Jeff Miller - CFO Kevin Burke - President and CEO Don Nikolaus - Chairman.

Christopher Campbell - KBW.

Good morning. My name is Scott and I will be your conference operator today. At this time, I would like to welcome everyone to the Donegal Group Inc.’s Q3 2016 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there’ll be a question-and-answer session.

[Operator Instructions] Thank you. Jeff Miller, Chief Financial Officer, you may begin your conference..

Thank you very much. And good morning and welcome to the Donegal Group conference call for the third quarter and first nine months ended September 30, 2016. I will begin today’s call with commentary on our quarterly financial results.

Kevin Burke, President and Chief Executive Officer, will then discuss our current business developments and growth initiatives. Following that, our Chairman, Don Nikolaus will share his perspective on the quarter and our ongoing business strategy before we open the line for questions.

You should be aware that certain statements made in our news release and in 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 Investors 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 Investors section of our website.

Our third quarter was highlighted by strong organic growth in our core markets, which was evidenced by higher premiums throughout the period in both our commercial and personal lines of business. Kevin and Don will go into more detail. All of the trends are moving in the right direction in terms of growth.

In particular, we saw double-digit growth in our commercial lines, which is a continuation of a trend we’ve reported consistently over recent quarters. This led to an 8.2% increase in our net premiums written for the quarter. And again, Kevin will further discuss the factors driving this growth, later in the call.

Turning to the bottom line for the third quarter of 2016, Donegal reported net income of $4.8 million or $0.18 per diluted Class A share compared to $5.7 million or $0.21 per diluted Class A share for the third quarter of 2015. Our statutory combined ratio for the third quarter was 99.5% compared to 97.4% for the prior year period.

And our third quarter GAAP combined ratio was 108% compared to 99.5% last year. While the increase was due to higher than expected loss ratio for the period, we do not believe it is indicative of any notable trend and that it represented a normal quarterly fluctuation in reported claim activity.

I’ll now go over a number of factors that contributed to the increase in net losses incurred compared to the third quarter of 2015. To begin, we experienced a modest increase in claims frequency and severity in our personal automobile line of business.

The increase occurred in certain physical damage coverage lines as well as there were a handful of reserve increases on first party medical claims that occurred in the first half of 2016.

The physical damage component of the loss ratio increased from 56% to 65% for the third quarter, attributable to a combination of increases in collision severity and to a lesser extent comprehensive frequency.

Again, we do not have any reason to believe that these factors will represent a longer term trend in our loss ratio and we expect that loss ratio to moderate going forward as we continue to file rate increases.

Our workers’ compensation loss ratio also increased compared to the prior year quarter due to a higher volume of large claims, which we define as over $50,000. However, we continued to achieve excellent workers’ compensation results as the 86.8% combine ratio indicates.

These increases were offset by few weather-related losses of $11.7 million compared to $14.6 million for the prior year quarter. We monitor our weather-related losses within a longer term context and we were pleased that our losses during the quarter were lower than our average third quarter weather losses over the past five years.

And notably, we haven’t had any material impact from recent storm events including Hurricane Matthew that would adversely affect our fourth quarter results. Large fire losses were $6.7 million or 4 percentage points of the Company’s loss ratio, in line with the $6.8 million or 4.4 percentage points of our loss ratio for the third quarter of 2015.

We were pleased to report favorable net development of reserves for losses incurred in prior accident years for all lines of business, continuing the trend of improving reserve development patterns that we have experienced over the past two years.

The favorable development reduced our loss ratio for the third quarter of 2016 by 1 percentage point compared to unfavorable development that added 1 percentage point to our loss ratio for the third quarter of 2015.

In our commercial multi-peril line of business, the absence of large fire losses and significant weather-related loss activity contributed to a decline in claims frequency but we did note a modest increase in liability claims severity. All things considered, we were pleased with the 94.7% combined ratio in commercial multi-peril for the quarter.

Moving to the expense ratio, we saw a slight increase in our GAAP expense ratio to 33.5% for the third quarter of 2016, compared to 32.1% for the prior year quarter.

The increase in our expense ratio reflected higher underwriting based incentive costs that were related to higher premium production and favorable underwriting results for the first nine months of 2016.

In summary, apart from seasonal increases in casually loss activity, we were generally pleased with our underwriting results during third the quarter of 2016. When adding them to our excellent first half, we are very pleased with our underwriting results for the first nine months of 2016, which equated to a statutory combined ratio of 95.6%.

Turning briefly to the investment portfolio, investment income increased 3.4% for the third quarter, primarily related to a 7.2% increase in average invested assets compared to the prior year quarter. Book value per share increased to $16.59 at September 30, 2016, compared to $15.66 at yearend 2015.

We attribute that increase to our favorable first nine months results, which generated a 33% increase in net income and 7.9% annualized return on average equity.

And finally, our Board of Directors declared regular quarterly cash dividends at $0.1375 per share of our Class A common stock and $0.12 per share of our Class B common stock, and those dividends are payable on November 15th to stockholders of record as of the close of business on November 1st.

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

Thank you, Jeff. Good morning, everyone. We’re pleased with the continued growth and profitable results we achieved for the third quarter, as well as our overall year-to-date results.

Our focus on executing our long-term business strategy including our commitment to sound underwriting discipline, expanding our market share, providing best-in-class technology and being responsive to not only our customers but also to our independent agents who’ve contributed greatly to our positive results.

The positive trends have increased premium growth, profitable underwriting results and a steady increase of policies in force are direct result of increased market penetration and strong policy retention. The double-digit premium growth we have seen recently in our commercial lines segment continued into the third quarter.

Let me take a moment to separately review the commercial and personal lines underwriting segments of our business. During the third quarter, net premiums written increased 12% in commercial lines with each line multi-peril, workers’ comp, auto reporting strong premium growth.

In addition, we achieved solid underwriting performance in most of these lines that helped contribute to a statutory combined ratio of a 94.3% for the quarter and 90.3% year-to-date. We continue to see opportunities to obtain modest renewal premium increases with increased competition for quality accounts.

Our renewal premium increases during the third quarter generally range from 3% to 5%, which is consistent with the past several quarters.

As we continue to obtain renewal premium increases and maintain excellent retention ratios, we’re optimistic that this segment of our business will continue to grow and achieve the underwriting results we’re targeting.

Moving to personal lines segment of our business, we’re pleased to report an increase of 5.6% in net premiums written compared to the third quarter of 2015. We’re achieving new business growth within our auto and homeowners lines in spite of the competitive marketplace.

And our agent relationships as well as years of building our brand within our regions have allowed us to attract new business while maintaining excellent retention levels in these lines.

We have implemented rate increases in the low single-digit percentage range, depending upon the state in subsidiary and we’ll continue to follow rate increases where appropriate. We also continue to expand use of our predictive modeling tools to refine our pricing and underwriting criteria.

Now, let me give you an update on our marketing efforts in distribution. We’ve continued to expand our independent agency distribution system by appointing new high-quality agents through all of our operating areas. The ongoing initiative has contributed to the increase in commercial lines and personal lines premium growth over the past several years.

And it is our expectation that the new agencies will continue to represent additional growth opportunities for us in the future. One of our strategic goals is to increase our market share in the 21 states in which we operate.

We continue to make progress in this area and to enhance our geographical footprint by emphasizing premium growth and profitability with our existing agents to further develop and increase their loyalty and commitment to us.

We believe Donegal’s commitment to the independent agency system and the value we bring to our agents and customers were major contributors to our continued success for the third quarter. We continue to see significant growth in the number of what we call our leaders agents.

These are Donegal agencies that generate the highest level of written premium with our group of companies. And we have additional agencies in the pipeline moving towards that objective. Our efforts to enhance our relationships with these larger agencies have resulted in an increase in new business submissions.

And we believe the leaders agents represent an excellent source of future premium growth for our organization. Finally, each quarter we spend a few minutes discussing technology enhancements and where we are in terms of implementing those enhancements.

We have had some very positive developments during the third quarter for several initiatives that are all part of our ongoing commitment to leverage our best-in-class technology to enhance ease of doing business with our agents and policy holders.

We are pleased to report the implementation of Donegal’s new policy rating engine for personal lines is now complete. This allows for greater speed to market for rate coverage actions. And we are starting to realize the benefits of this new technology as we make refinements to our personal lines products.

We are now beginning the process of transitioning our commercial lines on to the new rating engine platform, and this will be an important initiative for us moving forward into 2017.

To maintain and build upon our reputation as a strong regional carrier, it’s important that we have the ability to bring products to market quickly and to be nimble when reacting to new market trends.

We are working on the replacement and upgrading of our agency management system to newer technology with enhanced functionality to help us in the administration of our agency contracts and communications.

We are committed to constantly evaluating or replacing remaining legacy systems with newer, more efficient technology following a measured approach to ensure minimal disruption for our agents, employees and customers.

For example, our multi-year transition from our legacy billing system to a state-of-the-art billing solution is progressing smoothly with all new business now billed through the new system. We are gradually converting renewal policies to the new systems and we expect to complete that conversion in early 2017.

Our long-term goal is to continue to maintain an efficient technology platform that can easily sustain our expected growth while at the same time streamlining our operating costs. This measured approach will help mitigate risk associated with various system changes while moving the organization forward in its technology initiatives.

At this point, I’ll turn the call over to Don Nikolaus for his comments before we open the lines for questions. Thank you..

Thanks Kevin. Good morning everyone, welcome to our earnings conference call. The third quarter and more importantly the first nine months have been a solid indication of Donegal’s ability to achieve string growth without compromising underwriting profitability. As Jeff has indicated, we have for the nine months a statutory combined ratio of 95.6%.

We have a strong focus on quality underwriting. We gauge our success on this principle and are pleased to have achieved gains in net income, book value and return on equity. Further, we have continued to return capital to shareholders via cash dividend.

The core of our Company’s success is our longstanding commitment building relationships with our independent agents. We don’t take this for granted and we are constantly communicating with our agents to gather information and ensure that we understand changes within our regional markets.

This communication is not only important for Donegal in terms of achieving proper rate for the risk we write in each of our states, but also writing and retaining profitable business. To conclude, we were very pleased with our financial results from the first nine months.

We feel our financial strength, diversified book of business, focus on underwriting ,conservative investment strategy, technology resources and our regional business approach has helped us achieve those favorable results. I will now turn it back over to Jeff and the operator for questions..

Okay. Thank you, Don. Scott, we can now open the line for questions..

[Operator Instructions] Your first question comes from the line of Christopher Campbell from KBW. Your line is open..

My first question is just on your auto books. We saw the highest net written premium growth is where you have the highest combined ratios this quarter.

So, I just wanted to get a little bit more color on where you’re at with your auto rate plans for personal and commercial, and how they compare with your current loss cost trends?.

This is Jeff. I’ll start and then Don or Kevin can certainly add to my comments. We are continuing to increase rates in both the personal auto and commercial auto. And I can probably -- maybe it would make sense to give you some additional color on what we saw as far as the components of the loss ratio increase in the third quarter.

And let’s start with personal auto. The increase in the third quarter loss ratio compared to the prior year quarter was primarily in the physical damage component of that loss ratio, as I mentioned in my prepared remarks increasing 8.5 points to 9 points over the prior year quarter.

And to some extent, the prior year quarter was unusually low as far as the loss ratio we experienced in 2015. But we did see increases in nearly all of our subsidiaries during the quarter and it is higher as far as the physical damage component of the loss ratio. It is higher than what we experienced in the first half.

We did notice though that collision severity has increased in 2016 and that would be consistent with what you’re reading in the industry publications. As vehicles cost more to repair, collision severity has increased. Comprehensive frequency also increased in the third quarter.

But as we looked at our year-to-date frequency for comprehensive coverages that was -- it is consistent with what we had last year. So, we think that the physical damage claim increased during the quarter. It was more related to typical increased driving activities in the summer months, more than any other factor.

But of course, the collision severity and the higher cost of repairs that’s going to continue. And we expect our rate increases to keep pace with that. On the liability side, actually our BI frequency trends have remained very stable. So, we’re not seeing any increase in our BI frequencies.

We saw slight increase over 2015 but when we looked at the longer term trends, actually 2015 represented a 10-year low. So, the modest increase we saw in 2016 is still -- compared to our historical experience, the frequency levels are very low. BI severity also increased in 2016 but that’s pretty much consistent with medical inflation rates.

And during the third quarter, we did increase some reserves for a few Michigan no-fault medical claims that had occurred in the first half of the year. So, that contributed to the elevated loss ratio.

So, I guess in summary, we don’t think that the underlying factors that led to an elevated third quarter loss ratio are necessarily longer term trends in relation to our rate increases that we have taken.

I think there is some seasonal timing variations there, and we don’t expect further development from the physical damage claims because they settle very quickly.

The loss ratios we have been taking in personal order are in below to mid-single digits and we would continue to monitor the loss cost increases and file appropriate rate increases as necessary to make sure that we are keeping pace with any loss trends that we are seeing..

This is Don Nikolaus. As a follow-up to what Jeff is saying, I think it also has to be kept in mind that the third quarter includes two very heavy summer months where the amount of driving is increased. And therefore, we believe what we have seen is somewhat seasonal.

And we are very proactive and as Jeff has said in looking at rate adequacy which is to refine our predictive modeling for automobile. So that we are encouraged that the longer term trends should be good for us in all automobile, both on the personal line and the commercial line side..

Great, that’s very helpful. If I can ask a question kind of moving down.

The favorable development of 100 bps that you have this time, where has that developed -- what lines is that coming from and is there any negative development in any of your order liability coverages that could be kind of masked by that 100 bps release?.

Sure. That’s an insightful question. We have seen favorable development in workers’ comp. So that’s consistent with what we would have seen last year. That’s the line that is developing most favorably.

We did have actually some favorable development in personal auto liability in the current quarter and that would be a welcome change from what we had seen a few years back. So, we did actually see relatively modest but it is favorable about $600,000 a favorable development in personal auto liability.

In commercial auto liability, we did have some adverse development right around $1 million of adverse development in commercial auto liability. However, I would point out that that is lower than the adverse developments we had experienced in the third quarter of 2015 that was about 1.5 million 1.6 million.

So, we are seeing improving development trends although we recognize that commercial auto is still an area that we have to continue to focus on. We also had a little bit of adverse development in CMP, in commercial multi-peril. But again, it’s improved over where we would have been a year ago.

So, workers’ comp, the most favorable, offset by some modest development in CMP, commercial auto and then a small amount of favorable development in personal auto liability..

This is Don Nikolaus. Sort of as a summary, we are delighted that we had favorable loss development in the third quarter, because it has been an issue that we have dealt with over the last number of quarters. So that we are very pleased about it and we think it’s a very positive development. Thank you..

And just one final question on the workers’ comp which was up this quarter, but after a big drop of last quarter. And Jeff, I think you attributed that to a higher volume of large claim. And I just want to get a sense of how credible is this latest quarterly data point going forward..

Sure. In workers’ comp, because large loss for us would be a 1 million or higher, in the third quarter 2016, we actually had one claim that was in excess of $1 million and we do have an aggregate annual deductible on our reinsurance program for workers’ comp. So, we actually took a $1.5 million hit from that one claim.

So, our large losses -- and as I said that’s any losses over $50,000, they were actually about $3 million higher than the third quarter of 2015 and $4 million higher than the second quarter of 2016.

So, as we look through the data, it was -- there was a handful of larger claims that we incurred during the third quarter and they were actually third quarter 2016 losses. And we think that that’s an unusual aberration; we don’t believe it’s going to continue. But in relationship to the quarter, it certainly had an impact.

But, year-to-date, our workers’ comp combined ratio is still very strong. As I mentioned, we had some favorable development from over claims that helped to offset these larger claims in the current quarter..

And just as a follow-up to Jeff. We remind everybody that the combined ratio for the three months for workers’ comp was 86.8 and for nine months 85.3 which is just absolutely excellent, and we’re just really pleased with it..

[Operator Instructions].

Seeing no other questions in the queue, we will wrap this up. So, we thank everyone for your participation in our call. And we’ll talk to you after the end of the fourth quarter. Thank you very much..

Thank you, everybody..

This concludes today’s conference call. You may now disconnect..