Donegal Group Inc. — 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018; the filing also reports fourth-quarter results. Donegal is a property-and-casualty insurance holding company operating through independent agents in 22 states. Its principal lines include personal auto and homeowners, and commercial auto, multi-peril and workers’ compensation. Donegal Mutual controls approximately 72% of combined voting power and shares operations and reinsurance arrangements with the company.
Financial results and key metrics
| Metric | 2018 | 2017 |
|---|---|---|
| Net premiums earned | $741.3 million | $702.5 million |
| Total revenues | $771.8 million | $739.0 million |
| Net income (loss) | $(32.8) million | $7.1 million |
| Diluted EPS, Class A / Class B | $(1.18) / $(1.09) | $0.26 / $0.22 |
| Combined ratio (GAAP) | 110.1% | 103.0% |
| Cash from operating activities | $63.8 million | $81.0 million |
| Total assets / stockholders’ equity | $1.832 billion / $398.9 million | $1.738 billion / $448.7 million |
| Debt obligations | $65.0 million | $64.0 million |
- Net premiums written increased 2.0% to $744.0 million. Commercial lines grew 6.3%; personal lines declined 1.5% as pricing and underwriting actions reduced new business and renewals.
- Net investment income rose 14.4% to $26.9 million; investment results swung to a $4.8 million loss from a $5.7 million gain, principally due to lower equity-security values and new fair-value accounting.
- Loss ratio rose to 77.8% from 69.4%; expense ratio improved to 31.6% from 32.9%. The combined ratio above 100% indicates an underwriting loss. Commercial auto and personal auto combined ratios were 133.3% and 117.4%, respectively.
- Cash and short-term liquidity included $52.6 million of cash and $16.7 million of short-term investments at year-end. The investment portfolio totaled $1.031 billion; 99.8% of debt securities were investment grade.
- Book value per share fell to $14.05 from $15.95. Stockholders’ equity declined $49.8 million, reflecting the net loss, unrealized investment losses and dividends. Dividends declared totaled $15.8 million.
Material changes versus prior period
- Net loss replaced 2017 net income as underwriting deterioration and investment losses more than offset higher premiums and investment income.
- Prior-year loss reserve development increased sharply to $35.6 million from $6.6 million. Management attributed it chiefly to higher-than-expected severity in commercial multi-peril, personal auto and commercial auto claims, including worsening litigation trends and delayed claim reporting. Net loss reserves rose to $475.4 million from $383.4 million.
- Weather-related losses were above historical norms. Unfavorable loss experience affected both personal and commercial lines.
- At year-end, the company did not meet minimum net-worth and interest-coverage covenants under its $60 million credit facility. In March 2019 it replaced that facility with a $30 million revolving line, transferred the $25 million balance, and reported compliance with the new covenants as of the filing date. Separately, Atlantic States had $35 million of Federal Home Loan Bank advances; total debt also included $5 million of subordinated debentures.
Outlook, management commentary, risks and unusual items
- Management said 2018 actions positioned the business for 2019 and beyond, while providing no numerical earnings or premium guidance. Actions included rate increases, reserve strengthening, an orderly exit from personal-lines markets in seven states, Peninsula branch consolidation, a consolidated 2019 reinsurance program and a multi-year systems modernization effort.
- Donegal Mutual and Donegal Group completed the sale of DFSC on March 8, 2019, after year-end. Donegal Group received approximately $14.1 million in a pre-closing dividend and $41.4 million in cash and Northwest Bancshares stock; the company expected to record a sale gain in first-quarter 2019.
- Peninsula consolidation resulted in a $1.9 million restructuring charge and a $1.1 million real-estate impairment charge in 2018. The branch property sale closed in January 2019 for net proceeds of $1.2 million.
- Reserves remain a key uncertainty: a 1% change in net loss and loss-expense reserves would affect pre-tax results by approximately $4.8 million. The actuarial most-likely estimate was $475.4 million, within a disclosed range of $436.1 million to $518.3 million.
- Other material risks include catastrophe exposure and geographic concentration, competitive pricing, further claim-severity or litigation increases, reinsurance recoverability and availability, investment-market and interest-rate risk, dependence on independent agents and shared technology, and constraints arising from Donegal Mutual’s control and related-party arrangements. Management reported no material adverse effect expected from routine litigation. Auditors gave an unqualified opinion on the financial statements and internal controls.
Important facts for investors to verify
- Whether 2018 reserve strengthening adequately reflects continuing auto claim severity, litigation and reporting delays, and how subsequent accident-year development evolves.
- Whether rate actions and the seven-state personal-lines exit improve underwriting results, particularly auto, and whether growth in commercial lines remains profitable.
- Compliance with the replacement credit facility’s covenants, available borrowing capacity, and the company’s ability to service debt and sustain dividends amid insurer-level dividend restrictions.
- The realized value and reported gain from the DFSC sale, including the value of Northwest shares and the use of proceeds for insurance operations.
- Performance of the 2019 reinsurance program and exposure to reinsurance counterparties, including Michigan Catastrophic Claims Association recoverables.