Jeffrey Miller - CFO Kevin Burke - Acting CEO.

Vincent DeAugustino - KBW.

Good morning. My name is Audrey, and I will be your conference operator today. At this time, I would like to welcome everyone to the Donegal Group Inc.'s Q3 2014 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions).

Thank you. Jeffrey Miller, Chief Financial Officer. You may begin your conference..

Thank you. Good morning everyone and welcome to the Donegal Group conference call for the third quarter ended September 30, 2014. As introduced I am Jeff Miller, Chief Financial Officer, and I will begin today's call by highlighting the quarterly financial results.

Kevin Burke, Acting Chief Executive Officer is also on the call this morning and will provide additional commentary on the quarter and an update on our current business trends and development. As we announced in August, Don Nikolaus, our President and CEO, has taken a medical leave of absence and he is not on the call with us today.

You should be aware that certain statements made in our news release within this conference call are forward-looking in nature, and involve a number of risks and uncertainties. Please refer to our news release for more information about forward-looking statements.

Further information on Risk Factors that could cause actual results to differ materially from those projected in the forward-looking statements is available in the report on Form 10-K that we submitted to the SEC. You can find a copy of our Form 10-K in the Investor section of our website under the SEC filings link.

Further reconciliation of non-GAAP information as required by SEC regulation G was provided in our news release, which is also available in the Investor section of our website. Turning to the quarterly results. We were pleased to achieve a 14% increase in net income for the third quarter and a 15% increase in operating income.

At $8.7 million third quarter net income improved significantly over our quarterly results for the first half of the year and supports our ongoing optimism for the effectiveness of our business strategy.

Our net premiums written increased 8.2% for the quarter, as we continue to benefit from premium rate increases in most of our business lines, new business growth, and commercial lines, and this year's additional contribution from a reduction in Michigan Insurance Company's external quota-share reinsurance.

Kevin will give you more information about our growth initiatives and the progress we're making to increase our market share within our regional markets. Our third quarter profitability was greatly improved compared to the first half of 2014 and I'll highlight several of the key areas of impact for the current quarter.

Weather losses of $10.9 million were actually above our average for third quarter losses over the past five years, and exceeded the $9.4 million of weather losses we incurred in the third quarter of 2013.

We incurred no accumulations of losses that exceeded our property catastrophe reinsurance retention amount but our results did reflect an elevated impact from localized severe weather events in the Midwest that included wind, hail, and heavy rain.

We continue to receive losses from a few of the storms that occurred in the first half of the year but we are recovering reinsurance for nearly all of those losses, and there was minimal impact from earlier events to our third quarter results.

Large fire losses totaled $6.3 million, which was close to our quarterly average over the past two years but higher than the $3.1 million in the prior year quarter. Our quarterly underwriting results in both personal and commercial lines were excellent.

Beginning with personal lines, the third quarter combined ratio of 95.2% was the lowest we have achieved for that segment in recent history. We attribute the favorable results to the continuing benefits of cumulative rate increase activity over the past several years.

We are also seeing lower frequency and severity of personal auto bodily injury liability losses, which is generally in line with reported industry trends. We mentioned in the second quarter call that underlying improvement in our personal auto combined ratio was masked by the impact of hail claims.

And our third quarter combined ratio of 94% demonstrates the underlying improvements we have been observing in that line of business. Our commercial lines combined ratio was 94.4% with strong performance within our commercial multi-peril and worker's comp line.

We are continuing to address the profitability issues within our commercial automobile line of business by increasing rates in selected geographies and in classes of business where we are not hitting our combined ratio target. Our worker's compensation line of business had an 89.3% combined ratio for the quarter.

We track all incoming losses and reserve adjustments over $50,000 and actually had a higher incidence of those large losses compared to the prior year quarter. So we also had offsetting subrogation recoveries, favorable settlements on a number of claims, and lower frequency in general.

The overall result was an excellent quarter for us in worker's comp. Total prior accident year loss reserve development added a relatively modest $2 million to our incurred losses in the quarter, comparing favorably to the $3.1 million development in the third quarter of 2013.

The current quarter development was primarily in the personal automobile line of business and it had a minimal impact on our overall loss ratio. Turning to the investment portfolio, investment income was down $325,000 or 7% for the quarter, reflecting the lower average investment yield in our fixed-maturity portfolio.

The quarterly yield is somewhat hampered by an increased allocation of expenses to the investment function during the quarter. During the past three months, we added some municipal bonds to our portfolio mix taking advantage of more attractive yields in that sector.

But we also invested funds in shorter duration, mortgage-backed securities to provide consistent cash flows in the future. We expect to continue to stay the course from a strategic standpoint and to invest excess cash within our currently targeted investment classes as opportunities arise.

We've set an internal portfolio allocation target of up to 50% for municipal bond as we view that asset class to be the optimal way for us to maintain yield in this uncertain rate environment. Net unrealized gains on our available-for-sale investment portfolio increased by approximately $6.5 million after-tax, compared to the year-end 2013 level.

That increase was due to reduced market interest rate, and along with our favorable operating earnings, contributed to an increase in our book value per share to $15.43 at September 30, 2014, compared to $15.02 at year-end 2013.

Last Thursday, our Board of Directors approved quarterly cash dividends of $13.15 per share of Class A common stock and $11.06 per share of Class B common stock, payable November 17 to stockholders of record as of November 3. We had not repurchased any common stock during the quarter.

At this point, I'll turn the call over to Kevin for his comments on the quarter..

Thank you, Jeff. Good morning everyone. As Jeff has reported, we are very pleased with our third quarter results and we are focused on executing our business plan as we enter the fourth quarter.

I will review the commercial and personal lines underwriting segments of our business as we touch upon expanding distribution system and the continued enhancements that we are making in the area of our technology.

Based on rate indicators and market data, we continue to focus on rate adequacy and quality underwriting to achieve our target profitability levels in commercial lines and personal lines.

Both our commercial lines and personal lines business segments performed well in the third quarter, with personal lines achieving a combined ratio of 95.2% and the commercial lines a 94.4% combined ratio. These results demonstrate our commitment to sound underwriting discipline and loss control initiatives.

In commercial lines, we continue to see strong premium growth with the commercial lines book of business now rising to approximately 43% of our total writings for the year. Commercial lines renewal premium increases were within the range of 6% to 7% during the third quarter.

Despite some industry reports of the softening commercial market, we continue to experience favorable renewal rates, with some classes of business showing some modest rate softening. Commercial lines net premiums written increased 12% for the third quarter with retention levels in the mid 80% range.

And based upon loss ratio results in market data, we are making select rate filings in various lines of our commercial business with increases in the low-to-high-single-digits depending on the line of business and state. Our commercial auto line of business has not performed to the level we expect.

And we are reviewing our commercial auto book of business to ensure appropriate underwriting and loss control measures are in place. And where necessary we have filed rate increases for commercial auto in the range from the low-single-digits 9%, depending on the state and subsidiary.

In personal lines, we continue to strive to maintain rate adequacy in all of our lines of personal lines business, and we will continue to submit appropriate rate filings. As we have seen in our third quarter numbers, we continue to see progress towards our targeted profitability levels in personal lines.

Rate filing increases and homeowners are within the 4% to 9% range depending on the state and subsidiary. And rate filing increases in automobile range in the low-single-digits, again depending on the state and subsidiary. Net premiums written for the third quarter increased by 5.7% and retention levels remain strong in the high 80% range.

We are encouraged by our third quarter personal lines results and we are optimistic this momentum will carry over into the fourth quarter. Given the current investment rate environment, it is critically important that we focus on sound underwriting principles. We believe the third quarter numbers reflected a number of positive developments.

Underwriting profit margins continue to improve, which is the direct result of the positive impact of premium and rate increases in our earned premiums. Also, I wanted to highlight the continued expansion of our independent agency distribution system.

In addition to the appointment of new high quality agents, we also focused on further growth within our existing agency plan. As a key component in our 2014 business plan, specific goals were established to enhance the level of premiums written within each agency.

Moving agents from one level or premium strata to the next higher level serves to further enhance the overall business relationship between the agent and Donegal. And the quality and frequency of submissions also improves as agencies commit to an increased percentage of their business to Donegal.

As of the third quarter, we have appointed 106 new agents throughout the regions in which we operate. All these newly appointed agents have a strong interesting growing with Donegal and have the ability to grow commercially with us.

Currently, we have over 130 agencies that are projected to move into higher premium stratus by the end of the fourth quarter, 18 of these agents will exceed the $1 million written premium level with an additional five agents exceeding the $2 million written premium level.

Just like to take a few minutes and discuss Donegal's technology and our commitment to leveraging the best-in-class technology to ensure ease of doing business with our agents and policyholders. Our mobile application currently is live in all the states in which we do business.

Ongoing enhancements will include application geared toward the independent agent; giving agents enhanced capabilities to view their book of business, follow-up on a status of an insurance claim through their mobile devices. As a result of agent feedback, we are adding this functionality with a rollout planned in early 2015.

We have rolled out e-signature for personal lines new business in Pennsylvania, which allows our customers to sign, confirm documents electronically. The digital signatures we obtain are recognized by the state as an original signature. Additional states will follow as we rollout e-signature for personal lines.

We are also looking into the benefit of using e-signature for commercial lines. This is an initiative that is also the direct result of agency feedback and improves the efficiency of our underwriting process. Also on the technology side IVANS Insurance Solutions recently awarded our organization with the Applied IVANS Interface Leadership Award.

IVANS recognized that Donegal Insurance Group as one of the top 10 carriers for excellence in information exchange with our independent insurance agencies. Effective agency carrier interface is critically important to us and we are pleased to have received this recognition. We are also pleased to communicate that on October 7, 2014, A. M.

Best affirm the financial strength rating of A excellent for the Donegal Insurance Group and Donegal Group Inc. Before we move into our question-and-answer session, we'd like to update you briefly about the medical condition of our President and Chief Executive Officer, Don Nikolaus.

In late August, we publicly reported that Don was taking a medical leave of absence as CEO of the Donegal Group. And around the same time we indicated publically that he was continuing to perform certain duties in his other capacities within the Donegal Insurance Group.

In early October, Don underwent surgery to correct his medical condition, the surgery was successful but Don will require a certain amount of ongoing medical treatment for the next several months. As he continues to recuperate Don expects to gradually increase his involvement in the affairs of the company.

At this point, I would like to turn the call back to Jeff to return to any questions or answers that you have..

All right. Thank you, Kevin. And at this point Audrey we will ask you to open the lines for questions and complete the queue..

(Operator Instructions). Your first question comes from the line of Vincent DeAugustino with KBW. Your line is open..

Nice quarter. Just a few quick questions. As far as looking back over 2014 to-date so the weather and kind of the cat line has bounced around a little bit. But one of the things that's been consistent in each of the quarters is that the core loss ratio improving. And so that's clearly been one of your big initiatives.

And with that kind of going in the right direction I was kind of curious, as you go through the year-end planning process if there's anything beyond kind of the margin improvement aspect that you're accelerating as an initiative into 2015.

And I know you guys talked about some of the agency penetration aspects, but just wanted to maybe touch on that more specifically..

Sure Vincent, this is Jeff and we're going to continue to do what we've been doing throughout the year 2014 and that is emphasizing growth in commercial lines, we see that as a critical element in improving our profitability over time, because our commercial lines results have outperformed personal lines historically.

So we expect to continue to do that. We're continuing to take all the same underwriting initiatives that we have put into place as far as improving our personal lines results, particularly in the homeowner's area by continuing to increase rates to increase deductibles.

Much of that has already worked its way through their underwriting process but we'll continue to maintain vigilance to keep those results where we need them to be.

So I don't think there is anything especially new that we're projecting to do in 2015 but that planning process will be kicking off here, it's already underway at some level but we'll begin in earnest here in the next few weeks to finalize our thinking for 2015..

Okay. Good to know. And then just to make sure I took this down correctly from your comments, Jeff. So from the first half there is some development on the storm events but that's all hitting your reinsurers at this point.

Was that kind of what you guys talked about?.

Yes, that is correct. There is a very modest couple of $100,000 impact from some of the smaller events that had not yet hit the retention out in the Midwest. But we have a very low retention out in the Midwest; it's only $0.5 million. So it's a couple of $100,000 impact at the current quarter nothing material..

Got it, okay. And then from the net investment income side so you had mentioned some higher investment expenses kind of hitting this quarter.

Is that one-time or is that ongoing from this point?.

It was elevated in the current quarter. We'd not expect that to continue. It has to do with some of the technical ways we allocate expenses in the pooling agreement with Donegal Mutual and some of those expenses were somewhat unusual. So I would not project that the level of the expenses going forward..

Okay. Good to know. And so last quarter -- forgive me if you mentioned it but last quarter there was some elevated fire losses, that there was some subrogation work that you guys were going to be doing.

So I just wanted to see if we could touch on that real quick?.

Sure. And I did follow-up with our claims management to get an update on those. There are a number of claims where we are pursuing subrogation. No recoveries to speak up in the third quarter that's a process that takes some time. But there are a number of claims where we do believe that there is a potential for picking up some subrogation.

And you mentioned large fire losses that's probably an area where we could give some additional color.

We have tracked large fire losses not because we think it's such a material thing that we need to look at and deal with but it's one of those areas that generally explain some volatility in our quarterly results, whether up or down, and it also is a metric that many of our peers report.

And so the level for the current quarter it's just over $6 million. As I mentioned it was just slightly above our quarterly average for last year.

It's reduced from where it was at the second quarter though we did see kind of a return to a more normal level of fire losses and the increase we saw was relative to the third quarter of 2013 was more related to the fact that that prior year quarter was fairly low and also it's just a handful of fire losses in our Michigan Insurance Company subsidiary where we are retaining a larger portion of that business.

So that gives you just a few more details on the fire losses but we see them returning to a more normal level in the third quarter..

Okay, good. And then, as you might expect, a question on the auto reserves. And so in some cases in the past we've talked about some particular cases moving that number around a little bit on personal auto.

Was that a similar dynamic this quarter?.

No, this quarter there was nothing that I could point to as far as handful of cases, it was more an overall development, it was, as I mentioned in personal auto where we had a very good combined ratio. So we absorbed that development within the quarterly result..

Got you. Just my reserve OCD. So one last question, if I might. So one of your, I wouldn't call it a director competitor, but in any case, on one of the conference calls yesterday, Pennsylvania worker's comp was mentioned as a particular state in line of challenge.

And so are you guys particularly seeing anything of those sorts in Pennsylvania? And, I guess, secondly, I know you guys focus more on the smaller account size so perhaps that would be part of the explanation, if you're not seeing it. So I'd just be curious of any thoughts that you might have..

Yes, Vincent, this is Kevin. Good question, what we're seeing is obviously we're getting good results with our worker's comp business. But we are starting to see and one of the comments I had said was the softening of the market in commercial. And again in most lines we have not seen it but we have started to see it in worker's comp.

So, we continue to get the appropriate rate. We are starting to see some softening in the worker's comp market but for us it really has not been an issue and it may be as you talked about may be the segment of business that we're and the size of the accounts that we're going after..

Okay. I think that wraps me up. So again, guys, nice quarter and especially on that core loss ratio. So I look forward to talking to you soon. And if you could, please give Don my wishes. So take care..

Thank you. We will do that. Thanks, Vincent..

(Operator Instructions). And there are no further audio questions at this time..

All right. Well we thank everyone for participating in the conference call today and wish you a good day. Thank you for joining us..

Thank you..

That concludes today's conference call. You may now disconnect..