Scott Beilharz - Vice President, Investor Relations
Terrence Cavanaugh -President and Chief Executive Officer
Marcia Dall - Executive Vice President and Chief Financial Officer
Sean McLaughlin - Executive Vice President, Secretary and General Counsel
Adam Klauber - William Blair
Erie Indemnity Company (ERIE) Q3 2013 Earnings Call November 1, 2013 10:00 AM ET
Good morning and welcome to the Erie Indemnity Company third quarter 2013 earnings conference call. I would like to introduce Scott Beilharz, Vice President of Investor Relations, and our host for today's call.
Thank you, Janine, and welcome everyone. We appreciate you joining us. On today's call, we'll discuss our third quarter 2013 results and matters related to the company's third quarter operations. Joining me today are Terry Cavanaugh, President and CEO; Marcia Dall, Executive Vice President and Chief Financial Officer; and Sean McLaughlin, Executive Vice President, Secretary and General Counsel.
Our earnings release and financial supplements were issued yesterday afternoon and are currently available on our website, erieinsurance.com. In this call, we'll first hear statements from Terry and Marcia, and then open it up for questions.
Before we begin, I'd like to remind everyone that today's discussions may contain forward-looking remarks that reflect the company's current views about future events. These remarks are based on assumptions, subject to known and unexpected risks and uncertainties. These risks and uncertainties may cause results to differ materially from those described in these remarks.
For information on important factors that may cause these differences, please see the Safe Harbor statements in our latest 10-Q filing with the SEC, dated October 31, 2013, and in the related press release. Also, during this call, we may discuss non-GAAP measures. A reconciliation to the GAAP-based results can be found in the 10-Q.
This call is being recorded and recording is the property of Erie Indemnity Company. It may not be reproduced 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 PM Eastern time. Your participation on this call constitutes your consent to recording, its publication, webcast and broadcast and the use of your name, voice and comments by Erie Indemnity. If you do not agree with these terms, please disconnect at this time.
With that, I'll now turn the call over to Terry.
Thank you, Scott, and good morning, everyone. Indemnity's third quarter 2013 results were impacted by three primary factors, strong management fee revenue, higher operating expenses and lower investment income. Combined, these led to net income for the quarter of $0.87 per share compared to $0.96 per share last year.
Today I will discuss our topline growth and operating expense trends. I'll then provide an update on our current geographic expansion strategy. Then Marcia will discuss our financial results in more detail.
In the third quarter, Indemnity continued to see strong topline growth, achieving a 9.6% increase in the direct written premium of the property and casualty group. We were able to grow in all major lines of business, as we increased both the number of policies enforce and the average premium per policy. Our retention also remains healthy at 90.7%.
Looking at our operating expense trends, the most significant factor during the third quarter was an increase in the projected expense for agency bonus program. This bonus program rewards our agents for growth and profitability related to their book of business over a three-year period of time. As a strategic tool, the bonus program aligns the interest of our agents with the goals of our insurance entities to achieve profitable growth over the long-term.
The property and casualty group's strong growth in direct written premium and underwriting profitability year-to-date has caused us to increase our projected program expense. As a reminder, last year the projected bonus payout to our agents decreased during the third quarter due to the severe weather losses experienced by the property and casualty group.
Geographic expansion is an important component of our overall growth strategy. In that regard, I am pleased to announce that we are expanding the property and casualty and life insurance operations of Erie Insurance Group into the Commonwealth of Kentucky by early 2015.
Kentucky will be a valuable addition to our footprint, becoming the 12 state, serviced by our network of independent agents. The state offers an attractive growth opportunity for Erie and our agents. With our footprint probably surrounding Kentucky, we will be able to provide a growth opportunity for our most effective and loyal existing agents from those bordering states.
With the expansion in Kentucky, we will leverage our existing resources and expertise in sales management, underwriting and claims, to effectively support writing and servicing this new business. We look forward to bring in our above all-in service brand to the consumers in Kentucky.
Before I turn the call over to Marcia, I'd like to welcome a new member of Erie's executive team, Sean McLaughlin. As I mentioned last quarter, Sean joined Erie as our new Executive Vice President, Secretary and General Council. Sean brings an impressive background and valuable skill set to Erie, having most recently served as Chief Judge for the U.S. District Court for the Western District of Pennsylvania.
With that, I'll now turn the call over to Marcia to review our financial results.
Thank you, Terry, and good morning, everyone. As Terry mentioned, while topline growth has remained strong, higher operational expenses and lower investment income are impacting the overall financial results.
Our net income was $0.87 per share in the current quarter compared to $0.96 per share in the prior year quarter. This reflects a decrease in both management operations income and investment income. Our management operations pre-tax income totaled $60 million compared to $66 million in the third quarter 2012.
Revenue from our management operations grew $28 million to $341 million in the third quarter. This represents a 9.2% increase over the prior year period and is consistent with the 9.6% increase in direct written premium of the property and casualty group.
With the help of our independent agents, we delivered policy enforced growth of 4.7% and nearly 5% increase in year-over-year average premium per policy. Even with the rate increases we've been taking, our 90.7% retention is exceptionally strong. Equally important, we are also attracting new customers, delivering nearly 22% increase in new business premium.
Turning now to our expenses for the quarter. Our cost of management operations grew $34 million to $281 million. Commission expense increased $24 million, up 14.4% in the third quarter compared to last year. This increase is the result of base commission growth from direct written premium and an increase to projected agent bonuses.
As Terry stated, the strong growth in our book of business and the property and casualty group underwriting profitability year-to-date has caused us to increase our projected payout for agent bonuses.
Non-commission expenses increased $10 million compared to the prior year quarter, reflecting increased acquisition related expenses for new business growth and an increase in personnel related expenses. The overall expense increase reduced the gross margin for management operations from 20.9% in the third quarter of 2012 to 17.7% for the third quarter of 2013.
Indemnity's investment income decreased $2 million for the quarter to $10 million pre-tax. This decrease is attributable to lower net realized gains and lower earnings on our limited partnership investments.
Now, let's look at our results for the first nine months of 2013. Indemnity's net income totaled a $127 million compared to $113 million for the same period last year. On a per share diluted basis, net income was $2.41 per share compared to $2.43 per share for the prior year.
In our management operations, income before taxes decreased $3 million to $168 million. The gross margin for management operations for the first nine months of 2013 was 17.1% compared to 18.8% for 2012.
As we discussed last quarter, 2012 commission expenses included a $6 million commission adjustment. Excluding the adjustment, the gross margin would have been 18.2% for the first nine months of 2012. Indemnity's investment income dropped $1 million to $25 million for the first nine months of 2013 due to lower levels of realized gains.
Turning to our stock repurchase program. During the third quarter, the company repurchased approximately 76,000 shares of our outstanding Class A common stock at a total cost of $5.7 million. As of September 30, 2013, we have approximately $47 million of repurchase authorization remaining in our program.
And now, I'll turn the call back over to Terry.
Thanks, Marcia. Before we get to your questions, I am very proud to announce an important recognition we recently received. In September, Erie was named by J.D. Power and Associates, as highest in customer satisfaction with small business commercial insurance.
In this study, the first of its kind in the small business sector, Erie ranked highest in the factors affecting customer satisfaction, interaction and policy offerings. Erie agents played a key role in running our score for interaction, which far outpaced every other competitor and for policy offerings, which small business owners indicate are a leading reason for staying with their insurer.
We're delighted to be the first insurance company to be recognized by J.D. Power and Associates for both our personnel and commercial platforms. A vital component in that success is Erie's unique relationship with their agents, which provides a strong platform for long-term profitable growth.
And now, I'll turn the call back over to the operator to open the line for questions.
(Operator Instructions) The first question is from Adam Klauber of William Blair.
Adam Klauber - William Blair
Couple different questions. Could you talk about, how is the rollout of the underwriting systems going, number one. And how should we think about that from an expense standpoint next year?
I think the rollout which has been multiyear rollout is going well and has picked up momentum in 2013. Clearly the DS-Pro system that is our personal lines platform has continued to grow in terms of its capability. It's handling new business very effectively across a multitude of products now. It's in all of our jurisdictions. And so I think that what you're seeing is, again, our total value offering is being well received based upon the kind of growth we have in new business and our overall retention rate.
The commercial lines platform, which is called the C-line has again begun to build momentum in terms of a smaller product offering, then it's not over the entire platform as of yet, but is gaining acceptance and the agency plant is getting familiar with it and beginning to embrace it. And so again, I think looking at the results we have in terms of our ability to write new business commercially and to retain that business, again it's a nice addition. And it will continue to be more important in 2014, on both sides.
We also have a very effective platform for our life insurance business that hasn't gotten much play, but I think is one of the strongest state-of-the-art platforms in the marketplace and it is serving us well in the life insurance business. We will continue to invest in those platforms. I think that it is imperative that we do so both in terms of making sure that we maintain our competitive edge and it is quite frankly a good time to do so. I think we've got a strong capability to do so.
And we will invest in that business as we roll further products into the commercial lines platform. There are opportunities to continue to add competencies, and I'll call the front-end of the personal lines system more user-friendly. And the other thing that we're just spending money on is again continuing to build, I'll call it, pricing sophistication that requires technology that may not be as obvious to the consumer or the agent or the investor, but we're spending money there also. And again, that's a never ending journey as we look to make sure that we have pricing schemes that are effective in terms of picking the right customer at the right price.
Adam Klauber - William Blair
Switching to growth, you're clearly continuing to grow the business nicely. Is there a distinction between your more mature markets, like Pennsylvania, versus some of the newer, smaller markets? Are you growing more in the newer markets or are you just growing really across the board?
As I indicated, we're growing across the board. We've been able to grow market share in every state over the last couple of years in every product line. So I mean that's, just to me, a great testament to, again, the power of our brand when you think about market penetration and place like Pennsylvania or West Virginia.
But clearly we are growing faster in those state that maybe newer, although I will tell you, one of our stronger states is Tennessee and we've been there for a couple of decades. But we just are spending a lot more time understanding the marketplace, putting the right talent in place, dealing with the right agents, and so we're getting some nice growth in those other states.
But we're doing so in a way that we think is effective. I'm the big believer in growth with profit and you have to make sure you balance that and I think we're being able to do that. But there are also pockets -- again, I'm always amazed that there are always opportunities in those more mature states, places like New York and Virginia. And again, part of our marketing capability and part of technology is allowing us to drilldown by county and by ZIP code to find where those opportunities are.
Adam Klauber - William Blair
As far as rates, it looks like across the board you're getting almost five points of rate on most lines of business. When I look at the commercial market, it seems like just overall the market is getting more competitive. When I'm just looking at your accident year for nine months, the weather has been good, so there that's a help, but you're running at 94% accident year in your commercial. As you look to next year, do you think rates will moderate in commercial somewhat?
I wish I could answer that definitively. What I think there still remains a good discipline in the market. I think based upon the realities of what you can drive-off of your asset side of your balance sheet. So I think, while people are interested at in terms of retaining business and growing business, I think there still remains a good underwriting discipline in the industry. I might suggest its more so on the personal line side than the commercial line side.
But I think our sort of market shelf in terms of the smaller commercial business is more resilient in terms of being able to be better served by a brand like Erie in terms of having a agent close to that business owner, with underwriters that know that business, that make individual underwriting decisions, and so I guess, I am confident that we'll continue to get the right rate for the risk and be able to retain the business and grow business.
Adam Klauber - William Blair
And then switching to personal lines, from what we hear in talking with some of the other companies, there's a number of regional companies and some large national companies who have been really looking to fix their homeowners' book and even fix their auto book and that I imagine you've been benefiting from that. Are you seeing any change in that direction or are you still seeing good room to grow in those markets?
I mean, I never know what our competitors are doing, but clearly we think again there is more discipline in that marketplace, better capital allocation by product line across the personal line space, which is I think allowing the industry to price the business more effectively by product and by geography. So I think that's something that we're seeing.
So I do believe that we will still see rate increases in the personal lines space, whether they slowdown, I'm not sure. The good news there also is that you've got an exposure base there that continues to evolve as people buy and sell cars. And even today with the tough economy, they are more homes out there than they were five years ago at every economic strata. And so we're pretty bullish on the personal lines marketplace.
Adam Klauber - William Blair
And then finally, as far as the non-commission expense growth, I think you did a nice job of showing it to grow, it grew $10 million. You mentioned a couple of items that pushed it higher, that's I think around 11% growth. As we think about that next year, not asking for an exact figure, but is it going to continue the run rate that higher or is it potentially it starts coming down?
Again, we continue to invest in our business as we grow. We obviously have needs to continue to support, again our focus on service, which is when we talk about services, its service to the customer, its policy, administration services, its underwriting capability, its actuarial talent. And so we have invested in those platforms to make sure that we don't overrun our growth.
So again that's one thing we're very, very cognizant to make sure that we have the platform to be able to service this new business, to be able to service the renewal book of business. So we have added staff across those areas that I've just discussed. I would like to believe that we can run a prudent business in '14 and beyond that will make sure that we are in effective operation from expense standpoint as well as investment standpoint.
I would now like to turn the conference back to Mr. Beilharz for any further remarks.
Janine, do you first want to see if there's no more questions. If there's no more questions, thanks again for joining us. We appreciate your participation and the questions. Recording of this call will be posted on our website, erieinsurance.com after 12:30 PM Eastern Time today. If you have any additional questions, please call me at 814-870-7312. Thank you.
Thank you everyone, for your time. Have a good day.
Ladies and gentlemen, thank you for participating in today's program. This does conclude the presentation. And you may all disconnect. Everyone, have a good day.
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