Donegal Group Inc. — Q3 2016 Form 10-Q
Business context and period. Property-and-casualty insurer writing personal and commercial lines through independent agents, with an equity-method investment in Donegal Financial Services Corporation (DFSC). The unaudited quarter and nine months ended September 30, 2016 are compared with the same 2015 periods. Atlantic States shares pooled underwriting results 80/20 with Donegal Mutual.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net premiums earned | $166.8m | $153.1m | $487.2m | $450.1m |
| Total revenue | $175.3m | $159.8m | $511.2m | $472.6m |
| Income before tax | $6.4m | $7.0m | $34.5m | $24.4m |
| Net income | $4.8m | $5.7m | $25.2m | $19.0m |
| Diluted EPS, Class A | $0.18 | $0.21 | $0.95 | $0.69 |
| Statutory combined ratio | 100.8% | 99.5% | 97.3% | 99.0% |
- Net premiums written rose 8.2% in Q3 to $171.9m and 8.1% year to date to $520.3m, driven by rate increases and commercial-lines growth, including new accounts. Commercial-lines written premiums grew 12.0% in Q3 and 12.1% year to date; personal lines grew 5.6% and 5.0%.
- Q3 net income fell 15% year over year despite higher premiums. The combined ratio exceeded 100%, with the expense ratio rising to 33.5% from 32.1%; management cited higher underwriting incentive costs. Q3 loss ratio was 66.6%, versus 66.8%.
- Year-to-date earnings increased 33%, supported by improved underwriting: the statutory combined ratio improved to 97.3% from 99.0%. Commercial-lines underwriting income was $14.1m versus $6.4m; personal lines remained loss-making at $7.0m versus $6.5m.
- Q3 realized investment gains were $1.0m, versus a $0.8m loss in 2015; year-to-date gains were $2.2m versus $0.7m. Net investment income rose to $5.6m for Q3 and $16.5m year to date. Equity earnings from DFSC declined to $0.36m for Q3 and $0.70m year to date.
Financial position, cash flow and liquidity
- At September 30, total assets were $1.624bn, up from $1.538bn at year-end 2015; stockholders’ equity was $444.0m, up from $408.4m. Cash was $32.1m, and investments totaled $943.8m.
- Operating cash flow was $46.3m for the first nine months, compared with $48.5m in 2015. Investing activities used $34.3m; financing activities used $8.0m. Cash increased $4.0m to $32.1m.
- Borrowings totaled $74.0m: $39.0m under the renewed $60m M&T revolving credit facility (2.78% rate; expires July 2019) and $35.0m of Atlantic States FHLB advances (0.59%). The M&T facility had $21m remaining capacity. The company reported compliance with its covenants.
- Unpaid losses and loss expenses were $594.3m, including $254.2m of reinsurance recoverables; net reserves were $340.0m. Unearned premiums were $476.4m. The company reported $26.3m of 2016 subsidiary dividends available without prior regulatory approval.
- Available-for-sale investments had $21.1m of gross unrealized gains and $0.6m of gross unrealized losses. Accumulated other comprehensive income increased to $6.3m from $0.8m at year-end, reflecting investment valuation changes.
Management commentary, outlook and risks
- No earnings or premium guidance was provided. Management cautioned that nine-month results are not necessarily indicative of full-year 2016 results.
- Prior-year reserve development was favorable by approximately $1.6m in Q3 2016, versus $1.5m unfavorable in Q3 2015; year-to-date development was unfavorable by $2.1m, improved from $4.8m unfavorable in 2015. Management considers reserves adequate but emphasizes estimation uncertainty; a 1% change in net reserve estimates would affect pretax results by approximately $3.4m.
- Management cited gradually rising average claim severity, litigation trends, medical costs, and slower settlement of litigated claims. Other identified risks include catastrophic weather, reinsurance availability and cost, interest rates, competition, legal or regulatory changes, and investment credit and market risk.
- The company reported no investment impairment losses in either nine-month comparison period and considered unrealized losses on 55 debt securities and seven equity securities temporary. Catastrophe reinsurance generally covers losses above a $5m retention, subject to a $1m annual aggregate deductible, up to $170m per occurrence.
- The board declared a quarterly dividend on October 20, 2016 of $0.1375 per Class A share and $0.12 per Class B share, payable November 15, 2016. No material changes to risk factors, market-risk exposure, or internal controls were reported; no legal proceedings were reported.
Investor verification priorities
- Review whether commercial-lines growth and pricing are sufficient to offset weak personal-lines underwriting; Q3’s statutory combined ratio was 100.8%.
- Track loss-reserve development, especially workers’ compensation and claim severity, and assess reinsurance recoverability and counterparty exposure.
- Confirm the sustainability of earnings excluding realized investment gains, and monitor the reduced contribution from DFSC.
- Check borrowing levels, facility terms, subsidiary dividend capacity, and regulatory capital constraints.
- Assess the investment portfolio’s interest-rate, credit, valuation and catastrophe-related exposure, including unrealized gains and losses.