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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark One)
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT of 1934
For the quarterly period ended September 30, 2003
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, P.O. Box 302, Marietta, PA 17547-0302
(Address of principal executive offices) (Zip code)
(717) 426-1931
(Registrant's telephone number, including area code)
N/A
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether 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 the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date: 6,333,795 shares of
Class A Common Stock, $0.01 par value, and 3,011,049 shares of Class B Common
Stock, $0.01 par value, outstanding on October 30, 2003.
Part 1. Financial Information
Item 1. Financial Statements.
Donegal Group Inc. and Subsidiaries
Consolidated Balance Sheets
September 30, 2003 December 31, 2002
------------------ -----------------
(Unaudited)
Assets
Investments
Fixed maturities
Held to maturity, at amortized cost $ 113,746,157 $ 86,701,556
Available for sale, at market value 178,898,282 194,731,660
Equity securities, available for sale, at market 24,955,565 21,836,460
Short-term investments, at cost, which
approximates market 40,719,827 29,029,418
------------- ------------
Total investments 358,319,831 332,299,094
Cash 4,953,416 1,124,604
Accrued investment income 3,552,475 3,815,449
Premiums receivable 28,618,329 26,286,482
Reinsurance receivable 82,776,225 83,207,272
Deferred policy acquisition costs 16,223,275 14,567,070
Federal income tax receivable 867,226 -
Deferred federal income taxes 7,102,419 6,955,707
Prepaid reinsurance premiums 31,929,612 27,853,996
Property and equipment, net 4,193,920 4,430,394
Accounts receivable - securities - 146,507
Due from affiliate 1,987,655 -
Other 1,073,673 531,589
------------- -------------
Total assets $ 541,598,056 $ 501,218,164
============= =============
Liabilities and Stockholders' Equity
Liabilities
Losses and loss expenses $ 216,652,733 $ 210,691,752
Unearned premiums 135,529,373 121,002,447
Accrued expenses 6,668,348 6,583,825
Reinsurance balances payable 1,395,557 1,100,443
Federal income taxes payable - 357,547
Cash dividend declared to stockholders - 887,315
Borrowings under line of credit 12,800,000 19,800,000
Subordinated debentures 15,000,000 -
Accounts payable - securities 1,000,000 2,121,619
Due to affiliate 4,441,311 4,080,415
Other 1,711,291 1,409,951
----------- -----------
Total liabilities 395,198,613 368,035,314
=========== ===========
Stockholders' Equity
Preferred stock, $1.00 par value, authorized
2,000,000 shares; none issued
Class A common stock, $.01 par value, authorized
30,000,000 shares, issued 6,403,342 and 6,269,093
shares and outstanding 6,321,818 and 6,187,569 shares 64,034 62,691
Class B common stock, $.01 par value, authorized
10,000,000 shares, issued 3,051,811 and 3,024,742
shares and outstanding 3,011,049 and 2,983,980 shares 30,518 30,247
Additional paid-in capital 63,288,003 60,651,751
Accumulated other comprehensive income 5,328,261 4,911,953
Retained earnings 78,580,375 68,417,956
Treasury stock (891,748) (891,748)
------------- -------------
Total stockholders' equity 146,399,443 133,182,850
------------- -------------
Total liabilities and stockholders' equity $ 541,598,056 $ 501,218,164
============= =============
See accompanying notes to consolidated financial statements.
Donegal Group Inc. and Subsidiaries
Consolidated Statements of Income
(Unaudited)
Nine Months Ended September 30,
2003 2002
----- -----
Revenues:
Net premiums earned $ 146,082,154 $ 138,355,520
Investment income, net of investment expenses 10,006,831 11,063,848
Realized investment gains (losses) 494,763 (13,931)
Lease income 628,749 589,660
Service charge income 1,879,643 1,861,169
Other income 205,850 -
------------- ------------
Total revenues 159,297,990 151,856,266
------------- ------------
Expenses:
Net losses and loss expenses 94,268,337 95,857,481
Amortization of deferred policy acquisition costs 22,861,000 22,095,000
Other underwriting expenses 21,531,514 19,812,982
Policy dividends 711,160 851,741
Interest 879,496 870,079
Other expenses 985,478 872,160
------------- -----------
Total expenses 141,236,985 140,359,443
------------- -----------
Income before income taxes 18,061,005 11,496,823
Income taxes 4,946,235 3,121,597
Net income $ 13,114,770 $ 8,375,226
============ ===========
Earnings per common share
Basic $ 1.42 $ 0.92
============ ===========
Diluted $ 1.37 $ 0.91
============ ===========
Consolidated Statements of Comprehensive Income
(Unaudited)
Nine Months Ended September 30,
2003 2002
----- -----
Net income $ 13,114,770 $ 8,375,226
Other comprehensive income, net of tax
Unrealized gains on securities:
Unrealized holding gain during the period,
net of income tax 737,904 2,307,524
Reclassification adjustment, net of income tax (321,596) 9,194
------------- ------------
Other comprehensive income 416,308 2,316,718
------------- ------------
Comprehensive income $ 13,531,078 $ 10,691,944
============= ============
See accompanying notes to consolidated financial statements.
Donegal Group Inc. and Subsidiaries
Consolidated Statements of Income
(Unaudited)
Three Months Ended September 30,
2003 2002
----- -----
Revenues:
Net premiums earned $ 49,719,584 $ 46,792,748
Investment income, net of investment expenses 3,326,603 3,623,262
Realized investment gains (losses) 408,873 (201,190)
Lease income 215,017 200,574
Service charge income 615,676 670,023
------------ ------------
Total revenues 54,285,753 51,085,417
------------ ------------
Expenses:
Net losses and loss expenses 32,759,356 32,423,893
Amortization of deferred policy acquisition costs 7,874,000 7,365,000
Other underwriting expenses 7,239,091 6,511,832
Policy dividends 242,003 280,375
Interest 357,965 249,271
Other expenses 310,250 158,583
------------ ------------
Total expenses 48,782,665 46,988,954
------------ ------------
Income before income taxes 5,503,088 4,096,463
Income taxes 1,501,703 1,080,787
Net income $ 4,001,385 $ 3,015,676
============ ===========
Earnings per common share
Basic $ 0.43 $ 0.33
============ ===========
Diluted $ 0.40 $ 0.33
============ ===========
Consolidated Statements of Comprehensive Income
(Unaudited)
Three Months Ended September 30,
2003 2002
----- -----
Net income $ 4,001,385 $ 3,015,676
Other comprehensive income, net of tax
Unrealized gains on securities:
Unrealized holding gain (loss) during the period,
net of income tax (727,636) 1,846,413
Reclassification adjustment, net of income tax (265,767) 132,785
------------ ------------
Other comprehensive income (loss) (993,403) 1,979,198
------------ ------------
Comprehensive income $ 3,007,982 $ 4,994,874
============ ============
See accompanying notes to consolidated financial statements.
Donegal Group Inc. and Subsidiaries
Consolidated Statement of Stockholders' Equity
(Unaudited)
Nine Months Ended September 30, 2003
Additional Other
Paid-In Comprehensive
Class A Shares Class B Shares Class A Amount Class B Amount Capital Income
---------------------------------------------------------------- -------- -------
Balance, December 31, 2002 6,269,093 3,024,742 $ 62,691 $ 30,247 $ 60,651,751 $ 4,911,953
Issuance of common stock 134,249 27,069 1,343 271 1,487,936
Net income
Cash dividends
Grant of stock options 969,219
Tax benefit on exercise of stock options 179,097
Other comprehensive income 416,308
----------------------------------------------------------------------------------------
Balance, September 30, 2003 6,403,342 3,051,811 $ 64,034 $ 30,518 $ 63,288,003 $ 5,328,261
========================================================================================
Total
Retained Treasury Stockholders'
Earnings Stock Equity
Balance, December 31, 2002 --------- ------ -------
Issuance of common stock $ 68,417,956 $ (891,748) 133,182,850
Net income 1,489,550
Cash dividends 13,114,770 13,114,770
Grant of stock options (1,983,132) (1,983,132)
Tax benefit on exercise of stock options (969,219) -
Other comprehensive income
179,097
Balance, September 30, 2003 416,308
$ 78,580,375 $ (891,748) $146,399,443
See accompanying notes to consolidated financial statements.
Donegal Group Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(Unaudited)
Nine Months Ended September 30,
2003 2002
----- -----
Cash Flows from Operating Activities:
Net income $ 13,114,770 $ 8,375,226
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 1,177,226 898,350
Realized investment (gains) losses (494,763) 13,931
Changes in assets and liabilities:
Losses and loss expenses 5,960,981 17,204,081
Unearned premiums 14,526,926 9,392,067
Premiums receivable (2,331,847) (3,173,917)
Deferred policy acquisition costs (1,656,205) (1,442,805)
Deferred income taxes (442,847) (781,528)
Reinsurance receivable 431,047 (5,450,622)
Prepaid reinsurance premiums (4,075,616) 1,050,029
Accrued investment income 262,974 272,591
Due to affiliate (1,626,759) (1,508,039)
Reinsurance balances payable 295,114 229,633
Current income taxes (1,224,773) 887,019
Accrued expenses 84,523 (802,829)
Other, net (240,744) 357,935
----------- ----------
Net adjustments 10,645,237 17,145,896
----------- ----------
Net cash provided by operating activities 23,760,007 25,521,122
----------- ----------
Cash Flows from Investing Activities:
Purchase of fixed maturities
Held to maturity (47,007,788) (28,117,044)
Available for sale (65,381,246) (50,953,675)
Purchase of equity securities, available for sale (12,217,011) (11,251,602)
Maturity of fixed maturities
Held to maturity 18,692,360 28,917,827
Available for sale 67,426,694 38,528,033
Sale of fixed maturities
Held to maturity - 415,000
Available for sale 13,819,634 461,965
Sale of equity securities, available for sale 9,882,789 9,243,147
Net purchase of property and equipment (254,418) (482,379)
Net purchase of short-term investments (11,690,409) (440,410)
----------- ----------
Net cash used in investing activities (26,729,395) (13,679,138)
----------- ----------
Cash Flows from Financing Activities:
Cash dividends paid (2,870,447) (2,625,006)
Issuance of common stock 1,668,647 1,163,428
Issuance of subordinated debt 15,000,000 -
Line of credit, net (7,000,000) (7,800,000)
----------- ----------
Net cash provided by (used in) financing activities 6,798,200 (9,261,578)
----------- ----------
Net increase in cash 3,828,812 2,580,406
Cash at beginning of period 1,124,604 4,075,288
----------- ----------
Cash at end of period $ 4,953,416 $ 6,655,694
=========== ===========
Cash paid during period - Interest $ 705,515 $ 584,185
Net cash paid during period - Taxes $ 6,430,000 $ 3,390,000
See accompanying notes to consolidated financial statements.
DONEGAL GROUP INC. AND SUBSIDIARIES
(Unaudited)
Summary Notes to Consolidated Financial Statements
1 - Organization
Donegal Group Inc. was organized as a regional insurance holding company
by Donegal Mutual Insurance Company (the "Mutual Company") on August 26, 1986
and operates in the Mid-Atlantic and Southeastern regions through its wholly
owned insurance subsidiaries, Atlantic States Insurance Company ("Atlantic
States") and Southern Insurance Company of Virginia ("Southern") (collectively,
the "Insurance Subsidiaries"). We have three operating segments: the investment
function, the personal lines of insurance and the commercial lines of insurance.
Products offered in the personal lines of insurance consist primarily of
homeowners and private passenger automobile policies. Products offered in the
commercial lines of insurance consist primarily of commercial automobile,
commercial multiple-peril and workers' compensation policies. Our Insurance
Subsidiaries are subject to regulation by Insurance Departments in those states
in which they operate and undergo periodic examinations by those departments.
Our Insurance Subsidiaries are also subject to competition from other insurance
companies in their operating areas. Atlantic States participates in an
inter-company pooling agreement with the Mutual Company and assumes 70% of the
pooled business. At September 30, 2003, the Mutual Company held approximately
65% of our outstanding Class A and approximately 62% of our outstanding Class B
common stock.
Prior to 2002, Southern ceded 50% of its business to the Mutual Company.
On January 1, 2002, the Mutual Company and Southern terminated their quota share
agreement, under which Southern ceded 50% of its direct business, less
reinsurance, to the Mutual Company. As a result of this termination, our prepaid
reinsurance premiums decreased $7,310,471, unearned premiums decreased
$5,117,330 and deferred policy acquisition costs increased $714,853. The Mutual
Company transferred $1,478,288 in cash to us related to this termination. We did
not recognize a gain or loss on this transaction.
As of September 30, 2003, we owned 47.5% of the outstanding stock of
Donegal Financial Services Corporation ("DFSC"), a thrift holding company, which
we acquired for $3,042,000 in cash during 2000 and $3,500,000 of cash in June of
2003. The remaining 52.5% of the outstanding stock of DFSC is owned by the
Mutual Company. DFSC owns Province Bank, a Federal savings bank that began
operations in 2000.
We have streamlined our corporate structure by merging a number of our
subsidiaries. Delaware Atlantic Insurance Company ("Delaware"), Pioneer
Insurance Company, New York, ("Pioneer-New York") and Pioneer Insurance Company,
Ohio ("Pioneer-Ohio"), previously wholly owned subsidiaries, were merged into
Atlantic States on August 1, 2001, September 30, 2001 and May 8, 2002,
respectively. Southern Heritage Insurance Company ("Southern Heritage"),
previously a wholly owned subsidiary, was merged into Southern on April 30,
2002. The mergers were accounted for as reorganizations of entities under common
control as they were all within the consolidated group. The mergers had no
financial impact on the consolidated entity.
Southern has (and Delaware, Pioneer-Ohio, Southern Heritage and
Pioneer-New York had prior to their mergers) an agreement with the Mutual
Company under which it cedes, and then reassumes back, 100% of its business, net
of reinsurance. The primary purpose of these agreements is to assist Southern
and the former subsidiaries in maintaining the same A.M. Best rating (currently
"A" or "Excellent") as the Mutual Company. These agreements do not transfer
insurance risk. While these insurance subsidiaries ceded and reassumed amounts
received from policyholders of $34,914,840 and $36,796,527 and claims of
$20,954,958 and $23,320,493 under these agreements in the nine months ended
September 30, 2003 and 2002, respectively, the amounts are not reflected in the
consolidated financial statements. The aggregate liabilities ceded and reassumed
under these agreements were $44,503,193 and $43,541,766 at September 30, 2003
and December 31, 2002, respectively.
On September 4, 2003, we announced our intention to acquire Le Mars
Insurance Company ("Le Mars") from the Mutual Company. Our acquisition is
subject to the approval of the Insurance Commissioner of Iowa, which we
anticipate receiving in November 2003. We expect the Le Mars acquisition to be
completed on or about January 1, 2004. We will invest approximately $12,500,000
in cash to fund the acquisition of Le Mars.
2 - Basis of Presentation
The financial information for the interim periods included herein is
unaudited; however, such information reflects all adjustments, consisting only
of normal recurring adjustments, that, in the opinion of management, are
necessary to a fair presentation of our financial position, results of
operations and cash flows for the interim periods included herein. Our results
of operations for the nine months ended September 30, 2003 are not necessarily
indicative of our results of operations for the twelve months ending December
31, 2003.
These financial statements should be read in conjunction with the
financial statements and notes thereto contained in our Annual Report on Form
10-K for the year ended December 31, 2002.
3 - Earnings Per Share
The computation of basic and diluted earnings per share is as follows:
Average
Weighted Earnings
Net Shares Per
Income Outstanding Share
Three Months Ended September 30:
2003
Basic $ 4,001,385 9,315,339 $0.43
Effect of stock options --- 590,153 (0.03)
------------------ ---------- ----------
Diluted $ 4,001,385 9,905,492 $0.40
=========== ========= =====
2002
Basic $ 3,015,676 9,098,935 $0.33
Effect of stock options --- 98,998 ---
------------------ ------------ ---------
Diluted $ 3,015,676 9,197,933 $0.33
============ ========= =====
Nine Months Ended September 30:
2003
Basic $13,114,770 9,265,308 $1.42
Effect of stock options --- 325,501 (0.05)
------------------- ---------- ----------
Diluted $13,114,770 9,590,809 $1.37
=========== ========= =====
2002
Basic $ 8,375,226 9,063,109 $0.92
Effect of stock options --- 103,205 (0.01)
------------------ ------------ --------
Diluted $ 8,375,226 9,166,314 $0.91
============ ========= =====
The following options to purchase shares of common stock were not
included in the computation of diluted earnings per share because the exercise
price of the options was greater than the average market price during the
relevant period:
For The Three Months For The Nine Months
Ended September 30, Ended September 30,
2003 2002 2003 2002
Number of shares 5,000 941,501 5,000 941,501
======== ======= ========= ========
4 - Segment Information
We evaluate the performance of the personal lines and commercial lines
based upon underwriting results as determined under statutory accounting
practices (SAP), which is used by management to measure performance for our
total business. Financial data by segment is as follows:
Three Months Ended
September 30,
----------------------------------
--------------- ------------------
2003 2002
---- ----
($ in thousands)
Revenues:
Premiums earned:
Commercial lines $ 18,024 $ 16,473
Personal lines 31,695 30,319
---------- ----------
Total premiums earned 49,719 46,792
---------- ----------
Net investment income 3,327 3,623
Realized investment gains (losses) 409 (201)
Other 831 871
------------ ------------
Total revenues $ 54,286 $ 51,085
========= =========
Income before income taxes:
Underwriting income (loss):
Commercial lines $ 1,967 $ 1,944
Personal lines (985) (1,116)
------------- -----------
SAP underwriting income 982 828
GAAP adjustments 623 (616)
------------ ------------
GAAP underwriting income 1,605 212
Net investment income 3,327 3,623
Realized investment gains (losses) 409 (201)
Other 162 463
------------ ------------
Income before income taxes $ 5,503 $ 4,097
========== ==========
Nine Months Ended
September 30,
----------------------------------
--------------- ------------------
2003 2002
---- ----
($ in thousands)
Revenues:
Premiums earned:
Commercial lines $ 52,667 $ 49,245
Personal lines 93,415 89,110
--------- ----------
Total premiums earned 146,082 138,355
-------- --------
Net investment income 10,007 11,064
Realized investment gains (losses) 495 (14)
Other 2,714 2,451
----------- -----------
Total revenues $159,298 $151,856
======== ========
Income before income taxes:
Underwriting income (loss):
Commercial lines $ 6,222 $ 4,548
Personal lines (794) (5,289)
------------- -----------
SAP underwriting income (loss) 5,428 (741)
GAAP adjustments 1,282 479
------------ ------------
GAAP underwriting income (loss) 6,710 (262)
Net investment income 10,007 11,064
Realized investment gains (losses) 495 (14)
Other 849 709
------------ ------------
Income before income taxes $ 18,061 $ 11,497
========= =========
5- Subordinated Debentures
On May 15, 2003, we received $15.0 million in proceeds from the issuance
of floating rate junior subordinated debentures. The debentures mature on May
15, 2033 and are callable at our option, at par, after five years. The
debentures carry an interest rate equal to the three-month LIBOR rate plus
4.10%, which is adjustable quarterly. At September 30, 2003 the interest rate on
the debentures was 5.23%, and the rate will next be subject to adjustment on
November 15, 2003.
6- Stock-Based Compensation Plans
We account for stock-based compensation plans under the provisions of
Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued
to Employees," and related interpretations. During 2001, we adopted an Equity
Incentive Plan for key employees that made 1,500,000 shares of Class A common
stock available. The plan provides for the granting of awards by the Board of
Directors in the form of stock options, stock appreciation rights, restricted
stock or any combination of the above. During 2001, we also adopted an Equity
Incentive Plan for Directors that made 200,000 shares of Class A common stock
available. Awards may be made in the form of stock options, and the plan
additionally provides for the issuance of 175 shares of restricted stock to each
director on the first business day of January in each year. No stock-based
employee compensation is reflected in income, except for expense associated with
restricted stock issued, as all options granted under those plans had an
exercise price equal to, or greater than, the market value of the underlying
common stock on the date of the grant. The following table illustrates the
effect on net income and earnings per share as if we had applied the provisions
of statement of Financial Accounting Standards (SFAS) No. 123 (as amended by
SFAS No. 148), "Accounting for Stock-Based Compensation."
Three Months Ended Nine Months Ended
September 30, September 30,
2003 2002 2003 2002
-------- -------- -------- --------
(in thousands, except per share data)
Net income, as reported $4,001 $3,016 $13,115 $8,375
Less:
Total stock-based
employee compensation
expense determined
under fair value
based method for
all awards, net of
related tax effects (127) (62) (231) (185)
---- ----- ----- -----
Pro forma net income $ 3,874 $ 2,954 $12,884 $ 8,190
========= ========= ======== ========
Basic earnings
per share:
As reported $ 0.43 $ 0.33 $ 1.42 $ 0.92
Pro forma $ 0.42 $ 0.32 $ 1.39 $ 0.90
Diluted earnings
per share:
As reported $ 0.40 $ 0.33 $ 1.37 $ 0.91
Pro forma $ 0.39 $ 0.32 $ 1.34 $ 0.89
7- Subsequent Events
On October 30, 2003, we announced the signing of an agreement to purchase
all of the outstanding capital stock of the Peninsula Insurance Group
("Peninsula") from Folksamerica Holding Company, Inc., for approximately $23.0
million in cash. Peninsula does business in Maryland, Delaware and Virginia. We
expect this acquisition to be consummated on or about January 1, 2004.
On October 29, 2003, we received $10.0 million in proceeds from the
issuance of floating rate junior subordinated debentures. The debentures mature
on October 29, 2033 and are callable at our option, at par, after five years.
The debentures carry an interest rate equal to the three-month LIBOR rate plus
3.85%, which is adjustable quarterly. The interest rate for the initial period
ending approximately January 29, 2004 is 5.010%.
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations.
Results of Operations -Three Months Ended September 30, 2003 Compared
to Three Months Ended September 30, 2002
Net Premiums Written. Net premiums written for the three months ended
September 30, 2003 were $53.0 million, compared to $48.8 million for the same
period in 2002. Commercial lines net premiums written increased $2.0 million, or
12.1%, in the third quarter of 2003 compared to same period in 2002. Personal
lines net premiums written increased $2.2 million, or 6.8%, in the third quarter
of 2003 compared to same period in 2002. We have benefited during these periods,
and expect to continue to benefit, from premium increases by the insurance
subsidiaries that have resulted from pricing actions approved by regulators.
These increases related primarily to private passenger automobile, commercial
multiple-peril, workers' compensation and homeowners lines of business realized
across most of the states in which we operate. In addition to pricing increases,
we have also benefited from organic growth in most of the states in which we
operate.
Net Premiums Earned. Net premiums earned increased to $49.7 million for
the third quarter of 2003, an increase of $2.9 million, or 6.3%, over the third
quarter of 2002. Earned premiums have grown during the 2003 period due to the
increase in written premiums in the past year. Premiums are earned, or
recognized as revenue, over the terms of our policies, which are one year or
less in duration. Therefore, increases or decreases in net premiums earned will
generally reflect increases or decreases in net premiums written in the
preceding twelve-month period compared to the same period in one year earlier.
Investment Income. For the three months ended September 30, 2003, our
net investment income decreased 8.2% to $3.3 million, compared to $3.6 million
for the same period one year ago. An increase in average invested assets from
$312.3 million in the third quarter of 2002 to $359.9 million in the third
quarter of 2003 was more than offset by a decrease in the annualized average
return on investments from 4.6% for the third quarter of 2002 to 3.7% for the
third quarter of 2003, and accounted for the decrease in investment income in
the 2003 period compared to the 2002 period. The decrease in our annualized
average return during both periods reflects a declining interest rate
environment.
Net Realized Investment Gains/Losses. Net realized investment gains in
the third quarter of 2003 were $408,873, compared to net realized investment
losses of $201,190 for the same period in 2002. No impairment charges were
recognized in the third quarter of 2003, compared to impairment charges of
$226,244 recognized in the third quarter of 2002. The impairment charges for
2002 were the result of declines in the market value of common stocks that we
determined to be other than temporary. The remaining net realized investment
gains and losses in both periods resulted from normal turnover within our
investment portfolio.
Losses and Loss Expenses. Our loss ratio, which is the ratio of
incurred losses and loss expenses to premiums earned, in the third quarter of
2003 was 65.9%, compared to 69.3% in the third quarter of 2002. The commercial
lines loss ratio decreased to 58.9% in the third quarter of 2003, compared to
60.2% in the third quarter of 2002. The personal lines loss ratio also improved
from 72.6% in the third quarter of 2002 to 70.3% in the third quarter of 2003.
Improvements in our 2003 loss ratios reflect the benefits of premium pricing
increases and more favorable prior accident year loss development compared to
the same period in 2002.
Underwriting Expenses. Our expense ratio, which is the ratio of policy
acquisition and other underwriting expenses to premiums earned, for the third
quarter of 2003 was 30.4%, compared to 29.7% for the third quarter of 2002.
Improvements from expense control efforts were offset by higher
underwriting-based incentive costs incurred in the third quarter of 2003
compared to the third quarter of 2002.
Combined Ratio. The combined ratio was 96.8% and 99.5% for the three
months ended September 30, 2003 and 2002, respectively. The combined ratio
represents the sum of the loss ratio, expense ratio and dividend ratio, which is
the ratio of workers' compensation policy dividends incurred to premiums earned.
The improvement in the combined ratio was primarily attributable to the decrease
in the loss ratio for the 2003 period compared to the 2002 period.
Interest Expense. Interest expense for the third quarter of 2003 was
$357,965, compared to $249,271 for the third quarter of 2002, and reflected an
increase in interest expense related to the issuance of $15 million of
subordinated debentures in May 2003, offset by decreases in the average interest
rates and average borrowings under our line of credit for the 2003 period
compared to the 2002 period.
Income Taxes. Income tax expense was $1.5 million for the third quarter
of 2003, representing an effective tax rate of 27.3%, compared to $1.1 million
for the third quarter of 2002, representing an effective tax rate of 26.4%. The
change in effective tax rates is due to tax-exempt interest income representing
a smaller proportion of net income before taxes in the 2003 period compared to
the 2002 period.
Net Income and Earnings Per Share. Our net income for the third quarter
of 2003 was $4.0 million, an increase of 32.7% over the $3.0 million reported
for the third quarter of 2002. Diluted earnings per share were $0.40 for the
third quarter of 2003 compared to $0.33 for the same period last year.
Results of Operations - Nine Months Ended September 30, 2003 Compared
to Nine Months Ended September 30, 2002
Net Premiums Written. During the first nine months of 2003, our net
premiums written increased by 5.2% to $156.5 million, compared to $148.8 million
for the first nine months of 2002. Commercial lines net premiums written
increased $4.5 million, or 8.4%, for the first nine months of 2003 compared to
the first nine months of 2002. Personal lines net premiums written increased
$3.2 million, or 3.4%, for the first nine months of 2003 compared to the same
period in 2002. We have benefited during these periods, and expect to continue
to benefit, from premium increases by our insurance subsidiaries that have
resulted from pricing actions approved by regulators. These increases related
primarily to private passenger automobile, commercial multiple peril, workers'
compensation and homeowners lines of business realized in most of the states in
which we operate. In addition to pricing increases, we have also benefited from
organic growth in most of the states in which we operate.
Net Premiums Earned. Our net premiums earned increased to $146.1
million for the first nine months of 2003, an increase of $7.7 million, or 5.6%,
over the first nine months of 2002. Our net earned premiums during the 2003
period have grown due to the increase in written premiums during the period.
Premiums are earned, or recognized as revenue, over the terms of our policies,
which are one year or less in duration. Therefore, increases or decreases in net
premiums earned will generally reflect increases or decreases in net premiums
written in the preceding twelve-month period compared to the same period in one
year earlier.
Investment Income. For the nine months ended September 30, 2003, our
net investment income decreased 9.6% to $10.0 million, compared to $11.1 million
for the same period one year ago. An increase in our average invested assets
from $310.0 million for the first nine months of 2002 to $345.3 million for the
first nine months of 2003 was more than offset by a decrease in our annualized
average return on investments from 4.8% for the first nine months of 2002 to
3.9% for the first nine months of 2003, and accounted for the decrease in
investment income in the 2003 period compared to the 2002 period. The decrease
in our annualized average return during both periods compared to prior periods
reflects a declining interest rate environment.
Net Realized Investment Gains/Losses. Our net realized investment gains
for the first nine months of 2003 were $494,763, compared to net realized
investment losses of $13,931 for the same period in 2002. Our net realized
investment gains in the first nine months of 2003 were net of impairment charges
of $255,874, compared to impairment charges of $358,574 recognized in the first
nine months of 2002. Our impairment charges for both years were the result of
declines in the market value of common stocks that we determined to be other
than temporary. The remaining net realized investment gains and losses in both
periods resulted from normal turnover within our investment portfolio.
Losses and Loss Expenses. Our loss ratio, which is the ratio of
incurred losses and loss expenses to premiums earned, for the first nine months
of 2003 was 64.5%, compared to 69.3% for the first nine months of 2002. Our
commercial lines loss ratio decreased to 56.2% for the first nine months of
2003, compared to 60.3% for the first nine months of 2002. Our commercial
automobile and workers' compensation loss ratios showed improvement for the
first nine months of 2003, with the commercial automobile loss ratio decreasing
to 54.0% for 2003, compared to 59.8% for the same period in 2002, and the
workers' compensation loss ratio decreasing to 63.2% for 2003, compared to 69.7%
for the same period of 2002. The personal lines loss ratio improved from 73.9%
for the first nine months of 2002 to 69.2% for the first nine months of 2003,
primarily as a result of improvement in the personal automobile loss ratio.
Improvements in our 2003 loss ratios reflect the benefits of premium pricing
increases and more favorable prior accident year loss development compared to
the same period in 2002.
Underwriting Expenses. Our expense ratio, which is the ratio of policy
acquisition and other underwriting expenses to premiums earned, for the first
nine months of 2003 was 30.4%, compared to 30.3% for the first nine months of
2002. Improvements from expense control efforts were offset by higher
underwriting-based incentive costs incurred in the first nine months of 2003
compared to the first nine months of 2002.
Combined Ratio. Our combined ratio was 95.4% and 100.2% for the nine
months ended September 30, 2003 and 2002, respectively. The combined ratio
represents the sum of the loss ratio, expense ratio and dividend ratio, which is
the ratio of workers' compensation policy dividends incurred to premiums earned.
The improvement in our combined ratio was primarily attributable to the decrease
in the loss ratio between periods.
Interest Expense. Our interest expense for the first nine months of
2003 was $879,496, compared to $870,079 for the first nine months of 2002,
reflecting an increase in interest expense related to the issuance of $15.0
million of subordinated debentures in May 2003, offset by decreases in the
average interest rates and average borrowings under our line of credit for the
2003 period compared to the 2002 period.
Income Taxes. Income tax expense was $4.9 million for the first nine
months of 2003, compared to $3.1 million for the first nine months of 2002,
representing effective tax rates of 27.4% and 27.2%, respectively.
Net Income and Earnings Per Share. Our net income for the first nine
months of 2003 was $13.1 million, an increase of 56.6% over the $8.4 million
reported for the first nine months of 2002. Our diluted earnings per share were
$1.37 for the first nine months of 2003 compared to $0.91 for the same period
last year.
Liquidity and Capital Resources
Liquidity is a measure of an entity's ability to secure enough cash to
meet its contractual obligations and operating needs as they arise. Our major
sources of funds from operations are the net cash flows generated from our
insurance subsidiaries' underwriting results, investment income and maturing
investments.
We generate sufficient net positive cash flow from our operations to
fund our commitments and build our investment portfolio, thereby increasing
future investment returns. We maintain a high degree of liquidity in our
investment portfolio in the form of readily marketable fixed maturities, equity
securities and short-term investments. Net cash flows provided by operating
activities in the first nine months of 2003 and 2002 were $23.8 million and
$25.5 million, respectively. Net cash flows provided by operating activities in
2002, 2001 and 2000, were $34.1 million, $22.0 million and $18.5 million,
respectively.
On May 15, 2003, we received $15.0 million in proceeds from the
issuance of subordinated debentures. The debentures mature on May 15, 2033 and
are callable at our option, at par, after five years. The debentures carry an
interest rate equal to the three-month LIBOR rate plus 4.10%, which is
adjustable quarterly. At September 30, 2003, the interest rate on the debentures
was 5.23% and the rate will next be subject to adjustment on November 15, 2003.
We also had unsecured borrowings of $12.8 million as of September 30,
2003 under a credit agreement with Fleet National Bank of Connecticut ("the
Bank"). Per the terms of the credit agreement, we may currently borrow up to
$16.0 million at interest rates equal to the Bank's then current prime rate or
the then current London interbank eurodollar bank rate plus 1.70%. At September
30, 2003, the interest rate on the outstanding balances was 2.825% on an
outstanding eurodollar balance of $4.8 million and 2.84% on an outstanding
eurodollar balance of $8.0 million. In addition, we pay a non-use fee at a rate
of 3/10 of 1% per annum on the average daily unused portion of the Bank's
commitment. Each July 27th, the credit line is reduced by $8.0 million and was
$16.0 million as of September 30, 2003. Any outstanding loan in excess of the
remaining credit line, after such reduction, will then be payable.
We have received a commitment letter from Manufacturers and Traders
Trust Company relating to a $35.0 million line of credit. We anticipate this
financing will be completed by November 30, 2003, at which time we would draw
against the line of credit to repay our existing indebtedness of $12.8 million
to Fleet National Bank. We currently have no other plans to draw against this
line of credit.
On October 29, 2003, DGI Statutory Trust II (the "Trust"), which is a
wholly owned Connecticut statutory trust, issued $10 million aggregate principal
amount of trust preferred securities. The Company owns all of the common
securities of the Trust. The proceeds from the issuance of the common securities
and the trust preferred securities were used by the Trust to purchase $10.31
million of floating rate junior subordinated deferrable interest debentures of
the Company, which pay interest at a floating rate adjustable quarterly equal to
the three-month LIBOR plus 385 basis points. The interest rate for the initial
period ending January 29, 2004 is 5.010%.
The following table shows our significant contractual obligations as of
September 30, 2003.
After
(amounts in thousands) Total 2003 2004 2005 2006 2007 2007
----- ---- ---- ---- ---- ---- ----
Borrowings under line of credit $12,800 $ --- $4,800 $8,000 $ --- $--- $---
Subordinated debentures 15,000 --- --- --- --- --- 15,000
-------- --------- ------- ---------- ------- ---------- --------
Total contractual obligations $27,800 $ --- $4,800 $8,000 $ --- $ --- $15,000
======= ======== ====== ====== ========= ========= =======
Dividends declared to stockholders totaled $3.5 million, $3.5 million
and $3.2 million in 2002, 2001 and 2000, respectively. There are no regulatory
restrictions on the payment of dividends to our stockholders, although there are
state law restrictions on the payment of dividends from our Insurance
Subsidiaries to us. Atlantic States and Southern are required by law to maintain
certain minimum surplus on a statutory basis, and are subject to regulations
under which payment of dividends from statutory surplus is restricted and may
require prior approval of their domiciliary insurance regulatory authorities.
Atlantic States and Southern are subject to risk-based capital (RBC)
requirements. At December 31, 2002, Atlantic States' and Southern's capital were
each substantially above RBC requirements. At January 1, 2003, amounts available
for distribution as dividends to us without prior approval of their domiciliary
insurance regulatory authorities were $10.6 million from Atlantic States and
$2.5 from Southern, and a total of $4.7 million remained available at September
30, 2003.
On September 4, 2003, we announced our intention to acquire Le Mars
from the Mutual Company. We expect the Le Mars acquisition to be completed on or
about January 1, 2004. We will invest approximately $12.5 million in cash to
fund this acquisition.
On October 30, 2003, we announced that we entered into an agreement to
purchase Peninsula from Folksamerica Holding Company, Inc. for approximately
$23.0 million in cash. We expect this acquisition to be consummated on or about
January 1, 2004.
As of September 30, 2003, we had no material commitments for capital
expenditures.
Equity Price Risk
Our portfolio of marketable equity securities, which is carried on the
consolidated balance sheets at estimated fair value, has exposure to the risk of
loss resulting from an adverse change in prices. We manage this risk by
performing an analysis of prospective investments and through regular reviews of
our portfolio by our investment staff.
Credit Risk
Our portfolio of fixed-maturity securities and, to a lesser extent,
short-term investments are subject to credit risk. This risk is defined as the
potential loss in market value resulting from adverse changes in the borrower's
ability to repay the debt. We manage this risk by performing an analysis of
prospective investments and through regular reviews of our portfolio by our
investment staff. We also limit the amount that any one security can constitute
of our total investment portfolio.
We provide property and liability insurance coverages through
independent insurance agencies located throughout our operating area. The
majority of this business is billed directly to the insured, although a portion
of our commercial business is billed through our agents who are extended credit
in the normal course of business.
Because the pooling agreement does not relieve Atlantic States of
primary liability as the originating insurer, we are subject to a concentration
of credit risk arising from business ceded to the Mutual Company. Our insurance
subsidiaries maintain reinsurance agreements in place with the Mutual Company
and with a number of other major unaffiliated authorized reinsurers.
Impact of Inflation
Property and casualty insurance premium rates are established before
the amount of losses and loss settlement expenses, or the extent to which
inflation may impact such expenses, are known. Consequently, we attempt, in
establishing rates, to anticipate the potential impact of inflation.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Our market risk generally represents the risk of gain or loss that may
result from the potential change in the fair value of our investment portfolio
as a result of fluctuations in prices and interest rates and, to a lesser
extent, our debt obligations. We attempt to manage our interest rate risk by
maintaining an appropriate relationship between the average duration of the
investment portfolio and the approximate duration of our liabilities, i.e.,
policy claims and debt obligations.
We have maintained approximately the same duration of our investment
portfolio to our liabilities from December 31, 2002 to September 30, 2003. In
addition, we have maintained approximately the same investment mix during this
period.
There have been no material changes to our quantitative or qualitative
market risk exposure from December 31, 2002 through September 30, 2003.
Item 4. Control and Procedures
We carried out an evaluation, under the supervision and with the
participation of our management, including our Chief Executive Officer and Chief
Financial Officer, of the effectiveness of our controls and procedures pursuant
to Rule 13a-15 under the Securities Exchange Act of 1934, as amended, as of the
end of the period covered by this report. Based upon that evaluation, our Chief
Executive Officer and Chief Financial Officer concluded that the our disclosure
controls and procedures are effective to ensure that information required to be
disclosed by us (including our consolidated subsidiaries) in our periodic
filings with the Securities and Exchange Commission is recorded, processed,
summarized and reported, within the time periods specified in the Commission's
rules and forms. There has been no change in our internal control over financial
reporting during the quarter covered by this report that has materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting.
Part II. Other Information
Item 1.Legal Proceedings.
None.
Item 2.Changes in Securities and Use of Proceeds.
None.
Item 3.Defaults upon Senior Securities.
None.
Item 4.Submission of Matters to a Vote of Security Holders.
None.
Item 5. Other Information.
None.
Item 6.Exhibits and Reports on Form 8-K.
(a) Exhibits
Exhibit No. Description
Exhibit 31.1 Certification of Chief Executive Officer
Exhibit 31.2 Certification of Chief Financial Officer
Exhibit 32.1 Statement of Chief Executive Officer
pursuant to 18 U.S.C. Section 1350 of
Title 18 of the United States Code
Exhibit 32.2 Statement of Chief Financial Officer
pursuant to 18 U.S.C. Section 1350 of
Title 18 of the United States Code
(b) Reports on Form 8-K:
On July 22, 2003, we filed a report on Form 8-K including
as an exhibit our second quarter 2003 earnings press
release.
On September 4, 2003, we filed a report of Form 8-K
including as an exhibit our press release related to our
agreement to acquire Le Mars Mutual Insurance Company.
On September 26, 2003, we filed a report of Form 8-K
including as an exhibit our press release related to the
financial impact of Hurricane Isabel.
On October 17, 2003, we filed a report on Form 8-K
including as an exhibit our third quarter 2003 earnings
press release.
Signatures
Pursuant to the requirements 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.
October 31, 2003 By: /s/ Donald H. Nikolaus
-----------------------
Donald H. Nikolaus, President
and Chief Executive Officer
October 31, 2003 By: /s/ Ralph G. Spontak
-------------------------
Ralph G. Spontak, Senior Vice President,
Chief Financial Officer and Secretary