DONEGAL GROUP INC.
INDEX
TO FORM 10-K REPORT
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| PART I | | |
| Item 1. | | 1 |
| Item 1A. | | 27 |
| Item 1B. | | 41
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| Item 1C. | | 41
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| Item 2. | | 42
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| Item 3. | | 42
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| Item 4. | | 42
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| PART II | | |
| Item 5. | | 43
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| Item 6. | | 44
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| Item 7. | | 45
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| Item 7A. | | 62
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| Item 8. | | 64
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| Item 9. | | 108
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| Item 9A. | | 108
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| Item 9B. | | 109
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| PART III | | |
| Item 10. | | 111
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| Item 11. | | 111 |
| Item 12. | | 111 |
| Item 13. | | 111 |
| Item 14. | | 111 |
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| PART IV | | |
| Item 15. | | 112 |
| Item 16. | | 115 |
PART I
Introduction
Donegal Group Inc., or DGI, is an insurance holding company whose insurance subsidiaries and affiliates offer property and casualty insurance in 23 Mid-Atlantic, Midwestern, New England, Southern and Southwestern states. DGI has no significant business operations and is separate and distinct from its insurance subsidiaries. As used in this Form 10-K Report, the terms “we,” “us” and “our” refer to Donegal Group Inc. and its insurance subsidiaries. Our Class A common stock and our Class B common stock trade on the NASDAQ Global Select Market under the symbols “DGICA” and “DGICB,” respectively.
Donegal Mutual Insurance Company, or Donegal Mutual, organized us as an insurance holding company on August 26, 1986. At December 31, 2023, Donegal Mutual held approximately 44% of our outstanding Class A common stock and approximately 84% of our outstanding Class B common stock. Donegal Mutual’s ownership provides Donegal Mutual with approximately 71% of the combined voting power of our outstanding shares of Class A common stock and our outstanding shares of Class B common stock. Our insurance subsidiaries and Donegal Mutual have interrelated operations due to an intercompany pooling agreement and other intercompany agreements and transactions we describe in Note 3 of the Notes to Consolidated Financial Statements. While maintaining the separate corporate existence of each company, our insurance subsidiaries conduct business together with Donegal Mutual and its insurance subsidiaries as the Donegal Insurance Group. The Donegal Insurance Group is not a legal entity, is not an insurance company and does not issue or administer insurance policies. Rather, it is a trade name that refers to the group of insurance companies that are affiliated with Donegal Mutual.
At December 31, 2023, we had three segments: our investment function, our commercial lines of insurance and our personal lines of insurance. We set forth financial information about these segments in Note 19 of the Notes to Consolidated Financial Statements. The commercial lines products of our insurance subsidiaries consist primarily of commercial automobile, commercial multi-peril and workers’ compensation policies. The personal lines products of our insurance subsidiaries consist primarily of homeowners and private passenger automobile policies.
Our insurance subsidiaries and Donegal Mutual provide their policyholders with a selection of insurance products and pursue profitability by adhering to a strict underwriting discipline. Our insurance subsidiaries derive a substantial portion of their insurance business from smaller to mid-sized regional communities. We believe this focus provides our insurance subsidiaries with competitive advantages in terms of local market knowledge, marketing, underwriting, claims servicing and policyholder service. At the same time, we believe our insurance subsidiaries have cost advantages over many smaller regional insurers that result from economies of scale our insurance subsidiaries realize through centralized accounting, administrative, data processing, investment and other services.
We believe we have a substantial opportunity, as a well-capitalized regional insurance holding company with a solid business strategy, to grow profitably and compete effectively with larger national property and casualty insurers. Our downstream holding company structure, with Donegal Mutual holding approximately 71% of the combined voting power of our common stock, has proven its effectiveness and success over the 37 years of our existence. Over that time period, we have grown significantly in terms of revenue and financial strength, and the Donegal Insurance Group has developed an excellent reputation as a regional group of property and casualty insurers.
Since 1998, we and Donegal Mutual have completed seven transactions involving acquisitions of property and casualty insurance companies or participation in the business of property and casualty insurance companies through Donegal Mutual’s entry into quota-share reinsurance agreements with them. While we are currently placing less emphasis on pursuing acquisitions due to several ongoing major initiatives to enhance our technology infrastructure as well as our analytical and processing capabilities, we expect to continue to acquire other insurance companies to expand our business in a given region over time.
Donegal Mutual completed the merger of Mountain States Mutual Casualty Company, or Mountain States, with and into Donegal Mutual effective May 25, 2017. Donegal Mutual was the surviving company in the merger, and Mountain States’ insurance subsidiaries, Mountain States Indemnity Company and Mountain States Commercial Insurance Company (collectively, the “Mountain States insurance subsidiaries”), became insurance subsidiaries of Donegal Mutual upon completion of the merger. Upon completion of the merger, Donegal Mutual assumed all of the policy obligations of Mountain States and began to market its products together with the Mountain States insurance subsidiaries as the Mountain States Insurance Group in four Southwestern states. Donegal Mutual also entered into a 100% quota-share reinsurance agreement with the Mountain States insurance subsidiaries on the merger date. Beginning with policies effective in 2021, Donegal Mutual began to place the business of the Mountain States Insurance Group into the underwriting pool we describe in “History and Organizational Structure.”
Available Information
You may obtain our Annual Reports on Form 10-K, including this Form 10-K Report, our quarterly reports on Form 10-Q, our current reports on Form 8-K, our proxy statement and our other filings pursuant to the Securities Exchange Act of 1934, or the Exchange Act, without charge by viewing our website at www.donegalgroup.com. You may also view our Code of Business Conduct and Ethics and the charters of the executive committee, the audit committee, the compensation committee and the nominating committee of our board of directors on our website. Upon request to our corporate secretary, we will also provide printed copies of any of these documents to you without charge. We have provided the address of our website solely for the information of investors. We do not intend the reference to our website address to be an active link or to otherwise incorporate the contents of our website into this Form 10-K Report. In addition to our website, the Securities and Exchange Commission (the “SEC”) maintains an Internet site at www.sec.gov that contains our reports, proxy and information statements and other information that we electronically file with, or furnish to, the SEC.
History and Organizational Structure
In the mid-1980’s, Donegal Mutual, as a mutual insurance company, recognized the desirability of developing additional sources of capital and surplus so it could remain competitive, expand its business and ensure its long-term viability. Accordingly, Donegal Mutual determined that the implementation of a downstream holding company structure was a viable business strategy to accomplish that objective. Thus, in 1986, Donegal Mutual formed us as a downstream holding company, and we incorporated in the state of Delaware as Donegal Group Inc. After Donegal Mutual formed us, we in turn formed Atlantic States Insurance Company, or Atlantic States, as our wholly owned property and casualty insurance company subsidiary.
In connection with the formation of Atlantic States and the establishment of our downstream insurance holding company system, Donegal Mutual and Atlantic States entered into a proportional reinsurance agreement, or pooling agreement. Under the pooling agreement, Donegal Mutual and Atlantic States contribute substantially all of their respective premiums, losses and loss expenses to the underwriting pool, and the underwriting pool, acting through Donegal Mutual, then allocates 80% of the pooled business to Atlantic States. Thus, Donegal Mutual and Atlantic States share the underwriting results of the pooled business in proportion to their respective participation in the underwriting pool.
The member companies of the Donegal Insurance Group, which include our insurance subsidiaries, share a combined business plan to enhance market penetration and underwriting profitability objectives. We believe Donegal Mutual’s majority interest in the combined voting power of our Class A common stock and of our Class B common stock fosters our ability to implement our business philosophies, enjoy management continuity, maintain superior employee relations and provide a stable environment within which we can grow our businesses.
The products the member companies of the Donegal Insurance Group offer are generally complementary, which permits the Donegal Insurance Group to offer a broad range of products in a given market and to expand the Donegal Insurance Group’s ability to service an entire personal lines or commercial lines account. Distinctions within the products the member companies of the Donegal Insurance Group offer generally relate to specific risk profiles within similar classes of business, such as preferred tier products versus standard tier products. The member companies of the Donegal Insurance Group do not allocate all of the standard risk gradients to one company. As a result, the underwriting profitability of the business the individual companies write directly will vary. However, the underwriting pool homogenizes the risk characteristics of all business that Donegal Mutual and Atlantic States write directly and all business that Donegal Mutual assumes from its affiliates and places into the underwriting pool. The business Atlantic States derives from the underwriting pool represents a significant percentage of our total consolidated revenues.
As the capital of Atlantic States and our other insurance subsidiaries has increased, the underwriting capacity of our insurance subsidiaries has increased proportionately. The size of the underwriting pool has also increased substantially. Therefore, as we originally planned in the mid-1980s, Atlantic States has successfully raised the capital necessary to support the growth of its direct business as well as to accept increases in its allocation of business from the underwriting pool. The portion of the underwriting pool allocated to Atlantic States has increased from an initial allocation of 35% in 1986 to an 80% allocation since March 1, 2008. We do not anticipate any further change in the pooling agreement between Atlantic States and Donegal Mutual, including any change in the percentage participation of Atlantic States in the underwriting pool.
In addition to Atlantic States, our insurance subsidiaries are Michigan Insurance Company, or MICO, The Peninsula Insurance Company and its wholly owned subsidiary, Peninsula Indemnity Company, or collectively, Peninsula, and Southern Insurance Company of Virginia, or Southern. Donegal Mutual has a 100% quota-share reinsurance agreement with Southern Mutual Insurance Company, or Southern Mutual, and Donegal Mutual places its assumed business from Southern Mutual into the underwriting pool. Donegal Mutual wholly owns and has a 100% quota-share reinsurance agreement with the Mountain States insurance subsidiaries. Beginning with policies effective in 2021, Donegal Mutual places its assumed business from the Mountain States insurance subsidiaries into the underwriting pool.
The following chart depicts our organizational structure, including all of our property and casualty insurance subsidiaries and affiliates:
| | (1) | Because of the different relative voting power of our Class A common stock and our Class B common stock, our public stockholders hold approximately 29% of the combined voting power of our Class A common stock and our Class B common stock and Donegal Mutual holds approximately 71% of the combined voting power of our Class A common stock and our Class B common stock. |
Relationship with Donegal Mutual
Donegal Mutual provides facilities, management and other services to us and our insurance subsidiaries. In addition, Donegal Mutual purchases and maintains the information technology systems that support the business of Donegal Mutual and our insurance subsidiaries. Donegal Mutual allocates certain related expenses to Atlantic States in accordance with the relative participation of Donegal Mutual and Atlantic States in the pooling agreement. Our insurance subsidiaries other than Atlantic States reimburse Donegal Mutual for allocated costs of services Donegal Mutual provides on their behalf based on their proportion of the total direct premiums written of the Donegal Insurance Group and other metrics. Allocated expenses from Donegal Mutual for services it provided to Atlantic States and our other insurance subsidiaries totaled $219.0 million, $199.2 million and $186.6 million for 2023, 2022 and 2021, respectively.
Donegal Mutual is the employer of record for all personnel who provide services for our insurance subsidiaries. Donegal Mutual strives to maintain a culture that is based on integrity and respect, with an environment designed to facilitate excellent service to the agents and customers of the Donegal Insurance Group. At December 31, 2023, Donegal Mutual had 872 employees, of which 456 were based in its Marietta, Pennsylvania headquarters and 416 were based in regional offices or were permanent remote employees. There were 861 full-time employees and 11 part-time employees. Many of Donegal Mutual’s employees work remotely from their homes or follow a hybrid schedule that includes working several days in their assigned office to allow for enhanced collaboration and interaction with other employees. Donegal Mutual targets employee compensation that is competitive and consistent with an employee’s position, knowledge, experience and skill level. Donegal Mutual provides annual wage increases that are based on merit. Donegal Mutual provides an annual cash incentive plan for all of its employees that provides an opportunity for Donegal Mutual’s employees to earn a bonus as a percentage of their annual wages that varies based on the level of underwriting profit Donegal Insurance Group achieves for a calendar year. In addition, Donegal Mutual provides to its full-time employees a comprehensive employee benefits program, including medical, dental and vision insurance, paid time off, and a 401(k) retirement plan that includes company matching provisions. Donegal Mutual also provides substantial training, development and wellness programs and resources to its employees.
Our insurance subsidiaries have a catastrophe reinsurance agreement with Donegal Mutual, pursuant to which Donegal Mutual provides coverage for losses related to any catastrophic occurrence over a set retention of $3.0 million ($2.0 million for 2022 and 2021) for each participating insurance subsidiary, with a combined retention of $6.0 million ($5.0 million for 2022 and 2021) for a catastrophe involving a combination of participating insurance subsidiaries, up to the amount Donegal Mutual and our insurance subsidiaries retain under catastrophe reinsurance agreements with unaffiliated reinsurers. The purpose of the catastrophe reinsurance agreement is to lessen the effects of an accumulation of losses arising from one event to levels that are appropriate given each subsidiary’s size, underwriting profile and surplus.
Donegal Mutual had a quota-share reinsurance agreement with MICO for policies effective through December 31, 2021. The purpose of the quota-share reinsurance agreement with MICO was to transfer to Donegal Mutual 25% of the premiums and losses related to MICO’s business. Donegal Mutual placed its assumed business from MICO into the underwriting pool. Donegal Mutual and MICO terminated this reinsurance agreement on a run-off basis effective January 1, 2022. As a result, MICO retains 100% of its net premiums and losses beginning with policies effective as of that date.
Donegal Mutual had a quota-share reinsurance agreement with Peninsula for policies effective through December 31, 2021. The purpose of the quota-share reinsurance agreement with Peninsula was to transfer to Donegal Mutual 100% of the premiums and losses related to the workers’ compensation product line of Peninsula in certain states. Donegal Mutual placed its assumed business from Peninsula into the underwriting pool. Donegal Mutual and Peninsula terminated this reinsurance agreement on a run-off basis effective January 1, 2022. As a result, Peninsula retains 100% of its net workers’ compensation premiums and losses beginning with policies effective as of that date.
We and Donegal Mutual have maintained a coordinating committee since our formation in 1986. The coordinating committee consists of two members of our board of directors, neither of whom is a member of Donegal Mutual’s board of directors, and two members of Donegal Mutual’s board of directors, neither of whom is a member of our board of directors. The purpose of the coordinating committee is to establish and maintain a process for an ongoing evaluation of the transactions between Donegal Mutual, our insurance subsidiaries and us. The coordinating committee considers the fairness of each intercompany transaction to Donegal Mutual and its policyholders and to us and our stockholders.
A new agreement or any change to a previously approved agreement must receive coordinating committee approval. The approval process for a new agreement between Donegal Mutual and us or one of our insurance subsidiaries or a change in such an agreement is as follows:
| • | both of our members on the coordinating committee must determine that the new agreement or the change in an existing agreement is fair and equitable to us and in the best interests of our stockholders; |
| • | both of Donegal Mutual’s members on the coordinating committee must determine that the new agreement or the change in an existing agreement is fair and equitable to Donegal Mutual and in the best interests of its policyholders; |
| • | our board of directors must approve the new agreement or the change in an existing agreement; and |
| • | Donegal Mutual’s board of directors must approve the new agreement or the change in an existing agreement. |
The coordinating committee also meets annually to review each existing agreement between Donegal Mutual and us or our insurance subsidiaries, including all reinsurance agreements between Donegal Mutual and our insurance subsidiaries. The purpose of this annual review is to examine the results of the agreements over the past year and, in the case of reinsurance agreements, over several years and to determine if the results of the existing agreements remain fair and equitable to us and our stockholders and fair and equitable to Donegal Mutual and its policyholders or if Donegal Mutual and we should mutually agree to certain adjustments to the terms of the agreements. In the case of reinsurance agreements, the annual adjustments typically relate to the reinsurance premiums and loss retention amounts. These agreements are ongoing in nature and will continue in effect throughout 2024 in the ordinary course of our business.
Our members on the coordinating committee, as of the date of this Form 10-K Report, are Barry C. Huber and Richard D. Wampler, II. Donegal Mutual’s members on the coordinating committee as of such date are Michael W. Brubaker and Michael K. Callahan, who replaced Cyril J. Greenya in January 2024. We refer to our proxy statement for our annual meeting of stockholders to be held on April 18, 2024 for further information about the members of the coordinating committee.
We believe our relationships with Donegal Mutual offer us and our insurance subsidiaries a number of competitive advantages, including the following:
| • | enabling our stable management, the consistent underwriting discipline of our insurance subsidiaries, external growth, long-term profitability and financial strength; |
| • | creating operational and expense synergies from the combination of resources and integrated operations of the Donegal Insurance Group; |
| • | producing more stable and uniform underwriting results for our insurance subsidiaries over extended periods of time than we could achieve without our relationship with Donegal Mutual; |
| • | providing opportunities for growth because of the ability of Donegal Mutual to affiliate and enter into reinsurance agreements with, or otherwise acquire control of, mutual insurance companies and place the business it assumes into the underwriting pool; and |
| • | providing Atlantic States with a significantly larger underwriting capacity because of the underwriting pool Donegal Mutual and Atlantic States have maintained since 1986. |
In the first quarter of 2024, our board of directors and the board of directors of Donegal Mutual each undertook a review of the relationships between Donegal Mutual and DGI and determined that continuing the current relationships and the current corporate structure of Donegal Mutual and DGI is in the best interests of DGI and its various constituencies.
Business Strategy
We and Donegal Mutual are focused on several primary strategies, including achieving sustained excellent financial performance, strategically modernizing our operations and processes to transform our business, capitalizing on opportunities to grow profitably and delivering a superior experience to our agents and policyholders. Our strategies are designed to provide value to the policyholders of Donegal Mutual and our respective insurance subsidiaries and, ultimately, to provide value to our stockholders. The annual net premiums earned of our insurance subsidiaries have increased from $301.5 million in 2006 to $882.1 million in 2023, a compound annual growth rate of 6.5%.
The combined ratio of our insurance subsidiaries and that of the United States property and casualty insurance industry as computed using United States generally accepted accounting principles, or GAAP, and statutory accounting principles, or SAP, for the years 2019 through 2023 are shown in the following table:
| | | 2023 | | | 2022 | | | 2021 | | | 2020 | | | 2019 | |
| Our GAAP combined ratio | | | 104.4 | % | | | 103.3 | % | | | 101.0 | % | | | 96.0 | % | | | 99.5 | % |
| Our SAP combined ratio | | | 104.2 | | | | 103.3 | | | | 100.8 | | | | 95.4 | | | | 98.7 | |
Industry SAP combined ratio (1) | | | 103.7 | | | | 103.1 | | | | 99.6 | | | | 98.4 | | | | 98.9 | |
| (1) | As reported (projected for 2023) by A.M. Best Company. |
We and Donegal Mutual believe we can continue to expand our insurance operations over time through organic growth and acquisitions of, or affiliations with, other insurance companies. Our insurance subsidiaries and Donegal Mutual seek to increase their premium base by making quality independent agency appointments, enhancing their competitive position within each agency, introducing new and enhanced insurance products and developing and maintaining automated systems to improve service, communications and efficiency.
A detailed review of our business strategies follows:
| • | Achieving sustained excellent financial performance. |
Our insurance subsidiaries seek to achieve consistent underwriting profitability. Underwriting profitability is a fundamental component of our long-term financial strength because it allows our insurance subsidiaries to generate profits without relying exclusively on their investment income for profitability.
Our insurance subsidiaries seek to enhance their underwriting results by:
| • | carefully selecting the product lines they underwrite; |
| • | carefully selecting the individual risks they underwrite; |
| • | utilizing data analytics and predictive modeling tools to inform risk selection and pricing decisions; |
| • | managing their property exposures in catastrophe-prone areas; and |
| • | evaluating their claims history on a regular basis to ensure the adequacy of their underwriting guidelines and product pricing. |
Our insurance subsidiaries maintain discipline in their pricing by effecting rate increases to sustain or improve their underwriting results without unduly affecting their customer retention. In addition to appropriate pricing, our insurance subsidiaries seek to ensure that their premium rates are adequate relative to the risk exposures they insure. Our insurance subsidiaries review loss trends on a regular basis to identify changes in the frequency and severity of their claims and to assess the adequacy of their rates and underwriting standards. Our insurance subsidiaries also carefully monitor and audit the information they use to price their policies for the purpose of enabling them to receive an adequate level of premiums for the risk they assume. For example, our insurance subsidiaries audit the payroll data of their workers’ compensation customers to verify that the assumptions used to price a particular policy were accurate. By implementing appropriate rate increases and understanding the risks our insurance subsidiaries agree to insure, our insurance subsidiaries seek to achieve consistent underwriting profitability.
Our insurance subsidiaries monitor the performance of the product lines they underwrite and the geographies in which they offer their insurance products. Our insurance subsidiaries take specific actions to remediate underperforming product lines or geographies that include pricing increases, underwriting adjustments, reunderwriting initiatives as well as discontinuing a given product or withdrawing from a geography when our insurance subsidiaries determine they cannot reasonably expect to generate targeted profitability over time. For example, our insurance subsidiaries ceased writing new commercial lines policies and began non-renewing all existing commercial lines accounts in the states of Georgia and Alabama during 2023. Our insurance subsidiaries took this action after determining that they could not reasonably expect to generate targeted profitability within a reasonable period of time for commercial lines of business in those states.
Our insurance subsidiaries have no material exposures to asbestos or environmental liabilities. Our insurance subsidiaries seek to provide more than one policy to a given personal lines or commercial lines customer because this “account selling” strategy diversifies their risk and has historically improved their underwriting results. Our insurance subsidiaries also use reinsurance to manage their exposure and limit their maximum net loss from large single risks or risks in concentrated areas.
Our insurance subsidiaries maintain stringent expense controls under direct supervision of their senior management. We centralize the processing and administrative activities of our insurance subsidiaries to realize operating synergies and better expense control. Our insurance subsidiaries utilize technology to automate much of their underwriting, claims and billing processes and to facilitate agency and policyholder communications on an efficient, timely and cost-effective basis. Our insurance subsidiaries have increased their annual premium per employee, a measure of efficiency that our insurance subsidiaries use to evaluate their operations, from approximately $470,000 in 1999 to approximately $1.2 million in 2023.
Return on invested assets is an important element of the financial results of our insurance subsidiaries. The investment strategy of our insurance subsidiaries is to generate an appropriate amount of after-tax income on invested assets while limiting the potential impact of equity market volatility and minimizing credit risk through investments in high-quality securities. As a result, our insurance subsidiaries seek to invest a high percentage of their assets in diversified, highly rated and marketable fixed-maturity instruments. The fixed-maturity portfolios of our insurance subsidiaries consist of both taxable and tax-exempt securities. Our insurance subsidiaries maintain a portion of their portfolios in short-term securities to provide liquidity for the payment of claims and operation of their respective businesses. Our insurance subsidiaries maintain a small percentage (2.0% at December 31, 2023) of their portfolios in equity securities that have a history of paying cash dividends or that our insurance subsidiaries expect will appreciate in value over time.
| • | Strategically modernizing our operations and processes to transform our business. |
In 2018, Donegal Mutual initiated a multi-year systems modernization project to replace its remaining legacy systems, streamline business processes and workflows and enhance data analytics and modeling capabilities. In February 2020, Donegal Mutual implemented the first release of new systems related to the project, and our insurance subsidiaries began to issue workers’ compensation policies from the new systems in the second quarter of 2020. In August 2021, Donegal Mutual implemented the second release of new systems related to the project, including a new agency portal and the rating, underwriting and policy issuance capabilities necessary to support the launch of new personal lines products, and our insurance subsidiaries began to issue new personal lines products from the new systems in the fourth quarter of 2021. In 2023, Donegal Mutual implemented two additional major releases of new systems, which included three commercial lines of business with enhanced straight-through-processing capabilities as well as dwelling fire and conversion of legacy homeowners renewal policies in two initial states. Over the next two years, Donegal Mutual expects to implement new systems for the remaining lines of business the Donegal Insurance Group issues currently and for the conversion of remaining legacy renewal policies of the Donegal Insurance Group.
We have an enterprise analytics department that is focused on integrating data and analytics into strategy and decision-making at all levels of our organization. The enterprise analytics team is responsible for core functions of rate-making, predictive analytics, data management and business intelligence. These responsibilities include the development and expansion of risk-based pricing segmentation, analytical innovation, predictive modeling solutions, formal data strategies, performance monitoring and enhanced reporting mechanisms. We developed and began executing a pricing and analytics roadmap that will continue to deliver data-driven insights to our underwriters. This roadmap includes ongoing development and enhancement of quality tools that allow us to operationalize pricing and underwriting predictive models, integrate internal and external data for better-informed pricing and underwriting decisions and enhance the automation and precision of our rate indication methodology. Our enterprise analytics team is continuing to develop new tools and solutions that are enhancing our product portfolio management capabilities, competitive intelligence, pricing sophistication and utilization of data to monitor and manage our operations. The team also generates reporting and analyses that enable us to draw business insights from data that drive actions to improve performance.
We are focused on process excellence and have prepared a multi-year roadmap for addressing those opportunities. We are also expanding our data management personnel and capabilities to continually ensure the data upon which we rely for our business decisions and financial reporting is complete, accurate and secure. We have assigned an innovation task force the responsibility to research emerging technologies and identify potential technology solutions that might assist us in achieving our business strategies.
| • | Capitalizing on opportunities to grow profitably. |
Continued expansion of our insurance subsidiaries within their existing markets will be a key source of their continued premium growth, and maintaining an effective network of independent agencies is integral to this expansion. Our insurance subsidiaries seek to be among the top three insurers within each of the independent agencies for the lines of business our insurance subsidiaries write by providing a consistent, competitive and stable market for their products. We believe that the consistency of the product offerings of our insurance subsidiaries enables our insurance subsidiaries to compete effectively for independent agents with other insurers whose product offerings may fluctuate based on industry conditions. Our insurance subsidiaries offer a competitive compensation program to their independent agents that rewards them for producing profitable growth and maintaining profitable books of business with our insurance subsidiaries.
Our insurance subsidiaries execute a combined annual business plan with Donegal Mutual and its insurance subsidiaries. Within the past several years, we enhanced the annual planning process to ensure that we are directing efforts and resources toward geographic regions, market segments, product lines and classes of business that will give us the best opportunities to achieve sustained growth and profitability. As part of the planning process, we perform a detailed analysis of internal and external data with respect to each state within our operating regions. We assess state-specific marketing dynamics and opportunities, including an evaluation of the historical experience of our insurance subsidiaries. We then assign a strategic posture for each state and develop action plans to execute state-specific strategies for growth or reduction of premiums, agency distribution and enhanced profit generation over the next several years. As part of our property exposure management, we implemented tools that have allowed us to assign a strategic posture at a county level within each state. Our insurance subsidiaries utilize these tools to further manage and refine their concentrations of property risk exposure and to enhance their geographic risk diversification. We expect this strategy will reduce over time the overall impact of losses from severe weather events to the results of our insurance subsidiaries.
In recent years, the consolidation of independent agencies has accelerated, resulting in the acquisition of independent agencies from which our insurance subsidiaries and Donegal Mutual currently receive business by national cluster groups and aggregators. We have expanded our national accounts team that is responsible for the management and expansion of our relationships with these national agency groups. The national accounts team serves as a centralized point of contact for these groups and works directly with our regional sales and marketing teams to support and develop relationships with independent agents affiliated with national agency groups. We believe our relationships with existing and emerging national agency groups will continue to expand and that these groups represent a significant opportunity for profitable future growth.
| • | Delivering a superior experience to our agents and policyholders. |
Donegal Mutual and our insurance subsidiaries strive to maintain technology comparable to that of their larger competitors. “Ease of doing business” is a critically important component of an insurer’s value to an independent agency. Our insurance subsidiaries provide fully automated underwriting and policy issuance portals that substantially ease data entry and facilitate the quoting and issuance of policies for the independent agents of our insurance subsidiaries. As a result, applications of the independent agents for our insurance subsidiaries can result in policy issuance without further re-entry of information. These systems also interface with the agency management systems of the independent agents of our insurance subsidiaries. In addition, we continue to explore and implement new agency relationship management solutions to expand the abilities of our insurance subsidiaries to manage their agency relationships and enhance their agency communications and interactions.
Our insurance subsidiaries also provide their independent agents with ongoing support to enable them to better attract and service customers, including:
| • | availability of a personal lines service center that provides comprehensive service for our personal lines policyholders; |
| • | availability of a commercial lines small business unit to monitor straight-through processing results and enhance turnaround time for responses to agents for less complicated commercial risks; |
| • | availability of a commercial lines service center, which is an optional service enhancement for agencies who prefer that we interact directly with their customers for mid-term policy coverage changes and other service requests; and |
| • | accessibility to and regular interactions with marketing and underwriting personnel and senior management of our insurance subsidiaries. |
Our insurance subsidiaries appoint independent agencies with a strong underwriting and growth track record. We believe that our insurance subsidiaries will drive continued long-term growth by carefully selecting, motivating and supporting their independent agencies.
We believe that excellent policyholder service is important in attracting new policyholders and retaining existing policyholders. Our insurance subsidiaries work closely with their independent agents to provide a consistently responsive level of claims service, underwriting and customer support. Our insurance subsidiaries seek to respond expeditiously and effectively to address customer and independent agent inquiries in a number of ways, including:
| • | availability of a customer call center, secure website and mobile application for claims reporting; |
| • | availability of a secure website and mobile application for access to policy information and documents, payment processing and other features; |
| • | timely replies to information requests and policy submissions; and |
| • | prompt responses to, and processing of, claims. |
Our insurance subsidiaries periodically conduct policyholder surveys to evaluate the effectiveness of their service to policyholders. The management of our insurance subsidiaries meets on a regular basis with the personnel of the independent insurance agents our insurance subsidiaries appoint to seek service improvement recommendations, react to service issues and better understand local market conditions.
| • | Acquiring property and casualty insurance companies to augment the organic growth of our insurance subsidiaries. |
We have been an effective consolidator of smaller “main street” property and casualty insurance companies. While we are currently placing less emphasis on pursuing acquisitions due to several ongoing major initiatives to enhance our technology infrastructure as well as our analytical and processing capabilities, we expect to continue to acquire other insurance companies to expand our business in a given region over time.
Since 1998, we and Donegal Mutual have completed seven transactions involving acquisitions of property and casualty insurance companies or participation in the business of property and casualty insurance companies through Donegal Mutual’s entry into quota-share reinsurance agreements with them. We and Donegal Mutual intend to continue our growth by pursuing affiliations and acquisitions that meet our criteria. Our primary criteria are:
| • | location in regions where our insurance subsidiaries and Donegal Mutual are currently conducting business or that offer an attractive opportunity to conduct profitable business; |
| • | a mix of business similar to the mix of business of our insurance subsidiaries and Donegal Mutual; |
| • | annual premium volume between $50.0 million to $100.0 million; and |
| • | fair and reasonable transaction terms. |
We believe that our relationship with Donegal Mutual assists us in pursuing affiliations with, and subsequent acquisitions of, mutual insurance companies because, through Donegal Mutual, we understand the concerns and issues that mutual insurance companies face. In particular, Donegal Mutual has had success affiliating with underperforming mutual insurance companies that were operating at a competitive disadvantage due to lack of economies of scale compared to other industry participants, and we have either acquired them following their conversion to a stock company or benefited from their underwriting results as a result of Donegal Mutual’s entry into a 100% quota-share reinsurance agreement with them and placement of that assumed business into the pooling agreement. We evaluate a number of areas for operational synergies when considering acquisitions, including product underwriting, expenses, the cost of reinsurance and technology.
We believe that our ability to make direct acquisitions of stock insurance companies and to make indirect acquisitions of mutual insurance companies through Donegal Mutual provides us with flexibility that is a competitive advantage in making acquisitions. We also believe our historic record demonstrates our ability to acquire control of an underperforming insurance company utilizing a number of different acquisition structures and affiliation strategies, re-underwrite its book of business, reduce its cost structure and return it to sustained profitability.
While Donegal Mutual and we generally engage in preliminary discussions with potential direct or indirect acquisition candidates from time to time, neither Donegal Mutual nor we make any public disclosure regarding a proposed acquisition until Donegal Mutual or we have entered into a definitive acquisition agreement.
The following table highlights our and Donegal Mutual’s history of insurance company acquisitions and affiliations since 1998:
| Company Name | | State of Domicile | | Year Control Acquired | | Method of Acquisition/Affiliation |
Southern Heritage Insurance Company (1) | | Georgia | | 1998 | | Purchase of stock by us in 1998. |
| | | | | | | |
Le Mars Mutual Insurance Company of Iowa and then Le Mars Insurance Company (1) | | Iowa | | 2002 | | Surplus note investment by Donegal Mutual in 2002; conversion to stock company in 2004; acquisition of stock by us in 2004. |
| | | | | | | |
Peninsula Insurance Group | | Maryland | | 2004 | | Purchase of stock by us in 2004. |
| | | | | | | |
Sheboygan Falls Mutual Insurance Company and then Sheboygan Falls Insurance Company (1) | | Wisconsin | | 2007 | | Contribution note investment by Donegal Mutual in 2007; conversion to stock company in 2008; acquisition of stock by us in 2008. |
| | | | | | | |
Southern Mutual Insurance Company (2) | | Georgia | | 2009 | | Surplus note investment by Donegal Mutual and quota-share reinsurance in 2009. |
| | | | | | | |
Michigan Insurance Company | | Michigan | | 2010 | | Purchase of stock by us in 2010. |
| | | | | | | |
Mountain States Mutual Casualty Company(3) | | New Mexico | | 2017 | | Merger with and into Donegal Mutual in 2017. |
| | (1) | To reduce administrative and compliance costs and expenses, these subsidiaries subsequently merged into one of our existing insurance subsidiaries. |
| (2) | Control acquired by Donegal Mutual. |
| (3) | Donegal Mutual completed the merger of Mountain States with and into Donegal Mutual effective May 25, 2017. Donegal Mutual was the surviving company in the merger, and Mountain States insurance subsidiaries became insurance subsidiaries of Donegal Mutual upon completion of the merger. Donegal Mutual also entered into a 100% quota-share reinsurance agreement with the Mountain States insurance subsidiaries on the merger date. Beginning with policies effective in 2021, Donegal Mutual places the business of the Mountain States Insurance Group into the underwriting pool. |
Competition
The property and casualty insurance industry is highly competitive on the basis of both price and service. Numerous companies compete for business in the geographic areas where our insurance subsidiaries operate. Many of these other insurance companies are substantially larger and have greater financial resources than those of our insurance subsidiaries. In addition, because our insurance subsidiaries and Donegal Mutual market their respective insurance products exclusively through independent insurance agencies, most of which represent more than one insurance company, our insurance subsidiaries face competition within agencies, as well as competition to retain qualified independent agents. Insurance companies that are substantially larger than our insurance subsidiaries are likely to benefit from certain cost synergies, and insurance companies that market their products directly to end consumers are likely to incur lower relative acquisition costs compared to those of our insurance subsidiaries.
Products and Underwriting
We report the results of our insurance operations in two segments: commercial lines of insurance and personal lines of insurance. The commercial lines our insurance subsidiaries write consist primarily of commercial automobile, commercial multi-peril and workers’ compensation insurance. The personal lines our insurance subsidiaries write consist primarily of private passenger automobile and homeowners insurance. We describe these lines of insurance in greater detail below:
Commercial
| • | Commercial automobile — policies that provide protection against liability for bodily injury and property damage arising from automobile accidents and protection against loss from damage to automobiles owned by the insured. |
| • | Commercial multi-peril — policies that provide protection to businesses against many perils, usually combining liability and physical damage coverages. |
| • | Workers’ compensation — policies employers purchase to provide benefits to employees for injuries sustained during employment. The workers’ compensation laws of each state determine the extent of the coverage we provide. |
Personal
| • | Private passenger automobile — policies that provide protection against liability for bodily injury and property damage arising from automobile accidents and protection against loss from damage to automobiles owned by the insured. |
| • | Homeowners — policies that provide coverage for damage to residences and their contents from a broad range of perils, including fire, lightning, windstorm and theft. These policies also cover liability of the insured arising from injury to other persons or their property while on the insured’s property and under other specified conditions. |
In recent years, we have taken actions to shift our business mix to a higher proportion of commercial business, where we believe we will continue to have opportunities to achieve profitable, sustainable long-term growth. Due to our decision to exit the commercial lines markets in Georgia and Alabama that reduced commercial lines premiums and the significant personal lines rate increases we implemented to restore profitability while maintaining strong policy retention rates that increased personal lines premiums, our 2023 business mix did not reflect this strategic shift that we expect will resume as we concentrate on profitable commercial growth opportunities in the future. We are executing state-specific strategies that include accelerating growth in states where we see opportunities for profitable growth and reducing exposures in states we have targeted for profit improvement. While we expect to place greater emphasis on commercial growth for the foreseeable future, we desire to maintain a profitable book of personal business to provide enhanced stability across our product portfolio and increase our brand value to our independent agents. Donegal Mutual and our insurance subsidiaries offer personal lines products in ten states through a modern, user-friendly online agency portal. These products feature comprehensive coverage options, modernized rating methodology, enhanced pricing segmentation, application of predictive analytical models and utilization of third-party data to augment pricing and risk selection. Due to ongoing inflationary pressures on loss costs, we carefully managed personal lines exposure growth in 2023, while implementing premium rate increases throughout the year. In 2024, we plan to continue implementing premium rate increases and managing exposures to restore the profitability of our personal lines segment.
The following table sets forth the net premiums written of our insurance subsidiaries by line of insurance for the periods indicated:
| | | Year Ended December 31, | |
| | | 2023 | | | 2022 | | | 2021 | |
| (dollars in thousands) | | Amount | | | % | | | Amount | | | % | | | Amount | | | % | |
| Commercial lines: | | | | | | | | | | | | | | | | | | |
| Automobile | | $ | 174,741 | | | | 19.5 | % | | $ | 167,774 | | | | 19.9 | % | | $ | 161,947 | | | | 20.1 | % |
| Workers’ compensation | | | 107,598 | | | | 12.0 | | | | 111,892 | | | | 13.3 | | | | 113,256 | | | | 14.1 | |
| Commercial multi-peril | | | 195,632 | | | | 21.8 | | | | 200,045 | | | | 23.7 | | | | 188,242 | | | | 23.4 | |
| Other | | | 50,458 | | | | 5.7 | | | | 51,135 | | | | 6.0 | | | | 49,229 | | | | 6.1 | |
| Total commercial lines | | | 528,429 | | | | 59.0 | | | | 530,846 | | | | 62.9 | | | | 512,674 | | | | 63.7 | |
| Personal lines: | | | | | | | | | | | | | | | | | | | | | | | | |
| Automobile | | | 215,957 | | | | 24.1 | | | | 181,129 | | | | 21.5 | | | | 170,578 | | | | 21.2 | |
| Homeowners | | | 139,688 | | | | 15.6 | | | | 120,087 | | | | 14.2 | | | | 109,974 | | | | 13.7 | |
| Other | | | 11,623 | | | | 1.3 | | | | 11,468 | | | | 1.4 | | | | 11,041 | | | | 1.4 | |
| Total personal lines | | | 367,268 | | | | 41.0 | | | | 312,684 | | | | 37.1 | | | | 291,593 | | | | 36.3 | |
| Total business | | $ | 895,697 | | | | 100.0 | % | | $ | 843,530 | | | | 100.0 | % | | $ | 804,267 | | | | 100.0 | % |
The commercial lines and personal lines underwriting departments of our insurance subsidiaries evaluate and select those risks that they believe will enable our insurance subsidiaries to achieve an underwriting profit. Within each of the underwriting departments, our insurance subsidiaries have dedicated product development and management teams responsible for the development of quality products at competitive prices to promote growth and profitability as well as the enhancement of our current products to meet targeted customer needs.
In order to achieve underwriting profitability on a consistent basis, our insurance subsidiaries:
| • | assess and select primarily standard and preferred risks; |
| • | adhere to disciplined underwriting guidelines; |
| • | seek to price risks appropriately based on exposure, risk characteristics, utilization of predictive models and application of underwriting judgment; and |
| • | utilize various types of risk management and loss control services. |
Our insurance subsidiaries also review their existing portfolio of insured accounts to determine whether certain risks or classes of business continue to meet their underwriting guidelines and margin expectations. If a given account or class of business no longer meets those underwriting guidelines or margin expectations, our insurance subsidiaries will take appropriate action regarding that account or class of business, including raising premium rates or non-renewing policies to the extent applicable laws and regulations permit.
As part of the effort of our insurance subsidiaries to maintain acceptable underwriting results, they conduct annual reviews of agencies that have failed to meet their underwriting profitability criteria. The review process includes an analysis of the underwriting and re-underwriting practices of the agency, the completeness and accuracy of the applications the agency submits, the adequacy of the training of the agency’s staff and the agency’s record of adherence to the underwriting guidelines and service standards of our insurance subsidiaries. Based on the results of this review process, the marketing and underwriting personnel of our insurance subsidiaries develop, together with the agency, a plan to improve its underwriting profitability. Our insurance subsidiaries monitor the agency’s compliance with the plan and take other measures as required in the judgment of our insurance subsidiaries, including the termination, to the extent applicable laws and regulations permit, of agencies that are unable to achieve acceptable underwriting profitability.
Distribution
Our insurance subsidiaries market their products primarily in the Mid-Atlantic, Midwestern, New England, Southern and Southwestern regions through approximately 2,200 independent insurance agencies. At December 31, 2023, the Donegal Insurance Group actively wrote business in 23 states (Arizona, Colorado, Delaware, Georgia, Illinois, Indiana, Iowa, Maine, Maryland, Michigan, Nebraska, New Hampshire, New Mexico, North Carolina, Ohio, Pennsylvania, South Carolina, South Dakota, Tennessee, Texas, Utah, Virginia, and Wisconsin). Donegal Mutual includes the business it writes directly and assumes from the Mountain States insurance subsidiaries in five Southwestern states (Arizona, Colorado, New Mexico, Texas and Utah) in the pooling agreement between Donegal Mutual and Atlantic States. We believe the relationships of our insurance subsidiaries with their independent agents are valuable in identifying, obtaining and retaining profitable business. Our insurance subsidiaries maintain a stringent agency selection procedure that emphasizes appointing agencies with proven marketing strategies for the development of profitable business, and our insurance subsidiaries only appoint agencies with a strong underwriting history and potential growth capabilities. Our insurance subsidiaries also regularly evaluate the independent agencies that represent them based on their profitability and performance in relation to the objectives of our insurance subsidiaries. Our insurance subsidiaries seek to be among the top three insurers within each of their agencies for the lines of business our insurance subsidiaries write.
The following table sets forth the percentage of direct premiums our insurance subsidiaries write, including 80% of the direct premiums Donegal Mutual and Atlantic States include in the underwriting pool, in each of the states where they conducted a significant portion of their business in 2023:
| Pennsylvania | | | 36.7 | % |
| Michigan | | | 15.9 | |
| Maryland | | | 8.7 | |
| Delaware | | | 6.6 | |
| Virginia | | | 6.3 | |
| Ohio | | | 3.9 | |
| Georgia | | | 3.2 | |
| Wisconsin | | | 3.2 | |
| Indiana | | | 2.8 | |
| North Carolina | | | 2.4 | |
| Tennessee | | | 1.7 | |
| Other | | | 8.6 | |
| Total | | | 100.0 | % |
Our insurance subsidiaries employ a number of policies and procedures that we believe enable them to attract, retain and motivate their independent agents. We believe that the consistency of the product offerings of our insurance subsidiaries enables our insurance subsidiaries to compete effectively for independent agents with other insurers whose product offerings may fluctuate based upon industry conditions. Our multi-year systems modernization project is further enhancing the ability of our insurance subsidiaries to conduct business with their independent agents and to develop and implement new products. Our insurance subsidiaries have a competitive compensation program for their independent agents that includes base commissions, growth incentive plans and a profit-sharing plan, consistent with applicable state laws and regulations, under which the independent agents may earn additional commissions based upon the volume of premiums produced and the profitability of the business our insurance subsidiaries receive from that agency. We have an agency stock purchase plan that allows our independent agents to purchase our Class A common stock at a discount to market prices to further align the interests of our independent agents with the interests of our stockholders.
Our insurance subsidiaries encourage their independent agents to focus on “account selling,” or serving all of a particular insured’s property and casualty insurance needs, which our insurance subsidiaries believe generally results in more favorable loss experience than covering a single risk for an individual insured.
Technology
Donegal Mutual owns and manages the technology that our insurance subsidiaries utilize on a daily basis. The technology is comprised of highly integrated agency-facing and back-end processing systems that operate within an advanced, modernized infrastructure that provides high service levels for performance, reliability, security and availability. Donegal Mutual maintains disaster recovery and backup systems and tests these systems on a regular basis. Our insurance subsidiaries bear their proportionate share of information services expenses based on their respective percentage of the total net premiums written of the Donegal Insurance Group.
The business strategy and ultimate success of our insurance subsidiaries depends on the effectiveness of efficient and integrated business systems and technology infrastructure. These systems enable our insurance subsidiaries to provide quality service to agents and policyholders by processing business in a timely and dependable manner, communicate and share data with agents and provide a variety of methods for the payment of premiums. These systems also allow for the accumulation and analysis of data and information for the management of our insurance subsidiaries. Donegal Mutual is currently in the midst of a multi-year effort to modernize certain of its key infrastructure and applications systems we describe in more detail under “Business - Business Strategy - Strategically modernizing our operations and processes to transform our business.”
The modernized proficiency of these integrated technology systems facilitates high service levels for the agents and policyholders of our insurance subsidiaries, increased efficiencies in processing the business of our insurance subsidiaries and lower operating costs. Key components of these technology systems include agency interface systems, automated policy management systems, a claims processing system and a billing administration system. The agency interface systems provide our insurance subsidiaries with a comprehensive single source to facilitate data sharing both to and from agents’ systems and also provides agents with an integrated means of processing new business. The automated policy management systems provide agents with the ability to generate underwritten quotes and automatically issue policies that meet the underwriting guidelines of our insurance subsidiaries with limited or no intervention by their personnel. The claims processing system allows our insurance subsidiaries to process claims efficiently and in an automated environment. The billing administration system allows our insurance subsidiaries to process premium billing and collection efficiently and in an automated environment.
We believe Donegal Mutual’s agency-facing technology systems compare well against those of many national property and casualty insurance carriers in terms of feature capabilities and service levels. Donegal Mutual maintains a regular interactive forum with its independent agents to be proactive in identifying opportunities for continued automation and technology enhancements.
Claims
The management of claims is a critical component of the philosophy of our insurance subsidiaries to achieve underwriting profitability on a consistent basis and is fundamental to the successful operations of our insurance subsidiaries and their dedication to excellent service. Our senior claims management oversees the claims processing units of each of our insurance subsidiaries to assure consistency in the claims settlement process. The field office staff of our insurance subsidiaries receives support from home office technical, litigation, material damage, subrogation and medical audit personnel.
The claims departments of our insurance subsidiaries rigorously manage claims to assure that they settle legitimate claims quickly and fairly and that they identify questionable claims for defense. In the majority of cases, the personnel of our insurance subsidiaries, who have significant experience in the property and casualty insurance industry and know the service philosophy of our insurance subsidiaries, adjust claims. Our insurance subsidiaries provide various means of claims reporting on a 24-hours a day, seven-days a week basis, including toll-free numbers and electronic reporting through our website and mobile application. Our insurance subsidiaries strive to respond to notifications of claims promptly, generally within the day reported. Our insurance subsidiaries believe that, by responding promptly to claims, they provide quality customer service and minimize the ultimate cost of the claims. Our insurance subsidiaries engage independent adjusters as needed to handle claims in areas in which the volume of claims is not sufficient to justify the hiring of internal claims adjusters by our insurance subsidiaries. Our insurance subsidiaries also employ independent adjusters and private investigators, structural experts and outside legal counsel to supplement their internal staff and to assist in the investigation of claims. Our insurance subsidiaries have a special investigative unit primarily staffed by former law enforcement officers that attempts to identify and prevent fraud and abuse and to investigate questionable claims.
The management of the claims departments of our insurance subsidiaries develops and implements policies and procedures for the establishment of adequate claim reserves. Our insurance subsidiaries employ an actuarial staff that regularly reviews their reserves for incurred but not reported claims. The management and staff of the claims departments resolve policy coverage issues, manage and process reinsurance recoveries and handle salvage and subrogation matters. The litigation and personal injury sections of our insurance subsidiaries manage all claims litigation. Branch office claims above certain thresholds require home office review and settlement authorization. Our insurance subsidiaries provide their claims adjusters reserving and settlement authority based upon their experience and demonstrated abilities. Larger or more complicated claims require consultation and approval of senior claims department management.
Liabilities for Losses and Loss Expenses
Liabilities for losses and loss expenses are estimates at a given point in time of the amounts an insurer expects to pay with respect to incurred policyholder claims based on facts and circumstances the insurer knows at that point in time. For example, legislative, judicial and regulatory actions may expand coverage definitions, retroactively mandate coverage or otherwise require our insurance subsidiaries to pay losses for damages that their policies explicitly excluded or did not intend to cover. At the time of establishing its estimates, an insurer recognizes that its ultimate liability for losses and loss expenses will exceed or be less than such estimates. Our insurance subsidiaries base their estimates of liabilities for losses and loss expenses on assumptions as to future loss trends, expected claims severity, judicial theories of liability and other factors. However, during the loss adjustment period, our insurance subsidiaries may learn additional facts regarding individual claims, and, consequently, it often becomes necessary for our insurance subsidiaries to refine and adjust their estimates for these liabilities. We reflect any adjustments to the liabilities for losses and loss expenses of our insurance subsidiaries in our consolidated results of operations in the period in which our insurance subsidiaries make adjustments to their estimates.
Our insurance subsidiaries maintain liabilities for the payment of losses and loss expenses with respect to both reported and unreported claims. Our insurance subsidiaries establish these liabilities for the purpose of covering the ultimate costs of settling all losses, including investigation and litigation costs. Our insurance subsidiaries base the amount of their liability for reported losses primarily upon a case-by-case evaluation of the type of risk involved, knowledge of the circumstances surrounding each claim and the insurance policy provisions relating to the type of loss the policyholder incurred. Our insurance subsidiaries determine the amount of their liability for unreported claims and loss expenses on the basis of historical information by line of insurance. Our insurance subsidiaries account for inflation in the reserving function through analysis of costs and trends and reviews of historical reserving results. Our insurance subsidiaries monitor their liabilities closely and recompute them periodically using new information on reported claims and a variety of statistical techniques. Our insurance subsidiaries do not discount their liabilities for losses and loss expenses.
Reserve estimates can change over time because of unexpected changes in assumptions related to our insurance subsidiaries’ external environment and, to a lesser extent, assumptions related to our insurance subsidiaries’ internal operations. For example, our insurance subsidiaries have experienced an increase in claims severity and a lengthening of the claim settlement periods on bodily injury claims during the past several years. In addition, the COVID-19 pandemic and related government mandates and restrictions resulted in various changes from historical claims reporting and settlement trends during 2020 and resulted in significant increases in loss costs in 2022 and 2023 due to a number of factors, including supply chain disruption, higher new and used automobile values, increases in the cost of replacement automobile parts and rising labor rates. While these trend changes have begun to normalize, they caused significant disruption to historical loss patterns and give rise to greater uncertainty as to the pattern of future loss settlements. Related uncertainties regarding future trends include social inflation, availability and cost of replacement automobile parts and building materials, availability of skilled labor, the rate of plaintiff attorney involvement in claims and the cost of medical technologies and procedures. Assumptions related to our insurance subsidiaries’ external environment include the absence of significant changes in tort law and the legal environment that increase liability exposure, consistency in judicial interpretations of insurance coverage and policy provisions and the rate of loss cost inflation. Internal assumptions include consistency in the recording of premium and loss statistics, consistency in the recording of claims, payment and case reserving methodology, accurate measurement of the impact of rate changes and changes in policy provisions, consistency in the quality and characteristics of business written within a given line of business and consistency in reinsurance coverage and collectability of reinsured losses, among other items. To the extent our insurance subsidiaries determine that underlying factors impacting their assumptions have changed, our insurance subsidiaries make adjustments in their reserves that they consider appropriate for such changes. Accordingly, our insurance subsidiaries’ ultimate liability for unpaid losses and loss expenses will likely differ from the amount recorded at December 31, 2023. For every 1% change in our insurance subsidiaries’ loss and loss expense reserves, net of reinsurance recoverable, the effect on our pre-tax results of operations would be approximately $6.9 million.
The establishment of appropriate liabilities is an inherently uncertain process and we can provide no assurance that our insurance subsidiaries’ ultimate liability will not exceed our insurance subsidiaries’ loss and loss expense reserves and have an adverse effect on our results of operations and financial condition. Furthermore, we cannot predict the timing, frequency and extent of adjustments to our insurance subsidiaries’ estimated future liabilities, because the historical conditions and events that serve as a basis for our insurance subsidiaries’ estimates of ultimate claim costs may change. As is the case for substantially all property and casualty insurance companies, our insurance subsidiaries have found it necessary in the past to increase their estimated future liabilities for losses and loss expenses in certain periods and, in other periods, their estimated future liabilities for losses and loss expenses have exceeded their actual liabilities for losses and loss expenses. Changes in our insurance subsidiaries’ estimates of their liability for losses and loss expenses generally reflect actual payments and their evaluation of information received subsequent to the prior reporting period. Our insurance subsidiaries recognized a decrease in their liability for losses and loss expenses of prior years of $16.7 million, $44.8 million and $31.2 million in 2023, 2022 and 2021, respectively. Our insurance subsidiaries made no significant changes in their reserving philosophy or claims management personnel, and they have made no significant offsetting changes in estimates that increased or decreased their loss and loss expense reserves in those years. The 2023 development represented 2.5% of the December 31, 2022 net carried reserves and resulted primarily from lower-than-expected loss emergence in the personal automobile and commercial automobile lines of business for accident years prior to 2023. The majority of the 2023 development related to decreases in the liability for losses and loss expenses of prior years for Atlantic States and MICO. The 2022 development represented 7.2% of the December 31, 2021 net carried reserves and resulted primarily from lower-than-expected loss emergence in the personal automobile and commercial automobile lines of business for accident years prior to 2022. The majority of the 2022 development related to decreases in the liability for losses and loss expenses of prior years for Atlantic States and MICO. The 2021 development represented 5.6% of the December 31, 2020 net carried reserves and resulted primarily from lower-than-expected loss emergence in the personal automobile, workers’ compensation and commercial automobile lines of business for accident years prior to 2021. The majority of the 2021 development related to decreases in the liability for losses and loss expenses of prior years for Atlantic States and MICO.
Excluding the impact of severe weather events and the COVID-19 pandemic, our insurance subsidiaries have noted stable amounts in the number of claims incurred and the number of claims outstanding at period ends relative to their premium base in recent years across most of their lines of business. However, the amount of the average claim outstanding has increased gradually over the past several years due to various factors such as increased property and automobile repair and replacement costs, rising medical loss costs and increased litigation trends. We have also experienced a general slowing of settlement rates in litigated claims and lengthening of repair completion times for property and automobile claims. Our insurance subsidiaries could have to make further adjustments to their estimates in the future. However, on the basis of our insurance subsidiaries’ internal procedures, which analyze, among other things, their prior assumptions, their experience with similar cases and historical trends such as reserving patterns, loss payments, pending levels of unpaid claims and product mix, as well as court decisions, economic conditions and public attitudes, we believe that our insurance subsidiaries have made adequate provision for their liability for losses and loss expenses.
Atlantic States’ participation in the underwriting pool with Donegal Mutual exposes Atlantic States to adverse loss development on the business that Donegal Mutual contributes to the underwriting pool. However, pooled business represents the predominant percentage of the net underwriting activity of both companies, and Donegal Mutual and Atlantic States share proportionately any adverse risk development relating to the pooled business. The business in the underwriting pool is homogeneous, and each company has a pro-rata share of the entire underwriting pool. Since the predominant percentage of the business of Atlantic States and Donegal Mutual is pooled and the results shared by each company according to its participation level under the terms of the pooling agreement, the intent of the underwriting pool is to produce a more uniform and stable underwriting result from year to year for each company than either would experience individually and to spread the risk of loss between the companies.
Differences between liabilities reported in our financial statements prepared on a GAAP basis and our insurance subsidiaries’ financial statements prepared on a SAP basis result from anticipating salvage and subrogation recoveries for GAAP but not for SAP. These differences amounted to $32.4 million, $28.7 million and $23.5 million at December 31, 2023, 2022 and 2021, respectively.
The following table sets forth a reconciliation of the beginning and ending GAAP net liability of our insurance subsidiaries for unpaid losses and loss expenses for the periods indicated:
| | | Year Ended December 31, | |
| (in thousands) | | 2023 | | | 2022 | | | 2021 | |
| Gross liability for unpaid losses and loss expenses at beginning of year | | $ | 1,121,046 | | | $ | 1,077,620 | | | $ | 962,007 | |
| Less reinsurance recoverable | | | 451,184 | | | | 451,261 | | | | 404,818 | |
| Cumulative effect of adoption of updated accounting guidance for credit losses at January 1 | | | 1,132 | | | | — | | | | — | |
| Net liability for unpaid losses and loss expenses at beginning of year | | | 670,994 | | | | 626,359 | | | | 557,189 | |
Provision for net losses and loss expenses for claims incurred in the current year | | | 625,831 | | | | 608,900 | | | | 551,918 | |
Change in provision for estimated net losses and loss expenses for claims incurred in prior years | | | (16,653 | ) | | | (44,821 | ) | | | (31,208 | ) |
| Total incurred | | | 609,178 | | | | 564,079 | | | | 520,710 | |
| Net losses and loss expense payments for claims incurred during: | | | | | | | | | | | | |
| The current year | | | 330,290 | | | | 302,272 | | | | 269,317 | |
| Prior years | | | 260,739 | | | | 218,304 | | | | 182,223 | |
| Total paid | | | 591,029 | | | | 520,576 | | | | 451,540 | |
| Net liability for unpaid losses and loss expenses at end of year | | | 689,143 | | | | 669,862 | | | | 626,359 | |
| Plus reinsurance recoverable | | | 437,014 | | | | 451,184 | | | | 451,261 | |
| Gross liability for unpaid losses and loss expenses at end of year | | $ | 1,126,157 | | | $ | 1,121,046 | | | $ | 1,077,620 | |
The following table sets forth the development of the liability for net unpaid losses and loss expenses of our insurance subsidiaries from 2013 to 2023. Loss data in the table includes business Atlantic States received from the underwriting pool.
“Net liability at end of year for unpaid losses and loss expenses” sets forth the estimated liability for net unpaid losses and loss expenses recorded at the balance sheet date for each of the indicated years. This liability represents the estimated amount of net losses and loss expenses for claims arising in the current and all prior years that are unpaid at the balance sheet date, including losses incurred but not reported.
The “Net liability re-estimated as of” portion of the table shows the re-estimated amount of the previously recorded liability based on experience for each succeeding year. The estimate increases or decreases as payments are made and more information becomes known about the severity of the remaining unpaid claims. For example, the 2013 liability has developed a deficiency after ten years because we expect the re-estimated net losses and loss expenses to be $23.7 million more than the estimated liability we initially established in 2013 of $265.6 million.
The “Cumulative deficiency (excess)” shows the cumulative deficiency or excess at December 31, 2023 of the liability estimate shown on the top line of the corresponding column. A deficiency in liability means that the liability established in prior years was less than the amount of actual payments and currently re-estimated remaining unpaid liability. An excess in liability means that the liability established in prior years exceeded the amount of actual payments and currently re-estimated unpaid liability remaining.
The “Cumulative amount of liability paid through” portion of the table shows the cumulative net losses and loss expense payments made in succeeding years for net losses incurred prior to the balance sheet date. For example, the 2013 column indicates that at December 31, 2023 payments equal to $282.0 million of the currently re-estimated ultimate liability for net losses and loss expenses of $289.3 million had been made.
| | | Year Ended December 31, | |
| (in thousands) | | 2013 | | | 2014 | | | 2015 | | | 2016 | | | 2017 | | | 2018 | | | 2019 | | | 2020 | | | 2021 | | | 2022 | | | 2023 | |
| Net liability at end of year for unpaid losses and loss expenses | | $ | 265,605 | | | $ | 292,301 | | | $ | 322,054 | | | $ | 347,518 | | | $ | 383,401 | | | $ | 475,398 | | | $ | 506,906 | | | $ | 557,189 | | | $ | 626,359 | | | $ | 669,862 | | | $ | 689,143 | |
| Net liability re-estimated as of: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
One year later | | | 280,074 | | | | 299,501 | | | | 325,043 | | | | 354,139 | | | | 419,032 | | | | 462,466 | | | | 493,961 | | | | 525,981 | | | | 581,538 | | | | 653,209 | | | | | |
Two years later | | | 281,782 | | | | 299,919 | | | | 329,115 | | | | 375,741 | | | | 413,535 | | | | 450,862 | | | | 479,927 | | | | 498,724 | | | | 564,326 | | | | | | | | | |
Three years later | | | 281,666 | | | | 304,855 | | | | 338,118 | | | | 376,060 | | | | 404,902 | | | | 440,168 | | | | 463,441 | | | | 490,177 | | | | | | | | | | | | | |
Four years later | | | 284,429 | | | | 307,840 | | | | 339,228 | | | | 372,230 | | | | 398,560 | | | | 432,027 | | | | 459,835 | | | | | | | | | | | | | | | | | |
Five years later | | | 285,130 | | | | 310,354 | | | | 338,020 | | | | 370,960 | | | | 396,695 | | | | 431,115 | | | | | | | | | | | | | | | | | | | | | |
Six years later | | | 287,439 | | | | 310,380 | | | | 338,200 | | | | 372,346 | | | | 396,748 | | | | | | | | | | | | | | | | | | | | | | | | | |
Seven years later | | | 287,063 | | | | 311,594 | | | | 339,625 | | | | 371,859 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Eight years later | | | 288,298 | | | | 313,354 | | | | 340,191 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Nine years later | | | 289,066 | | | | 313,539 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Ten years later | | | 289,278 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Cumulative deficiency (excess) | | | 23,673 | | | | 21,238 | | | | 18,137 | | | | 24,341 | | | | 13,347 | | | | (44,283 | ) | | | (47,071 | ) | | | (67,012 | ) | | | (62,033 | ) | | | (16,653 | ) | | | | |
| Cumulative amount of liability paid through: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
One year later | | $ | 131,766 | | | $ | 131,779 | | | $ | 149,746 | | | $ | 163,005 | | | $ | 175,883 | | | $ | 195,956 | | | $ | 172,497 | | | $ | 182,223 | | | $ | 218,304 | | | $ | 260,739 | | | | | |
Two years later | | | 194,169 | | | | 206,637 | | | | 228,506 | | | | 250,678 | | | | 276,331 | | | | 275,993 | | | | 276,069 | | | | 297,860 | | | | 346,107 | | | | | | | | | |
Three years later | | | 233,371 | | | | 251,654 | | | | 274,235 | | | | 306,338 | | | | 317,447 | | | | 335,310 | | | | 343,912 | | | | 374,043 | | | | | | | | | | | | | |
Four years later | | | 255,451 | | | | 274,248 | | | | 300,715 | | | | 324,628 | | | | 342,583 | | | | 371,231 | | | | 393,068 | | | | | | | | | | | | | | | | | |
Five years later | | | 265,841 | | | | 287,178 | | | | 309,630 | | | | 337,946 | | | | 362,061 | | | | 394,251 | | | | | | | | | | | | | | | | | | | | | |
Six years later | | | 272,431 | | | | 292,327 | | | | 315,105 | | | | 349,496 | | | | 372,584 | | | | | | | | | | | | | | | | | | | | | | | | | |
Seven years later | | | 275,357 | | | | 295,106 | | | | 321,777 | | | | 355,809 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Eight years later | | | 277,315 | | | | 300,306 | | | | 326,617 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Nine years later | | | 279,928 | | | | 303,708 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Ten years later | | | 282,030 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Year Ended December 31, | |
| (in thousands) | | 2015 | | | 2016 | | | 2017 | | | 2018 | | | 2019 | | | 2020 | | | 2021 | | | 2022 | | | 2023 | |
| Gross liability at end of year | | $ | 578,205 | | | $ | 606,665 | | | $ | 676,672 | | | $ | 814,665 | | | $ | 869,674 | | | $ | 962,007 | | | $ | 1,077,620 | | | $ | 1,121,046 | | | $ | 1,126,157 | |
| Reinsurance recoverable | | | 256,151 | | | | 259,147 | | | | 293,271 | | | | 339,266 | | | | 362,768 | | | | 404,818 | | | | 451,261 | | | | 451,184 | | | | 437,014 | |
| Net liability at end of year | | | 322,054 | | | | 347,518 | | | | 383,401 | | | | 475,398 | | | | 506,906 | | | | 557,189 | | | | 626,359 | | | | 669,862 | | | | 689,143 | |
| Gross re-estimated liability | | | 593,565 | | | | 626,950 | | | | 682,354 | | | | 758,861 | | | | 797,903 | | | | 883,492 | | | | 950,867 | | | | 1,047,996 | | | | | |
| Re-estimated recoverable | | | 253,374 | | | | 255,091 | | | | 285,606 | | | | 327,746 | | | | 338,068 | | | | 393,315 | | | | 386,541 | | | | 394,787 | | | | | |
| Net re-estimated liability | | | 340,191 | | | | 371,859 | | | | 396,748 | | | | 431,115 | | | | 459,835 | | | | 490,177 | | | | 564,326 | | | | 653,209 | | | | | |
| Gross cumulative deficiency (excess) | | | 15,360 | | | | 20,285 | | | | 5,682 | | | | (55,804 | ) | | | (71,771 | ) | | | (78,515 | ) | | | (126,753 | ) | | | (73,050 | ) | | | | |
Third-Party Reinsurance
Our insurance subsidiaries and Donegal Mutual purchase certain third-party reinsurance on a combined basis. Our insurance subsidiaries use several different reinsurers, all of which, consistent with the requirements of our insurance subsidiaries and Donegal Mutual, have an A.M. Best rating of A- (Excellent) or better or, with respect to foreign reinsurers, have a financial condition that, in the opinion of our management, is equivalent to a company with at least an A- (Excellent) rating from A.M. Best.
The external reinsurance our insurance subsidiaries and Donegal Mutual purchased for 2023 included:
| • | excess of loss reinsurance, under which Donegal Mutual and our insurance subsidiaries recovered losses over a set retention of $3.0 million for all losses except workers’ compensation, for which the set retention was $2.0 million (set retention of $4.0 million for all property losses and $3.0 million retention for all casualty and workers’ compensation losses for 2024); and |
| • | catastrophe reinsurance, under which Donegal Mutual and our insurance subsidiaries recovered 100% of an accumulation of many losses resulting from a single event, including natural disasters, over a set retention of $25.0 million up to aggregate losses of $175.0 million per occurrence (no change for 2024). |
For property insurance, our insurance subsidiaries had excess of loss reinsurance that provided for coverage of $37.0 million per loss over a set retention of $3.0 million ($36.0 million per loss over a set retention of $4.0 million for 2024). For liability insurance, our insurance subsidiaries had excess of loss reinsurance that provided for coverage of $72.0 million per occurrence over a set retention of $3.0 million (no change for 2024). For workers’ compensation insurance, our insurance subsidiaries had excess of loss reinsurance that provided for coverage of $18.0 million on any one life over a set retention of $2.0 million ($17.0 million on any one life over a set retention of $3.0 million for 2024).
Our insurance subsidiaries and Donegal Mutual also purchased facultative reinsurance to cover certain exposures, including property exposures that exceeded the limits provided by their respective treaty reinsurance.
Investments
At December 31, 2023, 95.2% of all debt securities our insurance subsidiaries held had an investment-grade rating. The investment portfolios of our insurance subsidiaries did not contain any mortgage loans or any non-performing assets at December 31, 2023.
The following table shows the composition of the debt securities (at carrying value) in the investment portfolios of our insurance subsidiaries, excluding short-term investments, by rating at December 31, 2023:
| (dollars in thousands) | | December 31, 2023 | |
Rating(1) | | Amount | | | Percent | |
U.S. Treasury and U.S. agency securities(2) | | $ | 455,251 | | | | 35.9 | % |
| Aaa or AAA | | | 22,270 | | | | 1.8 | |
| Aa or AA | | | 346,977 | | | | 27.3 | |
| A | | | 205,259 | | | | 16.2 | |
| BBB | | | 179,265 | | | | 14.1 | |
| BB | | | 61,149 | | | | 4.8 | |
| Allowance for expected credit losses | | | (1,326 | ) | | | (0.1 | ) |
| Total | | $ | 1,268,845 | | | | 100.0 | % |
| | (1) | Ratings assigned by Moody’s Investors Services, Inc. or Standard & Poor’s Corporation. |
| | (2) | Includes mortgage-backed securities of $278.3 million. |
Our insurance subsidiaries invest in both taxable and tax-exempt securities as part of their strategy to maximize after-tax income. Tax-exempt securities made up approximately 18.2%, 19.9% and 21.1% of the fixed-maturity securities in the combined investment portfolios of our insurance subsidiaries at December 31, 2023, 2022 and 2021, respectively.
The following table shows the classification of our investments and the investments of our insurance subsidiaries at December 31, 2023, 2022 and 2021 (at carrying value):
| | | December 31, | |
| | | 2023 | | | 2022 | | | 2021 | |
| (dollars in thousands) | | Amount | | | Percent of Total | | | Amount | | | Percent of Total | | | Amount | | | Percent of Total | |
Fixed maturities(1): | | | | | | | | | | | | | | | | | | |
| Held to maturity: | | | | | | | | | | | | | | | | | | |
| U.S. Treasury securities and obligations of U.S. government corporations and agencies | | $ | 91,517 | | | | 6.9 | % | | $ | 103,362 | | | | 7.9 | % | | $ | 89,268 | | | | 7.0 | % |
Obligations of states and political subdivisions | | | 376,898 | | | | 28.4 | | | | 382,097 | | | | 29.3 | | | | 371,436 | | | | 29.1 | |
| Corporate securities | | | 201,847 | | | | 15.2 | | | | 190,949 | | | | 14.6 | | | | 191,147 | | | | 15.0 | |
Mortgage-backed securities | | | 9,235 | | | | 0.7 | | | | 12,031 | | | | 1.0 | | | | 16,254 | | | | 1.2 | |
| Total held to maturity | | | 679,497 | | | | 51.2 | | | | 688,439 | | | | 52.8 | | | | 668,105 | | | | 52.3 | |
| Available for sale: | | | | | | | | | | | | | | | | | | | | | | | | |
| U.S. Treasury securities and obligations of U.S. government corporations and agencies | | | 85,419 | | | | 6.4 | | | | 63,521 | | | | 4.9 | | | | 32,185 | | | | 2.5 | |
Obligations of states and political subdivisions | | | 38,116 | | | | 2.9 | | | | 40,156 | | | | 3.1 | | | | 57,378 | | | | 4.5 | |
| Corporate securities | | | 196,793 | | | | 14.8 | | | | 202,838 | | | | 15.5 | | | | 221,611 | | | | 17.4 | |
Mortgage-backed securities | | | 269,020 | | | | 20.3 | | | | 217,277 | | | | 16.6 | | | | 221,455 | | | | 17.3 | |
| Total available for sale | | | 589,348 | | | | 44.4 | | | | 523,792 | | | | 40.1 | | | | 532,629 | | | | 41.7 | |
| Total fixed maturities | | | 1,268,845 | | | | 95.6 | | | | 1,212,231 | | | | 92.9 | | | | 1,200,734 | | | | 94.0 | |
Equity securities(2) | | | 25,903 | | | | 2.0 | | | | 35,105 | | | | 2.7 | | | | 63,420 | | | | 5.0 | |
Short-term investments(3) | | | 32,306 | | | | 2.4 | | | | 57,321 | | | | 4.4 | | | | 12,692 | | | | 1.0 | |
| Total investments | | $ | 1,327,054 | | | | 100.0 | % | | $ | 1,304,657 | | | | 100.0 | % | | $ | 1,276,846 | | | | 100.0 | % |
| (1) | We refer to Notes 1 and 4 to our Consolidated Financial Statements. We value those fixed maturities we classify as held to maturity at amortized cost; we value those fixed maturities we classify as available for sale at fair value. The total fair value of fixed maturities we classified as held to maturity was $611.5 million at December 31, 2023, $598.0 million at December 31, 2022 and $697.4 million at December 31, 2021. The amortized cost of fixed maturities we classified as available for sale was $629.7 million at December 31, 2023, $571.9 million at December 31, 2022 and $523.3 million at December 31, 2021. |
| (2) | We value equity securities at fair value. The total cost of equity securities was $18.8 million at December 31, 2023, $30.8 million at December 31, 2022 and $43.3 million at December 31, 2021. |
| (3) | We value short-term investments at cost, which approximates fair value. |
The following table sets forth the maturities (at carrying value) in the fixed maturity portfolio of our insurance subsidiaries at December 31, 2023, 2022 and 2021:
| | | December 31, | |
| | | 2023 | | | 2022 | | | 2021 | |
| (dollars in thousands) | | Amount | | | Percent of Total | | | Amount | | | Percent of Total | | | Amount | | | Percent of Total | |
Due in(1): | | | | | | | | | | | | | | | | | | |
One year or less | | $ | 54,392 | | | | 4.3 | % | | $ | 39,094 | | | | 3.2 | % | | $ | 48,771 | | | | 4.1 | % |
Over one year through three years | | | 130,158 | | | | 10.3 | | | | 107,689 | | | | 8.9 | | | | 93,100 | | | | 7.7 | |
Over three years through five years | | | 141,994 | | | | 11.2 | | | | 133,068 | | | | 11.0 | | | | 120,038 | | | | 10.0 | |
Over five years through ten years | | | 347,035 | | | | 27.3 | | | | 357,114 | | | | 29.5 | | | | 362,266 | | | | 30.2 | |
Over ten years through fifteen years | | | 201,585 | | | | 15.9 | | | | 191,118 | | | | 15.8 | | | | 165,327 | | | | 13.8 | |
Over fifteen years | | | 116,747 | | | | 9.2 | | | | 154,840 | | | | 12.7 | | | | 173,523 | | | | 14.4 | |
Mortgage-backed securities | | | 278,260 | | | | 21.9 | | | | 229,308 | | | | 18.9 | | | | 237,709 | | | | 19.8 | |
| Allowance for expected credit losses | | | (1,326 | ) | | | (0.1 | ) | | | — | | | | — | | | | — | | | | — | |
| | | $ | 1,268,845 | | | | 100.0 | % | | $ | 1,212,231 | | | | 100.0 | % | | $ | 1,200,734 | | | | 100.0 | % |
| (1) | Based on stated maturity dates with no prepayment assumptions. Actual maturities will differ because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. |
As shown above, our insurance subsidiaries held investments in mortgage-backed securities having a carrying value of $278.3 million at December 31, 2023. The mortgage-backed securities consist primarily of investments in governmental agency balloon pools with stated maturities between one and 34 years. The stated maturities of these investments limit the exposure of our insurance subsidiaries to extension risk in the event that interest rates rise and prepayments decline. Our insurance subsidiaries perform an analysis of the underlying loans when evaluating a mortgage-backed security for purchase, and they select those securities that they believe will provide a return that properly reflects the prepayment risk associated with the underlying loans.
The following table sets forth the investment results of our insurance subsidiaries for the years ended December 31, 2023, 2022 and 2021:
| | | Year Ended December 31, | |
| (dollars in thousands) | | 2023 | | | 2022 | | | 2021 | |
Invested assets(1) | | $ | 1,315,855 | | | $ | 1,290,752 | | | $ | 1,249,024 | |
Investment income(2) | | | 40,853 | | | | 34,016 | | | | 31,126 | |
| Average yield | | | 3.1 | % | | | 2.6 | % | | | 2.5 | % |
| Average tax-equivalent yield | | | 3.2 | | | | 2.7 | | | | 2.6 | |
| (1) | Average of the aggregate invested amounts at the beginning and end of the period. |
| (2) | Investment income is net of investment expenses and does not include investment gains or losses or provision for income taxes. |
A.M. Best Rating
Donegal Mutual and our insurance subsidiaries have an A.M. Best rating of A (Excellent), based upon the respective current financial condition and historical statutory results of operations of Donegal Mutual and our insurance subsidiaries. We believe that the A.M. Best rating of Donegal Mutual and our insurance subsidiaries is an important factor in their marketing of their products to their agents and customers. A.M. Best’s ratings are industry ratings based on a comparative analysis of the financial condition and operating performance of insurance companies. A.M. Best’s classifications are A++ and A+ (Superior), A and A- (Excellent), B++ and B+ (Good), B and B- (Fair), C++ and C+ (Marginal), C and C- (Weak), D (Poor), E (Under Regulatory Supervision), F (Liquidation) and S (Suspended). A.M. Best bases its ratings upon factors relevant to the payment of claims of policyholders and are not directed toward the protection of investors in insurance companies. According to A.M. Best, the “Excellent” rating that the Donegal Insurance Group maintains is assigned to those companies that, in A.M. Best’s opinion, have an excellent ability to meet their ongoing insurance obligations.
Regulation
The supervision and regulation of insurance companies consists primarily of the laws and regulations of the various states in which the insurance companies transact business, with the primary regulatory authority being the insurance regulatory authorities in the state of domicile of the insurance company. Such supervision and regulation relate to numerous aspects of an insurance company’s business and financial condition. The primary purpose of such supervision and regulation is the protection of policyholders. The authority of the state insurance departments includes the establishment of standards of solvency that insurers must meet and maintain, the licensing of insurers and insurance agents to do business, the nature of, and limitations on, investments, premium rates for property and casualty insurance, the provisions that insurers must make for current losses and future liabilities, the deposit of securities for the benefit of policyholders, the approval of policy forms, notice requirements for the cancellation of policies and the approval of certain changes in control. State insurance departments also conduct periodic examinations of the affairs of insurance companies and require the filing of annual and other reports relating to the financial condition of insurance companies.
In addition to state-imposed insurance laws and regulations, the National Association of Insurance Commissioners, or the NAIC, maintains a risk-based capital system, or RBC, for assessing the adequacy of the statutory capital and surplus of insurance companies that augments the states’ current fixed dollar minimum capital requirements for insurance companies. At December 31, 2023, our insurance subsidiaries and Donegal Mutual each exceeded the minimum levels of statutory capital the RBC rules require by a substantial margin.
Generally, every state has guaranty fund laws under which insurers licensed to do business in that state can be assessed on the basis of premiums written by the insurer in that state in order to fund policyholder liabilities of insolvent insurance companies. Under these laws in general, an insurer is subject to assessment, depending upon its market share of a given line of business, to assist in the payment of policyholder claims against insolvent insurers. Our insurance subsidiaries and Donegal Mutual have made accruals for their portion of assessments related to such insolvencies based upon the most current information furnished by the guaranty associations.
We are part of an insurance holding company system of which Donegal Mutual is the ultimate controlling person. All of the states in which our insurance companies and Donegal Mutual maintain a domicile have legislation that regulates insurance holding company systems. Each insurance company in the insurance holding company system must register with the insurance supervisory agency of its state of domicile and furnish information concerning the operations of companies within the insurance holding company system that may materially affect the operations, management or financial condition of the insurers within the system. Pursuant to these laws, the respective insurance departments in which our subsidiaries and Donegal Mutual maintain a domicile may examine our insurance subsidiaries or Donegal Mutual at any time, require disclosure of material transactions by the holding company with another member of the insurance holding company system and require prior notice or prior approval of certain transactions, such as “extraordinary dividends” from the insurance subsidiaries to the holding company. We have insurance subsidiaries domiciled in Michigan, Pennsylvania and Virginia.
The Pennsylvania Insurance Holding Companies Act, which generally applies to Donegal Mutual, us and our insurance subsidiaries, requires that all transactions within an insurance holding company system to which an insurer is a party must be fair and reasonable and that any charges or fees for services performed must be reasonable. Any management agreement, service agreement, cost sharing arrangement and material reinsurance agreement must be filed with the Pennsylvania Insurance Department, or the Department, and is subject to the Department’s review. We have filed with the Department the pooling agreement between Donegal Mutual and Atlantic States that established the underwriting pool and all material agreements between Donegal Mutual and our insurance subsidiaries.
Approval of the applicable insurance commissioner is also required prior to consummation of transactions affecting the control of an insurer. In virtually all states, including the states where our insurance subsidiaries are domiciled, the acquisition of 10% or more of the outstanding capital stock of an insurer or its holding company or the intent to acquire such an interest creates a rebuttable presumption of a change in control. Pursuant to an order issued in April 2003, the Department approved Donegal Mutual’s ownership of up to 70% of our outstanding Class A common stock and Donegal Mutual’s ownership of up to 100% of our outstanding Class B common stock.
Our insurance subsidiaries have the legal obligation under state insurance laws to participate in involuntary insurance programs for automobile insurance, as well as other property and casualty insurance lines, in the states in which they conduct business. These programs include joint underwriting associations, assigned risk plans, fair access to insurance requirements plans, reinsurance facilities, windstorm plans and tornado plans. Legislation establishing these programs requires all companies that write lines covered by these programs to provide coverage, either directly or through reinsurance, for insureds who are unable to obtain insurance in the voluntary market. The legislation creating these programs usually allocates a pro rata portion of risks attributable to such insureds to each company on the basis of the direct premiums it has written in that state or the number of automobiles it insures in that state. Generally, state law requires participation in these programs as a condition to obtaining a certificate of authority. Our loss ratio on insurance we write under these involuntary programs has traditionally been significantly greater than our loss ratio on insurance we voluntarily write in those states.
Regulatory requirements, including RBC requirements, may impact our insurance subsidiaries’ ability to pay dividends. The amount of statutory capital and surplus necessary for our insurance subsidiaries to satisfy regulatory requirements, including RBC requirements, was not significant in relation to our insurance subsidiaries’ statutory capital and surplus at December 31, 2023. Generally, the maximum amount that one of our insurance subsidiaries may pay to us as ordinary dividends during any year after notice to, but without prior approval of, the insurance commissioner of its domiciliary state is limited to a stated percentage of that subsidiary’s statutory capital and surplus at December 31 of the preceding fiscal year or the net income of that subsidiary for its preceding fiscal year. Our insurance subsidiaries paid dividends to us of $13.0 million and $5.0 million in 2023 and 2021, respectively. Our insurance subsidiaries did not pay any dividends to us in 2022. At December 31, 2023, the amount of ordinary dividends our insurance subsidiaries could pay to us during 2024, without the prior approval of their respective domiciliary insurance commissioners, is shown in the following table.
| Name of Insurance Subsidiary | | Ordinary Dividend Amount | |
| | | |
| Atlantic States | | $ | 27,362,614 | |
| MICO | | | 7,160,857 | |
| Peninsula | | | 5,039,840 | |
| Southern | | | — | |
| Total | | $ | 39,563,311 | |
Donegal Mutual Insurance Company
Donegal Mutual organized as a mutual fire insurance company in Pennsylvania in 1889. At December 31, 2023, Donegal Mutual had admitted assets of $712.8 million and policyholders’ surplus of $364.2 million. At December 31, 2023, Donegal Mutual had total liabilities of $348.6 million, including reserves for net losses and loss expenses of $161.5 million and unearned premiums of $71.5 million. Donegal Mutual’s investment portfolio of $448.9 million at December 31, 2023 consisted primarily of investment-grade bonds of $212.1 million and its investment in our Class A common stock and our Class B common stock. At December 31, 2023, Donegal Mutual owned 12,095,090 shares, or approximately 44%, of our Class A common stock, which Donegal Mutual carried on its books at $151.7 million, and 4,708,570 shares, or approximately 84%, of our Class B common stock, which Donegal Mutual carried on its books at $59.0 million. We present Donegal Mutual’s financial information in accordance with SAP as the NAIC Accounting Practices and Procedures Manual requires. Donegal Mutual does not, nor is it required to, prepare financial statements in accordance with GAAP.
Information about Our Executive Officers
The following table sets forth information regarding the executive officers of Donegal Mutual and the Registrant as of the date of this Form 10-K Report:
| Name | | Age | | Position |
| Kevin G. Burke | | 58 | | President and Chief Executive Officer of us since 2015; President and Chief Executive Officer of Donegal Mutual since 2018; Executive Vice President and Chief Operating Officer of Donegal Mutual from 2014 to 2018; Senior Vice President of Human Resources of Donegal Mutual and us from 2005 to 2014; other positions from 2000 to 2005. |
| W. Daniel DeLamater | | 51 | | Executive Vice President and Chief Operating Officer of Donegal Mutual and us since 2024; Senior Vice President of us from 2022 to 2024; Senior Vice President and Head of Field Operations & National Accounts of Donegal Mutual from 2022 to 2024; Senior Vice President of National Accounts for Donegal Mutual from 2020 to 2022; President of Southern Mutual Insurance Company since 2016; other positions at Southern Mutual Insurance Company from 2000 to 2016. |
| Jeffrey D. Miller | | 59 | | Executive Vice President and Chief Financial Officer of Donegal Mutual and us since 2014; Senior Vice President and Chief Financial Officer of Donegal Mutual and us from 2005 to 2014; other positions from 1993 to 2005. |
| Kristi S. Altshuler | | 43 | | Senior Vice President and Chief Analytics Officer of us since 2020; Senior Vice President and Chief Analytics Officer of Donegal Mutual since 2019; Director of Willis Towers Watson from 2018 to 2019; Director of Pricing Innovation of USAA from 2014 to 2018; other positions at USAA from 2001 to 2014. |
| Noland R. Deas, Jr. | | 56 | | Senior Vice President of Field Operations & National Accounts of Donegal Mutual and Senior Vice President of us since 2024; Senior Regional Vice President of Donegal Mutual from 2022 to 2024 and Regional Vice President of Donegal Mutual from 2020 to 2022; other positions with Donegal Mutual from 2006 to 2020. |
| William A. Folmar | | 65 | | Senior Vice President of Claims of Donegal Mutual and Senior Vice President of us since 2019; Vice President of Claims of Donegal Mutual from 2010 to 2019; other positions from 1998 to 2010. |
| Jeffery T. Hay | | 49 | | Senior Vice President and Chief Underwriting Officer of Donegal Mutual and Senior Vice President of us since 2021; Senior Director of Willis Towers Watson from 2018 to 2021; Head of Personal Lines Product Management of The Hartford from 2015 to 2018; other positions at The Hartford from 2005 to 2015. |
| Christina M. Hoffman | | 49 | | Senior Vice President and Chief Risk Officer of Donegal Mutual and us since 2019; Senior Vice President of Internal Audit of Donegal Mutual and Senior Vice President of us from 2013 to 2019; Vice President of Internal Audit of Donegal Mutual and Vice President of us from 2009 to 2013. |
| Matthew T. Hudnall | | 46 | | Senior Vice President of Commercial Lines of Donegal Mutual and Senior Vice President of us since 2022; Senior Vice President of Underwriting of Preferred Mutual from 2021 to 2022; Vice President of Small Commercial Underwriting of Hanover Insurance Group from 2016 to 2021; Vice President of Casualty Underwriting at Hanover Insurance Group from 2013 to 2016. |
| Robert R. Long, Jr. | | 65 | | Senior Vice President and General Counsel of Donegal Mutual and us since 2018; Vice President and House Counsel of Donegal Mutual from 2012 to 2018; other positions from 2010 to 2012. |
| Sanjay Pandey | | 57 | | Senior Vice President and Chief Information Officer of Donegal Mutual and us since 2013; other positions from 2000 to 2013. |
| David W. Sponic | | 59 | | Senior Vice President of Personal Lines of Donegal Mutual and Senior Vice President of us since 2022; Vice President of Personal Lines of Donegal Mutual from 2008 to 2022; other positions from 1990 to 2008. |
| V. Anthony Viozzi | | 50 | | Senior Vice President and Chief Investment Officer of Donegal Mutual and us since 2012; Vice President of Investments of Donegal Mutual and us from 2007 to 2012. |
| Daniel J. Wagner | | 63 | | Senior Vice President and Treasurer of Donegal Mutual and us since 2005; other positions from 1987 to 2005. |
Cautionary Statement Regarding Forward-Looking Statements
This Form 10-K Report and the documents we incorporate by reference in this Form 10-K Report contain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include certain discussions relating to underwriting, premium and investment income volumes, business strategies, reserves, profitability, Donegal Mutual’s ongoing information systems implementation, business relationships and our other business activities during 2023 and beyond. In some cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “could,” “would,” “expect,” “plan,” “intend,” “anticipate,” “believe,” “estimate,” “objective,” “project,” “predict,” “potential,” “goal” and similar expressions. These forward-looking statements reflect our current views about future events and our current assumptions, and are subject to known and unknown risks and uncertainties that may cause our results, performance or achievements to differ materially from those we anticipate or imply by our forward-looking statements. We cannot control or predict many of the factors that could determine our future financial condition or results of operations. Such factors may include those we describe under “Risk Factors.” The forward-looking statements contained in this Form 10-K Report reflect our views and assumptions only as of the date of this Form 10-K Report. Except as required by law, we do not intend to update, and we assume no responsibility for updating, any forward-looking statements we have made. We qualify all of our forward-looking statements by these cautionary statements.
Risk Factors
Risks Relating to the Property and Casualty Insurance Industry
Industry trends, such as increasing loss severity due to higher rates of litigation against the insurance industry and individual insurers, the willingness of courts to expand covered causes of loss, rising jury awards, escalating medical, automobile and property repair costs and other factors may contribute to increased costs and result in ultimate loss settlements that exceed the reserves of our insurance subsidiaries.
Loss severity in the property and casualty insurance industry has increased in recent years, principally driven by factors such as distracted driving, larger court judgments, higher jury awards and increasing medical and automobile and property repair costs, including increases due to inflation and supply chain disruption. In addition, many classes of complainants have brought legal actions and proceedings that tend to increase the size of judgments. The propensity of policyholders and third-party claimants to litigate and the willingness of courts to expand causes of loss and the size of awards, to eliminate exclusions and to increase coverage limits may result in ultimate settlements of current and future losses that exceed the loss reserves of our insurance subsidiaries.
Our insurance subsidiaries are subject to catastrophe losses and losses from other severe weather events, which are unpredictable and may adversely affect our results of operations, liquidity and financial condition.
The underwriting results of our insurance subsidiaries are subject to weather and other conditions that may adversely affect our financial condition, liquidity or results of operations. Because the occurrence and severity of catastrophes are inherently unpredictable and may vary significantly from year to year and region to region, our historical results of operations may not be indicative of our future results of operations. Our property and casualty insurance operations expose us to claims arising from catastrophic events affecting multiple policyholders. Such catastrophic events consist of various natural disasters, including, but not limited to, hurricanes, tropical storms, tornadoes, windstorms, hailstorms, fires and wildfires, flooding, landslides, earthquakes, severe winter weather events and man-made disasters such as terrorist attacks, explosions and infrastructure failures. Historically, our insurance subsidiaries have experienced weather-related losses from hurricanes and tropical storms in Mid-Atlantic and Southern states, tornadoes and hailstorms in Mid-Atlantic, Midwestern and Southern states and severe winter weather events in Mid-Atlantic, Midwestern and New England states.
Losses from catastrophic events are a function of both the extent of our insurance subsidiaries’ exposures, the frequency and severity of the events themselves and the level of reinsurance coverage our insurance subsidiaries purchase. The increased frequency and severity of weather-related catastrophes and other losses, such as from wildfires and flooding, incurred by the industry in recent years may be indicative of changing weather patterns due to climate change. Should those patterns continue to emerge, increased weather-related catastrophes in the states in which our insurance subsidiaries operate would lead to higher overall losses that they may be unable to offset through pricing actions.
Our insurance subsidiaries seek to reduce their exposure to catastrophe losses through their underwriting strategies and their purchase of catastrophe reinsurance. Nevertheless, reinsurance may prove inadequate under certain circumstances. While the emerging science regarding climate change and its connection to extreme weather events continues to be studied, climate change, to the extent it produces rising temperatures and changes in weather patterns, could affect the frequency and severity of weather events and other losses and thus impact the affordability and availability of catastrophe reinsurance coverage for our insurance subsidiaries. Our insurance subsidiaries’ ability to appropriately manage catastrophe risk depends partially on catastrophe models, which may be affected by inaccurate or incomplete data, the uncertainty of the frequency and severity of future events and the uncertain impact of changing climate conditions that tend to occur gradually over time.
Changing climate conditions could lead to new or revised regulations with which our insurance subsidiaries would have to comply. Such regulations could impact the ability of our insurance subsidiaries to manage their exposures in areas impacted by increased weather activity, require our insurance companies to alter the terms and conditions of their policies or impact the ability of our insurance subsidiaries to obtain sufficient pricing increases to offset higher loss activity.
Our insurance subsidiaries must establish premium rates and loss and loss expense reserves from forecasts of the ultimate costs they expect will arise from risks underwritten during the policy period, and the profitability of our insurance subsidiaries could be adversely affected if their premium rates or reserves are insufficient to satisfy their ultimate costs.
One of the distinguishing features of the property and casualty insurance industry is that it prices its products before it knows its costs, since insurers generally establish their premium rates before they know the amount of losses they will incur. Accordingly, our insurance subsidiaries establish premium rates from forecasts of the ultimate costs they expect to arise from risks they have underwritten during the policy period. Proposed increases in premium rates are subject to regulatory approval on a state-by-state basis, and there is a lag between the time that our insurance subsidiaries file for such approval and the date upon which our insurance subsidiaries can implement any such approved premium rate increase across their book of business for a product in a particular state. The premium rates our insurance subsidiaries charge may not be sufficient to cover the ultimate losses they incur. Further, our insurance subsidiaries must establish reserves for losses and loss expenses as balance sheet liabilities based upon estimates involving actuarial and statistical projections at a given time of what our insurance subsidiaries expect their ultimate liability to be. Significant periods of time often elapse between the occurrence of an insured loss, the reporting of the loss and the settlement of that loss. It is possible that our insurance subsidiaries’ ultimate liability could exceed these estimates because of the future development of known losses, the existence of losses that have occurred but are currently unreported and larger than historical settlements of pending and unreported claims. The process of estimating reserves is inherently judgmental and can be influenced by a number of factors, including the following:
| • | trends in claim frequency and severity; |
| • | emerging economic and social trends; |
| • | economic and social inflation; and |
| • | changes in the regulatory and litigation environments. |
If our insurance subsidiaries determine that their reserves are insufficient to cover their ultimate liability, they will increase their reserves. An increase in reserves results in an increase in losses and a reduction in net income for the period in which our insurance subsidiaries recognize a deficiency in reserves. Accordingly, an increase in reserves may adversely impact the business, liquidity, financial condition and results of operations of our insurance subsidiaries.
The financial results of our insurance subsidiaries depend primarily on their ability to underwrite risks effectively and to charge adequate rates to policyholders.
The financial condition, cash flows and results of operations of our insurance subsidiaries depend on their ability to underwrite and set rates accurately for a full spectrum of risks across a number of lines of insurance. Rate adequacy is necessary to generate sufficient premium to pay losses, loss adjustment expenses and underwriting expenses and to realize a profit.
The ability to underwrite and set rates effectively is subject to a number of risks and uncertainties, including those related to:
| • | the availability of sufficient, reliable data; |
| • | the ability to conduct a complete and accurate analysis of available data; |
| • | the ability to recognize in a timely manner changes in trends and to project both the severity and frequency of losses with reasonable accuracy; |
| • | uncertainties generally inherent in estimates and assumptions; |
| • | the ability to project changes in certain operating expense levels with reasonable certainty; |
| • | the development, selection and application of appropriate rating formulae or other pricing methodologies; |
| • | the effective development, governance and appropriate use of modeling tools to assist with correctly and consistently achieving the intended results in underwriting and pricing; |
| • | the ability to innovate with new pricing strategies and the success of those innovations upon implementation; |
| • | the ability to secure regulatory approval of premium rates on an adequate and timely basis; |
| • | the ability to predict policyholder retention accurately; |
| • | unanticipated court decisions, legislation or regulatory action; |
| • | unanticipated changes in our claim settlement practices; |
| • | changes in driving patterns for auto exposures; |
| • | changes in weather patterns for property exposures; |
| • | changes in the medical sector of the economy that impact bodily injury loss costs; |
| • | changes in new and used car prices, auto repair costs and auto parts prices, including the increasing integration of sophisticated technology-related components; |
| • | the impact of emerging technologies, including driver assistance technologies and autonomous vehicles, on pricing, insurance coverages and loss costs; |
| • | the impact of inflation and other factors on the cost and availability of construction materials and labor; |
| • | the ability to monitor property concentration in catastrophe-prone areas, such as hurricane, earthquake and wind/hail regions; and |
| • | the general state of the economy in the states in which our insurance subsidiaries operate. |
Such risks may result in our insurance subsidiaries basing their premium rates on inadequate or inaccurate data or inappropriate assumptions or methodologies and may cause our estimates of future changes in the frequency or severity of claims to be incorrect. As a result, our insurance subsidiaries could underprice risks, which would negatively affect our margins, or our insurance subsidiaries could overprice risks, which could reduce their premium volume and competitiveness. In either event, underpricing or overpricing risks could adversely impact our operating results, financial condition and cash flows.
The pace of innovation within the insurance industry is rapidly increasing, and our insurance subsidiaries may be unable to effectively implement new technologies and anticipate changes in customer preferences and insurance needs, which could put our insurance subsidiaries at a competitive disadvantage and adversely affect their future profitability.
Innovation, recent technological developments, changing customer demographics and preferences, societal shifts and emerging technologies such as artificial intelligence are greatly impacting the insurance industry. Our insurance subsidiaries compete with much larger insurers that are focused on implementing technology and innovative solutions to select and price risks, enhance the experience of their customers and improve their operations. If our insurance subsidiaries are unable to anticipate changes in customer expectations and keep pace with the technological changes their competitors implement, our insurance subsidiaries may not be able to attract and maintain quality accounts, adequately price risks or operate as efficiently as their competitors. In addition, emerging technologies such as electric and autonomous vehicles, driver-assistance and accident avoidance features on vehicles, sensor technology and other forms of automation may reduce the future need for, or decrease the future pricing of, the insurance products our insurance subsidiaries offer.
Loss or significant restriction of the use of credit scoring in the pricing and underwriting of the personal lines insurance products by our insurance subsidiaries could adversely affect their future profitability.
Our insurance subsidiaries use credit scoring as a factor in making risk selection and pricing decisions for personal lines insurance products where allowed by state law. There is increasing regulatory debate as to whether use of credit scoring unfairly discriminates against people with low incomes, minority groups and the elderly. Consumer groups and regulators often call for the prohibition or restriction on the use of credit scoring in underwriting and pricing. Laws or regulations that significantly curtail the use of credit scoring in the underwriting process could reduce the future profitability of our insurance subsidiaries.
Changes in applicable insurance laws or regulations or changes in the way insurance regulators administer those laws or regulations could adversely affect the operating environment of our insurance subsidiaries and increase their exposure to loss or put them at a competitive disadvantage.
Property and casualty insurers are subject to extensive supervision in their domiciliary states and in the states in which they do business. This regulatory oversight includes matters relating to:
| • | licensing and examination; |
| • | approval of premium rates; |
| • | limitations on the nature and amount of certain investments; |
| • | mandated participation in involuntary markets and guaranty funds; |
| • | transactions between affiliates; |
| • | the amount of dividends that insurers may pay; and |
| • | restrictions on underwriting standards. |
Such regulation and supervision are primarily for the benefit and protection of policyholders rather than stockholders.
The NAIC and state insurance regulators re-examine existing laws and regulations from time to time, specifically focusing on areas such as:
| • | insurance company investments; |
| • | issues relating to the solvency of insurance companies; |
| • | risk-based capital guidelines; |
| • | restrictions on the terms and conditions included in insurance policies; |
| • | certain methods of accounting; |
| • | reserves for unearned premiums, losses and other purposes; |
| • | the values at which insurance companies may carry investment securities and the definition of other-than-temporary impairment of investment securities; and |
| • | interpretations of existing laws and the development of new laws. |
Changes in state laws and regulations, as well as changes in the way state regulators view related-party transactions in particular, could change the operating environment of our insurance subsidiaries and have an adverse effect on their business.
Insurance companies are subject to assessments, based on their market share in a given line of business, to assist in the payment of unpaid claims and related costs of insolvent insurance companies. Such assessments could adversely affect the financial condition of our insurance subsidiaries.
Our insurance subsidiaries are subject to assessments pursuant to the guaranty fund laws of the various states in which they conduct business. Generally, under these laws, our insurance subsidiaries can be assessed, depending upon the market share of our insurance subsidiaries in a given line of insurance business, to assist in the payment of unpaid claims and related costs of insolvent insurance companies in those states. We cannot predict the number and magnitude of future insurance company failures in the states in which our insurance subsidiaries conduct business, but future assessments could adversely affect the business, financial condition and results of operations of our insurance subsidiaries.
Risks Relating to Us and Our Business
The COVID-19 pandemic affected the business operations of our insurance subsidiaries and Donegal Mutual, and economic disruption related to a future pandemic may adversely affect our revenues, profitability, results of operations, cash flows, liquidity and financial condition.
During 2020 and 2021, the COVID-19 pandemic resulted in significant disruptions in economic activity throughout our operating regions. We cannot predict the ultimate impact that the economic and financial disruption related to a pandemic may have on us. Risks related to a pandemic include, but are not limited to, the following:
| • | the business operations or a specific operational function of our insurance subsidiaries and Donegal Mutual could be disrupted by the illness of significant numbers of their employees and remedial efforts that would be required upon discovery of exposure to a communicable illness within their facilities; |
| • | the business operations of our insurance subsidiaries and Donegal Mutual are dependent upon technology systems for which regular physical access is required to maintain critical operational capabilities, and the business operations of our insurance subsidiaries and Donegal Mutual would be adversely impacted by government mandates requiring closure of facilities where those technology systems are located or restricting physical access to such facilities; |
| • | the revenues of our insurance subsidiaries and Donegal Mutual may decrease as a result of reduced demand for their insurance products as economic disruption adversely impacts current and potential insurance customers; |
| • | our insurance subsidiaries and Donegal Mutual may incur an increase in their losses and loss expenses in certain lines of business as a result of a pandemic and related economic disruption, and such losses and loss expenses may exceed the reserves our insurance subsidiaries and Donegal Mutual have established or may establish in the future; |
| • | our insurance subsidiaries and Donegal Mutual may incur increased costs related to legal disputes over policy coverages or exclusions and their defense against litigation related to a pandemic; |
| • | legislative, judicial and regulatory actions may expand coverage definitions, retroactively mandate coverage or otherwise require our insurance subsidiaries and Donegal Mutual to pay losses for damages that their policies explicitly excluded or did not intend to cover; |
| • | legislative, judicial and regulatory actions may require our insurance subsidiaries and Donegal Mutual to reduce or refund premiums, suspend cancellation of policies for non-payment of premiums or otherwise grant extended grace periods and time allowances for the payment of premium balances due to them; |
| • | our insurance subsidiaries and Donegal Mutual may not be able to collect premium balances due to them, resulting in reduced operating cash flows and an increase in premium write-offs that would increase their operating expenses; |
| • | our insurance subsidiaries may suffer declines in the market values of their investments as a result of financial market volatility related to pandemic concerns and related economic disruption; and |
| • | economic disruption related to a pandemic could result in significant declines in the credit quality of issuers, ratings downgrades or changes in financial market conditions and regulatory changes that might adversely impact the value of the fixed-maturity investments that our insurance subsidiaries own. |
Donegal Mutual is our controlling stockholder. Donegal Mutual and its directors and executive officers have potential conflicts of interest between the best interests of our stockholders and the best interests of the policyholders of Donegal Mutual.
Donegal Mutual controls the election of all of the members of our board of directors. Six of the eleven members of our board of directors are also directors of Donegal Mutual. Donegal Mutual and we share the same executive officers. These common directors and executive officers have a fiduciary duty to our stockholders and also have a fiduciary duty to the policyholders of Donegal Mutual. Among the potential conflicts of interest that could arise from these separate fiduciary duties are the following:
| • | we and Donegal Mutual periodically review the percentage participation of Atlantic States and Donegal Mutual in the underwriting pool that Donegal Mutual and Atlantic States have maintained since 1986; |
| • | our insurance subsidiaries and Donegal Mutual annually review and then establish the terms of certain reinsurance agreements between our insurance subsidiaries and Donegal Mutual; |
| • | we and Donegal Mutual allocate certain shared expenses among ourselves and our insurance subsidiaries in accordance with various inter-company expense-sharing agreements; and |
| • | we and our insurance subsidiaries may enter into other transactions or contractual relationships with Donegal Mutual. |
Donegal Mutual has sufficient voting power to determine the outcome of substantially all matters submitted to our stockholders for approval.
Each share of our Class A common stock has one-tenth of a vote per share and generally votes as a single class with our Class B common stock. Each share of our Class B common stock has one vote per share and generally votes as a single class with our Class A common stock. Donegal Mutual has the right to vote approximately 71% of the combined voting power of our Class A common stock and our Class B common stock and has sufficient voting control to and has acted to:
| • | elect all of the members of our board of directors, who determine our management and policies; and |
| • | control the outcome of any corporate transaction or other matter submitted to a vote of our stockholders for approval, including mergers or other acquisition proposals and the sale of all or substantially all of our assets, in each case regardless of how all of our stockholders other than Donegal Mutual vote their shares. |
The interests of Donegal Mutual in maintaining this greater-than-majority voting control of us may have an adverse effect on the price of our Class A common stock and the price of our Class B common stock because of the absence of any potential “takeover” premium and may, therefore, be inconsistent with the interests of our stockholders other than Donegal Mutual.
Donegal Mutual’s majority voting control of us, certain provisions of our certificate of incorporation and by-laws and certain provisions of Delaware law make it remote that anyone could acquire actual control of us unless Donegal Mutual were in favor of another person’s acquisition of control of us.
Donegal Mutual’s majority voting control of us, certain anti-takeover provisions in our certificate of incorporation and by-laws and certain provisions of the Delaware General Corporation Law, or the DGCL, could delay or prevent the removal of members of our board of directors and could make a merger, tender offer or proxy contest involving us more expensive as well as unlikely to succeed, even if such events were in the best interests of our stockholders other than Donegal Mutual. These factors could also discourage a third party from attempting to acquire control of us. In particular, our certificate of incorporation and by-laws include the following anti-takeover provisions:
| • | our board of directors is classified into three classes, so that our stockholders elect only one-third of the members of our board of directors each year; |
| • | our stockholders may remove our directors only for cause; |
| • | our stockholders may not take stockholder action except at an annual or special meeting of our stockholders; |
| • | the request of stockholders holding at least 20% of the combined voting power of our Class A common stock and our Class B common stock is required for a stockholder to call a special meeting of our stockholders; |
| • | our by-laws require that stockholders provide advance notice to us to nominate candidates for election to our board of directors or to propose any other item of stockholder business at a stockholders’ meeting; |
| • | we do not permit cumulative voting rights in the election of our directors; |
| • | our certificate of incorporation does not provide for preemptive rights in connection with any issuance of securities by us; and |
| • | our board of directors may issue, without stockholder approval unless otherwise required by law, preferred stock with such terms as our board of directors may determine. |
We have authorized preferred stock that we could issue without stockholder approval to make it more difficult for a third party to acquire us.
We have 2.0 million authorized shares of preferred stock that we could issue in one or more series without further stockholder approval, unless the DGCL or the rules of the NASDAQ Global Select Market otherwise require, and upon such terms and conditions, and having such rights, privileges and preferences, as our board of directors may determine. Our potential issuance of preferred stock may make it more difficult for a third party to acquire control of us.
Because we are an insurance holding company, no person can acquire or seek to acquire a 10% or greater interest in us without first obtaining approval of the insurance commissioners of the states of domicile of each of our insurance subsidiaries.
We own insurance subsidiaries domiciled in the states of Michigan, Pennsylvania and Virginia, and Donegal Mutual is domiciled in Pennsylvania and owns or controls insurance companies domiciled in Georgia and New Mexico. The insurance laws of each of these states provide that no person can acquire or seek to acquire a 10% or greater interest in us without first filing specified information with the insurance commissioners of those states and obtaining the prior approval of the proposed acquisition of a 10% or greater interest in us by each of the state insurance commissioners based on statutory standards designed to protect the safety and soundness of us and our insurance subsidiaries.
Our insurance subsidiaries and Donegal Mutual currently conduct business in a limited number of states, with a concentration of business in Pennsylvania, Michigan, Maryland, Delaware and Virginia. Any single catastrophe occurrence or other condition affecting losses in these states could adversely affect the results of operations of our insurance subsidiaries.
Our insurance subsidiaries and Donegal Mutual conduct business in 23 states located primarily in the Mid-Atlantic, Midwestern, New England, Southern and Southwestern states. A substantial portion of their business consists of private passenger and commercial automobile, homeowners, commercial multi-peril and workers’ compensation insurance in Pennsylvania, Michigan, Maryland, Delaware and Virginia. While our insurance subsidiaries and Donegal Mutual actively manage their respective exposure to catastrophes through their underwriting processes and the purchase of reinsurance, a single catastrophic occurrence, destructive weather pattern, general economic trend, terrorist attack, regulatory development or other condition affecting one or more of the states in which our insurance subsidiaries conduct substantial business could materially adversely affect their business, financial condition and results of operations. Common catastrophic events include hurricanes, earthquakes, tornadoes, wind and hailstorms, fires and wildfires, explosions and severe winter storms.
If the independent agents who market the products of our insurance subsidiaries and Donegal Mutual do not maintain their current levels of premium writing with us and Donegal Mutual, fail to comply with established underwriting guidelines of our insurance subsidiaries and Donegal Mutual or otherwise inappropriately market the products of our insurance subsidiaries and Donegal Mutual, the business, financial condition and results of operations of our insurance subsidiaries could be adversely affected.
Our insurance subsidiaries and Donegal Mutual market their insurance products solely through a network of approximately 2,200 independent insurance agencies. This agency distribution system is one of the most important components of the competitive profile of our insurance subsidiaries and Donegal Mutual. As a result, our insurance subsidiaries and Donegal Mutual depend to a material extent upon their independent agents, each of whom has the authority to bind one or more of our insurance subsidiaries or Donegal Mutual to insurance coverage. To the extent that such independent agents’ marketing efforts fail to result in the maintenance of their current levels of volume and quality or they bind our insurance subsidiaries or Donegal Mutual to unacceptable insurance risks, fail to comply with the established underwriting guidelines of our insurance subsidiaries and Donegal Mutual or otherwise inappropriately market the products of our insurance subsidiaries and Donegal Mutual, the business, financial condition and results of operations of our insurance subsidiaries could suffer.
The business of our insurance subsidiaries and Donegal Mutual may not continue to grow and may be materially adversely affected if our insurance subsidiaries and Donegal Mutual cannot retain existing, and attract new, independent agents or if insurance consumers increase their use of insurance distribution channels other than independent agents.
The ability of our insurance subsidiaries and Donegal Mutual to retain existing, and to attract new, independent agents is essential to the continued growth of the business of our insurance subsidiaries and Donegal Mutual. If independent agents find it easier to do business with the competitors of our insurance subsidiaries and Donegal Mutual, our insurance subsidiaries and Donegal Mutual could find it difficult to retain their existing business or to attract new business. While our insurance subsidiaries and Donegal Mutual believe they maintain good relationships with the independent agents they have appointed, our insurance subsidiaries and Donegal Mutual cannot be certain that these independent agents will continue to sell the products of our insurance subsidiaries and Donegal Mutual to the consumers these independent agents represent. Some of the factors that could adversely affect the ability of our insurance subsidiaries and Donegal Mutual to retain existing, and attract new, independent agents include:
| • | the significant competition among insurance companies to attract independent agents; |
| • | the labor-intensive and time-consuming process of selecting new independent agents; |
| • | the insistence of our insurance subsidiaries and Donegal Mutual that independent agents adhere to certain standards; |
| • | the ability of our insurance subsidiaries and Donegal Mutual to pay competitive and attractive commissions, bonuses and other incentives to independent agents; and |
| • | the ongoing consolidation of independent agencies, which may result in the acquisition of independent agencies from which our insurance subsidiaries and Donegal Mutual currently receive business by larger entities with which our insurance subsidiaries and Donegal Mutual do not have business relationships. |
While our insurance subsidiaries and Donegal Mutual sell insurance to policyholders solely through their network of independent agencies, many competitors of our insurance subsidiaries and Donegal Mutual sell insurance through a variety of delivery methods, including independent agencies, captive agencies and direct sales. To the extent that current and potential policyholders change their distribution channel preference, the business, financial condition and results of operations of our insurance subsidiaries may be adversely affected.
Dividends from our insurance subsidiaries are the primary source of funds for the payment of our operating expenses and dividends to our stockholders; however, there are regulatory restrictions and business considerations that may limit the amount of dividends our insurance subsidiaries may pay to us.
As a holding company, we rely primarily on dividends from our insurance subsidiaries as a source of funds to meet our corporate obligations and to pay dividends to our stockholders. The amount of dividends our insurance subsidiaries can pay to us is subject to regulatory restrictions and depends on the amount of surplus our insurance subsidiaries maintain. From time to time, the NAIC and various state insurance regulators consider modifying the method of determining the amount of dividends that an insurance company may pay without prior regulatory approval. The maximum amount of ordinary dividends that our insurance subsidiaries can pay to us in 2024 without prior regulatory approval is approximately $39.6 million. Other business and regulatory considerations, such as the impact of dividends on surplus that could affect the ratings of our insurance subsidiaries, competitive conditions, RBC requirements, the investment results of our insurance subsidiaries and the amount of premiums that our insurance subsidiaries write could also adversely impact the ability of our insurance subsidiaries to pay dividends to us.
If A.M. Best downgrades the rating it has assigned to Donegal Mutual or any of our insurance subsidiaries, it would adversely affect their competitive position.
Industry ratings are a factor in establishing and maintaining the competitive position of insurance companies. A.M. Best, an industry-accepted source of insurance company financial strength ratings, rates Donegal Mutual and our insurance subsidiaries. A.M. Best ratings provide an independent opinion of an insurance company’s financial health and its ability to meet its obligations to its policyholders. We believe that the financial strength rating of A.M. Best is material to the operations of Donegal Mutual and our insurance subsidiaries. For example, certain lenders require customers to purchase insurance from an insurance carrier that has received an A.M. Best rating that exceeds a certain level. Currently, Donegal Mutual and our insurance subsidiaries each have an A (Excellent) rating from A.M. Best. In April 2023, A.M. Best affirmed its A (Excellent) ratings of Donegal Mutual and our insurance subsidiaries. However, if A.M. Best were to downgrade the rating of Donegal Mutual or any of our insurance subsidiaries, it would adversely affect the competitive position of Donegal Mutual or that insurance subsidiary and make it more difficult for it to market its products and retain its existing policyholders.
The growth and profitability of our insurance subsidiaries depend, in part, on the effective maintenance and ongoing development of Donegal Mutual’s information technology systems, and the allocation of related costs to our insurance subsidiaries may adversely impact their profitability.
Our insurance subsidiaries utilize Donegal Mutual’s information technology systems to conduct their insurance business, including policy quoting and issuance, claims processing, processing of incoming premium payments and other important functions. As a result, the ability of our insurance subsidiaries to grow their business and conduct profitable operations depends on Donegal Mutual’s ability to maintain its existing information technology systems and to develop new technology systems that will support the business of Donegal Mutual and our insurance subsidiaries in a cost-efficient manner and provide information technology capabilities equivalent to those of our competitors. The allocation among our insurance subsidiaries and Donegal Mutual of the costs of developing and maintaining Donegal Mutual’s information technology systems may adversely impact our insurance subsidiaries’ expense ratio and underwriting profitability, and such costs may exceed Donegal Mutual’s and our expectations.
Donegal Mutual is currently in the midst of a multi-year effort to modernize certain of its key infrastructure and applications systems, and the allocation of related costs to our insurance subsidiaries has resulted in an increase to their expense ratio. These new systems are intended to provide various benefits to the member companies of the Donegal Insurance Group, including streamlined workflows and business processes, service enhancements for their agents and policyholders, opportunities to implement new product models and innovative business solutions, greater utilization of data analytics and operational efficiencies. Our insurance subsidiaries began to issue workers’ compensation policies from the new systems in the second quarter of 2020 and began to issue personal lines policies from the new systems, including a new personal lines agency portal, in the fourth quarter of 2021. In 2023, Donegal Mutual implemented two additional major releases of new systems, which included three commercial lines of business with enhanced straight-through-processing capabilities as well as dwelling fire and conversion of legacy homeowners renewal policies in two initial states. Over the next two years, Donegal Mutual expects to implement new systems for the remaining lines of business the Donegal Insurance Group issues currently and for the conversion of remaining legacy renewal policies of the Donegal Insurance Group. Even with Donegal Mutual’s and our best planning and efforts and the involvement of third-party experts, Donegal Mutual may not complete the implementation of these new systems within its planned timeframes or budget. Further, Donegal Mutual’s information technology systems may not deliver the benefits Donegal Mutual and we expect and may fail to keep pace with our competitors’ information technology systems. As a result, Donegal Mutual and our insurance subsidiaries may not have the ability to grow their business and meet their profitability objectives.
Our strategy to grow in part through acquisitions of other insurance companies exposes us to risks that could adversely affect our results of operations and financial condition.
The affiliation with, and acquisition of, other insurance companies involves risks that could adversely affect our results of operations and financial condition. The risks associated with these affiliations and acquisitions include:
| • | the potential inadequacy of reserves for losses and loss expenses of the other insurer; |
| • | the need to supplement management of the other insurer with additional experienced personnel; |
| • | conditions imposed by regulatory agencies that make the realization of cost-savings through integration of the operations of the other insurer with our operations more difficult; |
| • | our management’s lack of familiarity with the geography, demographics and distribution systems in the markets the other insurer serves that cause the other insurer to fail to meet the growth and profitability objectives we anticipated at the time of the acquisition or affiliation; |
| • | the need of the other insurer for additional capital that we did not anticipate at the time of the acquisition or affiliation; and |
| • | the use of more of our management’s time in improving the operations of the other insurer than we originally anticipated. |
If we cannot obtain sufficient capital to fund the organic growth of our insurance subsidiaries and to make acquisitions, we may not be able to expand our business.
Our strategy is to expand our business through the organic growth of our insurance subsidiaries and through our strategic acquisitions of regional insurance companies. Our insurance subsidiaries may require additional capital in the future to support this strategy. If we cannot obtain sufficient capital on satisfactory terms and conditions, we may not be able to expand the business of our insurance subsidiaries or to make future acquisitions. Our ability to obtain additional financing will depend on a number of factors, many of which are beyond our control. For example, we may not be able to obtain additional debt or equity financing because we or our insurance subsidiaries may already have substantial debt at the time, because we or our insurance subsidiaries do not have sufficient cash flow to service or repay our existing or additional debt or because financial institutions are not making financing available. In addition, any equity capital we obtain in the future could be dilutive to our existing stockholders.
Competition within the property and casualty insurance industry may adversely impact the revenues and profit margins of our insurance subsidiaries.
The property and casualty insurance industry is intensely competitive. Competition can be based on many factors, including:
| • | the perceived financial strength of the insurer; |
| • | policy terms and conditions; |
Our insurance subsidiaries and Donegal Mutual compete with many regional and national property and casualty insurance companies, including direct sellers of insurance products, insurers having their own agency organizations and other insurers represented by independent agents. Many of these insurers have greater capital than our insurance subsidiaries and Donegal Mutual, have substantially greater financial, technical and operating resources, have substantially greater exposure and access to potential customers and have equal or higher ratings from A.M. Best than our insurance subsidiaries and Donegal Mutual. In addition, our competitors may become increasingly better capitalized in the future as the property and casualty insurance industry continues to consolidate.
The greater capitalization of many of the competitors of our insurance subsidiaries and Donegal Mutual enables them to operate with lower profit margins and, therefore, allows them to market their products more aggressively, to take advantage more quickly of new marketing opportunities and to offer lower premium rates. In addition to established insurers, our insurance subsidiaries and Donegal Mutual compete with a growing number of start-ups, some of which have received substantial infusions of capital, that seek to disrupt traditional business platforms and distribution channels. Our insurance subsidiaries and Donegal Mutual may not be able to maintain their current competitive position in the markets in which they operate if their competitors offer prices for their products that are lower than the prices our insurance subsidiaries and Donegal Mutual are prepared to offer. Moreover, if these competitors lower the price of their products and our insurance subsidiaries and Donegal Mutual meet their pricing, the profit margins and revenues of our insurance subsidiaries and Donegal Mutual may decrease and their ratios of claims and expenses to premiums may increase. All of these factors could materially adversely affect the financial condition and results of operations of our insurance subsidiaries and their A.M. Best ratings.
The investment portfolios of our insurance subsidiaries consist primarily of fixed-income securities; therefore, the investment income and the fair value of the investment portfolios of our insurance subsidiaries could decrease as a result of a number of factors.
Our insurance subsidiaries invest the premiums they receive from their policyholders and maintain investment portfolios that consist primarily of fixed-income securities. The effective management of these investment portfolios is an important component of the profitability of our insurance subsidiaries. Our insurance subsidiaries derive a significant portion of their operating income from the income they receive on their invested assets. A number of factors may affect the quality and/or yield of their investment portfolios, including the general economic and business environment, government monetary policy, changes in the credit quality of the issuers of the fixed-income securities our insurance subsidiaries own, changes in market conditions and regulatory changes. The fixed-income securities our insurance subsidiaries own consist primarily of securities issued by domestic entities that are backed by either the credit or collateral of the underlying issuer. Factors such as an economic downturn, disruption in the credit market or the availability of credit, a regulatory change pertaining to a particular issuer’s industry, a significant deterioration in the cash flows of the issuer or a change in the issuer’s marketplace may adversely affect the ability of our insurance subsidiaries to collect principal and interest from the issuer in which they invest.
The investments of our insurance subsidiaries are also subject to risk resulting from interest rate fluctuations. As we experienced when market interest rates increased significantly in 2022, increasing interest rates or a widening in the spread between interest rates available on U.S. Treasury securities and corporate debt or asset-backed securities will typically have an adverse impact on the market values of fixed-rate securities. If interest rates decline, our insurance subsidiaries will generally have a lower overall rate of return on investments of cash their operations generate. In addition, in the event of the call or maturity of investments in a low interest rate environment, our insurance subsidiaries may not be able to reinvest the proceeds in securities with comparable interest rates. Changes in interest rates may reduce both the profitability and the return on the invested capital of our insurance subsidiaries.
We and our insurance subsidiaries depend on key personnel. The loss of any member of our executive management or the senior management of our insurance subsidiaries could negatively affect the continuation of our business strategies and achievement of our growth objectives.
The loss of, or failure to attract, key personnel could significantly impede our financial plans, growth, marketing and other objectives and those of our insurance subsidiaries. The continued success of our insurance subsidiaries depends to a substantial extent on the ability and experience of their senior management. Our insurance subsidiaries and we believe that our future success is dependent on our ability to attract and retain additional skilled and qualified personnel and to expand, train and manage our employees. We and Donegal Mutual have employment agreements with our senior officers, including all of our named executive officers.
The reinsurance agreements on which our insurance subsidiaries rely do not relieve our insurance subsidiaries from their primary liability to their policyholders, and our insurance subsidiaries face a risk of non-payment from their reinsurers as well as the non-availability of reinsurance in the future.
Our insurance subsidiaries rely on reinsurance agreements to limit their maximum net loss from large single catastrophic risks or excess of loss risks in areas where our insurance subsidiaries may have a concentration of policyholders. Reinsurance also enables our insurance subsidiaries to increase their capacity to write insurance because it has the effect of leveraging the surplus of our insurance subsidiaries. Although the reinsurance our insurance subsidiaries maintain provides that the reinsurer is liable to them for any reinsured losses, the reinsurance agreements do not generally relieve our insurance subsidiaries from their primary liability to their policyholders if the reinsurer fails to pay the reinsurance claims of our insurance subsidiaries. To the extent that a reinsurer is unable to pay losses for which it is liable to our insurance subsidiaries, our insurance subsidiaries remain liable for such losses. At December 31, 2023, our insurance subsidiaries had approximately $117.4 million of reinsurance receivables from third-party reinsurers relating to paid and unpaid losses. Any insolvency or inability of these reinsurers to make timely payments to our insurance subsidiaries under the terms of their reinsurance agreements would adversely affect the results of operations of our insurance subsidiaries.
Michigan law requires MICO to provide certain medical benefits under the personal injury protection, or PIP, coverage of the personal automobile and commercial automobile policies it writes in the state of Michigan. Michigan law also requires MICO to be a member of the Michigan Catastrophic Claims Association, or MCCA, in order to write automobile insurance. The MCCA receives funding through assessments that its members collect from policyholders in the state and provides reinsurance for PIP claims that exceed a set retention. At December 31, 2023, MICO had approximately $54.8 million of reinsurance receivables from MCCA relating to paid and unpaid losses. The MCCA has generated significant operating deficits in past years. While the MCCA generated an increase in surplus in recent years, the MCCA board approved the return of a significant portion of its accumulated surplus to policyholders in the form of cash refunds in early 2022. Although we currently consider the risk to be remote, should the MCCA be unable to fulfill its payment obligations to MICO in the future, MICO’s financial condition and results of operations could be adversely affected.
In addition, our insurance subsidiaries face a risk of the non-availability of reinsurance or an increase in reinsurance costs that could adversely affect their ability to write business or their results of operations. Market conditions beyond the control of our insurance subsidiaries, such as the amount of surplus in the reinsurance market and the frequency and severity of natural and man-made catastrophes, affect both the availability and the cost of the reinsurance our insurance subsidiaries purchase. If our insurance subsidiaries cannot maintain their current level of reinsurance or purchase new reinsurance protection in amounts that our insurance subsidiaries consider sufficient, our insurance subsidiaries would either have to accept an increase in their net risk retention or reduce their insurance writings, either of which could adversely affect them. For example, due to increased reinsurance pricing and reduced reinsurance market capacity, our insurance subsidiaries increased their net retentions under several of their reinsurance programs for 2023 and 2024.
The disruption or failure of Donegal Mutual’s information technology systems or the compromise of the security of those systems that results in the theft or misuse of confidential information could materially impact adversely the business of Donegal Mutual and our insurance subsidiaries.
Our insurance subsidiaries’ business operations depend significantly upon the availability and successful operation of Donegal Mutual’s information technology systems. In addition, in the normal course of their operations, Donegal Mutual and our insurance subsidiaries collect, utilize and maintain confidential information regarding individuals and businesses. While Donegal Mutual has established various security measures to protect its information technology systems and confidential data, unanticipated computer viruses, malware, ransomware, power outages, unauthorized access or other cyberattacks could disrupt those systems or result in the misappropriation or loss of confidential data. Donegal Mutual could experience technology system failures or other outages that would impact the availability of its information technology systems. Donegal Mutual has experienced brief disruptions of systems in the past, including those systems that allow underwriting and processing of new policies. Disruption in the availability of Donegal Mutual’s information technology systems could affect the ability of Donegal Mutual and our insurance subsidiaries to underwrite and process their policies timely, process and settle claims promptly and provide expected levels of customer service to agents and policyholders.
While Donegal Mutual has identified threats to the security of its information technology systems, Donegal Mutual and we are unaware of any significant breach of the security measures Donegal Mutual maintains. A significant breach of the security of Donegal Mutual’s information technology systems that results in the misappropriation or misuse of confidential information could damage the business reputation of Donegal Mutual and our insurance subsidiaries and could expose Donegal Mutual and our insurance subsidiaries to litigation. The financial impact to Donegal Mutual, us and our insurance subsidiaries of a significant breach could be material.
Risks Relating to Our Common Stock
The price of our common stock may be adversely affected by its low trading volume.
Our Class A common stock and our Class B common stock have limited liquidity. Reported average daily trading volume for our Class A common stock and our Class B common stock for the year ended December 31, 2023 was approximately 36,167 shares and approximately 1,324 shares, respectively. This limited liquidity could subject our shares of Class A common stock and our shares of Class B common stock to greater price volatility.
Donegal Mutual’s majority voting control of our stock, anti-takeover provisions of our certificate of incorporation and by-laws and certain state laws make it unlikely anyone could acquire control of us unless Donegal Mutual were in favor of the acquisition of control.
Donegal Mutual’s ownership of our Class A common stock and Class B common stock, certain anti-takeover provisions of our certificate of incorporation and by-laws, certain provisions of Delaware law and the insurance laws and regulations of Georgia, Michigan, New Mexico, Pennsylvania and Virginia could delay or prevent the removal of members of our board of directors and could make it more difficult for a merger, tender offer or proxy contest involving us to succeed, even if our stockholders other than Donegal Mutual believed any of such events would be beneficial to them. These factors could also discourage a third party from attempting to acquire control of us. The classification of our board of directors could also have the effect of delaying or preventing a change in our control.
In addition, we have 2.0 million authorized shares of preferred stock that we could issue in one or more series without stockholder approval, to the extent applicable law permits, and upon such terms and conditions, and having such rights, privileges and preferences, as our board of directors may determine. Our ability to issue preferred stock could make it difficult for a third party to acquire us. We have no current plans to issue any preferred stock.
| Item 1B. | Unresolved Staff Comments. |
We have no unresolved written comments from the Securities and Exchange Commission staff regarding our filings under the Exchange Act.
Our insurance subsidiaries utilize the information systems Donegal Mutual maintains. Donegal Mutual has a robust information security program in place as a component of the enterprise-level risk management program of Donegal Mutual and us. The integration of Donegal Mutual’s information security program into the enterprise-level risk management program is intended to promote the inclusion of cybersecurity considerations in decision-making processes throughout Donegal Mutual. Donegal Mutual has implemented multiple layers of cybersecurity systems and related defensive measures that are intended to assist with assessing, identifying and managing material risks from cybersecurity threats to Donegal Mutual’s information systems. Examples of these systems and measures include firewalls, data encryption, intrusion detection and prevention systems, endpoint detection and response systems, data-loss prevention systems and multi-factor authentication requirements for remote and privileged access. Donegal Mutual also regularly evaluates the effectiveness of its information security program through enterprise risk assessments.
Donegal Mutual also requires annual cybersecurity awareness training for all employees who serve Donegal Mutual and our insurance subsidiaries. Donegal Mutual expects all employees to assist in safeguarding its information systems and to assist in the discovery and reporting of cybersecurity incidents. This enterprise-wide program is intended to identify and assess internal and external cyber and information security risks that may threaten the security or integrity of the information stored on the Donegal Mutual’s information systems or those of third-party providers from unauthorized access, use or other malicious acts.
Donegal Mutual employs a third-party security operations center that provides after-hours alert services to help ensure continuous monitoring for cybersecurity threats. On an annual basis, Donegal Mutual also engages third-party cybersecurity consultants to perform cyberattack and penetration testing on its information systems and to conduct tabletop exercises to enhance preparedness of its crisis management team. This crisis management team includes technical and senior-level management personnel, and the exercises are intended to help maintain their readiness by reviewing the roles they will be expected to perform and the procedures they will be expected to follow in the event of a cybersecurity incident. These consultants advise Donegal Mutual on the effectiveness of its cybersecurity processes and assist Donegal Mutual in remediating any identified vulnerabilities and implementing any recommended measures to improve its cybersecurity defenses and readiness.
In addition to monitoring cybersecurity threats to Donegal Mutual’s information systems and information technology infrastructure, Donegal Mutual and we also assess and monitor the information security posture of third-party service providers whose services we deem critical to our operations. This process is designed to help Donegal Mutual’s information security personnel identify and mitigate risks related to data breaches or other cybersecurity incidents originating from third-party service providers in order to better protect Donegal Mutual’s information systems and information technology infrastructure.
Donegal Mutual and we are not aware of any cybersecurity incidents or risks from cybersecurity threats that have materially affected, or are reasonably likely to affect, our business strategy, results of operations or financial condition. While Donegal Mutual maintains cybersecurity insurance, the costs related to cybersecurity threats or disruptions may not be fully insured. For more information regarding the risks Donegal Mutual and we face from cybersecurity threats, see “Risk Factors - Risks Relating to Us and Our Business.”
Donegal Mutual employs an information security officer who has relevant experience and expertise in information security and holds the management position that is primarily responsible for assessing and managing cybersecurity risks. In addition, the chief risk officer of Donegal Mutual and us has extensive experience in the field of risk management, which is helpful for developing and executing Donegal Mutual’s information security program in a manner that aligns with the overall enterprise-level risk management program of Donegal Mutual and us.
In connection with carrying out their overall oversight responsibilities, the boards of directors of Donegal Mutual and us have delegated certain cybersecurity oversight responsibilities to the joint audit committee of those boards. The joint audit committee meets at least quarterly and is central to the boards’ oversight of cybersecurity risks. The joint audit committee actively monitors these risks in order to assist in coordinating prevention and mitigation efforts by, among other things, participating in risk management committee meetings and receiving quarterly reports from the chief risk officer of Donegal Mutual and us on cybersecurity risks and related matters. Donegal Mutual’s information security officer also provides an annual cybersecurity report to the boards of directors of Donegal Mutual and us. The annual cybersecurity reports encompass a broad range of topics, including types of threats and attempted infiltrations, applicable regulatory developments, information security program activities and planned cybersecurity enhancements to address emerging threats.
Donegal Mutual and we also maintain a risk management committee that is comprised of our shared executive officers and other key management personnel. This committee meets quarterly and is responsible for our enterprise risk strategy and management, which includes identifying, assessing, addressing and monitoring cybersecurity risks. Donegal Mutual’s information security officer provides quarterly updates to the risk management committee. Those updates include current cybersecurity issues and trends and any relevant information related to the prevention, detection, mitigation and remediation of cybersecurity incidents.
We and our insurance subsidiaries share administrative headquarters with Donegal Mutual in a building in Marietta, Pennsylvania that Donegal Mutual owns. The Marietta headquarters has approximately 270,000 square feet of office space. Southern owns a facility of approximately 10,000 square feet in Glen Allen, Virginia. In addition, Donegal Mutual leases office space in Albuquerque, New Mexico, MICO leases office space in Grand Rapids, Michigan, and Southern Mutual owns a building in Athens, Georgia. Donegal Mutual and our insurance subsidiaries share property-related expenses proportionately under a services allocation agreement.
| Item 3. | Legal Proceedings. |
Our insurance subsidiaries are parties to routine litigation that arises in the ordinary course of their insurance business. We believe that the resolution of these lawsuits will not have a material adverse effect on the financial condition or results of operations of our insurance subsidiaries. However, regardless of outcome, litigation and related matters could have an adverse impact on us and our insurance subsidiaries due to defense and settlement costs, diversion of management resources, negative publicity, reputational harm and other factors.
| Item 4. | Mine Safety Disclosures. |
Not applicable.
PART II
| Item 5. | Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. |
Our Class A common stock and Class B common stock trade on the NASDAQ Global Select Market under the symbols “DGICA” and “DGICB,” respectively.
At the close of business on March 1, 2024, we had approximately 1,748 holders of record of our Class A common stock and approximately 216 holders of record of our Class B common stock.
We declared dividends of $0.68 per share on our Class A common stock and $0.61 per share on our Class B common stock in 2023, compared to $0.66 per share on our Class A common stock and $0.59 per share on our Class B common stock in 2022.
Unregistered Sales of Equity Securities and Use of Proceeds.
Between October 1, 2023 and December 31, 2023, Donegal Mutual purchased shares of our Class A common stock as set forth in the table below:
| Period | | (a) Total Number of Shares (or Units) Purchased | | (b) Average Price Paid per Share (or Unit) | | (c) Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs | | (d) Maximum Number (or Approximate Dollar Value) of Shares (or Units) that May Yet Be Purchased Under the Plans or Programs |
Month #1 October 1-31, 2023 | | Class A – 13,545 Class B – None | | Class A – $14.24 Class B – None | | Class A – 13,545 Class B – None | | (1) |
| | | | | | | | | |
Month #2 November 1-30, 2023 | | Class A – None Class B – None | | Class A – None Class B – None | | Class A – None Class B – None | | |
| | | | | | | | | |
Month #3 December 1-31, 2023 | | Class A – None Class B – None | | Class A – None Class B – None | | Class A – None Class B – None | | |
| | | | | | | | | |
| Total | | Class A – 13,545 Class B – None | | Class A – $14.24 Class B – None | | Class A – 13,545 Class B – None | | |
| (1) | Donegal Mutual purchased these shares pursuant to its disclosure on April 29, 2022 that it will, at its discretion, purchase shares of our Class A common stock and Class B common stock at market prices prevailing from time to time in the open market subject to the provisions of SEC Rule 10b-18 and in privately negotiated transactions. Such disclosure did not stipulate a maximum number of shares that may be purchased under this program. |
Stock Performance Chart.
The following graph provides an indicator of cumulative total stockholder returns on our Class A common stock and our Class B common stock for the period beginning on December 31, 2018 and ending on December 31, 2023, compared to the Russell 2000 Index and a peer group comprised of six property and casualty insurance companies over the same period. The peer group consists of Cincinnati Financial Corp., Hanover Insurance Group Inc., Horace Mann Educators Corp., Kemper Corp., Selective Insurance Group Inc. and United Fire Group Inc. The graph shows the change in value of an initial $100 investment on December 31, 2018, assuming reinvestment of all dividends.
| | | 2018 | 2019 | 2020 | 2021 | 2022 | 2023 |
| | Donegal Group Inc. Class A | $100.00 | $113.15 | $108.55 | $118.71 | $123.52 | $127.47 |
| | Donegal Group Inc. Class B | 100.00 | 112.41 | 150.58 | 128.76 | 162.04 | 150.99 |
| | Russell 2000 | 100.00 | 125.52 | 113.73 | 172.90 | 137.56 | 160.85 |
| | Peer Group | 100.00 | 125.90 | 132.70 | 132.95 | 128.52 | 131.56 |
Research Data Group prepared the foregoing performance graph and data. The performance graph and accompanying data shall not be deemed “filed” as part of this Form 10-K Report for purposes of Section 18 of the Exchange Act or otherwise subject to the liabilities of that section and should not be deemed incorporated by reference into any other filing we make under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent we specifically incorporate the performance graph and accompanying data by reference into such filing.
| Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
Overview
Donegal Mutual Insurance Company (“Donegal Mutual”) organized us as an insurance holding company on August 26, 1986. See “Business - History and Organizational Structure” for more information. Our insurance subsidiaries are Atlantic States Insurance Company (“Atlantic States”), Michigan Insurance Company (“MICO”), The Peninsula Insurance Company and its wholly owned subsidiary, Peninsula Indemnity Company (collectively, “Peninsula”), and Southern Insurance Company of Virginia (“Southern”). Our insurance subsidiaries and their affiliates write commercial and personal lines of property and casualty coverages exclusively through a network of independent insurance agents in certain Mid-Atlantic, Midwest, New England, Southern and Southwestern states. The commercial lines products of our insurance subsidiaries consist primarily of commercial automobile, commercial multi-peril and workers’ compensation policies. The personal lines products of our insurance subsidiaries consist primarily of homeowners and private passenger automobile policies.
At December 31, 2023, Donegal Mutual held approximately 44% of our outstanding Class A common stock and approximately 84% of our outstanding Class B common stock. This ownership provides Donegal Mutual with approximately 71% of the combined voting power of our outstanding shares of Class A common stock and our outstanding shares of Class B common stock.
Donegal Mutual and Atlantic States have participated in a proportional reinsurance agreement, or pooling agreement, since 1986. Under the pooling agreement, Donegal Mutual and Atlantic States contribute substantially all of their respective premiums, losses and loss expenses to the underwriting pool, and the underwriting pool, acting through Donegal Mutual, then allocates 80% of the pooled business to Atlantic States. Thus, Donegal Mutual and Atlantic States share the underwriting results of the pooled business in proportion to their respective participation in the underwriting pool. The operations of our insurance subsidiaries and Donegal Mutual are interrelated due to the pooling agreement and other factors. While maintaining the separate corporate existence of each company, our insurance subsidiaries conduct business together with Donegal Mutual and its insurance subsidiaries as the Donegal Insurance Group. The Donegal Insurance Group is not a legal entity, is not an insurance company and does not issue or administer insurance policies. Rather, it is a trade name that refers to the group of insurance companies that are affiliated with Donegal Mutual. See “Business - Relationship with Donegal Mutual” for more information regarding the pooling agreement and other transactions with our affiliates.
Donegal Mutual and our insurance subsidiaries operate together as the Donegal Insurance Group and share a combined business plan designed to achieve market penetration and underwriting profitability objectives. The products our insurance subsidiaries and Donegal Mutual offer are generally complementary, thereby allowing Donegal Insurance Group to offer a broader range of products to a given market and to expand Donegal Insurance Group’s ability to service an entire personal lines or commercial lines account. Distinctions within the products of Donegal Mutual and our insurance subsidiaries generally relate to specific risk profiles targeted within similar classes of business, such as preferred tier products compared to standard tier products, but we do not allocate all of the standard risk gradients to one company. Therefore, the underwriting profitability of the business the individual companies write directly will vary. However, because the pool homogenizes the risk characteristics of the predominant percentage of the business Donegal Mutual and Atlantic States write directly and each company shares the underwriting results according to each company’s participation percentage, each company realizes its percentage share of the underwriting results of the pool.
Donegal Mutual completed the merger of Mountain States Mutual Casualty Company, or Mountain States, with and into Donegal Mutual effective May 25, 2017. Donegal Mutual was the surviving company in the merger, and Mountain States’ insurance subsidiaries, Mountain States Indemnity Company and Mountain States Commercial Insurance Company (collectively, the “Mountain States insurance subsidiaries”), became insurance subsidiaries of Donegal Mutual upon completion of the merger. Upon completion of the merger, Donegal Mutual assumed all of the policy obligations of Mountain States and began to market its products together with the Mountain States insurance subsidiaries as the Mountain States Insurance Group in four Southwestern states. Donegal Mutual also entered into a 100% quota-share reinsurance agreement with the Mountain States insurance subsidiaries on the merger date. Beginning with policies effective in 2021, Donegal Mutual began to place the business of the Mountain States Insurance Group into the underwriting pool.
In July 2013, our board of directors authorized a share repurchase program pursuant to which we have the authority to purchase up to 500,000 additional shares of our Class A common stock at prices prevailing from time to time in the open market subject to the provisions of the SEC Rule 10b-18 and in privately negotiated transactions. We did not purchase any shares of our Class A common stock under this program during 2023 or 2022. We have purchased a total of 57,658 shares of our Class A common stock under this program from its inception through December 31, 2023.
On April 29, 2022, Donegal Mutual disclosed that it will, at its discretion, purchase shares of our Class A common stock and our Class B common stock at market prices prevailing from time to time in the open market subject to the provisions of SEC Rule 10b-18 and in privately negotiated transactions. Such disclosure did not stipulate a maximum number of shares that may be purchased under this program. Donegal Mutual purchased 516,620 and 1,035,778 shares of our Class A common stock during 2023 and 2022, respectively. Donegal Mutual did not purchase any shares of our Class B common stock during 2023. Donegal Mutual purchased 54,231 shares of our Class B common stock during 2022.
Critical Accounting Policies and Estimates
We combine our financial statements with those of our insurance subsidiaries and present them on a consolidated basis in accordance with GAAP.
Our insurance subsidiaries make estimates and assumptions that can have a significant effect on amounts and disclosures we report in our financial statements. The most significant estimates relate to the reserves of our insurance subsidiaries for property and casualty insurance unpaid losses and loss expenses. While we believe our estimates and the estimates of our insurance subsidiaries are appropriate, the ultimate amounts may differ from the estimates we provided. We regularly review our methods for making these estimates, and we reflect any adjustment we consider necessary in our results of operations for the period in which we make an adjustment.
Liability for Losses and Loss Expenses
Liabilities for losses and loss expenses are estimates at a given point in time of the amounts an insurer expects to pay with respect to incurred policyholder claims based on facts and circumstances the insurer knows at that point in time. For example, legislative, judicial and regulatory actions may expand coverage definitions, retroactively mandate coverage or otherwise require our insurance subsidiaries to pay losses for damages that their policies explicitly excluded or did not intend to cover. At the time of establishing its estimates, an insurer recognizes that its ultimate liability for losses and loss expenses will exceed or be less than such estimates. Our insurance subsidiaries base their estimates of liabilities for losses and loss expenses on assumptions as to future loss trends, expected claims severity, judicial theories of liability and other factors. However, during the loss adjustment period, our insurance subsidiaries may learn additional facts regarding individual claims, and, consequently, it often becomes necessary for our insurance subsidiaries to refine and adjust their estimates for these liabilities. We reflect any adjustments to the liabilities for losses and loss expenses of our insurance subsidiaries in our consolidated results of operations in the period in which our insurance subsidiaries make adjustments to their estimates.
Our insurance subsidiaries maintain liabilities for the payment of losses and loss expenses with respect to both reported and unreported claims. Our insurance subsidiaries establish these liabilities for the purpose of covering the ultimate costs of settling all losses, including investigation and litigation costs. Our insurance subsidiaries base the amount of their liability for reported losses primarily upon a case-by-case evaluation of the type of risk involved, knowledge of the circumstances surrounding each claim and the insurance policy provisions relating to the type of loss the policyholder incurred. Our insurance subsidiaries determine the amount of their liability for unreported claims and loss expenses on the basis of historical information by line of insurance. Our insurance subsidiaries account for inflation in the reserving function through analysis of costs and trends and reviews of historical reserving results. Our insurance subsidiaries monitor their liabilities closely and recompute them periodically using new information on reported claims and a variety of statistical techniques. Our insurance subsidiaries do not discount their liabilities for losses and loss expenses.
Reserve estimates can change over time because of unexpected changes in assumptions related to our insurance subsidiaries’ external environment and, to a lesser extent, assumptions related to our insurance subsidiaries’ internal operations. For example, our insurance subsidiaries have experienced an increase in claims severity and a lengthening of the claim settlement periods on bodily injury claims during the past several years. In addition, the COVID-19 pandemic and related government mandates and restrictions resulted in various changes from historical claims reporting and settlement trends during 2020 and resulted in significant increases in loss costs in 2022 and 2023 due to a number of factors, including supply chain disruption, higher new and used automobile values, increases in the cost of replacement automobile parts and rising labor rates. While these trend changes have begun to normalize, they caused significant disruption to historical loss patterns and give rise to greater uncertainty as to the pattern of future loss settlements. Related uncertainties regarding future trends include social inflation, availability and cost of replacement automobile parts and building materials, availability of skilled labor, the rate of plaintiff attorney involvement in claims and the cost of medical technologies and procedures. Assumptions related to our insurance subsidiaries’ external environment include the absence of significant changes in tort law and the legal environment that increase liability exposure, consistency in judicial interpretations of insurance coverage and policy provisions and the rate of loss cost inflation. Internal assumptions include consistency in the recording of premium and loss statistics, consistency in the recording of claims, payment and case reserving methodology, accurate measurement of the impact of rate changes and changes in policy provisions, consistency in the quality and characteristics of business written within a given line of business and consistency in reinsurance coverage and collectability of reinsured losses, among other items. To the extent our insurance subsidiaries determine that underlying factors impacting their assumptions have changed, our insurance subsidiaries make adjustments in their reserves that they consider appropriate for such changes. Accordingly, our insurance subsidiaries’ ultimate liability for unpaid losses and loss expenses will likely differ from the amount recorded at December 31, 2023. For every 1% change in our insurance subsidiaries’ loss and loss expense reserves, net of reinsurance recoverable, the effect on our pre-tax results of operations would be approximately $6.9 million.
The establishment of appropriate liabilities is an inherently uncertain process and we can provide no assurance that our insurance subsidiaries’ ultimate liability will not exceed our insurance subsidiaries’ loss and loss expense reserves and have an adverse effect on our results of operations and financial condition. Furthermore, we cannot predict the timing, frequency and extent of adjustments to our insurance subsidiaries’ estimated future liabilities, because the historical conditions and events that serve as a basis for our insurance subsidiaries’ estimates of ultimate claim costs may change. As is the case for substantially all property and casualty insurance companies, our insurance subsidiaries have found it necessary in the past to increase their estimated future liabilities for losses and loss expenses in certain periods and, in other periods, their estimated future liabilities for losses and loss expenses have exceeded their actual liabilities for losses and loss expenses. Changes in our insurance subsidiaries’ estimates of their liability for losses and loss expenses generally reflect actual payments and their evaluation of information received subsequent to the prior reporting period.
Our insurance subsidiaries recognized a decrease in their liability for losses and loss expenses of prior years of $16.7 million, $44.8 million and $31.2 million in 2023, 2022 and 2021, respectively. Our insurance subsidiaries made no significant changes in their reserving philosophy or claims management personnel, and they have made no significant offsetting changes in estimates that increased or decreased their loss and loss expense reserves in those years. The 2023 development represented 2.5% of the December 31, 2022 net carried reserves and resulted primarily from lower-than-expected loss emergence in the personal automobile and commercial automobile lines of business for accident years prior to 2023. The majority of the 2023 development related to decreases in the liability for losses and loss expenses of prior years for Atlantic States and MICO. The 2022 development represented 7.2% of the December 31, 2021 net carried reserves and resulted primarily from lower-than-expected loss emergence in the personal automobile and commercial automobile lines of business for accident years prior to 2022. The majority of the 2022 development related to decreases in the liability for losses and loss expenses of prior years for Atlantic States and MICO. The 2021 development represented 5.6% of the December 31, 2020 net carried reserves and resulted primarily from lower-than-expected loss emergence in the personal automobile, workers’ compensation and commercial automobile lines of business for accident years prior to 2021. The majority of the 2021 development related to decreases in the liability for losses and loss expenses of prior years for Atlantic States and MICO.
Excluding the impact of severe weather events and the COVID-19 pandemic, our insurance subsidiaries have noted stable amounts in the number of claims incurred and the number of claims outstanding at period ends relative to their premium base in recent years across most of their lines of business. However, the amount of the average claim outstanding has increased gradually over the past several years due to various factors such as increased property and automobile repair and replacement costs, rising medical loss costs and increased litigation trends. We have also experienced a general slowing of settlement rates in litigated claims. Our insurance subsidiaries could have to make further adjustments to their estimates in the future. However, on the basis of our insurance subsidiaries’ internal procedures, which analyze, among other things, their prior assumptions, their experience with similar cases and historical trends such as reserving patterns, loss payments, pending levels of unpaid claims and product mix, as well as court decisions, economic conditions and public attitudes, we believe that our insurance subsidiaries have made adequate provision for their liability for losses and loss expenses.
Atlantic States’ participation in the pool with Donegal Mutual exposes Atlantic States to adverse loss development on the business of Donegal Mutual that the pool includes. However, pooled business represents the predominant percentage of the net underwriting activity of both companies, and Donegal Mutual and Atlantic States share proportionately any adverse risk development relating to the pooled business. The business in the pool is homogeneous and each company has a pro-rata share of the entire pool. Since the predominant percentage of the business of Atlantic States and Donegal Mutual is pooled and the results shared by each company according to its participation level under the terms of the pooling agreement, the intent of the underwriting pool is to produce a more uniform and stable underwriting result from year to year for each company than either would experience individually and to spread the risk of loss between the companies.
Our insurance subsidiaries’ liability for losses and loss expenses by major line of business at December 31, 2023 and 2022 consisted of the following:
| | | 2023 | | | 2022 | |
| | | (in thousands) | |
| Commercial lines: | | | | | | |
| Automobile | | $ | 168,749 | | | $ | 174,833 | |
| Workers’ compensation | | | 122,473 | | | | 120,539 | |
| Commercial multi-peril | | | 217,292 | | | | 203,567 | |
| Other | | | 27,167 | | | | 23,071 | |
| Total commercial lines | | | 535,681 | | | | 522,010 | |
| | | | | | | | | |
| Personal lines: | | | | | | | | |
| Automobile | | | 112,509 | | | | 108,715 | |
| Homeowners | | | 28,001 | | | | 28,481 | |
| Other | | | 12,952 | | | | 10,656 | |
| Total personal lines | | | 153,462 | | | | 147,852 | |
| | | | | | | | | |
| Total commercial and personal lines | | | 689,143 | | | | 669,862 | |
| Plus reinsurance recoverable | | | 437,014 | | | | 451,184 | |
| Total liability for losses and loss expenses | | $ | 1,126,157 | | | $ | 1,121,046 | |
We have evaluated the effect on our insurance subsidiaries’ loss and loss expense reserves and our stockholders’ equity in the event of reasonably likely changes in the variables we consider in establishing loss and loss expense reserves. We established the range of reasonably likely changes based on a review of changes in accident year development by line of business and applied it to our insurance subsidiaries’ loss reserves as a whole. The selected range does not necessarily indicate what could be the potential best or worst case or the most-likely scenario. The following table sets forth the effect on our insurance subsidiaries’ loss and loss expense reserves and our stockholders’ equity in the event of reasonably likely changes in the variables considered in establishing loss and loss expense reserves:
Change in Loss and Loss Expense Reserves Net of Reinsurance | | Adjusted Loss and Loss Expense Reserves Net of Reinsurance at December 31, 2023 | | Percentage Change in Equity at December 31, 2023(1) | | Adjusted Loss and Loss Expense Reserves Net of Reinsurance at December 31, 2022 | | Percentage Change in Equity at December 31, 2022(1) |
| (dollars in thousands) |
| -10.0% | | $620,229 | | 11.3% | | $602,876 | | 10.9% |
| -7.5 | | 637,457 | | 8.5 | | 619,622 | | 8.2 |
| -5.0 | | 654,686 | | 5.7 | | 636,369 | | 5.5 |
| -2.5 | | 671,914 | | 2.8 | | 653,115 | | 2.7 |
| Base | | 689,143 | | — | | 669,862 | | — |
| 2.5 | | 706,372 | | -2.8 | | 686,609 | | -2.7 |
| 5.0 | | 723,600 | | -5.7 | | 703,355 | | -5.5 |
| 7.5 | | 740,829 | | -8.5 | | 720,102 | | -8.2 |
| 10.0 | | 758,057 | | -11.3 | | 736,848 | | -10.9 |
| | (1) | Net of income tax effect. |
Our insurance subsidiaries base their reserves for unpaid losses and loss expenses on current trends in loss and loss expense development and reflect their best estimates for future amounts needed to pay losses and loss expenses with respect to incurred events currently known to them plus incurred but not reported (“IBNR”) claims. Our insurance subsidiaries develop their reserve estimates based on an assessment of known facts and circumstances, review of historical loss settlement patterns, estimates of trends in claims severity, frequency, legal and regulatory changes and other assumptions. Our insurance subsidiaries consistently apply actuarial loss reserving techniques and assumptions, which rely on historical information as adjusted to reflect current conditions, including consideration of recent case reserve activity. Our insurance subsidiaries use the point estimate their actuaries select. For the year ended December 31, 2023, the actuaries developed a range from a low of $651.1 million to a high of $728.7 million and selected a point estimate of $689.1 million. The actuaries’ range of estimates for commercial lines in 2023 was $507.2 million to $565.4 million, and the actuaries selected a point estimate of $535.7 million. The actuaries’ range of estimates for personal lines in 2023 was $144.0 million to $163.3 million, and the actuaries selected a point estimate of $153.5 million. For the year ended December 31, 2022, the actuaries developed a range from a low of $621.6 million to a high of $721.6 million and selected a point estimate of $669.9 million. The actuaries’ range of estimates for commercial lines in 2022 was $486.4 million to $560.5 million, and the actuaries selected a point estimate of $522.0 million. The actuaries’ range of estimates for personal lines in 2022 was $135.2 million to $161.1 million, and the actuaries selected a point estimate of $147.9 million.
Our insurance subsidiaries seek to enhance their underwriting results by carefully selecting the product lines they underwrite. For personal lines products, our insurance subsidiaries insure standard and preferred risks in private passenger automobile and homeowners lines. For commercial lines products, the commercial risks that our insurance subsidiaries primarily insure are business offices, wholesalers, service providers, contractors, artisans and light manufacturing operations. Our insurance subsidiaries have limited exposure to asbestos and other environmental liabilities. Through the consistent application of this disciplined underwriting philosophy, our insurance subsidiaries have avoided many of the “long-tail” issues other insurance companies have faced. We consider workers’ compensation to be a “long-tail” line of business, in that workers’ compensation claims tend to be settled over a longer time frame than those in the other lines of business of our insurance subsidiaries.
The following table presents 2023 and 2022 claim count and payment amount information for workers’ compensation. Workers’ compensation losses primarily consist of indemnity and medical costs for injured workers.
| | | For the Year Ended December 31, | |
| (dollars in thousands) | | 2023 | | | 2022 | |
| Number of claims pending, beginning of period | | | 3,366 | | | | 3,336 | |
| Number of claims reported | | | 5,928 | | | | 6,683 | |
| Number of claims settled or dismissed | | | 6,150 | | | | 6,653 | |
| Number of claims pending, end of period | | | 3,144 | | | | 3,366 | |
| | | | | | | | | |
| Losses paid | | $ | 54,336 | | | $ | 55,809 | |
| Loss expenses paid | | $ | 12,292 | | | | 12,062 | |
Management Evaluation of Operating Results
Despite challenging insurance market conditions and increasing property and casualty loss severity trends that affected our results in recent years, we believe that our focused business strategy, including our insurance subsidiaries’ ongoing implementation of premium rate increases and refinements to their underwriting practices, have positioned us well for 2024 and beyond.
Because our insurance subsidiaries do not prepare GAAP financial statements, we evaluate the performance of our commercial lines and personal lines segments utilizing statutory accounting practices (“SAP”), which include financial measures that reflect the growth trends and underwriting results of our insurance subsidiaries.
We use the following financial data to monitor and evaluate our operating results:
| | | Year Ended December 31, | |
| (in thousands) | | 2023 | | | 2022 | | | 2021 | |
| | | | | | | | | | |
| Net premiums written: | | | | | | | | | |
| Commercial lines: | | | | | | | | | |
| Automobile | | $ | 174,741 | | | $ | 167,774 | | | $ | 161,947 | |
| Workers’ compensation | | | 107,598 | | | | 111,892 | | | | 113,256 | |
| Commercial multi-peril | | | 195,632 | | | | 200,045 | | | | 188,242 | |
| Other | | | 50,458 | | | | 51,135 | | | | 49,229 | |
| Total commercial lines | | | 528,429 | | | | 530,846 | | | | 512,674 | |
| Personal lines: | | | | | | | | | | | | |
| Automobile | | | 215,957 | | | | 181,129 | | | | 170,578 | |
| Homeowners | | | 139,688 | | | | 120,087 | | | | 109,974 | |
| Other | | | 11,623 | | | | 11,468 | | | | 11,041 | |
| Total personal lines | | | 367,268 | | | | 312,684 | | | | 291,593 | |
| Total net premiums written | | $ | 895,697 | | | $ | 843,530 | | | $ | 804,267 | |
| | | | | | | | | | | | | |
| Components of combined ratio: | | | | | | | | | | | | |
| Loss ratio | | | 69.1 | % | | | 68.6 | % | | | 67.1 | % |
| Expense ratio | | | 34.7 | | | | 34.1 | | | | 33.3 | |
| Dividend ratio | | | 0.6 | | | | 0.6 | | | | 0.6 | |
| Combined ratio | | | 104.4 | % | | | 103.3 | % | | | 101.0 | % |
| | | | | | | | | | | | | |
| Revenues: | | | | | | | | | | | | |
| Net premiums earned: | | | | | | | | | | | | |
| Commercial lines | | $ | 533,029 | | | $ | 521,227 | | | $ | 478,966 | |
| Personal lines | | | 349,042 | | | | 301,263 | | | | 297,049 | |
| Total net premiums earned | | | 882,071 | | | | 822,490 | | | | 776,015 | |
| Net investment income | | | 40,853 | | | | 34,016 | | | | 31,126 | |
| Investment gains (losses) | | | 3,173 | | | | (10,185 | ) | | | 6,477 | |
| Other | | | 1,241 | | | | 1,900 | | | | 2,848 | |
| Total revenues | | $ | 927,338 | | | $ | 848,221 | | | $ | 816,466 | |
| | | Year Ended December 31, | |
| (in thousands) | | 2023 | | | 2022 | | | 2021 | |
| | | | | | | | | | |
| Components of net income (loss): | | | | | | | | | |
| Underwriting (loss) income: | | | | | | | | | |
| Commercial lines | | $ | (6,998 | ) | | $ | (22,665 | ) | | $ | (35,174 | ) |
| Personal lines | | | (35,118 | ) | | | (13,506 | ) | | | 17,235 | |
| SAP underwriting loss | | | (42,116 | ) | | | (36,171 | ) | | | (17,939 | ) |
| GAAP adjustments | | | 3,735 | | | | 8,667 | | | | 9,945 | |
| GAAP underwriting loss | | | (38,381 | ) | | | (27,504 | ) | | | (7,994 | ) |
| Net investment income | | | 40,853 | | | | 34,016 | | | | 31,126 | |
| Investment gains (losses) | | | 3,173 | | | | (10,185 | ) | | | 6,477 | |
| Other | | | (582 | ) | | | 35 | | | | 730 | |
| Income (loss) before income tax expense (benefit) | | | 5,063 | | | | (3,638 | ) | | | 30,339 | |
| Income tax expense (benefit) | | | 637 | | | | (1,679 | ) | | | 5,085 | |
| Net income (loss) | | $ | 4,426 | | | $ | (1,959 | ) | | $ | 25,254 | |
Non-GAAP Information
We prepare our consolidated financial statements on the basis of GAAP. Our insurance subsidiaries prepare financial statements based on SAP. SAP financial measures are considered non-GAAP financial measures under applicable SEC rules because the SAP financial measures include or exclude certain items that the most comparable GAAP financial measures do not ordinarily include or exclude. Our calculation of non-GAAP financial measures may differ from similar measures other companies use. As a result, investors should exercise caution when comparing our non-GAAP financial measures to the non-GAAP financial measures other companies use. The SAP financial measures we utilize are net premiums written and statutory combined ratio.
Net Premiums Written
We define net premiums written as the amount of full-term premiums our insurance subsidiaries record for policies effective within a given period less premiums our insurance subsidiaries cede to reinsurers. Net premiums earned is the most comparable GAAP financial measure to net premiums written. Net premiums earned represent the sum of the amount of net premiums written and the change in net unearned premiums during a given period. Our insurance subsidiaries earn premiums and recognize them as revenue over the terms of their policies, which are one year or less in duration. Therefore, increases or decreases in net premiums earned generally reflect increases or decreases in net premiums written in the preceding 12-month period compared to the comparable period one year earlier.
The following table provides a reconciliation of our net premiums earned to our net premiums written for 2023, 2022 and 2021:
| | | Year Ended December 31, | |
| | | 2023 | | | 2022 | | | 2021 | |
| | | | | | | | | | |
| Net premiums earned | | $ | 882,071,386 | | | $ | 822,489,450 | | | $ | 776,015,201 | |
| Change in net unearned premiums | | | 13,625,254 | | | | 21,039,149 | | | | 28,251,308 | |
| Net premiums written | | $ | 895,696,640 | | | $ | 843,528,599 | | | $ | 804,266,509 | |
Statutory Combined Ratio
The combined ratio is a standard measurement of underwriting profitability for an insurance company. The combined ratio does not reflect investment income, net investment gains or losses, federal income taxes or other non-operating income or expense. A combined ratio of less than 100% generally indicates underwriting profitability.
The statutory combined ratio is a non-GAAP financial measure that is based upon amounts determined under SAP. We calculate our statutory combined ratio as the sum of:
| • | the statutory loss ratio, which is the ratio of calendar-year net incurred losses and loss expenses to net premiums earned; |
| • | the statutory expense ratio, which is the ratio of expenses incurred for net commissions, premium taxes and underwriting expenses to net premiums written; and |
| • | the statutory dividend ratio, which is the ratio of dividends to holders of workers’ compensation policies to net premiums earned. |
The calculation of our statutory combined ratio differs from the calculation of our GAAP combined ratio. In calculating our GAAP combined ratio, we do not deduct installment payment fees from incurred expenses, and we base the expense ratio on net premiums earned instead of net premiums written. Differences between our GAAP loss ratio and our statutory loss ratio result from anticipating salvage and subrogation recoveries for our GAAP loss ratio but not for our statutory loss ratio.
The following table presents comparative details with respect to our GAAP and statutory combined ratios for the years ended December 31, 2023, 2022 and 2021:
| | | Year Ended December 31, | |
| | | 2023 | | | 2022 | | | 2021 | |
| GAAP Combined Ratios (Total Lines) | | | | | | | | | |
| Loss ratio - core losses | | | 57.5 | % | | | 59.8 | % | | | 59.4 | % |
| Loss ratio - weather-related losses | | | 8.3 | | | | 7.7 | | | | 5.8 | |
| Loss ratio - large fire losses | | | 5.2 | | | | 6.5 | | | | 5.9 | |
| Loss ratio - net prior-year reserve development | | | -1.9 | | | | -5.4 | | | | -4.0 | |
| Loss ratio | | | 69.1 | | | | 68.6 | | | | 67.1 | |
| Expense ratio | | | 34.7 | | | | 34.1 | | | | 33.3 | |
| Dividend ratio | | | 0.6 | | | | 0.6 | | | | 0.6 | |
| Combined ratio | | | 104.4 | % | | | 103.3 | % | | | 101.0 | % |
| | | | | | | | | | | | | |
| Statutory Combined Ratios | | | | | | | | | | | | |
| Commercial lines: | | | | | | | | | | | | |
| Automobile | | | 97.3 | % | | | 98.0 | % | | | 108.6 | % |
| Workers’ compensation | | | 96.6 | | | | 97.3 | | | | 94.6 | |
| Commercial multi-peril | | | 112.3 | | | | 116.9 | | | | 114.1 | |
| Other | | | 85.5 | | | | 80.8 | | | | 77.5 | |
| Total commercial lines | | | 101.6 | | | | 103.7 | | | | 104.9 | |
| Personal lines: | | | | | | | | | | | | |
| Automobile | | | 109.7 | | | | 103.8 | | | | 94.4 | |
| Homeowners | | | 108.6 | | | | 111.0 | | | | 102.9 | |
| Other | | | 75.8 | | | | 52.1 | | | | 49.3 | |
| Total personal lines | | | 108.2 | | | | 102.8 | | | | 94.4 | |
| Total commercial and personal lines | | | 104.2 | | | | 103.3 | | | | 100.8 | |
Results of Operations
YEAR ENDED DECEMBER 31, 2023 COMPARED TO YEAR ENDED DECEMBER 31, 2022
Net Premiums Earned
Our insurance subsidiaries’ net premiums earned increased to $882.1 million for 2023, an increase of $59.6 million, or 7.2%, compared to 2022, primarily reflecting solid premium retention and renewal premium increases. Our insurance subsidiaries earn premiums and recognize them as income over the terms of the policies they issue. Such terms are generally one year or less in duration. Therefore, increases or decreases in net premiums earned generally reflect increases or decreases in net premiums written in the preceding twelve-month period compared to the same period one year earlier.
Net Premiums Written
Our insurance subsidiaries’ 2023 net premiums written increased 6.2% to $895.7 million, compared to $843.5 million for 2022. Commercial lines net premiums written decreased $2.4 million, or 0.5%, for 2023 compared to 2022. We attribute the decrease in commercial lines net premiums written primarily to planned attrition in states we are exiting or have targeted for profit improvement, lower new business writings and reinsurance reinstatement premiums on our property excess of loss reinsurance program, offset partially by strong premium retention and a continuation of renewal premium increases in lines other than workers’ compensation. Personal lines net premiums written increased $54.6 million, or 17.5%, for 2023 compared to 2022. We attribute the increase in personal lines net premiums written primarily to renewal premium increases and strong policy retention.
Investment Income
For 2023, our net investment income increased 20.1% to $40.9 million, compared to $34.0 million for 2022, due primarily to higher average reinvestment yields and higher average invested assets for 2023 compared to 2022.
Net Investment Gains (Losses)
Our net investment gains for 2023 were $3.2 million. Our net investment losses for 2022 were $10.2 million. The net investment gains (losses) for 2023 and 2022 were primarily related to increases (decreases) in the market value of the equity securities held at the end of the respective periods. We did not recognize any impairment losses during 2023 or 2022.
Losses and Loss Expenses
Our insurance subsidiaries’ loss ratio, which is the ratio of incurred losses and loss expenses to premiums earned, was 69.1% for 2023, compared to 68.6% for 2022. Our insurance subsidiaries’ commercial lines loss ratio decreased to 64.8% for 2023, compared to 67.1% for 2022. This decrease resulted primarily from the commercial multi-peril loss ratio decreasing to 73.1% for 2023, compared to 79.2% for 2022, primarily due to a decrease in severity of non-weather claims. The personal lines loss ratio increased to 75.6% for 2023, compared to 71.0% for 2022. The personal automobile loss ratio increased to 78.5% for 2023, compared to 72.1% for 2022, primarily due to an increase in automobile claim severity due to the ongoing impact of supply chain disruption and labor shortages on the costs of repair and replacement vehicles. Our insurance subsidiaries experienced favorable loss reserve development of approximately $16.7 million, or 1.9 percentage points of the loss ratio, during 2023 in their reserves for prior accident years, compared to approximately $44.8 million, or 5.4 percentage points of the loss ratio, during 2022. The favorable loss reserve development in 2023 resulted primarily from lower-than-expected loss emergence in the personal automobile and commercial automobile lines of business for accident years prior to 2023. Weather-related losses of $72.9 million, or 8.3 percentage points of the loss ratio, for 2023 increased from $63.5 million, or 7.7 percentage points of the loss ratio, for 2022, with the increase primarily impacting the homeowners line of business. Large fire losses, which we define as individual fire losses in excess of $50,000, were $45.4 million, or 5.2 percentage points of the loss ratio, for 2023, compared to $53.5 million, or 6.5 percentage points of the loss ratio, for 2022. The decrease was related to lower average claim severity of both commercial property and home fires in 2023 compared to 2022.
Underwriting Expenses
Our insurance subsidiaries’ expense ratio, which is the ratio of policy acquisition and other underwriting expenses to premiums earned, was 34.7% for 2023, compared to 34.1% for 2022. We attribute the modest increase to higher technology system-related expenses for 2023 compared to 2022, offset somewhat by decreased underwriting-based incentive costs for our employees for 2023 compared to 2022. The increase in technology systems-related expenses for 2023 was primarily due to an increased allocation of costs from Donegal Mutual to our insurance subsidiaries following the successful implementation of two additional major releases of new systems as part of our ongoing systems modernization project in 2023. We expect the impact from allocated costs from Donegal Mutual to our insurance subsidiaries related to the ongoing systems modernization project will peak at approximately 1.25 percentage points of the expense ratio in 2024 before beginning to subside gradually in subsequent years.
Policyholder Dividends
Our insurance subsidiaries pay policyholder dividends primarily on workers’ compensation policies on a sliding scale based on the profitability of a given policy.
Combined Ratio
Our insurance subsidiaries’ combined ratio was 104.4% and 103.3% for 2023 and 2022, respectively. The combined ratio represents the sum of the loss ratio, the expense ratio and the dividend ratio, which is the ratio of workers’ compensation policy dividends incurred to premiums earned. We attribute the increase in our combined ratio primarily to the increases in the loss and expense ratios.
Interest Expense
Our interest expense for 2023 decreased slightly to $619,813, compared to $620,558 for 2022.
Income Taxes
Our income tax expense was $637,972 for 2023, compared to an income tax benefit of $1.7 million for 2022. Our effective tax rate for 2023 was 12.6%.
Net Income (Loss) and Earnings (Loss) Per Share
Our net income for 2023 was $4.4 million, or $0.14 per share of Class A common stock on a diluted basis and $0.11 per share of Class B common stock, compared to a net loss for 2022 of $2.0 million, or $0.06 per share of Class A common stock and $0.07 per share of Class B common stock. We had 27.8 million and 27.1 million Class A shares outstanding at December 31, 2023 and 2022, respectively. We had 5.6 million Class B shares outstanding for both periods. There are no outstanding securities that dilute our shares of Class B common stock.
Book Value Per Share
Our stockholders’ equity decreased by $3.8 million during 2023, primarily due to the cash dividends we declared exceeding our net income and other increases during the year, resulting in a decrease in our book value per share to $14.39 at December 31, 2023, compared to $14.79 a year earlier.
YEAR ENDED DECEMBER 31, 2022 COMPARED TO YEAR ENDED DECEMBER 31, 2021
Net Premiums Earned
Our insurance subsidiaries’ net premiums earned increased to $822.5 million for 2022, an increase of $46.5 million, or 6.0%, compared to 2021, primarily reflecting solid premium retention and renewal premium increases. Our insurance subsidiaries earn premiums and recognize them as income over the terms of the policies they issue. Such terms are generally one year or less in duration. Therefore, increases or decreases in net premiums earned generally reflect increases or decreases in net premiums written in the preceding twelve-month period compared to the same period one year earlier.
Net Premiums Written
Our insurance subsidiaries’ 2022 net premiums written increased 4.9% to $843.5 million, compared to $804.3 million for 2021. Commercial lines net premiums written increased $18.0 million, or 3.6%, for 2022 compared to 2021. We attribute the increase in commercial lines net premiums written primarily to modest new business writings, strong premium retention and a continuation of renewal premium increases in lines other than workers’ compensation, offset partially by planned attrition in regions we have targeted for profit improvement. Personal lines net premiums written increased $21.3 million, or 7.0%, for 2022 compared to 2021. We attribute the increase in personal lines net premiums written primarily to renewal premium increases, strong policy retention and new business writings in certain states where we have introduced an updated suite of products.
Investment Income
For 2022, our net investment income increased 9.3% to $34.0 million, compared to $31.1 million for 2021, due primarily to higher average reinvestment yields and higher average invested assets for 2022 compared to 2021.
Net Investment (Losses) Gains
Our net investment losses for 2022 were $10.2 million. Our net investment gains for 2021 were $6.5 million. The net investment (losses) gains for 2022 and 2021 were primarily related to (decreases) increases in unrealized (losses) gains within our equity securities portfolio. We did not recognize any impairment losses during 2022 or 2021.
Losses and Loss Expenses
Our insurance subsidiaries’ loss ratio, which is the ratio of incurred losses and loss expenses to premiums earned, was 68.6% for 2022, compared to 67.1% for 2021. Our insurance subsidiaries’ commercial lines loss ratio decreased to 67.1% for 2022, compared to 68.6% for 2021. This decrease resulted primarily from the commercial automobile loss ratio decreasing to 64.2% for 2022, compared to 75.0% for 2021. The personal lines loss ratio increased to 71.0% for 2022, compared to 64.8% for 2021. The personal automobile loss ratio increased to 72.1% for 2022, compared to 65.6% for 2021, primarily due to an increase in automobile claim severity due to the ongoing impact of supply chain disruption and labor shortages on the costs of repair and replacement vehicles. The homeowners loss ratio increased to 76.1% for 2022, compared to 69.6% for 2021, primarily due to increased average claim severity due to the ongoing impact of supply chain disruption and labor shortages on repair and replacement costs for homes. Our insurance subsidiaries experienced favorable loss reserve development of approximately $44.8 million, or 5.4 percentage points of the loss ratio, during 2022 in their reserves for prior accident years, compared to approximately $31.2 million, or 4.0 percentage points of the loss ratio, during 2021. The favorable loss reserve development in 2022 resulted primarily from lower-than-expected loss emergence in the personal automobile and commercial automobile lines of business for accident years prior to 2022. Weather-related losses of $63.5 million, or 7.7 percentage points of the loss ratio, for 2022 increased from $45.3 million, or 5.8 percentage points of the loss ratio, for 2021, with the increase primarily impacting the commercial multi-peril line of business. Large fire losses, which we define as individual fire losses in excess of $50,000, were $53.5 million, or 6.5 percentage points of the loss ratio, for 2022, compared to $45.6 million, or 5.9 percentage points of the loss ratio, for 2021. The increase was related to increased average claim severity of both commercial property and home fires in 2022 compared to 2021, which we attribute in part to inflationary repair cost increases.
Underwriting Expenses
Our insurance subsidiaries’ expense ratio, which is the ratio of policy acquisition and other underwriting expenses to premiums earned, was 34.1% for 2022, compared to 33.3% for 2021. We attribute the modest increase to higher technology system-related expenses for 2022 compared to 2021, offset somewhat by lower commercial growth incentive costs for our agents and decreased underwriting-based incentive costs for our employees for 2022 compared to 2021. The increase in technology systems-related expenses for 2022 was primarily due to an increased allocation of costs from Donegal Mutual to our insurance subsidiaries following the successful implementation of the second phase of our ongoing systems modernization project in August 2021.
Policyholder Dividends
Our insurance subsidiaries pay policyholder dividends primarily on workers’ compensation policies on a sliding scale based on the profitability of a given policy.
Combined Ratio
Our insurance subsidiaries’ combined ratio was 103.3% and 101.0% for 2022 and 2021, respectively. The combined ratio represents the sum of the loss ratio, the expense ratio and the dividend ratio, which is the ratio of workers’ compensation policy dividends incurred to premiums earned. We attribute the increase in our combined ratio primarily to the increase in the loss ratio.
Interest Expense
Our interest expense for 2022 decreased to $620,558, compared to $895,605 for 2021. We attribute the decrease to lower average borrowings under our lines of credit during 2022 compared to 2021.
Income Taxes
Our income tax benefit was $1.7 million for 2022, compared to income tax expense of $5.1 million for 2021. Our effective tax rate for 2021 was 16.8%.
Net (Loss) Income and (Loss) Earnings Per Share
Our net loss for 2022 was $2.0 million, or $.06 per share of Class A common stock and $.07 per share of Class B common stock, compared to net income for 2021 of $25.3 million, or $0.83 per share of Class A common stock on a diluted basis and $0.74 per share of Class B common stock. We had 27.1 million and 25.8 million Class A shares outstanding at December 31, 2022 and 2021, respectively. We had 5.6 million Class B shares outstanding for both periods. There are no outstanding securities that dilute our shares of Class B common stock.
Book Value Per Share
Our stockholders’ equity decreased by $47.4 million during 2022, primarily due to $45.4 million of after-tax unrealized losses within our available-for-sale fixed-maturity portfolio, resulting in a decrease in our book value per share to $14.79 at December 31, 2022, compared to $16.95 a year earlier.
Financial Condition
Liquidity and Capital Resources
Liquidity is a measure of an entity’s ability to secure enough cash to meet its contractual obligations and operating needs as they arise. Our major sources of funds from operations are the net cash flows generated from our insurance subsidiaries’ underwriting results, investment income and maturing investments.
We have historically generated sufficient net positive cash flow from our operations to fund our commitments and build our investment portfolio, thereby increasing future investment returns. The pooling agreement with Donegal Mutual historically has been cash flow positive because of the profitability of the underwriting pool. Because we settle the pool monthly, our cash flows are substantially similar to the cash flows that would result from the underwriting of direct business. We maintain a high degree of liquidity in our investment portfolio in the form of marketable fixed maturities, equity securities and short-term investments. We structure our fixed-maturity investment portfolio following a “laddering” approach so that projected cash flows from investment income and principal maturities are evenly distributed from a timing perspective. This laddering approach provides an additional measure of liquidity to meet our obligations and the obligations of our insurance subsidiaries should an unexpected variation occur in the future. Net cash flows provided by operating activities in 2023, 2022 and 2021 were $28.6 million, $67.1 million and $76.7 million, respectively. The decrease in net cash flows provided by operating activities for 2023 was primarily related to higher cash outflows for claim payments compared to 2022 and 2021.
At December 31, 2023, we had no outstanding borrowings under our line of credit with M&T and had the ability to borrow up to $20.0 million at interest rates equal to the then-current Term SOFR rate plus 2.11%. At December 31, 2023, Atlantic States had a $35.0 million outstanding advance with the FHLB of Pittsburgh that carries a fixed interest rate of 1.74% and is due in August 2024. In March 2020, Atlantic States issued $50.0 million of debt to the FHLB of Pittsburgh in exchange for a cash advance in the same amount for contingent liquidity funding in light of uncertainty surrounding the economic impact of the COVID-19 pandemic. Atlantic States repaid this advance when it became due in March 2021. In September 2021, upon receipt of approval from the Michigan Department of Insurance and Financial Services, MICO repaid in full the $5.0 million surplus note held previously by Donegal Mutual, along with accrued interest of $178,082. We discuss in Note 9 – Borrowings our estimate of the timing of the amounts payable for the borrowings under our lines of credit based on their contractual maturities.
We estimate the timing of claim payments associated with the liabilities for losses and loss expenses of our insurance subsidiaries based on historical experience and expectations of future payment patterns. Amounts Atlantic States assumes pursuant to the pooling agreement with Donegal Mutual represent a substantial portion of our insurance subsidiaries’ gross liabilities for losses and loss expenses, and amounts Atlantic States cedes pursuant to the pooling agreement represent a substantial portion of our insurance subsidiaries’ reinsurance recoverable on unpaid losses and loss expenses. We include cash settlement of Atlantic States’ assumed liabilities from the pool in monthly settlements of pooled activity, as we net amounts ceded to and assumed from the pool. Although Donegal Mutual and we do not anticipate any changes in the pool participation levels in the foreseeable future, any such change would be prospective in nature and therefore would not impact the timing of expected payments by Atlantic States for its percentage share of pooled losses occurring in periods prior to the effective date of such change.
The cash dividends we declared to our stockholders totaled $22.2 million, $20.9 million and $19.6 million in 2023, 2022 and 2021, respectively. There are no regulatory restrictions on our payment of dividends to our stockholders, although there are restrictions under applicable state laws on the payment of dividends from our insurance subsidiaries to us. Our insurance subsidiaries are required by law to maintain certain minimum surplus on a statutory basis and are subject to regulations under which their payment of dividends from statutory surplus is restricted and may require prior approval of their domiciliary insurance regulatory authorities. Our insurance subsidiaries are also subject to risk-based capital (“RBC”) requirements. The amount of statutory capital and surplus necessary for our insurance subsidiaries to satisfy regulatory requirements, including the RBC requirements, was not significant in relation to our insurance subsidiaries’ statutory capital and surplus at December 31, 2023. Amounts available for distribution to us as dividends from our insurance subsidiaries without prior approval of insurance regulatory authorities in 2024 are approximately $27.4 million from Atlantic States, $7.2 million from MICO and $5.0 million from Peninsula, or a total of approximately $39.6 million.
Investments
At December 31, 2023 and 2022, our investment portfolio of primarily investment-grade bonds, common stock, short-term investments and cash totaled $1.3 billion, representing 58.6% and 58.2%, respectively, of our total assets. See “Business - Investments” for more information.
| | | December 31, | |
| | | 2023 | | | 2022 | |
| | | | | | Percent of | | | | | | Percent of | |
| (dollars in thousands) | | Amount | | | Total | | | Amount | | | Total | |
| Fixed maturities: | | | | | | | | | | | | |
| Total held to maturity | | $ | 679,497 | | | | 51.2 | % | | $ | 688,439 | | | | 52.8 | % |
| Total available for sale | | | 589,348 | | | | 44.4 | | | | 523,792 | | | | 40.1 | |
| Total fixed maturities | | | 1,268,845 | | | | 95.6 | | | | 1,212,231 | | | | 92.9 | |
| Equity securities | | | 25,903 | | | | 2.0 | | | | 35,105 | | | | 2.7 | |
| Short-term investments | | | 32,306 | | | | 2.4 | | | | 57,321 | | | | 4.4 | |
| Total investments | | $ | 1,327,054 | | | | 100.0 | % | | $ | 1,304,657 | | | | 100.0 | % |
The carrying value of our fixed maturity investments represented 95.6% and 92.9% of our total invested assets at December 31, 2023 and 2022, respectively.
Our fixed maturity investments consisted of high-quality marketable bonds, of which 95.2% were rated at investment-grade levels at December 31, 2023 and 2022, respectively.
At December 31, 2023, the net unrealized loss on our available-for-sale fixed maturity investments, net of deferred taxes, amounted to $31.9 million, compared to a net unrealized loss of $38.0 million at December 31, 2022.
Impact of Inflation
Our insurance subsidiaries establish their property and casualty insurance premium rates before they know the amount of losses and loss settlement expenses or the extent to which inflation may impact such expenses. Consequently, our insurance subsidiaries attempt, in establishing rates, to anticipate the potential future impact of inflation. Our insurance subsidiaries account for inflation in the reserving function through analysis of costs and trends and reviews of historical reserving results.
Impact of Changing Climate Conditions
Insured losses from severe weather events could significantly impact the underwriting results of our insurance subsidiaries. Losses from catastrophic events are a function of both the extent of our insurance subsidiaries’ exposures, the frequency and severity of the events themselves and the level of reinsurance coverage our insurance subsidiaries purchase. The increased frequency and severity of weather-related catastrophes and other losses, such as from wildfires and flooding, incurred by the industry in recent years may be indicative of changing weather patterns due to climate change. Should those patterns continue to emerge, increased weather-related catastrophes in the states in which our insurance subsidiaries operate would lead to higher overall losses that they may be unable to offset through pricing actions.
Our insurance subsidiaries seek to reduce their exposure to catastrophe losses through their underwriting strategies and their purchase of catastrophe reinsurance. While the emerging science regarding climate change and its connection to extreme weather events continues to be studied, climate change, to the extent it produces rising temperatures and changes in weather patterns, could affect the frequency and severity of weather events and other losses and thus impact the affordability and availability of catastrophe reinsurance coverage for our insurance subsidiaries. Our insurance subsidiaries’ ability to appropriately manage catastrophe risk depends partially on catastrophe models, which rely on historical data that might not be representative of the frequency and severity of future events. Such models might also be unable to anticipate the uncertain impact of changing climate conditions that tend to occur gradually over time. Because the policies of our insurance subsidiaries renew not less frequently than annually, our insurance subsidiaries have the ability to respond to the impact of changing climate conditions through adjustments to their underwriting standards, pricing, and policy terms and conditions, subject to applicable regulatory approvals.
Changing climate conditions could lead to new or revised regulations with which our insurance subsidiaries would have to comply. Such regulations could impact the ability of our insurance subsidiaries to manage their exposures in areas impacted by increased weather activity, require our insurance companies to alter the terms and conditions of their policies or impact the ability of our insurance subsidiaries to obtain sufficient pricing increases to offset higher loss activity.
Impact of New Accounting Standards
In September 2016, the FASB issued guidance that amended previous guidance on the impairment of financial instruments by adding an impairment model that requires an entity to recognize expected credit losses as an allowance rather than impairments as credit losses are incurred. The intent of this guidance is to reduce complexity and result in a more timely recognition of expected credit losses. In November 2019, the FASB issued guidance that delayed the effective date for “smaller reporting companies,” as defined in Item 10(f)(1) of Regulation S-K, to annual and interim reporting periods beginning after December 15, 2022 from December 15, 2019. We were a smaller reporting company at the time this guidance was issued, and our adoption of this guidance on January 1, 2023 resulted in an after-tax decrease in retained earnings of $1.9 million. The adoption of this guidance did not have a significant impact on our results of operations or cash flows.
Off-Balance Sheet Arrangements
As of December 31, 2023 and 2022, we did not have any off-balance sheet arrangements as defined in Item 303(a)(4)(ii) of Regulation S-K.
| Item 7A. | Quantitative and Qualitative Disclosures About Market Risk. |
We are exposed to the impact of interest rate changes, to changes in fair values of investments and to credit risk.
In the normal course of business, we employ established policies and procedures to manage our exposure to changes in interest rates, fluctuations in the fair market value of our debt and equity securities and credit risk. We seek to mitigate these risks by various actions we describe below.
Interest Rate Risk
Our exposure to market risk for a change in interest rates is concentrated in our investment portfolio. We monitor this exposure through periodic reviews of our asset and liability positions. We regularly monitor estimates of cash flows and the impact of interest rate fluctuations relating to our investment portfolio. Generally, we do not hedge our exposure to interest rate risk because we have the capacity to, and do, hold fixed-maturity investments to maturity.
Principal cash flows and related weighted-average interest rates by stated maturity dates for the financial instruments we held at December 31, 2023 that are sensitive to interest rates are as follows:
| (in thousands) | | Principal Cash Flows | | | Weighted-Average Interest Rate | |
| Fixed-maturity and short-term investments: | | | | | | |
| 2024 | | $ | 87,195 | | | | 4.39 | % |
| 2025 | | | 62,973 | | | | 4.25 | |
| 2026 | | | 70,764 | | | | 3.99 | |
| 2027 | | | 72,905 | | | | 3.81 | |
| 2028 | | | 81,134 | | | | 4.11 | |
| Thereafter | | | 973,216 | | | | 3.21 | |
| Total | | $ | 1,348,187 | | | | | |
| Fair value | | $ | 1,258,196 | | | | | |
| Debt: | | | | | | | | |
| 2024 | | $ | 35,000 | | | | 1.74 | % |
| Total | | $ | 35,000 | | | | | |
| Fair value | | $ | 35,000 | | | | | |
Actual cash flows from investments may differ from those depicted above as a result of calls and prepayments.
Equity Price Risk
Our portfolio of equity securities, which we carry on our consolidated balance sheets at estimated fair value, has exposure to price risk, which is the risk of potential loss in estimated fair value resulting from an adverse change in prices. Our objective is to mitigate this risk and to earn competitive relative returns by investing in a diverse portfolio of high-quality, liquid securities.
Credit Risk
Our objective is to earn competitive returns by investing in a diversified portfolio of securities. Our portfolio of fixed maturity securities and, to a lesser extent, short-term investments is subject to credit risk. We define this risk as the potential loss in fair value resulting from adverse changes in the borrower’s ability to repay the debt. We manage this risk by performing an analysis of prospective investments and through regular reviews of our portfolio by our investment personnel. We also limit the amount of our total investment portfolio that we invest in any one security.
Our insurance subsidiaries provide property and liability insurance coverages through independent insurance agencies located throughout their operating areas. Our insurance subsidiaries bill the majority of this business directly to the insured, although our insurance subsidiaries bill a portion of their commercial business through their agents, to whom they extend credit in the normal course of business.
Because the pooling agreement does not relieve Atlantic States of primary liability as the originating insurer, Atlantic States is subject to a concentration of credit risk arising from the business Atlantic States cedes to Donegal Mutual. Our insurance subsidiaries maintain reinsurance agreements with Donegal Mutual and with a number of other major unaffiliated authorized reinsurers. To the extent that a reinsurer cannot pay losses for which it is liable under the terms of a reinsurance agreement with one or more of our insurance subsidiaries, our insurance subsidiaries retain continued liability for such losses.
