Exhibit 13
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL
CONDITION
Donegal Group Inc. ("DGI" or the "Company") is a regional insurance holding
company doing business in the Mid-Atlantic and Southern states through its five
wholly-owned property-casualty insurance subsidiaries, Atlantic States Insurance
Company ("Atlantic States"), Southern Insurance Company of Virginia
("Southern"), Southern Heritage Insurance Company ("Southern Heritage"),
Delaware Atlantic Insurance Company ("Delaware") and Pioneer Insurance Company
("Pioneer") (collectively "Insurance Subsidiaries"). The Company has three
operating segments: the investment function, the personal lines of insurance and
the commercial lines of insurance. Products offered in the personal lines of
insurance consist primarily of homeowners and private passenger automobile
policies. Products offered in the commercial lines of insurance consist
primarily of commercial automobile, commercial multiple peril and workers'
compensation policies. The Insurance Subsidiaries are subject to regulation by
Insurance Departments in those states in which they operate and undergo periodic
examination by those departments. The Insurance Subsidiaries are also subject to
competition from other insurance carriers in their operating areas. DGI was
formed in September 1986 by Donegal Mutual Insurance Company (the "Mutual
Company"), which owns 62% of the outstanding common shares of the Company as of
December 31, 1999.
Atlantic States participates in an intercompany pooling arrangement with the
Mutual Company and assumes 65% of the pooled business. Southern cedes 50% of its
business to the Mutual Company and Delaware cedes 70% of its workers'
compensation business to the Mutual Company. Because the Mutual Company places
substantially all of the business assumed from Southern and Delaware into the
pool, from which the Company has a 65% allocation, the Company's results of
operations include approximately 83% of the business written by Southern and
approximately 76% of the workers' compensation business written by Delaware.
In November 1998, the Company acquired all of the outstanding stock of
Southern Heritage. This transaction was accounted for as a "purchase." The
Company's financial statements include Southern Heritage as a consolidated
subsidiary from November 1, 1998.
In addition to the Company's Insurance Subsidiaries, it also owned all of the
outstanding stock of Atlantic Insurance Services, Inc. ("AIS"), an insurance
services organization which provided inspection and policy auditing information
on a fee-for-service basis to its affiliates and the insurance industry. The
Company sold all of the outstanding shares of AIS on October 1, 1999.
RESULTS OF OPERATIONS 1999 COMPARED TO 1998
Total revenues for 1999 were $159,711,107, which were $29,124,742, or 22.3%,
greater than 1998. Net premiums earned increased to $143,873,970, an increase of
$27,704,978, or 23.9%, over 1998. The acquisition of Southern Heritage accounted
for $19,674,071, or 71% of the increase in earned premiums in 1999. Direct
premiums written of the combined pool of Atlantic States and the Mutual Company
increased $9,516,654 or 6.6%. A 9.4% increase in the direct premiums written of
Southern, a 4.9% increase in the direct premiums written of Delaware and a 13.9%
increase in the direct premiums written of Pioneer accounted for the majority of
the remaining change. The Company reported net realized investment losses of
$38,702, compared to net realized investment losses of $13,562 in 1998. Net
realized losses in both years resulted from normal turnover of the Company's
investment portfolio. As of December 31, 1999, 99.9% of the Company's bond
portfolio was classified as Class 1 (highest quality) by the National
Association of Insurance Commissioners' Securities Valuation Office. Investment
income increased $1,225,876. An increase in the average invested assets from
$208,303,664 to $258,218,661, offset by a decrease in the average yield to 5.1%
from 5.6% in 1998, accounted for the change.
The GAAP combined ratio of insurance operations was 106.5% in 1999, compared
to 99.8% in 1998. The GAAP combined ratio is the sum of the ratios of incurred
losses and loss expenses to premiums earned (loss ratio), underwriting expenses
to premiums earned (expense ratio) and policyholder dividends to premiums earned
(dividend ratio). The loss ratio in 1999 was 69.0%, compared to 63.0% in 1998.
The increase in the loss ratio in 1999 resulted from a deterioration in
operating results in both the commercial and personal lines segments of the
Company. The commercial lines loss ratio increased from 54.9% in 1998 to 68.8%
in 1999, with results in workers' compensation suffering the largest increase
from 46.9% in 1998 to 68.8% in 1999. Homeowners results suffered the largest
increase in personal lines as the loss ratio increased from 72.3% in 1998 to
77.1% in 1999. This increase was somewhat offset by a decrease in the private
passenger automobile loss ratio from 71.0% in 1998 to 69.4% in 1999. The expense
ratio for 1999 was 36.6%, compared to 35.4% in 1998, with the dividend ratio
decreasing from 1.4% in 1998 to 0.9% in 1999. The expense ratio was adversely
affected by a charge to earnings resulting from a restructuring charge of $2
million which increased the expense ratio by 1.4%. The dividend ratio decreased
due to a higher loss ratio in workers' compensation in 1999 compared to 1998.
The Company benefited from a federal income tax law change that was enacted
during 1999 which allows net operating loss carryforwards of an acquired company
to be used to offset future taxable income of other affiliated companies filing
as part of a consolidated tax return.
page 10
Prior law allowed such net operating loss carryforward to be used to offset
taxable income of the acquired company only. Due to this law change, the net
operating loss carryforward, obtained as part of the acquisition of Southern
Heritage, can now be used to offset taxable income generated by the other
consolidated affiliates. Because of this change, management determined that a
valuation allowance for Southern Heritage's net operating loss carryforward is
no longer needed, and the Company recognized a tax benefit of $3,004,524 in
1999.
RESULTS OF OPERATIONS 1998 COMPARED TO 1997
Total revenues for 1998 were $130,586,365, which were $9,258,759, or 7.6%,
greater than 1997. Net premiums earned increased to $116,168,992, an increase of
$8,866,824, or 8.3%, over 1997. The acquisition of Southern Heritage contributed
$4,835,036, or 4.5%, to the earned premiums in 1998. Direct premiums written by
the combined pool of Atlantic States and the Mutual Company increased $6,426,444
or 4.7%. A 17.5% increase in the direct premiums written of Southern, a 6.5%
decrease in the direct premiums written of Delaware and an 11.7% decrease in the
direct premiums written of Pioneer accounted for the majority of the remaining
change. The Company reported net realized investment losses of $13,562, compared
to net realized investment gains of $314,136 in 1997. Net realized gains and
losses in both years resulted from normal turnover of the Company's investment
portfolio. As of December 31, 1998, 99.9% of the Company's bond portfolio was
classified as Class 1 (highest quality) by the National Association of Insurance
Commissioners' Securities Valuation Office. Investment income increased
$490,384. An increase in the average invested assets from $198,727,027 to
$208,303,664, offset by a decrease in the average yield to 5.6% from 5.8% in
1997, accounted for the change.
The GAAP combined ratio of insurance operations was 99.8% in 1998, compared
to 97.6% in 1997. The GAAP combined ratio is the sum of the ratios of incurred
losses and loss expenses to premiums earned (loss ratio), underwriting expenses
to premiums earned (expense ratio) and policyholder dividends to premiums earned
(dividend ratio). The loss ratio in 1998 was 63.0%, compared to 63.1% in 1997.
The expense ratio for 1998 was 35.4%, compared to 33.3% in 1997, with the
dividend ratio increasing from 1.2% in 1997 to 1.4% in 1998. The increase in the
Company's expense ratio accounted for the change in its combined ratio. The
expense ratio was adversely affected by a charge to earnings in the third
quarter resulting from an unprecedented large mandatory Pennsylvania Insurance
Guaranty Association assessment arising from the insolvency of two medical
malpractice companies. The Company's share of the Guaranty Association liability
arising from these two companies was $1.3 million. Guaranty Association
assessments represent mandatory regulatory charges that must be absorbed by
substantially all property and casualty insurance companies doing business in a
state where an insolvent company had been writing business, including companies,
like Donegal, who do not write lines of business that the insolvent companies
were writing.
LIQUIDITY AND CAPITAL RESOURCES
The Company generates sufficient funds from its operations and maintains a high
degree of liquidity in its investment portfolio. The primary source of funds to
meet the demands of claim settlements and operating expenses are premium
collections, investment earnings and maturing investments. As of December 31,
1999, the Company had no material commitment for capital expenditures.
In investing funds made available from operations, the Company maintains
securities' maturities consistent with its projected cash needs for the payment
of claims and expenses. The Company maintains a portion of its investment
portfolio in relatively short-term and highly liquid assets to ensure the
availability of funds.
As of December 31, 1999, pursuant to a credit agreement dated December 29,
1995, with Fleet National Bank of Connecticut, the Company had unsecured
borrowings of $37 million. Such borrowings were made in connection with the
acquisitions of Delaware, Pioneer and Southern Heritage and various capital
contributions to the subsidiaries. Per the terms of the credit agreement, the
Company may borrow up to $40 million at interest rates equal to the bank's then
current prime rate or the then current London interbank Eurodollar bank rate
plus 1.70%. At December 31, 1999, the interest rates on the outstanding balances
were 8.5% on an outstanding prime rate balance of $22 million and 7.84% on an
outstanding Eurodollar rate balance of $15 million. In addition, the Company
pays a rate of 3/10 of 1% per annum on the average daily unused portion of the
bank's commitment. On each July 27, commencing July 27, 2001, the credit line
will be reduced by $8 million. Any outstanding loan in excess of the remaining
credit line after such reduction will then be payable.
The Company's principal sources of cash with which to meet obligations and
pay stockholder dividends are dividends from the Insurance Subsidiaries which
are required by law to maintain certain minimum surplus on a statutory basis and
are subject to regulations under which payment of dividends from statutory
surplus is restricted and may require prior approval of their domiciliary
insurance regulatory authorities. The Insurance Subsidiaries are also subject to
Risk Based Capital (RBC) requirements which may further impact their ability to
pay dividends. At December 31, 1999, all five companies' statutory capital and
surplus were substantially above the RBC requirements. At December 31, 1999,
amounts available for distribution as dividends to DGI without prior approval of
the insurance regulatory authorities were $6,851,802 from Atlantic States,
$184,285 from Southern, $956,381 from Delaware, $567,793 from Pioneer and
$1,650,842 from Southern Heritage.
Net unrealized gains (losses) resulting from fluctuations in the fair value
of investments reported in the balance sheet at fair value were $(2,073,989)
(net of applicable federal income tax benefit) at December 31, 1999, and
$1,315,425 (net of applicable federal income tax) at December 31, 1998.
page 11
CREDIT RISK
The Company provides property and liability coverages through its subsidiaries'
independent agency systems located throughout its operating area. The majority
of this business is billed directly to the insured, although a portion of the
Company's commercial business is billed through its agents, who are extended
credit in the normal course of business.
The Company's Insurance Subsidiaries have reinsurance agreements in place
with the Mutual Company, as described in Note 3 of the financial statements, and
with a number of other major authorized reinsurers, as described in Note 9 of
the financial statements.
IMPACT OF INFLATION
Property and casualty insurance premiums are established before the amount of
losses and loss expenses, or the extent to which inflation may impact such
expenses, are known. Consequently, the Company attempts, in establishing rates,
to anticipate the potential impact of inflation.
YEAR 2000 ISSUES
The Company has not encountered difficulties to date with respect to the Year
2000 millennium change, either internally or with third parties. The Company
will continue to monitor exposure to any Year 2000 related problems.
The Company's expenses to address Year 2000 issues were not material.
The Company has risk that claims related to Year 2000 issues will be made
under insurance policies that it underwrites. The Company has concluded that its
policies do not generally provide coverage for losses relating to Year 2000
issues and has issued endorsements further clarifying this exclusion. However,
due in part to the potential for judicial decisions which expand policies to
cover risks that were not contemplated by the policy, which in turn may produce
unanticipated claims, and because there is no prior history of such claims at
this point in time, the amount of any potential Year 2000 coverage liabilities
is not determinable. However, the Company has not had any claims reported to
date.
IMPACT OF NEW ACCOUNTING STANDARDS
ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND
HEDGING ACTIVITIES - DEFERRAL OF THE EFFECTIVE DATE
In June 1999, Statement of Financial Accounting Standards (SFAS) No. 137,
"Accounting for Derivative Instruments and Hedging Activities - Deferral of the
Effective Date of FASB Statement No. 133," was issued deferring the effective
date of SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities," from all fiscal quarters of fiscal years beginning after June 15,
1999 to all fiscal quarters of fiscal years beginning after June 15, 2000. The
Company is in the process of determining the effect, if any, of SFAS No. 133 on
its financial statements. The Company has not held or issued derivative
financial instruments.
QUANTITATIVE AND QUALITATIVE DISCLOSURE
ABOUT MARKET RISK
INTEREST RATE RISK
The Company's exposure to market risk for changes in interest rates is
concentrated in its investment portfolio and, to a lesser extent, its debt
obligations. The Company monitors this exposure through periodic reviews of
asset and liability positions. Estimates of cash flows and the impact of
interest rate fluctuations relating to the investment portfolio are modeled
regularly.
Principal cash flows and related weighted-average interest rates by expected
maturity dates for financial instruments sensitive to interest rates at December
31, 1999 are as follows:
Principal Weighted-Average
Cash Interest
Flows Rate
- --------------------------------------------------------------------------------
Fixed maturities and
short-term investments:
2000 $ 34,005,257 5.96%
2001 17,174,618 6.58%
2002 10,435,292 5.98%
2003 17,600,000 5.79%
2004 13,500,000 5.73%
Thereafter 161,493,548 6.03%
- --------------------------------------------------------------------------------
Total $254,208,715
================================================================================
Market value $250,034,799
================================================================================
Debt
2000 $ 0 8.23%
2001 5,000,000 8.23%
2002 8,000,000 8.23%
2003 8,000,000 8.23%
2004 8,000,000 8.23%
Thereafter 8,000,000 8.23%
- --------------------------------------------------------------------------------
Total $ 37,000,000
================================================================================
Fair value $ 37,000,000
================================================================================
Actual cash flows may differ from those stated as a result of calls and
prepayments.
EQUITY PRICE RISK
The Company's portfolio of equity securities, which is carried on the balance
sheet at market value, has exposure to price risk. Price risk is defined as the
potential loss in market value resulting from an adverse change in prices.
Portfolio characteristics are analyzed regularly and market risk is actively
managed through a variety of techniques. The portfolio is diversified across
industries, and concentrations in any one company or industry are limited by
parameters established by management.
The combined total of realized and unrealized equity investment gains and
(losses) were $(404,147), $(307,147), and $586,178 in 1999, 1998 and 1997,
respectively. During these three years the largest total equity investment gain
and (loss) in a quarter was $897,971 and $(1,435,101), respectively.
page 12
DONEGAL GROUP INC.
CONSOLIDATED BALANCE SHEETS
Year Ended December 31, 1999 1998
- ------------------------------------------------------------------------------------------------------------------------------
Assets
Investments
Fixed maturities
Held to maturity, at amortized cost (fair value $133,995,994 and $131,633,299) $136,173,547 $127,183,788
Available for sale, at fair value (amortized cost $103,419,994 and $89,089,995) 100,043,548 90,525,855
Equity securities, available for sale, at fair value (cost $9,043,818 and $6,206,735) 9,229,498 6,763,943
Short-term investments, at cost, which approximates fair value 15,995,257 30,521,887
- ------------------------------------------------------------------------------------------------------------------------------
Total investments 261,441,850 254,995,473
Cash 3,922,403 8,227,042
Accrued investment income 3,474,430 3,164,599
Premiums receivable 18,218,525 19,824,894
Reinsurance receivable 53,070,283 48,339,223
Deferred policy acquisition costs 11,203,302 11,334,301
Federal income taxes receivable 698,969 227,841
Deferred tax asset, net 9,121,232 3,536,692
Prepaid reinsurance premiums 32,154,837 27,203,111
Property and equipment, net 5,516,688 5,920,420
Accounts receivable--securities -- 329,299
Due from affiliate 262,954 --
Other 647,184 2,128,611
- ------------------------------------------------------------------------------------------------------------------------------
Total assets $399,732,657 $385,231,506
==============================================================================================================================
Liabilities and Stockholders' Equity
Liabilities
Losses and loss expenses $149,979,141 $141,409,008
Unearned premiums 97,657,020 94,722,785
Accrued expenses 5,888,392 4,821,594
Drafts payable 597,775 1,394,373
Reinsurance balances payable 1,216,034 1,785,914
Cash dividend declared to stockholders 760,673 708,513
Borrowings under line of credit 37,000,000 37,500,000
Accounts payable--securities 2,500,000 503,840
Due to affiliate -- 870,083
Other 719,010 884,392
- ------------------------------------------------------------------------------------------------------------------------------
Total liabilities 296,318,045 284,600,502
- ------------------------------------------------------------------------------------------------------------------------------
Stockholders' Equity
Preferred stock, $1.00 par value, authorized 2,000,000 shares; none issued
Common stock, Class A, authorized 15,000,000 shares; none issued
Common stock, $1.00 par value, authorized 20,000,000 shares,
issued 8,574,210 and 8,325,221 shares and outstanding
8,451,922 and 8,202,933 shares 8,574,210 8,325,221
Additional paid-in capital 43,536,748 41,271,322
Accumulated other comprehensive income (loss) (2,073,989) 1,315,425
Retained earnings 54,269,399 50,610,792
Treasury stock, at cost (891,756) (891,756)
- ------------------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 103,414,612 100,631,004
- ------------------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $399,732,657 $385,231,506
==============================================================================================================================
See accompanying notes to consolidated financial statements.
page 13
DONEGAL GROUP INC.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
Year Ended December 31, 1999 1998 1997
- ---------------------------------------------------------------------------------------------------------------------------
STATEMENTS OF INCOME
Revenues
Premiums earned $211,361,789 $172,507,090 $159,055,645
Premiums ceded 67,487,819 56,338,098 51,753,477
- ---------------------------------------------------------------------------------------------------------------------------
Net premiums earned 143,873,970 116,168,992 107,302,168
Investment income, net of investment expenses 13,223,537 11,997,661 11,507,277
Installment payment fees 1,439,334 895,283 818,981
Lease income 819,474 753,408 643,183
Service fees 393,494 784,583 741,861
Net realized investment gains (losses) (38,702) (13,562) 314,136
- ---------------------------------------------------------------------------------------------------------------------------
Total revenues 159,711,107 130,586,365 121,327,606
- ---------------------------------------------------------------------------------------------------------------------------
Expenses
Losses and loss expenses 145,493,825 110,448,552 99,408,492
Reinsurance recoveries 46,288,823 37,281,467 31,751,974
- ---------------------------------------------------------------------------------------------------------------------------
Net losses and loss expenses 99,205,002 73,167,085 67,656,518
Amortization of deferred policy acquisition costs 24,608,000 19,490,000 18,696,000
Other underwriting expenses 28,034,876 21,712,346 17,058,668
Policy dividends 1,341,294 1,635,300 1,319,384
Interest 1,535,249 1,292,992 910,237
Other 1,357,585 1,611,627 1,513,256
- ---------------------------------------------------------------------------------------------------------------------------
Total expenses 156,082,006 118,909,350 107,154,063
- ---------------------------------------------------------------------------------------------------------------------------
Income before income tax expense (benefit) 3,629,101 11,677,015 14,173,543
Income tax expense (benefit) (3,027,836) 2,659,175 3,532,357
- ---------------------------------------------------------------------------------------------------------------------------
Net income $ 6,656,937 $ 9,017,840 $ 10,641,186
===========================================================================================================================
Net income per common share
Basic $ .80 $ 1.11 $ 1.33
===========================================================================================================================
Diluted $ .80 $ 1.09 $ 1.32
===========================================================================================================================
STATEMENTS OF COMPREHENSIVE INCOME
Net income $ 6,656,937 $ 9,017,840 $ 10,641,186
- ---------------------------------------------------------------------------------------------------------------------------
Other comprehensive income (loss), net of tax
Unrealized gains (losses) on securities:
Unrealized holding gain (loss) arising during the period,
net of income tax expense (benefit) of
$(1,781,261), $151,999 and $409,974 (3,414,957) 295,057 795,831
Reclassification adjustment for (gains) losses included
in net income, net of income tax expense (benefit) of
$(13,159), $(4,611) and $106,806 25,543 8,951 (207,330)
- ---------------------------------------------------------------------------------------------------------------------------
Other comprehensive income (loss) (3,389,414) 304,008 588,501
- ---------------------------------------------------------------------------------------------------------------------------
Comprehensive income $ 3,267,523 $ 9,321,848 $ 11,229,687
===========================================================================================================================
See accompanying notes to consolidated financial statements.
page 14
DONEGAL GROUP INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Accumulated
Common Stock Additional Other Total
------------------ Paid-in Comprehensive Retained Treasury Stockholders'
Shares Amount Capital Income (Loss) Earnings Stock Equity
- ------------------------------------------------------------------------------------------------------------------------------------
Balance,
January 1, 1997 4,540,569 $4,540,569 $37,862,715 $ 422,916 $39,664,830 $(891,756) $ 81,599,274
- ------------------------------------------------------------------------------------------------------------------------------------
Issuance of common stock 61,523 61,523 1,069,402 1,130,925
Net income 10,641,186 10,641,186
Other comprehensive income 588,501 588,501
Cash dividends
$.2925 per share (2,363,223) (2,363,223)
Stock dividend 1,520,339 1,520,329 (1,520,329)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance,
December 31, 1997 6,122,431 $6,122,431 $38,932,117 $ 1,011,417 $46,422,454 $(891,756) $ 91,596,663
- ------------------------------------------------------------------------------------------------------------------------------------
Issuance of common stock 141,542 141,542 2,339,205 2,480,747
Net income 9,017,840 9,017,840
Other comprehensive income 304,008 304,008
Cash dividends
$.3375 per share (2,768,254) (2,768,254)
Stock dividend 2,061,248 2,061,248 (2,061,248)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance,
December 31, 1998 8,325,221 $8,325,221 $41,271,322 $ 1,315,425 $50,610,792 $(891,756) $100,631,004
- ------------------------------------------------------------------------------------------------------------------------------------
Issuance of common stock 248,989 248,989 2,265,426 2,514,415
Net income 6,656,937 6,656,937
Other comprehensive loss (3,389,414) (3,389,414)
Cash dividends
$.36 per share (2,998,330) (2,998,330)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance,
December 31, 1999 8,574,210 $8,574,210 $43,536,748 $(2,073,989) $54,269,399 $(891,756) $103,414,612
====================================================================================================================================
See accompanying notes to consolidated financial statements.
page 15
DONEGAL GROUP INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31, 1999 1998 1997
- ------------------------------------------------------------------------------------------------------------------------------
Cash Flows from Operating Activities:
Net income $ 6,656,937 $ 9,017,840 $10,641,186
- ------------------------------------------------------------------------------------------------------------------------------
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 936,373 520,675 390,857
Realized investment (gains) losses 38,702 13,562 (314,136)
Changes in Assets and Liabilities, net of acquisition:
Losses and loss expenses 8,570,133 7,125,806 3,490,429
Unearned premiums 2,934,235 6,478,435 811,785
Accrued expenses 1,066,798 (542,693) 827,727
Premiums receivable 1,606,369 (1,253,529) (169,213)
Deferred policy acquisition costs 130,999 (399,428) (610,161)
Deferred income taxes (3,790,122) 158,593 7,108
Reinsurance receivable (4,731,060) (6,182,621) (78,023)
Accrued investment income (309,831) (186,170) (112,644)
Amounts due to/from affiliate (1,133,037) (4,180,378) (438,442)
Reinsurance balances payable (569,880) (127,931) (11,926)
Prepaid reinsurance premiums (4,951,726) (3,819,226) (508,964)
Current income taxes (471,128) (171,387) (700,983)
Other, net 519,441 100,292 192,808
- ------------------------------------------------------------------------------------------------------------------------------
Net adjustments (153,734) (2,466,000) 2,776,222
- ------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 6,503,203 6,551,840 13,417,408
- ------------------------------------------------------------------------------------------------------------------------------
Cash Flows from Investing Activities:
Purchase of fixed maturities
Held to maturity (23,132,805) (24,774,417) (15,834,418)
Available for sale (32,233,424) (43,662,157) (21,614,427)
Purchase of equity securities (14,258,861) (15,824,465) (10,598,546)
Sale of fixed maturities
Available for sale 503,895 2,207,500 --
Maturity of fixed maturities
Held to maturity 14,393,638 24,815,155 11,909,421
Available for sale 19,049,880 16,106,644 18,860,222
Sale of equity securities 11,767,268 16,155,130 6,695,236
Sale of Atlantic Insurance Services, net (48,810) -- --
Acquisition of Southern Heritage -- (18,028,072) --
Purchase of property and equipment (443,498) (650,014) (2,758,851)
Net sales (purchases) of short-term investments 14,526,630 15,099,631 (1,242,030)
- ------------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (9,876,087) (28,555,065) (14,583,393)
- ------------------------------------------------------------------------------------------------------------------------------
Cash Flows from Financing Activities:
Issuance of common stock 2,514,415 2,480,747 1,130,925
Borrowings (payments) under line of credit, net (500,000) 27,000,000 2,000,000
Cash dividends paid (2,946,170) (2,663,795) (2,251,788)
- ------------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities (931,755) 26,816,952 879,137
- ------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash (4,304,639) 4,813,727 (286,848)
Cash at beginning of year 8,227,042 3,413,315 3,700,163
- ------------------------------------------------------------------------------------------------------------------------------
Cash at end of year $ 3,922,403 $ 8,227,042 $ 3,413,315
==============================================================================================================================
See accompanying notes to consolidated financial statements.
page 16
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND BUSINESS
Donegal Group Inc. (the "Company") was organized as a regional insurance holding
company by Donegal Mutual Insurance Company (the "Mutual Company") and operates
in the Mid-Atlantic and Southern states through its wholly-owned stock insurance
companies, Atlantic States Insurance Company ("Atlantic States"), Southern
Insurance Company of Virginia ("Southern"), Southern Heritage Insurance Company
("Southern Heritage"), Delaware Atlantic Insurance Company ("Delaware"), and
Pioneer Insurance Company ("Pioneer") (collectively "Insurance Subsidiaries").
The Company has three operating segments: the investment function, the personal
lines of insurance and the commercial lines of insurance. Products offered in
the personal lines of insurance consist primarily of homeowners and private
passenger automobile policies. Products offered in the commercial lines of
insurance consist primarily of commercial automobile, commercial multiple peril
and workers' compensation policies. The Insurance Subsidiaries are subject to
regulation by Insurance Departments in those states in which they operate and
undergo periodic examination by those departments. The Insurance Subsidiaries
are also subject to competition from other insurance carriers in their operating
areas. Atlantic States participates in an intercompany pooling arrangement with
the Mutual Company and assumes 65% of the pooled business. Southern cedes 50% of
its business to the Mutual Company and Delaware cedes 70% of its Workers'
Compensation business to the Mutual Company. At December 31, 1999, the Mutual
Company held 62% of the outstanding common stock of the Company.
In addition to the Company's Insurance Subsidiaries, it also owned all of the
outstanding stock of Atlantic Insurance Services, Inc. ("AIS"), an insurance
services organization. The Company sold all of the stock of AIS on October 1,
1999.
BASIS OF CONSOLIDATION
The consolidated financial statements, which have been prepared in accordance
with generally accepted accounting principles, include the accounts of Donegal
Group Inc. and its wholly-owned subsidiaries. All significant inter-company
accounts and transactions have been eliminated in consolidation. The term
"Company" as used herein refers to the consolidated entity.
USE OF ESTIMATES
In preparing the consolidated financial statements, management is required to
make estimates and assumptions that affect the reported amounts of assets and
liabilities as of the date of the balance sheet and revenues and expenses for
the period. Actual results could differ significantly from those estimates.
Material estimates that are particularly susceptible to significant change in
the near-term relate to the determination of the liabilities for losses and loss
expenses. While management uses available information to provide for such
liabilities, future changes to these liabilities may be necessary based on
changes in trends in claim frequency and severity.
INVESTMENTS
The Company classifies its debt and equity securities into the following
categories:
Held to Maturity--Debt securities that the Company has the positive intent
and ability to hold to maturity; reported at amortized cost.
Available for Sale--Debt and equity securities not classified as held to
maturity; reported at fair value, with unrealized gains and losses excluded
from income and reported as a separate component of stockholders' equity (net
of tax effects).
Short-term investments are carried at amortized cost, which approximates fair
value.
If there is a decline in fair value below amortized cost which is other than
temporary, the cost basis for such investments in the held to maturity and
available for sale categories is reduced to fair value. Such decline in cost
basis is recognized as a realized loss and charged to income.
Premiums and discounts on debt securities are amortized over the life of the
security as an adjustment to yield using the effective interest method. Realized
investment gains and losses are computed using the specific identification
method.
Premiums and discounts for mortgage-backed debt securities are amortized
using anticipated prepayments with significant changes in estimated prepayments
accounted for under the prospective method.
page 17
FAIR VALUES OF FINANCIAL INSTRUMENTS
The Company has used the following methods and assumptions in estimating its
fair value disclosures:
Investments--Fair values for fixed maturity securities are based on quoted
market prices, when available. If quoted market prices are not available,
fair values are based on quoted market prices of comparable instruments or
values obtained from independent pricing services through a bank trustee. The
fair values for equity securities are based on quoted market prices.
Cash and Short-Term Investments--The carrying amounts reported in the balance
sheet for these instruments approximate their fair values.
Premium and Reinsurance Receivables and Payables--The carrying amounts
reported in the balance sheet for these instruments approximate their fair
values.
Borrowings Under Line of Credit--The carrying amounts reported in the balance
sheet for the line of credit approximate fair value due to the variable rate
nature of the line of credit.
REVENUE RECOGNITION
Insurance premiums are recognized as income over the terms of the policies.
Unearned premiums are calculated on a daily pro-rata basis.
POLICY ACQUISITION COSTS
Policy acquisition costs, consisting primarily of commissions, premium taxes and
certain other variable underwriting costs, are deferred and amortized over the
period in which the premiums are earned. Anticipated losses and loss expenses,
expenses for maintenance of policies in force and anticipated investment income
are considered in the determination of the recoverability of deferred
acquisition costs.
PROPERTY AND EQUIPMENT
Property and equipment are reported at depreciated cost that is computed using
the straight-line method based upon estimated useful lives of the assets.
LOSSES AND LOSS EXPENSES
The liability for losses and loss expenses includes amounts determined on the
basis of estimates for losses reported prior to the close of the accounting
period and other estimates, including those for incurred but not reported losses
and salvage and subrogation recoveries.
These liabilities are continuously reviewed and updated by management, and
management believes that such liabilities are adequate to cover the ultimate net
cost of claims and expenses. When management determines that changes in
estimates are required, such changes are included in current earnings.
The Company has no material exposures to environmental liabilities.
INCOME TAXES
The Company and its subsidiaries currently file a consolidated federal income
tax return.
The Company accounts for income taxes using the asset and liability method.
The objective of the asset and liability method is to establish deferred tax
assets and liabilities for the temporary differences between the financial
reporting basis and the tax basis of the Company's assets and liabilities at
enacted tax rates expected to be in effect when such amounts are realized or
settled.
CREDIT RISK
The Company provides property and liability coverages through its Insurance
Subsidiaries' independent agency systems located throughout its operating area.
The majority of this business is billed directly to the insured, although a
portion of the Company's commercial business is billed through its agents, who
are extended credit in the normal course of business.
The Company's Insurance Subsidiaries have reinsurance agreements in place
with the Mutual Company and with a number of other authorized reinsurers with at
least an A.M. Best rating of A- or an equivalent financial condition.
REINSURANCE ACCOUNTING AND REPORTING
The Company relies upon reinsurance agreements to limit its maximum net loss
from large single risks or risks in concentrated areas, and to increase its
capacity to write insurance. Reinsurance does not relieve the primary insurer
from liability to its policyholders. To the extent that a reinsurer may be
unable to pay losses for which it is liable under the terms of a reinsurance
agreement, the Company is exposed to the risk of continued liability for such
losses. However, in an effort to reduce the risk of non-payment, the Company
requires all of its reinsurers to have an A.M. Best rating of A- or better or,
with respect to foreign reinsurers, to have a financial condition which, in the
opinion of management, is equivalent to a company with at least an A- rating.
page 18
STOCK-BASED COMPENSATION
Stock-based compensation plans are accounted for under the provisions of
Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued
to Employees," and related interpretations. As such, compensation expense would
be recorded on the date of a stock option grant only if the current market price
of the underlying stock exceeded the exercise price. Statement of Financial
Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation,"
permits entities to recognize as expense, over the vesting period, the fair
value of all stock-based awards on the date of the grant. Alternatively, SFAS
No. 123 allows entities to continue to apply the provisions of APB Opinion No.
25 and provide pro-forma net income and earnings per share disclosures for
employee stock option grants made as if the fair-value-based method defined in
SFAS No. 123 had been applied. The Company has elected to continue to apply the
provisions of APB Opinion No. 25 and provide the pro-forma disclosures under
SFAS No. 123.
EARNINGS PER SHARE
Basic earnings per share are calculated by dividing net income by the
weighted-average number of common shares outstanding for the period, while
diluted earnings per share reflects the dilution that could occur if securities
or other contracts to issue common stock were exercised or converted into common
stock.
2--ACQUISITIONS OF BUSINESSES
In November 1998, the Company acquired all of the outstanding stock of Southern
Heritage for a cash price of $18,824,950. Southern Heritage primarily writes
personal automobile and homeowners policies in the Southeastern region of the
country. This transaction was accounted for as a "purchase." The Company's
financial statements include Southern Heritage as a consolidated subsidiary from
November 1, 1998.
Assets in the amount of $56,568,710 were acquired, and liabilities in the
amount of $38,330,912 were assumed in the purchase transaction. The purchase
price exceeded the fair value of net assets acquired by $587,152, which is
recognized as goodwill and is being amortized over five years.
The following table reflects unaudited pro-forma combined results of
operations of the Company and Southern Heritage on the basis that the
acquisition had taken place at the beginning of each year. The pro-forma
information is presented for information purposes only and is not indicative of
the actual results that would have resulted if the acquisition had been made as
of those dates. The pro-forma is not intended to be a projection of future
results.
1998 1997
- --------------------------------------------------------------------------------
Revenues $161,307,562 $157,037,483
Net income 2,978,411 9,558,889
Earnings per common share
Basic .37 1.20
Diluted .36 1.19
The above table includes interest expense and amortization of goodwill as if
the acquisition occurred January 1, 1997.
In March 1997, the Company acquired all of the outstanding stock of Pioneer.
This transaction was accounted for as if it were a "pooling of interest," and as
such the Company's financial statements have been restated to include Pioneer as
a consolidated subsidiary from January 1, 1993 to the present.
3--TRANSACTIONS WITH AFFILIATES
The Company conducts business and has various agreements with the Mutual Company
which are described below:
A. REINSURANCE POOLING AND OTHER REINSURANCE ARRANGEMENTS
Atlantic States cedes to the Mutual Company all of its insurance business and
assumes from the Mutual Company 65% of the Mutual Company's total pooled
insurance business, including that assumed from Atlantic States and
substantially all of the business assumed and retained by the Mutual Company
from Southern and Delaware. Atlantic States, Southern, Delaware and Pioneer each
have a catastrophe reinsurance agreement with the Mutual Company which limits
the maximum liability under any one catastrophic occurrence to $400,000,
$300,000, $300,000 and $200,000, respectively, and $700,000 for a catastrophe
involving more than one of the companies. The Mutual Company and Delaware have
an excess of loss reinsurance agreement in which the Mutual Company assumes up
to $200,000 of losses in excess of $50,000 and a workers' compensation quota
share agreement whereby Delaware cedes 70% of that business. The Mutual Company
and Pioneer have an excess of loss reinsurance agreement in which the Mutual
Company assumes up to $200,000 of losses in excess of $50,000. The Mutual
Company and Pioneer also have an aggregate excess of loss reinsurance agreement,
entered into as part of the sale of Pioneer from the Mutual Company to
Donegal Group Inc., in which the Mutual Company agreed to assume the adverse
loss development of claims with dates of loss prior to December 31, 1996, as
developed through December 31, 1998, and to assume losses in excess of a 60%
loss ratio through December 31, 1998. The Mutual Company and Southern have an
excess of loss reinsurance agreement in which the Mutual Company assumes up to
$25,000 of losses in excess of $100,000 and a quota share agreement whereby
Southern cedes 50% of its direct business less certain reinsurance to the Mutual
Company. Southern, Delaware and Pioneer each have retrocessional reinsurance
agreements with the Mutual Company under which they cede, and then assume back,
100% of their business net of other reinsurance.
page 19
The following amounts represent reinsurance transactions with the Mutual
Company during 1999, 1998 and 1997:
CEDED REINSURANCE: 1999 1998 1997
====================================================================
Premiums written $ 66,090,699 $ 55,372,556 $ 47,946,847
====================================================================
Premiums earned $ 60,977,975 $ 51,617,429 $ 47,488,716
====================================================================
Losses and loss expenses $ 41,775,579 $ 32,791,739 $ 28,582,315
====================================================================
Unearned premiums $ 30,999,377 $ 25,886,653 $ 22,131,526
====================================================================
Liability for losses and
loss expenses $ 43,907,885 $ 39,039,648 $ 35,295,994
====================================================================
ASSUMED REINSURANCE:
====================================================================
Premiums written $124,433,678 $114,667,549 $107,604,989
====================================================================
Premiums earned $119,364,863 $111,333,956 $107,302,168
====================================================================
Losses and loss expenses $ 80,325,374 $ 69,869,999 $ 68,104,859
====================================================================
Unearned premiums $ 56,887,815 $ 51,819,000 $ 48,485,408
====================================================================
Liability for losses
and loss expenses $ 90,397,135 $ 85,766,514 $ 83,271,292
====================================================================
Losses and loss expenses assumed from the Mutual Company for 1999, 1998 and
1997 are reported net of inter-company catastrophe recoveries which amounted to
approximately $2.0 million, $2.3 million, and $0 million, respectively.
B. EXPENSE SHARING
The Mutual Company provides facilities, management and other services to the
Company, and the Company reimburses the Mutual Company for such services on a
periodic basis under usage agreements and pooling arrangements. The charges are
based upon the relative participation of the Company and the Mutual Company in
the pooling arrangement, and management of both the Company and the Mutual
Company consider this allocation to be reasonable. Charges for these services
totalled $27,466,898, $25,250,873 and $22,115,329 for 1999, 1998 and 1997,
respectively.
C. LEASE AGREEMENT
The Company leases office equipment and automobiles to the Mutual Company under
a 10-year lease dated January 1, 1990.
D. WORKERS' COMPENSATION AGREEMENTS
The Mutual Company has agreements in place with Delaware, Southern and Pioneer
to reallocate the loss results of workers' compensation business written by
those companies as part of commercial accounts primarily written by the Mutual
Company or Atlantic States. These agreements provide for the workers'
compensation loss ratios of each company to be no worse than the average
workers' compensation loss ratio for all of the companies combined.
E. LEGAL SERVICES
Donald H. Nikolaus, President and a director of the Company, is also a partner
in the law firm of Nikolaus & Hohenadel. Such firm has served as general counsel
to the Company since 1986, principally in connection with the defense of claims
litigation arising in Lancaster, Dauphin and York counties. Such firm is paid
its customary fees for such services.
4--INVESTMENTS
The amortized cost and estimated fair values of fixed maturities and equity
securities at December 31, 1999 and 1998, are as follows:
1999
- -------------------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
HELD TO MATURITY Cost Gains Losses Value
- -------------------------------------------------------------------------------
U.S. Treasury securities
and obligations of
U.S. government
corporations
and agencies $ 36,860,655 $ 34,292 $1,219,840 $35,675,107
Canadian government
obligation 498,245 -- 8,245 490,000
Obligations of states
and political
subdivisions 67,823,291 819,155 1,005,936 67,636,510
Corporate securities 15,819,143 73,228 639,010 15,253,361
Mortgage-backed
securities 15,172,213 30,077 261,274 14,941,016
- -------------------------------------------------------------------------------
Totals $136,173,547 $956,752 $3,134,305 $133,995,994
===============================================================================
1999
- -------------------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
AVAILABLE FOR SALE Cost Gains Losses Value
- -------------------------------------------------------------------------------
U.S. Treasury securities
and obligations of
U.S. government
corporations
and agencies $63,645,993 $ 1,982 $2,443,578 $ 61,204,397
Obligations of states
and political
subdivisions 20,524,977 204,284 506,415 20,222,846
Corporate securities 15,472,456 578 419,871 15,053,163
Mortgage-backed
securities 3,776,568 321 213,747 3,563,142
Equity securities 9,043,818 1,384,882 1,199,202 9,229,498
- ------------------------------------------------------------------------------
Totals $112,463,812 $1,592,047 $4,782,813 $109,273,046
==============================================================================
1998
- ------------------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
HELD TO MATURITY Cost Gains Losses Value
- ------------------------------------------------------------------------------
U.S. Treasury securities
and obligations of
U.S. government
corporations
and agencies $ 32,890,694 $ 484,622 $ 29,816 $ 33,345,500
Obligations of states
and political
subdivisions 66,941,133 3,489,849 10,044 70,420,938
Corporate securities 9,131,114 422,916 4,030 9,550,000
Mortgage-backed
securities 18,220,847 96,014 -- 18,316,861
- ------------------------------------------------------------------------------
Totals $127,183,788 $ 4,493,401 $ 43,890 $131,633,299
==============================================================================
page 20
1998
- ------------------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
AVAILABLE FOR SALE Cost Gains Losses Value
- ------------------------------------------------------------------------------
U.S. Treasury securities
and obligations of
U.S. government
corporations
and agencies $ 54,975,813 $ 570,376 $106,689 $ 55,439,500
Obligations of states
and political
subdivisions 19,140,686 822,884 6,497 19,957,073
Corporate securities 10,642,598 150,045 5,324 10,787,319
Mortgage-backed
securities 4,330,898 11,065 -- 4,341,963
Equity securities 6,206,735 743,210 186,002 6,763,943
- ------------------------------------------------------------------------------
Totals $ 95,296,730 $2,297,580 $304,512 $ 97,289,798
==============================================================================
The amortized cost and estimated fair value of fixed maturities at December
31, 1999, by contractual maturity, are shown below. Expected maturities will
differ from contractual maturities because borrowers may have the right to call
or prepay obligations with or without call or prepayment penalties.
- --------------------------------------------------------------------
Estimated
Amortized Fair
Cost Value
- --------------------------------------------------------------------
HELD TO MATURITY
Due in one year or less $ 6,063,143 $ 6,064,900
Due after one year through five years 27,717,192 27,557,500
Due after five years through ten years 65,406,112 64,593,457
Due after ten years 21,814,887 20,839,121
Mortgage-backed securities 15,172,213 14,941,016
- --------------------------------------------------------------------
Total held to maturity $136,173,547 $133,995,994
====================================================================
AVAILABLE FOR SALE
Due in one year or less $ 11,952,924 11,948,304
Due after one year through five years 30,723,822 30,267,827
Due after five years through ten years 40,342,032 39,476,379
Due after ten years 16,624,648 14,787,896
Mortgage-backed securities 3,776,568 3,563,142
- --------------------------------------------------------------------
Total available for sale $103,419,994 $100,043,548
====================================================================
The amortized cost of fixed maturities on deposit with various regulatory
authorities at December 31, 1999 and 1998, amounted to $5,655,877 and
$5,285,367, respectively.
Net investment income of the Company, consisting primarily of interest and
dividends, is attributable to the following sources:
1999 1998 1997
- --------------------------------------------------------------------
Fixed maturities $12,738,765 $10,981,353 $10,703,397
Equity securities 439,660 294,646 238,777
Short-term investments 770,562 1,385,500 1,141,834
Real estate 236,139 175,250 127,250
- --------------------------------------------------------------------
Investment income 14,185,126 12,836,749 12,211,258
Investment expenses 961,589 839,088 703,981
- --------------------------------------------------------------------
Net investment income $13,223,537 $11,997,661 $11,507,277
====================================================================
Gross realized gains and losses from sales of investments and the change in
the difference between fair value and cost of investments, before applicable
income taxes, are as follows:
1999 1998 1997
- -------------------------------------------------------------------------
Gross realized gains:
Fixed maturities $ -- $ 132,431 $ 84,196
Equity securities 586,745 1,119,679 408,429
- -------------------------------------------------------------------------
586,745 1,252,110 492,625
- -------------------------------------------------------------------------
Gross realized losses:
Fixed maturities 6,083 5,180 694
Equity securities 619,364 1,260,492 177,795
- -------------------------------------------------------------------------
625,447 1,265,672 178,489
- -------------------------------------------------------------------------
Net realized gains (losses) $ (38,702) $ (13,562) $ 314,136
=========================================================================
Change in difference between
fair value and cost of
investments:
Fixed maturities $(11,439,370) $1,439,782 $2,248,484
Equity securities (371,528) (166,335) 355,544
- -------------------------------------------------------------------------
$(11,810,898) $1,273,447 $2,604,028
=========================================================================
Income taxes (benefit) on realized investment gains were ($13,159), ($4,611)
and $106,806 for 1999, 1998 and 1997, respectively. Deferred income taxes
applicable to net unrealized investment gains and losses included in
shareholders' equity were $(1,116,777) and $677,643 at December 31, 1999 and
1998, respectively.
Donegal Group has not held or issued derivative financial instruments.
5--DEFERRED POLICY ACQUISITION COSTS
Changes in deferred policy acquisition costs are as follows:
1999 1998 1997
- -------------------------------------------------------------------------
Balance, January 1 $ 11,334,301 $ 8,448,060 $ 7,837,899
Acquisition of
Southern Heritage -- 2,486,813 --
Acquisition costs deferred 24,477,001 19,889,428 19,306,161
Amortization charged
to earnings 24,608,000 19,490,000 18,696,000
- -------------------------------------------------------------------------
Balance, December 31 $ 11,203,302 $11,334,301 $ 8,448,060
=========================================================================
6--PROPERTY AND EQUIPMENT
Property and equipment at December 31, 1999 and 1998, consisted of the
following:
- -------------------------------------------------------------------------
Estimated
Useful
1999 1998 Life
- -------------------------------------------------------------------------
Cost--office equipment $ 4,615,884 $ 5,648,108 5-15 years
automobiles 958,313 890,264 3 years
leasehold improvements -- 59,233 15-40 years
real estate 2,627,599 2,627,597 15-50 years
software 315,973 434,344 5 years
- -------------------------------------------------------------------------
8,517,769 9,659,546
Accumulated depreciation (3,001,081) (3,739,126)
- -------------------------------------------------------------------------
$ 5,516,688 $ 5,920,420
=========================================================================
Depreciation expense for 1999, 1998, and 1997 amounted to $847,228, $559,710
and $442,726, respectively.
page 21
7--LIABILITY FOR LOSSES AND LOSS EXPENSES
Activity in the liability for losses and loss expenses is summarized as
follows:
1999 1998 1997
- ------------------------------------------------------------------------
Balance at January 1 $141,409,008 $118,112,390 $114,621,961
Less reinsurance
recoverable 47,545,592 40,638,565 39,194,405
- ------------------------------------------------------------------------
Net balance at January 1 93,863,416 77,473,825 75,427,556
Acquisition of
Southern Heritage -- 14,967,242 --
- ------------------------------------------------------------------------
New balance at beginning
as adjusted 93,863,416 92,441,067 75,427,556
- ------------------------------------------------------------------------
Incurred related to:
Current year 99,659,002 75,463,085 69,040,518
Prior years (454,000) (2,296,000) (1,384,000)
- ------------------------------------------------------------------------
Total incurred 99,205,002 73,167,085 67,656,518
- ------------------------------------------------------------------------
Paid related to:
Current year 58,906,426 44,388,736 39,133,249
Prior years 36,668,000 27,356,000 26,477,000
- ------------------------------------------------------------------------
Total paid 95,574,426 71,744,736 65,610,249
- ------------------------------------------------------------------------
Net balance at
December 31 97,493,992 93,863,416 77,473,825
Plus reinsurance
recoverable 52,485,149 47,545,592 40,638,565
- ------------------------------------------------------------------------
Balance at December 31 $149,979,141 $141,409,008 $118,112,390
========================================================================
The Company recognized a decrease in the liability for losses and loss
expenses of prior years (favorable development) of $0.5 million, $2.3 million
and $1.4 million in 1999, 1998 and 1997, respectively. These favorable
developments are primarily attributable to lower-than-expected claim severity in
the private passenger automobile liability, workers' compensation and commercial
multiple peril lines of business.
8--LINE OF CREDIT
At December 31, 1999 and 1998, pursuant to a credit agreement dated December 29,
1995, and amended as of July 27, 1998, with Fleet National Bank of Connecticut,
the Company had unsecured borrowings of $37 million and $37.5 million,
respectively. Such borrowings were made in connection with the acquisitions of
Delaware, Pioneer, and Southern Heritage and various capital contributions to
the subsidiaries. Per the terms of the credit agreement, the Company may borrow
up to $40 million at interest rates equal to the bank's then current prime rate
or the then current London interbank Eurodollar bank rate plus 1.70%. At
December 31, 1999, the interest rates were 8.5% on an outstanding prime rate
balance of $22 million and 7.84% on an outstanding Eurodollar rate balance of
$15 million. In addition, the Company pays a rate of 3/10 of 1% per annum on the
average daily unused portion of the bank's commitment. On each July 27,
commencing July 27, 2001, the credit line will be reduced by $8 million. Any
outstanding loan in excess of the remaining credit line, after such reduction,
will then be payable. The Company violated one of the covenants in the loan
agreement that required Donegal Mutual's surplus to be maintained at a certain
level. This violation was waived by the bank and the agreement was amended to
lower this requirement.
9--UNAFFILIATED REINSURERS
In addition to the primary reinsurance in place with the Mutual Company, the
Insurance Subsidiaries have other reinsurance in place, principally with four
unaffiliated reinsurers. The following amounts represent reinsurance
transactions with unaffiliated reinsurers during 1999, 1998 and 1997:
Ceded reinsurance: 1999 1998 1997
- -----------------------------------------------------------------------
Premiums written $ 6,348,846 $4,784,768 $4,315,594
=======================================================================
Premiums earned $ 6,509,844 $4,720,669 $4,264,761
=======================================================================
Losses and loss expenses $ 4,513,244 $4,489,728 $3,169,659
=======================================================================
Unearned premiums $ 1,155,460 $1,316,458 $ 750,757
=======================================================================
Liability for losses and
loss expenses $ 8,577,264 $8,505,944 $5,342,571
=======================================================================
10--INCOME TAXES
The provision for income tax consists of the following:
1999 1998 1997
- -----------------------------------------------------------------------
Current $ 762,286 $2,500,582 $3,525,249
Deferred (3,790,122) 158,593 7,108
- -----------------------------------------------------------------------
Federal tax provision $(3,027,836) $2,659,175 $3,532,357
=======================================================================
The effective tax rate is different than the amount computed at the statutory
federal rate of 34% for 1999, 1998 and 1997. The reason for such difference and
the related tax effect are as follows:
1999 1998 1997
- ------------------------------------------------------------------------
Income before
income taxes $ 3,629,101 $11,677,015 $14,173,543
========================================================================
Computed "expected"
taxes at 34% $ 1,233,894 $ 3,970,185 $ 4,819,005
Recognition of net operating
loss carryover of
Southern Heritage (3,004,524) -- --
Tax-exempt interest (1,352,657) (1,180,773) (1,130,311)
Dividends received deduction (83,948) (177,374) (48,477)
Other, net 179,399 47,137 (107,860)
- ------------------------------------------------------------------------
Federal income
tax provision $(3,027,836) $ 2,659,175 $ 3,532,357
========================================================================
page 22
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at December 31,
1999 and 1998, are as follows:
1999 1998
- --------------------------------------------------------------------
Deferred tax assets:
Unearned premium $ 4,454,147 $ 4,593,745
Loss reserves 4,666,536 4,581,026
AMT credit carryforward 577,611 --
Net operating loss carryforward -
Southern Heritage 2,646,172 3,429,107
Valuation allowance -- (3,429,107)
Unrealized loss 1,116,777 --
Other 306,412 --
- --------------------------------------------------------------------
Total $13,767,655 $ 9,174,771
====================================================================
Deferred tax liabilities:
Depreciation expense $ 469,426 $ 425,292
Deferred policy acquisition costs 3,809,123 3,853,662
Salvage recoverable 367,874 483,960
Unrealized gain -- 677,643
Other -- 197,522
- --------------------------------------------------------------------
Total $ 4,646,423 $ 5,638,079
====================================================================
Net deferred tax assets $ 9,121,232 $ 3,536,692
====================================================================
A valuation allowance is provided when it is more likely than not that some
portion of the tax asset will not be realized. At December 31, 1998, management
determined that a valuation allowance related to the net operating loss
carryforward of Southern Heritage should be established. Management has
determined that it is not required to establish a valuation allowance for any
deferred tax asset at December 31, 1999, since it is more likely than not that
the deferred tax assets will be realized through reversals of existing temporary
differences, future taxable income, carryback to taxable income in prior years
and the implementation of tax planning strategies.
A change in the federal income laws was enacted during 1999 which now allows
net operating loss carryforwards of an acquired company to be used to offset
future taxable income of other affiliated companies filing as part of a
consolidated tax return. Prior law allowed such net operating loss carryforward
to be used to offset taxable income of the acquired company only. Due to this
law change, the net operating loss carryforward, obtained as part of the
acquisition of Southern Heritage, can now be used to offset taxable income
generated by the other consolidated affiliates. This is the primary factor in
management's determination that no valuation allowance is required at the end of
1999. Accordingly, the tax benefit of this carryforward, as adjusted for the
1998 tax return as filed, of $3,004,524 was recognized in 1999.
At December 31, 1999 the Company has a net operating loss carryforward of
$7,782,859 which is available to offset taxable income of the Company. Such net
operating loss carryforward will expire beginning in 2009. Federal income tax
laws limit the amount of net operating loss carryforward that the Company can
use in any one year to approximately $1 million.
11--STOCK COMPENSATION PLANS
EQUITY INCENTIVE PLANS
The Company has had an Equity Incentive Plan for key employees since 1986 and
adopted a nearly identical new plan in 1996. Both plans provide for the granting
of awards by the Board of Directors in the form of stock options, stock
appreciation rights, restricted stock or any combination of the above. The new
plan was adopted in 1996 and amended in 1997 and 1999 making a total of
1,800,000 shares available. The plans provide that stock options may become
exercisable up to 10 years from date of grant, with an option price not less
than fair market value on date of grant. The stock appreciation rights permit
surrender of the option and receipt of the excess of current market price over
option price in cash.
Information regarding activity in the Company's stock option plans is
presented below:
Weighted-Average
Number of Exercise Price
Shares Per Share
- ---------------------------------------------------------------
Outstanding at December 31, 1996 -- $ --
Granted - 1997 532,451 13.50
Exercised - 1997 2,963 13.50
Forfeited - 1997 13,632 13.50
- ---------------------------------------------------------------
Outstanding at December 31, 1997 515,856 13.50
Granted - 1998 505,333 18.00
Exercised - 1998 10,073 13.50
Forfeited - 1998 -- --
- ---------------------------------------------------------------
Outstanding at December 31, 1998 1,011,116 15.73
Granted - 1999 433,500 8.00
Exercised - 1999 -- --
Forfeited - 1999 19,335 15.52
- ---------------------------------------------------------------
Outstanding at December 31, 1999 1,425,281 $13.50
===============================================================
Exercisable at:
December 31, 1997 173,333 $13.50
===============================================================
December 31, 1998 502,965 $15.00
===============================================================
December 31, 1999 826,226 $16.20
===============================================================
Shares available for future grants at December 31, 1999 are 374,719.
The following table summarizes information about fixed stock options at
December 31, 1999:
Exercise Prices
---------------------------------
$8.00 $13.50 $18.00
- -----------------------------------------------------------------------------
Options outstanding at
December 31, 1999:
Number of options 418,500 495,115 511,666
- -----------------------------------------------------------------------------
Weighted-average remaining
contractual life 5.0 years 2.0 years .25 years
- -----------------------------------------------------------------------------
Options exercisable at
December 31, 1999:
Number of options -- 495,115 331,111
- -----------------------------------------------------------------------------
page 23
1996 EQUITY INCENTIVE PLAN FOR DIRECTORS
During 1996 the Company adopted an Equity Incentive Plan For Directors. The plan
was amended in 1998, making 265,735 shares available for award. Awards may be
made in the form of stock options, and the plan additionally provides for the
issuance of 177 shares of restricted stock to each director on the first
business day of January in each year, commencing January 2, 1997. As of December
31, 1999, the Company has 71,112 unexercised options under this plan.
Additionally 2,124, 2,124 and 2,124 shares of restricted stock were issued on
January 2, 1999, 1998 and 1997, respectively.
EMPLOYEE STOCK PURCHASE PLANS
During 1996 the Company adopted the 1996 Employee Stock Purchase Plan which
replaced a similar plan that had been adopted effective January 1, 1988. The
1996 plan made 162,873 shares available for issuance.
The 1996 Plan extends over a 10-year period and provides for shares to be
offered to all eligible employees at a purchase price equal to the lesser of 85%
of the fair market value of the Company's common stock on the last day before
the first day of the enrollment period (June 30 and December 31). A summary of
plan activity follows:
Shares Issued
-----------------
Price Shares
- -------------------------------------------------------------
January 1, 1997 $ 8.24766 11,689
July 1, 1997 $ 9.26367 11,357
January 1, 1998 $11.65430 8,901
July 1, 1998 $13.06875 9,179
January 1, 1999 $13.28125 10,227
July 1, 1999 $ 9.66875 11,876
On January 1, 2000, the Company issued an additional 23,906 shares at a price
of $5.41875 per share under this plan.
AGENCY STOCK PURCHASE PLAN
On December 31, 1996, the Company adopted the Agency Stock Purchase Plan which
made 514,102 shares available for issuance. The plan provides for agents of
affiliated companies of Donegal Group Inc. to invest up to $12,000 per
subscription period (April 1 to September 30 and October 1 to March 31) under
various methods. Stock is issued at the end of the subscription period at a
price equal to 90% of the average market price during the last ten trading days
of the subscription period. During 1999, 1998 and 1997, 47,841, 35,003 and
40,200 shares, respectively, were issued under this plan.
PRO-FORMA DISCLOSURES
The weighted-average grant date fair value of options granted for the various
plans during 1999, 1998 and 1997 was $1.98, $4.48 and $4.74, respectively.
The fair values above were calculated based upon risk-free interest rates of
6.3% for the Stock Purchase Plans and the Equity Incentive Plans, expected lives
of 6 months for the Stock Purchase Plans and 5 years for the Equity Incentive
Plans, expected volatility of 47% for 1999 and 34% for 1998 and 1997 and an
expected dividend yield of 5.0% for 1999 and 2.4% for 1998 and 1997.
The Company applies APB Opinion No. 25 in accounting for its stock-based
compensation plans. Accordingly, no compensation cost has been recognized for
its fixed stock option plans and certain of its stock purchase plans. Had the
Company recognized stock compensation expense in accordance with SFAS No. 123,
net income and earnings per share would have been reduced to the pro-forma
amounts shown below:
1999 1998 1997
- -------------------------------------------------------------------------
Net income:
As reported $6,656,937 $9,017,840 $10,641,186
Pro-forma 5,457,591 8,362,764 10,263,965
Basic earnings per share:
As reported .80 1.11 1.33
Pro-forma .66 1.03 1.28
Diluted earnings per share:
As reported .80 1.09 1.32
Pro-forma .66 1.01 1.28
12--STATUTORY NET INCOME, CAPITAL AND SURPLUS AND DIVIDEND RESTRICTIONS
The following is selected information for the Insurance Subsidiaries as
determined in accordance with accounting practices prescribed or permitted by
insurance regulatory authorities:
1999 1998 1997
- ------------------------------------------------------------------------------
ATLANTIC STATES
Statutory capital
and surplus $ 68,518,020 $ 62,672,151 $ 56,606,354
=============================================
Statutory unassigned
surplus $ 37,557,156 $ 31,711,287 $ 25,645,490
=============================================
Statutory net income $ 3,855,803 $ 6,480,524 $ 7,349,284
===========================================================================
SOUTHERN
Statutory capital
and surplus $ 7,293,856 $ 6,388,316 $ 7,069,112
=============================================
Statutory unassigned
surplus $ 2,191,586 $ 1,636,046 $ 2,316,842
=============================================
Statutory net income $ 184,285 $ 66,297 $ 703,727
===========================================================================
DELAWARE
Statutory capital
and surplus $ 9,563,808 $ 8,548,354 $ 7,657,691
=============================================
Statutory unassigned
surplus $ 4,363,808 $ 3,348,354 $ 2,457,691
=============================================
Statutory net income $ 898,360 $ 1,085,807 $ 1,070,463
===========================================================================
PIONEER
Statutory capital
and surplus $ 5,677,926 $ 5,300,349 $ 5,377,492
=============================================
Statutory unassigned
deficit $ (1,322,074) $ (1,699,651) $ (1,622,508)
=============================================
Statutory net income $ 108,322 $ 188,579 $ 542,799
===========================================================================
SOUTHERN HERITAGE
Statutory capital
and surplus $ 16,508,422 $ 15,805,641 $ 16,532,876
=============================================
Statutory unassigned
deficit $(16,006,893) $(16,709,674) $(12,482,439)
=============================================
Statutory net income (loss) $ 487,098 $ (3,937,548) $ 151,135
===========================================================================
page 24
The Company's principal source of cash for payment of dividends are dividends
from its Insurance Subsidiaries which are required by law to maintain certain
minimum capital and surplus on a statutory basis and are subject to regulations
under which payment of dividends from statutory surplus is restricted and may
require prior approval of their domiciliary insurance regulatory authorities.
Atlantic States, Southern, Delaware, Pioneer and Southern Heritage are also
subject to Risk Based Capital (RBC) requirements which may further impact their
ability to pay dividends. At December 31, 1999, all five companies' statutory
capital and surplus were substantially above the RBC requirements. At December
31, 1999, amounts available for distribution as dividends to Donegal Group Inc.
without prior approval of insurance regulatory authorities are $6,851,802 from
Atlantic States, $184,285 from Southern, $956,381 from Delaware, $567,793 from
Pioneer and $1,650,842 from Southern Heritage.
13--RECONCILIATION OF STATUTORY FILINGS TO AMOUNTS REPORTED HEREIN
The Company's Insurance Subsidiaries are required to file statutory financial
statements with state insurance regulatory authorities. Accounting principles
used to prepare these statutory financial statements differ from financial
statements prepared on the basis of generally accepted accounting principles.
Reconciliations of statutory net income and capital and surplus, as
determined using statutory accounting principles, to the amounts included in the
accompanying financial statements are as follows:
Year Ended December 31,
- ---------------------------------------------------------------------------
1999 1998 1997
- ---------------------------------------------------------------------------
Statutory net income of
Insurance Subsidiaries $5,533,868 $ 8,301,081 $ 9,666,273
Increases (decreases):
Deferred policy
acquisition costs (130,999) 399,428 610,161
Deferred federal
income taxes 3,790,122 (158,593) (7,108)
Salvage and subrogation
recoverable (226,617) 1,217,092 984,981
Consolidating eliminations
and adjustments (1,387,864) (967,940) (950,000)
Parent-only net income (loss) (908,987) 178,249 291,831
Non-insurance subsidiary
net income (loss) (12,586) 48,523 45,048
- ---------------------------------------------------------------------------
Net income as
reported herein $6,656,937 $ 9,017,840 $ 10,641,186
===========================================================================
December 31,
- ----------------------------------------------------------------------------
1999 1998 1997
- ----------------------------------------------------------------------------
Statutory capital and surplus
of Insurance Subsidiaries $107,562,032 $ 98,714,811 $76,710,649
Increases (decreases):
Deferred policy
acquisition costs 11,203,302 11,334,301 8,448,060
Deferred federal
income taxes 9,121,232 3,592,605 3,302,043
Salvage and subrogation
recoverable 7,736,942 7,963,559 6,155,467
Statutory reserves 5,066,505 9,066,998 8,712,694
Non-admitted assets and
other adjustments, net 793,715 1,178,102 394,432
Fixed maturities
available for sale (2,889,365) 2,038,604 808,908
Consolidating eliminations
and adjustments (36,630,839) (36,383,362) (16,121,711)
Parent-only equity 1,451,088 2,843,990 2,953,248
Non-insurance
subsidiary equity -- 281,396 232,873
- ----------------------------------------------------------------------------
Stockholders' equity as
reported herein $103,414,612 $100,631,004 $91,596,663
============================================================================
14--SUPPLEMENTARY INFORMATION ON STATEMENT OF CASH FLOWS
The following reflects income taxes and interest paid during 1999,
1998 and 1997:
1999 1998 1997
- ---------------------------------------------------------------------
Income taxes $1,233,414 $ 2,671,969 $ 4,094,338
=====================================================================
Interest $1,370,155 $ 1,270,646 $ 904,385
=====================================================================
During 1999, the Company wrote off fixed assets with a net carrying
value of $407,000 which was a non-cash charge to earnings.
15--EARNINGS PER SHARE
The following information illustrates the computation of net income,
outstanding shares and earnings per share on both a basic and diluted
basis for the years ending December 31, 1999, 1998 and 1997:
Weighted-
Average Earnings
Net Shares Per
Income Outstanding Share
- ----------------------------------------------------------------
1999:
Basic $ 6,656,937 8,327,356 $ .80
Effect of stock options -- -- --
- ----------------------------------------------------------------
Diluted $ 6,656,937 8,327,356 $ .80
================================================================
1998:
Basic $ 9,017,840 8,126,286 $1.11
Effect of stock options -- 123,404 (0.02)
- ----------------------------------------------------------------
Diluted $ 9,017,840 8,249,690 $1.09
================================================================
1997:
Basic $10,641,186 7,994,937 $1.33
Effect of stock options -- 41,274 (0.01)
- ----------------------------------------------------------------
Diluted $10,641,186 8,036,211 $1.32
================================================================
page 25
The following options to purchase shares of common stock were not included in
the computation of diluted earnings per share because the exercise price of the
options was greater than the average market price:
1999 1998 1997
- --------------------------------------------------------------------------------
Options excluded from
diluted earnings per share 1,425,281 887,712 474,582
================================================================================
16--CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY
CONDENSED BALANCE SHEETS
($ in thousands)
December 31, 1999 1998
- --------------------------------------------------------------------------------
ASSETS
Investment in subsidiaries (equity method) $138,702 $134,441
Cash 371 599
Property and equipment 2,232 2,276
Other 750 2,124
- --------------------------------------------------------------------------------
Total assets $142,055 $139,440
================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Cash dividends declared to stockholders $ 761 $ 708
Line of credit 37,000 37,500
Other 879 601
- --------------------------------------------------------------------------------
Total liabilities 38,640 38,809
- --------------------------------------------------------------------------------
Stockholders' equity
Preferred stock, $1.00 par value, authorized
2,000,000 shares, none issued
Common stock, Class A, authorized
15,000,000 shares, none issued
Commonstock, $1.00 par value, authorized
20,000,000 shares, issued 8,574,210
and 8,325,221 shares and outstanding
8,451,922 and 8,202,933 shares 8,574 8,325
Additional paid-in capital 43,537 41,271
Accumulated other comprehensive income (loss) (2,074) 1,316
Retained earnings, including equity in
undistributed net income of
subsidiaries($72,539 and $64,922) 54,270 50,611
Treasury stock, at cost (892) (892)
- --------------------------------------------------------------------------------
Total stockholders' equity 103,415 100,631
- --------------------------------------------------------------------------------
Total liabilities and stockholders' equity $142,055 $139,440
================================================================================
CONDENSED STATEMENTS OF INCOME
($ in thousands)
Years Ended December 31, 1999 1998 1997
- --------------------------------------------------------------------------------
Revenues
Dividends-subsidiaries $ 820 $ 1,000 $ 950
Other 865 776 658
- --------------------------------------------------------------------------------
Total revenues 1,685 1,776 1,608
- --------------------------------------------------------------------------------
Expenses
Operating expenses 938 718 643
Interest 2,463 1,293 1,022
- --------------------------------------------------------------------------------
Total expenses 3,401 2,011 1,665
- --------------------------------------------------------------------------------
Loss before income tax benefit
and equity in undistributed net
income of subsidiaries (1,716) (235) (57)
Income tax benefit (807) (413) (346)
- --------------------------------------------------------------------------------
Income (loss) before equity in undistributed
net income of subsidiaries (909) 178 289
Equity in undistributed net income
of subsidiaries 7,566 8,840 10,352
- --------------------------------------------------------------------------------
Net income $ 6,657 $ 9,018 $10,641
================================================================================
CONDENSED STATEMENTS OF CASH FLOWS
($ in thousands)
Years Ended December 31, 1999 1998 1997
- --------------------------------------------------------------------------------
Cash flows from operating activities:
Net income $ 6,657 $ 9,018 $10,641
- --------------------------------------------------------------------------------
Adjustments:
Equity in undistributed net
income of subsidiaries (7,566) (8,840) (10,352)
Other 2,365 (921) 382
- --------------------------------------------------------------------------------
Net adjustments (5,201) (9,761) (9,970)
- --------------------------------------------------------------------------------
Net cash provided (used) 1,456 (743) 671
- --------------------------------------------------------------------------------
Cash flows from investing activities:
Net purchase of property and
equipment (426) (564) (1,251)
Capital contribution to subsidiaries -- (2,000) --
Sale of AIS 100 -- --
Acquisition of Southern Heritage -- (18,028) --
Other (426) (5,613) 4
- --------------------------------------------------------------------------------
Net cash used (752) (26,205) (1,247)
- --------------------------------------------------------------------------------
Cash flows from financing activities:
Cash dividends paid (2,946) (2,664) (2,252)
Issuance of common stock 2,514 2,481 1,131
Line of credit, net (500) 27,000 2,000
- --------------------------------------------------------------------------------
Net cash provided (used) (932) 26,817 879
- --------------------------------------------------------------------------------
Net change in cash (228) (131) 303
Cash at beginning of year 599 730 427
- --------------------------------------------------------------------------------
Cash at ending of year $ 371 $ 599 $ 730
================================================================================
page 26
17--SEGMENT INFORMATION
As an underwriter of property and casualty insurance, the Company has three
reportable segments which consist of the investment function, the personal lines
of insurance and the commercial lines of insurance. Using independent agents,
the Company markets personal lines of insurance to individuals and commercial
lines of insurance to small and medium-sized businesses.
The Company evaluates the performance of the personal lines and commercial
lines primarily based upon underwriting results as determined under statutory
accounting practices (SAP) for the total business of the Company.
Assets are not allocated to the personal and commercial lines and are
reviewed in total by management for purposes of decision making. Donegal Group
Inc. operates only in the United States and no single customer or agent provides
10 percent or more of revenues.
Financial data by segment is as follows:
1999 1998 1997
-----------------------------------------
($ in thousands)
- --------------------------------------------------------------------------------
Revenues:
Premiums earned:
Commercial lines $ 47,707 $ 44,493 $ 45,702
Personal lines 96,167 71,676 61,600
- --------------------------------------------------------------------------------
Total premiums earned 143,874 116,169 107,302
- --------------------------------------------------------------------------------
Net investment income 13,224 11,998 11,507
Realized investment
gains (losses) (39) (14) 314
Other 2,652 2,433 2,205
- --------------------------------------------------------------------------------
Total revenues $159,711 $130,586 $121,328
================================================================================
Income before income taxes:
Underwriting income (loss):
Commercial lines $ (826) $ 3,688 $ 3,497
Personal lines (8,238) (5,327) (2,734)
- --------------------------------------------------------------------------------
SAP underwriting gain
(loss) (9,064) (1,639) 763
GAAP adjustments (251) 1,803 1,809
- --------------------------------------------------------------------------------
GAAP underwriting gain
(loss) (9,315) 164 2,572
Net investment income 13,224 11,998 11,507
Realized investment gains (losses) (39) (14) 314
Other (241) (471) (219)
- --------------------------------------------------------------------------------
Income before income taxes $ 3,629 $ 11,677 $ 14,174
================================================================================
18--RESTRUCTURING CHARGE
On September 29, 1999, the Company announced a plan to consolidate certain
subsidiary support functions into its Marietta, Pennsylvania office. As a result
of this consolidation, the Company recorded a restructuring charge of $2,206,000
for employee termination benefits, occupancy charges, lease cancellation costs,
and asset impairments. The charge is included in other underwriting expenses.
The consolidation is expected to be compete by the end of the first quarter of
2000.
Employee termination benefits of $782,000 include severance payments, which
may be paid in a lump sum or over a defined period, and related benefits for
approximately 60 employees. Of the terminated employees, approximately 50% were
from subsidiary support functions and approximately 50% were from the Marietta,
Pennsylvania office. By December 31, 1999, all of the terminated employees had
left the employment of the Company.
Included in occupancy charges of $488,000 are future lease obligations,
less anticipated sublease benefits, for leased space which will no longer be
used by the Delaware and Southern Heritage subsidiary support functions.
Also included in the restructuring charge was $529,000 related to contract
cancellation costs that represented the estimated cost to buy out of the
remaining term on printer, copier, and computer processing contracts that
provided no future benefit to the Company as a result of the restructuring. All
such assets have been taken out of service.
Asset impairments, which were a direct result of the consolidation of
subsidiary functions, amounted to $407,000. They consisted of capitalized
programming and data center costs, voice systems, and leasehold and office
improvements. These assets were written-down to zero. All such assets have been
taken out of service.
Activity in the restructuring accrual is as follows:
Employee
Termination Contract
Benefits Occupancy Cancellations Total
- --------------------------------------------------------------------------------
Restructuring
charge $782,000 $488,000 $529,000 $1,799,000
Cash payments (343,000) (47,000) (365,000) (755,000)
Reversal of
prior accrual (71,000) -- (91,000) (162,000)
- --------------------------------------------------------------------------------
Balance at
December 31,
1999 $368,000 $441,000 $ 73,000 $ 882,000
================================================================================
Based on revised estimates, $162,000 of the restructuring accrual was
reversed by a reduction to the restructuring charge in other underwriting
expenses in the fourth quarter of 1999. Employee termination benefits and
contract cancellation costs were lower than original estimates.
19--GUARANTY FUND AND OTHER INSURANCE-RELATED ASSESSMENTS
The Company accrues for guaranty-fund and other insurance-related assessments in
accordance with Statement of Position (SOP) 97-3, "Accounting by Insurance and
Other Enterprises for Insurance-Related Assessments." SOP 97-3 provides guidance
for determining when an entity should recognize a liability for guaranty-fund
and other insurance-related assessments, how to measure that liability, and when
an asset may be recognized for the recovery of such assessments through premium
tax offsets or policy surcharges. The Company's liability for guaranty-fund and
other insurance-related assessments was $534,518 at December 31, 1999, most of
which the Company expects to pay in 2000.
page 27
20--INTERIM FINANCIAL DATA (UNAUDITED)
1999
----------------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
- --------------------------------------------------------------------------------
Net premiums
earned $36,093,971 $35,829,815 $35,955,556 $35,994,628
Total revenues 40,109,990 39,787,987 39,802,234 40,010,896
Net losses and loss
expenses 24,451,651 24,162,300 26,449,962 24,141,089
Net income (loss) 2,151,367 1,300,736 (2,442,880) 5,647,714
Net income (loss) per
common share
Basic $.26 $.16 $(.29) $.67
Diluted .26 .16 (.29) .67
1998
----------------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
- --------------------------------------------------------------------------------
Net premiums
earned $27,204,544 $27,578,257 $28,064,764 $33,321,427
Total revenues 30,896,144 31,023,026 31,654,736 37,012,459
Net losses and loss
expenses 15,801,905 19,225,138 20,434,534 17,705,508
Net income 3,316,653 1,892,892 44,414 3,763,881
Net income per
common share
Basic $.41 $.22 $.01 $.46
Diluted .40 .22 .01 .46
- --------------------------------------------------------------------------------
INDEPENDENT AUDITORS' REPORT
The Stockholders and Board of Directors
Donegal Group Inc.
We have audited the accompanying consolidated balance sheets of Donegal Group
Inc. and subsidiaries as of December 31, 1999 and 1998, and the related
consolidated statements of income and comprehensive income, stockholders'
equity, and cash flows for each of the years in the three-year period ended
December 31, 1999. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Donegal
Group Inc. and subsidiaries as of December 31, 1999 and 1998, and the results of
their operations and their cash flows for each of the years in the three-year
period ended December 31, 1999 in conformity with generally accepted accounting
principles.
KPMG LLP
Philadelphia, Pennsylvania
February 18, 2000
page 28
SELECTED CONSOLIDATED FINANCIAL DATA
- ------------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 1999 1998 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------------------------
INCOME STATEMENT DATA:
Premiums earned $143,873,970 $116,168,992 $107,302,168 $104,527,038 $ 89,522,203
Investment income, net 13,223,537 11,997,661 11,507,277 10,799,369 9,713,744
Realized investment gains (losses) (38,702) (13,562) 314,136 172,734 399,706
Total revenues 159,711,107 130,586,365 121,327,606 117,581,664 101,615,698
Income before income taxes 3,629,101 11,677,015 14,173,543 10,736,628 12,060,351
Income taxes (3,027,836) 2,659,175 3,532,357 2,178,854 2,500,741
Net income 6,656,937 9,017,840 10,641,186 8,557,774 9,559,610
Basic earnings per share 0.80 1.11 1.33 1.10 1.29
Diluted earnings per share 0.80 1.09 1.32 1.09 1.26
Cash dividends per share 0.36 0.34 0.29 0.25 0.23
BALANCE SHEET DATA AT YEAR END:
Total investments $261,441,850 $254,995,473 $204,964,805 $192,489,250 $168,215,538
Total assets 399,732,657 385,231,506 304,104,505 287,990,994 244,943,598
Debt obligations 37,000,000 37,500,000 10,500,000 8,500,000 5,000,000
Stockholders' equity 103,414,612 100,631,004 91,596,663 81,599,274 73,020,689
Stockholders' equity per share 12.24 12.27 11.39 10.26 9.64
- ------------------------------------------------------------------------------------------------------------------------------------
In November 1998, the Company acquired all of the outstanding stock of Southern
Heritage. This transaction was accounted for as a "purchase." The Company's
financial statements include Southern Heritage as a consolidated subsidiary from
November 1, 1998.
page 29
CORPORATE INFORMATION
ANNUAL MEETING
April 20, 2000 at the Company's headquarters at 10:00 a.m.
FORM 10-K
A copy of Donegal Group's Annual Report on Form 10-K will be furnished free upon
written request to Ralph G. Spontak, Senior Vice President and Chief Financial
Officer, at the corporate address.
MARKET INFORMATION
Donegal Group's common stock is traded on NASDAQ under the symbol "DGIC." During
1998 and 1999, the stock price ranged as follows:
CASH DIVIDEND
DECLARED
QUARTER HIGH LOW PER SHARE
1998
1st 17.625 15.188 --
2nd 22.781 16.875 .0825
3rd 19.875 14.250 .085
4th 15.750 12.625 .17
1999
1st 16.250 10.500 --
2nd 13.000 10.063 .09
3rd 11.625 6.125 .09
4th 10.625 5.750 .18
CORPORATE OFFICES
1195 River Road
P.O. Box 302
Marietta, Pennsylvania 17547-0302
(717) 426-1931
E-mail Address: fctc@em.fcnbd.com
Donegal Website: http://www.donegalgroup.com
TRANSFER AGENT
First Chicago Trust Co., a Division of EquiServe
P.O. Box 2500
Jersey City, NJ 07303-2500
(800) 317-4445
E-mail Address: fctc@em.fcnbd.com
FCTC Website: http://www.fctc.com
Hearing Impaired: TDD: 201-222-4955
DIVIDEND RINVESTMENT PLAN
The Company offers a dividend reinvestment plan
through its transfer agent.
For information contact:
Donegal Group Inc. Dividend Reinvestment Plan
c/o First Chicago Trust Co., a Division of EquiServe
P.O. Box 2598
Jersey City, NJ 07303-2598
(800) 317-4445
STOCKHOLDERS
The number of common stockholders of record as
of December 31, 1999 was 622.
31