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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002
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 23-2424711
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1195 RIVER ROAD, MARIETTA, PENNSYLVANIA 17547
(Address of principal executive offices (Zip code))
Registrant's telephone number, including area code: (888) 877-0600
Securities registered pursuant to Section 12(b) of the Act: None.
Securities registered pursuant to Section 12(g) of the Act:
CLASS A COMMON STOCK, $.01 PAR VALUE
CLASS B COMMON STOCK, $.01 PAR VALUE
(Title of class)
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 [X]. 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
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes [ ]. No [X].
On June 28, 2002, the aggregate market value (based on the closing sales prices
on that date) of the voting stock held by non-affiliates of the Registrant was
$31,102,112.
Indicate the number of shares outstanding of each of the Registrant's classes of
common stock, as of the latest practicable date: 6,187,569 shares of Class A
Common Stock and 2,988,757 shares of Class B Common Stock were outstanding on
March 11, 2003.
DOCUMENTS INCORPORATED BY REFERENCE:
1. Portions of the Registrant's annual report to stockholders for the fiscal
year ended December 31, 2002 are incorporated by reference into Parts I, II
and IV of this report.
2. Portions of the Registrant's proxy statement relating to the annual meeting
of stockholders to be held April 17, 2003 are incorporated by reference
into Part III of this report.
DONEGAL GROUP INC.
INDEX TO FORM 10-K REPORT
PAGE
PART I ...........................................................................................................1
Item 1. Business 1
Item 2. Properties.....................................................................................30
Item 3. Legal Proceedings..............................................................................30
Item 4. Submission of Matters to a Vote of Security Holders............................................30
PART II .........................................................................................................31
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters......................31
Item 6. Selected Financial Data........................................................................31
Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations.....................................................................................31
Item 8. Financial Statements and Supplementary Data....................................................31
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure.....................................................................................31
PART III ........................................................................................................32
Item 10. Directors and Executive Officers of the Registrant.............................................32
Item 11. Executive Compensation.........................................................................32
Item 12. Security Ownership of Certain Beneficial Owners and Management.................................32
Item 13. Certain Relationships and Related Transactions.................................................33
Item 14. Controls and Procedures........................................................................33
PART IV .........................................................................................................34
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K................................34
-i-
PART I
ITEM 1. BUSINESS.
(a) GENERAL DEVELOPMENT OF BUSINESS.
Donegal Group Inc. is an insurance holding company formed in August 1986,
which is headquartered in Pennsylvania and engages, through its subsidiaries, in
the property and casualty insurance business in 14 Mid-Atlantic and Southeastern
states. As used in this Report, "DGI" or the "Company" refers to Donegal Group
Inc. and its insurance subsidiaries, Atlantic States Insurance Company
("Atlantic States") and Southern Insurance Company of Virginia ("Southern"). To
reduce expenses and enhance operating efficiencies, during 2001, two of DGI's
former insurance company subsidiaries, Delaware Atlantic Insurance Company
("Delaware Atlantic") and Pioneer Insurance Company, a New York company
("Pioneer New York"), merged into Atlantic States. During 2002, one of DGI's
former insurance company subsidiaries, Pioneer Insurance Company, an Ohio
company ("Pioneer Ohio"), was merged into Atlantic States, and another of DGI's
former insurance subsidiaries, Southern Heritage Insurance Company ("Southern
Heritage"), was merged into Southern. Except as otherwise noted, all financial
information included in this Report for Atlantic States and Southern includes
the financial information of those former subsidiaries through the dates of the
mergers.
Donegal Mutual Insurance Company (the "Mutual Company") currently owns
approximately 66% of the outstanding Class A Common Stock and approximately 62%
of the outstanding Class B Common Stock of the Company. DGI and its subsidiaries
and the Mutual Company underwrite a broad line of personal and commercial
coverages, consisting of private passenger and commercial automobile,
homeowners, commercial multi-peril, workers' compensation and other lines of
insurance.
The Company's strategy is to seek growth both internally and through
acquisitions. Since the formation of the Company and Atlantic States in 1986,
the Company has completed the following acquisitions:
NET PREMIUMS
WRITTEN YEAR
YEAR PRIOR TO
COMPANY ACQUIRED ACQUIRED ACQUISITION
---------------- -------- -----------
Southern Insurance Company of Virginia 1988 $1,128,843
Delaware Atlantic Insurance Company(1) 1995 2,824,398
Pioneer Insurance Company (Ohio)(2) 1997 4,499,273
Southern Heritage Insurance Company(3) 1998 32,002,540
Pioneer Insurance Company (New York)(1) 2001 1,917,723
------------
(1) Merged into Atlantic States in 2001.
(2) Merged into Atlantic States in 2002.
(3) Merged into Southern in 2002.
-1-
The Company evaluates other acquisition candidates on a continuing basis.
However, there can be no assurance as to whether or when the Company will effect
any additional acquisitions.
In June 2002, the Mutual Company established an affiliation with Le Mars
Mutual Insurance Company of Iowa, an Iowa property and casualty insurance
company ("Le Mars"), under which the Mutual Company purchased a $4 million
surplus note from Le Mars and provides management services to Le Mars. Designees
of the Mutual Company constitute a majority of the members of the Board of
Directors of Le Mars. Neither the Company nor the Mutual Company owns any equity
interest in Le Mars. The financial results of Le Mars are not consolidated with
the financial results of the Company or the Mutual Company, and neither the
Company nor the Mutual Company bears any responsibility for the insurance
obligations of Le Mars.
Atlantic States, which DGI organized in September 1986, participates in an
underwriting pool whereby it cedes to the Mutual Company the premiums, losses
and loss expenses from all of its insurance business and assumes from the Mutual
Company a specified portion of the pooled business, which also includes
substantially all of the Mutual Company's property and casualty insurance
business. Effective as of October 1, 1986, DGI entered into a pooling agreement
with the Mutual Company whereby Atlantic States assumed 35% of the pooled
business written or in force on or after October 1, 1986, with the Mutual
Company remaining solely responsible for any losses in the pooled business with
dates of loss on or before the close of business on September 30, 1986. Pursuant
to amendments to the pooling agreement subsequent to October 1, 1986, the Mutual
Company has increased the percentage of retrocessions of the pooled business to
Atlantic States, and, since July 1, 2000, 70% of the pooled business has been
retroceded to Atlantic States.
From January 1, 1991 to December 31, 2001, Southern ceded 50% of its direct
written premiums to the Mutual Company. This reinsurance arrangement was
terminated effective December 31, 2001. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations" included in Item 7
hereof and Note 2 to the Consolidated Financial Statements incorporated by
reference herein.
DGI and the Mutual Company jointly own Donegal Financial Services
Corporation ("Donegal Financial"), the holding company for Province Bank FSB
("Province Bank"), a federal savings bank headquartered in Marietta,
Pennsylvania. Province Bank opened for business in September 2000, and its
deposits are insured by the Savings Association Insurance Fund of the Federal
Deposit Insurance Corporation. Donegal Financial's capital stock is owned 55% by
the Mutual Company and 45% by the Company.
Effective as of the close of business on April 19, 2001, the Company: (a)
effected a one-for-three reverse stock split of its previously authorized Common
Stock and redesignated that Common Stock as Class B Common Stock; and (b)
declared a dividend of two shares of Class A Common Stock payable on each share
of Class B Common Stock then outstanding. As a result of the reverse stock split
and the stock dividend, each person who held shares of the Company's previously
authorized Common Stock as of the close of business on April 19, 2001 thereafter
continued to hold, exclusive of any fractional interest in a share of Class B
Common Stock, the
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same number of shares of the Company's capital stock, two-thirds of which were
shares of Class A Common Stock and one-third of which were shares of Class B
Common Stock. Except as otherwise required by law, each share of Class A Common
Stock is entitled one-tenth of a vote with respect to each matter submitted to
the stockholders of the Company for approval and each share of Class B Common
Stock is entitled to one vote with respect to each matter submitted to the
stockholders of the Company for approval. The Class A Common Stock and the Class
B Common Stock vote together as a single class unless otherwise required by law.
A slightly higher dividend is paid on the Class A Common Stock than on the Class
B Common Stock. All share information set forth in this Report for periods after
April 19, 2001 reflects these transactions.
(b) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS.
The Company has three segments, which consist of its investment function,
its personal lines of insurance and its commercial lines of insurance. Financial
information about these segments is set forth in Note 17 to the Consolidated
Financial Statements incorporated by reference herein.
(c) NARRATIVE DESCRIPTION OF BUSINESS.
RELATIONSHIP WITH THE MUTUAL COMPANY
DGI's insurance operations are interrelated with the insurance operations
of the Mutual Company and, because of the percentage of the pooled business
assumed by DGI's subsidiary, Atlantic States, DGI's results of operations are
dependent to a material extent upon the success of the Mutual Company. In
addition, various reinsurance agreements exist between the Company's insurance
subsidiaries and the Mutual Company. The Mutual Company is responsible for
underwriting and marketing the pooled business and provides facilities,
employees and services required to conduct the business of DGI on a
cost-allocated basis. As of March 11, 2003, the Mutual Company owned
approximately 66.0% of DGI's Class A Common Stock and approximately 62.0% of
DGI's Class B Common Stock.
Through the pool and through its insurance subsidiaries, DGI writes
personal and commercial property and casualty insurance lines, including
automobile, homeowners, commercial multi-peril, workers' compensation and other
lines of business.
The Mutual Company provides all personnel for the Company and its insurance
subsidiaries. Expenses are allocated to the Company and Southern according to a
time allocation and estimated usage agreement, and to Atlantic States in
relation to the relative participation of the Mutual Company and Atlantic States
in the pooling agreement described herein. Expenses allocated to the Company
under such agreement were $28,586,888 in 2002.
The Mutual Company leases office equipment and automobiles from the Company
under a lease dated January 1, 2000. The Mutual Company made lease payments to
the Company of $789,697 in 2002.
Under the terms of the intercompany pooling agreement, Atlantic States
cedes to the Mutual Company the premiums, losses and loss expenses on all of its
insurance business.
-3-
Substantially all of the Mutual Company's property and casualty insurance
business is included in the pooled business. Pursuant to amendments to the
pooling agreement since its commencement on October 1, 1986, the Mutual Company
has increased the percentage of retrocessions of the pooled business to Atlantic
States, and, as most recently amended, effective as of July 1, 2000, 70% of the
pooled business is retroceded to Atlantic States. All premiums, losses, loss
expenses and other underwriting expenses are prorated among the parties on the
basis of their participation in the pool. The pooling agreement may be amended
or terminated at the end of any calendar year by agreement of the parties,
subject to approval by the Coordinating Committee discussed below. The
allocations of pool participation percentages between the Mutual Company and
Atlantic States are based on the pool participants' relative amounts of capital
and surplus, expectations of future relative amounts of capital and surplus and
the ability of the Company to raise capital for Atlantic States. The Company
does not currently anticipate a further increase in Atlantic States' percentage
of participation in the pool, nor does the Company intend to terminate the
participation of Atlantic States in the pooling agreement.
The underwriting pool is intended to produce a more uniform and stable
underwriting result from year to year for the participants in the pool than they
would experience individually and to spread the risk of loss among all the
participants. Each company participating 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 additional capacity
exists because such policy exposures are spread among the pool participants,
each of which has its own capital and surplus.
The Mutual Company and Province Bank are parties to a lease dated September
1, 2000, whereby Province Bank leases from the Mutual Company 3,600 square feet
of one of the Mutual Company's buildings located in Marietta, Pennsylvania for
an annual rent based on an independent appraisal. The Mutual Company and
Province Bank are also parties to an Administrative Services Agreement dated
September 1, 2000, whereby the Mutual Company is obligated to provide various
human resource services, principally payroll and employee benefits
administration, administrative support, facility and equipment maintenance
services and purchasing, to Province Bank, subject to the overall limitation
that the costs charged by the Mutual Company may not exceed the costs of
independent vendors for similar services and further subject to annual maximum
cost limitations specified in the Administrative Services Agreement. The Mutual
Company and the Company conduct business with Province Bank, primarily through
checking accounts, on the same terms and conditions as are offered to the other
large commercial customers of Province Bank.
All of the Company's officers are officers of the Mutual Company, four of
the Company's six directors are directors of the Mutual Company and two of the
Company's executive officers are directors of the Mutual Company. The Company
and the Mutual Company maintain a Coordinating Committee, which consists of two
outside directors from each of the Company and the Mutual Company, none of whom
holds seats on both Boards. Under the Company's and the Mutual Company's
By-laws, any new agreement between the Company and the Mutual Company and any
proposed change in any existing agreement between the Company and the Mutual
Company must first be submitted for approval by the respective Boards of
Directors of the Company and the Mutual Company and, if approved, submitted to
the Coordinating Committee for approval. The proposed new agreement or change in
an existing
-4-
agreement will receive Coordinating Committee approval only if both of the
Company's Coordinating Committee members conclude the new agreement or change in
an existing agreement is fair and equitable to the Company and its stockholders
and if both of the Mutual Company's members conclude the agreement is fair and
equitable to the Mutual Company and its policyholders. The decisions of the
Coordinating Committee are binding on the Company and the Mutual Company. The
purpose of this provision is to protect the interests of the stockholders of the
Company and the interests of the policyholders of the Mutual Company. The
Coordinating Committee meets on an as-needed basis.
DGI'S BUSINESS STRATEGY
DGI, in conjunction with the Mutual Company, has multiple strategies that
the management of DGI believes have resulted in underwriting results that are
favorable when compared to those of the property and casualty insurance industry
in general over the past five years. The principal strategies comprise the
following:
o A regional company concept designed to provide the advantages of local
marketing, underwriting and claims servicing with the economies of
scale from centralized accounting, administrative, investment, data
processing and other services.
o An underwriting program and product mix designed to produce a
Company-wide underwriting profit, i.e., a combined ratio of less than
100%, from careful risk selection and adequate pricing.
o A goal of a closely balanced ratio between commercial business and
personal business.
o An agent selection process that focuses on appointing agencies with
proven market strategies for the development of profitable business
and an agent compensation plan providing for incentive commissions
based upon premium volume and profitability and the right to
participate in the Company's Agency Stock Purchase Plan.
o A continuing effort to attract and retain qualified employees who
receive incentive compensation based upon underwriting profitability.
o A goal of expanding operations in its current marketing areas in the
Mid-Atlantic and Southeastern regions of the United States and into
the Mid-Western region of the United States.
o A goal of obtaining sufficient rate increases in both commercial and
personal lines to improve underwriting results while maintaining the
existing book of business and preserving the Company's ability to
write new business.
-5-
PROPERTY AND CASUALTY INSURANCE PRODUCTS AND SERVICES
The following table indicates the percentage of DGI's net premiums written
represented by commercial lines and by personal lines for the years ended
December 31, 2002, 2001 and 2000:
YEAR ENDED DECEMBER 31,
-----------------------------------------
2002 2001 2000
---- ---- ----
Net Premiums Written:
Commercial............................................ 35.3% 36.9% 37.2%
Personal.............................................. 64.7 63.1 62.8
The commercial lines consist primarily of automobile, multi-peril and
workers' compensation insurance. The personal lines consist primarily of
automobile and homeowners insurance. These types of insurance are described in
greater detail below:
COMMERCIAL
o Commercial automobile - policies that provide protection against
liability for bodily injury and property damage arising from
automobile accidents, and provide protection against loss from damage
to automobiles owned by the insured.
o Workers' compensation - policies purchased by employers to provide
benefits to employees for injuries sustained during employment. The
extent of coverage is established by the workers' compensation laws of
each state.
o Commercial multi-peril - policies that provide protection to
businesses against many perils, usually combining liability and
physical damage coverages.
PERSONAL
o Private passenger automobile - policies that provide protection
against liability for bodily injury and property damage arising from
automobile accidents, and provide protection against loss from damage
to automobiles owned by the insured.
o 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.
The following table sets forth the combined ratios of DGI, prepared in
accordance with accounting principles generally accepted in the United States of
America ("GAAP") and statutory accounting principles prescribed or permitted by
state insurance authorities. The GAAP combined ratio is the sum of the ratios of
incurred losses and loss expenses to net premiums earned (loss ratio),
underwriting expenses to net premiums earned (expense ratio) and policyholder
dividends to net premiums earned (dividend ratio). The statutory combined ratio
is the sum of the ratios of incurred losses and loss expenses to net premiums
earned (loss ratio),
-6-
underwriting expense to net premiums written (expense ratio) and policyholder
dividends to net premiums written (dividend ratio). These ratios can differ for
various reasons, including the following: the Company does not anticipate
salvage and subrogation in recording losses for statutory purposes but does so
for GAAP; and guaranty fund assessments are estimated and accrued when an
insolvency occurs based on the ultimate loss from the insolvency for statutory
purposes while for GAAP the assessments are accrued on an annual basis as
premiums upon which the assessment will be based are written.
The combined ratio is a traditional measure of underwriting profitability.
When the combined ratio is under 100%, underwriting results are generally
considered profitable. Conversely, when the combined ratio is over 100%,
underwriting results are generally considered unprofitable. The combined ratio
does not reflect investment income, federal income taxes or other non-operating
income or expense. DGI's operating income depends on income from both
underwriting operations and investments.
YEAR ENDED DECEMBER 31,
-------------------------------------
2002 2001 2000
----- ----- -----
GAAP combined ratio ................ 99.6% 103.8% 101.8%
====== ====== ======
Statutory operating ratios:
Loss ratio .................... 69.1 70.5 68.8
Expense ratio ................. 28.3 31.4 30.9
Dividend ratio ................ 0.6 1.0 0.9
----- ----- -----
Statutory combined ratio ........... 98.0% 102.9% 100.6%
===== ===== =====
Industry statutory combined ratio(1) 105.7% 118.0% 110.5%
===== ===== =====
- ------------
(1) Source: A.M. Best Company, Inc.
DGI is required to participate in involuntary insurance programs for
automobile insurance, as well as other property and casualty insurance lines, in
states in which DGI operates. These programs include joint underwriting
associations, assigned risk plans, fair access to insurance requirements (FAIR)
plans, reinsurance facilities and windstorm 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
cannot obtain insurance in the voluntary market. The legislation creating these
programs usually allocates a pro rata portion of risks attributable to such
insureds to each company on the basis of direct premiums written or the number
of automobiles insured. Generally, state law requires participation in such
programs as a condition to doing business. The loss ratio on insurance written
under involuntary programs has traditionally been greater than the loss ratio on
insurance in the voluntary market.
During 2002, 2001 and 2000, the Company incurred assessments totaling
$486,190, $1,286,578 and $813,000, respectively, from the Pennsylvania Insurance
Guaranty Association relating to the insolvencies of three medical malpractice
insurers and Reliance Insurance Company.
Also during 2002, the Company experienced an increase in costs with
assigned risk buyout programs in the State of New York. Under a buyout program,
one insurer pays another
7
issuer to assume the first insurer's obligations to participate in a
state-mandated involuntary coverage program, such as an assigned risk plan, for
those who are unable to obtain automobile insurance in the voluntary market
because of underwriting considerations. Under these programs, the servicing
carrier performs all administrative functions relating to the assigned risk
policies, including collecting premiums and making payments for losses and loss
adjustment expenses. The Company makes payments to the servicing carrier, which
includes an administrative fee, as well as a fee for rate inadequacy costs above
the collected premiums. The Company's costs for the buyout program in New York
State were $445,295 for the first five months of 2002, compared to $146,218 for
all of 2001; as a result, in June 2002 the Company suspended writing private
passenger and commercial automobile lines in New York State. The rise in costs
in the State of New York was the result of significant increases in the
population of assigned risk policies and the deteriorating rate adequacy in the
residual market.
The following table sets forth the net premiums written and combined ratios
by line of insurance for the business of DGI, prepared in accordance with
statutory accounting practices prescribed or permitted by state insurance
authorities, for the periods indicated.
YEAR ENDED DECEMBER 31,
----------------------------------------
2002 2001 2000
-------- -------- --------
(dollars in thousands)
Net Premiums Written:
Commercial:
Automobile .................... $17,451 $16,527 $15,112
Workers' compensation ......... 23,845 22,979 21,174
Commercial multi-peril ........ 25,536 24,174 21,722
Other ......................... 1,895 1,725 1,597
-------- -------- --------
Total commercial .......... 68,727 65,405 59,605
-------- -------- --------
Personal:
Automobile .................... 84,643 74,396 65,528
Homeowners .................... 34,637 31,431 29,413
Other ......................... 6,497 5,796 5,576
-------- -------- --------
Total personal ............ 125,777 111,623 100,517
-------- -------- --------
Total business ..................... $194,504 $177,028 $160,122
======== ======== ========
Statutory Combined Ratios:
Commercial:
Automobile .................... 88.9% 108.9% 99.9%
Workers' compensation ......... 94.9 109.9 91.9
Commercial multi-peril ........ 85.8 96.2 102.2
Other ......................... 72.4 77.0 39.0
-------- -------- --------
Total commercial .......... 89.3 103.7 96.2
-------- -------- --------
Personal:
Automobile .................... 106.4 104.5 100.3
Homeowners .................... 97.4 101.6 110.9
Other ......................... 84.1 86.8 103.5
-------- -------- --------
Total personal ............ 102.8 102.7 103.6
-------- -------- --------
Total business ..................... 98.0% 102.9% 100.6%
======== ======== ========
PROPERTY AND CASUALTY UNDERWRITING
The underwriting department is responsible for the establishment of
underwriting and risk selection guidelines and criteria for the various
insurance products written by DGI. The underwriting department, in conjunction
with the marketing representatives, works closely with DGI's independent
insurance agents to insure a comprehensive knowledge on the part of the agents
of DGI's underwriting requirements and risk selection process.
-8-
DGI's underwriting and pricing strategy is designed to produce an
underwriting profit resulting in a Company-wide combined ratio below 100%. DGI
and the Mutual Company have a conservative underwriting philosophy, which, in
the opinion of management, is one of the prime reasons for DGI's favorable loss
ratios relative to the property and casualty insurance industry over the last
five years.
The underwriting department has over time initiated risk inspection
procedures and underwriting analyses on a per risk and class of business basis.
It has also automated underwriting processing utilizing technology such as bar
coding. Management has established monitoring and auditing processes to verify
compliance with underwriting requirements and procedures.
The underwriting department and the research and development department are
responsible for the development of new insurance products and enhancements of
existing products. Underwriting profitability is enhanced by the creation of
niche products focused on classes of business which traditionally have provided
underwriting profits.
Reference is made to "Risk Factors" for information on risks that affect
the business of the Company and the Mutual Company.
MARKETING
DGI's insurance products, together with the products of its subsidiaries
and the Mutual Company, are marketed through approximately 1,500 insurance
agencies. Business is written by either DGI or the Mutual Company depending upon
geographic location, agency license and product. Management has developed an
agency appointment procedure that focuses on appointing agencies with proven
marketing strategies for the development of profitable business. DGI regularly
evaluates its agency force and continues to strive to obtain and retain a
significant position within each agency relative to the amount of business
similar to that of DGI placed by the agency with other insurers. DGI and the
Mutual Company have developed a successful contingent commission plan for
agents, under which additional commissions are payable based
9
upon the volume of premiums produced and the profitability of the business of
the agency written by DGI and the Mutual Company. Management believes the
contingent commission program and the Company's Agency Stock Purchase Plans have
enhanced the ability of DGI and the Mutual Company to write profitable business.
DGI has granted certain agents the authority to bind insurance within
underwriting and pricing limits specified by DGI without the prior approval of
DGI. However, DGI generally reviews all coverages placed by its agents and,
subject to applicable insurance regulations, may cancel the coverage if it is
inconsistent with DGI's guidelines.
DGI believes that its regional structure enables it to compete effectively
with large national companies. This regional structure permits DGI to take
advantage of its knowledge of local operating territories and the opportunity to
form strong, long-term relationships with the agents that represent DGI and the
Mutual Company.
DGI and the Mutual Company have developed comprehensive growth strategies
for each of the commercial and personal lines of insurance business. DGI has
focused on the small- to medium-sized commercial insurance markets, which have
traditionally been a more stable and profitable segment of the property and
casualty insurance business than the large commercial insurance markets.
Commercial lines marketing is characterized by account selling, in which
multiple lines of insurance are offered to a single policyholder.
DGI believes that competitive and comprehensive products targeted to
selected classes of personal lines business, along with excellent service to
agents and policyholders, provides a foundation for growth and profitability. As
is customary in the industry, insureds are encouraged to place both their
homeowners and personal automobile insurance with DGI or the Mutual Company and
are offered a discount for doing so.
CLAIMS
The claims department develops and implements policies and procedures for
the establishment of claim reserves and the timely resolution and payment of
claims. The management and staff of the claims department resolve policy
coverage issues, manage and process reinsurance recoveries and handle salvage
and subrogation matters.
Insurance claims are normally investigated and adjusted by internal claims
adjusters and supervisory personnel. Independent adjusters are employed as
needed to handle claims in areas in which the volume of claims is not sufficient
to justify hiring internal claims adjusters. The litigation and personal injury
sections manage all claims litigation, and all claims above $35,000 require home
office review and settlement authorization.
Field office staffs are supported by home office technical, litigation,
material damage, subrogation and medical audit personnel who provide specialized
claims support. An investigative unit attempts to prevent fraud and abuse and to
control losses.
10
LIABILITIES FOR LOSSES AND LOSS EXPENSES
Liabilities for losses and loss expenses are estimates at a given point in
time of what the insurer expects to pay to claimants, based on facts and
circumstances then known, and it can be expected that the ultimate liability
will exceed or be less than such estimates. Liabilities are based on estimates
of future trends and claims severity, judicial theories of liability and other
factors. However, during the loss adjustment period, additional facts regarding
individual claims may become known, and consequently it often becomes necessary
to refine and adjust the estimates of liability. Any adjustments are reflected
in operating results in the period in which the changes in estimates are made.
DGI maintains liabilities for the eventual payment of losses and loss
expenses with respect to both reported and unreported claims. Liabilities for
loss expenses are intended to cover the ultimate costs of settling all losses,
including investigation and litigation costs from such losses. The amount of
liability for reported losses is primarily based upon a case-by-case evaluation
of the type of risk involved and knowledge of the circumstances surrounding each
claim and the insurance policy provisions relating to the type of loss. The
amount of liability for unreported claims and loss expenses is determined on the
basis of historical information by line of insurance. Inflation is implicitly
provided for in the reserving function through analysis of costs and trends and
reviews of historical reserving results. Liabilities are closely monitored and
are recomputed periodically by the Company and the Mutual Company using new
information on reported claims and a variety of statistical techniques.
Liabilities for losses are not discounted.
The establishment of appropriate liabilities is an inherently uncertain
process, and there can be no assurance that the ultimate liability will not
exceed DGI's loss and loss expense reserves and have an adverse effect on DGI's
results of operations and financial condition. As is the case for virtually all
property and casualty insurance companies, DGI has found it necessary in the
past to revise estimated future liabilities for losses and loss expenses, and
further adjustments could be required in the future. On the basis of DGI's
internal procedures, which analyze, among other things, DGI's 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, management of DGI believes that
adequate provision has been made for DGI's liability for losses and loss
expenses.
Differences between liabilities reported in DGI's financial statements
prepared on the basis of GAAP and its insurance subsidiaries' financial
statements prepared on a statutory accounting basis result from reducing
statutory liabilities for anticipated salvage and subrogation recoveries. These
differences amounted to $7,334,635, $8,197,948 and $8,042,860 at December 31,
2002, 2001 and 2000, respectively.
11
The following tables set forth a reconciliation of the beginning and ending
net liability for unpaid losses and loss expenses for the periods indicated on a
GAAP basis for the Company.
YEAR ENDED DECEMBER 31,
----------------------------------------------
2002 2001 2000
---- ---- ----
(in thousands)
Gross liability for unpaid losses and loss expenses
at beginning of year.................................. $179,840 $156,476 $144,180
Less reinsurance recoverable............................... 65,296 53,767 44,946
-------- -------- --------
Net liability for unpaid losses and loss expenses
at beginning of year.................................. 114,544 102,709 99,234
Provision for net losses and loss expenses for
claims incurred in the current year................... 122,434 110,143 103,671
Change in provision for estimated net losses
and loss expenses for claims incurred in
prior years........................................... 6,834 8,035 712
-------- -------- --------
Total incurred............................................. 129,268 118,178 104,383
Net losses and loss payments for claims
incurred during:
The current year........................................... 67,656 63,290 61,848
Prior years................................................ 46,869 43,053 39,060
-------- -------- --------
Total paid................................................. 114,525 106,343 100,908
YEAR ENDED DECEMBER 31,
----------------------------------------------
2002 2001 2000
---- ---- ----
(in thousands)
Net liability for unpaid losses and loss expenses
at end of year........................................ 129,485 114,544 102,709
Plus reinsurance recoverable............................... 81,405 65,296 53,767
-------- -------- --------
Gross liability for unpaid losses and loss expenses
at end of year........................................ $210,692 $179,840 $156,476
======== ======== ========
The Company recognized an increase in the liability of losses and loss
expenses of prior years of $6,834,000, $8,035,000 and $712,000 in 2002, 2001 and
2000, respectively. These developments are primarily attributable to variations
from expected claim severity in the private passenger and commercial automobile
liability, workers' compensation and commercial multiple peril lines of
business.
The following table sets forth the development of the liability for net
unpaid losses and loss expenses for DGI on a GAAP basis from 1992 to 2002, with
supplemental loss data for 2001 and 2002. Loss data in the table includes
business assumed from the Mutual Company as part of the pooling arrangement.
"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.
12
The "Liability reestimated as of" portion of the table shows the
reestimated amount of the previously recorded liability based on experience for
each succeeding year. The estimate is increased or decreased as payments are
made and more information becomes known about the severity of the remaining
unpaid claims. For example, the 1993 liability has developed an excess after
nine years, in that reestimated net losses and loss expenses are expected to be
$12.7 million less than the estimated liability initially established in 1993 of
$52.8 million.
The "Cumulative excess" shows the cumulative excess at December 31, 2002 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
actual net losses and loss expenses or were reevaluated at less than the
original amount. A deficiency in liability would mean that the liability
established in prior years was less than actual net losses and loss expenses or
were reevaluated at more than the original amount.
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
1993 column indicates that as of December 31, 2002 payments equal to $41.4
million of the currently reestimated ultimate liability for net losses and loss
expenses of $40.1 million had been made.
During the past several years, the Company has experienced a period during
which redundancies in its loss and loss expense reserves have declined. In the
most recent two years, the Company has experienced deficiencies in these
reserves. These deficiencies were primarily related to the workers' compensation
and commercial automobile lines of business. During 2002, the Company addressed
the deficiencies in these two lines of business by strengthening both case basis
and IBNR reserves.
-13-
YEAR ENDED DECEMBER 31
---------------------------------------------------------------
1992 1993 1994 1995 1996 1997
---- ---- ---- ---- ---- ----
(in thousands)
Net liability at end of
year for unpaid losses
and loss expenses............. $44,339 $52,790 $63,317 $75,372 $78,889 $80,256
Net liability
reestimated as of:
One year later............... 45,408 50,583 60,227 72,380 77,400 77,459
Two years later.............. 42,752 48,132 56,656 70,451 73,438 76,613
Three years later............ 40,693 44,956 54,571 66,936 71,816 74,851
Four years later............. 38,375 42,157 51,825 64,356 69,378 73,456
Five years later............. 37,096 41,050 50,493 63,095 69,485 73,103
Six years later.............. 36,682 40,572 49,593 62,323 69,949
Seven years later............ 36,730 39,991 49,504 62,534
Eight years later............ 36,437 40,113 49,758
Nine years later............. 36,515 40,131
Ten years later.............. 36,586
Cumulative (excess) deficiency. $(7,753) $(12,659) $(13,559) $(12,838) $(8,940) $(7,153)
======= ======== ======== ======== ======= =======
Cumulative amount of
liability paid through:
One year later............... $16,579 $16,126 $19,401 $24,485 $27,229 $27,803
Two years later.............. 24,546 25,393 30,354 37,981 41,532 46,954
Three years later............ 29,385 32,079 38,684 47,027 53,555 58,883
Four years later............. 32,925 36,726 43,655 53,276 59,995 65,898
Five years later............. 34,757 39,122 46,331 56,869 63,048 70,642
Six years later.............. 35,739 40,440 47,802 58,286 65,595
Seven years later............ 36,518 40,903 48,520 59,160
Eight years later............ 36,809 41,152 48,925
Nine years later............. 37,000 39,877
Ten years later.............. 37,174
YEAR ENDED DECEMBER 31
---------------------------------------------------
1998 1999 2000 2001 2002
---- ---- ---- ---- ----
(in thousands)
Net liability at end of
year for unpaid losses
and loss expenses............. $96,015 $99,234 $102,709 $114,544 $129,287
Net liability
reestimated as of:
One year later............... 95,556 100,076 110,744 121,378
Two years later.............. 95,315 103,943 112,140
Three years later............ 94,830 104,073
Four years later............. 94,354
Five years later.............
Six years later..............
Seven years later............
Eight years later............
Nine years later.............
Ten years later..............
Cumulative (excess) deficiency. $(1,661) $4,839 $9,431 $6,834
======= ===== ===== =====
Cumulative amount of
liability paid through:
One year later............... $37,427 $39,060 $43,053 46,869
Two years later.............. 57,347 60,622 67,689
Three years later............ 69,973 76,811
Four years later............. 78,757
Five years later.............
Six years later..............
Seven years later............
Eight years later............
Nine years later.............
Ten years later..............
YEAR ENDED DECEMBER 31
-------------------------------------------------------
1994 1995 1996 1997
---- ---- ---- ----
(in thousands)
Gross liability at end of year ..... $ 88,484 $ 108,118 $ 113,346 $ 115,801
Reinsurance recoverable ............ 25,167 32,746 34,457 35,545
Net liability at end of year ....... 63,317 75,372 78,889 80,256
Gross reestimated liability - latest 66,058 84,341 102,370 105,667
Reestimated recoverable - latest ... 16,300 21,807 32,421 32,564
Net reestimated liability - latest . 49,758 62,534 69,949 73,103
Gross cumulative deficiency (excess) (22,426) (23,777) (10,976) (10,134)
YEAR ENDED DECEMBER 31
----------------------------------------------------------------
1998 1999 2000 2001 2002
---- ---- ---- ---- ----
(in thousands)
Gross liability at end of year ..... $ 136,727 $144,180 $156,476 $179,840 210,692
Reinsurance recoverable ............ 40,712 44,946 53,767 65,296 81,405
Net liability at end of year ....... 96,015 99,234 102,709 114,544 129,287
Gross reestimated liability - latest 129,795 158,315 173,051 194,303
Reestimated recoverable - latest ... 35,441 54,242 60,911 72,925
Net reestimated liability - latest . 94,354 104,073 112,140 121,378
Gross cumulative deficiency (excess) (6,932) 14,135 16,575 14,463
-14-
REINSURANCE
DGI and the Mutual Company use several different reinsurers, all of which
have an A.M. Best rating of A- (Excellent) or better or, with respect to foreign
reinsurers, have a financial condition which, in the opinion of management, is
equivalent to a company with at least an A- rating.
The external reinsurance purchased by DGI and the Mutual Company includes
"excess treaty reinsurance," under which losses are automatically reinsured over
a set retention ($300,000 for 2002), and "catastrophic reinsurance," under which
the reinsured recovers 95% of an accumulation of many losses resulting from a
single event, including natural disasters (for 2002, $3,000,000 retention).
DGI's principal reinsurance agreement in 2002, other than that with the Mutual
Company, was an excess of loss treaty in which the reinsurers were Dorinco
Reinsurance Company, GMAC Re Corporation and Erie Insurance Group. Reinsurance
is also purchased on an individual policy basis to reinsure losses that may
occur from large risks, specific risk types or specific locations. The amount of
coverage provided under each of these types of reinsurance depends upon the
amount, nature, size and location of the risk being reinsured. For property
insurance, excess of loss treaties provide for coverage up to $1,000,000. For
liability insurance, excess of loss treaties provide for coverage up to
$30,000,000. Property catastrophe contracts provide coverage up to $80,000,000
resulting from one event. On both property and casualty insurance, DGI and the
Mutual Company purchase facultative reinsurance to cover exposures from losses
that exceed the limits provided by their respective treaty reinsurance. Atlantic
States cedes to the Mutual Company all of its insurance business and assumes
from the Mutual Company 70% (65% prior to July 1, 2000) of the Mutual Company's
total pooled insurance business, including that assumed from Atlantic States and
substantially all of the business assumed and retained by the Mutual Company
from Southern prior to 2002. Atlantic States and Southern each have a
catastrophe reinsurance agreement with the Mutual Company that limits the
maximum liability under any one catastrophic occurrence to $400,000 and
$450,000, respectively, and $1,000,000 for a catastrophe involving more than one
of the companies. The Mutual Company and Southern are parties to an excess of
loss reinsurance agreement under which the Mutual Company assumes up to $175,000
of losses in excess of $125,000. Southern also has an agreement with the Mutual
Company, under which it cedes, and then reassumes back, 100% of its business net
of reinsurance. The purpose of this agreement is to provide Southern with the
same A.M. Best rating (currently "A" or Excellent) as the Mutual Company, which
Southern might not achieve without this agreement in place.
COMPETITION
The property and casualty insurance industry is highly competitive on the
basis of both price and service. There are numerous companies competing for this
business in the geographic areas where the Company operates, many of which are
substantially larger and have greater financial resources than DGI, and no
single company dominates. In addition, because the insurance products of DGI and
the Mutual Company are marketed exclusively through independent insurance
agencies, most of which represent more than one company, DGI faces competition
to retain qualified independent agencies, as well as competition within
agencies.
-15-
INVESTMENTS
DGI's return on invested assets is an important element of its financial
results. Currently, the investment objective is to maintain a widely diversified
fixed maturities portfolio structured to maximize after-tax investment income
while minimizing credit risk through investments in high quality instruments. At
December 31, 2002, all debt securities were rated investment grade with the
exception of one unrated obligation of $252,500, and the investment portfolio
did not contain any mortgage loans or any non-performing assets.
The following table shows the composition of the debt securities investment
portfolio (at carrying value), excluding short-term investments, by rating as of
December 31, 2002:
DECEMBER 31, 2002
-------------------------------
RATING(1) AMOUNT PERCENT
- --------- ------ -------
(dollars in thousands)
U.S. Treasury and U.S. agency
securities(2)........................ $99,183 35.24%
Aaa or AAA............................. 90,469 32.15
Aa or AA............................... 51,870 18.43
A...................................... 19,979 7.10
BBB.................................... 19,679 6.99
Not rated (3).......................... 253 .09
-------- ------
Total............................... $281,433 100.00%
======== ======
- ------------
(1) Ratings assigned by Moody's Investors Services, Inc. or Standard & Poor's
Corporation.
(2) Includes mortgage-backed securities of $28,254,582.
(3) Represents one unrated obligation of The Lancaster County Hospital
Authority Mennonite Home Project, which management of DGI believes to be
equivalent to investment grade securities with respect to repayment risk.
DGI invests in both taxable and tax-exempt securities as part of its
strategy to maximize after-tax income. Such strategy considers, among other
factors, the alternative minimum tax. Tax-exempt securities made up
approximately 41.0%, 30.9% and 33.0% of the debt securities investment portfolio
at December 31, 2002, 2001 and 2000, respectively.
The following table shows the classification of the investments (at
carrying value) of DGI and its subsidiaries at December 31, 2002, 2001 and 2000.
-16-
DECEMBER 31,
----------------------------------------------------------------------
2002 2001 2000
------------------- --------------------- -------------------
PERCENT PERCENT PERCENT
OF OF 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 ........... $ 12,641 3.8% $ 23,809 7.9% $ 38,779 13.4%
Canadian government
obligation ............. 499 0.2 499 0.2 499 0.2
Obligations of states and
political subdivisions . 33,892 10.2 24,982 8.3 66,831 23.1
Corporate securities ..... 29,552 8.9 27,423 9.1 21,621 7.5
Mortgage-backed
securities ............. 10,118 3.0 8,610 2.9 15,452 5.3
-------- ----- -------- ----- -------- -----
Total held to
maturity ............... 86,702 26.1 85,323 28.4 143,182 49.5
-------- ----- -------- ----- -------- -----
Available for sale:
U.S. Treasury securities
and obligations of U.S.
government corporations
and agencies ........... 58,287 17.5 68,975 23.0 67,901 23.5
Obligations of states and
political subdivisions . 81,446 24.5 55,147 18.3 18,256 6.3
Corporate securities ..... 36,863 11.1 34,807 11.6 22,908 7.9
Mortgage-backed
securities ............. 18,136 5.5 14,790 4.9 5,546 1.9
-------- ----- -------- ----- -------- -----
Total available
for sale ............... 194,732 58.6 173,719 57.8 114,611 39.6
-------- ----- -------- ----- -------- -----
Total fixed
maturities ............. 281,434 84.7 259,042 86.2 257,793 89.1
Equity securities(2) ..... 21,836 6.6 17,517 5.8 12,112 4.2
Short-term
investments(3) ......... 29,029 8.7 24,074 8.0 19,440 6.7
-------- ----- -------- ----- -------- -----
Total investments ........ $332,299 100.0% $300,633 100.0% $289,345 100.0%
======== ===== ======== ===== ======== =====
-17-
(1) The Company accounts for its investments in accordance with Statement of
Financial Accounting Standards (SFAS) No. 115, "Accounting For Certain
Investments in Debt and Equity Securities." See Notes 1 and 3 to the
Consolidated Financial Statements incorporated by reference herein. Fixed
maturities held to maturity are valued at amortized cost; those fixed
maturities available for sale are valued at fair value. Total fair value of
fixed maturities held to maturity was $89,785,318 at December 31, 2002,
$86,939,393 at December 31, 2001 and $144,662,436 at December 31, 2000. The
amortized cost of fixed maturities available for sale was $187,495,949 at
December 31, 2002, $170,269,584 at December 31, 2001 and $114,524,472 at
December 31, 2000.
(2) Equity securities are valued at fair value. Total cost of equity securities
was $21,587,317 at December 31, 2002, $16,630,618 at December 31, 2001 and
$12,500,558 at December 31, 2000.
(3) Short-term investments are valued at cost, which approximates market.
The following table sets forth the maturities (at carrying value) in the
fixed maturity and short-term investment portfolio at December 31, 2002,
December 31, 2001 and December 31, 2000.
DECEMBER 31,
----------------------------------------------------------------------
2002 2001 2000
------------------- ------------------ --------------------
PERCENT PERCENT PERCENT
OF OF OF
AMOUNT TOTAL AMOUNT TOTAL AMOUNT TOTAL
------ ----- ------ ------- ------ -------
(dollars in thousands)
Due in(1):
One year or less ......... $ 47,034 15.1% $ 37,120 13.1% $ 37,731 13.6%
Over one year
through three years .... 47,367 15.3 44,845 15.8 35,426 12.8
Over three years
through five years ..... 66,655 21.5 69,585 24.6 41,995 15.1
Over five years
through ten years ...... 64,271 20.7 96,642 34.1 112,396 40.6
Over ten years
through fifteen years .. 52,517 16.9 7,573 2.7 22,243 8.0
Over fifteen years ....... 4,365 1.4 3,950 1.4 6,445 2.3
Mortgage-backed
securities ............. 28,254 9.1 23,401 8.3 20,997 7.6
-------- ----- -------- ----- -------- -----
$310,463 100.0% $283,116 100.0% $277,233 100.0%
======== ===== ======== ===== ======== =====
- ------------
(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, the Company held investments in mortgage-backed securities
having a carrying value of $28.3 million at December 31, 2002. Included in these
investments are
-18-
collateralized mortgage obligations ("CMOs") with a carrying value of $4.7
million at December 31, 2002. The Company has attempted to reduce the prepayment
risks associated with mortgage-backed securities by investing approximately
100%, as of December 31, 2002, of the Company's holdings of CMOs in planned
amortization and very accurately defined tranches. Such investments are designed
to alleviate the risk of prepayment by providing predictable principal
prepayment schedules within a designated range of prepayments. If principal is
repaid earlier than originally anticipated, investment yields may decrease due
to reinvestment of the proceeds at current interest rates (which may be lower)
and capital gains or losses may be realized since the book value of securities
purchased at premiums or discounts may be different from the prepayment amount.
Investment results of DGI and its subsidiaries for the years ended December
31, 2002, 2001 and 2000 are shown in the following table:
YEAR ENDED DECEMBER 31,
-------------------------------------
2002 2001 2000
----- ----- -----
(dollars in thousands)
Invested assets(1) ................. $319,066 $294,989 $278,678
Investment income(2) ............... 14,581 15,886 16,395
Average yield ...................... 4.6% 5.3% 5.9%
- ------------
(1) Average of the aggregate invested amounts at the beginning and end of the
period, including cash.
(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
Currently, the A.M. Best rating of the Mutual Company, Atlantic States and
Southern is "A" (Excellent), based upon their respective current financial
conditions and historical statutory results of operations and retrocessional
agreements. Management believes that this A.M. Best rating is an important
factor in marketing DGI's products to its 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 as determined by
their publicly available reports. A.M. Best's classifications are A++ and A+
(Superior), A and A- (Excellent), B++ and B+ (Very Good), B and B- (Good), C++
and C+ (Fair), C and C- (Marginal), D (below minimum standards) and E and F
(Liquidation). A.M. Best's ratings are based upon factors relevant to
policyholders and are not directed toward the protection of investors. According
to A.M. Best, an "excellent" rating is assigned to those companies which, in
A.M. Best's opinion, have achieved excellent overall performance when compared
to the norms of the property and casualty insurance industry and have generally
demonstrated a strong ability to meet policyholder and other contractual
obligations.
-19-
REGULATION
Insurance companies are subject to supervision and regulation in the states
in which they transact business. 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 extent of such regulation varies, but generally derives from
state statutes that delegate regulatory, supervisory and administrative
authority to state insurance departments. Accordingly, the authority of the
state insurance departments includes the establishment of standards of solvency
that must be met and maintained by insurers, the licensing to do business of
insurers and agents, the nature of and limitations on investments, premium rates
for property and casualty insurance, the provisions which 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 (the "NAIC") has established a risk-based
capital system for assessing the adequacy of statutory capital and surplus,
which augments the states' current fixed dollar minimum capital requirements for
insurance companies. At December 31, 2002, DGI's insurance subsidiaries and the
Mutual Company each exceeded the required levels of capital. There can be no
assurance that the capital requirements applicable to DGI's insurance
subsidiaries will not increase in the future.
The states in which Atlantic States (Pennsylvania, Maryland, Delaware,
Connecticut, Ohio and New York), the Mutual Company (Pennsylvania, Ohio,
Maryland, New York, Virginia, Delaware and North Carolina) and Southern
(Virginia, Alabama, Arkansas, Georgia, Illinois, Louisiana, Mississippi, North
Carolina, South Carolina, Tennessee and Pennsylvania) are licensed to do
business have guaranty fund laws under which insurers doing business in such
states 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. Atlantic States, the
Mutual Company and Southern have made accruals for their portion of assessments
related to such insolvencies based upon the most current information furnished
by the guaranty associations. During 2002, 2001 and 2000, the Company incurred
assessments totaling $486,190, $1,286,578 and $813,000, respectively, from the
Pennsylvania Insurance Guaranty Association relating to the insolvencies of
three medical malpractice insurers and Reliance Insurance Company.
Most states have enacted legislation that regulates insurance holding
company systems. Each insurance company in the holding company system is
required to register with the insurance supervisory agency of its state of
domicile and furnish information concerning the operations of companies within
the 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 may examine the Mutual Company, the
-20-
Company and the Company's insurance subsidiaries at any time, require disclosure
of material transactions by the holding company and require prior notice or
prior approval of certain transactions, such as "extraordinary dividends" from
the insurance subsidiaries to the holding company.
All transactions within the holding company system affecting the Mutual
Company and the Company's insurance subsidiaries must be fair and equitable.
Approval of the applicable insurance commissioner is required prior to
consummation of transactions affecting the control of an insurer. In some
states, including Pennsylvania, the acquisition of 10% or more of the
outstanding capital stock of an insurer or its holding company is presumed to be
a change in control. Pursuant to an order issued in July 2001, the Pennsylvania
Insurance Department has approved the Mutual Company's ownership of up to 65% of
the outstanding Class A Common Stock and up to 100% of the outstanding Class B
Common Stock of DGI. The Mutual Company has filed an application with the
Insurance Department seeking approval of an amendment to the order to permit the
Mutual Company to own up to 70% of the outstanding Class A Common Stock of DGI.
These laws also require notice to the applicable insurance commissioner of
certain material transactions between an insurer and any person in its holding
company system and, in some states, certain of such transactions cannot be
consummated without the prior approval of the applicable insurance commissioner.
The Company's insurance subsidiaries are restricted by the insurance laws
of their respective states of domicile as to the amount of dividends or other
distributions they may pay to the Company without the prior approval of the
respective state regulatory authorities. Generally, the maximum amount that may
be paid by an insurance subsidiary during any year after notice to, but without
prior approval of, the insurance commissioners of these states is limited to a
stated percentage of that subsidiary's statutory capital and surplus as of a
certain date, or the net income or net investment income not including realized
capital gains of the subsidiary for the preceding year. As of December 31, 2002,
amounts available for payment of dividends in 2003 without the prior approval of
the various insurance commissioners were $10,646,804 from Atlantic States and
$2,493,398 from Southern. See Note 12 to the Consolidated Financial Statements
incorporated by reference herein.
THE MUTUAL COMPANY
The Mutual Company, which was organized in 1889, has an A.M. Best rating of
A (Excellent). At December 31, 2002, the Mutual Company had admitted assets of
$192,066,638 and policyholders' surplus of $75,613,870. At December 31, 2002,
the Mutual Company had no debt and, of its total liabilities of $116,452,768,
reserves for net losses and loss expenses accounted for $59,084,662 and unearned
premiums accounted for $29,660,560. Of the Mutual Company's investment portfolio
of $115,505,220 at December 31, 2002, investment-grade bonds accounted for
$20,855,377 and mortgages accounted for $6,295,933. At December 31, 2002, the
Mutual Company owned 4,031,912 shares, or approximately 66.0%, of the Company's
Class A Common Stock, which were carried on the Mutual Company's books at
$46,366,987, and 1,852,088 shares, or approximately 62.0%, of the Company's
Class B Common Stock, which were carried on the Mutual Company's books at
$21,299,012. The foregoing financial information is presented on the statutory
basis of accounting required by the NAIC Accounting Practices and Procedures
Manual. The Mutual Company does not, nor is it required to, prepare financial
statements in accordance with GAAP.
-21-
EMPLOYEES
The Company has no employees. As of December 31, 2002, the Mutual Company
had 410 employees. The Mutual Company's employees provide a variety of services
to DGI, Atlantic States and Southern, as well as to the Mutual Company.
CAUTIONARY NOTICE REGARDING FORWARD LOOKING STATEMENTS
Certain statements contained in or incorporated by reference in this Report
are forward-looking in nature. These statements can be identified by the use of
forward-looking words such as "believes," "expects," "may," "will," "should,"
"intends," "plans" or "anticipates," or the negative thereof or comparable
terminology, or by discussions of strategy. The Company's business and
operations are subject to a variety of risks and uncertainties and,
consequently, the Company's actual results may materially differ from those
projected by any forward-looking statements. Certain of these risks and
uncertainties are discussed below under "Risk Factors."
RISK FACTORS
Unless otherwise specified or unless the context otherwise requires, the
following risks not only apply to the Company but also to the Mutual Company.
RISKS RELATING TO THE PROPERTY AND CASUALTY BUSINESS OF THE COMPANY
THE COMPANY CONDUCTS BUSINESS IN ONLY 14 STATES WITH A CONCENTRATION OF
BUSINESS IN MARYLAND, VIRGINIA AND, PARTICULARLY, PENNSYLVANIA. ANY SINGLE
CATASTROPHE OCCURRENCE OR OTHER CONDITION DISPROPORTIONATELY AFFECTING LOSSES IN
THESE STATES COULD ADVERSELY AFFECT THE COMPANY'S RESULTS OF OPERATIONS.
The Company conducts business in only 14 states primarily in the
Mid-Atlantic and Southeastern portions of the United States. A substantial
portion of this business is private passenger and commercial automobile,
homeowners and workers' compensation insurance in Maryland, Virginia and,
particularly, Pennsylvania. As a result, a single catastrophe occurrence,
destructive weather pattern, general economic trend, terrorist attack,
regulatory development or other condition disproportionately affecting one or
more of the states in which the Company conducts substantial business could
materially adversely affect the results of operations of the Company. Common
catastrophe events include hurricanes, earthquakes, tornadoes, wind and hail
storms, fires and explosions. The Company and the Mutual Company maintain
reinsurance against catastrophic losses in excess of $3.0 million per occurrence
and the Company's insurance subsidiaries maintain various catastrophe
reinsurance with the Mutual Company to minimize the liability of the insurance
subsidiaries in any one occurrence.
-22-
THE BUSINESS AND RESULTS OF OPERATIONS OF THE COMPANY WILL BE ADVERSELY
AFFECTED IF THE INDEPENDENT AGENTS THAT MARKET THE COMPANY'S PRODUCTS DO NOT
MAINTAIN THEIR CURRENT LEVELS OF PREMIUM WRITING, FAIL TO COMPLY WITH
ESTABLISHED UNDERWRITING GUIDELINES OR OTHERWISE IMPROPERLY MARKET THE COMPANY'S
PRODUCTS.
The Company markets its insurance products solely through a network of over
1,500 independent insurance agencies. As a result, the Company is wholly
dependent upon these
agencies, each of which has the authority to bind the Company to insurance
contracts. To the extent that these agencies' marketing efforts cannot be
maintained at their current levels of volume and quality or they bind the
Company to unacceptable insurance risks, fail to comply with established
underwriting guidelines or otherwise improperly market the Company's products,
the results of operations and business of the Company will suffer.
THE BUSINESS OF THE COMPANY MAY NOT CONTINUE TO GROW AND MAY BE MATERIALLY
ADVERSELY AFFECTED IF THE COMPANY CANNOT RETAIN EXISTING, AND ATTRACT NEW,
INDEPENDENT AGENCIES OR IF INSURANCE CONSUMERS INCREASE USE OF OTHER INSURANCE
DELIVERY SYSTEMS.
The continued growth of the business of the Company is partially dependent
upon the Company's ability to retain existing, and attract new, independent
agencies. The following factors are among those that may cause the growth and
retention in the number of independent agencies of the Company, and thereby its
growth in revenue to be slower than it otherwise would have been:
o There is significant competition to attract independent agencies;
o The Company's process to select a new independent agency is intensive and
typically requires from two to six months;
o The Company has stringent criteria for new independent agencies and
requires adherence by independent agencies to consistent underwriting
standards; and
o The Company may be required to reduce agents' commissions, bonuses and
other incentives, thereby reducing its attractiveness to agencies, to
compete with other insurance delivery systems.
The Company sells insurance solely through its network of independent
agencies. Many of the Company's competitors sell insurance through a variety of
delivery methods, including independent agencies, captive agencies, the Internet
and direct sales. To the extent that business migrates to a delivery system
other than independent agencies because of changing consumer preferences, the
Company's business will be adversely affected.
IF RATINGS FOR FINANCIAL STRENGTH ASSIGNED TO THE COMPANY'S INSURANCE
SUBSIDIARIES BY INDUSTRY RATING ORGANIZATIONS WERE SIGNIFICANTLY DOWNGRADED, THE
COMPETITIVE POSITION OF THE COMPANY'S INSURANCE SUBSIDIARIES WOULD BE ADVERSELY
AFFECTED.
Ratings are a factor in establishing the competitive position of insurance
companies. The Company's insurance subsidiaries receive ratings from A.M. Best &
Company, Inc., which are industry-accepted measures of an insurance company's
financial strength and are specifically designed to provide an independent
opinion of an insurance company's financial health and ability to meet ongoing
obligations to policyholders.
-23-
THE COMPANY COMPETES WITH MANY INSURERS THAT ARE FINANCIALLY STRONGER THAN
THE COMPANY.
The property and casualty insurance industry is intensely competitive.
Competition is based on many factors, including the perceived financial strength
of the insurer, premiums charged, policy terms and conditions, policyholder
service, reputation and experience. The Company competes 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 are better
capitalized than the Company, have substantially greater financial, technical
and operating resources and have equal or higher ratings from A.M. Best Company.
The superior capitalization of many of the Company's competitors enables
them to withstand lower profit margins and, therefore, to market their products
more aggressively, to take advantage more quickly of new marketing opportunities
and to offer lower premium rates. Moreover, if the Company's competitors price
their premiums more aggressively and the Company meets their pricing, the
Company's profit margins and revenues may be reduced and its ratios of claims
and expenses to premiums may increase.
The Company's competition may become increasingly better capitalized in the
future as the traditional barriers between insurance companies and banks and
other financial institutions erode and as the property and casualty industry
continues to consolidate. The Company's ability to compete against its larger,
better capitalized competitors depends largely on its ability to provide
superior policyholder service and to maintain its historically strong
relationships with independent insurance agents, on whom the Company is entirely
dependent to generate premium volume.
There is no assurance that the Company will maintain its current
competitive position in the markets in which it operates, or that it will be
able to expand its operations into new markets. If it fails to do so, its
business could be materially adversely affected.
RISKS RELATING TO THE PROPERTY AND CASUALTY INSURANCE INDUSTRY
THE COMPANY FACES SIGNIFICANT EXPOSURE TO TERRORISM.
Although the Company did not incur any losses as a result of the tragic
World Trade Center terrorist attack, that attack resulted in staggering losses
for the insurance industry and has caused uncertainty in the insurance and
reinsurance markets. Accordingly, the industry has been compelled to re-examine
policy language and to address the potential for future threats of terrorist
events and losses. The Company's personal and commercial property and casualty
insurance policies were not priced to cover the risk of terrorist attacks and
losses such as those suffered in the World Trade Center terrorist attack.
Therefore, exposure to terrorism exists under several lines, including personal
lines and workers' compensation, and, in most states, losses caused by an
ensuing fire. The recently enacted Terrorism Risk Insurance Act of 2002
established a program for commercial property and casualty losses, including
workers' compensation, resulting from foreign acts of terrorism. The Terrorism
Risk Insurance Act requires commercial insurers to make terrorism coverage
available and provides limited federal
-24-
protection above individual company retention levels, based upon a percentage of
direct earned premium, and above aggregate industry retention levels that range
from $10 billion in the first year to $15 billion in the third year. The federal
government will pay 90% of covered terrorism losses that exceed retention
levels. The Terrorism Risk Insurance Act is scheduled to expire on December 31,
2005. Personal lines are not included under the protection of the Terrorism Risk
Insurance Act, and state regulators have not approved exclusions for acts of
terrorism in personal lines policies. The Company could incur large unexpected
losses if future terrorist attacks occur.
INCREASED LITIGATION AGAINST THE INDUSTRY, WILLINGNESS OF COURTS TO EXPAND
COVERED CAUSES OF LOSS, RISING JURY AWARDS, INCREASING MEDICAL COSTS AND THE
ESCALATION OF LOSS SEVERITY MAY CONTRIBUTE TO INCREASED COSTS AND TO THE
DETERIORATION OF THE COMPANY'S RESERVES.
Loss severity continues to increase, principally driven by larger court
judgments and increasing medical costs in recent years. In addition, many legal
actions and proceedings have been brought on behalf of classes of complainants,
which can increase the size of judgments. The propensity of policyholders to
litigate and the willingness of courts to expand causes of loss and the size of
awards may render loss reserves inadequate for current and future losses. Loss
reserves are liabilities established by insurers and reinsurers to reflect the
estimated cost of loss payments and the related loss adjustment expenses that
the insurer or reinsurer will ultimately be required to pay in respect of
insurance or reinsurance it has written.
The Company has exposure to mold claims for which there has recently been a
sharp increase in the industry generally. Sometimes referred to as "sick
building syndrome," tenants claiming to suffer illnesses caused by mold may seek
financial compensation from building owners. Businesses also may claim
loss-of-use business income interruption losses. Homeowners have also been
submitting claims based on mold that has occurred from water damage. The
Company's exposure to mold, to date, including known and expected claims, has
been insignificant.
CHANGES IN APPLICABLE INSURANCE LAWS, REGULATIONS OR CHANGES IN THE WAY
REGULATORS ADMINISTER THOSE LAWS OR REGULATIONS COULD MATERIALLY ADVERSELY
CHANGE THE COMPANY'S OPERATING ENVIRONMENT AND INCREASE ITS EXPOSURE TO LOSS OR
PUT IT AT A COMPETITIVE DISADVANTAGE.
Property and casualty insurers are subject to extensive supervision in the
states in which they do business. This regulatory oversight includes, by way of
example, matters relating to licensing and examination, rate setting, market
conduct, policy forms, limitations on the nature and amount of certain
investments, claims practices, mandated participation in involuntary markets and
guaranty funds, reserve adequacy, insurer solvency, transactions between
affiliates, the amount of dividends that may be paid and restrictions on
underwriting standards. Such regulation and supervision are primarily for the
benefit and protection of policyholders and not for the benefit of stockholders.
For instance, the Company is subject to involuntary participation in specified
markets in various states in which it operates, and the rate levels the Company
is permitted to charge do not always correspond with the underlying costs
associated with the coverage issued.
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
-25-
insurance companies, risk-based capital guidelines, 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 materially change the operating environment for the Company
and significantly increase the amount of loss to which the Company is exposed
after an insurance policy has been issued.
The state insurance regulatory framework recently has come under increased
federal scrutiny. Congress is considering legislation that would create an
optional federal charter for insurers. Federal chartering has the potential to
create an uneven playing field for insurers. Federally chartered companies could
be subject to different regulatory requirements than state chartered insurers in
areas such as market conduct oversight, solvency regulation, guaranty fund
participation and premium tax burdens. If this occurs, federally chartered
insurers may obtain a competitive advantage over state licensed carriers.
Federal chartering also raises the specter of a matrix of regulation and costly
duplicative, or conflicting, federal and state requirements. Specific federal
regulatory developments include the potential repeal of the McCarran-Ferguson
Act. The repeal of the McCarran-Ferguson Act and its partial exemption for the
insurance industry from federal antitrust laws would make it extremely difficult
for insurers to compile and share loss data, develop standard policy forms and
manuals and predict future loss costs. The ability of the industry, under the
exemption permitted in the McCarran-Ferguson Act, to collect loss cost data and
build a credible database as a means of predicting future loss costs is an
extremely important part of cost-based pricing. If the ability to collect this
data were removed, then the predictability of future loss costs, and hence, the
reliability of pricing would be greatly undermined.
IF CERTAIN STATE REGULATORS, LEGISLATORS AND SPECIAL INTEREST GROUPS ARE
SUCCESSFUL IN ATTEMPTS TO REDUCE, FREEZE OR SET RATES FOR INSURANCE POLICIES,
ESPECIALLY AUTOMOBILE POLICIES, AT LEVELS THAT DO NOT, IN OUR MANAGEMENT'S VIEW,
CORRESPOND WITH UNDERLYING COSTS, THE COMPANY'S RESULTS OF OPERATIONS WILL BE
ADVERSELY AFFECTED.
From time to time, the automobile insurance industry in particular has been
under pressure from certain state regulators, legislators and special interest
groups to reduce, freeze or set rates at levels that do not, in the view of the
Company's management, correspond with underlying costs, including initiatives to
roll back automobile and other personal lines rates. This activity may in the
future adversely affect the profitability of the Company's automobile insurance
line of business in various states because increasing costs of litigation and
medical treatment, combined with rising automobile repair costs, continue to
increase the costs of providing automobile insurance coverage. Adverse
legislative and regulatory activity constraining the Company's ability to price
automobile insurance coverage adequately may occur in the future. The impact of
the automobile insurance regulatory environment on the results of operations of
the Company in the future is not predictable.
-26-
THE COMPANY IS SUBJECT TO ASSESSMENT, DEPENDING UPON ITS MARKET SHARE OF A
GIVEN LINE OF BUSINESS, TO ASSIST IN THE PAYMENT OF UNPAID CLAIMS AND RELATED
COSTS OF INSOLVENT INSURANCE COMPANIES; SUCH ASSESSMENTS COULD SIGNIFICANTLY
AFFECT THE COMPANY'S FINANCIAL CONDITION.
The Company is obligated to pay assessments under the guaranty fund laws of
the various states in which it is licensed. Generally, under these laws, an
insurer is subject to assessment, depending upon its market share of a given
line of business, to assist in the payment of unpaid claims and related costs of
insolvent insurance companies. The number and magnitude of future insurance
company failures in the states in which the Company does business cannot be
predicted, but resulting assessments could significantly affect the financial
condition of the Company. The Company believes that it is likely it will receive
an assessment in the next year relating to the insolvency of The Pennsylvania
Hospital Insurance Company (PHICO), the amount of which cannot currently be
estimated.
PREMIUM RATES AND RESERVES MUST BE ESTABLISHED BY THE COMPANY FROM
FORECASTS OF THE ULTIMATE COSTS EXPECTED TO ARISE FROM RISKS UNDERWRITTEN DURING
THE POLICY PERIOD; THE COMPANY'S PROFITABILITY COULD BE ADVERSELY AFFECTED TO
THE EXTENT ITS PREMIUM RATES OR RESERVES ARE TOO LOW.
One of the distinguishing features of the property and casualty insurance
industry in general is that its products are priced before its costs are known,
as premium rates are generally determined before losses are reported.
Accordingly, premium rates must be established from forecasts of the ultimate
costs expected to arise from risks underwritten during the policy period and may
not prove to be adequate. Further, property and casualty insurers establish
reserves for losses and loss adjustment expenses based upon estimates, and it is
possible that the ultimate liability will 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 factors that are subject to variation. If
pricing or reserves established by the Company is not sufficient, its
profitability may be adversely impacted.
THE CYCLICAL NATURE OF THE PROPERTY AND CASUALTY INSURANCE INDUSTRY MAY
REDUCE THE COMPANY'S REVENUES AND PROFIT MARGINS.
The property and casualty insurance industry is highly cyclical, and
individual lines of business experience their own cycles within the overall
industry cycle. Premium rate levels are related to the availability of insurance
coverage, which varies according to the level of surplus in the industry. The
level of surplus in the industry varies with returns on invested capital and
regulatory barriers to withdrawal of surplus. Increases in surplus have
generally been accompanied by increased price competition among property and
casualty insurers. If the Company finds it necessary to reduce premiums or limit
premium increases due to these competitive pressures on pricing, the Company may
experience a reduction in profit margins and revenues, an increase in its ratios
of claims and expenses to premiums and, therefore, lower profitability.
Volatile and unpredictable developments also offset significantly the
cyclical trends in the industry and the industry's profitability. These
developments include natural disasters (such as storms, earthquakes, hurricanes,
floods and fires), terrorism risks, fluctuations in interest rates
-27-
and other changes in the investment environment that affect the market prices of
the Company's investments and the income from those investments, inflationary
pressures that affect the size of losses and judicial decisions that affect its
liabilities. The occurrence of these developments may adversely affect the
Company's business and financial condition.
RISKS RELATING TO THE COMPANY'S RELATIONSHIP WITH THIRD PARTIES
THE REINSURANCE AGREEMENTS ON WHICH THE COMPANY RELIES DO NOT RELIEVE THE
COMPANY FROM LIABILITY TO ITS POLICYHOLDERS.
The Company relies on reinsurance agreements to limit its maximum net loss
from large single risks or risks in concentrated areas, and to increase its
capacity to write insurance. Each reinsurance agreement satisfies all applicable
regulatory requirements. Reinsurance, however, does not relieve the Company from
liability to its policyholders. To the extent that a reinsurer may be unable to
pay losses for which it is liable under the terms of its reinsurance agreement
with the Company, the Company remains liable for such losses. However, in an
effort to reduce the risk of non-payment, the Company requires all of its
reinsurers to have an A.M. Best rating of A- or better or, with respect to
foreign reinsurers, to have a financial condition that, in the opinion of the
Company's management, is equivalent to a company with at least an A- rating. If
the Company's reinsurers incur losses from their reinsurance arrangements with
the Company, it is probable that the reinsurance premiums payable by the Company
in the future could increase or that the reinsurance might not be renewed.
THE MUTUAL COMPANY IS THE COMPANY'S LARGEST SHAREHOLDER AND PROVIDES IT
WITH FACILITIES AND SERVICES.
The Mutual Company currently owns approximately 66% of the Company's
outstanding Class A Common Stock and approximately 62% of the Company's
outstanding Class B Common Stock. Accordingly, the Mutual Company controls the
election of members of the Company's Board of Directors. Although the Mutual
Company could exercise its control in ways that are contrary to the interests of
the Company's stockholders other than the Mutual Company, the Company and the
Mutual Company have established a Coordinating Committee consisting of two
outside directors from each company who do not also serve as directors of the
other company. Under the Company's and the Mutual Company's By-laws, any new
agreement between the Company and the Mutual Company and any proposed change in
any existing agreement between the Company and the Mutual Company must first be
submitted for approval by the respective Boards of Directors of the Company and
the Mutual Company and, if approved, submitted to the Coordinating Committee for
approval. The proposed new agreement or change in an existing agreement will
receive Coordinating Committee approval only if both of the Company's
Coordinating Committee members conclude the new agreement or change in an
existing agreement is fair to the Company and its stockholders and if both of
the Mutual Company's Coordinating Committee members conclude the agreement or
change in an existing agreement is fair and equitable to the Mutual Company and
its policyholders. The decisions of the Coordinating Committee are binding on
the Company and the Mutual Company. The purpose of this provision is to protect
the interests of the stockholders of the Company and the interests of the
policyholders of the Mutual Company.
-28-
The Company is dependent upon the Mutual Company for the retention of
agents and the underwriting of insurance, the servicing of policyholder claims
and all other aspects of the Company's operations. All of the Company's officers
are officers and employees of the Mutual Company. The Mutual Company also
provides all of the facilities and data processing and administrative services
required to conduct the Company's business, for which the Company pays a pro
rata portion of the cost.
BECAUSE THE COMPANY PARTICIPATES IN AN INSURANCE POOLING ARRANGEMENT WITH
THE MUTUAL COMPANY, THE COMPANY'S RESULTS OF OPERATIONS ARE DEPENDENT UPON THE
FINANCIAL SUCCESS OF THE MUTUAL COMPANY.
The Company's insurance subsidiary, Atlantic States, participates in an
intercompany pooling arrangement with the Mutual Company, under which the
parties share the premiums earned and underwriting results on substantially all
of the property and casualty insurance business written by both companies. Under
the terms of the intercompany pooling agreement, Atlantic States cedes all of
its insurance business to the Mutual Company and assumes from the Mutual Company
70% of the total pooled insurance business of the Mutual Company and Atlantic
States. The allocations of pool participation percentages between the Mutual
Company and Atlantic States are based on the pool participants' relative amounts
of capital and surplus, expectations of future relative amounts of capital and
surplus and the Company's ability to raise capital for Atlantic States.
Because of the pooled business the Company assumes, the Company's insurance
operations are interrelated with the insurance operations of the Mutual Company
and the Company's results of operations are dependent upon the financial success
of the Mutual Company. Although the underwriting pool is intended to produce a
more uniform and stable underwriting result from year to year for the
participants in the pool than they would experience individually and to spread
the risk of loss among all the participants, if the Mutual Company experiences
unusually severe or frequent losses or does not adequately price its premiums,
the Company's results of operations could suffer. The Company's results of
operations also may suffer if the Mutual Company did not participate in the
pooling arrangement because the pool participants would then be limited to
policy exposures of a size commensurate with their own capital and surplus
instead of having at their disposal the capacity of the entire pool.
THE COMPANY IS DEPENDENT ON DIVIDENDS FROM ITS SUBSIDIARIES FOR THE PAYMENT
OF ITS OPERATING EXPENSES, ITS DEBT SERVICE AND DIVIDENDS TO STOCKHOLDERS.
As a holding company, the Company relies primarily on its subsidiaries for
dividends and other permitted payments to meet its obligations for corporate
expenses. Payment of dividends by the Company's subsidiaries is subject to
regulatory restrictions and depends on the surplus of the subsidiaries. From
time to time, the NAIC and various state insurance regulators consider modifying
the method of determining the amount of dividends that may be paid by an
insurance company without prior regulatory approval.
-29-
ITEM 2. PROPERTIES.
DGI and Atlantic States share headquarters with the Mutual Company's
headquarters in a building owned by the Mutual Company. The Mutual Company
charges DGI for an appropriate portion of the building expenses under an
intercompany allocation agreement which is consistent with the terms of the
pooling agreement. The headquarters of the Mutual Company has approximately
172,600 square feet of office space. Southern has a facility of approximately
10,000 square feet in Glen Allen, Virginia, which it owns. Province Bank leases
approximately 3,600 square feet of a building located in Marietta, Pennsylvania
owned by the Mutual Company. The Mutual Company charges Province Bank annual
rent based on an independent appraisal.
ITEM 3. LEGAL PROCEEDINGS.
DGI is a party to numerous lawsuits arising in the ordinary course of its
insurance business. DGI believes that the resolution of these lawsuits will not
have a material adverse effect on its financial condition or results of
operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matter was submitted to a vote of holders of the Company's Class A
Common Stock and/or Class B Common Stock during the fourth quarter of 2002.
EXECUTIVE OFFICERS OF THE COMPANY
The following table sets forth information regarding the persons who served
as executive officers of DGI on March 24, 2003:
NAME AGE POSITION
- ---- --- --------
Donald H. Nikolaus 60 President and Chief Executive Officer since 1981
Ralph G. Spontak 50 Senior Vice President since 1991; Chief Financial Officer and Vice
President since 1983; Secretary since 1988
Cyril J. Greenya 58 Senior Vice President-Commercial Underwriting since 1997; Vice
President-Commercial Underwriting for five years prior thereto;
Manager-Commercial Underwriting for nine years prior thereto
Robert G. Shenk 50 Senior Vice President-Claims since 1997; Vice President-Claims for
five years prior thereto
Daniel J. Wagner 42 Treasurer since 1993; Controller for five years prior thereto
-30-
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.
The response to this Item is incorporated in part by reference to page 30
of the Company's Annual Report to Stockholders for the year ended December 31,
2002, which is included as Exhibit (13) to this Form 10-K Report. As of March
20, 2003, the Company had approximately 613 holders of record of its Class A
Common Stock and 513 holders of record of its Class B Common Stock. The Company
declared dividends of $.40 per share on its Class A Common Stock and $.36 per
share on its Class B Common Stock in 2002, and $.40 per share on its Class A
Common Stock and $.36 per share on its Class B Common Stock in 2001.
ITEM 6. SELECTED FINANCIAL DATA.
The response to this Item is incorporated by reference to page 1 of the
Company's Annual Report to Stockholders for the year ended December 31, 2002,
which is included as Exhibit (13) to this Form 10-K Report.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
The response to this Item is incorporated by reference to pages 10 through
13 of the Company's Annual Report to Stockholders for the year ended December
31, 2002, which is included as Exhibit (13) to this Form 10-K Report.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The response to this Item is incorporated by reference to pages 14 through
29 of the Company's Annual Report to Stockholders for the year ended December
31, 2002, which is included as Exhibit (13) to this Form 10-K Report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
-31-
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The response to this Item with respect to the Company's directors is
incorporated by reference to page 5 and pages 7 through 8 of the Company's proxy
statement relating to the Company's annual meeting of stockholders to be held
April 17, 2003. The response to this Item with respect to the Company's
executive officers is incorporated by reference to Part I of this Form 10-K
Report.
ITEM 11. EXECUTIVE COMPENSATION.
The response to this Item is incorporated by reference to pages 9 through
13 of the Company's proxy statement relating to the Company's annual meeting of
stockholders to be held April 17, 2003, except for the Report of Compensation
Committee, the Performance Graph and the Report of the Audit Committee, which
are not incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The response to this Item is incorporated by reference to pages 3 through 4
of the Company's proxy statement relating to the Company's annual meeting of
stockholders to be held April 17, 2003.
The following table sets forth information regarding equity compensation
plans of the Company.
Equity Compensation Plan Information
NUMBER OF SECURITIES
(CLASS) REMAINING
NUMBER OF SECURITIES AVAILABLE FOR FUTURE
(CLASS) TO BE ISSUED WEIGHTED-AVERAGE ISSUANCE UNDER EQUITY
UPON EXERCISE OF EXERCISE PRICE OF COMPENSATION PLANS
OUTSTANDING OPTIONS, OUTSTANDING OPTIONS (EXCLUDING SECURITIES
PLAN CATEGORY WARRANTS AND RIGHTS WARRANTS AND RIGHTS REFLECTED IN COLUMN (A))
- ------------- ------------------- ------------------- ------------------------
(a) (b) (c)
Equity compensation plans
approved by security holders 1,080,101 (Class A) $13.52 (Class A) 1,228,900 (Class A)
313,900 (Class B) $13.12 (Class B) -- (Class B)
Equity compensation plans not
approved by security holders -- -- --
--------- ------ ---------
Total 1,394,001 $13.43 1,228,900
-32-
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The response to this Item is incorporated by reference to pages 5 through 6
and page 15 of the Company's proxy statement relating to the Company's annual
meeting of stockholders to be held April 17, 2003.
ITEM 14. CONTROLS AND PROCEDURES.
Within the 90 days prior to the date of this Form 10-K Report, the Company
carried out an evaluation of the effectiveness of the design and operation of
its disclosure controls and procedures. This evaluation was performed under the
supervision and with the participation of management, including the Company's
President and Chief Executive Officer and the Company's Chief Financial Officer.
Under the rules of the Securities and Exchange Commission, the term
"disclosure controls and procedures" means controls and other procedures of the
Company that are designed to ensure that information required to be disclosed by
the Company in reports that it files or submits under the Securities Exchange
Act of 1934 is recorded, processed, summarized and reported within the time
periods specified in the rules and forms. Disclosure controls and procedures
include, without limitation, controls and procedures designed to ensure that
information required to be disclosed by the Company in such reports is
accumulated and communicated to the Company's management, including the
President and Chief Executive Officer and the Chief Financial Officer, as
appropriate to permit management to make timely decisions regarding required
disclosure.
Based on this evaluation, the Company's President and Chief Executive
Officer and the Company's Chief Financial Officer concluded that the Company's
disclosure controls and procedures are effective for gathering, analyzing and
disclosing the information that the Company is required to disclose in the
reports it files under the Securities Exchange Act of 1934, within the time
periods specified in the rules and forms of the Securities and Exchange
Commission. Subsequent to the date of this evaluation, there have been no
significant changes in the Company's internal controls or in other factors that
could significantly affect internal controls.
A control system, no matter how well-designed and operated, cannot provide
absolute assurance that the objectives of the controls system are met, and no
evaluation of controls can provide absolute assurance that all control issues
and instances of fraud, if any, within a company have been detected.
-33-
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) Financial statements, financial statement schedules and exhibits
filed:
(1) Consolidated Financial Statements
PAGE*
-----
Report of Independent Auditors.............................................................. 29
Donegal Group Inc. and Subsidiaries:
Consolidated Balance Sheets as of
December 31, 2002 and 2001................................................................ 14
Consolidated Statements of Income and
Comprehensive Income for the three years ended
December 31, 2002, 2001 and 2000.......................................................... 15
Consolidated Statements of Stockholders'
Equity for the three years ended
December 31, 2002, 2001 and 2000.......................................................... 16
Consolidated Statements of Cash Flows for the three years ended
December 31, 2002, 2001 and 2000........................................................... 17
Notes to Consolidated Financial Statements.................................................. 18-28
(2) Financial Statement Schedules
PAGE
----
Donegal Group Inc. and Subsidiaries
Independent Auditors' Consent and Report on Schedules Exhibit 23
Schedule I. Summary of Investments - Other
Than Investments in Related Parties...................................
Schedule II. Condensed Financial Information of Parent Company.......................
Schedule III. Supplementary Insurance Information.....................................
Schedule IV. Reinsurance.............................................................
Schedule VI. Supplemental Insurance Information Concerning
Property and Casualty Subsidiaries....................................
All other schedules have been omitted since they are not required, not
applicable or the information is included in the financial statements or notes
thereto.
- ------------
* Refers to the respective page of Donegal Group Inc.'s 2002 Annual Report to
Stockholders. The Consolidated Financial Statements and Notes to Consolidated
Financial Statements and Auditor's Report thereon on pages 14 through 28 are
incorporated herein by
-34-
reference. With the exception of the portions of such Annual Report specifically
incorporated by reference in this Item and Items 5, 6, 7 and 8 hereof, such
Annual Report shall not be deemed filed as part of this Form 10-K Report or
otherwise subject to the liabilities of Section 18 of the Securities Exchange
Act of 1934.
(3) Exhibits
EXHIBIT NO. DESCRIPTION OF EXHIBITS REFERENCE
----------- ----------------------- ---------
(3)(i) Certificate of Incorporation of Registrant, as amended. (a)
(3)(ii) Amended and Restated By-laws of Registrant. (b)
MANAGEMENT CONTRACTS AND COMPENSATORY PLANS OR ARRANGEMENTS
(10)(A) Donegal Group Inc. Amended and Restated 1996 Equity (c)
Incentive Plan.
(10)(B) Donegal Group Inc. 2001 Equity Incentive Plan for Employees. (d)
(10)(C) Donegal Group Inc. 2001 Equity Incentive Plan for Directors. (d)
(10)(D) Donegal Group Inc. 2001 Employee Stock Purchase Plan, as (e)
amended.
(10)(E) Donegal Group Inc. Amended and Restated 2001 Agency Stock Purchase Plan. (f)
(10)(F) Donegal Mutual Insurance Company 401(k) Plan. (g)
(10)(G) Amendment No. 1 effective January 1, 2000 to Donegal Mutual Insurance (g)
Company 401(k) Plan.
(10)(H) Amendment No. 2 effective January 6, 2000 to Donegal Mutual Insurance (b)
Company 401(k) Plan.
(10)(I) Amendment No. 3 effective July 23, 2001 to Donegal Mutual Insurance (b)
Company 401(k) Plan.
(10)(J) Amendment No. 4 effective January 1, 2002 to Donegal Mutual Insurance (b)
Company 401(k) Plan.
(10)(K) Amendment No. 5 effective December 31, 2001 to Donegal Mutual Insurance (b)
Company 401(k) Plan.
(10)(L) Amendment No. 6 effective July 1, 2002 to Donegal Mutual Insurance Filed
Company 401(k) Plan. herewith
-35-
EXHIBIT NO. DESCRIPTION OF EXHIBITS REFERENCE
----------- ----------------------- ---------
(10)(M) Donegal Mutual Insurance Company Executive Restoration Plan. (h)
OTHER MATERIAL CONTRACTS
------------------------
(10)(N) Tax Sharing Agreement dated September 29, 1986 between Donegal Group Inc. (i)
and Atlantic States Insurance Company.
(10)(O) Services Allocation Agreement dated September 29, 1986 between Donegal (i)
Mutual Insurance Company, Donegal Group Inc. and Atlantic States
Insurance Company.
(10)(P) Proportional Reinsurance Agreement dated September 29,
1986 between (i) Donegal Mutual Insurance Company and
Atlantic States Insurance Company.
(10)(Q) Amendment dated October 1, 1988 to Proportional Reinsurance Agreement (j)
between Donegal Mutual Insurance Company and Atlantic States Insurance
Company.
(10)(R) Multi-Line Excess of Loss Reinsurance Agreement effective January 1, 2002 Filed
among Donegal Mutual Insurance Company, Dorinco Reinsurance Company and herewith
Erie Insurance Group.
(10)(S) Amendment dated July 16, 1992 to Proportional Reinsurance Agreement (k)
between Donegal Mutual Insurance Company and Atlantic States Insurance
Company.
(10)(T) Amendment dated as of December 21, 1995 to Proportional Reinsurance (l)
Agreement between Donegal Mutual Insurance Company and Atlantic States
Insurance Company.
(10)(U) Reinsurance and Retrocession Agreement dated May 21,
1996 between Donegal Mutual Insurance Company and
Southern Insurance Company of Virginia.
(10)(V) Amended and Restated Credit Agreement dated as of July 27, 1998 among (m)
Donegal Group Inc., the banks and other financial institutions from time
to time party thereto and Fleet National Bank, as agent.
(10)(W) First Amendment and Waiver to the Amended and Restated Credit Agreement (g)
dated as of December 31, 1999.
-36-
EXHIBIT NO. DESCRIPTION OF EXHIBITS REFERENCE
----------- ----------------------- ---------
(10)(X) Amendment dated as of April 20, 2000 to Proportional Reinsurance (n)
Agreement between Donegal Mutual Insurance Company and Atlantic States
Insurance Company.
(10)(Y) Lease Agreement dated as of September 1, 2000 between Donegal Mutual (d)
Insurance Company and Province Bank FSB.
(10)(Z) Aggregate Excess of Loss Reinsurance Agreement dated as of January 1, (d)
2001 between Donegal Mutual Insurance Company and Atlantic States
Insurance Company (as successor-in-interest to Pioneer Insurance Company).
(13) 2002 Annual Report to Stockholders (electronic filing contains only those Filed
portions incorporated by reference into this Form 10-K Report). herewith
(20) Proxy Statement relating to the Annual Meeting of Stockholders to be held (o)
on April 17, 2003; provided, however, that the Report of the Compensation
Committee, the Performance Graph and the Report of the Audit Committee
shall not be deemed filed as part of this Form 10-K Report.
(21) Subsidiaries of Registrant. Filed herewith
(23) Consent of Independent Auditors. Filed herewith
(99.1) Statement of Chief Executive Officer Pursuant to Section 1350 of the Filed herewith
United States Code.
(99.2) Statement of Chief Financial Officer Pursuant to Section 1350 of the Filed herewith
United States Code.
- ------------
(a) Such exhibit is hereby incorporated by reference to the like-described
exhibit in Registrant's Form S-3 Registration Statement No. 333-59828 filed
April 30, 2001.
(b) Such exhibit is hereby incorporated by reference to the like-described
exhibit in Registrant's Form 10-K Report for the year ended December 31,
2001.
(c) Such exhibit is hereby incorporated by reference to the like-described
exhibit in Registrant's Form 10-K Report for the year ended December 31,
1998.
-37-
EXHIBIT NO. DESCRIPTION OF EXHIBITS REFERENCE
- ----------- ----------------------- ---------
(d) Such exhibit is hereby incorporated by reference to the like-described
exhibit in Registrant's Form 10-K Report for the year ended December 31,
2000.
(e) Such exhibit is hereby incorporated by reference to the like-described
exhibit in Registrant's Form S-8 Registration Statement No. 333-62974 filed
June 14, 2001.
(f) Such exhibit is hereby incorporated by reference to the like-described
exhibit in Registrant's Form S-2 Registration Statement No. 333-63102
declared effective February 8, 2002.
(g) Such exhibit is hereby incorporated by reference to the like-described
exhibit in Registrant's Form 10-K Report for the year ended December 31,
1999.
(h) Such exhibit is hereby incorporated by reference to the like-described
exhibit in Registrant's Form 10-K Report for the year ended December 31,
1996.
(i) Such exhibit is hereby incorporated by reference to the like-described
exhibit in Registrant's Form S-1 Registration Statement No. 33-8533
declared effective October 29, 1986.
(j) Such exhibit is hereby incorporated by reference to the like-described
exhibit in Registrant's Form 10-K Report for the year ended December 31,
1988.
(k) Such exhibit is hereby incorporated by reference to the like-described
exhibit in Registrant's Form 10-K Report for the year ended December 31,
1992.
(l) Such exhibit is hereby incorporated by reference to the like-described
exhibit in Registrant's Form 8-K Report dated December 21, 1995.
(m) Such exhibit is hereby incorporated by reference to the like-described
exhibit in Registrant's Form 8-K Report dated November 17, 1998.
(n) Such exhibit is hereby incorporated by reference to the like-described
exhibit in Registrant's Form 8-K Report dated May 31, 2000.
(o) Such exhibit is hereby incorporated by reference to the Registrant's
definitive proxy statement filed March 24, 2003.
(b) Reports on Form 8-K:
None.
-38-
DONEGAL GROUP INC. AND SUBSIDIARIES
SCHEDULE I - SUMMARY OF INVESTMENTS
OTHER THAN INVESTMENTS IN RELATED PARTIES
-----------------------------------------
($ in thousands)
December 31, 2002
AMOUNT AT WHICH
FAIR SHOWN IN THE
COST VALUE BALANCE SHEET
-------- -------- --------------
Fixed Maturities:
Held to maturity:
United States government and
Governmental agencies and authorities ................ $ 12,641 $ 13,049 $ 12,641
Obligations of states and political subdivisions ..... 33,892 34,400 33,892
Canadian government obligation ....................... 499 540 499
All other corporate bonds ............................ 29,552 31,285 29,522
Mortgage-backed securities ........................... 10,118 10,511 10,118
-------- -------- --------
Total fixed maturities
held to maturity ..................................... 86,702 89,785 86,702
-------- -------- --------
Available for sale:
United States government and
Governmental agencies and authorities ................ 56,344 58,287 58,287
Obligations of states and political subdivisions ..... 78,516 81,446 81,446
All other corporate bonds ............................ 34,849 36,863 36,863
Mortgage-backed securities ........................... 17,787 18,136 18,136
-------- -------- --------
Total fixed maturities
available for sale ................................... 187,496 194,732 194,732
-------- -------- --------
Total fixed maturities ............................... 274,198 284,517 281,434
-------- -------- --------
Equity Securities:
Preferred stocks:
Public utilities ..................................... 227 254 254
Banks ................................................ 9,001 9,190 9,190
Industrial and miscellaneous ......................... 1,639 1,663 1,663
-------- -------- --------
Total preferred stocks ............................... 10,867 11,107 11,107
-------- -------- --------
Common stocks:
Banks and insurance companies ........................ 3,673 4,176 4,176
Industrial and miscellaneous ......................... 7,047 6,553 6,553
-------- -------- --------
Total common stocks .................................. 10,720 10,729 10,729
-------- -------- --------
Total equity securities .............................. 21,587 21,836 21,836
-------- -------- --------
Short-term investments ................................. 29,029 29,029 29,029
-------- -------- --------
Total investments .................................... $324,814 $335,382 $332,299
======== ======== ========
-39-
DONEGAL GROUP INC. AND SUBSIDIARIES
SCHEDULE III - SUPPLEMENTARY INSURANCE INFORMATION
--------------------------------------------------
($ in thousands)
Years Ended December 31, 2002, 2001 and 2000
AMORTIZATION
OF DEFERRED
NET NET NET LOSSES POLICY OTHER NET
EARNED INVESTMENT AND LOSS ACQUISITION UNDERWRITING PREMIUMS
SEGMENT PREMIUMS INCOME EXPENSES COSTS EXPENSES WRITTEN
------- -------- ------ -------- ----- -------- -------
Year Ended
December 31, 2002
Personal lines $119,838 $ -- $ 87,790 $ 19,005 $ 16,335 $125,777
Commercial lines 66,003 -- 41,478 10,468 8,997 68,727
Investments -- 14,581 -- -- -- --
-------- -------- -------- -------- -------- --------
$185,841 $ 14,581 $129,268 $ 29,473 $ 25,332 $194,504
======== ======== ======== ======== ======== ========
Year Ended
December 31, 2001
Personal lines $104,893 $ -- $ 72,534 $ 17,002 $ 16,881 $111,623
Commercial lines 62,877 -- 45,644 10,192 10,119 65,405
Investments -- 15,886 -- -- -- --
-------- -------- -------- -------- -------- --------
$167,770 $ 15,886 $118,178 $ 27,194 $ 27,000 $177,028
======== ======== ======== ======== ======== ========
Year Ended
December 31, 2000
Personal lines $ 97,065 $ -- $ 68,003 $ 16,206 $ 14,950 $100,517
Commercial lines 54,581 -- 36,380 9,113 9,113 59,605
Investments -- 16,395 -- -- -- --
-------- -------- -------- -------- -------- --------
$151,646 $ 16,395 $104,383 $ 25,319 $ 25,319 $160,122
======== ======== ======== ======== ======== ========
-40-
DONEGAL GROUP INC. AND SUBSIDIARIES
SCHEDULE III - SUPPLEMENTARY INSURANCE INFORMATION, CONTINUED
---------------------------------------------------------------
($ in thousands)
At December 31,
---------------------------------------------------------------
DEFERRED LIABILITY OTHER POLICY
POLICY FOR LOSSES CLAIMS AND
ACQUISITION AND LOSS UNEARNED BENEFITS
SEGMENT COSTS EXPENSES PREMIUMS PAYABLE
------- ----------- ---------- -------- ------------
2002
----
Personal lines $ 9,423 $106,096 $ 78,273 $ --
Commercial lines 5,144 104,596 42,729 --
Investments -- -- -- --
-------- -------- -------- --------
$ 14,567 $210,692 $121,002 $ --
======== ======== ========
2001
----
Personal lines $ 8,394 $ 84,726 $ 70,388 $ --
Commercial lines 5,210 95,114 43,691 --
Investments -- -- -- --
-------- -------- -------- --------
$ 13,604 $179,840 $114,079 $ --
======== ======== ======== ========
-41-
DONEGAL GROUP INC. AND SUBSIDIARIES
SCHEDULE IV - REINSURANCE
-------------------------
CEDED ASSUMED PERCENTAGE
GROSS TO OTHER FROM OTHER NET ASSUMED
AMOUNT COMPANIES COMPANIES AMOUNT TO NET
============ =========== ============ ============ ==========
Year Ended
December 31, 2002
Property and casualty premiums $110,412,498 $58,817,518 $134,246,213 $185,841,193 72%
============ =========== ============ ============ ==
Year Ended
December 31, 2001
Property and casualty premiums $105,214,059 $64,220,420 $126,776,215 $167,769,854 76%
============ =========== ============ ============ ==
Year Ended
December 31, 2000
Property and casualty premiums $ 95,671,588 $54,981,016 $110,955,627 $151,646,199 73%
============ =========== ============ ============ ==
-42-
DONEGAL GROUP INC. AND SUBSIDIARIES
SCHEDULE VI - SUPPLEMENTARY INSURANCE INFORMATION
CONCERNING PROPERTY AND CASUALTY SUBSIDIARIES
---------------------------------------------
DISCOUNT,
DEFERRED LIABILITY IF ANY,
POLICY FOR LOSSES DEDUCTED
ACQUISITION AND LOSS FROM UNEARNED
COSTS EXPENSES RESERVES PREMIUMS
----- -------- -------- --------
At December 31,
2002 $14,567,070 $210,691,752 $-- $121,002,447
=========== ============ === ============
2001 $13,604,215 $179,839,905 $-- $114,079,264
=========== ============ === ============
2000 $12,284,214 $156,476,124 $-- $ 99,940,381
=========== ============ === ============
(continued)
-43-
DONEGAL GROUP INC. AND SUBSIDIARIES
SCHEDULE VI - SUPPLEMENTARY INSURANCE INFORMATION
CONCERNING PROPERTY AND CASUALTY SUBSIDIARIES, CONTINUED
--------------------------------------------------------
Years ended December 31, 2002, 2001 and 2000
LOSSES AND LOSS
EXPENSES RELATED TO
----------------------------------
NET
EARNED INVESTMENT CURRENT PRIOR
PREMIUMS INCOME YEAR YEARS
-------- ------ ---- -----
Year Ended
December 31, 2002 $185,841,193 $ 14,581,252 $122,433,653 $ 6,834,033
============ ============ ============ ============
Year Ended
December 31, 2001 $167,769,854 $ 15,885,544 $110,142,467 $ 8,035,082
============ ============ ============ ============
Year Ended
December 31, 2000 $151,646,199 $ 16,394,747 $103,671,401 $ 711,775
============ ============ ============ ============
AMORTIZATION
OF DEFERRED NET
POLICY PAID LOSSES NET
ACQUISITION AND LOSS PREMIUMS
COST EXPENSES WRITTEN
---- -------- -------
Year Ended
December 31, 2002 $ 29,473,000 $114,525,368 $194,503,847
============ ============ ============
Year Ended
December 31, 2001 $ 27,194,000 $106,342,848 $177,027,654
============ ============ ============
Year Ended
December 31, 2000 $ 25,319,000 $100,907,860 $160,122,420
============ ============ ============
-44-
SIGNATURES
----------
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.
DONEGAL GROUP INC.
Date: March 28, 2003 By: s/Donald H. Nikolaus
-------------------------------------
Donald H. Nikolaus, President
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 DATE
--------- ----- ----
President and a Director March 28, 2003
s/Donald H. Nikolaus (principal executive officer)
- ------------------------------
Donald H. Nikolaus
Senior Vice President, Chief March 28, 2003
Financial Officer and
Secretary (principal financial
s/Ralph G. Spontak and accounting officer)
- ------------------------------
Ralph G. Spontak
s/Robert S. Bolinger Director March 28, 2003
- ------------------------------
Robert S. Bolinger
s/Patricia A. Gilmartin Director March 28, 2003
- ------------------------------
Patricia A. Gilmartin
s/Philip H. Glatfelter Director March 28, 2003
- ------------------------------
Philip H. Glatfelter
Director March , 2003
- ------------------------------
John J. Lyons
Director March , 2003
- ------------------------------
R. Richard Sherbahn
-45-
CERTIFICATION
-------------
I, Donald H. Nikolaus, President of Donegal Group Inc., certify that:
1. I have reviewed this annual report on Form 10-K for the year ended
December 31, 2002 of Donegal Group Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this annual report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
(c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
-46-
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 28, 2003 s/Donald H. Nikolaus
----------------------------------------
Donald H. Nikolaus, President
-47-
CERTIFICATION
-------------
I, Ralph G. Spontak, Senior Vice President, Chief Financial Officer and
Secretary of Donegal Group Inc., certify that:
1. I have reviewed this annual report on Form 10-K for the year ended
December 31, 2002 of Donegal Group Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this annual report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
(c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
-48-
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 28, 2003 s/Ralph G. Spontak
----------------------------------------
Ralph G. Spontak, Senior Vice
President, Chief Financial Officer
and Secretary
-49-
EXHIBIT INDEX
(Pursuant to Item 601 of Regulation S-K)
EXHIBIT NO. DESCRIPTION OF EXHIBITS REFERENCE
----------- ----------------------- ---------
(3)(i) Certificate of Incorporation of Registrant, as amended. (a)
(3)(ii) Amended and Restated By-laws of Registrant. (b)
MANAGEMENT CONTRACTS AND COMPENSATORY PLANS OR ARRANGEMENTS
-----------------------------------------------------------
(10)(A) Donegal Group Inc. Amended and Restated 1996 Equity (c)
Incentive Plan.
(10)(B) Donegal Group Inc. 2001 Equity Incentive Plan for Employees. (d)
(10)(C) Donegal Group Inc. 2001 Equity Incentive Plan for Directors. (d)
(10)(D) Donegal Group Inc. 2001 Employee Stock Purchase Plan, as (e)
amended.
(10)(E) Donegal Group Inc. Amended and Restated 2001 Agency Stock Purchase Plan. (f)
(10)(F) Donegal Mutual Insurance Company 401(k) Plan. (g)
(10)(G) Amendment No. 1 effective January 1, 2000 to Donegal Mutual Insurance (g)
Company 401(k) Plan.
(10)(H) Amendment No. 2 effective January 6, 2000 to Donegal Mutual Insurance (b)
Company 401(k) Plan.
(10)(I) Amendment No. 3 effective July 23, 2001 to Donegal Mutual Insurance (b)
Company 401(k) Plan.
(10)(J) Amendment No. 4 effective January 1, 2002 to Donegal Mutual Insurance (b)
Company 401(k) Plan.
(10)(K) Amendment No. 5 effective December 31, 2001 to Donegal Mutual Insurance (b)
Company 401(k) Plan.
(10)(L) Amendment No. 6 effective July 1, 2002 to Donegal Mutual Insurance Filed
Company 401(k) Plan. herewith
(10)(M) Donegal Mutual Insurance Company Executive Restoration Plan. (h)
-50-
EXHIBIT NO. DESCRIPTION OF EXHIBITS REFERENCE
----------- ----------------------- ---------
OTHER MATERIAL CONTRACTS
------------------------
(10)(N) Tax Sharing Agreement dated September 29, 1986 between Donegal Group Inc. (i)
and Atlantic States Insurance Company.
(10)(O) Services Allocation Agreement dated September 29, 1986 between Donegal (i)
Mutual Insurance Company, Donegal Group Inc. and Atlantic States
Insurance Company.
(10)(P) Proportional Reinsurance Agreement dated September 29,
1986 between (i) Donegal Mutual Insurance Company and
Atlantic States Insurance Company.
(10)(Q) Amendment dated October 1, 1988 to Proportional Reinsurance Agreement (j)
between Donegal Mutual Insurance Company and Atlantic States Insurance
Company.
(10)(R) Multi-Line Excess of Loss Reinsurance Agreement effective January 1, 2002 Filed
among Donegal Mutual Insurance Company, Dorinco Reinsurance Company and herewith
Erie Insurance Group.
(10)(S) Amendment dated July 16, 1992 to Proportional Reinsurance Agreement (k)
between Donegal Mutual Insurance Company and Atlantic States Insurance
Company.
(10)(T) Amendment dated as of December 21, 1995 to Proportional Reinsurance (l)
Agreement between Donegal Mutual Insurance Company and Atlantic States
Insurance Company.
(10)(U) Reinsurance and Retrocession Agreement dated May 21,
1996 between Donegal (h) Mutual Insurance Company and
Southern Insurance Company of Virginia.
(10)(V) Amended and Restated Credit Agreement dated as of July 27, 1998 among (m)
Donegal Group Inc., the banks and other financial institutions from time
to time party thereto and Fleet National Bank, as agent.
(10)(W) First Amendment and Waiver to the Amended and Restated Credit Agreement (g)
dated as of December 31, 1999.
(10)(X) Amendment dated as of April 20, 2000 to Proportional Reinsurance (n)
Agreement between Donegal Mutual Insurance Company and Atlantic States
Insurance Company.
-51-
EXHIBIT NO. DESCRIPTION OF EXHIBITS REFERENCE
----------- ----------------------- ---------
(10)(Y) Lease Agreement dated as of September 1, 2000 between Donegal Mutual (d)
Insurance Company and Province Bank FSB.
(10)(Z) Aggregate Excess of Loss Reinsurance Agreement dated as of January 1, (d)
2001 between Donegal Mutual Insurance Company and Atlantic States
Insurance Company (as successor-in-interest to Pioneer Insurance Company).
(13) 2002 Annual Report to Stockholders (electronic filing contains only those Filed
portions incorporated by reference into this Form 10-K Report). herewith
(20) Proxy Statement relating to the Annual Meeting of Stockholders to be held (o)
on April 17, 2003; provided, however, that the Report of the Compensation
Committee, the Performance Graph and the Report of the Audit Committee
shall not be deemed filed as part of this Form 10-K Report.
(21) Subsidiaries of Registrant. Filed herewith
(23) Consent of Independent Auditors. Filed herewith
(99.1) Statement of Chief Executive Officer Pursuant to Section 1350 of the Filed herewith
United States Code.
(99.2) Statement of Chief Financial Officer Pursuant to Section 1350 of the Filed herewith
United States Code.
- ------------
(a) Such exhibit is hereby incorporated by reference to the like-described exhibit in
Registrant's Form S-3 Registration Statement No. 333-59828 filed April 30, 2001.
(b) Such exhibit is hereby incorporated by reference to the like-described exhibit in
Registrant's Form 10-K Report for the year ended December 31, 2001.
(c) Such exhibit is hereby incorporated by reference to the like-described exhibit in
Registrant's Form 10-K Report for the year ended December 31, 1998.
(d) Such exhibit is hereby incorporated by reference to the like-described exhibit in
Registrant's Form 10-K Report for the year ended December 31, 2000.
-52-
EXHIBIT NO. DESCRIPTION OF EXHIBITS REFERENCE
----------- ----------------------- ---------
(e) Such exhibit is hereby incorporated by reference to the like-described exhibit in
Registrant's Form S-8 Registration Statement No. 333-62974 filed June 14, 2001.
(f) Such exhibit is hereby incorporated by reference to the like-described exhibit in
Registrant's Form S-2 Registration Statement No. 333-63102 declared effective
February 8, 2002.
(g) Such exhibit is hereby incorporated by reference to the like-described exhibit in
Registrant's Form 10-K Report for the year ended December 31, 1999.
(h) Such exhibit is hereby incorporated by reference to the like-described exhibit in
Registrant's Form 10-K Report for the year ended December 31, 1996.
(i) Such exhibit is hereby incorporated by reference to the like-described exhibit in
Registrant's Form S-1 Registration Statement No. 33-8533 declared effective
October 29, 1986.
(j) Such exhibit is hereby incorporated by reference to the like-described exhibit in
Registrant's Form 10-K Report for the year ended December 31, 1988.
(k) Such exhibit is hereby incorporated by reference to the like-described exhibit in
Registrant's Form 10-K Report for the year ended December 31, 1992.
(l) Such exhibit is hereby incorporated by reference to the like-described exhibit in
Registrant's Form 8-K Report dated December 21, 1995.
(m) Such exhibit is hereby incorporated by reference to the like-described exhibit in
Registrant's Form 8-K Report dated November 17, 1998.
(n) Such exhibit is hereby incorporated by reference to the like-described exhibit in
Registrant's Form 8-K Report dated May 31, 2000.
(o) Such exhibit is hereby incorporated by reference to the Registrant's definitive
proxy statement filed March 24, 2003.
-53-