Donegal Group Inc. — Q3 2013 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2013. Unaudited consolidated results. Donegal writes personal and commercial property and casualty insurance through independent agents and owns 48.2% of Donegal Financial Services Corporation (DFSC).
Key financial results
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Net premiums earned | $130.6 million | $120.9 million | $382.3 million | $353.2 million |
| Total revenues | $138.3 million | $130.4 million | $407.7 million | $383.1 million |
| Income before tax | $9.5 million | $8.9 million | $20.5 million | $20.8 million |
| Net income | $7.7 million | $6.8 million | $16.8 million | $16.9 million |
| Class A diluted EPS | $0.30 | $0.27 | $0.65 | $0.66 |
| Class B EPS | $0.27 | $0.25 | $0.60 | $0.61 |
- Q3 insurance combined ratio was 97.6%, compared with 99.6% a year earlier; the nine-month ratio was 100.1%, versus 101.5%. A ratio below 100% generally indicates underwriting profit. The separately reported statutory combined ratios were 96.0% and 98.2% for Q3 and nine months 2013, respectively.
- Net premiums written rose 5.7% in Q3 to $136.7 million and 7.3% year to date to $409.7 million. Growth reflected rate increases, commercial-lines expansion and a reduction in MICO’s external quota-share reinsurance from 40% to 30% effective January 1, 2013.
- Operating cash flow was $32.5 million for the first nine months, versus $13.5 million a year earlier. Cash at September 30 was $22.8 million.
- Total assets were $1.390 billion, total investments $788.4 million, and stockholders’ equity $389.1 million at September 30. Equity was down from $400.0 million at year-end 2012, primarily alongside a $27.5 million nine-month other comprehensive loss from investment valuation changes.
- Borrowings under lines of credit totaled $64.5 million: $49.5 million under the M&T facility and $15.0 million of FHLB advances. The M&T facility had $10.5 million of remaining availability. The balance sheet also reported $5.0 million of subordinated debentures; the company prepaid $15.5 million of other subordinated debentures during Q1.
Material changes and management commentary
- Q3 net income increased year over year, while nine-month net income was slightly lower. Premium growth and improved personal-lines results supported underwriting performance, but commercial-lines loss ratios worsened year to date.
- Q3 loss ratio improved to 65.0% from 67.9%, helped by less severe weather and fewer large fire losses in personal lines. Nine-month loss ratio improved to 68.0% from 69.4%; commercial-lines loss ratio increased to 69.0% from 62.9%, while personal-lines loss ratio declined to 67.7% from 73.4%.
- Unfavorable prior-year reserve development was approximately $3.1 million in Q3 and $9.6 million for the first nine months, compared with $2.9 million and $5.6 million in the respective 2012 periods. Management considered reserves adequate but emphasized that ultimate claim costs may differ from estimates.
- Investment income declined to $4.6 million for Q3 and $14.1 million year to date, mainly due to lower average yields. Realized investment gains also declined year over year. DFSC earnings fell to $0.7 million in Q3 and $2.5 million year to date, partly reflecting lower acquisition-accounting benefits and, year to date, fewer realized investment gains.
- Available-for-sale investments had $17.8 million of gross unrealized losses at September 30. Management attributed substantially all fixed-maturity unrealized losses to higher market interest rates, considered the declines temporary and recorded no investment impairment losses in the first nine months.
Liquidity, capital actions and outlook
- The company describes operating cash flows and marketable investments as its primary liquidity sources and uses a maturity-laddered fixed-income portfolio. Insurance subsidiaries paid $10.0 million in dividends to Donegal during the first nine months; approximately $19.2 million remained available for distribution in 2013 without prior regulatory approval, subject to applicable constraints.
- The M&T revolving credit agreement was renewed in June 2013 and expires in July 2016. The company reported compliance with its covenants. Borrowings carry variable rates; management estimated annual interest cost of about $1.2 million on line-of-credit borrowings at period-end rates.
- The board authorized a new program in July to repurchase up to 500,000 additional Class A shares; none were repurchased under that program in the reported nine-month period. On October 17, 2013, the board declared quarterly dividends of 12.75 cents per Class A share and 11.50 cents per Class B share.
- No specific earnings or revenue guidance was provided. The filing cautions that nine-month results are not necessarily indicative of full-year 2013 results. Risks include reserve uncertainty, severe weather, reinsurance availability and collectability, interest rates, competition, economic conditions, and legal and regulatory developments. The filing reported no material change in previously disclosed risk factors and no legal proceedings.
Most important facts for investors to verify
- Whether reserve development continues, especially in commercial automobile, personal automobile and workers’ compensation; a 1% change in estimated net loss reserves would affect pretax results by approximately $2.7 million.
- Whether commercial-lines pricing and underwriting performance offset the year-to-date deterioration in commercial loss ratios.
- The size and duration of unrealized investment losses, sensitivity to interest rates, and continued absence of credit impairments.
- Availability and cost of reinsurance, and the collectability of reinsurance recoverables; gross unpaid losses were $496.5 million, including $229.8 million of reinsurance recoverables.
- Use of the credit facilities, compliance with covenants and insurance-subsidiary capacity to pay dividends to the parent.