DONEGAL GROUP INC. Overview
Donegal Mutual Insurance Company ("Donegal Mutual") organized us as an insurance holding company onAugust 26, 1986 . See "Business - History and Organizational Structure" for more information. Our insurance subsidiaries,Atlantic States Insurance Company ("Atlantic States"),Southern Insurance Company of Virginia ("Southern"),The Peninsula Insurance Company andPeninsula Indemnity Company (collectively, "Peninsula"), andMichigan Insurance Company ("MICO") and their affiliates write personal and commercial lines of property and casualty coverages exclusively through a network of independent insurance agents in certain Mid-Atlantic , Midwest,New England , Southern and Southwestern states. The personal lines products of our insurance subsidiaries consist primarily of homeowners and private passenger automobile policies. The commercial lines products of our insurance subsidiaries consist primarily of commercial automobile, commercial multi-peril and workers' compensation policies. Beginning in 2018, we and Donegal Mutual implemented a number of actions to improve our financial results and enhance our operations in the future. Those actions included implementing premium rate increases in many of our operating states and business lines, strengthening our loss reserves in response to changing loss reporting and litigation trends, entering into a transfer agreement to facilitate an orderly exit from the personal lines markets in seven states where we had projected continuing underwriting losses, consolidating a regional branch office into our home office, consolidating our reinsurance program and initiating a multi-year systems modernization project. Donegal Mutual completed the merger ofMountain States Mutual Casualty Company , or Mountain States, with and into Donegal Mutual effectiveMay 25, 2017 . Donegal Mutual was the surviving company in the merger, and Mountain States' insurance subsidiaries,Mountain States Indemnity Company andMountain States Commercial Insurance Company (collectively, the "Mountain States insurance subsidiaries"), became insurance subsidiaries of Donegal Mutual upon completion of the merger. Upon completion of the merger, Donegal Mutual assumed all of the policy obligations of Mountain States and began to market its products together with the Mountain States insurance subsidiaries as theMountain States Insurance Group in four Southwestern states. Donegal Mutual also entered into a 100% quota-share reinsurance agreement with the Mountain States insurance subsidiaries on the merger date. Beginning with policies effective in 2021, Donegal Mutual began to place the business of theMountain States Insurance Group into the underwriting pool we describe in "Business - History and Organizational Structure." As a result, our consolidated financial results throughDecember 31, 2020 excluded the results of theMountain States Insurance Group operations in those Southwestern states.We andDonegal Mutual Insurance Company soldDonegal Financial Services Corporation ("DFSC") to Northwest Bancshares, Inc. ("Northwest") onMarch 8, 2019 , resulting in proceeds valued at approximately$85.8 million in a combination of cash and Northwest common stock. Immediately prior to the closing of the merger, DFSC paid a dividend of approximately$29.2 million to us and Donegal Mutual. As the owner of 48.2% of DFSC's common stock, we received a dividend payment from DFSC of approximately$14.1 million and consideration from Northwest valued at approximately$41.4 million . We recorded a gain of$12.7 million from the sale of DFSC in our results of operations during 2019. We sold the Northwest common stock that we received as part of the consideration during 2019. This transaction represented the culmination of a banking strategy that began with the formation of DFSC in 2000. EffectiveDecember 1, 2019 , our insurance subsidiariesLe Mars Insurance Company ("Le Mars") andSheboygan Falls Insurance Company ("Sheboygan Falls") merged with and into Atlantic States (the "Mergers"). As a result of the Mergers, the separate corporate existences of Le Mars and Sheboygan Falls ceased andAtlantic States continued as the surviving insurance company. Atlantic States placed the business of Le Mars and Sheboygan Falls, as their policies renewed subsequent to the effective date of the Mergers, into the underwriting pool. AtDecember 31, 2020 , Donegal Mutual held approximately 42% of our outstanding Class A common stock and approximately 84% of our outstanding Class B common stock. This ownership provides Donegal Mutual with approximately 71% of the combined voting power of our outstanding shares of Class A common stock and our outstanding shares of Class B common stock. -48- -------------------------------------------------------------------------------- Table of Contents Donegal Mutual and Atlantic States have participated in a proportional reinsurance agreement, or pooling agreement, since 1986. Under the pooling agreement, Donegal Mutual and Atlantic States contribute substantially all of their respective premiums, losses and loss expenses to the underwriting pool, and the underwriting pool, acting through Donegal Mutual, then allocates 80% of the pooled business to Atlantic States. Thus, Donegal Mutual and Atlantic States share the underwriting results of the pooled business in proportion to their respective participation in the underwriting pool. The operations of our insurance subsidiaries and Donegal Mutual are interrelated due to the pooling agreement and other factors. While maintaining the separate corporate existence of each company, our insurance subsidiaries conduct business together with Donegal Mutual and its insurance subsidiaries as theDonegal Insurance Group .The Donegal Insurance Group is not a legal entity, is not an insurance company and does not issue or administer insurance policies. Rather, it is a trade name that refers to the group of insurance companies that are affiliated with Donegal Mutual. See "Business - History and Organizational Structure" for more information regarding the pooling agreement and other transactions with our affiliates. InJuly 2013 , our board of directors authorized a share repurchase program pursuant to which we have the authority to purchase up to 500,000 additional shares of our Class A common stock at prices prevailing from time to time in the open market subject to the provisions of theSEC Rule 10b-18 and in privately negotiated transactions. We did not purchase any shares of our Class A common stock under this program during 2020 or 2019. We have purchased a total of 57,658 shares of our Class A common stock under this program from its inception throughDecember 31, 2020 . Critical Accounting Policies and Estimates We combine our financial statements with those of our insurance subsidiaries and present them on a consolidated basis in accordance with GAAP. Our insurance subsidiaries make estimates and assumptions that can have a significant effect on amounts and disclosures we report in our financial statements. The most significant estimates relate to the reserves of our insurance subsidiaries for property and casualty insurance unpaid losses and loss expenses. While we believe our estimates and the estimates of our insurance subsidiaries are appropriate, the ultimate amounts may differ from the estimates we provided. We regularly review our methods for making these estimates, and we reflect any adjustment we consider necessary in our results of operations for the period in which we make an adjustment. Liability for Losses and Loss Expenses Liabilities for losses and loss expenses are estimates at a given point in time of the amounts an insurer expects to pay with respect to incurred policyholder claims based on facts and circumstances the insurer knows at that point in time. For example, legislative, judicial and regulatory actions may expand coverage definitions, retroactively mandate coverage or otherwise require our insurance subsidiaries to pay losses for damages that their policies explicitly excluded or did not intend to cover. At the time of establishing its estimates, an insurer recognizes that its ultimate liability for losses and loss expenses will exceed or be less than such estimates. Our insurance subsidiaries base their estimates of liabilities for losses and loss expenses on assumptions as to future loss trends, expected claims severity, judicial theories of liability and other factors. However, during the loss adjustment period, our insurance subsidiaries may learn additional facts regarding individual claims, and, consequently, it often becomes necessary for our insurance subsidiaries to refine and adjust their estimates for these liabilities. We reflect any adjustments to the liabilities for losses and loss expenses of our insurance subsidiaries in our consolidated results of operations in the period in which our insurance subsidiaries make adjustments to their estimates. Our insurance subsidiaries maintain liabilities for the payment of losses and loss expenses with respect to both reported and unreported claims. Our insurance subsidiaries establish these liabilities for the purpose of covering the ultimate costs of settling all losses, including investigation and litigation costs. Our insurance subsidiaries base the amount of their liability for reported losses primarily upon a case-by-case evaluation of the type of risk involved, knowledge of the circumstances -49- -------------------------------------------------------------------------------- Table of Contents surrounding each claim and the insurance policy provisions relating to the type of loss the policyholder incurred. Our insurance subsidiaries determine the amount of their liability for unreported claims and loss expenses on the basis of historical information by line of insurance. Our insurance subsidiaries account for inflation in the reserving function through analysis of costs and trends and reviews of historical reserving results. Our insurance subsidiaries monitor their liabilities closely and recompute them periodically using new information on reported claims and a variety of statistical techniques. Our insurance subsidiaries do not discount their liabilities for losses and loss expenses. Reserve estimates can change over time because of unexpected changes in assumptions related to our insurance subsidiaries' external environment and, to a lesser extent, assumptions related to our insurance subsidiaries' internal operations. For example, our insurance subsidiaries have experienced an increase in claims severity and a lengthening of the claim settlement periods on bodily injury claims during the past several years. In addition, the COVID-19 pandemic and related government mandates and restrictions resulted in various changes from historical claims reporting and settlement trends during 2020. These trend changes give rise to greater uncertainty as to the pattern of future loss settlements on bodily injury claims. Related uncertainties regarding future trends include social inflation, the rate of plaintiff attorney involvement in claims and the cost of medical technologies and procedures. Assumptions related to our insurance subsidiaries' external environment include the absence of significant changes in tort law and the legal environment that increase liability exposure, consistency in judicial interpretations of insurance coverage and policy provisions and the rate of loss cost inflation. Internal assumptions include consistency in the recording of premium and loss statistics, consistency in the recording of claims, payment and case reserving methodology, accurate measurement of the impact of rate changes and changes in policy provisions, consistency in the quality and characteristics of business written within a given line of business and consistency in reinsurance coverage and collectability of reinsured losses, among other items. To the extent our insurance subsidiaries determine that underlying factors impacting their assumptions have changed, our insurance subsidiaries make adjustments in their reserves that they consider appropriate for such changes. Accordingly, our insurance subsidiaries' ultimate liability for unpaid losses and loss expenses will likely differ from the amount recorded atDecember 31, 2020 . For every 1% change in our insurance subsidiaries' loss and loss expense reserves, net of reinsurance recoverable, the effect on our pre-tax results of operations would be approximately$5.6 million . The establishment of appropriate liabilities is an inherently uncertain process and we can provide no assurance that our insurance subsidiaries' ultimate liability will not exceed our insurance subsidiaries' loss and loss expense reserves and have an adverse effect on our results of operations and financial condition. Furthermore, we cannot predict the timing, frequency and extent of adjustments to our insurance subsidiaries' estimated future liabilities, because the historical conditions and events that serve as a basis for our insurance subsidiaries' estimates of ultimate claim costs may change. As is the case for substantially all property and casualty insurance companies, our insurance subsidiaries have found it necessary in the past to increase their estimated future liabilities for losses and loss expenses in certain periods and, in other periods, their estimated future liabilities for losses and loss expenses have exceeded their actual liabilities for losses and loss expenses. Changes in our insurance subsidiaries' estimates of their liability for losses and loss expenses generally reflect actual payments and their evaluation of information received subsequent to the prior reporting period. Our insurance subsidiaries recognized a decrease in their liability for losses and loss expenses of prior years of$12.9 million for each of 2020 and 2019. Our insurance subsidiaries recognized an increase in their liability for losses and loss expenses of prior years of$35.6 million in 2018. Our insurance subsidiaries made no significant changes in their reserving philosophy or claims management personnel, and they have made no significant offsetting changes in estimates that increased or decreased their loss and loss expense reserves in those years. The 2020 development represented 2.6% of theDecember 31, 2019 net carried reserves and resulted primarily from lower-than-expected severity in the workers' compensation and personal automobile lines of business, partially offset by higher-than-expected severity in the commercial automobile and commercial multi-peril lines of business, for accident years prior to 2020. The majority of the 2020 development related to decreases in the liability for losses and loss expenses of prior years for Atlantic States and MICO. The 2019 development represented 2.7% of theDecember 31, 2018 net carried reserves and resulted primarily from lower-than-expected severity in the workers' compensation line of business, partially offset by higher-than-expected severity in the commercial automobile and commercial multi-peril lines of business, for accident years prior to 2019. The majority of the 2019 development related to decreases in the liability for losses and loss expenses of prior years for Atlantic States and MICO. The 2018 development represented 9.3% of theDecember 31, 2017 net carried reserves and resulted primarily from higher-than-expected severity in the commercial multi- -50- -------------------------------------------------------------------------------- Table of Contents peril, personal automobile and commercial automobile lines of business, offset by lower-than-expected severity in the workers' compensation line of business, for accident years prior to 2018. The majority of the 2018 development related to increases in the liability for losses and loss expenses of prior years for Atlantic States and Southern. During 2018, our insurance subsidiaries received new information on previously-reported commercial automobile and personal automobile claims that led our insurance subsidiaries to conclude that their prior actuarial assumptions did not fully anticipate recent changes in severity and reporting trends. Our insurance subsidiaries have encountered increasing difficulties in projecting the ultimate severity of automobile losses over recent accident years, which our insurance subsidiaries attribute to worsening litigation trends and an increased delay in the reporting to our insurance subsidiaries of information with respect to the severity of claims. As a result, our insurance subsidiaries' actuaries increased their projections of the ultimate cost of our insurance subsidiaries' prior-year personal automobile and commercial automobile losses, and our insurance subsidiaries added$17.7 million to their reserves for personal automobile and$20.8 million to their reserves for commercial automobile for accident years prior to 2018. Excluding the impact of severe weather events and the COVID-19 pandemic, our insurance subsidiaries have noted stable amounts in the number of claims incurred and the number of claims outstanding at period ends relative to their premium base in recent years across most of their lines of business. However, the amount of the average claim outstanding has increased gradually over the past several years due to various factors such as rising medical loss costs and increased litigation trends. We have also experienced a general slowing of settlement rates in litigated claims. Our insurance subsidiaries could have to make further adjustments to their estimates in the future. However, on the basis of our insurance subsidiaries' internal procedures, which analyze, among other things, their prior assumptions, their experience with similar cases and historical trends such as reserving patterns, loss payments, pending levels of unpaid claims and product mix, as well as court decisions, economic conditions and public attitudes, we believe that our insurance subsidiaries have made adequate provision for their liability for losses and loss expenses. Atlantic States' participation in the pool with Donegal Mutual exposesAtlantic States to adverse loss development on the business of Donegal Mutual that the pool includes. However, pooled business represents the predominant percentage of the net underwriting activity of both companies, and Donegal Mutual andAtlantic States share proportionately any adverse risk development relating to the pooled business. The business in the pool is homogeneous and each company has a pro-rata share of the entire pool. Since the predominant percentage of the business of Atlantic States and Donegal Mutual is pooled and the results shared by each company according to its participation level under the terms of the pooling agreement, the intent of the underwriting pool is to produce a more uniform and stable underwriting result from year to year for each company than either would experience individually and to spread the risk of loss between the companies. Donegal Mutual and our insurance subsidiaries operate together as theDonegal Insurance Group and share a combined business plan designed to achieve market penetration and underwriting profitability objectives. The products our insurance subsidiaries and Donegal Mutual offer are generally complementary, thereby allowingDonegal Insurance Group to offer a broader range of products to a given market and to expandDonegal Insurance Group's ability to service an entire personal lines or commercial lines account. Distinctions within the products of Donegal Mutual and our insurance subsidiaries generally relate to specific risk profiles targeted within similar classes of business, such as preferred tier products compared to standard tier products, but we do not allocate all of the standard risk gradients to one company. Therefore, the underwriting profitability of the business the individual companies write directly will vary. However, because the pool homogenizes the risk characteristics of the predominant percentage of the business Donegal Mutual and Atlantic States write directly and each company shares the underwriting results according to each company's participation percentage, each company realizes its percentage share of the underwriting results of the pool. -51- -------------------------------------------------------------------------------- Table of Contents Our insurance subsidiaries' liability for losses and loss expenses by major line of business atDecember 31, 2020 and 2019 consisted of the following: 2020 2019 (in thousands) Commercial lines: Automobile$ 151,813 $ 126,224 Workers' compensation 118,037 109,060 Commercial multi-peril 126,299 102,424 Other 13,212 9,115 Total commercial lines 409,361 346,823 Personal lines: Automobile 120,861 132,191 Homeowners 20,976 23,494 Other 5,991 4,398 Total personal lines 147,828 160,083 Total commercial and personal lines 557,189 506,906 Plus reinsurance recoverable 404,818 362,768
Total liability for losses and loss expenses
We have evaluated the effect on our insurance subsidiaries' loss and loss
expense reserves and our stockholders' equity in the event of reasonably likely
changes in the variables we consider in establishing loss and loss expense
reserves. We established the range of reasonably likely changes based on a
review of changes in accident year development by line of business and applied
it to our insurance subsidiaries' loss reserves as a whole. The selected range
does not necessarily indicate what could be the potential best or worst case or
the most-likely scenario. The following table sets forth the effect on our
insurance subsidiaries' loss and loss expense reserves and our stockholders'
equity in the event of reasonably likely changes in the variables considered in
establishing loss and loss expense reserves:
Adjusted Loss and Loss
Adjusted Loss and Loss
Percentage Change in Expense Reserves Net of Percentage Change in
Expense Reserves Net of
Change in Loss and Loss Equity at December 31, Reinsurance at Equity at
Expense Reserves Net of Reinsurance at
Reinsurance December 31, 2020 2020(1) December 31, 2019 December 31, 2019(1)
(dollars in thousands)
-10.0% $ 501,470 8.5 % $ 456,215 8.9 %
-7.5 515,400 6.4 468,888 6.7
-5.0 529,330 4.3 481,561 4.4
-2.5 543,259 2.1 494,233 2.2
Base 557,189 - 506,906 -
2.5 571,119 -2.1 519,579 -2.2
5.0 585,048 -4.3 532,251 -4.4
7.5 598,978 -6.4 544,924 -6.7
10.0 612,908 -8.5 557,597 -8.9
(1) Net of income tax effect.
Our insurance subsidiaries base their reserves for unpaid losses and loss
expenses on current trends in loss and loss expense development and reflect
their best estimates for future amounts needed to pay losses and loss expenses
with respect to incurred events currently known to them plus incurred but not
reported ("IBNR") claims. Our insurance subsidiaries develop their
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reserve estimates based on an assessment of known facts and circumstances,
review of historical loss settlement patterns, estimates of trends in claims
severity, frequency, legal and regulatory changes and other assumptions. Our
insurance subsidiaries consistently apply actuarial loss reserving techniques
and assumptions, which rely on historical information as adjusted to reflect
current conditions, including consideration of recent case reserve activity. Our
insurance subsidiaries use the point estimate their actuaries select.
For the year ended December 31, 2020 , the actuaries developed a range from a low
of $512.9 million to a high of $605.3 million and selected a point estimate of
$557.2 million . The actuaries' range of estimates for commercial lines in 2020
was $376.9 million to $444.7 million , and the actuaries selected a point
estimate of $409.4 million . The actuaries' range of estimates for personal lines
in 2020 was $136.0 million to $160.6 million , and the actuaries selected a point
estimate of $147.8 million . For the year ended December 31, 2019 , the actuaries
developed a range from a low of $468.8 million to a high of $548.1 million and
selected a point estimate of $506.9 million . The actuaries' range of estimates
for commercial lines in 2019 was $320.8 million to $375.0 million , and the
actuaries selected a point estimate of $346.8 million . The actuaries' range of
estimates for personal lines in 2019 was $148.0 million to $173.1 million , and
the actuaries selected a point estimate of $160.1 million .
Our insurance subsidiaries seek to enhance their underwriting results by
carefully selecting the product lines they underwrite. For personal lines
products, our insurance subsidiaries insure standard and preferred risks in
private passenger automobile and homeowners lines. For commercial lines
products, the commercial risks that our insurance subsidiaries primarily insure
are business offices, wholesalers, service providers, contractors, artisans and
light manufacturing operations. Our insurance subsidiaries have limited exposure
to asbestos and other environmental liabilities. Our insurance subsidiaries
write no medical malpractice liability risks. Through the consistent application
of this disciplined underwriting philosophy, our insurance subsidiaries have
avoided many of the "long-tail" issues other insurance companies have faced. We
consider workers' compensation to be a "long-tail" line of business, in that
workers' compensation claims tend to be settled over a longer time frame than
those in the other lines of business of our insurance subsidiaries.
The following table presents 2020 and 2019 claim count and payment amount
information for workers' compensation. Workers' compensation losses primarily
consist of indemnity and medical costs for injured workers.
For the Year Ended
(dollars in thousands) 2020 2019
Number of claims pending, beginning of period 3,014
2,902
Number of claims reported 5,935
6,868
Number of claims settled or dismissed 6,051
6,756
Number of claims pending, end of period 2,898 3,014 Losses paid$ 38,204 $ 42,043 Loss expenses paid 9,065 8,885 -53-
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Management Evaluation of Operating Results
Despite challenging insurance market conditions, increasing casualty loss
severity trends and unusually adverse weather conditions that affected our
results in recent years, our operating results improved in 2020 compared to
2019.
Because our insurance subsidiaries do not prepare GAAP financial statements, we
evaluate the performance of our commercial lines and personal lines segments
utilizing statutory accounting practices ("SAP"), which include financial
measures that reflect the growth trends and underwriting results of our
insurance subsidiaries.
We use the following financial data to monitor and evaluate our operating
results:
Year Ended December 31,
(in thousands) 2020 2019 2018
Net premiums written:
Commercial lines:
Automobile $ 135,294 $ 122,142 $ 108,123
Workers' compensation 109,960 113,684 109,022
Commercial multi-peril 147,993 138,750 117,509
Other 32,739 30,303 15,241
Total commercial lines 425,986 404,879 349,895
Personal lines:
Automobile 184,602 210,507 249,275
Homeowners 111,886 117,118 123,782
Other 19,666 20,097 21,064
Total personal lines 316,154 347,722 394,121
Total net premiums written $ 742,140 $ 752,601 $ 744,016
Components of combined ratio:
Loss ratio 62.0 % 67.0 % 77.8 %
Expense ratio 33.0 31.3 31.6
Dividend ratio 1.0 1.2 0.7
Combined ratio 96.0 % 99.5 % 110.1 %
Revenues:
Net premiums earned:
Commercial lines $ 412,877 $ 385,465 $ 337,924
Personal lines 329,163 370,613 403,367
Total net premiums earned 742,040 756,078 741,291
Net investment income 29,504 29,515 26,908
Investment gains (losses) 2,778 21,985 (4,802 )
Equity in earnings of DFSC - 295 2,694
Other 3,497 4,578 5,737
Total revenues $ 777,819 $ 812,451 $ 771,828
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Year Ended December 31,
(in thousands) 2020 2019 2018
Components of net income (loss):
Underwriting income (loss):
Commercial lines $ (858 ) $ 8,404 $ (22,059 )
Personal lines 31,764 (1,617 ) (53,590 )
SAP underwriting income (loss) 30,906 6,787 (75,649 )
GAAP adjustments (959 ) (3,079 ) 894
GAAP underwriting income (loss) 29,947 3,708 (74,755 )
Net investment income 29,504 29,515 26,908
Investment gains (losses) 2,778 21,985 (4,802 )
Equity in earnings of DFSC - 295 2,694
Other 1,043 1,578 1,718
Income (loss) before income tax expense (benefit) 63,272 57,081 (48,237 )
Income tax expense (benefit) 10,457 9,929 (15,477 )
Net income (loss) $ 52,815 $ 47,152 $ (32,760 )
Non-GAAP
Information
We prepare our consolidated financial statements on the basis of GAAP. Our
insurance subsidiaries also prepare financial statements based on SAP. SAP
financial measures are considered
non-GAAP
financial measures under applicable SEC rules because the SAP financial measures
include or exclude certain items that the most comparable GAAP financial
measures do not ordinarily include or exclude. Our calculation of
non-GAAP
financial measures may differ from similar measures other companies use. As a
result, investors should exercise caution when comparing our
non-GAAP
financial measures to the
non-GAAP
financial measures other companies use. The SAP financial measures we utilize
are net premiums written and statutory combined ratio.
Net Premiums Written
We define net premiums written as the amount of full-term premiums our insurance
subsidiaries record for policies effective within a given period less premiums
our insurance subsidiaries cede to reinsurers. Net premiums earned is the most
comparable GAAP financial measure to net premiums written. Net premiums earned
represent the sum of the amount of net premiums written and the change in net
unearned premiums during a given period. Our insurance subsidiaries earn
premiums and recognize them as revenue over the terms of their policies, which
are one year or less in duration. Therefore, increases or decreases in net
premiums earned generally reflect increases or decreases in net premiums written
in the preceding
12-month
period compared to the comparable period one year earlier.
The following table provides a reconciliation of our net premiums earned to our
net premiums written for 2020, 2019 and 2018:
Year Ended December 31,
2020 2019 2018
Net premiums earned $ 742,040,339 $ 756,078,400 $ 741,290,873
Change in net unearned premiums 99,554 (3,477,111 ) 2,724,931
Net premiums written $ 742,139,893 $ 752,601,289 $ 744,015,804
The decrease in the change in net unearned premiums for 2020 and 2019 compared
to 2018 reflects lower growth in net premiums written during 2020 and 2019,
which we attribute primarily to net attrition in our personal lines segment that
resulted from increased pricing on renewal policies and underwriting measures
our insurance subsidiaries implemented to slow new policy growth and improve
profitability.
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Statutory Combined Ratio
The combined ratio is a standard measurement of underwriting profitability for
an insurance company. The combined ratio does not reflect investment income, net
investment gains or losses, federal income taxes or other
non-operating
income or expense. A combined ratio of less than 100% generally indicates
underwriting profitability.
The statutory combined ratio is a
non-GAAP
financial measure that is based upon amounts determined under SAP. We calculate
our statutory combined ratio as the sum of:
• the statutory loss ratio, which is the ratio of calendar-year net
incurred losses and loss expenses to net premiums earned;
• the statutory expense ratio, which is the ratio of expenses incurred for
net commissions, premium taxes and underwriting expenses to net premiums
written; and
• the statutory dividend ratio, which is the ratio of dividends to holders
of workers' compensation policies to net premiums earned.
The calculation of our statutory combined ratio differs from the calculation of our GAAP combined ratio. In calculating our GAAP combined ratio, we do not deduct installment payment fees from incurred expenses, and we base the expense ratio on net premiums earned instead of net premiums written. Differences between our GAAP loss ratio and our statutory loss ratio result from anticipating salvage and subrogation recoveries for our GAAP loss ratio but not for our statutory loss ratio. The following table presents comparative details with respect to our GAAP and statutory combined ratios for the years endedDecember 31, 2020 , 2019 and 2018: Year Ended December 31, 2020 2019 2018 GAAP Combined Ratios (Total Lines) Loss ratio (non-weather) 55.1 % 60.9 % 69.0 % Loss ratio (weather-related) 6.9 6.1 8.8 Expense ratio 33.0 31.3 31.6 Dividend ratio 1.0 1.2 0.7 Combined ratio 96.0 % 99.5 % 110.1 % Statutory Combined Ratios Commercial lines: Automobile 112.7 % 117.4 % 133.3 % Workers' compensation 86.3 78.5 86.6 Commercial multi-peril 98.4 93.7 98.1 Other 74.0 72.6 54.6 Total commercial lines 97.8 95.0 103.8 Personal lines: Automobile 91.3 105.7 117.4 Homeowners 97.2 101.2 110.5 Other 74.9 73.2 96.4 Total personal lines 92.4 102.6 114.1
Total commercial and personal lines 95.4 98.7 109.4
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Results of Operations
YEAR ENDED DECEMBER 31, 2020 COMPARED TO YEAR ENDED DECEMBER 31, 2019
Net Premiums Earned
Our insurance subsidiaries' net premiums earned decreased to $742.0 million for
2020, a decrease of $14.1 million , or 1.9%, compared to 2019, primarily
reflecting decreases in personal lines premiums written during 2019 and 2020.
Our insurance subsidiaries earn premiums and recognize them as income over the
terms of the policies they issue. Such terms are generally one year or less in
duration. Therefore, increases or decreases in net premiums earned generally
reflect increases or decreases in net premiums written in the preceding
twelve-month period compared to the same period one year earlier.
Net Premiums Written
Our insurance subsidiaries' 2020 net premiums written decreased 1.4% to
$742.1 million , compared to $752.6 million for 2019. We attribute the decrease
primarily to net attrition in our personal lines segment that resulted from
increased pricing on renewal policies and underwriting measures our insurance
subsidiaries implemented to slow new policy growth and improve profitability,
offset somewhat by the impact of premium rate increases and an increase in the
writing of new accounts in commercial lines of business. Commercial lines net
premiums written increased $21.1 million , or 5.2%, for 2020 compared to 2019.
Personal lines net premiums written decreased $31.6 million , or 9.1%, for 2020
compared to 2019.
Investment Income
For 2020, our net investment income was unchanged at $29.5 million , as an
increase in average invested assets offset a modest decrease in the average
investment yield.
Net Investment Gains
Our net investment gains for 2020 and 2019 were $2.8 million and $22.0 million ,
respectively. The net investment gains for 2020 were primarily related to an
increase in unrealized gains within our equity securities portfolio. The net
investment gains for 2019 included $12.7 million from the sale of DFSC and
$8.9 million related to unrealized gains within our equity securities portfolio.
We did not recognize any impairment losses during 2020 or 2019.
Losses and Loss Expenses
Our insurance subsidiaries' loss ratio, which is the ratio of incurred losses
and loss expenses to premiums earned, was 62.0% for 2020, compared to 67.0% for
2019. Our insurance subsidiaries' commercial lines loss ratio increased to 63.9%
for 2020, compared to 63.0% for 2019. This increase resulted primarily from the
workers' compensation loss ratio increasing to 51.1% for 2020, compared to 44.6%
for 2019, and the commercial multi-peril loss ratio increasing to 65.9% for
2020, compared to 63.1% for 2019. The personal lines loss ratio decreased to
59.5% for 2020, compared to 71.1% for 2019. The personal automobile loss ratio
decreased to 60.1% for 2020, compared to 76.1% for 2019, primarily as a result
of lower claim frequency due to reduced driving activity and traffic density and
various underwriting adjustments our insurance subsidiaries
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implemented in recent years. The homeowners loss ratio decreased to 61.8% for
2020, compared to 67.1% for 2019, primarily as a result of decreased
weather-related losses that we attribute to our exit from several weather-prone
markets in 2019. Our insurance subsidiaries experienced favorable loss reserve
development of approximately $12.9 million , or 1.7 percentage points of the loss
ratio, during 2020 in their reserves for prior accident years, compared to
favorable loss reserve development of approximately $12.9 million , or 1.7
percentage points of the loss ratio, during 2019. The favorable loss reserve
development in 2020 resulted primarily from lower-than-expected severity in the
workers' compensation and personal automobile lines of business, partially
offset by higher-than-expected severity in the commercial automobile and
commercial multi-peril lines of business, for accident years prior to 2020.
Weather-related losses of $51.4 million , or 6.9 percentage points of the loss
ratio, for 2020 increased from $46.1 million , or 6.1 percentage points of the
loss ratio, for 2019, with the increase primarily impacting the commercial
multi-peril line of business.
Underwriting Expenses
Our insurance subsidiaries' expense ratio, which is the ratio of policy
acquisition and other underwriting expenses to premiums earned, was 33.0% for
2020, compared to 31.3% for 2019. We attribute the modest increase to higher
commercial growth incentive costs for our agents, higher underwriting-based
incentive compensation for our agents and employees and higher
technology-related expenses for 2020 compared to 2019. The increase in
technology systems-related expenses for 2020 was primarily due to an increased
allocation of costs from Donegal Mutual to our insurance subsidiaries following
the successful implementation of the first phase of our ongoing systems
modernization project in February 2020 .
Policyholder Dividends
Our insurance subsidiaries pay policyholder dividends primarily on workers'
compensation policies on a sliding scale based on the profitability of a given
policy. We attribute the decrease in dividends incurred for 2020 compared to
2019 to a modest decline in the profitability of the workers' compensation line
of business over the respective periods to which the dividends applied.
Combined Ratio
Our insurance subsidiaries' combined ratio was 96.0% and 99.5% for 2020 and
2019, respectively. The combined ratio represents the sum of the loss ratio, the
expense ratio and the dividend ratio, which is the ratio of workers'
compensation policy dividends incurred to premiums earned. We attribute the
decrease in our combined ratio primarily to the decrease in our loss ratio.
Interest Expense
Our interest expense for 2020 decreased to $1.2 million , compared to
$1.6 million for 2019. We attribute the decrease to lower interest rates on our
borrowings under our lines of credit during 2020 compared to 2019.
Income Taxes
Our income tax expense was $10.5 million for 2020, compared to $9.9 million for
2019. Our effective tax rate for 2020 was 16.5%, compared to 17.4% for 2019. Our
income tax expense for 2020 included a $1.6 million income tax benefit related
to the carryback of 2018 net operating losses to past tax years with higher
statutory income tax rates than are currently in effect, as allowed under the
Coronavirus Aid, Relief and Economic Security Act that was enacted in March
2020 . Our income tax expense for 2019 included Pennsylvania state income taxes
of $825,000 that were related to the gain we realized on the sale of DFSC.
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Net Income and Earnings Per Share
Our net income for 2020 was $52.8 million , or $1.83 per share of Class A common
stock on a diluted basis and $1.65 per share of Class B common stock, compared
to net income for 2019 of $47.2 million , or $1.67 per share of Class A common
stock on a diluted basis and $1.51 per share of Class B common stock. We had
24.6 million and 23.2 million Class A shares outstanding at December 31, 2020
and 2019, respectively. We had 5.6 million Class B shares outstanding for both
periods. There are no outstanding securities that dilute our shares of Class B
common stock.
Book Value Per Share
Our stockholders' equity increased by $66.8 million during 2020 as a result of
our net income and net unrealized gains within our
available-for-sale
fixed maturity investments. Our book value per share increased to $17.13 at
December 31, 2020 , compared to $15.67 a year earlier.
YEAR ENDED DECEMBER 31, 2019 COMPARED TO YEAR ENDED DECEMBER 31, 2018
Net Premiums Earned
Our insurance subsidiaries' net premiums earned increased to $756.1 million for
2019, an increase of $14.8 million , or 2.0%, over 2018, reflecting increases in
commercial premiums written during 2018 and 2019. Our insurance subsidiaries
earn premiums and recognize them as income over the terms of the policies they
issue. Such terms are generally one year or less in duration. Therefore,
increases or decreases in net premiums earned generally reflect increases or
decreases in net premiums written in the preceding twelve-month period compared
to the same period one year earlier.
Net Premiums Written
Our insurance subsidiaries' 2019 net premiums written increased 1.2% to
$752.6 million , compared to $744.0 million for 2018. We attribute the increase
primarily to the impact of premium rate increases and an increase in the writing
of new accounts in commercial lines of business. Commercial lines net premiums
written increased $47.8 million , or 13.4%, for 2019 compared to 2018. Personal
lines net premiums written decreased $39.2 million , or 10.1%, for 2019 compared
to 2018. We attribute the decrease in personal lines primarily to net attrition
as a result of underwriting measures our insurance subsidiaries have implemented
to slow new policy growth and increased pricing on renewal policies, as well as
the previously announced
non-renewal
of unprofitable personal lines business in seven states that began in February
2019 , partially offset by premium rate increases our insurance subsidiaries have
implemented over the past five quarters and lower reinsurance premiums.
Investment Income
For 2019, our net investment income increased to $29.5 million , an increase of
$2.6 million , or 9.7%, over 2018. We attribute the increase primarily to an
increase in average invested assets.
Net Investment Gains (Losses)
Our net investment gains (losses) for 2019 and 2018 were $22.0 million and
($4.8 million ), respectively. The net investment gains for 2019 included
$12.7 million from the sale of DFSC and $8.9 million related to unrealized gains
within our equity securities portfolio. The net investment losses for 2018 were
primarily related to a decrease in the market value of the equity securities we
held at December 31, 2018 . We did not recognize any impairment losses during
2019 or 2018.
Losses and Loss Expenses
Our insurance subsidiaries' loss ratio, which is the ratio of incurred losses
and loss expenses to premiums earned, was 67.0% for 2019, compared to 77.8% for
2018. Our insurance subsidiaries' commercial lines loss ratio decreased to 63.0%
for 2019, compared to 72.9% for 2018. This decrease resulted primarily from the
commercial automobile loss ratio decreasing to 86.2% for 2019, compared to
101.9% for 2018, and the commercial multi-peril loss ratio decreasing to 63.1%
for 2019,
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compared to 67.0% for 2018. The personal lines loss ratio was 71.1% for 2019,
compared to 81.8% for 2018. Our insurance subsidiaries experienced favorable
loss reserve development of approximately $12.9 million , or 1.7 percentage
points of the loss ratio, during 2019 in their reserves for prior accident
years, compared to unfavorable loss reserve development of approximately
$35.6 million , or 4.8 percentage points of the loss ratio, during 2018. The
favorable loss reserve development in 2019 resulted primarily from
lower-than-expected severity in the workers' compensation line of business,
partially offset by higher-than-expected severity in the commercial automobile
and commercial multi-peril lines of business, for accident years prior to 2019.
Weather-related losses of $46.1 million , or 6.1 percentage points of the loss
ratio, for 2019 decreased from $65.0 million , or 8.8 percentage points of the
loss ratio, for 2018.
Underwriting Expenses
Our insurance subsidiaries' expense ratio, which is the ratio of policy
acquisition and other underwriting expenses to premiums earned, was 31.3% for
2019, compared to 31.6% for 2018. We attribute the modest decrease to expense
savings that were largely offset by higher underwriting-based incentive
compensation in 2019.
Policyholder Dividends
Our insurance subsidiaries pay policyholder dividends primarily on workers'
compensation policies on a sliding scale based on the profitability of a given
policy. We attribute the increase in dividends incurred for 2019 compared to
2018 to growth and profitability of the workers' compensation line of business
over the respective periods to which the dividends applied. We also partially
attribute the increase to growth in workers' compensation writings in Wisconsin ,
a state in which our insurance subsidiaries and their competitors pay a higher
rate of dividends compared to other states and where such dividends are not
dependent on the profitability of a given policy.
Combined Ratio
Our insurance subsidiaries' combined ratio was 99.5% and 110.1% for 2019 and
2018, respectively. The combined ratio represents the sum of the loss ratio, the
expense ratio and the dividend ratio, which is the ratio of workers'
compensation policy dividends incurred to premiums earned. We attribute the
decrease in our combined ratio primarily to the decrease in our loss ratio.
Interest Expense
Our interest expense for 2019 decreased to $1.6 million , compared to
$2.3 million for 2018. We attribute the decrease to lower average borrowings
under our lines of credit during 2019 compared to 2018.
Income Taxes
Our income tax expense was $9.9 million for 2019, compared to an income tax
benefit of $15.5 million for 2018. Our effective tax rate was 17.4% for 2019.
Our income tax expense for 2019 included Pennsylvania state income taxes of
$825,000 that were related to the gain we realized on the sale of DFSC in 2019.
Our 2018 income tax benefit reflected our anticipation of an estimated carryback
of our taxable loss in 2018 to prior tax years.
Net Income (Loss) and Earnings (Loss) Per Share
Our net income for 2019 was $47.2 million , or $1.67 per share of Class A common
stock on a diluted basis and $1.51 per share of Class B common stock, compared
to a net loss of $32.8 million , or $1.18 per share of Class A common stock and
$1.09 per share of Class B common stock, for 2018. We had 23.2 million and
22.8 million Class A shares outstanding at December 31, 2019 and 2018,
respectively. We had 5.6 million Class B shares outstanding for both periods.
There are no outstanding securities that dilute our shares of Class B common
stock.
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Book Value Per Share
Our stockholders' equity increased by $52.1 million during 2019 as a result of
our net income and net unrealized gains within our
available-for-sale
fixed maturity investments. Our book value per share increased to $15.67 at
December 31, 2019 , compared to $14.05 a year earlier.
Financial Condition
Liquidity and Capital Resources
Liquidity is a measure of an entity's ability to secure enough cash to meet its
contractual obligations and operating needs as they arise. Our major sources of
funds from operations are the net cash flows generated from our insurance
subsidiaries' underwriting results, investment income and maturing investments.
We have historically generated sufficient net positive cash flow from our
operations to fund our commitments and build our investment portfolio, thereby
increasing future investment returns. The pooling agreement with Donegal Mutual
historically has been cash flow positive because of the profitability of the
underwriting pool. Because we settle the pool monthly, our cash flows are
substantially similar to the cash flows that would result from the underwriting
of direct business. We maintain a high degree of liquidity in our investment
portfolio in the form of marketable fixed maturities, equity securities and
short-term investments. We structure our fixed-maturity investment portfolio
following a "laddering" approach so that projected cash flows from investment
income and principal maturities are evenly distributed from a timing
perspective. This laddering approach provides an additional measure of liquidity
to meet our obligations and the obligations of our insurance subsidiaries should
an unexpected variation occur in the future. Net cash flows provided by
operating activities in 2020, 2019 and 2018 were $101.1 million , $76.4 million
and $63.8 million , respectively.
In August 2020 , we entered into a new credit agreement with Manufacturers and
Traders Trust Company ("M&T") that related to a $20.0 million unsecured demand
line of credit. The line of credit has no expiration date, no annual fees and no
covenants. At December 31, 2020 , we had no outstanding borrowings from M&T and
had the ability to borrow up to $20.0 million at interest rates equal to the
then-current LIBOR rate plus 2.00%.
Atlantic States is a member of the FHLB of Pittsburgh . Through its membership,
Atlantic States has the ability to issue debt to the FHLB of Pittsburgh in
exchange for cash advances. In August 2019 , Atlantic States exchanged a
variable-rate cash advance of $35.0 million that was due in March 2020 for a
fixed-rate cash advance of $35.0 million that was outstanding at December 31,
2020 . Atlantic States incurred a penalty of $176,000 related to the early
termination of its previous cash advance. The new cash advance carries a fixed
interest rate of 1.74% and is due in August 2024 . In March 2020 , Atlantic States
issued $50.0 million of debt to the FHLB of Pittsburgh in exchange for a cash
advance in the same amount that was outstanding at December 31, 2020 . Atlantic
States obtained this contingent liquidity funding in light of uncertainty
surrounding the economic impact of the
COVID-19
pandemic. The debt carries a fixed interest rate of 0.83%, and Atlantic States
plans to repay this cash advance in full at its March 2021 maturity.
The following table shows expected payments for our significant contractual
obligations at December 31, 2020 :
Less than 1
1-3 4-5 After 5
(in thousands) Total year years years years
Net liability for unpaid losses and loss
expenses of our insurance subsidiaries $ 557,189 $ 256,165 $ 260,460 $ 20,237 $ 20,327
Subordinated debentures 5,000 - - - 5,000
Borrowings under lines of credit 85,000 50,000 - 35,000 -
Total contractual obligations $ 647,189 $ 306,165 $ 260,460 $ 55,237 $ 25,327
-61--------------------------------------------------------------------------------- Table of Contents We estimated the timing of the amounts for the net liability for unpaid losses and loss expenses of our insurance subsidiaries based on historical experience and expectations of future payment patterns. We have shown the liability net of reinsurance recoverable on unpaid losses and loss expenses to reflect expected future cash flows related to such liability. Assumed amounts from the underwriting pool with Donegal Mutual represent a substantial portion of our insurance subsidiaries' gross liability for unpaid losses and loss expenses, and ceded amounts to the underwriting pool represent a substantial portion of our insurance subsidiaries' reinsurance recoverable on unpaid losses and loss expenses. We include cash settlements of Atlantic States' assumed liability from the pool in our monthly settlements of pooled activity. In these monthly settlements, we net amounts ceded to and assumed from the pool. Donegal Mutual and Atlantic States do not anticipate any changes in the pool participation levels in the foreseeable future. However, any such change would be prospective in nature and therefore would not impact the timing of expected payments for Atlantic States' proportionate liability for pooled losses occurring in periods prior to the effective date of such change. We discuss in Note 9 - Borrowings our estimate of the timing of the amounts payable for the borrowings under our lines of credit based on their contractual maturities. The borrowings under our lines of credit carry interest rates that we discuss in Note 9 - Borrowings. The cash dividends we declared to our stockholders totaled$17.3 million ,$16.2 million and$15.8 million in 2020, 2019 and 2018, respectively. There are no regulatory restrictions on our payment of dividends to our stockholders, although there are restrictions under applicable state laws on the payment of dividends from our insurance subsidiaries to us. Our insurance subsidiaries are required by law to maintain certain minimum surplus on a statutory basis and are subject to regulations under which their payment of dividends from statutory surplus is restricted and may require prior approval of their domiciliary insurance regulatory authorities. Our insurance subsidiaries are also subject to risk-based capital ("RBC") requirements. The amount of statutory capital and surplus necessary for our insurance subsidiaries to satisfy regulatory requirements, including the RBC requirements, was not significant in relation to our insurance subsidiaries' statutory capital and surplus atDecember 31, 2020 . Amounts available for distribution to us as ordinary dividends from our insurance subsidiaries without prior approval of insurance regulatory authorities in 2021 are approximately$28.0 million from Atlantic States,$300,000 from Southern,$10.9 million from Peninsula and$12.2 million from MICO, or a total of approximately$51.4 million . -62- -------------------------------------------------------------------------------- Table of Contents Investments AtDecember 31, 2020 and 2019, our investment portfolio of primarily investment-grade bonds, common stock, short-term investments and cash totaled$1.3 billion and$1.2 billion , respectively, representing 61.3% and 60.3%, respectively, of our total assets. See "Business - Investments" for more information. December 31, 2020 2019 Percent of Percent of (dollars in thousands) Amount Total Amount Total Fixed maturities: Total held to maturity$ 586,609 48.0 %$ 476,094 42.9 % Total available for sale 555,136 45.5 564,952 50.8 Total fixed maturities 1,141,745 93.5 1,041,046 93.7 Equity securities 58,556 4.8 55,477 5.0 Short-term investments 20,901 1.7 14,030 1.3 Total investments$ 1,221,202 100.0 %$ 1,110,553 100.0 % The carrying value of our fixed maturity investments represented 93.5% and 93.7% of our total invested assets atDecember 31, 2020 and 2019, respectively. Our fixed maturity investments consisted of high-quality marketable bonds, of which 99.8% were rated at investment-grade levels atDecember 31, 2020 and 2019. AtDecember 31, 2020 , the net unrealized gain on our available-for-sale fixed maturity investments, net of deferred taxes, amounted to$15.9 million , compared to a net unrealized gain of$6.4 million atDecember 31, 2019 . Impact of Inflation Our insurance subsidiaries establish their property and casualty insurance premium rates before they know the amount of losses and loss settlement expenses or the extent to which inflation may impact such expenses. Consequently, our insurance subsidiaries attempt, in establishing rates, to anticipate the potential future impact of inflation. Our insurance subsidiaries account for inflation in the reserving function through analysis of costs and trends and reviews of historical reserving results. Impact of New Accounting Standards InFebruary 2016 , the FASB issued guidance that requires lessees to recognize leases, including operating leases, on the lessee's balance sheet, unless a lease is considered a short-term lease. This guidance also requires entities to make new judgments to identify leases. The guidance was effective for annual and interim reporting periods beginning afterDecember 15, 2018 and permitted early adoption. Our adoption of this guidance onJanuary 1, 2019 did not have a significant impact on our financial position, results of operations or cash flows. InJanuary 2017 , the FASB issued guidance that simplifies the measurement of goodwill by modifying the goodwill impairment test previous guidance required. The guidance requires an entity to perform its annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount and recognize impairment for the amount by which the reporting unit's carrying amount exceeds its fair value. The guidance was effective for annual and interim reporting periods beginning afterDecember 15, 2019 and permitted early adoption. We early adopted this guidance in 2019. The adoption of this guidance did not have a significant impact on our financial position, results of operations or cash flows. InAugust 2018 , the FASB issued guidance that modifies disclosure requirements related to fair value measurements. The guidance removes the requirements to disclose the amounts of, and reasons for, transfers between Level 1 and Level 2 of the fair value hierarchy. The guidance was effective for annual and interim reporting periods beginning afterDecember 15, 2019 and permitted early adoption. We early adopted this guidance in 2019. The adoption of this guidance onJanuary 1, 2019 did not have a significant impact on our financial position, results of operations or cash flows. -63-
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Table of Contents InSeptember 2016 , the FASB issued guidance that amends previous guidance on the impairment of financial instruments by adding an impairment model that requires an entity to recognize expected credit losses as an allowance rather than impairments as credit losses are incurred. The intent of this guidance is to reduce complexity and result in a more timely recognition of expected credit losses. InNovember 2019 , the FASB issued guidance that delays the effective date for "smaller reporting companies," as defined in Item 10(f)(1) of Regulation S-K, to annual and interim reporting periods beginning afterDecember 15, 2022 fromDecember 15, 2019 . We are a smaller reporting company and are in the process of evaluating the impact of the adoption of this guidance on our financial position, results of operations and cash flows. InDecember 2019 , the FASB issued guidance that simplifies accounting for income taxes. The guidance eliminates certain exceptions related to the approach for intra-period tax allocation, the methodology for calculating income taxes in an interim period and the recognition of deferred tax liabilities for outside basis differences. The guidance was effectiveJanuary 1, 2021 , using the retrospective method or modified retrospective method for certain changes and the prospective method for all other changes, and permits early adoption. We do not expect our adoption of this guidance in 2021 to have a significant impact on our financial position, results of operations or cash flows. Off-Balance Sheet Arrangements As ofDecember 31, 2020 and 2019, we did not have any off-balance sheet arrangements as defined in Item 303(a)(4)(ii) of Regulation S-K.
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