EX-13 4 w95544exv13.txt 2003 ANNUAL REPORT TO STOCKHOLDERS . . . EXHIBIT 13 SELECTED CONSOLIDATED FINANCIAL DATA
Year Ended December 31, 2003 2002 2001 2000 1999 ----------------------- ------------- ------------- ------------- ------------- ------------- INCOME STATEMENT DATA: Premiums earned $ 196,792,696 $ 185,841,193 $ 167,769,854 $ 151,646,199 $ 145,517,457 Investment income, net 13,315,936 14,581,252 15,885,544 16,394,747 13,590,695 Realized investment gains (losses) 1,368,031 144,190 (880,254) 170,852 (38,702) Total revenues 214,992,328 203,803,561 185,163,623 170,581,587 161,739,336 Income before income taxes 25,436,375 16,494,584 7,091,729 11,743,028 3,844,641 Income taxes (benefit) 7,142,399 4,491,862 1,273,598 2,906,248 (2,950,556) Net income 18,293,976 12,002,722 5,818,131 8,836,780 6,795,197 Basic earnings per common share 1.91 1.32 0.65 1.01 0.82 Diluted earnings per common share 1.85 1.31 0.64 1.01 0.82 Cash dividends per share of common stock (a) N/A N/A N/A 0.36 0.36 Cash dividends per share of Class A common stock (a) .43 0.40 0.40 N/A N/A Cash dividends per share of Class B common stock (a) .39 0.36 0.36 N/A N/A BALANCE SHEET DATA AT YEAR END: Total investments $ 421,276,467 $ 332,299,094 $ 300,633,355 $ 289,344,642 $ 268,010,854 Total assets 602,036,042 501,218,164 456,632,372 426,008,780 389,688,804 Debt obligations 25,774,000 19,800,000 27,600,000 40,000,000 37,000,000 Stockholders' equity 208,649,232 133,182,850 120,928,349 114,129,591 103,792,334 Stockholders' equity per share 16.29 14.52 13.44 12.88 12.28
In January 2001, the Company acquired all of the outstanding stock of Pioneer-New York from the Mutual Company, which previously owned 100% of Pioneer-New York. The acquisition has been accounted for as a reorganization of entities under common control, similar to a pooling of interests, as both Pioneer-New York and the Company are under the common management and control of the Mutual Company. As such, all financial data prior to January 1, 2001 has been restated to include Pioneer-New York as a consolidated subsidiary. (a) In April 2001, the Company reclassified its common stock as Class B common stock and created a new class of common stock with one-tenth of a vote per share designated as Class A common stock. Also in April 2001, the Company effected a one-for-three reverse split of the Company's Class B common stock and issued a dividend of two shares of Class A common stock for each share of Class B common stock. The effect of the reverse split and the stock dividend taken together is that the Company had the same total number of shares outstanding after the reverse split and the stock dividend as it did before the reverse split and the stock dividend. Therefore, there was no change in the historical earnings per share of the Class A common stock and the Class B common stock. page 8 FINANCIAL INFORMATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION ........................................................ 10 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 CORPORATE INFORMATION .......................................................... 32
page 9 MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION GENERAL We were organized as a regional insurance holding company by Donegal Mutual Insurance Company (the "Mutual Company") on August 26, 1986. We operate predominantly as an underwriter of personal and commercial lines of property and casualty insurance through our subsidiaries. Our personal lines products consist primarily of homeowners and private passenger automobile policies. Our commercial lines products consist primarily of commercial automobile, commercial multiple peril and workers' compensation policies. Our two insurance subsidiaries, Atlantic States Insurance Company ("Atlantic States") and Southern Insurance Company of Virginia ("Southern") write personal and commercial lines of property and casualty coverages exclusively through a network of independent insurance agents in the Mid-Atlantic and Southern states. In January 2004, we acquired Le Mars Insurance Company ("Le Mars") and the Peninsula Insurance Group ("Peninsula"), which consists of Peninsula Indemnity Company and The Peninsula Insurance Company. We also own 47.5% of the outstanding stock of Donegal Financial Services Corporation ("DFSC"), a thrift holding company. The Mutual Company owns the remaining 52.5% of the outstanding stock of DFSC. At December 31, 2003, the Mutual Company held approximately 42% of our outstanding Class A common stock and approximately 62% of our outstanding Class B common stock. We refer to the Mutual Company and our insurance subsidiaries as the Donegal Insurance Group. TRANSACTIONS WITH AFFILIATES Atlantic States, our largest subsidiary, and the Mutual Company have a pooling agreement under which both companies are allocated a given percentage of their combined underwriting results, excluding certain reinsurance assumed by the Mutual Company from our insurance subsidiaries. Atlantic States has a 70% share of the results of the pool, and the Mutual Company has a 30% share of the results of the pool. The pooling agreement is intended to produce more uniform and stable underwriting results from year to year for each pool participant than they would experience individually and to spread the risk of loss among the participants based on each participant's relative amount of surplus and relative access to capital. Each participant in the pool has at its disposal the capacity of the entire pool, rather than being limited to policy exposures of a size commensurate with its own capital and surplus. In addition to the pooling agreement and third-party reinsurance, our insurance subsidiaries have various reinsurance arrangements with the Mutual Company. These agreements include: - catastrophe reinsurance agreements with each of our insurance subsidiaries, - an excess of loss reinsurance agreement with Southern - a workers' compensation reallocation agreement with Southern and - a 100% retrocessional agreement with Southern. The excess of loss and catastrophe reinsurance agreements are intended to lessen the effects of a single large loss, or an accumulation of losses arising from one event, to levels that are appropriate given each subsidiary's size, underwriting profile and surplus position. The Mutual Company and Southern have an agreement in place to reallocate the loss results of workers' compensation business written by Southern as part of commercial accounts primarily written by the Mutual Company or Atlantic States. This agreement provides for the workers' compensation loss ratio of Southern to be no worse than the average workers' compensation loss ratio for the Donegal Insurance Group. Southern has a 100% retrocessional agreement between the Mutual Company that is intended to provide Southern with the same A.M. Best rating, currently A (Excellent), as the Mutual Company, which Southern might not be able to achieve without this agreement in place. The retrocessional agreement does not otherwise provide for pooling or reinsurance with or by the Mutual Company and does not transfer insurance risk. The Mutual Company provides facilities, personnel and other services to us, and the related expenses are allocated between Atlantic States and the Mutual Company in relation to their relative participation in the pooling agreement. Southern reimburses the Mutual Company for its personnel costs and bears its proportionate share of information services costs based on its percentage of total written premiums of the Donegal Insurance Group. Subsequent to the receipt of applicable board approvals, all agreements and all changes to existing agreements between our subsidiaries and the Mutual Company are subject to approval by a coordinating committee that is comprised of two of our board members who do not serve on the Mutual Company board and two board members of the Mutual Company who do not serve on our board. In order to approve an agreement or a change in an agreement, our members on the coordinating committee must conclude that the agreement or change is fair to us and our stockholders, and the Mutual Company's members on the coordinating committee must conclude that the agreement or change is fair to the Mutual Company and its policyholders. page 10 CRITICAL ACCOUNTING POLICIES AND ESTIMATES Our financial statements are combined with those of our insurance subsidiaries and are presented on a consolidated basis in accordance with United States generally accepted accounting principles. We make estimates and assumptions that can have a significant effect on amounts and disclosures we report in our financial statements. The most significant estimates relate to our reserves for property and casualty insurance unpaid losses and loss expenses, valuation of investments, policy acquisition costs and guaranty fund liability accruals. While we believe our estimates are appropriate, the ultimate amounts may differ from the estimates provided. The methods for making these estimates are reviewed on a regular basis, and any adjustment considered necessary is reflected in our current results of operations. LIABILITY FOR LOSSES AND LOSS EXPENSES With respect to reserves for property and casualty unpaid losses and loss expenses, significant components of our estimates include a variety of factors such as medical inflation trends, regulatory and judicial rulings, legal settlements, property replacements, repair cost trends and losses for assumed reinsurance. In recent years, certain of these component costs, such as medical inflation trends and legal settlements, have experienced significant volatility and resulted in incurred amounts higher than our original estimates, and we have factored these changes in trends into our loss estimates. However, due to the nature of these liabilities, actual results could ultimately vary significantly from the amounts recorded. Loss reserves are set at full-expected cost. Inflation is implicitly provided for in the reserving function through analysis of costs, trends and reviews of historical reserving results. We occasionally receive new information on files that had previously been closed. For example, one of our policyholders may incur losses that were not known at the time of the original claim settlement. We are also exposed to larger than historical settlements due to changes in law, precedent or underlying inflation on pending and unreported claims. When we experience adverse development of losses from prior accident years, our current year underwriting results are negatively impacted. To the extent our prior year reserve deficiencies are indicative of deteriorating underlying loss trends and are material, we seek to increase the pricing of affected lines of business to the extent permitted by state departments of insurance. We also review trends in loss development in order to determine if adjustments, such as reserve strengthening, are appropriate. Because of our participation in the pool, we are exposed to adverse loss development on the business of the Mutual Company included in the pool. INVESTMENTS We make estimates concerning the valuation of our investments and the recognition of other than temporary declines in the value of our investments. When we consider the decline in value of an individual investment to be other than temporary, we write down the investment to its estimated net realizable value, and the amount of the write-down is reflected as a realized loss in our statement of income. We individually monitor all investments for other than temporary declines in value. Generally, if an individual equity security has depreciated in value by more than 20% of original cost, and has been in an unrealized loss position for more than six months, we assume there has been an other than temporary decline in value. With respect to debt securities, we assume there has been an other than temporary decline in value if it is probable that contractual payments will not be received. In addition, we may write down securities in an unrealized loss position based on a number of other factors, including: the fair value of the investment being significantly below its cost, the deteriorating financial condition of the issuer of a security, the occurrence of industry, company and geographic events that have negatively impacted the value of a security or rating agency downgrades. Our investments in available-for-sale fixed maturity and equity securities are presented at estimated fair value, which generally represents quoted market prices. During 2003, we sold certain bonds that had been classified as held to maturity due to a series of rating agency downgrades. These bonds had an amortized cost of $1.8 million, and the sale resulted in a realized gain of $165,564. During 2002, we sold certain bonds that had been classified as held to maturity due to significant deterioration in the issuer's credit worthiness. These bonds had an amortized cost of $488,901, and the sale resulted in a realized loss of $73,901. There were no other sales or transfers from the held to maturity portfolio in 2003 and 2002. POLICY ACQUISITION COSTS Policy acquisition costs, consisting primarily of commissions, premium taxes and certain other underwriting costs that vary with and are directly related to the production of business, are deferred and amortized over the period in which the premiums are earned. The method followed in computing deferred policy acquisition costs limits the amount of such deferred costs to their estimated realizable value, which gives effect to the premium to be earned, related investment income, losses and loss expenses and certain other costs expected to be incurred as the premium is earned. GUARANTY FUND LIABILITY ACCRUALS We make estimates of our insurance subsidiaries' liabilities for guaranty fund and other assessments because of insurance company insolvencies from states in which the subsidiaries are licensed. Generally, an insurer is subject to assessment, depending upon its market share of a given line of business, to assist in the payment of unpaid claims and related costs of insolvent insurance companies. We generally record our liability for such assessments as premiums upon which those assessments are based are written. As a result of several large insolvencies in recent years, we are currently being assessed at the maximum level permitted by Pennsylvania law for several of our lines of business, and we expect we will continue to be assessed by Pennsylvania at the maximum level for these business lines for a number of years. page 11 MANAGEMENT EVALUATION OF OPERATING RESULTS We evaluate the performance of the commercial lines and personal lines segments primarily based upon underwriting results as determined under statutory accounting practices (SAP), which our management uses to measure performance for our total business. We use the following financial data to monitor and evaluate our operating results:
Year Ended December 31, ------------------------------------ (amount in thousands) 2003 2002 2001 --------------------- --------- --------- --------- Net Premiums Written: Personal lines: Automobile $ 86,644 $ 84,643 $ 74,396 Homeowners 36,989 34,637 31,431 Other 6,753 6,497 5,796 --------- --------- --------- Total personal lines 130,386 125,777 111,623 --------- --------- --------- Commercial lines: Automobile 18,655 17,451 16,527 Workers' compensation 25,627 23,845 22,979 Commercial multiperil 30,199 25,536 24,174 Other 2,114 1,895 1,725 --------- --------- --------- Total commercial lines 76,595 68,727 65,405 --------- --------- --------- Total net premiums written $ 206,981 $ 194,504 $ 177,028 ========= ========= ========= Components of GAAP Combined Ratio: Loss ratio 64.2% 69.6% 70.5% Expense ratio 30.2 29.5 32.3 Dividend ratio 0.6 0.5 1.0 --------- --------- --------- GAAP combined ratio 95.0% 99.6% 103.8% ========= ========= ========= Revenues: Premiums earned: Personal lines $ 125,322 $ 119,838 $ 104,893 Commercial lines 71,471 66,003 62,877 --------- --------- --------- Total premiums earned 196,793 185,841 167,770 --------- --------- --------- Net investment income 13,316 14,581 15,886 Realized investment gains (losses) 1,368 144 (880) Other 3,515 3,238 2,388 --------- --------- --------- Total revenues $ 214,992 $ 203,804 $ 185,164 ========= ========= ========= Components of Net Income: Underwriting income (loss): Personal lines $ 2,004 $ (5,056) $ (5,090) Commercial lines 7,173 6,326 (3,037) --------- --------- --------- SAP underwriting income (loss) 9,177 1,270 (8,127) GAAP adjustments 692 (558) 1,833 --------- --------- --------- GAAP underwriting income (loss) 9,869 712 (6,294) Net investment income 13,316 14,581 15,886 Realized investment gains (losses) 1,368 144 (880) Other 883 1,058 (1,620) --------- --------- --------- Income before income taxes 25,436 16,495 7,092 Income taxes 7,142 4,492 1,274 --------- --------- --------- Net income $ 18,294 $ 12,003 $ 5,818 ========= ========= =========
RESULTS OF OPERATIONS YEARS ENDED DECEMBER 31, 2003 AND 2002 NET PREMIUMS WRITTEN Our 2003 net premiums written increased by 6.4% to $207.0 million, compared to $194.5 million for 2002. Commercial lines net premiums written increased $7.9 million, or 11.4%, for 2003 compared to 2002. Personal lines net premiums written increased $4.6 million, or 3.7%, for 2003 compared to 2002. We have benefited during these periods, and expect to continue to benefit, from premium increases by our insurance subsidiaries that have resulted from pricing actions approved by regulators. These increases related primarily to private passenger automobile, commercial multiple peril, workers' compensation and homeowners lines of business realized in most of the states in which we operate. In addition to pricing increases, we have also benefited from organic growth in most of the states in which we operate. NET PREMIUMS EARNED Our net premiums earned increased to $196.8 million for 2003, an increase of $11.0 million, or 5.9%, over 2002. Our net earned premiums during 2003 have grown due to the increase in written premiums during the year. Premiums are earned, or recognized as income, over the terms of our policies, which are generally one-year or less in duration. Therefore, increases or decreases in net premiums earned will generally reflect increases or decreases in net premiums written in the preceding twelve-month period compared to the same period one year earlier. INVESTMENT INCOME For 2003, our net investment income decreased 8.7% to $13.3 million, compared to $14.6 million for 2002. An increase in our average invested assets from $316.5 million in 2002 to $376.8 million in 2003 was more than offset by a decrease in our annualized average return on investments from 4.6% in 2002 to 3.5% in 2003, and accounted for the decrease in investment income in 2003 compared to 2002. The decrease in our annualized average return during both years compared to the prior years reflects a declining interest rate environment. NET REALIZED INVESTMENT GAINS/LOSSES Our net realized investment gains in 2003 were $1.4 million, compared to $144,190 in 2002. Our net realized investment gains in 2003 were net of impairment charges of $237,724, compared to impairment charges of $378,672 recognized in 2002. Our impairment charges for both years were the result of declines in the market value of common stocks that we determined to be other than temporary. The remaining net realized investment gains and losses in both periods resulted from normal turnover within our investment portfolio. LOSSES AND LOSS EXPENSES Our loss ratio, which is the ratio of incurred losses and loss expenses to premiums earned, in 2003 was 64.2%, compared to 69.6% in 2002. Our commercial lines loss ratio decreased to 57.7% in 2003, compared to 61.5% in 2002. Our commercial automobile and workers' compensation loss ratios showed improvement in 2003, with page 12 the commercial automobile loss ratio decreasing to 51.9% in 2003, compared to 61.6% in 2002, and the workers' compensation loss ratio decreasing to 60.5% in 2003, compared to 73.1% in 2002. The personal lines loss ratio improved from 73.3% in 2002 to 67.8% in 2003, primarily as a result of improvement in the personal automobile loss ratio in 2003 compared to 2002. Improvements in our 2003 loss ratios reflect the benefits of premium pricing increases and more favorable prior accident year loss development compared to the same period in 2002. UNDERWRITING EXPENSES Our expense ratio, which is the ratio of policy acquisition and other underwriting expenses to premiums earned, in 2003 was 30.2%, compared to 29.5% in 2002. Improvements from expense control efforts were offset by higher underwriting-based incentive costs incurred in 2003 compared to 2002. COMBINED RATIO Our combined ratio was 95.0% and 99.6% in 2003 and 2002, respectively. The combined ratio represents the sum of the loss ratio, expense ratio and dividend ratio, which is the ratio of workers' compensation policy dividends incurred to premiums earned. The improvement in our combined ratio was attributable to the decrease in the loss ratio between years. INTEREST EXPENSE Our interest expense in 2003 was $1.3 million, compared to $1.1 million in 2002, reflecting an increase in interest expense related to the issuance of $25.8 million of subordinated debentures in 2003, offset by decreases in the average interest rates and average borrowings under our line of credit in 2003 compared to 2002. INCOME TAXES Our income tax expense was $7.1 million in 2003, compared to $4.5 million in 2002, representing effective tax rates of 28.1% and 27.2%, respectively. The change between effective tax rates is due to tax-exempt interest representing a slightly smaller proportion of net income before taxes in 2003 compared to 2002. NET INCOME AND EARNINGS PER SHARE Our net income in 2003 was $18.3 million, an increase of 52.4% over the $12.0 million reported in 2002. Our diluted earnings per share were $1.85 in 2003 compared to $1.31 in 2002. BOOK VALUE PER SHARE AND RETURN ON EQUITY Our stockholders' equity increased by $75.5 million in 2003, primarily as a result of the issuance of 3.45 million shares of Class A common stock in December 2003, which resulted in $59.0 million in net proceeds to us. Book value per share increased by 12.2% to $16.29 at December 31, 2003, compared to $14.52 a year earlier. Our return on average equity was 12.2% in 2003, compared to 9.4% in 2002. YEARS ENDED DECEMBER 31, 2002 AND 2001 NET PREMIUMS WRITTEN Our net premiums written in 2002 increased by 9.9% to $194.5 million, compared to $177.0 million in 2001. Personal lines net premiums written increased $14.2 million, or 12.7%, for 2002 compared to 2001. Commercial lines net premiums written increased $3.3 million, or 5.1%, for 2002 compared to 2001. We implemented rate increases in various lines of business throughout the year to improve profitability. NET PREMIUMS EARNED Our net premiums earned for 2002 increased to $185.8 million, an increase of $18.1 million, or 10.8%, over 2001. Earned premiums grew due to the increase in written premiums during 2002. INVESTMENT INCOME Our investment income for 2002 decreased 8.2% to $14.6 million, compared to $15.9 million for 2001. An increase in average invested assets from $295.0 million in 2001 to $316.5 million in 2002 was more than offset by a decrease in the annualized average return on investments from 5.3% in 2001 to 4.6% in 2002, and accounted for the decrease in investment income in 2002 compared to 2001. The decrease in our annualized average return reflects a declining interest rate environment during both periods. NET REALIZED INVESTMENT GAINS/LOSSES Our net realized investment gains in 2002 were $144,190, compared to net realized investment losses of $880,254 in 2001. Our net realized investment gains in 2002 were net of impairment charges of $378,672, compared to impairment charges of $1.5 million in 2001. The impairment charges in both years were the result of declines in the market value of common stocks that were determined to be other than temporary. LOSSES AND LOSS EXPENSES Our loss ratio in 2002 was 69.6%, compared to 70.5% in 2001. Our commercial lines loss ratio decreased significantly to 61.5% in 2002, compared to 72.7% in 2001, with the commercial automobile loss ratio showing the greatest improvement as it decreased from 85.0% in 2001 to 61.6% in 2002. Our personal lines loss ratio increased from 69.2% in 2001 to 73.3% in 2002. Net losses and loss expenses for 2002 and 2001 included adverse development of prior accident year losses amounting to $6.8 million and $8.0 million, respectively. In 2002, the adverse loss development was primarily in private passenger automobile liability and physical damage and, to a lesser extent, in commercial lines of business, such as workers' compensation, commercial automobile liability and commercial multiperil. The 2002 loss development resulted principally from accident year 2001 claims and the normal claims review process and not from any changes in key assumptions or changes in reserving philosophy. The 2001 adverse loss development was primarily in commercial lines of business. The 2001 development included $4.2 million of reserve strengthening primarily in the workers' compensation and commercial auto lines of business. page 13 UNDERWRITING EXPENSES Our expense ratio in 2002 was 29.5%, compared to 32.3% in 2001. Improvement in our expense ratio was primarily a result of the cost reduction program implemented in late 2001. The expense ratio in 2001 included a guaranty fund assessment of approximately $543,000 resulting from the insolvency of Reliance Insurance Company. This assessment also contributed to the change in the expense ratio between years. COMBINED RATIO Our combined ratio was 99.6% in 2002, compared to 103.8% in 2001. The improvement in our combined ratio was primarily attributable to the decrease in the expense ratio between periods. INTEREST EXPENSE Interest expense in 2002 was $1.1 million, compared to $2.2 million in 2001, reflecting decreases in average borrowings under our line of credit and decreases in the average interest rates for the respective periods. INCOME TAXES Income tax expense was $4.5 million in 2002, an effective tax rate of 27.2%, compared to $1.3 million, or an effective tax rate of 18.0%, in 2001. Tax-exempt interest represented a smaller proportion of net income before taxes in 2002 compared to 2001 and accounted for the difference between the effective rates. NET INCOME AND EARNINGS PER SHARE Our net income in 2002 was $12.0 million, an increase of 106.3% over the $5.8 million reported in 2001. Diluted earnings per share were $1.31 for 2002 compared to $0.64 for the previous year. FINANCIAL CONDITION LIQUIDITY AND CAPITAL RESOURCES Liquidity is a measure of an entity's ability to secure enough cash to meet its contractual obligations and operating needs as they arise. Our major sources of funds from operations are the net cash flow generated from our insurance subsidiaries' underwriting results, investment income and maturing investments. We generate sufficient net positive cash flow from our operations to fund our commitments and build our investment portfolio, thereby increasing future investment returns. We maintain a high degree of liquidity in our investment portfolio in the form of readily marketable fixed maturities, equity securities and short-term investments. Net cash flows provided by operating activities in 2003, 2002 and 2001, were $30.8 million, $34.1 million and $22.0 million, respectively. On May 15, 2003, we received $15.0 million in net proceeds from the issuance of subordinated debentures. The debentures mature on May 15, 2033 and are callable at our option, at par, after five years. The debentures carry an interest rate equal to the three-month LIBOR rate plus 4.10%, which is adjustable quarterly. At December 31, 2003, the interest rate on the debentures was 5.28%. On October 29, 2003, we received $10.0 million in net proceeds from the issuance of subordinated debentures. The debentures mature on October 29, 2033 and are callable at our option, at par, after five years. The debentures carry an interest rate equal to the three-month LIBOR rate plus 3.85%, which is adjustable quarterly. At December 31, 2003, the interest rate on the debentures was 5.01%. On November 25, 2003, we entered into a credit agreement with Manufacturers and Traders Trust Company ("M&T") relating to a four-year $35.0 million unsecured, revolving line of credit. As of December 31, 2003, we may borrow up to $35.0 million at interest rates equal to the bank's current prime rate or the then current LIBOR rate plus between 1.50% and 1.75%, depending on our leverage ratio. In addition, we pay a fee of 0.15% per annum on the loan commitment amount, regardless of usage. The agreement requires our compliance with certain covenants, which include minimum levels of our net worth, leverage ratio and statutory surplus and A.M. Best ratings of our subsidiaries. As of December 31, 2003, there were no borrowings outstanding, and we complied with all requirements of the agreement. On December 1, 2003, we completed an underwritten public offering of 3.45 million shares of our Class A common stock, resulting in net proceeds of $59.0 million to us. At December 31, 2002, pursuant to a credit agreement dated December 29, 1995, and amended as of July 27, 1998, with Fleet National Bank, we had unsecured borrowings of $19.8 million. Such borrowings were made in connection with the various acquisitions and capital contributions to our subsidiaries. The borrowings under this line of credit were repaid during 2003, and this credit agreement was terminated on December 2, 2003. Dividends declared to stockholders totaled $4.4 million, $3.5 million and $3.5 million in 2003, 2002 and 2001, respectively. There are no regulatory restrictions on the payment of dividends to our stockholders, although there are state law restrictions on the payment of dividends from our insurance subsidiaries to us. Atlantic States and Southern are required by law to maintain certain minimum surplus on a statutory basis, and are subject to regulations under which payment of dividends from statutory surplus is restricted and may require prior approval of their domiciliary insurance regulatory authorities. Atlantic States and Southern are subject to risk-based capital (RBC) requirements. At December 31, 2003, Atlantic States' and Southern's capital were each substantially above the RBC requirements. In 2004, amounts available for distribution as dividends to us without prior approval of their domiciliary insurance regulatory authorities are $13.3 million from Atlantic States and $4.1 million from Southern. We had two pending acquisitions at December 31, 2003, both of which were consummated in January 2004. As of January 1, 2004, we acquired all of the outstanding capital stock of Le Mars, the successor to Le Mars Mutual Insurance Company of Iowa following its conversion to a stock insurance company pursuant to a plan of conversion. We acquired the capital stock of Le Mars for approximately $12.6 million in cash, including payment of $4.4 million to the Mutual Company for a surplus note and accrued interest that the Mutual Company had infused into Le Mars. Le Mars operates as a multiple line carrier in Iowa, Nebraska, Oklahoma and South Dakota. Personal lines coverages represent a majority of premiums written, with the balance coming from farmowners and mercantile and service businesses. Le Mars' largest lines of business are private passenger automobile liability and physical damage; other principal lines include homeowners and commercial multiperil. page 14 On January 6, 2004, we acquired all of the outstanding common stock of Peninsula from Folksamerica Holding Company, Inc. pursuant to a Stock Purchase Agreement. The cash purchase price of approximately $23.3 million was equal to 107.5% of the consolidated GAAP stockholders' equity of Peninsula as of the date of closing of the acquisition. The Peninsula companies are each Maryland-domiciled insurance companies headquartered in Salisbury, Maryland, which write primarily private passenger automobile coverages, and also write homeowners, commercial multiperil, workers' compensation and commercial automobile coverages. Peninsula's principal operating area is Maryland, Delaware and Virginia. INVESTMENTS At December 31, 2003 and 2002, our investment portfolio of investment-grade bonds, common stock, preferred stock, short-term investments and cash totaled $427.2 million, and $333.4 million, respectively, representing 71.0% and 66.5%, respectively, of our total assets. At December 31, 2003 and 2002, the carrying value of our fixed maturity investments represented 73.9% and 84.7% of our total invested assets, respectively. Our fixed maturity investments consisted of high-quality marketable bonds, all of which were rated at investment-grade levels, at December 31, 2003 and 2002. At December 31, 2003, the net unrealized gain on fixed maturities, net of deferred taxes, amounted to $4.1 million, compared to $4.7 million at December 31, 2002. At December 31, 2003, the net unrealized gain on our equity securities held, net of deferred taxes, amounted to $1.2 million, compared to $163,500 at December 31, 2002. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are exposed to the impact of interest rate changes, changes in market values of investments and to credit risk. In the normal course of business, we employ established policies and procedures to manage our exposure to changes in interest rates, fluctuations in the value of the fair market value of our debt and equity securities and credit risk. We seek to mitigate these risks by various actions described below. INTEREST RATE RISK Our exposure to market risk for a change in interest rates is concentrated in the investment portfolio. We monitor 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 monitored regularly. Generally, we do not hedge our exposure to interest rate risk because we have the capacity to, and do, hold fixed maturity investments to maturity. Principal cash flows and related weighted-average interest rates by expected maturity dates for financial instruments sensitive to interest rates at December 31, 2003 are as follows:
Principal Weighted-average (amounts in thousands) cash flows interest rate ---------------------- ---------- ---------------- Fixed maturities and short-term bonds: 2004 $ 92,194 1.74% 2005 13,337 5.86% 2006 32,989 4.81% 2007 31,236 4.63% 2008 40,075 4.01% Thereafter 169,209 4.85% --------- Total $ 379,040 ========= Market Value $ 392,910 ========= Debt: 2033 $ 25,774 5.17% --------- Total $ 25,774 ========= Fair value $ 25,774 =========
Actual cash flows from investments may differ from those stated as a result of calls and prepayments. EQUITY PRICE RISK Our portfolio of marketable equity securities, which is carried on the consolidated balance sheets at estimated fair value, has exposure to price risk, the risk of potential loss in estimated fair value resulting from an adverse change in prices. Our objective is to earn competitive relative returns by investing in a diverse portfolio of high-quality, liquid securities. CREDIT RISK Our objective is to earn competitive returns by investing in a diversified portfolio of securities. Our portfolios of fixed maturity securities and, to a lesser extent, short-term investments are subject to credit risk. This risk is defined as the potential loss in market value resulting from adverse changes in the borrower's ability to repay the debt. We manage this risk by performing up front underwriting analysis and through regular reviews by the Company's investment staff. The fixed maturity investments are also maintained between minimum and maximum percentages of invested assets. We provide property and liability insurance coverages through independent insurance agencies located throughout our operating area. The majority of this business is billed directly to the insured, although a portion of our commercial business is billed through our agents who are extended credit in the normal course of business. Our insurance subsidiaries maintain reinsurance agreements in place with the Mutual Company and with a number of other major unaffiliated authorized reinsurers. IMPACT OF INFLATION Property and casualty insurance premium rates are established before the amount of losses and loss settlement expenses, or the extent to which inflation may impact such expenses, are known. Consequently, we attempt, in establishing rates, to anticipate the potential impact of inflation. page 15 Donegal Group Inc. CONSOLIDATED BALANCE SHEETS
December 31, 2003 2002 ------------ ---- ---- ASSETS Investments Fixed maturities Held to maturity, at amortized cost (fair value $116,133,002 and $89,785,318) $ 113,050,784 $ 86,701,556 Available for sale, at fair value (amortized cost $192,097,372 and $187,495,949) 198,433,337 194,731,660 Equity securities, available for sale, at fair value (cost $29,644,333 and $21,587,317) 31,448,221 21,836,460 Short-term investments, at cost, which approximates fair value 78,344,125 29,029,418 --------------- -------------- Total investments 421,276,467 332,299,094 Cash 5,908,521 1,124,604 Accrued investment income 3,752,075 3,815,449 Premiums receivable 29,016,940 26,286,482 Reinsurance receivable 81,009,106 83,207,272 Deferred policy acquisition costs 16,223,765 14,567,070 Deferred tax asset, net 7,032,409 6,955,707 Prepaid reinsurance premiums 30,691,654 27,853,996 Property and equipment, net 4,151,671 4,430,394 Accounts receivable -- securities 1,524,384 146,507 Other 1,449,050 531,589 --------------- -------------- Total assets $ 602,036,042 $ 501,218,164 =============== ============== LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities Losses and loss expenses $ 217,914,057 $ 210,691,752 Unearned premiums 134,028,035 121,002,447 Accrued expenses 7,769,879 6,583,825 Reinsurance balances payable 1,355,796 1,100,443 Federal income taxes payable 315,808 357,547 Cash dividend declared to stockholders 1,378,993 887,315 Borrowings under line of credit -- 19,800,000 Subordinated debentures 25,774,000 -- Accounts payable -- securities 2,438,784 2,121,619 Due to affiliate 904,452 4,080,415 Other 1,507,006 1,409,951 --------------- -------------- Total liabilities 393,386,810 368,035,314 --------------- -------------- Stockholders' Equity Preferred stock, $1.00 par value, authorized 2,000,000 shares; none issued -- -- Class A common stock, $.01 par value, authorized 30,000,000 shares, issued 9,880,506 and 6,269,093 shares and outstanding 9,798,982 and 6,187,569 shares 98,805 62,691 Class B common stock, $.01 par value, authorized 10,000,000 shares, issued 3,051,811 and 3,024,742 shares and outstanding 3,011,049 and 2,983,980 shares 30,518 30,247 Additional paid-in capital 122,744,905 60,651,751 Accumulated other comprehensive income 5,290,923 4,911,953 Retained earnings 81,375,829 68,417,956 Treasury stock, at cost (891,748) (891,748) --------------- -------------- Total stockholders' equity 208,649,232 133,182,850 --------------- -------------- Total liabilities and stockholders' equity $ 602,036,042 $ 501,218,164 =============== ==============
See accompanying notes to consolidated financial statements. page 16 Donegal Group Inc. CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
Year Ended December 31, 2003 2002 2001 ----------------------- ------------- -------------- -------------- STATEMENTS OF INCOME Revenues Net premiums earned (includes affiliated reinsurance of $94,173,934, $86,195,962 and $71,989,136) $ 196,792,696 $ 185,841,193 $ 167,769,854 Investment income, net of investment expenses 13,315,936 14,581,252 15,885,544 Installment payment fees 2,464,604 2,447,229 1,587,396 Lease income 845,211 789,697 801,083 Net realized investment gains (losses) 1,368,031 144,190 (880,254) Other income 205,850 -- -- ------------- -------------- -------------- Total revenues 214,992,328 203,803,561 185,163,623 ------------- -------------- -------------- Expenses Net losses and loss expenses (includes affiliated reinsurance of $53,659,974, $54,684,955 and $50,283,481) 126,243,311 129,267,686 118,177,549 Amortization of deferred policy acquisition costs 30,839,000 29,473,000 27,194,000 Other underwriting expenses 28,686,365 25,331,777 27,000,485 Policy dividends 1,154,773 1,056,790 1,691,759 Interest 1,287,197 1,119,204 2,247,465 Other 1,345,307 1,060,520 1,760,636 ------------- -------------- -------------- Total expenses 189,555,953 187,308,977 178,071,894 ------------- -------------- -------------- Income before income tax expense 25,436,375 16,494,584 7,091,729 Income tax expense 7,142,399 4,491,862 1,273,598 ------------- -------------- -------------- Net income $ 18,293,976 $ 12,002,722 $ 5,818,131 ============= ============== ============== Net income per common share Basic $ 1.91 $ 1.32 $ .65 ============= ============== ============== Diluted $ 1.85 $ 1.31 $ .64 ============= ============== ============== STATEMENTS OF COMPREHENSIVE INCOME Net income $ 18,293,976 $ 12,002,722 $ 5,818,131 ------------- -------------- -------------- Other comprehensive income, net of tax Unrealized gains on securities: Unrealized holding gain arising during the period, net of income tax expense of $754,840,$1,148,224 and $1,277,504 1,268,190 2,144,813 2,479,860 Reclassification adjustment for (gains)losses included in net income, net of income tax expense (benefit) of $478,811, $49,565 and $(299,286) (889,220) (94,625) 580,968 ------------- -------------- -------------- Other comprehensive income 378,970 2,050,188 3,060,828 ------------- -------------- -------------- Comprehensive income $ 18,672,946 $ 14,052,910 $ 8,878,959 ============= ============== ==============
See accompanying notes to consolidated financial statements. page 17 Donegal Group Inc. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Common Stock ------------------------------------------------------------- Prior Class A Class B Prior Class A Class B Shares Shares Shares Amount Amount Amount ---------- --------- --------- ----------- -------- ------- Balance, January 1, 2001 8,980,977 -- -- $ 8,980,977 $ -- $ -- ---------- --------- --------- ----------- -------- ------- Issuance of common stock 61,830 60,144 3,758 61,830 601 38 Recapitalization (9,042,807) 6,027,975 3,013,987 (9,042,807) 60,280 30,140 Net income Cash dividends Exercise of stock options 9,095 4,220 91 42 Grant of stock options Other comprehensive income ---------- --------- --------- ----------- -------- ------- Balance, December 31, 2001 -- 6,097,214 3,021,965 $ -- $ 60,972 $30,220 ---------- --------- --------- ----------- -------- ------- Issuance of common stock 166,972 1,670 Net income Cash dividends Exercise of stock options 4,907 2,777 49 27 Grant of stock options Other comprehensive income ---------- --------- --------- ----------- -------- ------- Balance, December 31, 2002 -- 6,269,093 3,024,742 $ -- $ 62,691 $30,247 ---------- --------- --------- ----------- -------- ------- Issuance of common stock 3,547,000 35,470 Net income Cash dividends Exercise of stock options 64,413 27,069 644 271 Grant of stock options Other comprehensive income ---------- --------- --------- ----------- -------- ------- Balance, December 31, 2003 -- 9,880,506 3,051,811 $ -- $ 98,805 $30,518 ========== ========= ========= =========== ======== ======= Accumulated Additional Other Total Paid-In Comprehensive Retained Treasury Stockholders' Capital Income (Loss) Earnings Stock Equity ------------ ------------- ------------ --------- ------------- Balance, January 1, 2001 $ 46,969,840 $ (199,063)$ 59,269,593 $(891,756) $ 114,129,591 ------------ ------------- ------------ --------- ------------- Issuance of common stock 1,200,202 1,262,671 Recapitalization 8,949,361 8 (3,018) Net income 5,818,131 5,818,131 Cash dividends (3,466,947) (3,466,947) Exercise of stock options 126,960 127,093 Grant of stock options 1,641,352 (1,641,352) -- Other comprehensive income 3,060,828 3,060,828 ------------ ------------- ------------ --------- ------------- Balance, December 31, 2001 $ 58,887,715 $ 2,861,765 $ 59,979,425 $(891,748) $ 120,928,349 ------------ ------------- ------------ --------- ------------- Issuance of common stock 1,641,547 1,643,217 Net income 12,002,722 12,002,722 Cash dividends (3,526,157) (3,526,157) Exercise of stock options 84,455 84,531 Grant of stock options 38,034 (38,034) -- Other comprehensive income 2,050,188 2,050,188 ------------ ------------- ------------ --------- ------------- Balance, December 31, 2002 $ 60,651,751 $ 4,911,953 $ 68,417,956 $(891,748) $ 133,182,850 ------------ ------------- ------------ --------- ------------- Issuance of common stock 60,193,670 60,229,140 Net income 18,293,976 18,293,976 Cash dividends (4,360,026) (4,360,026) Exercise of stock options 923,407 924,322 Grant of stock options 976,077 (976,077) -- Other comprehensive income 378,970 378,970 ------------ ------------- ------------ --------- ------------- Balance, December 31, 2003 $122,744,905 $ 5,290,923 $ 81,375,829 $(891,748) $ 208,649,232 ============ ============= ============ ========= =============
See accompanying notes to consolidated financial statements. page 18 Donegal Group Inc. CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31, 2003 2002 2001 ----------------------- ------------- ------------- ------------- Cash Flows from Operating Activities: Net income $ 18,293,976 $ 12,002,722 $ 5,818,131 ------------- ------------- ------------- Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 1,532,664 1,236,592 1,127,510 Realized investment (gains) losses (1,368,031) (144,190) 880,254 Changes in Assets and Liabilities: Losses and loss expenses 7,222,305 30,851,847 23,363,781 Unearned premiums 13,025,588 6,923,183 14,138,883 Accrued expenses 1,186,054 (602,282) 1,308,632 Premiums receivable (2,730,458) (2,142,951) (2,385,029) Deferred policy acquisition costs (1,656,695) (962,855) (1,320,001) Deferred income taxes (352,731) (579,654) (1,360,633) Reinsurance receivable 2,198,166 (15,354,098) (13,309,290) Accrued investment income 63,374 (50,373) 237,388 Amounts due to/from affiliate (3,175,963) 65,341 (513,922) Reinsurance balances payable 255,353 261,287 (795,819) Prepaid reinsurance premiums (2,837,658) 1,739,471 (4,881,083) Current income taxes (41,739) 650,165 (32,656) Other, net (820,406) 181,965 (271,364) ------------- ------------- ------------- Net adjustments 12,499,823 22,073,448 16,186,651 ------------- ------------- ------------- Net cash provided by operating activities 30,793,799 34,076,170 22,004,782 ------------- ------------- ------------- Cash Flows from Investing Activities: Purchase of fixed maturities Held to maturity (51,747,067) (35,867,577) (45,201,470) Available for sale 104,935,346) (75,783,783) (71,700,918) Purchase of equity securities (20,779,807) (18,325,041) (12,440,994) Sale of fixed maturities Held to maturity 1,971,000 415,000 -- Available for sale 16,575,179 461,965 16,250,109 Maturity of fixed maturities Held to maturity 22,256,933 34,967,828 51,313,296 Available for sale 84,393,268 58,798,825 50,781,533 Sale of equity securities 12,683,028 13,394,123 7,089,532 Net purchase of property and equipment (371,477) (552,005) (161,269) Net purchases of short-term investments (49,314,707) (4,955,218) (4,634,695) ------------- ------------- ------------- Net cash used in investing activities (89,268,996) (27,445,883) (8,704,876) ------------- ------------- ------------- Cash Flows from Financing Activities: Issuance of common stock 61,153,462 1,727,748 1,386,746 Issuance of subordinated debentures 25,774,000 -- -- Payments on line of credit (19,800,000) (7,800,000) (12,400,000) Cash dividends paid (3,868,348) (3,508,719) (3,394,352) ------------- ------------- ------------- Net cash provided by (used in) financing activities 63,259,114 (9,580,971) (14,407,606) ------------- ------------- ------------- Net increase (decrease) in cash 4,783,917 (2,950,684) (1,107,700) Cash at beginning of year 1,124,604 4,075,288 5,182,988 ------------- ------------- ------------- Cash at end of year $ 5,908,521 $ 1,124,604 $ 4,075,288 ============= ============= =============
See accompanying notes to consolidated financial statements. page 19 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ORGANIZATION AND BUSINESS We were organized as a regional insurance holding company by Donegal Mutual Insurance Company (the "Mutual Company") and operate predominantly as an underwriter of property and casualty insurance through our subsidiaries. Our two property and casualty insurance subsidiaries during 2003, Atlantic States Insurance Company ("Atlantic States") and Southern Insurance Company of Virginia ("Southern") write personal and commercial lines property and casualty coverages exclusively through a network of independent insurance agents in the Mid-Atlantic and Southern states. In January 2004, we also acquired Le Mars Insurance Company ("Le Mars") and the Peninsula Insurance Group ("Peninsula"), which consists of Peninsula Indemnity Company and The Peninsula Insurance Company. We have three operating segments: the investment function, the personal lines function and the commercial lines function. Our personal lines products consist primarily of homeowners and private passenger automobile policies. Our commercial lines products consist primarily of commercial automobile, commercial multiple peril and workers' compensation policies. At December 31, 2003, the Mutual Company held approximately 42% of our outstanding Class A common stock and approximately 62% of our outstanding Class B common stock. Atlantic States participates in a pooling agreement with the Mutual Company. Under the pooling agreement, the insurance business of the two companies is pooled, and Atlantic States assumes 70% of the pooled business. Prior to January 1, 2002, Southern ceded 50% of its business to the Mutual Company. We also own 47.5% of the outstanding stock of Donegal Financial Services Corporation ("DFSC"), a thrift holding company. The remaining 52.5% of the outstanding stock of DFSC is owned by the Mutual Company. Pioneer Insurance Company of Ohio ("Pioneer-Ohio"), Delaware Atlantic Insurance Company ("Delaware") and Pioneer Insurance Company of New York ("Pioneer-New York"), previously wholly owned subsidiaries, were merged into Atlantic States on May 1, 2002, August 1, 2001 and September 30, 2001, respectively. Southern Heritage Insurance Company, previously a wholly owned subsidiary, was merged into Southern on May 1, 2002. The mergers were accounted for as statutory mergers and had no financial impact on the consolidated entity. On December 1, 2003, we completed an underwritten public offering of 3,450,000 shares of our Class A common stock, resulting in net proceeds of $59.0 million to us. In June 2002, the Mutual Company consummated an affiliation with Le Mars. As part of the affiliation, the Mutual Company entered into a management agreement with and made a $4.0 million surplus note investment in Le Mars. During 2003, Le Mars' board of directors adopted a plan of conversion to convert to a stock insurance company. Following policyholder and regulatory approval of the plan of conversion, we acquired Le Mars as of January 1, 2004 for approximately $12.6 million in cash, including payment of the surplus note and accrued interest to the Mutual Company. On January 6, 2004, we purchased Peninsula for a price in cash equal to 107.5% of Peninsula's GAAP stockholders' equity as of the closing of the acquisition, or approximately $23.3 million. BASIS OF CONSOLIDATION The consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America, include our accounts and those of our wholly owned subsidiaries. All significant inter-company accounts and transactions have been eliminated in consolidation. The term "we," "us," "our," or the "Company" as used herein refer 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. We make estimates and assumptions that can have a significant effect on amounts and disclosures we report in our financial statements. The most significant estimates relate to our reserves for property and casualty insurance unpaid losses and loss expenses, valuation of investments, policy acquisition costs and guaranty fund liability accruals. While we believe our estimates are appropriate, the ultimate amounts may differ from the estimates provided. The methods for making these estimates are continually reviewed, and any adjustment considered necessary is reflected in our current results of operations. INVESTMENTS We classify our debt and equity securities into the following categories: Held to Maturity--Debt securities that we have the positive intent and ability to hold to maturity; reported at amortized cost. Available for Sale--Debt and equity securities not classified as held to maturity; reported at fair value, with unrealized gains and losses excluded from income and reported as a separate component of stockholders' equity (net of tax effects). Short-term investments are carried at amortized cost, which approximates fair value. If there is a decline in fair value below amortized cost that 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. page 20 FAIR VALUES OF FINANCIAL INSTRUMENTS We have used the following methods and assumptions in estimating our 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 and Subordinated Debentures--The carrying amounts reported in the balance sheet for the line of credit and subordinated debentures approximate fair value due to their variable rate nature. 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. We have no material exposures to environmental liabilities. GUARANTY FUND LIABILITY ACCRUALS We make estimates of our insurance subsidiaries' liabilities for guaranty fund and other assessments because of insurance company insolvencies from states in which the subsidiaries are licensed. Generally, an insurer is subject to assessment, depending upon its market share of a given line of business, to assist in the payment of unpaid claims and related costs of insolvent insurance companies. We generally record our liability for such assessments as premiums upon which those assessments are based are written. As a result of several large insolvencies in recent years, we are currently being assessed at the maximum level permitted by Pennsylvania law for several of our lines of business, and we expect we will continue to be assessed by Pennsylvania at the maximum level for these business lines for a number of years. INCOME TAXES We currently file a consolidated federal income tax return. We account for income taxes using the asset and liability method. The objective of the asset and liability method is to establish deferred tax assets and liabilities for the temporary differences between the financial reporting basis and the tax basis of our assets and liabilities at enacted tax rates expected to be in effect when such amounts are realized or settled. CREDIT RISK We provide property and liability coverages through our subsidiaries' independent agency systems located throughout our operating area. The majority of this business is billed directly to the insured, although a portion of our commercial business is billed through our agents, who are extended credit in the normal course of business. Our 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 We rely upon reinsurance agreements to limit our maximum net loss from large single risks or risks in concentrated areas, and to increase our 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, we are exposed to the risk of continued liability for such losses. However, in an effort to reduce the risk of non-payment, we require all of our reinsurers to have an A.M. Best rating of A- or better or, with respect to foreign reinsurers, to have a financial condition that, in the opinion of management, is equivalent to a company with at least an A- rating. STOCK-BASED COMPENSATION We account for stock-based compensation plans under the provisions of Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. During 2001, we adopted an Equity Incentive Plan for key employees that made 1,500,000 shares of Class A common stock available for issuance. The plan provides for the granting of awards by the Board of Directors in the form of stock options, stock page 21 appreciation rights, restricted stock or any combination of the above. During 2001, we also adopted an Equity Incentive Plan for Directors that made 200,000 shares of Class A common stock available for issuance. Awards may be made in the form of stock options, and the plan additionally provides for the issuance of 175 shares of restricted stock to each director on the first business day of January in each year. No stock-based employee compensation is reflected in income, except for expense associated with restricted stock issued, as all options granted under those plans had an exercise price equal to, or greater than, the market value of the underlying common stock on the date of the grant. The following table illustrates the effect on net income and earnings per share as if we had applied the provisions of Statement of Financial Accounting Standards (SFAS) No. 123 (as amended by SFAS No. 148), "Accounting for Stock-Based Compensation."
2003 2002 2001 -------------- -------------- -------------- Net income, as reported $ 18,293,976 $ 12,002,722 $ 5,818,131 Less: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects (30,814) (234,935) (200,358) -------------- -------------- -------------- Pro-forma net income $ 18,263,162 $ 11,767,787 $ 5,617,773 ============== ============== ============== Basic earnings per share: As reported $ 1.91 $ 1.32 $ .65 Pro-forma 1.91 1.30 .63 Diluted earnings per share: As reported $ 1.85 $ 1.31 $ .64 Pro-forma 1.85 1.28 .62
The weighted-average grant date fair value of options granted for the various plans during 2000 was $2.23. The fair values above were calculated based upon risk-free interest rates of 5.75% for the Stock Purchase Plans and the Equity Incentive Plans, expected lives of 6 months for the Stock Purchase Plans and 5 years for the Equity Incentive Plans, expected volatility of 54% for 2000 and an expected dividend yield of 4.5% for 2000. 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. 2--TRANSACTIONS WITH AFFILIATES We conduct business and have various agreements with the Mutual Company that are described below: a. REINSURANCE POOLING AND OTHER REINSURANCE ARRANGEMENTS Atlantic States cedes to the Mutual Company all of its insurance business and assumes from the Mutual Company 70% of the Mutual Company's total pooled insurance business, including that assumed from Atlantic States and substantially all of the business assumed by the Mutual Company from Southern (prior to January 1, 2002). The Mutual Company and Atlantic States write business with different risk profiles. Through the pooling arrangement, each is able to share proportionately in the results of all policies written by the other. Atlantic States ceded premiums earned of $55,846,128, $45,229,457 and $37,345,259 and ceded losses and loss expenses incurred of $35,840,578, $34,471,381 and $29,094,804 under this arrangement during 2003, 2002 and 2001, respectively. It also assumed premiums earned of $153,068,026, $134,236,778 and $126,769,521 and assumed losses and loss expenses incurred of $99,677,221, $96,517,930 and $93,470,958 under this arrangement during 2003, 2002 and 2001, respectively. Atlantic States had prepaid reinsurance premiums of $29,981,597, $26,517,322 and $20,942,093 and a ceded liability for losses and loss expenses of $52,263,271, $47,862,627 and $39,321,214 under this arrangement as of December 31, 2003, 2002 and 2001, respectively. It also had assumed unearned premiums of $77,782,685, $69,208,310 and $63,636,858 and an assumed liability for losses and loss expenses of $121,297,553, $113,850,952 and $99,664,285 under this arrangement at December 31, 2003, 2002 and 2001, respectively. Prior to January 1, 2002, the Mutual Company and Southern had a quota share agreement whereby Southern ceded 50% of its direct business, less reinsurance, to the Mutual Company. The business assumed by the Mutual Company from Southern became part of the pooling arrangement between the Mutual Company and Atlantic States. Southern ceded premiums earned of $0, $0 and $14,995,606 and ceded losses and loss expenses incurred of $(73,077), $488,055 and $9,898,422 under this agreement during 2003, 2002 and 2001, respectively. Southern had prepaid reinsurance premiums of $0, $0 and $7,310,471 and a ceded liability for losses and loss expenses of $4,175,127, $6,399,727 and $10,068,604 under this agreement at December 31, 2003, 2002 and 2001, respectively. This agreement was terminated as of January 1, 2002. Atlantic States and Southern each have a catastrophe reinsurance agreement with the Mutual Company that limits the maximum liability under any one catastrophic occurrence to $500,000 with a combined limit of $1,000,000 for a catastrophe involving both of the companies. Prior to merging into Atlantic States, Pioneer-Ohio, Delaware and Pioneer-New York each had a catastrophe reinsurance agreement with the Mutual Company that limited the maximum liability under any one catastrophic occurrence to $200,000, $300,000 and $400,000, respectively. Prior to merging into Southern, Southern Heritage had a catastrophe reinsurance agreement with the Mutual Company that limited the maximum liability under any one catastrophic occurrence to $400,000. Prior to merging into Atlantic States, Delaware and the Mutual Company had an excess of loss reinsurance agreement in which the Mutual Company assumed up to $250,000 of losses in excess of $50,000. Prior to merging into Atlantic States, Pioneer-Ohio and the Mutual Company had an excess of loss reinsurance agreement in which the Mutual Company assumed up to $250,000 ($200,000 in 2000) of page 22 losses in excess of $50,000. The Mutual Company and Southern have an excess of loss reinsurance agreement in which the Mutual Company assumes up to $150,000 ($175,000 in 2002 and $50,000 in 2001) of losses in excess of $150,000 ($125,000 in 2002 and $100,000 in 2001). Prior to merging into Atlantic States, Pioneer-New York and the Mutual Company had an excess of loss reinsurance agreement in which the Mutual Company assumed up to $250,000 ($200,000 in 2000) of losses in excess of $50,000. Effective October 1, 2000 and prior to merging into Southern, Southern Heritage and the Mutual Company had an excess of loss reinsurance agreement in which the Mutual Company assumed up to $175,000 of losses in excess of $125,000. The Mutual Company has agreements in place with Southern (and Pioneer-Ohio and Delaware prior to merging into Atlantic States) to reallocate the loss results of workers' compensation business written by those companies as part of commercial accounts primarily written by the Mutual Company or Atlantic States. These agreements provide for the workers' compensation loss ratios of Southern to be no worse than the average workers' compensation loss ratio for all of the companies combined. The Mutual Company and Pioneer-New York also had an aggregate excess of loss reinsurance agreement in which the Mutual Company agreed to assume the adverse loss development of claims with dates of loss prior to December 31, 2000, as developed through December 31, 2002, and to assume losses in excess of a 60% loss ratio through December 31, 2002. The subsidiaries ceded premiums earned of $3,047,964, $2,811,359 and $2,439,520 and ceded losses and loss expenses incurred of $10,249,746, $6,873,539 and $4,194,251 under these various agreements during 2003, 2002 and 2001, respectively. The subsidiaries had a ceded liability for losses and loss expenses of $7,218,397, $6,397,326 and $5,395,528 under these various agreements at December 31, 2003, 2002, and 2001, respectively. Southern (and Delaware, Pioneer-Ohio, Southern Heritage and and Pioneer-New York prior to mergers) has an agreement with the Mutual Company under which it cedes, and then reassumes back, 100% of its business net of reinsurance. The primary purpose of the agreement is to provide Southern with the same A.M. Best rating (currently "A") as the Mutual Company, which this subsidiary could not achieve without this contract in place. This agreement does not transfer insurance risk. While these subsidiaries ceded and reassumed amounts received from policyholders of $46,885,317, $48,921,377 and $41,142,936 and claims of $26,497,971, $28,859,644 and $23,348,952 under these agreements in 2003, 2002 and 2001, respectively, the amounts are not reflected in the consolidated financial statements. The aggregate liabilities ceded and reassumed under these agreements were $47,217,323 and $43,541,766 at December 31, 2003, and 2002, respectively. b. EXPENSE SHARING The Mutual Company provides facilities, management and other services to us, and we reimburse 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 us and the Mutual Company in the pooling arrangement, and our management and the management of the Mutual Company consider this allocation to be reasonable. Charges for these services totalled $33,047,769, $28,586,888 and $29,298,569 for 2003, 2002 and 2001, respectively. c. LEASE AGREEMENT We lease office equipment and automobiles with terms ranging from 3 to 10 years to the Mutual Company under a 10-year lease agreement dated January 1, 2000. d. LEGAL SERVICES Donald H. Nikolaus, President and one of our directors, is also a partner in the law firm of Nikolaus & Hohenadel. Such firm has served as our general counsel since 1986, principally in connection with the defense of claims litigation arising in Lancaster, Dauphin and York counties. Such firm is paid its customary fees for such services. e. PROVINCE BANK As of December 31, 2003, we had $5,661,089 in checking accounts with Province Bank, a wholly owned subsidiary of DFSC. We earned $24,972 in interest on these accounts during 2003. 3--INVESTMENTS The amortized cost and estimated fair values of fixed maturities and equity securities at December 31, 2003 and 2002, are as follows:
2003 ------------------------------------------------------------ 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 $ 29,130,684 $ 66,050 $ 368,967 $ 28,827,767 Canadian government obligation 499,630 25,370 -- 525,000 Obligations of states and political subdivisions 45,187,284 1,117,513 60,847 46,243,950 Corporate securities 25,192,044 2,086,465 9 27,278,500 Mortgage-backed securities 13,041,142 287,732 71,089 13,257,785 ------------ ------------ ------------ ------------ Totals $113,050,784 $ 3,583,130 $ 500,912 $116,133,002 ============ ============ ============ ============
2003 ------------------------------------------------------------ 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 $ 69,481,186 $ 1,094,878 $ 68,714 $ 70,507,350 Obligations of states and political subdivisions 81,104,794 3,281,260 604 84,385,450 Corporate securities 28,766,844 1,932,256 -- 30,699,100 Mortgage-backed securities 12,744,548 99,886 2,997 12,841,437 Equity securities 29,644,333 1,897,441 93,553 31,448,221 ------------ ------------ ------------ ------------ Totals $221,741,705 $ 8,305,721 $ 165,868 $229,881,558 ============ ============ ============ ============
page 23
2002 ------------------------------------------------------------------------------------------------ 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 $ 12,641,126 $ 407,958 $ -- $ 13,049,084 Canadian government obligation 499,250 40,750 -- 540,000 Obligations of states and political subdivisions 33,891,385 574,768 66,463 34,399,690 Corporate securities 29,551,491 1,745,990 12,103 31,285,378 Mortgage-backed securities 10,118,304 393,857 995 10,511,166 ------------ ------------ ------------ ------------ Totals $ 86,701,556 $ 3,163,323 $ 79,561 $ 89,785,318 ============ ============ ============ ============
2002 ------------------------------------------------------------------------------------------------ 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 $ 56,344,340 $ 1,943,229 $ 337 $ 58,287,232 Obligations of states and political subdivisions 78,515,340 3,083,256 152,996 81,445,600 Corporate securities 34,848,807 2,016,526 2,783 36,862,550 Mortgage-backed securities 17,787,462 363,649 14,833 18,136,278 Equity securities 21,587,317 1,007,030 757,887 21,836,460 ------------ ------------ ------------ ------------ Totals $209,083,266 $ 8,413,690 $ 928,836 $216,568,120 ============ ============ ============ ============
The amortized cost and estimated fair value of fixed maturities at December 31, 2003, 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 $ 3,951,952 $ 4,048,500 Due after one year through five years 33,077,638 34,294,650 Due after five years through ten years 22,362,319 23,141,267 Due after ten years 40,617,733 41,390,800 Mortgage-backed securities 13,041,142 13,257,785 -------------- -------------- Total held to maturity $ 113,050,784 $ 116,133,002 ============== ============== AVAILABLE FOR SALE Due in one year or less $ 9,896,463 $ 10,100,250 Due after one year through five years 75,387,586 78,092,950 Due after five years through ten years 48,518,923 50,694,900 Due after ten years 45,549,852 46,703,800 Mortgage-backed securities 12,744,548 12,841,437 -------------- -------------- Total available for sale $ 192,097,372 $ 198,433,337 ============== ==============
The amortized cost of fixed maturities on deposit with various regulatory authorities at December 31, 2003 and 2002, amounted to $5,095,211 and $5,400,597, respectively. Net investment income, consisting primarily of interest and dividends, is attributable to the following sources:
2003 2002 2001 -------------- -------------- -------------- Fixed maturities $ 13,255,492 $ 14,285,049 $ 15,145,949 Equity securities 834,578 804,087 546,243 Short-term investments 523,527 564,738 920,538 Other 29,250 29,249 255,250 -------------- -------------- -------------- Investment income 14,642,847 15,683,123 16,867,980 Investment expenses 1,326,911 1,101,871 982,436 -------------- -------------- -------------- Net investment income $ 13,315,936 $ 14,581,252 $ 15,885,544 ============== ============== ==============
Gross realized gains and losses from investments and the change in the difference between fair value and cost of investments, before applicable income taxes, are as follows:
2003 2002 2001 -------------- -------------- -------------- Gross realized gains: Fixed maturities $ 1,002,461 $ 128,714 $ 554,560 Equity securities 637,856 911,994 323,451 -------------- -------------- -------------- 1,640,317 1,040,708 878,011 -------------- -------------- -------------- Gross realized losses: Fixed maturities 33,759 106,789 28,618 Equity securities 238,527 789,729 1,729,647 -------------- -------------- -------------- 272,286 896,518 1,758,265 -------------- -------------- -------------- Net realized gains (losses) $ 1,368,031 $ 144,190 $ (880,254) ============== ============== ============== Change in difference between fair value and cost of investments: Fixed maturities $ (901,290) $ 5,253,785 $ 3,498,259 Equity securities 1,554,745 (637,585) 1,275,050 -------------- -------------- -------------- $ 653,455 $ 4,616,200 $ 4,773,309 ============== ============== ==============
Income taxes (benefit) on realized investment gains (losses) were $478,811, $49,565, and $(299,286) for 2003, 2002 and 2001, respectively. Deferred income taxes applicable to net unrealized investment gains included in shareholders' equity were $2,848,930 and $2,572,901 at December 31, 2003 and 2002, respectively. We held available for sale fixed maturities and equity securities with unrealized losses representing declines that we considered temporary at December 31, 2003 as follows:
Less than 12 months 12 months or longer ---------------------------- ---------------------------- Fair Unrealized Fair Unrealized Value Losses Value Losses ------------ ------------ ------------ ------------ U.S. Treasury securities and obligations of U.S. government corporations and agencies $ 5,020,000 $ 68,714 $ -- $ -- Obligations of states and political subdivisions 525,000 604 -- -- Mortgage-backed securities 2,226,680 2,997 -- -- Equity securities 1,275,737 54,198 898,130 39,355 ------------ ------------ ------------ ------------ Totals $ 9,047,417 $ 126,513 $ 898,130 $ 39,355 ============ ============ ============ ============
page 24 During 2003, 2002 and 2001, certain investments trading below cost had declined on an other-than-temporary basis. Losses of $237,724, $378,672 and $1,462,913 were included in net realized investment gains (losses) for these investments in 2003, 2002 and 2001, respectively. During 2003, we sold certain bonds that had been classified as held to maturity due to a series of rating agency downgrades related to these securities. These bonds had an amortized cost of $1.8 million, and the sale resulted in a realized gain of $165,564. During 2002, we sold certain bonds that had been classified as held to maturity due to significant deterioration in the issuer's credit worthiness. These bonds had an amortized cost of $488,901, and the sale resulted in a realized loss of $73,901. There were no other sales or transfers from the held to maturity portfolio in 2003 or 2002. On January 1, 2001, we transferred investments with an amortized cost of $51,640,154 and fair value of $52,444,675 from the held to maturity classification to the available for sale classification under the provisions of SFAS No. 133 and 138. The unrealized holding gain of $804,521 at January 1, 2001 was reported in other comprehensive income. The transfer had no impact on net income. We have no derivative instruments or hedging activities. 4--DEFERRED POLICY ACQUISITION COSTS Changes in deferred policy acquisition costs are as follows:
2003 2002 2001 -------------- -------------- -------------- Balance, January 1 $ 14,567,070 $ 13,604,215 $ 12,284,214 Acquisition costs deferred 32,495,695 30,435,855 28,514,001 Amortization charged to earnings 30,839,000 29,473,000 27,194,000 -------------- -------------- -------------- Balance, December 31 $ 16,223,765 $ 14,567,070 $ 13,604,215 ============== ============== ==============
5--PROPERTY AND EQUIPMENT Property and equipment at December 31, 2003 and 2002, consisted of the following:
Estimated Useful 2003 2002 Life -------------- -------------- -------------- Cost--office equipment $ 5,293,302 $ 5,441,882 5-15 years automobiles 903,162 785,572 3 years real estate 2,676,636 3,105,851 15-50 years software 325,323 561,146 5 years -------------- -------------- 9,198,423 9,894,451 Accumulated depreciation (5,046,752) (5,464,057) -------------- -------------- $ 4,151,671 $ 4,430,394 ============== ==============
Depreciation expense for 2003, 2002, and 2001 amounted to $650,200, $690,263 and $829,100, respectively. 6--LIABILITY FOR LOSSES AND LOSS EXPENSES Activity in the liability for losses and loss expenses is summarized as follows:
2003 2002 2001 -------------- -------------- -------------- Balance at January 1 $ 210,691,752 $ 179,839,905 $ 156,476,124 Less reinsurance recoverable 79,583,319 65,295,790 53,766,710 -------------- -------------- -------------- Net balance at January 1 131,108,433 114,544,115 102,709,414 -------------- -------------- -------------- Incurred related to: Current year 126,693,421 122,433,653 110,142,467 Prior years (450,110) 6,834,033 8,035,082 -------------- -------------- -------------- Total incurred 126,243,311 129,267,686 118,177,549 -------------- -------------- -------------- Paid related to: Current year 72,187,103 67,655,902 63,289,736 Prior years 46,268,571 45,047,466 43,053,112 -------------- -------------- -------------- Total paid 118,455,674 112,703,368 106,342,848 -------------- -------------- -------------- Net balance at December 31 138,896,070 131,108,433 114,544,115 Plus reinsurance recoverable 79,017,987 79,583,319 65,295,790 -------------- -------------- -------------- Balance at December 31 $ 217,914,057 $ 210,691,752 $ 179,839,905 ============== ============== ==============
We recognized an increase (decrease) in the liability for losses and loss expenses of prior years of $(450,110), $6.8 million and $8.0 million in 2003, 2002 and 2001, respectively. These developments are primarily attributable to variations from expected claim severity in the private passenger and commercial automobile liability, workers' compensation and commercial multiple peril lines of business. 7--BORROWINGS LINE OF CREDIT On November 25, 2003, we entered into a credit agreement with Manufacturers and Traders Trust Company ("M&T") relating to a four-year $35.0 million unsecured, revolving line of credit. As of December 31, 2003, we may borrow up to $35.0 million at interest rates equal to the bank's current prime rate or the then current London interbank Eurodollar bank rate plus between 1.50% and 1.75%, depending on our leverage ratio. In addition, we pay a fee of 0.15% per annum on the loan commitment amount, regardless of usage. The agreement requires our compliance with certain covenants, which include minimum levels of our net worth, leverage ratio and statutory surplus and A.M. Best ratings of our subsidiaries. As of December 31, 2003, there were no borrowings outstanding, and we complied with all requirements of the agreement. At December 31, 2002, pursuant to a credit agreement dated December 29, 1995, and amended as of July 27, 1998, with Fleet National Bank, we had unsecured borrowings of $19.8 million. Such borrowings were made in connection with various acquisitions and capital contributions to our subsidiaries. The borrowings under this line of credit were repaid during 2003, and this credit agreement was terminated on December 2, 2003. page 25 SUBORDINATED DEBENTURES On May 15, 2003, we received $15.0 million in net proceeds from the issuance of subordinated debentures. The debentures mature on May 15, 2033 and are callable at our option, at par, after five years. The debentures carry an interest rate equal to the three-month LIBOR rate plus 4.10%, which is adjustable quarterly. At December 31, 2003, the interest rate on these debentures was 5.28%, next subject to adjustment on February 15, 2004. As of December 31, 2003, we have an equity interest of $464,000 in a trust and subordinated debentures of $15.5 million related to this transaction. On October 29, 2003, we received $10.0 million in net proceeds from the issuance of subordinated debentures. The debentures mature on October 29, 2033 and are callable at our option, at par, after five years. The debentures carry an interest rate equal to the three-month LIBOR rate plus 3.85%, which is adjustable quarterly. At December 31, 2003, the interest rate on these debentures was 5.01%, next subject to adjustment on January 29, 2004. As of December 31, 2003, we have an equity interest of $310,000 in a trust and subordinated debentures of $10.3 million related to this transaction. 8--REINSURERS UNAFFILIATED REINSURERS In addition to the reinsurance in place with the Mutual Company, our subsidiaries have other reinsurance in place, principally with four unaffiliated reinsurers. We monitor the financial strength of our unaffiliated reinsurers, requiring that companies rated by A.M. Best Company maintain a rating of A- or higher and that foreign reinsurers not rated by A.M. Best Company maintain a level of financial strength equivalent to companies qualifying for an A.M. Best Company rating of A- or higher. The following amounts represent ceded reinsurance transactions with unaffiliated reinsurers during 2003, 2002 and 2001:
2003 2002 2001 ------------ ------------ ------------ Premiums written $ 10,908,851 $ 10,772,473 $ 9,348,853 ============ ============ ============ Premiums earned $ 11,535,468 $ 10,776,702 $ 9,440,035 ============ ============ ============ Losses and loss expenses $ 10,646,851 $ 13,693,184 $ 6,907,947 ============ ============ ============ Prepaid reinsurance premiums $ 710,057 $ 1,336,674 $ 1,340,903 ============ ============ ============ Liability for losses and loss expenses $ 15,361,192 $ 18,923,639 $ 10,510,444 ============ ============ ============
TOTAL REINSURANCE The following amounts represent the total of all ceded reinsurance transactions with both affiliated and unaffiliated reinsurers during 2003, 2002 and 2001:
2003 2002 2001 ------------ ------------ ------------ Premiums earned $ 70,429,560 $ 58,817,518 $ 64,220,420 ============ ============ ============ Losses and loss expenses $ 56,664,098 $ 55,526,159 $ 50,095,424 ============ ============ ============ Prepaid reinsurance premiums $ 30,691,654 $ 27,853,996 $ 29,593,467 ============ ============ ============ Liability for losses and loss expenses $ 79,017,987 $ 79,583,319 $ 65,295,790 ============ ============ ============
The following amounts represent the effect of reinsurance on premiums written for 2003, 2002 and 2001:
2003 2002 2001 ------------ ------------ ------------ Direct $118,605,732 $111,767,756 $110,298,533 Assumed 161,642,112 139,814,138 135,830,624 Ceded 73,267,218 57,078,047 69,101,503 ------------ ------------ ------------ Net premiums written $206,980,626 $194,503,847 $177,027,654 ============ ============ ============
The following amounts represent the effect of reinsurance on premiums earned for 2003, 2002 and 2001:
2003 2002 2001 ------------ ------------ ------------ Direct $114,154,202 $110,412,498 $105,214,059 Assumed 153,068,054 134,246,213 126,776,215 Ceded 70,429,560 58,817,518 64,220,420 ------------ ------------ ------------ Net premiums earned $196,792,696 $185,841,193 $167,769,854 ============ ============ ============
9--INCOME TAXES The provision for income tax consists of the following:
2003 2002 2001 ------------ ------------ ------------ Current $ 7,495,130 $ 5,071,516 $ 2,634,231 Deferred (352,731) (579,654) (1,360,633) ------------ ------------ ------------ Federal tax provision $ 7,142,399 $ 4,491,862 $ 1,273,598 ============ ============ ============
The effective tax rate is different from the amount computed at the statutory federal rate of 35% for 2003 and 34% for 2002 and 2001. The reasons for such difference and the related tax effects are as follows:
2003 2002 2001 ------------ ------------ ------------ Income before income taxes $ 25,436,375 $ 16,494,584 $ 7,091,729 ============ ============ ============ Computed "expected" taxes 8,902,731 5,608,159 2,411,188 Tax-exempt interest (1,824,830) (1,304,197) (1,399,238) Dividends received deduction (49,147) (31,830) (21,908) Other, net 113,645 219,730 283,556 ------------ ------------ ------------ Federal income tax provision $ 7,142,399 $ 4,491,862 $ 1,273,598 ============ ============ ============
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2003 and 2002, are as follows:
2003 2002 ------------ ------------ Deferred tax assets: Unearned premium $ 7,246,680 $ 6,438,461 Loss reserves 5,943,747 5,786,195 Net operating loss carryforward - Southern Heritage 1,459,722 1,744,081 Other 1,449,747 1,133,488 ------------ ------------ Total $ 16,099,896 $ 15,102,225 ============ ============ Deferred tax liabilities: Depreciation expense $ 331,291 $ 343,362 Deferred policy acquisition costs 5,678,318 5,007,431 Salvage recoverable 208,948 222,824 Unrealized gain 2,848,930 2,572,901 ------------ ------------ Total $ 9,067,487 $ 8,146,518 ============ ============ Net deferred tax assets $ 7,032,409 $ 6,955,707 ============ ============
page 26 A valuation allowance is provided when it is more likely than not that some portion of the tax asset will not be realized. Management has determined that it is not required to establish a valuation allowance for any deferred tax asset at December 31, 2003, since it is more likely than not that the deferred tax assets will be realized through reversals of existing temporary differences, future taxable income, carryback to taxable income in prior years and the implementation of tax planning strategies. At December 31, 2003, we have a net operating loss carryforward of $4,170,635, which is available to offset our taxable income. Such net operating loss carryforward will expire beginning in 2009. Federal income tax laws limit the amount of net operating loss carryforward that we can use in any one year to approximately $1 million. 10--STOCKHOLDERS' EQUITY On April 19, 2001 our stockholders approved an amendment to our Certificate of Incorporation. Among other things, the amendment reclassified our common stock as Class B common stock and effected a one-for-three reverse split of our Class B common stock effective April 19, 2001. The amendment also authorized a new class of common stock with one-tenth of a vote per share designated as Class A common stock. Our Board also approved a dividend of two shares of Class A common stock for each share of Class B common stock, after the one-for-three reverse split, held of record at the close of business April 19, 2001. The effect of the reverse split and the stock dividend taken together is that we had the same total number of shares outstanding after the reverse split and the stock dividend as we did before the reverse split and the stock dividend. Therefore, there is no change in the historical earnings per share of the Class A common stock and the Class B common stock after the reverse split and the stock dividend compared to before the reverse split and the stock dividend. Each share of Class A common stock outstanding at the time of the declaration of any dividend or other distribution payable in cash upon the shares of Class B common stock is entitled to a dividend or distribution payable at the same time and to stockholders of record on the same date in an amount at least 10% greater than any dividend declared upon each share of Class B common stock. In the event of our merger or consolidation with or into another entity, the holders of Class A common stock and the holders of Class B common stock are entitled to receive the same per share consideration in such merger or consolidation. In the event of our liquidation, dissolution or winding-up, any assets available to common stockholders will be distributed pro-rata to the holders of Class A common stock and Class B common stock. 11--STOCK COMPENSATION PLANS EQUITY INCENTIVE PLANS During 1996, we adopted an Equity Incentive Plan for key employees. During 2001, we adopted a nearly identical plan that made a total of 1,500,000 shares of Class A common stock available for issuance. Each plan provides for the granting of awards by the Board of Directors in the form of stock options, stock appreciation rights, restricted stock or any combination of the above. The plans provide that stock options may become exercisable up to 10 years from date of grant, with an option price not less than fair market value on date of grant. The stock appreciation rights permit surrender of the option and receipt of the excess of current market price over option price in cash. No stock appreciation rights have been issued. During 1996, we adopted an Equity Incentive Plan For Directors. During 2001, we adopted a nearly identical plan that made 200,000 shares of Class A common stock available for issuance. Awards may be made in the form of stock options, and the plan additionally provides for the issuance of 175 shares of restricted stock to each director on the first business day of January in each year. As of December 31, 2003, we have 40,000 unexercised options under these plans. Additionally 1,925, 2,100 and 1,947 shares of restricted stock were issued on January 2, 2003, 2002 and 2001, respectively. All options issued prior to 2001 were converted to options on Class A and Class B common stock as a result of our recapitalization. No further shares are available for plans in effect prior to 2001. Information regarding activity in our stock option plans is presented below:
Weighted-Average Number of Exercise Price Options Per Share --------- ---------------- Outstanding at December 31, 2000 1,516,338 $ 13.19 Granted - 2001 459,000 13.93 Exercised - 2001 13,315 8.00 Forfeited - 2001 27,556 13.50 --------- ---------------- Outstanding at December 31, 2001 1,934,467 $ 13.27 Granted - 2002 10,000 14.00 Exercised - 2002 7,684 8.00 Forfeited - 2002 18,334 14.36 Expired - 2002 524,448 13.50 --------- ---------------- Outstanding at December 31, 2002 1,394,001 $ 13.43 Granted - 2003 667,500 12.00 Exercised - 2003 91,482 8.15 Forfeited - 2003 14,000 10.57 Expired - 2003 476,667 18.00 --------- ---------------- Outstanding at December 31, 2003 1,479,352 $ 11.72 ========= ================ Exercisable at: December 31, 2001 1,321,905 $ 13.89 ========= ================ December 31, 2002 1,085,000 $ 13.29 ========= ================ December 31, 2003 883,707 $ 11.11 ========= ================
Options available for future grants at December 31, 2003 are 577,975. The following table summarizes information about fixed stock options at December 31, 2003:
Number of Weighted-Average Number of Exercise Options Remaining Options Price Outstanding Contractual Life Exercisable ----- ----------- ---------------- ----------- $ 8.00 353,585 1.0 year 353,585 9.00 4,500 2.5 years 4,500 12.00 650,668 4.5 years 216,889 14.00 455,599 2.5 years 303,733 18.00 5,000 1.5 years 5,000 18.25 5,000 4.5 years -- 21.00 5,000 5.0 years -- --------- ------- Total 1,479,352 883,707 ========= =======
page 27 EMPLOYEE STOCK PURCHASE PLANS During 1996, we adopted an Employee Stock Purchase Plan. During 2001, we adopted a nearly identical plan that made 300,000 shares of Class A common stock available for issuance. The new plan extends over a 10-year period and provides for shares to be offered to all eligible employees at a purchase price equal to the lesser of 85% of the fair market value of our common stock on the last day before the first day of the enrollment period (June 1 and December 1) of the plan or 85% of the fair market value of our common stock on the last day of the subscription period (June 30 and December 31). A summary of plan activity follows:
Shares Issued ------------------- Price Shares --------- ------ January 1, 2001 $ 5.9500 16,438 July 1, 2001 8.7125 11,377 January 1, 2002 8.8485 12,769 July 1, 2002 8.7720 10,520 January 1, 2003 9.1375 9,425 July 1, 2003 10.1575 8,776
On January 1, 2004, we issued an additional 7,637 shares at a price of $11.4495 per share under this plan. AGENCY STOCK PURCHASE PLANS On December 31, 1996, we adopted an Agency Stock Purchase Plan. During 2001, we adopted a nearly identical plan that made 300,000 shares of Class A common stock available for issuance. The plan provides for agents of our affiliated companies 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 2003, 2002 and 2001, 28,547, 16,310, and 16,557 shares, respectively, were issued under this plan. Expense recognized under the plan was not material. 12--STATUTORY NET INCOME, CAPITAL AND SURPLUS AND DIVIDEND RESTRICTIONS The following is selected information, as filed with insurance regulatory authorities, for our subsidiaries as determined in accordance with accounting practices prescribed or permitted by such insurance regulatory authorities:
2003 2002 2001 ------------ ------------ ------------ ATLANTIC STATES Statutory capital and surplus $109,854,398 $ 95,405,603 $ 91,649,362 ============ ============ ============ Statutory unassigned surplus $ 56,193,534 $ 46,744,739 $ 42,988,498 ============ ============ ============ Statutory net income (loss) $ 13,272,651 $ 10,646,804 $ (676,125) ============ ============ ============ SOUTHERN Statutory capital and surplus $ 40,649,495 $ 31,243,897 $ 30,730,757 ============ ============ ============ Statutory unassigned surplus $ (1,968,090) $ (6,373,688) $ (6,886,828) ============ ============ ============ Statutory net income $ 5,275,909 $ 2,505,891 $ 5,180,964 ============ ============ ============
Our principal source of cash for payment of dividends are dividends from our 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 and Southern are also subject to Risk Based Capital (RBC) requirements that may further impact their ability to pay dividends. At December 31, 2003, the companies' statutory capital and surplus were substantially above the RBC requirements. Amounts available for distribution as dividends to us without prior approval of insurance regulatory authorities in 2004 are $13,272,651 from Atlantic States and $4,064,950 from Southern. The National Association of Insurance Commissioners (NAIC) adopted the Codification of Statutory Accounting Principles with an effective date of January 1, 2001. The codified principles are intended to provide a basis of accounting recognized and adhered to in the absence of conflict with, or silence of, state statutes and regulations. The impact of the codified principles on the statutory capital and surplus of our subsidiaries as of January 1, 2001 was as follows: Atlantic States - $6,482,380 increase and Southern - $2,254,558 increase. 13--RECONCILIATION OF STATUTORY FILINGS TO AMOUNTS REPORTED HEREIN Our 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, -------------------------------------------- 2003 2002 2001 ------------ ------------ ------------ Statutory net income of insurance subsidiaries $ 18,548,560 $ 13,152,695 $ 4,504,839 Increases (decreases): Deferred policy acquisition costs 1,656,695 962,855 1,320,001 Deferred federal income taxes 352,731 579,654 1,360,633 Salvage and subrogation recoverable (167,627) (863,313) 155,088 Consolidating eliminations and adjustments (8,099,197) (11,264,732) (13,783,695) Parent-only net income 6,002,814 9,435,563 12,261,265 ------------ ------------ ------------ Net income as reported herein $ 18,293,976 $ 12,002,722 $ 5,818,131 ============ ============ ============
page 28
December 31, ----------------------------------------------- 2003 2002 2001 ------------- ------------- ------------- Statutory capital and surplus of insurance subsidiaries $ 150,503,893 $ 126,649,500 $ 122,380,119 Increases (decreases): Deferred policy acquisition costs 16,223,765 14,567,070 13,604,215 Deferred federal income taxes (4,268,453) (3,499,656) (820,313) Salvage and subrogation recoverable 7,167,008 7,334,635 8,197,948 Non-admitted assets and other adjustments, net 907,955 735,946 334,092 Fixed maturities 6,521,246 7,517,290 3,793,048 Consolidating eliminations and adjustments (51,984,856) (40,891,418) (39,693,089) Parent-only equity 83,578,674 20,769,483 13,132,329 ------------- ------------- ------------- Stockholders' equity as reported herein $ 208,649,232 $ 133,182,850 $ 120,928,349 ============= ============= =============
14--SUPPLEMENTARY CASH FLOW INFORMATION The following reflects income taxes and interest paid during 2003, 2002 and 2001:
2003 2002 2001 ------------- ------------- ------------- Income taxes $ 7,356,674 $ 4,410,000 $ 2,666,887 ============= ============= ============= Interest $ 1,291,992 $ 1,047,237 $ 3,049,844 ============= ============= =============
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 ended December 31, 2003, 2002 and 2001:
Weighted- Average Earnings Net Shares Per Income Outstanding Share ------ ----------- ----- 2003: Basic $18,293,976 9,570,872 $1.91 Effect of stock options -- 323,972 (.06) ----------- --------- ----- Diluted $18,293,976 9,894,844 $1.85 =========== ========= ===== 2002: Basic $12,002,722 9,085,914 $1.32 Effect of stock options -- 107,199 (.01) ----------- --------- ----- Diluted $12,002,722 9,193,113 $1.31 =========== ========= ===== 2001: Basic $ 5,818,131 8,941,781 $ .65 Effect of stock options -- 136,669 (.01) ----------- --------- ----- Diluted $ 5,818,131 9,078,450 $ .64 =========== ========= =====
The following options to purchase shares of common stock were not included in the computation of diluted earnings per share because the exercise price of the options was greater than the average market price:
2003 2002 2001 ---- ---- ---- Options excluded from diluted earnings per share -- 939,167 1,467,782 == ======= =========
16--CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY CONDENSED BALANCE SHEETS ($ in thousands)
December 31, 2003 2002 ------------------------------------------------------- --------- --------- ASSETS Fixed-maturity investments $ 1,987 $ -- Investment in subsidiaries (equity method) 183,402 156,684 Short-term investments 47,559 -- Cash 365 604 Property and equipment 1,579 1,640 Other 1,345 99 --------- --------- Total assets $ 236,237 $ 159,027 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities Cash dividends declared to stockholders $ 1,379 $ 887 Line of credit -- 19,800 Subordinated debentures 25,774 -- Due to affiliate -- 4,441 Other 435 716 --------- --------- Total liabilities 27,588 25,844 --------- --------- Stockholders' equity 208,649 133,183 --------- --------- Total liabilities and stockholders' equity $ 236,237 $ 159,027 ========= =========
CONDENSED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME ($ in thousands)
Year Ended December 31, 2003 2002 2001 ------------------------------------ -------- -------- -------- STATEMENTS OF INCOME Revenues Dividends from subsidiaries $ 7,000 $ 10,400 $ 14,419 Other 1,034 797 824 -------- -------- -------- Total revenues 8,034 11,197 15,243 -------- -------- -------- Expenses Operating expenses 1,345 1,057 1,761 Interest 1,320 1,139 2,288 -------- -------- -------- Total expenses 2,665 2,196 4,049 -------- -------- -------- Income before income tax benefit and equity in undistributed net income (loss) of subsidiaries 5,369 9,001 11,194 Income tax benefit (634) (435) (1,067) -------- -------- -------- Income before equity in undistributed net income (loss) of subsidiaries 6,003 9,436 12,261 Equity in undistributed net income (loss) of subsidiaries 12,291 2,567 (6,443) -------- -------- -------- Net income $ 18,294 $ 12,003 $ 5,818 ======== ======== ======== STATEMENTS OF COMPREHENSIVE INCOME Net income $ 18,294 $ 12,003 $ 5,818 -------- -------- -------- Other comprehensive income, net of tax Unrealized gain (loss) - parent (42) 15 26 Unrealized gain - subsidiaries 421 2,035 3,035 -------- -------- -------- Other comprehensive income 379 2,050 3,061 -------- -------- -------- Comprehensive income $ 18,673 $ 14,053 $ 8,879 ======== ======== ========
page 29 CONDENSED STATEMENTS OF CASH FLOWS ($ in thousands)
Year Ended December 31, 2003 2002 2001 ------------------------------------- -------- -------- -------- Cash flows from operating activities: Net income $ 18,294 $ 12,003 $ 5,818 -------- -------- -------- Adjustments: Equity in undistributed net loss (income) of subsidiaries (12,291) (2,567) 6,443 Other (4,316) 788 252 -------- -------- -------- Net adjustments (16,607) (1,779) 6,695 -------- -------- -------- Net cash provided 1,687 10,224 12,513 -------- -------- -------- Cash flows from investing activities: Net purchase of fixed maturities (1,938) -- -- Net purchase of short-term investments (47,559) -- -- Net purchase of property and equipment (433) (480) (122) Investment in subsidiaries (14,274) -- -- Other (981) 38 38 -------- -------- -------- Net cash used (65,185) (442) (84) -------- -------- -------- Cash flows from financing activities: Cash dividends paid (3,868) (3,509) (3,394) Issuance of common stock 61,153 1,728 1,387 Issuance of subordinated debentures 25,774 -- -- Line of credit, net (19,800) (7,800) (12,400) -------- -------- -------- Net cash provided (used) 63,259 (9,581) (14,407) -------- -------- -------- Net change in cash (239) 201 (1,978) Cash at beginning of year 604 403 2,381 -------- -------- -------- Cash at end of year $ 365 $ 604 $ 403 ======== ======== ========
17--SEGMENT INFORMATION As an underwriter of property and casualty insurance, we have three reportable segments which consist of the investment function, the personal lines of insurance and the commercial lines of insurance. Using independent agents, we market personal lines of insurance to individuals and commercial lines of insurance to small and medium-sized businesses. We evaluate the performance of the personal lines and commercial lines primarily based upon underwriting results as determined under statutory accounting practices (SAP) for our total business. Assets are not allocated to the personal and commercial lines and are reviewed in total by management for purposes of decision making. We operate 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:
2003 2002 2001 --------- --------- --------- ($ in thousands) --------------------------------- Revenues: Premiums earned: Commercial lines $ 71,471 $ 66,003 $ 62,877 Personal lines 125,322 119,838 104,893 --------- --------- --------- Total premiums earned 196,793 185,841 167,770 --------- --------- --------- Net investment income 13,316 14,581 15,886 Realized investment gains (losses) 1,368 144 (880) Other 3,515 3,238 2,388 --------- --------- --------- Total revenues $ 214,992 $ 203,804 $ 185,164 ========= ========= =========
2003 2002 2001 -------- -------- -------- ($ in thousands) ------------------------------- Income before income taxes: Underwriting income (loss): Commercial lines $ 7,173 $ 6,326 $ (3,037) Personal lines 2,004 (5,056) (5,090) -------- -------- -------- SAP underwriting income (loss) 9,177 1,270 (8,127) GAAP adjustments 692 (558) 1,833 -------- -------- -------- GAAP underwriting income (loss) 9,869 712 (6,294) Net investment income 13,316 14,581 15,886 Realized investment gains (losses) 1,368 144 (880) Other 883 1,058 (1,620) -------- -------- -------- Income before income taxes $ 25,436 $ 16,495 $ 7,092 ======== ======== ========
18--GUARANTY FUND AND OTHER INSURANCE-RELATED ASSESSMENTS We accrue for guaranty-fund and other insurance-related assessments in accordance with Statement of Position (SOP) 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments." SOP 97-3 provides guidance for determining when an entity should recognize a liability for guaranty-fund and other insurance-related assessments, how to measure that liability and when an asset may be recognized for the recovery of such assessments through premium tax offsets or policy surcharges. Our liabilities for guaranty-fund and other insurance-related assessments were $3,556,227 and $2,970,182 at December 31, 2003 and 2002, respectively. These liabilities included $283,509 and $538,578 related to surcharges collected by us on behalf of regulatory authorities for 2003 and 2002, respectively. 19--INTERIM FINANCIAL DATA (UNAUDITED)
2003 ----------------------------------------------------- First Second Third Fourth Quarter Quarter Quarter Quarter ----------- ----------- ----------- ----------- Net premiums earned $47,928,881 $48,433,689 $49,719,584 $50,710,542 Total revenues 52,185,419 52,826,818 54,285,753 55,694,338 Net losses and loss expenses 31,850,515 29,658,466 32,759,356 31,974,974 Net income 3,844,432 5,268,953 4,001,385 5,179,206 Net income per common share Basic .42 .57 .43 .49 Diluted .41 .56 .40 .47
2002 ----------------------------------------------------- First Second Third Fourth Quarter Quarter Quarter Quarter ----------- ----------- ----------- ----------- Net premiums earned $45,452,260 $46,110,512 $46,792,748 $47,485,673 Total revenues 50,034,046 50,736,803 51,085,417 51,947,295 Net losses and loss expenses 31,297,569 32,136,019 32,423,893 33,410,205 Net income 2,180,716 3,178,834 3,015,676 3,627,496 Net income per common share Basic .24 .35 .33 .40 Diluted .24 .35 .33 .39
page 30 INDEPENDENT AUDITORS' REPORT The Stockholders and Board of Directors Donegal Group Inc. We have audited the accompanying consolidated balance sheets of Donegal Group Inc. and subsidiaries as of December 31, 2003 and 2002, 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, 2003. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Donegal Group Inc. and subsidiaries as of December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2003 in conformity with accounting principles generally accepted in the United States of America. /s/ KPMG LLP Philadelphia, Pennsylvania February 19, 2004 page 31 CORPORATE INFORMATION ANNUAL MEETING April 15, 2004 at the Company's headquarters at 10:00 a.m. FORM 10-K A copy of Donegal Group's Annual Report on Form 10-K will be furnished free upon written request to Ralph G. Spontak, Senior Vice President and Chief Financial Officer, at the corporate address. MARKET INFORMATION Donegal Group's Class A common stock and Class B common stock are traded on the Nasdaq National Market under the symbols "DGICA" and "DGICB." The following table shows the dividends paid per share and the stock price range for each quarter during 2003 and 2002:
CASH DIVIDEND DECLARED QUARTER HIGH LOW PER SHARE 2002 - CLASS A 1st $ 10.770 $ 8.750 $ -- 2nd 12.250 9.050 .10 3rd 10.990 9.120 .10 4th 12.120 9.250 .20 2002 - CLASS B 1st 12.800 8.780 -- 2nd 11.000 9.750 .09 3rd 11.500 9.510 .09 4th 11.440 9.200 .18 2003 - CLASS A 1st 11.750 9.500 -- 2nd 15.200 10.980 .10 3rd 19.000 12.100 .11 4th 23.970 15.250 .22 2003 - CLASS B 1st 11.320 10.720 -- 2nd 13.790 10.350 .09 3rd 16.010 11.760 .10 4th 20.000 14.750 .20
CORPORATE OFFICES 1195 River Road P.O. Box 302 Marietta, Pennsylvania 17547-0302 (800) 877-0600 E-mail Address: info@donegalgroup.com Donegal Web Site: www.donegalgroup.com TRANSFER AGENT EquiServe Trust Company, N.A. P.O. Box 43069 Providence, Rhode Island 02940-3069 (800) 317-4445 Web Site: www.equiserve.com Hearing Impaired: TDD: 800-952-9245 DIVIDEND REINVESTMENT AND STOCK PURCHASE PLAN The Company offers a dividend reinvestment and stock purchase plan through its transfer agent. For information contact: Donegal Group Inc. Dividend Reinvestment and Stock Purchase Plan EquiServe Trust Company, N.A. P.O. Box 43069 Providence, Rhode Island 02940-3069 STOCKHOLDERS The following represent the number of common stockholders of record as of December 31, 2003: Class A common stock 638 Class B common stock 479 page 32