DONEGAL GROUP INC annual report, FY2020

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Donegal Group Inc. — 2020 Form 10-K

Business context and reporting period

Annual report for the fiscal year ended December 31, 2020; fourth-quarter figures are also noted below. Donegal Group is an insurance holding company whose subsidiaries write personal and commercial property and casualty insurance, primarily through independent agents in 24 states. Donegal Mutual controls approximately 71% of combined voting power and participates in significant pooling and other related-party arrangements.

Financial performance and position

  • Revenue: Total revenue was $777.8 million, down 4.3% from $812.5 million in 2019. Net premiums earned fell 1.9% to $742.0 million; net premiums written fell 1.4% to $742.1 million.
  • Profit: Net income increased to $52.8 million from $47.2 million. Diluted EPS was $1.83 for Class A and $1.65 for Class B. Fourth-quarter net income was $14.6 million, with diluted EPS of $0.49 and $0.44, respectively.
  • Underwriting and margins: The combined ratio improved to 96.0% from 99.5%; below 100% generally indicates underwriting profit. The loss ratio fell to 62.0% from 67.0%, while the expense ratio rose to 33.0% from 31.3%. Commercial and personal lines combined ratios under statutory accounting were 97.8% and 92.4%, respectively.
  • Cash flow: Operating cash flow was $101.1 million, versus $76.4 million in 2019. Cash at year-end was $103.1 million.
  • Investments and liquidity: Investments totaled $1.221 billion, up from $1.111 billion; total assets were $2.161 billion. Nearly all debt securities were investment grade. The company had a $20 million unused unsecured credit line and reported $51.4 million of ordinary dividends available from insurance subsidiaries in 2021 without prior regulatory approval.
  • Debt and equity: Debt obligations were $90.0 million, compared with $40.0 million a year earlier: $50 million of FHLB funding due March 2021, $35 million due August 2024, and $5 million of subordinated debentures. Stockholders’ equity rose to $517.8 million from $451.0 million; book value per share increased to $17.13 from $15.67.

Material changes versus the prior period

  • Lower 2019–2020 personal-lines business drove the decrease in premiums: personal net premiums written fell 9.1%, while commercial lines grew 5.2%. Commercial business increased to 57.4% of net premiums written, from 53.8%.
  • Lower claims, especially in personal auto, helped improve underwriting results. Management attributed the personal-auto loss-ratio improvement partly to reduced driving and traffic during the pandemic and to prior underwriting actions.
  • Investment gains declined to $2.8 million from $22.0 million in 2019. The prior-year figure included a $12.7 million gain on the sale of Donegal Financial Services Corporation and $8.9 million of equity-security gains.
  • Favorable prior-year reserve development was $12.9 million in both 2020 and 2019; 2018 had $35.6 million of unfavorable development.

Outlook, commentary, risks and unusual items

  • Management emphasizes disciplined underwriting, rate adequacy, profitable commercial-lines growth, expense control, technology investment and possible acquisitions. The filing provides no quantified earnings or premium guidance.
  • Weather-related losses were $51.4 million in 2020, up from $46.1 million in 2019. Management cited continuing uncertainty from casualty severity, litigation and social inflation, and pandemic-related shifts in claims reporting and settlement patterns.
  • Net reserves for unpaid losses and loss expenses were $557.2 million; gross reserves were $962.0 million, with $404.8 million of reinsurance recoverables. A 1% change in net reserves would affect pretax results by approximately $5.6 million. The external auditor identified reserve estimation as a critical audit matter.
  • Technology modernization is a multi-year project. The first release entered service in 2020; further implementation is planned, including phased personal-lines rollout beginning in the third quarter of 2021. Associated costs and execution are risks.
  • COVID-19 created uncertainty around demand, claims, investment income and asset values. The company also flagged catastrophe exposure, reinsurance collectability and availability, low interest rates, and regulatory constraints on subsidiary dividends.
  • Related-party governance merits attention: Donegal Mutual controls the company, and the pooling agreement allocates 80% of pooled business to Atlantic States. The filing reports $153.9 million in 2020 charges from Donegal Mutual for services to insurance subsidiaries.
  • The company recorded a $1.6 million tax benefit from the CARES Act carryback of 2018 net operating losses. The auditor issued unqualified opinions on the financial statements and internal controls; management also reported effective internal controls.

Important facts for investors to verify

  • Whether the improvement in loss experience persists as driving activity and claims patterns normalize, and how casualty severity develops.
  • Whether recorded reserves and reinsurance recoverables prove adequate and collectible; review reserve development by line and accident year.
  • Repayment of the $50 million FHLB advance due March 2021 and the company’s subsequent debt and liquidity position.
  • Execution, timing and costs of the remaining technology modernization releases, including the planned 2021 personal-lines phase.
  • Terms and fairness of pooling, service-cost allocations and other transactions with controlling stockholder Donegal Mutual, alongside subsidiary dividend capacity.