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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, 1998
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
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DONEGAL GROUP INC.
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(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: (717) 426-1931
Securities registered pursuant to Section 12(b) of the Act: None.
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $1.00 par value
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(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. [ ]
On March 15, 1999, the aggregate market value (based on the closing sales price
on that date) of the voting stock held by non-affiliates of the Registrant was
$43,493,338.
Indicate the number of shares outstanding of each of the Registrant's classes of
common stock, as of the latest practicable date: 8,248,731 shares of Common
Stock outstanding on March 15, 1999.
DOCUMENTS INCORPORATED BY REFERENCE:
1. Portions of the Registrant's annual report to stockholders for the fiscal
year ended December 31, 1998 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 15, 1999 are incorporated by reference
into Part III of this report.
<PAGE>
DONEGAL GROUP INC.
INDEX TO FORM 10-K REPORT
Page
----
I. PART I.
Item 1. Business 1
Item 2. Properties 22
Item 3. Legal Proceedings 22
Item 4. Submission of Matters to a Vote of
Security Holders 22
Executive Officers of the Company 22
II. PART II.
Item 5. Market for Registrant's Common Equity and
Related Stockholder Matters 24
Item 6. Selected Financial Data 24
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations 24
Item 8. Financial Statements and Supplementary Data 24
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure 24
III. PART III.
Item 10. Directors and Executive Officers of the
Registrant 25
Item 11. Executive Compensation 25
Item 12. Security Ownership of Certain Beneficial
Owners and Management 25
Item 13. Certain Relationships and Related
Transactions 25
IV. PART IV.
Item 14. Exhibits, Financial Statement Schedules
and Reports on Form 8-K 26
(i)
<PAGE>
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 19 mid-Atlantic
and southeastern states. As used herein, "DGI" or the "Company" refers to
Donegal Group Inc. and its insurance subsidiaries, Atlantic States Insurance
Company ("Atlantic States"), Southern Insurance Company of Virginia
("Southern"), Delaware Atlantic Insurance Company ("Delaware Atlantic"), Pioneer
Insurance Company ("Pioneer") and Southern Heritage Insurance Company ("Southern
Heritage"). DGI is currently 60% owned by Donegal Mutual Insurance Company (the
"Mutual 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:
<TABLE>
<CAPTION>
Net Net Premiums
Premiums Written Year
Written Year Ended
Year Prior to December 31,
Company Acquired Acquired Acquisition 1998
- ---------------- -------- ----------- ----
<S> <C> <C> <C>
Southern Insurance Company of Virginia 1988 $1,128,843 12,836,852
Delaware Atlantic Insurance Company 1995 2,824,398 3,795,928
Pioneer Insurance Company 1997 4,499,273 3,188,476
Southern Heritage Insurance Company 1998 32,002,540 27,856,117
</TABLE>
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.
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 adjustment 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. Pursuant to
amendments to the
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pooling agreement subsequent to October 1, 1986, the Mutual Company, which is
solely responsible for any losses in the pooled business with dates of loss on
or before the close of business on September 30, 1986, has increased the
percentage of retrocessions of the pooled business to Atlantic States. Since
January 1, 1996, 65% of the pooled business has been retroceded to Atlantic
States. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations" included in Item 7 hereof and Note 3 to the Consolidated
Financial Statements incorporated by reference herein.
On December 29, 1988, DGI acquired all of the outstanding capital
stock of Southern in exchange for a $3,000,000 equity contribution to Southern.
Since January 1, 1991, Southern has ceded to the Mutual Company 50% of its
direct premiums written and 50% has been retained by Southern. Because the
Mutual Company places substantially all of the business assumed from Southern in
the pool, in which DGI has a 65% allocation, DGI's results of operations include
approximately 80% of the business written by Southern. See Note 3 to the
Consolidated Financial Statements incorporated by reference herein.
As of December 31, 1995, the Company acquired all of the outstanding
capital stock of Delaware Atlantic pursuant to a Stock Purchase Agreement dated
as of December 21, 1995 between the Company and the Mutual Company. As part of
this transaction, the Mutual Company entered into an aggregate excess of loss
reinsurance agreement with Delaware Atlantic for a specified period. This
reinsurance agreement did not result in any additional payment from the Mutual
Company to Delaware Atlantic.
Effective July 1, 1996, the Mutual Company entered into retrocessional
reinsurance agreements with each of Southern, Delaware Atlantic and Pioneer
(individually, an "Affiliate"), whereby the Mutual Company agreed to reinsure
each Affiliate in respect of 100% of the net liability that may accrue to such
Affiliate from its insurance operations and retrocede 100% of the net liability
back to each Affiliate, which the Affiliate assumes.
As of March 31, 1997, the Company acquired all of the outstanding
capital stock of Pioneer pursuant to a stock purchase agreement dated as of
April 7, 1997 between the Company and the Mutual Company. As part of this
transaction, the Mutual Company entered into an aggregate excess of loss
reinsurance agreement with Pioneer whereby the Mutual Company assumed the risk
of any loss from an adverse development in Pioneer's loss and loss adjustment
expense reserve at the end of 1996 compared to the end of 1998 by reason of the
fact that Pioneer's loss and loss adjustment expense ratio for those periods
exceeded the lesser of the loss and loss expense ratios of immediately preceding
periods or 60%. This reinsurance agreement resulted in additional payments of
$306,400 from the Mutual Company to Pioneer in 1998.
On November 17, 1998, DGI purchased all of the outstanding capital
stock of Southern Heritage, a Georgia-domiciled property and casualty insurance
company, from Southern Heritage Limited Partnership for a purchase price of
$18,361,279 in cash. The purchase price is subject to adjustment based upon the
final determination of certain account balances of
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<PAGE>
Southern Heritage as of October 31, 1998 and the resolution of certain breach of
representation and warranty claims that DGI has asserted against Southern
Heritage Limited Partnership.
Unless otherwise stated, all information in this report gives
retroactive effect to: (i) the four-for-three split of the Company's Common
Stock effected through a stock dividend of one share of Common Stock for each
three shares outstanding, which was paid on July 15, 1997 to stockholders of
record on June 25, 1997, and (ii) the four-for-three split of the Company's
Common Stock effected through a stock dividend of one share of Common Stock for
each three shares outstanding, which was paid on June 25, 1998 to stockholders
of record on June 10, 1998.
(b) Financial Information about Industry Segments.
The Company has three segments, which consist of the investment
function, the personal lines of insurance and the 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 operations are interrelated with the operations of the Mutual
Company and, because of the percentage of the pooled business assumed by DGI,
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 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. The Mutual Company owned 60% of DGI as of March 15, 1999.
Through the pool, DGI writes personal and commercial property and
casualty insurance lines, including automobile, homeowners, commercial
multi-peril, workers' compensation and other lines of business. The insurance
agencies under contract with the Mutual Company serve as representatives for the
pool participants.
Under the terms of the intercompany pooling agreement, which took
effect on October 1, 1986, Atlantic States cedes to the Mutual Company the
premiums, losses and loss expenses on all of its insurance business.
Substantially all of the Mutual Company's property and casualty insurance
business, including the business reinsured from Southern, written or in force on
or after October 1, 1986, is also included in the pooled business. Pursuant to
amendments to the pooling agreement subsequent to October 1, 1986, the Mutual
Company, which is solely responsible for any losses in the pooled business with
dates of loss on or before the close of business on September 30, 1986, has
increased the percentage of retrocessions of the pooled business to Atlantic
States. Since January 1, 1996, 65% of the pooled business has been retroceded to
Atlantic States. All premiums, losses, loss expenses, other underwriting
expenses and policy
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dividends 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. The Company does not intend to
terminate its participation in the pooling agreement. 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 and
expectations of future relative amounts of capital and surplus. The pooling
agreement does not legally discharge Atlantic States from its primary liability
for the full amount of the policies ceded. However, it makes the Mutual Company
liable to Atlantic States to the extent of the business ceded.
All of DGI's officers are officers of the Mutual Company, and five of
DGI's seven directors are directors of the Mutual Company. A Coordinating
Committee, which consists of two outside directors from each of DGI and the
Mutual Company, none of whom holds seats on the Boards of Directors of both DGI
and the Mutual Company, reviews and approves changes in the pooling agreement
and is responsible for matters involving actual or potential conflicts of
interest. The decisions of the Coordinating Committee are binding on the two
companies. DGI's members must conclude that intercompany transactions are fair
and reasonable in order for such transactions to be approved.
The underwriting pool is intended to produce a more uniform and stable
underwriting result from year to year for the companies 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 have their own capital and surplus.
In addition to the underwriting pool, through the retrocessional
reinsurance agreements with each of Southern, Delaware Atlantic and Pioneer, the
Mutual Company reinsures each Affiliate in respect of 100% of the net liability
that may accrue to such Affiliate from its insurance operations and the Mutual
Company retrocedes 100% of the net liability back to each Affiliate, which the
Affiliate assumes as part of the retrocession.
DGI's Business Strategy
DGI, in conjunction with the Mutual Company, has multiple strategies
which 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.
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<PAGE>
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 additional
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 historical results.
o A goal of expanding operations in current and adjacent states.
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, 1998, 1997 and 1996:
Year Ended December 31,
---------------------------
1998 1997 1996
---- ---- ----
Net Premiums Written:
Commercial.................... 38.2% 41.0% 44.3%
Personal...................... 61.8% 59.0% 55.7%
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.
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<PAGE>
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 generally accepted accounting principles and statutory
accounting principles prescribed or permitted by state insurance authorities.
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,
---------------------------
1998 1997 1996
---- ---- ----
GAAP combined ratio ..................... 99.8% 97.6% 100.4%
Statutory operating ratios:
Loss ratio ......................... 64.0 64.0 68.4
Expense ratio ...................... 35.4 34.0 31.1
Dividend ratio ..................... 1.4 1.2 1.5
Statutory combined ratio ................ 100.8% 99.2% 101.0%
===== ===== =====
Industry statutory combined ratio(1) .... 105.6% 101.6% 107.0%
===== ===== =====
- ----------
(1) Source: A.M. Best Co.
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
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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 1998, the Company received an
assessment from the Pennsylvania Insurance Guaranty Association totaling $1.3
million relating to the insolvency of two medical malpractice insurers. The
impact of these involuntary programs on DGI were not material during 1996 and
1997.
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,
--------------------------------
1998 1997 1996
---- ---- ----
(dollars in thousands)
Net Premiums Written:
Commercial:
Automobile ........................... $ 11,120 $ 10,522 $ 10,149
Workers' compensation ............... 15,446 15,590 17,998
Commercial multi-peril ............... 17,046 16,357 17,153
Other ................................ 1,473 1,612 3,127
-------- -------- --------
Total commercial ................... 45,085 44,081 48,427
-------- -------- --------
Personal:
Automobile ........................... 46,609 38,989 37,739
Homeowners ........................... 21,737 19,939 18,979
Other ................................ 4,724 4,597 4,070
-------- -------- --------
Total personal ..................... 73,070 63,525 60,788
-------- -------- --------
Total business ......................... $118,155 $107,606 $109,215
======== ======== ========
Statutory Combined Ratios:
Commercial:
Automobile ........................... 118.2% 89.9% 97.6%
Workers compensation ................. 80.4 89.5 67.2
Commercial multi-peril ............... 85.6 103.0 106.4
Other ................................ 71.1 57.7 42.8
----- ---- ----
Total commercial ................... 91.3 93.5 86.5
----- ---- ----
Personal:
Automobile ........................... 104.2 98.7 100.7
Homeowners ........................... 115.7 116.4 139.1
Other ................................ 91.2 87.6 109.6
----- ----- -----
Total personal ..................... 106.7 103.4 112.7
----- ----- -----
Total business .................. 100.8% 99.2% 101.0%
===== ===== =====
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<PAGE>
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 agents
to insure a comprehensive knowledge on the part of the agents of DGI's
underwriting requirements and risk selection process.
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.
Marketing
DGI's insurance products, together with the products of the Mutual
Company and their respective subsidiaries, are marketed through approximately
3,300 independent insurance agents associated with approximately 1,200 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 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 Plan have enhanced the ability of DGI and
the Mutual Company to write profitable business.
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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, which have become increasingly competitive in the past several years.
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 territories 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
$25,000 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.
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<PAGE>
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 year in which the changes 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, 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 expenses 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 in
non-material amounts, and further adjustments could be required in the future.
However, 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 generally accepted accounting principles and financial
statements prepared on a statutory accounting basis result from reducing
statutory liabilities for anticipated salvage and subrogation recoveries. These
differences amounted to $7,963,559, $6,155,467 and $5,170,486 at December 31,
1998, 1997 and 1996, respectively.
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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,
-----------------------------
1998 1997 1996
---- ---- ----
(in thousands)
Net liability for unpaid losses
and loss expenses at
beginning of year ........................ $77,474 $75,428 $71,155
Net liabilities of acquired company ........ 14,967 -- --
------- ------- -------
Net beginning balance as adjusted .......... $92,441 $75,428 $71,155
Provision for net losses and
loss expenses for claims
incurred in the current year ............. 75,463 69,040 73,212
Decrease in provision for estimated
net losses and loss expenses for
claims incurred in prior years ........... (2,296) (1,384) (2,791)
------- ------- -------
Total incurred ............................. 73,167 67,656 70,421
Net losses and loss payments
for claims incurred during:
The current year ........................... 44,389 39,133 42,669
Prior years ................................ 27,356 26,477 23,479
------- ------- -------
Total paid ................................. 71,745 65,610 66,148
Net liability for unpaid losses
and loss expenses at
end of year .............................. $93,863 $77,474 $75,428
======= ======= =======
The following table sets forth the development of the liability for
net unpaid losses and loss expenses for DGI on a GAAP basis from 1988 to 1998,
with supplemental loss data for 1998 and 1997.
"Net liability at end of year for unpaid losses and loss expenses"
sets forth the estimated liability for net unpaid losses and loss expenses
recorded at the balance sheet date for each of the indicated years. This
liability represents the estimated amount of net losses and loss expenses for
claims arising in the current and all prior years that are unpaid at the balance
sheet date including losses incurred but not reported.
The "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
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the severity of the remaining unpaid claims. For example, the 1990 liability has
developed an excess after eight years, in that reestimated net losses and loss
expenses are expected to be less than the estimated liability initially
established in 1990 of $31,898 by $2,723.
The "Cumulative deficiency (excess)" shows the cumulative deficiency
or excess at December 31, 1998 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 means
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
1990 column indicates that as of December 31, 1998 payments equal to $28,841 of
the currently reestimated ultimate liability for net losses and loss expenses of
$29,175 had been made.
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<TABLE>
<CAPTION>
Year Ended December 31
--------------------------------------------------------------------------------------------------
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998
---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ----
(in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net liability at end of
year for unpaid losses
and loss expenses ........... $20,734 $27,767 $31,898 $36,194 $44,339 $ 52,790 $ 63,317 $71,155 $75,428 $77,474 $93,863
Net liability
reestimated as of:
One year later ............. 21,598 29,175 32,923 37,514 45,408 50,583 60,227 68,348 74,044 75,178
Two years later ............ 20,475 28,861 33,550 37,765 42,752 48,132 56,656 66,520 70,545
Three years later .......... 19,823 28,545 32,803 35,446 40,693 44,956 54,571 63,187
Four years later ........... 19,296 27,717 31,004 33,931 38,375 42,157 51,825
Five years later ........... 18,796 26,759 30,041 32,907 37,096 41,050
Six years later ............ 18,457 26,180 29,595 32,234 36,682
Seven years later .......... 18,189 25,971 29,417 31,976
Eight years later .......... 18,117 25,828 29,175
Nine years later ........... 18,050 25,904
Ten years later ............ 18,015
Cumulative deficiency
(excess) ................... $(2,719) $(1,863) $(2,723) $(4,218) $(7,657) $(11,740) $(11,492) $(7,968) $(4,883) $(2,296)
======= ======= ======= ======= ======= ======== ======== ======= ======= =======
Cumulative amount of
liability paid through:
One year later ............. $ 8,855 $11,401 $13,003 $13,519 $16,579 $ 16,126 $ 19,401 $23,479 $26,477 $27,356
Two years later ............ 12,280 17,421 19,795 20,942 24,546 25,393 30,354 37,078 40,384
Three years later .......... 14,912 20,986 24,178 25,308 29,385 32,079 38,684 45,796
Four years later ........... 16,292 23,268 26,413 27,826 32,925 36,726 43,655
Five years later ........... 17,201 24,331 27,439 29,605 34,757 39,122
Six years later ............ 17,706 24,909 28,157 30,719 35,739
Seven years later .......... 17,782 25,280 28,627 31,173
Eight years later .......... 17,884 25,599 28,841
Nine years later ........... 17,986 25,695
Ten years later ............ 17,980
<CAPTION>
Year Ended December 31
-----------------------------------------------------------
1992 1993 1994 1995 1996 1997 1998
---- ---- ---- ---- ---- ---- ----
(in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Gross liability at end of year ................................... $57,777 $70,093 $88,484 $98,894 $114,622 $118,112 $141,409
Reinsurance recoverable .......................................... 13,438 17,303 25,167 27,739 39,194 40,638 47,546
Net liability at end of year ..................................... 44,339 52,790 63,317 71,155 75,428 77,474 93,863
Gross reestimated liability -- latest ............................ 58,733 56,969 76,260 89,706 109,735 118,309
Reestimated recoverable -- latest ................................ 22,051 15,919 24,435 26,519 39,190 43,131
Net reestimated liability -- latest .............................. 36,682 41,050 51,825 63,187 70,545 75,178
Gross cumulative deficiency (excess) ............................. 956 (13,124) (12,224) (9,188) (4,887) 197
</TABLE>
-13-
<PAGE>
Reinsurance
DGI and the Mutual Company use several different reinsurers,
all of which have a Best rating of A- 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 ($250,000 for 1998), and "catastrophic
reinsurance," under which the reinsured recovers 95% of an accumulation of many
losses resulting from a single event, including natural disasters (for 1998,
$3,000,000 retention). DGI's principal reinsurance agreement in 1998, other than
that with the Mutual Company, was an excess of loss treaty in which the
reinsurers were Continental Casualty Company, Employers Reinsurance Corporation
and Dorinco Reinsurance Company. 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 $70,000,000 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 65% of the Mutual
Company's total pooled insurance business, including that assumed from Atlantic
States and substantially all of the business assumed and retained by the Mutual
Company from Southern and Delaware Atlantic. Atlantic States, Southern, Delaware
Atlantic and Pioneer each have a catastrophe reinsurance agreement with the
Mutual Company which limits the maximum liability under any one catastrophic
occurrence to $400,000, $300,000, $300,000 and $200,000, respectively, and
$700,000 for a catastrophe involving more than one of the companies. The Mutual
Company and Delaware Atlantic have an excess of loss reinsurance agreement in
which the Mutual Company assumes up to $200,000 of losses in excess of $50,000
and a workers' compensation quota share agreement whereby Delaware Atlantic
cedes 70% of that business. The Mutual Company and Pioneer have an excess of
loss reinsurance agreement in which the Mutual Company assumes up to $200,000 of
losses in excess of $50,000. The Mutual Company and Pioneer also have an
aggregate excess of loss reinsurance agreement, entered into as part of the sale
of Pioneer from the Mutual Company to the Company, in which the Mutual Company
agrees to assume the adverse loss development of claims with dates of loss prior
to December 31, 1996, as developed through December 31, 1998, and to assume
losses in excess of a 60% loss ratio through December 31, 1998. The Mutual
Company and Southern have an excess of loss reinsurance agreement in which the
Mutual Company assumes up to $25,000 of losses in excess of $100,000 and a quota
share agreement whereby Southern cedes 50% of its direct business less certain
reinsurance to the Mutual Company. Southern, Delaware Atlantic and Pioneer each
have retrocessional reinsurance agreements effective July 1, 1996 with the
Mutual Company, under which they cede, and then assume back, 100% of their
business net of other reinsurance.
-14-
<PAGE>
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.
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, 1998, all debt securities were rated
investment grade with the exception of one unrated obligation of $10,000, 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, 1998:
December 31, 1998
-----------------------
Rating(1) Amount Percent
- --------- ------ -------
(dollars in thousands)
U.S. Treasury and U.S. agency
agency securities(2) ...................... $104,188 47.8%
Aaa or AAA .................................. 61,786 28.4
Aa or AA .................................... 36,486 16.8
A ........................................... 15,138 7.0
BBB.......................................... 102 --
Not rated(3) ................................ 10 --
-------- ---
Total ..................................... $217,710 100%
======== ===
- ----------
(1) Ratings assigned by Moody's Investors Services, Inc. or Standard & Poor's
Corporation.
(2) Includes mortgage-backed securities of $22,563.
(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.
-15-
<PAGE>
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 34.1%, 34.3% and 36.4% of the total investment portfolio at
December 31, 1998, 1997 and 1996, respectively.
16
<PAGE>
The following table shows the classification of the investments (at
carrying value) of DGI and its subsidiaries at December 31, 1998, 1997 and 1996.
<TABLE>
<CAPTION>
December 31,
--------------------------------------------------------
1998 1997 1996
---------------- ----------------- ------------------
Percent Percent Percent
of of of
Amount Total Amount Total Amount Total
------ ----- ------- ----- ------ -----
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Fixed maturities(1):
Held to maturity:
U.S. Treasury
securities and
obligations of
U.S. government
corporations
and agencies .......... $ 32,891 12.9% $ 41,450 20.2% $38,64 20.1%
Obligations of
states and
political
subdivisions .......... 66,941 26.2 57,621 28.1 57,095 29.6
Corporate
securities.............. 9,131 3.6 7,250 3.5 5,917 3.1
Mortgage-backed
securities.............. 18,221 7.1 10,925 5.4 12,680 6.6
-------- ----- -------- ----- -------- -----
Total held to
maturity ............... 127,184 49.8 117,246 57.2 114,339 59.4
-------- ----- -------- ----- -------- -----
Available for sale:
U.S. treasury
securities and
obligations of U.S.
government
corporations
and agencies ........... 55,439 21.8 40,197 19.6 35,507 18.4
Obligations of states
and political
subdivisions ........... 19,957 7.8 12,762 6.2 12,987 6.8
Corporate securities .... 10,787 4.2 3,252 1.6 3,436 1.8
Mortgage-backed
securities ............. 4,342 1.7 1,520 0.8 1,606 0.8
-------- ----- -------- ----- -------- -----
Total available
for sale ............... 90,525 35.5 57,731 28.2 53,536 27.8
-------- ----- -------- ----- -------- -----
Total fixed
maturities ............. 217,709 85.3 174,977 85.4 167,875 87.2
Equity securities(2) .... 6,764 2.7 7,275 3.5 3,143 1.6
Short-term investments(3) 30,522 12.0 22,713 11.1 21,471 11.2
-------- ----- -------- ----- -------- -----
Total investments ....... $254,995 100.0% $204,965 100.0% $192,489 100.0%
======== ===== ======== ===== ======== =====
</TABLE>
17
<PAGE>
(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 4 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 $131,633,299 at December 31, 1998,
$120,882,886 at December 31, 1997 and $116,264,317 at December 31, 1996.
The amortized cost of fixed maturities available for sale was $89,089,995
at December 31, 1998, $56,922,342 at December 31, 1997 and $53,264,748 at
December 31, 1996.
(2) Equity securities are valued at fair value. Total cost of equity securities
was $6,206,735 at December 31, 1998, $6,551,020 at December 31, 1997 and
$2,774,946 at December 31, 1996.
(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, 1998,
December 31, 1997 and December 31, 1996.
<TABLE>
<CAPTION>
December 31,
---------------------------------------------------------------
1998 1997 1996
---------------- ---------------- ------------------
Percent Percent Percent
of of of
Amount Total Amount Total Amount Total
------ ----- ------- ----- ------ -----
(dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Due in:(1)
One year or less .................. $ 47,760 19.2% $ 36,013 18.2% $ 34,836 18.4%
Over one year
through three years ............. 31,964 12.9 30,910 15.6 26,392 13.9
Over three years
through five years .............. 23,139 9.3 20,303 10.3 21,163 11.2
Over five years
through ten years ............... 78,061 31.4 65,122 32.9 45,370 24.0
Over ten years
through ffiteen years ........... 37,940 15.3 32,384 16.4 46,248 24.4
Over fifteen years ................ 6,805 2.8 513 0.3 1,051 0.6
Mortgage-backed
securities ...................... 22,563 9.1 12,445 6.3 14,286 7.5
-------- ----- -------- ---- -------- -----
$248,232 100.0% $197,690 100.0% $189,346 100.0%
======== ===== ======== ===== ======== =====
</TABLE>
- ----------
(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 $22,563 at December 31, 1998. Included in
these investments are
18
<PAGE>
collateralized mortgage obligations ("CMOs") with a carrying value of $22,287 at
December 31, 1998. The Company has attempted to reduce the prepayment risks
associated with mortgage-backed securities by investing approximately 99%, as of
December 31, 1998, 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 lower current interest rates 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, 1998, 1997 and 1996 are shown in the following table:
Year Ended December 31,
-----------------------------
1998 1997 1996
---- ---- ----
(dollars in thousands)
Invested assets(1)............. $208,304 $202,283 $183,401
Investment income(2)........... 11,998 11,507 10,799
Average yield.................. 5.6% 5.7% 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
In 1998, the A.M. Best rating of the Mutual Company, Atlantic States,
Southern, Delaware Atlantic and Pioneer was "A", based upon their respective
current financial conditions and historical statutory results of operations.
Southern Heritage, which DGI acquired in November 1998, currently has a Best
rating of B++. Management believes that this Best rating is an important factor
in marketing DGI's products to its agents and customers. 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. 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). Best's
ratings are based upon factors relevant to policyholders and are not directed
toward the protection of investors. According to Best, an "excellent" rating is
assigned to those companies which, in 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
<PAGE>
Regulation
Insurance companies are subject to supervision and regulation in the
states in which they transact business. Such supervision and regulation relates
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 which 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, in
December 1993 the National Association of Insurance Commissioners (the "NAIC")
adopted 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, 1998, DGI's
insurance subsidiaries 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 and
Delaware), the Mutual Company (Pennsylvania, Ohio, Maryland, New York, Virginia,
Delaware and North Carolina), Southern (Virginia and Pennsylvania), Delaware
Atlantic (Delaware, Maryland and Pennsylvania), Pioneer (Ohio and Pennsylvania)
and Southern Heritage (Alabama, Arkansas, Florida, Georgia, Illinois, Kentucky,
Louisiana, Mississippi, North Carolina, South Carolina, Tennessee and Virginia)
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. The Mutual Company,
Atlantic States, Southern, Delaware Atlantic, Pioneer and Southern Heritage have
made accruals for their portion of assessments related to such insolvencies
based upon the most current information furnished by the guaranty associations.
During 1998, the Company received an assessment from the Pennsylvania Insurance
Guaranty Association totaling $1.3 million relating to the insolvency of two
medical malpractice insurers. For 1996 and 1997, assessments paid by the Company
were not material.
The property and casualty insurance industry has recently received a
considerable amount of publicity because of rising insurance costs and the
unavailability of insurance. New regulations and legislation are being proposed
to limit damage awards, to control plaintiffs' counsel fees, to bring the
industry under regulation by the federal government and to control premiums,
policy terminations and other policy terms. It is not possible to predict
whether, in what form or in what jurisdictions any of these proposals might be
adopted or the effect thereof, if any, on the Company.
20
<PAGE>
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
Company and their respective 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 October 1998, the
Pennsylvania Insurance Department has approved the Mutual Company's ownership of
up to 65% of the outstanding 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, 1998, amounts available for payment of dividends in 1999 without
the prior approval of the various insurance commissioners were $6,480,524 from
Atlantic States, $638,832 from Southern, $1,085,807 from Delaware Atlantic,
$530,035 from Pioneer and $1,580,564 from Southern Heritage. See Note 12 to the
Consolidated Financial Statements incorporated by reference herein.
The Mutual Company
The Mutual Company, which was organized in 1889, has a Best rating of
A (Excellent). At December 31, 1998, the Mutual Company had admitted assets of
$182,704,688 and policyholders' surplus of $98,549,558. At December 31, 1998,
the Mutual Company had no debt and, of its total liabilities of $84,155,130,
reserves for net losses and loss expenses accounted for $46,442,067 and unearned
premiums accounted for $23 million. Of the Mutual Company's investment portfolio
of $137,594,316 at December 31, 1998, investment-grade bonds accounted for
$40,356,021, cash and short-term investments accounted for $2 million and
mortgages accounted for $7,940,878. At December 31, 1998, the Mutual Company
owned 4,918,364 shares of the Company's Common Stock, which were carried on the
Mutual Company's books at $76,849,434. The foregoing financial information is
presented on the statutory basis of accounting.
21
<PAGE>
Employees
As of December 31, 1998, the Mutual Company had 372 employees. The
Mutual Company's employees provide a variety of services to DGI, Atlantic
States, Delaware Atlantic, Southern, Pioneer and Southern Heritage as well as to
the Mutual Company and its subsidiaries. As of December 31, 1998, Southern
Heritage had 69 employees.
Item 2. Properties.
DGI shares headquarters with the Mutual Company 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 163,500 square feet of office space. Southern
has a facility of approximately 10,000 square feet in Glen Allen, Virginia,
which it owns. Delaware Atlantic has a facility of approximately 3,000 square
feet in Wilmington, Delaware, which it leases. Pioneer has a facility of
approximately 10,000 square feet in Greenville, Ohio, which it owns. Southern
Heritage has a facility of approximately 14,000 square feet in Duluth, Georgia,
which it leases.
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 Common
Stock during the fourth quarter of 1998.
Executive Officers of the Company
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<S> <C> <C>
Donald H. Nikolaus 56 President and Chief Executive Officer since 1981
Ralph G. Spontak 46 Senior Vice President since 1991; Chief Financial Officer
and Vice President since 1983; Secretary since 1988
Cyril J. Greenya 54 Senior Vice President - Commercial Underwriting since 1997;
Vice President - Commercial Underwriting for five years
prior thereto; Manager - Commercial Underwriting for nine
years prior thereto
Frank J. Wood 65 Senior Vice President - Marketing since 1997; Vice-President -
Marketing for nine years prior thereto; Manager - Marketing
for one year prior thereto
</TABLE>
22
<PAGE>
<TABLE>
<S> <C> <C>
James B. Price 63 Senior Vice President - Claims since 1997; Vice President -
Claims for 25 years prior thereto
Robert G. Shenk 46 Senior Vice President - Claims since 1997; Vice President -
Claims for five years prior thereto
William H. Shupert 72 Senior Vice President - Underwriting since 1991; Vice
President - Underwriting for 18 years prior thereto
Daniel J. Wagner 38 Treasurer since 1993; Controller for five years prior thereto
</TABLE>
23
<PAGE>
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
33 of the Company's Annual Report to Stockholders for the year ended December
31, 1998, which is included as Exhibit (13) to this Form 10-K Report. As of
March 15, 1999, the Company had approximately 566 holders of record of its
Common Stock. The Company declared dividends of $.2925 per share in 1997 and
$.3375 per share in 1998.
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,
1998, 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 12
through 15 of the Company's Annual Report to Stockholders for the year ended
December 31, 1998, 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 16
through 30 of the Company's Annual Report to Stockholders for the year ended
December 31, 1998, 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.
24
<PAGE>
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 pages 7 through 10 of the Company's proxy statement
relating to the Company's annual meeting of stockholders to be held April 15,
1999. 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 10
through 15 of the Company's proxy statement relating to the Company's annual
meeting of stockholders to be held April 15, 1999, except for the Compensation
Committee Report and the Performance Graph, 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 2
through 4 of the Company's proxy statement relating to the Company's annual
meeting of stockholders to be held April 15, 1999.
Item 13. Certain Relationships and Related Transactions.
The response to this Item is incorporated by reference to pages 4
through 6 and page 14 of the Company's proxy statement relating to the Company's
annual meeting of stockholders to be held April 15, 1999.
25
<PAGE>
PART IV
Item 14. 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......................... 31
Donegal Group Inc. and Subsidiaries:
Consolidated Balance Sheets as of December 31, 1998
and 1997 .......................................... 16
Consolidated Statements of Income for the three years
ended December 31, 1998, 1997 and 1996 ............ 17
Consolidated Statements of Stockholders' Equity for
the three years ended December 31, 1998, 1997 and
1996............................................... 18
Consolidated Statements of Cash Flows for the three
years ended December 31, 1998, 1997 and 1996....... 19
Notes to Consolidated Financial Statements............ 20-30
(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............ 31
Schedule II. Condensed Financial Information of
Parent Company............................ 32
Schedule III Supplementary Insurance Information....... 35
Schedule IV. Reinsurance............................... 37
Schedule VI. Supplemental Insurance Information
Concerning Property and Casualty
Subsidiary................................ 38
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 1998 Annual Report to
Stockholders. The Consolidated Financial Statements and Notes to Consolidated
Financial Statements and Auditor's Report thereon on pages 16 through 31 are
incorporated herein by 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, 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.
26
<PAGE>
(3) Exhibits
Exhibit No. Description of Exhibits Reference
- ----------- ----------------------- ---------
(3)(i) Certificate of Incorporation of (a)
Registrant
(3)(ii) Amended and Restated By-laws of (b)
Registrant
(4) Form of Registrant's Common Stock (a)
Certificate
Management Contracts and Compensatory Plans or Arrangements
(10)(A) Donegal Mutual Insurance Company (a)
Money Purchase Pension Plan and
Trust dated March 12, 1985
(10)(B) Donegal Mutual Insurance Company (a)
Profit Sharing Plan and Trust
dated March 12, 1985
(10)(C) Donegal Group Inc. Key Executive (c)
Incentive Bonus Plan dated
September 29, 1986
(10)(D) Donegal Group Inc. Employee Stock (c)
Purchase Plan, as amended
(10)(E) Donegal Group Inc. Equity Incentive (c)
Plan, as amended
(10)(F) Donegal Group Inc. Agency (j)
Stock Purchase Plan
(10)(G) Donegal Group Inc. Amended and filed herewith
Restated 1996 Equity Incentive
Plan
(10)(H) Donegal Group Inc. Amended (i)
and Restated 1996 Equity Incentive
Plan for Directors
27
<PAGE>
(10)(I) Donegal Group Inc. Executive (b)
Restoration Plan
Other Material Contracts
(10)(J) Tax Sharing Agreement dated (a)
September 29, 1986 between Donegal
Group Inc. and Atlantic States
Insurance Company
(10)(K) Services Allocation Agreement dated (a)
September 29, 1986 between Donegal
Mutual Insurance Company, Donegal
Group Inc. and Atlantic States
Insurance Company
(10)(L) Proportional Reinsurance Agreement (a)
dated September 29, 1986 between
Donegal Mutual Insurance Company
and Atlantic States Insurance Company
(10)(M) Amendment dated October 1, 1988 to (d)
Proportional Reinsurance Agreement
between Donegal Mutual Insurance Company
and Atlantic States Insurance Company
(10)(N) Multi-Line Excess of Loss Reinsurance (f)
Agreement effective January 1, 1993
between Donegal Mutual Insurance Company,
Southern Insurance Company of Virginia,
Atlantic States Insurance Company and
Pioneer Mutual Insurance Company, and
Christiana General Insurance Corporation
of New York, Cologne Reinsurance Company
of America, Continental Casualty Company,
Employers Reinsurance Corporation and
Munich American Reinsurance Company
(10)(O) Amendment dated July 16, 1992 to Propor- (e)
tional Reinsurance Agreement between
Donegal Mutual Insurance Company and
Atlantic States Insurance Company
(10)(P) Amendment dated as of December 21, 1995 (g)
to Proportional Reinsurance Agreement
between Donegal Mutual Insurance Company
and Atlantic States Insurance Company
28
<PAGE>
(10)(Q) Credit Agreement dated as of December 29, (g)
1995 between Donegal Group Inc. and Fleet
National Bank of Connecticut
(10)(R) Stock Purchase Agreement dated as of (g)
December 21, 1995 between Donegal Mutual
Insurance Company and Donegal Group Inc.
(10)(S) Donegal Group Inc. 1996 Employee Stock (h)
Purchase Plan
(10)(T) Reinsurance and Retrocession Agreement (b)
dated May 21, 1996 between Donegal Mutual
Insurance Company and Pioneer Insurance
Company
(10)(U) Reinsurance and Retrocession Agreement (b)
dated May 21, 1996 between Donegal
Mutual Insurance Company and
Delaware American Insurance Company
(10)(V) Reinsurance and Retrocession Agreement (b)
dated May 21, 1996 between Donegal
Mutual Insurance Company and Southern
Insurance Company of Virginia
(10)(W) Stock Purchase Agreement dated as of
May 14, 1998 between Donegal Group Inc.
and Southern Heritage Limited Partnership (k)
(10)(X) Amendment dated November 17, 1998 to (k)
Stock Purchase Agreement dated as of
May 14, 1998 between Donegal Group Inc.
and Southern Heritage Limited Partnership
(10)(Y) Amended and Restated Credit Agreement (k)
dated as of July 27, 1998 among
Donegal Group Inc., the banks and other
financial institutions from time to time
party thereto and Fleet National Bank, as
Agent
(13) 1998 Annual Report to Stockholders filed herewith
(electronic filing contains only those
portions incorporated by reference into
this Form 10-K report)
(20) Proxy Statement relating to the Annual (l)
Meeting of Stockholders to be held on
29
<PAGE>
April 15, 1999, provided, however, that the Compensation
Committee Report and the Performance Graph 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
(27) Financial Data Schedule filed herewith
- ------------------
(a) Such exhibit is hereby incorporated by reference to the
like-described exhibits in Registrant's Form S-1 Registration
Statement No. 33-8533 declared effective October 29, 1986.
(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, 1996.
(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, 1986.
(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, 1988.
(e) 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.
(f) Such exhibit is hereby incorporated by reference to the
like-described exhibit in Registrant's Form S-2 Registration
Statement No. 33-67346 declared effective September 29, 1993.
(g) Such exhibit is hereby incorporated by reference to the
like-described exhibit in Registrant's Form 8-K Report dated
December 21, 1995.
(h) Such exhibit is hereby incorporated by reference to the
like-described exhibit in Registrant's Form S-8 Registration
Statement No. 333-1287 filed February 29, 1996.
(i) 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, 1997.
(j) Such exhibit is hereby incorporated by reference to the
like-described exhibit in Registrant's Form S-2 Registration
Statement No. 333-06787 declared effective August 1, 1996.
(k) Such exhibit is hereby incorporated by reference to the
like-described exhibit in Registrant's Form 8-K Report dated
November 17, 1998.
(l) Such exhibit is hereby incorporated by reference to the Registrant's
definitive proxy statement filed March 22, 1999.
30
<PAGE>
DONEGAL GROUP INC. AND SUBSIDIARIES
SCHEDULE I - SUMMARY OF INVESTMENTS
OTHER THAN INVESTMENTS IN RELATED PARTIES
December 31, 1998
Amount at Which
Fair Shown in the
Cost Value Balance Sheet
---- ----- -------------
Fixed Maturities:
Held to maturity:
United States government
and governmental agencies
and authorities including
obligations of states and
political subdivisions..... $ 99,832 $103,766 $ 99,832
All other corporate
bonds..................... 9,131 9,550 9,131
Mortgage-backed
securities................ 18,221 18,317 18,221
-------- --------- ---------
Total fixed maturities
held to maturity........... 127,184 131,633 127,184
-------- --------- ---------
Available for sale:
United States government
and governmental agencies
and authorities including
obligations of states
and political
subdivisions............... 74,116 75,397 75,396
All other corporate
bonds..................... 10,643 10,787 10,787
Mortgage-backed
securities................ 4,331 4,342 4,342
-------- --------- ---------
Total fixed maturities
available for sale........ 89,090 90,526 90,525
-------- --------- ---------
Total fixed maturities..... 216,274 222,159 217,709
-------- --------- ---------
Equity Securities:
Preferred stocks
Public utilities........... 250 250 250
Banks...................... 2,713 2,801 2,801
Industrial and
miscellaneous............. 987 1,022 1,022
-------- --------- ---------
Total preferred stocks..... 3,950 4,073 4,073
-------- --------- ---------
Common stocks
Public utilities........... 57 56 56
Banks and insurance
companies................. 308 852 852
Industrial and
miscellaneous............. 1,892 1,783 1,783
-------- --------- ---------
Total common stocks........ 2,257 2,691 2,691
-------- --------- ---------
Total equity securities.... 6,207 6,764 6,764
-------- --------- ---------
Short-term investments....... 30,522 30,522 30,522
-------- --------- ---------
Total investments........... $253,003 $259,445 $254,995
======== ========= =========
31
<PAGE>
DONEGAL GROUP INC. AND SUBSIDIARIES
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY
Condensed Balance Sheets
($ in thousands)
December 31, 1998 and 1997
ASSETS
1998 1997
---- ----
Investment in subsidiaries
(equity method) $134,441 $ 99,857
Short-term investments, at cost,
which approximates market 3 3
Cash 599 730
Property and equipment 2,276 2,139
Goodwill 121 --
Current income taxes 568 243
Loan costs 254 205
Other receivables 1,178 --
--------- --------
Total assets $139,440 $103,177
========= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
1998 1997
---- ----
Cash dividends declared to
stockholders $ 708 $ 604
Accounts payable and accrued
expenses 277 208
Deferred income taxes 324 268
Line of credit 37,500 10,500
-------- -------
Total liabilities 38,809 11,580
Stockholders' equity
Preferred stock, $1.00 par value,
authorized 1,000,000 shares, none
issued
Common stock, $1.00 par value,
authorized 15,000,000 shares, issued
8,325,221 and 6,122,431 shares and
outstanding 8,202,933 and 6,030,715
shares 8,325 6,123
Additional paid-in capital 41,271 38,932
Accumulated other comprehensive income
Retained earnings, including equity in
undistributed net income of subsidiaries 1,316 1,012
($64,922 and $56,082) 50,611 46,422
Treasury stock, at cost (892) (892)
-------- --------
Total stockholders' equity 100,631 91,597
-------- --------
Total liabilities and stockholders'
equity $139,440 $103,177
======== ========
32
<PAGE>
DONEGAL GROUP INC. AND SUBSIDIARIES
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY
Condensed Statements of Income
($ in thousands)
Years ended December 31, 1998, 1997 and 1996
1998 1997 1996
---- ---- ----
Revenues
Dividends-subsidiary $1,000 $950 $ 0
Lease income 754 643 541
Investment income 22 15 31
------ ------- ------
Total revenues 1,776 1,608 572
Expenses
Operating Expenses 718 643 548
Interest 1,293 1,022 416
------ ------- ------
Total expenses 2,011 1,665 964
------ ------- ------
Loss before income tax
benefit and equity in
undistributed net
income of subsidiaries (235) (57) (392)
Income tax benefit (413) (346) (533)
------ ------- ------
Income before equity in
undistributed net income
of subsidiaries 178 289 141
Equity in undistributed
net income of subsidiaries 8,840 10,352 8,417
------ ------- ------
Net income $9,018 $10,641 $8,558
====== ======= ======
33
<PAGE>
DONEGAL GROUP INC. AND SUBSIDIARIES
SCHEDULE II - CONDENSED INFORMATION OF PARENT COMPANY
Condensed Statements of Cash Flows
($ in thousands)
Years ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- -------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 9,018 $ 10,641 $ 8,558
-------- -------- -------
Adjustments to reconcile net income to net cash
provided by operating activities:
Equity in undistributed net income of
subsidiaries (8,840) (10,352) (8,417)
Change in accounts payable and accrued
expenses 35 34 (143)
Depreciation and amortization 491 401 309
Change in deferred income tax 56 2 16
Change in current income tax receivable (325) (85) 183
Change in other receivables (1,178) 30 8
-------- -------- -------
Net adjustments (9,761) (9,970) (8,044)
-------- -------- -------
Net cash provided by (used in) operating activities (743) 671 514
-------- -------- -------
Cash flows from investing activities:
Net sales (purchases) of short-term investments (5,280) 4 1,110
Net purchase of property and equipment (564) (1,251) (203)
Capital contribution to subsidiaries (2,000) --- (5,000)
Acquisition of Southern Heritage (18,361) --- ---
Acquisition of Delaware Atlantic --- --- (202)
-------- -------- -------
Net cash provided by (used in) investing activities (26,205) (1,247) (4,295)
-------- -------- -------
Cash flows from financing activities:
Cash dividends paid (2,664) (2,252) (1,879)
Issuance of common stock 2,481 1,131 2,512
Purchase of treasury stock --- --- (72)
Line of credit, net 27,000 2,000 3,500
-------- -------- -------
Net cash provided by (used in) financing activities 26,817 879 4,061
-------- -------- -------
Net change in cash (131) 303 280
Cash beginning 730 427 147
-------- -------- -------
Cash ending $ 599 $ 730 $ 427
======== ======== =======
</TABLE>
-34-
<PAGE>
DONEGAL GROUP INC. AND SUBSIDIARIES
SCHEDULE III - SUPPLEMENTARY INSURANCE INFORMATION
<TABLE>
<CAPTION>
Amortization
Net of Deferred
Net Net Losses Policy Other Net
Earned Investment and Loss Acquisition Underwriting Premiums
Segment Premiums Income Expenses Costs Expenses Written
------- -------- ---------- -------- ------------ ------------ --------
<S> <C> <C> <C> <C> <C> <C>
Year Ended
December 31, 1998
- -----------------
Personal Lines $ 71,676 $ --- $49,141 $12,614 $14,052 $ 73,070
Commercial Lines 44,493 --- 24,026 6,876 7,660 45,084
Investments --- 11,998 --- --- --- ---
-------- ------- ------- ------- ------- --------
$116,169 $11,998 $73,167 $19,490 $21,712 $118,154
======== ======= ======= ======= ======= ========
Year Ended
December 31, 1997
- -----------------
Personal Lines $ 61,600 $ --- $41,074 $11,578 $10,564 $ 63,525
Commercial Lines 45,702 --- 26,583 7,118 6,495 44,081
Investments --- 11,507 --- --- --- ---
-------- ------- ------- ------- ------- --------
$107,302 $11,507 $67,657 $18,696 $17,059 $107,606
======== ======= ======= ======= ======= ========
Year Ended
December 31, 1996
- -----------------
Personal Lines $ 58,356 $ --- $45,822 $10,286 $ 9,588 $ 60,788
Commercial Lines 46,171 --- 24,599 6,746 6,289 48,427
Investments --- 10,799 --- --- --- ---
-------- ------- ------- ------- ------- --------
$104,527 $10,799 $70,421 $17,032 $15,877 $109,215
======== ======= ======= ======= ======= ========
</TABLE>
(continued)
-35-
<PAGE>
DONEGAL GROUP INC. AND SUBSIDIARIES
SCHEDULE III - SUPPLEMENTARY INSURANCE INFORMATION
At December 31,
Deferred Liability Other Policy
Policy for Losses Claims and
Acquisition and Loss Unearned Benefits
Segment Costs Expenses Premiums Payable
------- ----------- ---------- -------- ---------------
1998
----
Personal Lines $ 7,648 $ 77,482 $63,916 $ --
Commercial Lines 3,686 63,927 30,807 --
Investments -- -- -- --
------- -------- ------- -------
$11,334 $141,409 $94,723 $ --
======= ======== ======= =======
1997
----
Personal Lines $ 4,732 $ 54,309 $39,972 $ --
Commercial Lines 3,716 63,803 31,396 --
Investments -- -- -- --
------- -------- ------- -------
$ 8,448 $118,112 $71,368 $ --
======= ======== ======= =======
-36-
<PAGE>
DONEGAL GROUP INC. AND SUBSIDIARIES
SCHEDULE IV - REINSURANCE
<TABLE>
<CAPTION>
Ceded Assumed Percentage
Gross to Other from Other Net Assumed
Amount Companies Companies Amount to Net
------ --------- ---------- ------ ----------
<S> <C> <C> <C> <C> <C>
Year Ended
December 31, 1998
- -----------------
Property and
casualty premiums $61,173,134 $56,338,098 $111,333,956 $116,168,992 96%
=========== =========== ============ ============ ====
Year Ended
December 31, 1997
- -----------------
Property and
casualty premiums $51,753,477 $51,753,477 $107,302,168 $107,302,168 100%
=========== =========== ============ ============ ====
Year Ended
December 31, 1996
- -----------------
Property and
casualty premiums $49,802,516 $41,185,853 $ 95,910,375 $104,527,038 92%
=========== =========== ============ ============ ====
</TABLE>
-37-
<PAGE>
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,
1998 $11,334,301 $141,409,008 $ --- $94,722,785
=========== ============ ========= ===========
1997 $ 8,448,060 $118,112,390 $ --- $71,367,691
=========== ============ ========= ===========
(continued)
-38-
<PAGE>
DONEGAL GROUP INC. AND SUBSIDIARIES
SCHEDULE VI - SUPPLEMENTARY INSURANCE INFORMATION
CONCERNING PROPERTY AND CASUALTY SUBSIDIARIES
<TABLE>
<CAPTION>
Losses and Loss
Expenses Related to Amortization
--------------------- of Deferred Net
Net (1) (2) Policy Paid Losses Net
Earned Investment Current Prior Acquisition and Loss Premiums
Premiums Income Year Years Costs Expenses Written
-------- ---------- ------- ----- ------------ ----------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Year Ended
December 31, 1998 $116,168,992 $11,997,661 $75,463,085 $(2,296,000) $19,490,000 $71,744,736 $118,153,817
============ =========== =========== =========== =========== =========== ============
Year Ended
December 31, 1997 $107,302,168 $11,492,012 $69,040,518 $(1,384,000) $18,696,000 $65,610,249 $107,604,989
============ =========== =========== =========== =========== =========== ============
Year Ended
December 31, 1996 $104,527,038 $10,768,518 $73,211,924 $(2,791,000) $17,032,000 $66,148,749 $109,169,176
============ =========== =========== =========== =========== =========== ============
</TABLE>
-39-
<PAGE>
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 30, 1999 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.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ Donald H. Nikolaus President and a Director March 30, 1999
- ------------------------------- (principal executive officer)
Donald H. Nikolaus
/s/ Ralph G. Spontak Senior Vice President and March 30, 1999
- ------------------------------- Secretary (principal financial
Ralph G. Spontak and accounting officer)
/s/ Robert S. Bolinger Director March 30, 1999
- -------------------------------
Robert S. Bolinger
Director March , 1999
- -------------------------------
Thomas J. Finley
/s/ Patricia A. Gilmartin Director March 30, 1999
- -------------------------------
Patricia A. Gilmartin
/s/ Philip H. Glatfelter, II Director March 30, 1999
- -------------------------------
Philip H. Glatfelter, II
/s/ C. Edwin Ireland Director March 30, 1999
- -------------------------------
C. Edwin Ireland
Director March , 1999
- -------------------------------
R. Richard Sherbahn
</TABLE>
-40-
<PAGE>
EXHIBIT INDEX
(Pursuant to Item 601 of Regulation S-K)
Exhibit No. Description of Exhibits Reference
----------- ----------------------- ---------
(3)(i) Certificate of Incorporation of (a)
Registrant
(3)(ii) Amended and Restated By-laws of (b)
Registrant
(4) Form of Registrant's Common Stock (a)
Certificate
Management Contracts and Compensatory Plans or Arrangements
- -----------------------------------------------------------
(10)(A) Donegal Mutual Insurance Company (a)
Money Purchase Pension Plan and
Trust dated March 12, 1985
(10)(B) Donegal Mutual Insurance Company (a)
Profit Sharing Plan and Trust
dated March 12, 1985
(10)(C) Donegal Group Inc. Key Executive (c)
Incentive Bonus Plan dated
September 29, 1986
(10)(D) Donegal Group Inc. Employee Stock (c)
Purchase Plan, as amended
(10)(E) Donegal Group Inc. Equity Incentive (c)
Plan, as amended
(10)(F) Donegal Group Inc. Agency (j)
Stock Purchase Plan
(10)(G) Donegal Group Inc. Amended and filed herewith
Restated 1996 Equity Incentive
Plan
(10)(H) Donegal Group Inc. Amended and (i)
Restated 1996 Equity Incentive
Plan for Directors
(10)(I) Donegal Group Inc. Executive (b)
Restoration Plan
-41-
<PAGE>
Other Material Contracts
- ------------------------
(10)(J) Tax Sharing Agreement dated (a)
September 29, 1986 between Donegal
Group Inc. and Atlantic States
Insurance Company
(10)(K) Services Allocation Agreement dated (a)
September 29, 1986 between Donegal
Mutual Insurance Company, Donegal
Group Inc. and Atlantic States
Insurance Company
(10)(L) Proportional Reinsurance Agreement (a)
dated September 29, 1986 between
Donegal Mutual Insurance Company
and Atlantic States Insurance Company
(10)(M) Amendment dated October 1, 1988 to (d)
Proportional Reinsurance Agreement
between Donegal Mutual Insurance Company
and Atlantic States Insurance Company
(10)(N) Multi-Line Excess of Loss Reinsurance (f)
Agreement effective January 1, 1993
between Donegal Mutual Insurance Company,
Southern Insurance Company of Virginia,
Atlantic States Insurance Company and
Pioneer Mutual Insurance Company, and
Christiana General Insurance Corporation
of New York, Cologne Reinsurance Company
of America, Continental Casualty Company,
Employers Reinsurance Corporation and
Munich American Reinsurance Company
(10)(O) Amendment dated July 16, 1992 to Propor- (e)
tional Reinsurance Agreement between
Donegal Mutual Insurance Company and
Atlantic States Insurance Company
(10)(P) Amendment dated as of December 21, 1995 (g)
to Proportional Reinsurance Agreement
between Donegal Mutual Insurance Company
and Atlantic States Insurance Company
(10)(Q) Credit Agreement dated as of December 29, (g)
1995 between Donegal Group Inc. and Fleet
National Bank of Connecticut
-42-
<PAGE>
(10)(R) Stock Purchase Agreement dated as of (g)
December 21, 1995 between Donegal Mutual
Insurance Company and Donegal Group Inc.
(10)(S) Donegal Group Inc. 1996 Employee Stock (h)
Purchase Plan
(10)(T) Reinsurance and Retrocession Agreement (b)
dated May 21, 1996 between Donegal
Mutual Insurance Company and Pioneer
Insurance Company
(10)(U) Reinsurance and Retrocession Agree- (b)
ment dated May 21, 1996 between
Donegal Mutual Insurance Company and
Delaware American Insurance Company
(10)(V) Reinsurance and Retrocession Agree- (b)
ment dated May 21, 1996 between
Donegal Mutual Insurance Company and
Southern Insurance Company of Virginia
(10)(W) Stock Purchase Agreement dated (k)
as of May 14, 1998 between Donegal
Group Inc. and Southern Heritage
Limited Partnership
(10)(X) Amendment dated November 17, 1998 (k)
to Stock Purchase Agreement dated
as of May 14, 1998 between Donegal
Group Inc. and Southern Heritage
Limited Partnership
(10)(Y) Amended and Restated Credit Agreement (k)
dated as of July 27, 1998 among
Donegal Group Inc., the banks and
other financial institutions from
time to time party thereto and Fleet
National Bank, as Agent
(13) 1998 Annual Report to Stockholders filed herewith
(electronic filing contains only
those portions incorporated by
reference into this Form 10-K
report)
-43-
<PAGE>
(20) Proxy Statement relating to the Annual (l)
Meeting of Stockholders to be held on
April 15, 1999, provided, however, that the
Compensation Committee Report and the
Performance Graph 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
(27) Financial Data Schedule filed herewith
- ------------------
(a) 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.
(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,
1996.
(c) Such exhibit is hereby incorporated by reference to the like-described
exhibits in Registrant's Form 10-K Report for the year ended December 31,
1986.
(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,
1988.
(e) 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.
(f) Such exhibit is hereby incorporated by reference to the like-described
exhibit in Registrant's Form S-2 Registration Statement No. 33-67346
declared effective September 29, 1993.
(g) Such exhibit is hereby incorporated by reference to the like-described
exhibit in Registrant's Form 8-K Report dated December 21, 1995.
(h) Such exhibit is hereby incorporated by reference to the like-described
exhibit in Registrant's Form S-8 Registration Statement No. 333-1287 filed
February 29, 1996.
(i) 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,
1997.
(j) Such exhibit is hereby incorporated by reference to the like-described
exhibit in Registrant's Form S-2 Registration Statement No. 333-06787
declared effective August 1, 1996.
(k) Such exhibit is hereby incorporated by reference to the like-described
exhibit in Registrant's Form 8-K Report dated November 17, 1998.
(l) Such exhibit is hereby incorporated by reference to the Registrant's
definitive proxy statement filed March 22, 1999.
-44-
Exhibit 10.g
DONEGAL GROUP INC.
AMENDED AND RESTATED
1996 EQUITY INCENTIVE PLAN
1. Purpose. The purpose of the Donegal Group Inc. Amended and Restated 1996
Equity Incentive Plan (the "Plan") is to further the growth, development and
financial success of Donegal Group Inc. (the "Company"), its parent and the
subsidiaries of the Company and its parent by providing additional incentives to
those officers and key employees who are responsible for the management of the
business affairs of the Company, its parent and/or subsidiaries of the Company
or its parent, which will enable them to participate directly in the growth of
the capital stock of the Company. The Company intends that the Plan will
facilitate securing, retaining and motivating management employees of high
caliber and potential. To accomplish these purposes, the Plan provides a means
whereby management employees may receive stock options ("Options") to purchase
the Company's Common Stock, $1.00 par value (the "Common Stock").
2. Administration.
(a) Composition of the Committee. The Plan shall be administered by a
committee (the "Committee"), which shall be appointed by, and serve at the
pleasure of, the Company's Board of Directors (the "Board"). The Committee shall
be comprised of two or more members of the Board, each of whom shall be a
"non-employee director" within the meaning of Rule 16b-3 under the Securities
Exchange Act of 1934 (the "Exchange Act"). In addition, each member of the
Committee shall be an "outside director" within the meaning of Section 162(m) of
the Internal Revenue Code of 1986, as amended (the "Code"). Subject to the
foregoing, from time to time the Board may increase or decrease the size of the
Committee, appoint additional members thereof, remove members (with or without
cause), appoint new members, fill vacancies or remove all members of the
Committee and thereafter directly administer the Plan.
(b) Authority of the Committee. The Committee shall have full and final
authority, in its sole discretion, to interpret the provisions of the Plan and
to decide all questions of fact arising in its application; to determine the
employees to whom Options shall be granted and the type, amount, size and terms
of each such grant; to determine the time when Options shall be granted; and to
make all other determinations necessary or advisable for the administration of
the Plan. All decisions, determinations and interpretations of the Committee
shall be final and binding on all optionees and all other holders of Options
granted under the Plan.
(c) Authority of the Board. Notwithstanding anything to the contrary set
forth in the Plan, all authority granted hereunder to the Committee may be
exercised at any time and from time to time by the Board at its election. All
decisions, determinations and interpretations of the Board shall be final and
binding on all optionees and all other holders of Options granted under the
Plan.
3. Stock Subject to the Plan. Subject to Section 16 hereof, the shares that
may be issued under the Plan shall not exceed in the aggregate 1,800,000
-1-
<PAGE>
shares of Common Stock. Such shares may be authorized and unissued shares or
shares issued and subsequently reacquired by the Company. Except as otherwise
provided herein, any shares subject to an Option that for any reason expires or
is terminated unexercised as to such shares shall again be available under the
Plan.
4. Eligibility To Receive Options. Persons eligible to receive Options
under the Plan shall be limited to those officers and other key employees of the
Company, its parent and any subsidiary of the Company or its parent (as defined
in Section 425 of the Code or any amendment or substitute thereto) who are in
positions in which their decisions, actions and counsel significantly impact
upon the profitability and success of the Company, its parent or any subsidiary
of the Company or its parent. Directors of the Company who are not also officers
or employees of the Company, its parent or any subsidiary of the Company or its
parent shall not be eligible to participate in the Plan. Notwithstanding
anything to the contrary set forth in the Plan, the maximum number of shares of
Common Stock for which Options may be granted to any employee in any calendar
year shall be 100,000 shares.
5. Types of Options. Grants may be made at any time and from time to time
by the Committee in the form of stock options to purchase shares of Common
Stock. Options granted hereunder may be Options that are intended to qualify as
incentive stock options within the meaning of Section 422 of the Code or any
amendment or substitute thereto ("Incentive Stock Options") or Options that are
not intended to so qualify ("Nonqualified Stock Options").
6. Option Agreements. Options for the purchase of Common Stock shall be
evidenced by written agreements in such form not inconsistent with the Plan as
the Committee shall approve from time to time. The Options granted hereunder may
be evidenced by a single agreement or by multiple agreements, as determined by
the Committee in its sole discretion. Each option agreement shall contain in
substance the following terms and conditions:
(a) Type of Option. Each option agreement shall identify the Options
represented thereby either as Incentive Stock Options or Nonqualified Stock
Options, as the case may be.
(b) Option Price. Each option agreement shall set forth the purchase price
of the Common Stock purchasable upon the exercise of the Option evidenced
thereby. Subject to the limitation set forth in Section 6(d)(ii) of the Plan,
the purchase price of the Common Stock subject to an Incentive Stock Option
shall be not less than 100% of the fair market value of such stock on the date
the Option is granted, as determined by the Committee, but in no event less than
the par value of such stock. The purchase price of the Common Stock subject to a
Nonqualified Stock Option shall be not less than 100% of the fair market value
of such stock on the date the Option is granted, as determined by the Committee.
For this purpose, fair market value on any date shall mean the closing price of
the Common Stock, as reported in The Wall Street Journal, or if not so reported,
as otherwise reported by the National Association of Securities Dealers
Automated Quotation ("Nasdaq"), or if the Common Stock is not reported by
Nasdaq, the fair market value shall be as determined by the Committee pursuant
to Section 422 of the Code.
(c) Exercise Term. Each option agreement shall state the period or periods
of time within which the Option may be exercised, in whole or in part, as
-2-
<PAGE>
determined by the Committee, provided that no Option shall be exercisable after
ten years from the date of grant thereof. The Committee shall have the power to
permit an acceleration of previously established exercise terms, subject to the
requirements set forth herein, upon such circumstances and subject to such terms
and conditions as the Committee deems appropriate.
(d) Incentive Stock Options. In the case of an Incentive Stock Option, each
option agreement shall contain such other terms, conditions and provisions as
the Committee determines to be necessary or desirable in order to qualify such
Option as a tax-favored Option (within the meaning of Section 422 of the Code or
any amendment or substitute thereto or regulation thereunder) including without
limitation, each of the following, except that any of these provisions may be
omitted or modified if it is no longer required in order to have an Option
qualify as a tax-favored Option within the meaning of Section 422 of the Code or
any substitute therefor:
(i) The aggregate fair market value (determined as of the date the
Option is granted) of the Common Stock with respect to which Incentive Stock
Options are first exercisable by any employee during any calendar year (under
all plans of the Company) shall not exceed $100,000.
(ii) No Incentive Stock Options shall be granted to any employee if at
the time the Option is granted to the individual who owns stock possessing more
than 10% of the total combined voting power of all classes of stock of the
Company or its subsidiaries unless at the time such Option is granted the Option
price is at least 110% of the fair market value of the stock subject to the
Option and, by its terms, the Option is not exercisable after the expiration of
five years from the date of grant.
(iii) No Incentive Stock Options shall be exercisable more than three
months (or one year, in the case of an employee who dies or becomes disabled
within the meaning of Section 72(m)(7) of the Code or any substitute therefor)
after termination of employment.
(e) Substitution of Options. Options may be granted under the Plan from
time to time in substitution for stock options held by employees of other
corporations who are about to become, and who do concurrently with the grant of
such options become, employees of the Company, its parent or a subsidiary of the
Company or its parent as a result of a merger or consolidation of the employing
corporation with the Company, its parent or a subsidiary of the Company or its
parent, or the acquisition by the Company, its parent or a subsidiary of the
Company or its parent of the assets or capital stock of the employing
corporation. The terms and conditions of the substitute options so granted may
vary from the terms and conditions set forth in this Section 6 to such extent as
the Committee at the time of grant may deem appropriate to conform, in whole or
in part, to the provisions of the stock options in substitution for which they
are granted.
7. Date of Grant. The date on which an Option shall be deemed to have been
granted under the Plan shall be the date of the Committee's authorization of the
Option or such later date as may be determined by the Committee at the time the
Option is authorized. Notice of the determination shall be given to each
individual to whom an Option is so granted within a reasonable time after the
date of such grant.
-3-
<PAGE>
8. Exercise and Payment for Shares. Options may be exercised in whole or in
part, from time to time, by giving written notice of exercise to the Secretary
of the Company, specifying the number of shares to be purchased. The purchase
price of the shares with respect to which an Option is exercised shall be
payable in full with the notice of exercise in cash, Common Stock at fair market
value, or a combination thereof, as the Committee may determine from time to
time and subject to such terms and conditions as may be prescribed by the
Committee for such purpose. The Committee may also, in its discretion and
subject to prior notification to the Company by an optionee, permit an optionee
to enter into an agreement with the Company's transfer agent or a brokerage firm
of national standing whereby the optionee will simultaneously exercise the
Option and sell the shares acquired thereby through the Company's transfer agent
or such a brokerage firm and either the Company's transfer agent or the
brokerage firm executing the sale will remit to the Company from the proceeds of
sale the exercise price of the shares as to which the Option has been exercised.
9. Rights upon Termination of Employment. In the event that an optionee
ceases to be an employee of the Company, its parent or any subsidiary of the
Company or its parent for any reason other than death, retirement, as
hereinafter defined, or disability (within the meaning of Section 72(m)(7) of
the Code or any substitute therefor), the optionee shall have the right to
exercise the Option during its term within a period of three months after such
termination to the extent that the Option was exercisable at the time of
termination, or within such other period, and subject to such terms and
conditions, as may be specified by the Committee. In the event that an optionee
dies, retires or becomes disabled prior to the expiration of his Option and
without having fully exercised his Option, the optionee or his successor shall
have the right to exercise the Option during its term within a period of one
year after termination of employment due to death, retirement or disability to
the extent that the Option was exercisable at the time of termination, or within
such other period, and subject to such terms and conditions, as may be specified
by the Committee. As used in this Section 9, "retirement" means a termination of
employment by reason of an optionee's retirement at or after his earliest
permissible retirement date pursuant to and in accordance with his employer's
regular retirement plan or personnel practices. Notwithstanding the provisions
of Section 6(d)(iii) hereof, if the term of an Incentive Stock Option continues
for more than three months after termination of employment due to retirement or
more than one year after termination of employment due to death or disability,
such Option shall thereupon lose its status as an Incentive Stock Option and
shall be treated as a Nonqualified Stock Option.
10. General Restrictions. Each Option granted under the Plan shall be
subject to the requirement that, if at any time the Committee shall determine
that (i) the listing, registration or qualification of the shares of Common
Stock subject or related thereto upon any securities exchange or under any state
or federal law, or (ii) the consent or approval of any government regulatory
body, or (iii) the satisfaction of any tax payment or withholding obligation, or
(iv) an agreement by the recipient of an Option with respect to the disposition
of shares of Common Stock, is necessary or desirable as a condition of or in
connection with the granting of such Option or the issuance or purchase of
shares of Common Stock thereunder, such Option shall not be consummated in whole
or in part unless such listing, registration, qualification, consent, approval
or agreement shall have been effected or obtained free of any conditions not
acceptable to the Committee.
-4-
<PAGE>
11. Rights of a Stockholder. The recipient of any Option under the Plan,
unless otherwise provided by the Plan, shall have no rights as a stockholder
unless and until certificates for shares of Common Stock are issued and
delivered to him.
12. Right to Terminate Employment. Nothing contained in the Plan or in any
option agreement entered into pursuant to the Plan shall confer upon any
optionee the right to continue in the employment of the Company, its parent or
any subsidiary of the Company or its parent or affect any right that the
Company, its parent or any subsidiary of the Company or its parent may have to
terminate the employment of such optionee.
13. Withholding. Whenever the Company proposes or is required to issue or
transfer shares of Common Stock under the Plan, the Company shall have the right
to require the recipient to remit to the Company an amount sufficient to satisfy
any federal, state or local withholding tax requirements prior to the delivery
of any certificate or certificates for such shares. If and to the extent
authorized by the Committee, in its sole discretion, an optionee may make an
election, by means of a form of election to be prescribed by the Committee, to
have shares of Common Stock that are acquired upon exercise of an Option
withheld by the Company or to tender other shares of Common Stock or other
securities of the Company owned by the optionee to the Company at the time of
exercise of an Option to pay the amount of tax that would otherwise be required
by law to be withheld by the Company as a result of any exercise of an Option.
Any such election shall be irrevocable and shall be subject to termination by
the Committee, in its sole discretion, at any time. Any securities so withheld
or tendered will be valued by the Committee as of the date of exercise.
14. Non-Assignability. No Option under the Plan shall be assignable or
transferable by the recipient thereof except by will or by the laws of descent
and distribution or by such other means as the Committee may approve. During the
life of the recipient, such Option shall be exercisable only by such person or
by such person's guardian or legal representative.
15. Non-Uniform Determinations. The Committee's determinations under the
Plan (including without limitation determinations of the persons to receive
Options, the form, amount and timing of such grants, the terms and provisions of
Options, and the agreements evidencing same) need not be uniform and may be made
selectively among persons who receive, or are eligible to receive, grants of
Options under the Plan whether or not such persons are similarly situated.
-5-
<PAGE>
16. Adjustments.
(a) Changes in Capitalization. Subject to any required action by the
stockholders of the Company, the number of shares of Common Stock covered by
each outstanding Option and the number of shares of Common Stock that have been
authorized for issuance under the Plan but as to which no Options have yet been
granted or which have been returned to the Plan upon cancellation or expiration
of an Option, as well as the price per share of Common Stock covered by each
such outstanding Option, shall be proportionately adjusted for any increase or
decrease in the number of issued shares of Common Stock resulting from a stock
split, reverse stock split, stock dividend, combination or reclassification of
the Common Stock, or any other increase or decrease in the number of issued
shares of Common Stock effected without receipt of consideration by the
Company; provided, however, that conversion of any convertible securities of the
Company shall not be deemed to have been "effected without receipt of
consideration." Such adjustment shall be made by the Committee, whose
determination in that respect shall be final, binding and conclusive. Except as
expressly provided herein, no issuance by the Company of shares of stock of any
class, or securities convertible into shares of stock of any class, shall
affect, and no adjustment by reason thereof shall be made with respect to, the
number or price of shares of Common Stock subject to an Option.
(b) Dissolution or Liquidation. In the event of the proposed dissolution or
liquidation of the Company, all outstanding Options will terminate immediately
prior to the consummation of such proposed action, unless otherwise provided by
the Committee. The Committee may, in the exercise of its discretion in such
instances, declare that any Option shall terminate as of a date fixed by the
Committee and give each Option holder the right to exercise his Option as to all
or any part of the shares of Common Stock covered by the Option, including
shares as to which the Option would not otherwise be exercisable.
(c) Sale or Merger. In the event of a proposed sale of all or substantially
all of the assets of the Company, or the merger of the Company with or into
another corporation, the Committee, in the exercise of its sole discretion, may
take such action as it deems desirable, including, but not limited to:
(i) causing an Option to be assumed or an equivalent option to be substituted by
the successor corporation or a parent or subsidiary of such successor
corporation, (ii) providing that each Option holder shall have the right to
exercise his Option as to all of the shares of Common Stock covered by the
Option, including shares as to which the Option would not otherwise be
exercisable, or (iii) declaring that an Option shall terminate at a date fixed
by the Committee provided that the Option holder is given notice and opportunity
to exercise the then exercisable portion of his Option prior to such date.
17. Amendment. The Committee may terminate or amend the Plan at any time,
with respect to shares as to which Options have not been granted, subject to any
required stockholder approval or any stockholder approval that the Board may
deem to be advisable for any reason, such as for the purpose of obtaining or
retaining any statutory or regulatory benefits under tax, securities or other
laws or satisfying any applicable stock exchange listing requirements. The
Committee may not, without the consent of the holder of an Option, alter or
impair any Option previously granted under the Plan, except as specifically
authorized herein.
-6-
<PAGE>
18. Reservation of Shares. The Company, during the term of the Plan, will
at all times reserve and keep available such number of shares as shall be
sufficient to satisfy the requirements of the Plan. Inability of the Company to
obtain authority from any regulatory body having jurisdiction, which authority
is deemed by the Company's counsel to be necessary to the lawful issuance and
sale of any shares hereunder, shall relieve the Company of any liability for the
failure to issue or sell such shares as to which such requisite authority shall
not have been obtained.
19. Effect on Other Plans. Participation in the Plan shall not affect an
employee's eligibility to participate in any other benefit or incentive plan of
the Company, its parent or any subsidiary of the Company or its parent. Any
Options granted pursuant to the Plan shall not be used in determining the
benefits provided under any other plan of the Company, its parent or any
subsidiary of the Company or its parent unless specifically provided.
20. Duration of the Plan. The Plan shall remain in effect until all Options
granted under the Plan have been satisfied by the issuance of shares, but no
Option shall be granted more than ten years after the earlier of the date the
Plan is adopted by the Company or is approved by the Company's stockholders.
21. Forfeiture for Dishonesty. Notwithstanding anything to the contrary in
the Plan, if the Committee finds, by a majority vote, after full consideration
of the facts presented on behalf of both the Company and any optionee, that the
optionee has been engaged in fraud, embezzlement, theft, commission of a felony
or dishonest conduct in the course of his employment or retention by the
Company, its parent or any subsidiary of the Company or its parent that damaged
the Company, its parent or any subsidiary of the Company or its parent or that
the optionee has disclosed confidential information of the Company, its parent
or any subsidiary of the Company or its parent, the optionee shall forfeit all
unexercised Options and all exercised Options under which the Company has not
yet delivered the certificates. The decision of the Committee in interpreting
and applying the provisions of this Section 21 shall be final. No decision of
the Commit tee, however, shall affect the finality of the discharge or
termination of such optionee by the Company, its parent or any subsidiary of the
Company or its parent in any manner.
22. No Prohibition on Corporate Action. No provision of the Plan shall be
construed to prevent the Company or any officer or director thereof from taking
any action deemed by the Company or such officer or director to be appropriate
or in the Company's best interest, whether or not such action could have an
adverse effect on the Plan or any Options granted hereunder, and no optionee or
optionee's estate, personal representative or beneficiary shall have any claim
against the Company or any officer or director thereof as a result of the taking
of such action.
23. Indemnification. With respect to the administration of the Plan, the
Company shall indemnify each present and future member of the Committee and the
Board against, and each member of the Committee and the Board shall be entitled
without further action on his part to indemnity from the Company for, all
expenses (including the amount of judgments and the amount of approved
settlements made with a view to the curtailment of costs of litigation, other
than amounts paid to the Company itself) reasonably incurred by him in
connection with or arising out of, any action, suit or proceeding in which he
may be involved by reason of his being or having been a member of the Committee
-7-
<PAGE>
or the Board, whether or not he continues to be such member at the time of
incurring such expenses; provided, however, that such indemnity shall not
include any expenses incurred by any such member of the Committee or the Board
(i) in respect of matters as to which he shall be finally adjudged in any such
action, suit or proceeding to have been guilty of gross negligence or willful
misconduct in the performance of his duty as such member of the Committee or the
Board; or (ii) in respect of any matter in which any settlement is effected for
an amount in excess of the amount approved by the Company on the advice of its
legal counsel; and provided further that no right of indemnification under the
provisions set forth herein shall be available to or enforceable by any such
member of the Committee or the Board unless, within 60 days after institution of
any such action, suit or proceeding, he shall have offered the Company in
writing the opportunity to handle and defend same at its own expense. The
foregoing right of indemnification shall inure to the benefit of the heirs,
executors or administrators of each such member of the Committee or the Board
and shall be in addition to all other rights to which such member may be
entitled as a matter of law, contract or otherwise.
24. Miscellaneous Provisions.
(a) Compliance with Plan Provisions. No optionee or other person shall have
any right with respect to the Plan, the Common Stock reserved for issuance under
the Plan or in any Option until a written option agreement shall have been
executed by the Company and the optionee and all the terms, conditions and
provisions of the Plan and the Option applicable to such optionee (and each
person claiming under or through him) have been met.
(b) Approval of Counsel. In the discretion of the Committee, no shares of
Common Stock, other securities or property of the Company or other forms of
payment shall be issued hereunder with respect to any Option unless counsel for
the Company shall be satisfied that such issuance will be in compliance with
applicable federal, state, local and foreign legal, securities exchange and
other applicable requirements.
(c) Compliance with Rule 16b-3. To the extent that Rule 16b-3 under the
Exchange Act applies to the Plan or to Options granted under the Plan, it is the
intention of the Company that the Plan comply in all respects with the
requirements of Rule 16b-3, that any ambiguities or inconsistencies in
construction of the Plan be interpreted to give effect to such intention and
that, if the Plan shall not so comply, whether on the date of adoption or by
reason of any later amendment to or interpretation of Rule 16b-3, the provisions
of the Plan shall be deemed to be automatically amended so as to bring them into
full compliance with such rule.
(d) Effects of Acceptance of Option. By accepting any Option or other
benefit under the Plan, each optionee and each person claiming under or through
him shall be conclusively deemed to have indicated his acceptance and
ratification of, and consent to, any action taken under the Plan by the Company,
the Board and/or the Committee or its delegates.
(e) Construction. The masculine pronoun shall include the feminine and
neuter, and the singular shall include the plural, where the context so
indicates.
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<PAGE>
25. Stockholder Approval. The exercise of any Option granted under the Plan
shall be subject to the approval of the Plan by the affirmative vote of the
holders of a majority of the outstanding shares of the Common Stock present, or
represented, and entitled to vote at a meeting duly held.
-9-
Exhibit 13
Financial Highlights
<TABLE>
<CAPTION>
Year Ended December 31,
Income statement data 1998 1997 1996 1995 1994
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net premiums earned $116,168,992 $107,302,168 $104,527,038 $ 89,522,203 $ 79,026,809
Investment income 11,997,661 11,507,277 10,799,369 9,713,744 8,188,852
Total revenues 130,586,365 121,327,606 117,581,664 101,615,698 88,607,550
Net income 9,017,840 10,641,186 8,557,774 9,559,610 4,589,397
Net income per common share
Basic 1.11 1.33* 1.10* 1.29* .63*
Diluted 1.09 1.32* 1.09* 1.26* .62*
- ---------------------------------------------------------------------------------------------------------------------------
Balance sheet data
- ---------------------------------------------------------------------------------------------------------------------------
Total assets $385,231,506 $304,104,505 $287,990,994 $244,943,598 $215,013,165
Stockholders' equity 100,631,004 91,596,663 81,599,274 73,020,689 61,338,761
Book value per share 12.27 11.39* 10.26* 9.64* 8.42*
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
* Restated
<PAGE>
Management's Discussion and Analysis of Results of
Operation and Financial Condition 12
Consolidated Balance Sheets 16
Consolidated Statements of Income and Comprehensive Income 17
Consolidated Statements of Stockholders' Equity 18
Consolidated Statements of Cash Flows 19
Notes to Consolidated Financial Statements 20
Independent Auditors' Report 31
Board of Directors and Officers 32
Corporate Information 33
<PAGE>
Management's Discussion and Analysis of Results of Operation and Financial
Condition
Donegal Group Inc. ("DGI" or the "Company") is a regional insurance holding
company doing business in the Mid-Atlantic and Southern states through its five
wholly-owned property-casualty insurance subsidiaries, Atlantic States Insurance
Company ("Atlantic States"), Southern Insurance Company of Virginia
("Southern"), Southern Heritage Insurance Company ("Southern Heritage"),
Delaware Atlantic Insurance Company ("Delaware") and Pioneer Insurance Company
("Pioneer") (collectively "Insurance Subsidiaries"). The Company has three
operating segments: the investment function, the personal lines of insurance and
the commercial lines of insurance. Products offered in the personal lines of
insurance consist primarily of homeowners and private passenger automobile
policies. Products offered in the commercial lines of insurance consist
primarily of commercial automobile, commercial multiple peril and workers'
compensation policies. The Insurance Subsidiaries are subject to regulation by
Insurance Departments in those states in which they operate and undergo periodic
examination by those departments. The Insurance Subsidiaries are also subject to
competition from other insurance carriers in their operating areas. DGI was
formed in September 1986 by Donegal Mutual Insurance Company (the "Mutual
Company"), which owns 60% of the outstanding common shares of the Company as of
December 31, 1998.
On June 25, 1998, the Company issued a 4-for-3 stock split in the form of a
33 1/3% stock dividend to stockholders of record as of June 10, 1998. Per share
information prior to June 25, 1998, has been restated for this change.
Atlantic States participates in an intercompany pooling arrangement with the
Mutual Company and assumes 65% of the pooled business. Southern cedes 50% of its
business to the Mutual Company and Delaware cedes 70% of its Workers'
Compensation business to the Mutual Company. Because the Mutual Company places
substantially all of the business assumed from Southern and Delaware into the
pool, from which the Company has a 65% allocation, the Company's results of
operations include approximately 83% of the business written by Southern and
approximately 76% of the Workers' Compensation business written by Delaware.
In November 1998, the Company acquired all of the outstanding stock of
Southern Heritage. This transaction was accounted for as a "purchase." The
Company's financial statements include Southern Heritage as a consolidated
subsidiary from November 1, 1998.
In addition to the Company's Insurance Subsidiaries, it also owns all of the
outstanding stock of Atlantic Insurance Services, Inc. ("AIS"), an insurance
services organization currently providing inspection and policy auditing
information on a fee-for-service basis to its affiliates and the insurance
industry.
Results of Operation 1998 Compared to 1997
Total revenues for 1998 were $130,586,365, which were $9,258,759, or 7.6%,
greater than 1997. Net premiums earned increased to $116,168,992, an increase of
$8,866,824, or 8.3%, over 1997. The acquisition of Southern Heritage contributed
$4,835,036, or 4.5%, to the earned premiums in 1998. Direct premiums written by
the combined pool of Atlantic States and the Mutual Company increased $6,426,444
or 4.7%. A 17.5% increase in the direct premiums written of Southern, a 6.5%
decrease in the direct premiums written of Delaware and an 11.7% decrease in the
direct premiums written of Pioneer accounted for the majority of the remaining
change. The Company reported realized investment losses of $13,562, compared to
realized investment gains of $314,136 in 1997. Realized gains and losses in both
years resulted from normal turnover of the Company's investment portfolio. As of
December 31, 1998, 99.9% of the Company's bond portfolio was classified as Class
1 (highest quality) by the National Association of Insurance Commissioners'
Securities Valuation Office. Investment income increased $490,384. An increase
in the average invested assets from $198,727,027 to $208,303,664, offset by a
decrease in the average yield to 5.6% from 5.8% in 1997, accounted for the
change.
The GAAP combined ratio of insurance operations was 99.8% in 1998, compared
to 97.6% in 1997. The GAAP combined ratio is the sum of the ratios of incurred
losses and loss adjustment expenses to premiums earned (loss ratio),
underwriting expenses to premiums earned (expense ratio) and policyholder
dividends to premiums earned (dividend ratio). The loss ratio in 1998 was 63.0%,
compared to 63.1% in 1997. The expense ratio for 1998 was 35.4%, compared to
33.3% in 1997, with the dividend ratio increasing from 1.2% in 1997 to 1.4% in
1998. The increase in the Company's expense ratio accounted for the change in
its combined ratio. The expense ratio was adversely affected by a charge to
earnings in the third quarter resulting from an unprecedented large mandatory
Pennsylvania Insurance Guaranty Association assessment arising from the
insolvency of two medical malpractice companies. The Company's share of the
Guaranty Association liability arising from these two companies was
12 / Donegal Group Annual Report 1998
<PAGE>
$1.3 million. Guaranty Association assessments represent mandatory regulatory
charges that must be absorbed by substantially all property and casualty
insurance companies doing business in a state where an insolvent company had
been writing business, including companies, like Donegal, who do not write lines
of business that the insolvent companies were writing.
Results of Operation 1997 Compared to 1996
Total revenues for 1997 were $121,327,606 which were $3,745,942, or 3.2%,
greater than 1996. Net premiums earned increased to $107,302,168, an increase of
$2,775,130, or 2.7%, over 1996. Direct premiums written by the combined pool of
Atlantic States and the Mutual Company decreased $107,786, with Workers'
Compensation decreasing $4,052,981, or 19.5%, due to a mandatory rate rollback
for that line in Pennsylvania. A 12.4% increase in the direct premiums written
of Southern, a 6.6% increase in the direct premiums written of Delaware and an
18.5% decrease in the direct premiums written of Pioneer accounted for the
majority of the remaining increase. The Company reported realized investment
gains of $314,136, compared to realized investment gains of $172,734 in 1996.
Gains in both years resulted from normal turnover of the Company's investment
portfolio. As of December 31, 1997, 99.9% of the Company's bond portfolio was
classified as Class 1 (highest quality) by the National Association of Insurance
Commissioners' Securities Valuation Office. Investment income increased
$707,908. An increase in the average invested assets from $180,352,394 to
$198,727,027, offset by a decrease in the average yield to 5.8% from 6.0% in
1996, accounted for the change.
The GAAP combined ratio of insurance operations was 97.6% in 1997, compared
to 100.4% in 1996. The GAAP combined ratio is the sum of the ratios of incurred
losses and loss adjustment expenses to premiums earned (loss ratio),
underwriting expenses to premiums earned (expense ratio) and policyholder
dividends to premiums earned (dividend ratio). The loss ratio in 1997 was 63.1%,
compared to 67.4% in 1996, accounting for the majority of the change in the
combined ratio. This decrease in the loss ratio resulted from a return to more
normal weather patterns in 1997, compared to severe winter weather experienced
in the primary operating areas of the Company in the first quarter of 1996. The
expense ratio for 1997 was 33.3%, compared to 31.5% in 1996, with the dividend
ratio decreasing from 1.5% in 1996 to 1.2% in 1997 due primarily to the rate
rollback in Workers' Compensation in 1997.
Liquidity and Capital Resources
The Company generates sufficient funds from its operations and maintains a high
degree of liquidity in its investment portfolio. The primary source of funds to
meet the demands of claim settlements and operating expenses are premium
collections, investment earnings and maturing investments. As of December 31,
1998, the Company had no material commitment for capital expenditures.
In investing funds made available from operations, the Company maintains
securities' maturities consistent with its projected cash needs for the payment
of claims and expenses. The Company maintains a portion of its investment
portfolio in relatively short-term and highly liquid assets to ensure the
availability of funds.
As of December 31, 1998, pursuant to a credit agreement dated December 29,
1995, with Fleet National Bank of Connecticut, the Company had unsecured
borrowings of $37.5 million. Such borrowings were made in connection with the
acquisitions of Delaware, Pioneer and Southern Heritage and various capital
contributions to the subsidiaries. Per the terms of the credit agreement, the
Company may borrow up to $40 million at interest rates equal to the bank's then
current prime rate or the then current London interbank Eurodollar bank rate
plus 1.70%. At December 31, 1998, the interest rates on the outstanding balances
were 7.75% on an outstanding prime rate balance of $22.5 million and 6.93375% on
an outstanding Eurodollar rate balance of $15 million. In addition, the Company
pays a rate of 3/10 of 1% per annum on the average daily unused portion of the
bank's commitment. On each July 27, commencing July 27, 2001, the credit line
will be reduced by $8 million. Any outstanding loan in excess of the remaining
credit line after such reduction will then be payable.
The Company's principal sources of cash with which to meet obligations and
pay stockholder dividends are dividends from the Insurance Subsidiaries which
are required by law to maintain certain minimum surplus on a statutory basis and
are subject to regulations under which payment of dividends from statutory
surplus is restricted and may require prior approval of their domiciliary
insurance regulatory authorities. The Insurance Subsidiaries are also subject to
Risk Based Capital (RBC) requirements which may further impact their ability to
pay dividends. At December 31, 1998, all five companies' statutory capital and
surplus were substantially above the RBC requirements. At December 31, 1998,
amounts available for distribution as dividends to DGI without prior approval of
the insurance regulatory authorities were $6,480,524 from Atlantic States,
$638,832 from Southern, $1,085,807 from Delaware, $530,035 from Pioneer and
$1,580,564 from Southern Heritage.
Donegal Group Annual Report 1998 / 13
<PAGE>
Net unrealized gains resulting from fluctuations in the fair value of
investments reported in the balance sheet at fair value were $1,315,425 (net of
applicable federal income tax) at December 31, 1998, and $1,011,417 (net of
applicable federal income tax) at December 31, 1997.
Credit Risk
The Company provides property and liability coverages through its subsidiaries'
independent agency systems located throughout its operating area. The majority
of this business is billed directly to the insured, although a portion of the
Company's commercial business is billed through its agents, who are extended
credit in the normal course of business.
The Company's Insurance Subsidiaries have reinsurance agreements in place
with the Mutual Company, as described in Note 3 of the financial statements, and
with a number of other major authorized reinsurers, as described in Note 9 of
the financial statements.
Impact of Inflation
Property and casualty insurance premiums are established before the amount of
losses and loss settlement expenses, or the extent to which inflation may impact
such expenses, are known. Consequently, the Company attempts, in establishing
rates, to anticipate the potential impact of inflation.
Year 2000 Issues
The Year 2000 issue (i.e. the ability of computer systems to properly process
information which contains dates beginning with January 1, 2000 and thereafter)
affects virtually all companies. All computer systems used for processing of
business for the Company are owned and operated by the Mutual Company.
The ability to process information in a timely and accurate manner is vital
to the Company's property and casualty insurance business. The Company
recognizes that the systems used to process its business must be able to
accurately identify and process information containing year 2000 dates. The
Mutual Company has had a vigorous and comprehensive project underway since 1995
to ensure substantial compliance by the end of 1998. This project was initiated
as part of a review of the main application systems utilized by the Mutual
Company and was geared towards the implementation of new or current versions of
its applications software to bring greater efficiencies and operational
improvements to its users. The project was expanded to include a review of all
hardware, peripheral software and inquiries of agents and vendors to determine
the readiness of each related to the Year 2000 problem. During 1998 the Mutual
Company put into production its updated, Year-2000-compliant versions of its
main application softwares and late in the year began issuing policies with
expiration dates in the year 2000. The implementations of these updated systems
were without major problems and the Mutual Company's mission-critical systems
were substantially Year-2000-compliant by the end of 1998. Testing of less
critical systems, documentation of vendors' readiness and final testing of
certain other potential problem dates will continue during the first half of
1999. Costs directly related to Year 2000 changes were not material.
With respect to insurance policies issued by the Company providing coverages
to insureds who may incur losses as a result of Year 2000 problems, the Company
is evaluating its possible exposure under such coverages. Endorsements excluding
losses related to or resulting from Year 2000 issues are being attached to
commercial policies.
Given the nature of its business, the Company believes that its exposure to
embedded chip Year 2000 issues is minimal. The Company believes that its most
significant Year 2000 exposure is the potential business disruption that would
be caused by widespread failure of public utility systems. Prolonged failure of
power and telecommunications systems could have a material adverse effect on the
Company's results of operations, cash flows and consolidated financial position.
This Year 2000 disclosure contains statements which are forward-looking
statements that involve risks and uncertainties and qualify for the statutory
safe harbor under the Private Securities Litigation Reform Act of 1995. Future
Year 2000 readiness activities may not adhere to the anticipated schedule
because more problems may be encountered than anticipated in the various stages
of testing and trained personnel may not be available to work on internal
systems in the time required; or there may be unexpected problems with the
readiness of third party business partners and vendors who cannot produce
services, or utility companies may not be able to provide the vital services
required to maintain operations.
Impact of New Accounting Standards
Accounting for Derivative Instruments and for Hedging Activities
Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for
Derivative Instruments and for Hedging Activities," requires enterprises to
record derivatives on the balance sheet at fair
14 / Donegal Group Annual Report 1998
<PAGE>
value and establishes special accounting for the following three different types
of hedges: hedges of changes in the fair value of assets, liabilities or firm
commitments; hedges of the variable cash flows of forecasted transactions; and
hedges of foreign currency exposures of net investments in foreign operations.
SFAS No. 133 is effective for years beginning after June 15, 1999, with earlier
adoption permitted. The Company believes that the effect of adoption of SFAS No.
133 will not be material.
Accounting by Insurance and Other Enterprises for
Insurance-Related Assessments
In 1997, the AICPA issued Statement of Position (SOP) 97-3, "Accounting by
Insurance and Other Enterprises for Insurance-Related Assessments," which
provides guidance for determining when to recognize, and how to determine, a
liability for guaranty-fund and other insurance-related assessments. SOP 97-3 is
effective for financial statements issued for fiscal years beginning after
December 15, 1998. The Company expects to adopt this SOP on January 1, 1999 and
currently believes that the cumulative effect of this change in accounting
principle will not be material.
Accounting for Costs of Computer Software Developed or
Obtained for Internal Use
In March 1998, the AICPA issued SOP 98-1, "Accounting for Costs of Computer
Software Developed or Obtained for Internal Use." This SOP requires that certain
costs related to the development or purchase of internal-use software be
capitalized and amortized over the estimated useful life of the software. This
SOP also requires that costs related to the preliminary project stage and the
post-implementation/operations stage in an internal-use computer software
development project be expensed as incurred. SOP 98-1 is effective for financial
statements issued for fiscal years beginning after December 15, 1998. The
Company expects to adopt this SOP on January 1, 1999 and is currently assessing
its impact on the Company's financial reporting.
Quantitative and Qualitative Disclosure
About Market Risk
Interest Rate Risk
The Company's exposure to market risk for changes in interest rates is
concentrated in its investment portfolio and, to a lesser extent, its debt
obligations. The Company monitors this exposure through periodic reviews of
asset and liability positions. Estimates of cash flows and the impact of
interest rate fluctuations relating to the investment portfolio are modeled
regularly.
Principal cash flows and related weighted-average interest rates by expected
maturity dates for financial instruments sensitive to interest rates at December
31, 1998 are as follows:
Principal Weighted-Average
Cash Interest
Flows Rate
- -------------------------------------------------------------------------------
Fixed maturities and
short-term investments:
1999 $ 47,671,887 5.78%
2000 18,010,000 5.79%
2001 14,625,261 6.87%
2002 9,911,162 6.07%
2003 13,100,000 5.71%
Thereafter 141,981,802 5.82%
- -------------------------------------------------------------------------------
Total $245,300,112
===============================================================================
Market value $252,681,041
===============================================================================
Debt
1999 $ 0 7.42%
2000 0 7.42%
2001 5,500,000 7.42%
2002 8,000,000 7.42%
2003 8,000,000 7.42%
Thereafter 16,000,000 7.42%
- -------------------------------------------------------------------------------
Total $ 37,500,000
===============================================================================
Fair value $ 37,500,000
===============================================================================
Actual cash flows may differ from those stated as a result of calls and
prepayments.
Equity Price Risk
The Company's portfolio of equity securities, which is carried on the balance
sheet at market value, has exposure to price risk. Price risk is defined as the
potential loss in market value resulting from an adverse change in prices.
Portfolio characteristics are analyzed regularly and market risk is actively
managed through a variety of techniques. The portfolio is diversified across
industries, and concentrations in any one company or industry are limited by
parameters established by management.
The combined total of realized and unrealized equity investment gains and
(losses) were ($307,147), $586,178, and $199,733 in 1998, 1997 and 1996,
respectively. During these three years the largest total equity investment gain
and (loss) in a quarter was $897,971 and ($1,435,101), respectively.
Donegal Group Annual Report 1998 / 15
<PAGE>
Donegal Group Inc.
Consolidated Balance Sheets
<TABLE>
<CAPTION>
Year Ended December 31, 1998 1997
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Assets
Investments
Fixed maturities
Held to maturity, at amortized cost (fair value $131,633,299 and $120,882,886) $127,183,788 $117,246,205
Available for sale, at fair value (amortized cost $89,089,995 and $56,922,342) 90,525,855 57,731,251
Equity securities, available for sale, at fair value (cost $6,206,735 and $6,551,020) 6,763,943 7,274,562
Short-term investments, at cost, which approximates fair value 30,521,887 22,712,787
- --------------------------------------------------------------------------------------------------------------------------------
Total investments 254,995,473 204,964,805
Cash 8,227,042 3,413,315
Accrued investment income 3,164,599 2,741,207
Premiums receivable 19,824,894 11,244,628
Reinsurance receivable 48,339,223 40,953,032
Deferred policy acquisition costs 11,334,301 8,448,060
Federal income taxes receivable 227,841 56,454
Deferred tax asset, net 3,536,692 3,302,043
Prepaid reinsurance premiums 27,203,111 22,882,283
Property and equipment, net 5,920,420 4,938,524
Accounts receivable--securities 329,299 456,493
Due from affiliate -- 141,313
Other 2,128,611 562,348
================================================================================================================================
Total assets $385,231,506 $304,104,505
================================================================================================================================
Liabilities and Stockholders' Equity
Liabilities
Losses and loss expenses $141,409,008 $118,112,390
Unearned premiums 94,722,785 71,367,691
Accrued expenses 4,821,594 3,214,767
Drafts payable 1,394,373 --
Reinsurance balances payable 1,785,914 735,009
Cash dividend declared to stockholders 708,513 604,054
Borrowings under line of credit 37,500,000 10,500,000
Accounts payable--securities 503,840 2,499,059
Due to affiliate - Pioneer acquisition -- 5,191,774
Due to affiliate - other 870,083 --
Other 884,392 283,098
================================================================================================================================
Total liabilities 284,600,502 212,507,842
================================================================================================================================
Stockholders' Equity
Preferred stock, $1.00 par value, authorized 1,000,000 shares; none issued
Common stock, $1.00 par value, authorized 15,000,000 shares,
issued 8,325,221 and 6,122,431 shares and outstanding
8,202,933 and 6,030,715 shares 8,325,221 6,122,431
Additional paid-in capital 41,271,322 38,932,117
Accumulated other comprehensive income 1,315,425 1,011,417
Retained earnings 50,610,792 46,422,454
Treasury stock, at cost (891,756) (891,756)
- --------------------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 100,631,004 91,596,663
================================================================================================================================
Total liabilities and stockholders' equity $385,231,506 $304,104,505
================================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
16 / Donegal Group Annual Report 1998
<PAGE>
Donegal Group Inc.
Consolidated Statements of Income and Comprehensive Income
<TABLE>
<CAPTION>
Year Ended December 31, 1998 1997 1996
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Statements of Income
Revenues
Premiums earned $172,507,090 $159,055,645 $145,712,891
Premiums ceded 56,338,098 51,753,477 41,185,853
- ---------------------------------------------------------------------------------------------------------------------------------
Net premiums earned 116,168,992 107,302,168 104,527,038
Investment income, net of investment expenses 11,997,661 11,507,277 10,799,369
Installment payment fees 895,283 818,981 786,779
Lease income 753,408 643,183 541,010
Service fees 784,583 741,861 754,734
Net realized investment gains (losses) (13,562) 314,136 172,734
- ---------------------------------------------------------------------------------------------------------------------------------
Total revenues 30,586,365 121,327,606 117,581,664
- ---------------------------------------------------------------------------------------------------------------------------------
Expenses
Losses and loss expenses 110,448,552 99,408,492 98,615,417
Reinsurance recoveries 37,281,467 31,751,974 28,194,493
- ---------------------------------------------------------------------------------------------------------------------------------
Net losses and loss expenses 73,167,085 67,656,518 70,420,924
Amortization of deferred policy acquisition costs 19,490,000 18,696,000 17,032,000
Other underwriting expenses 21,712,346 17,058,668 15,876,797
Policy dividends 1,635,300 1,319,384 1,609,369
Interest 1,292,992 910,237 375,311
Other 1,611,627 1,513,256 1,530,635
- ---------------------------------------------------------------------------------------------------------------------------------
Total expenses 118,909,350 107,154,063 106,845,036
- ---------------------------------------------------------------------------------------------------------------------------------
Income before income taxes 11,677,015 14,173,543 10,736,628
Income taxes 2,659,175 3,532,357 2,178,854
- ---------------------------------------------------------------------------------------------------------------------------------
Net income $ 9,017,840 $ 10,641,186 $ 8,557,774
=================================================================================================================================
Net income per common share
Basic $ 1.11 $ 1.33* $ 1.10*
=================================================================================================================================
Diluted $ 1.09 $ 1.32* $ 1.09*
=================================================================================================================================
Statements of Comprehensive Income
Net income $ 9,017,840 $ 10,641,186 $ 8,557,774
- ---------------------------------------------------------------------------------------------------------------------------------
Other comprehensive income (loss), net of tax
Unrealized gains on securities:
Unrealized holding gain (loss) arising during the period,
net of income tax expense (benefit) of
$151,999, $409,974 and ($186,364) 295,057 795,831 (361,766)
Reclassification adjustment for (gains) losses included
in net income, net of income tax expense (benefit) of
($4,611), $106,806 and $58,730 8,951 (207,330) (114,004)
- ---------------------------------------------------------------------------------------------------------------------------------
Other comprehensive income (loss) 304,008 588,501 (475,770)
- ---------------------------------------------------------------------------------------------------------------------------------
Comprehensive income $ 9,321,848 $ 11,229,687 $ 8,082,004
=================================================================================================================================
</TABLE>
* Restated for 4-for-3 stock split
See accompanying notes to consolidated financial statements.
Donegal Group Annual Report 1998 / 17
<PAGE>
Donegal Group Inc.
Consolidated Statements of Stockholders' Equity
<TABLE>
<CAPTION>
Accumulated
Preferred Stock Common Stock Additional Other Total
------------------------------------- Paid-in Comprehensive Retained Treasury Stockholders'
Shares Amount Shares Amount Capital Income Earnings Stock Equity
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance,
January 1, 1996 0 $ 0 4,326,362 $4,326,362 $35,564,792 $ 898,696 $33,050,629 $(819,780) $ 73,020,689
- -----------------------------------------------------------------------------------------------------------------------------------
Issuance of common stock 214,207 214,207 2,297,923 2,512,130
Net income 8,557,774 8,557,774
Other comprehensive loss (475,770) (475,770)
Purchase of 43,739 shares
of treasury stock (71,976) (71,976)
Cash dividends
$.2475 per share* (1,943,573) (1,943,573)
- -----------------------------------------------------------------------------------------------------------------------------------
Balance,
December 31, 1996 0 $ 0 4,540,569 $4,540,569 $37,862,715 $ 422,916 $39,664,830 $(891,756) $ 81,599,274
- -----------------------------------------------------------------------------------------------------------------------------------
Issuance of common stock 61,523 61,523 1,069,402 1,130,925
Net income 10,641,186 10,641,186
Other comprehensive income 588,501 588,501
Cash dividends
$.2925 per share* (2,363,223) (2,363,223)
Stock dividend 1,520,339 1,520,329 (1,520,329)
- -----------------------------------------------------------------------------------------------------------------------------------
Balance,
December 31, 1997 0 $ 0 6,122,431 $6,122,431 $38,932,117 $1,011,417 $46,422,454 $(891,756) $ 91,596,663
- -----------------------------------------------------------------------------------------------------------------------------------
Issuance of common stock 141,542 141,542 2,339,205 2,480,747
Net income 9,017,840 9,017,840
Other comprehensive income 304,008 304,008
Cash dividends
$.3375 per share* (2,768,254) (2,768,254)
Stock dividend 2,061,248 2,061,248 (2,061,248)
- -----------------------------------------------------------------------------------------------------------------------------------
Balance,
December 31, 1998 0 $ 0 8,325,221 $8,325,221 $41,271,322 $1,315,425 $50,610,792 $(891,756) $100,631,004
===================================================================================================================================
</TABLE>
* Restated for 4-for-3 stock split
See accompanying notes to consolidated financial statements.
18 / Donegal Group Annual Report 1998
<PAGE>
Donegal Group Inc.
Consolidated Statements of Cash Flow
<TABLE>
<CAPTION>
Year Ended December 31, 1998 1997 1996
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash Flows from Operating Activities:
Net income $ 9,017,840 $10,641,186 $ 8,557,774
- ------------------------------------------------------------------------------------------------------------------------------------
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 520,675 390,857 256,694
Realized investment (gains) losses 13,562 (314,136) (172,734)
Changes in Assets and Liabilities, net of acquisition:
Losses and loss expenses 7,125,806 3,490,429 15,727,682
Unearned premiums 6,478,435 811,785 13,923,360
Accrued expenses (542,693) 827,727 (300,425)
Premiums receivable (1,253,529) (169,213) 1,509,474
Deferred policy acquisition costs (399,428) (610,161) (935,681)
Deferred income taxes 158,593 7,108 3,380
Reinsurance receivable (6,182,621) (78,023) (12,649,518)
Accrued investment income (186,170) (112,644) (124,330)
Amounts due from affiliate (4,180,378) (438,442) 1,514,009
Reinsurance balances payable (127,931) (11,926) 64,586
Prepaid reinsurance premiums (3,819,226) (508,964) (9,281,222)
Current income taxes (171,387) (700,983) 1,353,718
Other, net 100,292 192,808 44,969
- ------------------------------------------------------------------------------------------------------------------------------------
Net adjustments (2,466,000) 2,776,222 10,933,962
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 6,551,840 13,417,408 19,491,736
- ------------------------------------------------------------------------------------------------------------------------------------
Cash Flows from Investing Activities:
Purchase of fixed maturities
Held to maturity (24,774,417) (15,834,418) (30,795,475)
Available for sale (43,662,157) (21,614,427) (21,900,833)
Purchase of equity securities (15,824,465) (10,598,546) (9,077,146)
Sale of fixed maturities
Available for sale 2,207,500 -- 7,247,675
Maturity of fixed maturities
Held to maturity 24,815,155 11,909,421 11,996,190
Available for sale 16,106,644 18,860,222 17,634,933
Sale of equity securities 16,155,130 6,695,236 9,493,480
Acquisition of Delaware Atlantic -- -- (202,243)
Acquisition of Southern Heritage (18,028,072) -- --
Purchase of property and equipment (650,014) (2,758,851) (255,754)
Net sales (purchases) of short-term investments 15,099,631 (1,242,030) (6,391,292)
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (28,555,065) (14,583,393) (22,250,465)
- ------------------------------------------------------------------------------------------------------------------------------------
Cash Flows from Financing Activities:
Issuance of common stock 2,480,747 1,130,925 2,512,130
Borrowings under line of credit, net 27,000,000 2,000,000 3,500,000
Cash dividends paid (2,663,795) (2,251,788) (1,878,648)
Purchase of treasury stock -- -- (71,976)
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 26,816,952 879,137 4,061,506
- ------------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash 4,813,727 (286,848) 1,302,777
Cash at beginning of year 3,413,315 3,700,163 2,397,386
===================================================================================================================================
Cash at end of year $ 8,227,042 $ 3,413,315 $ 3,700,163
===================================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.
Donegal Group Annual Report 1998 / 19
<PAGE>
Notes to Consolidated Financial Statements
1--Summary of Significant Accounting Policies
Organization and Business
Donegal Group Inc. (the "Company") was organized as a regional insurance holding
company by Donegal Mutual Insurance Company (the "Mutual Company") and operates
in the Mid-Atlantic and Southern states through its wholly-owned stock insurance
companies, Atlantic States Insurance Company ("Atlantic States"), Southern
Insurance Company of Virginia ("Southern"), Southern Heritage Insurance Company
("Southern Heritage"), Delaware Atlantic Insurance Company ("Delaware"), and
Pioneer Insurance Company ("Pioneer") (collectively "Insurance Subsidiaries").
The Company has three operating segments: the investment function, the personal
lines of insurance and the commercial lines of insurance. Products offered in
the personal lines of insurance consist primarily of homeowners and private
passenger automobile policies. Products offered in the commercial lines of
insurance consist primarily of commercial automobile, commercial multiple peril
and workers' compensation policies. The Insurance Subsidiaries are subject to
regulation by Insurance Departments in those states in which they operate and
undergo periodic examination by those departments. The Insurance Subsidiaries
are also subject to competition from other insurance carriers in their operating
areas. Atlantic States participates in an intercompany pooling arrangement with
the Mutual Company and assumes 65% of the pooled business. Southern cedes 50% of
its business to the Mutual Company and Delaware cedes 70% of its Workers'
Compensation business to the Mutual Company. At December 31, 1998, the Mutual
Company held 60% of the outstanding common stock of the Company.
On June 25, 1998, the Company issued a 4-for-3 stock split in the form of a
33 1/3% stock dividend to stockholders of record as of June 10, 1998. Per share
information prior to June 25, 1998, has been restated for this change.
In addition to the Company's Insurance Subsidiaries, it also owns all of the
outstanding stock of Atlantic Insurance Services, Inc. ("AIS"), an insurance
services organization currently providing inspection and policy auditing
information on a fee-for-service basis to its affiliates and the insurance
industry.
Basis of Consolidation
The consolidated financial statements, which have been prepared in accordance
with generally accepted accounting principles, include the accounts of Donegal
Group Inc. and its wholly-owned subsidiaries. All significant inter-company
accounts and transactions have been eliminated in consolidation. The term
"Company" as used herein refers to the consolidated entity.
Use of Estimates
In preparing the consolidated financial statements, management is required to
make estimates and assumptions that affect the reported amounts of assets and
liabilities as of the date of the balance sheet and revenues and expenses for
the period. Actual results could differ significantly from those estimates.
Material estimates that are particularly susceptible to significant change in
the near-term relate to the determination of the liabilities for losses and loss
expenses. While management uses available information to provide for such
liabilities, future changes to these liabilities may be necessary based on
changes in trends in claim frequency and severity.
Investments
The Company classifies its debt and equity securities into the following
categories:
Held to Maturity--Debt securities that the Company has the positive intent
and ability to hold to maturity; reported at amortized cost.
Available for Sale--Debt and equity securities not classified as held to
maturity; reported at fair value, with unrealized gains and losses excluded
from income and reported as a separate component of stockholders' equity (net
of tax effects).
Short-term investments are carried at amortized cost, which approximates fair
value.
If there is a decline in fair value below amortized cost which is other than
temporary, the cost basis for such investments in the held to maturity and
available for sale categories is reduced to fair value. Such decline in cost
basis is recognized as a realized loss and charged to income.
Premiums and discounts on debt securities are amortized over the life of the
security as an adjustment to yield using the effective interest method. Realized
investment gains and losses are computed using the specific identification
method.
Premiums and discounts for mortgage-backed debt securities are amortized
using anticipated prepayments with significant changes in estimated prepayments
accounted for under the prospective method.
20 / Donegal Group Annual Report 1998
<PAGE>
Fair Values of Financial Instruments
The Company has used the following methods and assumptions in estimating its
fair value disclosures:
Investments--Fair values for fixed maturity securities are based on quoted
market prices, when available. If quoted market prices are not available,
fair values are based on quoted market prices of comparable instruments or
values obtained from independent pricing services through a bank trustee. The
fair values for equity securities are based on quoted market prices.
Cash and Short-Term Investments--The carrying amounts reported in the balance
sheet for these instruments approximate their fair values.
Premium and Reinsurance Receivables and Payables--The carrying amounts
reported in the balance sheet for these instruments approximate their fair
values.
Borrowings Under Line of Credit--The carrying amounts reported in the balance
sheet for the line of credit approximate fair value due to the variable rate
nature of the line of credit.
Revenue Recognition
Insurance premiums are recognized as income over the terms of the policies.
Unearned premiums are calculated on a daily pro-rata basis.
Policy Acquisition Costs
Policy acquisition costs, consisting primarily of commissions, premium taxes and
certain other variable underwriting costs, are deferred and amortized over the
period in which the premiums are earned. Anticipated losses and loss expenses,
expenses for maintenance of policies in force and anticipated investment income
are considered in the determination of the recoverability of deferred
acquisition costs.
Property and Equipment
Property and equipment are reported at depreciated cost that is computed using
the straight-line method based upon estimated useful lives of the assets.
Losses and Loss Expenses
The liability for losses and loss expenses includes amounts determined on the
basis of estimates for losses reported prior to the close of the accounting
period and other estimates, including those for incurred but not reported losses
and salvage and subrogation recoveries.
These liabilities are continuously reviewed and updated by management, and
management believes that such liabilities are adequate to cover the ultimate net
cost of claims and expenses. When management determines that changes in
estimates are required, such changes are included in current earnings.
The Company has no material exposures to environmental liabilities.
Income Taxes
The Company and its subsidiaries currently file a consolidated federal income
tax return.
The Company accounts for income taxes using the asset and liability method.
The objective of the asset and liability method is to establish deferred tax
assets and liabilities for the temporary differences between the financial
reporting basis and the tax basis of the Company's assets and liabilities at
enacted tax rates expected to be in effect when such amounts are realized or
settled.
Credit Risk
The Company provides property and liability coverages through its Insurance
Subsidiaries' independent agency systems located throughout its operating area.
The majority of this business is billed directly to the insured, although a
portion of the Company's commercial business is billed through its agents, who
are extended credit in the normal course of business.
The Company's Insurance Subsidiaries have reinsurance agreements in place
with the Mutual Company and with a number of other authorized reinsurers with at
least an A.M. Best rating of A- or an equivalent financial condition.
Reinsurance Accounting and Reporting
The Company relies upon reinsurance agreements to limit its maximum net loss
from large single risks or risks in concentrated areas, and to increase its
capacity to write insurance. Reinsurance does not relieve the primary insurer
from liability to its policyholders. To the extent that a reinsurer may be
unable to pay losses for which it is liable under the terms of a reinsurance
agreement, the Company is exposed to the risk of continued liability for such
losses. However, in an effort to reduce the risk of non-payment, the Company
requires all of its reinsurers to have an A.M. Best rating of A- or better or,
with respect to foreign reinsurers, to have a financial condition which, in the
opinion of management, is equivalent to a company with at least an A- rating.
Donegal Group Annual Report 1998 / 21
<PAGE>
Stock-Based Compensation
Stock-based compensation plans are accounted for under the provisions of
Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued
to Employees," and related interpretations. As such, compensation expense would
be recorded on the date of a stock option grant only if the current market price
of the underlying stock exceeded the exercise price. Statement of Financial
Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation,"
permits entities to recognize as expense, over the vesting period, the fair
value of all stock-based awards on the date of the grant. Alternatively, SFAS
No. 123 allows entities to continue to apply the provisions of APB Opinion No.
25 and provide pro-forma net income and earnings per share disclosures for
employee stock option grants made as if the fair-value-based method defined in
SFAS No. 123 had been applied. The Company has elected to continue to apply the
provisions of APB Opinion No. 25 and provide the pro-forma disclosures under
SFAS No. 123.
Earnings per Share
Basic earnings per share are calculated by dividing net income by the
weighted-average number of common shares outstanding for the period, while
diluted earnings per share reflects the dilution that could occur if securities
or other contracts to issue common stock were exercised or converted into common
stock.
Comprehensive Income
In 1998, the Company adopted SFAS No. 130, "Comprehensive Income," which
established standards for the reporting and disclosure of comprehensive income
and its components. Comprehensive income consists of net income and net
unrealized investment gains or losses and is presented in the Consolidated
Statements of Income and Comprehensive Income. The adoption of SFAS No. 130 had
no impact on total shareholders' equity. Prior year financial statements have
been reclassified to conform to these requirements.
2--Acquisitions of Businesses
In November 1998, the Company acquired all of the outstanding stock of Southern
Heritage for a cash price of $18,361,279. Southern Heritage primarily writes
personal automobile and homeowners policies in the Southeastern region of the
country. This transaction was accounted for as a "purchase." The Company's
financial statements include Southern Heritage as a consolidated subsidiary from
November 1, 1998.
Assets in the amount of $56,568,710 were acquired, and liabilities in the
amount of $38,330,912 were assumed in the purchase transaction. The purchase
price exceeded the fair value of net assets acquired by $123,481, which is
recognized as goodwill and is being amortized over ten years.
The following table reflects unaudited pro-forma combined results of
operations of the Company and Southern Heritage on the basis that the
acquisition had taken place at the beginning of each year. The pro-forma
information is presented for information purposes only and is not indicative of
the actual results that would have resulted if the acquisition had been made as
of those dates. The pro-forma is not intended to be a projection of future
results.
1998 1997
- -------------------------------------------------------------------------------
Revenues $161,307,562 $157,037,483
Net income 2,978,411 9,558,889
Earnings per common share
Basic .37 1.20
Diluted .36 1.19
The above table includes interest expense and amortization of goodwill as if
the acquisition occurred January 1, 1997.
In March 1997, the Company acquired all of the outstanding stock of Pioneer.
This transaction was accounted for as if it were a "pooling of interest," and as
such the Company's financial statements have been restated to include Pioneer as
a consolidated subsidiary from January 1, 1993 to the present.
3--Transactions with Affiliates
The Company conducts business and has various agreements with the Mutual Company
which are described below.
a. Reinsurance Pooling and Other Reinsurance Arrangements
Atlantic States cedes to the Mutual Company all of its insurance business and
assumes from the Mutual Company 65% of the Mutual Company's total pooled
insurance business, including that assumed from Atlantic States and
substantially all of the business assumed and retained by the Mutual Company
from Southern and Delaware. Atlantic States, Southern, Delaware and Pioneer each
have a catastrophe reinsurance agreement with the Mutual Company which limits
the maximum liability under any one catastrophic occurrence to $400,000,
$300,000, $300,000 and $200,000, respectively, and $700,000 for a catastrophe
involving more than one of the companies. The Mutual Company and Delaware have
an excess of loss reinsurance agreement in which the Mutual Company assumes up
to $200,000 of losses in excess of $50,000 and a workers' compensation quota
share agreement whereby Delaware cedes 70% of that business. The Mutual Company
and Pioneer have an excess of loss reinsurance agreement in which the Mutual
Company assumes up to $200,000 of losses in excess of $50,000. The Mutual
Company and Pioneer also have an aggregate excess of loss reinsurance agreement,
entered into as part of the sale of Pioneer from the Mutual Company to Donegal
Group Inc., in which the Mutual Company agrees to assume the adverse loss
development of claims with dates of loss prior to
22 / Donegal Group Annual Report 1998
<PAGE>
December 31, 1996, as developed through December 31, 1998, and to assume losses
in excess of a 60% loss ratio through December 31, 1998. The Mutual Company and
Southern have an excess of loss reinsurance agreement in which the Mutual
Company assumes up to $25,000 of losses in excess of $100,000 and a quota share
agreement whereby Southern cedes 50% of its direct business less certain
reinsurance to the Mutual Company. Southern, Delaware and Pioneer each have
retrocessional reinsurance agreements effective July 1, 1996 with the Mutual
Company under which they cede, and then assume back, 100% of their business net
of other reinsurance.
The following amounts represent reinsurance transactions with the Mutual
Company during 1998, 1997 and 1996:
Ceded reinsurance: 1998 1997 1996
================================================================================
Premiums written $ 55,372,556 $ 47,946,847 $ 46,443,220
================================================================================
Premiums earned $ 51,617,429 $ 47,488,716 $ 37,175,897
================================================================================
Losses and loss expenses $ 32,791,739 $ 28,582,315 $ 25,838,753
================================================================================
Unearned premiums $ 25,886,653 $ 22,131,526 $ 21,673,395
================================================================================
Liability for losses and
loss expenses $ 39,039,648 $ 35,295,994 $ 33,850,684
================================================================================
Assumed reinsurance:
================================================================================
Premiums written $114,667,549 $107,604,989 $108,982,894
================================================================================
Premiums earned $111,333,956 $107,302,168 $ 95,910,375
================================================================================
Losses and loss expenses $ 69,869,999 $ 68,104,859 $ 65,579,955
================================================================================
Unearned premiums $ 51,819,000 $ 48,485,408 $ 48,182,587
================================================================================
Liability for losses
and loss expenses $ 85,766,514 $ 83,271,292 $ 80,203,642
================================================================================
Losses and loss expenses assumed from the Mutual Company for 1998, 1997 and
1996 are reported net of inter-company catastrophe recoveries which amounted to
approximately $2.3 million, $0, and $9.5 million, respectively.
b. Expense Sharing
The Mutual Company provides facilities, management and other services to the
Company, and the Company reimburses the Mutual Company for such services on a
periodic basis under usage agreements and pooling arrangements. The charges are
based upon the relative participation of the Company and the Mutual Company in
the pooling arrangement, and management of both the Company and the Mutual
Company consider this allocation to be reasonable. Charges for these services
totalled $24,065,066, $21,739,911 and $19,365,166 for 1998, 1997 and 1996,
respectively.
c. Lease Agreement
The Company leases office equipment and automobiles to the Mutual Company under
a 10-year lease dated January 1, 1990. Future annual commitments under these
leases are $723,000 for 1999 and 2000.
d. Inspection and Policy Auditing Services
AIS provides inspection and policy auditing services to the Mutual Company on a
fee-for-service basis. Charges for these services totalled $559,845, $544,651,
and $600,453 for 1998, 1997 and 1996, respectively.
4--Investments
The amortized cost and estimated fair values of fixed maturities and equity
securities at December 31, 1998 and 1997, are as follows:
1998
- --------------------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Held to Maturity Cost Gains Losses Value
- --------------------------------------------------------------------------------
U.S. Treasury securities
and obligations of
U.S. government
corporations
and agencies $ 32,890,694 $ 484,622 $ 29,816 $ 33,345,500
Obligations of states
and political
subdivisions 66,941,133 3,489,849 10,044 70,420,938
Corporate securities 9,131,114 422,916 4,030 9,550,000
Mortgage-backed
securities 18,220,847 96,014 -- 18,316,861
- --------------------------------------------------------------------------------
Totals $127,183,788 $4,493,401 $ 43,890 $131,633,299
================================================================================
1998
- --------------------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Available for Sale Cost Gains Losses Value
- --------------------------------------------------------------------------------
U.S. Treasury securities
and obligations of
U.S. government
corporations
and agencies $ 54,975,813 $ 570,376 $106,689 $ 55,439,500
Obligations of states
and political
subdivisions 19,140,686 822,884 6,497 19,957,073
Corporate securities 10,642,598 150,045 5,324 10,787,319
Mortgage-backed
securities 4,330,898 11,065 -- 4,341,963
Equity securities 6,206,735 743,210 186,002 6,763,943
================================================================================
Totals $ 95,296,730 $2,297,580 $304,512 $ 97,289,798
================================================================================
Donegal Group Annual Report 1998 / 23
<PAGE>
1997
- ------------------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Held to Maturity Cost Gains Losses Value
- ------------------------------------------------------------------------------
U.S. Treasury securities
and obligations of
U.S. government
corporations
and agencies $ 41,450,057 $ 341,162 $ 99,819 $ 41,691,400
Obligations of states
and political
subdivisions 57,620,998 2,955,526 -- 60,576,524
Corporate securities 7,249,829 327,364 6,693 7,570,500
Mortgage-backed
securities 10,925,321 154,057 34,916 11,044,462
- ------------------------------------------------------------------------------
Totals $117,246,205 $3,778,109 $141,428 $120,882,886
==============================================================================
1997
- ------------------------------------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Available for Sale Cost Gains Losses Value
- ------------------------------------------------------------------------------
U.S. Treasury securities
and obligations of
U.S. government
corporations
and agencies $ 40,066,278 $159,106 $28,883 $ 40,196,501
Obligations of states
and political
subdivisions 12,109,254 652,996 -- 12,762,250
Corporate securities 3,247,602 8,412 3,514 3,252,500
Mortgage-backed
securities 1,499,208 20,792 -- 1,520,000
Equity securities 6,551,020 821,409 97,867 7,274,562
- ------------------------------------------------------------------------------
Totals $ 63,473,362 $1,662,715 $130,264 $ 65,005,813
==============================================================================
The amortized cost and estimated fair value of fixed maturities at December
31, 1998, by contractual maturity, are shown below. Expected maturities will
differ from contractual maturities because borrowers may have the right to call
or prepay obligations with or without call or prepayment penalties.
- ------------------------------------------------------------------------------
Estimated
Amortized Fair
Cost Value
- ------------------------------------------------------------------------------
Held to maturity
Due in one year or less $ 1,797,072 $ 1,813,000
Due after one year through five years 23,716,416 24,449,650
Due after five years through ten years 57,304,006 59,895,700
Due after ten years 26,145,447 27,158,088
Mortgage-backed securities 18,220,847 18,316,861
- ------------------------------------------------------------------------------
Total held to maturity $127,183,788 $131,633,299
==============================================================================
Available for sale
Due in one year or less $ 15,348,958 $ 15,441,000
Due after one year through five years 31,110,027 31,386,819
Due after five years through ten years 19,930,607 20,756,500
Due after ten years 18,369,505 18,599,573
Mortgage-backed securities 4,330,898 4,341,963
- ------------------------------------------------------------------------------
Total available for sale $ 89,089,995 $ 90,525,855
==============================================================================
The amortized cost of fixed maturities on deposit with various regulatory
authorities at December 31, 1998 and 1997, amounted to $5,285,367 and
$2,785,752, respectively.
Net investment income of the Company, consisting primarily of interest and
dividends, is attributable to the following sources:
1998 1997 1996
- ------------------------------------------------------------------------------
Fixed maturities $10,981,353 $10,703,397 $ 9,924,660
Equity securities 294,646 238,777 233,072
Short-term investments 1,385,500 1,141,834 1,091,855
Real estate 175,250 127,250 81,650
- ------------------------------------------------------------------------------
Investment income 12,836,749 12,211,258 11,331,237
Investment expenses 839,088 703,981 531,868
- ------------------------------------------------------------------------------
Net investment income $11,997,661 $11,507,277 $10,799,369
==============================================================================
Gross realized gains and losses from sales of investments and the change in
the difference between fair value and cost of investments, before applicable
income taxes, are as follows:
1998 1997 1996
- ------------------------------------------------------------------------------
Gross realized gains:
Fixed maturities $ 132,431 $ 84,196 $ 29,206
Equity securities 1,119,679 408,429 404,381
- ------------------------------------------------------------------------------
1,252,110 492,625 433,587
- ------------------------------------------------------------------------------
Gross realized losses:
Fixed maturities 5,180 694 689
Equity securities 1,260,492 177,795 260,164
- ------------------------------------------------------------------------------
1,265,672 178,489 260,853
- ------------------------------------------------------------------------------
Net realized gains (losses) $ (13,562) $ 314,136 $ 172,734
==============================================================================
Change in difference between
fair value and cost of
investments:
Fixed maturities $ 1,439,782 $ 2,248,484 $ (870,761)
Equity securities (166,335) 355,544 54,461
- ------------------------------------------------------------------------------
$ 1,273,447 $ 2,604,028 $ (816,300)
==============================================================================
Income taxes on realized investment gains were ($4,611), $106,806 and $58,730
for 1998, 1997 and 1996, respectively. Deferred income taxes applicable to net
unrealized investment gains included in shareholders' equity were $677,643 and
$521,033 at December 31, 1998 and 1997, respectively. Donegal Group has not held
or issued derivative financial instruments.
24 / Donegal group Annual Report 1998
<PAGE>
5--Deferred Policy Acquisition Costs
Changes in deferred policy acquisition costs are as follows:
1998 1997 1996
- ------------------------------------------------------------------------------
Balance, January 1 $ 8,448,060 $ 7,837,899 $ 6,902,218
Acquisition of
Southern Heritage 2,486,813 -- --
Acquisition costs deferred 19,889,428 19,306,161 17,967,681
Amortization charged
to earnings 19,490,000 18,696,000 17,032,000
- ------------------------------------------------------------------------------
Balance, December 31 $11,334,301 $ 8,448,060 $ 7,837,899
==============================================================================
6--Property and Equipment
Property and equipment at December 31, 1998 and 1997, consisted of the
following:
- ------------------------------------------------------------------------------
Estimated
Useful
1998 1997 Life
- -------------------------------------------------------------------------------
Cost--office equipment $ 5,648,108 $ 3,653,494 5-15 years
automobiles 890,264 768,643 3 years
leasehold improvements 59,233 59,233 15-40 years
real estate 2,627,597 2,621,896 15-50 years
software 434,344 31,526 5 years
- -------------------------------------------------------------------------------
9,659,546 7,134,792
Accumulated depreciation (3,739,126) (2,196,268)
- ------------------------------------------------------------------------------
$ 5,920,420 $ 4,938,524
===============================================================================
Depreciation expense for 1998, 1997, and 1996 amounted to $559,710, $442,726
and $384,154, respectively.
7--Liability for Losses and Loss Expenses
Activity in the liability for losses and loss expenses is summarized as follows:
1998 1997 1996
- ------------------------------------------------------------------------------
Balance at January 1 $118,112,390 $114,621,961 $ 98,894,279
Less reinsurance
recoverable 40,638,565 39,194,405 27,738,898
- ------------------------------------------------------------------------------
Net balance at January 1 77,473,825 75,427,556 71,155,381
Acquisition of
Southern Heritage 14,967,242 -- --
- ------------------------------------------------------------------------------
New balance at beginning
as adjusted 92,441,067 75,427,556 71,155,381
- ------------------------------------------------------------------------------
Incurred related to:
Current year 75,463,085 69,040,518 73,211,924
Prior years (2,296,000) (1,384,000) (2,791,000)
- ------------------------------------------------------------------------------
Total incurred 73,167,085 67,656,518 70,420,924
- ------------------------------------------------------------------------------
Paid related to:
Current year 44,388,736 39,133,249 42,669,749
Prior years 27,356,000 26,477,000 23,479,000
- ------------------------------------------------------------------------------
Total paid 71,744,736 65,610,249 66,148,749
- ------------------------------------------------------------------------------
Net balance at
December 31 93,863,416 77,473,825 75,427,556
Plus reinsurance
recoverable 47,545,592 40,638,565 39,194,405
- ------------------------------------------------------------------------------
Balance at December 31 $141,409,008 $118,112,390 $114,621,961
==============================================================================
The Company recognized a decrease in the liability for losses and loss
expenses of prior years (favorable development) of $2.3 million, $1.4 million
and $2.8 million in 1998, 1997 and 1996, respectively. These favorable
developments are primarily attributable to lower-than-expected claim severity in
the private passenger automobile liability, workers' compensation and commercial
multiple peril lines of business.
8--Line of Credit
At December 31, 1998, pursuant to a credit agreement dated December 29, 1995,
and amended as of July 27, 1998, with Fleet National Bank of Connecticut, the
Company had unsecured borrowings of $37.5 million. Such borrowings were made in
connection with the acquisitions of Delaware, Pioneer, and Southern Heritage and
various capital contributions to the subsidiaries. Per the terms of the credit
agreement, the Company may borrow up to $40 million at interest rates equal to
the bank's then current prime rate or the then current London interbank
Eurodollar bank rate plus 1.70%. At December 31, 1998, the interest rates were
7.75% on an outstanding prime rate balance of $22.5 million and 6.93375% on an
outstanding Eurodollar rate balance of $15 million. In addition, the Company
pays a rate of 3/10 of 1% per annum on the average daily unused portion of the
bank's commitment. On each July 27, commencing July 27, 2001, the credit line
will be reduced by $8 million. Any outstanding loan in excess of the remaining
credit line, after such reduction, will then be payable.
9--Unaffiliated Reinsurers
In addition to the primary reinsurance in place with the Mutual Company, the
Insurance Subsidiaries have other reinsurance in place, principally with four
unaffiliated reinsurers. The following amounts represent reinsurance
transactions with unaffiliated reinsurers during 1998, 1997 and 1996:
Ceded reinsurance: 1998 1997 1996
- ------------------------------------------------------------------------------
Premiums written $4,784,768 $4,315,594 $4,023,855
==============================================================================
Premiums earned $4,720,669 $4,264,761 $4,009,956
==============================================================================
Losses and loss expenses $4,489,728 $3,169,659 $2,355,740
==============================================================================
Unearned premiums $1,316,458 $ 750,757 $ 699,924
==============================================================================
Liability for losses and
loss expenses $8,505,944 $5,342,571 $5,343,721
==============================================================================
Donegal Group Annual Report 1998 / 25
<PAGE>
10--Income Taxes
The provision for income tax consists of the following:
1998 1997 1996
- ------------------------------------------------------------------------------
Current $2,500,582 $3,525,249 $2,175,474
Deferred 158,593 7,108 3,380
- ------------------------------------------------------------------------------
Federal tax provision $2,659,175 $3,532,357 $2,178,854
==============================================================================
The effective tax rate is different than the amount computed at the statutory
federal rate of 34% for 1998, 1997 and 1996. The reason for such difference and
the related tax effect are as follows:
1998 1997 1996
- ------------------------------------------------------------------------------
Income before
income taxes $11,677,015 $14,173,543 $10,736,628
==============================================================================
Computed "expected"
taxes at 34% $ 3,970,185 $ 4,819,005 $ 3,650,454
Tax-exempt interest (1,180,773) (1,130,311) (1,076,764)
Dividends received deduction (177,374) (48,477) (48,108)
Deduction for exercise
of option -- (1,700) (399,904)
Other, net 47,137 (106,160) 53,176
- ------------------------------------------------------------------------------
Federal income
tax provision $ 2,659,175 $ 3,532,357 $ 2,178,854
==============================================================================
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at December 31
1998 and 1997, are as follows:
1998 1997
- ------------------------------------------------------------------------------
Deferred tax assets:
Unearned premium $4,593,745 $3,297,008
Loss reserves 4,581,026 4,064,877
Net operating loss carryforward -
Southern Heritage 3,429,107 --
Valuation allowance (3,429,107) --
==============================================================================
Total $9,174,771 $7,361,885
==============================================================================
Deferred tax liabilities:
Depreciation expense $ 425,292 $ 341,945
Deferred policy acquisition costs 3,853,662 2,872,343
Salvage receivable 483,960 324,521
Unrealized gain 875,165 521,033
- ------------------------------------------------------------------------------
Total $5,638,079 $4,059,842
==============================================================================
Net deferred tax assets $3,536,692 $3,302,043
==============================================================================
A valuation allowance is provided when it is more likely than not that some
portion of the tax asset will not be realized. Management has determined that a
valuation allowance related to the net operating loss carryforward of Southern
Heritage should be established at December 31, 1998. Management has determined
that it is not required to establish a valuation allowance for the other
deferred tax assets of $9,174,771 and $7,361,885 at December 31, 1998 and 1997,
since it is more likely than not that the deferred tax assets will be realized
through reversals of existing temporary differences, future taxable income,
carryback to taxable income in prior years, previously realized investment gain
and the implementation of tax planning strategies.
As a result of the acquisition of Southern Heritage, net deferred tax
asset of $549,851 were acquired.
At December 31, 1998 the Company has a net operating loss carryforward
of $10,085,608 which is available to offset taxable income of Southern Heritage.
Such net operating loss carryforward will expire beginning in 2009. Federal
income tax laws limit the amount of net operating loss carryforward that the
Company can use in any one year to $903,056.
11--Stock Compensation Plans
All share data presented in the following sections has been adjusted for the
Company's 4-for-3 stock splits in July 1997 and June 1998.
Equity Incentive Plans
The Company has had an Equity Incentive Plan for key employees since 1986 and
adopted a nearly identical new plan in 1996. Both plans provide for the granting
of awards by the Board of Directors in the form of stock options, stock
appreciation rights, restricted stock or any combination of the above. The new
plan was adopted in 1996 and amended in 1997 making a total of 1,233,141 shares
available. The plans provide that stock options may become exercisable up to 10
years from date of grant, with an option price not less than fair market value
on date of grant. The stock appreciation rights permit surrender of the option
and receipt of the excess of current market price over option price in cash.
Information regarding activity in the Company's stock option plans is
presented below:
Weighted-Average
Number of Exercise Price
Shares Per Share
- -------------------------------------------------------------------------------
Outstanding at December 31, 1995 270,000 $ 8.57
Granted - 1996 -- --
Exercised - 1996 270,000 8.57
Forfeited - 1996 -- --
- -------------------------------------------------------------------------------
Outstanding at December 31, 1996 -- --
Granted - 1997 532,451 13.50
Exercised - 1997 2,963 13.50
Forfeited - 1997 13,632 13.50
- -------------------------------------------------------------------------------
Outstanding at December 31, 1997 515,856 13.50
- -------------------------------------------------------------------------------
Granted - 1998 497,333 18.00
Exercised - 1998 10,073 13.50
Forfeited - 1998 -- --
- -------------------------------------------------------------------------------
Outstanding at December 31, 1998 1,003,116 $15.73
===============================================================================
Exercisable at:
December 31, 1996 -- --
===============================================================================
December 31, 1997 173,333 $13.50
===============================================================================
December 31, 1998 502,965 $15.00
===============================================================================
Shares available for future grants at December 31, 1998 are 216,248.
26 / Donegal Group Annual Report 1998
<PAGE>
The following table summarizes information about fixed stock options at
December 31, 1998:
Exercise Prices
- -------------------------------------------------------------------------------
$13.50 $18.00
- -------------------------------------------------------------------------------
Options outstanding at December 31, 1998:
Number of options 505,783 497,333
- -------------------------------------------------------------------------------
Weighted-average remaining
contractual life 3.0 years 4.25 years
- -------------------------------------------------------------------------------
Options exercisable at December 31, 1998:
Number of options 337,188 165,777
- -------------------------------------------------------------------------------
1996 Equity Incentive Plan For Directors
During 1996 the Company adopted an Equity Incentive Plan For Directors. The plan
was amended in 1998, making 265,735 shares available for award. Awards may be
made in the form of stock options, and the plan additionally provides for the
issuance of 177 shares of restricted stock to each director on the first
business day of January in each year, commencing January 2, 1997. As of December
31, 1998, the Company has 80,004 unexercised options under this plan.
Additionally, 2,124, 2,124 and 0 shares of restricted stock were issued on
January 2, 1998, 1997 and 1996, respectively.
Employee Stock Purchase Plans
During 1996 the Company adopted the 1996 Employee Stock Purchase Plan which
replaced a similar plan that had been adopted effective January 1, 1988. The
1996 plan made 162,873 shares available for issuance.
The 1996 Plan extends over a 10-year period and provides for shares to be
offered to all eligible employees at a purchase price equal to the lesser of 85%
of the fair market value of the Company's common stock on the last day before
the first day of the enrollment period (June 1 and December 31). A summary of
plan activity follows:
Shares Issued
- -------------------------------------------------------------------------------
Price Shares
- -------------------------------------------------------------------------------
January 1, 1996 $ 8.00859 10,009
July 1, 1996 $ 8.24766 10,804
January 1, 1997 $ 8.24766 11,689
July 1, 1997 $ 9.26367 11,357
January 1, 1998 $11.65430 8,901
July 1, 1998 $13.06875 9,179
On January 1, 1999, the Company issued an additional 10,227 shares at a price
of $13.28125 per share under this plan.
Agency Stock Purchase Plan
On December 31, 1996, the Company adopted the Agency Stock Purchase Plan which
made 514,102 shares available for issuance. The plan provides for agents of
affiliated companies of Donegal Group Inc. to invest up to $12,000 per
subscription period (April 1 to September 30 and October 1 to March 31) under
various methods. Stock is issued at the end of the subscription period at a
price equal to 90% of the average market price during the last ten trading days
of the subscription period. During 1998, 1997 and 1996, 35,003, 40,200 and 0
shares, respectively, were issued under this plan.
Pro-forma Disclosures
The weighted-average grant date fair value of options granted for the various
plans during 1998, 1997 and 1996 was $4.48, $4.74 and $3.27, respectively.
The fair values above were calculated based upon risk-free interest rates of
5% for the Stock Purchase Plans and 6% for the Equity Incentive Plans, expected
lives of 6 months for the Stock Purchase Plans and 5 years for the Equity
Incentive Plans, expected volatility of 34% and an expected dividend yield of
2.40%.
The Company applies APB Opinion No. 25 in accounting for its stock-based
compensation plans. Accordingly, no compensation cost has been recognized for
its fixed stock option plans and certain of its stock purchase plans. Had the
Company recognized stock compensation expense in accordance with SFAS No. 123,
net income and earnings per share would have been reduced to the pro-forma
amounts shown below:
1998 1997 1996
- -------------------------------------------------------------------------------
Net income:
As reported $9,017,840 $10,641,186 $8,557,774
Pro-forma 8,362,764 10,263,965 8,530,468
Basic earnings per share:
As reported 1.11 1.33 1.10
Pro-forma 1.03 1.28 1.09
Diluted earnings per share:
As reported 1.09 1.32 1.09
Pro-forma 1.01 1.28 1.08
The calculation of pro-forma net income reflects only options granted in
1998, 1997 and 1996.
Donegal Group Annual Report 1998 / 27
<PAGE>
12--Statutory Net Income, Capital and Surplus and Dividend Restrictions
The following is selected information for the Insurance Subsidiaries as
determined in accordance with accounting practices prescribed or permitted by
insurance regulatory authorities.
1998 1997 1996
- --------------------------------------------------------------------------
Atlantic States
Statutory capital
and surplus $ 62,672,151 $ 56,606,354 $ 47,914,415
=============================================
Statutory unassigned
surplus $ 31,711,287 $ 25,645,490 $ 16,953,551
=============================================
Statutory net income $ 6,480,524 $ 7,349,284 $ 5,410,536
=============================================
- --------------------------------------------------------------------------
Southern
Statutory capital
and surplus $ 6,388,316 $ 7,069,112 $ 6,608,944
=============================================
Statutory unassigned
surplus $ 1,636,046 $ 2,316,842 $ 1,856,674
=============================================
Statutory net income $ 66,297 $ 703,727 $ 255,480
=============================================
- --------------------------------------------------------------------------
Delaware
Statutory capital
and surplus $ 8,548,354 $ 7,657,691 $ 6,798,477
=============================================
Statutory unassigned
surplus $ 3,348,354 $ 2,457,691 $ 1,598,477
=============================================
Statutory net income $ 1,085,807 $ 1,070,463 $ 1,120,952
=============================================
- --------------------------------------------------------------------------
Pioneer
Statutory capital
and surplus $ 5,300,349 $ 5,377,492 $ 5,048,582
=============================================
Statutory unassigned
surplus $ (1,699,651) $ (1,622,508) $ (1,951,418)
=============================================
Statutory net income (loss) $ 188,579 $ 542,799 $ (367,614)
=============================================
- --------------------------------------------------------------------------
Southern Heritage
Statutory capital
and surplus $ 15,805,641 $ 16,532,876 $ 16,504,236
=============================================
Statutory unassigned
surplus $(16,709,674) $(12,482,439) $(12,511,079)
=============================================
Statutory net income (loss) $ (3,937,548) $ 151,135 $ (149,007)
=============================================
- --------------------------------------------------------------------------
The Company's principal source of cash for payment of dividends are dividends
from its Insurance Subsidiaries which are required by law to maintain certain
minimum capital and surplus on a statutory basis and are subject to regulations
under which payment of dividends from statutory surplus is restricted and may
require prior approval of their domiciliary insurance regulatory authorities.
Atlantic States, Southern, Delaware, Pioneer and Southern Heritage are also
subject to Risk Based Capital (RBC) requirements which may further impact their
ability to pay dividends. At December 31, 1998, all five companies' statutory
capital and surplus were substantially above the RBC requirements. At December
31, 1998, amounts available for distribution as dividends to Donegal Group Inc.
without prior approval of insurance regulatory authorities are $6,480,524 from
Atlantic States, $638,832 from Southern, $1,085,807 from Delaware, $530,035 from
Pioneer and $1,580,564 from Southern Heritage.
13--Reconciliation of Statutory Filings to Amounts Reported Herein
The Company's Insurance Subsidiaries are required to file statutory financial
statements with state insurance regulatory authorities. Accounting principles
used to prepare these statutory financial statements differ from financial
statements prepared on the basis of generally accepted accounting principles.
Reconciliations of statutory net income and capital and surplus, as
determined using statutory accounting principles, to the amounts included in the
accompanying financial statements are as follows:
Year Ended December 31,
-----------------------------------------
1998 1997 1996
- --------------------------------------------------------------------------
Statutory net income of
insurance subsidiaries $8,301,081 $ 9,666,273 $6,419,354
Increases (decreases):
Deferred policy
acquisition costs 399,428 610,161 935,681
Deferred federal
income taxes (158,593) (7,108) (3,380)
Salvage and subrogation
recoverable 1,217,092 984,981 1,067,201
Consolidating eliminations
and adjustments (967,940) (950,000) --
Parent-only net income 178,249 291,831 155,894
Non-insurance subsidiary
net income (loss) 48,523 45,048 (16,976)
- --------------------------------------------------------------------------
Net income as
reported herein $9,017,840 $10,641,186 $8,557,774
==========================================================================
December 31,
--------------------------------------
1998 1997 1996
- --------------------------------------------------------------------------
Statutory capital and surplus
of insurance subsidiaries $ 98,714,811 $ 76,710,649 $ 66,370,418
Increases (decreases):
Deferred policy
acquisition costs 11,334,301 8,448,060 7,837,899
Deferred federal
income taxes 3,592,605 3,302,043 3,613,307
Salvage and subrogation
recoverable 7,963,559 6,155,467 5,170,486
Statutory reserves 9,066,998 8,712,694 10,035,325
Non-admitted assets and
other adjustments, net 1,178,102 394,432 355,540
Fixed maturities
available for sale 2,038,604 808,908 271,795
Consolidating eliminations
and adjustments (36,383,362) (16,121,711) (16,121,711)
Parent-only equity 2,843,990 2,953,248 3,878,390
Non-insurance
subsidiary equity 281,396 232,873 187,825
- --------------------------------------------------------------------------
Stockholders' equity as
reported herein $100,631,004 $ 91,596,663 $ 81,599,274
==========================================================================
28 / Donegal Group Annual Report 1998
<PAGE>
14--Supplementary Information on Statement of Cash Flows
The following schedule reflects income taxes and interest paid during 1998, 1997
and 1996:
1998 1997 1996
- --------------------------------------------------------------------------
Income taxes $2,671,969 $4,094,338 $825,136
==========================================================================
Interest $1,270,646 $ 904,385 $369,869
==========================================================================
15--Earnings Per Share
The following information illustrates the computation of net income, outstanding
shares and earnings per share on both a basic and diluted basis for the years
ending December 31, 1998, 1997 and 1996:
Weighted-
Average Earnings
Net Shares Per
Income Outstanding Share
- --------------------------------------------------------------------------
1998:
Basic $ 9,017,840 8,126,286 $1.11
Effect of stock options -- 123,404 (0.02)
- --------------------------------------------------------------------------
Diluted $ 9,017,840 8,249,690 $1.09
==========================================================================
1997:
Basic $10,641,186 7,994,937 $1.33
Effect of stock options -- 41,274 (0.01)
- --------------------------------------------------------------------------
Diluted $10,641,186 8,036,211 $1.32
==========================================================================
1996:
Basic $ 8,557,774 7,814,007 $1.10
Effect of stock options -- 53,818 (0.01)
- --------------------------------------------------------------------------
Diluted $ 8,557,774 7,867,825 $1.09
==========================================================================
16--Condensed Financial Information of Parent Company
Condensed Balance Sheets
($ in thousands)
December 31, 1998 1997
- --------------------------------------------------------------------------
Assets
Investment in subsidiaries (equity method) $134,441 $ 99,857
Cash 599 730
Property and equipment 2,276 2,139
Other 2,124 451
- --------------------------------------------------------------------------
Total assets $139,440 $103,177
==========================================================================
Liabilities and Stockholders' Equity
Liabilities
Cash dividends declared to stockholders $ 708 $ 604
Line of credit 37,500 10,500
Other 601 476
- --------------------------------------------------------------------------
Total liabilities 38,809 11,580
==========================================================================
Stockholders' equity
Preferred stock, $1.00 par value, authorized
1,000,000 shares, none issued
Commonstock, $1.00 par value, authorized
15,000,000 shares, issued 8,325,221
and 6,122,431 shares and outstanding
8,202,933 and 6,030,715 shares 8,325 6,123
Additional paid-in capital 41,271 38,932
Accumulated other comprehensive income 1,316 1,012
Retained earnings, including equity in
undistributed net income of
subsidiaries($64,922 and $56,082) 50,611 46,422
Treasury stock, at cost (892) (892)
- --------------------------------------------------------------------------
Total stockholders' equity 100,631 91,597
- --------------------------------------------------------------------------
Total liabilities and stockholders' equity $139,440 $103,177
==========================================================================
Condensed Statements of Income
($ in thousands)
Years Ended December 31, 1998 1997 1996*
- --------------------------------------------------------------------------
Revenues
Dividends-subsidiaries $1,000 $ 950 $ 0
Other 776 658 572
- --------------------------------------------------------------------------
Total revenues 1,776 1,608 572
==========================================================================
Expenses
Operating expenses 718 643 548
Interest 1,293 1,022 416
- --------------------------------------------------------------------------
Total expenses 2,011 1,665 964
==========================================================================
Income before income tax benefit
and equity in undistributed net
income of subsidiaries (235) (57) (392)
Income tax benefit (413) (346) (533)
- --------------------------------------------------------------------------
Income before equity in undistributed
net income of subsidiaries 178 289 141
Equity in undistributed net income
of subsidiaries 8,840 10,352 8,417
- --------------------------------------------------------------------------
Net income $9,018 $10,641 $8,558
==========================================================================
* Restated
Condensed Statements of Cash Flows
($ in thousands)
Years Ended December 31, 1998 1997 1996
- --------------------------------------------------------------------------
Cash flows from operating activities:
Net income $ 9,018 $ 10,641 $ 8,558
- --------------------------------------------------------------------------
Adjustments:
Equity in undistributed net
income of subsidiaries (8,840) (10,352) (8,417)
Other (921) 382 373
- --------------------------------------------------------------------------
Net adjustments (9,761) (9,970) (8,044)
- --------------------------------------------------------------------------
Net cash provided (743) 671 514
- --------------------------------------------------------------------------
Cash flows from investing activities:
Net purchase of property and
equipment (564) (1,251) (203)
Capital contribution to subsidiaries (2,000) -- (5,000)
Acquisition of Delaware Atlantic -- -- (202)
Acquisition of Southern Heritage (18,361) -- --
Other (5,280) 4 1,110
- --------------------------------------------------------------------------
Net cash used (26,205) (1,247) (4,295)
- --------------------------------------------------------------------------
Cash flows from financing activities:
Cash dividends paid (2,664) (2,252) (1,879)
Issuance of common stock 2,481 1,131 2,512
Purchase of treasury stock -- -- (72)
Line of credit, net 27,000 2,000 3,500
- --------------------------------------------------------------------------
Net cash provided 26,817 879 4,061
Net change in cash (131) 303 280
Cash at beginning of year 730 427 147
- --------------------------------------------------------------------------
Cash at ending of year $ 599 $ 730 $ 427
==========================================================================
Donegal Group Annual Report 1998 / 29
<PAGE>
17--Segment Information
In 1998, Donegal Group Inc. adopted SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information" which establishes standards for reporting
information about operating segments. As an underwriter of property and casualty
insurance, the Company has three reportable segments which consist of the
investment function, the personal lines of insurance and the commercial lines of
insurance. Using independent agents, the Company markets personal lines of
insurance to individuals and commercial lines of insurance to small and
medium-sized businesses.
The Company evaluates the performance of the personal lines and commercial
lines primarily based upon underwriting results as determined under statutory
accounting practices (SAP) for the total business of the Company.
Assets are not allocated to the personal and commercial lines and are
reviewed in total by management for purposes of decision making. Donegal Group
Inc. operates only in the United States and no single customer or agent provides
10 percent or more of revenues.
Financial data by segment is as follows:
1998 1997 1996
---------------------------------
($ in thousands)
- --------------------------------------------------------------------------
Revenues:
Premiums earned:
Commercial lines $ 44,493 $ 45,702 $ 46,171
Personal lines 71,676 61,600 58,356
- --------------------------------------------------------------------------
Total premiums earned 116,169 107,302 104,527
- --------------------------------------------------------------------------
Net investment income 11,998 11,507 10,799
Realized investment
gains (losses) (14) 314 173
Other 2,433 2,205 2,083
- --------------------------------------------------------------------------
Total revenues $130,586 $121,328 $117,582
==========================================================================
Income before income taxes:
Underwriting income (loss):
Commercial lines $ 3,688 $ 3,497 $ 6,121
Personal lines (5,327) (2,734) (8,699)
- --------------------------------------------------------------------------
SAP underwriting gain
(loss) (1,639) 763 (2,578)
GAAP adjustments 1,803 1,809 2,166
- --------------------------------------------------------------------------
GAAP underwriting gain
(loss) 164 2,572 (412)
Net investment income 11,998 11,507 10,799
Realized investment gains (losses) (14) 314 173
Other (471) (219) 177
- --------------------------------------------------------------------------
Income before income taxes $ 11,677 $ 14,174 $ 10,737
==========================================================================
18--Interim Financial Data (unaudited)
1998
------------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
- --------------------------------------------------------------------------
Net premiums
earned $27,204,544 $27,578,257 $28,064,764 $33,321,427
Total revenues 30,896,144 31,023,026 31,654,736 37,012,459
Loss and loss
adjusting
expenses 15,801,905 19,225,138 20,434,534 17,705,508
Net income 3,316,653 1,892,892 44,414 3,763,881
Net income per
common share
Basic $.41 $.22 $.01 $.46
Diluted .40 .22 .01 .46
1997
------------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
- --------------------------------------------------------------------------
Net premiums
earned $26,404,333 $26,823,505 $27,260,693 $26,813,637
Total revenues 29,823,371 30,253,860 30,909,916 30,340,459
Loss and loss
adjusting
expenses 16,912,543 17,329,403 17,111,129 16,303,443
Net income 2,562,433 2,400,597 2,911,728 2,766,428
Net income per
common share
Basic $.32 $.30 $.37 $.35
Diluted .32 .30 .36 .34
30 / Donegal Group Annual Report 1998
<PAGE>
Donegal Group Inc.
Independent Auditors' Report
The Stockholders and Board of Directors
Donegal Group Inc.
We have audited the accompanying consolidated balance sheets of Donegal Group
Inc. as of December 31, 1998 and 1997, and the related consolidated statements
of income and comprehensive income, stockholders' equity, and cash flows for
each of the years in the three-year period ended December 31, 1998. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Donegal
Group Inc. as of December 31, 1998 and 1997, and the results of their operations
and their cash flows for each of the years in the three-year period ended
December 31, 1998 in conformity with generally accepted accounting principles.
KPMG LLP
Philadelphia, Pennsylvania
March 2, 1999
Donegal Group Annual Report 1998 / 31
<PAGE>
Market Information
Donegal Group's common stock is traded on NASDAQ under
the symbol "DGIC." During 1997 and 1998, the stock price
ranged as follows (information prior to June 25, 1998
restated for 4-for-3 stock split on that date):
Cash Dividend
Declared
Quarter High Low Per Share
1997
1st* 14.203 11.25 --
2nd* 14.25 12.75 .0675
3rd* 15.75 13.6875 .075
4th* 16.6875 15.1875 .15
1998
1st* 17.625 15.188 --
2nd* 22.781 16.875 .0825
3rd 19.875 14.250 .085
4th 15.750 12.625 .17
* Restated
EXHIBIT 21
SUBSIDIARIES OF REGISTRANT
Registrant owns 100% of the outstanding stock of the following
insurance companies:
Name State of Formation
- ---- ------------------
Atlantic States Insurance Company Pennsylvania
Southern Insurance Company of Virginia Virginia
Pioneer Insurance Company Ohio
Delaware Atlantic Insurance Company Delaware
Southern Heritage Insurance Company Georgia
Registrant owns 100% of the outstanding stock of the following
business corporation:
Name State of Formation
- ---- ------------------
Atlantic Inspection Services, Inc. Maryland
EXHIBIT 23
Independent Auditors' Consent and Report on Schedules
The Board of Directors
Donegal Group Inc.:
The audits referred to in our report dated March 2, 1999 include the related
financial statement schedules as of December 31, 1998, and for each of the years
in the three-year period ended December 31, 1998, included in the annual report
on Form 10-K. These financial statement schedules are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statement schedules based on our audits. In our opinion, such
financial statement schedules, when considered in relation to the basic
consolidated financial statements taken as a whole, present fairly, in all
material respects, the information set forth therein.
We consent to incorporation by reference in the registration statements (Nos.
333-1287, 333-06681, 33-26693 and 33-61095) on Form S-8 and registration
statement (No. 333-36585) on Form S-3 of Donegal Group Inc. of our report dated
March 2, 1999, relating to the consolidated balance sheets of Donegal Group Inc.
as of December 31, 1998 and 1997, and the related consolidated statements of
income and comprehensive income, stockholders' equity and cash flows and related
financial statement schedules for each of the years in the three-year period
ended December 31, 1998, which report appears in the December 31, 1998 annual
report on Form 10-K of Donegal Group Inc.
KPMG LLP
Philadelphia, Pennsylvania
March 26, 1999
<TABLE> <S> <C>
<ARTICLE> 7
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<DEBT-HELD-FOR-SALE> 90,525,855
<DEBT-CARRYING-VALUE> 127,183,788
<DEBT-MARKET-VALUE> 131,633,299
<EQUITIES> 6,763,943
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 254,995,473
<CASH> 8,227,042
<RECOVER-REINSURE> 0
<DEFERRED-ACQUISITION> 11,334,301
<TOTAL-ASSETS> 385,231,506
<POLICY-LOSSES> 141,409,008
<UNEARNED-PREMIUMS> 94,722,785
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 37,500,000
0
0
<COMMON> 8,325,221
<OTHER-SE> 92,305,783
<TOTAL-LIABILITY-AND-EQUITY> 385,231,506
116,168,992
<INVESTMENT-INCOME> 11,997,661
<INVESTMENT-GAINS> (13,562)
<OTHER-INCOME> 2,433,274
<BENEFITS> 73,167,085
<UNDERWRITING-AMORTIZATION> 19,490,000
<UNDERWRITING-OTHER> 21,712,346
<INCOME-PRETAX> 11,677,015
<INCOME-TAX> 2,659,175
<INCOME-CONTINUING> 9,017,840
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 9,017,840
<EPS-PRIMARY> 1.11
<EPS-DILUTED> 1.09
<RESERVE-OPEN> 92,441,067
<PROVISION-CURRENT> 75,463,085
<PROVISION-PRIOR> (2,296,000)
<PAYMENTS-CURRENT> 44,388,736
<PAYMENTS-PRIOR> 27,356,000
<RESERVE-CLOSE> 93,863,416
<CUMULATIVE-DEFICIENCY> (2,296,000)
</TABLE>
