Good morning. My name is Keisha, and I will be your conference operator today. At this time, I would like to welcome everyone to the Donegal Group Inc. Q1 2013 Earnings Conference Call. [Operator Instructions] Thank you. Mr. Jeff Miller, you may begin your conference.

Thank you. Good morning, and welcome to the Donegal Group conference call for the first quarter ended March 31, 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. 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 for 2012. 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. Turning to the first quarter results. We are pleased to report $6.5 million in net income, but we did not achieve the profitability levels that we are targeting. Operating income for the first quarter of 2013 was $5.6 million, compared to $6.5 million for the first quarter of 2012. As Don will cover in his remarks, our net premiums written rose 9.2% for the quarter. That growth helped to bolster underwriting profitability across all business lines and is one of the reasons we remain optimistic that we can achieve more favorable results in the future. As the release notes, the 3 major drivers of the premium growth were, once again, premium rate increases in most…

Thank you, Jeff, and good morning, everyone. Before I give my commentary on the results for the first quarter, I would like to just give some general commentary with regard to the Shepard tender offer. I would want to refer all of you to the 14D-9 that would have been filed by Donegal Group, along with the press release and Letter to Shareholders, all of which can be found either on the SEC website or on the Investor portion of our Donegal Group website, so that you can see the details of it, and it does give details of our position. And the Board of Directors of Donegal Group, Inc., in that 14D-9, urge the shareholders to reject the tender offer, because the offer is basically illusory. Tomorrow is our Annual Stockholders Meeting for Donegal Group Inc. and there will be some presentations made tomorrow related to the 14D-9, and also the subsequent filing by Mr. Shepard amending his filing as it relates to the options and the history of options as granted by the Donegal Group. The presentations and the outlines for those presentations will be filed in an 8-K that will be available prior to the public meeting tomorrow. And other results of the public meeting will be subsequently filed in an 8-K so that everyone will have the opportunity of seeing and understanding the presentation. It is not our intent, this morning, at this conference call on earnings, to get into any details because we don't want to preempt the presentations that will be presented tomorrow. And also, it will be clearly available for any of you or other investors as the result of the SEC filings. Now, referring to the first quarter. Jeff has given you a very good summary of the quarter. One of the…

Okay. Thank you, Don. Keisha, if you would open the line for questions, please.

[Operator Instructions] And your first question comes from the line of Rich Todaro.

I want to first start by saying, I like you guys and I like what you've done, I just, as a fiduciary for my shareholders, I struggle to see how the company on a standalone basis achieves the valuation that's being talked about from Shepard. And so I have a fiduciary responsibility to vote for what I think is the highest value for my clients. I don't -- I guess what I would ask is, in your presentation tomorrow to shareholders, is somehow you use a normal metric that any insurance analyst would use, times some sort of earnings or ROE number to show how you would get there in a reasonable period of time. Because today, it looks like you would have to achieve like a 20% ROE on a standalone basis. And I don't know if you think you're going to get there somehow, a different way to get the stock to $30 or -- but I would argue that you would need to lay out a presentation to shareholders how you could get to $30 from a 1 – a 15% ROE or -- and your book value grows to here, and et cetera. If not, I have -- I struggle how that board is looking out for shareholders. And maybe that's something you want to cover tomorrow, but I just wanted to voice my opinion.

Well, thank you for that. As we said at the beginning, we don't want this to turn into a question-and-answer session on Shepard's tender offer. But let me make one general commentary about what you have said. First of all, as in our 14D-9, we believe the tender offer is illusory, in that it is -- there are many conditions over which Mr. Shepard has no control, but he has set those as conditions that he would not pay such a price unless they are met. And the concept -- set that aside, but the concept that the shares of Donegal Group have a value that is potentially twice the current book value. If you look at the historic views of Mr. Shepard, are based upon the concept that the mutual company would be part of the transaction and it would give itself away and its 66% ownership, without consideration, or very little consideration. So it is a difficult concept to rationalize. We respect the fact that you have a fiduciary responsibility and we would not, in any way, suggest that you not discharge what you see as your fiduciary responsibility. Certainly, we will be covering some of that in our presentation tomorrow, but we would ask that those of you who have interest in this topic, that you do you read in full the 14D-9 so that you can somewhat understand the position of the Donegal Group, Inc. Board of Directors.

I understand what you're saying about the mutual and all that, and then in prior transactions, Harley, Ziller [ph], whatever, it's my understanding that the regulators felt more comfortable that the -- that through the transaction that the mutual holders were more benefited by having somebody up above them that had more capital than just the normal holdco, but maybe I'm off base there. That mutual holders actually were more secure after a transaction than less, but that may not be the case. I just -- that was my understanding.

Next question.

And our next question comes from Samir Keer [ph] with Capital New Jersey Management.

I just had a few questions regarding the workers' comp book and the reinsurance on this line of business. First, can you just talk about the pricing environment in workers' comp and then what you guys are assuming on loss trend, given you guys are seeing higher severity?

Well, as far as what we're seeing in loss trends, I think the first quarter loss ratio was somewhat elevated relative to what we would have experienced in the prior several quarters. That's primarily due, as the release indicated, to several large losses that occurred during the quarter. And the structure of our reinsurance programs for that particular line of business, which basically ends up front-loading some of the loss activity into the early part of the year, when we do receive some severe injury type of cases. Looking at the historical results of that line of business, they have been quite good. Our expectation for the current accident year is that, in the absence of those large losses that I just mentioned, that our loss ratio would be expected to be similar to what we have had in the past several years. We are getting rate increases in workers' comp on an aggregate basis -- on an average basis. And so the types of -- the classes of business that we're writing in workers' comp and our historical experience would suggest to us that we can write that line of business profitably.

A little follow-up to that, also in the first quarter of 2013 in workers' comp, our frequency is actually down, although we're growing premium in that line of business, the frequency looks quite good. The loss ratio is primarily the result of several large workers' comp claims that occur as severity losses in the first quarter which, generally, they are minimal in terms of the number of those. But it certainly bears watching, but our historic record has been quite strong in writing that line of business and, emphasizing what Jeff said, the classes of business that we write.

Great. And just regarding that, the reinsurance on workers' comp, if you can just let us know when that renews? And if you can talk about the annual aggregate deductible. What level it attaches at? Where you guys are in terms of your workers' comp that contribute to the deductible?

Our workers' comp and our casualty treaties renewed 1/1/13, so they are in place for 2013. And the aggregate annual deductible is for a number of our companies, particular the larger ones, is $1.5 million. And we have a separate treaty that covers Michigan Insurance Company, and that is lower at, I believe, $500,000. So we think that our treaties are well-structured, and they certainly are in place for the year 2013.

Just to follow up on that, Samir, the Michigan treaty, we have met the deductible. So there will be no further losses on any loss that would exceed $1 million, that would be fully reinsured. And on the Donegal's company side, I believe used up about half of that deductible. So there's -- for the large part, we have met the majority of those deductibles.

Okay. And this deductible's been in place for many years or is it the first year it's kind of been put in place?

No, we've had a workers' comp annual aggregate deductible for a number of years. It's new at Michigan, but the Donegal Insurance Group companies, what we call the core companies, have had that in place for several years.

Our next question comes from Brett Shirreffs from KBW.

A couple times you mentioned, you failed to reach your profitability targets during the quarter. I was wondering if you could provide a little bit more detail on what your targets are.

Well, we have targets that we've set for both combined ratios and ROE objectives. And our combined ratio objective is in the 94% to 96% range, and our ROE objectives are in the 7% to 9% range. And obviously, we have not met either of those objectives in the first quarter. So we are certainly looking over the long term to return to a 10% ROE. But in the current investment environment, our objectives we were 7% to 9% for the current year.

Okay. And then the expense ratio improvement in the quarter, is that something that we could extrapolate for the rest of the year? Or were there lower commissions for some reason in the quarter?

It's very dependent upon the underwriting profitability because the swing in the expense ratio is generally related to the incentive compensation to agents and employees, which is based upon a loss ratio. So in quarters or in a full year, when the loss ratio improves, then the expense ratio is generally a bit higher. But there -- it's generally within a range of 28% to 30% on a statutory basis, and 30% to 32% on a GAAP basis. But you're seeing the impact of higher premiums, which is helping the cause, let's see, especially on a statutory basis where we use net written premiums as the base. The growth that we're achieving in premiums is helping to lower [Audio Gap] the rest of the year. I would say that, that number is probably low, as a number, a run rate, assuming that we're going to achieve some improvement in our loss ratios.

Okay. And then on the personal auto side, can you talk about where you are in terms of achieving profitability there? It's been -- the combined ratio has been a bit above 100% for some time now. Maybe you can compare the rate increases you're getting to loss trends you're seeing right now?

I'll let Don speak to the level of rate increases that we're achieving. But certainly, as far as where that line has been and where it's currently, we're seeing some improvement obviously, but not to the level we want to see. So it's a matter of those rate increases that we've taken over the past several years catching up to the loss inflation. But we're just now seeing the increase in the earned premium that's resulted from the rate increases we would've taken a year-plus ago.

Brett, as you have probably seen in the earnings release, on a statutory basis, the loss ratio or the combined ratio for personal auto was 106.9% in the first quarter of 2012. It's 104.2% in the first quarter of 2013. And I believe in the last quarter of 2012, it was certainly higher than the 104.2%. The rate increases are certainly beginning to help. We are taking rate increases generally, and in, if not all states, most states, as it will take some time, certainly, for that to be fully earned. But I would point out that just as many other companies, what we are also doing is refining the underwriting process by increasing and enhancing the amount of predictive modeling and other methodology for refining, to make sure that we're writing and appropriately pricing risk. And that's always work-in-process, but I believe, going forward, we will continue to see some improvement related to that part of the underwriting equation.

Okay. And on the large fire losses, a couple of items there, one, was there any -- can you provide some more information on it? And was there any geographic concentration to those? And then also on that, are there any reinsurance implications for the remainder of the year based on those?

Sure. I'll be glad to give you some additional color on that. As far as homeowners' fires, they were elevated in the quarter. We had about $4 million of homeowners' fires versus $2.6 million in the prior year quarter. But the big story would've been in the commercial side. The first quarter 2012 had only $700,000 of commercial fires, which was extremely low. This particular quarter, in 2013, we had $4.2 million of commercial fires. And as we have mentioned in the release, there's a number of unusual fires in that number. We had one that was a large fire in an apartment building that would've been capped by reinsurance at $1 million. We had 4 separate fires in our Peninsula subsidiary, which writes primarily garage risks. And garage risks are generally not the type of risk where you receive a lot of fire losses. And historically, we've received very few fire losses from that entity. But this particular quarter, $1.4 million of fire losses occurred there. So that is an unusual occurrence. We also saw an increase in Michigan in their commercial fires. So some unusual activity, but it is spread out throughout a number of our subsidiaries. There really are no reinsurance implications as it relates to, going forward, we don't have any deductibles such as we discussed about workers' comp. We do have a $1 million retention on any loss that occurs on a property risk. And so that would be in place for the rest of the year.

Okay, great. And then just one last one. I understand you might not care to comment on it, Don, but from the press release and the filing on the tender offer, it seems like there were some issues with federal or state regulatory approvals in time. Was that the main reason for the board's recommendation? Or were there other factors in there, if you care to comment?

Well, I -- candidly, a close review of the 14D-9 will disclose that the board looked at about 5 or 6 of the conditions that were set down as not being likely or improbable of being achieved. So it's not only just the regulatory ones. There were a number of other ones, but I would refer you to the 14D-9 where that is fairly well discussed.

[Operator Instructions] And there are no further questions at this time.

Okay. Well, at this time, we'd like to thank everyone for listening in and for their participation in the question-and-answer session and wish you a good day.

Thank you, everybody. We appreciate your time. Thank you.

And this does conclude today's conference call. Thanks for your participation. You may now disconnect.