Donegal Group Inc. — Q3 2015 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2015; filed November 6, 2015. Donegal writes personal and commercial property-and-casualty insurance through independent agents and owns 48.2% of Donegal Financial Services Corporation (DFSC). Atlantic States shares pooled underwriting results with Donegal Mutual, 80%/20%, respectively.
Financial performance
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Total revenue | $159.8 million | $149.1 million | $472.6 million | $435.0 million |
| Net premiums earned | $153.1 million | $142.1 million | $450.1 million | $412.3 million |
| Net income | $5.7 million | $8.7 million | $19.0 million | $10.1 million |
| Class A EPS | $0.21 | $0.33 | $0.69 diluted | $0.38 diluted |
| Operating cash flow | Not separately stated | Not separately stated | $48.5 million | $25.9 million |
- Q3 revenue increased about 7%, but net income fell about 35%. The loss ratio rose to 66.8% from 64.0%; the combined ratio increased to 99.5% from 96.8%. Investment income rose to $5.4 million, but the company recorded $754,000 of realized investment losses versus $351,000 of gains a year earlier.
- For the first nine months, revenue rose about 9% and net income about 89%. The combined ratio improved to 99.0% from 101.8%; the loss ratio declined to 65.8% from 69.5%, while the expense ratio increased to 32.7% from 31.8%. Net realized investment gains were $683,000, down from $2.3 million.
- Net premiums written rose 7.5% in Q3 and 8.4% year to date. Growth reflected rate increases, stronger commercial-line writings, and MICO’s termination of third-party quota-share reinsurance effective January 1, 2015.
Financial position, liquidity and debt
- At September 30, total assets were $1.531 billion, total investments $887.5 million, cash $24.9 million and stockholders’ equity $441.6 million. At December 31, 2014, these were $1.459 billion, $832.9 million, $35.6 million and $416.1 million, respectively.
- Unpaid losses and loss expenses were $569.1 million, including $255.3 million of reinsurance recoverable; net reserves were $313.8 million. Unearned premiums were $441.3 million.
- Reported borrowings under lines of credit were $48.0 million, down from $53.5 million at year-end. This comprised $13.0 million outstanding on a $60 million M&T revolving facility, with $47.0 million available, and $35.0 million of FHLB of Pittsburgh advances at a 0.36% rate. The M&T facility expires in July 2018. Management expected the FHLB financing to reduce annual interest expense by approximately $420,000.
- Operating activities generated $48.5 million in cash, while investing activities used $59.1 million and financing activities used $61,000. Cash declined by $10.7 million during the period. Management attributed higher operating cash flow year over year primarily to lower claim payments.
- The board declared post-quarter quarterly dividends of $0.135 per Class A share and $0.1175 per Class B share. Insurance subsidiaries had approximately $29.2 million available for distribution to the parent without prior regulatory approval, subject to statutory and risk-based-capital limits.
Material changes, outlook and risks
- Commercial lines drove much of the year-to-date underwriting improvement: statutory combined ratio was 93.2% versus 101.3%. Personal lines remained weaker at 99.8% versus 99.1%; Q3 personal lines underwriting was pressured by higher automobile and homeowners loss ratios. Q3 commercial automobile was also challenged, with a 118.0% statutory combined ratio.
- Prior-year reserve development remained unfavorable: approximately $1.5 million in Q3 and $4.8 million year to date, although both were better than the respective 2014 periods. Management said its reserves were adequate, but noted uncertainty from claim severity, litigation, medical costs and settlement trends. A 1% change in estimated net loss reserves would affect pretax results by approximately $3.1 million.
- Unrealized investment losses were considered temporary; the filing reports no investment impairment losses in the first nine months of either 2015 or 2014. Q3 realized losses primarily reflected a limited partnership investing in equity securities. Fair values, particularly for less liquid securities, may differ from realizable sale prices.
- No specific earnings or premium guidance was provided. Management cautioned that interim results are not necessarily indicative of full-year results. Identified risks include reserve adequacy, catastrophic weather, reinsurance availability and cost, interest rates, competition, economic conditions, and legal or regulatory changes. The filing reported no material changes to the risk factors in the 2014 Form 10-K and no legal proceedings.
Investor verification priorities
- Track whether premium growth converts into sustainable underwriting profitability, especially in personal lines and commercial automobile.
- Review subsequent loss-reserve development, reinsurance recoverables and the $3.1 million pretax sensitivity to a 1% reserve estimate change.
- Confirm the effect of the MICO reinsurance change and the FHLB financing on net premiums, risk exposure and interest expense.
- Monitor investment portfolio valuation and realized results, alongside liquidity, debt maturities and regulatory limits on subsidiary dividends.
- Reconcile quarter-to-quarter earnings volatility with year-to-date improvement, including realized investment losses and reserve development.