Erie Indemnity Co (ERIE) 2010 Q2 法說會逐字稿

Hello and welcome to the Erie Indemnity Company's second quarter 2010 earnings conference. At the request of 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 would like to introduce your host for today's conference call. Karen Kraus Philips, Vice President and Director of Investor Relations.

Thank you, Karen, and good morning. We appreciate all of you joining us. On today's call management will discuss our second quarter 2010 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, 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 released and additional supplements yesterday afternoon. If you need a copy of the press released 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.

As a reminder, last quarter we began reporting our results on a consolidated basis with the Erie Insurance Exchange in accordance with Accounting Standards Codification, or ASC-810. Due to consolidation with the Exchange, the presentation of our results is significantly different from that of periods prior to December 31st 2009. The actual results, however, are unaffected by the change. On today's call Terry and Marcia will discuss only the results related to Indemnity. Management will also share important information about current and future Company initiatives. 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 July 29th, 2010, and in the related press release and the consolidated financial statements and footnotes included in our Form 8-K filed on May 6th, 2010. In this call we will discuss non-GAAP measures. You can find the reconciliation to the GAAP-based results in the 10-Q. 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 the Erie Indemnity Company.

A replay will be available on our website today after 12.30 PM Eastern Time. Your participation on the call will constitute consent to the recording, publication webcast broadcast, and use of your name, voice and comments by Erie Indemnity. If you do not agree with these terms, please disconnect at this time. And now Erie's President and CEO, Terry Cavanaugh. Terry.

Thank you Karen. Good morning, everyone. I am pleased to report on a solid second quarter for Erie Indemnity. Erie agents and employees are fully engaged in delivering result which is evident in the Company's performance. For the second quarter of 2010, Indemnity net income was $49 million, or $0.86 per share, compared to $33 million, or $0.57 per share a year ago. Net operating income per share increased to $0.89, compared to $0.56 at the end of the second quarter 2009.

We are continuing to see gains in Property and Casualty Group direct written premium, up 4.1% for the quarter. This was driven by policy enforced growth of 3.5%, supported by a continued high retention rate, and strong growth in new policies. In our personal lines, representing 70% of our business, direct written premium increased 5.5% over a year ago. We have taken small rate increases in both private passenger auto and homeowners, which lead to an increase in personal lines average premium per policy. Our personal lines retention ratio remains strong at 91.3%, albeit slightly lower than last year as a result of tighter underwriting, and price increases in our homeowners book of business.

For the first time in several quarters, the written premium on our commercial lines has increased. This was driven primarily by an increase in new written premium, as a result of growth in new commercial policies in force. The commercial market continues to be highly competitive, and our commercial business, particularly workers compensation continues to be impacted by the slow economic recovery. Despite these challenges our commercial team has put on a full court press to support our agent's commercial sales, and the results to date have been encouraging.

Also in supported commercial lines, during the quarter we initiated a pilot with several agencies of our new commercial system for a business owner's policy. In its early stages, this system is proving successful, reducing the time to quote, and the time to write an application significantly. Early results are encouraging, and we expect to deploy the system company-wide throughout 2011. Our PC results along with the strong life business continue to provide a market leading platform for our agents, and a complete product portfolio for our customers.

Overall our results reflect our ongoing actions to enhance our competitive position, motivate agents to sell Erie, effectively target our marketing efforts, manage our costs, and as always ensure the delivery of superior service. That last item, delivering superior service, again earned us the top spot for Customer Satisfaction in JD Power & Associates 2010 Auto Insurance Shopping Experience Study. This is the third year in a row Erie has claimed the number one position. Congratulations once again to all of our agents and employees. We have also earned impressive marks from our customers who were affected by the devastating storms this winter and spring. Erie's claims employees delivered on our promise of prompt compassion service, and our agents and customers took note. We have received hundreds of letters and e-mails acknowledging Erie's good work.

We have also gained new customers as a result. Being above all in service is not just a tag line in Erie. It is what our people do day in and day out. And it is at the end of it all what makes the difference. We also recently received affirmation from two rating agencies, AM Best and The Ward Group, that Erie remains a financially strong organization. AM Best affirmed our A+ Superior rating with a stable outlook, and the Ward Group again placed Erie on the Ward's 50 Group of Top Performing insurance companies. The Ward Group analyzes the financial performance of 3,000 property and casualty companies, and recognizes the top performers for achieving outstanding financial results over a five-year period. This is the 13th year we have been included in the Ward Top 50. For Erie and it agents, the award is an important acknowledgment of a commitment to a strong balance sheet, and an operating model designed to meet and anticipate customer needs. Now Marcia will take us through the financials, and then we will get to your questions. Marcia?

Thank you, Terry and good morning. I am pleased to share our results for the second quarter 2010. In my discussion of the results, I will focus only on the results that pertain to Erie Indemnity Company, and not on the financial results of the Exchange. Let's look at the second quarter 2010 results. Indemnity net income was $49 million in second quarter 2010, compared to $33 million in second quarter 2009. On a per diluted share basis, net income was $0.86 per share in the current quarter, compared to $0.57 per share in the prior year quarter. Net operating income per share was $0.89 per share, compared to $0.56 per share in the prior year quarter. Income before taxes from our management operations was $62 million, compared to $60 million in second quarter 2009. Our second quarter 2010 result was driven by a 4.3% increase in management fee revenue.

The increase in management fee revenue for the current quarter is consistent with a 4.1% increase in the property and casualty groups direct written premium. This growth was driven by a 3.5% year-over-year increase in policies in force. We continue to have a strong overall retention rate of 90.5%. Our personalized premium grew 5.5%, reflecting a 3.5% growth in policies in force, a 1.3% increase in the year-over-year average premium per policy, and a strong 91.3% retention rate. Commercial lines written premium increased 0.7%, reflecting a 3.6% growth in policies in force, so it was offset by a 5.2% decrease in the year-over-year average premium per policy. The commercial lines policy retention rate was 85.2%. Operating costs were up approximately $9 million, or 4.7% in the second quarter 2010 compared to a year ago. Approximately two-thirds of this increase was driven by increases in commissions, and the other one-third was a result of increased personnel costs.

The gross margins from our management operations in the second quarter 2010 decreased slightly to 22%, compared to 22.5% in 2009. Just as a reminder, our margins are typically higher in the second and third quarter, due to the seasonal increase in premium during these quarters. Now I will review the results of our property and casualty insurance operations. We realized a $2 million loss before taxes from our property and casualty operations in second quarter 2010, compared to income before taxes of $2 million a year ago. The second quarter 2010 GAAP combined ratio for the P&C operations was 101.8%, compared to 96.6% a year ago. The current accident year loss and loss expense ratio, excluding catastrophe losses was 67.9% in the second quarter 2010, compared to 66.7% in the prior year quarter.

The increase in the combined ratio was driven by catastrophe losses which added 8.1 points to the quarter's combined ratio. Cat losses contributed 1.5 points to the combined ratio a year ago. Favorable development of prior accident years improved the quarter's combined ratio by 2.3 points, compared to an improvement of 1 point a year ago. The favorable development in the second quarter 2010 was driven primarily by improved severity trends in workers compensation and commercial multi-peril. Now I will review the results of our life insurance operations segment. Indemnity's income before taxes from Erie Family Life increased from $1 million in second quarter 2009 to $3 million in second quarter 2010, driven primarily by improved investment results.

And finally I will review Indemnity's investment operations. Indemnity's investment operations recorded a profit before taxes of $11 million, compared to losses before taxes of $16 million in the prior year quarter. Net investment income was flat year-over-year at $9 million. While average asset levels have increased during the second quarter 2010, yields on new security purchases are down. Net realized losses on investments were $3 million in the second quarter 2010, compared to gains of $4 million a year ago, primarily due to valuation decreases on our common stock portfolio. Impairment losses for the quarter were $1 million, compared to impairment losses of $2 million in the prior year quarter. Our income from equity and limited partnership investments was $6 million in the second quarter 2010, compared to losses of $27 million in the prior year quarter.

The second quarter 2010 results was driven by increases in the fair value in our private equity and mezzanine debt limited partnership. During the second quarter 2010, we repurchased 329,346 shares of our Class A common stock, in conjunction with our stock repurchase plan, at a total cost of $15 million. Approximately $85 million remains under the plan. On a year-to-date basis, Indemnity's net income was $96 million, or $1.68 per share diluted for the first six months of 2010, compared to $44 million, or $0.76 per share diluted for the six months ending June 30th 2009. Now I would like to turn the call back over to Karen.

Thank you, Marcia. We will now open the call for questions. We ask that your questions focus on the results of Erie Indemnity Company for second quarter 2010. Operator, please open the call.

(Operator Instructions). Our first question comes from the line of Dan Schlemmer of Macquarie.

Hi, good morning. Wanted to ask, Marcia, you made a reference in your prepared remarks about the seasonal increase in premium. I think we have talked about it before, but can you refresh us on why that occurs, why your premium isn't spread evenly?

Dan, I think there are a number of factors when you look at our results, that influence why the premium might be higher in second and third quarter, things such as when people buy homes occur during that period of time. So our book of business is built up over time to have higher premium during those periods. Also kind of new car sales, and when those occur, and then also just some of our contest and various incentives that we run are more concentrated in sort of that second and third quarter period of time. It is a number of factors. And when you look back in time, you see that seasonal increase during second and third quarter.

Great. And on the property and casualty results, I guess the underwriting results, you mentioned in the press release about some cat losses, Pennsylvania, Maryland, and Ohio were actually specifically mentioned, which I thought was interesting. It seems like the industry is talking a lot about the flooding in Tennessee. So I guess maybe my question first is, were you not seeing the same impact in Tennessee that others are seeing? And is there a specific reason why? And maybe if you can give us some general background on the cat losses experience, and what you are seeing specifically going on has sort of been a recurring story across Midwest cats now, versus the big news we always hear, that is usually related to cats on the coast.

Dan, this is Terry. Good morning. Tennessee I think is a function of I would like to believe some good underwriting, as well as clearly a market share issue there in terms of the fact that our market share is not nearly as significant as it is in some of the other places that we would have been affected by natural disasters. It has been an issue in terms of where as you say it has not been one named storm, but there has been a series of storms going back obviously to the first quarter in terms of the winter weather. And then obviously the second quarter has been affected by a number of hail activity and thunderstorms and many tornados. And so it has been a busy quarter for our agents in terms of responding to those folks, and it has been a busy quarter for our claims professionals. We have got a couple of cat teams right out in Silver Springs right now working on some significant activity that occurred, and they do a great job of again, bringing this value proposition called Erie Insurance alive. It has been one of those years where there has been just a number of storms. I think we are well-positioned in terms of our results are to date, and I think we are well-positioned for the second half of the year.

And then last question, I guess if you can talk a little about on the personal line in particular, and the homeowners pretty good premium growth plus almost 7% on the quarter, less on the auto. Is that a shift in the mix of business, or is that a shift in pricing, or something else that I am missing?

It is driven by pricing. Clearly we see that line of business as having the greatest rate need. I think the industry is also responding to that need, and we are able to execute on that strategy.

And is that driven somewhat by, is that connected somewhat to the cats we were just talking about, or is it really more of just general losses that overall loss trends?

I would say it is both. That business, clearly the homeowners' business is subject to cat activity probably by virtue of the number of exposure units that you have in any one place versus commercial. And so therefore cat activity is a very integral part of the pricing formulas that we utilize in homeowners. It is something that we think is, it happens every day, and we build it into our model. I would not suggest that the cat activity is driving our pricing. It is just good, prudent management recognizing that we have to get rate for the exposure that we have.

Great color. Thanks.

Thank you.

Thank you, sir. (Operator Instructions). Our next question comes from the line of James Pan of CP&E Partners.

Hi, guys. Good job in growing your policies and I also noticed that you had some buy backs. I appreciate that. Question about the management company's capital. You have like $950 million in capital up there in the management company. How much do you think you would need to maintain a well-capitalized status. In other words, how much do you think of that 950 is actually excess, and that you don't need, and you might want to return to the shareholders?

This is Marcia. We are continuing to work to refine our measurement as far as what we believe to be the excess capital within the entity versus what we need to maintain, but there are a number of factors that I would offer that you should consider when you are thinking about that. Clearly we do have alternative investments within the structure, and so those have, for example, less liquidity than other investments we might have. We do also support our line of credit with the capital position that we have as well. And that is considered as well. And then obviously the capital required for future growth. And obviously factoring in both our dividend strategy, as well as our share repurchase strategy. Although I am not able to give you a number today, it is something that we continue to work to refine.

Is there a cost minimum hurdle on the alternative investment strategy that you require?

We are currently not making any new investments in Indemnity in alternative investments. So we are really just managing that portfolio today, based on the remaining unfunded commitments, and the current runoff for distributions that are coming from that portfolio.

Okay, thanks a lot, guys.

Thanks, James.

Thank you, and we have a follow-up question from the line of Dan Schlemmer of Macquarie.

Just real quick actually, Marcia, you were mentioning dividend strategy and buy back strategy. Can you talk a little bit, when you think about returning capital shareholders, you have a fairly healthy dividend and then you did some buy backs. How you think about maybe it is time to raise the dividend, or no we don't want to raise the dividend and we prefer to do buy backs at this time, and how you play those two against each other?

Well, we look at a number of things on an ongoing basis. Clearly we have a strategy of consistent dividend growth over time. We continue to look at that not just for this year, but also for the long-term ability to be able to do that. We also actively look at our cash management and our investment portfolio as far as what is available. And we factor that in with our share repurchase strategy. We do look at a payout ratio. And obviously and one of the things we have continued to look at is where that is in relation to our current projections for the year. And that is something that we actively have dialogues around here within the business.

Dan, it is not an either/or proposition. Clearly we look at both, and we feel strongly about both, and we recognize that there are, that capital management is an important part of what we do here, and we spend a lot of time on a consistent basis making sure that we make the right decisions.

Great, thanks.

Thanks, Dan.

Thank you. And our next question is another follow-up from the line of James Pan from CP&E Partners.

Just a follow-up on the dividend question. How much thought or discussion on the Board level is there, in terms of perhaps paying out a special dividend, given the possible change in tax rates at the end of this year?

So James, we are in continuing dialogue as Terry just mentioned from a capital management perspective, so we have no plans at this time to do that, but we are continuing to look at our capital management strategies going forward.

Alright. Thanks a lot, guys.

Thank you. So does that conclude your question?

Yes.

Yes.

Thank you, we have no further questions in queue at this time. I would like to turn it back over to Karen Kraus Philips for further remarks. Karen Kraus Phillips: Just a reminder that a recording of the call will be posted on our website, Erieinsurance.com after 12.30 PM Eastern Time today. And if you have any questions, please call me at 814-870-4665. 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 great weekend.