Donegal Group Inc.

Thank you, Mae Ann. Good morning, everyone, and welcome to the Donegal Group conference call for the first quarter ended March 31, 2012.

I'm Jeff Miller, Chief Financial Officer, and I will begin the conference call by providing commentary on the quarterly results. Don Nikolaus, President and Chief Executive Officer, will then provide additional comments on the quarter and give an update on our business strategies and opportunities.

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 submit to the SEC. You can find a copy of our 2011 Form 10-K in the Investors section of our website under the SEC Filings link.

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.

We are pleased to announce significant improvement in our first quarter results relative to the prior year quarter. Our net income of $8 million represents the highest quarterly earnings we've achieved since 2007 and reflects favorable underwriting results, relatively stable investment income and realized gains.

Our operating income was $6.5 million for the quarter compared to $2 million for the first quarter of 2011.

We experienced favorable winter weather in our operating regions in the first quarter, with weather-related losses of $5.1 million. Those losses were below our 5-year average for first quarter weather claims and far less than the weather impact we experienced in each quarter of 2011.

Some of the claims we incurred resulted from localized wind and hail events, but the effect of those events on our results was limited by reinsurance to $2.7 million before tax.

We reported solid premium growth for the quarter, with net premiums earned increasing by 10.5% and net premiums written increasing by 8.1%. About 1/3 of our first quarter written premium growth related to additional Michigan Insurance Company premium.

The other 2/3 came from organic growth, which I will discuss in a moment.

If you followed our company developments over the past year or so, you know that we made our largest acquisition to date in December 2010. Michigan Insurance Company has over $100 million in direct writings, but historically had retained only 25% of those premiums for its own account.

At the time of the acquisition, we made the decision to replace the 75% reinsurance that Michigan had placed with its former parent with a 50% quota-share reinsurance agreement with external parties and a 25% quota-share reinsurance agreement with Donegal Mutual.

Donegal Mutual places its assumed business into the pooling agreement with Atlantic States, which is our largest subsidiary, thereby transferring 80% of that assumed business to Atlantic States. Therefore, our consolidated results for 2011 included 45% of Michigan's underwriting results, consisting of the 25% that Michigan retained, plus the 20% through Atlantic States.

Over the past year, we noted that the 50% reinsured by external parties represented a future growth opportunity for Donegal, since we could choose to reduce that percentage over time and retain a larger portion of Michigan's business.

As we mentioned in the fourth quarter call, effective January 1, 2012, we did in fact reduce the external reinsurance percentage to 40% from the previous 50%. As a result, for the portion of Michigan's business that is effective in 2012, our consolidated results will reflect 55% of Michigan's underwriting results, an additional 10% compared to 2011.

For the first quarter, the reinsurance change added $2.7 million to our net premium writings, and we expect the full year increase to be approximately $10 million.

Turning to organic growth. Our commercial lines' premiums written, excluding the Michigan quota-share change, grew by $4.8 million or 11.2%.

The growth primarily came from new business writings. Our commercial lines reported an excellent combined ratio of 88.8%, largely due to lower claim frequency during the quarter.

For personal lines, again excluding the quota-share change, our writings increased $1.6 million or 2.3%, primarily from rate increases we implemented during 2011. We expect to continue to benefit from personal lines' rate increases throughout the year.

And Don will cover our organic growth in rate increase activity in further detail in a few minutes.

Moving to underwriting results. We were pleased to see significant improvement in our underwriting profitability, with our statutory combined ratio at 96.9% and a GAAP combined ratio at 99.4%.

The differential between the statutory and GAAP combined ratio is mainly because our premiums have been growing and the level of our earned premiums is lagging the level of our written premiums. Because of the statutory expense ratio is based on the higher written premium number, the statutory combined ratio for the first quarter of 2012 is a few points lower than the GAAP combined ratio.

We present both ratios, because we analyze our line of business results using statutory accounting and also because our 2011 GAAP ratios were impacted by acquisition accounting amortization adjustments that distorted the comparability of those ratios.

The improvement over last year's first quarter's underwriting results is attributable to various underwriting activities we've implemented over the past year or 2 and also due to the lower weather-related loss activity I already mentioned, as well as the lower number of large fire losses during the quarter. We incurred $3.3 million in large fire losses, which was somewhat lower than our historical average level for quarterly large fire losses, which we define as greater than $50,000 in damages.

With the exception of private passenger auto, where we -- a few of our subsidiaries saw an uptick in severity during the quarter, all of our other lines of business performed very well with combined ratios well below 100%.

Turning to investments. We reported a 2.7% decrease in investment income compared to the prior year quarter.

The decrease is primarily due to declining yields in our portfolio, as we continue to navigate through the sustained low interest rate environment. We are committed to maintaining the high quality of our investment portfolio and have no plans to materially alter our investment strategy at this time.

We have no alternative investments in our portfolio, although one could view our investment in an affiliated bank holding company as a form of investment diversification.

We increased our investment in Donegal Financial Services Corporation when it acquired Union National Financial Corporation in May 2011. Our banking operations contributed $1.2 million in equity earnings to our 2012 first quarter net income compared to $119,000 in the first quarter of 2011.

Finally, our book value per share increased to $15.28 at March 31, 2012, up from $15.01 at year end. We did not repurchase any shares during the first quarter.

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

Thank you, Jeff, and good morning to everyone. Welcome to our first quarter conference call.

Needless to say, we're pleased with the significant improvement in our results. And I believe that our statistics show that it's the best quarter that we have reported since the fourth quarter of 2007.

As we have stated in prior earnings calls, our primary focus over the last year has been to return to underwriting profitability, which in our business drives the bottom line. Jeff has, of course, spoken about the increases in net premiums written and net premiums earned.

And one of the things I want to talk about are what rate changes and other actions we have taken and are taking, because part of the results are beginning to reflect the premium and rate increases that we would've been putting into effect over the last year.

And from the standpoint of retention, our retention in commercial lines is 86%, which we believe, according to industry standards, is quite good. Our personal lines retention is 89%, which also is quite favorable.

One of the issues that we know that all those that follow the property casualty insurance industry are interested in hearing is what is the -- what is happening with pricing in the marketplace? And it is our sense, and we believe backed up by what we hear from hundreds of agencies in our own experience, is that it is clearly a market in which rates are firming.

And it may not be described as a hard market, because it probably isn't, but it is clear that many property casualty insurance companies are raising rates, primarily in commercial lines and in homeowners.

Private passenger automobile continues to be somewhat of a more competitive line. But certainly in homeowners, carriers including ourselves continue to make rate increases, in our case, in all the states in which we have that product line.

In our circumstances, we have been increasing premium since the beginning of the year on all renewals or a high percentage of renewals. We can't say probably all, but a high percentage of commercial renewals.

And it would range anywhere from 3% to 8%. If the accounts have particularly loss experience, then the changes would be significantly above that.

We can't say that we're getting increases in every account, but we're endeavoring to get it in a very high percentage.

We just completed 20 agency meetings across about 9 states. And beginning in January of each year, we have agency meetings in various cities, in the various states in which we do business.

And we can have assembled at those meetings anywhere from 40 to 150 or 160 agency personnel. It's an excellent opportunity for our marketing people, as well as our underwriting and senior management.

Out of the 20, I have attended 17 of them. It's an excellent opportunity to get to hear what agents have to say.

And what is significant about that is that agents, who are the primary people that sell our product, are in a positive mood about premium and rate increases. And from our discussions with them and the questions at our session, we also recognize that our own company is well perceived by them, and that we are well positioned in the marketplace.

On other topics of interest, in the quarter, we appointed 35 new agencies across the various states. It's a lower number than in some prior years, primarily because we are focusing on increasing the percentage of agency appointments over the last 3 years, the percentage of the business that they have to offer that it be placed with our companies.

We want to grow with them, to make sure that we have meaningful relationships with those agencies.

One of the topics, of course, is when you have rate increases and premium increases, what part of your growth is increases, and what part of the percentage of it is increase of exposures? According to our calculations, in personal lines, that almost 100% of the 4% growth that we are reflecting for the quarter is rate increases, because we have very little personal lines exposure growth.

On the commercial side, a much higher percentage is exposure growth, but I would estimate that it's probably somewhere in the 20% to 25% of it is premium growth. We would expect to see that accelerate over the successive quarters, in terms of the percentage of the premium increases attributable to rate increases, because we've only aggressively begun to take those actions of increasing individual premiums on commercial accounts probably in the December timeframe.

One of the other areas that we always comment on is our most recent large acquisition, Michigan Insurance Company. One of the things that we endeavor to do in the first 1.5 years of an acquisition is to migrate them onto our IS [ph] systems.

And within the last several months, the commercial lines began to renew onto our systems, as well as new business. And within the last week, personal lines, new business as well as renewals began to migrate -- migration process has begun.

We're very pleased with that acquisition, and we are looking forward to the continued growth of that entity.

We always make comments about acquisitions. Currently, we do not have any specific acquisition that is far along, but we continue to have ongoing conversations with various modest-sized property casualty insurance companies throughout the various regions in which we do business, because we believe that over a reasonable period of time there will be increased opportunity, and we think that given our experience in doing acquisitions and our other positioning, that we will be a participant in whatever additional acquisitions and consolidations might be available.

At this point, I'll turn it back to Jeff, and we'll do our traditional question session.

Okay. Thank you, Don.

Mae Ann, if you would open the line for questions, please.

My questions are about the letter you received from the SEC dated February 16. Essentially advising that they would be okay with your company committing stockholder proposals of a potential sale or merger from the proxy of your upcoming annual stockholders' meeting.

Could you discuss the details around this, specifically who the shareholder was? Any subsequent discussion you guys have had since that initial proposal?

And then whether or not you know if the shareholder has proposed some more actions with other companies? And any other details you care to elaborate on.

Well, let me try to respond to that. In the February 16 letter, it's a no-action letter, which is the type of letter that the SEC issues.

We opposed the shareholder's proposal of one very appropriate grounds in terms of the way it was proposed and the content of it. And in effect, the SEC, for all practical purposes, concurred that our position was appropriate.

We have no knowledge of whether that particular shareholder has made proposals to other companies, have no way of knowing that. The gentleman's name -- and it's certainly in the SEC records -- his name is Greg Shepard.

And, hopefully, I've answered your question.

Can -- are you able to elaborate on the way it was proposed and the content that was actually in the letter, or -- yes, in the proposal letter?

Well, I think if you would like the details of that, there is a whole stream of letters, et cetera, that would've been supplied to the SEC by his counsel and our counsel. So I think there's a whole history of that, that is available that you can get the various details of it.

And, basically, it was a proposal that there be put into the proxy for shareholder consideration, whether the Donegal Insurance Group should [indiscernible] that type of a Harleysville transaction. So you can go to the SEC website and you can look at all the details of that.

And then one other question. You spoke about the commercial accounts in aggregate, but specifically for the 24% increase in workers' comp, how much of the increase would you say is from actual rate increases?

How much would you say is from payroll -- increase in payroll with existing clients? And how much would you say is from new business, if you were to break that out?

I will try to do that. I'm sure that many on the call are aware that in workers' comp, the rating bureaus of the respective states sets the loss cost, and then the respective companies set their loss cost multipliers accordingly.

Unfortunately, that's one line of business that the rating bureau is not in all states, but in most states have been promulgating increases in the loss cost. And secondly, we have also been increasing, in many states, the loss cost multiplier, which means that we are adding on some additional rate increase.

We would project that probably about 60-plus percent of that is new business and probably about 10%, 15%, maybe, is increase in payrolls for existing customers. And the balance would be the effect of these rate increases.

Keeping in mind that what is reported is, of course, a picture of the particular quarter. As I've said earlier, I believe those percentages of rate increase versus exposure increase will accelerate over the succeeding quarters.

Just wanted to ask a quick question on some of the retention figures you gave. You said the commercial is at 86%.

Just wondering based on the rate increases you've been proposing, how is that retention been impacted by some of the rates you've been pushing?

We don't think it's been impacted at all. Matter of fact, our retention in commercial seems to be about consistent with what it's been over the last 18 months.

Okay, great. And then also, you -- in the release you've mentioned reinvesting some of your short-term investments in the higher-yielding securities, just wondering where you're looking for those new investments?

In the first quarter, we were investing in a kind of a mix of some U.S. government and agency bonds and corporate bonds.

And, of course, we focused over the years on municipal bonds, both taxable and tax-exempt, focusing more in the first quarter on taxable munis, just because we had some NOL of loss carryforwards being used up from last year. But that -- there's a mix there of looking for a reasonable yield, if there is such a thing in this current environment.

All right, that's great. And, I guess, just lastly, it looked like there was no buyback in the quarter, is that right?

That is correct. We did not repurchase any shares in the quarter.

Okay. And is there any -- would you care to provide any outlook on that, or...

Well, we have -- from time to time and in most quarters, we have purchased shares not extensively, then we would be open to that going forward.

And while we pause to see if there's any other questions are in the queue, let me just comment briefly on the impact of an accounting change that became effective in 2012, with regard to deferred acquisition costs. Across the insurance sector, I've noticed that many companies are seeing significant impacts.

And we mentioned on our fourth quarter call that we've historically maintained a fairly conservative accounting policy regarding the cost that we've deferred. And as a result, the impact of the accounting change in our results was fairly insignificant, approximately $270,000 increase for the first quarter expenses.

We expect the full year impact to be between $1 million, $1.2 million, only about 1/4 of a point on our combined ratio, which is quite modest when compared with many of our peers.

And seeing no other questions in the queue, I believe we're ready to wrap up here. And we thank everyone for participating in the call, and wish you a good day.

Thank you, everyone.