Donegal Group Inc. (DGICA) Q2 2016 Earnings Report, Transcript and Summary

Good morning. My name is Mariama and I will be your conference operator today. At this time, I would like to welcome everyone to the Donegal Group Inc's Q2, 2016 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. [Operator Instructions] Thank you. I would now like to turn the call over to Chief Financial Officer, Jeff Miller. You may begin your conference.

Thank you very much. Good morning and welcome to the Donegal Group conference call for the second quarter and first half ended June, 30, 2016. Our second results were highlighted by continued premium growth and bottom-line improvement. I will be begin today's call with commentary on these quarterly financial results, Kevin Burke, President and Chief Executive Officer, will then discuss our current business developments and growth initiatives, Don Nikolaus, our Chairman, will follow up with his perspective on the quarter and our ongoing business strategy before we open the line for questions. You should be aware that certain statements made in our news release and in this conference call are forward-looking in nature and involve a number of risks and uncertainties. Please refer to our news release for more information about forward-looking statements. Further information on risk factors that could cause actual results to differ materially from those projected in the forward-looking statements is available in the report on Form 10-K that we submitted to the SEC. You can find a copy of our Form 10-K in the Investors section of our website under the SEC Filings link. Further, reconciliation of non-GAAP information, as required by SEC regulation G, was provided in our news release which is also available in the Investor section of our website. Turning to the second results, we were pleased to report a 33% increase in our net income to $8.6 million or $0.32 per diluted Class A share, compared to $6.5 million or $0.24 per diluted Class A share for the second quarter of 2015. Our net premiums written grew 7.7% for the quarter, due primarily to commercial lines new business growth, as well as modest premium rate increases across our lines of business. Kevin will discuss the growth in our regional markets in greater detail later in the call. Our statutory combined ratio of 95% reflected solid underwriting profitability for the second quarter and compared favorably to 96.4% for the second quarter of 2015, 1.3 percentage point net improvement in our statutory loss ratio drove the decline in our combined ratio and I'll go over a number of factors that contributed to that net improvement. First, large fire losses totaled $3.7 million, down from $5.9 million for the prior year quarter. This is a second consecutive quarter in which we saw low incidences of large fire losses compared to our historical experience. Second, while weather losses of $11.2 million increased from $8.9 million for the prior year quarter, those losses remained lower than our $12.4 million average for second quarter weather losses over the past five years. While we read several reports from our peers, citing increased catastrophe activity during the second quarter, we incurred only one wind and hail events that exceeded our reinsurance retention. That event involved our Le Mars subsidiary in the Midwest region and the separate reinsurance program that company has in place limited or incurred losses for the event to only $750,000. We did incur $1 million in reinstatement premiums due the relative magnitude of the reinsurance recovery for that subsidiary. The Midwest cat [ph] events primarily impacted our homeowner's line of our business which in spite of that event produced a 98.7% combined ratio for the quarter. Prior accident year reserve development, while relatively modest in terms of our reserves as a whole contributed to an up-tick in the combined ratios for our personal and commercial automobile line. In commercial auto, we also observed an increase in claims frequency during the quarter that we believe to be a seasonal anomaly. As our press release indicated, our commercial auto frequency statistics for the first half of 2016 compared favorably to similar statistics for the past several years. On the personal auto side, we continue to experience stability and consistency in our claims frequency trend. In our commercial multi multi-peril of business the absence of large fire losses and significant weather related loss activity contributed to declines in both claims frequency and severity. Those favorable trends were partially offset by $2.1 million of prior year reserve development largely from the 2015 accident year. All things considered, we were very pleased with the 85.9% combined ratio in commercial multi-peril for the quarter. Our workers compensation line of business performed very well posting an 82.7% combined ratio for the quarter and contributing to the excellent 88.5% combined ratio for our commercial line segment as a whole. In total, our solid second quarter underwriting experience reflected a continuation of the excellent results we achieved in the first quarter of 2016. For the first half of 2016, our statutory combined ratio was 93.6%, a three point improvement over the first half of 2015. Our personal lines combined ratio was 98% and our commercial lines combined ratio was 88.2% for the first half of 2016. Shifting to the investment portfolio, investment income increased 3.6% for the second quarter, primarily related to an increase in average invested assets compared to the prior year period. Since year end, we have concentrated our new money investments into corporate and mortgage backed fixed income securities, as well as an increased allocation to dividend paying equity securities. As a result, our municipal bond investments have declined to about 35% of our overall portfolio compared to nearly 40% at year end 2015. The combined effect of higher premium revenue, improved underwriting results and positive net investment income drove the 33% increase in our net income. Our book value per share increased to $16.62 at June 30, 2016, compared to $15.66 at year end 2015. We attribute that increase to our favorable first half results which generated a 9.6% annualized return on average equity. And finally, our board of directors last week approved quarterly cash dividends of $0.1375 per share of Class A common stock and $0.12 per share of Class B common stock payable August 15th to stockholders of record as of August 1st. At this point, I'll turn the call over to Kevin for his comments on the quarter.

Thank you, Jeff. We are very pleased with the continued growth and bottom-line improvements we achieved for the second quarter, as well as for the first six months of 2016. We are driving this profitable growth by staying true to the core fundamental philosophy of Donegal, sound conservative underwriting, proactive claims management, and strengthening our agent relationships within our 21 states. We have seen notable growth in our commercial lines throughout our marketing regions from regions where we are well established to new markets such as Indiana where we have been actively writing for only two years. Let me take a moment to review our commercial and first lines underwriting segments of our business. During the second quarter, we achieved 12.4% growth in our commercial lines with each business line, multi-peril, workers comp and auto reporting strong growth. In addition, we achieved solid underwriting performance in all of these lines that help contribute to an excellent combined ratio. Our workers comp products which we provide predominantly for small to mid-sized businesses performed incredibly well in the second quarter and in the first half of the year. We are seeing a decided trend of lower claims frequency. We feel that our proactive approach to claims management has also had a positive impact. We are continuing to see opportunities to obtain modest renewal premium increase with increased competition for quality accounts, our renewal premium increases during the second quarter generally range from 3% to 5% which is consistent with past - the past several quarters. Our commercial lines retention levels remain strong and we believe we are in an excellent position within the marketplace to continue to profitably grow our commercial lines. Moving to the personal lines segment of our business, we are pleased to report an increase of 4% in net premium written, compared to the second quarter of 2015. We're achieving modest new business growth within our auto and homeowners lines where we are continuing to experience competitive market conditions. And our agent relationships in years of building our brand within regions have allowed us to maintain excellent retention ratios in these lines. We have implemented and we'll continue to file rate increase where appropriate. We will continue to expand our utilization of predictive modeling tools to refine our pricing and underwriting criteria. To give you a sense of recent re-filing activity in personal lines, we have filed rate increases in homeowners in the 2% to 4% range depending upon the states and subsidiaries. Rate increases in personal automobile range from the low single digits depending upon the state in subsidiary. Let me give you an update on our marketing efforts and distribution. As many of you know, we have maintained a robust independent agency distribution system of approximately 2400 select agents located throughout the 21 states where we write business. Our goal has been to appoint specific agents with the commercial lines focus, while also serving to expand our geographical representation. But we are also very focused on expanding our agency relationship within our current network in exchange for our efforts to provide comprehensive products and best-in-class service to our agents, we are actively seeking an increased commitment from them in terms of quality business submissions to us. We continue to take great efforts to communicate the Donegal value proposition to our agents. Our goal is to be the agent, the agent's go to carrier, but we expect to achieve this through being highly responsive, delivering best-in-class claims service, being reliable in the stable market. Our agents value the relationships we have developed over many years and appreciate our stability in the marketplace. Within the past few years, we have seen significant growth in the number of what we call leaders agents. These are Donegal agencies that generate the highest levels of written premium with our group of companies. We continue to develop additional agencies that are in the pipeline moving towards that objective and have developed specific ways to incentivize our agents to move more of their profitable business to us. Our efforts to enhance our relationship with these agents have resulted in an increase in new business submissions and we believe the leader’s agents will continue to be an excellent source of future premium growth for our organization. New agency appointments have contributed to increased commercial lines and personal lines premium growth over the past several years and in the second quarter and it is our expectations these new agencies will continue to represent additional growth opportunities for us. For the second quarter, we appointed 49 new agencies throughout the regions in which we operate and we are excited about the potential quality growth opportunities these additional agencies represent. Finally, I want to spend a few minutes on recent technology enhancements. These initiatives are all part of our ongoing commitment to leverage our best-in-class technology, to enhance ease of doing business with our agents and policyholders. We continue to move forward with a phased rollout of our new billing system which is now live for new business in all the two states in which we do business. The completion of this rollout for new business is scheduled to be completed within the next 30 days and we have already begun the phased rollout for policy renewals. The new billing system will ultimately replace our legacy system and provide flexible billing and payment plan options, along with the new format for billing forms that are easier to understand. We are pleased to announce the upcoming implementation of electronic signature for commercial lines. We currently offer electronic signature as we refer to it as E-Signature to our agents and policyholders for personal lines forms and documents. The same functionality will be available for commercial lines accounts with implementation starting in August, we will represent a significant service enhancement. The implementation of Donegal's new policy rating engine for personal lines is nearing completion. The new rating engine allows for greater speed to market for rate and coverage actions and we are starting to see the benefits of this new technology as we make refinements to personal lines products. To continue to build on our reputation as a strong regional carrier, it’s important that we have the ability to bring products to market quickly and to efficiently react to market trends as they develop. To conclude, it was an excellent quarter for Donegal, number of the initiatives we have implemented in terms of our agency relationships, in technology enhancements are proving to be effective in driving profitability is sustainable growth. At this point, I will turn the call over to Don Nikolaus for his comments on our business strategy, before we open the lines for questions. Thank you.

Thank you, Kevin. Good morning everybody and welcome to our earnings conference call. We have been pleased with the favorable trends and our financial results over the last number of quarters, which we believe is been driven by a number of the long-term initiatives that we have implemented that Kevin has detailed in his presentation. We operate in an industry where you can achieve growth, if you so desire, but potentially at the expense of profitability and it is to say the needs always to be a balance between growth and profitability. We focus on underwriting profitability, a diverse book of business, strong agency relationships and ensuring that our technology and service to our agents and customers are superior to our competition. Last quarter I made reference to the importance of rate adequacy. This has been at the forefront of our business strategy for many years, are we properly rating the business we write and still achieving consistent growth. It is to say that’s an ongoing analysis and an ongoing challenge. We have a high experience actuarial department that works to ensure each of our lines of business are priced adequately to generate appropriate process levels, but at the same time to maintain retention levels we desire and to allow us to grow. In addition, as Kevin has mentioned, we rely on constant communications with our agency force to have close trends [ph] to the market, because it’s extremely important to understand what’s going on in the marketplace. We try very hard to listen, we respond and I think our agent appreciated and respected. In closing, we are pleased to report a second strong quarter and first half for our stockholders. Net income and book value increased nicely and we are pleased to be able to return capital to stockholders in the form of a consistent quarterly dividend. The first half represented an excellent start of the year and we are clearly optimistic for the remainder of 2016. At this point, I will turn it back to Jeff.

Great. Thank you, Don. And Mariama, we are ready to open the line for questions please.

[Operator Instruction] Your first question comes from the line of Meyer Shields from KBW. Your line is open.

Thanks. Good morning, everyone.

Good morning, Meyer.

I guess in workers compensation the results were fairly stellar. Was there any prior year reserve adjustments in the 827 or is that an accident order number?

There is a modest amount of prior year, favorable prior year developments somewhere around $600,000. So it’s not a significant number, but there was a small amount of favorable development in that number.

Okay. And then turning to the auto side, is there – I am not sure if this the right way to ask this, but is there a target combined ratios because basically from your comments of low single digit increases, it sounds like that might keep pace with loss trend, but necessarily get ahead of it, I'm thinking about that the right way?

For a personnel auto, I think we feel like the rate increases that we are able to get our keeping pace with the loss cost increase, we believe that our target loss ratio, our combined ratio is of course under 100 for personal auto and that we've been seeing some improvements there. Commercial auto side is a little more challenging. That line has a run a temperature in terms of the combined ratio. We've taken the number of actions to address that particular line. We've taken rate increases across all of the states where we do business. Those rate increases range from 2% to 10% with the majority of the states being closer to 2%, but a few of the states where we've seen some outsized loss activity, we have increased as much as 10%. And I think we've talked in the past of the commercial auto improvement program we have in place where we have a multi-functional group of senior management team members that meet monthly to grow over large losses, to look at the various classes of business where we’re seeing losses. So we do have a target to reduce that combine ratio to a profitable level, but that one is work in progress. And certainly as we mentioned in the second quarter, we did see an up-tick in reported losses, in commercial auto, there were some adverse development from prior accident years may have about 700,000 and then there was an additional about a $1 million of reported losses that increased over what we would have seen in the second quarter of 2015. And it’s little difficult to pin point a number that small, as to what the cause may have been. But it was spread across a number of our subsidiaries and we don’t think it’s a trend. We think it was just a timing anomaly in those reported losses. So hopefully that gives you some color, I don’t know if there is any additional detail you'd like us to talk about.

No, that's very helpful. Appreciate that. One last question, if I can. Just in terms of the overall growth in commercial, is that coming more from other regional companies or from some of the national carriers, is there a good way of looking at that?

Yes, it’s actually coming from a cross section of both, I mean, we’ve got one of the things that I had mentioned in my comments was the word stability has been listed a couple of times and mentioned. And so whether it’s a national carrier that is may be making some changes or we’ve seen it also amongst the regional as well with that when there is disruption in the marketplace from a commercial line standpoint, we're in a really great position to take some advantage of that, the agents, US not only is a very good commercial market, but is a stable, stable carrier. And so we're seeing it actually from across the board, there is no one particular size of organization or even geographically we are seeing it from as we mentioned Indiana which we've been writing only for the last two years we've been in there. We are seeing very solid growth in the commercial line side from all their states that we’re operating in. And so we're very pleased with the up-tick in commercial growth. And it’s our expectation that that’s going to continue, we've got some very good momentum build.

Okay, fantastic. Thank you so much.

[Operator Instructions] And your next question comes from the line of Louis Feldman from Wells Capital Management. Your line is open.

Thank you. Good morning, gentlemen.

Good morning, Lou.

Good morning, Lou.

Can you give a little color on your decision to start increasing your equity weighting in the investment portfolio?

Sure. As you’ve fully recognize its very difficult to find yield in the fixed income market and we’ve been increasing the allocation to dividend paying equities, where the dividend yield is comparable or even in some cases higher than what we’re able to get in the types of fixed income securities that we’ve historically invested in. But still a very modest allocation relative to our portfolio as a whole, but it’s – we've been increasing it in recognition of the yield, the attractiveness of the yield in equity.

And I would like to emphasize that yes, we are increasing it, but underscore what Jeff has said, the dollar amount relative fixed income, it is a modest percentage. So we are not making any major shift into equity. We are simply increasing it moderately to reflect that there are some very good higher dividend paying stocks that are quality equities.

And Lou just give you some details there, primarily Blue Chip value stocks and I think we’re currently earning around a 3.15% dividend yield on the portfolio. So it’s definitely an income play.

I guess, being working free value shop I would question some of the valuations at this point in time to be perfectly candid with you, gentlemen.

We guarantee that we will monitor it closely.

Okay.

And then, one of the reasons why the dollar amount is quite modest because we recognize that the markets are certainly under all kinds of pressure, whether it be Brexit [ph] or other things that are going on in society and the economy. So being the conservative company that we are we will be very careful what we are doing.

Okay. Thank you very much, gentlemen.

Thank you,

Thanks, Lou.

There are no further questions at this time. I will turn the call back over to the presenters.

All right. Thank you very much. We appreciate everyone’s participation today and interest in following our conference call and we will talk to you next quarter.

Yes, thank you everyone.

Thank you.

This concludes today’s conference call. You may now disconnect.