Erie Indemnity Co (ERIE) 2009 Q2 法說會逐字稿

Hello, and welcome to the Erie Indemnity Company's second quarter 2009 earnings conference. At the request of Erie Indemnity, this conference is being recorded for replay purposes. At this time all participants are in a listen only mode. Following prepared remarks today 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 Director of Investor Relations.

Thank you Lisa, and good morning everyone. We appreciate all of you joining us today. On today's call management will discuss our second quarter 2009 results. Joining me are Terry Cavanaugh, President and CEO; Marcia Dall, Executive Vice President and Chief Financial Officer; Jim Tanous, Executive Vice President, Secretary, and General Counsel; Mike Zavasky, Executive Vice President Insurance Operations; and George Lucore, Executive Vice President Field Operations.

Today's prepared remarks will be approximately 20 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 in the investor relations section of our website at erieinsurance.com. We also filed Form 10Q with the SEC.

On these calls 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 reflect the Company's current views about future events, and are based on assumptions subject to known and unknown risks and uncertainties. These risks and uncertainties may cause results to differ materially from those anticipated, as described in those statements.

Many of the factors that will determine future events or achievements are beyond our ability to control or predict. For information on important factors that may cause such differences please see the safe harbor statement in our latest 10Q filing with the SEC, dated August 5, 2009, and in the related press release and 8K.

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 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 written 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, web cast broadcast, and the use of your name, voice and comments by Erie Indemnity. If you do not agree with these terms, please disconnect at this time. And now Erie's President and CEO, Terry Cavanaugh. Terry?

Thank you Karen. Good morning, and welcome to the call. I'll start off today by sharing my perspectives on the quarter, and then Marcia will get into the financials.

It was an active second quarter; of course Marcia joined the team in April and we held our annual shareholders' meeting in May, where all twelve of the Company's directors were reelected. We also conducted our traditional spring annual dinner meetings with agents and employees in nine of our field offices, and held our agents advisory council.

Also during the quarter AM Best affirmed our A+ superior rating with a stable outlook; and the A Excellent rating of Erie Family Life. All of these events provide us greater insights and help us shape the way we operate our company.

Turning to our results, we finished the quarter with net income per share of $0.57 compared to $0.71 per share for the same period in 2008. Net operating income was $0.56 per share in the second quarter of 2009, compared to $0.87 per share for the same period one year ago. Limited partnerships drove down our net and operating income again this quarter.

Overall I'm pleased with the Company's performance during the second quarter. Our management fee revenue was up, non-commission expenses were relatively flat, and we produced an underwriting profit.

Outside investments operations, our performance indicators are moving in the right direction. From a growth perspective we continue to benefit from strong retention and policy growth. Our customer retention ratio is very strong, 90.8%, up from 90.4% a year ago, and policies in force grew by 3.4%.

During this quarter we also saw the largest year over year increase in direct written premium for the property and casualty group that we've seen in four and a half years. However, in spite of rate increases we've taken in 2009, we have seen a reduction in our average premium per policy, particularly in commercial lines.

As I indicated, we did generate an underwriting profit for the quarter, with a GAAP combined ratio of 96.6%. I believe that the results we're seeing are driven by our effective relationships with our agents, combined with Erie's overall value proposition. Erie agents are dedicated insurance advisors who provide significant benefit to our customers. Our customers recognize that. They know they can count on their agent to help them customize insurance coverages to fit their needs at every stage of their lives. Couple that with Erie's competitive price, financial protection, and unbeatable claims service, and you have a powerful and differentiating combination. We continue to use that advantage to grow in the states where we do business.

One way we're doing that is continuing to expand our agency force. Erie currently has 2,045 agencies with almost 8,800 licensed representatives. Thus far this year, we've appointed 54 new agencies, adding 164 licensed representatives to our agency force. By the end of 2009 we expect to have more than 2,100 agencies with over 9,000 licensed representatives focused on selling Erie insurance products. The property and casualty insurance business is about service, execution on core fundamentals, and financial strength. Erie has a great platform, and we have traction in the marketplace.

The accountability and alignment I've discussed in the past has taken hold. Effective execution is a central theme for us. I believe we're sharper and more focused and we are moving Erie forward. Our performance bears that out. Further evidence of this is that during the quarter Erie again received top rankings; one for customer satisfaction, and one for financial strength, from two rating organizations, JD Power and Associates and Wards Top 50. These achievements are gratifying and our strong retention and growth in new policies are evidence that Erie customers trust in our value proposition.

We will continue to focus on our products, customers, agents, and balance sheet. Our customers want service at a fair price, delivered by local experts; our agents, our loss control staff, and our claims network. As evidenced by our [PITH] growth, the Erie value proposition is attractive in all economic cycles. I'm excited about our prospects for the remainder of the year. Now I'll turn over the call to Marcia to talk about the quarter's financial results, and then we'll take your questions. Marcia?

Thanks Terry, and good morning everyone. Today I will share a summary of overall results and additional detail on our management operations, underwriting, and investment performance for the second quarter of 2009.

Net income for the second quarter 2009 was $32.7 million. On a per diluted share basis, net income was $0.57 per share, compared to $0.71 per share in the second quarter of 2008. Net operating income per share was $0.56 per share, compared to $0.87 per share in the same quarter last year. Our earnings from management and underwriting operations were solid for the quarter, however, our investment operations generated a loss of $0.16 per share after tax. This reflected, primarily, the impact from our equity investments and limited partnerships, which flow through to our net operating income.

For the second quarter of 2009 net operating income was affected by losses from equity investments and limited partnerships of $0.30 per share, after tax, compared to earnings of $0.13 per share, after tax, for the second quarter 2008.

Now I'll provide some additional detail on the results of our management operations. Income before taxes from our management operations was $60.3 million compared to $50.4 million in the second quarter of 2008, reflecting solid growth in management fee revenue of 1.5%. The growth in management fee revenue reflected the benefits of the 1.4% increase in the direct written premiums of the property and casualty group. Our policies in force growth of 3.4% was partially offset by a decline in the average premium per policy.

As Terry said, the retention ratio has been steadily improving, increasing to 90.8% at the end of the second quarter 2009, up from 90.6% at December 31, 2008, and up from 90.4% at June 30, 2008. The market remains competitive, that's reflected in the decline in the year over year average premium per policy, which moved from $960 for the 12 months ended June 30, 2008 to $936 for the 12 months ended June 30, 2009.

Premiums for new business increased 2.9% to $117 million in the second quarter of 2009, versus $114 million in the second quarter of 2008. Strong new business growth in personal lines was partially offset by a decline in commercials lines' new business. Premiums generated from renewal business increased 1.2% year over year.

The total cost of management operations for the second quarter of 2009 decreased by 2.4% versus the second quarter of 2008. Commissions related to our independent agents, which make up the majority of our management costs, decreased by 3.6% quarter over quarter. The cost of management operations, excluding commission costs, was relatively flat for the second quarter of 2009. This generated gross margins from management operations of 22.5% in the second quarter of 2009 compared to 19.1% in the second quarter of 2008.

Now I'll provide more detail on the results of our insurance underwriting operations. We generated an underwriting profit, before taxes, of $1.7 million, compared to $3.2 million in 2008. The GAAP combined ratio for the Company was 96.6% in the second quarter of this year compared to 93.7% last year. The increase in the combined ratio reflected a loss ratio of 67.3% compared to 65.4% last year.

The loss ratio is driven by the following three components; first the loss ratio related to the current accident year, excluding catastrophes, was 66%, .3 points lower than the second quarter of 2008. Second, favorable development of prior accident year loss reserves improved the loss ratio by only .3 points compared to favorable development of 3.9 points for the second quarter of 2008. And third, catastrophe losses contributed 1.6 points to the loss ratio, compared to 3 points in the second quarter of 2008.

Now I'll review the results of our investment operations. The Company's investment operations recorded a loss before taxes of $14.3 million during the second quarter of 2009 compared to a profit of $7.9 million for the same period in 2008. This was driven primarily by losses from our investments and limited partnerships. We saw a decrease in net investment income for the second quarter of 2009, from $11.5 million in the second quarter of 2008 to $9.5 million for this quarter. This was driven primarily by lower investment income that resulted from the sale of some non-redeemable preferred stock investments in 2008 and 2009.

Net impairment losses totaled $2.5 million compared to losses of $12.4 million in the second quarter of 2008, reflecting the improvements in the financial market and the adoption of three new financial accounting standards regarding fair value measurements and impairments to securities. The primary impact from the adoption of the three new accounting standards is that credit related losses, and any losses on securities with a decline in fair value that we intend to sell, are recognized in earnings, while the remaining decline is recognized in other comprehensive income.

Equity and losses related to our limited partnership investments were $26.8 million for the second quarter of 2009, compared to earnings of $11.3 million in the second quarter of 2008. The losses in the second quarter of 2009 were primarily related to real estate limited partnership investments. As we've said previously, there is a quarter lag in the financial statements we receive from our general partners, which serve as our primary basis for valuation of limited partnership interests.

The losses in limited partnerships reported in the second quarter of 2009, represent actual results for the first quarter of 2009, which were significantly affected by volatile market conditions.

While completing the closed process for the second quarter 2009, we identified an adjustment related to the first quarter 2009, Equity and Losses of Limited Partnerships. The adjustment resulted from a misinterpretation of the facts that existed at the time the financial statements were prepared. The effect of this error was recorded as an adjustment in the second quarter of 2009. The impact of the adjustment reduced second quarter 2009 net income by $5 million and diluted earnings per share by $0.09. This adjustment did not impact our cash flows.

Related to our investment in Erie Family Life Insurance Company, we reflected a profit of $2 million in the second quarter of 2009, compared to a loss of $0.6 million in the second quarter of 2008.

As we've discussed previously, we are committed to providing our customers and agents a full portfolio of products, including life insurance and annuities. In line with this commitment, during the second quarter of 2009, the Indemnity and Exchange invested $55 million into the life company in proportion to each company's shareholdings. The indemnity company's 21.6% share of that investment was $11.9 million. The investment from the Exchange was $43.1 million.

Regarding stock repurchases, there were no stock repurchases in the second quarter of 2009. In May, 2009, the board of directors approved a continuation of the current stock repurchase program through June 30, 2010 and we have $100 million of repurchase authority remaining.

In summary, the balance sheets of Erie Indemnity Company, the Erie Insurance Exchange and Erie Family Life remain strong and are well positioned to support our growth.

Karen, we can open the call for questions.

Thank you, Marcia. Lisa, if you could open the call?

(OPERATOR INSTRUCTIONS)

We have a question from Michael Phillips with Stifel Nicolaus. Please go ahead, sir.

Hi, good morning, everybody.

Good morning.

A question on agency stuff first; what sense do you have of how concentrated your agents are today with your book of business, or with your products, and how that maybe has changed over the past couple of years?

I'll do a preamble and I'll let George Lucore, who has a better timeline than I have to be able to respond to that. But we, as a general statement, have the majority of an agent's premium that is that they would write with Erie. And that, I guess, has changed a little bit. It's gone down a little bit, not -- because we actually have more premium per agent than we did 10 years ago. The market share of our book has changed a little bit as we've gone onto new states and have appointed more new independent agents.

But we have a very robust relationship with those people and, in fact, the data we would get today would indicate that we're getting even more of their new business than we did two years ago. George?

Yes, Michael. As Terry indicated, when we enter a new state and partner with new agencies, we see a decline in the average premium that we're receiving on an agency-by-agency basis as we acclimate the new agents into the Erie family.

We just made a presentation to the Board this week and it shows that, while we are a little lower than we were several years ago, we are about 10 points higher now on the new business coming our way than we are on the total book in [premium] distribution. So, we are, once again, on the road to having the market share that we've enjoyed historically.

Thanks. You know, I think the reason -- you know, I still get a sense that agency loyalty is very strong and probably one of the key metrics of your company.

But I guess the sense I have is that that concentration -- and you mentioned that it has come down slightly, not a big change but it's come down slightly. And to the extent that it is coming down and maybe might continue to come down over the next couple of years, how do you think about what that might mean for implications of agency loyalty when they have more carriers in their shop than they did a couple of years ago?

Well Michael, the other thing I think is, just from an operational standpoint and from a strategic standpoint, we are committed to the distribution force of the independent agent.

That is our sole focus and we think if we create products and tools, both in terms of where their customer is, as well as what we can do for them, that's a winning proposition. And we are looking to grow significantly with that distribution system.

I think that's a good segue to my second question, Terry, if you don't mind, is if you could point to either one or two specific items that you think need the most attention, either your product offering or some kind of agency interface, you know, one or two things that are the most in need of immediate attention from you and a kind of timeframe to fix whatever those one or two things are?

You know, I wouldn't characterize it as a fix. I would characterize it as just to continue trying to improve our capability with our distribution force and convert -- and additionally to our customer base.

I think, again, we do see a great opportunity to be of a further asset to the independent agent in our footprint. So we are in the process of developing tools, whether they be educational tools, whether they be tools to help them in their term in transitioning their business to the next generation of agency owner; whether it be, perhaps, financial support. And we think that is a great opportunity for us and so, we're in the process of developing that capability to roll that out in a more robust fashion in 2010.

The other piece, I guess I would say, in terms of we recognize that we have to be, as I call it, more valuable and visible to the customer. And we think in conjunction with the agency automation that we can create a customer portal that, in conjunction with personalized, localized service, would be a very, very significant capability for Erie and our distribution force.

All right, thanks, Terry. And the last one for me for now is, on the personal auto bonus, you've had with employees for a while now and I think you've got some kind of lift from that. Any concerns of the agent reaction when you eventually do pull those?

We have not stated we are pulling them.

Not implied that you have, no.

Okay.

Not that it seems that they're going to last forever, either.

I think the point is, there are many ways to deal with opportunities in the market place that I think we have to recognize as the market evolves, both in terms of competition, customer need and our cost structure. And we will continue to move forward and I think this is just one more arrow in our quiver. I would suggest there will be more arrows in our quiver as we go forward.

Okay, thanks. I like the arrow in the quiver. I'm done for now. Thank you, Terry.

(OPERATOR INSTRUCTIONS) And our next question comes Wilmond [Kidd] with Central Securities Corporation. Please go ahead, sir.

Hi. Thanks for taking my question. I was curious to ask you about the outlook for the limited partnerships and then, maybe as a follow on, what your investment policy is, in an overall sense, on a go forward basis.

I mean, I did notice that you mentioned that there was this adjustment made of $5 million, which, if I understand that, would mean that the limited partnerships -- actually the loss decreased substantially from the first quarter and I don't know whether that's a trend. So, maybe some, if you could expand on that a little bit for me, that would be helpful.

This is Marcia. The error that you mentioned, that we booked in the second quarter, was related to the valuation of a few of our limited partnerships, based on their financial statements for the fourth quarter, 2008, that was reported in our first quarter 2009 financial statements. So, that error was identified; we made the correction in second quarter and that's reflected in our earnings.

As far as the outlook for limited partnerships, as you may know, the market is more illiquid today than it was in the past. And it also has been impacted by the market conditions and is more volatile, which again, has been evidenced in the financials that you've seen from us from the past few quarters.

It is difficult to project, or predict, the future returns related to those limited partnerships, although we are working with our partners to actively manage our investments within those limited partnerships.

Well, I mean, when you say the market is less liquid, are you talking about the market for the limited partnerships in the secondary market? Or are you talking about the market for the [SS], the limited partnerships own?

The market in the secondary market.

But, just out of curiosity, would you even consider selling these things today?

We continue to look for ways to optimize the return on our investment portfolio.

Well, I mean, I -- good. But the secondary markets, as far as I understand, are so outrageously bad that it would be almost criminal to sell into them.

That's right and that's why we have not.

Good. What about -- can you talk a little bit about how this relates, I mean if this is a fair question, to what your investment policy is going to be going forward?

As I said, we continue to look for ways to optimize the return on our investment.

Oh, I mean near-term in an overall sense.

Yes, in an overall sense, that's right. So, we continue to evaluate the opportunities that exist within the market, both in the bond market as well as the equity market and alternative investments.

Any idea of what the overall distribution, between equities and fixed income might be, going forward?

That is not something that I think we would share on a public basis.

Do you get any feel from the general partners about the outlook for the limited partnerships, you know, from an operational standpoint? I mean, is there any feeling that they've reached the nadir of their operational performance? Yes, I mean, it would seem -- I mean, possible that some of them have? I'm just curious.

The way I would put it in perspective is that we have a well dispersed set of investments in limited partnerships, relatively small amounts per partnership. And we actively work with them to manage the investments that they have, to understand the investments that they are making within the market place.

We have it well dispersed, across various different industries, as well as different geographies. And some have performed very well; others have had more challenges within the existing market conditions. And again, it's difficult to predict that, going forward.

Well, thank you very much. I appreciate your --.

Thank you very much, Wilmond.

Thank you.

I believe, Lisa, we have another question from Michael?

Yes, we have a follow up question from Michael Phillips, with Stifel Nicolaus. Please go ahead, sir.

Hi, just a quick easy one. Unless I missed it, you're no longer giving the guidance on non-commission expense for the annual 2009. Is that correct?

Right.

You feel like 16% for the year, but it looks like that's not there this time?

Correct.

Okay, just confirming. Thank you.

Thank you, Michael.

(OPERATOR INSTRUCTIONS)

All right. Well Lisa, thank you very much. Just a reminder to everyone that the recording of the call will be posted on our website, erieinsurance.com, after 12:30 p.m. Eastern Time today. And if you have any questions at all, as always, please give me a call at 814 870 4665. Thanks again, everyone and make it a great day.

And that concludes today's teleconference. Thank you for your participation.