FINANCIAL INFORMATION
Management's Discussion and Analysis of Results of Operations and Financial Condition.. 10
Consolidated Balance Sheets ........................................................... 15
Consolidated Statements of Income and Comprehensive Income ............................ 16
Consolidated Statements of Stockholders' Equity ....................................... 17
Consolidated Statements of Cash Flows ................................................. 18
Notes to Consolidated Financial Statements ............................................ 19
Independent Auditors' Report .......................................................... 31
Corporate Information ................................................................. 32
9
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 four
wholly owned property-casualty insurance subsidiaries, Atlantic States Insurance
Company ("Atlantic States"), Southern Insurance Company of Virginia
("Southern"), Southern Heritage Insurance Company ("Southern Heritage") and
Pioneer Insurance Company of Ohio ("Pioneer-Ohio") (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 63% of the
outstanding common shares of the Company as of December 31, 2001.
Atlantic States participates in an intercompany pooling arrangement with
the Mutual Company and assumes 70% of the pooled business (65% prior to July 1,
2000). Southern cedes 50% of its business to the Mutual Company. Because the
Mutual Company places substantially all of the business assumed from Southern
into the pool, from which the Company has a 70% allocation, the Company's
results of operations include approximately 85% of the business written by
Southern.
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 outstanding shares
of AIS on October 1, 1999.
During 2000, the Company acquired 45% of the outstanding stock of Donegal
Financial Services Corporation ("DFSC"), a bank holding company. The remaining
55% of the outstanding stock of DFSC is owned by the Mutual Company.
On January 3, 2001, the Company announced that it had purchased all of the
outstanding stock of Pioneer Insurance Company of New York ("Pioneer-New York")
from the Mutual Company effective January 1, 2001. The purchase price was
$4,441,311, representing Pioneer-New York's adjusted statutory equity at
December 31, 2000. The acquisition has been accounted for as a reorganization of
entities under common control, similar to a pooling of interests, as both
Pioneer-New York and the Company are under the common management and control of
the Mutual Company. As such, the Company's financial statements have been
restated to include Pioneer-New York as a consolidated subsidiary. In connection
with this transaction, the Company issued the Mutual Company a $4,441,311 note,
which bears a 6% rate and was due in one year. The due date was subsequently
extended to January 2003. The 6% rate was based upon commercial market rates in
effect as of January 1, 2001.
Delaware Atlantic Insurance Company ("Delaware"), previously a wholly owned
subsidiary, and Pioneer-New York were merged into Atlantic States Insurance
Company on August 1, 2001 and September 30, 2001, respectively. The mergers were
accounted for as statutory mergers and had no financial impact on the
consolidated entity.
TRANSACTIONS WITH AFFILIATES
The Company's insurance subsidiaries have various reinsurance arrangements with
the Mutual Company, which include a pooling agreement with Atlantic States, a
50% quota share contract with Southern, catastrophe reinsurance agreements with
each of the subsidiaries and excess of loss reinsurance agreements with
Southern, Southern Heritage and Pioneer-Ohio. The Mutual Company also has 100%
retrocessional agreements with Southern, Southern Heritage and Pioneer-Ohio.
Each contract is reviewed by a Coordinating Committee comprised of two board
members of the Company and two board members of the Mutual Company. This
committee reviews the business purpose and terms of each agreement based on
degree of risk, fairness to the participating companies and market conditions.
The committee must unanimously approve all agreements and all changes to
existing agreements between the Company's subsidiaries and the Mutual Company.
The pooling agreement between the Mutual Company and Atlantic States is
intended to produce a more uniform and stable underwriting result from year to
year for the participants in the pool than they would experience individually
and to spread the risk of loss
10
among the participants. Each company participating in the pool has at its
disposal the capacity of the entire pool, rather than being limited to policy
exposure of a size commensurate with its own capital and surplus. In addition,
the ability of the Company to raise capital, and infuse that capital into
Atlantic States, provides the participants of the pool with an ability to grow
their total direct premiums at a greater rate than would be possible without the
existence of the pool. Premiums, losses, loss expenses and underwriting expenses
are shared proportionately by each of the participants, with Atlantic States
currently assuming 70% of the pooled business and the Mutual Company retaining
30% of the pooled business.
The 50% quota share reinsurance contract between Southern and the Mutual
Company provides additional capacity for direct premium growth to Southern
during periods of growth that exceeds Southern's ability to finance that growth
through internal equity. Premiums, losses and loss expenses are shared equally
by the participants with the Mutual Company paying commissions to Southern to
reimburse its costs related to the underwriting process.
The excess of loss and catastrophe reinsurance agreements are intended to
lessen the effects of a single large loss, or an accumulation of losses arising
from one event, to a level that is more in line with each company's size,
underwriting profile and equity position. The retention levels of these
contracts are more appropriate for each company than the retention levels
included within reinsurance contracts with outside reinsurers, which may be
appropriate for the insurance companies taken as a whole but would be excessive
for any individual company within the group.
The 100% retrocessional agreements are intended to provide the subsidiaries
with the same A.M. Best rating (currently "A") as the Mutual Company, which
these companies could not achieve without these contracts in place.
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 $29,298,569, $26,985,080 and $27,466,898 for 2001, 2000 and 1999,
respectively.
CRITICAL ACCOUNTING POLICIES
The Company's financial statements are combined with those of its subsidiaries
and presented on a consolidated basis in accordance with U.S. generally accepted
accounting principle.
The Company uses estimates and assumptions that can have a significant
effect on the amounts that are reported in its financial statements. The Company
believes the following are its most significant accounting policies as they may
require a higher degree of judgment and estimation.
LIABILITY FOR LOSSES AND LOSS EXPENSES
The most significant estimates relate to reserves for losses and loss expenses.
The liability represents estimates of the ultimate unpaid cost of claims
incurred, including claims incurred but not reported to the Company as of the
close of the reporting period. The estimates of losses for reported claims are
based on reviews of the individual claims considering known information and the
policy provisions relating to the loss. Estimates of losses and loss expenses
for unreported claims are established based on historical data by line of
insurance as adjusted for current conditions considering factors such as
inflation, recent trends and other analysis of costs. The Company continually
reviews and analyzes its estimates, but actual losses may turn out to be
significantly different than expected when the estimates were made.
INVESTMENTS
In the Company's investment portfolio, the difference between cost and the fair
value of investments is monitored regularly. The Company evaluates significant
declines in fair value below cost on an individual investment basis. This
evaluation considers the magnitude of the decline below cost, the period of time
the investment has been significantly below cost and the prospects for the fair
value to recover in the near term. If any investment experiences a decline in
value that is believed to be other than temporary, the cost basis of the
investment is written down and a realized loss is recorded in earnings.
REINSURANCE
Reinsurance accounting is followed when risk transfer requirements have been
met. These requirements may involve significant assumptions being made related
to the amount and timing of expected cash flows, as well as interpretation of
the underlying contract terms.
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 estimated in the determination of the recoverability of deferred acquisition
costs. Future changes in estimates, the most significant of which is expected
loss and loss expenses, may require adjustment to policy acquisition costs.
11
RESULTS OF OPERATIONS 2001 COMPARED TO 2000
Total revenues for 2001 were $185,163,623, which were $14,582,036, or 8.5%,
greater than 2000. Net premiums earned increased to $167,769,854, an increase of
$16,123,655, or 10.6%, over 2000. The change in Atlantic State's share of the
pooling arrangement with the Mutual Company from 65% to 70% effective July 1,
2000, accounted for $4,273,297 of the increase in net premiums earned. Direct
premiums written of the combined pool of Atlantic States and the Mutual Company
increased $23,152,222 or 13.2%. A 4.0% increase in the direct premiums written
of Southern, an 8.6% increase in the direct premiums written of Pioneer-Ohio and
a 9.6% increase in the direct premiums written of Southern Heritage accounted
for the majority of the remaining change. The Company reported net realized
investment losses of $880,254 in 2001 compared to net realized investment gains
of $170,852 in 2000. During 2001 and 2000, certain investments trading below
cost had declined on an other-than-temporary basis. Losses of $1,462,913 and
$436,943 were included in net realized investment gains (losses) for these
investments in 2001 and 2000, respectively. The remaining realized gains and
losses in both years resulted from normal turnover of the Company's investment
portfolio. As of December 31, 2001, 100.0% 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 decreased $509,203
in 2001. An increase in the average invested assets from $278,677,748 to
$294,988,999, offset by a decrease in the average yield to 5.3% from 5.9% in
2000, accounted for the change.
The GAAP combined ratio of insurance operations was 103.8% in 2001,
compared to 101.8% in 2000. The 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 2001 was 70.5% compared to
68.8% in 2000. The increased loss ratio reflected the impact of loss and loss
expense reserve strengthening of approximately $4.2 million in the commercial
automobile and workers' compensation lines of business. The commercial lines
loss ratio increased significantly to 72.7% in 2001 compared to 67.0% in 2000.
The personal lines loss ratio decreased from 70.3% in 2000 to 69.2% in 2001. The
commercial automobile and workers' compensation loss ratios showed considerable
deterioration in 2001 with the commercial automobile loss ratio increasing to
85.0% in 2001 compared to 78.1% in 2000 and the workers' compensation loss ratio
increasing to 82.5% in 2001 compared to 64.2% in 2000. The expense ratio for
2001 was 32.3% compared to 32.1% in 2000 with the dividend ratio increasing
slightly to 1.0% in 2001 compared to 0.9% in 2000. The expense ratio in 2001
included a guaranty fund assessment of approximately $543,000 resulting from the
insolvency of Reliance Insurance Company. This assessment accounted for most of
the increase in the expense ratio.
Income tax expense was $1,273,598, an effective rate of 18.0%, compared to
$2,906,248, an effective rate of 24.7% in 2000. Tax exempt interest represented
a larger proportion of net income before taxes in 2001 as compared to 2000,
accounting for most of this difference.
RESULTS OF OPERATIONS 2000 COMPARED TO 1999
Total revenues for 2000 were $170,581,587, which were $8,842,251, or 5.5%,
greater than 1999. Net premiums earned increased to $151,646,199, an increase of
$6,128,742, or 4.2%, over 1999. The change in Atlantic State's share of the
pooling arrangement with the Mutual Company from 65% to 70% effective July 1,
2000, accounted for $4,113,078 of the increase in net premiums earned. Direct
premiums written of the combined pool of Atlantic States and the Mutual Company
increased $13,851,692 or 9.0%. A 5.1% increase in the direct premiums written of
Southern, a 2.1% decrease in the direct premiums written of Delaware, a 13.2%
increase in the direct premiums written of Pioneer-New York, a 25.4% increase in
the direct premiums written of Pioneer-Ohio and a 15.6% decrease in the direct
premiums written of Southern Heritage accounted for the majority of the
remaining change. The Company reported net realized investment gains of
$170,852, compared to net realized investment losses of $38,702 in 1999. During
2000, certain investments trading below cost had declined on an
other-than-temporary basis. Losses of $436,943 were included in net realized
investment gains for these investments in 2000. Net realized gains and losses in
1999 resulted from normal turnover of the Company's investment portfolio. As of
December 31, 2000, 100.0% 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
$2,804,052 in 2000. An increase in the average invested assets from $264,758,816
to $278,677,748, and an increase in the average yield to 5.9% from 5.1% in 1999,
accounted for the change.
12
The GAAP combined ratio of insurance operations was 101.8% in 2000,
compared to 106.5% in 1999. 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 both 2000 and 1999 was
68.8%. The commercial lines loss ratio decreased from 68.8% in 1999 to 67.0% in
2000. The personal lines loss ratio increased from 69.7% in 1999 to 70.3% in
2000. The expense ratio for 2000 was 32.1%, compared to 36.8% in 1999, with the
dividend ratio remaining unchanged at 0.9%. The expense ratio in 1999 was
adversely affected by a charge to earnings resulting from a restructuring charge
of $1.6 million which increased the expense ratio by 1.1%.
Income tax expense (benefit) was $2,906,248, compared to $(2,950,556) in
1999. The Company benefited from a federal income tax law change in 1999.
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,
2001, 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, 2001, pursuant to a credit agreement dated December 29,
1995, and amended as of July 27, 1998, with Fleet National Bank, the Company had
unsecured borrowings of $27.6 million. Such borrowings were made in connection
with the acquisitions of Delaware, Pioneer-Ohio and Southern Heritage and
various capital contributions to the subsidiaries. As of December 31, 2001, the
Company may borrow up to $32 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, 2001, the interest rates were 4.75% on an
outstanding prime rate balance of $2.6 million, 3.825% on an outstanding
Eurodollar rate balance of $10 million and 3.6375% on another 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, the credit line is 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, 2001, all four companies' statutory capital and
surplus were substantially above the RBC requirements. Amounts available for
distribution as dividends to DGI without prior approval of the insurance
regulatory authorities in 2002 are $8,612,490 from Atlantic States, $1,086,348,
from Southern, $552,447 from Pioneer-Ohio and $3,514,487 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 $2,861,765 (net
of applicable federal income tax benefit) at December 31, 2001, and $(199,063)
(net of applicable federal income tax) at December 31, 2000.
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 2 of the financial statements, and
with a number of other major authorized reinsurers, as described in Note 8 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.
13
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, 2001 are as follows:
Principal Weighted-Average
Cash Interest
Flows Rate
- --------------------------------------------------------------------------------
Fixed maturities and
short-term investments:
2002 $ 37,038,816 3.84%
2003 19,700,000 5.74%
2004 24,025,000 5.79%
2005 28,632,768 5.91%
2006 48,879,557 5.83%
Thereafter 119,957,853 5.93%
- --------------------------------------------------------------------------------
Total $278,233,994
================================================================================
Market value $284,732,437
================================================================================
Debt
2002 $ 3,600,000 3.81%
2003 8,000,000 3.81%
2004 8,000,000 3.81%
2005 8,000,000 3.81%
- --------------------------------------------------------------------------------
Total $ 27,600,000
================================================================================
Fair value $ 27,600,000
================================================================================
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 losses were
$131,146, $650,229, and $394,931 in 2001, 2000, and 1999, respectively. During
these three years the largest total equity investment gain and (loss) in a
quarter was $829,914 and $(730,481), respectively.
14
Donegal Group Inc.
CONSOLIDATED BALANCE SHEETS
December 31, 2001 2000*
- ---------------------------------------------------------------------------------------------------------------------------------
ASSETS
Investments
Fixed maturities
Held to maturity, at amortized cost (fair value $86,939,393 and $144,662,436) $ 85,322,965 $143,181,718
Available for sale, at fair value (amortized cost $170,269,584 and $114,524,472) 173,718,844 114,611,183
Equity securities, available for sale, at fair value (cost $16,630,618
and $12,500,558) 17,517,346 12,112,236
Short-term investments, at cost, which approximates fair value 24,074,200 19,439,505
- ---------------------------------------------------------------------------------------------------------------------------------
Total investments 300,633,355 289,344,642
Cash 4,075,288 5,182,988
Accrued investment income 3,765,076 4,002,464
Premiums receivable 24,143,531 21,758,502
Reinsurance receivable 67,853,174 54,543,884
Deferred policy acquisition costs 13,604,215 12,284,214
Federal income taxes receivable 292,618 259,962
Deferred tax asset, net 7,474,730 7,690,886
Prepaid reinsurance premiums 29,593,467 24,712,384
Property and equipment, net 4,568,652 5,236,483
Accounts receivable-securities 50,023 234,817
Other 578,243 757,554
- ---------------------------------------------------------------------------------------------------------------------------------
Total assets $456,632,372 $426,008,780
=================================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Losses and loss expenses $179,839,905 $156,476,124
Unearned premiums 114,079,264 99,940,381
Accrued expenses 7,186,107 5,877,475
Reinsurance balances payable 839,156 1,634,975
Cash dividend declared to stockholders 869,877 797,282
Borrowings under line of credit 27,600,000 40,000,000
Accounts payable-securities -- 959,652
Due to affiliate 4,015,074 4,528,996
Other 1,274,640 1,664,304
- ---------------------------------------------------------------------------------------------------------------------------------
Total liabilities 335,704,023 311,879,189
- ---------------------------------------------------------------------------------------------------------------------------------
Stockholders' Equity
Preferred stock, $1.00 par value, authorized 2,000,000 shares; none issued
Common stock, $1.00 par value, authorized 20,000,000 shares,
issued 0 and 8,980,977 shares and outstanding
0 and 8,858,689 shares -- 8,980,977
Class A common stock, $.01 par value, authorized 30,000,000 shares,
issued 6,097,214 and 0 shares and outstanding 6,015,690 and 0 shares 60,972 --
Class B common stock, $.01 par value, authorized 10,000,000 shares,
issued 3,021,965 and 0 shares and outstanding 2,981,203 and 0 shares 30,220 --
Additional paid-in capital 58,887,715 46,969,840
Accumulated other comprehensive income (loss) 2,861,765 (199,063
Retained earnings 59,979,425 59,269,593
Treasury stock, at cost (891,748) (891,756
- ---------------------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 120,928,349 114,129,591
- ---------------------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $456,632,372 $426,008,780
=================================================================================================================================
*Restated - see note 1
See accompanying notes to consolidated financial statements.
15
Donegal Group Inc.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
Year Ended December 31, 2001 2000* 1999*
- ---------------------------------------------------------------------------------------------------------------------
STATEMENTS OF INCOME
Revenues
Net premiums earned (includes affiliated reinsurance of
$71,989,136, $63,989,424 and $60,234,261) $167,769,854 $151,646,199 $145,517,457
Investment income, net of investment expenses 15,885,544 16,394,747 13,590,695
Installment payment fees 1,587,396 1,532,792 1,456,918
Lease income 801,083 836,997 819,474
Service fees -- -- 393,494
Net realized investment gains (losses) (880,254) 170,852 (38,702)
- ---------------------------------------------------------------------------------------------------------------------
Total revenues 185,163,623 170,581,587 161,739,336
- ---------------------------------------------------------------------------------------------------------------------
Expenses
Net losses and loss expenses (includes affiliated reinsurance of
$50,283,481, $36,767,436 and $38,549,795) 118,177,549 104,383,176 100,080,616
Amortization of deferred policy acquisition costs 27,194,000 25,319,000 24,931,000
Other underwriting expenses 27,000,485 23,355,781 28,648,951
Policy dividends 1,691,759 1,330,330 1,341,294
Interest 2,247,465 3,285,036 1,535,249
Other 1,760,636 1,165,236 1,357,585
- ---------------------------------------------------------------------------------------------------------------------
Total expenses 178,071,894 158,838,559 157,894,695
- ---------------------------------------------------------------------------------------------------------------------
Income before income tax expense (benefit) 7,091,729 11,743,028 3,844,641
Income tax expense (benefit) 1,273,598 2,906,248 (2,950,556)
- ---------------------------------------------------------------------------------------------------------------------
Net income $ 5,818,131 $ 8,836,780 $ 6,795,197
====================================================================================================================
Net income per common share
Basic $ .65 $ 1.01 $ .82
====================================================================================================================
Diluted $ .64 $ 1.01 $ .82
====================================================================================================================
STATEMENTS OF COMPREHENSIVE INCOME
Net income $ 5,818,131 $ 8,836,780 $ 6,795,197
- ---------------------------------------------------------------------------------------------------------------------
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
$1,277,504, $1,057,179, and $(1,804,294) 2,479,860 2,020,267 (3,459,669)
Reclassification adjustment for (gains) losses included
in net income, net of income tax expense (benefit) of
$(299,286), $58,090, and $(13,159) 580,968 (112,762) 25,543
- ---------------------------------------------------------------------------------------------------------------------
Other comprehensive income (loss) 3,060,828 1,907,505 (3,434,126)
- ---------------------------------------------------------------------------------------------------------------------
Comprehensive income $ 8,878,959 $ 10,744,285 $ 3,361,071
====================================================================================================================
*Restated - see note 1
See accompanying notes to consolidated financial statements.
16
Donegal Group Inc.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
`
Common Stock
--------------------------------------------------------------------------
Prior Class A Class B Prior Class A Class B
Shares Shares Shares Amount Amount Amount
- -----------------------------------------------------------------------------------------------------------
Balance,
January 1, 1999* 8,325,221 $8,325,221 $ $
- -----------------------------------------------------------------------------------------------------------
Issuance of common stock 248,989 248,989
Net income
Other comprehensive loss
Cash dividends
- -----------------------------------------------------------------------------------------------------------
Balance,
December 31, 1999* 8,574,210 $8,574,210 $ $
- -----------------------------------------------------------------------------------------------------------
Issuance of common stock 406,767 406,767
Net income
Other comprehensive income
Grant of stock options
Cash dividends
- -----------------------------------------------------------------------------------------------------------
Balance,
December 31, 2000* 8,980,977 $8,980,977 $ $
- -----------------------------------------------------------------------------------------------------------
Issuance of common stock 61,830 60,144 3,758 61,830 601 38
Recapitalization (9,042,807) 6,027,975 3,013,987 (9,042,807) 60,280 30,140
Net income
Cash dividends
Exercise of stock options 9,095 4,220 91 42
Grant of stock options
Other comprehensive income
- -----------------------------------------------------------------------------------------------------------
Balance,
December 31, 2001 -- 6,097,214 3,021,965 $ -- $60,972 $30,220
===========================================================================================================
Accumulated
Additional Other Total
Paid-In Comprehensive Retained Treasury Stockholders'
Capital Income (Loss) Earnings Stock Equity
- ----------------------------------------------------------------------------------------------------------
Balance,
January 1, 1999* $42,330,011 $ 1,327,558 $49,824,144 $(891,756) $100,915,178
- ----------------------------------------------------------------------------------------------------------
Issuance of common stock 2,265,426 2,514,415
Net income 6,795,197 6,795,197
Other comprehensive loss (3,434,126) (3,434,126)
Cash dividends (2,998,330) (2,998,330)
- ----------------------------------------------------------------------------------------------------------
Balance,
December 31, 1999* $44,595,437 $(2,106,568) $53,621,011 $(891,756) $103,792,334
- ----------------------------------------------------------------------------------------------------------
Issuance of common stock 2,349,773 2,756,540
Net income 8,836,780 8,836,780
Other comprehensive income 1,907,505 1,907,505
Grant of stock options 24,630 (24,630) --
Cash dividends (3,163,568) (3,163,568)
- ----------------------------------------------------------------------------------------------------------
Balance,
December 31, 2000* $46,969,840 $ (199,063) $59,269,593 $(891,756) $114,129,591
- ----------------------------------------------------------------------------------------------------------
Issuance of common stock 1,200,202 1,262,671
Recapitalization 8,949,361 8 (3,018)
Net income 5,818,131 5,818,131
Cash dividends (3,466,947) (3,466,947)
Exercise of stock options 126,960 127,093
Grant of stock options 1,641,352 (1,641,352) --
Other comprehensive income 3,060,828 3,060,828
- ----------------------------------------------------------------------------------------------------------
Balance,
December 31, 2001 $58,887,715 $ 2,861,765 $59,979,425 $(891,748) $120,928,349
==========================================================================================================
*Restated - see note 1
See accompanying notes to consolidated financial statements.
17
Donegal Group Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31, 2001 2000 1999
- ------------------------------------------------------------------------------------------------------------
Cash Flows from Operating Activities:
Net income $ 5,818,131 $ 8,836,780 $ 6,795,197
- ------------------------------------------------------------------------------------------------------------
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 1,127,510 982,926 1,078,594
Realized investment (gains) losses 880,254 (170,852) 38,702
Changes in Assets and Liabilities, net of acquisition:
Losses and loss expenses 23,363,781 12,296,118 7,452,899
Unearned premiums 14,138,883 7,788,243 2,395,965
Accrued expenses 1,308,632 (165,997) 1,166,287
Premiums receivable (2,385,029) (3,296,815) 1,477,671
Deferred policy acquisition costs (1,320,001) (316,463) 64,545
Deferred income taxes (1,360,633) 499,976 (3,783,354)
Reinsurance receivable (13,309,290) (8,970,330) (3,809,600)
Accrued investment income 237,388 (455,059) (311,975)
Amounts due to/from affiliate (513,922) 350,639 (1,133,037)
Reinsurance balances payable (795,819) 262,686 (499,423)
Prepaid reinsurance premiums (4,881,083) (3,156,232) (4,041,033)
Current income taxes (32,656) 374,620 (388,577)
Change in pooling participation -- 3,322,031 --
Other, net (271,364) 268,316 508,807
- ------------------------------------------------------------------------------------------------------------
Net adjustments 16,186,651 9,613,807 216,471
- ------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 22,004,782 18,450,587 7,011,668
- ------------------------------------------------------------------------------------------------------------
Cash Flows from Investing Activities:
Purchase of fixed maturities
Held to maturity (45,201,470) (17,340,175) (23,782,305)
Available for sale (71,700,918) (30,355,507) (32,890,963)
Purchase of equity securities (12,440,994) (28,286,533) (14,258,861)
Sale of fixed maturities
Available for sale 16,250,109 8,719,165 503,895
Maturity of fixed maturities
Held to maturity 51,313,296 13,490,715 15,563,638
Available for sale 50,781,533 11,928,622 19,049,880
Sale of equity securities 7,089,532 24,572,288 11,767,268
Sale of Atlantic Insurance Services, net -- -- (48,810)
Net purchase of property and equipment (161,269) (275,982) (461,669)
Net sales (purchases) of short-term investments (4,634,695) (2,850,343) 14,619,107
- ------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (8,704,876) (20,397,750) (9,938,820)
- ------------------------------------------------------------------------------------------------------------
Cash Flows from Financing Activities:
Issuance of common stock 1,386,746 2,756,540 2,514,415
Borrowings (payments) under line of credit, net (12,400,000) 3,000,000 (500,000)
Cash dividends paid (3,394,352) (3,126,959) (2,946,170)
- ------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities (14,407,606) 2,629,581 (931,755)
- ------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash (1,107,700) 682,418 (3,858,907)
Cash at beginning of year 5,182,988 4,500,570 8,359,477
- ------------------------------------------------------------------------------------------------------------
Cash at end of year $ 4,075,288 $ 5,182,988 $ 4,500,570
============================================================================================================
*Restated - see note 1
See accompanying notes to consolidated financial statements.
18
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") and Pioneer Insurance Company of Ohio ("Pioneer-Ohio")
(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 70% of the pooled business (65% prior to July 1, 2000).
Southern cedes 50% of its business to the Mutual Company. At December 31, 2001,
the Mutual Company held 63% 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.
During 2000, the Company acquired 45% of the outstanding stock of Donegal
Financial Services Corporation ("DFSC"), a bank holding company, for $3,042,000
in cash. The remaining 55% of the outstanding stock of DFSC is owned by the
Mutual Company.
On January 3, 2001, the Company announced that it had purchased all of the
outstanding stock of Pioneer Insurance Company of New York ("Pioneer-New York")
from the Mutual Company effective January 1, 2001. The purchase price was
$4,441,311, representing Pioneer-New York's adjusted statutory equity at
December 31, 2000. The acquisition has been accounted for as a reorganization of
entities under common control, similar to a pooling of interests, as both
Pioneer-New York and the Company are under the common management and control of
the Mutual Company. As such, the Company's financial statements have been
restated to include Pioneer-New York as a consolidated subsidiary. In connection
with the transaction, the Company issued the Mutual Company a $4,441,311 note,
which bears a 6% rate and is due in January 2003. The Company classifies this
note in Due to Affiliate.
Delaware Atlantic Insurance Company ("Delaware"), previously a wholly owned
subsidiary, and Pioneer-New York were merged into Atlantic States Insurance
Company on August 1, 2001 and September 30, 2001, respectively. The mergers were
accounted for as statutory mergers and had no financial impact on the
consolidated entity.
BASIS OF CONSOLIDATION
The consolidated financial statements, which have been prepared in accordance
with accounting principles generally accepted in the United States of America,
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.
19
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.
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.
20
STOCK-BASED COMPENSATION
Effective July 1, 2000, the Company adopted Financial Accounting Standards Board
Interpretation No. 44 (FIN No. 44), "Accounting for Certain Transactions
involving Stock Compensation," and Emerging Issues Task Force Issue No. 00-23
(EITF 00-23), "Issues Related to the Accounting for Stock Compensation under
Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to
Employees, and FIN No. 44, Accounting for Certain Transactions involving Stock
Compensation." FIN No. 44 states that APB Opinion No. 25 does not apply in the
separate financial statements of a subsidiary to the accounting for stock
compensation granted by the subsidiary to employees of the parent or another
subsidiary. EITF 00-23 states that when employees of a controlling entity are
granted stock compensation, the entity granting the stock compensation should
measure the fair value of the award at the grant date and recognize that fair
value as a dividend to the controlling entity. These provisions apply to the
Company, as the Mutual Company is the employer of record for all employees that
provide services to the Company.
Prior to July 1, 2000, the Company's stock-based compensation plans were
accounted for under the provisions of APB Opinion No. 25 and related
interpretations. As such, compensation expense was recorded on the date of stock
option grant only if the current market price of the underlying stock exceeded
the exercise price. Additionally, the Company provides the pro-forma net income
and earnings per share disclosures required by Statement of Financial Accounting
Standards (SFAS No. 123), "Accounting for Stock-Based Compensation," for grants
prior to the adoption of FIN No. 44.
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.
RECLASSIFICATIONS
Certain amounts in these financial statements have been reclassified from those
previously presented. Gross and ceded premiums earned and losses and loss
expenses are no longer presented in the statements of income. Reinsurance
receivable, prepaid reinsurance premiums, unearned premiums, and the liabilities
for losses and loss expenses have been reduced in the consolidated balance sheet
as they no longer include the amounts under the agreements discussed in the last
paragraph of note 2a. The amounts in note 6 as well as the consolidated
statements of cash flows have been revised to conform to the changes in the
consolidated balance sheets. Note 2a has been expanded to include the purpose of
the various agreements and to separately disclose amounts under the various
arrangements versus the aggregate disclosure previously provided. These
reclassifications had no effect on total revenues, total expenses, net income,
net income per share, cash flows provided by operating activities, or
stockholders' equity.
2--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 70% (65% prior to July 1, 2000) of the Mutual
Company's total pooled insurance business, including that assumed from Atlantic
States and substantially all of the business assumed by the Mutual Company from
Southern and Delaware (prior to January 1, 2000). The Mutual Company and
Atlantic States write business with different risk profiles. Through the pooling
arrangement, each is able to share proportionately in the results of all
policies written by the other. Atlantic States ceded premiums earned of
$37,345,259, $30,414,395 and $23,745,989 and ceded losses and loss expenses
incurred of $29,094,804, $22,966,106 and $15,625,894 under this arrangement
during 2001, 2000 and 1999, respectively. It also assumed premiums earned of
$126,769,521, $110,943,962 and $101,017,767 and assumed losses and loss expenses
incurred of $93,470,958, $75,007,089 and $68,563,183 under this arrangement
during 2001, 2000 and 1999, respectively. Atlantic States had prepaid
reinsurance premiums of $20,942,093, $16,251,612 and $12,978,863 and a ceded
liability for losses and loss expenses of $39,321,214, $31,068,101 and
$24,025,502 under this arrangement as of December 31, 2001, 2000 and 1999,
respectively. It also had assumed unearned premiums of $63,636,858, $54,578,621
and $46,283,485 and an assumed liability for losses and loss expenses of
$99,664,285, $84,805,937 and $80,258,589 under this arrangement at December 31,
2001, 2000 and 1999, respectively.
The Mutual Company and Southern have a quota share agreement whereby
Southern cedes 50% of its direct business, less reinsurance, to the Mutual
Company. The business assumed by the Mutual Company from Southern becomes part
of the pooling arrangement between the Mutual Company and Atlantic States.
Southern ceded premiums earned of $14,995,606, $14,413,261 and $13,517,603 and
ceded losses and loss expenses incurred of $9,898,422, $9,885,436 and $9,986,718
under this agreement during 2001, 2000 and 1999, respectively. Southern had
prepaid reinsurance premiums of $7,310,471, $7,084,729 and $6,683,001 and a
ceded liability for losses and loss expenses of $10,068,604, $7,924,750 and
$7,054,012 under this agreement at December 31, 2001, 2000 and 1999,
respectively. This agreement was terminated as of January 1, 2002.
Atlantic States, Southern, Pioneer-Ohio and Southern Heritage 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,
$200,000 and $400,000 (effective January 1, 2000), respectively, and $1,000,000
($700,000 in 1999) for a catastrophe involving more than one of the companies.
Prior to merging into Atlantic States, Delaware and Pioneer-New York each had a
catastrophe reinsurance agreement with the Mutual Company which limited the
maximum liability under any one catastrophic occurrence to $300,000 and
$400,000, respectively. Prior to merging into Atlantic States, Delaware and the
Mutual Company had an excess of loss reinsurance agreement in
21
which the Mutual Company assumed up to $250,000 of losses in excess of $50,000
and prior to January 1, 2000, a workers' compensation quota share agreement
whereby Delaware ceded 70% of that business. The Mutual Company and Pioneer-Ohio
have an excess of loss reinsurance agreement in which the Mutual Company assumes
up to $250,000 ($200,000 in 2000 and 1999) of losses in excess of $50,000. The
Mutual Company and Southern have an excess of loss reinsurance agreement in
which the Mutual Company assumes up to $50,000 ($25,000 in 2000 and 1999) of
losses in excess of $100,000. Prior to merging into Atlantic States, Pioneer-New
York and the Mutual Company had an excess of loss reinsurance agreement in which
the Mutual Company assumed up to $250,000 ($200,000 in 2000 and 1999) of losses
in excess of $50,000. Effective October 1, 2000 the Mutual Company and Southern
Heritage have an excess of loss reinsurance agreement in which the Mutual
Company assumed up to $175,000 ($125,000 in 2000) of losses in excess of
$125,000. The Mutual Company has agreements in place with Southern and
Pioneer-Ohio (and Delaware prior to merging into Atlantic States) 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. The Mutual Company and Pioneer-New York also
had an aggregate excess of loss reinsurance agreement, entered into as part of
the sale of Pioneer-New York 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, 2000, as developed through December 31,
2002, and to assume losses in excess of a 60% loss ratio through December 31,
2002. The subsidiaries ceded premiums earned of $2,439,520, $2,126,882 and
$3,519,914 and ceded losses and loss expenses incurred of $4,194,251, $5,388,111
and $4,400,776 under these various agreements during 2001, 2000 and 1999,
respectively. The subsidiaries had prepaid reinsurance premiums of $0, $0 and
$733,183 and a ceded liability for losses and loss expenses of $5,395,528,
$4,941,116 and $2,689,825 under these various agreements at December 31, 2001,
2000, and 1999, respectively.
Southern, Pioneer-Ohio and Southern Heritage (and Delaware and Pioneer-New
York prior to merging into Atlantic States) each have agreements with the Mutual
Company under which they cede, and then reassume back, 100% of their business
net of reinsurance. The primary purpose of the agreements is to provide these
subsidiaries with the same A.M. Best rating (currently "A") as the Mutual
Company, which these subsidiaries could not achieve without these contracts in
place. These agreements do not transfer insurance risk. While these subsidiaries
ceded and reassumed amounts received from policyholders of $41,142,936,
$25,790,126 and $22,486,490 and claims of $23,348,952, $15,325,638 and
$13,177,186 under these agreements in 2001, 2000 and 1999, respectively, the
amounts are not reflected in the consolidated financial statements. The
aggregate liabilities ceded and reassumed under these agreements were
$36,494,487 and $26,572,959 at December 31, 2001, and 2000, 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 $29,298,569, $26,985,080 and $27,466,898 for 2001, 2000 and 1999,
respectively.
C. LEASE AGREEMENT
The Company leases office equipment and automobiles to the Mutual Company under
a 10-year lease dated January 1, 2000.
D. 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.
E. PROVINCE BANK
As of December 31, 2001, the Company had $3,585,566 in checking accounts with
Province Bank, a wholly owned subsidiary of DFSC. The Company earned $6,350 in
interest on these accounts during 2001.
3--INVESTMENTS
The amortized cost and estimated fair values of fixed maturities and equity
securities at December 31, 2001 and 2000, are as follows:
2001
- ----------------------------------------------------------------------------------------------------------------------------
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 $23,808,841 $ 336,288 $ 27,500 $ 24,117,629
Canadian government
obligation 498,894 36,106 -- 535,000
Obligations of states
and political
subdivisions 24,981,562 690,700 53,312 25,618,950
Corporate securities 27,423,039 659,961 121,021 27,961,979
Mortgage-backed
securities 8,610,629 113,541 18,335 8,705,835
- ----------------------------------------------------------------------------------------------------------------------------
Totals $85,322,965 $1,836,596 $ 220,168 $ 86,939,393
============================================================================================================================
22
2001
- ----------------------------------------------------------------------------------------------------------------------------
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 $ 67,468,897 $1,755,874 $ 249,306 $ 68,975,465
Obligations of states
and political
subdivisions 53,962,895 1,269,340 85,535 55,146,700
Corporate securities 34,094,195 828,344 115,939 34,806,600
Mortgage-backed
securities 14,743,597 78,666 32,184 14,790,079
Equity securities 16,630,618 1,270,239 383,511 17,517,346
- ----------------------------------------------------------------------------------------------------------------------------
Totals $186,900,202 $5,202,463 $866,475 $191,236,190
============================================================================================================================
2000
- ----------------------------------------------------------------------------------------------------------------------------
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 $ 38,779,230 $ 343,819 $ 255,049 $ 38,868,000
Canadian government
obligation 498,559 11,441 -- 510,000
Obligations of states
and political
subdivisions 66,831,090 1,499,955 45,904 68,285,141
Corporate securities 21,621,472 228,851 195,287 21,655,036
Mortgage-backed
securities 15,451,367 47,120 154,228 15,344,259
- ----------------------------------------------------------------------------------------------------------------------------
Totals $143,181,718 $2,131,186 $ 650,468 $144,662,436
============================================================================================================================
2000
- ----------------------------------------------------------------------------------------------------------------------------
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 $ 68,007,634 $ 544,135 $ 650,339 $ 67,901,430
Obligations of states
and political
subdivisions 17,965,179 327,256 36,885 18,255,550
Corporate securities 22,902,588 312,426 306,664 22,908,350
Mortgage-backed
securities 5,649,071 14,790 118,008 5,545,853
Equity securities 12,500,558 880,419 1,268,741 12,112,236
- ----------------------------------------------------------------------------------------------------------------------------
Totals $127,025,030 $2,079,026 $2,380,637 $126,723,419
============================================================================================================================
The amortized cost and estimated fair value of fixed maturities at December
31, 2001, 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 $ 1,000,081 $ 1,012,500
Due after one year through five years 33,277,659 33,857,210
Due after five years through ten years 38,671,342 39,626,349
Due after ten years 3,763,254 3,737,500
Mortgage-backed securities 8,610,629 8,705,834
- --------------------------------------------------------------------------------
Total held to maturity $ 85,322,965 $ 86,939,393
================================================================================
AVAILABLE FOR SALE
Due in one year or less $ 11,815,944 $ 12,046,000
Due after one year through five years 79,085,686 81,151,668
Due after five years through ten years 56,670,691 57,971,097
Due after ten years 7,953,666 7,760,000
Mortgage-backed securities 14,743,597 14,790,079
- --------------------------------------------------------------------------------
Total available for sale $170,269,584 $173,718,844
================================================================================
The amortized cost of fixed maturities on deposit with various regulatory
authorities at December 31, 2001 and 2000, amounted to $5,667,959 and
$6,056,374, respectively.
Net investment income of the Company, consisting primarily of interest and
dividends, is attributable to the following sources:
2001 2000 1999
- --------------------------------------------------------------------------------
Fixed maturities $15,145,949 $15,180,008 $13,046,603
Equity securities 546,243 635,049 440,268
Short-term investments 920,538 1,221,724 809,949
Other 255,250 255,250 316,139
- --------------------------------------------------------------------------------
Investment income 16,867,980 17,292,031 14,612,959
Investment expenses 982,436 897,284 1,022,264
- --------------------------------------------------------------------------------
Net investment income $15,885,544 $16,394,747 $13,590,695
================================================================================
Gross realized gains and losses from investments and the change in the
difference between fair value and cost of investments, before applicable income
taxes, are as follows:
2001 2000 1999
- --------------------------------------------------------------------------------
Gross realized gains:
Fixed maturities $ 554,560 $ 237,748 $ --
Equity securities 323,451 1,813,242 586,745
- --------------------------------------------------------------------------------
878,011 2,050,990 586,745
- --------------------------------------------------------------------------------
Gross realized losses:
Fixed maturities 28,618 20,597 6,083
Equity securities 1,729,647 1,859,541 619,364
- -------------------------------------------------------------------------------
1,758,265 1,880,138 625,447
- -------------------------------------------------------------------------------
Net realized gains (losses) $ (880,254) $ 170,852 $ (38,702)
===============================================================================
Change in difference between
fair value and cost of
investments:
Fixed maturities $ 3,498,259 $ 7,300,279 $(11,668,991)
Equity securities 1,275,050 (603,930) (362,312)
- --------------------------------------------------------------------------------
$ 4,773,309 $ 6,696,349 $(12,031,303)
================================================================================
23
Income taxes (benefit) on realized investment gains (losses) were
$(299,286), $58,090, and $(13,159) for 2001, 2000 and 1999, respectively.
Deferred income taxes (benefits) applicable to net unrealized investment gains
(losses) included in shareholders' equity were $1,474,242 and $(102,548) at
December 31, 2001 and 2000, respectively.
During 2001 and 2000, certain investments trading below cost had declined
on an other-than-temporary basis. Losses of $1,462,913 and $436,943 were
included in net realized investment gains (losses) for these investments in 2001
and 2000, respectively.
The Company has no derivative instruments or hedging activities. On January
1, 2001, the Company transferred investments with an amortized cost of
$51,640,154 and fair value of $52,444,675 from the held to maturity
classification to the available for sale classification under the provisions of
SFAS No. 133 and 138. The unrealized holding gain of $804,521 at January 1, 2001
was reported in other comprehensive income. The transfer had no impact on net
income.
4--DEFERRED POLICY ACQUISITION COSTS
Changes in deferred policy acquisition costs are as follows:
2001 2000 1999
- --------------------------------------------------------------------------------
Balance, January 1 $12,284,214 $11,445,572 $11,510,117
Acquisition costs deferred 28,514,001 26,157,642 24,866,455
Amortization charged
to earnings 27,194,000 25,319,000 24,931,000
- --------------------------------------------------------------------------------
Balance, December 31 $13,604,215 $12,284,214 $11,445,572
================================================================================
5--PROPERTY AND EQUIPMENT
Property and equipment at December 31, 2001 and 2000, consisted of the
following:
- --------------------------------------------------------------------------------
Estimated
Useful
2001 2000 Life
- --------------------------------------------------------------------------------
Cost--office equipment $5,012,290 $4,981,970 5-15 years
automobiles 992,412 947,865 3 years
real estate 3,063,646 3,063,646 15-50 years
software 561,146 561,146 5 years
- --------------------------------------------------------------------------------
9,629,494 9,554,627
Accumulated depreciation (5,060,842) (4,318,144)
- --------------------------------------------------------------------------------
$4,568,652 $5,236,483
================================================================================
Depreciation expense for 2001, 2000, and 1999 amounted to $829,100,
$899,750 and $970,331, respectively.
6--LIABILITY FOR LOSSES AND LOSS EXPENSES
Activity in the liability for losses and loss expenses is summarized as follows:
2001 2000 1999
- --------------------------------------------------------------------------------
Balance at January 1 $156,476,124 $144,180,006 $136,727,107
Less reinsurance
recoverable 53,766,710 44,945,908 40,712,330
- --------------------------------------------------------------------------------
Net balance at January 1 102,709,414 99,234,098 96,014,777
- --------------------------------------------------------------------------------
Incurred related to:
Current year 110,142,467 103,671,401 100,573,192
Prior years 8,035,082 711,775 (492,576)
- --------------------------------------------------------------------------------
Total incurred 118,177,549 104,383,176 100,080,616
- --------------------------------------------------------------------------------
Paid related to:
Current year 63,289,736 61,848,261 59,434,306
Prior years 43,053,112 39,059,599 37,426,989
- --------------------------------------------------------------------------------
Total paid 106,342,848 100,907,860 96,861,295
- --------------------------------------------------------------------------------
Net balance at
December 31 114,544,115 102,709,414 99,234,098
Plus reinsurance
recoverable 65,295,790 53,766,710 44,945,908
- --------------------------------------------------------------------------------
Balance at December 31 $179,839,905 $156,476,124 $144,180,006
================================================================================
The Company recognized an increase (decrease) in the liability for losses
and loss expenses of prior years of $8.0 million, $0.7 million and $(0.5
million) in 2001, 2000 and 1999, respectively. These developments are primarily
attributable to variations from expected claim severity in the private passenger
and commercial automobile liability, workers' compensation and commercial
multiple peril lines of business.
7--LINE OF CREDIT
At December 31, 2001 and 2000, pursuant to a credit agreement dated December 29,
1995, and amended as of July 27, 1998, with Fleet National Bank, the Company had
unsecured borrowings of $27.6 million and $40 million, respectively. Such
borrowings were made in connection with the acquisitions of Delaware,
Pioneer-Ohio, and Southern Heritage and various capital contributions to the
subsidiaries. As of December 31, 2001, the Company may borrow up to $32 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, 2001,
the interest rates were 4.75% on an outstanding prime rate balance of $2.6
million, 3.825% on an outstanding Eurodollar rate balance of $10 million and
3.6375% on another 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, the credit line is reduced by $8
million. Any outstanding loan in excess of the remaining credit line, after such
reduction, will then be payable.
24
8--REINSURERS
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 ceded reinsurance
transactions with unaffiliated reinsurers during 2001, 2000 and 1999:
2001 2000 1999
- ----------------------------------------------------------------------------
Premiums written $ 9,348,853 $ 8,241,416 $ 8,391,805
============================================================================
Premiums earned $ 9,440,035 $ 8,026,478 $ 8,549,509
============================================================================
Losses and loss expenses $ 6,907,947 $ 3,027,810 $ 5,537,410
============================================================================
Prepaid reinsurance premiums $ 1,340,903 $ 1,376,043 $ 1,161,105
============================================================================
Liability for losses and
loss expenses $10,510,444 $ 9,832,743 $11,176,569
============================================================================
TOTAL REINSURANCE
The following amounts represent the total of all ceded reinsurance transactions
with both affiliated and unaffiliated reinsurers during 2001, 2000, and 1999:
2001 2000 1999
- ----------------------------------------------------------------------------
Premiums earned $64,220,420 $54,981,016 $49,333,015
============================================================================
Losses and loss expenses $50,095,424 $41,267,463 $35,550,798
============================================================================
Prepaid reinsurance premiums $29,593,467 $24,712,384 $21,556,152
============================================================================
Liability for losses and
loss expenses $65,295,790 $53,766,710 $44,945,908
============================================================================
The following amounts represent the effect of reinsurance on premiums
written for 2001, 2000, and 1999:
2001 2000 1999
- ----------------------------------------------------------------------------
Direct $110,298,533 $ 99,042,235 $ 91,854,011
Assumed 135,830,624 119,217,433 105,392,426
Ceded 69,101,503 58,137,248 53,374,048
- ----------------------------------------------------------------------------
Net premiums written $177,027,654 $160,122,420 $143,872,389
============================================================================
The following amounts represent the effect of reinsurance on premiums
earned for 2001, 2000, and 1999:
2001 2000 1999
- ----------------------------------------------------------------------------
Direct $105,214,059 $ 95,671,588 $ 93,399,834
Assumed 126,776,215 110,955,627 101,450,638
Ceded 64,220,420 54,981,016 49,333,015
- ----------------------------------------------------------------------------
Net premiums earned $167,769,854 $151,646,199 $145,517,457
============================================================================
9--INCOME TAXES
The provision for income tax consists of the following:
2001 2000 1999
- -----------------------------------------------------------------------------
Current $ 2,634,231 $ 2,406,272 $ 832,798
Deferred (1,360,633) 499,976 (3,783,354)
- ----------------------------------------------------------------------------
Federal tax provision $ 1,273,598 $ 2,906,248 $(2,950,556)
============================================================================
The effective tax rate is different than the amount computed at the
statutory federal rate of 34% for 2001, 2000 and 1999. The reason for such
difference and the related tax effect are as follows:
2001 2000 1999
- -----------------------------------------------------------------------------
Income before
income taxes $7,091,729 $11,743,028 $ 3,844,641
=============================================================================
Computed "expected"
taxes at 34% 2,411,188 3,992,630 1,307,178
Recognition of net operating
loss carryover of
Southern Heritage -- -- (3,004,524)
Tax-exempt interest (1,399,238) (1,347,959) (1,355,816)
Dividends received deduction (21,908) (25,423) (83,948)
Other, net 283,556 287,000 186,554
- -----------------------------------------------------------------------------
Federal income
tax provision $1,273,598 $ 2,906,248 $(2,950,556)
=============================================================================
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at December 31,
2001 and 2000, are as follows:
2001 2000
- -----------------------------------------------------------------------------
Deferred tax assets:
Unearned premium $ 5,778,529 $ 5,139,217
Loss reserves 5,433,005 4,878,850
Net operating loss carryforward -
Southern Heritage 2,032,094 2,339,133
Unrealized loss -- 102,548
Other 1,013,899 174,886
- -----------------------------------------------------------------------------
Total $14,257,527 $12,634,634
=============================================================================
Deferred tax liabilities:
Depreciation expense $ 379,594 $ 464,235
Deferred policy acquisition costs 4,625,433 4,176,632
Salvage recoverable 303,528 302,881
Unrealized gain 1,474,242 --
- -----------------------------------------------------------------------------
Total $ 6,782,797 $ 4,943,748
=============================================================================
Net deferred tax assets $ 7,474,730 $ 7,690,886
=============================================================================
A valuation allowance is provided when it is more likely than not that some
portion of the tax asset will not be realized. Management has determined that it
is not required to establish a valuation allowance for any deferred tax asset at
December 31, 2001, 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 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 was the primary factor in
management's determination that no valuation allowance was 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.
25
At December 31, 2001, the Company has a net operating loss carryforward of
$5,976,747, 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.
10--STOCKHOLDERS' EQUITY
On April 19, 2001 the Company's stockholders approved an amendment to the
Company's Certificate of Incorporation. Among other things, the amendment
reclassified the Company's common stock as Class B common stock and effected a
one-for-three reverse split of the Company's Class B common stock effective
April 19, 2001. The amendment also authorized a new class of common stock with
one-tenth of a vote per share designated as Class A common stock. The Company's
Board also approved a dividend of two shares of Class A common stock for each
share of Class B common stock, after the one-for-three reverse split, held of
record at the close of business April 19, 2001. The effect of the reverse split
and the stock dividend taken together is that the Company had the same total
number of shares outstanding after the reverse split and the stock dividend as
it did before the reverse split and the stock dividend. Therefore, there is no
change in the historical earnings per share of the Class A common stock and the
Class B common stock after the reverse split and the stock dividend compared to
before the reverse split and the stock dividend.
Each share of Class A common stock outstanding at the time of the
declaration of any dividend or other distribution payable in cash upon the
shares of Class B common stock is entitled to a dividend or distribution payable
at the same time and to stockholders of record on the same date in an amount at
least 10% greater than any dividend declared upon each share of Class B common
stock. In the event of a merger or consolidation of the Company with or into
another entity, the holders of Class A common stock and the holders of Class B
common stock are entitled to receive the same per share consideration in such
merger or consolidation. In the event of any liquidation, dissolution or
winding-up of the Company, any assets available to common stockholders will be
distributed pro-rata to the holders of Class A and Class B common stock.
11--STOCK COMPENSATION PLANS
EQUITY INCENTIVE PLANS
During 1996 the Company adopted an Equity Incentive Plan for key employees.
During 2001 the Company adopted a nearly identical plan that made a total of
1,500,000 shares of Class A common stock available. Each plan provides 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 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. No stock appreciation
rights have been issued.
During 1996 the Company adopted an Equity Incentive Plan For Directors.
During 2001 the Company adopted a nearly identical plan that made 200,000 shares
of Class A common stock available. Awards may be made in the form of stock
options, and the plan additionally provides for the issuance of 175 shares of
restricted stock to each director on the first business day of January in each
year. As of December 31, 2001, the Company has 76,112 unexercised options under
these plans. Additionally 1,947, 1,947 and 2,124 shares of restricted stock were
issued on January 2, 2001, 2000 and 1999, respectively.
All options issued prior to 2001 were converted to options on Class A and
Class B common stock as a result of the Company's recapitalization. No further
shares are available for plans in effect prior to 2001.
Information regarding activity in the Company's stock option plans is
presented below:
Weighted-Average
Number of Exercise Price
Options Per Share
- --------------------------------------------------------------------------------
Outstanding at December 31, 1998 1,091,120 $15.73
Granted - 1999 433,500 8.00
Exercised - 1999 -- --
Forfeited - 1999 28,227 15.52
- --------------------------------------------------------------------------------
Outstanding at December 31, 1999 1,496,393 $13.50
Granted - 2000 59,500 8.05
Exercised - 2000 -- --
Forfeited - 2000 39,555 12.84
- --------------------------------------------------------------------------------
Outstanding at December 31, 2000 1,516,338 $13.19
Granted - 2001 459,000 13.93
Exercised - 2001 13,315 8.00
Forfeited - 2001 27,556 13.50
- --------------------------------------------------------------------------------
Outstanding at December 31, 2001 1,934,467 $13.27
================================================================================
Exercisable at:
December 31, 1999 897,338 $15.99
================================================================================
December 31, 2000 1,190,004 $16.68
================================================================================
December 31, 2001 1,321,905 $13.89
================================================================================
Options available for future grants at December 31, 2001 are 1,241,000.
The following table summarizes information about fixed stock options at
December 31, 2001:
Number of Weighted-Average Number of
Exercise Options Remaining Options
Price Outstanding Contractual Life Exercisable
- --------------------------------------------------------------------------------
$ 8.00 457,685 3.0 years 305,123
$ 9.00 9,500 4.5 years 2,000
$13.50 524,448 0.1 years 524,448
$14.00 452,500 4.5 years --
$18.00 490,334 1.25 years 490,334
EMPLOYEE STOCK PURCHASE PLANS
During 1996 the Company adopted an Employee Stock Purchase Plan. During 2001,
the Company adopted a nearly identical plan that made 300,000 shares of Class A
common stock available for issuance.
26
The new 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 1 and December 1) of the plan or
85% of the fair market value of the Company's common stock on the last day of
the subscription period (June 30 and December 31). A summary of plan activity
follows:
Shares Issued
---------------------------
Price Shares
- -------------------------------------------------------------------------------
January 1, 1999 $13.28125 10,227
July 1, 1999 $ 9.66875 11,876
January 1, 2000 $ 5.41875 23,906
July 1, 2000 $ 4.88750 21,714
January 1, 2001 $ 5.95000 16,438
July 1, 2001 $ 8.71250 11,377
On January 1, 2002, the Company issued an additional 12,769 shares at a
price of $8.84850 per share under this plan.
AGENCY STOCK PURCHASE PLANS
On December 31, 1996, the Company adopted an Agency Stock Purchase Plan. During
2001, the Company adopted a nearly identical plan that made 300,000 shares of
Class A common stock 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 2001, 2000 and 1999, 16,557, 46,603, and
47,841 shares, respectively, were issued under this plan. Expense recognized
under the plan was not material.
PRO-FORMA DISCLOSURES
The weighted-average grant date fair value of options granted for the various
plans during 2000 and 1999 was $2.23 and $1.98, respectively.
The fair values above were calculated based upon risk-free interest rates
of 5.75% 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 54% for 2000 and 47% for 1999, and an
expected dividend yield of 4.5% for 2000 and 5.0% for 1999.
Through June 30, 2000, the Company applied 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:
2001 2000 1999
- --------------------------------------------------------------------------------
Net income:
As reported $5,818,131 $8,836,780 $6,795,197
Pro-forma 5,617,773 8,071,825 5,595,851
Basic earnings per share:
As reported .65 1.01 .82
Pro-forma .63 .92 .68
Diluted earnings per share:
As reported .64 1.01 .82
Pro-forma .62 .92 .68
12--STATUTORY NET INCOME, CAPITAL AND SURPLUS AND DIVIDEND RESTRICTIONS
The following is selected information, as filed with insurance regulatory
authorities, for the Insurance Subsidiaries as determined in accordance with
accounting practices prescribed or permitted by such insurance regulatory
authorities (restated for mergers):
2001 2000 1999
- ------------------------------------------------------------------------------
ATLANTIC STATES
Statutory capital
and surplus $ 86,124,896 $ 88,620,380 $ 82,401,227
============================================
Statutory unassigned
surplus $ 44,464,032 $ 46,959,516 $ 40,740,363
============================================
Statutory net income (loss) $ (54,605) $ 8,134,135 $ 4,832,737
- ----------------------------------============================================
SOUTHERN
Statutory capital
and surplus $ 10,863,481 $ 9,082,587 $ 7,293,856
============================================
Statutory unassigned
surplus $ 5,761,211 $ 3,980,317 $ 2,191,586
============================================
Statutory net income $ 1,666,477 $ 1,543,128 $ 184,285
- ----------------------------------============================================
PIONEER-OHIO
Statutory capital
and surplus $ 5,524,466 $ 5,811,315 $ 5,677,926
============================================
Statutory unassigned
deficit $ (1,475,534) $ (1,188,685) $ (1,322,074)
============================================
Statutory net income $ (621,520) $ (176,011) $ 108,322
- ----------------------------------============================================
SOUTHERN HERITAGE
Statutory capital
and surplus $ 19,867,276 $ 16,975,171 $ 16,508,422
============================================
Statutory unassigned
deficit $(12,648,039) $(15,540,144) $(16,006,893)
============================================
Statutory net income $ 3,514,487 $ 1,486,698 $ 487,098
============================================
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, Pioneer-Ohio and Southern
Heritage are also subject to Risk Based Capital (RBC) requirements which may
further impact their ability to pay dividends. At December 31, 2001, all four
companies' statutory capital and surplus were substantially above the RBC
requirements. Amounts available for distribution as dividends to Donegal Group
Inc. without prior approval of insurance regulatory authorities in 2002 are
$8,612,490 from Atlantic States, $1,086,348 from Southern, $552,447 from
Pioneer-Ohio and $3,514,487 from Southern Heritage.
The National Association of Insurance Commissioners (NAIC) has adopted the
Codification of Statutory Accounting Principles with an effective date of
January 1, 2001. The codified principles are intended to provide a basis of
accounting recognized and adhered to in the absence of conflict with, or silence
of, state statutes and regulations. The impact of the codified principles on the
statutory capital and surplus of the Company's Insurance Subsidiaries as of
January 1, 2001 is as follows: Atlantic States - $6,168,742 increase; Southern
Heritage - $1,083,354 increase; Pioneer-Ohio - $313,638 increase; and Southern -
$1,171,204 increase.
27
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,
-----------------------
2001 2000 1999
- --------------------------------------------------------------------------------
Statutory net income of
Insurance Subsidiaries $ 4,504,839 $10,987,950 $ 5,612,442
Increases (decreases):
Deferred policy
acquisition costs 1,320,001 838,642 (64,545)
Deferred federal
income taxes 1,360,633 (499,976) 3,783,354
Salvage and subrogation
recoverable 155,088 305,918 (226,617)
Consolidating eliminations
and adjustments (13,783,695) (4,318,624) (1,387,864)
Parent-only net income (loss) 12,261,265 1,522,870 (908,987)
Non-insurance subsidiary
net income (loss) -- -- (12,586)
- --------------------------------------------------------------------------------
Net income as
reported herein $ 5,818,131 $ 8,836,780 $ 6,795,197
================================================================================
December 31,
------------------------------------------
2001 2000 1999
- --------------------------------------------------------------------------------
Statutory capital and surplus
of Insurance Subsidiaries $122,380,119 $120,489,453 $111,881,431
Increases (decreases):
Deferred policy
acquisition costs 13,604,215 12,284,214 11,445,572
Deferred federal
income taxes (820,313) 7,690,886 9,221,874
Salvage and subrogation
recoverable 8,197,948 8,042,860 7,736,942
Statutory reserves -- 2,623,921 5,154,062
Non-admitted assets and
other adjustments, net 334,092 911,370 942,170
Fixed maturities 3,793,048 493,055 (2,968,655)
Consolidating eliminations
and adjustments (39,693,089) (40,973,097) (41,072,150)
Parent-only equity 13,132,329 2,566,929 1,451,088
- --------------------------------------------------------------------------------
Stockholders' equity as
reported herein $120,928,349 $114,129,591 $103,792,334
================================================================================
14--SUPPLEMENTARY INFORMATION ON STATEMENT OF CASH FLOWS
The following reflects income taxes and interest paid during 2001, 2000 and
1999:
2001 2000 1999
- --------------------------------------------------------------------------------
Income taxes $2,666,887 $2,031,652 $1,221,375
================================================================================
Interest $3,049,844 $2,731,048 $1,370,155
================================================================================
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, 2001, 2000 and 1999:
Weighted-
Average Earnings
Net Shares Per
Income Outstanding Share
- --------------------------------------------------------------------------------
2001:
Basic $5,818,131 8,941,781 .65
Effect of stock options -- 136,669 (.01)
- --------------------------------------------------------------------------------
Diluted $5,818,131 9,078,450 .64
================================================================================
2000:
Basic $8,836,780 8,715,899 $1.01
Effect of stock options -- 21,011 --
- --------------------------------------------------------------------------------
Diluted $8,836,780 8,736,910 $1.01
================================================================================
1999:
Basic $6,795,197 8,327,356 $ .82
Effect of stock options -- -- --
- --------------------------------------------------------------------------------
Diluted $6,795,197 8,327,356 $ .82
================================================================================
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:
2001 2000 1999
- --------------------------------------------------------------------------------
Options excluded from
diluted earnings per share 1,467,282 1,045,338 1,496,393
================================================================================
28
16--CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY
CONDENSED BALANCE SHEETS
($ in thousands)
December 31, 2001 2000
- --------------------------------------------------------------------------------
ASSETS
Investment in subsidiaries (equity method) $152,089 $155,600
Cash 403 2,381
Property and equipment 1,623 1,997
Other 264 715
- --------------------------------------------------------------------------------
Total assets $154,379 $160,693
================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Cash dividends declared to stockholders $ 870 $ 797
Line of credit 27,600 40,000
Due to affiliate 4,441 4,441
Other 540 1,325
- --------------------------------------------------------------------------------
Total liabilities 33,451 46,563
- --------------------------------------------------------------------------------
Stockholders' equity 120,928 114,130
- --------------------------------------------------------------------------------
Total liabilities and stockholders' equity $154,379 $160,693
================================================================================
CONDENSED STATEMENTS OF INCOME
($ in thousands)
Year Ended December 31, 2001 2000 1999
- --------------------------------------------------------------------------------
Revenues
Dividends-subsidiaries $14,419 $3,900 $ 820
Other 824 866 865
- --------------------------------------------------------------------------------
Total revenues 15,243 4,766 1,685
- --------------------------------------------------------------------------------
Expenses
Operating expenses 1,761 1,165 938
Interest 2,288 3,304 2,463
- --------------------------------------------------------------------------------
Total expenses 4,049 4,469 3,401
- --------------------------------------------------------------------------------
Income (loss) before income tax benefit
and equity in undistributed net
income of subsidiaries 11,194 297 (1,716)
Income tax benefit (1,067) (1,226) (807)
- --------------------------------------------------------------------------------
Income (loss) before equity in
undistributed net income (loss)
of subsidiaries 12,261 1,523 (909)
Equity in undistributed
net income (loss)
of subsidiaries (6,443) 7,314 7,704
- --------------------------------------------------------------------------------
Net income $ 5,818 $8,837 $6,795
================================================================================
CONDENSED STATEMENTS OF CASH FLOWS
($ in thousands)
Year Ended December 31, 2001 2000 1999
- --------------------------------------------------------------------------------
Cash flows from operating activities:
Net income $ 5,818 $ 8,837 $ 6,795
- --------------------------------------------------------------------------------
Adjustments:
Equity in undistributed
net loss (income)
of subsidiaries 6,443 (7,314) (7,704)
Other 252 1,123 2,365
- --------------------------------------------------------------------------------
Net adjustments 6,695 (6,191) (5,339)
- --------------------------------------------------------------------------------
Net cash provided 12,513 2,646 1,456
- --------------------------------------------------------------------------------
Cash flows from investing activities:
Net purchase of property and
equipment (122) (262) (426)
Sale of AIS -- -- 100
Investment in Donegal Financial
Services Corp. -- (3,042) --
Other 38 38 (426)
- --------------------------------------------------------------------------------
Net cash used (84) (3,266) (752)
- --------------------------------------------------------------------------------
Cash flows from financing activities:
Cash dividends paid (3,394) (3,127) (2,946)
Issuance of common stock 1,387 2,757 2,514
Line of credit, net (12,400) 3,000 (500)
- --------------------------------------------------------------------------------
Net cash provided (used) (14,407) 2,630 (932)
- --------------------------------------------------------------------------------
Net change in cash (1,978) 2,010 (228)
Cash at beginning of year 2,381 371 599
- --------------------------------------------------------------------------------
Cash at end of year $ 403 $ 2,381 $ 371
================================================================================
29
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:
2001 2000 1999
-------------------------------------
($ in thousands)
- --------------------------------------------------------------------------------
Revenues:
Premiums earned:
Commercial lines $ 62,877 $ 54,581 $ 47,804
Personal lines 104,893 97,065 97,713
- --------------------------------------------------------------------------------
Total premiums earned 167,770 151,646 145,517
- --------------------------------------------------------------------------------
Net investment income 15,886 16,395 13,591
Realized investment
gains (losses) (880) 171 (39)
Other 2,388 2,370 2,670
- --------------------------------------------------------------------------------
Total revenues $185,164 $170,582 $161,739
================================================================================
Income before income taxes:
Underwriting income (loss):
Commercial lines $ (3,037) $ 763 $ (839)
Personal lines (5,090) (4,649) (8,461)
- --------------------------------------------------------------------------------
SAP underwriting loss (8,127) (3,886) (9,300)
GAAP adjustments 1,833 1,144 (184)
- --------------------------------------------------------------------------------
GAAP underwriting loss (6,294) (2,742) (9,484)
Net investment income 15,886 16,395 13,591
Realized investment gains (losses) (880) 171 (39)
Other (1,620) (2,081) (223)
- --------------------------------------------------------------------------------
Income before income taxes $ 7,092 $ 11,743 $ 3,845
================================================================================
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
in 1999 for employee termination benefits, occupancy charges, lease cancellation
costs, and asset impairments. The charge was included in other underwriting
expenses. The consolidation was completed by the end of the first quarter of
2000.
Employee termination benefits of $782,000 included severance payments,
which were 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 were future lease obligations,
less anticipated sublease benefits, for leased space which is no longer 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
- --------------------------------------------------------------------------------
Cash payments (339,000) (155,000) (73,000) (567,000)
Accrual adjustment -- 12,000 -- 12,000
- --------------------------------------------------------------------------------
Balance at
December 31,
2000 $ 29,000 $ 298,000 $ -- $ 327,000
Cash payments (10,000) (91,000) -- (101,000)
- --------------------------------------------------------------------------------
Balance at
December 31,
2001 $ 19,000 $ 207,000 $ -- $ 226,000
================================================================================
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 liabilities for guaranty-fund
and other insurance-related assessments were $3,605,090 and $880,154 at December
31, 2001 and 2000, respectively. These liabilities included $676,149 and
$397,832 related to surcharges collected by the Company on behalf of regulatory
authorities for 2001 and 2000, respectively.
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20--INTERIM FINANCIAL DATA (UNAUDITED)
2001
------------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
- --------------------------------------------------------------------------------
Net premiums
earned $40,040,902 $41,651,990 $ 42,598,703 $43,478,259
Total revenues 44,792,026 46,496,969 46,365,986 47,508,642
Net losses and loss
expenses 26,158,684 27,931,189 30,026,448 34,061,228
Net income (loss) 2,954,595 2,697,269 1,023,422 (857,155)
Net income (loss) per
common share
Basic .33 .30 .11 (.10)
Diluted .33 .30 .11 (.10)
2000
------------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
- --------------------------------------------------------------------------------
Net premiums
earned $36,088,698 $36,447,134 $39,149,006 $39,961,361
Total revenues 40,357,333 41,333,363 44,229,060 44,661,831
Net losses and loss
expenses 25,948,912 24,823,941 26,795,640 26,814,683
Net income 1,162,682 2,502,499 2,566,975 2,604,624
Net income per
common share
Basic $.14 $.29 $.29 $.29
Diluted .14 .29 .29 .29
- --------------------------------------------------------------------------------
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, 2001 and 2000, 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, 2001. 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 auditing standards generally
accepted in the United States of America. 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, 2001 and 2000, and the results of
their operations and their cash flows for each of the years in the three-year
period ended December 31, 2001 in conformity with accounting principles
generally accepted in the United States of America.
KPMG LLP
Philadelphia, Pennsylvania
February 21, 2002
31
CORPORATE INFORMATION
ANNUAL MEETING
April 18, 2002 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 Class A common stock and Class B common stock are traded on the
Nasdaq National Market under the symbols "DGICA" and "DGICB." The Class A common
stock and Class B common stock have traded on the Nasdaq National Market since
April 20, 2001. All information given prior to that date relates to the
Company's Common Stock, which previously traded on the Nasdaq National Market
under the symbol "DGIC." The following table shows the dividends paid per share
and the stock price range for each quarter during 2001 and 2000:
CASH DIVIDEND
DECLARED
QUARTER HIGH LOW PER SHARE
2000
1st 8.625 5.750 --
2nd 8.250 5.750 .09
3rd 8.000 5.750 .09
4th 13.938 7.125 .18
2001 - CLASS A
1st 12.750 8.688 --
2nd 14.500 10.000 .10
3rd 14.590 12.170 .10
4th 13.880 9.100 .20
2001 - CLASS B
1st 12.750 8.688 --
2nd 12.500 8.750 .09
3rd 13.100 11.010 .09
4th 11.750 9.000 .18
CORPORATE OFFICES
1195 River Road
P.O. Box 302
Marietta, Pennsylvania 17547-0302
(717) 426-1931
E-mail Address: info@donegalgroup.com
Donegal Web Site: www.donegalgroup.com
TRANSFER AGENT
EquiServe Trust Company, N.A.
P.O. Box 2500
Jersey City, New Jersey 07303-2500
(800) 317-4445
Web Site: www.equiserve.com
Hearing Impaired: TDD: 201-222-4955
DIVIDEND REINVESTMENT PLAN
The Company offers a dividend reinvestment plan through its transfer agent.
For information contact:
Donegal Group Inc. Dividend Reinvestment Plan
EquiServe Trust Company, N.A.
P.O. Box 2500
Jersey City, New Jersey 07303-2500
STOCKHOLDERS
The following represent the number of common stockholders of record as of
December 31, 2001:
Class A common stock 586
Class B common stock 532
32