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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION 
Washington, D.C. 20549 
FORM 10-K
 	 	
[X]	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934	
For the fiscal year ended December 31, 2003 
OR 
 	 	
[  ]	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 
DONEGAL GROUP INC.

(Exact name of registrant as specified in its charter)
 	 	 	
Delaware 	 	23-2424711	

 	
(State or other jurisdiction of
incorporation or organization) 	 	(I.R.S. Employer
Identification No.)	
 	 	 	
1195 River Road, Marietta, Pennsylvania 	 	17547	

 	
(Address of principal executive offices) 	 	(Zip code)	
Registrant’s telephone number, including area code: (888) 877-0600 
Securities registered pursuant to Section 12(b) of the Act: None. 
Securities registered pursuant to Section 12(g) of the Act: 
Class A Common Stock, $.01 par value 

Class B Common Stock, $.01 par value 

(Title of class) 
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 [X]. No [  ]. 

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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 Registrant’s 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. [X] 
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes [  ]. No [X]. 
On June 30, 2003, the aggregate market value (based on the closing sales prices on that date) of the voting stock held by non-affiliates of the Registrant was $41,317,014. 
Indicate the number of shares outstanding of each of the Registrant’s classes of common stock, as of the latest practicable date: 9,809,352 shares of Class A Common Stock and 3,011,049 shares of Class B Common Stock were outstanding on February 20, 2004. 
DOCUMENTS INCORPORATED BY REFERENCE: 
 	1.	 	Portions of the Registrant’s annual report to stockholders for the fiscal year ended December 31, 2003 are incorporated by reference into Parts I, II and IV of this report.		
 	
 	2.	 	Portions of the Registrant’s proxy statement relating to the annual meeting of stockholders to be held April 15, 2004 are incorporated by reference into Part III of this report.		

DONEGAL GROUP INC. 
INDEX TO FORM 10-K REPORT 
 	 	 	 	 		
 	 	Page
		
PART I	 	 	 	 		
Item 1. Business	 	 	1	 		
Item 2. Properties	 	 	40	 		
Item 3. Legal Proceedings	 	 	40	 		
Item 4. Submission of Matters to a Vote of Security Holders	 	 	41	 		
Executive Officers of the Company	 	 	41	 		
PART II	 	 	 	 		
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	 	 	42	 		
Item 6. Selected Financial Data	 	 	42	 		
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations	 	 	42	 		
Item 7A. Quantitative and Qualitative Disclosures About Market Risk	 	 	42	 		
Item 8. Financial Statements and Supplementary Data	 	 	44	 		
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	 	 	44	 		
Item 9A. Controls and Procedures	 	 	44	 		
PART III	 	 	 	 		
Item 10. Directors and Executive Officers of the Registrant	 	 	46	 		
Item 11. Executive Compensation	 	 	46	 		
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	 	 	46	 		
Item 13. Certain Relationships and Related Transactions	 	 	47	 		
Item 14. Principal Accountant Fees and Services	 	 	47	 		
PART IV	 	 	 	 		
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K	 	 	48	 		
 AMENDED AND RESTATED BY-LAWS	
 2003 ANNUAL REPORT TO STOCKHOLDERS	
 CODE OF ETHICS	
 SUBSIDIARIES OF REGISTRANT	
 CONSENT OF INDEPENDENT AUDITORS	
 CERTIFICATION OF CHIEF EXECUTIVE OFFICER	
 CERTIFICATION OF CHIEF FINANCIAL OFFICER	
 SECTION 1350 CERTIFICATION OF CEO	
 SECTION 1350 CERTIFICATION OF CFO	
 (i) 

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PART I 
Item 1. Business. 
General Development of Business. 
          We are a property and casualty insurance holding company whose insurance subsidiaries offer personal and commercial lines of insurance to businesses and individuals in 14 Mid-Atlantic and Southeastern states. We provide our policyholders with a selection of insurance products at competitive rates, while pursuing profitability through adherence to a strict underwriting discipline. At December 31, 2003, we had total assets of $602.0 million and stockholders’ equity of $208.6 million. Our net income was $18.3 million for the year ended December 31, 2003 compared to $12.0 million for the year ended December 31, 2002. 
          Donegal Mutual Insurance Company (the “Mutual Company”) owns approximately 42% of our Class A common stock and approximately 62% of our Class B common stock. The operations of our insurance subsidiaries are interrelated with the operations of the Mutual Company and, while maintaining the separate corporate existence of each company, our insurance subsidiaries and the Mutual Company conduct business together as the Donegal Insurance Group. As such, we share the same business philosophy, management, employees and facilities as the Mutual Company and offer the same types of insurance products. 
          Our growth strategy includes the acquisition of other insurance companies to expand our business in a given region or to commence operations in a new region. Our prior acquisitions have either taken the form of: 
 	•	 	a purchase of the stock of an existing stock insurance company; or		
 	
 	•	 	a two-step acquisition of an existing mutual insurance company as follows:		
 	•	 	First, a surplus note in the target mutual insurance company is purchased, a management agreement with the target mutual insurance company is entered into and our designees are appointed as a majority of the target mutual insurance company’s board of directors.		
 	
 	•	 	Second, the mutual insurance company is demutualized. We acquire the stock of the resulting stock insurance company after the company has been restructured and its book of business has been reunderwritten to our satisfaction.		
          We believe that our ability to make direct acquisitions or to structure acquisitions through Mutual Company surplus note transactions provides us with flexibility that is a competitive advantage in seeking acquisitions. We also believe we have demonstrated our ability to acquire control of a troubled insurance company, reunderwrite its book of business, reduce its cost structure and return it to profitability. When the Mutual 
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Company makes a surplus note investment in another company, the financial results of that company are not consolidated with our financial results or those of the Mutual Company, and neither we nor the Mutual Company are responsible for the insurance obligations of that company. 
          Unless otherwise specifically stated, all information in this Form 10-K Annual Report is as of December 31, 2003. 
Le Mars Insurance Company (“Le Mars”) 
          In June 2002, the Mutual Company consummated an affiliation with Le Mars. As part of this affiliation, the Mutual Company entered into a management agreement with Le Mars and acquired control of Le Mars through the appointment of five Mutual Company designees to Le Mars’ nine-member board of directors. At the time of the affiliation, the Mutual Company made a $4.0 million investment in Le Mars’ surplus and was issued a surplus note, which we refer to as the Le Mars Surplus Note. 
          On August 11, 2003, Le Mars’ board of directors adopted a plan of conversion to convert to a stock insurance company. The plan of conversion was approved by the policyholders of Le Mars on October 6, 2003, and, on October 7, 2003, the Insurance Commissioner of Iowa held a public hearing regarding approval of the plan of conversion. Following the November 2003 regulatory approval of the plan of conversion, we acquired Le Mars as of January 1, 2004 for approximately $12.6 million in cash. 
          Le Mars, which was organized under the laws of Iowa in 1901, operates as a property and casualty insurer in Iowa, Nebraska, Oklahoma and South Dakota. Personal lines coverages represent a majority of Le Mars’ premiums written, with the balance coming from farmowners and mercantile and service businesses. Le Mars’ largest lines of business are private passenger automobile liability and physical damage; its other principal lines are homeowners and commercial multi-peril. Le Mars had net premiums earned of $20.5 million in 2002 and $17.9 million in 2003. The statutory surplus and total admitted assets on a statutory basis of Le Mars as of December 31, 2003 were $12.0 million and $37.0 million, respectively. 
The Peninsula Insurance Group (“Peninsula”) 
          On January 6, 2004, we purchased Peninsula Indemnity Company and The Peninsula Insurance Company, both of which are organized under Maryland law, with headquarters in Salisbury, Maryland from Folksamerica Holding Company, Inc., a part of the White Mountains Insurance Group, Ltd., for a price in cash equal to 107.5% of Peninsula’s GAAP stockholders’ equity as of the closing of the acquisition, or approximately $23.3 million. 
          Peninsula specializes in private passenger automobile coverages. Peninsula also writes homeowners, commercial multi-peril, workers’ compensation and commercial automobile coverages. Peninsula operates primarily in Maryland, Delaware and Virginia. For the years ended December 31, 2002 and 2003, Peninsula had net premiums earned of $29.7 million and $32.7 million, respectively. Peninsula’s stockholders’ equity and total admitted 
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assets on a statutory basis as of December 31, 2003 were $19.5 million and $52.6 million, respectively. The Peninsula companies have an A.M. Best rating of A (Excellent). 
          On December 1, 2003, we completed an underwritten public offering of 3,450,000 shares of our Class A common stock, resulting in net proceeds of $59 million to us. 
Financial Information About Industry Segments. 
          The Company has three segments, which consist of its investment function, its personal lines of insurance and its commercial lines of insurance. Financial information about these segments is set forth in Note 17 to the Consolidated Financial Statements incorporated by reference herein. 
Narrative Description of Business. 
Who We Are 
          We are a property and casualty insurance holding company whose insurance subsidiaries offer personal and commercial lines of insurance to small businesses and individuals in 14 Mid-Atlantic and Southeastern states. We provide our policyholders with a selection of insurance products at competitive rates, while pursuing profitability through adherence to a strict underwriting discipline. 
          We derive a substantial portion of our insurance business from smaller to mid-sized regional communities. We believe this focus provides us with competitive advantages in terms of local market knowledge, marketing, underwriting, claims servicing and policyholder service. At the same time, we believe we have cost advantages over many regional insurers because of our centralized accounting, administrative, investment, data processing and other services. 
Strategy 
          Our annual premiums earned have increased from $117.5 million in 1998 to $196.8 million in 2003, a compound annual growth rate of 10.9%. Over the same time period, our combined ratio has consistently been more favorable than that of the property and casualty insurance industry as a whole. We seek to grow our business and enhance our profitability by: 
•	 	Achieving underwriting profitability.	
          We focus on achieving a combined ratio of less than 100%, and believe that underwriting profitability is a fundamental component of our long-term financial strength because it allows us to generate profits without relying on our investment income. We seek to enhance our underwriting results by carefully selecting the product lines we underwrite, minimizing our exposure to catastrophe-prone areas and continually evaluating our claims history to ensure the adequacy of our underwriting guidelines and product pricing. For our personal lines products, we insure standard and preferred risks primarily in private passenger automobile and homeowners lines. We have no exposure to asbestos, and limited exposure 
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to other environmental liabilities. We seek to provide more than one policy to a given personal or commercial customer because this “account selling” strategy diversifies our risk and has historically improved our underwriting results. Finally, we use reinsurance to manage our exposure and limit our maximum net loss from large single risks or risks in concentrated areas. We believe these practices are key factors in our ability to maintain a combined ratio that has been traditionally more favorable than the combined ratio of the property and casualty insurance industry. 
          Our combined ratio and that of our industry for the years 1998 through 2003 are shown in the following table: 
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	1998
	 	1999
	 	2000
	 	2001
	 	2002
	 	2003
	
Donegal GAAP combined ratio	 	 	100.1	%	 	 	106.5	%	 	 	101.8	%	 	 	103.8	%	 	 	99.6	%	 	 	95.0	%	
Industry SAP combined ratio(1)	 	 	106.0	 	 	 	108.1	 	 	 	110.4	 	 	 	115.9	 	 	 	107.4	 	 	 	101.1	 	

(1)	 	As reported by A.M. Best.	
•	 	Pursuing profitable growth by organic expansion within our traditional operating territories through developing and maintaining quality agency representation.	
          We believe that continued expansion within our existing markets will be a key source of our continued premium growth, and maintaining an effective and growing network of independent agents is integral to our expansion. We seek to be among the top three insurers within each of our agencies for the lines of business we write by providing a consistent, competitive and stable market for our products. We believe that the consistency of our product offerings enables us to compete effectively for agents with other insurers whose product offerings fluctuate based on industry conditions. We offer our agents a competitive compensation program that rewards them for pursuing profitable growth on our behalf, and we provide them with ongoing support that enables them to better attract and service customers, including Internet-based information systems, training programs, marketing support and field visitations by our marketing personnel and senior management. Finally, we appoint agencies with a strong underwriting and growth track record. We believe that by carefully selecting, motivating and supporting our agency force, we will be able to drive continued long-term growth. 
•	 	Acquiring property and casualty insurance companies to augment our organic growth in existing markets and to expand into new geographic regions.	
          We have completed six acquisitions of property and casualty insurance companies since 1995. We believe we have an opportunity to continue our growth by selectively pursuing affiliations and acquisitions that meet our criteria. Our criteria include: 
•	 	Location in regions where we are currently conducting business or would like to conduct business;		
 	
•	 	A mix of business similar to our business;		
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•	 	Targeted premium volume between $20.0 million and $80.0 million; and		
 	
•	 	Transaction terms that are fair and reasonable to us.		
          We believe that our affiliation with the Mutual Company assists us in pursuing affiliations with and subsequent acquisitions of other mutual companies because we have a strong understanding of the concerns and issues that mutual companies face. In particular, we have had success affiliating with and acquiring undercapitalized mutual companies by utilizing our strengths and financial position to improve their operations significantly post-affiliation. We generally evaluate a number of areas for operational improvement when considering acquisitions, including product underwriting, expenses, the cost of reinsurance and technology. 
•	 	Focusing on expense controls and utilization of technology to increase our operating efficiency.	
          We maintain stringent expense controls with direct involvement by our senior management. We consolidate all processing and administrative activities at our home office to realize operating synergies and better control expenses. We utilize technology to automate much of our underwriting to facilitate agency and policyholder communications on an efficient and cost-effective basis. In 2002, we completed a reorganization begun in 2001 that streamlined our operations and allowed us to operate more efficiently. As a result of our focus on expense control, we have reduced our expense ratio from 35.9% for 1998 to 30.2% for 2003. We have also increased our annual premium per employee, a measure of efficiency that we use to evaluate our operations, from approximately $470,000 in 1998 to approximately $700,000 in 2003. 
•	 	Providing responsive and friendly customer and agent service to enable us to attract new policyholders and retain existing policyholders.	
          We believe that excellent policyholder service is important to attracting new policyholders and retaining existing policyholders. We work closely with our agency force to provide a consistently responsive level of claims service, underwriting and customer support. We seek to respond expeditiously and effectively to address customer and agent inquiries, including working to: 
•	 	Quickly reply to information requests and policy submissions; and		
 	
•	 	Promptly respond to and process claims.		
          As a part of our focus on customer service, we conduct policyholder service surveys to evaluate the effectiveness of our support programs, and our management meets frequently with agency personnel to seek service improvement recommendations, react to service issues and better understand local market conditions. 
•	 	Maintaining premium rate adequacy to enhance our underwriting results, while maintaining our existing book of business and preserving our ability to write new business.	
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          We are committed to maintaining discipline in our pricing by pursuing rate increases to maintain or improve our underwriting profitability without unduly affecting our ability to attract and retain customers. In addition to pursuing appropriate pricing, we take numerous actions to ensure that our premium rates are adequate relative to our level of underwriting risk. We review loss trends on a periodic basis to identify changes in the frequency and severity of our claims and to assess the adequacy of our rates and underwriting standards. We also carefully monitor and audit the key information that we use to price our policies, enabling us to receive an adequate level of premiums for our risk. For example, we inspect and perform loss control surveys on most of the risks we insure to determine adequacy of insurance to value, assess property conditions and identify any liability exposures. We audit the payroll data of our workers’ compensation customers to verify that the assumptions we used to price a particular policy were accurate. By aggressively pursuing appropriate rate increases and thoroughly understanding the risks we insure, we are able to support our strategy of achieving consistent underwriting profitability. 
Our Organizational Structure 
          We conduct most of our operations through our five insurance subsidiaries. We also own 47.5% of Donegal Financial Services Corporation (“DFSC”), a registered savings and loan holding company that owns Province Bank, a federal savings bank that began operations in 2000. The Mutual Company owns the remaining 52.5% of DFSC. While not yet profitable nor material to our operations, we believe Province Bank, with total assets of $50.4 million at December 31, 2003, will complement our product offerings. The following chart depicts our organizational structure, including our principal subsidiaries. 

(1)	 	Because of the different relative voting power of our Class A common stock and our Class B common stock, our public stockholders hold approximately 43% of the aggregate voting power.	
 		
(2)	 	Because of the different relative voting power of our Class A common stock and our Class B common stock, the Mutual Company holds approximately 57% of the aggregate voting power.	
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          Atlantic States, our largest insurance subsidiary, and the Mutual Company have a pooling agreement under which both companies are allocated a specified percentage of their combined underwriting results, excluding certain intercompany reinsurance assumed by the Mutual Company from our insurance subsidiaries. Under the terms of the pooling agreement, Atlantic States cedes its underwriting results to the Mutual Company. The Mutual Company in turn pools its underwriting results with the underwriting results of Atlantic States. The pooled underwriting results are then allocated 70% to Atlantic States and 30% to the Mutual Company. Pursuant to amendments to the pooling agreement since its commencement on October 1, 1986, the participation of Atlantic States in the underwriting results of the pool has gradually increased. 
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          The following chart depicts our underwriting pool: 
 
          The pooling agreement may be amended or terminated at the end of any calendar year by agreement of the parties, subject to approval by the coordinating committee discussed below. The allocations of pool participation percentages between the Mutual Company and Atlantic States have been based on their approximate relative amounts of capital and surplus, expectations of future relative amounts of capital and surplus and our ability to raise capital for Atlantic States. We do not currently anticipate a further increase in Atlantic States’ percentage of participation in the pool, nor do we intend to terminate the participation of Atlantic States in the pooling agreement. 
          The Mutual Company provides facilities, personnel and other services to us, and the related expenses are allocated between Atlantic States and the Mutual Company in relation to their relative participation in the pooling agreement. Southern reimburses the Mutual Company for its personnel costs and bears its proportionate share of information services costs based on its percentage of total written premiums of the Donegal Insurance Group. Expenses allocated to us under such agreements were $33.0 million in 2003. 
          Subsequent to receipt of approval by our board and the board of the Mutual Company, all agreements and all changes to existing agreements between the Mutual Company and us are subject to approval by a coordinating committee that is comprised of two of our board members who do not serve on the Mutual Company’s board and two board members of the Mutual Company who do not serve on our board. In order to approve an agreement or a change in an agreement, our members on the coordinating committee must conclude that the agreement or change is fair to us and our stockholders, and the Mutual Company’s members on the coordinating committee must conclude that the agreement or change is fair to the Mutual Company and its policyholders. 
          We believe our relationship with the Mutual Company offers us a number of competitive advantages, including: 
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•	 	Facilitating our stable management, consistent underwriting discipline, external growth and long-term profitability.		
 	
•	 	Creating operational and expense synergies given the combined resources and operating efficiencies of the Mutual Company and us.		
 	
•	 	Enhancing our ability to affiliate with and eventually acquire other mutual insurance companies.		
 	
•	 	Producing a more uniform and stable underwriting result from year to year than we could achieve on our own.		
 	
•	 	Giving Atlantic States the benefit of the underwriting capacity of the entire pool, rather than being limited by the amount of its own capital and surplus.		
Acquisitions 
          The following table highlights our acquisition history since 1988: 
 	 	 	 	 	 	 	 	 	
 	 	 	 	Year	 	 	
Insurance Company	 	 	 	Acquired	 	Method of	
Acquired
	 	State
	 	by Us
	 	Acquisition
	
Southern Mutual Insurance Company 	 	Virginia 	 	 	1988	 	 	Surplus note investment by the Mutual Company in 1984; demutualization in 1988; acquisition of stock by us in 1988.	
 	 	 	 	 	 	 	 	 	
Delaware Mutual Insurance Company(1) 	 	Delaware 	 	 	1995	 	 	Surplus note investment by the Mutual Company in 1993; demutualization in 1994; acquisition of stock by us in 1995.	
 	 	 	 	 	 	 	 	 	
Pioneer Mutual Insurance Company(1) 	 	Ohio 	 	 	1997	 	 	Surplus note investment by the Mutual Company in 1992; demutualization in 1993; acquisition of stock by us in 1997.	
 	 	 	 	 	 	 	 	 	
Southern Heritage Insurance Company(1) 	 	Georgia 	 	 	1998	 	 	Stock purchase in 1998.	
 	 	 	 	 	 	 	 	 	
Pioneer Mutual Insurance Company(1) 	 	New York 	 	 	2001	 	 	Surplus note investment by the Mutual Company in 1995; demutualization in 1998; acquisition of stock by us in 2001.	
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 	 	 	 	Year	 	 	
Insurance Company	 	 	 	Acquired	 	Method of	
Acquired
	 	State
	 	by Us
	 	Acquisition
	
Le Mars Insurance Company 	 	Iowa 	 	 	2004	 	 	Surplus note investment by the Mutual Company in 2002; demutualization approved; acquisition of stock by us as of January 1, 2004.	
 	 	 	 	 	 	 	 	 	
Peninsula Insurance Group 	 	Maryland 	 	 	2004	 	 	Stock purchase on January 6, 2004.	

(1)	 	To reduce administrative and compliance costs and expenses, the designated entities were merged into one of our existing insurance subsidiaries.	
          We generally maintain the home office of an acquired company as part of our strategy to provide local marketing, underwriting and claims servicing even if the acquired company is merged into another subsidiary. 
Distribution 
          Our insurance products are marketed primarily in the Mid-Atlantic and Southeast regions through approximately 1,200 insurance agencies that are comprised of approximately 6,800 agents. At December 31, 2003, the Donegal Insurance Group was licensed to do business in 15 states and operated in 14 states (Alabama, Arkansas, Connecticut, Delaware, Georgia, Louisiana, Maryland, New York, North Carolina, Ohio, Pennsylvania, South Carolina, Tennessee and Virginia). We believe our relationships with our independent agents are valuable in identifying, obtaining and retaining profitable business. We maintain a stringent agency selection procedure that emphasizes appointing agencies with proven marketing strategies for the development of profitable business and we appoint only agencies with a strong underwriting and growth track record. We also regularly evaluate our agencies based on their profitability and performance in relation to our objectives. We seek to be among the top three insurers within each of our agencies for the lines of business we write. 
          The following table sets forth the percentage of our share of 2003 direct premiums written in each of the states where we conducted business in 2003: 
 	 	 	 	 	
Pennsylvania	 	 	58.3	%	
Virginia	 	 	14.6	 	
Georgia	 	 	6.3	 	
Maryland	 	 	5.7	 	
Delaware	 	 	5.1	 	
Ohio	 	 	4.3	 	
North Carolina	 	 	1.7	 	
New York	 	 	1.4	 	
Other	 	 	2.6	 	

Total	 	 	100.0	%	

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          We believe we have developed a number of policies and procedures that enable us to attract, retain and motivate our agents. The consistency, competitiveness and stability of our product offerings assists us in competing effectively for agents with other insurers whose product offerings may fluctuate based upon industry conditions. We have developed a competitive contingent commission plan for agents, under which additional commissions are payable based upon the volume of premiums produced and the profitability of the business of the agency. We provide our agents ongoing support that enables them to better attract and retain customers, including Internet-based information systems, training programs, marketing support and field visitations by our marketing personnel and senior management. Finally, we encourage our independent agencies to focus on “account selling”, or serving all of a particular insured’s property and casualty insurance needs, which we believe generally results in more favorable loss experience than covering a single risk for an individual insured. 
Products 
          Our personal lines of business consist primarily of automobile and homeowners insurance. Our commercial lines of business consist primarily of commercial automobile, commercial multi-peril and workers’ compensation insurance. These types of insurance are described 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,		
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 	 	windstorm and theft. These policies also cover liability of the insured arising from injury to other persons or their property while on the insured’s property and under other specified conditions.	
          Commercial 
•	 	Commercial multi-peril – policies that provide protection to businesses against many perils, usually combining liability and physical damage coverages.		
 	
•	 	Workers’ compensation – policies purchased by employers to provide benefits to employees for injuries sustained during employment. The extent of coverage is established by the workers’ compensation laws of each state.		
 	
•	 	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.		
          The following table sets forth the net premiums written by line of insurance for our business for the periods indicated: 
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Year Ended December 31,
	
 	 	2001
	 	2002
	 	2003
	
(dollars in thousands)
	 	Amount
	 	%
	 	Amount
	 	%
	 	Amount
	 	%
	
Net Premiums Written:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Personal lines:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Automobile	 	$	74,396	 	 	 	42.0	%	 	$	84,643	 	 	 	43.5	%	 	$	86,644	 	 	 	41.9	%	
Homeowners	 	 	31,431	 	 	 	17.8	 	 	 	34,637	 	 	 	17.8	 	 	 	36,989	 	 	 	17.9	 	
Other	 	 	5,796	 	 	 	3.3	 	 	 	6,497	 	 	 	3.4	 	 	 	6,753	 	 	 	3.2	 	

 	 	 	 	

 	 	 	 	
 	 	
Total personal lines	 	 	111,623	 	 	 	63.1	 	 	 	125,777	 	 	 	64.7	 	 	 	130,386	 	 	 	63.0	 	

 	 	 	 	

 	 	 	 	
 	 	
Commercial lines:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Automobile	 	 	16,527	 	 	 	9.3	 	 	 	17,451	 	 	 	9.0	 	 	 	18,655	 	 	 	9.0	 	
Workers’ compensation	 	 	22,979	 	 	 	13.0	 	 	 	23,845	 	 	 	12.2	 	 	 	25,627	 	 	 	12.4	 	
Commercial multi-peril	 	 	24,174	 	 	 	13.6	 	 	 	25,536	 	 	 	13.1	 	 	 	30,199	 	 	 	14.6	 	
Other	 	 	1,725	 	 	 	1.0	 	 	 	1,895	 	 	 	1.0	 	 	 	2,114	 	 	 	1.0	 	

 	 	 	 	

 	 	 	 	
 	 	
Total commercial lines	 	 	65,405	 	 	 	36.9	 	 	 	68,727	 	 	 	35.3	 	 	 	76,595	 	 	 	37.0	 	

 	 	 	 	

 	 	 	 	
 	 	
Total business	 	$	177,028	 	 	 	100.0	%	 	$	194,504	 	 	 	100.0	%	 	$	206,981	 	 	 	100.0	%	

 	 	 	 	

 	 	 	 	
 	 	
Underwriting 
     Our underwriting department, which is divided into personal lines underwriting and commercial lines underwriting, evaluates and selects those risks that we believe will enable us to achieve an underwriting profit. Our underwriting department has significant 
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interaction with our independent agents regarding our underwriting philosophy and underwriting guidelines and assists our 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, we: 
•	 	assess and select quality standard and preferred risks;		
 	
•	 	adhere to disciplined underwriting and reunderwriting guidelines;		
 	
•	 	inspect substantially all commercial lines risks and a substantial number of personal lines risks; and		
 	
•	 	utilize various types of risk management and loss control services.		
          We also review our existing policies and accounts to determine whether those risks continue to meet our underwriting guidelines. If a given policy or account no longer meets our underwriting guidelines, we 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 our effort to maintain acceptable underwriting results, we conduct annual reviews of agencies that have failed to meet our underwriting profitability criteria. Our 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 agency’s staff and the agency’s record of adherence to our underwriting guidelines and service standards. Based on the results of this review process, our marketing and underwriting personnel develop, together with the agency, a plan to improve its underwriting profitability. We monitor the agency’s compliance with the plan, and take other measures as required in our judgment, including the termination of agencies that are unable to achieve acceptable underwriting profitability to the extent permitted by applicable law. 
Claims 
          The management of claims is a critical component of our philosophy of underwriting profitability and is fundamental to our successful operations and our dedication to excellent service. 
          Our claims department rigorously manages claims to assure that legitimate claims are settled quickly and fairly and that questionable claims are identified for defense. In the majority of cases, claims are adjusted by our own personnel, whom we believe are experienced in our industry and who know our service philosophy. We provide various means of claims reporting on a 24-hour, seven day a week basis, including toll-free numbers and Internet reporting through our website. We strive to respond to notifications of claims promptly, generally within the day reported. We believe that by responding promptly to claims, we provide quality customer service and minimize the ultimate cost of the claims. We engage independent adjusters as needed to handle claims in areas in which the volume of 
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claims is not sufficient to justify our hiring of internal claims adjusters. We also employ private investigators, structural experts and various outside legal counsel to supplement our in-house staff and assist us in the investigation of claims. We 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. 
          Our claims department management develops and implements policies and procedures for the establishment of adequate claim reserves. The management and staff of our claims department resolve policy coverage issues, manage and process reinsurance recoveries and handle salvage and subrogation matters. Our litigation and personal injury sections manage all claims litigation, and all branch office claims above $35,000 require home office review and settlement authorization. Claims adjusters are given reserving and settlement authority based upon their experience and demonstrated abilities. Larger or more complicated claims require consultation and approval of senior department management. 
          Our field office staff is supported by home office technical, litigation, material damage, subrogation and medical audit personnel who provide specialized claims support. 
Liabilities for Losses and Loss Expenses 
          Liabilities for losses and loss expenses are estimates at a given point in time of what an insurer expects to pay to claimants, based on facts and circumstances then known, and it can be expected that the insurer’s ultimate liability for losses and loss expenses will exceed or be less than such estimates. Our estimates of liabilities for losses and loss expenses are based on estimates of future trends and claims severity, judicial theories of liability and other factors. However, during the loss adjustment period, we may learn additional facts regarding individual claims, and consequently it often becomes necessary to refine and adjust our estimates of our liability. We reflect any adjustments to our liabilities for losses and loss expenses in our operating results in the period in which the changes in estimates are made. 
          We maintain liabilities for the eventual payment of losses and loss expenses with respect to both reported and unreported claims. Liabilities for loss expenses are intended to cover the ultimate costs of settling all losses, including investigation and litigation costs from such losses. We 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. We determine the amount of our liability for unreported claims and loss expenses on the basis of historical information by line of insurance. We account for inflation in the reserving function through analysis of costs and trends and reviews of historical reserving results. We closely monitor our liabilities and recompute them periodically using new information on reported claims and a variety of statistical techniques. Our liabilities for losses are not discounted. 
          The establishment of appropriate liabilities is an inherently uncertain process, and there can be no assurance that the ultimate liability will not exceed our loss and loss expense reserves and have an adverse effect on our results of operations and financial condition. As is the case for substantially all property and casualty insurance companies, we have found it necessary in the past to revise our estimated future liabilities for losses and 
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loss expenses, and further adjustments could be required in the future. On the basis of our internal procedures, which analyze, among other things, our 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 adequate provision has been made for our liability for losses and loss expenses. 
          Differences between liabilities reported in our financial statements prepared on the basis of 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 $8.2 million, $7.3 million and $7.2 million at December 31, 2001, 2002 and 2003, respectively. 
          The following table sets forth a reconciliation of our beginning and ending net liability for unpaid losses and loss expenses for the periods indicated: 
 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Year Ended December 31,
	
(in thousands)
	 	2001
	 	2002
	 	2003
	
Gross liability for unpaid losses and loss expenses at beginning of year	 	$	156,476	 	 	$	179,840	 	 	$	210,692	 	
Less reinsurance recoverable	 	 	53,767	 	 	 	65,296	 	 	 	79,584	 	

 	 	 	 	
 	 	
Net liability for unpaid losses and loss expenses at beginning of year	 	 	102,709	 	 	 	114,544	 	 	 	131,108	 	
Provision for net losses and loss expenses for claims incurred in the current year	 	 	110,143	 	 	 	122,434	 	 	 	126,693	 	
Change in provision for estimated net losses and loss expenses for claims incurred in prior years	 	 	8,035	 	 	 	6,834	 	 	 	(450	)	

 	 	 	 	
 	 	
Total incurred	 	 	118,178	 	 	 	129,268	 	 	 	126,243	 	
Net losses and loss payments for claims incurred during:	 	 	 	 	 	 	 	 	 	 	 	 	
The current year	 	 	63,290	 	 	 	67,656	 	 	 	72,187	 	
Prior years	 	 	43,053	 	 	 	45,048	 	 	 	46,268	 	

 	 	 	 	
 	 	
Total paid	 	 	106,343	 	 	 	112,704	 	 	 	118,455	 	
Net liability for unpaid losses and loss expenses at end of year	 	 	114,544	 	 	 	131,108	 	 	 	138,896	 	
Plus reinsurance recoverable	 	 	65,296	 	 	 	79,584	 	 	 	79,018	 	

 	 	 	 	
 	 	
Gross liability for unpaid losses and loss expenses at end of year	 	$	179,840	 	 	$	210,692	 	 	$	217,914	 	

 	 	 	 	
 	 	
          We recognized an increase (decrease) in the liability of losses and loss expenses for prior years of $8.0 million, $6.8 million and $(450,110) in 2001, 2002 and 2003, respectively. These developments are primarily attributable to variations from expected claim severity in the private passenger and commercial automobile liability, workers’ compensation and commercial multiple peril lines of business. 
          The following table sets forth the development of our liability for net unpaid losses and loss expenses from 1993 to 2003, with supplemental loss data for 2002 and 2003. Loss data in the table includes business we are allocated from the Mutual Company as part of the pooling agreement. 
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     “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 is increased or decreased as payments are made and more information becomes known about the severity of the remaining unpaid claims. For example, the 1993 liability has developed a redundancy after nine years, in that reestimated net losses and loss expenses are expected to be $12.8 million less than the estimated liability initially established in 1993 of $52.8 million. 
          The “Cumulative (excess) deficiency” shows the cumulative excess or deficiency at December 31, 2003 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 were reevaluated at less than the original amount. A deficiency in liability means that the liability established in prior years was less than actual net losses and loss expenses or were reevaluated at more than the original amount. 
          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 1994 column indicates that as of December 31, 2003 payments equal to $49.3 million of the currently reestimated ultimate liability for net losses and loss expenses of $49.5 million had been made. 
          During 2000, 2001 and 2002, we experienced deficiencies in reserves for certain prior years. These deficiencies were primarily related to the workers’ compensation, private passenger automobile, commercial automobile and commercial multiple-peril lines of business. 
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 	 	Year Ended December 31,
	
(in thousands)
	 	1993
	 	1994
	 	1995
	 	1996
	 	1997
	 	1998
	 	1999
	 	2000
	 	2001
	 	2002
	 	2003
	
Net liability at end of year for unpaid losses and loss expenses	 	$	52,790	 	 	$	63,317	 	 	$	75,372	 	 	$	78,889	 	 	$	80,256	 	 	$	96,015	 	 	$	99,234	 	 	$	102,709	 	 	$	114,544	 	 	$	131,108	 	 	$	138,896	 	
Net liability reestimated as of:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
One year later	 	 	50,583	 	 	 	60,227	 	 	 	72,380	 	 	 	77,400	 	 	 	77,459	 	 	 	95,556	 	 	 	100,076	 	 	 	110,744	 	 	 	121,378	 	 	 	130,658	 	 	 	 	 	

Two years later	 	 	48,132	 	 	 	56,656	 	 	 	70,451	 	 	 	73,438	 	 	 	76,613	 	 	 	95,315	 	 	 	103,943	 	 	 	112,140	 	 	 	120,548	 	 	 	 	 	 	 	 	 	

Three years later	 	 	44,956	 	 	 	54,571	 	 	 	66,936	 	 	 	71,816	 	 	 	74,851	 	 	 	94,830	 	 	 	104,073	 	 	 	110,673	 	 	 	 	 	 	 	 	 	 	 	 	 	

Four years later	 	 	42,157	 	 	 	51,825	 	 	 	64,356	 	 	 	69,378	 	 	 	73,456	 	 	 	94,354	 	 	 	101,880	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	

Five years later	 	 	41,050	 	 	 	50,493	 	 	 	63,095	 	 	 	69,485	 	 	 	73,103	 	 	 	93,258	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	

Six years later	 	 	40,572	 	 	 	49,593	 	 	 	62,323	 	 	 	69,949	 	 	 	72,706	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	

Seven years later	 	 	39,991	 	 	 	49,504	 	 	 	62,534	 	 	 	69,415	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	

Eight years later	 	 	40,113	 	 	 	49,758	 	 	 	62,067	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	

Nine years later	 	 	40,131	 	 	 	49,539	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	

Ten years later	 	 	40,016	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	

Cumulative (excess) deficiency	 	$	(12,774	)	 	$	(13,778	)	 	$	(13,305	)	 	$	(9,474	)	 	$	(7,550	)	 	$	(2,757	)	 	$	2,646	 	 	$	7,964	 	 	$	6,004	 	 	$	(450	)	 	 	 	 	

 	 	 	 	

 	 	 	 	

 	 	 	 	

Cumulative amount of liability paid through:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
One year later	 	$	16,126	 	 	$	19,401	 	 	$	24,485	 	 	$	27,229	 	 	$	27,803	 	 	$	37,427	 	 	$	39,060	 	 	$	43,053	 	 	$	45,048	 	 	$	46,268	 	 	 	 	 	
Two years later	 	 	25,393	 	 	 	30,354	 	 	 	37,981	 	 	 	41,532	 	 	 	46,954	 	 	 	57,347	 	 	 	60,622	 	 	 	67,689	 	 	 	70,077	 	 	 	 	 	 	 	 	 	
Three years later	 	 	32,079	 	 	 	38,684	 	 	 	47,027	 	 	 	53,555	 	 	 	58,883	 	 	 	69,973	 	 	 	76,811	 	 	 	82,268	 	 	 	 	 	 	 	 	 	 	 	 	 	
Four years later	 	 	36,726	 	 	 	43,655	 	 	 	53,276	 	 	 	59,995	 	 	 	65,898	 	 	 	78,757	 	 	 	85,453	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Five years later	 	 	39,122	 	 	 	46,331	 	 	 	56,869	 	 	 	63,048	 	 	 	70,642	 	 	 	83,038	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Six years later	 	 	40,440	 	 	 	47,802	 	 	 	58,286	 	 	 	65,595	 	 	 	72,801	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Seven years later	 	 	40,903	 	 	 	48,520	 	 	 	59,160	 	 	 	66,976	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Eight years later	 	 	41,152	 	 	 	48,925	 	 	 	59,802	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Nine years later	 	 	39,877	 	 	 	49,288	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Ten years later	 	 	40,110	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Year Ended December 31
	
 	 	1995
	 	1996
	 	1997
	 	1998
	 	1999
	 	2000
	 	2001
	 	2002
	 	2003
	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	(in thousands)	 	 	 	 	 	 	 	 	 	 	 	 	
Gross liability at end of year	 	$	108,118	 	 	$	113,346	 	 	$	115,801	 	 	$	136,727	 	 	$	144,180	 	 	$	156,476	 	 	$	179,840	 	 	$	210,692	 	 	$	217,914	 	
Reinsurance recoverable	 	 	32,746	 	 	 	34,457	 	 	 	35,545	 	 	 	40,712	 	 	 	44,946	 	 	 	53,767	 	 	 	65,296	 	 	 	79,584	 	 	 	79,018	 	
Net liability at end of year	 	 	75,372	 	 	 	78,889	 	 	 	80,256	 	 	 	96,015	 	 	 	99,234	 	 	 	102,709	 	 	 	114,544	 	 	 	131,108	 	 	 	138,896	 	
Gross reestimated liability – latest	 	 	83,265	 	 	 	101,136	 	 	 	104,328	 	 	 	127,657	 	 	 	154,481	 	 	 	172,905	 	 	 	195,097	 	 	 	214,635	 	 	 	 	 	
Reestimated recoverable – latest	 	 	21,198	 	 	 	31,721	 	 	 	31,622	 	 	 	34,399	 	 	 	52,601	 	 	 	62,232	 	 	 	74,549	 	 	 	83,977	 	 	 	 	 	
Net reestimated liability – latest	 	 	62,067	 	 	 	69,415	 	 	 	72,706	 	 	 	93,258	 	 	 	101,880	 	 	 	110,673	 	 	 	120,548	 	 	 	130,658	 	 	 	 	 	
Gross cumulative deficiency (excess)	 	 	(24,853	)	 	 	(12,210	)	 	 	(11,473	)	 	 	(9,070	)	 	 	10,301	 	 	 	16,429	 	 	 	15,257	 	 	 	3,943	 	 	 	 	 	
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Technology 
          The Mutual Company owns our technology systems, and we use them pursuant to an intercompany agreement. Our technology systems consist of an integrated central processing computer, a series of server-based computer networks and various communications systems that allow our home office and branch offices to utilize the same systems for the processing of business. The Mutual Company maintains backup facilities and systems through a contract with a leading provider of computer disaster recovery sites, and these backup facilities and systems are tested on a regular basis. Atlantic States and Southern bear their proportionate share of information services expenses based on their percentages of the total net written premiums of the Donegal Insurance Group. 
          Our business strategy depends on the use, development and implementation of integrated technology systems. These systems enable us to provide a high level of service to our agents and policyholders by processing our business in a timely and efficient manner, communicating and sharing data with our agents, providing a variety of methods for the payment of premiums and allowing for the accumulation and analysis of information for our management. 
          We believe the implementation of our various technology systems has resulted in improved service to our agents and customers and increased efficiencies in the processing of our business, resulting in lower operating costs. Two of the key components of our integrated system are our agency interface system and our imaging system. Our agency interface system provides us with a high level of data sharing both to, and from, our agents’ systems and also provides our agents with an integrated means of processing new business. Our imaging system reduces our need to handle paper files, while providing greater access to the same information by a variety of personnel. 
Third Party Reinsurance 
          We and the Mutual Company use several different reinsurers, all of which, consistent with our requirements, 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. 
          The external reinsurance we and the Mutual Company purchase includes: 
•	 	“excess of loss reinsurance,” under which our losses are automatically reinsured, through a series of contracts, over a set retention ($300,000 for 2003), and		
 	
•	 	“catastrophic reinsurance,” under which we recover, through a series of contracts, between 95% and 100% of an accumulation of many losses resulting from a single event, including natural disasters ($3.0 million retention for 2003).		
     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. 
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          Our principal third party reinsurance agreement in 2003 was a multi-line per risk excess of loss treaty with GMAC Re Corporation, Dorinco Reinsurance Company and Erie Insurance Group that provides coverage up to $1.0 million for both property and liability losses. 
          For property insurance, we also have excess of loss treaties that provide for additional coverage over the multi-line treaty up to $2.5 million per occurrence. For liability insurance, we 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, we have excess of loss treaties that provide for additional coverage over the multi-line treaty up to $5.0 million on any one life. 
          We have property catastrophe coverage through a series of layered treaties up to aggregate losses of $80.0 million for the Donegal Insurance Group for any single event. This coverage is provided through as many as twenty reinsurers on any one treaty with no reinsurer taking more than 20.0% of any one contract. 
          On both property and casualty insurance, we and the Mutual Company purchase facultative reinsurance to cover exposures from losses that exceed the limits provided by our respective treaty reinsurance. 
Competition 
          The property and casualty insurance industry is highly competitive on the basis of both price and service. There are numerous companies competing for business in the geographic areas where we operate, many of which are substantially larger and have greater financial resources than we do, and no single company dominates. In addition, because our insurance products and those of the Mutual Company are marketed exclusively through independent insurance agencies, most of which represent more than one insurance company, we face competition within agencies as well as competition to retain qualified independent agencies. 
Investments 
          Our return on invested assets is an important element of our financial results, and our investment strategy is to generate sufficient after-tax income on invested assets while minimizing credit risk through investments in high-quality securities. As a result, we seek to invest a high percentage of our funds in a diversified, highly rated and readily marketable group of fixed-maturity instruments. Our fixed-maturity portfolio consists of both taxable and tax-exempt securities. We maintain a sufficient portion of our portfolio in short-term securities, such as investments in commercial paper, to provide liquidity for the payment of claims and operation of our business and maintain a small percentage of our portfolio in equity securities. 
          At December 31, 2003, all of our debt securities were rated investment grade with the exception of one unrated obligation of $252,500 and the investment portfolio did not contain any mortgage loans or any non-performing assets. 
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          The following table shows the composition of our debt securities investment portfolio (at carrying value), excluding short-term investments, by rating as of December 31, 2003: 
 	 	 	 	 	 	 	 	 	
 	 	December 31, 2003
	
(dollars in thousands)
	 	Amount
	 	Percent
	
Rating(1)	 	 	 	 	 	 	 	 	
U.S. Treasury and U.S. agency securities(2)	 	$	125,520	 	 	 	40.30	%	
Aaa or AAA	 	 	100,278	 	 	 	32.19	 	
Aa or AA	 	 	54,109	 	 	 	17.37	 	
A	 	 	26,411	 	 	 	8.48	 	
BBB	 	 	4,913	 	 	 	1.58	 	
Not rated(3)	 	 	253	 	 	 	.08	 	

 	 	
Total	 	$	311,484	 	 	 	100.00	%	

 	 	

(1)	 	Ratings assigned by Moody’s Investors Services, Inc. or Standard & Poor’s Corporation.	
 		
(2)	 	Includes mortgage-backed securities of $25,882,579.	
 		
(3)	 	Represents one unrated obligation of The Lancaster County Hospital Authority Mennonite Home Project that our management believes to be equivalent to investment grade securities with respect to repayment risk.	
          We invest in both taxable and tax-exempt securities as part of our strategy to maximize after-tax income. Our strategy considers, among other factors, the alternative minimum tax. Tax-exempt securities made up approximately 30.9%, 41.0% and 41.6% of our debt securities investment portfolio at December 31, 2001, 2002 and 2003, respectively. 
          The following table shows the classification of our investments (at carrying value) at December 31, 2001, 2002 and 2003: 
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	December 31,
	
 	 	2001
	 	2002
	 	2003
	
 	 	 	 	 	 	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	 	$	23,809	 	 	 	7.9	%	 	$	12,641	 	 	 	3.8	%	 	$	29,131	 	 	 	6.9	%	
Canadian government obligation	 	 	499	 	 	 	0.2	 	 	 	499	 	 	 	0.2	 	 	 	499	 	 	 	0.1	 	
Obligations of states and political subdivisions	 	 	24,982	 	 	 	8.3	 	 	 	33,892	 	 	 	10.2	 	 	 	45,188	 	 	 	10.7	 	
Corporate securities	 	 	27,423	 	 	 	9.1	 	 	 	29,552	 	 	 	8.9	 	 	 	25,192	 	 	 	6.0	 	
Mortgage-backed securities	 	 	8,610	 	 	 	2.9	 	 	 	10,118	 	 	 	3.0	 	 	 	13,041	 	 	 	3.1	 	

 	 	 	 	

 	 	 	 	
 	 	
Total held to maturity	 	 	85,323	 	 	 	28.4	 	 	 	86,702	 	 	 	26.1	 	 	 	113,051	 	 	 	26.8	 	

 	 	 	 	

 	 	 	 	
 	 	
Available for sale:	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
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 	 	December 31,
	
 	 	2001
	 	2002
	 	2003
	
 	 	 	 	 	 	Percent	 	 	 	 	 	Percent	 	 	 	 	 	Percent	
 	 	 	 	 	 	of	 	 	 	 	 	of	 	 	 	 	 	of	
(dollars in thousands)
	 	Amount
	 	Total
	 	Amount
	 	Total
	 	Amount
	 	Total
	
U.S. Treasury securities and obligations of U.S. government corporations and agencies	 	 	68,975	 	 	 	23.0	 	 	 	58,287	 	 	 	17.5	 	 	 	70,507	 	 	 	16.7	 	
Obligations of states and political subdivisions	 	 	55,147	 	 	 	18.3	 	 	 	81,446	 	 	 	24.5	 	 	 	84,386	 	 	 	20.0	 	
Corporate securities	 	 	34,807	 	 	 	11.6	 	 	 	36,863	 	 	 	11.1	 	 	 	30,699	 	 	 	7.3	 	
Mortgage-backed securities	 	 	14,790	 	 	 	4.9	 	 	 	18,136	 	 	 	5.5	 	 	 	12,841	 	 	 	3.1	 	

 	 	 	 	

 	 	 	 	
 	 	
Total available for sale	 	 	173,719	 	 	 	57.8	 	 	 	194,732	 	 	 	58.6	 	 	 	198,433	 	 	 	47.1	 	

 	 	 	 	

 	 	 	 	
 	 	
Total fixed maturities	 	 	259,042	 	 	 	86.2	 	 	 	281,434	 	 	 	84.7	 	 	 	311,484	 	 	 	73.9	 	
Equity securities(2)	 	 	17,517	 	 	 	5.8	 	 	 	21,836	 	 	 	6.6	 	 	 	31,448	 	 	 	7.5	 	
Short-term investments(3)	 	 	24,074	 	 	 	8.0	 	 	 	29,029	 	 	 	8.7	 	 	 	78,344	 	 	 	18.6	 	

 	 	 	 	

 	 	 	 	
 	 	
Total investments	 	$	300,633	 	 	 	100.0	%	 	$	332,299	 	 	 	100.0	%	 	$	421,276	 	 	 	100.0	%	

 	 	 	 	

 	 	 	 	

(1)	 	We account for our investments in accordance with Statement of Financial Accounting Standards (SFAS) No. 115, “Accounting For Certain Investments in Debt and Equity Securities.” See Notes 1 and 3 to the Consolidated Financial Statements incorporated by reference herein. Fixed maturities classified as held to maturity are valued at amortized cost; those fixed maturities classified as available for sale are valued at fair value. Total fair value of fixed maturities classified as held to maturity was $86.9 million at December 31, 2001, $89.8 million at December 31, 2002 and $116.1 million at December 31, 2003. The amortized cost of fixed maturities classified as available for sale was $170.3 million at December 31, 2001, $187.5 million at December 31, 2002 and $192.1 million at December 31, 2003.	
 		
(2)	 	Equity securities are valued at fair value. Total cost of equity securities was $16.6 million at December 31, 2001, $21.6 million at December 31, 2002 and $29.6 million at December 31, 2003.	
 		
(3)	 	Short-term investments are valued at cost, which approximates market.	
          The following table sets forth the maturities (at carrying value) in our fixed maturity and short-term investment portfolio at December 31, 2001, December 31, 2002 and December 31, 2003: 
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	December 31,
	
 	 	2001
	 	2002
	 	2003
	
 	 	 	 	 	 	Percent	 	 	 	 	 	Percent	 	 	 	 	 	Percent	
 	 	 	 	 	 	of	 	 	 	 	 	of	 	 	 	 	 	of	
(dollars in thousands)
	 	Amount
	 	Total
	 	Amount
	 	Total
	 	Amount
	 	Total
	
Due in(1):	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
One year or less	 	$	37,120	 	 	 	13.1	%	 	$	47,034	 	 	 	15.1	%	 	$	92,396	 	 	 	23.7	%	
Over one year through three years	 	 	44,845	 	 	 	15.8	 	 	 	47,367	 	 	 	15.3	 	 	 	46,840	 	 	 	12.0	 	
Over three years through five years	 	 	69,585	 	 	 	24.6	 	 	 	66,655	 	 	 	21.5	 	 	 	64,331	 	 	 	16.5	 	
Over five years through ten years	 	 	96,642	 	 	 	34.1	 	 	 	64,271	 	 	 	20.7	 	 	 	73,057	 	 	 	18.7	 	
Over ten years through fifteen years	 	 	7,573	 	 	 	2.7	 	 	 	52,517	 	 	 	16.9	 	 	 	81,016	 	 	 	20.8	 	
Over fifteen years	 	 	3,951	 	 	 	1.4	 	 	 	4,365	 	 	 	1.4	 	 	 	6,306	 	 	 	1.6	 	
Mortgage-backed securities	 	 	23,400	 	 	 	8.3	 	 	 	28,254	 	 	 	9.1	 	 	 	25,882	 	 	 	6.7	 	

 	 	 	 	

 	 	 	 	
 	 	
 	 	$	283,116	 	 	 	100.0	%	 	$	310,463	 	 	 	100.0	%	 	$	389,828	 	 	 	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.	
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          As shown above, we held investments in mortgage-backed securities having a carrying value of $25.9 million at December 31, 2003. Our mortgage-backed securities consist primarily of investments in governmental agency balloon pools with stated maturities of five and seven years. The stated maturities of these investments limits our exposure to extension risk should interest rates rise and prepayments decline. We perform an analysis of the underlying loans when evaluating a mortgage-backed security for purchase, and we select those securities that we believe will provide a return that properly reflects the prepayment risk associated with the underlying loans. 
          Our investment results for the years ended December 31, 2001, 2002 and 2003 are shown in the following table: 
 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	Year Ended December 31,
	
(dollars in thousands)
	 	2001
	 	2002
	 	2003
	
Invested assets(1)	 	$	294,989	 	 	$	316,466	 	 	$	376,788	 	
Investment income(2)	 	 	15,886	 	 	 	14,581	 	 	 	13,316	 	
Average yield	 	 	5.3	%	 	 	4.6	%	 	 	3.5	%	

(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 
          Currently, the A.M. Best rating of Atlantic States, Southern and the Mutual Company is A (Excellent), based upon their respective current financial condition and historical statutory results of operations and retrocessional agreements. We believe that our A.M. Best rating is an important factor in marketing our products to our agents and customers. A.M. Best’s ratings are industry ratings based on a comparative analysis of the financial condition and operating performance of insurance companies as determined by their publicly available reports. A.M. Best’s 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. Best’s ratings are based upon factors relevant to policyholders and are not directed toward the protection of investors. According to A.M. Best, an “Excellent” rating is assigned to those companies that, in A.M. Best’s opinion, have achieved excellent overall performance when compared to the norms of the property and casualty insurance industry and have generally demonstrated a strong ability to meet policyholder and other contractual obligations. 
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 company’s 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 
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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 to do business of insurers and agents, 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 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 (“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, 2003, our insurance subsidiaries and the Mutual Company each exceeded the minimum levels of statutory capital required by the risk-based capital rules. There can be no assurance that the statutory capital requirements applicable to our insurance subsidiaries or the Mutual Company will not increase in the future. 
          Generally, every state has guaranty fund laws under which insurers licensed to do business in the 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. Atlantic States, Southern and the Mutual Company have made accruals for their portion of assessments related to such insolvencies based upon the most current information furnished by the guaranty associations. During 2001, 2002 and 2003, we incurred assessments totaling $1.3 million, $486,000 and $217,000, respectively, from the Pennsylvania Insurance Guaranty Association primarily relating to the insolvencies of three medical malpractice insurers and Reliance Insurance Company. 
          Most states have enacted legislation that regulates insurance holding company systems. Each insurance company in the 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 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 the Mutual Company at any time, require disclosure of material transactions by the holding company 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 requires that all transactions within a 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 
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agreement must be filed with the Pennsylvania Insurance Department and is subject to Department review. The pooling agreement and other intercompany reinsurance agreements were accordingly filed with the Pennsylvania Insurance Department. The Pennsylvania Insurance Department has never provided any notification of disapproval to any member of the Mutual Company or us. 
          Approval of the applicable insurance commissioner is also required prior to consummation of transactions affecting the control of an insurer. In some states, including Pennsylvania, the acquisition of 10% or more of the outstanding capital stock of an insurer or its holding company creates a rebuttable presumption of a change in control. Pursuant to an order issued in April 2003, the Pennsylvania Insurance Department approved the Mutual Company’s ownership of up to 70% of our outstanding Class A common stock and up to 100% of our outstanding Class B common stock. Insurance holding company laws also require notice to the applicable insurance commissioner of certain material transactions between an insurer and any person in its holding company system and, in some states, certain of such transactions cannot be consummated without the prior approval of the applicable insurance commissioner. 
          We are required to participate in involuntary insurance programs for automobile insurance, as well as other property and casualty insurance lines, in states in which we operate. These programs include joint underwriting associations, assigned risk plans, fair access to insurance requirements (FAIR) plans, reinsurance facilities and windstorm 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. 
          Our insurance subsidiaries are restricted by the insurance laws of their respective states of domicile as to the amount of dividends or other distributions they may pay to us without the prior approval of the respective state regulatory authorities. Generally, the maximum amount that may be paid by an insurance subsidiary 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 subsidiary’s statutory capital and surplus as of the end of the preceding year or the net income excluding realized capital gains of the subsidiary for the preceding year. As of December 31, 2003, the amount of dividends Atlantic States and Southern could pay us during 2004 without the prior approval of the various insurance commissioners was $13.3 million and $4.1 million, respectively. 
The Mutual Company 
          The Mutual Company was organized in 1889. At December 31, 2003, the Mutual Company had admitted assets of $214.6 million and policyholders’ surplus of $84.9 million. At December 31, 2003, the Mutual Company had no debt and, of its total liabilities of 
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$129.7 million, reserves for net losses and loss expenses accounted for $62.3 million and unearned premiums accounted for $33.3 million. Of the Mutual Company’s investment portfolio of $135.5 million at December 31, 2003, investment-grade bonds accounted for $24.4 million and mortgages accounted for $4.2 million. At December 31, 2003, the Mutual Company owned 4,139,792 shares, or approximately 42%, of our Class A common stock, which were carried on the Mutual Company’s books at $56.7 million, and 1,852,088 shares, or approximately 62%, of our Class B common stock, which were carried on the Mutual Company’s books at $25.4 million. The foregoing financial information is presented on the statutory basis of accounting required by the NAIC Accounting Practices and Procedures Manual. The Mutual Company does not, nor is it required to, prepare financial statements in accordance with GAAP. 
Donegal Financial Services Corporation 
          Because of our and the Mutual Company’s ownership of DFSC, both we and the Mutual Company are regulated as unitary savings and loan holding companies. As such, both we and the Mutual Company 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, or HOLA. As a federally chartered and insured stock savings association, Province Bank is subject to regulation and supervision by the OTS, which is the primary federal regulator of savings associations, and by the Federal Deposit Insurance Corporation, in its role as federal deposit insurer. 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 association’s holding company and non-banking companies that are under common control with the savings association. These affiliate restrictions 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 the Mutual Company. 
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 2004 and beyond. In some cases, you can identify forward-looking statements by terms such as “may,” “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 
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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 annual 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. 
Risk Factors 
          Risks Relating to Us and Our Business 
          Our operations are interrelated with those of the Mutual Company, which is our controlling stockholder, and potential conflicts exist between the best interests of our stockholders and the best interests of the policyholders of the Mutual Company. 
          The Mutual Company, which currently owns shares of our common stock generally entitling it to cast approximately 57% of the aggregate votes eligible to be cast by our stockholders at any meeting of stockholders, controls the election of the members of our board of directors, and four of the seven members of our board of directors are also members of the board of directors of the Mutual Company. These directors have a fiduciary duty to our stockholders, and also have a fiduciary duty to the policyholders of the Mutual Company. Our executive officers have the same positions with both the Mutual Company and us, and therefore have competing fiduciary duties. Certain potential and actual conflicts of interest arise from these separate fiduciary duties. Among these conflicts of interest are: 
•	 	We and the Mutual Company periodically review the percentage participation rate of Atlantic States in the underwriting pool.		
 	
•	 	We and the Mutual Company must annually establish the terms of certain inter-company reinsurance agreements.		
 	
•	 	We and the Mutual Company must make judgments about the allocation of shared expenses between the Mutual Company and us in accordance with various inter-company expense-sharing agreements.		
 	
•	 	We may enter into other transactions and contractual relationships with the Mutual Company and its subsidiaries.		
          As a consequence, we and the Mutual Company have established a coordinating committee that consists of two of our directors who are not directors of the Mutual Company and two directors of the Mutual Company who are not members of our board of directors. Under our by-laws and those of the Mutual Company, any new agreement or transaction between the Mutual Company and us, as well as any proposed change to an existing agreement between the Mutual Company and us, must first be submitted to the Mutual Company’s and our boards of directors for approval. If approved by both boards of directors, the proposed agreement or transaction, or the change in an existing agreement, must receive the approval of the coordinating committee. Coordinating committee approval is granted only if both of our coordinating committee members conclude 
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that the new agreement or transaction or proposed change in an existing agreement is fair and equitable to us and our stockholders and both of the Mutual Company’s coordinating committee members conclude that the new agreement or transaction or proposed change in an existing agreement is fair and equitable to the Mutual Company and its policyholders. 
          The Mutual Company has the ability to determine the outcome of all matters submitted for approval by our stockholders. The price of our Class A common stock may be adversely affected because of the Mutual Company’s ownership of our Class A common stock and Class B common stock or by the difference in voting power between our Class A common stock and Class B common stock. 
          Each share of our Class A common stock has one-tenth of a vote per share and generally can vote as a separate class only on matters pertaining to the rights of holders of Class A common stock. Voting control of the Company is vested in the Mutual Company. The Mutual Company owns approximately 42% of our outstanding Class A common stock and approximately 62% of our outstanding Class B common stock and controls approximately 57% of the votes that may be cast on any matter submitted to a vote of our stockholders. The Mutual Company has sufficient voting control to: 
•	 	elect a majority of our board of directors, who in turn determines our management and policies; and		
 	
•	 	control the outcome of any corporate transaction or other matter submitted to our stockholders for approval, including mergers, consolidations and the sale of all or substantially all of our assets.		
          The interests of the Mutual Company may conflict with the interests of our other stockholders. In addition, the voting power of the Mutual Company may have a negative effect on the price of our Class A common stock. 
          Our results of operations could suffer if the Mutual Company were to experience unusually severe or frequent losses or were not able to price its premiums adequately. 
          Our insurance subsidiary, Atlantic States, participates in a pooling agreement with the Mutual Company, under which the parties share the underwriting results on substantially all of the property and casualty insurance business written by both companies. Under the terms of the pooling agreement, Atlantic States has a 70% share of the results of the pool and the Mutual Company has a 30% share of the results of the pool. The allocation of pool participation percentages between the Mutual Company and Atlantic States has been established based on the pool participants’ relative amounts of capital and surplus, expectations of future relative amounts of capital and surplus and our ability to raise capital for Atlantic States. We do not expect the allocation to change in the foreseeable future. 
          Because of the pooled business allocated to us, our insurance operations are interrelated with the insurance operations of the Mutual Company, and our results of operations are dependent, in part, upon the underwriting results of the Mutual Company. Although the underwriting pool is intended to produce a more uniform and stable 
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underwriting result from year to year for the participants in the pool than they would experience individually and to spread the risk of loss among the participants, if the Mutual Company experiences unusually severe or frequent losses or does not adequately price its premiums, our business, financial condition and results of operations could suffer. 
          We currently conduct business in a limited number of states, with a concentration of business in Pennsylvania and Virginia. Any single catastrophe occurrence or other condition affecting losses in these states could adversely affect our results of operations. 
          We conduct business in states located primarily in the Mid-Atlantic and Southeastern portions of the United States. A substantial portion of our business is private passenger and commercial automobile, homeowners and workers’ compensation insurance in Pennsylvania and Virginia. While we actively manage our exposure to catastrophes through our underwriting process and the purchase of reinsurance, a single catastrophe occurrence, destructive weather pattern, general economic trend, terrorist attack, regulatory development or other condition affecting one or more of the states in which we conduct substantial business could materially adversely affect our business, financial condition and results of operations. Common catastrophic events include hurricanes, earthquakes, tornadoes, wind and hail storms, fires, explosions and severe winter storms. 
          Our business, financial condition and results of operations may be adversely affected if the independent agents that market our products do not maintain their current levels of premium writing, fail to comply with established underwriting guidelines or otherwise inappropriately market our products. 
          We market our insurance products solely through a network of approximately 1,200 independent insurance agencies, with approximately 6,800 agents. Our agency force is one of the most important components of our competitive profile. As a result, we are materially dependent upon these independent agents, each of whom has the authority to bind us to insurance contracts. To the extent that these independent agents’ marketing efforts cannot be maintained at their current levels of volume and quality or they bind us to unacceptable insurance risks, fail to comply with our established underwriting guidelines or otherwise inappropriately market our products, our business, financial condition and results of operations will suffer. 
          Our business may not continue to grow and may be materially adversely affected if we cannot retain existing, and attract new, independent agents or if insurance consumers increase their use of other insurance delivery systems. 
          The continued growth of our business will depend materially upon our ability to retain existing, and attract new, independent agents. If independent agencies find it easier to do business with our competitors, it would be difficult for us to retain our existing business or attract new business. While we believe we maintain good relationships with our independent agents, we cannot be certain that these independent agents will continue to sell our products to the consumers they represent. Some of the factors that could adversely affect our ability to retain existing, and attract new, independent agents include: 
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 	•	 	the significant competition among our competitors to attract independent agents;	
 	•	 	our intense and time-consuming process to select a new independent agent;	
 	•	 	our stringent criteria that require independent agents to adhere to consistent underwriting standards; and	
 	•	 	our ability to pay competitive and attractive commissions, bonuses and other incentives to independent agents as compensation for selling our products.	
          While we sell insurance solely through our network of independent agents, many of our competitors sell insurance through a variety of delivery methods, including independent agents, captive agencies, the Internet and direct sales. To the extent that individuals represented by our independent agents change their delivery system preference, our business, financial condition and results of operations 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 stockholders; however, our insurance subsidiaries may be unable to pay dividends 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. Payment of dividends by our insurance subsidiaries is subject to regulatory restrictions and depends on the surplus of our subsidiaries. From time to time, the NAIC and various state insurance regulators consider modifying the method of determining the amount of dividends that may be paid by an insurance company without prior regulatory approval. The maximum amount of dividends that Atlantic States and Southern, our insurance subsidiaries during 2003, can pay us in 2004 without prior regulatory approval is approximately $17.4 million. In addition, state insurance regulators have broad discretion to limit the payment of dividends by our insurance subsidiaries in the future. The ability of our insurance subsidiaries to pay dividends to us may be further constrained by business and regulatory considerations, such as the impact of dividends on surplus that could affect our ratings, competitive position, the amount of premiums that we can write and our ability to pay future dividends. 
          If the A.M. Best rating assigned to the Mutual Company or our insurance subsidiaries is significantly downgraded, our competitive position would be adversely affected. 
          Industry ratings are a factor in establishing the competitive position of insurance companies. Our insurance subsidiaries and the Mutual Company are rated by A.M. Best, an industry-accepted source of insurance company financial strength ratings. A.M. Best ratings are specifically designed to provide an independent opinion of an insurance company’s financial health and its ability to meet ongoing obligations to policyholders. We believe that the financial strength rating of A.M. Best is material to our insurance operations. Currently, the Mutual Company, Atlantic States and Southern each have an A (Excellent) 
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rating from A.M. Best. If the Mutual Company or any of our insurance subsidiaries were to be downgraded by A.M. Best, it would adversely affect our competitive position and make it more difficult for us to market our products and retain our existing policyholders. 
          Our strategy to grow in part through acquisitions of smaller insurance companies exposes us to a number of risks that could adversely affect our results of operations and financial condition. 
          The acquisition of smaller and undercapitalized insurance companies involves a number of risks that could adversely affect our results of operations and financial condition. The risks associated with the acquisition of this type of company include: 
 	•	 	the inadequacy of reserves for loss and loss expenses;	
 	•	 	the need to supplement management with additional experienced personnel;	
 	•	 	conditions imposed by regulatory agencies that make the realization of cost-savings through integration of operations more difficult;	
 	•	 	a need for additional capital that was not anticipated at the time of the acquisition; and	
 	•	 	the use of more of our management’s time than was originally anticipated.	
          If we cannot obtain sufficient capital to fund our organic growth and acquisitions, we may not be able to expand our business. 
          Our strategy is to expand our business through organic growth and through strategic acquisitions of regional insurance companies. We will require additional capital in the future to support this objective. If we are unable to obtain sufficient capital on satisfactory terms and conditions, we may not be able to expand our business or 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 we may already have substantial debt at the time or because we do not have sufficient cash flow to service or repay our existing or additional debt. In addition, any equity capital we obtain in the future could be dilutive to our existing stockholders. 
          Many of our competitors are financially stronger than we are and may be able to offer lower-priced products with which we may be unable to compete. 
          The property and casualty insurance industry is intensely competitive. Competition is based on many factors, including the perceived financial strength of the insurer, premiums charged, policy terms and conditions, policyholder service, reputation and experience. We 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 are better capitalized than we are, have substantially greater financial, technical and 
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operating resources and have equal or higher ratings from A.M. Best. In addition, our competition may become increasingly better capitalized in the future as the traditional barriers between insurance companies, banks and other financial institutions erode and as the property and casualty insurance industry continues to consolidate. 
          The greater capitalization of many of our competitors enables them to operate with lower profit margins and, therefore, allows them to market their products more aggressively, take advantage more quickly of new marketing opportunities and offer lower premium rates. We may not be able to maintain our current competitive position in the markets in which we operate if our competitors offer prices on products that are lower than the prices we can offer. Moreover, if our competitors lower the price of their products and we meet their pricing, our profit margins and revenues may be reduced and our ratios of claims and expenses to premiums may increase, which may materially adversely affect our business, financial condition and results of operations. 
          Because our investment portfolio is made up primarily of fixed-income securities, our investment income and the fair value of our investment portfolio could suffer as a result of a number of factors. 
          We invest the premiums we receive from our policyholders and maintain an investment portfolio that consists primarily of fixed-income securities. The management of our investment portfolio is an important component of our profitability because a significant portion of our operating income is generated from the income we receive on our invested assets. The quality and/or yield of our portfolio may be affected by a number of factors, including the general economic and business environment, changes in the credit quality of the issuers of the fixed-income securities we own, changes in market conditions and regulatory changes. The fixed-income securities we own are issued primarily by domestic entities and are backed either by the credit or collateral of the underlying issuer. Factors such as an economic downturn, a regulatory change pertaining to a particular issuer’s industry, a significant deterioration in the cash flows of the issuer or a change in the issuer’s marketplace may adversely affect our ability to collect principal and interest from the issuer. 
          Our investments are also subject to risk resulting from interest rate fluctuations. Increasing interest rates or a widening in the spread between interest rates available on United States Treasury securities and corporate debt or asset-backed securities, for example, will typically have an adverse impact on the market values of the fixed-rate securities in our investment portfolio. If interest rates decline, we generally achieve a lower overall rate of return on investments of cash generated from our operations. In addition, in the event that investments are called or mature in a declining interest rate environment, we may be unable to reinvest the proceeds in securities with comparable interest rates. Changes in interest rates may reduce both our profitability and our return on invested capital. 
          We are dependent on our key personnel, and the loss of any member of our senior management could negatively affect the implementation of our business strategy and achievement of our growth objectives. 
          The loss of, or failure to attract, key personnel could significantly impede our financial plans, growth, marketing and other objectives. Our success depends to a 
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substantial extent on the ability and experience of our senior management. We believe that our future success will depend in large part on our ability to attract and retain additional skilled and qualified personnel and to expand, train and manage our employees. We may not be successful in doing so, because the competition for experienced personnel in the insurance industry is intense. We do not have employment agreements with our key personnel, all of whom are employed by the Mutual Company. 
          Recently enacted and proposed changes in securities laws and regulations are likely to increase our costs. 
          The Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”), which became law in July 2002, required changes in our corporate governance, public disclosure and compliance practices. Sarbanes-Oxley also required the Securities and Exchange Commission (the “SEC”), to promulgate new rules on a variety of corporate governance and disclosure subjects. In addition to final rules and rule proposals already made, the Nasdaq National MarketSM (“Nasdaq”) has adopted revisions to its requirements for companies listed on Nasdaq, like us. We expect these developments to increase our legal and financial compliance costs. 
          We also expect these developments to make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced coverage or incur substantially higher costs to obtain coverage. These developments could make it more difficult for us to attract and retain additional members of our board of directors, particularly to serve on our audit committee, and additional executive officers. 
          The reinsurance agreements on which we rely do not relieve us from liability to our policyholders, and we face a risk of non-payment from our reinsurers and the non-availability of reinsurance in the future. 
          We rely on reinsurance agreements to limit our maximum net loss from large single risks or risks in concentrated areas, and to increase our capacity to write insurance. Although the reinsurance we maintain provides that the reinsurer is liable to us, our reinsurance does not relieve us from liability to our policyholders. To the extent that a reinsurer may be unable to pay losses for which it is liable to us under the terms of its reinsurance agreement with us, we remain liable for such losses. As of December 31, 2003, we had approximately $16.0 million of reinsurance receivables from third party reinsurers for paid and unpaid losses for which we believe we are entitled to reimbursement. The insolvency or inability to make timely payments by our reinsurers under the terms of our reinsurance agreements would adversely affect our results of operations. 
          In addition, we face a risk of the non-availability of reinsurance or an increase in reinsurance costs that could adversely affect our ability to write business or our results of operations. Market conditions beyond our control, such as the amount of surplus in the reinsurance market and natural and man-made catastrophes, affect the availability and cost of the reinsurance we purchase. We cannot assure you that reinsurance will remain available to us to the same extent and on substantially the same terms and rates as it is currently available. If we are unable to maintain our current level of reinsurance or purchase new 
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reinsurance protection in amounts that we consider sufficient, we would either have to be willing to accept an increase in our net retention or reduce our insurance writings, and our business, financial condition and results of operations could be adversely affected. 
Risks Relating to the Property and Casualty Insurance Industry 
          We face significant exposure to terrorism. 
          As a result of the September 11, 2001 terrorist attacks, the insurance industry has been compelled to re-examine policy terms and conditions and to address the potential for future threats of terrorist attacks and resulting losses. Our personal and commercial property and casualty insurance policies are not priced to cover the risk of terrorist attacks and losses such as those suffered in the World Trade Center terrorist attack. Therefore, we have exposure to terrorism under the lines of insurance products that we offer. The Terrorism Risk Insurance Act of 2002 may reduce the impact of future losses as a result of terrorism in connection with commercial insurance products we offer; however, because of the uncertainty regarding the application of the Terrorism Risk Insurance Act, the amount of losses we may be required to retain as a result of terrorism may result in a material adverse effect on our business, financial condition and results of operations. The Terrorism Risk Insurance Act is scheduled to expire on December 31, 2005, so it will not provide coverage beyond that time unless it is extended. The Terrorism Risk Insurance Act does not cover the personal insurance products we offer, and state regulators have not approved exclusions for acts of terrorism in our personal insurance products. Therefore we could incur large unexpected losses from the personal insurance policies that we issue, which could have a material adverse effect on our business, financial condition and results of operations. 
          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, increasing medical costs and the escalation of loss severity may contribute to increased costs and to the deterioration of our reserves. 
          Loss severity in our industry has continued to increase in recent years, principally driven by larger court judgments and increasing medical costs. In addition, many legal actions and proceedings have been brought on behalf of classes of complainants, which can 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 may render our loss reserves inadequate for current and future losses if we become subject to litigation. 
          Loss or significant restriction of the use of credit scoring in the pricing and underwriting of our personal insurance products could reduce our future profitability. 
          We use credit scoring as a factor in making risk selection and pricing decisions where allowed by state law for our personal 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 are calling for the prohibition or restriction on the use of credit scoring in underwriting and pricing. Laws or regulations enacted in a number of states 
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that significantly curtail the use of credit scoring in the underwriting process could reduce our future profitability. 
          Changes in applicable insurance laws or regulations or changes in the way regulators administer those laws or regulations could materially adversely change our operating environment and increase our exposure to loss or put us at a competitive disadvantage. 
          Property and casualty insurers are subject to extensive supervision in the states in which they do business. This regulatory oversight includes, by way of example, matters relating to licensing and examination, rate setting, 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 may be paid and restrictions on underwriting standards. Such regulation and supervision are primarily for the benefit and protection of policyholders and not for the benefit of stockholders. For instance, we are subject to involuntary participation in specified markets in various states in which we operate, and the rate levels we are permitted to charge do not always correspond with our underlying costs associated with the coverage we have issued. 
          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 terms and conditions included in insurance policies, certain methods of accounting, reserves for unearned premiums, losses and other purposes, 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 materially change our operating environment and have an adverse effect on our business. 
          The state insurance regulatory framework recently has come under increased federal scrutiny. Congress is considering legislation that would 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 specter of a matrix of regulation and costly duplicative, or conflicting, federal and state requirements. In addition, if federal legislation repeals the partial exemption for the insurance industry from federal antitrust laws, it would make it extremely difficult for insurers to compile and share loss data and predict future loss costs, which is an important part of cost-based pricing for insurers. If the ability to collect this data were removed, then the predictability of future loss costs, and hence, the reliability of our pricing, would be greatly undermined. 
          If certain state regulators, legislators and special interest groups are successful in attempts to reduce, freeze or set rates for insurance policies, especially automobile policies, at levels that do not, in our management’s view, correspond with underlying costs, our results of operations will be adversely affected. 
          From time to time, the automobile insurance industry in particular has been under pressure from certain state regulators, legislators and special interest groups to 
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reduce, freeze or set rates at levels that do not, in the view of our management, correspond with underlying costs, including initiatives to roll back automobile and other personal lines rates. This activity may in the future adversely affect the profitability of our automobile insurance line of business in various states because increasing costs of litigation and medical treatment, combined with rising automobile repair costs, continue to increase our cost of providing automobile insurance coverage that we may not be able to offset by increasing the rates for our automobile insurance products. Adverse legislative and regulatory activity constraining our ability to price automobile insurance coverage adequately may occur in the future. The impact of the automobile insurance regulatory environment on our results of operations in the future is not predictable. 
          We are subject to assessments, based on our market share in a given line of business, to assist in the payment of unpaid claims and related costs of insolvent insurance companies; these assessments could significantly affect our financial condition. 
          We are obligated to pay assessments under the guaranty fund laws of the various states in which we are licensed. Generally, under these laws, we are subject to assessment, depending upon our market share of a given line of insurance business, to assist in the payment of unpaid claims and related costs of insolvent insurance companies in those states. The number and magnitude of future insurance company failures in the states in which we conduct business cannot be predicted, but resulting assessments could significantly affect our business, financial condition and results of operations. We are currently being assessed at the maximum level permitted by Pennsylvania law for several of our lines of business, and we expect that we will continue to be assessed by Pennsylvania at the maximum level for these business lines for a number of years. 
          We must establish premium rates and loss and loss expense reserves from forecasts of the ultimate costs expected to arise from risks underwritten during the policy period, and our profitability could be adversely affected to the extent our premium rates or reserves are too low. 
          One of the distinguishing features of the property and casualty insurance industry is that its products are priced before its costs are known, as premium rates are generally determined before losses are reported. Accordingly, we must establish premium rates from forecasts of the ultimate costs we expect to arise from risks we have underwritten during the policy period, and our premium rates may not be adequate to cover the ultimate losses incurred. Further, we must establish reserves for losses and loss expenses based upon estimates involving actuarial and statistical projections at a given time of what we expect to be our ultimate liability, and it is possible that our ultimate liability will 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 factors that are subject to variation. If the premium rates or reserves we establish are not sufficient, our business, financial condition and results of operations may be adversely impacted. 
          The cyclical nature of the property and casualty insurance industry may reduce our revenues and profit margins. 
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          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 are related to the availability of insurance coverage, which varies according to the level of surplus 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 have generally been accompanied by increased price competition among property and casualty insurers. If we find it necessary to reduce premiums or limit premium increases due to these competitive pressures on pricing, we may experience a reduction in our profit margins and revenues, an increase in our 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 trading liquidity. Reported average daily trading volume in our Class A common stock for the year ended December 31, 2003, was approximately 15,000 shares. This limited trading liquidity subjects our shares of Class A common stock to greater price volatility. 
          The market price of our Class A common stock may be adversely affected by future sales of a substantial number of shares of our Class A common stock or Class B common stock or the availability of such shares for sale. 
          The sale, or the availability for sale, of a significant number of shares of our Class A common stock or Class B common stock could adversely affect the prevailing market prices of our Class A common stock and could impair our ability to raise capital through future sales of our equity securities. As of February 20, 2004, we had outstanding 9,809,352 shares of our Class A common stock and 3,011,049 shares of our Class B common stock. Apart from the shares held by the Mutual Company, all of our outstanding shares of Class A common stock and Class B common stock are freely tradeable without restrictions under the Securities Act. Sales of a substantial number of shares of our Class A common stock or Class B common stock by the Mutual Company could cause the price of our Class A common stock to fall. 
          The Mutual Company’s ownership of our stock, provisions of our certificate of incorporation and by-laws and certain state laws make it unlikely anyone could acquire control of us unless the Mutual Company were in favor of the change of control. 
          The Mutual Company’s ownership of our Class A common stock and Class B common stock, certain provisions of our certificate of incorporation and by-laws and the insurance laws and regulations of Pennsylvania and Virginia could delay or prevent the removal of members of our board of directors and could make more difficult a merger, tender offer or proxy contest involving us to succeed, even if such events were beneficial to the interest of our stockholders other than the Mutual Company. These factors could also discourage a third party from attempting to acquire control of us. The classification of our 
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board of directors could also have the effect of delaying or preventing a change in control of us. 
          In addition, we have authorized 2,000,000 shares of series preferred stock that we could issue without further stockholder approval and upon such terms and conditions, and having such rights, privileges and preferences, as our board of directors may determine and that may make it difficult for a third party to acquire control of us. We have no current plans to issue any preferred stock. Moreover, the Delaware General Corporation Law contains certain provisions that prohibit certain business combination transactions under certain circumstances. In addition, state insurance laws and regulations generally prohibit any persons from acquiring 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. 
Available Information 
          Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports are available without charge on our website, www.donegalgroup.com, as soon as reasonably practicable after they are filed electronically with the 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 Internet site 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 report. 
Item 2. Properties. 
          We and Atlantic States share headquarters with the Mutual Company in a building owned by the Mutual Company. The Mutual Company charges us for an appropriate portion of the building expenses under an inter-company allocation agreement that is consistent with the terms of the pooling agreement. The headquarters of the Mutual Company has approximately 172,600 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 and Peninsula owns a facility of approximately 14,600 square feet in Salisbury, Maryland. 
Item 3. Legal Proceedings. 
          We are a party to numerous lawsuits arising in the ordinary course of our insurance business. We believe that the resolution of these lawsuits will not have a material adverse effect on our financial condition or results of operations. 
Item 4. Submission of Matters to a Vote of Security Holders. 
          No matter was submitted to a vote of holders of our Class A common stock or Class B common stock during the fourth quarter of 2003. 
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Executive Officers of the Company 
     The following table sets forth information regarding the executive officers of the companies that comprise the Donegal Insurance Group, each of whom has served with us for more than 15 years: 
 	 	 	 	 	 	 	
Name
	 	Age
	 	Position
	
Donald H. Nikolaus 	 	 	61	 	 	President and Chief Executive Officer of the Mutual Company since 1981; President and Chief Executive Officer of the Company since 1986.	
 	 	 	 	 	 	 	
Ralph G. Spontak 	 	 	51	 	 	Senior Vice President of the Mutual Company and the Company since 1991; Chief Financial Officer of the Mutual Company since 1983 and of the Company since 1986 and Secretary of the Mutual Company and the Company since 1988.	
 	 	 	 	 	 	 	
Robert G. Shenk 	 	 	50	 	 	Senior Vice President, Claims, of the Mutual Company since 1997; Vice President, Claims, of the Mutual Company from 1992 to 1997 and Manager, Casualty Claims, of the Mutual Company from 1985 to 1992.	
 	 	 	 	 	 	 	
Cyril J. Greenya 	 	 	59	 	 	Senior Vice President, Underwriting, of the Mutual Company since 1997, Vice President, Commercial Underwriting, of the Mutual Company from 1992 to 1997 and Manager, Commercial Underwriting of the Mutual Company from 1983 to 1992.	
 	 	 	 	 	 	 	
Daniel J. Wagner 	 	 	43	 	 	Treasurer of the Mutual Company and the Company since 1993; Controller of the Mutual Company and the Company from 1988 to 1993.	
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PART II 

Item 5. 	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.	
          The response to this Item is incorporated in part by reference to page 32 of our Annual Report to Stockholders for the year ended December 31, 2003, which is included as Exhibit (13) to this Form 10-K Report. As of February 20, 2004, we had approximately 633 holders of record of our Class A common stock and 478 holders of record of our Class B common stock. We declared dividends of $0.43 per share on our Class A common stock and $0.39 per share on our Class B common stock in 2003 and $.40 per share on our Class A common stock and $.36 per share on our Class B common stock in 2002. 
          During the year ended December 31, 2003, we did not repurchase any of our Class A common stock or Class B common stock. During 2004, we may repurchase shares of our Class B common stock from time to time in open market transactions in accordance with SEC Rule 10b-18 or in private transactions. 
Item 6. Selected Financial Data. 
          The response to this Item is incorporated by reference to page 8 of our Annual Report to Stockholders for the year ended December 31, 2003, which is included as Exhibit (13) to this Form 10-K Report. 

Item 7. 	Management’s Discussion and Analysis of Financial Condition and Results of Operations.	
          The response to this Item is incorporated by reference to pages 10 through 15 of our Annual Report to Stockholders for the year ended December 31, 2003, which is included as Exhibit (13) to this Form 10-K Report. 
Item 7A. Quantitative and Qualitative Disclosures About Market Risk. 
          We are exposed to the impact of interest rate changes, changes in market values of investments and to credit risk. 
          In the normal course of business, we employ established policies and procedures to manage our exposure to changes in interest rates, fluctuations in the 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 
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positions. Estimates of cash flows and the impact of interest rate fluctuations relating to our investment portfolio are monitored regularly. Generally, we do not hedge our exposure to interest rate risk because we have the capacity to, and do, hold fixed maturity investments to maturity. 
          Principal cash flows and related weighted-average interest rates by expected maturity dates for financial instruments sensitive to interest rates are as follows: 
 	 	 	 	 	 	 	 	 	
 	 	As of December 31, 2003
	
 	 	 	 	 	 	Weighted-average	
(amounts in thousands)
	 	Principal cash flows
	 	interest rate
	
Fixed maturities and short-term investments:	 	 	 	 	 	 	 	 	
2004	 	$	92,194	 	 	 	1.74	%	
2005	 	 	13,337	 	 	 	5.86	 	
2006	 	 	32,989	 	 	 	4.81	 	
2007	 	 	31,236	 	 	 	4.63	 	
2008	 	 	40,075	 	 	 	4.01	 	
Thereafter	 	 	169,209	 	 	 	4.85	 	

Total	 	$	379,040	 	 	 	 	 	

Market Value	 	$	392,910	 	 	 	 	 	

Debt:	 	 	 	 	 	 	 	 	
2033	 	$	25,774	 	 	 	5.17	%	

Total	 	$	25,774	 	 	 	 	 	

Fair Value	 	$	25,774	 	 	 	 	 	

          Actual cash flows from investments may differ from those stated as a result of calls and prepayments. 
          Equity Price Risk 
          Our portfolio of marketable equity securities, which is carried on the consolidated balance sheets at estimated fair value, has exposure to price risk, the risk of potential loss in estimated fair value resulting from an adverse change in prices. Our objective is to earn competitive relative returns by investing in a diverse portfolio of high-quality, liquid securities. 
          Credit Risk 
          Our objective is to earn competitive returns by investing in a diversified portfolio of securities. Our portfolio of fixed-maturity securities and, to a lesser extent, our short-term investments are subject to credit risk. This risk is defined as the potential loss in market value resulting from adverse changes in the borrower’s ability to repay the debt. We manage this risk by performing up front underwriting analysis and through regular reviews by our investment staff. The fixed maturity investments are also maintained between minimum and maximum percentages of invested assets. 
          We provide property and liability insurance coverages through independent insurance agencies located throughout our operating areas. The majority of this business is 
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billed directly to the insured, although a portion of our commercial business is billed through our agents, who are extended credit in the normal course of business. 
          Our insurance subsidiaries maintain reinsurance agreements in place with the Mutual Company and with a number of other major unaffiliated authorized reinsurers. 
Item 8. Financial Statements and Supplementary Data. 
          The response to this Item is incorporated by reference to pages 16 through 31 of our Annual Report to Stockholders for the year ended December 31, 2003, which is included as Exhibit (13) to this Form 10-K 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 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 Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, our disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by us in the reports that we file or submit under the Exchange Act. 
          Internal Control over Financial Reporting 
          There have not been any changes in 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 2003 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. 
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PART III 
Item 10. Directors and Executive Officers of the Registrant. 
          The response to this Item with respect to our directors is incorporated by reference to pages 4 through 6 and pages 9 through 16 of our proxy statement relating to our annual meeting of stockholders to be held April 15, 2004. The response to this Item with respect to our executive officers is incorporated by reference to Part I of this Form 10-K Report. 
          We have adopted a Code of Ethics, the full text of which is included as Exhibit 14 to this Form 10-K Report. 
Item 11. Executive Compensation. 
          The response to this Item is incorporated by reference to pages 16 through 21 of our proxy statement relating to our annual meeting of stockholders to be held April 15, 2004, except for the Report of the Compensation Committee, the Performance Graph and the Report of the Audit Committee, which are not incorporated herein by reference. 

Item 12. 	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.	
          The response to this Item is incorporated by reference to pages 4 through 6 of our proxy statement relating to our annual meeting of stockholders to be held April 15, 2004. 
          The following table sets forth information regarding our equity compensation plans: 
Equity Compensation Plan Information 
 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	 	 	 	 	 	 	 	 	Number of securities	
 	 	 	 	 	 	 	 	 	 	(class) remaining	
 	 	 	 	 	 	 	 	 	 	available for future	
 	 	Number of securities	 	 	 	 	 	issuance under equity	
 	 	(class) to be issued	 	Weighted-average	 	compensation plans	
 	 	upon exercise of	 	exercise price of	 	(excluding securities	
 	 	outstanding options,	 	outstanding options,	 	reflected	
Plan category
	 	warrants and rights
	 	warrants and rights
	 	in column (a))
	
 	 	(a)	 	(b)	 	(c)	
Equity compensation plans approved by	 	 	1,353,728	 (Class A)	 	$	12.05	 (Class A)	 	 	577,975	 (Class A)	
securityholders	 	 	125,624	 (Class B)	 	 	8.14	 (Class B)	 	 	—	 (Class B)	
Equity compensation plans not approved by securityholders	 	 	—	 	 	 	—	 	 	 	—	 	

 	 	 	 	
 	 	
Total	 	 	1,479,352	 	 	$	11.72	 	 	 	577,975	 	

 	 	 	 	
 	 	
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Item 13. Certain Relationships and Related Transactions. 
          The response to this Item is incorporated by reference to pages 17 and 18 of our proxy statement relating to our annual meeting of stockholders to be held April 15, 2004. 
Item 14. Principal Accountant Fees and Services. 
          The response to this Item is incorporated by reference to pages 22 through 24 of our proxy statement relating to our annual meeting of stockholders to be held April 15, 2004. 
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PART IV 
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K. 
Financial statements, financial statement schedules and exhibits filed: 
Consolidated Financial Statements 
 	 	 	
 	 	Page*
	
Report of Independent Auditors	 	31	
Donegal Group Inc. and Subsidiaries:	 	 	
Consolidated Balance Sheets as of December 31, 2003 and 2002	 	16	
Consolidated Statements of Income and Comprehensive Income for the three years ended December 31, 2003, 2002 and 2001	 	17	
Consolidated Statements of Stockholders’ Equity for the three years ended December 31, 2003, 2002 and 2001	 	18	
Consolidated Statements of Cash Flows for the three years ended December 31, 2003, 2002 and 2001	 	19	
Notes to Consolidated Financial Statements	 	20	
Financial Statement Schedules 
 	 	 	
 	 	Page
	
Independent Auditors’ Consent and Report on Schedules	 	Exhibit 23	
Donegal Group Inc. and Subsidiaries	 	 	
Schedule I. Summary of Investments – Other Than Investments in Related Parties	 	S-1	
Schedule II. Condensed Financial Information of Parent Company	 	S-2	
Schedule III. Supplementary Insurance Information	 	S-5	
Schedule IV. Reinsurance	 	S-7	
Schedule VI. Supplemental Insurance Information Concerning Property and Casualty Subsidiaries	 	S-8	
          All other schedules have been omitted since they are not required, not applicable or the information is included in the financial statements or notes thereto. 

*    Refers to pages of our 2003 Annual Report to Stockholders. The Consolidated Financial Statements and Notes to Consolidated Financial Statements and Auditor’s Report thereon on pages 16 through 31 are incorporated herein by reference. With the exception of the portions of such Annual Report specifically incorporated by reference in this Item and Items 5, 6, 7 and 8 hereof, such 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.	
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Exhibits 
 	 	 	 	 	
Exhibit No.
	 	Description of Exhibits
	 	Reference
	
(3)(i) 	 	Certificate of Incorporation of Registrant, as amended. 	 	(a)	
 	 	 	 	 	
(3)(ii) 	 	Amended and Restated By-laws of Registrant. 	 	(b)	
 	 	 	 	 	
(3)(iii) 	 	Amended and Restated By-laws of Registrant as of March 19, 2004 	 	Filed herewith	
 	 	 	 	 	
	 	Management Contracts and Compensatory Plans or Arrangements	 	 	
 	 	 	 	 	
(10)(A) 	 	Donegal Group Inc. Amended and Restated 1996 Equity Incentive Plan. 	 	(c)	
 	 	 	 	 	
(10)(B) 	 	Donegal Group Inc. 2001 Equity Incentive Plan for Employees. 	 	(d)	
 	 	 	 	 	
(10)(C) 	 	Donegal Group Inc. 2001 Equity Incentive Plan for Directors. 	 	(d)	
 	 	 	 	 	
(10)(D) 	 	Donegal Group Inc. 2001 Employee Stock Purchase Plan, as amended. 	 	(e)	
 	 	 	 	 	
(10)(E) 	 	Donegal Group Inc. Second Amended and Restated 2001 Agency Stock Purchase Plan. 	 	(f)	
 	 	 	 	 	
(10)(F) 	 	Donegal Mutual Insurance Company 401(k) Plan. 	 	(g)	
 	 	 	 	 	
(10)(G) 	 	Amendment No. 1 effective January 1, 2000 to Donegal Mutual Insurance Company 401(k) Plan. 	 	(g)	
 	 	 	 	 	
(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)	
 	 	 	 	 	
(10)(L) 	 	Amendment No. 6 effective July 1, 2002 to Donegal Mutual Insurance Company 401(k) Plan. 	 	(r)	
 	 	 	 	 	
(10)(M) 	 	Donegal Mutual Insurance Company Executive Restoration Plan. 	 	(h)	
 	 	 	 	 	
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Table of Contents
 	 	 	 	 	
Exhibit No.
	 	Description of Exhibits
	 	Reference
	
	 	Other Material Contracts	 	 	
 	 	 	 	 	
(10)(N) 	 	Tax Sharing Agreement dated September 29, 1986 between Donegal Group Inc. and Atlantic States Insurance Company. 	 	(i)	
 	 	 	 	 	
(10)(O) 	 	Services Allocation Agreement dated September 29, 1986 between Donegal Mutual Insurance Company, Donegal Group Inc. and Atlantic States Insurance Company. 	 	(i)	
 	 	 	 	 	
(10)(P) 	 	Proportional Reinsurance Agreement dated September 29, 1986 between Donegal Mutual Insurance Company and Atlantic States Insurance Company. 	 	(i)	
 	 	 	 	 	
(10)(Q) 	 	Amendment dated October 1, 1988 to Proportional Reinsurance Agreement between Donegal Mutual Insurance Company and Atlantic States Insurance Company. 	 	(j)	
 	 	 	 	 	
(10)(R) 	 	Multi-Line Excess of Loss Reinsurance Agreement effective January 1, 2002 among Donegal Mutual Insurance Company, Dorinco Reinsurance Company and Erie Insurance Group. 	 	(r)	
 	 	 	 	 	
(10)(S) 	 	Amendment dated July 16, 1992 to Proportional Reinsurance Agreement between Donegal Mutual Insurance Company and Atlantic States Insurance Company. 	 	(k)	
 	 	 	 	 	
(10)(T) 	 	Amendment dated as of December 21, 1995 to Proportional Reinsurance Agreement between Donegal Mutual Insurance Company and Atlantic States Insurance Company. 	 	(l)	
 	 	 	 	 	
(10)(U) 	 	Reinsurance and Retrocession Agreement dated May 21, 1996 between Donegal Mutual Insurance Company and Southern Insurance Company of Virginia. 	 	(h)	
 	 	 	 	 	
(10)(V) 	 	Amended and Restated Credit Agreement dated as of July 27, 1998 among Donegal Group Inc., the banks and other financial institutions from time to time party thereto and Fleet National Bank, as agent. 	 	(m)	
 	 	 	 	 	
(10)(W) 	 	First Amendment and Waiver to the Amended and Restated Credit Agreement dated as of December 31, 1999. 	 	(g)	
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Table of Contents
 	 	 	 	 	
Exhibit No.
	 	Description of Exhibits
	 	Reference
	
(10)(X) 	 	Amendment dated as of April 20, 2000 to Proportional Reinsurance Agreement between Donegal Mutual Insurance Company and Atlantic States Insurance Company. 	 	(n)	
 	 	 	 	 	
(10)(Y) 	 	Lease Agreement dated as of September 1, 2000 between Donegal Mutual Insurance Company and Province Bank FSB. 	 	(d)	
 	 	 	 	 	
(10)(Z) 	 	Aggregate Excess of Loss Reinsurance Agreement dated as of January 1, 2001 between Donegal Mutual Insurance Company and Atlantic States Insurance Company (as successor-in-interest to Pioneer Insurance Company). 	 	(d)	
 	 	 	 	 	
(10)(AA) 	 	Stock Purchase Agreement dated as of October 28, 2003 between Donegal Group Inc. and Folksamerica Holding Company, Inc. 	 	(p)	
 	 	 	 	 	
(10)(BB) 	 	Credit Agreement dated as of November 25, 2003 between Donegal Group Inc. and Manufacturers and Traders Trust Company 	 	(q)	
 	 	 	 	 	
(13) 	 	2003 Annual Report to Stockholders (electronic filing contains only those portions incorporated by reference into this Form 10-K Report). 	 	Filed herewith	
 	 	 	 	 	
(14) 	 	Code of Ethics 	 	Filed herewith	
 	 	 	 	 	
(20) 	 	Proxy Statement relating to the Annual Meeting of Stockholders to be held on April 15, 2004; provided, however, that the Report of the Compensation Committee, the Performance Graph and the Report of the Audit Committee shall not be deemed filed as part of this Form 10-K Report. 	 	(o)	
 	 	 	 	 	
(21) 	 	Subsidiaries of Registrant. 	 	Filed herewith	
 	 	 	 	 	
(23) 	 	Consent of Independent Auditors. 	 	Filed herewith	
 	 	 	 	 	
(31.1) 	 	Rule 13a-14(a)/15(d)-14(a) Certification of Chief Executive Officer 	 	Filed herewith	
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Exhibit No.
	 	Description of Exhibits
	 	Reference
	
(31.2) 	 	Rule 13a-14(a)/15(d)-14(a) Certification of Chief Financial Officer 	 	Filed herewith	
 	 	 	 	 	
(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 Registrant’s 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 Registrant’s 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 Registrant’s Form 10-K Report for the year ended December 31, 1998.	
 		
(d)	 	Such exhibit is hereby incorporated by reference to the like-described exhibit in Registrant’s Form 10-K Report for the year ended December 31, 2000.	
 		
(e)	 	Such exhibit is hereby incorporated by reference to the like-described exhibit in Registrant’s Form S-8 Registration Statement No. 333-62974 filed June 14, 2001.	
 		
(f)	 	Such exhibit is hereby incorporated by reference to the like-described exhibit in Registrant’s Form S-2/A Registration Statement No. 333-63102 filed December 21, 2001.	
 		
(g)	 	Such exhibit is hereby incorporated by reference to the like-described exhibit in Registrant’s Form 10-K Report for the year ended December 31, 1999.	
 		
(h)	 	Such exhibit is hereby incorporated by reference to the like-described exhibit in Registrant’s Form 10-K Report for the year ended December 31, 1996.	
 		
(i)	 	Such exhibit is hereby incorporated by reference to the like-described exhibit in Registrant’s Form S-1 Registration Statement No. 33-8533 declared effective October 29, 1986.	
 		
(j)	 	Such exhibit is hereby incorporated by reference to the like-described exhibit in Registrant’s Form 10-K Report for the year ended December 31, 1988.	
 		
(k)	 	Such exhibit is hereby incorporated by reference to the like-described exhibit in Registrant’s Form 10-K Report for the year ended December 31, 1992.	
 		
(l)	 	Such exhibit is hereby incorporated by reference to the like-described exhibit in Registrant’s Form 8-K Report dated December 21, 1995.	
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(m)	 	Such exhibit is hereby incorporated by reference to the like-described exhibit in Registrant’s Form 8-K Report dated November 17, 1998.	
 		
(n)	 	Such exhibit is hereby incorporated by reference to the like-described exhibit in Registrant’s Form 8-K Report dated May 31, 2000.	
 		
(o)	 	Such exhibit is hereby incorporated by reference to the Registrant’s definitive proxy statement filed March 25, 2004.	
 		
(p)	 	Such exhibit is hereby incorporated by reference to the like-described exhibits in Registrant’s Form 8-K Report dated October 28, 2003.	
 		
(q)	 	Such exhibit is hereby incorporated by reference to the like-described exhibit in Registrant’s Form 8-K Report dated November 24, 2003.	
 		
(r)	 	Such exhibit is hereby incorporated by reference to the like-described exhibit in Registrant’s Form 10-K Report for the year ended December 31, 2002.	
Reports on Form 8-K: 
          On October 17, 2003, the Company filed a Current Report on Form 8-K in connection with the Company’s release of financial results for the quarter and nine months ended September 30, 2003. 
          On November 3, 2003, the Company filed a Current Report on Form 8-K in connection with the Company’s execution of a stock purchase agreement to acquire all of the outstanding common stock of The Peninsula Insurance Company and Peninsula Indemnity Company; the approval by the policyholders of Le Mars Mutual Insurance Company of Iowa of its conversion; the October 31, 2003 filing by the Company of a Form S-2 registration statement relating to the Company’s public offering of 3,450,000 shares of its Class A common stock and the receipt by the Company of a commitment letter from Manufacturers and Traders Trust Company relating to a $35.0 million line of credit, which would be used to repay the Company’s outstanding line of credit with Fleet National Bank. 
          On December 1, 2003, the Company filed a Current Report on Form 8-K in connection with the Company’s execution of a Credit Agreement with Manufacturers and Traders Trust Company relating to a four-year $35.0 million unsecured, revolving line of credit and the repayment of the Company’s outstanding line of credit with Fleet National Bank and the announcement of the effectiveness of the Company’s Form S-2 Registration Statement relating to the public offering of 3,450,000 shares of the Company’s Class A common stock and the pricing of the shares being offered. 
-49- 

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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 26, 2004 
          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 	 	President and a Director 	 	March 26, 2004	
	 	(principal executive officer)	 	 	
Donald H. Nikolaus	 	 	 	 	
 	 	 	 	 	
/s/ Ralph G. Spontak 	 	Senior Vice President, Chief 	 	March 26, 2004	
	 	Financial Officer and	 	 	
Ralph G. Spontak 	 	Secretary (principal financial	 	 	
  	 	and accounting officer)	 	 	
 	 	 	 	 	
/s/ Robert S. Bolinger 	 	Director 	 	March 26, 2004	
	 	 	 	 	
Robert S. Bolinger	 	 	 	 	
 	 	 	 	 	
/s/ Patricia A. Gilmartin 	 	Director 	 	March 26, 2004	
	 	 	 	 	
Patricia A. Gilmartin	 	 	 	 	
 	 	 	 	 	
/s/ Philip H. Glatfelter 	 	Director 	 	March 26, 2004	
	 	 	 	 	
Philip H. Glatfelter	 	 	 	 	
 	 	 	 	 	
/s/ John J. Lyons 	 	Director 	 	March 26, 2004	
	 	 	 	 	
John J. Lyons	 	 	 	 	
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Signature
	 	Title
	 	Date
	
/s/ R. Richard Sherbahn 	 	Director 	 	March 26, 2004	
	 	 	 	 	
R. Richard Sherbahn	 	 	 	 	
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DONEGAL GROUP INC. AND SUBSIDIARIES 
SCHEDULE I – SUMMARY OF INVESTMENTS
OTHER THAN INVESTMENTS IN RELATED PARTIES
($ in thousands) 
December 31, 2003 
 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	 	 	 	 	 	 	 	 	Amount at Which	
 	 	 	 	 	 	Fair	 	Shown in the	
 	 	Cost
	 	Value
	 	Balance Sheet
	
Fixed Maturities:	 	 	 	 	 	 	 	 	 	 	 	 	
Held to maturity:	 	 	 	 	 	 	 	 	 	 	 	 	
United States government and governmental agencies and authorities	 	$	29,131	 	 	$	28,828	 	 	$	29,131	 	
Obligations of states and political subdivisions	 	 	45,188	 	 	 	46,244	 	 	 	45,188	 	
Canadian government obligation	 	 	499	 	 	 	525	 	 	 	499	 	
All other corporate bonds	 	 	25,192	 	 	 	27,278	 	 	 	25,192	 	
Mortgage-backed securities	 	 	13,041	 	 	 	13,258	 	 	 	13,041	 	

 	 	 	 	
 	 	
Total fixed maturities held to maturity	 	 	113,051	 	 	 	116,133	 	 	 	113,051	 	

 	 	 	 	
 	 	
Available for sale:	 	 	 	 	 	 	 	 	 	 	 	 	
United States government and governmental agencies and authorities	 	 	69,481	 	 	 	70,507	 	 	 	70,507	 	
Obligations of states and political subdivisions	 	 	81,105	 	 	 	84,386	 	 	 	84,386	 	
All other corporate bonds	 	 	28,767	 	 	 	30,699	 	 	 	30,699	 	
Mortgage-backed securities	 	 	12,744	 	 	 	12,841	 	 	 	12,841	 	

 	 	 	 	
 	 	
Total fixed maturities available for sale	 	 	192,097	 	 	 	198,433	 	 	 	198,433	 	

 	 	 	 	
 	 	
Total fixed maturities	 	 	305,148	 	 	 	314,566	 	 	 	311,484	 	

 	 	 	 	
 	 	
Equity Securities:	 	 	 	 	 	 	 	 	 	 	 	 	
Preferred stocks:	 	 	 	 	 	 	 	 	 	 	 	 	
Public utilities	 	 	102	 	 	 	126	 	 	 	126	 	
Banks	 	 	8,617	 	 	 	9,000	 	 	 	9,000	 	
Industrial and miscellaneous	 	 	1,450	 	 	 	1,504	 	 	 	1,504	 	

 	 	 	 	
 	 	
Total preferred stocks	 	 	10,169	 	 	 	10,630	 	 	 	10,630	 	

 	 	 	 	
 	 	
Common stocks:	 	 	 	 	 	 	 	 	 	 	 	 	
Banks and insurance companies	 	 	7,098	 	 	 	7,529	 	 	 	7,529	 	
Industrial and miscellaneous	 	 	12,377	 	 	 	13,289	 	 	 	13,289	 	

 	 	 	 	
 	 	
Total common stocks	 	 	19,475	 	 	 	20,818	 	 	 	20,818	 	

 	 	 	 	
 	 	
Total equity securities	 	 	29,644	 	 	 	31,448	 	 	 	31,448	 	

 	 	 	 	
 	 	
Short-term investments	 	 	78,344	 	 	 	78,344	 	 	 	78,344	 	

 	 	 	 	
 	 	
Total investments	 	$	413,136	 	 	$	424,358	 	 	$	421,276	 	

 	 	 	 	
 	 	
S- 1 

Table of Contents
DONEGAL GROUP INC. AND SUBSIDIARIES 
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY 
Condensed Balance Sheets
($ in thousands)
December 31, 2003 and 2002 
 	 	 	 	 	 	 	 	 	
 	 	2003
	 	2002
	
ASSETS	 	 	 	 	 	 	 	 	
Fixed-maturity investments	 	$	1,987	 	 	$	—	 	
Investment in subsidiaries (equity method)	 	 	183,402	 	 	 	156,684	 	
Short-term investments	 	 	47,559	 	 	 	—	 	
Cash	 	 	365	 	 	 	604	 	
Property and equipment	 	 	1,579	 	 	 	1,640	 	
Other	 	 	1,345	 	 	 	99	 	

 	 	
Total assets	 	$	236,237	 	 	$	159,027	 	

 	 	
LIABILITIES AND STOCKHOLDERS’ EQUITY	 	 	 	 	 	 	 	 	
Cash dividends declared to stockholders	 	$	1,379	 	 	$	887	 	
Line of credit	 	 	—	 	 	 	19,800	 	
Subordinated debentures	 	 	25,774	 	 	 	—	 	
Due to affiliate	 	 	—	 	 	 	4,441	 	
Other	 	 	435	 	 	 	716	 	

 	 	
Total liabilities	 	 	27,588	 	 	 	25,844	 	

 	 	
Stockholders’ equity	 	 	208,649	 	 	 	133,183	 	

 	 	
Total liabilities and stockholders’ equity	 	$	236,237	 	 	$	159,027	 	

 	 	
S-2 

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DONEGAL GROUP INC. AND SUBSIDIARIES

SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY 
(Continued) 
Condensed Statements of Income and Comprehensive Income
($ in thousands) 
Years Ended December 31, 2003, 2002 and 2001 
 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	2003
	 	2002
	 	2001
	
Statements of Income	 	 	 	 	 	 	 	 	 	 	 	 	
Revenues	 	 	 	 	 	 	 	 	 	 	 	 	
Dividends from subsidiaries	 	$	7,000	 	 	$	10,400	 	 	$	14,419	 	
Other	 	 	1,034	 	 	 	797	 	 	 	824	 	

 	 	 	 	
 	 	
Total revenues	 	 	8,034	 	 	 	11,197	 	 	 	15,243	 	

 	 	 	 	
 	 	
Expenses	 	 	 	 	 	 	 	 	 	 	 	 	
Operating expenses	 	 	1,345	 	 	 	1,057	 	 	 	1,761	 	
Interest	 	 	1,320	 	 	 	1,139	 	 	 	2,288	 	

 	 	 	 	
 	 	
Total expenses	 	 	2,665	 	 	 	2,196	 	 	 	4,049	 	

 	 	 	 	
 	 	
Income before income tax benefit and equity in undistributed net income (loss) of subsidiaries	 	 	5,369	 	 	 	9,001	 	 	 	11,194	 	
Income tax benefit	 	 	(634	)	 	 	(435	)	 	 	(1,067	)	

 	 	 	 	
 	 	
Income before equity in undistributed net income (loss) of subsidiaries	 	 	6,003	 	 	 	9,436	 	 	 	12,261	 	
Equity in undistributed net income (loss) of subsidiaries	 	 	12,291	 	 	 	2,567	 	 	 	(6,443	)	

 	 	 	 	
 	 	
Net income	 	$	18,294	 	 	$	12,003	 	 	$	5,818	 	

 	 	 	 	
 	 	
Statements of Comprehensive Income	 	 	 	 	 	 	 	 	 	 	 	 	
Net income	 	$	18,294	 	 	$	12,003	 	 	$	5,818	 	

 	 	 	 	
 	 	
Other comprehensive income, net of tax	 	 	 	 	 	 	 	 	 	 	 	 	
Unrealized gain (loss) — parent	 	 	(42	)	 	 	15	 	 	 	26	 	
Unrealized gain — subsidiaries	 	 	421	 	 	 	2,035	 	 	 	3,035	 	

 	 	 	 	
 	 	
Other comprehensive income	 	 	379	 	 	 	2,050	 	 	 	3,061	 	

 	 	 	 	
 	 	
Comprehensive income	 	$	18,673	 	 	$	14,053	 	 	$	8,879	 	

 	 	 	 	
 	 	
S-3

Table of Contents
DONEGAL GROUP INC. AND SUBSIDIARIES 
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY 
(Continued) 
Condensed Statements of Cash Flows
($ in thousands) 
Years Ended December 31, 2003, 2002 and 2001 
 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	2003
	 	2002
	 	2001
	
Cash flows from operating activities:	 	 	 	 	 	 	 	 	 	 	 	 	
Net income	 	$	18,294	 	 	$	12,003	 	 	$	5,818	 	

 	 	 	 	
 	 	
Adjustments:	 	 	 	 	 	 	 	 	 	 	 	 	
Equity in undistributed net loss (income) of subsidiaries	 	 	(12,291	)	 	 	(2,567	)	 	 	6,443	 	
Other	 	 	(4,316	)	 	 	788	 	 	 	252	 	

 	 	 	 	
 	 	
Net adjustments	 	 	(16,607	)	 	 	(1,779	)	 	 	6,695	 	

 	 	 	 	
 	 	
Net cash provided	 	 	1,687	 	 	 	10,224	 	 	 	12,513	 	

 	 	 	 	
 	 	
Cash flows from investing activities:	 	 	 	 	 	 	 	 	 	 	 	 	
Net purchase of fixed maturities	 	 	(1,938	)	 	 	—	 	 	 	—	 	
Net purchase of short-term investments	 	 	(47,559	)	 	 	—	 	 	 	—	 	
Net purchase of property and equipment	 	 	(433	)	 	 	(480	)	 	 	(122	)	
Investment in subsidiaries	 	 	(14,274	)	 	 	—	 	 	 	—	 	
Other	 	 	(981	)	 	 	38	 	 	 	38	 	

 	 	 	 	
 	 	
Net cash used	 	 	(65,185	)	 	 	(442	)	 	 	(84	)	

 	 	 	 	
 	 	
Cash flows from financing activities:	 	 	 	 	 	 	 	 	 	 	 	 	
Cash dividends paid	 	 	(3,868	)	 	 	(3,509	)	 	 	(3,394	)	
Issuance of common stock	 	 	61,153	 	 	 	1,728	 	 	 	1,387	 	
Issuance of subordinated debentures	 	 	25,774	 	 	 	—	 	 	 	—	 	
Line of credit, net	 	 	(19,800	)	 	 	(7,800	)	 	 	(12,400	)	

 	 	 	 	
 	 	
Net cash provided	 	 	63,259	 	 	 	(9,581	)	 	 	(14,407	)	

 	 	 	 	
 	 	
Net change in cash	 	 	(239	)	 	 	201	 	 	 	(1,978	)	
Cash at beginning of year	 	 	604	 	 	 	403	 	 	 	2,381	 	

 	 	 	 	
 	 	
Cash at end of year	 	$	365	 	 	$	604	 	 	$	403	 	

 	 	 	 	
 	 	
S-4 

Table of Contents
DONEGAL GROUP INC. AND SUBSIDIARIES
SCHEDULE III – SUPPLEMENTARY INSURANCE INFORMATION
($ in thousands) 
Years Ended December 31, 2003, 2002 and 2001 
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	 	 	 	 	 	 	 	 	 	 	 	 	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, 2003	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Personal lines	 	$	125,322	 	 	$	—	 	 	$	85,057	 	 	$	19,639	 	 	$	18,268	 	 	$	130,386	 	
Commercial lines	 	 	71,471	 	 	 	—	 	 	 	41,186	 	 	 	11,200	 	 	 	10,418	 	 	 	76,595	 	
Investments	 	 	—	 	 	 	13,316	 	 	 	—	 	 	 	—	 	 	 	—	 	 	 	—	 	

 	 	 	 	

 	 	 	 	
 	 	
 	 	$	196,793	 	 	$	13,316	 	 	$	126,243	 	 	$	30,839	 	 	$	28,686	 	 	$	206,981	 	

 	 	 	 	

 	 	 	 	
 	 	
Year Ended December 31, 2002	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Personal lines	 	$	119,838	 	 	$	—	 	 	$	87,790	 	 	$	19,005	 	 	$	16,335	 	 	$	125,777	 	
Commercial lines	 	 	66,003	 	 	 	—	 	 	 	41,478	 	 	 	10,468	 	 	 	8,997	 	 	 	68,727	 	
Investments	 	 	—	 	 	 	14,581	 	 	 	—	 	 	 	—	 	 	 	—	 	 	 	—	 	

 	 	 	 	

 	 	 	 	
 	 	
 	 	$	185,841	 	 	$	14,581	 	 	$	129,268	 	 	$	29,473	 	 	$	25,332	 	 	$	194,504	 	

 	 	 	 	

 	 	 	 	
 	 	
Year Ended December 31, 2001	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Personal lines	 	$	104,893	 	 	$	—	 	 	$	72,534	 	 	$	17,002	 	 	$	16,881	 	 	$	111,623	 	
Commercial lines	 	 	62,877	 	 	 	—	 	 	 	45,644	 	 	 	10,192	 	 	 	10,119	 	 	 	65,405	 	
Investments	 	 	—	 	 	 	15,886	 	 	 	—	 	 	 	—	 	 	 	—	 	 	 	—	 	

 	 	 	 	

 	 	 	 	
 	 	
 	 	$	167,770	 	 	$	15,886	 	 	$	118,178	 	 	$	27,194	 	 	$	27,000	 	 	$	177,028	 	

 	 	 	 	

 	 	 	 	
 	 	
S-5 

Table of Contents
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
	
2003	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Personal lines	 	$	9,897	 	 	$	110,700	 	 	$	81,757	 	 	$	—	 	
Commercial lines	 	 	6,327	 	 	 	107,214	 	 	 	52,271	 	 	 	—	 	
Investments	 	 	—	 	 	 	—	 	 	 	—	 	 	 	—	 	

 	 	 	 	

 	 	$	16,224	 	 	$	217,914	 	 	$	134,028	 	 	$	—	 	

 	 	 	 	

2002	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Personal lines	 	$	9,423	 	 	$	106,096	 	 	$	78,273	 	 	$	—	 	
Commercial lines	 	 	5,144	 	 	 	104,596	 	 	 	42,729	 	 	 	—	 	
Investments	 	 	—	 	 	 	—	 	 	 	—	 	 	 	—	 	

 	 	 	 	

 	 	$	14,567	 	 	$	210,692	 	 	$	121,002	 	 	$	—	 	

 	 	 	 	

S-6 

Table of Contents
DONEGAL GROUP INC. AND SUBSIDIARIES 
SCHEDULE IV – REINSURANCE 
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	 	 	 	 	Ceded	 	Assumed	 	 	 	Percentage	
 	 	Gross	 	To Other	 	from Other	 	Net	 	Assumed	
 	 	Amount
	 	Companies
	 	Companies
	 	Amount
	 	To Net
	
Year Ended December 31, 2003	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Property and casualty premiums	 	$	114,154,202	 	 	$	70,429,560	 	 	$	153,068,054	 	 	$	196,792,696	 	 	 	78	%	

 	 	 	 	

 	 	
Year Ended December 31, 2002	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Property and casualty premiums	 	$	110,412,498	 	 	$	58,817,518	 	 	$	134,246,213	 	 	$	185,841,193	 	 	 	72	%	

 	 	 	 	

 	 	
Year Ended December 31, 2001	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
Property and casualty premiums	 	$	105,214,059	 	 	$	64,220,420	 	 	$	126,776,215	 	 	$	167,769,854	 	 	 	76	%	

 	 	 	 	

 	 	
S-7 

Table of Contents
DONEGAL GROUP INC. AND SUBSIDIARIES 
SCHEDULE VI – SUPPLEMENTARY INSURANCE INFORMATION
CONCERNING PROPERTY AND CASUALTY SUBSIDIARIES 
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	 	 	 	 	 	 	 	 	Discount,	 	 	
 	 	Deferred	 	Liability	 	if any,	 	 	
 	 	Policy	 	For Losses	 	Deducted	 	 	
 	 	Acquisition	 	And Loss	 	From	 	Unearned	
At December 31,
	 	Costs
	 	Expenses
	 	Reserves
	 	Premiums
	
2003	 	$	16,223,765	 	 	$	217,914,057	 	 	$	—	 	 	$	134,028,035	 	

 	 	 	 	

2002	 	$	14,567,070	 	 	$	210,691,752	 	 	$	—	 	 	$	121,002,447	 	

 	 	 	 	

2001	 	$	13,604,215	 	 	$	179,839,905	 	 	$	—	 	 	$	114,079,264	 	

 	 	 	 	

(continued) 
S- 8 

Table of Contents
DONEGAL GROUP INC. AND SUBSIDIARIES 
SCHEDULE VI - SUPPLEMENTARY INSURANCE INFORMATION
CONCERNING PROPERTY AND CASUALTY SUBSIDIARIES, CONTINUED 
Years ended December 31, 2002, 2001 and 2000 
 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	
 	 	 	 	 	 	 	 	 	 	Losses and Loss	 	Amortization	 	 	 	 	
 	 	 	 	 	 	 	 	 	 	Expenses Related to	 	of Deferred	 	Net	 	 	
 	 	Net	 	 	 	 	 		 	Policy	 	Paid Losses	 	Net	
 	 	Earned	 	Investment	 	Current	 	Prior	 	Acquisition	 	and Loss	 	Premiums	
 	 	Premiums
	 	Income
	 	Year
	 	Years
	 	Cost
	 	Expenses
	 	Written
	
Year Ended December 31, 2003	 	$	196,792,696	 	 	$	13,315,936	 	 	$	126,693,421	 	 	$	(450,110	)	 	$	30,839,000	 	 	$	118,455,674	 	 	$	206,980,626	 	

 	 	 	 	

 	 	 	 	

Year Ended December 31, 2002	 	$	185,841,193	 	 	$	14,581,252	 	 	$	122,433,653	 	 	$	6,834,033	 	 	$	29,473,000	 	 	$	112,703,368	 	 	$	194,503,847	 	

 	 	 	 	

 	 	 	 	

Year Ended December 31, 2001	 	$	167,769,854	 	 	$	15,885,544	 	 	$	110,142,467	 	 	$	8,035,082	 	 	$	27,194,000	 	 	$	106,342,848	 	 	$	177,027,654	 	

 	 	 	 	

 	 	 	 	

S-9 

                                                                 EXHIBIT 3 (iii)

                              AMENDED AND RESTATED

                                     BY-LAWS

                                       of

                               DONEGAL GROUP INC.

                                    Article 1

                               CORPORATION OFFICE

         Section 1.1. Registered Office. The registered office of the
Corporation shall be 1100 North Market Street Building, Wilmington, County of
New Castle, Delaware, 19801.

         Section 1.2. Principal Office. The principal office of the Corporation
shall be in Marietta, Pennsylvania.

         Section 1.3. Other Offices. The Corporation may also have offices at
such other places as the Board of Directors may from time to time designate or
the business of the Corporation may from time to time require.

                                    Article 2

                                  STOCKHOLDERS

         Section 2.1. Place and Time of Meetings. All meetings of the
stockholders shall be held at such time and place as may be fixed from time to
time by the Board of Directors and stated in the notice of meeting or in a duly
executed waiver of notice thereof. If no such place is fixed by the Board of
Directors, meetings of the stockholders shall be held at the principal office of
the Corporation.

                                      -52-

         Section 2.2. Annual Meetings. The annual meeting of the stockholders
shall be held on the third Thursday in April in each year, if not a legal
holiday, and, if a legal holiday, then on the next full business day, at the
Corporation's principal office or at such other place, date and time as shall be
designated from time to time by the Board of Directors and stated in the notice
of meeting or a duly executed waiver of notice thereof.

         At such annual meeting, the stockholders shall elect successors to the
directors whose terms shall expire that year to serve for the following three
years and until their successors shall have been duly elected and qualified or
until their earlier resignation or removal. The stockholders also shall transact
such other business as may properly be brought before the meeting and as are
consistent with the provisions of these By-laws.

         Section 2.3. Stockholder Proposals.

         (a)      Stockholder Proposals Relating to Nominations for and Election
of Directors.

                  (i)      Nominations of candidates for election by
stockholders to the Board of Directors shall be made exclusively by the
Nominating Committee of the Board of Directors.

                  (ii)     A proposal by a stockholder for the nomination by the
Nominating Committee of the Board of Directors of a candidate for election by
stockholders as a director at any meeting of stockholders at which directors are
to be elected may only be made by notice in writing, delivered in person or by
first class United States mail postage prepaid or by reputable overnight
delivery service, to the Nominating Committee of the Board of Directors of the
Corporation to the attention of the Secretary of the Corporation at the
principal office of the Corporation, within the time limits specified herein.

                  (iii)    In the case of an annual meeting of stockholders, any
such written proposal of nomination must be received by the Nominating Committee
not less than 90

                                      -53-

calendar days nor more than 120 calendar days before the first anniversary of
the date on which the Corporation first mailed its proxy statement to
stockholders for the annual meeting of stockholders in the immediately preceding
year; provided, however, that in the case of an annual meeting of stockholders
that is called for a date which is not within 30 calendar days before or after
the first anniversary date of the annual meeting of stockholders in the
immediately preceding year, any such written proposal of nomination must be
received by the Board of Directors not less than five business days after the
date the Corporation shall have mailed notice to its stockholders that an annual
meeting of stockholders will be held or issued a press release, filed a periodic
report with the Securities and Exchange Commission or otherwise publicly
disseminated notice that an annual meeting of stockholders will be held.

                  (iv)     In the case of a special meeting of stockholders, any
such written proposal of nomination must be received by the Nominating Committee
not less than five business days after the earlier of the date that the
Corporation shall have mailed notice to its stockholders that a special meeting
of stockholders will be held or issued a press release, filed a periodic report
with the Securities and Exchange Commission or otherwise publicly disseminated
notice that a special meeting of stockholders will be held.

                  (v)      Such written proposal of nomination shall set forth
(A) the name and address of the stockholder who intends to make the nomination
(the "Nominating Stockholder"), (B) the name, age, business address and, if
known, residence address of each person so proposed, (C) the principal
occupation or employment of each person so proposed for the past five years, (D)
the number of shares of capital stock of the Corporation beneficially owned
within the meaning of Securities and Exchange Commission Rule 13d-3

                                      -54-

by each person so proposed and the earliest date of acquisition of any such
capital stock, (E) a description of any arrangement or understanding between
each person so proposed and the Nominating Stockholder with respect to such
person's proposal for nomination and election as a director and actions to be
proposed or taken by such person as a director, (F) the written consent of each
person so proposed to serve as a director if nominated and elected as a director
and (G) such other information regarding each such person as would be required
under the proxy solicitation rules of the Securities and Exchange Commission if
proxies were to be solicited for the election as a director of each person so
proposed.

                  (vi)     If a written proposal of nomination submitted to the
Nominating Committee fails, in the reasonable judgment of the Nominating
Committee, to contain the information specified in clause (v) hereof or is
otherwise deficient, the Chairperson of the Nominating Committee shall, as
promptly as is practicable under the circumstances, provide written notice to
the Nominating Stockholder of such failure or deficiency in the written proposal
of nomination and such Nominating Stockholder shall have five business days from
receipt of such notice to submit a revised written proposal of nomination that
corrects such failure or deficiency in all material respects.

                  (vii)    Only candidates nominated for election by
stockholders as a member of the Board of Directors in accordance with the
foregoing provisions of this Section 2.3(a) shall be eligible for election as a
member of the Board of Directors at such meeting of stockholders, and any
candidate not nominated in accordance with such provisions shall not be
considered or acted upon for election as a director at such meeting of
stockholders.

                                      -55-

         (b)      Stockholder Proposals Relating to Other Than Nominations for
and Elections of Directors.

                  (i)      A stockholder of the Corporation may bring a matter
before a meeting of stockholders only if (A) (x) such matter is a proper matter
for stockholder action and (y) such stockholder shall have provided notice in
writing, delivered in person or by first class United States mail postage
prepaid or by reputable overnight delivery service, to the Board of Directors of
the Corporation to the attention of the Secretary of the Corporation at the
principal office of the Corporation, within the time limits specified herein or
(B) the stockholder complies with the provisions of Rule 14a-8 under the
Securities Exchange Act of 1934 relating to inclusion of stockholder proposals
in the Corporation's proxy statement.

                  (ii)     In the case of an annual meeting of stockholders, any
such written notice of presentation of a matter must be received by the Board of
Directors not less than 90 calendar days nor more than 120 calendar days before
the first anniversary of the date on which the Corporation first mailed its
proxy statement to stockholders for the annual meeting of stockholders in the
immediately preceding year; provided, however, that in the case of an annual
meeting of stockholders that is called for a date which is not within 30
calendar days before or after the first anniversary date of the annual meeting
of stockholders in the immediately preceding year, any such written notice of
presentation of a matter must be received by the Board of Directors not less
than five business days after the date the Corporation shall have mailed notice
to its stockholders that an annual meeting of stockholders will be held or
issued a press release, filed a periodic report with the Securities and Exchange
Commission or otherwise publicly disseminated notice that an annual meeting of
stockholders will be held.

                                      -56-

                  (iii)    In the case of a special meeting of stockholders, any
such written notice of presentation of a matter must be received by the Board of
Directors not less than five business days after the earlier of the date the
Corporation shall have mailed notice to its stockholders that a special meeting
of stockholders will be held or issued a press release, filed a periodic report
with the Securities and Exchange Commission or otherwise publicly disseminated
notice that a special meeting of stockholders will be held.

                  (iv)     Such written notice of presentation of a matter shall
set forth information regarding such matter equivalent to the information
regarding such matter that would be required under the proxy solicitation rules
of the Securities and Exchange Commission if proxies were solicited for
stockholder consideration of such matter at a meeting of stockholders.

                  (v)      If a written notice of presentation of a matter
submitted to the Board of Directors fails, in the reasonable judgment of the
Board of Directors, to contain the information specified in clause (iv) hereof
or is otherwise deficient, the Chairperson of the Board of Directors shall, as
promptly as is practicable under the circumstances, provide written notice to
the stockholder who submitted the written notice of presentation of a matter of
such failure or deficiency in the written notice of presentation of a matter and
such stockholder shall have five business days from receipt of such notice to
submit a revised written notice of presentation of a matter that corrects such
failure or deficiency in all material respects.

                  (vi)     Only matters submitted in accordance with the
foregoing provisions of this Section 2.3(b) shall be eligible for presentation
of such meeting of stockholders, and any

                                      -57-

matter not submitted to the Board of Directors in accordance with such
provisions shall not be considered or acted upon at such meeting of
stockholders.

         Section 2.4. Special Meetings. Special meetings of stockholders for any
purpose or purposes may be called at any time by the President of the
Corporation, and shall be called by the Secretary of the Corporation at the
request in writing of a majority of the Board of Directors or stockholders
owning at least one-fifth of the entire capital stock of the Corporation issued
and outstanding and entitled to vote thereat. Any request for a special meeting
of stockholders shall be signed by the person or persons making the request and
shall state the purpose or purposes of the proposed meeting. Upon receipt of any
such request, it shall be the duty of the Secretary of the Corporation to call a
special meeting of stockholders to be held at such time, not less than ten nor
more than sixty days thereafter, as the Secretary of the Corporation may fix. If
the Secretary of the Corporation shall neglect or refuse to issue such call
within five days from the receipt of such request, the person or persons making
the request may do so. Business transacted at any special meeting of
stockholders shall be limited to the purposes stated in the notice of such
meeting or a duly executed waiver of notice thereof.

         Section 2.5. Notice of Meetings. Written notice of all meetings of
stockholders other than adjourned, postponed or continued meetings of
stockholders, stating the place, date and hour, and, in the case of special
meetings of stockholders, the purpose or purposes thereof, shall be served upon
or mailed, postage prepaid, or telegraphed, charges prepaid, not less than ten
nor more than sixty days before the date of the meeting to each stockholder
entitled to vote thereat at such address as appears on the books of the
Corporation. Such notices may be given at the discretion of, or in the name of,
the Board of Directors, the President, any Vice

                                      -58-

President, the Secretary or any Assistant Secretary. When a meeting is
adjourned, postponed or continued it shall not be necessary to give any notice
of the adjourned, postponed or continued meeting or of the business to be
transacted at the adjourned, postponed or continued meeting, other than by
announcement at the meeting at which such adjournment, postponement or
continuation is taken.

         Section 2.6. Participation in Meetings by Conference Telephone. One or
more stockholders may participate in any meeting of the stockholders by means of
conference telephone or similar communications equipment which enables all
persons participating in the meeting to hear one another, and such person or
persons shall be counted for purposes of a quorum.

         Section 2.7. Quorum of and Action by Stockholders. The presence, in
person, by proxy or by telephonic or similar communications equipment, of
stockholders entitled to cast a majority of the votes which all stockholders are
entitled to cast on the particular matter shall constitute a quorum for purposes
of considering such matter, and, unless otherwise specifically provided by
statute, the acts of such stockholders at a duly organized meeting shall be the
acts of stockholders with respect to such matter.

         If, however, such quorum shall not be present at any meeting of the
stockholders, the stockholders entitled to vote thereat present in person, by
proxy or by such communications equipment may, except as otherwise provided by
statute, adjourn, postpone or continue the meeting from time to time to such
time and place as they may determine, without notice other than an announcement
at the meeting, until a quorum shall be present in person, by proxy or by such
communications equipment.

                                      -59-

         At any adjourned, postponed or continued meeting at which a quorum had
been present, stockholders present in person, by proxy or by such communications
equipment at a duly organized and constituted meeting, can continue to do
business with respect to any matter properly submitted to the meeting until
adjournment, postponement or continuation thereof notwithstanding the withdrawal
of enough stockholders to leave less than a quorum for the purposes of
considering any particular such matter.

         Section 2.8. Voting. Except as may be otherwise provided by statute or
by the Certificate of Incorporation, at every meeting of the stockholders, every
holder of Class A Common Stock entitled to vote thereat shall have the right to
one-tenth of one vote for every share of Class A Common Stock standing in his
name on the stock transfer books of the Corporation on the record date fixed for
the meeting and every holder of Class B Common Stock entitled to vote thereat
shall have the right to one vote for every share of Class B Common Stock
standing in his name on the stock transfer books of the Corporation on the
record date fixed for the meeting. No share shall be voted at any meeting if any
installment is due and unpaid thereon.

         When a quorum exists at any meeting, the vote of the holders of Class A
Common Stock and Class B Common Stock having a majority of the voting power
present at such meeting in person, by proxy or by telephonic or similar
communications equipment shall decide any question brought before such meeting,
unless the question is one for which, by express provision of statute or of the
Certificate of Incorporation or of these By-laws, a different vote is required.
Upon demand made by a stockholder at any election of directors before the voting
begins, the election shall be by ballot, in which event the vote shall be taken

                                      -60-

by written ballot, and the judge or judges of election or, if none, the
Secretary of the meeting, shall tabulate and certify the results of such vote.

         Section 2.9. Voting by Proxy. Every stockholder entitled to vote at a
meeting of the stockholders or to express consent or dissent to corporate action
in writing without a meeting may authorize another person or persons to act for
him by proxy. Every proxy shall be executed in writing by the stockholder or his
duly authorized attorney in fact and filed with the Secretary of the
Corporation. A proxy, unless coupled with an interest, shall be revocable at
will, notwithstanding any other agreement or any provision in the proxy to the
contrary, but the revocation of a proxy shall not be effective until written
notice thereof has been given to the Secretary of the Corporation. No unrevoked
proxy shall be voted or acted upon after three years from the date of its
execution, unless a longer time is expressly provided therein. A proxy shall not
be revoked by the death or incapacity of the maker, unless, before the vote is
counted or the authority is exercised, written notice of such death or
incapacity is given to the Secretary of the Corporation.

         Section 2.10. Record Date. The Board of Directors may fix a time, not
more than sixty nor less than ten days prior to the date of any meeting of the
stockholders, or the date fixed for the payment of any dividend or distribution,
or the date for the allotment of rights or the date when any change or
conversion or exchange of shares will be made or go into effect, as the record
date for the determination of the stockholders entitled to notice of, or to vote
at, such meeting, or to receive any such allotment of rights or to exercise the
rights in respect to any such change or conversion or exchange of shares. In
such case, only such stockholders as shall be stockholders of record on the date
so fixed shall be entitled to notice of, or to vote at, such meeting or to
receive payment of such dividend, or to receive such allotment of rights or

                                      -61-

to exercise such rights, as the case may be, notwithstanding any transfer of any
shares on the books of the Corporation after any record date fixed as aforesaid.

         The Board of Directors may close the books of the Corporation against
transfers of shares during the whole or any part of such period, and in such
case written or printed notice thereof shall be mailed at least ten days before
the closing thereof to each stockholder of record at the address appearing on
the stock transfer books of the Corporation or supplied by him to the
Corporation for the purpose of notice. While the stock transfer books of the
Corporation are closed, no transfer of shares shall be made thereon. If no
record date is fixed by the Board of Directors for the determination of
stockholders who are entitled to receive notice of, or to vote at, a meeting of
the stockholders, or to receive payment of any such dividend or distribution, or
to receive any such allotment of rights or to exercise the rights in respect to
any such change or conversion or exchange of shares, transferees of shares which
are transferred on the stock transfer books of the Corporation within the ten
days immediately preceding the date of such meeting, dividend, distribution,
allotment of rights or exercise of such rights shall not be entitled to notice
of, or to vote at, such meeting, or to receive payment of any dividend or
distribution, or to receive any such allotment of rights or to exercise the
rights in respect to any such change or conversion or exchange of shares.

         Section 2.11. Stockholders List. The officer or agent having charge of
the stock transfer books for shares of the Corporation shall make, at least ten
days before each meeting of the stockholders, a complete alphabetical list of
the stockholders entitled to vote at the meeting, with their addresses and the
number of shares held by each, which list shall be kept on file either at a
place within the city where the meeting is to be held, which place shall be
specified in the notice of the meeting or if not so specified, at the place
where the meeting is

                                      -62-

to be held and shall be subject to inspection by any stockholder for any purpose
germane to the meeting at any time during usual business hours for a period of
at least ten days prior to the meeting. Such list shall be produced at the
meeting and shall be kept open for inspection by any stockholder during the
entire meeting. The original stock transfer books of the Corporation shall be
prima facie evidence as to who are the stockholders entitled to exercise the
rights of a stockholder.

         Section 2.12. Inspectors of Election. In advance of any meeting of the
stockholders, the Board of Directors shall appoint inspectors of election, who
need not be stockholders, to act at such meeting or any adjournment,
postponement or continuation thereof. If no inspector of election so appointed
is able to act at a meeting of stockholders, the chairman of any such meeting
shall make such appointment at the meeting. The number of inspectors of election
shall be one or three. No person who is a candidate for office shall act as an
inspector of election.

         The inspectors of election shall do all such acts as may be proper to
conduct the election or vote and such other duties as may be prescribed by
statute with fairness to all stockholders, and shall make a written report of
any matter determined by them and execute a certificate as to any fact found by
them. If there are three inspectors of election, the decision, act or
certificate of a majority shall be the decision, act or certificate of all.

         Section 2.13. Action by Written Consent of the Stockholders. Any action
required to be taken at an annual or special meeting of stockholders, or of a
class thereof, or any action which may be taken at any annual or special meeting
of such stockholders, or of a class thereof, may be taken without a meeting,
without prior notice and without a vote, if a consent or consents in writing
setting forth the action so taken shall be signed by the holders

                                      -63-

of outstanding stock having not less than the minimum number of votes that would
be necessary to authorize or take such action at a meeting at which all shares
entitled to vote thereon were present and voted and shall be delivered to the
Secretary of the Corporation at its principal place of business as specified in
Section 1.2 hereof.

                                    Article 3

                                    DIRECTORS

         Section 3.1. Powers.

         (a)      General Powers. The Board of Directors shall have all the
power and authority granted by law to the Board of Directors, including all
powers necessary or appropriate to the management of the business and affairs of
the Corporation.

         (b)      Specific Powers. Without limiting the general powers conferred
by the last preceding clause and the powers conferred by the Certificate of
Incorporation and the By-laws of the Corporation, it is hereby expressly
declared that the Board of Directors shall have the following powers:

                  (i)      To appoint any person, firm or corporation to accept
and hold in trust for the Corporation any property belonging to the Corporation
or in which it is interested, and to authorize any such person, firm or
corporation to execute any documents and perform any duties that may be
requisite in relation to any such trust;

                  (ii)     To appoint a person or persons to vote shares of
another corporation held and owned by the Corporation and, in the absence of any
such appointment, the Board of Directors of the Corporation shall have the
authority to vote any such shares;

                                      -64-

                  (iii)    By resolution adopted by a majority of the whole
Board of Directors, to designate one or more committees, each committee to
consist of two or more of the directors of the Corporation. To the extent
provided in any such resolution, and to the extent permitted by law, a committee
so designated shall have and may exercise the authority of the Board of
Directors in the management of the business and affairs of the Corporation. The
Board of Directors may designate one or more directors as alternate members of
any committee, who may replace any absent or disqualified member at any meeting
of the committee. If specifically granted this power by the Board of Directors
in its resolution establishing the committee, in the absence or disqualification
of any member and all designated alternates of such committee or committees or
if the whole Board of Directors has failed to designate alternate members, the
member or members thereof present at any meeting and not disqualified from
voting, whether or not he or they constitute a quorum, may unanimously appoint
another director to act at the meeting in the place of any such absent or
disqualified member;

                  (iv)     To fix the place, time and purpose of meetings of the
stockholders; and

                  (v)      To fix the compensation of directors and officers for
their services.

         Section 3.2. Number and Terms of Directors. The number of directors
which shall constitute the whole Board of Directors shall be not less than seven
nor more than twelve, who shall be natural persons of full age and need not be
residents of Delaware or stockholders of the Corporation. Within the limits
above specified, the number of directors shall be as determined from time to
time by resolution of the Board of Directors. Except as hereinafter provided in
the case of vacancies, each director shall be elected by the affirmative vote of
a plurality of the votes cast by the holders of Class A Common Stock and of
Class B

                                      -65-

Common Stock for a term of three years and until his successor has been elected,
subject to removal as provided by statute.

         Section 3.3. Classes. The Board of Directors shall be divided into
three classes: Class A, Class B and Class C. At each annual meeting of the
stockholders, the successors to the directors of the class whose term shall
expire in that year shall be elected for a term of three years so that the term
of office of one class of directors shall expire in each year. The number of
directors in each class shall be as nearly equal as possible so that, except for
temporary vacancies, the number in any class shall not exceed the number in any
other class by more than one.

         Section 3.4. Powers and Duties of the Chairman of the Board of
Directors. The Board of Directors shall appoint one of their number as the
Chairman of the Board who shall preside at all meetings of the Board of
Directors and who shall have such other powers and duties as may be assigned to
him from time to time by the Board of Directors.

         Section 3.5. Powers and Duties of the Vice Chairman of the Board of
Directors. The Board of Directors may, in its discretion, appoint one of its
number as a Vice Chairman of the Board of Directors. In the absence of the
Chairman of the Board of Directors, the Vice Chairman of the Board of Directors
shall preside at all meetings of the Board of Directors. In addition, the Vice
Chairman of the Board of Directors shall have such other powers and duties as
may be assigned to him from time to time by the Board of Directors.

         Section 3.6. Vacancies. Vacancies on the Board of Directors, including
vacancies resulting from an increase in the number of directors, shall be filled
by a majority of the remaining members of the Board of Directors, though less
than a quorum, or by the sole remaining director, as the case may be,
irrespective of whether holders of any class or series

                                      -66-

of stock or other voting securities of the Corporation are entitled to elect one
or more directors to fill such vacancies or newly created directorships at the
next annual meeting of the stockholders. Each person so elected shall be a
director until his successor is elected by the stockholders at the annual
meeting of the stockholders at which the class of directors to which he was
elected is up for election or at any special meeting of the stockholders prior
thereto duly called for that purpose.

         Section 3.7. Organization Meetings. The organization meeting of each
newly elected Board of Directors shall be held immediately following each annual
meeting of the stockholders at which directors were elected without the
necessity of notice to such directors to constitute a legally convened meeting
or at such time and place as may be fixed by a notice, or a waiver of notice, or
a consent signed by all of such directors. At such meeting, the Board of
Directors shall elect officers of the Corporation and may also choose an
Executive Committee consisting of two members of the Board of Directors in
addition to the President.

         Section 3.8. Regular Meetings. The Board of Directors shall have the
power to fix by resolution the place, date and hour of regular meetings of the
Board of Directors.

         Section 3.9. Special Meetings. Special meetings of the Board of
Directors may be called by the President of the Corporation on one day's notice
to each director, either personally or by mail, telephone or telegram. Special
meetings of the Board of Directors shall be called by the President or the
Secretary of the Corporation in like manner and on like notice upon the written
request of any five directors.

         Section 3.10. Notices of Meetings. All meetings of the Board of
Directors may be held at such times and places as may be specified in the notice
of meeting or in a duly executed

                                      -67-

waiver of notice thereof. Notice of regular meetings of the Board of Directors
shall be given to each director at least three days before each meeting either
personally or by mail, telegram or telephone. One or more directors may
participate in any meeting of the Board of Directors, or of any committee
thereof, by means of a conference telephone or similar communications equipment
which enables all persons participating in the meeting to hear one another, and
such participation in a meeting shall constitute presence in person at the
meeting.

         Section 3.11. Quorum. At all meetings of the Board of Directors, the
presence, in person or by telephonic or similar communications equipment, of a
majority of the members of the Board of Directors shall constitute a quorum for
the transaction of business, and the acts of a majority of the directors present
at a duly convened meeting at which a quorum is present shall be the acts of the
Board of Directors, except as may be otherwise specifically provided by statute,
by the Certificate of Incorporation of the Corporation or by these By-laws. If a
quorum shall not be present, in person or by telephonic or similar
communications equipment, at any meeting of the Board of Directors, the
directors present may adjourn, postpone or continue the meeting from time to
time, without notice other than announcement at the meeting, until a quorum
shall be so present.

         Section 3.12. Action by Unanimous Written Consent. Any action required
or permitted to be taken at any meeting of the Board of Directors or of any
committee thereof may be taken without a meeting if all members of the Board of
Directors or a committee thereof, as the case may be, consent thereto in
writing, and such consent is filed with the minutes of proceedings of the Board
of Directors, or committee.

                                      -68-

         Section 3.13. Compensation. Directors, as such, may receive a stated
salary for their services, or a fixed sum and expenses for attendance at regular
or special meetings of the Board of Directors, or any committee thereof, or any
combination of the foregoing as may be determined from time to time by
resolution of the Board of Directors, and nothing contained herein shall be
construed to preclude any director from serving the Corporation in any other
capacity and receiving compensation therefor.

         Section 3.14. The Coordinating Committee. The Coordinating Committee
shall consist of two members of the Corporation's Board of Directors, each of
whom is not a member of the Board of Directors or an officer of Donegal Mutual
Insurance Company, and two members of the Board of Directors of Donegal Mutual
Insurance Company, each of whom is not a member of the Board of Directors or an
officer of the Corporation. The Coordinating Committee shall review and either
approve or disapprove all contracts and other matters involving actual or
potential conflicts of interest between the Corporation and Donegal Mutual
Insurance Company. Whenever any new contract between the Corporation and Donegal
Mutual Insurance Company is proposed or any change is proposed in any existing
contract between the Corporation and Donegal Mutual Insurance Company or any
other matter arises that presents an actual or potential conflict of interest
between the Corporation and Donegal Mutual Insurance Company, such new contract,
change in an existing contract or other matter shall (i) first be submitted for
approval to the respective Boards of Directors of the Corporation and of Donegal
Mutual Insurance Company, (ii) only following approval by the respective Boards
of Directors of the Corporation and Donegal Mutual Insurance Company shall the
new contract, change in an existing contract or other matter be submitted to the
Coordinating Committee for its consideration thereof and (iii) the proposed new

                                      -69-

contract, change in an existing contract or other matter shall be consummated
only if (A) both of the Corporation's members of the Coordinating Committee
conclude that such new contract, change in an existing contract or other matter
is fair and equitable to the Corporation and its stockholders and (B) both of
Donegal Mutual Insurance Company's members of the Coordinating Committee
conclude that such new contract, change in an existing contract or other matter
is fair and equitable to Donegal Mutual Insurance Company and its policyholders.
For purposes of this Section 3.14, the term "the Corporation" shall mean Donegal
Group Inc. and its direct and indirect wholly owned subsidiaries and the term
"Donegal Mutual Insurance Company" shall mean Donegal Mutual Insurance Company
and its direct and indirect wholly owned subsidiaries.

         Section 3.15. Executive Committee. There shall be an Executive
Committee that shall have and exercise all power and authority of the Board of
Directors between meetings of the Board of Directors to the extent consistent
with Delaware law. The Executive Committee shall consist of not fewer than three
members of the Board of Directors, one of whom shall be the Chief Executive
Officer of the Corporation and who shall be Chairman of the Executive Committee,
unless another member shall be designated by resolution of the Board of
Directors. The members of the Executive Committee shall be designated from time
to time by resolution of the Board of Directors. Not less than one-third of the
committee must be directors who are not officers or employees of the Corporation
or of any entity controlling, controlled by or under common control with the
Corporation and who are not beneficial owners of a controlling interest in the
voting securities of the Corporation. The Executive Committee shall meet at any
time and place designated upon not fewer than six hours oral or written notice
given by or on behalf of the Chairman of the Executive Committee. The

                                      -70-

Executive Committee shall report promptly to the entire Board of Directors the
substance of any action taken by the Executive Committee.

         Section 3.16. Audit Committee. The Board of Directors shall appoint
annually an Audit Committee that shall consist of not fewer than three directors
who satisfy applicable independence requirements, are not officers or employees
of the Corporation or of any entity controlling, controlled by or under common
control with the Corporation and who are not beneficial owners of a controlling
interest in the voting securities of the Corporation. The Audit Committee shall
operate in accordance with its written charter adopted by the Board of Directors
on March 19, 2004 and shall have responsibility for the selection of the
Corporation's independent public accountants, reviewing the scope and results of
the audit and reviewing the adequacy of the Corporation's accounting, financial,
internal and operating controls.

         Section 3.17. Nominating Committee. The Board of Directors shall
appoint annually a Nominating Committee which shall consist of not fewer than
two directors who satisfy applicable independence requirements, are not officers
or employees of the Corporation or of any entity controlling, controlled by, or
under common control with the Corporation and who are not beneficial owners of a
controlling interest in the voting securities of the Corporation. The Nominating
Committee shall operate in accordance with its written charter as adopted by the
Board of Directors on March 19, 2004 and shall have responsibility for
identification of individuals believed to be qualified to become members of the
Board of Directors and to recommend to the Board of Directors nominees to stand
for election as directors, identification of members of the Board of Directors
qualified to serve on the various committees of the Board of Directors,
evaluation of the procedures and processes by

                                      -71-

which the committees of the Board of Directors conduct a self-evaluation of
their performance and provision to the Board of Directors of an annual
performance evaluation of the Nominating Committee. The Chief Executive Officer
of the Company shall be an ex-officio member of the Nominating Committee.

         Section 3.18. Compensation Committee. The Board of Directors shall
appoint annually a Compensation Committee that shall consist of not fewer than
two directors who satisfy applicable independence requirements, are not officers
or employees of the Corporation or of any entity controlling, controlled by, or
under common control with the Corporation and who are not beneficial owners of a
controlling interest in the voting securities of the Corporation. The
Compensation Committee shall be responsible for the annual review of the
compensation of the Corporation's executive officers, the provision of annual
compensation recommendations to the Board of Directors for all of the
Corporation's officers, the determination of employees who participate in the
Corporation's employee stock option plans and the provision of recommendations
to the Board of Directors as to individual stock option grants and the general
oversight of the Corporation's employee benefit plans.

                                    Article 4

                                    OFFICERS

         Section 4.1. Election and Office. The officers of the Corporation shall
be elected annually by the Board of Directors at its organization meeting and
shall consist of a President, a Secretary and a Treasurer. The Board of
Directors may also elect one or more Vice Presidents and such other officers and
appoint such agents as it shall deem necessary. Each officer of the Corporation
shall hold office for such term, have such authority and perform such duties as
set forth in these By-laws or as may from time to time be prescribed

                                      -72-

by the Board of Directors in consultation with the President. Any two or more
offices may be held by the same person.

         Section 4.2. Salaries. The salaries of all officers of the Corporation
shall be fixed by the Board of Directors.

         Section 4.3. Removal and Vacancies. The Board of Directors may remove
any officer or agent elected or appointed at any time and within the period, if
any, for which such person was elected or employed whenever in the judgment of
the Board of Directors it is in the best interests of the Corporation, and all
persons shall be elected and employed subject to the provisions hereof. If the
office of any officer becomes vacant for any reason, the vacancy shall be filled
by the Board of Directors.

         Section 4.4. Powers and Duties of the President. Unless otherwise
determined by the Board of Directors, the President shall have the usual duties
of a chief executive officer with general supervision over and direction of the
affairs of the Corporation. In the exercise of these duties and subject to the
limitations of the laws of the State of Delaware or any other applicable law,
these By-laws and the actions of the Board of Directors, he may appoint, suspend
and discharge employees, agents and assistant officers, may fix the compensation
of all officers and assistant officers, shall preside at all meetings of the
stockholders at which he shall be present, and, unless there is a Chairman of
the Board of Directors, shall preside at all meetings of the Board of Directors
and shall be a member of all committees. He shall also do and perform such other
duties as from time to time may be assigned to him by the Board of Directors.

         Unless otherwise determined by the Board of Directors, the President
shall have full power and authority on behalf of the Corporation to attend and
to act and to vote at any

                                      -73-

meeting of the stockholders of any corporation in which the Corporation may hold
stock, and, at any such meeting, shall possess and may exercise any and all the
rights and powers incident to the ownership of such stock and which, as the
owner thereof, the Corporation might have possessed and exercised.

         Section 4.5. Powers and Duties of Vice Presidents. Each Vice President
shall have such duties as may be assigned to him from time to time by the Board
of Directors, the Executive Committee or the President. In the event of a
temporary absence of the President on vacation or business, the President may
designate a Vice President or Vice Presidents who will perform the duties of the
President in such absence. In the event of a prolonged absence of the President
due to illness or disability or for any other reason, the Board of Directors
shall designate a Vice President or Vice Presidents who will perform the duties
of the President during such absence.

         Section 4.6. Powers and Duties of the Secretary. The Secretary of the
Corporation shall attend all meetings of the Board of Directors and of the
stockholders and shall keep accurate records thereof in one or more minute books
kept for that purpose, shall give, or cause to be given, the required notice of
all meetings of the stockholders and of the Board of Directors, shall keep in
safe custody the corporate seal of the Corporation and affix the same to any
instrument requiring it, and when so affixed, it shall be attested by his
signature or by the signature of the Treasurer or any Assistant Secretary or
Assistant Treasurer of the Corporation. The Secretary also shall keep, or cause
to be kept, the stock certificate books, stock transfer books and stock ledgers
of the Corporation, in which shall be recorded all stock issues, transfers, the
dates of same, the names and addresses of all stockholders and the number of
shares held by each, shall, when necessary, prepare new certificates upon the

                                      -74-

transfer of shares and the surrender of the old certificates, shall cancel such
surrendered certificates and shall perform such other duties as may be assigned
to him by the President.

         Section 4.7. Powers and Duties of the Treasurer. The Treasurer of the
Corporation shall have the custody of the Corporation's funds and securities,
shall keep full and accurate accounts of receipts and disbursements in books
belonging to the Corporation, shall deposit all moneys and other valuable
effects in the name and to the credit of the Corporation in such depositories as
shall be designated by the President, shall disburse the funds of the
Corporation as may be ordered by the President or the Board of Directors, taking
proper vouchers for such disbursements, shall render to the President and the
Board of Directors, at the regular meetings of the Board of Directors or
whenever they may require it, an account of all his transactions as Treasurer
and of the financial condition of the Corporation and shall have the right to
affix the seal of the Corporation to any instrument requiring it, and to attest
to the same by his signature and, if so required by the Board of Directors, he
shall give bond in such sum and with such surety as the Board of Directors may
from time to time direct.

         Section 4.8. Designation of a Chief Financial Officer. The Board of
Directors shall have the power to designate from among the President, any Vice
President or the Treasurer of the Corporation a Chief Financial Officer who
shall be deemed the principal financial and accounting officer. In the event
that the Treasurer is not designated by the Board of Directors as the Chief
Financial Officer, the Treasurer shall report to the Chief Financial Officer
from time to time concerning all duties which the Treasurer is obligated to
perform and the Chief Financial Officer shall, subject to the reasonable
direction of the President or the Board of Directors, at his election, assume
such of the duties of the Treasurer as are provided in Section 4.7 hereof as he
shall deem appropriate.

                                      -75-

                                    Article 5

                                 INDEMNIFICATION

         Section 5.1. Indemnification. The Corporation shall indemnify any
director or officer of the Corporation and any director or officer of its
subsidiaries against expenses, including legal fees, judgments, fines and
amounts paid in settlement, actually and reasonably incurred by him to the
fullest extent now or hereafter permitted by law in connection with any
threatened, pending or completed action, suit or proceeding, whether derivative
or nonderivative, and whether civil, criminal, administrative or investigative,
brought or threatened to be brought against him by reason of his performance or
status as a director or officer of the Corporation, any of its subsidiaries or
any other entity in which he was serving at the request of the Corporation or in
any other capacity on behalf of the Corporation, its parent or any of its
subsidiaries if such officer or director acted in good faith and in a manner he
reasonably believed to be in, or not opposed to, the best interests of the
Corporation, and, with respect to any criminal action or proceeding, had no
reasonable cause to believe his conduct was unlawful.

         Notwithstanding the foregoing, in the case of any threatened, pending
or completed action or suit by or in the right of the Corporation, no
indemnification shall be made in respect of any claim, issue or matter as to
which such officer or director shall have been adjudged to be liable to the
Corporation unless and only to the extent the court in which such action or suit
was brought shall determine upon application that, despite the adjudication of
liability but in view of all the circumstances of the case, such person is
fairly and reasonably entitled to indemnity for such expenses which the court
shall deem proper.

                                      -76-

         The Board of Directors by resolution adopted in each specific instance
may similarly indemnify any person other than a director or officer of the
Corporation for liabilities incurred by him in connection with services rendered
by him for or at the request of the Corporation or any of its subsidiaries.

         The provisions of this Section 5.1 shall be applicable to all actions,
suits or proceedings commenced after its adoption, whether such arise out of
acts or omissions which occurred prior or subsequent to such adoption and shall
continue as to a person who has ceased to be a director or officer or to render
services for or at the request of the Corporation and shall inure to the benefit
of the heirs, executors and administrators of such a person. The rights of
indemnification provided for herein shall not be deemed the exclusive rights to
which any such director, officer or other person may be entitled.

         Section 5.2. Authorization and Determination of Indemnification. Any
indemnification under this Article 5, unless ordered by a court, shall be made
by the Corporation only as authorized in the specific case upon a determination
that indemnification of the director, officer or other person is proper in the
circumstances because he has met the applicable standard of conduct as specified
in Section 5.1 of this Article 5. A person shall be deemed to have met such
applicable standard of conduct if his action is based on the records or books of
account of the Corporation or another enterprise, or on information supplied to
him by the officers of the Corporation or another enterprise in the course of
their duties, or on the advice of legal counsel for the Corporation or another
enterprise or on information or records given or reports made to the Corporation
or another enterprise by an independent certified public accountant or by an
appraiser or other expert selected with reasonable care by the Corporation or
another enterprise.

                                      -77-

         Such determination shall be made (i) by the Board of Directors by a
majority vote of a quorum consisting of directors who were not parties to such
action, suit or proceeding, or (ii) if such a quorum is not obtainable, or, even
if obtainable, a majority vote of a quorum of disinterested directors so
directs, by independent legal counsel in a written opinion or (iii) by the
stockholders. To the extent, however, that a director, officer or other person
has been successful on the merits or otherwise in defense of any action, suit or
proceeding described above, or in defense of any claim, issue or matter therein,
he shall be indemnified against expenses, including attorneys' fees, actually
and reasonably incurred by him in connection therewith, without the necessity of
authorization in the specific case.

         The provisions of this Section 5.2 shall not be deemed to be exclusive
or to limit in any way the circumstances in which a person may be deemed to have
met such applicable standard of conduct.

         Section 5.3. Advances. Expenses incurred in defending or investigating
a threatened or pending action, suit or proceeding shall be paid by the
Corporation in advance of the final disposition of such action, suit or
proceeding as authorized by the Board of Directors upon receipt of an
undertaking by or on behalf of the director, officer or other person to repay
such amount if it shall ultimately be determined that he is not entitled to be
indemnified by the Corporation as authorized in this Article 5.

         Section 5.4. Scope and Alteration of Indemnification Provisions. The
indemnification and advancement of expenses provided by, or granted pursuant to,
the other sections of this Article 5 shall not be deemed exclusive of any other
rights to which those seeking indemnification or advancement of expenses may be
entitled under any By-law, agreement, contract, vote of the stockholders or
disinterested directors or pursuant to the direction,

                                      -78-

howsoever embodied, of any court of competent jurisdiction or otherwise, both as
to action in his official capacity and as to action in another capacity while
holding such office, it being the policy of the Corporation that indemnification
of, and advancement of expenses to, the persons specified in Section 5.1 of this
Article 5 shall be made to the fullest extent permitted by law.

         To this end, the provisions of this Article 5 shall be deemed to have
been amended for the benefit of such persons effective immediately upon any
modification of the General Corporation Law of the State of Delaware which
expands or enlarges the power or obligation of corporations organized under such
law to indemnify, or advance expenses to, such persons. The provisions of this
Article 5 shall not be deemed to preclude the indemnification of, or advancement
of expenses to, any person who is not specified in this Section 5.4 or Section
5.1 of this Article 5 but whom the Corporation has the power or obligation to
indemnify, or to advance expenses for, under the provisions of the General
Corporation Law of the State of Delaware or otherwise.

         Section 5.5. Insurance. The Corporation may purchase and maintain
insurance on behalf of any person who is or was a director, officer or employee
of the Corporation, or is or was serving at the request of the Corporation as a
director, officer or employee of another corporation, partnership, joint
venture, trust or other enterprise against any liability asserted against him
and incurred by him in any such capacity, or arising out of his status as such,
whether or not the Corporation would have the power or the obligation to
indemnify him against such liability under the provisions of this Article 5.

         Section 5.6. Definitions. For purposes of this Article 5, references to
the "Corporation" shall include, in addition to the resulting corporation, any
constituent corporation (including

                                      -79-

any constituent of a constituent) absorbed in a consolidation or merger which,
if its separate existence had continued, would have had power and authority to
indemnify its directors, officers, and employees or agents, so that any person
who is or was a director, officer or employee of such constituent corporation,
or is or was serving at the request of such constituent corporation as a
director, officer or employee of another corporation, partnership, joint
venture, trust or other enterprise, shall stand in the same position under the
provisions of this Article 5 with respect to the resulting or surviving
corporation as he would have with respect to such constituent corporation if its
separate existence had continued.

         The term "another enterprise" as used in this Article 5 shall mean any
other corporation or any partnership, joint venture, trust or other entity of
which such person is or was serving at the request of the Corporation as a
director, officer, employee or agent and shall include employee benefit plans.

                                    Article 6

                                  CAPITAL STOCK

         Section 6.1. Stock Certificates. The certificates for shares of the
Corporation's capital stock shall be numbered and registered in a share register
as they are issued, shall bear the name of the registered holder, the number and
class of shares represented thereby and the par value of each share or a
statement that such shares are without par value, as the case may be, shall be
signed by the President or any Vice President of the Corporation and the
Secretary, any Assistant Secretary or the Treasurer of the Corporation or any
other person properly authorized by the Board of Directors and shall bear the
seal of the Corporation, which seal may be a facsimile engraved or printed.
Where the certificate is signed by a transfer agent or a registrar, the
signature of any corporate officer on such certificate may be

                                      -80-

a facsimile engraved or printed. In case any officer who has signed, or whose
facsimile signature has been placed upon, any share certificate shall have
ceased to be such officer because of death, resignation or otherwise, before the
certificate is issued, it may be issued by the Corporation with the same effect
as if the officer had not ceased to be such at the date of its issue.

         Section 6.2. Transfer of Shares. Upon surrender to the Corporation of a
share certificate duly endorsed by the person named in the certificate or by an
attorney duly appointed in writing and accompanied where necessary by proper
evidence of succession, assignment or authority to transfer, a new certificate
shall be issued to the person entitled thereto and the old certificate cancelled
and the transfer recorded upon the stock transfer books and share register of
the Corporation.

         Section 6.3. Lost Certificates. Should any stockholder of the
Corporation allege the loss, theft or destruction of one or more certificates
for shares of the Corporation and request the issuance by the Corporation of a
substitute certificate therefor, the Board of Directors may direct that a new
certificate of the same tenor and for the same number of shares be issued to
such person upon such person's making of an affidavit in form satisfactory to
the Board of Directors setting forth the facts in connection therewith, provided
that prior to the receipt of such request the Corporation shall not have either
registered a transfer of such certificate or received notice that such
certificate has been acquired by a bona fide purchaser. When authorizing such
issuance of a new certificate, the Board of Directors may, in its discretion and
as a condition precedent to the issuance of such certificate, require the owner
of such lost, stolen or destroyed certificate, or his heirs or legal
representatives, as the case may be, to advertise the same in such manner as the
Board of Directors shall require and/or to give the

                                      -81-

Corporation a bond in such form and for such sum and with such surety or
sureties, with fixed or open penalty, as shall be satisfactory to the Board of
Directors, as indemnity for any liability or expense which it may incur by
reason of the original certificate remaining outstanding.

         Section 6.4. Dividends. The Board of Directors may, from time to time,
at any duly convened regular or special meeting or by unanimous consent, declare
and pay dividends upon the outstanding shares of capital stock of the
Corporation in cash, property or shares of the Corporation.

         Before payment of any dividend, there may be set aside out of any funds
of the Corporation available for dividends such sum or sums as the Board of
Directors from time to time, in its absolute discretion, shall deem proper as a
reserve fund to meet contingencies, or for equalizing dividends, or for
repairing or maintaining any property of the Corporation or for such other
purposes as the Board of Directors shall believe to be in the best interests of
the Corporation, and the Board of Directors may reduce or abolish any such
reserve in the manner in which it was created.

                                    Article 7

                        FINANCIAL REPORT TO STOCKHOLDERS

         The President of the Corporation and the Board of Directors shall
present at each annual meeting of the stockholders a full and complete statement
of the business and affairs of the Corporation for the preceding year. Such
statement shall be prepared and presented in whatever manner the Board of
Directors shall deem advisable and need not be verified by a certified public
accountant or sent to the stockholders of the Corporation.

                                      -82-

                                    Article 8

                                CHECKS AND NOTES

         All checks or demands for money and notes of the Corporation shall be
signed by such officer or officers or such other person or persons as the Board
of Directors or the President may from time to time designate.

                                    Article 9

                                   FISCAL YEAR

         The fiscal year of the Corporation shall be as determined from time to
time by resolution of the Board of Directors.

                                   Article 10

                                      SEAL

         The seal of the Corporation shall have inscribed thereon the name of
the Corporation, the year of its organization and the words "Corporate Seal,
Delaware." Said seal may be used by causing it or a facsimile thereof to be
impressed or affixed or in any manner reproduced.

                                   Article 11

                         NOTICES; COMPUTING TIME PERIODS

         Section 11.1. Method and Contents of Notice. Whenever, under the
provisions of statute or of the Certificate of Incorporation or of these
By-laws, written notice is required to be given to any person, it may be given
to such person either personally or by sending a copy thereof through the mail,
postage prepaid, or by telegram, charges prepaid, to his address appearing on
the books of the Corporation or supplied by him to the Corporation for the
purpose of notice. If the notice is sent by mail or telegraph, it shall be
deemed to have been

                                      -83-

given to the person entitled thereto when deposited in the United States mail or
with a telegraph office for transmission to such person. Such notice shall
specify the place, day and hour of the meeting, if any, and, in the case of a
special meeting of the stockholders, the general nature of the business to be
transacted.

         Section 11.2. Waiver of Notice. Any written notice required to be given
to any person may be waived in a writing signed by the person entitled to such
notice whether before or after the time stated therein. Attendance of any person
entitled to notice, whether in person or by proxy, at any meeting shall
constitute a waiver of notice of such meeting, except where any person attends a
meeting for the express purpose of objecting to the transaction of any business
because the meeting was not lawfully called or convened. Where written notice is
required for any meeting, the waiver thereof must specify the purpose only if it
is for a special meeting of the stockholders.

         Section 11.3. Computing Time Periods. In computing the number of days
for purposes of these By-laws, all days shall be counted, including Saturdays,
Sundays or holidays; provided, however, that if the final day of any time period
falls on a Saturday, Sunday or holiday, then the final day shall be deemed to be
the next day which is not a Saturday, Sunday or holiday. In computing the number
of days for the purpose of giving notice of any meeting, the date upon which the
notice is given shall be counted but the day set for the meeting shall not be
counted.

                                   Article 12

                                   AMENDMENTS

                                      -84-

         These By-laws may be altered, amended or repealed by a majority vote of
the stockholders entitled to vote thereon at any annual or special meeting duly
convened after notice to the stockholders of that purpose or by a majority vote
of the members of the Board of Directors at any regular or special meeting of
the Board of Directors duly convened after notice to the Board of Directors of
that purpose, subject always to the power of the stockholders to change such
action of the Board of Directors.

                                   Article 13

                            INTERPRETATION OF BY-LAWS

         All words, terms and provisions of these By-laws shall be interpreted
and defined by and in accordance with the General Corporation Law of the State
of Delaware, as amended, and as amended from time to time hereafter.

Last Amended March 19, 2004

                                      -85-

                                                                               .
                                                                               .
                                                                               .

                                                                      EXHIBIT 13

                      SELECTED CONSOLIDATED FINANCIAL DATA

       Year Ended December 31,                2003            2002            2001             2000            1999
       -----------------------            -------------   -------------   -------------    -------------   -------------
                                                                                            
INCOME STATEMENT DATA:
Premiums earned                           $ 196,792,696   $ 185,841,193   $ 167,769,854    $ 151,646,199   $ 145,517,457
Investment income, net                       13,315,936      14,581,252      15,885,544       16,394,747      13,590,695
Realized investment gains (losses)            1,368,031         144,190        (880,254)         170,852         (38,702)
Total revenues                              214,992,328     203,803,561     185,163,623      170,581,587     161,739,336
Income before income taxes                   25,436,375      16,494,584       7,091,729       11,743,028       3,844,641
Income taxes (benefit)                        7,142,399       4,491,862       1,273,598        2,906,248      (2,950,556)
Net income                                   18,293,976      12,002,722       5,818,131        8,836,780       6,795,197
Basic earnings per common share                    1.91            1.32            0.65             1.01            0.82
Diluted earnings per common share                  1.85            1.31            0.64             1.01            0.82
Cash dividends per share
   of common stock (a)                              N/A             N/A             N/A             0.36            0.36
Cash dividends per share
   of Class A common stock (a)                      .43            0.40            0.40              N/A             N/A
Cash dividends per share
   of Class B common stock (a)                      .39            0.36            0.36              N/A             N/A

BALANCE SHEET DATA AT YEAR END:
Total investments                         $ 421,276,467   $ 332,299,094   $ 300,633,355    $ 289,344,642   $ 268,010,854
Total assets                                602,036,042     501,218,164     456,632,372      426,008,780     389,688,804
Debt obligations                             25,774,000      19,800,000      27,600,000       40,000,000      37,000,000
Stockholders' equity                        208,649,232     133,182,850     120,928,349      114,129,591     103,792,334
Stockholders' equity per share                    16.29           14.52           13.44            12.88           12.28

In January 2001, the Company acquired all of the outstanding stock of
Pioneer-New York from the Mutual Company, which previously owned 100% of
Pioneer-New York. The acquisition has been accounted for as a reorganization of
entities under common control, similar to a pooling of interests, as both
Pioneer-New York and the Company are under the common management and control of
the Mutual Company. As such, all financial data prior to January 1, 2001 has
been restated to include Pioneer-New York as a consolidated subsidiary.

(a) In April 2001, the Company reclassified its common stock as Class B common
    stock and created a new class of common stock with one-tenth of a vote per
    share designated as Class A common stock. Also in April 2001, the Company
    effected a one-for-three reverse split of the Company's Class B common stock
    and issued a dividend of two shares of Class A common stock for each share
    of Class B common stock. The effect of the reverse split and the stock
    dividend taken together is that the Company had the same total number of
    shares outstanding after the reverse split and the stock dividend as it did
    before the reverse split and the stock dividend. Therefore, there was no
    change in the historical earnings per share of the Class A common stock and
    the Class B common stock.

                                     page 8

                              FINANCIAL INFORMATION

                                                                                   
MANAGEMENT'S DISCUSSION AND
ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION ........................................................      10

CONSOLIDATED BALANCE SHEETS ....................................................      16

CONSOLIDATED STATEMENTS OF INCOME AND
COMPREHENSIVE INCOME ...........................................................      17

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY ................................      18

CONSOLIDATED STATEMENTS OF CASH FLOWS ..........................................      19

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS .....................................      20

INDEPENDENT AUDITORS' REPORT ...................................................      31

CORPORATE INFORMATION ..........................................................      32

                                     page 9

MANAGEMENT'S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION

GENERAL

We were organized as a regional insurance holding company by Donegal Mutual
Insurance Company (the "Mutual Company") on August 26, 1986. We operate
predominantly as an underwriter of personal and commercial lines of property and
casualty insurance through our subsidiaries. Our personal lines products consist
primarily of homeowners and private passenger automobile policies. Our
commercial lines products consist primarily of commercial automobile, commercial
multiple peril and workers' compensation policies. Our two insurance
subsidiaries, Atlantic States Insurance Company ("Atlantic States") and Southern
Insurance Company of Virginia ("Southern") write personal and commercial lines
of property and casualty coverages exclusively through a network of independent
insurance agents in the Mid-Atlantic and Southern states. In January 2004, we
acquired Le Mars Insurance Company ("Le Mars") and the Peninsula Insurance Group
("Peninsula"), which consists of Peninsula Indemnity Company and The Peninsula
Insurance Company. We also own 47.5% of the outstanding stock of Donegal
Financial Services Corporation ("DFSC"), a thrift holding company. The Mutual
Company owns the remaining 52.5% of the outstanding stock of DFSC.

         At December 31, 2003, the Mutual Company held approximately 42% of our
outstanding Class A common stock and approximately 62% of our outstanding Class
B common stock. We refer to the Mutual Company and our insurance subsidiaries as
the Donegal Insurance Group.

TRANSACTIONS WITH AFFILIATES

Atlantic States, our largest subsidiary, and the Mutual Company have a pooling
agreement under which both companies are allocated a given percentage of their
combined underwriting results, excluding certain reinsurance assumed by the
Mutual Company from our insurance subsidiaries. Atlantic States has a 70% share
of the results of the pool, and the Mutual Company has a 30% share of the
results of the pool. The pooling agreement is intended to produce more uniform
and stable underwriting results from year to year for each pool participant than
they would experience individually and to spread the risk of loss among the
participants based on each participant's relative amount of surplus and relative
access to capital. Each participant in the pool has at its disposal the capacity
of the entire pool, rather than being limited to policy exposures of a size
commensurate with its own capital and surplus.

         In addition to the pooling agreement and third-party reinsurance, our
insurance subsidiaries have various reinsurance arrangements with the Mutual
Company. These agreements include:

         -    catastrophe reinsurance agreements with each of our insurance
              subsidiaries,

         -    an excess of loss reinsurance agreement with Southern

         -    a workers' compensation reallocation agreement with Southern and

         -    a 100% retrocessional agreement with Southern.

         The excess of loss and catastrophe reinsurance agreements are intended
to lessen the effects of a single large loss, or an accumulation of losses
arising from one event, to levels that are appropriate given each subsidiary's
size, underwriting profile and surplus position.

         The Mutual Company and Southern have an agreement in place to
reallocate the loss results of workers' compensation business written by
Southern as part of commercial accounts primarily written by the Mutual Company
or Atlantic States. This agreement provides for the workers' compensation loss
ratio of Southern to be no worse than the average workers' compensation loss
ratio for the Donegal Insurance Group.

         Southern has a 100% retrocessional agreement between the Mutual Company
that is intended to provide Southern with the same A.M. Best rating, currently A
(Excellent), as the Mutual Company, which Southern might not be able to achieve
without this agreement in place. The retrocessional agreement does not otherwise
provide for pooling or reinsurance with or by the Mutual Company and does not
transfer insurance risk.

         The Mutual Company provides facilities, personnel and other services to
us, and the related expenses are allocated between Atlantic States and the
Mutual Company in relation to their relative participation in the pooling
agreement. Southern reimburses the Mutual Company for its personnel costs and
bears its proportionate share of information services costs based on its
percentage of total written premiums of the Donegal Insurance Group.

         Subsequent to the receipt of applicable board approvals, all agreements
and all changes to existing agreements between our subsidiaries and the Mutual
Company are subject to approval by a coordinating committee that is comprised of
two of our board members who do not serve on the Mutual Company board and two
board members of the Mutual Company who do not serve on our board. In order to
approve an agreement or a change in an agreement, our members on the
coordinating committee must conclude that the agreement or change is fair to us
and our stockholders, and the Mutual Company's members on the coordinating
committee must conclude that the agreement or change is fair to the Mutual
Company and its policyholders.

                                    page 10

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our financial statements are combined with those of our insurance subsidiaries
and are presented on a consolidated basis in accordance with United States
generally accepted accounting principles.

         We make estimates and assumptions that can have a significant effect on
amounts and disclosures we report in our financial statements. The most
significant estimates relate to our reserves for property and casualty insurance
unpaid losses and loss expenses, valuation of investments, policy acquisition
costs and guaranty fund liability accruals. While we believe our estimates are
appropriate, the ultimate amounts may differ from the estimates provided. The
methods for making these estimates are reviewed on a regular basis, and any
adjustment considered necessary is reflected in our current results of
operations.

LIABILITY FOR LOSSES AND LOSS EXPENSES

With respect to reserves for property and casualty unpaid losses and loss
expenses, significant components of our estimates include a variety of factors
such as medical inflation trends, regulatory and judicial rulings, legal
settlements, property replacements, repair cost trends and losses for assumed
reinsurance. In recent years, certain of these component costs, such as medical
inflation trends and legal settlements, have experienced significant volatility
and resulted in incurred amounts higher than our original estimates, and we have
factored these changes in trends into our loss estimates. However, due to the
nature of these liabilities, actual results could ultimately vary significantly
from the amounts recorded.

         Loss reserves are set at full-expected cost. Inflation is implicitly
provided for in the reserving function through analysis of costs, trends and
reviews of historical reserving results.

         We occasionally receive new information on files that had previously
been closed. For example, one of our policyholders may incur losses that were
not known at the time of the original claim settlement. We are also exposed to
larger than historical settlements due to changes in law, precedent or
underlying inflation on pending and unreported claims. When we experience
adverse development of losses from prior accident years, our current year
underwriting results are negatively impacted. To the extent our prior year
reserve deficiencies are indicative of deteriorating underlying loss trends and
are material, we seek to increase the pricing of affected lines of business to
the extent permitted by state departments of insurance. We also review trends in
loss development in order to determine if adjustments, such as reserve
strengthening, are appropriate. Because of our participation in the pool, we are
exposed to adverse loss development on the business of the Mutual Company
included in the pool.

INVESTMENTS

We make estimates concerning the valuation of our investments and the
recognition of other than temporary declines in the value of our investments.
When we consider the decline in value of an individual investment to be other
than temporary, we write down the investment to its estimated net realizable
value, and the amount of the write-down is reflected as a realized loss in our
statement of income. We individually monitor all investments for other than
temporary declines in value. Generally, if an individual equity security has
depreciated in value by more than 20% of original cost, and has been in an
unrealized loss position for more than six months, we assume there has been an
other than temporary decline in value. With respect to debt securities, we
assume there has been an other than temporary decline in value if it is probable
that contractual payments will not be received. In addition, we may write down
securities in an unrealized loss position based on a number of other factors,
including: the fair value of the investment being significantly below its cost,
the deteriorating financial condition of the issuer of a security, the
occurrence of industry, company and geographic events that have negatively
impacted the value of a security or rating agency downgrades.

         Our investments in available-for-sale fixed maturity and equity
securities are presented at estimated fair value, which generally represents
quoted market prices.

         During 2003, we sold certain bonds that had been classified as held to
maturity due to a series of rating agency downgrades. These bonds had an
amortized cost of $1.8 million, and the sale resulted in a realized gain of
$165,564. During 2002, we sold certain bonds that had been classified as held to
maturity due to significant deterioration in the issuer's credit worthiness.
These bonds had an amortized cost of $488,901, and the sale resulted in a
realized loss of $73,901. There were no other sales or transfers from the held
to maturity portfolio in 2003 and 2002.

POLICY ACQUISITION COSTS

Policy acquisition costs, consisting primarily of commissions, premium taxes and
certain other underwriting costs that vary with and are directly related to the
production of business, are deferred and amortized over the period in which the
premiums are earned. The method followed in computing deferred policy
acquisition costs limits the amount of such deferred costs to their estimated
realizable value, which gives effect to the premium to be earned, related
investment income, losses and loss expenses and certain other costs expected to
be incurred as the premium is earned.

GUARANTY FUND LIABILITY ACCRUALS

We make estimates of our insurance subsidiaries' liabilities for guaranty fund
and other assessments because of insurance company insolvencies from states in
which the subsidiaries are licensed. Generally, an insurer is subject to
assessment, depending upon its market share of a given line of business, to
assist in the payment of unpaid claims and related costs of insolvent insurance
companies. We generally record our liability for such assessments as premiums
upon which those assessments are based are written. As a result of several large
insolvencies in recent years, we are currently being assessed at the maximum
level permitted by Pennsylvania law for several of our lines of business, and we
expect we will continue to be assessed by Pennsylvania at the maximum level for
these business lines for a number of years.

                                    page 11

MANAGEMENT EVALUATION OF OPERATING RESULTS

We evaluate the performance of the commercial lines and personal lines segments
primarily based upon underwriting results as determined under statutory
accounting practices (SAP), which our management uses to measure performance for
our total business. We use the following financial data to monitor and evaluate
our operating results:

                                                  Year Ended December 31,
                                          ------------------------------------
      (amount in thousands)                  2003         2002         2001
      ---------------------               ---------    ---------     ---------
                                                            
Net Premiums Written:
  Personal lines:
     Automobile                           $  86,644    $  84,643     $  74,396
     Homeowners                              36,989       34,637        31,431
     Other                                    6,753        6,497         5,796
                                          ---------    ---------     ---------
  Total personal lines                      130,386      125,777       111,623
                                          ---------    ---------     ---------
  Commercial lines:
     Automobile                              18,655       17,451        16,527
     Workers' compensation                   25,627       23,845        22,979
     Commercial multiperil                   30,199       25,536        24,174
     Other                                    2,114        1,895         1,725
                                          ---------    ---------     ---------
  Total commercial lines                     76,595       68,727        65,405
                                          ---------    ---------     ---------
     Total net
     premiums written                     $ 206,981    $ 194,504     $ 177,028
                                          =========    =========     =========
Components of GAAP Combined Ratio:
  Loss ratio                                   64.2%        69.6%         70.5%
  Expense ratio                                30.2         29.5          32.3
  Dividend ratio                                0.6          0.5           1.0
                                          ---------    ---------     ---------
     GAAP combined ratio                       95.0%        99.6%        103.8%
                                          =========    =========     =========
Revenues:
  Premiums earned:
     Personal lines                       $ 125,322    $ 119,838     $ 104,893
     Commercial lines                        71,471       66,003        62,877
                                          ---------    ---------     ---------
       Total
       premiums earned                      196,793      185,841       167,770
                                          ---------    ---------     ---------
  Net investment income                      13,316       14,581        15,886
  Realized investment
  gains (losses)                              1,368          144          (880)
  Other                                       3,515        3,238         2,388
                                          ---------    ---------     ---------
     Total revenues                       $ 214,992    $ 203,804     $ 185,164
                                          =========    =========     =========
Components of Net Income:
  Underwriting income (loss):
     Personal lines                       $   2,004    $  (5,056)    $  (5,090)
     Commercial lines                         7,173        6,326        (3,037)
                                          ---------    ---------     ---------
       SAP underwriting
       income (loss)                          9,177        1,270        (8,127)
     GAAP adjustments                           692         (558)        1,833
                                          ---------    ---------     ---------
     GAAP underwriting
     income (loss)                            9,869          712        (6,294)
  Net investment income                      13,316       14,581        15,886
  Realized investment
  gains (losses)                              1,368          144          (880)
  Other                                         883        1,058        (1,620)
                                          ---------    ---------     ---------
  Income before income taxes                 25,436       16,495         7,092
  Income taxes                                7,142        4,492         1,274
                                          ---------    ---------     ---------
     Net income                           $  18,294    $  12,003     $   5,818
                                          =========    =========     =========

RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2003 AND 2002
NET PREMIUMS WRITTEN

Our 2003 net premiums written increased by 6.4% to $207.0 million, compared to
$194.5 million for 2002. Commercial lines net premiums written increased $7.9
million, or 11.4%, for 2003 compared to 2002. Personal lines net premiums
written increased $4.6 million, or 3.7%, for 2003 compared to 2002. We have
benefited during these periods, and expect to continue to benefit, from premium
increases by our insurance subsidiaries that have resulted from pricing actions
approved by regulators. These increases related primarily to private passenger
automobile, commercial multiple peril, workers' compensation and homeowners
lines of business realized in most of the states in which we operate. In
addition to pricing increases, we have also benefited from organic growth in
most of the states in which we operate.

NET PREMIUMS EARNED

Our net premiums earned increased to $196.8 million for 2003, an increase of
$11.0 million, or 5.9%, over 2002. Our net earned premiums during 2003 have
grown due to the increase in written premiums during the year. Premiums are
earned, or recognized as income, over the terms of our policies, which are
generally one-year or less in duration. Therefore, increases or decreases in net
premiums earned will generally reflect increases or decreases in net premiums
written in the preceding twelve-month period compared to the same period one
year earlier.

INVESTMENT INCOME

For 2003, our net investment income decreased 8.7% to $13.3 million, compared to
$14.6 million for 2002. An increase in our average invested assets from $316.5
million in 2002 to $376.8 million in 2003 was more than offset by a decrease in
our annualized average return on investments from 4.6% in 2002 to 3.5% in 2003,
and accounted for the decrease in investment income in 2003 compared to 2002.
The decrease in our annualized average return during both years compared to the
prior years reflects a declining interest rate environment.

NET REALIZED INVESTMENT GAINS/LOSSES

Our net realized investment gains in 2003 were $1.4 million, compared to
$144,190 in 2002. Our net realized investment gains in 2003 were net of
impairment charges of $237,724, compared to impairment charges of $378,672
recognized in 2002. Our impairment charges for both years were the result of
declines in the market value of common stocks that we determined to be other
than temporary. The remaining net realized investment gains and losses in both
periods resulted from normal turnover within our investment portfolio.

LOSSES AND LOSS EXPENSES

Our loss ratio, which is the ratio of incurred losses and loss expenses to
premiums earned, in 2003 was 64.2%, compared to 69.6% in 2002. Our commercial
lines loss ratio decreased to 57.7% in 2003, compared to 61.5% in 2002. Our
commercial automobile and workers' compensation loss ratios showed improvement
in 2003, with

                                    page 12

the commercial automobile loss ratio decreasing to 51.9% in 2003, compared to
61.6% in 2002, and the workers' compensation loss ratio decreasing to 60.5% in
2003, compared to 73.1% in 2002. The personal lines loss ratio improved from
73.3% in 2002 to 67.8% in 2003, primarily as a result of improvement in the
personal automobile loss ratio in 2003 compared to 2002. Improvements in our
2003 loss ratios reflect the benefits of premium pricing increases and more
favorable prior accident year loss development compared to the same period in
2002.

UNDERWRITING EXPENSES

Our expense ratio, which is the ratio of policy acquisition and other
underwriting expenses to premiums earned, in 2003 was 30.2%, compared to 29.5%
in 2002. Improvements from expense control efforts were offset by higher
underwriting-based incentive costs incurred in 2003 compared to 2002.

COMBINED RATIO

Our combined ratio was 95.0% and 99.6% in 2003 and 2002, respectively. The
combined ratio represents the sum of the loss ratio, expense ratio and dividend
ratio, which is the ratio of workers' compensation policy dividends incurred to
premiums earned. The improvement in our combined ratio was attributable to the
decrease in the loss ratio between years.

INTEREST EXPENSE

Our interest expense in 2003 was $1.3 million, compared to $1.1 million in 2002,
reflecting an increase in interest expense related to the issuance of $25.8
million of subordinated debentures in 2003, offset by decreases in the average
interest rates and average borrowings under our line of credit in 2003 compared
to 2002.

INCOME TAXES

Our income tax expense was $7.1 million in 2003, compared to $4.5 million in
2002, representing effective tax rates of 28.1% and 27.2%, respectively. The
change between effective tax rates is due to tax-exempt interest representing a
slightly smaller proportion of net income before taxes in 2003 compared to 2002.

NET INCOME AND EARNINGS PER SHARE

Our net income in 2003 was $18.3 million, an increase of 52.4% over the $12.0
million reported in 2002. Our diluted earnings per share were $1.85 in 2003
compared to $1.31 in 2002.

BOOK VALUE PER SHARE AND RETURN ON EQUITY

Our stockholders' equity increased by $75.5 million in 2003, primarily as a
result of the issuance of 3.45 million shares of Class A common stock in
December 2003, which resulted in $59.0 million in net proceeds to us. Book value
per share increased by 12.2% to $16.29 at December 31, 2003, compared to $14.52
a year earlier. Our return on average equity was 12.2% in 2003, compared to 9.4%
in 2002.

YEARS ENDED DECEMBER 31, 2002 AND 2001

NET PREMIUMS WRITTEN

Our net premiums written in 2002 increased by 9.9% to $194.5 million, compared
to $177.0 million in 2001. Personal lines net premiums written increased $14.2
million, or 12.7%, for 2002 compared to 2001. Commercial lines net premiums
written increased $3.3 million, or 5.1%, for 2002 compared to 2001. We
implemented rate increases in various lines of business throughout the year to
improve profitability.

NET PREMIUMS EARNED

Our net premiums earned for 2002 increased to $185.8 million, an increase of
$18.1 million, or 10.8%, over 2001. Earned premiums grew due to the increase in
written premiums during 2002.

INVESTMENT INCOME

Our investment income for 2002 decreased 8.2% to $14.6 million, compared to
$15.9 million for 2001. An increase in average invested assets from $295.0
million in 2001 to $316.5 million in 2002 was more than offset by a decrease in
the annualized average return on investments from 5.3% in 2001 to 4.6% in 2002,
and accounted for the decrease in investment income in 2002 compared to 2001.
The decrease in our annualized average return reflects a declining interest rate
environment during both periods.

NET REALIZED INVESTMENT GAINS/LOSSES

Our net realized investment gains in 2002 were $144,190, compared to net
realized investment losses of $880,254 in 2001. Our net realized investment
gains in 2002 were net of impairment charges of $378,672, compared to impairment
charges of $1.5 million in 2001. The impairment charges in both years were the
result of declines in the market value of common stocks that were determined to
be other than temporary.

LOSSES AND LOSS EXPENSES

Our loss ratio in 2002 was 69.6%, compared to 70.5% in 2001. Our commercial
lines loss ratio decreased significantly to 61.5% in 2002, compared to 72.7% in
2001, with the commercial automobile loss ratio showing the greatest improvement
as it decreased from 85.0% in 2001 to 61.6% in 2002. Our personal lines loss
ratio increased from 69.2% in 2001 to 73.3% in 2002. Net losses and loss
expenses for 2002 and 2001 included adverse development of prior accident year
losses amounting to $6.8 million and $8.0 million, respectively. In 2002, the
adverse loss development was primarily in private passenger automobile liability
and physical damage and, to a lesser extent, in commercial lines of business,
such as workers' compensation, commercial automobile liability and commercial
multiperil. The 2002 loss development resulted principally from accident year
2001 claims and the normal claims review process and not from any changes in key
assumptions or changes in reserving philosophy. The 2001 adverse loss
development was primarily in commercial lines of business. The 2001 development
included $4.2 million of reserve strengthening primarily in the workers'
compensation and commercial auto lines of business.

                                    page 13

UNDERWRITING EXPENSES

Our expense ratio in 2002 was 29.5%, compared to 32.3% in 2001. Improvement in
our expense ratio was primarily a result of the cost reduction program
implemented in late 2001. The expense ratio in 2001 included a guaranty fund
assessment of approximately $543,000 resulting from the insolvency of Reliance
Insurance Company. This assessment also contributed to the change in the expense
ratio between years.

COMBINED RATIO

Our combined ratio was 99.6% in 2002, compared to 103.8% in 2001. The
improvement in our combined ratio was primarily attributable to the decrease in
the expense ratio between periods.

INTEREST EXPENSE

Interest expense in 2002 was $1.1 million, compared to $2.2 million in 2001,
reflecting decreases in average borrowings under our line of credit and
decreases in the average interest rates for the respective periods.

INCOME TAXES

Income tax expense was $4.5 million in 2002, an effective tax rate of 27.2%,
compared to $1.3 million, or an effective tax rate of 18.0%, in 2001. Tax-exempt
interest represented a smaller proportion of net income before taxes in 2002
compared to 2001 and accounted for the difference between the effective rates.

NET INCOME AND EARNINGS PER SHARE

Our net income in 2002 was $12.0 million, an increase of 106.3% over the $5.8
million reported in 2001. Diluted earnings per share were $1.31 for 2002
compared to $0.64 for the previous year.

FINANCIAL CONDITION

LIQUIDITY AND CAPITAL RESOURCES

Liquidity is a measure of an entity's ability to secure enough cash to meet its
contractual obligations and operating needs as they arise. Our major sources of
funds from operations are the net cash flow generated from our insurance
subsidiaries' underwriting results, investment income and maturing investments.

         We generate sufficient net positive cash flow from our operations to
fund our commitments and build our investment portfolio, thereby increasing
future investment returns. We maintain a high degree of liquidity in our
investment portfolio in the form of readily marketable fixed maturities, equity
securities and short-term investments. Net cash flows provided by operating
activities in 2003, 2002 and 2001, were $30.8 million, $34.1 million and $22.0
million, respectively.

         On May 15, 2003, we received $15.0 million in net proceeds from the
issuance of subordinated debentures. The debentures mature on May 15, 2033 and
are callable at our option, at par, after five years. The debentures carry an
interest rate equal to the three-month LIBOR rate plus 4.10%, which is
adjustable quarterly. At December 31, 2003, the interest rate on the debentures
was 5.28%.

         On October 29, 2003, we received $10.0 million in net proceeds from the
issuance of subordinated debentures. The debentures mature on October 29, 2033
and are callable at our option, at par, after five years. The debentures carry
an interest rate equal to the three-month LIBOR rate plus 3.85%, which is
adjustable quarterly. At December 31, 2003, the interest rate on the debentures
was 5.01%.

         On November 25, 2003, we entered into a credit agreement with
Manufacturers and Traders Trust Company ("M&T") relating to a four-year $35.0
million unsecured, revolving line of credit. As of December 31, 2003, we may
borrow up to $35.0 million at interest rates equal to the bank's current prime
rate or the then current LIBOR rate plus between 1.50% and 1.75%, depending on
our leverage ratio. In addition, we pay a fee of 0.15% per annum on the loan
commitment amount, regardless of usage. The agreement requires our compliance
with certain covenants, which include minimum levels of our net worth, leverage
ratio and statutory surplus and A.M. Best ratings of our subsidiaries. As of
December 31, 2003, there were no borrowings outstanding, and we complied with
all requirements of the agreement.

         On December 1, 2003, we completed an underwritten public offering of
3.45 million shares of our Class A common stock, resulting in net proceeds of
$59.0 million to us.

         At December 31, 2002, pursuant to a credit agreement dated December 29,
1995, and amended as of July 27, 1998, with Fleet National Bank, we had
unsecured borrowings of $19.8 million. Such borrowings were made in connection
with the various acquisitions and capital contributions to our subsidiaries. The
borrowings under this line of credit were repaid during 2003, and this credit
agreement was terminated on December 2, 2003.

         Dividends declared to stockholders totaled $4.4 million, $3.5 million
and $3.5 million in 2003, 2002 and 2001, respectively. There are no regulatory
restrictions on the payment of dividends to our stockholders, although there are
state law restrictions on the payment of dividends from our insurance
subsidiaries to us. Atlantic States and Southern are required by law to maintain
certain minimum surplus on a statutory basis, and are subject to regulations
under which payment of dividends from statutory surplus is restricted and may
require prior approval of their domiciliary insurance regulatory authorities.
Atlantic States and Southern are subject to risk-based capital (RBC)
requirements. At December 31, 2003, Atlantic States' and Southern's capital were
each substantially above the RBC requirements. In 2004, amounts available for
distribution as dividends to us without prior approval of their domiciliary
insurance regulatory authorities are $13.3 million from Atlantic States and $4.1
million from Southern.

         We had two pending acquisitions at December 31, 2003, both of which
were consummated in January 2004. As of January 1, 2004, we acquired all of the
outstanding capital stock of Le Mars, the successor to Le Mars Mutual Insurance
Company of Iowa following its conversion to a stock insurance company pursuant
to a plan of conversion. We acquired the capital stock of Le Mars for
approximately $12.6 million in cash, including payment of $4.4 million to the
Mutual Company for a surplus note and accrued interest that the Mutual Company
had infused into Le Mars.

         Le Mars operates as a multiple line carrier in Iowa, Nebraska, Oklahoma
and South Dakota. Personal lines coverages represent a majority of premiums
written, with the balance coming from farmowners and mercantile and service
businesses. Le Mars' largest lines of business are private passenger automobile
liability and physical damage; other principal lines include homeowners and
commercial multiperil.

                                    page 14

         On January 6, 2004, we acquired all of the outstanding common stock of
Peninsula from Folksamerica Holding Company, Inc. pursuant to a Stock Purchase
Agreement. The cash purchase price of approximately $23.3 million was equal to
107.5% of the consolidated GAAP stockholders' equity of Peninsula as of the date
of closing of the acquisition.

         The Peninsula companies are each Maryland-domiciled insurance companies
headquartered in Salisbury, Maryland, which write primarily private passenger
automobile coverages, and also write homeowners, commercial multiperil, workers'
compensation and commercial automobile coverages. Peninsula's principal
operating area is Maryland, Delaware and Virginia.

INVESTMENTS

At December 31, 2003 and 2002, our investment portfolio of investment-grade
bonds, common stock, preferred stock, short-term investments and cash totaled
$427.2 million, and $333.4 million, respectively, representing 71.0% and 66.5%,
respectively, of our total assets.

         At December 31, 2003 and 2002, the carrying value of our fixed maturity
investments represented 73.9% and 84.7% of our total invested assets,
respectively.

         Our fixed maturity investments consisted of high-quality marketable
bonds, all of which were rated at investment-grade levels, at December 31, 2003
and 2002.

         At December 31, 2003, the net unrealized gain on fixed maturities, net
of deferred taxes, amounted to $4.1 million, compared to $4.7 million at
December 31, 2002.

         At December 31, 2003, the net unrealized gain on our equity securities
held, net of deferred taxes, amounted to $1.2 million, compared to $163,500 at
December 31, 2002.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to the impact of interest rate changes, changes in market values
of investments and to credit risk.

         In the normal course of business, we employ established policies and
procedures to manage our exposure to changes in interest rates, fluctuations in
the value of the fair market value of our debt and equity securities and credit
risk. We seek to mitigate these risks by various actions described below.

INTEREST RATE RISK

Our exposure to market risk for a change in interest rates is concentrated in
the investment portfolio. We monitor this exposure through periodic reviews of
asset and liability positions. Estimates of cash flows and the impact of
interest rate fluctuations relating to the investment portfolio are monitored
regularly. Generally, we do not hedge our exposure to interest rate risk because
we have the capacity to, and do, hold fixed maturity investments to maturity.

         Principal cash flows and related weighted-average interest rates by
expected maturity dates for financial instruments sensitive to interest rates at
December 31, 2003 are as follows:

                                          Principal   Weighted-average
(amounts in thousands)                    cash flows    interest rate
- ----------------------                    ----------  ----------------
                                                
Fixed maturities and short-term bonds:
   2004                                   $  92,194        1.74%
   2005                                      13,337        5.86%
   2006                                      32,989        4.81%
   2007                                      31,236        4.63%
   2008                                      40,075        4.01%
   Thereafter                               169,209        4.85%
                                          ---------
   Total                                  $ 379,040
                                          =========
   Market Value                           $ 392,910
                                          =========

Debt:
   2033                                   $  25,774        5.17%
                                          ---------
   Total                                  $  25,774
                                          =========
   Fair value                             $  25,774
                                          =========

         Actual cash flows from investments may differ from those stated as a
result of calls and prepayments.

EQUITY PRICE RISK

Our portfolio of marketable equity securities, which is carried on the
consolidated balance sheets at estimated fair value, has exposure to price risk,
the risk of potential loss in estimated fair value resulting from an adverse
change in prices. Our objective is to earn competitive relative returns by
investing in a diverse portfolio of high-quality, liquid securities.

CREDIT RISK

Our objective is to earn competitive returns by investing in a diversified
portfolio of securities. Our portfolios of fixed maturity securities and, to a
lesser extent, short-term investments are subject to credit risk. This risk is
defined as the potential loss in market value resulting from adverse changes in
the borrower's ability to repay the debt. We manage this risk by performing up
front underwriting analysis and through regular reviews by the Company's
investment staff. The fixed maturity investments are also maintained between
minimum and maximum percentages of invested assets.

         We provide property and liability insurance coverages through
independent insurance agencies located throughout our operating area. The
majority of this business is billed directly to the insured, although a portion
of our commercial business is billed through our agents who are extended credit
in the normal course of business.

         Our insurance subsidiaries maintain reinsurance agreements in place
with the Mutual Company and with a number of other major unaffiliated authorized
reinsurers.

IMPACT OF INFLATION

Property and casualty insurance premium rates are established before the amount
of losses and loss settlement expenses, or the extent to which inflation may
impact such expenses, are known. Consequently, we attempt, in establishing
rates, to anticipate the potential impact of inflation.

                                    page 15

Donegal Group Inc.

CONSOLIDATED BALANCE SHEETS

December 31,                                                                                       2003            2002
- ------------                                                                                       ----            ----
                                                                                                         
ASSETS
Investments
   Fixed maturities
     Held to maturity, at amortized cost (fair value $116,133,002 and $89,785,318)           $   113,050,784   $   86,701,556
     Available for sale, at fair value (amortized cost $192,097,372 and $187,495,949)            198,433,337      194,731,660
   Equity securities, available for sale, at fair value (cost $29,644,333 and $21,587,317)        31,448,221       21,836,460
   Short-term investments, at cost, which approximates fair value                                 78,344,125       29,029,418
                                                                                             ---------------   --------------
     Total investments                                                                           421,276,467      332,299,094
Cash                                                                                               5,908,521        1,124,604
Accrued investment income                                                                          3,752,075        3,815,449
Premiums receivable                                                                               29,016,940       26,286,482
Reinsurance receivable                                                                            81,009,106       83,207,272
Deferred policy acquisition costs                                                                 16,223,765       14,567,070
Deferred tax asset, net                                                                            7,032,409        6,955,707
Prepaid reinsurance premiums                                                                      30,691,654       27,853,996
Property and equipment, net                                                                        4,151,671        4,430,394
Accounts receivable -- securities                                                                  1,524,384          146,507
Other                                                                                              1,449,050          531,589
                                                                                             ---------------   --------------
     Total assets                                                                            $   602,036,042   $  501,218,164
                                                                                             ===============   ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
   Losses and loss expenses                                                                  $   217,914,057   $  210,691,752
   Unearned premiums                                                                             134,028,035      121,002,447
   Accrued expenses                                                                                7,769,879        6,583,825
   Reinsurance balances payable                                                                    1,355,796        1,100,443
   Federal income taxes payable                                                                      315,808          357,547
   Cash dividend declared to stockholders                                                          1,378,993          887,315
   Borrowings under line of credit                                                                        --       19,800,000
   Subordinated debentures                                                                        25,774,000               --
   Accounts payable -- securities                                                                  2,438,784        2,121,619
   Due to affiliate                                                                                  904,452        4,080,415
   Other                                                                                           1,507,006        1,409,951
                                                                                             ---------------   --------------
     Total liabilities                                                                           393,386,810      368,035,314
                                                                                             ---------------   --------------
Stockholders' Equity
   Preferred stock, $1.00 par value, authorized 2,000,000 shares; none issued                             --               --
   Class A common stock, $.01 par value, authorized 30,000,000 shares,
     issued 9,880,506 and 6,269,093 shares and outstanding 9,798,982 and 6,187,569 shares             98,805           62,691
   Class B common stock, $.01 par value, authorized 10,000,000 shares,
     issued 3,051,811 and 3,024,742 shares and outstanding 3,011,049 and 2,983,980 shares             30,518           30,247
   Additional paid-in capital                                                                    122,744,905       60,651,751
   Accumulated other comprehensive income                                                          5,290,923        4,911,953
   Retained earnings                                                                              81,375,829       68,417,956
   Treasury stock, at cost                                                                          (891,748)        (891,748)
                                                                                             ---------------   --------------
     Total stockholders' equity                                                                  208,649,232      133,182,850
                                                                                             ---------------   --------------
     Total liabilities and stockholders' equity                                              $   602,036,042   $  501,218,164
                                                                                             ===============   ==============

See accompanying notes to consolidated financial statements.

                                    page 16

Donegal Group Inc.

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

                     Year Ended December 31,                                2003             2002            2001
                     -----------------------                            -------------   --------------   --------------
                                                                                                
STATEMENTS OF INCOME

Revenues
     Net premiums earned (includes affiliated reinsurance of
        $94,173,934, $86,195,962 and $71,989,136)                       $ 196,792,696   $  185,841,193   $  167,769,854
     Investment income, net of investment expenses                         13,315,936       14,581,252       15,885,544
     Installment payment fees                                               2,464,604        2,447,229        1,587,396
     Lease income                                                             845,211          789,697          801,083
     Net realized investment gains (losses)                                 1,368,031          144,190         (880,254)
     Other income                                                             205,850               --               --
                                                                        -------------   --------------   --------------
        Total revenues                                                    214,992,328      203,803,561      185,163,623
                                                                        -------------   --------------   --------------
Expenses
     Net losses and loss expenses (includes affiliated reinsurance of
        $53,659,974, $54,684,955 and $50,283,481)                         126,243,311      129,267,686      118,177,549
     Amortization of deferred policy acquisition costs                     30,839,000       29,473,000       27,194,000
     Other underwriting expenses                                           28,686,365       25,331,777       27,000,485
     Policy dividends                                                       1,154,773        1,056,790        1,691,759
     Interest                                                               1,287,197        1,119,204        2,247,465
     Other                                                                  1,345,307        1,060,520        1,760,636
                                                                        -------------   --------------   --------------
        Total expenses                                                    189,555,953      187,308,977      178,071,894
                                                                        -------------   --------------   --------------
Income before income tax expense                                           25,436,375       16,494,584        7,091,729

Income tax expense                                                          7,142,399        4,491,862        1,273,598
                                                                        -------------   --------------   --------------
Net income                                                              $  18,293,976   $   12,002,722   $    5,818,131
                                                                        =============   ==============   ==============
Net income per common share
     Basic                                                              $        1.91   $         1.32   $          .65
                                                                        =============   ==============   ==============
     Diluted                                                            $        1.85   $         1.31   $          .64
                                                                        =============   ==============   ==============
STATEMENTS OF COMPREHENSIVE INCOME

Net income                                                              $  18,293,976   $   12,002,722   $    5,818,131
                                                                        -------------   --------------   --------------
Other comprehensive income, net of tax
   Unrealized gains on securities:
     Unrealized holding gain arising during the period, net of income
        tax expense of $754,840,$1,148,224 and $1,277,504                   1,268,190        2,144,813        2,479,860
     Reclassification adjustment for (gains)losses included
        in net income, net of income tax expense (benefit) of
        $478,811, $49,565 and $(299,286)                                     (889,220)         (94,625)         580,968
                                                                        -------------   --------------   --------------
Other comprehensive income                                                    378,970        2,050,188        3,060,828
                                                                        -------------   --------------   --------------
Comprehensive income                                                    $  18,672,946   $   14,052,910   $    8,878,959
                                                                        =============   ==============   ==============

See accompanying notes to consolidated financial statements.

                                    page 17

Donegal Group Inc.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

                                                   Common Stock
                           -------------------------------------------------------------
                              Prior     Class A   Class B     Prior     Class A  Class B
                              Shares    Shares     Shares     Amount     Amount   Amount
                           ----------  --------- --------- -----------  -------- -------
                                                               
Balance,
   January 1, 2001          8,980,977         --        -- $ 8,980,977  $     -- $    --
                           ----------  --------- --------- -----------  -------- -------
Issuance of common stock       61,830     60,144     3,758      61,830       601      38
Recapitalization           (9,042,807) 6,027,975 3,013,987  (9,042,807)   60,280  30,140
Net income
Cash dividends
Exercise of stock options                  9,095     4,220                    91      42
Grant of stock options
Other comprehensive income
                           ----------  --------- --------- -----------  -------- -------
Balance,
   December 31, 2001               --  6,097,214 3,021,965 $        --  $ 60,972 $30,220
                           ----------  --------- --------- -----------  -------- -------

Issuance of common stock                 166,972                           1,670
Net income
Cash dividends
Exercise of stock options                  4,907     2,777                    49      27
Grant of stock options
Other comprehensive income
                           ----------  --------- --------- -----------  -------- -------
Balance,
   December 31, 2002               --  6,269,093 3,024,742 $        --  $ 62,691 $30,247
                           ----------  --------- --------- -----------  -------- -------
Issuance of common stock               3,547,000                          35,470
Net income
Cash dividends
Exercise of stock options                 64,413    27,069                   644     271
Grant of stock options
Other comprehensive income
                           ----------  --------- --------- -----------  -------- -------
Balance,
   December 31, 2003               --  9,880,506 3,051,811 $        --  $ 98,805 $30,518
                           ==========  ========= ========= ===========  ======== =======

                                         Accumulated
                            Additional      Other                                  Total
                             Paid-In    Comprehensive   Retained     Treasury  Stockholders'
                             Capital    Income (Loss)   Earnings       Stock       Equity
                           ------------ ------------- ------------  ---------  -------------
                                                                
Balance,
   January 1, 2001         $ 46,969,840 $    (199,063)$ 59,269,593  $(891,756) $ 114,129,591
                           ------------ ------------- ------------  ---------  -------------
Issuance of common stock      1,200,202                                            1,262,671
Recapitalization              8,949,361                                     8         (3,018)
Net income                                               5,818,131                 5,818,131
Cash dividends                                          (3,466,947)               (3,466,947)
Exercise of stock options       126,960                                              127,093
Grant of stock options        1,641,352                 (1,641,352)                       --
Other comprehensive income                  3,060,828                              3,060,828
                           ------------ ------------- ------------  ---------  -------------
Balance,
   December 31, 2001       $ 58,887,715 $   2,861,765 $ 59,979,425  $(891,748) $ 120,928,349
                           ------------ ------------- ------------  ---------  -------------

Issuance of common stock      1,641,547                                            1,643,217
Net income                                              12,002,722                12,002,722
Cash dividends                                          (3,526,157)               (3,526,157)
Exercise of stock options        84,455                                               84,531
Grant of stock options           38,034                    (38,034)                       --
Other comprehensive income                  2,050,188                              2,050,188
                           ------------ ------------- ------------  ---------  -------------
Balance,
   December 31, 2002       $ 60,651,751 $   4,911,953 $ 68,417,956  $(891,748) $ 133,182,850
                           ------------ ------------- ------------  ---------  -------------
Issuance of common stock     60,193,670                                           60,229,140
Net income                                              18,293,976                18,293,976
Cash dividends                                          (4,360,026)               (4,360,026)
Exercise of stock options       923,407                                              924,322
Grant of stock options          976,077                   (976,077)                       --
Other comprehensive income                    378,970                                378,970
                           ------------ ------------- ------------  ---------  -------------
Balance,
   December 31, 2003       $122,744,905 $   5,290,923 $ 81,375,829  $(891,748) $ 208,649,232
                           ============ ============= ============  =========  =============

See accompanying notes to consolidated financial statements.

                                    page 18

Donegal Group Inc.

CONSOLIDATED STATEMENTS OF CASH FLOWS

                  Year Ended December 31,                         2003             2002             2001
                  -----------------------                     -------------    -------------    -------------
                                                                                       
Cash Flows from Operating Activities:
   Net income                                                 $  18,293,976    $  12,002,722    $   5,818,131
                                                              -------------    -------------    -------------
   Adjustments to reconcile net income to net cash
        provided by operating activities:
     Depreciation and amortization                                1,532,664        1,236,592        1,127,510
     Realized investment (gains) losses                          (1,368,031)        (144,190)         880,254
   Changes in Assets and Liabilities:
     Losses and loss expenses                                     7,222,305       30,851,847       23,363,781
     Unearned premiums                                           13,025,588        6,923,183       14,138,883
     Accrued expenses                                             1,186,054         (602,282)       1,308,632
     Premiums receivable                                         (2,730,458)      (2,142,951)      (2,385,029)
     Deferred policy acquisition costs                           (1,656,695)        (962,855)      (1,320,001)
     Deferred income taxes                                         (352,731)        (579,654)      (1,360,633)
     Reinsurance receivable                                       2,198,166      (15,354,098)     (13,309,290)
     Accrued investment income                                       63,374          (50,373)         237,388
     Amounts due to/from affiliate                               (3,175,963)          65,341         (513,922)
     Reinsurance balances payable                                   255,353          261,287         (795,819)
     Prepaid reinsurance premiums                                (2,837,658)       1,739,471       (4,881,083)
     Current income taxes                                           (41,739)         650,165          (32,656)
     Other, net                                                    (820,406)         181,965         (271,364)
                                                              -------------    -------------    -------------
        Net adjustments                                          12,499,823       22,073,448       16,186,651
                                                              -------------    -------------    -------------
     Net cash provided by operating activities                   30,793,799       34,076,170       22,004,782
                                                              -------------    -------------    -------------

Cash Flows from Investing Activities:
   Purchase of fixed maturities
     Held to maturity                                           (51,747,067)     (35,867,577)     (45,201,470)
     Available for sale                                         104,935,346)     (75,783,783)     (71,700,918)
   Purchase of equity securities                                (20,779,807)     (18,325,041)     (12,440,994)
   Sale of fixed maturities
     Held to maturity                                             1,971,000          415,000               --
     Available for sale                                          16,575,179          461,965       16,250,109
   Maturity of fixed maturities
     Held to maturity                                            22,256,933       34,967,828       51,313,296
     Available for sale                                          84,393,268       58,798,825       50,781,533
   Sale of equity securities                                     12,683,028       13,394,123        7,089,532
   Net purchase of property and equipment                          (371,477)        (552,005)        (161,269)
   Net purchases of short-term investments                      (49,314,707)      (4,955,218)      (4,634,695)
                                                              -------------    -------------    -------------
     Net cash used in investing activities                      (89,268,996)     (27,445,883)      (8,704,876)
                                                              -------------    -------------    -------------

Cash Flows from Financing Activities:
   Issuance of common stock                                      61,153,462        1,727,748        1,386,746
   Issuance of subordinated debentures                           25,774,000               --               --
   Payments on line of credit                                   (19,800,000)      (7,800,000)     (12,400,000)
   Cash dividends paid                                           (3,868,348)      (3,508,719)      (3,394,352)
                                                              -------------    -------------    -------------
     Net cash provided by (used in) financing activities         63,259,114       (9,580,971)     (14,407,606)
                                                              -------------    -------------    -------------

Net increase (decrease) in cash                                   4,783,917       (2,950,684)      (1,107,700)
Cash at beginning of year                                         1,124,604        4,075,288        5,182,988
                                                              -------------    -------------    -------------
Cash at end of year                                           $   5,908,521    $   1,124,604    $   4,075,288
                                                              =============    =============    =============

See accompanying notes to consolidated financial statements.

                                    page 19

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

ORGANIZATION AND BUSINESS

We were organized as a regional insurance holding company by Donegal Mutual
Insurance Company (the "Mutual Company") and operate predominantly as an
underwriter of property and casualty insurance through our subsidiaries. Our two
property and casualty insurance subsidiaries during 2003, Atlantic States
Insurance Company ("Atlantic States") and Southern Insurance Company of Virginia
("Southern") write personal and commercial lines property and casualty coverages
exclusively through a network of independent insurance agents in the
Mid-Atlantic and Southern states. In January 2004, we also acquired Le Mars
Insurance Company ("Le Mars") and the Peninsula Insurance Group ("Peninsula"),
which consists of Peninsula Indemnity Company and The Peninsula Insurance
Company. We have three operating segments: the investment function, the personal
lines function and the commercial lines function. Our personal lines products
consist primarily of homeowners and private passenger automobile policies. Our
commercial lines products consist primarily of commercial automobile, commercial
multiple peril and workers' compensation policies. At December 31, 2003, the
Mutual Company held approximately 42% of our outstanding Class A common stock
and approximately 62% of our outstanding Class B common stock.

         Atlantic States participates in a pooling agreement with the Mutual
Company. Under the pooling agreement, the insurance business of the two
companies is pooled, and Atlantic States assumes 70% of the pooled business.
Prior to January 1, 2002, Southern ceded 50% of its business to the Mutual
Company. We also own 47.5% of the outstanding stock of Donegal Financial
Services Corporation ("DFSC"), a thrift holding company. The remaining 52.5% of
the outstanding stock of DFSC is owned by the Mutual Company.

         Pioneer Insurance Company of Ohio ("Pioneer-Ohio"), Delaware Atlantic
Insurance Company ("Delaware") and Pioneer Insurance Company of New York
("Pioneer-New York"), previously wholly owned subsidiaries, were merged into
Atlantic States on May 1, 2002, August 1, 2001 and September 30, 2001,
respectively. Southern Heritage Insurance Company, previously a wholly owned
subsidiary, was merged into Southern on May 1, 2002. The mergers were accounted
for as statutory mergers and had no financial impact on the consolidated entity.

         On December 1, 2003, we completed an underwritten public offering of
3,450,000 shares of our Class A common stock, resulting in net proceeds of $59.0
million to us.

         In June 2002, the Mutual Company consummated an affiliation with Le
Mars. As part of the affiliation, the Mutual Company entered into a management
agreement with and made a $4.0 million surplus note investment in Le Mars.
During 2003, Le Mars' board of directors adopted a plan of conversion to convert
to a stock insurance company. Following policyholder and regulatory approval of
the plan of conversion, we acquired Le Mars as of January 1, 2004 for
approximately $12.6 million in cash, including payment of the surplus note and
accrued interest to the Mutual Company.

         On January 6, 2004, we purchased Peninsula for a price in cash equal to
107.5% of Peninsula's GAAP stockholders' equity as of the closing of the
acquisition, or approximately $23.3 million.

BASIS OF CONSOLIDATION

The consolidated financial statements, which have been prepared in accordance
with accounting principles generally accepted in the United States of America,
include our accounts and those of our wholly owned subsidiaries. All significant
inter-company accounts and transactions have been eliminated in consolidation.
The term "we," "us," "our," or the "Company" as used herein refer to the
consolidated entity.

USE OF ESTIMATES

In preparing the consolidated financial statements, management is required to
make estimates and assumptions that affect the reported amounts of assets and
liabilities as of the date of the balance sheet and revenues and expenses for
the period. Actual results could differ significantly from those estimates.

         We make estimates and assumptions that can have a significant effect on
amounts and disclosures we report in our financial statements. The most
significant estimates relate to our reserves for property and casualty insurance
unpaid losses and loss expenses, valuation of investments, policy acquisition
costs and guaranty fund liability accruals. While we believe our estimates are
appropriate, the ultimate amounts may differ from the estimates provided. The
methods for making these estimates are continually reviewed, and any adjustment
considered necessary is reflected in our current results of operations.

INVESTMENTS

We classify our debt and equity securities into the following categories:

         Held to Maturity--Debt securities that we have the positive intent and
         ability to hold to maturity; reported at amortized cost.

         Available for Sale--Debt and equity securities not classified as held
         to maturity; reported at fair value, with unrealized gains and losses
         excluded from income and reported as a separate component of
         stockholders' equity (net of tax effects).

         Short-term investments are carried at amortized cost, which
approximates fair value.

         If there is a decline in fair value below amortized cost that is other
than temporary, the cost basis for such investments in the held to maturity and
available for sale categories is reduced to fair value. Such decline in cost
basis is recognized as a realized loss and charged to income.

         Premiums and discounts on debt securities are amortized over the life
of the security as an adjustment to yield using the effective interest method.
Realized investment gains and losses are computed using the specific
identification method.

         Premiums and discounts for mortgage-backed debt securities are
amortized using anticipated prepayments.

                                     page 20

FAIR VALUES OF FINANCIAL INSTRUMENTS

We have used the following methods and assumptions in estimating our fair value
disclosures:

         Investments--Fair values for fixed maturity securities are based on
         quoted market prices, when available. If quoted market prices are not
         available, fair values are based on quoted market prices of comparable
         instruments or values obtained from independent pricing services
         through a bank trustee. The fair values for equity securities are based
         on quoted market prices.

         Cash and Short-Term Investments--The carrying amounts reported in the
         balance sheet for these instruments approximate their fair values.

         Premium and Reinsurance Receivables and Payables--The carrying amounts
         reported in the balance sheet for these instruments approximate their
         fair values.

         Borrowings Under Line of Credit and Subordinated Debentures--The
         carrying amounts reported in the balance sheet for the line of credit
         and subordinated debentures approximate fair value due to their
         variable rate nature.

REVENUE RECOGNITION

Insurance premiums are recognized as income over the terms of the policies.
Unearned premiums are calculated on a daily pro-rata basis.

POLICY ACQUISITION COSTS

Policy acquisition costs, consisting primarily of commissions, premium taxes and
certain other variable underwriting costs, are deferred and amortized over the
period in which the premiums are earned. Anticipated losses and loss expenses,
expenses for maintenance of policies in force and anticipated investment income
are considered in the determination of the recoverability of deferred
acquisition costs.

PROPERTY AND EQUIPMENT

Property and equipment are reported at depreciated cost that is computed using
the straight-line method based upon estimated useful lives of the assets.

LOSSES AND LOSS EXPENSES

The liability for losses and loss expenses includes amounts determined on the
basis of estimates for losses reported prior to the close of the accounting
period and other estimates, including those for incurred but not reported losses
and salvage and subrogation recoveries.

         These liabilities are continuously reviewed and updated by management,
and management believes that such liabilities are adequate to cover the ultimate
net cost of claims and expenses. When management determines that changes in
estimates are required, such changes are included in current earnings.

         We have no material exposures to environmental liabilities.

GUARANTY FUND LIABILITY ACCRUALS

We make estimates of our insurance subsidiaries' liabilities for guaranty fund
and other assessments because of insurance company insolvencies from states in
which the subsidiaries are licensed. Generally, an insurer is subject to
assessment, depending upon its market share of a given line of business, to
assist in the payment of unpaid claims and related costs of insolvent insurance
companies. We generally record our liability for such assessments as premiums
upon which those assessments are based are written. As a result of several large
insolvencies in recent years, we are currently being assessed at the maximum
level permitted by Pennsylvania law for several of our lines of business, and we
expect we will continue to be assessed by Pennsylvania at the maximum level for
these business lines for a number of years.

INCOME TAXES

We currently file a consolidated federal income tax return.

         We account for income taxes using the asset and liability method. The
objective of the asset and liability method is to establish deferred tax assets
and liabilities for the temporary differences between the financial reporting
basis and the tax basis of our assets and liabilities at enacted tax rates
expected to be in effect when such amounts are realized or settled.

CREDIT RISK

We provide property and liability coverages through our subsidiaries'
independent agency systems located throughout our operating area. The majority
of this business is billed directly to the insured, although a portion of our
commercial business is billed through our agents, who are extended credit in the
normal course of business.

         Our subsidiaries have reinsurance agreements in place with the Mutual
Company and with a number of other authorized reinsurers with at least an A.M.
Best rating of A- or an equivalent financial condition.

REINSURANCE ACCOUNTING AND REPORTING

We rely upon reinsurance agreements to limit our maximum net loss from large
single risks or risks in concentrated areas, and to increase our capacity to
write insurance. Reinsurance does not relieve the primary insurer from liability
to its policyholders. To the extent that a reinsurer may be unable to pay losses
for which it is liable under the terms of a reinsurance agreement, we are
exposed to the risk of continued liability for such losses. However, in an
effort to reduce the risk of non-payment, we require all of our reinsurers to
have an A.M. Best rating of A- or better or, with respect to foreign reinsurers,
to have a financial condition that, in the opinion of management, is equivalent
to a company with at least an A- rating.

STOCK-BASED COMPENSATION

We account for stock-based compensation plans under the provisions of Accounting
Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to
Employees," and related interpretations. During 2001, we adopted an Equity
Incentive Plan for key employees that made 1,500,000 shares of Class A common
stock available for issuance. The plan provides for the granting of awards by
the Board of Directors in the form of stock options, stock

                                    page 21

appreciation rights, restricted stock or any combination of the above. During
2001, we also adopted an Equity Incentive Plan for Directors that made 200,000
shares of Class A common stock available for issuance. Awards may be made in the
form of stock options, and the plan additionally provides for the issuance of
175 shares of restricted stock to each director on the first business day of
January in each year. No stock-based employee compensation is reflected in
income, except for expense associated with restricted stock issued, as all
options granted under those plans had an exercise price equal to, or greater
than, the market value of the underlying common stock on the date of the grant.
The following table illustrates the effect on net income and earnings per share
as if we had applied the provisions of Statement of Financial Accounting
Standards (SFAS) No. 123 (as amended by SFAS No. 148), "Accounting for
Stock-Based Compensation."

                                                  2003               2002               2001
                                             --------------     --------------     --------------
                                                                          
Net income, as reported                      $   18,293,976     $   12,002,722     $    5,818,131
Less:
    Total stock-based
    employee compensation
    expense determined
    under fair value
    based method for
    all awards, net of
    related tax effects                             (30,814)          (234,935)          (200,358)
                                             --------------     --------------     --------------
Pro-forma net income                         $   18,263,162     $   11,767,787     $    5,617,773
                                             ==============     ==============     ==============

Basic earnings per share:
    As reported                              $         1.91     $         1.32     $          .65
    Pro-forma                                          1.91               1.30                .63
Diluted earnings per share:
    As reported                              $         1.85     $         1.31     $          .64
    Pro-forma                                          1.85               1.28                .62

         The weighted-average grant date fair value of options granted for the
various plans during 2000 was $2.23.

         The fair values above were calculated based upon risk-free interest
rates of 5.75% for the Stock Purchase Plans and the Equity Incentive Plans,
expected lives of 6 months for the Stock Purchase Plans and 5 years for the
Equity Incentive Plans, expected volatility of 54% for 2000 and an expected
dividend yield of 4.5% for 2000.

EARNINGS PER SHARE

Basic earnings per share are calculated by dividing net income by the
weighted-average number of common shares outstanding for the period, while
diluted earnings per share reflects the dilution that could occur if securities
or other contracts to issue common stock were exercised or converted into common
stock.

2--TRANSACTIONS WITH AFFILIATES

We conduct business and have various agreements with the Mutual Company that are
described below:

a. REINSURANCE POOLING AND OTHER REINSURANCE ARRANGEMENTS

Atlantic States cedes to the Mutual Company all of its insurance business and
assumes from the Mutual Company 70% of the Mutual Company's total pooled
insurance business, including that assumed from Atlantic States and
substantially all of the business assumed by the Mutual Company from Southern
(prior to January 1, 2002). The Mutual Company and Atlantic States write
business with different risk profiles. Through the pooling arrangement, each is
able to share proportionately in the results of all policies written by the
other. Atlantic States ceded premiums earned of $55,846,128, $45,229,457 and
$37,345,259 and ceded losses and loss expenses incurred of $35,840,578,
$34,471,381 and $29,094,804 under this arrangement during 2003, 2002 and 2001,
respectively. It also assumed premiums earned of $153,068,026, $134,236,778 and
$126,769,521 and assumed losses and loss expenses incurred of $99,677,221,
$96,517,930 and $93,470,958 under this arrangement during 2003, 2002 and 2001,
respectively. Atlantic States had prepaid reinsurance premiums of $29,981,597,
$26,517,322 and $20,942,093 and a ceded liability for losses and loss expenses
of $52,263,271, $47,862,627 and $39,321,214 under this arrangement as of
December 31, 2003, 2002 and 2001, respectively. It also had assumed unearned
premiums of $77,782,685, $69,208,310 and $63,636,858 and an assumed liability
for losses and loss expenses of $121,297,553, $113,850,952 and $99,664,285 under
this arrangement at December 31, 2003, 2002 and 2001, respectively.

         Prior to January 1, 2002, the Mutual Company and Southern had a quota
share agreement whereby Southern ceded 50% of its direct business, less
reinsurance, to the Mutual Company. The business assumed by the Mutual Company
from Southern became part of the pooling arrangement between the Mutual Company
and Atlantic States. Southern ceded premiums earned of $0, $0 and $14,995,606
and ceded losses and loss expenses incurred of $(73,077), $488,055 and
$9,898,422 under this agreement during 2003, 2002 and 2001, respectively.
Southern had prepaid reinsurance premiums of $0, $0 and $7,310,471 and a ceded
liability for losses and loss expenses of $4,175,127, $6,399,727 and $10,068,604
under this agreement at December 31, 2003, 2002 and 2001, respectively. This
agreement was terminated as of January 1, 2002.

         Atlantic States and Southern each have a catastrophe reinsurance
agreement with the Mutual Company that limits the maximum liability under any
one catastrophic occurrence to $500,000 with a combined limit of $1,000,000 for
a catastrophe involving both of the companies. Prior to merging into Atlantic
States, Pioneer-Ohio, Delaware and Pioneer-New York each had a catastrophe
reinsurance agreement with the Mutual Company that limited the maximum liability
under any one catastrophic occurrence to $200,000, $300,000 and $400,000,
respectively. Prior to merging into Southern, Southern Heritage had a
catastrophe reinsurance agreement with the Mutual Company that limited the
maximum liability under any one catastrophic occurrence to $400,000. Prior to
merging into Atlantic States, Delaware and the Mutual Company had an excess of
loss reinsurance agreement in which the Mutual Company assumed up to $250,000 of
losses in excess of $50,000. Prior to merging into Atlantic States, Pioneer-Ohio
and the Mutual Company had an excess of loss reinsurance agreement in which the
Mutual Company assumed up to $250,000 ($200,000 in 2000) of

                                    page 22

losses in excess of $50,000. The Mutual Company and Southern have an excess of
loss reinsurance agreement in which the Mutual Company assumes up to $150,000
($175,000 in 2002 and $50,000 in 2001) of losses in excess of $150,000 ($125,000
in 2002 and $100,000 in 2001). Prior to merging into Atlantic States,
Pioneer-New York and the Mutual Company had an excess of loss reinsurance
agreement in which the Mutual Company assumed up to $250,000 ($200,000 in 2000)
of losses in excess of $50,000. Effective October 1, 2000 and prior to merging
into Southern, Southern Heritage and the Mutual Company had an excess of loss
reinsurance agreement in which the Mutual Company assumed up to $175,000 of
losses in excess of $125,000. The Mutual Company has agreements in place with
Southern (and Pioneer-Ohio and Delaware prior to merging into Atlantic States)
to reallocate the loss results of workers' compensation business written by
those companies as part of commercial accounts primarily written by the Mutual
Company or Atlantic States. These agreements provide for the workers'
compensation loss ratios of Southern to be no worse than the average workers'
compensation loss ratio for all of the companies combined. The Mutual Company
and Pioneer-New York also had an aggregate excess of loss reinsurance agreement
in which the Mutual Company agreed to assume the adverse loss development of
claims with dates of loss prior to December 31, 2000, as developed through
December 31, 2002, and to assume losses in excess of a 60% loss ratio through
December 31, 2002. The subsidiaries ceded premiums earned of $3,047,964,
$2,811,359 and $2,439,520 and ceded losses and loss expenses incurred of
$10,249,746, $6,873,539 and $4,194,251 under these various agreements during
2003, 2002 and 2001, respectively. The subsidiaries had a ceded liability for
losses and loss expenses of $7,218,397, $6,397,326 and $5,395,528 under these
various agreements at December 31, 2003, 2002, and 2001, respectively.

         Southern (and Delaware, Pioneer-Ohio, Southern Heritage and and
Pioneer-New York prior to mergers) has an agreement with the Mutual Company
under which it cedes, and then reassumes back, 100% of its business net of
reinsurance. The primary purpose of the agreement is to provide Southern with
the same A.M. Best rating (currently "A") as the Mutual Company, which this
subsidiary could not achieve without this contract in place. This agreement does
not transfer insurance risk. While these subsidiaries ceded and reassumed
amounts received from policyholders of $46,885,317, $48,921,377 and $41,142,936
and claims of $26,497,971, $28,859,644 and $23,348,952 under these agreements in
2003, 2002 and 2001, respectively, the amounts are not reflected in the
consolidated financial statements. The aggregate liabilities ceded and reassumed
under these agreements were $47,217,323 and $43,541,766 at December 31, 2003,
and 2002, respectively.

b. EXPENSE SHARING

The Mutual Company provides facilities, management and other services to us, and
we reimburse the Mutual Company for such services on a periodic basis under
usage agreements and pooling arrangements. The charges are based upon the
relative participation of us and the Mutual Company in the pooling arrangement,
and our management and the management of the Mutual Company consider this
allocation to be reasonable. Charges for these services totalled $33,047,769,
$28,586,888 and $29,298,569 for 2003, 2002 and 2001, respectively.

c. LEASE AGREEMENT

We lease office equipment and automobiles with terms ranging from 3 to 10 years
to the Mutual Company under a 10-year lease agreement dated January 1, 2000.

d. LEGAL SERVICES

Donald H. Nikolaus, President and one of our directors, is also a partner in the
law firm of Nikolaus & Hohenadel. Such firm has served as our general counsel
since 1986, principally in connection with the defense of claims litigation
arising in Lancaster, Dauphin and York counties. Such firm is paid its customary
fees for such services.

e. PROVINCE BANK

As of December 31, 2003, we had $5,661,089 in checking accounts with Province
Bank, a wholly owned subsidiary of DFSC. We earned $24,972 in interest on these
accounts during 2003.

3--INVESTMENTS

The amortized cost and estimated fair values of fixed maturities and equity
securities at December 31, 2003 and 2002, are as follows:

                                                                2003
                                    ------------------------------------------------------------
                                                        Gross          Gross         Estimated
                                     Amortized       Unrealized      Unrealized         Fair
    HELD TO MATURITY                   Cost             Gains          Losses           Value
    ----------------                ------------    ------------    ------------    ------------
                                                                        
U.S. Treasury securities
       and obligations of
       U.S. government
       corporations
       and agencies                 $ 29,130,684    $     66,050    $    368,967    $ 28,827,767

Canadian government
       obligation                        499,630          25,370              --         525,000

Obligations of states
       and political
       subdivisions                   45,187,284       1,117,513          60,847      46,243,950

Corporate securities                  25,192,044       2,086,465               9      27,278,500

Mortgage-backed
       securities                     13,041,142         287,732          71,089      13,257,785
                                    ------------    ------------    ------------    ------------
    Totals                          $113,050,784    $  3,583,130    $    500,912    $116,133,002
                                    ============    ============    ============    ============

                                                                2003
                                    ------------------------------------------------------------
                                                        Gross          Gross         Estimated
                                     Amortized       Unrealized      Unrealized         Fair
   AVAILABLE FOR SALE                  Cost             Gains          Losses           Value
   ------------------               ------------    ------------    ------------    ------------
                                                                        
U.S. Treasury securities
       and obligations of
       U.S. government
       corporations
       and agencies                 $ 69,481,186    $  1,094,878    $     68,714    $ 70,507,350

Obligations of states
       and political
       subdivisions                   81,104,794       3,281,260             604      84,385,450

Corporate securities                  28,766,844       1,932,256              --      30,699,100

Mortgage-backed
       securities                     12,744,548          99,886           2,997      12,841,437

Equity securities                     29,644,333       1,897,441          93,553      31,448,221
                                    ------------    ------------    ------------    ------------
    Totals                          $221,741,705    $  8,305,721    $    165,868    $229,881,558
                                    ============    ============    ============    ============

                                    page 23

                                                2002
- ------------------------------------------------------------------------------------------------
                                                        Gross          Gross         Estimated
                                     Amortized       Unrealized      Unrealized         Fair
   HELD TO MATURITY                    Cost             Gains          Losses           Value
   ----------------                 ------------    ------------    ------------    ------------
                                                                        
U.S. Treasury securities
       and obligations of
       U.S. government
       corporations
       and agencies                 $ 12,641,126    $    407,958      $       --    $ 13,049,084

Canadian government
       obligation                        499,250          40,750              --         540,000

Obligations of states
       and political
       subdivisions                   33,891,385         574,768          66,463      34,399,690

Corporate securities                  29,551,491       1,745,990          12,103      31,285,378

Mortgage-backed
       securities                     10,118,304         393,857             995      10,511,166
                                    ------------    ------------    ------------    ------------
    Totals                          $ 86,701,556    $  3,163,323    $     79,561    $ 89,785,318
                                    ============    ============    ============    ============

                                                2002
- ------------------------------------------------------------------------------------------------
                                                        Gross          Gross         Estimated
                                     Amortized       Unrealized      Unrealized         Fair
   AVAILABLE FOR SALE                  Cost             Gains          Losses           Value
   ------------------               ------------    ------------    ------------    ------------
                                                                        
U.S. Treasury securities
       and obligations of
       U.S. government
       corporations
       and agencies                 $ 56,344,340    $  1,943,229    $        337    $ 58,287,232

Obligations of states
       and political
       subdivisions                   78,515,340       3,083,256         152,996      81,445,600

Corporate securities                  34,848,807       2,016,526           2,783      36,862,550

Mortgage-backed
       securities                     17,787,462         363,649          14,833      18,136,278

Equity securities                     21,587,317       1,007,030         757,887      21,836,460
                                    ------------    ------------    ------------    ------------
    Totals                          $209,083,266    $  8,413,690    $    928,836    $216,568,120
                                    ============    ============    ============    ============

         The amortized cost and estimated fair value of fixed maturities at
December 31, 2003, by contractual maturity, are shown below. Expected maturities
will differ from contractual maturities because borrowers may have the right to
call or prepay obligations with or without call or prepayment penalties.

                                                                     Estimated
                                                   Amortized           Fair
                                                     Cost              Value
                                                 --------------    --------------
                                                             
HELD TO MATURITY
Due in one year or less                          $    3,951,952    $    4,048,500
Due after one year through five years                33,077,638        34,294,650
Due after five years through ten years               22,362,319        23,141,267
Due after ten years                                  40,617,733        41,390,800
Mortgage-backed securities                           13,041,142        13,257,785
                                                 --------------    --------------
    Total held to maturity                       $  113,050,784    $  116,133,002
                                                 ==============    ==============
AVAILABLE FOR SALE
Due in one year or less                          $    9,896,463    $   10,100,250
Due after one year through five years                75,387,586        78,092,950
Due after five years through ten years               48,518,923        50,694,900
Due after ten years                                  45,549,852        46,703,800
Mortgage-backed securities                           12,744,548        12,841,437
                                                 --------------    --------------
    Total available for sale                     $  192,097,372    $  198,433,337
                                                 ==============    ==============

         The amortized cost of fixed maturities on deposit with various
regulatory authorities at December 31, 2003 and 2002, amounted to $5,095,211 and
$5,400,597, respectively.

         Net investment income, consisting primarily of interest and dividends,
is attributable to the following sources:

                                                  2003               2002               2001
                                             --------------     --------------     --------------
                                                                          
Fixed maturities                             $   13,255,492     $   14,285,049     $   15,145,949
Equity securities                                   834,578            804,087            546,243
Short-term investments                              523,527            564,738            920,538
Other                                                29,250             29,249            255,250
                                             --------------     --------------     --------------
Investment income                                14,642,847         15,683,123         16,867,980
Investment expenses                               1,326,911          1,101,871            982,436
                                             --------------     --------------     --------------
Net investment income                        $   13,315,936     $   14,581,252     $   15,885,544
                                             ==============     ==============     ==============

         Gross realized gains and losses from investments and the change in the
difference between fair value and cost of investments, before applicable income
taxes, are as follows:

                                                  2003               2002               2001
                                             --------------     --------------     --------------
                                                                          
Gross realized gains:
    Fixed maturities                         $    1,002,461     $      128,714     $      554,560
    Equity securities                               637,856            911,994            323,451
                                             --------------     --------------     --------------
                                                  1,640,317          1,040,708            878,011
                                             --------------     --------------     --------------
Gross realized losses:
    Fixed maturities                                 33,759            106,789             28,618
    Equity securities                               238,527            789,729          1,729,647
                                             --------------     --------------     --------------
                                                    272,286            896,518          1,758,265
                                             --------------     --------------     --------------
Net realized gains (losses)                  $    1,368,031     $      144,190     $     (880,254)
                                             ==============     ==============     ==============
Change in difference between
    fair value and cost of
    investments:
    Fixed maturities                         $     (901,290)    $    5,253,785     $    3,498,259
    Equity securities                             1,554,745           (637,585)         1,275,050
                                             --------------     --------------     --------------
                                             $      653,455     $    4,616,200     $    4,773,309
                                             ==============     ==============     ==============

         Income taxes (benefit) on realized investment gains (losses) were
$478,811, $49,565, and $(299,286) for 2003, 2002 and 2001, respectively.
Deferred income taxes applicable to net unrealized investment gains included in
shareholders' equity were $2,848,930 and $2,572,901 at December 31, 2003 and
2002, respectively.

         We held available for sale fixed maturities and equity securities with
unrealized losses representing declines that we considered temporary at December
31, 2003 as follows:

                                        Less than 12 months             12 months or longer
                                    ----------------------------    ----------------------------
                                       Fair          Unrealized        Fair          Unrealized
                                       Value           Losses          Value           Losses
                                    ------------    ------------    ------------    ------------
                                                                        
U.S. Treasury securities
    and obligations of
    U.S. government
    corporations and
    agencies                        $  5,020,000    $     68,714    $         --    $         --
Obligations of states and
    political subdivisions               525,000             604              --              --
Mortgage-backed
    securities                         2,226,680           2,997              --              --
Equity securities                      1,275,737          54,198         898,130          39,355
                                    ------------    ------------    ------------    ------------
    Totals                          $  9,047,417    $    126,513    $    898,130    $     39,355
                                    ============    ============    ============    ============

                                     page 24

         During 2003, 2002 and 2001, certain investments trading below cost had
declined on an other-than-temporary basis. Losses of $237,724, $378,672 and
$1,462,913 were included in net realized investment gains (losses) for these
investments in 2003, 2002 and 2001, respectively.

         During 2003, we sold certain bonds that had been classified as held to
maturity due to a series of rating agency downgrades related to these
securities. These bonds had an amortized cost of $1.8 million, and the sale
resulted in a realized gain of $165,564. During 2002, we sold certain bonds that
had been classified as held to maturity due to significant deterioration in the
issuer's credit worthiness. These bonds had an amortized cost of $488,901, and
the sale resulted in a realized loss of $73,901. There were no other sales or
transfers from the held to maturity portfolio in 2003 or 2002. On January 1,
2001, we transferred investments with an amortized cost of $51,640,154 and fair
value of $52,444,675 from the held to maturity classification to the available
for sale classification under the provisions of SFAS No. 133 and 138. The
unrealized holding gain of $804,521 at January 1, 2001 was reported in other
comprehensive income. The transfer had no impact on net income.

         We have no derivative instruments or hedging activities.

4--DEFERRED POLICY ACQUISITION COSTS

Changes in deferred policy acquisition costs are as follows:

                                                  2003               2002               2001
                                             --------------     --------------     --------------
                                                                          
Balance, January 1                           $   14,567,070     $   13,604,215     $   12,284,214
Acquisition costs deferred                       32,495,695         30,435,855         28,514,001
Amortization charged
    to earnings                                  30,839,000         29,473,000         27,194,000
                                             --------------     --------------     --------------
Balance, December 31                         $   16,223,765     $   14,567,070     $   13,604,215
                                             ==============     ==============     ==============

5--PROPERTY AND EQUIPMENT

Property and equipment at December 31, 2003 and 2002, consisted of the
following:

                                                                                     Estimated
                                                                                       Useful
                                                  2003               2002               Life
                                             --------------     --------------     --------------
                                                                          
Cost--office equipment                       $    5,293,302     $    5,441,882      5-15 years
       automobiles                                  903,162            785,572        3 years
       real estate                                2,676,636          3,105,851      15-50 years
       software                                     325,323            561,146        5 years
                                             --------------     --------------
                                                  9,198,423          9,894,451
Accumulated depreciation                         (5,046,752)        (5,464,057)
                                             --------------     --------------
                                             $    4,151,671     $    4,430,394
                                             ==============     ==============

         Depreciation expense for 2003, 2002, and 2001 amounted to $650,200,
$690,263 and $829,100, respectively.

6--LIABILITY FOR LOSSES AND LOSS EXPENSES

Activity in the liability for losses and loss expenses is summarized as follows:

                                                  2003               2002               2001
                                             --------------     --------------     --------------
                                                                          
Balance at January 1                         $  210,691,752     $  179,839,905     $  156,476,124
    Less reinsurance
       recoverable                               79,583,319         65,295,790         53,766,710
                                             --------------     --------------     --------------
Net balance at January 1                        131,108,433        114,544,115        102,709,414
                                             --------------     --------------     --------------
Incurred related to:
    Current year                                126,693,421        122,433,653        110,142,467
    Prior years                                    (450,110)         6,834,033          8,035,082
                                             --------------     --------------     --------------
Total incurred                                  126,243,311        129,267,686        118,177,549
                                             --------------     --------------     --------------
Paid related to:
    Current year                                 72,187,103         67,655,902         63,289,736
    Prior years                                  46,268,571         45,047,466         43,053,112
                                             --------------     --------------     --------------
Total paid                                      118,455,674        112,703,368        106,342,848
                                             --------------     --------------     --------------
Net balance at
       December 31                              138,896,070        131,108,433        114,544,115
    Plus reinsurance
       recoverable                               79,017,987         79,583,319         65,295,790
                                             --------------     --------------     --------------
Balance at December 31                       $  217,914,057     $  210,691,752     $  179,839,905
                                             ==============     ==============     ==============

         We recognized an increase (decrease) in the liability for losses and
loss expenses of prior years of $(450,110), $6.8 million and $8.0 million in
2003, 2002 and 2001, respectively. These developments are primarily attributable
to variations from expected claim severity in the private passenger and
commercial automobile liability, workers' compensation and commercial multiple
peril lines of business.

7--BORROWINGS

LINE OF CREDIT

On November 25, 2003, we entered into a credit agreement with Manufacturers and
Traders Trust Company ("M&T") relating to a four-year $35.0 million unsecured,
revolving line of credit. As of December 31, 2003, we may borrow up to $35.0
million at interest rates equal to the bank's current prime rate or the then
current London interbank Eurodollar bank rate plus between 1.50% and 1.75%,
depending on our leverage ratio. In addition, we pay a fee of 0.15% per annum on
the loan commitment amount, regardless of usage. The agreement requires our
compliance with certain covenants, which include minimum levels of our net
worth, leverage ratio and statutory surplus and A.M. Best ratings of our
subsidiaries. As of December 31, 2003, there were no borrowings outstanding, and
we complied with all requirements of the agreement.

         At December 31, 2002, pursuant to a credit agreement dated December 29,
1995, and amended as of July 27, 1998, with Fleet National Bank, we had
unsecured borrowings of $19.8 million. Such borrowings were made in connection
with various acquisitions and capital contributions to our subsidiaries. The
borrowings under this line of credit were repaid during 2003, and this credit
agreement was terminated on December 2, 2003.

                                     page 25

SUBORDINATED DEBENTURES

         On May 15, 2003, we received $15.0 million in net proceeds from the
issuance of subordinated debentures. The debentures mature on May 15, 2033 and
are callable at our option, at par, after five years. The debentures carry an
interest rate equal to the three-month LIBOR rate plus 4.10%, which is
adjustable quarterly. At December 31, 2003, the interest rate on these
debentures was 5.28%, next subject to adjustment on February 15, 2004. As of
December 31, 2003, we have an equity interest of $464,000 in a trust and
subordinated debentures of $15.5 million related to this transaction.

         On October 29, 2003, we received $10.0 million in net proceeds from the
issuance of subordinated debentures. The debentures mature on October 29, 2033
and are callable at our option, at par, after five years. The debentures carry
an interest rate equal to the three-month LIBOR rate plus 3.85%, which is
adjustable quarterly. At December 31, 2003, the interest rate on these
debentures was 5.01%, next subject to adjustment on January 29, 2004. As of
December 31, 2003, we have an equity interest of $310,000 in a trust and
subordinated debentures of $10.3 million related to this transaction.

8--REINSURERS

UNAFFILIATED REINSURERS

In addition to the reinsurance in place with the Mutual Company, our
subsidiaries have other reinsurance in place, principally with four unaffiliated
reinsurers. We monitor the financial strength of our unaffiliated reinsurers,
requiring that companies rated by A.M. Best Company maintain a rating of A- or
higher and that foreign reinsurers not rated by A.M. Best Company maintain a
level of financial strength equivalent to companies qualifying for an A.M. Best
Company rating of A- or higher. The following amounts represent ceded
reinsurance transactions with unaffiliated reinsurers during 2003, 2002 and
2001:

                                                2003            2002            2001
                                            ------------    ------------    ------------
                                                                   
Premiums written                            $ 10,908,851    $ 10,772,473    $  9,348,853
                                            ============    ============    ============
Premiums earned                             $ 11,535,468    $ 10,776,702    $  9,440,035
                                            ============    ============    ============
Losses and loss expenses                    $ 10,646,851    $ 13,693,184    $  6,907,947
                                            ============    ============    ============
Prepaid reinsurance premiums                $    710,057    $  1,336,674    $  1,340,903
                                            ============    ============    ============
Liability for losses and
    loss expenses                           $ 15,361,192    $ 18,923,639    $ 10,510,444
                                            ============    ============    ============

TOTAL REINSURANCE

The following amounts represent the total of all ceded reinsurance transactions
with both affiliated and unaffiliated reinsurers during 2003, 2002 and 2001:

                                                2003            2002            2001
                                            ------------    ------------    ------------
                                                                   
Premiums earned                             $ 70,429,560    $ 58,817,518    $ 64,220,420
                                            ============    ============    ============
Losses and loss expenses                    $ 56,664,098    $ 55,526,159    $ 50,095,424
                                            ============    ============    ============
Prepaid reinsurance premiums                $ 30,691,654    $ 27,853,996    $ 29,593,467
                                            ============    ============    ============
Liability for losses and
    loss expenses                           $ 79,017,987    $ 79,583,319    $ 65,295,790
                                            ============    ============    ============

         The following amounts represent the effect of reinsurance on premiums
written for 2003, 2002 and 2001:

                                                2003            2002            2001
                                            ------------    ------------    ------------
                                                                   
Direct                                      $118,605,732    $111,767,756    $110,298,533
Assumed                                      161,642,112     139,814,138     135,830,624
Ceded                                         73,267,218      57,078,047      69,101,503
                                            ------------    ------------    ------------
Net premiums written                        $206,980,626    $194,503,847    $177,027,654
                                            ============    ============    ============

         The following amounts represent the effect of reinsurance on premiums
earned for 2003, 2002 and 2001:

                                                2003            2002            2001
                                            ------------    ------------    ------------
                                                                   
Direct                                      $114,154,202    $110,412,498    $105,214,059
Assumed                                      153,068,054     134,246,213     126,776,215
Ceded                                         70,429,560      58,817,518      64,220,420
                                            ------------    ------------    ------------
Net premiums earned                         $196,792,696    $185,841,193    $167,769,854
                                            ============    ============    ============

9--INCOME TAXES

The provision for income tax consists of the following:

                                                2003            2002            2001
                                            ------------    ------------    ------------
                                                                   
Current                                     $  7,495,130    $  5,071,516    $  2,634,231
Deferred                                        (352,731)       (579,654)     (1,360,633)
                                            ------------    ------------    ------------
Federal tax provision                       $  7,142,399    $  4,491,862    $  1,273,598
                                            ============    ============    ============

         The effective tax rate is different from the amount computed at the
statutory federal rate of 35% for 2003 and 34% for 2002 and 2001. The reasons
for such difference and the related tax effects are as follows:

                                                2003            2002            2001
                                            ------------    ------------    ------------
                                                                   
Income before
    income taxes                            $ 25,436,375    $ 16,494,584    $  7,091,729
                                            ============    ============    ============
Computed "expected"
    taxes                                      8,902,731       5,608,159       2,411,188
Tax-exempt interest                           (1,824,830)     (1,304,197)     (1,399,238)
Dividends received deduction                     (49,147)        (31,830)        (21,908)
Other, net                                       113,645         219,730         283,556
                                            ------------    ------------    ------------
Federal income
    tax provision                           $  7,142,399    $  4,491,862    $  1,273,598
                                            ============    ============    ============

      The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at December 31,
2003 and 2002, are as follows:

                                                   2003             2002
                                               ------------     ------------
                                                          
Deferred tax assets:
    Unearned premium                           $  7,246,680     $  6,438,461
    Loss reserves                                 5,943,747        5,786,195
    Net operating loss carryforward -
       Southern Heritage                          1,459,722        1,744,081
    Other                                         1,449,747        1,133,488
                                               ------------     ------------
       Total                                   $ 16,099,896     $ 15,102,225
                                               ============     ============
Deferred tax liabilities:
    Depreciation expense                       $    331,291     $    343,362
    Deferred policy acquisition costs             5,678,318        5,007,431
    Salvage recoverable                             208,948          222,824
    Unrealized gain                               2,848,930        2,572,901
                                               ------------     ------------
       Total                                   $  9,067,487     $  8,146,518
                                               ============     ============
       Net deferred tax assets                 $  7,032,409     $  6,955,707
                                               ============     ============

                                     page 26

         A valuation allowance is provided when it is more likely than not that
some portion of the tax asset will not be realized. Management has determined
that it is not required to establish a valuation allowance for any deferred tax
asset at December 31, 2003, since it is more likely than not that the deferred
tax assets will be realized through reversals of existing temporary differences,
future taxable income, carryback to taxable income in prior years and the
implementation of tax planning strategies.

         At December 31, 2003, we have a net operating loss carryforward of
$4,170,635, which is available to offset our taxable income. Such net operating
loss carryforward will expire beginning in 2009. Federal income tax laws limit
the amount of net operating loss carryforward that we can use in any one year to
approximately $1 million.

10--STOCKHOLDERS' EQUITY

On April 19, 2001 our stockholders approved an amendment to our Certificate of
Incorporation. Among other things, the amendment reclassified our common stock
as Class B common stock and effected a one-for-three reverse split of our Class
B common stock effective April 19, 2001. The amendment also authorized a new
class of common stock with one-tenth of a vote per share designated as Class A
common stock. Our Board also approved a dividend of two shares of Class A common
stock for each share of Class B common stock, after the one-for-three reverse
split, held of record at the close of business April 19, 2001. The effect of the
reverse split and the stock dividend taken together is that we had the same
total number of shares outstanding after the reverse split and the stock
dividend as we did before the reverse split and the stock dividend. Therefore,
there is no change in the historical earnings per share of the Class A common
stock and the Class B common stock after the reverse split and the stock
dividend compared to before the reverse split and the stock dividend.

         Each share of Class A common stock outstanding at the time of the
declaration of any dividend or other distribution payable in cash upon the
shares of Class B common stock is entitled to a dividend or distribution payable
at the same time and to stockholders of record on the same date in an amount at
least 10% greater than any dividend declared upon each share of Class B common
stock. In the event of our merger or consolidation with or into another entity,
the holders of Class A common stock and the holders of Class B common stock are
entitled to receive the same per share consideration in such merger or
consolidation. In the event of our liquidation, dissolution or winding-up, any
assets available to common stockholders will be distributed pro-rata to the
holders of Class A common stock and Class B common stock.

11--STOCK COMPENSATION PLANS

EQUITY INCENTIVE PLANS

During 1996, we adopted an Equity Incentive Plan for key employees. During 2001,
we adopted a nearly identical plan that made a total of 1,500,000 shares of
Class A common stock available for issuance. Each plan provides for the granting
of awards by the Board of Directors in the form of stock options, stock
appreciation rights, restricted stock or any combination of the above. The plans
provide that stock options may become exercisable up to 10 years from date of
grant, with an option price not less than fair market value on date of grant.
The stock appreciation rights permit surrender of the option and receipt of the
excess of current market price over option price in cash. No stock appreciation
rights have been issued.

         During 1996, we adopted an Equity Incentive Plan For Directors. During
2001, we adopted a nearly identical plan that made 200,000 shares of Class A
common stock available for issuance. Awards may be made in the form of stock
options, and the plan additionally provides for the issuance of 175 shares of
restricted stock to each director on the first business day of January in each
year. As of December 31, 2003, we have 40,000 unexercised options under these
plans. Additionally 1,925, 2,100 and 1,947 shares of restricted stock were
issued on January 2, 2003, 2002 and 2001, respectively.

         All options issued prior to 2001 were converted to options on Class A
and Class B common stock as a result of our recapitalization. No further shares
are available for plans in effect prior to 2001.

         Information regarding activity in our stock option plans is presented
below:

                                                                Weighted-Average
                                                  Number of      Exercise Price
                                                   Options         Per Share
                                                  ---------     ----------------
                                                          
Outstanding at December 31, 2000                  1,516,338     $          13.19
    Granted - 2001                                  459,000                13.93
    Exercised - 2001                                 13,315                 8.00
    Forfeited - 2001                                 27,556                13.50
                                                  ---------     ----------------
Outstanding at December 31, 2001                  1,934,467     $          13.27
    Granted - 2002                                   10,000                14.00
    Exercised - 2002                                  7,684                 8.00
    Forfeited - 2002                                 18,334                14.36
    Expired - 2002                                  524,448                13.50
                                                  ---------     ----------------
Outstanding at December 31, 2002                  1,394,001     $          13.43
    Granted - 2003                                  667,500                12.00
    Exercised - 2003                                 91,482                 8.15
    Forfeited - 2003                                 14,000                10.57
    Expired - 2003                                  476,667                18.00
                                                  ---------     ----------------
Outstanding at December 31, 2003                  1,479,352     $          11.72
                                                  =========     ================
Exercisable at:
    December 31, 2001                             1,321,905     $          13.89
                                                  =========     ================
    December 31, 2002                             1,085,000     $          13.29
                                                  =========     ================
    December 31, 2003                               883,707     $          11.11
                                                  =========     ================

         Options available for future grants at December 31, 2003 are 577,975.

         The following table summarizes information about fixed stock options at
December 31, 2003:

             Number of    Weighted-Average     Number of
Exercise      Options         Remaining         Options
 Price      Outstanding   Contractual Life    Exercisable
 -----      -----------   ----------------    -----------
                                     
$   8.00       353,585         1.0 year         353,585
    9.00         4,500        2.5 years           4,500
   12.00       650,668        4.5 years         216,889
   14.00       455,599        2.5 years         303,733
   18.00         5,000        1.5 years           5,000
   18.25         5,000        4.5 years              --
   21.00         5,000        5.0 years              --
             ---------                          -------
   Total     1,479,352                          883,707
             =========                          =======

                                     page 27

EMPLOYEE STOCK PURCHASE PLANS

During 1996, we adopted an Employee Stock Purchase Plan. During 2001, we adopted
a nearly identical plan that made 300,000 shares of Class A common stock
available for issuance.

         The new plan extends over a 10-year period and provides for shares to
be offered to all eligible employees at a purchase price equal to the lesser of
85% of the fair market value of our common stock on the last day before the
first day of the enrollment period (June 1 and December 1) of the plan or 85% of
the fair market value of our common stock on the last day of the subscription
period (June 30 and December 31). A summary of plan activity follows:

                                                 Shares Issued
                                              -------------------
                                                Price      Shares
                                              ---------    ------
                                                     
January 1, 2001                               $  5.9500    16,438
July 1, 2001                                     8.7125    11,377
January 1, 2002                                  8.8485    12,769
July 1, 2002                                     8.7720    10,520
January 1, 2003                                  9.1375     9,425
July 1, 2003                                    10.1575     8,776

         On January 1, 2004, we issued an additional 7,637 shares at a price of
$11.4495 per share under this plan.

AGENCY STOCK PURCHASE PLANS

On December 31, 1996, we adopted an Agency Stock Purchase Plan. During 2001, we
adopted a nearly identical plan that made 300,000 shares of Class A common stock
available for issuance. The plan provides for agents of our affiliated companies
to invest up to $12,000 per subscription period (April 1 to September 30 and
October 1 to March 31) under various methods. Stock is issued at the end of the
subscription period at a price equal to 90% of the average market price during
the last ten trading days of the subscription period. During 2003, 2002 and
2001, 28,547, 16,310, and 16,557 shares, respectively, were issued under this
plan. Expense recognized under the plan was not material.

12--STATUTORY NET INCOME, CAPITAL AND SURPLUS AND DIVIDEND RESTRICTIONS

The following is selected information, as filed with insurance regulatory
authorities, for our subsidiaries as determined in accordance with accounting
practices prescribed or permitted by such insurance regulatory authorities:

                                     2003           2002           2001
                                 ------------   ------------   ------------
                                                      
ATLANTIC STATES
Statutory capital
    and surplus                  $109,854,398   $ 95,405,603   $ 91,649,362
                                 ============   ============   ============
Statutory unassigned
    surplus                      $ 56,193,534   $ 46,744,739   $ 42,988,498
                                 ============   ============   ============
Statutory net income (loss)      $ 13,272,651   $ 10,646,804   $   (676,125)
                                 ============   ============   ============

SOUTHERN
Statutory capital
    and surplus                  $ 40,649,495   $ 31,243,897   $ 30,730,757
                                 ============   ============   ============
Statutory unassigned
    surplus                      $ (1,968,090)  $ (6,373,688)  $ (6,886,828)
                                 ============   ============   ============
Statutory net income             $  5,275,909   $  2,505,891   $  5,180,964
                                 ============   ============   ============

         Our principal source of cash for payment of dividends are dividends
from our subsidiaries which are required by law to maintain certain minimum
capital and surplus on a statutory basis and are subject to regulations under
which payment of dividends from statutory surplus is restricted and may require
prior approval of their domiciliary insurance regulatory authorities. Atlantic
States and Southern are also subject to Risk Based Capital (RBC) requirements
that may further impact their ability to pay dividends. At December 31, 2003,
the companies' statutory capital and surplus were substantially above the RBC
requirements. Amounts available for distribution as dividends to us without
prior approval of insurance regulatory authorities in 2004 are $13,272,651 from
Atlantic States and $4,064,950 from Southern.

         The National Association of Insurance Commissioners (NAIC) adopted the
Codification of Statutory Accounting Principles with an effective date of
January 1, 2001. The codified principles are intended to provide a basis of
accounting recognized and adhered to in the absence of conflict with, or silence
of, state statutes and regulations. The impact of the codified principles on the
statutory capital and surplus of our subsidiaries as of January 1, 2001 was as
follows: Atlantic States - $6,482,380 increase and Southern - $2,254,558
increase.

13--RECONCILIATION OF STATUTORY FILINGS TO AMOUNTS REPORTED HEREIN

Our subsidiaries are required to file statutory financial statements with state
insurance regulatory authorities. Accounting principles used to prepare these
statutory financial statements differ from financial statements prepared on the
basis of generally accepted accounting principles.

         Reconciliations of statutory net income and capital and surplus, as
determined using statutory accounting principles, to the amounts included in the
accompanying financial statements are as follows:

                                              Year Ended December 31,
                                   --------------------------------------------
                                       2003            2002            2001
                                   ------------    ------------    ------------
                                                          
Statutory net income of
    insurance subsidiaries         $ 18,548,560    $ 13,152,695    $  4,504,839
Increases (decreases):
    Deferred policy
       acquisition costs              1,656,695         962,855       1,320,001
    Deferred federal
       income taxes                     352,731         579,654       1,360,633
    Salvage and subrogation
       recoverable                     (167,627)       (863,313)        155,088
    Consolidating eliminations
       and adjustments               (8,099,197)    (11,264,732)    (13,783,695)
    Parent-only net income            6,002,814       9,435,563      12,261,265
                                   ------------    ------------    ------------
Net income as
    reported herein                $ 18,293,976    $ 12,002,722    $  5,818,131
                                   ============    ============    ============

                                     page 28

                                                      December 31,
                                    -----------------------------------------------
                                         2003            2002             2001
                                    -------------    -------------    -------------
                                                             
Statutory capital and surplus
    of insurance subsidiaries       $ 150,503,893    $ 126,649,500    $ 122,380,119
Increases (decreases):
    Deferred policy
           acquisition costs           16,223,765       14,567,070       13,604,215
    Deferred federal
           income taxes                (4,268,453)      (3,499,656)        (820,313)
    Salvage and subrogation
           recoverable                  7,167,008        7,334,635        8,197,948
    Non-admitted assets and
           other adjustments, net         907,955          735,946          334,092
    Fixed maturities                    6,521,246        7,517,290        3,793,048
    Consolidating eliminations
           and adjustments            (51,984,856)     (40,891,418)     (39,693,089)
    Parent-only equity                 83,578,674       20,769,483       13,132,329
                                    -------------    -------------    -------------
Stockholders' equity as
    reported herein                 $ 208,649,232    $ 133,182,850    $ 120,928,349
                                    =============    =============    =============

14--SUPPLEMENTARY CASH FLOW INFORMATION

The following reflects income taxes and interest paid during 2003, 2002 and
2001:

                                         2003            2002             2001
                                    -------------    -------------    -------------
                                                             
Income taxes                        $   7,356,674    $   4,410,000    $   2,666,887
                                    =============    =============    =============
Interest                            $   1,291,992    $   1,047,237    $   3,049,844
                                    =============    =============    =============

15--EARNINGS PER SHARE

The following information illustrates the computation of net income, outstanding
shares and earnings per share on both a basic and diluted basis for the years
ended December 31, 2003, 2002 and 2001:

                                         Weighted-
                                          Average    Earnings
                               Net         Shares      Per
                             Income     Outstanding   Share
                             ------     -----------   -----
                                            
2003:
Basic                     $18,293,976    9,570,872    $1.91
Effect of stock options            --      323,972     (.06)
                          -----------    ---------    -----
Diluted                   $18,293,976    9,894,844    $1.85
                          ===========    =========    =====
2002:
Basic                     $12,002,722    9,085,914    $1.32
Effect of stock options            --      107,199     (.01)
                          -----------    ---------    -----
Diluted                   $12,002,722    9,193,113    $1.31
                          ===========    =========    =====
2001:
Basic                     $ 5,818,131    8,941,781    $ .65
Effect of stock options            --      136,669     (.01)
                          -----------    ---------    -----
Diluted                   $ 5,818,131    9,078,450    $ .64
                          ===========    =========    =====

         The following options to purchase shares of common stock were not
included in the computation of diluted earnings per share because the exercise
price of the options was greater than the average market price:

                                 2003       2002       2001
                                 ----       ----       ----
                                           
Options excluded from
 diluted earnings per share        --      939,167  1,467,782
                                   ==      =======  =========

16--CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY

                            CONDENSED BALANCE SHEETS
                                ($ in thousands)

                    December 31,                                 2003       2002
- -------------------------------------------------------       ---------   ---------
                                                                    
ASSETS
Fixed-maturity investments                                    $   1,987   $      --
Investment in subsidiaries (equity method)                      183,402     156,684
Short-term investments                                           47,559          --
Cash                                                                365         604
Property and equipment                                            1,579       1,640
Other                                                             1,345          99
                                                              ---------   ---------
           Total assets                                       $ 236,237   $ 159,027
                                                              =========   =========

LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
    Cash dividends declared to stockholders                   $   1,379   $     887
    Line of credit                                                   --      19,800
    Subordinated debentures                                      25,774          --
    Due to affiliate                                                 --       4,441
    Other                                                           435         716
                                                              ---------   ---------
           Total liabilities                                     27,588      25,844
                                                              ---------   ---------
Stockholders' equity                                            208,649     133,183
                                                              ---------   ---------
           Total liabilities and stockholders' equity         $ 236,237   $ 159,027
                                                              =========   =========

             CONDENSED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
                                ($ in thousands)

      Year Ended December 31,           2003        2002        2001
- ------------------------------------  --------    --------    --------
                                                     
STATEMENTS OF INCOME
Revenues
Dividends from subsidiaries           $  7,000    $ 10,400    $ 14,419
Other                                    1,034         797         824
                                      --------    --------    --------
           Total revenues                8,034      11,197      15,243
                                      --------    --------    --------
Expenses
Operating expenses                       1,345       1,057       1,761
Interest                                 1,320       1,139       2,288
                                      --------    --------    --------
           Total expenses                2,665       2,196       4,049
                                      --------    --------    --------
Income before income tax benefit
    and equity in undistributed net
    income (loss) of subsidiaries        5,369       9,001      11,194
Income tax benefit                        (634)       (435)     (1,067)
                                      --------    --------    --------
Income before equity in
    undistributed net income (loss)
    of subsidiaries                      6,003       9,436      12,261
Equity in undistributed
    net income (loss)
    of subsidiaries                     12,291       2,567      (6,443)
                                      --------    --------    --------
Net income                            $ 18,294    $ 12,003    $  5,818
                                      ========    ========    ========

STATEMENTS OF COMPREHENSIVE INCOME
Net income                            $ 18,294    $ 12,003    $  5,818
                                      --------    --------    --------
Other comprehensive income,
net of tax
    Unrealized gain (loss) - parent        (42)         15          26
    Unrealized gain - subsidiaries         421       2,035       3,035
                                      --------    --------    --------
Other comprehensive income                 379       2,050       3,061
                                      --------    --------    --------
Comprehensive income                  $ 18,673    $ 14,053    $  8,879
                                      ========    ========    ========

                                     page 29

                       CONDENSED STATEMENTS OF CASH FLOWS
                                ($ in thousands)

      Year Ended December 31,             2003        2002        2001
- -------------------------------------   --------    --------    --------
                                                       
Cash flows from operating activities:
    Net income                          $ 18,294    $ 12,003    $  5,818
                                        --------    --------    --------
    Adjustments:
       Equity in undistributed
       net loss (income)
       of subsidiaries                   (12,291)     (2,567)      6,443
       Other                              (4,316)        788         252
                                        --------    --------    --------
              Net adjustments            (16,607)     (1,779)      6,695
                                        --------    --------    --------
       Net cash provided                   1,687      10,224      12,513
                                        --------    --------    --------
Cash flows from investing activities:
    Net purchase of fixed maturities      (1,938)         --          --
    Net purchase of short-term
       investments                       (47,559)         --          --
    Net purchase of property and
       equipment                            (433)       (480)       (122)
    Investment in subsidiaries           (14,274)         --          --
    Other                                   (981)         38          38
                                        --------    --------    --------
       Net cash used                     (65,185)       (442)        (84)
                                        --------    --------    --------
Cash flows from financing activities:
    Cash dividends paid                   (3,868)     (3,509)     (3,394)
    Issuance of common stock              61,153       1,728       1,387
    Issuance of subordinated
       debentures                         25,774          --          --
    Line of credit, net                  (19,800)     (7,800)    (12,400)
                                        --------    --------    --------
       Net cash provided (used)           63,259      (9,581)    (14,407)
                                        --------    --------    --------
Net change in cash                          (239)        201      (1,978)
    Cash at beginning of year                604         403       2,381
                                        --------    --------    --------
    Cash at end of year                 $    365    $    604    $    403
                                        ========    ========    ========

17--SEGMENT INFORMATION

As an underwriter of property and casualty insurance, we have three reportable
segments which consist of the investment function, the personal lines of
insurance and the commercial lines of insurance. Using independent agents, we
market personal lines of insurance to individuals and commercial lines of
insurance to small and medium-sized businesses.

         We evaluate the performance of the personal lines and commercial lines
primarily based upon underwriting results as determined under statutory
accounting practices (SAP) for our total business.

         Assets are not allocated to the personal and commercial lines and are
reviewed in total by management for purposes of decision making. We operate only
in the United States and no single customer or agent provides 10 percent or more
of revenues.

         Financial data by segment is as follows:

                                      2003        2002       2001
                                   ---------   ---------   ---------
                                            ($ in thousands)
                                   ---------------------------------
                                                  
Revenues:
    Premiums earned:
       Commercial lines            $  71,471   $  66,003   $  62,877
       Personal lines                125,322     119,838     104,893
                                   ---------   ---------   ---------
           Total premiums earned     196,793     185,841     167,770
                                   ---------   ---------   ---------
       Net investment income          13,316      14,581      15,886
       Realized investment
           gains (losses)              1,368         144        (880)
       Other                           3,515       3,238       2,388
                                   ---------   ---------   ---------
Total revenues                     $ 214,992   $ 203,804   $ 185,164
                                   =========   =========   =========

                                        2003       2002        2001
                                      --------   --------    --------
                                            ($ in thousands)
                                      -------------------------------
                                                    
Income before income taxes:
 Underwriting income (loss):
    Commercial lines                  $  7,173   $  6,326    $ (3,037)
    Personal lines                       2,004     (5,056)     (5,090)
                                      --------   --------    --------
        SAP underwriting
           income (loss)                 9,177      1,270      (8,127)
    GAAP adjustments                       692       (558)      1,833
                                      --------   --------    --------
        GAAP underwriting
           income (loss)                 9,869        712      (6,294)
 Net investment income                  13,316     14,581      15,886
 Realized investment gains (losses)      1,368        144        (880)
 Other                                     883      1,058      (1,620)
                                      --------   --------    --------
Income before income taxes            $ 25,436   $ 16,495    $  7,092
                                      ========   ========    ========

18--GUARANTY FUND AND OTHER INSURANCE-RELATED ASSESSMENTS

We accrue for guaranty-fund and other insurance-related assessments in
accordance with Statement of Position (SOP) 97-3, "Accounting by Insurance and
Other Enterprises for Insurance-Related Assessments." SOP 97-3 provides guidance
for determining when an entity should recognize a liability for guaranty-fund
and other insurance-related assessments, how to measure that liability and when
an asset may be recognized for the recovery of such assessments through premium
tax offsets or policy surcharges. Our liabilities for guaranty-fund and other
insurance-related assessments were $3,556,227 and $2,970,182 at December 31,
2003 and 2002, respectively. These liabilities included $283,509 and $538,578
related to surcharges collected by us on behalf of regulatory authorities for
2003 and 2002, respectively.

19--INTERIM FINANCIAL DATA (UNAUDITED)

                                              2003
                      -----------------------------------------------------
                         First         Second        Third        Fourth
                        Quarter       Quarter       Quarter       Quarter
                      -----------   -----------   -----------   -----------
                                                    
Net premiums earned   $47,928,881   $48,433,689   $49,719,584   $50,710,542
Total revenues         52,185,419    52,826,818    54,285,753    55,694,338
Net losses and loss
    expenses           31,850,515    29,658,466    32,759,356    31,974,974
Net income              3,844,432     5,268,953     4,001,385     5,179,206
Net income per
    common share
       Basic                  .42           .57           .43           .49
       Diluted                .41           .56           .40           .47

                                              2002
                      -----------------------------------------------------
                         First         Second        Third        Fourth
                        Quarter       Quarter       Quarter       Quarter
                      -----------   -----------   -----------   -----------
                                                    
Net premiums earned   $45,452,260   $46,110,512   $46,792,748   $47,485,673
Total revenues         50,034,046    50,736,803    51,085,417    51,947,295
Net losses and loss
    expenses           31,297,569    32,136,019    32,423,893    33,410,205
Net income              2,180,716     3,178,834     3,015,676     3,627,496
Net income per
    common share
       Basic                  .24           .35           .33           .40
       Diluted                .24           .35           .33           .39

                                     page 30

INDEPENDENT AUDITORS' REPORT

The Stockholders and Board of Directors

Donegal Group Inc.

We have audited the accompanying consolidated balance sheets of Donegal Group
Inc. and subsidiaries as of December 31, 2003 and 2002, and the related
consolidated statements of income and comprehensive income, stockholders'
equity, and cash flows for each of the years in the three-year period ended
December 31, 2003. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.

         We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

         In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Donegal
Group Inc. and subsidiaries as of December 31, 2003 and 2002, and the results of
their operations and their cash flows for each of the years in the three-year
period ended December 31, 2003 in conformity with accounting principles
generally accepted in the United States of America.

/s/ KPMG LLP
Philadelphia, Pennsylvania
February 19, 2004

                                     page 31

                              CORPORATE INFORMATION

ANNUAL MEETING

April 15, 2004 at the Company's headquarters at 10:00 a.m.

FORM 10-K

A copy of Donegal Group's Annual Report on Form 10-K will be furnished free upon
written request to Ralph G. Spontak, Senior Vice President and Chief Financial
Officer, at the corporate address.

MARKET INFORMATION

Donegal Group's Class A common stock and Class B common stock are traded on the
Nasdaq National Market under the symbols "DGICA" and "DGICB." The following
table shows the dividends paid per share and the stock price range for each
quarter during 2003 and 2002:

                                      CASH DIVIDEND
                                        DECLARED
   QUARTER            HIGH     LOW      PER SHARE
                             
2002 - CLASS A
    1st            $ 10.770  $ 8.750  $          --
    2nd              12.250    9.050            .10
    3rd              10.990    9.120            .10
    4th              12.120    9.250            .20
2002 - CLASS B
    1st              12.800    8.780             --
    2nd              11.000    9.750            .09
    3rd              11.500    9.510            .09
    4th              11.440    9.200            .18
2003 - CLASS A
    1st              11.750    9.500             --
    2nd              15.200   10.980            .10
    3rd              19.000   12.100            .11
    4th              23.970   15.250            .22
2003 - CLASS B
    1st              11.320   10.720             --
    2nd              13.790   10.350            .09
    3rd              16.010   11.760            .10
    4th              20.000   14.750            .20

CORPORATE OFFICES

1195 River Road
P.O. Box 302
Marietta, Pennsylvania 17547-0302
(800) 877-0600
E-mail Address: info@donegalgroup.com
Donegal Web Site: www.donegalgroup.com

TRANSFER AGENT

EquiServe Trust Company, N.A.
P.O. Box 43069
Providence, Rhode Island 02940-3069
(800) 317-4445
Web Site:  www.equiserve.com
Hearing Impaired: TDD: 800-952-9245

DIVIDEND REINVESTMENT AND STOCK PURCHASE PLAN

The Company offers a dividend reinvestment and stock purchase plan through its
transfer agent.

For information contact:

Donegal Group Inc.
Dividend Reinvestment and Stock Purchase Plan
EquiServe Trust Company, N.A.
P.O. Box 43069
Providence, Rhode Island 02940-3069

STOCKHOLDERS

The following represent the number of common stockholders of record as of
December 31, 2003:

Class A common stock 638
Class B common stock 479

                                     page 32

                                                                      EXHIBIT 14

                               DONEGAL GROUP INC.

                                 CODE OF ETHICS

         This Code of Ethics of the Company applies to the Chief Executive
Officer, the Chief Financial Officer, the Chief Accounting Officer, the
Treasurer and the Controller of the Company (each, a "Covered Person"). The
Covered Persons hold important roles in corporate governance. This Code of
Ethics is designed to deter wrongdoing and promote ethical conduct and
compliance with applicable laws and regulations.

         Each Covered Person has the obligation to:

         a)       Engage in and promote honest and ethical conduct, including
                  the ethical handling of actual or apparent conflicts of
                  interest between personal and professional relationships;

         b)       Produce full, fair, accurate, timely and understandable
                  disclosure in reports and documents that the Company or its
                  subsidiaries file with, or submit to, the Securities and
                  Exchange Commission and other regulators and in other public
                  communications made by the Company or its subsidiaries;

         c)       Comply with applicable governmental laws, rules and
                  regulations, as well as the rules and regulations of the
                  Nasdaq Stock Market; and

         d)       Promptly report any possible violation of this Code of Ethics
                  to the Audit Committee or any of the persons designated from
                  time to time by the Company's Board of Directors for such
                  purposes.

         Each Covered Person is prohibited from directly or indirectly taking
any action to fraudulently influence, coerce, manipulate or mislead the Company
or its subsidiaries' independent public accountants for the purpose of rendering
the financial statements of the Company or its subsidiaries misleading.

         Each Covered Person will be held accountable for the Covered Person's
adherence to this Code of Ethics. Failure to observe the terms of this Code of
Ethics may result in disciplinary action, up to and including termination of
employment. Violations of this Code of Ethics may also constitute violations of
law and may result in civil and criminal penalties for the Covered Person, his
or her supervisors or the Company.

         Reporting any possible violation of this Code of Ethics may be made
anonymously. Questions regarding the best course of action in a particular
situation should promptly be directed to Donald H. Nikolaus, President and Chief
Executive Officer, with a copy to the Company's chief legal officer.

As adopted by the Board of Directors on March 19, 2004.

                                      -86-

                                                                               .
                                                                               .
                                                                               .

                                                                      EXHIBIT 21

                           SUBSIDIARIES OF REGISTRANT

Registrant owns 100% of the outstanding stock of the following insurance
companies:

                Name                                                           State of Formation
                ----                                                           ------------------
                                                                            
Atlantic States Insurance Company                                              Pennsylvania

Southern Insurance Company of Virginia                                         Virginia

                                      -87-

                                                                      EXHIBIT 23

              INDEPENDENT AUDITORS' CONSENT AND REPORT ON SCHEDULES

The Board of Directors

Donegal Group Inc.:

The audits referred to in our report dated February 19, 2004 include the related
financial statement schedules as of December 31, 2003, and for each of the years
in the three-year period ended December 31, 2003, included in the annual report
on Form 10-K. These financial statement schedules are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statement schedules based on our audits. In our opinion, such
financial statement schedules, when considered in relation to the basic
consolidated financial statements taken as a whole, present fairly, in all
material respects, the information set forth therein.

We consent to incorporation by reference in the registration statements (Nos.
333-06681, 333-25541, 333-26693, 333-61095, 333-93785, 333-94301, 333-89644,
333-62970, 333-62974 and 333-62976) on Form S-8 and registration statement (No.
333-59828) on Form S-3 of Donegal Group Inc. of our reports dated February 19,
2004, with respect to the consolidated balance sheets of Donegal Group Inc. as
of December 31, 2003 and 2002, and the related consolidated statements of income
and comprehensive income, stockholders' equity and cash flows for each of the
years in the three-year period ended December 31, 2003, and all related
financial statement schedules, which reports are incorporated by reference or
appear in the December 31, 2003 annual report on Form 10-K of Donegal Group Inc.

/s/ KPMG LLP

Philadelphia, Pennsylvania

March 22, 2004

                                      -88-

                                                                    EXHIBIT 31.1

                                  CERTIFICATION

         I, Donald H. Nikolaus, President of Donegal Group Inc., certify that:

         1.       I have reviewed this annual report on Form 10-K for the year
ended December 31, 2003 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 registrant's 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)) 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)       Evaluated the effectiveness of the registrant's 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

         c)       Disclosed in this report any change in the registrant's
         internal control over financial reporting that occurred during the
         registrant's most recent fiscal quarter (the registrant's fourth fiscal
         quarter in the case of an annual report) that has materially affected,
         or is reasonably likely to materially affect, the registrant's internal
         control over financial reporting; and

         5.       The registrant's other certifying officer and I have
disclosed, based on our most recent evaluation of internal control over
financial reporting, to the registrant's auditors and the audit committee of
registrant's 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

                                      -89-

         affect the registrant's 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 registrant's
         internal control over financial reporting.

                                      /s/ Donald H. Nikolaus
                                      ------------------------------------------
                                      Donald H. Nikolaus, President

Date: March 26, 2004

                                      -90-

                                                                    EXHIBIT 31.2

                                  CERTIFICATION

         I, Ralph G. Spontak, Senior Vice President, Chief Financial Officer and
Secretary of Donegal Group Inc., certify that:

         1.       I have reviewed this annual report on Form 10-K for the year
ended December 31, 2003 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 registrant's 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)) 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)       Evaluated the effectiveness of the registrant's 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

         c)       Disclosed in this report any change in the registrant's
         internal control over financial reporting that occurred during the
         registrant's most recent fiscal quarter (the registrant's fourth fiscal
         quarter in the case of an annual report) that has materially affected,
         or is reasonably likely to materially affect, the registrant's internal
         control over financial reporting; and

         5.       The registrant's other certifying officer and I have
disclosed, based on our most recent evaluation of internal control over
financial reporting, to the registrant's auditors and the audit committee of
registrant's 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

                                      -91-

         affect the registrant's 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 registrant's
         internal control over financial reporting.

                                      /s/ Ralph G. Spontak
                                      ------------------------------------------
                                      Ralph G. Spontak, Senior Vice President
                                      Chief Financial Officer and Secretary

Date: March 26, 2004

                                      -92-

                                                                    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 Company's Form 10-K Annual Report for the period ended
December 31, 2003 (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.

                                      /s/ Donald H. Nikolaus
                                      ------------------------------------------
                                      Donald H. Nikolaus, President

Date: March 26, 2004

                                      -93-

                                                                    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,
Ralph G. Spontak, Senior Vice President and Chief Financial Officer of Donegal
Group Inc. (the "Company"), hereby certify that, to the best of my knowledge:

         1.       The Company's Form 10-K Annual Report for the period ended
December 31, 2003 (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.

                                      /s/ Ralph G. Spontak
                                      ------------------------------------------
                                      Ralph G. Spontak, Senior Vice President
                                      Chief Financial Officer and Secretary

Date: March 26, 2004

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