Jeff Miller – Chief Financial Officer Kevin Burke – President and Chief Executive Officer.

Christopher Campbell – KBW Bob Farnam – Boenning and Scattergood Jamie Inglis – Philo Smith Financial.

Good morning and thank you for standing by. At this time, we would like to welcome everyone to the Donegal Group Incorporated Quarter One 2018 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] It’s now my pleasure to turn today’s conference over to Jeff Miller, Chief Financial Officer. Please go ahead sir..

Thank you very much. Good morning and welcome to the Donegal Group conference call for the first quarter ended March 31, 2018. Yesterday afternoon we issued a news release outlining our quarterly results. For a copy of that release, please visit the Investor Relations section of our website at donegalgroup.com.

In a minute, Kevin Burke, President and Chief Executive Officer, will provide commentary on the quarter and discuss our current business developments and initiatives. After which I’ll provide a brief overview of our quarterly financial details. Following our prepared comments, we will open the line for any questions you may have.

Before we get started, 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 statement is available in the report on Form 10-K that we submitted to the SEC. You can access our Form 10-K through the Investors section of our website under the SEC Filings link.

Also we provided a reconciliation of non-GAAP information, as required by SEC Regulation G, in the news release we issued yesterday afternoon. With that let me turn it over to Kev..

Thanks, Jeff. Throughout the past year, we remain focused on growing book value by adhering to our core values of maintaining a conservative underwriting culture and pricing discipline, continuing our investment in technology, maintaining a conservative investment approach.

We’ve been satisfied with the performance in several of our lines, specifically in workers’ compensation.

However, we certainly encountered challenges in the first quarter that included weather loss activity that was well above our historical average, a larger than normal incident of fire losses, and reserve development within our personal and commercial auto segments.

In both automobile segments, we continue to experience escalating loss trends relating primarily to higher loss severity and changes in claims reporting trends.

Over the past several years, we’ve been increasing automobile premium rates and we were proactive in implementing technological advancements to allow us to more appropriately price risk throughout all of our geographies.

However, in the first quarter, we recognized that those measures do not fully address the escalating loss trends, and we determined that we needed to take further action to address the issues. The challenges that we are facing are not unique to Donegal. It is an industry-wide challenge.

On this call we will discuss the steps we took in the first quarter 2018 and how we see our company positioned to address the challenges going forward. First, let’s start with our identification of the issue.

Like many of our peers, we began to experience the impact of increasing automobile loss trends over the past 12 to 24 months and we began to respond based on information available to us at that time.

We, along with many of our peers and other industry experts, attributed the increased loss cost trends to factors such as higher cost of vehicle repairs, increased accident activity due to distracted driving or driving activity related to lower unemployment rates and changes in weather patterns.

We’ve been responding to these trends by increasing our premium rates and further integrating predictive modeling technology into our underwriting processes.

However, during the first quarter of 2018, we received new information on previously reported commercial automobile and personal automobile claims that led us to conclude that our prior actuarial assumptions do not fully anticipate the changes in loss severity and changes in claims reporting trends.

While we noted these trends across several of our operating regions, a large percentage of the case reserve adjustments related to commercial auto claims occurred in the state of Georgia, a state in which we have grown rapidly in recent years, and where we have seen an increase in the inventory of open claims.

It has become increasingly difficult to predict the ultimate cost to settle what initially appeared to be minor automobile claims.

In many instances, these claims become subject to litigation and we receive information from plaintiff’s attorney several months or even years after the occurrence of the claim that indicates far more severe injuries and related medical treatment than we anticipated based on initial reports.

That information is typically accompanied by a high settlement demand to which we must respond within a relatively tight time frame.

While we vigorously defend any non-credible claims, we ultimately settle a claim for less than the initial demand and we continue to conservatively case-reserve increase information based on when we receive information from the claimant that allows us to establish a potential ultimate cost of the claim.

So after evaluating new information they receive in the first quarter of a specific prior year claims, our claims adjustors increase the case reserves to reflect their expectations of higher settlement costs. The financial impact of those case reserve increases was far greater than we ever experienced in a quarterly period.

After analyzing the unexpected case reserve activity, our actuaries determined that the historical data upon which their forecasting models were based did not fully anticipate the changing loss trends and they increased their estimates of the ultimate severity of our automobile losses for prior accident years.

So that’s what we identified during the quarter. I’ll provide some additional information regarding our response and what we intend to do to address the challenge going forward.

Through a combination of additional case reserves and corresponding actuarial adjustments, we added $7.4 million to our personal automobile reserves and $18.8 million to loss reserves for commercial automobile where we write higher liability limits. The bulk of those adjustments were allocated to accident years 2016 and 2017.

Our actuarial projections for 2018 accident year reflect the trend changes and our expected loss ratios are much higher than we anticipated last year for the first quarter of 2017.

The logical question is, what are we doing to mitigate the adverse loss trends? Like many other carriers, we’ve been implementing and utilizing predictive modeling to analyze the adequacy of our pricing based on individual risk characteristics of an account.

We have been using a predictive model in our underwriting process for personal automobile new business for several years. And we expanded the utilization of that model to our evaluation of pricing of existing personal auto policies at renewal.

We’ve already taken aggressive rate and underwriting actions that we expect will significantly improve our personal auto results over time. While we’ve been focused on addressing our commercial auto underperformance, we have significantly escalated those efforts.

We implemented a new predictive model in June of 2017 to assist us in evaluating and pricing new commercial automobile risk. Effective May 1, 2018, we are expanding the implementation of our commercial auto predictive model to all policy renewals.

Within the past week, we have initiated commercial auto re-underwriting projects on a state-by-state basis, and we will take definitive underwriting and pricing actions based on the scoring of each renewal policy.

That process will begin in Georgia and we will be conducting on a state-by-state basis, prioritized according to the severity of the loss trends. We’ve instituted underwriting guidelines that prohibit the writing of monoline commercial auto accounts.

Our number one priority is to take every available action to address our automobile changes and reduce our loss ratios to an acceptable level. Rate adequacy is paramount. We must charge the price that properly reflects the risk of loss.

While our net written premium growth has remained remarkably consistent over the past several years, we expect that our actions may result in some lower of new business growth and modest decreases in retention ratios. Ultimately, it’s in our goal to refine our book of business to put our company in solid position to achieve long-term success.

We are committed to accomplishing that goal and we believe the actions we took in the quarter will put us on solid footing as we move forward. With that, let me turn it over to Jeff to go through some of the other aspects of our financial results for the first quarter..

Thanks, Kevin. I’ll briefly go through the financial results and provide some additional details. Our net premiums written increased by $10.8 million to $195.3 million or approximately 6% compared to the prior year quarter.

That increase included $6.1 million of commercial lines premiums that we attribute to new commercial accounts and premium rate increases, and $4.7 million in personal lines premiums that primarily reflects rate increases. Of the 6% increase, approximately 4.6% represents the impact of premium rate increases.

For personal auto, the entire 5.9% increase was attributable to rate increases. And for commercial auto, over half of the 12.7% increase was attributable to premium rate increases. Net premiums earned of $181.8 million for the first quarter of 2018 increased 7.5% compared to the first quarter of 2017.

We expect our premium growth to reflect a proportionately higher impact of rate increases versus exposure growth as the year progresses. Moving to the bottom line.

As a result of the reserve strengthening Kevin described as well as significant weather-related losses and an increase in large fire losses, we incurred a net loss of $18.2 million or $0.66 per Class A share for the first quarter of 2018 compared to net income of $5.1 million or $0.18 per diluted Class A share for the first quarter in 2017.

Our combined ratio was 119.3% for the first quarter of 2018 compared to 101.4% for the prior year quarter. The increase related primarily to an increase in our loss ratio to 86.1% compared to 67.7% for the first quarter of 2017.

Kevin provided details about the loss reserve development impact, so I’ll focus on the impact from the weather-related and large fire losses.

We incurred losses from a number of winter weather events in the Mid-Atlantic and Southern regions that adversely impacted our underwriting results for our homeowners and commercial multi-peril lines of business during the first quarter 2018.

Weather-related losses of $13.7 million for the first quarter of 2018 were 7.5 percentage points of our loss ratio, decreased slightly from the $14.3 million for the first quarter of 2017 or 8.4 percentage points of our loss ratio.

However, the weather-related loss activity for the first quarter of 2018 exceeded our five-year average of $10.2 million for first quarter weather-related losses by a significant margin.

First quarter 2018 loss events included a period of extremely cold temperatures in early January that resulted in numerous frozen pipe claims and a Northeastern March that resulted in claims from high winds across several of our operating states.

Catastrophe reinsurance capped the financial impact of losses from those events resulting in reinsurance reinstatement premiums of $2.1 million. Large fire losses, which we define as individual fire losses exceeding $50,000 in damages, were $9.7 million or 5.3 percentage points of our loss ratio for the first quarter of 2018.

That amount surpassed the large fire losses of $5.9 million or 3.5 percentage points of our loss ratio for the prior year quarter. We noted increase in both homeowners and commercial fires, but we did not observe any unusual trends with respect to the increases.

Our expense ratio was 32.5% for the first quarter of 2018 compared to 33.2% for the first quarter of 2017. The decrease in our expense ratio reflected lower underwriting-based incentive costs for the first quarter 2018. We’re continuing to evaluate ways to improve our operating efficiency.

As we announced previously, we plan to consolidate the operations of our Peninsula Insurance subsidiary into the home office operations.

We expect to record a $1.9 million restructuring charge for this consolidation in the second quarter, and we estimate that it will generate nearly $3.7 million in annualized expense savings beginning in the third quarter of 2018. Moving to investments.

Our first quarter 2018 net investment income increased 10.8% to $6.4 million compared to $5.8 million in the prior year period due to an increase in average invested assets.

We adopted accounting guidance effective January 1, 2018, that requires entities to measure equity investments at fair value and recognize changes in fair value in the results of operations.

Net realized investment losses primarily from unrealized losses in our equity securities portfolio were approximately $918,000 for the first quarter of 2018 compared to net realized investment gains of $2.5 million for the first quarter of 2017.

Our total investments exceed $1 billion with approximately 90% invested in high-quality fixed security investments. To conclude, at March 31, 2018, our book value per share was $15.08 compared to $15.95 at December 31, 2017.

While the impact of reserve strengthening and significant weather-related and fire losses to our first quarter results were substantial, it is important to note that the decrease in our book value was limited to 5% and we expect to reverse that trend throughout the remainder of the year.

At this point let me turn it back to Kevin for some closing remarks..

Thanks, Jeff. In terms of our outlook, we are pleased with the opportunities we see for our organization to leverage our position within the marketplace through the diversified products we offer in the geographies in which we serve.

Our workers’ compensation results remain very strong and our commercial multi-peril is performing within our expectations after normalizing for weather impact.

We will complete a series of 32 agency sales meetings this week, and in our meetings with our agents we’ve received very favorable feedback that leads us to expect that we will continue to gain market share from competitors within our regional markets as we continue to enhance our commercial lines products and services.

Looking forward to the rest of 2018, we will continue to work towards a desired balance between commercial and personal lines and we expect to begin to benefit from the proactive measures we have taken. Ultimately, we will remain focused on underwriting profitability and book value appreciation over time.

With that, we’ll ask the operator to open the lines for any questions that you may have. Thank you..

[Operator Instructions] Our first question is going to come from the line of Christopher Campbell, KBW..

Yes. Hi, good morning, Gentlemen..

Good morning, Chris..

I guess, my first question, just I mean, will touch on the reserves. So I guess, just looking at like glass-half-full type of approach. Like one of the positives is that by truing up the reserves you’re going to eliminate this adverse reserve development going forward in the auto lines, which should move in closer to profitability.

Now Jeff mentioned revising the accident year 2018 loss picks higher.

So with these loss picks for personal auto and commercial auto and combined with what you are assuming on the expense ratios, would there be a targeting underwriting profitability in 2018? Or is there more a glide path over a few years to get there?.

Chris, this is Jeff. I think the way we would answer that question is that we expect improvement in 2018, but we would not necessarily expect to be in a position where we would be achieving an underwriting profit in 2018.

We have taken a lot of actions on the rate side as well as making underwriting adjustments that we believe will have a very positive impact. But as you would understand, those actions take some time before they filter their way into the earned premium impact.

So although we expect to see significant rate premiums from rate increases in 2018, the real impact of that will likely be deferred into 2019 as it relates to underwriting profitability..

Okay, got it. That’s very helpful. Thanks. So auto has got a lot of focus of last night release. But how are you thinking about homeowners as well? I mean, I guess, CMP like the issues are there more weather-related.

But if I just take a step back on homeowners, it’s got about 110 combined ratio over the past five quarters and feels like that might be a little bit of work as well.

How you’re thinking about your personal lines, homeowners book?.

Chris, this is Kevin. From the homeowners perspective, we’ve had some weather-related losses, and that’s why you’re seeing the uptick in some of the loss ratios. But overall, the book has performed relatively well. We’re taking some modest rate increases, retention levels are good.

And so for us the homeowners area is something that we will continue to address with some modest rate increases, but we don’t view it as an area of real concern for us right now..

Okay. And then just the worker’s comp combined ratio that was up 260 bps.

Any states or job classes where you’re starting to see competition increasing?.

Competition is pretty intense across the board. We do see significant competition for work comp accounts in Michigan. And that would be a state where we have seen a very competitive market over the last year to 18 months. We have taken some rate decreases in Michigan to continue to compete for the quality accounts that we’ve written there.

Our experience in all the states has been very good. That would be a state that we can stand out as more competitive than most. In the current quarter, we did have one very large loss that impacted the results.

So as you’re looking at our work comp results in the current quarter, we want you to understand that there was kind of one loss that impacted the combined ratio.

And the reason for that is that we have an aggregate deductible – annual aggregate deductible under our workers’ comp reinsurance so that the first loss that exceeds the $1 million, we don’t collect reinsurance until we have exceeded a $1.2 million aggregate deductible.

And we did one claim that accounted for $2 million of losses in the quarter as a result. So hopefully that answers your question there, Chris..

Okay, got it.

So will there be still – so basically your losses were $2 million higher because of this one claim?.

Yes. So although – generally, we would typically have a limit on any one claim to $1 million under our reinsurance program. And so this particular claim, the limit was increased to approximately $2 million for the current quarter..

Okay. Great. And Jeff, you had mentioned the consolidation of Peninsula and looking at operational efficiencies.

So how should we think about the Peninsula consolidation? Is that kind of a one-off expense management initiative? Or a part of a broader effort where Donegal is looking at its overall expense structure and rationalizing it and will see if things makes sense?.

Well, Chris, one of the items that we looked at was, obviously there was an opportunity to from an expense savings standpoint to capitalize on it. But it was more than that. There is really a product – their garage product was really available in six to nine states.

And we saw an opportunity to not only expand the product to all 26 states by bringing it into the home office under the commercial lines underwriting wing. We think that it really creates an opportunity to expand that product across the entire Donegal geographical footprint.

And at the same time, adding some service levels and then consolidating obviously reduces the expenses.

So we saw it as a couple of different items that it was an expansion of product line as well as an opportunity to reduce the manual expenses and we think that it’s going to bear some fruit over the next year or two as we start to expand that product line..

Well. Thanks for the answers. Good luck in second quarter..

Our next question is going to comes from the line of Bob Farnam, Boenning and Scattergood..

Hey, there and good morning. I have a question on the predictive model that you started using last year on new business.

Now I’m sure if it’s too early to tell, but can you give us any idea of how successful that product has been for you?.

So Bob, this is Kevin. So we’re talking about the commercial arena. Yes, when we implemented that, which was mid-year last year, we were able to implement that across the board in all of our geographic locations.

And what I did was it really allowed the commercial underwriters to take a much deeper dive when we start to get risk index scores, which we categorize as 9s and 10s. And so it was impactful for us. And we think that with May 1, being able to now do that on our entire renewal book, we should see additional lift in that.

And that’s why when we start to talk about adverse development versus what we’re doing to improve profitability within commercial lines and personal lines, obviously it’s two separate issues in terms of the adverse development, which we had to deal with this quarter.

We do think that the corrective actions that we’re taking on commercial auto with the predictive analytics will start to show some results over the next several quarters..

Right. I was kind of going with the – how much of this – the Georgia book was put through the predictive model? But since it was kind of mid-year last year, this is mostly– the development’s mostly on policies that hadn’t gone to the model yet, I assume..

That’s true. If we look at the results as Jeff and I reported, the majority of that adverse development were reflective of the 2016-2017 years. Lots of growth within that regional office and that model was put in June – late June time frame, Bob. So we’re not really seeing the full result of it yet..

And Bob, this is Jeff. If I could just add to that. The new business only represents about 10% of our overall portfolio. So there is 90% of that commercial auto book that has not been subjected to the predictive modeling. So we expect significant lift from that renewal implementation..

Yes. Right. But I think since you’re growing in Georgia, you probably have more new business in Georgia than you had in your overall book.

What – how will this impact your – kind of your growth strategy in Georgia? And how will this impact, the growth strategy, I guess, in another states?.

Let’s talk specifically about Georgia first. When we look at our geographical footprint, we’re looking in terms of where Donegal operates. We tend to stay away from the metropolitan areas.

We’ve had such strong growth within that Georgia marketplace, and it becomes very obvious that many of the accounts that we are writing are within the surrounding metro areas of Atlanta.

And so for that reason, and I think as we start to take a deeper dive into that book of business in Atlanta, we will be taking a hard look at obviously the risk factors associated with that book of business. I do believe we’re going to be much more selective in that geographical location. It’s a very litigious state and area.

And so as we’re seeing with the development that occurred this quarter, it was a large percentage of that development was really in that Georgia marketplace. So we will see some changes there over the coming quarters. And I think it would be in our best interest to do that from a profitability standpoint.

Across the entire geographical footprint, we will be taking a hard look at commercial auto in every area. Georgia just seems to be highlighted because of all the growth in the development. But the commercial auto marketplace across the entire spectrum has been problematic.

And one of the issues, as you know, that gets associated with it is because as we’re a packaged writer, oftentimes the package is performing well and it’s profitable. However, the commercial auto is part of that and at times gets masked the profitability of the overall commercial package product.

It’s very clear to us that you really can’t take that approach with this adverse development.

And so we’re carving that out and looking across the entire geographical footprint to make sure that we’re aggressive in terms of rate taking and also using that predictable model to look into those files to ensure that it’s the type of account that we want to have on the books..

Bob, this is Jeff. Just to add to the Georgia – just to frame the Georgia discussion a bit that commercial auto premium in Georgia represents about 12% of our overall commercial auto book, about $12 million of premiums in 2017. So we believe it’s manageable. We can get in there, re-underwrite that book of business fairly quickly and efficiently..

Okay. And one last one from me. So you noted a few times about the kind of the delay in getting information.

So where do you see the bottleneck from getting the – where that delay is coming from?.

It’s primarily at plaintiff attorney’s level. We have – Jeff and I over the last several weeks in partnership with the claims division, when we started to see the adverse development and we started to see the claims results over the last several weeks, we took a deeper dive.

And you look at some of those claim files, and our claims representatives over the past year would make several calls, six, seven, a dozen phone calls trying to obtain information on a claim that maybe happened 12, 18 months ago. And so the effort was there. Our processing for handling claims has not changed.

But it really – the onus really rests on the plaintiff’s attorney that is holding information. And due to the statute of limitations, by the time we actually get the information, which in some cases shows severe issues that we now have to plan for from a claims perspective, it’s usually at the 12th hour.

And so this first quarter really represents some of the change, if you will, in terms of withholding information and then providing it at the late hour. Unfortunately, it hit us this quarter. But I think that we’ve taken a very straightforward head-on approach to making sure that we put these reserves up..

It seems kind of unusual. I’m not sure if you see this in other states. And it’s just masked because some are good and some are bad. But just seems – what is it about Georgia, do you have the plaintiff’s attorneys that aren’t as communicative, I guess? I imagine, you don’t know. But that’s for them, but I’m just curious..

This is Jeff. And I asked that very question to our claim manager who has happened to be in home office last week for a meeting. And I talked to him briefly about it.

And he said, in his experience, things have really changed in that marketplace, whereas I would say three or four years ago, there was a much lower percentage of claims that were in litigation. And that has really escalated over the last several years to the point that almost every claim is in litigation there.

The plaintiff’s attorney are very active and pursuing claims. Anytime there’s a claim or an accident, they are right there to ensure that they’re representing whoever was involved. So it’s just become a much more litigious environment in that particular area.

And although you’ve seen at other places, it is particularly severe in Georgia and especially in Atlanta area..

And it seems like the only way you’re really able to combat that is with rates. I can’t imagine there’s stuff you can really do in terms of the policy language that can impact that. That just seems like it’s a rate thing..

Yes, you’re exactly right. Especially because the number of claims were uninsured or underinsured motorist claims where it wasn’t necessarily our operator that was at fault. So looking at the underwriting of the particular account you would write it every day of the week.

However, this particular insured operator was in an accident with someone who wasn’t carrying sufficient limits to cover the extent of the injuries, and so we end up paying the loss. So you’re exactly right, it is really something where we have to make sure that we’re charging the appropriate rate to represent the risk that we’re taking..

[Operator Instructions] Our next question is going to come from the line of Jamie Inglis, Philo Smith Financial..

Hi, good morning guys..

Good morning..

I was thinking about your – the growth rate.

If you think – if you look at the written premium, it would suggest that in commercial lines certainly – maybe your personal lines as well that you’re picking up market share here separate from wins? And I’m wondering if you have any sense of where that might be coming from in terms of type of – are they regionals, are they nationals, who is putting that market share up to do guys?.

It’s really across the board. There is no – we’re not winning specific accounts, specifically with other regional carriers. When we – it varies by region. And when you go to the Midwest, oftentimes you find that we’re competing very well with other regional carriers. And yes, we do win market share.

Oftentimes it’s based on the relationship we have with our key agents. But that varies when you move more to the East Coast. Yes, we win market share, but oftentimes it’s against some national carriers.

So it would be very hard for us to pinpoint, are we winning in certain areas versus others? We compete well with the regionals as well as a nationals, and I think that, that continued premium growth that you’re seeing in market share growth is very positive.

I mean, that’s why we’re optimistic that going forward we’re going to get this reserve issue hopefully behind us and we’re taking aggressive steps to do that. But in terms of market share and how we compete in the marketplace, we’re very, very competitive, and I think that, that will continue..

Okay. And sort of I guess, a related question.

It’s certainly early on, but have you thought about whether the announcement that Nationwide made might be – is that an opportunity if you guys? Is that a risk for you? Where do think that may all shake-out or is it too early to tell?.

In terms of the Nationwide announcement, can you give us specifically what announcement?.

They were talking about the agency – allowing the agency force to – in a way not to be a captive agent, but wait for other carriers?.

Sure. That’s something that’s actually been in the works for a while. We’ve heard for the better part of two years of how we’re going to get out the captive market and allow the agents to be more independent. I’m not sure what the motivation is behind Nationwide’s decision to do that.

Does it create opportunities for us? Potentially, if it’s due to some disruption, but honestly, I don’t think that, that decision in any way would have any impact on us positive or negative in terms of us continuing to gain market share..

And at this time, we have no further questions in the queue..

All right. Well, thanks so much to all of you for joining the call today. And we look forward to speaking to you, again, in July after the release of our second quarter results. Have a good day..

Once again, we’d like to thank you for participating on today’s conference call. You may now disconnect..