Erie Indemnity Co (ERIE) 2009 Q3 法說會逐字稿

Hello and welcome to the Erie Indemnity Company third-quarter 2009 earnings conference call.

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 from management, we will open the call for questions and answers.

Now, I'd like to introduce you host for today's conference, Karen Kraus Phillips, Vice President and Director of Investor Relations.

Thank you, Karen, and good morning, everyone. We appreciate you joining us on the call today. On today's call, management will discuss our third-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 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 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 statements in our latest 10-Q filing with the SEC dated October 29, 2009 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 written consent of Erie Indemnity Company. A 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.

Now, Erie's President and CEO, Terry Cavanaugh. Terry?

Thank you. Good morning and thank you for joining us on today's call. I will begin with a high-level review of the quarter and talk briefly about some current initiatives. Then Marcia will provide more detail on the quarter's financials.

Some key points I'd like to highlight as we move through this discussion -- first, the year-over-year comparison in on net and operating income reflects the improvement in the investment markets. I'm sure we all painfully can recall what happened during the third quarter of 2008. I am pleased to say, more than a year later, things are getting better.

Second, even as the economy shows the first signs of movement toward recovery, high unemployment and weak consumer spending continue to have in dampening impact on exposures in both personal lines and commercial. This is reflected in the decline in our average premium per policy.

Finally, as people continue to look for value and savings, they are actively shopping insurance. Here, you've seen benefit from this behavior as a result of our value proposition, which is reflected in our policies in force growth.

Now onto our results. Here, we finished the third quarter of 2009 with net income per share of $0.69, compared to $0.07 per share at the close of the third quarter in 2008. Net operating income per share for the third quarter 2009 was $0.66 compared to $0.54 a year ago.

Our earnings this quarter were primarily affected by positive earnings from investment operations, the first positive result in four quarters. This, again, reflects the strengthening investment markets as well as improved earnings from our ownership interest in Erie Family Life; second, a profitable underwriting performance with a GAAP combined ratio of 98.1%; and finally, reduced operating margin in our Management Operations segment.

This is the second quarter in a row Erie has seen positive premium growth at a time when the property and casualty industry overall continues to see premiums contract. I am encouraged by consumers' response to Erie's value proposition and our agents' ability to sell Erie and retain customers during these tough economic times.

We continue to take modest rate increases, but changes in the mix of business and exposure reductions have caused the average premium for policy to decline. This is being offset by growth in policies in force, up 3.4% year-over-year. A component of this growth is customer retention. At the end of the third quarter, our retention rate was a very strong 90.7%.

Regarding our cost of management operations for the quarter, the decline in our gross margin can be attributed in large part to investments we continue to make in technology. These investments are targeted marketing, processing and service enhancements and are key to Erie's continued success.

For example, you know that Erie is committed solely to the independent agency system. To support our agents' efforts to compete with direct distribution systems, we are providing Erie-hosted websites to our agencies. This initiative, which we call Erie Agents Online, provides agencies with a customizable agency website that includes Erie functionality such as personal auto quote and online bill payment. Customers will also be able to access their policies on these agent sites as well as on Erieinsurance.com. This is one way we are increasing access for our customers. It is also core to our cobranding efforts to increase awareness of Erie and our agencies. We will continue to provide self-service functionality on these sites as well, increasing efficiencies and enhancing our customer service experience with Erie and our agencies.

Another technology enhancement rolled out this quarter is Commercial Auto Connection. This upgraded system is designed to make it easier for agents to quote and write commercial auto fleet and non-fleet business with Erie. We are getting very positive feedback from our agents.

As we discussed before, we are not taking a Big Bang approach to technology enhancements but an incremental approach designed for effectiveness and cost efficiencies. It's actions like these, combined with Erie's high service reputation, that help to distinguish us in the marketplace and within our agents' offices.

Before I turn the call over to Marcia, I would like to acknowledge the recent passing of one of our directors, Patricia Garrison Corbin. Pat joined Erie's Board in 2000 and was a member of a number of committees on the Board. Her contributions to the community and to Erie Insurance were many. She will be missed. Our condolences go out to her family.

Now, I'd like to turn the call over to Marcia to discuss this quarter's financials, and then we will address 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 third quarter of 2009.

Net income was $39.7 million. On a per diluted share basis, net income was $0.69 per share compared to $0.07 per share in the third quarter of 2008. Net operating income per share was $0.66 per share compared to $0.54 per share in the same quarter last year. All of our operating segments contributed positively to our net income result for the quarter.

So let's take a look now at each of our operating segments, beginning with Management Operations. Income before taxes from our Management Operations was $47.2 million, compared to $49.4 million in the third quarter of 2008. This result for the current quarter was impacted by two primary factors -- first, a 2% increase in management fee revenue; and second, an increase in operating expenses of 3.6%.

The growth in management fee revenue is consistent with a 2% increase in the Property and Casualty Group's direct written premium. As Terry said, this increase was driven by year-over-year policy in force growth of 3.4%. This growth in policy volume offset the decline in average premium per policy of 2.2% from the prior year.

Premiums from new business increased 4.8%, and business premiums were up 1.6%. The majority of the premium increase came from our personal lines with new business premiums increasing by 6.5% and renewal premiums increasing by 3.7%.

Commercial Lines new business premiums were up 1.1%, while renewal premiums were down 4.5%, reflecting declines in exposures.

Given economic pressures on small and mid-sized businesses, it is no surprise that we continue to see reductions in commercial average premium per policy, especially in Workers Compensation product, as a result of lower exposure level.

Turning now to the cost of management operations which, as I indicated, increased 3.6% from the prior year, commissions related to our independent agents, which make up the majority of our management costs, increased 2.3% quarter-over-quarter, consistent with our growth in direct written premiums. The cost of management operations, excluding commission costs, was up 6.8%. This increase was driven primarily by contract labor related to our technology initiative and pension-related expenses.

So, in summary, the margins from our Management Operations declined to 18.1% compared to 19.3% for the same period a year ago.

Now, turning to our Insurance Underwriting operations, we generated a small underwriting profit before taxes of less than $1 million. The GAAP combined ratio for the Company was 98.1% in the third quarter of this year, compared to 99.4% last year.

The decrease in the GAAP combined ratio reflected a loss ratio of 63.7%, compared to 71.4% 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 65.6%, 1.8 points higher than third quarter of 2008. Second, favorable development of prior accident year loss reserves improved the loss ratio by 4.3 points, compared to favorable development of only 0.4 points for the third quarter of 2008. The favorable development in the current quarter primarily related to the settlement of two large commercial claims that resulted in reserve releases. Third, catastrophe losses contributed 2.4 points to the loss ratio, compared to 8.1 points in the same period last year. We were fortunate to not experience the magnitude of catastrophic losses in this quarter that we experienced last year as a result of Hurricane Ike.

The GAAP combined ratio for the current quarter was also affected by a write-off of assumed and voluntary reinsurance recoverables related to the North Carolina beach and coastal plans, due to recent state legislation. Our share of this write-off is $2.8 million and added 5.2 points to the third-quarter 2009 GAAP combined ratio.

Now, I will review the results of our investment operations. The Company's investment operations recorded a profit before taxes of $8.3 million during the third quarter of 2009, compared to losses of $40.2 million for the same period last year, as a result of significantly lower levels of impairment.

Net investment income decreased 7.4% compared to a year earlier. This was driven primarily by lower investment income that resulted from the sale of some non-redeemable preferred stock investments.

We recorded net realized gains on investments of $5.5 million in the quarter, compared to losses of $3.9 million in the third quarter of 2008.

We saw a significant reduction in net impairment losses this quarter compared to a year ago. Net impairment losses totaled $3.2 million, compared to losses of $37.4 million in the third quarter of 2008.

Equity and losses related to our limited partnership investments was $8.8 million, compared to earnings of $1.1 million in the third quarter of 2008. The losses in the current quarter were primarily related to real estate limited partnership investments.

Related to our investment in Erie Family Life Insurance Company, we realized a profit of $5.4 million compared to a loss of $10.1 million in the third quarter of 2008, reflecting lower levels of impairment-related losses.

In summary, we continue to attract and retain customers, which is indicative of our competitive products and pricing and Erie's high service reputation. The balance sheets of all three companies -- Erie Indemnity, Erie Insurance Exchange, and Erie Family Life -- are strong and provide solid support for continued momentum.

Now let's get to your questions.

Karen, if you could please open the call for questions.

Of course. (Operator Instructions). Michael Phillips, Stifel Nicolaus.

Good morning. Can you talk about auto -- personal auto agency bonuses and anything you might be doing there to -- kind of any changes you might be making to spur new business, more new business from larger agencies versus other agencies?

Sure, Mike. This is Terry. I'm going to let George handle the bulk of this, but as we did just recently revise our compensation to agents in the Personal and Automobile line where we've gone to a standardized 15% for new business and have worked on a bonus for conversion of that business versus applications of the policy -- so we think it's a much more positive formula and it will drive positive results.

Michael, this is George Lucore. Michael, we just announced, two weeks ago today, that we were changing our (inaudible) on a bonus structure. We are eliminating the current program in February, February 1, 2010, and replacing it with, as Terry mentioned, a 15% first-year of commission and a 10% renewal commission.

We did retain a bonus program that will be based on converting a quote to application ratio, so there's still a bonus program out there for (inaudible) agencies who are quoting, who are writing more qualifying business with Erie and quoting at a higher ratio. So we are very confident that this is going to respond to the desires of our agency (inaudible) program was well intended but it wasn't getting the [lift] that we wanted at the lower [cost].

Can you help me, just remind me what the actual -- I guess the current program is (inaudible) so it's 15% new, 10% renewal and then to convert quote to apps, I mean how is any of that different than what you currently have?

The old program was strictly based upon a number of new lines submitted, and it had an -- for the first year, it was just a $50 bonus and then about 18 months ago, it moved to an escalating bonus. So this one now is indexed to what the revenue is in relationship to the policy, so it's 15% on the premium per policy. Then we have a very, we think, a very attractive bonus plan that will allow those agents that are good at converting business to us to get more money.

Okay, so it's not really -- I guess what I was referring to at the beginning of -- a different program for -- a different structure program for (inaudible) the agency? It's not really that, then?

No.

Okay, fair enough, thanks. Specific line of business here -- Workers Comp. The strong favorable reserve development, is that -- what years is that coming from?

Those were from prior years, so they are not current-year claims.

I mean, how far back? (inaudible) prior year, but 1992 or 1975?

George is saying four or five years.

Okay, thank you.

Well, I think it was 2004, Michael.

2004, George?

(inaudible) claim.

It was -- it revolved basically around one claim.

This quarter's was all around one claim?

Correct.

There was one Worker's Comp and one other commercial claim.

Got you. Okay, thank you. I will jump off (multiple speakers)

Yes, the commercial claim was incurred from last year.

Thanks, I will jump off and come back on if I need to. Thank you.

(Operator Instructions). Dan Schlemmer, FPK & Associates.

Good morning. Nice quarter. Congratulations.

Sort of following up on Michael's question actually, the favorable development -- and there it sounds like it was a pretty decent-sized number but really two claims driving it. Are those claims -- are they actually closed or you are just reevaluating the reserve on them at this point, or can you give us a little more color on what caused the -- what specifically caused you to revalue the claim?

Both of those claims actually were settled, so the settlement amount was materially lower than the reserve that had been in place for those claims.

Great, thank you. Then I hope I didn't miss it in the early comments. Terry, you had talked about, last quarter, a year-end agency number. You were looking for 2100 agencies, 9000 representatives. Can you give us sort of an update? Are you on track for that? How is that going with adding new agents?

Yes, we are relatively on track with that number. We are not quite at -- the 2100 was an annualized number for 2009, so we are a little under that. We are I guess somewhere between -- we are about 2075 or something like that.

Well, at the end of September, 2056.

2056. Obviously, there is a corresponding -- you know, the licensed representatives pretty much tag along with the individual agencies that we appoint, so that is a positive number there.

The good news is that we continue to get good uplift on all of the agents,. We spent a lot of time making sure that we are getting better performance from all 2000. We've done a very good job, I think, of making sure the last I will call it 400 to 450 that have been appointed over the last four or five years are getting the research that they need to be effective and are producing the numbers that we want. We are very excited about the prospects going forward.

Great, thanks. Then Terry, sticking with another one of your comments, you had said, in your prepared remarks today, you were talking about people are actively shopping and I guess, in a weak economy, that is sort of intuitively what you would expect.

You know, what's your comfort level or how do you think about that as a net benefit versus -- you know, the benefit is of course more people shopping so you get more looks. The downside of course is some of your own insureds are looking. How do you think about that in terms of what the net impact will be or what you're doing To try to capitalize that on a net inflow/outflow basis?

Well, as you can see, the good news that is our retention actually is getting better. So we kind of have the best of both worlds. I think we are a fortunate company that people look at our total value proposition, which obviously includes our great distribution system; the service they give our customers on a daily basis in the towns they operate in; our product and our price. Once they get to Erie, they find a reason to stay with us. So I think that is a very -- so I think it is a win-win proposition, unlike some companies that have struggled with retention.

Sort of as a follow-up on the retention, in particular, I looked at your personal lines number and I say they can't really go higher, can they? You are in the 91%, 92% range. I mean, do you think it's -- do you have an outlook on that? And I say that half in jest; you can't go higher, but there is a cap at 100%. You're not going to get there.

So what do you think about the current retention numbers? Is there potential to push that, or where is that going? Is there anywhere to go but down?

No, I think, again, as you point, there's another 8 points to go up. So it becomes more difficult but again, we have, we believe, service is a strong part of our culture. We believe that it's very important to be able to look at that number and not be satisfied with it.

Those retention numbers are holding, but growing little bit; that's very important to our model. We are building loyalty in our customers on a daily basis.

So you know, it is a balancing act in terms of all we do for them. But the good news is -- and I would suggest, in some of the toughest economic times that we've had as an industry and as a country, our value proposition is being recognized and we are growing.

Great, and last question I will throw out -- in terms of the costs on the Management Operations piece that jumped, that sort of came in and I think was characterized as contract labor, for those of us that try to model this forward on a forward basis, can you comment on what that jump is more specifically and maybe how that will look going forward?

Well, I'm not supposed to talk about things going forward! (laughter) I would --

How about if I ask is -- are those costs that are ongoing at this point? Is that a little safer?

We continue to make investments in our platform, although I will tell you it is a lumpy spend. So, I would not -- there is no big -- we are building a business based upon these important but incremental changes. As a result, we are not looking for Big Bangs. We are looking to, again, continue to improve our platform both for agents and our customers. I think we are very comfortable in terms of how we are spending our money.

Great, thank you.

(Operator Instructions). James Pan, CP&E Partners.

Thanks for more of a treat than a trick on this day in terms of your (multiple speakers)

You're welcome, James!

Just a broad question -- I know that we've been a little less active in share repurchase in the last nine months, and that could be understandable, given the economic conditions.

I was wondering what internal financial conditions or operational conditions that Erie would have to produce or general economic situations on a macro level would have to happen for you to repurchase shares.

The only reason I ask is because, the last time you repurchased your shares was I think in the '50s; it had a 5 in front of it. Now you stock is seemingly a lot lower, well not seemingly; it is a lot lower. It just seems like a better deal now than it was when it obviously had a 50 in it.

James, first of all, none of this management team bought any shares that started with a 50 on it, okay? So we have, you know, this as a tool in our toolkit. Obviously, you talked about the issues that we have to deal with and there's both internal and external considerations having to deal with how do we use our cash in the most effective way for the benefit of the organization long-term and for our shareholders. We look at this on a quarterly basis.

That's all great boilerplate. With all due respect, that didn't really answer that question.

I'm not going to give you a trick or a treat! (laughter)

I would say that was more of a trick. (laughter) What financial ratios are you looking at? Just I mean, it just seems that was a pretty -- not a very shareholder-friendly answer, with all due respect. You know, can you be more specific in terms of how you think about it? I mean, how else are you going to be using the cash flow?

Basically, all of your earnings is free cash flow. You can pay back 80% of your earnings either via increased dividends or buybacks. What are you going to do with that extra cash? I mean (multiple speakers)

James, this is Marcia. I think, you know, what Terry is I think trying to say is that we continue to evaluate it. As you know, we have authorization for $100 million of share buyback. On a quarterly basis, we do look at it, not just on ratio basis but on an ongoing basis with the cash flow needs of the entity. That factors in lots of things, like our dividend levels looking forward as other growth opportunities that we may have, as well as the share buyback. So, that's something that we actively look at and will continue to look at going forward.

Okay, you mentioned other growth opportunities. What kind of after-tax return would you need for that other growth opportunity, versus buying back your shares at these levels? What type of rate of return would you require?

Clearly, that's something that we continue to look at as far as what is the right level of return, based on the different opportunities that are in the market.

I'm asking you that. What is the right level of return?

I am suggesting that it depends upon the opportunity.

All right. Not very inspiring, guys. Thanks a lot.

Dan Schlemmer.

Yes, sort of following up on my earlier question, actually on the PIF and the retention levels, you do have pretty phenomenal levels on the Personal Lines and actually they are quite good on Commercial as well. But Commercial you see more, it is more flat, maybe a little bit down versus the Personal Lines has improved over the last couple of years.

Can you sort of -- is that purely market conditions, or is there something else driving that? I think, generally, the Commercial Lines might be more competitive, but just curious if that's the differential in the two or if there is something else.

You are relating specifically to the Commercial Lines piece?

Yes, I mean, why is the Commercial Lines, the PIF and the retention level -- why is it not as good as the Personal Lines and maybe the trend line on the Commercial is also not as good as Personal?

Yes, I think the primary driver would be the economy in terms of what we see there. I think we also have more underwriting issues that we deal with on a commercial account when you are trying to sell them three or four different lines of business. As you say, historically and in the industry, those retention levels have always been greater than Personal Lines.

We are not seeing anything particularly troubling in terms of other issues. It's just that it's a tough economy.

Mike, do you have any other commentary there?

The only thing I would add to that is there is a pricing floor for the risk you take. Sometimes though you'll find a competitor who is willing to be a little responsible in the marketplace and take an account from you in Commercial because it is a larger dollar account. As Terry said, there's multiple policies wrapped up together.

Can I make a comment? This is George Lucore. We also, in anticipation of a hardening commercial market, we see the ever-present phenomenon in advance of those expensive markets. There's a little bit of softpricing to acquire business to take advantage of the coming price increases, so we are experiencing that as well.

Despite the fact that businesses may fail (technical difficulty) people working those businesses still have their autos and homes, and so the Personal Lines retention ratio I think naturally survives to a greater extent than Commercial in these kinds of economies.

That's a lot of good color, thank you.

Then completely changing gears, but can you just comment a little bit on the real estate limited partnerships and realizing you don't have a specific, maybe forward view on it? But can you tell us a little bit where the loss is coming from, or if there's anything specific and maybe a little background on how many different partnerships are you involved in? And are you seeing a particular trend that the losses are coming from a particular type, particular geography, etc.?

Dan, the way we think about it -- this is Marcia -- is that, when you think about our alternative investments, we have about $1 billion in investments overall, about 64% of that is in taxable bonds and tax-exempted money markets. I will get to your question in a minute. The balance is in common stock and alternative investments and preferreds.

When you look at our alternative investment portfolio, about 44% of it is in real estate, of which about 60% is in the US and 40% is international. I would say that, overall, it's really just the softness from the commercial real estate market related to occupancy rates and other things that are pressuring pretty much across-the-board. I mean, we have a pretty well-diversified real estate portfolio in different types of real estate, but again it is just that overall commercial real estate pressure based on the economy that we are seeing come through.

Just if I can clarify, are you saying your portfolio is focused on Commercial, or you are saying the losses in your portfolio are all -- are predominately coming from the Commercial portion of your portfolio, or both?

44% of our alternative investments are in commercial real estate.

Okay. Very helpful, thank you.

At this time, there are no further questions. Ms. Kraus Phillips, please go ahead.

Just a reminder that a recording of this call will be posted on our website, erieinsurance.com, after 12:30 Eastern time today. If you have any questions at all, please call me at 814-870-4665. Thanks again, everyone, and make it a great day.

Once again, that does conclude our conference for today. Thank you again for your participation.