Donegal Group Inc. — 2021 Form 10-K
Business context and reporting period. This annual report covers the fiscal year ended December 31, 2021. Donegal Group is a property and casualty insurance holding company operating through insurance subsidiaries in 24 states, primarily via independent agents. Its main business lines are commercial auto, commercial multi-peril, workers’ compensation, personal auto and homeowners. Donegal Mutual controls approximately 70% of combined voting power, and Donegal Group’s largest subsidiary, Atlantic States, participates in an 80%/20% underwriting pool with Donegal Mutual.
Financial performance and position
| Metric | 2021 | 2020 |
|---|---|---|
| Total revenue | $816.5 million | $777.8 million |
| Net premiums earned | $776.0 million | $742.0 million |
| Net premiums written | $804.3 million | $742.1 million |
| Net investment income | $31.1 million | $29.5 million |
| Net income | $25.3 million | $52.8 million |
| Diluted EPS, Class A / Class B | $0.83 / $0.74 | $1.83 / $1.65 |
| Combined ratio | 101.0% | 96.0% |
| Operating cash flow | $76.7 million | $101.1 million |
Net income fell 52% year over year. The 2021 combined ratio above 100% indicates an underwriting loss; GAAP underwriting loss was $8.0 million. The loss ratio rose to 67.1% from 62.0%, while the expense ratio edged up to 33.3% from 33.0%. The company recorded $6.5 million of net investment gains, primarily related to unrealized equity-security gains.
At December 31, 2021, total assets were $2.255 billion, stockholders’ equity was $531.0 million and investments totaled $1.277 billion. Cash was $57.7 million. Borrowings were $35.0 million, consisting of an FHLB advance due in August 2024 at 1.74%; the company had no borrowings on its $20.0 million M&T line of credit. Its insurance subsidiaries had approximately $47.3 million available for ordinary dividends to the parent in 2022 without prior regulatory approval. The company paid $19.6 million in stockholder dividends in 2021.
Material changes versus 2020
- Net premiums written increased 8.4%. Commercial lines rose 17.8% to $501.8 million, while personal lines fell 4.3% to $302.5 million.
- Commercial lines grew partly because business from the Mountain States Insurance Group entered the underwriting pool for policies effective in 2021. This change affects comparability with 2020.
- Commercial lines statutory underwriting results weakened to a $35.2 million loss from a $0.9 million loss; the commercial combined ratio was 104.9%, with commercial multi-peril at 114.1% and commercial auto at 108.6%. Personal lines statutory underwriting income declined to $17.2 million from $31.8 million.
- Higher claim frequency as driving activity returned toward pre-pandemic levels, increased claim severity and property/fire losses contributed to higher losses. Weather-related losses declined to $45.3 million from $51.4 million, but large fire losses rose to $45.6 million from $22.8 million.
- Favorable prior-year reserve development increased to $31.2 million from $12.9 million, benefiting 2021 results. This release was primarily associated with personal auto, workers’ compensation and commercial auto.
- Net cash from operations declined, and cash and short-term investments were lower. The company repaid a $50.0 million FHLB advance that matured in March 2021 and repaid MICO’s $5.0 million surplus note.
Outlook, management commentary and risks
Management said disciplined underwriting, modernization, analytics and profitable growth remain priorities, and stated that the business is positioned for 2022 and beyond despite challenging market conditions, rising casualty severity and adverse weather. No specific earnings or premium guidance was provided. New personal-lines products began a phased rollout in late 2021; further rollout across seven states was planned during 2022, with a goal of modest personal-lines premium growth after completion. The next planned systems release, covering three commercial lines, was scheduled to begin in the first half of 2023. Management is placing less emphasis on acquisitions while these technology and analytics initiatives continue.
- Claims and reserves: The $1.078 billion gross loss and loss expense liability is a significant estimate. Management identified inflation, supply-chain constraints, higher vehicle and repair costs, social inflation, litigation and slower claim settlements as sources of uncertainty. A 1% change in net reserves would affect pretax results by approximately $6.3 million. The reserve estimate was also the auditor’s critical audit matter.
- Catastrophes and climate: Severe weather, geographic concentration and uncertainty in catastrophe models or reinsurance availability could increase losses beyond pricing or coverage assumptions.
- Reinsurance and affiliates: Reinsurance does not remove the insurers’ primary obligation to policyholders; third-party reinsurer failure could create losses. Related-party pooling, service allocations and reinsurance are material. Allocated expenses from Donegal Mutual were $186.6 million in 2021, up from $153.9 million.
- Changes effective 2022: Donegal Mutual’s 25% quota-share agreement with MICO and 100% quota-share agreement for certain Peninsula workers’ compensation business ended for new policies on January 1, 2022 and are running off. MICO and Peninsula will retain 100% of the applicable new business, changing their net exposures.
- Michigan policyholder refunds: The Michigan Catastrophic Claims Association refund resulted in an $18.1 million receivable and matching payable at year-end; refunds were expected in the first half of 2022.
- Other risks and governance: The filing cites competition, rate adequacy, technology execution and cyber risk, regulatory limits on subsidiary dividends, and Donegal Mutual’s voting control and potential conflicts of interest. The company reported no material adverse effect expected from routine litigation.
KPMG issued unqualified opinions on the consolidated financial statements and internal control over financial reporting; management also concluded disclosure controls were effective. No off-balance-sheet arrangements were reported.
Investor verification priorities
- Track loss trends and reserve development by line, especially commercial multi-peril, commercial auto and workers’ compensation; assess how much earnings depended on the $31.2 million favorable reserve release.
- Separate organic premium growth from the Mountain States pool inclusion and assess profitability of the expanded commercial book.
- Monitor the personal-lines product rollout, premium retention, pricing adequacy and technology implementation costs and milestones.
- Review the post-2021 MICO and Peninsula quota-share changes, affiliate expense allocations and the fairness and effect of the pooling arrangements.
- Confirm collection of the MCCA refund receivable and payment of policyholder refunds, and monitor reinsurance recoverables and counterparty strength.
- Assess liquidity, debt repayment capacity, dividend dependence on regulated subsidiaries, and the effects of Donegal Mutual’s voting control on minority shareholders.