Erie Indemnity's CEO Discusses Q4 2013 Results - Earnings Call Transcript

Feb.28.14 | About: Erie Indemnity (ERIE)

Erie Indemnity Company (NASDAQ:ERIE)

Q4 2013 Earnings Conference Call

February 28, 2013 10:00 AM ET

Executives

Scott Beilharz – VP, Investor Relations

Terrence W. Cavanaugh – President and CEO

Marcia A. Dall – EVP and CFO

Analysts

Jeffrey S. Halis – Tyndall Management LLC

Ron D. Bobman – Capital Returns Management LLC

Operator

Good morning and welcome to the Erie Indemnity Company Fourth Quarter 2013 earnings conference call. I would like to introduce Scott Beilharz, Vice President of Investor Relations, and our host for today's call. Please go ahead.

Scott Beilharz

Thank you, Danielle, and welcome everyone. We appreciate you joining us. On today's call, we'll discuss our fourth quarter 2013 results and matters related to the company's fourth quarter and full year 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-K filing with the SEC, dated February 27, 2014 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-K.

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.

Terrence W. Cavanaugh

Thank you, Scott, and good morning, everyone. In 2013 our focus was on execution. On driving the initiatives that we put in place over the last few years, in terms of products, processes, technology and talent development. The result and the intent, was to strengthen the connections we have with our agents, our customers and our employees.

During 2013, the Exchange reached the milestone in direct written premium of over $5 billion and a record high of $6.5 billion in surplus. Throughout 2013, we were able to grow in all major lines of business, by increasing both policies in force and average premium per policy. We are proud that our retention remains strong at 90.6%. The Exchange’s strong top-line growth helped drive gains and Indemnity’s net income and earnings per share.

Indemnity's net income per share increased from $2.99 per share in 2012, to $3.08 per share for 2013. Our success is fueled by top-line growth and our ability to conduct our business efficiently.

Success wouldn’t be possible without our team. Our agents who connect with our customers and sell our value proposition every day and our employees who provide superior service to our customers.

We take these connections very seriously at Erie, whether it's the support we give to our agents, the product and services we provide to our customers, or the dedicated presence we have in the communities we serve.

With that, I'll now turn the call over to Marcia, to review our financials.

Marcia A. Dall

Thank you, Terry, and good morning, everyone. Today I’ll review the results for the fourth quarter and the full-year 2013. First let’s look at our fourth quarter results.

After tax net income for the quarter was $36 million compared to $30 million for the same period a year ago. On a diluted share basis, net income was $0.67 per share in the current quarter compared to $0.56 per share in the prior year quarter. This reflects an increase in income from both management operations and investment operations.

Revenues from our management operations grew by $26 million to $309 million in the fourth quarter. This represents nearly 9% increase over the prior year period and is consistent with 9.5% increase in direct written premium achieved by the property and casualty group.

The growth in direct written premiums for the quarter was the result of a continued strong policy retention rate of 90.6%, and 11% increase in new business policies and nearly 5% increase in the average premium per policy.

Turning now to our expenses for the quarter, our cost of management operations grew by $19 million to $268 million. Commission expense increased $14 million and nearly 9% primarily driven by the increased premium generated by the property and casualty group.

Non-commission expenses increased $5 million [or] [ph] 5% due primarily to personnel cost. These include increases in pension and medical expenses, and an increase related to the incentive plan compensation cost.

Pre-tax income from management operations totaled $41 million compared to $34 million in the fourth quarter of 2012. Indemnity's investment income for the quarter, increased by $3 million to $13 million pre-tax. This increase was due to favorable results from limited partnership investments.

As Terry mentioned, Indemnity’s net income per share increased from $2.99 per share in 2012 to $3.08 per share for 2013. For the year, Indemnity benefited from an increase in its income from both management operations and investment operations. Pre-tax income for management operations in 2013 totaled $209 million, compared to $205 million in 2012. Excluding a $6 million adjustment related to North Carolina Reinsurance Commission, 2012 income from management operations would have been $199 million.

The increase in income from management operations was driven by $109 million or 9% increase in revenue, reflecting the strong top line growth in the Exchange’s direct written premium. Contributing to the Exchange’s overall premium growth was a 4.8% increase in total policies in force and a 4.5% increase in average premium per policy.

The increase in direct written premium also benefited from a strong 90.6% retention rate, a double-digit premium growth from new business. Management operation expenses for the year grew $105 million or 11% overall. Indemnity’s commission related expenses grew $75 million or 12% primarily as a result of growth in premium and 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. Indemnity’s non-commission expenses grew $30 million or 8.6% in 2013. This increase is primarily due to growth in new business and increased personnel cost. The increase in personnel related expenses reflects higher projected incentive awards and increased costs related to our benefit program.

Turning now to capital management, Indemnity has consistently paid dividends since 1933. Last year, our financial performance and the strength of our balance sheet enabled us to return nearly $84 million in dividends to our shareholders. In December 2013, our Board approved a 7.2% increase in a regular quarterly cash dividend of the Class A and Class B shares.

We also continued our stock repurchase program in 2013. During the fourth quarter, the company repurchased approximately 142,000 shares of our outstanding Class A common stock at a cost of $10 million. For the full year 2013, we repurchased approximately 432,000 shares at a cost of $31 million. As of February 14, 2014, we had approximately $32 million of share repurchase authorization remaining in our program.

And now, I’ll turn the call back over to Terry.

Terrence W. Cavanaugh

Thanks, Marcia. I mentioned that 2013 was a year of strong execution. We remain focused on the strategic products, processes and capabilities we’ll need in order to continue our momentum in the marketplace. Our multiyear business strategy focuses on four key priorities. First, we are working to enhance the overall experience between our agents and customers. Our agents are the critical link between Erie and our customers, and these connections are the strategic advantages that differentiate our service, our company and our brand.

Second, our strategy is to continue to expand our product offerings, allowing our agents to remain competitive and relevant in the marketplace. The third component of our strategy is our commitment to service. Being above all in service means always reaching higher. We must continue to identify how services needs are changing and what consumers expect from their insurance company. We look to reinforce value with every interaction, and deliver a best-in-class service experience.

The fourth and final component to our strategy is geographic expansion. As we announced in the third quarter, we plan to begin operations in the Commonwealth of Kentucky by the first quarter of 2015 or earlier is possible.

These four key priorities will ensure that our overall strategy is successful for our agents, our customers and our shareholders.

Finally, I would like to close my comments by recognizing the passion of Lucian Morrison. Lucian became a Director of Erie Indemnity in 2006 and served with distinction on several committees during his time with us. The entire Board and management team mourns his death. His intellect, business skill and humor will be missed by the Erie Family. We extend our condolences to Lucian’s wife Nancy and their family and friends.

And now I'll turn the call back over to the operator, to open the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions) And our first question comes from Jeff Halis from Tyndall Management. Please go ahead.

Jeffrey S. Halis – Tyndall Management LLC

Hi Terry and Marcia. Good morning. A question about expenses. In 2003 non-commission expenses as a percentage of management operation revenues was 19.6%. Five years after that, the year that you took charge, 2008, it had risen to 26%. In this past year it had risen to 29.1%. This ongoing pattern suggest to me either a significant deterioration in the business model or significant failures by management. If the cause is a deterioration in the business model, could you describe the changes so that we can consider the future implications?

Terrence W. Cavanaugh

I would not characterize it as a change in business model, it’s more a recognition of how the industry is evolving and changing along with the consumer demands. So, I suggest that over that period of time many industries have changed and I think the insurance industry has been one of those. And I think we as a successful participant in that industry have been able to recognize those changes and they would revolve around aspects of producer compensation, technology.

Jeffrey S. Halis – Tyndall Management LLC

This obviously don’t include commissions.

Terrence W. Cavanaugh

I’m just trying to broaden the conversation to talk about that, what we consider the value model that we bring to the agents and to the consumer. Clearly, technology has been a big player in this. We continue invest in our people platform. Again, this focus we have on service is unwavering and I would suggest that the consumer needs to have more capability in terms of being able to be comfortable and confident with their insurance provider. And so we are spending money around that. I would suggest again, whole world of benefits continues to expand in terms of issues of medical and other aspects of engaging our employees. We have variable compensation in there in terms of again that is not tied to the agency compensation, but again as we continue to grow unit count and attract new customers, we have significant cost there in terms of being able to acquire that business as it relates to surveys and other underwriting tools that we utilize. And so I do recognize that number has grown, but I think again overall we run a successful business.

Jeffrey S. Halis – Tyndall Management LLC

Well, Terry, it's not a question of whether you run a successful business, it just seems meaningfully less successful than it used to be. I think you've always had a great reputation for service and more than 50% increase in the relative share of non-commission expense also represents an actual doubling of the non-commission expense. That can’t continue and the company remain profitable and successful. So, I guess I still don't understand enough about why it went up so that I can understand whether it's going to grow another 50% in the future?

Terrence W. Cavanaugh

Again I can’t speculate on what the demands of the marketplace will be going forward, in terms of where we need to invest in our business to remain a good value proposition for our distribution force and for our customers.

Jeffrey S. Halis – Tyndall Management LLC

So you think a 50% increase in expense is relative to revenues in a 10 year period represents sound management policy in the context of the existing marketplace?

Terrence W. Cavanaugh

I think in a question like that, you got a look at again the specifics of the industry, what’s taken place. I can’t I guess at this point time look at what the platform look like in 2003, and necessarily….

Jeffrey S. Halis – Tyndall Management LLC

Okay, in 2008 when you took over it's I think a 10% or 11% relative increase in five years.

Terrence W. Cavanaugh

Yes, it has been. And I would suggest that, I think we have done a lot over the last five years to create a business that is reflective of the kind of business success we are having in the marketplace. I think we’ve been prudent, but also I would suggest we’ve been proactive in investing in areas that we think we will continue to provide value around again sound actuarial science in terms of marketing, capability that we brought to our agents whether it be more effective and tighter financial controls, stronger legal presence. And so all these things that I think they are necessary to run a business effectively we have invested in over the last five years.

Jeffrey S. Halis – Tyndall Management LLC

Do you think Erie was unsuccessful five years ago and that had lower cost structure?

Terrence W. Cavanaugh

Was it more successful five years ago?

Jeffrey S. Halis – Tyndall Management LLC

No. Was it unsuccessful, when it had the lower cost structure?

Terrence W. Cavanaugh

Well, again it’s just one aspect of the business. Five years ago it was also – It hadn’t grown in three or four years. It had a major underwriting issue before that time. And so again I would suggest that an investor needs to look at the totality of our business and in any one time they’re going to be things you can look at, but I guess may concern you. But I think we are very comfortable that we’re doing the right thing with our dollars to run a business effectively today and more importantly to run a effective business tomorrow.

Jeffrey S. Halis – Tyndall Management LLC

Well, when you say look at the totality, you cited the earnings per share reflecting significant buybacks. In 2013 it was $3.08, 2012 it was to $2.99, 2011 it was $3.08, 2010 is $2.85. Is that successful growing business?

Terrence W. Cavanaugh

I think again in terms of again growing the business for all the constituencies I thing we are satisfied that we are doing well, in terms of being – I make sure all of those constituencies, the agency, the customer, the employee and the shareholder are effectively rewarded.

Jeffrey S. Halis – Tyndall Management LLC

Is that listing the shareholder last – the listing that you think about because it doesn’t seem like the shareholder was very rewarded in the last three or four years?

Terrence W. Cavanaugh

I’m sorry you feel that way. Again, we do spend time worrying about and making sure that the shareholders are rewarded. I will tell you that I think the return that we’ve been able to create economically over that period of time has not been insignificant. And I do spend time worrying about again, I’ll call it, the engine that drives shareholder value on a daily basis, we’ve got to do the things that are effective for our agents, for those people that choose to do business with us. We spend time very much worried about the consumer in terms of again, their choice to choose us as their insurance carrier and then how we respond to their needs when a claim occurs.

Jeffrey S. Halis – Tyndall Management LLC

I just want to be clear. so you are giving no indication that the expense level, which is that a peak in 50% higher than it was 10 years ago, will ever go down and it might go up from where it is today.

Terrence W. Cavanaugh

I did not give that.

Jeffrey S. Halis – Tyndall Management LLC

I just want to be clear that you’re not giving any indication of reduction.

Terrence W. Cavanaugh

I’m not giving any indication one way or the other.

Jeffrey S. Halis – Tyndall Management LLC

Okay, which means no indication of reduction. Well, I’ll let some ask – also ask some questions.

Operator

(Operator Instructions) And our next question comes from Ron Bobman from Capital Returns. Please go ahead.

Ron D. Bobman – Capital Returns Management LLC

Hi, thanks for the opportunity. I just – obviously, expense management has come up I think at least a couple of times in the most recent calls. And I do think given the trend – the historical run rate of expenses – that it would be prudent and very reasonable for – if it’s not this call, it’s the next call, that you give us some expectation for expenses.

Now, I’m not asking you to look three, four, five years out, but surely you’ve got a business plan for the next 12 and maybe 24 months. And it is what it is. I’m not challenging the trend line, but we would appreciate some sort of insight as to whether you think this current relationship on a percentage basis of non-commissional expenses is going to sort of be at this level, is going to top out or requires additional expense. And it’s – we’re not asking for, I think you used the word crystal ball. but if you could give us some guidance at some point and some point soon, that would be appreciated. Thanks and best of luck.

Terrence W. Cavanaugh

Thank you very much for the input.

Operator

Thank you. And I’m not showing any further questions at this time. I would like to turn the call back to Beilharz for any further remarks.

Scott Beilharz

Thank you, Danielle. And as there are no more questions, thank you again, for joining us. We appreciate your participation and questions. A recording of this call will be posted on our website, erieinsurance.com after 12:30 P.M. Eastern Time today. Our 2014 Annual Meeting of Shareholders is scheduled for Tuesday, April 15 at 9:30 A.M. Eastern Time at our corporate headquarters in the Erie, Pennsylvania. If you have any additional questions, please call me at 814-870-7312. Thank you.

Operator

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude today’s program. you may all disconnect. Everyone, have a great day.

Terrence W. Cavanaugh

Thank you very much for your interest.

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