Erie Indemnity Co

NASDAQ:ERIE

Earnings Call Transcript 2018-Q4

[Operator]

Good morning, and welcome to the Erie Indemnity Company Fourth Quarter 2018 Earnings Conference Call. This call was pre-recorded, and there will be no question-and-answer session following the recording.

Now, I'd like to introduce your host for the call, Vice President of Investor Relations. Scott Beilharz. Please go ahead.

[Scott Beilharz, VP of IR]

Thank you, and welcome, everyone. We appreciate you joining us for this recorded discussion about our 2018 fourth quarter and full-year results. This recording will include remarks from Tim NeCastro, President and Chief Executive Officer; and Greg Gutting, Executive Vice President and Chief Financial Officer. 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.

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 21, 2019, and in the related press release.

This pre-recorded call 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.

With that, we move on to Tim's remarks.

[Tim NeCastro, President and CEO]

Thanks, Scott, and thanks to everyone for taking time to learn more about Erie's performance in the fourth quarter of 2018 and our year-end results.

Last year was another strong year for Erie Company. As you saw in our press release filed yesterday, we reported net income of $62 million or $1.19 per diluted share for the quarter, that's $30 million more than the fourth quarter of 2017. Greg, will talk more about the drivers of that increase in a few minutes.

But before we get into more detail around Indemnity's results, I'd like to share some highlights from the year for Erie Insurance Exchange, the insurance operation we manage. The results of the Indemnity reflect the success of the Exchange. 2018 was another year of robust growth in our property/casualty business.

In 2018, the Exchange grew property/casualty premiums 7% over the prior year to more than $7 billion. This result exceeds Conning's latest industry growth forecast of 5.6% for the year. Our 2018 premium growth marks the 11th straight year that Erie run faster than the industry, while making steady gains in market share across our territory.

Our property/casualty results reflect the solid combination and strong retention, higher average premium per policy and growth in new business. In contrast to 2017, weather-related losses were bigger part of the Exchange's experience in 2018, while no single event stands out. Snow, wind and hail losses market in many of our territories with greater frequency throughout the year.

The combined ratio of 103.1% reflects these storms. For comparison, the Exchange recorded a combined ratio of 96.2% a year ago, following a stretch relatively mild weather across our territory. Severe weather is never welcome, but at Erie it's an opportunity to demonstrate our value to our agents, our customers and the communities that rely on us. I'm proud to say that we did just that in our response to 71,000 weather-related claims in 2018.

Compassionate service is essential in our business and so is the strong financial foundation. We'll position to deliver on both fronts just as we did last year. The Exchange ended the year with policyholder surplus $8.6 billion, 2.3% below 2017's $8.8 billion. The slight decrease reflects the increased level of storm claims and a down investment year. It also follows a year of significant gains in the surplus, in 2017 when surplus grew by over $1 billion.

Erie's operational and financial position remained healthy. I want to thank our employees and agents for their commitment and hard work this past year. We delivered on our promise to service at every turn, while continuing to grow premium and make solid progress on our strategic ventures.

I'll talk more about that progress in a few moments following Greg's review of the financials. Greg?

[Greg Gutting, EVP and CFO]

Thanks Tim.

As Tim mentioned, we are very pleased with Indemnity's financial results for 2018. They reflect the dedicated service of our agents and our employees, as well as our commitment to deliver on our strategy.

Starting with the fourth quarter of 2018, net income was $62 million or $1.19 per diluted share compared to $32 million or $0.61 per diluted share in the fourth quarter of 2017. I think it's important at this time to remind everyone that the 2017 fourth quarter and full-year results were negatively impacted by the enactment of the Federal Tax Cuts and Jobs Act as a result of the remeasurement of our net deferred tax assets at the lower tax rate. This resulted in the reduction of 2017 fourth quarter and full-year net income of $10 million or $0.19 per diluted share.

Operating income in the most recent quarter increased $16 million, up 27.5% compared to the fourth quarter of 2017. Management fee revenue from policy issuance and renewal services increased $14 million in the fourth quarter of 2018 compared to the same period in 2017.

While Management fee revenue from administrative services totaled $14 million in the quarter. Both amounts were driven by the 6.7% increase in the direct and assumed premiums written by the Exchange in the fourth quarter.

Indemnity's cost of operations for policy issuance and renewal services increased $11 million compared to the same period in 2017. Commission expenses increased $4 million, as a result of the increase in the direct and assumed premiums written by the Exchange, somewhat offset by lower agent incentive costs related to less profitable growth.

Non-commission expenses increased $7 million in the quarter compared to the fourth quarter of last year. Underwriting and policy processing costs increased $3 million, information technology costs increased just over $2 million, and customer service costs increased roughly $1 million.

Total pre-tax investment income in the quarter was $5 million, down $2 million compared to the same period in 2017. Drivers of the decrease included net realized losses on investments and losses from limited partnerships. The losses were partially offset by increased net investment income.

Turning to full-year 2018 results. Net income was $288 million or $5.51 per diluted share compared to $197 million or $3.76 per diluted share in 2017. The increase in earnings per share in 2018 was driven by the lower corporate income tax rate in 2018 as a result of the Tax Cuts and Jobs Act, and a significant increase in operating income.

Operating income before taxes increased $54 million or 18.6% in 2018 compared to 2017. Management fee revenue for policy issuance and renewal services increased $57 million in 2018 compared to 2017, while management fee revenue from administrative services totaled $54 million in the year. Both amounts were driven by the 7% increase in the direct and assumed premiums written by the Exchange.

Commissions paid to our independent agents increased $36 million in 2018 compared to 2017, resulting from the increase in the direct and assumed premiums written by the Exchange, somewhat offset by lower agent incentive costs related to less profitable growth.

Non-commission expenses in 2018 increased nearly $20 million compared to 2017, increases of $8 million in underwriting and policy processing costs, $5 million in information technology costs, and just over $4 million in customer service costs were the primary drivers of the increase.

Personnel costs in all categories were impacted by bonuses awarded to employees, as a result of savings realized from the lower corporate income tax rate in 2018 compared to 2017, as well as increased medical costs.

Income from investments on a pre-tax basis totaled $26 million for the year compared to $29 million in 2017, while net investment income increased by nearly $6 million, a loss of $1 million in 2018 from our limited partnership portfolio compared to earnings of $3 million in 2017 combined with realized losses and impairment losses of $4 million resulted in the year-over-year reduction in total investment income.

Finally, Indemnity's strong financial performance has allowed us to pay our shareholders $156 million in dividends during 2018. And in December of last year, our Board approved a 7.1% increase in the regular quarterly cash dividend for both Class A and Class B shares for 2019.

Now, I'll turn the call back over to Tim.

[Tim NeCastro, President and CEO]

Thanks Greg.

We remain firmly in position for continued profitable growth and we continue to invest in areas that support our strategic direction. Throughout 2018, we engaged our teams on initiatives centered on four areas of strategic focus; strengthening our business platforms and uses of data, continuing to enhance the Erie experience, identifying and developing new sources of revenue, and preparing the workforce of the future. We further developed and detailed priorities in each area and continue to deliver new capabilities improving service levels, product offerings and the efficiency of our agents and employees.

In terms of our platforms, our agents have new online capabilities for writing business with Erie and servicing customer needs. In commercial lines, for instance, we expanded agents' ability to cope more lines of business online and introduce functionality to drive more cross-selling and boost commercial revenue. We continue to see double-digit premium growth in commercial lines that are in large part attributable to this online system.

In personal lines, we began the rollout of our online capabilities for servicing homeowners business. The rollout will be completed in 2019, marking a significant step for improved online capabilities for our agents' personal lines business with Erie.

We also delivered new and enhanced products, including a second option for homeowners insurance that will further strengthen our competitive position. Within our Erie experience initiatives, we began to work necessary to expand our distinctive service culture, what we call the service model of the future.

We're engaging our customers, our agents and policyholders throughout this effort to gain our insights and build an even stronger understanding of their experience and expectations. Their understanding is key as we worked with a couple of best digital capabilities with the human touch where it matters most.

We've also extended pilot testing the capabilities of telematics for pricing private passenger auto insurance and expanding the use of home sensors to customers in most of our states. More than 3,000 young drivers are using telematics in our pilot states of Ohio and West Virginia. We're very pleased with the response and with the experience and we're looking to expand that program in 2019. We plan to be in two more states this summer and then deploy additional territories later in 2019.

Since expanding the home sensor pilot, we've grown the program to more than 2,000 households. While we continue to dig into the data, customer feedback pulses with the program is making a difference. One customer in Ohio, for instance, reported that his sensor detected a refrigerator leak just two days after installation and helped them avoid a costly loss.

Another customer in Pennsylvania credited the sensor for alarming him for water leak in his basement and allowing him to take steps to prevent damages. Examples like these reflect the improved proactive experienced customers can have with Erie, while also saving us and them the cost of the claim.

The other operations we remain strongly engage through the rationalization of our hometown of Erie, Pennsylvania. Being a good corporate citizen is important to us. So it's also good business. A vibrant downtown core will attract new businesses and people, helping us recruit and retain top talent at Erie.

Late last year we announced investments in two start-up companies to help support their endeavors and also encouraged other innovators to consider Northwest Pennsylvania as an attractive base for setting up their operations.

The Company's products are also relevant to our operations. The first investment is in SimpleSense, which has developed a sensor system that can aid emergency response by identifying if people are occupying a building and where they're located in that building and also identify the process route for the first responders to reach them.

The other company, CityGrows, has created a cloud-based system to help local governments to manage, permitting, licensing and other processes online. We're looking forward to a productive partnership with both companies.

This past year was also one of the heavy recognition from JD Power for customer satisfaction with Erie and our agents. In October, just three years after the launch of our new claims management system, Erie ranked highest in overall customer satisfaction in JD Power's 2018 US Auto Claims Satisfaction Study.

This is Erie's first JD Power arm for auto claims handling and our 24th award since JD Power began studying our industry in 1999. It's an honor to reflect the deep commitment of our claims team to do the right thing for our customers and claimants, as well as our ability to do it even better today.

Erie also earned top honors for customer satisfaction in the auto insurance purchase experience and in auto insurance in the Mid-Atlantic region. Those awards are some of the difference made by our agents and our customers experience from the time of purchase through renewal.

Before we close, I'd like to recognize Sean McLaughlin, who retired from Erie at the end of 2018. Sean served as Executive Vice President and General Counsel for five years, following a 19-year career as a highly regarded Federal Judge. He is now practicing at the firm where he started has a lawyer in 1981. We wish Sean a very best and appreciate his service and contributions to Erie.

Our financial results, the progress and direction on our strategy and the continued recognition from third parties, like JD Power, give us great confidence that Erie remains well equipped for success in the property/casualty market and in the hearts and minds of our customers, employees, agents, and you, our shareholders.

Thank you for your time today. We appreciate your continued interest in Erie.

[Operator]

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day.