Donegal Group Inc. — Q3 2012 Form 10-Q
Reporting period: Three and nine months ended September 30, 2012; unaudited. Donegal writes personal and commercial property and casualty insurance through independent agents and also holds a 48.2% interest in Donegal Financial Services Corporation (DFSC).
Financial performance
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Net premiums earned | $120.9 million | $108.5 million | $353.2 million | $317.3 million |
| Total revenues | $130.4 million | $119.2 million | $383.1 million | $347.8 million |
| Net income | $6.8 million | $0.8 million | $16.9 million | $1.3 million |
| Class A EPS | $0.27 | $0.03 | $0.66 diluted | $0.05 diluted |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $13.5 million | $18.1 million |
- Net premiums written rose 11.3% in Q3 to $129.3 million and 10.3% for the first nine months to $381.8 million. Growth reflected rate increases, stronger commercial-line writings and MICO’s reduction in its external quota-share reinsurance from 50% to 40%.
- Q3 underwriting improved: management-reported combined ratio was 99.6%, versus 112.6% a year earlier; the loss ratio fell to 67.9% from 82.4%. For nine months, the combined ratio was 101.5%, versus 109.7%, and the loss ratio was 69.4%, versus 77.8%.
- The filing also presents statutory combined ratios: 97.6% for Q3 and 99.3% for nine months, compared with 110.6% and 106.2%, respectively, in 2011. Statutory and management-reported combined ratios use different accounting bases.
- GAAP underwriting remained loss-making for the first nine months: $5.3 million loss, improved from $30.7 million loss in 2011. Commercial-line underwriting improved, while personal lines continued to report underwriting losses.
- Investment income declined to $4.7 million in Q3 and $14.7 million year to date, primarily because of lower yields despite higher average invested assets. Net realized investment gains were $1.3 million and $5.2 million, respectively, below prior-year comparisons. DFSC earnings increased to $1.3 million for Q3 and $3.6 million year to date.
Financial position, liquidity and capital
- At September 30, total assets were $1.337 billion, total liabilities $933.8 million and stockholders’ equity $402.9 million. Cash was $20.0 million; total investments were $803.4 million.
- Operating cash flow for nine months was $13.5 million, down from $18.1 million. Management attributed the decline primarily to increased claim settlements. Cash increased by $6.8 million during the period.
- The balance sheet reports $49.7 million of line-of-credit borrowings and $20.5 million of subordinated debentures. The company separately disclosed $48.5 million drawn on its $60 million M&T revolving facility, leaving $11.5 million available; the additional $1.2 million was MICO FHLB borrowing, repaid in October. The M&T facility expires in July 2015; the company reported compliance with its covenants at quarter-end.
- Stockholders’ equity increased from $383.5 million at year-end 2011. The company paid $9.1 million in dividends and repurchased shares during the first nine months. A quarterly dividend declared in October was $0.1225 per Class A share and $0.11 per Class B share.
Changes, outlook and risks
- Improved underwriting results primarily reflected lower weather-related losses and reduced reported casualty-claim frequency. However, prior-year reserve development was unfavorable by approximately $2.9 million in Q3 and $5.6 million year to date; the comparable nine-month 2011 period had $2.5 million of favorable development.
- Management stated that interim results are not necessarily indicative of full-year 2012 results. The filing provides no specific earnings or premium guidance.
- Loss-reserve estimates are a key uncertainty. Management estimated that a 1% change in reserves, net of reinsurance, would affect pretax results by approximately $2.5 million. The filing also discusses rising average claim severity, litigation trends, medical costs and slower settlements.
- Catastrophe coverage increased from $130 million to $145 million per occurrence effective June 8, 2012, above generally stated retentions. Reinsurance recoverability and catastrophic weather remain risks.
- Management considered investment losses temporary and reported no other-than-temporary impairment charges in the first nine months. The portfolio had $44.1 million of gross unrealized gains and $0.4 million of gross unrealized losses on available-for-sale securities at quarter-end; management notes fair-value estimates may differ from realizable proceeds, particularly in less liquid markets.
- The 2011 comparison includes a $4.9 million income-tax benefit, while 2012 reported tax expense; this contributes to the sharp year-over-year net-income comparison. The company also recorded a $1.8 million immaterial prior-period correction, reclassifying amounts between accumulated other comprehensive income and retained earnings, with no change to total equity.
- No material changes to disclosed risk factors were reported; no legal proceedings or defaults were reported. Disclosure controls were judged effective.
Most important facts for investors to verify
- Whether premium growth and improved combined ratios persist, especially given ongoing personal-lines underwriting losses.
- Reserve adequacy and subsequent development, particularly for workers’ compensation and personal automobile claims.
- The sources and sustainability of earnings, including weather-loss variability, investment yields and DFSC’s contribution.
- Reinsurance protection, counterparty collectability and the company’s remaining borrowing capacity and covenant headroom.
- The reconciliation of the reported $49.7 million balance-sheet line-of-credit borrowings with the $48.5 million M&T draw and $1.2 million FHLB borrowing disclosed separately.