Donegal Group Inc. — 2017 Second-Quarter Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017. 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 2017 | Q2 2016 | First half 2017 | First half 2016 |
|---|---|---|---|---|
| Net premiums earned | $175.0 million | $161.9 million | $344.2 million | $320.4 million |
| Total revenues | $183.6 million | $169.8 million | $362.6 million | $335.9 million |
| Net income (loss) | $(2.3) million | $8.6 million | $2.8 million | $20.4 million |
| Diluted EPS, Class A | $(0.08) | $0.32 | $0.10 | $0.78 |
| Statutory combined ratio | 106.4% | 97.0% | 103.9% | 95.5% |
| Operating cash flow | Not separately stated | Not separately stated | $44.4 million | $27.5 million |
Net premiums written increased 7.0% in Q2 to $190.8 million and 7.7% in the first half to $375.3 million. Management attributed growth to rate increases and new accounts across personal and commercial lines. Investment income rose to $5.6 million in Q2 and $11.4 million in the first half; realized gains were $1.1 million and $3.6 million, respectively.
Material changes and drivers
- Underwriting results deteriorated: the statutory combined ratio exceeded 100% in both periods, indicating an underwriting loss. The first-half GAAP underwriting loss was $13.4 million, versus underwriting income of $14.3 million a year earlier.
- Losses and loss expenses increased 24% in Q2 and 22% in the first half. Weather-related losses were $20.1 million in Q2 versus $11.2 million, and $34.3 million in the first half versus $18.1 million.
- Prior-year reserve development was unfavorable by approximately $5.8 million in Q2 and $8.4 million in the first half, versus $3.7 million in the comparable prior-year periods. Development principally reflected higher-than-expected severity in commercial multi-peril and commercial automobile liability, partly offset by workers’ compensation.
- Personal-lines underwriting was particularly weak: its statutory combined ratio was 114.1% in Q2 and 109.2% in the first half. Commercial-lines ratios were 92.8% and 93.6%, respectively.
- First-half net income fell despite higher premiums and investment gains, as underwriting losses rose. The effective tax rate was 16.3% for the first half, compared with 27.2% in 2016; management cited tax-exempt interest income as a larger share of pretax income.
Financial position, liquidity and debt
- At June 30, total assets were $1.70 billion, total investments $984.9 million, cash $28.8 million and stockholders’ equity $443.1 million. Assets increased from $1.62 billion at year-end 2016.
- Unpaid losses and loss expenses were $643.2 million, including $272.9 million of reinsurance recoverables; unearned premiums were $509.8 million.
- Total borrowings were $69.0 million: $34.0 million under the M&T revolving line and $35.0 million of Atlantic States advances from the Federal Home Loan Bank of Pittsburgh. M&T availability was $26.0 million; its rate was 3.48%, while the FHLB advances carried a 1.25% rate.
- Donegal renewed its $60 million unsecured M&T credit facility in July 2017, after quarter-end; it expires in July 2020. The company reported compliance with its covenants.
- First-half cash increased $4.3 million to $28.8 million. Investing activities used $36.1 million and financing activities used $4.1 million, including $7.4 million of dividends paid.
- Insurance subsidiaries had approximately $33.4 million available for distribution to the parent in 2017 without prior regulatory approval, subject to regulatory and statutory limits. A quarterly dividend was declared July 20, 2017: $0.14 per Class A share and $0.1225 per Class B share.
Outlook, risks and unusual items
- The filing provides no numerical full-year earnings or premium guidance. Management cautions that interim results are not necessarily indicative of full-year results.
- Key uncertainties include severe weather, loss-reserve adequacy, claim severity and litigation trends, reinsurance availability and cost, competition, interest rates, regulation, and economic conditions. Management notes that a 1% change in net loss reserves would affect pretax results by approximately $3.7 million.
- The filing describes a May 2017 merger of Mountain States Mutual into Donegal Mutual. Mountain States’ Southwestern operations are excluded from Donegal Group’s consolidated results and, for an indefinite period, from the Atlantic States pooling agreement.
- Donegal reported no material investment impairment losses in the first half. It considered unrealized losses on 207 debt securities and eight equity securities temporary.
- No material change in disclosed risk factors, no legal proceedings reported, and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether weather losses and adverse prior-year reserve development persist, and how subsequent actuarial estimates affect reserves.
- Whether premium growth and pricing actions improve underwriting profitability, particularly in personal auto and homeowners and commercial auto and multi-peril.
- The composition and recoverability of reinsurance receivables, and the effect of the pooling arrangement with Donegal Mutual.
- Borrowing terms, covenant headroom, and the effect of variable interest rates on financing costs.
- The effect of the Mountain States integration and its exclusion from Donegal Group’s reported results.