Donegal Group Inc. — Q2 2019 Form 10-Q
Business context and reporting period
Donegal Group is a property-and-casualty insurer operating through independent agents across Mid-Atlantic, Midwestern, New England and Southern states. Its main products include personal auto and homeowners, and commercial auto, multi-peril and workers’ compensation. This unaudited report covers the quarter and six months ended June 30, 2019; comparisons are with the corresponding 2018 periods.
Financial and operating highlights
- Q2 revenue and earnings: Total revenues were $198.8 million, up from $195.8 million. Net income was $4.8 million, or $0.17 per diluted Class A share and $0.15 per Class B share, versus a net loss of $0.8 million, or $0.03 per share for each class.
- First-half revenue and earnings: Total revenues were $413.5 million, versus $385.1 million. Net income was $27.8 million, or $0.99 diluted per Class A share and $0.90 per Class B share, versus a net loss of $19.0 million in the first half of 2018.
- Premiums: Net premiums earned rose 1.6% in Q2 to $188.8 million and 2.5% for the first half to $376.8 million. First-half net premiums written increased 1.7% to $397.7 million. Commercial net premiums written grew 13.1% for the first half, while personal lines fell 9.3%.
- Underwriting: The GAAP combined ratio improved to 102.0% in Q2 from 105.6%, and to 100.7% for the first half from 112.4%. On a statutory basis, the first-half combined ratio improved to 98.9% from 111.0%. Commercial lines performed better than personal lines; the first-half statutory ratios were 94.6% and 103.1%, respectively.
- Losses and reserves: First-half net losses and loss expenses were $254.6 million, down from $292.3 million. The company reported $6.9 million of favorable prior-year reserve development, compared with $26.2 million adverse development in 2018. Q2 weather losses were $17.0 million; first-half weather losses were $26.7 million.
- Investments and unusual earnings items: Net investment income increased to $7.3 million in Q2 and $14.3 million for the first half. First-half net investment gains were $19.7 million, including a $12.7 million gain on the sale of Donegal Financial Services Corporation (DFSC) and equity-security gains. The DFSC sale closed in March 2019; Donegal received a $14.1 million dividend and sale consideration including cash and Northwest Bancshares stock, which it sold during the quarter.
- Balance sheet and liquidity: At June 30, total assets were $1.90 billion, investments $1.08 billion, cash $35.9 million and stockholders’ equity $437.9 million. Total liabilities were $1.46 billion. Cash declined from $52.6 million at year-end 2018.
- Cash flow and debt: First-half operating cash flow was $21.2 million, down from $36.1 million. Investing activities used $6.6 million and financing activities used $31.2 million; cash dividends paid were $8.0 million and $25.0 million of credit borrowings were repaid. At quarter-end, $35.0 million of FHLB advances remained outstanding at 2.76%; the separate M&T revolving line had no borrowings and provided up to $30.0 million. Subordinated debentures were $5.0 million, making reported borrowings and debentures $40.0 million in total.
Material changes versus the prior comparable period
- Profitability rebounded from a Q2 2018 loss and first-half 2018 loss, helped by lower incurred losses, improved combined ratios and favorable reserve development.
- First-half earnings included the non-recurring DFSC sale gain; investment gains rose to $19.7 million from $0.6 million in the prior-year period.
- Commercial premiums expanded while personal lines contracted. Management attributed the personal decline to underwriting actions, renewal pricing and non-renewals of unprofitable business in seven states beginning in February 2019.
- The company’s first-half operating cash flow was lower year over year, despite the improved net income.
Outlook, commentary and risks
- The filing gives no specific earnings or premium guidance. Management cautions that first-half results are not necessarily indicative of full-year 2019 results.
- Management cited commercial rate increases, new commercial accounts and lower reinsurance premiums as growth drivers. Personal-line underwriting actions are intended to curb unprofitable growth and improve pricing.
- Loss reserving remains a major uncertainty. Management noted rising average claim severity, litigation trends and slower settlement of litigated claims, as well as longer delays in reporting liability claims. A 1% change in net loss and loss expense reserves would affect pre-tax results by approximately $4.9 million.
- Property catastrophe exposure is partly protected by a combined third-party reinsurance program effective January 1, 2019. Catastrophe coverage has a $10 million retention and covers aggregate losses up to $190 million per occurrence, subject to the stated terms and deductible; other excess-of-loss and facultative protections also apply.
- Other stated risks include severe weather, reinsurance availability and collectability, interest rates, competition, regulatory and legal changes, technology systems and maintaining underwriting profitability. The company reported no material change in disclosed risk factors or market-risk exposure during the period.
- The M&T credit agreement contains financial and insurance-related covenants; the company reported compliance. Insurance-subsidiary dividends are subject to regulatory and statutory-capital restrictions. Approximately $30.9 million was available for distribution to the parent without prior regulatory approval at June 30, 2019.
- Management concluded disclosure controls were effective, and reported no material change in internal control over financial reporting. The filing reported no legal proceedings.
Important facts for investors to verify
- How much of first-half earnings is repeatable after excluding the $12.7 million DFSC gain and equity-security gains?
- Whether commercial-line growth and improved loss ratios persist, and whether personal auto and homeowners underwriting results improve.
- Whether favorable reserve development continues, particularly given claim severity, litigation and reporting-delay risks; monitor reserve changes and reinsurance recoverables.
- How catastrophe losses, reinsurance terms and counterparty collectability affect results and liquidity.
- The use and repayment terms of FHLB advances, availability of the M&T line and regulatory capacity for subsidiary dividends.