Good day ladies and gentlemen. And welcome to Donegal Group, Incorporated Q3 2017 Earnings Conference Call. [Operator Instructions] I would now like to introduce your host, Mr. Jeff Miller. Sir, the podium is yours.

Thank you, very much. Good morning and welcome to the Donegal Group conference call for the third quarter and first nine months ended September 30, 2017. I will begin today's call with commentary on our quarterly financial results. Kevin Burke, President and Chief Executive Officer will then discuss our current business developments and growth initiatives. As we announced earlier this month, Don Nikolaus, our Chairman, has taken a medical leave of absence and he is not on the call with us today. 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’ve 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. Moving to the third quarter results. Donegal Group reported improved underwriting results during the third quarter of 2017 driven by a favorable loss trends that contributed to a 48% increase in net income to $7.1 million or $0.26 per diluted Class A share compared to $4.8 million or $0.18 per diluted Class A share for the prior year third quarter. Our combined ratio was 99.6% for the third quarter 2017 compared to 100.8% for the third quarter of 2016. We attribute this improvement to excellent overall results in our Commercial Lines segment and particularly…

Thanks, Jeff. Good morning, everyone, and thank for joining our call. The third quarter of 2017 was very positive in many respects for Donegal Group. We saw a premium growth net income and book value growth. We continue to leverage our position as a well-capitalized regional insurance group with a business strategy centered on growing profitably and offering best-in-class service to differentiate ourselves from our competitors. We also benefit from a balance between multiple lines of business that allow us to expand in areas and we feel that are best suited for our value proposition. Our growth rate remain consistent and we had favorable loss trends in many of our lines. For the third quarter, we achieved net written premium growth of 6.1% to $182.5 million, which is well within our targeted growth rate. We are pleased to report that premium growth continued in both Commercial Lines and Personal Lines. When evaluating our consistent growth over time, it's important to note the important role that our independent agents play. Our top-tier independent agents clearly understand the value proposition of Donegal. And we're winning the day-to-day battles for quality accounts. As a result, we are seeing particularly really strong growth in geographical markets such as the Midwest and Southeast regions. These are committed agents that we value greatly and have had relationship with for years. To a lesser extent in terms of premium impact, we are also benefiting from our hardening market conditions in several of our lines. As we discussed last quarter, we continue to be proactive in making adjustments to our rates to ensure that the profitability of certain lines, such as personal and commercial auto, increases to levels that indicate our pricing is adequate based on recent loss experience and continuing trends. As we take these necessary rate…

[Operator Instructions] Our first question comes from the line of Christopher Campbell from KBW. Sir, your line is now open.

Yes, thank you. Good morning and congrats on a quarter.

Good morning. Thank you, Chris.

Good morning, Chris.

My first question is on personal auto's statutory combined ratio. Really strong improvement year-over-year in spite of it sounds like there was like $1.5 million of adverse development. Is there any way to unpack? Like, how much of that auto improvement came from like core loss ratios? You had mentioned reserve development so we have that number. Weather and the expenses like, do you kind of see the underlying trends in those components?

Chris, this is Jeff. The only thing I could add to what's already in the release would be that on the weather front, weather did not have a significant impact to personal auto in the current quarter. As we had in earlier parts – the earlier quarters in the year we had more hail events that impacted our results and, of course, that has a detrimental impact on the loss ratio for personal auto. But most of the events in the third quarter were wind related so less hail and more wind. So there was not much of a weather impact. So that definitely had something to do with the improvement during the current quarter.

Right. And then on the expenses, it looks like overall the expenses were higher because of like higher underwriting related comp, would auto have shared in that as well?

Yes. That would have been shared across all of the lines. And you're correct, the incentive-based compensation both for agents and employees increased during the third quarter, because our performance was much better than the second quarter. So there's some catch-up in the third quarter related to the incentive costs.

Okay. That makes sense. Just switching to commercial auto, which it looks like, you are kind of still having some severity challenges there. Can we get an update on what you're doing just beyond rates in terms of to try to improve that performance? I know you had mentioned improving the model or maybe rolling that out further. And then like – just how would you characterize – I know you have an account focus, how would you characterize the rates that you're taking in commercial auto now versus the loss cost trends you're seeing?

Chris, this is Kevin. We will start off with some of the rates that we're taking in commercial auto. You are right. We are account writers and so in the past we're applying credits, usually commercial auto is the one where we are maybe a little bit underpriced where we need to be to get the total account. But we've had such stellar loss ratios in workers' comp and some others, the total account becomes very profitable. However, what we're seeing is the fact that there really is an underpriced book of business as it relates to commercial auto. And I would tell you that we are seeing a greater increase in terms of pricing for the commercial auto piece even if it's in as part of the account. Our commercial lines, underwriting home office groups understands that it's imperative that we start making some inroads on that. With that, we can also speak to a little bit about the predictive analytics that we're applying. All new commercial business across our entire geographical footprint with the exception of Mountain States, New Mexico, is currently being scored right now for all new business. And so the risk factors are being applied. The commercial lines underwriters are able to take a really deeper dive to look at the account. And then also look at the risk factors associated with elevating the losses sometimes associated with those risk factors. We also had a profit improvement plan in place. It's been in place for the better part of the year and a half. Our home office commercial group has a cross-functional department including claims representatives, research and development and actuary that look at each account in its entirety to start to hone down whether some of the risk characteristics that we are seeing a trend with and then pricing it accordingly. And last but not least, I know that the commercial lines underwriting group has really taken a deeper dive in each accounts that when an underwriter gets an account that scores high in the risk index score, it's really on a referral basis. So the underwriter actually needs to look at the account and again, take a deeper dive because of the risk index scores are scoring very high, which tells you that we either don't have appropriate price or there is risk factors associated with that loss with that bigger account. So I think we are doing a number of things to start to build that business back up from a profitability standpoint. And I would be optimistic and say that over the next several quarters, we should start to see that the industry overall is being, I think, trying to be fairly aggressive in rating commercial auto and applying appropriate rate. We should start to see that filter through the book and earn premium over the next several quarters.

Got it. Just switching to reserves real quick. I notice there wasn't any adverse development this quarter in CMP after last quarter's reserve charge. It looks like there was like some positive development as well. Should we assume that Donegal feels all the CMP issues are behind it at this point?

This is Jeff again, Chris. I would fairly stop short of saying that all of the issues are behind us. We would certainly like to hope that we're moving in the right direction. You are correct that in third quarter there was slightly favorable development really immaterial to the overall loss ratio. But relative to first two quarters when we had about I think, we got $2.4 million in each of the first two quarters of unfavorable development, that certainly a move in the right direction. We have put a lot of emphasis on getting the IBNR reserves up to speed in that line over the last 12 to 18 months. And we're continuing to take a conservative approach to the current accident year, including some additional IBNR in that line. So we think we're on the right track. That's not to say that we can't have a loss or two that pop up that we weren't expecting because, as you know, it doesn't take a lot of losses to generate that unfavorable development. But we certainly expect that the things will continue to improve.

Okay. And just one final one I had on taxes. So year-to-date you are about 16.4%. Should we expect a true-up at year end? Just how should we be thinking about taxes heading into 4Q?

I would say that the year-to-date effective tax rate is a pretty good run rate. We're still projecting in the 19% to 20% range. Obviously, our profitability in the first half was not what we expected and that's driving down somewhat relative to our initial expectations. But I think in the current quarter was little lower than you were probably expecting. And that's related to small favorable settlement in that when we filed the final 2016 tax return, as well as we picked up some benefit from the exercised options, which runs through the current provision now that the accounting rules changed the beginning of 2017. So those two items are likely what impacted the current quarter effective tax rate relative to your expectations.

Okay, that makes sense. Well, thanks for all the answers and good luck in the fourth quarter.

All right, thanks Chris.

Thanks, Chris.

[Operator Instructions] Our next question comes from the line of Jamie Inglis from Philo Smith. Your line is now open.

Good morning, guys.

Good morning, Jamie.

Good morning.

Would you think about your average or typically commercial account? So we are talking about some account underwriting a second ago. Can you give me a sense of what you think of that account in terms of size, like premium size? And secondly, in accounts of that for typical or average size, do they respond well to loss control measures in the commercial auto line or is it – or all those accounts too different for that to really work?

Well, first – this is Kevin. First off, let's talk a little bit about size of account. I think this has really been part of Donegal's real strong position in the marketplace. When you look at our average size accounts, we write a fair amount of accounts that are $5,000 in premium up to about $50,000 that sort of what we consider to be our sweet spot. We write a lot of larger accounts as well. But for the most part, that's sort of the area that we target. What you find with accounts that size is they tend not to turn that off, the meaning that they are not necessarily shopping the market. You can have great influence on accounts of that size in terms of loss control measures. And they’re also not as sensitive to various rate increases in terms of being able to move the accounts. So for a lot of different reasons, Donegal's focus on accounts of that size in commercial auto has been very, very positive. And I think if you go back quarter-over-quarter, the results show that and the agency base really looks at us as sort of the go-to-marketplace for accounts that size. When you start getting into much larger accounts and I'm going to see accounts that are over $150,000 and above, and again we write those, willingly. But it does require a whole different set of loss control components. The expectations on behalf of accounts of that size are a little bit different as you can imagine. And also when you start to try to get your hands around, in this case we're talking about commercial auto, around the size of the fleet, being able that you have sold into that size, I think it also spills into what Jeff was talking about earlier in terms of our outstanding workers' comp results. Smaller accounts do allow you to control the account a little bit better in a lot of different respects. And I think that it's a very positive position for our organization to be in.

Yes, I would think so. I mean that what Donegal is doing in selling, if you will, is sort of that longer term relationship and its sort of which as you said, works – has worked over the long-term. Secondly, to what extent do you write personal auto or home as along with those small accounts?

We do – oftentimes, we will get as you can imagine, you have the business owner, and we have a $25,000 business owner account. We look to see if they were interested in moving their personal accounts with us. We've had that. It's a good bridge as part of the relationship building with the agent as well as the policyholder. I can't quote you a percentage of how often that happens, but we do cross-sell.

All right. Okay. Great. Thanks a lot, guys.

Absolutely. Thank you.

And I'm currently seeing no further questions.

All right. If there are no further questions, then – looks like maybe we have one entering the queue?

We do have a question from Bob Farnam from Boenning & Scattergood. Your line is now open.

Thanks. I thought I had entered my number before, but I guess not. So I have a question on the growth as it relates to your agency plan. How much of the growth is related to new agents versus increasing the share of existing agents?

Bob, thanks for the question. This is Kevin. The majority for our growth is still coming from our existing agency plan. In the last two years, we have really emphasized the ability to grow within our existing agency plan and build upon that relationship. We have appointed 42 new agents across spectrum of our geographical footprint. So we are still out there appointing agents. The majority of these agents are very commercial focused because that's really where our charter is going forward. And we do get a fair amount of business off some of the new agents. But overall majority of our growth is coming from existing agency relationships that we have and we are really moving those existing agents to higher levels of premium with us. So it's been very, very positive. Those agents, as you can imagine, understand Donegal extremely well. In many cases, they have been with us for years. And now they are writing $2 million, $3 million, $5 million worth of premium with us. That relationship, where they know us and vice versa, it really has been a very, very positive approach because oftentimes the profitability level of those larger agents that have been with us for a while they understand our appetite, and it's been a really good approach for us.

Right. And I guess, with the existing agents like do you have an idea of what percentage you can get up to for these agents? Like I'm trying to figure how much more room you have to continue to grow in the existing agents?

We have so much room ahead of us. I will give you an example. We have right now in the neighborhood of about 65 agents that write more than $2 million worth of premium with the Donegal Insurance Group, the whole enterprise. We have six more currently that I'm aware of that are going to be hitting that $2 million mark. And many of those agents that are in that $2 million mark or greater, the agency size is $10 million, $15 million, $20 million agent. So the runway with the existing agency base is great. And then a lot of the new appointed agents that we're bringing onboard, we are really appointing quality agents that have some real upward mobility in terms of growth with us. So we're not necessary looking for an agent that just likes the value proposition and might be able to get to $0.5 million with us over five years. We're looking for the agents that are energetic, moving forward, have a business plan, have a commercial component with it, that are really looking to grow to a $2 million to a $5 million agency, and there's plenty of them out there. And as I said in my comments, we're winning the day-to-day battle for accounts. That's really where it comes down to. Every day, being able to complete and win market share on a day-to-day basis and we're doing that with some of our key agents. So there is a great runway out there for us.

All right. And just kind of related to that, I know with Mountain States, I know you're not getting the premium on the public company. But – is the agency profile there going to be the same as your current book? And second question there is, how is the assimilation of that business going according to your expectations, are you ahead or behind schedule or whatnot? Just trying to get some feel for there.

Sure. Let's talk about the agency profile first. We believe that the agents that are currently appointed with Mountain States, these are very loyal agents, Bob. When they had lost their rating five years ago and Mountain States ended up being a derated company, this group of agents stayed with them through sort of a tough time. So they are very loyal group of independent agents. We've had an opportunity to meet some of them. I think their profile is very similar to a Donegal agent. And on Wednesday of this week, I will actually be in Albuquerque, New Mexico, and we have roughly 60 agents showing out for what I'd consider to be a kickoff meeting in Albuquerque. They will get opportunity to meet us. We're going to talk about our value proposition and it's really going to give us an opportunity to get to meet these agents and find out what they're looking for. My expectation is there going to be in the same profile that we currently have. So we're optimistic about what we might be able to do with that region.

Okay.

The second piece is where you talk about schedule where we are. If you think about it, we closed on this merger affiliation at the end of May. And in record time, we're – we have appointed agents in New Mexico. We're – on January 1, we will have our operating platform in place, meaning our technology and products. That's why we are going to be out there on Wednesday. So the hope is that all new business and all renewal business will be on the Donegal platform January 1. So we're on schedule. But as I had said in some of my earlier comments, we also need to take an approach that we're not going to bring it into the pooling arrangement until we're very confident that we have worked through some of the underwriting and loss ratio issues. I don't know how long that's going to take, but we're going to be very conservative about it to ensure that when we bring it in, we are confident that we can grow the business profitably.

Right. And that's – and if I remember that's all commercial or was that – there's a personal element there too?

It is. It is 100% commercial lines.

Right. Okay. Last question from me. With the predictive modeling, do have an idea – like can you quantify the impact you think might have on your underwriting when this is fully implemented?

Our confidence has grown greatly this past year with our predictive model. It has been in place for a couple of years. We were piloting it. We kind of went into it slowly to make sure that we were making the right decisions. This past year as we've implemented the predictive model that we have for private passenger auto, and then we did some analysis behind the scoring mechanism, we were very, very confident that what that predictive model was telling us was accurate. So there is very strong confidence. We're scoring all of our new business in private passenger auto, and we are scoring all of our new business on commercial auto. The real lift that we're going to get, which we are optimistic for is when we can actually score our existing renewal book of business, which we're aggressively moving forward with. When that occurs, I think that we're going to be in a much better position to ensure that we're pricing the risks appropriately.

Right. So basically this is a new business right now. So you can't really compare old book versus new book to see how profitability has been impacted. This is more – it's a just new business?

Yes, it is. It's a new business right now and. So it's been a good process looking forward to getting it on the renewal book, because our retention numbers, as you see, are leading the industry. I mean, we have mid 80%s to upper 80%s to 90% retention. And so if we can accurately get at that business, making sure that we have rate adequacy in that book, it should yield very good results.

Right. Okay. Well, that’s great. Thanks for the interest, and we’ll talk to you soon.

Thanks, Bob.

And our next question comes from the line of Jamie Inglis from Philo Smith. Your line is now open.

Hi. My perception of Donegal over a very long period of time is that you – sorry, the other phone was ringing. You've been with a few companies that has been able to demonstrate an ability to acquire or affiliate or merge companies into the group and fix them in a way or improve them, let's say it that way. In the past have you pooled the business on acquisition affiliations immediately or have you waited a couple of years?

Hi, Jamie, this is Jeff. Excellent question, and it's really depended upon the fact case for a particular acquisition. A number of the mutual companies that we had affiliated with in the past, Donegal Mutual would affiliate with the mutual company, I mean, to the surplus note investment. And there would be a period of time in which Donegal Mutual would then do all the various underwriting improvement activities. And so there was a period of time before the mutualization of those entities and then ultimately Donegal Group would purchase the company from Donegal Mutual. So there was a period of time where there was basically a cleanup period before the companies would become public company subsidiaries. In addition, we had a couple of instances where we had quote-share agreements, where the business, the Donegal Mutual, would have assumed from other companies was placed into the pooling agreement with Atlantic States. So we've had a number of different approaches that really depended upon the profitability of the company, when we acquired it and the level of activity that was required to improve the profitability of those companies. And with Mountain States, it's a little bit different yet doing a merger of the mutual into Donegal Mutual. That was done because Mountain States Mutual had a significant amount of surplus that we could utilize to help to fund the turnaround of the company. So we look at these different affiliations and acquisitions independently and determine what we think is the best route. And having the Donegal Mutual in our structure gives us a lot of flexibility in how we approach to these types of deals.

Do you think that the book of business at Mountain States is that different than the other acquisitions you guys have done going back?

There are nuances to that region as to the types of risks that they have written. But as we dug into the details, it's not really that much different than what we do everyday in our other regions, there a few – obviously, there is some oil and gas activities in that region. And Mountain States has historically written accounts that serviced that industry, electricians and that type of companies that would build fences around the wells and that type of things; the writing – not writing, the well coverage, over-the-hole coverage things, which are more risky.

Right.

So as we looked at the book, there is a not a lot of disparity in the types of the classes of business that they write, but certainly they're looking forward to the improvements in underwriting systems and controls that we can bring to them, as well as we will bring a focus on the smaller business and the types of account that we've been historically successful.

Okay, I guess, I was trying to get a sense of what your sort of preliminary view on timing might be to include it in the pool or not, but I guess that it would depend. It's hard to compare history because all those other acquisitions were done at different times and different underwriting cycles sort of et cetera. So I'm not sure you'd be able to make a guess, a reasonable guess as to when it might be moved in?

You’re very correct, Jamie. We’re not at the point where we can make even an educated guess on what the timing might be. But we can tell you that we're working very hard every day to accelerate it and to get the company turned around. And we think there is a significant opportunity there for profitable growth going forward.

Sure. Okay. Great. Thanks.

You’re welcome.

And I’m currently seeing no further questions.

All right. Well, we thank everyone for your participation in the call and for the great questions.

Thank you.

Have a great day.

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program, you may all disconnect. Everyone, have a great day.