Donegal Group Inc.
Q4 2007 Earnings Call Transcript

Published: 20 Feb 2008

[Operator:]

Good day, ladies and gentlemen, and welcome to the fourth quarter 2007 Donegal Group Earnings Conference Call. (Operator Instructions) I would now like to turn the presentation over to your host for today’s call Mr. Jeff Miller, Senior Vice President and Chief Financial Officer. Please proceed.

[Jeff Miller:]

Good morning, everyone and welcome to the Donegal Group Earnings Release Conference Call for the fourth quarter and year ended December 31, 2007. I am Jeff Miller, Senior Vice President and Chief Financial Officer and I will begin the conference call with some financial highlights and discussion of the quarterly and full year financial results. I will then turn the call over to Don Nikolaus, President and Chief Executive Officer for his comments on our results and an update on the business trends that we are experiencing. Certain statements made in our earnings release and this conference call are forward looking in nature and involve a number of risks and uncertainties. Please refer to our earnings release for more information about forward looking statements. Further information on risk factors that could actual results to differ materially from those projected in the forward-looking statement is available in the report on Form 10-K that we submitted to the SEC. You can find a copy of our Form 10K on the investor’s portion of our website under the SEC Filings link. We are pleased to report a solid level of earnings for the fourth quarter 2007, reflecting the continuation of favorable underwriting results in spite of a modest increase in weather related claim activity and a moderation in favorable prior accident year claims settlement during the quarter versus the fourth quarter of 2006. Our net income for the fourth quarter 2007 was $10.8 million or $0.43 per share of Class A common stock on a diluted basis compared to $11 million or $0.44 per share of class A stock on a diluted basis for the fourth quarter of 2006. Total revenues for the fourth quarter of 2007 were $86.9 million, an increase of 3.2 % over the total revenues of $84.2 million for the fourth quarter of 2006. [Inaudible] of the fourth quarter increased 2.6% to 78.2 million compared to 76.2 million for the prior year period. Net premiums risen through the fourth quarter 2007 were comparable to those reported for the year earlier period with a slight shift in business mix as personal lines writing increased 4.4% and commercial lines writings were down 7.6% compared to fourth quarter 2006. Our investment income was $5.9 million for the fourth quarter 2007 in line with the amount received in the fourth quarter 2006 and increasing modestly over $5.8 million received in the third quarter of 2007. As in previous quarters, we continue to increase our tax exempt municipal bond holdings and as we have stated in prior calls we have no sub prime exposure in our investment portfolio. We did not hold any collateralized debt obligations and our mortgage backed securities are clean agency names paper purchased for their steady cash flow. Moving to the underwriting results, our fourth quarter 2007 loss ratio was 58.4% compared to 54.9% reported for the fourth quarter of 2006. We experienced a modest increase in claims from winter weather in each of our regions as compared to the fourth quarter 2006 when we enjoyed very mild weather conditions. Favorable prior accident year reserve development in the fourth quarter 2007 was around $2 million slightly less than the average amounts realized in the first three quarters of 2007 and significantly lower that the $5 million experienced in the fourth quarter of 2006 when there was an abnormally high level of claims settlements. I thought it might be helpful at this point to provide a comparison of the full year reserve development and information for 2007 and 2006 to give you additional perspective on the moderation of favorable reserve development. The full year favorable prior accident year development in 2006 was $13.6 million or 7.9% of net reserves as of the beginning of the year. So the full year 2007 we had favorable prior accident year development of $10 million or 6.1% of net reserves at the beginning of the year. Considering the reduced inventory of outstanding claims each from years previous to 2007 favorable development to be well within the reasonable range. I would hasten to remind everyone that the favorable development we have experienced was a result of actual settlements of open claims and not the result of any bulk prior year reserve releases. Our expense ratio was 31.6% for the fourth quarter of 2007 compared to 32.8% reported for the fourth quarter of 2006 with the reduction primarily attributable to year-end accrual adjustments to the actual expected payouts for underwriting based incentive compensation costs. A combined ratio for the fourth quarter 2007 was 90.5% compared to 88.2% for the fourth quarter of 2006 with a difference primarily due to increased loss ratio. I will now spend just a few minutes highlighting the full year results for 2007. Our total revenues increased 3.2% to 340.6 million with net premiums earned increasing 2.9% to $310.1 million. Net premiums written increased 2% over our net writings in 2006. The personal lines increasing 4.8% and commercial lines decreasing 2.7%., investment income increased 6.9% to $22.8 million for the year. Our net income for the full year 2007 was $38.8 million compared to net income of $40.2 million for 2006 with 2007 ranking as our second highest year in terms of net income. Our combined ratio for the full year 2007 was 91.3% compared to 89% for the full year 2006. Earnings per share for the year were $1.53 per share of Class A common stock on a diluted basis compared to $1.60 per share for 2006. Our book value per share increased in $13.92 as of year-end representing 9.6% increase over the $12.70 book value as of the end of 2006. In March of 2007, we initiated a share repurchase program authorizing the repurchase of up to 500,000 shares of our Class A common stock. Pursuant to this plan, we purchased approximately 100,000 shares during the fourth quarter bringing the total number of shares repurchased to date to 266,000 shares. On January 30, 2008, we announced that our Board of Directors and the Board of Donegal Mutual and each approved an amendment to the pooling agreement between Donegal Mutual and Atlantic States Insurance Company our largest subsidiary. We received regulatory approval for this change on February 11. Therefore we are pleased to report effective March 1 the pooling percentage for Atlantic States will increase from 70% to 80%. Based upon current pool premium levels we expect Atlantic States to receive an additional allocation of written and earned premiums of approximately $30 million annually. Also as of March 1, Donegal Mutual will transfer approximately $12 million in cash and net unearned premium reserves to Atlantic States, which will result in a modest increase to Atlantic States investment income from that date forward. We in Donegal Mutual have realized significant benefits from the pooling agreement since it was established 21 years ago and we believe this change will provide a continuation of those benefits in 2008 and future years. At this point I will turn the call over to our President Don Nikolaus for his comments on the quarterly results, Don.

[Don Nikolaus:]

Thank you Jeff and good morning everyone, thank you for joining our call. As Jeff has reviewed with you we have had quite a solid fourth quarter in what many of you know to be a challenging environment in the property casualty insurance industry. We feel a sense of gratification and satisfaction that obtaining a 90.5% combined with some weather plus the competitive environment we think is confirmation of the very underwriting focused strategy that we have been operating under for quite some period of time. What I would like to do is cover a number of specifics that would have taken place during the fourth quarter and talk a little bit about the marketplace and what we have planned and how we’re going to implement and execute in the first quarter and the balance of the year 2008. Generally, at these calls we make an announcement in regard to the number of new agency appointments. The number of new agency appointments in the fourth quarter was 42. It would bring to a total for the year of 2007 of 199 new agency appointments. It is certainly above what we would have projected. I think we were talking somewhere in the 165 to 170 range for the year. We have exceeded that. It is certainly a major part of our initiative to expand our distribution system. To give you a little bit of additional statistics on newly appointed agencies, those agencies that would have been appointed in 2005, 2006 and 2007 accounted for approximately 25% of the new policies written for the year 2007 that’s personal lines policies and they would have accounted for about 22% of the commercial lines new policies written. Needless to say, as you appoint agencies as we have indicated previously, it takes time to get them oriented to get them understanding your product line and certainly time for them to become familiar with our people and for us to build relationships with them. It is an ongoing process and just because you appoint an agency in 2007 doesn’t say that they are firing on all cylinders by the middle of 2008 but it certainly an areas that we continue to work on aggressively. As it relates to 2008 staying with the theme of the distribution system, it certainly will continue to be one of our major goals is to continue to aggressively appoint quality agencies that fit the profile for the book of business that we like to underwrite both from the type insurance products but also the quality of what we write. In 2008 we will continue to enhance our technology which is primarily embedded in WritePro and WriteBiz in our interactive website. We see more and more of our business coming through those enhanced electronic portals and we want to continue to make them as friendly and as expansive as possible. Certainly, I would want to point out that underwriting and the quality of our underwriting practices needs to be a constant area of focus. In a competitive market place it is easy for insurance companies, hopefully not ours, to fall victim to the idea that you increase your premiums by making your requirements somewhat less restrictive. Although we certainly are always looking for sound prudent opportunities to either expand the product line or to enhance the classes of business that we write, we always want to make sure that we continue to be focused on underwriting profitability. At the end of the day the longer term the profitability of the book of business is certainly is equally important if not more important than some extra additional percentage of premium growth. We are also going to be looking in the year 2008 to continue to work on how to drive down expenses by increasing productivity making sure that we have as many aspects of our operation automated as possible because as the environment remains competitive, we have to make sure that we are as productive and efficient as possible. Jeff also referred to the pooling agreement change, which we think for the public company as well as the mutual, will be a constructive process. Those of you who have followed us for some years know that that percentage of the pooling agreement has migrated over the 21 years that we have been a public company. We are pleased to see that the regulatory body, the Insurance Department of Pennsylvania, is the primary regulator for us that they were receptive to that and readily approved it. One other area of importance is reinsurance. We are pleased to tell you that we had a productive 2008 reinsurance renewal. We have increased our per occurrence retention from $400,000 to $600,000 and companies on a basis based upon their size, their capital structure, their financial numbers look at what the retention should be and over a period of time, we like many other companies have increased that. We have not done that for some years and we thought that was appropriate. We wanted to make sure that the market would be aware of that. It’s always a balance between not wanting to see too much premium to a reinsurer and at the same time and not wanting to assume excessive amount of risk. We think we have struck a favorable balance. In 2008, we will continue what I would describe a proactive outreach for doing acquisitions. I think that many of you have been on our conference calls before know that we have a history of doing acquisitions a lot of them have been the mutualizations of mutual companies. We would intend to continue, as we have to pursue prudent acquisitions, we’re receptive to it, and we’re always looking for opportunities. One of the other areas that will be and continue to be, not that it’s a new theme, but in the sort of difficult financial markets that we see many of our brethren in the banking industry in and some very large insurance companies, we think that it’s a time for a strong focus on balance sheet strength. Profitability has always been extremely important to us as well as balance sheet strength. We recognize that this is certainly a time when one needs to be strongly focused on the balance sheet. Going forward we believe there will be opportunities whether they be in acquisitions, whether they be when the market turns that we want to have to make sure that we have a very strong capital position and be able to be opportunistic. I know that there will be questions about what we’re seeing in the competitive environment and certainly we’ll be willing to answer any questions in that regard but to give you little bit of a preface to it. From our view of the world the competitive environment both commercially and personal lines, we do not think is materially changed. It has been quite competitive all throughout 2007 and certainly going back into 2006. We have not seen anything to indicate that it’s intensifying. We do read and hear that some companies have made claims that they have made various rate increase filings in personal lines. If that be the case, we would view that as being constructive. We hope that’s the case. We will be looking for market indicators to be able to confirm that but we are of course reading some of the same information that some of you probably have heard. We ourselves have selectively and I would want to say that, have selectively filed for some rate increases in our home owners line of business in several states and we be proactive in making additional filings with additional product lines if we deem that to be appropriate from the standpoint of rate adequacy and from profitability levels. On the commercial side, clearly commercial lines continue to be more competitive for us and I believe for the industry as a whole than personal lines. In general, I think we are seeing our renewals on commercial lines going out flat to down, low, single digits in the 2 to 4%. Certainly on new business we’re for the write account we are certainly be competitive but as we all know in any business there needs to be a point at which you’re not willing to take on new business if it isn’t properly priced sort of a walk away price. That is a discipline and it requires a daily balance and it needs to be well managed because you never want to miss opportunities but at the same time you don’t want to have rose colored glasses on. That gives you sort of an overview of the fourth quarter and some of the strategies that we will continue to implement in 2008. Much of it is a continuation of what we have been doing and we are a company that doesn’t like to have sort of a goal or project of the week. We like to have a longer term to develop strategy and make sure that we keep it current but that we stay focused and we execute on it. I will turn it back to Jeff at this point and we will move forward with the question and answer process.

[Jeff Miller:]

Thank you Don, Karen if we could open the line for questions please.

[Operator:]

(Operator Instructions) Your first question comes from the line of Joseph Demarino with Piper Jaffray please proceed.

[Joseph Demarino:]

Good afternoon, you gave some detail on your thoughts on acquisitions but just looking for a little bit more color in terms of the size of the acquisitions you might be looking at and how it might be financed.

[Jeff Miller:]

We would be happy to answer that. We look at acquisitions of various sizes; we are sometimes willing to look at a smaller acquisition if it will give us access to a new state because generally we like to enter into new jurisdictions with some reasonably credible book of business. So, we might be willing to take a look at an acquisition where the premiums are 10, 15 to $20 million. The ideal acquisition would certainly be above that and in terms of the maximum size, we certainly wouldn’t rule out and would certainly look for opportunities for acquisitions where the premiums would be 75 or $100 million. In terms of financing them, many of the acquisitions that we have done to this point have been on the mutual side where we have infused surplus notes and have gained management control through our mutual and then eventually demutualizing it so there’s initially less capital required. From the standpoint of if it were a stock acquisition, we believe we are well capitalized; we have access to lines of credit if we need to have that so that we think that we would have the necessary resources to do acquisitions within the ranges that we would think would make sense for us.

[Joseph Demarino:]

Also, I apologize if you’ve already answered this but what was the favorable development in the fourth quarter and then what is your statutory capital?

[Jeff Miller:]

The favorable development in the fourth quarter I believe I quoted as $2 million, the statutory surplus was $318.9 million, and that’s a bit lower than what we would have told you in September. That’s a result of some inner company dividends that are paid up to Donegal Group, the holding company in December in the amount of $18 million.

[Joseph Demarino:]

Okay thanks one last question, what caused the change in your reinsurance recoverable? I think it went from 90.6 to 78.9 in the quarter.

[Jeff Miller:]

The change in the reinsurance recoverable is largely related to the reduction of reserves. If you look at the corresponding change in the liability for losses and loss expenses, you will see a comparable reduction and that relates to the settlement of larger claims from which we have collected the reinsurance.

[Joseph Demarino:]

Okay, thank you.

[Jeff Miller:]

You’re welcome.

[Operator:]

Your next question comes from the line of Scott LaRau with Donegal Insurance please proceed.

[Scott LaRau:]

I wish I was with Donegal Insurance; I am a private investor. Jeff, a year ago we bought 78,000 shares, Donegal did, at $19.90 today the share price is 20% lower, $16.00. Why is Donegal not, I repeat not, fully buying back shares?

[Jeff Miller:]

As I told you in my comments Scott, we did buy back 100,000 shares during the fourth quarter and have not been active in the markets since the end of the year because that’s a quiet period and we do not buy shares during that quiet period.

[Scott LaRau:]

We have a 500,000 share repurchase, you have 266,000 that tells me you have 45% more to go. Why are you holding back at these levels? I can’t understand you have one million in net income per week and you would think it’s time to reward the shareholder.

[Don Nikolaus:]

Well Scott, this is Don Nikolaus. As you know companies, review their capital management on an ongoing basis and it’s a judgment factor in terms of whether it’s an appropriate circumstance time to be using capital to repurchase shares. In the fourth quarter, we repurchased 100,000 shares which we think is a substantial number of shares. When we announced the buy back, we indicated that it would be a buy back over a period of time and that we have, we think, handled that appropriately and prudently. There is not necessarily any silver bullet to concluding that buying back your shares is somehow or another going to magically increase the stock price because there are many companies very large ones that have spent billions of dollars in the last year buying back shares and the price of their stock is down. There’s a lot of dynamics that go into where the price of your stock is the most of which we absolutely have no control over other than making sure that we try to run this business on a day to day basis to create shareholder value and to generate the maximum profitability.

[Scott LaRau:]

I understand but there is 72% of the float at Donegal Insurance. Donegal Group held by four institutions, four. I can’t believe they are happy including the mutual with the performance of the stock down 20% in a year. The company having more gas 245,000 more shares to buy and they’re not buying it.

[Don Nikolaus:]

Well Scott I am going to answer one more answer and then I think we have to move on to the next question. One of the issues of course is that we have always been concerned over a 20 year period of time with the amount of the daily float in our stock. Therefore, buying it back and depending upon how much you buy back doesn’t help the amount of float that’s out there. We have heard over the years different opinions but certainly some vocal opinion that you don’t want to be doing things that are going to reduce the amount of float because there are many institutions that want to see a larger float if they are to consider your particular company in their investment strategy. There are lots of issues but we understand your input and we appreciate it.

[Operator:]

There are no additional questions at this time. I would now like to turn the call over to Mr. Jeff Miller for closing remarks.

[Jeff Miller:]

We appreciate everyone’s participation this morning in the conference call and wish everyone a good day. Thank you very much.

[Operator:]

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect, good day.