Donegal Group Inc.
Q4 2020 Earnings Call Transcript

Published: 24 Feb 2021

[Operator:]

Ladies and gentlemen, thank you for standing by and welcome to the Donegal Group Incorporated Fourth Quarter 2020 Earnings Conference Call. It's now my pleasure to hand the conference over to Chief Financial Officer, Jeff Miller. Mr. Miller, I hand it to you.

[Jeff Miller:]

Thank you very much. Good morning and welcome to the Donegal Group conference call for the fourth quarter and year ended December 31, 2020. On behalf of everyone at Donegal Group I want to thank you all for your interest in our company. 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. Yesterday we reported favorable fourth quarter results that contributed to excellent results for the full year of 2020. We are grateful for the financial success we achieved despite the events and challenges we all faced in 2020. As I stated in past earnings calls and other forums, our goal has been to build upon the foundational changes we implemented throughout our organization over the past several years. And our improved underwriting performance demonstrates that these changes are having an impact. We feel that Donegal is positioned perfectly to take advantage of the hardening commercial insurance market conditions in our operating regions. We are also continuing to stabilize our Personal Lines segment. We've been emphasizing profitability overgrowth in recent years. We reported net income of $14.6 million or $0.49 per diluted Class A share for the fourth quarter of 2020, a $52.8 million or $1.83 per diluted Class A share for the full year. We achieved solid level of underwriting profitability with combined ratios of approximately 96% for both the quarter and year. And we've achieved favorable loss reserve development in each of the past few years. We are particularly pleased with our full year 2020 results in light of the significant uncertainty surrounding the pandemic and its effect on economic and business conditions, as well as the record setting severe weather activity throughout the U.S.

[Jeff Miller:]

Thanks, Kevin. I'll highlight a few of the operational and financial metrics for the fourth quarter of 2020, and I'll also comment on notable metrics for the full year, and we'll be glad to address any questions later in the call. We entered 2020 with strong momentum, anticipating favorable impacts from the many actions we implemented over the past several years to improve our financial results. As Kevin noted, we understood that some of those actions would slow premium growth in the short-term, but we also knew they would benefit profitability over the longer term. We believe the majority of the negative growth impact is now behind us, and that we are nearing an inflection point from which measured organic growth will resume at profitability levels that we deem acceptable.

[Kevin Burke:]

Thanks, Jeff. Last year, Donegal held its fourth quarter conference call on February 25th, which was shortly before the onset of pandemic conditions that dramatically altered the lives of our employees, our agents, and our customers. Within one-month of that call, life as we knew it had changed in ways we could not have imagined just weeks earlier. Despite what may seem at times is an underpinning barrage of challenging circumstances, Donegal's management team, our employees and network of independent agents pulled together like never before to overcome the obstacles that pandemic place before us. Now let's fast forward one-year later. We have not missed a step. We are steadily moving forward to execute our strategic plan and fulfill our mission to be there when it matters most for our employees. As we execute these strategies, we expect to continue to build and enhance the book value of Donegal Group for the benefit of all of our stockholders. Before we open the lines for questions, I want to take a moment to highlight the market valuation of Donegal Group in comparison to the industry as a whole. We recently spoke with a long-term star holder who encouraged us to emphasize to potential investors where Donegal is positioned within its peer group in terms of price to book value. As of yesterdays close Donegal Group traded at an 18% discount to our previously reported book value at September 30, 2020. If you compare that price to our December 31, 2020 book value of $17.13, the discount is now at 19%. In our financial supplement, we include comparable multiples for many of our peer companies. As of February 22, 2021 the average price to book value multiple across the base of those companies was 1.3 to 1 or a 30% premium over book value. Donegal Group has now achieved 8 strong operating quarters in a row, is in arguably the strongest financial position in our history and has a long history of returning solid dividends to our stockholders. Ensure we will continue to be proactive in communicating our investment thesis to prospective investors over the course of 2021. With that, we'll ask the operator to open the lines for any questions that you may have.

[Operator:]

Thank you. And our first question will come from the line of Bob Farnam with Boenning & Scattergood.

[Bob Farnam:]

Good morning. It sounds like you're going to – for personal lines you'll be in a holding pattern this year. The profitabilities where you wanted to be, so are we going to say that the growth expectations this year is going to be basically flattish for personal lines?

[Kevin Burke:]

Good morning, Bob. Thanks for the question. Yes, we anticipate right now that the first half of the year, I think that that's appropriately said that we are in a bit of a holding pattern. We've made a lot of improvement in sustaining and maintaining the existing personal lines book of business. All the rate action that we had to take in late 2017, 2018, we believe that the impact of that disruption to the book of business is behind us. Each month for the last several months, we've seen an increase in additional quoting activity in personal lines. The rate increases if any that we've taken have been very modest. So we think the first half of the year, there's really no disruption to that book of business. And we do see some very incremental improvement. As you've categorized it correctly, the second half of the year, when we roll out the initial wave of the personal lines products, obviously we're very anxious to do that. We think that from a pricing standpoint, we have it dialed inappropriately. But the reality is we're really not going to see any real lift from the new product – new personalized products until 2022. But we are anxious to launch those products the second half of the year, and we will see some uptick, but I think that we're looking at very modest increases if any it's more about making sure that we've got a price product that is going to make sure that from a profitability standpoint, we can grow that line with confidence. So we're anxious to launch that product second half of the year.

[Bob Farnam:]

All right. Okay. Thanks for that. And it looks like, all right, so now you're going to be taking premium from the Mountain States operations. You had winter storm losses in Texas in the past week or so. Any impact on that, on this book that, you're going to be taking some of the exposure?

[Jeff Miller:]

Yes. Bob thanks. This is Jeff. First of all, our thoughts go out to all those that are affected by that recent weather event particularly in Texas. It's still early, but we have not received a significant number of reported claims from that event so far and specific to the Texas exposures Mountain States rights only commercial business, and has a relatively small amount of premium writings in that state. From a stockholder perspective, there is an important point that I should make in relation to Mountain States and the potential first quarter financial impact to Donegal Group. Any losses that relate to policies written prior to 2021 will be fully recognized by Donegal Mutual. So Donegal Group will only begin participating in losses for policies that renew or are newly written in 2021. The only Mountain States losses that will be included in the pooling agreement then would be related to those policies that were either written new or renewed in the last seven weeks. So as of this morning, we checked on that and Mountain States has only received a handful of claims on 2021 effective date policies.

[Bob Farnam:]

Okay, great. And last question for me is for commercial auto, it sounds like obviously the rates have been going up for quite a while. Can you just give us an idea of the things you've been doing in terms of the exposure sides or the re-underwriting side that should benefit that book going forward?

[Kevin Burke:]

Sure. Let's talk a little bit about some baseline results, and then we can talk about where we're going, and what we anticipate. From a statutory combined ratio we have made improvement in the line. So last year was it a 117.4% or now to 112.7%, still unacceptable, but we've made almost a 5 point swing. We do have a commercial auto profit improvement team that meets frequently and they make adjustments as needed every month. Rate increases for 2021 is going to vary greatly by state, and we started to look at a state-by-state basis. I will give you an example of Wisconsin is at the low end of that scale. And we're probably looking at a 5% to 7% rate increase for commercial auto in Wisconsin. At the other end of the spectrum is Georgia, which you've heard us report about on numerous quarters, and Georgia continues to be a challenge for us. In addition to rate increases that we're taking and those rate increases, Bob are upwards of 30%. Also in accounts that we define is heavy exposure. Now those are accounts with 10 vehicles or more, in the past year in 2020 we have reduced our total vehicle count in Georgia by 22%. So by reducing the exposure and continuing to do that in the first half of this year aggressively taking rate action were warranted. We believe that this line is going to come into rate adequacy here, maybe by the end of the year, first quarter, next year. We do have a number of States that are already very close to that, and it's been, as you know, it's been a long-term process for us.

[Bob Farnam:]

Have the customer is been accepting those rate increases like how is your retention fared – premium retention fared as you've been trying to put through those rate increases?

[Kevin Burke:]

Yes. The retention is very good, and so obviously that's indicative of what's going on in the industry. And just as a reminder, it was 2011 from an industry standpoint was the last time that commercial auto was profitable other than industry level. So yes, the environment is right for those rate increases and our retention is good. And so we're going to continue to push those Rate increases and do what we need to do to get this line back in check. And we are well on our way to doing that.

[Bob Farnam:]

Great. Best of luck in 2021. That's it for me. Thanks.

[Kevin Burke:]

Thank you.

[Operator:]

And our next question will come from the line of Doug Eden with Eden Capital Management.

[Doug Eden:]

Good morning, Kevin and Jeff morning.

[Kevin Burke:]

Good morning, Doug.

[Doug Eden:]

Congratulations on another strong quarter and especially the eight consecutive quarters now of the stable and favorable loss reserves. Very well done by you and all the employees, especially during this challenging and unusual past year we've had. Also Kevin, your comments at the end of your prepared remarks regarding the stock price discount, not only just to the company's new $17.13 book value, but also to the peer P&C companies premiums to their book value multiples was very well said. And I hope that message continues to get them imparted to the investment community. I have a couple of questions. Number one maybe dovetailing a little bit on the weather question in Texas. We also had in the first quarter of this year already the nor'easter have come up through the mid-Atlantic, a few through the Southeast, and I believe a few up in New England as well. So I just wanted to know you mentioned Jeff the impact on Texas being minimal. I was just curious about the nor'easter and some of the other first quarter, weather what you're seeing there in the existing more populated states from a book of business standpoint? And then secondly, several of the publicly traded reinsurers have mentioned they obtained one-one renewal rate increases in the 10% to 15% range. Did Donegal experience something similar in your January pricing and did you retain higher net levels as you did a few years ago to offset the additional expense?

[Jeff Miller:]

Sure. Doug this is Jeff. Thank you for those questions and for your comments as well. On the weather front to this point in the year we have not seen a significant impact from the nor'easters and the weather, the cold temperatures that we're in much of the country. It is still early but we started the year in January with a very mild month weather-wise and almost record low weather losses. So to the extent that we have a few losses from the nor'easters and the snow events, we don't expect that to be anywhere close to above average for the first quarter. So, so far so good and we're cautiously optimistic as the temperatures are rising here in our home area, in Pennsylvania. So hopefully the worst – the worst of the winter is behind us. On the second question as to re-insurance increases, we did have a very successful renewal of our re-insurance program. And as I believe you are aware – our reinsurance program is now consolidated for the entire Donegal Insurance Group. And it all renews as of 1/1/2021 we renewed the entire program. We did have some pricing increases on our program because there were several of our contracts where we did have losses in 2020. We utilized the re-insurance that we purchased both from a weather perspective as well as some casually losses that we incurred. We actually expect to recover nearly half of the re-insurance premiums that we paid in reinsurance losses for 2020. But as a result of that loss activity, we did incur some premium price increases on the program that on average we're about 20%. So a little bit higher than the range that you quoted there, and that range is at the low end of the range for insurers who had loss activity on their reinsurance program. So we were necessarily pleased with a 20% increase in reinsurance costs, but it was in line with what we expected. And we did not increase our retentions. We did not change any of the retentions on our program. But we did actually increased some of the coverage on a few of the casualty lines to reflect the fact that we are writing larger commercial accounts. So all in all, we were pleased with the renewal. It went very well. And we have a very solid panel of reinsurers on the program and that hopefully it gives you a good solid understanding of the impact.

[Doug Eden:]

It does. And I know we consolidated amongst the different subsidiary companies from a purchasing standpoint a few years ago, which made a lot of sense. Do you expect much of an EPS hit then or impact in 2021 because of the re-insurance pricing or it's pretty well going to be covered and when you think of the rate increases spread out amongst the overall book that you're getting from a primary basis?

[Jeff Miller:]

Right, it's going to be part of the mix and we're going to have organic growth. We're going to see the Mountain States growth from bringing that into the pool. As Kevin mentioned, we'll likely see some continuing declines, modest declines in personal lines, but we expect the commercial lines to – we're projecting as high as perhaps an 18% net premium written growth in commercial lines. When you add in the organic growth and the Mountain States growth, which should translate to somewhere around 7% to 7.5% net premium written growth overall, when you include the decline in personal lines.

[Doug Eden:]

Yes. That would be great. That would be back towards the historical averages. Finally, one final question, if I may. Regarding the work comp line I know in the fourth quarter premiums dropped a little bit at a – more of a rapid pace in comp than they did compared to the year-to-date and even some of the more historic quarterly trends. Are you seeing pricing, as you mentioned in the last few quarters stabilizing a bit in that line or rate level still going down? I was curious if the decreasing in premiums was more reflective of fewer item count, as opposed to just rate level decreases?

[Jeff Miller:]

It was not necessarily item count decreases, it was primarily rate decreases. And it's unfortunately not – we're not necessarily seeing a bottom yet, but we are seeing a moderation of those decreases. We are attempting to offset the bureau rate decreases with our own changes to loss cost multipliers and other internal factors that we control over. We would like to see those the worker's comp rates kind of net out to roughly flat for 2020. We'll be working toward doing that. But it wouldn't surprise me if we're still in a slightly negative growth or negative reduction in workers' comp premiums going into 2021. It's just a matter of getting those rate bureaus to recognize that the loss costs are now increasing in certain areas, but yes, so far the profitability of that line continues to hold steady and we're expecting that to continue into 2021.

[Doug Eden:]

Okay. Thanks, Jeff. Well, thanks to both of you and to the entire team. And again congratulations on another very strong and consistent quarter, a very strong close to 2020. Sounds like 2021 is going to continue that momentum and hopefully the stock price will start to narrow that gap to not only the curtain of the existing book value, but even more importantly, to get to where the peers are, because I think we certainly deserve it. But from an execution – from operational execution standpoint, I think you all, and the team are leading and hitting on all cylinders. So, on behalf of a lot of shareholders, thank you for doing everything you're doing. It's very well noted and appreciated.

[Jeff Miller:]

Thank you, Doug.

[Operator:]

And our next question is going to come from the line of James Bach with KBW.

[James Bach:]

Hi. I had a question on the commercial auto rates. I saw a 6.8% for the quarter, which looks like it's climbing down a bit from the first three – first nine months of 2020. So I was just wondering if there's kind of a broader or more enduring trend towards decelerating rates in the commercial auto line.

[Jeff Miller:]

This is Jeff, James. Following up on what Kevin said earlier, I would say that we are expecting the rates on average to be higher than that fourth quarter increase, likely closer to the high single digits. So based upon the mix of states and the activities that there are certain states where we're not pushing for as high of an increase, but they're still in the 5% range or higher. And then when you layer in the states where we are pushing for, 22% as high as 30% we think that should average out to close to a 10% rate increase for 2021. So yes, the fourth quarter we think was somewhat lower than what we expect to see going forward.

[James Bach:]

All right. And kind of longer term, what are the plans for trying to get the commercial auto combined ratio to sort of a more acceptable level in your view?

[Jeff Miller:]

Yes, as we earn the premium increases that we put through in 2020, and then as we – 2021 planned increases are earned. We expect to get a lot closer to having an underwriting profit. We're targeting a – like a 96% combined ratio, but we know it's going to take us probably at least two years to get there. So I would say by the end of 2022, we would expect to be at least to a breakeven if not starting to see some modest profitability in the line, assuming that lost cause continue on the current rate.

[James Bach:]

Perfect. Thank you so much.

[Jeff Miller:]

You're welcome. Any questions?

[Kevin Burke:]

Thank you.

[Operator:]

Thank you. And at this time we have no further questions. I'll turn the conference over to Mr. Miller for closing comments.

[Jeff Miller:]

Thank you, Holly. And thanks to all of you for joining the call today. We appreciate the questions and the participation, and we look forward to speaking to you again after reporting first quarter results. Have a great day.

[Kevin Burke:]

Thank you.

[Operator:]

Once again we'd like to thank you for participating on today's Donegal conference call. You may now disconnect.