Donegal Group Inc.

Thank you. Good morning, and welcome to the Donegal Group Conference Call for the Second Quarter Ended June 30, 2013.

I'm Jeff Miller, Chief Financial Officer, and I will begin today's call with commentary on the quarterly financial results. Don Nikolaus, President and Chief Executive Officer, will then provide additional comments on the quarter and our current business trends and developments.

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.

We might also mention that we recently expanded the Investors section of our website, and we encourage you to take advantage of that resource at investors.donegalgroup.com.

Turning to the quarterly results, our operating and net income for the second quarter of 2013 showed significant increases over the prior year quarter as we've made progress on several key objectives and benefited from a continuation of our recent premium growth trends. However, our net income fell short of our expectations due to a number of factors that I will cover during my remarks this morning.

Our net premiums written grew by 7.2% for the quarter. Similar to prior periods, the growth was due to premium rate increases in most of our business lines, commercial lines, new business growth and an additional contribution from a reduction in Michigan Insurance Company's external quota-share reinsurance agreement.

Don will talk more about our outlook for rate increases in premium growth in a few minutes, but we are pleased that our earned premiums increased 8% in the second quarter as a result of our ongoing initiative to improve our underwriting profitability and to grow our commercial business.

There are a number of loss-related items that impacted our second quarter profitability, so I'll provide some additional details for several key areas of impact. Weather losses of $9.4 million were higher than our average quarterly range but over $2 million lower than our average second quarter weather losses for the previous 5 years.

We incurred $2 million of catastrophe losses from Midwest wind and hail storms, but most of our weather losses during the quarter were related to non-catastrophe weather events. Large fire losses totaled $5.7 million, very close to our quarterly average over the past 2 years.

Our personal lines combined ratio improved significantly over the prior year quarter, coming in at 100.2%, reflecting the benefits of rate increase activity over a multiyear period and other underwriting actions. We are pleased with the improvement in our homeowners and personal auto results and expect to build on that momentum as the year continues.

Our commercial lines combined ratio rose to 101.4%. An uptick in the number of larger workers' comp losses and development of prior year reserves were the 2 most significant drivers of the increase.

In our workers' compensation line of business, we saw an increase in the number of losses that exceeded $50,000 during the quarter. As you might expect, our commercial lines underwriting team has been reviewing the details of these losses to identify any common trend.

While no significant trends have emerged, we have taken action to raise loss cost multipliers in selected classes and are giving additional underwriting attention to underperforming agencies and geographies.

Prior-accident-year loss reserve development added $4.7 million to our incurred losses in the quarter compared to $2.3 million in the second quarter of 2012. The increase in development was primarily related to our commercial multi-peril line of business, where we incurred an unexpected increase in severity on a handful of prior year liability claims for which we received new information during the quarter.

Despite a number of second quarter loss-related items that deviated from our historical experience, our consolidated statutory and GAAP combined ratios both improved for the first 6 months of 2013, which we view as a positive indicator for the longer term.

Turning to the investment portfolio. We reported a 5% decline in investment income for the quarter, mainly as a result of lower investment yields in our fixed maturity portfolio.

We do not currently anticipate any change in our investment strategy and portfolio mix, and we have structured our portfolio using a laddered approach that will allow us to reinvest proceeds from maturing investments at higher rates as they might become available in the future.

As a result of a spike in market interest rates at June 30, 2013, net unrealized gains on our investment portfolio declined by $26 million after tax compared to year-end 2012. This decline directly impacted our reported book value per share, which decreased to $14.84 at June 30, compared to $15.63 at year-end 2012.

However, our book value per share excluding net unrealized gains was almost level with the year-end amount.

In terms of other items that had a lesser individual impact on our second quarter results, we've reported lower realized investment gains and a lower contribution from the earnings of Donegal Financial Services Corporation, our banking subsidiary. We did realize $300,000 savings in interest expense in the second quarter, primarily related to the refinancing of our trust-preferred debt in the first quarter of 2013, offset by higher holding company expenses, primarily due to increased legal fees.

Last Thursday, our Board of Directors approved quarterly dividends of $0.1275 per share of our Class A common stock and $0.115 per share of our Class B common stock. The board also authorized a 500,000-share repurchase program for our Class A common stock.

We have nearly utilized the previous authorization of 300,000 shares, returning over $3.7 million to our stockholders over the past several years. This new program will allow us to continue to repurchase a modest number of shares as we have excess funds available and deem such repurchases to be appropriate and beneficial.

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

Thank you, Jeff. Good morning, everyone.

Welcome to our call. Jeff has done a very nice job of overviewing the quarter and the 6 months to date.

And certainly there's more detail that is outlined in the earnings release that would have been released earlier this morning. A few of the highlights that I would want to cover and also some detail is that, certainly, the continuation of increase in revenues, and particularly increase in net premiums written at 7.2% increase, we think is continuing to be indicative of the business strategy and the constructive environment that currently the property, casualty insurance industry has been experiencing.

And I will give more detail about rates and so forth in a little bit of time.

Some of the very positives that we find in our quarter, which we would want to point out -- although certainly, our earnings are not where we would want them to be and our combined ratio on both the GAAP and the stat basis are not consistent with our plan. But there is a statistic that we think is very meaningful and very positive, and that's our personal lines combined ratio of 100.2% versus in the prior year of 108.4%.

And if you go back to 2011, it was a similar 107%, 108%. There has been a lot of work and effort over the last 2-plus years in both obtaining rate increases, re-underwriting, reinspections, all of the typical underwriting approaches that we believe had played a meaningful role in significantly improving the personal lines combined ratio.

And we would expect that there would be some ongoing opportunities there to continue to work and improve on that combined ratio.

In the personal lines area, from a growth standpoint, our growth was up 2.7%, which is not significant but it's significant in this sense that we do see that some other carriers, particularly one very large national carrier that is publicly traded, that has indicated that their automobile premiums were down 7% and although ours are flat, we are pleased that even with rate increases and underwriting action that we have not experienced a decline in that important line of business. From the standpoint of rate filings and rate increases in personal lines in the second quarter, we continue to make various rate filings in auto and home in various states with increases, depending upon the product line that might range -- in the range of 4% in automobile to as high as 9% in homeowners.

On the commercial side, we are seeing an average of 7% to 8% in increases of premiums on renewals from the expiring term to the new. And in the size and classes of business that we write, we are continuing to see the opportunity for rate and premium increases in commercial lines.

We, as you, have probably read articles about the competitive environment being more competitive in certain larger accounts. We write some large accounts but we're primarily a writer of small to midsized accounts anywhere from $5,000 to $75,000, and we're finding that it continues to be a constructive environment.

Clearly in the quarter, other than the Midwest, weather in other parts of our operating regions, where certainly the weather was better than in some prior years -- but however, we did experience a number of catastrophes in the Midwest, in the Iowa-Nebraska-South Dakota area. On the losses in commercial that Jeff has referred to, we do not believe, through an analysis of our book of business, that there is any trend in terms of commercial loss ratios being trending higher.

We did experience this quarter where S&P [ph] and workers' comp as a result of a modest number of larger losses. But we do not believe that, that will represent a trend.

Needless to say, we are being very focused on making sure that we have rate adequacy and that we are being very careful in terms of the underwriting approach in terms of the quality of business that we are writing.

In premium increases in personal lines, clearly, the premium increases that we are reporting, that 80% of it would clearly be rate increases. In commercial lines, it's somewhere in the 40% to 45% of the increase's rate.

We did have a reasonably successful quarter from the standpoint of agency appointments. We've appointed an additional 54 agencies in the various 20-plus states in which we do business.

And as we have stated earlier, although we certainly do not believe that the earnings are anywhere near where we would like them to be or where they should be, we think the progress and the trend in terms of the quality of the book and the pricing of the book of business, is going to be very helpful in our business strategy and our results going forward.

As I know that you would have interest in the tender offer that was discussed at the earnings call for the first quarter within the last several days, Mr. Shepard has filed his 10th amendment reflecting that he has entered into an understanding with the Federal Reserve Board for a 45-day extension for their review so they can determine whether to approve or disapprove his particular application.

Needless to say, we have provided input to the Federal Reserve Board, as well as the 6 states in which we have domiciled companies, where Mr. Shepard has filed Form As.

And we have provided input and clearly, we do not believe it's appropriate for him to receive Form A approvals.

As we've indicated in prior calls and in the various filings, we believe that his tender offer is illusory. That some of the conditions are simply not capable of being met in our judgment.

And that we believe that our company has a successful long-term business strategy in both as a mutual company and the public company's board of directors, continue to be very supportive of the independence of our companies.

So Jeff, we'll turn it back and go for questions.

Okay. Thank you, Don.

Crystal, if you could open the lines for questions, please?

I just want to start off with some of the pricing commentary you touched on. Just curious how those rate increases compare to some of the recent previous quarters and different lines of business?

I would say, Brett, that they are -- let's say commercial first, that they are very similar. Matter of fact, in some of the, what I would call, regions in which we do business, that some of our pricing increases are slightly more aggressive since the beginning of the year.

But I would say, overall, they are very comparable to the percentages that we would have been obtaining in the first quarter and the third and fourth quarter of 2012. In personal lines, the filings are very similar in percentages that we would have filed in the first quarter and the second quarter and third quarter and fourth quarter of 2012.

Okay, great. And then also along those lines, do you have a sense of how your competitive positioning within those products has tracked over those periods as well?

Is it pretty much similar as well?

Well, let's take commercial. I believe that given the 14.5% increase in commercial writing would be reflective of the fact that our premium increases have been accepted by the marketplace and that we are where we think we need to be.

In personal lines, as we all know, when you raise rates, you don't necessarily grow at the same level as if you had left rates flat or you had cut rates. But given what we're seeing throughout the industry as a whole, we're not displeased with our 2.7% increase.

And we see, as an example, in a number of states that competitive companies continued to make rate filings or increases in both homeowners and automobile. So we think that nothing significant has changed in the constructive and pricing environment that we have been experiencing.

Okay, great. And touching on the reserve development piece, I was wondering if you could provide a little bit more color there, because it seems like most inflation statistics have been pretty low but these -- there seems to be a recurrence of a few additions to all the accident years.

I was wondering if you could just provide a little bit more color there.

Sure, Brett, I'll be glad to do that. The majority of the development as we saw in the second quarter was in the 2012 year -- some in the 2011 year.

The difference year-over-year, as I said in our -- in my prepared remarks, was related to the CMP line, commercial multi-peril, which is not a line that we've historically seen significant development. As I dug into the details there, I found that there were a handful of liability claims that we had received new information in the second quarter that resulted in some reserve increases.

That's a line that we usually think of as a property line, not a lot of liability claims are presented in that line. So that's a bit unusual.

In the other lines, workers' comp is fairly comparable to what we would have seen over the past several quarters with some modest development, which is primarily related to some severity. But as you mentioned, we're not seeing any significant trends that would suggest medical inflation or other types of macro trends that are impacting the development.

But we would consider most of this development that we've had normal with the exception of the commercial multi-peril losses, which is something we have not typically seen and don't expect to see on a recurring basis.

Okay, great. Thanks for the color.

And also just quickly, I noticed duration went up quite a bit in the investment portfolio. Anything happening there?

Not anything that we have done intentionally to expand. That's generally because of the increase in the interest rates and the fact that the callable bonds now have different duration characteristics as a result of the increase in market rates.

Because -- and then in your mortgage-backed securities, those payments tend to extend as well when you see an increase in interest rates. So it's all related to the market and what we saw there at the end of June, which of course we think was somewhat overdone, quite a large selloff in bonds that related -- or that resulted from some of the comments from the Fed.

A lot of that has moderated since June 30. So we see that as kind of an overreaction by the market and don't see that as an indication of an increase in rates due to any significant extent in the near-term.

Sorry, just one more quick question. The buyback program that was announced, is there anything to read in there on the timing or the upsize in size?

It doesn't look like you've repurchased any shares in recent quarters, but -- so that's just a standard renewal?

It is, just we had utilized the previous authorization and wanted to have flexibility for the future as such opportunities might arise. No plans immediately to embark on some large scale purchases of our stock.

It's there for the long-term as we might see opportunities.

Seeing no further questions in the queue. I believe we're ready to conclude the call.

We thank everyone for their participation this morning and wish you a good day.

Thank you, everyone.