Donegal Group (NASDAQ:DGICA) Q2 2020 Earnings Call

0:00 Ladies and gentlemen, thank you for standing by and welcome to the Donegal Group, Inc. Second Quarter 2020 Earnings Conference Call. At this time, all participants have been placed in a listen-only mode and the floor will be open for your questions following the presentation. If you would like to ask a question at that time, please press star 1 on your touchtone phone. If at any point your question has been answered, you may remove yourself from the queue by pressing the pound key. I will now turn the call over to Jeff Miller, Chief Financial Officer, to begin.

0:32 Thank you very much. Good morning, everyone. Welcome to the Donegal Group conference call for the second quarter, ended June 30, 2020. Yesterday afternoon, we issued a news release outlining our quarterly results. For a copy of that release, please visit the investor relations section of our website at donegalgroup.com. In today's call, Kevin Burke, President and Chief Executive Officer, We'll provide an update on our business strategy and discuss recent developments. I'll follow Kevin's comments with highlights of our quarterly financial results. At the conclusion of our prepared comments, we will open the line for any questions you might have. Before we get started, please be aware that our commentary today includes forward-looking statements that involve a number of risks and uncertainties. We described forward-looking statements in our news release and we provided further information about risk factors that could cause actual results to differ materially from those we project in the forward-looking statements in the report on Form 10-K that we submitted to the SEC. You can access our Form 10-K through the Investors section of our website.

1:35 Also, we use certain non-GAAP financial measures to analyze our business results and we refer you to the Reconciliation of Non-GAAP Information also included in the news release we issued yesterday. With that, I'll turn it over to Kevin.

1:50 Thanks, Jeff, and welcome, everyone. Overall, we are pleased with our second quarter results. We remain cautiously optimistic as we monitor uncertain long-term impacts created by the COVID-19 pandemic. Our employees and independent agents, as well as our customers, have proven to be adaptive and resilient in responding to the challenges related to COVID-19 and the related economic disruptions. Conditions and government responses have varied widely across our regions with restrictive mandates that may vary even from county to county within a given state. We've continued to focus our efforts on serving our agents and customers while paying close attention to all the regulatory activity to ensure compliance with all the state and local requirements that apply to us.

2:35 In late March, we moved aggressively to equip our employees with the technology and tools they needed to conduct our business remotely. While the vast majority of our employees continue to work from home, we are beginning to bring small numbers of employees back into our offices. And when our agents and customers are comfortable doing so, our marketing staff and agents are beginning to resume limited in-person meetings. I want to emphasize that we are taking the health and well-being of our employees, agents, and customers very seriously. And as such, we're being extremely vigilant when it comes to making sure our interactions are conducted with appropriate precautions. All the states in which we conduct business began to ease restrictions and reopen their economies during the second quarter, but a number of states have taken a step back following reports of virus resurgence.

3:25 Since it appears that we may be dealing with starts and stops for the foreseeable future, we are pleased that our online agency portals allow our agents to easily generate new business and provide support to our customers as needed. As a reminder, our business is roughly 60% commercial lines, primarily including multi-parallel, automobile, and workers' compensation products. While we write our fair share of larger accounts, we specifically target small to medium-sized businesses like contractors and Main Street business owners that serve critical roles in their local communities. Many of these small businesses received critical, well-deserved financial assistance through government programs that helped to bridge the gap until they could fully or partially reopen for business.

4:12 As a result, we experienced relative stability within our commercial lines premiums. The level of new business submissions from our agents remained very strong, even as our overall premium retention rate increased during the quarter. We quickly responded to any requests for reductions in commercial premiums because material decreases and exposure related to the pandemic Mid-term endorsements reduced premiums in excess of $1 million during the second quarter, and we expect that we will continue to see declines in exposure-based premiums as we complete premium audits at the end of the policy terms during which shelter-in-place orders were in effect. Moving to personal lines, we saw a substantial decline in personal auto claims activity in the months of April and May that led to significant improvement in our second quarter loss ratio. Auto claims in the month of June began to return closer to our historical experience as driving activity began to increase, and we view the early months of the second quarter as a short-term aberration that will not likely reoccur.

5:17 We will continue to monitor our personal auto results over the course of the remainder of the year and file rate adjustments we believe are appropriate in light of our loss experience. I am pleased to report we continue to make progress on the development of our new auto and homeowners products We are on track for deployment for the first group of states in July of 2021. In a minute, I'll turn a call over to Jeff for his comments on the results for the second quarter, but I want to highlight our net income of $22.7 million, or 79 cents per diluted Class A share for the quarter. We had much improved underwriting performance in our insurance operations, with a second quarter combined ratio of 92.3 percent compared to 102 percent in the second quarter of last year. Included in our net income figure was $5.1 million or 18 cents per diluted Class A share of after-tax net investment gains as the market value of our equity security holdings rebounded during the quarter.

6:21 The net income coupled with the increase in the value of our available for sale bond portfolio drove a 7% increase in book value to $16.77 at June 30, 2020, compared with $15.67 at December 31, 2019. We also continue to maintain our dividend payments and policies throughout recent months as one of Donegal's core objectives is to achieve solid results and returns and also reward our stockholders over time. We declared a regular quarterly cash dividend of $0.15 per share of our Class A common stock and 13.25 cents per share of our Class B common stock. The dividends are payable on August 17, 2020 to stockholders of record as of the close of business on August 3, 2020.

7:14 With that, I'll turn the call over to Jeff for more details about our second quarter operating results.

7:21 Thanks, Kevin. As usual, I'll highlight a few of the operational and financial metrics for the second quarter. And again, we'll be glad to address any questions later in the call. Overall, net premiums written decreased 2.1% to $193.7 million, and net premiums earned declined 2.3% to $184.4 million for the second quarter of 2020. Included in the net premiums earned figure is the impact of personal auto premium refunds in Michigan that totaled approximately $840,000. Net premiums written for commercial lines increased 4% while net premiums written in personal lines declined by 8.7% during the quarter.

8:07 Commercial premiums accounted for approximately 55.6% of our net premiums written during the second quarter of 2020 compared to 52.3% for the second quarter of 2019 and 61% during the first quarter of 2020 as a large number of commercial accounts renewed at January 1st. We were pleased that our underwriting activity remained steady during the second quarter in light of the challenges our agents and customers faced as they dealt with significant uncertainty as the coronavirus spread and government shutdowns went into effect. Net premiums written in our commercial auto business grew by 10.5% in the second quarter, with premium rate increases accounting for 8.3% of the total growth. Commercial multi-parallel increased by 6.7%, with virtually no rate adjustment. Conversely, workers' comp net premiums written declined 8% with rate decreases responsible for 5.5% of the decline and the remainder attributable to the widespread disruption of business activity due to coronavirus-driven restrictions.

9:16 In addition to a continuation of steady premium growth, we are also pleased that our commercial lines business segment continued to perform well. delivering a statutory combined ratio of 93.5% for the second quarter of 2020, which was comparable to the 92.9% combined ratio for the prior year second quarter. The reduction in personalized net premiums written continued to be a function of lower new business growth, partially offset by rate increases that averaged 4.1% for the quarter. The decline was again due to our emphasis on pricing discipline which resulted in a natural attrition in premiums that exceeded new business writings. Primarily as a result of lower claim frequency in personal auto related to reduced driving activity during the period, we experienced greatly improved underwriting performance as evidenced by the 88.1% statutory combined ratio in our personalized segment for the second quarter of 2020 compared to 108.5% for the prior second quarter.

10:22 Moving to the loss factors that impacted our underwriting results, we reported a 57.1% loss ratio for the second quarter of 2020, which compared favorably to the 69.7% loss ratio for the second quarter of 2019. We already mentioned the reduced auto claim frequency, which was one of the primary drivers of the improvement. Weather-related losses of $18.7 million, or 10.1 percentage points of the loss ratio for the second quarter of 2020, were higher than $17 million, or 9 percentage points of the loss ratio for the second quarter of 2019. The weather-related loss activity for the second quarter was above our previous five-year average of $15.1 million, or 8.7 percentage points of the loss ratio for second quarter weather-related losses.

11:15 Large fire losses, which we define as individual fire losses in excess of $50,000 for the second quarter of 2020 were 7.4 million or four percentage points of the loss ratio. That amount was modestly higher than the large fire losses of $6.2 million or 3.3 percentage points of the loss ratio for the second quarter of 2019. We had favorable reserve development for losses incurred in prior accident years of $6.6 million reducing the second quarter of 2020 loss ratio by 3.6 percentage points. The development was primarily in our personal auto and workers' compensation lines of business, although we had modest favorable development across our other major lines of business as well. We continued to increase overall reserve strength with actuarially determined reserve increases continuing to exceed the rate of exposure growth during the second quarter.

12:15 The expense ratio was 34.3% for the second quarter of 2020, compared with 31.3% for the second quarter of 2019. We attribute the increase to several factors, including an addition of $1.6 million to our reserve for potential premium receivable write-offs as a result of COVID-19 economic disruption, an increase in technology systems-related expenses, commercial lines growth incentives for our agents, and higher underwriting-based incentive costs for the second quarter of 2020. Overall, our combined ratio was 92.3% for the second quarter, comparing favorably to the 102% combined ratio for the prior year quarter.

13:02 Net investment income of $7.2 million was down $118,000 for the second quarter of 2020, and many more. We are continuing to maintain a higher than usual level of short-term investments and the very low investment rates on those funds further contributed to the decline in the average yield in our portfolio compared to the prior year quarter. Net investment gains of $6.5 million for the second quarter of 2020 compared favorably to the $1.6 million for the prior second quarter.

13:52 The net investment gains in 2020 were due primarily to improvements in the value of equity securities we held at June 30, 2020. as the equity markets rebounded from the COVID-19 concern-driven sell-off at the end of the first quarter. In conclusion, net income excluding net investment gains was $17.6 million or 61 cents per diluted Class A share for the second quarter of 2020 compared to $3.6 million or 13 cents per Class A share for the second quarter of 2019. With that, I'll turn it back to Kevin for closing comments.

14:29 Thanks, Jeff. I want to again thank everyone at Donegal for their resilience and perseverance as we continue to navigate uncharted waters. It's been a challenging time for all of us, and the commitment of our agents and employees has been phenomenal. Despite the headwinds from coronavirus-driven economic disruption, our solid operational results for the second quarter reflected improving underwriting profitability, operational efficiency, and our ability to successfully compete in the marketplace. Our focus on operational excellence is gradually translating into improved financial performance and book value growth. In closing, our goal remains to successfully execute on strategies designed to generate consistent, favorable returns for our stockholders over the long term. With that, we'll ask the operator to open the lines for any questions that you may have. Thank you.

15:20 Thank you. As a reminder, if you would like to ask a question, please press star then the number 1 on your telephone keypad. Again, that is star 1 to ask a question. Our first question comes from the line of Shawn Reitenbach of KBW.

15:36 Hi. So my first question is, what are you guys seeing with workers' compensation claim frequencies in the quarter, and what do you expect that for? Is it going to sustain the current rate decreases going forward?

15:53 Good morning, Sean. Thanks for that question. This is Jeff. We did see a significant decline in frequency in the early months of the quarter, April particularly. Then the second half of May and into June, we saw a fairly steep increase in the frequency that came back very close to kind of our normal claim reporting levels. In some of the regions, we didn't see as much of a drop-off as we did in others, but there was a kind of a short-term decline in the frequency. And one of the things that impacted the overall and the loss ratio for workers' comp is that we did see a lesser amount of favorable prior year reserve development compared to the second quarter of 2019.

16:44 So that somewhat skewed the loss ratio if you compare quarter over quarter. As it relates to the rate decreases that you mentioned, we continue to see some modest declines in the overall rate impact of workers' comp. It's been fairly steady over the last four or five quarters. This quarter was 5.5%, which is relatively close to what it would have been toward the end of 2019. We believe we will continue to see some modest declines in the overall rate impact to our book of business. I know some have been suggesting that we might be nearing a bottom We have not necessarily seen that. We do expect those declines to somewhat moderate, but we're continuing to see very good experience in workers' comp, and so we kind of expect that the rate bureaus and NCCI will continue to show us some lower rates going forward.

17:53 Thank you for that. And then also on auto clean frequency, I think you guys talked about it reverting back. Do you expect that to be kind of sporadic coming back or a steady climb from here? And do you have any read on kind of future frequency in terms of changing consumer habits and what the impacts of that might be?

18:15 Sean, this is Kevin. Yeah, June, we did see, we start to see a return back to some level of normalcy on the auto, on private passenger auto in particular. The activity is clearly picking up, and despite, again, some starts and stops in different regions, we're seeing that there's a lot more activity on the road. If you go back and you just reflect on two months ago, Just even within the state of Pennsylvania, you go back two months ago and you think about what the traffic was like or lack thereof. And today there is a very noticeable increase. And so we did start to see frequency of claims increase in June. As we look forward over the next two quarters, it's very, very difficult to forecast what may happen.

19:09 Our view on it is that we're going to continue to see an uptick in getting back to normal driving habits because we're not anticipating necessarily that you're going to see a shutdown that we had dealt with in April and May. I think that, if anything, by the end of the year, we may get back to that break-even point in terms of loss ratio. So that's what we're anticipating. But again, we're going to be keenly watching it quarter after quarter. and so we'll see what the remainder of the year looks like.

19:44 Thank you. Our next question comes from the line of Bob Farnham of Banning and Scattergood.

19:51 Hey there, good morning. I have a question on the reserve development. One, can you offer kind of the dollar amount of development you saw and two, I wanted to talk about the personal auto because I know that's been a troublesome line. I was kind of surprised we saw a pretty good amount of favorable, you mentioned a pretty good amount of favorable development there, so I just wanted to know what was driving that.

20:20 Sure, Bob, this is Jeff and I'll start with the auto and then I can talk about the other lines, but personal auto favorable development in the quarter was about $3.4 million and we were pleasantly surprised by that number as well. As you know, that was a line that gave us some difficulties a few years ago. And I think that's part of the explanation is that as we strengthened reserves in 2018, we wanted to be sure that we were conservative at that point, and we are seeing some modest favorable development in several of the older accident years, really from 2015 all the way through 2019, we're seeing relatively and a lot of comparable favorable development in each of those accident years for the liability claims. So that would tell us that we got it right in our estimation, at least at this point in time as we're looking back on it, that we were slightly conservative.

21:23 In terms of the physical damage claims, we are also seeing some favorable development in the physical damage portion of the Book, and that contributed about half of the development in the current quarter. And again, the physical damage claims, that's a very short term, short line of business there, short tail line of business. And we know fairly quickly what those claims are going to be. And we had been increasing IBNR over the last several years to make sure that we adequately reserved for primarily weather impact that would spill over from the late accident year into the next accident year. And so most of that's in the 2019 accident year and basically our reserves were redundant in the physical damage portion. As it relates to other lines of business, workers' comp was about $1.3 million of favorable development in the quarter.

22:31 That is much lower. As I mentioned, in the second quarter of 2019, it was as high as $6.5 million, which was unusually high in that particular quarter. We are seeing some moderation in the favorable development in workers' comp, which is not surprising with the rate declines that we've seen over the past two years. But we are pleased to see that that line continues to perform well and to have some modest redundancy in our reserves. The rest of the development is kind of split across the remaining lines. CMP had some modest favorable development, as did homeowners. Commercial auto was roughly pretty much flat. But again, that's a line that we were just pleased not to have any adverse development because it's a line that we've been working on to get our reserves up.

23:24 So hopefully that gives you the color you're asking for.

23:27 Yeah, no, that's good. Yeah, I'm just curious about the auto side. I guess on the higher expense ratio, I know you mentioned a couple factors that was driving that higher. Maybe can you provide more detail as to how much the agent's incentives drove that number higher? And that's the first question. The second question is the reserve for the credit losses. Do you see that continuing or is that more of a one-time charge?

24:01 Sure. Jeff, again, that's an excellent question. The receivable reserve, the premiums receivable reserve, a $1.6 million impact in the current quarter. We don't necessarily expect that to increase. We had put about $400,000 up in the first quarter, so we're sitting with a $2 million reserve for potential uncollectible premiums. Our cash receipts have been very strong. We had suspended cancellations for a 60-day period from the end of March to the end of May. When we ended that suspension, we essentially brought all of those past due balances current and spread them across any remaining installments that our customers had on their policies to give them some additional time to pay those premiums.

24:53 That has resulted in obviously no cancellation activity, and it has and many more. Thank you. were around $800,000 in the second quarter. That is partially, we believe, attributable to, as we look at the strong new business growth that we were able to book in the second quarter, we believe that's partially attributable to those incentives that we put out there for our agents.

25:51 The major impact on the expense ratio was the incentive-based compensation with the better, lower loss ratios The agency compensation, profit sharing, as well as employee incentives, the accruals were higher than they would have historically been. And then also the technology systems related expenses, that was about a $700,000 impact quarter over quarter, specifically related to the technology initiative, what we call Project Nautilus. We expect that will continue throughout the year.

26:26 I assume that the loss ratio-based incentives, that's probably more of a one-time thing based on the auto experience during the quarter, probably returning back to normal, so you're not going to see that huge benefit on the loss ratio going forward?

26:43 That is correct. The expense ratio is directly inverse to the loss ratio in that respect.

26:50 Right. And one more question. Kevin You said that you're probably expecting further premium pressure due to audits and whatnot going forward. Can you give us any color as to maybe what you've seen thus far in terms of audits?

27:08 Yeah, we really have not completed many of the audits at this point. What we've done, Bob, is for the first six months really had backed off in terms of the access to the accounts. So one of the challenges that we're having is trying to forecast what that premium adjustment might be. As noted in my comments, there was a premium adjustment of about a million dollars so far. One of the things that we're seeing, though, is the accounts are paying their premiums. We're not having a lot of businesses go out of business. The interactions that we've had with our agents and working closely with them, they tell us that despite the economic challenges, the majority of their accounts are in business, even if they're partially reopened.

28:03 And so those are all very, very positive signals. Where we end up in terms of potential premium reductions is to be determined. I would hate to forecast that at this point.

28:18 All right. I thought I'd give it a try. See what you thought.

28:25 I appreciate the effort. You're not the only one that's asked that question.

28:28 I'm sure. Okay. That's it for me. Thanks, guys.

28:31 Thank you. Our next question comes from the line of Jamie Inglis of Philo Smith.

28:40 Hi. Good morning, guys. Hey, Jamie. Can you talk about the homeowners line? The all in the combined ratio improved by about four points. And you talked to weather-related losses, maybe one point of that. What else is behind that?

29:04 Sure, Jamie. This is Jeff. A couple of metrics here I can give you to help explain. So the core loss ratio in homeowners in the second quarter of 2019 was around 27.3%. That actually declined to 24.9% in the second quarter of 2020. The weather impact was about five points higher in 2020. The fire loss impact was about two points lower, and the remainder was kind of a shift in the development impact. So we had a An adverse development impact in the second quarter of 2019 of just around five points, and we had favorable development of about three points in the second quarter of 2020. So a number of moving parts there that contributed to the decline quarter over quarter.

30:03 And we have reduced some of our exposure as well in terms of some of the homeowners' numbers of policies in the past year. That's correct. Okay.

30:13 Okay, good. In switching over to commercial auto, which showed a nice improvement obviously for the reasons you talked about, what I'm trying to get a sense of is do you have any feel for what might have happened to the loss ratio had Miles Driven been the same or whatever? I mean, you guys have done a lot to improve the underlying book of business. Can you get a sense of whether that impact is still working for you or is it not helping anymore? Any more thoughts on that would be great.

30:52 The continued action that we're taking on it has absolutely helped. I also asked Jeff to comment on this as well. It would be very, very difficult to forecast The impact that the pandemic has had on the loss ratio for commercial auto. Clearly, less miles driven, less activity has had some role. To pinpoint that is going to be very difficult. What we've continued to do is be fairly aggressive on taking rate. Average rate for the second quarter was 8.3% in commercial auto. And we've also taken several steps to limit just the exposure of having the number of vehicles that we're currently writing. And that does vary by geography.

31:39 So we have certain regions that we have continued to struggle with in terms of getting our commercial auto profitable. And as you can imagine, we're being more aggressive in that area, not just on rate, but also from an underwriting standpoint and limiting exposure going forward. Other regions have performed adequate. and so we continue to take rate but we're not being as aggressive in terms of limiting exposure from that standpoint. So we hope that over the next continued quarters that that is going to continue to work itself through the book of business and we'll continue to see a drop in loss ratios.

32:18 Yeah, this is Jeff. Just to add to that, I think one other consideration is that we have been raising rates now for almost three years. On average, over the past two years, our rate increases, quarterly rate increases have been just under 9%. This is the third year that we're reporting rate increases in excess of 8%. There's a compounding of those rate increases over the last several years. Despite that, we've continued to struggle to get that line of business profitable, but We do believe that that significant additional rate will eventually compensate for the loss ratio. As Kevin said, it's really unfortunate in some respects that we've had the pandemic effect because it's difficult to parse that experience improvement from what would have happened in the absence of it.

33:26 We're continuing to work at that line of business, and we do expect that the – we know that the decline in claim frequency on the commercial auto was much less impactful than it was in the personal lines, obviously. But there was some impact there.

33:46 Okay, great. Thanks a lot. Thank you. Once again, if you would like to ask a question, please press star one. Your next question comes from the line of Douglas Eden of ECM.

34:00 Good morning, Kevin and Jeff. Good morning, Doug. Yeah, congratulations on another strong quarter. And it hasn't gone unrecognized at all that you've now reported six straight quarters of stable reserves and favorable loss development. So well done by you all on the team. I do have two questions. First, is Mountain States still on track to come into the public company domain? I think we talked before about January or sometime in the first quarter of 2021. And number two, any sense, I know it's a little bit early perhaps, but on reinsurance pricing, I know you guys go well out in advance talking to the brokers with regard to COVID and so forth. Any sense on what reinsurance pricing is going to be for you all at the next renewal?

34:51 Doug, this is Kevin. Appreciate the supportive comments on our results. As far as Mountain States is concerned, it is on track. We are looking for a January, probably a January timeframe that we would bring them into the pool. The results have continued to get better quarter after quarter. and Jeff and I continue to look at it on a monthly basis, just making sure that the book of business is reflecting the changes that we've, the underwriting changes that we made a couple years ago. We're continuing to see some solid growth in a couple of those states that we've got a targeted, one of which is Utah. And so right now that is currently on track and we're pleased to be able to potentially bring them in, so.

35:41 and I'll defer to Jeff on the reinsurance question.

35:45 Sure. It is a bit early, Doug, as you can imagine. We've just started to talk to our intermediaries about the reinsurance renewal. We're pulling together information data to provide to the reinsurance market in the next month or two. And the early indications are that certainly there's a lot of talk about reinsurance rates firming and that will be somewhat and many more. Depending upon the individual loss experience of a given carrier, we expect that there will be some pressure on our reinsurance rates going into 2021. We have had some loss activity on the property for risk side, not so much on the casualty side and not on the CAT side. So, we don't expect any significant rate increase, Pressure on the casualty program as social inflation continues to be a concern of the reinsurers and certainly now with the COVID losses that could put some pressure on reinsurance rates even though we haven't had any COVID losses directly.

36:58 We do expect there will be a lot of attention on the exclusionary wording related to the pandemic losses. and that doesn't necessarily concern us because all of our policies have those exclusions but we expect that the reinsurance contracts will the reinsurers will want some sort of exclusions on the reinsurance side as well.

37:24 That's helpful. Thanks to you both. Another great quarter.

37:27 Thanks Doug. At this time there are no further questions. I'll now return the call to Jeff Miller for any additional comments.

37:38 We appreciate everyone's participation today. Thank you for joining the call and we look forward to speaking to you again after reporting our third quarter financial results. Have a great day.

37:47 Thank you.