Donegal Group Inc. — Q2 2013 Form 10-Q
Reporting period: Three and six months ended June 30, 2013; interim financial statements are unaudited. Donegal is a property-and-casualty insurer writing personal and commercial lines through independent agents, and owns 48.2% of Donegal Financial Services Corporation (DFSC).
Financial performance
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Total revenues | $135.5 million | $127.3 million | $269.4 million | $252.6 million |
| Net premiums earned | $127.0 million | $117.6 million | $251.7 million | $232.3 million |
| Income before tax | $2.9 million | $2.1 million | $10.9 million | $12.0 million |
| Net income | $2.6 million | $2.0 million | $9.1 million | $10.0 million |
| Class A diluted EPS | $0.10 | $0.08 | $0.35 | $0.39 |
| Net cash from operations | — | $16.8 million | $3.2 million |
- Q2 revenues rose 6.4% and net income rose 30% year over year. For the first half, revenues rose 6.6%, while net income fell 9.3%.
- Net premiums written increased 7.2% in Q2 and 8.2% for the first half, supported by rate increases, commercial-lines growth and MICO reducing its external quota-share reinsurance from 40% to 30%.
- Q2 loss ratio improved to 70.5% from 73.5%; first-half loss ratio improved to 69.6% from 70.2%. The expense ratio was 32.3% in Q2 versus 31.9%, and 31.5% for the first half versus 32.1%.
- Management reports GAAP combined ratios of 103.1% for Q2 versus 105.4%, and 101.4% for the first half versus 102.5%. The statutory combined-ratio table reports 100.6% versus 103.5% for Q2 and 99.3% versus 100.2% for the first half; the filing notes that statutory and GAAP calculations differ.
- Investment income declined to $4.7 million in Q2 and $9.5 million for the first half, principally due to lower yields. Realized investment gains were $1.3 million and $2.6 million, respectively, lower than in the comparable 2012 periods. DFSC earnings also declined.
Financial position, debt and liquidity
- At June 30, 2013, total assets were $1.374 billion, total liabilities $989.7 million and stockholders’ equity $384.8 million. Total investments were $772.9 million and cash was $25.0 million.
- Equity declined from $400.0 million at year-end 2012, largely reflecting a $26.0 million first-half other comprehensive loss from unrealized investment losses. Accumulated other comprehensive income fell to $0.3 million from $26.4 million.
- Borrowings under lines of credit totaled $61.5 million, versus $52.0 million at year-end; subordinated debentures were $5.0 million versus $20.5 million. The company prepaid $15.5 million of debentures during the first half, using financing that included a $15.0 million Atlantic States advance from the Federal Home Loan Bank of Pittsburgh.
- The renewed M&T unsecured revolving facility is $60.0 million and expires in July 2016. Donegal had $46.5 million drawn and $13.5 million available at June 30; its borrowing rate was 2.44%. The filing states that the company complied with all facility covenants.
- Operating cash flow increased to $16.8 million from $3.2 million, while cash increased to $25.0 million. Insurance subsidiaries paid $10.0 million in dividends to Donegal in the first half; approximately $19.2 million remained available for distribution in 2013 without prior regulatory approval, subject to applicable restrictions.
Changes, outlook and risks
- Commercial-lines underwriting weakened relative to the prior-year first half: the statutory combined ratio rose to 99.9% from 92.0%, while personal lines improved to 99.2% from 105.0%. In Q2, commercial lines were 101.4% versus 95.1%; personal lines were 100.2% versus 108.4%.
- First-half large fire losses increased to $13.8 million from $10.2 million. Unfavorable prior-year reserve development was approximately $6.5 million for the first half, versus $2.7 million; Q2 development was $4.7 million versus $2.3 million.
- Management considers loss reserves adequate, but stresses their estimation uncertainty. A 1% change in estimated net loss and loss-expense reserves would affect pretax results by approximately $2.6 million. Claims severity, litigation trends, medical costs, slower settlements and reinsurance collectability are identified concerns.
- Available-for-sale investments had $16.5 million of gross unrealized losses at June 30, all considered temporary; none were in a loss position for more than 12 months. The company reported no investment impairment losses and no direct subprime mortgage-backed-securities or collateralized-debt-obligation exposure. Market valuation, interest-rate, credit and liquidity risks remain relevant.
- The filing provides no specific full-year earnings or premium guidance and cautions that first-half results are not necessarily indicative of full-year results. Forward-looking risks include reserve adequacy, weather catastrophes, reinsurance availability and cost, interest rates, competition, legal developments and regulation.
- After quarter-end, the board authorized repurchases of up to 500,000 additional Class A shares and declared quarterly dividends of $0.1275 per Class A share and $0.115 per Class B share. No material risk-factor changes or legal proceedings were reported; disclosure controls were deemed effective.
Important facts for investors to verify
- Whether unfavorable reserve development and elevated commercial-lines losses persist, especially in workers’ compensation, commercial multi-peril and personal auto.
- How premium growth translates into underwriting profitability, accounting for the MICO reinsurance change and rate increases.
- The sensitivity of equity and earnings to interest-rate movements and further unrealized investment losses.
- Liquidity, debt maturities, M&T covenants, and the capacity of regulated insurance subsidiaries to continue paying dividends to the parent.
- Reinsurance recoverability and the exposure associated with Donegal Mutual pooling arrangements and catastrophe losses.