Donegal Group Inc. — 2011 Form 10-K
Business context and reporting period. This annual report covers the fiscal year ended December 31, 2011, with quarterly data through Q4. Donegal is a property-and-casualty insurance holding company operating through independent agents in 22 states, primarily in personal auto and homeowners and commercial auto, multi-peril and workers’ compensation. Its largest insurer, Atlantic States, shares substantially all pooled business with Donegal Mutual; Atlantic States has an 80% participation. Donegal Mutual controls approximately 66% of the company’s voting power.
Financial results and key metrics
| Metric | 2011 | 2010 |
|---|---|---|
| Total revenue | $475.0 million | $408.5 million |
| Net premiums earned | $431.5 million | $378.0 million |
| Net premiums written | $454.1 million | $391.5 million |
| Net investment income | $20.9 million | $19.9 million |
| Net realized investment gains | $12.3 million | $4.4 million |
| Pre-tax income (loss) | ($6.7 million) | $9.8 million |
| Net income | $0.45 million | $11.47 million |
| GAAP combined ratio | 110.6% | 104.7% |
| Operating cash flow | $21.1 million | $22.0 million |
- 2011 diluted EPS was $0.02 for Class A and $0.01 for Class B, versus $0.46 and $0.41, respectively, in 2010. Q4 2011 net loss was $0.9 million, compared with Q4 2010 net income of $4.6 million.
- The 2011 loss ratio rose to 78.9% from 72.6%; the expense ratio improved to 31.4% from 32.0%. Underwriting loss was $45.8 million on a GAAP basis; personal lines generated a $40.7 million SAP underwriting loss and commercial lines a $6.6 million loss.
- At year-end, total assets were $1.291 billion, investments $785.3 million, cash $13.2 million and stockholders’ equity $383.5 million. Book value was $15.01 per share, up from $14.86.
- Total debt was $75.0 million: $54.5 million drawn on a $60 million revolving credit facility and $20.5 million in subordinated debentures. The revolving line had $5.5 million of remaining capacity.
Material changes versus the prior comparable period
- Written premiums grew 16.0% and earned premiums 14.2%. Growth reflected the full-year contribution from acquired Michigan Insurance Company (MICO), which contributed $42.8 million of net written premiums, as well as commercial account growth and personal-lines rate increases.
- Underwriting performance deteriorated: the combined ratio increased 5.9 percentage points. Weather-related losses reached $52.6 million, versus $33.0 million in 2010 and a prior five-year average of $23.3 million. Homeowners claims were a key pressure; commercial auto and commercial multi-peril results also weakened.
- Investment gains increased to $12.3 million, including $8.0 million from planned sales of an equity holding after its selling restriction expired. The average investment yield declined to 2.8% from 2.9%.
- Debt increased, primarily to fund the MICO acquisition and the May 2011 merger of Donegal Financial Services Corporation with Union National Financial Corporation. Donegal and Donegal Mutual contributed $20.6 million and $22.1 million, respectively, to DFSC for the merger.
Outlook, risks and unusual items
- Management’s stated underwriting objective is a combined ratio below 100%; it acknowledged that the company did not meet that target in 2010 or 2011. Management cited economic uncertainty, soft insurance pricing and adverse weather, and expressed confidence in its strategy and positioning for 2012, but provided no specific earnings or premium guidance.
- The lender waived the minimum interest-coverage covenant at December 31, 2011. Management expected to meet the requirement by March 31, 2012; the filing states required EBIT of approximately $4.5 million for Q1 2012 and $18.2 million for full-year 2012, assuming no material increase in interest rates.
- Loss reserves are a key estimation risk: net reserves were $243.0 million, and a 1% change in net reserves would affect pre-tax results by approximately $2.4 million. Prior-year reserve development was slightly favorable in 2011 ($0.17 million), versus $2.9 million favorable in 2010.
- Other risks include catastrophe concentration in Pennsylvania, Maryland and Virginia; rising claim severity and medical costs; reinsurance recoverability and availability; low investment yields; dependence on independent agents; and potential conflicts arising from Donegal Mutual’s control and extensive affiliate transactions. The company reported approximately $115.5 million of third-party reinsurance receivables.
- Ordinary-course litigation was not expected to have a material adverse effect. The independent auditor issued an unqualified opinion on the financial statements and internal controls; management also concluded disclosure controls were effective.
Most important facts for investors to verify
- Whether weather losses normalize and pricing actions improve personal-lines results and the combined ratio.
- Whether the company meets its interest-coverage covenant and manages the nearly fully drawn revolving facility.
- Whether reserve estimates, especially workers’ compensation severity and claim trends, develop as assumed.
- Whether growth is profitable after separating acquisition-related premium increases from organic growth.
- How affiliate pooling, reinsurance, expense allocations and Donegal Mutual’s voting control affect public shareholders.