Donegal Group Inc. — Q3 2011 Form 10-Q
Business context and period. This unaudited report covers the quarter and nine months ended September 30, 2011. Donegal writes personal and commercial property-and-casualty insurance through independent agents, alongside an investment function. The December 2010 acquisition of Michigan Insurance Company contributed to premium and asset growth; the company also owns 48.2% of Donegal Financial Services Corporation.
Financial performance
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Total revenue | $119.2 million | $103.8 million | $347.8 million | $303.1 million |
| Net premiums earned | $108.5 million | $94.9 million | $317.3 million | $279.3 million |
| Pre-tax income (loss) | ($4.1 million) | $5.0 million | ($3.5 million) | $7.2 million |
| Income tax benefit (expense) | $4.9 million | ($0.1 million) | $4.9 million | ($0.3 million) |
| Net income | $0.8 million | $4.9 million | $1.3 million | $6.9 million |
| EPS, Class A / Class B | $0.03 / $0.03 | $0.20 / $0.18 | $0.05 / $0.05 | $0.28 / $0.25 |
- Premium growth: Net premiums written rose 14.0% in Q3 to $116.2 million and 16.5% year to date to $346.3 million. Management attributed much of the increase to Michigan, with additional commercial-lines growth and, year to date, personal-lines price increases.
- Underwriting: GAAP combined ratios were 112.6% in Q3 and 109.7% year to date, versus 103.2% and 105.2% in the respective 2010 periods. The statutory combined ratios were 110.6% and 106.2%, versus 100.7% and 102.8%. Ratios above 100% indicate underwriting losses. Q3 GAAP underwriting loss was $13.7 million; year-to-date loss was $30.7 million.
- Loss trends: Loss ratios rose to 82.4% in Q3 from 71.0%, and to 77.8% year to date from 73.0%. Q3 included $6.2 million of catastrophe losses after reinsurance from five events and another $6.4 million of other weather-related losses. Prior-year reserve development was unfavorable by about $0.6 million in Q3, but favorable by about $2.5 million year to date.
- Investment and other income: Net investment income increased to $5.0 million in Q3 and $15.7 million year to date. Net realized investment gains were $2.5 million and $7.1 million, respectively; year-to-date gains included $4.1 million from planned sales of an equity holding after its sale restriction expired. No investment impairment losses were recorded in the first nine months.
- Cash flow: Operating cash flow was $18.1 million for the first nine months, compared with $11.8 million in 2010. Investing activities used $30.9 million; financing provided $9.4 million. Cash declined $3.4 million to $12.9 million.
Financial position and liquidity
- At September 30, 2011, total assets were $1.285 billion, up from $1.175 billion at year-end 2010. Total investments were $788.5 million; stockholders’ equity was $387.7 million, compared with $380.1 million.
- Unpaid losses and loss expenses were $414.4 million, including $189.7 million of reinsurance recoverables. Unearned premiums were $346.9 million.
- Line-of-credit borrowings were $54.5 million, with $5.5 million of the $60 million facility available. Subordinated debentures were $20.5 million; total reported borrowings and debentures were about $75.0 million. The line matures in July 2014. The company reported compliance with credit covenants.
- Quarterly operating cash flow and marketable investments support liquidity, but cash was $12.9 million and the credit facility was nearly fully drawn. Dividends paid in the nine months were $8.9 million. A quarterly dividend of $0.12 per Class A share and $0.1075 per Class B share was declared after quarter-end.
Changes, outlook, risks and unusual items
- Despite premium and revenue growth, net income fell sharply year over year as losses and underwriting expenses increased; the tax benefit offset the pre-tax loss and supported positive net income.
- Management said the nine-month results are not necessarily indicative of full-year 2011 results. The filing provides no specific earnings or premium guidance.
- Michigan acquisition accounting reduced earned premiums by $3.2 million year to date; $76,000 of remaining fair-value adjustments was expected to be amortized in Q4. Acquisition-related borrowing and the May 2011 merger of Union National Financial Corporation into DFSC contributed to higher debt/investments in affiliates.
- Management identified loss-reserve adequacy, weather and catastrophe losses, claim severity and litigation, reinsurance availability and cost, investment valuations, interest rates, competition, regulation, and acquisition integration as risks. A 1% change in estimated unpaid losses, net of reinsurance, would affect pre-tax results by approximately $2.2 million. The company said it believed reserves were adequate, while noting ultimate liabilities may differ.
- Catastrophe reinsurance retention increased to $5.0 million in 2011 from $3.0 million in 2010. Reinstatement premiums were $5.8 million year to date, versus $2.1 million, and $2.6 million in Q3, versus $0.3 million.
- The company reported no material changes to disclosed risk factors or market-risk exposure, no material capital-expenditure commitments, and no legal proceedings. Disclosure controls were deemed effective.
Investor verification priorities
- Check subsequent underwriting and catastrophe results, especially personal auto, homeowners, commercial auto and commercial multi-peril performance.
- Review reserve development and reinsurance recoverability, including exposure to Donegal Mutual through the pooling arrangement.
- Confirm the source and sustainability of the tax benefit and the extent to which it depends on future taxable income.
- Track line-of-credit usage, borrowing costs, covenant headroom and cash available after dividends and repurchases.
- Assess Michigan integration and acquisition-accounting effects, as well as the quality and concentration of investment holdings and realized gains.