Donegal Group Inc. — Q2 2020 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2020. Donegal writes property and casualty insurance through independent agents, principally personal auto and homeowners and commercial auto, commercial multi-peril and workers’ compensation. Its insurance operations share a pooling arrangement with Donegal Mutual.
Financial performance
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Total revenue | $198.9 million | $198.8 million | $383.8 million | $413.5 million |
| Net premiums earned | $184.4 million | $188.8 million | $371.6 million | $376.8 million |
| Net income | $22.7 million | $4.8 million | $26.4 million | $27.8 million |
| Class A diluted EPS | $0.79 | $0.17 | $0.92 | $0.99 |
| GAAP combined ratio | 92.3% | 102.0% | 94.7% | 100.7% |
| Operating cash flow | Not presented separately | Not presented separately | $48.0 million | $21.2 million |
- Q2 profitability: Net income rose sharply year over year as incurred losses fell and investment gains increased. Q2 net investment gains were $6.5 million versus $1.6 million a year earlier, mainly reflecting unrealized equity gains as markets rebounded from March.
- First-half performance: Net income declined despite lower losses and a better combined ratio, principally because investment results shifted from $19.7 million of gains in 2019 to $4.2 million of losses in 2020. The prior-year period included a $12.7 million gain on the sale of Donegal Financial Services Corporation (DFSC).
- Underwriting and growth: Q2 net premiums written fell 2.1% to $193.7 million; first-half written premiums fell 1.5% to $391.9 million. Commercial written premiums grew 4.0% in Q2 and 5.6% in the first half, while personal lines declined 8.7% and 9.9%, respectively. Management attributed the personal-lines declines mainly to deliberate underwriting actions and net attrition.
- Loss trends: Lower personal-auto claim frequency during COVID-related reductions in driving contributed to lower loss ratios. Q2 weather losses were $18.7 million, above the prior five-year Q2 average of $15.1 million. Favorable prior-year reserve development was $6.6 million in Q2 and $10.9 million in the first half.
- Expenses and margins: The GAAP expense ratio increased to 34.3% in Q2 from 31.3%, and to 33.8% in the first half from 32.0%. Management cited technology costs, agent growth and incentive costs, and reserves for potentially uncollectible premiums. The statutory combined ratio was 91.0% in Q2 and 93.3% for the first half.
Financial position, cash flow and liquidity
- At June 30, total assets were $2.10 billion, investments $1.19 billion, cash $71.8 million and stockholders’ equity $487.9 million. Equity increased from $451.0 million at year-end 2019, including higher accumulated other comprehensive income from investment valuation gains.
- First-half operating cash flow was $48.0 million; investing activities used $71.2 million and financing activities provided $45.7 million. Cash increased by $22.5 million to $71.8 million.
- Borrowings included $85.0 million of Federal Home Loan Bank advances at June 30: $50.0 million due March 2021 at 0.83% and $35.0 million due August 2024 at 1.74%. The company also had $5.0 million of subordinated debentures bearing 5.00%. It had no M&T line borrowings at quarter-end; a new $20.0 million unsecured demand facility took effect August 1, 2020.
- Atlantic States had $14.8 million of additional FHLB borrowing capacity reported as available. Insurance-subsidiary dividends available for distribution without prior regulatory approval in 2020 totaled approximately $30.5 million, subject to applicable restrictions.
Outlook, risks and unusual items
- The filing provides no numerical earnings, premium-growth or combined-ratio guidance. Management says first-half results are not necessarily indicative of full-year results.
- COVID-19 creates significant uncertainty. Risks cited include reduced insurance demand and premium collections, potential claims and litigation over coverage, possible regulatory or legal changes to coverage or premium rules, investment-value declines, lower reinvestment yields, and weaker issuer credit quality.
- Management recorded $2.0 million in first-half reserves for potential credit losses on uncollectible premiums related to COVID-19 disruption. The CARES Act also produced a $1.6 million first-quarter tax benefit related to carrying back 2018 net operating losses.
- Loss reserving remains an inherently uncertain estimate. Management reported that each 1% change in net loss and loss expense reserves would affect pretax results by approximately $5.3 million. Longer bodily-injury claim settlement periods, rising severity and litigation trends are additional concerns.
- The board declared post-quarter dividends of $0.15 per Class A share and $0.1325 per Class B share, payable August 17, 2020.
Important facts for investors to verify
- Whether reduced personal-auto claim frequency and favorable reserve development persist as driving activity and claims experience normalize.
- Whether personal-lines premium attrition, commercial-lines growth and rate increases support sustainable underwriting profitability.
- How COVID-related coverage disputes, premium collectability and the $2.0 million credit-loss reserve evolve.
- Investment portfolio performance and sensitivity to market prices, credit deterioration and lower reinvestment yields; Q2 gains were largely unrealized equity gains.
- Reserve adequacy, FHLB debt repayment and continued access to liquidity, including regulatory limits on insurance-subsidiary dividends.