e10vk
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2009
OR
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number 0-15341
(Exact name of registrant as specified in its charter)
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Delaware
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23-2424711 |
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(State or other jurisdiction of
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(I.R.S. Employer |
incorporation or organization)
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Identification No.) |
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1195 River Road, Marietta, Pennsylvania
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17547 |
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(Address of principal executive offices)
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(Zip code) |
Registrants telephone number, including area code: (888) 877-0600
Securities registered pursuant to Section 12(b) of the Act:
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Title of Each Class
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Name of Each Exchange on Which Registered |
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Class A Common Stock, $.01 par value
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The NASDAQ Global Select Market |
Class B Common Stock, $.01 par value
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The NASDAQ Global Select Market |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant is a well-known seasoned issuer as defined in Rule
405 of the Securities Act: Yes o. No þ.
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or
15(d) of the Exchange Act. Yes o. No þ.
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports) and (2) has been subject
to such filing requirements for the past 90 days. Yes þ. No o.
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate website, if any, every Interactive Data File required to be submitted and posted pursuant
to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files). Yes o. No o.
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is
not contained herein, and will not be contained, to the best of registrants knowledge, in
definitive proxy or information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer,
non-accelerated filer, or a smaller reporting company. See definition of large accelerated
filer, accelerated filer or smaller reporting company in Rule 12b-2 of the Exchange Act (check
one):
Large accelerated filer o |
Accelerated filer þ |
Non-accelerated filer o (Do not check if a smaller reporting company) |
Smaller reporting company o |
Indicate by check mark whether the registrant is a shell company. Yes o. No þ.
State the aggregate market value of the voting and non-voting common equity held by non-affiliates
computed by reference to the price at which the common equity was last sold, or the average bid and
asked price of such common equity, as of the last business day of the registrants most recently
completed second fiscal quarter. $184,425,596.
Indicate the number of shares outstanding of each of the registrants classes of common stock, as
of the latest practicable date: 19,924,944 shares of Class A common stock and 5,576,775 shares of
Class B common stock outstanding on February 26, 2010.
DOCUMENTS INCORPORATED BY REFERENCE:
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Portions of the registrants annual report to stockholders for the fiscal year
ended December 31, 2009 are incorporated by reference into Parts I, II and IV of this
report. |
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2. |
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Portions of the registrants proxy statement relating to registrants annual
meeting of stockholders to be held April 15, 2010 are incorporated by reference into
Part III of this report. |
DONEGAL GROUP INC.
INDEX TO FORM 10-K REPORT
(i)
PART I
Item 1. Business.
(a) General Development of Business.
We are an insurance holding company whose insurance subsidiaries offer personal and commercial
lines of property and casualty insurance to businesses and individuals in 18 Mid-Atlantic,
Midwestern and Southeastern states. Our insurance subsidiaries provide their policyholders with a
selection of insurance products at competitive rates, while pursuing profitability through
adherence to a strict underwriting discipline. At December 31, 2009, we had total assets of $935.6
million and stockholders equity of $385.5 million. Our net income was $18.8 million for the year
ended December 31, 2009 compared to $25.5 million for the year ended December 31, 2008.
Donegal Mutual Insurance Company (Donegal Mutual) owns approximately 41.9% of our Class A
common stock and approximately 75.0% of our Class B common stock. Donegal Mutuals stock ownership
in the aggregate represents approximately two-thirds of the voting power of our outstanding common
stock. Our insurance subsidiaries and Donegal Mutual have interrelated operations. 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 have the same business philosophy, the same management, the same employees
and the same facilities and offer the same types of insurance products.
Our growth strategies include the acquisition of other insurance companies to expand our
business in a given region or to commence operations in a new region. We and Donegal Mutual have
the ability to employ a number of acquisition and affiliation methods. Our prior acquisitions and
affiliations have taken one of the following forms:
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a purchase of all of the outstanding stock of a stock insurance company; |
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a purchase of a book of business; |
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a reinsurance transaction; or |
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a two-step acquisition of a mutual insurance company in which: |
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as the first step, Donegal Mutual purchases a surplus note from the mutual
insurance company, Donegal Mutual enters into a management agreement with the
mutual insurance company and Donegal Mutuals designees become a majority of the members of the board of directors of
the mutual insurance company. |
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as the second step, the mutual insurance company enters into a quota-share
reinsurance agreement with Donegal Mutual or demutualizes, or converts, into a
stock insurance company. Upon the conversion, we purchase the surplus note
from Donegal Mutual and exchange it for all of the stock of the stock
insurance company resulting from the conversion. |
We believe that our ability to make direct acquisitions of stock insurance companies and to
make indirect acquisitions of mutual insurance companies through a sponsored conversion or a
quota-share reinsurance agreement provides us with flexibility that is a competitive advantage in
seeking acquisitions. We also believe we have demonstrated our ability to acquire control of an
underperforming insurance company, reunderwrite its book of business, reduce its cost structure and
return it to profitability.
While Donegal Mutual and we generally engage in preliminary discussions with potential direct
or indirect acquisition candidates on an almost continuous basis and are so engaged at the date of
this Form 10-K Report, neither Donegal Mutual nor we make any public disclosure regarding an
acquisition until Donegal Mutual or we have entered into a definitive acquisition agreement.
Donegal Mutual completed a quota-share reinsurance transaction with Southern Mutual Insurance
Company, a Georgia-domiciled mutual property and casualty insurance company (Southern Mutual),
effective October 31, 2009. As part of the transaction, Donegal Mutual purchased a $2.5 million
surplus note of Southern Mutual for $2.5 million in cash. Simultaneously, Southern Mutual elected
seven Donegal Mutual designees as members of the 12-member board of directors of Southern Mutual.
For the year ended December 31, 2009, Southern Mutual had direct written premium of $13.3 million.
Effective October 31, 2009, Donegal Mutual began to include business assumed from Southern Mutual
in its pooling agreement with Atlantic States. As a result, our consolidated results of operations
include 80% of Southern Mutuals underwriting activity from and after October 31, 2009.
(b) Financial Information About Industry Segments.
We have three segments, which consist of our investment function, our personal lines function
and our commercial lines function. Financial information about these segments is set forth in Note
20 to our consolidated financial statements incorporated by reference in this Form 10-K Report.
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(c) Narrative Description of Business.
Who We Are
We are an insurance holding company whose insurance subsidiaries offer personal and commercial
lines of property and casualty insurance to small businesses and individuals in 18 Mid-Atlantic,
Midwestern and Southeastern states. Our insurance subsidiaries provide their policyholders with a
selection of insurance products at competitive rates, while pursuing profitability by adhering to a
strict underwriting discipline.
Our insurance subsidiaries derive a substantial portion of their insurance business from
smaller to mid-sized regional communities. We believe this focus provides our insurance
subsidiaries with competitive advantages in terms of local market knowledge, marketing,
underwriting, claims servicing and policyholder service. At the same time, we believe our
insurance subsidiaries have cost advantages over many smaller regional insurers because of the
centralized accounting, administrative, data processing, investment and other services available to
our insurance subsidiaries on a cost-effective basis because of economies of scale.
Strategy
The annual net premiums our insurance subsidiaries earn have increased from $196.8 million in
2003 to $355.0 million in 2009, a compound annual growth rate of 10%. Over the same time period,
our insurance subsidiaries have achieved a combined ratio consistently more favorable than that of
the property and casualty insurance industry as a whole. Our insurance subsidiaries seek to
increase their annual net premiums earned and enhance their profitability by:
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Achieving underwriting profitability. |
Our insurance subsidiaries focus on achieving a combined ratio of less than 100%. We believe
that underwriting profitability is a fundamental component of our long-term financial strength
because it allows our insurance subsidiaries to generate profits without relying on their
investment income. Our insurance subsidiaries seek to enhance their underwriting results by:
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carefully selecting the product lines each underwrites; |
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carefully selecting the individual risks each underwrites; |
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minimizing its individual exposure to catastrophe-prone areas; and |
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evaluating their claims history on a regular basis to ensure the adequacy
of their underwriting guidelines and product pricing. |
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Our insurance subsidiaries have no material exposures to asbestos and environmental
liabilities. Our insurance subsidiaries seek to provide more than one policy to a given personal
or commercial customer because this account selling strategy diversifies their risk and has
historically improved their underwriting results. Finally, our insurance subsidiaries use
reinsurance to manage their exposure and limit their maximum net loss from large single risks or
risks in concentrated areas. Our insurance subsidiaries believe these practices are key factors in
their ability to maintain a combined ratio that has been traditionally more favorable than the
combined ratio of the property and casualty insurance industry.
The combined ratio of our insurance subsidiaries and that of the property and casualty
insurance industry for the years 2005 through 2009 are shown in the following table:
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2005 |
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Our GAAP combined ratio |
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89.5 |
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89.0 |
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91.3 |
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97.2 |
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102.2 |
% |
Our SAP combined ratio |
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88.2 |
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87.4 |
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90.2 |
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95.1 |
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101.1 |
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Industry SAP combined ratio(1) |
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101.2 |
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92.4 |
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95.6 |
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104.7 |
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100.6 |
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As reported or projected by A.M. Best. |
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Pursuing profitable growth by organic expansion within the traditional
operating territories of our insurance subsidiaries through developing and maintaining
quality agency representation. |
We believe that continued expansion of our insurance subsidiaries within their existing
markets will be a key source of their continued premium growth and that maintaining an effective
and growing network of independent agencies is integral to their expansion. Our insurance
subsidiaries seek to be among the top three insurers within each of the independent agencies for
the lines of business our insurance subsidiaries write by providing a consistent, competitive and
stable market for their products. We believe that the consistency of their product offerings
enables our insurance subsidiaries to compete effectively for agents with other insurers whose
product offerings fluctuate based on industry conditions. Our insurance subsidiaries offer a
competitive compensation program to their independent agents that rewards them for producing
profitable growth for our insurance subsidiaries. Our insurance subsidiaries provide their
independent agents with ongoing support to enable them to better attract and service customers,
including:
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fully automated underwriting and policy issuance systems for both personal
and commercial lines; |
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training programs; |
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marketing support; and |
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field visitations by marketing and underwriting personnel and senior
management of our insurance subsidiaries. |
Finally, our insurance subsidiaries appoint independent agencies with a strong underwriting and
growth track record. We believe that our insurance subsidiaries, by carefully selecting,
motivating and supporting their independent agency forces, will be able to drive continued
long-term growth.
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Acquiring property and casualty insurance companies to augment the organic growth
of our insurance subsidiaries in existing markets and to expand into new geographic
regions. |
We have completed six acquisitions of property and casualty insurance companies or their
business since 1995. We intend to continue our growth by pursuing affiliations and acquisitions
that meet our criteria. Our primary criteria include:
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Location in regions where our insurance subsidiaries are currently
conducting business or that offer an attractive opportunity to conduct
profitable business; |
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A mix of business similar to the mix of business of our insurance
subsidiaries; |
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Premium volume up to $100.0 million; and |
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Fair and reasonable transaction terms. |
We believe that our interrelationship with Donegal Mutual assists us in pursuing affiliations
with and subsequent acquisitions of mutual insurance companies because, through Donegal Mutual, we
understand the concerns and issues that mutual insurance companies face. In particular, we have
had success affiliating with underperforming mutual insurance companies and acquiring them
following their conversion to a stock company by utilizing our strengths and financial position to
improve their operations significantly. We evaluate a number of areas for operational synergies
when considering acquisitions, including product underwriting, expenses, the cost of reinsurance
and technology.
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Focusing on expense controls and utilization of technology to increase the
operating efficiency of our insurance subsidiaries. |
Our insurance subsidiaries maintain stringent expense controls under direct supervision of
their senior management. We centralize many processing and administrative activities of our
insurance subsidiaries to realize operating synergies and better control expenses. Our insurance
subsidiaries utilize technology to automate much of their underwriting and to facilitate agency and
policyholder communications on an efficient and
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cost-effective basis. We operate on a paperless basis. As a result of our focus on expense control, our insurance subsidiaries have reduced their
expense ratio from 36.6% in 1999 to 31.3% in 2009. Our insurance subsidiaries have also increased
their annual premium per employee, a measure of efficiency that our insurance subsidiaries use to
evaluate their operations, from approximately $470,000 in 1999 to approximately $777,000 in 2009.
Our insurance subsidiaries maintain technology comparable to that of the largest of their
competitors. Ease of doing business is an increasingly important component of an insurers value
to an independent agency. Our insurance subsidiaries provide a fully automated personal lines
underwriting and policy issuance system called WritePro®. WritePro® is a
web-based user interface that substantially eases data entry and facilitates the quoting and
issuance of policies for our independent agents. Our insurance subsidiaries also provide a similar
commercial business system called WriteBiz®. WriteBiz® is a web-based
interface that provides the independent agents of our insurance subsidiaries with an online ability
to quote and issue commercial automobile, workers compensation, businessowners and tradesman
policies automatically. As a result, applications of the independent agents for our insurance
subsidiaries can become policies without further re-entry of information. Both systems download
the policy information to the policy management systems of the independent agents of our insurance
subsidiaries.
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Providing responsive and friendly customer and agent service to enable our
insurance subsidiaries to attract new policyholders and retain existing policyholders. |
We believe that excellent policyholder service is important in attracting new policyholders
and retaining existing policyholders. Our insurance subsidiaries work closely with their
independent agents to provide a consistently responsive level of claims service, underwriting and
customer support. Our insurance subsidiaries seek to respond expeditiously and effectively to
address customer and independent agent inquiries, including:
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Availability of a state-of-the-art customer call center; |
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Availability of a secure website for access to policy information and
documents, payment processing and other features; |
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Quick replies to information requests and policy submissions; and |
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Prompt responses to and processing of claims. |
Our insurance subsidiaries periodically conduct policyholder surveys to evaluate the
effectiveness of their service to policyholders. The management of our insurance subsidiaries
meets frequently with the personnel of the independent insurance agents our insurance subsidiaries
appoint to seek service improvement recommendations, react to service issues and better understand
local market conditions.
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Maintaining premium rate adequacy to enhance the underwriting results of our
insurance subsidiaries, while maintaining their existing book of business and
preserving their ability to write new business. |
Our insurance subsidiaries seek discipline in their pricing by effecting rate increases to
maintain or improve their underwriting profitability without unduly affecting their customer
retention. In addition to appropriate pricing, our insurance subsidiaries seek to ensure that
their premium rates are adequate relative to their level of underwriting risk. Our insurance
subsidiaries review loss trends on a periodic basis to identify changes in the frequency and
severity of their claims and to assess the adequacy of their rates and underwriting standards. Our
insurance subsidiaries also carefully monitor and audit the information they use to price their
policies, enabling them to receive an adequate level of premiums for their risk. For example, our
insurance subsidiaries inspect substantially all commercial lines risks and a substantial number of
personal lines property risks they insure to determine the adequacy of the insured amount to the
value of the insured property, assess property conditions and identify any liability exposures.
Our insurance subsidiaries audit the payroll data of their workers compensation customers to
verify that the assumptions used to price a particular policy were accurate. By implementing
appropriate rate increases and understanding the risks our insurance subsidiaries insure, they are
able to achieve their strategy of achieving consistent underwriting profitability.
Our Organizational Structure
We have six insurance subsidiaries: Atlantic States Insurance Company (Atlantic States),
Southern Insurance Company of Virginia (Southern), Le Mars Insurance Company (Le Mars),
Peninsula Insurance Group, which consists of The Peninsula Insurance Company and its wholly owned
subsidiary, Peninsula Indemnity Company (collectively, the Peninsula Companies) and Sheboygan.
In addition, we benefit from Donegal Mutuals 100% quota-share reinsurance agreement with Southern
Mutual and Donegal Mutuals placement of its assumed business from Southern Mutual in the pooling
agreement. We also own 48.2% of Donegal Financial Services Corporation (DFSC), a registered
savings and loan holding company that owns Province Bank FSB, or Province Bank, a federal savings
bank that began operations in 2000. Donegal Mutual owns the remaining 51.8% of DFSC. While
not material to our operations, we believe Province Bank, with total assets of $98.4 million
at December 31, 2009, complements the product offerings of our insurance subsidiaries. The
following chart summarizes our organizational structure and includes all of our property and
casualty insurance subsidiaries and Southern Mutual:
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Because of the different relative voting power of our Class A common stock and our Class B
common stock, our public stockholders hold approximately 33.7% of the aggregate voting power of our
Class A common stock and Class B common stock and Donegal Mutual holds approximately 66.3% of the
aggregate voting power of our Class A common stock and Class B common stock. |
In the mid-1980s, Donegal Mutual recognized the need to develop additional sources of
capital and surplus to remain competitive and to have the capacity to expand its business and
assure its long-term viability. Donegal Mutual determined to implement a downstream holding
company structure as a strategic response. Thus, in 1986, Donegal Mutual formed us as a downstream
holding company then wholly owned by Donegal Mutual. We in turn formed Atlantic States as our
wholly owned subsidiary. We then effected a public offering to provide the surplus necessary to
support the business we began to receive on October 1, 1986 pursuant to a proportional reinsurance
agreement, or pooling agreement, between Donegal Mutual and Atlantic States that became effective
on that date.
Under this pooling agreement, Donegal Mutual and Atlantic States pool substantially all of
their respective premiums, losses and loss expenses. Donegal Mutual then cedes 80% of the pooled
business to Atlantic States.
As the capital of Atlantic States has increased, its underwriting capacity has increased
proportionately. Therefore, as we originally planned in the mid-1980s, Atlantic States has
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successfully raised the capital necessary to support the growth of its direct business as well as
accept increases in its allocation of business from the underwriting pool, which has increased from
an initial allocation of 35% in 1986 to an 80% allocation since March 1, 2008. The size of the
underwriting pool has increased substantially. We do not anticipate any further changes in the
pooling agreement between Atlantic States and Donegal Mutual in the foreseeable future, including
any change in the percentage participation of Atlantic States in the underwriting pool.
Since we established our downstream holding company structure in 1986, Donegal Mutual and our
insurance subsidiaries have conducted business together while maintaining their separate legal and
corporate existence. As such, Donegal Mutual and our insurance subsidiaries share the same
business philosophies, the same management, the same employees, the same facilities and we offer
the same types of insurance products.
In addition, as the Donegal Insurance Group, Donegal Mutual and our insurance subsidiaries
share a combined business plan to achieve market penetration and underwriting profitability
objectives. The products Donegal Mutual and our insurance subsidiaries offer are generally
complementary, thereby allowing the Donegal Insurance Group to offer a broader range of products to
a given market and to expand the Donegal Insurance Groups ability to service an entire personal
lines or commercial lines account. Distinctions within the products of Donegal Mutual and our
insurance subsidiaries often generally relate to specific risk profiles targeted within similar
classes of business, such as preferred tier versus standard tier products, but we and Donegal
Mutual do not allocate all of the standard risk gradients to one company. Therefore, the
underwriting profitability of the business the individual companies write directly will vary.
However, since the underwriting pool homogenizes the risk characteristics of all business Donegal
Mutual and Atlantic States write directly, Donegal Mutual and Atlantic States share the
underwriting results in proportion to their respective participation in the pool. We realize 80%
of the underwriting results of the pool because Atlantic States has an 80% participation in the
pool. The business Atlantic States derives from the pool represents the predominant percentage of
our total revenues.
The following chart depicts the underwriting pool as effective since March 1, 2008:
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Donegal Mutual provides facilities, personnel and other services to us and our insurance
subsidiaries. Donegal Mutual allocates certain related expenses to Atlantic States in relation to
the relative participation of Donegal Mutual and Atlantic States in the pooling agreement. Our
insurance subsidiaries other than Atlantic States reimburse Donegal Mutual for their respective
personnel costs and bear their proportionate share of information services costs based on their
respective percentage of the total written premiums of the Donegal Insurance Group. Charges for
these services totaled $60.2 million, $52.3 million and $48.8 million for 2009, 2008 and 2007,
respectively.
We and Donegal Mutual have maintained a coordinating committee since our formation in 1986.
The coordinating committee consists of two members of our board of directors, neither of whom is a
member of Donegal Mutuals board of directors, and two members of Donegal Mutuals board of
directors, neither of whom is a member of our board of directors. The purpose of the coordinating
committee is to establish and maintain a process whereby the transactions between Donegal Mutual
and our insurance subsidiaries can be the subject of an annual evaluation process, in which both
parties have separate approval rights, that considers the fairness of each intercompany transaction
to Donegal Mutual and its policyholders and to us and our stockholders.
A new agreement or any change to a previously approved agreement must receive coordinating
committee approval. The coordinating committee approval process for a new agreement between Donegal Mutual and us or one of our insurance subsidiaries or a change in
such an agreement is as follows:
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both of our members on the coordinating committee must determine that the new
agreement or the change in an existing agreement is fair and equitable to us and in
the best interests of our stockholders; |
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both of Donegal Mutuals members on the coordinating committee must determine that
the new agreement or the change in an existing agreement is fair and equitable to
Donegal Mutual and its policyholders; |
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the new agreement or the change in an existing agreement must be approved by our
board of directors; and |
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the new agreement or the change in an existing agreement must be approved by the
Donegal Mutual board of directors. |
The coordinating committee also meets annually to review each existing agreement between
Donegal Mutual and us or our insurance subsidiaries, including a number of reinsurance agreements
between Donegal Mutual and our insurance subsidiaries. The purpose of the review is to examine the
results of the reinsurance agreements over the past year and over a five-year period and to
determine if the terms of the existing agreements remain fair and equitable to us and our
stockholders and fair and equitable to Donegal Mutual and its policyholders or if Donegal Mutual
and we should mutually agree to certain adjustments. In the case of these reinsurance agreements,
the adjustments typically relate to the reinsurance premiums, losses and reinstatement premiums.
These agreements are ongoing in nature and will continue in effect throughout 2010 in the ordinary
course of business.
Our members on the coordinating committee are Robert S. Bolinger and John J. Lyons. Donegal
Mutuals members on the coordinating committee are John E. Hiestand and Frederick W. Dreher.
Reference is made to our proxy statement for our annual meeting of stockholders on April 15, 2010
for information on the members of the coordinating committee.
We believe our relationships with Donegal Mutual offer us and our insurance subsidiaries a
number of competitive advantages, including the following:
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Facilitating the stable management, consistent underwriting discipline, external
growth and long-term profitability of our insurance subsidiaries; |
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Creating operational and expense synergies given the combined resources and
operating efficiencies of Donegal Mutual, us and our insurance subsidiaries; |
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Enhancing our opportunities to expand by acquisition because of the ability of
Donegal Mutual to acquire control of other mutual insurance companies and |
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thereafter
demutualize them and then sell them to us at a price that is based on a fairness
opinion; |
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Producing more uniform and stable underwriting results for our insurance
subsidiaries that we, over extended periods of time, could achieve without the
relationship between Donegal Mutual and our insurance subsidiaries; and |
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Providing Atlantic States with a significantly larger underwriting capacity because
of the underwriting pool Donegal Mutual and Atlantic States have maintained since
1986. |
Acquisitions
The following table highlights our acquisition history since 1988:
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Year |
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Control |
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Company Name |
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State of Domicile |
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Acquired(2) |
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Method of Acquisition |
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Southern Mutual Insurance
Company and now Southern
Insurance Company of Virginia
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Virginia
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1984 |
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Surplus note investment by
Donegal Mutual in 1984;
demutualization in 1988;
acquisition of stock by us in
1988. |
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Pioneer Mutual Insurance
Company and then
Pioneer Insurance Company (1)
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Ohio
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1992 |
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Surplus note investment by
Donegal Mutual in 1992;
demutualization in 1993;
acquisition of stock by us in
1997. |
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Delaware Mutual Insurance
Company and then
Delaware Atlantic Insurance
Company (1)
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Delaware
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1993 |
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Surplus note investment by
Donegal Mutual in 1993;
demutualization in 1994;
acquisition of stock by us in
1995. |
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Year |
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Control |
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Company Name |
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State of Domicile |
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Acquired(2) |
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Method of Acquisition |
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Pioneer Mutual Insurance
Company and then
Pioneer Insurance Company (1)
|
|
New York
|
|
|
1995 |
|
|
Surplus note investment by
Donegal Mutual in 1995;
demutualization in 1998;
acquisition of stock by us in
2001. |
|
|
|
|
|
|
|
|
|
Southern Heritage Insurance
Company (1)
|
|
Georgia
|
|
|
1998 |
|
|
Purchase of stock by us in 1998. |
|
|
|
|
|
|
|
|
|
Le Mars Mutual Insurance
Company of Iowa and now
Le Mars Insurance Company
|
|
Iowa
|
|
|
2002 |
|
|
Surplus note investment by
Donegal Mutual in 2002;
demutualization in 2004;
acquisition of stock by us in
2004. |
|
|
|
|
|
|
|
|
|
Peninsula Insurance Group
|
|
Maryland
|
|
|
2004 |
|
|
Purchase of stock by us in 2004. |
|
|
|
|
|
|
|
|
|
Sheboygan Falls Mutual
Insurance Company and now
Sheboygan Falls Insurance
Company
|
|
Wisconsin
|
|
|
2007 |
|
|
Contribution note investment by
Donegal Mutual in 2007;
demutualization in 2008;
acquisition of stock by us in
2008. |
|
|
|
|
|
|
|
|
|
Southern Mutual Insurance
Company
|
|
Georgia
|
|
|
2009 |
|
|
Surplus note investment by
Donegal Mutual and quota-share
reinsurance. |
|
|
|
(1) |
|
To reduce administrative and compliance costs and expenses, these subsidiaries subsequently
merged into one of our existing insurance subsidiaries. |
|
(2) |
|
Control acquired by Donegal Mutual or us. |
Distribution
Our insurance subsidiaries market their products primarily in the Mid-Atlantic, Midwest and
Southeast regions through approximately 2,000 independent insurance
agencies. At December 31, 2009, the Donegal Insurance Group actively wrote business in 18
states (Alabama, Delaware, Georgia, Iowa, Maryland, Nebraska, New Hampshire, New York,
-13-
North Carolina, Ohio, Oklahoma, Pennsylvania, South Carolina, South Dakota, Tennessee, Virginia, West
Virginia and Wisconsin). We believe the relationships of our insurance subsidiaries with their
independent agents are valuable in identifying, obtaining and retaining profitable business. Our
insurance subsidiaries maintain a stringent agency selection procedure that emphasizes appointing
agencies with proven marketing strategies for the development of profitable business, and our
insurance subsidiaries only appoint agencies with a strong underwriting history and potential
growth capabilities. Our insurance subsidiaries also regularly evaluate the independent agencies
that represent them based on their profitability and performance in relation to the objectives of
our insurance subsidiaries. Our insurance subsidiaries seek to be among the top three insurers
within each of their agencies for the lines of business they write.
The following table sets forth the percentage of direct premiums our insurance subsidiaries
write, including 80% of the direct premiums Donegal Mutual and Atlantic States write, in each of
the states where they conducted a significant portion of their business in 2009:
|
|
|
|
|
Pennsylvania |
|
|
46.6 |
% |
Maryland |
|
|
11.7 |
|
Virginia |
|
|
10.9 |
|
Georgia |
|
|
7.0 |
|
Delaware |
|
|
6.4 |
|
Ohio |
|
|
3.5 |
|
Iowa |
|
|
3.1 |
|
Wisconsin |
|
|
2.4 |
|
Tennessee |
|
|
1.9 |
|
Nebraska |
|
|
1.5 |
|
South Dakota |
|
|
1.4 |
|
Oklahoma |
|
|
1.0 |
|
Other |
|
|
2.6 |
|
|
|
|
|
|
Total |
|
|
100.0 |
% |
|
|
|
|
|
We believe our insurance subsidiaries employ a number of policies and procedures that enable
them to attract, retain and motivate their independent agents. The consistency, competitiveness
and stability of the product offerings of our insurance subsidiaries assist them in competing
effectively for independent agents with other insurers whose product offerings may fluctuate based
upon industry conditions. Our insurance subsidiaries have a competitive profit sharing plan for
their independent agents consistent with applicable state laws and regulations, under which the independent agents may earn additional commissions based
upon the volume of premiums produced and the profitability of the business our insurance
subsidiaries receive from that agency. Our insurance subsidiaries provide their
-14-
independent agents ongoing support that better enables the agents to attract and retain customers, including:
|
|
|
fully automated underwriting and policy issuance systems for both personal and
commercial lines; |
|
|
|
|
training programs; |
|
|
|
|
marketing support; and |
|
|
|
|
field visitations from marketing and underwriting personnel and senior management
of our insurance subsidiaries. |
Finally, our insurance subsidiaries encourage their independent agents to focus on account
selling, or serving all of a particular insureds property and casualty insurance needs, which our
insurance subsidiaries believe generally results in more favorable loss experience than covering a
single risk for an individual insured.
Products
The personal lines our insurance subsidiaries write consist primarily of private passenger
automobile and homeowners insurance. The commercial lines our insurance subsidiaries write consist
primarily of commercial automobile, commercial multi-peril and workers compensation insurance. We
describe these types of insurance in greater detail below:
Personal
|
|
|
Private passenger automobile policies that provide protection against liability
for bodily injury and property damage arising from automobile accidents, and
protection against loss from damage to automobiles owned by the insured. |
|
|
|
|
Homeowners policies that provide coverage for damage to residences and their
contents from a broad range of perils, including fire, lightning, windstorm and theft.
These policies also cover liability of the insured arising from injury to other
persons or their property while on the insureds property and under other specified
conditions. |
Commercial
|
|
|
Commercial automobile policies that provide protection against liability for bodily
injury and property damage arising from automobile accidents, and protection against loss from
damage to automobiles owned by the insured. |
-15-
|
|
|
Commercial multi-peril policies that provide protection to businesses
against many perils, usually combining liability and physical damage coverages. |
|
|
|
|
Workers compensation policies employers purchase to provide benefits to
employees for injuries sustained during employment. The workers compensation laws of
each state determine the extent of the coverage we provide. |
The following table sets forth the net premiums written by line of insurance by our insurance
subsidiaries for the periods indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, |
|
|
|
2007 |
|
|
2008 |
|
|
2009 |
|
(dollars in thousands) |
|
Amount |
|
|
% |
|
|
Amount |
|
|
% |
|
|
Amount |
|
|
% |
|
Net Premiums Written: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Personal lines: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Automobile |
|
$ |
132,452 |
|
|
|
42.2 |
% |
|
$ |
154,091 |
|
|
|
42.2 |
% |
|
$ |
161,932 |
|
|
|
44.6 |
% |
Homeowners |
|
|
58,602 |
|
|
|
18.7 |
|
|
|
72,195 |
|
|
|
19.8 |
|
|
|
77,420 |
|
|
|
21.3 |
|
Other |
|
|
11,299 |
|
|
|
3.6 |
|
|
|
13,254 |
|
|
|
3.6 |
|
|
|
13,135 |
|
|
|
3.6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total personal lines |
|
$ |
202,353 |
|
|
|
64.5 |
|
|
$ |
239,540 |
|
|
|
65.6 |
|
|
$ |
252,487 |
|
|
|
69.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial lines: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Automobile |
|
|
32,059 |
|
|
|
10.2 |
|
|
$ |
35,959 |
|
|
|
9.9 |
|
|
$ |
34,054 |
|
|
|
9.4 |
|
Workers compensation |
|
|
32,361 |
|
|
|
10.3 |
|
|
|
36,459 |
|
|
|
10.0 |
|
|
|
28,921 |
|
|
|
8.0 |
|
Commercial multi-peril |
|
|
43,559 |
|
|
|
13.9 |
|
|
|
49,004 |
|
|
|
13.4 |
|
|
|
44,000 |
|
|
|
12.1 |
|
Other |
|
|
3,357 |
|
|
|
1.1 |
|
|
|
3,979 |
|
|
|
1.1 |
|
|
|
3,767 |
|
|
|
1.0 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total commercial lines |
|
$ |
111,336 |
|
|
|
35.5 |
|
|
$ |
125,401 |
|
|
|
34.4 |
|
|
$ |
110,742 |
|
|
|
30.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total business |
|
$ |
313,689 |
|
|
|
100.0 |
% |
|
$ |
364,941 |
|
|
|
100.0 |
% |
|
$ |
363,229 |
|
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Underwriting
The personal lines and commercial lines underwriting departments of our insurance subsidiaries
evaluate and select those risks that they believe will enable our insurance subsidiaries to achieve
an underwriting profit. The underwriting departments have significant interaction with the
independent agents regarding the underwriting philosophy and underwriting guidelines of our
insurance subsidiaries. Our underwriting personnel also assist the research and development
department in the development of quality products at competitive prices to promote growth and
profitability.
In order to achieve underwriting profitability on a consistent basis, our insurance
subsidiaries:
|
|
|
assess and select quality standard and preferred risks; |
|
|
|
|
adhere to disciplined underwriting and reunderwriting guidelines; |
-16-
|
|
|
inspect substantially all commercial lines risks and a substantial number of
personal lines property risks; and |
|
|
|
|
utilize various types of risk management and loss control services. |
Our insurance subsidiaries also review their existing policies and accounts to determine
whether those risks continue to meet their underwriting guidelines. If a given policy or account
no longer meets those underwriting guidelines, our insurance subsidiaries will take appropriate
action regarding that policy or account, including raising premium rates or non-renewing the policy
to the extent permitted by applicable law.
As part of the effort of our insurance subsidiaries to maintain acceptable underwriting
results, they conduct annual reviews of agencies that have failed to meet their underwriting
profitability criteria. The review process includes an analysis of the underwriting and
reunderwriting practices of the agency, the completeness and accuracy of the applications submitted
by the agency, the adequacy of the training of the agencys staff and the agencys record of
adherence to the underwriting guidelines and service standards of our insurance subsidiaries.
Based on the results of this review process, the marketing and underwriting personnel of our
insurance subsidiaries develop, together with the agency, a plan to improve its underwriting
profitability. Our insurance subsidiaries monitor the agencys compliance with the plan, and take
other measures as required in the judgment of our insurance subsidiaries, including the termination
of agencies that are unable to achieve acceptable underwriting profitability to the extent
applicable law permits.
Claims
The management of claims is a critical component of the philosophy of our insurance
subsidiaries to achieve underwriting profitability on a consistent basis and is fundamental to the
successful operations of our insurance subsidiaries and their dedication to excellent service.
The claims departments of our insurance subsidiaries rigorously manage claims to assure that
they settle legitimate claims quickly and fairly and that they identify questionable claims for
defense. In the majority of cases, the personnel of our insurance subsidiaries, who have
significant experience in the property and casualty insurance industry and know the service
philosophy of our insurance subsidiaries, adjust claims. Our insurance subsidiaries provide
various means of claims reporting on 24-hours a day, seven-day a week basis, including toll-free
numbers and electronic reporting through our website. Our insurance subsidiaries strive to respond
to notifications of claims promptly, generally within the day reported. Our insurance subsidiaries
believe that by responding promptly to claims, they provide quality customer service and minimize
the ultimate cost of the claims. Our insurance subsidiaries engage independent adjusters as needed
to handle claims in areas in which the volume of claims is not sufficient to justify our hiring of
internal claims adjusters.
-17-
Our insurance subsidiaries also employ private adjusters and investigators, structural experts
and various outside legal counsel to supplement our in-house staff and to assist in the
investigation of claims. Our insurance subsidiaries have a special investigative unit staffed by
former law enforcement officers that attempts to identify and prevent fraud and abuse and to
control questionable claims.
The management of the claims departments of our insurance subsidiaries develops and implements
policies and procedures for the establishment of adequate claim reserves. Our insurance
subsidiaries employ an actuarial staff that regularly reviews their reserves for incurred but not
reported claims. The management and staff of the claims departments resolve policy coverage
issues, manage and process reinsurance recoveries and handle salvage and subrogation matters. The
litigation and personal injury sections of our insurance subsidiaries manage all claims litigation,
and branch office claims above certain thresholds require home office review and settlement
authorization. Our insurance subsidiaries provide their claims adjusters reserving and settlement
authority based upon their experience and demonstrated abilities. Larger or more complicated
claims require consultation and approval of senior department management.
The field office staff of our insurance subsidiaries receives support from home office
technical, litigation, material damage, subrogation and medical audit personnel.
Liabilities for Losses and Loss Expenses
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 policyholder claims based on facts and circumstances then
known. 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 and 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 of liability. We reflect any adjustments to our
insurance subsidiaries liabilities for losses and loss expenses in our operating results in the
period in which our insurance subsidiaries make the changes in their estimates.
Our insurance subsidiaries maintain liabilities for the payment of losses and loss expenses
with respect to both reported and unreported claims. Our insurance subsidiaries establish these
liabilities for the purpose of covering the ultimate costs of settling all losses, including
investigation and litigation costs. Our insurance subsidiaries base the amount of their liability
for reported losses primarily upon a case-by-case evaluation of the type of risk involved,
knowledge of the circumstances surrounding each claim and the insurance policy provisions relating
to the type of loss. Our insurance subsidiaries determine the amount of
-18-
their liability for unreported claims and loss expenses on the basis of historical information
by line of insurance. Our insurance subsidiaries account for inflation in the reserving function
through analysis of costs and trends and reviews of historical reserving results. Our insurance
subsidiaries closely monitor their liabilities and recompute them periodically using new
information on reported claims and a variety of statistical techniques. Our insurance subsidiaries
do not discount their liabilities for losses.
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 as to our
insurance subsidiaries internal operations. For example, our insurance subsidiaries have
experienced a decrease in claims frequency on workers compensation claims during the past several
years while claims severity has gradually increased. These trend changes give rise to greater
uncertainty as to the pattern of future loss settlements on workers compensation claims. Related
uncertainties regarding future trends include the cost of medical technologies and procedures and
changes in the utilization of medical procedures. Assumptions related to our insurance
subsidiaries external environment include the absence of significant changes in tort law and legal
decisions that increase liability exposure, consistency in judicial interpretations of insurance
coverage and policy provisions and the rate of loss cost inflation. Internal assumptions include
consistency in the recording of premium and loss statistics, consistency in the recording of
claims, payment and case reserving methodology, accurate measurement of the impact of rate changes
and changes in policy provisions, consistency in the quality and characteristics of business
written within a given line of business and consistency in reinsurance coverage and the
collectability of reinsured losses, among other items. To the extent our insurance subsidiaries
determine that underlying factors impacting their assumptions have changed, our insurance
subsidiaries attempt to make appropriate adjustments for such changes in their reserves.
Accordingly, our insurance subsidiaries ultimate liability for unpaid losses and loss expenses
will likely differ from the amount recorded at December 31, 2009. For every 1% change in our
insurance subsidiaries loss and loss expense reserves, net of reinsurance recoverable, the effect
on our pre-tax results of operations would be approximately $1.8 million.
The establishment of appropriate liabilities is an inherently uncertain process, and there can
be no assurance that our insurance subsidiaries ultimate liability will not exceed our insurance
subsidiaries loss and loss expense reserves and have an adverse effect on our results of
operations and financial condition. Furthermore, we cannot predict the timing, frequency and
extent of adjustments to our insurance subsidiaries estimated future liabilities, since 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
-19-
insurance subsidiaries estimate of their liability for losses and loss expenses generally
reflect actual payments and the evaluation of information received since the prior reporting date.
Our insurance subsidiaries recognized an increase (decrease) in their liability for losses and loss
expenses of prior years of $9.8 million, $2.7 million and ($10.0) million in 2009, 2008 and 2007,
respectively. Our insurance subsidiaries made no significant changes in their reserving
philosophy, key reserving assumptions or claims management personnel, and there have been no
significant offsetting changes in estimates that increased or decreased their loss and loss expense
reserves in those years. The majority of the 2009 development related to increases in the
liability for losses and loss expenses of prior years for Atlantic States and Southern. The 2009
development represented 6.0% of our December 31, 2008 carried reserves and was driven primarily by
higher-than-expected severity in the private passenger automobile liability, homeowners and
workers compensation lines of business in accident year 2008. The 2008 development represented
1.2% of our December 31, 2007 carried reserves and was driven primarily by higher-than-expected
severity in the private passenger automobile liability line of business in accident year 2007. We
recognized favorable development in 2007 related primarily to the private passenger automobile
liability, workers compensation, commercial automobile liability and commercial multi-peril lines
of business.
Excluding the impact of isolated catastrophic weather events, our insurance subsidiaries have
noted stable amounts in the number of claims incurred and slight downward trends in the number of
claims outstanding at period ends relative to their premium base in recent years across most of
their lines of business. However, the amount of the average claim outstanding has increased
gradually over the past several years as the property and casualty insurance industry has
experienced increased litigation trends and economic conditions that have extended the estimated
length of disabilities and contributed to increased medical loss costs and a general slowing of
settlement rates in litigated claims. Our insurance subsidiaries could be required to make further
adjustments to their estimates in the future. However, on the basis of our insurance subsidiaries
internal procedures which analyze, among other things, their prior assumptions, their experience
with similar cases and historical trends such as reserving patterns, loss payments, pending levels
of unpaid claims and product mix, as well as court decisions, economic conditions and public
attitudes, we believe that our insurance subsidiaries have made adequate provision for their
liability for losses and loss expenses.
Differences between liabilities reported in our financial statements prepared on the basis of
generally accepted accounting principles (GAAP) and our insurance subsidiaries financial
statements prepared on a statutory accounting basis (SAP) result from anticipating salvage and
subrogation recoveries for GAAP but not for SAP. These differences amounted to $8.3 million, $8.7
million and $9.2 million at December 31, 2007, 2008 and 2009, respectively.
-20-
The following table sets forth a reconciliation of the beginning and ending GAAP net liability
of our insurance subsidiaries for unpaid losses and loss expenses for the periods indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, |
|
(in thousands) |
|
2007 |
|
|
2008 |
|
|
2009 |
|
Gross liability for unpaid losses and loss expenses
at beginning of year |
|
$ |
259,022 |
|
|
$ |
226,432 |
|
|
$ |
239,809 |
|
Less reinsurance recoverable |
|
|
95,710 |
|
|
|
76,280 |
|
|
|
78,502 |
|
|
|
|
|
|
|
|
|
|
|
Net liability for unpaid losses and loss expenses
at beginning of year |
|
|
163,312 |
|
|
|
150,152 |
|
|
|
161,307 |
|
Acquisition of Sheboygan |
|
|
|
|
|
|
2,173 |
|
|
|
|
|
Provision for net losses and loss expenses for
claims incurred in the current year |
|
|
187,797 |
|
|
|
221,617 |
|
|
|
241,012 |
|
Change in provision for estimated net losses and
loss expenses for claims incurred in prior years |
|
|
(10,013 |
) |
|
|
2,684 |
|
|
|
9,823 |
|
|
|
|
|
|
|
|
|
|
|
Total incurred |
|
|
177,784 |
|
|
|
224,301 |
|
|
|
250,835 |
|
Net losses and loss payments for claims
incurred during: |
|
|
|
|
|
|
|
|
|
|
|
|
The current year |
|
|
118,444 |
|
|
|
143,369 |
|
|
|
152,293 |
|
Prior years |
|
|
72,500 |
|
|
|
71,950 |
|
|
|
79,587 |
|
|
|
|
|
|
|
|
|
|
|
Total paid |
|
|
190,944 |
|
|
|
215,319 |
|
|
|
231,880 |
|
Net liability for unpaid losses and loss expenses
at end of year |
|
|
150,152 |
|
|
|
161,307 |
|
|
|
180,262 |
|
Plus reinsurance recoverable |
|
|
76,280 |
|
|
|
78,502 |
|
|
|
83,337 |
|
|
|
|
|
|
|
|
|
|
|
Gross liability for unpaid losses and loss expenses
at end of year |
|
$ |
226,432 |
|
|
$ |
239,809 |
|
|
$ |
263,599 |
|
|
|
|
|
|
|
|
|
|
|
The following table sets forth the development of the liability for net unpaid losses and
loss expenses of our insurance subsidiaries from 1999 to 2009. Loss data in the table includes
business ceded to Atlantic States from the underwriting pool.
Net liability at end of year for unpaid losses and loss expenses sets forth the estimated
liability for net unpaid losses and loss expenses recorded at the balance sheet date for each of
the indicated years. This liability represents the estimated amount of net losses and loss
expenses for claims arising in the current and all prior years that are unpaid at the balance sheet
date, including losses incurred but not reported.
The Net liability reestimated as of portion of the table shows the reestimated amount of the
previously recorded liability based on experience for each succeeding year. The estimate increases
or decreases as payments are made and more information becomes known about the severity of the
remaining unpaid claims. For example, the 2005 liability has developed a redundancy after four
years because we expect the reestimated net losses and loss expenses to be $22.8 million less than
the estimated liability we initially established in 2005 of $173.0 million.
-21-
The Cumulative (excess) deficiency shows the cumulative excess or deficiency at December 31,
2009 of the liability estimate shown on the top line of the corresponding column. An excess in
liability means that the liability established in prior years exceeded actual net losses and loss
expenses or our insurance subsidiaries reevaluated the liability at less than the original
estimate. A deficiency in liability means that the liability established in prior years was less
than actual net losses and loss expenses or our insurance subsidiaries reevaluated the liability at
more than the original estimate.
The Cumulative amount of liability paid through portion of the table shows the cumulative
net losses and loss expense payments made in succeeding years for net losses incurred prior to the
balance sheet date. For example, the 2005 column indicates that as of December 31, 2009 payments
equal to $133.8 million of the currently reestimated ultimate liability for net losses and loss
expenses of $150.2 million had been made.
Amounts shown in the 2004
column of the table include
information for Le Mars and
the Peninsula Companies for
all accident years prior to
2004. Amounts shown in the
2008 column of the table
include information for
Sheboygan for all accident
years prior to 2008.
-22-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, |
|
(in thousands) |
|
1999 |
|
|
2000 |
|
|
2001 |
|
|
2002 |
|
|
2003 |
|
|
2004 |
|
|
2005 |
|
|
2006 |
|
|
2007 |
|
|
2008 |
|
|
2009 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net liability at end of
year for unpaid losses
and loss expenses |
|
$ |
99,234 |
|
|
$ |
102,709 |
|
|
$ |
114,544 |
|
|
$ |
131,108 |
|
|
$ |
138,896 |
|
|
$ |
171,431 |
|
|
$ |
173,009 |
|
|
$ |
163,312 |
|
|
$ |
150,152 |
|
|
$ |
161,307 |
|
|
$ |
180,262 |
|
Net liability
reestimated as of: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One year later |
|
|
100,076 |
|
|
|
110,744 |
|
|
|
121,378 |
|
|
|
130,658 |
|
|
|
136,434 |
|
|
|
162,049 |
|
|
|
159,393 |
|
|
|
153,299 |
|
|
|
152,836 |
|
|
|
171,130 |
|
|
|
|
|
Two years later |
|
|
103,943 |
|
|
|
112,140 |
|
|
|
120,548 |
|
|
|
128,562 |
|
|
|
130,030 |
|
|
|
152,292 |
|
|
|
153,894 |
|
|
|
150,934 |
|
|
|
154,435 |
|
|
|
|
|
|
|
|
|
Three years later |
|
|
104,073 |
|
|
|
110,673 |
|
|
|
118,263 |
|
|
|
124,707 |
|
|
|
123,399 |
|
|
|
148,612 |
|
|
|
151,792 |
|
|
|
150,078 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Four years later |
|
|
101,880 |
|
|
|
108,766 |
|
|
|
114,885 |
|
|
|
119,817 |
|
|
|
120,917 |
|
|
|
147,280 |
|
|
|
150,183 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Five years later |
|
|
100,715 |
|
|
|
107,561 |
|
|
|
113,070 |
|
|
|
118,445 |
|
|
|
119,968 |
|
|
|
145,874 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six years later |
|
|
100,479 |
|
|
|
106,950 |
|
|
|
112,614 |
|
|
|
118,605 |
|
|
|
119,731 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Seven years later |
|
|
99,968 |
|
|
|
106,298 |
|
|
|
112,921 |
|
|
|
118,905 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Eight years later |
|
|
99,927 |
|
|
|
106,835 |
|
|
|
113,350 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine years later |
|
|
100,223 |
|
|
|
107,474 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ten years later |
|
|
100,837 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cumulative (excess) deficiency |
|
|
1,603 |
|
|
|
4,765 |
|
|
|
(1,194 |
) |
|
|
(12,203 |
) |
|
|
(19,165 |
) |
|
|
(25,557 |
) |
|
|
(22,826 |
) |
|
|
(13,234 |
) |
|
|
4,283 |
|
|
|
9,823 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cumulative amount of
liability paid through: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One year later |
|
$ |
39,060 |
|
|
$ |
43,053 |
|
|
$ |
45,048 |
|
|
$ |
46,268 |
|
|
$ |
51,965 |
|
|
$ |
67,229 |
|
|
$ |
71,718 |
|
|
|
72,499 |
|
|
|
71,950 |
|
|
|
79,592 |
|
|
|
|
|
Two years later |
|
|
60,622 |
|
|
|
67,689 |
|
|
|
70,077 |
|
|
|
74,693 |
|
|
|
81,183 |
|
|
|
102,658 |
|
|
|
107,599 |
|
|
|
104,890 |
|
|
|
105,576 |
|
|
|
|
|
|
|
|
|
Three years later |
|
|
76,811 |
|
|
|
82,268 |
|
|
|
87,198 |
|
|
|
93,288 |
|
|
|
99,910 |
|
|
|
123,236 |
|
|
|
125,926 |
|
|
|
121,711 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Four years later |
|
|
85,453 |
|
|
|
92,127 |
|
|
|
97,450 |
|
|
|
105,143 |
|
|
|
109,964 |
|
|
|
133,844 |
|
|
|
133,805 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Five years later |
|
|
91,337 |
|
|
|
98,007 |
|
|
|
104,551 |
|
|
|
111,523 |
|
|
|
113,684 |
|
|
|
136,377 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six years later |
|
|
94,420 |
|
|
|
101,664 |
|
|
|
108,136 |
|
|
|
114,145 |
|
|
|
114,499 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Seven years later |
|
|
96,823 |
|
|
|
103,767 |
|
|
|
110,193 |
|
|
|
114,641 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Eight years later |
|
|
98,268 |
|
|
|
105,046 |
|
|
|
110,447 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine years later |
|
|
98,847 |
|
|
|
104,990 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ten years later |
|
|
98,283 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31 |
|
|
|
2001 |
|
|
2002 |
|
|
2003 |
|
|
2004 |
|
|
2005 |
|
|
2006 |
|
|
2007 |
|
|
2008 |
|
|
2009 |
|
|
|
(in thousands) |
|
Gross liability at end of year |
|
$ |
179,840 |
|
|
$ |
210,692 |
|
|
$ |
217,914 |
|
|
$ |
267,190 |
|
|
$ |
265,730 |
|
|
$ |
259,022 |
|
|
$ |
226,432 |
|
|
$ |
239,809 |
|
|
$ |
263,599 |
|
Reinsurance recoverable |
|
|
65,296 |
|
|
|
79,584 |
|
|
|
79,018 |
|
|
|
95,759 |
|
|
|
92,721 |
|
|
|
95,710 |
|
|
|
76,280 |
|
|
|
78,502 |
|
|
|
83,337 |
|
Net liability at end of year |
|
|
114,544 |
|
|
|
131,108 |
|
|
|
138,896 |
|
|
|
171,431 |
|
|
|
173,009 |
|
|
|
163,312 |
|
|
|
150,152 |
|
|
|
161,307 |
|
|
|
180,262 |
|
Gross reestimated liability latest |
|
|
191,184 |
|
|
|
207,187 |
|
|
|
207,667 |
|
|
|
237,608 |
|
|
|
238,713 |
|
|
|
238,592 |
|
|
|
232,342 |
|
|
|
253,179 |
|
|
|
|
|
Reestimated recoverable latest |
|
|
77,834 |
|
|
|
88,282 |
|
|
|
87,936 |
|
|
|
91,734 |
|
|
|
88,530 |
|
|
|
88,514 |
|
|
|
77,907 |
|
|
|
82,049 |
|
|
|
|
|
Net reestimated liability latest |
|
|
113,350 |
|
|
|
118,905 |
|
|
|
119,731 |
|
|
|
145,874 |
|
|
|
150,183 |
|
|
|
150,078 |
|
|
|
154,435 |
|
|
|
171,130 |
|
|
|
|
|
Gross cumulative deficiency (excess) |
|
|
11,344 |
|
|
|
(3,505 |
) |
|
|
(10,247 |
) |
|
|
(29,582 |
) |
|
|
(27,017 |
) |
|
|
(20,430 |
) |
|
|
5,910 |
|
|
|
13,370 |
|
|
|
|
|
-23-
Technology
Donegal Mutual owns the majority of the technology systems our insurance subsidiaries use.
The technology systems consist primarily of an integrated central processing computer, a series of
server-based computer networks and various communications systems that allow the home office of our
insurance subsidiaries and their branch offices to utilize the same systems for the processing of
business. Donegal Mutual maintains backup facilities and systems at the office of one of our
insurance subsidiaries and through a contract with a leading provider of computer disaster recovery
sites and tests these backup facilities and systems on a regular basis. Our insurance subsidiaries
bear their proportionate share of information services expenses based on their respective
percentage of the total net written premiums of the Donegal Insurance Group.
The business strategy of our insurance subsidiaries depends on the use, development and
implementation of integrated technology systems. These systems enable our insurance subsidiaries
to provide a high level of service to agents and policyholders by processing business in a timely
and efficient manner, communicating and sharing data with agents, providing a variety of methods
for the payment of premiums and allowing for the accumulation and analysis of information for the
management of our insurance subsidiaries.
We believe the availability and use of these technology systems has resulted in improved
service to agents and policyholders, increased efficiencies in processing the business of our
insurance subsidiaries and lower operating costs. Four key components of these integrated
technology systems are the agency interface system, the WritePro® and
WriteBiz® systems, a claims processing system and an imaging system. The agency
interface system provides our insurance subsidiaries with a high level of data sharing both to and
from agents systems and also provides agents with an integrated means of processing new business.
The WritePro® and WriteBiz® systems are fully automated underwriting and
policy issuance systems that provide agents with the ability to generate underwritten quotes and
automatically issue policies that meet the underwriting guidelines of our insurance subsidiaries
with limited or no intervention by their personnel. The claims processing system allows our
insurance subsidiaries to process claims efficiently and in an automated environment. The imaging
system eliminates the need to handle paper files, while providing greater access to the same
information by a variety of personnel.
Third-Party Reinsurance
Our insurance subsidiaries and Donegal Mutual purchase certain third-party reinsurance on a
combined basis. Le Mars, the Peninsula Companies and Sheboygan also have separate reinsurance
programs that provide certain coverage that is commensurate with their relative size and exposures.
Our insurance subsidiaries use several different reinsurers,
all of which, consistent with the requirements of our insurance subsidiaries and Donegal
-24-
Mutual, have an A.M. Best rating of A- (Excellent) or better or, with respect to foreign
reinsurers, have a financial condition that, in the opinion of our management, is equivalent to a
company with at least an A- rating from A.M. Best.
The external reinsurance our insurance subsidiaries and Donegal Mutual purchase includes:
|
|
|
excess of loss reinsurance, under which their losses are automatically reinsured,
through a series of contracts, over a set retention (generally $750,000 for 2009); and |
|
|
|
|
catastrophic reinsurance, under which they recover, through a series of contracts,
100% of an accumulation of many losses resulting from a single event, including natural
disasters, over a set retention (generally $3.0 million for 2009). |
The amount of coverage provided under each of these types of reinsurance depends upon the
amount, nature, size and location of the risk being reinsured.
Our insurance subsidiaries principal third-party reinsurance agreement in 2009 was a
multi-line per risk excess of loss treaty that provided 100% coverage up to $1.0 million for both
property and liability losses over the set retention.
For property insurance, our insurance subsidiaries also have excess of loss treaties that
provide for additional coverage over the multi-line treaty up to $2.5 million per loss. For
liability insurance, our insurance subsidiaries have excess of loss treaties that provide for
additional coverage over the multi-line treaty up to $40.0 million per occurrence. For workers
compensation insurance, our insurance subsidiaries have excess of loss treaties that provide for
additional coverage over the multi-line treaty up to $10.0 million on any one life.
Our insurance subsidiaries and Donegal Mutual have property catastrophe coverage through a
series of layered treaties up to aggregate losses of $100.0 million for any single event.
Our insurance subsidiaries and Donegal Mutual also purchase facultative reinsurance to cover
exposures from property and casualty losses that exceed the limits provided by their respective
treaty reinsurance.
Competition
The property and casualty insurance industry is highly competitive on the basis of both price
and service. Numerous companies compete for business in the geographic areas where our insurance
subsidiaries operate, many of which are substantially larger and have greater financial resources
than those of our insurance subsidiaries. In addition, because the
-25-
insurance products of our
insurance subsidiaries and those of Donegal Mutual are marketed exclusively through independent
insurance agencies, most of which represent more than one insurance company, our insurance
subsidiaries face competition within agencies as well as competition to retain qualified
independent agents.
Investments
Return on invested assets is an important element of the financial results of our insurance
subsidiaries, and the investment strategy of our insurance subsidiaries is to generate an
appropriate amount of after-tax income on invested assets while minimizing credit risk through
investments in high-quality securities. As a result, our insurance subsidiaries seek to invest a
high percentage of their assets in diversified, highly rated and marketable fixed-maturity
instruments. The fixed-maturity portfolios of our insurance subsidiaries consist of both taxable
and tax-exempt securities. Our insurance subsidiaries maintain a portion of their portfolios in
short-term securities, such as investments in commercial paper, to provide liquidity for the
payment of claims and operation of their businesses. Our insurance subsidiaries maintain a
negligible percentage (less than 1.5% at December 31, 2009) of their portfolios in equity
securities.
At December 31, 2009, 99.8% of all debt securities held by our insurance subsidiaries had an
investment-grade rating. The investment portfolios of our insurance subsidiaries did not contain
any mortgage loans or any non-performing assets at December 31, 2009.
The following table shows the composition of the debt securities (at carrying value) in the
investment portfolios of our insurance subsidiaries, excluding short-term investments, by rating as
of December 31, 2009:
(dollars in thousands)
|
|
|
|
|
|
|
|
|
|
|
December 31, 2009 |
|
Rating(1) |
|
Amount |
|
|
Percent |
|
U.S. Treasury and U.S. agency securities(2) |
|
$ |
137,399 |
|
|
|
23.2 |
% |
Aaa or AAA |
|
|
202,624 |
|
|
|
34.3 |
|
Aa or AA |
|
|
163,692 |
|
|
|
27.7 |
|
A |
|
|
82,247 |
|
|
|
13.9 |
|
BBB |
|
|
2,597 |
|
|
|
0.5 |
|
BB |
|
|
250 |
|
|
|
|
|
B |
|
|
1,254 |
|
|
|
0.2 |
|
CCC |
|
|
1,448 |
|
|
|
0.2 |
|
|
|
|
|
|
|
|
Total |
|
$ |
591,511 |
|
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
(1) |
|
Ratings assigned by Moodys Investors Services, Inc. or Standard & Poors Corporation. |
|
(2) |
|
Includes residential mortgage-backed securities of $94.8 million. |
-26-
Our insurance subsidiaries invest in both taxable and tax-exempt securities as part of
their strategy to maximize after-tax income and are currently increasing their investments in
tax-exempt securities. This strategy considers, among other factors, the alternative minimum tax.
Tax-exempt securities made up approximately 67.9%, 75.8% and 71.0% of the debt securities in the
combined investment portfolios of DGI and its insurance subsidiaries at December 31, 2007, 2008 and
2009, respectively.
The following table shows the classification of our investments and the investments of our
insurance subsidiaries (at carrying value) at December 31, 2007, 2008 and 2009:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, |
|
|
|
2007 |
|
|
2008 |
|
|
2009 |
|
|
|
|
|
|
|
Percent |
|
|
|
|
|
|
Percent |
|
|
|
|
|
|
Percent |
|
|
|
|
|
|
|
of |
|
|
|
|
|
|
of |
|
|
|
|
|
|
of |
|
(dollars in thousands) |
|
Amount |
|
|
Total |
|
|
Amount |
|
|
Total |
|
|
Amount |
|
|
Total |
|
Fixed maturities(1): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Held to maturity: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury securities and
obligations of U.S. government
corporations and agencies |
|
$ |
51,611 |
|
|
|
8.5 |
% |
|
$ |
8,517 |
|
|
|
1.4 |
% |
|
$ |
2,000 |
|
|
|
0.3 |
% |
Obligations of states and
political subdivisions |
|
|
81,457 |
|
|
|
13.5 |
|
|
|
76,451 |
|
|
|
12.1 |
|
|
|
61,736 |
|
|
|
9.3 |
|
Corporate securities |
|
|
9,838 |
|
|
|
1.6 |
|
|
|
8,341 |
|
|
|
1.3 |
|
|
|
6,243 |
|
|
|
0.9 |
|
Residential mortgage-backed securities |
|
|
11,384 |
|
|
|
1.9 |
|
|
|
6,569 |
|
|
|
1.0 |
|
|
|
3,828 |
|
|
|
0.6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total held to maturity |
|
|
154,290 |
|
|
|
25.5 |
|
|
|
99,878 |
|
|
|
15.8 |
|
|
|
73,807 |
|
|
|
11.1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Available for sale: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury securities and
obligations of U.S. government
corporations and agencies |
|
|
25,374 |
|
|
|
4.2 |
|
|
|
6,630 |
|
|
|
1.0 |
|
|
|
40,630 |
|
|
|
6.1 |
|
Obligations of states and
political subdivisions |
|
|
251,866 |
|
|
|
41.6 |
|
|
|
337,003 |
|
|
|
53.3 |
|
|
|
358,367 |
|
|
|
53.7 |
|
Corporate securities |
|
|
15,228 |
|
|
|
2.5 |
|
|
|
23,936 |
|
|
|
3.8 |
|
|
|
27,766 |
|
|
|
4.2 |
|
Residential mortgage-backed securities |
|
|
43,850 |
|
|
|
7.2 |
|
|
|
78,247 |
|
|
|
12.4 |
|
|
|
90,941 |
|
|
|
13.6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total available for sale |
|
|
336,318 |
|
|
|
55.5 |
|
|
|
445,816 |
|
|
|
70.5 |
|
|
|
517,704 |
|
|
|
77.6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed maturities |
|
|
490,608 |
|
|
|
81.0 |
|
|
|
545,694 |
|
|
|
86.3 |
|
|
|
591,511 |
|
|
|
88.7 |
|
Equity securities(2) |
|
|
36,361 |
|
|
|
6.0 |
|
|
|
5,895 |
|
|
|
0.9 |
|
|
|
9,915 |
|
|
|
1.5 |
|
Investments in affiliates(3) |
|
|
8,649 |
|
|
|
1.4 |
|
|
|
8,594 |
|
|
|
1.4 |
|
|
|
9,309 |
|
|
|
1.4 |
|
Short-term investments(4) |
|
|
70,252 |
|
|
|
11.6 |
|
|
|
71,953 |
|
|
|
11.4 |
|
|
|
56,100 |
|
|
|
8.4 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total investments |
|
$ |
605,870 |
|
|
|
100.0 |
% |
|
$ |
632,136 |
|
|
|
100.0 |
% |
|
$ |
666,835 |
|
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
See Notes 1 and 5 to our consolidated financial statements incorporated by reference herein. We value fixed maturities
classified as held to maturity at amortized cost; we value those fixed maturities classified as available for sale at
fair value. Total fair value of fixed maturities classified as held to maturity was $155.4 million at December 31,
2007, $101.5 million at December 31, 2008 and $77.0 million at December 31, 2009. The amortized cost of fixed
maturities classified as available for sale was $331.8 million at December 31, 2007, $449.0 million at December 31, 2008
and $503.7 million at December 31, 2009. |
|
(2) |
|
We value equity securities at fair value. Total cost of equity securities was $30.0 million at December 31, 2007, $2.9
million at December 31, 2008 and $3.8 million at December 31, 2009. |
-27-
|
|
|
(3) |
|
We value investments in affiliates at cost, adjusted for our share of earnings and losses of our affiliates as well as
changes in equity of our affiliates due to unrealized gains and losses. |
|
(4) |
|
We value short-term investments at cost, which approximates fair value. |
The following table sets forth the maturities (at carrying value) in fixed maturity and
short-term investment portfolios of DGI and its insurance subsidiaries at December 31, 2007,
December 31, 2008 and December 31, 2009:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, |
|
|
|
2007 |
|
|
2008 |
|
|
2009 |
|
|
|
|
|
|
|
Percent |
|
|
|
|
|
|
Percent |
|
|
|
|
|
|
Percent |
|
|
|
|
|
|
|
of |
|
|
|
|
|
|
of |
|
|
|
|
|
|
of |
|
(dollars in thousands) |
|
Amount |
|
|
Total |
|
|
Amount |
|
|
Total |
|
|
Amount |
|
|
Total |
|
Due in(1): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One year or less |
|
$ |
29,299 |
|
|
|
6.0 |
% |
|
$ |
14,008 |
|
|
|
2.6 |
% |
|
$ |
16,410 |
|
|
|
2.8 |
% |
Over one year through three years |
|
|
61,523 |
|
|
|
12.5 |
|
|
|
33,772 |
|
|
|
6.2 |
|
|
|
35,007 |
|
|
|
5.9 |
|
Over three years through five years |
|
|
36,360 |
|
|
|
7.4 |
|
|
|
44,579 |
|
|
|
8.2 |
|
|
|
46,392 |
|
|
|
7.8 |
|
Over five years through ten years |
|
|
186,441 |
|
|
|
38.0 |
|
|
|
174,130 |
|
|
|
31.9 |
|
|
|
166,352 |
|
|
|
28.1 |
|
Over ten years through fifteen years |
|
|
86,089 |
|
|
|
17.5 |
|
|
|
89,889 |
|
|
|
16.5 |
|
|
|
121,308 |
|
|
|
20.5 |
|
Over fifteen years |
|
|
35,662 |
|
|
|
7.3 |
|
|
|
104,500 |
|
|
|
19.1 |
|
|
|
111,273 |
|
|
|
18.9 |
|
Residential mortgage-backed securities |
|
|
55,234 |
|
|
|
11.3 |
|
|
|
84,816 |
|
|
|
15.5 |
|
|
|
94,769 |
|
|
|
16.0 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
490,608 |
|
|
|
100.0 |
% |
|
$ |
545,694 |
|
|
|
100.0 |
% |
|
$ |
591,511 |
|
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Based on stated maturity dates with no prepayment assumptions. Actual maturities will differ because
borrowers may have the right to call or prepay obligations with or without call or prepayment
penalties. |
As shown above, our insurance subsidiaries held investments in residential
mortgage-backed securities having a carrying value of $94.8 million at December 31, 2009. The
mortgage-backed securities consist primarily of investments in governmental agency balloon pools
with stated maturities between one and 24 years. The stated maturities of these investments limit
the exposure of our insurance subsidiaries to extension risk should interest rates rise and
prepayments decline. Our insurance subsidiaries perform an analysis of the underlying loans when
evaluating a residential mortgage-backed security for purchase, and they select those securities
that they believe will provide a return that properly reflects the prepayment risk associated with
the underlying loans.
The following table sets forth the investment results of DGI and its insurance subsidiaries
for the years ended December 31, 2007, 2008 and 2009:
-28-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, |
(dollars in thousands) |
|
2007 |
|
2008 |
|
2009 |
Invested assets(1) |
|
$ |
598,604 |
|
|
$ |
619,003 |
|
|
$ |
649,486 |
|
Investment income(2) |
|
|
22,785 |
|
|
|
22,756 |
|
|
|
20,631 |
|
Average yield |
|
|
3.8 |
% |
|
|
3.7 |
% |
|
|
3.2 |
% |
Average tax-equivalent yield |
|
|
4.8 |
|
|
|
4.9 |
|
|
|
4.4 |
|
|
|
|
(1) |
|
Average of the aggregate invested amounts at the beginning and end of the period. |
|
(2) |
|
Investment income is net of investment expenses and does not include realized investment gains or
losses or provision for income taxes. |
A.M. Best Rating
Donegal Mutual and our insurance subsidiaries have an A.M. Best rating of A (Excellent), based
upon their respective current financial condition and historical statutory results of operations
and retrocessional agreements. We believe that the A.M. Best rating of Donegal Mutual and our
insurance subsidiaries is an important factor in their marketing of their products to their agents
and customers. A.M. Bests ratings are industry ratings based on a comparative analysis of the
financial condition and operating performance of insurance companies. A.M. Bests classifications
are A++ and A+ (Superior), A and A- (Excellent), B++ and B+ (Very Good), B and B- (Good), C++ and
C+ (Fair), C and C- (Marginal), D (Below Minimum Standards) and E and F (Liquidation). A.M. Bests
ratings are based upon factors relevant to the payment of claims of policyholders and are not
directed toward the protection of investors in insurance companies. According to A.M. Best, the
Excellent rating that the Donegal Insurance Group maintains is assigned to those companies that,
in A.M. Bests opinion, have an excellent ability to meet their ongoing obligations to
policyholders.
Regulation
Insurance companies are subject to supervision and regulation in the states in which they
transact business. Such supervision and regulation relate to numerous aspects of an insurance
companys business and financial condition. The primary purpose of such supervision and
regulation is the protection of policyholders. The extent of such regulation varies, but generally
derives from state statutes that delegate regulatory, supervisory and administrative authority
to state insurance departments. Accordingly, the authority of the state insurance departments
includes the establishment of standards of solvency that must be met and maintained by insurers,
the licensing of insurers and agents to do business, the nature of and limitations on
investments, premium rates for property and casualty insurance, the provisions that insurers must
make for current losses and future liabilities, the deposit of securities for the benefit of
policyholders, the approval of policy forms, notice requirements for the cancellation
of policies and the approval of certain changes in control. State insurance departments
also conduct periodic examinations of the affairs of insurance companies and
-29-
require the filing of annual and other reports relating to the financial condition of insurance
companies.
In addition to state-imposed insurance laws and regulations, the National Association of
Insurance Commissioners (the NAIC) has established a risk-based capital system for assessing the
adequacy of statutory capital and surplus that augments the states current fixed dollar minimum
capital requirements for insurance companies. At December 31, 2009, our insurance subsidiaries and
Donegal Mutual each exceeded the minimum levels of statutory capital the risk-based capital rules
require by a substantial margin.
Generally, every state has guaranty fund laws under which insurers licensed to do business in
that state can be assessed on the basis of premiums written by the insurer in that state in order
to fund policyholder liabilities of insolvent insurance companies. Under these laws in general, an
insurer is subject to assessment, depending upon its market share of a given line of business, to
assist in the payment of policyholder claims against insolvent insurers. Our insurance
subsidiaries and Donegal Mutual have made accruals for their portion of assessments related to such
insolvencies based upon the most current information furnished by the guaranty associations.
Most states have legislation that regulates insurance holding company systems. Each
insurance company in the insurance holding company system is required to register with the
insurance supervisory agency of its state of domicile and furnish information concerning the
operations of companies within the insurance holding company system that may materially affect the
operations, management or financial condition of the insurers within the system. Pursuant to these
laws, the respective insurance departments may examine our insurance subsidiaries or Donegal Mutual
at any time, require disclosure of material transactions by the holding company with another member
of the insurance holding company system and require prior notice or prior approval of certain
transactions, such as extraordinary dividends from the insurance subsidiaries to the holding
company.
The Pennsylvania Insurance Holding Companies Act, which generally applies to Donegal
Mutual, us and our insurance subsidiaries, requires that all transactions within an insurance
holding company system to which an insurer is a party must be fair and reasonable and that any
charges or fees for services performed must be reasonable. Any management agreement, service
agreement, cost sharing arrangement and reinsurance agreement must be filed with the Pennsylvania
Insurance Department (the Department) and is subject to Department review. We have filed the
pooling agreement between Donegal Mutual and Atlantic States that established the underwriting pool
and the reinsurance agreements between Donegal Mutual and our insurance subsidiaries with the
Department.
Approval of the applicable insurance commissioner is also required prior to consummation of
transactions affecting the control of an insurer. In virtually all states, including Pennsylvania,
Iowa, Maryland, Virginia and Wisconsin where our insurance
-30-
subsidiaries are domiciled, the acquisition of 10% or more of the outstanding capital stock of
an insurer or its holding company or the intent to acquire such an interest creates a rebuttable
presumption of a change in control. Pursuant to an order issued in April 2003, the Department
approved Donegal Mutuals ownership of up to 70% of our outstanding Class A common stock and up to
100% of our outstanding Class B common stock.
Our insurance subsidiaries participate in involuntary insurance programs for automobile
insurance, as well as other property and casualty insurance lines, in the states in which they
operate. These programs include joint underwriting associations, assigned risk plans, fair access
to insurance requirements (FAIR) plans, reinsurance facilities, windstorm plans and tornado plans.
Legislation establishing these programs requires all companies that write lines covered by these
programs to provide coverage, either directly or through reinsurance, for insureds who cannot
obtain insurance in the voluntary market. The legislation creating these programs usually
allocates a pro rata portion of risks attributable to such insureds to each company on the basis of
direct premiums written or the number of automobiles insured in the particular state. Generally,
state law requires participation in such programs as a condition to doing business. The loss ratio
on insurance written under involuntary programs has traditionally been greater than the loss ratio
on insurance written in the voluntary market.
The insurance laws of the respective states of domicile of our insurance subsidiaries
restrict the amount of dividends or other distributions our insurance subsidiaries may pay to us
without the prior approval of the insurance regulatory authorities of that state. Generally, the
maximum amount that an insurance subsidiary may pay during any year after notice to, but without
prior approval of, the insurance commissioners of these states is limited to a stated percentage of
that subsidiarys statutory capital and surplus as of the end of the preceding year or the net
income of the subsidiary for the preceding year. As of December 31, 2009, the amount of dividends
our insurance subsidiaries could pay us during 2010, without the prior approval of the various
insurance commissioners, was:
|
|
|
|
|
Name of Insurance Subsidiary |
|
Ordinary Dividend Amount |
|
|
|
|
|
|
Atlantic States |
|
$ |
12.4 |
million |
Southern |
|
None |
Le Mars |
|
|
2.8 |
million |
Peninsula Companies |
|
|
3.9 |
million |
Sheboygan |
|
|
0.6 |
million |
|
|
|
Total |
|
$ |
19.7 |
million |
|
|
|
Donegal Mutual
Donegal Mutual organized as a mutual fire insurance company in Pennsylvania in 1889. At
December 31, 2009, Donegal Mutual had admitted assets of $325.0 million and
-31-
policyholders surplus of $172.1 million. At December 31, 2009, Donegal Mutual had total
liabilities of $152.9 million, including debt of $13.1 million, reserves for net losses and loss
expenses of $44.3 million and unearned premiums of $29.3 million. Donegal Mutuals investment
portfolio of $221.6 million at December 31, 2009 consisted primarily of investment-grade bonds of
$18.5 million and its investment in our common stock. At December 31, 2009, Donegal Mutual owned
8,355,184 shares, or approximately 42% of our Class A common stock, Donegal Mutual carried on its
books at $111.6 million, and 4,180,234 shares, or approximately 75%, of our Class B common stock,
Donegal Mutual carried on its books at $55.8 million. The foregoing financial information is
presented on the statutory basis of accounting required by the NAIC Accounting Practices and
Procedures Manual. Donegal Mutual does not, nor is it required to, prepare financial statements in
accordance with generally accepted accounting principles.
Donegal Financial Services Corporation
Because of Donegal Mutuals and our ownership of DFSC, both Donegal Mutual and we are
regulated as unitary savings and loan holding companies. As such, Donegal Mutual and we are
subject to regulation by the Office of Thrift Supervision, or the OTS, under the holding company
provisions of the federal Home Owners Loan Act. As a federally chartered and insured stock
savings association, Province Bank is subject to regulation and supervision by the OTS, which is
the primary regulator of federal savings banks, and by the Federal Deposit Insurance Corporation.
The primary purpose of the statutory and regulatory scheme is to protect depositors, the financial
institutions and the financial system as a whole rather than the shareholders of financial
institutions or their holding companies.
Transactions between a savings association and its affiliates are subject to
quantitative and qualitative restrictions under Sections 23A and 23B of the Federal Reserve Act.
Affiliates of a savings association include, among other entities, the savings associations
holding company and non-banking companies that are under common control with the savings
association. These restrictions on transactions with affiliates apply to transactions between DFSC
and Province Bank, on the one hand, and us and our insurance subsidiaries, on the other hand.
These restrictions also apply to transactions among DFSC, Province Bank and Donegal Mutual.
Cautionary Statement Regarding Forward-Looking Statements
This annual report and the documents incorporated by reference into this annual report
contain forward-looking statements within the meaning of the Private Securities Litigation Reform
Act of 1995. These statements include certain discussions relating to underwriting, premium
and investment income volume, business strategies, reserves, profitability and business
relationships and our other business activities during 2009 and beyond. In some cases, you can
identify forward-looking statements by terms such as may,
-32-
will, should, could, would, expect, plan, intend, anticipate, believe,
estimate, objective, project, predict, potential, goal and similar expressions. These
forward-looking statements reflect our current views about future events, are based on our current
assumptions and are subject to known and unknown risks and uncertainties that may cause our
results, performance or achievements to differ materially from those anticipated in or implied by
those statements. Many of the factors that will determine future events or achievements are beyond
our ability to control or predict. Such factors may include those described under Risk Factors.
The forward-looking statements contained in this annual report reflect our views and assumptions
only as of the date of this Form 10-K Report. Except as required by law, we do not intend to, and
assume no responsibility for, updating any forward-looking statements. We qualify all of our
forward-looking statements by these cautionary statements.
Available Information
Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form
8-K and our other filings pursuant to the Securities Exchange Act of 1934, or the Exchange Act, are
available without charge on our website, www.donegalgroup.com, as soon as reasonably practicable
after we file them electronically with the Securities and Exchange Commission, or SEC. Our Code of
Business Conduct and Ethics and the charters of our audit committee and our nominating committee
are available on our website. Upon request to our corporate secretary, printed copies are also
available. We are providing the address to our website solely for the information of investors.
We do not intend the reference to our website address to be an active link or to otherwise
incorporate the contents of the website into this Form 10-K report.
Risk Factors
Risks Relating to Us and Our Business
Donegal Mutual is our controlling stockholder, and it and its directors and executive officers
have potential conflicts of interest between the best interests of our stockholders and the best
interests of the policyholders of Donegal Mutual.
Donegal Mutual controls the election of all of the members of our board of directors. Five of
the 11 members of our board of directors are also directors of Donegal Mutual. Donegal Mutual and
we have the same executive officers. These common directors and
executive officers have a fiduciary duty to our stockholders and also have a fiduciary duty to
the policyholders of Donegal Mutual. Among the potential conflicts of interest that could arise
from these separate fiduciary duties are:
-33-
|
|
|
We and Donegal Mutual periodically review the percentage participation of Atlantic
States and Donegal Mutual in the underwriting pool that the two companies have
maintained since 1986; |
|
|
|
|
Our insurance subsidiaries and Donegal Mutual annually review and then establish the
terms of certain reinsurance agreements between them with the objective over the
long-term of having an approximately equal balance between payments and recoveries; |
|
|
|
|
We and Donegal Mutual periodically allocate certain shared expenses among Donegal
Mutual, us and our insurance subsidiaries in accordance with various inter-company
expense-sharing agreements; and |
|
|
|
|
Our insurance subsidiaries may enter into other transactions or contractual
relationships with Donegal Mutual, including, for example, our purchases from time to
time from Donegal Mutual of the surplus note of a mutual insurance company that will
convert into a stock insurance company. |
Donegal Mutual has sufficient voting power to determine the outcome of all matters submitted
to our stockholders for approval.
Each share of our Class A common stock has one-tenth of a vote per share and votes as a single
class with our Class B common stock, which has one vote per share except for matters that would
uniquely affect the rights of holders of our Class A common stock. Donegal Mutual has the right to
vote approximately 66% of the aggregate voting power of our Class A common stock and our Class B
common stock and has sufficient voting control to:
|
|
|
elect all of the members of our board of directors, who determine our management and
policies; and |
|
|
|
|
control the outcome of any corporate transaction or other matter submitted to our
stockholders for approval, including mergers or other acquisition proposals and the
sale of all or substantially all of our assets, in each case regardless of how our
other stockholders vote their shares. |
The interests of Donegal Mutual in maintaining this majority control of us may have an adverse
effect on the price of our Class A common stock and our Class B common stock
because of the absence of any potential takeover premium and may be inconsistent with the
interests of our stockholders other than Donegal Mutual.
Donegal Mutuals voting control, certain provisions of our certificate of incorporation and
by-laws and certain provisions of Delaware law make it remote that anyone could acquire control of
us unless Donegal Mutual were in favor of the acquisition of control.
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Donegal Mutuals voting control, certain anti-takeover provisions in our certificate of
incorporation and by-laws and certain provisions of the Delaware General Corporation Law (the
DGCL) could delay or prevent the removal of members of our board of directors and could make more
difficult or more expensive a merger, tender offer or proxy contest involving us to succeed, even
if such events were in the best interests of our stockholders other than Donegal Mutual. These
factors could also discourage a third party from attempting to acquire control of us. In
particular, our certificate of incorporation and by-laws include the following anti-takeover
provisions:
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our board of directors is classified into three classes, so that our stockholders
elect only one-third of the members of our board of directors each year; |
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our stockholders may remove our directors only for cause; |
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our stockholders may not take stockholder action except at an annual or special
meeting of our stockholders; |
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the request of stockholders holding at least 20% of the aggregate voting power of
our Class A common stock and our Class B common stock is required to call a special
meeting of our stockholders; |
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stockholders are required to provide advance notice to us to nominate candidates for
election to our board of directors or to make a stockholder proposal at a stockholders
meeting; |
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cumulative voting rights are not available in the election of our directors; |
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pre-emptive rights are not available in connection with the securities we issue; and |
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our board of directors may issue, without stockholder approval unless otherwise
required by law, preferred stock with such terms as our board of directors may
determine. |
Moreover, the DGCL contains certain provisions that prohibit certain business combination
transactions with an interested stockholder under certain circumstances.
We have authorized preferred stock that we could issue to make it more difficult for a third
party to acquire us.
We have 2,000,000 authorized shares of preferred stock that we could issue in one or more
series without further stockholder approval, unless otherwise required by law, and upon such terms
and conditions, and having such rights, privileges and preferences, as our
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board of directors may
determine our potential issuance of preferred stock and that may make it difficult for a third
party to acquire control of us.
Because we are an insurance holding company, no person can acquire or seek to acquire a 10% or
greater interest in us without first obtaining approval of the insurance commissioners of the
states of domicile of our insurance subsidiaries.
We own insurance subsidiaries domiciled in the states of Pennsylvania, Maryland, Virginia,
Iowa and Wisconsin and Donegal Mutual controls an insurance company domiciled in Georgia. The
insurance laws of each of these states provide that no person can acquire or seek to acquire a 10%
or greater interest in us without first filing specified information with the insurance
commissioner of that state and obtaining the prior approval of the proposed acquisition of a 10% or
greater interest in us by the state insurance commissioner based on statutory standards designed to
protect the safety and soundness of the insurance holding company and its subsidiary.
Our insurance subsidiaries currently conduct business in a limited number of states, with a
concentration of business in Pennsylvania, Maryland and Virginia. Any single catastrophe
occurrence or other condition affecting losses in these states could adversely affect the results
of operations of our insurance subsidiaries.
Our insurance subsidiaries conduct business in states located primarily in the Mid-Atlantic,
Midwestern and Southeastern portions of the United States. A substantial portion of their business
consists of private passenger and commercial automobile, homeowners and workers compensation
insurance in Pennsylvania, Maryland and Virginia. While our insurance subsidiaries actively manage
their exposure to catastrophes through their underwriting process and the purchase of reinsurance,
a single catastrophic occurrence, destructive weather pattern, general economic trend, terrorist
attack, regulatory development or other condition affecting one or more of the states in which our
insurance subsidiaries conduct substantial business could materially adversely affect their
business, financial condition and results of operations. Common catastrophic events include
hurricanes, earthquakes, tornadoes, wind and hail storms, fires, explosions and severe winter
storms.
The business, financial condition and results of operations of our insurance subsidiaries may
be adversely affected if the independent agents who market the products of our insurance
subsidiaries do
not maintain their current levels of premium writing with us, fail to comply with established
underwriting guidelines of our insurance subsidiaries or otherwise inappropriately market the
products of our insurance subsidiaries.
Our insurance subsidiaries market their insurance products solely through a network of
approximately 2,000 independent insurance agencies. This agency force is one of the most important
components of the competitive profile of our insurance subsidiaries. As a result, our insurance
subsidiaries are materially dependent upon the independent agents they use,
-36-
each of whom has the
authority to bind our insurance subsidiaries to insurance policies. To the extent that our
independent agents marketing efforts cannot maintain their current levels of volume and quality or
they bind our insurance subsidiaries to unacceptable insurance risks, fail to comply with the
established underwriting guidelines of our insurance subsidiaries or otherwise inappropriately
market the products of our insurance subsidiaries, the business, financial condition and results of
operations of our insurance subsidiaries could suffer.
The business of our insurance subsidiaries may not continue to grow and may be materially
adversely affected if they cannot retain existing, and attract new, independent agents or if
insurance consumers increase their use of insurance marketing systems other than independent
agents.
Our ability to retain existing and to attract new independent agents is essential to the
continued growth of the business of our insurance subsidiaries. If independent agents find it
easier to do business with the competitors of our insurance subsidiaries, our insurance
subsidiaries could find it difficult to retain their existing business or to attract new business.
While our insurance subsidiaries believe they maintain good relationships with the independent
agents they appoint, our insurance subsidiaries cannot be certain that these independent agents
will continue to sell the products of our insurance subsidiaries to the consumers these independent
agents represent. Some of the factors that could adversely affect the ability of our insurance
subsidiaries to retain existing and attract new independent agents include:
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the significant competition among insurance companies to attract independent agents; |
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the intense and time-consuming process of selecting new independent agents; |
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the insistence of our insurance subsidiaries that independent agents adhere to
consistent underwriting standards; and |
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the ability of our insurance subsidiaries to pay competitive and attractive
commissions, bonuses and other incentives to independent agents. |
While our insurance subsidiaries sell insurance to policyholders solely through their network
of independent agencies, many competitors of our insurance subsidiaries sell insurance through a
variety of delivery methods, including independent agencies, captive agencies, the Internet and
direct sales. To the extent that these policyholders change their marketing system preference, the
business, financial condition and results of operations of our insurance subsidiaries may be
adversely affected.
We are dependent on dividends from our insurance subsidiaries for the payment of our operating
expenses, our debt service and dividends to our stockholders; however, there are regulatory
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restrictions and business considerations that limit the amount of dividends our insurance
subsidiaries may pay to us.
As a holding company, we rely primarily on dividends from our insurance subsidiaries as a
source of funds to meet our corporate obligations. The amount of dividends our insurance
subsidiaries can pay to us is subject to regulatory restrictions and depends on the amount of
surplus our subsidiaries maintain. From time to time, the NAIC and various state insurance
regulators consider modifying the method of determining the amount of dividends that an insurance
company may pay without prior regulatory approval. The maximum amount of ordinary dividends that
our insurance subsidiaries can pay to us in 2010 without prior regulatory approval is approximately
$19.7 million. Other business and regulatory considerations, such as the impact of dividends on
surplus that could affect the ratings, competitive conditions, the investment results of our
subsidiaries and the amount of premiums that our insurance subsidiaries can write could also
adversely impact the ability of our insurance subsidiaries to pay dividends to us.
If A.M. Best downgrades the rating it has assigned to Donegal Mutual or our insurance
subsidiaries, it would adversely affect their competitive position.
Industry ratings are a factor in establishing and maintaining the competitive position of
insurance companies. A.M. Best, an industry-accepted source of insurance company financial
strength ratings, rates Donegal Mutual and our insurance subsidiaries. A.M. Best ratings provide
an independent opinion of an insurance companys financial health and its ability to meet its
obligations to its policyholders. We believe that the financial strength rating of A.M. Best is
material to the operations of Donegal Mutual and our insurance subsidiaries. Currently, Donegal
Mutual and our insurance subsidiaries each have an A (Excellent) rating from A.M. Best. If A.M.
Best were to downgrade the rating of Donegal Mutual or any of our insurance subsidiaries, it would
adversely affect the competitive position of Donegal Mutual and our insurance subsidiaries and make
it more difficult for them to market their products and retain their existing policyholders.
Our strategy to grow in part through acquisitions of smaller insurance companies exposes us to
risks that could adversely affect our results of operations and financial condition.
The affiliation with and acquisition of smaller and other undercapitalized insurance companies
involves risks that could adversely affect our results of operations and financial condition. The
risks associated with these affiliations and acquisitions include:
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the potential inadequacy of reserves for loss and loss expenses; |
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the need to supplement management with additional experienced personnel; |
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conditions imposed by regulatory agencies that make the realization of cost-savings
through integration of operations more difficult; |
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a need for additional capital that was not anticipated at the time of the
acquisition; and |
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the use of more of our managements time than we originally anticipated. |
If we cannot obtain sufficient capital to fund the organic growth of our insurance
subsidiaries and to make acquisitions, we may not be able to expand our business.
Our strategy is to expand our business through the organic growth of our insurance
subsidiaries and through our strategic acquisitions of regional insurance companies. Our insurance
subsidiaries will require additional capital in the future to support this strategy. If we cannot
obtain sufficient capital on satisfactory terms and conditions, we may not be able to expand the
business of our insurance subsidiaries or to make future acquisitions. Our ability to obtain
additional financing will depend on a number of factors, many of which are beyond our control. For
example, we may not be able to obtain additional financing because our insurance subsidiaries may
already have substantial debt at the time, because we do not have sufficient cash flow to service
or repay our existing or additional debt or because financial institutions are not making financing
available. In addition, any equity capital we obtain in the future could be dilutive to our
existing stockholders.
Many of the competitors of our insurance subsidiaries have greater financial strength than our
insurance subsidiaries, and these competitors may be able to offer their products at lower prices
than our insurance subsidiaries can afford to do.
The property and casualty insurance industry is intensely competitive. Competition can be
based on many factors, including:
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the perceived financial strength of the insurer; |
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premium rates; |
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policy terms and conditions; |
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policyholder service; |
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reputation; and |
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experience. |
Our insurance subsidiaries compete with many regional and national property and casualty
insurance companies, including direct sellers of insurance products, insurers having their own
agency organizations and other insurers represented by independent agents. Many of these insurers
have greater capital than our insurance subsidiaries, have substantially greater financial,
technical and operating resources and have equal or higher ratings from A.M. Best than our
insurance subsidiaries. In addition, competition may
-39-
become increasingly better capitalized in the
future as the traditional barriers between insurance companies and other financial institutions
erode and as the property and casualty insurance industry continues to consolidate.
The greater capitalization of many of the competitors of our insurance subsidiaries enables
them to operate with lower profit margins and, therefore, allows them to market their products more
aggressively, to take advantage more quickly of new marketing opportunities and to offer lower
premium rates. Our insurance subsidiaries may not be able to maintain their current competitive
position in the markets in which they operate if their competitors offer prices on products that
are lower than the prices our insurance subsidiaries are prepared to offer. Moreover, if these
competitors lower the price of their products and our insurance subsidiaries meet their pricing,
the profit margins and revenues of our insurance subsidiaries may decrease and their ratios of
claims and expenses to premiums may increase. All of these factors materially adversely affect the
financial condition and results of operations of our insurance subsidiaries.
Because the investment portfolios of our insurance subsidiaries consist primarily of
fixed-income securities, their investment income and the fair value of their investment portfolios
could decrease as a result of a number of factors.
Our insurance subsidiaries invest the premiums they receive from their policyholders and
maintain investment portfolios that consist primarily of fixed-income securities. Therefore, the
management of these investment portfolios is an important component of their profitability and a
significant portion of the operating income of our insurance subsidiaries is generated from the
income they receive on their invested assets. A number of factors offset the quality and/or yield
of their portfolios may be affected by a number of factors, including
the general economic and business environment, government monetary policy, changes in the
credit quality of the issuers of the fixed-income securities our insurance subsidiaries own,
changes in market conditions and regulatory changes. The fixed-income securities our insurance
subsidiaries own consist primarily of securities issued by domestic entities that are backed either
by the credit or collateral of the underlying issuer. Factors such as an economic downturn,
disruption in the credit market or the availability of credit, a regulatory change pertaining to a
particular issuers industry, a significant deterioration in the cash flows of the issuer or a
change in the issuers marketplace may adversely affect the ability of our insurance subsidiaries
to collect principal and interest from the issuer.
The investments of our insurance subsidiaries are also subject to risk resulting from interest
rate fluctuations. Increasing interest rates or a widening in the spread between interest rates
available on U.S. Treasury securities and corporate debt or asset-backed securities, for example,
will typically have an adverse impact on the market values of fixed-rate securities. If interest
rates decline, our insurance subsidiaries would generally achieve a lower overall rate of return on
investments of cash generated from their operations. In addition, in the event of the call or
maturity of investments in a declining interest rate
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environment, our insurance subsidiaries may
not be able to reinvest the proceeds in securities with comparable interest rates. Changes in
interest rates may reduce both the profitability and the return on the invested capital of our
insurance subsidiaries.
Our insurance subsidiaries depend on key personnel. The loss of any member of their senior
management or our executive management could negatively affect the implementation of their business
strategies and achievement of their growth objectives.
The loss of, or failure to attract, key personnel could significantly impede the financial
plans, growth, marketing and other objectives of our insurance subsidiaries. Their success depends
to a substantial extent on the ability and experience of their senior management. Our insurance
subsidiaries believe that their future success is dependent on their ability to attract and retain
additional skilled and qualified personnel and to expand, train and manage their employees. Our
insurance subsidiaries may be unable to do so because of the intense competition for experienced
personnel in the insurance industry. With limited exceptions, our insurance subsidiaries do not
have employment agreements with their key personnel.
The reinsurance agreements on which our insurance subsidiaries rely do not relieve our
insurance subsidiaries from their primary liability to their policyholders, and our insurance
subsidiaries face a risk of non-payment from their reinsurers as well as the non-availability of
reinsurance in the future.
Our insurance subsidiaries rely on reinsurance agreements to limit their maximum net loss from
large single catastrophic risks or excess of loss risks in areas where are insurance
subsidiaries may have a concentration of policyholders. Reinsurance also enables our
insurance subsidiaries to increase their capacity to write insurance. Although the reinsurance our
insurance subsidiaries maintain provides that the reinsurer is liable to them for any reinsured
losses, the reinsurance does not relieve our insurance subsidiaries from their primary liability to
their policyholders if the reinsurer fails to pay our insurance subsidiaries. To the extent that a
reinsurer is unable to pay losses for which it is liable to our insurance subsidiaries, our
insurance subsidiaries remain liable for such losses. As of December 31, 2009, our insurance
subsidiaries had approximately $24.0 million of reinsurance receivables from third-party reinsurers
relating to paid and unpaid losses. Any insolvency or inability of these reinsurers to make timely
payments to our insurance subsidiaries under the terms of their reinsurance agreements would
adversely affect the results of operations of our insurance subsidiaries.
In addition, our insurance subsidiaries face a risk of the non-availability of reinsurance or
an increase in reinsurance costs that could adversely affect their ability to write business or
their results of operations. Market conditions beyond the control of our insurance subsidiaries,
such as the amount of surplus in the reinsurance market and the frequency and severity of natural
and man-made catastrophes, affect both the availability and the cost of the reinsurance our
insurance subsidiaries purchase. If our insurance subsidiaries can not
-41-
maintain their current
level of reinsurance or purchase new reinsurance protection in amounts that our insurance
subsidiaries consider sufficient, our insurance subsidiaries would either have to be willing to
accept an increase in their net risk retention or reduce their insurance writings which would
adversely affect them.
Risks Relating to the Property and Casualty Insurance Industry
Industry trends, such as increased litigation against the insurance industry and individual
insurers, the willingness of courts to expand covered causes of loss, rising jury awards,
escalating medical costs and increasing loss severity may contribute to increased costs and to the
deterioration of the reserves of our insurance subsidiaries.
Loss severity in the property and casualty insurance industry has increased in recent years,
principally driven by larger court judgments and increasing medical costs. In addition, many
classes of complainants have brought legal actions and proceedings that tend to increase the size
of judgments. The propensity of policyholders and third-party claimants to litigate and the
willingness of courts to expand causes of loss and the size of awards to eliminate exclusions and
to increase coverage limits may make the loss reserves of our insurance subsidiaries inadequate for
current and future losses.
Loss or significant restriction of the use of credit scoring in the pricing and underwriting
of the personal lines insurance products by our insurance subsidiaries could adversely affect their
future profitability.
Our insurance subsidiaries use credit scoring as a factor in making risk selection and pricing
decisions where allowed by state law for personal lines insurance products. Recently, some
consumer groups and regulators have questioned whether the use of credit scoring unfairly
discriminates against people with low incomes, minority groups and the elderly. These consumer
groups and regulators often call for the prohibition or restriction on the use of credit scoring in
underwriting and pricing. Laws or regulations enacted in a number of states that significantly
curtail the use of credit scoring in the underwriting process could reduce the future profitability
of our insurance subsidiaries.
Changes in applicable insurance laws or regulations or changes in the way regulators
administer those laws or regulations could adversely affect the operating environment of our
insurance subsidiaries and increase their exposure to loss or put them at a competitive
disadvantage.
Property and casualty insurers are subject to extensive supervision in their domiciliary
states and in the states in which they do business. This regulatory oversight includes, by way of
example, matters relating to licensing and examination, approval of premium rates, market conduct,
policy forms, limitations on the nature and amount of certain investments, claims practices,
mandated participation in involuntary markets and guaranty funds, reserve adequacy, insurer
solvency, transactions between affiliates, the amount of dividends that
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insurers may pay and
restrictions on underwriting standards. Such regulation and supervision are primarily for the
benefit and protection of policyholders rather than stockholders. For instance, our insurance
subsidiaries are subject to involuntary participation in specified markets in various states in
which they operate, and the premium rates our insurance subsidiaries may charge do not always
correspond with the underlying costs of providing that coverage.
The NAIC and state insurance regulators are re-examining existing laws and regulations,
specifically focusing on insurance company investments, issues relating to the solvency of
insurance companies, risk-based capital guidelines, restrictions on the terms and conditions
included in insurance policies, certain methods of accounting, reserves for unearned premiums,
losses and other purposes, the values at which they may carry investment securities and the
definition of other-than-temporary impairment, interpretations of existing laws and the development
of new laws. Changes in state laws and regulations, as well as changes in the way state regulators
view related-party transactions in particular, could change the operating environment of our
insurance subsidiaries and have an adverse effect on their business.
The state insurance regulatory framework has recently come under increased federal scrutiny
partly as a result of the substantial emergency funding the federal government provided AIG.
Congress is considering proposals that it should create an optional federal charter for insurers.
Federal chartering has the potential to create an uneven playing field for insurers by subjecting
federally-chartered and state-chartered insurers to different regulatory requirements. Federal
chartering also raises the possibility of duplicative or conflicting federal and state
requirements. In addition, if federal legislation repeals the partial exemption for the insurance
industry from federal antitrust laws, our ability to collect and share loss cost data with the
industry could adversely affect the results of operations of our insurance subsidiaries.
Our insurance subsidiaries are subject to assessments, based on their market share in a given
line of business, to assist in the payment of unpaid claims and related costs of insolvent
insurance companies. Such assessments could adversely affect the financial condition of our
insurance subsidiaries.
Our insurance subsidiaries must pay assessments pursuant to the guaranty fund laws of the
various states in which they conduct business. Generally, under these laws, our insurance
subsidiaries can be assessed, depending upon the market share of our insurance subsidiaries in a
given line of insurance business, to assist in the payment of unpaid claims and related costs of
insolvent insurance companies in those states. We cannot predict the number and magnitude of
future insurance company failures in the states in which our insurance subsidiaries conduct
business, but future assessments could adversely affect the business, financial condition and
results of operations of our insurance subsidiaries.
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Our insurance subsidiaries must establish premium rates and loss and loss expense reserves
from forecasts of the ultimate costs they expect will arise from risks underwritten during the
policy period, and the profitability of our insurance subsidiaries could be adversely affected if
their premium rates or reserves are insufficient to satisfy their ultimate costs.
One of the distinguishing features of the property and casualty insurance industry is that it
prices its products before it knows its costs since insurers generally establish their premium
rates before they know the amount of losses they will incur. Accordingly, our insurance
subsidiaries establish premium rates from forecasts of the ultimate costs they expect to arise from
risks they have underwritten during the policy period. These premium rates may not be sufficient
to cover the ultimate losses incurred. Further, our insurance subsidiaries must establish reserves
for losses and loss expenses as balance sheet liabilities based upon estimates involving actuarial
and statistical projections at a given time of what our insurance subsidiaries expect their
ultimate liability to be. Significant periods of time often elapse from the occurrence of an
insured loss to the reporting of the loss and the payment of that loss. It is possible that their
ultimate liability could exceed these estimates
because of the future development of known losses, the existence of losses that have occurred
but are currently unreported and larger than historical settlements on pending and unreported
claims. The process of estimating reserves is inherently judgmental and can be influenced by
variable factors including:
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trends in claim frequency and severity; |
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changes in operations; |
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emerging economic and social trends; |
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inflation; and |
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changes in the regulatory and litigation environments. |
If our insurance subsidiaries have insufficient premium rates or reserves, insurance
regulatory authorities may require increases to these reserves. An increase in reserves results in
an increase in losses and a reduction in net income for the period in which the deficiency in
reserves exists. Accordingly, if an increase in reserves is not sufficient, it may adversely
impact their business, liquidity, financial condition and results of operations.
The financial results of our insurance subsidiaries depend primarily on the ability to
underwrite risks effectively and to charge adequate rates to policyholders.
The financial condition, cash flows and results of operations of our insurance subsidiaries
depend on the ability to underwrite and set rates accurately for a full spectrum of risks, across a
number of lines of insurance. Rate adequacy is necessary to generate
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sufficient premium to pay
losses, loss adjustment expenses and underwriting expenses and to earn a profit.
The ability to underwrite and set rates effectively is subject to a number of risks and
uncertainties, including:
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the availability of sufficient, reliable data; |
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the ability to conduct a complete and accurate analysis of available data; |
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the ability to timely recognize changes in trends and to project both the severity
and frequency of losses with reasonable accuracy; |
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uncertainties generally inherent in estimates and assumptions; |
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the ability to project changes in certain operating expense levels with reasonable
certainty; |
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the development, selection and application of appropriate rating formulae or other
pricing methodologies; |
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the use of modeling tools to assist with correctly and consistently achieving the
intended results in underwriting and pricing ; |
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the ability to innovate with new pricing strategies, and the success of those
innovations on implementation; |
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the ability to secure regulatory approval of premium rates on an adequate and timely
basis; |
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the ability to predict policyholder retention accurately; |
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unanticipated court decisions, legislation or regulatory action; |
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unanticipated changes in our claim settlement practices; |
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changing driving patterns for auto exposures; changing weather patterns for property
exposures; |
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changes in the medical sector of the economy; |
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unanticipated changes in auto repair costs, auto parts prices and used car prices; |
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impact of inflation and other factors on cost of construction materials and labor; |
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the ability to monitor property concentration in catastrophe prone areas, such as
hurricane, earthquake and wind/hail regions; and |
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the general state of the economy in the states in which we operate. |
Such risks may result in the premium rates of our insurance subsidiaries being based on
inadequate or inaccurate data or inappropriate assumptions or methodologies, and may cause our
estimates of future changes in the frequency or severity of claims to be incorrect. As a result,
our insurance subsidiaries could underprice risks, which would negatively affect our margins, or we
could overprice risks, which could reduce our volume and competitiveness. In either event,
underpricing or overpricing risks could adversely impact their operating results, financial
condition and cash flows.
The cyclical nature of the property and casualty insurance industry may reduce the revenues
and profit margins of our insurance subsidiaries.
The property and casualty insurance industry is highly cyclical with respect to both
individual lines of business and the overall insurance industry. Premium rate levels relate to the
availability of insurance coverage, which varies according to the level of surplus available in the
insurance industry. The level of surplus in the industry varies with returns on invested capital
and regulatory barriers to withdrawal of surplus. Increases in surplus may result in increased
price competition among property and casualty insurers. If our insurance subsidiaries find it
necessary to reduce premiums or limit premium increases due to these competitive pressures on
pricing, our insurance subsidiaries may experience a reduction in their profit margins and
revenues, an increase in their ratios of losses and expenses to premiums and, therefore, lower
profitability.
Risks Relating to Our Class A Common Stock
The price of our Class A common stock may be adversely affected by its low trading volume.
Our Class A common stock has limited liquidity. Reported average daily trading volume in
our Class A common stock for the year ended December 31, 2009 was approximately 27,000 shares.
This limited liquidity subjects our shares of Class A common stock to greater price volatility.
Donegal Mutuals ownership of our stock, anti-takeover provisions of our certificate of
incorporation and by-laws and certain state laws make it unlikely anyone could acquire control of
us unless Donegal Mutual were in favor of the acquisition of control.
Donegal Mutuals ownership of our Class A common stock and Class B common stock, certain
anti-takeover provisions of our certificate of incorporation and by-laws, certain provisions
of Delaware law and the insurance laws and regulations of Pennsylvania, Maryland, Iowa, Virginia,
Wisconsin and Georgia could delay or prevent the removal of
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members of our board of directors and could make it more difficult for a merger, tender offer or
proxy contest involving us to succeed, even if our stockholders other than Donegal Mutual believed
such events were beneficial to them. These factors could also discourage a third party from
attempting to acquire control of us. The classification of our board of directors could also have
the effect of delaying or preventing a change in control of us.
In addition, we have 2,000,000 authorized shares of preferred stock that we could issue in one
or more series without stockholder approval, to the extent permitted by applicable law, and upon
such terms and conditions, and having such rights, privileges and preferences, as our board of
directors may determine. Our ability to issue preferred stock could make it
difficult for a third party to acquire us. We have no current plans to issue any preferred
stock.
Moreover, the DGCL contains certain provisions that prohibit certain business combination
transactions under certain circumstances. In addition, state insurance laws and regulations
generally prohibit any person from acquiring, or seeking to acquire, a 10% or greater interest in
an insurance company without the prior approval of the state insurance commissioner of the state
where the insurer is domiciled.
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Item 1B. |
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Unresolved Staff Comments. |
We have no unresolved written comments from the SEC staff regarding our filings under the
Exchange Act.
We and our insurance subsidiaries share administrative headquarters with Donegal Mutual in a
building in Marietta, Pennsylvania owned by Donegal Mutual. Donegal Mutual charges us and our
insurance subsidiaries for an appropriate portion of the building expenses under an inter-company
allocation agreement. The Marietta headquarters has approximately 230,000 square feet of office
space. Southern owns a facility of approximately 10,000 square feet in Glen Allen, Virginia. Le
Mars owns a facility of approximately 25,500 square feet in Le Mars, Iowa, the Peninsula Companies
own a facility of approximately 14,600 square feet in Salisbury, Maryland and Sheboygan owns a
facility of approximately 8,800 square feet in Sheboygan Falls, Wisconsin.
|
|
|
Item 3. |
|
Legal Proceedings. |
Our insurance subsidiaries are parties to routine litigation that arises in the ordinary
course of their insurance business. We believe that the resolution of these lawsuits will not have
a material adverse effect on the financial condition or results of operations of our insurance
subsidiaries.
-47-
Not applicable.
Executive Officers of the Company
The following table sets forth information regarding the executive officers of Donegal Mutual
and us, each of whom has served with us for more than 10 years:
|
|
|
|
|
|
|
Name |
|
Age |
|
Position |
|
|
|
|
|
|
|
Donald H. Nikolaus
|
|
|
67 |
|
|
President and Chief Executive Officer of
Donegal Mutual since 1981; President and
Chief Executive Officer of us since 1986. |
|
|
|
|
|
|
|
Robert G. Shenk
|
|
|
56 |
|
|
Senior Vice President, Claims, of Donegal
Mutual and us since 1997; other positions
from 1986 to 1997. |
|
|
|
|
|
|
|
Cyril J. Greenya
|
|
|
65 |
|
|
Senior Vice President and Chief Underwriting
Officer, of Donegal Mutual and us since
2005, Senior Vice President, Underwriting of
Donegal Mutual from 1997 to 2005; other
positions from 1986 to 2005. |
|
|
|
|
|
|
|
Daniel J. Wagner
|
|
|
49 |
|
|
Senior Vice President and Treasurer of
Donegal Mutual and us since 2005; Vice
President and Treasurer of Donegal Mutual
and us from 2000 to 2005; other positions
from 1993 to 2005. |
|
|
|
|
|
|
|
Jeffrey D. Miller
|
|
|
45 |
|
|
Senior Vice President and Chief Financial
Officer of Donegal Mutual and us since 2005;
Vice President and Controller of Donegal
Mutual and us from 2000 to 2005; other
positions from 1995 to 2005. |
-48-
PART II
|
|
|
Item 5. |
|
Market for Registrants Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities. |
We incorporate the response to this Item in part by reference to page 40 of our Annual Report
to Stockholders for the year ended December 31, 2009, or 2009 Annual Report. Our 2009 Annual
Report is included as Exhibit (13) to this Form 10-K Report.
As of February 26, 2010, we had approximately 1,229 holders of record of our Class A common
stock and approximately 418 holders of record of our Class B common stock.
We declared dividends of $0.42 per share on our Class A common stock and $0.37 per share on
our Class B common stock in 2008 and $0.45 per share on our Class A common stock and $0.40 per
share on our Class B common stock in 2009.
Between October 1, 2009 and December 31, 2009, we and Donegal Mutual purchased shares of our
Class A common stock and Class B common stock as set forth in the table below.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(d) Maximum |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number (or |
|
|
|
|
|
|
|
|
|
|
|
(c) Total Number of |
|
|
Approximate Dollar |
|
|
|
|
|
|
|
|
|
|
|
Shares (or Units) |
|
|
Value) of Shares |
|
|
|
|
|
|
|
|
|
|
|
Purchased as Part |
|
|
(or Units) that May |
|
|
|
(a) Total Number of |
|
|
(b) Average Price |
|
|
of Publicly |
|
|
Yet Be Purchased |
|
|
|
Shares (or Units) |
|
|
Paid per Share |
|
|
Announced Plans |
|
|
Under the Plans |
|
Period |
|
Purchased |
|
|
(or Unit) |
|
|
of Programs |
|
|
or Programs(1) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Month #1 |
|
Class A |
|
Class A $ |
|
Class A |
|
|
|
|
October 1-31, 2009 |
|
Class B |
|
Class B $ |
|
Class B |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Month #2 |
|
Class A 12,900 |
|
Class A $15.10 |
|
Class A 12,900 |
|
|
|
|
November 1-30, 2009 |
|
Class B |
|
Class B $ |
|
Class B |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Month #3 |
|
Class A |
|
Class A $ |
|
Class A |
|
|
|
|
December 1-31, 2009 |
|
Class B |
|
Class B $ |
|
Class B |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
Class A 12,900 |
|
Class A $15.10 |
|
Class A 12,900 |
|
|
|
|
|
|
Class B |
|
Class B $ |
|
Class B |
|
|
|
|
|
|
|
(1) |
|
We announced on February 23, 2009 that we will purchase up to
300,000 shares of Class A common stock at market prices
prevailing from time to time in the open market subject to the
provisions of SEC Rule 10b-18 and in privately negotiated
transactions. We have 292,331 additional shares of Class A
common stock available for purchase under this program. |
Our performance graph is included on page 39 of our 2009 Annual Report.
-49-
|
|
|
Item 6. |
|
Selected Financial Data. |
We incorporate the response to this Item by reference to page 6 of our 2009 Annual Report.
|
|
|
Item 7. |
|
Managements Discussion and Analysis of Financial Condition and Results of
Operations. |
We incorporate the response to this Item by reference to pages 8 through 16 of our 2009 Annual
Report.
|
|
|
Item 7A. |
|
Quantitative and Qualitative Disclosures About Market Risk. |
Our insurance subsidiaries are exposed to the impact of changes in interest rates, changes in
fair values of investments and credit risk because each them maintains a substantial investment
portfolio in relation to its total assets.
In the normal course of business, we and our insurance subsidiaries employ established
policies and procedures to manage and mitigate exposure to changes in interest rates, fluctuations
in the fair market value of debt and equity securities and credit risk.
Interest Rate Risk
Our insurance subsidiaries monitor interest rate exposure through regular reviews of their
respective asset and liability positions. Our insurance subsidiaries regularly monitor their cash
flow estimates and the impact of interest rate fluctuations on their investment portfolio. Our
insurance subsidiaries generally do not hedge their exposure to interest rate risk because each of
them has the capacity to, and does, hold fixed-maturity investments to maturity.
The following table presents the principal cash flows and related weighted-average interest
rates by expected maturity dates for financial instruments sensitive to interest rates of our
insurance subsidiaries:
-50-
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2009 |
|
|
|
|
|
|
|
Weighted-average |
|
(amounts in thousands) |
|
Principal cash flows |
|
|
interest rate |
|
|
|
|
|
|
|
|
|
|
Fixed maturities and short-term
investments: |
|
|
|
|
|
|
|
|
2010 |
|
$ |
74,981 |
|
|
|
1.4 |
% |
2011 |
|
|
15,457 |
|
|
|
4.3 |
|
2012 |
|
|
20,476 |
|
|
|
3.3 |
|
2013 |
|
|
20,220 |
|
|
|
4.2 |
|
2014 |
|
|
26,965 |
|
|
|
4.1 |
|
Thereafter |
|
|
479,472 |
|
|
|
4.4 |
|
|
|
|
|
|
|
|
|
Total |
|
$ |
637,571 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Market value |
|
$ |
650,810 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Debt: |
|
|
|
|
|
|
|
|
Thereafter |
|
$ |
15,465 |
|
|
|
4.3 |
% |
|
|
|
|
|
|
|
|
Total |
|
$ |
15,465 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value |
|
$ |
15,465 |
|
|
|
|
|
|
|
|
|
|
|
|
|
The actual cash flows of our insurance subsidiaries and Donegal Mutual from investments
may differ from those indicated above because of calls and prepayments.
Equity Price Risk
Our insurance subsidiaries carry their portfolios of marketable equity securities on their
consolidated balance sheets at estimated fair value. These securities have exposure to equity
price risk. We define equity price risk as the risk of potential loss in estimated fair value
resulting from an adverse change in prices. Our insurance subsidiaries seek to mitigate equity
price risk and exposure by earning competitive relative returns on diverse portfolios of
high-quality and liquid securities.
Credit Risk
The fixed-maturity securities portfolios our insurance subsidiaries maintain and, to a lesser
extent, their short-term investments of our insurance subsidiaries are subject to credit risk. We
define credit risk as the potential loss in market value resulting from adverse changes in a
borrowers ability to repay its debt. Our insurance subsidiaries seek to manage this risk through
pre-investment underwriting analysis and regular reviews by our investment staff. Each of our
insurance subsidiaries seeks to limit its credit risk by limiting the amount of its fixed-maturity
investments in the securities of any one issuer.
Our insurance subsidiaries provide property and casualty insurance coverages through
independent insurance agencies located throughout the states in which Donegal Mutual and our
insurance subsidiaries conduct business. Our insurance subsidiaries bill the majority of this
business directly to the policyholder, although our insurance subsidiaries bill
-51-
a portion of their commercial business through the agents of our insurance subsidiaries. Our
insurance subsidiaries who extend credit to agents in the normal course of their business.
Our insurance subsidiaries place reinsurance with Donegal Mutual and with major unaffiliated
authorized reinsurers. Although our insurance subsidiaries as a matter of law retain ultimate
responsibility to our policyholders if a reinsurer fails for any reason to pay an insurance risk we
have ceded, we do not regard this legal conclusion as a material risk because each of our insurance
subsidiaries has an A.M. Best rating of A.
|
|
|
Item 8. |
|
Financial Statements and Supplementary Data. |
We incorporate the response to this Item by reference to pages 17 through 35 of our 2009
Annual Report.
|
|
|
Item 9. |
|
Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure. |
None.
|
|
|
Item 9A. |
|
Controls and Procedures. |
Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and our Chief Financial
Officer, has evaluated the effectiveness of our disclosure controls and procedures (as such term is
defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of December 31, 2009 covered by
this Form 10-K Report. Based on such evaluation, our Chief Executive Officer and our Chief
Financial Officer have concluded that, as of December 31, 2009, our disclosure controls and
procedures are effective in recording, processing, summarizing and reporting, on a timely basis,
information we are required to disclose in the reports that we file or submit under the Exchange
Act and our disclosure controls and procedures are also effective to ensure that information we
disclose in the reports we file or submit under the Exchange Act is accumulated and communicated to
our management, including our Chief Executive Officer and our Chief Financial Officer, to allow
timely decisions regarding required disclosure.
Internal Control over Financial Reporting
Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, we include a report of our
managements assessment of the design and effectiveness of our internal control over financial
reporting as part of our 2009 Annual Report. KPMG LLP, an independent registered public accounting
firm, audited the effectiveness of our internal control over financial reporting as of December 31,
2009 based on criteria establish by Internal Control
-52-
Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission. We include the report of KPMG LLP dated March 11, 2010 as part of our 2009 Annual
Report.
Changes in Internal Control over Financial Reporting
We have not changed our internal control over financial reporting (as such term is defined in
Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fourth quarter of 2009 that have
materially affected, or are reasonably likely to affect materially, our internal control over
financial reporting.
|
|
|
Item 9B. |
|
Other Information. |
None.
-53-
PART III
|
|
|
Item 10. |
|
Directors, Executive Officers and Corporate Governance of the Registrant. |
We respond to this Item by reference to our proxy statement, or the Proxy Statement, we will
file with respect to the annual meeting of our stockholders that we will hold on April 15, 2010.
We respond to this Item with respect to our executive officers by reference to Part I of this Form
10-K Report.
We incorporate the full text of our Code of Business Conduct and Ethics by reference to
Exhibit 15 to this Form 10-K Report.
|
|
|
Item 11. |
|
Executive Compensation. |
We incorporate the response to this Item by reference to our proxy statement filed with the
SEC relating to our annual meeting of stockholders to be held April 15, 2010. Neither the Report
of our Compensation Committee nor the Report of our Audit Committee is deemed filed with the SEC or
deemed incorporated by reference into any filing we make under the Securities Act or the Exchange
Act, except to the extent we specifically incorporate it by reference.
|
|
|
Item 12. |
|
Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters. |
We respond to this Item by reference to our Proxy Statement.
|
|
|
Item 13. |
|
Certain Relationships and Related Transactions and Director Independence. |
We respond to this Item by reference to our Proxy Statement.
|
|
|
Item 14. |
|
Principal Accountant Fees and Services. |
We respond to this Item by reference to our Proxy Statement.
-54-
PART IV
Item 15. Exhibits and Financial Statement Schedule.
|
(a) |
|
Financial statements, financial statement schedule and exhibits filed: |
|
(a) |
|
Consolidated Financial Statements |
|
|
|
|
|
|
|
Page* |
|
|
|
|
|
|
Reports of Independent Registered Public Accounting Firm |
|
|
36, 38 |
|
|
|
|
|
|
Donegal Group Inc. and Subsidiaries: |
|
|
|
|
|
|
|
|
|
Consolidated Balance Sheets as of December 31, 2009 and 2008 |
|
|
17 |
|
|
|
|
|
|
Consolidated Statements of Income and Comprehensive Income
for each of the years in the three-year period ended December 31,
2009, 2008 and 2007 |
|
|
18 |
|
|
|
|
|
|
Consolidated Statements of Stockholders Equity for each of the
years in the three-year period ended December 31, 2009, 2008
and 2007 |
|
|
19 |
|
|
|
|
|
|
Consolidated Statements of Cash Flows for each of the years in the
three-year period ended December 31, 2009, 2008 and 2007 |
|
|
20 |
|
|
|
|
|
|
Notes to Consolidated Financial Statements |
|
|
21 |
|
|
|
|
|
|
Report and Consent of Independent Registered Public
Accounting Firm |
|
Exhibit 23 |
|
(b) |
|
Financial Statement Schedule |
|
|
|
|
|
|
|
Page |
|
|
|
|
|
|
Donegal Group Inc. and Subsidiaries |
|
|
|
|
|
|
|
|
|
Schedule III Supplementary Insurance Information |
|
|
S-1 |
|
We have omitted all other schedules since they are not required, not applicable or the
information is included in the financial statements or notes thereto.
|
|
|
* |
|
Refers to pages of our 2009 Annual Report to Stockholders. We incorporate by reference to pages
17 through 38 of our 2009 Annual Report, our Consolidated Financial
Statements, Notes to Consolidated Financial Statements, Report of Independent Registered Public
Accounting Firm on consolidated financial statements, Managements Report on |
-55-
|
|
|
|
|
Internal Control over
Financial Reporting and Report of Independent Registered Public Accounting Firm on Internal Control
Over Financial Reporting. With the exception of the portions of our 2009 Annual Report in this
Item and Items 5, 6, 7 and 8 of this Form 10-K Report, our 2009 Annual Report shall not be deemed
filed as part of this Form 10-K Report or otherwise subject to the liabilities of Section 18 of the
Exchange Act. |
|
|
|
|
|
Exhibit No. |
|
Description of Exhibits |
|
Reference |
|
|
|
|
|
(3)(i)
|
|
Certificate of Incorporation of Donegal Group Inc., as amended.
|
|
(a) |
|
|
|
|
|
(3)(ii)
|
|
Amended and Restated By-laws of Donegal Group Inc.
|
|
(r) |
|
|
|
|
|
Management Contracts and Compensatory Plans or Arrangements |
|
|
|
|
|
|
|
(10)(B)
|
|
Donegal Group Inc. 2001 Equity Incentive Plan for Employees.
|
|
(c) |
|
|
|
|
|
(10)(C)
|
|
Donegal Group Inc. 2001 Equity Incentive Plan for Directors.
|
|
(c) |
|
|
|
|
|
(10)(D)
|
|
Donegal Group Inc. 2001 Employee Stock Purchase Plan, as
amended.
|
|
(d) |
|
|
|
|
|
(10)(E)
|
|
Donegal Group Inc. Amended and Restated 2001 Agency Stock
Purchase Plan.
|
|
(e) |
|
|
|
|
|
(10)(F)
|
|
Donegal Mutual Insurance Company 401(k) Plan.
|
|
(f) |
|
|
|
|
|
(10)(G)
|
|
Amendment No. 1 effective January 1, 2000 to Donegal Mutual
Insurance Company 401(k) Plan.
|
|
(f) |
|
|
|
|
|
(10)(H)
|
|
Amendment No. 2 effective January 6, 2000 to Donegal Mutual
Insurance Company 401(k) Plan.
|
|
(b) |
|
|
|
|
|
(10)(I)
|
|
Amendment No. 3 effective July 23, 2001 to Donegal Mutual
Insurance Company 401(k) Plan.
|
|
(b) |
|
|
|
|
|
(10)(J)
|
|
Amendment No. 4 effective January 1, 2002 to Donegal Mutual
Insurance Company 401(k) Plan.
|
|
(b) |
|
|
|
|
|
(10)(K)
|
|
Amendment No. 5 effective December 31, 2001 to Donegal Mutual
Insurance Company 401(k) Plan.
|
|
(b) |
-56-
|
|
|
|
|
Exhibit No. |
|
Description of Exhibits |
|
Reference |
|
|
|
|
|
(10)(L)
|
|
Amendment No. 6 effective July 1, 2002 to Donegal Mutual
Insurance Company 401(k) Plan.
|
|
(p) |
|
|
|
|
|
(10)(M)
|
|
Donegal Group Inc. 2007 Equity Incentive Plan for Employees.
|
|
(s) |
|
|
|
|
|
(10)(N)
|
|
Donegal Group Inc. 2007 Equity Incentive Plan for Directors.
|
|
(s) |
|
|
|
|
|
(10)(O)
|
|
Donegal Group Inc. Incentive Compensation Program.
|
|
(u) |
|
|
|
|
|
Other Material Contracts |
|
|
|
|
|
|
|
(10)(O)
|
|
Amended and Restated Tax Sharing Agreement dated as of October
19, 2006 among Donegal Group Inc., Atlantic States Insurance
Company, Southern Insurance Company of Virginia, Le Mars
Insurance Company, The Peninsula Insurance Company and
Peninsula Indemnity Company.
|
|
(p) |
|
|
|
|
|
(10)(P)
|
|
Amended and Restated Services Allocation Agreement dated July
20, 2006 among Donegal Group Inc., Atlantic States Insurance
Company, Southern Insurance Company, Le Mars Insurance
Company, The Peninsula Insurance Company, Peninsula Indemnity
Company and Donegal Mutual Insurance Company.
|
|
(b) |
|
|
|
|
|
(10)(Q)
|
|
Proportional Reinsurance Agreement dated September 29, 1986
between Donegal Mutual Insurance Company and Atlantic States
Insurance Company.
|
|
(h) |
|
|
|
|
|
(10)(R)
|
|
Amendment dated October 1, 1988 to Proportional Reinsurance
Agreement between Donegal Mutual Insurance Company and
Atlantic States Insurance Company.
|
|
(i) |
|
|
|
|
|
(10)(S)
|
|
Amendment dated July 16, 1992 to Proportional Reinsurance
Agreement between Donegal Mutual Insurance Company and
Atlantic States Insurance Company.
|
|
(j) |
|
|
|
|
|
(10)(T)
|
|
Amendment dated as of December 21, 1995 to Proportional
Reinsurance Agreement between Donegal Mutual Insurance Company
and Atlantic States Insurance Company.
|
|
(k) |
-57-
|
|
|
|
|
Exhibit No. |
|
Description of Exhibits |
|
Reference |
|
|
|
|
|
(10)(U)
|
|
Reinsurance and Retrocession Agreement dated May 21, 1996
between Donegal Mutual Insurance Company and Southern
Insurance Company of Virginia.
|
|
(g) |
|
|
|
|
|
(10)(V)
|
|
Amendment dated as of April 20, 2000 to Proportional
Reinsurance Agreement between Donegal Mutual Insurance Company
and Atlantic States Insurance Company.
|
|
(l) |
|
|
|
|
|
(10)(W)
|
|
Lease Agreement dated as of September 1, 2000 between Donegal
Mutual Insurance Company and Province Bank FSB.
|
|
(c) |
|
|
|
|
|
(10)(X)
|
|
Plan of Conversion of Le Mars Mutual Insurance Company of Iowa
adopted August 11, 2003.
|
|
(n) |
|
|
|
|
|
(10)(Y)
|
|
Stock Purchase Agreement dated as of October 28, 2003 between
Donegal Group Inc. and Folksamerica Holding Company, Inc.
|
|
(m) |
|
|
|
|
|
(10)(Z)
|
|
Credit Agreement dated as of November 25, 2003 between Donegal
Group Inc. and Manufacturers and Traders Trust Company.
|
|
(n) |
|
|
|
|
|
(10)(AA)
|
|
First Amendment to Credit Agreement dated as of July 20, 2006
between Donegal Group Inc. and Manufacturers and Traders Trust
Company.
|
|
(b) |
|
|
|
|
|
(10)(BB)
|
|
Amended and Restated Services Allocation Agreement dated
October 19, 2006 among Donegal Group Inc., Atlantic States
Insurance Company, Southern Insurance Company of Virginia, Le
Mars Insurance Company, The Peninsula Insurance Company,
Peninsula Indemnity Company and Donegal Mutual Insurance
Company.
|
|
(q) |
|
|
|
|
|
(10)(CC)
|
|
Amendment dated as of February 11, 2008 to Proportional
Reinsurance Agreement between Donegal Mutual Insurance Company
and Atlantic States Insurance Company.
|
|
(t) |
|
|
|
|
|
(10)(DD)
|
|
Contribution Note Purchase Agreement dated as of December 27,
2006 between Donegal Mutual Insurance Company and Sheboygan
Falls Mutual Insurance Company.
|
|
(v) |
-58-
|
|
|
|
|
Exhibit No. |
|
Description of Exhibits |
|
Reference |
|
|
|
|
|
(10)(EE)
|
|
Plan of Conversion of Sheboygan Falls Mutual Insurance Company
adopted October 14, 2008.
|
|
(v) |
|
|
|
|
|
(10)(FF)
|
|
Surplus Note Purchase Agreement dated as of September 8, 2009
between Donegal Mutual Insurance Company and Southern Mutual
Insurance Company.
|
|
Filed
herewith |
|
|
|
|
|
(10)(GG)
|
|
Quota-share Reinsurance Agreement dated as of October 30, 2009
but effective as of 11:59 p.m. on October 31, 2009 between
Donegal Mutual Insurance Company and Southern Mutual Insurance
Company.
|
|
Filed
herewith |
|
|
|
|
|
(10)(HH)
|
|
Services and Affiliation Agreement dated as of October 30,
2009 between Donegal Mutual Insurance Company and Southern
Mutual Insurance Company.
|
|
Filed
herewith |
|
|
|
|
|
(10)(II)
|
|
Technology License Agreement dated as of October 30, 2009
between Donegal Mutual Insurance Company and Southern Mutual
Insurance Company.
|
|
Filed
herewith |
|
|
|
|
|
(10)(JJ)
|
|
Amended and Restated Proportional Reinsurance Agreement dated
March 1, 2010 between Donegal Mutual Insurance Company and
Atlantic States Insurance Company.
|
|
Filed
herewith |
|
|
|
|
|
(13)
|
|
2009 Annual Report to Stockholders (electronic filing contains
only those portions incorporated by reference into this Form
10-K Report).
|
|
Filed
herewith |
|
|
|
|
|
(14)
|
|
Code of Business Conduct and Ethics
|
|
(o) |
|
|
|
|
|
(21)
|
|
Subsidiaries of Registrant.
|
|
Filed
herewith |
|
|
|
|
|
(23)
|
|
Report and Consent of Independent Registered Public Accounting
Firm
|
|
Filed herewith |
|
|
|
|
|
(31.1)
|
|
Rule 13a-14(a)/15(d)-14(a) Certification of Chief Executive
Officer
|
|
Filed herewith |
|
|
|
|
|
(31.2)
|
|
Rule 13a-14(a)/15(d)-14(a) Certification of Chief Financial
Officer
|
|
Filed herewith |
-59-
|
|
|
|
|
Exhibit No. |
|
Description of Exhibits |
|
Reference |
|
|
|
|
|
(32.1)
|
|
Section 1350 Certification of Chief Executive Officer
|
|
Filed herewith |
|
|
|
|
|
(32.2)
|
|
Section 1350 Certification of Chief Financial Officer
|
|
Filed herewith |
|
|
|
(a) |
|
Such exhibit is hereby incorporated by reference to the like-described exhibit in Registrants Form S-3
Registration Statement No. 333-59828 filed April 30, 2001. |
|
(b) |
|
Such exhibit is hereby incorporated by reference to the like-described exhibit in Registrants Form 10-K
Report for the year ended December 31, 2001. |
|
(c) |
|
Such exhibit is hereby incorporated by reference to the like-described exhibit in Registrants Form 10-K
Report for the year ended December 31, 2000. |
|
(d) |
|
Such exhibit is hereby incorporated by reference to the like-described exhibit in Registrants Form S-8
Registration Statement No. 333-62974 filed June 14, 2001. |
|
(e) |
|
Such exhibit is hereby incorporated by reference to the like-described exhibit in Registrants Form S-2
Registration Statement No. 333-63102 declared effective February 8, 2002. |
|
(f) |
|
Such exhibit is hereby incorporated by reference to the like-described exhibit in Registrants Form 10-K
Report for the year ended December 31, 1999. |
|
(g) |
|
Such exhibit is hereby incorporated by reference to the like-described exhibit in Registrants Form 10-K
Report for the year ended December 31, 1996. |
|
(h) |
|
Such exhibit is hereby incorporated by reference to the like-described exhibit in Registrants Form S-1
Registration Statement No. 33-8533 declared effective October 29, 1986. |
|
(i) |
|
Such exhibit is hereby incorporated by reference to the like-described exhibit in Registrants Form 10-K
Report for the year ended December 31, 1988. |
|
(j) |
|
Such exhibit is hereby incorporated by reference to the like-described exhibit in Registrants Form 10-K
Report for the year ended December 31, 1992. |
|
(k) |
|
Such exhibit is hereby incorporated by reference to the like-described exhibit in Registrants Form 8-K
Report dated December 21, 1995. |
|
(l) |
|
Such exhibit is hereby incorporated by reference to the like-described exhibit in Registrants Form 8-K
Report dated May 31, 2000. |
|
(m) |
|
Such exhibit is hereby incorporated by reference to the like-described exhibits in |
-60-
|
|
|
|
|
Registrants Form 8-K
Report dated November 3, 2003. |
|
(n) |
|
Such exhibit is hereby incorporated by reference to the like-described exhibit in Registrants Form 8-K
Report dated December 1, 2003. |
|
(o) |
|
Such exhibit is hereby incorporated by reference to the like-described exhibit in Registrants Form 10-K
Annual Report for the year ended December 31, 2003. |
|
(p) |
|
Such exhibit is hereby incorporated by reference to the like-described exhibit in Registrants Form 8-K
Report dated October 23, 2006. |
|
(q) |
|
Such exhibit is hereby incorporated by reference to the like-described exhibit in Registrants Form 10-Q
Quarterly Report for the quarter ended September 30, 2006. |
|
(r) |
|
Such exhibit is hereby incorporated by reference to the like-described exhibit in Registrants Form 8-K
Report dated December 22, 2006. |
|
(s) |
|
Such exhibit is hereby incorporated by reference to the like-numbered exhibit in Registrants Form 8-K
Report dated April 20, 2007. |
|
(t) |
|
Such exhibit is hereby incorporated by reference to the like-numbered exhibit in Registrants Form 8-K
Report dated February 13, 2008. |
|
(u) |
|
Such exhibit is hereby incorporated by reference to the description of such plan in Registrants
definitive proxy statement for its Annual Meeting of Stockholders to be held on April 15, 2010. |
|
(v) |
|
Such exhibit is hereby incorporated by reference to the like-described exhibit in Registrants Form 10-K
Annual Report for the year ended December 31, 2008. |
-61-
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
|
|
|
|
|
|
DONEGAL GROUP INC.
|
|
|
By: |
/s/ Donald H. Nikolaus
|
|
|
|
Donald H. Nikolaus, President |
|
|
|
|
|
|
Date: March 11, 2010
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been
signed by the following persons on behalf of the Registrant in the capacities and on the dates
indicated.
|
|
|
|
|
Signature |
|
Title |
|
Date |
|
|
|
|
|
/s/ Donald H. Nikolaus
Donald H. Nikolaus
|
|
President and a Director
(principal executive officer)
|
|
March 11, 2010 |
|
|
|
|
|
/s/ Jeffrey D. Miller
Jeffrey D. Miller
|
|
Senior Vice President and
Chief Financial Officer
(principal financial
and accounting officer)
|
|
March 11, 2010 |
|
|
|
|
|
/s/ Robert S. Bolinger
Robert S. Bolinger
|
|
Director
|
|
March 11, 2010 |
|
|
|
|
|
/s/ Philip A. Garcia
Philip A. Garcia
|
|
Director
|
|
March 11, 2010 |
-62-
|
|
|
|
|
Signature |
|
Title |
|
Date |
|
|
|
|
|
/s/ Patricia A. Gilmartin
Patricia A. Gilmartin
|
|
Director
|
|
March 11, 2010 |
|
|
|
|
|
/s/ Philip H. Glatfelter, II
Philip H. Glatfelter, II
|
|
Director
|
|
March 11, 2010 |
|
|
|
|
|
/s/ Kevin M. Kraft, Sr.
Kevin M. Kraft, Sr.
|
|
Director
|
|
March 11, 2010 |
|
|
|
|
|
/s/ John J. Lyons
John J. Lyons
|
|
Director
|
|
March 11, 2010 |
|
|
|
|
|
/s/ Jon M. Mahan
Jon M. Mahan
|
|
Director
|
|
March 11, 2010 |
|
|
|
|
|
/s/ S. Trezevant Moore, Jr.
S. Trezevant Moore, Jr.
|
|
Director
|
|
March 11, 2010 |
|
|
|
|
|
|
|
Director
|
|
March 11, 2010 |
|
|
|
|
|
/s/ Richard D. Wampler, II
Richard D. Wampler, II
|
|
Director
|
|
March 11, 2010 |
-63-
DONEGAL GROUP INC. AND SUBSIDIARIES
SCHEDULE III SUPPLEMENTARY INSURANCE INFORMATION
($ in thousands)
Years Ended December 31, 2009, 2008 and 2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization |
|
|
|
|
|
|
|
|
|
Net |
|
|
Net |
|
|
Net Losses |
|
|
of Deferred |
|
|
Other |
|
|
Net |
|
|
|
Earned |
|
|
Investment |
|
|
And Loss |
|
|
Policy |
|
|
Underwriting |
|
|
Premiums |
|
Segment |
|
Premiums |
|
|
Income |
|
|
Expenses |
|
|
Acquisition Costs |
|
|
Expenses |
|
|
Written |
|
Year Ended
December 31, 2009 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Personal lines |
|
$ |
241,844 |
|
|
$ |
|
|
|
$ |
178,040 |
|
|
$ |
41,071 |
|
|
$ |
34,634 |
|
|
$ |
252,487 |
|
Commercial lines |
|
|
113,181 |
|
|
|
|
|
|
|
72,795 |
|
|
|
19,221 |
|
|
|
16,209 |
|
|
|
110,742 |
|
Investments |
|
|
|
|
|
|
20,631 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
355,025 |
|
|
$ |
20,631 |
|
|
$ |
250,835 |
|
|
$ |
60,292 |
|
|
$ |
50,843 |
|
|
$ |
363,229 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended
December 31, 2008 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Personal lines |
|
$ |
225,024 |
|
|
$ |
|
|
|
$ |
155,573 |
|
|
$ |
37,821 |
|
|
$ |
34,482 |
|
|
$ |
239,540 |
|
Commercial lines |
|
|
121,551 |
|
|
|
|
|
|
|
68,728 |
|
|
|
20,429 |
|
|
|
18,626 |
|
|
|
125,401 |
|
Investments |
|
|
|
|
|
|
22,756 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
346,575 |
|
|
$ |
22,756 |
|
|
$ |
224,301 |
|
|
$ |
58,250 |
|
|
$ |
53,108 |
|
|
$ |
364,941 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended
December 31, 2007 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Personal lines |
|
$ |
196,429 |
|
|
$ |
|
|
|
$ |
124,602 |
|
|
$ |
32,438 |
|
|
$ |
33,402 |
|
|
$ |
202,353 |
|
Commercial lines |
|
|
113,642 |
|
|
|
|
|
|
|
53,182 |
|
|
|
18,767 |
|
|
|
19,324 |
|
|
|
111,336 |
|
Investments |
|
|
|
|
|
|
22,785 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
310,071 |
|
|
$ |
22,785 |
|
|
$ |
177,784 |
|
|
$ |
51,205 |
|
|
$ |
52,726 |
|
|
$ |
313,689 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
S-1
DONEGAL GROUP INC. AND SUBSIDIARIES
SCHEDULE III SUPPLEMENTARY INSURANCE INFORMATION, CONTINUED
($ in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At December 31, |
|
|
|
Deferred |
|
|
Liability |
|
|
|
|
|
|
Other Policy |
|
|
|
Policy |
|
|
For Losses |
|
|
|
|
|
|
Claims and |
|
|
|
Acquisition |
|
|
And Loss |
|
|
Unearned |
|
|
Benefits |
|
Segment |
|
Costs |
|
|
Expenses |
|
|
Premiums |
|
|
Payable |
|
2009 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Personal lines |
|
$ |
22,925 |
|
|
$ |
130,745 |
|
|
$ |
168,791 |
|
|
$ |
|
|
Commercial lines |
|
|
9,919 |
|
|
|
132,854 |
|
|
|
73,030 |
|
|
|
|
|
Investments |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
32,844 |
|
|
$ |
263,599 |
|
|
$ |
241,821 |
|
|
$ |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2008 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Personal lines |
|
$ |
19,468 |
|
|
$ |
114,149 |
|
|
$ |
150,920 |
|
|
$ |
|
|
Commercial lines |
|
|
10,073 |
|
|
|
125,660 |
|
|
|
78,094 |
|
|
|
|
|
Investments |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
29,541 |
|
|
$ |
239,809 |
|
|
$ |
229,014 |
|
|
$ |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying Report and Consent of Independent Registered Public Accounting Firm.
S-2
exv10wff
Exhibit 10 (FF)
SURPLUS NOTE PURCHASE AGREEMENT
Between
DONEGAL MUTUAL INSURANCE COMPANY
and
SOUTHERN MUTUAL INSURANCE COMPANY
DATED AS OF SEPTEMBER 8, 2009
CONTENTS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Page |
|
|
|
|
|
|
|
|
|
RECITALS |
|
|
1 |
|
I. |
|
DEFINITIONS |
|
|
2 |
|
|
|
1.1
|
|
Definitions
|
|
|
2 |
|
|
|
|
|
|
|
|
|
|
II. |
|
SALE AND PURCHASE OF SURPLUS NOTE |
|
|
9 |
|
|
|
2.1
|
|
Sale and Purchase of Surplus Note
|
|
|
9 |
|
|
|
2.2
|
|
Payment of Purchase Price and Delivery of Surplus Note
|
|
|
9 |
|
|
|
2.3
|
|
Closing Date
|
|
|
9 |
|
|
|
|
|
|
|
|
|
|
III. |
|
REPRESENTATIONS AND WARRANTIES OF SOUTHERN MUTUAL |
|
|
10 |
|
|
|
3.1
|
|
Organization and Standing
|
|
|
10 |
|
|
|
3.2
|
|
Subsidiaries
|
|
|
11 |
|
|
|
3.3
|
|
Authority; No Violation
|
|
|
11 |
|
|
|
3.4
|
|
Consents and Approvals of Government Entities
|
|
|
12 |
|
|
|
3.5
|
|
Financial Statements; Examinations
|
|
|
12 |
|
|
|
3.6
|
|
Material Changes Since December 31, 2008
|
|
|
13 |
|
|
|
3.7
|
|
Availability of Assets and Legality of Use
|
|
|
13 |
|
|
|
3.8
|
|
Title to Assets
|
|
|
13 |
|
|
|
3.9
|
|
Books and Records
|
|
|
13 |
|
|
|
3.10
|
|
Accounts Receivable
|
|
|
14 |
|
|
|
3.11
|
|
Compliance with Legal Requirements; Governmental
Authorizations
|
|
|
14 |
|
|
|
3.12
|
|
Real Property and Leases
|
|
|
15 |
|
|
|
3.13
|
|
Insurance
|
|
|
15 |
|
|
|
3.14
|
|
Conduct of Business
|
|
|
16 |
|
|
|
3.15
|
|
No Undisclosed Material Liabilities
|
|
|
17 |
|
|
|
3.16
|
|
No Defaults or Litigation
|
|
|
17 |
|
|
|
3.17
|
|
Tax Liabilities
|
|
|
17 |
|
|
|
3.18
|
|
Contracts
|
|
|
17 |
|
|
|
3.19
|
|
Employee Agreements
|
|
|
18 |
|
|
|
3.20
|
|
Employee Relations
|
|
|
19 |
|
|
|
3.21
|
|
Employee Retirement Income Security Act
|
|
|
19 |
|
|
|
3.22
|
|
Conflicts; Sensitive Payments
|
|
|
20 |
|
|
|
3.23
|
|
Corporate Name
|
|
|
20 |
|
|
|
3.24
|
|
Trademarks and Proprietary Rights
|
|
|
20 |
|
|
|
3.25
|
|
Environmental Matters
|
|
|
20 |
|
|
|
3.26
|
|
Insurance Issued by Southern Mutual
|
|
|
21 |
|
|
|
3.27
|
|
Health and Safety Matters
|
|
|
22 |
|
|
|
3.28
|
|
No Omissions
|
|
|
23 |
|
|
|
3.29
|
|
Finders
|
|
|
23 |
|
(i)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Page |
|
|
|
|
|
|
|
|
|
|
|
3.30
|
|
Representations and Warranties to Be True on the Closing Date
|
|
|
23 |
|
|
|
|
|
|
|
|
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IV. |
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REPRESENTATIONS AND WARRANTIES OF DONEGAL MUTUAL |
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23 |
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4.1
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Organization and Standing
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23 |
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4.2
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Authority; No Violation
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24 |
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4.3
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Consents and Approvals of Government Entities
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25 |
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4.4
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Transferability
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25 |
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4.5
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Finders
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25 |
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4.6
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Representations and Warranties to be True on the Closing Date
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25 |
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V. |
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CERTAIN COVENANTS |
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25 |
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5.1
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Investigation of Southern Mutual
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25 |
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5.2
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Confidential Nature of Information
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26 |
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5.3
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Preserve Accuracy of Representations and Warranties
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26 |
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5.4
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Maintain Southern Mutual As a Going Concern
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27 |
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5.5
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Make No Material Change in Southern Mutual
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27 |
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5.6
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No Public Announcement
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28 |
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5.7
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Required Filings
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28 |
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5.8
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No Solicitation
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28 |
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5.9
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Future Actions Regarding Southern Mutual
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29 |
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5.10
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Advisory Board
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31 |
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VI. |
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CONDITIONS |
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31 |
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6.1
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Conditions to Each Partys Obligations
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31 |
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6.2
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Conditions to Obligations of Donegal Mutual
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32 |
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6.3
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Conditions to Obligations of Southern Mutual
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34 |
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VII. |
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TERMINATION |
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34 |
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7.1
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Termination
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34 |
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7.2
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Final Termination Date
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35 |
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7.3
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Effect of Termination
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35 |
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VIII. |
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AMENDMENT, WAIVER AND INDEMNIFICATION |
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36 |
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8.1
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Amendment
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36 |
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8.2
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Extension; Waiver
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36 |
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8.3
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Survival of Obligations
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37 |
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8.4
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Indemnification
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37 |
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IX. |
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MISCELLANEOUS |
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39 |
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9.1
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Notices
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39 |
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9.2
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Expenses
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40 |
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9.3
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Governing Law
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40 |
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9.4
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Successors and Assigns
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40 |
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9.5
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Partial Invalidity
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41 |
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9.6
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Execution in Counterparts
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41 |
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(ii)
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Page |
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9.7
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Titles and Headings
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41 |
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9.8
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Entire Agreement; Statements as Representations
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41 |
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9.9
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Specific Performance
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41 |
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SIGNATURES |
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42 |
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APPENDICES:
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APPENDIX A
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Form of Surplus Note
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A-1 |
APPENDIX B
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Form of Services and Affiliation Agreement
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B-1 |
APPENDIX C
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Form of Employment Agreement
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C-1 |
APPENDIX D
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Form of Technology License Agreement
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D-1 |
APPENDIX E
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Form of Quota Share Reinsurance Agreement
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E-1 |
SCHEDULES:
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3.5(C)
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Southern Mutual Report of Examination by Georgia Department |
3.5(F)
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Southern Mutual Bank Accounts and Authorizations |
3.11
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Southern Mutual Insurance Licenses and Permits |
3.12
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Southern Mutual Real Property Leases |
3.13
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Southern Mutual Insurance Policies |
3.14
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Southern Mutual Pending Claims |
3.18
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Contracts |
3.19
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Southern Mutual Employment Agreements |
3.20
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Southern Mutual Compensation Schedule |
3.22
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Conflicts; Sensitive Payments |
3.24
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Southern Mutual Trademarks and Proprietary Rights |
3.25(E)
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Environmental Issues |
3.27
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Southern Mutual Health and Safety Permits and Licenses |
(iii)
SURPLUS NOTE PURCHASE AGREEMENT
THIS SURPLUS NOTE PURCHASE AGREEMENT (this Agreement) made as of this 8th day of
September, 2009 between DONEGAL MUTUAL INSURANCE COMPANY, a Pennsylvania mutual fire insurance
company (Donegal Mutual) and SOUTHERN MUTUAL INSURANCE COMPANY, a Georgia mutual fire insurance
company (Southern Mutual).
WITNESSETH:
WHEREAS, Southern Mutual proposes to issue a surplus note (the Surplus Note), the repayment
of which would be subordinated to the claims of policyholders of Southern Mutual and otherwise be
in compliance with applicable provisions of the Georgia Insurance Code and the regulations of the
Commissioner of Insurance of the State of Georgia in the principal amount of Two Million Five
Hundred Thousand Dollars ($2,500,000) in substantially the form of Appendix A;
WHEREAS, Donegal Mutual proposes to purchase the Surplus Note;
WHEREAS, Donegal Mutual and Southern Mutual propose that Southern Mutual will (i) make certain
changes in the composition of the Board of Directors of Southern Mutual in connection with the
transactions contemplated by this Agreement, (ii) enter into employment agreements with certain of
its executive officers in substantially the form of Appendix C and (iii) reconstitute its Board of
Directors as provided in this Agreement;
WHEREAS, Donegal Mutual and Southern Mutual propose that Donegal Mutual and Southern Mutual
enter into: (i) a Services Agreement in substantially the form of Appendix B whereby Donegal
Mutual will provide the services specified therein to Southern Mutual in accordance with the terms
of such Services Agreement, (ii) a Technology License Agreement in substantially the form of
Appendix D whereby Donegal Mutual will license certain of its computer applications and systems to
Southern Mutual in accordance with the terms of such Technology License Agreement and (iii) a Quota
Share Reinsurance Agreement in substantially the form of Appendix E, whereby Southern Mutual will
cede up to 100% of its net written premiums to Donegal Mutual in accordance with the terms of such
Quota Share Reinsurance Agreement but Southern Mutual shall retain sole responsibility for all of
its other liabilities;
WHEREAS, the Board of Directors of Donegal Mutual has approved this Agreement, the form of
Surplus Note Donegal Mutual will purchase, the Services Agreement, the Technology License Agreement
and the Quota Share Reinsurance Agreement by resolutions duly adopted; and
-1-
WHEREAS, the Board of Directors of Southern Mutual has approved this Agreement, the Surplus
Note, the Services Agreement, the Employment Agreements, the Technology License Agreement and the
Quota Share Reinsurance Agreement by resolutions duly adopted;
NOW, THEREFORE, in consideration of the mutual covenants set forth in this Agreement and the
Ancillary Agreements, and intending to be legally bound hereby, Donegal Mutual and Southern Mutual
agree as follows:
ARTICLE I
DEFINITIONS
1.1 Definitions. When used in this Agreement, the following words or phrases have the
following meanings:
Advisory Board shall have the meaning set forth in Section 5.10.
Affiliate shall mean a Person that directly, or indirectly through one or more
intermediaries, controls, is controlled by or is under common control with another Person or
beneficially owns or has the power to vote or direct the vote of 10% or more of any class of voting
stock or of any form of voting equity interest of such other Person in the case of a Person that is
not a corporation. For purposes of this definition, control, including the terms controlling
and controlled, means the power to direct or cause the direction of the management and policies
of a Person, directly or indirectly, whether through the ownership of securities or partnership or
other ownership interests, by contract or otherwise.
Agreement shall have the meaning ascribed to it in the preamble.
Ancillary Documents shall mean the Surplus Note, the Services Agreement, the Employment
Agreements, the Technology License Agreement and the Quota Share Reinsurance Agreement.
Annual Statements shall mean the annual statements of condition and affairs filed pursuant
to the Georgia Insurance Code.
Assets shall mean all rights, titles, franchises and interests in and to every species of
property, real, personal and mixed, tangible and intangible, and things in action relating thereto,
including, without limitation, cash and cash equivalents, securities, including, without
limitation, exempted securities under the Securities Act of 1933, as amended (the Securities
Act), receivables, recoverables from reinsurance and otherwise, deposits and advances, loans,
agents balances, real property, together with buildings, structures and the improvements thereon,
fixtures contained therein and appurtenances thereto and easements
-2-
and other rights relating thereto, machinery, equipment, furniture, fixtures, leasehold
improvements, vehicles and other assets or property, leases, licenses, permits, approvals,
authorizations, joint venture agreements, contracts or commitments, whether written or oral, policy
forms, training materials, underwriting manuals, lists of policyholders and agents, processes,
trade secrets, know-how, computer software, computer programs and source codes, protected formulae,
all other Intellectual Property, research, goodwill, prepaid expenses, books of account, records,
files, invoices, data, rights, claims and privileges and any other assets whatsoever.
Closing and Closing Date shall have the respective meanings set forth in Section 2.3.
Code shall mean the Internal Revenue Code of 1986, as amended.
Commissioner of Insurance shall mean the Commissioner of Insurance of the State of Georgia.
Condition shall mean, as to a Person, the financial condition, business, results of
operations, prospects, liabilities and/or properties or other Assets of such Person.
Confidentiality Agreement shall mean the Confidentiality Agreement between Southern Mutual
and Donegal Mutual dated as of May 29, 2009.
Contract shall mean a contract, indenture, bond, note, mortgage, deed of trust, lease,
agreement or commitment, whether written or oral, including, without limitation, an Insurance
Contract.
Disclosure Schedules shall mean the Disclosure Schedules of Southern Mutual attached to this
Agreement.
Donegal Mutual shall have the meaning ascribed to it in the preamble.
Employment Agreements shall mean the Employment Agreements to be entered into between
Southern Mutual and each of Allen R. Green, W. Daniel Delamater, Martin E. Webb and Kimberly L.
McClain, in substantially the form of Appendix C.
Employee Welfare Plan shall have the meaning set forth in Section 3(1) of ERISA.
Environmental Claim shall mean any written notice by a Person alleging actual or potential
Liability, including, without limitation, potential Liability for any investigatory cost, cleanup
cost, governmental response cost, natural resources damage, property damage, personal injury or
penalty, arising out of, based on or resulting from (a) the presence, transport, disposal,
discharge or release, of any Hazardous Materials at any location, whether
-3-
or not owned by Southern Mutual, as the case may be, or (b) circumstances forming the basis of
any violation or alleged violation of any Environmental Law.
Environmental Law shall mean all federal, state, local and foreign Laws relating to
pollution or protection of human health or the environment, including, without limitation, ambient
air, surface water, ground water, land surface or subsurface strata, including, without limitation,
Laws relating to emissions, discharges, releases or threatened releases, or the presence of
Hazardous Materials, or otherwise relating to the manufacture, processing, distribution, use,
existence, treatment, storage, disposal, transport, recycling, reporting or handling of Hazardous
Materials.
ERISA shall mean the Employee Retirement Income Security Act of 1974, as amended, and the
rules and regulations promulgated thereunder.
ERISA Affiliate shall mean, with respect to Southern Mutual, any trade or business that
together with Southern Mutual would be deemed a single employer within the meaning of Section
4001(a)(14) of ERISA.
Georgia Department shall mean the Department of Insurance of the State of Georgia.
Georgia Insurance Code shall mean Title 33 of the Official Code of Georgia Annotated, as
amended, and the regulations promulgated thereunder.
Governmental Entity shall mean a court, legislature, governmental agency, commission or
administrative or regulatory authority or instrumentality, domestic or foreign.
Hazardous Materials shall mean any (i) hazardous substance, pollutants, or containment
as defined in Sections 101(14) and (33) of the United States Comprehensive Environmental Response,
Compensation and Liability Act, as amended (CERCLA) or the regulations issued pursuant to Section
102 of CERCLA, including any element, compound, mixture, solution or substance that is or may be
designated pursuant to Section 102 of CERCLA; (ii) substance that is or may be designated pursuant
to Section 311(b)(2)(A) of the Federal Water Pollution Control Act, as amended (FWCPA); (iii)
hazardous waste having the characteristics identified under or listed pursuant to Section 3001 of
the Resource Conservation and Recovery Act, as amended (RCRA) or having the characteristics that
may subsequently be considered under RCRA to constitute a hazardous waste; (iv) substance
containing petroleum, as that term is defined in Section 9001(8) of RCRA; (v) toxic pollutant that
is or may be listed under Section 307(a) of FWCPA; (vi) hazardous air pollutant that is or may be
listed under Section 112 of the Clean Air Act, as amended; (vii) imminently hazardous chemical
substance or mixture with respect to which action has been or may be taken pursuant to Section 7 of
the Toxic Substance Control Act, as amended; (viii) source, special nuclear or by-product material
as defined by the Atomic Energy Act of 1954, as amended; (ix) asbestos-containing material, or urea
formaldehyde or material that contains it;
-4-
(x) waste oil and other petroleum products and (xi) any other toxic materials, contaminants or
hazardous substances or wastes pursuant to any Environmental Law.
Health and Safety Requirements shall mean all federal, state, local and foreign statutes,
regulations, ordinances and other provisions having the force and effect of Law, all judicial and
administrative orders and determinations, all contractual obligations and all common law concerning
public health and safety, worker health and safety, including without limitation those relating to
the presence, use, production, generation, handling, transportation, treatment, storage, disposal,
labeling, testing, processing, discharge, release, threatened release, control or cleanup of any
hazardous materials, substances or wastes, chemical substances or mixtures, pesticides, pollutants,
contaminants, toxic chemicals, petroleum products or byproducts, asbestos, polychlorinated
biphenyls or noise, each as amended and as now or hereafter in effect.
Insurance Contract shall mean any Contract of insurance including, without limitation,
reinsurance contracts issued by Southern Mutual.
Insurance License shall mean a License granted by a Governmental Entity to transact an
insurance or reinsurance business.
Intellectual Property shall mean (i) all inventions whether patentable or unpatentable and
whether or not reduced to practice, all improvements thereof and all patents, applications and
patent disclosures, together with all reissuance, continuations, continuations-in-part, revisions,
extensions and reexaminations thereof; (ii) all trademarks, service marks, trade dress, logos,
trade names and corporate names, together with all translations, adaptations, derivations and
applications, registrations and renewals in connection therewith; (iii) all copyrightable works,
all copyrights and all applications, registrations and renewals in connection therewith; (iv) all
mask works and all applications, registrations and renewals thereof; (v) all trade secrets and
confidential business information including ideas, research and development, know-how, formulas,
data, designs, drawings, specifications, policy forms, training materials, underwriting manuals,
pricing and cost information and business and marketing plans and proposals; (vi) all computer
software including data and related documentation; (vii) all other proprietary rights and (viii)
all copies and tangible embodiments thereof in whatever form or medium.
Investment Assets shall mean bonds, notes, debentures, mortgage loans, collateral loans and
all other instruments of indebtedness, stocks, partnership interests and other equity interests,
real estate and leasehold and other interests therein, certificates issued by or interests in
trusts, cash on hand and on deposit, personal property and interests therein and all other Assets
acquired for investment purposes.
IRS shall mean the Internal Revenue Service.
-5-
Knowledge as to Southern Mutual shall mean the knowledge of Allen R. Green, W. Daniel
Delamater, Martin E. Webb or Kimberly L. McClain after due inquiry. Knowledge as to Donegal
Mutual shall mean the knowledge of Donald H. Nikolaus, Jeffrey D. Miller or Daniel J. Wagner after
due inquiry.
Law shall mean a law, ordinance, rule or regulation enacted or promulgated, or an Order
issued or rendered, by any Governmental Entity.
Liability shall mean a liability, obligation, claim or cause of action of any kind or nature
whatsoever, whether absolute, accrued, contingent or other and whether known or unknown, including,
without limitation, any liability, obligation, claim or cause of action arising as a result of an
Insurance Contract.
License shall mean a license, certificate of authority, permit or other authorization to
transact an activity or business issued or granted by a Governmental Entity.
Lien shall mean a lien, mortgage, deed to secure debt, pledge, security interest, lease,
sublease, charge, levy or other encumbrance of any kind.
Losses shall mean losses, claims, damages, costs, expenses, Liabilities and judgments,
including, without limitation, court costs and attorneys and expert witness fees.
Material Adverse Effect means, with respect to Southern Mutual or Donegal Mutual, any fact,
event, circumstance, change, condition or effect that (i) has been, or could reasonably be expected
to be, material and adverse to the assets, liabilities, properties, financial position, results of
operations, cash flows or business of Southern Mutual or Donegal Mutual and its subsidiaries taken
as a whole or (ii) has materially impaired, or could reasonably be expected to impair materially,
the ability of Southern Mutual or Donegal Mutual to perform their respective obligations under this
Agreement or otherwise materially affect the consummation of the transactions this Agreement
contemplates; provided, however, that Material Adverse Effect shall not be deemed to include the
impact of (a) changes after the date of this Agreement in SAP, (b) any action or omission of
Southern Mutual or Donegal Mutual with the prior consent of the other or as otherwise contemplated
by this Agreement in connection with the consummation of the transactions this Agreement
contemplates, (c) changes after the date of this Agreement in laws, (d) changes in general economic
conditions that did not disproportionally adversely affect Southern Mutual, (e) reasonable
expenses, including the retention of legal advisors, in connection with the negotiation, execution
and delivery of this Agreement and the consummation of the transactions this Agreement contemplates
and (f) the financial condition or the results of operations of Southern Mutual for the six months
ended June 30, 2009 and the results of operations or financial condition of Southern Mutual for the
period July 1, 2009 through the Closing Date.
-6-
Member shall mean a policyholder of Southern Mutual other than a policyholder of a
reinsurance contract.
Officers Certificate shall mean, with respect to any Person, a certificate executed by the
Chief Executive Officer, the President or an appropriate Vice President of such Person, as attested
by the Secretary or an Assistant Secretary of such Person.
Ordinary Course of Business shall mean an action taken by a Person if: (i) such action is
consistent with the past practices of such Person and is taken in the ordinary course of the normal
day-to-day operations of such Person; (ii) such action is not required to be authorized by the
board of directors of such Person or by any Person or group of Persons exercising similar authority
or by a parent company and (iii) such action is similar in nature and magnitude to actions
customarily taken, without any authorization by the board of directors or by any Person or group of
Persons exercising similar authority or by a parent company, in the ordinary course of the normal
day-to-day operations of other Persons that are in the same line of business as such Person.
Order shall mean an order, writ, ruling, judgment, injunction or decree of, or any
stipulation to or agreement with, any arbitrator, mediator or Governmental Entity.
PBGC shall mean the Pension Benefit Guaranty Corporation or any successor entity.
Permits shall have the meaning set forth in Section 3.11(d).
Permitted Liens shall mean as to Southern Mutual, (i) all Liens approved in writing by
Donegal Mutual, (ii) statutory Liens arising out of operation of Law with respect to a Liability
incurred in the Ordinary Course of Business of Southern Mutual and that is not delinquent and can
be paid without interest or penalty and (iii) such Liens and other imperfections of title that do
not materially detract from the value or impair the use of the property subject thereto.
Person shall mean an individual, corporation, partnership, association, joint stock company,
Governmental Entity, business trust, unincorporated organization or other legal entity.
Proceedings shall mean actions, suits, hearings, claims and other similar proceedings.
Quarterly Statements shall mean the quarterly statements of condition and affairs filed
pursuant to state insurance Laws.
Quota Share Reinsurance Agreement shall mean the Quota Share Reinsurance Agreement between
Donegal Mutual and Southern Mutual in substantially the form of Appendix E.
-7-
Reorganization Proposal shall have the meaning set forth in Section 5.8.
Required Filings and Approvals shall mean the filing of this Agreement with and the approval
of such by the Commissioner of Insurance, and such other applications, registrations, declarations,
filings, authorizations, Orders, consents and approvals as may be required to be made or obtained
prior to consummation of the transactions contemplated hereby under the Laws of any jurisdiction.
SAP shall mean statutory accounting practices as prescribed or permitted by the Commissioner
of Insurance and the National Association of Insurance Commissioners subject, in the case of
unaudited interim financial statements, to normal year-end adjustments and the absence of
footnotes.
Services Agreement shall mean the Services and Affiliation Agreement between Donegal Mutual
and Southern Mutual in substantially the form of Appendix B.
Southern Mutual shall have the meaning ascribed to it in the preamble.
Southern Mutual Financial Statements shall have the meaning set forth in Section 3.5.
Southern Mutual Property shall mean any property on which Southern Mutual holds a Lien or
any facility that is owned by Southern Mutual or in the management of which Southern Mutual
actively participates.
Subsidiary of a Person means any Person with respect to whom such specified Person, directly
or indirectly, beneficially owns 50% or more of the equity interests in, or holds the voting
control of 50% or more of the equity interests in, such Person.
Surplus Note shall mean the Surplus Note to be issued by Southern Mutual to Donegal Mutual
in substantially the form of Appendix A.
Taxes shall mean all income, gross income, gross receipts, premium, sales, use, transfer,
franchise, profits, withholding, payroll, employment, excise, severance, property and windfall
profits taxes, and all other taxes, assessments or similar charges of any kind whatsoever thereon
or applicable thereto, together with any interest and any penalties, additions to tax or additional
amounts, in each case imposed by any taxing authority, domestic or foreign, upon Southern Mutual,
including, without limitation, all such amounts imposed as a result of being a member of an
affiliated or combined group.
Tax Returns or Returns shall mean all tax returns, declarations, reports, estimates,
information returns and statements required to be filed under federal, state, local or foreign
Laws.
-8-
Technology License Agreement shall mean the Technology License Agreement between Donegal
Mutual and Southern Mutual in substantially the form of Appendix D.
ARTICLE II
SALE AND PURCHASE OF SURPLUS NOTE
2.1 Sale and Purchase of Surplus Note. Upon the terms, conditions, representations
and warranties herein set forth, Southern Mutual hereby agrees to sell the Surplus Note to Donegal
Mutual and Donegal Mutual hereby agrees to purchase the Surplus Note from Southern Mutual.
2.2 Payment of Purchase Price and Delivery of Surplus Note. The purchase price of the
Surplus Note shall be Two Million Five Hundred Thousand Dollars ($2,500,000). Donegal Mutual will
pay the entire purchase price of the Surplus Note in cash to Southern Mutual on the Closing Date
against delivery of the executed Surplus Note by Southern Mutual to Donegal Mutual.
2.3 Closing Date.
(a) The transactions contemplated by this Agreement shall be consummated (the Closing) at
10:00 a.m. on October 31, 2009 or within five business days following the date on which the
Commissioner has approved the change of control described in Donegal Mutuals Form A Statement if
such approval has not been received by October 31, 2009 (the Closing Date), provided that all of
the conditions set forth in Article VI shall have been fulfilled not later than the Closing Date.
Unless otherwise mutually agreed by Donegal Mutual and Southern Mutual, the Closing shall be held
at the offices of Duane Morris LLP, Atlantic Center Plaza, Suite 700, 1180 West Peachtree Street
NW, Atlanta, GA 30309-3448 on the Closing Date.
(b) At the Closing, Southern Mutual shall deliver to Donegal Mutual (i) copies of each
resolution adopted by the Board of Directors of Southern Mutual approving and adopting this
Agreement, the Surplus Note, the Services Agreement, the Employment Agreements, the Technology
License Agreement and the Quota Share Reinsurance Agreement and authorizing the consummation of the
transactions contemplated hereby and thereby, certified by the Secretary of Southern Mutual that
each such resolution is then in full force and effect and without amendment; (ii) any Officers
Certificate specified in Section 6.2 duly executed by the President of Southern Mutual; (iii) the
Services Agreement duly executed by Southern Mutual; (iv) the Technology License Agreement duly
executed by Southern Mutual; (v) the Quota Share Reinsurance Agreement duly executed by Southern
Mutual; (vi) the Surplus Note duly executed by Southern Mutual; (vii) duly executed copies of the
resignations of all but five current members of the Board of Directors of Southern
-9-
Mutual designated by Southern Mutual and evidence of the appointment of the seven designees of
Donegal Mutual as members of a 12-member Southern Mutual Board of Directors as specified in Section
6.2(d); (viii) evidence of the termination of any severance or similar agreement required by
Section 6.2(e), (ix) duly executed copies of the Employment Agreements as specified in Section
6.2(e), (x) appointment of the Advisory Board as provided in Section 5.10 and (xi) an officers
certificate to the effect that the Bylaws of Southern Mutual as amended effective as of the Closing
Date remain in full force and effect without any change.
(c) At the Closing, Donegal Mutual shall deliver to Southern Mutual (i) copies of each
resolution adopted by the Board of Directors of Donegal Mutual approving and adopting this
Agreement, the form of the Surplus Note Donegal Mutual will purchase, the Services Agreement, the
Technology License Agreement and the Quota Share Reinsurance Agreement and authorizing the
consummation of the transactions contemplated hereby and thereby, certified by the Secretary of
Donegal Mutual that each such resolution is then in full force and effect and without amendment;
(ii) the Services Agreement duly executed by Donegal Mutual; (iii) the Technology License Agreement
duly executed by Donegal Mutual; (iv) the Quota Share Reinsurance Agreement duly executed by
Donegal Mutual and (v) any Officers Certificate specified in Section 6.3 duly executed by Donegal
Mutual.
ARTICLE III
REPRESENTATIONS AND WARRANTIES OF SOUTHERN MUTUAL
As an inducement to Donegal Mutual to enter into this Agreement and to consummate the
transactions contemplated herein, Southern Mutual represents and warrants to Donegal Mutual and
agrees that with the exception of the matters specifically described in the Disclosure Schedules
delivered by Southern Mutual to Donegal Mutual prior to the date of this Agreement:
3.1 Organization and Standing.
(a) Southern Mutual is a mutual fire insurance company duly organized, validly existing and in
good standing under the laws of the State of Georgia and has the requisite corporate power and
authority to conduct its business as it is currently being conducted. Southern Mutual is admitted
to transact an insurance business as a foreign insurance company in South Carolina, which is the
only foreign jurisdiction where Southern Mutuals failure to be admitted would have a Southern
Mutual Material Adverse Effect.
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(b) Southern Mutual has previously delivered accurate and complete copies of its Amended
Charter as currently in effect and its Bylaws as amended to be effective as of the Closing Date to
Donegal Mutual.
3.2 Subsidiaries. Southern Mutual has no subsidiaries.
3.3 Authority; No Violation.
(a) Southern Mutual has the requisite corporate power and authority to execute and deliver
this Agreement and the Ancillary Documents and, subject to the receipt of the Required Filings and
Approvals, to consummate the transactions contemplated hereby and thereby. The execution and
delivery of this Agreement and the Ancillary Agreements have been duly approved and authorized by
the Board of Directors of Southern Mutual and the consummation of the transactions contemplated
hereby and thereby effective on the Closing Date.
(b) Subject to receipt of the Required Filings and Approvals, no other corporate proceedings
on the part of Southern Mutual are necessary to authorize this Agreement and the Ancillary
Documents and the transactions contemplated hereby and thereby.
(c) Subject to receipt of the Required Filings and Approvals, this Agreement and the Ancillary
Documents, when executed and delivered by Southern Mutual and assuming the due execution thereof by
the other requisite parties thereto will constitute the valid, legal and binding agreements of
Southern Mutual enforceable in accordance with their respective terms, except that (i) such
enforcement may be subject to bankruptcy, rehabilitation, liquidation, conservation, dissolution,
insolvency, reorganization, moratorium or other similar Laws now or hereafter in effect relating to
creditors rights generally and (ii) the remedy of specific performance and injunctive and other
forms of equitable relief may be subject to equitable defenses and to the discretion of the court
before which any Proceeding therefor may be brought.
(d) Neither the execution, delivery and performance of this Agreement or the Ancillary
Documents nor the consummation of the transactions contemplated hereby or thereby, nor compliance
with and the fulfillment of the terms and provisions hereof and thereof, will (i) conflict with or
result in a breach of the terms, conditions or provisions of or constitute a default under Bylaws
of Southern Mutual, as amended effective as of the Closing Date, or any instrument, agreement,
mortgage, judgment, Order, award, decree or other restriction to which Southern Mutual is a party
or by which Southern Mutual is bound; (ii) give any party to or with rights under any such
instrument, agreement, mortgage, judgment, Order, award, decree or other restriction the right to
terminate, modify or otherwise change the rights or obligations of Southern Mutual under such
instrument, agreement, mortgage, judgment, Order, award, decree or other restriction or (iii)
require the approval, consent or
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authorization of or any filing with or notification to any federal, state or local court or
Governmental Entity, except (y) the Required Filings and Approvals and (z) any approval, consent or
authorization the failure of which to obtain would not, individually or in the aggregate, have a
Southern Mutual Material Adverse Effect.
3.4 Consents and Approvals of Government Entities. Other than the Required Filings
and Approvals, no consent, approval, Order or authorization of, or registration, application,
declaration or filing with any Governmental Entity is required with respect to Southern Mutual in
connection with the execution and delivery of this Agreement and the Ancillary Documents.
3.5 Financial Statements; Examinations.
(a) Southern Mutual has furnished to Donegal Mutual the audited balance sheets of Southern
Mutual as of December 31, 2006, 2007 and 2008 and the related statements of operations and of
changes in financial position for the periods then ended, together with appropriate notes to such
financial statements (collectively, the Southern Mutual Financial Statements). The Southern
Mutual Financial Statements are accompanied by the reports thereon by Habif, Arogeti & Wynne, LLP,
independent registered public accountants. The Southern Mutual Financial Statements are correct
and complete in all material respects and fairly present the financial position of Southern Mutual
as at the respective dates thereof, the results of its operations and the changes in its financial
position for the respective periods covered thereby and have been prepared in conformity with SAP
consistently applied throughout all periods.
(b) Each of the Annual Statements of Southern Mutual for 2006, 2007 and 2008 was in compliance
in all material respects with applicable Law when filed.
(c) The most recently completed report of examination of Southern Mutual conducted by the
Georgia Department was for the period set forth in Schedule 3.5(C), and a complete and correct copy
of such report is attached to Schedule 3.5(C).
(d) Since the dates of all examinations referred to in Schedule 3.5(C), Southern Mutual has
not been the subject of further examination by any insurance Governmental Entity, and Southern
Mutual is not currently undergoing examination by any insurance Governmental Entity.
(e) Southern Mutual has also furnished to Donegal Mutual its unaudited financial statements
for the six months ended June 30, 2009. Such financial statements fairly present the financial
position of Southern Mutual as of June 30, 2009 and the results of its operations for the six
months then ended and have been prepared in conformity with SAP as used in the preparation of the
Southern Mutual Financial Statements.
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(f) Schedule 3.5(F) sets forth a correct and complete list of all (i) accounts, borrowing
resolutions and deposit boxes maintained by Southern Mutual at any bank or other financial
institution, (ii) the names of the persons authorized to sign or otherwise act for Southern Mutual
with respect thereto and (iii) powers of attorney for Southern Mutual with respect thereto.
3.6 Material Changes Since December 31, 2008. Since December 31, 2008, Southern
Mutual has operated its business in the Ordinary Course of Business and, whether or not in the
Ordinary Course of Business of Southern Mutual, other than as disclosed in this Agreement or the
Schedules to this Agreement, there has not been, occurred or arisen (i) any material adverse change
in the Condition of Southern Mutual from that shown on the balance sheet of Southern Mutual as of
December 31, 2008 referred to in Section 3.5; (ii) any damage or destruction in the nature of a
casualty loss, whether covered by insurance or not, to any Asset that is material to the financial
condition, operations or business of Southern Mutual; (iii) any material increase in any employee
benefit plan listed in Section 3.19; (iv) any amendment or termination of any agreement, or
cancellation or reduction of any debt owing to Southern Mutual or waiver or relinquishment of any
right of material value to Southern Mutual or (v) any other event, condition or state of facts of
any character that would constitute a Southern Mutual Material Adverse Effect.
3.7 Availability of Assets and Legality of Use. The Assets owned or leased by
Southern Mutual constitute all of the Assets that Southern Mutual is using in its business, and
such Assets, to the Knowledge of Southern Mutual, are in good and serviceable condition, normal
wear and tear excepted, and suitable and adequate for the uses for which intended and such Assets
and their uses conform in all material respects to all applicable Laws. Such Assets will be
sufficient for the continued conduct of Southern Mutuals business immediately after the Closing in
substantially the same manner as Southern Mutuals business was conducted immediately prior to the
Closing.
3.8 Title to Assets. Southern Mutual has good and marketable title to all of its
Assets, including the Assets reflected on the December 31, 2008 balance sheet referred to in
Section 3.5 and all of the Assets thereafter acquired by it, except to the extent that such Assets
have thereafter been disposed of for fair value in the Ordinary Course of Business of Southern
Mutual.
3.9 Books and Records. The books of account, minute books and other records of
Southern Mutual, all of which have been made available to Donegal Mutual, are complete and correct
and have been maintained in accordance with sound business practices and the requirements of the
Georgia Insurance Code and any other applicable Laws, including, but not limited to, the
requirements of Section 13(b)(2) of the Securities Exchange Act of 1934, as amended, to the extent
applicable to Southern Mutual, and Southern Mutual maintains an adequate system of internal
controls. Since January 1, 2004, the minute books of Southern Mutual contain accurate and complete
records of all meetings held of, and corporate action
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taken by, the policyholders, the Board of Directors and committees of the Board of Directors
of Southern Mutual, and no meeting of any such policyholders, Board of Directors or committees
thereof has been held for which minutes have not been prepared and are not contained in such minute
books. At the Closing, all of the aforementioned books and records will be in the possession of
Southern Mutual.
3.10 Accounts Receivable. All accounts receivable reflected on the December 31, 2008
balance sheet referred to in Section 3.5 and all accounts receivable arising subsequent to such
date and prior to the date of this Agreement, not collected at the date hereof, have arisen from
bona fide transactions in the Ordinary Course of Business of Southern Mutual. To the Knowledge of
Southern Mutual, none of such receivables is subject to counterclaims or set-offs or is in dispute
and all of such accounts are good and collectible in the Ordinary Course of Business at the
aggregate recorded amounts thereof, subject in each case to the allowance for possible losses shown
on such balance sheet. All accounts receivable existing on the Closing Date will be good and
collectible in the Ordinary Course of Business at the aggregate recorded amounts thereof, net of
any applicable allowance for doubtful accounts, which allowance will be determined on a basis
consistent with the basis used in determining the allowance for doubtful accounts reflected in the
December 31, 2008 balance sheet referred to in Section 3.5.
3.11 Compliance with Legal Requirements; Governmental Authorizations. Schedule 3.11
contains a complete and accurate list and copy of the licenses of Southern Mutual to transact
insurance in a state and each other material license, permit and other authorization held by
Southern Mutual in the operation of its business. Except as set forth in Schedule 3.10:
(a) To the Knowledge of Southern Mutual, Southern Mutual is, and at all times since January 1,
2004 has been, in compliance in all material respects with the Georgia Insurance Code, and all
other Laws that are applicable to it or to the conduct or operation of its business or the
ownership or use of any of its Assets.
(b) To the Knowledge of Southern Mutual, no event has occurred or circumstance exists that
with or without notice or lapse of time (i) may constitute or result in a violation by Southern
Mutual of, or a failure on the part of Southern Mutual to comply with, any Law in any material
respect or (ii) may give rise to any material obligation on the part of Southern Mutual to
undertake, or to bear all or any portion of the cost of, any remedial action of any nature.
(c) Southern Mutual has not received, at any time since January 1, 2004, any oral or written
notice or other communication from any Governmental Entity or any other Person regarding (i) any
actual, alleged, possible or potential violation of, or failure to comply with, any Law in any
material respect or (ii) any actual, alleged, possible or potential material obligation that may
give rise on the part of Southern Mutual to undertake, or to bear all or any portion of the cost
of, any material remedial action of any nature.
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(d) Southern Mutual possesses all material Licenses, Permits and other authorizations
necessary to own or lease and operate its properties and to conduct its business as now conducted
and, to the Knowledge of Southern Mutual, each of Southern Mutuals agents is duly licensed as
such. All of such Licenses, Permits and authorizations of Southern Mutual and such agents
appointments are hereinafter collectively called the Permits. All Permits are in full force and
effect and will continue in effect after the date hereof and the Closing Date without the consent,
approval or act of, or the making of any filing with, any Governmental Entity other than the
Required Filings and Approvals. To the Knowledge of Southern Mutual, Southern Mutual is, and at
all times since January 1, 2004 has been, in material compliance with all terms and requirements of
each Permit. Neither Southern Mutual nor, to the Knowledge of Southern Mutual, any of Southern
Mutuals agents are in material violation of the terms of any Permit, and Southern Mutual has not
received notice of any violation or claimed violation thereunder. All applications required to
have been filed for the renewal of any and all Permits have been duly filed on a timely basis with
the appropriate Governmental Entity, and all other filings required to have been made with such
Governmental Entities with respect to the Permits have been duly made on a timely basis.
3.12 Real Property and Leases. Southern Mutual does not own any real property except
as listed on Schedule 3.12(A), and, except as listed on Schedule 3.12(A), Southern Mutual is not a
party to any lease or agreement under which Southern Mutual is lessee or sublessee of, or holds or
operates, any real property owned by any third party. All of such leases and agreements are in
full force and effect and constitute legal, valid and binding obligations of Southern Mutual, and,
to the Knowledge of Southern Mutual, the other parties thereto. Southern Mutual is not in default
in any material respect under any such lease or agreement nor has any event occurred that, with the
passage of time or giving of notice or both would constitute such a default and Southern Mutual
will not take any action or fail to take required action between the date hereof and the Closing
Date that would permit any such default or event to occur. None of such leases and agreements
requires the consent of any party thereto in order to undertake or consummate the transactions
contemplated by this Agreement.
3.13 Insurance. Southern Mutual maintains policies of fire and casualty, product and
other liability and other forms of insurance in such amounts and against such risks and losses as
are adequate and reasonable for its business as currently conducted and properties and are
sufficient for compliance with all Laws applicable to Southern Mutual. All such policies are
valid, duly issued and enforceable in accordance with their respective terms and conditions. The
attached Schedule 3.13 lists all policies of insurance that are or were owned, held or maintained
by or for the benefit of Southern Mutual or under which Southern Mutual is or was a named insured
from January 1, 2006 to the date hereof, including policy numbers, nature of coverage, limits,
deductibles, carriers, premiums and effective and termination dates, under which Southern Mutual
has any remaining coverage. To the Knowledge of
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Southern Mutual, Southern Mutual has complied with each of such policies and has not failed to
give any notice or present any known claim thereunder. Southern Mutual will keep such insurance in
full force and effect through the Closing Date. Southern Mutual has not received, and, to the
Knowledge of Southern Mutual, no event or omission has occurred that may cause it to receive,
notice that any such policies will be cancelled or will be reduced in amount or scope. Southern
Mutual has delivered true and complete copies of all such policies to Donegal Mutual.
3.14 Conduct of Business.
(a) Schedule 3.14 lists all claims arising in other than the Ordinary Course of Business of
Southern Mutual that are pending or, to the Knowledge of Southern Mutual, threatened against
Southern Mutual and correctly sets forth the data reflected therein, including the insurance
carrier to which the claim has been reported. No insurance carrier listed therein has denied
coverage of any claim listed opposite its name or accepted investigation of any such loss or
defense of any such claim under a reservation of rights.
(b) The aggregate actuarial reserves and other actuarial amounts held in respect of
Liabilities with respect to Insurance Contracts of Southern Mutual as established or reflected in
the December 31, 2008 Annual Statement of Southern Mutual and in the Southern Mutual Financial
Statements as of December 31, 2008: (i) were determined in accordance with sound actuarial
standards consistently applied, (ii) were fairly stated in accordance with sound actuarial
principles, (iii) were based on actuarial assumptions that are in accordance with those specified
in the related Insurance Contracts, (iv) met meet the requirements of the insurance Laws of the
applicable jurisdiction in all material respects and (v) to the Knowledge of Southern Mutual, were
adequate to cover the total amount of all reasonably anticipated matured and unmatured Liabilities
of Southern Mutual under all outstanding Insurance Contracts pursuant to which Southern Mutual has
any Liability. For purposes of clause (v) above, (x) the adequacy of reserves shall be determined
only on the basis of facts and circumstances known based on procedures consistently applied by
Southern Mutual in connection with assessing the adequacy of reserves from time to time by Southern
Mutual as at the date hereof and (y) the fact that reserves covered by any such representation may
be subsequently adjusted at times and under circumstances consistent with Southern Mutuals
ordinary practice of periodically reassessing the adequacy of its reserves shall not be used to
support any claim regarding the accuracy of such representation.
(c) All of Southern Mutuals outstanding insurance coverage is, to the extent required by
applicable Law, on forms and at rates approved by the insurance regulatory authority of the
jurisdiction where issued or has been filed with and not objected to by such authority within the
period provided for objection. To the Knowledge of Southern Mutual, Southern Mutual has not
exceeded any authority granted to it by any party to bind it in connection with Southern Mutuals
business.
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3.15 No Undisclosed Material Liabilities. Southern Mutual is not subject to any
material Liability, including, to the Knowledge of Southern Mutual, unasserted claims, absolute or
contingent, that is not shown or that is in excess of amounts shown or reserved for in the December
31, 2008 balance sheet referred to in Section 3.5, other than Liabilities of the same nature as
those set forth in such balance sheet and reasonably incurred in the Ordinary Course of Business of
Southern Mutual after December 31, 2008.
3.16 No Defaults or Litigation. Southern Mutual is not in default in any material
respect under any Contract to which it is a party. There are no lawsuits, proceedings, claims or
governmental investigations pending or, to the Knowledge of Southern Mutual, threatened against
Southern Mutual or against the properties or business thereof that might, individually or in the
aggregate, have a Southern Mutual Material Adverse Effect and Southern Mutual has no Knowledge of
any factual basis for any such lawsuit, proceeding, claim or investigation and there is no action,
suit, proceeding or investigation pending, threatened or contemplated that questions the legality,
validity or propriety of the transactions contemplated by this Agreement.
3.17 Tax Liabilities. The amounts reflected as liabilities for Taxes on the December
31, 2008 balance sheet referred to in Section 3.5 are sufficient for the payment of all Taxes of
Southern Mutual accrued for or applicable to the period ended on such balance sheet date and all
years and periods prior thereto. All Tax Returns that are required to be filed by or in respect of
Southern Mutual up to and including the date hereof have been filed and all Taxes, including any
interest and penalties thereon, which have become due pursuant to such Returns or pursuant to any
assessment have been paid and no extension of the time for filing of any such return is presently
in effect. All such Returns that have been filed or will be filed by or in respect of Southern
Mutual for any period ending on or before the Closing Date are or will be true and correct. There
exists no proposed assessment against Southern Mutual. No consent to the application of Section
341(f)(2) of the Code has been filed with respect to any Southern Mutual Property. Southern Mutual
has withheld and paid all Taxes required to have been withheld and paid in connection with amounts
paid or owing to any employee, independent contractor or other third party. No claim has ever been
made by a Governmental Entity in a jurisdiction where Southern Mutual does not file Tax Returns
that it is or may be subject to taxation by that jurisdiction. Southern Mutual has delivered to
Donegal Mutual correct and complete copies of all federal, state and local Tax Returns, examination
reports and statements of deficiencies assessed against or agreed to by Southern Mutual since
January 1, 2004. The federal Tax Returns for Southern Mutual have never been examined by the IRS,
and the applicable statute of limitations relating thereto has expired for the tax year ended
December 31, 2004 and all prior periods.
3.18 Contracts. Except as disclosed on Schedule 3.18, Southern Mutual is not a party
to (i) any contract for the purchase or sale of real property to or from any third party; (ii) any
contract for the lease or sublease of personal property from or to any third party that
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provides for annual rentals in excess of $25,000, or any group of contracts for the lease or
sublease of similar kinds of personal property from or to third parties that provides in the
aggregate for annual rentals in excess of $25,000; (iii) any contract for the purchase or sale of
equipment, computer software, lists of clients, insurance carriers or agents or similar
information, commodities, merchandise, supplies, other materials or personal property or for the
furnishing or receipt of services that calls for performance over a period of more than 60 days and
involves more than the sum of $25,000; (iv) any license agreement involving the use of copyrights,
franchises, licenses, trademarks, or information owned by Southern Mutual or others; (v) any
brokers representative, sales, agency or advertising contract that is not terminable on notice of
30 days or less; (vi) any contract involving the borrowing or lending of money or the guarantee of
the obligations of officers, directors, employees or others or (vii) any other contract, whether or
not made in the Ordinary Course of Business of Southern Mutual that is material to the business or
Assets of Southern Mutual. No outstanding purchase commitment by Southern Mutual is in excess of
its ordinary business requirements or at a price in excess of market price at the date thereof.
None of such contracts and agreements will expire or be terminated or be subject to any
modification of terms or conditions by reason of the consummation of the transactions contemplated
by this Agreement. With respect to its contracts with insurance agents, none of the agents who are
a party to any such agreement has terminated, threatened to terminate or given any notice, written
or oral, of an intention to terminate its agreement with Southern Mutual or to substantially reduce
the volume of business placed with or through Southern Mutual, and Southern Mutual has no Knowledge
of any condition or state of facts or circumstances that would cause any such termination or
reduction in the foreseeable future. Southern Mutual is not in default in any material respect
under the terms of any such contract nor is it in default in the payment of any insurance premiums
due to insurance carriers nor any principal of or interest on any indebtedness for borrowed money
nor has any event occurred that, with the passage of time or giving of notice, or both, would
constitute such a default by Southern Mutual and, to the Knowledge of Southern Mutual, no other
party to any such contract is in default in any material respect thereunder nor has any such event
occurred with respect to such party. Without the prior written consent of Donegal Mutual, Southern
Mutual will not make any changes or modifications in any of the foregoing, nor incur any further
obligations or commitments, nor make any further additions to its properties, except in each case
in the Ordinary Course of Business of Southern Mutual and as contemplated by this Agreement.
3.19 Employee Agreements. Schedule 3.19 lists all plans, contracts and arrangements,
oral or written, including but not limited to, union contracts, employee benefit plans, deferred
compensation agreements, split dollar agreements, employment agreements, consulting agreements,
confidentiality agreements, non-competition agreements or other agreements with any of Southern
Mutuals employees, whereunder Southern Mutual has any obligation, other than obligations to make
current wage or salary payments terminable on notice of 30 days or less, to or on behalf of its
officers, employees or their beneficiaries or whereunder any of such persons owes money to Southern
Mutual.
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3.20 Employee Relations. Southern Mutual has not engaged in any unfair labor
practice, unlawful employment practice or unlawful discriminatory practice in the conduct of its
business. To the Knowledge of Southern Mutual, Southern Mutual has complied in all material
respects with all applicable Laws relating to wages, hours and collective bargaining and has
withheld all amounts required by agreement to be withheld from the wages or salaries of employees.
The relations of Southern Mutual with its employees are satisfactory, and Southern Mutual is not a
party to or affected by or threatened with, or to the Knowledge of Southern Mutual in danger of,
being a party to or affected by, any labor dispute that materially interferes or would materially
interfere with the conduct of its business. Schedule 3.20 sets forth the name and total annual
compensation, including bonuses, payable to each of the officers, directors and employees of
Southern Mutual whose total annual compensation, including bonuses, during the year ended December
31, 2008 exceeded the sum of $75,000. Since December 31, 2008, there has been no material increase
in the compensation payable to any of such officers, directors or employees, except as set forth in
Schedule 3.20.
3.21 Employee Retirement Income Security Act.
(a) Schedule 3.19 contains a list of any employee benefit plan within the meaning of Section
3(3) of ERISA established or maintained by Southern Mutual or to which Southern Mutual has made any
contribution. Southern Mutual is not required, and was not required within the immediately
preceding five years, to make any contribution to any multiemployer plan within the meaning of
Section 3(37) of ERISA. Southern Mutual has no liability in respect of any employee benefit plan
established or maintained or to which contributions are or were made by it to the PBGC or to any
beneficiary of such plans. Southern Mutual has timely filed all required reports and descriptions,
including Form 5500 Annual Reports, summary annual reports, PBGC-1s and summary plan descriptions,
and distributed such documents appropriately with respect to each such employee benefit plan.
Southern Mutual has met the requirements of COBRA with respect to each such employee benefit plan
that is an Employee Welfare Plan.
(b) (i) No employee pension benefit plan, as defined in Section 3(2) of ERISA, maintained or
contributed to by Southern Mutual or in respect of which Southern Mutual is considered an
employer under Section 414 of the Code, has incurred any accumulated funding deficiency, as
defined in Section 412 of the Code, whether or not waived, or has incurred any liability to PBGC
and (ii) to the Knowledge of Southern Mutual, Southern Mutual has not breached any of the
responsibilities, obligations or duties imposed on it by ERISA with respect to any employee pension
benefit plan maintained by it, which breach has given rise to, or will in the future give rise to,
an obligation to pay money. To the Knowledge of Southern Mutual, neither Southern Mutual nor any
of its affiliates or, to the Knowledge of Southern Mutual, any party in interest, as defined in
Section 3(14) of ERISA, in respect of any such plan has engaged in any non-exempted prohibited
transaction
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described in Sections 406 and 408 of ERISA or Section 4975 of the Code. No reportable event,
as defined in Section 4043 of ERISA, has occurred with respect to any employee pension benefit plan
maintained or contributed to by Southern Mutual or in respect of which Southern Mutual is an
employer under Section 414 of the Code and none of such plans has been terminated by the plan
administrator thereof or by the PBGC. To the Knowledge of Southern Mutual, none of Southern Mutual
or its affiliates has incurred any liability for non-compliance with ERISA or any regulations
thereunder. The original or a complete and correct copy of each plan listed in Schedule 3.19 has
been delivered to Donegal Mutual.
3.22 Conflicts; Sensitive Payments. To the Knowledge of Southern Mutual, and except
as set forth on Schedule 3.22, since January 1, 2004, there are (i) no material situations
involving the interests of Southern Mutual or, to the Knowledge of Southern Mutual, any officer or
director of Southern Mutual, that may be generally characterized as a conflict of interest,
including, but not limited to, the leasing of property to or from Southern Mutual or direct or
indirect interests in the business of competitors, suppliers or customers of Southern Mutual and
(ii) no situations involving illegal payments or payments of doubtful legality from corporate funds
of Southern Mutual since January 1, 2004 to governmental officials or others that may be generally
characterized as a sensitive payment.
3.23 Corporate Name. Southern Mutual owns and possesses all rights to the use of the
name Southern Mutual Insurance Company in the operation of Southern Mutuals present business or
any other business similar to or competitive with that being conducted by Southern Mutual,
including, but not limited to, the right to use such name in advertising.
3.24 Trademarks and Proprietary Rights. All trademarks, trade names, copyrights and
applications therefor that Southern Mutual owns or that are registered in the name of or licensed
to Southern Mutual are listed and briefly described in Schedule 3.24. No proceedings have been
instituted, or are pending or threatened or, to the Knowledge of Southern Mutual, contemplated that
challenge the validity of the ownership by Southern Mutual of any of such trademarks, trade names,
copyrights or applications. Southern Mutual has not licensed anyone to use any of the foregoing or
any other technical knowhow or other proprietary rights of Southern Mutual, and Southern Mutual has
no Knowledge of the infringing use if any of such trademarks and trade names or the infringement of
any such copyrights by any Person. Southern Mutual is legally entitled to use all trademarks,
trade names, copyrights, processes and other technical know-how and other proprietary rights now
used in the conduct of its business and has not received any notice of conflict with the asserted
rights of others.
3.25 Environmental Matters.
(a) Southern Mutual is, and, to the Knowledge of Southern Mutual, all Southern Mutual Property
including, with respect to any Southern Mutual Property, all owners or operators thereof, are, and
at all times have been in substantial compliance with all
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applicable Environmental Laws. Southern Mutual has not received any communication, written or
oral, that alleges that Southern Mutual or any Southern Mutual Property including, with respect to
any Southern Mutual Property, any owner or operator thereof, is not in such compliance, and, to the
Knowledge of Southern Mutual, there are no circumstances that may prevent or interfere with such
compliance in the future.
(b) No Environmental Claim pending against Southern Mutual or any Southern Mutual Property or,
to the Knowledge of Southern Mutual, threatened against Southern Mutual or any Southern Mutual
Property, or any Person whose Liability for any Environmental Claims Southern Mutual has or may
have retained or assumed either contractually or by operation of Law, except for Environmental
Claims that, individually or in the aggregate, would not have a Southern Mutual Material Adverse
Effect.
(c) There are no past or present actions, activities, circumstances, conditions, events or
incidents, including, without limitation, the release, emission, discharge, disposal or presence of
any Hazardous Materials, that, to the Knowledge of Southern Mutual, could form the basis of any
Environmental Claim against Southern Mutual, any Southern Mutual Property or any Person whose
Liability for any Environmental Claim Southern Mutual has or may have retained or assumed either
contractually or by operation of Law.
(d) There are no Hazardous Materials present on or in any Southern Mutual Property, including
Hazardous Materials contained in barrels, above or underground storage tanks, landfills, land
deposits, dumps, equipment, whether movable or fixed, or other containers, either temporary or
permanent, and deposited or located in land, water, sumps or any other part of Southern Mutual
Property or such adjoining property, or incorporated into any structure therein or thereon.
(e) Without in any way limiting the generality of the foregoing, and except as set forth on
Schedule 3.25(e), to the Knowledge of Southern Mutual, (i) there are no underground storage tanks
and currently or formerly located on any Southern Mutual Property, (ii) there is no friable
asbestos contained in or forming part of any building or structure owned or leased by Southern
Mutual and (iii) no polychlorinated biphenyls are used or stored at or on any Southern Mutual
Property.
3.26 Insurance Issued by Southern Mutual.
(a) Southern Mutual has provided Donegal Mutual with a list of all forms of Insurance
Contracts used by Southern Mutual as of August 1, 2009, and has made available to Donegal Mutual
copies of all forms of Insurance Contracts used by Southern Mutual as of August 1, 2009 that are
not standard Insurance Services Office forms. Since August 1, 2009, no forms of Insurance
Contracts written by Southern Mutual have been amended and no sales of any new forms of Insurance
Contracts have been commenced, other than changes to forms, which changes are not, in the
aggregate, material.
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(b) To the Knowledge of Southern Mutual, all benefits payable on or prior to the date as of
which this representation is made by Southern Mutual under Insurance Contracts have in all material
respects been paid, or provision for payment thereof has been made, in accordance with the terms of
the Insurance Contracts under which they arose, such payments were not delinquent and were paid, or
if provision has been made will be paid, without fines or penalties, except for fines or penalties
that do not exceed $10,000, individually, or $25,000, in the aggregate, and except for such
benefits for which Southern Mutual reasonably believes there is a reasonable basis to contest
payment and is taking such action.
(c) To the Knowledge of Southern Mutual, all outstanding Insurance Contracts of Southern
Mutual were issued in conformity with underwriting standards that conform in all material respects
to industry accepted practices and, with respect to Insurance Contracts reinsured in whole or in
part, conform in all material respects to the standards required pursuant to the terms of the
related reinsurance, coinsurance or other similar Contracts.
(d) To the Knowledge of Southern Mutual, (i) all amounts recoverable under reinsurance,
coinsurance or other similar Contracts including, without limitation, amounts based on paid and
unpaid Losses are fully collectible; (ii) each insurance agent or broker, at the time such agent or
broker wrote, sold or produced business for Southern Mutual, was duly licensed as an insurance
agent or broker for the type of business written, sold or produced by such insurance agent or
broker in the particular jurisdiction in which such agent or broker wrote, sold or produced such
business for Southern Mutual, except for such failures to be so licensed that would not, in the
aggregate, have a Southern Mutual Material Adverse Effect and (iii) no such insurance agent or
broker has violated or has taken any action that with notice or lapse of time or both, would have
violated any Law except for such violations as would not have a Southern Mutual Material Adverse
Effect.
(e) Southern Mutual has no outstanding Liability under assumed reinsurance agreements of any
nature.
3.27 Health and Safety Matters.
(a) To the Knowledge of Southern Mutual, Southern Mutual has complied and is in compliance
with all Health and Safety Requirements.
(b) Without limiting the generality of the foregoing, Southern Mutual has obtained and
complied with, and is in compliance with, all Permits, licenses and other authorizations that are
required pursuant to the Health and Safety Requirements for the occupation of its facilities and
the operation of its business, a list of all such Permits, licenses and other authorizations is
included as Schedule 3.27.
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(c) Southern Mutual has not received any written or oral notice, report or other information
regarding any actual or alleged violation of Health and Safety Requirements, or any Liabilities or
potential Liabilities, including any investigatory, remedial or corrective obligations, relating to
Southern Mutual or its facilities arising under Health and Safety Requirements.
3.28 No Omissions. None of the representations or warranties of Southern Mutual
contained in this Agreement, none of the information contained in the Schedules referred to in this
Article III and none of the other information or documents furnished to Donegal Mutual or its
representatives by Southern Mutual in connection with this Agreement are false or misleading in any
material respect or omit to state a fact herein or therein necessary to make the statements herein
or therein not misleading in any material respect. To the Knowledge of Southern Mutual, there is
no fact that adversely affects, or in the future is reasonably likely to affect adversely, the
business or Assets of Southern Mutual in any material respect that has not been disclosed in
writing to Donegal Mutual.
3.29 Finders. Southern Mutual has not paid or become obligated to pay any fee or
commission to any broker, finder or intermediary in connection with the transactions contemplated
by this Agreement.
3.30 Representations and Warranties to Be True on the Closing Date. All of the
representations and warranties of Southern Mutual set forth in this Article III shall be true and
correct on the Closing Date.
ARTICLE IV
REPRESENTATIONS AND WARRANTIES OF DONEGAL MUTUAL
Donegal Mutual represents and warrants to Southern Mutual as follows:
4.1 Organization and Standing.
(a) Donegal Mutual is a mutual fire insurance company duly organized, validly existing and in
good standing under the Laws of the Commonwealth of Pennsylvania and has the requisite corporate
power and authority to conduct its business as it is currently being conducted. Donegal Mutual is
duly qualified to do business and is in good standing in the respective jurisdictions where the
character of its Assets owned or leased or the nature of its business makes such qualification
necessary.
(b) Donegal Mutual has previously delivered copies of its Articles of Agreement and its
Amended and Restated By-laws as currently in effect to Southern Mutual, and all such copies are
accurate and complete as of the date hereof.
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4.2 Authority; No Violation.
(a) Donegal Mutual has the requisite corporate power and authority to execute and deliver this
Agreement, the Services Agreement, the Technology License Agreement and the Quota Share Reinsurance
Agreement and to consummate the transactions contemplated hereby and thereby. The execution and
delivery of this Agreement, the Services Agreement, the Technology License Agreement and the Quota
Share Reinsurance Agreement and the consummation of the transactions contemplated hereby and
thereby have been duly approved and authorized by the Board of Directors of Donegal Mutual.
(b) Subject to the receipt of the Required Filings and Approvals, no other corporate
proceedings on the part of Donegal Mutual are necessary to authorize this Agreement, the Services
Agreement, the Technology License Agreement and the Quota Share Reinsurance Agreement and the
transactions contemplated hereby and thereby.
(c) Subject to the receipt of the Required Filings and Approvals, this Agreement and the
Services Agreement, the Technology License Agreement and the Quota Share Reinsurance Agreement when
executed and delivered by Donegal Mutual and, assuming the due execution thereof by Southern
Mutual, will constitute the valid, legal and binding obligations of Donegal Mutual enforceable
against Donegal Mutual in accordance with their respective terms, except that (i) such enforcement
may be subject to bankruptcy, rehabilitation, liquidation, conservation, dissolution, insolvency,
reorganization, moratorium or other similar Laws now or hereafter in effect relating to creditors
rights generally and (ii) the remedy of specific performance and injunctive and other forms of
equitable relief may be subject to equitable defenses and to the discretion of the court before
which any Proceeding therefor may be brought.
(d) Neither the execution, delivery and performance of this Agreement or the Services
Agreement, the Technology License Agreement or the Quota Share Reinsurance Agreement nor the
consummation of the transactions contemplated hereby and thereby nor compliance with and
fulfillment of the terms and provisions hereof and thereof, will (i) conflict with or result in a
breach of the terms, conditions or provisions of or constitute a default under the Articles of
Agreement or the Amended and Restated By-laws of Donegal Mutual, or any instrument, agreement,
mortgage, judgment Order, award, decree or other restriction to which Donegal Mutual is a party or
by which Donegal Mutual is bound; (ii) give any party to or with rights under any such instrument,
agreement, mortgage, judgment, Order, award, decree or other restriction the right to terminate,
modify or otherwise change the rights or obligations of Donegal Mutual under such instrument,
agreement, mortgage, judgment, Order, award, decree or other restriction or (iii) require the
approval, consent or authorization of or any filing with or notification to any federal, state or
local court or Governmental Entity, except (y) the Required Filings and Approvals and (z) any
approval, consent or authorization the failure of which to obtain would not, individually or in the
aggregate, have a Donegal Mutual Material Adverse Effect.
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4.3 Consents and Approvals of Government Entities. Other than the Required Filings
and Approvals, no consent, approval, Order or authorization of, or registration, application,
declaration or filing with any Governmental Entity is required with respect to Donegal Mutual in
connection with the execution and delivery of this Agreement, the Services Agreement, the
Technology License Agreement and the Quota Share Reinsurance Agreement.
4.4 Transferability. Donegal Mutual will acquire the Surplus Note for its own
account, and not with a view to, and not in connection with, a public distribution or resale
thereof. Without the prior approval of the Commissioner of Insurance and provided such transferee
has agreed to be bound by this Section 4.4 prior to such transfer, Donegal Mutual will not transfer
the Surplus Note except in a transaction registered or exempt from registration under the
Securities Act or to a non-affiliate of Donegal Mutual. Southern Mutual acknowledges that Donegal
Mutuals investments are at all times within its control and direction.
4.5 Finders. Donegal Mutual has not paid or become obligated to pay any fee or
commission to any broker, finder or intermediary on account of the transactions provided for in
this Agreement, except for Sanders Morris Group Inc. Donegal Mutual shall be responsible for the
payment of all fees and expenses payable for or on account of the transactions provided for in this
Agreement and other such fees based on actions taken or agreements entered into by Donegal Mutual.
4.6 Representations and Warranties to Be True on the Closing Date. All of the
representations and warranties set forth in this Article IV shall be true and correct on the
Closing Date.
ARTICLE V
CERTAIN COVENANTS
5.1 Investigation of Southern Mutual. Southern Mutual shall afford to the officers,
employees and authorized representatives, including, without limitation, independent registered
public accountants and attorneys, of Donegal Mutual such reasonable access upon reasonable prior
notice during normal working hours to the offices, properties, personnel, business and financial
and other records of Southern Mutual as Donegal Mutual shall deem necessary or desirable, and shall
furnish to Donegal Mutual or its authorized representatives such additional documents and financial
and operating and other data as Donegal Mutual shall reasonably require, including all such
documents, information and data as shall be necessary in order to enable Donegal Mutual or its
representatives to verify to their satisfaction the accuracy of the Southern Mutual Financial
Statements and the representations and warranties contained in Article III of this Agreement. No
investigation made by Donegal
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Mutual or its representatives shall affect the representations and warranties of Southern
Mutual hereunder or the liability of Southern Mutual with respect thereto.
5.2 Confidential Nature of Information.
(a) Donegal Mutual and Southern Mutual agree that, in the event that the transactions
contemplated by this Agreement shall not be consummated, each will treat in confidence all
documents, materials and other information that it shall have obtained during the course of the
negotiations leading to this Agreement, the investigation of the other party hereto and the
preparation of this Agreement and other documents relating to this Agreement with the exception of
any filings made by Donegal Mutual or Southern Mutual with the Georgia Department (collectively,
the Confidential Information), and shall return to the other party all copies of the Confidential
Information that have been furnished in connection therewith.
(b) In the event that a party hereto becomes legally compelled to disclose any of the
Confidential Information, it shall provide the other party with reasonable notice so that it may
seek a protective order or other appropriate remedy or waive compliance with the provisions of this
Section 5.2. In the event that such protective order or other remedy is not obtained or that the
other party waives compliance with the provisions of this Section 5.2, the first party will furnish
only that portion of the Confidential Information that it is advised by opinion of counsel, which
counsel shall be reasonably acceptable to the other party, is legally required and will endeavor to
obtain assurance that confidential treatment will be accorded the Confidential Information so
furnished.
(c) Donegal Mutual and Southern Mutual agree and acknowledge that a breach of the provisions
of this Section 5.2 may cause the other party to suffer irreparable damage that could not be
adequately remedied by an action at law. Accordingly, each party agrees that the other party shall
have the right to seek specific performance of the provisions of this Section 5.2 to enjoin a
breach or attempted breach of the provisions of this Section 5.2, such right being in addition to
all other rights and remedies that are available to each party at law, in equity or otherwise. The
foregoing shall be in addition to the rights and obligations under the Confidentiality Agreement.
5.3 Preserve Accuracy of Representations and Warranties.
(a) Southern Mutual shall refrain from taking any action that would render any representation
or warranty contained in Article III of this Agreement inaccurate as of the Closing Date. Southern
Mutual will promptly notify Donegal Mutual of any lawsuits, claims, proceedings or investigations
that, to the Knowledge of Southern Mutual, may be threatened, brought, asserted or commenced
against Southern Mutual, its officers or its directors (i) involving in any way the transactions
this Agreement contemplates or (ii) that would, if determined adversely, have a Southern Mutual
Material Adverse Effect.
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(b) Donegal Mutual shall refrain from taking any action that would render any representation
or warranty contained in Article IV of this Agreement inaccurate as of the Closing Date. Donegal
Mutual shall promptly notify Southern Mutual of any lawsuits, claims, proceedings or investigations
that, to the Knowledge of Donegal Mutual, may be threatened, brought, asserted or commenced against
Donegal Mutual, its officers or directors (i) involving in any way the transactions this Agreement
contemplates or (ii) that would, if determined adversely, have a Donegal Mutual Material Adverse
Effect .
5.4 Maintain Southern Mutual As a Going Concern. Except as otherwise specifically
provided in this Agreement, Southern Mutual shall conduct its business in accordance with past
practices and use its best efforts to maintain its business organization intact, keep available the
services of Southern Mutuals officers, employees and agents and preserve the good will of its
insurance underwriters, employees, clients and others having business relations with it. Southern
Mutual shall provide Donegal Mutual promptly with interim monthly financial information and any
other management reports, as and when they shall become available, confer with Donegal Mutual
concerning operational matters of a material nature and otherwise report periodically to Donegal
Mutual concerning the status of the business, operations and financial condition of Southern
Mutual.
5.5 Make No Material Change in Southern Mutual. Prior to the Closing Date, Southern
Mutual shall not, without the prior written approval of Donegal Mutual, (i) make any material
change in the business or operations of Southern Mutual except as set forth in this Agreement; (ii)
make any material change in the accounting policies applied in the preparation of the financial
statements referred to in Section 3.5; (iii) make any material change in the compensation of the
officers, directors or key employees of Southern Mutual other than in the Ordinary Course of
Business of Southern Mutual; (iv) enter into any contract, license, franchise or commitment other
than in the Ordinary Course of Business of Southern Mutual or waive any rights of substantial
value; (v) make any donation to any charitable, civic, educational or other eleemosynary
institution in excess of donations made in comparable past periods, (vi) make any reduction in any
loss expense reserve or incurred but not reported reserve prior to the Closing Date; (vii) make any
change in the levels, procedures or methods employed in the setting or changing of case basis loss
reserves; (viii) make any reduction in net case basis loss reserves not consistent with the levels,
procedures or methods employed by Southern Mutual in the setting or changing of case basis loss
reserves as in effect on the date of this Agreement and, in any event, within 10 days following any
reduction in Southern Mutuals net case basis loss reserve in any one claim file in excess of
$25,000, except for a reduction occurring because a payment has been made on the reserve or because
the claim has been settled and the case closed, and, in any case, Southern Mutual shall provide
Donegal Mutual with a written explanation of such reduction in reasonable detail certified by
Southern Mutuals President or (ix) enter into any other transaction affecting in any material
respect the business of Southern Mutual other than in the Ordinary
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Course of Business of Southern Mutual and in conformity with the past practices of Southern
Mutual or as contemplated by this Agreement.
5.6 No Public Announcement. Neither Southern Mutual nor Donegal Mutual shall, without
the approval of the other, make any press release or other public announcement or filing concerning
the transactions this Agreement contemplates, except as and to the extent that any such party shall
so determine is required by law, in which case the other party shall be advised thereof and given a
reasonable opportunity to comment thereon.
5.7 Required Filings. As promptly as practical after the date of this Agreement,
Southern Mutual and Donegal Mutual shall promptly commence and make all Required Filings with the
appropriate Governmental Entity required by Law to be made by any of them in order to consummate
the transactions contemplated by this Agreement. Between the date of this Agreement and the
Closing Date, Southern Mutual shall cooperate with Donegal Mutual with respect to all Required
Filings that Donegal Mutual elects to make or is required by law to make in connection with the
transactions this Agreement contemplates.
5.8 No Solicitation. Southern Mutual shall not, nor shall it authorize or permit any
of its officers, directors or employees or any investment banker, financial advisor, attorney,
accountant, actuary or other Person retained by it or on its behalf to: (a) solicit or encourage,
including, without limitation, by way of furnishing information, or take any action to facilitate
or pursue, any inquiries or the making of any proposal that constitutes, or may reasonably be
expected to lead to, any Reorganization Proposal or (b) agree to, approve or endorse any
Reorganization Proposal; provided, however, that nothing contained in this Section 5.8 shall
prohibit the Board of Directors of Southern Mutual from furnishing information to, or entering into
discussions or negotiations with, any person or entity that made an unsolicited bona fide proposal
to acquire Southern Mutual pursuant to a Reorganization Proposal if and only to the extent that,
(i) the Board of Directors of Southern Mutual determines in good faith that such action is required
to comply with its fiduciary duties to its Members imposed by Law, (ii) prior to furnishing such
information to, or entering into discussions or negotiations with, such person or entity, Southern
Mutual provides written notice to Donegal Mutual to the effect that it is furnishing information
to, or entering into discussions or negotiations with, such person or entity and (iii) Southern
Mutual continues to keep Donegal Mutual informed of the status of any such discussions or
negotiations. Nothing in this Section 5.8 shall (x) permit Southern Mutual to terminate this
Agreement, except as specifically provided in Article VII, (y) permit Southern Mutual to enter into
any agreement with respect to a Reorganization Proposal during the term of this Agreement or (z)
affect any other obligation of Southern Mutual under this Agreement. Southern Mutual shall
promptly advise Donegal Mutual orally and in writing of any such inquiries or proposals however
preliminary and whether written or oral, and shall communicate the full and complete details of any
such inquiry or proposal including, without limitation, the identity of all Persons involved. As
used in this Agreement,
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Reorganization Proposal shall mean any proposal for, or to discuss, a merger, consolidation,
sale of all or substantially all of the Assets, demutualization, quota share, assumption or other
assumption reinsurance arrangement or other reorganization, arrangement or business combination
involving Southern Mutual or any proposal or offer for, or to discuss, the acquisition in any
manner of control of a substantial portion of the Assets of or business conducted by Southern
Mutual other than the transactions this Agreement contemplates.
5.9 Future Actions Regarding Southern Mutual. Donegal Mutual and Southern Mutual
agree that the following undertakings with respect to certain future action relating to Southern
Mutual were important inducements to the decision of Southern Mutual and Donegal Mutual to enter
into this Agreement unless at least three of the Southern Mutual designees then serving on the
Board of Directors of Southern Mutual vote to approve such action.
(a) Donegal Mutual agrees that it shall not, and shall use commercially reasonable efforts to
ensure that its director designees do not, take any act that would have the effect of changing the
status of Southern Mutual as a Georgia-domiciled mutual insurance company or change the name of
Southern Mutual, demutualize Southern Mutual, redomesticate Southern Mutual or enter into a bulk
reinsurance or bulk reinsurance assumption agreement or transfer all or part of Southern Mutuals
business to a non-affiliate of Donegal Mutual. This covenant shall not preclude Donegal Mutuals
assumption of Southern Mutuals insurance policies with and into another insurance company through
one or more reinsurance agreements or Donegal Mutuals inclusion of such business in its pooling
agreement with Atlantic States Insurance Company.
(b) Donegal Mutual and Southern Mutual have agreed that until the later to occur of (i)
repayment of the principal amount and all accrued but unpaid interest on the Surplus Note, (ii) the
termination of the Technology License Agreement in accordance with its terms and (iii) the
termination of the Quota Share Reinsurance Agreement in accordance with its terms, Southern Mutual
shall use its best efforts to assure that for a period of seven years from the Closing Date the
Board of Directors of Southern Mutual shall consist of 12 members, five of whom shall be designees
of Southern Mutual and seven of whom shall be designees of Donegal Mutual. Donegal Mutual further
agrees, for a period of not less than seven years from the Closing Date, to cause its designees on
the Southern Mutuals Board of Directors to nominate the initial Southern Mutual designees for
election as successors to such designees upon the expiration of their respective terms. In the
event a Southern Mutual designee is no longer able to serve as a director, Donegal Mutual agrees to
cause its designees on the Southern Mutual Board to nominate for election by Southern Mutuals
members or appoint as a successor director to fill a vacancy on the Board of Directors, as the case
may be, a person who is recommended by the remaining Southern Mutual designees on the Board.
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After seven years from the Closing Date, Donegal Mutual agrees to maintain an appropriate
Georgia presence on the Board of Directors of Southern Mutual.
(c) For a period of seven years from the Closing Date, Donegal Mutual will not take any action
to relocate or close the existing facilities of Southern Mutual in Athens, Georgia.
(d) Donegal Mutual agrees to use commercially reasonable efforts to maintain continued
employment of underwriting, claims and marketing personnel at Southern Mutuals home office, with
the levels of employment commensurate with the premium volume of Southern Mutual.
(e) Donegal Mutual and Southern Mutual agree to establish, within 30 days from the date of the
Closing, a technology team consisting of employees of Donegal Mutual and employees of Southern
Mutual. The technology team shall analyze the existing Southern Mutual computer system and
determine if it would be beneficial to Southern Mutual to migrate Southern Mutuals computer system
over time to Donegal Mutuals computer system. The technology team shall also analyze the
adaptation of Southern Mutuals current computer system so that Southern Mutuals computer system
could operate Donegal Mutuals WritePro and WriteBiz applications, all subject to the terms of the
Technology License Agreement.
(f) Donegal Mutual shall develop in coordination with Southern Mutual a business plan to
expand the volume of premium Donegal Mutual and Southern Mutual write in Georgia and South
Carolina. The business plan shall provide that Southern Mutual will continue to be a viable and
competitive market for preferred and standard personal lines and other products with an expanding
agency distribution system.
(g) Southern Mutual shall preserve and keep in full force and effect its existence as a mutual
fire insurance company authorized under the Laws of the State of Georgia to write the lines of
business Southern Mutual is authorized to conduct on the date of this Agreement and its admission
to transact an insurance business in Georgia and South Carolina;
(h) Donegal Mutual, pursuant to the Services Agreement, shall provide Southern Mutual with
support and assistance in its principal business areas, including underwriting, accounting and
finance, reinsurance, actuarial, claims, investments and technology;
(i) At any reasonable time and from time to time, Southern Mutual agrees to permit Donegal
Mutual or any agents or representatives thereof to examine and make copies of and take abstracts
from the records and books of account of, and visit the properties of, Southern Mutual during
regular business hours and upon five days prior notice to
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Southern Mutual, and to discuss the affairs, finances and accounts of Southern Mutual with
Southern Mutuals officers;
(j) For a period of seven years from the Closing Date, all meetings of the Boards of Directors
and the Advisory Board of Directors of Southern Mutual shall be held at the home office of Southern
Mutual in Athens, Clarke County, Georgia, it being understood, however, that Article 3, Section 20,
of Southern Mutuals Amended Bylaws permits directors to participate in a board meeting by
conference telephone or other form of communication by means of which all persons participating in
the meeting can hear each other and that such participation shall constitute presence in person at
such meeting;
(k) Southern Mutual shall have filed the August 31, 2009 amendments to its Bylaws with the
Department which amended Bylaws shall become effective as of the Closing Date; and
(l) Donegal Mutual and Southern Mutual shall not amend, repeal, change, or modify this
Agreement or the Surplus Note after the Closing Date without the approval of three of the Southern
mutual designees.
5.10 Advisory Board. Effective as of the Closing Date and for a period of seven years
following the Closing Date, Donegal Mutual and Southern Mutual shall take all necessary action to
establish an Advisory Board of Directors and appoint to the Advisory Board of Directors each
current director of Southern Mutual who will not continue as a director of Southern Mutual after
the Closing Date. For two years following the Closing Date, members of the Advisory Board of
Directors shall be paid the same compensation as members of the Board of Directors of Southern
Mutual. Thereafter, the Board of Directors of Southern Mutual shall annually establish the
compensation of the members of its Advisory Board of Directors.
ARTICLE VI
CONDITIONS
6.1 Conditions to Each Partys Obligations. The respective obligations of each party
to effect the purchase and sale of the Surplus Note and their other respective obligations under
this Agreement shall be subject to the fulfillment at the Closing Date of the following conditions:
(a) All Required Filings and Approvals required to be obtained prior to the Closing Date
solely for this Agreement, the Ancillary Documents and the Amended Bylaws that will become
effective as of the Closing Date and the election of designees of Donegal Mutual as a majority of
the members of the Board of Directors of Southern Mutual shall have been obtained and not rescinded
or adversely modified or limited as set forth in the proviso
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below or, if merely required to be filed, such filings shall have been made and accepted, and
all waiting periods prescribed by applicable Law shall have expired or been terminated in
accordance with applicable Law; provided that such approvals shall not contain any conditions or
limitations that compel or seek to compel Southern Mutual to dispose of all or any portion of the
business or Assets of Southern Mutual or impose or seek to impose any limitation on the ability of
Southern Mutual to conduct its business or own its Assets after the Closing Date in substantially
the same manner as Southern Mutual presently conducts its business and owns its Assets;
(b) No Order entered or Law promulgated or enacted by any Governmental Entity shall be in
effect that would prevent the consummation of the purchase or sale of the Surplus Note or the other
transactions contemplated hereby and no Proceeding brought by a Governmental Entity shall have been
commenced and be pending that seeks to restrain, prevent or materially delay or restructure the
transactions contemplated hereby or that otherwise questions the validity or legality of any such
transaction; and
(c) There shall be no pending or threatened litigation initiated by a private party seeking to
restrain, prevent, rescind or change the terms of this Agreement or the sale of the Surplus Note or
to obtain damages in connection with this Agreement or the consummation thereof or with the sale of
the Surplus Note that, in the reasonable opinion of Southern Mutual or Donegal Mutual, makes it
inadvisable to proceed with this Agreement or with the sale of the Surplus Note.
6.2 Conditions to Obligations of Donegal Mutual. The obligation of Donegal Mutual to
purchase and pay for the Surplus Note and to perform its other obligations under this Agreement to
be performed on the Closing Date shall, at the option of Donegal Mutual, be subject to the
satisfaction on or prior to the Closing Date, of the following conditions:
(a) Southern Mutual shall have performed or complied in all material respects with all
obligations and agreements required to be performed and complied with by it under this Agreement,
including the deliveries required by Section 2.3(b), at or prior to the Closing Date, and Donegal
Mutual shall have received an Officers Certificate to that effect, dated as of the Closing Date,
and signed on behalf of Southern Mutual.
(b) There shall have been no material breach by Southern Mutual in the performance of any of
its covenants and agreements in this Agreement, each of the representations and warranties of
Southern Mutual contained in this Agreement that is qualified by materiality shall be true and
correct on the Closing Date as though made on the Closing Date and each of the representations and
warranties of Southern Mutual that is not so qualified shall be true and correct in all material
respects on the Closing Date as though made on the Closing Date, other than representations and
warranties that address matters only as of a certain date, which shall be true and correct in all
material respects as of such certain date, and the information concerning Southern Mutual contained
in its Annual
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Statements for the years ended December 31, 2006, 2007 and 2008 shall be true and correct in
all material respects as of the last day of each such year, and Southern Mutual shall deliver to
Donegal Mutual on the Closing Date an Officers Certificate or Certificates to that effect dated as
of the Closing Date, and signed on behalf of Southern Mutual;
(c) Except as set forth in the Disclosure Schedules, there shall have been, between the date
hereof and the Closing Date, (i) no Southern Mutual Material Adverse Effect, (ii) no adverse
federal, state or local legislative or regulatory change affecting in any material respect the
services or business of Southern Mutual, (iii) no material damage to any Southern Mutual Property
or Assets of Southern Mutual by fire, flood, casualty, act of God or the public enemy or other
cause, regardless of insurance coverage for such damage, so as to impair in any material respect
the ability of Southern Mutual to render services or continue operations and (iv) no material and
adverse development or proceeding affecting Southern Mutuals Insurance Licenses in Georgia and
South Carolina. Southern Mutual shall deliver to Donegal Mutual on the Closing Date an Officers
Certificate, dated as of the Closing Date, and signed on behalf of Southern Mutual by its President
to the effect that (a) between the date of this Agreement and the Closing Date there has been no
such Southern Mutual Material Adverse Effect as stated in clause (i), (b) no such material damage
as stated in clause (iii), (c) no adverse licensing development as stated in clause (iv) and (d)
further stating that nothing has come to the signers attention, in the course of his activities on
behalf of Southern Mutual, that causes him to believe that during such period there occurred any
adverse federal, state or local legislative or regulatory change affecting in any material respect
the services or business of Southern Mutual;
(d) Southern Mutual shall have increased the membership of its Board of Directors to 12
persons and Southern Mutual shall have received the resignations of five directors of Southern
Mutual, other than Allen R. Green, on or prior to the Closing Date and Southern Mutuals Board of
Directors shall have appointed as directors of Southern Mutual effective as of the Closing Date,
with the prior approval of the Commissioner of Insurance, seven persons designated by Donegal
Mutual from among the current directors of Donegal Mutual;
(e) Not later than the Closing Date, each of Allen R. Green, W. Daniel Delamater, Martin E.
Webb and Kimberly L. McClain shall have entered into an Employment Agreement with Southern Mutual
in substantially the form of Appendix D and, except as provided in such Employment Agreements,
Southern Mutual shall have no other obligation to any of such persons in respect of his or her
employment by Southern Mutual or the termination of such employment;
(f) The policyholders surplus of Southern Mutual, determined in accordance with SAP, shall be
not less than $6.0 million as of the last day of the month immediately preceding the month in which
the Closing occurs; and
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(g) Southern Mutual shall not have made any material expenditures through the Closing Date,
except in accordance with its current Board-approved budget.
6.3 Conditions to Obligations of Southern Mutual. The obligation of Southern Mutual
to sell the Surplus Note and to perform its other obligations under this Agreement to be performed
on the Closing Date shall, at the option of Southern Mutual, be subject to the satisfaction on or
prior to the Closing Date, of the following conditions:
(a) Donegal Mutual shall have performed or complied in all material respects with all
obligations and agreements required to be performed and complied with by it under this Agreement,
including the deliveries required by Section 2.3(c), at or prior to the Closing Date and Southern
Mutual shall have received an Officers Certificate from Donegal Mutual as to the satisfaction of
this condition;
(b) There shall have been no material breach by Donegal Mutual in the performance of any of
its covenants and agreements in this Agreement, each of the representations and warranties of
Donegal Mutual contained in this Agreement that is qualified by materiality shall be true and
correct on the Closing Date as though made on the Closing Date and each of the representations and
warranties of Donegal Mutual that is not so qualified shall be true and correct in all material
respects on the Closing Date as though made on the Closing Date, other than representations and
warranties that address matters only as of a certain date and which shall be true and correct in
all material respects as of such certain date, and Donegal Mutual shall deliver to Southern Mutual
on the Closing Date an Officers Certificate or Certificates to that effect, dated as of the
Closing Date, and signed on behalf of Donegal Mutual;
(c) At Closing, Donegal Mutual shall have tendered to Southern Mutual payment of the purchase
price of the Surplus Note as specified in Section 2.2.
ARTICLE VII
TERMINATION
7.1 Termination. This Agreement may be terminated and the purchase and sale of the
Surplus Note and the other transactions contemplated by this Agreement may be abandoned at any time
prior to the Closing Date:
(a) by mutual consent of Southern Mutual and Donegal Mutual;
(b) subject to Section 7.2, by either Southern Mutual or Donegal Mutual by one days written
notice to Donegal Mutual or Southern Mutual, as the case may be, if the Closing shall not have been
consummated on the date determined pursuant to Section 7.2, provided that the right to terminate
this Agreement under this Section 7.1(b) shall not be
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available to any party whose failure to fulfill any obligation under this Agreement has been
the cause of, or resulted in, the failure of the purchase and sale of the Surplus Note to have been
consummated on or before such date;
(c) by either Donegal Mutual or Southern Mutual by one days written notice to Southern Mutual
or Donegal Mutual, as the case may be, if any of the conditions to such partys obligations to
consummate the transactions contemplated by this Agreement shall have become impossible to satisfy;
or
(d) by Donegal Mutual if (i) Southern Mutual is in breach at any time prior to the Closing
Date of any of the representations and warranties made by Southern Mutual as though made on and as
of such date, unless the breach (without giving effect to any materiality or material adverse
effect qualifications or materiality exceptions contained therein) in such representations and
warranties, individually or in the aggregate, have not had and would not reasonably be expected to
result in a Material Adverse Effect as to Southern Mutual or (ii) Southern Mutual shall not have
performed and complied in all material respects with all covenants required by this Agreement to be
performed or complied with by it on and as of such date, which breach cannot be or has not been
cured, in all material respects within 15 days after the giving of written notice thereof by
Donegal Mutual to Southern Mutual.
(e) by Southern Mutual if (i) Donegal Mutual is in breach at any time prior to the Closing
Date of any of the representations and warranties made by Donegal Mutual as though made on and as
of such date, unless the breach (without giving effect to any materiality or material adverse
effect qualifications or materiality exceptions contained therein) in such representations and
warranties, individually or in the aggregate, have not had and would not reasonably be expected to
result in a Material Adverse Effect as to Donegal Mutual or (ii) Donegal Mutual shall not have
performed and complied in all material respects, with all covenants required by this Agreement to
be performed or complied with by it on and as of such date, which breach cannot be or has not been
cured, in all material respects, within 15 days after the giving of written notice thereof by
Southern Mutual to Donegal Mutual.
7.2 Final Termination Date. Southern Mutual or Donegal Mutual may terminate this
Agreement on one days notice to Donegal Mutual or Southern Mutual, as the case may be, on the
date, if any, on which the Commissioner disapproves the change of control of Southern Mutual
described in Donegal Mutuals Form A Statement or on December 31, 2009, whichever shall first
occur.
7.3 Effect of Termination. In the event of the termination of this Agreement by
either Southern Mutual or Donegal Mutual, as provided in Section 7.1, this Agreement shall
thereafter become void, each party shall bear all expenses it incurred, including professional
fees, in connection with the transactions contemplated by this Agreement and there shall be
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no Liability on the part of any party hereto against any other party hereto, or their
respective directors, officers, policyholders or agents, except that (i) any such termination shall
be without prejudice to the rights of any party hereto arising out of the willful breach by any
other party of any covenant or agreement contained in this Agreement, (ii) Section 5.2 and Article
IX shall continue in full force and effect notwithstanding such termination and (iii) each of the
parties hereto shall provide the other party hereto with a copy of any proposed public announcement
regarding the occurrence of such termination and an opportunity to comment thereon prior to its
dissemination.
ARTICLE VIII
AMENDMENT, WAIVER AND INDEMNIFICATION
8.1 Amendment. This Agreement may be amended or modified in whole or in part at any
time by an agreement in writing executed in the same manner as this Agreement, provided, however,
that no amendment shall be made that changes the terms of this Agreement in any material respect or
that requires the further approval or proceedings of any insurance Governmental Entity without such
approval having first been obtained or such proceedings having been first completed.
8.2 Extension; Waiver. At any time prior to the Closing Date, either party hereto
may:
(a) extend the time for the performance of any of the obligations or other acts of the other
party hereto,
(b) waive any inaccuracies in the representations and warranties contained in this Agreement
or in any document delivered pursuant to this Agreement, and
(c) waive compliance with any of the agreements or conditions contained herein.
Any agreement on the part of a party to any such extension or waiver shall be valid only if set
forth in an instrument in writing signed on behalf of such party by its President. The failure of
any party hereto to enforce at any time any provision of this Agreement shall not be construed to
be a waiver of such provision, nor in any way to affect the validity of this Agreement or any part
hereof or the right of such party hereafter to enforce each and every such provision. No waiver of
any breach of this Agreement shall be held to constitute a waiver of any other or subsequent
breach.
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8.3 Survival of Obligations.
(a) The covenants and agreements of Donegal Mutual and Southern Mutual set forth in Section
5.9 of this Agreement shall survive the Closing of the transactions this Agreement contemplates and
shall remain in full force and effect until such covenants expire in accordance with the terms
thereof.
(b) All certifications, representations and warranties made herein by Southern Mutual and
Donegal Mutual and their obligations to be performed pursuant to the terms hereof, shall survive
the Closing Date hereunder, notwithstanding any notice of any inaccuracy, breach or failure to
perform not waived in writing and notwithstanding the consummation of the transactions contemplated
herein with knowledge of such inaccuracy, breach or failure. All representations and warranties
contained herein shall terminate upon the earlier of (i) repayment in full of the principal amount
of the Surplus Note and all accrued but unpaid interest thereon or (ii) 90 days after Donegal
Mutual shall have received the audited financial statements of Southern Mutual for the year ending
December 31, 2010; provided that (i) the representations and warranties contained in Section 3.16
shall expire two years after the Closing Date or, with respect to each claim under Section 3.16
arising before or during such two-year period, upon the earlier to occur of (x) such claims final
judicial determination or settlement and satisfaction of any judgment or full payment of any
settlement, as the case may be or (y) such time, if any, as the claim shall be barred by the
applicable statute of limitations or (z) the payment in full of the Surplus Note and (ii) the
representations and warranties contained in Section 3.17 shall expire four years after the Closing
Date or with respect to any dispute with the IRS upon the earlier to occur of (x) such disputes
final resolution and the payment of all taxes, interests and penalties arising therefrom and (y)
the expiration of the applicable statute of limitations.
8.4 Indemnification.
(a) From and after the Closing Date, Southern Mutual agrees to indemnify and hold harmless
Donegal Mutual and its subsidiaries, affiliates, partners, successors and assigns (collectively,
the Indemnified Persons) from and against any and all (x) Liabilities, losses, costs,
deficiencies or damages (Loss) and (y) reasonable attorneys and accountants fees and expenses,
court costs and all other reasonable out-of-pocket expenses (Expense) incurred by any Indemnified
Person, in each case net of any insurance proceeds received and retained by such Indemnified
Person, in connection with or arising from (i) any breach by Southern Mutual of any of its
covenants in, or any failure of Southern Mutual to perform any of its obligations under, this
Agreement or (ii) any material breach of any warranty or the material inaccuracy of any
representation of Southern Mutual contained or referred to in this Agreement or in any Officers
Certificate delivered by or on behalf of Southern Mutual pursuant to this Agreement provided that
the liability of Southern Mutual shall be limited (the Liability Limit) to an aggregate of Two
Million Five Hundred Thousand Dollars ($2,500,000).
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(b) If any Indemnified Person has suffered or incurred any Loss or incurred any Expense, it
shall so notify Southern Mutual promptly in writing describing such Loss or Expense, the amount
thereof, if known, and the method of computation of such Loss or Expense, all with reasonable
particularity and containing a reference to the provision of this Agreement or any Officers
Certificate delivered pursuant hereto in respect of which such Loss or Expense shall have occurred.
If any action at law or suit in equity is instituted by or against a third party with respect to
which any Indemnified Person intends to claim any liability or expense as Loss or Expense under
this Section 8.4, such Indemnified Person shall promptly notify Southern Mutual of such action or
suit. The failure of an Indemnified Person to notify Southern Mutual promptly of a claim as
contemplated by the preceding sentence shall not relieve Southern Mutual of its obligations under
this Section 8.4 except to the extent that Southern Mutual is prejudiced in its defense of such
claim as a result of such failure to give prompt notice.
(c) Subject to paragraph (d) of this Section 8.4, the Indemnified Persons shall have the right
to conduct and control, through counsel of their choosing, any third party claim, action or suit
and may compromise or settle the same, provided that any of the Indemnified Persons shall give
Southern Mutual advance notice of any proposed compromise or settlement. The Indemnified Persons
shall permit Southern Mutual to participate in the defense of any such action or suit through
counsel chosen by it, provided that the fees and expenses of such counsel shall be borne by
Southern Mutual. Any compromise or settlement with respect to a claim for money damages effected
after Southern Mutual, by notice to the Indemnified Persons, shall have disapproved such compromise
or settlement, shall discharge Southern Mutual from liability with respect to the subject matter
thereof, and no amount in respect thereof shall be claimed as Loss or Expense under this Section
8.4; provided that if Southern Mutual shall disapprove of a proposed compromise or settlement of a
claim the acceptance of which is recommended by counsel conducting the defense of such claim and
the amount of such settlement would exceed an applicable Liability Limit, Southern Mutual shall,
notwithstanding such Liability Limit, be liable for the full amount of any judgment entered in
respect of, or later compromise or settlement approved by Southern Mutual of, such claim less the
amount by which the proposed compromise or settlement disapproved by Southern Mutual exceeded such
Liability Limit.
(d) If the remedy sought in any action or suit referred to in paragraph (c) of this Section
8.4 is solely money damages and the sum of (i) the amount claimed in such action or suit, (ii) all
amounts previously paid by Southern Mutual pursuant to this Section 8.4 and (iii) all amounts
claimed in all pending claims for indemnity under this Section 8.4 does not exceed the aggregate
liability of Southern Mutual under this Section 8.4, Southern Mutual shall have 15 business days
after receipt of the notice referred to in the last sentence of paragraph (b) of this Section 8.4
to notify the Indemnified Persons that it elects to conduct and control such action or suit. If
Southern Mutual does not give the foregoing notice, the Indemnified Persons shall have the right to
defend, contest, settle or compromise such action
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or suit in the exercise of their exclusive discretion and Southern Mutual shall, upon request
from any of the Indemnified Persons, promptly pay to such Indemnified Persons in accordance with
the other terms of this Section 8.4 the amount of any Loss resulting from its liability to the
third party claimant and all related Expense. If Southern Mutual gives the foregoing notice,
Southern Mutual shall have the right to undertake, conduct and control, through counsel of its own
choosing and at its sole expense, the conduct and settlement of such action or suit, and the
Indemnified Persons shall cooperate with Southern Mutual in connection therewith; provided that (x)
Southern Mutual shall not thereby permit to exist any Lien upon any Asset of any Indemnified
Person, (y) Southern Mutual shall permit the Indemnified Persons to participate in such conduct or
settlement through counsel chosen by the Indemnified Persons, but the fees and expenses of such
counsel shall be borne by the Indemnified Persons, except as provided in clause (z) hereof and (z)
Southern Mutual shall agree to reimburse promptly to the extent required under this Section 8.4 the
Indemnified Persons for the full amount of any Loss resulting from such action or suit and all
related Expense incurred by the Indemnified Persons, except fees and expenses of counsel for the
Indemnified Persons incurred after the assumption of the conduct and control of such action or suit
by Southern Mutual. So long as Southern Mutual is contesting any such action or suit in good
faith, the Indemnified Persons shall not pay or settle any such action or suit. Notwithstanding
the foregoing, the Indemnified Persons shall have the right to pay or settle any such action or
suit, provided that in such event the Indemnified Persons shall waive any right to indemnity
therefor by Southern Mutual and no amount in respect thereof shall be claimed as Loss or Expense
under this Section 8.4.
ARTICLE IX
MISCELLANEOUS
9.1 Notices. All notices or other communications required or permitted hereunder
shall be in writing and shall be given by confirmed facsimile or registered mail, postage prepaid,
addressed as follows:
if to Donegal Mutual, to:
Donegal Mutual Insurance Company
1195 River Road, P.O. Box 302
Marietta, Pennsylvania 17547
Attention: Donald H. Nikolaus, President
Facsimile: 717-426-7009
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with a copy to:
Duane Morris LLP
30 South 17th Street
Philadelphia, Pennsylvania 19103-4196
Attention: Frederick W. Dreher, Esq.
Facsimile: 215-979-1213
if to Southern Mutual, to:
Southern Mutual Insurance Company
360 Alps Road
Athens, Georgia 30606
Attention: Allen R. Green, President
Facsimile: 706-549-7855
with a copy to:
Constantine & Associates
2900 Paces Ferry Rd., Ste. C-2000
Atlanta, Georgia 30339
Attention: Robert P. Constantine, Jr., Esq.
Facsimile: 404-223-6833
or to such other address or facsimile number as the Person to whom notice is given may have
previously furnished to the other party in writing in accordance herewith.
9.2 Expenses. Except as otherwise provided herein, each party hereto shall pay its
own expenses including, without limitation, legal and accounting fees and expenses incident to its
negotiation and preparation of this Agreement and to its performance and compliance with the
provisions contained herein.
9.3 Governing Law. This Agreement and the Ancillary Documents shall be governed by
and construed in accordance with the laws of the State of Georgia without regard to its rules on
conflicts of law.
9.4 Successors and Assigns. This Agreement shall be binding upon and inure to the
benefit of the parties hereto and their respective successors and assigns, provided that the rights
of Southern Mutual herein may not be assigned and the rights of Donegal Mutual may be assigned only
(a) to such other business organization that shall succeed to substantially all the assets,
liabilities and business of Donegal Mutual or (b) to a wholly owned subsidiary of Donegal Mutual,
in which event such assignment shall not relieve Donegal Mutual of any of Donegal Mutuals
obligations to Southern Mutual under this Agreement. Nothing in this
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Agreement, expressed or implied, is intended to confer upon any other Person any rights or
remedies of any nature under or by reason of this Agreement.
9.5 Partial Invalidity. In case any one or more of the provisions contained herein
shall, for any reason, be held to be invalid, illegal or unenforceable in any respect, such
invalidity, illegality or unenforceability shall not affect any other provision of this Agreement,
and this Agreement shall be construed as if such invalid, illegal or unenforceable provision or
provisions had never been contained herein unless the deletion of such provision or provisions
would result in such a material change as to cause completion of the transactions contemplated
herein to be unreasonable or materially and adversely frustrate the objectives of the parties as
expressed in this Agreement.
9.6 Execution in Counterparts. This Agreement may be executed in two counterparts,
both of which shall be considered one and the same agreement, and shall become a binding agreement
when one or more counterparts have been signed by each of the parties and delivered to the other
party.
9.7 Titles and Headings. Titles and headings to Articles and Sections herein are
inserted for convenience of reference only and are not intended to be a part of or to affect the
meaning or interpretation of this Agreement.
9.8 Entire Agreement; Statements as Representations. This Agreement, together with
the Surplus Note, the Services Agreement, the Employment Agreements, the Technology License
Agreement, the Quota Share Reinsurance Agreement, the Disclosure Schedules, the Confidentiality
Agreement and any documents delivered pursuant to Articles II and VI, contain the entire
understanding of Southern Mutual and Donegal Mutual with regard to the subject matter of this
Agreement. All statements contained in this Agreement or in any schedule, exhibit, certificate,
list or other document delivered pursuant to this Agreement shall be deemed representations and
warranties as such terms are used in this Agreement.
9.9 Specific Performance. Each of Southern Mutual and Donegal Mutual acknowledges and
agrees that the other would be irreparably damaged in the event any of the provisions of this
Agreement were not performed in accordance with their specific terms or were otherwise breached.
Accordingly, each of Southern Mutual and Donegal Mutual agrees that they each shall be entitled to
an injunction or injunctions to prevent breaches of the provisions of this Agreement and to enforce
specifically this Agreement and the terms and provisions hereof in any action instituted in any
court of the United States or any state thereof having subject matter jurisdiction, in addition to
any other remedy to which Southern Mutual or Donegal Mutual may be entitled at law or in equity.
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IN WITNESS WHEREOF, each party hereto has caused this Agreement to be executed on its behalf
as of the date first above written.
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DONEGAL MUTUAL INSURANCE COMPANY
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By: |
/s/ Donald H. Nikolaus
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Donald H. Nikolaus, President |
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SOUTHERN MUTUAL INSURANCE COMPANY
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By: |
/s/ Allen R. Green
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Allen R. Green, President |
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exv10wgg
Exhibit 10(GG)
QUOTA SHARE REINSURANCE AGREEMENT
THIS QUOTA SHARE REINSURANCE AGREEMENT (this Agreement) is made this 30th day of
October, 2009 but effective as of 11:59 p.m. on October 31, 2009 (the Effective Date) between
SOUTHERN MUTUAL INSURANCE COMPANY, a Georgia mutual insurance company with its principal office in
Athens, Georgia (Southern Mutual), and DONEGAL MUTUAL INSURANCE COMPANY, a Pennsylvania mutual
fire insurance company with its principal office in Marietta, Pennsylvania (Donegal Mutual).
WITNESSETH:
WHEREAS, Donegal Mutual has offered to provide reinsurance to Southern Mutual to the extent
and on the terms and conditions set forth in this Agreement and nothing stated in this Agreement
shall in any manner create any obligations or establish any rights against Donegal Mutual in favor
of any person not a party to this Agreement; and
WHEREAS, Southern Mutual has agreed to place such reinsurance with Donegal Mutual to the
extent and on the terms and conditions set forth in this Agreement;
NOW, THEREFORE, in consideration of the mutual covenants set forth in this Agreement, and
intending to be legally bound hereby, Donegal Mutual and Southern Mutual agree as follows:
ARTICLE 1
DEFINITIONS
1.1 Definitions. As used in this Agreement:
Actual Effective Date Reserves shall have the meaning set forth in Section 6.1(a)(ii) of
this Agreement.
Allocated Loss Adjustment Expenses shall mean all court costs, interest upon judgments and
mitigation, investigation, adjustment and legal expenses chargeable to or incurred in (i) the
mitigation, investigation, negotiation, settlement of or defense against a Loss under a Covered
Policy, (ii) loss prevention mitigation or investigation in respect of any Covered Policy as to
which Southern Mutual has posted a loss reserve, (iii) the investigation, prevention and workout of
a potential Loss under a Covered Policy, (iv) the protection, perfection and exercise of any
subrogation or salvage or rights of reimbursement with respect to any Covered Policy or (v) any
deficiency resulting from the loss settlement or the workout of a potential Loss under a Covered
Policy. Allocated Loss Adjustment Expenses shall
exclude all office expenses and salaries of officers and employees of Southern Mutual. All
loss adjustment expenses that are not Allocated Loss Adjustment Expenses shall constitute
Unallocated Loss Adjustment Expenses.
Ceding Commission shall have the meaning set forth in Section 6.1(b).
Covered Policies shall mean an insurance policy first issued by Southern Mutual on or after
12:01 a.m. on January 1, 1976. Donegal Mutual is not assuming any liability from any insurance
policy Southern Mutual first issued on or before 12:01 a.m. on January 1, 1976.
Donegal Mutual shall have the meaning set forth in the introductory paragraph of this
Agreement.
Effective Date shall have the meaning set forth in the introductory paragraph of this
Agreement.
Estimated Effective Date Reserves shall have the meaning set forth in Section 6.1(a)(ii) of
this Agreement.
Extra Contractual Obligations shall mean all liabilities (i) for compensatory,
consequential, exemplary, punitive or similar damages which directly relate to any alleged or
actual act, error, omission, fraud or misrepresentation by any Person, any of its affiliates or any
of its or its affiliates officers or employees, whether intentional or otherwise, in connection
with the Covered Policies or (ii) from any alleged or actual reckless conduct or bad faith by any
Person, any of its affiliates or any of its or its affiliates officers or employees in connection
with such Persons handling of any claim under any of the Covered Policies, including the
settlement, defense of or appeal of any claim or in connection with the issuance, offer, sale,
delivery, cancellation or administration by any Person or any of its affiliates or any of its or
its affiliates officers or employees under any of the Covered Policies.
Loss shall mean (i) amounts incurred by Southern Mutual in settlement or satisfaction of
claims under or in respect of the Covered Policies, (ii) any and all Allocated Loss Adjustment
Expenses Southern Mutual incurs under or in respect of the Covered Policies, (iii) amounts payable
to reinsurers other than Donegal Mutual under or with respect to the Covered Policies and (iv)
Extra Contractual Obligations arising after the Effective Date from the acts of Donegal Mutual, in
each case net of amounts actually collected by Donegal Mutual or Southern Mutual under Third Party
Reinsurance Agreements.
Occurrence shall be the definition of said term as set forth in Southern Mutuals Covered
Policies, provided, however, in the event Occurrence is not defined in any Covered Policy that is
reinsured pursuant to this Agreement, then, as to such policy, the term each Occurrence shall
mean each accident or Occurrence or series of accidents or Occurrences arising out of one event,
and shall include aggregate limits of liability for a period not exceeding 12 months when a Covered
Policy applies in excess of aggregate limits.
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If Southern Mutual and Donegal Mutual cannot specifically determine the date of any Loss,
accident, casualty or loss Occurrence, the date of such Loss, accident, casualty or loss Occurrence
shall be the inception date of the original Covered Policy reinsured pursuant to this Agreement,
provided that such policy period shall be deemed not to exceed 12 calendar months.
Person shall mean any individual, corporation, limited liability company, association,
joint-stock company, business trust or other similar organization, partnership, joint venture,
trust, unincorporated association or government or any agency, instrumentality or political
subdivision of a government.
Quota Share shall mean 100%.
Recovery shall mean any amount actually received by Southern Mutual in respect of any Loss
covered by Donegal Mutual under this Agreement, whether by subrogation, salvage, reimbursement or
other recovery.
Recovery Expenses shall mean any expense, including court costs and legal expenses Southern
Mutual incurs for purposes of obtaining a Recovery with respect to Losses, but excluding the
expenses and salaries of the officers and employees of Southern Mutual or its affiliates or normal
overhead expenses of Southern Mutual and its affiliates and excluding any expense that would
constitute an Allocated Loss Adjustment Expense.
Southern Mutual shall have the meaning set forth in the introductory paragraph of this
Agreement.
Termination Date shall have the meaning assigned to it in Section 17.1.
Third-Party Reinsurance Agreements shall mean, to the extent such treaties or agreements
relate to Covered Policies, (i) all reinsurance treaties and agreements under which Southern Mutual
is a ceding party that were in force on the date of this Agreement, and (ii) any such treaty or
agreement that is terminated or expired but under which Southern Mutual may continue to receive
reinsurance coverage.
Unallocated Loss Adjustment Expenses shall have the meaning set forth in the definition of
Allocated Loss Adjustment Expenses.
Ultimate Net Loss as used in this Agreement means the actual loss Southern Mutual pays or
that Southern Mutual becomes liable to pay under the Covered Policies reinsured pursuant to this
Agreement, including all loss adjustment expense, 100% of any Extra Contractual Obligations and
100% of any Loss in Excess of Policy Limits as defined in Sections 12.1 and 12.2 of this Agreement.
Ultimate Net Loss shall include any expenses of litigation, accrued interest where such accrued
interest is a part of any judgment, and all other loss expenses of Southern Mutual including legal
expenses and costs incurred in
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connection with coverage and validity issues and any legal proceedings with respect thereto
that are allocable to a Covered Policy.
ARTICLE 2
APPLICATION OF AGREEMENT
2.1 Business Covered. This Agreement applies to all insurance policies Southern
Mutual issued that are in effect as of the Effective Date and all policies that Southern Mutual
issues after the Effective Date and which Southern Mutual issues during the term of this Agreement
until 11:59 p.m. on the Termination Date.
ARTICLE 3
COVER
3.1 Quota Share Reinsurance. Subject to the terms and conditions of this Agreement,
Southern Mutual hereby cedes to Donegal Mutual, and Donegal Mutual hereby accepts and reinsures
from Southern Mutual, the Quota Share of any Losses, including loss development on all Covered
Policies issued prior to the Effective Date, under the Covered Policies. Such Losses and all
other liabilities of Southern Mutual with respect to the Covered Policies are sometimes
collectively referred to in this Agreement as the Reinsured Liabilities. Such cession by
Southern Mutual and acceptance and reinsurance by Donegal Mutual shall, in the sole discretion of
Donegal Mutual, be gross or net of any losses covered by the Third-Party Reinsurance Agreements of
Southern Mutual. To the extent Donegal Mutual elects to accept and reinsure such cession net of
any losses covered by Third Party Reinsurance Agreements of Southern Mutual, Donegal Mutual hereby
guarantees Southern Mutual from and against any uncollectible third-party reinsurance recoverables.
Donegal Mutual is not assuming under this Agreement any liabilities of Southern Mutual that do not
constitute Reinsured Liabilities and any liabilities of Southern Mutual that are not Reinsured
Liabilities shall remain the liabilities of Southern Mutual.
ARTICLE 4
REINSURANCE FOLLOWS ORIGINAL POLICIES
4.1 Follow the Fortunes. Except to the extent specifically otherwise provided in this
Agreement or as Southern Mutual and Donegal Mutual may agree in writing, all reinsurance under this
Agreement shall be subject in all respects to the same rates, terms, conditions, waivers and
interpretations, and to the same modifications, cancellations and alterations as the Covered
Policies, the true intent of this Agreement being that Donegal Mutual shall, in every case to which
this Agreement applies, follow the fortunes of Southern Mutual; provided, however, that the
Agreement shall not be construed to expand the liability
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of Donegal Mutual beyond the liabilities Donegal Mutual has specifically assumed pursuant to
this Agreement.
4.2 Third-Party Rights. Except as set forth in Sections 7.1 or 13.1, nothing in this
Agreement shall in any manner create any obligations or establish any rights against Donegal Mutual
in favor of any Person not a party to this Agreement.
ARTICLE 5
CHANGE IN POLICY FORMS
5.1 Policy Forms. Southern Mutual and Donegal Mutual have agreed on the forms of
Covered Policies that Southern Mutual will issue and that Donegal Mutual will reinsure pursuant to
this Agreement. Southern Mutual shall advise Donegal Mutual of any change in any form of any
Covered Policy no less than 90 days prior to the implementation of any such change, and such change
shall not be implemented unless Donegal Mutual shall have approved such change in writing within 30
days after receipt of such notice from Southern Mutual, such approval not to be unreasonably
withheld by Donegal Mutual.
ARTICLE 6
PREMIUMS AND COMMISSIONS
6.1 Premiums and Commissions. In consideration of the respective obligations of
Southern Mutual and Donegal Mutual under this Agreement, Donegal Mutual and Southern Mutual shall
make the following respective payments:
(a) On the Effective Date, Southern Mutual shall pay to Donegal Mutual an amount equal to the
Effective Date Reserves (as defined below) as follows:
(i) On the Effective Date, Southern Mutual shall pay to Donegal Mutual an amount equal to the
Estimated Effective Date Reserves to this Agreement net of the Estimated Effective Date Ceding
Commission. The payment this Section 6.1(a)(i) requires shall be made by Southern Mutuals
delivery to Donegal Mutual of cash or securities whose value Donegal Mutual shall have approved no
earlier than the third business day preceding the Effective Date having a fair market value as of
the market close on the business day immediately preceding the Effective Date equal to the amount
payable pursuant to this Section 6.1(a)(i).
(ii) Promptly following the Effective Date, Southern Mutual and Donegal Mutual agree to
determine the Actual Effective Date Reserves on a definitive basis. Not later than 60 days after
the Effective Date, Southern Mutual shall deliver a statement to Donegal Mutual that sets forth
Southern Mutuals determination of the Actual Effective Date Reserves. If Donegal Mutual does not
provide an objection notice to such statement, such
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Southern Mutual statement shall be deemed to have been accepted in the form in which it was
delivered to Donegal Mutual and shall be final and binding upon the parties in the absence of fraud
or manifest error. If Donegal Mutual shall object to such Southern Mutual statement or if Southern
Mutual shall object to any response to such statement by Donegal Mutual, the objecting party shall
give the other party written notice of such objection within 30 days of the objecting partys
receipt of such statement or response. Such notice of objection shall set forth in reasonable
detail the elements and amounts to which the objecting party objects and the basis for such
objections. If either party provides an objection notice, the other party, within 15 days after
its receipt of the objection notice, shall seek to resolve the objection. In the event Southern
Mutual and Donegal Mutual are unable to resolve the objection within 15 days thereafter, the
parties shall submit the matter to KPMG LLP (KPMG) for final resolution of the matter. Within 30
days of the submission of the matter to KPMG, KPMG shall deliver its resolution of the matter to
Southern Mutual and Donegal Mutual. KPMGs resolution of the matter shall be binding on Southern
Mutual and Donegal Mutual. Southern Mutual and Donegal Mutual shall bear equally the costs of KPMG
in determining such resolution.
(iii) To the extent the amount of the Actual Effective Date Reserves as so determined was less
than the Estimated Effective Date Reserves, Donegal Mutual shall forthwith remit to Southern Mutual
the amount by which the Estimated Effective Date Reserves exceeded the Actual Effective Date
Reserves.
(iv) To the extent the amount of the Actual Effective Date Reserves as so determined was
greater than the Estimated Effective Date Reserves, Southern Mutual shall forthwith remit to
Donegal Mutual the amount by which the Actual Effective Date Reserves exceeded the Estimated
Effective Date Reserves.
(b) On the Effective Date, Donegal Mutual shall pay to Southern Mutual a Ceding Commission
equal to 36% of the amount of Southern Mutuals unearned premium reserves included in the Estimated
Effective Date Reserves as follows:
(i) On the Effective Date, Donegal Mutual shall be deemed to have paid to Southern Mutual an
Estimated Ceding Commission equal to 36% of the Estimated Effective Date Reserves (the Estimated
Effective Date Ceding Commission) upon Southern Mutuals netting the amount of the amount of the
Estimated Effective Date Ceding Commission against the amount of the Estimated Effective Date
Reserves.
(ii) Promptly following the Closing Date, Southern Mutual and Donegal Mutual agree to
determine the Actual Effective Date Ceding Commission on a definitive basis according to the
determination of the Actual Effective Date Reserves. Not later than 60 days after the Effective
Date, Donegal Mutual shall deliver a statement to Southern Mutual that sets forth the amount of the
Actual Effective Date Ceding Commission.
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(iii) To the extent that the amount of the Actual Effective Date Ceding Commission as so
determined exceeds the amount of the Estimated Effective Date Ceding Commission, Donegal Mutual
shall forthwith remit to Southern Mutual the amount by which the Actual Effective Date Ceding
Commission exceeds the Estimated Effective Date Ceding Commission.
(iv) To the extent that the amount of the Estimated Effective Date Ceding Commission as so
determined was greater than the amount of the Actual Effective Date Ceding Commission, Southern
Mutual shall forthwith remit to Donegal Mutual the amount by which the Estimated Effective Date
Ceding Commission exceeded the Actual Effective Date Ceding Commission.
(c) As additional consideration in connection with the reinsurance this Agreement establishes,
Donegal Mutual shall be entitled to the Quota Share of any premium, fee and other amounts actually
collected, with the exception of service charges, on or after the Effective Date by Southern Mutual
with respect to the Covered Policies and Donegal Mutual shall be responsible for all Losses,
including loss development, on Covered Policies after the Effective Date. Southern Mutual shall
promptly remit to Donegal Mutual any such amounts that Southern Mutual receives net of any
reinsurance reinstatement premiums paid.
(d) If, after the Effective Date, either Southern Mutual or Donegal Mutual discovers an error
or omission in the calculation of any amount under this Section 6.1, Southern Mutual and Donegal
Mutual shall rectify such error or omission as promptly as practicable after the discovery of the
error or omission. Without limiting the foregoing, after the Effective Date, Donegal Mutual will
promptly pay to Southern Mutual, upon notice from Southern Mutual, without interest, any amount
Southern Mutual paid to Donegal Mutual pursuant to this Agreement, net of Ceding Commissions
without interest, with respect to any insurance policy that Southern Mutual or Donegal Mutual
determines was not a Covered Policy as of the Effective Date. In addition, in the event that after
the Effective Date, Southern Mutual or Donegal Mutual discover that Southern Mutual has made
payments to Donegal Mutual pursuant to this Section 6.1 with respect to premiums that have been
refunded in whole or in part, Donegal Mutual will promptly upon notice from Southern Mutual return
to Southern Mutual, without interest, all of the amount Southern Mutual paid to Donegal Mutual
pursuant to this Section 6.1 in respect of such insurance policy to the extent necessary to put
Southern Mutual in the same position it would have been in had Southern Mutual been aware of the
return of premium prior to the Effective Date net of Ceding Commissions.
ARTICLE 7
LOSSES AND LOSS ADJUSTMENT EXPENSES
7.1 Payment to Southern Mutual for Ultimate Net Losses. Donegal Mutual shall pay to
Southern Mutual the Quota Share of sums actually paid by Southern Mutual in
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settlement of the Ultimate Net Losses under the Covered Policies, on and after the Effective
Date; provided, however, that in the event of the insolvency of Southern Mutual, Donegal Mutual
shall pay such amount to the liquidator, receiver or statutory successor of Southern Mutual in
accordance with the provisions of Article 13 of this Agreement.
7.2 Expenses to be Borne by Donegal Mutual. Donegal Mutual shall bear its Quota Share
of all external loss adjustment expenses Southern Mutual incurs in the investigation, adjustment
and litigation of all claims under the Covered Policies.
7.3 Salvage. Donegal Mutual shall receive its Quota Share of all salvage, recoveries
and payments received subsequent to a Loss settlement under this Agreement whether received before
or after the final adjudication of any claim under the Covered Policies.
7.4 Loss Development. Southern Mutual shall advise Donegal Mutual promptly of all
claims and any subsequent loss reserve developments pertaining to the Covered Policies reinsured
pursuant to this Agreement.
7.5 Defense of Claims. Southern Mutual shall investigate and, to the extent that may
be required by the Covered Policies reinsured under this Agreement, defend any claim affecting the
reinsurance provided by this Agreement and pursue such claim to final determination.
7.6 Donegal Mutual Participation. Southern Mutual agrees, upon the request of Donegal
Mutual, that when so requested, Southern Mutual will afford Donegal Mutual an opportunity to
participate with Southern Mutual, at the expense of Donegal Mutual, in the defense or control of
any claim, suit or proceeding involving the reinsurance provided pursuant to this Agreement; and
Southern Mutual and Donegal Mutual shall cooperate in all material respects in the defense of such
suit, claim or proceeding.
ARTICLE 8
PREMIUM
8.1 Payment of Direct Written Premium. During the term of this Agreement, Donegal
Mutual shall assume from Southern Mutual 100% of Southern Mutuals net written premiums applicable
to its liability under the Covered Policies for the reinsurance provided pursuant to this
Agreement. Southern Mutual shall pay such premiums, net of any premiums for third-party
reinsurance.
8.2 Summary Statements. As soon as possible after the end of each month, Southern
Mutual shall submit to Donegal Mutual a statement that summarizes the net premiums ceded, return
premiums and conversions on Southerns net written business, the actual premiums due, net of
commission, and Southern Mutual shall pay to Donegal Mutual any amount due within 15 days of
Southern Mutuals delivery of such statement to Donegal
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Mutual. Southern Mutual shall furnish quarterly to Donegal Mutual, Southern Mutuals unearned
premium reserve on the Covered Policies. Southern Mutual shall compute its unearned premium
reserve on the daily pro rata basis.
8.3 Payment of Losses. Donegal Mutual shall pay its proportion of Loss and loss
expenses paid by Southern Mutual to Southern Mutual within 15 days after Southern Mutual renders a
monthly account summarizing the Losses and loss expenses. Donegal Mutual shall have the right, at
its option, to offset the amount of such Loss or loss expense as provided in Article 14.
ARTICLE 9
CEDING COMMISSION
9.1 Payment of Ceding Commission. Donegal Mutual shall pay a ceding commission as
provided in Article 6 to Southern Mutual on the net written premiums Southern Mutual cedes to
Donegal Mutual under this Agreement. On all return premiums, Southern Mutual shall promptly return
to Donegal Mutual the Ceding Commission applicable to such returned premium.
9.2 Statement of Ceding Commission. As soon as possible after the end of each month,
Donegal Mutual shall submit to Southern Mutual a statement that sets forth the Ceding Commission
fees, and Donegal Mutual shall pay any amount due within fifteen (15) days of Donegal Mutuals
receipt of the monthly statements required by Section 8.2.
9.3 Taxes. The Ceding Commission allowance that Donegal Mutual pays to Southern
Mutual on the Covered Policies reinsured pursuant to this Agreement includes provision for all
premium taxes, licenses and fees with the exception of service charges, assessments and any other
expenses whatsoever, except external loss adjustment expenses.
ARTICLE 10
INSPECTION
10.1 Right of Inspection. Southern Mutual shall place at the disposal of Donegal
Mutual and Donegal Mutual shall have the right to inspect, through its authorized representatives,
at all reasonable times during the term of this Agreement and thereafter, the books, records and
papers of Southern Mutual pertaining to the reinsurance provided pursuant to this Agreement and all
claims made in connection therewith.
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ARTICLE 11
RESERVES AND TAXES
11.1 Maintenance of Reserves. Donegal Mutual shall maintain legal reserves with
respect to the unearned premiums and claims it assumes pursuant to this Agreement.
11.2 Premium Taxes. Southern Mutual shall be liable for all taxes on premiums
reported to Donegal Mutual under this Agreement and Southern Mutual shall reimburse Donegal Mutual
for such taxes where Donegal Mutual is required to pay the same.
ARTICLE 12
EXTRA CONTRACTUAL OBLIGATIONS/EXCESS OF POLICY LIMITS
12.1 Extra Contractual Obligations. The obligations reinsured pursuant to this
Agreement shall include Extra Contractual Obligations under the Covered Policies.
12.2 Losses In Excess of Policy Limits. The obligations reinsured pursuant to this
Agreement shall include Loss in Excess of Policy Limits with respect to any Covered Policy. Loss
in Excess of Policy Limits shall mean losses in excess of the policy limit, having been incurred
because of, but not limited to, failure by Southern Mutual to settle within the Covered Policy
limit or by reason of alleged or actual negligence, fraud or bad faith in rejecting an offer of
settlement or in preparation of the defense or in the trial of any action against its insured or
reinsured or in the preparation or prosecution of an appeal consequent upon such action.
12.3 Date of Occurrence. An Extra Contractual Obligation and Loss in Excess of Policy
Limits shall be deemed to have occurred on the same date as the Loss covered under a Covered
Policy, and shall constitute part of the original Loss.
12.4 Meaning of Loss. For the purposes of the Loss in Excess of Policy Limits
coverage under this Agreement, the word Loss shall mean any amount for which Southern Mutual
would have been contractually liable to pay had it not been for the limit of the Covered Policy.
12.5 Loss Adjustment Expense. Loss adjustment expense in respect of Extra Contractual
Obligations and Loss in Excess of Policy Limits shall be covered under this Agreement in the same
manner as other loss adjustment expense.
12.6 Georgia Law. In no event shall Donegal Mutual provide reinsurance to Southern
Mutual to the extent not permitted under the laws of Georgia.
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ARTICLE 13
INSOLVENCY CLAUSE
13.1 Insolvency. In the event of the insolvency and the appointment of a conservator,
rehabilitator, liquidator or statutory successor of Southern Mutual,
(a) the reinsurance provided by this Agreement and each and every reinsurance agreement
heretofore or hereafter entered into between Donegal Mutual and Southern Mutual shall be payable,
subject to Section 13.1(b) by Donegal Mutual directly to Southern Mutual or to its conservator,
rehabilitator, liquidator, receiver or statutory successor on the basis of the liability of
Southern Mutual under the Covered Policies without diminution because of the insolvency of Southern
Mutual or because the conservator, rehabilitator, liquidator, receiver, or statutory successor has
failed to pay all or any portion of any claims.
(b) Donegal Mutual shall make the payments as set forth above directly to Southern Mutual or
to its conservator, rehabilitator, liquidator, receiver or statutory successor. If an insured
under a Covered Policy submits a claim to Southern Mutuals conservator, rehabilitator, liquidator,
receiver or statutory successor, Donegal Mutual shall have the right, in lieu of making a payment
to such conservator, rehabilitator, liquidator, receiver or statutory successor, to make a payment
on the claim directly to the insured. Any such payment by Donegal Mutual shall discharge Donegal
Mutual from its related payment obligation under such Covered Policy.
ARTICLE 14
OFFSET CLAUSE
14.1 Offset. Except for payments to be made pursuant to Section 6.1, which may only
be offset against each other, Donegal Mutual and Southern Mutual shall each have, and may exercise
at any time and from time to time, the right to offset any balance or amount, whether on account of
premiums, premium adjustments, commissions, claims, Losses, Recoveries or otherwise, due from such
party to the other party hereto under this Agreement. The party asserting the right of offset
shall have and may exercise such right at any time whether the balance or balances due or to become
due to such party from the other are on account of premiums or on account of Losses or otherwise.
If Donegal Mutual is required to make a payment directly to an insured under a Covered Policy, no
offset shall be allowed between Donegal Mutual and the insured under a Covered Policy, provided,
however, that Donegal Mutual shall continue to maintain its offset rights against Southern Mutual
pursuant to this Agreement.
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ARTICLE 15
ARBITRATION
15.1 Arbitration. Should an irreconcilable difference of opinion arise between
Southern Mutual and Donegal Mutual as to the interpretation of this Agreement or the transactions
this Agreement contemplates, as a condition precedent to any right of action under this Agreement,
such difference shall be submitted to arbitration to the decision of a board of arbitration
composed of two arbitrators and an umpire, meeting in Atlanta, Georgia under the rules of the
American Arbitration Association.
15.2 Identity of Arbitrators. The members of the board of arbitration shall be active
or retired disinterested executive officers of insurance or reinsurance companies. Each party
shall appoint one arbitrator and the two arbitrators shall choose an umpire before they enter into
arbitration. If either party fails to appoint its arbitrator within four weeks after being
requested to do so, the other party shall also appoint the second arbitrator. If the two
arbitrators fail to agree upon the appointment of an umpire within four weeks after their
nominations, each of them shall name three nominees for umpire, of whom each arbitrator shall
decline two nominees and the decision among the two remaining nominees shall be made by the
claimant party drawing lots.
15.3 Default Selection. In the event that either party shall fail to choose an
arbitrator within four weeks following a request by Donegal Mutual or Southern Mutual for
arbitration, the requesting party shall choose two arbitrators who shall choose the umpire.
15.4 Submission of Initial Brief. The claimant shall submit its initial brief within
20 days from appointment of the umpire. The respondent shall submit its brief within 20 days after
receipt of the claimants brief and the claimant may submit a reply brief within 10 days after
receipt of the respondents brief.
15.5 Arbitrator Decision. The board of arbitration shall make its decision with
regard to the custom and usage of the insurance and reinsurance business. The board of arbitration
shall issue its decision in writing based upon a hearing in which evidence may be introduced
without following strict rules of evidence but in which cross examination and rebuttal shall be
allowed. The board of arbitration shall make its decision within 60 days following the conclusion
of the hearings unless the parties consent to an extension. The majority decision of the board of
arbitration shall be final and binding upon all parties to the proceeding. Judgment may be
entered upon the award of the board of arbitration in any court having jurisdiction thereof.
15.6 Multiple Reinsurers. If more than one reinsurer is involved in the same dispute,
all such reinsurers shall constitute and act as one party for purposes of this clause and
communications shall be made by Southern Mutual to each of the reinsurers constituting
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the one party, provided, however, that nothing therein shall impair the rights of such
reinsurers to assert several, rather than joint defenses or claims, nor be construed as changing
the liability of the reinsurers under the terms of this Agreement from several to joint.
15.7 Arbitration Expenses. Each party shall bear the expense of its own arbitrator
and shall jointly and equally bear with the other party the expense of the umpire. The remaining
costs of the arbitration proceedings shall be allocated by the board of arbitration.
ARTICLE 16
GOVERNING LAW
16.1 Governing Law. This Agreement shall be interpreted under and pursuant to the
laws of the State of Georgia in all respects.
ARTICLE 17
COMMENCEMENT AND TERMINATION
17.1 Effective Time. This Agreement shall take effect as of 12:01 A.M. on the
Effective Date and is entered into for an unlimited term, but either party may terminate the term
of this Agreement at any time by giving not less than 12 months notice in writing to the other
party of a date of termination of this Agreement (the Termination Date).
17.2 Participation Until Termination. Donegal Mutual shall participate in business
coming within the terms of this Agreement until the date of termination of this Agreement.
17.3 Run-Off. In the event either party terminates this Agreement the reinsurance
pursuant to this Agreement shall be provided on a run-off basis for all Covered Policies under
this Agreement written prior to the Termination Date until all liabilities under the Covered
Policies have been satisfied in full.
ARTICLE 18
CURRENCY OF PAYMENT
18.1 Currency of Payment. All payments under this Agreement shall be made in the
currency of the United States of America.
ARTICLE 19
ACCESS TO RECORDS
19.1 Access to Records. Donegal Mutual, by its duly appointed representatives, shall
have the right at any reasonable time, to examine all papers in the possession of
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Southern Mutual that relate to the Covered Policies that Donegal Mutual has reinsured pursuant
to this Agreement.
ARTICLE 20
STATISTICS
20.1 Statistics. Southern Mutual shall furnish Donegal Mutual such statistics as may
be necessary to comply with statutory requirements and in such form as Donegal Mutual may
reasonably request from Southern Mutual.
ARTICLE 21
ERRORS AND OMISSIONS
21.1 Errors and Omissions. Any inadvertent delay, omission or error by either party
shall not relieve the other party from any liability that would have attached under this Agreement,
provided that such delay, omission or error shall not impose any greater liability on Donegal
Mutual than would have attached under this Agreement if such act, delay, omission or error had not
occurred, and such act, delay, omission or error is promptly and reasonably rectified upon
discovery by the responsible party.
ARTICLE 22
MISCELLANEOUS
22.1 Notices. All reports, remittances, notices, letters, financial statements or any
other communications between the parties to this Agreement shall be addressed as follows:
To Donegal Mutual:
Donegal Mutual Insurance Company
1195 River Road
Marietta, Pennsylvania 17547
Attention: President
Facsimile: (717) 426-7009
To Southern Mutual:
Southern Mutual Insurance Company
360 Alps Road
Athens, Georgia 30606
Attention: President
Facsimile: (706) 549-7855
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22.2 Assignment. Neither this Agreement nor any rights or obligations under this
Agreement may be assigned or otherwise transferred by any party to this Agreement, including by
operation of law, without the consent of the other party to this Agreement and the prior approval
of the Commissioner of Insurance of the State of Georgia; provided, however, that Donegal Mutual
may assign its rights or obligations under this Agreement to any entity that has a current A.M.
Best rating equal to or greater than A.
22.3 Severability. If any provision of this Agreement shall be held to be invalid,
illegal or unenforceable in any respect, such invalidity, illegality or unenforceability shall not
affect any other provision of this Agreement and this Agreement shall be construed as if such
invalid, illegal or unenforceable provision had never been part of this Agreement unless the
deletion of such provision would result in such a material change as to cause completion or
continuation of the transactions contemplated by this Agreement to be unreasonable or materially
frustrate the objectives of Southern Mutual and Donegal Mutual as expressed in this Agreement.
22.4 Counterparts. This Agreement may be executed in any number of counterparts, each
of which shall be an original, but such counterparts together shall constitute one and the same
agreement.
IN WITNESS WHEREOF the parties hereto have caused this Agreement to be executed in duplicate
and delivered as of the day and year first above written.
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DONEGAL MUTUAL INSURANCE COMPANY
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/s/ Donald H. Nikolaus
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Donald H. Nikolaus, President |
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SOUTHERN MUTUAL INSURANCE COMPANY
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By: |
/s/ Allen R. Green
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Allen R. Green, President |
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exv10whh
Exhibit 10(HH)
SERVICES AND AFFILIATION AGREEMENT
THIS SERVICES AND AFFILIATION AGREEMENT (this Agreement) is entered into this 30th day of
October, 2009 between SOUTHERN MUTUAL INSURANCE COMPANY, a Georgia mutual fire insurance company
(Southern Mutual) and DONEGAL MUTUAL INSURANCE COMPANY, a Pennsylvania mutual fire insurance
company (Donegal Mutual) in accordance with the terms of a Surplus Note Purchase Agreement dated
as of September 8, 2009 (the Note Purchase Agreement) with Donegal Mutual. All capitalized terms
used herein but not defined herein shall have the respective meanings assigned to them in the Note
Purchase Agreement.
WITNESSETH:
WHEREAS, Donegal Mutual purchased on the date hereof a surplus note (the Surplus Note) of
Southern Mutual in the principal amount of Two Million Five Hundred Thousand Dollars ($2,500,000)
pursuant to the Note Purchase Agreement;
WHEREAS, a condition precedent in the Note Purchase Agreement to Donegal Mutuals purchase of
the Surplus Note is that Southern Mutual and Donegal Mutual enter into this Agreement to assist
Southern Mutual in reducing its expense ratio and to provide advice and assistance to the officers
and employees of Southern Mutual in connection with their conduct of the operations of Southern
Mutual;
WHEREAS, Donegal Mutual and Southern Mutual are entering into a Quota Share Reinsurance
Agreement purchase to which Southern Mutual shall cede to, and Donegal Mutual shall assume from,
Southern Mutual up to 100% of the net written premiums of Southern Mutual; and
WHEREAS, Southern Mutual and Donegal Mutual are also entering into a Technology License
Agreement whereby Donegal Mutual will license certain of its computer applications and systems to
Southern Mutual on the terms and conditions set forth in the Technology License Agreement;
NOW, THEREFORE, in consideration of the premises and mutual covenants herein contained, and
intending to be legally bound hereby, Donegal Mutual and Southern Mutual agree as follows:
1. Effective Date. The effective date of this Agreement shall be the date of the
Closing under the Note Purchase Agreement. This Agreement shall continue in effect unless and
until terminated pursuant to Section 5.
2. Services To Be Rendered.
(a) In order to achieve the objectives of Southern Mutual in entering into this Agreement,
Donegal Mutual shall have the authority, subject to the ultimate authority of the Board of
Directors of Southern Mutual, to oversee all of Southern Mutuals principal business activities
including the following operations:
(i) Underwriting the development, implementation and administration of policies relating
to
underwriting and the acceptance of risks, the maintenance of underwriting manuals and guidelines
and services relating to the development of rates, the provision of all actuarial services
necessary or appropriate for the operation of Southern Mutuals business, the analysis of loss
trends and reserve developments and risk concentrations and the arranging for insurance and other
reasonable risk management services in the underwriting process to protect Southern Mutual and its
properties and other assets against loss, damage and liabilities;
(ii) Claims the admitting, adjusting, compromising, rejection and settlement of claims
under insurance policies issued by Southern Mutual and the collection of reinsurance and
recoverables;
(iii) Reinsurance the review, negotiation, monitoring and coordination of all
reinsurance
contracts and placements, including the determination of the amounts, terms, types and structure of
reinsurance to be obtained and the selection of the reinsurers;
(iv) Investments the oversight of the investment of all available funds in the name of
and
on behalf of Southern Mutual pursuant to its investment policy;
(v) Data Processing Analysis analysis and consultation regarding the advisability and
potential benefits of migrating Southern Mutuals computer systems to Donegal Mutuals computer
systems and the adaptation of Southern Mutuals computer system so it can operate Donegal Mutuals
WritePro® and WriteBiz® applications;
(vi) Personnel and Professional Services the appointment, direction, removal and
suspension, in the name of and on behalf of Southern Mutual, of employees and agents, including the
determination of the appropriate levels thereof, and the ongoing review and analysis of
professional services, including the retention of counsel, accountants and other consultants and
the payment to them, from the funds of Southern Mutual, of their reasonable fees for services and
reasonable expenses incurred in connection with such services;
(vii) Financial Reporting the analysis and reporting of actual performance to budgeted
performance, including analysis of financial results through the
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budgeted period and the preparation of all statements and reports necessary or appropriate for
Southern Mutuals business, including reports to insurance regulatory authorities.
(viii) Tax Administration the ordinary and necessary tax administration services for
income
taxes, premium taxes, sales and use taxes, franchise and similar taxes and any other taxes
incurred;
(ix) Accounting Services the providing of routine accounting and bookkeeping services
relating to cash, cash equivalents, receivables, supplies and other inventory items, fixed assets
and other asset accounting, accounts payable, notes payable, other trade payables, payroll and
payroll taxes, other general ledger items, accounting services relating to investments and the
reconciliation of all bank accounts; and
(x) Policyholder Services the maintenance of policyholders customer relation
services and
the maintenance of policyholder information, including names, addresses, policy anniversary dates
and premiums due.
(b) Donegal Mutual shall use its commercially reasonable efforts to provide the services
described above and such other or additional services as Southern Mutuals Board of Directors may
from time to time request pursuant to this Agreement in such manner as Southern Mutuals Board of
Directors, in its business judgment, exercised in accordance with applicable law, deems necessary
or appropriate. Notwithstanding the foregoing, Southern Mutual agrees that Donegal Mutual shall
have no obligation to provide services to Southern Mutual of a quality greater than the quality of
such services that Donegal Mutual maintains for its own operations. All byproducts from the
services provided by Donegal Mutual pursuant to this Agreement shall be the property of Southern
Mutual except whereby expressly provided to the contrary in this Agreement or in the Technology
License Agreement. Donegal Mutual shall cause the services to be rendered by it to Southern Mutual
pursuant to this Agreement to be covered by Donegal Mutuals disaster recovery plans.
(c) Nothing in this Agreement shall constitute or be construed to be or create a partnership
or joint venture relationship between Southern Mutual and Donegal Mutual. In connection with the
performance of services under this Agreement, neither Southern Mutual nor Donegal Mutual shall make
any statement or take any action that is inconsistent with the provisions of this Section 2(c).
3. Payment for Services.
(a) Donegal Mutual agrees to bear the costs of the services Donegal Mutual provides pursuant
to this Services Agreement in consideration of the Quota Share Reinsurance Agreement between
Donegal Mutual and Southern Mutual. Southern Mutual shall pay from its own funds all of its own
operating costs and expenses in accordance with the Ordinary Course of Southern Mutuals business.
-3-
(b) Southern Mutual shall be solely responsible for, and shall hold harmless and indemnify
Donegal Mutual, including its successors, officers, directors, employees, agents and affiliates,
from and against all losses, claims, damages, liabilities and expenses, including any and all
reasonable expenses and attorneys fees and disbursements incurred in investigating, preparing or
defending against any litigation or proceeding, whether commenced or threatened, or any other claim
whatsoever, whether or not resulting in any liability, suffered, incurred, made, brought or
asserted by any person not a party to this Agreement in connection with Donegal Mutuals provision
of services to Southern Mutual, unless such loss, claim, damage, liability or expense results from
the negligence, willful misconduct or fraud of Donegal Mutual or its officers, directors,
employees, agents or affiliates or any other person engaged by Donegal Mutual to provide services
to Southern Mutual.
(c) Donegal Mutual shall be solely responsible for, and shall hold harmless and indemnify
Southern Mutual, including its successors, officers, directors, employees, agents and affiliates,
from and against all losses, claims, damages, liabilities and expenses, including any and all
reasonable expenses and attorneys fees and disbursements incurred in investigating, preparing or
defending against any litigation or proceeding, whether commenced or threatened, or any other claim
whatsoever, whether or not resulting in any liability, suffered, incurred, made, brought or
asserted by any person not a party to this Agreement resulting from the negligence, willful
misconduct or fraud of Donegal Mutual or its officers, directors, employees, agents or affiliates
or any other person engaged by Donegal Mutual to provide services to Southern Mutual.
4. Approval by Commissioner. Donegal Mutual and Southern Mutual agree to submit this
Agreement and any other required information and filings to the Commissioner of Insurance of the
State of Georgia (the Commissioner) for his review and approval in accordance with the Georgia
Insurance Code.
5. Termination; Extension.
(a) This Agreement shall terminate on December 31, 2014, except if extended by Southern Mutual
as provided in Section 5(b); and further provided, however, that this Agreement may be terminated
at any time prior to such date in any of the following events:
(i) By Donegal Mutual, upon written notice to Southern Mutual, if Southern Mutual shall become
insolvent or shall become subject to any voluntary or involuntary conservatorship, rehabilitation,
receivership, reorganization, liquidation or bankruptcy case or proceeding or the surplus of
Southern Mutual is less than the minimum amount of surplus required by the laws of the State of
Georgia for the classes of insurance Southern Mutual is then transacting;
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(ii) By Donegal Mutual, upon written notice to Southern Mutual, if the designees of Donegal
Mutual shall cease to constitute a majority of the members of the Board of Directors of Southern
Mutual;
(iii) By Southern Mutual, upon written notice to Donegal Mutual, if Donegal Mutual shall
become insolvent or shall become subject to any voluntary or involuntary conservatorship,
receivership, reorganization, liquidation or bankruptcy case or proceeding; or
(iv) By Southern Mutual, upon written notice to Donegal Mutual, subsequent to payment in full
of the Surplus Note.
(b) Subject to subsection (a) of this Section 5, Southern Mutual shall have the option to
extend the term of this Agreement for one additional year upon delivery of a written notice of
extension to Donegal Mutual not later than 90 days prior to the expiration of the then current
term. Southern Mutual shall have the right to exercise the extension option for five successive
years commencing with an option to extend the scheduled termination date of December 31, 2014 to
December 31, 2015 and ending with an option to extend the termination date to December 31, 2019.
(c) Any termination of this Agreement by Donegal Mutual pursuant to Sections 5(a)(i) or
5(a)(ii) of this Agreement shall only become effective (i) 18 months after the date on which
written notice of termination is given to Southern Mutual by Donegal Mutual and (ii) subject to the
receipt of any necessary insurance regulatory approvals.
6. Confidentiality. Donegal Mutual agrees during the term of this Agreement and
subsequent to the termination of this Agreement to hold in confidence all documents, materials and
other information that Donegal Mutual shall have obtained about Southern Mutual during the term of
this Agreement (the Confidential Information).
7. Miscellaneous.
(a) All notices or other communications required or permitted under this Agreement shall be in
writing and shall be given by confirmed facsimile or registered mail, postage prepaid, addressed as
follows:
if to Southern Mutual, to:
Southern Mutual Insurance Company
360 Alps Road
Athens, Georgia 30606
Attention: Allen R. Green, President
Facsimile: 706-549-7855
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if to Donegal Mutual, to:
Donegal Mutual Insurance Company
1195 River Road
Marietta, Pennsylvania 17547
Attention: Donald H. Nikolaus, President
Facsimile: 717-426-7009
Such notice shall be given at such other address or to such other representative as a party to this
Agreement may furnish pursuant to this Section 7(a) to the other party to this Agreement.
(b) No assignment, transfer or delegation, whether by merger or other operation of law or
otherwise, of any rights or obligations under this Agreement shall be made by a party to this
Agreement without the prior written consent of the other party to this Agreement and, if required
by applicable law, the Commissioner and any other insurance regulatory authority having
jurisdiction over this Agreement. This Agreement shall be binding upon the parties hereto and
their respective permitted successors and assigns.
(c) This Agreement constitutes the entire agreement of the parties to this Agreement with
respect to its subject matter, supersedes all prior agreements, if any, of the parties to this
Agreement with respect to its subject matter and may not be amended except in writing signed by the
party to this Agreement against whom the change is asserted. The failure of any party to this
Agreement at any time or times to require the performance of any provision of this Agreement shall
in no manner affect the right to enforce the same and no waiver by any party to this Agreement of
any provision or breach of any provision of this Agreement in any one or more instances shall be
deemed or construed either as a further or continuing waiver of any such provision or breach or as
a waiver of any other provision or breach of any other provision of this Agreement.
(d) In case any one or more of the provisions contained herein shall, for any reason, be held
to be invalid, illegal or unenforceable in any respect, such invalidity, illegality or
unenforceability shall not affect any other provision of this Agreement, but this Agreement shall
be construed as if such invalid, illegal or unenforceable provision or provisions had never been
contained herein unless the deletion of such provision or provisions would result in such a
material change as to cause continued performance of this Agreement as contemplated herein to be
unreasonable or materially and adversely frustrate the objectives of the parties as expressed in
this Agreement.
(e) This Agreement shall be governed by and construed in accordance with the laws of the State
of Georgia.
-6-
IN WITNESS WHEREOF, the parties hereto have executed this Agreement the day and year first
above written.
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SOUTHERN MUTUAL INSURANCE COMPANY
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By: |
/s/ Allen R. Green
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Allen R. Green, President |
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DONEGAL MUTUAL INSURANCE COMPANY
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By: |
/s/ Donald H. Nikolaus
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Donald H. Nikolaus, President |
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-7-
exv10wii
Exhibit 10(II)
TECHNOLOGY LICENSE AGREEMENT
THIS TECHNOLOGY LICENSE AGREEMENT (this Agreement) is entered into this 30th day of October,
2009 between SOUTHERN MUTUAL INSURANCE COMPANY, a Georgia mutual fire insurance company (Southern
Mutual) and DONEGAL MUTUAL INSURANCE COMPANY, a Pennsylvania mutual fire insurance company
(Donegal Mutual).
WITNESSETH:
WHEREAS, Southern Mutual, in order to obtain additional surplus and assure its future
competitive viability, entered into a Surplus Note Purchase Agreement (the Note Purchase
Agreement) dated as of September 8, 2009 with Donegal Mutual;
WHEREAS, Donegal Mutual purchased on the date hereof a surplus note (the Surplus Note) of
Southern Mutual in the principal amount of Two Million Five Hundred Thousand Dollars ($2,500,000)
pursuant to the Note Purchase Agreement;
WHEREAS, a condition precedent to Donegal Mutuals purchase of the Surplus Note is that
Southern Mutual and Donegal Mutual enter into this Agreement whereby Donegal Mutual will license
certain of its computer applications and systems to Southern Mutual on the terms and conditions set
forth in this Agreement; and
WHEREAS, Southern Mutual and Donegal Mutual are also entering into a Services Agreement
whereby Donegal Mutual will provide advice and assistance to Southern Mutual in connection with its
on-going business operations including the IT System (as defined below);
NOW, THEREFORE, in consideration of the premises and mutual covenants herein contained, and
intending to be legally bound hereby, Donegal Mutual and Southern Mutual agree as follows:
1. Definitions. In this Agreement:
(a) Applications means the data processing and computer applications listed on Exhibit A to
be licensed by Donegal Mutual for use by Southern Mutual for the following purposes:
(1) policy underwriting, issuance and administration;
(2) claims administration;
(3) investment management;
(4) payroll administration;
(5) financial and tax accounting, bookkeeping, recordkeeping and reporting, including
preparation and keeping of financial journals, ledgers, records, reports and returns relating to
all categories of cash inflows and outflows, accounts payable and receivable, income accrued or
received, expenses accrued or paid, assets and liabilities; and
(6) general applications to support the foregoing and other aspects of Southern Mutuals
business as mutually agreed by Southern Mutual and Donegal Mutual from time to time.
(b) Data means the following three types of data:
(1) Form Data, which means data used to populate Application templates to generate standard
forms such as application forms, policy forms, claims forms and financial reporting forms;
(2) Input Data, which means data to be processed or used by an Application to generate
Output Data, such as the information submitted by a policy applicant; and
(3) Output Data, which means data generated by processing Input Data and/or Form Data on the
Applications, such as a completed policy form.
(c) Hardware means all computers, servers, processors, routers, communications equipment,
storage equipment and other devices, equipment, peripherals and hardware owned by, or leased or
licensed to, Donegal Mutual and used or useful in operating the Software.
(d) IT System means the Applications, Hardware and Software but excludes the Data.
(e) Software means the machine readable object code installed and operated on the Hardware
for the products listed on Exhibit A hereto as necessary or useful to support the Applications, as
the same may be supplemented, updated, modified or replaced by Donegal Mutual in its reasonable
discretion from time to time during the term of this Agreement.
(f) User Documentation means all user documentation, manuals and other materials, whether in
paper, electronic or other form, provided by Software vendors and/or Donegal Mutual with respect to
the Applications.
-2-
2. IT Services and License. Upon the terms and subject to the conditions set forth in
this Agreement, Donegal Mutual will provide Southern Mutual with access to and use of the
Applications on Donegal Mutuals IT System as follows:
(a) Customization of Applications. Donegal Mutual and Southern Mutual agree to
establish, within 30 days from the date of this Agreement, a technology transition team consisting
of employees of Donegal Mutual and employees of Southern Mutual to facilitate the customization of
the Applications for use by Southern Mutual, with commencement of Southern Mutuals use of the
Applications expected to occur within six months of the date of this Agreement. Southern Mutual
will continue to bear the costs of operating its own existing IT systems as so authorized.
(b) Hosting of IT System. Donegal Mutual will host the IT System on its Hardware and
will supply all Software and Applications to Southern Mutual. Southern Mutual will supply all Form
Data to populate the Applications, and Donegal Mutual will host the Form Data on its Hardware.
Southern Mutual will be responsible for reviewing, updating and maintaining the Form Data during
the term of this Agreement.
(c) Administration and Maintenance of IT System. Donegal Mutual will provide, or
contract with third parties to provide, all administration and maintenance of Donegal Mutuals IT
System, including routine and emergency servicing and maintenance of Hardware and Software,
installation and testing of all updates, new versions and patches to the Software as recommended by
the vendors and/or agreed by such vendors and Donegal Mutual, routine backup of all Software and
Data files hosted on the Hardware, monitoring and implementation of security procedures.
(d) Access to IT System. Southern Mutual and Donegal Mutual will agree to a mutually
acceptable process to allow Southern Mutual to designate and change its authorized employee users
from time to time. Authorized users may have full or partial access to Data and the IT System, and
will have designated rights to process Data on the Applications, as designated by mutual agreement
of Southern Mutual and Donegal Mutual. Authorized users who work in designated Southern Mutual
facilities will have networked access to the Applications and will also have the ability to access
certain Applications over the Internet. Southern Mutual agents who are so designated by Southern
Mutual will have comparable access to and use of Donegal Mutuals WritePro System and WriteBiz
System and Donegal Mutuals website as is afforded to agents of Donegal Mutual who are so
designated by Donegal Mutual.
(e) Facilities Required. All Southern Mutual authorized users will need the
communications facilities and services and computer equipment designated in the relevant User
Documentation, which will generally include a dedicated high-speed communications link to the IT
System (to be arranged by Donegal Mutual at Southern Mutuals cost) for networked access,
high-speed Internet access and appropriate computer systems, scanners,
-3-
printers and other peripherals, local area networks and other hardware and software. All such
facilities will be the responsibility of Southern Mutual and not Donegal Mutual.
(f) User Documentation. Donegal Mutual will provide Southern Mutual with such access
to User Documentation in Donegal Mutuals possession or control relating to the Applications as is
necessary to permit use of the Applications by Southern Mutual as described in this Agreement.
(g) Training. At the conclusion of the customization of Applications pursuant to
Section 2(a), Donegal Mutual will provide initial training for Southern Mutual personnel at the
facilities of Southern Mutual as mutually agreed by Southern Mutual and Donegal Mutual and Donegal
Mutual shall bear the expenses of providing training to Southern Mutuals personnel.
(h) Form Data and Input Data. Southern Mutual will bear all responsibility for
generating and inputting all Form Data and Input Data onto the IT System.
(i) Output Data. Donegal Mutual will use commercially reasonable efforts to ensure
that the IT System is capable of generating Output Data using the Form Data and Input Data supplied
by Southern Mutual.
(j) Data Transfers, Storage and Retrieval. All electronic files will reside on
Donegal Mutuals servers at facilities owned or controlled by Donegal Mutual. In appropriate
circumstances, cached or downloaded files may reside at Southern Mutuals facilities on a temporary
or permanent basis.
(k) Customer Support. Donegal Mutual will provide Southern Mutuals authorized users
with access to and use of its help desk resources for the same purposes and at the same service
levels and hours as those made available to employees of Donegal Mutual.
(l) Southern Mutual, for purposes of its customer privacy policy, hereby acknowledges that the
Donegal Mutual employees providing the services described in this Agreement constitute a
third-party insurance service provider and are authorized to have access to nonpublic personal
financial information of the policyholders of Southern Mutual in order to perform their
responsibilities under this Agreement.
(m) Donegal Mutual shall use its best efforts to provide the services described above and such
other or additional services as Southern Mutuals Board of Directors may from time to time request
pursuant to this Agreement in such manner as Southern Mutuals Board of Directors, in its business
judgment, exercised in accordance with applicable law, deems necessary or appropriate.
Notwithstanding the foregoing, Southern Mutual agrees that Donegal Mutual shall have no obligation
to provide services to Southern Mutual of a quality greater than the quality of such services that
Donegal Mutual maintains
-4-
for its own operations. Donegal Mutual shall include the services to be rendered by it to
Southern Mutual pursuant to this Agreement in Donegal Mutuals disaster recovery plans.
3. Financial Arrangements.
(a) In consideration of the Quota Share Reinsurance Agreement between Southern Mutual and
Donegal Mutual, Donegal Mutual shall not charge Southern Mutual for the license and support to be
provided pursuant to Section 2 of this Agreement.
(b) Southern Mutual will pay from its own funds all of its own operating costs and expenses.
(c) Southern Mutual will be solely responsible for, and will hold harmless and indemnify
Donegal Mutual, including its successors, officers, directors, employees, agents and affiliates,
from and against all losses, claims, damages, liabilities and expenses, including any and all
reasonable expenses and attorneys fees and disbursements incurred in investigating, preparing or
defending against any litigation or proceeding, whether commenced or threatened, or any other claim
whatsoever, whether or not resulting in any liability, suffered, incurred, made, brought or
asserted by any person not a party to this Agreement in connection with Donegal Mutuals provision
of services to Southern Mutual, unless such loss, claim, damage, liability or expense results from
the negligence, willful misconduct or fraud of Donegal Mutual or its officers, directors,
employees, agents or affiliates or any other person engaged by Donegal Mutual to provide services
to Southern Mutual.
(d) Donegal Mutual will be solely responsible for, and will hold harmless and indemnify
Southern Mutual, including its successors, officers, directors, employees, agents and affiliates,
from and against all losses, claims, damages, liabilities and expenses, including any and all
reasonable expenses and attorneys fees and disbursements incurred in investigating, preparing or
defending against any litigation or proceeding, whether commenced or threatened, or any other claim
whatsoever, whether or not resulting in any liability, suffered, incurred, made, brought or
asserted by any person not a party to this Agreement resulting from any failure of Donegal Mutual
to obtain all required legal rights to use the IT System as described in Section 4(b) of this
Agreement and to obtain all required licenses necessary for that use, negligence, willful
misconduct or fraud of Donegal Mutual or its officers, directors, employees, agents or affiliates
or any other person engaged by Donegal Mutual to provide services to Southern Mutual.
4. Intellectual Property Rights.
(a) Donegal Mutual and/or its licensors/vendors will retain ownership of all rights in the IT
System, including the Southern Mutual customization work product for the Applications. All access
to and use by Southern Mutual of the IT System hereunder will be a
-5-
revocable license limited to the scope and purposes enumerated in this Agreement, and Southern
Mutual will acquire no other rights in the aforesaid items under this Agreement. Notwithstanding
the foregoing, Southern Mutual will retain a non-exclusive license to customization work product
for the Applications.
(b) Donegal Mutual has the full legal right to use the IT System and to provide the
Applications in accordance with this Agreement and to obtain all required licenses for that use.
The provision of the Applications and the use of the IT System and any other material or services
provided or licensed to Southern Mutual under this Agreement will not infringe upon the proprietary
rights of any Third Party.
(c) Southern Mutual will own all rights in the Form Data and Input Data.
(d) Output Data may comprise derivative works that include elements of Input Data, Form Data
and the Applications or Software. Any tangible copies embodying Output Data can be used and
retained by Southern Mutual but retention of those rights does not imply ownership of the IT
System.
(e) Southern Mutual and Donegal Mutual will coordinate their respective trade secret
protection, privacy and information security policies so as to ensure each complies with (i) all
applicable laws and regulations, (ii) all applicable contractual commitments to third parties and
(iii) best business practices.
(f) Southern Mutual shall not, and shall not permit any of its employees, to disclose, whether
orally, in writing or electronically, any confidential information regarding the IT System to any
person except authorized employees of Southern Mutual and Donegal Mutual.
(g) Donegal Mutual agrees that its employees performing the services contemplated by this
Agreement shall not disclose any nonpublic personal financial information about the policyholders
of Southern Mutual in violation of applicable law and the customer privacy policy of Southern
Mutual.
5. Risk Allocations.
(a) Southern Mutual will be responsible for accuracy and entry of all Input Data and Form
Data. Southern Mutual will ensure that all its access control representatives and authorized users
do not use the IT System or any Data held on the IT System (i) for any unlawful purpose, (ii) in
any manner that may cause harm to the IT System or any data residing on the IT System, (iii) to
provide services for any other business (whether for a fee or not) as a service bureau or otherwise
or (iv) for any purpose other than to operate the Applications for Southern Mutual.
-6-
(b) Both Southern Mutual and Donegal Mutual will implement commercially reasonable security
procedures.
(c) Except as expressly set forth in this Agreement, neither Donegal Mutual nor Southern
Mutual makes any representation or warranty to the other, express or implied, including, without
limitation, any warranty of description, merchantability or fitness for a particular purpose.
(d) NOTWITHSTANDING ANYTHING IN THIS AGREEMENT OR ELSEWHERE TO THE CONTRARY, IN NO EVENT WILL
EITHER PARTY HAVE ANY LIABILITY UNDER THIS AGREEMENT OR OTHERWISE IN RESPECT OF THE SERVICES AND
LICENSES THAT ARE THE SUBJECT OF THIS AGREEMENT FOR ANY INDIRECT, CONSEQUENTIAL, INCIDENTAL,
COLLATERAL, EXEMPLARY, PUNITIVE, ENHANCED, SPECIAL OR OTHER SIMILAR DAMAGES OF ANY KIND OR NATURE
WHATSOEVER, INCLUDING LOST PROFITS TO THE OTHER PARTY FROM FUTURE BUSINESS OPPORTUNITIES, LOSS OF
USE OR REVENUE, LOSS OF SAVINGS OR LOSSES BY REASON OF THE COST OF CAPITAL, WHETHER OR NOT THE
OTHER PARTY HAS BEEN ADVISED OF, OR OTHERWISE MIGHT OR SHOULD HAVE ANTICIPATED, THE POSSIBILITY OR
LIKELIHOOD OF SUCH DAMAGES.
(e) NOTWITHSTANDING ANYTHING IN THIS AGREEMENT TO THE CONTRARY, EXCEPT FOR CLAIMS, DAMAGES,
LIABILITIES AND EXPENSES AS DESCRIBED IN SECTION 3(e) OF THIS AGREEMENT, THE AGGREGATE LIABILITY OF
EITHER PARTY TO THE OTHER PARTY UNDER THIS AGREEMENT FOR ANY REASON AND UPON ALL CLAIMS OR CAUSES
OF ACTION WILL BE LIMITED TO A MAXIMUM OF THE AGGREGATE AMOUNT OF THE FEES AND EXPENSES PAID OR
PAYABLE BY SOUTHERN MUTUAL TO DONEGAL MUTUAL UNDER THIS AGREEMENT. THE LIMITATION OF LIABILITY SET
FORTH IN THIS SECTION 5(e) APPLIES TO ALL CAUSES OF ACTION OR CLAIMS IN THE AGGREGATE, INCLUDING
BREACH OF CONTRACT, BREACH OF WARRANTY, NEGLIGENCE, STRICT LIABILITY, MISREPRESENTATION OR ANY
OTHER LEGAL OR EQUITABLE GROUNDS, EXCEPT FOR CLAIMS, DAMAGES, LIABILITIES AND EXPENSES AS DESCRIBED
IN SECTION 3(e) OF THIS AGREEMENT.
(f) Donegal Mutual will not be held responsible or incur any liability for any delay or
failure in performance of any part of this Agreement to the extent that such delay or failure
results from causes beyond its control, including fire, flood, explosion, war, labor dispute,
embargo, government requirement, civil or military authority, natural disasters or other similar
types of situations. If such a situation occurs, Donegal Mutual will give prompt notice to
Southern Mutual and Donegal Mutual will use commercially reasonable efforts to resume performance,
to the extent possible, as soon as practical after the cessation of the situation. This Section
5(f) will not relieve Southern Mutual of its obligation
-7-
to pay all fees and expenses that are due Donegal Mutual but may be the basis for a delay in
payment.
6. Miscellaneous Provisions.
(a) This Agreement is effective on the Closing Date (as defined in the Note Purchase
Agreement) and will terminate on December 31, 2014, except if extended by Southern Mutual as
provided in Section 6(b); provided, however that this Agreement may be terminated at any time prior
to such date in any of the following events:
(i) By Donegal Mutual, upon written notice to Southern Mutual, if Southern Mutual becomes
insolvent or becomes subject to any voluntary or involuntary conservatorship, rehabilitation,
receivership, reorganization, liquidation or bankruptcy case or proceeding or the surplus of
Southern Mutual is less than the minimum amount of surplus required by the laws of the State of
Georgia for the classes of insurance Southern Mutual is then transacting;
(ii) By Donegal Mutual, upon written notice to Southern Mutual, if the designees of Donegal
Mutual cease to constitute a majority of the members of the Board of Directors of Southern Mutual;
(iii) By Southern Mutual, upon written notice to Donegal Mutual, if Donegal Mutual becomes
insolvent or becomes subject to any voluntary or involuntary conservatorship, receivership,
reorganization, liquidation or bankruptcy case or proceeding;
(iv) By Southern Mutual, upon written notice to Donegal Mutual, subsequent to payment in full
of the Surplus Note; or
(v) By Donegal Mutual or Southern Mutual, upon written notice to the other, upon the
termination of the Services Agreement in accordance with its terms. Termination of this Agreement
pursuant to this section 6(a)(v) shall be effective on the same date as the termination of the
Services and Affiliation Agreement becomes effective.
(b) Subject to Section 6(a), Southern Mutual shall have the option to extend the term of this
Agreement for one additional year upon delivery of a written notice of extension to Donegal Mutual
not later than 90 days prior to the expiration of the then current term. Southern Mutual will have
the right to exercise the extension option for five successive years commencing with an option to
extend the scheduled termination date of December 31, 2014 to December 31, 2015 and ending with an
option to extend the termination date to December 31, 2019.
(c) Any termination of this Agreement by Donegal Mutual pursuant to Sections 6(a)(i), 6(a)(ii)
or 6(a)(v) of this Agreement shall only become effective after (i) 18 months after written notice
of such termination is given to Southern Mutual by Donegal
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Mutual and (ii) subject to the receipt of any necessary insurance regulatory approvals and
filings.
(d) Donegal Mutual agrees that upon termination or expiration of this Agreement for any
reason, Donegal Mutual will exercise commercially reasonable efforts and cooperation to effect an
orderly and efficient transition to a successor provider of Applications.
(e) Southern Mutual will be responsible for any federal, state or local income, excise, ad
valorem, sales or use taxes imposed with respect to the services and license made available or
provided under this Agreement other than any tax that may be imposed on the income of Donegal
Mutual.
(f) Donegal Mutual will arrange for all Data residing on its Hardware to be covered by any
insurance coverage it maintains for other data residing on its Hardware, and the incremental cost
of such coverage will be for the account of Southern Mutual.
(g) All notices or other communications required or permitted under this Agreement shall be
given in writing and shall be given by confirmed facsimile or registered mail, postage prepaid,
addressed as follows:
if to Southern Mutual, to:
Southern Mutual Insurance Company
360 Alps Road
Athens, Georgia 30606
Attention: Allen R. Green, President
Facsimile: 706-549-7855
if to Donegal Mutual, to:
Donegal Mutual Insurance Company
1195 River Road
Marietta, Pennsylvania 17547
Attention: Donald H. Nikolaus, President
Facsimile: 717-426-7009
Such notice will be given at such other address or to such other representative as a party to this
Agreement may furnish pursuant to this Section 6(g) to the other party to this Agreement.
(h) No assignment, transfer or delegation, whether by merger or other operation of law or
otherwise, of any rights or obligations under this Agreement will be
-9-
made by a party to this Agreement without the prior written consent of the other party to this
Agreement and, if required by applicable law, the Commissioner of Insurance of the State of Georgia
and any other insurance regulatory authority having jurisdiction over this Agreement. This
Agreement will be binding upon the parties hereto and their respective permitted successors and
assigns.
(i) This Agreement constitutes the entire agreement of the parties to this Agreement with
respect to its subject matter, supersedes all prior agreements, if any, of the parties to this
Agreement with respect to its subject matter and may not be amended except in writing signed by the
party to this Agreement against whom the change is asserted. The failure of any party to this
Agreement at any time or times to require the performance of any provision of this Agreement will
in no manner affect the right to enforce the same and no waiver by any party to this Agreement of
any provision or breach of any provision of this Agreement in any one or more instances will be
deemed or construed either as a further or continuing waiver of any such provision or breach or as
a waiver of any other provision or breach of any other provision of this Agreement.
(j) In case any one or more of the provisions contained herein shall, for any reason, be held
to be invalid, illegal or unenforceable in any respect, such invalidity, illegality or
unenforceability shall not affect any other provision of this Agreement, but this Agreement shall
be construed as if such invalid, illegal or unenforceable provision or provisions had never been
contained herein unless the deletion of such provision or provisions would result in such a
material change as to cause continued performance of this Agreement as contemplated herein to be
unreasonable or materially and adversely frustrate the objectives of the parties as expressed in
this Agreement.
(k) This Agreement will be governed by and construed in accordance with the laws of the State
of Georgia.
IN WITNESS WHEREOF, the parties hereto have executed this Agreement the day and year first
above written.
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SOUTHERN MUTUAL INSURANCE COMPANY
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By: |
/s/ Allen R. Green
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Allen R. Green, President |
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DONEGAL MUTUAL INSURANCE COMPANY
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By: |
/s/ Donald H. Nikolaus
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Donald H. Nikolaus, President |
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-10-
EXHIBIT A
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Network Software: |
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ImageRight
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Electronic Document Imaging |
Allenbrook
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Commercial Underwriting and Policy Issuance |
www.donegalgroup.com
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Internet Web Site Functionality |
WritePro
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Personal Lines Automated Underwriting and Policy
Issuance System (Proprietary) |
WriteBiz
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Commercial Lines Automated Underwriting and
Policy Issuance System (Proprietary) |
SCSI (JBIAS)
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Report Ordering Software Utilized in WritePro
Application |
Cold Fusion Web Software
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Web Site Development Tool |
Oracle
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Database Management |
Cognos
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Database Report Writing Tool |
Polk
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Vehicle Identification Number Database |
Map Info
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Mapping Software used in WritePro |
Mapquest
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Location Software used for the Website Agency
Locater |
Transall
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Print Software used within Allenbrook |
Group1, PC Finalist
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Address Verification Software |
CITRIX
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Remote Access |
CA, Allenbrook Interface
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Interfaces Allenbrook to the Mainframe
Applications |
Quest Reporter
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Report Writing Tool used in WritePro |
Blue Cod Products
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Add-on Products to the Allenbrook Application |
Phoenix Direct
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Agency Front-End to Allenbrook |
ACORD AL3
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Industry-Standard Interface used in Data
Transmission to and from Agency Systems |
ISO, PPC Location, WP
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Software used to Code Property Protection Classes
in WritePro |
SQL for WritePro
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Programming Language used in WritePro |
Guidewire Claims Center
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Claims Management |
ADP
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Payroll |
Great Plains Dynamics
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General Ledger and Accounts Payable |
Sungard EPS
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Investment Accounting |
A-1
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Mainframe Software: |
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CA QA Hyperstation
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Mainframe Quality Assurance Management |
Docucorp
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Policy Document Maintenance |
CSC V7
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Policy Management and Billing System |
BCMS
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Account Billing System |
IBM VM
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Mainframe Operating System Software |
IBM System Software
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Mainframe Operating System Software |
CA System Software
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Mainframe Operating System Software |
MacKinney
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Mainframe Operating System Software |
Finalist
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Address Verification Software |
CompuWare System Software
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Mainframe Operating System Software |
Polk
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Vehicle Identification Number Database |
Solimar
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Mainframe Interface to ImageRight |
A-2
exv10wjj
Exhibit 10(JJ)
AMENDED AND RESTATED PROPORTIONAL REINSURANCE AGREEMENT
THIS AMENDED AND RESTATED PROPORTIONAL REINSURANCE AGREEMENT (this Agreement) is made and
entered into as of March 1, 2010 between DONEGAL MUTUAL INSURANCE COMPANY, a mutual fire insurance
company organized and existing under the laws of the Commonwealth of Pennsylvania (Donegal
Mutual), and ATLANTIC STATES INSURANCE COMPANY, a stock casualty insurance company organized and
existing under the laws of the Commonwealth of Pennsylvania (Atlantic States).
WITNESSETH:
WHEREAS, Donegal Mutual determined in 1986 to implement a downstream insurance holding company
structure in order to develop additional sources of capital and surplus so that Donegal Mutual
could remain competitive, support its capacity to expand its business and assure its long-term
viability;
WHEREAS, Donegal Mutual established a downstream insurance holding company structure in 1986
by the formation of Donegal Group Inc., a Delaware business corporation (DGI), as a wholly owned
subsidiary of Donegal Mutual, and by the formation of Atlantic States as a wholly owned subsidiary
of DGI;
WHEREAS, a proportional reinsurance agreement (the Original Agreement) between Donegal
Mutual and Atlantic States became effective as of 12:01 a.m. on October 1, 1986 (the Original
Effective Time) and Donegal Mutual and Atlantic States each commenced the transfer of
substantially all of their respective premiums, losses and expenses to an underwriting pool (the
Underwriting Pool);
WHEREAS, Donegal Mutual and Atlantic States have amended the Original Agreement on October 1,
1988, July 16, 1992, December 21, 1995, April 20, 2000, February 11, 2008 and October 16, 2008
(collectively, the Amendments) to increase the amount and percentage of business allocated to
Atlantic States from the Underwriting Pool from 35% in 1986 to 80% on and after March 1, 2008;
WHEREAS, Donegal Mutual and Atlantic States have agreed, subject to the receipt of the
approvals noted below, by this Agreement to amend the Original Agreement as amended by the
Amendments and to restate in this Agreement the Original Agreement as amended by the Amendments and
this Agreement;
WHEREAS, since 1986 Donegal Mutual and DGI have maintained a coordinating committee (the
Coordinating Committee) that consists of two directors of Donegal Mutual
who are not also directors of DGI and two directors of DGI who are not also directors of
Donegal Mutual to review and evaluate any new agreement or relationship or any change in an
existing agreement or relationship between Donegal Mutual and DGI or any DGI subsidiary, including
the Original Agreement and the Amendments;
WHEREAS, at a meeting held on January 27, 2010, the Coordinating Committee unanimously
determined that this Agreement is fair and equitable to Donegal Mutual and its policyholders and
that this Agreement is fair and equitable to DGI and its stockholders;
WHEREAS, the Board of Directors of Donegal Mutual believes this Agreement is in the best
interests of Donegal Mutual and its policyholders and, at a meeting held on February 18, 2010,
approved the execution and delivery of this Agreement by Donegal Mutual;
WHEREAS, the Board of Directors of Atlantic States believes this Agreement is in the best
interests of Atlantic States and its stockholder and, at a meeting held on February 18, 2010,
approved the execution and delivery of this Agreement by Atlantic States; and
WHEREAS, Donegal Mutual and Atlantic States have agreed to include in the Underwriting Pool
such net premiums, losses and expenses that the Coordinating Committee has approved in the past and
may approve in the future;
NOW, THEREFORE, Donegal Mutual and Atlantic States, in consideration of their mutual covenants
and agreements contained in the Original Agreement, the Amendments and this Agreement, and
intending to be legally bound hereby, covenant and agree as follows:
1. Definitions. As used in this Agreement, the following words or phrases shall have
the following respective meanings:
Affiliate shall mean a Person that directly, or indirectly through one or more
intermediaries, controls, is controlled by or is under common control with another Person or
beneficially owns or has the power to vote or direct the vote of 10% or more of any class of voting
stock or of any form of voting equity interest of such other Person in the case of a Person that is
not a corporation. For purposes of this definition, control, including the terms controlling
and controlled, means the power to direct or cause the direction of the management and policies
of a Person, directly or indirectly, whether through the ownership of securities or partnership or
other ownership interests, by contract or otherwise. The term Affiliate shall include any
insurance company as to which either Donegal Mutual or DGI has the right to elect a majority of the
members of such insurance companys board of directors.
Agreement shall have the meaning ascribed to it in the preamble.
-2-
Annual Statements shall mean the annual statements of condition and affairs Donegal Mutual
and Atlantic States file pursuant to the Pennsylvania Insurance Company Law.
Ceding Company shall mean Donegal Mutual and Atlantic States.
Commissioner of Insurance shall mean the Commissioner of Insurance of the Commonwealth of
Pennsylvania.
Effective Time shall mean 12:01 a.m., Eastern Standard Time, on March 1, 2010.
Insurance Liabilities shall mean a liability, obligation, claim or cause of action of any
kind or nature whatsoever, whether absolute, accrued, contingent or other and whether known or
unknown, including, without limitation, outstanding case and incurred-but-not-reported loss and
loss adjustment reserves, unearned premiums and any other liability, obligation, claim or cause of
action arising as a result to an insurance policy issued by Donegal Mutual or Atlantic States.
Insurance Liabilities shall also include the Insurance Liabilities assumed from an Affiliate to the
extent the Coordinating Committee shall have approved such inclusion in advance.
Net Expenses shall mean loss expenses incurred and other underwriting expenses incurred,
including expense items that reflect underwriting, including dividends to policyholders but
excluding investment income expenses and federal income taxes, all as shown on the Annual
Statements for the particular year. All investment income and expenses allocable to the investment
operations of Donegal Mutual and Atlantic States under the statutory accounting principles
prescribed or permitted by the Insurance Department of the Commonwealth of Pennsylvania shall not
be included and shall not be subject to this Agreement.
Net Liability shall mean (i) the direct liability of Donegal Mutual or Atlantic States as
evidenced by all outstanding policies of insurance issued by Donegal Mutual or Atlantic States less
reinsurance purchased with respect thereto from other insurers not a party to this Agreement and
(ii) the assumed liability of Donegal Mutual or Atlantic States related to the reinsurance of the
Insurance Liabilities of an Affiliate to the extent the Coordinating Committee shall have approved
such inclusion in advance.
Net Premiums and Losses shall mean the net written premiums and net losses paid of Donegal
Mutual or Atlantic States after Atlantic States or Donegal Mutual gives effect to reinsurance
transactions with other insurers or reinsurers who are not a party to this Agreement, including the
net written premiums and net losses paid Donegal Mutual or Atlantic States may from time to time
assume from an Affiliate but only to the extent the Coordinating Committee shall have approved such
inclusion in advance.
-3-
Person shall mean an individual, corporation, partnership, association, joint stock company,
governmental entity, business trust, unincorporated organization or other legal entity.
2. General Provisions.
(a) This Agreement shall become effective as of 12:01 a.m., Eastern Standard Time, on March 1,
2010 (the Effective Time).
(b) In the event that a Ceding Company becomes insolvent or is otherwise subject to
liquidation or receivership proceedings, the remaining accepting companies shall adjust their
respective assumed portions of the combined Net Liability of the Ceding Companies, each on a pro
rata basis, so as to absorb or assume collectively in full the Net Liability of the Ceding
Companies, including the portion that would otherwise be the responsibility of the insolvent or
otherwise impaired Ceding Company.
3. Ceding and Accepting the Book of Business Then in Force.
(a) From and after the Effective Time, Atlantic States shall, as provided in the Original
Agreement, the Amendments and in this Agreement, continue to cede all of the Insurance Liabilities
of Atlantic States to the Underwriting Pool.
(b) From and after the Effective Time, Donegal Mutual shall, as provided in the Original
Agreement, the Amendments and in this Agreement, continue to cede all of the Insurance Liabilities
of Donegal Mutual to the Underwriting Pool.
(c) From and after the Effective Time, Donegal Mutual shall continue to accept and assume its
proportionate share as set forth on Exhibit I to this Agreement of the Insurance Liabilities of the
Underwriting Pool outstanding on or after the Effective Time. Donegal Mutual shall continue to be
solely responsible for Insurance Liabilities related to loss occurrences that took place prior to
the Original Effective Time.
(d) From and after the Effective Time, Atlantic States shall continue to accept and assume its
proportionate share as set forth on Exhibit I to this Agreement the Insurance Liabilities of the
Underwriting Pool outstanding on or after the Effective Time. Atlantic States shall not be liable
for Insurance Liabilities related to loss occurrences that took place prior to the Original
Effective Time.
4. Accounting. Donegal Mutual and Atlantic States agree as follows:
(a) To the extent that transfers of non-cash assets may be required to effectuate the
settlements this Agreement requires, any such transfers shall be made at fair market values as of
the date either Donegal Mutual or Atlantic States makes such transfers.
-4-
(b) Atlantic States and Donegal Mutual agree to render to the other party a monthly accounting
within 30 days after the close of each month and the other party shall have the opportunity for
examination and audit, and the balance due shall be paid not later than 90 days after the close of
the applicable month.
5. Termination.
(a) Donegal Mutual and Atlantic States agree that this Agreement shall continue in effect for
an indeterminate period. This Agreement shall be subject to termination only upon 90 days advance
notice from one party to the other party. Any such termination shall only be effective at the
next succeeding December 31, and Donegal Mutual and Atlantic States shall provide coverage on a
run-off basis for policies issued prior to the effective date of the termination until all
liabilities under such policies have been satisfied in full.
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed by their
respective officers thereunto duly authorized on this 1st day March, 2010.
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[SEAL] |
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DONEGAL MUTUAL INSURANCE COMPANY |
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Attest: |
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/s/ Sheri O. Smith
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By:
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/s/ Donald H. Nikolaus |
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Sheri O. Smith, Secretary
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Donald H. Nikolaus, President |
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[SEAL] |
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ATLANTIC STATES INSURANCE COMPANY |
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Attest: |
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/s/ Cyril J. Greenya
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By:
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/s/ Jeffrey D. Miller |
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Cyril J. Greenya, Senior Vice President
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Jeffrey D. Miller, Senior Vice President |
-5-
EXHIBIT I
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Name of Party |
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Corporation Pool Participation |
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Donegal Mutual Insurance Company
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20 |
% |
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Atlantic States Insurance Company
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80 |
% |
-6-
exv13
Exhibit 13
SELECTED CONSOLIDATED FINANCIAL DATA
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|
|
|
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|
|
|
|
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|
Year Ended December 31, |
|
2009 |
|
|
2008 |
|
|
2007 |
|
|
2006 |
|
|
2005 |
|
|
INCOME STATEMENT DATA |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Premiums earned |
|
$ |
355,025,477 |
|
|
$ |
346,575,266 |
|
|
$ |
310,071,534 |
|
|
$ |
301,478,162 |
|
|
$ |
294,498,023 |
|
Investment income, net |
|
|
20,630,583 |
|
|
|
22,755,784 |
|
|
|
22,785,252 |
|
|
|
21,320,081 |
|
|
|
18,471,963 |
|
Realized investment gains (losses) |
|
|
4,479,558 |
|
|
|
(2,970,716 |
) |
|
|
2,051,050 |
|
|
|
1,829,539 |
|
|
|
1,802,809 |
|
Total revenues |
|
|
386,733,407 |
|
|
|
372,424,227 |
|
|
|
340,618,294 |
|
|
|
329,967,034 |
|
|
|
319,847,194 |
|
Income before income taxes |
|
|
20,676,689 |
|
|
|
32,092,044 |
|
|
|
52,848,938 |
|
|
|
56,622,263 |
|
|
|
52,345,495 |
|
Income taxes |
|
|
1,846,611 |
|
|
|
6,550,066 |
|
|
|
14,569,033 |
|
|
|
16,407,541 |
|
|
|
15,395,998 |
|
Net income |
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|
18,830,078 |
|
|
|
25,541,978 |
|
|
|
38,279,905 |
|
|
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40,214,722 |
|
|
|
36,949,497 |
|
Basic earnings per share Class A |
|
|
.76 |
|
|
|
1.03 |
|
|
|
1.55 |
|
|
|
1.65 |
|
|
|
1.57 |
|
Diluted earnings per share Class A |
|
|
.76 |
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|
|
1.02 |
|
|
|
1.53 |
|
|
|
1.60 |
|
|
|
1.51 |
|
Cash dividends per share Class A |
|
|
.45 |
|
|
|
.42 |
|
|
|
.36 |
|
|
|
.33 |
|
|
|
.30 |
|
Basic earnings per share Class B |
|
|
.68 |
|
|
|
.92 |
|
|
|
1.39 |
|
|
|
1.48 |
|
|
|
1.41 |
|
Diluted earnings per share Class B |
|
|
.68 |
|
|
|
.92 |
|
|
|
1.39 |
|
|
|
1.48 |
|
|
|
1.41 |
|
Cash dividends per share Class B |
|
|
.40 |
|
|
|
.37 |
|
|
|
.31 |
|
|
|
.28 |
|
|
|
.26 |
|
|
BALANCE SHEET DATA AT YEAR END |
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|
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Total investments |
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$ |
666,835,186 |
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|
$ |
632,135,526 |
|
|
$ |
605,869,587 |
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|
$ |
591,337,674 |
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|
$ |
547,746,114 |
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Total assets |
|
|
935,601,927 |
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|
|
880,109,036 |
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|
|
834,095,576 |
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|
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831,697,811 |
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|
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781,421,588 |
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Debt obligations |
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|
15,465,000 |
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|
|
15,465,000 |
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|
|
30,929,000 |
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|
|
30,929,000 |
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|
|
30,929,000 |
|
Stockholders equity |
|
|
385,505,699 |
|
|
|
363,583,865 |
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|
|
352,690,191 |
|
|
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320,802,262 |
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277,896,186 |
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Book value per share |
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|
15.12 |
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|
14.29 |
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|
|
13.92 |
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|
|
12.70 |
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|
11.30 |
|
6
FINANCIAL INFORMATION
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Managements Discussion and Analysis of Results of Operations and Financial Condition |
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|
8 |
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Consolidated Balance Sheets |
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|
17 |
|
Consolidated Statements of Income and Comprehensive Income |
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|
18 |
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Consolidated Statements of Stockholders Equity |
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|
19 |
|
Consolidated Statements of Cash Flows |
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|
20 |
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Notes to Consolidated Financial Statements |
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|
21 |
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Report of Independent Registered Public Accounting Firm Consolidated Financial Statements |
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|
36 |
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Managements Report on Internal Control Over Financial Reporting |
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|
37 |
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Report of Independent Registered Public Accounting Firm Internal Control Over Financial Reporting |
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|
38 |
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Comparison of Total Return on Our Common Stock with Certain Averages |
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|
39 |
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Corporate Information |
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|
40 |
|
7
MANAGEMENTS DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
General
Donegal Mutual Insurance Company (Donegal Mutual)
organized us as a downstream insurance holding company on
August 26, 1986. Our insurance subsidiaries, Atlantic
States Insurance Company (Atlantic States), Southern
Insurance Company of Virginia (Southern), Le Mars
Insurance Company (Le Mars), the Peninsula Insurance
Group (Peninsula), which consists of Peninsula Indemnity
Company and The Peninsula Insurance Company, and Sheboygan
Falls Insurance Company (Sheboygan), write personal and
commercial lines of property and casualty coverages
exclusively through a network of independent insurance
agents in certain Mid-Atlantic, Midwest and Southern
states. We acquired Sheboygan on December 1, 2008, and
Sheboygans results of operations have been included in
our consolidated results from that date. 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.
We also own 48.2% of the outstanding stock of Donegal
Financial Services Corporation (DFSC), a thrift holding
company. Donegal Mutual owns the remaining 51.8% of the
outstanding stock of DFSC.
At December 31, 2009, Donegal Mutual owned approximately
42% of our outstanding Class A common stock and
approximately 75% of our outstanding Class B common
stock. Our insurance subsidiaries and Donegal Mutual have
interrelated operations. 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 March 2007, our board of directors authorized a share
repurchase program, pursuant to which we purchased 500,000
shares of our Class A common stock at market prices
prevailing from time to time in the open market subject to
the provisions of
Securities and Exchange Commission (SEC) Rule 10b-18 and
in privately negotiated transactions. We purchased 19,231
and 214,343 shares of our Class A common stock under this
program during 2009 and 2008, respectively. As of December
31, 2009, we had no remaining authorization to purchase
shares under this program.
In December 2006, Donegal Mutual consummated an
affiliation with Sheboygan. As part of the affiliation,
Donegal Mutual made a $3.5 million contribution note
investment in Sheboygan. During 2008, Sheboygans board of
directors adopted a plan of conversion to convert to a
stock insurance company. Following policyholder and
regulatory approval of the plan of conversion, we acquired
Sheboygan as of December 1, 2008 for approximately $12.0
million in cash, including payment of the contribution
note and accrued interest to Donegal Mutual.
In February 2009, our board of directors authorized a
share repurchase program, pursuant to which we may
purchase up to 300,000 shares of our Class A common stock
at market prices prevailing from time to time in the open
market subject to the provisions of SEC Rule 10b-18 and in
privately negotiated transactions. We purchased 7,669
shares of our Class A common stock under this program
during 2009. As of December 31, 2009, we had the authority
to purchase 292,331 shares under this program.
In October 2009, Donegal Mutual consummated an affiliation
with Southern Mutual Insurance Company (Southern
Mutual), pursuant to which Donegal Mutual purchased a
surplus note of Southern Mutual in the
principal amount of $2.5 million, Donegal Mutual
designees became a majority of the members of Southern
Mutuals board of directors and Donegal Mutual agreed to
provide quota share reinsurance to Southern Mutual for
100% of its business. Effective October 31, 2009, Donegal
Mutual began to include business assumed from Southern
Mutual in its pooling agreement with Atlantic States.
Southern Mutual writes primarily personal lines of
insurance in Georgia and South Carolina and had direct
premiums written of approximately $13.3 million for the
year ended December 31, 2009.
Pooling Agreement and Other Transactions with Affiliates
In the mid-1980s, Donegal Mutual recognized the need to
develop additional sources of capital and surplus to
remain competitive and to have the capacity to expand its
business and assure its long-term viability. Donegal
Mutual determined to implement a downstream holding
company structure as a strategic response. Thus, in 1986,
Donegal Mutual formed us as a downstream holding company,
then wholly owned by Donegal Mutual. We in turn formed
Atlantic States as our wholly owned subsidiary. Donegal
Mutual and Atlantic States then entered into a
proportional reinsurance agreement, or pooling agreement,
in 1986. Under this pooling agreement, Donegal Mutual and
Atlantic States pool substantially all of their respective
premiums, losses and loss expenses. Donegal Mutual then
cedes 80% of the pooled business to Atlantic States.
Since 1986, we have completed three public offerings. A
major purpose of those offerings was to provide capital
for Atlantic States and our other insurance subsidiaries
and to fund acquisitions. As the capital of Atlantic
States increased, its underwriting capacity increased
proportionately. Thus, as we
originally planned in the mid-1980s, Atlantic States has
had access to the capital necessary to support the growth
of its direct business and increases in the amount and
percentage of business it assumes from the underwriting
pool. As a result, the participation of Atlantic States in
the inter-company pool has increased over the years from
its initial 35% participation in 1986 to its 80%
participation in 2008, and the size of the pool has
increased substantially. From July 1, 2000 through
February 29, 2008, Atlantic States had a 70% share of the
results of the pool, and Donegal Mutual had a 30% share of
the results of the pool. Effective March 1, 2008, Donegal
Mutual and Atlantic States amended the pooling agreement
to increase Atlantic States share of the pooled business
to 80%.
The risk profiles of the business Atlantic States and
Donegal Mutual write have historically been, and continue
to be, substantially similar. The same executive
management and underwriting personnel administer
products, classes of business underwritten, pricing
practices and underwriting standards of Donegal Mutual
and our insurance subsidiaries.
In addition, as the Donegal Insurance Group, Donegal
Mutual and our insurance subsidiaries share a combined
business plan to achieve market penetration and
underwriting profitability objectives. The products our
insurance subsidiaries and Donegal Mutual offer are
generally complementary, thereby allowing the Donegal
Insurance Group to offer a broader range of products to a
given market and to expand the Donegal Insurance Groups
ability to service an entire personal lines or commercial
lines account. Distinctions within the products of
Donegal Mutual and our insurance subsidiaries generally
relate to specific risk profiles targeted within similar
classes of business, such as preferred tier versus
standard tier products, but we and Donegal Mutual do not
allocate all of the standard risk gradients to one
company. Therefore, the underwriting
8
profitability of the business written directly by the
individual companies will vary. However, since the
underwriting pool homogenizes the risk characteristics of
all business written directly by Donegal Mutual and
Atlantic States, Donegal Mutual and Atlantic States share
the underwriting results in proportion to their respective
participation in the pool. We realize 80% of the
underwriting results of the pool because of the 80%
participation of Atlantic States in the underwriting pool.
The business Atlantic States derives from the pool
represents the predominant percentage of our total
revenues. See Note 3 Transactions with Affiliates for
more information regarding the pooling agreement.
In addition to the pooling agreement and third-party
reinsurance, our insurance subsidiaries have various
reinsurance arrangements with Donegal Mutual. These
agreements include:
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catastrophe reinsurance agreements with Atlantic
States, Le Mars and Southern; |
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an excess of loss reinsurance agreement with
Southern; |
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a quota-share reinsurance agreement
with Le Mars; |
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|
|
a quota-share reinsurance
agreement with Peninsula; and |
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|
|
|
a quota-share
reinsurance agreement with Southern. |
The intent of the excess of loss and catastrophe
reinsurance agreements is to lessen the effects of a
single large loss, or an accumulation of smaller losses
arising from one event, to levels that are appropriate
given each subsidiarys size, underwriting profile and
surplus position.
The intent of the quota-share reinsurance agreement with
Le Mars is to transfer to Le Mars 100% of the premiums
and losses related to certain products Donegal Mutual
offers in certain Midwest states, which provide the
availability of additional complementary products to Le
Mars commercial accounts.
Donegal Mutual and Peninsula have a quota-share
reinsurance agreement that transfers to Donegal Mutual
100% of the premiums and losses related to the workers
compensation product line of Peninsula in certain states,
which provides the availability of an additional workers
compensation tier to Donegal Mutuals commercial accounts.
The intent of the quota-share reinsurance agreement with
Southern is to transfer to Southern 100% of the premiums
and losses related to certain personal lines products
Donegal Mutual offers in Virginia through the use of its
automated policy quoting and issuance system.
Donegal Mutual provides facilities, personnel and other
services to us and our insurance subsidiaries. Donegal
Mutual allocates certain related expenses to Atlantic
States in relation to the relative participation of
Donegal Mutual and Atlantic States in the pooling
agreement. Our insurance subsidiaries other than Atlantic
States reimburse Donegal Mutual for their personnel costs
and bear their proportionate share of information services
costs based on their percentage of total written premiums
of the Donegal Insurance Group.
All new agreements and all changes to existing agreements
between our insurance subsidiaries and Donegal Mutual must
first be approved by a coordinating committee comprised of
two of our board members who do not serve on Donegal
Mutuals board and two members of Donegal Mutuals board
who do not serve on our board. In order to approve a new
agreement or a change in an agreement, our members on the
coordinating committee must conclude that the agreement or
change is fair and equitable to us and in the best
interests of our stockholders, and Donegal Mutuals
members on the coordinating committee must conclude that
the agreement or change is fair and equitable to Donegal
Mutual and in the best interests of its policyholders.
There were no significant changes to the pooling
agreement or other reinsurance agreements with
Donegal Mutual during 2009 and 2008 except as noted
above.
Critical Accounting Policies and Estimates
We combine our financial statements with those of our
insurance subsidiaries and present them on a consolidated
basis in accordance with United States generally accepted
accounting principles (GAAP).
Our insurance subsidiaries make estimates and assumptions
that can have a significant effect on amounts and
disclosures we report in our financial statements. The
most significant estimates relate to the reserves of our
insurance subsidiaries for property and casualty insurance
unpaid losses and loss
expenses, valuation of investments and determination of
other-than-temporary impairment and our insurance
subsidiaries policy acquisition costs. While we believe
our estimates and the estimates of our insurance
subsidiaries are appropriate, the ultimate amounts may
differ from the estimates provided. We regularly review
our methods for making these estimates, and we reflect any
adjustment considered necessary in our current results of
operations.
Liability for Losses and Loss Expenses
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 policyholder claims based on facts and
circumstances then known. 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 and
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 of liability. We reflect
any adjustments to our insurance subsidiaries liabilities
for losses and loss expenses in our operating results in
the period in which our insurance subsidiaries make the
changes in estimates.
Our insurance subsidiaries maintain liabilities for the
payment of losses and loss expenses with respect to both
reported and unreported claims. Our insurance subsidiaries
establish these liabilities for the purpose of covering
the ultimate costs of settling all losses, including
investigation and litigation costs. Our insurance
subsidiaries base the amount of their liability for
reported losses primarily upon a case-by-case evaluation
of the type of risk involved, knowledge of the
circumstances surrounding each claim and the insurance
policy provisions relating to the type of loss. Our
insurance subsidiaries determine the amount of their
liability for unreported claims and loss expenses on the
basis of historical information by line of insurance. Our
insurance subsidiaries account for inflation in the
reserving function through analysis of costs and trends
and reviews of historical reserving results. Our insurance
subsidiaries closely monitor their liabilities and
recompute them periodically using new information on
reported claims and a variety of statistical techniques.
Our insurance subsidiaries do not discount their
liabilities for losses.
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 as to our insurance subsidiaries
internal operations. For example, our insurance
subsidiaries have experienced a decrease in claims
frequency on workers compensation claims during the past
several years while claims severity has gradually
increased. These trend changes give rise to greater
uncertainty as to the pattern of future loss settlements
on workers compensation claims.
Related uncertainties regarding future trends include
the cost of medical technologies and procedures and
changes in the utilization of medical procedures.
Assumptions related to our insurance subsidiaries
external environment include the absence of significant
changes in tort law and legal decisions
that increase liability exposure, consistency in
judicial
9
interpretations of insurance coverage and policy
provisions and the rate of loss cost inflation. Internal
assumptions include consistency in the recording of
premium and loss statistics, consistency in the recording
of claims, payment and case reserving methodology,
accurate measurement of the impact of rate changes and
changes in policy provisions, consistency in the quality
and characteristics of business written within a given
line of business and consistency in reinsurance coverage
and collectibility of reinsured losses, among other items.
To the extent our insurance subsidiaries determine that
underlying factors impacting their assumptions have
changed, our insurance subsidiaries attempt to make
appropriate adjustments for such changes in their
reserves. Accordingly, our insurance subsidiaries
ultimate liability for unpaid losses and loss expenses
will likely differ from the amount recorded at December
31, 2009. For every 1% change in our insurance
subsidiaries estimate for loss and loss expense reserves,
net of reinsurance recoverable, the effect on our pre-tax
results of operations would be approximately $1.8 million.
The establishment of appropriate liabilities is an
inherently uncertain process, and there can be no
assurance that our insurance subsidiaries ultimate
liability will not exceed our insurance subsidiaries loss
and loss expense reserves and have an adverse effect on
our results of operations and financial condition.
Furthermore, we cannot predict the timing, frequency and
extent of adjustments to our insurance subsidiaries
estimated future liabilities, since 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 the evaluation of information received
since the prior reporting date. Our insurance subsidiaries
recognized an increase (decrease) in their liability for
losses and loss expenses of prior years of $9.8 million,
$2.7 million and ($10.0) million in 2009, 2008 and 2007,
respectively. Our insurance subsidiaries made no
significant changes in their reserving philosophy, key
reserving assumptions or claims management personnel, and
there have been no significant offsetting changes in
estimates that increased or decreased their loss and loss
expense reserves in those years. The majority of the 2009
development related to increases in the liability for
losses and loss expenses of prior years for Atlantic
States and Southern. The 2009 development represented 6.0%
of our December 31, 2008 carried reserves and was driven
primarily by higher-than-expected severity in the private
passenger automobile liability, homeowners and workers
compensation lines of business in accident year 2008.
Excluding the impact of isolated catastrophic weather
events, our insurance subsidiaries have noted stable
amounts in the number of claims incurred and slight
downward trends in the number of claims outstanding at
period ends relative to their premium base in recent years
across most of their lines of business. However, the
amount of the average claim
outstanding has increased gradually over the past several
years as the property and casualty insurance industry has
experienced increased litigation trends and economic
conditions that have extended the estimated length of
disabilities and contributed to increased medical loss
costs and a general slowing of settlement rates in
litigated claims. Our insurance subsidiaries could have to
make further adjustments to their estimates in the future.
However, on the basis of our insurance subsidiaries
internal procedures, which analyze, among other things,
their prior assumptions, their experience with similar
cases and historical trends such as reserving patterns,
loss payments, pending levels of unpaid claims and product
mix, as well as court decisions, economic conditions and
public attitudes, we believe that our insurance
subsidiaries have made adequate provision for their
liability for losses and loss expenses.
Atlantic States participation in the pool with Donegal
Mutual exposes it to adverse loss development on the
business of Donegal Mutual that is included in the pool.
However, pooled business represents the
predominant percentage of the net underwriting activity
of both companies, and Donegal Mutual and Atlantic States
would proportionately share any adverse risk development
of the pooled business. The business in the pool is
homogenous, and each company has a pro-rata share of the
entire pool. Since substantially all 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 they 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 as of December
31, 2009 and 2008 consisted of the following:
|
|
|
|
|
|
|
|
|
(in thousands) |
|
2009 |
|
2008 |
|
Commercial lines: |
|
|
|
|
|
|
|
|
Automobile |
|
$ |
21,465 |
|
|
$ |
19,758 |
|
Workers compensation |
|
|
38,092 |
|
|
|
36,667 |
|
Commercial multi-peril |
|
|
30,640 |
|
|
|
27,808 |
|
Other |
|
|
1,886 |
|
|
|
1,893 |
|
|
Total commercial lines |
|
|
92,083 |
|
|
|
86,126 |
|
|
Personal lines: |
|
|
|
|
|
|
|
|
Automobile |
|
|
70,019 |
|
|
|
60,939 |
|
Homeowners |
|
|
16,312 |
|
|
|
11,796 |
|
Other |
|
|
1,848 |
|
|
|
2,445 |
|
|
Total personal lines |
|
|
88,179 |
|
|
|
75,180 |
|
|
Total commercial and personal lines |
|
|
180,262 |
|
|
|
161,306 |
|
Plus reinsurance recoverable |
|
|
83,337 |
|
|
|
78,503 |
|
|
Total liability for losses and loss expenses |
|
$ |
263,599 |
|
|
$ |
239,809 |
|
|
We have evaluated the effect on our insurance
subsidiaries loss and loss expense reserves and our
stockholders equity in the event of reasonably likely
changes in the variables
considered in establishing loss and loss expense
reserves. We established the range of reasonably likely
changes based on a review of changes in accident year
development by line of business and applied it to our
insurance subsidiaries loss reserves as a whole. The
selected range does not necessarily indicate what could
be the potential best or worst case or likely scenario.
The following table sets forth the effect on our
insurance subsidiaries loss and loss expense reserves
and our stockholders equity in the event of reasonably
likely changes in the variables considered in
establishing loss and loss expense reserves:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjusted Loss and |
|
|
|
|
|
Adjusted Loss and |
|
|
|
|
Loss Expense |
|
Percentage |
|
Loss Expense |
|
Percentage |
Change in Loss |
|
Reserves Net of |
|
Change in |
|
Reserves Net of |
|
Change in |
and Loss Expense |
|
Reinsurance as of |
|
Equity as of |
|
Reinsurance as of |
|
Equity as of |
Reserves Net of |
|
December 31, |
|
December 31, |
|
December 31, |
|
December 31, |
Reinsurance |
|
2009 |
|
2009(1) |
|
2008 |
|
2008(1) |
(dollars in thousands) |
-10.0% |
|
$ |
162,236 |
|
|
|
3.0 |
% |
|
$ |
145,175 |
|
|
|
2.9 |
% |
-7.5 |
|
|
166,742 |
|
|
|
2.3 |
|
|
|
149,208 |
|
|
|
2.2 |
|
-5.0 |
|
|
171,249 |
|
|
|
1.5 |
|
|
|
153,241 |
|
|
|
1.4 |
|
-2.5 |
|
|
175,755 |
|
|
|
0.8 |
|
|
|
157,273 |
|
|
|
0.7 |
|
Base |
|
|
180,262 |
|
|
|
|
|
|
|
161,306 |
|
|
|
|
|
2.5 |
|
|
184,769 |
|
|
|
-0.8 |
|
|
|
165,339 |
|
|
|
-0.7 |
|
5.0 |
|
|
189,275 |
|
|
|
-1.5 |
|
|
|
169,371 |
|
|
|
-1.4 |
|
7.5 |
|
|
193,782 |
|
|
|
-2.3 |
|
|
|
173,404 |
|
|
|
-2.2 |
|
10.0 |
|
|
198,288 |
|
|
|
-3.0 |
|
|
|
177,437 |
|
|
|
-2.9 |
|
|
|
|
(1) |
|
Net of income tax effect. |
10
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 reserve estimates
based on an assessment of known facts and circumstances,
review of historical loss settlement patterns, estimates
of trends in claims severity, frequency, legal and
regulatory changes and other assumptions. Actuarial loss
reserving techniques and assumptions, which rely on
historical information as adjusted to reflect current
conditions, are consistently applied, including
consideration of recent case reserve activity. For the
year ended December 31, 2009, our insurance subsidiaries
used the most-likely number as determined by our
actuaries. Based upon information provided by our
actuaries during the development of our insurance
subsidiaries net reserves for losses and loss expenses
for the year ended December 31, 2009, we developed a range
from a low of $165.6 million to a high of $196.2 million
and with a most-likely number of $180.3 million. The range
of estimates for commercial lines in 2009 was
$84.6 million to $100.2 million (we selected the
actuaries most-likely number of $92.1 million) and for
personal lines in 2009 was $81.0 million to $96.0 million
(we selected the actuaries most-likely number of $88.2
million). Based upon information provided by our actuaries
during the development of our insurance subsidiaries net
reserves for losses and loss
expenses for the year ended December 31, 2008, we
developed a range from a low of $147.9 million to a high
of $176.0 million and with a most-likely number of $161.3
million. The range of estimates for commercial lines in
2008 was $79.0 million to $94.0 million (we selected the
actuaries most-likely number of $86.1 million) and for
personal lines in 2008 was $68.9 million to $82.1 million
(we selected the actuaries most-likely number of $75.2
million).
Our insurance subsidiaries seek to enhance their
underwriting results by carefully selecting the product
lines they underwrite. For personal lines products, our
insurance subsidiaries insure standard and preferred risks
in private passenger automobile and homeowners lines. For
commercial lines products, the commercial risks that our
insurance subsidiaries primarily insure are mercantile
risks, business offices, wholesalers, service providers,
contractors and artisan risks, limiting industrial and
manufacturing exposures. Our insurance subsidiaries have
limited exposure to asbestos and other environmental
liabilities. Our insurance subsidiaries write no medical
malpractice or professional liability risks. Through the
consistent application of this disciplined underwriting
philosophy, our insurance subsidiaries have avoided many
of the long-tail issues other insurance companies have
faced. We consider workers compensation to be a
long-tail line of business, in that workers
compensation claims tend to be settled over a longer
timeframe than those in our other lines of business. The
following table presents 2009 and 2008 claim count and
payment amount information for workers compensation.
Workers compensation losses primarily consist of
indemnity and medical costs for injured workers.
Substantially all of the claims are relatively small
individual claims of a similar type.
|
|
|
|
|
|
|
|
|
|
|
For the Year Ended |
|
|
|
December 31, |
|
|
|
|
2009 |
|
|
2008 |
|
|
|
|
(dollars in thousands) |
|
|
Number of claims pending, beginning of period |
|
|
1,401 |
|
|
|
1,452 |
|
Number of claims reported |
|
|
2,449 |
|
|
|
2,976 |
|
Number of claims settled or dismissed |
|
|
2,554 |
|
|
|
3,027 |
|
|
Number of claims pending, end of period |
|
|
1,296 |
|
|
|
1,401 |
|
|
Losses paid |
|
$ |
17,131 |
|
|
$ |
17,068 |
|
Loss expenses paid |
|
|
3,944 |
|
|
|
3,377 |
|
Investments
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 write down the investment to its fair
value, and we reflect the amount of the write-down as a
realized loss in our results of operations when we
consider the decline in value of an individual investment
to be other than temporary. We individually monitor all
investments for other-than-temporary declines in value.
Generally, we assume there has been an
other-than-temporary decline in value if an individual
equity security has depreciated in value by more than 20%
of original cost and has been in such an unrealized loss
position for more than six months. We held five equity
securities that were in an unrealized loss position at
December 31, 2009. Based upon our analysis of general
market
conditions and underlying factors impacting these equity
securities, we considered these declines in value to be
temporary. 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 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. We held 73
debt securities that were in an unrealized loss position
at December 31, 2009. Based upon our analysis of general
market conditions and underlying factors impacting these
debt securities, we considered these declines in value to
be temporary. We included losses of $0, $1.2 million and
$469,000 in net realized investment gains (losses) in
2009, 2008 and 2007, respectively, for certain equity
investments trading below cost on an other-than-temporary
basis.
We held fixed maturities and equity securities with
unrealized losses representing declines that we considered
temporary at December 31, 2009 as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less than 12 months |
|
|
12 months or longer |
|
|
|
|
Fair |
|
|
Unrealized |
|
|
Fair |
|
|
Unrealized |
|
|
|
Value |
|
|
Losses |
|
|
Value |
|
|
Losses |
|
|
U.S. Treasury securities
and obligations of U.S. government
corporations
and agencies |
|
$ |
26,703,601 |
|
|
$ |
585,364 |
|
|
$ |
|
|
|
$ |
|
|
Obligations of states
and political
subdivisions |
|
|
17,971,018 |
|
|
|
256,527 |
|
|
|
29,582,488 |
|
|
|
786,970 |
|
Corporate securities |
|
|
1,284,405 |
|
|
|
23,525 |
|
|
|
666,941 |
|
|
|
61,366 |
|
Residential mortgage-backed securities |
|
|
23,514,855 |
|
|
|
328,969 |
|
|
|
477,421 |
|
|
|
543 |
|
Equity securities |
|
|
2,139,457 |
|
|
|
227,798 |
|
|
|
|
|
|
|
|
|
|
Totals |
|
$ |
71,613,336 |
|
|
$ |
1,422,183 |
|
|
$ |
30,726,850 |
|
|
$ |
848,879 |
|
|
11
We held fixed maturities and equity securities with
unrealized losses representing declines that we considered
temporary at December 31, 2008 as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less than 12 months |
|
12 months or longer |
|
|
Fair |
|
Unrealized |
|
Fair |
|
Unrealized |
|
|
Value |
|
Losses |
|
Value |
|
Losses |
|
U.S. Treasury securities
and obligations of
U.S. government
corporations
and agencies |
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
Obligations of states
and political
subdivisions |
|
|
117,360,120 |
|
|
|
6,880,692 |
|
|
|
65,626,857 |
|
|
|
3,331,443 |
|
Corporate securities |
|
|
16,780,992 |
|
|
|
448,760 |
|
|
|
2,536,165 |
|
|
|
733,109 |
|
Residential mortgage-backed securities |
|
|
2,925,368 |
|
|
|
24,376 |
|
|
|
2,928,685 |
|
|
|
22,526 |
|
Equity securities |
|
|
484,000 |
|
|
|
59,458 |
|
|
|
|
|
|
|
|
|
|
Totals |
|
$ |
137,550,480 |
|
|
$ |
7,413,286 |
|
|
$ |
71,091,707 |
|
|
$ |
4,087,078 |
|
|
We present our investments in available-for-sale fixed
maturity and equity securities at estimated fair value and
classify them in one of three categories described in Note
6 Fair Value Measurements. The estimated fair value of
a security may differ from the amount that could be
realized if the security were sold 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 for
substantially all of our fixed maturity and equity
investments. We generally obtain one price 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
using proprietary pricing applications, which include
available relevant market information, benchmark yields,
sector curves and matrix pricing. The pricing services do
not use broker quotes in determining the fair values of
our investments. We review the estimates of fair value
provided by the pricing services to determine if the
estimates obtained are representative of fair values based
upon our general knowledge of the market, our research
findings related to unusual fluctuations in value and our
comparison of such values to execution prices for similar
securities. As of December 31, 2009 and 2008, we received
one estimate per security from one of the pricing
services, and we priced all but an insignificant amount of
our Level 1 and Level 2 investments using those prices. In
our review of the estimates provided by the pricing
services as of December 31, 2009 and 2008, we did not
identify any discrepancies, and we did not make any
adjustments to the estimates the pricing services
provided. We reclassified one equity security to Level 3 during 2009. We utilized a fair
value model that incorporated significant unobservable
inputs, such as estimated volatility, to estimate the
equity securitys fair value.
We had no sales or transfers from the held to maturity
portfolio in 2009, 2008 or 2007.
Policy Acquisition Costs
We defer our insurance subsidiaries policy acquisition
costs, consisting primarily of commissions, premium taxes
and certain other underwriting costs that vary with and
are directly related to the production of business, and
amortize these costs over the period in which our
insurance subsidiaries earn the premiums. The method we
follow in computing deferred policy acquisition costs
limits the amount of such deferred costs to their
estimated realizable value, which gives effect to the
premium to be earned, related investment income, losses
and loss expenses and certain other costs expected to be
incurred as the premium is earned.
Management Evaluation of Operating Results
We believe that principal factors contributing to our
earnings over the past several years have been our
insurance subsidiaries overall premium growth, earnings
from acquisitions and our insurance subsidiaries
disciplined underwriting practices.
The property and casualty insurance industry is highly
cyclical, and individual lines of business experience
their own cycles within the overall insurance industry
cycle. Premium rate levels have a relationship to the
availability of insurance coverage, which varies according
to the level of surplus in the insurance industry and
other factors. The level of surplus in the industry varies
with returns on capital and regulatory barriers to the
withdrawal of surplus. Increases in surplus have generally
been accompanied by increased price competition among
property and casualty insurers. If our insurance
subsidiaries were to find it necessary to reduce premiums
or limit premium increases due to competitive pressures on
pricing, our insurance subsidiaries could experience a
reduction in profit margins and revenues, an increase in
ratios of losses and expenses to premiums and, therefore,
lower profitability. The cyclicality of the insurance
market and its potential impact on our results is
difficult to predict with any significant reliability. We
evaluate the performance of our commercial lines and
personal lines segments primarily based upon the
underwriting results of our insurance subsidiaries as
determined under statutory accounting practices (SAP),
which our management uses to measure performance for the
total business of our insurance subsidiaries. We use the
following financial data to monitor and evaluate our
operating results:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, |
(in thousands) |
|
2009 |
|
2008 |
|
2007 |
|
Net premiums written: |
|
|
|
|
|
|
|
|
|
|
|
|
Personal lines: |
|
|
|
|
|
|
|
|
|
|
|
|
Automobile |
|
$ |
161,932 |
|
|
$ |
154,091 |
|
|
$ |
132,452 |
|
Homeowners |
|
|
77,420 |
|
|
|
72,195 |
|
|
|
58,602 |
|
Other |
|
|
13,135 |
|
|
|
13,254 |
|
|
|
11,299 |
|
|
Total personal lines |
|
|
252,487 |
|
|
|
239,540 |
|
|
|
202,353 |
|
|
Commercial lines: |
|
|
|
|
|
|
|
|
|
|
|
|
Automobile |
|
|
34,054 |
|
|
|
35,959 |
|
|
|
32,059 |
|
Workers compensation |
|
|
28,921 |
|
|
|
36,459 |
|
|
|
32,361 |
|
Commercial multi-peril |
|
|
44,000 |
|
|
|
49,004 |
|
|
|
43,559 |
|
Other |
|
|
3,767 |
|
|
|
3,979 |
|
|
|
3,357 |
|
|
Total commercial lines |
|
|
110,742 |
|
|
|
125,401 |
|
|
|
111,336 |
|
|
Total net premiums written |
|
$ |
363,229 |
|
|
$ |
364,941 |
|
|
$ |
313,689 |
|
|
Components of GAAP combined ratio: |
|
|
|
|
|
|
|
|
|
|
|
|
Loss ratio |
|
|
70.7 |
% |
|
|
64.7 |
% |
|
|
57.4 |
% |
Expense ratio |
|
|
31.3 |
|
|
|
32.1 |
|
|
|
33.5 |
|
Dividend ratio |
|
|
0.2 |
|
|
|
0.4 |
|
|
|
0.4 |
|
|
GAAP combined ratio |
|
|
102.2 |
% |
|
|
97.2 |
% |
|
|
91.3 |
% |
|
Revenues: |
|
|
|
|
|
|
|
|
|
|
|
|
Premiums earned: |
|
|
|
|
|
|
|
|
|
|
|
|
Personal lines |
|
$ |
242,313 |
|
|
$ |
225,143 |
|
|
$ |
196,429 |
|
Commercial lines |
|
|
113,233 |
|
|
|
121,567 |
|
|
|
113,642 |
|
|
SAP premiums earned |
|
|
355,546 |
|
|
|
346,710 |
|
|
|
310,071 |
|
GAAP adjustments |
|
|
(521 |
) |
|
|
(135 |
) |
|
|
|
|
|
GAAP premiums earned |
|
|
355,025 |
|
|
|
346,575 |
|
|
|
310,071 |
|
Net investment income |
|
|
20,631 |
|
|
|
22,756 |
|
|
|
22,785 |
|
Realized investment gains (losses) |
|
|
4,480 |
|
|
|
(2,971 |
) |
|
|
2,051 |
|
Other |
|
|
6,597 |
|
|
|
5,952 |
|
|
|
5,711 |
|
|
Total revenues |
|
$ |
386,733 |
|
|
$ |
372,312 |
|
|
$ |
340,618 |
|
|
Components of net income: |
|
|
|
|
|
|
|
|
|
|
|
|
Underwriting income (loss): |
|
|
|
|
|
|
|
|
|
|
|
|
Personal lines |
|
$ |
(17,235 |
) |
|
$ |
(7,609 |
) |
|
$ |
1,736 |
|
Commercial lines |
|
|
5,805 |
|
|
|
13,819 |
|
|
|
22,744 |
|
|
SAP underwriting
(loss) income |
|
|
(11,430 |
) |
|
|
6,210 |
|
|
|
24,480 |
|
GAAP adjustments |
|
|
3,636 |
|
|
|
3,530 |
|
|
|
2,603 |
|
|
GAAP underwriting
(loss) income |
|
|
(7,794 |
) |
|
|
9,740 |
|
|
|
27,083 |
|
Net investment income |
|
|
20,631 |
|
|
|
22,756 |
|
|
|
22,785 |
|
Realized investment
gains (losses) |
|
|
4,480 |
|
|
|
(2,971 |
) |
|
|
2,051 |
|
Other |
|
|
3,360 |
|
|
|
2,567 |
|
|
|
930 |
|
|
Income before income taxes |
|
|
20,677 |
|
|
|
32,092 |
|
|
|
52,849 |
|
Income taxes |
|
|
(1,847 |
) |
|
|
(6,550 |
) |
|
|
(14,569 |
) |
|
Net income |
|
$ |
18,830 |
|
|
$ |
25,542 |
|
|
$ |
38,280 |
|
|
12
Results of Operations
Years Ended December 31, 2009 and 2008
Net Premiums Written
Our insurance subsidiaries 2009 net premiums written
decreased slightly to $363.2 million, compared to $364.9
million for 2008. Commercial lines net premiums written
decreased $14.7 million, or 11.7%, for 2009 compared to
2008. Personal lines net premiums written increased $13.0
million, or 5.4%, for 2009 compared to 2008. Net premiums
written for 2009 included a $5.4 million transfer of
unearned premium related to Donegal Mutuals affiliation
with Southern Mutual. Net premiums written for 2008
included a $13.6 million transfer of unearned premiums related to the change in the pooling
agreement between Atlantic States and Donegal Mutual
effective March 1, 2008.
Net Premiums Earned
Our insurance subsidiaries net premiums earned increased
to $355.0 million for 2009, an increase of $8.4 million,
or 2.4%, over 2008. Our insurance subsidiaries net earned
premiums during 2009 have grown due to the increase in
written premiums during 2008. 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 will generally reflect
increases or decreases in net premiums written in the
preceding twelvemonth period compared to the same period
one year earlier.
Investment Income
For 2009, our net investment income was $20.6 million, a
9.7% decrease from 2008. An increase in our average
invested assets from $619.0 million in 2008 to $649.5
million in 2009 was offset by a decrease in our annualized
average return to 3.2% in 2009, compared to 3.7% in 2008.
The decrease in our annualized average rate of return on
investments was primarily due to lower reinvestment rates
for securities added to our fixed income portfolio during
2009.
Installment Payment Fees
Our insurance subsidiaries installment fees increased
primarily as a result of increases in policy counts
during 2009.
Net Realized Investment Gains/Losses
Our net realized investment gains (losses) in 2009 and
2008 were $4.5 million and ($3.0) million, respectively.
Realized investment gains in 2009 resulted primarily from
sales of equity securities as well as fixed maturity
investments that had appreciated significantly during the
year. Realized investment losses in 2008 included $2.4
million representing our pro rata share of investment
losses in a limited partnership investment that was
solely invested in equity securities. We recognized no
impairment charges in 2009, compared to impairment
charges of $1.2 million in 2008. Our impairment charges
for 2008 were the result of declines in the fair value of
equity securities that we determined to be other than
temporary. The remaining net realized investment gains
and losses in both periods resulted from turnover within
our investment portfolio.
Losses and Loss Expenses
Our insurance subsidiaries loss ratio, which is the
ratio of incurred losses and loss expenses to premiums
earned, was 70.7% in 2009, compared to 64.7% in 2008. Our insurance subsidiaries commercial
lines loss ratio increased to 64.3% in 2009, compared to
56.6% in 2008. This increase primarily resulted from the
workers compensation loss ratio increasing to 75.1% in 2009, compared to 58.9% in 2008, and the
commercial automobile loss ratio increasing to 56.4% in
2009, compared to 53.5% in 2008, as a result of increased
claim severity and less favorable prior-accident-year
loss reserve development. The personal lines loss ratio
increased to 73.6% in 2009, compared to 69.1% in 2008 ,
primarily as a result of an increase in the homeowners
loss ratio to 78.3% in 2009, compared to 63.0% in 2008,
as a result of an increase in weather-related claims and increased property claims from
fires.
Underwriting Expenses
Our insurance subsidiaries expense ratio, which is
the ratio of policy acquisition and other underwriting
expenses to premiums earned, was 31.3% in 2009, compared to 32.1% in 2008. The decrease
in the 2009 expense ratio reflects decreased
underwriting-based incentive compensation costs in 2009
compared to 2008 and expense savings initiatives that
commenced in the fourth quarter of 2008.
Combined Ratio
Our insurance subsidiaries combined ratio was 102.2% and
97.2% in 2009 and 2008, respectively. The combined ratio
represents the sum of the loss ratio, expense ratio and
dividend ratio, which is the ratio of workers
compensation policy dividends incurred to premiums earned.
Interest Expense
Our interest expense in 2009 was $1.7 million, compared to
$1.8 million in 2008. The decrease in interest expense
reflected the redemption of $15.5 million of subordinated
debentures in August 2008 and a decrease in average
interest rates on our subordinated debentures in 2009
compared to 2008, offset by interest expense related to a
premium tax litigation settlement.
Income Taxes
Our income tax expense was $1.8 million in 2009,
compared to $6.6 million in 2008, representing an
effective tax rate of 8.9%, compared to 20.4% in 2008. The change in effective tax rates is
primarily due to tax-exempt interest income representing a
larger proportion of income before income tax expense in
2009 compared to 2008. We benefited from a 9.9% increase
in tax-exempt interest income in 2009 compared to 2008.
Net Income and Earnings Per Share
Our net income in 2009 was $18.8 million, or $.76 per
share of Class A common stock and $.68 per share of Class
B common stock on a diluted basis, compared to our net
income of $25.5 million, or $1.02 per share of Class A
common stock and $.92 per share of Class B common stock
on a diluted basis, in 2008. Our fully diluted Class A
shares outstanding for 2009 decreased slightly to 19.9
million, compared to 20.0 million for December 31, 2008,
as a result of our repurchase of treasury stock. Our
Class B shares outstanding did not change at 5.6 million.
Book Value Per Share and Return on Equity
Our stockholders equity increased by $21.9 million in
2009, primarily as a result of favorable operating results
and unrealized gains within our investment portfolio. Book
value per share increased by 5.8% to $15.12 at December
31, 2009, compared to $14.29 a year earlier. Our return on
average equity was 5.0% for 2009, compared to 7.1% for
2008.
Years Ended December 31, 2008 and 2007
Net Premiums Written
Our insurance subsidiaries 2008 net premiums written
increased by 16.3% to $364.9 million, compared to $313.7
million for 2007. Commercial lines net premiums written
increased $14.1 million, or 12.7%, for 2008 compared to
2007. Personal lines net premiums written increased $37.1
million, or 18.3%, for 2008 compared to 2007. Net premiums
written for 2008 included a $13.6 million transfer of
unearned premiums related to the change in the pooling
agreement between Atlantic States and Donegal Mutual
effective March 1, 2008 and reflected the impact of the
increased pooling allocation of approximately $24.4
million for the remainder of 2008. Net premiums written
during the year also benefited from the renewal of our
2008 reinsurance program at lower rates compared to 2007.
The lower reinsurance rates were largely due to our
decision to increase our per loss retention from $400,000
to $600,000 effective January 1, 2008.
Net Premiums Earned
Our insurance subsidiaries net premiums earned increased
to $346.6 million for 2008, an increase of $36.5 million,
or 11.8%, over 2007. Our insurance subsidiaries net
earned premiums during 2008 grew due to the
13
increase in written premiums during the year. 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
will generally reflect increases or decreases in net
premiums written in the preceding twelvemonth period
compared to the same period one year earlier. Net premiums
earned in 2008 reflected the impact of an increased
pooling allocation and benefited from the renewal of our
2008 reinsurance program at lower rates compared to 2007.
Investment Income
For 2008, our net investment income was unchanged from
2007 at $22.8 million. An increase in our average invested
assets from $598.6 million in 2007 to $619.0 million in
2008 was offset by a decrease in our annualized average
return to 3.7% in 2008 compared to 3.8% in 2007. The
decrease in our annualized average rate of return on
investments was primarily due to reduced yields on
increased holdings of short-term U.S. Treasury investments
during 2008. The use of invested assets to redeem $15.5
million of subordinated debentures in August 2008 also
impacted net investment income for 2008.
Installment Payment Fees
Our insurance subsidiaries installment fees increased
primarily as a result of increases in policy counts
during 2008.
Net Realized Investment Gains/Losses
Our net realized investment (losses) gains in 2008 and
2007 were ($3.0) million and $2.1 million, respectively.
Realized investment losses in 2008 included $2.4 million
representing our pro rata share of investment losses in a
limited partnership investment that is solely invested in
equity securities. Our net realized investment losses in
2008 also included impairment charges of $1.2 million,
compared to impairment charges of $469,000 recognized in
2007. Our impairment charges for both years were the
result of declines in the fair value of equity securities
that we determined to be other than temporary. The
remaining net realized investment gains and losses in both
periods resulted from turnover within our investment
portfolio.
Losses and Loss Expenses
Our insurance subsidiaries loss ratio, which is the
ratio of incurred losses and loss expenses to premiums
earned, was 64.7% in 2008, compared to 57.3% in 2007. Our insurance subsidiaries commercial
lines loss ratio increased to 56.6% in 2008, compared to
46.8% in 2007. This increase primarily resulted from the
workers compensation loss ratio increasing to 58.9% in 2008, compared to 44.8% in 2007, and the
commercial automobile loss ratio increasing to 53.5% in
2008, compared to 49.1% in 2007, as a result of increased
claim severity and less favorable prior-accident-year
loss reserve development. The personal lines loss ratio
increased to 69.1% in 2008, compared to 63.4% in 2007,
primarily as a result of an increase in the personal
automobile loss ratio to 73.0% in 2008, compared to 66.0%
in 2007, as a result of increased claim severity and less
favorable prior-accident-year loss reserve development
and an increase in the homeowners loss ratio to 63.0% in
2008, compared to 61.8% in 2007, as a result of an increase in weather-related claims.
Underwriting Expenses
Our insurance subsidiaries expense ratio, which is
the ratio of policy acquisition and other underwriting
expenses to premiums earned, was 32.1% in 2008, compared to 33.5% in 2007. The decrease in
the 2008 expense ratio reflected the benefit of increased
net premiums written during the year and decreased
underwriting-based incentive compensation costs in 2008
compared to 2007.
Combined Ratio
Our insurance subsidiaries combined ratio was 97.2% and
91.3% in 2008 and 2007, respectively. The combined ratio
represents the sum of the loss ratio, expense ratio and
dividend ratio, which is the ratio of workers
compensation policy dividends incurred to premiums earned.
Interest Expense
Our interest expense in 2008 was $1.8 million, compared to
$2.9 million in 2007, The decrease in interest expense
reflected the redemption of $15.5 million of subordinated
debentures in August 2008 and a decrease in average
interest rates on our subordinated debentures in 2008
compared to 2007.
Income Taxes
Our income tax expense was $6.6 million in 2008, compared
to $14.6 million in 2007, representing an effective tax
rate of 20.4%, compared to 27.6% in 2007. The change in effective tax rates is
primarily due to tax-exempt interest income representing
a larger proportion of income before income tax expense
in 2008 compared to 2007, as we benefited from a 24.6% increase in tax-exempt interest income in 2008 compared to 2007.
Net Income and Earnings Per Share
Our net income in 2008 was $25.5 million, or $1.02 per
share of Class A common stock and $.92 per share of Class
B common stock on a diluted basis, compared to our net
income of $38.3 million, or $1.53 per share of Class A
common stock and $1.39 per share of Class B common stock
on a diluted basis, in 2007. Our fully diluted Class A
shares outstanding in 2008 did not change at 20.0 million.
Our Class B shares outstanding did not change at 5.6
million.
Book Value Per Share and Return on Equity
Our stockholders equity increased by $10.9 million in
2008, primarily as a result of favorable operating
results. Book value per share increased by 2.7% to $14.29
at December 31, 2008, compared to $13.92 a year earlier.
Our return on average equity was 7.1% in 2008, compared
to 11.4% in 2007.
Financial Condition
Liquidity and Capital Resources
Liquidity is a measure of an entitys ability to secure
enough cash to meet its contractual obligations and
operating needs as they arise. Our major sources of funds
from operations are the net cash flows generated from our
insurance subsidiaries underwriting results, investment
income and maturing investments.
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 impact of the pooling agreement
with Donegal Mutual historically has been cash flow
positive because of the historical profitability of the
underwriting pool. We settle the pool monthly, thereby
resulting in cash flows substantially similar to 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, thereby
providing 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 2009, 2008 and 2007, were $34.1 million, $52.9 million
and $26.7 million, respectively.
On November 25, 2003, we entered into a credit agreement with Manufacturers and Traders Trust Company (M&T) relating to a four-year
$35.0 million unsecured, revolving line of credit. On July
20, 2006, we amended the agreement with M&T to extend the
credit agreement for four years from the date of amendment
on substantially the same terms. As of December 31, 2009,
we have the ability to borrow $35.0 million at interest
rates equal to M&Ts current prime rate or the then
current LIBOR rate plus between 1.50% and 1.75%, depending
on our leverage ratio. In addition, we pay a fee of 0.15%
per annum on the loan commitment amount, regardless of
usage. The credit agreement requires our compliance with
certain covenants, which include minimum levels of net
worth, leverage ratio and statutory surplus and A.M. Best
ratings of our insurance
14
subsidiaries. As of December 31, 2009, we had no
borrowings outstanding, and we complied with all
requirements of the credit agreement. We intend to extend
the credit agreement during 2010.
The following table shows expected payments for
our significant contractual obligations as of
December 31, 2009:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less |
|
|
|
|
|
|
|
|
|
|
|
|
than 1 |
|
1-3 |
|
4-5 |
|
After 5 |
(in thousands) |
|
Total |
|
year |
|
years |
|
years |
|
years |
|
Net liability for
unpaid losses and
loss expenses
|
|
$ |
180,262 |
|
|
$ |
82,528 |
|
|
$ |
81,278 |
|
|
$ |
7,558 |
|
|
$ |
8,898 |
|
Subordinated
debentures |
|
|
15,465 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
15,465 |
|
|
Total contractual
obligations |
|
$ |
195,727 |
|
|
$ |
82,528 |
|
|
$ |
81,278 |
|
|
$ |
7,558 |
|
|
$ |
24,363 |
|
|
We estimate 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. The liability has
been shown 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 will
include future cash settlement of Atlantic States assumed
liability from the pool in our monthly settlements of
pooled activity, wherein we net amounts ceded to and
assumed from the pool. Although Donegal Mutual and
Atlantic States do not anticipate any further changes in
the pool participation levels in the foreseeable future,
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 estimate the timing of the amounts for the subordinated
debentures based on their contractual maturities. We may
redeem the debentures at our option, at par, as discussed
in Note 10 Borrowings. Our subordinated debentures
carry interest rates that vary based upon the three-month
LIBOR rate and adjust quarterly. Based upon the interest
rates in effect as of December 31, 2009, our annual
interest cost associated with our subordinated debentures
is approximately $643,000. For every 1% change in the
three-month LIBOR rate, the effect on our annual interest
cost would be approximately $150,000.
Dividends declared to stockholders totaled $11.2 million, $10.4 million and
$8.4 million in 2009, 2008 and 2007, respectively. There
are no regulatory restrictions on the payment of dividends
to our stockholders, although there are state law
restrictions on the payment of dividends from our
insurance subsidiaries to us. Our insurance subsidiaries
are required to maintain certain minimum surplus on a
statutory basis and are subject to regulations under which
payment of dividends from statutory surplus is restricted
and may require prior approval of their domiciliary
insurance regulatory authorities. Our insurance
subsidiaries are subject to risk-based capital (RBC)
requirements. At December 31, 2009, each of our insurance
subsidiaries had capital substantially above the RBC
requirements. In 2010, amounts available for distribution
as dividends to us from our insurance subsidiaries without
prior approval of their domiciliary insurance regulatory
authorities are $12.4 million from Atlantic States, $2.8
million from Le Mars, $3.9 million from Peninsula,
$584,431 from Sheboygan and $0 from Southern.
Investments
At December 31, 2009 and 2008, our investment portfolio
of primarily investment-grade bonds, common stock,
short-term investments and cash totaled $679.8 million
and $634.0 million, respectively, representing 72.7% and
72.1%, respectively, of our total assets.
At December 31, 2009 and 2008, the carrying value of our
fixed maturity investments represented 88.7% and 86.3% of
our total invested assets, respectively.
Our fixed maturity investments consisted of high-quality
marketable bonds, of which 99.0% and 99.5% were rated at
investment-grade levels at December 31, 2009 and 2008,
respectively. As we invested excess cash from operations
and proceeds from maturities of fixed maturity
investments during 2009, we increased our holdings of
tax-exempt fixed maturity investments in order to obtain
more favorable after-tax yields.
At December 31, 2009, the net unrealized gain or loss on
available-for-sale fixed maturity investments, net of
deferred taxes, amounted to a gain of $9.2 million,
compared to a loss of $2.1 million at December 31, 2008.
At December 31, 2009, the net unrealized gain on our
equity securities, net of deferred taxes, amounted to
$5.8 million, compared to $3.7 million at December 31,
2008.
Quantitative and Qualitative Disclosures About Market Risk
We are exposed to the impact of interest rate changes,
changes in fair values of investments and to credit
risk.
In the normal course of business, we employ established
policies and procedures to manage our exposure to changes
in interest rates, fluctuations in the fair market value
of our debt and equity securities and credit risk. We seek
to mitigate these risks by various actions described
below.
Interest Rate Risk
Our exposure to market risk for a change in interest
rates is concentrated in our investment portfolio. We
monitor this exposure through periodic reviews of asset
and liability positions. We regularly monitor estimates
of cash flows and the impact of interest rate
fluctuations relating to the investment portfolio.
Generally, we do not hedge our exposure to interest rate
risk because we have the capacity to, and do, hold fixed
maturity investments to maturity.
Principal cash flows and related weighted-average interest
rates by expected maturity dates for financial instruments
sensitive to interest rates at December 31, 2009 are as
follows:
|
|
|
|
|
|
|
|
|
|
|
Principal |
|
Weighted-Average |
(in thousands) |
|
Cash Flows |
|
Interest Rate |
|
Fixed maturity
and short-term investments: |
|
|
|
|
|
|
|
|
2010 |
|
$ |
74,981 |
|
|
|
1.44 |
% |
2011 |
|
|
15,457 |
|
|
|
4.26 |
|
2012 |
|
|
20,476 |
|
|
|
3.32 |
|
2013 |
|
|
20,220 |
|
|
|
4.22 |
|
2014 |
|
|
26,965 |
|
|
|
4.06 |
|
Thereafter |
|
|
479,472 |
|
|
|
4.40 |
|
|
Total |
|
$ |
637,571 |
|
|
|
|
|
|
Fair value |
|
$ |
650,810 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Debt: |
|
|
|
|
|
|
|
|
Thereafter |
|
$ |
15,465 |
|
|
|
4.29 |
% |
|
Total |
|
$ |
15,465 |
|
|
|
|
|
|
Fair value |
|
$ |
15,465 |
|
|
|
|
|
|
Actual cash flows from investments may differ from
those stated as a result of calls and prepayments.
Equity Price Risk
Our portfolio of equity securities, which we carry on our
consolidated balance sheets at estimated fair value, has
exposure to price risk, which is the risk of potential
loss in estimated fair value resulting from an adverse
change in prices. Our objective is to earn competitive
relative returns by investing in a diverse portfolio of
high-quality, liquid securities.
15
Credit Risk
Our objective is to earn competitive returns by investing
in a diversified portfolio of securities. Our portfolio
of fixed maturity securities and, to a lesser extent,
short-term investments is subject to credit risk. We
define this risk as the potential loss in fair value
resulting from adverse changes in the borrowers ability
to repay the debt. We manage this risk by performing an
analysis of prospective investments and through regular
reviews of our portfolio by our investment staff. We also
limit the amount of our total investment portfolio that
we invest in any one security.
Our insurance subsidiaries provide property and liability
insurance coverages through independent insurance
agencies located throughout their operating areas. Our
insurance subsidiaries bill the majority of this business
directly to the insured, although our insurance
subsidiaries bill a portion of their commercial business
through their agents to whom they extend credit in the
normal course of business.
Because the pooling agreement does not relieve Atlantic
States of primary liability as the originating insurer,
Atlantic States is subject to a concentration of credit
risk arising from business it cedes to Donegal Mutual. Our
insurance subsidiaries maintain reinsurance agreements
with Donegal Mutual and with a number of other major
unaffiliated authorized reinsurers.
Impact of Inflation
Our insurance subsidiaries establish their property and
casualty insurance premium rates before they know the
amount of losses and loss settlement expenses or the
extent to which inflation may impact such expenses. Consequently, our
insurance subsidiaries attempt, in establishing rates, to
anticipate the potential impact of inflation.
Impact of New Accounting Standards
In April 2009, the Financial Accounting Standards Board
(FASB) issued FASB Staff Position (FSP) FAS 115-2 and
Financial Accounting Standard (FAS) 124-2, Recognition
and Presentation of Other-Than-Temporary Impairments,
codified in FASB Accounting Standards Codification (ASC)
section 320-10-65. ASC section 320-10-65 provides
guidance designed to create greater clarity and
consistency in accounting for and presenting impairment
losses on debt securities. ASC section 320-10-65 is
effective for interim and annual periods ending after
June 15, 2009. Effective April
1, 2009, we adopted ASC section 320-10-65. We had no
cumulative effect adjustment because we had no debt
securities we had determined previously to be
other-than-temporarily impaired. Beginning on April 1,
2009, we analyzed our debt securities for
other-than-temporary impairment adjustments using the
guidance in ASC section 320-10-65.
In April 2009, the FASB issued FSP FAS 157-4,
Determining Fair Value When the Volume and Level of
Activity for the Asset or Liability Have Significantly
Decreased and Identifying Transactions That Are Not
Orderly, codified in ASC section 820-10-35. ASC section
820-10-35 provides guidelines for making fair value
measurements that are more consistent with the principles
presented in FAS 157, Fair Value Measurements, codified
in ASC subtopic 820-10. ASC section 820-10-35 is
effective for interim and annual periods ending after
June 15, 2009. Effective April 1, 2009, we adopted ASC
section 820-10-35. The adoption of ASC section 820-10-35
expanded certain fair value disclosures in our financial
statements but had no effect on our results of
operations, financial condition or liquidity.
In April 2009, the FASB issued FSP FAS 107-1 and
Accounting Principles Board (APB) 28-1, Interim
Disclosures about Fair Value of Financial Instruments,
codified in ASC section 825-10-65. ASC section 825-10-65
amends FAS 107, Disclosures about Fair Value of
Financial Instruments, codified in ASC subtopic 825-10, to require disclosures
about the fair value of financial instruments for interim
periods as well as in annual financial statements. ASC
section 825-10-65 is effective for interim and annual
periods ending after June 30, 2009. Effective July 1,
2009, we adopted ASC section 825-10-65.
In May 2009, the FASB issued FAS 165, Subsequent Events,
codified in ASC section 855-10-50. ASC section 855-10-50
establishes general standards of accounting for and
disclosure of events that occur after the balance sheet
date but before a company issues its financial statements
or such statements are available for issuance. ASC section
855-10-50 is effective for interim and annual periods
ending after June 15, 2009. Effective June 30, 2009, we adopted ASC section
855-10-50. We have evaluated subsequent events for
potential recognition or disclosure.
In June 2009, the FASB issued FAS 168, The FASB
Accounting Standards Codification and the Hierarchy of
Generally Accepted Accounting Principles a replacement
of FASB Statement No. 162,codified in ASC topic 105. On the
effective date of this Standard, ASC became the source of
authoritative U.S. accounting and reporting standards for
nongovernmental entities, in addition to guidance issued
by the SEC. ASC significantly changes the way financial
statement preparers, auditors and academic personnel
perform accounting research. This statement is effective
for financial statements issued for interim and annual
periods ending after September 15, 2009. The new standard
flattens the GAAP hierarchy to two levels: one that is
authoritative (in ASC) and one that is non-authoritative
(not in ASC). We began to use the new guidelines and
numbering system prescribed by the Codification referring
to GAAP in the third quarter of 2009. As the intent of
Codification was not to change or alter existing GAAP, the
adoption did not impact our financial position or results
of operations.
In June 2009, the FASB issued FAS 166, Accounting for
Transfers of Financial Assets, an Amendment of FASB
Statement No. 140,codified in ASC subtopic 860-20. FAS
166 amends the derecognition guidance in Statement 140
and eliminates the concept of qualifying special-purpose
entities. FAS 166 is effective for fiscal years and
interim periods beginning after November 15, 2009. We
adopted FAS 166 on January 1, 2010 but have not yet
determined the effect of its adoption on our consolidated
financial statements.
In June 2009, the FASB issued FAS 167, Amendments to FASB
Interpretation No. 46(R), which amends the consolidation
guidance applicable to variable interest entities (VIEs)
and is codified in ASC subtopic 810-10. An entity would
consolidate a VIE, as the primary beneficiary, when the
entity has both of the following characteristics: (a) the
power to direct the activities of a VIE that most
significantly impact the entitys economic performance and
(b) the obligation to absorb losses of the entity that
could potentially be significant to the VIE or the right
to receive benefits from the entity that could potentially
be significant to the VIE. FAS 167 requires ongoing
reassessment of whether an enterprise is the primary
beneficiary of a VIE. FAS 167 amends FASB Interpretation
No. 46(R) to eliminate the quantitative approach
previously required for determining the primary
beneficiary of a VIE. FAS 167 is effective for fiscal
years and interim periods beginning after November 15,
2009. We adopted FAS 167 on January 1, 2010 but have not
yet determined the effect of its adoption on our
consolidated financial statements.
In January 2010, the FASB issued Accounting Standards
Update (ASU) 2010-06, Improving Disclosures about Fair
Value Measurements. ASU 2010-06 provides amendments to
ASC subtopic 820-10 requiring new and clarifying existing
fair value disclosures. ASU 2010-06 is effective for
fiscal years beginning after December 15, 2010 and for
interim periods within those fiscal years. We will adopt
ASU 2010-06 on January 1, 2011 and have not yet determined
the effect of its adoption on our consolidated financial
statements.
16
Donegal Group Inc.
CONSOLIDATED BALANCE SHEETS
|
|
|
|
|
|
|
|
|
December 31, |
|
2009 |
|
2008 |
|
|
|
|
|
|
|
|
|
|
Assets |
|
|
|
|
|
|
|
|
Investments |
|
|
|
|
|
|
|
|
Fixed maturities |
|
|
|
|
|
|
|
|
Held to maturity, at amortized cost (fair value $77,005,740 and $101,449,024) |
|
$ |
73,807,126 |
|
|
$ |
99,878,156 |
|
Available for sale, at fair value (amortized cost $503,745,585 and $449,009,842) |
|
|
517,703,672 |
|
|
|
445,815,749 |
|
Equity securities, available for sale, at fair value (cost $3,804,064 and $2,939,236) |
|
|
9,914,626 |
|
|
|
5,894,975 |
|
Investments in affiliates |
|
|
9,309,347 |
|
|
|
8,594,177 |
|
Short-term investments, at cost, which approximates fair value |
|
|
56,100,415 |
|
|
|
71,952,469 |
|
|
Total investments |
|
|
666,835,186 |
|
|
|
632,135,526 |
|
Cash |
|
|
12,923,898 |
|
|
|
1,830,954 |
|
Accrued investment income |
|
|
6,202,710 |
|
|
|
6,655,506 |
|
Premiums receivable |
|
|
61,187,021 |
|
|
|
55,337,270 |
|
Reinsurance receivable |
|
|
84,670,009 |
|
|
|
79,952,971 |
|
Deferred policy acquisition costs |
|
|
32,844,179 |
|
|
|
29,541,281 |
|
Deferred tax asset, net |
|
|
5,086,949 |
|
|
|
10,994,644 |
|
Prepaid reinsurance premiums |
|
|
56,040,728 |
|
|
|
51,436,487 |
|
Property and equipment, net |
|
|
6,592,223 |
|
|
|
6,686,684 |
|
Accounts receivable securities |
|
|
588,292 |
|
|
|
862,790 |
|
Federal income taxes recoverable |
|
|
663,047 |
|
|
|
2,590,928 |
|
Other |
|
|
1,967,685 |
|
|
|
2,083,995 |
|
|
Total assets |
|
$ |
935,601,927 |
|
|
$ |
880,109,036 |
|
|
|
|
|
|
|
|
|
|
|
Liabilities and Stockholders Equity |
|
|
|
|
|
|
|
|
Liabilities |
|
|
|
|
|
|
|
|
Losses and loss expenses |
|
$ |
263,598,844 |
|
|
$ |
239,809,276 |
|
Unearned premiums |
|
|
241,821,419 |
|
|
|
229,013,929 |
|
Accrued expenses |
|
|
10,578,695 |
|
|
|
14,149,754 |
|
Reinsurance balances payable |
|
|
2,561,426 |
|
|
|
1,566,816 |
|
Cash dividends declared to stockholders |
|
|
2,798,378 |
|
|
|
2,602,104 |
|
Subordinated debentures |
|
|
15,465,000 |
|
|
|
15,465,000 |
|
Accounts payable securities |
|
|
6,828,873 |
|
|
|
1,820,574 |
|
Due to affiliate |
|
|
3,813,294 |
|
|
|
3,148,057 |
|
Drafts payable |
|
|
884,993 |
|
|
|
876,210 |
|
Due to Sheboygan policyholders |
|
|
316,927 |
|
|
|
6,843,454 |
|
Other |
|
|
1,428,379 |
|
|
|
1,229,997 |
|
|
Total liabilities |
|
|
550,096,228 |
|
|
|
516,525,171 |
|
|
|
|
|
|
|
|
|
|
|
Stockholders Equity |
|
|
|
|
|
|
|
|
Preferred stock, $1.00 par value, authorized 2,000,000 shares; none issued |
|
|
|
|
|
|
|
|
Class A common stock, $.01 par value, authorized 30,000,000 shares,
issued 20,569,930 and 20,494,764 shares and outstanding 19,917,331
and 19,869,065 shares |
|
|
205,700 |
|
|
|
204,948 |
|
Class B common stock, $.01 par value, authorized 10,000,000 shares,
issued 5,649,240 shares and outstanding 5,576,775 shares |
|
|
56,492 |
|
|
|
56,492 |
|
Additional paid-in capital |
|
|
164,585,214 |
|
|
|
163,136,938 |
|
Accumulated other comprehensive income |
|
|
15,007,044 |
|
|
|
1,713,836 |
|
Retained earnings |
|
|
214,755,495 |
|
|
|
207,182,253 |
|
Treasury stock, at cost |
|
|
(9,104,246 |
) |
|
|
(8,710,602 |
) |
|
Total stockholders equity |
|
|
385,505,699 |
|
|
|
363,583,865 |
|
|
Total liabilities and stockholders equity |
|
$ |
935,601,927 |
|
|
$ |
880,109,036 |
|
|
See accompanying notes to consolidated financial statements.
17
Donegal Group Inc.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, |
|
2009 |
|
2008 |
|
2007 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Statements of Income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues |
|
|
|
|
|
|
|
|
|
|
|
|
Net premiums earned (includes affiliated
reinsurance of $128,747,699, $130,067,404 and
$107,045,158 see footnote 3) |
|
$ |
355,025,477 |
|
|
$ |
346,575,266 |
|
|
$ |
310,071,534 |
|
Investment income, net of investment expenses |
|
|
20,630,583 |
|
|
|
22,755,784 |
|
|
|
22,785,252 |
|
Installment payment fees |
|
|
5,205,109 |
|
|
|
5,025,138 |
|
|
|
4,650,139 |
|
Lease income |
|
|
921,583 |
|
|
|
926,690 |
|
|
|
1,060,319 |
|
Net realized investment gains (losses) |
|
|
4,479,558 |
|
|
|
(2,970,716 |
) |
|
|
2,051,050 |
|
Other |
|
|
471,097 |
|
|
|
112,065 |
|
|
|
|
|
|
Total revenues |
|
|
386,733,407 |
|
|
|
372,424,227 |
|
|
|
340,618,294 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expenses |
|
|
|
|
|
|
|
|
|
|
|
|
Net losses and loss expenses (includes
affiliated reinsurance of $68,712,989,
$85,598,098 and $70,676,398 see footnote 3) |
|
|
250,835,396 |
|
|
|
224,300,964 |
|
|
|
177,783,632 |
|
Amortization of deferred policy acquisition costs |
|
|
60,292,000 |
|
|
|
58,250,000 |
|
|
|
51,205,000 |
|
Other underwriting expenses |
|
|
50,843,464 |
|
|
|
53,108,436 |
|
|
|
52,726,155 |
|
Policy dividends |
|
|
848,882 |
|
|
|
1,175,809 |
|
|
|
1,273,323 |
|
Interest |
|
|
1,746,509 |
|
|
|
1,821,229 |
|
|
|
2,884,861 |
|
Other |
|
|
1,490,467 |
|
|
|
1,675,745 |
|
|
|
1,896,385 |
|
|
Total expenses |
|
|
366,056,718 |
|
|
|
340,332,183 |
|
|
|
287,769,356 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income tax expense |
|
|
20,676,689 |
|
|
|
32,092,044 |
|
|
|
52,848,938 |
|
Income tax expense |
|
|
1,846,611 |
|
|
|
6,550,066 |
|
|
|
14,569,033 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
18,830,078 |
|
|
$ |
25,541,978 |
|
|
$ |
38,279,905 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic earnings per common share: |
|
|
|
|
|
|
|
|
|
|
|
|
Class A common stock |
|
$ |
0.76 |
|
|
$ |
1.03 |
|
|
$ |
1.55 |
|
Class B common stock |
|
$ |
0.68 |
|
|
$ |
0.92 |
|
|
$ |
1.39 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted earnings per common share: |
|
|
|
|
|
|
|
|
|
|
|
|
Class A common stock |
|
$ |
0.76 |
|
|
$ |
1.02 |
|
|
$ |
1.53 |
|
Class B common stock |
|
$ |
0.68 |
|
|
$ |
0.92 |
|
|
$ |
1.39 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Statements of Comprehensive Income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
18,830,078 |
|
|
$ |
25,541,978 |
|
|
$ |
38,279,905 |
|
|
Other comprehensive income (loss), net of tax |
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized gains (losses) on securities: |
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized holding gain (loss) arising during
the period, net of income tax (benefit) of
$8,680,941, ($3,872,368)and $1,748,072 |
|
|
16,249,716 |
|
|
|
(7,191,540 |
) |
|
|
3,246,420 |
|
Reclassification adjustment for (gains)
losses included in net income, net of income
tax (benefit) of $1,523,050, ($1,039,751)
and $717,867 |
|
|
(2,956,508 |
) |
|
|
1,930,965 |
|
|
|
(1,333,183 |
) |
|
Other comprehensive income (loss) |
|
|
13,293,208 |
|
|
|
(5,260,575 |
) |
|
|
1,913,237 |
|
|
Comprehensive income |
|
$ |
32,123,286 |
|
|
$ |
20,281,403 |
|
|
$ |
40,193,142 |
|
|
See accompanying notes to consolidated financial statements.
18
Donegal Group Inc.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated |
|
|
|
|
|
|
|
|
|
|
|
|
Common Stock |
|
Additional |
|
Other |
|
|
|
|
|
|
|
|
|
Total |
|
|
Class A |
|
Class B |
|
Class A |
|
Class B |
|
Paid-In |
|
Comprehensive |
|
Retained |
|
Treasury |
|
Stockholders |
|
|
Shares |
|
Shares |
|
Amount |
|
Amount |
|
Capital |
|
Income |
|
Earnings |
|
Stock |
|
Equity |
|
Balance, January 1, 2007 |
|
|
19,834,248 |
|
|
|
5,649,240 |
|
|
$ |
198,342 |
|
|
$ |
56,492 |
|
|
$ |
152,391,301 |
|
|
$ |
5,061,174 |
|
|
$ |
163,986,701 |
|
|
$ |
(891,748 |
) |
|
$ |
320,802,262 |
|
|
Issuance of common stock (stock compensation plans) |
|
|
333,751 |
|
|
|
|
|
|
|
3,338 |
|
|
|
|
|
|
|
3,539,241 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,542,579 |
|
Net income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
38,279,905 |
|
|
|
|
|
|
|
38,279,905 |
|
Cash dividends |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(8,394,572 |
) |
|
|
|
|
|
|
(8,394,572 |
) |
Grant of stock options |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
65,179 |
|
|
|
|
|
|
|
(65,179 |
) |
|
|
|
|
|
|
|
|
Tax benefit on exercise of stock options |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
854,945 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
854,945 |
|
Purchase of treasury stock |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(4,308,165 |
) |
|
|
(4,308,165 |
) |
Other comprehensive income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,913,237 |
|
|
|
|
|
|
|
|
|
|
|
1,913,237 |
|
|
Balance, December 31, 2007 |
|
|
20,167,999 |
|
|
|
5,649,240 |
|
|
$ |
201,680 |
|
|
$ |
56,492 |
|
|
$ |
156,850,666 |
|
|
$ |
6,974,411 |
|
|
$ |
193,806,855 |
|
|
$ |
(5,199,913 |
) |
|
$ |
352,690,191 |
|
|
Issuance of common stock
(stock compensation plans) |
|
|
326,765 |
|
|
|
|
|
|
|
3,268 |
|
|
|
|
|
|
|
3,853,328 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,856,596 |
|
Net income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
25,541,978 |
|
|
|
|
|
|
|
25,541,978 |
|
Cash dividends |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(10,417,517 |
) |
|
|
|
|
|
|
(10,417,517 |
) |
Grant of stock options |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,749,063 |
|
|
|
|
|
|
|
(1,749,063 |
) |
|
|
|
|
|
|
|
|
Tax benefit on exercise of stock options |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
683,881 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
683,881 |
|
Purchase of treasury stock |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(3,510,689 |
) |
|
|
(3,510,689 |
) |
Other comprehensive loss |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(5,260,575 |
) |
|
|
|
|
|
|
|
|
|
|
(5,260,575 |
) |
|
Balance, December 31, 2008 |
|
|
20,494,764 |
|
|
|
5,649,240 |
|
|
$ |
204,948 |
|
|
$ |
56,492 |
|
|
$ |
163,136,938 |
|
|
$ |
1,713,836 |
|
|
$ |
207,182,253 |
|
|
$ |
(8,710,602 |
) |
|
$ |
363,583,865 |
|
|
Issuance of common stock
(stock compensation plans) |
|
|
75,166 |
|
|
|
|
|
|
|
752 |
|
|
|
|
|
|
|
1,385,285 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,386,037 |
|
Net income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
18,830,078 |
|
|
|
|
|
|
|
18,830,078 |
|
Cash dividends |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(11,193,845 |
) |
|
|
|
|
|
|
(11,193,845 |
) |
Grant of stock options |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
62,991 |
|
|
|
|
|
|
|
(62,991 |
) |
|
|
|
|
|
|
|
|
Purchase of treasury stock |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(393,644 |
) |
|
|
(393,644 |
) |
Other comprehensive income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
13,293,208 |
|
|
|
|
|
|
|
|
|
|
|
13,293,208 |
|
|
Balance, December 31, 2009 |
|
|
20,569,930 |
|
|
|
5,649,240 |
|
|
$ |
205,700 |
|
|
$ |
56,492 |
|
|
$ |
164,585,214 |
|
|
$ |
15,007,044 |
|
|
$ |
214,755,495 |
|
|
$ |
(9,104,246 |
) |
|
$ |
385,505,699 |
|
|
See accompanying notes to consolidated financial statements.
19
Donegal Group Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, |
|
2009 |
|
|
2008 |
|
|
2007 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash Flows from Operating Activities: |
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
18,830,078 |
|
|
$ |
25,541,978 |
|
|
$ |
38,279,905 |
|
|
Adjustments to reconcile net income to net cash
provided by operating activities: |
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization |
|
|
2,552,186 |
|
|
|
2,401,345 |
|
|
|
2,446,126 |
|
Net realized investment (gains) losses |
|
|
(4,479,558 |
) |
|
|
2,970,716 |
|
|
|
(2,051,050 |
) |
Equity (income) loss |
|
|
(471,097 |
) |
|
|
(112,065 |
) |
|
|
182,502 |
|
Changes in Assets and Liabilities: |
|
|
|
|
|
|
|
|
|
|
|
|
Losses and loss expenses |
|
|
23,789,568 |
|
|
|
9,952,760 |
|
|
|
(32,590,057 |
) |
Unearned premiums |
|
|
12,807,490 |
|
|
|
22,477,395 |
|
|
|
6,527,588 |
|
Accrued expenses |
|
|
(3,571,059 |
) |
|
|
966,958 |
|
|
|
(440,584 |
) |
Premiums receivable |
|
|
(5,849,751 |
) |
|
|
(3,173,057 |
) |
|
|
(1,089,799 |
) |
Deferred policy acquisition costs |
|
|
(3,302,898 |
) |
|
|
(3,306,209 |
) |
|
|
(1,496,143 |
) |
Deferred income taxes |
|
|
(1,250,187 |
) |
|
|
(832,628 |
) |
|
|
1,029,042 |
|
Reinsurance receivable |
|
|
(4,717,038 |
) |
|
|
204,249 |
|
|
|
18,779,861 |
|
Accrued investment income |
|
|
452,796 |
|
|
|
(668,682 |
) |
|
|
(105,821 |
) |
Amounts due to/from affiliate |
|
|
665,237 |
|
|
|
2,906,139 |
|
|
|
(1,325,173 |
) |
Reinsurance balances payable |
|
|
994,610 |
|
|
|
(636,074 |
) |
|
|
70,529 |
|
Prepaid reinsurance premiums |
|
|
(4,604,241 |
) |
|
|
(4,111,609 |
) |
|
|
(2,909,383 |
) |
Current income taxes |
|
|
1,927,881 |
|
|
|
(2,618,163 |
) |
|
|
1,374,521 |
|
Other, net |
|
|
323,491 |
|
|
|
898,872 |
|
|
|
152,805 |
|
|
Net adjustments |
|
|
15,267,430 |
|
|
|
27,319,947 |
|
|
|
(11,445,036 |
) |
|
Net cash provided by operating activities |
|
|
34,097,508 |
|
|
|
52,861,925 |
|
|
|
26,834,869 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash Flows from Investing Activities: |
|
|
|
|
|
|
|
|
|
|
|
|
Purchase of fixed maturities |
|
|
|
|
|
|
|
|
|
|
|
|
Available for sale |
|
|
(158,409,231 |
) |
|
|
(204,882,809 |
) |
|
|
(43,360,830 |
) |
Purchase of equity securities |
|
|
(39,163,607 |
) |
|
|
(45,091,418 |
) |
|
|
(29,316,342 |
) |
Sale of fixed maturities |
|
|
|
|
|
|
|
|
|
|
|
|
Available for sale |
|
|
62,668,210 |
|
|
|
28,971,515 |
|
|
|
|
|
Maturity of fixed maturities |
|
|
|
|
|
|
|
|
|
|
|
|
Held to maturity |
|
|
25,617,925 |
|
|
|
53,830,674 |
|
|
|
14,222,283 |
|
Available for sale |
|
|
48,363,915 |
|
|
|
69,699,141 |
|
|
|
40,206,090 |
|
Sale of equity securities |
|
|
39,638,895 |
|
|
|
71,177,458 |
|
|
|
30,160,998 |
|
Payments to Sheboygan policyholders |
|
|
(6,526,527 |
) |
|
|
(3,352,938 |
) |
|
|
|
|
Net (increase) decrease in investment in affiliates |
|
|
(100,000 |
) |
|
|
464,000 |
|
|
|
(50,000 |
) |
Net purchase of property and equipment |
|
|
(941,020 |
) |
|
|
(1,222,246 |
) |
|
|
(1,363,622 |
) |
Net sales (purchases) of short-term investments |
|
|
15,852,054 |
|
|
|
(453,790 |
) |
|
|
(25,037,964 |
) |
|
Net cash used in investing activities |
|
|
(12,999,386 |
) |
|
|
(30,860,413 |
) |
|
|
(14,539,387 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash Flows from Financing Activities: |
|
|
|
|
|
|
|
|
|
|
|
|
Issuance of common stock |
|
|
1,386,037 |
|
|
|
3,856,596 |
|
|
|
3,542,579 |
|
Redemption of subordinated debentures |
|
|
|
|
|
|
(15,464,000 |
) |
|
|
|
|
Cash dividends paid |
|
|
(10,997,571 |
) |
|
|
(10,025,711 |
) |
|
|
(8,627,232 |
) |
Purchase of treasury stock |
|
|
(393,644 |
) |
|
|
(3,510,689 |
) |
|
|
(4,308,165 |
) |
Tax benefit on exercise of stock options |
|
|
|
|
|
|
683,881 |
|
|
|
854,945 |
|
|
Net cash used in financing activities |
|
|
(10,005,178 |
) |
|
|
(24,459,923 |
) |
|
|
(8,537,873 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net increase (decrease) in cash |
|
|
11,092,944 |
|
|
|
(2,458,411 |
) |
|
|
3,757,609 |
|
Cash at beginning of year |
|
|
1,830,954 |
|
|
|
4,289,365 |
|
|
|
531,756 |
|
|
Cash at end of year |
|
$ |
12,923,898 |
|
|
$ |
1,830,954 |
|
|
$ |
4,289,365 |
|
|
See accompanying notes to consolidated financial statements.
20
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1 Summary of Significant Accounting Policies
Organization and Business
Donegal Mutual Insurance Company (Donegal Mutual)
organized us as an insurance holding company on August 26,
1986. Our insurance subsidiaries, Atlantic States
Insurance Company (Atlantic States), Southern Insurance
Company of Virginia (Southern), Le Mars Insurance
Company (Le Mars), the Peninsula Insurance Group
(Peninsula), which consists of Peninsula Indemnity
Company and The Peninsula Insurance Company, and Sheboygan
Falls Insurance Company (Sheboygan), write personal and
commercial lines of property and casualty coverages
exclusively through a network of independent insurance
agents in certain Mid-Atlantic, Midwest and Southern
states. We acquired Sheboygan on December 1, 2008, and
Sheboygans results of operations have been included in
our consolidated results from that date. We have three
operating segments, which consist of our investment
function, our personal lines function and our commercial
lines function. 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.
At December 31, 2009, Donegal Mutual owned approximately
42% of our outstanding Class A common stock and
approximately 75% of our outstanding Class B common
stock. Our insurance subsidiaries and Donegal Mutual have
interrelated operations. 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.
Atlantic States, our largest subsidiary, participates in
a pooling agreement with Donegal Mutual. Under the
pooling agreement, Donegal Mutual and Atlantic States
pool substantially all of their insurance business.
Donegal Mutual then cedes 80% of the pooled business to
Atlantic States. From July 1, 2000 through February 29,
2008, Atlantic States had a 70% share of the results of
the pool, and Donegal Mutual had a 30% share of the
results of the pool. Effective March 1, 2008, Donegal
Mutual and Atlantic States amended the pooling agreement
to increase Atlantic States share of the pooled business
to 80%.
The risk profiles of the business Atlantic States and
Donegal Mutual write have historically been, and continue
to be, substantially similar. The same executive
management and underwriting personnel administer
products, classes of business underwritten, pricing
practices and underwriting standards of Donegal Mutual
and our insurance subsidiaries.
In addition, as the Donegal Insurance Group, Donegal
Mutual and our insurance subsidiaries share a combined
business plan to achieve market penetration and underwriting
profitability objectives. The products our insurance
subsidiaries and Donegal Mutual market are generally
complementary, thereby allowing the Donegal Insurance
Group to offer a broader range of products to a given
market and to expand the Donegal Insurance Groups ability
to service an entire personal lines or commercial lines
account. Distinctions within the products of Donegal
Mutual and our insurance subsidiaries generally relate to
specific risk profiles targeted within similar classes of
business, such as preferred tier versus standard tier
products, but we and Donegal Mutual do not allocate all of
the standard risk gradients to one company. Therefore, the
underwriting profitability of the business written
directly by the individual companies will vary.
However, since the underwriting pool homogenizes the risk
characteristics of all business written directly by
Donegal Mutual and Atlantic States, Donegal Mutual and
Atlantic States share the underwriting results in
proportion to their respective participation in the
pool. Pooled business represents the predominant
percentage of the net underwriting activity of both
Donegal Mutual and Atlantic States. See Note 3
Transactions with Affiliates for more information
regarding the pooling agreement.
In October 2009, Donegal Mutual consummated an affiliation
with Southern Mutual Insurance Company (Southern
Mutual), pursuant to which Donegal Mutual purchased a
surplus note of Southern Mutual in the principal amount of
$2.5 million, Donegal Mutual designees became a majority
of the members of Southern Mutuals board of directors,
and Donegal Mutual agreed to provide quota share
reinsurance to Southern Mutual for 100% of its business.
Effective October 31, 2009, Donegal Mutual began to
include business assumed from Southern Mutual in its
pooling agreement with Atlantic States. Southern Mutual
writes primarily personal lines of insurance in Georgia
and South Carolina and had direct premiums written of
approximately $13.3 million in 2009. Pursuant to
applicable accounting standards, Southern Mutual is a
variable interest entity, of which we are not the primary
beneficiary.
We also own 48.2% of the outstanding stock of Donegal
Financial Services Corporation (DFSC), a thrift holding
company that owns Province Bank FSB. Donegal Mutual owns
the remaining 51.8% of the outstanding stock of DFSC.
Basis of Consolidation
Our consolidated financial statements, which have been
prepared in accordance with accounting principles
generally accepted in the United States of America,
include our accounts and those of our wholly owned
subsidiaries. We have eliminated all significant
inter-company accounts and transactions in
consolidation. The terms we, us, our or the
Company as used herein refer to the consolidated
entity.
Use of Estimates
In preparing our consolidated financial statements, our
management makes estimates and assumptions that affect the
reported amounts of assets and liabilities as of the date
of the balance sheet and revenues and expenses for the
period. Actual results could differ significantly from
those estimates.
We make estimates and assumptions that can have a
significant effect on amounts and disclosures we report
in our consolidated financial statements. The most
significant estimates relate to our insurance
subsidiaries reserves for property and casualty
insurance unpaid losses and loss expenses, valuation of
investments and determination of other-than-temporary
impairment and our insurance subsidiaries policy
acquisition costs. While we believe our estimates and the
estimates of our insurance subsidiaries are appropriate,
the ultimate amounts may differ from the estimates
provided. We regularly review the methods for making
these estimates, and reflect any adjustment considered
necessary in our current results of operations.
Reclassification
We have reclassified certain amounts in 2009 as reported in our
Consolidated Statements of Income and Consolidated
Statements of Cash Flows to conform to the current year
presentation.
Investments
We classify our debt and equity securities into the following categories:
Held to MaturityDebt securities that we have the
positive intent and ability to hold to maturity;
reported at amortized cost.
21
Available for SaleDebt and equity securities not
classified as held to maturity; reported at fair value,
with unrealized gains and losses excluded from income
and reported as a separate component of stockholders
equity (net of tax effects).
Short-term investments are carried at amortized
cost, which approximates fair value.
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 write down the investment to its fair
value, and we reflect the amount of the write-down as a
realized loss in our results of operations when we
consider the decline in value of an individual investment
to be other than temporary. We individually monitor all
investments for other-than-temporary declines in value.
Generally, we assume there has been an
other-than-temporary decline in value if an individual
equity security has depreciated in value by more than 20%
of original cost and has been in such an unrealized loss
position for more than six months. As of April 1, 2009, we
adopted new accounting guidance related to the accounting
for and presentation of impairment losses on debt
securities as discussed in Note 2 Impact of New
Accounting Standards. 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 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.
We amortize premiums and discounts on debt securities
over the life of the security as an adjustment to yield
using the effective interest method. We compute realized
investment gains and losses using the specific
identification method.
We amortize premiums and discounts for mortgage-backed
debt securities using anticipated prepayments.
We account for investments in affiliates using the equity
method of accounting. Under the equity method, we record
our investment at cost, with adjustments for our share of
the affiliates earnings and losses as well as changes in
the affiliates equity due to unrealized gains and losses.
Fair Values of Financial Instruments
We have used the following methods and assumptions in
estimating our fair value disclosures:
InvestmentsWe present our investments in
available-for-sale fixed maturity and equity securities
at estimated fair value. The estimated fair value of a
security may differ from the amount that could be
realized if the security were sold 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
for substantially all of our fixed maturity and
equity investments. We generally obtain one price 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 using proprietary pricing
applications, which include available relevant market
information, benchmark yields, sector curves and
matrix pricing. The pricing services do not use
broker quotes in determining the fair values of our
investments. We review the estimates of fair value
provided by the pricing services to determine if the
estimates obtained are representative of fair values
based upon our general knowledge of the market, our
research findings related to unusual fluctuations in
value and our comparison of such values to execution
prices for similar securities. See Note 6 Fair
Value Measurements for more information regarding our methods and assumptions in estimating
fair values.
Cash and Short-Term InvestmentsThe carrying amounts
reported in the balance sheet for these instruments
approximate their fair values.
Premium and Reinsurance Receivables and PayablesThe
carrying amounts reported in the balance sheet for
these instruments approximate their fair values.
Subordinated DebenturesThe carrying amounts reported
in the balance sheet for these instruments approximate
their fair values due to their variable rate nature.
Revenue Recognition
Our insurance subsidiaries recognize insurance premiums
as income over the terms of the policies they issue. Our
insurance subsidiaries calculate unearned premiums on a
daily pro-rata basis.
Policy Acquisition Costs
We defer our insurance subsidiaries policy acquisition
costs, consisting primarily of commissions, premium taxes
and certain other underwriting costs that vary with and
are directly related to the production of business, and
amortize those costs over the period in which our
insurance subsidiaries earn the premiums. The method we
follow in computing deferred policy acquisition costs
limits the amount of such deferred costs to their
estimated realizable value, which gives effect to the
premium to be earned, related investment income, losses
and loss expenses and certain other costs we expect to
incur as our insurance subsidiaries earn the premium.
Estimates in the calculation of policy acquisition costs
have not shown material variability because of
uncertainties in applying accounting principles or as a
result of sensitivities to changes in key assumptions.
Property and Equipment
We report property and equipment at depreciated cost
that we compute using the straight-line method based
upon estimated useful lives of the assets.
Losses and Loss Expenses
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 policyholder claims based on facts and
circumstances then known. An insurer recognizes at the
time of establishing its estimates that its ultimate
liability for losses and loss expenses will exceed or be
less than such estimates. We base our insurance
subsidiaries estimates of liabilities for losses and loss
expenses on assumptions as to future loss trends and
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 of liability. We reflect
any adjustments to our insurance subsidiaries liabilities
for losses and loss expenses in our operating results in
the period in which we make the changes in estimates.
22
Our insurance subsidiaries maintain liabilities for the
payment of losses and loss expenses with respect to both
reported and unreported claims. Our insurance subsidiaries establish
these liabilities for the purpose of covering the ultimate
costs of settling all losses, including investigation and
litigation costs. Our insurance subsidiaries base the
amount of liability for reported losses primarily upon a
case-by-case evaluation of the type of risk involved,
knowledge of the circumstances surrounding each claim and
the insurance policy provisions relating to the type of
loss. Our insurance subsidiaries determine the amount of
their liability for unreported claims and loss expenses on
the basis of historical information by line of insurance.
Our insurance subsidiaries account for inflation in the
reserving function through analysis of costs and trends
and reviews of historical reserving results. Our insurance
subsidiaries closely monitor their liabilities and
recompute them periodically using new information on
reported claims and a variety of statistical techniques.
Our insurance subsidiaries do not discount their
liabilities for losses.
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 as to our insurance
subsidiaries internal operations. For example, our
insurance subsidiaries have experienced a decrease in
claims frequency on workers compensation claims during
the past several years while claims severity has
gradually increased. These trend changes give rise to
greater uncertainty as to the pattern of future loss
settlements on workers compensation claims.
Related uncertainties regarding future trends include the
cost of medical technologies and procedures and changes in
the utilization of medical procedures. Assumptions related
to our insurance subsidiaries external environment
include the absence of significant changes in tort law and
the legal environment that increase liability exposure,
consistency in judicial interpretations of insurance
coverage and policy provisions and the rate of loss cost
inflation. Internal assumptions include consistency in the
recording of premium and loss statistics, consistency in
the recording of claims, payment and case reserving
methodology, accurate measurement of the impact of rate
changes and changes in policy provisions, consistency in
the quality and characteristics of business written within
a given line of business and consistency in reinsurance
coverage and collectibility of reinsured losses, among
other items. To the extent our insurance subsidiaries
determine that underlying factors impacting their
assumptions have changed, our insurance subsidiaries
attempt to make appropriate adjustments for such changes
in their reserves. Accordingly, our insurance
subsidiaries ultimate liability for unpaid losses and
loss expenses will likely differ from the amount recorded.
Our insurance subsidiaries seek to enhance their
underwriting results by carefully selecting the product
lines they underwrite. Our insurance subsidiaries
personal lines products include standard and preferred
risks in private passenger automobile and homeowners
lines. Our insurance subsidiaries commercial lines
products primarily include mercantile risks, business
offices, wholesalers, service providers and artisan
risks, avoiding industrial and manufacturing exposures.
Our insurance subsidiaries have limited exposure to
asbestos and other environmental liabilities. Our
insurance subsidiaries write no medical malpractice or
other professional liability risks.
Income Taxes
We currently file a consolidated federal income tax return.
We account for income taxes using the asset and liability
method. The objective of the asset and liability method is
to establish deferred tax assets and liabilities for the
temporary differences between the financial reporting
basis and the tax basis of our assets and liabilities at
enacted tax rates expected to be in effect when we realize
or settle such amounts.
Credit Risk
Our objective is to earn competitive returns by investing
in a diversified portfolio of securities. Our portfolio
of fixed maturity securities and, to a lesser extent,
short-term investments is subject to credit risk. We
define this risk as the potential loss in fair value
resulting from adverse changes in the borrowers ability
to repay the debt. We manage this risk by performing an
analysis of prospective investments and through regular
reviews of our portfolio by our investment staff. We also
limit the amount of our total investment portfolio that
we invest in any one security.
Our insurance subsidiaries provide property and liability
coverages through independent agency systems located
throughout their operating areas. Our insurance
subsidiaries bill the majority of this business directly
to the insured, although they bill a portion of their
commercial business through their agents, to whom they
extend credit in the normal course of business.
Our insurance subsidiaries have reinsurance agreements
with Donegal Mutual and with a number of other authorized
reinsurers with at least an A.M. Best rating of A- or an
equivalent financial condition.
Reinsurance Accounting and Reporting
Our insurance subsidiaries rely upon reinsurance
agreements to limit their maximum net loss from large
single risks or risks in concentrated areas and to
increase their capacity to write insurance. Reinsurance
does not relieve our insurance subsidiaries from liability
to their respective policyholders. To the extent that a
reinsurer cannot pay losses for which it is liable under
the terms of a reinsurance agreement, our insurance
subsidiaries retain continued liability for such losses.
However, in an effort to reduce the risk of non-payment,
our insurance subsidiaries require all of their reinsurers
to have an A.M. Best rating of A- or better or, with
respect to foreign reinsurers, to have a financial
condition that, in the opinion of management, is
equivalent to a company with at least an A- rating from
A.M. Best. See Note 11 Reinsurance for more information
regarding our reinsurance agreements.
Stock-Based Compensation
We measure all share-based payments to employees,
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 granted to directors and
employees of our subsidiaries and affiliates other than
Donegal Mutual, 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.
We classified tax benefits realized upon the exercise of stock options of
$0, $683,881 and $854,945 for the years ended December 31,
2009, 2008 and 2007, respectively, as financing activities
in our consolidated statements of cash flows.
Earnings per Share
We calculate basic earnings per share by dividing net
income by the weighted-average number of common shares
outstanding for the period. Diluted earnings per share
reflects the dilution that could occur if securities or
other contracts to issue common stock were exercised or
converted into common stock.
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 cash dividends that are at
least 10% higher than those declared and paid 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
23
share separately for each class of common stock based
on dividends declared and an allocation of remaining
undistributed earnings using a participation percentage
reflecting the dividend rights of each class.
2 Impact of New Accounting Standards
In April 2009, the Financial Accounting Standards Board
(FASB) issued FASB Staff Position (FSP) FAS 115-2 and
Financial Accounting Standard (FAS) 124-2, Recognition
and Presentation of Other-Than-Temporary Impairments,
codified in FASB Accounting Standards Codification (ASC)
section 320-10-65. ASC section 320-10-65 provides
guidance designed to create greater clarity and
consistency in accounting for and presenting impairment
losses on debt securities. ASC section 320-10-65 is
effective for interim and annual periods ending after
June 15, 2009. Effective April 1, 2009, we adopted ASC section 320-10-65. We had no
cumulative effect adjustment because we had no debt
securities determined previously to be
other-than-temporarily impaired. Beginning on April 1,
2009, we analyzed our debt securities for
other-than-temporary impairment adjustments using the
guidance in ASC section 320-10-65.
In April 2009, the FASB issued FSP FAS 157-4,
Determining Fair Value When the Volume and Level of
Activity for the Asset or Liability Have Significantly
Decreased and Identifying Transactions That Are Not
Orderly, codified in ASC section 820-10-35. ASC section
820-10-35 provides guidelines for making fair value
measurements that are more consistent with the principles
presented in FAS 157, Fair Value Measurements, codified
in ASC subtopic 820-10. ASC section 820-10-35 is
effective for interim and annual periods ending after
June 15, 2009. Effective April 1, 2009, we adopted ASC
section 820-10-35. The adoption of ASC section 820-10-35
expanded certain fair value disclosures in our financial
statements but had no effect on our results of
operations, financial condition or liquidity.
In April 2009, the FASB issued FSP FAS 107-1 and
Accounting Principles Board (APB) 28-1, Interim
Disclosures about Fair Value of Financial Instruments,
codified in ASC section 825-10-65. ASC section 825-10-65 amends FAS 107, Disclosures
about Fair Value of Financial Instruments, codified in
ASC subtopic 825-10, to require disclosures about fair
value of financial instruments for interim periods as
well as in annual financial statements. ASC section
825-10-65 is effective for interim and annual periods
ending after June 30, 2009. Effective July 1, 2009, we
adopted ASC section 825-10-65.
In May 2009, the FASB issued FAS 165, Subsequent Events,
codified in ASC section 855-10-50. ASC section 855-10-50
establishes general standards of accounting for and
disclosure of events that occur after the balance sheet
date but before financial statements are issued or are
available to be issued. ASC section 855-10-50 is effective
for interim and annual periods ending after June 15, 2009.
Effective June 30, 2009, we adopted ASC section 855-10-50.
We have evaluated subsequent events for potential
recognition or disclosure.
In June 2009, the FASB issued FAS 168, The FASB
Accounting Standards Codification and the Hierarchy of
Generally Accepted Accounting Principles a replacement
of FASB Statement No. 162, codified in ASC topic 105. On
the effective date of this Standard, ASC became the source
of authoritative U.S. accounting and reporting standards
for nongovernmental entities, in addition to guidance
issued by the SEC. ASC significantly changes the way
financial statement preparers, auditors and academic
personnel perform accounting research. This statement is
effective for financial statements issued for interim and
annual periods ending after September 15, 2009. The new
standard flattens the GAAP hierarchy to two levels: one
that is authoritative (in ASC) and one that is
non-authoritative (not in ASC). We began to use the new
guidelines and numbering system prescribed by the Codification referring
to GAAP in the third quarter of 2009. As the intent of
Codification was not to change or alter existing GAAP,
the adoption did not impact our financial position or
results of operations.
In June 2009, the FASB issued FAS 166, Accounting for
Transfers of Financial Assets, an Amendment of FASB
Statement No. 140, codified in ASC subtopic 860-20. FAS
166 amends the derecognition guidance in Statement 140 and
eliminates the concept of qualifying special-purpose
entities (QSPEs). FAS 166 is effective for fiscal years
and interim periods beginning after November 15, 2009. We
adopted FAS 166 on January 1, 2010 but have not yet
determined the effect of its adoption on our consolidated
financial statements.
In June 2009, the FASB issued FAS 167, Amendments to FASB
Interpretation No. 46(R), which amends the consolidation
guidance applicable to variable interest entities (VIEs)
and is codified in ASC subtopic 810-10. An entity would
consolidate a VIE, as the primary beneficiary, when the
entity has both of the following characteristics: (a) the
power to direct the activities of a VIE that most
significantly impact the entitys economic performance and
(b) the obligation to absorb losses of the entity that
could potentially be significant to the VIE or the right
to receive benefits from the entity that could potentially
be significant to the VIE. FAS 167 requires ongoing
reassessment of whether an enterprise is the primary
beneficiary of a VIE. FAS 167 amends FASB Interpretation
No. 46(R) to eliminate the quantitative approach
previously required for determining the primary
beneficiary of a VIE. FAS 167 is effective for fiscal years and interim periods beginning after November 15,
2009. We adopted FAS 167 on January 1, 2010 but have not
yet determined the effect of its adoption on our
consolidated financial statements.
In January 2010, the FASB issued Accounting Standards
Update (ASU) 2010-06, Improving Disclosures about Fair
Value Measurements. ASU 2010-06 provides amendments to
ASC subtopic 820-10 requiring new and clarifying existing
fair value disclosures. ASU 2010-06 is effective for
fiscal years beginning after December 15, 2010 and for
interim periods within those fiscal years. We will adopt
ASU 2010-06 on January 1, 2011 and have not yet determined
the effect of its adoption on our consolidated financial
statements.
3 Transactions with Affiliates
Our insurance subsidiaries conduct business and have
various agreements with Donegal Mutual that are described
below:
a. Reinsurance Pooling and Other Reinsurance Arrangements
Atlantic States, our largest subsidiary, and Donegal
Mutual have a pooling agreement under which both companies
pool substantially all of their respective premiums,
losses and loss expenses and receive an allocated
percentage of their combined underwriting results. From
July 1, 2000 through February 29, 2008, Atlantic States
had a 70% share of the results of the pool, and Donegal
Mutual had a 30% share of the results of the pool.
Effective March 1, 2008, Donegal Mutual and Atlantic
States amended the pooling agreement to increase Atlantic
Statess share of the results of the pool to 80%. The
intent of the pooling agreement is to produce more uniform
and stable underwriting results from year to year for each
pool participant than they would experience individually
and to spread the risk of loss between the participants
based on each participants relative amount of surplus and
relative access to capital. Each participant in the pool
has at its disposal the capacity of the entire pool,
rather than being limited to policy exposures of a size
commensurate with its own capital and surplus.
24
The following amounts represent reinsurance Atlantic
States ceded to the pool during 2009, 2008 and 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2009 |
|
2008 |
|
2007 |
|
Premiums earned |
|
$ |
96,502,445 |
|
|
$ |
93,336,444 |
|
|
$ |
86,026,309 |
|
|
Losses and loss expenses |
|
$ |
68,248,082 |
|
|
$ |
54,407,168 |
|
|
$ |
42,017,980 |
|
|
Prepaid reinsurance
premiums |
|
$ |
52,199,831 |
|
|
$ |
48,448,624 |
|
|
$ |
45,275,947 |
|
|
Liability for losses and
loss expenses |
|
$ |
55,396,390 |
|
|
$ |
45,777,168 |
|
|
$ |
46,226,796 |
|
|
The following amounts represent reinsurance Atlantic
States assumed from the pool during 2009, 2008 and 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2009 |
|
2008 |
|
2007 |
|
Premiums earned |
|
$ |
223,223,583 |
|
|
$ |
220,641,805 |
|
|
$ |
193,690,192 |
|
|
Losses and loss expenses |
|
$ |
138,058,878 |
|
|
$ |
140,969,892 |
|
|
$ |
109,118,227 |
|
|
Unearned premiums |
|
$ |
117,044,000 |
|
|
$ |
110,064,380 |
|
|
$ |
95,691,236 |
|
|
Liability for losses and
loss expenses |
|
$ |
131,247,578 |
|
|
$ |
121,366,321 |
|
|
$ |
113,458,587 |
|
|
Donegal Mutual and Southern have a quota-share reinsurance
agreement whereby Southern assumes 100% of the premiums
and losses related to personal lines products Donegal
Mutual offers in Virginia through the use of its automated
policy quoting and issuance system. Donegal Mutual and Le
Mars have a quota-share reinsurance agreement whereby Le
Mars assumes 100% of the premiums and losses related to
certain products offered in certain Midwest states by
Donegal Mutual, which provide the availability of
complementary products to Le Mars commercial accounts.
The following amounts represent reinsurance Southern and
Le Mars assumed from Donegal Mutual pursuant to the
quota-share reinsurance agreements during 2009, 2008 and
2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2009 |
|
2008 |
|
2007 |
|
Premiums earned |
|
$ |
12,856,983 |
|
|
$ |
9,690,726 |
|
|
$ |
5,378,608 |
|
|
Losses and loss expenses |
|
$ |
10,987,391 |
|
|
$ |
7,612,090 |
|
|
$ |
3,797,947 |
|
|
Unearned premiums |
|
$ |
6,998,285 |
|
|
$ |
6,064,734 |
|
|
$ |
4,101,974 |
|
|
Liability for losses and
loss expenses |
|
$ |
4,868,486 |
|
|
$ |
2,672,698 |
|
|
$ |
1,152,041 |
|
|
Donegal Mutual and Peninsula have a quota-share
reinsurance agreement whereby Donegal Mutual assumes 100%
of the premiums and losses related to the workers
compensation product line of Peninsula in certain states.
Prior to January 1, 2002, Donegal Mutual and Southern had
a quota-share agreement whereby Southern ceded 50% of its
direct business, less reinsurance, to Donegal Mutual. The
business assumed by Donegal Mutual becomes part of the
pooling agreement between Donegal Mutual and Atlantic
States. The following amounts represent reinsurance ceded
to Donegal Mutual pursuant to the quota-share reinsurance
agreements during 2009, 2008 and 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2009 |
|
2008 |
|
2007 |
|
Premiums earned |
|
$ |
2,515,075 |
|
|
$ |
880,017 |
|
|
$ |
457,074 |
|
|
Losses and loss expenses |
|
$ |
2,342,895 |
|
|
$ |
697,929 |
|
|
$ |
(165,655 |
) |
|
Prepaid reinsurance
premiums |
|
$ |
1,855,076 |
|
|
$ |
889,993 |
|
|
$ |
60,961 |
|
|
Liability for losses and
loss expenses |
|
$ |
1,980,626 |
|
|
$ |
679,718 |
|
|
$ |
836,031 |
|
|
Atlantic States, Southern and Le Mars each have a
catastrophe reinsurance agreement with Donegal Mutual that
limits the maximum liability under any one catastrophic
occurrence to $1,000,000, $750,000 and $500,000,
respectively, with a combined limit of $1,800,000 for a
catastrophe involving a combination of these subsidiaries.
Donegal Mutual and Southern have an excess of loss
reinsurance agreement in which Donegal Mutual assumes up
to $350,000 ($300,000 in 2008 and $150,000 in 2007) of
losses in excess of $400,000 ($300,000 in 2008 and
$250,000 in 2007). Donegal Mutual and Sheboygan had an
excess of loss reinsurance agreement during 2009 in which
Donegal Mutual assumed up to $50,000 of losses in excess
of $150,000. The following amounts represent reinsurance
ceded to Donegal Mutual pursuant to these reinsurance
agreements during 2009, 2008 and 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2009 |
|
2008 |
|
2007 |
|
Premiums earned |
|
$ |
8,315,347 |
|
|
$ |
5,508,666 |
|
|
$ |
5,540,259 |
|
|
Losses and loss expenses |
|
$ |
9,742,303 |
|
|
$ |
7,878,787 |
|
|
$ |
387,451 |
|
|
Liability for losses and
loss expenses |
|
$ |
3,268,129 |
|
|
$ |
5,456,611 |
|
|
$ |
3,171,245 |
|
|
The following amounts represent the effect of
affiliated reinsurance transactions on net premiums our
insurance subsidiaries earned during 2009, 2008 and
2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2009 |
|
2008 |
|
2007 |
|
Assumed |
|
$ |
236,080,566 |
|
|
$ |
230,332,531 |
|
|
$ |
199,068,800 |
|
Ceded |
|
|
(107,332,867 |
) |
|
|
(99,725,127 |
) |
|
|
(92,023,642 |
) |
|
Net |
|
$ |
128,747,699 |
|
|
$ |
130,607,404 |
|
|
$ |
107,045,158 |
|
|
The following amounts represent the effect of
affiliated reinsurance transactions on net losses and
loss expenses our insurance subsidiaries incurred
during 2009, 2008 and 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2009 |
|
2008 |
|
2007 |
|
Assumed |
|
$ |
149,046,269 |
|
|
$ |
148,581,982 |
|
|
$ |
112,916,174 |
|
Ceded |
|
|
(80,333,280 |
) |
|
|
(62,983,884 |
) |
|
|
(42,239,776 |
) |
|
Net |
|
$ |
68,712,989 |
|
|
$ |
85,598,098 |
|
|
$ |
70,676,398 |
|
|
b. Expense Sharing
Donegal Mutual provides facilities, management and other
services to us and our insurance subsidiaries. Donegal
Mutual allocates certain related expenses to Atlantic
States in relation to the relative participation of
Atlantic States and Donegal Mutual in the pooling
agreement. Our insurance subsidiaries other than Atlantic
States reimburse Donegal Mutual for their personnel costs
and bear their proportionate share of information services
costs based on their percentage of total written premiums
of the Donegal Insurance Group. Charges for these services
totalled $60,175,789, $56,819,869 and $52,268,253 for
2009, 2008 and 2007, respectively.
c. Lease Agreement
We lease office equipment and automobiles with terms
ranging from 3 to 10 years to Donegal Mutual under a
10-year lease agreement dated January 1, 2000.
d. Legal Services
Donald H. Nikolaus, our President and one of our
directors, is a partner in the law firm of Nikolaus &
Hohenadel. Such firm has served as our general counsel since 1986, principally in
connection with the defense of claims litigation arising
in Lancaster, Dauphin and York counties of Pennsylvania.
We pay such firm its customary fees for such services.
e. Province Bank
As of December 31, 2009 and 2008, we had $10,163,195 and
$2,063,569, respectively, in checking accounts with
Province Bank, a wholly owned subsidiary of DFSC. We
earned $3,260, $133,251 and $210,654 in interest on these
accounts during 2009, 2008 and 2007, respectively.
25
4 Business Combinations
During 2008, we acquired all of the outstanding stock of
Sheboygan. We accounted for this acquisition as a
business combination.
In December 2006, Donegal Mutual consummated an
affiliation with Sheboygan. As part of the affiliation,
Donegal Mutual entered into a management agreement with
and purchased a $3.5 million surplus note issued by
Sheboygan. During 2007, Sheboygans board of directors
adopted a plan of conversion to convert to a stock
insurance company. Following policyholder and regulatory
approval of the plan of conversion, we acquired all of
the outstanding stock of Sheboygan as of December 1, 2008
for approximately $12.0 million in cash, including
payment of the principal amount of the surplus note ($3.5
million) and accrued interest ($32,171) to Donegal Mutual. The payment also included a
surplus contribution ($8.5 million) to Sheboygan to
support future premium growth. Sheboygans results of
operations have been included in our consolidated results
from December 1, 2008. At December 31, 2009 and 2008,
Sheboygan had amounts due to policyholders pursuant to
the plan of conversion of $316,927 and $6.8 million,
respectively.
The acquisition of Sheboygan enabled us to extend our
insurance business to Wisconsin. Sheboygan, organized
under the laws of Wisconsin in 1899, operates as a
property and casualty insurer in Wisconsin. Personal lines
coverages represent a majority of Sheboygans premiums
written, with the balance coming from farmowners and
mercantile and service businesses. Sheboygans largest
lines of business are homeowners, private passenger
automobile liability and physical damage. For the years
ended December 31, 2008 and 2007, Sheboygan had net
premiums earned of $7.9 million and $7.7 million,
respectively. For the years ended December 31, 2008 and
2007, Sheboygan had a statutory net (loss) income of
($1.1) million, and $632,202, respectively. Sheboygans
total admitted assets on a statutory basis as of December
31, 2008 and 2007 were $25.7 million and $17.5 million,
respectively. Sheboygans surplus on a statutory basis as
of December 31, 2008 and 2007 was $11.2 million and $10.6
million, respectively. Net loss for 2008 and all amounts
for 2007 are unaudited. We based the purchase price of
Sheboygan upon an independent valuation of Sheboygan as of
September 30, 2008.
5 Investments
The amortized cost and estimated fair values of fixed
maturities and equity securities at December 31, 2009 and
2008 are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2009 |
|
|
|
|
|
|
Gross |
|
Gross |
|
Estimated |
|
|
Amortized |
|
Unrealized |
|
Unrealized |
|
Fair |
Held to Maturity |
|
Cost |
|
Gains |
|
Losses |
|
Value |
|
U.S. Treasury securities
and obligations of
U.S. government
corporations
and agencies |
|
$ |
2,000,000 |
|
|
$ |
80,260 |
|
|
$ |
|
|
|
$ |
2,080,260 |
|
Obligations of states
and political
subdivisions |
|
|
61,736,351 |
|
|
|
3,011,092 |
|
|
|
24,034 |
|
|
|
64,723,409 |
|
Corporate securities |
|
|
6,243,138 |
|
|
|
72,300 |
|
|
|
13,034 |
|
|
|
6,302,404 |
|
Residential mortgage-backed securities |
|
|
3,827,637 |
|
|
|
72,059 |
|
|
|
29 |
|
|
|
3,899,667 |
|
|
Totals |
|
$ |
73,807,126 |
|
|
$ |
3,235,711 |
|
|
$ |
37,097 |
|
|
$ |
77,005,740 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2009 |
|
|
|
|
|
|
Gross |
|
Gross |
|
Estimated |
|
|
Amortized |
|
Unrealized |
|
Unrealized |
|
Fair |
Available for Sale |
|
Cost |
|
Gains |
|
Losses |
|
Value |
|
U.S. Treasury securities
and obligations of
U.S. government
corporations
and agencies |
|
$ |
41,061,366 |
|
|
$ |
154,076 |
|
|
|
585,363 |
|
|
$ |
40,630,079 |
|
Obligations of states
and political
subdivisions |
|
|
346,798,545 |
|
|
|
12,587,395 |
|
|
|
1,019,462 |
|
|
|
358,366,478 |
|
Corporate securities |
|
|
26,971,526 |
|
|
|
866,136 |
|
|
|
71,859 |
|
|
|
27,765,803 |
|
Residential mortgage-backed securities |
|
|
88,914,148 |
|
|
|
2,356,647 |
|
|
|
329,483 |
|
|
|
90,941,312 |
|
|
Fixed maturities |
|
|
503,745,585 |
|
|
|
15,964,254 |
|
|
|
2,006,167 |
|
|
|
517,703,672 |
|
Equity securities |
|
|
3,804,064 |
|
|
|
6,338,360 |
|
|
|
227,798 |
|
|
|
9,914,626 |
|
|
Totals |
|
$ |
507,549,649 |
|
|
$ |
22,302,614 |
|
|
$ |
2,233,965 |
|
|
$ |
527,618,298 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2008 |
|
|
|
|
|
|
Gross |
|
Gross |
|
Estimated |
|
|
Amortized |
|
Unrealized |
|
Unrealized |
|
Fair |
Held to Maturity |
|
Cost |
|
Gains |
|
Losses |
|
Value |
|
U.S. Treasury securities
and obligations of
U.S. government
corporations
and agencies |
|
$ |
8,516,714 |
|
|
$ |
176,071 |
|
|
$ |
|
|
|
$ |
8,692,785 |
|
Obligations of states
and political
subdivisions |
|
|
76,450,762 |
|
|
|
1,954,867 |
|
|
|
231,545 |
|
|
|
78,174,084 |
|
Corporate securities |
|
|
8,341,519 |
|
|
|
57,124 |
|
|
|
391,701 |
|
|
|
8,006,942 |
|
Residential mortgage-backed securities |
|
|
6,569,161 |
|
|
|
35,256 |
|
|
|
29,204 |
|
|
|
6,575,213 |
|
|
Totals |
|
$ |
99,878,156 |
|
|
$ |
2,223,318 |
|
|
$ |
652,450 |
|
|
$ |
101,449,024 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2008 |
|
|
|
|
|
|
Gross |
|
Gross |
|
Estimated |
|
|
Amortized |
|
Unrealized |
|
Unrealized |
|
Fair |
Available for Sale |
|
Cost |
|
Gains |
|
Losses |
|
Value |
|
U.S. Treasury securities
and obligations of
U.S. government
corporations
and agencies |
|
$ |
6,525,568 |
|
|
$ |
104,732 |
|
|
|
|
|
|
$ |
6,630,300 |
|
Obligations of states
and political
subdivisions |
|
|
341,662,882 |
|
|
|
5,320,541 |
|
|
|
9,980,590 |
|
|
|
337,002,833 |
|
Corporate securities |
|
|
24,517,546 |
|
|
|
208,337 |
|
|
|
790,169 |
|
|
|
23,935,714 |
|
Residential mortgage-backed securities |
|
|
76,303,846 |
|
|
|
1,960,753 |
|
|
|
17,697 |
|
|
|
78,246,902 |
|
|
Fixed maturities |
|
|
449,009,842 |
|
|
|
7,594,363 |
|
|
|
10,788,456 |
|
|
|
445,815,749 |
|
Equity securities |
|
|
2,939,236 |
|
|
|
3,015,197 |
|
|
|
59,458 |
|
|
|
5,894,975 |
|
|
Totals |
|
$ |
451,949,078 |
|
|
$ |
10,609,560 |
|
|
$ |
10,847,914 |
|
|
$ |
451,710,724 |
|
|
26
The amortized cost and estimated fair value of fixed maturities at
December 31, 2009, by contractual maturity, are shown
below. Expected maturities may differ from contractual
maturities because borrowers may have the right to call
or prepay obligations with or without call or prepayment
penalties.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Estimated |
|
|
Amortized |
|
Fair |
|
|
Cost |
|
Value |
|
Held to maturity |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Due in one year or less |
|
$ |
4,500,006 |
|
|
$ |
4,555,420 |
|
Due after one year through five years |
|
|
6,014,660 |
|
|
|
6,170,132 |
|
Due after five years through ten years |
|
|
56,119,315 |
|
|
|
58,971,616 |
|
Due after ten years |
|
|
3,345,508 |
|
|
|
3,408,905 |
|
Mortgage-backed securities |
|
|
3,827,637 |
|
|
|
3,899,667 |
|
|
Total held to maturity |
|
$ |
73,807,126 |
|
|
$ |
77,005,740 |
|
|
Available for sale |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Due in one year or less |
|
$ |
11,664,381 |
|
|
$ |
11,910,987 |
|
Due after one year through five years |
|
|
73,398,473 |
|
|
|
75,384,290 |
|
Due after five years through ten years |
|
|
106,810,216 |
|
|
|
110,232,681 |
|
Due after ten years |
|
|
222,958,367 |
|
|
|
229,234,402 |
|
Mortgage-backed securities |
|
|
88,914,148 |
|
|
|
90,941,312 |
|
|
Total available for sale |
|
$ |
503,745,585 |
|
|
$ |
517,703,672 |
|
|
The amortized cost of fixed maturities on deposit
with various regulatory authorities at December 31, 2009
and 2008 amounted to $9,761,979 and $9,189,695,
respectively.
Investments in affiliates consisted of the following at
December 31, 2009 and 2008:
|
|
|
|
|
|
|
|
|
|
|
2009 |
|
2008 |
|
DFSC |
|
$ |
8,844,347 |
|
|
$ |
8,129,177 |
|
Other |
|
|
465,000 |
|
|
|
465,000 |
|
|
Total |
|
$ |
9,309,347 |
|
|
$ |
8,594,177 |
|
|
We made additional equity investments in DFSC in the
amounts of $100,000 and $0 during 2009 and 2008,
respectively. Other income and expenses in our
consolidated statements of income include income
(expenses) of $471,097, $112,065 and ($182,502) for 2009,
2008 and 2007, respectively, representing our share of
DFSCs income or loss. In addition, other comprehensive
income (loss) in our statements of comprehensive income
includes net unrealized gains of $93,647, $193,241 and
$206,871 for 2009, 2008 and 2007, respectively,
representing our share of DFSCs unrealized investment
gains.
Other investment in affiliates represents our investment
in statutory trusts that hold our subordinated debentures
as discussed in Note 10 Borrowings.
We derive net investment income, consisting primarily
of interest and dividends, from the following sources:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2009 |
|
2008 |
|
2007 |
|
Fixed maturities |
|
$ |
24,458,118 |
|
|
$ |
23,379,999 |
|
|
$ |
21,670,399 |
|
Equity securities |
|
|
69,287 |
|
|
|
552,575 |
|
|
|
853,960 |
|
Short-term investments |
|
|
199,735 |
|
|
|
1,079,325 |
|
|
|
2,146,342 |
|
Other |
|
|
47,514 |
|
|
|
36,008 |
|
|
|
34,214 |
|
|
Investment income |
|
|
24,774,654 |
|
|
|
25,047,907 |
|
|
|
24,704,915 |
|
Investment expenses |
|
|
(4,144,071 |
) |
|
|
(2,292,123 |
) |
|
|
(1,919,663 |
) |
|
Net investment income |
|
$ |
20,630,583 |
|
|
$ |
22,755,784 |
|
|
$ |
22,785,252 |
|
|
Gross realized gains and losses from investments and
the change in the difference between fair value and cost
of investments, before applicable income taxes, are as
follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2009 |
|
2008 |
|
2007 |
|
Gross realized gains: |
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturities |
|
$ |
2,654,648 |
|
|
$ |
1,641,249 |
|
|
$ |
246,959 |
|
Equity securities |
|
|
2,179,331 |
|
|
|
2,397,716 |
|
|
|
2,830,592 |
|
|
|
|
|
4,833,979 |
|
|
|
4,038,965 |
|
|
|
3,077,551 |
|
|
Gross realized losses: |
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturities |
|
|
102,143 |
|
|
|
311,900 |
|
|
|
11,286 |
|
Equity securities |
|
|
252,278 |
|
|
|
6,697,781 |
|
|
|
1,015,215 |
|
|
|
|
|
354,421 |
|
|
|
7,009,681 |
|
|
|
1,026,501 |
|
|
Net realized gains (losses) |
|
$ |
4,479,558 |
|
|
$ |
(2,970,716 |
) |
|
$ |
2,051,050 |
|
|
Change in difference between
fair value and cost of
investments: |
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturities |
|
$ |
18,779,926 |
|
|
$ |
(7,235,434 |
) |
|
$ |
5,132,415 |
|
|
Equity securities |
|
|
3,154,823 |
|
|
|
(3,440,944 |
) |
|
|
(639,612 |
) |
|
Totals |
|
$ |
21,934,749 |
|
|
$ |
(10,676,378 |
) |
|
$ |
4,492,803 |
|
|
We held fixed maturities and equity securities with
unrealized losses representing declines that we considered
temporary at December 31, 2009 as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less than 12 months |
|
12 months or longer |
|
|
Fair |
|
Unrealized |
|
Fair |
|
Unrealized |
|
|
Value |
|
Losses |
|
Value |
|
Losses |
|
U.S. Treasury securities
and obligations of
U.S. government
corporations
and agencies |
|
$ |
26,703,601 |
|
|
$ |
585,364 |
|
|
$ |
|
|
|
$ |
|
|
Obligations of states
and political
subdivisions |
|
|
17,971,018 |
|
|
|
256,527 |
|
|
|
29,582,488 |
|
|
|
786,970 |
|
Corporate securities |
|
|
1,284,405 |
|
|
|
23,525 |
|
|
|
666,941 |
|
|
|
61,366 |
|
Residential mortgage-
backed securities |
|
|
23,514,855 |
|
|
|
328,969 |
|
|
|
477,421 |
|
|
|
543 |
|
Equity securities |
|
|
2,139,457 |
|
|
|
227,798 |
|
|
|
|
|
|
|
|
|
|
Totals |
|
$ |
71,613,336 |
|
|
$ |
1,422,183 |
|
|
$ |
30,726,850 |
|
|
$ |
848,879 |
|
|
We held fixed maturities and equity securities with
unrealized losses representing declines that we considered
temporary at December 31, 2008 as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less than 12 months |
|
12 months or longer |
|
|
Fair |
|
Unrealized |
|
Fair |
|
Unrealized |
|
|
Value |
|
Losses |
|
Value |
|
Losses |
|
U.S. Treasury securities
and obligations of
U.S. government
corporations
and agencies |
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
Obligations of states
and political
subdivisions |
|
|
117,360,120 |
|
|
|
6,880,692 |
|
|
|
65,626,857 |
|
|
|
3,331,443 |
|
Corporate securities |
|
|
16,780,992 |
|
|
|
448,760 |
|
|
|
2,536,165 |
|
|
|
733,109 |
|
Residential mortgage-
backed securities |
|
|
2,925,368 |
|
|
|
24,376 |
|
|
|
2,928,685 |
|
|
|
22,526 |
|
Equity securities |
|
|
484,000 |
|
|
|
59,458 |
|
|
|
|
|
|
|
|
|
|
Totals |
|
$ |
137,550,480 |
|
|
$ |
7,413,286 |
|
|
$ |
71,091,707 |
|
|
$ |
4,087,078 |
|
|
27
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 write down the investment to its fair value
and we reflect the amount of the write-down as a realized
loss in our results of operations when we consider the
decline in value of an individual investment to be other
than temporary. We individually monitor all investments
for other-than-temporary declines in value. Generally, we
assume there has been an other-than-temporary decline in
value if an individual equity security has depreciated in
value by more than 20% of original cost and has been in
such an unrealized loss position for more than six months.
We held five equity securities that were in an unrealized
loss position at December 31, 2009. Based upon our
analysis of general market conditions and underlying
factors impacting these equity securities, we considered
these declines in value to be temporary. 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 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. We held 73
debt securities that were in an unrealized loss position
at December 31, 2009. Based upon our analysis of general
market conditions and underlying factors impacting these
debt securities, we considered these declines in value to
be temporary.
We included losses of $0, $1.2 million and $469,000 in
net realized investment gains (losses) in 2009, 2008 and
2007, respectively, for certain equity investments
trading below cost on an other-than-temporary basis.
We had no sales or transfers from the held to maturity
portfolio in 2009, 2008 or 2007.
We have no derivative instruments or hedging activities.
6 Fair Value Measurements
We account for financial assets using a framework that
establishes a hierarchy that ranks the quality and
reliability of inputs, or assumptions, used in the
determination of fair value, and we classify financial
assets and liabilities carried at fair value in one of the
following three categories:
Level 1 quoted prices in active markets for
identical assets and liabilities;
Level 2 directly or indirectly observable inputs
other than Level 1 quoted prices; and
Level 3 unobservable inputs not corroborated by market data.
For investments that have quoted market prices in active
markets, we use the quoted market price as fair value and
include these investments in Level 1 of the fair value
hierarchy. We classify publicly traded equity securities
as Level 1. When quoted market prices in active markets
are not available, we base fair values on quoted market
prices of comparable instruments or broker quotes. We
classify our fixed maturity investments as Level 2. Our
fixed maturity investments consist of U.S. Treasury
securities and obligations of U.S. government corporations
and agencies, obligations of states and political
subdivisions, corporate securities and residential
mortgage-backed securities.
We reclassified one equity security to Level 3 during
2009. We utilized a fair value model that incorporated
significant unobservable inputs, such as estimated
volatility, to estimate the equity securitys fair value.
We are restricted from selling this equity security, which
we obtained in an initial public offering, for a period of
18 to 24 months, and the fair value we determined as of
December 31, 2009 reflects this selling restriction. We
recorded an unrealized gain of $3.4 million related to
this security in other comprehensive income for the year
ended December 31, 2009.
We present our investments in available-for-sale fixed
maturity
and equity securities at estimated fair value. The
estimated fair value of a security may differ from the
amount that could be realized if the security were sold 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 for
substantially all of our fixed maturity and equity
investments. We generally obtain one price 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
using proprietary pricing applications, which include
available relevant market information, benchmark yields,
sector curves and matrix pricing. The pricing services do
not use broker quotes in determining the fair values of
our investments. We review the estimates of fair value
provided by the pricing services to determine if the
estimates obtained are representative of fair values based
upon our general knowledge of the market, our research
findings related to unusual fluctuations in value and our
comparison of such values to execution prices for similar
securities. As of December 31, 2009 and 2008, we received
one estimate per security from one of the pricing
services, and we priced all but an insignificant amount of
our Level 1 and Level 2 investments using those prices. In
our review of the estimates provided by the pricing
services as of December 31, 2009 and 2008, we did not
identify any discrepancies, and we did not make any
adjustments to the estimates the pricing services
provided.
We present our cash and short-term investments at cost,
which approximates fair value. The carrying values in our
consolidated balance sheets for premium and reinsurance
receivables and payables approximate their fair values.
The carrying amounts reported in our consolidated balance
sheets for our subordinated debentures approximate their
fair values due to their variable rate nature.
We evaluate our assets and liabilities on a regular basis
to determine the appropriate level at which to classify
them for each reporting period.
28
The following table presents our fair value measurements
for our investments in available-for-sale fixed
maturities and equity securities as of December 31, 2009:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Measurements Using |
|
|
|
|
|
|
Quoted Prices in |
|
Significant |
|
|
|
|
|
|
|
|
Active Markets |
|
Other |
|
Significant |
|
|
|
|
|
|
for Identical |
|
Observable |
|
Unobservable |
|
|
|
|
|
|
Assets |
|
Inputs |
|
Inputs |
|
|
Fair Value |
|
(Level 1) |
|
(Level 2) |
|
(Level 3) |
|
U.S. Treasury
securities and
obligations of
U.S. government
corporations and
agencies |
|
$ |
40,630,079 |
|
|
$ |
|
|
|
$ |
40,630,079 |
|
|
$ |
|
|
Obligations of
states and political
subdivisions |
|
|
358,366,478 |
|
|
|
|
|
|
|
358,366,478 |
|
|
|
|
|
Corporate securities |
|
|
27,765,803 |
|
|
|
|
|
|
|
27,765,803 |
|
|
|
|
|
Residential mortgage-
backed securities |
|
|
90,941,312 |
|
|
|
|
|
|
|
90,941,312 |
|
|
|
|
|
Equity securities |
|
|
9,914,626 |
|
|
|
2,426,567 |
|
|
|
1,256,405 |
|
|
|
6,231,654 |
|
|
Totals |
|
$ |
527,618,298 |
|
|
$ |
2,426,567 |
|
|
$ |
518,960,077 |
|
|
$ |
6,231,654 |
|
|
The following table presents our fair value
measurements for our investments in available-for-sale
fixed maturities and equity securities as of December 31,
2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Measurements Using |
|
|
|
|
|
|
Quoted Prices in |
|
Significant |
|
|
|
|
|
|
|
|
Active Markets |
|
Other |
|
Significant |
|
|
|
|
|
|
for Identical |
|
Observable |
|
Unobservable |
|
|
|
|
|
|
Assets |
|
Inputs |
|
Inputs |
|
|
Fair Value |
|
(Level 1) |
|
(Level 2) |
|
(Level 3) |
|
U.S. Treasury
securities and
obligations of
U.S. government
corporations and
agencies |
|
$ |
6,630,300 |
|
|
$ |
|
|
|
$ |
6,630,300 |
|
|
$ |
|
|
Obligations of
states and political
subdivisions |
|
|
337,002,833 |
|
|
|
|
|
|
|
337,002,833 |
|
|
|
|
|
Corporate securities |
|
|
23,935,714 |
|
|
|
|
|
|
|
23,935,714 |
|
|
|
|
|
Residential mortgage-
backed securities |
|
|
78,246,902 |
|
|
|
|
|
|
|
78,246,902 |
|
|
|
|
|
Equity securities |
|
|
5,894,975 |
|
|
|
4,970,501 |
|
|
|
924,474 |
|
|
|
|
|
|
Totals |
|
$ |
451,710,724 |
|
|
$ |
4,970,501 |
|
|
$ |
446,740,223 |
|
|
$ |
|
|
|
The following table presents a roll forward of the
significant unobservable inputs for our Level 3 equity
securities for 2009:
|
|
|
|
|
Balance, January 1 |
|
$ |
|
|
Reclassification to Level 3 |
|
|
4,958,531 |
|
Sales of securities |
|
|
(1,293,600 |
) |
Change in net unrealized gains |
|
|
2,566,723 |
|
|
Balance, December 31 |
|
$ |
6,231,654 |
|
|
7 Deferred Policy Acquisition Costs
Changes in our insurance subsidiaries deferred policy
acquisition costs are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2009 |
|
2008 |
|
2007 |
|
Balance, January 1 |
|
$ |
29,541,281 |
|
|
$ |
26,235,072 |
|
|
$ |
24,738,929 |
|
Acquisition costs deferred |
|
|
63,594,898 |
|
|
|
61,556,209 |
|
|
|
52,701,143 |
|
Amortization charged
to earnings |
|
|
(60,292,000 |
) |
|
|
(58,250,000 |
) |
|
|
(51,205,000 |
) |
|
Balance, December 31 |
|
$ |
32,844,179 |
|
|
$ |
29,541,281 |
|
|
$ |
26,235,072 |
|
|
8 Property and Equipment
Property and equipment at December 31, 2009 and 2008
consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Estimated |
|
|
|
|
|
|
|
|
|
|
Useful |
|
|
2009 |
|
2008 |
|
Life |
|
Office equipment |
|
$ |
8,177,197 |
|
|
$ |
7,835,404 |
|
|
5-15 years |
Automobiles |
|
|
1,591,133 |
|
|
|
1,576,055 |
|
|
3 years |
Real estate |
|
|
5,016,722 |
|
|
|
4,981,529 |
|
|
15-50 years |
Software |
|
|
1,631,763 |
|
|
|
1,077,790 |
|
|
5 years |
|
|
|
|
16,416,815 |
|
|
|
15,470,778 |
|
|
|
|
|
Accumulated depreciation |
|
|
(9,824,592 |
) |
|
|
(8,784,094 |
) |
|
|
|
|
|
|
|
$ |
6,592,223 |
|
|
$ |
6,686,684 |
|
|
|
|
|
|
Depreciation expense for 2009, 2008 and 2007 amounted to $1.0 million,
$1.0 million and $901,798, respectively.
9 Liability for Losses and Loss Expenses
The establishment of an appropriate liability for losses
and loss expenses is an inherently uncertain process, and
there can be 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. Furthermore, we
cannot predict the timing, frequency and extent of
adjustments to our insurance subsidiaries estimated
future liabilities, since the historical conditions and
events that serve as a basis for their 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 our insurance subsidiaries
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.
We summarize activity in our insurance subsidiaries
liability for losses and loss expenses as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2009 |
|
2008 |
|
2007 |
|
Balance at January 1 |
|
$ |
239,809,276 |
|
|
$ |
226,432,402 |
|
|
$ |
259,022,459 |
|
Less reinsurance
recoverable |
|
|
(78,502,518 |
) |
|
|
(76,280,437 |
) |
|
|
(95,710,496 |
) |
|
Net balance at January 1 |
|
|
161,306,758 |
|
|
|
150,151,965 |
|
|
|
163,311,963 |
|
|
Acquisition of Sheboygan |
|
|
|
|
|
|
2,173,374 |
|
|
|
|
|
|
Incurred related to: |
|
|
|
|
|
|
|
|
|
|
|
|
Current year |
|
|
241,012,436 |
|
|
|
221,617,127 |
|
|
|
187,796,474 |
|
Prior years |
|
|
9,822,960 |
|
|
|
2,683,837 |
|
|
|
(10,012,842 |
) |
|
Total incurred |
|
|
250,835,396 |
|
|
|
224,300,964 |
|
|
|
177,783,632 |
|
|
Paid related to: |
|
|
|
|
|
|
|
|
|
|
|
|
Current year |
|
|
152,292,967 |
|
|
|
143,369,098 |
|
|
|
118,444,254 |
|
Prior years |
|
|
79,587,069 |
|
|
|
71,950,447 |
|
|
|
72,499,376 |
|
|
Total paid |
|
|
231,880,036 |
|
|
|
215,319,545 |
|
|
|
190,943,630 |
|
|
Net balance at
December 31 |
|
|
180,262,118 |
|
|
|
161,306,758 |
|
|
|
150,151,965 |
|
Plus reinsurance
recoverable |
|
|
83,336,726 |
|
|
|
78,502,518 |
|
|
|
76,280,437 |
|
|
Balance at December 31 |
|
$ |
263,598,844 |
|
|
$ |
239,809,276 |
|
|
$ |
226,432,402 |
|
|
29
Our insurance subsidiaries recognized an increase
(decrease) in their liability for losses and loss expenses
of prior years of $9.8 million, $2.7 million and ($10.0)
million in 2009, 2008 and 2007, respectively. Our
insurance subsidiaries made no significant changes in
their reserving philosophy, key reserving assumptions or
claims management personnel, and have made no significant
offsetting changes in estimates that increased or
decreased their loss and loss expense reserves in these
years. The majority of the 2009 development related to
increases in the liability for losses and loss expenses of
prior years for Atlantic States and Southern. The 2009
development represented 6.0% of our December 31, 2008
carried reserves and was driven primarily by
higher-than-expected severity in the private passenger
automobile liability, homeowners and workers compensation
lines of business in accident year 2008. The 2008
development represented 1.2% of our December 31, 2007
carried reserves and was driven primarily by
higher-than-expected severity in the private passenger
automobile liability line of business in accident year
2007. Our insurance subsidiaries recognized favorable
development in 2007 primarily in the private passenger
automobile liability, workers compensation, commercial
automobile liability and commercial multi-peril lines of
business.
10 Borrowings
Line of Credit
On November 25, 2003, we entered into a credit agreement with
Manufacturers and Traders Trust Company (M&T) relating to a four-year
$35.0 million unsecured, revolving line of credit. On July
20, 2006, we amended the agreement with M&T to extend the
credit agreement for four years from the date of amendment
on substantially the same terms. As of December 31, 2009,
we may borrow up to $35.0 million at interest rates equal
to M&Ts current prime rate or the then current London
Interbank Eurodollar bank rate (LIBOR) plus between 1.50%
and 1.75%, depending on our leverage ratio. In addition,
we pay a fee of 0.15% per annum on the loan commitment
amount, regardless of usage. The agreement requires our
compliance with certain covenants, which include minimum
levels of our net worth, leverage ratio and statutory
surplus and A.M. Best ratings of our insurance
subsidiaries. During the year ended December 31, 2009, we
had no outstanding borrowings, and we complied with all
requirements of the credit agreement. We intend to extend
the credit agreement during 2010.
Subordinated Debentures
On May 15, 2003, we received $15.0 million in net
proceeds from the issuance of subordinated debentures.
We redeemed these debentures on August 15, 2008.
On October 29, 2003, we received $10.0 million in net
proceeds from the issuance of subordinated debentures.
The debentures mature on October 29, 2033 and are
callable at our option, at par. The debentures carry an
interest rate equal to the three-month LIBOR rate plus
4.10%, which is adjustable quarterly. At December 31,
2009, the interest rate on these debentures was 4.37% and
was next subject to adjustment on February 15, 2010. As
of December 31, 2009 and 2008, our consolidated balance
sheets included an investment in a statutory trust of
$310,000 and subordinated debentures of $10.3 million
related to this transaction.
On May 24, 2004, we received $5.0 million in net proceeds
from the issuance of subordinated debentures. The
debentures mature on May 24, 2034 and are callable at our
option, at par. The debentures carry an interest rate
equal to the three-month LIBOR rate plus 3.85%, which is
adjustable quarterly. At December 31, 2009, the interest
rate on these debentures was 4.11% and was next subject
to adjustment on February 24, 2010. As of December 31,
2009 and 2008, our consolidated balance sheets included
an investment in a statutory trust of $155,000 and
subordinated debentures of $5.2 million related to this
transaction.
11 Reinsurance
Unaffiliated Reinsurers
Our insurance subsidiaries and Donegal Mutual purchase
certain third-party reinsurance on a combined basis. Le
Mars, Peninsula and Sheboygan also have separate
third-party reinsurance programs that provide certain
coverage that is commensurate with their relative size and
exposures. Our insurance subsidiaries use several
different reinsurers, all of which, consistent with the
requirements of our insurance subsidiaries and Donegal
Mutual, have an A.M. Best rating of A- (Excellent) or
better or, with respect to foreign reinsurers, have a
financial condition that, in the opinion of our
management, is equivalent to a company with at least an A-
rating from A.M. Best. The external reinsurance our
insurance subsidiaries and Donegal Mutual purchase
includes excess of loss reinsurance, under which their
losses are automatically reinsured, through a series of
contracts, over a set retention (generally $750,000), and
catastrophic reinsurance, under which they recover,
through a series of contracts, 100% of an accumulation of
many losses resulting from a single event, including
natural disasters, over a set retention (generally $3.0
million). Our insurance subsidiaries principal third
party reinsurance agreement in 2009 was a multi-line per
risk excess of loss treaty that provided 100% coverage up
to $1.0 million for both property and liability losses
over the set retention. For property insurance, our
insurance subsidiaries also had excess of loss treaties
that provided for additional coverage over the multi-line
treaty up to $2.5 million per loss. For liability
insurance, our insurance subsidiaries had excess of loss
treaties that provided for additional coverage over the
multi-line treaty up to $40.0 million per occurrence. For
workers compensation insurance, our insurance
subsidiaries had excess of loss treaties that provided for
additional coverage over the multi-line treaty up to $10.0
million on any one life. Our insurance subsidiaries and
Donegal Mutual had property catastrophe coverage through a
series of layered treaties up to aggregate losses of
$100.0 million for any single event. As many as nine
reinsurers provided coverage on any one treaty with no
reinsurer taking more than 29.0% of any one contract. The amount of coverage
provided under each of these types of reinsurance depends
upon the amount, nature, size and location of the risks
being reinsured. Donegal Mutual and our insurance
subsidiaries also purchased facultative reinsurance to
cover exposures from losses that exceeded the limits
provided by our respective treaty reinsurance. The
following amounts represent ceded reinsurance
transactions with unaffiliated reinsurers during 2009,
2008 and 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2009 |
|
2008 |
|
2007 |
|
Premiums written |
|
$ |
19,758,224 |
|
|
$ |
19,458,572 |
|
|
$ |
22,922,229 |
|
|
Premiums earned |
|
$ |
19,870,265 |
|
|
$ |
19,348,674 |
|
|
$ |
22,805,393 |
|
|
Losses and loss expenses |
|
$ |
6,796,388 |
|
|
$ |
11,129,036 |
|
|
$ |
4,934,928 |
|
|
Prepaid reinsurance premiums |
|
$ |
1,985,821 |
|
|
$ |
2,097,870 |
|
|
$ |
1,949,428 |
|
|
Liability for losses and
loss expenses |
|
$ |
22,692,993 |
|
|
$ |
27,258,815 |
|
|
$ |
26,046,365 |
|
|
Total Reinsurance
The following amounts represent our total ceded
reinsurance transactions with both affiliated and
unaffiliated reinsurers during 2009, 2008 and 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2009 |
|
2008 |
|
2007 |
|
Premiums earned |
|
$ |
127,203,132 |
|
|
$ |
119,073,801 |
|
|
$ |
114,829,037 |
|
|
Losses and loss expenses |
|
$ |
87,129,668 |
|
|
$ |
74,112,920 |
|
|
$ |
47,174,704 |
|
|
Prepaid reinsurance premiums |
|
$ |
56,040,728 |
|
|
$ |
51,436,487 |
|
|
$ |
47,286,334 |
|
|
Liability for losses and
loss expenses |
|
$ |
83,336,726 |
|
|
$ |
78,502,518 |
|
|
$ |
76,280,437 |
|
|
30
The following amounts represent the effect of
reinsurance on premiums written for 2009, 2008 and
2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2009 |
|
2008 |
|
2007 |
|
Direct |
|
$ |
250,989,795 |
|
|
$ |
241,371,353 |
|
|
$ |
229,328,954 |
|
Assumed |
|
|
244,046,312 |
|
|
|
246,755,110 |
|
|
|
202,099,203 |
|
Ceded |
|
|
(131,807,381 |
) |
|
|
(123,185,408 |
) |
|
|
(117,738,418 |
) |
|
Net premiums written |
|
$ |
363,228,726 |
|
|
$ |
364,941,055 |
|
|
$ |
313,689,739 |
|
|
The following amounts represent the effect of
reinsurance on premiums earned for 2009, 2008 and 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2009 |
|
2008 |
|
2007 |
|
Direct |
|
$ |
246,074,766 |
|
|
$ |
235,212,229 |
|
|
$ |
225,684,220 |
|
Assumed |
|
|
236,153,843 |
|
|
|
230,436,838 |
|
|
|
199,216,351 |
|
Ceded |
|
|
(127,203,132 |
) |
|
|
(119,073,801 |
) |
|
|
(114,829,037 |
) |
|
Net premiums earned |
|
$ |
355,025,477 |
|
|
$ |
346,575,266 |
|
|
$ |
310,071,534 |
|
|
12 Income Taxes
Our provision for income tax consists of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2009 |
|
2008 |
|
2007 |
|
Current |
|
$ |
3,096,798 |
|
|
$ |
7,382,694 |
|
|
$ |
13,539,991 |
|
Deferred |
|
|
(1,250,187 |
) |
|
|
(832,628 |
) |
|
|
1,029,042 |
|
|
Federal tax provision |
|
$ |
1,846,611 |
|
|
$ |
6,550,066 |
|
|
$ |
14,569,033 |
|
|
Our effective tax rate is different from the amount
computed at the statutory federal rate of 35% for 2009,
2008 and 2007. The reasons for such difference and the
related tax effects are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2009 |
|
2008 |
|
2007 |
|
Income before
income taxes |
|
$ |
20,676,689 |
|
|
$ |
32,092,044 |
|
|
$ |
52,848,938 |
|
|
Computed expected taxes |
|
|
7,236,841 |
|
|
|
11,232,215 |
|
|
|
18,497,128 |
|
Tax-exempt interest |
|
|
(6,237,961 |
) |
|
|
(5,668,566 |
) |
|
|
(4,548,711 |
) |
Dividends received deduction |
|
|
(17,574 |
) |
|
|
(62,470 |
) |
|
|
(125,977 |
) |
Other, net |
|
|
865,305 |
|
|
|
1,048,887 |
|
|
|
746,593 |
|
|
Federal income tax provision |
|
$ |
1,846,611 |
|
|
$ |
6,550,066 |
|
|
$ |
14,569,033 |
|
|
The tax effects of temporary differences that give
rise to significant portions of the deferred tax assets
and deferred tax liabilities at December 31, 2009 and 2008
are as follows:
|
|
|
|
|
|
|
|
|
|
|
2009 |
|
2008 |
|
Deferred tax assets: |
|
|
|
|
|
|
|
|
Unearned premium |
|
$ |
13,043,976 |
|
|
$ |
12,506,590 |
|
Loss reserves |
|
|
5,715,157 |
|
|
|
5,309,536 |
|
Net
operating loss carryforward
acquired companies |
|
|
2,497,122 |
|
|
|
2,628,568 |
|
Other |
|
|
4,000,325 |
|
|
|
3,510,896 |
|
|
Total gross deferred assets |
|
|
25,256,580 |
|
|
|
23,955,590 |
|
Less valuation allowance |
|
|
(746,368 |
) |
|
|
(746,368 |
) |
|
Net deferred tax assets |
|
|
24,510,212 |
|
|
|
23,209,222 |
|
|
Deferred tax liabilities: |
|
|
|
|
|
|
|
|
Depreciation expense |
|
|
597,036 |
|
|
|
570,539 |
|
Deferred policy acquisition costs |
|
|
11,505,045 |
|
|
|
10,531,684 |
|
Salvage recoverable |
|
|
200,789 |
|
|
|
189,521 |
|
Net unrealized gains |
|
|
7,120,393 |
|
|
|
922,834 |
|
|
Total gross deferred liabilities |
|
|
19,423,263 |
|
|
|
12,214,578 |
|
|
Net deferred tax asset |
|
$ |
5,086,949 |
|
|
$ |
10,994,644 |
|
|
We provide a valuation allowance when we believe it is
more likely than not that we will not realize some portion
of the tax asset. We established a valuation allowance of
$746,368 related to a portion of the net operating loss
carryforward of Le Mars at January 1, 2004. We have
determined that we are not required to establish a
valuation allowance for the other net deferred tax assets
of $24.5 million and $23.2 million at December 31, 2009
and 2008, respectively, since it is more likely than not
that we will realize these deferred tax assets through
reversals of existing temporary differences, future
taxable income, carrybacks to taxable income in prior
years and the implementation of tax planning strategies.
At December 31, 2009, we have a net operating loss
carryforward of $7.2 million, which is available to offset
our taxable income. This amount will begin to expire in
2011 if not utilized and is subject to an annual
limitation in the amount that we can use in any one year
of approximately $376,000. We also have an alternative
minimum tax credit carryforward of $412,374 with an
indefinite life.
13 Stockholders Equity
On April 19, 2001, our stockholders approved an amendment
to our certificate of incorporation. Among other things,
the amendment reclassified our common stock as Class B
common stock and effected a one-for-three reverse split of
our Class B common stock effective April 19, 2001. The amendment also
authorized a new class of common stock with one-tenth of a
vote per share designated as Class A common stock. Our
board of directors also declared a dividend of two shares
of Class A common stock for each share of Class B common
stock, after the one-for-three reverse split, held of
record at the close of business on April 19, 2001.
Each share of Class A common stock outstanding at the time
of the declaration of any dividend or other distribution
payable in cash upon the shares of Class B common stock is
entitled to a dividend or distribution payable at the same
time and to stockholders of record on the same date in an
amount at least 10% greater than any dividend declared
upon each share of Class B common stock. In the event of
our merger or consolidation with or into another entity,
the holders of Class A common stock and the holders of
Class B common stock are entitled to receive the same per
share consideration in such merger or consolidation. In
the event of our liquidation, dissolution or winding-up,
any assets available to common stockholders will be
distributed pro-rata to the holders of Class A common
stock and Class B common stock after payment of all our
obligations.
In March 2007, our board of directors authorized a share
repurchase program, pursuant to which we purchased 500,000
shares of our Class A common stock at market prices
prevailing from time to time in the open market subject to
the provisions of Securities and Exchange Commission (SEC)
Rule 10b-18 and in privately negotiated transactions. We
purchased 19,231 and 214,343 shares of our Class A common
stock under this program during 2009 and 2008,
respectively. As of December 31, 2009, we had no remaining
authorization to purchase shares under this program.
In February 2009, our board of directors authorized a
share repurchase program, pursuant to which we may
purchase up to 300,000 shares of our Class A common stock
at market prices prevailing from time to time in the open
market subject to the provisions of SEC Rule 10b-18 and in
privately negotiated transactions. We purchased 7,669
shares of our Class A common stock under this program
during 2009. As of December 31, 2009, we had the authority
to purchase 292,331 shares under this program.
As of December 31, 2009, our treasury stock consisted of
652,599 and 72,465 shares of Class A common stock and
Class B common stock, respectively. As of December 31,
2008, our treasury stock consisted of 625,699 and 72,465
shares of Class A common stock and Class B common stock,
respectively.
31
14 Stock Compensation Plans
Equity Incentive Plans
During 1996, we adopted an Equity Incentive Plan for
Employees. During 2001, we adopted a nearly identical plan
that made a total of 2,666,667 shares of Class A common
stock available for issuance to employees of our
subsidiaries and affiliates. During 2005, we amended the
plan to make a total of 4,000,000 shares of Class A common
stock available for issuance. During 2007, we adopted a
nearly identical plan that made a total of 3,500,000
shares of Class A common stock available for issuance to
employees of our subidiaries and affiliates. Each plan
provides for the granting of awards by our board of
directors in the form of stock options, stock appreciation
rights, restricted stock or any combination of the above.
The plans provide that stock options may become
exercisable up to ten years from date of grant with an
option price not less than fair market value on date of
grant. We have not granted any stock appreciation rights.
During 1996, we adopted an Equity Incentive Plan for
Directors. During 2001, we adopted a nearly identical plan
that made 355,556 shares of Class A common stock available
for issuance to our directors and those of our
subsidiaries and affiliates. During 2007, we adopted a
nearly identical plan that made 400,000 shares of Class A
common stock available for issuance to our directors and
the directors of our subsidiaries and affiliates. We may
make awards in the form of stock options. The plan also
provides for the issuance of 311 shares of restricted
stock to each director on the first business day of
January in each year. As of December 31, 2009, we had
302,499 unexercised options under these plans. In
addition, we issued 4,665, 4,665 and 4,976 shares of
restricted stock on January 2, 2009, 2008 and 2007,
respectively.
We measure all share-based payments to employees,
including grants of employee stock options, using a
fair-value-based method and the recording of such expense
in our results of operations. In determining the expense
we record for stock options granted to directors and
employees of our subsidiaries and affiliates other than
Donegal Mutual, 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. The risk-free interest rate is the
implied yield currently available on U.S. Treasury zero
coupon issues with a remaining term equal to the expected
term used as the assumption in the model. The expected
term of an option award is based on historical experience
of similar awards. The dividend yield is determined by
dividing the per share dividend by the grant date stock
price. The expected volatility is based on the volatility
of our stock price over a historical period comparable to
the expected term.
The weighted-average grant date fair value of options
granted during 2009 was $1.63. We calculated this fair
value based upon a risk-free interest rate of 1.50%,
expected life of 3 years, expected volatility of 24% and
expected dividend yield of 3%.
The weighted-average grant date fair value of options
granted during 2008 was $2.06. We calculated this fair
value based upon a risk-free interest rate of 2%,
expected life of 3 years, expected volatility of 21%
and expected dividend yield of 2%.
The weighted-average grant date fair value of options
granted during 2007 was $1.15. We calculated this fair
value based upon a risk-free interest rate of 3%,
expected life of 3 years, expected volatility of 20%
and expected dividend yield of 2%.
We charged compensation expense for our stock compensation
plans against income before income taxes of $232,872,
$205,288 and $343,442 for the years ended December 31,
2009, 2008 and 2007, respectively, with a corresponding
income tax benefit of $79,176, $71,851 and $120,205. As of
December 31, 2009 and 2008, our total unrecognized
compensation cost related to nonvested share-based
compensation granted under the plan was $91,026 and
$257,610, respectively. We expect to recognize this cost
over a weighted average period of 2.6 years.
We account for share-based compensation to employees and
directors of Donegal Mutual as share-based compensation
to employees of a controlling entity. As such, we measure
the fair value of the award at the grant date and
recognize the fair value as a dividend to the controlling
entity. These provisions apply to options granted to the
employees and directors of Donegal Mutual, the employer
of record for the employees that provide services to us.
We recorded implied dividends of $62,991, $1,749,063 and
$65,179 for the years ended December 31, 2009, 2008 and
2007, respectively.
Cash received from option exercises under all stock
compensation plans for the years ended December 31, 2009,
2008 and 2007 was $0, $2,358,916 and $1,768,799,
respectively. The actual tax benefit realized for the tax
deductions from option exercises of share-based
compensation was $0, $683,881 and $854,945 for the years
ended December 31, 2009, 2008 and 2007, respectively.
All options issued prior to 2001 converted to options on
Class A and Class B common stock as a result of our
recapitalization. No further shares are available for
plans in effect prior to 2008.
Information regarding activity in our stock option plans follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-Average |
|
|
Number of |
|
Exercise Price |
|
|
Options |
|
Per Share |
|
Outstanding at December 31, 2006 |
|
|
2,683,827 |
|
|
$ |
16.44 |
|
Granted 2007 |
|
|
20,500 |
|
|
|
21.00 |
|
Exercised 2007 |
|
|
(246,327 |
) |
|
|
7.18 |
|
Forfeited 2007 |
|
|
(73,278 |
) |
|
|
19.17 |
|
|
Outstanding at December 31, 2007 |
|
|
2,384,722 |
|
|
|
17.36 |
|
Granted 2008 |
|
|
1,368,500 |
|
|
|
17.52 |
|
Exercised 2008 |
|
|
(247,955 |
) |
|
|
9.51 |
|
Forfeited 2008 |
|
|
(82,835 |
) |
|
|
17.80 |
|
|
Outstanding at December 31, 2008 |
|
|
3,422,432 |
|
|
|
17.98 |
|
Granted 2009 |
|
|
5,000 |
|
|
|
17.50 |
|
Forfeited 2009 |
|
|
(137,333 |
) |
|
|
17.97 |
|
|
Outstanding at December 31, 2009 |
|
|
3,290,099 |
|
|
$ |
17.98 |
|
|
Exercisable at: |
|
|
|
|
|
|
|
|
December 31, 2007 |
|
|
1,303,097 |
|
|
$ |
15.90 |
|
|
December 31, 2008 |
|
|
1,767,810 |
|
|
$ |
17.74 |
|
|
December 31, 2009 |
|
|
2,451,556 |
|
|
$ |
18.13 |
|
|
Shares available for future option grants at
December 31, 2009 total 2,622,670 shares under all
plans.
The following table summarizes information about
outstanding stock options at December 31, 2009:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of |
|
Weighted-Average |
|
Number of |
Exercise |
|
Options |
|
Remaining |
|
Options |
Price |
|
Outstanding |
|
Contractual Life |
|
Exercisable |
|
$ |
15.75 |
|
|
|
1,059,432 |
|
|
0.5 years |
|
|
1,059,432 |
|
|
17.50 |
|
|
|
1,244,500 |
|
|
3.5 years |
|
|
414,792 |
|
|
17.65 |
|
|
|
4,000 |
|
|
0.5 years |
|
|
4,000 |
|
|
18.70 |
|
|
|
3,000 |
|
|
3.5 years |
|
|
1,000 |
|
|
21.00 |
|
|
|
958,667 |
|
|
2.0 years |
|
|
958,667 |
|
|
21.00 |
|
|
|
20,500 |
|
|
3.0 years |
|
|
13,665 |
|
|
Total |
|
|
3,290,099 |
|
|
|
|
|
|
|
2,451,556 |
|
|
Employee Stock Purchase Plans
During 1996, we adopted an Employee Stock Purchase Plan.
During 2001, we adopted a nearly identical plan that made
533,333 shares of Class A common stock available for
issuance.
The 2001 plan extends over a ten-year period and provides
for shares to be offered to all eligible employees at a
purchase price equal to the lesser of 85% of the fair
market value of our Class A common stock on the last day
before the first day of each enrollment period (June 1 and
December 1 of each year) under the plan or 85% of the fair
market value of our
32
common stock on the last day of each subscription
period (June 30 and December 31 of each year). A
summary of plan activity follows:
|
|
|
|
|
|
|
|
|
|
|
Shares Issued |
|
|
Price |
|
Shares |
|
January 1, 2007 |
|
$ |
15.02 |
|
|
|
10,929 |
|
July 1, 2007 |
|
|
12.67 |
|
|
|
13,264 |
|
January 1, 2008 |
|
|
12.98 |
|
|
|
14,593 |
|
July 1, 2008 |
|
|
13.49 |
|
|
|
11,498 |
|
January 1, 2009 |
|
|
14.25 |
|
|
|
10,770 |
|
July 1, 2009 |
|
|
12.93 |
|
|
|
11,304 |
|
On January 1, 2010, we issued an additional 11,717 shares at a price of
$12.85 per share under this plan.
Agency Stock Purchase Plans
During 1996, we adopted an Agency Stock Purchase Plan.
During 2001, we adopted a nearly identical plan that made
533,333 shares of Class A common stock available for
issuance. The plan provides for agents of our insurance
subsidiaries and Donegal Mutual to invest up to $12,000
per subscription period (April 1 to September 30 and
October 1 to March 31 of each year) under various methods.
We issue stock at the end of each subscription period at a
price equal to 90% of the average market price during the
last ten trading days of each subscription period. During
2009, 2008 and 2007, we issued 48,427, 48,054 and 58,255
shares, respectively, under this plan. Expense recognized
under the plan was not material.
15 Statutory Net Income, Capital and Surplus and Dividend Restrictions
The following is selected information, as filed with
insurance regulatory authorities, for our insurance
subsidiaries as determined in accordance with
accounting practices prescribed or permitted by such
insurance regulatory authorities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2009 |
|
2008 |
|
2007 |
|
Atlantic States |
|
|
|
|
|
|
|
|
|
|
|
|
Statutory capital
and surplus |
|
$ |
189,679,919 |
|
|
$ |
182,403,593 |
|
|
$ |
180,739,409 |
|
|
Statutory unassigned
surplus |
|
$ |
133,732,099 |
|
|
$ |
128,742,729 |
|
|
$ |
127,078,545 |
|
|
Statutory net income |
|
$ |
12,445,231 |
|
|
$ |
18,412,955 |
|
|
$ |
24,052,423 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Southern |
|
|
|
|
|
|
|
|
|
|
|
|
Statutory capital
and surplus |
|
$ |
64,519,825 |
|
|
$ |
64,272,437 |
|
|
$ |
64,507,274 |
|
|
Statutory unassigned
surplus |
|
$ |
15,402,239 |
|
|
$ |
15,154,851 |
|
|
$ |
15,389,688 |
|
|
Statutory net (loss) income |
|
$ |
(1,017,998 |
) |
|
$ |
1,608,947 |
|
|
$ |
5,046,129 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Le Mars |
|
|
|
|
|
|
|
|
|
|
|
|
Statutory capital
and surplus |
|
$ |
28,288,730 |
|
|
$ |
27,914,815 |
|
|
$ |
28,311,698 |
|
|
Statutory unassigned
surplus |
|
$ |
15,277,563 |
|
|
$ |
15,322,075 |
|
|
$ |
15,718,958 |
|
|
Statutory net income |
|
$ |
716,138 |
|
|
$ |
1,886,785 |
|
|
$ |
5,127,324 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Peninsula |
|
|
|
|
|
|
|
|
|
|
|
|
Statutory capital
and surplus |
|
$ |
38,986,329 |
|
|
$ |
39,137,131 |
|
|
$ |
36,904,467 |
|
|
Statutory unassigned
surplus |
|
$ |
20,832,470 |
|
|
$ |
21,337,717 |
|
|
$ |
19,105,053 |
|
|
Statutory net income |
|
$ |
1,023,349 |
|
|
$ |
4,082,064 |
|
|
$ |
5,037,902 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sheboygan |
|
|
|
|
|
|
|
|
|
|
|
|
Statutory capital
and surplus |
|
$ |
11,857,971 |
|
|
$ |
11,176,704 |
|
|
$ |
10,644,246 |
|
|
Statutory unassigned
(deficit) surplus |
|
$ |
(243,626 |
) |
|
$ |
(855,467 |
) |
|
$ |
7,144,246 |
|
|
Statutory net income (loss) |
|
$ |
588,098 |
|
|
$ |
(1,110,861 |
) |
|
$ |
632,202 |
|
|
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 on a
statutory basis. Our insurance subsidiaries are subject to
regulations that restrict payment of dividends from
statutory surplus and may require prior approval of their
domiciliary insurance regulatory authorities. Our
insurance subsidiaries are also subject to risk-based
capital (RBC) requirements that may further impact their
ability to pay dividends. At December 31, 2009, our
insurance subsidiaries had statutory capital and surplus
substantially above their respective RBC requirements.
Amounts available for distribution to us as dividends from
our insurance subsidiaries without prior approval of
insurance regulatory authorities in 2010 are $12,445,231
from Atlantic States, $0 from Southern, $2,828,873 from Le
Mars, $3,898,633 from Peninsula and $584,431 from
Sheboygan.
16 Reconciliation of Statutory Filings to Amounts Reported Herein
Our insurance subsidiaries must file financial statements
with state insurance regulatory authorities using
accounting principles and practices established by those
authorities, which we refer to as statutory accounting
principles (SAP). Accounting principles used to prepare
these statutory financial statements differ from financial
statements prepared on the basis of generally accepted
accounting principles.
Reconciliations of statutory net income and capital
and surplus, as determined using SAP, to the amounts
included in the accompanying financial statements are
as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, |
|
|
2009 |
|
2008 |
|
2007 |
|
Statutory net income of
insurance subsidiaries |
|
$ |
13,754,818 |
|
|
$ |
25,946,589 |
|
|
$ |
39,263,778 |
|
Increases (decreases): |
|
|
|
|
|
|
|
|
|
|
|
|
Deferred policy
acquisition costs |
|
|
3,302,898 |
|
|
|
3,306,209 |
|
|
|
1,496,143 |
|
Deferred federal
income taxes |
|
|
1,250,187 |
|
|
|
811,722 |
|
|
|
(1,029,042 |
) |
Salvage and subrogation
recoverable |
|
|
542,000 |
|
|
|
270,000 |
|
|
|
131,000 |
|
Consolidating eliminations
and adjustments |
|
|
(13,521,106 |
) |
|
|
(23,708,578 |
) |
|
|
(17,731,328 |
) |
Parent-only net income |
|
|
13,501,281 |
|
|
|
18,916,036 |
|
|
|
16,149,354 |
|
|
Net income as
reported herein |
|
$ |
18,830,078 |
|
|
$ |
25,541,978 |
|
|
$ |
38,279,905 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, |
|
|
2009 |
|
2008 |
|
2007 |
|
Statutory capital and surplus
of insurance subsidiaries |
|
$ |
333,332,774 |
|
|
$ |
324,904,680 |
|
|
$ |
310,462,848 |
|
Increases (decreases): |
|
|
|
|
|
|
|
|
|
|
|
|
Deferred policy
acquisition costs |
|
|
32,844,179 |
|
|
|
29,541,281 |
|
|
|
26,235,072 |
|
Deferred federal
income taxes |
|
|
(15,676,995 |
) |
|
|
(5,914,123 |
) |
|
|
(7,918,623 |
) |
Salvage and subrogation
recoverable |
|
|
9,207,000 |
|
|
|
8,665,000 |
|
|
|
8,275,000 |
|
Non-admitted assets and
other adjustments, net |
|
|
2,913,878 |
|
|
|
2,795,785 |
|
|
|
1,906,929 |
|
Fixed maturities |
|
|
13,135,848 |
|
|
|
(3,419,625 |
) |
|
|
4,637,841 |
|
Parent-only equity and
other adjustments |
|
|
9,749,015 |
|
|
|
7,010,867 |
|
|
|
9,091,124 |
|
|
Stockholders equity as
reported herein |
|
$ |
385,505,699 |
|
|
$ |
363,583,865 |
|
|
$ |
352,690,191 |
|
|
33
17 Supplementary Cash Flow Information
The following table reflects income taxes and interest
paid during 2009, 2008 and 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2009 |
|
2008 |
|
2007 |
|
Income taxes |
|
$ |
1,307,418 |
|
|
$ |
9,325,000 |
|
|
$ |
11,300,000 |
|
|
Interest |
|
$ |
1,828,278 |
|
|
$ |
2,040,017 |
|
|
$ |
2,905,512 |
|
|
During 2009, we paid interest and penalties in the
amount of $974,204 related to a premium tax litigation
settlement. We recorded this amount as interest expense in
accordance with our accounting policy.
18 Earnings Per Share
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 cash dividends that are at
least 10% higher than the cash dividends declared and paid
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
reflecting the dividend rights of each class.
We present below a reconciliation of the numerators and
denominators we used in the basic and diluted per share
computations for our Class A common stock:
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in thousands, except per share data) |
Year Ended December 31, |
|
2009 |
|
2008 |
|
2007 |
|
Basic earnings per share: |
|
|
|
|
|
|
|
|
|
|
|
|
Numerator: |
|
|
|
|
|
|
|
|
|
|
|
|
Allocation of net income |
|
$ |
15,049 |
|
|
$ |
20,404 |
|
|
$ |
30,514 |
|
|
Denominator: |
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average
shares outstanding |
|
|
19,903,069 |
|
|
|
19,866,099 |
|
|
|
19,685,674 |
|
|
Basic earnings per share |
|
$ |
0.76 |
|
|
$ |
1.03 |
|
|
$ |
1.55 |
|
|
Diluted earnings per share: |
|
|
|
|
|
|
|
|
|
|
|
|
Numerator: |
|
|
|
|
|
|
|
|
|
|
|
|
Allocation of net income |
|
$ |
15,049 |
|
|
$ |
20,404 |
|
|
$ |
30,514 |
|
|
Denominator: |
|
|
|
|
|
|
|
|
|
|
|
|
Number of shares used in
basic computation |
|
|
19,903,069 |
|
|
|
19,866,099 |
|
|
|
19,685,674 |
|
Weighted-average effect of
dilutive securities
|
|
|
|
|
|
|
|
|
|
|
|
|
Add: Director and employee stock options |
|
|
|
|
|
|
89,419 |
|
|
|
277,184 |
|
|
Number of shares used in
per share computations |
|
|
19,903,069 |
|
|
|
19,955,518 |
|
|
|
19,962,858 |
|
|
Diluted earnings per share |
|
$ |
0.76 |
|
|
$ |
1.02 |
|
|
$ |
1.53 |
|
|
We used the following information in the basic
and diluted per share computations for our Class B
common stock:
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in thousands, except per share data) |
Year Ended December 31, |
|
2009 |
|
2008 |
|
2007 |
|
Basic and diluted
earnings per share: |
|
|
|
|
|
|
|
|
|
|
|
|
Numerator: |
|
|
|
|
|
|
|
|
|
|
|
|
Allocation of net income |
|
$ |
3,781 |
|
|
$ |
5,138 |
|
|
$ |
7,766 |
|
|
Denominator: |
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average
shares outstanding |
|
|
5,576,775 |
|
|
|
5,576,775 |
|
|
|
5,576,775 |
|
|
Basic and diluted
earnings per share |
|
$ |
0.68 |
|
|
$ |
0.92 |
|
|
$ |
1.39 |
|
|
During 2009, 2008 and 2007, we did not include
certain options to purchase shares of common stock in
the computation of diluted earnings per share because
the exercise price of the options was greater than the
average market price. The following reflects such
options that remained outstanding at December 31, 2009,
2008 and 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2009 |
|
2008 |
|
2007 |
|
Options excluded from diluted
earnings per share |
|
|
3,290,099 |
|
|
|
1,018,167 |
|
|
|
1,028,667 |
|
|
19 Condensed Financial Information of Parent Company
|
|
|
|
|
|
|
|
|
|
|
|
|
Condensed Balance
Sheets |
(in thousands) |
December 31, |
|
2009 |
|
2008 |
|
|
|
|
|
Assets |
|
|
|
|
|
|
|
|
|
|
|
|
Fixed-maturity investments |
|
$ |
|
|
|
$ |
|
|
|
|
|
|
Investment in subsidiaries/affiliates
(equity method) |
|
|
385,445 |
|
|
|
366,252 |
|
|
|
|
|
Short-term investments |
|
|
15,445 |
|
|
|
12,836 |
|
|
|
|
|
Cash |
|
|
1,105 |
|
|
|
1,612 |
|
|
|
|
|
Property and equipment |
|
|
1,262 |
|
|
|
1,067 |
|
|
|
|
|
Other |
|
|
875 |
|
|
|
594 |
|
|
|
|
|
|
Total assets |
|
$ |
404,132 |
|
|
$ |
382,361 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities and Stockholders Equity |
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities |
|
|
|
|
|
|
|
|
|
|
|
|
Cash dividends declared to stockholders |
|
$ |
2,798 |
|
|
$ |
2,602 |
|
|
|
|
|
Subordinated debentures |
|
|
15,465 |
|
|
|
15,465 |
|
|
|
|
|
Other |
|
|
364 |
|
|
|
710 |
|
|
|
|
|
|
Total liabilities |
|
|
18,627 |
|
|
|
18,777 |
|
|
|
|
|
|
Stockholders equity |
|
|
385,505 |
|
|
|
363,584 |
|
|
|
|
|
|
Total liabilities and stockholders equity |
|
$ |
404,132 |
|
|
$ |
382,361 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Condensed Statements
of Income and Comprehensive Income |
(in thousands) |
Year Ended December 31, |
|
2009 |
|
2008 |
|
2007 |
|
Statements of Income |
|
|
|
|
|
|
|
|
|
|
|
|
Revenues |
|
|
|
|
|
|
|
|
|
|
|
|
Dividends from subsidiaries |
|
$ |
14,000 |
|
|
$ |
20,000 |
|
|
$ |
18,000 |
|
Other |
|
|
1,005 |
|
|
|
1,785 |
|
|
|
1,950 |
|
|
Total revenues |
|
|
15,005 |
|
|
|
21,785 |
|
|
|
19,950 |
|
|
Expenses |
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses |
|
|
1,019 |
|
|
|
1,558 |
|
|
|
1,896 |
|
Interest |
|
|
773 |
|
|
|
1,822 |
|
|
|
2,886 |
|
|
Total expenses |
|
|
1,792 |
|
|
|
3,380 |
|
|
|
4,782 |
|
|
Income before income tax benefit
and equity in undistributed net
income of subsidiaries |
|
|
13,213 |
|
|
|
18,405 |
|
|
|
15,168 |
|
Income tax benefit |
|
|
(288 |
) |
|
|
(511 |
) |
|
|
(981 |
) |
|
Income before equity in
undistributed net income
of subsidiaries |
|
|
13,501 |
|
|
|
18,916 |
|
|
|
16,149 |
|
|
Equity in undistributed
net income of subsidiaries |
|
|
5,329 |
|
|
|
6,626 |
|
|
|
22,131 |
|
|
Net income |
|
$ |
18,830 |
|
|
$ |
25,542 |
|
|
$ |
38,280 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Statements of
Comprehensive Income |
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
18,830 |
|
|
$ |
25,542 |
|
|
$ |
38,280 |
|
|
Other comprehensive (loss) income,
net of tax |
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized (loss) gain parent |
|
|
|
|
|
|
(60 |
) |
|
|
102 |
|
Unrealized gain (loss) subsidiaries |
|
|
13,293 |
|
|
|
(5,201 |
) |
|
|
1,811 |
|
|
Other comprehensive income (loss),
net of tax |
|
|
13,293 |
|
|
|
(5,261 |
) |
|
|
1,913 |
|
|
Comprehensive income |
|
$ |
32,123 |
|
|
$ |
20,281 |
|
|
$ |
40,193 |
|
|
34
|
|
|
|
|
|
|
|
|
|
|
|
|
Condensed Statements
of Cash Flows |
(in thousands) |
Year Ended December 31, |
|
2009 |
|
2008 |
|
2007 |
|
Cash flows from operating activities: |
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
18,830 |
|
|
$ |
25,542 |
|
|
$ |
38,280 |
|
|
Adjustments: |
|
|
|
|
|
|
|
|
|
|
|
|
Equity in undistributed net
income of subsidiaries |
|
|
(5,329 |
) |
|
|
(6,626 |
) |
|
|
(22,131 |
) |
Other |
|
|
(669 |
) |
|
|
924 |
|
|
|
254 |
|
|
Net adjustments |
|
|
(5,998 |
) |
|
|
(5,702 |
) |
|
|
(21,877 |
) |
|
Net cash provided |
|
|
12,832 |
|
|
|
19,840 |
|
|
|
16,403 |
|
|
Cash flows from investing activities: |
|
|
|
|
|
|
|
|
|
|
|
|
Net sale of fixed maturities |
|
|
|
|
|
|
5,214 |
|
|
|
2,000 |
|
Net (purchase) sale of short-term
investments |
|
|
(2,609 |
) |
|
|
11,367 |
|
|
|
(9,174 |
) |
Net purchase of property and
equipment |
|
|
(644 |
) |
|
|
(408 |
) |
|
|
(428 |
) |
Investment in subsidiaries |
|
|
(100 |
) |
|
|
(11,568 |
) |
|
|
(50 |
) |
Other |
|
|
19 |
|
|
|
110 |
|
|
|
189 |
|
|
Net cash (used) provided |
|
|
(3,334 |
) |
|
|
4,715 |
|
|
|
(7,463 |
) |
|
Cash flows from financing activities: |
|
|
|
|
|
|
|
|
|
|
|
|
Cash dividends paid |
|
|
(10,998 |
) |
|
|
(10,026 |
) |
|
|
(8,627 |
) |
Issuance of common stock |
|
|
1,386 |
|
|
|
3,857 |
|
|
|
3,543 |
|
Tax benefit on exercise of stock options |
|
|
|
|
|
|
684 |
|
|
|
855 |
|
Redemption of subordinated debentures |
|
|
|
|
|
|
(15,464 |
) |
|
|
|
|
Repurchase of treasury stock |
|
|
(393 |
) |
|
|
(3,511 |
) |
|
|
(4,308 |
) |
|
Net cash used |
|
|
(10,005 |
) |
|
|
(24,460 |
) |
|
|
(8,537 |
) |
|
Net change in cash |
|
|
(507 |
) |
|
|
95 |
|
|
|
403 |
|
Cash at beginning of year |
|
|
1,612 |
|
|
|
1,517 |
|
|
|
1,114 |
|
|
Cash at end of year |
|
$ |
1,105 |
|
|
$ |
1,612 |
|
|
$ |
1,517 |
|
|
20 Segment Information
We have three reportable segments, which consist of our
investment function, our personal lines of insurance
and our commercial lines of insurance. Using
independent agents, our insurance subsidiaries market
personal lines of insurance to individuals and
commercial lines of insurance to small and medium-sized
businesses.
We evaluate the performance of our personal lines and
commercial lines primarily based upon our insurance
subsidiaries underwriting results as determined under
SAP for our total business.
We do not allocate assets to our personal and commercial
lines and review them 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.
Financial data by segment is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2009 |
|
2008 |
|
2007 |
|
|
(in thousands) |
|
|
|
|
|
Revenues |
|
|
|
|
|
|
|
|
|
|
|
|
Premiums earned: |
|
|
|
|
|
|
|
|
|
|
|
|
Commercial lines |
|
$ |
113,233 |
|
|
$ |
121,567 |
|
|
$ |
113,642 |
|
Personal lines |
|
|
242,313 |
|
|
|
225,143 |
|
|
|
196,429 |
|
|
SAP premiums earned |
|
|
355,546 |
|
|
|
346,710 |
|
|
|
310,071 |
|
GAAP adjustments |
|
|
(521 |
) |
|
|
(135 |
) |
|
|
|
|
|
GAAP premiums earned |
|
|
355,025 |
|
|
|
346,575 |
|
|
|
310,071 |
|
Net investment income |
|
|
20,631 |
|
|
|
22,756 |
|
|
|
22,785 |
|
Realized investment gains (losses) |
|
|
4,480 |
|
|
|
(2,971 |
) |
|
|
2,051 |
|
Other |
|
|
6,597 |
|
|
|
6,064 |
|
|
|
5,711 |
|
|
Total revenues |
|
$ |
386,733 |
|
|
$ |
372,424 |
|
|
$ |
340,618 |
|
|
Income before income tax expense: |
|
|
|
|
|
|
|
|
|
|
|
|
Underwriting income (loss): |
|
|
|
|
|
|
|
|
|
|
|
|
Commercial lines |
|
$ |
5,805 |
|
|
$ |
13,819 |
|
|
$ |
22,744 |
|
Personal lines |
|
|
(17,235 |
) |
|
|
(7,609 |
) |
|
|
1,736 |
|
|
SAP underwriting (loss) income |
|
|
(11,430 |
) |
|
|
6,210 |
|
|
|
24,480 |
|
GAAP adjustments |
|
|
3,636 |
|
|
|
3,530 |
|
|
|
2,603 |
|
|
GAAP underwriting (loss) income |
|
|
(7,794 |
) |
|
|
9,740 |
|
|
|
27,083 |
|
Net investment income |
|
|
20,631 |
|
|
|
22,756 |
|
|
|
22,785 |
|
Realized investment gains (losses) |
|
|
4,480 |
|
|
|
(2,971 |
) |
|
|
2,051 |
|
Other |
|
|
3,360 |
|
|
|
2,567 |
|
|
|
930 |
|
|
Income before income tax expense |
|
$ |
20,677 |
|
|
$ |
32,092 |
|
|
$ |
52,849 |
|
|
21 Guaranty Fund and Other Insurance-Related Assessments
Our insurance subsidiaries liabilities for guaranty fund
and other insurance-related assessments were $2,663,049
and $2,603,899 at December 31, 2009 and 2008,
respectively. These liabilities included $517,610 and
$307,456 related to surcharges collected by our insurance
subsidiaries on behalf of regulatory authorities for 2009
and 2008, respectively.
22 Interim Financial Data (unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2009 |
|
|
First |
|
Second |
|
Third |
|
Fourth |
|
|
Quarter |
|
Quarter |
|
Quarter |
|
Quarter |
|
Net premiums earned |
|
$ |
88,349,543 |
|
|
$ |
87,540,345 |
|
|
$ |
87,997,723 |
|
|
$ |
91,137,866 |
|
Total revenues |
|
|
95,501,614 |
|
|
|
94,823,420 |
|
|
|
94,882,167 |
|
|
|
101,526,206 |
|
Net losses and loss
expenses |
|
|
65,949,165 |
|
|
|
61,903,131 |
|
|
|
58,609,247 |
|
|
|
64,373,853 |
|
Net income |
|
|
169,804 |
|
|
|
4,387,624 |
|
|
|
6,744,851 |
|
|
|
7,527,799 |
|
Net earnings per
common share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Class A common
stock basic |
|
|
0.01 |
|
|
|
0.18 |
|
|
|
0.27 |
|
|
|
0.30 |
|
Class A common
stock diluted |
|
|
0.01 |
|
|
|
0.18 |
|
|
|
0.27 |
|
|
|
0.30 |
|
Class B common
stock basic
and diluted |
|
|
0.01 |
|
|
|
0.16 |
|
|
|
0.24 |
|
|
|
0.27 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2008 |
|
|
First |
|
Second |
|
Third |
|
Fourth |
|
|
Quarter |
|
Quarter |
|
Quarter |
|
Quarter |
|
Net premiums earned |
|
$ |
82,007,766 |
|
|
$ |
87,329,195 |
|
|
$ |
88,170,757 |
|
|
$ |
89,067,548 |
|
Total revenues |
|
|
89,773,677 |
|
|
|
94,026,701 |
|
|
|
92,733,420 |
|
|
|
95,890,429 |
|
Net losses and loss
expenses |
|
|
53,785,061 |
|
|
|
56,364,145 |
|
|
|
54,700,316 |
|
|
|
59,451,442 |
|
Net income |
|
|
6,559,083 |
|
|
|
6,318,177 |
|
|
|
6,270,421 |
|
|
|
6,394,297 |
|
Net earnings per
common share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Class A common
stock basic |
|
|
0.26 |
|
|
|
0.25 |
|
|
|
0.25 |
|
|
|
0.26 |
|
Class A common
stock diluted |
|
|
0.26 |
|
|
|
0.25 |
|
|
|
0.25 |
|
|
|
0.26 |
|
Class B common
stock basic
and diluted |
|
|
0.24 |
|
|
|
0.23 |
|
|
|
0.23 |
|
|
|
0.23 |
|
|
35
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and Board of Directors of Donegal Group Inc.
We have audited the accompanying consolidated balance sheets of Donegal Group Inc. and subsidiaries
(Company) as of December 31, 2009 and 2008, and the related consolidated statements of income and
comprehensive income, stockholders equity, and cash flows for each of the years in the three-year
period ended December 31, 2009. These consolidated financial statements are the responsibility of
the Companys management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all
material respects, the financial position of Donegal Group Inc. and subsidiaries as of December 31,
2009 and 2008, and the results of their operations and their cash flows for each of the years in
the three-year period ended December 31, 2009, in conformity with U.S. generally accepted
accounting principles.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), Donegal Group Inc.s internal control over financial reporting as of
December 31, 2009 based on the criteria established in Internal Control Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our
report dated March 11, 2010 expressed an unqualified opinion on the effectiveness of the Companys
internal control over financial reporting.
Philadelphia, Pennsylvania
March 11, 2010
36
MANAGEMENTS REPORT ON INTERNAL CONTROL
OVER FINANCIAL REPORTING
Our management is responsible for establishing and maintaining adequate internal control over
financial reporting, as that term is defined in Rule 13a-15(f) under the Securities Exchange Act of
1934. Under the supervision and with the participation of our Chief Executive Officer and our Chief
Financial Officer, our management has conducted an evaluation of the effectiveness of our internal
control over financial reporting as of December 31, 2009, based on the framework and criteria
established in Internal Control Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (the COSO Framework).
Based on our evaluation under the COSO Framework, our management has concluded that our internal
control over financial reporting was effective as of
December 31, 2009.
Internal control over financial reporting cannot provide absolute assurance of achieving financial
reporting objectives because of its inherent limitations. Internal control over financial reporting
is a process that involves human diligence and compliance and is subject to lapses in judgment and
breakdowns resulting from human failures. Internal control over financial reporting also can be
circumvented by collusion or improper management override. Because of such limitations, there is a
risk that material misstatements may not be prevented or detected on a timely basis by internal
control over financial reporting. However, these inherent limitations are known features of the
financial reporting process. Therefore, it is possible to design into the process safeguards to
reduce, though not eliminate, this risk.
Because of its inherent limitations, a system of internal control over financial reporting may not
prevent or detect all misstatements. Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become inadequate because of changes in
conditions, or the degree of compliance with the policies or procedures may deteriorate.
The effectiveness of our internal control over financial reporting has been audited by KPMG LLP, an
independent registered public accounting firm, as stated in their report which is included herein.
Donald H. Nikolaus
President and Chief Executive Officer
Jeffrey D. Miller
Senior Vice President and Chief Financial Officer
March 11, 2010
37
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and Board of Directors of Donegal Group Inc.
We have audited Donegal Group Inc.s (Company) internal control over financial reporting as of
December 31, 2009, based on criteria established in Internal Control Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Donegal Group
Inc.s management is responsible for maintaining effective internal control over financial
reporting and for its assessment of the effectiveness of internal control over financial reporting,
included in the accompanying Managements Report on Internal Control Over Financial Reporting. Our
responsibility is to express an opinion on the Companys internal control over financial reporting
based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether effective internal control over financial reporting was
maintained in all material respects. Our audit included obtaining an understanding of internal
control over financial reporting, assessing the risk that a material weakness exists, and testing
and evaluating the design and operating effectiveness of internal control based on the assessed
risk. Our audit also included performing such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable basis for our opinion.
A companys internal control over financial reporting is a process designed to provide reasonable
assurance regarding the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted accounting principles. A
companys internal control over financial reporting includes those policies and procedures that (1)
pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of the assets of the company; (2) provide reasonable assurance that
transactions are recorded as necessary to permit preparation of financial statements in accordance
with generally accepted accounting principles, and that receipts and expenditures of the company
are being made only in accordance with authorizations of management and directors of the company;
and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the companys assets that could have a material effect on the
financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or
detect misstatements. Also, projections of any evaluation of effectiveness to future periods are
subject to the risk that controls may become inadequate because of changes in conditions, or that
the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Donegal Group Inc. maintained, in all material respects, effective internal control
over financial reporting as of December 31, 2009, based on
criteria established in Internal Control Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), the consolidated balance sheets of Donegal Group Inc. and subsidiaries as of
December 31, 2009 and 2008, and the related consolidated statements of income and comprehensive
income, stockholders equity, and cash flows for each of the years in the three-year period ended
December 31, 2009, and our report dated March 11, 2010 expressed an unqualified opinion on those
consolidated financial statements.
Philadelphia, Pennsylvania
March 11, 2010
38
COMPARISON OF TOTAL RETURN ON OUR
COMMON STOCK WITH CERTAIN
AVERAGES
The following graph provides an indicator of cumulative total stockholder returns on our common
stock compared to the Russell 2000 Index and a peer group of property and casualty insurance
companies selected by Value Line, Inc. The members of the peer group are as follows: 21st Century
Holding Co., Acceptance Insurance Cos. Inc., ACE Ltd., ACMAT Corp., Affirmative Insurance Holdings
Inc., Allied World Assurance Co. Holdings Ltd., Allstate Corp., American Financial Group Inc.,
American Physicians Capital Inc., American Safety Insurance Holdings Ltd., AMERISAFE Inc., AmTrust
Financial Services Inc., Anthony Clark International Insurance Brokers Ltd., Arch Capital Group
Ltd., Argo Group International Holdings Ltd., Aspen Insurance Holdings Ltd., AssuranceAmerica
Corp., Assurant Inc., AXIS Capital Holdings Ltd., Baldwin & Lyons Inc. (Cl A), Baldwin & Lyons Inc.
(Cl B), Chubb Corp., Cincinnati Financial Corp., CNA Financial Corp., CNA Surety Corp., Cninsure
Inc., Conseco Inc., CRM Holdings Ltd., Donegal Group Inc. (Cl A), Donegal Group Inc. (Cl B),
Eastern Insurance Holdings Inc., eHealth Inc., EMC Insurance Group Inc., Employers Holdings Inc.,
Endurance Specialty Holdings Ltd., Erie Indemnity Co. (Cl A), Fairfax Financial Holdings Ltd.,
Fidelity National Financial Inc., First Mercury Financial Corp., Flagstone Reinsurance Holdings
Ltd., Fremont Michigan InsuraCorp Inc., GAINSCO Inc., Hallmark Financial Services Inc.,
Harleysville Group Inc., HCC Insurance Holdings Inc., Homeowners Choice Inc., Industrial Alliance
Insurance & Financial Services Inc., Infinity Property & Casualty Corp., Kingsway Financial
Services Inc., Maiden Holdings Ltd., Manifold Capital Corp., Markel Corp., Meadowbrook Insurance
Group Inc., Mercer Insurance Group Inc., Mercury General Corp., Montpelier Re Holdings Ltd.,
National Interstate Corp., Old Republic International Corp., OneBeacon Insurance Group Ltd. (Cl A),
Penn Millers Holding Corp., Platinum Underwriters Holdings Ltd., PMA Capital Corp. (Cl A), PMI
Group Inc., Progressive Corp., RLI Corp., Safety Insurance Group Inc., SeaBright Insurance Holdings
Inc., Selective Insurance Group Inc., Specialty Underwriters Alli Com, State Auto Financial Corp.,
Sun Life Financial Inc., The Hanover Insurance Group Inc., Tower Group Inc., Travelers Cos. Inc.,
United America Indemnity Ltd., United Fire & Casualty Co., United Insurance Holdings Corp.,
Universal Insurance Holdings Inc., Validus Holdings Ltd., W.R. Berkley Corp., XL Capital Ltd. (Cl
A) and Zenith National Insurance Corp.
Comparison of Five-Year Cumulative Total Return*
Donegal Group Inc. Class A, Donegal Group Inc. Class B, Russell 2000 Index and Value Line Insurance (Property/Casualty)
Assumes $100 invested at the close of trading on December 31, 2004 in Donegal Group Inc. Class A
common stock, Donegal Group Inc. Class B common stock, Russell 2000 Index and Value Line Insurance
(Property/Casualty).
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2004 |
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2005 |
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2006 |
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2007 |
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2008 |
|
2009 |
Donegal Group Inc.
Class A |
|
$ |
100.00 |
|
|
$ |
139.16 |
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$ |
159.36 |
|
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$ |
142.68 |
|
|
$ |
142.76 |
|
|
$ |
136.20 |
|
Donegal Group Inc.
Class B |
|
|
100.00 |
|
|
|
129.76 |
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|
|
147.95 |
|
|
|
152.59 |
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|
|
145.66 |
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|
|
146.90 |
|
Russell 2000 Index |
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|
100.00 |
|
|
|
103.32 |
|
|
|
120.89 |
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|
|
117.57 |
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|
|
76.65 |
|
|
|
95.98 |
|
Insurance
(Property/Casualty) |
|
|
100.00 |
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|
|
110.92 |
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|
|
126.97 |
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|
|
154.61 |
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|
110.20 |
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|
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135.70 |
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* |
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Cumulative total return assumes reinvestment of dividends. |
39
CORPORATE INFORMATION
Annual Meeting
April 15, 2010 at the Companys headquarters at 10:00 a.m.
Form 10-K
A copy of Donegal Groups Annual Report on
Form 10-K will be furnished free upon
written request to Jeffrey D. Miller,
Senior Vice President and Chief Financial
Officer, at the corporate address.
Market Information
Donegal Groups Class A common stock and
Class B common stock trade on the NASDAQ
Global Select Market under the symbols
DGICA and DGICB. The following table
shows the dividends paid per share and the
stock price range for both classes of stock
for each quarter during 2009 and 2008:
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Cash |
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Dividend |
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Declared |
Quarter |
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High |
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Low |
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Per Share |
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2008 Class A |
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|
|
1st |
|
$ |
18.00 |
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|
$ |
15.60 |
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|
$ |
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2nd |
|
|
17.95 |
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|
|
15.51 |
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|
|
.105 |
|
3rd |
|
|
23.00 |
|
|
|
15.31 |
|
|
|
.105 |
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4th |
|
|
18.00 |
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|
|
11.24 |
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|
.21 |
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2008 Class B |
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|
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1st |
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$ |
19.98 |
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$ |
17.67 |
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$ |
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2nd |
|
|
19.01 |
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|
17.00 |
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|
.0925 |
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3rd |
|
|
18.93 |
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17.00 |
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|
.0925 |
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4th |
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18.76 |
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|
11.04 |
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|
.185 |
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2009 Class A |
|
|
|
|
|
|
|
|
|
|
|
|
1st |
|
$ |
17.00 |
|
|
$ |
12.25 |
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|
$ |
|
|
2nd |
|
|
17.47 |
|
|
|
13.61 |
|
|
|
.1125 |
|
3rd |
|
|
16.60 |
|
|
|
14.31 |
|
|
|
.1125 |
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4th |
|
|
16.02 |
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|
|
14.22 |
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|
.225 |
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2009 Class B |
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1st |
|
$ |
17.50 |
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$ |
13.06 |
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$ |
|
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2nd |
|
|
16.68 |
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|
|
13.41 |
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|
.10 |
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3rd |
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|
17.68 |
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12.75 |
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.10 |
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4th |
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22.00 |
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15.43 |
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.20 |
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Corporate Offices
1195 River Road
P.O. Box 302
Marietta, Pennsylvania 17547-0302
(800) 877-0600
E-mail Address: info@donegalgroup.com
Donegal Web Site: www.donegalgroup.com
Transfer Agent
Computershare Trust Company, N.A.
P.O. Box 43078
Providence, Rhode Island 02940-3078
(800) 317-4445
Web Site: www.computershare.com
Hearing Impaired: TDD: 800-952-9245
Dividend Reinvestment and Stock Purchase Plan
The Company offers a dividend
reinvestment and stock purchase plan
through its transfer agent.
For information contact:
Donegal Group Inc.
Dividend Reinvestment and Stock Purchase Plan
Computershare Trust Company, N.A.
P.O. Box 43078
Providence, Rhode Island 02940-3078
Stockholders
The following represent the number of
common stockholders of record
as of December 31, 2009:
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Class A common stock |
|
|
1,220 |
|
Class B common stock |
|
|
421 |
|
40
exv21
EXHIBIT 21
SUBSIDIARIES OF REGISTRANT
Registrant owns 100% of the outstanding stock of the following companies, except as noted:
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Name |
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State of Formation |
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Atlantic States Insurance Company |
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Pennsylvania |
Southern Insurance Company of Virginia |
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Virginia |
Le Mars Insurance Company |
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Iowa |
The Peninsula Insurance Company |
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Maryland |
Peninsula Indemnity Company* |
|
Maryland |
Donegal Financial Services Corporation** |
|
Delaware |
Province BankFSB*** |
|
U.S. |
Sheboygan Falls Insurance Company |
|
Wisconsin |
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* |
|
Wholly owned by The Peninsula Insurance Company. |
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** |
|
Registrant owns 48.2%. Donegal Mutual Insurance Company owns 51.8%. |
|
*** |
|
Wholly owned by Donegal Financial Services Corporation. |
exv23
EXHIBIT 23
REPORT AND CONSENT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors
Donegal Group Inc.:
The audits referred to in our audit report dated March 11, 2010 with respect to the
consolidated financial statements of Donegal Group Inc. and subsidiaries (Company) included the
related financial statement schedule as of December 31, 2009 and 2008, and for each of the years in
the three-year period ended December 31, 2009, included in the annual report on Form 10-K. This
financial statement schedule is the responsibility of the Companys management. Our responsibility
is to express an opinion on this financial statement schedule based on our audits. In our opinion,
such financial statement schedule, when considered in relation to the basic consolidated financial
statements taken as a whole, presents fairly in all material respects the information set forth
therein.
We consent to the incorporation by reference in the registration statements (Nos. 333-93785,
333-94301, 333-89644, 333-62970, 333-62974, 333-62976 and 333-142614) on Form S-8 and registration
statements (Nos. 333-59828 and 333-63102) on Form S-3 of Donegal Group Inc. of our reports dated
March 11, 2010, with respect to the consolidated balance sheets of Donegal Group Inc. and
subsidiaries as of December 31, 2009 and 2008, and the related consolidated statements of income
and comprehensive income, stockholders equity and cash flows for each of the years in the
three-year period ended December 31, 2009, and the related financial statement schedule and the
effectiveness of internal control over financial reporting as of December 31, 2009, which reports
are incorporated by reference or appear in the December 31, 2009 annual report on Form 10-K of
Donegal Group Inc.
/s/ KPMG LLP
Philadelphia, Pennsylvania
March 11, 2010
exv31w1
EXHIBIT 31.1
CERTIFICATION
I, Donald H. Nikolaus, certify that:
1. I have reviewed this annual report on Form 10-K for the year ended December 31, 2009 of
Donegal Group Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact
or omit to state a material fact necessary to make the statements made, in light of the
circumstances under which such statements were made, not misleading with respect to the period
covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included
in this report, fairly present in all material respects the financial condition, results of
operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrants other certifying officer and I are responsible for establishing and
maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and
15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules
13a-15(f) and 15a-15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and
procedures to be designed under our supervision, to ensure that material information relating to
the registrant, including its consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control
over financial reporting to be designed under our supervision, to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting principles;
(c) Evaluated the effectiveness of the registrants disclosure controls and procedures and
presented in this report our conclusions about the effectiveness of the disclosure controls and
procedures, as of the end of the period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrants internal control over financial
reporting that occurred during the registrants most recent fiscal quarter (the registrants fourth
fiscal quarter in the case of an annual report) that has materially affected,
or is reasonably likely to materially affect, the registrants internal control over financial
reporting; and
5. The registrants other certifying officer and I have disclosed, based on our most recent
evaluation of internal control over financial reporting, to the registrants auditors and the audit
committee of registrants board of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or operation of
internal control over financial reporting which are reasonably likely to adversely affect the
registrants ability to record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a
significant role in the registrants internal control over financial reporting.
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/s/ Donald H. Nikolaus
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Donald H. Nikolaus, President |
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Date: March 11, 2010
-2-
exv31w2
EXHIBIT 31.2
CERTIFICATION
I, Jeffrey D. Miller, certify that:
1. I have reviewed this annual report on Form 10-K for the year ended December 31, 2009 of
Donegal Group Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact
or omit to state a material fact necessary to make the statements made, in light of the
circumstances under which such statements were made, not misleading with respect to the period
covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included
in this report, fairly present in all material respects the financial condition, results of
operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrants other certifying officer and I are responsible for establishing and
maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and
15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules
13a-15(f) and 15a-15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and
procedures to be designed under our supervision, to ensure that material information relating to
the registrant, including its consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control
over financial reporting to be designed under our supervision, to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting principles;
(c) Evaluated the effectiveness of the registrants disclosure controls and procedures and
presented in this report our conclusions about the effectiveness of the disclosure controls and
procedures, as of the end of the period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrants internal control over financial
reporting that occurred during the registrants most recent fiscal quarter (the registrants fourth
fiscal quarter in the case of an annual report) that has materially affected,
or is reasonably likely to materially affect, the registrants internal control over financial
reporting; and
5. The registrants other certifying officer and I have disclosed, based on our most recent
evaluation of internal control over financial reporting, to the registrants auditors and the audit
committee of registrants board of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or operation of
internal control over financial reporting which are reasonably likely to adversely affect the
registrants ability to record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a
significant role in the registrants internal control over financial reporting.
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/s/ Jeffrey D. Miller
|
|
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Jeffrey D. Miller, Senior Vice President |
|
|
and Chief Financial Officer |
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|
Date: March 11, 2010
-2-
exv32w1
EXHIBIT 32.1
Statement of President
Pursuant to Section 1350 of Title 18 of the United States Code
Pursuant to Section 1350 of Title 18 of the United States Code, I, Donald H. Nikolaus, the
President of Donegal Group Inc. (the Company), hereby certify that, to the best of my knowledge:
1. The Companys Form 10-K Annual Report for the period ended December 31, 2009 (the Report)
fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of
1934; and
2. The information contained in the Report fairly presents, in all material respects, the
financial condition and results of operations of the Company.
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/s/ Donald H. Nikolaus
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Donald H. Nikolaus, President |
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Date: March 11, 2010
exv32w2
EXHIBIT 32.2
Statement of Chief Financial Officer
Pursuant to Section 1350 of Title 18 of the United States Code
Pursuant to Section 1350 of Title 18 of the United States Code, I, Jeffrey D. Miller, Vice
President and Chief Financial Officer of Donegal Group Inc. (the Company), hereby certify that,
to the best of my knowledge:
1. The Companys Form 10-K Annual Report for the period ended December 31, 2009 (the Report)
fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of
1934; and
2. The information contained in the Report fairly presents, in all material respects, the
financial condition and results of operations of the Company.
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/s/ Jeffrey D. Miller
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Jeffrey D. Miller, Vice President |
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and Chief Financial Officer |
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Date: March 11, 2010