Donegal Group Inc. — Q2 2014 Form 10-Q
Business context and period: Property and casualty insurer reporting the three and six months ended June 30, 2014. Its insurance subsidiaries distribute personal and commercial coverage through independent agents; the company also owns 48.2% of Donegal Financial Services Corporation (DFSC). Atlantic States shares pooled insurance results with Donegal Mutual, with an 80%/20% allocation, respectively. Financial statements are unaudited.
Financial results and position
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Net premiums earned | $136.6 million | $127.0 million | $270.1 million | $251.7 million |
| Total revenue | $145.5 million | $135.5 million | $285.8 million | $269.4 million |
| Net income | $1.9 million | $2.6 million | $1.3 million | $9.1 million |
| Class A diluted EPS | $0.07 | $0.10 | $0.05 | $0.35 |
| Operating cash flow | Not separately stated for Q2 | $1.8 million | $16.8 million | |
| Combined ratio | 104.0% | 103.1% | 104.3% | 101.4% |
Net premiums written rose 7.7% in Q2 to $151.4 million and 8.4% for the half to $296.0 million. GAAP underwriting losses were $5.5 million in Q2 and $11.7 million for the half; a combined ratio above 100% indicates underwriting losses. Q2 loss and expense ratios were 71.7% and 31.9%, respectively; first-half ratios were 72.4% and 31.6%.
At June 30, total assets were $1.462 billion, versus $1.385 billion at December 31, 2013; stockholders’ equity was $405.5 million, versus $396.9 million. Cash was $20.6 million, down from $27.6 million at year-end. Investments totaled $819.3 million. Unpaid losses and loss expenses were $526.4 million, including $250.0 million of reinsurance recoverables.
Total borrowings were $60.0 million: $45.0 million under the M&T revolving facility and $15.0 million of FHLB advances. The M&T facility was renewed through July 2017, with $15.0 million of remaining capacity; its outstanding rate was 2.41%. A further $5.0 million subordinated surplus note bears 5.00% interest and requires regulatory approval for repayment and interest payments.
Changes and management commentary
- Revenue growth did not translate into higher earnings: net income fell 26% in Q2 and 86% for the first half. For the half, losses and loss expenses increased to $195.5 million from $175.1 million, while DFSC earnings declined to $0.8 million from $1.8 million.
- Management attributed premium growth to rate increases, increased commercial writings and MICO’s reduction of its external quota-share reinsurance from 30% to 20%, effective January 1, 2014.
- Q2 weather-related losses rose to $11.6 million from $9.4 million; first-half weather losses were $26.9 million versus $15.0 million. Large fire losses in Q2 were $9.3 million versus $5.7 million.
- Prior-year reserve development was unfavorable by approximately $6.0 million in Q2 and $5.6 million for the first half. Management stated it believes reserves are adequate, but estimates may change; a 1% change in net loss reserves would affect pretax results by approximately $2.8 million.
- Operating cash flow declined to $1.8 million from $16.8 million for the first half, primarily due to increased claim payments. Net cash used in investing activities was $7.6 million; net cash used in financing activities was $1.3 million.
- Net investment income decreased slightly, which management attributed primarily to lower average yields. The company reported no investment impairment losses in the first half and considered identified unrealized losses temporary.
Outlook, risks and other items
The filing provides no specific earnings or premium guidance. Management cautioned that first-half results are not necessarily indicative of full-year 2014 results. Principal risks include reserve adequacy and claims severity, weather and catastrophe losses, reinsurance availability and collectability, interest rates, investment valuation and credit risk, competition, legal developments, and regulatory requirements. The filing reports no material change to the risk factors in the 2013 Form 10-K, no legal proceedings, and no material change in internal control; management concluded disclosure controls were effective.
Catastrophe reinsurance generally covers 100% of eligible accumulation losses above a stated retention, generally $5.0 million, after an annual aggregate deductible generally $1.5 million, up to $149.0 million per occurrence. The board declared quarterly dividends on July 17, 2014 of $0.1315 per Class A share and $0.1160 per Class B share, payable August 15.
Important facts for investors to verify
- Whether higher loss ratios and unfavorable reserve development persist, especially in commercial auto, commercial multi-peril and personal auto.
- How much premium growth reflects pricing and new business versus MICO’s reduced reinsurance cession, and the implications for retained risk.
- Reserve adequacy and reinsurance recoverability, including the exposure associated with the Donegal Mutual pooling arrangement.
- Sources and sustainability of earnings, including realized investment gains and DFSC earnings, as well as continued pressure from lower investment yields.
- Liquidity and debt capacity, including compliance with credit-facility covenants and availability of subsidiary dividends subject to insurance regulation.