Q4 2022 Donegal Group Inc Earnings Call (Pre-Recorded)

<unk> 22 earnings release outlining its results the release and the supplemental investor presentation are available.

Turning to earnings release outlining its results the release and the supplemental investor presentation are available in the Investor Relations section of <unk> website at Www Dot Donegal group Dot com.

Please be advised that today's conference was pre recorded and all participants are in listen only mode. After management remarks, there'll be a question and answer session for questions submitted ahead of the call.

Speaking today will be president and Chief Executive Officer, Kevin Burke, Chief Financial Officer, Jeff Miller, Chief Underwriting Officer, Jeff, Hey, Senior Vice President of field operations, Dan Telemeter.

Chief Investment Officer, Tony VIP.

Please be aware that statements made during this call that are not historical facts are forward looking statements and necessarily involve risks and uncertainties that could cause actual results to vary materially.

These factors can be found in Donegal group's filings with the security and Exchange Commission, including its annual report on Form 10-K, and quarterly reports on Form 10-Q, the company disclaims any obligation to update or publicly announce the results of any revisions that they may make to any forward looking statements to reflect the occurrence of any.

Dissipated or unanticipated events or circumstances after the date of such statements.

With that it's my pleasure to turn it over to Mr. Kevin Burke Kevin.

Thank you Karen and welcome everyone from a growth and profitability perspective, our performance in the fourth quarter of 2022, largely reflected the continuation of the trends we experienced throughout the year.

Anyone following the insurance industry knows how impactful the current inflationary environment has been for insurance carriers are historically unprecedented spike in loss cost is cause, particularly harsh impacts to carriers with substantial volumes of personal lines business, where the process of obtaining regulatory approvals extends the timeline.

For implementing rate actions that are necessary to respond to rapid increases in loss costs and general profit improvement, while our 2022 financial results did not meet our long term profitability targets I am proud of the diligent efforts of the entire Donegal team as we continue to navigate through the inflationary challenges and took aggressive.

<unk> of actions to position our company for future growth and success, we made significant progress in a number of strategic initiatives during the year and I will provide a summary overview of our accomplishments during the year in the call today.

I will then hand, the call over to Jeff Miller for a review of our financial details who will then be followed by Jeff Hey for a deeper dive into our commercial and personal lines segment performance.

You will also hear from Dan Delamater, the head of our field operations for the Donegal Insurance group, who will provide you his perspective on our sales and marketing efforts and opportunities as we move into 2023.

Tony <unk> will end, our prepared remarks with an investment update before we respond to questions. We received in advance of this call.

We had several strategic areas of focus for 2022 and I am pleased with the progress we made in each first we maintain growth momentum within our commercial market segment, we made substantial progress in rebalancing, our commercial risk portfolio through the successful execution of state specific strategies that Jeff Hey will cover in more.

Later in the call.

While the level of commercial new business writings fell short of our business plan that shortfall was more than offset by excellent premium retention that was supported by solid renewal premium increases we achieved throughout the year.

<unk> been providing regular quarterly updates on our multi year systems modernization project. Following the successful launch of new personalized products in three states in the fourth quarter of 2021, we continued our new product rollout and six additional states throughout 2022.

While we are waiting final regulatory approval to introduce new products in Michigan, which will be the 10th and final state to complete this initiative.

We are pleased that the new product launch and rollout has been successful to date and our agents have responded favorably to what was essentially a reentry into the personal lines market.

We are actively monitoring the pricing of our new products and the underlying risk characteristics of the policies. We are writing as well as carefully managing our growth in the current environment.

The systems modernization project team has been working for over the past two years on the next software release, which is on track for deployment at the end of March. This release will include a new sophisticated business owners product along with modernized commercial auto and umbrella products that incorporate advanced predictive models for refined risk.

Pricing and underwriting the release will also enable enhanced straight through processing capabilities that we expect will allow us to attract a higher volume of small commercial accounts, we will be focusing our efforts on the small commercial market as our primary source of profitable commercial lines growth over the next few years in terms of timing.

We plan to introduce the new systems and products in three states in the second quarter of 2023, followed by the remaining 22 states in the third quarter. We are currently offering commercial lines products in 24 States and we'll add the state of Arizona to our service area as part of this rollout we added experienced leadership.

Talent to augment our team during the past several years and we're making great strides towards moving the organization forward at a rapid pace.

In addition to forward progress in data analytics business intelligence on underwriting portfolio management, we are focusing on operational excellence process improvement and data driven decision, making we have enhanced our analysis of loss trends and rate indications as well as our regional business planning and performance monitoring processes.

That include detailed state strategy reviews and monthly monitoring.

We remain committed to our strategic plan that we believe will help us achieve sustained excellent financial performance, we have more work to do but I look forward to reporting to you the favorable impact of these efforts in future periods. At this point I'll turn the call over to Jeff Miller for a review of our financial results.

Thank you Kevin for the fourth quarter of 2022 net premiums earned grew by six 5% to $213 million. We achieved net premium written growth of 10, 2%, which was mostly related to higher new business writings in personal lines strong retention results and premium rate.

Creases that averaged eight 9% for all lines, excluding workers' compensation.

Our underwriting results were impacted by elevated weather related losses, and ongoing inflationary pressures on loss costs for property in automobile physical damage coverages.

The overall combined ratio for the fourth quarter of 2022 was 102, 8% compared to 101, 6% for the prior year quarter.

The deterioration of the combined ratio was primarily driven by an increase in the expense ratio, which we primarily attribute to higher technology costs related to our ongoing systems modernization initiatives.

The fourth quarter loss ratios were comparable for 2022, and 2021 as higher weather related losses in the fourth quarter of 2022 were largely offset by a higher benefit of net favorable development of reserves for losses incurred in prior accident years compared to the prior year quarter.

Weather related losses totaled $16 5 million or seven seven percentage points on the loss ratio for the fourth quarter of 2022.

We incurred $5 million in losses from Winter Storm Elliott in late December with our reinsurance agreement with Donegal mutual limiting the net impact of that amount.

Total quarterly weather claim impact was higher than our previous five year average of four four percentage points for the fourth quarter.

We experienced favorable net development of reserves for losses incurred in prior accident years of $14 $2 million or a six seven point reduction in the loss ratio for the fourth quarter of 2022 compared to $5 3 million, where a two seven point reduction in the loss ratio for the same periods last year.

Our insurance subsidiaries experienced favorable development, primarily related to reserves for accident years, 2019, 2020, and 2021 and personal automobile commercial automobile and homeowners lines of business, where actual loss emergence during 2022 was lower than our actuarial.

That's at the end of 2021.

Large fire losses contributed six two percentage points to our fourth quarter of 2022 loss ratio slightly higher than the five five percentage point impact of the loss ratio of the prior year quarter with.

With an increase in commercial fire severity due in part to higher cost of repairing damaged properties.

Our core loss ratio, which excludes the impact of weather large fires in prior period Reserve development was relatively in line with the prior year quarter with both periods, reflecting an elevated impact of inflation.

The underwriting loss, we experienced for the fourth quarter of 2022 was more than offset by $9 $4 million of investment income and $626000 of net investment gains contributing to after tax net income of $3 $5 million.

Turning briefly to results for the full year of 2022, we achieved a 6% increase in net premiums earned and net premium written growth of four 9%, which was mostly related to higher new business writings in personal lines strong retention results and premium rate increases averaging seven 2% for <unk>.

All lines, excluding workers' compensation.

Our full year underwriting results also reflected the ongoing inflationary pressures on loss costs I mentioned earlier.

The overall combined ratio was 103, 3% for the full year of 2022 compared to 101% for 2021 the.

The increase in the combined ratio was primarily driven by a higher loss ratio.

Weather related losses contributed seven seven percentage points to our 2022 loss ratio, which was just slightly higher than our seven two percentage 0.5 year average weather impact, but was nearly two percentage points higher than the 2021 weather loss impact net favorable development of reserves for losses incurred in <unk>.

Fire accident years reduced the loss ratio by five four percentage points for 2022 compared to a four percentage point reduction for 2021.

The expense ratio of 34, 1% for the full year 2022 increased compared to 33, 3% for 2021, primarily related to the impact of higher technology systems related costs investment income of $34 million for 2022 was more than offset by the underwriting loss.

And net investment losses of $10 $2 million, resulting in a $2 million after tax net loss for 2022 compared to $25 3 million of net income for 2021.

With that I will turn the call over to Jeff Hey to provide more details about our commercial and personal lines segment results.

Thank you, Jeff while our underwriting results for the fourth quarter and full year 2022 fell short of our long term profit objective, we did take aggressive steps throughout 2022 to improve our results across our operations.

As I summarized the drivers of our fourth quarter results in both commercial and personal lines segments.

Also discuss many of the actions we've taken to date along with additional actions we plan to take to generate more favorable results in future periods.

I'll start with our commercial line segment, we continued our controlled growth momentum in commercial lines net written premiums for the quarter, taking a more conservative approach to new business opportunities as we continue to manage through the challenging inflationary impact on loss trends.

Premium retention remains strong in the fourth quarter holding in the mid 90 percentage range across most of our lines of business largely resulting from strong quarterly average rate increase of nine 4% excluding workers' compensation.

Retention levels were lower in our Midwest and southeast regions, where we're taking more aggressive non renewal actions to drive profit improvement. We also experienced a lower average negative rate impact in workers compensation as we utilized various underwriting levers to offset filed bureau loss cost decreases were experience warrants that action.

I mentioned in prior calls that we would refine the commercial auto rate guidance, we provide to our underwriters, thereby enabling them to pursue more rate on risks that are under priced in order to accelerate improved margins within their risk portfolios.

I'm pleased to report that we're achieving stronger rate increases in our lowest margin business and maintaining a higher retention levels in our highest margin business.

Now providing similar rate guidance for other lines of business in our commercial lines segment.

Moving on to claim trends in the quarter, although claim frequency generally remained in line with historical averages. We continue to see elevated severity trends across most of our commercial lines of business as inflationary pressures continue to drive increases in loss costs, particularly in our property and auto physical damage coverages.

As Jeff Miller reported earlier weather related losses in our commercial segment were elevated compared to previous five year averages.

The increase was largely driven by the freeze event in late December that led to a significant volume of water damage claims from frozen pipes, including ruptured sprinkler lines in commercial properties as temperatures plummeted throughout a wide area of the country, while more than half of the claims occurred in our flagship state of Pennsylvania. We also received claims throughout our operating.

<unk>, including Georgia, Virginia, Maryland, Ohio, and Michigan.

While the majority of the claims were related to homeowners losses. The majority of the loss impact was in commercial property, where the average claim severity was much higher including several large claims due to extensive water damage and lost income large fire losses in the fourth quarter were slightly elevated compared to the prior year quarter, but down significantly from the third quarter of 2022.

Although the frequency of fire losses remains largely in line with that of the fourth quarter of 2021, we experienced higher severity, which has been a recurring theme throughout the year that we attribute in part to the higher cost of materials and labor to repair the damage properties.

It has been difficult to find commonality and the underlying causes of the large fire losses, we've incurred over the past few years, we have identified a handful of classes of business and certain property risk characteristics that have higher than average vulnerability to fire losses, and we're taking immediate actions to reduce exposures in those class.

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For commercial auto we're pleased to see our fourth quarter core loss ratio improved over 10 percentage points from the prior year quarter, which we can attribute in large part to profit improvement actions, we've implemented over the past several years.

Those actions included a substantial reduction of commercial auto exposures in the state of Georgia, and the provision of enhanced rate guidance to our underwriters that I mentioned earlier for commercial multi peril. We saw three five percentage point improvement in the fourth quarter core loss ratio compared to the prior year quarter.

We achieved an average rate increase that exceeded 9% in this line for the fourth quarter and we expect to push 2023 rate increases for this line into double digit percentages as well as adjusting our automated inflation factors to increase property exposure values by 8% beginning in the first quarter we.

We expect our commercial multi peril line performance will improve as we earn a significant additional rate and as we reap the benefits of numerous underwriting actions, including targeted non renewals for unprofitable classes the implementation of higher minimum deductibles in catastrophe exposed areas and the tightening of underwriting guidelines in certain geographies.

Shifting to personal lines were pleased with the return to growth in net premiums written with 15, 6% growth in the quarter as a result of new business from our new suite of products continued strong policy retention and renewal rate increases averaging eight 3%.

The personal auto core loss ratio was elevated compared to the prior year quarter due to higher loss severity related to ongoing inflationary impact to loss trends due to supply chain disruption and labor shortage that we've talked about throughout 2022.

As well as modestly higher claim frequency from higher driving activity.

As for the homeowners line of business the winter freeze event at the end of December caused a spike in the loss ratio with weather related losses, comprising 24 percentage points of the homeowners loss ratio in the fourth quarter of 2022 compared to $17 seven percentage points in the prior year quarter.

The homeowners impact of large fire losses was lower than the prior year quarter, but remained generally in line with the third quarter of 2022.

While it was great to see our agents reengage with us to write new personal lines accounts, the fourth quarter, new business growth rate actually exceeded our target. We're closely monitoring the success of our new product suite in the market to ensure we're writing the risks we want to write and we're achieving expected margins were also maintaining focus on the performance of our legacy renewable book of <unk>.

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We're also seeing ongoing inflationary pressures on loss costs.

Our analysis indicates that in spite of significant rate increases implemented during 2022, we have not yet achieved rate adequacy.

As loss severity trends for both personal auto and homeowners continued on an upward trend in the second half of 2022, we will request regulatory approval for additional rate increases across our 10 personal line states.

We are also further adjusted our rate segmentation and tightened underwriting guidelines along with other measures to carefully manage our growth rate and improve profit margins as quickly as possible.

At this time I'd like to turn it over to Dan <unk> for an update on our sales and marketing efforts.

Thank you, Jeff I am excited for the opportunity to share some details about the sales and marketing efforts at Donegal.

First and foremost an important distinctive for Donegal and one that we believe provides tremendous benefit and opportunity is that we distribute our products solely through independent agents and.

In 2020 to our agency partners continued to provide new business opportunities to us that resulted in over $100 million in new business writings with over 70% of that new business in commercial lines.

Our agents also helped us to retain quality accounts in spite of significant price increases that were made necessary by the spike in inflation over the past year.

It is important to note that our appointed agency relationships include hundreds of traditional independently owned agencies as well as hundreds more agencies, who have either joined the larger membership group or sold to a national or regional organization.

Mergers and acquisitions within the independent agency channel have set all time high records for several years running.

While this activity has brought significant amounts of new capital into the distribution side of the insurance business.

Agency ownership changes have also created a challenging competitive landscape for insurance carriers.

We are dealing with these market challenges head on by working strategically with 12 national account organizations that represent agencies responsible for approximately 30% of our total premium portfolio.

We will continue to maintain strong relationships with our traditional agents, who have contributed to our growth and success over many years, we view our relationships with these expanding national account organizations as significant opportunities for profitable future growth.

Kevin mentioned, our progress in the implementation of new underwriting systems and products. In addition to these advancements. We are also enhancing the sophistication of our sales and marketing efforts with excellent data and automation tools at our fingertips.

New and improved business intelligence, and CRM capabilities are providing greater insights into market opportunities and agency performance.

These resources are helping us identify prospective customers perpetuate.

Perpetuate customer and premium retention.

Manage agency growth and profitability.

And to further support our best in class service commitment to our agents.

We remain focused on providing excellent products and service to ensure we are there when it matters most for our agents and our policyholders at Donegal. Our goal is to build an effective and efficient sales process for current and prospective policyholders that are independent agents entrust to us with all of our advancements in product development and.

Underwriting acumen, we proudly remain a relationship driven people first company.

With that I will turn it over to Tony for an update on our investment segment.

Thank you Dan for the fourth consecutive quarter, we increased average investment yields with the fourth quarter average yield up 31 basis points from a year ago to $2 nine zero percent.

This increase was driven by rising market rates and selectively moving into the most attractive spread products.

Additionally, our average reinvestment yield again exceeded that of the maturities calls and MBS cash flow, we received by approximately 200 basis points for the quarter.

Total investment assets rose by $27 $8 million or 2% from December 31, 2021.

Net investment income increased to $9 $4 million.

Up 14, 5% compared to the fourth quarter of 2021 as a result of an increase in average investment assets as well as the increase in portfolio yield we.

We expect ongoing improvement in our investment income throughout 2023, as we believe cash equivalent rates will increase in fixed income rates will stabilize as we progress through the year.

Net investment gains of $626000 were down more than 50% compared to the prior year quarter, but we were pleased to see an increase in the market value of the equity securities after experiencing significant declines earlier in the year.

While equity markets remain volatile the performance of our relatively modest equity portfolio was generally in line with that of the S&P 500 index.

We made a conscious decision to decrease our equity exposure by nearly half over the course of 2022, and we shifted into a heavier weighting of value style stocks.

We also experienced a significant decline in our fixed income portfolio as market interest rates rose sharply during the year. However.

However, we believe that our ladder maturities, coupled with our conservative investment philosophy and flexibility in managing our overall portfolio has put us in a solid position to recover those rate driven declines as we hold those investments to our stated maturities.

The decrease in the market value of our available for sale bonds reduced our book value by $1 39 and.

In 2022 other.

Other business drivers also contributed to an overall book value decline of $2 16.

Or 12, 7% from December 31, 2021, ending 2022 at $14 79.

We expect to grow our book value through improved operating results and through a recovery of the market value of our bonds over time.

I will now turn it back to Karen our Investor Relations consultant.

Thank you Tony.

Moving on to a question and answer session. We requested and received questions from interested parties in advance of today's call. While we have worked answers can last questions into our prepared remarks, we will address a few of the questions directly.

The first question is given commentary by many market participants that this year's renewal was the hardest market they've seen in their lifetime is Donegal mutual and the Donegal group subsidiaries can make any notable changes to their reinsurance program and will your reinsurance cost increase for 2023.

This is Jeff Miller, and I will be glad to respond to that question Donegal mutual and the insurance subsidiaries of Donegal group purchase reinsurance together to achieve economies of scale.

We have historically purchased reinsurance coverage at relatively conservative loss retention levels, because reinsurance costs are generally reasonable at lower retention levels due to a relatively conservative risk profile.

But as the question suggested our experience with similar to other reinsurance purchasers, who found it challenging to renew coverage at January one.

Based on some preliminary discussions we have with many of our reinsurers last October we expected that we would be pressured to increase loss retention under our reinsurance program for 2023, and we performed various analyses to model the impact of potential changes on our group's economic capital.

That analysis served us well as we proceeded through the renewal process and with the assistance of our reinsurance intermediary we were able to successfully renew our program for 2023 with increases to retention amounts for several of the programs.

<unk> remained well within our risk tolerances.

We increased our per risk retentions for property and casualty losses from $2 million for 2000 $22 million to $3 million for 2023.

That change did not apply to workers' compensation losses for which our retention remains at $2 million per loss.

For property catastrophe reinsurance, we increased our external reinsurance retention from $15 million per event for 2000 $22 million to $25 million per event for 2023, However, I would hasten to point out that Donegal mutual continues to provide underlying catastrophe reinsurance protection for the subsidiaries of <unk>.

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The individual Donegal Group, Inc. Subsidiary retention was increased from $2 million per event for 2000 $22 million to $3 million per event for 2023.

The aggregate retention for any event that impacts multiple subsidiaries was increased from $5 million for 2000 $22 million to $6 million for 2023.

Therefore relative to 2022, the incremental increase in losses Donegal Group, Inc. Will retain for any catastrophe event in 2023 is limited to $1 million.

As a result of increasing our reinsurance retentions, we will have a modest reduction in our reinsurance premiums spend compared to 2022.

With projected reinsurance premium savings for the Donegal Group, Inc. Subsidiaries of approximately $1 8 million for the year.

Thank you for that update Jeff.

Next question relates to medical inflation are you seeing any material changes in medical inflation impacting your book and how should we be thinking about donegal potential exposure to medical inflation more broadly.

This is Jeff Hey, and I can take that one Karen in my prepared remarks, I discussed the impact of inflation and supply chain disruption is having on our loss cost trends, but that is primarily impacting property and auto physical damage coverages.

Medical inflation also impact several of our products, primarily affecting bodily injury liability claims under both personal and commercial auto coverages as well as claims for incidents such as slips and falls under general liability and the medical costs related to injuries covered by workers compensation policies, while we continue to experience inflation impact on these meds.

<unk> sensitive loss costs and has been more stable and predictable than for our physical damage claims.

Medical inflation is captured within our bodily injury claims severity trend for which our current increase is in the 7% to 8% range a modest downward trend in loss frequency for bodily injury claims partially offsets the severity increase and has over the past few years and we account for all of these trends and our pricing strategies.

Thank you.

Next question relates to workers' compensation can you dig deeper into the workers comp trend. What are you seeing from a pricing perspective changes in loss trends reserving ore reserve development standpoint, and is there anything you're watching or concerned about.

Jeff Hey, here again as I said in my response to the previous question medical costs are increasing but to a lesser extent for workers' compensation claims and that's for a few reasons, primarily lower utilization is tempering the medical loss cost for this line and that's an industry wide phenomenon.

Utilization relates to the number of services needed to treat an injured worker, we and other carriers are seeing a shift from inpatient to outpatient procedures and a movement away from opioids and towards generic drugs and in some cases mris and other medical services are becoming less expensive.

Those factors and other advances in medical treatments have contributed to lower utilization that has helped to offset inflation and the cost of medical services generally.

There are a few other factors impacting workers' comp loss trends, the lower unemployment rate level is driving wage costs higher but wage inflation is not uniform across all industries.

Lower wage earners are seeing larger increases and there's been a shifting workforce, which is having varying impacts by industry and class of business.

With generally higher wages and less experienced workers for the construction and manufacturing classes, we do see a greater risk of higher loss costs in those classes.

With all that said our loss transfer workers' comp remains favorable overall, our premiums have declined as a result of continued aggressive bureau rate decreases in the mid single digits, which we are working to offset through discretionary pricing actions to the extent possible.

And as far as reserve and a reserve development is concerned we have had consistent favorable reserve development in the workers comp line over many years and while we closely monitor the loss trends I. Just discussed we have not made any significant changes to our philosophy or approach to reserving for this line.

Thank you Jeff.

Next question pertains to reserve development can you provide a breakdown of the reserve development by line of business and any color on the drivers of that development.

Sure Karin this is Jeff Miller for the fourth quarter, we had $14 $2 million of favorable reserve development in total mainly comprised of $7 million in commercial auto $2 8 million and homeowners to $5 million in personal auto $1 6 million and other commercial which is.

Primarily commercial umbrella liability and a $900000 in workers compensation.

For the full year, we had $44 8 million of favorable reserve development in total mainly comprised of $18 4 million in commercial auto $10 8 million in personal auto $4 8 million in homeowners $4 $8 million in workers' compensation and $4 3 million in commercial multi peril.

As far as drivers are concerned the actual emergence of paid loss in case reserve activity, primarily for the 2020 and 2021 accident years was more favorable than anticipated based on historical averages.

Particularly for our commercial and personal automobile lines of business. The lower emergence was due to a combination of favorable loss settlements and the benefits we realized from various profit improvement initiatives, including significant reductions of exposures in the state of Georgia over the past few years.

Thank you and then last question relates to capital management could you provide us with an update on your approach to capital management, and where your priority stand heading into 2023.

Jeff Miller again, we've taken a very consistent approach to capital management utilizing cash dividends as the primary means of returning capital to our shareholders.

We believe this approach appropriately rewards long term shareholders and our dividend yield continues to rank among the highest of our regional insurance peers.

We continue to focus on growing book value by generating favorable operating returns and we do not expect any material change in our approach to capital management in the foreseeable future.

Thank you for that update Jeff if there are any additional questions. Please feel free to reach out to us I will now turn it back to Mr. Kevin Burke for final remarks.

Thanks, Karen while there were significant weather related and large loss impacted the fourth quarter and full year results. We are pleased with the execution and the benefits of the various strategic initiatives.

We are confident that the substantial improvements we are making to our operations will allow us to better serve our agents and policyholders for the years to come while our focus on improving our results will lead us to sustainable profitability. Thanks for joining us today.

This now concludes the fourth quarter and full year 2022 earnings webcast you may now disconnect.