DONEGAL GROUP
2013
ANNUAL
REPORT
Our long-range strategy for growth and success
Financial Highlights
YEAR ENDED DECEMBER 31,
2013
2012
2011
2010
2009
INCOME STATEMENT DATA
Premiums earned
Investment income, net
Realized investment gains
Total revenues
$ 515,291,944
$ 475,002,222
$ 431,470,184
$ 378,030,129
$ 355,025,477
18,795,239
20,168,919
20,858,179
19,949,714
20,630,583
2,423,442
6,859,439
12,281,267
4,395,720
4,479,558
547,110,065
514,982,585
475,017,619
408,549,446
386,733,407
Income (loss) before income taxes (benefit)
32,710,265
27,858,260
(6,739,313)
9,844,149
20,676,689
Income taxes (benefit)
Net income
6,388,273
4,765,640
(7,192,266)
26,321,992
23,092,620
452,953
(1,623,030)
11,467,179
1,846,611
18,830,078
Basic earnings per share - Class A
Diluted earnings per share - Class A
Cash dividends per share - Class A
Basic earnings per share - Class B
Diluted earnings per share - Class B
Cash dividends per share - Class B
BALANCE SHEET DA TA AT YEAR END
Total investments
Total assets
Debt obligations
Stockholders’ equity
Book value per share
1.04
1.02
0.51
0.94
0.94
0.46
0.92
0.91
0.49
0.83
0.83
0.44
0.02
0.02
0.48
0.01
0.01
0.43
.46
.46
.46
.41
.41
.41
.76
.76
.45
.68
.68
.40
$ 791,808,307
$ 806,429,032
$ 785,308,991
$ 728,541,814
$ 666,835,186
1,385,410,502
1,336,889,187
1,290,793,478
1,174,619,523
935,601,927
63,000,000
72,465,000
74,965,000
56,082,371
15,465,000
396,877,111
400,034,094
383,451,592
380,102,810
385,505,699
15.02
15.63
15.01
14.86
15.12
TOTAL REVENUES
[ i[ i[[ n mn mmn millillionions ]s ]
NET INCOME
ionionionioions ]s ]s ]]]
[ i[ i[ ii[ n mn mmn mn millillllili
STOCKHOLDERS’ EQUITY
[ i[ i[ in mn mn millillillionionions ]s ]s ]
$ 550
$ 500
$ 450
$ 400
$ 30
$ 20
$ 10
$ 400
$ 350
$ 300
$ 250
$ 350
090909099
1010100010
111111111
12121212
1313
$ 0
099
10100
111111111111111111111111111111111111111111111111111
1212
1313
$ 200
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1313
2013
ANNUAL
REPORT
DONEGAL GROUP
Donegal Group Inc. is an insurance holding company
that offers property and casualty insurance through its
wholly owned insurance subsidiaries and through a pooling
agreement with Donegal Mutual Insurance Company. The insur-
ance operations, rated A (Excellent) by A.M. Best Company, market
full lines of personal and commercial insurance products through a
network of independent insurance agencies in 22 states.
As an effective acquirer of small to medium-sized “main street” property and casualty
insurers, Donegal Group has grown profitably for more than two decades. As reported
by Forbes, Donegal Group was named to a list of 100 Most Trustworthy Companies for 2013
and 2012, ranking the company among firms that have consistently demonstrated transparent
and conservative accounting practices and solid corporate governance and management.
Donegal Group employs a multi-faceted strategy that includes prudent organic and
acquisition growth, conservative underwriting, pricing discipline, superior tech-
nological capabilities, efficient operations and conservative investing. This
strategy is designed to allow Donegal Group to achieve its long-standing
goal to outperform the property and casualty insurance industry in
terms of service, profitability and book value growth. Achiev-
ing that goal provides value to its insurance subsidiaries’
policyholders and to its stockholders.
Our long-range strategy for growth and success
1
To Our Stockholders
Since our inception in 1986, Donegal Group has followed a consistent business
strategy with a steady focus on our long-term objectives of prudent premium growth,
2013
underwriting profitability and book value growth.
MILESTONES
6.2
PERCENT
TOTAL
REVENUES
14.0
PERCENT
NET
INCOME
We compete for quality property and casualty insurance business within
an industry that continues to face external and internal challenges. Those
global challenges include a continuing low interest rate environment that has
constricted investment returns and excess capital levels that have contributed
to a competitive premium rate environment in most lines of business.
In light of the continuing challenges our industry faces, we were pleased
to achieve several significant milestones in 2013. Our total revenues for 2013
increased 6.2 percent to $547.1 million, compared to $515.0 million for
2012. We achieved 2013 net income of $26.3 million, or $1.02 per share of
our Class A common stock on a diluted basis, compared to $23.1 million,
or $.91 per share of our Class A common stock on a diluted basis, for 2012.
Our net income for 2013 represented our highest level of annual earnings
in the past five years, an accomplishment that reflects our substantial
efforts to enhance our profitability over that time period.
We continue to expand our product offerings, leverage existing agency relationships and
appoint additional commercially-focused agents.
8.5
PERCENT
14.1
PERCENT
NET PREMIUMS
EARNED
COMMERCIAL
PREMIUMS
Our net premiums earned increased by a healthy 8.5 percent, representing
a combination of solid organic growth in our commercial lines of insurance
and the benefits of the premium rate increases we have implemented
in the past two years.
Our strategic efforts led to a 14.1 percent increase in net premiums written
within our commercial insurance segment in 2013. We achieved this organic
growth through a combination of renewal premium increases and new com-
mercial lines accounts throughout our operating regions. We will continue
to seek to strengthen our relationships with our independent agents by
providing excellent service, competitive compensation and state-of-the-art
technology to facilitate efficient communications with them.
2
DONEGAL GROUP
We also continue to pursue acquisitions as a core element of our forward strategy,
searching for suitable acquisitions and affiliations to build on the ten transactions we
have completed over the past 25 years.
Our 2013 premium growth reflected continuing benefits from our December
2010 acquisition of Michigan Insurance Company. At the time of our acquisi-
tion, Michigan reinsured 50 percent of its premiums through a quota-share
reinsurance agreement with third parties. Since our acquisition, Michigan
has gradually reduced the amount of its premiums it reinsures as we have
integrated Michigan into our operations. For 2012 and 2013, Michigan
reduced its external reinsurance to 40 percent and 30 percent, respectively.
For 2014, Michigan has reduced further the level of its external quota-share
reinsurance from 30 percent to 20 percent, which we estimate will add
another $10 million to our net premiums written, not counting any growth
from new business or rate increases. This strategy has continued to provide
us acquisition-driven premium growth over a multi-year time horizon.
$10
MILLION
ESTIMATED
ACQUISITION
NET PREMIUM
INCREASE
IN 2014
Increased premium revenue from strategic growth initiatives and higher premium rates
was a key component of our improved underwriting results.
Our statutory combined ratio for 2013 improved to 97.4 percent, comparing
favorably to our statutory combined ratio of 99.8 percent for 2012 and A.M.
Best Company’s projected industry statutory combined ratio of 97.6 percent
for 2013. Fewer weather losses and a lower frequency of casualty losses
also contributed to the improvement in our underwriting profitability.
97.4
PERCENT
STATUTORY
COMBINED RATIO
We continue to view underwriting profitability as our primary revenue source, but we
also strive to supplement that income with stable investment income.
As a result of increases in market interest rates during 2013, we experienced
a decrease in the market value of our fixed-maturity investment portfolio.
That decrease led to a modest decrease in our book value to $15.02 per
share of our common stock at December 31, 2013, compared to
$15.63 at December 31, 2012.
2013
ANNUAL
REPORT
3
Our affiliation with Donegal Mutual Insurance Company provides our insurance subsidiaries
2013
access to state-of-the-art technology tools.
MILESTONES
These technology tools allow our insurance subsidiaries to improve operational
efficiency and to provide excellent service to their agents and customers.
During 2013, we fully integrated Michigan Insurance Company’s systems into
those of Donegal Mutual. This integration reduced Michigan’s operating costs
and enhanced its service levels to agents and customers. We also introduced
a new mobile application during 2013 that allows our insurance subsidiaries’
customers to access their policy information, pay their premiums and report
claims from their mobile phones. During 2014, Donegal Mutual has begun
to develop a new policy billing system and a new personal lines rating system
that will replace its legacy systems and significantly enhance our combined
insurance operations when fully implemented.
CUSTOMER
MOBILE APP
We reaffirm our long-held belief that substantial opportunity exists for a well-capitalized
regional insurance group with a solid business strategy to grow profitably and compete
effectively with national property and casualty insurance companies.
OUR
LONG-RANGE
STRATEGY
We remain focused on expanding our insurance operations within our
regional insurance markets. We believe we can continue to excel as a regional
provider of quality property and casualty insurance products. We believe we
have established a successful track record of growth and profitability, and we
remain committed to achieving our long-standing goals to outperform the
property and casualty insurance industry in terms of service, profitability
and book value growth.
We are executing our long-range strategy for growth and success that we
believe will enhance the value of our stockholders’ investment. We appreciate
your confidence as we manage operations to achieve our long-term objectives.
Donald H. Nikolaus
PRESIDENT
4
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2013
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________________ to _________________
Commission file number 0-15341
DONEGAL GROUP INC.
(Exact name of registrant as specified in its charter)
Delaware
(State or other jurisdiction of
incorporation or organization)
1195 River Road, Marietta, Pennsylvania
(Address of principal executive offices)
23-2424711
(I.R.S. Employer
Identification No.)
17547
(Zip code)
Securities registered pursuant to Section 12(b) of the Act:
Registrant’s telephone number, including area code: (888) 877-0600
Title of Each Class
Name of Each Exchange on Which Registered
Class A Common Stock, $.01 par value
The NASDAQ Global Select Market
Class B Common Stock, $.01 par value
The NASDAQ Global Select Market
Securities registered pursuant to Section 12(g) of the Act: None.
Indicate by check mark whether the registrant is a well-known seasoned issuer as defined in Rule 405 of the Securities Act: Yes
. No
.
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act. Yes
. No
.
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes
. No
.
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File
required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files). Yes
. No
.
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant’s knowledge, in definitive proxy or information statements we incorporate by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.
See definition of “large accelerated filer,” “accelerated filer” or “smaller reporting company” in Rule 12b-2 of the Exchange Act (check one):
Large accelerated filer
Accelerated filer
Non-accelerated filer
(Do not check if a smaller reporting company)
Smaller reporting company
Indicate by check mark whether the registrant is a shell company. Yes
. No
.
State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the
common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently
completed second fiscal quarter. $191,025,187.
Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date: 20,870,231 shares of
Class A common stock and 5,576,775 shares of Class B common stock outstanding on March 1, 2014.
The registrant incorporates by reference portions of the registrant’s definitive proxy statement relating to registrant’s annual meeting of
stockholders to be held April 17, 2014 into Part III of this report.
Documents Incorporated by Reference
DONEGAL GROUP INC.
INDEX TO FORM 10-K REPORT
PART I
Item 1.
Business
Item 1A. Risk Factors
Item 1B. Unresolved Staff Comments
Item 2.
Item 3.
Item 4.
Properties
Legal Proceedings
Reserved
Executive Officers of the Company
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity
Securities
Item 6.
Selected Financial Data
Item 7. Management’s Discussion and Analysis of Results of Operations and Financial Condition
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Item 8.
Item 9.
Financial Statements and Supplementary Data
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9A. Controls and Procedures
Item 9B. Other Information
PART III
Item 10. Directors, Executive Officers and Corporate Governance of the Registrant
Item 11. Executive Compensation
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item 13. Certain Relationships and Related Transactions and Director Independence
Item 14.
Principal Accountant Fees and Services
PART IV
Item 15. Exhibits and Financial Statement Schedules
Page
1
22
33
33
33
33
34
35
38
39
54
56
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92
92
94
94
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(i)
[THIS PAGE INTENTIONALLY LEFT BLANK]
Item 1. Business.
Introduction
PART I
Donegal Group Inc., or DGI, is an insurance holding company whose insurance subsidiaries offer personal and commercial
lines of property and casualty insurance to businesses and individuals in 22 Mid-Atlantic, Midwestern, New England and
Southern states. As used herein, the terms “we,” “us” and “our” refer to Donegal Group Inc. and its subsidiaries.
Donegal Mutual Insurance Company, or Donegal Mutual, organized us as an insurance holding company on August 26,
1986. At December 31, 2013, Donegal Mutual held approximately 37% of our outstanding Class A common stock and
approximately 76% of our outstanding Class B common stock. This ownership provides Donegal Mutual with approximately
65% of the aggregate voting power of our outstanding shares of Class A common stock and our outstanding shares of Class B
common stock. Our insurance subsidiaries and Donegal Mutual have interrelated operations due to a pooling agreement and
other intercompany agreements and transactions we describe in Note 3 of the Notes to Consolidated Financial Statements.
While maintaining the separate corporate existence of each company, our insurance subsidiaries and Donegal Mutual conduct
business together as the Donegal Insurance Group. As such, Donegal Mutual and our insurance subsidiaries share the same
business philosophy, the same management, the same employees and the same facilities and offer the same types of insurance
products.
We have been an effective consolidator of smaller “main street” property and casualty insurance companies, and we expect
to continue to acquire other insurance companies to expand our business in a given region or to commence operations in a new
region. Since 1995, we have completed six acquisitions of property and casualty insurance companies or began to participate in
their business through Donegal Mutual's entry into quota-share reinsurance agreements with them.
Our insurance subsidiaries and Donegal Mutual provide their policyholders with a selection of insurance products at
competitive rates, while pursuing profitability by adhering to a strict underwriting discipline. Our insurance subsidiaries derive
a substantial portion of their insurance business from smaller to mid-sized regional communities. We believe this focus
provides our insurance subsidiaries with competitive advantages in terms of local market knowledge, marketing, underwriting,
claims servicing and policyholder service. At the same time, we believe our insurance subsidiaries have cost advantages over
many smaller regional insurers that result from economies of scale they realize through centralized accounting, administrative,
data processing, investment and other services.
We believe we have a substantial opportunity, as a well-capitalized regional insurance holding company with a solid
business strategy, to grow profitably and compete effectively with national property and casualty insurers. Our downstream
holding company structure, with Donegal Mutual holding approximately 65% of the aggregate voting power of our common
stock, has proven its effectiveness and success over the past 28 years of our existence. Over that time frame, we have grown
significantly in terms of revenue and financial strength, and the Donegal Insurance Group has developed an excellent
reputation as a regional group of property and casualty insurers.
We own 48.2% of Donegal Financial Services Corporation, or DFSC. DFSC is a grandfathered unitary savings and loan
holding company that owns all of the outstanding capital stock of Union Community Bank, a state savings bank, or UCB. UCB
has 13 banking offices, all of which are located in Lancaster County, Pennsylvania. Donegal Mutual owns the remaining 51.8%
of DFSC. For further information regarding DFSC, we refer to "Business - Donegal Financial Services Corporation" in this
Form 10-K Annual Report.
We have four segments: our investment function, our personal lines of insurance, our commercial lines of insurance and our
investment in DFSC. We set forth financial information about these segments in Note 19 of the Notes to Consolidated Financial
Statements. The personal lines products of our insurance subsidiaries consist primarily of homeowners and private passenger
automobile policies. The commercial lines products of our insurance subsidiaries consist primarily of commercial automobile,
commercial multi-peril and workers' compensation policies.
Available Information
You may obtain our Annual Reports on Form 10-K, including this Form 10-K Annual Report, our quarterly reports on
Form 10-Q, our current reports on Form 8-K, our proxy statement and our other filings pursuant to the Securities Exchange Act
of 1934, or the Exchange Act, without charge by viewing our website at www.donegalgroup.com. You may also view our Code
of Business Conduct and Ethics and the charters of our executive committee, our audit committee, our compensation committee
-1-
and our nominating committee on our website. Upon request to our corporate secretary, we will also provide printed copies of
any of these documents to you without charge. We have provided the address of our website solely for the information of
investors. We do not intend the reference to our website address to be an active link or to otherwise incorporate the contents of
our website into this Form 10-K Annual Report.
History and Organizational Structure
In the mid-1980's, Donegal Mutual recognized the desirability, as a mutual insurance company, of developing additional
sources of capital and surplus so it could remain competitive and have the surplus to expand its business and ensure its long-
term viability. Donegal Mutual determined to implement a downstream holding company structure as one of its business
strategies. Accordingly, in 1986, Donegal Mutual formed us as a downstream holding company. Initially, Donegal Mutual
owned all of our outstanding common stock. After Donegal Mutual formed us, we in turn formed Atlantic States as our wholly
owned property and casualty insurance company subsidiary.
In connection with the establishment of Atlantic States and our downstream insurance holding company system, Donegal
Mutual and DGI entered into a proportional reinsurance agreement, or pooling agreement, that became effective October 1,
1986. Under the pooling agreement, Donegal Mutual and Atlantic States pool substantially all of their respective premiums,
losses and loss expenses to the reinsurance pool, and the reinsurance pool, acting through Donegal Mutual, then cedes a portion
of the pooled business, currently 80%, to our subsidiary, Atlantic States. Since we established Atlantic States in 1986, Donegal
Mutual and our insurance subsidiaries have conducted business together as the Donegal Insurance Group, while retaining their
separate legal and corporate existences. Donegal Mutual and Atlantic States share the underwriting results in proportion to
their respective participation in the underwriting pool. As the Donegal Insurance Group, Donegal Mutual and our insurance
subsidiaries share a combined business plan to enhance market penetration and underwriting profitability objectives. As such,
Donegal Mutual and our insurance subsidiaries share the same business philosophies, the same management, the same
employees and the same facilities and offer the same types of insurance products. We believe Donegal Mutual's majority
interest in the combined voting power of our Class A common stock and of our Class B common stock fosters our ability to
implement our business philosophies, enjoy management continuity, maintain superior employee relations and provide a stable
environment within which we can grow our businesses.
The products Donegal Mutual and our insurance subsidiaries offer are generally complementary, which permits the
Donegal Insurance Group to offer a broad range of products in a given market and to expand the Donegal Insurance Group's
ability to service an entire personal lines or commercial lines account. Distinctions within the products Donegal Mutual and
our insurance subsidiaries offer generally relate to specific risk profiles within similar classes of business, such as preferred tier
products versus standard tier products. Donegal Mutual and we do not allocate all of the standard risk gradients to one
company. As a result, the underwriting profitability of the business the individual companies write directly will vary.
However, the underwriting pool homogenizes the risk characteristics of all business Donegal Mutual and Atlantic States write
directly. We receive 80% of the results of the underwriting pool because Atlantic States has an 80% participation in the pool.
The business Atlantic States derives from the underwriting pool represents a significant percentage of our total consolidated
revenues. However, that percentage has gradually decreased over the past few years as we have acquired a number of other
property and casualty insurance companies in other jurisdictions that do not participate in the underwriting pool.
As the capital of Atlantic States and our other insurance subsidiaries has increased, the underwriting capacity of our
insurance subsidiaries, including Atlantic States, has proportionately increased. The size of the underwriting pool has increased
substantially. Therefore, as we originally planned in the mid-1980s, Atlantic States has successfully raised the capital necessary
to support the growth of its direct business as well as to accept increases in its allocation of business from the underwriting
pool. In addition, the portion of the underwriting pool allocated to Atlantic States has increased from an initial allocation of
35% in 1986 to an 80% allocation since March 1, 2008. We do not anticipate any further change in the pooling agreement
between Atlantic States and Donegal Mutual in the foreseeable future, including any change in the percentage participation of
Atlantic States in the underwriting pool.
In addition to Atlantic States, our insurance subsidiaries include Southern Insurance Company of Virginia, or Southern, Le
Mars Insurance Company, or Le Mars, The Peninsula Insurance Company and its wholly owned subsidiary, Peninsula
Indemnity Company, or collectively, Peninsula, Sheboygan Falls Insurance Company, or Sheboygan, and Michigan Insurance
Company, or MICO. We also benefit from Donegal Mutual’s 100% quota-share reinsurance agreement with Southern Mutual
Insurance Company, or Southern Mutual, and Donegal Mutual’s placement of its assumed business from Southern Mutual into
the pooling agreement.
-2-
The following chart depicts our organizational structure. The chart depicts all of our property and casualty insurance
subsidiaries, Southern Mutual and our interest in DFSC:
Because of the different relative voting power of our Class A common stock and Class B common stock, our public stockholders
(1)
hold approximately 34.6% of the aggregate voting power of our Class A common stock and Class B common stock and Donegal Mutual
holds approximately 65.4% of the aggregate voting power of our Class A common stock and Class B common stock.
Relationship with Donegal Mutual
Donegal Mutual provides facilities, personnel and other services to us and our insurance subsidiaries. Donegal Mutual
allocates certain related expenses to Atlantic States in relation to the relative participation of Donegal Mutual and Atlantic
States in the underwriting pool. Our insurance subsidiaries other than Atlantic States reimburse Donegal Mutual for their
respective personnel costs and bear their proportionate share of information services costs based on their respective percentage
of the total written premiums of the Donegal Insurance Group. Charges for these services totaled $94.0 million, $78.8 million
and $64.7 million for 2013, 2012 and 2011, respectively.
Our insurance subsidiaries have various reinsurance arrangements with Donegal Mutual. These agreements include:
•
•
•
•
•
excess of loss reinsurance agreements with Le Mars, Peninsula, Sheboygan and Southern;
catastrophe reinsurance agreements with Atlantic States, Le Mars and Southern;
a quota-share reinsurance agreement with Le Mars;
a quota-share reinsurance agreement with Peninsula; and
a quota-share reinsurance agreement with MICO.
The purpose of the excess of loss and catastrophe reinsurance agreements is to lessen the effects of a single large loss, or
an accumulation of smaller losses arising from one event, to levels that are appropriate given each subsidiary's size,
underwriting profile and surplus position.
The purpose of the quota-share reinsurance agreement with Le Mars is to transfer to Le Mars 100% of the premiums and
losses related to certain products Donegal Mutual offers in certain Midwest states, which provide the availability of
complementary products to Le Mars' commercial accounts.
The purpose of the quota-share reinsurance agreement with Peninsula is to transfer to Donegal Mutual 100% of the
premiums and losses related to the workers' compensation product line of Peninsula in certain states, which provides the
-3-
availability of an additional workers' compensation tier to Donegal Mutual's commercial accounts. Donegal Mutual places its
assumed business from Peninsula into the underwriting pool.
The purpose of the quota-share reinsurance agreement with MICO is to transfer to Donegal Mutual 25% of the premiums
and losses related to MICO's business. Donegal Mutual places its assumed business from MICO into the underwriting pool.
Effective November 1, 2012, Donegal Mutual and Southern terminated their quota-share reinsurance agreement on a run-
off basis. The intent of the quota-share reinsurance agreement with Southern was to transfer to Southern 100% of the premiums
and losses related to certain personal lines products Donegal Mutual offered in Virginia through the use of its automated policy
quoting and issuance system.
We and Donegal Mutual have maintained a coordinating committee since our formation in 1986. The coordinating
committee consists of two members of our board of directors, neither of whom is a member of Donegal Mutual’s board of
directors, and two members of Donegal Mutual’s board of directors, neither of whom is a member of our board of directors.
The purpose of the coordinating committee is to establish and maintain a process for an annual evaluation of the transactions
between Donegal Mutual, our insurance subsidiaries and us. The coordinating committee considers the fairness of each
intercompany transaction to Donegal Mutual and its policyholders and to us and our stockholders.
A new agreement or any change to a previously approved agreement must receive coordinating committee approval. The
coordinating committee approval process for a new agreement between Donegal Mutual and us or one of our insurance
subsidiaries or a change in such an agreement is as follows:
•
•
•
•
both of our members on the coordinating committee must determine that the new agreement or the change in an
existing agreement is fair and equitable to us and in the best interests of our stockholders;
both of Donegal Mutual’s members on the coordinating committee must determine that the new agreement or the
change in an existing agreement is fair and equitable to Donegal Mutual and in the best interests of its policyholders;
the new agreement or the change in an existing agreement must be approved by our board of directors; and
the new agreement or the change in an existing agreement must be approved by Donegal Mutual's board of directors.
The coordinating committee also meets annually to review each existing agreement between Donegal Mutual and us or our
insurance subsidiaries, including all reinsurance agreements between Donegal Mutual and our insurance subsidiaries. The
purpose of this annual review is to examine the results of the agreements over the past year and, in the case of reinsurance
agreements, over a five-year period and to determine if the results of the existing agreements remain fair and equitable to us
and our stockholders and fair and equitable to Donegal Mutual and its policyholders or if Donegal Mutual and we should
mutually agree to certain adjustments. In the case of these reinsurance agreements, the annual adjustments typically relate to
the reinsurance premiums, losses and reinstatement premiums. These agreements are ongoing in nature and will continue in
effect throughout 2014 in the ordinary course of business.
Our members on the coordinating committee, as of the date of this Form 10-K Annual Report, are Robert S. Bolinger and
John J. Lyons. Donegal Mutual’s members on the coordinating committee as of such date are Dennis J. Bixenman and John E.
Hiestand. We refer to our proxy statement for our annual meeting of stockholders on April 17, 2014 for further information
about the members of the coordinating committee.
We believe our relationships with Donegal Mutual offer us and our insurance subsidiaries a number of competitive
advantages, including the following:
•
•
•
enabling our stable management, the consistent underwriting discipline of our insurance subsidiaries, external growth,
long-term profitability and financial strength;
creating operational and expense synergies from the combination of resources and integrated operations of Donegal
Mutual and our insurance subsidiaries;
enhancing our opportunities to expand by acquisition because of the ability of Donegal Mutual to affiliate with and
acquire control of other mutual insurance companies and, thereafter, demutualize them and combine them with us;
-4-
•
•
•
producing more stable and uniform underwriting results for our insurance subsidiaries over extended periods of time
than we could achieve without our relationship with Donegal Mutual;
providing opportunities for growth because of the ability of Donegal Mutual to enter into reinsurance agreements with
other mutual insurance companies and place the business it assumes into the pooling agreement; and
providing Atlantic States with a significantly larger underwriting capacity because of the underwriting pool Donegal
Mutual and Atlantic States have maintained since 1986.
In the latter portion of the fourth quarter of 2013 and the first quarter of 2014, our board of directors and the board of
directors of Donegal Mutual each undertook a review of the relationships of Donegal Mutual and DGI and determined that
continuing the current relationships and the current corporate structure of Donegal Mutual and DGI is in the best interests of
DGI and its various constituencies.
Business Strategy
Our strategy is designed to allow our insurance subsidiaries to achieve their longstanding goal of outperforming the United
States property and casualty insurance industry in terms of profitability and service, thereby providing value to the
policyholders of our insurance subsidiaries and, ultimately, providing value to our stockholders. The annual net premiums
earned of our insurance subsidiaries have increased from $265.8 million in 2004 to $515.3 million in 2013, a compound annual
growth rate of 7.6%. Over the same time period, our insurance subsidiaries have generally achieved a statutory combined ratio
more favorable than that of the United States property and casualty insurance industry as a whole.
The combined ratio of our insurance subsidiaries and that of the United States property and casualty insurance industry as
computed using United States generally accepted accounting principles, or GAAP, and statutory accounting principles, or SAP,
for the years 2009 through 2013 are shown in the following table:
Our GAAP combined ratio (1)
Our SAP combined ratio
Industry SAP combined ratio (2)
2013
98.8%
97.4
97.6
2012
101.6%
99.8
102.2
2011
110.6%
107.9
106.7
2010
104.7%
102.9
101.2
2009
102.2%
101.1
99.5
(1) Our GAAP combined ratio for 2011 was adversely affected by accounting adjustments related to the acquisition of MICO.
(2) As reported or projected by A.M. Best Company.
We and Donegal Mutual believe we can continue to expand our insurance operations over time through organic growth and
acquisitions of, or affiliations with, other insurance companies. We and Donegal Mutual have enhanced the performance of
companies we have acquired, while leveraging the acquired companies' core strengths and local market knowledge to expand
their operations. Our insurance subsidiaries and Donegal Mutual also seek to increase their premium base by making quality
independent agency appointments, enhancing their competitive position within each agency, introducing new and enhanced
insurance products and developing and maintaining automated systems to improve service, communications and efficiency.
We translate these initiatives into our book value growth in a number of ways, including the following:
• maintaining a conservative underwriting culture and pricing discipline to sustain our record of underwriting
profitability;
•
continuing our investment in technology to achieve operating efficiencies that lower expenses, enhance the service we
provide to agencies and policyholders and increase the speed of our communications with agencies and policyholders;
and
• maintaining a conservative investment approach.
-5-
A detailed review of our business strategies follows:
• Achieving underwriting profitability.
Our insurance subsidiaries focus on achieving a combined ratio of less than 100%. Our insurance subsidiaries achieved that
objective in 2013, and we remain committed to achieving consistent underwriting profitability. We believe that underwriting
profitability is a fundamental component of our long-term financial strength because it allows our insurance subsidiaries to
generate profits without relying exclusively on their investment income. Our insurance subsidiaries seek to enhance their
underwriting results by:
•
•
carefully selecting the product lines they underwrite;
carefully selecting the individual risks they underwrite;
• minimizing their individual exposure to catastrophe-prone areas; and
•
evaluating their claims history on a regular basis to ensure the adequacy of their underwriting guidelines and
product pricing.
Our insurance subsidiaries have no material exposures to asbestos and environmental liabilities. Our insurance subsidiaries
seek to provide more than one policy to a given personal lines or commercial lines customer because this “account selling”
strategy diversifies their risk and has historically improved their underwriting results. Our insurance subsidiaries also use
reinsurance to manage their exposure and limit their maximum net loss from large single risks or risks in concentrated areas.
Our insurance subsidiaries believe these practices are key factors in their ability to maintain a statutory combined ratio that has
generally been more favorable than the combined ratio of the United States property and casualty insurance industry.
• Pursuing profitable growth by organic expansion within the traditional operating territories of our insurance
subsidiaries through developing and maintaining quality agency representation.
We believe that continued expansion of our insurance subsidiaries within their existing markets will be a key source of their
continued premium growth and that maintaining an effective and growing network of independent agencies is integral to their
expansion. Our insurance subsidiaries seek to be among the top three insurers within each of the independent agencies for the
lines of business our insurance subsidiaries write by providing a consistent, competitive and stable market for their products.
We believe that the consistency of their product offerings enables our insurance subsidiaries to compete effectively for agents
with other insurers whose product offerings fluctuate based on industry conditions. Our insurance subsidiaries offer a
competitive compensation program to their independent agents that rewards them for producing profitable growth for our
insurance subsidiaries. Our insurance subsidiaries provide their independent agents with ongoing support to enable them to
better attract and service customers, including:
•
fully automated underwriting and policy issuance systems for both personal, commercial and farm lines of
insurance;
•
training programs;
• marketing support;
•
•
availability of a service center that provides comprehensive service for our personal lines policyholders; and
field visitations by marketing and underwriting personnel and senior management of our insurance subsidiaries.
Our insurance subsidiaries appoint independent agencies with a strong underwriting and growth track record. We believe
that our insurance subsidiaries, by carefully selecting, motivating and supporting their independent agencies, will drive
continued long-term growth.
-6-
• Acquiring property and casualty insurance companies to augment the organic growth of our insurance subsidiaries
in existing markets and to expand into new geographic regions.
We have been an effective consolidator of smaller “main street” property and casualty insurance companies, and we expect
to continue to acquire other insurance companies to expand our business in a given region or to commence operations in a new
region.
Since 1995, we have completed six acquisitions of property and casualty insurance companies or participated in their
business through Donegal Mutual's entry into quota-share reinsurance agreements with them. We intend to continue our growth
by pursuing affiliations and acquisitions that meet our criteria. Our primary criteria are:
•
•
•
•
location in regions where our insurance subsidiaries are currently conducting business or that offer an attractive
opportunity to conduct profitable business;
a mix of business similar to the mix of business of our insurance subsidiaries;
premium volume up to $100.0 million; and
fair and reasonable transaction terms.
We believe that our interrelationship with Donegal Mutual assists us in pursuing affiliations with, and subsequent
acquisitions of, mutual insurance companies because, through Donegal Mutual, we understand the concerns and issues that
mutual insurance companies face. In particular, Donegal Mutual has had success affiliating with underperforming mutual
insurance companies, and we have either acquired them following their conversion to a stock company or benefited from their
underwriting results as a result of Donegal Mutual's entry into a 100% quota-share reinsurance agreement with them and
placement of its assumed business into the pooling agreement. We have utilized our strengths and financial position to improve
the operations of those underperforming insurance companies significantly. We evaluate a number of areas for operational
synergies when considering acquisitions, including product underwriting, expenses, the cost of reinsurance and technology.
We and Donegal Mutual have the ability to employ a number of acquisition and affiliation methods. Our prior acquisitions
and affiliations have taken one of the following forms:
•
•
•
•
purchase of all of the outstanding stock of a stock insurance company;
purchase of a book of business;
quota-share reinsurance transaction; or
two-step acquisition of a mutual insurance company in which:
•
•
as the first step, Donegal Mutual purchases a surplus note from the mutual insurance company, Donegal
Mutual enters into a services agreement with the mutual insurance company and Donegal Mutual’s
designees become a majority of the members of the board of directors of the mutual insurance company;
and
as the second step, the mutual insurance company enters into a quota-share reinsurance agreement with
Donegal Mutual or demutualizes, or converts, into a stock insurance company. Upon the demutualization
or conversion, we purchase the surplus note from Donegal Mutual and exchange it for all of the stock of
the stock insurance company resulting from the demutualization or conversion.
We believe that our ability to make direct acquisitions of stock insurance companies and to make indirect acquisitions of
mutual insurance companies through a sponsored conversion or a quota-share reinsurance agreement provides us with
flexibility that is a competitive advantage in making acquisitions. We also believe our historic record clearly demonstrates our
ability to acquire control of an underperforming insurance company, re-underwrite its book of business, reduce its cost structure
and return it to sustained profitability.
While Donegal Mutual and we generally engage in preliminary discussions with potential direct or indirect acquisition
candidates on an almost continuous basis and are so engaged at the date of this Form 10-K Report, neither Donegal Mutual nor
-7-
we make any public disclosure regarding a proposed acquisition until Donegal Mutual or we have entered into a definitive
acquisition agreement.
The following table highlights our history of insurance company acquisitions and affiliations since 1988:
Company Name
Southern Mutual Insurance
Company and now Southern
Insurance Company of Virginia
Pioneer Mutual Insurance
Company and then Pioneer
Insurance Company (1)(2)
State of Domicile
Virginia
Year Control
Acquired
1984
Ohio
1992
Delaware Mutual Insurance
Delaware
1993
Company and then Delaware
Atlantic Insurance Company (1)(2)
New York
1995
Pioneer Mutual Insurance
Company and then Pioneer
Insurance Company (1)(2)
Southern Heritage Insurance
Company (2)
Method of Acquisition/Affiliation
Surplus note investment by Donegal Mutual in 1984;
demutualization in 1988; acquisition of stock by us in
1988.
Surplus note investment by Donegal Mutual in 1992;
demutualization in 1993; acquisition of stock by us in
1997.
Surplus note investment by Donegal Mutual in 1993;
demutualization in 1994; acquisition of stock by us in
1995.
Surplus note investment by Donegal Mutual in 1995;
demutualization in 1998; acquisition of stock by us in
2001.
Georgia
1998
Purchase of stock by us in 1998.
Le Mars Mutual Insurance
Company of Iowa and now Le
Mars Insurance Company (1)
Iowa
Peninsula Insurance Group
Sheboygan Falls Mutual Insurance
Company and now Sheboygan
Falls Insurance Company (1)
Maryland
Wisconsin
Southern Mutual Insurance
Company (3)
Georgia
Michigan Insurance Company
Michigan
2002
2004
2007
2009
2010
Surplus note investment by Donegal Mutual in 2002;
demutualization in 2004; acquisition of stock by us in
2004.
Purchase of stock by us in 2004.
Contribution note investment by Donegal Mutual in
2007; demutualization in 2008; acquisition of stock
by us in 2008.
Surplus note investment by Donegal Mutual and
quota-share reinsurance in 2009.
Purchase of stock by us and surplus note investment
by Donegal Mutual in 2010.
(1) Each of these acquisitions initially took the form of an affiliation with Donegal Mutual. Donegal Mutual provided surplus note
financing to the insurance company, and, in connection therewith, sufficient designees of Donegal Mutual were appointed so as to
constitute a majority of the members of the board of directors of the insurance company. Donegal Mutual and the insurance
company simultaneously entered into a services agreement whereby Donegal Mutual provided services to improve the operations of
the insurance company. Once the insurance company's results of operations improved to the satisfaction of Donegal Mutual,
Donegal Mutual sponsored the demutualization of the insurance company. Upon the consummation of the demutualization,
Donegal Mutual converted the surplus note to capital stock of the newly demutualized insurance company. We then purchased all of
the capital stock of the insurance company from Donegal Mutual and made an additional capital contribution in cash to assure
compliance with minimum capital and surplus requirements and to provide adequate surplus to support the insurance company's
planned premium growth.
(2) To reduce administrative and compliance costs and expenses, these subsidiaries subsequently merged into one of our existing
insurance subsidiaries.
(3) Control acquired by Donegal Mutual.
• Providing responsive and friendly customer and agent service to enable our insurance subsidiaries to attract new
policyholders and retain existing policyholders.
We believe that excellent policyholder service is important in attracting new policyholders and retaining existing
policyholders. Our insurance subsidiaries work closely with their independent agents to provide a consistently responsive level
of claims service, underwriting and customer support. Our insurance subsidiaries seek to respond expeditiously and effectively
to address customer and independent agent inquiries in a number of ways, including:
-8-
•
•
•
•
availability of a customer call center for claims reporting;
availability of a secure website for access to policy information and documents, payment processing and other
features;
timely replies to information requests and policy submissions; and
prompt responses to and processing of claims.
Our insurance subsidiaries periodically conduct policyholder surveys to evaluate the effectiveness of their service to
policyholders. The management of our insurance subsidiaries meets on a regular basis with the personnel of the independent
insurance agents our insurance subsidiaries appoint to seek service improvement recommendations, react to service issues and
better understand local market conditions.
• Maintaining premium rate adequacy to enhance the underwriting results of our insurance subsidiaries, while
maintaining their existing book of business and preserving their ability to write new business.
Our insurance subsidiaries seek discipline in their pricing by effecting rate increases to maintain or improve their
underwriting profitability without unduly affecting their customer retention. In addition to appropriate pricing, our insurance
subsidiaries seek to ensure that their premium rates are adequate relative to the amount of risk they insure. Our insurance
subsidiaries review loss trends on a periodic basis to identify changes in the frequency and severity of their claims and to assess
the adequacy of their rates and underwriting standards. Our insurance subsidiaries also carefully monitor and audit the
information they use to price their policies for the purpose of enabling them to receive an adequate level of premiums for the
risk they assume. For example, our insurance subsidiaries inspect substantially all commercial lines risks and a substantial
number of personal lines property risks before they commit to insure them to determine the adequacy of the insured amount to
the value of the insured property, assess property conditions and identify any liability exposures. Our insurance subsidiaries
audit the payroll data of their workers’ compensation customers to verify that the assumptions used to price a particular policy
were accurate. By implementing appropriate rate increases and understanding the risks our insurance subsidiaries agree to
insure, they are generally able to achieve their strategy of achieving consistent underwriting profitability.
• Focusing on expense controls and utilization of technology to increase the operating efficiency of our insurance
subsidiaries.
Our insurance subsidiaries maintain stringent expense controls under direct supervision of their senior management. We
centralize many processing and administrative activities of our insurance subsidiaries to realize operating synergies and better
control expenses. Our insurance subsidiaries utilize technology to automate much of their underwriting and to facilitate agency
and policyholder communications on an efficient, timely and cost-effective basis. We operate on a paperless basis. As a result
of our focus on expense control, our insurance subsidiaries have reduced their expense ratio from 36.6% in 1999 to 31.8% in
2013. Our insurance subsidiaries have also increased their annual premium per employee, a measure of efficiency that our
insurance subsidiaries use to evaluate their operations, from approximately $470,000 in 1999 to approximately $915,000 in
2013.
Our insurance subsidiaries maintain technology comparable to that of the largest of their competitors. “Ease of doing
business” is an increasingly important component of an insurer’s value to an independent agency. Our insurance subsidiaries
provide a fully automated personal lines underwriting and policy issuance system called “WritePro®.” WritePro® is a web-
based user interface that substantially eases data entry and facilitates the quoting and issuance of policies for the independent
agents of our insurance subsidiaries. Our insurance subsidiaries also provide a similar commercial business system called
“WriteBiz®.” WriteBiz® is a web-based user interface that provides the independent agents of our insurance subsidiaries with
an online ability to quote and issue commercial automobile, workers’ compensation, business owners and tradesman policies
automatically. WriteFarm® is a web-based user interface that provides the independent agents of our insurance subsidiaries with
an online ability to quote and issue farm policies. As a result, applications of the independent agents for our insurance
subsidiaries can become policies without further re-entry of information. These systems also interface with the policy
management systems of the independent agents of our insurance subsidiaries.
• Maintaining a conservative investment approach.
Return on invested assets is an important element of the financial results of our insurance subsidiaries. The investment
strategy of our insurance subsidiaries is to generate an appropriate amount of after-tax income on invested assets while
minimizing credit risk through investments in high-quality securities. As a result, our insurance subsidiaries seek to invest a
-9-
high percentage of their assets in diversified, highly rated and marketable fixed-maturity instruments. The fixed-maturity
portfolios of our insurance subsidiaries consist of both taxable and tax-exempt securities. Our insurance subsidiaries maintain a
portion of their portfolios in short-term securities to provide liquidity for the payment of claims and operation of their
respective businesses. Our insurance subsidiaries maintain a negligible percentage (1.5% at December 31, 2013) of their
portfolios in equity securities.
Competition
The property and casualty insurance industry is highly competitive on the basis of both price and service. Numerous
companies compete for business in the geographic areas where our insurance subsidiaries operate. Many of these other
insurance companies are substantially larger and have greater financial resources than those of our insurance subsidiaries. In
addition, because our insurance subsidiaries and Donegal Mutual market their respective insurance products exclusively
through independent insurance agencies, most of which represent more than one insurance company, our insurance subsidiaries
face competition within agencies, as well as competition to retain qualified independent agents.
Products and Underwriting
We report the results of our insurance operations in two segments: personal lines of insurance and commercial lines of
insurance. The personal lines our insurance subsidiaries write consist primarily of private passenger automobile and
homeowners insurance. The commercial lines our insurance subsidiaries write consist primarily of commercial automobile,
commercial multi-peril and workers’ compensation insurance. We describe these lines of insurance in greater detail below:
Personal
•
Private passenger automobile — policies that provide protection against liability for bodily injury and property
damage arising from automobile accidents and protection against loss from damage to automobiles owned by the
insured.
• Homeowners — policies that provide coverage for damage to residences and their contents from a broad range of
perils, including fire, lightning, windstorm and theft. These policies also cover liability of the insured arising from
injury to other persons or their property while on the insured’s property and under other specified conditions.
Commercial
• Commercial automobile — policies that provide protection against liability for bodily injury and property damage
arising from automobile accidents and protection against loss from damage to automobiles owned by the insured.
• Commercial multi-peril — policies that provide protection to businesses against many perils, usually combining
liability and physical damage coverages.
• Workers’ compensation — policies employers purchase to provide benefits to employees for injuries sustained during
employment. The workers’ compensation laws of each state determine the extent of the coverage we provide.
-10-
The following table sets forth the net premiums written of our insurance subsidiaries by line of insurance for the periods
indicated:
(dollars in thousands)
Personal lines:
Automobile
Homeowners
Other
Total personal lines
Commercial lines:
Automobile
Workers’ compensation
Commercial multi-peril
Other
Total commercial lines
Total business
Year Ended December 31,
2013
2012
2011
Amount
%
Amount
%
Amount
%
$ 196,363
36.8% $ 195,132
39.3% $ 186,677
41.1%
106,420
15,915
318,698
58,165
77,589
74,516
4,463
214,733
20.0
3.0
59.8
10.9
14.5
14.0
0.8
40.2
97,120
16,319
308,571
51,261
65,390
64,476
6,749
187,876
19.6
3.3
62.2
10.3
13.2
13.0
1.3
37.8
89,405
14,983
291,065
46,168
51,849
57,988
6,981
162,986
19.7
3.3
64.1
10.2
11.4
12.8
1.5
35.9
$ 533,431
100.0% $ 496,447
100.0% $ 454,051
100.0%
The personal lines and commercial lines underwriting departments of our insurance subsidiaries evaluate and select those
risks that they believe will enable our insurance subsidiaries to achieve an underwriting profit. The underwriting departments
have significant interaction with the independent agents regarding the underwriting philosophy and the underwriting guidelines
of our insurance subsidiaries. Our underwriting personnel also assist the research and development department in the
development of quality products at competitive prices to promote growth and profitability.
In order to achieve underwriting profitability on a consistent basis, our insurance subsidiaries:
•
•
•
•
assess and select quality standard and preferred risks;
adhere to disciplined underwriting and re-underwriting guidelines;
inspect substantially all commercial lines risks and a substantial number of personal lines property risks; and
utilize various types of risk management and loss control services.
Our insurance subsidiaries also review their existing policies and accounts to determine whether those risks continue to
meet their underwriting guidelines. If a given policy or account no longer meets those underwriting guidelines, our insurance
subsidiaries will take appropriate action regarding that policy or account, including raising premium rates or non-renewing the
policy to the extent applicable law permits.
As part of the effort of our insurance subsidiaries to maintain acceptable underwriting results, they conduct annual reviews
of agencies that have failed to meet their underwriting profitability criteria. The review process includes an analysis of the
underwriting and re-underwriting practices of the agency, the completeness and accuracy of the applications the agency
submits, the adequacy of the training of the agency’s staff and the agency’s record of adherence to the underwriting guidelines
and service standards of our insurance subsidiaries. Based on the results of this review process, the marketing and underwriting
personnel of our insurance subsidiaries develop, together with the agency, a plan to improve its underwriting profitability. Our
insurance subsidiaries monitor the agency’s compliance with the plan and take other measures as required in the judgment of
our insurance subsidiaries, including the termination to the extent applicable law permits of agencies that are unable to achieve
acceptable underwriting profitability.
-11-
Distribution
Our insurance subsidiaries market their products primarily in the Mid-Atlantic, Midwestern, New England and Southern
regions through approximately 2,600 independent insurance agencies. At December 31, 2013, the Donegal Insurance Group
actively wrote business in 22 states (Alabama, Delaware, Georgia, Indiana, Iowa, Maine, Maryland, Michigan, Nebraska, New
Hampshire, New York, North Carolina, Ohio, Oklahoma, Pennsylvania, South Carolina, South Dakota, Tennessee, Vermont,
Virginia, West Virginia and Wisconsin). We believe the relationships of our insurance subsidiaries with their independent agents
are valuable in identifying, obtaining and retaining profitable business. Our insurance subsidiaries maintain a stringent agency
selection procedure that emphasizes appointing agencies with proven marketing strategies for the development of profitable
business, and our insurance subsidiaries only appoint agencies with a strong underwriting history and potential growth
capabilities. Our insurance subsidiaries also regularly evaluate the independent agencies that represent them based on their
profitability and performance in relation to the objectives of our insurance subsidiaries. Our insurance subsidiaries seek to be
among the top three insurers within each of their agencies for the lines of business they write.
The following table sets forth the percentage of direct premiums our insurance subsidiaries write, including 80% of the
direct premiums Donegal Mutual and Atlantic States write, in each of the states where they conducted a significant portion of
their business in 2013:
Pennsylvania
Michigan
Virginia
Maryland
Delaware
Georgia
Ohio
Wisconsin
Iowa
Tennessee
Nebraska
South Dakota
Ten other states
Total
37.3%
18.1
9.0
8.5
5.6
5.1
3.3
2.9
2.5
2.2
2.0
1.0
2.5
100.0%
Our insurance subsidiaries employ a number of policies and procedures that we believe enable them to attract, retain and
motivate their independent agents. The consistency, competitiveness and stability of the product offerings of our insurance
subsidiaries assist them in competing effectively for independent agents with other insurers whose product offerings may
fluctuate based upon industry conditions. Our insurance subsidiaries have a competitive profit-sharing plan for their
independent agents, consistent with applicable state laws and regulations, under which the independent agents may earn
additional commissions based upon the volume of premiums produced and the profitability of the business our insurance
subsidiaries receive from that agency.
Our insurance subsidiaries encourage their independent agents to focus on “account selling,” or serving all of a particular
insured’s property and casualty insurance needs, which our insurance subsidiaries believe generally results in more favorable
loss experience than covering a single risk for an individual insured.
Technology
Donegal Mutual owns the majority of the technology systems our insurance subsidiaries use. The technology systems
consist primarily of an integrated central processing computer system, a series of server-based computer networks and various
communication systems that allow the home office of our insurance subsidiaries and their branch offices to utilize the same
systems for the processing of business. Donegal Mutual maintains backup facilities and systems at the office of one of our
insurance subsidiaries and through a contract with a leading provider of computer disaster recovery sites and tests these backup
facilities and systems on a regular basis. Our insurance subsidiaries bear their proportionate share of information services
expenses based on their respective percentage of the total net written premiums of the Donegal Insurance Group.
-12-
The business strategy of our insurance subsidiaries depends on the use, development and implementation of integrated
technology systems. These systems enable our insurance subsidiaries to provide a high level of service to agents and
policyholders by processing business in a timely and efficient manner, communicating and sharing data with agents, providing
a variety of methods for the payment of premiums and allowing for the accumulation and analysis of information for the
management of our insurance subsidiaries.
We believe the availability and use of these technology systems has resulted in improved service to agents and
policyholders, increased efficiencies in processing the business of our insurance subsidiaries and lower operating costs. Key
components of these integrated technology systems are the agency interface system, the WritePro®, WriteBiz® and WriteFarm®
systems, a claims processing system and an imaging system. The agency interface system provides our insurance subsidiaries
with a high level of data sharing both to and from agents’ systems and also provides agents with an integrated means of
processing new business. The WritePro®, WriteBiz® and WriteFarm® systems are fully automated underwriting and policy
issuance systems that provide agents with the ability to generate underwritten quotes and automatically issue policies that meet
the underwriting guidelines of our insurance subsidiaries with limited or no intervention by their personnel. The claims
processing system allows our insurance subsidiaries to process claims efficiently and in an automated environment. The
imaging system eliminates the need to handle paper files, while providing greater access to the same information by a variety of
personnel. We believe our technology systems compare favorably to those of many national property and casualty insurance
carriers in terms of quality and service levels.
Claims
The management of claims is a critical component of the philosophy of our insurance subsidiaries to achieve underwriting
profitability on a consistent basis and is fundamental to the successful operations of our insurance subsidiaries and their
dedication to excellent service. Our senior claims management oversees the claims processing units of each of our insurance
subsidiaries to assure consistency in the claims settlement process. The field office staff of our insurance subsidiaries receives
support from home office technical, litigation, material damage, subrogation and medical audit personnel.
The claims departments of our insurance subsidiaries rigorously manage claims to assure that they settle legitimate claims
quickly and fairly and that they identify questionable claims for defense. In the majority of cases, the personnel of our
insurance subsidiaries, who have significant experience in the property and casualty insurance industry and know the service
philosophy of our insurance subsidiaries, adjust claims. Our insurance subsidiaries provide various means of claims reporting
on a 24-hours a day, seven-days a week basis, including toll-free numbers and electronic reporting through our website. Our
insurance subsidiaries strive to respond to notifications of claims promptly, generally within the day reported. Our insurance
subsidiaries believe that, by responding promptly to claims, they provide quality customer service and minimize the ultimate
cost of the claims. Our insurance subsidiaries engage independent adjusters as needed to handle claims in areas in which the
volume of claims is not sufficient to justify the hiring of internal claims adjusters by our insurance subsidiaries. Our insurance
subsidiaries also employ private adjusters and investigators, structural experts and various outside legal counsel to supplement
their internal staff and to assist in the investigation of claims. Our insurance subsidiaries have a special investigative unit
staffed by former law enforcement officers that attempts to identify and prevent fraud and abuse and to control questionable
claims.
The management of the claims departments of our insurance subsidiaries develops and implements policies and procedures
for the establishment of adequate claim reserves. Our insurance subsidiaries employ an actuarial staff that regularly reviews
their reserves for incurred but not reported claims. The management and staff of the claims departments resolve policy
coverage issues, manage and process reinsurance recoveries and handle salvage and subrogation matters. The litigation and
personal injury sections of our insurance subsidiaries manage all claims litigation. Branch office claims above certain
thresholds require home office review and settlement authorization. Our insurance subsidiaries provide their claims adjusters
reserving and settlement authority based upon their experience and demonstrated abilities. Larger or more complicated claims
require consultation and approval of senior department management.
Liabilities for Losses and Loss Expenses
Liabilities for losses and loss expenses are estimates at a given point in time of the amounts an insurer expects to pay with
respect to incurred policyholder claims based on facts and circumstances then known. At the time of establishing its estimates,
an insurer recognizes that its ultimate liability for losses and loss expenses will exceed or be less than such estimates. Our
insurance subsidiaries base their estimates of liabilities for losses and loss expenses on assumptions as to future loss trends and
expected claims severity, judicial theories of liability and other factors. However, during the loss adjustment period, our
insurance subsidiaries may learn additional facts regarding individual claims, and, consequently, it often becomes necessary for
our insurance subsidiaries to refine and adjust their estimates of liability. We reflect any adjustments to our insurance
-13-
subsidiaries’ liabilities for losses and loss expenses in our operating results in the period in which our insurance subsidiaries
record the changes in their estimates.
Our insurance subsidiaries maintain liabilities for the payment of losses and loss expenses with respect to both reported
and unreported claims. Our insurance subsidiaries establish these liabilities for the purpose of covering the ultimate costs of
settling all losses, including investigation and litigation costs. Our insurance subsidiaries base the amount of their liability for
reported losses primarily upon a case-by-case evaluation of the type of risk involved, knowledge of the circumstances
surrounding each claim and the insurance policy provisions relating to the type of loss their policyholder incurred. Our
insurance subsidiaries determine the amount of their liability for unreported claims and loss expenses on the basis of historical
information by line of insurance. Our insurance subsidiaries account for inflation in the reserving function through analysis of
costs and trends and reviews of historical reserving results. Our insurance subsidiaries closely monitor their liabilities and
recompute them periodically using new information on reported claims and a variety of statistical techniques. Our insurance
subsidiaries do not discount their liabilities for losses.
Reserve estimates can change over time because of unexpected changes in assumptions related to our insurance
subsidiaries’ external environment and, to a lesser extent, assumptions as to our insurance subsidiaries’ internal operations. For
example, our insurance subsidiaries have experienced a decrease in claims frequency on workers’ compensation claims during
the past several years while claims severity has gradually increased. These trend changes give rise to greater uncertainty as to
the pattern of future loss settlements on workers’ compensation claims. Related uncertainties regarding future trends include the
cost of medical technologies and procedures and changes in the utilization of medical procedures. Assumptions related to our
insurance subsidiaries’ external environment include the absence of significant changes in tort law and legal decisions that
increase liability exposure, consistency in judicial interpretations of insurance coverage and policy provisions and the rate of
loss cost inflation. Internal assumptions include consistency in the recording of premium and loss statistics, consistency in the
recording of claims, payment and case reserving methodology, accurate measurement of the impact of rate changes and
changes in policy provisions, consistency in the quality and characteristics of business written within a given line of business
and consistency in reinsurance coverage and the collectability of reinsured losses, among other items. To the extent our
insurance subsidiaries determine that underlying factors impacting their assumptions have changed, our insurance subsidiaries
attempt to make appropriate adjustments for such changes in their reserves. Accordingly, our insurance subsidiaries’ ultimate
liability for unpaid losses and loss expenses will likely differ from the amount recorded at December 31, 2013. For every 1%
change in our insurance subsidiaries’ loss and loss expense reserves, net of reinsurance recoverable, the effect on our pre-tax
results of operations would be approximately $2.7 million.
The establishment of appropriate liabilities is an inherently uncertain process, and we can provide no assurance that our
insurance subsidiaries’ ultimate liability will not exceed our insurance subsidiaries’ loss and loss expense reserves and have an
adverse effect on our results of operations and financial condition. Furthermore, we cannot predict the timing, frequency and
extent of adjustments to our insurance subsidiaries’ estimated future liabilities, since the historical conditions and events that
serve as a basis for our insurance subsidiaries’ estimates of ultimate claim costs may change. As is the case for substantially all
property and casualty insurance companies, our insurance subsidiaries have found it necessary in the past to increase their
estimated future liabilities for losses and loss expenses in certain periods, and, in other periods, their estimates have exceeded
their actual liabilities. Changes in our insurance subsidiaries’ estimate of their liability for losses and loss expenses generally
reflect actual payments and the evaluation of information received since the prior reporting date. Our insurance subsidiaries
recognized an increase (decrease) in their liability for losses and loss expenses of prior years of $10.4 million, $7.6 million and
($168,460) in 2013, 2012 and 2011, respectively. Our insurance subsidiaries made no significant changes in their reserving
philosophy, key reserving assumptions or claims management personnel, and have made no significant offsetting changes in
estimates that increased or decreased their loss and loss expense reserves in these years. The 2013 development represented
4.1% of the December 31, 2012 net carried reserves and resulted primarily from higher-than-expected severity in the private
passenger automobile liability, commercial multiple peril, commercial automobile and workers' compensation lines of business
in accident years prior to 2013. The majority of the 2013 development related to increases in the liability for losses and loss
expenses of prior years for Atlantic States and Southern. The 2012 development represented 3.1% of the December 31, 2011
net carried reserves and resulted primarily from higher-than-expected severity in the private passenger automobile liability and
workers' compensation lines of business in accident years prior to 2012. The majority of the 2012 development related to
increases in the liability for losses and loss expenses of prior years for Atlantic States and Southern. The 2011 development
represented an immaterial percentage of the December 31, 2010 net carried reserves.
Excluding the impact of catastrophic weather events, our insurance subsidiaries have noted stable amounts in the number
of claims incurred and slight downward trends in the number of claims outstanding at period ends relative to their premium
base in recent years across most of their lines of business. However, the amount of the average claim outstanding has increased
gradually over the past several years as the property and casualty insurance industry has experienced increased litigation trends
and economic conditions that have extended the estimated length of disabilities and contributed to increased medical loss costs
-14-
and a general slowing of settlement rates in litigated claims. Our insurance subsidiaries could be required to make further
adjustments to their estimates in the future. However, on the basis of our insurance subsidiaries’ internal procedures which
analyze, among other things, their prior assumptions, their experience with similar cases and historical trends such as reserving
patterns, loss payments, pending levels of unpaid claims and product mix, as well as court decisions, economic conditions and
public attitudes, we believe that our insurance subsidiaries have made adequate provision for their liability for losses and loss
expenses at December 31, 2013.
Differences between liabilities reported in our financial statements prepared on a GAAP basis and our insurance
subsidiaries’ financial statements prepared on a SAP basis result from anticipating salvage and subrogation recoveries for
GAAP but not for SAP. These differences amounted to $13.1 million, $12.0 million and $11.2 million at December 31, 2013,
2012 and 2011, respectively.
The following table sets forth a reconciliation of the beginning and ending GAAP net liability of our insurance subsidiaries
for unpaid losses and loss expenses for the periods indicated:
(in thousands)
Year Ended December 31,
2013
2012
2011
Gross liability for unpaid losses and loss expenses at beginning of year
$
458,827
$
442,408
$
Less reinsurance recoverable
Net liability for unpaid losses and loss expenses at beginning of year
Provision for net losses and loss expenses for claims incurred in the
current year
Change in provision for estimated net losses and loss expenses for claims
incurred in prior years
Total incurred
Net losses and loss payments for claims incurred during:
The current year
Prior years
Total paid
Net liability for unpaid losses and loss expenses at end of year
Plus reinsurance recoverable
207,891
250,936
199,393
243,015
10,358
343,128
201,782
126,677
328,459
265,605
230,014
7,596
332,872
205,876
119,074
324,950
250,936
207,891
Gross liability for unpaid losses and loss expenses at end of year
$
495,619
$
458,827
$
332,770
325,276
340,671
383,319
165,422
217,897
(168)
340,503
219,183
96,202
315,385
243,015
199,393
442,408
The following table sets forth the development of the liability for net unpaid losses and loss expenses of our insurance
subsidiaries from 2003 to 2013. Loss data in the table includes business Atlantic States received from the underwriting pool.
“Net liability at end of year for unpaid losses and loss expenses” sets forth the estimated liability for net unpaid losses and
loss expenses recorded at the balance sheet date for each of the indicated years. This liability represents the estimated amount
of net losses and loss expenses for claims arising in the current and all prior years that are unpaid at the balance sheet date,
including losses incurred but not reported.
The “Net liability re-estimated as of” portion of the table shows the re-estimated amount of the previously recorded
liability based on experience for each succeeding year. The estimate increases or decreases as payments are made and more
information becomes known about the severity of the remaining unpaid claims. For example, the 2005 liability has developed a
redundancy after eight years because we expect the re-estimated net losses and loss expenses to be $21.8 million less than the
estimated liability we initially established in 2005 of $173.0 million.
The “Cumulative (excess) deficiency” shows the cumulative excess or deficiency at December 31, 2013 of the liability
estimate shown on the top line of the corresponding column. An excess in liability means that the liability established in prior
years exceeded the amount of actual payments and currently re-estimated unpaid liability remaining. A deficiency in liability
means that the liability established in prior years was less than the amount of actual payments and currently re-estimated
remaining unpaid liability.
The “Cumulative amount of liability paid through” portion of the table shows the cumulative net losses and loss expense
payments made in succeeding years for net losses incurred prior to the balance sheet date. For example, the 2005 column
-15-
indicates that at December 31, 2013 payments equal to $146.9 million of the currently re-estimated ultimate liability for net
losses and loss expenses of $151.2 million had been made.
Amounts shown in the 2004 column of the table include information for Le Mars and Peninsula for all accident years prior
to 2004. Amounts shown in the 2008 column of the table include information for Sheboygan for all accident years prior to
2008. Amounts shown in the 2010 column of the table include information for MICO for the month of December 2010.
(in thousands)
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
Year Ended December 31,
Net liability at end of
year for unpaid
losses and loss
expenses
Net liability re-
estimated as of:
$138,896
$171,431
$173,009
$163,312
$150,152
$161,307
$180,262
$217,896
$243,015
$250,936
$265,605
One year later
136,434
162,049
159,393
153,299
152,836
171,130
177,377
217,728
250,611
261,294
Two years later
130,030
152,292
153,894
150,934
154,435
167,446
177,741
217,355
255,612
Three years later
123,399
148,612
151,792
150,078
152,315
166,756
178,403
218,449
Four years later
120,917
147,280
150,183
148,745
151,120
166,852
179,909
Five years later
119,968
145,874
150,087
148,407
151,287
166,788
Six years later
119,731
146,101
150,555
149,031
151,739
Seven years later
120,425
146,739
151,161
149,487
Eight years later
120,768
147,597
151,243
Nine years later
121,505
147,705
Ten years later
121,631
Cumulative (excess)
deficiency
Cumulative amount
of liability paid
through:
(17,265)
(23,726)
(21,766)
(13,825)
1,587
5,481
(353)
553
12,597
10,358
One year later
$ 51,965
$ 67,229
$ 71,718
$ 72,499
$ 71,950
$ 79,592
$ 84,565
$ 96,202
$119,074
$126,677
Two years later
Three years later
81,183
99,910
102,658
107,599
104,890
105,576
116,035
123,204
148,140
181,288
123,236
125,926
121,711
124,659
136,837
147,165
178,073
Four years later
109,964
133,844
133,805
132,698
135,392
148,243
161,363
Five years later
113,684
136,377
139,935
138,878
140,280
155,331
Six years later
114,499
139,847
143,309
141,752
143,778
Seven years later
116,727
142,016
145,492
143,784
Eight years later
118,169
143,894
146,894
Nine years later
119,123
144,565
Ten years later
119,509
2005
2006
2007
2008
2009
2010
2011
2012
2013
Year Ended December 31,
(in thousands)
$265,730
$259,022
$226,432
$239,809
$263,599
$383,317
$442,408
$458,827
$495,619
92,721
95,710
76,280
78,502
83,337
165,421
199,393
207,891
230,014
173,009
163,312
150,152
161,307
180,262
217,896
243,015
250,936
265,605
243,402
241,395
232,173
253,815
207,525
370,297
473,949
488,557
92,159
91,908
80,434
87,027
27,616
151,848
218,337
227,263
151,243
149,487
151,739
166,788
179,909
218,449
255,612
261,294
Gross liability at end
of year
Reinsurance
recoverable
Net liability at end of
year
Gross re-estimated
liability
re-estimated
recoverable
Net re-estimated
liability
Gross cumulative
deficiency
(excess)
(22,328)
(17,627)
5,741
14,006
(56,074)
(13,020)
31,542
29,730
-16-
Third-Party Reinsurance
Our insurance subsidiaries and Donegal Mutual purchase certain third-party reinsurance on a combined basis. Le Mars,
Peninsula, Sheboygan and MICO also have separate reinsurance programs that provide certain coverage that is commensurate
with their relative size and exposures. Our insurance subsidiaries use several different reinsurers, all of which, consistent with
the requirements of our insurance subsidiaries and Donegal Mutual, have an A.M. Best rating of A- (Excellent) or better or,
with respect to foreign reinsurers, have a financial condition that, in the opinion of our management, is equivalent to a company
with at least an A- (Excellent) rating from A.M. Best.
The external reinsurance our insurance subsidiaries and Donegal Mutual purchase includes:
•
•
“excess of loss reinsurance,” under which their losses are automatically reinsured, through a series of contracts, over a
set retention (generally $1,000,000 for 2013 and 2012 and $750,000 for 2011); and
catastrophe reinsurance, under which Donegal Mutual, Atlantic States and Southern recover, through a series of
reinsurance agreements, 100% of an accumulation of many losses resulting from a single event, including natural
disasters, over a set retention (generally $5.0 million) and after exceeding an annual aggregate deductible ($5.0 million
in 2013 and $0 in 2012 and 2011) up to aggregate losses of $145.0 million per occurrence.
The amount of coverage each of these types of reinsurance provides depends upon the amount, nature, size and location of
the risk being reinsured.
For property insurance, our insurance subsidiaries have excess of loss treaties that provide for coverage of $4.0 million per
loss over a set retention of $1.0 million. For liability insurance, our insurance subsidiaries have excess of loss treaties that
provide for coverage of $49.0 million per occurrence over a set retention of $1.0 million. For workers’ compensation insurance,
our insurance subsidiaries have excess of loss treaties that provide for coverage of $9.0 million on any one life over a set
retention of $1.0 million.
Our insurance subsidiaries and Donegal Mutual also purchase facultative reinsurance to cover exposures from property and
casualty losses that exceed the limits provided by their respective treaty reinsurance.
MICO maintains a quota-share reinsurance agreement with third-party reinsurers to reduce its net exposures. Effective
from December 1, 2010 to December 31, 2011, the quota-share reinsurance percentage was 50%. Effective January 1, 2012,
MICO reduced the quota-share reinsurance percentage from 50% to 40%. Effective January 1, 2013, MICO reduced the quota-
share reinsurance percentage from 40% to 30%. Effective January 1, 2014, MICO reduced the quota-share reinsurance
percentage from 30% to 20%.
Investments
At December 31, 2013, 100% of all debt securities our insurance subsidiaries held had an investment-grade rating. The
investment portfolios of our insurance subsidiaries did not contain any mortgage loans or any non-performing assets at
December 31, 2013.
The following table shows the composition of the debt securities (at carrying value) in the investment portfolios of our
insurance subsidiaries, excluding short-term investments, by rating at December 31, 2013:
(dollars in thousands)
(1)
Rating
U.S. Treasury and U.S. agency securities(2)
Aaa or AAA
Aa or AA
A
BBB
Total
December 31, 2013
Amount
Percent
$
202,494
31.4%
35,814
255,117
140,949
9,648
5.6
39.6
21.9
1.5
$
644,022
100.0%
(1) Ratings assigned by Moody’s Investors Services, Inc. or Standard & Poor’s Corporation.
(2) Includes mortgage-backed securities of $140.2 million.
-17-
Our insurance subsidiaries invest in both taxable and tax-exempt securities as part of their strategy to maximize after-tax
income. This strategy considers, among other factors, the alternative minimum tax. Tax-exempt securities made up
approximately 59.0%, 59.8% and 63.8% of the debt securities in the combined investment portfolios of our insurance
subsidiaries at December 31, 2013, 2012 and 2011, respectively.
The following table shows the classification of our investments and the investments of our insurance subsidiaries at
December 31, 2013, 2012 and 2011 (at carrying value):
2013
December 31,
2012
2011
Percent of
Percent of
Percent of
Amount
Total
Amount
Total
Amount
Total
(dollars in thousands)
Fixed maturities(1):
Held to maturity:
U.S. Treasury securities and obligations of
U.S. government corporations and agencies $
47,946
6.1% $
1,000
0.1% $
1,000
0.1%
Obligations of states and political subdivisions
108,435
Corporate securities
Mortgage-backed securities
Total held to maturity
Available for sale:
14,875
69,114
240,370
U.S. Treasury securities and obligations of
U.S. government corporations and agencies
14,334
Obligations of states and political subdivisions
277,547
Corporate securities
Mortgage-backed securities
Total available for sale
Total fixed maturities
Equity securities(2)
Investments in affiliates(3)
Short-term investments(4)
Total investments
13.7
1.9
8.7
30.4
1.8
35.1
5.1
8.9
50.9
81.3
1.6
4.5
12.6
40,909
—
191
42,100
71,311
416,987
77,356
128,856
694,510
736,610
8,757
37,236
23,826
5.1
—
—
5.2
8.8
51.7
9.6
16.0
86.1
91.3
1.1
4.6
3.0
56,966
250
274
58,490
60,978
398,877
64,113
122,630
646,598
705,088
7,438
32,322
40,461
7.3
—
—
7.4
7.8
50.8
8.2
15.6
82.4
89.8
1.0
4.1
5.1
40,672
71,099
403,652
644,022
12,423
35,685
99,678
$ 791,808
100.0% $ 806,429
100.0% $ 785,309
100.0%
(1) We refer to Notes 1 and 4 to our Consolidated Financial Statements. We value those fixed maturities we classify as held to maturity
at amortized cost; we value those fixed maturities we classify as available for sale at fair value. The total fair value of fixed
maturities we classified as held to maturity was $238.8 million at December 31, 2013, $43.7 million at December 31, 2012 and
$61.4 million at December 31, 2011. The amortized cost of fixed maturities we classified as available for sale was $390.3 million at
December 31, 2013, $655.2 million at December 31, 2012 and $614.3 million at December 31, 2011.
(2) We value equity securities at fair value. Total cost of equity securities was $12.2 million at December 31, 2013, $8.7 million at
December 31, 2012 and $7.2 million at December 31, 2011.
(3) We value investments in affiliates at cost, adjusted for our share of earnings and losses of our affiliates as well as changes in equity
of our affiliates due to unrealized gains and losses.
(4) We value short-term investments at cost, which approximates fair value.
-18-
The following table sets forth the maturities (at carrying value) in the fixed maturity portfolio of our insurance subsidiaries
at December 31, 2013, 2012 and 2011:
(dollars in thousands)
Due in(1):
One year or less
Over one year through three years
Over three years through five years
Over five years through ten years
Over ten years through fifteen years
Over fifteen years
Mortgage-backed securities
2013
Percent
of
Total
Amount
December 31,
2012
Percent
of
Total
Amount
2011
Percent
of
Total
Amount
$
8,257
1.3% $
10,004
1.4% $
16,181
2.3%
22,424
40,234
190,440
166,186
76,267
140,214
3.5
6.2
29.6
25.8
11.8
21.8
31,176
64,839
201,953
191,179
108,412
129,047
4.2
8.8
27.4
26.0
14.7
17.5
27,912
71,820
188,523
172,956
104,792
122,904
4.0
10.2
26.7
24.5
14.9
17.4
$ 644,022
100.0% $ 736,610
100.0% $ 705,088
100.0%
(1) Based on stated maturity dates with no prepayment assumptions. Actual maturities will differ because borrowers may have the right
to call or prepay obligations with or without call or prepayment penalties.
As shown above, our insurance subsidiaries held investments in mortgage-backed securities having a carrying value of
$140.2 million at December 31, 2013. The mortgage-backed securities consist primarily of investments in governmental agency
balloon pools with stated maturities between one and 24 years. The stated maturities of these investments limit the exposure of
our insurance subsidiaries to extension risk in the event that interest rates rise and prepayments decline. Our insurance
subsidiaries perform an analysis of the underlying loans when evaluating a mortgage-backed security for purchase, and they
select those securities that they believe will provide a return that properly reflects the prepayment risk associated with the
underlying loans.
The following table sets forth the investment results of our insurance subsidiaries for the years ended December 31, 2013,
2012 and 2011:
(dollars in thousands)
Invested assets(1)
Investment income(2)
Average yield
Average tax-equivalent yield
Year Ended December 31,
$
2013
799,119
18,795
$
2012
795,869
20,169
$
2011
756,925
20,858
2.4%
3.3
2.5%
3.5
2.8%
3.8
(1) Average of the aggregate invested amounts at the beginning and end of the period.
(2) Investment income is net of investment expenses and does not include realized investment gains or losses or provision for income
taxes.
A.M. Best Rating
Donegal Mutual and our insurance subsidiaries have an A.M. Best rating of A (Excellent), based upon the respective
current financial condition and historical statutory results of operations of Donegal Mutual and our insurance subsidiaries. We
believe that the A.M. Best rating of Donegal Mutual and our insurance subsidiaries is an important factor in their marketing of
the products to their agents and customers. A.M. Best’s ratings are industry ratings based on a comparative analysis of the
financial condition and operating performance of insurance companies. A.M. Best’s classifications are A++ and A+ (Superior),
A and A- (Excellent), B++ and B+ (Good), B and B- (Fair), C++ and C+ (Marginal), C and C- (Weak), D (Poor) and E (Under
Regulatory Supervision), F (Liquidation) and S (Suspended). A.M. Best bases its ratings upon factors relevant to the payment
of claims of policyholders and are not directed toward the protection of investors in insurance companies. According to A.M.
Best, the “Excellent” rating that the Donegal Insurance Group maintains is assigned to those companies that, in A.M. Best’s
opinion, have an excellent ability to meet their ongoing obligations to policyholders.
-19-
Regulation
The supervision and regulation of insurance companies consists primarily of the laws and regulations of the various states
in which the insurance companies transact business, with the primary regulatory authority being the insurance regulatory
authorities in the state of domicile of the insurance company. Such supervision and regulation relate to numerous aspects of an
insurance company’s business and financial condition. The primary purpose of such supervision and regulation is the protection
of policyholders. The authority of the state insurance departments includes the establishment of standards of solvency that
insurers must meet and maintain, the licensing of insurers and insurance agents to do business, the nature of, and limitations on,
investments, premium rates for property and casualty insurance, the provisions that insurers must make for current losses and
future liabilities, the deposit of securities for the benefit of policyholders, the approval of policy forms, notice requirements for
the cancellation of policies and the approval of certain changes in control. State insurance departments also conduct periodic
examinations of the affairs of insurance companies and require the filing of annual and other reports relating to the financial
condition of insurance companies.
In addition to state-imposed insurance laws and regulations, the National Association of Insurance Commissioners, or the
NAIC, has established a risk-based capital system, or RBC, for assessing the adequacy of statutory capital and surplus that
augments the states’ current fixed dollar minimum capital requirements for insurance companies. At December 31, 2013, our
insurance subsidiaries and Donegal Mutual each exceeded the minimum levels of statutory capital the RBC rules require by a
substantial margin.
Generally, every state has guaranty fund laws under which insurers licensed to do business in that state can be assessed on
the basis of premiums written by the insurer in that state in order to fund policyholder liabilities of insolvent insurance
companies. Under these laws in general, an insurer is subject to assessment, depending upon its market share of a given line of
business, to assist in the payment of policyholder claims against insolvent insurers. Our insurance subsidiaries and Donegal
Mutual have made accruals for their portion of assessments related to such insolvencies based upon the most current
information furnished by the guaranty associations.
We are part of an insurance holding company system of which Donegal Mutual is the ultimate controlling person. All of
the states in which our insurance companies and Donegal Mutual maintain a domicile have legislation that regulates insurance
holding company systems. Each insurance company in the insurance holding company system must register with the insurance
supervisory agency of its state of domicile and furnish information concerning the operations of companies within the
insurance holding company system that may materially affect the operations, management or financial condition of the insurers
within the system. Pursuant to these laws, the respective insurance departments in which our subsidiaries and Donegal Mutual
maintain a domicile may examine our insurance subsidiaries or Donegal Mutual at any time, require disclosure of material
transactions by the holding company with another member of the insurance holding company system and require prior notice or
prior approval of certain transactions, such as “extraordinary dividends” from the insurance subsidiaries to the holding
company. We have insurance subsidiaries domiciled in Iowa, Maryland, Michigan, Pennsylvania, Virginia and Wisconsin.
The Pennsylvania Insurance Holding Companies Act, which generally applies to Donegal Mutual, us and our insurance
subsidiaries, requires that all transactions within an insurance holding company system to which an insurer is a party must be
fair and reasonable and that any charges or fees for services performed must be reasonable. Any management agreement,
service agreement, cost sharing arrangement and material reinsurance agreement must be filed with the Pennsylvania Insurance
Department, or the Department, and is subject to the Department's review. We have filed the pooling agreement between
Donegal Mutual and Atlantic States that established the underwriting pool and all material agreements between Donegal
Mutual and our insurance subsidiaries with the Department.
Approval of the applicable insurance commissioner is also required prior to consummation of transactions affecting the
control of an insurer. In virtually all states, including Iowa, Maryland, Michigan, Pennsylvania, Virginia and Wisconsin, where
our insurance subsidiaries are domiciled, the acquisition of 10% or more of the outstanding capital stock of an insurer or its
holding company or the intent to acquire such an interest creates a rebuttable presumption of a change in control. Pursuant to an
order issued in April 2003, the Department approved Donegal Mutual’s ownership of up to 70% of our outstanding Class A
common stock and up to 100% of our outstanding Class B common stock.
Our insurance subsidiaries have the legal obligation under state insurance laws to participate in involuntary insurance
programs for automobile insurance, as well as other property and casualty insurance lines, in the states in which they conduct
business. These programs include joint underwriting associations, assigned risk plans, fair access to insurance requirements
plans, reinsurance facilities, windstorm plans and tornado plans. Legislation establishing these programs requires all companies
that write lines covered by these programs to provide coverage, either directly or through reinsurance, for insureds who are
unable to obtain insurance in the voluntary market. The legislation creating these programs usually allocates a pro rata portion
-20-
of risks attributable to such insureds to each company on the basis of the direct premiums it has written in that state or the
number of automobiles it insures in that state. Generally, state law requires participation in these programs as a condition to
obtaining a certificate of authority. Our loss ratio on insurance we write under these involuntary programs has traditionally been
significantly greater than our loss ratio on insurance we voluntarily write in those states.
Regulatory requirements, including RBC requirements, may impact our insurance subsidiaries' ability to pay dividends.
The amount of statutory capital and surplus necessary for our insurance subsidiaries to satisfy regulatory requirements,
including RBC requirements, was not significant in relation to our insurance subsidiaries' statutory capital and surplus at
December 31, 2013. Generally, the maximum amount that an insurance subsidiary may pay to us as ordinary dividends during
any year after notice to, but without prior approval of, the insurance commissioner of its domiciliary state is limited to a stated
percentage of that subsidiary’s statutory capital and surplus at December 31 of the preceding fiscal year or the net income of
that subsidiary for its preceding fiscal year. Our insurance subsidiaries paid dividends to us of $12.5 million, $7.0 million and
$16.0 million in 2013, 2012 and 2011, respectively. At December 31, 2013, the amount of dividends our insurance subsidiaries
could pay to us during 2014, without the prior approval of their respective domiciliary insurance commissioners, is shown in
the following table.
Name of Insurance Subsidiary
Atlantic States
Southern
Le Mars
Peninsula
Sheboygan
MICO
Total
Ordinary
Dividend
Amount
$ 18,660,666
4,195,635
2,762,791
4,189,149
1,086,411
4,159,470
$ 35,054,122
Donegal Mutual Insurance Company
Donegal Mutual organized as a mutual fire insurance company in Pennsylvania in 1889. At December 31, 2013, Donegal
Mutual had admitted assets of $383.8 million and policyholders’ surplus of $204.5 million. At December 31, 2013, Donegal
Mutual had total liabilities of $179.4 million, including reserves for net losses and loss expenses of $48.7 million and unearned
premiums of $44.2 million. Donegal Mutual’s investment portfolio of $228.9 million at December 31, 2013 consisted primarily
of investment-grade bonds of $16.7 million, its investment in DFSC's common stock and its investment in our common stock.
At December 31, 2013, Donegal Mutual owned 7,755,953 shares, or approximately 37%, of our Class A common stock, which
Donegal Mutual carried on its books at $101.0 million, and 4,235,539 shares, or approximately 76%, of our Class B common
stock, which Donegal Mutual carried on its books at $55.1 million. We present Donegal Mutual’s financial information in
accordance with SAP as the NAIC Accounting Practices and Procedures Manual requires. Donegal Mutual does not, nor is it
required to, prepare financial statements in accordance with GAAP.
Donegal Financial Services Corporation
In 2000, we and Donegal Mutual formed DFSC as a unitary thrift holding company and its wholly owned subsidiary,
Province Bank FSB, as a federal savings bank. In May 2011, DFSC merged with Union National Financial Corporation, or
UNNF, with DFSC as the surviving company in the merger. Under the merger agreement, Province Bank FSB and Union
National Community Bank, which UNNF owned, also merged to form UCB. UCB is a state savings bank with 13 branch
offices in Lancaster County, Pennsylvania, and approximately $512.8 million in assets at December 31, 2013.
Because Donegal Mutual and we together own all of the outstanding capital stock of DFSC, the Board of Governors of the
Federal Reserve System, or the FRB, regulates Donegal Mutual, DFSC and us as grandfathered savings and loan holding
companies. As a result, Donegal Mutual, DFSC and we are subject to regulation by the FRB under the holding company
provisions of the federal Home Owners’ Loan Act, or HOLA. However, if any of Donegal Mutual, DFSC or we were to lose
this grandfathered status, they or we would become a bank holding company regulated by the FRB under the Bank Holding
Company Act. UCB, as a state-chartered stock savings bank, is subject to regulation and supervision by the Pennsylvania
Department of Banking and by the Federal Deposit Insurance Corporation. The primary purpose of the statutory and regulatory
supervision of financial institutions is to protect depositors, the financial institutions and the financial system as a whole rather
-21-
than the stockholders of financial institutions or their holding companies. UCB converted from a federally-chartered stock
savings bank to a Pennsylvania-chartered stock savings bank during 2013.
Sections 23A and 23B of the Federal Reserve Act impose quantitative and qualitative restrictions on transactions between a
savings association and its “affiliates.” Affiliates of a savings association include, among other entities, the savings
association’s holding company and non-banking companies under common control with the savings association such as
Donegal Mutual and us. These restrictions on transactions with affiliates apply to transactions between DFSC and UCB, on the
one hand, and Donegal Mutual and us and our insurance subsidiaries, on the other hand. These restrictions also apply to
transactions among DFSC, UCB and Donegal Mutual. Because DFSC directly controls UCB and Donegal Mutual and we
indirectly control UCB, DFSC, Donegal Mutual and we are subject to the Change in Bank Control Act.
Cautionary Statement Regarding Forward-Looking Statements
This Form 10-K Annual Report and the documents we incorporate by reference in this Form 10-K Annual Report contain
“forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-
looking statements include certain discussions relating to underwriting, premium and investment income volumes, business
strategies, reserves, profitability and business relationships and our other business activities during 2013 and beyond. In some
cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “could,” “would,” “expect,”
“plan,” “intend,” “anticipate,” “believe,” “estimate,” “objective,” “project,” “predict,” “potential,” “goal” and similar
expressions. These forward-looking statements reflect our current views about future events, our current assumptions and are
subject to known and unknown risks and uncertainties that may cause our results, performance or achievements to differ
materially from those we anticipate or imply by our forward-looking statements. We cannot control or predict many of the
factors that could determine our future financial conditions or results of operations. Such factors may include those we describe
under “Risk Factors.” The forward-looking statements contained in this annual report reflect our views and assumptions only as
of the date of this Form 10-K Report. Except as required by law, we do not intend to update, and we assume no responsibility
for updating, any forward-looking statements we have made. We qualify all of our forward-looking statements by these
cautionary statements.
Item 1A. Risk Factors.
Risk Factors
Risks Relating to Us and Our Business
Donegal Mutual is our controlling stockholder. Donegal Mutual and its directors and executive officers have potential
conflicts of interest between the best interests of our stockholders and the best interests of the policyholders of Donegal
Mutual.
Donegal Mutual controls the election of all of the members of our board of directors. Six of the 11 members of our board
of directors are also directors of Donegal Mutual. Donegal Mutual and we share the same executive officers. These common
directors and executive officers have a fiduciary duty to our stockholders and also have a fiduciary duty to the policyholders of
Donegal Mutual. Among the potential conflicts of interest that could arise from these separate fiduciary duties are the
following:
• We and Donegal Mutual periodically review the percentage participation of Atlantic States and Donegal Mutual in the
underwriting pool that Donegal Mutual and Atlantic States have maintained since 1986;
• Our insurance subsidiaries and Donegal Mutual annually review and then establish the terms of certain reinsurance
agreements between them with the objective, over the long-term, of having an approximately equal balance between
payments and recoveries;
• We and Donegal Mutual periodically allocate certain shared expenses among ourselves and our insurance subsidiaries
in accordance with various inter-company expense-sharing agreements; and
• Our insurance subsidiaries may enter into other transactions or contractual relationships with Donegal Mutual,
including, for example, our purchases from time to time from Donegal Mutual of the surplus note of a mutual
insurance company that will convert into a stock insurance company and ultimately become one of our wholly owned
subsidiaries.
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Donegal Mutual has sufficient voting power to determine the outcome of all matters submitted to our stockholders for
approval.
Each share of our Class A common stock has one-tenth of a vote per share and generally votes as a single class with our
Class B common stock. Our Class B common stock has one vote per share. Donegal Mutual has the right to vote approximately
65% of the aggregate voting power of our Class A common stock and our Class B common stock and has sufficient voting
control to:
•
•
elect all of the members of our board of directors, who determine our management and policies; and
control the outcome of any corporate transaction or other matter submitted to a vote of our stockholders for approval,
including mergers or other acquisition proposals and the sale of all or substantially all of our assets, in each case
regardless of how all of our other stockholders other than Donegal Mutual vote their shares.
The interests of Donegal Mutual in maintaining this greater-than-majority control of us may have an adverse effect on the
price of our Class A common stock and the price of our Class B common stock because of the absence of any potential
“takeover” premium and may, therefore, be inconsistent with the interests of our stockholders other than Donegal Mutual.
Donegal Mutual’s majority voting control, certain provisions of our certificate of incorporation and by-laws and
certain provisions of Delaware law make it remote that anyone could acquire actual control of us unless Donegal Mutual
were in favor of the acquisition of actual control.
Donegal Mutual’s majority voting control, certain anti-takeover provisions in our certificate of incorporation and by-laws
and certain provisions of the Delaware General Corporation Law, or the DGCL, could delay or prevent the removal of members
of our board of directors and could make a merger, tender offer or proxy contest involving us more expensive as well as
unlikely to succeed, even if such events were in the best interests of our stockholders other than Donegal Mutual. These factors
could also discourage a third party from attempting to acquire actual control of us. In particular, our certificate of incorporation
and by-laws include the following anti-takeover provisions:
•
•
•
•
•
our board of directors is classified into three classes, so that our stockholders elect only one-third of the members of
our board of directors each year;
our stockholders may remove our directors only for cause;
our stockholders may not take stockholder action except at an annual or special meeting of our stockholders;
the request of stockholders holding at least 20% of the aggregate voting power of our Class A common stock and our
Class B common stock is required for a stockholder to call a special meeting of our stockholders;
our by-laws require that stockholders provide advance notice to us to nominate candidates for election to our board of
directors or to propose any other item of stockholder business at a stockholders’ meeting;
• we do not permit cumulative voting rights in the election of our directors;
•
•
our certificate of incorporation does not provide for preemptive rights in connection with any issuance of securities by
us; and
our board of directors may issue, without stockholder approval unless otherwise required by law, preferred stock with
such terms as our board of directors may determine.
We have authorized preferred stock that we could issue without stockholder approval to make it more difficult for a
third party to acquire us.
We have 2.0 million authorized shares of preferred stock that we could issue in one or more series without further
stockholder approval, unless the DGCL or the NASDAQ Global Select Market otherwise requires, and upon such terms and
conditions, and having such rights, privileges and preferences, as our board of directors may determine our potential issuance
of preferred stock and that may make it difficult for a third party to acquire control of us.
-23-
Because we are an insurance holding company, no person can acquire or seek to acquire a 10% or greater interest in
us without first obtaining approval of the insurance commissioners of the states of domicile of our insurance subsidiaries.
We own insurance subsidiaries domiciled in the states of Iowa, Maryland, Michigan, Pennsylvania, Virginia and
Wisconsin, and Donegal Mutual controls an insurance company domiciled in Georgia. The insurance laws of each of these
states provide that no person can acquire or seek to acquire a 10% or greater interest in us without first filing specified
information with the insurance commissioner of that state and obtaining the prior approval of the proposed acquisition of a 10%
or greater interest in us by the state insurance commissioner based on statutory standards designed to protect the safety and
soundness of the insurance holding company and its subsidiary.
Because we are a grandfathered unitary savings and loan holding company, no person can acquire or seek to acquire
more than a 10% interest in either class of our common stock without first obtaining approval of, or an exemption from, the
FRB.
We own 48.2% of the outstanding stock of DFSC, which owns all of the outstanding stock of UCB. As a result of our
ownership interest in DFSC, we are a grandfathered unitary savings and loan holding company regulated by the FRB under
HOLA. No person may lawfully acquire more than 10% of any class of voting security of a unitary savings and loan holding
company registered under the Exchange Act without first filing specified information with the FRB and obtaining the FRB's
prior approval of the proposed acquisition or an exemption from the FRB.
Our insurance subsidiaries currently conduct business in a limited number of states, with a concentration of business in
Pennsylvania, Michigan, Maryland and Virginia. Any single catastrophe occurrence or other condition affecting losses in
these states could adversely affect the results of operations of our insurance subsidiaries.
Our insurance subsidiaries conduct business in 22 states located primarily in the Mid-Atlantic, Midwestern, New England
and Southern states. A substantial portion of their business consists of private passenger and commercial automobile,
homeowners and workers’ compensation insurance in Pennsylvania, Michigan, Maryland and Virginia. While our insurance
subsidiaries and Donegal Mutual actively manage our respective exposure to catastrophes through their underwriting process
and the purchase of reinsurance, a single catastrophic occurrence, destructive weather pattern, general economic trend, terrorist
attack, regulatory development or other condition affecting one or more of the states in which our insurance subsidiaries
conduct substantial business could materially adversely affect their business, financial condition and results of operations.
Common catastrophic events include hurricanes, earthquakes, tornadoes, wind and hail storms, fires, explosions and severe
winter storms.
If the independent agents who market the products of our insurance subsidiaries do not maintain their current levels of
premium writing with us, fail to comply with established underwriting guidelines of our insurance subsidiaries or otherwise
inappropriately market the products of our insurance subsidiaries, the business, financial condition and results of
operations of our insurance subsidiaries could be adversely affected.
Our insurance subsidiaries market their insurance products solely through a network of approximately 2,600 independent
insurance agencies. This agency distribution system is one of the most important components of the competitive profile of our
insurance subsidiaries. As a result, our insurance subsidiaries depend to a material extent upon their independent agents, each of
whom has the authority to bind our insurance subsidiaries to insurance coverage. To the extent that such independent agents’
marketing efforts fail to result in the maintenance of their current levels of volume and quality or they bind our insurance
subsidiaries to unacceptable insurance risks, fail to comply with the established underwriting guidelines of our insurance
subsidiaries or otherwise inappropriately market the products of our insurance subsidiaries, the business, financial condition
and results of operations of our insurance subsidiaries could suffer.
The business of our insurance subsidiaries may not continue to grow and may be materially adversely affected if our
insurance subsidiaries cannot retain existing, and attract new, independent agents or if insurance consumers increase their
use of insurance marketing systems other than independent agents.
Our insurance subsidiaries' ability to retain existing, and to attract new, independent agents is essential to the continued
growth of the business of our insurance subsidiaries. If independent agents find it easier to do business with the competitors of
our insurance subsidiaries, our insurance subsidiaries could find it difficult to retain their existing business or to attract new
business. While our insurance subsidiaries believe they maintain good relationships with the independent agents they have
appointed, our insurance subsidiaries cannot be certain that these independent agents will continue to sell the products of our
insurance subsidiaries to the consumers these independent agents represent. Some of the factors that could adversely affect the
ability of our insurance subsidiaries to retain existing, and attract new, independent agents include:
-24-
•
•
•
•
the significant competition among insurance companies to attract independent agents;
the labor-intensive and time-consuming process of selecting new independent agents;
the insistence of our insurance subsidiaries that independent agents adhere to consistent underwriting standards; and
the ability of our insurance subsidiaries to pay competitive and attractive commissions, bonuses and other incentives
to independent agents.
While our insurance subsidiaries sell insurance to policyholders solely through their network of independent agencies,
many competitors of our insurance subsidiaries sell insurance through a variety of delivery methods, including independent
agencies, captive agencies, the Internet and direct sales. To the extent that current and potential policyholders change their
marketing system preference, the business, financial condition and results of operations of our insurance subsidiaries may be
adversely affected.
We are dependent on dividends from our insurance subsidiaries for the payment of our operating expenses, our debt
service and dividends to our stockholders; however, there are regulatory restrictions and business considerations that
regulate the amount of dividends our insurance subsidiaries may pay to us.
As a holding company, we rely primarily on dividends from our insurance subsidiaries as a source of funds to meet our
corporate obligations and to pay dividends to our stockholders. The amount of dividends our insurance subsidiaries can pay to
us is subject to regulatory restrictions and depends on the amount of surplus our insurance subsidiaries maintain. From time to
time, the NAIC and various state insurance regulators consider modifying the method of determining the amount of dividends
that an insurance company may pay without prior regulatory approval. The maximum amount of ordinary dividends that our
insurance subsidiaries can pay to us in 2014 without prior regulatory approval is approximately $35.1 million. Other business
and regulatory considerations, such as the impact of dividends on surplus that could affect the ratings of our insurance
subsidiaries, competitive conditions, RBC requirements, the investment results of our insurance subsidiaries and the amount of
premiums that our insurance subsidiaries write could also adversely impact the ability of our insurance subsidiaries to pay
dividends to us.
If A.M. Best downgrades the rating it has assigned to Donegal Mutual or any of our insurance subsidiaries, it would
adversely affect their competitive position.
Industry ratings are a factor in establishing and maintaining the competitive position of insurance companies. A.M. Best,
an industry-accepted source of insurance company financial strength ratings, rates Donegal Mutual and our insurance
subsidiaries. A.M. Best ratings provide an independent opinion of an insurance company’s financial health and its ability to
meet its obligations to its policyholders. We believe that the financial strength rating of A.M. Best is material to the operations
of Donegal Mutual and our insurance subsidiaries. Currently, Donegal Mutual and our insurance subsidiaries each have an A
(Excellent) rating from A.M. Best. If A.M. Best were to downgrade the rating of Donegal Mutual or any of our insurance
subsidiaries, it would adversely affect the competitive position of Donegal Mutual or that insurance subsidiary and make it
more difficult for it to market its products and retain its existing policyholders.
Our strategy to grow in part through acquisitions of smaller insurance companies exposes us to risks that could
adversely affect our results of operations and financial condition.
The affiliation with and acquisition of smaller, and often undercapitalized, insurance companies involves risks that could
adversely affect our results of operations and financial condition. The risks associated with these affiliations and acquisitions
include:
•
•
•
the potential inadequacy of reserves for losses and loss expenses;
the need to supplement management with additional experienced personnel;
conditions imposed by regulatory agencies that make the realization of cost-savings through integration of operations
more difficult;
•
a need for additional capital that was not anticipated at the time of the acquisition; and
-25-
•
the use of more of our management’s time in improving operation of the subsidiary than we originally anticipated.
If we cannot obtain sufficient capital to fund the organic growth of our insurance subsidiaries and to make
acquisitions, we may not be able to expand our business.
Our strategy is to expand our business through the organic growth of our insurance subsidiaries and through our strategic
acquisitions of regional insurance companies. Our insurance subsidiaries will require additional capital in the future to support
this strategy. If we cannot obtain sufficient capital on satisfactory terms and conditions, we may not be able to expand the
business of our insurance subsidiaries or to make future acquisitions. Our ability to obtain additional financing will depend on a
number of factors, many of which are beyond our control. For example, we may not be able to obtain additional debt or equity
financing because we or our insurance subsidiaries may already have substantial debt at the time, because we or our insurance
subsidiaries do not have sufficient cash flow to service or repay our existing or additional debt or because financial institutions
are not making financing available. In addition, any equity capital we obtain in the future could be dilutive to our existing
stockholders.
A number of the competitors of our insurance subsidiaries have greater financial strength than our insurance
subsidiaries, and these competitors may be able to offer their products at lower prices than our insurance subsidiaries can
afford to offer their products.
The property and casualty insurance industry is intensely competitive. Competition can be based on many factors,
including:
•
•
•
•
•
•
the perceived financial strength of the insurer;
premium rates;
policy terms and conditions;
policyholder service;
reputation; and
experience.
Our insurance subsidiaries compete with many regional and national property and casualty insurance companies, including
direct sellers of insurance products, insurers having their own agency organizations and other insurers represented by
independent agents. Many of these insurers have greater capital than our insurance subsidiaries, have substantially greater
financial, technical and operating resources and have equal or higher ratings from A.M. Best than our insurance subsidiaries. In
addition, our competitors may become increasingly better capitalized in the future as the property and casualty insurance
industry continues to consolidate.
The greater capitalization of many of the competitors of our insurance subsidiaries enables them to operate with lower
profit margins and, therefore, allows them to market their products more aggressively, to take advantage more quickly of new
marketing opportunities and to offer lower premium rates. Our insurance subsidiaries may not be able to maintain their current
competitive position in the markets in which they operate if their competitors offer prices for their products that are lower than
the prices our insurance subsidiaries are prepared to offer. Moreover, if these competitors lower the price of their products and
our insurance subsidiaries meet their pricing, the profit margins and revenues of our insurance subsidiaries may decrease and
their ratios of claims and expenses to premiums may increase. All of these factors could materially adversely affect the
financial condition and results of operations of our insurance subsidiaries and their A.M. Best ratings.
Because the investment portfolios of our insurance subsidiaries consist primarily of fixed-income securities, their
investment income and the fair value of their investment portfolios could decrease as a result of a number of factors.
Our insurance subsidiaries invest the premiums they receive from their policyholders and maintain investment portfolios
that consist primarily of fixed-income securities. The management of these investment portfolios is an important component of
the profitability of our insurance subsidiaries. Our insurance subsidiaries derive a significant portion of their operating income
from the income they receive on their invested assets. A number of factors may affect the quality and/or yield of their
portfolios, including the general economic and business environment, government monetary policy, changes in the credit
quality of the issuers of the fixed-income securities our insurance subsidiaries own, changes in market conditions and
-26-
regulatory changes. The fixed-income securities our insurance subsidiaries own consist primarily of securities issued by
domestic entities that are backed either by the credit or collateral of the underlying issuer. Factors such as an economic
downturn, disruption in the credit market or the availability of credit, a regulatory change pertaining to a particular issuer’s
industry, a significant deterioration in the cash flows of the issuer or a change in the issuer’s marketplace may adversely affect
the ability of our insurance subsidiaries to collect principal and interest from the issuer in which they invest.
The investments of our insurance subsidiaries are also subject to risk resulting from interest rate fluctuations. Increasing
interest rates or a widening in the spread between interest rates available on U.S. Treasury securities and corporate debt or
asset-backed securities, for example, will typically have an adverse impact on the market values of fixed-rate securities. If
interest rates remain at historically low levels, our insurance subsidiaries will generally have a lower overall rate of return on
investments of cash their operations generate. In addition, in the event of the call or maturity of investments in a low interest
rate environment, our insurance subsidiaries may not be able to reinvest the proceeds in securities with comparable interest
rates. Changes in interest rates may reduce both the profitability and the return on the invested capital of our insurance
subsidiaries.
We and our insurance subsidiaries depend on key personnel. The loss of any member of our executive management or
the senior management of our insurance subsidiaries could negatively affect the continuation of our business strategies and
achievement of our growth objectives.
The loss of, or failure to attract, key personnel could significantly impede the financial plans, growth, marketing and other
objectives of us and our insurance subsidiaries. The continued success of our insurance subsidiaries depends to a substantial
extent on the ability and experience of their senior management. Our insurance subsidiaries and we believe that our future
success is dependent on our ability to attract and retain additional skilled and qualified personnel and to expand, train and
manage our employees. We and Donegal Mutual have two to five year automatically renewing employment agreements with
our senior officers, including all of our named executive officers.
The reinsurance agreements on which our insurance subsidiaries rely do not relieve our insurance subsidiaries from
their primary liability to their policyholders, and our insurance subsidiaries face a risk of non-payment from their
reinsurers as well as the non-availability of reinsurance in the future.
Our insurance subsidiaries rely on reinsurance agreements to limit their maximum net loss from large single catastrophic
risks or excess of loss risks in areas where our insurance subsidiaries may have a concentration of policyholders. Reinsurance
also enables our insurance subsidiaries to increase their capacity to write insurance because it has the effect of leveraging the
surplus of our insurance subsidiaries. Although the reinsurance our insurance subsidiaries maintain provides that the reinsurer is
liable to them for any reinsured losses, the reinsurance agreements do not generally relieve our insurance subsidiaries from
their primary liability to their policyholders if the reinsurer fails to pay the reinsurance claims of our insurance subsidiaries. To
the extent that a reinsurer is unable to pay losses for which it is liable to our insurance subsidiaries, our insurance subsidiaries
remain liable for such losses. At December 31, 2013, our insurance subsidiaries had approximately $128.4 million of
reinsurance receivables from third-party reinsurers relating to paid and unpaid losses. Any insolvency or inability of these
reinsurers to make timely payments to our insurance subsidiaries under the terms of their reinsurance agreements would
adversely affect the results of operations of our insurance subsidiaries.
Michigan law requires MICO to provide unlimited lifetime medical benefits under the personal injury protection, or PIP,
coverage of the personal automobile and commercial automobile policies it writes in the State of Michigan. Michigan law also
requires MICO to be a member of the Michigan Catastrophic Claims Association, or MCCA, in order to write automobile
insurance. The MCCA receives funding through assessments that its members collect from policyholders in the state and
provides reinsurance for PIP claims that exceed a set retention. At December 31, 2013, MICO had approximately $46.2 million
of reinsurance receivables from MCCA relating to paid and unpaid losses. The MCCA has generated significant operating
deficits in recent years. Although we currently consider the risk to be remote, should the MCCA be unable to fulfill its
payment obligations to MICO in the future, MICO's financial condition and results of operations could be adversely affected.
In addition, our insurance subsidiaries face a risk of the non-availability of reinsurance or an increase in reinsurance costs
that could adversely affect their ability to write business or their results of operations. Market conditions beyond the control of
our insurance subsidiaries, such as the amount of surplus in the reinsurance market and the frequency and severity of natural
and man-made catastrophes, affect both the availability and the cost of the reinsurance our insurance subsidiaries purchase. If
our insurance subsidiaries cannot maintain their current level of reinsurance or purchase new reinsurance protection in amounts
that our insurance subsidiaries consider sufficient, our insurance subsidiaries would either have to accept an increase in their
net risk retention or reduce their insurance writings, which would adversely affect them.
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Our equity investment in DFSC subjects us to certain risks inherent to community banking organizations.
Our equity in the earnings of DFSC primarily reflects the underlying profitability of UCB. UCB is subject to a number of
risks, which include, but are not limited to, the following:
•
•
•
•
•
•
variations in interest rates that may negatively affect UCB's financial performance;
inherent risks associated with UCB's lending activities;
a significant decline in general economic conditions in the specific markets in which UCB operates;
the potential adverse impact of extensive federal and state regulation and supervision;
potential declines in the value of UCB's investments that are considered other than temporary;
competition for loans and deposits with numerous regional and national banks and other financial institutions; and
• UCB's inability to attract and retain qualified key personnel.
Risks Relating to the Property and Casualty Insurance Industry
Industry trends, such as increased litigation against the insurance industry and individual insurers, the willingness of
courts to expand covered causes of loss, rising jury awards, escalating medical costs and increasing loss severity may
contribute to increased costs and result in the deterioration of the reserves of our insurance subsidiaries.
Loss severity in the property and casualty insurance industry has increased in recent years, principally driven by larger
court judgments and increasing medical costs. In addition, many classes of complainants have brought legal actions and
proceedings that tend to increase the size of judgments. The propensity of policyholders and third-party claimants to litigate
and the willingness of courts to expand causes of loss and the size of awards to eliminate exclusions and to increase coverage
limits may make the loss reserves of our insurance subsidiaries inadequate for current and future losses.
Loss or significant restriction of the use of credit scoring in the pricing and underwriting of the personal lines
insurance products by our insurance subsidiaries could adversely affect their future profitability.
Our insurance subsidiaries use credit scoring as a factor in making risk selection and pricing decisions where allowed by
state law for personal lines insurance products. Recently, some consumer groups and regulators have questioned whether the
use of credit scoring unfairly discriminates against people with low incomes, minority groups and the elderly. These consumer
groups and regulators often call for the prohibition or restriction on the use of credit scoring in underwriting and pricing. Laws
or regulations enacted in a number of states that significantly curtail the use of credit scoring in the underwriting process could
reduce the future profitability of our insurance subsidiaries.
Changes in applicable insurance laws or regulations or changes in the way regulators administer those laws or
regulations could adversely affect the operating environment of our insurance subsidiaries and increase their exposure to
loss or put them at a competitive disadvantage.
Property and casualty insurers are subject to extensive supervision in their domiciliary states and in the states in which they
do business. This regulatory oversight includes matters relating to:
•
•
licensing and examination;
approval of premium rates;
• market conduct;
•
•
•
policy forms;
limitations on the nature and amount of certain investments;
claims practices;
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• mandated participation in involuntary markets and guaranty funds;
•
•
•
•
•
reserve adequacy;
insurer solvency;
transactions between affiliates;
the amount of dividends that insurers may pay; and
restrictions on underwriting standards.
Such regulation and supervision are primarily for the benefit and protection of policyholders rather than stockholders. For
instance, our insurance subsidiaries are subject to involuntary participation in specified markets in various states in which they
operate and the premium rates our insurance subsidiaries may charge do not always correspond with the underlying costs of
providing that coverage.
The NAIC and state insurance regulators are re-examining existing laws and regulations, specifically focusing on:
•
•
•
•
•
•
•
insurance company investments;
issues relating to the solvency of insurance companies;
risk-based capital guidelines;
restrictions on the terms and conditions included in insurance policies;
certain methods of accounting;
reserves for unearned premiums, losses and other purposes;
the values at which insurance companies may carry investment securities and the definition of other-than-temporary
impairment; and
•
interpretations of existing laws and the development of new laws.
Changes in state laws and regulations, as well as changes in the way state regulators view related-party transactions in
particular, could change the operating environment of our insurance subsidiaries and have an adverse effect on their business.
The state insurance regulatory framework has recently come under increased federal scrutiny. Congress is considering
proposals that it should create an optional federal charter for insurers. Federal chartering has the potential to create an uneven
playing field for insurers by subjecting federally-chartered and state-chartered insurers to different regulatory requirements.
Federal chartering also raises the possibility of duplicative or conflicting federal and state requirements. In addition, if federal
legislation repeals the partial exemption for the insurance industry from federal antitrust laws, our ability to collect and share
loss cost data with the industry could adversely affect the results of operations of our insurance subsidiaries.
Insurance companies are subject to assessments, based on their market share in a given line of business, to assist in the
payment of unpaid claims and related costs of insolvent insurance companies. Such assessments could adversely affect the
financial condition of our insurance subsidiaries.
Our insurance subsidiaries must pay assessments pursuant to the guaranty fund laws of the various states in which they
conduct business. Generally, under these laws, our insurance subsidiaries can be assessed, depending upon the market share of
our insurance subsidiaries in a given line of insurance business, to assist in the payment of unpaid claims and related costs of
insolvent insurance companies in those states. We cannot predict the number and magnitude of future insurance company
failures in the states in which our insurance subsidiaries conduct business, but future assessments could adversely affect the
business, financial condition and results of operations of our insurance subsidiaries.
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Our insurance subsidiaries must establish premium rates and loss and loss expense reserves from forecasts of the
ultimate costs they expect will arise from risks underwritten during the policy period, and the profitability of our insurance
subsidiaries could be adversely affected if their premium rates or reserves are insufficient to satisfy their ultimate costs.
One of the distinguishing features of the property and casualty insurance industry is that it prices its products before it
knows its costs, since insurers generally establish their premium rates before they know the amount of losses they will incur.
Accordingly, our insurance subsidiaries establish premium rates from forecasts of the ultimate costs they expect to arise from
risks they have underwritten during the policy period. These premium rates may not be sufficient to cover the ultimate losses
incurred. Further, our insurance subsidiaries must establish reserves for losses and loss expenses as balance sheet liabilities
based upon estimates involving actuarial and statistical projections at a given time of what our insurance subsidiaries expect
their ultimate liability to be. Significant periods of time often elapse from the occurrence of an insured loss to the reporting of
the loss and the payment of that loss. It is possible that our insurance subsidiaries' ultimate liability could exceed these
estimates because of the future development of known losses, the existence of losses that have occurred but are currently
unreported and larger than historical settlements on pending and unreported claims. The process of estimating reserves is
inherently judgmental and can be influenced by a number of factors, including the following:
•
•
•
•
•
trends in claim frequency and severity;
changes in operations;
emerging economic and social trends;
inflation; and
changes in the regulatory and litigation environments.
If our insurance subsidiaries have insufficient premium rates or reserves, insurance regulatory authorities may require
increases to these reserves. An increase in reserves results in an increase in losses and a reduction in net income for the period
in which the deficiency in reserves exists. Accordingly, if an increase in reserves is not sufficient, it may adversely impact their
business, liquidity, financial condition and results of operations.
The financial results of our insurance subsidiaries depend primarily on their ability to underwrite risks effectively and
to charge adequate rates to policyholders.
The financial condition, cash flows and results of operations of our insurance subsidiaries depend on their ability to
underwrite and set rates accurately for a full spectrum of risks across a number of lines of insurance. Rate adequacy is
necessary to generate sufficient premium to pay losses, loss adjustment expenses and underwriting expenses and to earn a
profit.
The ability to underwrite and set rates effectively is subject to a number of risks and uncertainties, including:
•
•
•
•
•
•
•
the availability of sufficient, reliable data;
the ability to conduct a complete and accurate analysis of available data;
the ability to recognize in a timely manner changes in trends and to project both the severity and frequency of losses
with reasonable accuracy;
uncertainties generally inherent in estimates and assumptions;
the ability to project changes in certain operating expense levels with reasonable certainty;
the development, selection and application of appropriate rating formulae or other pricing methodologies;
the use of modeling tools to assist with correctly and consistently achieving the intended results in underwriting and
pricing;
•
the ability to innovate with new pricing strategies and the success of those innovations on implementation;
-30-
•
•
•
•
•
•
•
•
•
•
the ability to secure regulatory approval of premium rates on an adequate and timely basis;
the ability to predict policyholder retention accurately;
unanticipated court decisions, legislation or regulatory action;
unanticipated changes in our claim settlement practices;
changes in driving patterns for auto exposures;
changes in weather patterns for property exposures;
changes in the medical sector of the economy;
unanticipated changes in auto repair costs, auto parts prices and used car prices;
the impact of inflation and other factors on the cost of construction materials and labor;
the ability to monitor property concentration in catastrophe-prone areas, such as hurricane, earthquake and wind/hail
regions; and
•
the general state of the economy in the states in which our insurance subsidiaries operate.
Such risks may result in the premium rates of our insurance subsidiaries being based on inadequate or inaccurate data or
inappropriate assumptions or methodologies and may cause our estimates of future changes in the frequency or severity of
claims to be incorrect. As a result, our insurance subsidiaries could underprice risks, which would negatively affect our
margins, or our insurance subsidiaries could overprice risks, which could reduce their volume and competitiveness. In either
event, underpricing or overpricing risks could adversely impact our operating results, financial condition and cash flows.
The cyclical nature of the property and casualty insurance industry may reduce the revenues and profit margins of our
insurance subsidiaries.
The property and casualty insurance industry is highly cyclical with respect to both individual lines of business and the
overall insurance industry. Premium rate levels relate to the availability of insurance coverage, which varies according to the
level of surplus available in the insurance industry. The level of surplus in the industry varies with returns on invested capital
and regulatory barriers to withdrawal of surplus. Increases in surplus may result in increased price competition among property
and casualty insurers. If our insurance subsidiaries find it necessary to reduce premiums or limit premium increases due to
these competitive pressures on pricing, our insurance subsidiaries may experience a reduction in their profit margins and
revenues, an increase in their ratios of losses and expenses to premiums and, therefore, lower profitability.
Risks Relating to Our Common Stock
The price of our common stock may be adversely affected by its low trading volume.
Our Class A common stock and our Class B common stock have limited liquidity. Reported average daily trading volume
for our Class A common stock and our Class B common stock for the year ended December 31, 2013 was approximately
26,148 shares and approximately 823 shares, respectively. This limited liquidity could subject our shares of Class A common
stock and our shares of Class B common stock to greater price volatility.
Donegal Mutual’s ownership of our stock, anti-takeover provisions of our certificate of incorporation and by-laws and
certain state laws make it unlikely anyone could acquire control of us unless Donegal Mutual were in favor of the
acquisition of control.
Donegal Mutual’s ownership of our Class A common stock and Class B common stock, certain anti-takeover provisions of
our certificate of incorporation and by-laws, certain provisions of Delaware law and the insurance laws and regulations of
Iowa, Georgia, Maryland, Michigan, Pennsylvania, Virginia and Wisconsin could delay or prevent the removal of members of
our board of directors and could make it more difficult for a merger, tender offer or proxy contest involving us to succeed, even
if our stockholders other than Donegal Mutual believed any of such events would be beneficial to them. These factors could
-31-
also discourage a third party from attempting to acquire control of us. The classification of our board of directors could also
have the effect of delaying or preventing a change in our control.
In addition, we have 2,000,000 authorized shares of preferred stock that we could issue in one or more series without
stockholder approval, to the extent applicable law permits, and upon such terms and conditions, and having such rights,
privileges and preferences, as our board of directors may determine. Our ability to issue preferred stock could make it difficult
for a third party to acquire us. We have no current plans to issue any preferred stock.
Moreover, the DGCL contains provisions that prohibit certain business combination transactions under certain
circumstances. In addition, state insurance laws and regulations generally prohibit any person from acquiring, or seeking to
acquire, a 10% or greater interest in an insurance company without the prior approval of the state insurance commissioner of
the state of domicile of the insurer. Because of our indirect control of UCB, HOLA also prohibits the acquisition of a 10% or
greater interest in either our Class A common stock or our Class B common stock without the prior approval of the FRB or the
granting of an exemption by the FRB.
-32-
Item 1B. Unresolved Staff Comments.
We have no unresolved written comments from the Securities and Exchange Commission ("SEC") staff regarding our
filings under the Exchange Act.
Item 2. Properties.
We and our insurance subsidiaries share administrative headquarters with Donegal Mutual in a building in Marietta,
Pennsylvania that Donegal Mutual owns. Donegal Mutual charges us and our insurance subsidiaries for an appropriate portion
of the building expenses under an inter-company allocation agreement. The Marietta headquarters has approximately 230,000
square feet of office space. Southern owns a facility of approximately 10,000 square feet in Glen Allen, Virginia. Le Mars owns
a facility of approximately 25,500 square feet in Le Mars, Iowa, Peninsula owns a facility of approximately 14,600 square feet
in Salisbury, Maryland and Sheboygan owns a facility of approximately 8,800 square feet in Sheboygan Falls, Wisconsin.
Item 3. Legal Proceedings.
Our insurance subsidiaries are parties to routine litigation that arises in the ordinary course of their insurance business. We
believe that the resolution of these lawsuits will not have a material adverse effect on the financial condition or results of
operations of our insurance subsidiaries.
Item 4. Reserved.
Not applicable.
-33-
Executive Officers of the Company
The following table sets forth information regarding the executive officers of Donegal Mutual and us, each of whom has
served with us for more than 10 years:
Name
Donald H. Nikolaus
Age
Kevin G. Burke
Cyril J. Greenya
Jeffrey D. Miller
Sanjay Pandey
Position
71 President and Chief Executive Officer of Donegal Mutual since 1981; President
and Chief Executive Officer of us since 1986. Chairman of our board of directors
since April 2012.
48 Senior Vice President of Human Resources of Donegal Mutual and us since 2005;
Vice President of Human Resources of Donegal Mutual and us from 2001 to 2005;
other positions from 2000 to 2001.
69 Senior Vice President and Chief Underwriting Officer of Donegal Mutual and us
since 2005; Senior Vice President, Underwriting, of Donegal Mutual from 1997 to
2005; other positions from 1986 to 2005.
49 Senior Vice President and Chief Financial Officer of Donegal Mutual and us since
2005; Vice President and Controller of Donegal Mutual and us from 2000 to 2005;
other positions from 1995 to 2005.
47 Senior Vice President and Chief Information Officer of Donegal Mutual and us
since 2013; Vice President and Chief Information Officer of Donegal Mutual and
us from 2009 to 2013; other positions from 2000 to 2009.
Robert G. Shenk
60 Senior Vice President, Claims, of Donegal Mutual and us since 1997; other
positions from 1986 to 1997.
Daniel J. Wagner
53 Senior Vice President and Treasurer of Donegal Mutual and us since 2005; Vice
President and Treasurer of Donegal Mutual and us from 2000 to 2005; other
positions from 1993 to 2005.
-34-
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity
Securities.
Our Class A common stock and Class B common stock trade on the NASDAQ Global Select Market under the symbols
“DGICA” and “DGICB,” respectively. The following table shows the dividends paid per share and the stock price range for
both classes of stock for each quarter during 2013 and 2012:
Quarter
2013 - Class A
1st
2nd
3rd
4th
2013 - Class B
1st
2nd
3rd
4th
2012 - Class A
1st
2nd
3rd
4th
2012 - Class B
1st
2nd
3rd
4th
High
Low
Cash
Dividend
Declared
Per Share
$ 16.52
$ 12.93 $
—
15.59
14.90
16.88
13.90 0.1275
13.35 0.1275
14.15 0.2550
$ 28.49
27.85
$ 17.92 $
—
19.00 0.1150
24.03
26.00
18.00 0.1150
19.21 0.2300
$ 16.00
$ 12.73 $
—
15.36
14.93
14.69
12.87 0.1225
12.91 0.1225
12.25 0.2450
$ 17.89
$ 14.74 $
—
18.00
18.22
23.00
16.85 0.1100
16.04 0.1100
16.51 0.2200
At the close of business on March 3, 2014, we had approximately 1,926 holders of record of our Class A common stock
and approximately 340 holders of record of our Class B common stock.
We declared dividends of $0.51 per share on our Class A common stock and $0.46 per share on our Class B common stock
in 2013, compared to $0.49 per share on our Class A common stock and $0.44 per share on our Class B common stock in 2012.
-35-
Between October 1, 2013 and December 31, 2013, we and Donegal Mutual purchased shares of our Class A common stock
and Class B common stock as set forth in the table below:
Period
(a) Total Number of Shares
(or Units Purchased
(b) Average Price Paid per
Share (or Unit)
(c) Total Number of Shares
(or Units) Purchased as Part
of Publicly Announced
Plans of Programs
(d) Maximum Number (or
Approximate Dollar Value)
of Shares (or Units) that May
Yet Be Purchased Under the
Plans or Programs (1)
Month #1
October 1-31, 2013
Class A — —
Class B — —
Class A — $—
Class B — $—
Class A — —
Class B — —
Month #2
November 1-30, 2013
Class A — —
Class B — —
Class A — $—
Class B — $—
Class A — —
Class B — —
Month #3
December 1-31, 2013
Class A — 20,000
Class B — 13,000
Class A — $15.82
Class B — $23.62
Class A — 20,000
Class B — 13,000
(1)
(2)
Total
Class A — 20,000
Class B — 13,000
Class A — $15.82
Class B — $23.62
Class A — 20,000
Class B — 13,000
(1) We purchased these shares pursuant to our announcement first made on February 23, 2009 that we will purchase up to
300,000 shares of our Class A common stock at market prices prevailing from time to time in the open market subject to the
provisions of SEC Rule 10b-18 and in privately negotiated transactions. We may purchase up to 4,068 additional shares of our
Class A common stock under this stock repurchase program.
(2) Donegal Mutual purchased these shares pursuant to its announcement first made on August 17, 2004 that it will, at its
discretion, purchase shares of our Class A common stock and Class B common stock at market prices prevailing from time to
time in the open market subject to the provisions of SEC Rule 10b-18 and in privately negotiated transactions. Such
announcement did not stipulate a maximum number of shares that may be purchased under this program.
-36-
Stock Performance Chart.
The following graph provides an indicator of cumulative total stockholder returns on our Class A common stock and our
Class B common stock for the period beginning on December 31, 2008 and ending on December 31, 2013, compared to the
Russell 2000 Index and a peer group comprised of seven property and casualty insurance companies over the same period. The
peer group consists of Cincinnati Financial Corp., EMC Insurance Group Inc., Hanover Insurance, Horace Mann Educators,
Selective Insurance Group Inc., State Auto Financial Corp. and United Fire and Casualty Co. The graph shows the change in
value of an initial $100 investment on December 31, 2008, assuming reinvestment of all dividends.
Donegal Group Inc. Class A
Donegal Group Inc. Class B
Russell 2000 Index
Peer Group
2008
$100.00
100.00
100.00
100.00
2009
$95.41
100.85
125.22
90.53
2010
$91.93
108.23
156.90
108.19
2011
$93.33
103.50
148.35
100.42
2012
$95.84
116.23
170.06
127.24
2013
$112.39
155.94
232.98
181.94
Value Line Publishing LLC prepared the foregoing performance graph and data. The performance graph and accompanying
data shall not be deemed "filed" as part of this Form 10-K Annual Report for purposes of Section 18 of the Exchange Act or
otherwise subject to the liabilities of that section and should not be deemed incorporated by reference into any other filing we
make under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent we specifically incorporate the
performance graph and accompanying data by reference into such filing.
-37-
Item 6. Selected Financial Data.
Year Ended December 31,
2013
2012
2011
2010
2009
Income Statement Data
Premiums earned
Investment income, net
Realized investment gains
Total revenues
Income (loss) before income taxes
(benefit)
Income taxes (benefit)
Net income
Basic earnings per share - Class A
Diluted earnings per share - Class A
Cash dividends per share - Class A
Basic earnings per share - Class B
Diluted earnings per share - Class B
Cash dividends per share - Class B
Balance Sheet Data at Year End
Total investments
Total assets
Debt obligations
Stockholders' equity
Book value per share
$ 515,291,944 $ 475,002,222 $ 431,470,184 $ 378,030,129 $ 355,025,477
18,795,239
20,168,919
20,858,179
19,949,714
20,630,583
2,423,442
6,859,439
12,281,267
4,395,720
4,479,558
547,110,065
514,982,585
475,017,619
408,549,446 386,733,407
32,710,265
27,858,260
6,388,273
4,765,640
26,321,992
23,092,620
(6,739,313)
(7,192,266)
452,953
9,844,149
(1,623,030)
11,467,179
20,676,689
1,846,611
18,830,078
1.04
1.02
0.51
0.94
0.94
0.46
0.92
0.91
0.49
0.83
0.83
0.44
0.02
0.02
0.48
0.01
0.01
0.43
0.46
0.46
0.46
0.41
0.41
0.41
0.76
0.76
0.45
0.68
0.68
0.40
$ 791,808,307 $ 806,429,032 $ 785,308,991 $ 728,541,814 $ 666,835,186
1,385,410,502 1,336,889,187 1,290,793,478 1,174,619,523 935,601,927
63,000,000
72,465,000
74,965,000
56,082,371
15,465,000
396,877,111
400,034,094
383,451,592
380,102,810 385,505,699
15.02
15.63
15.01
14.86
15.12
-38-
Item 7. Management's Discussion and Analysis of Results of Operations and Financial Condition.
Overview
Donegal Mutual Insurance Company (“Donegal Mutual”) organized us as an insurance holding company on August 26,
1986. See “Business - History and Organizational Structure” for more information. Our insurance subsidiaries, Atlantic States
Insurance Company (“Atlantic States”), Southern Insurance Company of Virginia (“Southern”), Le Mars Insurance Company
(“Le Mars”), The Peninsula Insurance Company and Peninsula Indemnity Company (collectively, “Peninsula”), Sheboygan
Falls Insurance Company (“Sheboygan Falls”) and Michigan Insurance Company (“MICO”) write personal and commercial
lines of property and casualty coverages exclusively through a network of independent insurance agents in certain Mid-
Atlantic, Midwest, New England and Southern states. The personal lines products of our insurance subsidiaries consist
primarily of homeowners and private passenger automobile policies. The commercial lines products of our insurance
subsidiaries consist primarily of commercial automobile, commercial multi-peril and workers' compensation policies. We also
own 48.2% of the outstanding stock of Donegal Financial Services Corporation (“DFSC”), a grandfathered unitary savings and
loan holding company. Donegal Mutual owns the remaining 51.8% of the outstanding stock of DFSC.
At December 31, 2013, Donegal Mutual held approximately 37% of our outstanding Class A common stock and
approximately 76% of our outstanding Class B common stock. This ownership provides Donegal Mutual with approximately
65% of the aggregate voting power of our outstanding shares of Class A common stock and our outstanding shares of Class B
common stock.
Donegal Mutual and Atlantic States entered into a proportional reinsurance agreement, or pooling agreement, effective
October 1, 1986. Under this pooling agreement, Donegal Mutual and Atlantic States pool and then share proportionately
substantially all of their respective premiums, losses and expenses. Atlantic States' participation in the pool has been 80% since
March 1, 2008. The operations of our insurance subsidiaries and Donegal Mutual are interrelated due to the pooling agreement
and other factors. While maintaining the separate corporate existence of each company, our insurance subsidiaries and Donegal
Mutual conduct business together as the Donegal Insurance Group. As such, Donegal Mutual and our insurance subsidiaries
share the same business philosophy, the same management, the same employees and the same facilities and offer the same
types of insurance products. See “Business - History and Organizational Structure” for more information regarding the pooling
agreement and other transactions with our affiliates.
In May 2011, DFSC and Union National Financial Corporation (“UNNF”) merged, with DFSC as the surviving company
in the merger. Under the merger agreement, Province Bank FSB, which DFSC owned, and Union National Community Bank,
which UNNF owned, also merged and began doing business as Union Community Bank FSB (“UCB”). UCB became a state
savings bank in 2013. UCB had 13 branch offices in Lancaster County, Pennsylvania, and $512.8 million in assets at December
31, 2013. Donegal Mutual contributed $22.1 million and we contributed $20.6 million to DFSC as additional capital to
facilitate the mergers. We use the equity method of accounting for our investment in DFSC. Under the equity method, we
record our investment at cost, with adjustments for our share of DFSC's earnings and losses as well as changes in DFSC's
equity due to DFSC's unrealized gains and losses.
In February 2009, our board of directors authorized a share repurchase program, pursuant to which we may purchase up to
300,000 shares of our Class A common stock at prices prevailing from time to time in the open market subject to the provisions
of Securities and Exchange Commission (“SEC”) Rule 10b-18 and in privately negotiated transactions. We purchased 24,240
and 135,064 shares of our Class A common stock under this program during 2013 and 2012, respectively. At December 31,
2013, we had the authority remaining to purchase 4,068 shares under this program.
On July 18, 2013, our board of directors authorized a share repurchase program pursuant to which we have the authority to
purchase up to 500,000 additional shares of our Class A common stock at prices prevailing from time to time in the open
market subject to the provisions of the SEC Rule 10b-18 and in privately negotiated transactions. We did not purchase shares
under this program during 2013.
At our annual meeting of stockholders on April 18, 2013, our stockholders approved an amendment to our certificate of
incorporation that increased the number of shares of our Class A common stock we have the authority to issue from 30.0
million shares to 40.0 million shares.
-39-
Critical Accounting Policies and Estimates
We combine our financial statements with those of our insurance subsidiaries and present them on a consolidated basis in
accordance with GAAP.
Our insurance subsidiaries make estimates and assumptions that can have a significant effect on amounts and disclosures
we report in our financial statements. The most significant estimates relate to the reserves of our insurance subsidiaries for
property and casualty insurance unpaid losses and loss expenses, valuation of investments and determination of other-than-
temporary investment impairments and the policy acquisition costs of our insurance subsidiaries. While we believe our
estimates and the estimates of our insurance subsidiaries are appropriate, the ultimate amounts may differ from the estimates
we provided. We regularly review our methods for making these estimates and we reflect any adjustment we consider necessary
in our current results of operations.
Liability for Losses and Loss Expenses
Liabilities for losses and loss expenses are estimates at a given point in time of the amounts an insurer expects to pay with
respect to policyholder claims based on facts and circumstances then known. At the time of establishing its estimates, an insurer
recognizes that its ultimate liability for losses and loss expenses will exceed or be less than such estimates. Our insurance
subsidiaries base their estimates of liabilities for losses and loss expenses on assumptions as to future loss trends, expected
claims severity, judicial theories of liability and other factors. However, during the loss adjustment period, our insurance
subsidiaries may learn additional facts regarding individual claims, and, consequently, it often becomes necessary for our
insurance subsidiaries to refine and adjust their estimates of liability. We reflect any adjustments to our insurance subsidiaries'
liabilities for losses and loss expenses in our consolidated results of operations in the period in which our insurance subsidiaries
make the changes in estimates.
Our insurance subsidiaries maintain liabilities for the payment of losses and loss expenses with respect to both reported
and unreported claims. Our insurance subsidiaries establish these liabilities for the purpose of covering the ultimate costs of
settling all losses, including investigation and litigation costs. Our insurance subsidiaries base the amount of their liability for
reported losses primarily upon a case-by-case evaluation of the type of risk involved, knowledge of the circumstances
surrounding each claim and the insurance policy provisions relating to the type of loss the policyholder incurred. Our insurance
subsidiaries determine the amount of their liability for unreported claims and loss expenses on the basis of historical
information by line of insurance. Our insurance subsidiaries account for inflation in the reserving function through analysis of
costs and trends and reviews of historical reserving results. Our insurance subsidiaries closely monitor their liabilities and
recompute them periodically using new information on reported claims and a variety of statistical techniques. Our insurance
subsidiaries do not discount their liabilities for losses.
Reserve estimates can change over time because of unexpected changes in assumptions related to our insurance
subsidiaries' external environment and, to a lesser extent, assumptions related to our insurance subsidiaries' internal operations.
For example, our insurance subsidiaries have experienced a decrease in claims frequency on workers' compensation claims
during the past several years while claims severity has gradually increased. These trend changes give rise to greater uncertainty
as to the pattern of future loss settlements on workers' compensation claims. Related uncertainties regarding future trends
include the cost of medical technologies and procedures and changes in the utilization of medical procedures. Assumptions
related to our insurance subsidiaries' external environment include the absence of significant changes in tort law and the legal
environment that increase liability exposure, consistency in judicial interpretations of insurance coverage and policy provisions
and the rate of loss cost inflation. Internal assumptions include consistency in the recording of premium and loss statistics,
consistency in the recording of claims, payment and case reserving methodology, accurate measurement of the impact of rate
changes and changes in policy provisions, consistency in the quality and characteristics of business written within a given line
of business and consistency in reinsurance coverage and collectability of reinsured losses, among other items. To the extent our
insurance subsidiaries determine that underlying factors impacting their assumptions have changed, our insurance subsidiaries
attempt to make appropriate adjustments for such changes in their reserves. Accordingly, our insurance subsidiaries' ultimate
liability for unpaid losses and loss expenses will likely differ from the amount recorded at December 31, 2013. For every 1%
change in our insurance subsidiaries' estimate for loss and loss expense reserves, net of reinsurance recoverable, the effect on
our pre-tax results of operations would be approximately $2.7 million.
The establishment of appropriate liabilities is an inherently uncertain process and we can provide no assurance that our
insurance subsidiaries' ultimate liability will not exceed our insurance subsidiaries' loss and loss expense reserves and have an
adverse effect on our results of operations and financial condition. Furthermore, we cannot predict the timing, frequency and
extent of adjustments to our insurance subsidiaries' estimated future liabilities, since the historical conditions and events that
serve as a basis for our insurance subsidiaries' estimates of ultimate claim costs may change. As is the case for substantially all
-40-
property and casualty insurance companies, our insurance subsidiaries have found it necessary in the past to increase their
estimated future liabilities for losses and loss expenses in certain periods and, in other periods, their estimates of future
liabilities have exceeded their actual liabilities. Changes in our insurance subsidiaries' estimate of their liability for losses and
loss expenses generally reflect actual payments and their evaluation of information received since the prior reporting date. Our
insurance subsidiaries recognized an increase (decrease) in their liability for losses and loss expenses of prior years of $10.4
million, $7.6 million and ($168,460) in 2013, 2012 and 2011, respectively. Our insurance subsidiaries made no significant
changes in their reserving philosophy, key reserving assumptions or claims management personnel, and have made no
significant offsetting changes in estimates that increased or decreased their loss and loss expense reserves in these years. The
2013 development represented 4.1% of the December 31, 2012 net carried reserves and resulted primarily from higher-than-
expected severity in the private passenger automobile liability, commercial multiple peril, commercial automobile and workers'
compensation lines of business in accident years prior to 2013.
Excluding the impact of weather events, our insurance subsidiaries have noted stable amounts in the number of claims
incurred and a slight downward trend in the number of claims outstanding at period ends relative to their premium base in
recent years across most of their lines of business. However, the amount of the average claim outstanding has increased
gradually over the past several years as the United States property and casualty insurance industry has experienced increased
litigation trends and economic conditions that have extended the estimated length of disabilities and contributed to increased
medical loss costs. We have also experienced a general slowing of settlement rates in litigated claims. Our insurance
subsidiaries could have to make further adjustments to their estimates in the future. However, on the basis of our insurance
subsidiaries' internal procedures, which analyze, among other things, their prior assumptions, their experience with similar
cases and historical trends such as reserving patterns, loss payments, pending levels of unpaid claims and product mix, as well
as court decisions, economic conditions and public attitudes, we believe that our insurance subsidiaries have made adequate
provision for their liability for losses and loss expenses.
Atlantic States' participation in the pool with Donegal Mutual exposes it to adverse loss development on the business of
Donegal Mutual that the pool includes. However, pooled business represents the predominant percentage of the net
underwriting activity of both companies, and Donegal Mutual and Atlantic States proportionately share any adverse risk
development of the pooled business. The business in the pool is homogeneous and each company has a pro-rata share of the
entire pool. Since substantially all of the business of Atlantic States and Donegal Mutual is pooled and the results shared by
each company according to its participation level under the terms of the pooling agreement, the intent of the underwriting pool
is to produce a more uniform and stable underwriting result from year to year for each company than either would experience
individually and to spread the risk of loss between the companies.
Our insurance subsidiaries' liability for losses and loss expenses by major line of business at December 31, 2013 and 2012
consisted of the following:
Commercial lines:
Automobile
Workers' compensation
Commercial multi-peril
Other
2013
2012
(in thousands)
$
36,017
$
32,012
79,932
39,822
2,716
67,715
39,645
4,142
Total commercial lines
158,487
143,514
Personal lines:
Automobile
Homeowners
Other
92,280
13,367
1,471
93,966
11,643
1,813
Total personal lines
107,118
107,422
Total commercial and personal lines
Plus reinsurance recoverable
265,605
230,014
250,936
207,891
Total liability for losses and loss expenses
$ 495,619
$ 458,827
-41-
We have evaluated the effect on our insurance subsidiaries' loss and loss expense reserves and our stockholders' equity in
the event of reasonably likely changes in the variables we consider in establishing loss and loss expense reserves. We
established the range of reasonably likely changes based on a review of changes in accident year development by line of
business and applied it to our insurance subsidiaries' loss reserves as a whole. The selected range does not necessarily indicate
what could be the potential best or worst case or the most-likely scenario. The following table sets forth the effect on our
insurance subsidiaries' loss and loss expense reserves and our stockholders' equity in the event of reasonably likely changes in
the variables considered in establishing loss and loss expense reserves:
Change in Loss and Loss
Expense Reserves Net of
Reinsurance
Adjusted Loss and Loss
Expense Reserves Net of
Reinsurance at
December 31, 2013
Percentage Change in
Equity at
December 31, 2013(1)
(dollars in thousands)
Adjusted Loss and Loss
Expense Reserves Net of
Reinsurance at
December 31, 2012
Percentage Change in
Equity at
December 31, 2012(1)
-10.0%
$239,045
4.4%
$225,842
4.1%
-7.5
-5.0
-2.5
Base
2.5
5.0
7.5
10.0
245,685
252,325
258,965
265,605
272,245
278,885
285,525
292,166
(1) Net of income tax effect.
3.3
2.2
1.1
—
-1.1
-2.2
-3.3
-4.4
232,116
238,389
244,663
250,936
257,209
263,483
269,756
276,030
3.1
2.0
1.0
—
-1.0
-2.0
-3.1
-4.1
Our insurance subsidiaries base their reserves for unpaid losses and loss expenses on current trends in loss and loss
expense development and reflect their best estimates for future amounts needed to pay losses and loss expenses with respect to
incurred events currently known to them plus incurred but not reported (“IBNR”) claims. Our insurance subsidiaries develop
their reserve estimates based on an assessment of known facts and circumstances, review of historical loss settlement patterns,
estimates of trends in claims severity, frequency, legal and regulatory changes and other assumptions. Our insurance
subsidiaries consistently apply actuarial loss reserving techniques and assumptions, which rely on historical information as
adjusted to reflect current conditions, including consideration of recent case reserve activity. Our insurance subsidiaries use the
most-likely number their actuaries determine. For the year ended December 31, 2013, the actuaries developed a range from a
low of $238.8 million to a high of $295.5 million and with a most-likely number of $265.6 million. The actuaries' range of
estimates for commercial lines in 2013 was $142.5 million to $176.2 million, and the actuaries selected the most-likely number
of $158.5 million. The actuaries' range of estimates for personal lines in 2013 was $96.2 million to $119.3 million, and the
actuaries selected the most-likely number of $107.1 million. For the year ended December 31, 2012, the actuaries developed a
range from a low of $228.7 million to a high of $275.3 million and with a most-likely number of $250.9 million. The actuaries'
range of estimates for commercial lines in 2012 was $130.9 million to $157.4 million, and the actuaries selected the most-likely
number of $143.5 million. The actuaries' range of estimates for personal lines in 2012 was $97.8 million to $117.9 million, and
the actuaries selected the most-likely number of $107.4 million.
Our insurance subsidiaries seek to enhance their underwriting results by carefully selecting the product lines they
underwrite. For personal lines products, our insurance subsidiaries insure standard and preferred risks in private passenger
automobile and homeowners lines. For commercial lines products, the commercial risks that our insurance subsidiaries
primarily insure are business offices, wholesalers, service providers, contractors, artisans and light manufacturing operations.
Our insurance subsidiaries have limited exposure to asbestos and other environmental liabilities. Our insurance subsidiaries
write no medical malpractice liability risks. Through the consistent application of this disciplined underwriting philosophy, our
insurance subsidiaries have avoided many of the “long-tail” issues other insurance companies have faced. We consider workers'
compensation to be a “long-tail” line of business, in that workers' compensation claims tend to be settled over a longer time
frame than those in the other lines of business of our insurance subsidiaries.
-42-
The following table presents 2013 and 2012 claim count and payment amount information for workers' compensation.
Workers' compensation losses primarily consist of indemnity and medical costs for injured workers.
Number of claims pending, beginning of period
(dollars in thousands)
Number of claims reported
Number of claims settled or dismissed
Number of claims pending, end of period
Losses paid
Loss expenses paid
Investments
For the Year Ended December 31,
2013
2012
2,345
6,869
6,605
2,609
2,430
6,114
6,199
2,345
$
32,419 $
7,365
30,860
6,518
We make estimates concerning the valuation of our investments and the recognition of other-than-temporary declines in the
value of our investments. For equity securities, we write down the investment to its fair value and we reflect the amount of the
write-down as a realized loss in our results of operations when we consider the decline in value of an individual investment to
be other than temporary. We individually monitor all investments for other-than-temporary declines in value. Generally, we
assume there has been an other-than-temporary decline in value if an individual equity security has depreciated in value by
more than 20% of original cost and has been in such an unrealized loss position for more than six months. We held four equity
securities that were in an unrealized loss position at December 31, 2013. Based upon our analysis of general market conditions
and underlying factors impacting these equity securities, we considered these declines in value to be temporary. With respect to
a debt security that is in an unrealized loss position, we first assess if we intend to sell the debt security. If we determine we
intend to sell the debt security, we recognize the impairment loss in our results of operations. If we do not intend to sell the debt
security, we determine whether it is more likely than not that we will be required to sell the security prior to recovery. If we
determine it is more likely than not that we will be required to sell the debt security prior to recovery, we recognize an
impairment loss in our results of operations. If we determine it is more likely than not that we will not be required to sell the
debt security prior to recovery, we then evaluate whether a credit loss has occurred. We determine whether a credit loss has
occurred by comparing the amortized cost of the debt security to the present value of the cash flows we expect to collect. If we
expect a cash flow shortfall, we consider that a credit loss has occurred. If we determine that a credit loss has occurred, we
consider the impairment to be other than temporary. We then recognize the amount of the impairment loss related to the credit
loss in our results of operations, and we recognize the remaining portion of the impairment loss in our other comprehensive
income, net of applicable taxes. In addition, we may write down securities in an unrealized loss position based on a number of
other factors, including when the fair value of an investment is significantly below its cost, when the financial condition of the
issuer of a security has deteriorated, the occurrence of industry, company or geographic events that have negatively impacted
the value of a security and rating agency downgrades. We held 216 debt securities that were in an unrealized loss position at
December 31, 2013. Based upon our analysis of general market conditions and underlying factors impacting these debt
securities, we considered these declines in value to be temporary. We did not recognize any impairment losses in 2013, 2012 or
2011.
We held fixed maturities and equity securities with unrealized losses representing declines that we considered temporary at
December 31, 2013 as follows:
U.S. Treasury securities and obligations of U.S.
government corporations and agencies
$ 50,802,809 $
821,941 $ 4,642,775 $
104,331
Less than 12 months
12 months or longer
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
Obligations of states and political subdivisions
65,170,891
363,240 13,404,781
Corporate securities
Mortgage-backed securities
Equity securities
Totals
98,676
71,802
16,693,759
83,535
6,851,898
72,878,347
535,944 19,013,889
213,414
1,628,893
92,867
—
—
$ 207,174,699 $ 1,897,527 $43,913,343 $
488,223
-43-
We held fixed maturities and equity securities with unrealized losses representing declines that we considered temporary at
December 31, 2012 as follows:
Less than 12 months
12 months or longer
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
U.S. Treasury securities and obligations of U.S.
government corporations and agencies
$ 12,308,333 $
43,951 $
Obligations of states and political subdivisions
22,134,226
606,065
— $
—
—
—
Corporate securities
Mortgage-backed securities
Equity securities
Totals
12,271,750
79,136
2,958,520
29,573
22,491,562
66,443
2,226,050
106,748
—
—
—
—
$ 71,431,921 $
902,343 $ 2,958,520 $
29,573
We present our investments in available-for-sale fixed maturity and equity securities at estimated fair value. The estimated
fair value of a security may differ from the amount that could be realized if we sold the security in a forced transaction. In
addition, the valuation of fixed maturity investments is more subjective when markets are less liquid, increasing the potential
that the estimated fair value does not reflect the price at which an actual transaction would occur. We utilize nationally
recognized independent pricing services to estimate fair values or obtain market quotations for substantially all of our fixed
maturity and equity investments. We generally obtain one price per security. The pricing services utilize market quotations for
fixed maturity and equity securities that have quoted prices in active markets. For fixed maturity securities that generally do not
trade on a daily basis, the pricing services prepare estimates of fair value measurements based predominantly on observable
market inputs. The pricing services do not use broker quotes in determining the fair values of our investments. Our investment
personnel review the estimates of fair value the pricing services provide to determine if the estimates we obtain are
representative of fair values based upon their general knowledge of the market, their research findings related to unusual
fluctuations in value and their comparison of such values to execution prices for similar securities. Our investment personnel
monitor the market and are familiar with current trading ranges for similar securities and pricing of specific investments. Our
investment personnel review all pricing estimates that we receive from the pricing services against their expectations with
respect to pricing based on fair market curves, security ratings, coupon rates, security type and recent trading activity. Our
investment personnel review documentation with respect to the pricing services’ pricing methodology that they obtain
periodically to determine if the primary pricing sources, market inputs and pricing frequency for various security types are
reasonable. At December 31, 2013 and 2012, we received one estimate per security from one of the pricing services, and we
priced substantially all of our Level 1 and Level 2 investments using those prices. In our review of the estimates the pricing
services provided at December 31, 2013 and 2012, we did not identify any discrepancies, and we did not make any adjustments
to the estimates the pricing services provided.
We had no sales or transfers from the held to maturity portfolio in 2013, 2012 or 2011.
Policy Acquisition Costs
We defer our insurance subsidiaries' policy acquisition costs, consisting primarily of commissions, premium taxes and
certain other underwriting costs, reduced by ceded commissions, that vary with and relate directly to the production of
business. We amortize these costs over the period in which our insurance subsidiaries earn the premiums on that business. The
method our insurance subsidiaries follow in computing deferred policy acquisition costs limits the amount of such deferred
costs to their estimated realizable value, which gives effect to the premium to be earned, related investment income, losses and
loss expenses and certain other costs we expect to incur as our insurance subsidiaries earn the premium.
Management Evaluation of Operating Results
Despite headwinds from economic uncertainty, challenging insurance market conditions and unusually adverse weather
conditions that affected our results in recent years, we believe that our focused business strategy, including our insurance
subsidiaries' disciplined underwriting practices, have positioned us well for 2014 and beyond.
The property and casualty insurance industry is highly cyclical, and individual lines of business experience their own
cycles within the overall property and casualty insurance industry cycle. Premium rate levels relate to the availability of
insurance coverage, which varies according to the level of surplus in the insurance industry and other factors. The level of
surplus in the industry varies with returns on capital and regulatory barriers to the withdrawal of surplus. Increases in surplus
have generally been accompanied by increased price competition among property and casualty insurers. If our insurance
-44-
subsidiaries were to find it necessary to reduce premiums or limit premium increases due to competitive pressures on pricing,
our insurance subsidiaries could experience a reduction in profit margins and revenues, an increase in ratios of losses and
expenses to premiums and, therefore, lower profitability. The cyclicality of the insurance market and its potential impact on our
results is difficult to predict with any significant reliability. We evaluate the performance of our commercial lines and personal
lines segments primarily based upon the underwriting results of our insurance subsidiaries as determined under statutory
accounting practices (“SAP”), which our management uses to measure performance for the total business of our insurance
subsidiaries.
-45-
We use the following financial data to monitor and evaluate our operating results:
(in thousands)
Net premiums written:
Personal lines:
Automobile
Homeowners
Other
Total personal lines
Commercial lines:
Automobile
Workers' compensation
Commercial multi-peril
Other
Total commercial lines
Year Ended December 31,
2013
2012
2011
$ 196,363
$ 195,132
$ 186,677
106,420
15,915
318,698
58,165
77,589
74,516
4,463
97,120
16,319
89,405
14,983
308,571
291,065
51,261
65,390
64,476
6,749
46,168
51,849
57,988
6,981
214,733
187,876
162,986
Total net premiums written
$ 533,431
$ 496,447
$ 454,051
Components of GAAP combined ratio:
Loss ratio
Expense ratio
Dividend ratio
GAAP combined ratio
Revenues:
Premiums earned:
Personal lines
Commercial lines
SAP premiums earned
GAAP adjustments
GAAP premiums earned
Net investment income
Realized investment gains
Equity in earnings of DFSC
Other
Total revenues
66.6%
31.8
0.4
70.1%
31.2
0.3
78.9%
31.4
0.3
98.8%
101.6%
110.6%
$ 312,309
$ 300,272
$ 282,498
202,983
515,292
—
515,292
18,795
2,423
2,908
7,692
174,735
475,007
(5)
475,002
20,169
6,859
4,533
8,420
152,247
434,745
(3,275)
431,470
20,858
12,281
2,023
8,386
$ 547,110
$ 514,983
$ 475,018
-46-
(in thousands)
Components of net income:
Underwriting income (loss):
Personal lines
Commercial lines
SAP underwriting income (loss)
GAAP adjustments
GAAP underwriting income (loss)
Net investment income
Realized investment gains
Equity in earnings of DFSC
Other
Income (loss) before income tax (expense) benefit
Income tax (expense) benefit
Net income
Statutory Combined Ratios
Year Ended December 31,
2013
2012
2011
$
$
1,654
(524)
1,130
5,175
6,305
18,795
2,423
2,908
2,279
32,710
(6,388)
26,322
$
$
(18,236) $
5,251
(12,985)
5,545
(7,440)
20,169
6,859
4,533
3,737
27,858
(4,765)
23,093
$
(40,739)
(6,560)
(47,299)
1,532
(45,767)
20,858
12,281
2,023
3,866
(6,739)
7,192
453
We evaluate our insurance operations by monitoring certain key measures of growth and profitability. In addition to using
GAAP-based performance measurements, we also utilize certain non-GAAP financial measures that we believe are valuable in
managing our business and for comparison to our peers. These non-GAAP measures are underwriting (loss) income, statutory
combined ratio and net premiums written. An insurance company's statutory combined ratio is a standard measure of
underwriting profitability. This ratio is the sum of the ratio of calendar-year incurred losses and loss expenses to premiums
earned; the ratio of expenses incurred for commissions, premium taxes and underwriting expenses to premiums written and the
ratio of dividends to policyholders to premiums earned. The statutory combined ratio does not reflect investment income,
federal income taxes or other non-operating income or expense. A ratio of less than 100 percent generally indicates
underwriting profitability. The statutory combined ratio differs from the GAAP combined ratio. In calculating the GAAP
combined ratio, installment payment fees are not deducted from incurred expenses and the expense ratio is based on premiums
earned instead of premiums written. The following table sets forth our insurance subsidiaries' statutory combined ratios by
major line of business for the years ended December 31, 2013, 2012 and 2011:
Year Ended December 31,
2013
2012
2011
104.9%
94.5%
105.4%
96.9
92.9
NM1
95.7
103.2
93.0
80.5
98.8
97.4
98.1
90.5
15.0
91.2
108.1
100.9
89.4
105.0
99.8
96.0
103.0
46.1
99.0
106.9
126.3
103.6
112.6
107.9
Commercial lines:
Automobile
Workers' compensation
Commercial multi-peril
Other
Total commercial lines
Personal lines:
Automobile
Homeowners
Other
Total personal lines
Total commercial and personal lines
_____________
1Not meaningful
-47-
Results of Operations
YEAR ENDED DECEMBER 31, 2013 COMPARED TO YEAR ENDED DECEMBER 31, 2012
Net Premiums Written
Our insurance subsidiaries' 2013 net premiums written increased 7.5% to $533.4 million, compared to $496.4 million for
2012. We primarily attribute the increase to a reduction in MICO’s quota-share reinsurance, the impact of premium rate
increases and an increase in the writing of commercial lines of insurance. Effective January 1, 2013, MICO reduced its external
quota-share reinsurance percentage from 40% to 30%. Commercial lines net premiums written increased $26.6 million, or
14.1%, for 2013 compared to 2012. The increase includes $5.6 million related to the reduction in the amount of premium
MICO reinsured in 2013, with the remainder attributable to increased writings of new accounts in the commercial automobile,
commercial multi-peril and workers' compensation lines of business. Personal lines net premiums written increased
$10.4 million, or 3.4%, for 2013 compared to 2012. The increase includes $4.2 million resulting from the reduction in the
amount of premium MICO reinsured in 2013, with the remainder primarily attributable to premium rate increases our
subsidiaries implemented throughout 2012 and 2013 and reduced reinsurance reinstatement premiums.
Net Premiums Earned
Our insurance subsidiaries' net premiums earned increased to $515.3 million for 2013, an increase of $40.3 million, or
8.5%, over 2012, reflecting increases in net premiums written during 2012 and 2013. Our insurance subsidiaries earn premiums
and recognize them as income over the terms of the policies they issue. Such terms are generally one year or less in duration.
Therefore, increases or decreases in net premiums earned generally reflect increases or decreases in net premiums written in the
preceding twelve-month period compared to the same period one year earlier.
Investment Income
For 2013, our net investment income was $18.8 million, a $1.4 million decrease from 2012. An increase in our average
invested assets from $795.9 million in 2012 to $799.1 million in 2013 was offset by a decrease in our annualized average rate
of return to 2.4% in 2013, compared to 2.5% in 2012.
Installment Payment Fees
Our insurance subsidiaries' installment fees decreased primarily as a result of their customers' increased usage of payment
plans that have lower installment payment fees during 2013.
Net Realized Investment Gains/Losses
Our net realized investment gains in 2013 and 2012 were $2.4 million and $6.9 million, respectively. The net realized
investment gains in 2013 and 2012 resulted from normal turnover within our investment portfolio. We did not recognize any
impairment losses during 2013 or 2012.
Equity in Earnings of DFSC
Our equity in the earnings of DFSC in 2013 and 2012 was $2.9 million and $4.5 million, respectively. The decrease in
DFSC’s earnings resulted from a lesser benefit from acquisition accounting adjustments and lower net realized gains during
2013 compared to 2012.
Losses and Loss Expenses
Our insurance subsidiaries' loss ratio, which is the ratio of incurred losses and loss expenses to premiums earned, was
66.6% in 2013, compared to 70.1% in 2012. Our insurance subsidiaries' commercial lines loss ratio increased to 67.1% in 2013,
compared to 65.5% in 2012. This increase resulted primarily from the commercial automobile loss ratio increasing to 73.0% in
2013, compared to 63.8% in 2012, and the commercial multi-peril ratio increasing to 61.5% in 2013, compared to 60.2% in
2012. The personal lines loss ratio decreased to 66.3% in 2013, compared to 72.8% in 2012, primarily as a result of a decrease
in the homeowners loss ratio to 57.7% in 2013, compared to 66.1% in 2012, as a result of a decrease in weather-related claims.
Our insurance subsidiaries experienced unfavorable loss reserve development of approximately $10.4 million during 2013 in
their reserves for prior accident years, compared to unfavorable loss reserve development of approximately $7.6 million during
-48-
2012. The change in loss reserve development patterns occurred primarily within our insurance subsidiaries’ workers’
compensation, commercial automobile, commercial multi-peril and personal automobile reserves.
Underwriting Expenses
Our insurance subsidiaries' expense ratio, which is the ratio of policy acquisition and other underwriting expenses to
premiums earned, was 31.8% in 2013, compared to 31.2% in 2012.
Combined Ratio
Our insurance subsidiaries' combined ratio was 98.8% and 101.6% in 2013 and 2012, respectively. The combined ratio
represents the sum of the loss ratio, the expense ratio and the dividend ratio, which is the ratio of workers' compensation policy
dividends incurred to premiums earned.
Interest Expense
Our interest expense in 2013 was $1.6 million, compared to $2.4 million in 2012. The decrease was related to a lower
average interest rate on borrowings during 2013 compared to 2012 due to the utilization of Federal Home Loan Bank
(“FHLB”) borrowings to prepay $15.5 million of subordinated debentures during the first quarter of 2013.
Income Taxes
Our income tax expense was $6.4 million in 2013, compared to $4.8 million in 2012. Our effective tax rate for 2013 was
19.5%, compared to 17.1% for 2012. The change in effective tax rates is primarily due to tax-exempt interest income
representing a smaller proportion of income before income tax expense in 2013 compared to 2012.
Net Income and Earnings Per Share
Our net income in 2013 was $26.3 million, or $1.02 per share of Class A common stock on a diluted basis and $.94 per
share of Class B common stock, compared to $23.1 million, or $.91 per share of Class A common stock on a diluted basis and
$.83 per share of Class B common stock, in 2012. We had 20.8 million and 20.0 million Class A shares outstanding at
December 31, 2013 and 2012, respectively. We had 5.6 million Class B shares outstanding for both periods. There are no
outstanding securities that dilute our shares of Class B common stock.
Book Value Per Share and Return on Equity
Our stockholders' equity decreased by $3.2 million in 2013. We attribute the decrease to net after-tax unrealized losses
within our available-for-sale fixed maturity investment portfolio during 2013. Book value per share decreased to $15.02 at
December 31, 2013, compared to $15.63 a year earlier. Our return on average equity was 6.6% for 2013, compared to 5.9% for
2012.
YEAR ENDED DECEMBER 31, 2012 COMPARED TO YEAR ENDED DECEMBER 31, 2011
Net Premiums Written
Our insurance subsidiaries' 2012 net premiums written increased 9.3% to $496.4 million, compared to $454.1 million for
2011. We primarily attribute the increase to a change in MICO’s quota-share reinsurance, the impact of premium rate increases
and an increase in the writing of commercial lines of insurance. Effective January 1, 2012, MICO reduced its external quota-
share reinsurance percentage from 50% to 40%. Commercial lines net premiums written increased $26.7 million, or 16.5%, for
2012 compared to 2011. The increase includes $5.3 million related to the reduction in the amount of premium MICO reinsured
in 2012, with the remainder attributable to increased writings of new accounts in the commercial automobile, commercial
multi-peril and workers' compensation lines of business. Personal lines net premiums written increased $15.7 million, or 5.4%,
for 2012 compared to 2011. The increase includes $4.6 million resulting from the reduction in the amount of premium MICO
reinsured in 2012, with the remainder primarily attributable to premium rate increases our subsidiaries implemented throughout
2011 and 2012 and reduced reinsurance reinstatement premiums.
-49-
Net Premiums Earned
Our insurance subsidiaries' net premiums earned increased to $475.0 million for 2012, an increase of $43.5 million, or
10.1%, over 2011, reflecting increases in net premiums written during 2011 and 2012. Our insurance subsidiaries earn
premiums and recognize them as income over the terms of the policies they issue. Such terms are generally one year or less in
duration. Therefore, increases or decreases in net premiums earned generally reflect increases or decreases in net premiums
written in the preceding twelve-month period compared to the same period one year earlier.
Investment Income
For 2012, our net investment income was $20.2 million, a slight decrease from 2011. An increase in our average invested
assets from $756.9 million in 2011 to $795.9 million in 2012 was offset by a decrease in our annualized average rate of return
to 2.5% in 2012, compared to 2.8% in 2011.
Installment Payment Fees
Our insurance subsidiaries' installment fees increased primarily as a result of increases in policy counts during 2012.
Net Realized Investment Gains/Losses
Our net realized investment gains in 2012 and 2011 were $6.9 million and $12.3 million, respectively. The net realized
investment gains in 2012 resulted from normal turnover within our investment portfolio. The net realized investment gains for
2011 included $8.0 million in gains that resulted from the previously planned periodic sales of a portion of our holdings of an
equity security that we obtained in an initial public offering and for which a selling restriction expired during 2011. We did not
recognize any impairment losses during 2012 or 2011.
Equity in Earnings of DFSC
Our equity in the earnings of DFSC in 2012 and 2011 was $4.5 million and $2.0 million, respectively. The increase in
DFSC's earnings reflects the impact of the merger of UNNF and DFSC.
Losses and Loss Expenses
Our insurance subsidiaries' loss ratio, which is the ratio of incurred losses and loss expenses to premiums earned, was
70.1% in 2012, compared to 78.9% in 2011. Our insurance subsidiaries' commercial lines loss ratio decreased to 65.5% in
2012, compared to 71.8% in 2011. This decrease resulted primarily from the commercial automobile loss ratio decreasing to
63.8% in 2012, compared to 72.4% in 2011, and the commercial multi-peril ratio decreasing to 60.2% in 2012, compared to
74.8% in 2011, as a result of decreased claim severity. The personal lines loss ratio decreased to 72.8% in 2012, compared to
82.8% in 2011, primarily as a result of a decrease in the homeowners loss ratio to 66.1% in 2012, compared to 97.1% in 2011,
as a result of a decrease in weather-related claims. Our insurance subsidiaries experienced unfavorable loss reserve
development of approximately $7.6 million during 2012 in their reserves for prior accident years, compared to virtually no
development for 2011. The change in loss reserve development patterns occurred primarily within our insurance subsidiaries’
workers’ compensation and personal automobile reserves.
Underwriting Expenses
Our insurance subsidiaries' expense ratio, which is the ratio of policy acquisition and other underwriting expenses to
premiums earned, was 31.2% in 2012, compared to 31.4% in 2011.
Combined Ratio
Our insurance subsidiaries' combined ratio was 101.6% and 110.6% in 2012 and 2011, respectively. The combined ratio
represents the sum of the loss ratio, expense ratio and dividend ratio, which is the ratio of workers' compensation policy
dividends incurred to premiums earned.
Interest Expense
Our interest expense in 2012 was $2.4 million, compared to $2.1 million in 2011. The higher interest expense in 2012
reflected an increase in our borrowings under our line of credit.
-50-
Income Taxes
Our income tax expense was $4.8 million in 2012, compared to a tax benefit of $7.2 million in 2011. Our effective tax rate
for 2012 was 17.1%.
Net Income and Earnings Per Share
Our net income in 2012 was $23.1 million, or $.91 per share of Class A common stock on a diluted basis and $.83 per
share of Class B common stock, compared to $452,953, or $.02 per share of Class A common stock on a diluted basis and $.01
per share of Class B common stock, in 2011. We had 20.0 million Class A shares and 5.6 million Class B shares outstanding for
both periods. There are no outstanding securities that dilute our shares of Class B common stock.
Book Value Per Share and Return on Equity
Our stockholders' equity increased by $16.6 million in 2012. We attribute the increase to our net income of $23.1 million
and an increase in our net after-tax unrealized gains within our available-for-sale fixed maturity and equity investment portfolio
from $23.5 million at December 31, 2011 to $26.4 million at December 31, 2012. Book value per share increased by 4.1% to
$15.63 at December 31, 2012, compared to $15.01 a year earlier. Our return on average equity was 5.9% for 2012, compared to
0.1% for 2011.
Financial Condition
Liquidity and Capital Resources
Liquidity is a measure of an entity's ability to secure enough cash to meet its contractual obligations and operating needs as
they arise. Our major sources of funds from operations are the net cash flows generated from our insurance subsidiaries'
underwriting results, investment income and maturing investments.
We have historically generated sufficient net positive cash flow from our operations to fund our commitments and build
our investment portfolio, thereby increasing future investment returns. The pooling agreement with Donegal Mutual historically
has been cash flow positive because of the profitability of the underwriting pool. Because we settle the pool monthly, cash
flows are substantially similar to cash flows that would result from the underwriting of direct business. We maintain a high
degree of liquidity in our investment portfolio in the form of marketable fixed maturities, equity securities and short-term
investments. We structure our fixed-maturity investment portfolio following a “laddering” approach so that projected cash
flows from investment income and principal maturities are evenly distributed from a timing perspective. This laddering
provides an additional measure of liquidity to meet our obligations and the obligations of our insurance subsidiaries should an
unexpected variation occur in the future. Net cash flows provided by operating activities in 2013, 2012 and 2011 were
$46.0 million, $25.0 million and $21.1 million, respectively.
In June 2013, we renewed our existing credit agreement with Manufacturers and Traders Trust Company (“M&T”) relating
to a $60.0 million unsecured, revolving line of credit. The line of credit now expires in July 2016. We have the right to request
a one-year extension of the credit agreement as of each anniversary date of the agreement. At December 31, 2013, we had
$43.0 million in outstanding borrowings and had the ability to borrow an additional $17.0 million at interest rates equal to
M&T’s current prime rate or the then current LIBOR rate plus 2.25%. The interest rate on our outstanding borrowings is
adjustable quarterly. At December 31, 2013, the interest rate on our outstanding borrowings was 2.42%. We pay a fee of 0.2%
per annum on the loan commitment amount regardless of usage. The credit agreement requires our compliance with certain
covenants. These covenants include minimum levels of our net worth, leverage ratio, statutory surplus and the A.M. Best
ratings of our insurance subsidiaries. We complied with all requirements of the credit agreement during 2013.
MICO has an agreement with the FHLB of Indianapolis. Through its membership, MICO has the ability to issue debt to
the FHLB of Indianapolis in exchange for cash advances. There were no outstanding borrowings at December 31, 2013 or
2012.
Atlantic States is a member of the FHLB of Pittsburgh. Through its membership, Atlantic States has the ability to issue
debt to the FHLB of Pittsburgh in exchange for cash advances. During 2013, Atlantic States issued secured debt in the principal
amount of $15.0 million to the FHLB of Pittsburgh in exchange for cash advances in the amount of $15.0 million. The interest
-51-
rate on the advances was .26% at December 31, 2013. Atlantic States then loaned $15.0 million to us. We used the proceeds of
our loan from Atlantic States to fund our prepayment of our subordinated debentures. Atlantic States had no outstanding
borrowings with the FHLB of Pittsburgh at December 31, 2012.
The following table shows expected payments for our significant contractual obligations at December 31, 2013:
(in thousands)
Net liability for unpaid losses and loss expenses of our
insurance subsidiaries
Subordinated debentures
Borrowings under line of credit
Total contractual obligations
Total
Less than 1
year
1-3 years
4-5 years
After 5
years
$ 265,605 $ 125,781 $ 118,706 $
9,713 $
11,405
5,000
—
—
58,000
15,000
43,000
—
—
5,000
—
$ 328,605 $ 140,781 $ 161,706 $
9,713 $
16,405
We estimated the timing of the amounts for the net liability for unpaid losses and loss expenses of our insurance
subsidiaries based on historical experience and expectations of future payment patterns. We have shown the liability net of
reinsurance recoverable on unpaid losses and loss expenses to reflect expected future cash flows related to such liability.
Assumed amounts from the underwriting pool with Donegal Mutual represent a substantial portion of our insurance
subsidiaries' gross liability for unpaid losses and loss expenses, and ceded amounts to the underwriting pool represent a
substantial portion of our insurance subsidiaries' reinsurance recoverable on unpaid losses and loss expenses. We include cash
settlements of Atlantic States' assumed liability from the pool in our monthly settlements of pooled activity. In these monthly
settlements, we net amounts ceded to and assumed from the pool. Although Donegal Mutual and Atlantic States do not
anticipate any further changes in the pool participation levels in the foreseeable future, any such change would be prospective
in nature and therefore would not impact the timing of expected payments for Atlantic States' proportionate liability for pooled
losses occurring in periods prior to the effective date of such change.
We estimated the timing of the amounts for the borrowings under our lines of credit based on their contractual maturities
that we discuss in Note 9 - Borrowings. Our borrowings under our lines of credit carry interest rates that vary as discussed in
Note 9 - Borrowings. Based upon the interest rates in effect at December 31, 2013, our annual interest cost associated with our
borrowings under our lines of credit is approximately $1.1 million. For every 1% change in the interest rate associated with our
borrowings under our lines of credit, the effect on our annual interest cost would be approximately $580,000.
Cash dividends declared to stockholders totaled $13.0 million, $12.3 million and $12.0 million in 2013, 2012 and 2011,
respectively. There are no regulatory restrictions on our payment of dividends to our stockholders, although there are state law
restrictions on the payment of dividends from our insurance subsidiaries to us. Our insurance subsidiaries are required by law
to maintain certain minimum surplus on a statutory basis and are subject to regulations under which their payment of dividends
from statutory surplus is restricted and may require prior approval of their domiciliary insurance regulatory authorities. Our
insurance subsidiaries are subject to risk-based capital (“RBC”) requirements. The amount of statutory capital and surplus
necessary for our insurance subsidiaries to satisfy regulatory requirements, including the RBC requirements, was not significant
in relation to our insurance subsidiaries' statutory capital and surplus at December 31, 2013. In 2014, amounts available for
distribution as dividends to us from our insurance subsidiaries without prior approval of their domiciliary insurance regulatory
authorities are $18.7 million from Atlantic States, $4.2 million from Southern, $2.8 million from Le Mars, $4.2 million from
Peninsula, $1.1 million from Sheboygan and $4.1 million from MICO, or a total of approximately $35.1 million.
.
-52-
Investments
At December 31, 2013 and 2012, our investment portfolio of primarily investment-grade bonds, common stock, short-term
investments and cash totaled $819.4 million and $826.2 million, respectively, representing 59.1% and 61.8%, respectively, of
our total assets (see “Business - Investments” for more information).
2013
December 31,
2012
2011
Percent of
Percent of
Percent of
Amount
Total
Amount
Total
Amount
Total
(dollars in thousands)
Fixed maturities:
Total held to maturity
$ 240,370
30.4% $
42,100
5.2% $
58,490
7.4%
Total available for sale
Total fixed maturities
Equity securities
Investments in affiliates
Short-term investments
403,652
644,022
12,423
35,685
99,678
51.0
81.4
1.5
4.5
12.6
694,510
736,610
8,757
37,236
23,826
86.1
91.3
1.1
4.6
3.0
646,598
705,088
7,438
32,322
40,461
82.3
89.7
1.0
4.1
5.2
Total investments
$ 791,808
100.0% $ 806,429
100.0% $ 785,309
100.0%
The carrying value of our fixed maturity investments represented 81.4% and 91.3% of our total invested assets at
December 31, 2013 and 2012, respectively.
Our fixed maturity investments consisted of high-quality marketable bonds, of which 100.0% and 99.0% were rated at
investment-grade levels at December 31, 2013 and 2012, respectively.
At December 31, 2013, the net unrealized gain on available-for-sale fixed maturity investments, net of deferred taxes,
amounted to $8.7 million, compared to $25.6 million at December 31, 2012.
At December 31, 2013, the net unrealized gain on our equity securities, net of deferred taxes, amounted to $165,573,
compared to $61,149 at December 31, 2012.
Impact of Inflation
Our insurance subsidiaries establish their property and casualty insurance premium rates before they know the amount of
losses and loss settlement expenses or the extent to which inflation may impact such expenses. Consequently, our insurance
subsidiaries attempt, in establishing rates, to anticipate the potential impact of inflation.
Impact of New Accounting Standards
In February 2013, the Financial Accounting Standards Board (“FASB”) issued guidance that requires an entity to provide
information about amounts it reclassifies out of accumulated other comprehensive income. If GAAP requires an entity to
reclassify amounts out of accumulated other comprehensive income to net income in their entirety in the same reporting period,
the guidance requires an entity to present significant amounts it reclassifies out of accumulated other comprehensive income by
the respective line items of net income, either on the face of the statement where the entity presents net income or in the notes
to the entity’s financial statements,. For other amounts that GAAP does not require an entity to reclassify to net income in their
entirety, the guidance requires an entity to cross-reference such amounts to other disclosures GAAP requires that provide
additional detail about those amounts. The guidance was effective for interim and annual reporting periods after December 15,
2012. We adopted this new guidance as of January 1, 2013. Our adoption of this new guidance did not impact our financial
position, results of operations or cash flows.
-53-
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
We are exposed to the impact of interest rate changes, to changes in fair values of investments and to credit risk.
In the normal course of business, we employ established policies and procedures to manage our exposure to changes in
interest rates, fluctuations in the fair market value of our debt and equity securities and credit risk. We seek to mitigate these
risks by various actions described below.
Interest Rate Risk
Our exposure to market risk for a change in interest rates is concentrated in our investment portfolio. We monitor this
exposure through periodic reviews of our asset and liability positions. We regularly monitor estimates of cash flows and the
impact of interest rate fluctuations relating to the investment portfolio. Generally, we do not hedge our exposure to interest rate
risk because we have the capacity to, and do, hold fixed maturity investments to maturity.
Principal cash flows and related weighted-average interest rates by stated maturity dates for financial instruments sensitive
to interest rates at December 31, 2013 are as follows:
(in thousands)
Fixed maturity and short-term investments:
2014
2015
2016
2017
2018
Thereafter
Total
Fair value
Debt:
2014
2015
Thereafter
Total
Fair value
Principal
Cash Flows
Weighted-
Average
Interest Rate
$
107,794
0.38%
4.35
4.05
3.88
4.38
3.62
0.26%
2.42
5.00
9,664
13,265
20,015
21,535
569,970
742,243
742,120
15,000
43,000
5,000
63,000
63,000
$
$
$
$
$
Actual cash flows from investments may differ from those depicted above as a result of calls and prepayments.
Equity Price Risk
Our portfolio of equity securities, which we carry on our consolidated balance sheets at estimated fair value, has exposure
to price risk, which is the risk of potential loss in estimated fair value resulting from an adverse change in prices. Our objective
is to earn competitive relative returns by investing in a diverse portfolio of high-quality, liquid securities.
Credit Risk
Our objective is to earn competitive returns by investing in a diversified portfolio of securities. Our portfolio of fixed
maturity securities and, to a lesser extent, short-term investments is subject to credit risk. We define this risk as the potential
loss in fair value resulting from adverse changes in the borrower's ability to repay the debt. We manage this risk by performing
an analysis of prospective investments and through regular reviews of our portfolio by our investment staff. We also limit the
amount of our total investment portfolio that we invest in any one security.
-54-
Our insurance subsidiaries provide property and liability insurance coverages through independent insurance agencies
located throughout their operating areas. Our insurance subsidiaries bill the majority of this business directly to the insured,
although our insurance subsidiaries bill a portion of their commercial business through their agents, to whom they extend credit
in the normal course of business.
Because the pooling agreement does not relieve Atlantic States of primary liability as the originating insurer, Atlantic
States is subject to a concentration of credit risk arising from business ceded to Donegal Mutual. Our insurance subsidiaries
maintain reinsurance agreements with Donegal Mutual and with a number of other major unaffiliated authorized reinsurers.
Through November 30, 2010, MICO and West Bend were parties to quota-share reinsurance agreements whereby MICO
ceded 75% of its business to West Bend. MICO and West Bend terminated the reinsurance agreement in effect at
November 30, 2010 on a run-off basis. West Bend's obligations related to all past reinsurance agreements with MICO remain in
effect for all policies with effective dates prior to December 1, 2010. West Bend and MICO entered into a trust agreement on
December 1, 2010. Under the terms of the trust agreement, West Bend placed into trust, for the sole benefit of MICO, assets
with a fair value equal to the amount of unearned premiums and unpaid losses and loss expenses, reduced by any net premium
balances not yet paid by MICO, that West Bend had assumed pursuant to such reinsurance agreements at November 30, 2010.
The amount of assets required to be held in trust adjusts monthly based upon the remaining net obligations of West Bend. West
Bend may terminate the trust agreement on the earlier of December 1, 2020 or the date on which the obligations of West Bend
are equal to or less than $5.0 million. As of December 31, 2013, West Bend's net obligations under the reinsurance agreements
were approximately $15.9 million, and the fair value of assets held in trust was approximately $17.9 million.
-55-
Item 8. Financial Statements and Supplementary Data.
Consolidated Balance Sheets
Consolidated Statements of Income and Comprehensive Income
Consolidated Statements of Stockholders' Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm - Consolidated Financial Statements
57
58
59
60
61
91
-56-
Donegal Group Inc.
Consolidated Balance Sheets
December 31,
2013
2012
Assets
Investments
Fixed maturities
Held to maturity, at amortized cost (fair value $238,790,476 and $43,735,739 ). . . . . . $ 240,370,277
403,651,965
Available for sale, at fair value (amortized cost $390,254,251 and $655,173,806) . . . .
12,422,837
Equity securities, available for sale, at fair value (cost $12,168,110 and $8,663,183). . . .
35,685,433
Investments in affiliates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
99,677,795
Short-term investments, at cost, which approximates fair value . . . . . . . . . . . . . . . . . . . .
791,808,307
Total investments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
27,636,416
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
5,423,531
Accrued investment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
123,904,629
Premiums receivable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
244,239,113
Reinsurance receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
43,627,510
Deferred policy acquisition costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
20,310,558
Deferred tax asset, net. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
112,663,942
Prepaid reinsurance premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
6,424,703
Property and equipment, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1,187,866
Accounts receivable - securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
420,952
Federal income taxes recoverable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
5,625,354
Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other intangible assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
958,010
1,179,611
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,385,410,502
$
42,100,196
694,509,821
8,757,258
37,235,530
23,826,227
806,429,032
19,801,290
6,332,085
117,196,478
215,893,322
40,121,697
6,267,536
111,156,162
5,953,833
—
—
5,625,354
958,010
1,154,388
$ 1,336,889,187
Liabilities and Stockholders' Equity
Liabilities
Losses and loss expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 495,619,269
382,734,642
Unearned premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
19,265,097
Accrued expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
17,948,808
Reinsurance balances payable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
58,000,000
Borrowings under lines of credit. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
3,299,182
Cash dividends declared to stockholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
5,000,000
Subordinated debentures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
751,641
Accounts payable - securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
—
Federal income taxes payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2,170,225
Due to affiliate. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1,386,285
Drafts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2,358,242
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
988,533,391
Total liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 458,827,395
363,088,103
17,140,832
13,941,337
52,000,000
3,066,532
20,465,000
—
583,977
4,579,437
863,589
2,298,891
936,855,093
Stockholders' Equity
Preferred stock, $.01 par value, authorized 2,000,000 shares; none issued . . . . . . . . . . . .
Class A common stock, $.01 par value, authorized 40,000,000 and 30,000,000 shares,
issued 21,786,765 and 20,941,821 shares and outstanding 20,845,903 and 20,025,199
shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Class B common stock, $.01 par value, authorized 10,000,000 shares, issued 5,649,240
shares and outstanding 5,576,775 shares. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Additional paid-in capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accumulated other comprehensive (loss) income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Treasury stock, at cost. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total stockholders' equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
56,492
189,116,410
(2,312,890)
222,888,887
(13,089,656)
396,877,111
Total liabilities and stockholders' equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,385,410,502
56,492
176,416,585
26,394,577
209,670,214
(12,713,193)
400,034,094
$ 1,336,889,187
—
—
217,868
209,419
See accompanying notes to consolidated financial statements.
-57-
Donegal Group Inc.
Consolidated Statements of Income and Comprehensive Income
Years Ended December 31,
2012
2011
2013
Statements of Income
Revenues
Net premiums earned (includes affiliated reinsurance of $156,938,714,
$142,608,940 and $130,555,613 - see note 3). . . . . . . . . . . . . . . . . . . . . . $ 515,291,944
18,795,239
$ 475,002,222
$ 431,470,184
20,168,919
20,858,179
Investment income, net of investment expenses . . . . . . . . . . . . . . . . . . . . . .
Installment payment fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Lease income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net realized investment gains (includes $2,423,442 accumulated other
comprehensive income reclassification) . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Equity in earnings of DFSC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
6,841,778
7,465,532
7,427,509
849,795
953,216
957,353
2,423,442
2,907,867
6,859,439
4,533,257
12,281,267
2,023,127
547,110,065
514,982,585
475,017,619
Expenses
Net losses and loss expenses (includes affiliated reinsurance of
$86,962,750, $81,219,926 and $87,950,502 - see note 3). . . . . . . . . . . . .
Amortization of deferred policy acquisition costs . . . . . . . . . . . . . . . . . . . .
Other underwriting expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Policyholder dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Interest. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Income before income tax expense (benefit) . . . . . . . . . . . . . . . . . . . . . . . . . .
Income tax expense (benefit) (includes $823,970 income tax expense from
reclassification items) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
343,127,951
332,871,584
340,502,777
81,753,000
74,314,000
68,571,000
82,196,700
73,914,514
66,923,764
1,909,569
1,635,323
3,777,257
1,342,582
2,358,711
2,322,934
1,240,079
2,126,784
2,392,528
514,399,800
487,124,325
481,756,932
32,710,265
27,858,260
(6,739,313)
6,388,273
4,765,640
(7,192,266)
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 26,321,992
$ 23,092,620
$
452,953
Basic earnings per common share:
Class A common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
Class B common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
Diluted earnings per common share:
Class A common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
Class B common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $
1.04
0.94
1.02
0.94
$
$
$
$
0.92
0.83
0.91
0.83
$
$
$
$
0.02
0.01
0.02
0.01
Statements of Comprehensive Income
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 26,321,992
Other comprehensive (loss) income, net of tax
Unrealized (loss) gain on securities:
$ 23,092,620
$
452,953
Unrealized holding (loss) gain arising during the period, net of income
tax (benefit) expense of ($14,633,895), $4,833,143 and 12,237,669 . .
(27,107,995)
9,171,817
23,077,997
Reclassification adjustment for gains included in net income, net of
(4,527,230)
income tax of $823,970 $2,332,209 and $4,175,631. . . . . . . . . . . . . . .
4,644,587
Other comprehensive (loss) income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Comprehensive (loss) income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (2,385,475) $ 27,737,207
(1,599,472)
(28,707,467)
(8,105,636)
14,972,361
$ 15,425,314
See accompanying notes to consolidated financial statements.
-58-
Donegal Group Inc.
Consolidated Statements of Stockholders' Equity
Common Stock
Class A
Shares
Class B
Shares
Class A
Amount
Class B
Amount
Additional
Paid-In
Capital
Accumulated
Other
Comprehensive
Income (Loss)
Retained
Earnings
Treasury
Stock
Total
Stockholders'
Equity
Balance, January 1,
2011 . . . . . . . . . . . . . .
20,656,527
5,649,240
$ 206,566
$
56,492
$ 167,093,504
$
8,561,086
$213,435,095
$ (9,249,933) $380,102,810
Issuance of common
stock (stock
compensation plans) .
Net income . . . . . . . . . . .
Cash dividends . . . . . . . .
Grant of stock options . .
Purchase of treasury
stock. . . . . . . . . . . . . .
Other comprehensive
income . . . . . . . . . . . .
Balance, December 31,
96,472
964
1,459,579
2,283,860
452,953
(11,999,488)
(2,283,860)
1,460,543
452,953
(11,999,488)
—
(1,537,587)
(1,537,587)
14,972,361
14,972,361
2011 . . . . . . . . . . . . . .
20,752,999
5,649,240
$ 207,530
$
56,492
$ 170,836,943
$ 23,533,447
$199,604,700
$(10,787,520) $383,451,592
Issuance of common
stock (stock
compensation plans) .
Net income . . . . . . . . . . .
Cash dividends . . . . . . . .
Grant of stock options . .
Tax benefit on exercise
of stock options . . . . .
Purchase of treasury
stock. . . . . . . . . . . . . .
Other comprehensive
income . . . . . . . . . . . .
Other . . . . . . . . . . . . . . .
Balance, December 31,
188,822
1,889
2,995,622
23,092,620
(12,278,965)
(2,531,598)
2,531,598
52,422
2,997,511
23,092,620
(12,278,965)
—
52,422
(1,925,673)
(1,925,673)
4,644,587
(1,783,457)
1,783,457
4,644,587
—
2012 . . . . . . . . . . . . . .
20,941,821
5,649,240
209,419
56,492
176,416,585
26,394,577
209,670,214
(12,713,193)
400,034,094
Issuance of common
stock (stock
compensation plans) .
Net income . . . . . . . . . . .
Cash dividends . . . . . . . .
Grant of stock options . .
Tax benefit on exercise
of stock options . . . . .
Purchase of treasury
stock. . . . . . . . . . . . . .
Other comprehensive
loss. . . . . . . . . . . . . . .
Balance, December 31,
844,944
8,449
12,108,468
26,321,992
(13,043,121)
(60,198)
60,198
531,159
12,116,917
26,321,992
(13,043,121)
—
531,159
(376,463)
(376,463)
(28,707,467)
(28,707,467)
2013 . . . . . . . . . . . . . .
21,786,765
5,649,240
$ 217,868
$
56,492
$ 189,116,410
$
(2,312,890) $222,888,887
$(13,089,656) $396,877,111
See accompanying notes to consolidated financial statements.
-59-
Donegal Group Inc.
Consolidated Statements of Cash Flows
Years Ended December 31,
2012
2011
2013
Cash Flows from Operating Activities:
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 26,321,992
Adjustments to reconcile net income to net cash provided by operating
$ 23,092,620
$
452,953
activities:
Depreciation and amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net realized investment gains . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Equity in earnings of DFSC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
3,049,101
(2,423,442)
(2,907,867)
3,950,693
(6,859,439)
(4,533,257)
4,106,561
(12,281,267)
(2,023,127)
Changes in Assets and Liabilities:
Losses and loss expenses. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Unearned premiums. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accrued expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Premiums receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deferred policy acquisition costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Deferred income taxes. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Reinsurance receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accrued investment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Amounts due to affiliate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Reinsurance balances payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Prepaid reinsurance premiums . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Current income taxes. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net adjustments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net cash provided by operating activities . . . . . . . . . . . . . . . . . . . . . . . . . .
36,791,874
19,646,539
2,124,265
(6,708,151)
(3,505,813)
1,414,843
(28,345,791)
908,554
(2,409,212)
4,007,471
(1,507,780)
(1,004,929)
556,815
19,686,477
46,008,469
16,419,780
26,150,842
(3,815,717)
(12,481,151)
(3,696,742)
1,151,250
(6,069,415)
380,953
(806,954)
(6,098,002)
(4,706,144)
3,245,785
(360,477)
1,872,005
24,964,625
59,088,943
39,665,100
(330,857)
(8,247,378)
(1,979,376)
(5,922,491)
(35,987,161)
652,133
2,460,287
899,017
(17,084,247)
(1,713,483)
(674,296)
20,628,358
21,081,311
Cash Flows from Investing Activities:
Purchases of fixed maturities:
Available for sale. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Purchases of equity securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Sales of fixed maturities:
(148,486,404)
(47,156,954)
(241,343,085)
(31,254,324)
(189,111,596)
(23,857,802)
Available for sale. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
133,890,611
90,484,097
122,873,102
Maturity of fixed maturities:
Held to maturity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Available for sale. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Sales of equity securities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Purchase of MICO . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net decrease (increase) in investment in affiliates . . . . . . . . . . . . . . . . . . . . .
Net purchases of property and equipment. . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net (purchases) sales of short-term investments. . . . . . . . . . . . . . . . . . . . . . .
Net cash used in investing activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash Flows from Financing Activities:
Issuance of common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash dividends paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Purchases of treasury stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Payments on subordinated debentures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Payments on line of credit. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Borrowings under lines of credit. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net cash (used in) provided by financing activities . . . . . . . . . . . . . . . . . .
13,767,271
52,675,833
43,204,703
—
1,139,800
(1,254,767)
(75,851,568)
(28,071,475)
12,550,066
(12,810,471)
(376,463)
(15,465,000)
(15,500,000)
21,500,000
(10,101,868)
16,061,587
115,501,507
30,001,187
—
(100,000)
(744,082)
16,635,183
(4,757,930)
2,983,399
(12,208,509)
(1,925,673)
—
(6,000,000)
3,500,000
(13,650,783)
5,888,236
53,763,701
27,036,422
(7,207,471)
(20,570,000)
(238,538)
314,583
(31,109,363)
1,460,543
(11,874,367)
(1,537,587)
—
(3,617,371)
22,500,000
6,931,218
7,835,126
Net increase (decrease) in cash. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash at beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
19,801,290
Cash at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 27,636,416
6,555,912
13,245,378
$ 19,801,290
(3,096,834)
16,342,212
$ 13,245,378
See accompanying notes to consolidated financial statements.
-60-
Donegal Group Inc.
Notes to Consolidated Financial Statements
1 - Summary of Significant Accounting Policies
Organization and Business
Donegal Mutual Insurance Company (”Donegal Mutual”) organized us as an insurance holding company on August 26, 1986.
Our insurance subsidiaries, Atlantic States Insurance Company (“Atlantic States”), Southern Insurance Company of Virginia
(“Southern”), Le Mars Insurance Company (“Le Mars”), the Peninsula Insurance Group (“Peninsula”), which consists of Peninsula
Indemnity Company and The Peninsula Insurance Company, Sheboygan Falls Insurance Company (“Sheboygan”) and Michigan
Insurance Company (“MICO”), write personal and commercial lines of property and casualty coverages exclusively through a
network of independent insurance agents in certain Mid-Atlantic, Midwestern, New England and Southern states. We also own
48.2% of the outstanding stock of Donegal Financial Services Corporation (“DFSC”), a grandfathered unitary savings and loan
holding company that owns Union Community Bank (“UCB”), a state savings bank. UCB has 13 banking offices, all of which
are located in Lancaster County, Pennsylvania. Donegal Mutual owns the remaining 51.8% of the outstanding stock of DFSC.
We have four segments: our investment function, our personal lines of insurance, our commercial lines of insurance and our
investment in DFSC. The personal lines products of our insurance subsidiaries consist primarily of homeowners and private
passenger automobile policies. The commercial lines products of our insurance subsidiaries consist primarily of commercial
automobile, commercial multi-peril and workers' compensation policies.
At December 31, 2013, Donegal Mutual held approximately 37% of our outstanding Class A common stock and
approximately 76% of our outstanding Class B common stock. This ownership provides Donegal Mutual with approximately
65% of the total voting power of our common stock. Our insurance subsidiaries and Donegal Mutual have interrelated
operations due to a pooling agreement and other intercompany agreements and transactions. While each company maintains its
separate corporate existence, our insurance subsidiaries and Donegal Mutual conduct business together as the Donegal
Insurance Group. As such, Donegal Mutual and our insurance subsidiaries share the same business philosophy, the same
management, the same employees and the same facilities and offer the same types of insurance products.
Atlantic States, our largest subsidiary, participates in a pooling agreement with Donegal Mutual. Under the pooling
agreement, the two companies pool their insurance business and each company receives an allocated percentage of the pooled
business. Atlantic States has an 80% share of the results of the pooled business, and Donegal Mutual has a 20% share of the
results of the pooled business.
The same executive management and underwriting personnel administer products, classes of business underwritten,
pricing practices and underwriting standards of Donegal Mutual and our insurance subsidiaries. In addition, as the Donegal
Insurance Group, Donegal Mutual and our insurance subsidiaries share a combined business plan to achieve market penetration
and underwriting profitability objectives. The products our insurance subsidiaries and Donegal Mutual market are generally
complementary, thereby allowing the Donegal Insurance Group to offer a broader range of products to a given market and to
expand the Donegal Insurance Group's ability to service an entire personal lines or commercial lines account. Distinctions
within the products of Donegal Mutual and our insurance subsidiaries generally relate to specific risk profiles targeted within
similar classes of business, such as preferred tier versus standard tier products, but we do not allocate all of the standard risk
gradients to one company. Therefore, the underwriting profitability of the business the individual companies write directly will
vary. However, as the risk characteristics of all business Donegal Mutual and Atlantic States write directly are homogenized
within the underwriting pool, Donegal Mutual and Atlantic States share the underwriting results in proportion to their
respective participation in the pool. Pooled business represents the predominant percentage of the net underwriting activity of
both Donegal Mutual and Atlantic States. We refer to Note 3 - Transactions with Affiliates for more information regarding the
pooling agreement.
In May 2011, DFSC and Union National Financial Corporation (“UNNF”) merged, with DFSC as the surviving company
in the merger. Under the merger agreement, Province Bank FSB, which DFSC owned, and Union National Community Bank,
which UNNF owned, also merged and began doing business as UCB. Donegal Mutual contributed $22.1 million and we
contributed $20.6 million to DFSC as additional capital to facilitate the mergers. We use the equity method of accounting for
our investment in DFSC. Under the equity method, we record our investment at cost, with adjustments for our share of DFSC's
earnings and losses as well as changes in DFSC's equity due to unrealized gains and losses.
-61-
Basis of Consolidation
Our consolidated financial statements, which we have prepared in accordance with accounting principles generally
accepted in the United States of America ("GAAP"), include our accounts and those of our wholly owned subsidiaries. We have
eliminated all significant inter-company accounts and transactions in consolidation. The terms “we,” “us,” “our” or the
“Company” as used herein refer to the consolidated entity.
Use of Estimates
In preparing our consolidated financial statements, our management makes estimates and assumptions that affect the
reported amounts of assets and liabilities at the date of the balance sheet and revenues and expenses for the period. Actual
results could differ significantly from those estimates.
We make estimates and assumptions that can have a significant effect on amounts and disclosures we report in our
consolidated financial statements. The most significant estimates relate to our insurance subsidiaries' reserves for property and
casualty insurance unpaid losses and loss expenses, valuation of investments and determination of other-than-temporary
impairment and our insurance subsidiaries' policy acquisition costs. While we believe our estimates and the estimates of our
insurance subsidiaries are appropriate, the ultimate amounts may differ from the estimates provided. We regularly review our
methods for making these estimates as well as the continuing appropriateness of the estimated amounts, and we reflect any
adjustment we consider necessary in our current results of operations.
Investments
We classify our debt and equity securities into the following categories:
Held to Maturity - Debt securities that we have 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 carried at amortized cost, which approximates fair value.
We make estimates concerning the valuation of our investments and the recognition of other-than-temporary declines in the
value of our investments. For equity securities, we write down the investment to its fair value and we reflect the amount of the
write-down as a realized loss in our results of operations when we consider the decline in value of an individual investment to
be other than temporary. We individually monitor all of our investments for other-than-temporary declines in value. Generally,
we assume there has been an other-than-temporary decline in value if an individual equity security has depreciated in value by
more than 20% of original cost and has been in such an unrealized loss position for more than six months. With respect to a
debt security that is in an unrealized loss position, we first assess if we intend to sell the debt security. If we determine we
intend to sell the debt security, we recognize the impairment loss in our results of operations. If we do not intend to sell the debt
security, we determine whether it is more likely than not that we will be required to sell the debt security prior to recovery. If
we determine it is more likely than not that we will be required to sell the debt security prior to recovery, we recognize an
impairment loss in our results of operations. If we determine it is more likely than not that we will not be required to sell the
debt security prior to recovery, we then evaluate whether a credit loss has occurred. We determine whether a credit loss has
occurred by comparing the amortized cost of the debt security to the present value of the cash flows we expect to collect. If we
expect a cash flow shortfall, we consider that a credit loss has occurred. If we determine that a credit loss has occurred, we
consider the impairment to be other than temporary. We then recognize the amount of the impairment loss related to the credit
loss in our results of operations, and we recognize the remaining portion of the impairment loss in our other comprehensive
income, net of applicable taxes. In addition, we may write down securities in an unrealized loss position based on a number of
other factors, including when the fair value of an investment is significantly below its cost, when the financial condition of the
issuer of a security has deteriorated, the occurrence of industry, company or geographic events that have negatively impacted
the value of a security and rating agency downgrades.
We amortize premiums and discounts on debt securities over the life of the security as an adjustment to yield using the
effective interest method. We compute realized investment gains and losses using the specific identification method.
We amortize premiums and discounts for mortgage-backed debt securities using anticipated prepayments.
-62-
We account for investments in affiliates using the equity method of accounting. Under the equity method, we record our
investment at cost, with adjustments for our share of the affiliate's earnings and losses as well as changes in the affiliate's equity
due to unrealized gains and losses.
Fair Values of Financial Instruments
We use the following methods and assumptions in estimating our fair value disclosures:
Investments - We present our investments in available-for-sale fixed maturity and equity securities at estimated fair value.
The estimated fair value of a security may differ from the amount that could be realized if we sold the security in a forced
transaction. In addition, the valuation of fixed maturity investments is more subjective when markets are less liquid, increasing
the potential that the estimated fair value does not reflect the price at which an actual transaction would occur. We utilize
nationally recognized independent pricing services to estimate fair values for our fixed maturity and equity investments. We
generally obtain one price per security. The pricing services utilize market quotations for fixed maturity and equity securities
that have quoted prices in active markets. For fixed maturity securities that generally do not trade on a daily basis, the pricing
services prepare estimates of fair value measurements based predominantly on observable market inputs. The pricing services
do not use broker quotes in determining the fair values of our investments. Our investment personnel review the estimates of
fair value the pricing services provide to determine if the estimates obtained are representative of fair values based upon their
general knowledge of the market, their research findings related to unusual fluctuations in value and their comparison of such
values to execution prices for similar securities. Our investment personnel monitor the market and are familiar with current
trading ranges for similar securities and pricing of specific investments. Our investment personnel review all pricing estimates
that we receive from the pricing services against their expectations with respect to pricing based on fair market curves, security
ratings, coupon rates, security type and recent trading activity. Our investment personnel review documentation with respect to
the pricing services' pricing methodology that they obtain periodically to determine if the primary pricing sources, market
inputs and pricing frequency for various security types are reasonable. We refer to Note 5 - Fair Value Measurements for more
information regarding our methods and assumptions in estimating fair values.
Cash and Short-Term Investments - The carrying amounts reported in the balance sheet for these instruments
approximate their fair values.
Premiums and Reinsurance Receivables and Payables - The carrying amounts reported in the balance sheet for these
instruments related to premiums and paid losses and loss expenses approximate their fair values.
Subordinated Debentures - The carrying amounts reported in the balance sheet for these instruments approximate their
fair values.
Revenue Recognition
Our insurance subsidiaries recognize insurance premiums as income over the terms of the policies they issue. Our
insurance subsidiaries calculate unearned premiums on a daily pro-rata basis.
Policy Acquisition Costs
We defer our insurance subsidiaries' policy acquisition costs, consisting primarily of commissions, premium taxes and
certain other underwriting costs, reduced by ceding commissions, that vary with and relate directly to the production of
business. We amortize these deferred policy acquisition costs over the period in which our insurance subsidiaries earn the
premiums. The method we follow in computing deferred policy acquisition costs limits the amount of such deferred costs to
their estimated realizable value, which gives effect to the premium to be earned, related investment income, losses and loss
expenses and certain other costs we expect to incur as our insurance subsidiaries earn the premium. Estimates in the calculation
of policy acquisition costs have not shown material variability because of uncertainties in applying accounting principles or as
a result of sensitivities to changes in key assumptions.
Property and Equipment
We report property and equipment at depreciated cost that we compute using the straight-line method based upon estimated
useful lives of the assets.
-63-
Losses and Loss Expenses
Liabilities for losses and loss expenses are estimates at a given point in time of the amounts an insurer expects to pay with
respect to policyholder claims based on facts and circumstances then known. At the time of establishing its estimates, an insurer
recognizes that its ultimate liability for losses and loss expenses will exceed or be less than such estimates. Our insurance
subsidiaries base their estimates of liabilities for losses and loss expenses on assumptions as to future loss trends and expected
claims severity, judicial theories of liability and other factors. However, during the loss adjustment period, our insurance
subsidiaries may learn additional facts regarding certain claims, and consequently, it often becomes necessary for our insurance
subsidiaries to refine and adjust their estimates of liability. We reflect any adjustments to our insurance subsidiaries' liabilities
for losses and loss expenses in our operating results in the period in which our insurance subsidiaries record the changes in
estimates.
Our insurance subsidiaries maintain liabilities for the payment of losses and loss expenses with respect to both reported
and unreported claims. Our insurance subsidiaries establish these liabilities for the purpose of covering the ultimate costs of
settling all losses, including investigation and litigation costs. Our insurance subsidiaries base the amount of their liability for
reported losses primarily upon a case-by-case evaluation of the type of risk involved, knowledge of the circumstances
surrounding each claim and the insurance policy provisions relating to the type of loss their policyholder incurred. Our
insurance subsidiaries determine the amount of their liability for unreported claims and loss expenses on the basis of historical
information by line of insurance. Our insurance subsidiaries account for inflation in the reserving function through analysis of
costs and trends and reviews of historical reserving results. Our insurance subsidiaries closely monitor their liabilities and
recompute them periodically using new information on reported claims and a variety of statistical techniques. Our insurance
subsidiaries do not discount their liabilities for losses.
Reserve estimates can change over time because of unexpected changes in assumptions related to our insurance
subsidiaries' external environment and, to a lesser extent, assumptions as to our insurance subsidiaries' internal operations. For
example, our insurance subsidiaries have experienced a decrease in claims frequency on workers' compensation claims during
the past several years while claims severity has gradually increased. These trend changes give rise to greater uncertainty as to
the pattern of future loss settlements on workers' compensation claims. Related uncertainties regarding future trends include the
cost of medical technologies and procedures and changes in the utilization of medical procedures. Assumptions related to our
insurance subsidiaries' external environment include the absence of significant changes in tort law and the legal environment
that increase liability exposure, consistency in judicial interpretations of insurance coverage and policy provisions and the rate
of loss cost inflation. Internal assumptions include consistency in the recording of premium and loss statistics, consistency in
the recording of claims, payment and case reserving methodology, accurate measurement of the impact of rate changes and
changes in policy provisions, consistency in the quality and characteristics of business written within a given line of business
and consistency in reinsurance coverage and collectibility of reinsured losses, among other items. To the extent our insurance
subsidiaries determine that underlying factors impacting their assumptions have changed, our insurance subsidiaries attempt to
make appropriate adjustments for such changes in their reserves. Accordingly, our insurance subsidiaries' ultimate liability for
unpaid losses and loss expenses will likely differ from the amount recorded.
Our insurance subsidiaries seek to enhance their underwriting results by carefully selecting the product lines they
underwrite. Our insurance subsidiaries' personal lines products include standard and preferred risks in private passenger
automobile and homeowners lines. Our insurance subsidiaries' commercial lines products primarily include business offices,
wholesalers, service providers, contractors, artisans and light manufacturing operations. Our insurance subsidiaries have limited
exposure to asbestos and other environmental liabilities. Our insurance subsidiaries write no medical malpractice liability risks.
Income Taxes
We currently file a consolidated federal income tax return.
We account 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 our assets and liabilities at enacted tax rates expected to be in effect when we realize or settle such amounts.
Credit Risk
Our objective is to earn competitive returns by investing in a diversified portfolio of securities. Our portfolio of fixed
maturity securities and, to a lesser extent, short-term investments is subject to credit risk. We define this risk as the potential
loss in fair value resulting from adverse changes in the borrower's ability to repay the debt. We manage this risk by performing
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an analysis of prospective investments and through regular reviews of our portfolio by our investment staff. We also limit the
amount of our total investment portfolio that we invest in any one security.
Our insurance subsidiaries provide property and liability insurance coverages through independent insurance agencies
located throughout their operating areas. Our insurance subsidiaries bill the majority of this business directly to their
policyholders, although our insurance subsidiaries bill a portion of their commercial business through their agents, to whom
they extend credit in the normal course of business.
Our insurance subsidiaries have reinsurance agreements with Donegal Mutual and with a number of major unaffiliated
reinsurers.
Reinsurance Accounting and Reporting
Our insurance subsidiaries rely upon reinsurance agreements to limit their maximum net loss from large single risks or
risks in concentrated areas and to increase their capacity to write insurance. Reinsurance does not relieve our insurance
subsidiaries from liability to their respective policyholders. To the extent that a reinsurer cannot pay losses for which it is liable
under the terms of a reinsurance agreement with one of our insurance subsidiaries, our insurance subsidiaries retain continued
liability for such losses. However, in an effort to reduce the risk of non-payment, our insurance subsidiaries require all of their
reinsurers to have an A.M. Best rating of A- or better or, with respect to foreign reinsurers, to have a financial condition that, in
the opinion of management, is equivalent to a company with an A.M. Best rating of A- or better. We refer to Note 10 -
Reinsurance for more information regarding our reinsurance agreements.
Stock-Based Compensation
We measure all share-based payments to employees, including grants of stock options, using a fair-value-based method and
record such expense in our results of operations. In determining the expense we record for stock options granted to directors
and employees of our subsidiaries and affiliates, we estimate the fair value of each option award on the date of grant using the
Black-Scholes option pricing model. The significant assumptions we utilize in applying the Black-Scholes option pricing model
are the risk-free interest rate, expected term, dividend yield and expected volatility.
In 2013 and 2012, we realized $531,159 and $52,422, respectively in tax benefits upon the exercise of stock options. We
did not realize any tax benefits upon the exercise of stock options in 2011.
Earnings per Share
We calculate basic earnings per share by dividing net income by the weighted-average number of common shares
outstanding for the period. 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.
We have two classes of common stock, which we refer to as Class A common stock and Class B common stock. Our
Class A common stock is entitled to the declaration and payment of cash dividends that are at least 10% higher than those we
declare and pay on our Class B common stock. Accordingly, we use the two-class method for the computation of earnings per
common share. The two-class method is an earnings allocation formula that determines earnings per share separately for each
class of common stock based on dividends declared and an allocation of remaining undistributed earnings using a participation
percentage that reflects the dividend rights of each class.
Goodwill and Other Intangible Assets
Goodwill represents the excess of the purchase price over the underlying fair value of acquired entities. When completing
acquisitions, we seek also to identify separately identifiable intangible assets that we have acquired. We assess goodwill and
intangible assets with an indefinite useful life for impairment annually. We also assess goodwill and other intangible assets for
impairment upon the occurrence of certain events. In making our assessment, we consider a number of factors including
operating results, business plans, economic projections, anticipated future cash flows and current market data. Inherent
uncertainties exist with respect to these factors and to our judgment in applying them when we make our assessment.
Impairment of goodwill and other intangible assets could result from changes in economic and operating conditions in future
periods.
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2 - Impact of New Accounting Standards
In February 2013, the Financial Accounting Standards Board (“FASB”) issued guidance that requires an entity to provide
information about amounts it reclassifies out of accumulated other comprehensive income. If GAAP requires an entity to
reclassify amounts out of accumulated other comprehensive income to net income in their entirety in the same reporting period,
the guidance requires an entity to present significant amounts it reclassifies out of accumulated other comprehensive income by
the respective line items of net income, either on the face of the statement where the entity presents net income or in the notes
to the entity’s financial statements,. For other amounts that GAAP does not require an entity to reclassify to net income in their
entirety, the guidance requires an entity to cross-reference such amounts to other disclosures GAAP requires that provide
additional detail about those amounts. The guidance was effective for interim and annual reporting periods after December 15,
2012. We adopted this new guidance as of January 1, 2013. Our adoption of this new guidance did not impact our financial
position, results of operations or cash flows.
3 - Transactions with Affiliates
Our insurance subsidiaries conduct business and have various agreements with Donegal Mutual that we describe in the
following subparagraphs:
a. Reinsurance Pooling and Other Reinsurance Arrangements
Atlantic States, our largest insurance subsidiary, and Donegal Mutual have a pooling agreement under which both
companies contribute all of their direct written business to the pool and receive an allocated percentage of their combined
underwriting results, excluding certain reinsurance Donegal Mutual assumes from our insurance subsidiaries. Atlantic States
has an 80% share of the results of the pool, and Donegal Mutual has a 20% share of the results of the pool. The intent of the
pooling agreement is to produce more uniform and stable underwriting results from year to year for each pool participant than
they would experience individually and to spread the risk of loss between the participants based on each participant's relative
amount of surplus and relative access to capital. Each participant in the pool has at its disposal the capacity of the entire pool,
rather than being limited to policy exposures of a size commensurate with its own capital and surplus.
The following amounts represent reinsurance Atlantic States ceded to the pool during 2013, 2012 and 2011:
Premiums earned
Losses and loss expenses
Prepaid reinsurance premiums
Liability for losses and loss expenses
2013
2012
$ 145,678,744 $ 132,876,094 $ 118,812,725
2011
95,037,273
92,459,147
97,130,846
75,232,651
70,572,281
64,214,378
88,035,924
83,623,652
77,312,645
The following amounts represent reinsurance Atlantic States assumed from the pool during 2013, 2012 and 2011:
Premiums earned
Losses and loss expenses
Unearned premiums
Liability for losses and loss expenses
2013
2012
$ 337,548,492 $ 298,803,060 $ 266,687,610
2011
198,785,775
187,415,893
206,907,170
176,845,395
157,140,642
141,880,039
175,497,405
162,863,045
156,941,512
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Donegal Mutual and Le Mars have a quota-share reinsurance agreement whereby Le Mars assumes 100% of the premiums
and losses related to certain products Donegal Mutual offers in certain Midwestern states, which provide the availability of
complementary products to Le Mars' commercial accounts. Until October 31, 2012, Donegal Mutual and Southern had a quota-
share reinsurance agreement whereby Southern assumed 100% of the premiums and losses related to personal lines products
Donegal Mutual offered in Virginia through the use of its automated policy quoting and issuance system. The following
amounts represent reinsurance Southern and Le Mars assumed from Donegal Mutual pursuant to the quota-share reinsurance
agreements during 2013, 2012 and 2011:
Premiums earned
Losses and loss expenses
Unearned premiums
Liability for losses and loss expenses
2013
2012
$ 12,170,155 $ 22,189,399 $ 17,757,409
2011
10,839,444
19,620,587
14,983,405
1,831,672
9,926,381
10,225,922
7,838,274
8,873,592
7,770,053
Donegal Mutual and MICO have a quota-share reinsurance agreement whereby Donegal Mutual assumes 25% of the
premiums and losses related to the business of MICO. Donegal Mutual and Peninsula have a quota-share reinsurance
agreement whereby Donegal Mutual assumes 100% of the premiums and losses related to the workers' compensation product
line of Peninsula in certain states. The business Donegal Mutual assumes becomes part of the pooling agreement between
Donegal Mutual and Atlantic States.
The following amounts represent reinsurance ceded to Donegal Mutual pursuant to these quota-share reinsurance
agreements during 2013, 2012 and 2011:
Premiums earned
Losses and loss expenses
Prepaid reinsurance premiums
Liability for losses and loss expenses
2013
2012
$ 34,992,435 $ 33,046,914 $ 22,123,229
2011
25,301,470
22,569,557
16,038,590
16,032,985
15,457,605
14,181,338
25,298,464
18,285,182
11,868,641
Atlantic States, Southern and Le Mars each have a catastrophe reinsurance agreement with Donegal Mutual that provides
coverage under any one catastrophic occurrence above a set retention ($2,500,000, $2,000,000 and $500,000 for Atlantic
States, Southern and Le Mars, respectively), with a combined retention of $5,000,000 for a catastrophe involving a
combination of these subsidiaries, up to the amount Donegal Mutual and our insurance subsidiaries retain under catastrophe
reinsurance agreements with unaffiliated reinsurers . Donegal Mutual and Southern have an excess of loss reinsurance
agreement in which Donegal Mutual assumes up to $500,000 ($350,000 in 2011) of losses in excess of $500,000 ($400,000 in
2011).
The following amounts represent reinsurance that our insurance subsidiaries ceded to Donegal Mutual pursuant to these
reinsurance agreements during 2013, 2012 and 2011:
Premiums earned
Losses and loss expenses
Liability for losses and loss expenses
2013
2012
$ 12,108,754 $ 12,460,511 $ 12,953,452
2011
2,323,726
10,787,850
20,770,637
2,366,370
2,206,786
3,980,024
The following amounts represent the effect of affiliated reinsurance transactions on net premiums our insurance
subsidiaries earned during 2013, 2012 and 2011:
Assumed
Ceded
Net
2013
$ 349,718,647
(192,779,933)
$ 156,938,714
2012
$ 320,992,459
(178,383,519)
$ 142,608,940
2011
$ 284,445,019
(153,889,406)
$ 130,555,613
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The following amounts represent the effect of affiliated reinsurance transactions on net losses and loss expenses our
insurance subsidiaries incurred during 2013, 2012 and 2011:
Assumed
Ceded
Net
b. Expense Sharing
2013
2012
$ 209,625,219 $ 207,036,480 $ 221,890,575
(133,940,073)
(125,816,554)
$ 86,962,750 $ 81,219,926 $ 87,950,502
(122,662,469)
2011
Donegal Mutual provides facilities, management and other services to us and our insurance subsidiaries. Donegal Mutual
allocates certain related expenses to Atlantic States in relation to the relative participation of Atlantic States and Donegal
Mutual in the pooling agreement. Our insurance subsidiaries other than Atlantic States reimburse Donegal Mutual for their
personnel costs and bear their proportionate share of information services costs based on their percentage of the total written
premiums of the Donegal Insurance Group. Charges for these services totalled $94,021,056, $78,778,333 and $64,711,860 for
2013, 2012 and 2011, respectively.
c. Lease Agreement
We lease office equipment and automobiles with terms ranging from 3 to 10 years to Donegal Mutual under a 10-year lease
agreement dated January 1, 2011.
d. Legal Services
Donald H. Nikolaus, our Chairman of the Board and President and one of our directors, is a partner in the law firm of
Nikolaus & Hohenadel. Such firm has served as our general counsel since 1986, principally in connection with the defense of
claims litigation arising in Lancaster, Dauphin and York counties of Pennsylvania. We pay such firm its customary fees for such
services.
e. Union Community Bank
At December 31, 2013 and 2012, we had $24,001,726 and $18,806,576, respectively, in checking accounts with UCB, a
wholly owned subsidiary of DFSC. We earned $1,954, $1,591 and $1,019 in interest on these accounts during 2013, 2012 and
2011, respectively.
4 - Investments
The amortized cost and estimated fair values of fixed maturities and equity securities at December 31, 2013 and 2012 are as
follows:
Held to Maturity
U.S. Treasury securities and obligations of U.S.
government corporations and agencies
2013
Amortized Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Estimated Fair
Value
$ 47,945,882
$
— $
869,683
$ 47,076,199
Obligations of states and political subdivisions
108,435,110
465,309
446,695
108,453,724
Corporate securities
Mortgage-backed securities
Totals
14,874,969
69,114,316
17,337
32,810
111,957
14,780,349
666,922
68,480,204
$ 240,370,277
$
515,456
$
2,095,257
$ 238,790,476
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Available for Sale
U.S. Treasury securities and obligations of U.S.
government corporations and agencies
2013
Amortized Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Estimated Fair
Value
$ 14,272,550 $
117,736 $
56,589 $ 14,333,697
Obligations of states and political subdivisions
265,783,151
11,778,794
15,221
277,546,724
Corporate securities
Mortgage-backed securities
Fixed maturities
Equity securities
Totals
Held to Maturity
U.S. Treasury securities and obligations of U.S.
government corporations and agencies
Obligations of states and political subdivisions
Mortgage-backed securities
Totals
39,939,873
70,258,677
775,430
923,380
43,380
40,671,923
82,436
71,099,621
390,254,251
13,595,340
197,626
403,651,965
12,168,110
347,594
92,867
12,422,837
$ 402,422,361 $ 13,942,934 $
290,493 $ 416,074,802
2012
Amortized Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Estimated Fair
Value
$
1,000,000
40,909,132
$
191,064
$
11,510
1,609,211
14,822
$ 42,100,196
$
1,635,543
$
— $
—
1,011,510
42,518,343
—
205,886
— $ 43,735,739
Available for Sale
U.S. Treasury securities and obligations of U.S.
government corporations and agencies
2012
Amortized Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Estimated Fair
Value
$ 70,253,846 $
1,101,208 $
43,951 $ 71,311,103
Obligations of states and political subdivisions
385,371,983
32,221,045
606,065
416,986,963
Corporate securities
Mortgage-backed securities
Fixed maturities
Equity securities
Totals
73,941,532
3,522,954
108,709
77,355,777
125,606,445
3,315,976
66,443
128,855,978
655,173,806
40,161,183
825,168
694,509,821
8,663,183
200,823
106,748
8,757,258
$ 663,836,989 $ 40,362,006 $
931,916 $ 703,267,079
At December 31, 2013, our holdings of obligations of states and political subdivisions included general obligation bonds
with an aggregate fair value of $294.1 million and an amortized cost of $284.9 million. Our holdings also included special
revenue bonds with an aggregate fair value of $91.9 million and an amortized cost of $89.3 million. With respect to both
categories, we held no securities of any issuer that comprised more than 10% of the category at December 31, 2013. Education
bonds and water and sewer utility bonds represented 56% and 23%, respectively, of our total investments in special revenue
bonds based on their carrying values at December 31, 2013. Many of the issuers of the special revenue bonds we held at
December 31, 2013 have the authority to impose ad valorem taxes. In that respect, many of the special revenue bonds we held
are similar to general obligation bonds.
At December 31, 2012, our holdings of obligations of states and political subdivisions included general obligation bonds
with an aggregate fair value of $358.5 million and an amortized cost of $332.4 million. Our holdings also included special
revenue bonds with an aggregate fair value of $101.0 million and an amortized cost of $93.9 million. With respect to both
categories, we held no securities of any issuer that comprised more than 10% of the category at December 31, 2012. Education
bonds and water and sewer utility bonds represented 54% and 19%, respectively, of our total investments in special revenue
bonds based on their carrying values at December 31, 2012. Many of the issuers of the special revenue bonds we held at
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December 31, 2012 have the authority to impose ad valorem taxes. In that respect, many of the special revenue bonds we held
are similar to general obligation bonds.
We made reclassifications from available for sale to held to maturity of fixed maturities at fair value on November 30,
2013. We present the impact of the transfers in the following table, summarized by type of securities, at November 30, 2013:
U.S. Treasury securities and obligations of U.S.
government corporations and agencies
Obligations of states and political subdivisions
Corporate securities
Mortgage-backed securities
Totals
Amortized Cost
Estimated Fair
Value
$ 50,627,225 $ 47,914,311
88,456,842
79,866,801
15,745,976
14,879,294
72,465,250
69,567,883
$ 227,295,293 $ 212,228,289
We have segregated within accumulated other comprehensive loss the net unrealized losses of $15.1 million arising
prior to the November 30, 2013 reclassification date for fixed maturities reclassified from available for sale to held to maturity.
We will amortize this balance over the remaining life of the related securities as an adjustment of yield in a manner consistent
with the accretion of discount on the same fixed maturities.
We set forth below the amortized cost and estimated fair value of fixed maturities at December 31, 2013 by contractual
maturity. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties.
Held to maturity
Due after one year through five years
Due after five years through ten years
Due after ten years
Mortgage-backed securities
Total held to maturity
Available for sale
Due in one year or less
Due after one year through five years
Due after five years through ten years
Due after ten years
Mortgage-backed securities
Total available for sale
Amortized Cost
Estimated Fair
Value
$ 26,553,403 $ 26,883,591
65,434,886
64,537,687
79,267,672
78,888,994
69,114,316
68,480,204
$ 240,370,277 $ 238,790,476
$
8,172,570 $
8,256,627
35,310,675
36,104,054
119,933,647
125,005,089
156,578,682
163,186,574
70,258,677
71,099,621
$ 390,254,251 $ 403,651,965
The amortized cost of fixed maturities on deposit with various regulatory authorities at December 31, 2013 and 2012
amounted to $10,553,953 and $10,565,116, respectively.
Investments in affiliates consisted of the following at December 31, 2013 and 2012:
DFSC
Other
Total
2013
2012
$ 35,685,433 $ 36,770,530
—
465,000
$ 35,685,433 $ 37,235,530
We account for investments in our affiliates using the equity method of accounting. Under this method, we record our
investment at cost, with adjustments for our share of our affiliates' earnings and losses as well as changes in our affiliates' equity
due to unrealized gains and losses. Our investments in affiliates at December 31, 2013 represented our 48.2% ownership interest
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in DFSC. In May 2011, DFSC merged with UNNF, with DFSC as the surviving company in the merger. Under the merger
agreement, Province Bank FSB, which DFSC owned, and Union National Community Bank, which UNNF owned, also merged
and began doing business as UCB. Donegal Mutual contributed $22.1 million and we contributed $20.6 million to DFSC as
additional capital to facilitate the mergers. We made an additional equity investment in DFSC in the amount of $100,000 during
2012.
We include our share of DFSC's net income in our results of operations. We have compiled the following summary
financial information for DFSC at December 31, 2013 and 2012 from the financial statements of DFSC.
Balance sheets:
Total assets
Total liabilities
Stockholders' equity
December 31,
2013
2012
$ 512,577,883
$ 509,670,100
$ 438,649,355
$ 433,490,583
73,928,528
76,179,517
Total liabilities and stockholders' equity
$ 512,577,883
$ 509,670,100
Income statements:
Net income
Year Ended December 31,
2013
2012
2011
$ 6,030,292
$ 9,401,001
$ 4,196,054
Other comprehensive (loss) income in our statements of comprehensive income includes net unrealized (losses) gains of
($2.2 million), $138,771 and $479,401 for 2013, 2012 and 2011, respectively, representing our share of DFSC's unrealized
investment gains or losses.
At December 31, 2012, our investments in affiliates included our investments in statutory trusts that held our subordinated
debentures that we discuss in Note 9 - Borrowings.
We derive net investment income, consisting primarily of interest and dividends, from the following sources:
Fixed maturities
Equity securities
Short-term investments
Other
Investment income
Investment expenses
Net investment income
2013
$ 23,621,977
2012
$ 24,642,897
2011
$ 25,044,316
122,603
98,817
41,608
85,905
34,482
44,874
162,934
57,296
48,588
23,885,005
(5,089,766)
$ 18,795,239
24,808,158
(4,639,239)
$ 20,168,919
25,313,134
(4,454,955)
$ 20,858,179
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We present below gross realized gains and losses from investments, including those we classified as held to maturity, and
the change in the difference between fair value and cost of investments:
Gross realized gains:
Fixed maturities
Equity securities
Gross realized losses:
Fixed maturities
Equity securities
Net realized gains
Change in difference between fair value and cost of
investments:
Fixed maturities
Equity securities
Totals
2013
2012
2011
$ 4,774,437
$ 6,730,331
$ 4,959,707
1,634,315
6,408,752
926,053
8,760,511
7,656,384
13,720,218
3,091,538
893,772
3,985,310
42,135
754,810
796,945
163,316
1,275,635
1,438,951
$ 2,423,442
$ 6,859,439
$ 12,281,267
$(29,153,645) $ 5,739,506
(104,660)
$(28,992,993) $ 5,634,846
160,652
$ 29,646,545
(7,459,314)
$ 22,187,231
We held fixed maturities and equity securities with unrealized losses representing declines that we considered temporary at
December 31, 2013 as follows:
U.S. Treasury securities and obligations of U.S.
government corporations and agencies
$ 50,802,809 $
821,941 $ 4,642,775 $
104,331
Less than 12 months
12 months or longer
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
Obligations of states and political subdivisions
65,170,891
363,240
13,404,781
Corporate securities
Mortgage-backed securities
Equity securities
Totals
16,693,759
83,535
6,851,898
72,878,347
535,944
19,013,889
213,414
1,628,893
92,867
—
—
$207,174,699 $ 1,897,527 $ 43,913,343 $
488,223
98,676
71,802
We held fixed maturities and equity securities with unrealized losses representing declines that we considered temporary at
December 31, 2012 as follows:
Less than 12 months
12 months or longer
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
U.S. Treasury securities and obligations of U.S.
government corporations and agencies
$ 12,308,333 $
43,951 $
Obligations of states and political subdivisions
22,134,226
606,065
— $
—
—
—
Corporate securities
Mortgage-backed securities
Equity securities
Totals
12,271,750
79,136
2,958,520
29,573
22,491,562
66,443
2,226,050
106,748
—
—
—
—
$ 71,431,921 $
902,343 $ 2,958,520 $
29,573
We make estimates concerning the valuation of our investments and the recognition of other-than-temporary declines in the
value of our investments. For equity securities, we write down the investment to its fair value, and we reflect the amount of the
write-down as a realized loss in our results of operations when we consider the decline in value of an individual investment to
be other than temporary. We individually monitor all investments for other-than-temporary declines in value. Generally, we
assume there has been an other-than-temporary decline in value if an individual equity security has depreciated in value by more
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than 20% of original cost and has been in such an unrealized loss position for more than six months. We held four equity
securities that were in an unrealized loss position at December 31, 2013. Based upon our analysis of general market conditions
and underlying factors impacting these equity securities, we considered these declines in value to be temporary. With respect to
a debt security that is in an unrealized loss position, we first assess if we intend to sell the debt security. If we determine we
intend to sell the debt security, we recognize the impairment loss in our results of operations. If we do not intend to sell the debt
security, we determine whether it is more likely than not that we will be required to sell the debt security prior to recovery. If we
determine it is more likely than not that we will be required to sell the debt security prior to recovery, we recognize an
impairment loss in our results of operations. If we determine it is more likely than not that we will not be required to sell the
debt security prior to recovery, we then evaluate whether a credit loss has occurred. We determine whether a credit loss has
occurred by comparing the amortized cost of the debt security to the present value of the cash flows we expect to collect. If we
expect a cash flow shortfall, we consider that a credit loss has occurred. If we determine that a credit loss has occurred, we
consider the impairment to be other than temporary. We then recognize the amount of the impairment loss related to the credit
loss in our results of operations, and we recognize the remaining portion of the impairment loss in our other comprehensive
income, net of applicable taxes. In addition, we may write down securities in an unrealized loss position based on a number of
other factors, including when the fair value of an investment is significantly below its cost, when the financial condition of the
issuer of a security has deteriorated, the occurrence of industry, company or geographic events that have negatively impacted the
value of a security and rating agency downgrades. We held 216 debt securities that were in an unrealized loss position at
December 31, 2013. Based upon our analysis of general market conditions and underlying factors impacting these debt
securities, we considered these declines in value to be temporary.
We did not recognize any impairment losses in 2013, 2012 or 2011. We had no sales or transfers from the held to maturity
portfolio in 2013, 2012 or 2011. We have no derivative instruments or hedging activities.
5 - Fair Value Measurements
We account for financial assets using a framework that establishes a hierarchy that ranks the quality and reliability of
inputs, or assumptions, used in the determination of fair value and we classify financial assets and liabilities carried at fair
value in one of the following three categories:
Level 1 - quoted prices in active markets for identical assets and liabilities;
Level 2 - directly or indirectly observable inputs other than Level 1 quoted prices; and
Level 3 - unobservable inputs not corroborated by market data.
For investments that have quoted market prices in active markets, we use the quoted market price as fair value and include
these investments in Level 1 of the fair value hierarchy. We classify publicly traded equity securities as Level 1. When quoted
market prices in active markets are not available, we base fair values on quoted market prices of comparable instruments or
price estimates we obtain from independent pricing services. We classify our fixed maturity investments as Level 2. Our fixed
maturity investments consist of U.S. Treasury securities and obligations of U.S. government corporations and agencies,
obligations of states and political subdivisions, corporate securities and mortgage-backed securities.
We present our investments in available-for-sale fixed maturity and equity securities at estimated fair value. The estimated
fair value of a security may differ from the amount that could be realized if we sold the security in a forced transaction. In
addition, the valuation of fixed maturity investments is more subjective when markets are less liquid, increasing the potential
that the estimated fair value does not reflect the price at which an actual transaction would occur. We utilize nationally
recognized independent pricing services to estimate fair values or obtain market quotations for substantially all of our fixed
maturity and equity investments. We generally obtain one price per security. The pricing services utilize market quotations for
fixed maturity and equity securities that have quoted prices in active markets. For fixed maturity securities that generally do not
trade on a daily basis, the pricing services prepare estimates of fair value measurements based predominantly on observable
market inputs. The pricing services do not use broker quotes in determining the fair values of our investments. Our investment
personnel review the estimates of fair value the pricing services provide to determine if the estimates we obtain are
representative of fair values based upon their general knowledge of the market, their research findings related to unusual
fluctuations in value and their comparison of such values to execution prices for similar securities. Our investment personnel
monitor the market and are familiar with current trading ranges for similar securities and pricing of specific investments. Our
investment personnel review all pricing estimates that we receive from the pricing services against their expectations with
respect to pricing based on fair market curves, security ratings, coupon rates, security type and recent trading activity. Our
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investment personnel review documentation with respect to the pricing services’ pricing methodology that they obtain
periodically to determine if the primary pricing sources, market inputs and pricing frequency for various security types are
reasonable. At December 31, 2013 and 2012, we received one estimate per security from one of the pricing services, and we
priced substantially all of our Level 1 and Level 2 investments using those prices. In our review of the estimates the pricing
services provided at December 31, 2013 and 2012, we did not identify any discrepancies, and we did not make any adjustments
to the estimates the pricing services provided.
We present our cash and short-term investments at estimated fair value. The carrying values in the balance sheet for
premium receivables and reinsurance receivables and payables for premiums and paid losses and loss expenses approximate
their fair values. The carrying amounts reported in the balance sheet for our subordinated debentures and borrowings under
lines of credit approximate their fair values. We classify these items as Level 3. We evaluate our assets and liabilities on a
recurring basis to determine the appropriate level at which to classify them for each reporting period.
We evaluate our assets and liabilities on a regular basis to determine the appropriate level at which to classify them for
each reporting period. Based on our review of the methodology and summary of inputs the pricing services use, we have
concluded that our Level 1 and Level 2 investments were classified properly at December 31, 2013 and 2012.
The following table presents our fair value measurements for our investments in available-for-sale fixed maturity and
equity securities at December 31, 2013:
U.S. Treasury securities and obligations of U.S.
government corporations and agencies
Obligations of states and political subdivisions
Corporate securities
Mortgage-backed securities
Equity securities
Totals
Fair Value Measurements Using
Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
Significant
Other
Observable
Inputs (Level 2)
Significant
Unobservable
Inputs (Level 3)
Fair Value
$ 14,333,697 $
— $ 14,333,697 $
277,546,724
40,671,923
71,099,621
—
277,546,724
—
40,671,923
—
71,099,621
12,422,837
6,467,766
5,955,071
$ 416,074,802 $
6,467,766 $ 409,607,036 $
—
—
—
—
—
—
The following table presents our fair value measurements for our investments in available-for-sale fixed maturity and
equity securities at December 31, 2012:
U.S. Treasury securities and obligations of U.S.
government corporations and agencies
Obligations of states and political subdivisions
Corporate securities
Mortgage-backed securities
Equity securities
Totals
Fair Value Measurements Using
Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
Significant
Other
Observable
Inputs (Level 2)
Significant
Unobservable
Inputs (Level 3)
Fair Value
$ 71,311,103 $
— $ 71,311,103 $
416,986,963
77,355,777
128,855,978
—
416,986,963
—
77,355,777
—
128,855,978
8,757,258
5,365,721
3,391,537
$ 703,267,079 $
5,365,721 $ 697,901,358 $
—
—
—
—
—
—
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6 - Deferred Policy Acquisition Costs
Changes in our insurance subsidiaries' deferred policy acquisition costs are as follows:
Balance, January 1
Acquisition costs deferred
Amortization charged to earnings
Balance, December 31
7 - Property and Equipment
2013
$ 40,121,697
2012
$ 36,424,955
2011
$ 34,445,579
85,258,813
(81,753,000)
$ 43,627,510
78,010,742
(74,314,000)
$ 40,121,697
70,550,376
(68,571,000)
$ 36,424,955
Property and equipment at December 31, 2013 and 2012 consisted of the following:
Office equipment
Automobiles
Real estate
Software
Accumulated depreciation
2013
9,116,070 $
2012
8,863,377
$
Estimated Useful
Life
5-15 years
2,106,116
2,010,762
3 years
5,911,129
5,356,705 15-50 years
2,717,205
2,717,206
5 years
19,850,520
(13,425,817)
18,948,050
(12,994,217)
$
6,424,703 $
5,953,833
Depreciation expense for 2013, 2012 and 2011 amounted to $783,897, $944,632 and $1.0 million, respectively.
8 - Liability for Losses and Loss Expenses
The establishment of an appropriate liability for losses and loss expenses is an inherently uncertain process, and we can
provide no assurance that our insurance subsidiaries' ultimate liability will not exceed their loss and loss expense reserves and
have an adverse effect on our results of operations and financial condition. Furthermore, we cannot predict the timing,
frequency and extent of adjustments to our insurance subsidiaries' estimated future liabilities, because the historical conditions
and events that serve as a basis for our insurance subsidiaries' estimates of ultimate claim costs may change. As is the case for
substantially all property and casualty insurance companies, our insurance subsidiaries have found it necessary in the past to
increase their estimated future liabilities for losses and loss expenses in certain periods, and, in other periods, their estimates
have exceeded their actual liabilities. Changes in our insurance subsidiaries' estimate of their liability for losses and loss
expenses generally reflect actual payments and their evaluation of information received since the prior reporting date.
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We summarize activity in our insurance subsidiaries' liability for losses and loss expenses as follows:
Balance at January 1
Less reinsurance recoverable
Net balance at January 1
Incurred related to:
Current year
Prior years
Total incurred
Paid related to:
Current year
Prior years
Total paid
Net balance at December 31
Plus reinsurance recoverable
Balance at December 31
2013
$ 458,827,395
(207,891,560)
250,935,835
2012
$ 442,407,615
(199,392,836)
243,014,779
2011
$ 383,318,672
(165,422,373)
217,896,299
332,770,088
325,275,882
10,357,863
7,595,702
343,127,951
332,871,584
340,671,237
(168,460)
340,502,777
201,781,955
205,876,331
219,183,102
126,676,599
119,074,197
96,201,195
328,458,554
324,950,528
315,384,297
265,605,232
250,935,835
243,014,779
230,014,037
207,891,560
199,392,836
$ 495,619,269
$ 458,827,395
$ 442,407,615
Our insurance subsidiaries recognized an increase (decrease) in their liability for losses and loss expenses of prior years of
$10.4 million, $7.6 million and ($168,460) in 2013, 2012 and 2011, respectively. Our insurance subsidiaries made no
significant changes in their reserving philosophy, key reserving assumptions or claims management personnel, and they have
made no significant offsetting changes in estimates that increased or decreased their loss and loss expense reserves in these
years. The 2013 development represented 4.1% of the December 31, 2012 net carried reserves and resulted primarily from
higher-than-expected severity in the private passenger automobile liability, commercial multiple peril, commercial automobile
and workers' compensation lines of business in accident years prior to 2013. The majority of the 2013 development related to
increases in the liability for losses and loss expenses of prior years for Atlantic States and Southern. The 2012 development
represented 3.1% of the December 31, 2011 net carried reserves and resulted primarily from higher-than-expected severity in
the private passenger automobile liability and workers' compensation lines of business in accident years prior to 2012. The
majority of the 2012 development related to increases in the liability for losses and loss expenses of prior years for Atlantic
States and Southern. The 2011 development represented an immaterial percentage of the December 31, 2010 net carried
reserves.
9 - Borrowings
Lines of Credit
In June 2013, we renewed our existing credit agreement with Manufacturers and Traders Trust Company (“M&T”) relating
to a $60.0 million unsecured, revolving line of credit. The line of credit now expires in July 2016. We have the right to request
a one-year extension of the credit agreement as of each anniversary date of the agreement. At December 31, 2013, we had
$43.0 million in outstanding borrowings and had the ability to borrow an additional $17.0 million at interest rates equal to
M&T’s current prime rate or the then current LIBOR rate plus 2.25%. The interest rate on our outstanding borrowings is
adjustable quarterly. At December 31, 2013, the interest rate on our outstanding borrowings was 2.42%. We pay a fee of 0.2%
per annum on the loan commitment amount regardless of usage. The credit agreement requires our compliance with certain
covenants. These covenants include minimum levels of our net worth, leverage ratio, statutory surplus and the A.M. Best
ratings of our insurance subsidiaries. We complied with all requirements of the credit agreement during 2013.
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MICO has an agreement with the Federal Home Loan Bank (“FHLB”) of Indianapolis. Through its membership, MICO
has the ability to issue debt to the FHLB of Indianapolis in exchange for cash advances. There were no outstanding borrowings
at December 31, 2013 or 2012. The table below presents the amount of FHLB of Indianapolis stock MICO purchased,
collateral pledged and assets related to MICO's agreement at December 31, 2013.
FHLB stock purchased and owned as part of the agreement
$
252,100
Collateral pledged, at par (carrying value $2,789,386)
Borrowing capacity currently available
3,700,000
2,413,882
Atlantic States is a member of the FHLB of Pittsburgh. Through its membership, Atlantic States has the ability to issue
debt to the FHLB of Pittsburgh in exchange for cash advances. During 2013, Atlantic States issued secured debt in the principal
amount of $15.0 million to the FHLB of Pittsburgh in exchange for cash advances in the amount of $15.0 million. Atlantic
States then loaned $15.0 million to us. We used the proceeds of our loan from Atlantic States to fund our prepayment of our
subordinated debentures, as we discuss below. The interest rate on the advances was .26% at December 31, 2013. Atlantic
States had no outstanding borrowings with the FHLB of Pittsburgh at December 31, 2012. The table below presents the amount
of FHLB of Pittsburgh stock Atlantic States purchased, collateral pledged and assets related to Atlantic States’ membership in
the FHLB of Pittsburgh at December 31, 2013.
FHLB stock purchased and owned as part of the agreement
$
870,300
Collateral pledged, at par (carrying value $15,305,496)
Borrowing capacity currently available
19,000,000
305,496
Subordinated Debentures
On October 29, 2003, we received $10.0 million in net proceeds from the issuance of subordinated debentures. The
debentures had a maturity date of October 29, 2033 and were callable at our option, at par. The debentures carried an interest
rate equal to the three-month LIBOR rate plus 3.85%. On January 28, 2013, we prepaid these subordinated debentures in full
and liquidated our investment in the statutory trust.
On May 24, 2004, we received $5.0 million in net proceeds from the issuance of subordinated debentures. The debentures
had a maturity date of May 24, 2034 and were callable at our option, at par. The debentures carried an interest rate equal to the
three-month LIBOR rate plus 3.85%. On February 25, 2013, we prepaid these subordinated debentures in full and liquidated
our investment in the statutory trust.
In January 2002, West Bend purchased a surplus note from MICO for $5.0 million to increase MICO's statutory surplus.
On December 1, 2010, Donegal Mutual purchased the surplus note from West Bend at face value. The surplus note carries an
interest rate of 5.00%, and any repayment of principal or interest requires prior insurance regulatory approval. Upon receipt of
regulatory approval, MICO paid $250,000 in interest to Donegal Mutual during each of 2013 and 2012.
10 - Reinsurance
Unaffiliated Reinsurers
Our insurance subsidiaries and Donegal Mutual purchase certain third-party reinsurance on a combined basis. Le Mars,
MICO, Peninsula and Sheboygan also have separate third-party reinsurance programs that provide certain coverage that is
commensurate with their relative size and exposures. Our insurance subsidiaries use several different reinsurers, all of which,
consistent with the requirements of our insurance subsidiaries and Donegal Mutual, have an A.M. Best rating of A- (Excellent)
or better, or, with respect to foreign reinsurers, have a financial condition that, in the opinion of our management, is equivalent
to a company with at least an A- rating from A.M. Best. The external reinsurance our insurance subsidiaries and Donegal
Mutual purchase includes “excess of loss reinsurance,” under which their losses are automatically reinsured, through a series of
contracts, over a set retention (generally $1.0 million for 2013 and 2012 and $750,000 prior to 2012), and “catastrophic
reinsurance,” under which they recover, through a series of contracts, 100% of an accumulation of many losses resulting from a
single event, including natural disasters, over a set retention (generally $5.0 million) and after exceeding an annual aggregate
deductible ($5.0 million in 2013 and $0 in 2012 and 2011) up to aggregate losses of $145.0 million per occurrence. For
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property insurance, our insurance subsidiaries had excess of loss treaties that provided for coverage up to $5.0 million per loss.
For liability insurance, our insurance subsidiaries had excess of loss treaties that provided for coverage up to $40.0 million per
occurrence. For workers' compensation insurance, our insurance subsidiaries had excess of loss treaties that provided for
coverage up to $10.0 million on any one life. Our insurance subsidiaries and Donegal Mutual had property catastrophe
coverage through a series of layered treaties up to aggregate losses of $150.0 million for any single event. As many as 25
reinsurers provided coverage on any one treaty with no reinsurer taking more than 30.0% of any one treaty. The amount of
coverage provided under each of these types of reinsurance depends upon the amount, nature, size and location of the risks
being reinsured. Donegal Mutual and our insurance subsidiaries also purchased facultative reinsurance to cover exposures from
losses that exceeded the limits provided by the treaty reinsurance Donegal Mutual and our insurance subsidiaries purchased. In
order to write automobile insurance in the State of Michigan, MICO is required to be a member of the Michigan Catastrophic
Claims Association ("MCCA"). The MCCA provides reinsurance to MICO for personal automobile and commercial
automobile personal injury claims in the State of Michigan over a set retention.
Through December 1, 2010, MICO and West Bend were parties to quota-share reinsurance agreements whereby MICO
ceded 75% of its business to West Bend. MICO and West Bend agreed to terminate the reinsurance agreement in effect at
November 30, 2010 on a run-off basis. West Bend's obligations related to all past reinsurance agreements with MICO remain in
effect for all policies effective prior to December 1, 2010.
MICO maintains a quota-share reinsurance agreement with third-party reinsurers to reduce its net exposures. Effective
from December 1, 2010 to December 31, 2011, the quota-share reinsurance percentage was 50%. Effective January 1, 2012,
MICO reduced the quota-share reinsurance percentage from 50% to 40%. Effective January 1, 2013, MICO reduced the quota-
share reinsurance percentage from 40% to 30%. Effective January 1, 2014, MICO reduced the quota-share reinsurance
percentage from 30% to 20%.
The following amounts represent ceded reinsurance transactions with unaffiliated reinsurers during 2013, 2012 and 2011:
Premiums written
Premiums earned
Losses and loss expenses
Prepaid reinsurance premiums
Liability for losses and loss expenses
Total Reinsurance
2013
2012
$ 69,776,461 $ 76,736,510 $ 80,265,127
2011
73,504,433
79,680,782
88,297,408
58,556,283
56,179,284
82,836,893
21,398,306
25,126,276
28,054,302
114,313,279
103,775,940
106,231,527
The following amounts represent our total ceded reinsurance transactions with both affiliated and unaffiliated reinsurers
during 2013, 2012 and 2011:
Premiums earned
Losses and loss expenses
Prepaid reinsurance premiums
Liability for losses and loss expenses
2013
2012
$ 266,284,366 $ 258,064,301 $ 242,186,814
216,776,966
181,995,838
181,218,752
2011
112,663,942
111,156,162
106,450,018
230,014,037
207,891,560
199,392,836
The following amounts represent the effect of reinsurance on premiums written for 2013, 2012 and 2011:
Direct
Assumed
Ceded
Net premiums written
2013
2012
$ 441,469,330 $ 419,811,847 $ 397,810,566
2011
359,753,517
(267,792,144)
306,416,861
339,389,274
(250,176,390)
(262,754,201)
$ 533,430,703 $ 496,446,920 $ 454,051,037
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The following amounts represent the effect of reinsurance on premiums earned for 2013, 2012 and 2011:
Direct
Assumed
Ceded
Net premiums earned
2013
2012
$ 431,788,593 $ 408,846,530 $ 385,737,801
2011
349,787,717
(266,284,366)
287,919,197
324,219,993
(242,186,814)
(258,064,301)
$ 515,291,944 $ 475,002,222 $ 431,470,184
11 - Income Taxes
Our provision for income tax consists of the following:
Current
Deferred
Federal income tax (benefit) provision
2013
4,973,430 $
1,414,843
6,388,273
$
$
$
2011
2012
3,614,390 $ (1,269,775)
(5,922,491)
1,151,250
$ (7,192,266)
4,765,640
Our effective tax rate is different from the amount computed at the statutory federal rate of 35% for 2013, 2012 and 2011.
The reasons for such difference and the related tax effects are as follows:
Income (loss) before income taxes
Computed “expected” taxes (benefit)
Tax-exempt interest
Proration
Other, net
Federal income tax (benefit) provision
2013
2012
2011
$ 32,710,265 $ 27,858,260 $
11,448,593
(5,789,963)
868,306
(138,663)
6,388,273
$
9,750,391
(5,824,281)
869,551
(30,021)
4,765,640
$
$
(6,739,313)
(2,358,760)
(6,038,463)
905,326
299,631
(7,192,266)
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax
liabilities at December 31, 2013 and 2012 are as follows:
Deferred tax assets:
Unearned premium
Loss reserves
Net operating loss carryforward
Net operating loss carryforward - Le Mars
Alternative minimum tax credit carryforward
Net unrealized losses
Other
Total gross deferred assets
Less valuation allowance
Net deferred tax assets
Deferred tax liabilities:
Deferred policy acquisition costs
Net unrealized gains
Other
Total gross deferred tax liabilities
Net deferred tax asset
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2013
2012
$ 18,875,418 $ 17,613,415
6,966,581
—
1,665,748
7,275,091
1,942,128
1,797,194
10,011,483
7,964,853
1,245,400
—
1,261,546
1,413,285
40,026,176
(440,778)
39,585,398
38,005,966
(440,778)
37,565,188
15,269,629
14,042,594
—
14,212,465
4,005,211
3,042,593
19,274,840
31,297,652
$ 20,310,558 $
6,267,536
We provide a valuation allowance when we believe it is more likely than not that we will not realize some portion of the
tax asset. At December 31, 2013 and 2012, we established a valuation allowance of $440,778 related to a portion of the net
operating loss carryforward of Le Mars that we acquired on January 1, 2004. We determined that we were not required to
establish a valuation allowance for the other net deferred tax assets of $39.6 million and $37.6 million at December 31, 2013
and 2012, respectively, since it is more likely than not that we will realize these deferred tax assets through reversals of existing
temporary differences, future taxable income and the implementation of tax-planning strategies.
Tax years 2010 through 2013 remained open for examination at December 31, 2013. The net operating loss carryforward
of $4.8 million from Le Mars will begin to expire in 2020 if not utilized and is subject to an annual limitation of approximately
$376,000. We also had an alternative minimum tax credit carryforward of $10.0 million with an indefinite life.
12 - Stockholders' Equity
On April 19, 2001, our stockholders approved an amendment to our certificate of incorporation. Among other things, the
amendment reclassified our common stock as Class B common stock and effected a one-for-three reverse split of our 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. Our board of directors also declared 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.
At our annual meeting of stockholders on April 18, 2013, our stockholders approved an amendment to our certificate of
incorporation that increased the number of shares of our Class A common stock we have the authority to issue from 30.0
million shares to 40.0 million shares.
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 our merger or consolidation 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 our liquidation, dissolution or winding-up, any assets available to common stockholders will be
distributed pro-rata to the holders of Class A common stock and Class B common stock after payment of all of our obligations.
In February 2009, our board of directors authorized a share repurchase program, pursuant to which we may purchase up to
300,000 shares of our Class A common stock at market prices prevailing from time to time in the open market subject to the
provisions of Securities and Exchange Commission ("SEC") Rule 10b-18 and in privately negotiated transactions. We
purchased 24,240 and 135,064 shares of our Class A common stock under this program during 2013 and 2012, respectively. At
December 31, 2013, we had the authority remaining to purchase 4,068 shares under this program.
On July 18, 2013, our board of directors authorized a share repurchase program pursuant to which we have the authority
to purchase up to 500,000 additional shares of our Class A common stock at prices prevailing from time to time in the open
market subject to the provisions of SEC Rule 10b-18 and in privately negotiated transactions. We did not purchase shares under
this program during 2013.
At December 31, 2013, our treasury stock consisted of 940,862 and 72,465 shares of Class A common stock and Class B
common stock, respectively. At December 31, 2012, our treasury stock consisted of 916,622 and 72,465 shares of Class A
common stock and Class B common stock, respectively.
13 - Stock Compensation Plans
Equity Incentive Plans
During 1996, we adopted an Equity Incentive Plan for Employees. During 2001, we adopted a nearly identical plan that
made a total of 2,666,667 shares of Class A common stock available for issuance to employees of our subsidiaries and
affiliates. During 2005, we amended the plan to make a total of 4,000,000 shares of Class A common stock available for
issuance. During 2007, we adopted a nearly identical plan that made a total of 3,500,000 shares of Class A common stock
available for issuance to employees of our subsidiaries and affiliates. During 2011, we adopted a nearly identical plan that made
a total of 3,500,000 shares of Class A common stock available for issuance to employees of our subsidiaries and affiliates.
During 2013, we adopted a nearly identical plan that made a total of 4,500,000 shares of Class A common stock available for
issuance to employees of our subsidiaries and affiliates. Each plan provides for the granting of awards by our board of directors
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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 ten years from date of grant, with an option price not less than fair market value on
date of grant. We have not granted any stock appreciation rights.
During 1996, we adopted an Equity Incentive Plan for Directors. During 2001, we adopted a nearly identical plan that made
355,556 shares of Class A common stock available for issuance to our directors and those of our subsidiaries and affiliates.
During 2007, we adopted a nearly identical plan that made 400,000 shares of Class A common stock available for issuance to
our directors and the directors of our subsidiaries and affiliates. During 2011, we adopted a nearly identical plan that made
400,000 shares of Class A common stock available for issuance to our directors and the directors of our subsidiaries and
affiliates. During 2013, we adopted a nearly identical plan that made 600,000 shares of Class A common stock available for
issuance to our directors and the directors of our subsidiaries and affiliates. We may make awards in the form of stock options.
The plan also provides for the issuance of 400 shares of restricted stock on the first business day of January in each year to each
of our directors and each director of Donegal Mutual who does not serve as one of our directors. We issued 6,800, 6,800 and
5,598 shares of restricted stock on January 2, 2013, 2012 and 2011, respectively.
We measure all share-based payments to employees, including grants of employee stock options, using a fair-value-based
method and record such expense in our results of operations. In determining the expense we record for stock options granted to
directors and employees of our subsidiaries and affiliates, we estimate the fair value of each option award on the date of grant
using the Black-Scholes option pricing model. The significant assumptions we utilize in applying the Black-Scholes option
pricing model are the risk-free interest rate, expected term, dividend yield and expected volatility. The risk-free interest rate is
the implied yield currently available on U.S. Treasury zero coupon issues with a remaining term equal to the expected term
used as the assumption in the model. We base the expected term of an option award on our historical experience for similar
awards. We determine the dividend yield by dividing the per share dividend by the grant date stock price. We base the expected
volatility on the volatility of our stock price over a historical period comparable to the expected term.
The weighted-average grant date fair value of options granted during 2013 was $2.20. We calculated this fair value based
upon a risk-free interest rate of 1.63%, expected life of five years, expected volatility of 23% and expected dividend yield of
3%.
The weighted-average grant date fair value of options granted during 2012 was $2.85. We calculated this fair value based
upon a risk-free interest rate of .43%, expected life of five years, expected volatility of 33% and expected dividend yield of 3%.
The weighted-average grant date fair value of options granted during 2011 was $1.90. We calculated this fair value based
upon a risk-free interest rate of .75%, expected life of five years, expected volatility of 31% and expected dividend yield of 4%.
We charged compensation expense for our stock compensation plans against income before income taxes of $547,374,
$420,735 and $283,811 for the years ended December 31, 2013, 2012 and 2011, respectively, with a corresponding income tax
benefit of $186,107, $143,050 and $96,496. At December 31, 2013 and 2012, our total unrecognized compensation cost related
to non-vested share-based compensation granted under our stock compensation plans was $1.1 million and $1.2 million,
respectively. We expect to recognize this cost over a weighted average period of 1.0 years.
During 2013, we received cash from option exercises under all stock compensation plans of $9.7 million. We realized actual
tax benefits for the tax deductions from option exercises of share-based compensation of $531,159 for 2013. During 2012, we
received cash from option exercises under all stock compensation plans of $1.1 million. We realized actual tax benefits for the
tax deductions from option exercises of share-based compensation of $52,422 for 2012. We did not receive any cash from
option exercises in 2011. No further shares are available for future option grants for plans in effect prior to 2013.
-81-
Information regarding activity in our stock option plans follows:
Outstanding at December 31, 2010
Granted - 2011
Forfeited - 2011
Expired - 2011
Outstanding at December 31, 2011
Granted - 2012
Exercised - 2012
Forfeited - 2012
Expired - 2012
Outstanding at December 31, 2012
Granted - 2013
Exercised - 2013
Forfeited - 2013
Expired - 2013
Outstanding at December 31, 2013
Exercisable at:
December 31, 2011
December 31, 2012
December 31, 2013
Number of
Options
3,998,667 $
2,321,000
(52,000)
(958,667)
5,309,000
1,593,600
(82,102)
(109,673)
(10,000)
6,700,825
2,543,500
(722,322)
(116,669)
(1,204,000)
7,201,334 $
1,821,333 $
3,072,970 $
3,028,619 $
Weighted-
Average
Exercise Price
Per Share
16.80
12.52
15.63
21.00
14.18
14.50
13.01
13.84
21.00
14.27
15.90
13.45
13.65
17.52
14.39
16.42
15.03
13.47
Shares available for future option grants at December 31, 2013 totaled 2,556,500 shares under all plans.
The following table summarizes information about fixed stock options outstanding at December 31, 2013:
Exercise Price
$12.50
14.00
14.50
15.00
15.90
17.50
Total
Number of
Options
Outstanding
1,863,627
1,284,207
1,502,000
3,000
Weighted-Average
Remaining
Contractual Life
8.0 years
2.0 years
9.0 years
2.0 years
2,543,500
10.0 years
5,000
0.25 years
7,201,334
Number of
Options
Exercisable
1,242,417
1,277,540
500,662
3,000
—
5,000
3,028,619
Employee Stock Purchase Plans
During 1996, we adopted an Employee Stock Purchase Plan. During 2001, we adopted a nearly identical plan that made
533,333 shares of Class A common stock available for issuance. During 2011, we adopted another nearly identical plan that
made 300,000 shares of Class A common stock available for issuance.
The 2011 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 our Class A common stock on the last day before the first day of
each enrollment period (June 1 and December 1 of each year) under the plan or 85% of the fair market value of our common
stock on the last day of each subscription period (June 30 and December 31 of each year).
-82-
A summary of plan activity follows:
January 1, 2011
July 1, 2011
January 1, 2012
July 1, 2012
January 1, 2013
July 1, 2013
$
Shares Issued
Price
Shares
11.02
10.88
11.91
11.29
11.93
11.76
13,243
11,371
10,523
19,031
16,485
19,805
On January 1, 2014, we issued an additional 16,964 shares at a price of $12.58 per share under this plan.
Agency Stock Purchase Plans
During 1996, we adopted an Agency Stock Purchase Plan. During 2001, we adopted a nearly identical plan that made
533,333 shares of Class A common stock available for issuance. During 2011, we adopted another nearly identical plan that
made 300,000 shares of Class A common stock available for issuance. The plan provides for agents of our insurance
subsidiaries and Donegal Mutual to invest up to $12,000 per subscription period (April 1 to September 30 and October 1 to
March 31 of each year) under various methods. We issue stock at the end of each subscription period at a price equal to 90% of
the average market price during the last ten trading days of each subscription period. During 2013, 2012 and 2011, we issued
79,532, 70,366 and 66,260 shares, respectively, under this plan. Expense recognized under the plan was not material.
-83-
14 - Statutory Net Income, Capital and Surplus and Dividend Restrictions
The following table presents selected information, as filed with insurance regulatory authorities, for our insurance
subsidiaries as determined in accordance with accounting practices prescribed or permitted by such insurance regulatory
authorities:
Atlantic States:
Statutory capital and surplus
Statutory unassigned surplus
Statutory net income (loss)
Southern:
Statutory capital and surplus
Statutory unassigned surplus
Statutory net income (loss)
Le Mars:
Statutory capital and surplus
Statutory unassigned surplus
Statutory net income (loss)
Peninsula:
Statutory capital and surplus
Statutory unassigned surplus
Statutory net income
Sheboygan:
Statutory capital and surplus
Statutory unassigned surplus (deficit)
Statutory net income (loss)
MICO:
Statutory capital and surplus
Statutory unassigned surplus
Statutory net income
2013
2012
2011
$ 186,606,655 $ 180,465,658 $ 173,505,872
131,028,806
124,924,794
12,596,844
12,507,540
113,497,280
(7,729,040)
62,702,432
58,841,059
60,876,093
11,701,045
4,195,635
7,843,473
(1,539,943)
9,364,037
1,795,195
27,627,914
26,803,140
24,720,327
15,032,372
790,147
14,210,400
2,423,225
11,373,158
(1,661,327)
41,891,487
42,471,092
40,744,215
24,089,092
24,671,678
22,601,043
1,481,670
1,478,823
1,210,247
12,085,839
52,211
1,374,543
10,944,235
(1,087,936)
(33,316)
10,800,499
(1,437,493)
(1,237,478)
41,594,701
42,443,200
39,264,423
15,588,110
16,440,388
12,689,880
1,170,008
2,698,257
2,889,619
Our principal source of cash for payment of dividends is dividends from our insurance subsidiaries. State insurance laws
require our insurance subsidiaries to maintain certain minimum capital and surplus amounts on a statutory basis. Our insurance
subsidiaries are subject to regulations that restrict the payment of dividends from statutory surplus and may require prior
approval of their domiciliary insurance regulatory authorities. Our insurance subsidiaries are also subject to risk based capital
("RBC") requirements that may further impact their ability to pay dividends. Our insurance subsidiaries' statutory capital and
surplus at December 31, 2013 exceeded the amount of statutory capital and surplus necessary to satisfy regulatory
requirements, including the RBC requirements, by a significant margin. Amounts available for distribution to us as dividends
from our insurance subsidiaries without prior approval of insurance regulatory authorities in 2014 are $18.7 million from
Atlantic States, $4.2 million from Southern, $2.8 million from Le Mars, $4.2 million from Peninsula, $1.1 million from
Sheboygan and $4.1 million from MICO, or a total of approximately $35.1 million.
-84-
15 - Reconciliation of Statutory Filings to Amounts Reported Herein
Our insurance subsidiaries must file financial statements with state insurance regulatory authorities using accounting
principles and practices prescribed or permitted by those authorities. We refer to these accounting principles and practices as
statutory accounting principles (“SAP”). Accounting principles used to prepare these SAP financial statements differ from
those used to prepare financial statements on the basis of GAAP.
Reconciliations of statutory net income and capital and surplus, as determined using SAP, to the amounts included in the
accompanying GAAP financial statements are as follows:
Statutory net income (loss) of insurance subsidiaries
Increases (decreases):
Deferred policy acquisition costs
Deferred federal income taxes
Salvage and subrogation recoverable
Amortization of MICO fair value adjustments
Consolidating eliminations and adjustments
Parent-only net income
Year Ended December 31,
2013
$ 21,608,847
2012
$ 17,534,586
2011
$
(4,732,784)
3,505,813
(1,414,843)
1,059,400
—
(10,648,834)
12,211,609
3,696,742
(1,151,250)
772,600
(5,416)
(5,421,779)
7,667,137
1,979,376
5,922,490
1,273,000
(3,275,777)
(15,080,164)
14,366,812
Net income as reported herein
$ 26,321,992
$ 23,092,620
$
452,953
Statutory capital and surplus of insurance subsidiaries
Increases (decreases):
Deferred policy acquisition costs
Deferred federal income taxes
Salvage and subrogation recoverable
Non-admitted assets and other adjustments, net
Fixed maturities
Parent-only equity and other adjustments
Stockholders' equity as reported herein
16 - Supplementary Cash Flow Information
Year Ended December 31,
2013
$ 372,509,028
2012
$ 361,968,384
2011
$ 349,911,429
43,627,510
(12,251,398)
13,060,000
40,121,697
(25,682,004)
12,000,600
36,424,955
(21,007,223)
11,228,000
2,363,038
(1,465,363)
(20,965,704)
$ 396,877,111
2,005,603
1,478,988
39,607,340
(29,987,526)
$ 400,034,094
33,165,065
(27,749,622)
$ 383,451,592
The following table reflects net income taxes and interest paid during 2013, 2012 and 2011:
Income taxes
Interest
2013
5,450,000 $
2012
1,626,965 $
$
2011
324,291
1,527,037
2,128,693
1,793,366
-85-
17 - Earnings Per Share
We have two classes of common stock, which we refer to as Class A common stock and Class B common stock. Our
Class A common stock is entitled to be paid cash dividends that are at least 10% higher than the cash we pay on our Class B
common stock. Accordingly, we use the two-class method for the computation of earnings per common share. The two-class
method is an earnings allocation formula that determines earnings per share separately for each class of common stock based
on dividends declared and an allocation of remaining undistributed earnings using a participation percentage reflecting the
dividend rights of each class.
We present below a reconciliation of the numerators and denominators we used in the basic and diluted per share
computations for our Class A common stock:
(dollars in thousands, except per share data)
Basic earnings per share:
Numerator:
Allocation of net income
Denominator:
Weighted-average shares outstanding
Basic earnings per share
Diluted earnings per share:
Numerator:
Allocation of net income
Denominator:
Number of shares used in basic computation
Weighted-average effect of dilutive securities
Add: Director and employee stock options
Number of shares used in per share computations
Diluted earnings per share
Year Ended December 31,
2013
2012
2011
$
$
$
21,110 $
18,455 $
390
20,363,677
20,031,455
1.04 $
0.92 $
19,997,146
0.02
21,110 $
18,455 $
390
20,363,677
20,031,455
19,997,146
398,708
20,762,385
274,103
20,305,558
$
1.02 $
0.91 $
36,499
20,033,645
0.02
We used the following information in the basic and diluted per share computations for our Class B common stock:
(dollars in thousands, except per share data)
Basic and diluted earnings per share:
Numerator:
Allocation of net income
Denominator:
Weighted-average shares outstanding
Basic and diluted earnings per share
Year Ended December 31,
2013
2012
2011
$
$
5,212 $
4,638 $
63
5,576,775
5,576,775
5,576,775
0.94 $
0.83 $
0.01
During 2013, 2012 and 2011, we did not include certain options to purchase shares of our Class A common stock in the
computation of diluted earnings per share because the exercise price of the options was greater than the average market price of
our Class A common stock. The following table reflects such options that remained outstanding at December 31, 2013, 2012
and 2011:
Options excluded from diluted earnings per share
2013
2,548,500
2012
1,209,000
2011
1,238,000
-86-
18 - Condensed Financial Information of Parent Company
December 31,
Assets
Condensed Balance Sheets
(in thousands)
2013
2012
Investment in subsidiaries/affiliates (equity method)
$
457,886 $
470,565
Short-term investments
Cash
Property and equipment
Other
Total assets
Liabilities and Stockholders' Equity
Liabilities
149
1,604
927
586
326
805
883
304
$
461,152 $
472,883
Cash dividends declared to stockholders
$
3,299 $
Borrowings under lines of credit
Subordinated debentures
Other
Total liabilities
Stockholders' equity
Total liabilities and stockholders' equity
58,000
—
2,976
64,275
3,067
52,000
15,465
2,316
72,848
396,877
400,035
$
461,152 $
472,883
Condensed Statements of Income and Comprehensive Income
(in thousands)
Year Ended December 31,
Statements of Income
Revenues
Dividends from subsidiaries
Other
Total revenues
Expenses
Operating expenses
Interest
Total expenses
Income before income tax (benefit) expense and equity in
undistributed net income (loss) of subsidiaries
Income tax (benefit) expense
Income before equity in undistributed net income (loss) of
subsidiaries
Equity in undistributed net income (loss) of subsidiaries
Net income
Statements of Comprehensive Income
Net income
Other comprehensive (loss) income, net of tax
Unrealized (loss) gain - subsidiaries
Other comprehensive (loss) income, net of tax
Comprehensive (loss) income
-87-
2013
2012
2011
$
12,500
$
7,000
$
16,000
3,758
16,258
3,777
1,488
5,265
10,993
(1,219)
12,212
14,110
5,487
12,487
2,323
2,118
4,441
8,046
378
7,668
15,425
26,322
$
23,093
$
2,995
18,995
2,392
1,864
4,256
14,739
372
14,367
(13,914)
453
26,322
$
23,093
$
453
(28,707)
(28,707)
(2,385) $
4,644
4,644
27,737
$
14,972
14,972
15,425
$
$
$
Condensed Statements of Cash Flows
(in thousands)
Year Ended December 31,
Cash flows from operating activities:
Net income
Adjustments:
Equity in undistributed net (income) loss of subsidiaries
Other
Net adjustments
Net cash provided
Cash flows from investing activities:
Net sale of short-term investments
Net purchase of property and equipment
Investment in subsidiaries
Other
Net cash provided (used)
Cash flows from financing activities:
Cash dividends paid
Issuance of common stock
Payments on subordinated debentures
Payments on line of credit
Borrowings under lines of credit
Repurchase of treasury stock
Net cash (used) provided
Net change in cash
Cash at beginning of year
Cash at end of year
2013
2012
2011
$
26,322
$
23,093
$
453
(14,110)
(2,200)
(16,310)
10,012
176
(420)
990
44
790
(12,809)
12,648
(15,465)
(15,500)
21,500
(377)
(10,003)
799
805
$
1,604
$
(15,425)
(2,624)
(18,049)
5,044
8,932
(147)
(100)
44
8,729
(12,208)
2,983
—
(6,000)
3,500
(1,927)
(13,652)
121
684
805
13,914
(396)
13,518
13,971
6,437
(380)
(27,777)
43
(21,677)
(11,874)
1,461
—
(3,000)
22,500
(1,538)
7,549
(157)
841
$
684
-88-
19 - Segment Information
We have four reportable segments, which consist of our investment function, our personal lines of insurance, our
commercial lines of insurance and our investment in DFSC. Using independent agents, our insurance subsidiaries market
personal lines of insurance to individuals and commercial lines of insurance to small and medium-sized businesses.
We evaluate the performance of the personal lines and commercial lines primarily based upon our insurance subsidiaries'
underwriting results as determined under SAP for our total business.
We do not allocate assets to the personal and commercial lines and review the two segments in total for purposes of
decision-making. We operate only in the United States and no single customer or agent provides 10 percent or more of our
revenues.
Financial data by segment is as follows:
Revenues:
Premiums earned:
Commercial lines
Personal lines
SAP premiums earned
GAAP adjustments
GAAP premiums earned
Net investment income
Realized investment gains
Equity in earnings of DFSC
Other
Total revenues
Income before income taxes:
Underwriting income (loss):
Commercial lines
Personal lines
SAP underwriting income (loss)
GAAP adjustments
GAAP underwriting income (loss)
Net investment income
Realized investment gains
Equity in earnings of DFSC
Other
2013
2012
2011
(in thousands)
$
$
202,983
312,309
515,292
—
515,292
18,795
2,423
2,908
7,692
$
174,735
300,272
475,007
(5)
475,002
20,169
6,859
4,533
8,420
152,247
282,498
434,745
(3,275)
431,470
20,858
12,281
2,023
8,386
$
547,110
$
514,983
$
475,018
2013
2012
2011
(in thousands)
$
(524) $
1,654
1,130
5,175
6,305
18,795
2,423
2,908
2,279
$
5,251
(18,236)
(12,985)
5,545
(7,440)
20,169
6,859
4,533
3,737
(6,560)
(40,739)
(47,299)
1,532
(45,767)
20,858
12,281
2,023
3,866
(6,739)
Income (loss) before income taxes
$
32,710
$
27,858
$
20 - Guaranty Fund and Other Insurance-Related Assessments
Our insurance subsidiaries' liabilities for guaranty fund and other insurance-related assessments were $1,511,186 and
$1,403,829 at December 31, 2013 and 2012, respectively. These liabilities included $527,241 and $433,994 related to
surcharges collected by our insurance subsidiaries on behalf of regulatory authorities for 2013 and 2012, respectively.
-89-
21 - Interim Financial Data (unaudited)
Net premiums earned
Total revenues
Net losses and loss expenses
Net income
Net earnings per common share:
Class A common stock - basic
Class A common stock - diluted
Class B common stock - basic and diluted
Net premiums earned
Total revenues
Net losses and loss expenses
Net income
Net earnings per common share:
Class A common stock - basic
Class A common stock - diluted
Class B common stock - basic and diluted
2013
First Quarter
Fourth Quarter
$ 124,702,041 $ 126,963,328 $ 130,645,011 $ 132,981,564
Second Quarter
Third Quarter
133,872,592
135,507,635
138,334,960
139,394,878
85,533,016
89,519,350
84,882,734
83,192,851
6,475,436
2,628,987
7,653,734
9,563,835
0.26
0.25
0.23
0.10
0.10
0.09
2012
0.30
0.30
0.27
0.38
0.37
0.35
First Quarter
Fourth Quarter
$ 114,691,791 $ 117,569,122 $ 120,916,960 $ 121,824,349
Second Quarter
Third Quarter
125,348,162
76,609,219
127,299,190
86,385,353
130,431,531
82,105,094
131,903,702
87,771,918
8,010,147
2,023,067
6,839,384
6,220,022
0.32
0.31
0.29
0.08
0.08
0.07
0.27
0.27
0.25
0.25
0.25
0.22
-90-
Report of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors of Donegal Group Inc.
We have audited the accompanying consolidated balance sheets of Donegal Group Inc. and subsidiaries (the Company) as
of December 31, 2013 and 2012, 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, 2013. 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 did not audit the financial statements of Donegal Financial Services
Corporation (a 48.2 percent owned investee company). The Company's investment in Donegal Financial Services Corporation
at December 31, 2013 and 2012, was $35,685,433 and $36,770,530, respectively, and its equity in earnings of Donegal
Financial Services Corporation was $2,907,867 and $4,533,257 for the years 2013 and 2012, respectively. The financial
statements of Donegal Financial Services Corporation were audited by other auditors whose report has been furnished to us,
and our opinion, insofar as it relates to the amounts included for Donegal Financial Services Corporation, is based solely on the
report of the other auditors.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United
States). 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 and the
report of the other auditors provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of the other auditors, 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,
2013 and 2012, and the results of their operations and their cash flows for each of the years in the three-year period ended
December 31, 2013, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Oversight Board (United States), Donegal
Group Inc.'s internal control over financial reporting as of December 31, 2013 based on the criteria established in Internal
Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission
(COSO), and our report dated March 14, 2014 expressed an unqualified opinion on the effectiveness of the Company's internal
control over financial reporting.
Philadelphia, Pennsylvania
March 14, 2014
-91-
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, has evaluated the
effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the
Exchange Act) at December 31, 2013 covered by this Form 10-K Report. Based on such evaluation, our Chief Executive
Officer and our Chief Financial Officer have concluded that, at December 31, 2013, our disclosure controls and procedures are
effective in recording, processing, summarizing and reporting, on a timely basis, information we are required to disclose in the
reports that we file or submit under the Exchange Act and our disclosure controls and procedures are also effective to ensure
that information we disclose in the reports we file or submit under the Exchange Act is accumulated and communicated to our
management, including our Chief Executive Officer and our Chief Financial Officer, to allow timely decisions regarding
required disclosure.
Management's Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as that
term is defined in Rule 13a-15(f) under the Exchange Act. Under the supervision and with the participation of our Chief
Executive Officer and our Chief Financial Officer, our management has conducted an evaluation of the effectiveness of our
internal control over financial reporting based on the framework and criteria established in Internal Control - Integrated
Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the "COSO
Framework"). Based on our evaluation under the COSO Framework, our management has concluded that our internal control
over financial reporting was effective at December 31, 2013.
The effectiveness of our internal control over financial reporting at December 31, 2013 has been audited by KPMG LLP,
an independent registered public accounting firm, as stated in their report, which is included in this Form 10-K Annual Report.
Changes in Internal Control over Financial Reporting
We did not make any changes to our internal control over financial reporting (as such term is defined in Rules 13a-15(f)
and 15d-15(f) under the Exchange Act) during the fourth quarter of 2013 that have materially affected, or are reasonably likely
to affect materially, our internal control over financial reporting.
Item 9B. Other Information.
None.
-92-
Report of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors of Donegal Group Inc.
We have audited Donegal Group Inc.'s (the Company) internal control over financial reporting as of December 31, 2013,
based on criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). Donegal Group Inc.'s management is responsible for maintaining
effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial
reporting included in the accompanying Management's Report on Internal Control Over Financial Reporting. Our responsibility
is to express an opinion on the Company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United
States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding
of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the
design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other
procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our
opinion.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally
accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures
that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and
dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and
expenditures of the company are being made only in accordance with authorizations of management and directors of the
company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or
disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate
because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Donegal Group Inc. maintained, in all material respects, effective internal control over financial reporting
as of December 31, 2013, based on criteria established in Internal Control - Integrated Framework (1992) issued by the
Committee of Sponsoring Organizations of the Treadway Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United
States), the consolidated balance sheets of Donegal Group Inc. and subsidiaries as of December 31, 2013 and 2012, 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, 2013, and our report dated March 14, 2014 expressed an unqualified opinion
on those consolidated financial statements.
Philadelphia, Pennsylvania
March 14, 2014
-93-
Item 10. Directors, Executive Officers and Corporate Governance of the Registrant.
PART III
We incorporate the response to this Item 10 by reference to our proxy statement we will file with the SEC on or about
March 18, 2014 relating to our annual meeting of stockholders that we will hold on April 17, 2014, or our Proxy Statement. We
respond to this Item with respect to our executive officers by reference to Part I of this Form 10-K Report.
We incorporate the full text of our Code of Business Conduct and Ethics by reference to Exhibit 14 to this Form 10-K
Report.
Item 11. Executive Compensation.
We incorporate the response to this Item 11 by reference to our Proxy Statement. Neither the Report of our Compensation
Committee nor the Report of our Audit Committee included in our Proxy Statement shall constitute or be deemed to constitute
a filing with the SEC under the Securities Act or the Exchange Act or be deemed to have been incorporated by reference into
any filing we make under the Securities Act or the Exchange Act, except to the extent we specifically incorporate the Report of
Our Compensation Committee or the Report of Our Audit Company by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
We incorporate the response to this Item 12 by reference to our Proxy Statement.
Item 13. Certain Relationships and Related Transactions and Director Independence.
We incorporate the response to this Item 13 by reference to our Proxy Statement.
Item 14. Principal Accountant Fees and Services.
We incorporate the response to this Item 14 by reference to our Proxy Statement.
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PART IV
Item 15. Exhibits and Financial Statement Schedule.
(a) Financial statements, financial statement schedule and exhibits filed:
(a) Consolidated Financial Statements
Reports of Independent Registered Public Accounting Firm
Donegal Group Inc. and Subsidiaries:
Consolidated Balance Sheets at December 31, 2013 and 2012
Consolidated Statements of Income and Comprehensive Income for each of the years in the three-year period
ended December 31, 2013, 2012 and 2011
Consolidated Statements of Stockholders’ Equity for each of the years in the three-year period ended
December 31, 2013, 2012 and 2011
Consolidated Statements of Cash Flows for each of the years in the three-year period ended December 31,
2013, 2012 and 2011
Notes to Consolidated Financial Statements
Report and Consent of Independent Registered Public Accounting Firm
(Filed as Exhibit 23.1)
Consent of Independent Registered Public Accounting Firm
(Filed as Exhibit 23.2)
Consent of Independent Registered Public Accounting Firm
(Filed as Exhibit 23.3)
(b) Financial Statement Schedule
Schedule III — Supplementary Insurance Information
Consolidated Financial Statements of Donegal Financial Services Corporation
Page
91
57
58
59
60
61
Filed
herewith
Filed
herewith
We have omitted all other schedules since they are not required, not applicable or the information is included in the
financial statements or notes to the financial statements.
(c) Exhibits
Description of Exhibits
Reference
Exhibit No.
3.1
3.2
Certificate of Incorporation of Donegal Group Inc., as amended.
Amended and Restated By-laws of Donegal Group Inc.
Management Contracts and Compensatory Plans or Arrangements
10.1
10.2
10.3
10.4
10.5
Donegal Group Inc. 2013 Equity Incentive Plan for Employees.
Donegal Group Inc. 2013 Equity Incentive Plan for Directors.
Donegal Group Inc. 2011 Employee Stock Purchase Plan.
Donegal Group Inc. 2011 Equity Incentive Plan for Employees.
Donegal Group Inc. 2011 Equity Incentive Plan for Directors.
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(a)
(i)
(c)
(c)
(c)
(c)
(c)
10.6
10.7
10.8
10.9
10.10
10.11
10.12
10.13
10.14
10.15
10.16
10.17
10.18
10.19
Employment Agreement dated as of July 29, 2011 among Donegal Mutual Insurance Company,
Donegal Group Inc. and Donald H. Nikolaus.
Consulting Agreement dated as of July 29, 2011 among Donegal Mutual Insurance Company,
Donegal Group Inc. and Donald H. Nikolaus.
Employment Agreement dated as of July 29, 2011 among Donegal Mutual Insurance Company,
Donegal Group Inc. and Kevin G. Burke.
Employment Agreement dated as of July 29, 2011 among Donegal Mutual Insurance Company,
Donegal Group Inc. and Cyril J. Greenya.
Employment Agreement dated as of July 29, 2011 among Donegal Mutual Insurance Company,
Donegal Group Inc. and Jeffrey D. Miller.
(d)
(d)
(d)
(d)
(d)
Employment Agreement dated as of July 18, 2013 among Donegal Mutual Insurance Company,
Donegal Group Inc. and Sanjay Pandey.
Filed
herewith
Employment Agreement dated as of July 29, 2011 among Donegal Mutual Insurance Company,
Donegal Group Inc. and Robert G. Shenk.
Employment Agreement dated as of July 29, 2011 among Donegal Mutual Insurance Company,
Donegal Group Inc. and Daniel J. Wagner.
Donegal Mutual Insurance Company 401(k) Plan.
Amendment No. 1 effective January 1, 2000 to Donegal Mutual Insurance Company 401(k) Plan.
Amendment No. 2 effective January 6, 2000 to Donegal Mutual Insurance Company 401(k) Plan.
Amendment No. 3 effective July 23, 2001 to Donegal Mutual Insurance Company 401(k) Plan.
Amendment No. 4 effective January 1, 2002 to Donegal Mutual Insurance Company 401(k) Plan.
Amendment No. 5 effective December 31, 2001 to Donegal Mutual Insurance Company 401(k)
Plan.
10.20
Amendment No. 6 effective July 1, 2002 to Donegal Mutual Insurance Company 401(k) Plan.
10.21
Donegal Group Inc. 2007 Equity Incentive Plan for Employees.
10.22
Donegal Group Inc. 2007 Equity Incentive Plan for Directors.
10.23
Donegal Group Inc. Incentive Compensation Program.
Other Material Contracts
10.24
10.25
10.26
10.27
10.28
10.29
10.30
Reinsurance and Retrocession Agreement dated May 21, 1996 between Donegal Mutual Insurance
Company and Southern Insurance Company of Virginia.
Surplus Note Purchase Agreement dated September 8, 2009 between Donegal Mutual Insurance
Company and Southern Mutual Insurance Company.
Quota-share Reinsurance Agreement dated October 30, 2009 but effective 11:59 p.m. on
October 31, 2009 between Donegal Mutual Insurance Company and Southern Mutual Insurance
Company.
Services and Affiliation Agreement dated October 30, 2009 between Donegal Mutual Insurance
Company and Southern Mutual Insurance Company.
Technology License Agreement dated October 30, 2009 between Donegal Mutual Insurance
Company and Southern Mutual Insurance Company.
Amended and Restated Proportional Reinsurance Agreement dated March 1, 2010 between
Donegal Mutual Insurance Company and Atlantic States Insurance Company.
Agreement and Plan of Merger dated April 19, 2010, and as amended May 20, 2010, among
Donegal Acquisition Inc., Donegal Financial Services Corporation, Donegal Group Inc. and Union
National Financial Corporation; amended dated September 1, 2010; amended dated December 8,
2010.
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(d)
(d)
(e)
(e)
(b)
(b)
(b)
(b)
(h)
(j)
(j)
(k)
(f)
(l)
(l)
(l)
(l)
(l)
(m)
10.31
10.32
10.33
10.34
10.35
10.36
10.37
10.38
14
21
Amended and Restated Agreement and Plan of Merger dated December 6, 2010 among Michigan
Insurance Company, West Bend Mutual Insurance Company, Donegal Group Inc. and DGI
Acquisition Corp.
Amended and Restated Tax Sharing Agreement dated December 1, 2010 among Donegal Group
Inc., Atlantic States Insurance Company, Southern Insurance Company of Virginia, Le Mars
Insurance Company, The Peninsula Insurance Company, Peninsula Indemnity Company and
Michigan Insurance Company.
Amended and Restated Services Allocation Agreement dated December 1, 2010 among Donegal
Group Inc., Atlantic States Insurance Company, Southern Insurance Company of Virginia, Le Mars
Insurance Company, The Peninsula Insurance Company, Peninsula Indemnity Company and
Michigan Insurance Company.
Quota-share Reinsurance Agreement dated December 1, 2010 between Donegal Mutual Insurance
Company and Michigan Insurance Company.
Donegal Group Inc. 2011 Agency Stock Purchase Plan.
Credit Agreement dated June 21, 2010 between Donegal Group Inc. and Manufacturers and
Traders Trust Company, First Amendment to Credit Agreement dated October 12, 2010 and
Second Amendment to Credit Agreement dated June 1, 2011.
Third Amendment to Credit Agreement between Donegal Group Inc. and Manufacturers and
Traders Trust Company dated June 1, 2012 and Fourth Amendment to Credit Agreement dated
December 5, 2012.
Fifth Amendment to Credit Agreement between Donegal Group Inc. and Manufacturers and
Traders Trust Company dated June 1, 2013.
Code of Business Conduct and Ethics.
Subsidiaries of Registrant.
23.1
Report and Consent of Independent Registered Public Accounting Firm.
23.2
Consent of Independent Registered Public Accounting Firm.
23.3
Consent of Independent Registered Public Accounting Firm.
31.1
Rule 13a-14(a)/15(d)-14(a) Certification of Chief Executive Officer.
31.2
Rule 13a-14(a)/15(d)-14(a) Certification of Chief Financial Officer.
32.1
Section 1350 Certification of Chief Executive Officer.
32.2
Section 1350 Certification of Chief Financial Officer.
Exhibit 10
1.INS
Exhibit 10
1.SCH
Exhibit 10
1.PRE
Exhibit 10
1.CAL
Exhibit 10
1.LAB
XBRL Instance Document
XBRL Taxonomy Extension Schema Document
XBRL Taxonomy Presentation Linkbase Document
XBRL Taxonomy Calculation Linkbase Document
XBRL Taxonomy Label Linkbase Document
-97-
(n)
(o)
(o)
(o)
(p)
(q)
(r)
Filed
herewith
(g)
Filed
herewith
Filed
herewith
Filed
herewith
Filed
herewith
Filed
herewith
Filed
herewith
Filed
herewith
Filed
herewith
Filed
herewith
Filed
herewith
Filed
herewith
Filed
herewith
Filed
herewith
Exhibit 10
1.DEF
XBRL Taxonomy Extension Definition Linkbase Document
Filed
herewith
(a) We incorporate such exhibit by reference to the like-described exhibit in Registrant’s Form 10-Q for the quarterly period ended
March 31, 2013.
(b) We incorporate such exhibit by reference to the like-described exhibit in Registrant’s Form 10-K Report for the year ended
December 31, 2001.
(c) We incorporate such exhibit by reference to the like-described exhibit in Registrant's Form 8-K Report dated April 22, 2011.
(d) We incorporate such exhibit by reference to the like-described exhibit in Registrant's Form 8-K Report dated August 3, 2011.
(e) We incorporate such exhibit by reference to the like-described exhibit in Registrant’s Form 10-K Report for the year ended
December 31, 1999.
(f) We incorporate such exhibit by reference to the like-described exhibit in Registrant’s Form 10-K Report for the year ended
December 31, 1996.
(g) We incorporate such exhibit by reference to the like-described exhibit in Registrant’s Form 10-K Annual Report for the year ended
December 31, 2003.
(h) We incorporate such exhibit by reference to the like-described exhibit in Registrant’s Form 10-K Annual Report for the year ended
December 31, 2002.
(i) We incorporate such exhibit by reference to the like-described exhibit in Registrant’s Form 8-K Report dated July 18, 2008.
(j) We incorporate such exhibit by reference to the like-numbered exhibit in Registrant’s Form 8-K Report dated April 20, 2007.
(k) We incorporate such exhibit by reference to the description of such plan in Registrant’s definitive proxy statement for its Annual
Meeting of Stockholders held on April 21, 2011 filed on March 18, 2011.
(l) We incorporate such exhibit by reference to the like-described exhibit in Registrant’s Form 10-K Annual Report for the year ended
December 31, 2009.
(m) We incorporate such exhibit by reference to the like-described exhibit in Registrant’s Form S-4 registration statement filed June 25,
2010, Registrant’s Form 8-K Report dated September 1, 2010 and Registrant’s Form 8-K Report dated December 8, 2010.
(n) We incorporate such exhibit by reference to the like-described exhibit in Registrant’s Form 8-K Report dated December 8, 2010.
(o) We incorporate such exhibit by reference to the like-described exhibit in Registrant’s Form 10-K Annual Report for the year ended
December 31, 2010.
(p) We incorporate such exhibit by reference to the like-described exhibit filed in Registrant's Form S-3 registration statement filed on
May 27, 2011.
(q) We incorporate such exhibit by reference to the like-described exhibit in Registrant’s Form 10-K Annual Report for the year ended
December 31, 2011.
(r) We incorporate such exhibit by reference to the like-described exhibit in Registrant’s Form 10-K Annual Report for the year ended
December 31, 2012.
-98-
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused
this report to be signed on its behalf by the undersigned, thereunto duly authorized.
SIGNATURES
DONEGAL GROUP INC.
By: /s/ Donald H. Nikolaus
Donald H. Nikolaus, President
Date: March 14, 2014
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons
on behalf of the Registrant in the capacities and on the dates indicated.
Signature
Title
/s/ Donald H. Nikolaus
President and a Director
Donald H. Nikolaus
(principal executive officer)
/s/ Jeffrey D. Miller
Jeffrey D. Miller
/s/ Scott A. Berlucchi
Scott A. Berlucchi
/s/ Robert S. Bolinger
Robert S. Bolinger
/s/ Patricia A. Gilmartin
Patricia A. Gilmartin
Senior Vice President and Chief Financial Officer
(principal financial and accounting officer)
Director
Director
Director
/s/ Philip H. Glatfelter, II
Director
Philip H. Glatfelter, II
/s/ Jack L. Hess
Jack L. Hess
/s/ Kevin M. Kraft, Sr.
Kevin M. Kraft, Sr.
/s/ John J. Lyons
John J. Lyons
/s/ Jon M. Mahan
Jon M. Mahan
Director
Director
Director
Director
/s/ S. Trezevant Moore, Jr.
Director
S. Trezevant Moore, Jr.
/s/ Richard D. Wampler, II
Director
Richard D. Wampler, II
Date
March 14, 2014
March 14, 2014
March 14, 2014
March 14, 2014
March 14, 2014
March 14, 2014
March 14, 2014
March 14, 2014
March 14, 2014
March 14, 2014
March 14, 2014
March 14, 2014
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[THIS PAGE INTENTIONALLY LEFT BLANK]
2013
ANNUAL
REPORT
Corporate Information
DONEGAL GROUP
BOARD OF DIRECTORS
Donald H. Nikolaus
Chairman of the Board
and a Director
Director
Scott A. Berlucchi
Director
Robert S. Bolinger
Director
Patricia A. Gilmartin
Director
Philip H. Glatfelter, II
Director
Jack L. Hess
Director
Kevin M. Kraft, Sr.
Director
John J. Lyons
Director
Jon M. Mahan
S. Trezevant Moore, Jr. Director
Director
Richard D. Wampler, II
OFFICERS
Donald H. Nikolaus
Kevin G. Burke
Cyril J. Greenya
Jeffrey D. Miller
Sanjay Pandey
Robert G. Shenk
Sheri O. Smith
Christina M. Springer
V. Anthony Viozzi
Daniel J. Wagner
President and Chief
Executive Officer
Senior Vice President
Senior Vice President
Senior Vice President and
Chief Financial Officer
Senior Vice President
Senior Vice President
Secretary
Vice President
Senior Vice President and
Chief Investment Officer
Senior Vice President
and Treasurer
ANNUAL MEETING
April 17, 2014 at 10:00 a.m. at the
Heritage Hotel Lancaster
500 Centerville Road
Lancaster, Pennsylvania 17601
CORPORATE OFFICES
1195 River Road
P.O. Box 302
Marietta, Pennsylvania 17547-0302
(800) 877-0600
E-mail Address: info@donegalgroup.com
Donegal Web Site: www.donegalgroup.com
TRANSFER AGENT
Computershare Trust Company, N.A.
P.O. Box 43078
Providence, Rhode Island 02940-3078
(800) 317-4445
Web Site: www.computershare.com
Hearing Impaired: TDD: 800-952-9245
DIVIDEND REINVESTMENT
AND STOCK PURCHASE PLAN
The Company offers a dividend reinvestment
and stock purchase plan through its transfer agent.
For information contact:
Donegal Group Inc.
Dividend Reinvestment and Stock Purchase Plan
Computershare Trust Company, N.A.
P.O. Box 43078
Providence, Rhode Island 02940-3078
STOCKHOLDERS
The following represent the number of
common stockholders of record
as of December 31, 2013:
Class A common stock
Class B common stock
1,921
344
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