounded in our mission and values, deliberate, and disciplined. Our field sales employees are doing an outstanding job here. I'm very impressed with the new agents who are joining the Erie team.

Last July we began providing a $50.00 bonus to agents for every eligible private passenger auto application, and that bonus continues throughout 2007. The bonus is appreciated by our agents and, combined with rate reductions, is having a positive effect on sales. Even with a lower average premium per policy, new written premiums for private passenger auto increased 9.1% to $37.5 million during the first quarter.

Quick quote for auto, our online private passenger auto-quoting tool has seen considerable action since its implementation on our public website last November and is proving to be a good source for agent lead. In fact, about 100 agencies have included a link to this quoting feature on their websites. We're working on plans to enhance this feature and optimize its use for the Company and our agents.

We're also learning more about our customers and specifically how they view the Erie brand through a brand architecture initiative we launched during the first quarter. This research will help us refine our brand strategy and positioning and allow us to better leverage our word of mouth creating more co-branding opportunities for Erie and our agencies.

I'll turn it over to Phil to provide more details on our results, and then I'll come back and talk about our annual shareholders' meeting and then we'll take your questions. Phil.

Thanks, Jeff. Good morning everyone.

For the first quarter of 2007 net income increased by 13.9% to $56.4 million from $49.5 million at March 31, 2006. On a per diluted share basis net income increased $0.88 in the first quarter of '07 compared to $0.73 last year. Our net operating income per share increased by 18.9% to $0.86 per share in the first quarter of '07 compared to $0.72 per share last year.

The quarter was influenced by reduced expenses in our management operations, continued favorable underwriting results, strong earnings from limited partnership and a lower effective income tax rate during the quarter.

Our management fee revenue increased 1.8% as a result -- decreased 1.8% as a result of the decrease in direct written premiums of the Property Casualty Group. This reflects the impact of our rate reductions and changes to the risk characteristics of our policyholders and the coverages we provide. Our higher management fee rate in 2007 of 25% partially offset that decline in direct written premium.

Pricing pressures continue in the industry, primarily in private passenger auto, our largest line of business. We continuously evaluate our pricing and estimate that those pricing actions approved, filed, and contemplated for filing could reduce the direct premium of our Property and Casualty Group by approximately $79.5 million during 2007, of which approximately $34.4 million occurred in the first quarter of 2007.

A trend toward an increase in policy growth that began in 2006 continued in the first quarter of 2007 as polices in force and its new written premium continued to climb; policy retention rate increasing slightly as well.

Jeff mentioned our year over year policies in force grew by over 50,000 or 1.3% to over 3.8 million policies at March 31, 2007. However, premiums generated for new business increased 5.6% to $91.5 million. However, the year over year average premium per policy was $991 and $1,044 at March 31, 2007 and 2006 respectively, a decrease of 5.1%.

The total cost of management operations increased by 1.8% during the first quarter of 2007. Commission store independent agents make up the majority of those costs. Normal commissions decreased 2% in the first quarter due to lower Property Casualty Group premium volume.

Our estimate for our agents' bonuses and promotional incentives to agents decreased $0.9 million in the first quarter of 2007. Our costs related to the $50 private passenger auto bonus began in the second quarter of '06 were $1.5 million in the first quarter of '07.

The cost to management operations excluding commissions decreased 0.3% for the first quarter of 2007. Our personnel costs, which are the second largest component in the cost to management operations, decreased 4.8% or $1.7 million in the first quarter of 2007.

The decrease in personnel costs reflect the decrease of $2.4 million in the expense for management incentive plans in '07 and an offsetting increase of $1.2 million or 4.6% in salaries due to higher average pay rates. These higher pay rates were offset by a lower number of full time employees for the quarter and reduced benefit cost. Our benefit costs were lower primarily due to a reduction in pension expense from the change in the discount rate on the pension.

We're revising our estimate for growth in non-commission costs for the full year 2007, as Jeff mentioned, from 9% to 6% to reflect these first quarter expense trends. We still anticipate accelerated investments in technology in the remainder of 2007, and those investments are considered in this revised estimate.

As a consequence to the reduction of the cost management operations for the quarter our gross margins for management operations remained the same, about 19.4% from the first quarter of '06.

Now I'll give you some highlights of our underwriting operation.

Our insurance underwriting operations continued to perform profitably in the first quarter of '07, generating a gain of $5.6 million compared to $7.3 million in the first quarter of '06. The GAAP combined ratio for the Company was 89.2% in the first quarter of this year compared to 86.5% last year.

Underwriting losses are seasonally higher in the second and fourth quarters, and, as a consequence, our Property and Casualty combined ratio generally increases as the year progresses.

We recognize favorable development with prior accident year loss reserves which improved the loss ration 10.3 points compared to an improvement of 7.9 points for the first quarter of '06.

The majority of the favorable development for the quarter was from re-estimates of auto bodily injury, UM and UIM reserves due to improvement in accident quarter loss ratios as a result of improved frequency and severity trends. We believe these trends were influenced by our new claims impact specialty unit and the repeal of mandatory arbitration on these claims in Pennsylvania.

Offsetting these positive reserve re-estimates was strengthening of the reserves for certain worker's comp claims of which Erie Indemnity Company's share $0.4 million or 0.8 combined ratio points.

Property Casualty Group also strengthened adjusting other expense reserves to reflect estimated employee salaries and benefits of the exchange not fully considered in the reserve. Our share of these additional liabilities was 1.4 million and contributed 2.4 points to the combined ratio.

Finally, in the first quarter of '07 our share of the reduction to reserves related to the seasonality adjustments in our business was $3.3 million compared to $2.3 million in the first quarter of '06. The Company's investment operations reported income of $29.8 million during the first quarter of 2007 compared to $20.6 million for the same period in '06. This significant increase in investment income was driven by an increase in the equity in earnings of limited partnerships to $12.5 million in the first quarter of '07.

Favorable market conditions resulted in higher return on capital by some of our more seasoned mezzanine debt and private equity partnerships, investments and strong appreciation of commercial properties owned by our real estate limited partnerships.

Investment income net of expenses decreased by 6.8% to $14 million from $15 million a year earlier as a result of lower invested asset balances due to our share repurchase activity.

Our provision for income taxes was positively affected by tax adjustments of $2.5 million. These adjustments were offset by $0.8 million of interest on uncertain tax positions recorded from adoption of BIN 48 during the quarter. As a consequence, the effective income tax rate for the quarter was 30.5% which is lower than our normalized effective tax rate of about 33%.

Finally, during the first quarter of 2007 we repurchased 282,539 shares of our outstanding Class A common stock in conjunction with the continuation of our share repurchase plan that was authorized in February 2006. The shares were repurchased at a total cost of $15.1 million or $53.34 per share, and we have $115 million remaining under the repurchase plan which is authorized through December 31, 2009.

Thank you for your attention. I'll now turn the call back over to Jeff.

Thanks, Phil. For those of you that may have joined the call since my opening remarks I just want to remind everyone that both Phil and my remarks from the annual shareholders' meeting along with the related slides can be accessed through our website. Of course, later today you can also access a transcript of this call.

This week we begin another important tradition at Erie Insurance. Immediately after this call I'm headed to Raleigh, North Carolina for the second in a series of nine spring annual dinner meetings being held throughout May. The fall annual dinner meetings for our other nine branches will be held in October.

The annual dinner meetings are a favorite tradition that brings employees and agents together at the branch level to recognize outstanding performers in sales and service and to celebrate our joint success. These dinner meetings also give me an opportunity to personally share Erie's focus and direction and hear firsthand from agents about challenges and opportunities in their markets. Each meeting is preceded by a four-week sales contest that continues to deliver positive results year after year, this year being no different. So let's get to your questions.

Thank you. [OPERATOR INSTRUCTIONS] Our first question comes from Michael Phillips with Stifel Nicolaus.

Hey, good morning everybody.

Good morning, Mike.

Good morning, Michael.

Good morning.

Congrats on the quarter, and I'm really sorry I missed you at the annual meeting. Stranded in an airport for a couple of days. I would have rather been in the area.

Thanks for trying.

Thanks, Jeff. We'll try again next year hopefully, but I'd like to see you guys soon. Anyway, a couple questions. First on the insurance side, the reserve development, can you tell me what -- is there a specific [accident] year that is related to? Is that more like '06/'05 or further back?

Well, the majority of it is in the recent accident year so '06/'05, but it's all accident years going back. But the majority of it -- or the line share of it is in '06 and '05 and '04, and it relates to bodily injury and UM/UIM on both personal and commercial.

Okay. Good. If I look back to -- I had some stuff going back to the say the beginning of '04. It looks like the first quarter of each year is kind of the highest for reserve development in terms of favorable development. Anything in that or maybe because you do a reserve analysis more ground up at the end of the year and so close to in the first quarter or it's an anomaly or -

No. We do tend to release reserves in the first quarter if you go back and look at the history for the last three years. This year it happens to be in the BI/UM/UIM which we saw marked improvement in our frequency and severity trends in that line. So this quarter the numbers are a little bit greater than they were in the last two years. I think we had 7 or 8 points in the prior year, and this year it's 10.

Okay. But it's typically larger then in the first quarter, correct?

Yes.

Okay.

We also have a large prior year salvage sub effect in the first quarter. You saw 3.1 points.

Yep. Okay. I saw that.

And then finally on the underwriting side with the development that happened this quarter, about 10 points, your current period stuff looks like it's around 99%. I guess I wanted to get your thoughts on, given the rate cuts and inflation, what does that mean going forward? Is there a way to combat that? You're about breakeven on the underwriting side right now. Are you comfortable with that for now or any ways to combat that?

We expected our combined ratios to rise this year as we're taking rate reductions. Of course we have the positive effect of frequency, but severity is causing loss costs to rise. So with loss costs generally rising modestly -- and we're taking rate cuts. We expect our combined ratios to rise.

Now, the good news in this reserve release, this BI and UM/UIM reserve release is that we anticipate that were settling claims -- we're getting fewer claims and we're settling claims for less. So that's going to translate into improvement in current accident year loss ratios in automobile. So whether we translate those improvements into more pricing actions or not will be something we decide on later in the year. So we'll either get improvement in the combined -- auto combined ratio from those things -- from BI/UM/UIM or perhaps we'll decide that we want to get more competitive in those coverages and take some rate decreases as a result.

Okay. That's fair. Thanks.

If I could switch over to management operations on the expense side. So the new goal is 6% for non-commission. To get there for the year the rest of the year has got to grow by around 8%. I just want to make sure that sounds right, or does that sound too high? I mean, this stuff is so lumpy it's obviously pretty hard for guys like us to predict and it's just up and down every quarter.

Right.

But 6% for the year means about an 8% for 2Q through 4Q.

Yes. If that's the math. We anticipate 6% at the end of the year right now. That's our estimate. So, yes, I think your math works.

And can you remind me just real quick on the $50 bonus, how long does that last for?

It goes -- the $50 bonus goes through 12/31/07.

Okay. Okay, perfect. Thanks for your help.

And we'll move on to Adam Klauber with Cochran Caronia Waller.

Good morning. Thank you.

Good morning, Adam.

It's nice to see that [PIPs] is bottoming out and going positive in several of the lines. Can you talk geographically, is there any differentiation, are you doing better or worse in Pennsylvania? Are there certain states that are taking off more than other states?

Yes, Adam, thanks for joining the call. This is Jeff. We are actually performing very well. In fact, in every single one of our states we are growing our new business. And so we continue to be strong as I look across each and every one of them. We've been able to, as you know, improve our competitive position because of the disciplined approach that our agents, our employees together have provided. And, candidly, we're also distinguishing ourselves through the service that we're providing out there in the marketplace. So everywhere I look across our state has strong growth.

Very good. Seems like you're ahead of target on hiring or appointing new agents. Are these agents newer agents, or are they existing agents with books of business?

It's a combination of both scratch agencies or startup agencies, as well as existing agencies. And we are ahead of -- as you recognized and as I commented, we're ahead of our goal at this point in time. And that's really due to the intense efforts that our sales force have taken to make sure -- I mean, we recognize the earlier in the year we bring on these appointed agencies and then there's a lag oftentimes of maybe 30, possibly 60 days until their agency becomes effective after an appointment, then, of course, up and running. So we recognized, as did our sales force, the earlier we bring them on in the year the better we would be. But it's a nice balance of scratch as well as existing.

And, Jeff, can you remind me how long from day one does it take for a new agency to get up closer to what a typical Erie agency runs from a premium volume standpoint? And I realize there's a big range between differences, but are we talking about a two-year timeframe, three-year timeframe?

You know there really is as you said. There's just so many variables. Oftentimes as a scratch agent we may be bringing somebody in who was a producer for another agency, and they tend to just take off right out of the gate. At the same time we may bring in somebody who was an educator, a schoolteacher. We may bring somebody in who was in sales of business products, office equipment, any other number of sales backgrounds; and making sure that they have a solid foundation in the product knowledge, oftentimes starting in maybe one line of business such as personal lines, later expanding into commercial lines where they start to get that exponential impact.

I think your view about two to three years getting into the average I think that's a reasonable approach to take.

Okay. Okay. How about as far as technology? I know you hired a new head of technology a little while ago. What are the two or three projects that he's going to be working on rolling out, and could you give us some sort of timeframe, and could you put any cost estimates around those projects also?

I won't be able to put the specific cost, but let me just share with you. We're very pleased with Jeff [Stempur], our Chief Information Officer, who joined Erie last August. He and our IT people have done a tremendous job working closely together, finding ways to be more effective and efficient, focusing on becoming more agile as an IT organization, and they're doing that.

Our focus is on expanding usability and functionality as it relates to ease of doing business, primarily for our agents, but for our customers, for our employees. We're focusing on supporting our pricing strategy such as putting in a new rules and rating engines. And considering the competitive nature of our business, we know that we want to continue to make sure that technology is supporting our pricing models.

So we have a number of technology initiatives aimed at essentially making sure that all of our agents and employees are in a position to provide a high level of personalized service as a result of having information at their fingertips.

Data warehousing is another topic that we're working on to make sure that we continue to obtain customer data and research and trend data, and then we can focus both our products, our marketing efforts, and, of course, our pricing efforts as well.

Okay. And my last question, we've seen from several other auto insurance competitors they've noticed an uptick frequency in the auto line. Are you experiencing that also?

No, actually we're not. Our frequency, I'm proud to say, continues to tick down.

Okay. Thank you very much.

Thank you.

[OPERATOR INSTRUCTIONS] Our next question comes from Blake Phillips with Fox-Pitt Kelton.

Morning.

Hey, good morning.

Good morning, Blake.

Couple questions, one I think it was last quarter you mentioned you were going to be looking at a broader range of personal auto applications. I was wondering how that was helping premium growth at all.

Yes, Blake, this is Jeff. Thanks for joining us. We talked about expanding our appetite for automobile, and we have in fact done that. We've made sure that we can have a price point where when we have some blemishes on the record we can still satisfy servicing that customer with an appropriate price for that particular risk. But we've also delved deeper along that continuum. Do you take that all the way to the extreme of non-standard auto, as an example. And it's not our desire to go to that extreme. So while we've moved and expanded our appetite, we won't go to that nth degree.

Is that -- so is that increasing the number of applications that you get then, or is it just increasing the number of the ones that you'll accept?

I would say at this point it hasn't necessarily increased the number that we're writing. We've used it initially to address the number we would otherwise non-renew.

Okay. Okay. I guess my other question has to do with the capital, the exchange. It seems like it's getting -- just continually growing while not necessarily being worked out as much given the softening environment. I was wondering if you were looking more aggressively, perhaps at alternatives of maybe acquisitions or something that you could do with that capital to use it, or if there's anything I'm overlooking in ways that you could use it?

Fortunately we are in a very healthy position with our policyholder surplus, and emphasis on the word 'policyholder' because it is, in fact, their surplus. And we all know that the winds can blow at any time. In fact, the winds came blowing through here just a couple of nights ago, and, fortunately, we weren't affected too much. But at any time the winds can blow, and having a strong policyholder surplus is extremely important to all of us, both at the exchange and at the indemnity company, because it, in fact, positions the Company to expand and grow.

At the same time, we know that having capital creates options, and moving over to the Company side, of course we continue our repurchase program as Phil mentioned, and we consciously discuss other options. So it's a nice position to be in.

Okay, good. Thanks.

Thank you.

It appears there are no further questions at this time. Mr. Ludrof, I'd like to turn the conference back over to you for any additional words..

Okay. Thank you, and thank you again for joining the call today. As I said at the onset, we are making steady progress toward our growth and cost management goals. The number of policies on the books continues to increase, our retention rate keeps moving up, and we're making targeted investments in the business while managing our costs and appointing new agents at a record rate.

I look forward to sharing the good news with our agents tonight in Raleigh and again with you when we meet next time for our second quarter call.

And just a reminder that the recording of the call will be posted on our website, erieinsurance.com after 12:30 pm eastern time today. And, as always, if you have any questions please call me at 814-870-4665 and make it a great day. Thanks so much.

That completes the conference. Thank you for your participation and have a great day.