Erie Indemnity Co

NASDAQ:ERIE

Earnings Call Transcript 2017-Q4

[Operator]

Good morning and welcome to the Erie Indemnity Company Fourth Quarter 2017 Earnings Conference Call. I would like to introduce your host for today’s call, Scott Beilharz, Vice President of Investor Relations.

[Scott Beilharz, Vice President, Investor Relations]

Thank you, Grace and welcome everyone. We appreciate you joining us for today’s discussion about our 2017 fourth quarter and full-year results. Joining me today are Tim NeCastro, President and Chief Executive Officer; Greg Gutting, Executive Vice President and Chief Financial Officer; and Sean McLaughlin, Executive Vice President and General Counsel.

Our earnings release and financial supplement were issued yesterday afternoon after the market closed and are available within the Investor Relations section of our website, erieinsurance.com. We will start the call today with opening remarks from Tim and Greg and then we will open the call for your questions.

Before we begin, I would like to remind everyone that today’s discussion may contain forward-looking remarks that reflect the company’s current views about future events. These remarks are based on assumptions subject to known and unexpected risks and uncertainties. These risks and uncertainties may cause results to differ materially from those described in these remarks. For information on important factors that may cause such differences, please see the Safe Harbor statements in our Form 10-Q filing with the SEC dated February 22, 2018 and in the related press release.

This call is being recorded and recording is the property of Erie Indemnity Company. It may not be reproduced or rebroadcast by any other party without the prior written consent of Erie Indemnity Company. A replay will be available on our website today after 12:30 PM Eastern Time. Your participation on this call constitutes your consent to recording, its publication, webcast and broadcast and the use of your name, voice and comments by Erie Indemnity. If you do not agree with these terms, please disconnect at this time.

With that, I will now turn the call over to Tim.

[Tim NeCastro, President and Chief Executive Officer]

Thank you, Scott. Good morning everyone and thank you for joining us. 2017 was another very good year for Erie Indemnity. As we reported yesterday net income was $197 million resulting in earnings per share of $3.76 for the year, that's a decline from last year, but not unexpected.

The enactment of the new tax law reduced earnings by $10 million or $0.19 per share beginning in 2018 our earnings will benefit from the lower tax rates. Greg will speak more to that in a few minutes.

Our margins remain strong at 17%. We’re pleased with that result especially as we continue to invest in infrastructure improvements that will keep us current and imperative in the market.

Now let’s turn to the 2017 results for the Exchange, the insurance operations we manage. Those results were also quite strong. We saw a 6% increase in direct and assumed written premium, and last year marked the 10th straight year that we surpass Conning's industry forecast which is currently 4.8%.

In addition to premium growth our market share continues to increase in every state in our footprint based on results through the third quarter. The relatively mild weather across our states and our underwriting diligence yielded profitable results.

A key profitability metric for the Exchange, the combined ratio, finished very strong in 2017. Our reported combined ratio was 96.2% for the year. We are fortunate that our operating territories escaped significant impact from the hurricanes and wildfires that affected much of the industry last year.

You may recall, we had a Christmas snowstorm here in Erie, Pennsylvania that made national and even international news. While the local snowball was record-breaking, the storm had minimal impact on our 2017 losses.

Our claim service during this holiday storm showed why people trust Erie. We had cap adjusters and property re-inspectors on the ground engaged and ready to support our customers in their time of need.

The Exchange continues to perform well as a low-cost insurance provider offering great products and exceptional customer service. And because of its financial strength and solid reputation we were able to take a balanced approach of pricing, process enhancements, new product offerings and infrastructure improvements that were radius for future growth and success.

In 2017 we deliver our largest platform replacement in recent years with the final release of our new claims management system, Erie claim center. By year end we process more than a half-million claims in the new system. And we reach a significant milestone last month with the retirement of our legacy claim system.

With Erie claim center, we have improved our first notice of loss process for customers and agents. We know from JD Power’s customer studies that are better claims experience starts with an agent. To that end we delivered improved capability to our agents for better loss reporting, status reporting and service throughout the entire claims experience. The success for the Erie claim center adds to our confidence as we make improvements of various size and scale to other platforms.

Last year for instance we added quote and endorsement functionality for personal and commercial online systems. These updates are making it faster and easier for our agents to submit business and the service policies. These enhanced capabilities are translating into more rapid growth in many lines of business as we transition from quoting on legacy platforms.

With greater automation employees can apply their skills to high-value work. So underwriters for instance can focus on more on the risk that require their knowledge and expertise.

In addition to our platform and process improvements, we strive to offer new and emerging coverages. That's true in the shared economy space with products like ridesharing and home sharing coverages, in a mechanical and electronic breakdown microelectronic and cloud computing coverage or the business-class needs with our custom collection suite offered to more and more business owners.

We continue to challenge ourselves to raise the bar with our product portfolio. Late in 2017, Dionne Wallace Oakley was named Executive Vice President, Human Resources and Strategy recognizing her long-standing contribution to the executive team.

Dionne has been part of our Erie family for the past seven years serving as Senior Vice President of Human Resources and most recently as interim leader of our marketing division.

Last year, we also restructured many of our business areas to better align with our strategic focus. As a reminder we identified four broad areas of opportunity enhancing the area experience, creating new sources of revenue, improving our platforms and data capability and preparing the workforce of the future. With the restructuring in place our leaders are making progress in planning and continuing work around these accelerators.

Now I’ll turn things over to Greg to report on our results. Greg?

[Greg Gutting]

Thanks, Tim, and Good morning. Before I report on our results, I’ll comment briefly on the impact of the newly enacted Federal Tax Cuts and Jobs Act on our results. As Tim mentioned, enactment of the new tax law resulted in a reduction in net income of $10 million or $0.19 per diluted share for the fourth quarter and fully results, compared to the same period in 2016.

We’ve recorded a one-time non-cash tax expense of $20 million which resulted from the re-measurement of the net deferred tax asset at the newly enacted corporate income tax rate of 21%.

This was partially offset by the recognition of a current tax benefit of $10 million related to the acceleration of pension contributions. Beginning in 2018, we expect our effective corporate income tax rate to decline to approximately 21% from approximately 34% as a result of the new tax legislation.

Starting with our fourth quarter results, net income was $32 million or $0.61 per diluted share, compared to $46 million or $0.87 per diluted share in the fourth quarter of 2016. Operating revenue in the quarter was $401 million, up 5.7% over the $380 million we reported for the fourth quarter of 2016, and reflecting continued market share growth.

Operating expenses increased $20 million or 6.4% in the fourth quarter of 2017, compared to the fourth quarter of 2016. Commissions increased $10 million or 4.7% and non-commissioned expenses increased $10 million or 9.8% in the fourth quarter of 2017 compared to the same period in 2016.

Increased information technology costs and increase personnel costs were the primary drivers of the increase in non-commissioned expenses. Indemnity’s gross margin for the fourth quarter 2017 was 14.4% compared to 14.9% for the fourth quarter of 2016.

Investment income decreased by $6.4 million in the fourth quarter compared to the fourth quarter of 2016. You’ll recall that we had limited partnership earnings of $7 million in the fourth quarter of 2016.

Net income for the year was $197 million or $3.76 per diluted share, compared to $210 million or $4.01 per diluted share in 2016. Operating revenue was up 6% to $1.7 million compared to $1.6 billion for 2016, that growth reflects a 6% increase in the direct and assumed premiums written by the exchange as both policies enforce and average premium per policy experienced continued growth.

Operating expenses in 2017 increased $99 million or 7.6% compared to 2016. Commissions increased $54 million or 6% in 2017 compared to 2016, the increase was driven by the increase in the direct and assumed premiums written in the exchange.

Non-commissioned expenses increase $45 million or 11.1% compared to 2016 driven by the increase costs in underwriting and policy processing, information technology, customer service and administrative costs. As you can see we are continuing to invest in our platforms and data capabilities.

With that in mind, we are pleased with our strong operating margins. The gross margin for 2017 with 17% compared to 18.3% for 2016. Investment income in 2017 was up slightly to $29 million compared to $28 million in 2016. Once again income for limited partnerships was significantly lower in 2017 compared to 2016.

Finally our strong balance sheet has allowed us to pay our shareholders dividend in the amount of $146 million in 2017, and in December of last year our board voted to increase the annual dividend rate by 7.3% for 2018.

Now, before I turn the call back over to Tim, I want to talk briefly about the new revenue recognition guidance we adopted effective January 1, 2018. Under the new guidance a small portion of the management fee will be allocated to Indemnity acting as the attorney-in-fact for all claims handling and investment management services for the Exchange.

Under the previous guidance, all of the management fee was allocated to the policy issuance and renewal services. The revenue allocated to the claims handling and investment management services will be recognized over the typical claim settlement period.

Additionally, under the new guidance the claims handling and investment management expenses and related reimbursements will be reporting gross on the income statement. Previously these expenses and related reimbursement were presented net on the financial statements. The adoption of this guidance will not have a material impact on our financial condition earnings or earnings per share and it will have no impact on our cash flows.

And now I'll turn the call back over to Tim.

[Tim NeCastro, President and Chief Executive Officer]

Thank you, Greg. We measure our success impart by the positive response of our agents and customers, the increased engagement of our employees and the third-party recognition for our performance as a top-tier service provider.

In 2017 Erie rank highest among auto insurers in most satisfying purchase experience in the JD Power and Associates Insurance shopping study and highest in the Renters Insurance segment of their U.S. Home insurance study. And just yesterday we learned that we ranked third in their 2018 claims satisfaction study.

Our strong performance is a direct result of the skill, capability and dedication of our exceptional employees and our unrivaled agency force. I want to personally thank them for their outstanding work and contributions.

Together with our financial results these accolades affirm that Erie is strong and well positioned for continued success. For 2018, we will continue to invest in increased capability and to explore new sources of revenue.

Thank you for your time this morning. And now we’d be happy to take your questions.

[Operator]

Thank you. [Operator Instructions] And our first question comes from Katelyn Young with William Blair. Your line is now open.

[Katelyn Young, William Blair.]

Hi. Good morning.

[Tim NeCastro, President and Chief Executive Officer]

Good morning.

[Katelyn Young, William Blair.]

Couple of questions for you guys. First of all, in the light of the technology and ongoing infrastructure improvements being made, do you see 2017 is a good run rate for non-commission expenses relative to revenues? Or is there incremental investments that will be see in 2018? And with any incremental investment be at a rate that similar to 2017 or more or less?

[Greg Gutting]

We don’t really give forward-looking advice, but we are executing at a high level I’d say on the IT front and in other fronts, so we will continue to see some decent investment there.

[Tim NeCastro, President and Chief Executive Officer]

Katelyn, I’ll add to that. There’s a practical capacity for our spending and well, I can't tell you that the numbers are going to be exactly as they look going forward. We wouldn't provide that kind of guidance. We have accelerated our spending particular in the development arena over the past several years and we’re going to continue to make those investments.

[Katelyn Young, William Blair.]

Great. Thank you. And then just given the movement over the last couple of quarters and premiums written on the workers comp side, I appreciate that it is small. But can you just give any comment on rate trends or anything that you’re seeing in that space?

[Greg Gutting]

Yes. The actually policy counts are increasing at a decent rate, but the average premium is coming down and that’s a function of the unbelievable performance that we’re seeing as well as the industry seeing.

[Katelyn Young, William Blair.]

Make sense. And then anything that helps us in the other markets that was pretty consistent across the board?

[Greg Gutting]

Yes. I don’t know if there are any real outliers in that.

[Katelyn Young, William Blair.]

Okay. Thank you very much. That’s all I had.

[Tim NeCastro, President and Chief Executive Officer]

Thank you.

[Operator]

Thank you. [Operator Instructions]. I’m not showing any further questions. I would like to turn the call back to Scott Beilharz for any closing remarks.

[Scott Beilharz, Vice President, Investor Relations]

Thanks, Grace. And thanks again for joining us. A recording of this call will be posted on our website erieinsuramce.com after 12:30 PM Eastern Time. If you have any questions, please call me at 814-870-7312. Thank you.

[Tim NeCastro, President and Chief Executive Officer]

Thanks everybody.

[Operator]

Ladies and gentlemen, thank you for participating in today’s conference. A recording of this call will be posted on our website at erieinsuramce.com after 12:30 PM Eastern Time. If you have any questions please call at the area code 814-870-7312. Thank you.