Jeffrey D. Miller - EVP and CFO Kevin G. Burke - President and CEO Donald H. Nikolaus - Chairman.

Christopher Campbell - KBW Unidentified Analyst -.

Good morning. My name is Heidi and I will be your conference operator today. At this time, I would like to welcome everyone to the Donegal Group, Inc's Q2 2017 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. Jeff Miller, Chief Financial Officer, you may begin your conference..

Thank you, Heidi. Good morning everyone and welcome to the Donegal Group conference call for the second quarter and first half ended June 30, 2017. 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 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. With that let's move to a discussion on Donegal's operating results.

Our second quarter was highlighted by two main themes; first, continued and balanced premium growth in our core markets. This growth was driven by our commitment to leveraging our regional strategy to offer individuals and businesses a broad base of insurance products in the markets we know well.

Second, a higher frequency of weather related claims and higher than normal fire losses prevented us from reaching our profitability goals during the period. Kevin will go into greater detail on our top line growth but let me provide additional color on the losses we incurred during the second quarter.

Our statutory combined ratio increased to 104.5% for the second quarter of 2017 compared to 95% for the second quarter of 2016. The main driver for that increase was the weather impact to our statutory loss ratio which increased to 72.9% compared to 63.8% for the prior year quarter.

Weather related losses added approximately $20.1 million to our losses incurred for the second quarter of 2017 including a provision of approximately $3.6 million for additional weather related losses incurred but not yet reported and approximately $2.7 million from events that occurred during the first quarter.

The company's previous five year average for second quarter weather related losses was $10.5 million. Weather related losses contributed 11.5 percentage points to our loss ratio for the quarter compared to 6.9 points of our loss ratio for the second quarter of 2016.

The losses resulted from numerous wind and hail events throughout the quarter and were not attributable to any one major storm event or specific geographic region. In fact none of the loss accumulations from any of these events exceeded or are projected to exceed our $5 million third party catastrophe reinsurance retention.

Our homeowners line of business took the brunt of the weather loss impact during the quarter and from a longer term perspective that line of business has performed well in recent years, and we continually review our property risk profile to ensure appropriate diversification of geographical risk and rate adequacy.

In addition to the weather impact we incurred a higher than normal incidence of fire loss activity during the quarter. Large fire losses which we define as individual fire losses in excess of $50,000 totaled 7.6 million for the second quarter of 2017 or 4.3 percentage points of our loss ratio.

That amount was substantially higher than the fire losses of $3.7 million for the second quarter of 2016 or 2.3 percentage points of our loss ratio with the increase primarily in our home owners line of business.

We reviewed the claims and we did not note any particular trend or pattern in the data that causes range from typical electrical fires, cooking accidents, and careless smoking even to an unusual garage fire that resulted when a homeowner was attempting to smoke out ground hogs on his property.

From the volume of fire losses we incur in any given quarter tends to fluctuate and unfortunately the volume was higher than normal in the current quarter and comparatively higher than the prior year second quarter when our fire losses were below historic norms.

We were pleased that our workers compensation line of business continued to perform well while the decrease in net premiums written in that line reflected increased competition for quality account.

On the other hand commercial auto under performance continued driven primarily by reserve increases related to certain prior year liability losses for which we received additional information during the second quarter, and expect a lot and cost more to settle than we'd anticipated.

We've been working to improve the profitability of our commercial automobile line of business and we've implemented rate increases for that line in all of the states in which we conduct business, in addition to reviewing large claims and implementing enhanced underwriting procedures and controls.

Development of reserves for losses incurred in prior accident years added 3.3 percentage points to our loss ratio for the second quarter of 2017 compared to 2.3 percentage points of our loss ratio for the second quarter of 2016.

In addition to the reserve increases for commercial automobile liability losses that I already mentioned, the development in the second quarter 2017 related to higher than anticipated severity in commercial multi parallel liability claims and modest increases in case reserves or personal automobile liability claims primarily related to accident year 2016 offset by lower than anticipated severity in prior years workers compensation losses.

Our statutory expense ratio was 30.9% for the second quarter of 2017 consistent with 30.7% for the second quarter of 2016 and in line with our expectations. I'll take just a moment to highlight our investment performance for the period.

Net investment income increased 5.7% largely due to an increase in average invested assets relative to the prior year second quarter. Net realized investment gains were $1.1 million for the second quarter of 2017 compared to approximately 715,000 for the second quarter of 2016.

Our yield and duration have remained consistent over the past several quarters and while we have benefited marginally from the higher short-term rates we are receiving on our cash and short-term investments. Longer-term reinvestment yields for bonds remain lower than the yield to maturing bond investment.

As a result of the combination of various factors I highlighted we had a net loss of $2.3 million or $0.08 per diluted Class A share for the second quarter of 2017 compared to net income of $8.6 million or $0.32 per diluted Class A share for the second quarter of 2016. At this point I'll turn the call over to Kevin for his comments on the quarter..

Thank you, Jeff. Before I discuss the details of our quarterly results it's important to acknowledge the hard work and dedication of our claims staff and our independent agents during periods like our second quarter.

Providing exceptional claims service over a prolonged period of severe weather like Donegal experienced in the second quarter can often be more challenging in servicing one large event in a particular area. Because of our claims automation we have the capability to balance incoming claim workloads among all of our regional claims operations.

Our responsiveness to our policyholders and agents at the time of a claim is critically important as we deliver on our promise to be there when it matters most. We have viewed the unfortunate weather related issues as an opportunity to prove to our policyholders, agents, and stockholders that Donegal delivers.

Turning to premium growth we achieved in the second quarter, we are pleased to report premium growth continued in both commercial lines and personal lines and the momentum we gained in the first quarter continued in the second quarter.

We achieved a 7% increase in our net premiums written to $190.8 million for the quarter with 4.7% growth in our commercial lines and 8.9% in our personal lines.

We are actively monitoring our growth rates in both commercial lines and personal lines and making specific underwriting rate adjustments to achieve the desired balance within our overall book of business.

Balance is an ongoing strategic objective as we continue to grow our market share but at the same time recognize we need to take additional rate in certain lines such as personal auto, commercial auto where our results have not met our expectations.

While some of the quarterly premium growth came from rate increases, the majority of our growth was related to the writing of new accounts as our independent agents continued to increase their commitment to us.

Within the commercial segment we are continuing to see opportunities to attain modest renewal premium increases with increased competition for quality accounts, our renewal premium increases during the second quarter generally range from 3% to 5% which is consistent with the past several quarters.

Workers' compensation was the exception to that range as various regulatory actions and competitive forces have put pressure on rates. We're taking action to maintain quality accounting in increasingly competitive market for that profitable business.

Our workers' compensation products which we provide predominantly for small to midsize businesses continued to perform very well in the second quarter and the first half of the year.

We continue to benefit from continuing trend of lower claims frequency within indemnity and medical claims and we feel that our proactive approach to claims management has also had a positive impact on the results. Our commercial lines retention levels remain strong through the first half of 2017.

Our policy retention is in the mid 80% range which has been our historical average and we believe we are in excellent position within the marketplace to continue to profitably grow our commercial lines.

In personal automobile we have implemented and will continue to file rate increases in the mid to upper single-digit range depending upon the state and subsidiary. Market conditions support more aggressive automobile pricing and we are being selective in the areas where we are taking rate increases.

Personal lines retention levels remain strong with retention in the high 80% range. Over the last few years we invested considerably in technology that has both improved our agency facing portals for quoting and underwriting our commercial and personal lines products, as well as enhancing our claims management and billing activities.

Last quarter I highlighted the implementation of our commercial auto predictive model which specifically identifies predictive factors that correlate to higher loss ratios. We expanded the implementation going to second quarter to all states and expect to realize benefits from the underwriting enhancements in the coming months and quarters.

We believe the combination of rate adequacy and underwriting refinements will begin to show tangible results throughout Donegal's auto book in future periods. We are pleased to announce that Donegal has expanded its geographical footprint with our entry into the State of Illinois.

We recently entered the State of Illinois and have appointed 11 independent agents that will represent Donegal. We will take a conservative approach as we build the Illinois book of business and believe that we have appointed agents that understand our underwriting appetite.

Illinois will be part of our Ohio, Indiana region and we look forward to the profitable growth opportunities this state will provide. At this point I'll turn the call over to Don Nikolaus for his comments before we open the lines for questions. Thank you..

Thank you, Kevin and Jeff. Good morning everyone and welcome to our earnings conference call. Over several years I have mentioned to our stockholders that one of our most important metrics is book value appreciation over time. At June 30, 2017 our book value per share increased to $16.23 compared to $16.21 at December 31, 2016.

This is even in the face of a second quarter loss. Unrealized gains within our available for sale investment portfolio increased modestly and we believe that the premium growth that we have maintained reflects the appropriate combination of rate adequacy and new business.

We were pleased that during the first half of 2017 Donegal continued to increase book value in spite of the unusual weather related and other loss factors that Jeff and Kevin discussed. We are committed to delivering underwriting results that outperform the insurance industry and we have of course have referenced that from the past.

Combined with solid investment returns will help deliver our goal of superior book value appreciation overtime. Needless to say the insurance market with the weather conditions adds some additional complexity.

But we believe that we are well positioned going forward to take advantage of the circumstances and our businesses many of you know weather is going to occur from time to time and the important thing is not that the weather is bad in any one particular quarter.

But whether the company from an underwriting standpoint is structured to handle it and how we respond to it. At this point we would be glad to respond to any questions that you might have..

[Operator Instructions]. Your first question comes from the line of Christopher Campbell with KBW. Please go ahead..

Hi, good morning gentlemen..

Good morning Chris..

My first question is on DGIs premium growth which was a little bit heavier in personal versus commercial lines than I would have expected and Kevin you had mentioned in the introductory comments about balance. So, I am just -- and historically I think you guys have said that you want to be a little bit more focused on the commercial lines growth.

So just with the most recent data points, what are your current thoughts on the relative growth between the two segments?.

Chris, thanks for the question. Absolutely, our goal is to really bring this entire book of business into balance where we are split 50% commercial lines and personal lines. Given the second quarter results including the first half of the year, the personal lines business has continued to grow. There's a number of reasons for it from our perspective.

There has been some disruptive action in the marketplace, we've talked about that a little bit before, whether it's a national or regional carrier taking very, very aggressive stance on rate taking.

So we've also had some particular carriers remove themselves from various states and what that has done is it's created an opportunity where business is flowing our way, probably at an accelerated rate that we didn't really anticipate.

From our perspective there's a silver lining to this, and that is as we are aggressively taking rate in private passenger, auto in particular we've taken the rate anywhere from 2.5% up to 9% given the various regions and locations.

As that starts to filter through the book we think that we will start to see a very nice lift from the rate taking from an earned premium standpoint. Ideally Chris we would like to see our commercial lines grow at a faster pace than it has.

We've had a lot of success the last two years and this past quarter with personal lines growing at the rate that it has I think part of it is reflective of some of the disruption in the marketplace and agents are moving some of that business to Donegal..

Great, that's very helpful and just kind of a follow up question on the especially the personal auto, is there -- so it sounds like there's more business that is -- that Donegal is getting a chance to see.

Is your conversion ratio changing and what I mean by that is just the number of policies that you buy versus what you quote, is there any change in that metric as well?.

There is not and I think that's an important piece to remember. Despite maybe some of the disruptions that are happening in the marketplace and again as it relates to private passenger auto, the Donegal process for underwriting and account, looking at it before we buying coverage has not changed.

So it's important to recognize that we may have agents that come to us and say particular national carrier maybe do something very aggressive work stream. We're not interested in rolling a book of personal lines business into our portfolio.

Our phrase is that we're open for business and so that book of business will be put through the same underwriting criteria and discipline that we would put a single account through. And so the uptick that you're seeing is not that we've changed anything in terms of our underwriting appetite or flexibility.

We're underwriting to profitability but we have seen that uptick and we believe that it's something that with our rate increases that we are going to continue to take that should level out over the next few quarters..

Great. Yeah, just shifting to workers' comp, this quarter the premium growth was negative and stat combined ratio was up about 470 bps which I guess includes the reserve -- the modest reserve benefit.

Could we get more color what's driving the premium trends and then the lower underwriting profits and then what would the worker's comp stat combined ratio have been excluding the reserve development?.

From a premium standpoint Jeff is going to talk a little bit about some of the loss ratio issues there in the earnings. On the workers' comp Chris, we're seeing competitive, very aggressive competitiveness as it relates to the worker's comp business.

As you can imagine the worker's comp line has been a very profitable line for many carriers for multiple quarters and as a result as various carriers are seeing some of the erosion in profitability whether it's commercial auto or private passenger auto they have ratcheted up their pressure in terms of some of the workers' comp.

We believe that some of the lower numbers as it relates to that is some of the business we just simply were not going to price it at a lower rate.

And so from an underwriting standpoint we made sure that we had discipline and that if there is a slight downward turn in worker's comp from a premium standpoint we want to make sure that we're not necessarily chasing rate in underwriting a piece of business that we don't think is profitable. So it's increased pressure from a competitive standpoint..

Chris, this is Jeff. On the losses, the favorable development in the first quarter represented about 5.6 points on the loss ratio so it would have reduced the overall combined ratio during the quarter by about 5.6 points.

And the uptick relative to past periods is that that favorable development was somewhat lower than what we would have seen in the first quarter of 2017. It's consistent, actually a little bit better than what we saw in the second quarter 2016.

We have seen favorable development pretty consistently in workers' comp over the past several quarters but not quite as high in the second quarter 2017 as in the first quarter. So if you're looking at it on a comparative basis quarter-over-quarter that that would account for the difference in the loss ratio..

Right, so would it be fair to say that the core loss ratio if we back out the 5.6%, that's increasing and that as a result of just the increase competitiveness in the line?.

I would say its hasn’t changed significantly. The core loss ratio continued to be very good. We track large worker's comp losses which again we would consider a large loss over 50,000 and they were very consistent during the quarter. So the premium differential was on the written side not necessarily on the earned side.

So I think overall we would say the results are fairly consistent with the difference being the fluctuation in the prior year losses..

Okay and then just one follow-up on for Kevin or Jeff.

Just if there is lower workers compensation because of increasing competitor or increasing aggressiveness in pricing from competitors, is that going to hurt the given your account selling strategy is that going to hurt any of your selling efforts in auto or CMP?.

We don't believe that it is. So I mean it's a very valid point. We think that as we move forward we're going to continue to sell and use it as an account writing but, I don't believe that it's going to be a major issue for us..

Great, that's very helpful. Thanks a lot for all the answers and best of luck in 3Q..

Thank you Chris..

[Operator Instructions]. Your next question comes from the line of Bob Farnham. Please go ahead..

Hello, good morning.

I have a question on the technological advances that you guys have been working on over the last few years and it may be difficult to answer but I am just curious if you've seen any benefits or fruits to your labor behind the scenes, I know the cat losses or weather losses in development distort things but, I'm just curious if you are starting to see any improvements because of the technology?.

Bob, this is Kevin, thank you for the question. We have, let's talk specifically about private passenger autos since that is the area of focus of the industry and rightly so. Several years ago we moved forward with what we call risk index scoring as a result of predictive analytics.

And what we have done is number one, all of our new business has a scoring associated with it and in the past six months our personal and underwriting department has really looked at the higher risk scores, what we would categorize as nines and tens.

These are risk index scores Bob that tells us that we have perhaps under priced that particular category of business and so there's been really a deeper dive in the last couple months by our entire personal lines underwriting department to look at those risk index scores of nines and tens.

We think that it's relevant because we're really going to be able to start to hone in on maybe some different business that either needs additional rate and/or needs to different -- needs to be driven to a different score level where there would be rate attached to it.

So we're starting to see some additional deeper dive if you will as it relates to predictive analytics and where our hope is in combination with that and then being able to take additional rate what the market will bear, we think that over a period of a number of quarters we should start to see the result of that..

And I would assume since you're starting with the commercial auto side as well that you'd expect to start seeing some improvement there over the next few quarters?.

Absolutely, the same process is being undertaken in commercial auto. In homeowners as far as again the risk index scoring from predictive analytics as a result of that is also in pilot and so we're really looking to ratchet the work that we've put in over the last couple of years.

Really putting it to tangible work, so we're starting to see the results from a profitability standpoint..

This is Don Nikolaus, let me add a little bit of additional flavor to this. I think that what we're also seeing is that agents recognizing that our company has invested substantial amount in technology and that they are recognizing us as a company that is gaining and making progress with its technology.

So, at the end of the day that's important because agents want to be associated with companies that are in the forefront of technological advances. So, I think we are getting some of the benefits of that and that will play out over time. .

Right, great. Okay, thanks for that guys. .

Thank you Bob. .

And there are no further questions in the queue. .

Alright, at this point we will thank everyone for your participation and talk to you next quarter. .

Thank you everybody..

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