Donegal Group Inc. — Q3 2017 Form 10-Q
Reporting period: Three and nine months ended September 30, 2017; balance sheet compared with December 31, 2016. 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 | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net premiums earned | $177.3 million | $166.8 million | $521.5 million | $487.2 million |
| Total revenues | $185.7 million | $175.3 million | $548.3 million | $511.2 million |
| Net income | $7.1 million | $4.8 million | $9.9 million | $25.2 million |
| Diluted EPS, Class A | $0.26 | $0.18 | $0.36 | $0.95 |
| Operating cash flow | Not provided by quarter | Not provided by quarter | $62.7 million | $46.3 million |
- Q3 net premiums earned increased 6.3% year over year; nine-month premiums increased 7.0%. Net premiums written rose 6.1% for Q3 and 7.2% for the nine months, attributed to rate increases and new business.
- Net income rose in Q3, but fell substantially for the nine-month period. Nine-month underwriting results weakened and prior-year realized investment gains were lower; higher realized gains in 2017 partly offset underwriting pressure. The effective tax rate fell to 16.4% from 26.8%, principally reflecting a larger share of tax-exempt interest income.
- Insurance combined ratio was 99.6% in Q3 versus 100.8% a year earlier, but 102.4% for the nine months versus 97.3%. Below 100% generally indicates underwriting profit. Statutory combined ratios were 98.2% for Q3 and 100.8% year to date.
- Q3 loss ratio decreased to 64.5% from 66.6%; nine-month loss ratio increased to 68.4% from 63.6%, primarily because weather-related losses rose to $53.0 million from $29.8 million. Q3 had approximately $3.4 million of favorable prior-year reserve development; the nine-month period had approximately $5.0 million unfavorable development.
- For the nine months, commercial lines statutory combined ratio was 91.8%, while personal lines was 108.2%. Commercial automobile and personal homeowners results merit attention; their respective nine-month combined ratios were 110.5% and 115.2%.
Financial position, liquidity and debt
- At September 30, 2017, total assets were $1.719 billion, investments $998.8 million, cash $31.5 million, and stockholders’ equity $448.7 million. At year-end 2016, assets were $1.623 billion and equity $438.6 million.
- Unpaid losses and loss expenses were $644.4 million, including $275.4 million of reinsurance recoverable; net reserves were $368.9 million. Unearned premiums were $515.9 million.
- Reported borrowings totaled $69.0 million, unchanged from year-end: $34.0 million under the M&T revolving credit line and $35.0 million of Atlantic States advances from the Federal Home Loan Bank of Pittsburgh. M&T’s rate was 3.49%; the FHLB rate was 1.25%. A $5.0 million subordinated surplus note bears 5.00% and requires regulatory approval for principal or interest payments.
- The renewed M&T facility is a $60.0 million unsecured revolving line expiring July 2020; $26.0 million remained available. The company reported compliance with its covenants. Atlantic States had $1.9 million of additional FHLB borrowing capacity.
- Operating activities generated $62.7 million in cash in the first nine months, compared with $46.3 million in 2016. Cash increased $7.0 million to $31.5 million. Cash dividends paid were $11.1 million. Insurance subsidiaries paid $9.0 million in dividends to the parent, with approximately $29.9 million more available for distribution without prior regulatory approval, subject to applicable restrictions.
Management commentary, outlook and risks
- Management attributed premium growth to pricing and new accounts, investment-income growth to higher average invested assets, and higher DFSC earnings to loan-portfolio growth. No quantified earnings or premium guidance is provided; management cautions that interim results are not necessarily indicative of full-year results.
- Donegal Mutual merged Mountain States Mutual Casualty Company into itself in May 2017. Mountain States insurance operations were excluded from the pooling agreement and are not included in Donegal Group’s consolidated results.
- Reserve estimates are a significant uncertainty. Management states a 1% change in net loss reserves would affect pretax results by approximately $3.7 million. Average claim severity, litigation trends, delayed liability-claim reporting and workers’ compensation trends can affect estimates.
- Reinsurance provides catastrophe coverage generally above a $5.0 million retention and $1.0 million annual aggregate deductible, up to $170.0 million per occurrence. Reinsurance recoverability and exposure to severe weather remain relevant risks.
- Other disclosed risks include investment-market and interest-rate movements, credit risk, competition, regulatory changes, legal developments, reinsurance availability and cost, and the ability to maintain underwriting profitability. Management reported no material change in market-risk exposure or risk factors from the prior annual filing.
- At September 30, unrealized losses on securities were considered temporary; no investment impairment losses were recognized in the first nine months. Most available-for-sale fixed maturities are valued using observable inputs (Level 2), and management reported no material pricing discrepancies.
- The board declared post-quarter dividends of $0.14 per Class A share and $0.1225 per Class B share, payable November 15, 2017.
Important facts for investors to verify
- Whether weather-related losses and the elevated year-to-date combined ratio persist, and whether pricing actions adequately cover loss-cost trends.
- Reserve development by line and accident year, especially severity in commercial multi-peril and commercial automobile liability and the sensitivity of equity to reserve revisions.
- Underlying earnings excluding realized investment gains and the unusually lower effective tax rate; assess sustainability of the Q3 improvement against nine-month results.
- Reinsurance recoverables, counterparty quality, catastrophe protection terms and the financial impact of severe weather events.
- Debt maturities, variable-rate exposure, credit-line covenant headroom, and the amount of dividends subsidiaries can remit under insurance-regulatory limits.
- How the Mountain States business develops outside the pooling arrangement and whether it affects the group’s future growth or risk profile.