Erie Indemnity Co (ERIE) 2008 Q2 法說會逐字稿

Hello and welcome to the Erie Indemnity Company's second quarter 2008 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'll open up the call for questions and answers.

Now I'd like to introduce your host for today's conference call, Ms. Karen Kraus Phillips, Vice President and Manager of Corporate Communications and Investor Relations.

Thank you, Patrick and good morning, everyone. We appreciate all of you joining you today. On today's call Management will discuss our second quarter 2008 results. Joining me are Terry Cavanaugh, President and CEO, our outgoing, President and CEO, John Brinling, Executive Vice President and Chief Financial Officer, Phil Garcia, Jim Tanous, Executive Vice President and Secretary and General Counsel, Mike Zavasky, Executive Vice President Insurance Operations, and George Lucore, is Executive Vice President of Field Operations.

Today's prepared remarks will be approximately 30 minutes. Following those remarks we'll 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 on the investor relations section of our website at erie-insurance.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 at the Company. As a result, certain forward-looking statements may be incorporated into their comments. These forward-looking statements reflects 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 and the latest 10-Q filing with the SEC filed July 30th, 2008 and the related press release and 8-K.

In this call, we'll discuss some nonGAAP 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 erie-insurance.com. This call is being recorded and the recording is a property of Erie Indemnity Company. It's not intended for reproduction or rebroadcast by any other party without the prior written consent of Erie Indemnity Company. A replay will be available on our website today at 12:30 p.m. 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 I'm very pleased to introduce Erie's new, President and CEO, Terry Cavanaugh. Terry?

Thank you, Karen. Good morning, and thanks for joining us on today's call. I'll give you a little prospective on my transition to Erie before turning the call over to Phil Garcia to give the details of our second quarter results. Before I start telling you about myself, my feelings about being a member of the Erie team and my observations on our second quarter, I'd first like to extend my personal thanks to John Brinling. After what I've seen in the past couple days I understand why he is such a fine choice to serve as Interim President and CEO. John is respected and appreciate by employees and agents alike. In the short time I've known him it is clear he lives the Golden Rule. To my benefit, John is postponing his retirement a few more weeks to help with this transition, for that I am very grateful. Thanks John for what you're doing for me and of course for all you've done for our Company.

If you had a chance to read the press release announcing my appointment, you know that I'm an insurance guy. I spent 33 years, my entire career in the business working for Chubb in a variety of capacities. I know this business and I have a deep understanding and appreciation for Erie's operating model. Having said that, this is only my third day on the job, so at this point I guess most of you have a longer and deeper history with the Company than I do. But I can tell, I couldn't be more proud to be at the helm of this great Company. Before I even thought about being a CEO, I knew about the strength of the Erie brand, very customer and agent focused, and the reputation of Erie's people to always want to do the right thing.

And thinking about this CEO job, these are the things that came to mind: Erie has a great history and a strong operating platform. I think the Company is poised to take advantage of its skills and market conditions to continue to grow customers and strengthen the relationship with Erie agents, our distribution system. Over the next several weeks, I'll spend time with our employees and agents learning about opportunities we need to advance and challenges we need to address. I'm also looking forward to meeting many of you and hearing your perspectives about the Erie. On our third quarter call, I expect to give you my thoughts on how we're going to keep Erie moving forward and produce greater value for our shareholders.

Now onto second quarter results. When I look at our second quarter results, it's obvious that investment market conditions have had an impact. Our investment revenue showed a significant decline compared to our second quarter 2007. There's an edemic issue within and outside our industry and I don't see it changing anytime soon. Despite soft market conditions Erie did grow total policies enforce by 2.5%. To put that number in prospective private passenger auto new business increased 4.8%. Homeowners new business decreased 2.5%. And commercial lines new business policies enforce increased 9.6%. The Company also turned in a solid retention rate of 90.4%. This helped offset reductions in written premium that resulted in flat revenue growth in our management operation segment compared to a year earlier.

In our underwriting operations, the combined ratio continues to be positive, even though higher than our outstanding results Erie saw in the second quarter of last year. Our GAAP combined ratio for Erie Indemnity Company was 93.7. The result was effected by increased losses in the current accident year, particularly increases in homeowners severity and three catastrophic workers compensation claims. I'm going to turn it over now to Phil to take it us through the numbers. Phil?

Thanks, Terry and good morning, everybody. For the second quarter of 2008 our net income decreased by 41.4% to $41.3 million from $70.5 million at June 30th, 2007. On a per diluted share basis, net income decreased to $0.71 in the second quarter of '08 compared to $1.11 last year. Our net operating income per share decreased by the 19.6% to $0.87 in the second quarter of '08 compared to $1.09 last year. As Terry mentioned, the earnings decrease in the second quarter was mainly a result of a reduction in investment revenues due to $12.4 million of impairment charges and $4.6 million of changes in fair value on our common stock in accordance with FAS 159. We also had a decrease of $8.9 million in equity in earnings of our limited partnership. I'll talk about those issues in more detail when I review our investment operations results.

First let's look at the results of our management operations. Our management fee revenue was flat as our direct written premiums for the Property Casualty Group remained level in the second quarter of '08 compared to the second quarter of '07. As you know our management fee rate was 25% for the second quarters of both '08 and '07. As you know we frequently evaluate our pricing and currently we estimate that our pricing actions that are approved and filed and considered for filing could reduce the direct written premiums for the Property Casualty Group by about $31.5 million during 2008. Approximately $17.3 million of the total occurred in the first half of '08. The most significant rate reductions effective in '08 are in workers compensation of Pennsylvania and a homeowners rate reduction in Maryland. Our segmented pricing in auto and home, where we offer lower prices to better risks, has accelerated declined in our average premium per policy.

Given our accident year loss experience and the market conditions we are seeing, we are projecting premium rate increases of about 0% to 1% overall for 2009. The trend toward increased policy growth continued in the second quarter 2008 as our policies enforce and new written premium continued decline. Our year-over-year policies enforce grew 2.5% or about 98,000 policies to 3.945 million policies at June 30th, 2008 compared to year-over-year growth of 66,000 policies in the second quarter of '07. Our policy retention rate, as Terry mentioned, improved to 90.4% at the end of the second quarter '08, compared to 89.9% at the end of the second quarter last year.

Premiums generated from new business increased 1% to $113.5 million from $112.4 million in the second quarter of '08 compared to '07. The new business year-over-year average premium per policy was $866 and $852 at June 30th, '08 and '07 respectively, a increase of 1.6%. The total cost of management operations increased by 2.8% during the second quarter of '08, commissions to our independent agents as you know make up the majority of these costs. Our commissions in the second quarter of '08 reflect a decrease in the estimate for our agent bonuses of about $2.3 million, which was offset by an increase in normal and accelerated rate commissions of $1.8 million or 1.5% to $125.6 million in the the second quarter of '08.

On June 1st, 2008, we implemented a new tiered payment structure to replace the $50 bonus we had been paying on new private passenger auto applications. The new structure pays out between $50 and $200 per policy based on the number of qualifying new private passenger auto policies an agency issues. The cost of this program is expected to be around $9 million on an annualized basis. The original estimate for the $50 private passenger bonus was about $6 million annualized for 2008.

On July 1st, we also increased commissions on certain commercial lines, new business premiums from 15% to 20%. The increased commercial commissions resulted in about $0.5 million of additional commission expense in the second quarter on uncollected premium balances for new commercial policies at June 30th, 2008. The full impact of this commission increase is expected to be approximately $1.5 million for the remainder of '08 and about $2 million on an annualized run rate basis. Accelerated commissions were also higher because of the new agencies appointed during the year.

Cost of management operations excluding commissions increased $5.8 million or 9.8% for the second quarter of '08. Our personal-- personnel costs increased by 4.9% in the second quarter of '08 compared to '07 primarily as a result of a $1 million charge for executive severance cost. Excluding the severance charge, personnel costs rose 2%. Sales and policy issuance cost increased 32.3% due to a $1.3 million increase in advertising expense. All other operating cost increased 14.6% driven by a $2.2 million increase in consulting fees, primarily related to our current technology program. Our estimate for growth in noncommission operating expenses for the year 2008 is 13% due to our higher planned IT spend, which I will describe more fully in a minute, increased executive severance cost, higher agency-related expenses and advertising costs.

The increases in technology expenses we are incurring are to significantly enhance the functionality of our processing and agency interface systems through selective replacement of key system components. This work will improve the ease of doing business with our agents by enhancing agent and employee productivity and access to information. In 2007, we started looking at options for replacing our policy administration system and that process continued during the first half of this year. In the second half of 2008, we'll developing the design of the policy administration replacement system. As we disclosed in our first quarter release, we anticipate additional IT expense, excluding our internal labor for this project in the second half of 2008 to approximate about $10 million.

During the second quarter 2008, we made some short-term enhancements to our systems to improve the ease of doing business for our agents. Some of these enhancements include a 24-hour batch cycle, personalized downloads into agency management systems and continued upgrades to our existing agency interface DS Pro.

Now I'll provide you with some highlights of our underwriting operations. Our insurance underwriting operations continue to perform profitably in the second quarter of '08 generating a profit of $3.2 million compared to a underwriting profit of $7.9 million in the second quarter of '07. The Property and Casualty Group's adjusted statutory combined ratio at June 30th, 2008 was 87% compared to 77.7% at June 30th, 2007. The GAAP combined ratio for the Company was 93.7% in the second quarter of this year compared to 84.8% last year. Development of prior accident year loss reserves remained favorable improving the loss ratio of 3.9 points or $2 million in the second quarter of '08 compared to an improvement of 4.3 points in the second quarter of '07. The favorable development was concentrated in the auto bodily injury and uninsured-- underinsured motorist bodily injury coverages. Our catastrophe losses contributed 3 points and 2.2 points to the GAAP combined ratio in the second quarters of '08 and '07 respectively.

Finally, I'll review highlights of our investment operations. The Company's investment operations recorded income of $7.9 million during the second quarter of '08 compared to $37.8 million for the same period in '07. We had $12.4 million of impairment charges in the second quarter of '08, mostly on securities issued by entities in the financial service industry sector due to continued declines in the fair value of those investments. In addition, our net realized losses on investments during the quarter including $4.6 million evaluation adjustments on our common stocks, as I previously spoke about, recognized as a result of our adopting FAS 159. For the six months ended June 30th '08 and '07 impairment charges on the fixed maturities were $14 million and $1.6 million respectively and impairment charges on preferred stock were $10.4 million and $0.4 million.

Earnings from our limited partnerships were $11 million for the quarter versus $20 million for the second quarter of '07. Our private equity and mezzanine debt limited partnerships generated earnings of $7.2 million and $8.1 million for the quarters ended June 30th '08 and '07. And our real estate limited partnerships generated earnings of $4.1 million and $12.1 million in those same periods. The reduced earnings by our real estate limited partnerships are a result of the slowdown in the residential real estate markets.

Finally as part of our capital management program during the second quarter of '08 we purchased more than 737,000 shares of our outstanding class-A common stock under our stock repurchase plan that was authorized in February of '06. The shares were repurchased at a cost of $36.9 million or $49.97 per share. In April 2008, our Board of Directors authorized an additional $100 million of repurchases under this plan through June 30th, 2009 of which $94.2 million was outstanding on June 30th, 2008.

Thank you, Phil. Before we open the call to questions, I wanted to update you on our agent recruitment efforts. Our recruitment goal for 2008 is 140 new agents by year end. Through the second quarter we've appointed 84 new agencies bringing our total representation to 2,016 agencies throughout our system. We're also making good progress on our plans to enter Minnesota and are on target to begin writing business there by September 1st, 2009. We've done soft recruiting during the last quarter that is already sparked considerable interest from our independent agents in that state.

One last item before we take your questions. The Company had some very positive news in July. The Erie received the 2008 J.D. Power and Associates award for "Highest Customer Satisfaction with the Auto Insurance Purchase Experience." The reward was a result of Erie's top ranking in 2008 J.D. Power New Auto Insurance Buyer Study. This recognition by our newest policy holders affirms my thinking about the Company. It is a testament to the extreme focus Erie employees and agents have on exceeding customer expectations. Thank you for your attention. I think we're ready to open the call for questions.

(OPERATOR INSTRUCTIONS). We'll go first to Meyer Shields with Stifel Nicolaus.

Thanks, good morning and welcome I guess to Erie.

Thank you.

Good morning, Meyer.

How are you Phil, how are you, Terry?

Good.

I guess fundmental question. Can you talk a little bit about the rate increases you're seeing in personal and commercial lines for the insurance that you're targeting?

Sure, there in the markets we're in, I'm going to speak mostly about auto, the auto line. We see very rational pricing out there in the marketplace. I think you've heard on some of the other calls that what we're seeing is modest increases in personal auto almost across the board. Some minor decreases but mostly increases. And we're seeing that in our jurisdictions, but we think it's very rational.

On the commercial side?

Well on commercial, our average premium continues to drop as you've seen and I think commercial is a little bit more competitive and you're seeing more price decreases in commercial than you are in personalized.

And with regard to the decreases you've taken before, we've clearly see an uptick in retention of new business, but can you talk a little bit about how the changes match up with your expectations when you set the decreases?

You mean the changes in retention?

Yes.

Well when people open their renewals and they don't see large increases they tend not to shop and so what's happening out there in the macroenvironment price wise also effects our retention. And so rational-- the pricing's been very rational and so people aren't shopping and so we actually-- our retention is about where we predicted it would be at this point.

Okay, that's great. Thanks so much.

We'll take our next question from Dan Schlemmer with Fox-Pitt Kelton.

Hi, good morning, welcome, Terry.

Thank you.

Question on just understanding the loss ratio and looking at it year-over-year. The 55.6 went up to 63.8 and sort of reading through the text I get about 2% on pricing year-over-year, if I'm reading it right, and about maybe 1 point from prior year development and another point from catastrophes. Which I guess I read into that about 4% of loss ratio deterioration from loss trends. Am I reading that accurately or am I missing something there just in terms of the actual way I'm calculating that, about 4 points of loss ratio trend? Does that make sense?

Yes, you've got an extra point of caps from-- you're talking about the quarter, right?

Yes.

Because the year is a little different. But yes for the quarter we had an extra point of caps. And we had a little bit less in the development this year than we did last year in the second quarter, right?

Yes.

And then about 2.5 points of accident year deterioration, right?

Okay.

From a combination of severity and frequency and price.

Yes, I guess maybe I was hoping can you break that-- break it-- break that out in terms of frequency and severity? And probably the one thing that people I think are starting to see in the macroeconomy is gas prices and how that's effecting auto trends. But just overall where you're seeing the frequency and severity trends breakout favorably or unfavorably, most significantly.

Yes, our frequency trends continue to be positive. Our actuaries kind of muse on this-- on whether the gas prices are causing or changing frequency. They believe that when gas prices come back down that we'll see the return to the same frequency trend. And so that's not something necessarily that they're looking to price into the product going forward. So we are seeing positive-- continued positive frequency trends and moderating severity trends. That deterioration in our accident year result is mostly a result of our price actions, which you've seen our price actions have trended down in 2008, and our estimates for 2009 are trending down. Trending down from where they were, they're actually up about half a point.

I'm sorry can you clarify that last point? Trending down --

Well you'll see that we're taking price decreases in 2008, in the calander year of 2008, of about $31 million, and our guidance in this Q is for 2009 of a 0% to 1% increase.

Right, got you.

That's down from what we disclosed in the first quarter, Dan.

Yes. Can you sort of comment on the -- your growth rate in policies in force is pretty favorable. In particular if you look back at some of these charts that show sort of what's the growth rate's been over the last couple of years and pretty much everything is moving in the right direction on almost every one of your segments. So the rate decreases seems, seems -- I'm aware that there's a lot of rate decreases in the market and you have to stay competitive, but given how well you're doing with the policy enforce, it's a little bit surprising that you're taking aggregate decreases. Can you sort of comment on what the rational there is or why it seems like there's a little bit of a disconnect between you would take rate decreases at the same time as you're already seeing good PIF growth?

Well I just-- as an observation I would make over the last 48-hours is that I've seen a significantly vibrant organization and then I -- last night I spent four hours with an agency group that does a lot of business with us and I can assure you that the organization has been very focused over the last 12 months under John's direction. And they are very, very excited about the capabilities of the Erie in both terms of our field organization and the product capability that we're building in our corporate offices here. And so I think you're seeing sort of a dissection of two events occurring and that's why we're more confident in terms of the fact that we're going to be able to take rates modestly in 2009, and then you couple that then with a very focused Erie organization in terms of field and home office, and I think we're looking forward to a much more competitive playing field.

We have seen in our auto business and we've seen it quarter-after-quarter, Dan that we have had positive trends in prior reserve estimates, in particularly in automobile bodily injury and uninsured-- underinsured motorists, uninsured and underinsured motorists. So we factor that into our indications and it allows us to moderate our price a little bit. And we want to provide a competitive price for our agents out there too.

Great.

We are growing the units nicely.

Thanks. Last question just real quick. I think you went live with West Virginia workers comp about a month ago and just curious early read on that. Is that-- is there a significant amount of pickup there? What you're seeing in that market, just curious?

Mike, why don't you answer that question.

Dan, we're seeing about exactly what we expected. We went through a lot of training on our agents. Gave them a program, got them comfortable with how to operate in the workers comp market that they've never operated in before. And it's proven to have been a good strategic move. Business is coming in around at about the level we anticipated it being. And I'm real pleased with the quality of the business that we're seeing as well.

Great, thank you.

Thank you, Dan.

(OPERATOR INSTRUCTIONS) It appears we have no additional questions. I'd like to turn the call back over to the Management team for any additional and closing remarks.

Thanks, Patrick. Just a reminder to everyone that the call will be posted on our website, erie-insurance.com after 12:30 Eastern time today. And if-- always, if you have any questions please give me a call at 814-870-4665. Thanks again and make it a great day.

This concludes today's conference, we thank everyone for their participation. You may now disconnect your lines.