##### 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, 2005
 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
    

    (I.R.S. Employer Identification No.)incorporation or organization)1281 Murfreesboro Road, Nashville, TN
    
    37217(Address of principal executive offices)
    
    (Zip 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
 o
  Large accelerated filer o
    
    Accelerated filer þ
    
    Non-accelerated filer 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-KSIGNATURESEX-14  CODE OF ETHICSEX-21  SUBSIDIARIES OF REGISTRANTEX-23  CONSENT OF ERNST & YOUNG LLPEX-31.1  SECTION 302 CERTIFICATION OF THE CEOEX-31.2  SECTION 302 CERTIFICATION OF THE CFOEX-32.1  SECTION 906 CERTIFICATION OF THE CEOEX-32.2  SECTION 906 CERTIFICATION OF THE CFO    Table of Contents  
 PART I
 
 Item 1. Business.
  Our Business Model
  Our Products and Services
   ®
  1




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Year Ended December 31,2005
    
    
    2004
    
    
    2003($ in millions)Gross premiums:Gross premiums written  automobile
    
    $
    433.1
    
    
    $
    463.5
    
    
    $
    421.7Gross premiums written  life
    
    
    19.9
    
    
    
    18.4
    
    
    
    13.5Total gross premiums
    
    $
    453.0
    
    
    $
    481.9
    
    
    $
    435.2Ancillary income (1):Finance income
    
    
    44.4
    
    
    
    49.2
    
    
    
    44.9Commission and service fee income
    
    
    46.8
    
    
    
    48.6
    
    
    
    33.6Total ancillary income
    
    
    91.2
    
    
    
    97.8
    
    
    
    78.5Net investment income excluding
realized gains (losses) on
securities
    
    
    14.7
    
    
    
    10.8
    
    
    
    6.7Gross revenues (2)
    
    $
    558.9
    
    
    $
    590.5
    
    
    $
    520.4
 
 (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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Year Ended December 31,2005
    
    
    2004
    
    
    2003($ in millions)Ancillary income
    
    $
    91.2
    
    
    $
    97.8
    
    
    $
    78.5Operating expensesSelling, general and
administrative costs
    
    $
    133.6
    
    
    $
    108.5
    
    
    $
    74.5Interest expense
    
    
    8.3
    
    
    
    5.5
    
    
    
    6.4Total operating expenses
    
    $
    141.9
    
    
    $
    114.0
    
    
    $
    80.9Ratio of ancillary income to total
operating expenses
    
    
    64.3
    %
    
    
    85.8
    %
    
    
    97.0
    %
 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 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.
 3




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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 expect
to continue to develop additional sales offices in our expansion states of Texas,
Missouri and Virginia and throughout 2006. We also plan to provide alternative
distribution channels for our products including sales over the telephone and through
the Internet in all of our states by the end of 2006.
 Our Market
   
    
    down payment;
    
    payment frequency and amount;
    
    total policy premium; and
    
    customer service.
  Our Competition
  4




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Marketing and Distribution
  Television Advertising.
 Grass Roots Marketing
 Neighborhood Sales Offices.
  5




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##### Table of Contents



Employee-Agents.
 New State Expansion.
 Alternative Distribution Channels.
 Our Products and Services
 Non-Standard Personal Automobile Insurance
   6




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##### Table of Contents



Year Ended December 31,2005
    
    2004
    
    2003($ in millions)Gross
premiums written  Automobile
    
    $
    433.1
    
    
    $
    463.5
    
    
    $
    421.7
  Individual Term Life Insurance
   Year Ended December 31,2005
    
    2004
    
    2003($ in millions)Gross
premiums written  Life
    
    $
    19.9
    
    
    $
    18.4
    
    
    $
    13.5
 Premium Finance
   
    
    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
 7




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
    
    a more defined regulatory framework for financing premiums.
      Year Ended December 31,2005
    
    2004
    
    2003($ in millions)Finance income
    
    $
    44.4
    
    
    $
    49.2
    
    
    $
    44.9
 Ancillary Insurance Products
   8




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Year Ended December 31,2005
    
    2004
    
    2003($ in millions)Commission and service fee income
    
    $
    46.8
    
    
    $
    48.6
    
    
    $
    33.6
  Other Products and Services
  Direct Prepaid Visa ® , a Debit Card Program. ®
 Direct Cash Advance, a Payday Consumer Loan Program. Direct Cash Advance
  9




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##### Table of Contents



Direct Cash Advance
 Underwriting and Pricing
 Non-Standard Personal Automobile Insurance.
  Individual Term Life Insurance.
 Claims Handling
    10




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##### Table of Contents



Loss and Loss Adjustment Expense Reserves
    11




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Year Ended December 31,2005
    
    
    2004
    
    
    2003($ in millions)Balance at beginning of period
    
    $
    124.9
    
    
    $
    112.6
    
    
    $
    86.9Less reinsurance recoverables on unpaid losses
    
    
    22.9
    
    
    
    37.9
    
    
    
    29.0Net balance at beginning of period
    
    
    102.0
    
    
    
    74.7
    
    
    
    57.9Add Losses and LAE incurred, net of reinsurance related to:Current period
    
    
    299.0
    
    
    
    275.7
    
    
    
    168.1Prior period
    
    
    6.8
    
    
    
    6.3
    
    
    
    0.1Net losses and LAE incurred during the current year
    
    
    305.8
    
    
    
    282.0
    
    
    
    168.2Deduct losses and LAE paid, net of reinsurance, related to:Current period
    
    
    210.6
    
    
    
    191.2
    
    
    
    107.6Prior period
    
    
    83.3
    
    
    
    63.5
    
    
    
    43.8Net claim payments made during the current period
    
    
    293.9
    
    
    
    254.7
    
    
    
    151.4Net balance at end of period
    
    
    113.9
    
    
    
    102.0
    
    
    
    74.7Plus reinsurance recoverables on unpaid losses
    
    
    17.5
    
    
    
    22.9
    
    
    
    37.9Balance at end of period
    
    $
    131.4
    
    
    $
    124.9
    
    
    $
    112.6
     12




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As of December 31,1995
    
    
    1996
    
    
    1997
    
    
    1998
    
    
    1999
    
    
    2000
    
    
    2001
    
    
    2002
    
    
    2003
    
    
    2004
    
    
    2005($ in millions)Net reserves for losses and loss
adjustment expense:Originally estimated
    
    $
    16.8
    
    
    $
    16.0
    
    
    $
    18.4
    
    
    $
    31.4
    
    
    $
    33.9
    
    
    $
    34.5
    
    
    $
    37.0
    
    
    $
    57.9
    
    
    $
    74.7
    
    
    $
    102.0
    
    
    $
    113.9Cumulative amounts paid as of:One year later
    
    
    10.1
    
    
    
    9.7
    
    
    
    9.7
    
    
    
    18.4
    
    
    
    25.0
    
    
    
    31.2
    
    
    
    13.1
    
    
    
    43.8
    
    
    
    63.5
    
    
    
    83.2Two years later
    
    
    13.3
    
    
    
    12.4
    
    
    
    12.2
    
    
    
    24.8
    
    
    
    33.7
    
    
    
    35.3
    
    
    
    26.9
    
    
    
    55.4
    
    
    
    75.5Three years later
    
    
    14.3
    
    
    
    13.2
    
    
    
    13.7
    
    
    
    27.6
    
    
    
    36.1
    
    
    
    41.3
    
    
    
    32.7
    
    
    
    59.7Four years later
    
    
    14.6
    
    
    
    13.7
    
    
    
    14.4
    
    
    
    28.7
    
    
    
    38.4
    
    
    
    43.6
    
    
    
    34.7Five years later
    
    
    14.9
    
    
    
    13.9
    
    
    
    14.7
    
    
    
    29.3
    
    
    
    39.2
    
    
    
    44.5Six years later
    
    
    15.0
    
    
    
    14.0
    
    
    
    14.8
    
    
    
    29.7
    
    
    
    39.6Seven years later
    
    
    15.0
    
    
    
    14.1
    
    
    
    14.9
    
    
    
    29.8Eight years later
    
    
    15.1
    
    
    
    14.1
    
    
    
    15.0Nine years later
    
    
    15.1
    
    
    
    14.1Ten years later
    
    
    15.1Reserves re-estimated as of:One year later
    
    
    15.9
    
    
    
    15.7
    
    
    
    16.6
    
    
    
    29.1
    
    
    
    36.2
    
    
    
    43.1
    
    
    
    31.5
    
    
    
    58.0
    
    
    
    81.0
    
    
    
    108.8Two years later
    
    
    16.2
    
    
    
    15.6
    
    
    
    15.6
    
    
    
    28.8
    
    
    
    38.3
    
    
    
    42.7
    
    
    
    33.6
    
    
    
    61.2
    
    
    
    84.1Three years later
    
    
    16.0
    
    
    
    14.9
    
    
    
    15.3
    
    
    
    29.4
    
    
    
    38.7
    
    
    
    43.8
    
    
    
    35.1
    
    
    
    62.8Four years later
    
    
    15.5
    
    
    
    14.6
    
    
    
    15.1
    
    
    
    29.5
    
    
    
    39.3
    
    
    
    44.6
    
    
    
    35.9Five years later
    
    
    15.3
    
    
    
    14.3
    
    
    
    14.8
    
    
    
    29.7
    
    
    
    39.7
    
    
    
    45.1Six years later
    
    
    15.2
    
    
    
    14.1
    
    
    
    14.9
    
    
    
    29.8
    
    
    
    39.9Seven years later
    
    
    15.0
    
    
    
    14.1
    
    
    
    15.0
    
    
    
    29.9Eight years later
    
    
    15.1
    
    
    
    14.1
    
    
    
    15.0Nine years later
    
    
    15.1
    
    
    
    14.1Ten years later
    
    
    15.1Net cumulative deficiency/(redundancy):
    
    $
    (1.7
    )
    
    $
    (1.9
    )
    
    $
    (3.4
    )
    
    $
    (1.5
    )
    
    $
    6.0
    
    
    $
    10.6
    
    
    $
    (1.1
    )
    
    $
    4.9
    
    
    $
    9.4
    
    
    $
    6.8Gross liability  originally estimated
    
    $
    23.1
    
    
    $
    21.0
    
    
    $
    25.7
    
    
    $
    39.9
    
    
    $
    53.2
    
    
    $
    74.0
    
    
    $
    77.5
    
    
    $
    86.9
    
    
    $
    112.6
    
    
    $
    124.9
    
    
    $
    131.4Reinsurance recoverables
    
    
    6.3
    
    
    
    5.0
    
    
    
    7.3
    
    
    
    8.5
    
    
    
    19.3
    
    
    
    39.5
    
    
    
    40.5
    
    
    
    29.0
    
    
    
    37.9
    
    
    
    22.9
    
    
    
    17.5Net liability  originally estimated
    
    $
    16.8
    
    
    $
    16.0
    
    
    $
    18.4
    
    
    $
    31.4
    
    
    $
    33.9
    
    
    $
    34.5
    
    
    $
    37.0
    
    
    $
    57.9
    
    
    $
    74.7
    
    
    $
    102.0
    
    
    $
    113.9Gross estimated liability  latest
    
    $
    20.6
    
    
    $
    18.3
    
    
    $
    22.0
    
    
    $
    38.3
    
    
    $
    62.8
    
    
    $
    83.4
    
    
    $
    81.7
    
    
    $
    94.2
    
    
    $
    127.9
    
    
    $
    134.4
    
    
    $
    131.4Reinsurance recoverables  latest
    
    
    5.5
    
    
    
    4.2
    
    
    
    7.0
    
    
    
    8.4
    
    
    
    22.9
    
    
    
    38.3
    
    
    
    45.8
    
    
    
    31.4
    
    
    
    43.8
    
    
    
    25.6
    
    
    
    17.5Net estimated liability  as of 2005
    
    $
    15.1
    
    
    $
    14.1
    
    
    $
    15.0
    
    
    $
    29.9
    
    
    $
    39.9
    
    
    $
    45.1
    
    
    $
    35.9
    
    
    $
    62.8
    
    
    $
    84.1
    
    
    $
    108.8
    
    
    $
    113.9Gross cumulative deficiency/(redundancy)
    
    $
    (2.5
    )
    
    $
    (2.7
    )
    
    $
    (3.7
    )
    
    $
    (1.6
    )
    
    $
    9.6
    
    
    $
    9.4
    
    
    $
    4.2
    
    
    $
    7.3
    
    
    $
    15.3
    
    
    $
    9.5Net cumulative deficiency/(redundancy):
    
    $
    (1.7
    )
    
    $
    (1.9
    )
    
    $
    (3.4
    )
    
    $
    (1.5
    )
    
    $
    6.0
    
    
    $
    10.6
    
    
    $
    (1.1
    )
    
    $
    4.9
    
    
    $
    9.4
    
    
    $
    6.8
 Reinsurance
 Summary
   13




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Year Ended December 31,2005
    
    
    2004
    
    
    2003Written
    
    
    Earned
    
    
    Written
    
    
    Earned
    
    
    Written
    
    
    Earned($ in millions)Direct premiums
    
    $
    424.6
    
    
    $
    432.0
    
    
    $
    442.6
    
    
    $
    432.6
    
    
    $
    410.0
    
    
    $
    370.9Assumed premiums
    
    
    28.4
    
    
    
    29.6
    
    
    
    39.3
    
    
    
    39.2
    
    
    
    25.2
    
    
    
    24.0Gross premiums
    
    
    453.0
    
    
    
    461.6
    
    
    
    481.9
    
    
    
    471.8
    
    
    
    435.2
    
    
    
    394.9Ceded premiums
    
    
    (52.4
    )
    
    
    (57.5
    )
    
    
    (72.5
    )
    
    
    (99.3
    )
    
    
    (140.1
    )
    
    
    (166.4
    )Net premiums
    
    $
    400.6
    
    
    $
    404.1
    
    
    $
    409.4
    
    
    $
    372.5
    
    
    $
    295.1
    
    
    $
    228.5
 Reinsurance Risks
  Credit Risk.
   AmountSecured byNet
    
    
    
    
    
    
    Funds Held
    
    
    
    
    
    
    Letters ofRecoverable
    
    
    Net
    
    
    and Ceded
    
    
    Net
    
    
    Credit oron Paid
    
    
    Receivable
    
    
    Premiums
    
    
    Exposure to
    
    
    TrustReinsurer
    
    A.M. Best Rating
    
    Losses
    
    
    on Reserves
    
    
    Payable
    
    
    Reinsurer
    
    
    Accounts($ in millions)AXA Corporate Solutions
    
    A- (Excellent)
    
    $
    0.4
    
    
    $
    4.0
    
    
    $
    2.6
    
    
    $
    1.8
    
    
    $
    1.7Dorinco Reinsurance
    
    A- (Excellent)
    
    
    1.8
    
    
    
    19.0
    
    
    
    11.4
    
    
    
    9.4
    
    
    
    0.7National Union Fire
Insurance
    
    A+ (Superior)
    
    
    1.3
    
    
    
    8.3
    
    
    
    4.7
    
    
    
    4.9
    
    
    
    
 14




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##### Table of Contents



AmountSecured byNet
    
    
    
    
    
    
    Funds Held
    
    
    
    
    
    
    Letters ofRecoverable
    
    
    Net
    
    
    and Ceded
    
    
    Net
    
    
    Credit oron Paid
    
    
    Receivable
    
    
    Premiums
    
    
    Exposure to
    
    
    TrustReinsurer
    
    A.M. Best Rating
    
    Losses
    
    
    on Reserves
    
    
    Payable
    
    
    Reinsurer
    
    
    Accounts($ in millions)Overseas Partners
    
    NR-5 (Not Rated)
    
    
    0.3
    
    
    
    0.4
    
    
    
    
    
    
    
    0.7
    
    
    
    0.6SCOR Reinsurance Co.
    
    B++ (Very Good)
    
    
    0.4
    
    
    
    1.0
    
    
    
    
    
    
    
    1.4
    
    
    
    1.4Swiss Re America
    
    A+ (Superior)
    
    
    1.0
    
    
    
    8.2
    
    
    
    4.6
    
    
    
    4.6
    
    
    
    Other Reinsurers
    
    
    
    
    1.7
    
    
    
    1.1
    
    
    
    0.4
    
    
    
    2.4
    
    
    
    1.4Total
    
    
    
    $
    6.9
    
    
    $
    42.0
    
    
    $
    23.7
    
    
    $
    25.2
    
    
    $
    5.8
 Market Risk.
  2006 Reinsurance Program
 Quota Share.
 Excess Cessions.
 Catastrophe Reinsurance.
 15




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




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##### Table of Contents



Ratings
    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;
 17




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##### Table of Contents




    
    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;
    
    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.
 
    
    evaluation by the federal Antitrust Modernization Commission and the General
Accountability Office of the costs, benefits and possible reformation of various
federal antitrust exemptions and immunities, including the McCarran-Ferguson antitrust
exemption which 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;
    
    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;
    
    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 legislation. On the
federal level, a U.S. House of Representatives
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##### Table of Contents



subcommittee has held hearings to determine whether credit scoring is a fair and cost
effective tool for assessing risk and the Federal Trade Commission and Federal Reserve
Board have recently begun a study pursuant to the Fair and Accurate Credit Transactions
Act of 2003 related to the effects of credit scores and credit-based insurance scores on
the availability and affordability of financial products including property and casualty
insurance;
    
    the release in 2004 of a discussion draft of federal insurance regulatory
reform legislation entitled the State Modernization and Regulatory Transparency Act
(SMART Act) that would address areas of concern such as market conduct, product
availability, speed to market of new products, and insurance company and producer
licensing;
    
    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 examination by committee hearings of the U.S. House of Representatives into
insurance-broker conduct and related state legislation and/or regulations being
proposed or enacted concerning producer compensation that stemmed from the bid-rigging
and agent/broker compensation investigation by New York Attorney General, Eliot
Spitzer;
    
    the proposal by NAIC to use a best practices process to develop a market
conduct model that would apply consistent standards among multiple state insurance
departments;
    
    the NAICs ongoing consideration of the possible use of a risk based capital
(RBC) trend test in the property and casualty formula, monitoring of the American
Academy of Actuaries review of underwriting factors, and consideration of changes to
the RBC formula experience adjustment factors (see Regulatory Environment  Risk Based
Capital);
    
    the NAICs possible consideration of a model act to prohibit or restrict the
use of mandatory arbitration clauses in insurance contracts;
    
    various state legislative initiatives that purport to benefit or provide
protection to automobile insurance consumers, such as the enactment of Florida
legislation in 2004 concerning claims settlement practices related to motor vehicle
insurance;
    
    the enactment by the State of Florida of the Florida Motor Vehicle Insurance
Affordability Reform Act of 2003 (the Florida Act) which entailed various changes to
the States Motor Vehicle No-Fault Law that related to Personal Injury Protection
(PIP) coverage in Florida. According to the Study of PIP Insurance Changes issued by
the Florida Department of Financial Services in January 2005, the provisions of the
Florida Act were enacted in order to prevent PIP insurance fraud and abuse and to curb
escalating medical, legal, and other related costs and thereby restore the health of
the PIP insurance market in Florida; preserve the no-fault system; and realize cost
savings for consumers. The States Motor Vehicle No-Fault Law is set to expire in 2007
unless it is re-enacted in 2006.
    
    federal and individual state statutes and developing 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 requiring companies to notify customers of data security
breaches that pose a significant risk of identity theft;
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
    
    legislation in Texas that requires, among other things, the Department of
Insurance to (i) approve premium rates and policy forms filed by county mutual
insurance companies and (ii) conduct periodic examinations of the books and records of
such insurance companies. This legislation will make county mutual insurance companies
more closely resemble other property and casualty insurers conducting business in
Texas; and
    
    various proposed legislation in Tennessee, including initiatives to prohibit
insurance companies from using zip codes for setting rates and to make it a class C
misdemeanor for insurers to take sworn statements of an unrepresented policyholder
during investigations of disputed claims.
 Restrictions on Cancellation, Non-Renewal or Withdrawal.
 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 non-payment 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.
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Permissible InterestState
    
    RateArkansas
    
    Variable(1)(2)Florida
    
    
    12.0
    %(3)Georgia
    
    
    12.0
    %(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.(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 Regulations.
 Regulation of Our Ancillary Product Vendors.
 Licensing of Our Employee Agents and Adjustors.
 Trade Practices.
 
    
    disseminating false information or advertising;
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
    
    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;
    
    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
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
    
    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.
 Risk Based Capital.
 IRIS Ratios.
  24




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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;
    
    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.
 Direct Cash Advance
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Electronic Fund Transfers (EFT) Regulation
 Electronic Records and Signatures
 Employees
  Available Information
 www.directgeneral.com
 
 Item 1A. Risk Factors.
 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.
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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.
   Our business is highly competitive, which may make it difficult for us to market our core
products effectively and profitably.
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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.
    Our principal shareholder has the ability to control our operations, including the election of
our directors.
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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.
     Required Licensing.
 Transactions Between Insurance Companies and Their Affiliates.
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Regulation of Premium Rates and Approval of Policy Forms.
 Investment Restrictions.
 Restrictions on Cancellation, Non-Renewal or Withdrawal.
 Other Regulations
 
    
    the use of non-public consumer information and related privacy issues;
    
    investment restrictions;
    
    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.
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The outcome of recent litigation and insurance regulatory investigations 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.
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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 credit score and zip code as a factor
in making risk selections and pricing decisions;
    
    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 and the alleged diminution in value to insureds vehicles
involved in accidents;
    
    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.
  32




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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.
  
    
    one alleges we improperly cancelled insurance policies; and
    
    one alleges we charged and collected unlawful service and finance charges with
respect to the financing of purported automobile club memberships in violation of
Florida law.
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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.
  34




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##### Table of Contents



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.
   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.
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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.
   36




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##### Table of Contents



The frequent characterization of payday consumer lending by public perception, certain
consumer advocacy groups and some media reports as being predatory or abusive to the consumer could
negatively affect our stock price, as well as our overall results of operations.
 Direct Cash
Advance
 
 Item 1B. Unresolved Staff Comments.
  
 Item 2. Properties.
  
 Item 3. Legal Proceedings.
     37




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38




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##### Table of Contents



Item 4. Submission of Matters to a Vote of Security Holders.
  39




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PART II
 
 Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of
Equity Securities.
 Market Information
  High
    
    Low
    
    Dividend2006First quarter (through March 13, 2006)
    
    $
    17.62
    
    
    $
    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
    
    
    $
    0.042003Fourth quarter
    
    $
    33.78
    
    
    $
    25.00
    
    
    $
    0.04Third quarter (from August 12, 2003)
    
    $
    26.69
    
    
    $
    23.01
    
    
    None
 Repurchases of Common Stock
  Issuer Purchases of Equity Securities
 Total number ofshares
    
    Approximate dollarTotal
    
    Average
    
    purchased as
    
    value of shares thatnumber of
    
    price
    
    part of publicly
    
    may yet beshares
    
    paid per
    
    announced
    
    purchasedPeriod
    
    purchased
    
    share
    
    program
    
    under the programOctober 1 to October 31
    
    
    1,940
    
    
    $
    19.87
    
    
    
    1,940
    
    
    $
    10,000,000November 1 to November 30
    
    
    0
    
    
    $
    0
    
    
    
    0
    
    
    $
    10,000,000December 1 to December 31
    
    
    0
    
    
    $
    0
    
    
    
    0
    
    
    $
    10,000,000Total
    
    
    1,940
    
    
    $
    19.87
    
    
    
    1,940
    
    
    $
    10,000,000
 40




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##### Table of Contents



Holders
  Dividends
   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
    
    
    917,200
    
    
    $
    20.96
    
    
    
    734,0001996 Employee Stock Incentive Plan
    
    
    53,500
    
    
    $
    2.71
    
    
    
    0Equity compensation plans not
approved by security holders:NoneTotal
    
    
    970,700
    
    
    $
    20.05
    
    
    
    734,000
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Item 6. Selected Financial Data.
  Year Ended December 31,2005
    
    
    2004
    
    
    2003
    
    
    2002
    
    
    2001($ in millions, except per share data)Statement of Operations Data:Premiums earned
    
    $
    404.1
    
    
    $
    372.5
    
    
    $
    228.5
    
    
    $
    145.0
    
    
    $
    98.0Finance income
    
    
    44.4
    
    
    
    49.2
    
    
    
    44.9
    
    
    
    35.7
    
    
    
    27.3Commission and service fee income
    
    
    46.8
    
    
    
    48.6
    
    
    
    33.6
    
    
    
    27.2
    
    
    
    22.1Net investment income
    
    
    14.7
    
    
    
    10.8
    
    
    
    6.7
    
    
    
    5.3
    
    
    
    5.1Net realized gains (losses) on securities and other
    
    
    0.1
    
    
    
    0.0
    
    
    
    3.4
    
    
    
    (0.1
    )
    
    
    2.2Total revenues
    
    
    510.1
    
    
    
    481.1
    
    
    
    317.1
    
    
    
    213.1
    
    
    
    154.7Insurance losses and loss adjustment
expenses
    
    
    305.8
    
    
    
    282.0
    
    
    
    168.2
    
    
    
    100.7
    
    
    
    93.9Selling, general and administrative costs
    
    
    133.6
    
    
    
    108.5
    
    
    
    74.5
    
    
    
    59.7
    
    
    
    53.9Interest expense
    
    
    8.3
    
    
    
    5.5
    
    
    
    6.4
    
    
    
    6.2
    
    
    
    7.6Total expenses
    
    
    447.7
    
    
    
    396.0
    
    
    
    249.1
    
    
    
    166.6
    
    
    
    155.4Income (loss) before income taxes
    
    
    62.4
    
    
    
    85.1
    
    
    
    68.0
    
    
    
    46.5
    
    
    
    (0.7
    )Income tax expense (benefit)
    
    
    23.4
    
    
    
    31.1
    
    
    
    24.9
    
    
    
    15.5
    
    
    
    (1.1
    )Net income
    
    $
    39.0
    
    
    $
    54.0
    
    
    $
    43.1
    
    
    $
    31.0
    
    
    $
    0.4Net income (loss) available to common
shareholders
    
    $
    39.0
    
    
    $
    54.0
    
    
    $
    42.7
    
    
    $
    30.5
    
    
    $
    (0.1
    )Operating Data:Gross premiums written (1)
    
    $
    453.0
    
    
    $
    481.9
    
    
    $
    435.2
    
    
    $
    335.2
    
    
    $
    238.7Net premiums written (2)
    
    
    400.6
    
    
    
    409.4
    
    
    
    295.1
    
    
    
    181.0
    
    
    
    112.9Gross revenues (3)
    
    
    558.9
    
    
    
    590.5
    
    
    
    520.4
    
    
    
    403.4
    
    
    
    293.2Net income adjusted for write-off of reinsurance
recoverables from Reliance Insurance Company
(4)
    
    
    39.0
    
    
    
    54.0
    
    
    
    43.1
    
    
    
    31.0
    
    
    
    7.8Balance Sheet Data:Cash, cash equivalents and total
investments
    
    $
    456.2
    
    
    $
    407.5
    
    
    $
    353.6
    
    
    $
    213.3
    
    
    $
    145.2Total assets
    
    
    841.0
    
    
    
    787.5
    
    
    
    751.2
    
    
    
    569.1
    
    
    
    433.0Total liabilities and redeemable preferred
stock
    
    
    603.5
    
    
    
    542.4
    
    
    
    573.8
    
    
    
    509.9
    
    
    
    402.0Total shareholders equity
    
    
    237.5
    
    
    
    245.1
    
    
    
    177.4
    
    
    
    59.2
    
    
    
    31.0Per Share Data(5):Earnings per common share:Basic
    
    $
    1.83
    
    
    $
    2.44
    
    
    $
    2.74
    
    
    $
    2.30
    
    
    $
    (0.01
    )Diluted (6)
    
    
    1.82
    
    
    
    2.38
    
    
    
    2.20
    
    
    
    1.68
    
    
    
    (0.01
    )Book value per common share
    
    
    11.68
    
    
    
    10.96
    
    
    
    8.31
    
    
    
    4.12
    
    
    
    1.62Weighted average shares outstanding:Basic
    
    
    21,363,772
    
    
    
    22,114,917
    
    
    
    15,609,411
    
    
    
    13,264,452
    
    
    
    13,366,404Diluted (6)
    
    
    21,423,841
    
    
    
    22,687,198
    
    
    
    19,679,610
    
    
    
    18,733,056
    
    
    
    18,918,096Common shares outstanding
    
    
    20,339,175
    
    
    
    22,360,046
    
    
    
    21,350,640
    
    
    
    12,119,148
    
    
    
    13,447,512
 
 (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 42




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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 revenues to total revenues, which is the most directly comparable GAAP
financial measure included in our financial statements.(4)
    
    Net income for the year ended December 31, 2001 reflects a $7.4 million after-tax
loss attributable to a write-off of reinsurance recoverables from Reliance Insurance Company.
We consider net income adjusted for write-off of reinsurance recoverables from Reliance
Insurance Company to be a non-GAAP financial measure. Because we have not had any other
material write-offs of reinsurance recoverables in our history, we believe that the $7.8
million adjusted net income ($0.4 million reported net income plus the $7.4 million after-tax
impact of the write-off) is useful to management and investors in understanding our
improvement in operating results since 2001.(5)
    
    Adjusted to reflect a 12 for 1 stock split that became effective prior to the
closing of our initial public offering in August 2003.(6)
    
    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. 
 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.
 Overview
 Companys Operating Strategy
   43




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##### 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
 44




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##### Table of Contents




    
    interest expense primarily related to our premium finance revolving
credit facility and debentures payable
 Highlights for 2005
 
    
    We generated net income of $39.0 million and a return on average equity of 16%.
    
    We repurchased 2.2 million shares of our common stock for an aggregate
price of $40.1 million.
    
    Our overall capitalization was enhanced with the issuance of $40 million of
junior subordinated debentures providing us with a long-term source of funds for
various corporate purposes.
    
    We completed the acquisition of three independent agency operations in
Texas adding 82 sales offices in that State.
    
    We entered Virginia, our twelfth state, where we developed 9 sales offices over
the course of the year. We also developed an additional 18 sales offices in Texas and
20 sales offices in Missouri.
    
    Our acquisition of a shell property and casualty insurance company,
subsequently renamed Direct National Insurance Company, provided us with property
casualty licenses in 39 jurisdictions including the majority of our future expansion
states.
    
    We introduced a new distribution channel, telephone sales, in our home state of
Tennessee.
    
    We refined our marketing strategy in all of our markets to incorporate media
buys specifically targeted to our customers based on an analysis of approximately 70
designated marketing areas.
 2006 Outlook
 Direct Cash Advance
 Expansion States Growth
   45




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##### Table of Contents



Alternative Distribution Channels.
  Reduction in Quota Share Reinsurance.
 Profitability and Return
 Assumptions.
 
    
    increase in the renewal of insurance policies and sales of new policies;
    
    increase in sales of ancillary products;
    
    increase in sales of term life insurance policies;
    
    the timely and successful development and opening of additional neighborhood
sales offices in Texas, Missouri and Virginia;
    
    increase in sales of insurance policies in Texas through the independent
agencies that we acquired in 2005 and our developed neighborhood sales offices;
    
    the successful transitions from offering monthly policies in Texas to offering
six and/or twelve month policies that are supported by our premium finance subsidiary;
    
    favorable trends in inflation and other matters that could affect operating
expenses;
    
    our ability to effectively compete against other insurance companies and
independent agencies selling similar products in our markets;
    
    our ability to obtain timely approval of requested rate changes;
    
    the absence of unfavorable judicial and regulatory developments relative to the
automobile insurance industry;
    
    the absence of severe weather conditions and other catastrophes; and
    
    the absence of our losses and loss adjustment expenses exceeding our reserves
which would require us to increase our reserves which would lower our earnings.
 46




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##### Table of Contents



Measurement of Results
  Gross Premiums Written.
 Net Premiums Written.
 Gross Revenues (a non-GAAP financial measure).
 Loss Ratio.
 Expense Ratio.
 Combined Ratio.
 47




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##### Table of Contents



Ancillary Income Measures.
 Critical Accounting Policies
  Insurance Losses and Loss Adjustment Expense Reserves.
  Investments.
  48




---



##### Table of Contents



Effect of Future Cancellations.
 Allowance for Finance Receivable Losses.
  Results of Operations
  Year Ended December 31,2005
    
    
    2004
    
    
    2003($ in millions)Selected Financial DataGross premiums written
    
    $
    453.0
    
    
    $
    481.9
    
    
    $
    435.2Ancillary income
    
    
    91.2
    
    
    
    97.8
    
    
    
    78.5Net investment income
    
    
    14.7
    
    
    
    10.8
    
    
    
    6.7Gross revenues (1)
    
    $
    558.9
    
    
    $
    590.5
    
    
    $
    520.4Ceded premiums written
    
    
    (52.4
    )
    
    
    (72.5
    )
    
    
    (140.1
    )Change in net unearned premiums
    
    
    3.5
    
    
    
    (36.9
    )
    
    
    (66.6
    )Net realized (losses) gains on securities and other
    
    
    0.1
    
    
    
    
    
    
    
    3.4Total revenues
    
    $
    510.1
    
    
    $
    481.1
    
    
    $
    317.1Key Financial RatiosLoss ratio  net
    
    
    75.7
    %
    
    
    75.7
    %
    
    
    73.6
    %Expense ratio  net
    
    
    12.5
    
    
    
    4.3
    
    
    
    1.1Combined ratio  net
    
    
    88.2
    
    
    
    80.0
    
    
    
    74.7Ancillary income to gross premiums earned
    
    
    19.8
    
    
    
    20.7
    
    
    
    19.9Ancillary income to net operating expenses
    
    
    64.3
    
    
    
    85.8
    
    
    
    97.0
 
 (1)
    
    A non-GAAP financial measure. 49




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##### Table of Contents



Overview of Operating Results
 Year Ended December 31, 2005 Compared to Year Ended December 31, 2004.
 Year Ended December 31, 2004 Compared to Year Ended December 31, 2003.
 Revenues
 Premiums
    50




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##### Table of Contents



Year Ended December 31,2005
    
    
    2004
    
    
    2003($ in millions)Gross premiums written
Florida
    
    $
    223.6
    
    
    $
    243.3
    
    
    $
    223.5Tennessee
    
    
    58.7
    
    
    
    64.5
    
    
    
    63.0Texas
    
    
    39.1
    
    
    
    29.6
    
    
    
    15.6Georgia
    
    
    29.1
    
    
    
    33.7
    
    
    
    32.2Louisiana
    
    
    26.5
    
    
    
    32.8
    
    
    
    31.3Mississippi
    
    
    25.4
    
    
    
    25.3
    
    
    
    22.3All other states
    
    
    50.6
    
    
    
    52.7
    
    
    
    47.3Gross premiums written
    
    $
    453.0
    
    
    $
    481.9
    
    
    $
    435.2Ceded premiums written
    
    
    (52.4
    )
    
    
    (72.5
    )
    
    
    (140.1
    )Net premiums written
    
    $
    400.6
    
    
    $
    409.4
    
    
    $
    295.1Gross premiums earned
    
    $
    461.6
    
    
    $
    471.8
    
    
    $
    394.9Ceded premiums earned
    
    
    (57.5
    )
    
    
    (99.3
    )
    
    
    (166.4
    )Net premiums earned
    
    $
    404.1
    
    
    $
    372.5
    
    
    $
    228.5Net premiums written to gross premiums written
    
    
    88.4
    %
    
    
    85.0
    %
    
    
    67.8
    %Gross premiums earned to gross premiums written
    
    
    101.9
    
    
    
    97.9
    
    
    
    90.7Net premiums earned to net premiums written
    
    
    100.9
    
    
    
    91.0
    
    
    
    77.4
 Gross Premiums
 Year Ended December 31, 2005 Compared to Year Ended December 31, 2004.
   Year Ended December 31, 2004 Compared to Year Ended December 31, 2003.
 51




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Net Premiums
 Year Ended December 31, 2005 Compared to Year Ended December 31, 2004.
 Year Ended December 31, 2004 Compared to Year Ended December 31, 2003.
 Ancillary Income
  Year Ended December 31,2005
    
    
    2004
    
    
    2003($ in millions)Finance income
    
    $
    44.4
    
    
    $
    49.2
    
    
    $
    44.9Commission and service fee income
    
    
    46.8
    
    
    
    48.6
    
    
    
    33.6Total ancillary income
    
    $
    91.2
    
    
    $
    97.8
    
    
    $
    78.5
 52




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##### Table of Contents



Year Ended December 31, 2005 Compared to Year Ended December 31, 2004.
   Year Ended December 31, 2004 Compared to Year Ended December 31, 2003.
 Net Investment Income
  Year Ended December 31, 2005 Compared to Year Ended December 31, 2004.
 Year Ended December 31, 2004 Compared to Year Ended December 31, 2003.
 53




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Realized Gains (Losses) on Securities and Other
  Year Ended December 31, 2005 Compared to Year Ended December 31, 2004.
  Year Ended December 31, 2004 Compared to Year Ended December 31, 2003.
  Expenses
 Insurance Losses and Loss Adjustment Expenses
  54




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##### Table of Contents



Year Ended December 31, 2005 Compared to Year Ended December 31, 2004.
 Reserve Development.
  Year Ended December 31, 2004 Compared to Year Ended December 31, 2003.
 55




---



##### Table of Contents



Reserve Development.
   Operating Expenses
  Year Ended December 31, 2005 Compared to Year Ended December 31, 2004.
  56




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##### Table of Contents



Year Ended December 31, 2004 Compared to Year Ended December 31, 2003.
 Income Taxes
   Year Ended December 31,2005
    
    
    2004
    
    
    2003($ in millions)Income before income taxes
    
    $
    62.4
    
    
    $
    85.1
    
    
    $
    68.0Provision for taxes at the statutory rate
    
    $
    21.8
    
    
    $
    29.8
    
    
    $
    23.8Increase (reduction) in taxes for:Tax-exempt interest income
    
    
    (0.5
    )
    
    
    (0.5
    )
    
    
    (0.6
    )State income taxes
    
    
    2.0
    
    
    
    2.6
    
    
    
    2.0Other, net
    
    
    0.1
    
    
    
    (0.8
    )
    
    
    (0.3
    )Income tax expense
    
    $
    23.4
    
    
    $
    31.1
    
    
    $
    24.9
 Financial Condition
 Liquidity and Capital Reserves
 Sources and Uses of Funds
  57




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##### Table of Contents



Financing and Capital
 Capital Raising  Initial Public Offering.
 Capital Raising  Secondary Offering.
 Common Stock Repurchase.
 Capital Raising  Trust Preferred Securities.
 58




---



##### Table of Contents



Premium Finance Revolving Credit Facility.
      59




---



##### 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
    
    $
    150.0
    
    
    $
    
    
    
    $
    150.0
    
    
    $
    
    
    
    $
    Other notes payable
    
    
    3.0
    
    
    
    1.7
    
    
    
    1.3
    
    
    
    
    
    
    
    Debentures payable
    
    
    41.2
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    41.2Loss and loss adjustment expense reserves
    
    
    113.9
    
    
    
    99.9
    
    
    
    12.3
    
    
    
    1.1
    
    
    
    0.6Capital leases obligations
    
    
    2.8
    
    
    
    1.5
    
    
    
    1.1
    
    
    
    0.2
    
    
    
    Operating leases obligations
    
    
    18.6
    
    
    
    7.7
    
    
    
    9.4
    
    
    
    1.5
    
    
    
    Total
    
    $
    329.5
    
    
    $
    110.8
    
    
    $
    174.1
    
    
    $
    2.8
    
    
    $
    41.8
  Reinsurance
   60




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##### Table of Contents



Investments
  % of Totalat FairAmortized Cost
    
    
    Fair Value
    
    
    Value($ in millions)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
    %December 31, 2004Debt securities, available for sale
    
    $
    334.8
    
    
    $
    334.8
    
    
    
    82.2
    %Cash and cash equivalents
    
    
    71.0
    
    
    
    71.0
    
    
    
    17.4
    %Short-term and other investments
    
    
    1.7
    
    
    
    1.7
    
    
    
    0.4
    %Total
    
    $
    407.5
    
    
    $
    407.5
    
    
    
    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.
   61




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##### Table of Contents



Debt Securities.
    Gross
    
    
    GrossAmortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    FairCost
    
    
    Gains
    
    
    Losses
    
    
    Value($ in millions)December 31, 2005U.S. Treasury securities and obligations of U.S.
government corporations and agencies
    
    $
    67.8
    
    
    $
    0.1
    
    
    $
    1.4
    
    
    $
    66.5Obligations of states and political subdivisions
    
    
    70.2
    
    
    
    0.4
    
    
    
    0.6
    
    
    
    70.0Corporate debt securitiesBanks and financial institutions
    
    
    96.1
    
    
    
    0.1
    
    
    
    2.3
    
    
    
    93.9Credit cards and auto loans
    
    
    81.3
    
    
    
    
    
    
    
    1.5
    
    
    
    79.8Industrial
    
    
    37.2
    
    
    
    
    
    
    
    0.9
    
    
    
    36.3Insurance
    
    
    9.2
    
    
    
    
    
    
    
    0.3
    
    
    
    8.9Telecommunications
    
    
    16.0
    
    
    
    0.1
    
    
    
    0.5
    
    
    
    15.6Utilities
    
    
    17.4
    
    
    
    
    
    
    
    0.4
    
    
    
    17.0Total corporate debt securities
    
    
    257.2
    
    
    
    0.2
    
    
    
    5.9
    
    
    
    251.5Total
    
    $
    395.2
    
    
    $
    0.7
    
    
    $
    7.9
    
    
    $
    388.0
 62




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##### Table of Contents



Gross
    
    
    GrossAmortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    FairCost
    
    
    Gains
    
    
    Losses
    
    
    ValueDecember 31, 2004U.S. Treasury securities and obligations of U.S.
government corporations and agencies
    
    $
    52.3
    
    
    $
    0.3
    
    
    $
    0.7
    
    
    $
    51.9Obligations of states and political subdivisions
    
    
    62.5
    
    
    
    1.3
    
    
    
    0.1
    
    
    
    63.7Corporate debt securitiesBanks and financial institutions
    
    
    74.4
    
    
    
    0.4
    
    
    
    0.7
    
    
    
    74.1Credit cards and auto loans
    
    
    73.4
    
    
    
    0.1
    
    
    
    0.9
    
    
    
    72.6Industrial
    
    
    34.7
    
    
    
    0.4
    
    
    
    0.3
    
    
    
    34.8Insurance
    
    
    8.4
    
    
    
    
    
    
    
    0.1
    
    
    
    8.3Telecommunications
    
    
    15.5
    
    
    
    0.3
    
    
    
    0.1
    
    
    
    15.7Utilities
    
    
    13.6
    
    
    
    0.2
    
    
    
    0.1
    
    
    
    13.7Total corporate debt securities
    
    
    220.0
    
    
    
    1.4
    
    
    
    2.2
    
    
    
    219.2Total
    
    $
    334.8
    
    
    $
    3.0
    
    
    $
    3.0
    
    
    $
    334.8
  Amortized Cost
    
    
    Fair Value($ in millions)Years to maturity:One or less
    
    $
    14.1
    
    
    $
    14.0After one through five
    
    
    175.6
    
    
    
    172.4After five through ten
    
    
    125.3
    
    
    
    123.0After ten
    
    
    80.2
    
    
    
    78.6Total
    
    $
    395.2
    
    
    $
    388.0
   Amortized
    
    
    
    
    
    
    % of TotalS&P Rating
    
    NAIC Rating
    
    
    Cost
    
    
    Fair Value
    
    
    at Fair Value($ in millions)AAA
    
    
    1
    
    
    $
    153.3
    
    
    $
    150.7
    
    
    
    38.9
    %AA
    
    
    1
    
    
    
    32.6
    
    
    
    32.3
    
    
    
    8.3
    %A
    
    
    1
    
    
    
    105.7
    
    
    
    103.6
    
    
    
    26.7
    %BBB
    
    
    2
    
    
    
    35.6
    
    
    
    34.7
    
    
    
    8.9
    %B
    
    
    2
    
    
    
    0.8
    
    
    
    0.8
    
    
    
    0.2
    %Agency
    
    
    1
    
    
    
    67.2
    
    
    
    65.9
    
    
    
    17.0
    %$
    395.2
    
    
    $
    388.0
    
    
    
    100.0
    %
  63




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Cash and Cash Equivalents.
 Short-Term Investments.
 64




---



##### Table of Contents



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.
  65




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##### Table of Contents



Item 8. Financial Statements and Supplementary Data.
 MANAGEMENTS REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
    
 66




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##### Table of Contents



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
ON INTERNAL CONTROL OVER FINANCIAL REPORTING
 
 Internal ControlIntegrated Framework
      Ernst & Young
 
 67




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##### Table of Contents



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
    Internal ControlIntegrated Framework
 Ernst & Young
 
 68




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##### Table of Contents



DIRECT GENERAL CORPORATION AND SUBSIDIARIES
 CONSOLIDATED STATEMENTS OF OPERATIONS
 For the Years Ended December 31,2005
    
    
    2004
    
    
    2003(In thousands, except per share amounts)RevenuesPremiums earned
    
    $
    404,099
    
    
    $
    372,506
    
    
    $
    228,529Finance income
    
    
    44,401
    
    
    
    49,190
    
    
    
    44,886Commission and service fee income
    
    
    46,777
    
    
    
    48,630
    
    
    
    33,579Net investment income
    
    
    14,704
    
    
    
    10,808
    
    
    
    6,730Net realized gains (losses) on securities and other
    
    
    71
    
    
    
    (43
    )
    
    
    3,393Total revenues
    
    
    510,052
    
    
    
    481,091
    
    
    
    317,117ExpensesInsurance losses and loss adjustment expenses
    
    
    305,755
    
    
    
    281,969
    
    
    
    168,196Selling, general and administrative costs
    
    
    133,588
    
    
    
    108,532
    
    
    
    74,493Interest expense
    
    
    8,300
    
    
    
    5,484
    
    
    
    6,376Total expenses
    
    
    447,643
    
    
    
    395,985
    
    
    
    249,065Income before income taxes
    
    
    62,409
    
    
    
    85,106
    
    
    
    68,052Income tax expense
    
    
    23,398
    
    
    
    31,121
    
    
    
    24,960Net income
    
    
    39,011
    
    
    
    53,985
    
    
    
    43,092Preferred stock dividends  Series B
    
    
    
    
    
    
    
    
    
    
    345Net income available to common shareholders
    
    $
    39,011
    
    
    $
    53,985
    
    
    $
    42,747Earnings per ShareBasic earnings per common share
    
    $
    1.83
    
    
    $
    2.44
    
    
    $
    2.74Diluted earnings per common share
    
    $
    1.82
    
    
    $
    2.38
    
    
    $
    2.20
  69




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DIRECT GENERAL CORPORATION AND SUBSIDIARIES
 CONSOLIDATED BALANCE SHEETS
 As of December 31,2005
    
    
    2004(In thousands)AssetsInvestments:Debt securities available-for-sale at fair value (amortized cost
$395,159 and $334,770 at December 31, 2005 and 2004, respectively)
    
    $
    388,032
    
    
    $
    334,816Short-term investments and other invested assets
    
    
    3,688
    
    
    
    1,663Total investments
    
    
    391,720
    
    
    
    336,479Cash and cash equivalents
    
    
    64,527
    
    
    
    70,988Finance receivables, net
    
    
    214,796
    
    
    
    214,180Reinsurance balances receivable
    
    
    27,083
    
    
    
    35,671Prepaid reinsurance premiums
    
    
    24,440
    
    
    
    29,544Deferred policy acquisition costs
    
    
    13,804
    
    
    
    12,666Income taxes recoverable
    
    
    4,692
    
    
    
    7,177Deferred income taxes
    
    
    21,915
    
    
    
    20,040Property and equipment, net
    
    
    18,346
    
    
    
    15,823Goodwill and other intangible assets, net
    
    
    31,621
    
    
    
    22,188Other assets
    
    
    28,068
    
    
    
    22,696Total assets
    
    $
    841,012
    
    
    $
    787,452Liabilities and Shareholders EquityLoss and loss adjustment expense reserves
    
    $
    131,408
    
    
    $
    124,858Unearned premiums
    
    
    214,715
    
    
    
    223,303Reinsurance balances payable and funds held
    
    
    32,024
    
    
    
    33,996Accounts payable and accrued expenses
    
    
    12,550
    
    
    
    11,949Notes payable
    
    
    153,009
    
    
    
    135,626Debentures payable
    
    
    41,238
    
    
    
    Capital lease obligations
    
    
    2,636
    
    
    
    3,772Payable for securities
    
    
    3,187
    
    
    
    510Other liabilities
    
    
    12,713
    
    
    
    8,357Total liabilities
    
    
    603,480
    
    
    
    542,371Shareholders equityCommon stock, no par; authorized shares  100,000.0; issued shares 
20,339.2 and 22,360.0 at December 31, 2005 and December 31, 2004,
respectively
    
    
    69,700
    
    
    
    109,163Retained earnings
    
    
    171,780
    
    
    
    136,178Accumulated other comprehensive (loss) income:Net unrealized (depreciation) appreciation on investment securities
    
    
    (4,633
    )
    
    
    30Net gain (loss) on cash flow hedge
    
    
    685
    
    
    
    (290
    )Total shareholders equity
    
    
    237,532
    
    
    
    245,081Total liabilities and shareholders equity
    
    $
    841,012
    
    
    $
    787,452
  70




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##### Table of Contents



DIRECT GENERAL CORPORATION AND SUBSIDIARIES
 CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY
 For the Years Ended December 31, 2005, 2004 and 2003AccumulatedSeries B
    
    
    
    
    
    
    
    
    
    
    Other
    
    
    
    
    
    
    TotalPreferred
    
    
    Common
    
    
    Retained
    
    
    Comprehensive
    
    
    Treasury
    
    
    ShareholdersStock
    
    
    Stock
    
    
    Earnings
    
    
    Income (Loss)
    
    
    Stock
    
    
    Equity(In thousands)Balances at January 1, 2003
    
    $
    9,219
    
    
    $
    9,037
    
    
    $
    43,842
    
    
    $
    1,645
    
    
    $
    (4,548
    )
    
    $
    59,195Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    43,092
    
    
    
    
    
    
    
    
    
    
    
    43,092Net unrealized depreciation on
securities available-for-sale, net of
deferred
taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,093
    )
    
    
    
    
    
    
    (2,093
    )Net change during the year related to
cash flow hedge
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    255
    
    
    
    
    
    
    
    255Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    41,254Dividends on preferred stock
    
    
    
    
    
    
    
    
    
    
    (345
    )
    
    
    
    
    
    
    
    
    
    
    (345
    )Dividends on common stock
    
    
    
    
    
    
    
    
    
    
    (854
    )
    
    
    
    
    
    
    
    
    
    
    (854
    )Common stock issued for conversion
of Series A and Series B preferred
stock (5,264.0 shares)
    
    
    (9,219
    )
    
    
    14,904
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,685Common stock issued for exercise of
warrant (195.1 shares)
    
    
    
    
    
    
    800
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    800Common stock issued pursuant to initial
public offering, net of $7,122.2 issue
costs (3,750.0 shares)
    
    
    
    
    
    
    71,628
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    71,628Exercise of stock options (24.0 shares)
    
    
    
    
    
    
    65
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    65Purchase of treasury stock (1.6 shares)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (33
    )
    
    
    (33
    )Retirement of treasury stock (1,330.0
shares)
    
    
    
    
    
    
    (4,581
    )
    
    
    
    
    
    
    
    
    
    
    4,581
    
    
    
    Balances at December 31, 2003
    
    
    
    
    
    
    91,853
    
    
    
    85,735
    
    
    
    (193
    )
    
    
    
    
    
    
    177,395Comprehensive 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
    
    
    
    
    
    
    109,163
    
    
    
    136,178
    
    
    
    (260
    )
    
    
    
    
    
    
    245,081Comprehensive 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
    
    $
    
    
    
    $
    69,700
    
    
    $
    171,780
    
    
    $
    (3,948
    )
    
    $
    
    
    
    $
    237,532
  71




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##### Table of Contents



DIRECT GENERAL CORPORATION AND SUBSIDIARIES
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 For the Years Ended December 31,2005
    
    
    2004
    
    
    2003(In thousands)Operating activitiesNet income
    
    $
    39,011
    
    
    $
    53,985
    
    
    $
    43,092Adjustments to reconcile net income to net cash
provided by operating activities:Net realized (gains) losses on securities and other
    
    
    (71
    )
    
    
    43
    
    
    
    (3,393
    )Depreciation and amortization
    
    
    9,456
    
    
    
    5,809
    
    
    
    4,514Deferred income taxes
    
    
    111
    
    
    
    (1,466
    )
    
    
    (5,822
    )Changes in operating assets and liabilities:Finance receivables, net
    
    
    (616
    )
    
    
    (12,909
    )
    
    
    (34,336
    )Reinsurance balances receivable
    
    
    8,466
    
    
    
    21,801
    
    
    
    (6,598
    )Prepaid reinsurance premiums
    
    
    5,104
    
    
    
    26,853
    
    
    
    26,251Deferred policy acquisition costs
    
    
    (1,138
    )
    
    
    (1,234
    )
    
    
    (3,267
    )Income taxes recoverable/payable
    
    
    2,760
    
    
    
    (9,546
    )
    
    
    (813
    )Loss and loss adjustment expense reserves
    
    
    6,550
    
    
    
    12,240
    
    
    
    25,720Unearned premiums
    
    
    (8,588
    )
    
    
    10,053
    
    
    
    40,279Reinsurance balances payable and funds held
    
    
    (2,287
    )
    
    
    (28,227
    )
    
    
    (14,499
    )Accounts payable and accrued expenses
    
    
    599
    
    
    
    (1,204
    )
    
    
    (524
    )Other
    
    
    1,771
    
    
    
    (9,221
    )
    
    
    (3,497
    )Net cash provided by operating activities
    
    
    61,128
    
    
    
    66,977
    
    
    
    67,107Investing activitiesProceeds from sales and maturities of debt securities
available-for-sale
    
    
    81,141
    
    
    
    117,194
    
    
    
    96,675Purchase of debt securities available-for-sale
    
    
    (140,337
    )
    
    
    (185,100
    )
    
    
    (239,291
    )Payable for securities
    
    
    2,677
    
    
    
    510
    
    
    
    Net sales (purchases) of short-term investments
    
    
    426
    
    
    
    (341
    )
    
    
    1,423Purchase of common stock in trust
    
    
    (1,238
    )
    
    
    
    
    
    
    Purchase of property and equipment, net
    
    
    (8,879
    )
    
    
    (7,649
    )
    
    
    (5,380
    )Purchase of insurance agency assets
    
    
    (5,560
    )
    
    
    
    
    
    
    (13,792
    )Purchase of insurance companies
    
    
    (10,432
    )
    
    
    (7,330
    )
    
    
    Net cash used in investing activities
    
    
    (82,202
    )
    
    
    (82,716
    )
    
    
    (160,365
    )Financing activitiesRepurchase of common stock
    
    
    (40,075
    )
    
    
    
    
    
    
    Issuances of common stock
    
    
    612
    
    
    
    17,031
    
    
    
    72,493Net proceeds from (payments on) borrowings
    
    
    18,258
    
    
    
    (12,511
    )
    
    
    34,063Proceeds from debentures issued
    
    
    41,238
    
    
    
    
    
    
    
    Payment of principal on borrowings
    
    
    (2,011
    )
    
    
    (1,593
    )
    
    
    (11,751
    )Payment of dividends on common stock
    
    
    (3,409
    )
    
    
    (3,542
    )
    
    
    (1,199
    )Purchase of treasury stock
    
    
    
    
    
    
    
    
    
    
    (33
    )Net cash provided by (used in) financing activities
    
    
    14,613
    
    
    
    (615
    )
    
    
    93,573Net (decrease) increase in cash and cash equivalents
    
    
    (6,461
    )
    
    
    (16,354
    )
    
    
    315Cash and cash equivalents at beginning of period
    
    
    70,988
    
    
    
    87,342
    
    
    
    87,027Cash and cash equivalents at end of period
    
    $
    64,527
    
    
    $
    70,988
    
    
    $
    87,342Supplemental disclosures of cash flow informationCash paid during the year for:Interest
    
    $
    8,451
    
    
    $
    5,484
    
    
    $
    5,565Income taxes
    
    
    20,527
    
    
    
    42,507
    
    
    
    30,756
  72




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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
  73




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##### Table of Contents



Commission Income
  Service Fees
  Investments
     74




---



##### Table of Contents



Deferred Policy Acquisition Costs
  Property and Equipment
  Goodwill and Other Intangible Assets
  Cash Flow Hedge
  Income Taxes
   75




---



##### Table of Contents



Stock Split
  Stock Options
  Segment Reporting
    Reclassifications
  76




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##### Table of Contents



2. Investments
  Gross
    
    
    GrossAmortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    FairCost
    
    
    Gains
    
    
    Losses
    
    
    Value(In thousands)2005U.S. Treasury securities and obligations of
U.S. government corporations and agencies
    
    $
    67,748
    
    
    $
    51
    
    
    $
    1,349
    
    
    $
    66,450Obligations of states and political subdivisions
    
    
    70,161
    
    
    
    435
    
    
    
    643
    
    
    
    69,953Corporate debt securities
    
    
    257,250
    
    
    
    233
    
    
    
    5,854
    
    
    
    251,629Total
    
    $
    395,159
    
    
    $
    719
    
    
    $
    7,846
    
    
    $
    388,0322004U.S. Treasury securities and obligations of
U.S. government corporations and agencies
    
    $
    52,289
    
    
    $
    289
    
    
    $
    660
    
    
    $
    51,918Obligations of states and political subdivisions
    
    
    62,528
    
    
    
    1,305
    
    
    
    84
    
    
    
    63,749Corporate debt securities
    
    
    219,953
    
    
    
    1,452
    
    
    
    2,256
    
    
    
    219,149Total
    
    $
    334,770
    
    
    $
    3,046
    
    
    $
    3,000
    
    
    $
    334,816
  Less than 12 months
    
    
    12 months or longerTotalUnrealized
    
    
    
    
    
    
    Unrealized
    
    
    UnrealizedFair Value
    
    
    Losses
    
    
    Fair Value
    
    
    Losses
    
    
    Losses(In thousands)2005U.S. Treasury securities and obligations of
U.S. government corporations and agencies
    
    $
    48,113
    
    
    $
    618
    
    
    $
    18,337
    
    
    $
    731
    
    
    $
    1,349Obligations of states and political subdivisions
    
    
    63,394
    
    
    
    444
    
    
    
    6,559
    
    
    
    199
    
    
    
    643Corporate debt securities
    
    
    142,758
    
    
    
    2,282
    
    
    
    108,871
    
    
    
    3,572
    
    
    
    5,854Total
    
    $
    254,265
    
    
    $
    3,344
    
    
    $
    133,767
    
    
    $
    4,502
    
    
    $
    7,846
   2005
    
    
    2004
    
    
    2003(In thousands)Gross investment income:Debt securities available-for-sale
    
    $
    14,147
    
    
    $
    10,963
    
    
    $
    6,636Short-term investments and cash equivalents
    
    
    1,200
    
    
    
    390
    
    
    
    413Gross investment income
    
    
    15,347
    
    
    
    11,353
    
    
    
    7,049Investment expenses
    
    
    643
    
    
    
    545
    
    
    
    319Net investment income
    
    $
    14,704
    
    
    $
    10,808
    
    
    $
    6,730Gross realized gains on investments
    
    $
    2,843
    
    
    $
    2,838
    
    
    $
    4,341Gross realized losses on investments
    
    
    (3,049
    )
    
    
    (3,162
    )
    
    
    (559
    )Net unrealized gain (loss) on trading portfolio
    
    
    277
    
    
    
    281
    
    
    
    (389
    )Net realized (losses) gains on securities and other
    
    $
    71
    
    
    $
    (43
    )
    
    $
    3,393
 77




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##### Table of Contents



Amortized
    
    
    FairCost
    
    
    Value(In thousands)Years to maturity:One or less
    
    $
    14,071
    
    
    $
    13,982After one through five
    
    
    175,612
    
    
    
    172,420After five through ten
    
    
    125,278
    
    
    
    123,021After ten
    
    
    80,198
    
    
    
    78,609Total
    
    $
    395,159
    
    
    $
    388,032
  3. Finance Receivables
  2005
    
    
    2004(In thousands)Finance receivables
    
    $
    221,215
    
    
    $
    220,354Less allowance for losses
    
    
    (6,419
    )
    
    
    (6,174
    )Finance receivables, net
    
    $
    214,796
    
    
    $
    214,180
  2005
    
    
    2004
    
    
    2003(In thousands)Balance at January 1
    
    $
    6,174
    
    
    $
    5,942
    
    
    $
    5,010Provision for finance receivable losses
    
    
    10,266
    
    
    
    7,270
    
    
    
    6,962Charge-offs, net of recoveries
    
    
    (10,021
    )
    
    
    (7,038
    )
    
    
    (6,030
    )Balance at December 31
    
    $
    6,419
    
    
    $
    6,174
    
    
    $
    5,942
  2005
    
    2004Florida
    
    
    49.1
    %
    
    
    51.0
    %Tennessee
    
    
    14.0
    
    
    
    14.8Georgia
    
    
    7.0
    
    
    
    7.5Louisiana
    
    
    5.9
    
    
    
    7.5Texas
    
    
    4.3
    
    
    
    Other states, combined
    
    
    19.7
    
    
    
    19.2Total
    
    
    100.0
    %
    
    
    100.0
    %
  78




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##### Table of Contents



4. Property and Equipment
  2005
    
    
    2004(In thousands)Land
    
    $
    223
    
    
    $
    223Buildings and improvements
    
    
    8,867
    
    
    
    6,820Computer hardware and software
    
    
    22,296
    
    
    
    18,815Furniture and equipment
    
    
    8,403
    
    
    
    7,579Projects in progress
    
    
    767
    
    
    
    637Construction in progress
    
    
    2,126
    
    
    
    Capital leases:Building
    
    
    6,364
    
    
    
    6,364Equipment
    
    
    4,495
    
    
    
    4,33853,541
    
    
    
    44,776Less accumulated depreciation
    
    
    (35,195
    )
    
    
    (28,953
    )Property and equipment, net
    
    $
    18,346
    
    
    $
    15,823
    5. Insurance Losses and Loss Adjustment Expenses
  2005
    
    
    2004
    
    
    2003(In thousands)Balance at January 1
    
    $
    124,858
    
    
    $
    112,618
    
    
    $
    86,898Less reinsurance recoverables on unpaid losses
    
    
    22,859
    
    
    
    37,955
    
    
    
    28,974Net balance at January 1
    
    
    101,999
    
    
    
    74,663
    
    
    
    57,924Add losses and LAE incurred, net of reinsurance related to:Current year
    
    
    298,993
    
    
    
    275,651
    
    
    
    168,066Prior years
    
    
    6,762
    
    
    
    6,318
    
    
    
    130Net losses and LAE incurred during the current year
    
    
    305,755
    
    
    
    281,969
    
    
    
    168,196Deduct losses and LAE paid, net of reinsurance, related to:Current year
    
    
    210,655
    
    
    
    191,176
    
    
    
    107,649Prior years
    
    
    83,243
    
    
    
    63,457
    
    
    
    43,808Net claim payments made during the current year
    
    
    293,898
    
    
    
    254,633
    
    
    
    151,457Net balance at December 31
    
    
    113,856
    
    
    
    101,999
    
    
    
    74,663Plus reinsurance recoverables on unpaid losses
    
    
    17,552
    
    
    
    22,859
    
    
    
    37,955Balance at December 31
    
    $
    131,408
    
    
    $
    124,858
    
    
    $
    112,618
 79




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##### Table of Contents



6. Notes Payable
  2005
    
    
    2004(In thousands)Premium Finance revolving credit facility
    
    $
    150,000
    
    
    $
    135,200Corporate revolving credit facility
    
    
    
    
    
    
    Other
    
    
    3,009
    
    
    
    426Total
    
    $
    153,009
    
    
    $
    135,626
 Premium Finance Revolving Credit Facility
   Corporate Revolving Credit Facility
  80




---



##### Table of Contents



Debentures payable
    Other
  Scheduled Maturities
  PrinciplePaymentsDue(in thousands)Years due:2006
    
    $
    1,7292007
    
    
    150,6492008
    
    
    6312010 and after
    
    
    41,238Total
    
    $
    194,247
 7. Reinsurance
 Ceded Reinsurance
  81




---



##### Table of Contents



Assumed Reinsurance
   Premiums
    
    
    Premiums
    
    
    Losses andWritten
    
    
    Earned
    
    
    LAE(In thousands)2005Direct
    
    $
    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
    
    
    $
    281,9692003Direct
    
    $
    409,967
    
    
    $
    370,888
    
    
    $
    275,964Assumed
    
    
    25,220
    
    
    
    24,021
    
    
    
    14,164Ceded
    
    
    (140,128
    )
    
    
    (166,380
    )
    
    
    (121,932
    )Net
    
    $
    295,059
    
    
    $
    228,529
    
    
    $
    168,196
 8. Administrative Services
   2005
    
    
    2004
    
    
    2003(In thousands)Premiums produced for other carriersWritten premiums
    
    $
    36,176
    
    
    $
    47,413
    
    
    $
    33,818Earned premiums
    
    
    37,991
    
    
    
    47,399
    
    
    
    34,993Premiums assumed by the CompanyWritten premiums
    
    $
    28,367
    
    
    $
    39,300
    
    
    $
    25,220Earned premiums
    
    
    29,588
    
    
    
    39,246
    
    
    
    24,021
 82




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##### Table of Contents



9. Income Taxes
   2005
    
    
    2004
    
    
    2003(In thousands)Current:Federal
    
    $
    20,354
    
    
    $
    28,228
    
    
    $
    26,918State
    
    
    2,933
    
    
    
    4,359
    
    
    
    3,864Total current
    
    
    23,287
    
    
    
    32,587
    
    
    
    30,782Deferred:Federal
    
    
    20
    
    
    
    (1,180
    )
    
    
    (5,332
    )State
    
    
    91
    
    
    
    (286
    )
    
    
    (490
    )Total deferred
    
    
    111
    
    
    
    (1,466
    )
    
    
    (5,822
    )Total income tax expense
    
    $
    23,398
    
    
    $
    31,121
    
    
    $
    24,960
  2005
    
    
    2004
    
    
    2003(In thousands)Income before income taxes
    
    $
    62,409
    
    
    $
    85,106
    
    
    $
    68,052Income tax expense at statutory rate
    
    $
    21,843
    
    
    $
    29,787
    
    
    $
    23,818Tax effect of:State income taxes
    
    
    1,998
    
    
    
    2,548
    
    
    
    2,022Tax exempt interest
    
    
    (538
    )
    
    
    (476
    )
    
    
    (578
    )Other, net
    
    
    95
    
    
    
    (738
    )
    
    
    (302
    )Total income tax expense
    
    $
    23,398
    
    
    $
    31,121
    
    
    $
    24,960
 83




---



##### Table of Contents



2005
    
    
    2004(In thousands)Deferred income tax assets:Unearned premiums
    
    $
    12,492
    
    
    $
    12,854Loss and loss adjustment expense reserves
    
    
    2,809
    
    
    
    2,677Provision for return and unearned reinsurance commissions
    
    
    652
    
    
    
    810Provision for return and unearned service fees
    
    
    997
    
    
    
    1,041Provision for return commissions
    
    
    932
    
    
    
    907Allowance for losses on finance receivables
    
    
    2,247
    
    
    
    2,130Deferred gain on sale and leaseback
    
    
    85
    
    
    
    122Depreciation
    
    
    912
    
    
    
    36Net unrealized loss on available-for-sale securities
    
    
    2,495
    
    
    
    Unrealized loss related to cash flow hedge
    
    
    
    
    
    
    156Unearned policy fees
    
    
    859
    
    
    
    441Policy acquisition costs
    
    
    1,083
    
    
    
    838Other
    
    
    1,250
    
    
    
    1,388Total deferred income tax assets
    
    
    26,813
    
    
    
    23,400Deferred income tax liabilities:Deferred policy acquisition costs
    
    
    4,832
    
    
    
    4,434Net unrealized gains on available-for-sale securities
    
    
    
    
    
    
    16Unrealized gain related to cash flow hedge
    
    
    369
    
    
    
    Amortization
    
    
    1,253
    
    
    
    Other
    
    
    435
    
    
    
    993Total deferred income tax liabilities
    
    
    6,889
    
    
    
    5,443Net federal deferred income tax asset
    
    
    19,924
    
    
    
    17,957State deferred income tax asset
    
    
    1,991
    
    
    
    2,083Net deferred income tax asset
    
    $
    21,915
    
    
    $
    20,040
 10. Capital Stock
 Public Offerings
     84




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##### Table of Contents



Common Stock Repurchase
  Redeemable Series A Preferred Stock
  Series B Preferred Stock
  Common Stock  Stock Warrant
  Stock Option Plans
     85




---



##### Table of Contents



WeightedNumber of
    
    
    AverageShares
    
    
    Exercise PriceOptions outstanding January 1, 2003(558,036 exercisable)
    
    
    702,000
    
    
    
    1.96Granted
    
    
    924,000
    
    
    
    21.00Exercised
    
    
    24,000
    
    
    
    2.71Options outstanding December 31, 2003 (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
    
    
    $
    20.05
   2005
    
    
    2004
    
    
    2003(In thousands, except per share amounts)Net income available to common shareholders, as reported
    
    $
    39,011
    
    
    $
    53,985
    
    
    $
    42,747Deduct: Total stock-based employee compensation expense
determined under the fair value based method, net of
related tax effects
    
    
    (865
    )
    
    
    (878
    )
    
    
    (218
    )Net income available to common shareholders, pro forma
    
    $
    38,146
    
    
    $
    53,107
    
    
    $
    42,529Income for purposes of computing diluted earnings per share
common, as reported
    
    $
    39,011
    
    
    $
    53,985
    
    
    $
    43,386Deduct: Total stock-based employee compensation expense
determined under fair value based method, net of related
tax effects
    
    
    (865
    )
    
    
    (878
    )
    
    
    (218
    )Income for purposes of computing diluted earnings per share
common, pro forma
    
    $
    38,146
    
    
    $
    53,107
    
    
    $
    43,168Earnings per shareBasic  as reported
    
    $
    1.83
    
    
    $
    2.44
    
    
    $
    2.74Basic  pro forma
    
    $
    1.79
    
    
    $
    2.40
    
    
    $
    2.72Diluted  as reported
    
    $
    1.82
    
    
    $
    2.38
    
    
    $
    2.20Diluted  pro forma
    
    $
    1.78
    
    
    $
    2.34
    
    
    $
    2.19
 86




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##### Table of Contents



2005
    
    2004
    
    2003Expected option term
    
    5 years
    
    5 years
    
    5 yearsAnnualized volatility rate
    
    
    31.5
    %
    
    
    35
    %
    
    
    35
    %Risk-free rate of return
    
    
    4.12
    %
    
    3.1% to 3.5%
    
    
    3.37
    %Fair value at the date of grant (weighted-average)
    
    $
    18.06
    
    
    $
    31.80
    
    
    $
    21.00Dividend yield
    
    
    0.66
    %
    
    
    0.76
    %
    
    
    0.76
    %Black-Scholes value
    
    
    32.9
    %
    
    33.3% to 33.9%
    
    
    33.8
    %
 Reserved Shares
  Exercise of stock options under the 1996 Plan
    
    
    53,500Exercise of stock options under the 2003 Plan
    
    
    1,651,200Total common shares reserved
    
    
    1,704,700
 11. Statutory Financial Information and Accounting Policies
 Accounting
Principles and Procedures Manual
  Net IncomeYear ended December 31,
    
    
    Surplus December 31,2005
    
    
    2004
    
    
    2003
    
    
    2005
    
    
    2004
    
    
    2003(In thousands)Statutory basis amounts
    
    $
    23,685
    
    
    $
    16,121
    
    
    $
    6,569
    
    
    $
    169,249
    
    
    $
    141,646
    
    
    $
    114,050Deferred policy acquisition costs
    
    
    1,138
    
    
    
    1,234
    
    
    
    3,267
    
    
    
    13,804
    
    
    
    12,666
    
    
    
    11,432Deferred income taxes
    
    
    (475
    )
    
    
    1,231
    
    
    
    4,323
    
    
    
    5,754
    
    
    
    2,489
    
    
    
    1,324Reinsurance commissions
    
    
    451
    
    
    
    3,002
    
    
    
    850
    
    
    
    (1,862
    )
    
    
    (2,313
    )
    
    
    (4,982
    )Guaranty fund assessments
    
    
    96
    
    
    
    714
    
    
    
    809
    
    
    
    (244
    )
    
    
    (338
    )
    
    
    (1,052
    )Unearned policy fees
    
    
    (1,193
    )
    
    
    (1,261
    )
    
    
    
    
    
    
    (2,454
    )
    
    
    (1,261
    )
    
    
    Nonadmitted assets
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    887
    
    
    
    1,370
    
    
    
    1,539Unrealized appreciation of
securities available-for-sale
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (6,859
    )
    
    
    169
    
    
    
    1,069Other
    
    
    297
    
    
    
    211
    
    
    
    (507
    )
    
    
    13
    
    
    
    134
    
    
    
    104GAAP amounts
    
    $
    23,999
    
    
    $
    21,252
    
    
    $
    15,311
    
    
    $
    178,288
    
    
    $
    154,562
    
    
    $
    123,484
  87




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##### Table of Contents



12. Cash Flow Hedge
     As of December 31,2005
    
    
    2004(In thousands)Carrying
value of derivative  asset (liability)Interest rate collar
    
    $
    
    
    
    $
    (446
    )Interest rate swap
    
    
    1,055
    
    
    
    Total
    
    $
    1,055
    
    
    $
    (446
    )
 As of December 31,2005
    
    
    2004(In thousands)Other comprehensive income (loss), net of taxInterest rate collar
    
    $
    
    
    
    $
    (290
    )Interest rate swap
    
    
    685
    
    
    
    Total
    
    $
    685
    
    
    $
    (290
    )
 For the year ended December 31,2005
    
    
    2004
    
    
    2003(In thousands)Amounts transferred to income:Interest expenseInterest rate collar
    
    $
    402
    
    
    $
    922
    
    
    $
    969Interest rate swap
    
    
    78
    
    
    
    
    
    
    
    Total interest
    
    $
    480
    
    
    $
    922
    
    
    $
    969
 13. Commitments and Contingencies
 Commitments
  88




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##### Table of Contents



Capital
    
    
    OperatingLeases
    
    
    Leases(In thousands)2006
    
    $
    1,475
    
    
    $
    7,7102007
    
    
    1,155
    
    
    
    5,6102008
    
    
    205
    
    
    
    2,5272009
    
    
    
    
    
    
    1,2182010
    
    
    
    
    
    
    9582011
    
    
    
    
    
    
    587Total minimum lease payments
    
    
    2,835
    
    
    $
    18,610Less amount representing interest
    
    
    199Present value of minimum lease payments
    
    $
    2,636
 Contingencies
 Baton Rouge Facility.
  Litigation.
 SEC Inquiry.
 14. Fair Value of Financial Instruments
  Debt Securities
 Short-Term Investments and Other Invested Assets
 89




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##### Table of Contents



Finance Receivables, Net
 Reinsurance Balances Receivable and Reinsurance Balances Payable
 Notes payable
 Debentures payable
  2005
    
    2004Carrying
    
    Fair
    
    Carrying
    
    FairValue
    
    Value
    
    Value
    
    Value(In thousands)AssetsDebt securities available-for-sale
    
    $
    388,032
    
    
    $
    388,032
    
    
    $
    334,816
    
    
    $
    334,816Short-term investments and other invested assets
    
    
    3,688
    
    
    
    3,688
    
    
    
    1,663
    
    
    
    1,663Finance receivables, net
    
    
    214,796
    
    
    
    214,796
    
    
    
    214,180
    
    
    
    214,180Reinsurance balances receivable
    
    
    27,083
    
    
    
    27,083
    
    
    
    35,671
    
    
    
    35,671LiabilitiesReinsurance balances payable and funds held
    
    
    32,024
    
    
    
    32,024
    
    
    
    33,996
    
    
    
    33,996Notes payable
    
    
    153,009
    
    
    
    153,009
    
    
    
    135,626
    
    
    
    135,626Capital lease obligations
    
    
    2,636
    
    
    
    2,636
    
    
    
    3,772
    
    
    
    3,772Debentures payable
    
    
    41,238
    
    
    
    40,558
    
    
    
    
    
    
    
    
 15. Earnings per Share
  2005
    
    
    2004
    
    
    2003(In thousands, except per share amounts)Numerator:Net income available to common shareholders
    
    $
    39,011
    
    
    $
    53,985
    
    
    $
    42,747Dividends paid to preferred shareholders
    
    
    
    
    
    
    
    
    
    
    639Income for purposes of computing diluted earnings
per common share
    
    $
    39,011
    
    
    $
    53,985
    
    
    $
    43,386Denominator:Weighted average common shares outstanding
    
    
    21,363.8
    
    
    
    22,114.9
    
    
    
    15,609.4Dilutive stock options
    
    
    60.1
    
    
    
    572.3
    
    
    
    712.1Dilutive warrants
    
    
    
    
    
    
    
    
    
    
    84.3Dilutive preferred stock
    
    
    
    
    
    
    
    
    
    
    3,273.8Weighted average common shares outstanding for
purposes of computing diluted earnings per
common share
    
    
    21,423.9
    
    
    
    22,687.2
    
    
    
    19,679.6Basic earnings per common share
    
    $
    1.83
    
    
    $
    2.44
    
    
    $
    2.74Diluted earnings per common share
    
    $
    1.82
    
    
    $
    2.38
    
    
    $
    2.20
 90




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##### Table of Contents



16. Acquisitions
    17. Quarterly Financial Data (unaudited)
  Basic
    
    
    Diluted
    
    
    
    
    
    
    StockTotal
    
    
    Net
    
    
    Earnings
    
    
    Earnings
    
    
    
    
    
    
    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
    
    
    $
    16.902004Q1
    
    $
    111,608
    
    
    $
    15,018
    
    
    $
    0.70
    
    
    $
    0.67
    
    
    $
    36.20
    
    
    $
    30.64
    
    
    $
    36.20Q2
    
    
    120,591
    
    
    
    16,018
    
    
    
    0.72
    
    
    
    0.70
    
    
    
    37.18
    
    
    
    32.06
    
    
    
    32.24Q3
    
    
    123,762
    
    
    
    14,348
    
    
    
    0.64
    
    
    
    0.63
    
    
    
    32.72
    
    
    
    27.61
    
    
    
    28.92Q4
    
    
    125,130
    
    
    
    8,601
    
    
    
    0.38
    
    
    
    0.38
    
    
    
    32.65
    
    
    
    27.90
    
    
    
    32.10$
    481,091
    
    
    $
    53,985
    
    
    $
    2.44
    
    
    $
    2.38
    
    
    $
    37.18
    
    
    $
    27.61
    
    
    $
    32.10
 
 (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
  91




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##### Table of Contents



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
   Changes in Internal Control over Financial Reporting
  
 Item 9B. Other Information.
  92




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##### Table of Contents



PART III
  
 PART IV
 
 Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
 (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, 2005, 2005
and 2003Consolidated Balance Sheets  As of December 31, 2005 and 2004Consolidated Statements of Changes in Shareholders Equity  For the Years Ended
December 31, 2005, 2004 and 2003Consolidated Statements of Cash Flows  For the Years Ended December 31, 2005, 2004
and 2003Notes 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
OperationsReport 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.
 93




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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
and Barry D. Elkins dated as of July 21, 2003 incorporated herein by reference
to Exhibit 10.5 of the Registration Statement No. 333-105505 filed with the SEC
on July 21, 2003 as amended by the First Amendment to Employment Agreement
dated as of August 15, 2005 incorporated herein by reference to Exhibit 10.1 of
the Quarterly Report on Form 10-Q filed with the SEC on November 9, 2005.10.6
    
    Employment Agreement by and between Direct General Corporation
and J. Todd Hagely dated as of August 15, 2005 incorporated herein by reference
to Exhibit 10.2 of the Quarterly Report on Form 10-Q filed with the SEC on
November 9, 2005.10.7
    
    Employment Agreement by and between Direct General Corporation
and Kenneth A. Collom dated as of May 20, 2003 incorporated herein by reference
to Exhibit 10.23 of the Annual Report on Form 10-K filed with the SEC on March
16, 2005.10.8
    
    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, 2003.10.9
    
    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, 2003.10.10
    
    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, 2003.10.11
    
    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, 2003.10.12
    
    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, 2003.10.13
    
    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
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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 and the Seventh Amendment
to the Eighth Amended and Restated Loan Agreement dated as of December 3,
2004.10.14
    
    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 and the Sixth Amendment to the Seventh Amended and
Restated Pledge and Security Agreement dated December 3, 2004.10.15
    
    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 and the Sixth Amendment to the Seventh
Amended and Restated Security Agreement dated as of December 3, 2004.10.16
    
    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, 2003.10.17
    
    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, 2003.10.18
    
    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.
 95




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10.19
    
    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,
2003.10.20
    
    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, 2003.10.21
    
    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, 2003.10.22
    
    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, 2003.10.23
    
    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, 2003.10.24
    
    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,
2003.10.25
    
    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, 2005.10.26
    
    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, 2005.10.27
    
    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, 2005.14    *
    
    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. 96




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SIGNATURES
  DIRECT GENERAL CORPORATION(Registrant)March 15, 2006
    
    
    
    By:
    
    /s/ William C. Adair, Jr.Date
    
    
    
    
    
    (Signature)Name:
    
    William C. Adair, Jr.Title:
    
    Chairman, Chief Executive Officer
  March 15, 2006
    
    
    
    By:
    
    /s/ William C. Adair, Jr.Date
    
    
    
    
    
    (Signature)Name:
    
    William C. Adair, Jr.Title:
    
    Chairman, Chief Executive OfficerMarch 15, 2006
    
    
    
    By:
    
    /s/ Jacqueline C. AdairDate
    
    
    
    
    
    (Signature)Name:
    
    Jacqueline C. AdairTitle:
    
    Director, Executive Vice President and Chief Operating OfficerMarch 15, 2006
    
    
    
    By:
    
    /s/ Fred H. MedlingDate
    
    
    
    
    
    (Signature)Name:
    
    Fred H. MedlingTitle:
    
    DirectorMarch 15, 2006
    
    
    
    By:
    
    /s/ Raymond L. OsterhoutDate
    
    
    
    
    
    (Signature)Name:
    
    Raymond L. OsterhoutTitle:
    
    DirectorMarch 15, 2006
    
    
    
    By:
    
    /s/ Stephen L. RohdeDate
    
    
    
    
    
    (Signature)Name:
    
    Stephen L. RohdeTitle:
    
    DirectorMarch 15, 2006
    
    
    
    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, 2005
 Amount atWhichShown inthe BalanceType of Investment
    
    Cost
    
    
    Value
    
    
    Sheet(In thousands)Available-for-sale fixed maturity securities:Bonds:United States government and government agencies and
authorities
    
    $
    67,748
    
    
    $
    66,450
    
    
    $
    66,450States, municipalities, and political subdivisions
    
    
    70,161
    
    
    
    69,953
    
    
    
    69,953Public utilities
    
    
    17,382
    
    
    
    17,021
    
    
    
    17,021All other corporate bonds
    
    
    239,868
    
    
    
    234,608
    
    
    
    234,608Total fixed maturities
    
    
    395,159
    
    
    
    388,032
    
    
    
    388,032Short-term investments and other invested assets
    
    
    3,688
    
    
    
    3,688
    
    
    
    3,688Total investments
    
    $
    398,847
    
    
    $
    391,720
    
    
    $
    391,720
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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 31,2005
    
    
    2004
    
    
    2003(In thousands)RevenuesManagement fees from non-insurance subsidiaries
    
    $
    6,288
    
    
    $
    17,690
    
    
    $
    18,307Dividends from insurance subsidiaries
    
    
    11,650
    
    
    
    1,000
    
    
    
    1,000Other income
    
    
    187
    
    
    
    128
    
    
    
    70Total revenues
    
    
    18,125
    
    
    
    18,818
    
    
    
    19,377ExpensesGeneral and administrative expenses
    
    
    44
    
    
    
    978
    
    
    
    250Interest expense
    
    
    1,124
    
    
    
    
    
    
    
    958Total expenses
    
    
    1,168
    
    
    
    978
    
    
    
    1,208Income before income taxes and equity in
earnings of subsidiaries
    
    
    16,957
    
    
    
    17,840
    
    
    
    18,169Income tax expense
    
    
    1,501
    
    
    
    6,633
    
    
    
    6,726Income before equity in earnings of subsidiaries
    
    
    15,456
    
    
    
    11,207
    
    
    
    11,443Equity earnings in subsidiaries
    
    
    23,555
    
    
    
    42,778
    
    
    
    31,649Net income
    
    $
    39,011
    
    
    $
    53,985
    
    
    $
    43,092
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DIRECT GENERAL CORPORATION (PARENT COMPANY)
 SCHEDULE II. CONDENSED FINANCIAL INFORMATION OF REGISTRANT
 Condensed Balance Sheets
 As of December 31,2005
    
    
    2004(In thousands)AssetsDebt securities available-for-sale (amortized cost
$2,900 and $3,000 at December 31, 2005 and 2004,
respectively)
    
    $
    2,900
    
    
    $
    3,000Other invested assets
    
    
    1,238
    
    
    
    Cash and cash equivalents
    
    
    1,157
    
    
    
    747Receivables from affiliated companies, net
    
    
    19,623
    
    
    
    22,480Investment in subsidiaries
    
    
    242,628
    
    
    
    215,354Income tax recoverable
    
    
    6,492
    
    
    
    2,060Other assets
    
    
    6,049
    
    
    
    2,465Total assets
    
    $
    280,087
    
    
    $
    246,106Liabilities and shareholders equityDeferred income taxes
    
    $
    26
    
    
    $
    587Notes and debentures payable
    
    
    42,346
    
    
    
    Other liabilities
    
    
    183
    
    
    
    438Total liabilities
    
    
    42,555
    
    
    
    1,025Shareholders equityCommon stock
    
    
    69,700
    
    
    
    109,163Retained earnings
    
    
    171,780
    
    
    
    136,178Accumulated other comprehensive loss
    
    
    (3,948
    )
    
    
    (260
    )Total shareholders equity
    
    
    237,532
    
    
    
    245,081Total liabilities and shareholders equity
    
    $
    280,087
    
    
    $
    246,106
  100




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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 31,2005
    
    
    2004
    
    
    2003(In thousands)Net cash provided by operating activities
    
    $
    2,231
    
    
    $
    8,574
    
    
    $
    2,996Investing activitiesInvestment in subsidiaries
    
    
    (11,807
    )
    
    
    (11,500
    )
    
    
    (52,497
    )Advance to subsidiary to paydown on credit facility
    
    
    
    
    
    
    (13,000
    )
    
    
    (7,000
    )Advance to subsidiary to purchase insurance agency assets
    
    
    
    
    
    
    
    
    
    
    (2,500
    )Dividends received from insurance subsidiaries
    
    
    1,650
    
    
    
    1,000
    
    
    
    1,000Dividends received from non-insurance subsidiaries
    
    
    10,000
    
    
    
    
    
    
    
    Purchase of common stock in trust
    
    
    (1,238
    )
    
    
    
    
    
    
    Sale (purchase) of debt securities available-for-sale
    
    
    100
    
    
    
    (3,000
    )
    
    
    Net cash used in by investing activities
    
    
    (1,295
    )
    
    
    (26,500
    )
    
    
    (60,997
    )Financing activitiesIssuances of common stock
    
    
    612
    
    
    
    17,031
    
    
    
    72,493Repurchase of common stock
    
    
    (40,075
    )
    
    
    
    
    
    
    Proceeds from debentures issued
    
    
    41,238
    
    
    
    
    
    
    
    Proceeds from other notes payable
    
    
    1,108Payment of principal on borrowings
    
    
    
    
    
    
    
    
    
    
    (10,442
    )Payment of preferred stock dividends
    
    
    
    
    
    
    
    
    
    
    (345
    )Payment of common stock dividends
    
    
    (3,409
    )
    
    
    (3,542
    )
    
    
    (854
    )Purchase of treasury stock
    
    
    
    
    
    
    
    
    
    
    (33
    )Net cash (used in) provided by financing activities
    
    
    (526
    )
    
    
    13,489
    
    
    
    60,819Net increase (decrease) in cash and cash equivalents
    
    
    410
    
    
    
    (4,437
    )
    
    
    2,818Cash and cash equivalents at the beginning of the year
    
    
    747
    
    
    
    5,184
    
    
    
    2,366Cash and cash equivalents at the end of the year
    
    $
    1,157
    
    
    $
    747
    
    
    $
    5,184
  101




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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.2.
    
    Notes and Debentures PayableIn December 2004, the Parent Company entered into a $30,000,000 revolving credit facility. As
of December 31, 2005, no amounts were outstanding. During 2005, a portion of this facility had
been drawn for a short period of time, resulting in interest expense of $57,000. 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 $1,067,000 is included in the
accompanying financial statements related to these debentures. See Note 6 to the consolidated
financial statements for more information.During 2003, the Parent Company had a credit facility that was paid off in August 2003.
Interest expense under this facility was $950,000.3.
    
    Capital StockDuring 2005, the Company repurchased 2,157,871 shares of its outstanding common stock for an
aggregate price of approximately $40,075,000. Under prior approval by the Board of Directors,
the Company has the discretionary authority to buyback up to an additional $10,000,000 of its
outstanding common stock prior to the end of January 2007.See Note 10 to the consolidated financial statements for a description of the Parent Companys
capital structure.
 102




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DIRECT GENERAL CORPORATION AND SUBSIDIARIES
 SCHEDULE IV. REINSURANCE
 Assumed
    
    
    
    
    
    
    PercentageCeded to
    
    
    from
    
    
    
    
    
    
    of AmountGross
    
    
    Other
    
    
    Other
    
    
    Net
    
    
    Assumed toAmount
    
    
    Companies
    
    
    Companies
    
    
    Amount
    
    
    Net(In thousands)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
    %Year ended December 31, 2003Life insurance in force
    
    $
    1,013,010
    
    
    $
    
    
    
    $
    
    
    
    $
    1,013,010
    
    
    
    0.0
    %Premiums earned:Life insurance
    
    $
    10,596
    
    
    $
    
    
    
    $
    
    
    
    $
    10,596
    
    
    
    0.0
    %Property and liability insurance
    
    
    360,292
    
    
    
    166,380
    
    
    
    24,021
    
    
    
    217,933
    
    
    
    11.0
    %Total premiums earned
    
    $
    370,888
    
    
    $
    166,380
    
    
    $
    24,021
    
    
    $
    228,529
    
    
    
    10.5
    %
 103




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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, 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)
    
    
    
    
    
    
    4,982Year ended December 31, 2003Allowance for finance receivable losses
    
    $
    5,010
    
    
    $
    
    
    
    $
    6,962
    (a)
    
    $
    (6,030
    )(c)
    
    $
    5,942Provision for return ceding commissions
    
    
    4,960
    
    
    
    (1,869
    )
    
    
    
    
    
    
    
    
    
    
    3,091Provision for return commissions and service fees
    
    
    2,623
    
    
    
    
    
    
    
    2,306
    (b)
    
    
    
    
    
    
    4,929
 
 (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 104




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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, 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
    
    
    $
    391,023December 31, 2003
    
    $
    11,012
    
    
    $
    112,108
    
    
    $
    0
    
    
    $
    206,490
    
    
    $
    217,932
    
    
    $
    6,350
    
    
    $
    166,866
    
    
    $
    309
    
    
    $
    25,287
    
    
    $
    150,707
    
    
    $
    281,526
 105