Good morning. My name is Cheryl and I will be your conference operator today. At this time, I would like to welcome everyone to the Donegal Group Inc. Q2 2019 Earnings Conference Call. [Operator Instructions] Thank you. Jeff Miller, Chief Financial Officer, you may begin your conference.

Thank you very much. Good morning, everyone and welcome to the Donegal Group conference call for the second quarter and first half ended June 30, 2019. Yesterday afternoon, we issued a news release outlining our quarterly results. For a copy of that release, please visit the Investor Relations section of our website at donegalgroup.com. In today’s call, Kevin Burke, President and Chief Executive Officer will discuss a number of our recent developments and update you on our business strategy and initiatives. And I will follow his comments with a brief overview of our quarterly financial details. Following our prepared comments, we will open the line for any questions you might have. Before we get started, you should be aware that our commentary today includes forward-looking statements that involve a number of risks and uncertainties. We described forward-looking statements in our news release and we provided further information about risk factors that could cause actual results to differ materially from those we project in the forward-looking statements in the report on Form 10-K that we submitted to the SEC. You can access our Form 10-K through the Investors section of our website under the SEC Filings link. We use certain non-GAAP financial measures to analyze our business results and refer you to the reconciliation of non-GAAP information included in the news release we issued yesterday. With that, I will turn it over to Kevin.

Thanks, Jeff and welcome everyone. The main theme over the first half of 2019 has been a gradual shift of our mix of business towards commercial lines where we see a greater opportunity to achieve consistent underwriting profits. This shift is evident in our second quarter premiums where our commercial premiums represented approximately 52% of our total writings. We grew commercial lines by nearly 14% in the second quarter, which helped to drive higher underwriting profit and net income of $4.8 million or $0.17 per Class A share for the period. In addition, we are continuing to evaluate and implement underwriting and rate actions within our personal lines business segment with a goal of showing marked improvement in future quarters. Our commercial lines growth was largely the result of new business writings, as we are concentrating on growing our market share in geographical markets where we can both increase our scale and also compete profitably. As account writers, the growth was spread across our commercial business lines with each of our lines growing by at least 9% during the quarter. Commercial auto premiums increased by approximately 12% largely due to premium rate increases that averaged over 8% during the quarter. In spite of mandated rate reductions in a number of states, our workers’ compensation premiums grew by 9%. In commercial multi-peril, which ranges from small BOP policies covering artisan contractors, to packaged policies covering larger business customers, grew an outstanding 19% during the quarter. We have placed a strong emphasis on growing our footprint in areas where we have experienced several years of strong performance such as in several Midwestern states, while slowing commercial auto new business growth and walking away from renewals where we cannot obtain the level pricing increases, we believe, is required to generate a consistent underwriting…

Thanks, Kevin. I will briefly discuss a few of the operational and financial metrics for the second quarter and certainly welcome any questions later in the call. Overall, our net premiums written increased 0.9% to $197.8 million, and net premiums earned grew 1.6% to $188.8 million for the second quarter of 2019. Net premiums written for commercial lines increased 13.5%, which was offset by a 10% decline in personal lines net premiums written. As Kevin mentioned, our commercial lines net premiums written represented approximately 52% of our total writings. We attribute that growth primarily to new commercial accounts our insurance subsidiaries have written throughout their operating regions, the continuation of renewal pricing increases that averaged 2.1% for the quarter, and lower reinsurance premiums. The 10% reduction in net premiums written in our personal lines was largely due to lower new business growth and the impact of our exit from the personal lines market in 7 unprofitable states, partially offset by rate increases that averaged 5.9% for the quarter and lower reinsurance premiums. Moving to underwriting results, we reported a 69.7% loss ratio for the second quarter of 2019, which improves compared to the 73.1% loss ratio for the second quarter 2018. Weather-related losses of $17 million or 9 percentage points of the loss ratio for the second quarter of 2019 were primarily related to severe weather patterns that brought wind and hale to our operating regions during the month of May, with the overall impact of weather decreasing slightly from the $17.7 million or 9.5 percentage points of the loss ratio for the second quarter of 2018. Weather-related loss activity for the second quarter of 2019 was higher than our previous 5-year average of $14 million for second quarter weather-related losses. Large fire losses, which we define as individual fire…

Thanks, Jeff. While we were generally pleased with the second quarter results, we remain focused on executing key strategies and related initiatives designed to optimize our operational efficiencies, compete more effectively and ultimately improve our financial performance. Our net income during the first half of 2019 as well as unrealized gains within our available-for-sale fixed maturity portfolio during the period contributed to an increase in our book value to $15.34 on June 30, 2019 compared to $14.05 at December 31, 2018. While we were pleased that our book value grew modestly during the first half of 2019, our goal remains to implement these strategies that are designed to generate consistent favorable returns for our stockholders over the long-term. With that, we will ask the operator to open the lines for any questions that you may have. Thank you.

[Operator Instructions] The first question comes from Christopher Campbell of KBW. Please go ahead. Your line is open.

Yes. Hi, good morning.

Good morning, Chris.

Right. I guess my first question is it sounds like you guys have good rate momentum in a lot of your product lines. So I guess what is your current view of loss cost inflation like overall for the auto lines and then for workers’ comp?

Sure, Chris. Well, we are obviously monitoring those loss costs at a very granular level. And from an actuarial perspective, we are seeing loss cost remain fairly stable. Our frequency statistics have been declining modestly and we are seeing some increases in severity in certain pockets, especially in the auto lines, but overall loss costs have remained fairly stable generally in line with overall inflation. So we are not necessarily seeing a significant increase or decrease there. So we are continuing to kind of hold the line in terms of our rate increases although not to the same extent that we would have, let’s say a year ago. As we talked about the rate increase activity a year ago, we were in a sense playing catch-up and really hitting the rates hard. And I would say at this point that has moderated the rate increases that we are filing in personal lines. Homeowners continues to be fairly strong in the 6% to 7% range on average. Auto in the second quarter, for personal auto, the rate increases were in the 5.5% range, which is a little bit lower than what it was in the first quarter. So we are seeing auto rates start to moderate as we have seen those loss costs stabilize.

Got it. And so should we be thinking like overall like low to mid single-digit loss cost inflation?

Yes.

It’s probably most appropriate, yes.

And how is that – and how does that compare with just workers’ comp because I know that, that’s a line where you have seen like a lot of rate increases, increasing competition, kind of what’s happening with loss cost inflation there like pure premiums, frequency and then severity?

Well, in workers’ comp, frequency continues to decline. So that has been a line where really I think the industry as a whole has seen frequencies declining and we have also seen that phenomena. On the severity side although we have seen some larger loss activity it’s really in line with what we have seen in prior years. But I wouldn’t say that we are seeing any significant trends in terms of pure premium other than we do see a slight uptick in severity and frequencies going down. So our experience in that line has been excellent. If you look at the second quarter obviously the favorable development had a unfavorable impact on the combined ratio of workers’ comp. That’s not necessarily a run-rate going forward. But from a core loss ratio perspective, stripping out the favorable development, we did see some improvement in the second quarter relative to the second quarter 2018, so that the loss statistics there continue to be favorable.

Chris, just I have a detailed report here that we got from our claims division just the other day. And Jeff is accurate, where we have got workers’ comp claims, the numbers are relatively flat or down in every state with the exception of Iowa, there is a slight uptick. In Michigan, there is a slight uptick as well. The Michigan piece might be related to the additional growth that we have had out there in commercial. So all-in-all, from a number of claims, particularly in the second quarter, it’s relatively flat.

Got it. Thanks for that color. Just moving on Mountain State mutual, I guess where are you guys at with that turnaround and what are the prospects that those come into net written premiums in 2020?

Well, Mountain States right now is performing quite well. It’s beating and exceeding our 2019 business plan. We had a projected growth for them at about 10% for 2019 and they are exceeding that. Year-to-date, Chris, we are at about $25 million in written premium and the targeted goal was to end the year at about $35 million to $39 million. And so we are far exceeding that. What’s been particularly encouraging to see is month after month we have additional not only new business growth, most of it is in small – the small business sector, $5,000 premiums and less is sort of the lion’s share. But we have also been able to appoint some additional agents. And I think I may have mentioned on the last call, Utah has been a state that we sort of targeted. It was one of the four states that we acquired with Mountain States mutual. And we have a commercial lines production underwriter in the state. We have got a marketing representative. We have held an agency meeting out in Utah several months ago. And the new business that’s coming out of that state, we think it’s a very good state for us to be writing business in is far exceeding expectations. So when you think about all the re-underwriting we did with that book of business, it was thoroughly re-underwritten. We were fairly aggressive about it. We are sort of growing into our expense ratio. We did not terminate or remove any employees from that acquisition, because we knew we were going to grow into it. I think come late third quarter, fourth quarter, Jeff Miller and I will be sitting down deciding whether or not 2020 is the year that we bring that into the pooling arrangement, but we will not do that unless we see that it’s truly an advantage. But all indications continue to be very, very solid. Loss ratio continues to decline. So we are in pretty good shape. We are happy with where we are at with Mountain States right now.

Okay, great. And then just one last one, it doesn’t sound like you guys are going to be like too into it. But just M&A, I guess just you guys are about to like embark on like a bigger IT upgrade and I am thinking a lot of like your smaller competitors in a lot of different geographies would be kind of facing those same type of like IT type of expenditures where it would be like a bigger strain on their budgets. So, I mean I guess just do like rising costs or poor customer experiences, does that create like a good pipeline for like Donegal Mutual or for the group?

Well, I think that you are correct, with the changes that are going on in the marketplace and all the data-driven initiatives and competitive nature of the property and casualty world today, I think that there is going to be a lot of maybe smaller mutuals and others that may have some challenges being able to compete. Where we stand right now, Chris, this is for us it’s about executing our business plan and it’s not to say that we would not consider a potential acquisition, but it would be down the road. We would rather continue to gain market share. We would continue to execute the business plan. If you look what we are trying to do is quarter after quarter is show consistent incremental improvement in our loss ratios. And that’s aside from the technical upgrades that we are taking in terms of modernizing our mainframe systems. Aside from that, we also have a business plan that we need to execute on over the next at least 2 years. And once we find that we are in a very, very sound financial, stable position, by all means we would be open to look for those, but I do not see that in the immediate future.

Well, thanks for all the answers. Best of luck for rest of the year.

Thanks, Chris.

Your next question comes from Bob Farnam of Boenning and Scattergood. Please go ahead. Your line is open.

Thanks. Good morning. With the enhancements to your technology and the modernizing of the business, what kind of impact has that had and will it have on your expense ratio going forward?

Sure. This is Jeff, Bob. I appreciate that question. We are well into the legacy modernization project that we kicked off last October. It is going according to plan and it is a phased approach that we are following and there are four releases at this point that we have identified as the way we will bring the new systems online. The first release will go into production as scheduled on February 2020 and that release will be for the workers’ comp line of business as well as it includes some foundational work for personal lines. So that will be the first line of business that comes online, and then more lines of business will follow. The second release, which would be implemented in February 2021, includes fixed lines of business, including some commercial lines as well as some personal lines. So there’s a lot of work that’s underway. From an expense perspective, the expenses will start to hit the numbers in 2020 as we put that first release into production. We expect it to have somewhere in the neighborhood of 0.5 point of impact on the Donegal Group expense ratio in 2020. It will ramp up in ‘21, ‘22 and then start to come back down as we have projected it, but we expect in those years where the – when it peaks, it could have 1 point to 1.5 point impact on our expense ratio. So we are looking at other expenses and initiatives to try to offset those costs that we know will be coming over the next 2 to 3 years.

Right. So your – so the current expense ratio does – you are saying it does not sound like it includes a whole lot of that development expense yet?

Not really. It includes some licensing fees for the software that we have purchased and are implementing. But as far as all the consulting fees that would be related to the project, those will not hit until – because they are being capitalized and they will be depreciated and allocated to Donegal Group over the next 5 plus years.

Right. Okay, great. Thanks for that. And maybe one more about the exposure growth, I mean in commercial lines, it sounds like you are getting rate increases. But the premium growth is pretty strong. So I am assuming you are getting pretty solid exposure growth in commercial lines. Is that coming mostly from new geographies or new agents either in existing territories or in the new territories? I am just trying to get more – maybe more of a qualitative feel for where the exposure growth is coming from?

Sure. Bob, this is Kevin. It’s primarily coming from our existing geographical footprint. The only thing that we have done is we have sort of pivoted a little bit in terms of where we are emphasizing the commercial lines growth. We are looking back over the last several years and there are certain states and geographies that we tend to do exceptionally well. And we have put the appropriate talent in place and we are emphasizing those states. Wisconsin is an example that comes to mind. And on the flipside, we have got certain geographies from a commercial lines standpoint that we are starting to sort of pair it back in terms of the growth in the types of classes that we are writing. Georgia comes to mind as an example at the other end of the spectrum. And so from an exposure growth standpoint, when you look at particularly our second quarter that would be one of the first questions to come to mind is we are growing. There is exposure growth, but I feel very, very comfortable and confident that the underwriting discipline that we have on those accounts is very, very stable. We are walking away from accounts that we don’t think that is priced appropriately. I think that it’s strong growth, but it’s smart and the continuity within that commercial lines underwriting team has been a group that’s been here for many, many years and they are a very disciplined, conservative underwriting group. So there is some exposure growth, but I feel very comfortable in the business that we are bringing on and that it’s priced appropriately. And last but not least is making sure that we are really focused on the geographical areas that we have got a track record of success and as well as making sure that maybe we curtail some of the growth in some of the other states where there are lot of other factors at play.

Do you see much change in the appetite from competitors or it seems like are there competitors pulling out of markets or just reducing their exposure to certain lines?

I don’t see that there is any change on the competitive front in terms of entering or leaving certain classes of business. We are not seeing that. What is very good to see is the fact that our renewal business when we are seeing that we are getting 4% or 5% rate increases. It’s not that the market is hardening. We are not seeing that. But we are seeing it being relatively stable. So what we are doing is we are essentially winning market share in existing agents in existing geographies. And if you are going to grow, that’s the way you want to grow is being able to gain market share in that way. So I feel very good about the second quarter in terms of our commercial lines growth and how we are growing.

Great. Thanks for the color, Kevin. That’s it for me.

Thanks Bob.

There are no further questions at this time. I would like to turn the call back over to Jeff Miller for closing remarks.

Well, thank you everyone for joining the call today. And we appreciate the questions and the participation and we look forward to speaking to you again following our third quarter financial results. Have a good day.

Thank you.

This concludes today’s conference call. You may now disconnect.