Donegal's CEO Discusses Q4 2013 Results - Earnings Call Transcript

| About: Donegal Group, (DGICA)
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Donegal Group Inc. (NASDAQ:DGICA) Q4 2013 Results Earnings Conference Call February 21, 2014 11:00 AM ET


Jeff Miller - Chief Financial Officer

Don Nikolaus - President and CEO


Vincent DeAugustino - Keefe, Bruyette & Woods


Good morning. My name is [Brandy], and I will be your conference operator today. At this time, I would like to welcome everyone to the Donegal Group Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions)

Thank you. Mr. Jeff Miller, you may begin your conference.

Jeff Miller

Thank you. Good morning, everyone. Welcome to the Donegal Group conference call for the Fourth Quarter and Year Ended December 31, 2013. I am Jeff Miller, Chief Financial Officer, and I will begin today’s call by discussing highlights of our quarterly and full year financial results. Don Nikolaus, President and Chief Executive Officer, will then provide additional commentary on our results and provide an update on our business trends and developments.

Please 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. We refer you 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 statement is included in our 2012 Form 10-K which is available on our website under the SEC filings link. We plan to file our 2013 Form 10-K within the next few weeks.

Reconciliation of non-GAAP information as required by SEC Regulation G was provided in our news release which we have also made available in the Investor section of our website.

Turning to our fourth quarter results, we were pleased to report a 54% increase in net income and a 95% increase in operating income. We achieved solid underwriting results for the quarter, producing a 95.4% statutory combined ratio and a 94.9% GAAP combined ratio.

Earned premiums grew by 9.2% in the fourth quarter, contributing to our higher earnings and providing ongoing evidence of the success of our business plan and growth initiative. We achieved net premiums written growth of 7.9% for the quarter, which we attribute to premium rate increases in nearly all of our business lines, as well as commercial lines new business growth and additional premiums retained by Michigan Insurance Company as a result of the reinsurance change we discussed throughout 2013.

Let’s review some of the loss trend details for the fourth quarter, beginning with weather losses, we incurred $4.6 million of weather-related losses during the fourth quarter, that was in line with the prior year fourth quarter and slightly lower than our average fourth quarter amounts for the previous five years.

We had no significant impact during the quarter from any PCS designated catastrophe events in our operating areas, but we did experience an increase frequency of auto collision losses from localized winter storms in December.

Large fire losses totaled $6.3 million for the quarter, that amount was in line with the prior year quarter as well with $4.4 million in our homeowners line of business and $1.9 in our commercial property line.

Our personal lines combined ratio of 99.3% represented significant improvement over the prior year quarter. Once again benefiting from rate increases we have taken and generally favorable weather conditions.

Our commercial lines combined ratio was an excellent 89.4%, even with an uptick in the commercial auto combined ratio as a result of the higher number of weather-related collision losses.

Our workers compensation line of business performed well posting an 86.4% combined ratio. We had incurred a number of unusually large claims in the fourth quarter of 2012 that drove up the combined ratio last year. We were pleased to see that significant improvement. Prior accident year loss reserve development added a modest $800,000 to total losses in the quarter, compared to $1.9 million for the prior year quarter.

In summary, our statutory and combined -- GAAP combined ratios were the lowest quarterly combined ratios we have reported since 2008. The fourth quarter represented a strong finish to a very good year for us, with full year 2013 premiums written growing by 7.4%, a full year statutory combined ratio of 97.4% and overall underwritting profitability in both our personal and commercial insurance segments. Our 2014 business plan seeks to build on these successes and Don, will give more information about that in a moment.

Moving on to the investment portfolio, the year-over-year fourth quarter net investment income comparison is not particularly useful because of 2012 year end expense allocation adjustments. Our fourth quarter 2013 investment income was higher than the third quarter of 2013. So it was trending in the right direction.

For the full year, net investment income was down almost 7%, we feel we are holding our own but as we’ve stated in prior quarters, the low yield environment continues to represent challenge to our ability to maintain investment income.

Today’s release summarized actions we undertook during the fourth quarter to lower the overall duration of our fixed maturity portfolio and to position ourselves for eventual rise in market rates.

We fully recognize that those actions will lessen our investment income somewhat in short-term, but they are intended to soften the potential impact of rate increases on the valuation of our investments and book value. They also should allow us to take advantage of higher re-investment rates as they materialized overtime.

Our book value per share increased to $15.02 at December 31, 2013 from $14.95 at September 30, 2013 as a result of our net income and fluctuations in our portfolio market value. We repurchased 20,000 shares of Class A common stock during the quarter at an average cost of $15.82 per share.

I will now turn the call over to Don for his comments on our fourth quarter results.

Don Nikolaus

Well, good morning everyone and welcome to our earnings conference call for the fourth quarter. Needles to say we are very pleased with the results Jeff has gone through all the details of the 53.8% increase in net income and the significant improvement in both loss ratios and combined ratios.

So we believe that the fourth quarter certainly demonstrates the improvements in underwriting profitability brought about by continued conservative underwriting premium increases over the last two to three years, expense management and reasonable profitable growth.

One of the statistics that we think is certainly meaningful in our commercial lines of business for the fourth quarter. The combined ratio came in at 89.4% compared to the prior year of 95% and personal line came in at 99% compared to 108% in the prior year. Needles to say these are certainly very helpful statistics.

On the standpoint of some of the other achievements in 2013 fourth quarter and coming into 2014, in the fourth quarter, we appointed 21 new agencies for a total of 101 for the year 2013. As you know, we look to continue to grow our distribution system and probably the most important part is that we want to grow a higher percentage of the business that we attract from each given agency relative to the book of business that they have to offer.

On the rate increase side and everyone is generally always interested in that. Commercial renewals, we continue to average about 5% to 7% as the average increase of course that depends upon the particular state and so forth but we believe that’s very positive. We are optimistic that we can continue that as we move forward into 2014.

In personal lines, we have our usual rate analysis on an ongoing basis by product line in each state and we continue to file low-to-mid-single digit increases depending upon the state and product line and that we would be hopeful that that environment we continue going forward. Although we can't say that in commercial lines that there is anywhere near a hard market, we do continue to see the opportunity for premium increases which we think continues to be a positive trend.

Also in the commercial area as we have indicated in prior calls, we continue to rollout commercial lines in the various states where we gained access as a result of making acquisitions where those companies were primarily in personal lines. We have made strides in building our commercial presence in those states and to those entities.

Also throughout our operation, we have on an evolutionary basis that’s continued to expand our commercial appetite in terms of size and somewhat complexity. Although relative to many companies, it would be viewed as -- continued to be viewed as sort of a [Vanilla Main Street] book of business but we continue to evolve at which of course opens additional opportunities to us.

As we head into the spring, we begin to do over 28 agency meetings throughout the various 14 states in which we do those and those meetings would involve our primary marketing activity on a collective basis for the New Year and we would have anywhere from 50 agency personnel to maybe as many of the 175 at any one given location.

It's an opportunity for us to present an update agencies on our product what we are certainly emphasizing, give them more updates on technology and certainly many other topics, that was a pretty important part of our marketing and underwriting strategy as we move into 2014.

From the standpoint of our overall business strategy, as we have said many times we continue to have a dual growth strategy by organic growth and also by acquisition. As always, we continued to have our conversation with various companies about the potential for them to affiliate and be acquired. And as you know, that an ongoing process, it’s not something that you just do one day and you accomplish it the next but it continues to be a part of our strategy.

On the technology front, we’re pleased to say that in the end of the year early part of the 2014, we rolled out our Mobile App which gives us a new technology sophistication that policyholders can report claims on their Mobile App, they can pay a bill, they can look at their policy, they can find an agency. Also in 2014, we have launched technology project to install a new billing system and a new rating system, which will further enhance our customer service levels and also speed the market from the standpoint of the new rating system.

Our business strategy of course also continues to be focused on committing to grow book value and enhance shareholder value. And as is demonstrated by the fourth quarter results, we recognize that it is important that we returned the best possible financial results that we can because that's how you grow book value. And ultimately, over a period of time provide shareholder value and enhancements. So we are certainly as a management team, we are committed to that. And we believe our strategy is very much focused on accomplishing that.

So, I will turn it back to Jeff.

Jeff Miller

Hey. Thanks, Doug. Brandy, if you would open the line for questions, please?

Question-and-Answer Session


(Operator Instructions) And we do have a question from Vincent DeAugustino.

Vincent DeAugustino - Keefe, Bruyette & Woods

Hi. Good morning, everybody.

Jeff Miller

Good morning, Vince.

Don Nikolaus

Good morning.

Vincent DeAugustino - Keefe, Bruyette & Woods

So, first, congratulations on the nice finished 2013 in order. And as far as first question, Don, you mentioned the new rating system and I’m just curios how we might think about the potential for there being any segmentation benefit from the upgrade, if that was something that we should think about as being part of that strategy?

Don Nikolaus

Well, let me clarify, we have already installed and are rolling out and probably should have mentioned it, a more sophisticated productive modeling system in our personal lines auto and we are working on similar products for homeowners and commercial lines. What I was specifically referring to was rating from the standpoint of the mechanics behind the scene in terms of, if we are going to have a rate increase, we are going to introduce a new product, how that is all programmed and brought life.

And currently, the current system takes some bit of time for that to be accomplished. And the new system will enable it to be done in a very quick period of time, which will enhance the ability to get rate increases and other changes live in a faster period of time. So there are two separate things from predictive modeling, which we are already in the process and have been rolling out on a various stages.

Vincent DeAugustino - Keefe, Bruyette & Woods

Okay. That’s really helpful. Seems like you have maybe a better calculator but the algorithm behind it is -- you are kind of already working to improve that. So definitely good and just to change gears a little bit. In the press release you had mentioned unfavorable winter weather impact on auto and so just a few questions there from a winter weather standpoint. But first, kind of curios with the poor winter weather, if we might bee seeing some benefit to workers’ comp as the weather conditions might just be preventing some work being done in some of the higher hazard classes like construction. So, I’m just curios if there is anything going on there that we might be looking at?

Jeff Miller

I think there's certainly some dynamic to that as we looked at workers’ comp frequency. They were very favorable. In the fourth quarter, we didn’t see near the number of injuries being reported and certainly the level of severe injuries was down from what we would've seen earlier in year. So, I’m sure, the winter weather would've had some impact on that because there weren’t as many people doing that type of work.

Vincent DeAugustino - Keefe, Bruyette & Woods

Okay. Good. And then just kind of looking at first quarter, Lancaster and York counties in Pennsylvania hit pretty hard. Pennsylvania in general hit pretty hard. I’m just curios if is there any storm that see in the first week of February, just how if you have any initial thoughts on how claims might be coming up through and then just any color that you might have from some of the earlier storms in January?

Jeff Miller

Sure. I will be glad to make some comment on that. Depending on your locality of those who aren’t listening to this call, pretty much nationwide, you've likely been impacted by the very active winter weather pattern that we’ve had since the beginning of 2014.

Certainly the January deep freeze event that has been in the insurance press that has had a widespread impact, actually not just here in our local area, but from the Midwest to the Mid-Atlantic, to the Southeast and many of our peers have already been announcing that this event has generated record levels of water damage claims from frozen pipes. And we are certainly tracking that event as a catastrophe event in all of our regions and have claims that have been rolling in.

We have also had numerous snow and ice storms that have resulted in a higher than usual volume of various types of claims. So it’s been a very active winner so far. It’s really too early to quantify the financial impact to the first quarter because some of those claims are still being reported.

But it’s clear based upon what we’ve seen so far that the level of first quarter weather claims will exceed the average first quarter weather losses that we’ve had for the past five years and that figure is around $7 million on average and it’s clear that we’re going to be exceeding that in the first quarter, but too early really to give a more definite number.

Vincent DeAugustino - Keefe, Bruyette & Woods


Don Nikolaus

Unfortunately, over the next couple of days it suppose to be gradually warming somewhat which should hopefully help to remove some of the snow that’s on rooftops and other similar conditions that hopefully will be helpful in the overall loss process.

Vincent DeAugustino - Keefe, Bruyette & Woods

Okay. And just you guys had mentioned renewal rate increases are holding steady and I feel a lot of advantage in your smaller commercial focus as far as that being sustainable. But if I can play double advocate for a second, I’m curious if you might comment on how we should think about maybe the magnitude of loss ratio improvement going forward. It would be in the pipeline, if we kind of just think about migrating to a rate increase environment within commercial lines that basically only matches loss cost inflation. So, yes, I’m trying to get out is how should we think about rate now the pipeline between non-rate and than rate driven loss ratio improvement potential?

Don Nikolaus

Well, let see if between Jeff and I, we can provide you some color there. Needless to say as we have raised premiums and rates over a period of time, as you everyone knows that it takes time over year, year and a half for it to be earn.

So we would expect that for rate increases and premium increases in commercial that have been taken over the last year to year and a half that we have not felt all of the positive effects of earning that.

And the rate, the premium increases that I would have spoken about in the fourth quarter, needles to say that’s part of the written premiums for the fourth quarter. But we have really not, really earned much of that yet.

So we would be encouraged that we will see benefits from that. We can’t sitting here today quantify because we don’t know the extent of loss activity, but we think that it should continue to be a positive effect.

And I would also remind you that while we have been doing that over the last year and a half to two years and we’ll continue to do that. We have taken the opportunity in this positive environment to make sure that we are riding top quality risk and that there is a combination of factors that we think have been part of improving our loss ratios.

Its not just premium and rate increases, its enhance loss control and its also taking a kind of look at risk that we would potentially say, well, that risk may have changed overtime and therefore maybe we either need to have a significant rate increase or we need to move away from it.

Vincent DeAugustino - Keefe, Bruyette & Woods

Okay. Great. Thank you for the color and look forward to talking to you guys soon.

Don Nikolaus

Thank you, Vincent.

Jeff Miller

Thank you.


(Operator Instructions) And we do have a question from [Ryan Bowman].

Unidentified Analyst

Hi. Thanks a lot. I have a question about on the activist front, which hoping or thinking may have come to a conclusion. I want to say was the proposal or the activist was sort of pursuing which was drawn in the last week or two. From your perspective and where you all sit, do you assume that this sort of saga activity is sort of put to rest now?

Don Nikolaus

Well, let us clarify for u.

Unidentified Analyst


Don Nikolaus

What you would have seen in a recent 13-day that would have been filed by Mr. Shepherd, that he would have withdrawn is Form-A application in the six states in which we have domicile insurance company, which means that he withdrew his application to increase the percentage of share of DGI stock that he could purchase.

He still has pending a shareholder proposal having to do with the dual class voting structure which he has submitted as a shareholders proposal or the proxy that would be sent to shareholders in the month of March. So there is two different pieces to it. The Form-As have been withdrawn the other is still active.

Unidentified Analyst

With respect -- thank you very much for the summary. With respect to this remaining item, this proxy proposal, the dual class? With the mutual substantial holdings, is that a win list, that seem to be a win list proposal, am I missing the new ones to that?

Don Nikolaus

Well, no, you're not missing the new ones to that. Assuming that the mutual company votes its shares against this proposal and they owned 66% of the voting control, your assumption is correct. It's not a shareholder proposal that would pass.

Unidentified Analyst

Okay. Thanks again. So I guess quite obvious as far as a little closer. Best of luck.

Don Nikolaus

Thank you.


And we have a follow up question from Vincent.

Vincent DeAugustino - Keefe, Bruyette & Woods

Thanks for taking the follow-up. It's actually for Jeff on the investment portfolio changes. So just a couple of questions there and the first one would be as just wondering how large of a hit to the investment yield that we should be thinking about with some of the reallocations. And then second, with the reclassification the portion going to held for maturity, I was just kind of see there is a little bit interesting. I'm curious if there is anything driving that other than kind of one into side the mark-to-market impacts from interest rate movements.

And then last if you guys might be able to comment on who the external advisor is and any specifics on the mandate in terms of how there will be running the allocation? And thanks for taking the follow-ups as well.

Jeff Miller

Sure, absolutely. I will be glad to give some more information about that. As the investment committee looked at our portfolios late in the fourth quarter, we decided to do a number of things with the intention of lowering the duration of the portfolio and really positioning ourselves for the likelihood of rate increases in the future and the unlikelihood that rates would go any lower in our estimation.

And what we did was the longer duration securities that were within our portfolio we looked at those and primarily those with municipal bonds. And we thought there will be a dual benefit of lightening that concentration somewhat. So we sold about $34 million worth of muni bonds that were longer duration bonds. They had a yield of around 3.7%, duration about 7.4%. And so we unloaded those bonds and then transferred about a third of our remaining portfolio into held-to-maturity.

The thinking behind that was that we thought it would be prudent to match the accounting treatment of those bonds with our intent. And our intent was that we would hold them to maturity and we classify them as available for sale simply to give us maximum flexibility.

But it didn't makes sense to us that we would put ourselves in a position where we might incur a further declines in book value related to interest rate movements in the market on that portion of the portfolio when we clearly intended to hold that to maturity. So with the effort to match up the accounting treatment with our real intention.

And what that did was, our available for sale bonds that remained have a duration of about 3.1 years and our held-to-maturity portfolio as a duration of about 7.3. So you can see that basically what we did was move to higher duration bonds which are higher yielding bonds into that held-to-maturity classification.

On the outside investment, manager is an investment manager from Texas by the name of Sage Advisory and they specialized in fixed income, management and have been successful in managing money for other insurance companies. We were introduced to them by a local broker and we're impressed with their track record and abilities and saw that would be helpful to get another perspective from someone who is in that fixed income market everyday. And so we have allocated a fairly modest portion of our portfolio of $50 million that we've given to them to invest in fixed maturity investments.

And the parameters we've given to them, whether they were not to invest in municipal bonds to any greater extent because we already have that concentration. But we are looking to them to invest primarily in BBB-rated corporate bonds to increase that allocation within our portfolio. I don’t know if, Don wants to give any further commentary on that but that was kind of the thinking behind it.

Don Nikolaus

No, I think you've done a very good job of the overview of that. I would only add that we clearly researched the record and expertise usage and we were impressed with it. And in addition to some of the corporates, that they will be investing in and it's also other categories, agencies and mortgage-backed securities. And so we are -- at this point, we are pleased with the work that they have done.

Jeff Miller

I’m seeing no other questions in the queue. Let me just make a comment here related to our reinsurance renewal for 2014, because that will be relevant as we go into the first quarter. We were pleased to renew our external reinsurance program for 2014 with favorable terms compared to what we had in place for 2013. We were able to reduce our reinsurance premium cost, while also adding some additional coverage to further reduce our exposures in several areas of the program.

And as a result of that favorable renewal, we've made some revisions with Donegal Mutual agreements with our insurance subsidiaries, and the net effect of those revisions is to decrease our insurance subsidiaries potential exposure to catastrophe loss events with the magnitude of that decrease varying by subsidiary.

I would also want to mention that similar to the last two years, we have executed a reinsurance change for 2014 for Michigan Insurance Company to once again reduce the level of quota share reinsurance with external parties. We are reducing that percentage to 20% in 2014, and you will that remember that was 30% in 2013. So, we'll see a similar financial impact in 2014. It was adding around $10 million to our net premiums written for the year, which is above any growth that we get from the new business or rate increases. So, I just want to give that quick update.

I’m seeing no other questions in the queue. I think we're ready to wrap up the call. Thanks everyone for your participation today.

Don Nikolaus

Yes, thank you for participating. Have a good day.


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

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