Donegal Group Inc.

Thank you. Good morning, everyone and welcome to the Donegal Group Conference Call for the Fourth Quarter and Year Ended December 31, 2011.

I'm Jeff Miller, Chief Financial Officer and I'll begin the conference call by discussing a number of financial highlights and providing commentary on the quarterly and full year results. Don Nikolaus, President and Chief Executive Officer, will then provide additional comments on the quarter and give an update on our business and prospects for 2012.

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 on the report -- in the report on Form 10-K that we submit to the SEC. You can find a copy of our Form 10-K on the Investors portion of our website under the SEC Filings link.

We plan to file our 2011 Form 10-K within the next few weeks. Our fourth quarter was difficult from an underwriting perspective, and we posted a net loss of $879,000 or $0.03 per share for reasons that I will cover today.

Investment income, realized gains and an income tax benefit provided a substantial offset to the underwriting loss we incurred for the quarter. On the positive side, we achieved significant growth in premiums, primarily as a result of our Michigan acquisition and continuing success in growing our commercial lines of business.

Don will provide more commentary on our premium growth in a few minutes. On the other hand, we were disappointed that our fourth quarter losses incurred continue to reflect the effects of severe weather that we experienced during the first 9 months of the year.

In a moment, I'll provide more details on fourth quarter events, but let me focus first on the cat development that we announced last week. We pre-announced that we incurred development of $7.1 million from catastrophe events earlier in 2011, including a $2.4 million provision for claims that we project will be reported in 2012.

Our catastrophe reinsurance program is conservatively structured with $130 million of coverage above our $5 million retention for any 1 event, and is based on the modeled possibility of extreme catastrophe event. In terms of probable maximum loss estimates, the coverage represents close to 1- and 250-year event.

So in the case of a very large catastrophe event, we will be covered up to $135 million in total losses. You might think of that as coverage for severity as opposed to frequency.

I should add that the largest single cat event that we've ever experienced generated claims in the $15 million range. Our program is structured in 4 layers, and each layer contains annual limits to the coverage that layer provides.

During 2011, the first layer provided $10 million of coverage in excess of our $5 million retention and provided for 1 reinstatement of the $10 million coverage, for total coverage in the first layer of $20 million during 2011.

Prior to 2011, we have never had more than 2 catastrophe events that exceeded our retention. In 2011, however, there were 5 major catastrophe events, and that unprecedented frequency resulted in our utilization of the full $20 million of coverage under the first layer of our catastrophe reinsurance program.

As all 5 of that exceeded $5 million in losses, but none of the 5 events exceeded $15 million. Therefore, although we would have been covered from a severity perspective if any of the 5 events had pierced the first layer, the unusual frequency of events that fell within that $5 million to $15 million range resulted in approximately $7.1 million in claims that exceeded the first layer coverage limit.

As I mentioned, that amount includes $2.4 million of IBNR which we believe will be adequate to cover any further development of claims related to these storms going forward.

Turning to fourth quarter weather events, we incurred a fairly typical $5 million of weather-related claims, including about $1 million from that very unusual snowstorm that hit the northeast at the end of October and $1 million from a hailstorm in Tennessee that same month. Before I leave the topic of weather and reinsurance, let me give some overall statistics for the full year of 2011.

Our insurance subsidiaries incurred over $88 million in weather-related losses during the year, which for us is a staggering number. Our reinsurance coverage with Donegal Mutual and external parties limited the net impact of our financial results to $52.6 million, which was more than double our previous 5-year average weather losses at $23.3 million.

If we remove the impact of 19 catastrophe events from our numbers and included only what we will consider normal weather losses, our statutory combined ratio would have been 100.7% for 2011 compared to 100.3% on a similarly calculated basis for 2010. The impact of these 19 events to our full year 2011 Class A earnings per share was approximately $0.88.

As I mentioned in the earnings announcement for the full year, we had virtually no prior-accident-year reserve development, which compares to $2.9 million of favorable development for 2010. At this point, I'll make a few comments about investments and then turn the microphone over to Don.

Our investment income showed a modest decline from the fourth quarter of 2010, but the decline had little to do with investment income and more to do with the low level of investment expenses in last year's fourth quarter because of a year-end true-up of an expense allocation. More importantly, fourth quarter 2011 net investment income was modestly higher than the amount we earned during the third quarter of 2011, reflecting our efforts to maintain the yield levels in our fixed maturity portfolio.

As shown in our announcement, our average yields have remained fairly constant in spite of the ongoing pressure on reinvestment yields in the current low rate environment. The silver lining of the low rate environment is the resulting increase in the value of our bond portfolio and its impact on our book value per share, which was $15.01 at December 31, 2011, up from $14.86 at year-end 2010.

At this point, I will turn the call over to Don for his comments on the quarter.

Thank you, Jeff, and good morning to everyone, and welcome to our earnings conference call. Jeff has done an excellent job of describing the history of the fourth quarter and the adverse weather and the resulting loss that he has indicated.

What I'm going to focus on is where we currently are and where we're going. The year 2011 was a difficult year, not only for Donegal Group Inc.

but for the property casualty insurance industry as a whole, as you're all aware. However, we do believe that our company has achieved many very positive things in the year 2011, which we believe will position us well going forward.

Talking a little bit about premium, net written premium grew by 16% for the year, 14.2% for the fourth quarter. And as Jeff has emphasized, we have had considerable success in growing over the last 18 months our commercial book of business, which is our intent to have a greater percentage of our overall premiums, over time come from commercial business.

Having said that, for the year, we had approximately 30% commercial growth, 13% of that was organic, remembering that Michigan Insurance Company is included in the overall numbers. For the quarter, we had organic growth in commercial of 17% and about 30% overall.

So needless to say, those are very positive from a premium standpoint. And also in the year 2011, we integrated the largest acquisition to date for our company, a $100 million acquisition of Michigan Insurance Company.

We made lots of progress doing that integration, which we all know is one of the most important aspects of doing an acquisition. In the next week, we will be rolling them on, going live with Michigan on our information systems, which will fairly well complete the integration process.

In 2011, we continued to invest considerable sums in our technology, both in personal lines, commercial and farm, and other aspects of our technology. And we recognize, and I'm sure many of this folks on the line recognize, that you have to have the right technology in place because it's an element, a major element, of your competitive position within the industry.

We're also pleased to report that, yes, we did have lots of claims, well over 10,000 involving property risk in 2010 -- 2011 as a result of all the storms. And the positive side of that is our claims department responded in an excellent way and that we're pleased to say that well over 98% of those claims are closed as of the end of 2011.

We grew our distribution system by appointing 50 agencies in the fourth quarter, bringing the total for the year-to-date to 210, a very strong number. We expanded organically and are doing business in the state of Indiana, which is adding to our presence contiguous to the state of Ohio.

We will grow there of course by appointing 1 agency at a time. It brings our total distribution system to 22 states and somewhere between 2,400-plus agencies.

We believe that we are very well-positioned for 2012. One of the areas that certainly is important to address is how we're going to improve on profitability.

It's clear that we have done well in growing premium in 2011, but we would like to take talk a little bit about -- in 2012 as the result of the numerous rate increases and every line of business that we began to do, in personal lines, well over a year ago, and increased that in 2011, and were-- as we move into 2012, all commercial policies, we will be making a very serious effort to have premium increases in commercial lines anywhere from mid-to-upper-single digits, to as much as 7%, 8%, 9%, depending upon the particular class of business and depending upon the state in which it is located. One of the interesting things about the property casualty insurance industry at this point in time, as the result of all the catastrophes in 2010 and 2011, is that the P&C industry does have a reasonable level of pricing power, which many industries in our economy do not.

We are finally seeing rates firming after 4 to 5 years of a very soft rate environment.

Our primary goal for 2012, which is probably appears in numerous parts of our business plans for 2012, is underwriting profit. And we are committed and have been committed to doing all the things necessary to achieve that, continued rate increases, reinspections of property, re-underwriting of business that doesn't have the acceptable losses, and we're prepared to step away from business because at this point, it's very essential that underwriting profit have a highest priority over all other aspects of how we are operating, of course, all consistent with meeting all regulatory and statutory requirements in the respective states in which we are doing business.

We have begun our 28 agency meetings that we do in the spring, where we travel to some 12 to 14 states. Yesterday, we completed our sixth agency meeting, and these would be meetings where anywhere from 50 to 150 agencies would attend in various cities throughout the regions in which we do business.

One of the concerns that we had is, with all the rate increases, all the underwriting action, how would agents perceive that? And I am pleased to report that our sense from the process of meeting with the first 6 groups of agencies, is that they are supportive because they of course live on commission dollars and they also have been adversely affected from all of the issues of the last 3 to 4 years.

So we think that our distribution system is receptive, keeping in mind that they're the first line underwriters, and having their full support for focusing on underwriting profitability is a key. We think our business model and our strategy are right on.

We believe that we are better positioned than we have ever been, and certainly compared to years when our underwriting profits and net income were significant, our abilities and capabilities today are far better than what they would have been 2, 3, 4, 5 years ago.

Needless to say in the fourth quarter, we did not have good results, but we also didn't try to pull any rabbits out of a hat to try to make it look good at the end of the year. We have tried to be conservative in our reserving estimate and work on making sure that 2012 is the year that we all expect it to be.

We can't control the weather, but we do know that there's lots of other aspects of our business that we do have control over and that we are very focused. Everybody, whether you're in sales, underwriting, claims, financial, knows how important underwriting profitability and of course profitability from there.

We welcome the opportunity to answer questions. There's lots of things that we hadn't covered, such as we have increased the quota share -- decreased the quota share on the Michigan Insurance Company book of business from 50 to 40, which means that we will be taking that additional 10% into our 2012 premiums written, which provides additional amounts of premium.

But there's certainly various other aspects that we would be please to answer if and when you have questions on those as we move into the question-and-answer session. At this point, I will turn it back to Jeff, and we look forward to your questions.

Thank you, Don. Jamie, if you could open the line for questions, please.

I guess first question for Don. I noticed in the release you talked about your focusing on newer agents, less then sort of refining your core team more.

Just curious as to what's your -- the main drivers for your change of focus there a little bit? And then talking about the -- targeting price increases is great for 2012, but we've seen some companies sort of struggle with new business even though they're getting rate on sort of their renewal book.

I just want to get your thoughts there as well.

Sure. With regard to agencies, new appointments, we have made great progress in 2009, '10 and '11, and appointing additional new agencies, we're going to continue to do that to a degree in 2012.

But our emphasis in 2012 will be to spend additional time working with the agencies that we appointed in 2009, '10 and '11 and making sure that they're producing the right business and that we're getting credible volume from them. So we're de-emphasizing new appointments to a degree, but we will continue to do it.

With regard to rate increases and the ability to write new business, there is certainly is a trade-off, it was also a trade-off with regard to existing business as to what your tolerance for allowing business to run off if the insurer is not willing to accept your rate increases. At this point, we're seeing that commercial new business is doing well.

Personal lines, our growth in personal lines will probably organically not be as strong. However, we don't believe that that's going to anywhere affect our premium growth.

It's simply that our unit count will not necessarily be as strong in terms of growth.

Okay, great. And then just 2 numbers questions, for Jeff.

What was the duration on the portfolio at the end of the year?

The duration is 4.5. So it's down...

I know you guys repurchased just a few shares in the quarter, what was the price for those?

Our price was $14.30.

And while we wait to see if any other callers have any questions, let me comment briefly on some reinsurance changes that became effective for the Donegal Insurance Group in 2012. We eliminated our multi-line excess of loss reinsurance contract, which in 2011, that contract provided coverage for any individual losses that exceeded $750,000 up to $1 million, at which point we have coverage under other reinsurance contracts.

Therefore, for 2012, our per-risk retention is generally $1 million. Although a few of our smaller subsidiaries had separate reinsurance to lower their per-risk retention.

It should come as no surprise that catastrophe reinsurance rates increased for our 2012 renewals, netting the multi-line savings against the cat increases yields an overall increase in the reinsurance premiums of about $1.2 million for the year, and that's assuming the same premium base of 2011. We certainly view that increase in reinsurance cost as modest in relation to the size of our book of business.

And as Don mentioned, we did make a change in the external quota share that Michigan Insurance Company has by changing the percentage from 50% to 40%, which means that Michigan will retain an additional 10% of its net business, which translates to approximately $10 million in net written premium growth for us in 2012. We did not make any change to the Donegal Mutual quota share, whereby Donegal Mutual assumes 25% of Michigan's business and places that into the pooling agreement.

That's a little complex there, but the bottom line is that 55% of Michigan's underwriting results are in the Donegal Group results for 2012.

One of the things that I would emphasize is that we have not increased our retention on catastrophe coverage. So that we think that, that is currently conservatively structured and we want it to keep it with that structure going forward.

So I just wanted to follow-up on one point from Jeff's comments. You obviously -- while you talked that the rate increase is expected for reinsurance particularly the cat side.

Just curious to hear your thoughts on obviously, for large severity-driven events, the coverage is what it is. I was curious, if you had looked as you did this year in prior years.

I'm curious to get your sense in terms of what the cost would be more of a frequency-driven type of plan? As I know others have said that it would be quite expensive.

I'm curious if you get sort of feel -- better feel for the magnitude of what that kind of cost would be?

We have looked over the years at aggregates is basically what they are, and they're quite pricey and certainly in the catastrophe reinsurance market going into 2012, we believe that would have been a prohibitive cost. So it's -- the concept sounds nice, but in the markets over the last year, it would not have been in our judgment, not advisable or not cost effective.

Don, just in terms -- I know it's not apples-to-apples by a long shot, but I mean, are plans such as those -- and I know it's obviously with the frequency of weather this past year and then pretty much from '08 on. I mean, are those type of plans 2 to 3x more expensive the bottom line cost?

We -- our understanding we haven't priced it in about 3 years. Our understanding is that it might be as much as 1.5 to 2x.

But certainly -- here is our view of it that you want a reinsurance program to be in place for a longer period of time and if you have an aggregate in place, you're going to pay significantly higher costs every year. And 1 of the attributes or 1 of the philosophies of reinsurance is that you're going to have claims over time, and you want to insure against the severe event, but you want to make sure that over time, that you have a reasonable reinsurance cost and that's been our approach at least over the years.

I believe you touched on part of this. Could you talk about the rate movement in sort of the major lines that you write for the fourth quarter?

And maybe if you can compare them to what the rate movements were as compared to the third quarter of '11 and then correspondingly how retentions changed?

Let me address the rate part, and Jeff will talk about the retention. In personal lines, we of course have a schedule of the frequency with which we do rate reviews.

So as an example, on a homeowners lines of business, you generally do an annual rate review. And our rate reviews, we take it by state.

So that would've ranged anywhere from the first quarter of last year into the fourth quarter. And as the year progressed, we would have, because of results, we would have increased -- the indications would have increased significantly and as a result, we would have filed for higher percentage increases in the third and fourth quarter than compared to prior quarters.

On the commercial -- and they could be anywhere in homeowners anywhere as high as 12%, which is fairly significant. So we would have -- in automobile, private passenger automobile, they could range anywhere from 4% to 8%.

In commercial, commercial is more complex because many times your premium increases that you achieve have to do with how you deal with what are known as credits that you have by regulation the ability to price up or down, a risk off of a base rate. In our case, we would not, other than at worker's comp, would not have thought a lot of base rate changes, but on the thousands of renewals, you have the ability legally to adjust the amount of credits or debits that you apply, and that's the method by which you get your premium increases generally on commercial lines.

You also can have base rate increases.

We in the fourth quarter would have begun that process of increasing commercial rates much more than we would have in the first 3 quarters of 2011. And we have by product line and by state, a schedule that we are attempting to achieve and it would be anywhere from mid-single digits to as high as 10% or 12%, depending upon the specific risk of a --generally the increases in the case of risk without losses, will be in the range of 5% to 7%, any with losses could be as much as double digits or more, or potentially non-renewal.

So that process is accelerating as we move into 2012.

Could you comment about January of 2012, because it sounds like, if I understood your description rate on the commercial lines, you were not effectively pushing for rate in the first 3 quarters, but you in an earnest began in the fourth quarter. You gave us the ranges for the fourth quarter.

I'm not sure what the average increase was, but anyway, you gave us the ranges in the fourth quarter. Should we assume that in the early parts of '12, the numbers for commercial lines are either at or greater than these ranges that you gave us?

You just...

It is fair to assume that those ranges for commercial lines in the first quarter would be very similar to the fourth quarter because they are part of the business plan.

Similar, okay. How about retention, sir?

Sure, on the retention side, our personal lines retention -- well both personal and commercial lines, retention rates have stayed fairly constant. In personal lines a year ago, we would have been around 89% policy retention.

And through 2011, we're like at 88.5%. So it really didn't change a whole lot.

Commercial lines is mid-80s. And commercial lines retention might be down 1 percentage point.

But overall, very consistent. We have not seen a significant decrease in retention as a result of the rate increases that we've taken throughout the year.

So I guess that emboldens you to stay the course with the rate increases.

It does indeed.

Exactly.

Okay. We thank everyone for their participation on the call, and hope for a good 2012.

Thank you, everyone.