Donegal Group Inc. (DGICB) Q3 2012 Earnings Report, Transcript and Summary

Good morning. My name is Morris, and I will be your conference operator today. At this time, I would like to welcome everyone to the Donegal Group Inc. Q3 2012 Earnings Conference Call. [Operator Instructions] After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. Mr. Jeff Miller, you may now begin your conference.

Thank you. Good morning everyone, and welcome to the Donegal Group conference call for the third quarter ended September 30, 2012. I'm Jeff Miller, CFO, and I will begin today's call with commentary on the quarterly financial results. Don Nikolaus, President and CEO, will then provide additional comments on the quarter and give a business update. 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 submit to the SEC. You can find a copy of our 2011 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 Investors section of our website. We are very pleased to be able to report significant improvement in our third quarter results. Net income increased to $6.8 million from $820,000 in last year's third quarter, and operating income increased to $6 million from an operating loss of $800,000 last year. I'll discuss a number of factors that contributed to the improved results. First, we continue to benefit from premium and rate increases and an ongoing emphasis on growth in our commercial lines of business. We've discussed personalized rate actions in previous calls, and we are clearly benefiting from those rate increases and continue to file for additional increases. We're also experiencing substantial improvement in our commercial renewal premium increases, averaging between 7% and 8% over the premium levels on the same accounts 1 year ago. At the same time, our policy account retention percentages are holding steady and even improving slightly from the levels we would have experienced a year ago, which indicates to us that the environment is improving and we are retaining accounts at higher premium levels. Don will give more details regarding our growth initiatives, but clearly, increasing premium revenues played a large role in our improved underwriting performance with the statutory loss ratio improving by 14.2 percentage points from last year's third quarter. We look forward to further increases in our revenue as we earn the increased premiums that we are currently writing. To add some color to the 14.2-point improvement in the loss ratio, lower weather and large fire losses accounted for 4.3 percentage points of the decline. Less severe weather resulted in a $1.4 million decrease in weather-related claims, but our weather-related claims were still $3 million above our previous 5-year average for the third quarter of the year. Our homeowners result also benefited from a decline in large fire losses of $1.5 million compared to the prior year quarter. Without a doubt, we are most encouraged by the improved underlying underwriting results that contributed the majority of the improvement in our quarterly loss ratio. Notably, we experienced a measurable decline in the number of incoming claims in our private passenger auto liability and commercial auto liability lines of business during the third quarter. And we saw commensurate improvements in the 2012 accident year loss ratios of those 2 lines of business. In fact, our current accident year loss ratios for those lines in the third quarter were the lowest we have experienced about in any quarter over the past year. I would hasten to point out that the improvement relates to reported claim activity and not to any changes in actuarial reserving assumptions. In fact, our actuaries took a more conservative stance in adding a higher amount of IBNR to those lines than they would have normally have added for exposure growth alone. We will continue to monitor further developments of for this potential trend, and we're certainly pleased that the third quarter performance of our auto liability lines return closer to our historical norms for those lines of business. Our workers' compensation line of business also continued to perform well, generating a 93.4% combined ratio for the quarter. Although we consider it a relative non-issue, we had prior accident year loss reserve development of $2.9 million in the quarter compared to $567,000 in the third quarter of 2011. The development was primarily related to the 2011 accident year in workers' comp and auto liability. We consider the development to be quite modest as the levels we're talking about can result from a handful of claims that exceed our initial estimate. Overall, we're comfortable with the fact that our development against what was in the narrow range that we have historically considered reasonable and that is modest in relation to our reserves as a whole. When you combine all the factors I discussed so far, we're pleased with the improving trends that led to an underwriting profit in the third quarter. We are optimistic that we will be able to post even better results in future quarters, especially if the impact of weather losses reverts to amounts that are closer to our historical averages. Turning back to premium revenues, our net premiums written rose 11.3% for the quarter. The 3 major drivers of the premium growth, personal lines rate increases, commercial lines growth and an additional contribution from Michigan Insurance, are described in the release and remain consistent with the breakdown we saw in the first 2 quarters of the year. Our multifaceted growth strategy is clearly producing positive results. For the first 9 months of 2012, our net premiums written had increased $35.4 million or 10.2% over the first 9 months of 2011. As for investment income, we reported a decrease of $327,000 or 6.5% for the quarter as a result of declining yields in our portfolio due to the continuing low interest rate environment. The rate of decrease in our investment income slowed from the second quarter of 2012 in spite of the fact that we have not changed our investment strategy or increased the risk profile of our portfolio. We are continuing to stay the course as we cannot justify the level of risk we would have to take to pick up measurable amounts of additional yield in the current environment. Our book value per share increased to $15.74 at September 30, 2012, up from $15.01 at the yearend as a result of our positive operating results and unrealized gains in our bond portfolio. At this point, I'll turn the call over to Don for his comments on the quarter. Don?

Thank you, Jeff. And good morning to everyone, and welcome to our third quarter earnings call. Jeff has done a very fine job of doing a very good summary of the details of the third quarter. What I would like to do is to do just a little bit of a recap and then provide some input as to what we believe the reasons are for the significant improvement. The earnings per share that has been reported is $0.27 per share versus $0.03 per share in the prior year. Our statutory combined ratio came in at 97.6% versus 110.6% in 2011. Revenues were up 9.5% over the prior quarter. And a very interesting statistic, our commercial combined ratio for the third quarter was 91.4%, which we believe evidence very strong profitability on the business that we are writing commercially. Net premiums written are up 11.3. Our book value as $15.74 versus $15.01 at the end of 2011. Needless to say, we're pleased with this turn around, and we think that the trend is important. And we believe that, that's what we are experiencing and seeing here. Let's chat about some of the significant reasons for the improvement in the financial results. From a rate adequacy and rate premium increases we continue to file throughout 2012, rate increases in homeowners between 8% and 12%, depending upon the specific state. We are now working on the rate indications and filings for the beginning of 2013. We are seeing the same kind of trend. In private passenger automobile, where we have in 2012 and are looking to continue that with the applicable states that have not received that input, that we will be increasing private passenger automobile rates depending upon the state, somewhere between 4% and 7%. The overall market for commercial lines, rates continue to firm. We would not in any way say that it's a hard market, but there is not difficulty in obtaining the rate increases that we have spoken about previously, anywhere from 5% to 9%, depending upon the particular product line. And if it has losses in the account, it would be more significant than that. Jeff also reported an important statistic that are on our renewals that we are -- on average, we have been obtaining somewhere in the neighborhood of 7% to 8%. It will vary by state and by product line, but the important thing is that our range of renewal pricing versus expiring is reflecting the kind of activity from a rate standpoint that we find helpful. Also, and we would not want to diminish the importance of underwriting actions, in personal lines, we have what we would describe as an underwriting company, a tightened underwriting guide in many lines of business. We are certainly taking the opportunity in which you can get rate increases to make sure that we have the best possible book. We are doing a significant reinspection program, as we have reported to earlier in various quarters, particularly in homeowners. We have literally inspected over the 1.5 years in excess of 50,000 homeowner policies. We, of course, have always inspected every new commercial piece of business, which we think goes to the importance of the underwriting influence that we put on our business strategy here at the Donegal Insurance Group. And needless to say, our improved results have also improved as a result of better weather in many of the jurisdictions in which we do business. All in all, it's basically the result of implementing the strategy that the Donegal Insurance Group has developed, and it's important that we stay committed to that going forward. Also, on the commercial side, we would highlight again that one of the reasons for our commercial growth, not all of the reasons but one of the reasons, is within the last year, 1.5 years, we began to roll out commercial lines into a number of states in which we were primarily a personal lines market. And we are beginning to pick up traction in those additional states, such as Wisconsin, Indiana, states in the Midwest, Nebraska, Iowa, South Dakota, who already had workers' comp and other commercial lines, but we have began to put more emphasis on commercial lines. Jeff made reference to the retention percentages, and we don't want to overlook that. In personal lines, our retention percentages are as high as 90% to 91%, depending upon the state. Overall, it's about 89.5%, which we think is quite good. In commercial lines, it's approximately 85%, which we believe is better than some of the industry numbers that we have seen circulated during this earnings season of the third quarter. I'm also pleased to tell you that on the technology front and data front that in the first quarter of 2013, we will be -- anticipate rolling out an enhanced predictive model for personal lines auto. And we are continuing to expand our use of data in terms of better identifying the risk that we want to write and price at good rates, and that business that either we don't want to write or need to apply the appropriate pricing. With regards to other aspects of the company, I think that we have demonstrated an ability to successfully complete transactions and make them accretive, and I'm currently specifically talking about the Michigan Insurance Company acquisition in the end of 2010. We clearly have the discipline to remain focused on writing the best in class of business. I'm also pleased to tell you that in the latter part of January or September, we received from A.M. Best an affirmation of our A rating, and we're just very pleased about that. It's always good to have that confirmed. At this time, we'll turn it back to Jeff for questions.

I will ask Morris to open the line for questions. We'll be glad to respond to any questions that you might have.

[Operator Instructions] And we do have a question from Brett Shirreffs.

A couple of questions here. First, you mentioned the success in Michigan. Just wondering as we approach the end of the year, what you're thinking about doing with that, that quarter share for next year?

Well, as a matter of fact, that's a topic that is currently under discussion. We have not arrived at a decision about that. But if you look at last year, you will see that we reduced it. And that is certainly one of the significant possibilities here. But at this point, we have not made that decision or what that percentage would be.

Okay. And in the release, you mentioned that frequency was lower in casualty lines. Is there any sense as to why that's happening? Or anything you can provide there.

Well, we've seen some fluctuations in frequency in the casualty lines. If you look back to 2010, we would have had very similar statistics in the third quarter. So it's hard to say why losses do not occur. Easier to look at why losses might have occurred. But in the current quarter, we clearly saw a decrease in the number of reported claims across the various casualty lines of business, and it would be more consistent with what we saw in the 2010 year. So we don't think there's anything necessarily unusual about it. It's just one of those types of statistics that can fluctuate from quarter to quarter.

Now from a strictly underwriting perspective, Brett, we would like to think that some of that is the result of underwriting and focusing on making sure that we have the best business on the books. But we certainly aren't able to significantly measure that at this point.

Okay. We'll caulk it up to better risk selection. And you mentioned the rate increase in personal lines. Is the growth there primarily from rate increases? Or how has policy count been trending?

Policy count is fairly flat. So in personal lines, it's primarily rate increases.

Okay. And how about the policy count in commercial lines, is that up pretty significantly?

Policy count in commercial lines is up. I would note that I would say significantly keeping in mind that we generally measure premium increases more in commercial lines because you could have one policy that has a large premium and the next policy has a very small premium. But it's up. Jeff, do you have any statistics there?

I'm doing the math in my head. But it's up 8% or so up from a year ago.

And just lastly, I guess I saw some continued buyback this quarter. The stock is sold off a little bit last few weeks and trading below where you guys bought back during the third quarter. Any tendency to continue that now that the share price is a little bit lower?

Well, as historically, we have bought shares, and we would anticipate continuing to do that at appropriate times and at appropriate levels.

[Operator Instructions]

While we're waiting for any additional questions, we probably should discuss briefly the potential of Hurricane Sandy that's coming up at the coastline. And obviously, we're monitoring that with interest. The potential impact, if you're looking at what could a storm such as that hurricane do to our financial results, we do have reinsurance limits that would limit the impact to anywhere from $3 million to, if it includes all of our subsidiaries, somewhere in the $4.5 million range. We would remind you that last fourth quarter 2011, we had some significant development from storms that have occurred earlier in the year. So our results in the fourth quarter 2011 were significantly impacted by hurricanes and storms that had occurred earlier in 2011. So we are hopeful that our fourth quarter 2012 results will outperform what we reported in the fourth quarter of 2011. And of course, we're most hopeful that Hurricane Sandy just goes out to sea. But we're closely monitoring that and hope that anyone in harm's way will be safe.

And Jeff, is it fair to say that 2012 storms and events anywhere in the third quarter, second quarter and first quarter, that we would not anticipate any development in the fourth quarter of any of those events. That's there.

That is correct because in the third and the fourth quarter 2011, we were dealing with the 5 different events that had exceeded our retentions. We don't have anything like that in 2011. Only one event has exceeded our external retention. And so we have plenty of capacity available on our reinsurance.

And also, we're not weather forecasters. Hopefully, it will go out to sea or the impact will be minor. But if it does impact the East Coast, what Jeff has described is the impact on us financially will not be significant.

Morris, do we have another follow-up question?

We do have a follow-up question from Brett Shirreffs.

Just wondering if you could remind us what the impact of Hurricane Irene was last year?

Hurricane Irene did impact all of our subsidiaries in the mid-Atlantic. So there would have been a fairly significant impact. Because of the fact that we exceeded our reinsurance capacity, it had a more significant impact than what we would normally have expected. I don't have exact numbers, but I would say that there was probably somewhere in the $6 million range that Hurricane Irene would have impacted our results. So we would expect that if Sandy would hit the same track that Irene did, we would have a lesser impact because of the current reinsurance capacity that we have.

And when Jeff refers to exceeded reinsurers, he is talking about the first layer of our cat layers. Because of all the number of events in 2011, we would have used up the first layer. And therefore, when Irene hit, there wasn't much left in terms of that first layer cover to provide protection. But as with Sandy, we don't have any of those issues, and it's simply straightforward mathematical that even if it was a significant event, it should not cause our earnings a loss of $4 million to $4.5 million.

And there are no further questions in the queue.

Okay. Well, we thank everyone for listening in and wish you a good day.

Thank you, everybody. We appreciate your participation.

Thank you for participating in today's conference call. You may now disconnect.