Midwest, New England, Southern and Southwestern states. The personal lines products of our insurance subsidiaries consist primarily of homeowners and private passenger automobile policies. The commercial lines products of our insurance subsidiaries consist primarily of commercial automobile, commercial multi-peril and workers’ compensation policies.
Donegal Mutual completed the merger of Mountain States Mutual Casualty Company, or Mountain States, with and into Donegal Mutual effective May 25, 2017. Donegal Mutual was the surviving company in the merger, and Mountain States’ insurance subsidiaries, Mountain States Indemnity Company and Mountain States Commercial Insurance Company (collectively, the “Mountain States insurance subsidiaries”), became insurance subsidiaries of Donegal Mutual upon completion of the merger. Upon completion of the merger, Donegal Mutual assumed all of the policy obligations of Mountain States and began to market its products together with the Mountain States insurance subsidiaries as the Mountain States Insurance Group in four Southwestern states. Donegal Mutual also entered into a 100% quota-share reinsurance agreement with the Mountain States insurance subsidiaries on the merger date. Beginning with policies effective in 2021, Donegal Mutual began to place the business of the Mountain States Insurance Group into the underwriting pool we describe in “Business - History and Organizational Structure.” As a result, our consolidated financial results through December 31, 2020 excluded the results of the Mountain States Insurance Group operations in those Southwestern states.
We and Donegal Mutual Insurance Company sold Donegal Financial Services Corporation (“DFSC”) to Northwest Bancshares, Inc. (“Northwest”) on March 8, 2019, resulting in proceeds valued at approximately $85.8 million in a combination of cash and Northwest common stock. Immediately prior to the closing of the merger, DFSC paid a dividend of approximately $29.2 million to us and Donegal Mutual. As the owner of 48.2% of DFSC’s common stock, we received a dividend payment from DFSC of approximately $14.1 million and consideration from Northwest valued at approximately $41.4 million. We recorded a gain of $12.7 million from the sale of DFSC in our results of operations during 2019. We sold the Northwest common stock that we received as part of the consideration during 2019. This transaction represented the culmination of a banking strategy that began with the formation of DFSC in 2000.
and in privately negotiated transactions. We did not purchase any shares of our Class A common stock under this program during 2020 or 2019. We have purchased a total of 57,658 shares of our Class A common stock under this program from its inception through December 31, 2020.
Liabilities for losses and loss expenses are estimates at a given point in time of the amounts an insurer expects to pay with respect to incurred policyholder claims based on facts and circumstances the insurer knows at that point in time. For example, legislative, judicial and regulatory actions may expand coverage definitions, retroactively mandate coverage or otherwise require our insurance subsidiaries to pay losses for damages that their policies explicitly excluded or did not intend to cover. At the time of establishing its estimates, an insurer recognizes that its ultimate liability for losses and loss expenses will exceed or be less than such estimates. Our insurance subsidiaries base their estimates of liabilities for losses and loss expenses on assumptions as to future loss trends, expected claims severity, judicial theories of liability and other factors. However, during the loss adjustment period, our insurance subsidiaries may learn additional facts regarding individual claims, and, consequently, it often becomes necessary for our insurance subsidiaries to refine and adjust their estimates for these liabilities. We reflect any adjustments to the liabilities for losses and loss expenses of our insurance subsidiaries in our consolidated results of operations in the period in which our insurance subsidiaries make adjustments to their estimates.
Reserve estimates can change over time because of unexpected changes in assumptions related to our insurance subsidiaries’ external environment and, to a lesser extent, assumptions related to our insurance subsidiaries’ internal operations. For example, our insurance subsidiaries have experienced an increase in claims severity and a lengthening of the claim settlement periods on bodily injury claims during the past several years. In addition, the COVID-19
Atlantic States’ participation in the pool with Donegal Mutual exposes Atlantic States to adverse loss development on the business of Donegal Mutual that the pool includes. However, pooled business represents the predominant percentage of the net underwriting activity of both companies, and Donegal Mutual and Atlantic States share proportionately any adverse risk development relating to the pooled business. The business in the pool is homogeneous and each company has a pro-rata
share of the entire pool. Since the predominant percentage of the business of Atlantic States and Donegal Mutual is pooled and the results shared by each company according to its participation level under the terms of the pooling agreement, the intent of the underwriting pool is to produce a more uniform and stable underwriting result from year to year for each company than either would experience individually and to spread the risk of loss between the companies.
Our insurance subsidiaries’ liability for losses and loss expenses by major line of business at December 31, 2020 and 2019 consisted of the following:
Our insurance subsidiaries base their reserves for unpaid losses and loss expenses on current trends in loss and loss expense development and reflect their best estimates for future amounts needed to pay losses and loss expenses with respect to incurred events currently known to them plus incurred but not reported (“IBNR”) claims. Our insurance subsidiaries develop their
For the year ended December 31, 2020, the actuaries developed a range from a low of $512.9 million to a high of $605.3 million and selected a point estimate of $557.2 million. The actuaries’ range of estimates for commercial lines in 2020 was $376.9 million to $444.7 million, and the actuaries selected a point estimate of $409.4 million. The actuaries’ range of estimates for personal lines in 2020 was $136.0 million to $160.6 million, and the actuaries selected a point estimate of $147.8 million. For the year ended December 31, 2019, the actuaries developed a range from a low of $468.8 million to a high of $548.1 million and selected a point estimate of $506.9 million. The actuaries’ range of estimates for commercial lines in 2019 was $320.8 million to $375.0 million, and the actuaries selected a point estimate of $346.8 million. The actuaries’ range of estimates for personal lines in 2019 was $148.0 million to $173.1 million, and the actuaries selected a point estimate of $160.1 million.
The following table presents 2020 and 2019 claim count and payment amount information for workers’ compensation. Workers’ compensation losses primarily consist of indemnity and medical costs for injured workers.
financial measures under applicable SEC rules because the SAP financial measures include or exclude certain items that the most comparable GAAP financial measures do not ordinarily include or exclude. Our calculation of non-GAAP
financial measures may differ from similar measures other companies use. As a result, investors should exercise caution when comparing our non-GAAP
We define net premiums written as the amount of full-term premiums our insurance subsidiaries record for policies effective within a given period less premiums our insurance subsidiaries cede to reinsurers. Net premiums earned is the most comparable GAAP financial measure to net premiums written. Net premiums earned represent the sum of the amount of net premiums written and the change in net unearned premiums during a given period. Our insurance subsidiaries earn premiums and recognize them as revenue over the terms of their policies, which are one year or less in duration. Therefore, increases or decreases in net premiums earned generally reflect increases or decreases in net premiums written in the preceding 12-month
Our insurance subsidiaries’ net premiums earned decreased to $742.0 million for 2020, a decrease of $14.1 million, or 1.9%, compared to 2019, primarily reflecting decreases in personal lines premiums written during 2019 and 2020. Our insurance subsidiaries earn premiums and recognize them as income over the terms of the policies they issue. Such terms are generally one year or less in duration. Therefore, increases or decreases in net premiums earned generally reflect increases or decreases in net premiums written in the preceding twelve-month period compared to the same period one year earlier.
Our net investment gains for 2020 and 2019 were $2.8 million and $22.0 million, respectively. The net investment gains for 2020 were primarily related to an increase in unrealized gains within our equity securities portfolio. The net investment gains for 2019 included $12.7 million from the sale of DFSC and $8.9 million related to unrealized gains within our equity securities portfolio. We did not recognize any impairment losses during 2020 or 2019.
Our insurance subsidiaries’ loss ratio, which is the ratio of incurred losses and loss expenses to premiums earned, was 62.0% for 2020, compared to 67.0% for 2019. Our insurance subsidiaries’ commercial lines loss ratio increased to 63.9% for 2020, compared to 63.0% for 2019. This increase resulted primarily from the workers’ compensation loss ratio increasing to 51.1% for 2020, compared to 44.6% for 2019, and the commercial multi-peril loss ratio increasing to 65.9% for 2020, compared to 63.1% for 2019. The personal lines loss ratio decreased to 59.5% for 2020, compared to 71.1% for 2019. The personal automobile loss ratio decreased to 60.1% for 2020, compared to 76.1% for 2019, primarily as a result of lower claim frequency due to reduced driving activity and traffic density and various underwriting adjustments our insurance subsidiaries
Our insurance subsidiaries’ expense ratio, which is the ratio of policy acquisition and other underwriting expenses to premiums earned, was 33.0% for 2020, compared to 31.3% for 2019. We attribute the modest increase to higher commercial growth incentive costs for our agents, higher underwriting-based incentive compensation for our agents and employees and higher technology-related expenses for 2020 compared to 2019. The increase in technology systems-related expenses for 2020 was primarily due to an increased allocation of costs from Donegal Mutual to our insurance subsidiaries following the successful implementation of the first phase of our ongoing systems modernization project in February 2020.
Our insurance subsidiaries pay policyholder dividends primarily on workers’ compensation policies on a sliding scale based on the profitability of a given policy. We attribute the decrease in dividends incurred for 2020 compared to 2019 to a modest decline in the profitability of the workers’ compensation line of business over the respective periods to which the dividends applied.
Our insurance subsidiaries’ combined ratio was 96.0% and 99.5% for 2020 and 2019, respectively. The combined ratio represents the sum of the loss ratio, the expense ratio and the dividend ratio, which is the ratio of workers’ compensation policy dividends incurred to premiums earned. We attribute the decrease in our combined ratio primarily to the decrease in our loss ratio.
Our interest expense for 2020 decreased to $1.2 million, compared to $1.6 million for 2019. We attribute the decrease to lower interest rates on our borrowings under our lines of credit during 2020 compared to 2019.
Our income tax expense was $10.5 million for 2020, compared to $9.9 million for 2019. Our effective tax rate for 2020 was 16.5%, compared to 17.4% for 2019. Our income tax expense for 2020 included a $1.6 million income tax benefit related to the carryback of 2018 net operating losses to past tax years with higher statutory income tax rates than are currently in effect, as allowed under the Coronavirus Aid, Relief and Economic Security Act that was enacted in March 2020. Our income tax expense for 2019 included Pennsylvania state income taxes of $825,000 that were related to the gain we realized on the sale of DFSC.
Our stockholders’ equity increased by $66.8 million during 2020 as a result of our net income and net unrealized gains within our available-for-sale
fixed maturity investments. Our book value per share increased to $17.13 at December 31, 2020, compared to $15.67 a year earlier.
Our insurance subsidiaries’ 2019 net premiums written increased 1.2% to $752.6 million, compared to $744.0 million for 2018. We attribute the increase primarily to the impact of premium rate increases and an increase in the writing of new accounts in commercial lines of business. Commercial lines net premiums written increased $47.8 million, or 13.4%, for 2019 compared to 2018. Personal lines net premiums written decreased $39.2 million, or 10.1%, for 2019 compared to 2018. We attribute the decrease in personal lines primarily to net attrition as a result of underwriting measures our insurance subsidiaries have implemented to slow new policy growth and increased pricing on renewal policies, as well as the previously announced non-renewal
For 2019, our net investment income increased to $29.5 million, an increase of $2.6 million, or 9.7%, over 2018. We attribute the increase primarily to an increase in average invested assets.
Our net investment gains (losses) for 2019 and 2018 were $22.0 million and ($4.8 million), respectively. The net investment gains for 2019 included $12.7 million from the sale of DFSC and $8.9 million related to unrealized gains within our equity securities portfolio. The net investment losses for 2018 were primarily related to a decrease in the market value of the equity securities we held at December 31, 2018. We did not recognize any impairment losses during 2019 or 2018.
Our interest expense for 2019 decreased to $1.6 million, compared to $2.3 million for 2018. We attribute the decrease to lower average borrowings under our lines of credit during 2019 compared to 2018.
Our net income for 2019 was $47.2 million, or $1.67 per share of Class A common stock on a diluted basis and $1.51 per share of Class B common stock, compared to a net loss of $32.8 million, or $1.18 per share of Class A common stock and $1.09 per share of Class B common stock, for 2018. We had 23.2 million and 22.8 million Class A shares outstanding at December 31, 2019 and 2018, respectively. We had 5.6 million Class B shares outstanding for both periods. There are no outstanding securities that dilute our shares of Class B common stock.
fixed maturity investments. Our book value per share increased to $15.67 at December 31, 2019, compared to $14.05 a year earlier.
We have historically generated sufficient net positive cash flow from our operations to fund our commitments and build our investment portfolio, thereby increasing future investment returns. The pooling agreement with Donegal Mutual historically has been cash flow positive because of the profitability of the underwriting pool. Because we settle the pool monthly, our cash flows are substantially similar to the cash flows that would result from the underwriting of direct business. We maintain a high degree of liquidity in our investment portfolio in the form of marketable fixed maturities, equity securities and short-term investments. We structure our fixed-maturity investment portfolio following a “laddering” approach so that projected cash flows from investment income and principal maturities are evenly distributed from a timing perspective. This laddering approach provides an additional measure of liquidity to meet our obligations and the obligations of our insurance subsidiaries should an unexpected variation occur in the future. Net cash flows provided by operating activities in 2020, 2019 and 2018 were $101.1 million, $76.4 million and $63.8 million, respectively.
The following table shows expected payments for our significant contractual obligations at December 31, 2020:
We estimated the timing of the amounts for the net liability for unpaid losses and loss expenses of our insurance subsidiaries based on historical experience and expectations of future payment patterns. We have shown the liability net of reinsurance recoverable on unpaid losses and loss expenses to reflect expected future cash flows related to such liability. Assumed amounts from the underwriting pool with Donegal Mutual represent a substantial portion of our insurance subsidiaries’ gross liability for unpaid losses and loss expenses, and ceded amounts to the underwriting pool represent a substantial portion of our insurance subsidiaries’ reinsurance recoverable on unpaid losses and loss expenses. We include cash settlements of Atlantic States’ assumed liability from the pool in our monthly settlements of pooled activity. In these monthly settlements, we net amounts ceded to and assumed from the pool. Donegal Mutual and Atlantic States do not anticipate any changes in the pool participation levels in the foreseeable future. However, any such change would be prospective in nature and therefore would not impact the timing of expected payments for Atlantic States’ proportionate liability for pooled losses occurring in periods prior to the effective date of such change.
We discuss in Note 9 - Borrowings our estimate of the timing of the amounts payable for the borrowings under our lines of credit based on their contractual maturities. The borrowings under our lines of credit carry interest rates that we discuss in Note 9 - Borrowings.
The cash dividends we declared to our stockholders totaled $17.3 million, $16.2 million and $15.8 million in 2020, 2019 and 2018, respectively. There are no regulatory restrictions on our payment of dividends to our stockholders, although there are restrictions under applicable state laws on the payment of dividends from our insurance subsidiaries to us. Our insurance subsidiaries are required by law to maintain certain minimum surplus on a statutory basis and are subject to regulations under which their payment of dividends from statutory surplus is restricted and may require prior approval of their domiciliary insurance regulatory authorities. Our insurance subsidiaries are also subject to risk-based capital (“RBC”) requirements. The amount of statutory capital and surplus necessary for our insurance subsidiaries to satisfy regulatory requirements, including the RBC requirements, was not significant in relation to our insurance subsidiaries’ statutory capital and surplus at December 31, 2020. Amounts available for distribution to us as ordinary dividends from our insurance subsidiaries without prior approval of insurance regulatory authorities in 2021 are approximately $28.0 million from Atlantic States, $300,000 from Southern, $10.9 million from Peninsula and $12.2 million from MICO, or a total of approximately $51.4 million.
At December 31, 2020 and 2019, our investment portfolio of primarily investment-grade bonds, common stock, short-term investments and cash totaled $1.3 billion and $1.2 billion, respectively, representing 61.3% and 60.3%, respectively, of our total assets. See “Business - Investments” for more information.
The carrying value of our fixed maturity investments represented 93.5% and 93.7% of our total invested assets at December 31, 2020 and 2019, respectively.
In February 2016, the FASB issued guidance that requires lessees to recognize leases, including operating leases, on the lessee’s balance sheet, unless a lease is considered a short-term lease. This guidance also requires entities to make new judgments to identify leases. The guidance was effective for annual and interim reporting periods beginning after December 15, 2018 and permitted early adoption. Our adoption of this guidance on January 1, 2019 did not have a significant impact on our financial position, results of operations or cash flows.
In January 2017, the FASB issued guidance that simplifies the measurement of goodwill by modifying the goodwill impairment test previous guidance required. The guidance requires an entity to perform its annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount and recognize impairment for the amount by which the reporting unit’s carrying amount exceeds its fair value. The guidance was effective for annual and interim reporting periods beginning after December 15, 2019 and permitted early adoption. We early adopted this guidance in 2019. The adoption of this guidance did not have a significant impact on our financial position, results of operations or cash flows.
annual and interim reporting periods beginning after December 15, 2022 from December 15, 2019. We are a smaller reporting company and are in the process of evaluating the impact of the adoption of this guidance on our financial position, results of operations and cash flows.
As of December 31, 2020 and 2019, we did not have any off-balance
We have three segments: our investment function, our commercial lines of insurance and our personal lines of insurance. The commercial lines products of our insurance subsidiaries consist primarily of commercial automobile, commercial multi-peril and workers’ compensation policies. The personal lines products of our insurance subsidiaries consist primarily of homeowners and private passenger automobile policies.
At December 31, 2020, Donegal Mutual held approximately 42% of our outstanding Class A common stock and approximately 84% of our outstanding Class B common stock. This ownership provides Donegal Mutual with approximately 71% of the total voting power of our common stock. Our insurance subsidiaries and Donegal Mutual have interrelated operations due to a pooling agreement and other intercompany agreements and transactions. While each company maintains its separate corporate existence, our insurance subsidiaries and Donegal Mutual conduct business together as the Donegal Insurance Group. As such, Donegal Mutual and our insurance subsidiaries share the same business philosophy, the same management, the same employees and the same facilities and offer the same types of insurance products.
In July 2018, we consolidated the branch office operations of Peninsula into our home office operations to achieve economies of scale and enhance service levels for the policyholders of Peninsula. We recorded a restructuring charge of approximately $1.9 million in 2018 for employee termination costs associated with the Peninsula consolidation. We completed the sale of Peninsula’s branch office in 2019 for net proceeds of $1.2 million. We recorded an impairment charge of $1.1 million in other expenses in 2018 related to the value of this real estate.
We make estimates concerning the valuation of our investments and the recognition of other-than-temporary declines in the value of our investments. For equity securities, we measure investments at fair value and recognize changes in fair value in our results of operations. With respect to a debt security that is in an unrealized loss position, we first assess if we intend to sell the debt security. If we determine we intend to sell the debt security, we recognize the impairment loss in our results of operations. If we do not intend to sell the debt security, we determine whether it is more likely than not that we will be required to sell the debt security prior to recovery. If we determine it is more likely than not that we will be required to sell the debt security prior to recovery, we recognize an impairment loss in our results of operations. If we determine it is more likely than not that we will not be required to sell the debt security prior to recovery, we then evaluate whether a credit loss has occurred. We determine whether a credit loss has occurred by comparing the amortized cost of the debt security to the present value of the cash flows we expect to collect. If we expect a cash flow shortfall, we consider that a credit loss has occurred. If we determine that a credit loss has occurred, we consider the impairment to be other than temporary. We then recognize the amount of the impairment loss related to the credit loss in our results of operations, and we recognize the remaining portion of the impairment loss in our other comprehensive income, net of applicable taxes. In addition, we may write down securities in an unrealized loss position based on a number of other factors, including when the fair value of an investment is significantly below its cost, when the financial condition of the issuer of a security has deteriorated, the occurrence of industry, company or geographic events that have negatively impacted the value of a security and rating agency downgrades.
assumptions as to future loss trends, expected claims severity, judicial theories of liability and other factors. However, during the loss adjustment period, our insurance subsidiaries may learn additional facts regarding individual claims, and, consequently, it often becomes necessary for our insurance subsidiaries to refine and adjust their estimates for these liabilities. We reflect any adjustments to the liabilities for losses and loss expenses of our insurance subsidiaries in our consolidated results of operations in the period in which our insurance subsidiaries make adjustments to their estimates.
or better or, with respect to foreign reinsurers, to have a financial condition that, in the opinion of our management, is equivalent to a company with an A.M. Best rating of A-
Reinsurance for more information regarding the reinsurance agreements of our insurance subsidiaries.
We measure all share-based payments to our directors and the directors and employees of our subsidiaries and affiliates, including grants of stock options, using a fair-value-based method and record such expense in our results of operations. In determining the expense we record for stock options we grant to our directors and the directors and employees of our subsidiaries and affiliates, we estimate the fair value of each option award on the date of grant using the Black-Scholes option pricing model. The significant assumptions we utilize in applying the Black-Scholes option pricing model are the risk-free interest rate, expected term, dividend yield and expected volatility.
In 2020, 2019 and 2018, we realized $302,901, $64,765 and $25,938, respectively, in tax benefits upon the exercise of stock options.
We have two classes of common stock, which we refer to as Class A common stock and Class B common stock. Our Class A common stock is entitled to the declaration and payment of cash dividends that are at least 10% higher than those we declare and pay on our Class B common stock. Accordingly, we use the two-class method for the computation of earnings per common share. The two-class method
is an earnings allocation formula that determines earnings per share separately for each class of common stock based on dividends declared and an allocation of remaining undistributed earnings using a participation percentage that reflects the dividend rights of each class.
The following amounts represent reinsurance Atlantic States ceded to the pool during 2020, 2019 and 2018:
The following amounts represent reinsurance ceded to Donegal Mutual pursuant to these quota-share reinsurance agreements during 2020, 2019 and 2018:
In 2019 and 2020, each of our insurance subsidiaries had a catastrophe reinsurance agreement with Donegal Mutual that provided coverage under any one catastrophic occurrence above a set retention of $2,000,000, with a combined retention of $5,000,000 for a catastrophe involving a combination of our insurance subsidiaries, up to the amount Donegal Mutual and our insurance subsidiaries retained under catastrophe reinsurance agreements with unaffiliated reinsurers. Through December 31, 2018, Atlantic States, Southern and Le Mars each had a catastrophe reinsurance agreement with Donegal Mutual that provided coverage under any one catastrophic occurrence above a set retention ($2,500,000, $2,000,000 and $1,000,000 for Atlantic States, Southern and Le Mars, respectively, for 2018), with a combined retention of $5,000,000 for a catastrophe involving a combination of these subsidiaries, up to the amount Donegal Mutual and our insurance subsidiaries retained under catastrophe reinsurance agreements with unaffiliated reinsurers. Through December 31, 2018, Donegal Mutual and Southern had an excess of loss reinsurance agreement in which Donegal Mutual assumed up to $500,000 of Southern’s losses in excess of $500,000.
The following amounts represent reinsurance that our insurance subsidiaries ceded to Donegal Mutual pursuant to these reinsurance agreements during 2020, 2019 and 2018:
The following amounts represent the effect of affiliated reinsurance transactions on net premiums our insurance subsidiaries earned during 2020, 2019 and 2018:
Donegal Mutual is currently in the midst of a multi-year effort to modernize certain of its key technology infrastructure and application systems. In 2020, Donegal Mutual placed the first release of new systems into service and allocated $2.8 million of related costs to our insurance subsidiaries. Donegal Mutual will allocate to our insurance subsidiaries their proportionate share of the remaining $19.2 million of its costs for the first release over the next five years. Donegal Mutual incurred an additional $9.0 million of deferred costs related to releases under development that were not yet ready for their intended use at December 31, 2020.
We lease office equipment with terms ranging from 3 to 10 years to Donegal Mutual under a 10-year
The amortized cost and estimated fair values of our fixed maturities at December 31, 2020 and 2019 are as follows:
At December 31, 2020, our holdings of obligations of states and political subdivisions included general obligation bonds with an aggregate fair value of $263.6 million and an amortized cost of $247.5 million. Our holdings also included special revenue bonds with an aggregate fair value of $140.8 million and an amortized cost of $131.1 million. With respect to both categories of bonds, we held no securities of any issuer that comprised more than 10% of that category at December 31, 2020. Education bonds and water and sewer utility bonds represented 44% and 39%, respectively, of our total investments in special revenue bonds based on their carrying values at December 31, 2020. Many of the issuers of the special revenue bonds we held at December 31, 2020 have the authority to impose ad valorem taxes. In that respect, many of the special revenue bonds we held are similar to general obligation bonds.
The cost and estimated fair values of our equity securities at December 31, 2019 were as follows:
We held fixed maturities with unrealized losses representing declines that we considered temporary at December 31, 2020 as follows:
fixed maturity and equity securities at estimated fair value. The estimated fair value of a security may differ from the amount that we could realize if we sold the security in a forced transaction. In addition, the valuation of fixed maturity investments is more subjective when markets are less liquid, increasing the potential that the estimated fair value does not reflect the price at which an actual transaction would occur. We utilize nationally recognized independent pricing services to estimate fair values or obtain market quotations for substantially all of our fixed maturity and equity investments. We generally obtain
two prices per security. The pricing services utilize market quotations for fixed maturity and equity securities that have quoted prices in active markets. For fixed maturity securities that generally do not trade on a daily basis, the pricing services prepare estimates of fair value measurements based predominantly on observable market inputs. The pricing services do not use broker quotes in determining the fair values of our investments. Our investment personnel review the estimates of fair value the pricing services provide to determine if the estimates we obtain are representative of fair values based upon the general knowledge of the market of our investment personnel, their research findings related to unusual fluctuations in value and their comparison of such values to execution prices for similar securities. Our investment personnel monitor the market and are familiar with current trading ranges for similar securities and pricing of specific investments. Our investment personnel review all pricing estimates that we receive from the pricing services against their expectations with respect to pricing based on fair market curves, security ratings, coupon rates, security type and recent trading activity. Our investment personnel review documentation with respect to the pricing services’ pricing methodology that they obtain periodically to determine if the primary pricing sources, market inputs and pricing frequency for various security types are reasonable. At December 31, 2020, we received two estimates per security from the pricing services, and we priced substantially all of our Level 1 and Level 2 investments using those prices. In our review of the estimates the pricing services provided at December 31, 2020, we did not identify any material discrepancies, and we did not make any adjustments to the estimates the pricing services provided.
We evaluate our assets and liabilities on a regular basis to determine the appropriate level at which to classify them for each reporting period. Based on our review of the methodology and summary of inputs the pricing services use, we have concluded that our Level 1 and Level 2 investments were classified properly at December 31, 2020 and 2019.
The following table presents our fair value measurements for our investments in available-for-sale
The establishment of an appropriate liability for losses and loss expenses is an inherently uncertain process, and we can provide no assurance that our insurance subsidiaries’ ultimate liability will not exceed their loss and loss expense reserves and have an adverse effect on our results of operations and financial condition. For example, legislative, judicial and regulatory actions may expand coverage definitions, retroactively mandate coverage or otherwise require our insurance subsidiaries to pay losses for damages that their policies explicitly excluded or did not intend to cover. Furthermore, we cannot predict the timing, frequency and extent of adjustments to our insurance subsidiaries’ estimated future liabilities, because the historical conditions and events that serve as a basis for our insurance subsidiaries’ estimates of ultimate claim costs may change. As is the case for substantially all property and casualty insurance companies, our insurance subsidiaries have found it necessary in the past to increase their estimated future liabilities for losses and loss expenses in certain periods, and, in other periods, their estimates have exceeded their actual liabilities. Changes in our insurance subsidiaries’ estimate of their liability for losses and loss expenses generally reflect actual payments and their evaluation of information received since the prior reporting date.
Our insurance subsidiaries recognized a decrease in their liability for losses and loss expenses of prior years of
$12.9 million in each of 2020 and 2019. Our insurance subsidiaries recognized an increase in their liability for losses and loss expenses of prior years of
$35.6 million in 2018. Our insurance subsidiaries made no significant changes in their reserving philosophy or claims management personnel
In August 2020, we entered into a new credit agreement with Manufacturers and Traders Trust Company (“M&T”) that related to a $20.0 million unsecured demand line of credit. The line of credit has no expiration date, no
annual fees and no covenants. At December 31, 2020, we had no outstanding borrowings from M&T and had the ability to borrow up to $20.0 million at interest rates equal to the then-current LIBOR rate plus 2.00%.
Our insurance subsidiaries and Donegal Mutual implemented a combined third-party reinsurance program effective January 1, 2019. The coverage and parameters of the fully consolidated program are common to all of our insurance subsidiaries and Donegal Mutual. Our insurance subsidiaries use several different reinsurers, all of which have an A.M. Best rating of A-
rating from A.M. Best. The following information describes the external reinsurance our insurance subsidiaries had in place for 2020:
As many as 28 reinsurers provided coverage for 2020 on any one treaty with no reinsurer taking more than 20% of any one treaty.
The amount of coverage provided under each of these types of reinsurance depended upon the amount, nature, size and location of the risks being reinsured. In order to write automobile insurance in the State of Michigan, MICO is required to be a member of the Michigan Catastrophic Claims Association (“MCCA”). The MCCA provides reinsurance to MICO for personal automobile and commercial automobile personal injury claims in the State of Michigan over a set retention.
In addition to the pooling agreement and third-party reinsurance, our insurance subsidiaries had a catastrophe reinsurance agreement with Donegal Mutual, under which each of our insurance subsidiaries recovered 100% of an accumulation of multiple losses resulting from a single event, including natural disasters, over a set retention of $2.0 million up to aggregate losses of $13.0 million per occurrence. The agreement also provided additional coverage for an accumulation of losses from a single event including a combination of our insurance subsidiaries over a combined retention of $5.0 million.
The following amounts represent ceded reinsurance transactions with unaffiliated reinsurers during 2020, 2019 and 2018:
The following amounts represent the effect of reinsurance on premiums written for 2020, 2019 and 2018:
The following amounts represent the effect of reinsurance on premiums earned for 2020, 2019 and 2018:
The TCJA resulted in our reclassification of an alternative minimum tax credit carryforward of $8.5 million from net deferred tax assets to federal income taxes recoverable in 2017. We generated sufficient taxable income in 2019 to fully utilize this alternative minimum tax credit carryforward.
The tax effects of temporary differences that give rise to significant portions of our deferred tax assets and deferred tax liabilities at December 31, 2020 and 2019 are as follows:
We recorded a net operating loss carryforward for the portion of our taxable loss for 2018 that exceeded our taxable income in 2016 and 2017. We utilized the full net operating loss carryforward in 2019.
We provide a valuation allowance when we believe it is more likely than not that we will not realize some portion of a deferred tax asset. At December 31, 2020 and 2019, we established a valuation allowance of $7.9 million and $7.5 million, respectively, for the net state operating loss carryforward of DGI. We determined that we were not required to establish a
Each share of our Class A common stock outstanding at the time of the declaration of any dividend or other distribution payable in cash upon the shares of our Class B common stock is entitled to a dividend or distribution payable at the same time and to stockholders of record on the same date in an amount at least 10% greater than any dividend declared upon each share of our Class B common stock. In the event of our merger or consolidation with or into another entity, the holders of our Class A common stock and the holders of our Class B common stock are entitled to receive the same per share consideration in such merger or consolidation. In the event of our liquidation, dissolution or winding-up,
No further shares are available for future option grants for plans in effect prior to 2019.
share-based compensation granted under our stock compensation plans was $1.6 million and $2.0 million, respectively. We expect to recognize this cost over a weighted average period of 1.9 years.
On January 1, 2021, we issued 23,336 shares at a price of $11.96 per share under this plan.
The following table presents selected information, as filed with state insurance regulatory authorities, for our insurance subsidiaries as determined in accordance with accounting practices prescribed or permitted by such insurance regulatory authorities:
Our principal source of cash for payment of dividends is dividends from our insurance subsidiaries. State insurance laws require our insurance subsidiaries to maintain certain minimum capital and surplus amounts on a statutory basis. Our insurance
We do not allocate assets to the commercial and personal lines and review the two segments in total for purposes of decision-making. We operate only in the United States, and no single customer or agent provides 10 percent or more of our revenues.
Our insurance subsidiaries’ liabilities for guaranty fund and other insurance-related assessments were $1.6 million at December 31, 2020 and 2019. These liabilities included $485,322 and $519,462 related to surcharges collected by our insurance subsidiaries on behalf of regulatory authorities for 2020 and 2019, respectively.
We have audited the accompanying consolidated balance sheets of Donegal Group Inc. and subsidiaries (the Company) as of December 31, 2020 and 2019, the related consolidated statements of income (loss) and comprehensive income (loss), stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2020, and the related notes and financial statement schedule III (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2020, in conformity with U.S. generally accepted accounting principles.
issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated March 5, 2021 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
As discussed in Notes 1 and 8 to the consolidated financial statements, the Company estimates the liabilities for losses and loss expenses (reserves) through an internal reserve analysis that relies upon generally accepted actuarial practices. The Company develops reserve estimates by line of business and, as experience emerges and other information develops, the reserve estimates are assessed in aggregate and adjusted as necessary. As of December 31, 2020, the Company recorded a liability of $962,007,437 for reserves.
The following are the primary procedures we performed to address this critical audit matter. We evaluated, with the involvement of actuarial professionals, when appropriate, the design and tested the operating effectiveness of certain internal controls related to the Company’s reserving process. These included controls related to the Company’s actuarial analyses and determination of the Company’s estimate of recorded reserves. We involved actuarial professionals with specialized skills and knowledge, who assisted in:
evaluating the Company’s actuarial methods by comparing them to generally accepted actuarial practices
assessing the Company’s actuarial analyses, including their methods and assumptions, for certain remaining product lines comprised of those with smaller balances or shorter tail loss reporting and payment patterns