Donegal Group Inc Q1 FY2020 Earnings Call

Ladies and gentlemen, thank you for standing by, and welcome to the Donegal Group Inc. First Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker 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 your speaker today, Mr. Jeff Miller, Chief Financial Officer. Thank you. Please go ahead, sir.

Thank you very much. Good morning, everyone. Welcome to the Donegal Group conference call for the first quarter ended March 31, 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, will provide an update on our business strategy and highlight recent developments. I'll follow Kevin's comments with an overview of our quarterly financial details. At the conclusion of our prepared comments, we will open the line for any questions you might have. Before we get started, you should 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. We use certain non-GAAP financial measures to analyze our business results, and we refer you to the reconciliation of non-GAAP information included in the news release that we issued yesterday. With that, I'll turn it over to Kevin.

Thanks, Jeff, and welcome, everyone. I want to start by thanking our employees and independent agents for their dedication and commitment as we navigate through these challenging times. Like many companies, Donegal has mobilized a remote workforce with the majority of our employees working from home to ensure the continuation of vital services to agents and policyholders. I'm extremely proud of our team for pulling together during this crisis and making the necessary adjustments to maintain high standards of professionalism and exceptional customer service. Since it's on everyone's mind, let's start with the impact of COVID-19 and our response to date. Following advice from health officials and government shelter-in-place mandates, we implemented a business continuity plan to protect our employees and their families while continuing to provide services to agents and policyholders without disruption. Our core operations are functioning effectively, and we've been able to have regular communications with employees and agents to address challenges associated with operational changes. COVID-19 had a minimal impact on our first quarter 2020 results, and we were overall pleased with those results, which we will discuss shortly. We have now turned our attention to the second quarter and the remainder of the year to assess the impact of COVID-19 on our business. There are many questions at this time, but in the coming weeks and months, we'll gain a clearer understanding of the true economic impact, and we'll adjust our business plans as necessary. For those evaluating the long-term effects of the pandemic on our insurance operations, it's crucial to consider the types of risks we insure. Our business mix is approximately 60% commercial lines, mainly commercial multi-peril, commercial auto, and workers' compensation insurance. Most of our insurance accounts are small to medium-sized main street businesses, such as contractors, mercantile, service companies, office buildings, and restaurants. Our personal lines mainly consist of personal auto and homeowners insurance. Aside from Pennsylvania, which represents about 35% of our premium volume, we do not have significant geographical concentration. Based on what we know now and considering the diversity of our lines of business, we do not anticipate a significant financial impact from claims directly related to COVID-19, and we did not record any explicit reserves for these claims in the first quarter. Our policies require direct physical loss for coverage to apply, and nearly all also have the standard virus exclusion language. Still, we may incur additional costs to defend against litigation challenging coverage definitions and exclusions. We believe our exposure to virus-related workers' compensation losses is limited, but we are monitoring legislative efforts to expand occupational disease presumptions beyond healthcare workers and first responders to include more broadly any workers serving essential businesses. While we expect a short-term decline in claims due to reduced driving and business activity from shelter-in-place restrictions, it is too early to predict the ultimate effect of various factors on future profitability. Broad initiatives to expand coverage for business interruption and workers' compensation could severely impact our company and the industry as a whole. We concur with the thoughts of industry advocates and peer executives that forcing insurers to cover losses not intended in the coverage would destabilize the insurance industry and jeopardize its ability to protect customers. We commend our industry advocates and larger peer companies for educating legislators on these potential financial impacts and defending against attempts to broaden coverage beyond contractual obligations. When we last spoke in February, we highlighted several favorable trends from our fourth quarter 2019 results, which we believed would provide momentum into 2020. For instance, we surpassed our business plan targets for new commercial premium growth and enjoyed benefits from premium increases related to prior pricing actions throughout 2019. With COVID-19's emergence, we are closely assessing its impact on our 2020 business plan goals and will make adjustments as warranted. We will continue to adapt and comply with regulatory requirements and meet the challenging needs of our customers given the ongoing economic impact of COVID-19. Now, regarding the first-quarter results, we reported net income of $3.7 million or $0.13 per diluted Class A share. Our insurance operations saw improved underwriting performance, with a combined ratio of 97% compared to 99.3% in the first quarter of last year. However, this strong performance was offset by net investment losses of $10.7 million, largely due to unrealized losses in equity securities as COVID-19 concerns led to a significant drop in U.S. equity markets. The net income and a modest rise in the value of fixed maturity investments resulted in a 1.6% increase in book value to $15.92 at March 31, 2020, from $15.67 at December 31, 2019. Jeff will provide more details about the first-quarter results, but I want to focus on our insurance operations, noting that the first-quarter trends primarily occurred before COVID-19. We continue to seize opportunities for commercial premium growth, as our agency partners submitted a greater volume of new accounts. We also made strides toward sustainable, profitable growth in our personal lines business, including our exit from personal lines markets in seven states where we hadn't achieved profitability. Commercial premiums comprised about 61% of our net premiums written in the first quarter of 2020, compared to 57% in the first quarter of 2019, influenced by the seasonal renewal of numerous commercial accounts on January 1st. While we saw growth in all commercial lines, commercial auto premiums increased the most at 11.9%. As mentioned in our previous call, we are pursuing further rate increases in our commercial auto segment. The impact of rate increases was 10.8% for commercial auto and 2.9% for the entire commercial segment for the first quarter. Our commercial retention levels were stable during the first quarter of 2020, reflecting general market stability and the strong relationships our agents maintain with customers, along with our mutual commitment to provide excellent service. As the COVID-19 pandemic gradually diminishes, we anticipate promising opportunities to grow and increase scale in commercial lines across our regions. In terms of workers' compensation, we were pleased to see positive growth in this line despite a challenging rate environment in several regions. New business writings outweighed rate reductions, which continue to yield profitable outcomes. However, we remain cautious in underwriting new accounts and renewals given the declining rate environment and COVID-19 uncertainties. We are pleased that our commercial lines segment achieved a statutory combined ratio of 96% for the first quarter of 2020, similar to the 96.4% combined ratio from the previous year. Moving to personal lines, net written premiums fell by 11.2% in the first quarter of 2020. In February, we completed our exit from personal lines markets in seven states where we had not been profitable recently. The adjustments made in our personal lines business have led to improved underwriting performance, with the statutory combined ratio decreasing to 94.7% in the first quarter of 2020 from 97.8% in the previous year. The improvement stemmed mainly from fewer weather-related losses, positively impacting our homeowners line, where we achieved a combined ratio of 90.7% for the quarter. Our personal auto results, however, did not reach our targeted profitability level but showed modest improvement due to prior rate increases and underwriting adjustments. Our personal automobile results for the first quarter were essentially at breakeven, with a combined ratio of 100%. We expect further improvement in our personal lines business as we work to stabilize that segment and prepare to introduce new auto and homeowners products in 2021. With that, I'll turn it over to Jeff for more specifics about the quarter, and then I'll return with some closing remarks.

Thanks, Kevin. As usual, I'll highlight a few of the operational and financial metrics for the first quarter, and we'll be glad to address any questions later in the call. Overall, net premiums written decreased 0.8% to $198.2 million, and net premiums earned declined 0.4% to $187.3 million for the first quarter of 2020. Net premiums written for commercial lines increased 7.1%, while personal lines net premiums written declined by 11.2% during the quarter. We attribute the strong growth in commercial lines to market share gains by many of our insurance subsidiaries and a continuation of renewal premium increases. As Kevin mentioned, commercial renewal pricing increases averaged 2.9% for the quarter in total, as a 10.8% average rate increase in commercial auto was partially offset by a 3.8% average decrease in workers' compensation rates. In terms of trends, we continue to obtain higher pricing in commercial auto with increases well into double digits for accounts with loss experience or located in areas where a challenging legal environment is driving higher loss costs. As was the case throughout 2019, the reduction in net premiums written in our personal lines was largely due to lowered new business growth and the impact of our exit from the personal lines markets in seven unprofitable states, that were partially offset by rate increases that averaged 2.2% for the quarter. We had planned to continue implementing modest personal lines rate increases in 2020 to maintain the level of rate adequacy we worked diligently to restore over the past 18 months. But we will revisit those plans in light of the COVID-19 impact as the year progresses. Moving to underwriting results. We reported a 62.6% loss ratio for the first quarter of 2020, which compared favorably to the 65.5% loss ratio for the first quarter of 2019. Weather-related losses of $6.9 million or 3.7 percentage points in the loss ratio for the first quarter of 2020 were lower than the $9.7 million or 5.1 percentage points in the loss ratio for the first quarter of 2019. Weather loss activity for the first quarter of 2020 was also lower than our previous five-year average of $10.7 million or 6.3 percentage points of the loss ratio for first quarter related, weather-related losses. We did not receive substantial claims from any major storm or weather system during the quarter. Large fire losses, which we define as individual fire losses in excess of $50,000, for the first quarter of 2020 were $6.3 million or 3.4 percentage points of the loss ratio. That amount was in line with the large fire losses of $6.6 million or 3.5 percentage points of the loss ratio for the prior year quarter. We had favorable reserve development for losses incurred in prior accident years of $4.3 million, reducing the first quarter of 2020 loss ratio by 2.3 percentage points. With the exception of modest unfavorable development in our homeowners and commercial auto lines, we experienced favorable development across our lines of business in the first quarter of 2020. The expense ratio was 33.4% for the first quarter of 2020 compared with the 32.6% expense ratio for the first quarter of 2019. We primarily attribute that increase to an increase in technology systems related expenses and higher underwriting-based incentive costs for the first quarter of 2020. In total, our combined ratio was 97% for the first quarter, comparing favorably to the 99.3% combined ratio for the prior year quarter. Net investment income of $7.4 million was up 4.6%, primarily due to an increase in average invested assets relative to the prior year first quarter. Our average investment yield declined modestly due to a $58.7 million increase in short-term investments during the first quarter of 2020. While we have not experienced any material decline in cash flows to date, we are maintaining a high level of liquidity until we have a better idea of the ultimate cash flow impact in the coming months. In light of the uncertainty about the potential impact of COVID-19, as the crisis began to escalate in mid-March, we decided to borrow $50 million from the Federal Home Loan Bank to bolster our liquid assets as a measure of providing increased financial flexibility should we need it. The current yield on our additional short-term investments is fully offsetting the modest borrowing costs related to the FHLB loan. Net investment losses of $10.7 million for the first quarter of 2020 compared to net investment gains of $18.1 million for the prior year first quarter. The net investment losses in 2020 were due primarily to unrealized losses in the value of equity securities that we held at March 31, when the equity markets had declined sharply from year-end 2019 due to COVID-19 concerns. As a reminder, the net investment gains for the first quarter of 2019 included $12.7 million from the sale of Donegal Financial Services Corporation as well as unrealized gains in the value of equity securities at that quarter end, as a result of the general market recovery from year-end 2018 levels. In conclusion, net income for the first quarter of 2020 was $3.7 million or $0.13 per Class A share compared to net income of $23 million or $0.82 per Class A share for the first quarter of 2019, which included the gain on the sale of our former banking subsidiary. With that, let me turn it back to Kevin for some closing comments.

Thanks, Jeff. I want to again thank everyone at Donegal for rising to the occasion, as we continue to work through this incredibly challenging time. We've been working hard in recent years to enhance underwriting profitability, improve operational efficiency, compete more effectively, and ultimately, to further improve financial performance and enhance our book value growth. We were pleased to see positive momentum in the first quarter, and we look forward to continuing that progress as we persevere through and ultimately move past the current challenges. 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.

Your first question is from Bob Farnam with Boenning and Scattergood.

So I have a question on Workers' comp exposure. So obviously, you've had a few states that have put out some presumption of compensability for front-line workers and first responders. How much of your book is potentially exposed to something like that?

Bob, this is Jeff. Thanks for that question. We have looked at our Workers' comp exposures, particularly in light of a medical type of exposure. And we do insure a modest amount of medical facilities, such as urgent care centers, family practices in rural areas. Most of those are smaller in comparison with some of what you might think of in larger cities. We have not, to this point, received any Workers' compensation claims related to anyone who is positively tested for the COVID-19 virus. So we do not currently expect to have a significant amount of exposure to Workers' compensation claims. But as you have mentioned, there are some legislative attempts to expand the presumption of the Workers' compensation, the contracting of the disease relative to the occupational involvement of workers that are not necessarily just healthcare workers but also workers that are working in essential businesses. So we're monitoring all that. That could have an impact if those presumptions were to stand. We've noted that a number of those efforts have now been withdrawn. So we currently do not think we have a significant exposure to it.

Okay. I have two questions about your agents. First, how capable are they of writing new business while primarily working from home? Second, have they provided any insights regarding how their customers are doing? Are many of the customers completely shut down, operating at reduced capacity, or unaffected?

Bob, this is Kevin. Regarding the first question about our agents' ability to write new business while working remotely, I believe that most, if not all, of our agents are well-equipped to do so and are eager for the chance. The larger question relates to the second part, which remains uncertain. We have observed new business opportunities in commercial lines that contributed to a strong first quarter. We're also seeing promising prospects for the second quarter. However, there are indications that opportunities for new business may be diminishing. The statistical implications of this are unclear to me. Our agents have adapted well to remote work and are ready to pursue new business, but it ultimately depends on the broader economic outlook in the next 90 days and six months, which remains uncertain.

How has your kind of the policy retention been in the commercial lines? I'm assuming you have a lot of these main street businesses and stuff. Have they been pretty quick to renew? Is that a fair statement?

Policy retention is currently strong for both personal and commercial lines. Looking ahead, I cannot predict how this will change in the next three to six months. Presently, most of our businesses are renewing their policies and paying their premiums. The key factor will be whether the current economic shutdown continues for another 30 days. If it does, some businesses might rebound, but if it lasts for 60 or 90 days, the situation would significantly change. I cannot speculate on how many businesses might struggle to recover if the shutdown is prolonged beyond 30 days.

Our next question is from the line of Douglas Eden with ECM.

Congratulations on a solid quarter, especially given what is going on in the world currently. I have two questions also. First, now that there have been 4 quarters of nonrenewals of personal lines in the 7 states that we've been talking about, are you envisioning the rate of premium declines in that segment to improve going forward? And second, with regard to work comp and the softness in the pricing that you articulated in that line of business, are you continuing to add reserves at a faster clip than the overall premium growth in order to protect ourselves against some unexpected higher claims development in the future?

Well, Doug, let me talk briefly about the personal lines piece, and I'll ask Jeff also to comment, particularly on the Workers' comp side. For personal lines, that is the plan, as you have noted. With the 7 states now, that is completed, we have taken over the past year some modest rate increases as it relates to personal lines as compared to the prior 18 months where we were very aggressive. And so the business plan calls for more moderation in terms of the personal lines numbers. And so our business plan really calls for a very low single-digit decrease through the remainder of this year. And that was the plan, obviously, prior to COVID-19. But that is the plan, and I think that we will start to see that.

Doug, this is Jeff. On the Workers' compensation front, yes, we are, as you stated, we are seeing some moderation and some reductions in the overall premium rates. Just to give you a sense of that, in the first quarter, the premium rate impact was, I think I mentioned in my prepared remarks, a 3.8% decline. Over the past two years, the average decrease has been about 2.7%. That's the average quarterly decline. So the premium rate reduction has been somewhat modest. We are taking a more conservative view of the loss ratio for 2020. Our pick was higher than it would have been in the past several years. The core Workers' compensation loss ratio that we recorded was 62.7%. That is just modestly higher than what it has been over the past two years. But it is a couple of points higher than it would have been a year ago in the first quarter. So we are expecting some modest increase in the overall loss ratio. But as you saw in the combined ratio for Workers' comp, it's still quite profitable, and we expect that to continue. So with a 90% combined ratio in Workers' comp, there is some room there for some modest deterioration in that loss ratio.

Okay. And you think you're reserving for it. I know in the past, Jeff, you've mentioned adding more, a higher level of reserves to the line relative to the premium growth, just to protect the company for the future because that line, in particular, can have some unwelcome surprises. And it sounds like you continue to do that in 1Q?

We did. And as you can imagine, with our smaller businesses, many of them not being up and running in operations, currently, we have to take a look at what we do for the second quarter in terms of reserving. But certainly, we are expecting that we will see the reserves increase at a higher rate than premiums in this current environment.

Okay. And one final, if I may. Regarding the technology initiatives, how was COVID-19 and people working from home, has that delayed or made any change to the plans with regard to the rollout and the phases that you all put together such a detailed plan around? So what's been the impact on that that you're envisioning?

Well, we did have to take a 30-day pause, if you will, when travel restrictions started to be implemented, of course, with some of the external vendors that we use and rely on as well. And so it did create about a 30-day pause on what we call Project Nautilus, which is that modernization of our legacy systems. Happy to report, two weeks ago, we started the next phase of that. So as everyone settled in to working from home and working efficiently with our external vendors, we have now started the next phase of that project. And we did, we completed release 1. And so the timing of it, the timing is never good with the current situation that we're dealing with. However, we did complete release 1. It was fully deployed. Things went very well, and then COVID-19 showed up. And so we were thankful that we were not midstream in terms of one of these major releases. We had just completed the first release that went well. We paused for 30 days, Doug. And two weeks ago, we started back in. And so we're watching the progress that we make on that.

Your next question is from Meyer Shields with KBW.

I have one big picture question for Kevin. I'm trying to get a handle on what insurance agents are actually looking for as we go through the crisis?

What insurance agents are looking for? Well, first and foremost, they're anxiously awaiting to see, from an economic standpoint, when the various states, because it varies state-by-state in terms of opens up the economy. Georgia is a good example. As we know, Georgia has been opened up somewhat in the last week. And so we'll be monitoring what actually occurs within that state. In the 24 states in which we operate, that's going to vary. So the agents are anxiously awaiting to see that part start to open up. Secondly, they have gotten very efficient in terms of being able to work remotely. There, we've put together some aggressive plans to help them grow on the commercial lines side of it. So the agents are in a position where they're ready to move forward, but at the same time the macro issues at hand are limiting their ability to grow. We work very closely with our agents. We've got a great relationship with our agency partners. But, Meyer, I wish I had a clearer picture from an economic standpoint of what they might be looking for. And I also ask Jeff if he's got any additional comments as it relates to that?

Yes. We have been in constant communication with our agents and our marketing group. They are also seeking flexibility. We are striving to be as accommodating as possible for our customers. On the commercial front, we are endorsing policies that reduce payroll exposures. For instance, we are offering commercial auto layup options, allowing businesses to set aside unused commercial vehicles and avoid premiums for those vehicles. Regarding premium receivables, we have, like many other insurance companies, suspended any cancellation activities for at least 60 days and are not charging late fees for customers who are struggling to make their premium payments. This flexibility is crucial, and we emphasize it to our agents, ensuring that we will do everything possible to support our customers during this challenging period.

Okay. No, that's very helpful. I think that will pay off in the long term. Are you changing your new money investment allocation to possibly reduce investment risk even more due to the emerging risks currently?

Well, as you know, Meyer, we have a very conservative approach to our investment portfolio with a very modest allocation to equity securities, which, of course, served us well in the past 30 days or so. We are not making any significant changes, although we have been building liquidity. And if you looked at our balance sheet, we had, I think, $125 million of cash and short-term investments at the end of March, which included the $50 million that we borrowed from the Federal Home Loan Bank. So we've been building kind of a war chest of potential money if we need it now. To this point, as I said earlier, we really haven't seen a significant decrease in our incoming cash flows. And with loss activity down somewhat from the lower business activity and driving activity, we're in really good shape. But we're not really investing as aggressively as we may have in the bond portfolio, although there have been some opportunities that we've taken advantage of to put some money to work. But at this point, we're taking a very conservative approach, not necessarily investing in more equities or any other risky classes of investments, but trying to make sure that we maintain some level of investment yield, especially as the interest rates have dropped significantly. So far, in the second quarter, we've been able to maintain the investment yield in terms of what's been maturing and what we've put back into the portfolio. So we're kind of holding our own at this point.

There are no further questions.

We appreciate everyone's participation and the good questions. And we look forward to speaking with you again after we release our second quarter results. So thank you, everyone.

Thank you.

This concludes today’s conference call. Thank you for your participation. You may now disconnect.