Good day, ladies and gentlemen, and welcome to the ThirdQuarter 2007 Donegal Group Earnings Call. My name is Shiquana; I will be yourcoordinator for today. At this time, all participants are in a listen onlymode. We will facilitate a question and answer session towards the end of thisconference. (Operator Instructions). I would now like to turn the call over to your host fortoday's call, Mr. Jeff Miller, Chief Financial Officer. Please proceed, sir.

Thank you. Good morning and welcome to the Donegal GroupEarnings Release Conference Call for the third quarter ended September 30,2007. I am Jeff Miller, Senior Vice President and Chief FinancialOfficer, and I will begin the conference call by presenting financialhighlights and analysis of the quarterly and year-to-date financial results. Iwill then turn the call over to Don Nikolaus, President and Chief ExecutiveOfficer, for his commentary on the quarterly results and an update on ourbusiness strategy. Certain statements made in our Earnings Release and in thisconference call are forward-looking in nature, and involve a number of risksand uncertainties. Please refer to our earnings release for more informationabout forward-looking statements. Further information on risk factors thatcould cause actual results to differ materially from those projected in theforward-looking statements is available in the report on Form 10-K that wesubmitted to the SEC. You can find a copy of our Form 10-K on the investor'sportion of our website under the SEC filings link. We are pleased to announce that Donegal Group achievedrecord quarterly earnings for the third quarter of 2007, which were driven byexcellent underwriting results attributable to the absence of significantweather events, lowered claim frequency, and a continuation of favorable prioraccident year claim settlements during the quarter. Our net income for the third quarter of 2007 was $11.2million, or $0.45 per share of Class A common stock on a diluted basis, anincrease of 14.2% over the $9.8 million or $0.39 per share of Class A commonstock on a diluted basis for the third quarter of 2006. Total revenues for the third quarter of 2007 were $85.4million, an increase of 3.4% over the total revenues of $82.6 million in thethird quarter of 2006. Net premiums earned for the third quarter increased 2.5% to$77.6 million, compared to $75.7 million for the prior year period. Our…

Thank you, Jeff, and good morning to everyone, and thank youfor joining our earnings conference call for the third quarter. And needless tosay, we are quite pleased with the underwriting and overall net income levelsthat we have achieved for the third quarter. As Jeff has stated, a historicearnings for the quarter, and we certainly will continue to work hard todeliver these kinds of very positive results. The combined ratio of 88.3%, we believe is reflective of thecommitment to underwriting discipline, and adequacy in pricing, and acontinuation of the implementation of our overall strategy. Our return onaverage equity for the quarter of 13.3% is certainly well within the rangesthat we would have hoped to obtain. From the standpoint of the expansion of our distributionsystem in the third quarter, we're pleased to announce that we again had had avery successful quarter in terms of the appointment of new agents. We appointed40 in the third quarter, which brings the year-to-date total to 157, which isactually above what we would have projected to where we would have been at theend of the third quarter. It's a number that we had appointed in the third quarter isless than the first and second quarter, but I would remind everyone that wehave always tried to get a leg up and appoint as many in the first and secondquarter, so you would have a period of time to get them oriented early into themid-part of the year. However, it doesn't change the fact that we continue towork aggressively to appoint new agents, and will do that in the balance of theyear and certainly going into the year 2008. I know that everyone is always interested in knowing what isgoing on in the competitive environment in the property and casualty industry.We would confirm that commercial rates continue to be…

Okay. Thank you, Don. Shiquana, if you would open the linefor questions, please?

Yes, sir. (Operator Instructions). Your first question comesfrom the line of Mike Grasher with Jaffray. Please proceed.

Hi. It's Mike Grasher with Piper Jaffray. Jeff, a couple of questions.You made a comment about the tax rate perhaps going lower. How much lower doyou expect it to be during 2008?

Well, as I said, we continue to invest in tax-exemptmunicipal bonds. I believe in the third quarter the effective tax rate was like28.6%. It was lower on a year to date basis because of the lower pretax incomein the first quarter. But I think we would expect that effective tax rate tolevel and possibly go down a few more percentage, tenths of a percent in 2008as we continue to invest in the tax-exempt bonds, assuming the same level ofpretax income.

Your thinking is 10 to 20, maybe 30 basis points lower fromwhere we are today?

I think that would be a reasonable number.

Okay. And then do you have a statutory capital number?

Yes, I do. It is $327.9 million.

Okay. And then Don, a couple of questions. Could you provideany outlook for us with regard to premiums? Obviously, the WritePro could havea major impact. Can you give us some sense of what or where you think premiumsmight be headed for 2008, given the WritePro, as well as the offsetting softerenvironment?

Very candidly, Mike, that's a very difficult question toanswer because I'm sure all other companies are scratching their head aboutthat, as well as we would be. I don't know that we can say to you that we thinkthat premiums for our company are going to be up by a certain percentage, orwhether they're going to be flat. I can only say to you that we are workingaggressively to try to counter the competitive environment and I don't meanthat we're out slashing prices inappropriately. We're trying to become far more proactive in the marketplace,whether it be appointing new agencies or increasing the contacts with ourexisting agencies and doing some of the other things that I'd indicated. Myhope and expectation would be that our companies would see some reasonable,maybe low single-digit increases in premiums going forward. That wouldcertainly be what we would be looking to achieve as a minimum.

Okay. And could you remind us again in terms of when you'reappointing new agents, what is sort of the -- I guess how quickly are they upand running in terms of actual production for you?

It's generally, in all reality, we would like to thing it'sfaster than that, but in all reality, by the time that you get them appointedand get all the papers filed with the state insurance department and get themoriented as to your products, it probably takes a good six months before youbegin to really see any kind of activity out of them. And that's -- there willbe some that will in the first month will be banging out policies. There willbe others that won't do anything until four, five, six months after you get itstarted. But I would say we shouldn't expect a lot to happen until the latterpart of six months.

Okay. And then just to follow up on that, do you have asense of what normal or average production might be for a new agent during thefirst year and how that changes over a period of two or three years?

I can tell you what our expectation is of an agent, and Iguess I would caution you about going and doing modification of what I'm goingto tell you. But what we expect of an agent is after the first full year of anappointment, we would expect that they would have generated $100,000 ofpremiums, and by the end of the third year that they would have generated$300,000 of premium. And of course you get a bell curve out of that. You get acertain percentage that don't achieve that, you get a bunch that do, and youget a few that are above that. That gives you the criteria that we try tomanage against when we appoint new agencies.

Okay. And then final question on that issue is how long -- thinkingabout the bell curve, those that are short, how long do you allow them to getup to your expectations?

Well, there's another component of this, because we are sofocused on profitability, we will temper our decision with regard to a newagency if they have been submitting a quality book of business and if the lossratio is good. So as an example, you can have someone who starts to write atremendous amount of new business, and you see that their loss ratio isstarting to get a temperature and then you can see someone else who is notwriting a lot of new business but they're writing business but it's anexcellent book of business and the loss ratio is good. Well, our philosophy would be that we would be very patientwith the agent that is more gradual in their book but is quite profitable. Sowe look at a couple of criteria and needless to say, if you have someone whodoes nothing or very little and there's nothing to distinguish them as being afuture strong possibility as an agent. Then after a year, year and-a-half, wewill probably suggest that it's not a good relationship, and we might both be betteroff, if we didn't continue the relationship. And we try to have as little ofthat as possible but in all business relationships, those things occur.

Certainly. Well, thank you for your comments.

You're welcome.

Your next question comes from the line of Michael Phillipswith Stifel Nicolaus. Please proceed. Please proceed.

Thanks. Good morning, everybody.

Good morning, Mike.

Couple of questions. Jeff, I think Jeff said when he gavethe premium split it was 3.8 up in personal and down 8, 9 in commercial. Isthat correct?

That is correct on a written basis.

Okay. And can you help us. If I'm correct with my historicalstuff here, looks like that's a pretty big drop off for commercial for thefirst time in a little bit. Canyou help us besides is that just an increase in competition or anything elsethat's going on there that you can point to and when you maybe can think aboutthat going to at least turn around a little bit, or is that kind of are we atthe bottom here?

Well, I can give a few comments on that. Then I'll ask Don toweigh in on what he is seeing from the business side. But on a financial side, Ithink the direct written premiums for commercial were down about 6.4%, andbecause the earned premiums will be lagging that, and of course the earnedpremiums are down about 2%, and because the reinsurance is based upon theearned premiums, that is a larger number. We didn't get the correspondingsavings on the reinsurance on a written basis that you did on the direct side. Sothat's what's driving the net to be a lower number than we've seen in sometime. But as far as what's driving it, our commercial policycounts are actually increased. So what we're seeing is that we're writing alarger number of smaller accounts, and some of the larger accounts, becausethat's where the most intense competition is, we are losing some of thosepremiums and that's what's driving the decrease.

I probably would like to add a little flavor to this.Needless to say, we don't like the fact that commercial premiums for thequarter were down by that percentage. However, I'm not sure that we're preparedto read too much into it, in that, not all the months of the quarter would havereflected some kind of a downward trend. So, some were flatter, and I think oneof the months was somewhat more down than others. So I don't know that we'reseeing this as -- that this is further deterioration that we should necessarilyanticipate. And there was one of our subsidiaries that is in somewhat ofa specialty, I don't know why we use the word too much specialty, theybasically write some garage business, which is pretty, even now in mostpeople's world of ours it's a little bit of specialty from what we generallydo. That line of business was seemed to be more competitive in the quarter. Butas Jeff indicated, our actual policy count of new business in commercial was Ithink, as he quoted was, actually up. So we're cautiously optimistic that we'renot going to see those kinds of declines in the next quarter.

Okay. Great. That was very helpful. Don, I guess now if wecould turn to personal lines, your comments, some of your comments on personallines sort of reminded me a little bit of comments we heard yesterday fromAllstate, and that is I think what you said today was at least for you guysit's probably the first time I've heard you guys say in some of our smaller states we'retaking some rate increases. I haven't heard you say that in a while. Allstatesaid something similar to that yesterday, where they see the competitorlandscape, may be slightly changing not. The first part of the year waspredominantly rate decreases, and not it's so much at all, kind of a soft wayto say, maybe things are sort of starting to change in personnel lines. Do you see anything like that at all? Your comments of whatyou're doing sort of echo that a little bit. I just wanted to see what youthink about the competitive landscape in that regard?

Well as you can see the comment is no surprise to you, but wealso follow what some of our other competitive brothers are saying. I don'tknow that we can reflect exactly the same thing that they're saying. We find itstill to be quite competitive, but we have in this quarter felt that it wouldbe appropriate, in several of those states that we should go for some modestincreases. And so to that extent, there's probably some similarity between whatyou heard on the conference call and what you hear today. But they probably sounded a little bit more positive aboutthe environment, although it sounded to me as if our personal line growth wasup better than what you were hearing from them. So we have said for severalquarters, we didn't think that personal line rates had become irrational, thatwe thought that the competition was still rational, and we'll certainly stickwith that, with the ability to get certain rate increases, particularly inhomeowners.

Okay. Perfect. And just only one last kind of a nitpickingnumbers kind of a question, I guess a part for Jeff. The service fee income orservice charge income seemed to pick up a bit this quarter, more than I guesswe were looking for. Anything unusual there or is this kind of random noise?

I don't know that there's anything I can point tospecifically that's driving that increase. We have continued to chargeinstallment fees for policy holders that pay on installment. There's late feesin there. Policy counts again are up. So even though the premiums haven'tincreased as dramatically with the policy counts being up, that means there'smore payments coming in and more service charges being collected.

We're happy about that. More fee income.

That's right. Okay. Thanks, guys. Appreciate it.

Your next question comes from the line of [Scott Laurel].Please proceed.

Hey, Jeff. Donegal has $31 million in debt, interest rate 9%,and its callable next year. Do you plan on paying that off?

We're certainly talking about it, Mike as you've been -- orScott. As you've indicated, that is a high interest rate, and certainly if wedon't need that capital and can pay it off, it's certainly something we'relooking at as part of our overall capital management. As you mentioned, thereis a portion of it that's callable in May of next year. Its 15 million of the30 million is callable in May, and another 10 million in October. So those arethings that are on the radar. We're looking at them very closely. We would have the option of refinancing them if we had a usefor capital or need for capital. And the current interest rate environment ismore favorable than it would have been as far as the spread over LIBOR. It isbetter than it was when we participated in this trust preferred deals four orfive years ago. So it is certainly something we're looking at and we'll makethat decision sometime early next year.

All right. Also, in March you have a repurchase program. Howmany shares this quarter did you repurchase and at what price?

We weren't real active this quarter in repurchasing shares.We had 32,000 shares we purchased during the quarter. We're pulling out theaverage price here.

That was it?

That was it. $15.20 was the average price on those.

And the second quarter you repurchased 140,000?

It was 127. There's 165 total since March.

.:

Well, Scott, I think if you go back and read any of thetranscripts of these prior conference calls, we generally in the last threequarters have said very similar things, because it would be truthful andaccurate in each of those quarters. The fact that we haven't repurchased much of our stock hasabsolutely zero connection with any potential acquisition that we mightanticipate, and I can say to you that the numbers that you're quoting about thesize of an acquisition, that number is probably unrealistic at this point intime.

You really think? I mean, you can't handle $100 million?Easy.

The purpose of these calls is to answer questions. I'm happyto do that. What we're capable of doing, and what is reasonable in the market,and what is available and what we should consider at a point in time are twototally different things.

Well, I think you have enough of capital to do somethingmedium to larger, as you have done in the past. And please note, this is thefirst time you have said actively engaged in an acquisition.

I did not say that this morning. I said we're activelyengaged in discussions with companies about potential affiliations. It's nodifferent than we have said for multiple quarters. You should not read any moreinto those words than hopefully anybody has ever read into those words. We talk to people all the time. And we hope that at somepoint a discussion materializes into something more. But there's never anyassurance of that. And it depends on a lot of circumstances including whetherit's an appropriate acquisition, whether the price is right, whether the marketis correct where they may be located. So we're trying to be as -- disclose asmuch as is appropriate, but we certainly never want to mislead anybody in termsof what might happen or what might not happen.

Your next question comes from the line of Darnell Azeez withLord Abbett. Please proceed.

Hey, guys. Just a couple quick questions. Could you justtouch on the increase in investment income again? What exactly caused that?

Sure, be glad to Darnell. We have put more money to work, so the average investedassets are continuing to increase. And over the last year as we have put moneyto work, and as maturities of investments that we purchased several years agowhen the yields were much lower, we're finding that the replacement securitiesthat we're putting the money into, the yields are much better. So that'sstarting to show up in the investment income. As we put that money to work inmore favorable yielding securities. And also, the short-term interest rates have been prettygood over the last year, so that's also contributing to the increase ininvestment income.

Just one other question on the expense ratio

Sure.

It just seemed a little high, understanding that you hadpretty good underwriting results and bonuses or incentive of course is going toincrease. Is there anything you can do to possibly lower that or anything thatcan be done to possibly bring that down?

As we said before, the largest component of that isincentive costs, incentive underwriting based incentives for our agents that iswhat we call contingent commissions. That's not to be confused with contingentcommissions that are paid to brokers.

Okay.

Its profit sharing commissions that we pay to our agents.And those -- the plan that we have in place currently is very competitive withour other -- with our peers and we do pay out a fairly significant percentageif an agent does well and has a low loss ratio, we're happy to share thatprofit with them. And we think that that's a large part of the reason for oursuccess from an underwriting standpoint is that the agents are partnered withus and so we are comfortable with the amount of incentive compensation thatwe're paying. The third quarter, because we have nine months now of goodunderwriting results, and if you looked at our combined ratio through sixmonths, it wasn't as good as it was through nine months. And so there's stillsomewhat of a catch-up in the third quarter. Until we get to the end of theyear that should level off.

Okay.

Let me add something to the expense ratio issue. One of thetopics that I remember covering at the second quarter earnings call is, and wehave talked about it in general certainly internally. I said, when you have a soft market, as we have been in, itis also a time to be building your organization to be taking -- to be able totake advantage of circumstances as they might change over time, as the marketat some point might turn to a harder market. So we have been investing a lot of money in technology, alot of money in having the right people, expanding our franchise, basically ourdistribution system, because we think that we're building a much strongerentity for the future. And one of the easiest ways to drive down the expenseratio is of course to have increased writings. And those will occur over time. And we would be confident that as they do, that because ofall of the investment we have been making, and we think appropriate investmentin our future, that the expense ratio will come down appropriately as part ofthe implementation of that strategy.

Okay. Well, that's it. Nice results guys and best of luck.

Thank you.

Your next question comes from the line of Meyer Shields withStifel Nicolaus.

Thanks, good morning.

Good morning.

Good morning Meyer.

I apologize for the double teaming. But I'm out of theoffice today. When you have newly appointed agents, are there any initiallyhigher commission levels associated with them? I'm thinking it's analogous to Erie'sbonus program.

Well, in the high percentage of our agency appointments,there is not a higher commission structure, unless, as part of appointing thatagent, if we have been able to negotiate a book transfer. If we've been able to negotiate a book transfer from someother company that has been selected by that agent, sometimes there isadditional commission associated with that because it's very expensive for anagent to take the labor and time to transfer business from one book to anotherand they incur additional salary cost as a result of that. So many times in conjunction with a book transfer that wemight provide additional incentive, but as across the board, there are nothigher commissions paid to new agents. Now having, talking about incentive compensation for agents,for new business we have for all agents, including new agents, Meyer, we havenew business commissions that are targeted for certain levels of production andso forth.

Okay. That's helpful. Were there any book roles of size inthe quarter?

We are always working on book roles. I don't know that I canstatistically quote you the exact number, but it would not be uncommon for us throughoutour distribution system to be working on 10, 20 book roles in our various --because its part of the new business strategy, so -- and they might be smallbooks, they might be larger books. But that's been something we've done foryears.

Okay. That's helpful. One last question, if I can. Withinhomeowners, I guess we've been hearing some talk about companies raising rates.Are these rates keeping pace with the level of loss cost inflation or they justgetting back to a normal level of underwriting profit but below what we wouldhave seen in, let's say 2004 through '06?

Well, I think that they're probably keeping pace with losscosts, because keep in mind, that most homeowner losses involve some type ofphysical repair. And therefore, as construction cost, material cost, laborcosts have gone up, that's reflected in your homeowner loss cost and therefore,your rates sometimes have to respond to those factors.

Okay. Thanks so much.

You have a follow-up question from the line of Mike Grasherwith Piper Jaffray.

I just wanted to follow up from the acquisitions earlier,the questions around acquisitions. Don, could you remind us what your desiredlevel or optimal level of risk to capital would be?

In terms of the size of an entity? Size of an acquisition?

That was going to be my follow-up question, was what sizewould be ideal for acquisition. But just in general, operating on a risk tostatutory capital basis, are you comfortable at 1:5, 1:2, where would you liketo be?

We would be comfortable at somewhere between 1: 4 and 1:5.We certainly wouldn't want to be going much over 1:5 or 1:6 because ratingagencies begin to take a look at you there. But certainly we have certainlymore than adequate capital to grow aggressively, whether organically or byacquisition. In terms of the size of acquisition, it would certainly beideal to be able to do a $50 million or a $75 million in terms of premium, or$100 million acquisition for that matter. But that's not always necessarily thesize of entity that might be available or the size of entity that may be we wantto have those conversations. So it's not that we wouldn't be looking to identify thosesize of opportunities, but candidly many times the opportunities are anywherebetween $10 million and $30 million in premium, and we're not going to passthose up. But at the same time, we're not going to certainly say that we'llonly play in the larger type of opportunities. We think that sometimes size is not necessarily as importantas whether there are follow-on opportunities with an acquisition, maybe it getsyou into a geographic area where you want to start to do business and you wanta beachhead, a place to start. There can be a very strategic reason for anacquisition, and therefore, the size of it relative to your plan for growingyour franchise, its size might at some point be a secondary matter.

That's helpful. Appreciate the color around that.

(Operator Instructions). At this time, there are no furtherquestions. I would like for now to turn the call back over to Mr. Jeff Millerfor closing remarks.

Thank you and we certainly want to thank everyone for theirparticipation today and for listening to the conference call. And we wish you agood day. Thank you very much.

Yes, thank you everybody. We appreciate your interest.

Thank you for your participation in today's conference. Thisconcludes the presentation. You may now disconnect and have a good day.