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Edited Transcript of ERIE earnings conference call or presentation 24-Feb-17 3:00pm GMT

Thomson Reuters StreetEvents

Q4 2016 Erie Indemnity Co Earnings Call

ERIE Feb 24, 2017 (Thomson StreetEvents) -- Edited Transcript of Erie Indemnity Co earnings conference call or presentation Friday, February 24, 2017 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Scott Beilharz

Erie Indemnity Company - VP of IR

* Tim NeCastro

Erie Indemnity Company - President & CEO

* Greg Gutting

Erie Indemnity Company - EVP & CFO

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Conference Call Participants

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* Amit Kumar

Macquarie Research Equities - Analyst

* Adam Klauber

William Blair & Company - Analyst

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Presentation

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Operator [1]

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Good morning welcome to Erie Indemnity fourth-quarter 2016 earnings conference call. I'd like to introduce your host for today's call, Scott Beilharz, Vice President, Investor Relations

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Scott Beilharz, Erie Indemnity Company - VP of IR [2]

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Thank you, Nicole. And welcome everyone we appreciate you joining us for today's discussion about the fourth quarter and full-year 2016 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. Before we hear from Tim and Greg, 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-K filing with the SEC dated February 23, 2017 and in the related press release.

Also, during this call we may discuss non-GAAP measures. A reconciliation to the GAAP based results can be found on our Form 10-K that was filed with the SEC yesterday. This call is being recorded and the recording is the property of Erie Indemnity Company. It may not be reproduced, rebroadcast, by any other party without the prior written consumption Erie Indemnity Company.

A replay will be available on our website today that 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 not agree with these terms please disconnect at this time. WIth that, I will now turn the call over to Tim.

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Tim NeCastro, Erie Indemnity Company - President & CEO [3]

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Thank you Scott, and good morning everyone. Yesterday we reported Erie Indemnity's 2016 results and the numbers were very good across the board. Compared to 2015, net income was up over 20% and our gross margin improved by nearly 3 points.

Premiums written and assumed by Erie Insurance Exchange, drove Indemnity's top-line growth while continued attention to expense management helped improve the bottom line. We had a really good year and I'm very pleased to report record earnings per share of $4.01.

As you know growth and profitability of the Exchange is an integral part of Indemnity's success. So, with that relationship in mind, I'll offer some context around the performance of the Exchange, before Greg reviews Indemnity's 2016 financial results.

The results for last year are firm that the Exchange remains strong, growing profitably. In 2016, direct written premiums of the Exchange increased 6.2% over 2015, well ahead of Conning's current industry forecast of 3.6% and for 2016 the exchange reported a combined ratio of 96.5%. That too surpassed Conning's most recent industry forecast of 99.8%.

Policyholder surplus is now just over $7.7 billion. The Exchange is indeed thriving, and Indemnity continues to benefit from that solid performance. Indemnity also generated very strong results in 2016.

But 2016 was more than just a year of strong performance. It was also a transitional year at Erie marked by a new Executive Leadership and the anticipation of what that change might look like internally. And through that change our employees and agents remain true to our service promise conducting business with the dedication and expertise that allowed for a seamless transition and record results with no disruption to our operation.

I'm very thankful to our employees and agents for their consistent professionalism and dedication. We accomplished a great deal operationally last year as well, always mindful that we need to make it easier for our agents and customers to do business with us, we ramped up replacement of our legacy claims infrastructure, we provided the training resources our employees need to succeed, and in an effort to remain current and competitive in the marketplace we expanded our product offerings.

One of our greatest accomplishments last year was the expansion of our new claims management system to service our largest line of business, automobile. In addition to that we introduced a new online loss reporting process for agents enabling them to enhance the customer's claim experience from the start. Erie claims center is the largest technology improvement we've made in recent history and we rolled it out on time and on budget.

Although there are always challenges with a project of this magnitude this platform replacement, together with our newly centralized first notice of loss team and the ability to pay claims electronically, demonstrates our commitment to provide the best possible claim service well into the future. We also invested in our greatest asset our employees. Utilizing our state-of-the-art Technical Learning Center, were provided ongoing education and training to over 500 employees and agents in 2016, both in the classroom and with hands-on experience.

And our innovation lab, besides providing collaborative space for internal teams, hosted crowd sourcing events for IT employees, interns and apprentices allowing them to work alongside programmers and developers from other businesses in our community. These daylong sessions generated many new ideas some of which are now in our innovation pipeline for further research and development.

We also continue to offer new and improved products keeping our agents strong and our customers protected. In personal automobile for example, our motorcycle and rides sharing products continue to be very well received as we introduce them into more states. And at our homeowners line we introduced new coverages for underground service line damage and equipment breakdown, helping to fill common coverage gaps.

In commercial line, our custom collections suite of products was offered to additional business classes throughout the year. Finally, our accomplishments last year did not go unnoticed. We're very proud of the fact that we continue to earn recognition from J.D. Power and others, reinforcing the fact that we are good at what we do.

So as we look ahead to this year and beyond we'll continue to capitalize and build on our proven business model. I'll talk more about our business model and our strategic focus going forward after Greg discusses our 2016 financial results. Greg?

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Greg Gutting, Erie Indemnity Company - EVP & CFO [4]

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Thanks, Tim. Yesterday we reported excellent 2016 financial results for both the fourth quarter and full year. Beginning with the fourth-quarter results, net income increased to $46 million, or $0.87 per diluted share, compared to $30 million, or $0.57 per diluted share, in the fourth quarter of 2015.

The growth was driven by increased revenues, net revenues from operations, and total investment income. Net revenue from operations, before taxes, increased nearly $15 million in the fourth quarter of 2016, representing a 35% increase over the fourth quarter of 2015.

Indemnity's management fee revenue increased $23 million, or 6.7% in the fourth quarter of 2016 compared to 2015, while the cost of operations increased 2.7%, or just over $8 million in the same period. Commission related expenses in the fourth quarter increased $10 million compared to the fourth quarter of 2015 while non- commission related expenses decreased nearly $2 million during that same period. Our resulting gross margin for the fourth quarter of 2016 was14.9% versus 11.7% in the fourth quarter of 2015.

Finally investment income for the quarter totaled $13.5 million compared to $4.2 million in the fourth quarter of 2015. The increase was driven primarily by earnings from our limited partnerships.

Indemnity's full-year results also tell a story of strong growth. Net income for the year was $210 million, or $4.01 per diluted share, compared to $175 million, or $3.33 per diluted share, in 2015. The increased earnings were driven by net revenue from operations as revenue growth outpaced expense growth.

As result Indemnity's gross margin for the full-year 2016 was 18.3% compared to 15.4% in 2015. Management fee revenue in 2016 increased $92 million, or 6.2%, compared to 2015 while the total operating expenses increased just over $31 million, or 2.5% year-over-year.

When we talk about expenses we make a distinction between commission related and non-commission related costs. Commissions paid to independent agents are the largest component of our cost of operations. For the year, commissions increased nearly $46 million or 5.4% compared to 2015, driven by the 6.2% increase in direct and assumed written premiums of the Exchange.

Several factors contributed to a $14.6 million, or a 3.4% decrease in non-commission costs for the year compared to 2015. Year-over-year, information technology expenses were down over $2 million as a result of decreased personnel costs. And customer service expenses decreased nearly $5 million as we incurred fewer credit card processing fees.

Administrative costs decreased almost $8 million due to decreased personnel costs including incentive compensation forfeited by departing senior executives in 2016. Personnel costs in 2016 benefited from decreased pension costs and lower medical costs due to favorable medical claims experience compared to 2015. Pension costs decrease primarily due to an increase in the pension discount rate compared to 2015. However, pension benefit costs will increase in 2017 as a result of a lower discount rate and a lower assumed expected return on assets in 2017.

Finally, Indemnity's income from investments before taxes was $27.8 million in 2016 compared to $33.7 million in 2015. The decrease was primarily attributed to a decrease in limited partnership earnings, and once again I'll remind you that this asset classes is in [run-up] and we continue to expect more limited and inconsistent earnings from these investments.

Our 2016 results confirm that Indemnity had a very good year, both superior performance and the strength of our balance sheet enabled us to return $136 million in dividends to our shareholders and 2016. And in December our Board approved a 7.2% increase in the regular, quarterly cash dividend for both class-A and class-B shares for 2017.

Our financial strength also has enabled us to invest in the future with the construction of our new office building. Construction is expected to take approximately three years to complete. Now I'll turn the call back over to Tim.

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Tim NeCastro, Erie Indemnity Company - President & CEO [5]

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Thank you, Greg. As we look ahead to 2017 and Erie's business approach, our executive team isn't looking for revolutionary changes to our business model. We will capitalize on our brand strength evolving it and giving it a contemporary look. I know with certainty that we'll have to address disruptive trends in our industry and that the customer of the future will have a new face and new expectations.

And while change won't happen overnight, the evolving needs of the customer is a certainty that will help shape our priorities. We remain unquestionably committed to our proven distribution channel. Our dedicated, independent agents, will continue to be the face of Erie forging lasting relationships with our customers.

It will be our job to build out the core and improve on our existing business model. We'll continue to strengthen the Erie experience for our agents, customers, and employees, by linking digital capabilities with our distinctive human touch and becoming more efficient on a 24/7 timetable.

We want Erie to always be the agents and customers coverage of choice. We will also respond to changing consumer behavior, new risk patterns, and the needs that arise from emerging technology. And we will continue to look for prime opportunities to grow market share.

And as we did with Eric claims center we will look closely at our infrastructure and begin our journey of replacing legacy platforms with solutions to improve efficiency, service, and data management, paramount to better decision-making in our business. We will examine the workforce and workplace of tomorrow. Focusing on the skills, capabilities, and space needed to succeed in a changing industry.

We'll continue to recruit and develop talent and provide the environment that will keep our employees engaged, while allowing us to meet new levels of service for customers and agents. Flexibility where possible, leads to happier, healthier and more productive employees. Thinking ahead and anticipating disruptive forces will provide opportunity.

Our world and our industry are changing and while that change won't happen tomorrow, it will happen, and we have to start planning for it today. It is in this way that the Exchange will continue to thrive in Indemnity will continue to produce value for you, our shareholders, in 2017 and beyond. Now, we will be happy to take your questions.

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Questions and Answers

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Operator [1]

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Thank you.

(Operator Instructions)

Amit Kumar, Macquarie.

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Amit Kumar, Macquarie Research Equities - Analyst [2]

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Thanks and good morning. Just a few questions to start with. Number one, if I look at the combined ratio for private passenger auto, can you just broadly talk about how you are thinking about the loss cost trends and the rate increases you might be looking at going forward?

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Tim NeCastro, Erie Indemnity Company - President & CEO [3]

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Certainly, and good morning, Amit. Erie's experience is on par, and in fact, maybe a little bit better than the industry. And from our perspective, we look at personalized households and not just at the automobile line of business.

And so when we look at things in the aggregate, and as our agents sell more packaged policies, we are seeing very consistent profitability trends for ourselves in the first in line's arena. Certainly we are seeing increases in loss costs, like the industry is seeing. We know that those things are attributable to things like distracted driving and the advent of new technology is being utilized in cars.

For Erie, we see relatively moderate rate actions. We tend to handle profitability concerns really with three levers. So while we could take rate, and we certainly adjust rates periodically from time to time using sophisticated pricing, we also handle profitability through our agency management practices and our underwriting practices. And really underwriting has been one of the consistent strengths and strategic strengths of Erie for many many years.

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Amit Kumar, Macquarie Research Equities - Analyst [4]

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In terms of -- when you talk about that, is the loss cost uptick, is that on the bodily injury side? Or is that on the property damage side for you?

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Tim NeCastro, Erie Indemnity Company - President & CEO [5]

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It's predominantly on the property damage side. We (inaudible) we are seeing industry results that are far more skewed toward BI than ours are. But we are seeing it more on the PD side, and we attribute that to the increased repair cost on automobiles because there is so much technology built into them today.

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Amit Kumar, Macquarie Research Equities - Analyst [6]

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Got it. Moving on to the commercial auto piece, and I know it's a smaller piece for Erie, that's one of the new hotspots. Any thoughts on how you expect that to emerge over 2017?

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Greg Gutting, Erie Indemnity Company - EVP & CFO [7]

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This is Greg Gutting. Our book is a little bit different on commercial auto than the industry, so we have the small fleets and whatnot. So we are not seeing a lot of the same things that the industry is seeing there.

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Amit Kumar, Macquarie Research Equities - Analyst [8]

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Got it. The final question I have is in the past we've talked about cross-selling, if you will, in terms of personal alliance policy holders also owning life insurance policies. Any updated thoughts on the penetration levels on that?

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Greg Gutting, Erie Indemnity Company - EVP & CFO [9]

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We're seeing -- this is Greg again, we're seeing some gains there and that is something we're looking to focus on in the future, but nothing substantial at this point.

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Tim NeCastro, Erie Indemnity Company - President & CEO [10]

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Amit, this is Tim. Really some of the work that we've accomplished in that customer arena, it's really systems based, it's giving us a broader view of where our customers are and how deeply penetrated we are. I would say early on, we are seeing some marginal improvement, but we think that some of the work that -- the foundational work that's being accomplished is going to help us far more in the future.

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Amit Kumar, Macquarie Research Equities - Analyst [11]

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Got it. That makes sense. That's all I have for now. Thanks for the answers and good luck for the future.

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Tim NeCastro, Erie Indemnity Company - President & CEO [12]

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Great, thank you.

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Operator [13]

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Thank you.

(Operator Instructions)

Adam Klauber, William Blair.

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Adam Klauber, William Blair & Company - Analyst [14]

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Good morning, guys. Nice quarter. A couple different questions, and sorry I missed the first part of the call, so I apologize if you talked about these. For 2017, how should we think about the direction of some of the expense items, the salaries and some of the other expenses, technology investments? Could you -- and I apologize if you said that already, but could you walk through just directionally where those may go?

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Tim NeCastro, Erie Indemnity Company - President & CEO [15]

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Well, we had the advantage this year of some lower costs. The pension were down just as a function of the discount rate, so those costs are going to go up a little bit in 2017. The medical expenses were down and we're self-insured, so that flows through, so we experienced less medical claim severity there on the larger claims where we saw some of that.

We saw the benefit of some of the bonus plans for executives who have left [where we had an accrual up] which were removed, so that was part of it. We also altered the payment plans that we take credit cards on during 2016, which reduced the credit card expense, which we expect that to go back up a little bit in 2017. So we were benefited on a few fronts on the 2016 on the expenses.

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Greg Gutting, Erie Indemnity Company - EVP & CFO [16]

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And Adam, I would say on the technology front, we're going to continue to make investments in our legacy platform, replacing that platform. And it's difficult to predict what the expense stream is going to look like. A lot of it builds on itself, but we expect 2017 to be a very rigorous year in the technology arena.

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Adam Klauber, William Blair & Company - Analyst [17]

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Okay and as far as other expenses, non-tech, and again not looking for exact numbers, but are there going to be investments or is it just more normal growth of the expense base next year?

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Tim NeCastro, Erie Indemnity Company - President & CEO [18]

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We continually invest not only in IT but in other process improvement and customer experience things, but I don't see any major expenditures there. It's more in line with what we've done in the past.

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Adam Klauber, William Blair & Company - Analyst [19]

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Okay. Then how are we thinking about cash usage for 2017? What are your priorities?

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Greg Gutting, Erie Indemnity Company - EVP & CFO [20]

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We have very good cash flows. With the building coming on, we actually were able to leverage our strength there and lock in a very good rate for financing most of the building. So I see it as similar to what we've seen in the past.

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Tim NeCastro, Erie Indemnity Company - President & CEO [21]

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Really, I'd say predominately to fund our operations force, fund dividends for shareholders, but we don't anticipate any major drains on cash in 2017.

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Adam Klauber, William Blair & Company - Analyst [22]

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Okay. So still mainly dividends? Buybacks, is that consideration or not that much?

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Tim NeCastro, Erie Indemnity Company - President & CEO [23]

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The dividends, for sure. The buybacks --.

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Greg Gutting, Erie Indemnity Company - EVP & CFO [24]

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We'd look at those if it's opportunistic.

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Adam Klauber, William Blair & Company - Analyst [25]

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Okay. And then as far as growth of the agency force, which states, or which areas do you think you'll see some pockets of growth this year?

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Tim NeCastro, Erie Indemnity Company - President & CEO [26]

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We've had a relatively stable agency force in terms of numbers of agencies. It's been hovering around about 2,250 agencies or so. We continue to make appointments in some of the newer territories or lesser developed territories like Tennessee and Illinois.

I would continue to see those type's of appointments occur. The licensed producers is the area where we're seeing greater growth. We've seen an increase of almost 3,000 licensed producers over the past five years, and so now we are around 12,500 producers out there.

So that's growth within existing agencies, and I think that the number -- I think that we are averaging around $2.9 million of direct written premium per agency as we sit here today, and that's up from about $1.7 million about five years ago. So we are more deeply penetrated in the existing agency plant.

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Adam Klauber, William Blair & Company - Analyst [27]

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Great. So as we think about 2017, maybe not a lot of growth in the agency force, but continued growth in the number of produces? Is that a way to think about it?

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Tim NeCastro, Erie Indemnity Company - President & CEO [28]

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Yes. Now I failed to mention, we'll be appointing producers in Kentucky, our newest territory as well.

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Adam Klauber, William Blair & Company - Analyst [29]

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Okay, great. Thanks a lot.

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Operator [30]

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Thank you.

(Operator Instructions)

And I'm showing no further questions at this time. I'd like to hand the call back over to Scott Beilharz for any closing remarks.

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Scott Beilharz, Erie Indemnity Company - VP of IR [31]

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Thanks, Nicole. Thanks again for joining us. A recording of this call will be posted on our website, erieinsurance.com, after 12:30 PM Eastern time today. If you have any questions please call me at area code, 814-870-7312. Thank you.

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Tim NeCastro, Erie Indemnity Company - President & CEO [32]

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Thanks everybody.

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Operator [33]

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