Erie Indemnity Co (ERIE) 2009 Q4 法說會逐字稿

Hello and welcome to the Erie Indemnity Company fourth quarter and year-end 2009 earnings conference. At the request of the Erie Indemnity, this conference is being recorded for instant replay purposes. At this time, all participants are in a listen-only mode. Following prepared remarks from management, we will open the call for questions and answers.

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

Thank you and good morning. We appreciate all of you joining us today. On today's call, management will discuss our fourth-quarter and full-year 2009 results. Joining me are Terry Cavanaugh, President and CEO; Marcia Dall, Executive Vice President and Chief Financial Officer; Brian Bolash, Assistant Secretary and Associate General Counsel; and Mike Zavasky, Executive Vice President Insurance 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-K 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 future -- for information on important factors that may cause such differences, please see the Safe Harbor statement in our latest 10-K filing with the SEC dated February 25, 2010 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 the 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 p.m. Eastern time. Your participation on this call will constitute consent for the recording, publication, webcast, broadcast, and use of your name, voice, and comments by Erie Indemnity. If you do not agree with these points, please disconnect at this time.

And now Erie's President and CEO, Terry Cavanaugh.

Thank you, Karen, and good morning, everyone. We appreciate you joining us on the call. Today I will share my thoughts on the fourth quarter and the full year 2009 and our plans to keep Erie moving forward. Marcia will discuss our financial results in more detail and then we will get to your questions.

I am pleased with the progress we made during the fourth quarter, which capped off a successful year for the Company, especially when you consider the economic environment. Net income for the quarter was nearly $25 million, with net income per share of $0.43. This compares to a loss of $0.12 per share a year earlier.

When you look at the full year 2009 results, it's clear Erie managed well through the recession. We ended 2009 with net income per share of $1.89 compared to $1.19 per share at the end of 2008.

The balance sheets of Erie Insurance Property Casualty Group, Erie Indemnity, and Erie Family Life are even stronger today than a year ago. Our surplus is $4.8 billion, up nearly 12% from 2008.

In recognition of our financial strength, in December, the Board of Directors increased the regular quarterly cash dividend for each Class A share from $0.45 per share to $0.48 per share and for each Class B share from $67.50 to $72. This is a 6.7% increase per share over the 2008 dividend rates.

The Board also set the management fee rate paid to Erie Indemnity at 25%. At the onset of 2009, I talked with you about our areas of focus for the year, profitable revenue growth, better focus on execution, and agency management. I feel good about what this focus has helped us achieve during 2009 against a backdrop of a weakened economy.

Direct written premium for the property-casualty group was up 1.6% for 2009, while the industry overall is experiencing declines. For the fourth quarter, direct written premium grew 2.8% which resulted in a 2.9% increase in management fee revenue for Erie Indemnity.

To help generate profitable revenue growth, we have been keenly focused on improving our pricing sophistication. An example of this is the recently launched rate protection auto insurance product. This endorsement allows customers to lock in their auto insurance rate until they make a change to their vehicle, driver, or primary residence. It uses more sophisticated pricing models to calculate a customer's premium.

It is pricing and product innovations like this combined with Erie's high service reputation that help to distinguish us in the marketplace and within our agents' offices.

Another facet of profitable growth is expense management. The goal here is to spend wisely and look for process improvements that yield efficiencies and increase productivity. For example, we have adopted a team approach and commercial processing with quoting specialists and underwriters working together on accounts. This has significantly improved response times and increased productivity.

We have also begun to provide Erie-hosted agent websites to drive efficiencies and meet customer demand for convenience. These sites have self-service features that are linked into Erie's system. We launched this program last year and already 850 of our agents have these sites.

This initiative also ties into our third focus, agency management. We are working with our agencies to further develop business and perpetuation plans, build critical competencies, and support their sales efforts. We recognize that one of our greatest assets is the relationship we share with our agents. Preserving and building on that relationship is essential to our business.

One way we do that is by regularly communicating with our agents to understand how we can improve our service and product delivery to them and our mutual customers. For example, in January of this year, we held a meeting with representatives from our independent agencies. The purpose of the meeting was to listen and share information about what each of us, Company and agents, can do to support the achievement of our mutual objectives.

That focus and feedback is helping us move ahead on work that improves how we do business and grow business together. It was a very productive and successful meeting.

In 2010, we remain focused on profitable revenue growth, better execution, and agency management. We are executing our plans to sustain our core businesses, personal, commercial, and life insurance, while also developing new capabilities. To achieve this, we are focusing on five key assets.

First, our customers. We are refining our capability to identify target customers and prospects. We are also continuously enhancing our value proposition for existing customers and finding ways to meet their insurance needs in a cost-effective manner.

Next, our agents. We are committed to the independent agency distribution system and will continue to work with our agents to realize benefits for all Erie's stakeholders in terms of service, growth, and profitability.

People want a local expert they can trust to help them with the complexities of insurance. That combined with Erie's value proposition creates significant growth opportunities.

Our third asset is our people. Erie employees and agents truly are the lifeblood of this organization. We are investing in their development so they can continue to surpass the competition and meet the value expectations of our customers.

Next, process and information management. We continue to increase efficiencies and effectiveness in our operations that are leveraging our use of internal and external information.

And finally, Erie's balance sheet. We will continue to manage our financial strength and stability in line with our risk tolerances and risk exposures. By leveraging these assets, we will achieve five key objectives, grow market share in our footprint, outperformed the industries combined ratio, continuously improve service in a cost-effective fashion, improve competencies of employees and agents, and provide rewarding careers for Erie team members and manage the financial strength and stability of the enterprise.

I will share more with you about the execution of our plan at our annual shareholders meeting on April 20, the 85th anniversary of our Company.

Before I turn the call over to Marcia, I'd like to take a moment to thank George Lucore for his more than 35 years of service to Erie. George is retiring at the end of March, a much deserved retirement. George will have a lasting legacy with Erie. His contributions to our Company and to our agents are deep and broad. He has been a significant support to me. Marcia?

Thanks, Terry, and good morning, everyone. Today I will share a summary of overall results and some additional detail on our management, underwriting, and investment operations for the fourth quarter and the total year results for 2009. I will also spend a few minutes talking about the effects of Financial Accounting Standard 167 on the presentation of our financial statements before I open the call for questions.

So let me begin by walking through the results for fourth quarter 2009 compared to the fourth quarter 2008 results. As Terry said, net income was $25 million. On a per diluted share basis, net income was $0.43 per share compared to a loss of $0.12 per share in the fourth quarter of 2008. Net operating income per share was $0.39 per share compared to $0.29 per share.

Income before taxes from our management operations was $33.9 million compared to $27.3 million. The result for the current quarter was impacted by two primary factors. First, a 2.9% increase in management fee revenue. And second, relatively flat operating expenses.

The increase in the management fee revenue for the quarter is consistent with the 2.8% increase in the property and casualty group direct written premium. This result is being driven by year-over-year policy in-force growth of 3.5% for the quarter, which offset the 1.9% decline in average premium per policy.

Our premium growth is driven by our personal lines business or rate increases coupled with a very strong customer retention of 91.5% provide us policies in force growth of 3.7% and premium growth of 3.7%. Our overall premium growth was impacted by continued weakness in commercial lines premium.

We have seen policy growth on the commercial side of 2.7% in the fourth quarter of 2009 compared to a year ago. However, average premium per policy declined 6.1%. This was driven primarily by lower workers' compensation premium related to lower payrolls as businesses continued to deal with the struggling economy.

Now let's look at the cost of management operations. Costs were relatively flat in the fourth quarter compared to a year ago. Commissions related to our independent agents which make up the majority of our management costs increased slightly up 0.8% quarter-over-quarter. The cost of management operations excluding commission costs decreased 1.9%, primarily driven by the capitalization of certain technology-related expenses. The gross margins from our management operations in the fourth quarter 2009 increased to 14.6% compared to 12.1% in 2008.

Turning now to our insurance underwriting operations, we generated an underwriting profit before taxes of $4.7 million compared to a profit of $5.7 million a year ago. The GAAP combined ratio for the Company was 91.1% in the fourth quarter of this year, compared to 89% last year. The increase in the GAAP combined ratio was driven primarily by a quarter-over-quarter increase in catastrophe losses, 1.9 points compared to 0.8 points. The loss ratio for the current quarter excluding catastrophes was slightly lower, 68.1% compared to 68.7%.

Now I will review the results of our investment operations. The Company's investment operations recorded a profit before taxes of $1.2 million for the fourth quarter of 2009 compared to losses of $40.3 million for the same period in 2008. Net investment income decreased 5.7% compared to a year ago. This was driven primarily by lower preferred stock dividends.

Net realized gains on investments were $5.3 million in the quarter compared to losses of $25.1 million in the fourth quarter of 2008. Impairment losses totaled $1.7 million compared to losses of $7.7 million in the fourth quarter of 2008.

Equity and losses related to our limited partnership investments was $12.5 million compared to $14.6 million in the fourth quarter of 2008. The losses in the current quarter were again primarily related to real estate limited partnership investments.

Our investment in Erie Family Life Insurance Company resulted in a loss of $0.1 million in the fourth quarter of 2009 compared to losses of $3.7 million a year ago.

During the fourth quarter as part of our stock repurchase plan, we repurchased 49,220 shares of our Class the common stock at an average price of $38.57. We have approximately $98 million available for stock repurchases through June 30, 2010.

And now a quick look at our results for the full year. Net income totaled $108.5 million for the year or $1.89 per share compared to net income of $69.2 million or $1.19 per share in 2008. Net operating income decreased to $109.6 million or $1.91 per share in 2009 from $142.7 million or $2.46 per share in 2008.

The decrease in operating income in 2009 is primarily a result of equity and losses from limited partnerships of $76.1 million in 2009 compared to earnings of $5.7 million in 2008.

Income before taxes in our management operations was $186.5 million compared to $172.5 million a year earlier, driven by increases in direct written premium on the property and casualty group of 1.6%.

Gross margins from our management operations increased to 18.7% in 2009 from 17.6% in 2008. The GAAP combined ratio produced by our insurance underwriting operations was 99.2% in 2009 compared to 93.6% in 2008. The increase in the GAAP combined ratio was primarily driven by 2.6 points of lower favorable prior-year development and 1.3 points related to our share of the write-off of assumed involuntary reinsurance premium related to the North Carolina beach and coastal plans.

Lastly, our investment operations ended the year with losses of $30.4 million compared to losses of $77.8 million in 2008. Our equity security portfolios and fixed income portfolios benefited from improvements in the financial markets. However, alternative investments continued to be negatively impacted by difficult economic conditions primarily in our real estate limited partnership.

Before we get to your questions, I want to talk briefly about an upcoming change in the presentation of our financial statements. As a result of the Financial Accounting Standard 167, we will be consolidating Erie Insurance Exchanges financials with the financials of the Erie Indemnity beginning with the first quarter 2010. This will significantly change our reporting entity, related footnote disclosures and the overall presentation of management's discussion and analysis.

The financial results of the Indemnity Company will not be affected by this change but again, the presentation will be significantly different. It is very important to us that you can recognize and are able to discern the financial results of the Indemnity Company and we are working to give you that transparency.

We will issue an 8-K with the revised 2009 10-K reflecting the consolidation of the Erie Insurance Exchange and Erie Indemnity on the same day we make the first-quarter 2010 filing. This will give our investors the opportunity to compare the historical results in a consistent format with our new reporting presentation under FAS 167.

Now let's get to your questions.

(Operator Instructions) Vincent D'Agostino, Stifel Nicolaus.

Good morning. Just first, I was just kind of curious where the growth in CMP was coming from? If we are seeing rates are down to flat, just curious if you could just speak a little about the growth in the CMP.

It would primarily be coming from our PIF growth in terms of again we are able to grow the number of customers throughout our footprint. There may also -- there are probably a little bit of a mix change going on there too in terms of being able to -- probably a little smaller policies that have gone out the door and we are getting a little larger as we're looking to make sure that we respond to the appetite needs of our agents.

Great, then just curious with the adverse prior period development in personal auto, at 11%, is that something you can provide a little more color around why that would be so high?

I think what you'll see if you look at our 10-K, it's really coming from some of the update of our assumptions that we do periodically throughout the year. And so that was a one-time update related to some pre-1986 automobile massive injury reserves.

Is that on healthcare expenses or --?

It was related to the assumptions related to mortality.

Okay, great. Sorry, just lastly, on the workers' comp, is that rate 157% on that -- on the development?

Yes.

Just because that seems like kind of a rather odd -- oddly high number. Is there anything that we can look to driving that or is that -- should I just look in the K. for that?

I think you can look in the K. I think we (technical difficulty) pretty significant disclosure around there and it's really just around the medical inflation assumptions and a few other assumptions.

great. Thank you so much.

Dan Schlemmer, Macquarie Securities.

Yes, sort of staying on the theme of the lost development, I guess first of all, just looking at the aggregate number, not getting into the line details that you were doing, but it looks like from the disclosure from the release you had 6.2 points of favorable development on the combined ratio for Erie Indemnity. And then looking at the supplement, it looks like if I read it right, 1.7 points of favorable development for the group on the loss ratio. So those numbers are kind of far apart and I was hoping you can maybe connect the dots for what the differential is there, assuming I read it correctly.

Dan, the difference is that what you have in one display is actually the direct and then in the other presentation, it includes the ceded and assumed.

Okay, so it's not really -- it is really on the loss ratio, not some maybe expense adjustment or anything like that that was going through there.

That's right.

Okay, great. Thanks. Then just going back to sort of follow-up on the prior question you just did, what it sounds like if I heard it correctly, and I just want to maybe if you can confirm or clarify, it sounds like there is really -- the adjustment is not due to a change in the actual performance of the claims as much of it is your long-term projections and assumptions. Is that a fair way of thinking about it or was there a significant shift in maybe the actual claims experienced that I misunderstood?

No, there was not a shift in the actual claims performance. We do periodically update our assumptions such as medical inflation and other key assumptions, the discount rate, and different things that are in our reserves.

Okay, then the management operations, you talked about the general expenses and there is on I think it's page four of the supplement, it sort of breaks it out. The policy issuance sort of dropped down a fair amount and also the all other bucket. Is that -- can you talk more about that? And I think it really has to do with elevated levels in '08 for some capital expenditures versus -- is '09 the right run rate we should be looking at if we're modeling forward or is that -- are there other changes too?

I think when you think about 2009, we did have the capitalization in fourth quarter, so when you are looking at our fourth-quarter management margin rate, what you should see in there that we did capitalize some additional internal software development that normally would be more spread out through the total year. And then I think as you think about 2009, we remain focused on controlling our expenses while we continue to invest in technology that will help make us easier to do business with our agents.

Just to make sure I heard that right, the capitalized charge was during '08 or during '09?

No, it was during 2009.

Okay, thank you. Then last question real quick, just the net investment income, it was down year-over-year but it was actually up versus Q3. Was that -- it looked like the assets didn't change much, so I'm assuming there's a yield pickup. And if you can maybe tell us a little more about where that came from.

I believe it's relatively minor. We can take that off-line with you. I think that's a relatively minor change.

All right, thank you.

[Noah Lovey], [Tinsel Management].

Good morning, everyone. I wanted to get some more clarification on the FAS 167 issue if possible. Can you give us any more detail at this point in time on how the reported financials will change under the new rules?

Thank you, Noah. I think the important thing for everyone as investors of Erie Indemnity, the results of Erie Indemnity will not change but the required presentation from a FASB perspective will. And so on our summary financial statements, the income statement and the balance sheet in total will include the results of both the Exchange and the Indemnity. And we are going to strive very hard to ensure that we provide as part of our financial statements additional transparency so that the investors and analysts and our employees and agents can truly see the results of Erie Indemnity, which is the ongoing value to the shareholders of Erie Indemnity.

Okay, thank you.

Vincent D'Agostino, Stifel Nicolaus.

Back again for just two quick follow-ups. On the tax rate, it seemed a little bit higher in 4Q '09. Is there anything we can look to for the difference maybe sequentially from 3Q '09?

I don't think there's any material things going on there.

Then just a general question. In terms of homeowners with housing values trending down, are you or the industry as a whole, do you think in terms of homeowners electing to lower the total insured value or limits on their policies to reflect the depressed values? Or is that -- are you seeing that it has remained pretty sticky and hasn't really been changed from a policy standpoint?

Again, we are not seeing any decrease and as quite the contrary, I think it's one of the values of having a strong agency for us is that they are able to talk to customers and have them recognize the difference in what might be market value versus replacement value of the structures. And so again, we have been very vigilant in terms of educating our customers as to what they need to do.

And we also have obviously an inflation roll on capability that we utilize and so we are not seeing any erosion in terms of valuations in the homeowner book.

Great, that's helpful. That's all the questions I had. Thank you.

(Operator Instructions) Dan Schlemmer, Macquarie Securities.

-- around a comment that Terry made in the prepared remarks, you were talking about this lock-in of rate on the personal lines. I see where that is obviously a benefit for the customer. How does that reduce your flexibility in terms of your pricing or does that create -- how do you manage that risk that you now have some decreased flexibility?

Well, I think again you've got to recognize what percentage of the population that would fall into that category. Again, there are life events that create some flexibility and some movement in the ability of certain consumers to keep that from happening. But we think again one of the real benefits of our organization and our value proposition is the long-term perspective we take and the retention we have on our book of business.

So you look at that in comparison to this product and we are comfortable that we are providing a value that will create margin for us and something that is unique to the industry.

Thanks for that. Then last question, can you just -- it looks like the stock buybacks, there was a small pickup in the Q4 versus the first three quarters, but still a large outstanding authorization relative to what you've been doing. Is there a change in your position or what is your maybe threshold going forward for buybacks?

This is Marcia. As we look at our position and our financial position and as the markets have settled down a little bit, we do continue to evaluate that both our dividend levels as well as our share repurchase activity in relation to a payout ratio, and so we did reenter the market in fourth quarter of 2009. And as you know, we do have that open authority between now and June of 2010. We will continue to evaluate when it's appropriate for us to be in the market.

Great. Thanks a lot.

[James Tan], [CPE Partners].

Hey guys, good job on the operation. Just a quick follow-up question to the previous question. Do you have any projects on the horizon or acquisitions on the horizon that you would think would have a better return than returning your free cash flow to earn it to shareholders either via buyback or dividend? In other words, are there any acquisitions or internal projects that you think have a better IRR right now?

Those are two -- there are two questions there and I would say no to the first and we are always analyzing our ability to grow a business organically. And we have people working on that and we are continually looking to refine our platform.

I think what you saw in terms of the product enhancement in personal auto was an example of that. We will invest in our business when we think it creates return for the shareholders and benefits our customers and agents.

Okay, but just to be clear, you don't see any acquisitions or anything like that?

No.

Okay, great. Thank you.

(Operator Instructions) I see no further questions in queue at the moment. I would like to turn things back to Karen Kraus Phillips for any concluding remarks.

Than you, operator. Just a reminder that a recording of the call will be posted on our website today, erieinsurance.com after 12.30 p.m. Eastern time. If you have any questions at all, please give me a call at 814-870-4615. Thanks again and make it a great day.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may now disconnect. Everyone, have a good afternoon and a great weekend. Thank you.