Donegal Group Inc.
Q2 2021 Earnings Call Transcript

Published: 28 Jul 2021

[Operator:]

Good day. Thank you for standing by. Welcome to the Donegal Group Inc. Second Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker’s presentation there will be a question-and-answer session. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to Mr. Jeff Miller. Thank you. Please go ahead.

[Jeffrey Miller:]

Thank you very much. Good morning and welcome to the Donegal Group conference call for the second quarter ended June 30, 2021. Yesterday afternoon, we issued a news release outlining our financial results. For a copy of that release, please visit the Investor Relations section of our website at donegalgroup.com. In addition, we have made available a supplemental investor presentation on our website.

[Kevin Burke:]

Thanks, Jeff, and welcome, everyone. We are pleased to report solid underwriting results for the second quarter and for the first half of the year, resulting in annualized first half return on equity of 10% that contributed to continued book value appreciation. We achieve top line growth particularly in commercial lines, favorable reserve development, and we continue to make solid progress on our technology and analytical initiatives. For the second quarter of 2021 we reported net income of $16.2 million or $0.53 diluted share of our class A common stock, net premiums written increased 8.2% and our second quarter combined ratio is 96.1%. Comparisons to prior year quarter results are somewhat challenging given that all aspects of our business were impacted by the pandemic and related shutdowns throughout the country during that period. We are pleased that our results for the first half of 2021 represents significant improvement from pre-pandemic periods. Starting back in 2017 we made several significant changes to improve our profitability including a shift of our mix of business towards commercial lines where we believe we will continue to have opportunities to obtain profitable growth through our independent agents. Our organization navigated the challenges of 2020 successfully, thanks to the professionalism and dedication of our employees. We also leaned on the independent agency relationships that we have built and cultivated in some cases over several decades.

[Jeffrey Miller:]

Thank you, Kevin. As is my usual practice I'll provide some additional color on our financial performance for the second quarter. Beginning with net premiums written we reported an 8.2% increase to $209.6 million, with commercial lines representing approximately 62% of the total and personal lines representing approximately 38%. The inclusion of Mountain States Premiums which represent entirely commercial business has contributed to the ongoing shift toward a higher percentage of commercial business in our product mix. As Kevin mentioned, we expect new personalized products will begin to stabilize that segment beginning in 2022. Kevin also highlighted that commercial lines grew by 19.9% to $129 million led by commercial multi-peril growth of 26.7%. Overall, commercial growth included $10.7 million of Mountain States Ppremiums that were added to the pool business allocated to Donegal Group representing roughly half of the commercial growth for the second quarter. Factors driving organic growth included a steady flow of new business submissions, strong premium retention and renewal premium increases averaging 6.8% for the commercial segment or 8% excluding workers compensation. The commercial lines premium retention rate was 90% for the first half of 2021. We're continuing to achieve substantial commercial auto rate increases excluding the impact of no fault reform in Michigan, those rate increases averaged approximately 11% for the quarter. We've also been achieving higher renewal premium increases in our commercial multi-peril line of business, which averaged around 5% for the second quarter up from low single digits in the first quarter. While we were pleased to report growth in every commercial line of business we continue to closely monitor the underwriting results that segment is generating. The commercial line statutory combined ratio of 94.3% compared favorably to 99.3% for the first quarter of 2021 and was only modestly higher than 93.5% for the prior year second quarter which reflected lower claim activity due to the pandemic. There were a number of moving parts within the favorable commercial performance for the second quarter of 2021. Lower weather related losses were generally offset by higher large fire losses compared to the prior year quarter. Increases in claim activity relative to the prior year quarter were generally attributable to the resumption of economic and driving activities offset partially by favorable reserve development on claims incurred in prior years. We experienced favorable development across all commercial business lines but it was heavily weighted toward workers compensation where we benefited from favorable claim settlements as courts reopened and our claims personnel were able to bring cases to closure within the reserves we established. Those were primarily claims from accident years 2017 through 2019. the workers compensation development was quite a bit higher and then in the second quarter of 2020, but very comparable to the second quarter of 2019.

[Kevin Burke:]

Thanks, Jeff. Let me conclude our prepared remarks by stating we are only now beginning to benefit from the significant operational strategic changes we have implemented over the past three years. We are making solid progress on a number of critical inflight initiatives. We will continue to invest in additional technology and analytical capabilities to further enhance our underwriting and claims processes, enhance customer service capabilities, and operational efficiencies. We will enhance shareholder value by gradually expanding our premium base to provide additional scale, focusing on quality underwriting, and rate adequacy to maintain and improve our profitability, building on our excellent agency relationships to provide additional opportunities, to increase market share, and refining our marketing and underwriting strategies to maintain and enhance our position within our regional markets. At this time, we will ask the operator open the lines for any questions that you may have.

[Operator:]

And your first question comes from the line of James Inglis with Philo Smith.

[James Inglis:]

Hi, good morning, guys. Two unrelated questions. One is, can you tell me what's your thought process about how the company will look in sort of a post-COVID world as to the work environment? And secondly, what effect that might have on an expense ratio and/ or loss ratio, potentially as well I guess.

[Kevin Burke:]

Jamie, good morning. Thank you for the question. The first part of that will address in terms of what does Donegal look like post-COVID. Donegal, like many organizations is working through that right now and as I came in to the office this morning, there were more employees here in the home office than I've seen in the past year to 18 months. So we're delighted that we've got more employees coming back into the office. We really started the process in June, very gradual and bringing employees back. Our goal is that by the end of September that we will have a higher percentage of our employees back into the work environment. Donegal has always been a very what I'll categorize as a traditional office work environment. Majority of our employees were working here in the office. But COVID has really caused us to take a step back. Operationally we did extremely well in 2020. And so we see that there are opportunities to create hybrid work environments for employees. So we've got employees that are here, a couple days a week and also working from home. We've also really evaluated those employees that operationally have been very, very efficient working from home. And in those cases, those employees will continue to work from home. In terms of the second part of that, what does it do from an expense ratio standpoint, I think that's to be determined. I would hate to see that we're going to see some reduction or we don't need office space. I think that would be premature. But I do think that the Donegal organization from an office setting standpoint will have a different look to it for the second half of this year. And I've always held to the point that as long as operationally we are hitting the mark then we should remain flexible and open to make sure that we're providing the best and safe, safest environment for our employees.

[James Inglis:]

Okay, great. The other question that sort of a broader one is, with the potential state auto acquisition do you think there is any potential positive might come about as a result of that for you guys?

[Kevin Burke:]

Well, I appreciate the question. We have received several inquiries from stockholders following the recent announcement of the transaction with state auto financial which has a similar mutual company downstream holding company as ours. Recognizing that Donegal is the last remaining company with this unique structure may generate some additional questions and candidly that is to be expected. Jamie however, I will say that we are committed to staying focused on achieving and improving our operating results now and into the future. I think it's important to remember that this senior management team officially took control of Donegal in 2018 and we have made tremendous progress in our overall operating results of the company. And given the number of current initiatives that we've highlighted in past earnings calls, all of which are contributing to our current success and equally important our future success. The Donegal senior management team and both boards of directors the Donegal Mutual Board of Directors, as well as the public company Donegal's group board of directors are committed to long term success of our organization, and really wanting to see us execute on many of these initiatives that we have started in the last two to three years.

[James Inglis:]

Jeff, I appreciate that. I must have misstated my question or didn't stated clearly. I meant from an operational point of view, do you think there will be opportunities within the agency world which you operate in and so do they where agents don't want to place so much of their business will ultimately want enterprise?

[Kevin Burke:]

Well, anytime if there is an acquisition, in this case, similar to a state auto and liberty mutual given the size of that transaction, Jamie creates disruption in the marketplace. We would be very cautious in terms of what opportunities might come out of that transaction. But most certainly there will be some disruption in the marketplace.

[James Inglis:]

Okay, well, good luck with that. Thanks.

[Kevin Burke:]

Thank you.

[Operator:]

Our next question is from Meyer Shields with KBW.

[Meyer Shields:]

Thanks. I want to follow up on Jamie's question kind of open ended. Given the progress that you put together is undeniable. So not worried about that. But what are your thoughts on the fact that your operating structure like is now gone I mean, certainly the companies have failed, but we'll see been acquired or taken private. But is there any meaning to the fact that it's just on the side view non-existent right now?

[Kevin Burke:]

Well, I think Meyer one of the things that we need to consider is when we first saw the announcement the first reaction is to the headline. And when you start to look at it, it's very important, I believe, for our analysts, as well as our stockholders to understand that there are a number of very fundamental differences, unique differences between state auto and Donegal in terms of how it's structured, not necessarily a corporate organization, but just from a financial structure standpoint. In fact, it might be worth just going through a couple of bullet points on those just for clarity. Jeff, do you want to talk a little bit about the -- perhaps the surplus or even the ownership of the mutual not to mention the stock option component of this as well?

[Jeffrey Miller:]

Right. So to Meyer's question, certainly we are very similarly structured to state auto and from corporate perspective, but there are some subtle nuances that are somewhat meaningful in terms of the economics as we reviewed the transaction that was recently announced. One is that the mutual company for state auto owned a larger percentage of the economic value of the stock of the public company. The mutual company had a higher relative surplus position as a percentage of the entire enterprise. And we have other factors such as outstanding stock options that are higher than what state auto had. So there is a number of moving parts there and nuances that would impact the economics if you're trying just to do a kind of an apples to apples comparison of what would something like that look like for Donegal group. So yes I guess the reason for saying all that is just to say you can't necessarily make broad assumptions based upon the metrics of a given transaction. There's always very a lot of details that go into any transaction like that. But to your point, Meyer yes, we are the last remaining company that has this structure. That's not necessarily any different from when we were one of two companies that had that structure. We still believe that the structure works well for us. It has, we've tried to utilize that structure to the benefit of all of the various constituents that we serve including the mutual policyholders as well as the stockholders. Certainly there is plenty of debate that we could have as to how that has played out and the impact of the decisions that have been made by other companies that have that structure. But we're currently focused on our business strategy. We think we have a lot of runway ahead of us to continue to improve our results. And that's basically our focus at the current time.

[Meyer Shields:]

Great. That all makes perfect sense. Thanks. Quick modeling question. Is there any way of ballparking the magnitude of the reallocation of loss expense to underwriting expense, and I assume that that continues for the next three quarters?

[Kevin Burke:]

That's a great question and I appreciate the opportunity to kind of clarify that. It is somewhat technical. But let me just kind of walk you through that. As I said earlier, we implemented a new software tool during the quarter, and it was designed to enhance our expense allocation methodology. When in doing that, we determined that the overhead expenses that should be allocated to the loss function and the underwriting function should be done so on the basis of actual salaries for those functions as of June 30. That's similar to the method we had in the past, but we refined it and we updated all of the numbers that formed the base for those allocations as of the end of June. And the result was that we increased underwriting expenses and we decreased our loss expenses meaning that we added to the expense ratio, but with a corresponding reduction to the loss ratio. So no overall financial effect. In terms of the numbers, the impact increased the second quarter expense ratio by about 1.5 percentage points compared to the first quarter of 2021 expense ratio and about 1 percentage point compared to the prior year second quarter. On a year-to-date basis the relative allocation of overhead expenses to the loss function was fairly comparable. The 2021 allocation added about 0.3 percentage points, 30 basis points into the year-to-date expense ratio. So going forward, we don't expect to see that same level of, there won't be an additional reallocation. So the year-to-date expense ratio is a more accurate run rate at the current time.

[Meyer Shields:]

Okay, perfect. That's what I was looking for. Thank you.

[Kevin Burke:]

You're welcome.

[Operator:]

Your next question is from Robert Farnam with Boenning and Scattergood.

[Robert Farnam:]

Yes. Hi, thanks. Good morning. I want to continue the questions that Meyer was addressing with the expense ratio. Can you just kind of give us an idea of how much of that expense ratio was related to the incentive compensation as well? Just trying to figure out how that is trending and where that should be going, going forward.

[A - Kevin Burke:]

Sure, the higher agency incentive compensation accounts for about a 1 percentage point increased over the prior first half. So looking at the first half of 2021 relative to 2020 is about 1 percentage point increase. And like I said, that's based upon our projection of what we would pay out at the end of the year if the experience for all of our individual agents would continue to be as profitable and the growth rates would be maintained. We've talked about the technology project and the impact that has on the expense ratio and that's about 50 basis point addition to our expense ratio relative to prior to the our expense ratio prior to beginning that project. So it's not yet having a real material impact. But the higher agency compensation is definitely a factor.

[Robert Farnam:]

Right. Okay. In terms of the reserve development it sounds like most of it was from workers comp, but you did have some from personal commercial auto. Can you just give us some numbers to back it up and just give us an idea of specifically for the auto pieces what accident years those are coming from?

[Jeffrey Miller:]

Absolutely, yes, this is Jeff again. The $13.4 million of favorable development in the second quarter. That's a, I think, a record high for us in any one given quarter. 6.5 million was in workers compensation and as I mentioned earlier, that's primarily from favorable settlements from 2017 through 2019 accident years. There was some favorable development in the 2020 accident year as well which is kind of similar to what I talked about an auto with the assumptions of higher loss emergence that ended up not coming to fruition. On the commercial auto side of is $2.1 million and that's primarily in the 2020 accident year. And the personal auto was 3.4 million again primarily in the 2020 accident year. Although we did have modest favorable development in the earlier accident years for both of those lines. CMP rounds it out at about 1.1 million and that's again in the 2020 accident year primarily.

[Robert Farnam:]

Okay. So it sounds like you were just about everybody else said you don't have to with how 2020 went had some maybe conservative baking into their numbers just to be safe.

[Kevin Burke:]

Sure. We really didn't know how those patterns were going to emerge, and although frequency was down severity was up, I think, yes we and others were somewhat conservative just not knowing what to expect.

[Robert Farnam:]

Right. And maybe one for Kevin. I know you've got the new personal lines products coming out. If you could you've commented the fact that the personal lines growth has been negative but that should start to change going forward. Can you give us an idea of maybe the timing or expectations for growth going forward in personal lines?

[Kevin Burke:]

Sure. Obviously, we're looking forward to the rollout of the new product. We are going to be doing this in a staged approach sort of batch stages. We're calling them just in terms of timing third and fourth quarter of this year. So states like Indiana, Ohio, and Pennsylvania will be part of the first group that will be deployed. And then third and fourth quarters. I'm sorry, the second and third quarters for next year will be the other batches of states kind of rounding out the field. We're looking for some modest growth, Bob. Our hope is that some of the new business that we'll be able to add, brings us to a breakeven point where we get to a zero and maybe even in the plus column. As part of Jeff's remarks, he talked a little bit about an 87% policy retention rate and personal lines which has been excellent. It was part of our plan that that legacy book of business which is performing well and is profitable. But now we do need to start to offset the attrition and we believe with the new products that we're going to be rolling out throughout 2022 we'll start to see that lift to give you a sense of timing. I think 2023 is where we'll start to see the new business start to level off for overall personalized performance. But as you're aware, personal lines, business takes a couple of years to become profitable. So we are going to be relying to a certain extent on that legacy book of business. Again, that's been performing well. And we're going to know by midyear next year how well this product is doing and being received in the marketplace particularly with the deployment of Pennsylvania with policies effective January 1, 2022. By the end of the second quarter, we're going to see how well it's doing and we have taken a lot of time to ensure that our agency plan is ready. The marketing team has been out working with our agents. And so there's been a lot of build up as we prepare to deploy these personalized products throughout 2022.

[Robert Farnam:]

Okay. So it sounds like it's more of a 2023 where you might see some growth in the person lines. But between now and then it's going to be more of a slow trickle that it's trying to offset the attrition.

[Kevin Burke:]

Yes, that's correct. That's when I use the 0% to 1% or 2% at an 87% policy retention rate if we can close that gap in 2022 I think that sets us up for 2023 with your comments are right on that you'll start to see some modest growth, which is what we're looking forward to.

[Robert Farnam:]

Right. Okay. Thanks for that.

[Kevin Burke:]

Thank you.

[Operator:]

Your next question is from Douglas Eden with ECM.

[Douglas Eden:]

Good morning, Kevin and Jeff.

[Kevin Burke:]

Morning Dough.

[Douglas Eden:]

Congratulations on a solid quarter. Nice growth and book value and now 10 consecutive quarters of stable and favorable reserve development. How the stock is not trading, at least at book value is anathema to me. But that's a conversation for another day. I have two questions. First, with Michigan being a large territory for the company, I was wondering if you're seeing any initial impact from the recent storms and tornadoes that came across the state in the last week or two? And secondly, regarding the new personalized product, I know we just discussed it, but what of the CSRs said so far, who have tested it relative to how it differs from the current products and I guess even more importantly, how it's, what's its marketability compared with competitors in their offices in their agents locations.

[Kevin Burke:]

Well, two good questions. We'll start first with Michigan. We actually received the report yesterday in terms of potential losses as it relates to those storm related issues. And so far, it's been very modest. So we think that we're fortunate. We're not seeing some uptick in terms of claims activity. So for right now I can't report and tell you that. I think that we're in good shape in terms of those storms that hit Michigan particularly in northern Michigan. On the personal lines piece of it. Great question as it relates to the CSRs, because as they are the gatekeepers within any agency in terms of writing personalized business. One of the things that we have done is to ensure that our pricing is appropriate. We've run it through a couple of different models to ensure that the pricing that we have and we'll be deploying with the new products is competitive. And right now all indications are that those rates are very competitive. When we built the product itself, we took a number of our peer companies and some larger national companies and really looked at their product in depth, and built the product around it. So I think that from a coverage standpoint we are going to be in very good shape. But as you know, in personal lines, rate is king. And so we have to make sure that we're appropriately priced and we believe, based on all that we have seen that we're going to be just fine from a rate standpoint. The last couple of weeks in particular as we're getting ready to roll out this first batch of news of states for person lines our marketing team has spent a lot of time in Indiana, Pennsylvania and Ohio preparing our agents for this rollout and building some enthusiasm for it and the feedback that we've been getting back from our agents in particular the CSRs they're anxious to quote Donegal. They want to see his back engaged in that game and as historically Donegal has always been a very solid personal lines carrier and so it's been a couple of years removed because of the actions that we had to take to bring it back to profitability. We've executed on that but now it's time to reengage and we think that we are appropriately set to do that.

[Douglas Eden:]

Good and I think the timing will be fortuitous as well with the marketing folks able to travel again get out into the field visiting their agency plant just getting in front of the CSRs constantly is going to be the key to getting the repetitive quotes coming in. so I think that's going to work in our favor as well.

[Kevin Burke:]

We agree.

[Douglas Eden:]

Yes. Did you say Kevin Pennsylvania is in that first group? Is that a is that a fourth quarter or a first quarter?

[Kevin Burke:]

That is, it is in the first group. It's in the first group of states and so it will be for policies effective January 1, 2022. So we will be working in late September, October to deploy that product working with our agents and then we'll be writing on January, 1.

[Douglas Eden:]

Terrific. Okay. Well keep up the great work another good quarter from both of you and the whole team.

[Kevin Burke:]

Thank you very much.

[Operator:]

And there are no further questions at this time. I'll turn the call back over to management for closing remarks.

[Kevin Burke:]

Thanks to all of you for joining the call today and thanks for the good questions. We look forward to speaking to you again after reporting third quarter results. Enjoy your day.

[Jeffrey Miller:]

Thank you.

[Operator:]

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