##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-K
  þ
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For the fiscal year ended December 31, 2006
 or
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
 For the transition period from  to
 Commission File Number: 000-50360
 DIRECT GENERAL CORPORATION
  Tennessee
    
    62-1564496(State or other jurisdiction of 
incorporation or organization)
    
    (I.R.S. Employer Identification No.)1281 Murfreesboro Road, Nashville, TN
    
    37217(Address of principal executive offices)
    
    (Zip Code)
 (Registrants telephone number, including area code)
  Title of each class 
Common stock, no par value
    
    Name of each exchange on which registered
The Nasdaq National Market
   
  o þ
  o þ
  þ o
  þ
  o þ o
  o þ
   DOCUMENTS INCORPORATED BY REFERENCE




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TABLE OF CONTENTS  PART IItem 1. BusinessItem 1A. Risk FactorsItem 1B. Unresolved Staff CommentsItem 2. PropertiesItem 3. Legal ProceedingsItem 4. Submission of Matters to a Vote of Security HoldersPART IIItem 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity SecuritiesItem 6. Selected Financial DataItem 7. Managements Discussion and Analysis of Financial Condition and Results of OperationsItem 7A. Quantitative and Qualitative Disclosures About Market RiskItem 8. Financial Statements and Supplementary DataItem 9. Changes in and Disagreements With Accountants on Accounting and Financial DisclosureItem 9A. Controls and ProceduresItem 9B. Other InformationPART IIIPART IVItem 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-KSIGNATUREEx-14 Code of Ethics and Policy on Business ConductEx-21 List of Subsidiaries of the CompanyEx-23 Consent of Independent Registered Public Accounting FirmEx-31.1 Section 302 Certification of the CEOEx-31.2 Section 302 Certification of CFOEx-32.1 Section 906 Certification of the CFOEx-32.2 Section 906 Certification of CFO    Table of Contents  
 PART I
 
 Item 1. Business.
    Our Business Model
  Our Products and Services
  1




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®
   Year Ended December 31,2006
    
    
    2005
    
    
    2004($ in millions)Gross premiums:Gross premiums written  automobile
    
    $
    433.2
    
    
    $
    433.1
    
    
    $
    463.5Gross premiums written  life
    
    
    22.7
    
    
    
    19.9
    
    
    
    18.4Total gross premiums
    
    
    455.9
    
    
    
    453.0
    
    
    
    481.9Ancillary income (1):Finance income
    
    
    43.9
    
    
    
    44.4
    
    
    
    49.2Commission and service fee income
    
    
    45.6
    
    
    
    46.8
    
    
    
    48.6Total ancillary income
    
    
    89.5
    
    
    
    91.2
    
    
    
    97.8Net investment income excluding realized
gains (losses) on securities
    
    
    19.0
    
    
    
    14.7
    
    
    
    10.8Gross revenues (2)
    
    $
    564.4
    
    
    $
    558.9
    
    
    $
    590.5
 
 (1)
    
    Ancillary income includes income derived from revenue sources that do not entail
insurance underwriting risk.(2)
    
    Gross revenues, which we consider to be a non-GAAP financial measure, is
defined as gross premiums written,
including direct premiums written and assumed premiums written, finance income,
commission and service fee
income, and net investment income (excluding net realized gains (losses) on
securities). See Managements
Discussion and Analysis of Financial Condition and Results of Operations 
Measurement of Results. Our Favorable Cost Structure
  2




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##### Table of Contents



Year Ended December 31,2006
    
    
    2005
    
    
    2004($ in millions)Ancillary income
    
    $
    89.5
    
    
    $
    91.2
    
    
    $
    97.8Operating expensesSelling, general and administrative
costs
    
    $
    155.1
    
    
    $
    133.6
    
    
    $
    108.5Interest expense
    
    
    12.0
    
    
    
    8.3
    
    
    
    5.5Total operating expenses
    
    $
    167.1
    
    
    $
    141.9
    
    
    $
    114.0Ratio of ancillary income to total
operating expenses
    
    
    53.6
    %
    
    
    64.3
    %
    
    
    85.8
    %
 Our Strengths
  
    
    Our integrated business modelenables us to better manage our business
and capture a significant amount of premium finance revenues, term life
insurance premiums, commissions from the sale of non-core insurance products
and other revenues that would typically be paid, in an independent agency
 3




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distribution model, to an unaffiliated premium finance company, independent
agent or other third party.
 
    
    Our broad sales office network,which emphasizes the use of
employee-agents, is the cornerstone of our relationship with our customers,
who typically would prefer to conduct business face-to-face than by telephone
or on the Internet.
    
    Our premium finance operations,which support the majority of the
policies that we sell, provide attractive payment plans for our policyholders
and allow us to adjust payment plan structures to meet changes in market
demands more quickly than most of our competitors.
    
    Our favorable cost structureenables us to leverage our largely fixed
cost neighborhood sales offices staffed by company employees and reduce our
marginal operating cost as we increase revenues.
    
    Our ancillary revenues,including premium finance revenues,
commissions from the sale of non-core insurance products and other revenues,
none of which currently entails insurance underwriting risk, defray a
significant amount of our operating expenses.
    
    Our claims settlement philosophy and procedureshave been designed
with a clear emphasis on controlling costs through the use of our
employee-staffed claims operations.
    
    Our controlled policy underwriting and pricingare supported by an
integrated point of sale agency system and back office control system.
    
    Strong name branding in our marketsresults from our extensive use of
television advertising and the presence of our neighborhood sales offices
throughout the states in which we operate.
 Our Future Growth
  
    
    Increasing Revenues in Existing Markets.We are focused on increasing revenues in our existing
markets by:
 
    
    generating new customers through our advertising campaigns; and
    
    increasing the sales of our non-core insurance and non-insurance products and services.
 
    
    Expanding Our Product and Service Offerings.We intend to expand the
range of non-core insurance and non-insurance products and services we offer.
    
    Expanding Our Distribution Network.We intend to expand into new
states through acquisitions of local agencies and the opening of new sales
offices. We also plan to continue to expand alternative distribution channels
for our products including further development and enhancement of our
Internet distribution to all of our states during 2007.
 Our Market
  4




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
    
    down payment;
    
    payment frequency and amount;
    
    total policy premium; and
    
    customer service.
  Our Competition
   Marketing and Distribution
  Television Advertising.
 5




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Neighborhood Sales Offices.
    Employee-Agents.
 New State Expansion.
 Alternative Distribution Channels.
 6




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##### Table of Contents



Our Products and Services
 Non-Standard Personal Automobile Insurance
    Year Ended December 31,2006
    
    2005
    
    2004($ in millions)Gross premiums written  Automobile
    
    $
    433.2
    
    
    $
    433.1
    
    
    $
    463.5
  Individual Term Life Insurance
   Year Ended December 31,2006
    
    2005
    
    2004($ in millions)Gross premiums written  Life
    
    $
    22.7
    
    
    $
    19.9
    
    
    $
    18.4
 Premium Finance
  7




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
    
    the ability to finance multiple policies through a single premium finance agreement,
    
    returns comparable to or exceeding those of installment billing,
    
    a greater flexibility of payment plan structure and down payment,
    
    the ability to generate revenues in our non-insurance subsidiaries, and
    
    a more defined regulatory framework for financing premiums.
     8




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Year Ended December 31,2006
    
    2005
    
    2004($ in millions)Finance income
    
    $
    43.9
    
    
    $
    44.4
    
    
    $
    49.2
 Ancillary Insurance Products
     Year Ended December 31,2006
    
    2005
    
    2004($ in millions)Commission and service fee income
    
    $
    45.6
    
    
    $
    46.8
    
    
    $
    48.6
  Other Products and Services
  9




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Direct Prepaid Visa ® , a Debit Card Program. ®
 Direct Cash Advance, a Payday Consumer Loan Program. Direct Cash Advance,
 Direct Cash Advance
 Underwriting and Pricing
 Non-Standard Personal Automobile Insurance.
  Individual Term Life Insurance.
 Claims Handling
  10




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Loss and Loss Adjustment Expense Reserves
    11




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Year Ended December 31,2006
    
    
    2005
    
    
    2004($ in millions)Balance at beginning of period
    
    $
    131.4
    
    
    $
    124.9
    
    
    $
    112.6Less reinsurance recoverables on unpaid losses
    
    
    17.5
    
    
    
    22.9
    
    
    
    37.9Net balance at beginning of period
    
    
    113.9
    
    
    
    102.0
    
    
    
    74.7Add Losses and LAE incurred, net of reinsurance related to:Current period
    
    
    321.2
    
    
    
    299.0
    
    
    
    275.7Prior period
    
    
    (0.3
    )
    
    
    6.8
    
    
    
    6.3Net losses and LAE incurred during the current year
    
    
    320.9
    
    
    
    305.8
    
    
    
    282.0Deduct losses and LAE paid, net of reinsurance, related to:Current period
    
    
    221.7
    
    
    
    210.6
    
    
    
    191.2Prior period
    
    
    82.3
    
    
    
    83.3
    
    
    
    63.5Net claim payments made during the current period
    
    
    304.0
    
    
    
    293.9
    
    
    
    254.7Net balance at end of period
    
    
    130.8
    
    
    
    113.9
    
    
    
    102.0Plus reinsurance recoverables on unpaid losses
    
    
    6.0
    
    
    
    17.5
    
    
    
    22.9Balance at end of period
    
    $
    136.8
    
    
    $
    131.4
    
    
    $
    124.9
     12




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As of December 31,1996
    
    
    1997
    
    
    1998
    
    
    1999
    
    
    2000
    
    
    2001
    
    
    2002
    
    
    2003
    
    
    2004
    
    
    2005
    
    
    2006($ in millions)Net reserves for losses and loss
adjustment expense:Originally estimated
    
    $
    16.0
    
    
    $
    18.4
    
    
    $
    31.4
    
    
    $
    33.9
    
    
    $
    34.5
    
    
    $
    37.0
    
    
    $
    57.9
    
    
    $
    74.7
    
    
    $
    102.0
    
    
    $
    113.9
    
    
    $
    130.8Cumulative amounts paid as of:One year later
    
    
    9.7
    
    
    
    9.7
    
    
    
    18.4
    
    
    
    25.0
    
    
    
    31.2
    
    
    
    13.1
    
    
    
    43.8
    
    
    
    63.5
    
    
    
    83.2
    
    
    
    82.3Two years later
    
    
    12.4
    
    
    
    12.2
    
    
    
    24.8
    
    
    
    33.7
    
    
    
    35.3
    
    
    
    26.9
    
    
    
    55.4
    
    
    
    75.5
    
    
    
    99.9Three years later
    
    
    13.2
    
    
    
    13.7
    
    
    
    27.6
    
    
    
    36.1
    
    
    
    41.3
    
    
    
    32.7
    
    
    
    59.7
    
    
    
    82.0Four years later
    
    
    13.7
    
    
    
    14.4
    
    
    
    28.7
    
    
    
    38.4
    
    
    
    43.6
    
    
    
    34.7
    
    
    
    62.1Five years later
    
    
    13.9
    
    
    
    14.7
    
    
    
    29.3
    
    
    
    39.2
    
    
    
    44.5
    
    
    
    35.3Six years later
    
    
    14.0
    
    
    
    14.8
    
    
    
    29.7
    
    
    
    39.6
    
    
    
    44.8Seven years later
    
    
    14.1
    
    
    
    14.9
    
    
    
    29.8
    
    
    
    39.7Eight years later
    
    
    14.1
    
    
    
    15.0
    
    
    
    29.8Nine years later
    
    
    14.1
    
    
    
    15.0Ten years later
    
    
    14.1Reserves re-estimated as of:One year later
    
    
    15.7
    
    
    
    16.6
    
    
    
    29.1
    
    
    
    36.2
    
    
    
    43.1
    
    
    
    31.5
    
    
    
    58.0
    
    
    
    81.0
    
    
    
    108.8
    
    
    
    113.6Two years later
    
    
    15.6
    
    
    
    15.6
    
    
    
    28.8
    
    
    
    38.3
    
    
    
    42.7
    
    
    
    33.6
    
    
    
    61.2
    
    
    
    84.1
    
    
    
    112.3Three years later
    
    
    14.9
    
    
    
    15.3
    
    
    
    29.4
    
    
    
    38.7
    
    
    
    43.8
    
    
    
    35.1
    
    
    
    62.8
    
    
    
    86.5Four years later
    
    
    14.6
    
    
    
    15.1
    
    
    
    29.5
    
    
    
    39.3
    
    
    
    44.6
    
    
    
    35.9
    
    
    
    64.1Five years later
    
    
    14.3
    
    
    
    14.8
    
    
    
    29.7
    
    
    
    39.7
    
    
    
    45.1
    
    
    
    36.0Six years later
    
    
    14.1
    
    
    
    14.9
    
    
    
    29.8
    
    
    
    39.9
    
    
    
    45.2Seven years later
    
    
    14.1
    
    
    
    15.0
    
    
    
    29.9
    
    
    
    39.9Eight years later
    
    
    14.1
    
    
    
    15.0
    
    
    
    29.9Nine years later
    
    
    14.1
    
    
    
    15.0Ten years later
    
    
    14.1Net cumulative deficiency/(redundancy):
    
    $
    (1.9
    )
    
    $
    (3.5
    )
    
    $
    (1.6
    )
    
    $
    6.0
    
    
    $
    10.6
    
    
    $
    (1.0
    )
    
    $
    6.1
    
    
    $
    11.8
    
    
    $
    10.3
    
    
    $
    (0.3
    )Gross liability  originally estimated
    
    $
    21.0
    
    
    $
    25.7
    
    
    $
    39.9
    
    
    $
    53.2
    
    
    $
    74.0
    
    
    $
    77.5
    
    
    $
    86.9
    
    
    $
    112.6
    
    
    $
    124.9
    
    
    $
    131.4
    
    
    $
    136.8Reinsurance recoverables
    
    
    5.0
    
    
    
    7.3
    
    
    
    8.5
    
    
    
    19.3
    
    
    
    39.5
    
    
    
    40.5
    
    
    
    29.0
    
    
    
    37.9
    
    
    
    22.9
    
    
    
    17.5
    
    
    
    6.0Net liability  originally estimated
    
    $
    16.0
    
    
    $
    18.4
    
    
    $
    31.4
    
    
    $
    33.9
    
    
    $
    34.5
    
    
    $
    37.0
    
    
    $
    57.9
    
    
    $
    74.7
    
    
    $
    102.0
    
    
    $
    113.9
    
    
    $
    130.8Gross estimated
liability  latest
    
    $
    18.3
    
    
    $
    22.0
    
    
    $
    38.3
    
    
    $
    62.8
    
    
    $
    83.4
    
    
    $
    81.7
    
    
    $
    94.8
    
    
    $
    128.7
    
    
    $
    136.3
    
    
    $
    128.3
    
    
    $
    136.8Reinsurance recoverables  latest
    
    
    4.2
    
    
    
    7.0
    
    
    
    8.4
    
    
    
    22.9
    
    
    
    38.3
    
    
    
    45.8
    
    
    
    30.7
    
    
    
    42.2
    
    
    
    24.0
    
    
    
    14.8
    
    
    
    6.0Net estimated liability  as of 2006
    
    $
    14.1
    
    
    $
    15.0
    
    
    $
    29.9
    
    
    $
    39.9
    
    
    $
    45.1
    
    
    $
    35.9
    
    
    $
    64.1
    
    
    $
    86.5
    
    
    $
    112.3
    
    
    $
    113.6
    
    
    $
    130.8Gross cumulative deficiency/(redundancy)
    
    $
    (2.7
    )
    
    $
    (3.7
    )
    
    $
    (1.6
    )
    
    $
    9.6
    
    
    $
    9.4
    
    
    $
    4.2
    
    
    $
    7.9
    
    
    $
    16.1
    
    
    $
    11.5
    
    
    $
    (2.7
    )Net cumulative deficiency/(redundancy):
    
    $
    (1.9
    )
    
    $
    (3.5
    )
    
    $
    (1.6
    )
    
    $
    6.0
    
    
    $
    10.6
    
    
    $
    (1.0
    )
    
    $
    6.1
    
    
    $
    11.8
    
    
    $
    10.3
    
    
    $
    (0.3
    )
 Reinsurance
 Summary
   13




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Year Ended December 31,2006
    
    
    2005
    
    
    2004Written
    
    
    Earned
    
    
    Written
    
    
    Earned
    
    
    Written
    
    
    Earned($ in millions)Direct premiums
    
    $
    435.1
    
    
    $
    425.5
    
    
    $
    424.6
    
    
    $
    432.0
    
    
    $
    442.6
    
    
    $
    432.6Assumed premiums
    
    
    20.8
    
    
    
    21.0
    
    
    
    28.4
    
    
    
    29.6
    
    
    
    39.3
    
    
    
    39.2Gross premiums
    
    
    455.9
    
    
    
    446.5
    
    
    
    453.0
    
    
    
    461.6
    
    
    
    481.9
    
    
    
    471.8Ceded premiums
    
    
    2.7
    
    
    
    (21.7
    )
    
    
    (52.4
    )
    
    
    (57.5
    )
    
    
    (72.5
    )
    
    
    (99.3
    )Net premiums
    
    $
    458.6
    
    
    $
    424.8
    
    
    $
    400.6
    
    
    $
    404.1
    
    
    $
    409.4
    
    
    $
    372.5
 Reinsurance Risks
  Credit Risk.
  14




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AmountSecured byNet
    
    
    Net
    
    
    Funds Held
    
    
    Net
    
    
    Letters ofRecoverable
    
    
    Receivable
    
    
    and Ceded
    
    
    Exposure
    
    
    Credit oron Paid
    
    
    on
    
    
    Premiums
    
    
    to
    
    
    TrustReinsurer
    
    A.M. Best Rating
    
    Losses
    
    
    Reserves
    
    
    Payable
    
    
    Reinsurer
    
    
    Accounts($ in millions)AXA Corporate Solutions
    
    A (Excellent)
    
    $
    0.2
    
    
    $
    0.5
    
    
    $
    0.7
    
    
    $
    0.5
    
    
    $
    0.5Dorinco Reinsurance
    
    A-(Excellent)
    
    
    0.8
    
    
    
    2.7
    
    
    
    2.0
    
    
    
    2.6
    
    
    
    0.3National Union Fire
Insurance
    
    A+ (Superior)
    
    
    0.3
    
    
    
    1.3
    
    
    
    0.8
    
    
    
    1.2
    
    
    
    Swiss Re America
    
    A+ (Superior)
    
    
    0.3
    
    
    
    1.3
    
    
    
    0.8
    
    
    
    1.2
    
    
    
    Other Reinsurers
    
    
    
    
    0.2
    
    
    
    0.3
    
    
    
    0.4
    
    
    
    0.5
    
    
    
    Total
    
    
    
    $
    1.8
    
    
    $
    6.1
    
    
    $
    4.7
    
    
    $
    6.0
    
    
    $
    0.8
 Market Risk.
  2007 Reinsurance Program
 Catastrophe Reinsurance.
 Assumed Reinsurance.
 15




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Technology
  Sales Office Automation.
  Integration of Insurance and Premium Finance Systems.
 Payment Processing.
 Ratings
  16




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##### Table of Contents



Insurance Subsidiaries
  Subsidiary
    
    State of DomicileDirect General Insurance Company
    
    South Carolina (1)Direct Insurance Company
    
    TennesseeDirect General Insurance Company of Louisiana
    
    LouisianaDirect General Insurance Company of Mississippi
    
    MississippiDirect National Insurance Company
    
    ArkansasDirect Life Insurance Company
    
    GeorgiaDirect General Life Insurance Company
    
    South Carolina
 
 (1)
    
    Direct General Insurance Company is also commercially domiciled in Florida. Regulatory Environment
 Insurance Regulation Generally.
 
    
    regulating premium rates and forms;
    
    setting minimum solvency standards;
    
    setting capital and surplus requirements;
    
    licensing companies, agents and, in some states, adjusters;
    
    setting requirements for and limiting the types and amounts of investments;
    
    establishing requirements for the filing of annual statements and other financial reports;
    
    conducting periodic statutory examinations of the affairs of insurance companies;
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##### Table of Contents




    
    requiring prior approval of changes in control and of certain transactions with affiliates;
    
    limiting the amount of dividends that may be paid without prior regulatory approval; and
    
    setting standards for advertising and other market conduct activities.
 Required Licensing.
 Insurance Holding Company Regulation.
 Restrictions on Paying Dividends.
 Regulation of Rates and Policy Forms.
 18




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##### Table of Contents



Shared or Residual Markets.
 Guaranty Funds.
 Investment Regulation.
 Other Insurance Regulatory Initiatives and Proposed Legislation.
 
    
    proposed federal legislation aimed at regulating insurance, such as:
 
    
    the Insurance Industry Competition Act of 2007 and Insurance
Industry Antitrust Enforcement Act of 2007, which would amend the
McCarran-Ferguson Act to, among other things, allow the Federal Trade
Commission (FTC) regulatory control over unfair methods of competition
regardless of state law; grant FTC jurisdiction over other areas relating
to the business of insurance to the extent it is not regulated by state
law; and amend the FTC Act to remove the exemption for insurance under
the FTC Act in terms of antitrust and other investigations, giving the
FTC authority to investigate potential antitrust violations in the
insurance industry. Enactment of such legislation would result in
regulation of insurance at both the state and federal levels and could
impact certain insurance activities, such as joint rate development,
including risk classification, product and form standardization and loss
costs, as well as joint underwriting and marketing;
    
    the State Modernization and Regulatory Transparency Act (SMART
Act) that would address industry matters such as market conduct, product
availability, speed to market of new products, and insurance company and
producer licensing; and
 19




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##### Table of Contents




    
    the National Insurance Act of 2006, which would establish an
optional federal charters for insurance companies and agencies and
provide a comprehensive system for the regulation and supervision of
National Insurers and National Agencies.
 
    
    enactment of the Class Action Fairness Act of 2005 that enables
defendants to move large national class actions from state courts to federal
courts. The legislation also purports to provide protections to consumer
class members;
    
    federal and state statutes and regulations concerning consumer privacy
and data security, including the mandate for creating specific written
programs to safeguard customers privacy and legislation aimed at reducing
the risk of identity theft such as, restrictions on use and publication of
social security numbers and requiring companies to notify customers of data
security breaches that pose a significant risk of identity theft;
    
    restrictions on the use of credit scoring by insurance companies when
deciding whether to cover, or how much premium to charge, potential
customers, which have been in recent years, and continue to be, a frequent
subject of state and federal legislation and regulation. A number of state
insurance departments have issued bulletins, directives or regulations to
regulate the use of credit by insurers;
    
    the implementation of the Fair and Accurate Credit Transactions Act
and the duties and responsibilities that will be imposed on insurers
concerning affiliate sharing of information and adverse action notices and
related enacted or proposed state legislation, such as the Tennessee Credit
and Debit Card Number Identity Theft Prevention Act of 2005 that would make
it unlawful for any person that accepts a credit card or debit card for a
transaction of business to print more than five (5) digits of such card
number or the expiration date upon any receipt provided to the cardholder or
upon any merchant copy of the receipt that is signed by the cardholder and
retained by the merchant following such transactions;
    
    the interpretation of the Fair Credit Reporting Act particularly as it
relates to when adverse action notices are required to be given; who is
required to send adverse action notices; and the meaning of willfulness
under the Act;
    
    proposals for disclosure requirements concerning producer compensation
that stemmed from a bid-rigging and agent/broker compensation investigation
by the New York Attorney General;
    
    the NAICs ongoing consideration of proposals for structural changes
to risk based capital (RBC) formulas (including proposals related to a
principles-based RBC approach) (see Regulatory Environment  Risk Based
Capital);
    
    various state legislative initiatives that purport to benefit or
provide protection to automobile insurance consumers, such as proposed
legislation to restrict insurer access to a vehicles Event Data Recorder
(EDR) data;
    
    the uncertainty concerning the automobile insurance framework in the
State of Florida as the Florida Motor Vehicle No-Fault Law, which requires
mandatory minimum automobile insurance coverage for personal injury
protection (PIP) and property damage liability, and which will
automatically expire on October 1, 2007, unless the Florida legislature
reenacts it during the 2007 legislative session; and
    
    various proposed legislation in Tennessee, including initiatives to
prohibit insurance companies from using zip codes for setting rates.
 Restrictions on Cancellation, Non-Renewal or Withdrawal.
 20




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##### Table of Contents



Premium Finance Regulation.
 
    
    regulating the interest rates, fees and service charges we may charge our customers;
    
    imposing minimum capital requirements for our premium finance
subsidiaries or requiring surety bonds in addition to or as an alternative to
such capital requirements;
    
    governing the form and content of our financing agreements;
    
    prescribing minimum notice and cure periods before we may cancel a
customers policy for nonpayment under the terms of the financing agreement;
    
    prescribing timing and notice procedures for collecting unearned
premium from the insurance company, applying the unearned premium to our
customers premium finance account, and, if applicable, returning any refund
due to our customer;
    
    establishing standards for filing annual financial reports of our premium finance
companies;
    
    requiring our premium finance companies to qualify for and obtain a
license and to renew the license each year;
    
    conducting periodic financial and market conduct examinations and
investigations of our premium finance companies and its operations; and
    
    requiring prior notice to the regulating agency of any change of
control of our premium finance companies.
  State
    
    Permissible Interest RateArkansas
    
    Variable(1)(2)Florida
    
    
    12.0
    %(3)Georgia
    
    
    12.0
    %(3)Illinois
    
    
    10.0
    %(3)Kentucky
    
    
    12.0
    %(3)Louisiana
    
    
    36.0
    %(2)Mississippi
    
    
    24.0
    %(2)Missouri
    
    
    15.0
    %(3)North Carolina
    
    
    12.0
    %(3)South Carolina
    
    
    12.0
    %(3)Tennessee
    
    
    24.0
    %(2)Texas
    
    
    18.0
    %(3)Virginia
    
    
    12.0
    %(3)
 
 (1)
    
    The maximum allowable interest rate in Arkansas is equal to 500 basis
points above the Federal Reserve discount rate on 90-day commercial paper.(2)
    
    In these states the maximum permissible interest rate is calculated on an
actuarial basis, meaning that the interest is calculated to apply to the average of balances outstanding throughout the
period of indebtedness. 21




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##### Table of Contents



(3)
    
    In these states the maximum permissible interest rate is calculated on an
add-on basis, meaning that the annual interest rate is applied to the initial amount
financed.   Privacy and Information Safeguarding Regulations.
 Regulation of Our Ancillary Product Vendors.
 Licensing of Our Employee Agents and Adjustors.
 Trade Practices.
 
    
    disseminating false information or advertising;
    
    defamation;
    
    boycotting, coercion and intimidation;
    
    false statements or entries;
    
    unfair discrimination;
    
    rebating;
    
    lessening competition by a stock transaction;
    
    improper replacement of life insurance;
    
    improper use of proprietary information;
    
    illegal dealings in premiums;
 22




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##### Table of Contents




    
    excess or reduced charges for insurance; and
    
    sliding, packaging and other deceptive sales conduct.
  Claims Practices.
 
    
    misrepresenting pertinent facts or insurance policy provisions relating to coverages at
issue;
    
    failing to acknowledge and act reasonably promptly upon communications
with respect to claims arising under insurance policies;
    
    failing to affirm or deny coverage of claims within a reasonable time
after proof of loss statements have been completed;
    
    attempting to settle a claim for less than the amount to which a
reasonable person would have believed such person was entitled;
    
    attempting to settle claims on the basis of an application which was
altered without notice to or knowledge or consent of the insured;
    
    making known to insureds or claimants a policy of appealing from
arbitration awards in favor of insureds or claimants for the purpose of
compelling them to accept settlements or compromises less than the amount
awarded in arbitration;
    
    delaying the investigation or payment of claims by requiring an
insured, claimant, or the physician of either to submit a preliminary claim
report and then requiring the subsequent submission of formal proof of loss
forms, both of which submissions contain substantially the same information;
    
    failing to promptly settle claims, where liability has become
reasonably clear, under one portion of the insurance policy coverage in order
to influence settlements under other portions of the insurance policy
coverage; and
    
    not attempting in good faith to effectuate prompt, fair and equitable
settlements of claims in which liability has become reasonably clear.
  Quarterly and Annual Financial Reporting.
 Periodic Financial and Market Conduct Examinations.
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Risk Based Capital (RBC).
 IRIS Ratios.
  Payday Consumer Loan Regulation Direct
Cash Advance
 
    
    requiring our consumer products company to qualify for and obtain a
license, and to renew the license each year;
 24




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##### Table of Contents




    
    imposing minimum capital requirements for our consumer products subsidiary,
which sometimes requires a certain minimum amount of capital for each office
location within the state at which we offer payday loans to our customers;
    
    governing the form and content of our payday loan agreements;
    
    restricting the amount of finance or service charges or other fees we
may charge our customers in connection with any payday loan transaction;
    
    preventing our customers from rolling over an existing loan and/or
restricting the terms and manner in which our customer may pay off an
existing loan and enter into a new loan;
    
    limiting the amount that we may lend to any customer and/or
restricting the number of loans we may make to a customer at one time or over
a specified period of time;
    
    specifying the minimum and maximum maturity dates for payday loans
and, in some states, requiring mandatory cooling-off periods between
transactions;
    
    imposing financial control procedures and physical separation
guidelines that are designed to ensure that we maintain a clear distinction
between our payday lending activity and the other businesses we conduct in
our sales office locations;
    
    conducting periodic financial examinations and physical inspections of
our payday loan company and its operations; and
    
    subjecting our collection activities regarding past due loans to
federal and state consumer protection laws and regulations relating to debt
collection practices.
  Payday Consumer Loan Regulatory Initiatives or Proposed Legislation.
   25




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Electronic Fund Transfers (EFT) Regulation
 Electronic Records and Signatures
 Employees
  Available Information
 www.directgeneral.com
 26




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##### Table of Contents



Item 1A. Risk Factors.
 Risks Related to Our Pending Merger
 Completion of the Elara Merger is subject to various conditions; as a result we
cannot assure you that the Elara Merger will be completed.
  
    
    no statute, rule regulation, executive order, decree, injunction or
other order may be enacted, issued, promulgated, enforced or entered by any
governmental entity that is in effect and has the effect of making the merger
illegal or otherwise prohibits or prevents consummation of the merger;
    
    we and our subsidiaries and Elara and its subsidiaries must have
received, with no conditions or restrictions, all authorizations, consents
and approvals required from any department of insurance or department of
financing in the states in which we and our subsidiaries are domiciled or
where the conduct of our business requires the approval by such departments
and all such authorizations, consents and approvals must be in full force and
effect;
    
    no suit, action or proceeding shall be pending or threatened
by any governmental entity challenging or seeking to restrain or
prohibit the Elara Merger.
    
    Elaras closing on committed debt financing;
    
    the accuracy of our representations and warranties and the
representations and warranties of Elara in the merger agreement;
    
    the performance in all material respects by us and Elara of all
obligations required to be performed under the merger agreement at or prior
to the effective time of the transaction;
    
    the absence of an event, change, effect or development that,
individually or in the aggregate, has had or would reasonably be expected to
have, a material adverse effect on Direct General Corporation as defined in
the merger agreement; and
    
    if the closing of the merger does not occur on or before March 31,
2007, in certain circumstances we or Elara may elect not to complete the
transaction.
  Failure to complete the Elara Merger could negatively impact the market price of
our common stock and our ability to operate our business.
  
    
    the market price of our common stock could decline;
    
    we must pay some of the costs related to the transaction, such as
legal and accounting fees and, in specified circumstances, termination fees
and expense reimbursement payments;
    
    the diversion of managements attention from our day-to-day business
and the unavoidable disruption to our business during the period before
completion of the transaction may make it difficult for us to regain our
financial and market position if the transaction does not occur; and
 27




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##### Table of Contents




    
    if we lose key management and other employees, who may be uncertain
about their future roles and relationships with us following the completion
of the Elara Merger, the loss could make it difficult for us to operate our
business effectively and profitably, if we are unable to replace these
employees.
  Risks Related to Our Business
 Because our core product is non-standard personal automobile insurance, our
business may be adversely affected by negative developments in the conditions in this
industry.
    Because we write a substantial number of insurance policies in Florida and
Tennessee, our business may be adversely affected by conditions in these states.
  Severe weather conditions and other catastrophes may result in an increase in the
number and amount of claims filed against us.
  28




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##### Table of Contents



Our business is highly competitive, which may make it difficult for us to market
our core products effectively and profitably.
   Our results may fluctuate as a result of cyclical changes in the personal automobile
insurance industry.
  Current ratings of our insurance subsidiaries or any failure of our insurance
subsidiaries to maintain current financial strength ratings could materially and
adversely affect our business and our ability to obtain financing or reinsurance at
favorable rates.
   29




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##### Table of Contents



Our principal shareholder has the ability to control our operations, including the
election of our directors.
  As a holding company, we are dependent on the results of operations of our
operating subsidiaries and the regulatory and contractual capacity of our operating
subsidiaries to pay dividends to us.
  We are subject to comprehensive regulation that may restrict our ability to earn profits.
    30




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##### Table of Contents



Required Licensing.
 Transactions Between Insurance Companies and Their Affiliates.
 Regulation of Premium Rates and Approval of Policy Forms.
 Investment Restrictions.
 Restrictions on Cancellation, Non-Renewal or Withdrawal.
 31




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##### Table of Contents



Other Regulations
 
    
    the use of non-public consumer information and related privacy issues;
    
    the use of credit history in underwriting and rating;
    
    the payment of dividends;
    
    the acquisition or disposition of an insurance company or of any company
controlling an insurance company;
    
    the involuntary assignments of high-risk policies, participation
in reinsurance facilities and underwriting associations, assessments and
other governmental charges;
    
    reporting to state regulators with respect to financial condition;
    
    periodic reporting, corporate governance and other compliance
requirements imposed by the Sarbanes-Oxley Act of 2002 and other federal laws
and regulations applicable to publicly traded companies; and
    
    rules and regulations of the Nasdaq National Market, on which our common stock is listed
for trading.
  The anticipated decision of the United States Supreme Court in the Safeco
Insurance Company of America, et al. v. Burr and GEICO General Insurance Co., et
al. v. Edo may adversely impact our business procedures.
 Reynolds
v. Hartford Fin. Servs. Group Safeco Insurance Company of America, et al. v. Burr GEICO General
Insurance Co., et al. v. Edo
 
    
    The Fair Credit Reporting Act
(FCRA) requires an adverse action
notice to a customer whenever a
company uses credit information in determining the insurance rate that applies,
and that rate is not the lowest rate available to customers generally,
regardless of whether the rate is for a new policy or a renewal policy.
    
    Adverse action notices must contain certain
information not specifically outlined in FCRA.
  32




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##### Table of Contents



The outcome of recent industry litigation and insurance regulatory investigations
related to agent/broker compensation may adversely impact our business.
  Regulation may become more extensive in the future, which may adversely affect our business.
  Our insurance, premium finance and consumer products subsidiaries are subject to
capital requirements, and our failure to meet these standards could subject us to
regulatory actions.
   33




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##### Table of Contents



New pricing, claim, coverage and financing issues and class action litigation are
continually emerging in the automobile insurance industry, and these new issues could
adversely impact our revenues or our methods of doing business.
  
    
    concerns over the use of an applicants zip code as a factor in making
risk selections and pricing decisions as well as use of credit in
underwriting and related requirements under the federal Fair Credit Reporting
Act;
    
    a growing trend of plaintiffs targeting automobile insurers, including
us, in purported class action litigation relating to claims-handling
practices, such as the permitted use of aftermarket (non-original equipment
manufacturer) parts, total loss evaluation methodology, the alleged
diminution in value to insureds vehicles involved in accidents, and methods
used for evaluating and paying bodily injury, medical payments and personal
injury protection claims;
    
    a relatively new trend of plaintiffs targeting insurers, including
automobile insurers, in purported class action litigation which seek to
recharacterize installment fees and other allowed charges related to
insurers installment billing programs as interest that violates state usury
laws or other interest rate restrictions; and
    
    attempts by plaintiffs to initiate purported class action litigation
targeting premium finance operations relating to unearned interest rebates
and the collection of service and finance charges.
  Our assumed reinsurance arrangements may be deemed to be the unauthorized business of
insurance.
   Our largely fixed cost structure would work to our disadvantage if our sales volume
were to decline significantly.
  34




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##### Table of Contents



Our inability to refinance our current lines of credit or obtain additional
financing could have an adverse effect on our premium finance revenue.
  Our losses and loss adjustment expenses may exceed our reserves, which would
adversely impact our results of operations and financial condition.
  We are party to litigation, which, if decided adversely to us, could affect our
business, results of operations or financial condition.
  35




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##### Table of Contents



If we lose key personnel or are unable to recruit qualified personnel, our ability
to implement our business strategies could be delayed or hindered.
  Our investment portfolio may suffer reduced returns or losses, which could reduce our
profitability.
  We may not be successful in reducing our risk and increasing our underwriting
capacity through reinsurance arrangements, which could adversely affect our business,
financial condition and results of operations.
  36




---



##### Table of Contents



Because we have reduced our use of reinsurance, we will retain more risk, which could result
in losses.
  We rely on our information technology and telecommunication systems, and the
failure of these systems could materially and adversely affect our business.
   37




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##### Table of Contents



We may have difficulties in managing our expansion into new markets, and we may not
be successful in identifying agency acquisition candidates or integrating their
operations.
   Our plans to introduce new insurance and ancillary products may prove unsuccessful
or subject us to greater liability than anticipated.
   The frequent characterization of payday consumer lending by certain consumer
advocacy groups and some media reports as being predatory or abusive to the consumer
could negatively affect public perception of our business, and therefore affect our
stock price, as well as our overall results of operations.
  38




---



##### Table of Contents



Direct Cash Advance
 
 Item 1B. Unresolved Staff Comments.
  
 Item 2. Properties.
  
 Item 3. Legal Proceedings.
   Julie Buell vs. Direct General Insurance Agency, Inc. and Direct General
Insurance Company, th Buell. Buell Buell
  39




---



##### Table of Contents



nd nd
 nd
   Thompson v. Direct General
Corporation
 40




---



##### Table of Contents



th th
   
 Item 4. Submission of Matters to a Vote of Security Holders.
  41




---



##### Table of Contents



PART II
 
 Item 5. Market for Registrants Common Equity, Related Stockholder Matters and
Issuer Purchases of Equity Securities.
 Market Information
  High
    
    Low
    

Dividend2007First
quarter (through March 12, 2007)
    
    $
    21.01
    
    
    $
    20.50
    
    
    $
    0.002006Fourth quarter
    
    $
    20.84
    
    
    $
    12.84
    
    
    $
    0.04Third quarter
    
    $
    17.56
    
    
    $
    11.51
    
    
    $
    0.04Second quarter
    
    $
    18.79
    
    
    $
    15.96
    
    
    $
    0.04First quarter
    
    $
    17.64
    
    
    $
    15.10
    
    
    $
    0.042005Fourth quarter
    
    $
    19.92
    
    
    $
    15.12
    
    
    $
    0.04Third quarter
    
    $
    20.43
    
    
    $
    16.48
    
    
    $
    0.04Second quarter
    
    $
    20.61
    
    
    $
    15.50
    
    
    $
    0.04First quarter
    
    $
    32.62
    
    
    $
    18.47
    
    
    $
    0.042004Fourth quarter
    
    $
    32.65
    
    
    $
    27.90
    
    
    $
    0.04Third quarter
    
    $
    32.72
    
    
    $
    27.61
    
    
    $
    0.04Second quarter
    
    $
    37.18
    
    
    $
    32.06
    
    
    $
    0.04First quarter
    
    $
    36.20
    
    
    $
    30.64
    
    
    $
    0.04
 Repurchases of Common Stock
  Holders
  Dividends
  42




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##### Table of Contents



Securities Authorized for Issuance Under Equity Compensation Plans
  Equity Compensation Plan Information
 Number ofNumber of
    
    
    
    
    
    securitiessecurities to be
    
    Weighted-
    
    remaining forissued upon
    
    average exercise
    
    future issuanceexercise of
    
    price of
    
    under equityoutstanding
    
    outstanding
    
    compensationPlan category
    
    options
    
    options
    
    plansEquity compensation plans approved by
security holders:2003 Equity Incentive Plan
    
    
    907,200
    
    
    $
    20.76
    
    
    
    744,0001996 Employee Stock Incentive Plan
    
    
    45,000
    
    
    $
    2.71
    
    
    
    0Equity compensation plans not approved
by security holders:NoneTotal
    
    
    952,200
    
    
    $
    19.91
    
    
    
    744,000
 
 Item 6. Selected Financial Data.
  43




---



##### Table of Contents



Year Ended December 31,2006
    
    
    2005
    
    
    2004
    
    
    2003
    
    
    2002($ in millions, except per share data)Statement of Operations Data:Premiums earned
    
    $
    424.8
    
    
    $
    404.1
    
    
    $
    372.5
    
    
    $
    228.5
    
    
    $
    145.0Finance income
    
    
    43.8
    
    
    
    44.4
    
    
    
    49.2
    
    
    
    44.9
    
    
    
    35.7Commission and service fee income
    
    
    45.6
    
    
    
    46.8
    
    
    
    48.6
    
    
    
    33.6
    
    
    
    27.2Net investment income
    
    
    19.0
    
    
    
    14.7
    
    
    
    10.8
    
    
    
    6.7
    
    
    
    5.3Net realized gains (losses) on securities and other
    
    
    (0.3
    )
    
    
    0.1
    
    
    
    0.0
    
    
    
    3.4
    
    
    
    (0.1
    )Total revenues
    
    
    532.9
    
    
    
    510.1
    
    
    
    481.1
    
    
    
    317.1
    
    
    
    213.1Insurance losses and loss adjustment
expenses
    
    
    320.8
    
    
    
    305.8
    
    
    
    282.0
    
    
    
    168.2
    
    
    
    100.7Selling, general and administrative costs
    
    
    155.1
    
    
    
    133.6
    
    
    
    108.5
    
    
    
    74.5
    
    
    
    59.7Interest expense
    
    
    12.0
    
    
    
    8.3
    
    
    
    5.5
    
    
    
    6.4
    
    
    
    6.2Total expenses
    
    
    487.9
    
    
    
    447.7
    
    
    
    396.0
    
    
    
    249.1
    
    
    
    166.6Income before income taxes
    
    
    45.0
    
    
    
    62.4
    
    
    
    85.1
    
    
    
    68.0
    
    
    
    46.5Income tax expense
    
    
    17.0
    
    
    
    23.4
    
    
    
    31.1
    
    
    
    24.9
    
    
    
    15.5Net income
    
    $
    28.0
    
    
    $
    39.0
    
    
    $
    54.0
    
    
    $
    43.1
    
    
    $
    31.0Net income available to common
shareholders
    
    $
    28.0
    
    
    $
    39.0
    
    
    $
    54.0
    
    
    $
    42.7
    
    
    $
    30.5Operating Data:Gross premiums written (1)
    
    $
    455.9
    
    
    $
    453.0
    
    
    $
    481.9
    
    
    $
    435.2
    
    
    $
    335.2Net premiums written (2)
    
    
    458.6
    
    
    
    400.6
    
    
    
    409.4
    
    
    
    295.1
    
    
    
    181.0Gross revenues (3)
    
    
    564.4
    
    
    
    558.9
    
    
    
    590.5
    
    
    
    520.4
    
    
    
    403.4Balance Sheet Data:Cash, cash equivalents and total
investments
    
    $
    494.5
    
    
    $
    456.2
    
    
    $
    407.5
    
    
    $
    353.6
    
    
    $
    213.3Total assets (6)
    
    
    851.0
    
    
    
    841.9
    
    
    
    788.4
    
    
    
    751.2
    
    
    
    569.1Total liabilities and redeemable preferred
stock (6)
    
    
    587.9
    
    
    
    606.1
    
    
    
    545.0
    
    
    
    573.8
    
    
    
    509.9Total shareholders equity (6)
    
    
    263.0
    
    
    
    235.9
    
    
    
    243.4
    
    
    
    177.4
    
    
    
    59.2Per Share Data(4):Earnings per common share:Basic
    
    $
    1.38
    
    
    $
    1.83
    
    
    $
    2.44
    
    
    $
    2.74
    
    
    $
    2.30Diluted (5)
    
    
    1.37
    
    
    
    1.82
    
    
    
    2.38
    
    
    
    2.20
    
    
    
    1.68Book value per common share (6)
    
    
    12.93
    
    
    
    11.60
    
    
    
    10.89
    
    
    
    8.31
    
    
    
    4.12Weighted average shares outstanding:Basic
    
    
    20,346,627
    
    
    
    21,363,772
    
    
    
    22,114,917
    
    
    
    15,609,411
    
    
    
    13,264,452Diluted (5)
    
    
    20,384,954
    
    
    
    21,423,841
    
    
    
    22,687,198
    
    
    
    19,679,610
    
    
    
    18,733,056Common shares outstanding
    
    
    20,347,675
    
    
    
    20,339,175
    
    
    
    22,360,046
    
    
    
    21,350,640
    
    
    
    12,119,148
 
 (1)
    
    Gross premiums written is the sum of direct premiums written and assumed
premiums written. Direct premiums written is the sum of the total policy premium, net of
cancellations, associated with policies underwritten and issued by our insurance subsidiaries.
Assumed premiums written is the sum of total premiums associated with the insurance risk
transferred to us by other insurance companies pursuant to reinsurance contracts. See Note 7
to our audited consolidated financial statements included in this report.(2)
    
    Net premiums written is the sum of direct premiums written and assumed premiums written less
ceded premiums written. Ceded premiums written is the portion of our direct and assumed premiums
that we transfer to our reinsurers in accordance with the terms of our reinsurance contracts
based upon the risks they accept. See Note 7 to our audited consolidated financial statements
included in this report.(3)
    
    Gross revenues is the sum of direct premiums written and assumed premiums written (which we
refer to in this report as gross premiums written) plus other revenues including finance income,
commission and service fee income, and net investment income (excluding net realized gains
(losses) on securities). We consider gross revenues to be a non-GAAP financial measure and have
provided, in Managements Discussion and Analysis of Financial Condition and Results of
Operations  Measurement of Results, an explanation of why we believe gross revenues is a
financial measure that is useful to management and investors and a reconciliation of gross 44




---



##### Table of Contents



revenues to total revenues, which is the most directly comparable GAAP financial
measure included in our financial statements.(4)
    
    Adjusted to reflect a 12 for 1 stock split that became effective prior to
the closing of our initial public offering in August 2003.(5)
    
    Includes the weighted average common shares outstanding and assumes
conversion of our Series A redeemable
preferred stock and Series B preferred stock because both series of preferred stock
were convertible at the
option of the holders and were dilutive. Also includes the dilutive effect of the
common stock warrant which
was exercised upon the closing of our initial public offering; however, for the years
ended December 31, 2002,
2001, and 2000, the warrant was anti-dilutive and was not included in those periods.(6)
    
    The Company corrected the recorded liability for unearned policy fees as
of January 2004 during 2006 and
restated the January 1, 2004 Balance Sheet, which affected total assets, total liabilities, total stockholders
equity and book value per share as previously reported for 2005 and 2004. See Note 1 to our audited
consolidated financial statements. 
 Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations.
 The following discussion should be read in conjunction with our consolidated
financial statements and accompanying notes included in this report. This discussion
contains forward-looking statements that involve risks and uncertainties. Our actual
results could differ materially from those anticipated in these forward-looking
statements as a result of various factors, including those discussed below and elsewhere
in this report, particularly under the caption Risk Factors. Some tables may not foot
or cross foot due to rounding.
 Overview
 Companys Operating Strategy
     45




---



##### Table of Contents




    
    premiums we earn from sales of direct and assumed non-standard
personal automobile and term life insurance policies, which we refer to in
this report as gross premiums, less the portion of those premiums that is
ceded to other insurers, which we refer to in this report as ceded premiums,
with the difference being what we refer to as net premiums;
    
    ancillary income, which includes:
 
    
    interest and fees earned on the financing of insurance policies; and
    
    commission and service fee income that we earn in connection with
the sales and servicing of insurance products underwritten by other insurers
and other income; and
 
    
    investment income that we earn on the invested assets of
our subsidiaries.
  
    
    insurance losses and loss adjustment expenses (which we sometimes
refer to in this report as LAE) including estimates for losses incurred
during the period and changes in estimates from prior periods related to
direct and assumed non-standard personal automobile and term life insurance
policies (which we refer to in this report as gross insurance losses and loss
adjustment expenses), less the portion of those insurance losses and loss
adjustment expenses that are ceded to other insurers (which we refer to in
this report as ceded insurance losses and loss adjustment expenses) (we refer
to the difference as net insurance losses and loss adjustment expenses); and
    
    operating expenses that include:
 
    
    selling, general and administrative, or SGA costs, including
salaries, advertising, commissions and other expenses of our employee-agent
distribution channel reduced by ceding commissions received under our
reinsurance agreements; and
    
    interest expense primarily related to our premium finance
revolving credit facility and debentures payable
 Measurement of Results
  46




---



##### Table of Contents



Gross Premiums Written.
 Net Premiums Written.
 Gross Revenues (a non-GAAP financial measure).
 Loss Ratio.
 Expense Ratio.
 Combined Ratio.
 Ancillary Income Measures.
 47




---



##### Table of Contents



Critical Accounting Policies
  Insurance Losses and Loss Adjustment Expense Reserves.
  2006
    
    
    2005($ in millions)Private passenger automobile insurance:Case reserves
    
    $
    80.4
    
    
    $
    67.4IBNR reserves
    
    
    55.5
    
    
    
    63.3Total private passenger automobile insurance
    
    
    135.9
    
    
    
    130.7Term life insurance, reserve for policy benefits
    
    
    0.9
    
    
    
    0.7Total insurance losses and loss adjustment expense reserves
    
    $
    136.8
    
    
    $
    131.4
    48




---



##### Table of Contents



a.
    
    Incurred Loss Developmentb.
    
    Paid Loss Developmentc.
    
    Hindsight Average Reservesd.
    
    Berquist Shermane.
    
    Incurred Bornhuetter/Fergusonf.
    
    Paid Bornhuetter/Fergusong.
    
    Claims Closure Model
     49




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##### Table of Contents



Variability in Selected Frequency
    
    Variability in Selected SeverityImpact on Reserves
    
    
    
    
    
    Impact on ReservesCoverage
    
    % Change
    
    ($ in millions)
    
    % Change
    
    ($ in millions)Bodily Injury
    
    
    3.00
    %
    
    $
    1.8
    
    
    
    2.50
    %
    
    $
    1.5Personal Injury Protection
    
    
    2.50
    %
    
    $
    1.6
    
    
    
    4.00
    %
    
    $
    2.6Property Damage
    
    
    1.00
    %
    
    $
    0.9
    
    
    
    2.50
    %
    
    $
    2.2Physical Damage
    
    
    1.00
    %
    
    $
    0.9
    
    
    
    2.00
    %
    
    $
    1.7
 Investments.
  Effect of Future Cancellations.
 Allowance for Finance Receivable Losses.
  50




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##### Table of Contents



Results of Operations
  Year Ended December 31,2006
    
    
    2005
    
    
    2004($ in millions)Selected Financial DataGross premiums written
    
    $
    455.9
    
    
    $
    453.0
    
    
    $
    481.9Ancillary income
    
    
    89.5
    
    
    
    91.2
    
    
    
    97.8Net investment income
    
    
    19.0
    
    
    
    14.7
    
    
    
    10.8Gross revenues (1)
    
    $
    564.4
    
    
    $
    558.9
    
    
    $
    590.5Ceded premiums written
    
    
    2.6
    
    
    
    (52.4
    )
    
    
    (72.5
    )Change in net unearned premiums
    
    
    (33.8
    )
    
    
    3.5
    
    
    
    (36.9
    )Net realized (losses) gains on securities and other
    
    
    (0.3
    )
    
    
    0.1
    
    
    
    Total revenues
    
    $
    532.9
    
    
    $
    510.1
    
    
    $
    481.1Key Financial RatiosLoss ratio  net
    
    
    75.5
    %
    
    
    75.7
    %
    
    
    75.7
    %Expense ratio  net
    
    
    18.3
    
    
    
    12.5
    
    
    
    4.3Combined ratio  net
    
    
    93.8
    
    
    
    88.2
    
    
    
    80.0Ancillary income to gross premiums earned
    
    
    20.0
    
    
    
    19.8
    
    
    
    20.7Ancillary income to net operating expenses
    
    
    53.5
    
    
    
    64.3
    
    
    
    85.8
 
 (1)
    
    A non-GAAP financial measure. Overview of Operating Results
 Year Ended December 31, 2006 Compared to Year Ended December 31, 2005.
 Year Ended December 31, 2005 Compared to Year Ended December 31, 2004.
 Revenues
 Premiums
  51




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##### Table of Contents



Year Ended December 31,2006
    
    
    2005
    
    
    2004($ in millions)Gross premiums writtenFlorida
    
    $
    207.2
    
    
    $
    223.6
    
    
    $
    243.3Tennessee
    
    
    54.9
    
    
    
    58.7
    
    
    
    64.5Texas
    
    
    43.7
    
    
    
    39.1
    
    
    
    29.6Georgia
    
    
    30.3
    
    
    
    29.1
    
    
    
    33.7Louisiana
    
    
    26.6
    
    
    
    26.5
    
    
    
    32.8Mississippi
    
    
    27.9
    
    
    
    25.4
    
    
    
    25.3All other states
    
    
    65.3
    
    
    
    50.6
    
    
    
    52.7Gross premiums written
    
    $
    455.9
    
    
    $
    453.0
    
    
    $
    481.9Ceded premiums written
    
    
    2.6
    
    
    
    (52.4
    )
    
    
    (72.5
    )Net premiums written
    
    $
    458.5
    
    
    $
    400.6
    
    
    $
    409.4Gross premiums earned
    
    $
    446.5
    
    
    $
    461.6
    
    
    $
    471.8Ceded premiums earned
    
    
    (21.7
    )
    
    
    (57.5
    )
    
    
    (99.3
    )Net premiums earned
    
    $
    424.8
    
    
    $
    404.1
    
    
    $
    372.5Net premiums written to gross premiums written
    
    
    100.6
    %
    
    
    88.4
    %
    
    
    85.0
    %Gross premiums earned to gross premiums written
    
    
    97.9
    
    
    
    101.9
    
    
    
    97.9Net premiums earned to net premiums written
    
    
    92.6
    
    
    
    100.9
    
    
    
    91.0
 Gross Premiums
 Year Ended December 31, 2006 Compared to Year Ended December 31, 2005.
 52




---



##### Table of Contents



Year Ended December 31, 2005 Compared to Year Ended December 31, 2004.
   Net Premiums
 Year Ended December 31, 2006 Compared to Year Ended December 31, 2005.
 Year Ended December 31, 2005 Compared to Year Ended December 31, 2004.
 Ancillary Income
  53




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##### Table of Contents



Year Ended December 31,2006
    
    
    2005
    
    
    2004($ in millions)Finance income
    
    $
    43.9
    
    
    $
    44.4
    
    
    $
    49.2Commission and service fee income
    
    
    45.6
    
    
    
    46.8
    
    
    
    48.6Total ancillary income
    
    $
    89.5
    
    
    $
    91.2
    
    
    $
    97.8
 Year Ended December 31, 2006 Compared to Year Ended December 31, 2005.
   Year Ended December 31, 2005 Compared to Year Ended December 31, 2004.
   54




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##### Table of Contents



Net Investment Income
  Year Ended December 31, 2006 Compared to Year Ended December 31, 2005.
 Year Ended December 31, 2005 Compared to Year Ended December 31, 2004.
 Realized Gains (Losses) on Securities and Other
  Year Ended December 31, 2006 Compared to Year Ended December 31, 2005.
  Year Ended December 31, 2005 Compared to Year Ended December 31, 2004.
  55




---



##### Table of Contents



Expenses
   Year Ended December 31, 2006 Compared to Year Ended December 31, 2005.
 Reserve Analysis.
  56




---



##### Table of Contents



Year Ended December 31, 2005 Compared to Year Ended December 31, 2004.
 Reserve Analysis.
   Operating Expenses
  57




---



##### Table of Contents



Year Ended December 31, 2006 Compared to Year Ended December 31, 2005.
  Year Ended December 31, 2005 Compared to Year Ended December 31, 2004.
  Income Taxes
  58




---



##### Table of Contents



Year Ended December 31,2006
    
    
    2005
    
    
    2004($ in millions)Income before income taxes
    
    $
    45.0
    
    
    $
    62.4
    
    
    $
    85.1Provision for taxes at the statutory rate
    
    $
    15.8
    
    
    $
    21.8
    
    
    $
    29.8Increase (reduction) in taxes for:Tax-exempt interest income
    
    
    (0.6
    )
    
    
    (0.5
    )
    
    
    (0.5
    )State income taxes
    
    
    1.2
    
    
    
    2.0
    
    
    
    2.6Other, net
    
    
    0.6
    
    
    
    0.1
    
    
    
    (0.8
    )Income tax expense
    
    $
    17.0
    
    
    $
    23.4
    
    
    $
    31.1
 Financial Condition
 Liquidity and Capital Resources
 Sources and Uses of Funds
    59




---



##### Table of Contents



Financing and Capital
 Capital Raising  Secondary Offering.
 Common Stock Repurchase.
 Capital Raising  Trust Preferred Securities.
   Premium Finance Revolving Credit Facility.
   60




---



##### Table of Contents



Contractual Obligations.
 Payments due by PeriodLess than
    
    
    1-3
    
    
    3-5
    
    
    More thanTotal
    
    
    1 Year
    
    
    Years
    
    
    Years
    
    
    5 Years($ in millions)Premium finance revolving credit facility
    
    $
    159.2
    
    
    $
    10.8
    
    
    $
    148.4
    
    
    $
    
    
    
    $
    Other notes payable
    
    
    2.3
    
    
    
    1.7
    
    
    
    0.6
    
    
    
    
    
    
    
    Debentures payable
    
    
    143.3
    
    
    
    3.3
    
    
    
    6.5
    
    
    
    7.0
    
    
    
    126.5Loss and loss adjustment expense reserves
    
    
    136.7
    
    
    
    120.0
    
    
    
    14.7
    
    
    
    1.3
    
    
    
    0.7Capital leases obligations
    
    
    1.5
    
    
    
    1.2
    
    
    
    0.3
    
    
    
    
    
    
    
    Operating leases obligations
    
    
    23.6
    
    
    
    10.1
    
    
    
    10.7
    
    
    
    2.8
    
    
    
    Total
    
    $
    466.6
    
    
    $
    147.1
    
    
    $
    181.2
    
    
    $
    11.1
    
    
    $
    127.2
  61




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##### Table of Contents



Reinsurance
   Investments
  % of Totalat FairAmortized Cost
    
    
    Fair Value
    
    
    Value($ in millions)December 31, 2006Debt securities, available for sale
    
    $
    420.9
    
    
    $
    415.4
    
    
    
    84.0
    %Cash and cash equivalents
    
    
    74.8
    
    
    
    74.8
    
    
    
    15.1
    %Short-term and other investments
    
    
    4.3
    
    
    
    4.3
    
    
    
    0.9
    %Total
    
    $
    500.0
    
    
    $
    494.5
    
    
    
    100.0
    %December 31, 2005Debt securities, available for sale
    
    $
    395.2
    
    
    $
    388.0
    
    
    
    85.1
    %Cash and cash equivalents
    
    
    64.5
    
    
    
    64.5
    
    
    
    14.1
    %Short-term and other investments
    
    
    3.7
    
    
    
    3.7
    
    
    
    0.8
    %Total
    
    $
    463.4
    
    
    $
    456.2
    
    
    
    100.0
    %
 Investment Strategy.
 
    
    preservation of capital with a focus on total return;
    
    achieving the highest risk adjusted after tax return; and
    
    diversification in order to reduce risk.
  62




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Debt Securities.
   63




---



##### Table of Contents



December 31, 2006
    
    
    
    
    
    Gross
    
    Gross Unrealized LossesAmortized
    
    Unrealized
    
    Less than
    
    Greater than
    
    Fair($ in millions)
    
    Cost
    
    Gains
    
    12 months
    
    12 months
    
    ValueU.S. Treasury securities and
obligations of U.S. government
corporations and agencies
    
    $
    87.6
    
    
    $
    0.5
    
    
    $
    0.3
    
    
    $
    1.1
    
    
    $
    86.7Obligations of states and political
subdivisions
    
    
    72.2
    
    
    
    0.4
    
    
    
    
    
    
    
    0.6
    
    
    
    72.0Corporate debt securitiesBanks and financial institutions
    
    
    106.2
    
    
    
    0.3
    
    
    
    0.1
    
    
    
    2.0
    
    
    
    104.4Credit cards and auto loans
    
    
    74.7
    
    
    
    0.2
    
    
    
    
    
    
    
    1.1
    
    
    
    73.8Industrial
    
    
    38.8
    
    
    
    0.1
    
    
    
    
    
    
    
    0.9
    
    
    
    38.0Telecommunications
    
    
    17.1
    
    
    
    0.1
    
    
    
    
    
    
    
    0.4
    
    
    
    16.8Utilities and Electric Services
    
    
    14.7
    
    
    
    
    
    
    
    
    
    
    
    0.4
    
    
    
    14.3Insurance
    
    
    9.7
    
    
    
    
    
    
    
    
    
    
    
    0.3
    
    
    
    9.4Corporate debt securities
    
    
    261.2
    
    
    
    0.7
    
    
    
    0.1
    
    
    
    4.9
    
    
    
    256.7Total
    
    $
    421.0
    
    
    $
    1.6
    
    
    $
    0.4
    
    
    $
    6.6
    
    
    $
    415.4
 December 31, 2005
    
    
    
    
    
    Gross
    
    Gross Unrealized LossesAmortized
    
    Unrealized
    
    Less than
    
    Greater than
    
    Fair($ in millions)
    
    Cost
    
    Gains
    
    12 months
    
    12 months
    
    ValueU.S. Treasury securities and
obligations of U.S. government
corporations and agencies
    
    $
    67.8
    
    
    $
    0.1
    
    
    $
    0.6
    
    
    $
    0.8
    
    
    $
    66.5Obligations of states and political
subdivisions
    
    
    70.2
    
    
    
    0.4
    
    
    
    0.4
    
    
    
    0.2
    
    
    
    70.0Corporate debt securitiesBanks and financial institutions
    
    
    96.1
    
    
    
    0.1
    
    
    
    0.9
    
    
    
    1.4
    
    
    
    93.9Credit cards and auto loans
    
    
    81.3
    
    
    
    
    
    
    
    0.5
    
    
    
    1.0
    
    
    
    79.8Industrial
    
    
    37.2
    
    
    
    
    
    
    
    0.4
    
    
    
    0.5
    
    
    
    36.3Telecommunications
    
    
    16.0
    
    
    
    0.1
    
    
    
    0.3
    
    
    
    0.2
    
    
    
    15.6Utilities and Electric Services
    
    
    17.4
    
    
    
    
    
    
    
    0.2
    
    
    
    0.2
    
    
    
    17.0Insurance
    
    
    9.2
    
    
    
    
    
    
    
    
    
    
    
    0.3
    
    
    
    8.9Corporate debt securities
    
    
    257.2
    
    
    
    0.2
    
    
    
    2.3
    
    
    
    3.6
    
    
    
    251.5Total
    
    $
    395.2
    
    
    $
    0.7
    
    
    $
    3.3
    
    
    $
    4.6
    
    
    $
    388.0
  Amortized Cost
    
    

Fair
Value($ in millions)Years to maturity:One or less
    
    $
    16.3
    
    
    $
    16.1After one through five
    
    
    183.2
    
    
    
    180.2After five through ten
    
    
    133.6
    
    
    
    132.4After ten
    
    
    87.9
    
    
    
    86.7Total
    
    $
    421.0
    
    
    $
    415.4
 64




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##### Table of Contents



Amortized
    
    
    
    
    
    
    % of TotalS&P Rating
    
    NAIC Rating
    
    
    Cost
    
    
    Fair Value
    
    
    at Fair Value($ in millions)AAA
    
    
    1
    
    
    $
    165.2
    
    
    $
    163.5
    
    
    
    39.4
    %AA
    
    
    1
    
    
    
    55.6
    
    
    
    55.0
    
    
    
    13.2
    %A
    
    
    1
    
    
    
    80.6
    
    
    
    79.1
    
    
    
    19.0
    %BBB
    
    
    2
    
    
    
    32.0
    
    
    
    31.2
    
    
    
    7.5
    %B
    
    
    2
    
    
    
    
    
    
    
    
    
    
    
    0.0
    %Agency
    
    
    1
    
    
    
    87.6
    
    
    
    86.6
    
    
    
    20.9
    %$
    421.0
    
    
    $
    415.4
    
    
    
    100.0
    %
      65




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##### Table of Contents



Cash and Cash Equivalents.
 Short-Term Investments.
 Forward-Looking Statements
  
    
    statements and assumptions relating to future growth, earnings, earnings
per share and other financial performance measures, as well as managements
short-term and long-term performance goals;
    
    statements relating to the anticipated effects on results of operations
or financial condition from recent and expected developments or events;
    
    statements relating to our business and growth strategies; and
    
    any other statements or assumptions that are not historical facts.
   
 Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
  66




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Item 8. Financial Statements and Supplementary Data.
 MANAGEMENTS REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
    
 
 67




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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON
ON INTERNAL CONTROL OVER FINANCIAL REPORTING
 
 Internal Control Integrated
Framework COSO
  A
  COSO COSO
  Ernst Young LLP
 
 68




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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
      Internal ControlIntegrated Framework
 Ernst Young LLP
 
 69




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##### Table of Contents



DIRECT GENERAL CORPORATION AND SUBSIDIARIES
 CONSOLIDATED STATEMENTS OF OPERATIONS
 For the Years Ended December 31,2006
    
    
    2005
    
    
    2004(In thousands, except per share amounts)RevenuesPremiums earned
    
    $
    424,777
    
    
    $
    404,099
    
    
    $
    372,506Finance income
    
    
    43,856
    
    
    
    44,401
    
    
    
    49,190Commission and service fee income
    
    
    45,609
    
    
    
    46,777
    
    
    
    48,630Net investment income
    
    
    18,990
    
    
    
    14,704
    
    
    
    10,808Net realized (losses) gains on securities and other
    
    
    (304
    )
    
    
    71
    
    
    
    (43
    )Total revenues
    
    
    532,928
    
    
    
    510,052
    
    
    
    481,091ExpensesInsurance losses and loss adjustment expenses
    
    
    320,834
    
    
    
    305,755
    
    
    
    281,969Selling, general and administrative costs
    
    
    155,093
    
    
    
    133,588
    
    
    
    108,532Interest expense
    
    
    11,981
    
    
    
    8,300
    
    
    
    5,484Total expenses
    
    
    487,908
    
    
    
    447,643
    
    
    
    395,985Income before income taxes
    
    
    45,020
    
    
    
    62,409
    
    
    
    85,106Income tax expense
    
    
    17,019
    
    
    
    23,398
    
    
    
    31,121Net income
    
    $
    28,001
    
    
    $
    39,011
    
    
    $
    53,985Earnings per ShareBasic earnings per common share
    
    $
    1.38
    
    
    $
    1.83
    
    
    $
    2.44Diluted earnings per common share
    
    $
    1.37
    
    
    $
    1.82
    
    
    $
    2.38
  70




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DIRECT GENERAL CORPORATION AND SUBSIDIARIES
 CONSOLIDATED BALANCE SHEETS
 As of December 31,2005(Restated 2006
    
    

See
Note 1)(In thousands)AssetsInvestments:Debt securities available-for-sale at fair value (amortized cost $420,946 and
$395,159 at December 31, 2006 and 2005, respectively)
    
    $
    415,443
    
    
    $
    388,032Short-term investments and other invested assets
    
    
    4,267
    
    
    
    3,688Total investments
    
    
    419,710
    
    
    
    391,720Cash and cash equivalents
    
    
    74,753
    
    
    
    64,527Finance receivables, net
    
    
    225,227
    
    
    
    214,796Reinsurance balances receivable
    
    
    10,150
    
    
    
    27,083Prepaid reinsurance premiums
    
    
    116
    
    
    
    24,440Deferred policy acquisition costs
    
    
    21,258
    
    
    
    13,804Income taxes recoverable
    
    
    1,873
    
    
    
    4,692Deferred income taxes
    
    
    22,616
    
    
    
    22,820Property and equipment, net
    
    
    15,720
    
    
    
    18,346Goodwill and other intangible assets, net
    
    
    31,621
    
    
    
    31,621Other assets
    
    
    27,919
    
    
    
    28,068Total assets
    
    $
    850,963
    
    
    $
    841,917Liabilities and Shareholders EquityLoss and loss adjustment expense reserves
    
    $
    136,764
    
    
    $
    131,408Unearned premiums
    
    
    226,746
    
    
    
    217,300Reinsurance balances payable and funds held
    
    
    7,632
    
    
    
    32,024Accounts payable and accrued expenses
    
    
    14,715
    
    
    
    12,550Notes payable
    
    
    145,272
    
    
    
    153,009Debentures payable
    
    
    41,238
    
    
    
    41,238Capital lease obligations
    
    
    1,430
    
    
    
    2,636Payable for securities
    
    
    
    
    
    
    3,187Other liabilities
    
    
    14,134
    
    
    
    12,713Total liabilities
    
    
    587,931
    
    
    
    606,065Shareholders equityCommon stock, no par; authorized shares  100,000.0; issued shares  20,347.7
and 20,339.2 at December 31, 2006 and 2005, respectively
    
    
    71,008
    
    
    
    69,700Retained earnings
    
    
    194,845
    
    
    
    170,100Accumulated other comprehensive (loss) income:Net unrealized depreciation on investment securities
    
    
    (3,577
    )
    
    
    (4,633
    )Net gain on cash flow hedge
    
    
    756
    
    
    
    685Total shareholders equity
    
    
    263,032
    
    
    
    235,852Total liabilities and shareholders equity
    
    $
    850,963
    
    
    $
    841,917
  71




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DIRECT GENERAL CORPORATION AND SUBSIDIARIES
 CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY
 For the Years Ended December 31, 2006, 2005 and 2004AccumulatedOther
    
    
    TotalCommon
    
    
    Retained
    
    
    Comprehensive
    
    
    ShareholdersStock
    
    
    Earnings
    
    
    Income (Loss)
    
    
    Equity(In thousands)Balances at December 31, 2003 as previously
reported
    
    $
    91,853
    
    
    $
    85,735
    
    
    $
    (193
    )
    
    $
    177,395Correction of prior period error
    
    
    
    
    
    
    (1,680
    )
    
    
    
    
    
    
    (1,680
    )Balances at January 1, 2004, as adjusted
    
    
    91,853
    
    
    
    84,055
    
    
    
    (193
    )
    
    
    175,715Comprehensive income:Net income
    
    
    
    
    
    
    53,985
    
    
    
    
    
    
    
    53,985Net unrealized depreciation on securities
available-for-sale, net of deferred
taxes
    
    
    
    
    
    
    
    
    
    
    (665
    )
    
    
    (665
    )Net change during the year related to
cash flow hedge
    
    
    
    
    
    
    
    
    
    
    598
    
    
    
    598Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    53,918Dividends on common stock
    
    
    
    
    
    
    (3,542
    )
    
    
    
    
    
    
    (3,542
    )Common stock issued pursuant to
secondary offering, net of $246.6 issue
costs (497.1 shares)
    
    
    15,971
    
    
    
    
    
    
    
    
    
    
    
    15,971Compensatory stock options
    
    
    279
    
    
    
    
    
    
    
    
    
    
    
    279Exercise of stock options (512.3 shares)
    
    
    1,060
    
    
    
    
    
    
    
    
    
    
    
    1,060Balances at December 31, 2004 - restated
    
    
    109,163
    
    
    
    134,498
    
    
    
    (260
    )
    
    
    243,401Comprehensive income:Net income
    
    
    
    
    
    
    39,011
    
    
    
    
    
    
    
    39,011Net unrealized depreciation on securities
available-for-sale, net of deferred
taxes
    
    
    
    
    
    
    
    
    
    
    (4,663
    )
    
    
    (4,663
    )Net change during the year related to
cash flow hedge
    
    
    
    
    
    
    
    
    
    
    975
    
    
    
    975Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    35,323Dividends on common stock
    
    
    
    
    
    
    (3,409
    )
    
    
    
    
    
    
    (3,409
    )Common stock repurchase (2,157.9 shares)
    
    
    (40,075
    )
    
    
    
    
    
    
    
    
    
    
    (40,075
    )Compensatory stock options
    
    
    55
    
    
    
    
    
    
    
    
    
    
    
    55Exercise of stock options (137.0 shares)
    
    
    557
    
    
    
    
    
    
    
    
    
    
    
    557Balances at December 31, 2005 - restated
    
    
    69,700
    
    
    
    170,100
    
    
    
    (3,948
    )
    
    
    235,852Comprehensive income:Net income
    
    
    
    
    
    
    28,001
    
    
    
    
    
    
    
    28,001Net unrealized depreciation on securities
available-for-sale, net of deferred
taxes
    
    
    
    
    
    
    
    
    
    
    1,056
    
    
    
    1,056Net change during the year related to
cash flow hedge
    
    
    
    
    
    
    
    
    
    
    71
    
    
    
    71Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    29,128Dividends on common stock
    
    
    
    
    
    
    (3,256
    )
    
    
    
    
    
    
    (3,256
    )Compensatory stock options
    
    
    1,285
    
    
    
    
    
    
    
    
    
    
    
    1,285Exercise of stock options (8.5 shares)
    
    
    23
    
    
    
    
    
    
    
    
    
    
    
    23Balances at December 31, 2006
    
    $
    71,008
    
    
    $
    194,845
    
    
    $
    (2,821
    )
    
    $
    263,032
  72




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##### Table of Contents



DIRECT GENERAL CORPORATION AND SUBSIDIARIES
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 For the Years Ended December 31,2006
    
    
    2005
    
    
    2004(In thousands)Operating activitiesNet income
    
    $
    28,001
    
    
    $
    39,011
    
    
    $
    53,985Adjustments to reconcile net income to net cash provided by
operating activities:Net realized losses (gains) on securities and other
    
    
    304
    
    
    
    (71
    )
    
    
    43Depreciation and amortization
    
    
    8,757
    
    
    
    9,456
    
    
    
    5,809Deferred income taxes
    
    
    (402
    )
    
    
    111
    
    
    
    (1,466
    )Changes in operating assets and liabilities:Finance receivables, net
    
    
    (10,431
    )
    
    
    (616
    )
    
    
    (12,909
    )Reinsurance balances receivable
    
    
    16,933
    
    
    
    8,466
    
    
    
    21,801Prepaid reinsurance premiums
    
    
    24,324
    
    
    
    5,104
    
    
    
    26,853Deferred policy acquisition costs
    
    
    (7,454
    )
    
    
    (1,138
    )
    
    
    (1,234
    )Income taxes recoverable/payable
    
    
    2,819
    
    
    
    2,760
    
    
    
    (9,546
    )Loss and loss adjustment expense reserves
    
    
    5,356
    
    
    
    6,550
    
    
    
    12,240Unearned premiums
    
    
    9,446
    
    
    
    (8,588
    )
    
    
    10,053Reinsurance balances payable and funds held
    
    
    (24,392
    )
    
    
    (2,287
    )
    
    
    (28,227
    )Accounts payable and accrued expenses
    
    
    2,165
    
    
    
    599
    
    
    
    (1,204
    )Other
    
    
    2,964
    
    
    
    1,771
    
    
    
    (9,221
    )Net cash provided by operating activities
    
    
    58,390
    
    
    
    61,128
    
    
    
    66,917Investing activitiesProceeds from sales and maturities of debt securities
available-for-sale
    
    
    76,071
    
    
    
    81,141
    
    
    
    117,194Purchase of debt securities available-for-sale
    
    
    (104,076
    )
    
    
    (140,337
    )
    
    
    (185,100
    )Payable for securities
    
    
    (3,187
    )
    
    
    2,677
    
    
    
    510Net (purchases) sales of short-term investments
    
    
    (475
    )
    
    
    426
    
    
    
    (341
    )Purchase of common stock in trust
    
    
    
    
    
    
    (1,238
    )
    
    
    Purchase of property and equipment, net
    
    
    (4,322
    )
    
    
    (8,879
    )
    
    
    (7,330
    )Purchase of insurance agency assets
    
    
    
    
    
    
    (5,560
    )
    
    
    (82,716
    )Purchase of insurance companies
    
    
    
    
    
    
    (10,432
    )
    
    
    (7,330
    )Net cash used in investing activities
    
    
    (35,989
    )
    
    
    (82,202
    )
    
    
    (82,716
    )Financing activitiesRepurchase of common stock
    
    
    
    
    
    
    (40,075
    )
    
    
    Issuances of common stock
    
    
    23
    
    
    
    612
    
    
    
    17,031Net proceeds from (payments on) borrowings
    
    
    (5,307
    )
    
    
    18,258
    
    
    
    (12,511
    )Proceeds from debentures issued
    
    
    
    
    
    
    41,238
    
    
    
    Payment of principal on borrowing
    
    
    (3,635
    )
    
    
    (2,011
    )
    
    
    (1,593
    )Payment of dividends on common stock
    
    
    (3,256
    )
    
    
    (3,409
    )
    
    
    (3,542
    )Net cash (used in) provided by financing activities
    
    
    (12,175
    )
    
    
    14,613
    
    
    
    (615
    )Net increase (decrease) in cash and cash equivalents
    
    
    10,226
    
    
    
    (6,461
    )
    
    
    (16,354
    )Cash and cash equivalents at beginning of period
    
    
    64,527
    
    
    
    70,988
    
    
    
    87,342Cash and cash equivalents at end of period
    
    $
    74,753
    
    
    $
    64,527
    
    
    $
    70,988Supplemental disclosures of cash flow informationCash paid during the year for:Interest
    
    $
    11,388
    
    
    $
    8,451
    
    
    $
    5,484Income taxes
    
    
    14,786
    
    
    
    20,527
    
    
    
    42,507
  73




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##### Table of Contents



DIRECT GENERAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 1. Nature of Operations and Significant Accounting Policies
  Basis of Presentation
  Use of Estimates
  Premiums Earned and Unearned Premiums
  Insurance Losses and Loss Adjustment Expense Reserves
  Reinsurance
  Finance Income and Receivables
  74




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##### Table of Contents



Commission Income
  Service Fees
  Investments
     75




---



##### Table of Contents



Deferred Policy Acquisition Costs
  Property and Equipment
  Goodwill and Other Intangible Assets
  Cash Flow Hedge
  Income Taxes
   76




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##### Table of Contents



Stock Options
  Segment Reporting
    Restatement of the December 31, 2005 Balance Sheet
   December 31, 2005As PreviouslyReported
    
    Adjustments
    
    RestatedDeferred income taxes
    
    $
    21,915
    
    
    $
    905
    
    
    $
    22,820Total assets
    
    
    841,012
    
    
    
    905
    
    
    
    841,917Unearned premiums
    
    
    214,715
    
    
    
    2,585
    
    
    
    217,300Total liabilities
    
    
    603,480
    
    
    
    2,585
    
    
    
    606,065Retained earnings
    
    
    171,780
    
    
    
    (1,680
    )
    
    
    170,100Total shareholders equity
    
    
    237,532
    
    
    
    (1,680
    )
    
    
    235,852Total liabilities and shareholders equity
    
    
    841,012
    
    
    
    905
    
    
    
    841,917
 77




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##### Table of Contents



2. Investments
  Gross
    
    
    GrossUnrealized
    
    
    UnrealizedGross
    
    
    Losses
    
    
    LossesAmortized
    
    
    Unrealized
    
    
    Less than
    
    
    Greater than
    
    
    FairCost
    
    
    Gains
    
    
    12 months
    
    
    12 months
    
    
    Value(In thousands)2006U.S. Treasury securities and obligations of
U.S. government corporations and agencies
    
    $
    87,593
    
    
    $
    453
    
    
    $
    263
    
    
    $
    1,134
    
    
    $
    86,649Obligations of states and political subdivisions
    
    
    72,195
    
    
    
    422
    
    
    
    14
    
    
    
    541
    
    
    
    72,062Corporate debt securities
    
    
    261,158
    
    
    
    688
    
    
    
    165
    
    
    
    4,949
    
    
    
    256,732Total
    
    $
    420,946
    
    
    $
    1,563
    
    
    $
    442
    
    
    $
    6,624
    
    
    $
    415,4432005U.S. Treasury securities and obligations of
U.S. government corporations and agencies
    
    $
    67,748
    
    
    $
    51
    
    
    $
    618
    
    
    $
    731
    
    
    $
    66,450Obligations of states and political subdivisions
    
    
    70,161
    
    
    
    435
    
    
    
    444
    
    
    
    199
    
    
    
    69,953Corporate debt securities
    
    
    257,250
    
    
    
    233
    
    
    
    2,282
    
    
    
    3,572
    
    
    
    251,629Total
    
    $
    395,159
    
    
    $
    719
    
    
    $
    3,344
    
    
    $
    4,502
    
    
    $
    388,032
   2006
    
    
    2005
    
    
    2004(In thousands)Gross investment income:Debt securities available-for-sale
    
    $
    17,800
    
    
    $
    14,147
    
    
    $
    10,963Short-term investments and cash equivalents
    
    
    1,875
    
    
    
    1,200
    
    
    
    390Gross investment income
    
    
    19,675
    
    
    
    15,347
    
    
    
    11,353Investment expenses
    
    
    685
    
    
    
    643
    
    
    
    545Net investment income
    
    $
    18,990
    
    
    $
    14,704
    
    
    $
    10,808Gross realized gains on investments
    
    $
    1,243
    
    
    $
    2,843
    
    
    $
    2,838Gross realized losses on investments
    
    
    (1,478
    )
    
    
    (3,049
    )
    
    
    (3,162
    )Net unrealized (loss) gain on trading portfolio
    
    
    (69
    )
    
    
    277
    
    
    
    281Net realized (losses) gains on securities and other
    
    $
    (304
    )
    
    $
    71
    
    
    $
    (43
    )
  78




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##### Table of Contents



Amortized
    
    
    FairCost
    
    
    Value(In thousands)Years to maturity:One or less
    
    $
    16,299
    
    
    $
    16,106After one through five
    
    
    183,187
    
    
    
    180,151After five through ten
    
    
    133,588
    
    
    
    132,443After ten
    
    
    87,872
    
    
    
    86,743Total
    
    $
    420,946
    
    
    $
    415,443
  3. Finance Receivables
  2006
    
    
    2005(In thousands)Finance receivables
    
    $
    232,039
    
    
    $
    221,215Less allowance for losses
    
    
    (6,812
    )
    
    
    (6,419
    )Finance receivables, net
    
    $
    225,227
    
    
    $
    214,796
  2006
    
    
    2005
    
    
    2004(In thousands)Balance at January 1
    
    $
    6,419
    
    
    $
    6,174
    
    
    $
    5,942Provision for finance receivable losses
    
    
    11,322
    
    
    
    10,266
    
    
    
    7,270Charge-offs, net of recoveries
    
    
    (10,929
    )
    
    
    (10,021
    )
    
    
    (7,038
    )Balance at December 31
    
    $
    6,812
    
    
    $
    6,419
    
    
    $
    6,174
  2006
    
    2005Florida
    
    
    44.4
    %
    
    
    49.1
    %Tennessee
    
    
    13.4
    
    
    
    14.0Texas
    
    
    6.3
    
    
    
    4.3Georgia
    
    
    7.0
    
    
    
    7.0Mississippi
    
    
    6.2
    
    
    
    6.0Louisiana
    
    
    6.0
    
    
    
    5.9Other states, combined
    
    
    16.7
    
    
    
    13.7Total
    
    
    100.0
    %
    
    
    100.0
    %
  79




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##### Table of Contents



4. Property and Equipment
  2006
    
    
    2005(In thousands)Land
    
    $
    223
    
    
    $
    223Buildings and improvements
    
    
    9,484
    
    
    
    8,867Computer hardware and software
    
    
    23,850
    
    
    
    22,296Furniture and equipment
    
    
    8,620
    
    
    
    8,403Projects in progress
    
    
    1,718
    
    
    
    767Construction in progress
    
    
    2,361
    
    
    
    2,126Capital leases:Building
    
    
    6,364
    
    
    
    6,364Equipment
    
    
    4,644
    
    
    
    4,49557,264
    
    
    
    53,541Less accumulated depreciation
    
    
    (41,544
    )
    
    
    (35,195
    )Property and equipment, net
    
    $
    15,720
    
    
    $
    18,346
    5. Insurance Losses and Loss Adjustment Expenses
  2006
    
    
    2005
    
    
    2004(In thousands)Balance at January 1
    
    $
    131,408
    
    
    $
    124,858
    
    
    $
    112,618Less reinsurance recoverables on unpaid losses
    
    
    17,552
    
    
    
    22,859
    
    
    
    37,955Net balance at January 1
    
    
    113,856
    
    
    
    101,999
    
    
    
    74,663Add losses and LAE incurred, net of reinsurance related to:Current year
    
    
    321,150
    
    
    
    298,993
    
    
    
    275,651Prior years
    
    
    (316
    )
    
    
    6,762
    
    
    
    6,318Net losses and LAE incurred during the current year
    
    
    320,834
    
    
    
    305,755
    
    
    
    281,969Deduct losses and LAE paid, net of reinsurance, related to:Current year
    
    
    221,661
    
    
    
    210,655
    
    
    
    191,176Prior years
    
    
    82,292
    
    
    
    83,243
    
    
    
    63,457Net claim payments made during the current year
    
    
    303,953
    
    
    
    293,898
    
    
    
    254,633Net balance at December 31
    
    
    130,737
    
    
    
    113,856
    
    
    
    101,999Plus reinsurance recoverables on unpaid losses
    
    
    6,027
    
    
    
    17,552
    
    
    
    22,859Balance at December 31
    
    $
    136,764
    
    
    $
    131,408
    
    
    $
    124,858
 80




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##### Table of Contents



6. Notes Payable
  2006
    
    
    2005(In thousands)Premium Finance revolving credit facility
    
    $
    143,000
    
    
    $
    150,000Other
    
    
    2,272
    
    
    
    3,009Total
    
    $
    145,272
    
    
    $
    153,009
 Premium Finance Revolving Credit Facility
    81




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##### Table of Contents



Corporate Revolving Credit Facility
  Debentures payable
    Other
  Scheduled Maturities
  PrinciplePaymentsDue(in thousands)Years due:2007
    
    $
    1,6412008
    
    
    6312009
    
    
    143,0002010
    
    
    2011 and after
    
    
    41,238Total
    
    $
    186,510
 82




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##### Table of Contents



7. Reinsurance
 Ceded Reinsurance
   Assumed Reinsurance
   Premiums
    
    
    Premiums
    
    
    Losses andWritten
    
    
    Earned
    
    
    LAE(In thousands)2006Direct
    
    $
    435,154
    
    
    $
    425,478
    
    
    $
    319,244Assumed
    
    
    20,795
    
    
    
    21,027
    
    
    
    14,186Ceded
    
    
    2,597
    
    
    
    (21,728
    )
    
    
    (12,596
    )Net
    
    $
    458,546
    
    
    $
    424,777
    
    
    $
    320,8342005Direct
    
    $
    424,606
    
    
    $
    431,974
    
    
    $
    336,581Assumed
    
    
    28,367
    
    
    
    29,588
    
    
    
    18,769Ceded
    
    
    (52,359
    )
    
    
    (57,463
    )
    
    
    (49,595
    )Net
    
    $
    400,614
    
    
    $
    404,099
    
    
    $
    305,7552004Direct
    
    $
    442,577
    
    
    $
    432,577
    
    
    $
    334,570Assumed
    
    
    39,300
    
    
    
    39,246
    
    
    
    23,946Ceded
    
    
    (72,464
    )
    
    
    (99,317
    )
    
    
    (76,547
    )Net
    
    $
    409,413
    
    
    $
    372,506
    
    
    $
    281,969
 8. Administrative Services
  83




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##### Table of Contents



2006
    
    2005
    
    2004(In thousands)Premiums produced for other carriersWritten premiums
    
    $
    28,755
    
    
    $
    36,176
    
    
    $
    47,413Earned premiums
    
    
    28,868
    
    
    
    37,991
    
    
    
    47,399Premiums assumed by the CompanyWritten premiums
    
    $
    20,795
    
    
    $
    28,367
    
    
    $
    39,300Earned premiums
    
    
    21,027
    
    
    
    29,588
    
    
    
    39,246
 9. Income Taxes
   2006
    
    
    2005
    
    
    2004(In thousands)Current:Federal
    
    $
    15,274
    
    
    $
    20,354
    
    
    $
    28,228State
    
    
    2,147
    
    
    
    2,933
    
    
    
    4,359Total current
    
    
    17,421
    
    
    
    23,287
    
    
    
    32,587Deferred:Federal
    
    
    (54
    )
    
    
    20
    
    
    
    (1,180
    )State
    
    
    (348
    )
    
    
    91
    
    
    
    (286
    )Total deferred
    
    
    (402
    )
    
    
    111
    
    
    
    (1,466
    )Total income tax expense
    
    $
    17,019
    
    
    $
    23,398
    
    
    $
    31,121
  2006
    
    
    2005
    
    
    2004(In thousands)Income before income taxes
    
    $
    45,020
    
    
    $
    62,409
    
    
    $
    85,106Income tax expense at statutory rate
    
    $
    15,757
    
    
    $
    21,843
    
    
    $
    29,787Tax effect of:State income taxes
    
    
    1,188
    
    
    
    1,998
    
    
    
    2,548Tax exempt interest
    
    
    (606
    )
    
    
    (538
    )
    
    
    (476
    )Other, net
    
    
    680
    
    
    
    95
    
    
    
    (738
    )Total income tax expense
    
    $
    17,019
    
    
    $
    23,398
    
    
    $
    31,121
 84




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##### Table of Contents



2005(Restated2006
    
    
    See Note 1)(In thousands)Deferred income tax assets:Unearned premiums
    
    $
    14,707
    
    
    $
    12,492Loss and loss adjustment expense reserves
    
    
    2,666
    
    
    
    2,809Provision for return and unearned reinsurance commissions
    
    
    
    
    
    
    652Provision for return and unearned service fees
    
    
    995
    
    
    
    997Provision for return commissions
    
    
    936
    
    
    
    932Allowance for losses on finance receivables
    
    
    2,384
    
    
    
    2,247Depreciation
    
    
    1,780
    
    
    
    912Net unrealized loss on available-for-sale securities
    
    
    1,926
    
    
    
    2,495Unearned policy fees
    
    
    2,047
    
    
    
    1,764Policy acquisition costs
    
    
    1,303
    
    
    
    1,083Other
    
    
    2,286
    
    
    
    1,335Total deferred income tax assets
    
    
    31,030
    
    
    
    27,718Deferred income tax liabilities:Deferred policy acquisition costs
    
    
    7,440
    
    
    
    4,832Unrealized gain related to cash flow hedge
    
    
    407
    
    
    
    369Amortization
    
    
    2,401
    
    
    
    1,253Other
    
    
    505
    
    
    
    435Total deferred income tax liabilities
    
    
    10,753
    
    
    
    6,889Net federal deferred income tax asset
    
    
    20,277
    
    
    
    20,829State deferred income tax asset
    
    
    2,339
    
    
    
    1,991Net deferred income tax asset
    
    $
    22,616
    
    
    $
    22,820
 10. Capital Stock
 Public Offerings
  Common Stock Repurchase
  Stock Option Plans
   85




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##### Table of Contents



WeightedNumber of
    
    AverageShares
    
    Exercise PriceOptions outstanding January 1, 2004 (610,008 exercisable)
    
    
    1,602,000
    
    
    
    $12.93Granted
    
    
    131,000
    
    
    
    31.10Exercised
    
    
    516,300
    
    
    
    2.11Forfeited
    
    
    24,000
    
    
    
    21.00Options outstanding December 31, 2004 (317,700 exercisable)
    
    
    1,192,700
    
    
    
    19.45Granted
    
    
    40,000
    
    
    
    18.06Exercised
    
    
    137,000
    
    
    
    4.25Surrendered
    
    
    100,000
    
    
    
    30.96Forfeited
    
    
    25,000
    
    
    
    31.00Options outstanding December 31, 2005 (385,300 exercisable)
    
    
    970,700
    
    
    
    20.05Granted
    
    
    50,000
    
    
    
    17.50Exercised
    
    
    8,500
    
    
    
    2.71Forfeited
    
    
    60,000
    
    
    
    21.00Options outstanding December 31, 2006 (529,700 exercisable)
    
    
    952,200
    
    
    
    $19.91
    86




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##### Table of Contents



2005
    
    
    2004(In thousands, except pershare amounts)Net income available to common shareholders, as reported
    
    $
    39,011
    
    
    $
    53,985Deduct: Total stock-based employee compensation expense
determined under the fair value based method, net of
related tax effects
    
    
    (865
    )
    
    
    (878
    )Net income available to common shareholders and income for
purposes of computing diluted earnings per share, pro forma
    
    $
    38,146
    
    
    $
    53,107Earnings per shareBasic  as reported
    
    $
    1.83
    
    
    $
    2.44Basic  pro forma
    
    $
    1.79
    
    
    $
    2.40Diluted  as reported
    
    $
    1.82
    
    
    $
    2.38Diluted  pro forma
    
    $
    1.78
    
    
    $
    2.34
  2006
    
    2005
    
    2004Expected option term
    
    5 years
    
    5 years
    
    5 yearsAnnualized volatility rate
    
    14% to 21%
    
    31.5%
    
    35%Risk-free rate of return
    
    4.57% to 5.00%
    
    4.12%
    
    3.1% to 3.5%Fair value at the date of grant (weighted-average)
    
    $15.57 to $18.79
    
    $18.06
    
    $31.80Dividend yield
    
    0.63% to 0.77%
    
    0.66%
    
    0.76%Black-Scholes value
    
    22.9% to 26%
    
    32.9%
    
    33.3% to 33.9%
 Reserved Shares
  Exercise of stock options under the 1996 Plan
    
    
    45,000Exercise of stock options under the 2003 Plan
    
    
    1,651,200Total common shares reserved
    
    
    1,696,200
 11. Statutory Financial Information and Accounting Policies
 Accounting Principles and Procedures Manual
 87




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##### Table of Contents



Net IncomeYear ended December 31,
    
    
    Surplus December 31,2006
    
    
    2005
    
    
    2004
    
    
    2006
    
    
    2005
    
    
    2004(Restated See Note 1)(In thousands)Statutory basis amounts
    
    $
    21,789
    
    
    $
    23,685
    
    
    $
    16,121
    
    
    $
    185,507
    
    
    $
    169,249
    
    
    $
    141,646Deferred policy acquisition costs
    
    
    7,454
    
    
    
    1,138
    
    
    
    1,234
    
    
    
    21,258
    
    
    
    13,804
    
    
    
    12,666Deferred income taxes
    
    
    (494
    )
    
    
    (475
    )
    
    
    1,231
    
    
    
    3,644
    
    
    
    6,659
    
    
    
    3,394Reinsurance commissions
    
    
    1,862
    
    
    
    451
    
    
    
    3,002
    
    
    
    
    
    
    
    (1,862
    )
    
    
    (2,313
    )Guaranty fund assessments
    
    
    97
    
    
    
    96
    
    
    
    714
    
    
    
    (147
    )
    
    
    (244
    )
    
    
    (338
    )Unearned policy fees
    
    
    (809
    )
    
    
    (1,193
    )
    
    
    (1,261
    )
    
    
    (5,848
    )
    
    
    (5,039
    )
    
    
    (3,846
    )Nonadmitted assets
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,256
    
    
    
    887
    
    
    
    1,370Unrealized appreciation of
securities available-for-sale
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5,101
    )
    
    
    (6,859
    )
    
    
    169Other
    
    
    (159
    )
    
    
    297
    
    
    
    211
    
    
    
    (65
    )
    
    
    13
    
    
    
    134GAAP amounts
    
    $
    29,740
    
    
    $
    23,999
    
    
    $
    21,252
    
    
    $
    200,504
    
    
    $
    176,608
    
    
    $
    152,882
  12. Cash Flow Hedge
    88




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##### Table of Contents



As of December 31,2006
    
    
    2005(In thousands)Carrying value of derivative  asset (liability)Interest rate swap
    
    $
    1,162
    
    
    $
    1,055Total
    
    $
    1,162
    
    
    $
    1,055
 As of December 31,2006
    
    
    2005(In thousands)Other comprehensive income (loss), net of taxInterest rate swap
    
    $
    756
    
    
    $
    685Total
    
    $
    756
    
    
    $
    685
 For the year ended December 31,2006
    
    
    2005
    
    
    2004(In thousands)Amounts transferred to income:Interest expenseInterest rate collar
    
    $
    
    
    
    $
    402
    
    
    $
    922Interest rate swap
    
    
    (402
    )
    
    
    78
    
    
    
    Total interest
    
    $
    (402
    )
    
    $
    480
    
    
    $
    922
 13. Commitments and Contingencies
 Commitments
  Capital
    
    
    OperatingLeases
    
    
    Leases(In thousands)2007
    
    $
    1,209
    
    
    $
    10,0922008
    
    
    259
    
    
    
    6,8452009
    
    
    30
    
    
    
    3,9012010
    
    
    
    
    
    
    1,8662011
    
    
    
    
    
    
    9032012
    
    
    
    
    
    
    26Total minimum lease payments
    
    
    1,498
    
    
    $
    23,633Less amount representing interest
    
    
    68Present value of minimum lease payments
    
    $
    1,430
 Contingencies
 Baton Rouge Facility.
 89




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##### Table of Contents



Litigation.
 14. Fair Value of Financial Instruments
  Debt Securities
 Short-Term Investments and Other Invested Assets
 Finance Receivables, Net
 Reinsurance Balances Receivable and Reinsurance Balances Payable
 Notes payable
 Debentures payable
  2006
    
    2005Carrying
    
    Fair
    
    Carrying
    
    FairValue
    
    Value
    
    Value
    
    Value(In thousands)AssetsDebt securities available-for-sale
    
    $
    415,443
    
    
    $
    415,443
    
    
    $
    388,032
    
    
    $
    388,032Short-term investments and other invested assets
    
    
    4,267
    
    
    
    4,267
    
    
    
    3,688
    
    
    
    3,688Finance receivables, net
    
    
    225,227
    
    
    
    225,227
    
    
    
    214,796
    
    
    
    214,796Reinsurance balances receivable
    
    
    10,150
    
    
    
    10,150
    
    
    
    27,083
    
    
    
    27,083LiabilitiesReinsurance balances payable and funds held
    
    
    7,632
    
    
    
    7,632
    
    
    
    32,024
    
    
    
    32,024Notes payable
    
    
    145,272
    
    
    
    145,272
    
    
    
    153,009
    
    
    
    153,009Capital lease obligations
    
    
    1,430
    
    
    
    1,430
    
    
    
    2,636
    
    
    
    2,636Debentures payable
    
    
    41,238
    
    
    
    40,397
    
    
    
    41,238
    
    
    
    40,558
 90




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##### Table of Contents



15. Earnings per Share
  2006
    
    
    2005
    
    
    2004(In thousands, except per shareamounts)Numerator:Net income available to common shareholders
    
    $
    28,001
    
    
    $
    39,011
    
    
    $
    53,985Denominator:Weighted average common shares outstanding
    
    
    20,346.6
    
    
    
    21,363.8
    
    
    
    22,114.9Dilutive stock options
    
    
    38.4
    
    
    
    60.1
    
    
    
    572.3Weighted average common shares outstanding for
purposes of computing diluted earnings per
common share
    
    
    20,385.0
    
    
    
    21,423.9
    
    
    
    22,687.2Basic earnings per common share
    
    $
    1.38
    
    
    $
    1.83
    
    
    $
    2.44Diluted earnings per common share
    
    $
    1.37
    
    
    $
    1.82
    
    
    $
    2.38
 16. Acquisitions
    17. Quarterly Financial Data (unaudited)
  Basic
    
    
    DilutedTotal
    
    
    Net
    
    
    Earnings
    
    
    Earnings
    
    
    
    
    
    
    Stock Price(2)Revenues
    
    
    Income
    
    
    Per Share(1)
    
    
    Per Share(1)
    
    
    High
    
    
    Low
    
    
    Close(In thousands, except per share amounts)2006Q1
    
    $
    130,813
    
    
    $
    9,160
    
    
    $
    0.45
    
    
    $
    0.45
    
    
    $
    17.64
    
    
    $
    15.10
    
    
    $
    17.01Q2
    
    
    134,117
    
    
    
    7,152
    
    
    
    0.35
    
    
    
    0.35
    
    
    
    18.79
    
    
    
    15.96
    
    
    
    16.92Q3
    
    
    133,394
    
    
    
    7,035
    
    
    
    0.35
    
    
    
    0.35
    
    
    
    17.56
    
    
    
    11.51
    
    
    
    13.46Q4
    
    
    134,604
    
    
    
    4,654
    
    
    
    0.23
    
    
    
    0.23
    
    
    
    20.84
    
    
    
    12.84
    
    
    
    20.64$
    532,928
    
    
    $
    28,001
    
    
    $
    1.38
    
    
    $
    1.37
    
    
    $
    20.84
    
    
    $
    11.51
    
    
    $
    20.64
 91




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##### Table of Contents



Basic
    
    
    DilutedTotal
    
    
    Net
    
    
    Earnings
    
    
    Earnings
    
    
    
    
    
    
    Stock Price(2)Revenues
    
    
    Income
    
    
    Per Share(1)
    
    
    Per Share(1)
    
    
    High
    
    
    Low
    
    
    Close(In thousands, except per share amounts)2005Q1
    
    $
    131,711
    
    
    $
    13,583
    
    
    $
    0.61
    
    
    $
    0.61
    
    
    $
    32.62
    
    
    $
    18.47
    
    
    $
    20.54Q2
    
    
    131,243
    
    
    
    11,496
    
    
    
    0.53
    
    
    
    0.53
    
    
    
    20.61
    
    
    
    15.50
    
    
    
    18.61Q3
    
    
    125,930
    
    
    
    7,260
    
    
    
    0.34
    
    
    
    0.34
    
    
    
    20.43
    
    
    
    16.48
    
    
    
    19.73Q4
    
    
    121,168
    
    
    
    6,672
    
    
    
    0.33
    
    
    
    0.33
    
    
    
    19.92
    
    
    
    15.12
    
    
    
    16.90$
    510,052
    
    
    $
    39,011
    
    
    $
    1.83
    
    
    $
    1.82
    
    
    $
    32.62
    
    
    $
    15.12
    
    
    $
    16.90
 
 (1)
    
    As a result of rounding and weighted averages, the total of the four
quarters earnings per share may not
equal the earnings per share for the full year.(2)
    
    The Companys Common Shares are listed on the NASDAQ National Market under the
symbol of DRCT. 18. Recently Issued Accounting Pronouncements
    19. Pending Merger
  92




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##### Table of Contents



20. Subsequent Events  Litigation Settlements
 nd nd nd
 th th
 
 Item 9. Changes in and Disagreements With Accountants on Accounting and Financial
Disclosure.
  
 Item 9A. Controls and Procedures.
 Disclosure Controls and Procedures
  Internal Control Over Financial Reporting
   93




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##### Table of Contents



Changes in Internal Control over Financial Reporting
  
 Item 9B. Other Information.
  
 PART III
  
 PART IV
 
 Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K. [to be reviewed]
 (a)(1)
    
    Financial Statements  The following consolidated financial statements and
supplementary data of the Registrant and its subsidiaries included in Part
II, Item 8 in the Registrants 2005 Annual Report are incorporated by
reference:Managements Report on Internal Control Over Financial ReportingReport of Independent Registered Public Accounting Firm on Internal Control
Over Financial ReportingReport of Independent Registered Public Accounting FirmConsolidated Statements of Operations  For the Years Ended December 31, 2006, 2005
and 2004Consolidated Balance Sheets  As of December 31, 2006 and 2005Consolidated Statements of Changes in Shareholders Equity  For the Years
Ended December 31, 2006, 2005 and 2004Consolidated Statements of Cash Flows  For the Years Ended December 31, 2006,
2006 and 2004Notes to Consolidated Financial Statements(a)(2)
    
    Financial Statement Schedules  The following financial statement
schedules of the Registrant and its subsidiaries, Report of Independent
Registered Public Accounting Firm and Consent of Independent Registered
Public Accounting Firm are included in Item 15(d):Schedule I  Summary of Investments  Other Than Investments in Related PartiesSchedule II  Condensed Financial Information of RegistrantSchedule IV  ReinsuranceSchedule V  Valuation and Qualifying AccountsSchedule VI  Supplemental Information Concerning Property and Casualty Insurance
Operations
 94




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##### Table of Contents



Report of Independent Registered Public Accounting FirmConsent of Independent Registered
Public Accounting FirmNo other schedules are required to be filed herewith pursuant to Article 7 of
Regulation S-X.(a)(3)
    
    List of exhibits:
 2.1
    
    Agreement and Plan of Merger by and among Elara Holdings, Inc.,
Elara Merger Corporation and Direct General Corporation, dated as of
December 4, 2006 incorporated herein by reference to Exhibit 2.1 of the
Current Report on Form 8-K filed with the SEC on December 5, 2006.2.2
    
    Form of Limited Guarantee in favor of Direct General Corporation,
dated as of December 4, 2006 incorporated herein by reference to Exhibit
2.2 of the Current Report on Form 8-K filed with the SEC on December 5,
2006.3.1
    
    Second Amended and Restated Charter of Direct General Corporation
incorporated herein by reference to Exhibit 3.1 of the Registration
Statement No. 333-113289 filed with the SEC on March 4, 2004.3.2
    
    Amended and Restated Bylaws of Direct General Corporation
incorporated herein by reference to Exhibit 3.2 of the Registration
Statement No. 333-113289 filed with the SEC on March 4, 2004.4.1
    
    Specimen stock certificate representing the common stock, no par
value per share of Direct General Corporation incorporated herein by
reference to Exhibit 4.1 of the Registration Statement No. 333-105505 filed
with the SEC on August 1, 2003.10.1
    
    Employment Agreement by and between Direct General Corporation and
William C. Adair, Jr. dated as of July 21, 2003 incorporated herein by
reference to Exhibit 10.1 of the Registration Statement No. 333-105505
filed with the SEC on July 21, 2003.10.2
    
    Employment Agreement by and between Direct General Corporation and
Jacqueline C. Adair dated as of July 21, 2003 incorporated herein by
reference to Exhibit 10.2 of the Registration Statement No. 333-105505
filed with the SEC on July 21, 2003.10.3
    
    Employment Agreement by and between Direct General Corporation and
Tammy R. Adair dated as of July 21, 2003 incorporated herein by reference
to Exhibit 10.3 of the Registration Statement No. 333-105505 filed with the
SEC on July 21, 2003.10.4
    
    Employment Agreement by and between Direct General Corporation and
William J. Harter dated as of July 21, 2003 incorporated herein by
reference to Exhibit 10.4 of the Registration Statement No. 333-105505
filed with the SEC on July 21, 2003.10.5
    
    Employment Agreement by and between Direct General Corporation,
Elara Holdings, Inc., and Tammy R. Adair dated as of December 4, 2006
incorporated herein by reference to Exhibit 10.3 of the Current Report on
Form 8-K filed with the SEC on December 5, 2006.10.6
    
    Employment Agreement by and between Direct General Corporation,
Elara Holdings, Inc., and J. Todd Hagely dated as of December 4, 2006
incorporated herein by reference to Exhibit 10.4 of the Current Report on
Form 8-K filed with the SEC on December 5, 2006.10.7
    
    Resignation and Restrictive Covenants Agreement by and between
Direct General Corporation, Elara Holdings, Inc. and William C. Adair dated
as of December 4, 2006 incorporated herein by reference to Exhibit 10.1 of
the Current Report on Form 8-K filed with the SEC on December 5, 2006.10.8
    
    Resignation and Restrictive Covenants Agreement by and between
Direct General Corporation, Elara Holdings, Inc. and Jacqueline C. Adair
dated as of December 4, 2006 incorporated herein by reference to Exhibit
10.2 of the Current Report on Form 8-K filed with the SEC on December 5,
2006.10.9
    
    Employment Agreement by and between Direct General Corporation and
J. Todd Hagely dated as of August 15, 2005 incorporated herein by reference
to Exhibit 10.4 of the Quarterly Report on Form 10-Q filed with the SEC on
November 9, 2005.
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10.10
    
    Direct General Corporation 1996 Employee Stock Incentive Plan
incorporated herein by reference to Exhibit 10.6 of the Registration Statement
No. 333-105505 filed with the SEC on May 23, 2003.10.11
    
    Direct General Corporation 2003 Equity Incentive Plan incorporated herein by
reference to Exhibit 10.7 of the Registration Statement No. 333-105505 filed with
the SEC on May 23, 2003.10.12
    
    Excess of Liability Reinsurance Agreement between Direct General Insurance
Company and State National Specialty Insurance Company dated as of October 1,
2002 incorporated herein by reference to Exhibit 10.12 of the Registration
Statement No. 333-105505 filed with the SEC on June 27, 2003.10.13
    
    Quota Share Reinsurance Agreement between Direct General Insurance Company and
State National Specialty Insurance Company dated as of October 1, 2002
incorporated herein by reference to Exhibit 10.13 of the Registration Statement
No. 333-105505 filed with the SEC on May 23, 2003.10.14
    
    Quota Share Reinsurance Agreement between Direct General Insurance Company and
Old American County Mutual Fire Insurance Company dated as of January 1, 2003
incorporated herein by reference to Exhibit 10.14 of the Registration Statement
No. 333-105505 filed with the SEC on June 27, 2003.10.15
    
    Eighth Amended and Restated Loan Agreement by and among Direct General
Corporation and certain of its subsidiaries and First Tennessee Bank National
Association, as agent, and other banks described therein dated as of October 31,
2002, as amended by the First Amendment to the Eighth Amended and Restated Loan
Agreement dated as of March 31, 2003 and the Second Amendment to the Eighth
Amended and Restated Loan Agreement dated as of May 28, 2003 and the Third
Amendment to the Eighth Amended and Restated Loan Agreement dated as of June 30,
2003 and the Fourth Amendment to the Eighth Amended and Restated Loan Agreement
dated as of July 17, 2003 incorporated herein by reference to Exhibit 10.15 of
the Registration Statement No. 333-105505 filed with the SEC on August 1, 2003,
the Fifth Amendment to the Eighth Amended and Restated Loan Agreement dated as of
November 26, 2003 incorporated herein by reference to Exhibit 3.1 of the
Registration Statement No. 333-113289 filed with the SEC on March 4, 2004, the
Sixth Amendment to the Eighth Amended and Restated Loan Agreement dated as of
June 30, 2004, the Seventh Amendment to the Eighth Amended and Restated Loan
Agreement dated as of December 3, 2004, the Eighth Amendment to the Eighth
Amended and Restated Loan Agreement dated as of June 30, 2006 incorporated herein
by reference to Exhibit 10.1 of the Quarterly Report on Form 10-Q filed with the
SEC on August 8, 2006, and the Ninth Amendment to the Eighth Amended and Restated
Loan Agreement dated as of November 22, 2006, but effective as of the effective
date defined therein, incorporated herein by reference to Exhibit 10.1 of the
Current Report on Form 8-K filed with the SEC on December 13, 2006.10.16
    
    Seventh Amended and Restated Pledge and Security Agreement made by Direct
General Corporation in favor of First Tennessee Bank National Association, as
agent, and other banks described therein dated as of October 31, 2002, as amended
by the First Amendment to the Seventh Amended and Restated Pledge and Security
Agreement dated as of March 31, 2003 and the Second Amendment to the Seventh
Amended and Restated Pledge and Security Agreement dated as of May 28, 2003 and
the Third Amendment to the Seventh Amended and Restated Pledge and Security
Agreement dated as of June 30, 2003 incorporated herein by reference to Exhibit
10.16 of the Registration Statement No. 333-105505 filed with the SEC on August
1, 2003, the Fourth Amendment to the Seventh Amended and Restated Pledge and
Security Agreement dated as of November 26, 2003 incorporated herein by reference
to Exhibit 3.1 of the Registration Statement No. 333-113289 filed with the SEC on
March 4, 2004, the Fifth Amendment to the Seventh Amended and Restated Pledge and
Security Agreement dated as of June 30, 2004, the Sixth Amendment to the Seventh
Amended and Restated Pledge and Security Agreement dated December 3, 2004, the
Seventh Amendment to the Seventh Amended and Restated Pledge and Security
Agreement dated as of June 30, 2006 incorporated herein by
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reference to Exhibit 10.3 of the quarterly Report on Form 10-Q filed with the
SEC on August 8, 2006, and the Eighth Amendment to the Seventh Amended and
Restated Pledge and Security Agreement dated as of November 22, 2006, but
effective as of the effective date defined therein, incorporated herein by
reference to Exhibit 10.3 of the Current Report on Form 8-K filed with the SEC
on December 13, 2006.10.17
    
    Seventh Amended and Restated Security Agreement by and between Direct General
Financial Services, Inc. and First Tennessee Bank National Association, as agent,
and other banks described therein dated as of October 31, 2002, as amended by the
First Amendment to the Seventh Amended and Restated Security Agreement dated as
of March 31, 2003 and the Second Amendment to the Seventh Amended and Restated
Security Agreement dated as of May 28, 2003 and the Third Amendment to the
Seventh Amended and Restated Security Agreement dated as of June 30, 2003
incorporated herein by reference to Exhibit 10.17 of the Registration Statement
No. 333-105505 filed with the SEC on August 1, 2003, the Fourth Amendment to the
Seventh Amended and Restated Security Agreement dated as of November 26, 2003
incorporated herein by reference to Exhibit 3.1 of the Registration Statement No.
333-113289 filed with the SEC on March 4, 2004, the Fifth Amendment to the
Seventh Amended and Restated Security Agreement dated as of June 30, 2004, the
Sixth Amendment to the Seventh Amended and Restated Security Agreement dated as
of December 3, 2004, the Seventh Amendment to the Seventh Amended and Restate
Security Agreement dated as of June 30, 2006 incorporated herein by reference to
Exhibit 10.4 of the Quarterly Report on Form 10-Q filed with the SEC on August 8,
2006, and the Eighth Amendment to the Seventh Amended and Restated Security
Agreement dated as of November 22, 2006, but effective as of the effective date
defined therein, incorporated herein by reference to Exhibit 10.2 of the Current
Report on Form 8-K filed with the SEC on December 13, 2006.10.18
    
    Fifteenth Amended and Restated Guaranty Agreement by and between Direct General
Financial Services, Inc., Direct General Premium Finance Company, First Tennessee
Bank National Association, as agent, and other banks described therein dated as
of June 30, 2006, incorporated herein by reference to Exhibit 10.2 of the
Quarterly Report on Form 10-Q filed with the SEC on August 8, 2006.10.19
    
    Third Amended and Restated Loan Agreement among Direct General Corporation,
Direct General Financial Services, Inc., First Tennessee Bank National
Association and Hibernia National Bank dated as of October 31, 2002 incorporated
herein by reference to Exhibit 10.19 of the Registration Statement No. 333-105505
filed with the SEC on June 27, 2003.10.20
    
    Florida MGA Agreement between Direct General Insurance Company, Inc. and the
Maitland Underwriters dated as of August 16, 1999 incorporated herein by
reference to Exhibit 10.22 of the Registration Statement No. 333-105505 filed
with the SEC on June 27, 2003.10.21
    
    Option Agreement between Direct General Insurance Agency, Inc. and LR3
Enterprises, Inc. and Maitland Underwriters, Inc. dated as of August 16, 1999 as
amended by the Letter Agreements dated January 9, 2001 and February 20, 2002
incorporated herein by reference to Exhibit 10.23 of the Registration Statement
No. 333-105505 filed with the SEC on June 27, 2003.10.22
    
    Managing General Agency Agreement between Direct General Insurance Agency Inc.
and Old American County Mutual Fire Insurance Company dated as of January 1, 2003
incorporated herein by reference to Exhibit 10.24 of the Registration Statement
No. 333-105505 filed with the SEC on June 27, 2003.10.23
    
    Option Agreement between Direct General Insurance Agency, Inc. and All American
General Agency, Inc., Guaranteed Insurance Agency, Inc., and certain guarantors
described therein dated as of January 1, 2003 incorporated herein by reference to
Exhibit 10.25 of the Registration Statement No. 333-105505 filed with the SEC on
June 27, 2003.10.24
    
    Texas Sub-Producers Agreement between Direct General Insurance Agency, Inc. and
All American General Agency, Inc. dated as of January 1, 2003 incorporated herein
by reference to Exhibit 10.26 of the Registration Statement No. 333-105505 filed
with the SEC on June 27, 2003.
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10.25
    
    Security Trust Agreement between Direct General Insurance Company
and Old American County Mutual Fire Insurance Company and First Tennessee
Bank National Association dated as of January 1, 2003 incorporated herein
by reference to Exhibit 10.27 of the Registration Statement No.
333-105505 filed with the SEC on June 27, 2003.10.26
    
    Stock Purchase Agreement and Letter between Direct General
Corporation and Mutual Service Casualty Insurance Company dated as of
December 2, 2002 incorporated herein by reference to Exhibit 10.28 of the
Registration Statement No. 333-105505 filed with the SEC on June 27, 2003.10.27
    
    Stock Purchase Agreement among Direct General Corporation, New
York Life and Health Insurance Company, NYLCare Health Plans, Inc. and
Aetna Inc. dated as of June 26, 2003 incorporated herein by reference to
Exhibit 10.31 of the Quarterly Report on Form 10-Q filed with the SEC on
September 23, 2003.10.28
    
    Indenture by and between Direct General Corporation and Wilmington
Trust Company dated as of September 15, 2005 incorporated herein by
reference to Exhibit 10.3 of the Quarterly Report on Form 10-Q filed with
the SEC on November 9, 2005.10.29
    
    Guarantee Agreement by and between Direct General Corporation and
Wilmington Trust Company dated as of September 15, 2005 incorporated herein
by reference to Exhibit 10.4 of the Quarterly Report on Form 10-Q filed
with the SEC on November 9, 2005.10.30
    
    Amended and Restated Declaration of Trust by and among Wilmington
Trust Company, Direct General Corporation and William J. Harter, J. Todd
Hagely and Matthew P. McClure dated as of September 15, 2005 incorporated
herein by reference to Exhibit 10.5 of the Quarterly Report on Form 10-Q
filed with the SEC on November 9, 2005.10.31
    
    Form of Director Indemnification Agreement entered into between
Direct General Corporation and directors William C. Adair, Jr., Jacqueline
C. Adair, Fred H. Medling, Raymond L. Osterhout and Stephen L. Rohde, dated
December 4, 2006 incorporated herein by reference to Exhibit 10.5 of the
Current Report on Form 8-K filed with the SEC on December 5, 2006.10.32
    
    Form of Special Committee Indemnification Agreement entered into
between Direct General Corporation and Special Committee members Fred H.
Medling, Raymond L. Osterhout and Stephen L. Rohde, dated December 4, 2006
incorporated herein by reference to Exhibit 10.6 of the Current Report on
Form 8-K filed with the SEC on December 5, 2006.14
    *
    Code of Ethics and Policy on Business Conduct.21
    *
    List of Subsidiaries of the Company.23
    *
    Consent of Independent Registered Public Accounting Firm.31.1
    *
    Rule 13a-14(a) Certifications of CEO (pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002).31.2
    *
    Rule 13a-14(a) Certifications of CFO (pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002).32.1
    *
    Rule 1350 Certifications of CEO (pursuant to Section 906 of the Sarbanes-Oxley Act of
2002).32.2
    *
    Rule 1350 Certifications of CFO (pursuant to Section 906 of the Sarbanes-Oxley Act of
2002).
 
 *
    
    Filed herewith. (b)
    
    Exhibits:The applicable exhibits are included immediately after the signature pages.(c)
    
    Financial Statement Schedules:The applicable financial statement schedules are included immediately after the signature
pages.
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SIGNATURES
  DIRECT GENERAL CORPORATION(Registrant)March 14,
2007
    


    By: /s/ William C. Adair, Jr.Date
    



(Signature)Name: William C. Adair, Jr.Title: Chairman, Chief Executive Officer
  March 14,
2007
    


    By: /s/ William C. Adair, Jr.Date
    

    (Signature)Name: William C. Adair, Jr.Title: Chairman, Chief Executive OfficerMarch 14,
2007
    
    By: /s/ Jacqueline C. AdairDate
    

(Signature)Name: Jacqueline C. AdairTitle: Director, Executive Vice President and Chief Operating
OfficerMarch 14,
2007
    


    By: /s/ Fred H. MedlingDate
    
    (Signature)Name: Fred H. MedlingTitle: DirectorMarch 14, 2007
    

    By: /s/ Raymond L. OsterhoutDate
    
(Signature)Name: Raymond L. OsterhoutTitle: DirectorMarch 14, 2007
    

    By: /s/ Stephen L. RohdeDate
    
(Signature)Name: Stephen L. RohdeTitle: DirectorMarch 14, 2007
    

    By: /s/ J. Todd HagelyDate
    

(Signature)Name: J. Todd HagelyTitle: Senior Vice President and Chief Financial Officer
(Principal Accounting           Officer)
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DIRECT GENERAL CORPORATION AND SUBSIDIARIES
 SCHEDULE I. SUMMARY OF INVESTMENTS
 OTHER
THAN INVESTMENTS IN RELATED PARTIES 
December 31, 2006
 Amount atWhich Shown inthe BalanceType of Investment
    
    Cost
    
    
    Value
    
    
    Sheet(In thousands)Available-for-sale fixed maturity securities:Bonds:United States government and government agencies and
authorities
    
    $
    87,593
    
    
    $
    86,649
    
    
    $
    86,649States, municipalities, and political subdivisions
    
    
    72,195
    
    
    
    72,062
    
    
    
    72,062Public utilities
    
    
    14,685
    
    
    
    14,334
    
    
    
    14,334All other corporate bonds
    
    
    246,473
    
    
    
    242,398
    
    
    
    242,398Total fixed maturities
    
    
    420,946
    
    
    
    415,443
    
    
    
    415,443Short-term investments and other invested assets
    
    
    4,267
    
    
    
    4,267
    
    
    
    4,267Total investments
    
    $
    425,213
    
    
    $
    419,710
    
    
    $
    419,710
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DIRECT
GENERAL CORPORATION (PARENT COMPANY)
 SCHEDULE II. CONDENSED FINANCIAL INFORMATION OF REGISTRANT
 Condensed Statements of Operations
 For the Years Ended December 31,2006
    
    
    2005
    
    
    2004(In thousands)RevenuesManagement fees from non-insurance subsidiaries
    
    $
    1,576
    
    
    $
    6,288
    
    
    $
    17,690Dividends from insurance subsidiaries
    
    
    7,200
    
    
    
    11,650
    
    
    
    1,000Other income
    
    
    244
    
    
    
    187
    
    
    
    128Total revenues
    
    
    9,020
    
    
    
    18,125
    
    
    
    18,818ExpensesGeneral and administrative expenses
    
    
    1,408
    
    
    
    44
    
    
    
    978Interest expense
    
    
    3,465
    
    
    
    1,124
    
    
    
    Total expenses
    
    
    4,873
    
    
    
    1,168
    
    
    
    978Income before income taxes and equity in earnings of
subsidiaries
    
    
    4,147
    
    
    
    16,957
    
    
    
    17,840Income tax (benefit) expense
    
    
    (1,134
    )
    
    
    1,501
    
    
    
    6,633Income before equity in earnings of subsidiaries
    
    
    5,281
    
    
    
    15,456
    
    
    
    11,207Equity earnings in subsidiaries
    
    
    22,720
    
    
    
    23,555
    
    
    
    42,778Net income
    
    $
    28,001
    
    
    $
    39,011
    
    
    $
    53,985
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DIRECT GENERAL CORPORATION (PARENT COMPANY)
 SCHEDULE II. CONDENSED FINANCIAL INFORMATION OF REGISTRANT
 Condensed Balance Sheets
 As of December 31,2005(Restated 2006
    
    
    See Note 1)(In thousands)AssetsDebt securities available-for-sale (amortized cost $2,800 and $2,900 at
December 31, 2006 and 2005, respectively)
    
    $
    2,800
    
    
    $
    2,900Other invested assets
    
    
    1,238
    
    
    
    1,238Cash and cash equivalents
    
    
    476
    
    
    
    1,157Receivables from affiliated companies, net
    
    
    28,623
    
    
    
    19,623Investment in subsidiaries
    
    
    265,094
    
    
    
    240,948Income tax recoverable
    
    
    1,611
    
    
    
    6,492Other assets
    
    
    5,814
    
    
    
    6,049Total assets
    
    $
    305,656
    
    
    $
    278,407Liabilities and shareholders equityDeferred income taxes
    
    $
    129
    
    
    $
    26Notes and debentures payable
    
    
    42,230
    
    
    
    42,346Other liabilities
    
    
    265
    
    
    
    183Total liabilities
    
    
    42,624
    
    
    
    42,555Shareholders equityCommon stock
    
    
    71,008
    
    
    
    69,700Retained earnings
    
    
    194,845
    
    
    
    170,100Accumulated other comprehensive loss
    
    
    (2,821
    )
    
    
    (3,948
    )Total shareholders equity
    
    
    263,032
    
    
    
    235,852Total liabilities and shareholders equity
    
    $
    305,656
    
    
    $
    278,407
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DIRECT GENERAL CORPORATION (PARENT COMPANY)
 SCHEDULE II. CONDENSED FINANCIAL INFORMATION OF REGISTRANT
 Condensed Statements of Cash Flows
 For the Years Ended December 31,2006
    
    
    2005
    
    
    2004(In thousands)Net cash (used in) provided by operating activities
    
    $
    (5,835
    )
    
    $
    2,231
    
    
    $
    8,574Investing activitiesInvestment in subsidiaries
    
    
    (300
    )
    
    
    (11,807
    )
    
    
    (11,500
    )Advance to subsidiary to paydown on credit facility
    
    
    
    
    
    
    
    
    
    
    (13,000
    )Dividends received from insurance subsidiaries
    
    
    7,200
    
    
    
    1,650
    
    
    
    1,000Dividends received from non-insurance subsidiaries
    
    
    218
    
    
    
    10,000
    
    
    
    Purchase of common stock in trust
    
    
    
    
    
    
    (1,238
    )
    
    
    Sale (purchase) of debt securities available-for-sale
    
    
    100
    
    
    
    100
    
    
    
    (3,000
    )Net cash provided by (used in) by investing activities
    
    
    7,218
    
    
    
    (1,295
    )
    
    
    (26,500
    )Financing activitiesIssuances of common stock
    
    
    1,308
    
    
    
    612
    
    
    
    17,031Repurchase of common stock
    
    
    
    
    
    
    (40,075
    )
    
    
    (Payment) and proceeds from debentures issued
    
    
    
    
    
    
    41,238
    
    
    
    Proceeds from other notes payable
    
    
    (116
    )
    
    
    1,108Payment of common stock dividends
    
    
    (3,256
    )
    
    
    (3,409
    )
    
    
    (3,542
    )Net cash (used in) provided by financing activities
    
    
    (2,064
    )
    
    
    (526
    )
    
    
    13,489Net (decrease) increase in cash and cash equivalents
    
    
    (681
    )
    
    
    410
    
    
    
    (4,437
    )Cash and cash equivalents at the beginning of the year
    
    
    1,157
    
    
    
    747
    
    
    
    5,184Cash and cash equivalents at the end of the year
    
    $
    476
    
    
    $
    1,157
    
    
    $
    747
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DIRECT GENERAL CORPORATION (PARENT COMPANY)
 SCHEDULE II. CONDENSED FINANCIAL INFORMATION OF REGISTRANT
 Note to Condensed Financial Statements
 1.
    
    Basis of PresentationThe condensed financial statements should be read in conjunction with the
consolidated financial statements and notes thereto of Direct General Corporation and
Subsidiaries.In the Direct General Corporation (Parent Company) financial statements, the Parent
Companys investment in subsidiaries is stated at cost plus equity in undistributed
income of subsidiaries since the date of acquisition, net unrealized gains/losses on
the subsidiaries debt securities available-for-sale, and other changes in
subsidiaries accumulated other comprehensive income.During 2006, the company corrected its accounting for unearned
policy fees as of January 1, 2004 and restated the relevant December 31, 2005 balance sheet
amounts. In prior years, the impact of the unearned policy fee
calculation difference was not material. However, this difference
became material in 2006 because of the decline in operations. The impact of the adjustment on the statement of operations for any of the
years presented was not material.The following is a summary of the line items impacted by the restatement of the
December 31, 2005 balance sheet:
 December 31, 2005As PreviouslyReported
    
    Adjustments
    
    RestatedInvestment in subsidiary
    
    $
    242,678
    
    
    $
    (1,680
    )
    
    $
    240,948Total assets
    
    
    280,087
    
    
    
    (1,680
    )
    
    
    278,407Retained earnings
    
    
    171,780
    
    
    
    (1,680
    )
    
    
    170,100Total shareholders equity
    
    
    237,532
    
    
    
    (1,680
    )
    
    
    235,852Total liabilities and shareholders equity
    
    
    280,087
    
    
    
    (1,680
    )
    
    
    278,407
 2.
    
    Notes and Debentures PayableIn December 2004, the Parent Company entered into a $30,000,000 revolving credit
facility. As of December 31, 2006, no amounts were outstanding. See Note 6 to
consolidated financial statements for a description of this credit facility.In September 2005, Direct General Statutory Trust I (DGST I), a wholly owned
unconsolidated subsidiary trust of the Company, issued 40,000 shares of preferred
securities at $1,000 per share to outside investors and 1,238 shares of common
securities to the Company, also at $1,000 per share. The sole assets of DGST I are
$41,238,000 of junior subordinated debentures issued by the Company. The debentures
will mature on September 15, 2035 and are redeemable by the Company in whole or in
part beginning on September 15, 2010, at which time the preferred securities are
callable. The debentures pay a fixed rate of 7.915% until September 15, 2010, after
which the rate becomes variable. Interest expense of $3,385,000 is included in the
accompanying financial statements related to these debentures. See Note 6 to the
consolidated financial statements for more information.3.
    
    Capital StockDuring 2005, the Company repurchased 2,157,871 shares of its outstanding common stock
for an aggregate price of approximately $40,075,000.See Note 10 to the consolidated financial statements for a description of the Parent Companys
capital structure.
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4.
    
    Pending MergerOn December 4, 2006, the Company entered into a definitive merger agreement with
Elara Holdings, Inc., or Elara, an affiliate of Calera Capital and
TPG Capital (formerly known as Fremont Partners and Texas Pacific
Group respectively), and Elara Merger Corporation, pursuant to which Elara agreed to acquire all of
the Companys outstanding stock (the Elara Merger).
Upon completion of the Elara Merger, the
Companys shareholders will receive $21.25 in cash for each share of the Companys
common stock they hold, a 28.71% premium to the closing price of $16.51 on December
4, 2006. The total value of the Elara Merger, including debt, is approximately
$629,200,000. Our Board of Directors has approved the transaction and on March 8,
2007, our stockholders voted to approve the merger. The merger is subject to
customary conditions, including approval from the relevant state insurance and
finance commissioner or banking or similar department prior to the acquisition. All
required filings have been made.5.
    
    Subsequent Events  Litigation SettlementsIn early 2007, we engaged in mediation with lead plaintiffs in a pending consolidated
federal class action that resulted in a tentative oral settlement agreement. On March
2, 2007 the parties to the consolidated class action entered into a Memorandum of
Understanding (March 2nd MOU) that sets forth a settlement in principle
of this action. The stipulated settlement amount in the March 2nd MOU is
$14.94 million, which is apportioned among the defendants, and the plaintiffs have
agreed to dismiss with prejudice all claims against all defendants to the action.
Neither we nor any other defendant in this action has admitted any liability or
fault. The March 2nd MOU is subject to several conditions, including
approval by the Federal District Court. In addition, the defendants may withdraw from
the settlement, if a to be agreed upon percent of the class members opt out of the
settlement. The parties will submit a written Stipulation of Settlement to the
Federal District Court seeking preliminary approval of the settlement.On March 6, 2007, we and the other defendants in the consolidated federal shareholder
derivative action entered into a Memorandum of Understanding (March 6th
MOU) with the Plaintiffs in that action. Pursuant to the terms of the March
6th MOU, the defendants will pay an award of attorneys fees and expenses
of $675,000, and the federal derivative action, and related state derivative and
state class actions, claims will either be voluntarily dismissed with prejudice, or
the parties in the federal derivative litigation will take such action as is
necessary to have such claims dismissed with prejudice. Neither we nor any other
defendant in these actions has admitted any liability or fault. The parties also are
negotiating terms that would provide the plaintiffs with certain benefits if Elara
sells or divests Direct General Corporation within a certain time after the Elara
Merger closes. The settlement is subject to several conditions, including approval by
the court in which the federal litigation is pending.
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DIRECT GENERAL CORPORATION AND SUBSIDIARIES
 SCHEDULE IV. REINSURANCE
 PercentageCeded to
    
    
    Assumed from
    
    
    
    
    
    
    of AmountGross
    
    
    Other
    
    
    Other
    
    
    Net
    
    
    Assumed toAmount
    
    
    Companies
    
    
    Companies
    
    
    Amount
    
    
    Net(In thousands)Year ended December 31, 2006Life insurance in force
    
    $
    1,678,905
    
    
    $
    
    
    
    $
    
    
    
    $
    1,678,905
    
    
    
    0.0
    %Premiums earned:Life insurance
    
    $
    20,950
    
    
    $
    
    
    
    $
    
    
    
    $
    20,950
    
    
    
    0.0
    %Property and liability insurance
    
    
    404,528
    
    
    
    21,728
    
    
    
    21,027
    
    
    
    403,827
    
    
    
    5.2
    %Total premiums earned
    
    $
    425,478
    
    
    $
    21,728
    
    
    $
    21,027
    
    
    $
    424,777
    
    
    
    5.0
    %Year ended December 31, 2005Life insurance in force
    
    $
    1,471,075
    
    
    $
    
    
    
    $
    
    
    
    $
    1,471,075
    
    
    
    0.0
    %Premiums earned:Life insurance
    
    $
    18,761
    
    
    $
    
    
    
    $
    
    
    
    $
    18,761
    
    
    
    0.0
    %Property and liability insurance
    
    
    413,213
    
    
    
    57,463
    
    
    
    29,588
    
    
    
    385,338
    
    
    
    7.7
    %Total premiums earned
    
    $
    431,974
    
    
    $
    57,463
    
    
    $
    29,588
    
    
    $
    404,099
    
    
    
    7.3
    %Year ended December 31, 2004Life insurance in force
    
    $
    1,374,490
    
    
    $
    
    
    
    $
    
    
    
    $
    1,374,490
    
    
    
    0.0
    %Premiums earned:Life insurance
    
    $
    16,272
    
    
    $
    
    
    
    $
    
    
    
    $
    16,272
    
    
    
    0.0
    %Property and liability insurance
    
    
    416,305
    
    
    
    99,317
    
    
    
    39,246
    
    
    
    356,234
    
    
    
    11.0
    %Total premiums earned
    
    $
    432,577
    
    
    $
    99,317
    
    
    $
    39,246
    
    
    $
    372,506
    
    
    
    10.5
    %
 106




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##### Table of Contents



DIRECT GENERAL CORPORATION AND SUBSIDIARIES
 SCHEDULE V. VALUATION AND QUALIFYING ACCOUNTS
 Balance at
    
    Charged to
    
    
    
    
    
    
    
    
    
    Balance atBeginning of
    
    Costs and
    
    Charged to
    
    
    
    
    
    End ofDescription
    
    Period
    
    Expenses
    
    Other Accounts
    
    Deductions
    
    Period(In thousands)Year ended December 31, 2006Allowance for finance receivable losses
    
    $
    6,419
    
    
    $
    
    
    
    $
    11,322
    (a)
    
    $
    (10,929

)(c)
    
    $
    6,812Provision for return ceding commissions
    
    
    1,007
    
    
    
    (1,007
    )
    
    
    
    
    
    
    
    
    
    
    Provision for return commissions and service fees
    
    
    5,038
    
    
    
    
    
    
    
    476
    (b)
    
    
    
    
    
    
    5,514Year ended December 31, 2005Allowance for finance receivable losses
    
    $
    6,174
    
    
    $
    
    
    
    $
    10,266
    (a)
    
    $
    (10,021
    )(c)
    
    $
    6,419Provision for return ceding commissions
    
    
    1,136
    
    
    
    (129
    )
    
    
    
    
    
    
    
    
    
    
    1,007Provision for return commissions and service fees
    
    
    4,982
    
    
    
    
    
    
    
    56
    (b)
    
    
    
    
    
    
    5,038Year ended December 31, 2004Allowance for finance receivable losses
    
    $
    5,942
    
    
    $
    
    
    
    $
    7,270
    (a)
    
    $
    (7,038
    )(c)
    
    $
    6,174Provision for return ceding commissions
    
    
    3,091
    
    
    
    (1,955
    )
    
    
    
    
    
    
    
    
    
    
    1,136Provision for return commissions and service fees
    
    
    4,929
    
    
    
    
    
    
    
    53
    (b)
    
    
    
    
    
    
    4,982
 
 (a)
    
    provision for finance receivable losses charged to finance income(b)
    
    provision for return commissions and administrative fees charged to commission and service fee income(c)
    
    charge-offs, net of recoveries 107




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##### Table of Contents



DIRECT GENERAL CORPORATION AND SUBSIDIARIES
SCHEDULE VI. SUPPLEMENTAL INFORMATION
 Claims and Claim
    
    
    AmortizationDeferred
    
    
    Reserves for
    
    
    Discount,
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Adjustment Expenses
    
    
    of Deferred
    
    
    Paid ClaimsPolicy
    
    
    Unpaid
    
    
    if any,
    
    
    
    
    
    
    
    
    
    
    Net
    
    
    Incurred Related to
    
    
    Policy
    
    
    and ClaimAffiliation with
    
    Acquisition
    
    
    Claims and
    
    
    Deducted
    
    
    Unearned
    
    
    Earned
    
    
    Investment
    
    
    Current
    
    
    Prior
    
    
    Acquisition
    
    
    Adjustment
    
    
    WrittenRegistrant
    
    Costs
    
    
    Adjustment
    
    
    In Col. C
    
    
    Premiums
    
    
    Premiums
    
    
    Income
    
    
    Year
    
    
    Years
    
    
    Costs
    
    
    Expenses
    
    
    Premium(In thousands)Consolidated property  casualty entities:December 31, 2006
    
    $
    20,633
    
    
    $
    135,829
    
    
    $
    0
    
    
    $
    215,033
    
    
    $
    403,827
    
    
    $
    17,501
    
    
    $
    318,615
    
    
    $
    (316
    )
    
    $
    53,413
    
    
    $
    301,663
    
    
    $
    435,864December 31, 2005
    
    $
    13,294
    
    
    $
    130,718
    
    
    $
    0
    
    
    $
    204,734
    
    
    $
    385,339
    
    
    $
    13,558
    
    
    $
    296,923
    
    
    $
    6,972
    
    
    $
    37,625
    
    
    $
    291,998
    
    
    $
    380,749December 31, 2004
    
    $
    12,202
    
    
    $
    124,128
    
    
    $
    0
    
    
    $
    214,426
    
    
    $
    356,234
    
    
    $
    10,224
    
    
    $
    273,771
    
    
    $
    6,497
    
    
    $
    31,633
    
    
    $
    253,152
    
    
    $
    391,023
 108